SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2004
[ ] Transition report under Section 13
or 15(d) of the Securities Exchange Act of 1934
Commission file number 1-13445.
CAPITAL SENIOR LIVING CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 75-2678809
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14160 Dallas Parkway, Suite 300, Dallas, Texas 75254
(Address of principal executive offices)
972-770-5600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of November 9, 2004, the Registrant had 25,744,192 outstanding shares of its
Common Stock, $.01 par value.
CAPITAL SENIOR LIVING CORPORATION
INDEX
Page
Number
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets --
September 30, 2004 and December 31, 2003 3
Consolidated Statements of Operations --
Three and Nine Months Ended September 30, 2004 and 2003 4
Consolidated Statements of Cash Flows --
Nine Months Ended September 30, 2004 and 2003 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 21
Item 4. Controls and Procedures 21
Part II. Other Information
Item 1. Legal Proceedings 23
Item 6. Exhibits 24
Signature
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CAPITAL SENIOR LIVING CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands)
September 30, December 31,
2004 2003
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents................................................ $ 17,110 $ 6,594
Restricted cash.......................................................... 6,200 7,187
Accounts receivable, net................................................. 2,149 1,295
Accounts receivable from affiliates...................................... 264 604
Federal and state income taxes receivable................................ 3,629 994
Deferred taxes........................................................... 356 385
Property tax and insurance deposits...................................... 2,461 1,855
Prepaid expenses and other............................................... 4,904 2,437
----------- -----------
Total current assets............................................. 37,073 21,351
Property and equipment, net................................................ 372,949 380,115
Deferred taxes............................................................. 6,279 6,554
Notes receivable from affiliates........................................... 5,220 4,981
Investments in limited partnerships........................................ 1,898 1,762
Assets held for sale....................................................... 2,034 2,391
Other assets, net.......................................................... 7,280 4,179
----------- -----------
Total assets..................................................... $ 432,733 $ 421,333
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................................... $ 2,669 $ 2,158
Accrued expenses......................................................... 7,932 6,611
Current portion of notes payable......................................... 42,907 23,488
Customer deposits........................................................ 1,931 1,929
----------- -----------
Total current liabilities........................................ 55,439 34,186
Deferred income............................................................ 863 112
Deferred income from affiliates............................................ 120 102
Other long-term liabilities................................................ 7,480 6,736
Notes payable, net of current portion...................................... 217,316 255,549
Minority interest in consolidated partnership.............................. 254 281
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value:
Authorized shares -- 15,000; no shares issued or outstanding........... -- --
Common stock, $.01 par value:
Authorized shares -- 65,000
Issued and outstanding shares -- 25,736 and 19,847 at
September 30, 2004 and December 31, 2003, respectively............... 257 198
Additional paid-in capital............................................... 124,914 92,336
Retained earnings........................................................ 26,090 31,833
----------- -----------
Total shareholders' equity....................................... 151,261 124,367
----------- -----------
Total liabilities and shareholders' equity....................... $ 432,733 $ 421,333
=========== ===========
See accompanying notes.
3
CAPITAL SENIOR LIVING CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except earnings per share)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- --------------------------
2004 2003 2004 2003
--------------- --------------- --------------- --------------
Revenues:
Resident and health care revenue................. $ 22,964 $ 17,973 $ 67,569 $ 44,490
Unaffiliated management services revenue......... 229 -- 310 295
Affiliated management services revenue........... 503 665 1,460 2,467
Affiliated development fees...................... -- 26 -- 163
------ --------- --------- ---------
Total revenues.............................. 23,696 18,664 69,339 47,415
Expenses:
Operating expenses............................... 14,458 12,034 43,673 27,877
General and administrative expenses.............. 4,156 3,482 11,994 8,749
Depreciation and amortization.................... 3,023 2,541 8,931 5,227
------ --------- --------- ----------
Total expenses.............................. 21,637 18,057 64,598 41,853
------ --------- --------- ---------
Income from operations............................. 2,059 607 4,741 5,562
Other income (expense):
Interest income.................................. 147 441 468 3,862
Interest expense................................. (4,024) (3,784) (11,939) (8,954)
Other income..................................... 135 3,181 275 6,745
------ --------- --------- ---------
(Loss) income before income taxes and minority
interest in consolidated partnership............. (1,683) 445 (6,455) 7,215
Benefit (provision) for income taxes............... 325 (171) 1,421 (2,783)
------ --------- --------- ---------
(Loss) income before minority interest in
consolidated partnership......................... (1,358) 274 (5,034) 4,432
Minority interest in consolidated partnership...... 2 6 36 116
------ --------- --------- ---------
Net (loss) income.................................. $ (1,356) $ 280 $ (4,998) $ 4,548
======= ========= ========== =========
Per share data:
Basic (loss) earnings per share.................. $ (0.05) $ 0.01 $ (0.20) $ 0.23
====== ========= ========== =========
Diluted (loss) earnings per share................ $ (0.05) $ 0.01 $ (0.20) $ 0.23
====== ========= ========== =========
Weighted average shares outstanding -- basic..... 25,733 19,806 25,035 19,764
====== ========= ========== =========
Weighted average shares outstanding -- diluted... 25,733 20,005 25,035 19,922
====== ========= ========== =========
See accompanying notes.
4
CAPITAL SENIOR LIVING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Nine Months Ended September 30,
------------------------------
2004 2003
------------ ---------
Operating Activities
Net (loss) income................................................ $ (4,998) $ 4,548
Adjustments to reconcile net (loss) income to net cash provided
by operating activities:
Depreciation................................................... 8,884 5,227
Amortization of management contract rights..................... 47 --
Amortization of deferred financing charges..................... 971 786
Minority interest in consolidated partnership.................. (36) (116)
Deferred income from affiliates................................ 18 (317)
Deferred income................................................ 751 (7)
Deferred income taxes.......................................... 304 302
Equity in the earnings of affiliates........................... (116) (142)
Gain on sale of properties..................................... (159) (6,603)
Changes in operating assets and liabilities, net of
acquisitions:
Accounts receivable.......................................... (574) (144)
Accounts receivable from affiliates.......................... 340 (1,173)
Property tax and insurance deposits.......................... (606) 314
Prepaid expenses and other................................... (1,826) (1,189)
Other assets................................................. (663) 404
Accounts payable and accrued expenses........................ 1,523 (1,163)
Federal and state income taxes receivable.................... (2,490) 1,748
Customer deposits............................................ 2 (124)
---------- --------
Net cash provided by operating activities........................ 1,372 2,351
Investing Activities
Capital expenditures............................................. (1,718) (1,313)
Net cash acquired from Triad Entities acquisition................ -- 122
Proceeds from sale of assets..................................... 516 5,110
Proceeds from sale of assets to BRE/CSL.......................... -- 3,089
Cash paid for CGIM acquisition, net of cash received of $29...... (2,317) --
Advances to affiliates........................................... (327) (7,662)
Proceeds from limited partnerships............................... 77 158
---------- --------
Net cash used in investing activities............................ (3,769) (496)
Financing Activities
Proceeds from notes payable...................................... 2,998 4,510
Repayments of notes payable...................................... (23,563) (9,218)
Restricted cash.................................................. 987 --
Proceeds from the exercise of stock options...................... 316 122
Proceeds from common stock offering.............................. 32,175 --
Distributions to minority partners............................... -- (133)
Deferred loan charges paid....................................... -- (163)
---------- ---------
Net cash provided by (used in) financing activities.............. 12,913 (4,882)
---------- ---------
Increase (decrease) in cash and cash equivalents................. 10,516 (3,027)
Cash and cash equivalents at beginning of period................. 6,594 11,768
---------- --------
Cash and cash equivalents at end of period....................... $ 17,110 $ 8,741
========== ========
Supplemental Disclosures
Cash paid during the period for:
Interest....................................................... $ 11,098 $ 8,230
========== ========
Income taxes................................................... $ 862 $ 1,073
========== ========
See accompanying notes.
5
CAPITAL SENIOR LIVING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
1. BASIS OF PRESENTATION
Capital Senior Living Corporation, a Delaware corporation (the "Company"), was
incorporated on October 25, 1996. The accompanying consolidated financial
statements include the financial statements of Capital Senior Living Corporation
and its subsidiaries. All material intercompany balances and transactions have
been eliminated in consolidation.
The accompanying consolidated balance sheet, as of December 31, 2003, has been
derived from audited consolidated financial statements of the Company for the
year ended December 31, 2003, and the accompanying unaudited consolidated
financial statements, as of September 30, 2004 and 2003, have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and note disclosures normally included in the annual
financial statements prepared in accordance with U. S. generally accepted
accounting principles have been condensed or omitted pursuant to those rules and
regulations. For further information, refer to the financial statements and
notes thereto for the year ended December 31, 2003 included in the Company's
Annual Report on Form 10-K filed with the Securities and Exchange Commission on
March 29, 2004.
In the opinion of the Company, the accompanying consolidated financial
statements contain all adjustments (all of which were normal recurring accruals)
necessary to present fairly the Company's financial position as of September 30,
2004, results of operations for the three and nine months ended September 30,
2004 and 2003, respectively, and cash flows for the nine months ended September
30, 2004 and 2003. The results of operations for the three and nine months ended
September 30, 2004 are not necessarily indicative of the results for the year
ending December 31, 2004.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Net (Loss) Income Per Share
Basic net (loss) income per share is calculated by dividing net (loss) income by
the weighted average number of common shares outstanding during the period.
Diluted net (loss) income per share considers the dilutive effect of outstanding
options calculated using the treasury stock method.
The following table sets forth the computation of basic and diluted (loss)
earnings per share (in thousands, except for per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ------------------------
2004 2003 2004 2003
--------- --------- --------- --------
Net (loss) income........................ $ (1,356) $ 280 $ (4,998) $ 4,548
Weighted average shares outstanding - basic 25,733 19,806 25,035 19,764
Effect of dilutive securities:
Employee stock options................ -- 199 -- 158
-------- -------- -------- -------
Weighted average shares outstanding -
diluted............................... 25,733 20,005 25,035 19,922
======== ======== ======== ========
Basic (loss) earnings per share.......... $ (0.05) $ 0.01 $ (0.20) $ 0.23
======== ======== ======== ========
Diluted (loss) earnings per share........ $ (0.05) $ 0.01 $ (0.20) $ 0.23
======== ======== ======== ========
Options were not included in the computation of diluted loss per share because
the Company had net losses during the third quarter and first nine months of
fiscal 2004, and therefore, the effect would not be dilutive. For the third
quarter and first nine months of fiscal 2003, options to purchase 0.2 million
shares of common stock at prices ranging from $4.14 to $10.50 per share were not
included in the computation of diluted earnings per share because the average
daily price of the common stock during the third quarter and first nine months
of fiscal 2003 did not exceed the exercise price of the options, and therefore,
the effect would not be dilutive.
6
CAPITAL SENIOR LIVING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
On January 28, 2004, the Company granted options to certain employees to
purchase 10,000 shares of the Company's common stock at an exercise price of
$6.63. On May 19, 2004, the Company granted options to certain directors to
purchase 12,000 shares of the Company's common stock at an exercise price of
$4.85. On July 30, 2004, the Company granted options to certain employees to
purchase 22,000 shares of the Company's common stock at an exercise price of
$4.50. In addition, during the first nine months of 2004, the Company issued
139,127 shares of common stock pursuant to the exercise of stock options by
certain employees of the Company.
Stock-Based Compensation
Pro forma information regarding net (loss) income per share has been determined
as if the Company had accounted for its employee stock options under the fair
value method. The fair value for these options was estimated at the date of
grant using the Black-Scholes option-pricing model. The Black-Scholes option
valuation model was developed for use in estimating the fair value of traded
options that have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of highly subjective
assumptions including the expected stock price volatility. Because the Company's
employee stock options have characteristics significantly different from those
of traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the stock
options is amortized to expense over the options' vesting periods (in thousands,
except per share data).
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- -------------------------
2004 2003 2004 2003
---------- ---------- ---------- --------
Net (loss) income
As reported.................................................... $ (1,356) $ 280 $ (4,998) $ 4,548
Less: fair value stock compensation expense, net of tax.... (172) (24) (524) (274)
--------- --------- --------- ---------
Pro forma...................................................... (1,528) 256 (5,522) 4,274
========= ========= ========= =========
Net (loss) income per share - basic
As reported.................................................... $ (0.05) $ 0.01 $ (0.20) $ 0.23
Less: fair value stock compensation expense, net of tax.... $ (0.01) $ (0.00) $ (0.02) $ (0.01)
--------- -------- --------- ---------
Pro forma...................................................... $ (0.06) $ 0.01 $ (0.22) $ 0.22
========= ======== ========= =========
Net (loss) income per share - diluted
As reported.................................................... $ (0.05) $ 0.01 $ (0.20) $ 0.23
Less: fair value stock compensation expense, net of tax.... $ (0.01) $ (0.00) $ (0.02) $ (0.01)
--------- --------- --------- ---------
Pro forma...................................................... $ (0.06) $ 0.01 $ (0.22) $ 0.22
========= ========= ========= =========
The Financial Accounting Standards Board (the "FASB") issued Statement of
Financial Accounting Standards No. 148 "Accounting for Stock-Based Compensation
- -- Transition and Disclosures" ("SFAS 148") in December 2002. SFAS 148 amended
the disclosure provisions and transition alternatives of Statement of Financial
Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS
123") and was effective for fiscal years ending after December 15, 2002. The
Company adopted the disclosure provisions of SFAS 148 effective December 31,
2002. On March 31, 2004, the FASB issued its Exposure Draft, "Share-Based
Payments," which is a proposed amendment to SFAS 123. This proposed amendment
would require all share-based payments to employees, including grants of
employee stock options, to be recognized in the income statement based on their
fair values. On October 13, 2004, the FASB concluded that the amendment would be
effective for public companies for interim or annual periods beginning after
June 15, 2005.
Swap Agreements
The Company uses interest rate and treasury lock swap agreements for purposes
other than trading. Interest rate swap agreements are used to modify variable
7
CAPITAL SENIOR LIVING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
rate obligations to fixed rate obligations, thereby reducing the Company's
exposure to market rate fluctuations. The differential to be paid or received as
rates change is accounted for under the accrual method of accounting and the
amount payable to or receivable from counterparties is included as an adjustment
to accrued interest. The Company had interest rate swap agreements on $25.2
million notional amounts of indebtedness at September 30, 2004. The interest
rate swap agreements resulted in the Company recognizing an additional $0.2
million and $0.7 million in interest expense during the third quarter and first
nine months of fiscal 2004, respectively.
In addition, the Company is party to interest rate lock agreements, which are
used to hedge the risk that the costs of future issuance of debt may be
adversely affected by changes in interest rates. Under the treasury lock swap
agreements, the Company agrees to pay or receive an amount equal to the
difference between the net present value of the cash flows for a notional
principal amount of indebtedness based on the locked rate at the date when the
agreement was established and the yield of a United States Government 10-Year
Treasury Note on the settlement date of January 3, 2006. The treasury lock swap
agreements are reflected at fair value in the Company's balance sheet (other
long term liabilities) and the related gains or losses on these agreements are
deferred in stockholders' equity (as a component of other comprehensive income).
During the first nine months of fiscal 2004, the Company recognized other
comprehensive loss of $0.7 million from the change in fair value of the interest
rate and treasury lock swap agreements. Total comprehensive loss (net loss from
operations plus other comprehensive loss) for the nine months ended September
30, 2004 was $5.7 million.
Income Taxes
The effective tax rates differ from the statutory tax rates because of state
income taxes and permanent tax differences. The permanent tax differences
include net losses incurred by Triad I, which have been consolidated under the
provisions of FASB Interpretation No. 46.
3. TRANSACTIONS WITH AFFILIATES
BRE/CSL: The Company is party to three joint ventures (collectively "BRE/CSL")
with an affiliate of Blackstone Real Estate Advisors ("Blackstone") and the
joint ventures own six senior living communities and seek to acquire additional
senior housing properties. BRE/CSL is owned 90% by Blackstone and 10% by the
Company. Pursuant to the terms of the joint ventures, each of the Company and
Blackstone must approve any acquisitions made by BRE/CSL. Each party must also
contribute its pro rata portion of the costs of any acquisition.
On June 30, 2003, the Company contributed to BRE/CSL one of its senior living
communities with a capacity of 182 residents. As a result of the contribution
the Company repaid $7.4 million of long-term debt, received $3.1 million in cash
from BRE/CSL, and has a 10% equity interest in BRE/CSL of $0.4 million resulting
in the recognition of a gain of $3.4 million.
The Company manages the six communities owned by BRE/CSL under long-term
management contracts. The Company accounts for the BRE/CSL investment under the
equity method of accounting and for the nine months ended September 30, 2004 the
Company recognized equity in the earnings of BRE/CSL of $0.2 million. As of
September 30, 2004, the Company has deferred $0.1 million of management services
revenue as a result of its 10% interest in the BRE/CSL joint venture.
Spring Meadows: The Company is party to four joint ventures which collectively
own four senior living communities (the "Spring Meadows Communities"). The
Company's interests in the joint ventures that own the Spring Meadows
Communities include interests in certain loans to the ventures and an
approximate 19% member interest in each venture. The Company recorded its
initial advances of $1.3 million to the ventures as notes receivable as the
amount assigned for the 19% member interests was nominal. The Company accounts
for its investment in the Spring Meadows Communities under the equity method of
accounting based on the provisions of the partnership agreements and for the
nine months ended September 30, 2004 the Company recognized equity in the losses
of the Spring Meadows Communities of $0.1 million. The Company has managed the
Spring Meadows Communities since the opening of each community in late 2000 and
early 2001. In addition, the Company receives an asset management fee relating
8
CAPITAL SENIOR LIVING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
to each of the four communities. The Company has the obligation to fund certain
future operating deficits of the Spring Meadows Communities to the extent of its
19% member interest. No amounts were funded by the Company under this obligation
as of September 30, 2004.
Triad I: In 2003, the FASB issued FASB Interpretation No. 46, revised December
2003, ("FIN 46") "Consolidation of Variable Interest Entities" an interpretation
of ARB No. 51, effective immediately for variable interest entities created
after January 31, 2003 and effective as of December 31, 2003 for variable
interest entities that existed prior to February 1, 2003. The Company adopted
the provisions of this interpretation at December 31, 2003, which resulted in
the Company consolidating the financial position of Triad Senior Living I, L.P.
("Triad I") at December 31, 2003 and resulted in the Company consolidating the
operations of Triad I beginning January 1, 2004. Prior to adopting FIN 46 the
Company accounted for Triad I under the equity method of accounting.
The Company has the option, but not the obligation, to purchase the Triad I
communities for an amount specified in the partnership agreement. Furthermore,
Lehman Brothers, extended its agreement to December 1, 2004 to withdraw as a
partner in the Triad I partnership to the extent it has received distributions
in an amount equal to its capital contributions of $12.4 million. If Lehman
Brothers has not withdrawn as a partner by December 1, 2004, Lehman Brothers may
be entitled to certain rights under the Triad I partnership agreement.
The following unaudited pro forma financial information for the nine months
ended September 30, 2003 combines the results of the Company and Triad I as if
the provisions of FIN 46 had been applied at the beginning of fiscal 2003. The
pro forma financial information is presented for informational purposes only and
does not reflect the results of operations of the Company, that may have
actually resulted if Triad I had been consolidated as of the dates indicated, or
future results of operations of the Company (in thousands).
September 30,
2003
------------
Net revenue $ 57,894
Net income $ 2,008
Net income per share - basic $ 0.10
Net income per share - diluted $ 0.10
4. ACQUISITIONS AND DISPOSITIONS
Effective August 18, 2004, the Company acquired from the Covenant Group of
Texas, Inc. ("CGT") all of the outstanding stock of CGT's wholly owned
subsidiary, CGI Management, Inc. ("CGIM"). The Company paid approximately $2.3
million in cash and issued a note for approximately $1.4 million, subject to
various adjustments set forth in the purchase agreement, to acquire all of the
outstanding stock of CGIM. The note is due in three installments of
approximately $0.3 million, $0.4 million and $0.7 million due on the first,
third and fifth anniversaries of the closing, respectively, subject to reduction
if the management fees earned from the third party owned communities with
various terms are terminated and not replaced by substitute agreements during
the period, and certain other adjustments. This acquisition resulted in the
Company assuming the management contracts on 14 senior living communities with a
combined resident capacity of approximately 1,800 residents. The resident mix
for the communities related to the CGIM management contracts is 78% independent
living and 22% assisted living. In addition, the Company has the right to
acquire seven of the properties owned by CGT (which are part of the 14
communities managed by CGIM) based on sales prices specified in the stock
purchase agreement. The Company has not completed its analysis of this purchase
and the purchase accounting information disclosed should be considered
preliminary.
9
CAPITAL SENIOR LIVING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
The purchase price was allocated as follows (in thousands):
Tangible assets acquired $ 954
Tangible liabilities assumed (954)
Intangible contract rights 3,456
----------
Total purchase price $ 3,456
==========
The intangible contract rights are being amortized to expense over the expected
life of the management contracts acquired from CGIM.
In September 2003, the Company sold its Atrium of Carmichael ("Carmichael")
community to a subsidiary of Senior Housing Partners II, LP ("SHP"), a fund
managed by Prudential Real Estate Investors ("Prudential"), for $11.7 million
before closing costs of $0.6 million. Carmichael is an independent living
community located in Sacramento, California with a resident capacity of 156. As
a result of the sale, the Company retired $7.4 million in debt, received $3.6
million in cash and recognized a gain of $3.1 million. The Company manages the
Carmichael community for SHP under a long-term management contract.
Effective as of July 1, 2003, the Company acquired the partnership interest of
the general partner and the other third party limited partnership interests in
Triad Senior Living II, L.P., Triad Senior Living III, L.P., Triad Senior Living
IV, L.P. and Triad Senior Living V, L.P. (collectively the "Triad Entities") for
$1.3 million in cash, $0.4 million in notes payable and the assumption of all
outstanding debt and liabilities ($109.6 million bank debts, $73.2 million debt
due to the Company, and $9.9 million net working capital liabilities). The total
purchase price was $194.4 million and the acquisition was treated as a purchase
of property. The Company now wholly owns each of the Triad Entities. This
acquisition resulted in the Company acquiring ownership of 12 senior living
communities with a combined resident capacity of approximately 1,670 residents.
The resident capacity mix for the Triad Entities is 95% independent living and
5% assisted living, with all revenues derived from private pay sources. Prior to
the acquisition the Company had developed and managed the properties owned by
the Triad Entities. In the fourth quarter of 2003, the Company repaid the $0.4
million in notes payable related to this acquisition.
The purchase price was allocated as follows (in thousands):
Net cash acquired $ 122
Fair value of tangible assets acquired 11,720
Property and equipment 182,601
----------
Total purchase price $ 194,443
==========
The following unaudited pro forma financial information for the nine months
ended September 30, 2003 combines the results of the Company and the Triad
Entities as if the transaction had taken place at the beginning of fiscal 2003.
The pro forma financial information is presented for informational purposes only
and does not reflect the results of operations of the Company that may have
actually resulted if the purchase occurred as of the dates indicated or future
results of operations of the Company (in thousands).
September 30,
2003
-----------
Net sales $ 56,637
Net income 336
Net income per share - basic $ 0.02
Net income per share - diluted $ 0.02
5. DEBT
During the third quarter of 2004, the Company extended the maturity on $29.7
million of loans with GMAC from September 2005 to December 2005. The Company is
currently working with GMAC to refinance these loans and the Company expects
10
CAPITAL SENIOR LIVING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
these loans to be refinanced during the fourth quarter of fiscal 2004. In
addition, the Company classified $34.8 million of debt maturing in September
2005 with Freddie Mac as a current liability as of September 30, 2004. The
classification of this debt as current resulted in the Company violating a
certain loan covenant with two of its lenders. The Company has received a loan
modification eliminating the violation from one of its lenders and a waiver for
the third quarter of 2004 from its other lender. The Company is in the process
of evaluating various alternatives to permit it to meet its current obligations,
including entering into refinancing arrangements, amending current debt
agreements and other possible actions. The Company believes it has the ability
to meet its obligations for at least one year.
6. EQUITY
In the first quarter of fiscal 2004, the Company sold 5,750,000 shares of common
stock at a price of $6.00 per share. The net proceeds to the Company after
commissions and expenses were approximately $32.2 million. The Company used
$13.7 million of the net proceeds to retire debt that was scheduled to mature in
October 2004 and which had a current interest rate of 9.0%. In addition, the
Company wrote off $0.3 million of deferred loan costs relating to the retired
debt to interest expense.
7. CONTINGENCIES
In the fourth quarter of 2002, the Company (and two of its management
subsidiaries), Buckner Retirement Services, Inc. ("Buckner"), and a related
Buckner entity, and other unrelated entities were named as defendants in a
lawsuit in district court in Fort Bend County, Texas brought by the heir of a
former resident who obtained nursing home services at Parkway Place from
September 1998 to March 2001. The Company managed Parkway Place for Buckner
through December 31, 2001. The Company and its subsidiaries denied any
wrongdoing. On March 16, 2004, the Court granted the Company's Motion to
Dismiss.
In February 2004, the Company and certain subsidiaries, along with numerous
other senior living companies in California, were named as defendants in a
lawsuit in a district court in Los Angeles, California. This lawsuit was brought
by two public interest groups on behalf of seniors in California residing at the
facilities of the defendants. The plaintiffs allege that pre-admission fees
charged by the defendants' facilities were actually security deposits that must
be refunded in accordance with California law. The plaintiffs seek restitution,
treble damages, penalties, costs and injunctive relief. The Company at this time
is unable to estimate its liability, if any, related to this claim. The
Company's insurer is defending this claim subject to a reservation of rights
letter. The Company intends to vigorously defend against this claim.
The Company has other pending claims not mentioned above ("Other Claims")
incurred in the course of its business. Most of these Other Claims are believed
by management to be covered by insurance, subject to normal reservations of
rights by the insurance companies and possibly subject to certain exclusions in
the applicable insurance policies. Whether or not covered by insurance, these
Other Claims, in the opinion of management, based on advice of legal counsel,
should not have a material effect on the financial statements of the Company if
determined adversely to the Company.
11
CAPITAL SENIOR LIVING CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
The following discussion and analysis addresses (i) the Company's results of
operations for the three and nine months ended September 30, 2004 and 2003,
respectively, and (ii) liquidity and capital resources of the Company and should
be read in conjunction with the Company's consolidated financial statements
contained elsewhere in this report.
The Company is one of the largest operators of senior living communities in the
United States in terms of resident capacity. The Company's operating strategy is
to provide quality senior living services at an affordable price to its
residents, while achieving and sustaining a strong, competitive position within
its chosen markets, as well as to continue to enhance the performance of its
operations. The Company provides senior living services to the elderly,
including independent living, assisted living, skilled nursing and home care
services.
As of September 30, 2004, the Company operated 56 senior living communities in
20 states with an aggregate capacity of approximately 8,700 residents, including
41 senior living communities which the Company owned or in which the Company had
an ownership interest, 15 communities it managed for third parties including one
community in pre-lease. As of September 30, 2004, the Company also operated one
home care agency.
The Company generates revenue from a variety of sources. For the three months
ended September 30, 2004, the Company's revenue was derived as follows: 96.9%
from the operation of 31 owned and/or consolidated senior living communities
that are operated by the Company, 2.1% from management fees arising from
management services provided for 10 affiliate owned senior living communities
and 1.0% from management fees arising from management services provided for 15
unaffiliated senior living communities.
For the nine months ended September 30, 2004, the Company's revenue was derived
as follows: 97.5% from the operation of 31 owned and/or consolidated senior
living communities that are operated by the Company, and 2.1% from management
fees arising from management services provided for 10 affiliate owned senior
living communities and 0.4% from management fees arising from management
services provided for 15 unaffiliated senior living communities.
The Company believes that the factors affecting the financial performance of
communities managed under contracts with third parties do not vary substantially
from the factors affecting the performance of owned communities, although there
are different business risks associated with these activities.
The Company's third-party management fees are primarily based on a percentage of
gross revenues. The Company is not responsible for capital investments in
managed communities. While the management contracts are generally terminable
only for cause, in certain cases the contracts can be terminated upon the sale
of a community, subject to the Company's rights to offer to purchase such
community.
The Company's current management contracts expire on various dates through
September 2022 and provide for management fees based generally upon 5% of net
revenues. In addition, certain of the contracts provide for supplemental
incentive fees that vary by contract based upon the financial performance of the
managed community.
Effective August 18, 2004, the Company acquired from CGT all of the outstanding
stock of CGT's wholly owned subsidiary, CGIM. The Company paid approximately
$2.3 million in cash and issued a note for approximately $1.4 million, subject
to various adjustments set forth in the purchase agreement, to acquire all of
the outstanding stock of CGIM. The note is due in three installments of
approximately $0.3 million, $0.4 million and $0.7 million due on the first,
12
CAPITAL SENIOR LIVING CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
third and fifth anniversaries of the closing, respectively, subject to reduction
if the management fees earned from the third party owned communities with
various terms are terminated and not replaced by substitute agreements during
the period, and certain other adjustments. This acquisition resulted in the
Company assuming the management contracts on 14 senior living communities with a
combined resident capacity of approximately 1,800 residents. The resident mix
for the communities related to the CGIM management contracts is 78% independent
living and 22% assisted living. In addition, the Company has the right to
acquire seven of the properties owned by CGT (which are part of the 14
communities managed by CGIM) based on sales prices specified in the stock
purchase agreement.
Effective as of July 1, 2003, the Company acquired the partnership interest of
the general partners and the other third party limited partnership interests in
the Triad Entities for $1.3 million in cash, $0.4 million in notes payable and
the assumption of all outstanding debt and liabilities. The total purchase price
was $194.4 million and the acquisition was treated as a purchase of property.
The Company now wholly owns each of the Triad Entities. This acquisition
resulted in the Company acquiring the 12 senior living communities owned by the
Triad Entities with a combined resident capacity of approximately 1,670
residents. The resident capacity mix for the Triad Entities is 95% independent
living and 5% assisted living, with all revenues derived from private pay
sources. Subsequent to the end of the Company's third quarter of 2003, the
Company repaid the $0.4 million in notes payable related to this acquisition.
Prior to this acquisition, the Company owned 1% of the limited partnership
interests and managed the properties owned by the Triad Entities under a series
of long-term management contracts.
In September 2003, the Company sold its Carmichael community to a subsidiary of
SHP, a fund managed by Prudential, for $11.7 million before closing costs of
$0.6 million. Carmichael is an independent living community located in
Sacramento, California with a resident capacity of 156. As a result of the sale,
the Company retired $7.4 million in debt, received $3.6 million in cash and
recognized a gain of $3.1 million. The Company manages the Carmichael community
for SHP under a long-term management contract.
In 2003, the FASB issued FIN 46 "Consolidation of Variable Interest Entities",
an interpretation of ARB No. 51, effective immediately for variable interest
entities created after January 31, 2003 and effective as of December 31, 2003
for variable interest entities that existed prior to February 1, 2003. The
Company adopted the provisions of this interpretation, as of December 31, 2003,
which resulted in the Company consolidating Triad I's financial position as of
December 31, 2003 and resulted in the Company consolidating Triad I's results of
operations beginning January 1, 2004. The Company operates the five senior
living communities and two expansion communities in Triad I under a series of
long-term management agreements and accounted for Triad I under the equity
method of accounting prior to adopting the provisions of FIN 46.
The Company is party to three joint ventures with Blackstone and the joint
ventures own six senior living communities and seek to acquire additional senior
housing properties. BRE/CSL is owned 90% by Blackstone and 10% by the Company.
Pursuant to the terms of the joint ventures, each of the Company and Blackstone
must approve any acquisitions made by the joint venture. Each party must also
contribute its pro rata portion of the costs of any acquisition. The Company
manages the six communities owned by BRE/CSL under long-term management
contracts. The Company accounts for the BRE/CSL investment under the equity
method of accounting. The Company has deferred $0.1 million of management
services revenue as a result of its 10% interest in BRE/CSL.
The Company is party to four joint ventures which collectively own the Spring
Meadows Communities. The Company's interests in the joint ventures that own the
Spring Meadows Communities include interests in certain loans to the ventures
and an approximate 19% member interest in each venture. The Company recorded its
initial advances of $1.3 million to the ventures as notes receivable as the
amount assigned for the 19% member interests was nominal. The Company accounts
for its investment in the Spring Meadows Communities under the equity method of
accounting based on the provisions of the partnership agreements. The Company
has managed the Spring Meadows Communities since the opening of each community
in late 2000 and early 2001. In addition, the Company receives an asset
management fee relating to each of the four communities. The Company has the
obligation to fund certain future operating deficits of the Spring Meadows
Communities to the extent of its 19% member interest. No amounts were funded by
the Company under this obligation as of September 30, 2004.
In the first quarter of fiscal 2004, the Company sold 5,750,000 shares of common
stock at a price of $6.00 per share. The net proceeds to the Company after
13
CAPITAL SENIOR LIVING CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
commissions and expenses were approximately $32.2 million. The Company used
$13.7 million of the net proceeds to retire debt that was scheduled to mature in
October 2004 and which had a current interest rate of 9.0%. In addition, the
Company wrote off $0.3 million of deferred loan costs relating to the retired
debt to interest expense.
Website
The Company's internet website www.capitalsenior.com contains an Investor
Relations section, which provides links to the Company's annual reports on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy
statements, Section 16 filings and amendments to those reports, which reports
and filings are available free of charge as soon as reasonably practicable after
such material is electronically filed with or furnished to the Securities and
Exchange Commission ("SEC").
Results of Operations
The following table sets forth for the periods indicated, selected statements of
income data in thousands of dollars and expressed as a percentage of total
revenues.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------- --------------------------------------
2004 2003 2004 2003
------------------ ------------------ ------------------ -----------------
$ % $ % $ % $ %
--------- -------- --------- -------- --------- -------- -------- --------
Revenues:
Resident and healthcare revenue $ 22,964 96.9 $ 17,973 96.3 $ 67,569 97.5 $ 44,490 93.8
Unaffiliated management service
revenue........................... 229 1.0 -- -- 310 0.4 295 0.6
Affiliated management service
revenue........................... 503 2.1 665 3.6 1,460 2.1 2,467 5.2
Affiliated development fees.......... -- -- 26 0.1 -- -- 163 0.4
--------- -------- --------- -------- --------- -------- -------- --------
Total revenue...................... 23,696 100.0 18,664 100.0 69,339 100.0 47,415 100.0
Expenses:
Operating expenses................... 14,458 61.0 12,034 64.5 43,673 63.0 27,877 58.8
General and administrative expenses.. 4,156 17.5 3,482 18.7 11,994 17.3 8,749 18.5
Depreciation and amortization........ 3,023 12.8 2,541 13.6 8,931 12.9 5,227 11.0
--------- -------- --------- -------- --------- -------- -------- --------
Total expenses..................... 21,637 91.3 18,057 96.7 64,598 93.2 41,853 88.3
--------- -------- --------- -------- --------- -------- -------- --------
Income from operations ................. 2,059 8.7 607 3.3 4,741 6.8 5,562 11.7
Other income (expense):
Interest income...................... 147 0.6 441 2.4 468 0.7 3,862 8.1
Interest expense..................... (4,024) (17.0) (3,784) (20.3) (11,939) (17.2) (8,954) (18.9)
Other income......................... 135 0.6 3,181 17.1 275 0.4 6,745 14.2
--------- -------- --------- -------- --------- -------- -------- --------
(Loss) income before income taxes
and minority interest in
consolidated partnership............. (1,683) (7.1) 445 2.4 (6,455) (9.3) 7,215 15.2
Benefit (provision) for income taxes.... 325 1.4 (171) (0.9) 1,421 2.0 (2,783) (5.9)
--------- -------- --------- -------- --------- -------- -------- --------
(Loss) income before minority interest
in consolidated partnership.......... (1,358) (5.7) 274 1.5 (5,034) (7.3) 4,432 9.3
Minority interest in consolidated
partnership.......................... 2 -- 6 0.0 36 0.1 116 0.3
--------- -------- --------- -------- --------- -------- -------- --------
Net (loss) income.............. $ (1,356) (5.7) $ 280 1.5 $ (4,998) (7.2) $ 4,548 9.6
========= ======== ========= ======== ========= ======== ======== ========
Three Months Ended September 30, 2004 Compared to the Three Months Ended
September 30, 2003
Revenues. Total revenues were $23.7 million in the three months ended September
30, 2004 compared to $18.7 million for the three months ended September 30,
2003, representing an increase of approximately $5.0 million or 27.0%. This
increase in revenue is primarily the result of a $5.0 million increase in
resident and healthcare revenue, a $0.2 million increase in unaffiliated
14
CAPITAL SENIOR LIVING CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
management services revenue offset by a $0.2 million decrease in affiliated
management services revenue. The increase in resident and healthcare revenue
reflects an increase of $3.7 million from the consolidation of Triad I (five
communities and two expansions) under the provisions of FIN 46, and an increase
at the Company's other communities of $2.1 million offset by a decrease in
resident and healthcare revenue of $0.8 million relating to a community that was
sold at the end of the third quarter of fiscal 2003. Unaffiliated management
services revenue in 2004 was derived from the management of 15 third party
communities, 14 of which were assumed during the third quarter of 2004 as a
result of the Company's acquisition of CGIM. Affiliated management services
revenue decreased $0.2 million or 24.4% primarily as a result of the Company's
consolidation of Triad I.
Expenses. Total expenses were $21.6 million in the third quarter of fiscal 2004
compared to $18.1 million in the third quarter of fiscal 2003, representing an
increase of $3.6 million or 19.8%. This increase is primarily the result of a
$2.4 million increase in operating expenses, a $0.7 million increase in general
and administrative expenses and a $0.5 million increase in depreciation and
amortization expense. Operating expenses increased $2.6 million as a result of
the Company's consolidation of Triad I and increased $0.1 million at the
Company's other communities, offset by a decrease of $0.3 million relating to a
community that was sold during fiscal 2003. General and administrative expenses
increased $0.6 million as a result of the consolidation of Triad I and increased
$0.2 million as a result of increases at the Company's other communities and
increases in corporate overhead offset by a decrease of $0.1 million related to
a community that was sold in fiscal 2003. Depreciation and amortization expense
increased $0.5 million primarily as a result of the consolidation of Triad I.
Other income and expense. Interest income decreased $0.3 million or 66.7% to
$0.1 million in the third quarter of 2004 due to the Company's consolidation of
Triad I. The Company earned $0.3 million in interest income on loans to Triad I
during the third quarter of fiscal 2003. Interest expense increased $0.2 million
to $4.0 million in the third quarter of 2004 compared to $3.8 million in the
third quarter of 2003. This 6.3% increase in interest expense is primarily the
result of higher debt outstanding in the third quarter of fiscal 2004 compared
to the third quarter of fiscal 2003 due to $47.6 million of debt consolidated
related to Triad I offset by $7.4 million of debt repaid related to a community
sold during 2003 and $23.6 million of debt retired during the first nine months
of fiscal 2004. Other income decreased $3.1 million to $0.1 million in the third
quarter of fiscal 2004 compared to $3.2 million in the third quarter of fiscal
2003. This decrease in other income primarily results from a decrease in gain on
sale of assets of $2.9 million and a decrease in equity in the earnings of
affiliates of $0.1 million. Gain on sale of assets in the third quarter of
fiscal 2004 reflects the sale of the raw land for net proceeds of $0.6 million,
which resulted in the recognition of a $0.2 million gain on sale. Gain on sale
of assets in the third quarter of fiscal 2003 reflects the sale of the
Carmichael community to SHP and the sale of Crenshaw Creek community for net
proceeds of $4.7 million, which resulted in the recognition of a $3.1 million
gain on sale. Equity in the earnings of affiliates represents the Company's
share of the earnings and losses on its investments in BRE/CSL and the Spring
Meadows Communities.
Provision/benefit for income taxes. Benefit for income taxes in the third
quarter of fiscal 2004 was $0.3 million or 19.3% of loss before taxes, compared
to a provision for income taxes of $0.2 million or 37.9% of income before taxes
in the third quarter of fiscal 2003. The effective tax rates for the third
quarter of 2004 and 2003 differ from the statutory tax rates because of state
income taxes and permanent tax differences. The permanent tax differences in the
third quarter of fiscal 2004 include $0.8 million in net losses incurred by
Triad I, which has been consolidated under the provisions of FIN 46.
Minority interest. Minority interest represents the minority holder's share of
the losses incurred by Healthcare Properties, L.P. ("HCP").
Net income. As a result of the foregoing factors, net income decreased $1.7
million to a net loss of $1.4 million for the three months ended September 30,
2004, as compared to a net income of $0.3 million for the three months ended
September 30, 2003.
Nine Months Ended September 30, 2004 Compared to the Nine Months Ended
September 30, 2003
Revenues. Total revenues for the nine months ended September 30, 2004 were $69.3
million compared to $47.4 million for the nine months ended September 30, 2003,
15
CAPITAL SENIOR LIVING CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
representing an increase of approximately $21.9 million or 46.2%. This increase
in revenue is primarily the result of a $23.1 million increase in resident and
healthcare revenue offset by a decrease in affiliated management fees of $1.0
million and a decrease in affiliated development fee revenue of $0.2 million.
The increase in resident and healthcare revenue reflects an increase of $13.7
million from the acquisition of the Triad Entities (12 communities), an increase
of $11.1 million from the consolidation of Triad I (five communities and two
expansions) under the provisions of FIN 46, and an increase at the Company's
other communities of $2.3 million offset by a decrease in resident and
healthcare revenue of $4.0 million relating to two communities that were sold at
the end of the second and third quarters of fiscal 2003. Unaffiliated management
services revenue in 2004 was derived from the management of 15 third party
communities, 14 of which were assumed during the third quarter of 2004 as a
result of the Company's acquisition of CGIM. Unaffiliated management services
revenue in fiscal 2003 resulted from the settlement of a management contract
with Buckner. Affiliated management services revenue decreased $1.0 million
primarily as a result of the Company's acquisition of the Triad Entities and the
consolidation of Triad I.
Expenses. Total expenses in the first nine months of fiscal 2004 were $64.6
million compared to $41.9 million in the first nine months of fiscal 2003,
representing an increase of $22.7 million or 54.3%. This increase is primarily
the result of a $15.8 million increase in operating expenses, a $3.2 million
increase in general and administrative expenses and a $3.7 million increase in
depreciation and amortization expense. Operating expenses increased $8.9 million
as a result of the Company's acquisition of the Triad Entities, $8.0 million due
to the consolidation of Triad I and $0.9 million at the Company's other
communities offset by a decrease of $2.0 million relating to the two communities
that were sold during fiscal 2003. General and administrative expenses increased
$2.2 million as a result of the Company's acquisition of the Triad Entities,
$1.6 million due to the consolidation of Triad I offset by a decrease of $0.3
million relating to the two communities that were sold during fiscal 2003 and
$0.3 million relating to the Company's other communities and corporate overhead.
Depreciation and amortization expense increased $2.5 million as a result of the
Company's acquisition of the Triad Entities, $1.4 million due to the
consolidation of Triad I and $0.1 million at the Company's other communities
offset by a decrease of $0.3 million relating to the two communities that were
sold during 2003.
Other income and expense. Interest income decreased $3.4 million or 87.9% to
$0.5 million in the first nine months of fiscal 2004 primarily due to the
Company's acquisition of the Triad Entities and the consolidation of Triad I.
The Company earned $3.2 million in interest income on loans to the Triad
Entities and Triad I during the first nine months of fiscal 2003. Interest
expense increased $3.0 million to $11.9 million in the first nine months of 2004
compared to $8.9 million in the first nine months of 2003. This 33.3% increase
in interest expense is primarily the result of higher debt outstanding in the
first nine months of fiscal 2004 compared to the same period of fiscal 2003 due
to the assumption of $109.6 million of debt related to the acquisition of the
Triad Entities and due to $47.6 million of debt consolidated related to Triad I
offset by $14.9 million of debt repaid related to the two communities sold
during 2003 and $23.6 million of debt retired during the first nine months of
fiscal 2004. Other income decreased $6.4 million to $0.3 million in the first
nine months of fiscal 2004 compared to $6.7 million in the first nine months of
fiscal 2003. This decrease in other income primarily results from a decrease in
gain on sale of assets of $6.4 million. Gain on sale of assets in the first nine
months of fiscal 2004 reflects the sale of the raw land for net proceeds of $0.6
million, which resulted in the recognition of a $0.2 million gain on sale. Gain
on sale of assets in fiscal 2003 reflects the sale/contribution of the
Cottonwood community to BRE/CSL, sale of the Company's Carmichael community to
SHP, the sale of the Company's Crenshaw Creek community and the sale of one
parcel of land for net proceeds of $8.2 million, which resulted in the
recognition of a $6.6 million gain on sale. Equity in the earnings of affiliates
represents the Company's share of the earnings and losses on its investments in
BRE/CSL and the Spring Meadows Communities.
Provision/benefit for income taxes. Benefit for income taxes in the first nine
months of fiscal 2004 was $1.4 million or 22.1% of loss before taxes, compared
to a provision for income taxes of $2.8 million or 38.0% of income before taxes
in the first nine months of fiscal 2003. The effective tax rates for the first
nine months of 2004 and 2003 differ from the statutory tax rates because of
state income taxes and permanent tax differences. The permanent tax differences
in the first nine months of fiscal 2004 include $2.5 million in net losses
incurred by Triad I, which has been consolidated under the provisions of FIN 46.
Minority interest. Minority interest represents the minority holder's share of
the losses incurred by HCP.
16
CAPITAL SENIOR LIVING CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Net income. As a result of the foregoing factors, net income decreased $9.5
million to a net loss of $5.0 million for the nine months ended September 30,
2004, as compared to a net income of $4.5 million for the nine months ended
September 30, 2003.
Liquidity and Capital Resources
In addition to approximately $17.1 million of cash balances on hand as of
September 30, 2004, the Company's principal source of liquidity is expected to
be cash flows from operations, proceeds from the sale of assets, cash flows from
BRE/CSL and/or additional financing. Of the $17.1 million in cash balances, $0.6
million relates to cash held by HCP. The Company expects its available cash,
cash flow from operations, proceeds from the sale of assets, and cash flows from
BRE/CSL to be sufficient to fund its short-term working capital requirements,
subject to the Company's ability to refinance and/or amend certain debt. The
Company's long-term capital requirements, primarily for acquisitions, the
payment of operating deficit guarantees, and other corporate initiatives, could
be dependent on its ability to access additional funds through joint ventures
and the debt and/or equity markets. There can be no assurance that the Company
will continue to generate cash flows at or above current levels or that the
Company will be able to obtain the capital necessary to meet the Company's short
and long-term capital requirements.
During the third quarter of 2004, the Company extended the maturity on $29.7
million of loans with GMAC from September 2005 to December 2005. The Company is
currently working with GMAC to refinance these loans and the Company expects
these loans to be refinanced during the fourth quarter of fiscal 2004. In
addition, the Company classified $34.8 million of debt maturing in September
2005 with Freddie Mac as a current liability as of September 30, 2004. The
classification of this debt as current resulted in the Company violating a
certain loan covenant with two of its lenders. The Company has received a loan
modification eliminating the violation from one of its lenders and a waiver for
the third quarter of 2004 from its other lender. The Company is in the process
of evaluating various alternatives to permit it to meet its current obligations,
including entering into refinancing arrangements, amending current debt
agreements and other possible actions. The Company believes it has the ability
to meet its obligations for at least one year.
The Company had net cash provided by operating activities of $1.4 million and
$2.4 million in the first nine months of fiscal 2004 and 2003, respectively. In
the first nine months of fiscal 2004, net cash provided by operating activities
was primarily derived from net noncash charges of $10.7 million, and an increase
in accounts payable and accrued expenses of $1.5 million offset by a net loss of
$5.0 million, an increase in accounts receivable of $0.2 million, an increase in
property tax and insurance deposits of $0.6 million, an increase in prepaid
expenses of $1.8 million, an increase in other assets of $0.7 million, and an
increase in federal and state income tax receivable of $2.5 million. In the
first nine months of fiscal 2003, net cash provided by operating activities was
primarily derived from net income of $4.5 million, a decrease in property tax
and insurance deposits of $0.3 million, a decrease in other assets of $0.4
million and a decrease in federal and state income taxes receivable of $1.7
million, offset by net noncash benefits of $0.8 million, an increase in accounts
receivable of $1.3 million, an increase in prepaid and other assets of $1.2
million, and a decrease in accounts payable and accrued expenses of $1.2
million.
The Company had net cash used in investing activities of $3.8 million and $0.5
million in the first nine months of fiscal 2004 and 2003, respectively. In the
nine months of fiscal 2004, the net cash used in investing activities was
primarily the result of cash paid of $2.3 million for the acquisition of CGIM,
advances of $0.3 million to affiliates, and capital expenditures of $1.7 million
offset by net proceeds of $0.5 million from the sale of a parcel of land and
proceeds from limited partnerships of $0.1 million. In the first nine months of
fiscal 2003, net cash used in investing activities was primarily the result of
advances to affiliates of $7.7 million, and capital expenditures of $1.3 million
offset by net proceeds of $5.1 million from the sale of two communities and one
parcel of land, net proceeds of $3.1 million from the contribution of Cottonwood
to BRE/CSL, $0.2 million relating to distributions from BRE/CSL and $0.1 million
in net cash acquired from the acquisition of the Triad Entities. Advances to
affiliates include loans made to Triad I and the Triad Entities along with
interest earned on loans to Triad I, the Triad Entities and the Spring Meadows
Communities.
The Company had net cash provided by financing activities of $12.9 million in
the first nine months of fiscal 2004 compared to net cash used in financing
17
CAPITAL SENIOR LIVING CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
activities of $4.9 million in the first nine months of fiscal 2003. For the
first nine months of fiscal 2004 the net cash provided by financing activities
primarily results from the Company's sale of 5,750,000 shares of common stock
for net proceeds of $32.2 million, proceeds from the exercise of stock options
of $0.3 million and proceeds from the release of restricted cash of $1.0
million, offset by net repayments of notes payable of $20.6 million. For the
first nine months of fiscal 2003, net cash used in financing activities
primarily results from net repayments of notes payable of $4.7 million,
distributions to minority partners of $0.1 million and deferred loan charges
paid of $0.2 million offset by proceeds from the exercise of common stock of
$0.1 million.
The Company derives the benefits and bears the risks related to the communities
it owns. The cash flows and profitability of owned communities depends on the
operating results of such communities and are subject to certain risks of
ownership, including the need for capital expenditures, financing and other
risks such as those relating to environmental matters.
The Company believes that the factors affecting the financial performance of
communities managed under contracts with third parties do not vary substantially
from the factors affecting the performance of owned communities, although there
are different business risks associated with these activities.
The Company's third-party management fees are primarily based on a percentage of
gross revenues. The Company is not responsible for capital investments in
managed communities. While the management contracts are generally terminable
only for cause, in certain cases the contracts can be terminated upon the sale
of a community, subject to the Company's rights to offer to purchase such
community.
The Company's current management contracts expire on various dates through
September 2022 and provide for management fees based generally upon 5% of gross
revenues. In addition, certain of the contracts provide for supplemental
incentive fees that vary by contract based upon the financial performance of the
managed community.
Effective August 18, 2004, the Company acquired from CGT all of the outstanding
stock of CGT's wholly owned subsidiary, CGIM. Capital paid approximately $2.3
million in cash and issued a note for approximately $1.4 million, subject to
various adjustments set forth in the purchase agreement, to acquire all of the
outstanding stock of CGIM. The note is due in three installments of
approximately $0.3 million, $0.4 million and $0.7 million due on the first,
third and fifth anniversaries of the closing, respectively, subject to reduction
if the management fees earned from the third party owned communities with
various terms are terminated and not replaced by substitute agreements during
the period, and certain other adjustments. This acquisition resulted in the
Company assuming the management contracts on 14 senior living communities with a
combined resident capacity of approximately 1,800 residents. The resident mix
for the communities related to the CGIM management contracts is 78% independent
living and 22% assisted living. In addition, the Company has the right to
acquire seven of the properties owned by CGT (which are part of the 14
communities managed by CGIM) based on sales prices specified in the stock
purchase agreement. The Company has not completed its analysis of this purchase
and the purchase accounting information disclosed should be considered
preliminary.
The purchase price was allocated as follows (in thousands):
Tangible assets acquired $ 954
Tangible liabilities assumed (954)
Intangible contract rights 3,456
----------
Total purchase price $ 3,456
==========
The intangible contract rights are being amortized to expense over the expected
life of the management contracts acquired from CGIM.
In September 2003, the Company sold its Carmichael community to a subsidiary of
SHP, a fund managed by Prudential , for $11.7 million before closing costs of
$0.6 million. Carmichael is an independent living community located in
18
CAPITAL SENIOR LIVING CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Sacramento, California with a resident capacity of 156. As a result of the sale
the Company retired $7.4 million in debt and received $3.6 million in cash and
recognized a gain of $3.1 million. The Company manages the Carmichael community
for SHP under a long-term management contract.
The Company is party to three joint ventures with an affiliate of Blackstone and
the joint ventures own six senior living communities and seek to acquire
additional senior housing properties. BRE/CSL is owned 90% by Blackstone and 10%
by the Company. Pursuant to the terms of the joint ventures, each of the Company
and Blackstone must approve any acquisitions made by BRE/CSL. Each party must
also contribute its pro rata portion of the costs of any acquisition.
On June 30, 2003, the Company contributed to BRE/CSL one of its senior living
communities with a capacity of 182 residents. As a result of the contribution
the Company repaid $7.4 million of long-term debt, received $3.1 million in cash
from BRE/CSL, and has a 10% equity interest in BRE/CSL of $0.4 million resulting
in the recognition of a gain of $3.4 million.
The Company manages the six communities owned by BRE/CSL under long-term
management contracts. The Company accounts for the BRE/CSL investment under the
equity method of accounting and for the nine months ended September 30, 2004 the
Company recognized equity in the earnings of BRE/CSL of $0.2 million. As of
September 30, 2004, the Company has deferred $0.1 million of management services
revenue as a result of its 10% interest in the BRE/CSL joint venture.
The Company is party to four joint ventures which collectively own the Spring
Meadows Communities. The Company's interests in the joint ventures that own the
Spring Meadows Communities include interests in certain loans to the ventures
and an approximate 19% member interest in each venture. The Company recorded its
initial advances of $1.3 million to the ventures as notes receivable as the
amount assigned for the 19% member interests was nominal. The Company accounts
for its investment in the Spring Meadows Communities under the equity method of
accounting based on the provisions of the partnership agreements and for the
nine months ended September 30, 2004 the Company recognized equity in the losses
of the Spring Meadows Communities of $0.1 million. The Company has managed the
Spring Meadows Communities since the opening of each community in late 2000 and
early 2001. In addition, the Company receives an asset management fee relating
to each of the four communities. The Company has the obligation to fund certain
future operating deficits of the Spring Meadows Communities to the extent of its
19% member interest. No amounts were funded by the Company under this obligation
during the first nine months of fiscal 2004.
In 2003, the FASB issued FIN 46, "Consolidation of Variable Interest Entities"
an interpretation of ARB No. 51, effective immediately for variable interest
entities created after January 31, 2003 and effective as of December 31, 2003
for variable interest entities that existed prior to February 1, 2003. The
Company adopted the provisions of this interpretation at December 31, 2003,
which resulted in the Company consolidating the financial position of Triad I at
December 31, 2003 and resulted in the Company consolidating the operations of
Triad I beginning with the first quarter of fiscal 2004. Prior to adopting FIN
46 the Company accounted for Triad I under the equity method of accounting.
As of September 30, 2004, the Company was in violation of certain financial
covenants relating to two communities in Triad I. Subsequent to September 30,
2004, Triad I received a waiver from its lender relating these two financial
covenant violations.
The Company has the option, but not the obligation, to purchase the Triad I
communities for an amount specified in the partnership agreement. Furthermore,
Lehman Brothers, extended its agreement to December 1, 2004 to withdraw as a
partner in the Triad I partnership to the extent it has received distributions
in an amount equal to its capital contributions of $12.4 million. If Lehman
Brothers has not withdrawn as a partner by December 1, 2004, Lehman Brothers may
be entitled to certain rights under the Triad I partnership agreement.
The following unaudited pro forma financial information for the nine months
ended September 30, 2003 combines the results of the Company and Triad I as if
the provisions of FIN 46 had been applied at the beginning of fiscal 2003. The
pro forma financial information is presented for informational purposes only and
19
CAPITAL SENIOR LIVING CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
does not reflect the results of operations of the Company, that may have
actually resulted if Triad I had been consolidated as of the dates indicated, or
future results of operations of the Company (in thousands).
September 30,
2003
------------
Net revenue $ 57,894
Net income $ 2,008
Net income per share - basic $ 0.10
Net income per share - diluted $ 0.10
Effective as of July 1, 2003, the Company acquired the partnership interest of
the general partner and the other third party limited partnership interests in
the Triad Entities for $1.3 million in cash, $0.4 million in notes payable and
the assumption of all outstanding debt and liabilities ($109.6 million bank
debts, $73.2 million debt due to the Company, and $9.9 million net working
capital liabilities). The total purchase price was $194.4 million and the
acquisition was treated as a purchase of property. The Company now wholly owns
each of the Triad Entities. This acquisition resulted in the Company acquiring
ownership of 12 senior living communities with a combined resident capacity of
approximately 1,670 residents. The resident capacity mix for the Triad Entities
is 95% independent living and 5% assisted living, with all revenues derived from
private pay sources. Prior to the acquisition the Company had developed and
managed the properties owned by the Triad Entities. In the fourth quarter of
2003, the Company repaid the $0.4 million in notes payable related to this
acquisition.
The purchase price was allocated as follows:
Net cash acquired $ 122
Fair value of tangible assets acquired 11,720
Property and equipment 182,601
----------
Total purchase price $ 194,443
==========
The following unaudited pro forma financial information for the nine months
ended September 30, 2003 combines the results of the Company and the Triad
Entities as if the transaction had taken place at the beginning of fiscal 2003.
The pro forma financial information is presented for informational purposes only
and does not reflect the results of operations of the Company, that may have
actually resulted if the purchase occurred as of the dates indicated, or future
results of operations of the Company (in thousands).
September 30,
2003
-----------
Net sales $ 56,637
Net income 336
Net income per share - basic $ 0.02
Net income per share - diluted $ 0.02
Forward-Looking Statements
Certain information contained in this report constitutes "Forward-Looking
Statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which can be identified by the use of forward-looking terminology such as "may,"
"will," "expect," "anticipate," "estimate" or "continue" or the negative thereof
or other variations thereon or comparable terminology. The Company cautions
readers that forward-looking statements, including, without limitation, those
relating to the Company's future business prospects, revenues, working capital,
liquidity, the purchase of the Triad Entities, capital needs, interest costs and
income, are subject to certain risks and uncertainties that could cause actual
results to differ materially from those indicated in the forward-looking
statements, due to several important factors herein identified. These factors
include the Company's ability to find suitable acquisition properties at
favorable terms, financing, licensing, business conditions, risks of downturns
in economic condition generally, satisfaction of closing conditions such as
those pertaining to licensure, availability of insurance at commercially
20
CAPITAL SENIOR LIVING CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
reasonable rates, and changes in accounting principles and interpretations among
others, and other risks and factors identified from time to time in the
Company's reports filed with the Securities and Exchange Commission.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company's primary market risk is exposure to changes in interest rates on
debt instruments. As of September 30, 2004 the Company had $260.2 million in
outstanding debt comprised of various fixed and variable rate debt instruments
of $71.2 million and $189.0 million, respectively.
Changes in interest rates would affect the fair market value of the Company's
fixed rate debt instruments but would not have an impact on the Company's
earnings or cash flows. Fluctuations in interest rates on the Company's variable
rate debt instruments, that are tied to either LIBOR or the prime rate, would
affect the Company's earnings and cash flows but would not affect the fair
market value of the variable rate debt. A portion of the Company's variable rate
debt includes interest rate floors, which exceed current market rates. Once
these interest rate floors are reached each percentage point change in interest
rates, would increase the Company's annual interest expense by approximately
$1.9 million based on the Company's outstanding variable debt as of September
30, 2004.
The Company uses interest rate and treasury lock swap agreements for purposes
other than trading. Interest rate swap agreements are used to modify variable
rate obligations to fixed rate obligations, thereby reducing the Company's
exposure to market rate fluctuations. The differential to be paid or received as
rates change is accounted for under the accrual method of accounting and the
amount payable to or receivable from counterparties is included as an adjustment
to accrued interest. The Company had interest rate swap agreements on $25.2
million notional amounts of indebtedness at September 30, 2004. The interest
rate swap agreements resulted in the Company recognizing an additional $0.2
million and $0.7 million in interest expense during the third quarter and first
nine months of fiscal 2004, respectively.
In addition, the Company is party to interest rate lock agreements, which are
used to hedge the risk that the costs of future issuance of debt may be
adversely affected by changes in interest rates. Under the treasury lock swap
agreements, the Company agrees to pay or receive an amount equal to the
difference between the net present value of the cash flows for a notional
principal amount of indebtedness based on the locked rate at the date when the
agreement was established and the yield of a United States Government 10-Year
Treasury Note on the settlement date of January 3, 2006. The treasury lock swap
agreements are reflected at fair value in the Company's balance sheet (other
long term liabilities) and the related gains or losses on these agreements are
deferred in stockholders' equity (as a component of other comprehensive income).
During the first nine months of fiscal 2004, the Company recognized other
comprehensive loss of $0.7 million from the change in fair value of the interest
rate and treasury lock swap agreements. Total comprehensive loss (net loss from
operations plus other comprehensive loss) for the nine months ended September
30, 2004 was $5.7 million.
Item 4. CONTROLS AND PROCEDURES.
The Company's management, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the
period covered by this report. Based on such evaluation, the Company's Chief
Executive Officer and Chief Financial Officer have concluded that, as of the end
of such period, the Company's disclosure controls and procedures are effective
in recording, processing, summarizing and reporting, on a timely basis,
information required to be disclosed by the Company in the reports that it files
or submits under the Exchange Act.
As required by Section 404 of the Sarbanes Oxley Act of 2002, the Company
continues to test and evaluate our internal control procedures to determine
whether our controls are designed and operating effectively. The requirements of
Section 404 have caused most public companies to substantially increase the
21
CAPITAL SENIOR LIVING CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
documentation of internal controls and to implement additional controls. As a
result of the Company's testing and evaluation performed to date, the Company
has noted that improvements could be made in the Company's internal controls.
The Company believes that adequate compensating controls exist in these areas;
however, the Company has developed plans and is implementing improvements or
additional control procedures. The Company has disclosed these matters to the
audit committee of the Company's board of directors and to the Company's
independent auditors. There have not been any changes in the Company's internal
control over financial reporting (as such term is defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) during the fiscal quarter to which this report
relates that have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
22
CAPITAL SENIOR LIVING CORPORATION
OTHER INFORMATION
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
In the fourth quarter of 2002, the Company (and two of its management
subsidiaries), Buckner, and a related Buckner entity, and other unrelated
entities were named as defendants in a lawsuit in district court in Fort Bend
County, Texas brought by the heir of a former resident who obtained nursing home
services at Parkway Place from September 1998 to March 2001. The Company managed
Parkway Place for Buckner through December 31, 2001. The Company and its
subsidiaries denied any wrongdoing. On March 16, 2004, the Court granted the
Company's Motion to Dismiss.
In February 2004, the Company and certain subsidiaries, along with numerous
other senior living companies in California, were named as defendants in a
lawsuit in a district court in Los Angeles, California. This lawsuit was brought
by two public interest groups on behalf of seniors in California residing at the
facilities of the defendants. The plaintiffs allege that pre-admission fees
charged by the defendants' facilities were actually security deposits that must
be refunded in accordance with California law. The plaintiffs seek restitution,
treble damages, penalties, costs and injunctive relief. The Company at this time
is unable to estimate its liability, if any, related to this claim. The
Company's insurer is defending this claim subject to a reservation of rights
letter. The Company intends to vigorously defend against this claim.
The Company has other pending claims not mentioned above ("Other Claims")
incurred in the course of its business. Most of these Other Claims are believed
by management to be covered by insurance, subject to normal reservations of
rights by the insurance companies and possibly subject to certain exclusions in
the applicable insurance policies. Whether or not covered by insurance, these
Other Claims, in the opinion of management, based on advice of legal counsel,
should not have a material effect on the financial statements of the Company if
determined adversely to the Company.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not Applicable
Item 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
Item 5. OTHER INFORMATION
(a) Not Applicable
(b) Not Applicable
23
Item 6. EXHIBITS
Exhibits:
31.1 Certification of Chief Executive Officer
required by Rule 13a-14(a) or Rule 15d-14(a).
31.2 Certification of Chief Financial Officer
required by Rule 13a-14(a) or Rule 15d-14(a).
32.1 Certification of Lawrence A. Cohen pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Ralph A. Beattie pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
24
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Capital Senior Living Corporation
(Registrant)
By: /s/ Ralph A. Beattie
Ralph A. Beattie
Executive Vice President and Chief Financial
Officer (Principal Financial Officer and
Duly Authorized Officer)
Date: November 10, 2004