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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
__X__ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 30, 2003
or
_( )_ Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ____to____
Commission file number 01-13031
AMERICAN RETIREMENT CORPORATION
-------------------------------
(Exact Name of Registrant as Specified in its Charter)
Tennessee 62-1674303
- --------- ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
111 Westwood Place, Suite 200, Brentwood, TN 37027
- -------------------------------------------- -----
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (615) 221-2250
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes __X__ No ____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes ____ No __X__
As of August 8, 2003, 18,737,646 shares of the Registrant's common stock, $.01
par value, were outstanding.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page
Condensed Consolidated Balance Sheets as of
June 30, 2003 and December 31, 2002....................................3
Condensed Consolidated Statements of
Operations for the Three Months Ended
June 30, 2003 and 2002 ................................................4
Condensed Consolidated Statements of
Operations for the Six Months Ended
June 30, 2003 and 2002 ................................................5
Condensed Consolidated Statements of Cash
Flows for the Six Months Ended June 30,
2003 and 2002 .........................................................6
Notes to Condensed Consolidated Financial Statements ..................8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.........................19
Item 3. Quantitative and Qualitative Disclosures About Market Risk ...........35
Item 4. Controls and Procedures .............................................36
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders...................37
Item 6. Exhibits and Reports on Form 8-K......................................38
Signatures ...................................................................39
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share data) June December
30, 31,
---------------------
2003 2002
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 12,369 $ 18,244
Assets limited as to use 17,594 17,359
Accounts receivable, net of allowance for
doubtful accounts 12,833 12,522
Inventory 1,293 1,378
Prepaid expenses 2,781 3,903
Deferred income taxes 3,028 3,028
Assets held-for-sale 24,774 34,071
Other current assets 4,919 6,681
---------- ----------
Total current assets 79,591 97,186
Assets limited as to use, excluding amounts
classified as current 21,492 21,701
Land, buildings and equipment, net 562,143 578,804
Notes receivable 21,560 19,176
Goodwill, net 36,463 36,463
Leasehold acquisition costs, net 21,810 22,861
Other assets 60,995 63,807
---------- ----------
Total assets $ 804,054 $ 839,998
========== ==========
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Current portion of long-term debt $ 17,242 $ 13,526
Debt associated with assets held-for-sale 10,883 20,246
Accounts payable 5,732 5,187
Accrued interest 4,753 4,620
Accrued payroll and benefits 7,088 7,652
Accrued property taxes 7,720 9,917
Other accrued expenses 7,808 8,164
Other current liabilities 11,958 12,149
---------- ----------
Total current liabilities 73,184 81,461
Long-term debt, excluding current portion 496,627 506,879
Refundable portion of entrance fees 61,547 60,066
Deferred entrance fee income 117,123 118,041
Tenant deposits 4,728 4,898
Deferred gains on sale-leaseback transactions 25,941 27,622
Deferred income taxes 3,993 3,806
Other long-term liabilities 12,153 11,717
---------- ----------
Total liabilities 795,296 814,490
Minority interest 13,229 12,601
Commitments and contingencies (See notes)
Shareholders' (deficit) equity:
Preferred stock, no par value; 5,000,000 shares
authorized, no shares issued or outstanding - -
Common stock, $.01 par value; 200,000,000 shares
authorized, 18,711,644 and 17,341,191 shares
issued and outstanding, respectively 187 173
Additional paid-in capital 148,768 145,706
Accumulated deficit (153,426) (132,972)
---------- ----------
Total shareholders' (deficit) equity (4,471) 12,907
---------- ----------
Total liabilities and shareholders'
(deficit) equity $ 804,054 $ 839,998
========== ==========
See accompanying notes to the condensed consolidated financial statements.
3
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share data)
Three months ended
June 30,
---------------------
2003 2002
---------- ----------
Revenues:
Resident and health care $ 88,030 $ 79,952
Management services 1,314 620
Reimbursed expenses 1,280 1,236
---------- ----------
Total revenues 90,624 81,808
Operating expenses:
Community operating expenses 61,139 58,116
General and administrative 6,837 6,554
Lease expense 10,207 17,865
Depreciation and amortization 6,336 5,381
Amortization of leasehold acquisition costs 530 3,038
Reimbursed expenses 1,280 1,236
---------- ----------
Total operating expenses 86,329 92,190
---------- ----------
Operating income (loss) 4,295 (10,382)
Other income (expense):
Interest expense (13,977) (9,767)
Interest income 868 1,268
Gain (loss) on sale of assets 79 (27)
Other 281 233
---------- ----------
Other expense, net (12,749) (8,293)
---------- ----------
Loss from continuing operations before
income taxes and minority interest (8,454) (18,675)
Income tax expense 64 122
---------- ----------
Loss from continuing operations before
minority interest (8,518) (18,797)
Minority interest in earnings of consolidated
subsidiaries, net of tax (629) -
---------- ----------
Loss from continuing operations (9,147) (18,797)
Discontinued operations, net of tax (337) (621)
---------- ----------
Net loss $ (9,484) $ (19,418)
========== ==========
Basic loss per share:
Basic loss per share from continuing operations $ (0.51) $ (1.08)
Loss from discontinued operations, net of tax (0.02) (0.04)
---------- ----------
Basic loss per share $ (0.53) $ (1.12)
========== ==========
Diluted loss per share:
Diluted loss per share from continuing
operations $ (0.51) $ (1.08)
Loss from discontinued operations, net of tax (0.02) (0.04)
---------- ----------
Diluted loss per share $ (0.53) $ (1.12)
========== ==========
Weighted average shares used for basic loss per
share data 18,051 17,277
Effect of dilutive common stock options - -
---------- ----------
Weighted average shares used for diluted loss per
share data 18,051 17,277
========== ==========
See accompanying notes to the condensed consolidated financial statements.
4
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share data)
Six months ended
June 30,
---------------------
2003 2002
---------- ----------
Revenues:
Resident and health care $ 174,082 $ 154,482
Management services 1,774 685
Reimbursed expenses 2,972 2,687
---------- ----------
Total revenues 178,828 157,854
Operating expenses:
Community operating expenses 121,876 111,191
General and administrative 12,818 12,474
Lease expense 20,290 50,463
Depreciation and amortization 12,490 10,365
Amortization of leasehold acquisition costs 1,048 10,124
Reimbursed expenses 2,972 2,687
---------- ----------
Total operating expenses 171,494 197,304
---------- ----------
Operating income (loss) 7,334 (39,450)
Other income (expense):
Interest expense (26,776) (20,165)
Interest income 1,564 2,928
Gain (loss) on sale of assets 21 (53)
Other 455 830
---------- ----------
Other expense, net (24,736) (16,460)
---------- ----------
Loss from continuing operations before
income taxes and minority interest (17,402) (55,910)
Income tax expense 194 219
---------- ----------
Loss from continuing operations before
minority interest (17,596) (56,129)
Minority interest in earnings of consolidated
subsidiaries, net of tax (1,241) -
---------- ----------
Loss from continuing operations (18,837) (56,129)
Discontinued operations, net of tax (1,617) (1,360)
---------- ----------
Net loss $ (20,454) $ (57,489)
========== ==========
Basic loss per share:
Basic loss per share from continuing operations $ (1.07) $ (3.25)
Loss from discontinued operations, net of tax (0.09) (0.08)
---------- ----------
Basic loss per share $ (1.16) $ (3.33)
========== ==========
Diluted loss per share:
Diluted loss per share from continuing
operations $ (1.07) $ (3.25)
Loss from discontinued operations, net of tax (0.09) (0.08)
---------- ----------
Diluted loss per share $ (1.16) $ (3.33)
========== ==========
Weighted average shares used for basic loss per
share data 17,697 17,277
Effect of dilutive common stock options - -
---------- ----------
Weighted average shares used for diluted loss per
share data 17,697 17,277
========== ==========
See accompanying notes to the condensed consolidated financial statements.
5
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands) Six months ended
June 30,
---------------------
2003 2002
---------- ----------
Cash flows from operating activities:
Net loss $ (20,454) $ (57,489)
Loss from discontinued operations 1,617 1,360
---------- ----------
Loss from continuing operations (18,837) (56,129)
Adjustments to reconcile loss from continuing
operations to net cash and cash equivalents used
by continuing operations:
Depreciation and amortization 13,538 20,489
Amortization of deferred financing costs 1,001 1,658
Residual value guarantee losses, included in
lease expense - 30,279
Amortization of deferred entrance fee
revenue (6,854) (5,675)
Proceeds from entrance fee sales 14,668 9,131
Refunds of entrance fee terminations (6,385) (3,975)
Deferred income taxes 187 (85)
Amortization of deferred gain on
sale-leaseback transactions (1,681) (1,641)
Minority owners' allocation of income 1,241 -
Losses from unconsolidated joint ventures 121 279
(Gain) loss on sale of assets - 53
Changes in assets and liabilities, exclusive of
acquisitions and sale leaseback transactions:
Accounts receivable (326) (1,508)
Inventory 85 (28)
Prepaid expenses 1,066 114
Other assets (669) 4,477
Accounts payable 2,288 (4,849)
Accrued interest 140 (450)
Other accrued expenses and other current
liabilities (2,053) (4,646)
Tenant deposits (170) (633)
Other liabilities 437 1,800
---------- ----------
Net cash and cash equivalents used by continuing
operations (2,203) (11,339)
Cash flows from investing activities:
Additions to land, buildings and equipment (4,614) (8,053)
Proceeds from the sale of assets - 92,113
Purchase of assets limited as to use (26) (7,677)
Distributions from joint ventures 1,348 -
Issuance of notes receivable (2,384) (8,641)
Other investing activities (366) (2,235)
---------- ----------
Net cash (used) provided by investing activities (6,042) 65,507
Cash flows from financing activities:
Proceeds from issuance of stock - 67
Proceeds from the issuance of long-term
debt 7,617 181,432
Principal payments on long-term debt (9,020) (235,996)
Accrual of deferred interest 6,378 2,971
Distributions to minority interest holders (613) -
Principal reductions in master trust
liability (703) (704)
Accrual of contingent earnouts (594) (5,294)
Expenditures for financing costs (693) (3,675)
---------- ----------
Net cash provided (used) by financing activities 2,372 (61,199)
See accompanying notes to the condensed consolidated financial statements.
6
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(UNAUDITED)
(in thousands)
Six months ended
June 30,
---------------------
2003 2002
---------- ----------
Net cash and cash equivalents used by continuing
operations (5,873) (7,031)
Net cash and cash equivalents used by discontinued
operations (2) (53)
---------- ----------
Net decrease in cash and cash equivalents (5,875) (7,084)
Cash and cash equivalents at beginning of period 18,244 19,334
---------- ----------
Cash and cash equivalents at end of period $ 12,369 $ 12,250
========== ==========
Supplemental disclosure of cash flow information:
- -------------------------------------------------
Cash paid during the period for interest
(including capitalized interest) $ 19,572 $ 17,003
========== ==========
Income taxes paid $ 298 $ 330
========== ==========
Supplemental disclosure of non-cash transactions:
- -------------------------------------------------
During the six months ended June 30, 2003 the Company issued 1,366,862 common
shares, par value $0.01 per share to a holder of the 10% Series B Convertible
Senior Subordinated Notes. This holder elected to convert $3.1 million of the
convertible debentures to common stock at the conversion price of $2.25 per
share. As a result, debt and equity changed as follows:
Long-term debt $ (3,076) $ -
Common stock 14 -
Additional paid-in capital 3,062 -
During the six months ended June 30, 2003 the Company completed certain
conditions related to the sale transaction of land in Virginia. The Company
received net cash proceeds of $1.2 million in December 2002, and the buyer
assumed the related debt. As a result, assets and liabilities decreased as
follows:
Land, building and equipment $ 13,127 $ -
Other current liabilities 1,217 -
Debt associated with assets held-for-sale
(current) 11,910 -
During the six months ended June 30, 2003 the Company amended a lease agreement.
Under this amendment, a lease which had been accounted for as a financing is
now treated as an operating lease. As a result, assets and liabilities
decreased as follows:
Land, building and equipment $ 4,879 $ -
Other assets 821 -
Long-term debt 4,879 -
During the quarter ended June 30, 2002, the Company terminated a management
agreement and entered into a long-term operating lease. Under the terms of the
lease, the Company acquired the following assets and assumed the following
liabilities:
Accounts receivable $ - $ 991
Other current assets - 441
Note receivable - 18,756
Other assets - 11,651
Other current liabilities - 1,527
Refundable portion of entrance fees - 11,348
Deferred entrance fee income - 16,335
Other long-term liabilities - 2,629
During the six months ended June 30, 2002, the Company terminated five operating
leases, and acquired $69.3 million of land, buildings and equipment in exchange
for $58.1 million of notes recievable and $11.2 million of certificates of
deposit (included in assets limited as to use), previously securing these
leases. In conjunction with the transactions, assets and liabilities changed as
follows:
Notes receivable $ - $ (58,108)
Assets limited as to use - (11,176)
Land, buildings and equipment - 69,284
See accompanying notes to the condensed consolidated financial statements.
7
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
American Retirement Corporation (the "Company") have been prepared in accordance
with accounting principles generally accepted in the United States of America
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. These financial statements should be read in
conjunction with the consolidated financial statements and the notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2002. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States of
America for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals and other adjustments, such
as impairments) considered necessary for a fair presentation have been included.
Certain fiscal year 2002 amounts have been reclassified to conform to the fiscal
year 2003 presentation. Operating results for the three and six months ended
June 30, 2003 are not necessarily indicative of the results that may be expected
for the entire year ending December 31, 2003.
2. Principles of Consolidation
The accompanying condensed consolidated financial statements include the
financial statements of American Retirement Corporation and its wholly owned and
majority owned subsidiaries that manage, own and operate senior living
communities. The Company maintains each of its subsidiaries as a separate and
distinct legal entity. Absent express contractual provisions or agreements to
the contrary, neither the Company nor any of its subsidiaries are liable for,
nor are any of their respective assets available to satisfy, the obligations or
liabilities of any other subsidiary or the Company. The accounts of limited
liability companies, joint ventures and partnerships are consolidated when the
Company maintains effective control over such entities' assets and operations,
notwithstanding, in some cases, a lack of majority ownership. The Company would
consolidate any management contracts if the Company has the unilateral ability
to conduct the ordinary course of business of the subject communities. At
December 31, 2002 and June 30, 2003, the Company was not required to consolidate
any of the communities it manages for others. All significant inter-company
balances and transactions are eliminated in consolidation.
3. Recognition of Revenue
The Company provides residents with housing and health care services through
various types of agreements. The Company also receives fees for managing and
developing senior living communities owned by others. The Company's revenues are
recognized on a monthly basis as the services are provided to its residents.
Management services revenue is recorded monthly as services and administrative
support under management agreements are provided to the owners and lessees of
the subject communities. Such revenues are determined by an agreed formula set
forth in the applicable management agreement (e.g. a specified percentage of
revenues, income or cash flows of the managed community, or a negotiated fee per
the management agreement).
Certain communities provide housing and health care services under various
entrance fee agreements with residents (EF Communities). These agreements
require new independent living residents to pay an upfront entrance fee, and may
obligate the Company to provide a benefit in the form of future assisted living
or skilled nursing housing and services during the life of the resident.
Generally, a portion of the entrance fee is refundable to the resident or the
resident's estate upon termination of the agreement. The refundable amount is
recorded by the Company as refundable portion of entrance fees, a long-term
liability, until termination of the agreement. The remainder of the entrance fee
is recorded as deferred entrance fee income and is amortized into revenue using
the straight-line method over the estimated remaining life expectancy of the
resident, based upon actuarial projections. Generally residents with this type
contract are entitled to cleaning, maintenance, foodservices, transportation,
social and recreational activities, laundry, housekeeping, security, and health
care monitoring as long as they remain in the unit. A resident may typically
cancel this type of contract and move out of the unit after providing the
Company with 30 to 60 days written notice.
8
Certain communities also provide services under entrance fee agreements which
provide that the entrance fee is fully refundable to the resident or the
resident's estate, contingent upon the occupation of the unit by the next
resident. The resident also shares in a percentage, typically 50%, of any
appreciation in the entrance fee paid by the succeeding resident, but receives
no healthcare benefit. This contingent refund is paid to the preceding resident
only upon occupancy of the unit by a new, succeeding resident. Because these
refunds are contingent and only payable out of subsequent entrance fee proceeds,
these entrance fees are classified on the Company's consolidated balance sheet
as deferred entrance fee income. Because these units can be reoccupied during
the remaining life of the building and the Company's obligations exist as long
as the unit can be reoccupied, these refunds are amortized into revenue on a
straight-line basis over the remaining life of the building. In the unusual
event that the new resident's entrance fee is less than the previous resident's
entrance fee, the Company immediately recognizes the entire shortfall as a loss
during the current period.
4. Segment Information
The Company operates principally in three business segments: (1) large
retirement centers (Retirement Centers), (2) free-standing assisted living
residences (Free-standing ALs), and (3) management services (Management
Services). The Company currently operates 26 Retirement Centers, which provide a
continuum of care services such as independent living, assisted living and
skilled nursing care. Of the 26 Retirement Centers, the Company owned 11,
operated three pursuant to leases classified as financing obligations (which
include purchase options) and operated 12 pursuant to operating leases. The
Company currently operates 31 Free-standing ALs. Free-standing ALs are generally
comprised of stand-alone assisted living communities that are not located on a
Retirement Center campus, most of which also provide some specialized care such
as Alzheimer's and memory enhancement programs. Free-standing ALs are generally
much smaller than Retirement Centers. Of the 31 Free-standing ALs operated by
the Company, 10 are owned, seven are operated pursuant to lease financing
obligations, and 14 are operated pursuant to operating leases.
The Management Services segment includes fees from management agreements for
communities owned by others, and reimbursed expense revenues together with
associated expenses. The Company has eight management agreements with third
parties relating to six Retirement Centers and two Free-standing ALs. The
Company has invested $6.0 million in purchase options for these two Retirement
Centers. Of the remaining six managed communities, two are Retirement Center
cooperatives that are owned by their residents and one Retirement Center is
owned by a not-for-profit sponsor. In addition, two Free-standing ALs are
non-consolidated and owned by joint ventures, with which the Company has
management agreements. The Company owns 50% of one of the joint ventures and
37.5% of the other and has joined with its venture partners in guaranteeing $8.8
million of first mortgage debt secured by one of the joint venture assets. The
Company's remaining management agreement relates to the Freedom Square
Retirement Center ("Freedom Square"), a 735-unit EF Community which the Company
manages pursuant to a long-term management contract.
The Company manages and evaluates the performance of its business segments
principally based upon segment operating contributions, which the Company
defines as revenue for the segment less operating expenses associated with the
segment. During the first quarter of 2003, in response to Regulation G and Item
10 of Regulation S-K regarding the use of non-GAAP financial measures, the
Company has revised the composition of its segment presentation and restated all
prior periods presented. The following is a summary of total revenues, operating
contributions, and total assets by segment for the three and six months ended
June 30, 2003 and 2002 (in thousands).(1) (2)
9
Three Months Ended Six Months Ended
--------------------- ---------------------
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
---------- ---------- ---------- ----------
Revenues
Retirement centers $ 68,652 $ 64,140 $ 135,933 $ 123,913
Free-standing ALs 19,378 15,812 38,149 30,569
Management services (3) 2,594 1,856 4,746 3,372
-------------------------------------------
Total revenue $ 90,624 $ 81,808 $ 178,828 $ 157,854
===========================================
Retirement Centers
Resident and healthcare revenue $ 68,652 $ 64,140 $ 135,933 $ 123,913
Community operating expense 45,546 43,490 90,510 82,432
-------------------------------------------
Community operating contribution $ 23,106 $ 20,650 $ 45,423 $ 41,481
-------------------------------------------
Free-standing ALs
Resident and healthcare revenue $ 19,378 $ 15,812 $ 38,149 $ 30,569
Community operating expense 15,593 14,626 31,366 28,759
-------------------------------------------
Community operating contribution $ 3,785 $ 1,186 $ 6,783 $ 1,810
-------------------------------------------
Management services
Management services $ 1,314 $ 620 $ 1,774 $ 685
Reimbursed expense revenue 1,280 1,236 2,972 2,687
Reimbursed expenses 1,280 1,236 2,972 2,687
-------------------------------------------
Management services operating
contribution $ 1,314 $ 620 $ 1,774 $ 685
General and administrative expense $ 6,837 $ 6,554 $ 12,818 $ 12,474
Lease expense (4) 10,207 17,865 20,290 50,463
Depreciation and amortization (5) 6,866 8,419 13,538 20,489
-------------------------------------------
Operating income (loss) $ 4,295 $ (10,382) $ 7,334 $ (39,450)
===========================================
June December June
30, 31, 30,
2003 2002 2002
---------- ---------- ----------
Total Assets:
Retirement Centers $ 531,717 $ 539,764 $ 489,667
Free-standing ALs 213,689 210,376 202,207
Management services and other 58,648 89,858 99,553
--------------------------------
Total $ 804,054 $ 839,998 $ 791,427
================================
(1) Segment data does not include any inter-segment transactions or allocated
costs. During the three months ended June 30, 2003, the Company determined
that therapy revenues and expenses, previously reported net in
Free-standing AL revenues, should be reported gross within the respective
segments. During the three months ended March 31, 2003, in response to
Regulation G and Item 10 of Regulation S-K regarding the use of non-GAAP
financial measures, the Company revised the composition of its segment
presentation and restated all prior periods presented. During the fourth
quarter of 2002, the Company determined that a community which had
previously been classified as a Free-standing AL had more characteristics
of a Retirement Center and the community was accordingly reclassified as a
Retirement Center. The amounts for the three and six months ended June 30,
2002 and 2003 have been restated to conform with the revised presentation.
(2) During the quarter ended September 30, 2002, the Company determined that a
Free-standing AL would be held-for-sale. Subsequently, in the quarter ended
March 31, 2003, the Company determined two additional Free-standing ALs
would also be held-for-sale. The Company's 2002 segment data was restated
to remove the results of the discontinued operations.
(3) Management services revenues represent the Company's management services
revenues, as well as reimbursed expense revenue.
(4) Lease expense for the three and six months ended June 30, 2002 includes
$7.0 million and $30.2 million, respectively, of additional lease expense
related to the termination of certain synthetic leases as part of its 2002
Refinancing Plan described below.
(5) Depreciation and amortization expense for the three and six months ended
June 30, 2002 includes $2.3 million and $8.8 million, respectively, of
additional amortization expense related to the termination of certain
synthetic leases as part of the 2002 Refinancing Plan.
10
5. Stock Based Compensation
In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of FASB
Statement No. 123. SFAS 148 amends SFAS No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements. Certain of the disclosure modifications were required for
fiscal periods ending after December 15, 2002 and are included below.
The Company applies the intrinsic-value-based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations including FASB Interpretation (FIN) No.
44, Accounting for Certain Transactions involving Stock Compensation, an
interpretation of APB Opinion No. 25, to account for its stock options. Under
this method, compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price. SFAS
No. 123 established accounting and disclosure requirements using a
fair-value-based method of accounting for stock-based employee compensation
plans. As allowed by SFAS No. 123, the Company has elected to continue to apply
the intrinsic-value-based method of accounting described above, and has adopted
only the disclosure requirements of SFAS No. 123. The following table
illustrates the effect on net loss if the fair-value-based method had been
applied to all outstanding and unvested awards in each period (in thousands
except per share data).
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
--------------------- ---------------------
Net loss, as reported $ (9,484) $ (19,418) $ (20,454) $ (57,489)
Deduct total stock-based employee
compensation expense determined
under fair-value-based method (165) (320) (326) (640)
---------- ---------- ---------- ----------
Pro forma net loss $ (9,649) $ (19,738) $ (20,780) $ (58,129)
========== ========== ========== ==========
Loss per share:
Basic-as reported $ (.53) $ (1.12) $ (1.16) $ (3.33)
Basic-pro forma $ (.53) $ (1.14) $ (1.17) $ (3.36)
Diluted-as reported $ (.53) $ (1.12) $ (1.16) $ (3.33)
Diluted-pro forma $ (.53) $ (1.14) $ (1.17) $ (3.36)
11
6. Earnings per Share
Basic and diluted loss per share for the three months and six months ended June
30, 2003 has been computed on the basis of the weighted average number of shares
outstanding. Diluted earnings per share reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. During both the three and six months
ended June 30, 2003, there were 20,000 options to purchase shares of common
stock outstanding which had an exercise price below the average market price of
the common shares for the corresponding period. There were no options to
purchase shares of common stock outstanding during the three and six months
ended June 30, 2002 which had an exercise price below the average market price
of the common shares for the corresponding period. Such options were
anti-dilutive because the Company incurred a loss from continuing operations for
the three and six months ended June 30, 2003 and 2002, and therefore were not
included in the computation of diluted earnings per share.
The following options to purchase shares of common stock were outstanding during
each of the following periods, but were also not included in the computation of
diluted earnings per share because the options' exercise price was greater than
the average market price of the common shares for the respective periods and,
therefore, the effect would be anti-dilutive.
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------
2003 2002 2003 2002
-------------------------------------------
Number of options (in thousands) 2,045 2,108 2,076 2,124
Weighted-average exercise price $ 4.18 $ 4.83 $ 4.47 $ 4.83
The Company's 5 3/4% Convertible Subordinated Debentures due October 1, 2002
outstanding during the 2002 period presented were not included in the
computation of diluted earnings per share for the three and six months ended
June 30, 2002. The conversion price of $24.00 per share was greater than the
average market price of the common shares for the period and the Company had a
loss from continuing operations, and, therefore, the effect would be
anti-dilutive.
The Company's 10% Series B Convertible Senior Subordinated Notes due 2008
(Series B Notes) were not included in the computation of diluted earnings per
share for the three and six months ended June 30, 2003. The average market price
of the Company's common stock outstanding during the three and six months ended
June 30, 2003 was less than the $2.25 per share conversion price and the Company
had a loss from continuing operations and, therefore, the effect would be
anti-dilutive. At June 30, 2003, the Series B Notes were convertible into
5,724,445 shares of common stock.
During the six months ended June 30, 2003, holders of Series B Notes elected to
convert $3.1 million of the convertible debentures to common stock at the
conversion price of $2.25 per share. The Company issued 1,366,862 common shares,
par value $0.01 per share.
12
7. Long-term Debt and Other Transactions
A summary of long-term debt is as follows (in thousands):
June 30, December 31,
2003 2002
---------- ------------
Note payable bearing interest at a fixed rate of 19.5%, compounding quarterly.
Interest at 9% (increasing 0.55% annually after April 1, 2004) is payable
quarterly with principal and unpaid interest due on September 30, 2007 (HCPI
Loan). The loan is secured by a security interest in the borrower subsidiary's
ownership interests. $ 122,099 $ 115,721
Convertible debentures bearing interest at a fixed rate of 10.00% (Series B
Notes). Interest is due semi-annually on April 1 and October 1 through April 1,
2008, at which time all principal is due. 12,880 15,956
Various mortgage notes bearing interest at variable and fixed rates, generally
payable monthly with any unpaid principal and interest due between 2004 and
2037. Interest rates at June 30, 2003 range from 3.82% to 8.69%. The loans are
typically secured by certain land, buildings and equipment. 234,692 240,549
Lease financing obligations with principal and interest payable monthly bearing
interest at fixed rates ranging from 3.72% to 9.39%, with final payments due
between 2006 and 2017. The obligations are secured by certain land, buildings
and equipment. 127,021 128,575
Various other long-term debt, generally payable monthly with any unpaid
principal and interest due between 2004 and 2024. Variable and fixed interest
rates at June 30, 2003 range from 1.20% to 11.1%. The loans are secured by
certain land, buildings and equipment. 28,060 39,850
---------- ------------
Total long-term debt 524,752 540,651
Less current portion 17,242 13,526
Less debt associated with assets held-for-sale 10,883 20,246
---------- ------------
Long-term debt, excluding current portion $ 496,627 $ 506,879
========== ============
The aggregate scheduled maturities of long-term debt were as follows (in thousands):
June 30,
2003
----------
Year 1 $ 17,242
Year 1, debt associated with assets held-for-sale 10,883
Year 2 138,101
Year 3 8,656
Year 4 9,366
Year 5 170,704
Thereafter 169,800
----------
$ 524,752
==========
13
On September 26, 2002, the Company entered into a loan agreement with Health
Care Property Investors, Inc. ("HCPI"), a real estate investment trust, pursuant
to which HCPI loaned one of the Company's subsidiaries $112.8 million (the "HCPI
Loan"). The Company also contemporaneously entered into a contribution agreement
with HCPI under which HCPI agreed to make a $12.2 million equity investment (the
"HCPI Equity Investment") in certain other subsidiaries of the Company (the
"Real Estate Companies").
In addition to the scheduled maturities of long-term debt, the Company will be
required to pay all accrued but unpaid interest on the HCPI Loan at its maturity
or earlier. In addition to the original loan amount of $112.8 million, the
balance of accrued but unpaid interest, together with compounded interest, will
increase each year thereon. At June 30, 2003, the HCPI Loan balance was $122.1
million. Unless paid earlier, the Company will be accruing and compounding
quarterly the HCPI Loan interest. This interest, if paid at its September 2007
maturity, will compound to be approximately $202.7 million, or an additional
$80.6 million.
The Company is permitted to repay the HCPI Loan in whole or in part after three
years and redeem the HCPI Equity Investment after four years. In the event that
the Company does not repay the HCPI Loan at maturity in 2007, HCPI may foreclose
upon the Company's ownership interests in the Real Estate Companies that
currently own nine of the Company's Retirement Centers, and the Company will
continue to operate the nine Retirement Centers pursuant to a long-term lease
with an initial term of 15 years, and two ten year renewal options. The Company
intends to repay, subject to available funds, the HCPI Loan on or before its
maturity in 2007 and repurchase the HCPI Equity Investment. However, if the
Company does not repay the HCPI Loan and repurchase the HCPI Equity Investment
at the end of five years, and HCPI forecloses upon its collateral, the Company
will realize significant taxable income, which may exceed substantially the
Company's net operating loss carryforward resulting in a significant tax
liability to the Company.
In August 2003, the Company and one of its lenders signed an agreement to
refinance $40.4 million of mortgage debt previously due April 1, 2004. The
refinanced debt is due April 1, 2005. The Company has presented $33.0 million of
this debt as long-term and $7.4 million as debt related to assets held-for-sale
on the condensed consolidated financial statements herein.
During the six months ended June 30, 2003, holders of Series B Notes elected to
convert $3.1 million of the convertible debentures to common stock at the
conversion price of $2.25 per share. The Company issued 1,366,862 common shares,
par value $0.01 per share.
On February 28, 2003 the Company sold a Free-standing AL in Florida for $6.5
million. The sale agreement contains certain formula-based earnout provisions
which may provide for up to $1.1 million of additional sales proceeds to the
Company based on future performance. The Company contemporaneously leased the
property back from the buyer. As a result of the contingent earnout provision,
this Free-standing AL lease is classified as a financing transaction and the
Company recorded $6.5 million of lease obligation as debt, bearing interest at
8.76%. This community was added to a master lease agreement which the Company
entered into on March 28, 2002, which previously included three Retirement
Centers and three Free-standing ALs. The amended lease is a 15-year lease
(approximately 14 years remaining) with two ten-year renewal options. The
Company has the right of first refusal to repurchase the leased communities. As
a result of this lease amendment, the Company is no longer eligible for a
contingent earnout of one of these communities that is currently held-for-sale
(see note 9), resulting in a $821,000 write-off and conversion from financing to
operating lease treatment for this community.
During 2002, the Company successfully refinanced or extended substantially all
of its debt maturities to January 2004 or later pursuant to its Refinancing
Plan. However, it remains highly leveraged with a substantial amount of debt and
lease obligations. Furthermore, the Company replaced a significant amount of
mortgage debt and lower rate convertible debentures with debt and leases at
higher rates which significantly increased the Company's annual debt and lease
payments, plus additional accruals for HCPI Loan interest that is payable at
maturity of the HCPI Loan.
Certain of the Company's debt agreements and leases contain various financial
and other restrictive covenants. During the three and six months ended June 30,
2003, the Company obtained a covenant waiver on a lease related to a single
community. At June 30, 2003, the Company was in compliance with all other debt
and lease covenants. However, there can be no assurances that the Company will
remain in compliance with those covenants or that the Company's creditors will
grant amendments or waivers in the event of future non-compliance. Any
non-payment or other default under the Company's debt instruments, leases or
mortgages (including non-compliance with financial or restrictive covenants)
could cause the Company's lenders or lessors to declare defaults, accelerate
payment obligations or foreclose upon the communities securing such indebtedness
or exercise their remedies with respect to such communities. Furthermore,
because of cross-default provisions in most of the Company's mortgages, debt
instruments, and leases, a default by the Company on one of its debt instruments
or lease agreements is likely to result in a default or acceleration of
substantially all of the Company's other obligations, which would have a
material adverse effect on the Company.
14
The Company has scheduled principal payments of $28.1 million, which includes
$10.9 million of debt associated with assets held-for-sale, and minimum rental
obligations of $45.3 million under long-term operating leases due during the
twelve months ended June 30, 2004. As of June 30, 2003, the Company had
approximately $12.4 million in unrestricted cash and cash equivalents and $6.4
million of working capital. The Company's cash flows from operations for the six
months ended June 30, 2003 was negative. Because expected cash flows from
operations, including anticipated improvements, will not be sufficient to meet
these requirements, the Company plans to refinance or extend this debt prior to
its maturity. However, the Company expects that its current cash and cash
equivalents, expected cash flow from operations, the proceeds from additional
financing transactions, and the proceeds from the sale of assets currently
held-for-sale will be sufficient to fund operating requirements, capital
expenditure requirements, periodic debt service requirements and lease
obligations during the next twelve months. In order to meet its future payment
obligations, the Company will need to continue to improve its cash flow from
operations, complete the disposition of certain of the assets currently
held-for-sale, and consummate various financing transactions.
There can be no assurance that the Company's operations will improve as rapidly
as anticipated or that the contemplated asset disposition and refinancing
transactions can be consummated during the anticipated timeframes. The failure
to make its periodic debt and lease payment obligations, or the failure to
extend, refinance or repay any of its debt obligations as they become due would
have a material adverse effect upon the Company.
8. Discontinued Operations
During the quarter ended September 30, 2002, the Company determined that a
Free-standing AL would be held-for-sale. Subsequently, in the quarter ended
March 31, 2003, the Company determined two additional Free-standing ALs would
also be held-for-sale. The Company has executed sale agreements relating to
these three communities, which are subject to various contingencies. If
completed, the Company will use most of the proceeds to repay mortgage debt and
other related payments. For the three and six months ended June 30, 2003 and
2002, the Company recorded losses from discontinued operations of $337,000 and
$621,000, and $1.6 million and $1.4 million, respectively, for these three
Free-standing ALs. The loss recorded for the six months ended June 30, 2003
includes a loss of $821,000 resulting from the write-off of a contingent earnout
recorded as part of a first quarter 2003 amendment to a sale-leaseback
transaction of a Free-standing AL originally consummated during 2002 (see note
7). The Company's 2002 results were reclassified to reflect the loss from
discontinued operations.
9. Assets Held-for-Sale
The Company had $24.8 million of assets classified as held-for-sale at June 30,
2003. These assets consist of approximately $10.0 million related to four land
parcels which were originally purchased for development, $13.7 million related
to two of the three Free-standing ALs classified as discontinued operations and
$1.1 million of other assets. Debt associated with assets held-for-sale at June
30, 2003 was $10.9 million which is classified as a current liability.
15
10. Commitments and Contingencies
The Company is subject to various legal proceedings and claims that arise in the
ordinary course of its business. The Company also maintains accruals for various
claims, based upon estimated values of known claims as well as incurred but not
reported claims.
Insurance
The delivery of personal and health care services entails an inherent risk of
liability. In recent years, participants in the senior living and health care
services industry have become subject to an increasing number of lawsuits
alleging negligence or related legal theories, many of which involve large
claims and result in the incurrence of significant defense costs and significant
exposure. The Company currently maintains property, liability and professional
medical malpractice insurance policies for the Company's owned, leased and
certain of its managed communities under a master insurance program.
Effective January 1, 2003, the Company renewed its general and professional
liability policy, with increased retention levels ranging from $1.0 million to
$5.0 million. The Company currently maintains single incident and aggregate
liability protection in the amount of $15.0 million.
The Company has operated under a large deductible workers' compensation program,
with excess loss coverage provided by third party carriers, since July 1995. At
June 30 2003, the Company had coverage for workers' compensation and related
programs with excess loss coverage of $350,000 per individual claim and
approximately $7.25 million in the aggregate. The Company is self-insured for
amounts below the excess loss coverage. As of June 30, 2003, the Company
provides cash collateralized letters of credit in the aggregate amount of $3.9
million related to this program, which is reflected as assets limited as to use
on the Company's balance sheet. The Company utilizes a third party administrator
to process and pay filed claims.
On January 1, 2002, the Company initiated a self-insurance program for employee
medical coverage. The Company maintains stop loss insurance coverage of
approximately $150,000 per employee and approximately $17.5 million for
aggregate calendar 2003 claims and costs.
Estimated costs related to the self-insurance programs are accrued based on
known claims and projected settlements of unasserted claims incurred but not yet
reported to the Company. Subsequent changes in actual experience (including
claim costs, claim frequency, and other factors) could result in additional
costs to the Company.
Leases
As of June 30, 2003, the Company operated 36 of its senior living communities
under long-term leases. Of these 36 communities, 22 are operated under three
master lease agreements, with the remaining communities being subject to
individual lease agreements. The Company also leases its corporate offices and
is obligated under several ground leases for senior living communities. The
remaining primary lease terms vary from four to 22 years. Certain of the leases
provide for renewal and purchase options. Several of the leases have graduated
lease payments which the Company recognizes on a straight-line basis over the
term of the leases. Some leases have provisions for contingent lease payments
based on occupancy levels or other measures. The majority of leases which have
such provisions are measured quarterly and the Company recognizes contingent
lease expense in accordance with the terms of the lease.
Total lease expense was $10.2 million and $17.9 million for the three months and
$20.3 million and $50.5 million for the six months ended June 30, 2003 and 2002,
respectively. During the three and six months ended June 30, 2002, $7.0 and
$30.2 million, respectively, of lease expense was for residual value guarantees
related to the termination of certain synthetic leases as part of the Company's
2002 Refinancing Plan.
16
Future minimum lease payments as of June 30, 2003 were as follows (in
thousands):
Year 1 $ 45,344
Year 2 46,031
Year 3 46,733
Year 4 47,453
Year 5 47,089
Thereafter 371,281
----------
$ 603,931
==========
Financing Obligations
The Company operates many of its senior living communities under long-term
leases. Certain of these leases provide for various additional lease payments,
as well as renewal options. The Company, as the lessee, makes a determination
with respect to each of these leases whether they should be accounted for as
operating leases or lease financing obligations. The Company bases its
classification criteria on estimates regarding the fair value of the leased
community, minimum lease payments, the Company's effective cost of funds, the
economic life of the community and certain other terms in the lease agreements.
Sale lease-back transactions are recorded as financings when the transactions
include a form of continuing involvement, such as purchase options or contingent
earn-outs. Sale lease-back transactions recorded as financings result in the
fixed assets remaining on the Company's balance sheet as well as recording debt
equal to the net cash proceeds received. The Company recorded contingent
earn-outs during the fourth quarter of 2001 and during 2002, in conjunction with
the termination of synthetic leases that had residual value guarantees. The
leased assets were acquired and subsequently sold to third parties under
sale-leaseback transactions. As of June 30, 2003, the Company has recorded
contingent earn-outs of $5.3 million (out of a maximum of $13.3 million)
associated with the seven sale lease-back transactions. The earn-out provisions
of the sale lease-back agreements specify certain criteria that must be met to
receive the earn-out consideration. The actual contingent earn-out proceeds will
be realized at various measurement dates which expire no later than June 2005.
Based upon its review of the earn-out criteria, the Company believes that these
recorded amounts are realizable, however, actual results may differ from these
estimates under different assumptions or conditions. Management periodically
assesses the recoverability of the recorded balances and adjusts the carrying
amount to its revised estimate with a corresponding increase or decrease to
interest expense.
Regulatory Requirements
Federal, state and local governments and agencies regulate various aspects of
the Company's business. The development and operation of senior living
facilities and the provision of health care services are subject to federal,
state, and local licensure, certification, and inspection laws that regulate,
among other matters, the number of licensed beds, the provision of services, the
distribution of pharmaceuticals, marketing and maintaining entrance fee
contracts, billing practices and policies, equipment, staffing (including
professional licensing), operating policies and procedures, fire prevention
measures, environmental and medical waste matters, and compliance with building
and safety codes. The Company is also subject to provisions of the Health
Insurance Portability and Accountability Act of 1996 ("HIPAA"), which protects
the privacy and security of certain health information. Failure to comply with
these laws and regulations could result in, among other things, the denial of
reimbursement, the imposition of fines, temporary suspension of admission of new
residents, restrictions on marketing entrance fee contracts, suspension or
decertification from the Medicare programs, restrictions on the ability to
acquire new facilities or expand existing facilities, and, in extreme cases, the
revocation of a community's license or closure of a community. The Company has
implemented various programs to meet these regulations, and management believes
the Company was in compliance with all applicable regulations at June 30, 2003.
17
Guarantees
At June 30, 2003 the Company had guaranteed mortgage debt totaling $36.2
million, related to three communities. The mortgage debt guaranteed by the
Company relates to a Retirement Center under a long-term management agreement
(Freedom Square), a Retirement Center under a long-term operating lease and one
of the Company's two joint ventures.
Minimum Liquid Reserves
The Florida Department of Financial Services ("DFS") requires the Company to
maintain a minimum liquid reserve (MLR) balance for various communities based
upon certain financial calculations. As a result of certain elements of the
Company's 2002 Refinancing Plan, the Company may be required to deposit
additional MLR reserves. The Company is currently in negotiations with the
Florida DFS regarding the revised financial calculations and resulting timing of
the increased MLR requirement. The Company anticipates that, as a result of
refinancing, its MLR funding requirements may increase approximately $1.8
million over a period of approximately four years. The Company intends to meet
any DFS contribution requirements.
Income Tax Accrual
The Company currently has an accrual of $2.1 million related to estimated tax
assessments on communities acquired during 1998. The Company has agreed to a
settlement of $979,000 with the Internal Revenue Service which was paid July 31,
2003. Management believes the remaining accrual is sufficient to satisfy any
further assessments.
Other
The Centers for Medicare and Medicaid Services, (CMS), made several
announcements during the quarter that should increase Medicare reimbursement.
CMS indicated that it would not implement case-mix refinements at least until
fiscal 2005 and recommended a 3.0% market basket adjustment increase in Medicare
payment rates for fiscal 2004. In June 2003, CMS announced a proposal to
increase nursing center Medicare reimbursement by an additional 3.26% beginning
October 1, 2003. With the annual market basket adjustment and the correction
proposed by CMS, the Company expects Medicare revenues to increase by
approximately $20 per patient day.
Certain per person annual Medicare reimbursement limits on therapy services,
which had been temporarily suspended, will become effective on September 1, 2003
(unless extended further). Certain pending legislation may suspend the limits
again effective January 2004. While the Company is unable to quantify the impact
that these new rules will have, it is expected that the reimbursement
limitations, if not suspended further, will reduce therapy revenues, and
negatively impact the Company's operating results. The Company expects that
growth in its therapy business, as a result of additional clinics and expansion
of existing programs, will at least partially offset the impact of these new
limits.
11. Recent Accounting Pronouncements
In November 2002, the FASB issued FIN No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107
and a rescission of FASB Interpretation No. 34. This Interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees issued. The Interpretation
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
disclosure requirements are effective for financial statements of interim and
annual periods ending after December 15, 2002 and have been included in the
Notes to the condensed consolidated financial statements included herein. The
impact on the Company's financial statements from the application of the
recognition and measurement provisions of the Interpretation is dependent on the
level of guarantees issued or modified in 2003. No guaranties were issued or
modified during the three or six months ended June 30, 2003 which were impacted
by the provisions of FASB FIN No. 45.
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest
Entities, an interpretation of ARB No. 51. The primary objectives of FIN No. 46
are to provide guidance on the identification of entities for which control is
achieved through means other than through voting rights ("variable interest
entities" or "VIEs") and how to determine when and which business enterprise
should consolidate the VIE (the "primary beneficiary"). This new model for
consolidation applies to an entity in which either (1) the equity investors (if
any) do not have a controlling financial interest or (2) the equity investment
at risk is insufficient to finance that entity's activities without receiving
additional subordinated financial support from other parties. In addition, FIN
No. 46 requires that both the primary beneficiary and all other enterprises with
a significant variable interest in a VIE make additional disclosures. The
Company has three variable interest entities with which it holds a significant
variable interest, but is not the primary beneficiary:
18
Commencement Nature of Ownership Unit Capacity
Community of Operations Activity (Loss Exposure) Location IL AL MI SNF Total
--------- ------------- --------- --------------- -------- --- --- --- --- -----
Freedom Square July 1998 Managed 0.0% Seminole, 362 103 76 194 735
Florida
McLaren April 2000 Joint Venture 37.5% Flint,
Homewood Michigan 9 71 38 - 118
Village
Village of April 1998 Joint Venture 50.0% Lady Lake,
Homewood Florida - 32 15 - 47
-------------------------
371 206 129 194 900
=========================
The Company will adopt the provisions of FIN No. 46 beginning July 1, 2003. The
initial adoption of FIN No. 46 will not have any effect on the Company's
financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS 150").
SFAS 150 establishes how an issuer classifies and measures certain freestanding
financial instruments with characteristics of both liabilities and equity and
requires that such instruments be classified as liabilities. SFAS 150 was
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The Company has not entered into any financial
instruments within the scope of SFAS 150 since May 31, 2003, nor does it
currently hold any significant financial instruments within its scope. Adoption
of the standard is not expected to have a material impact on the Corporation's
consolidated financial position, results of operations or cash flows.
12. Subsequent Events
The Company has entered into an agreement, and is in discussions, relating to
the possible restructuring of the ownership of two communities currently managed
for a third party, whereby the Company would operate the communities under a
long-term lease through a joint venture. The transaction is subject to a number
of conditions and the terms of the transaction are not finalized. There can be
no assurance that the parties will agree upon the terms of this potential
transaction or that it will be consummated.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The Company is a national senior living and health care services provider
offering a broad range of care and services to seniors within a residential
setting. The range of the Company's services include independent living ("IL"),
assisted living ("AL"), memory enhancement services, with special programs and
living units for residents with Alzheimer's and other forms of dementia ("ME")
and skilled nursing ("SNF") services. The Company manages and evaluates its
performance based on three segments: (1) Retirement Centers, (2) Free-standing
AL's and (3) Management services. The Company currently operates and manages 65
senior living communities in 14 states with an aggregate unit capacity of
approximately 12,900 units and resident capacity of approximately 14,500. The
Company currently owns 21 communities, leases 36 communities pursuant to
long-term leases (including ten which are operated pursuant to lease financing
obligations and 24 which are operated pursuant to operating leases), and manages
eight communities.
19
The Retirement Centers are well-established communities, and generally maintain
high and consistent occupancy levels, most with waiting lists of prospective
residents. The Retirement Centers are of two basic types: (i) continuing care
retirement communities that provide a full continuum of IL, AL, and SNF
services; and (ii) congregate living communities which offer IL and AL, but do
not provide SNF services. The majority of the Company's Retirement Centers
operate under a monthly service fee rental structure (the "MSF Retirement
Centers"). In addition, five of the Company's Retirement Centers and one
Management Service community are EF Communities, which provide housing and
health care services through limited lifecare contracts and entrance fee
agreements with residents. Under these agreements, in addition to monthly
service fees, at initial occupancy the residents also pay entrance fees that
average approximately $158,000 per independent living unit. Depending on the
type of entrance fee contract, portions of the entrance fees are refundable to
the residents upon satisfaction of certain conditions.
The Company's Retirement Centers form the core segment of the Company's business
and comprise 26 of the 65 communities that the Company operates. Of the 26
Retirement Centers, the Company owned 11, operated three pursuant to leases
classified as financing obligations (which include purchase options) and
operated 12 pursuant to operating leases. The Company's Retirement Center
occupancy rates as of June 30, 2003 and 2002 remained stable at 93%, while
capacity increased slightly. In addition, the Company manages six Retirement
Centers included in Management Services. These 26 Retirement Centers have
approximately 7,800 units, representing approximately 61% of the total unit
capacity of the Company's communities.
The Company has 31 Free-standing ALs, ten owned and 21 leased (eight operated
pursuant to lease financing obligations and 13 operated pursuant to operating
leases), as well as two managed Free-standing ALs included in Management
Services. These 31 Free-standing ALs have approximately 2,800 units,
representing approximately 22% of the total unit capacity of the Company's
communities. The Company's Free-standing ALs provide specialized assisted living
care to residents in a comfortable residential atmosphere. Free-standing ALs are
much smaller than Retirement Centers and are stand-alone communities that are
not located on a Retirement Center campus. They provide personalized care plans
for each resident, extensive activity programs, and access to therapy or other
services as needed. Most of the Free-standing ALs also provide specialized care
such as Alzheimer's, memory enhancement and other dementia programs. Most of the
Company's Free-standing ALs were developed and opened during 1999 and 2000. The
Company's portfolio of Free-standing ALs is currently in the process of
completing its fill-up stage. The occupancy of the Company's Free-standing ALs
increased from 74% as of June 30, 2002 to 81% as of June 30, 2003.
The Management Services segment includes fees from eight management agreements,
including six large Retirement Communities and two Free-standing ALs owned by
others, as well as reimbursed expense revenues together with associated
expenses. These eight Management Service communities have approximately 2,300
units, representing approximately 17% of the total unit capacity of the
Company's communities. The Company has invested $6.0 million in purchase options
for two Retirement Centers of the eight managed communities. Of the remaining
six managed communities, two Retirement Centers are cooperatives that are owned
by their residents and one is owned by a not-for-profit sponsor. In addition,
two free-standing assisted living residences are non-consolidated and owned by
joint ventures. The Company owns 50% of one of the joint ventures and 37.5% of
the other and has joined with its venture partners in guaranteeing $8.8 million
of first mortgage debt secured by one of the joint venture assets. The Company's
remaining management agreement relates to Freedom Square, a 735-unit EF
Community which the Company manages pursuant to a long-term management contract.
The initial term of the Freedom Square management contract has 16 years
remaining, and there are two additional extension terms of 10 years each,
exercisable at the Company's option. The Company earns a formula based
management fee pursuant to the Freedom Square management contract that is based
upon the operational results of the community, as well as entrance fee sales
proceeds, less certain specified deductions, including a fixed $3.2 million
annual distribution to the owner, which escalates 3% annually. The Company has
guaranteed the $17.1 million first mortgage debt secured by the land, and
certain buildings and equipment at Freedom Square.
20
The tables below segregate the Company's portfolio of communities between
Retirement Centers, Free-standing ALs and Management Services, listing the
number of communities owned, leased or managed within each group, and the unit
capacity and occupancy as of June 30, 2003 and June 30, 2002:
June 30, 2003
------------------------------------------------------------------------------------
Unit Capacity
# of --------------------------------------------------------------------
Communities IL AL ME SNF Total Occupancy
----------- ------- ------- ------- ------- -------- -----------
Retirement Centers:
Owned 11 2,430 407 99 477 3,413 94%
Leased 15 2,889 670 127 745 4,431 93%
----------- ------- ------- ------- ------- -------- -----------
Sub-total 26 5,319 1,077 226 1,222 7,844 93%
----------- ------- ------- ------- ------- -------- -----------
Free-standing ALs:
Owned 10 83 709 170 - 962 78%
Leased 21 15 1,467 394 - 1,876 83%
----------- ------- ------- ------- ------- -------- -----------
Sub-total 31 98 2,176 564 - 2,838 81%
----------- ------- ------- ------- ------- -------- -----------
Management Services:
Retirement Centers 6 1,293 285 158 362 2,098 92%
Free-standing ALs 2 9 103 53 - 165 71%
----------- ------- ------- ------- ------- -------- -----------
Sub-total 8 1,302 388 211 362 2,263 90%
----------- ------- ------- ------- ------- -------- -----------
Total 65 6,719 3,641 1,001 1,584 12,945 90%
=========== ======= ======= ======= ======= ======== ===========
June 30, 2002(1)
------------------------------------------------------------------------------------
Unit Capacity
# of --------------------------------------------------------------------
Communities IL AL ME SNF Total Occupancy
----------- ------- ------- ------- ------- -------- -----------
Retirement Centers:
Owned 12 2,339 449 81 553 3,422 93%
Leased 14 2,973 560 173 668 4,374 93%
----------- ------- ------- ------- ------- -------- -----------
Sub-total 26 5,312 1,109 254 1,221 7,796 93%
----------- ------- ------- ------- ------- -------- -----------
Free-standing ALs:
Owned 7 - 454 145 - 599 73%
Leased 24 35 1,782 413 - 2,230 74%
----------- ------- ------- ------- ------- -------- -----------
Sub-total 31 35 2,236 558 - 2,829 74%
----------- ------- ------- ------- ------- -------- -----------
Management Services:
Retirement Centers 6 1,295 288 153 362 2,098 89%
Free-standing ALs 2 - 112 53 - 165 71%
----------- ------- ------- ------- ------- -------- -----------
Sub-total 8 1,295 400 206 362 2,263 87%
----------- ------- ------- ------- ------- -------- -----------
Total 65 6,642 3,645 1,018 1,583 12,888 88%
=========== ======= ======= ======= ======= ======== ===========
(1) During the fourth quarter of 2002, the Company determined that a community
which had previously been classified as a Free-standing AL had more
characteristics of a Retirement Center and the community was accordingly
reclassified as a Retirement Center. The June 30, 2002 information has been
restated to conform with the revised presentation.
Total unit capacity was approximately 12,900 at June 30, 2003 (7,800 in
Retirement Centers, 2,800 in Free-standing ALs and 2,300 in Management
Services). Total resident capacity, which includes an estimate of double
occupancy within a single unit, typically by married couples in independent
living units, was approximately 14,500 at June 30, 2003 (8,900 in Retirement
Centers, 2,800 in Free-standing ALs and 2,800 in Management Services). Of the 65
communities the Company operates, the financial statements for the eight
Management Service communities are not consolidated with the Company. In
addition, the three Free-standing ALs currently held-for-sale are included in
discontinued operations.
21
Critical Accounting Policies
Certain critical accounting policies are complex and involve significant
judgments by management, including the use of estimates and assumptions, which
affect the reported amounts of assets, liabilities, revenues and expenses. As a
result, changes in these estimates and assumptions could significantly affect
the Company's financial position or results of operations. The Company bases its
estimates on historical experience and on various other assumptions that it
believes to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities.
Actual results may differ from these estimates under different assumptions or
conditions. The significant and critical accounting policies used in the
preparation of the Company's financial statements are more fully described in
the Company's Annual Report on Form 10-K for the year ended December 31, 2002
and the Company's consolidated financial statements and the notes thereto.
Segment Results
The Company manages and evaluates the performance of its business segments
principally based upon segment operating contribution, which the Company defines
as revenue for the segment less operating expenses associated with the segment.
During the first quarter of 2003, in response to Regulation G and Item 10 of
Regulation S-K regarding the use of non-GAAP financial measures, the Company has
revised the composition of its segment presentation and restated all prior
periods presented. The following is a summary of total revenues, community
operating contribution, and total assets by segment for the three and six months
ended June 30, 2003 and 2002 (in thousands).(1)(2)
Three Months Ended
June 30, June 30, $ %
2003 2002 Change Change
---------- ---------- ---------- ----------
Revenues
Retirement centers $ 68,652 $ 64,140 $ 4,512 7.0%
Free-standing ALs 19,378 15,812 3,566 22.6%
Management services (3) 2,594 1,856 738 39.8%
-------------------------------------------
Total revenue $ 90,624 $ 81,808 $ 8,816 10.8%
===========================================
Retirement Centers
Resident and healthcare revenue $ 68,652 $ 64,140 $ 4,512 7.0%
Community operating expense 45,546 43,490 (2,056) (4.7%)
-------------------------------------------
Community operating contribution $ 23,106 $ 20,650 $ 2,456 11.9%
-------------------------------------------
Free-standing ALs
Resident and healthcare revenue $ 19,378 $ 15,812 $ 3,566 22.6%
Community operating expense 15,593 14,626 (967) (6.6%)
-------------------------------------------
Community operating contribution $ 3,785 $ 1,186 $ 2,599 219.1%
-------------------------------------------
Management services
Management services $ 1,314 $ 620 $ 694 111.9%
Reimbursed expense revenues 1,280 1,236 44 3.6%
Reimbursed expenses 1,280 1,236 (44) (3.6%)
-------------------------------------------
Management services operating
contribution $ 1,314 $ 620 $ 694 111.9%
-------------------------------------------
General and administrative expense $ 6,837 $ 6,554 (283) (4.3%)
Lease expense (4) 10,207 17,865 7,658 42.9%
Depreciation and amortization (5) 6,866 8,419 1,553 18.4%
-------------------------------------------
Operating income (loss) $ 4,295 $ (10,382) $ 14,677 141.4%
===========================================
22
Six Months Ended
June 30, June 30, $ %
2003 2002 Change Change
---------- ---------- ---------- ----------
Revenues
Retirement centers $ 135,933 $ 123,913 $ 12,020 9.7%
Free-standing ALs 38,149 30,569 7,580 24.8%
Management services (3) 4,746 3,372 1,374 40.8%
-------------------------------------------
Total revenue $ 178,828 $ 157,854 $ 20,974 13.3%
===========================================
Retirement Centers
Resident and healthcare revenue $ 135,933 $ 123,913 $ 12,020 9.7%
Community operating expense 90,510 82,432 (8,078) (9.8%)
-------------------------------------------
Community operating contribution $ 45,423 $ 41,481 $ 3,942 9.5%
-------------------------------------------
Free-standing ALs
Resident and healthcare revenue $ 38,149 $ 30,569 $ 7,580 24.8%
Community operating expense 31,366 28,759 (2,607) (9.1%)
-------------------------------------------
Community operating contribution $ 6,783 $ 1,810 $ 4,973 274.8%
-------------------------------------------
Management services
Management services $ 1,774 $ 685 $ 1,089 159.0%
Reimbursed expense revenues 2,972 2,687 285 10.6%
Reimbursed expenses 2,972 2,687 (285) (10.6%)
-------------------------------------------
Management services operating
contribution $ 1,774 685 $ 1,089 159.0%
-------------------------------------------
General and administrative expense $ 12,818 $ 12,474 (344) (2.8%)
Lease expense (4) 20,290 50,463 30,173 59.8%
Depreciation and amortization (5) 13,538 20,489 6,951 33.9%
-------------------------------------------
Operating income (loss) $ 7,334 $ (39,450) $ 46,784 118.6%
===========================================
June 30, December 31, $ %
2003 2002 Change Change
---------- ---------- ---------- ----------
Total Assets:
Retirement Centers $ 531,717 $ 539,764 $ (8,046) (1.5%)
Free-standing ALs 213,689 210,376 3,313 1.6%
Management services and other 58,648 89,858 (31,211) (34.7%)
-------------------------------------------
Total $ 804,054 $ 839,998 $ (35,944) (4.3%)
===========================================
Unit Occupancy
June 30, March 31, December 31, June 30,
2003 2003 2002 2002
---------- ---------- ---------- ----------
Resident Unit Occupancy:
Retirement Centers 93% 94% 94% 93%
Free-standing ALs 81% 81% 80% 74%
Management Services and other 90% 90% 90% 87%
-------------------------------------------
Total 90% 90% 91% 88%
===========================================
(1) Segment data does not include any inter-segment transactions or allocated
costs. During the three months ended June 30, 2003, the Company determined
that therapy revenues and expenses, previously reported net in
Free-standing AL revenues, should be reported gross within the respective
segments. During the three months ended March 31, 2003, in response to
Regulation G and Item 10 of Regulation S-K regarding the use of non-GAAP
financial measures, the Company has revised the composition of its segment
presentation and restated all prior periods presented. During the fourth
quarter of 2002, the Company determined that a community which had
previously been classified as a Free-standing AL had more characteristics
of a Retirement Center and the community was accordingly reclassified as a
Retirement Center. The amounts for the three and six months ended June 30,
2002 and 2003 have been restated to conform with the revised presentation.
23
(2) During the quarter ended September 30, 2002, the Company determined that a
Free-standing AL would be held-for-sale. Subsequently, in the quarter ended
March 31, 2003, the Company determined two additional Free-standing ALs
would also be held-for-sale. The Company's 2002 segment data was restated
to remove the results of discontinued operations.
(3) Management services revenues represent the Company's management services
revenues, as well as reimbursed expenses.
(4) Lease expense for the three and six months ended June 30, 2002 includes
$7.0 million and $30.2 million, respectively, of additional lease expense
for residual guarantees related to the termination of certain synthetic
leases as part of its 2002 Refinancing Plan.
(5) Depreciation and amortization expense for the three and six months ended
June 30, 2002 includes $2.3 million and $8.8 million, respectively, of
additional amortization expense related to the termination of certain
synthetic leases as part of the 2002 Refinancing Plan.
Results of Operations
The Company reported a net loss of $9.5 million, or $.53 loss per diluted share,
on total revenues of $90.6 million, as compared with a net loss of $19.4
million, or $1.12 loss per diluted share, on revenues of $81.8 million for the
three months ended June 30, 2003 and 2002, respectively. The loss for the three
months ended June 30, 2002 includes $7.0 million of additional lease expense
resulting from residual value guarantees on certain terminated synthetic lease
transactions and approximately $2.3 million of accelerated leasehold acquisition
cost amortization from these transactions. The Company reported a net loss of
$20.5 million, or $1.16 loss per diluted share, on total revenues of $178.8
million, as compared with a net loss of $57.5 million, or $3.33 loss per diluted
share, on revenues of $157.9 million for the six months ended June 30, 2003 and
2002, respectively. The loss for the six months ended June 30, 2002 includes
$30.2 million of additional lease expense resulting from residual value
guarantees on certain terminated synthetic lease transactions and approximately
$8.8 million of accelerated leasehold acquisition cost amortization from these
transactions. The improvements from 2002 were primarily the result of improved
community operating results and reduced lease and interest charges versus the
prior periods.
Three Months Ended June 30, 2003 Compared with the Three Months Ended June 30,
2002
Revenues. Total revenues were $90.6 million for the three months ended June 30,
2003, compared to $81.8 million for the three months ended June 30, 2002,
representing an increase of $8.8 million, or 10.8%. Resident and health care
revenues increased by $8.1 million during the 2003 period. Approximately $3.4
million related to increases in average billable revenue per unit, $2.7 million
related to increased revenues from ancillary services such as therapy and $2.5
million related to increased occupancy. The remaining increase relates primarily
to increased revenues from management services, offset by decreases in home
health and other revenues.
Management services revenue and reimbursed expenses both increased to $1.3
million, and both increased as a percentage of total revenue to 1.4% in the
three months ended June 30, 2003, from 0.8% and 1.5%, respectively, in the three
months ended June 30, 2002. The net increase in management services revenue is
primarily related to improvements in operating results at the managed
communities.
Retirement Center resident and health care revenues were $68.7 million in the
three months ended June 30, 2003, compared to $64.1 million in the three months
ended June 30, 2002, representing an increase of $4.5 million, or 7.0%.
Approximately $2.6 million related to increases in average billable revenue per
unit, increased revenues from EF Communities and ancillary services such as
therapy of $505,000 and $775,000, respectively, and $402,000 of this increase is
related to increased occupancy. The remaining increase relates to increased
revenues from other ancillary services.
Free-standing AL resident and health care revenues were $19.4 million in the
three months ended June 30, 2003, compared to $15.8 million in the three months
ended June 30, 2002, representing an increase of $3.6 million, or 22.6%. These
figures are net of the revenue for three communities held-for-sale and included
as a component of discontinued operations. Approximately $2.1 million of this
increase is related to increased occupancy, $662,000 related to increased
revenues from ancillary services such as therapy and $795,000 related to
increases in average billable revenue per unit.
24
In addition, certain per person annual Medicare reimbursement limits on therapy
services, which had been temporarily suspended, will become effective again on
September 1, 2003 (unless extended further). Certain pending legislation may
suspend the limits again effective January 2004. While the Company is unable to
quantify the impact that these new rules will have, it is expected that the
reimbursement limitations, if not suspended further, will reduce therapy
revenues, and negatively impact the Company's operating results. The Company
expects that growth in its therapy business, as a result of additional clinics
and expansion of existing programs, will at least partially offset the impact of
these new limits.
Entrance Fee Sales. The entrance fees paid by residents who enter EF Communities
represents a significant financial investment for residents. Recent economic
conditions and the declining stock market have had a negative effect on the
marketing of the Company's EF Communities. These negative market conditions have
been mitigated by the relatively strong resale housing market in many areas,
since many people utilize the equity in their homes to fund retirement housing.
In the prior period, the Company's significant debt obligations maturing in 2002
had a negative impact on the marketing of the EF Communities. With the
completion of the 2002 Refinancing Plan and increased sales and marketing
efforts at these EF Communities, the Company experienced stronger sales during
the first half of 2003 and anticipates continued progress during 2003 in the
marketing of its entrance fee units, resulting in higher cash flows from
entrance fee sales. During the quarter ended June 30, 2003, the Company's five
owned and leased EF Communities recorded $8.8 million of proceeds from entrance
fee sales, including $8.0 million from new sales and $800,000 from payments
received on deferred entrance fee receivables, and paid refunds as a result of
contract terminations of $3.7 million, resulting in $5.1 million net proceeds
from entrance fee sales. Additionally, the Company receives, through its formula
based management fee, the benefit of entrance fee sales of Freedom Square.
During the three months ended June 30, 2003, Freedom Square had proceeds from
entrance fee sales, net of refunds paid, of approximately $1.6 million.
Community Operating Expense. Community operating expense increased to $61.1
million in the three months ended June 30, 2003, as compared to $58.1 million in
the three months ended June 30, 2002, representing an increase of $3.0 million,
or 5.2%. Approximately $1.3 million of the increase resulted from increased
labor costs related to increased occupancy and to industry trends of higher
costs of nursing personnel. In addition, $663,000 of this increase is related to
costs associated with the expansion of therapy services to additional
communities during 2002 and 2003 and the growth of existing therapy programs,
$232,000 of additional marketing costs and food cost increases of $200,000,
primarily related to increased occupancy. The remaining increase results from
additional expenses such as insurance, utility, and property costs at various
communities. Community operating expense as a percentage of resident and health
care revenues decreased to 69.5% from 72.7% for the quarters ended June 30, 2003
and 2002, respectively.
Retirement Center community operating expenses were $45.5 million in the three
months ended June 30, 2003, compared to $43.5 million in the three months ended
June 30, 2002, representing an increase of $2.0 million, or 4.7%. Approximately
$335,000 of this increase is related to costs associated with the growth of the
therapy services program. In addition, increased labor costs related primarily
to industry trends of higher nursing and other costs amounted to $606,000. The
remaining increase results from additional expenses such as insurance, utility,
property and marketing costs at various communities.
Free-standing AL community operating expenses increased to $15.6 million in the
three months ended June 30, 2003 from $14.6 million in the three months ended
June 30, 2002, representing an increase of $1.0 million or 6.6%. Approximately
$664,000 of this increase is related to increased labor costs and approximately
$200,000 of food costs related primarily to occupancy increases. In addition,
costs associated with the growth of the therapy services program amounted to
$328,000. The remaining increase results from additional expenses such as
insurance, utility, property and marketing costs at various communities.
Segment Operating Contribution. The Company measures the performance of its
business segments, in part, based upon the operating contribution produced by
these business segments. The Company computes operating contribution by
deducting the operating expenses associated with a segment from the revenues
produced by that segment.
25
Retirement Center operating contribution increased $2.5 million, or 11.9%, to
$23.1 million for the three months ended June 30, 2003 from $20.6 million for
the three months ended June 30, 2002. This increase primarily relates to
continued operational improvement throughout the Retirement Centers resulting
from increased average billable revenue per unit, continued growth of the
therapy services program, stabilized occupancy and improved control of
community-level overhead expense.
Free-standing AL operating contribution improved by $2.6 million to $3.8 million
for the three months ended June 30, 2003, from $1.2 million for the three months
ended June 30, 2002, primarily as a result of increased occupancy at these
communities. In addition, the continued growth of the therapy services program
and increased average billable revenue per unit have increased the Free-standing
AL operating contribution.
Management services operating contribution increased by $694,000 to $1.3 million
in the three months ended June 30, 2003, attributable to increased management
fees resulting from improved operating results at managed communities.
General and Administrative. General and administrative expense increased to $6.8
million for the three months ended June 30, 2003, as compared to $6.6 million
for the three months ended June 30, 2002, representing an increase of $283,000,
or 4.3%. This increase is primarily related to slight increases related to
marketing, legal, relocation, and other costs. General and administrative
expense as a percentage of total consolidated revenues decreased to 7.5% as
compared to 8.0% for the three months ended June 30, 2003 and 2002,
respectively. The Company believes that measuring general and administrative
expense as a percentage of total consolidated revenues and combined revenues
(including unconsolidated managed revenues) provides insight as to the nature of
the Company's overhead in relation to total operating activities (including
managed). General and administrative expense as a percentage of total combined
revenues decreased to 6.2% from 6.5% for the three months ended June 30, 2003
and 2002, respectively, computed as follows:
Three Months ended
June 30,
---------------------
2003 2002
---------- ----------
Total consolidated revenues $ 90,624 $ 81,808
Revenues of unconsolidated managed communities 20,690 20,206
Less management fees (1,314) (620)
---------------------
Total combined revenue $ 110,000 $ 101,394
=====================
Total general and administrative expense $ 6,837 $ 6,554
====================
General and administrative expense as a % of total
consolidated revenues 7.5% 8.0%
=====================
General and administrative expense as a % of total
combined revenue 6.2% 6.5%
=====================
Lease Expense. As of June 30, 2003, the Company had operating leases for 26 of
its communities, including 12 Retirement Centers and 14 Free-standing ALs. Lease
expense decreased $7.7 million to $10.2 million for the three months ended June
30, 2003 from $17.9 million for the three months ended June 30, 2002. This
decrease was primarily attributable to the additional lease expense of $7.0
million recorded during the three months ended June 30, 2002, related to
residual value guarantees for the termination of certain synthetic leases on
Free-standing ALs. As of September 30, 2002, the Company no longer operated any
of its Free-standing ALs under synthetic lease structures. Excluding the
synthetic lease expense, lease expense increased $1.4 million as a result of
certain sale-leaseback transactions completed in 2002.
Depreciation and Amortization. Depreciation and amortization expense increased
to $6.3 million in the three months ended June 30, 2003 from $5.4 million in
the three months ended June 30, 2002, representing an increase of $955,000, or
17.7%. The increase was primarily related to an increase in depreciable assets
of approximately $63.3 million, mainly due to the addition of assets from the
termination of synthetic leases.
26
Amortization of Leasehold Acquisition Costs. Amortization of leasehold
acquisition costs decreased $2.5 million to $530,000 in the three months ended
June 30, 2003 from $3.0 million in the three months ended June 30, 2002. The
2002 period included $2.3 million of accelerated amortization of leasehold
acquisition costs related to the termination of synthetic leases.
Other Income (Expense). Interest expense increased to $14.0 million for the
three months ended June 30, 2003 from $9.8 million for the three months ended
June 30, 2002, representing an increase of $4.2 million, or 43.1%. This increase
was primarily attributable to higher average cost debt as a result of the
refinancing completed in 2002 (including the deferred interest on the HCPI loan,
not paid until maturity). Interest expense as a percentage of total revenues,
increased to 15.4% for the three months ended June 30, 2003 from 11.9% in the
three months ended June 30, 2002. Interest income decreased to $868,000 in the
three months ended June 30, 2003 from $1.3 million in the three months ended
June 30, 2002, representing a decrease of $400,000, or 31.5%. The decrease in
interest income was primarily attributable to reduced amounts of certificates of
deposit and notes receivable balances associated with certain terminated leasing
transactions and the Freedom Plaza Arizona management agreement.
Income Taxes. The provision for income taxes was an expense of $64,000 and
$122,000 for the three months ended June 30, 2003 and 2002, respectively, for
state taxes. The Company has applied a full deferred tax asset valuation
allowance related to its available net operating carryforwards.
Minority Interest in Earnings of Consolidated Subsidiaries, Net of Tax. Minority
interest in earnings of consolidated subsidiaries, net of tax, was $629,000 for
the three months ended June 30, 2003. This amount was attributable to the HCPI
Equity Investment during September 2002.
Discontinued Operations. During the quarter ended September 30, 2002, the
Company determined that a Free-standing AL would be held-for-sale. Subsequently,
in the quarter ended March 31, 2003, the Company determined two additional
Free-standing ALs would be held-for-sale. The Company has executed sale
agreements relating to these three communities, which are subject to various
contingencies. If consummated, the Company will use most of the proceeds to
repay mortgage debt and other related payments. For the three months ended June
30, 2003 and 2002, the Company recorded a loss from discontinued operations of
$337,000 and $621,000, respectively, for these three Free-standing ALs. The 2002
results of these communities were reclassified to discontinued operations.
Net Loss. Based upon the factors noted above, the Company experienced a net loss
of $9.5 million, or $.53 loss per dilutive share, compared to a net loss of
$19.4 million, or $1.12 loss per dilutive share, for the three months ended June
30, 2003 and 2002, respectively. The $.53 loss per dilutive share for the three
months ended June 30, 2003 was comprised of a $.51 loss from continuing
operations and $.02 loss from discontinued operations related to the three
communities held-for-sale. The loss of $1.12 per dilutive share for the three
months ended June 30, 2002 was comprised of a $1.08 loss from continuing
operations and $.04 loss from discontinued operations.
27
Six Months Ended June 30, 2003 Compared with the Six Months Ended June 30, 2002
Revenues. Total revenues were $178.8 million for the six months ended June 30,
2003, compared to $157.8 million for the six months ended June 30, 2002,
representing an increase of $21.0 million, or 13.3%. Resident and health care
revenues increased by $19.6 million during the 2003 period. Approximately $6.3
million related to increases in average billable revenue per unit and $5.8
million of this increase is related to increased occupancy. Over $4.1 million of
the increase attributable to the addition of Freedom Plaza Arizona as a
consolidated Retirement Center effective April 2002 as a result of the
conversion of the Company's prior management agreement into a lease, and $3.6
million is related to revenues from therapy services. These increases are offset
by reductions in home health revenues.
Management services revenue and reimbursed expenses increased to $1.8 million
and $3.0 million respectively, and increased as a percentage of total revenue to
1.0% and 1.7%, respectively, in the six months ended June 30, 2003, from 0.4%
and 1.7%, respectively, in the six months ended June 30, 2002. The net increase
in management services revenue is primarily related to changes in operating
results at the managed communities.
Retirement Center resident and health care revenues were $135.9 million in the
six months ended June 30, 2003, compared to $123.9 million in the six months
ended June 30, 2002, representing an increase of $12.0 million, or 9.7%.
Approximately $5.3 million of the increase resulted from increases in average
billable revenue per unit, $4.1 million of this increase is related to the April
1, 2002 long-term lease (and the resulting consolidation of revenues) of Freedom
Plaza Arizona, $2.4 million related to increased revenues from therapy services
and $588,000 related to increases in occupancy. These increases are offset by
reduced home health revenues.
Free-standing AL resident and health care revenues were $38.1 million in the six
months ended June 30, 2003, compared to $30.6 million in the six months ended
June 30, 2002, representing an increase of $7.5 million, or 24.8%. These figures
are net of the revenue for three communities held-for-sale which are included as
a component of discontinued operations. Approximately $5.2 million of this
increase is related to increased occupancy, $1.2 million related to increased
revenues from therapy services, and $1.0 million related to increases in average
billable revenue per unit. The remaining increase relates to increased revenues
from other ancillary fees and services.
In addition, certain per person annual Medicare reimbursement limits on therapy
services, which had been temporarily suspended, will become effective again on
September 1, 2003 (unless suspended further). Certain pending legislation may
suspend the limits again effective January 2004. While the Company is unable to
quantify the impact that these new rules will have, it is expected that the
reimbursement limitations, if not suspended further, will reduce therapy
revenues, and negatively impact the Company's operating results. The Company
expects that growth in its therapy business, as a result of additional clinics
and expansion of existing programs, will at least partially offset the impact of
these new limits.
Entrance Fee Sales. The entrance fee paid by residents who enter EF Communities
represents a significant financial investment for residents. Accordingly, recent
economic conditions and the declining stock market have had a negative effect on
the marketing of the Company's EF Communities. These negative market conditions
have been mitigated by the relatively strong resale housing market in many
areas, since many people utilize the equity in their homes to fund retirement
housing. In the prior period, the Company's significant debt obligations
maturing in 2002 had a negative impact on the marketing of the EF Communities.
With the completion of the 2002 Refinancing Plan and increased sales and
marketing efforts at these EF Communities, the Company experienced stronger
sales during the first half of 2003 and anticipates continued progress during
2003 in the marketing of its entrance fee units, resulting in higher cash flows
from entrance fee sales. During the six months ended June 30, 2003, the
Company's five owned and leased EF Communities recorded $14.7 million of
proceeds from entrance fee sales, including $13.2 million from new sales and
$1.5 million from payments received on deferred entrance fee receivables, and
paid refunds as a result of contract terminations of $6.4 million, resulting in
$8.3 million net proceeds from entrance fee sales. During the six months ended
June 30, 2002, the Company's five owned and leased EF Communities recorded $9.1
million of proceeds from entrance fee sales, including $8.2 million from new
sales and $900,000 from payments received on deferred entrance fee receivables,
and paid refunds as a result of contract terminations of $4.0 million, resulting
in $5.1 million net proceeds from entrance fee sales. Therefore, the Company
experienced $5.6 million of increased proceeds from entrance fee sales,
including $5.0 million from new sales and $600,000 from payments received on
deferred entrance fees receivable, and paid additional refunds as a result of
contract terminations of $2.4 million, resulting in $3.2 million of additional
net proceeds from entrance fee sales, when comparing the six month period ended
June 30, 2003 and 2002. Approximately $423,000 of the $3.2 million increase
results from the April 1, 2002 long-term lease (and the resulting consolidation)
of Freedom Plaza Arizona. The remaining increase relates to increased sales at
the EF Communities. Additionally, the Company receives, through its formula
based management fee, the benefit of entrance fee sales at Freedom Square.
During the six months ended June 30, 2003, Freedom Square had proceeds from
entrance fee sales, net of refunds paid, of approximately $1.9 million.
28
Community Operating Expense. Community operating expense increased to $121.9
million in the six months ended June 30, 2003, as compared to $111.2 million in
the six months ended June 30, 2002, representing an increase of $10.7 million,
or 9.6%. Approximately $3.3 million of the increase resulted primarily from
additional community expenses as a result of the long-term lease (and the
resulting consolidation of expenses) of Freedom Plaza Arizona. In addition,
increased labor costs amounted to $3.1 million related to occupancy increases,
and increased costs of nursing staff. Approximately $1.4 million of this
increase is related to costs associated with the expansion of therapy services
to additional communities during 2002 and 2003, additional marketing expense of
$574,000 and food cost increases amounted to $464,000. The remaining increase
results from additional expenses such as insurance, utility, and property costs
at various communities. Community operating expense as a percentage of resident
and health care revenues decreased to 70.0% from 72.0% for the six months ended
June 30, 2003 and 2002, respectively.
Retirement Center community operating expenses were $90.5 million in the six
months ended June 30, 2003, compared to $82.4 million in the six months ended
June 30, 2002, representing an increase of $8.1 million, or 9.8%. Approximately
$3.3 million of this increase was attributable to the April 1, 2002 long-term
lease of Freedom Plaza Arizona. In addition, increased labor costs amounted to
$1.5 million from increased rates and nursing costs of qualified personnel.
Approximately $811,000 relates to additional marketing expense and $804,000 of
this increase is related to costs associated with the growth of the therapy
services program. The remaining increase results from additional expenses such
as insurance, utility, and property costs at various communities.
Free-standing AL community operating expenses increased to $31.4 million in the
six months ended June 30, 2003 from $28.8 million in the six months ended June
30, 2002, representing an increase of $2.6 million or 9.1% Approximately $1.6
million of this increase is related to increased labor costs and $464,000 of
increased food costs related primarily to increased occupancy. In addition,
costs associated with the growth of the therapy services program amounted to
$600,000. The remaining variance results from additional expenses such as
insurance, offset by reductions in other expenses.
Segment Operating Contribution. The Company measures the performance of its
business segments, in part, based upon the operating contribution produced by
these business segments. The Company computes operating contribution by
deducting the operating expenses associated with a segment from the revenues
produced by that segment.
Retirement Center operating contribution increased $3.9 million, or 9.5%, to
$45.4 million for the six months ended June 30, 2003 from $41.5 million for the
six months ended June 30, 2002. This increase primarily relates to continued
operational improvement throughout the Retirement Centers resulting from
increased average billable revenue per unit, continued growth of the therapy
services program, stabilized occupancy and improved control of community-level
overhead expense, as well as the April 2002 addition of the long-term lease of
Freedom Plaza Arizona.
29
Free-standing AL operating contribution improved by $5.0 million to $6.8 million
for the six months ended June 30, 2003, from $1.8 million for the six months
ended June 30, 2002, primarily as a result of increased occupancy at these
communities. In addition, the continued growth of the therapy services program
and increased average billable revenue per unit have increased the Free-standing
AL operating contribution.
Management services operating contribution increased by $1.1 million to $1.8
million in the six months ended June 30, 2003, attributable to increased
management fees resulting from improved operating results at managed
communities.
General and Administrative. General and administrative expense increased to
$12.7 million for the six months ended June 30, 2003, as compared to $12.8
million for the six months ended June 30, 2002, representing an increase of
$394,000, or 2.8%. This increase is primarily related to slight increases
related to marketing, legal, relocation, and other costs. General and
administrative expense as a percentage of total consolidated revenues decreased
to 7.2% as compared to 7.9% for the six months ended June 30, 2003 and 2002,
respectively. The Company believes that measuring general and administrative
expense as a percentage of total consolidated revenues and combined revenues
(including unconsolidated managed revenues) provides insight as to the nature of
the Company's overhead in relation to total operating activities (including
managed). General and administrative expense as a percentage of total combined
revenues decreased to 5.9% from 6.2% for the six months ended June 30, 2003 and
2002, respectively, computed as follows:
Six Months ended
June 30,
---------------------
2003 2002
---------- ----------
Total consolidated revenues $ 178,828 $ 157,854
Revenues of unconsolidated managed communities 41,860 44,054
Less management fees (1,774) (685)
---------------------
Total combined revenue $ 218,914 $ 201,223
=====================
Total general and administrative expense $ 12,818 $ 12,474
=====================
General and administrative expense as a % of total
consolidated revenues 7.2% 7.9%
=====================
General and administrative expense as a % of total
combined revenue 5.9% 6.2%
=====================
Lease Expense. As of June 30, 2003, the Company had operating leases for 26 of
its communities, including 12 Retirement Centers and 14 Free-standing ALs. Lease
expense decreased $30.2 million to $20.3 million for the six months ended June
30, 2003 from $50.5 million for the six months ended June 30, 2002. This
decrease was attributable to the additional lease expense of $30.2 million
recorded during the six months ended June 30, 2002, related to residual value
guarantees for the termination of certain synthetic leases on Free-standing ALs.
As of September 30, 2002, the Company no longer operated any of its
Free-standing ALs under synthetic lease structures. Excluding the synthetic
lease expense, lease expense increased $4.9 million as a result of certain
sale-leaseback transactions completed in 2002.
Depreciation and Amortization. Depreciation and amortization expense increased
to $12.5 million in the six months ended June 30, 2003 from $10.4 million in the
six months ended June 30, 2002, representing an increase of $2.1 million, or
20.5%. The increase was primarily related to an increase in depreciable assets
of approximately $63.3 million, mainly due to the addition of assets from the
termination of synthetic leases and the addition of the Freedom Plaza Arizona
lease.
Amortization of Leasehold Acquisition Costs. Amortization of leasehold
acquisition costs decreased $9.1 million to $1.0 million in the six months ended
June 30, 2003 from $10.1 million in the six months ended June 30, 2002. The 2002
period included $8.8 million of accelerated amortization of leasehold
acquisition costs related to the termination of synthetic leases.
Other Income (Expense). Interest expense increased to $26.8 million for the six
months ended June 30, 2003 from $20.2 million for the six months ended June 30,
2002, representing an increase of $6.6 million, or 32.8%. This increase was
primarily attributable to higher average cost debt as a result of refinancing
completed in 2002 (including the deferred interest on the HCPI loan, not paid
until maturity). Interest expense as a percentage of total revenues increased to
15.0% for the six months ended June 30, 2003 from 12.8% in the six months ended
June 30, 2002. Interest income decreased to $1.5 million in the six months ended
June 30, 2003 from $2.9 million in the six months ended June 30, 2002,
representing a decrease of $1.4 million or 46.6%. The decrease in interest
income was primarily attributable to reduced amounts of certificates of deposit
and notes receivable balances associated with certain terminated leasing
transactions and the Freedom Plaza Arizona management agreement.
30
Income Taxes. The provision for income taxes was an expense of $194,000 and
$219,000 for the six months ended June 30, 2003 and 2002, respectively, for
state taxes. The Company has applied a full deferred tax asset valuation
allowance related to its available net operating carryforwards.
Minority Interest in Earnings of Consolidated Subsidiaries, Net of Tax. Minority
interest in earnings of consolidated subsidiaries, net of tax, was $1.2 million
or the six months ended June 30, 2003. This amount was primarily attributable to
the HCPI Equity Investment during September 2002.
Discontinued Operations. During the quarter ended September 30, 2002, the
Company determined that a Free-standing AL would be held-for-sale. Subsequently,
in the quarter ended March 31, 2003, the Company determined two additional
Free-standing ALs would be held-for-sale. The Company has executed sale
agreements relating to these three communities, which are subject to various
contingencies. If consummated, the Company will use most of the proceeds to
repay mortgage debt and other related payments. For the six months ended June
30, 2003 and 2002, the Company recorded a loss from discontinued operations of
$1.6 million and $1.4 million, respectively, for these three Free-standing ALs.
The loss recorded for the six months ended June 30, 2003 includes a loss of
$821,000 resulting from the write-off of a contingent earnout recorded as part
of a 2002 sale-leaseback transaction related to one of the Free-standing ALs.
The 2002 results of these communities were reclassified to reflect loss from
discontinued operations.
Net Loss. Based upon the factors noted above, the Company experienced a net loss
of $20.5 million, or $1.16 loss per dilutive share, compared to a net loss of
$57.5 million, or $3.33 loss per dilutive share, for the six months ended June
30, 2003 and 2002, respectively. The $1.16 loss per dilutive share for the six
months ended June 30, 2003 was comprised of a $1.07 loss from continuing
operations and $.09 loss from discontinued operations related to the three
communities held-for-sale. The loss of $3.33 per dilutive share for the six
months ended June 30, 2002 was comprised of a $3.25 loss from continuing
operations and $.08 loss from discontinued operations.
Liquidity and Capital Resources
As a result of completing the 2002 Refinancing Plan, the Company has extended
the maturity of substantially all of its debt arrangements to January 2004 or
later, and is now focused on increasing the operating cash flow of its three
business segments. During the three and six months ended June 30, 2003, although
the Company was able to reduce its net loss and improve operating results from
its Retirement Center and Free-standing AL business segments, it still
experienced a net cash use by continuing operations activities of $4.9 million.
The Company is focusing its efforts on generating positive cash from operating
activities, primarily through improvements in its operating results.
As of June 30, 2003, the Company had approximately $12.4 million in unrestricted
cash and cash equivalents and $6.4 million of working capital. The Company has
scheduled current debt principal payments of $28.1 million, which includes $10.9
million of debt associated with assets held-for-sale, and minimum rental
obligations of $45.3 million under long-term operating leases due during the
twelve months ended June 30, 2004. When assets held-for-sale are sold, the
Company will use most of the proceeds to repay mortgage debt and other related
payments.
The Company's cash flow from operations for the six months ended June 30, 2003
was negative. Because expected cash flows from operations, including anticipated
improvements, will not be sufficient to meet these requirements, the Company
plans to refinance or extend portions of this debt prior to its maturity.
However, the Company believes that its current cash and cash equivalents,
expected cash flow from operations, the proceeds from additional financing
transactions and the proceeds of assets currently held-for-sale will be
sufficient to fund its operating requirements, capital expenditure requirements,
periodic debt service requirements, and lease obligations during the next twelve
months.
31
In order to meet its future payment obligations, the Company will need to
continue to improve its cash flow from operations, complete the disposition of
certain of the assets currently held-for-sale, and consummate various financing
transactions. There can be no assurance that the Company's operations will
improve as rapidly as anticipated or that the contemplated asset disposition and
refinancing transactions can be consummated during the anticipated timeframes.
The failure to make its periodic debt and lease payment obligations, or the
failure to extend, refinance or repay any of its debt obligations as they become
due would have a material adverse effect upon the Company.
Cash Flow
Net cash used by continuing operations was $2.2 million for the six months ended
June 30, 2003, as compared with net cash used of $11.3 million for the six
months ended June 30, 2002. The Company's cash and cash equivalents totaled
$12.4 million as of June 30, 2003, as compared to $12.2 million as of June 30,
2002.
Net cash used by investing activities was $6.0 million for the six months ended
June 30, 2003, as compared with $65.5 million provided for the six months ended
June 30, 2002. During the six months ended June 30, 2003, the Company added $4.6
million to land, buildings and equipment, issued $2.4 million of notes
receivable, and received $1.3 million of distributions from joint ventures.
Net cash provided by financing activities was $2.4 million compared with $61.2
million used by financing activities during the six months ended June 30, 2003
and 2002, respectively. During the six months ended June 30, 2003 the Company
received proceeds of $7.6 million from the issuance of long-term debt, accrual
of deferred interest of $6.4 million, made principal payments on its
indebtedness of $9.0 million, paid $693,000 of financing costs and made
distributions to the minority interest holder of $613,000. In connection with
certain entrance fee communities, the Company made principal payments under
master trust agreements of $703,000.
Net cash used by discontinued operations was $2,000 and $53,000 for the six
months ended June 30, 2003 and 2002, respectively. Loss from discontinued
operations was $1.6 million and $1.4 million for the six months ended June 30,
2003 and 2002, respectively.
Financing Activity
In August 2003, the Company and one of its lenders signed an agreement to
refinance $40.4 million of mortgage debt previously due April 1, 2004. The
refinanced debt is due April 1, 2005. The Company has presented $33.0 million of
this debt as long-term and $7.4 million as debt related to assets held-for-sale
on the condensed consolidated financial statements herein.
During the six months ended June 30, 2003, holders of Series B Notes elected to
convert $3.1 million of the convertible debentures to common stock at the
conversion price of $2.25 per share. The Company issued 1,366,862 common shares,
par value $0.01 per share.
On February 28, 2003 the Company sold a Free-standing AL in Florida for $6.5
million. The sale agreement contains certain formula-based earnout provisions
which may provide for up to $1.1 million of additional sales proceeds to the
Company based on future performance. The Company contemporaneously leased the
property back from the buyer by including it in a pre-existing master lease with
the buyer. As a result of the contingent earnout provision, this Free-standing
AL lease is classified as a lease financing transaction and, accordingly, the
Company recorded $6.5 million of lease obligations as debt, bearing interest at
8.76%. The master lease agreement which the Company entered into on March 28,
2002, previously included three Retirement Centers and three Free-standing ALs.
The amended lease is a 15-year lease (approximately 14 years remaining) with two
ten-year renewal options.
32
The Company has the right of first refusal to repurchase the leased communities.
As a result of this lease amendment, the Company is no longer eligible for a
contingent earnout of one of these communities that is currently held-for-sale,
resulting in a $821,000 write-off and conversion from financing to operating
lease treatment for this community.
Although the Company successfully completed its Refinancing Plan during 2002, it
remains highly leveraged with a substantial amount of debt and lease
obligations. The 2002 Refinancing Plan replaced a significant amount of mortgage
debt and lower rate convertible debentures with debt and leases at higher rates,
significantly increasing the Company's annual debt and lease payments. In
addition to the scheduled maturities of long-term debt, the Company will be
required to pay all accrued but unpaid interest on the HCPI Loan at its maturity
or earlier repayment. Unless paid earlier, the accrued interest on the HCPI Loan
at its September 2007 maturity will be approximately $89.9 million.
The Company is permitted to repay the HCPI Loan in whole or in part after three
years and redeem the HCPI Equity Investment after four years. In the event that
the Company does not repay the HCPI Loan at maturity in 2007, HCPI may foreclose
upon the Company's ownership interests in the Real Estate Companies that
currently own nine of the Company's Retirement Centers, and the Company will
continue to operate the nine Retirement Centers pursuant to a long-term lease
with an initial term of 15 years, and two ten year renewal options. The Company
intends to repay, subject to available funds, the HCPI Loan on or before its
maturity in 2007 and repurchase the HCPI Equity Investment at the end of four
years. However, if the Company does not repay the HCPI Loan and repurchase the
HCPI Equity Investment at the end of five years, and HCPI forecloses upon its
collateral, the Company will realize significant taxable income, which may
exceed substantially the Company's net operating loss carryforward resulting in
a significant net tax liability to the Company.
Certain of the Company's debt agreements and leases contain various financial
and other restrictive covenants. During the three and six months ended June 30,
2003, the Company obtained a covenant waiver on a lease related to a single
community. At June 30, 2003, the Company was in compliance with all other debt
and lease covenants. However, there can be no assurances that the Company will
remain in compliance with those covenants or that the Company's creditors will
grant amendments or waivers in the event of future non-compliance. Any
non-payment or other default under the Company's debt instruments, leases or
mortgages (including non-compliance with financial or restrictive covenants)
could cause the Company's lenders or lessors to declare defaults, accelerate
payment obligations or foreclose upon the communities securing such indebtedness
or exercise their remedies with respect to such communities. Furthermore,
because of cross-default provisions in most of the Company's mortgages, debt
instruments, and leases, a default by the Company on one of its debt instruments
or lease agreements is likely to result in a default or acceleration of
substantially all of the Company's other obligations, which would have a
material adverse effect on the Company.
33
Future Cash Commitments
The following tables summarize the Company's total contractual obligations and
commercial commitments as of June 30, 2003 (amounts in thousands):
Payments Due by Period
------------------------------------------------------------------------------------
Total Year 1 Year 2 Year 3 Year 4 Year 5 Thereafter
----------- ---------- ---------- --------- --------- ---------- ----------
Long-term debt(1) $ 386,848 $ 11,589 $ 131,862 $ 1,765 $ 1,772 $ 162,376 $ 77,484
Debt associated with assets
held-for-sale 10,883 10,883 - - - - -
Lease financing obligations 127,021 5,653 6,239 6,891 7,594 8,328 92,316
Operating leases 603,931 45,344 46,031 46,733 47,453 47,089 371,281
Accrued interest on HCPI Loan(1) 80,561 - - - - 80,561 -
----------- ---------- ---------- --------- --------- ---------- ----------
Total contractual cash
obligations $1,209,244 $ 73,469 $ 184,132 $ 55,389 $ 56,819 $ 298,354 $ 541,081
----------- ---------- ---------- --------- --------- ---------- ----------
Interest income on notes
receivable(2) (25,531) (1,097) (1,084) (1,074) (1,062) (1,054) (20,160)
----------- ---------- ---------- --------- --------- ---------- ----------
Contractual obligations, net $1,183,713 $ 72,372 $ 183,048 $ 54,315 $ 55,757 $ 297,300 $ 520,921
=========== ========== ========== ========= ========= ========== ==========
Amount of Commitment Expiration Per Period
------------------------------------------------------------------------------------
Total
Committed Year 1 Year 2 Year 3 Year 4 Year 5 Thereafter
----------- ---------- ---------- --------- --------- ---------- ----------
Guaranties(3) $ 36,237 $ 1,130 $ 1,230 $ 1,340 $ 9,514 $ 1,382 $ 21,641
----------- ---------- ---------- --------- --------- ---------- ----------
Total commercial commitments $ 36,237 $ 1,130 $ 1,230 $ 1,340 $ 9,514 $ 1,382 $ 21,641
=========== ========== ========== ========= ========= ========== ==========
(1) The HCPI Loan matures on September 30, 2007 and has a cash interest payment
rate of 9% per year, which increases after April 2004 by fifty-five basis
points each year, plus additional accrued interest (which converts to
principal) to its stated interest rate of 19.5% compounding quarterly. The
Year 5 long-term debt amount includes $9.8 million of the accrued interest
which has converted to principal. The amount of interest reflected above
represents the unpaid interest which the Company will be accruing and
compounding quarterly until its September 30, 2007 maturity, unless
paid-off earlier.
(2) A portion of the lease payments noted in the above table is repaid to the
Company as interest income on notes receivable from the lessors.
(3) Guarantees include mortgage debt related to four communities and part of a
like-kind exchange acquired in 2001. The mortgage debt guaranteed by the
Company relates to two Retirement Centers under a long-term management
agreement and a long-term operating lease agreement and one of the
Company's two joint ventures.
The Company routinely makes capital expenditures to maintain or enhance
communities under its control. The Company's capital expenditure budget for
fiscal 2003 is approximately $13.3 million.
Risks Associated with Forward Looking Statements
This Form 10-Q contains certain forward-looking statements within the meaning of
the federal securities laws, which are intended to be covered by the safe
harbors created thereby. Those forward-looking statements include all statements
that are not historical statements of fact and those regarding the intent,
belief or expectations of the Company or its management including, but not
limited to, all statements concerning the Company's anticipated improvement in
operations and anticipated or expected cashflow; the discussions of the
Company's operating and growth strategy; the Company's liquidity and financing
needs; the Company's expectations regarding future entry fee sales or increasing
occupancy at its Retirement Centers or Free-standing ALs; the Company's
alternatives for raising additional capital and satisfying its periodic debt and
lease obligations; the projections of revenue, income or loss, capital
expenditures, and future operations; and the availability of insurance programs.
All forward-looking statements involve risks and uncertainties including,
without limitation, (i) the fact that the Company's cashflow does not currently
cover its obligations, (ii) the possibility of future defaults under the
Company's debt and lease agreements, (iii) the risks associated with the
Company's financial condition and the fact that the Company is highly leveraged,
(iv) the risk that the Company will be unable to reduce the operating losses at
its Free-standing ALs, sell its entry fee units or increase its cash flow or
generate expected levels of cash, (v) the risk that the Company's equity deficit
may adversely effect the Company's business and/or prospects, (vi) the risk that
alternative financing sources will not be available to the Company, (vii) the
risk that the Company will be unable to sell the assets that it currently has
held-for-sale, (viii) the risks associated with the adverse market conditions
for the senior living industry, (ix) the risk that the Company will be unable to
obtain liability insurance in the future or that the costs associated with such
insurance (including the costs of deductibles) will be prohibitive, (x) the
likelihood of further and tighter governmental regulation, and (xi) the risks
and uncertainties set forth under the caption "Risk Factors" in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2002 and the
Company's other filings with the Securities and Exchange Commission.
34
Should one or more of these risks materialize, actual results could differ
materially from those forecasted or expected. Although the Company believes that
the assumptions underlying the forward-looking statements contained herein are
reasonable, any of these assumptions could prove to be inaccurate, and
therefore, there can be no assurance that the forward-looking statements
included in this Form 10-Q will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking statements included
herein, the inclusion of such information should not be regarded as a
representation by the Company or any other person that the forecasts,
expectations, objectives or plans of the Company will be achieved. The Company
undertakes no obligation to publicly release any revisions to any
forward-looking statements contained herein to reflect events and circumstances
occurring after the date hereof or to reflect the occurrence of unanticipated
events.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Disclosure About Interest Rate Risk The Company is subject to market risk from
exposure to changes in interest rates based on its financing, investing, and
cash management activities. The Company utilizes a balanced mix of debt
maturities along with both fixed-rate and variable-rate debt to manage its
exposures to changes in interest rates. For fixed rate debt, changes in interest
rates generally affect the fair market value of the debt, but not earnings or
cash flows. Conversely, for variable rate debt, changes in interest rates
generally do not impact fair market value of the debt, but do affect the future
earnings and cash flows. The Company generally does not prepay fixed rate debt
prior to maturity without penalty. Therefore, interest rate risk and changes in
fair market value should not have a significant impact on the fixed rate debt
until the Company is required to refinance such debt. The Company has $200.8
million of variable rate debt at June 30, 2003. However, $164.7 million of the
variable rate debt agreements contain interest rate floors which allow market
interest rates to fluctuate without necessarily changing the Company's interest
rate. Therefore, considering the $36.1 million of variable rate debt without
such interest rate floors, each one-percentage point increase in interest rates
would result in an increase in interest expense for the coming year of
approximately $361,000.
The Company has previously entered into an interest rate swap agreement with a
major financial institution. The swap involves the receipt of a fixed interest
rate payment in exchange for the payment of a variable rate interest payment
without exchanging the notional principal amount. Receipts on the agreement are
recorded as a reduction to interest expense. Under the agreement the Company
receives a fixed rate of 6.87% on the $34.8 million of debt, and pays a floating
rate stated by the swap agreement based upon LIBOR and a foreign currency index
with a maximum rate of 8.12%. The Company has also entered into two interest
rate cap agreements on $32.8 million and $18.3 million of mortgage notes to
limit the Company's interest rate exposure, which expire on May 1, 2005 and July
1, 2005, respectively. Under the terms of the interest rate cap agreements, the
Company receives payments from the counterparty if 30-day LIBOR exceeds 5.8%
over the term of each mortgage.
The Company does not expect changes in interest rates to have a material effect
on income or cash flows in 2003, since $324.0 million, or 61.7% of the Company's
debt has fixed rates. There can be no assurances, however, that interest rates
will not significantly change and materially affect the Company.
35
Disclosure About Market Exchange Risk The Company has received notice from the
NYSE that it is currently below the NYSE's continued listing requirements
relating to total market capitalization of $50 million and minimum shareholder's
equity of $50 million. As permitted by the NYSE, the Company has submitted a
plan demonstrating how the Company intends to comply in the future with the
listing requirements. The NYSE has accepted the Company's plan, allowing it to
continue its listing, subject to ongoing monitoring by the NYSE of the Company's
progress versus this plan. There can be no assurance that the Company will be
able to comply with these requirements, or show sufficient progress toward
meeting the requirements within timeframes acceptable to the NYSE. If the
Company's common stock is not eligible for trading on the NYSE, the liquidity
and value of its common stock could be adversely affected. Should the Company's
shares cease to be traded on the NYSE, the Company believes an alternative
trading market will be available for its common stock. If the Company's common
stock were not listed or quoted on another market or exchange, trading in the
Company's common stock would be conducted in the over-the-counter market on an
electronic bulletin board established for unlisted securities. As a result, an
investor would find it more difficult to trade, or to obtain accurate quotations
for the price of, the Company's common stock. If the Company is not able to have
its common stock listed or quoted on another acceptable market or exchange, the
liquidity and value of its common stock would be adversely affected.
Item 4. Control and Procedures
(a) Evaluation of disclosure controls and procedures: Under the supervision and
with the participation of the Company's management, including the Company's
chief executive officer and chief financial officer, the Company conducted an
evaluation of its disclosure controls and procedures, as such term is defined
under Rules 13a-14(c) and 15d-14(c) promulgated under the Securities Exchange
Act of 1934, as amended, as of June 30, 2003. Based on this evaluation, the
chief executive officer and chief financial officer concluded that the Company's
disclosure controls and procedures are effective in timely alerting them to
material information required to be included in the Company's periodic reports
and is (i) accumulated and communicated to the Company's management in a timely
manner, and (ii) recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms.
(b) Changes in internal control over financial reporting: There have been no
significant changes (including corrective actions with regard to significant
deficiencies or material weaknesses) in the Company's internal control over
financial reporting or in other factors that could significantly affect this
control subsequent to the date of the most recent evaluation of the Company's
internal control over financial reporting.
36
PART II. OTHER INFORMATION
Item 4. Submission of Matters to A Vote of Security Holders
The Company held its annual meeting of shareholders on May 20, 2003 (the "Annual
Meeting"). At the Annual Meeting, the shareholders of the Company voted to elect
two Class III directors for a term of three years, and until their successors
are duly elected and qualified.
The following table sets forth the number of votes cast for, abstain/witheld
with respect to each of the director nominees:
Director Nominee For Abstain/Witheld
- ---------------- ----------- ---------------
W.E. Sheriff 12,453,456 562,754
John A. Morris, Jr., M.D. 12,468,885 547,325
In addition to the foregoing directors, the following table sets forth the other
members of the Board of Directors whose term of office continued after the
meeting and the year in which his or her term expires:
Name Term Expires
- ---- ------------
Christopher J. Coates 2004
Daniel K. O'Connell 2004
Lawrence J. Stuesser 2004
Frank M. Bumstead 2005
Clarence Edmunds 2005
Nadine C. Smith 2005
The shareholders of the Company also approved an amendment to the American
Retirement Corporation Employee Stock Purchase Plan to increase the number of
shares of common stock authorized for issuance pursuant to the plan. The
following table sets forth the votes cast for, votes cast against, votes
abstained and broker non-votes with respect to the amendment to the stock
purchase plan:
For Abstain Against
--- ------- -------
11,812,845 8,146 1,195,219
37
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
--------
31.1 Certification of W.E. Sheriff Pursuant to Rule 13a - 14(a).
31.2 Certification of Bryan D. Richardson Pursuant to Rule 13a - 14(a).
32.1 Section 1350 Certification of W.E. Sheriff.
32.2 Section 1350 Certification of Bryan D. Richardson.
(b) Reports on Form 8-K filed during the quarter ended June 30, 2003:
On May 8, 2003, the Company filed with the SEC a Form 8-K disclosing for
purposes of Regulation FD under Items 7, 9 and 12, a press release
issued by the Company.
On May 8, 2003, the Company filed with the SEC a Form 8-K disclosing for
purposes of Regulation FD under Items 7, 9 and 12, supplemental
financial information relating to the Company's three months ended March
31, 2003.
38
SIGNATURES
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.
AMERICAN RETIREMENT CORPORATION
Date: August 8, 2003 By:_/s/_Bryan_D._Richardson___________________
Bryan D. Richardson
Executive Vice President-Finance and Chief
Financial Officer (Principal Financial and
Accounting Officer)
39
Exhibit 31.1
CERTIFICATIONS
I, W.E. Sheriff, certify that:
1. I have reviewed this quarterly report on Form 10-Q of American Retirement
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we
have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of June
30, 2003 (the "Evaluation Date"); and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the three months
ended June 30, 2003 that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent function):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: August 8, 2003
/s/_W.E._Sheriff_______________________________
W.E. Sheriff
Chairman, President and Chief Executive Officer
40
Exhibit 31.2
CERTIFICATIONS
I, Bryan D. Richardson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of American Retirement
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we
have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of June
30, 2003 (the "Evaluation Date"); and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the three months
ended June 30, 2003 that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent function):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: August 8, 2003
/s/_Bryan_D._Richardson________
Bryan D. Richardson
Executive VP - Finance, and CFO
41
Exhibit 32.1
SECTION 1350 CERTIFICATION
In connection with the Quarterly Report of American Retirement Corporation (the
"Company") on Form 10-Q for the three and six months ending June 30, 2003 as
filed with the Securities and Exchange Commission on August 8, 2003 (the
"Report"), I, W.E. Sheriff, Chairman and Chief Executive Officer of the Company,
certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/_W.E._Sheriff_______________________________
W.E. Sheriff
Chairman, President and Chief Executive Officer
August 8, 2003
A SIGNED ORIGINAL OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906 HAS BEEN
PROVIDED TO AMERICAN RETIREMENT CORPORATION AND WILL BE RETAINED BY AMERICAN
RETIRMENT CORPORATION AND FURNISHED TO THE SECURITIES AND EXCHANGE COMMISSION OR
ITS STAFF UPON REQUEST.
42
Exhibit 32.2
SECTION 1350 CERTIFICATION
In connection with the Quarterly Report of American Retirement Corporation (the
"Company") on Form 10-Q for the three and six months ending June 30, 2003 as
filed with the Securities and Exchange Commission on August 8, 2003 (the
"Report"), I, Bryan D. Richardson, Executive Vice President - Finance and Chief
Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/_Bryan_D._Richardson_______________
Bryan D. Richardson
Executive Vice President - Finance and
Chief Financial Officer
August 8, 2003
A SIGNED ORIGINAL OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906 HAS BEEN
PROVIDED TO AMERICAN RETIREMENT CORPORATION AND WILL BE RETAINED BY AMERICAN
RETIRMENT CORPORATION AND FURNISHED TO THE SECURITIES AND EXCHANGE COMMISSION OR
ITS STAFF UPON REQUEST.
43