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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT 1934
For the quarterly period ended March 31, 2004.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-14012
EMERITUS CORPORATION
(Exact name of registrant as specified in its charter)
WASHINGTON 91-1605464
(State or other jurisdiction (I.R.S Employer
of incorporation or organization) Identification No.)
3131 Elliott Avenue, Suite 500
Seattle, WA 98121
(Address of principal executive offices)
(206) 298-2909
(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. [X] Yes [ ] No
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). [ ] Yes [X] No
As of April 30, 2004, there were 10,566,238 shares of the Registrant's Common
Stock, par value $.0001, outstanding.
EMERITUS CORPORATION
INDEX
Part I. Financial Information
Page No.
--------
Item 1. Financial Statements: . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Condensed Consolidated Balance Sheets as of March 31, 2004 and
December 31, 2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Condensed Consolidated Statements of Operations for the Three
Months ended March 31, 2004 and 2003. .. .. . . . .... .. . . . . .. . . . .. 3
Condensed Consolidated Statements of Cash Flows for the Three
Months ended March 31, 2004 and 2003 . . . . . . . . . . . . .. .. . . . . . . 4
Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . . 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations . . . .. . . . . . . . . . . . .. . . . .. . . . . . . . . . . 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . 25
Item 4. Controls and Procedures . . . . . . . . . . . .. . . . .. . . . . . . . . . 25
Part II. Other Information
Note: Items 1 through 4 of Part II are omitted because they are not
applicable.
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . .. ... . . . . 26
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . 27
Signature. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
[The rest of this page is intentionally left blank]
1
EMERITUS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(In thousands, except share data)
ASSETS
March 31, December 31,
2004 2003
----------- --------------
Current Assets:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,290 $ 6,368
Trade accounts receivable, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,687 2,769
Other receivables. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,524 1,961
Prepaid expenses and other current assets. . . . . . . . . . . . . . . . . . . . . . . . . 9,366 6,663
----------- --------------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,867 17,761
----------- --------------
Long-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,884 7,678
Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116,677 117,546
Property held for development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,254 1,254
Notes receivable from and investments in affiliates . . . . . . . . . . . . . . . . . . . . 1,835 2,409
Restricted deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,888 7,306
Lease acquisition costs, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,052 19,052
Other assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,785 5,581
----------- --------------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 177,242 $ 178,587
=========== ==============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities:
Current portion of long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,934 $ 4,750
Trade accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,142 6,774
Accrued employee compensation and benefits . . . . . . . . . . . . . . . . . . . . . . . . 6,300 5,885
Accrued interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,555 1,888
Accrued real estate taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,254 2,702
Accrued dividends on preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,798 8,228
Other accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,572 7,941
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,918 6,075
Other current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,726 6,879
----------- --------------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53,199 51,122
----------- --------------
Long-term debt, less current portion. . . . . . . . . . . . . . . . . . . . . . . . . . . . 134,963 136,388
Convertible debentures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,000 32,000
Deferred gain on sale of communities. . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,055 37,389
Deferred rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 263
Other long-term liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 433 519
----------- --------------
Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 258,855 257,681
----------- --------------
Commitments and contingencies
Shareholders' Deficit:
Preferred stock, $.0001 par value. Authorized 5,000,000 shares.
Series B, Authorized 70,000 shares; issued and outstanding 35,178 and 34,830 at
March 31, 2004, and December 31, 2003, respectively . . . . . . . . . . . . . . . . . . - -
Common stock, $.0001 par value. Authorized 40,000,000 shares; issued and outstanding
10,548,903 and 10,297,449 shares at March 31, 2004, and December 31, 2003, respectively 1 1
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72,716 71,703
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (154,330) (150,798)
----------- --------------
Total shareholders' deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (81,613) (79,094)
----------- --------------
Total liabilities and shareholders' deficit. . . . . . . . . . . . . . . . . . . . . . . . $ 177,242 $ 178,587
=========== ==============
See accompanying Notes to Condensed Consolidated Financial Statements and Management's
Discussion and Analysis of Financial Condition and Results of Operations
2
EMERITUS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(In thousands, except per share data)
Three Months ended March 31,
--------------------------------
2004 2003
--------------- ---------------
Revenues:
Community revenue . . . . . . . . . . . . $ 63,538 $ 43,087
Other service fees. . . . . . . . . . . . 1,365 993
Management fees . . . . . . . . . . . . . 1,633 3,097
--------------- ---------------
Total operating revenues. . . . . 66,536 47,177
--------------- ---------------
Expenses:
Community operations. . . . . . . . . . . 42,456 28,646
General and administrative. . . . . . . . 6,232 5,404
Depreciation and amortization . . . . . . 2,063 1,846
Facility lease expense. . . . . . . . . . 14,691 8,604
--------------- ---------------
Total operating expenses. . . . . 65,442 44,500
--------------- ---------------
Income from operations. . . . . . 1,094 2,677
Other income (expense):
Interest income . . . . . . . . . . . . . 153 156
Interest expense. . . . . . . . . . . . . (3,793) (3,274)
Other, net. . . . . . . . . . . . . . . . (66) 48
--------------- ---------------
Net other expense . . . . . . . . (3,706) (3,070)
--------------- ---------------
Net loss. . . . . . . . . . . . . (2,612) (393)
Preferred stock dividends . . . . . . . . . (920) (1,870)
--------------- ---------------
Net loss to common shareholders . (3,532) (2,263)
=============== ===============
Loss per common share:
Basic and diluted . . . . . . . . . . . $ (0.34) $ (0.22)
=============== ===============
Weighted average common shares outstanding:
Basic and diluted . . . . . . . . . . . 10,310 10,247
=============== ===============
See accompanying Notes to Condensed Consolidated Financial Statements and Management's
Discussion and Analysis of Financial Condition and Results of Operations
3
EMERITUS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(In thousands)
Three Months Ended March 31,
2004 2003
-------------- --------------
Cash flows from operating activities:
Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (2,612) $ (393)
Adjustments to reconcile net loss to
net cash provided by (used in) operating activities:
Minority interests. . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 50
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . 2,063 1,846
Amortization of deferred gain . . . . . . . . . . . . . . . . . . . . . . . (714) (99)
Equity investment losses . . . . . . . . . . . . . . . . . . . . . . . . . 794 -
Changes in operating assets and liabilities . . . . . . . . . . . . . . . . (3,241) (1,176)
-------------- --------------
Net cash provided by (used in) operating activities . . . . . . . . . (3,710) 228
-------------- --------------
Cash flows from investing activities:
Acquisition of property and equipment . . . . . . . . . . . . . . . . . . . . (846) (484)
Proceeds from sale of property and equipment. . . . . . . . . . . . . . . . . 165 -
Management and lease acquisition costs. . . . . . . . . . . . . . . . . . . . (302) (189)
Advances to affiliates and other managed communities. . . . . . . . . . . . . 13 (43)
Collection of notes receivable. . . . . . . . . . . . . . . . . . . . . . . . 2,657 -
Investment in affiliates. . . . . . . . . . . . . . . . . . . . . . . . . . . (303) (14)
Distributions to minority partners. . . . . . . . . . . . . . . . . . . . . . - (299)
-------------- --------------
Net cash provided by (used in) investing activities . . . . . . . . . 1,384 (1,029)
-------------- --------------
Cash flows from financing activities:
Proceeds from sale of stock under employee stock purchase and incentive plans 321 46
Increase in restricted deposits . . . . . . . . . . . . . . . . . . . . . . . (582) -
Debt issue and other financing costs. . . . . . . . . . . . . . . . . . . . . (101) (232)
Repayment of long-term borrowings . . . . . . . . . . . . . . . . . . . . . . (1,390) (1,019)
-------------- --------------
Net cash used in financing activities . . . . . . . . . . . . . . . . (1,752) (1,205)
-------------- --------------
Net decrease in cash and cash equivalents . . . . . . . . . . . . . . (4,078) (2,006)
Cash and cash equivalents at the beginning of the period. . . . . . . . . . . . 6,368 6,960
-------------- --------------
Cash and cash equivalents at the end of the period. . . . . . . . . . . . . . . $ 2,290 $ 4,954
============== ==============
Supplemental disclosure of cash flow information - cash paid during the period
for interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,127 $ 3,691
Noncash investing and financing activities:
Unrealized holding gains in investment securities . . . . . . . . . . . . . . $ - $ 144
Accrued and in-kind preferred stock dividends . . . . . . . . . . . . . . . . $ 920 $ 1,870
See accompanying Notes to Condensed Consolidated Financial Statements and Management's
Discussion and Analysis of Financial Condition and Results of Operations
4
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND USE OF ESTIMATES
The preparation of condensed consolidated financial statements requires Emeritus
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, Emeritus evaluates its estimates,
including those related to resident programs and incentives such as move-in
fees, bad debts, investments, intangible assets, impairment of long-lived
assets, income taxes, restructuring, long-term service contracts, contingencies,
self-insured retention, insurance deductibles, health insurance, and litigation.
Emeritus bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
Emeritus believes the following critical accounting policies are most
significant to the judgments and estimates used in the preparation of its
condensed consolidated financial statements. Revisions in such estimates are
charged to income in the period in which the facts that give rise to the
revision become known.
* For commercial general liability and professional liability insurance for
2004, Emeritus formed a wholly owned captive insurance company domiciled in
the U.S. The insurance policy issued by the captive is claims-made and
insures liabilities associated with general and professional liability. The
policy insures on a per occurrence and aggregate-limit basis in excess of a
self-insured retention. Estimated losses covered by the policy and the
self-insured retention are accrued based upon actuarial estimates of the
aggregate liability for claims within the policy year. The captive is
funded solely through contributions made by Emeritus, which is funded at
set intervals based on expected timing of losses. To the extent the captive
is required to pay claims in excess of Emeritus's contributions, Emeritus
is required to fund any shortfalls on demand. To the extent that claims
exceed the policy issued by the captive, Emeritus will be required to cover
all losses above the captive limits set per occurrence and in aggregate.
The captive is subject to regulatory agency control and reviews for
compliance with statutes. Results from these reviews may change the timing
or amount of subsequent funding. Should losses exceed actuarial estimates,
additional expense may be accrued at the time of determination.
* For health insurance, Emeritus self-insures up to a certain level for each
occurrence above which a catastrophic insurance policy covers any
additional costs. Health insurance expense is accrued based upon historical
experience of the aggregate liability for claims incurred. If these
estimates are insufficient, additional charges may be required.
* Workers' compensation insurance coverage applies for specific insurable
states (excluding Texas, New York, and the compulsory State Funds States)
through a high deductible, fully collateralized insurance policy. The
policy premium is based upon standard rates applied to estimated annual
payroll. The collateral requirement is determined by annual expected losses
for the policy year. The Company contracts with an independent third-party
administrator to administer the program; and paid claim expenses are drawn
from the collateral account. The sum of the premium and related costs,
estimated administration costs, and actuarial based estimated losses
("Estimated Total Costs") is accrued on a monthly basis. The difference
between the Estimated Total Costs and the posted collateral is carried as
an asset on the balance sheet. At policy expiration, an insurer audit is
conducted to adjust premiums based on actual, rather than estimated, annual
payroll. Any premium adjustment for the differences between estimated and
actual payroll will first be applied to the accrued asset and then, if
needed, as an adjustment to workers' compensation expense at the time such
adjustment is determined. The insurer also audits the claim total incurred
amount at least annually and may adjust the applicable policy year
collateral requirement. There is a reasonable expectation that the total
incurred losses will be less than the posted collateral, resulting in a
release of collateral back to the Company. The adjustment to the collateral
will be applied first to the accrued asset and then, if needed, as an
adjustment to the workers' compensation expense at the time such adjustment
is determined. The Company insures occupational injuries and illness in New
York through participation in a group pool insured
5
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(unaudited)
through a guaranteed cost insurance policy, with the premium payable on a
monthly basis. The insurer group contracts with an independent third-party
administrator on behalf of its members to manage the claims; and claim
expenses are paid by the insurer. For work-related injuries in Texas, the
Company insures through a qualified "Non-Subscriber Employee Retirement
Income Security Act Occupational Injury and Illness Benefit Plan" and an
insurance policy is in place to cover losses in excess of the deductible
amount. The Company contracts with an independent third-party administrator
to manage the claims. Claim expenses are paid as incurred and estimated
losses within the deductible are accrued on a monthly basis.
* Emeritus accounts for stock option awards to employees under the intrinsic
value-based method of accounting prescribed by APB No. 25, "Accounting for
Stock Issued to Employees". Under this method, no compensation expense is
recorded, provided the exercise price is equal to or greater than the
quoted market price of the stock at the grant date. The Company makes pro
forma disclosures of net income and earnings per share as if the fair
value-based method of accounting (the alternative method of accounting for
stock-based compensation) had been applied as required by FAS No. 123,
"Accounting for Stock-Based Compensation". The fair value-based method
requires the Company to make assumptions to determine expected risk-free
interest rates, stock price volatility, dividend yield, and
weighted-average option life. To the extent such things as actual
volatility or life of the options is different from estimated, pro forma
amounts expensed will be more or less than would have been disclosed
otherwise.
* Emeritus maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its residents to make required payments. If
the financial condition of Emeritus's residents were to deteriorate,
resulting in an impairment of their ability to make payments, additional
charges may be required.
* Emeritus records a valuation allowance to reduce its deferred tax assets to
the amount that is more likely than not to be realized, which at this time
shows a net asset valuation of zero. Emeritus has considered future taxable
income and ongoing prudent and feasible tax planning strategies in
assessing the need for the valuation allowance. However, in the event
Emeritus were to determine that it would be able to realize its deferred
tax assets in the future in excess of its net recorded amount, an
adjustment to the deferred tax asset would increase income in the period
such determination was made.
RECENT ACCOUNTING PRONOUNCEMENTS AND PROPOSED STATEMENTS
In January 2003, the FASB issued Interpretation No. 46 (FIN No. 46),
"Consolidation of Variable Interest Entities". This Interpretation was revised
in December 2003 and addresses consolidation by business enterprises of variable
interest entities (VIE's). A VIE is subject to the consolidation provisions of
FIN No. 46 if it cannot support its financial activities without additional
subordinated financial support from third parties or its equity investors lack
any one of the following characteristics: the ability to make decisions about
its activities through voting rights, the obligation to absorb losses of the
entity if they occur, or the right to receive residual returns of the entity if
they occur. FIN No. 46 requires a VIE to be consolidated by its primary
beneficiary. The primary beneficiary is the party that holds the variable
interests that expose it to a majority of the entity's expected losses and/or
residual returns. For purposes of determining a primary beneficiary, all
related party interests must be combined with the actual interests of the
Company in the VIE. The application of this Interpretation is immediate for
VIE's created or altered after January 31, 2003, and is effective at the end of
the first quarter of 2004 for variable interest entities that existed prior to
February 1, 2003.
The Company has evaluated the impact of FIN No. 46 on all its current
related-party management agreements, including those more fully discussed under
the section denoted as "Emeritrust Transactions" as well as other management
agreements and other arrangements with potential VIE's. The Company does not
believe it has any VIE's that require consolidation.
On March 31, 2004, the Financial Accounting Standards Board (FASB) issued a
proposed Statement, Share-Based Payment, an amendment of FASB Statements No. 123
and 95, that would require companies to account for stock-based compensation to
employees using a fair value method as of the grant date. The
6
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(unaudited)
proposed statement addresses the accounting for transactions in which a company
receives employee services in exchange for equity instruments such as stock
options, or liabilities that are based on the fair value of the company's equity
instruments or that may be settled through the issuance of such equity
instruments, which includes the accounting for employee stock purchase plans.
This proposed statement would eliminate a company's ability to account for
share-based awards to employees using APB Opinion 25, Accounting for Stock
Issued to Employees but would not change the accounting for transactions in
which a company issues equity instruments for services to non-employees or the
accounting for employee stock ownership plans. The proposed statement, if
adopted, would be effective for awards that are granted, modified, or settled in
fiscal years beginning after December 15, 2004.
BASIS OF PRESENTATION
The unaudited interim financial information furnished herein, in the opinion of
the Company's management, reflects all adjustments, consisting of only normally
recurring adjustments, which are necessary to state fairly the condensed
consolidated financial position, results of operations, and cash flows of
Emeritus as of March 31, 2004, and for the three months ended March 31, 2004 and
2003. The results of operations for the period ended March 31, 2004, are not
necessarily indicative of the operating results for the full year. The Company
presumes that those reading this interim financial information have read or have
access to its 2003 audited consolidated financial statements and Management's
Discussion and Analysis of Financial Condition and Results of Operations that
are contained in the 2003 Form 10-K filed March 30, 2004. Therefore, the
Company has omitted footnotes and other disclosures herein, which are disclosed
in the Form 10-K.
STOCK-BASED COMPENSATION
The Company applies APB Opinion No. 25, Accounting for Stock Issued to Employees
and related interpretations in measuring compensation costs for its stock option
plans. The Company discloses pro forma net loss and net loss per share as if
compensation cost had been determined consistent with Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation.
Had compensation costs for the Company's stock option plan been determined
pursuant to SFAS 123, the Company's pro forma net loss and pro forma net loss
per share would have been as follows:
Three Months ended March 31,
----------------------------------------
2004 2003
------------------- -------------------
(In thousands, except per share data)
Net loss to common shareholders
As reported. . . . . . . . . . . . . . . . . . . . . . . . $ (3,532) $ (2,263)
Add: Stock-based employee compensation expense
included in reported net income (loss) . . . . . . . . . - -
Deduct: Stock-based employee compensation
determined under fair value based method for all awards. (278) (286)
------------------- -------------------
Pro forma. . . . . . . . . . . . . . . . . . . . . . . . . $ (3,810) $ (2,549)
=================== ===================
Net loss per common share:
As reported - Basic and diluted. . . . . . . . . . . . . . $ (0.34) $ (0.22)
=================== ===================
Pro forma - Basic and diluted. . . . . . . . . . . . . . . $ (0.37) $ (0.25)
=================== ===================
7
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(unaudited)
The Company estimates the fair value of its options using the Black-Scholes
option value model, which is one of several methods that can be used to estimate
option values. 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. Option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. The
Company's options have characteristics significantly different from those of
traded options, and changes in the subjective input assumptions can materially
affect the fair value estimates. No options were granted in the first quarter
of 2004. The fair value of options granted and employee purchase plan shares in
the three months ended March 31, 2003, were estimated at the date of grant using
the following weighted average assumptions:
Three Months
Ended
March 31,
2003
--------------
Expected life from vest date (in years) 4
Risk-free interest rate . . . . . . . . 2.5%
Volatility. . . . . . . . . . . . . . . 89.3%
Dividend yield. . . . . . . . . . . . . -
Weighted average fair value (per share) $ 2.58
EMERITRUST TRANSACTIONS
Since 1999, Emeritus has managed 46 communities under arrangements with several
related investor groups that involved (i) payment of management fees to the
Company, (ii) options for the Company to purchase the communities at a price
determined by a formula, and (iii) obligations to fund operating losses of
certain communities. As of October 1, 2003, the 21 Emeritrust II Communities
Managed were acquired via operating leases and the results are included in the
Company's condensed consolidated financial statements.
Emeritrust I Communities Management. During 2003, Emeritus managed the
Emeritrust I communities, which included 25 of the 46 communities, under a
management agreement providing for a base fee of 3% of gross revenues generated
by the communities and an additional management fee of 4% of gross revenues,
payable to the extent of 50% of cash flow from the communities. The management
agreement also required the Company to fund cash operating losses of the
communities. In each of April and August 2003, the Emeritrust I owners disposed
of a community, reducing the number of managed communities to 23. Under this
arrangement, the Company received management fees (net of its funding
obligations) of approximately $837,000 in the first quarter of 2003. This
management agreement, as extended several times, was to have expired June 30,
2003, but was extended to January 2, 2004, although the Company was indemnified
by the investor group against liability under its obligation to fund cash
operating losses for the extension period. In January 2004, the management
arrangement was informally extended through March 31, 2004, at the stated
management fee and without any funding obligation. The options to purchase the
communities expired at the end of 2003. In March 2004, the Emeritrust I owners
disposed of a community, reducing the number of managed communities to 22.
Subsequently, effective April 1, 2004, the Emeritrust I owners extended the
underlying financing on the Emeritrust I communities. In connection with the
financing extension, the management agreement was amended to provide for a flat
management fee of 5% of gross revenues. This amendment also terminated the
opportunity for supplemental management fee revenues based upon operating
performance and extended the term of the agreement to March 31, 2005, with a
one-year extension available under certain circumstances. The Company also
expects that the Emeritrust I owners could sell additional communities, thereby
reducing the number of communities subject to the management agreement. Because
this management agreement can be terminated by either party on short notice,
there can be no guarantee that the management arrangement will continue for its
full term. Under the new management agreement, the Company received management
fees of approximately $640,000 in the first quarter of 2004.
8
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(unaudited)
Emeritrust II Communities Management. Through September 30, 2003, Emeritus
managed the Emeritrust II communities, which included 21 of the 46 communities,
under management agreements providing for a base management fee of 5% of gross
revenue generated by the communities and an additional management fee of 2%,
payable if the Company met certain cash flow standards. The management agreement
for five of the communities also required the Company to fund cash operating
losses of those communities. Under this arrangement, the Company received
management fees (net of its funding obligations) of approximately $675,000 in
the first quarter of 2003.
Emeritrust II Communities Lease. On September 30, 2003, Emeritus acquired the 21
Emeritrust II communities for a cash purchase price of $118.6 million, financed
through a combination of lease and mortgage financing with an independent real
estate investment trust in the aggregate amount of $121.5 million. A master
operating lease covers the Emeritrust II communities and four other communities
originally leased from the real estate investment trust in March 2002. The lease
is for an initial 15-year period, with one 15-year renewal, and grants the
Company a right of first opportunity to purchase any of the Emeritrust II
communities if the trust decides to sell. The lease is a net lease, with annual
base rent of $14.7 million (of which $10.5 million is attributable to the
Emeritrust II communities and $4.2 million is attributable to the four
previously leased communities), and periodic escalators. The real estate
investment trust also provided $11.5 million of debt financing secured by the
Company's leasehold interests in the Emeritrust II communities. This debt was
consolidated with other debt held by the real estate investment trust. As part
of the purchase price, the Company also agreed to issue to the Emeritrust II
investors warrants to purchase 500,000 shares of its common stock, of which
warrants to purchase 400,000 shares have been issued. The warrants expire
September 30, 2008, and have an exercise price of $7.60 (subject to certain
adjustments). The holders have limited registration rights. Emeritus included
the fair value of these warrants, totaling approximately $1.4 million, as lease
acquisition costs that it will amortize over the life of the lease.
ACCRUED DIVIDENDS ON PREFERRED STOCK
Since the third quarter of 2000, the Company has accrued its obligation to pay
cash dividends to the Series B preferred shareholders, which amounted to
approximately $8.8 million at March 31, 2004, including all penalties for
non-payment. Because the Company has not paid these dividends for more than six
consecutive quarters, under the Designation of Rights and Preferences of the
Series B preferred stock in the Company's Articles of Incorporation, the Series
B preferred shareholders may designate one director in addition to the other
directors that they are entitled to designate under the shareholders' agreement.
As of January 1, 2002, the Series B preferred shareholders became entitled to
designate an additional director under the Articles, but thus far have chosen
not to do so.
Series B preferred dividends are to be paid in cash and in additional shares of
Series B preferred shares. As of March 31, 2004, an additional 5,178 Series B
preferred shares had been issued as paid-in-kind dividends for all periods prior
to the first quarter of 2004, of which 348 shares were issued in the first
quarter of 2004. As of April 1, 2004, an additional 351 shares of Series B
preferred stock were issued as paid-in-kind dividends for the first quarter of
2004.
ALTERRA TRANSACTIONS
In December 2003, Emeritus invested $7.3 million, net of transaction costs, in a
limited liability company (LLC) that acquired Alterra Healthcare Corporation, a
national assisted living company headquartered in Milwaukee, Wisconsin that was
the subject of a voluntary Chapter 11 bankruptcy. The investment represents an
11% interest in the total invested capital of the LLC and includes an excess of
approximately $3.6 million over the underlying net book value. Alterra operated
304 assisted living communities in 22 states. The purchase price for Alterra was
$76 million and the transaction closed on December 4, 2003, following approval
by the Bankruptcy Court. The members of the LLC consists of an affiliate of
Fortress Investment Group LLC (Fortress), a New York based private equity fund,
which is the managing member, an entity controlled by Mr. Baty, and the Company.
Under the LLC agreement, distributions are first allocated to Fortress until it
receives payment on a $15.0 million loan to the LLC at 15% interest and its
original investment of $49 million together with a 15% preferred return, and
then are allocated to the three
9
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(unaudited)
investors in proportion to percentage interests, as defined in the agreement,
which are a 50% interest for Fortress and a 25% interest each for the Company
and the entity controlled by Mr. Baty.
Through January 31, 2004, the investment was structured as an ownership interest
in an LLC, which is a pass-through entity for tax purposes, similar to a limited
partnership. Under generally accepted accounting principles, the Company was
required to use the equity method of accounting for its LLC membership interest
and record a portion of Alterra's results of operations in its financial
statements. As a consequence, equity losses of approximately $794,000, which
are recorded on a quarter lag, are included under the caption "Other, net",
which represents the Company's portion of Alterra's net loss for December 2003
and January 2004.
The LLC made an election to be treated as a corporation for tax purposes
effective January 31, 2004, and is no longer a pass-through entity. As a result
of this election, beginning February 1, 2004, the Company will account for
Alterra on a cost basis under APB 18 "The Equity Method of Accounting for
Investments in Common Stock" until Fortress's investment falls below a certain
level and/or there is a change in structure such that the Company would have
significant influence over the operations of Alterra. If and when such an event
occurs, Emeritus will resume using the equity method of accounting for its
investment in Alterra.
CPM-JEA TRANSACTIONS
On April 1, 2004, the Company completed the first stage of its previously
announced lease acquisition of up to 24 assisted living facilities in 13 states,
including up to 10 stand-alone dementia care facilities, for an approximate
$190.5 million investment, inclusive of transaction fees. The completed first
stage involved 17 of the 24 senior housing and long-term care properties for a
total investment of about $140.7 million, inclusive of transaction fees. Nine of
the communities, all of which the Company managed in 2003, were owned by
entities that Daniel R. Baty, the Company's Chairman and Chief Executive
Officer, controls and in which he has financial interests ("Baty Entities"). The
remainder of the communities were owned by entities in which Mr. Baty had an
indirect ownership interest (the "JEA Entities"). With respect to the
communities formerly owned by the JEA Entities, the Company entered into a
management agreement with JEA Senior Living ("JEA"), a partner in the JEA
Entities, which is not affiliated with Mr. Baty, to provide certain management
services to the communities for a period of three years. Under the terms of this
management agreement, JEA is entitled to a monthly management fee of 5% of the
gross revenues of the communities and to a termination payment of $100,000 per
year for a period of ten years after the termination of the management
agreement. The Company also agreed to an earn-out payment to the JEA Entities of
up to $2.0 million based on the improvement in the net operating income of the
communities during the three-year period after the closing. Of the $140.7
million purchase price paid at closing, approximately $137.0 million was
financed through a real estate investment trust through an operating lease
agreement. The balance of the closing purchase price was paid $2.7 million in
cash and $1.0 million by the execution and delivery by the Company of its
promissory notes to two of the Baty Entities, which provide for interest at the
rate of 8% and a maturity date of April 1, 2007. The communities are leased
under two master leases, each with a 15-year term, with three 5-year renewal
options. The initial lease rate is 9% with Consumer Price Index based inflators.
The initial lease payment is expected to be approximately $1.0 million per
month. Of the up to $49.8 million balance of the transaction, at least $37.2
million is expected to close during the second quarter of 2004, or shortly
thereafter, subject to customary closing conditions.
LINE OF CREDIT
In March 2004, the Company secured a revolving line of credit with U.S. Bank in
the amount of $3.0 million, pledging certain of the Company's assets as
collateral and bearing interest at 1% above U.S. Bank's prime rate or LIBOR plus
3.5% for loans up to 3 months, at the Company's option. The current maturity
date on the line of credit is June 30, 2004.
LOSS PER SHARE
The capital structure of Emeritus includes convertible debentures, and
redeemable and non-redeemable convertible preferred stock, common stock
warrants, and stock options. Basic net loss per share is computed based on
weighted average shares outstanding and excludes any potential dilution. Diluted
net
10
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(unaudited)
loss per share is computed based on the weighted average number of shares
outstanding plus dilutive potential common shares. Options and warrants are
included under the "treasury stock method" to the extent they are dilutive.
Certain shares issuable upon the exercise of stock options and warrants and
conversion of convertible debentures and preferred stock have been excluded from
the computation because the effect of their inclusion would be anti-dilutive.
The following table summarizes those that are excluded in each period because
they are anti-dilutive (In thousands):
Three Months
Ended
March 31,
2004 2003
----- ------
Convertible Debentures. . . . . . . . . . . 1,455 1,455
Options . . . . . . . . . . . . . . . . . . 1,884 2,030
Warrants - Senior Housing Partners I, L.P.. 400 -
Warrants - Saratoga Partners. . . . . . . . 1,000 1,000
Series A Preferred (1). . . . . . . . . . . - 1,374
Series B Preferred. . . . . . . . . . . . . 4,872 4,636
----- ------
9,611 10,495
===== ======
(1) Repurchased in July and August 2003.
OTHER COMPREHENSIVE LOSS
Other comprehensive loss includes the following transactions for the three-month
periods ended March 31, 2004 and 2003, respectively (In thousands):
Three Months ended March 31,
2004 2003
-------------- --------------
Net loss to common shareholders. . $ (3,532) $ (2,263)
Other comprehensive income:
Unrealized holding gains
on investment securities - 144
-------------- --------------
Comprehensive loss . . . . . . . . $ (3,532) $ (2,119)
============== ==============
LIQUIDITY
The Company has incurred significant operating losses since its inception and
has a working capital deficit of $35.3 million, although $11.4 million
represents deferred revenue and unearned rental income, and $8.8 million of
preferred dividends is due only if declared by the Company's board of directors.
At times in the past, the Company has been dependent upon third-party financing
or disposition of assets to fund operations. If such transactions are necessary
in the future, Emeritus cannot guarantee that they will be available on a timely
basis, on terms attractive to the Company, or at all.
Throughout 2002 and continuing in the first quarter of 2003, the Company
refinanced substantially all of its debt obligations, extending the maturities
of such financings to dates in 2005 or thereafter, at which time the Company
will need to refinance or otherwise repay the obligations. Many of the Company's
debt instruments and leases contain "cross-default" provisions pursuant to which
a default under one obligation can cause a default under one or more other
obligations to the same lender or lessor. Such cross-default provisions affect
17 owned assisted living properties and 104 properties operated under leases.
Accordingly, any event of default could cause a material adverse effect on the
Company's financial
11
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(unaudited)
condition if such debt or leases are cross-defaulted. At March 31, 2004, the
Company complied with all such covenants, except for a portfolio of 23 leased
buildings. The Company has obtained a waiver from the lessor and is considered
to be in full compliance as of March 31, 2004.
Management believes that the Company will be able to sustain positive operating
cash flow on an annual basis and will have adequate cash for all necessary
investing and financing activities including required debt service and capital
expenditures through at least March 31, 2005.
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12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Emeritus is a Washington corporation organized by Daniel R. Baty and two other
founders in 1993. In November 1995, we completed our initial public offering.
From 1995 through 1999, we expanded rapidly through acquisition and internal
development and by December 31, 1999, operated 129 assisted living communities
with 11,726 units. We believe, however, that during this expansion, the
assisted living industry became significantly overbuilt, creating an environment
characterized by sluggish or falling occupancy and market resistance to rate
increases. As a result of these difficult operating circumstances, we limited
further growth and in 2000 began an increasing focus first on raising our
occupancy and later on operating efficiencies and cost controls as well as
implementing a systematic rate enhancement program.
We believe that the health of the assisted living industry is currently
improving and that there are developing opportunities to improve occupancy and
adjust rates. It is apparent that the assisted living industry is experiencing
increased regulation, increased insurance costs, and limited availability of
capital for smaller local and regional operators. In this type of environment,
we believe that we will continue to witness consolidation of smaller local and
regional operators into the larger national operators. Because of these
circumstances, we have been able to complete several acquisitions in the last
two years and have converted communities we managed to communities we own or
lease. Going forward, we will attempt to identify additional acquisition
opportunities. In 2000 and 2001, we continued to operate approximately 130
communities, but in 2002 and 2003, we increased that to 180 and 175 communities,
respectively, primarily through the lease of 24 communities formerly operated by
Marriott and through other selected acquisitions. From the end of 2000 to the
end of 2003, the communities we manage decreased from 69 to 47 and the owned and
leased communities increased from 61 to 128, reflecting both our increasing
confidence in the assisted living industry and the availability of capital.
In 2004, we expect to continue reviewing acquisition opportunities and seeking
to take ownership or lease positions in communities that we manage. To this end,
on April 1, 2004, we executed the first stage of the previously announced lease
acquisition of up to 13 communities that we formerly managed, a second lease
acquisition of nine memory loss facilities, and two other communities.
The following table sets forth a summary of our property interests:
As of March 31, As of December 31, As of March 31,
2004 2003 2003
---------------------- --------------------- ---------------------
Buildings Units Buildings Units Buildings Units
---------- ---------- ---------- ---------- --------- ---------
Owned (1) . . . . . . . . . . . . . . . 19 1,813 19 1,813 17 1,687
Leased (1). . . . . . . . . . . . . . . 109 8,303 109 8,303 67 5,279
Managed/Admin Services. . . . . . . . . 45 4,454 46 4,589 94 8,577
Joint Venture/Partnership . . . . . . . 1 140 1 140 2 219
---------- ---------- ---------- ---------- --------- ---------
Operated Portfolio . . . . . . . . 174 14,710 175 14,845 180 15,762
Percentage increase (decrease) (2) (0.6%) (0.9%) (2.8%) (5.8%) - -
- --------
(1) Included in our consolidated portfolio of communities.
(2) The percentage increase (decrease) indicates the change from the prior
year, or, in the case of March 31, 2004 and 2003, from the end of the prior
year.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Two of the important factors affecting our financial results are the rates we
charge our residents and the occupancy levels we achieve in our communities. We
rely primarily on our residents' ability to pay our charges for services from
their own or familial resources and expect that we will do so for the
foreseeable future. Although care in an assisted living community is typically
less expensive than in a skilled nursing facility, we believe that generally
only seniors with income or assets meeting or exceeding the regional median can
afford to reside in our communities. In this context, we must be sensitive to
our residents' financial circumstances and remain aware that rates and occupancy
are often interrelated.
In evaluating the rate component, we generally rely on the average monthly
revenue per unit, computed by dividing the total revenue for a particular period
by the average number of occupied units determined on a monthly basis for the
same period. In evaluating the occupancy component, we generally rely on an
average occupancy rate, computed by dividing the average units occupied,
determined on a monthly basis, during a particular period by the average number
of units available, determined on a monthly basis, during the period. We
evaluate these and other operating components for our consolidated portfolio,
which includes the communities we own and lease, and our operating portfolio,
which also includes the communities we manage.
In our consolidated portfolio, our average monthly revenue per unit for the
three months ended March 31, 2004, increased to $2,779 from $2,756 in 2003. This
change represents an increase of $23, or 0.8%, for the three months ended March
31, 2004, compared to the comparable period of 2003. This limited increase is
the result of repositioning several of our acquired communities over the past
year to be more rate-competitive and to establish a new presence in their
respective markets.
In our consolidated portfolio, our average occupancy rate increased to 78.4% for
the three months ended March 31, 2004, from 77.1% for the three months ended
March 31, 2003. We believe that this increase in occupancy rates, after several
years in which rates have declined, reflect industry-wide factors, such as the
declining supply of available units as well as our own actions and policies. We
believe that our rate enhancement program has adversely affected occupancy
growth in some markets in past years and that rate adjustments in selected
markets referred to above has helped our occupancy rates during the last year.
We continue to evaluate the factors of rate and occupancy to find the optimum
balance.
We have incurred operating losses since our inception in 1993, and as of March
31, 2004, we had an accumulated deficit of approximately $154.3 million. We
believe that these losses have resulted from our early emphasis on expansion,
financing costs arising from multiple financing and refinancing transactions
related to this expansion, administrative and corporate expenses that we
incurred in anticipation of further expansion that did not materialize, and
occupancy rates that have declined and remained lower for longer periods than we
anticipated.
SIGNIFICANT FIRST QUARTER 2004 TRANSACTIONS
In 2003 and continuing in 2004, we substantially increased the number of
communities we lease, reduced the number of communities we manage, and, in
connection with these changes, increased and restructured portions of our
long-term financing obligations. The transactions associated with these
developments are summarized below.
EMERITRUST TRANSACTIONS
Since 1999, we have managed 46 communities under arrangements with several
related investor groups that involved (i) payment of management fees to us, (ii)
options for us to purchase the communities at a price determined by a formula,
and (iii) obligations to fund operating losses of certain communities. As of
October 1, 2003, we acquired 21 Emeritrust II Communities that we had previously
managed via operating leases and the results are included in our condensed
consolidated financial statements.
Emeritrust I Communities Management. During 2003, we managed the Emeritrust I
communities, which included 25 of the 46 Emeritrust communities, under a
management agreement providing for a base fee of 3% of gross revenues generated
by the communities and an additional management fee of 4% of gross revenues,
payable to the extent of 50% of cash flow from the communities. The management
agreement also required us to fund cash operating losses of the communities. In
each of April and August 2003, the
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Emeritrust I owners disposed of a community, reducing the number of managed
communities to 23. Under this arrangement, we received management fees (net of
our funding obligations) of approximately $837,000 in the first quarter of 2003.
This management agreement, as extended several times, was to have expired June
30, 2003, but was extended to January 2, 2004, although we were indemnified by
the investor group against liability under our obligation to fund cash operating
losses for the extension period. In January 2004, the management arrangement
was informally extended through March 31, 2004, at the stated management fee and
without any funding obligation. The options to purchase the communities expired
at the end of 2003. In March 2004, the Emeritrust I owners disposed of a
community, reducing the number of communities that we managed to 22.
Subsequently, effective April 1, 2004, the Emeritrust I owners extended the
underlying financing on the Emeritrust I communities. In connection with the
financing extension, the management agreement was amended to provide for a flat
management fee of 5% of gross revenues. This amendment also terminated the
opportunity for supplemental management fee revenues based upon operating
performance and extended the term of the agreement to March 31, 2005, with a
one-year extension under certain circumstances. We also expect that the
Emeritrust I owners could sell additional communities, thereby reducing the
number of communities subject to the management agreement. Because this
management agreement can be terminated by either party on short notice, there
can be no guarantee that the management arrangement will continue for its full
term. Under the new management agreement, we received management fees of
approximately $640,000 in the first quarter of 2004.
Emeritrust II Communities Management. Through September 30, 2003, we managed the
Emeritrust II communities, which included 21 of the 46 Emeritrust communities,
under management agreements providing for a base management fee of 5% of gross
revenue generated by the communities and an additional management fee of 2%,
payable if we met certain cash flow standards. The management agreement for five
of the communities also required us to fund cash operating losses of those
communities. Under this arrangement, we received management fees (net of our
funding obligations) of approximately $675,000 in the first quarter of 2003.
Emeritrust II Communities Lease. On September 30, 2003, we acquired the 21
Emeritrust II communities that we had previously managed, for a purchase price
of $118.6 million, which we financed through a combination of lease and mortgage
financing with an independent real estate investment trust for approximately
$121.5 million. A master operating lease covers the 21 Emeritrust II
communities plus four other communities that we leased from the real estate
investment trust in March 2002. The master operating lease is for an initial
15-year period, with one 15-year renewal, and grants us a right of first
opportunity to purchase any of the Emeritrust II communities if the trust
decides to sell. The lease is a net lease, with annual base rent of $14.7
million (of which $10.5 million is attributable to the Emeritrust II communities
and $4.2 million is attributable to the four previously leased communities),
with periodic escalators. The real estate investment trust also provided us
$11.5 million of debt financing secured by our leasehold interests in the
Emeritrust II communities. This debt was consolidated with other debt held by
the real estate investment trust. As part of the purchase price, we also agreed
to issue to the Emeritrust II investors warrants to purchase 500,000 shares of
our common stock, of which warrants to purchase 400,000 shares have been issued.
The warrants expire September 30, 2008, and have an exercise price of $7.60
(subject to certain adjustments). The holders have limited registration rights
for the shares of common stock underlying the warrants. We included the fair
value of these warrants, totaling approximately $1.4 million, as lease
acquisition costs that we will amortize over the life of the lease.
ALTERRA TRANSACTIONS
In December 2003, we invested $7.3 million, net of transaction costs, in a
limited liability company (LLC) that acquired Alterra Healthcare Corporation, a
national assisted living company headquartered in Milwaukee, Wisconsin that was
the subject of a voluntary Chapter 11 bankruptcy. The investment represents an
11% interest in the total invested capital of the LLC and includes an excess of
approximately $3.6 million over the underlying net book value. Alterra operated
304 assisted living communities in 22 states. The purchase price for Alterra was
$76 million and the transaction closed on December 4, 2003, following approval
by the Bankruptcy Court. The members of the LLC consists of an affiliate of
Fortress Investment Group LLC (Fortress), a New York based private equity fund,
which is the managing member, an entity controlled by Mr. Baty, and us. Under
the LLC agreement, distributions are first allocated to Fortress until it
receives payment on a $15.0 million loan to the LLC at 15% interest and its
original
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
investment of $49 million together with a 15% preferred return, and then are
allocated to the three investors in proportion to percentage interests, as
defined in the agreement, which are a 50% interest for Fortress and a 25%
interest each for the entity controlled by Mr. Baty and us.
Through January 31, 2004, the investment was structured as an ownership interest
in an LLC, which is a pass-through entity for tax purposes, similar to a limited
partnership. Under generally accepted accounting principles, we were required
to use the equity method of accounting for our LLC membership interest and
record a portion of Alterra's results of operations in our financial statements.
As a consequence, equity losses of approximately $794,000, which are recorded on
a quarter lag, are included under the caption "Other, net", which represents our
portion of Alterra's net loss for December 2003 and January 2004.
The LLC made an election to be treated as a corporation for tax purposes
effective January 31, 2004, and is no longer a pass-through entity. As a result
of this election, beginning February 1, 2004, we will account for Alterra on a
cost basis under APB 18 "The Equity Method of Accounting for Investments in
Common Stock" until Fortress's investment falls below a certain level and/or
there is a change in structure such that we would have significant influence
over the operations of Alterra. If and when such an event occurs, we will
resume using the equity method of accounting for our investment in Alterra.
CPM-JEA TRANSACTIONS
On April 1, 2004, we completed the first stage of our previously announced lease
acquisition of up to 24 assisted living facilities in 13 states, including up to
10 stand-alone dementia care facilities, for an approximate $190.5 million
investment, inclusive of transaction fees. The completed first stage involved 17
of the 24 senior housing and long-term care properties for a total investment of
about $140.7 million, inclusive of transaction fees. Nine of the communities,
all of which we managed in 2003, were owned by entities that Daniel R. Baty, our
Chairman and Chief Executive Officer, controls and in which he has financial
interests ("Baty Entities"). The remainder of the communities were owned by
entities in which Mr. Baty had an indirect ownership interest (the "JEA
Entities"). With respect to the communities formerly owned by the JEA Entities,
we entered into a management agreement with JEA Senior Living ("JEA"), a partner
in the JEA Entities, which is not affiliated with Mr. Baty, to provide certain
management services to the communities for a period of three years. Under the
terms of this management agreement, JEA is entitled to a monthly management fee
of 5% of the gross revenues of the communities and to a termination payment of
$100,000 per year for a period of ten years after the termination of the
management agreement. We also agreed to an earn-out payment to the JEA Entities
of up to $2.0 million based on the improvement in the net operating income of
the communities during the three-year period after the closing. Of the $140.7
million purchase price paid at closing, approximately $137.0 million was
financed through a real estate investment trust through an operating lease
agreement. The balance of the closing purchase price was paid $2.7 million in
cash and $1.0 million by the execution and delivery by us of our promissory
notes to two of the Baty Entities, which provide for interest at the rate of 8%
and a maturity date of April 1, 2007. The communities are leased under two
master leases, each with a 15-year term, with three 5-year renewal options. The
initial lease rate is 9% with Consumer Price Index based inflators. The initial
lease payment is expected to be approximately $1.0 million per month. Of the up
to $49.8 million balance of the transaction, at least $37.2 million is expected
to close during the second quarter of 2004, or shortly thereafter, subject to
customary closing conditions.
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16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
RESULTS OF OPERATIONS
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND USE OF ESTIMATES
Our discussion and analysis of our financial condition and results of operations
are based upon our condensed consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, we evaluate our estimates, including
those related to resident programs and incentives such as move-in fees, bad
debts, investments, intangible assets, impairment of long-lived assets, income
taxes, restructuring, long-term service contracts, contingencies, self-insured
retention, health insurance, and litigation. We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We believe the following critical accounting policies are most significant to
the judgments and estimates used in the preparation of our condensed
consolidated financial statements. Revisions in such estimates are charged to
income in the period in which the facts that give rise to the revision become
known.
* For commercial general liability and professional liability insurance for
2004, we formed a wholly owned captive insurance company domiciled in the
U.S. The insurance policy issued by our captive is claims-made and insures
liabilities associated with general and professional liability. The policy
insures on a per occurrence and aggregate-limit basis in excess of a
self-insured retention. Estimated losses covered by the policy and the
self-insured retention are accrued based upon actuarial estimates of the
aggregate liability for claims within the policy year. The captive is
funded solely through contributions made by us, which is funded at set
intervals based on expected timing of losses. To the extent the captive is
required to pay claims in excess of our contributions, we are required to
fund any shortfalls on demand. To the extent that claims exceed the policy
issued by the captive, we will be required to cover all losses above the
captive limits set per occurrence and in aggregate. The captive is subject
to regulatory agency control and reviews for compliance with statutes.
Results from these reviews may change the timing or amount of subsequent
funding. Should losses exceed actuarial estimates, additional expense may
be accrued at the time of determination.
* For health insurance, we self-insure up to a certain level for each
occurrence above which a catastrophic insurance policy covers any
additional costs. Health insurance expense is accrued based upon historical
experience of the aggregate liability for claims incurred. If these
estimates are insufficient, additional charges may be required.
* Workers' compensation insurance coverage applies for specific insurable
states (excluding Texas, New York, and the compulsory State Funds States)
through a high deductible, fully collateralized insurance policy. The
policy premium is based upon standard rates applied to estimated annual
payroll. The collateral requirement is determined by annual expected losses
for the policy year. We contract with an independent third-party
administrator to administer the program; and paid claim expenses are drawn
from the collateral account. The sum of the premium and related costs,
estimated administration costs, and actuarial based estimated losses
("Estimated Total Costs") is accrued on a monthly basis. The difference
between the Estimated Total Costs and the posted collateral is carried as
an asset on the balance sheet. At policy expiration, an insurer audit is
conducted to adjust premiums based on actual, rather than estimated, annual
payroll. Any premium adjustment for the differences between estimated and
actual payroll will first be applied to the accrued asset and then, if
needed, as an adjustment to workers' compensation expense at the time such
adjustment is determined. The insurer also audits the claim total incurred
amount at least annually and may adjust the applicable policy year
collateral requirement. There is a reasonable expectation that the total
incurred losses will be less than the posted collateral, resulting in a
release of collateral back to us. The adjustment to the collateral will be
applied first to the accrued asset and then, if needed, as an adjustment to
the workers' compensation expense at the time such adjustment is
determined. We insure occupational injuries and illness in New York
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
through participation in a group pool insured through a guaranteed
cost insurance policy, with the premium payable on a monthly basis. The
insurer group contracts with an independent third-party administrator on
behalf of its members to manage the claims; and claim expenses are paid by
the insurer. For work-related injuries in Texas, we insure through a
qualified "Non-Subscriber Employee Retirement Income Security Act
Occupational Injury and Illness Benefit Plan" and an insurance policy is
In place to cover losses in excess of the deductible amount. We contract
with an independent third-party administrator to manage the claims.
Claim expenses are paid as incurred and estimated losses within the
deductible are accrued on a monthly basis.
* We account for stock option awards to employees under the intrinsic
value-based method of accounting prescribed by APB No. 25, "Accounting for
Stock Issued to Employees". Under this method, no compensation expense is
recorded, provided the exercise price is equal to or greater than the
quoted market price of the stock at the grant date. We make pro forma
disclosures of net income and earnings per share as if the fair value-based
method of accounting (the alternative method of accounting for stock-based
compensation) had been applied as required by FAS No. 123, "Accounting for
Stock-Based Compensation". The fair value-based method requires us to make
assumptions to determine expected risk-free interest rates, stock price
volatility, dividend yield, and weighted-average option life. To the extent
such things as actual volatility or life of the options is different from
estimated, pro forma amounts expensed will be more or less than would have
been disclosed otherwise.
* We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of our residents to make required payments. If the
financial condition of our residents were to deteriorate, resulting in an
impairment of their ability to make payments, additional charges may be
required.
* We record a valuation allowance to reduce our deferred tax assets to the
amount that is more likely than not to be realized, which at this time
shows a net asset valuation of zero. We have considered future taxable
income and ongoing prudent and feasible tax planning strategies in
assessing the need for the valuation allowance. However, in the event we
were to determine that we would be able to realize our deferred tax assets
in the future in excess of our net recorded amount, an adjustment to the
deferred tax asset would increase income in the period such determination
was made.
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18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
COMMON-SIZE INCOME STATEMENTS AND PERIOD-TO-PERIOD PERCENTAGE CHANGE
The following table sets forth, for the periods indicated, certain items from
our Condensed Consolidated Statements of Operations as a percentage of total
revenues and the percentage change of the dollar amounts from period to period.
Period to Period
Percentage
Increase
Percentage of Revenues (Decrease)
------------------------ Three Months
Three Months ended ended
March 31, March 31,
------------------------- --------------
2004 2003 2004-2003
------------ ------------ --------------
Revenues: . . . . . . . . . . . . . 100.0% 100.0% 41.0%
Expenses:
Community operations . . . . . 63.8 60.7 48.2
General and administrative . . 9.4 11.5 15.3
Depreciation and amortization. 3.1 3.9 11.8
Facility lease expense . . . . 22.0 18.2 70.7
------------ ------------ ------------
Total operating expenses . 98.3 94.3 47.1
------------ ------------ ------------
Income from operations. . . . . . . 1.7 5.7 (59.1)
Other income (expense)
Interest income. . . . . . . . 0.2 0.3 (1.9)
Interest expense . . . . . . . (5.7) (6.9) 15.9
Other, net . . . . . . . . . . (0.1) 0.1 (237.5)
------------ ------------ ------------
Net other expense . . . . (5.6) (6.5) 20.7
------------ ------------ ------------
Net loss. . . . . . . . . (3.9%) (0.8%) 560.0%
============ ============ ============
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19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Comparison of the three months ended March 31, 2004 and 2003
- ----------------------------------------------------------------------
Total Operating Revenues: Total operating revenues for the three months ended
March 31, 2004, increased by $19.4 million to $66.5 million from $47.2 million
for the comparable period in 2003, or 41.0%.
Community revenue increased by approximately $20.5 million in the three months
ended March 31, 2004, compared to the three months ended March 31, 2003. This
increase was primarily due to additional revenue related to acquisitions of 42
communities between March 31, 2003, and March 31, 2004, of which eight occurred
in the second quarter of 2003 and 36 occurred in the fourth quarter. Of the 42
communities, we had formerly managed 36. These acquired communities, which
represent revenue of approximately $19.5 million, were included in our
consolidated portfolio in the first quarter of 2004, but were not included in
the comparable quarter of 2003. The remaining increase in revenue is attributed
to the net effect of an increase in average monthly revenue per unit and an
increase in the occupancy rate. Average monthly revenue per unit was $2,779 for
the first quarter of 2004 compared to $2,756 for the comparable quarter of 2003,
an increase of approximately $23, or 0.8%. This relatively small increase
reflected effects of our rate enhancement program during 2003, partially offset
by marketing incentives; e.g., rate discounting and reduction of move-in fees,
implemented in the first quarter of 2004 to encourage increases in occupancy.
The occupancy rate for the three months ended March 31, 2004, increased 1.3
percentage points to 78.4% from 77.1% primarily from our marketing emphasis in
the first quarter of 2004.
Management fee income decreased by approximately $1.5 million to $1.6 million
from $3.1 million for the three months ended March 31, 2004 and 2003,
respectively. This decrease was primarily due to termination of 13 Regent
managed communities in July and August of 2003, and the acquisition of 29
communities that were previously managed but are now leased. Regent related
management fee income recognized for the three months ended March 31, 2004, was
approximately $24,000 compared to $352,000 for the three months ended March 31,
2003. Management fees related to the previously managed buildings for the three
months ended March 31, 2003, were approximately $870,000. The remaining
decrease in management fee income for the first quarter of 2004, was related to
the change in the Emeritrust I communities (change in the management agreement
and a decrease of three buildings compared to March 31, 2003, as discussed above
in "Emeritrust I Communities Management").
Community Operations: Community operating expenses for the three months ended
March 31, 2004, increased by $13.8 million to $42.5 million from $28.6 million
in the first quarter of 2003, or 48.2%. The change was primarily due to the
acquisition of 42 communities referred to above. These acquired communities,
which account for approximately $12.7 million of expense, were not included in
our consolidated portfolio in the first quarter of 2003, but are included in the
comparable quarter of 2004. The remaining increases were primarily attributable
to increases in personnel costs, property taxes, and utilities. Community
operating expenses as a percentage of total operating revenue increased to 63.8%
in the first quarter of 2004 from 60.7% in the first quarter of 2003, primarily
attributable to higher expense levels of new acquisitions and startup costs
associated with opening memory loss units.
General and Administrative: General and administrative (G&A) expenses for the
three months ended March 31, 2004, increased $828,000 to $6.2 million from $5.4
million for the comparable period in 2003, or 15.3%. As a percentage of total
operating revenues, G&A expenses decreased to 9.4% for the three months ended
March 31, 2004, compared to 11.5% for the three months ended March 31, 2003,
primarily as a result of increased revenue arising from the acquisition of 42
communities referred to above. G&A expenses increased primarily due to increases
in the number of employees to accommodate new acquisitions and normal increases
in employee salaries. Additionally, an expansion of program offerings has led to
additional employees. Since approximately 25% of the communities we operate are
managed rather than owned or leased, G&A expense as a percentage of operating
revenues for all communities, including managed communities, may be more
meaningful for industry-wide comparisons. G&A as a percentage of operating
revenues for all communities increased to 6.6% from 5.5% for the three months
ended March 31, 2004 and 2003, respectively, primarily as a result of the
increased personnel costs described above.
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Depreciation and Amortization: Depreciation and amortization for the three
months ended March 31, 2004, was $2.1 million compared to $1.8 million for the
comparable period in 2003, reflecting the purchase acquisition of five
communities in the fourth quarter of 2003. In 2004, depreciation and
amortization represents 3.1% of total operating revenues, compared to 3.9% for
the comparable period in 2003. This decrease as a percentage of revenue reflects
the increased revenue arising from the 2003 acquisition of 42 additional
communities, most of which were leased.
Facility Lease Expense: Facility lease expense for the three months ended March
31, 2004, was $14.7 million compared to $8.6 million for the comparable period
of 2003, representing an increase of $6.1 million, or 70.7%. This increase was
primarily due to the lease acquisition of 37 communities in 2003. We leased 109
communities as of March 31, 2004, compared to 67 leased communities as of March
31, 2003. The additional facility lease expense related to the acquired
communities is approximately $4.8 million. The remaining increase was due to a
three-community sale-leaseback in the second quarter of 2003 and the re-lease of
four communities in the third quarter of 2003. Facility lease expense as a
percentage of revenues was 22.0% for the three months ended March 31, 2004, and
18.2% for the three months ended March 31, 2003.
Interest Income: Interest income for the three months ended March 31, 2004, was
$153,000 versus $156,000 for the comparable period of 2003. This decrease was
primarily attributable to lower returns on certain restricted deposits.
Interest Expense: Interest expense for the three months ended March 31, 2004,
was $3.8 million compared to $3.3 million for the comparable period of 2003.
This increase of $519,000, or 15.9%, was primarily attributable to the
additional secured mortgage financing related to the five community mortgage
assumption acquisition in December 2003, partially offset by a sale-leaseback
transaction in the second quarter of 2003. As a percentage of total operating
revenues, interest expense decreased to 5.7% from 6.9% for the three months
ended March 31, 2004 and 2003, respectively.
Other, net: Other, net expense for the three months ended March 31, 2004, was
approximately $66,000 compared to $48,000 income for the comparable period in
2003. The $66,000 for the current year quarter is primarily the result of our
portion of Alterra's net loss for December 2003 and January 2004 (discussed
above under "Alterra Transactions") totaling $794,000, partially offset by
amortization of deferred gains related to Emeritrust I of approximately $278,000
and deferred gains related to the refinance of seven buildings related to the
Series A Preferred Stock repurchase in the second quarter of 2003 of
approximately $303,000, and other smaller miscellaneous items. The $48,000
income for the first quarter 2003 is comprised primarily of amortization of
deferred gains related to the sale-leaseback of three communities of
approximately $87,000 offset by smaller miscellaneous items.
Preferred dividends: For the three months ended March 31, 2004 and 2003,
preferred dividends totaled approximately $920,000 and $1.9 million,
respectively. The primary reason for the $950,000 decrease is the repurchase of
the Series A preferred shares in July and August 2003. Because we have not paid
the Series B preferred dividends for more than six consecutive quarters, under
the Designation of Rights and Preferences of the Series B preferred stock in our
Articles of Incorporation, the Series B preferred shareholders may designate one
director in addition to the other directors that they are entitled to designate
under the shareholders' agreement. As of January 1, 2002, the Series B
preferred shareholders became entitled to designate an additional director under
the Articles, but thus far have chosen not to do so.
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21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Same Community Comparison
We operated 84 communities on a comparable basis during both the three months
ended March 31, 2004 and 2003. The following table sets forth a comparison of
same community results of operations, excluding general and administrative
expenses, for the three months ended March 31, 2004 and 2003.
Three Months ended March 31,
(In thousands)
--------------------------------------------------
Dollar % Change
2004 2003 Change Fav / (Unfav)
------------ ------------ -------- -------------
Revenue . . . . . . . . . . . . . . . . . . $ 45,132 $ 44,057 $ 1,075 2.4%
Community operating expenses. . . . . . . . (29,212) (28,650) (562) (2.0)
------------ ------------ -------- -------------
Community operating income. . . . . . . 15,920 15,407 513 3.3
Depreciation & amortization . . . . . . . . (1,448) (1,613) 165 10.2
Facility lease expense. . . . . . . . . . . (9,661) (8,595) (1,066) (12.4)
------------ ------------ -------- -------------
Operating income. . . . . . . . . . . . 4,811 5,199 (388) (7.5)
Interest expense, net . . . . . . . . . . . (2,212) (2,591) 379 14.6
------------ ------------ -------- -------------
Operating income after interest expense $ 2,599 $ 2,608 $ (9) (0.3%)
============ ============ ======== =============
These 84 communities represented $45.1 million or 67.8% of our total revenue of
$66.5 million for the first quarter of 2004. Same community revenues increased
by $1.1 million or 2.4% for the quarter ended March 31, 2004, from the
comparable period in 2003, primarily due to the effect of move-in fee revenue
recognition; i.e., the recognition of previously deferred move-in fees was
greater .in the current quarter due to a higher level of move-in fees that were
charged over the past year Average revenue per occupied unit increased by $77
per month or 2.8% for the three months ended March 31, 2004, as compared to the
three months ended March 31, 2003. Average occupancy remained relatively
unchanged at approximately 77.7% in the first quarter of 2004 and 77.4% in the
first quarter of 2003.
Community operating expenses increased approximately $562,000 primarily due to
an increase in personnel expenses related to program expansion and other
employee costs of $554,000. Occupancy expenses, which consist of facility lease
expense, depreciation and amortization, and interest expense, increased by
approximately $522,000 as a result of a change in the composition of "Same
Communities" to reflect more leased buildings compared to owned buildings. The
change in composition was attributable to previously acquired communities that
we have operated for more than a year combined with the change from owned to
leased communities in connection with sale-leaseback transactions from the
second quarter of 2003. The net effect of this change was an increase in
facility lease expense of $865,000, partially offset by decreases in interest
expense of $322,000, and depreciation and amortization expense of $194,000. The
balance of the increase in occupancy expenses was due to rental increases based
on community performance under certain of our leases. For the quarters ended
March 31, 2004 and 2003, operating income after interest expense remained
relatively unchanged at approximately $2.6 million.
LIQUIDITY AND CAPITAL RESOURCES
For the three months ended March 31, 2004, net cash used in operating activities
was $3.7 million compared to $228,000 net cash used in operating activities for
the comparable period in the prior year. The primary components of operating
cash used in operating activities were the net loss of $2.6 million, the net
increase in other operating assets and liabilities of $2.4 million, and
amortization of deferred gain of $714,000, partially offset by depreciation and
amortization of $2.1 million. The primary components of operating cash used in
operating activities for the three months ended March 31, 2003, was the
depreciation and amortization of $1.8 million, partially offset by the net loss
of $393,000 and the net increase in other operating assets and liabilities of
$1.2 million.
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Net cash used in investing activities amounted to $1.4 million for the three
months ended March 31, 2004, and was comprised primarily of proceeds from the
repayment of a note receivable from a Baty entity of $2.7 million and proceeds
from the sale of property and equipment of approximately $165,000, partially
offset by purchases of approximately $846,000 of various property and equipment,
an increase in management and lease acquisition costs of $302,000, and
investment in affiliates of $303,000. Net cash used in investing activities
amounted to $1.0 million for the three months ended March 31, 2003, and was
comprised primarily of purchases of approximately $484,000 of various property
and equipment, distributions to minority partners of $299,000, and an increase
in management and lease acquisition costs of approximately $189,000.
For the three months ended March 31, 2004, net cash used in financing activities
was $1.8 million, primarily from the current portion of long-term debt
repayments of $1.1 million, an increase in restricted deposits of $582,000,
long-term debt repayments of $305,000, and an increase of approximately $101,000
in debt issuance and other financing costs, partially offset by the proceeds
from the sale of common stock under the employee stock purchase and incentive
plans of approximately $321,000. For the three months ended March 31, 2003, net
cash used in financing activities was $1.2 million, primarily from the current
portion of long-term debt repayments of $960,000 and an increase of
approximately $232,000 in debt issuance and other financing costs.
We have incurred significant operating losses since our inception and have a
working capital deficit of $35.3 million, although $11.4 million represents
deferred revenue and unearned rental income, and $8.8 million of preferred cash
dividends is only due if declared by our board of directors. At times in the
past, we have been dependent upon third-party financing or disposition of assets
to fund operations. If such transactions are necessary in the future, we cannot
guarantee that they will be available on a timely basis, on terms attractive to
us, or at all.
Throughout 2002 and continuing in the first quarter of 2003, we refinanced
substantially all of our debt obligations, extending the maturities of such
financings to dates in 2005 or thereafter, at which time we will need to
refinance or otherwise repay the obligations. Many of our debt instruments and
leases contain "cross-default" provisions pursuant to which a default under one
obligation can cause a default under one or more other obligations to the same
lender or lessor. Such cross-default provisions affect 17 owned assisted living
properties and 104 properties operated under leases. Accordingly, any event of
default could cause a material adverse effect on our financial condition if such
debt or leases are cross-defaulted. At March 31, 2004, we complied with all
such covenants, except for a portfolio of 23 leased buildings. We have obtained
a waiver from the lessor and are considered to be in full compliance as of March
31, 2004.
Management believes that we will be able to sustain positive operating cash flow
on an annual basis and will have adequate cash for all necessary investing and
financing activities including required debt service and capital expenditures
through at least March 31, 2005.
The following table summarizes our contractual obligations at March 31, 2004 (In
thousands):
Payments Due by Period
----------------------------------------------------------------------------------
Less than 1 More Than
Contractual Obligations Total year 1 - 3 years 4 - 5 years 5 years
- ------------------------------------------ --------------- --------------- --------------- --------------- ---------------
Long-Term Debt, including current portion $ 139,897 $ 4,934 $ 73,608 $ 60,749 $ 606
Operating Leases. . . . . . . . . . . . . $ 590,888 $ 56,339 $ 112,873 $ 107,276 $ 314,400
Convertible Debentures. . . . . . . . . . $ 32,000 $ - $ 32,000 $ - $ -
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
IMPACT OF INFLATION
To date, inflation has not had a significant impact on us. However, inflation
could affect our future revenues and operating income due to our dependence on
the senior resident population, most of whom rely on relatively fixed incomes to
pay for our services. The monthly charges for a resident's unit and assisted
living services are influenced by the location of the community and local
competition. Our ability to increase revenues in proportion to increased
operating expenses may be limited. We typically do not rely to a significant
extent on governmental reimbursement programs. In pricing our services, we
attempt to anticipate inflation levels, but there can be no assurance that we
will be able to respond to inflationary pressures in the future.
FORWARD-LOOKING STATEMENTS
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995: A number of the matters and subject areas discussed in this report that
are not historical or current facts deal with potential future circumstances,
operations, and prospects. The discussion of such matters and subject areas is
qualified by the inherent risks and uncertainties surrounding future
expectations generally, and also may materially differ from our actual future
experience as a result of such factors as: the effects of competition and
economic conditions on the occupancy levels in our communities; our ability
under current market conditions to maintain and increase our resident charges in
accordance with rate enhancement programs without adversely affecting occupancy
levels; increases in interest rates that would increase costs as a result of
variable rate debt; our ability to control community operation expenses,
including insurance and utility costs, without adversely affecting the level of
occupancy and the level of resident charges; our ability to generate cash flow
sufficient to service our debt and other fixed payment requirements; our ability
to find sources of financing and capital on satisfactory terms to meet our cash
requirements to the extent that they are not met by operations; and our
continued management of the Emeritrust I communities since our management
agreements for those communities could be terminated on short-term notice.
While we believe that the arrangements with our Emeritrust I communities will
continue, we cannot guarantee that they will and thus, we could lose the
management fee revenue from these communities. We have attempted to identify,
in context, certain of the factors that we currently believe may cause actual
future experience and results to differ from our current expectations regarding
the relevant matter or subject area. These and other risks and uncertainties
are detailed in our reports filed with the Securities and Exchange Commission
(SEC), including our Annual Reports on Form 10-K and Quarterly Reports on Form
10-Q.
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24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our earnings are affected by changes in interest rates as a result of our
short-term and long-term borrowings. We manage this risk by obtaining fixed
rate borrowings when possible. At March 31, 2004, our variable rate borrowings
totaled approximately $64.6 million. Currently, all our variable rate
borrowings are based upon LIBOR, subject to a LIBOR floor ranging from 2.0% to
2.5%. As of March 31, 2004, the LIBOR rates were below the floor. If LIBOR
interest rates were to average 2% more, our annual interest expense and net loss
would increase approximately $462,000 with respect to our variable rate
borrowings. This amount is determined by considering the impact of hypothetical
interest rates on our outstanding variable rate borrowings as of March 31, 2004,
and does not consider changes in the actual level of borrowings that may occur
subsequent to March 31, 2004. If LIBOR rates should increase above the floor,
we will be exposed to higher interest expense costs. This analysis also does
not consider the effects of the reduced level of overall economic activity that
could exist in such an environment, nor does it consider actions that management
might be able to take with respect to our financial structure to mitigate the
exposure to such a change.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a set of disclosure controls and procedures and internal controls
designed to ensure that information required to be disclosed in our filings
under the Securities Exchange Act of 1934 is recorded, processed, summarized,
and reported within the time periods specified in the Securities and Exchange
Commission's rules and forms. Our principal executive and financial officers
have evaluated our disclosure controls and procedures (as defined in Exchange
Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this
Quarterly Report on Form 10-Q and have determined that such disclosure controls
and procedures are effective.
No change was made to our internal control over financial reporting during the
quarter that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
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25
PART II. OTHER INFORMATION
ITEMS 1 THROUGH 4 ARE NOT APPLICABLE.
ITEM 5. OTHER INFORMATION.
On April 20, 2004, we appointed two new directors to serve on the Company's
Board of Directors, Bruce L. Busby and T. Michael Young.
Bruce L. Busby served as Chairman and Chief Executive Officer of The Hillhaven
Corporation, a Tacoma, Washington based skilled nursing company that merged with
Vencor, Inc. in 1995. Hillhaven operated 360 facilities throughout the US.
Before joining Hillhaven, Mr. Busby served National Medical Enterprises, Inc. as
Chief Executive Officer and President of the Venture Development Group from
April 1988 to March 1991, Chairman and Chief Executive Officer of the Long Term
Care Group from August 1986 to March 1988, and President of the Retail Services
Group from June 1986 to November 1987.
T. Michael Young is President and Chief Executive Officer of Metal Supermarkets
International, a privately held concern with operations in North America,
Europe, and the Middle East. Previously, Young, who is a CPA, was Chairman,
President and Chief Executive Officer of Hi-Lo Automotive, Inc., a public
retailer and wholesale distributor of auto parts and supplies. Young also was a
partner at Arthur Andersen from 1976 to 1980.
Both Busby and Young qualify as independent directors under new SEC and AMEX
rules for audit committees and will serve on our Audit Committee along with an
existing qualifying director.
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26
Item 6 Exhibits and Reports on Form 8-K
(a) Exhibits
Number Description Footnote
- --------- ------------------------------------------------------------------------------------------------------- ---------
10.52 Emeritrust communities
10.52.15 Fourth Amendment to Management Agreement with Option to Purchase by and among Emeritus
Management LLC ("Emeritus Management"), Emeritus Management I LP ("Texas Management"), Emeritus
Corporation ("Emeritus"), and AL Investors LLC ("AL Investors"), effective April 1, 2004.. . . . . . . . (1)
10.79 Loyalton of Folsom, California, The Lakes, Florida, Canterbury Woods, Massachusetts, Beckett Meadows,
Texas, Creekside, Texas, Oak Hollow, Texas, Pinehurst, Texas, Stonebridge, Texas, Desert Springs, Texas,
Austin Gardens, California, Kingsley Place Shreveport, Louisiana, Silverleaf Manor, Mississippi,
Pine Meadow, Mississippi, Pines of Goldsboro, North Carolina, Loyalton of Rockford, Illinois,
and Charleston Gardens, West Virginia. The following agreements are representative of those executed
in connection with these properties:
10.79.1 Purchase and Sale Agreement ("Agreement") by and between Lodi Care Group LLC, Aurora Bay/Columbus,
L.L.C., Aurora Bay/Hattiesburg, L.L.C., Spring Creek Group, Ltd., Bedford Care Group, Ltd.,
Tyler Group, Ltd., White Rock Care Group, Ltd., El Paso Care Group, Ltd., and Lubbock Group, Ltd.,
(each of the foregoing individually, a "Seller" and collectively, "Sellers") and Emeritus Corporation,
"Purchaser") and Aurora Bay Investments, LLC, ("ABI"), and JCI, LLC, ("JCI" and together with ABI,
the "Guarantors") dated March, 30, 2004 (the "Execution Date").. . . . . . . . . . . . . . . . . . . . . (4)
10.79.2 Purchase and Sale Agreement ("Agreement") by and among (i) THE LAKES ASSISTED LIVING, LLC,
SACRAMENTO COUNTY ASSISTED LLC, ROCKFORD RETIREMENT RESIDENCE, LLC, HB-ESC I,
LLC, CANTERBURY WOODS ASSISTED LIVING, LLC, AUTUMN RIDGE HERCULANEUM, L.L.C.,
MERIDIAN ASSISTED, L.L.C., GOLDSBORO ASSISTED, L.L.C., CAPE MAY ASSISTED LIVING, LLC,
TRAVIS COUNTY ASSISTED LIVING LP, RICHLAND ASSISTED, L.L.C., SILVER LAKE ASSISTED
LIVING LLC, CHARLESTON ASSISTED LIVING, LLC, and JOLIET ASSISTED L.L.C., (each of the
foregoing individually, a "Seller" and collectively, the "Sellers") and (ii) EMERITUS CORPORATION,
("Purchaser") dated March, 31, 2004 (the "Execution Date").. . . . . . . . . . . . . . . . . . . . . . . (4)
10.79.3 Master Lease agreement between NHP SENIOR HOUSING, INC., ("Landlord"), and EMERITUS
CORPORATION, ("Tenant"), dated March 31, 2004 to be effective as of April 1, 2004
(the "Effective Date"). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4)
10.79.4 Master Lease among the Entities Listed on Schedule 1A (collectively, "Landlord"), and the Entities Listed
on Schedule 1B (collectively, "Tenant"), for the respective real properties and improvements thereon
(each a "Facility" and collectively, the "Facilities"), dated March 31, 2004, to be effective as of
April 1, 2004 (the "Effective Date").. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4)
10.79.5 NOMINATION AGREEMENT ("Agreement") made as of March 31, 2004, by and between
NATIONWIDE HEALTH PROPERTIES, INC., ("NHP"), and EMERITUS CORPORATION, ("Emeritus").. . . . . . . . . . (4)
10.79.6 NOMINATION AGREEMENT ("Agreement") made as of March 31, 2004, by and between
NATIONWIDE HEALTH PROPERTIES, INC., ("NHP"), and EMERITUS CORPORATION, ("Emeritus"). . . . . . . . . . . (4)
10.80 Credit Agreement
10.80.1 Credit Agreement between U.S. National Association and Emeritus Corporation dated March 16, 2004.. . . . . (1)
10.80.2 Exhibit A to Credit Agreement; Revolving Note. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1)
10.80.3 Exhibit B to Credit Agreement; Pledge Agreement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1)
31.1 Certification of Periodic Reports
31.1.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 for Daniel R. Baty dated May 13, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . (1)
31.1.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 for Raymond R. Brandstrom dated May 13, 2004.. . . . . . . . . . . . . . . . . . . . . . . . (1)
32.1 Certification of Periodic Reports
32.1.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 for Daniel R. Baty dated May 13, 2004.. . . . . . . . . . . . . . . . . . . . . . . . . . . (1)
32.1.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 for Raymond R. Brandstrom dated May 13, 2004.. . . . . . . . . . . . . . . . . . . . . . . . (1)
99.1 Press Releases
99.1.1 Press Release dated January 5, 2004, announcing the acquisition of Five Communities. . . . . . . . . . . . (2)
99.1.2 Press Release dated January 12, 2004, announcing the acquisition of Seven Communities. . . . . . . . . . . (2)
99.1.3 Press Release dated March 25, 2004, reports on fourth quarter and year 2003 results. . . . . . . . . . . . (3)
99.1.4 Press Release dated March 29, 2004, reporting intent to acquire nine memory loss facilities. . . . . . . . (4)
99.1.5 Press Release dated March 29, 2004, reporting intent to acquire managed facilities.. . . . . . . . . . . . (4)
99.1.6 Press Release dated April 23, 2004, announcing appointment of new directors. . . . . . . . . . . . . . . . (1)
99.1.7 Press Release dated May 12, 2004, reports on first quarter 2004 results. . . . . . . . . . . . . . . . . . (5)
- --------------------------
(1) Filed herewith.
(2) Filed as an exhibit to a Form 8-K filed on January 14, 2004, and
incorporated herein by reference.
(3) Filed as an exhibit to a Form 10-K filed on March 30, 2004, and
incorporated herein by reference.
(4) Filed as an exhibit to a Form 8-K filed on April 12, 2004, and incorporated
herein by reference.
(5) Filed as an exhibit to a Form 8-K filed on May 13, 2004, and incorporated
herein by reference.
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(b) Reports on Form 8-K.
1. A report on Form 8-K dated December 31, 2003, was filed on January 14,
2004, announcing the acquisition of five communities.
2. A report on Form 8-K dated December 31, 2003, was filed on January 14,
2004, announcing a lease acquisition of seven communities from Mr. Baty.
3. A report on Form 8-K dated March 5, 2004, was filed on March 5, 2004,
reporting on the fourth quarter and December 31, 2003, year end results.
4. A report on Form 8-K/A dated December 31, 2003, was filed on March 15,
2004, related to the acquisition of eight communities from Mr. Baty. This
filing includes item 7.
5. A report on Form 8-K dated April 1, 2004, was filed on April 12, 2004,
announcing the first part of a 24 community lease acquisition.
6. A report on Form 8-K dated May 12, 2004, was filed on May 13, 2004,
reporting on the first quarter 2004 results.
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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.
Dated: May 13, 2004
EMERITUS CORPORATION
(Registrant)
/s/ Raymond R. Brandstrom
-----------------------------------------
Raymond R. Brandstrom, Vice President
of Finance, Chief Financial Officer, and
Secretary
29