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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 September 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 November 6, 2003, 18,753,217 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
September 30, 2003 and December 31, 2002..........................................3
Condensed Consolidated Statements of
Operations for the Three Months Ended
September 30, 2003 and 2002 ......................................................4
Condensed Consolidated Statements of
Operations for the Nine Months Ended
September 30, 2003 and 2002 ......................................................5
Condensed Consolidated Statements of Cash
Flows for the Nine Months Ended September 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................................... 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk ..................... 39
Item 4. Controls and Procedures ....................................................... 40
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................ 41
Signatures ............................................................................42
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share data) September 30, December 31,
-----------------------------
2003 2002
------------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 17,363 $ 18,244
Assets limited as to use 16,081 17,359
Accounts receivable, net of allowance
for doubtful accounts 14,070 12,522
Inventory 1,278 1,378
Prepaid expenses 4,041 3,903
Deferred income taxes 3,028 3,028
Assets held-for-sale 24,774 34,071
Other current assets 3,876 6,681
------------ -------------
Total current assets 84,511 97,186
Assets limited as to use, excluding
amounts classified as current 22,241 21,701
Land, buildings and equipment, net 466,826 578,804
Notes receivable 21,473 19,176
Goodwill, net 36,463 36,463
Leasehold acquisition costs, net 34,099 22,861
Other assets 53,198 63,807
------------ -------------
Total assets $ 718,811 $ 839,998
============ =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 13,357 $ 13,526
Debt associated with assets held-for-
sale 17,057 20,246
Accounts payable 6,827 5,187
Accrued interest 2,028 4,620
Accrued payroll and benefits 8,478 7,652
Accrued property taxes 9,975 9,917
Other accrued expenses 7,397 8,164
Other current liabilities 14,369 12,149
------------ -------------
Total current liabilities 79,488 81,461
Long-term debt, excluding current
portion 324,556 506,879
Refundable portion of entrance fees 61,188 60,066
Deferred entrance fee income 119,909 118,041
Tenant deposits 4,634 4,898
Deferred gains on sale-leaseback
transactions 95,073 27,622
Deferred income taxes 3,806 3,806
Other long-term liabilities 14,083 11,717
------------ -------------
Total liabilities 702,737 814,490
Minority interest 10,559 12,601
Commitments and contingencies (See
notes)
Shareholders' 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,
18,748,329 and 17,341,191 shares
issued and outstanding, respectively 188 173
Additional paid-in capital 148,873 145,706
Accumulated deficit (143,546) (132,972)
------------ -------------
Total shareholders' equity 5,515 12,907
------------ -------------
Total liabilities and
shareholders' equity $ 718,811 $ 839,998
============ =============
See accompanying notes to 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
September 30,
-------------------------
2003 2002
----------- ------------
Revenues:
Resident and health care $ 90,598 $ 82,986
Management services 1,504 432
Reimbursed expenses 1,430 1,198
---------- -----------
Total revenues 93,532 84,616
Operating expenses:
Community operating expenses 63,918 60,503
General and administrative 6,351 8,637
Lease expense 11,884 11,077
Depreciation and amortization 6,277 4,718
Amortization of leasehold acquisition
costs 597 521
Asset impairments - 2,511
Reimbursed expenses 1,430 1,198
---------- -----------
Total operating expenses 90,457 89,165
---------- -----------
Operating income (loss) 3,075 (4,549)
Other income (expense):
Interest expense (14,464) (11,415)
Interest income 600 1,049
Gain (loss) on sale of assets 23,149 (1,885)
Other (195) 962
---------- -----------
Other income (expense), net 9,090 (11,289)
---------- -----------
Income (loss) from continuing
operations before income taxes and
minority interest 12,165 (15,838)
Income tax expense 1,361 100
---------- -----------
Income (loss) from continuing
operations before minority interest 10,804 (15,938)
Minority interest in earnings of consolidated
subsidiaries, net of tax (671) -
---------- -----------
Income (loss) from continuing
operations 10,133 (15,938)
Discontinued operations, net of tax (254) (6,631)
---------- -----------
Net income (loss) $ 9,879 $ (22,569)
========== ===========
Basic income (loss) per share:
Basic income (loss) per share from
continuing operations $ 0.54 $ (0.92)
Loss from discontinued operations, net of
tax (0.01) (0.38)
---------- -----------
Basic income (loss) per share $ 0.53 $ (1.30)
========== ===========
Diluted income (loss) per share:
Diluted income (loss) per share from
continuing operations $ 0.42 $ (0.92)
Loss from discontinued operations, net of
tax (0.01) (0.38)
---------- -----------
Diluted income (loss) per share $ 0.41 $ (1.30)
========== ===========
Weighted average shares used for basic income
(loss) per share data 18,739 17,310
Effect of dilutive common stock options and
convertible debentures 5,839 -
---------- -----------
Weighted average shares used for diluted
income (loss) per share data 24,578 17,310
========== ===========
See accompanying notes to condensed consolidated financial statements.
4
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share data)
Nine months ended
September 30,
--------------------------
2003 2002
------------ ------------
Revenues:
Resident and health care $ 264,680 $ 237,468
Management services 3,278 1,117
Reimbursed expenses 4,402 3,885
----------- -----------
Total revenues 272,360 242,470
Operating expenses:
Community operating expenses 185,794 171,694
General and administrative 19,169 21,061
Lease expense 32,174 61,540
Depreciation and amortization 18,767 15,083
Amortization of leasehold acquisition
costs 1,645 10,645
Asset impairments - 2,561
Reimbursed expenses 4,402 3,885
----------- -----------
Total operating expenses 261,951 286,469
----------- -----------
Operating income (loss) 10,409 (43,999)
Other income (expense):
Interest expense (41,240) (31,579)
Interest income 2,164 3,977
Gain (loss) on sale of assets 23,170 (1,938)
Other 261 1,792
----------- -----------
Other expense, net (15,645) (27,748)
----------- -----------
Loss from continuing operations
before income taxes and minority
interest (5,236) (71,747)
Income tax expense 1,555 319
----------- -----------
Loss from continuing operations
before minority interest (6,791) (72,066)
Minority interest in earnings of
consolidated subsidiaries, net of tax (1,912) -
----------- -----------
Loss from continuing operations (8,703) (72,066)
Discontinued operations, net of tax (1,871) (7,992)
----------- -----------
Net loss $ (10,574) $ (80,058)
=========== ===========
Basic loss per share:
Basic loss per share from continuing
operations $ (0.48) $ (4.17)
Loss from discontinued operations,
net of tax $ (0.10) (0.46)
----------- -----------
Basic loss per share $ (0.59) $ (4.63)
=========== ===========
Diluted loss per share:
Diluted loss per share from continuing
operations $ (0.48) $ (4.17)
Loss from discontinued operations, net of
tax (0.10) (0.46)
----------- -----------
Diluted loss per share $ (0.59) $ (4.63)
=========== ===========
Weighted average shares used for basic loss
per share data 18,049 17,288
Effect of dilutive common stock options - -
----------- -----------
Weighted average shares used for diluted
loss per share data 18,049 17,288
=========== ===========
See accompanying notes to condensed consolidated financial statements.
5
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands) Nine months ended
September 30,
------------------------
2003 2002
----------- -----------
Cash flows from operating activities:
Net loss $ (10,574) $ (80,058)
Loss from discontinued operations 1,871 7,992
---------- ----------
Loss from continuing operations (8,703) (72,066)
Adjustments to reconcile loss from
continuing operations to net cash and cash
equivalents used by continuing operations:
Depreciation and amortization 20,412 25,728
Amortization of deferred financing costs 1,830 2,114
Residual value guarantee losses,
included in lease expense - 30,793
Asset impairments - 2,561
Amortization of deferred entrance fee
revenue (10,286) (9,044)
Proceeds from entrance fee sales 25,402 18,353
Refunds of entrance fee terminations (10,505) (6,571)
Deferred income tax benefit - (108)
Amortization of deferred gain on sale-
leaseback transactions (2,483) (3,045)
Minority owners' allocation of income 1,912 -
Losses from unconsolidated joint
ventures 211 445
(Gain) loss on sale of assets (23,170) 1,938
Changes in assets and liabilities, exclusive
of acquisitions and sale leaseback
transactions:
Accounts receivable (218) (665)
Inventory 99 29
Prepaid expenses (201) (378)
Other assets (2,140) (479)
Accounts payable 2,200 (1,718)
Accrued interest (828) 1,708
Other accrued expenses and other current
liabilities 3,236 6,489
Tenant deposits (265) (951)
Other liabilities 2,519 1,463
---------- ----------
Net cash and cash equivalents used by
continuing operations (978) (3,404)
Cash flows from investing activities:
Additions to land, buildings and
equipment (7,431) (9,529)
Proceeds from the sale of assets 8,405 25,396
Sale (purchase) of assets limited as to
use (736) 22,728
Distributions from joint ventures 1,268 -
Issuance of notes receivable (2,297) (3,364)
Other investing activities (368) (1,538)
---------- ----------
Net cash (used) provided by investing
activities (1,159) 33,693
Cash flows from financing activities:
Proceeds from issuance of stock 15 67
Proceeds from the issuance of long-term
debt 7,718 212,346
Principal payments on long-term debt (12,067) (236,561)
Accrual of deferred interest 8,930 -
(Distributions to) proceeds from
minority interest holders (913) 12,250
Principal reductions in master trust
liability (1,037) (1,080)
Accrual of contingent earnouts (594) (3,560)
Expenditures for financing costs (769) (8,104)
---------- ----------
Net cash provided (used) by financing
activities 1,283 (24,642)
See accompanying notes to condensed consolidated financial statements.
6
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(UNAUDITED)
(in thousands)
Nine months ended
September 30,
-------------------------
2003 2002
------------ -----------
Net cash and cash equivalents (used)
provided by continuing operations (854) 5,647
Net cash and cash equivalents (used)
provided by discontinued operations (27) 16
----------- -----------
Net (decrease) increase in cash and cash
equivalents (881) 5,663
Cash and cash equivalents at beginning of
period 18,244 19,334
----------- -----------
Cash and cash equivalents at end of period $ 17,363 $ 24,997
=========== ===========
Supplemental disclosure
of cash flow information:
- -------------------------
Cash paid during the period for interest
(including capitalized interest) $ 33,696 $ 25,134
=========== ===========
Income taxes paid (received) $ 437 $ (1,520)
=========== ===========
Supplemental disclosure
of non-cash transactions:
- -------------------------
During the nine months ended September 30, 2003, the Company issued 1,386,024
common shares, par value $0.01 per share to holders of the 10% Series B
Convertible Senior Subordinated Notes. The holders 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 $ (3,167) $ -
Common stock 15 -
Additional paid-in capital 3,152 -
During the nine months ended September 30, 2003, the Company completed a sale of
land in Virginia. The Company received net cash proceeds of $1.2 million in
December 2002, from the buyer, who also assumed debt associated with the land.
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 nine months ended September 30, 2003, the Company amended a lease
agreement. Under this amendment, the lease, which had been accounted for as a
financing, is now accounted for 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 nine months ended September 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 nine months ended September 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 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 nine months ended
September 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. During 2003, new
accounting literature expanded the interpretation regarding consolidation of
variable interest entities. See Note 12. Under this literature, the Company
would consolidate any communities it manages for others if the Company has the
unilateral ability to conduct the ordinary course of business of the subject
communities and is the primary beneficiary of the managed entities earnings or
losses. The Company plans to complete its review of these entities and
agreements, and will consolidate any managed entities in accordance with the
then current consolidation literature, as well as include any appropriate
disclosures beginning October 1, 2003. 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 27 Retirement Centers, which provide a
continuum of care services such as independent living, assisted living and
skilled nursing care. Of the 27 Retirement Centers, the Company owned seven,
operated two pursuant to leases classified as financing obligations (which
include purchase options) and operated 18 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, ten 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 seven management agreements with third
parties relating to five Retirement Centers and two Free-standing ALs. Of the
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.
A fourth Retirement Center is owned by an unaffiliated third party. 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 $8.7 million of first mortgage debt secured by one of the joint
venture assets. The Company's remaining management agreement relates to 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 nine months ended
September 30, 2003 and 2002 (in thousands).(1)(2)(3)
9
Three Months Ended Nine Months Ended
--------------------------------------------------------
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues
Retirement centers $ 70,650 $ 65,666 $ 206,583 $ 189,579
Free-standing ALs 19,948 17,320 58,097 47,889
Management services (4) 2,934 1,630 7,680 5,002
------------ ------------ ------------ ------------
Total revenue $ 93,532 $ 84,616 $ 272,360 $ 242,470
============ ============ ============ ============
Retirement Centers
Resident and healthcare revenue $ 70,650 $ 65,666 $ 206,583 $ 189,579
Community operating expense 48,505 45,166 139,015 127,598
------------ ------------ ------------ ------------
Community operating contribution $ 22,145 $ 20,500 $ 67,568 $ 61,981
------------ ------------ ------------ ------------
Free-standing ALs
Resident and healthcare revenue $ 19,948 $ 17,320 $ 58,097 $ 47,889
Community operating expense 15,413 15,337 46,779 44,096
------------ ------------ ------------ ------------
Community operating contribution $ 4,535 $ 1,983 $ 11,318 $ 3,793
------------ ------------ ------------ ------------
Management services
Management services $ 1,504 $ 432 $ 3,278 $ 1,117
Reimbursed expense revenue 1,430 1,198 4,402 3,885
Reimbursed expenses 1,430 1,198 4,402 3,885
------------ ------------ ------------ ------------
Management services operating
contribution $ 1,504 $ 432 $ 3,278 $ 1,117
------------ ------------ ------------ ------------
General and administrative expense $ 6,351 $ 8,637 $ 19,169 $ 21,061
Lease expense (5) 11,884 11,077 32,174 61,540
Asset impairments - 2,511 - 2,561
Depreciation and amortization (6) 6,874 5,239 20,412 25,728
------------ ------------ ------------ ------------
Operating income (loss) $ 3,075 $ (4,549) $ 10,409 $ (43,999)
============ ============ ============ ============
September December
30, 31,
2003 2002
---------- ---------
Total Assets:
Retirement Centers $ 449,442 $ 539,764
Free-standing ALs 208,562 210,376
Management services 60,807 89,858
---------- ---------
Total $ 718,811 $ 839,998
========== =========
(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 nine months ended September 30, 2002 have
been restated to conform with the revised presentation.
(2) On August 25, 2003, the Company acquired a leasehold interest in two
communities which had previously been Managed by the Company.
Subsequent to that date, the amounts have been classified as leased
Retirement Centers.
(3) 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 these discontinued
operations.
(4) Management services revenue represents the Company's management
services revenues, as well as reimbursed expense revenue.
(5) Lease expense for the three and nine months ended September 30, 2002
includes $600,000 and $30.8 million, respectively, of additional lease
expense related to the termination of certain synthetic leases as part
of its 2002 Refinancing Plan.
(6) Depreciation and amortization expense for the nine months ended
September 30, 2002 includes $8.8 million 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 Nine Months Ended
September 30, September 30,
--------------------- ----------------------
2003 2002 2003 2002
--------- ---------- ---------- ----------
Net income (loss), as reported $ 9,879 $ (22,569) $ (10,574) $ (80,058)
Deduct total stock-based employee
compensation expense determined
under fair-value-based method (159) (300) (470) (899)
--------- ---------- ---------- ----------
Pro forma net income (loss) $ 9,720 $ (22,869) $ (11,044) $ (80,957)
========= ========== ========== ==========
Income (loss) per share:
Basic-as reported $ .53 $ (1.30) $ (.59) $ (4.63)
Basic-pro forma $ .52 $ (1.32) $ (.61) $ (4.68)
Diluted-as reported $ .41 $ (1.30) $ (.59) $ (4.63)
Diluted-pro forma $ .40 $ (1.32) $ (.61) $ (4.68)
6. Earnings per Share
Basic and diluted loss per share for the three months and nine months ended
September 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 the three and nine months
ended September 30, 2003, there were approximately 141,000 and 85,800 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,
respectively. There were no options to purchase shares of common stock
outstanding during the three and nine months ended September 30, 2002 which had
an exercise price below the average market price of the common shares for the
corresponding period.
The Company's 10% Series B Convertible Senior Subordinated Notes due 2008
(Series B Notes) were included in the computation of diluted earnings per share
for the three months ended September 30, 2003, but were not included in the nine
months ended September 30, 2003. The Company had a loss from continuing
operations for the nine months ended September 30, 2003 and, therefore, the
effect of the Series B Notes would be anti-dilutive. At September 30, 2003, the
Series B Notes were convertible into 5,698,204 shares of common stock. The
average market price of the Company's common stock outstanding during the three
months ended September 30, 2003 was greater than the $2.25 per share conversion
price.
11
During the nine months ended September 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 1,386,024 common
shares, par value $0.01 per share.
A computation of diluted earnings per share is as follows (in thousands):
Three months ended Nine months ended
September 30, September 30,
--------------------- ----------------------
2003 2002 2003 2002
---------- --------- ---------- ----------
Income (loss) from continuing operations, before
minority interest $ 10,804 $ (15,938) $ (6,791) $ (72,066)
Interest expense from convertible
debentures, net of tax 289 - - -
---------- --------- ---------- ----------
Adjusted income (loss) from continuing
operations, before minority interest 11,093 (15,938) (6,791) (72,066)
Minority interest in earnings of consolidated
subsidiaries, net of tax (671) - (1,912) -
---------- --------- ---------- ----------
Income (loss) from continuing operations 10,422 (15,938) (8,703) (72,066)
Discontinued operations, net of tax (254) (6,631) (1,871) (7,992)
---------- --------- ---------- ----------
Net income (loss) $ 10,168 $ (22,569) $ (10,574) $ (80,058)
========== ========= ========== ==========
Weighted average shares used for basic earnings
per share data: 18,739 17,310 18,049 17,288
Effect of dilutive common securities:
Employee stock options 141 - - -
Series B convertible debentures 5,698 - - -
---------- --------- ---------- ----------
Weighted average shares used for diluted earnings
per share data 24,578 17,310 18,049 17,288
========== ========= ========== ==========
Basic income (loss) per share $ 0.53 $ (1.30) $ (0.59) $ (4.63)
Effect of dilutive securities (0.12) - - -
---------- --------- ---------- ----------
Diluted earnings (loss) per share $ 0.41 $ (1.30) $ (0.59) $ (4.63)
========== ========= ========== ==========
The following options to purchase shares of common stock were outstanding during
each of the following periods, but were 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.
12
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------------------------------------------
2003 2002 2003 2002
------------------------------------------------------------
Number of options (in thousands) 1,904 2,113 1,993 2,120
Weighted-average exercise price $ 4.18 $ 4.80 $ 4.41 $ 4.82
The Company's 5 3/4% Convertible Subordinated Debentures due October 1, 2002
that were outstanding during the 2002 period presented were not included in the
computation of diluted earnings per share for the three and nine months ended
September 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.
7. Land, Buildings and Equipment
A summary of land, buildings, and equipment is as follows (in thousands):
September 30, December 31,
2003 2002
---- ----
Land and improvements $ 34,898 $ 46,749
Land held for development 3,667 3,667
Buildings and improvements 440,600 549,724
Furniture, fixtures, and equipment 36,656 44,092
Leasehold improvements 8,823 7,425
----- -----
524,644 651,657
Less accumulated depreciation and amortization (60,821) (76,770)
Construction in progress 3,003 3,917
----- -----
Total $ 466,826 $ 578,804
======= =======
During the nine months ended September 30, 2003, the Company completed the sale
lease-back of three Retirement Centers and the sale of a fourth Retirement
Center. The Company also signed a long-term agreement to manage the fourth
Retirement Center for an unaffiliated third party. As part of these
transactions, a prior lease was amended to remove a purchase option related to
the land, buildings and equipment of a fifth Retirement Center. The lease for
this Retirement Center was previously accounted for as a financing, but as a
result of the amendment, is now accounted for as an operating lease. These
transactions resulted in the reduction of land, buildings and equipment of
approximately $92.0 million, net of accumulated depreciation of $32.3 million.
See Note 8.
Depreciation expense was $18.3 million and $14.0 million for the nine months
ended September 30, 2003 and 2002, respectively.
13
8. Long-term Debt and Other Transactions
A summary of long-term debt is as follows (in thousands):
September, 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 in certain of its subsidiaries. $75,930 $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. 12,821 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 September 30, 2003 range from 3.82% to 9.50%. The loans
are typically secured by certain land, buildings and equipment. 120,634 240,549
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. 101,509 128,575
Various other long-term debt, generally payable monthly with any unpaid
principal and interest due between 2004 and 2015. Variable and fixed interest
rates at September 30, 2003 range from 1.21% to 10.9%. The loans are secured by
certain land, buildings and equipment. 44,076 39,850
------------------- -----------------
Total long-term debt 354,970 540,651
Less current portion 13,357 13,526
Less debt associated with assets held-for-sale, of which only $1.7 million would
be due within the next twelve months by its terms 17,057 20,246
------------------- -----------------
Long-term debt, excluding current portion $324,556 $506,879
=================== =================
The aggregate scheduled maturities of long-term debt were as follows
(in thousands):
September 30,
2003
-------------------
Year 1 $ 13,357
Year 1, debt associated with assets held-for-sale, of which only $1.7
million would be due within the next twelve months by its terms 17,057
Year 2 44,598
Year 3 7,483
Year 4 84,059
Year 5 40,676
Thereafter 147,740
-------------------
$ 354,970
===================
14
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"). The Company's ownership interests in the Real Estate
Companies serve as collateral for the HCPI Loan. In addition to the long-term
debt, the Company will be required to pay all accrued but unpaid interest on the
HCPI Loan at its maturity or earlier. Unless paid earlier, the Company will be
accruing and compounding quarterly the unpaid interest on the HCPI Loan.
On September 23, 2003, the Company completed a multi-property transaction with
HCPI that involved the sale lease-back of three Retirement Centers and the sale
of a fourth Retirement Center. The Company also entered into a long-term
agreement to manage the fourth community for an unaffiliated third party. In
addition, the Company obtained $7.0 million of mortgage financings from HCPI
that are secured by certain land parcels adjoining two of the communities.
The proceeds of the transaction were used to repay $112.8 million of first
mortgage debt on the four Retirement Centers. In addition, after first mortgage
prepayment costs of $1.0 million, a $3.0 million credit for HCPI's existing
minority interest in the properties, and transaction costs, the remaining
proceeds of $51.8 million were used to repay a portion of the HCPI Loan and
accrued interest. The terms of the HCPI Loan originally did not permit
prepayment until after October 2005, however, the parties amended the agreement
to allow for this transaction and the resulting prepayment.
The four Retirement Centers were valued in the transaction at $163.5 million,
versus their net book value of $72.3 million. As a result of the transaction,
the Company realized gains of $93.1 million. During the third quarter of 2003,
$23.2 million of these gains were recognized related to the sale of the fourth
Retirement Center. The remaining $69.9 million of gains were deferred and will
be recognized over the lease terms. Approximately $66.2 million of the deferred
gains will be recognized over the initial ten year lease terms for the three
Retirement Centers included in the September 2003 sale lease-back. An additional
$3.7 million of deferred gain will be recognized over the remaining thirteen
years of a Retirement Center lease previously entered into with HCPI during the
first quarter of 2002. As part of the September 2003 transaction, this prior
lease was amended to remove a purchase option related to the land, buildings and
equipment of this community. The lease was previously accounted for as a
financing, but as a result of the amendment, will now be accounted for as an
operating lease. This lease amendment resulted in the $19.7 million reduction of
land, buildings and equipment and a $24.1 million reduction in debt.
The Company will continue to operate all four Retirement Centers involved in the
September 2003 transaction, two of which are located in Texas, one in Arizona,
and one in Colorado (which will be operated under a management agreement). The
communities have a combined capacity of 1,170 units, including independent
living, assisted living, memory enhancement and skilled nursing units. Three of
the Retirement Centers were leased-back from HCPI under a master lease agreement
with an initial term of ten years, plus two ten year renewal options. The lease
for these three Retirement Centers will be accounted for as an operating lease.
The initial lease rate for these three communities will be 9.5%, with annual
rent increases of 2.75%.
The Company additionally agreed to manage the fourth Retirement Center located
in Colorado for an unaffiliated third party under a long term management
agreement. The initial term of the management agreement is ten years, plus two
ten year renewal terms. Under the terms of the management agreement, the Company
will operate the Retirement Center under its existing tradename, and does not
anticipate any change in operations, employees or services. As a result of this
transaction, the Company will report management fee revenue earned under the
management agreement for the Colorado Retirement Center, instead of including
the revenues and expenses of this community as part of its consolidated results.
15
The Company also entered into a mortgage loan with HCPI in the amount of $7.0
million. Interest is payable monthly at LIBOR plus 3%, with the principal
balance due in September 2005. The Company used the proceeds from this loan in
conjunction with the repayment of the HCPI Loan as described above. The note is
secured by vacant land parcels adjacent to two of the Retirement Centers
included in the sale/lease-back transaction. Since these land parcels are
currently in the process of being sold, the $7.0 million loan is shown as a
current liability, as debt associated with assets held-for-sale (of which $0
would be due within the next twelve months by its terms).
The HCPI Loan balance at September 30, 2003 was $75.9 million, as compared with
$122.1 million at June 30, 2003. The $75.9 million HCPI Loan, and related
interest, if not paid until its September 2007 maturity, will compound to be
approximately $117.7 million, or an additional $41.8 million. The Company is
permitted to repay the HCPI Loan in whole or in part beginning October 2005 and
may redeem the HCPI Equity Investment beginning October 2006. 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 own
five of the Company's Retirement Centers, and the Company will continue to
operate the five 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 on or before the
2007 maturity, and HCPI forecloses upon its collateral, the Company would
realize significant taxable income, which may result in a substantial 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. As a result, the Company has presented
$33.0 million of this debt as long-term and $6.6 million as debt related to
assets held-for-sale on the condensed consolidated financial statements herein,
net of payments made during the three months ended September 30, 2003.
The Company previously had managed two Retirement Centers. The Company had
invested $6.0 million for options to purchase these communities. On August 25,
2003, the options were sold to a third party buyer for $3.0 million and the
third party buyer acquired each of the communities from the original developer.
The buyer simultaneously entered into a long-term lease with a newly formed
entity, owned by the Company and the original developer of the communities. In
order to complete the purchase transaction, the Company agreed on a non-recourse
basis to pay the original developer $11.3 million. The entity, which the Company
consolidates, recorded $10.0 million as debt and will impute interest at prime,
with all amounts due on the $11.3 million note on August 25, 2008. The lease
provides an initial 15 year term, with two 10 year extension options. Proceeds
from the additional funding, if any, will be used first to satisfy the Company's
$11.3 million obligation to the original developer. The Company recorded
leasehold acquisition costs of $13.0 million which consists of the $10.0 million
obligation to the original developer and the balance of the purchase option sold
to the third party buyer. The leasehold acquisition costs are being amortized
over the base term of the leases. The buyer has committed to provide additional
funding to the lessees depending upon the financial performance of the
communities. The Company also acquired an option from the buyer to purchase the
communities in nine years.
During the nine months ended September 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 1,386,024 common
shares, par value $0.01 per share. The average market price of the Company's
common stock outstanding during the three months ended September 30, 2003 was
greater than the $2.25 per share conversion price. At September 30, 2003, the
Series B Notes were convertible into 5,698,204 shares of common stock.
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 10), resulting in a $821,000 write-off and conversion from financing
to operating lease treatment for this community.
16
During 2002, the Company successfully refinanced or extended substantially all
of its debt maturities to January 2004 or later pursuant to its Refinancing
Plan. Although the Company has significantly reduced its outstanding debt during
2003, it has incurred additional obligations and remains highly leveraged with a
substantial amount of debt and lease obligations. 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 nine months ended
September 30, 2003, the Company obtained a financial covenant waiver on a lease
related to a single community. At September 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 could result in a default or
acceleration of certain of the Company's other obligations, which would have a
material adverse effect on the Company.
The Company has scheduled principal payments of $13.4 million and minimum rental
obligations of $64.2 million under long-term operating leases due during the
twelve months ended September 30, 2004. The Company also has $17.1 million of
debt associated with assets held-for-sale, which are classified as current
liabilities (of which only $1.7 million would be due within the next twelve
months by its terms). When assets held-for-sale are sold, the Company will use
most of the proceeds to repay mortgage debt and other related payments. As of
September 30, 2003, the Company had approximately $17.4 million in unrestricted
cash and cash equivalents and $5.0 million of working capital. The Company's
cash flows from operations for the nine months ended September 30, 2003 was
negative. 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 certain 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.
9. 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 is involved in negotiation relating to these
three communities, which are subject to various contingencies. If the sales are
completed (of which there can be no assurance), the Company will use most of the
proceeds to repay mortgage debt and other related payments. For the three and
nine months ended September 30, 2003 and 2002, the Company recorded losses from
discontinued operations of $254,000 and $6.6 million, and $1.9 million and $8.0
million, respectively, for these three Free-standing ALs. The loss recorded for
the nine months ended September 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 8). The loss recorded for the three and nine
months ended September 30, 2002 includes $5.9 million of impairment, related to
the assets held-for-sale. The Company's 2002 results were reclassified to
reflect the loss from discontinued operations.
17
10. Assets Held-for-Sale
The Company had $24.8 million of assets classified as held-for-sale at September
30, 2003. These assets consist of approximately $13.7 million related to three
Free-standing ALs held-for-sale, $10.1 million related to four land parcels
which were originally purchased for development and $1.0 million of other
assets. Debt associated with assets held-for-sale at September 30, 2003 was
$17.1 million, which is classified as a current liability (of which only $1.7
million is due over the next twelve months by its terms).
11. 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. As
of June 30 2003, the Company's coverage for workers' compensation and related
programs, excluding Texas, included 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 September 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. For work-related
injuries in Texas, the Company is a non-subscriber under Texas state law,
meaning that work-related losses are covered under a defined benefit program
outside of the Texas Workers' Compensation system. Losses are paid as incurred
and estimated losses are accrued on a monthly basis. 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.
18
Leases
As of September 30, 2003, the Company operated 32 of its senior living
communities under long-term leases. Of these 32 communities, 22 are operated
under four 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, excluding ground leases, vary from four to 21
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 $11.9 million and $11.1 million for the three months and
$32.2 million and $61.5 million for the nine months ended September 30, 2003 and
2002, respectively. During the three and nine months ended September 30, 2002,
$600,000 and $30.8 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.
Future minimum lease payments as of September 30, 2003 were as follows
(in thousands):
Year 1 $ 64,210
Year 2 65,421
Year 3 66,646
Year 4 67,902
Year 5 67,567
Thereafter 553,046
-----------------
$ 884,792
=================
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 certain synthetic leases that had residual value guarantees.
The leased assets were acquired and subsequently sold to third parties under
sale-leaseback transactions. As of September 30, 2003, the Company has recorded
contingent earn-outs of $5.3 million (out of a maximum of $13.3 million)
associated with six 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 September 30,
2003.
19
Guarantees
At September 30, 2003 the Company had guaranteed mortgage debt totaling $36.0
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 by approximately $2.7
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 $1.1 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, related to certain
communities acquired in 1998, which was paid July 31, 2003. Management believes
the remaining accrual is sufficient to satisfy any further assessments.
Other
Certain per person annual Medicare reimbursement limits on therapy services,
which had been temporarily suspended, became effective on September 1, 2003.
Certain pending legislation may suspend the limits again effective at some
future date. 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 significantly 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.
12. Recent Accounting Pronouncements
In November 2002, the Financial Accounting Standards Board (FASB) issued
Financial Interpretation Number (FIN) 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
became 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
nine months ended September 30, 2003 which were impacted by the provisions of
FIN 45.
20
In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest
Entities, an interpretation of ARB No. 51. The primary objectives of FIN 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
46 requires that both the primary beneficiary and all other enterprises with a
significant variable interest in a VIE make additional disclosures. Based upon
the Company's current understanding of the current guidance provided by the
FASB, the Company has three variable interest entities with which it holds a
significant variable interest:
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,
Florida 362 103 76 194 735
McLaren April 2000 Joint 37.5% Flint,
Homewood Village Venture Michigan 9 71 38 - 118
Lady Lake,
Village of April 1998 Joint 50.0% Florida - 32 15 - 47
Homewood Venture
----- ----- ----- ------ ------
371 206 129 194 900
===== ===== ===== ====== ======
During 2003, additional accounting literature and guidance has continued to
expand FIN 46's interpretation regarding consolidation of variable interest
entities. The Company is in the process of reviewing its managed entities and
agreements, and will consolidate any managed entities in accordance with the
then current consolidation literature beginning October 1, 2003.
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 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
was effective July 1, 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 did not have an impact on the Company's consolidated financial
position, results of operations or cash flows.
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 17 communities, leases 41 communities pursuant to
long-term leases (including nine which are operated pursuant to lease financing
obligations and 32 which are operated pursuant to operating leases), and manages
seven communities.
21
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 largest segment of the Company's
business and comprise 27 of the 65 communities that the Company operates. Of the
27 Retirement Centers, the Company owned seven, operated two pursuant to leases
classified as financing obligations (which include purchase options) and
operated 18 pursuant to operating leases. The Company's Retirement Center
occupancy rates as of September 30, 2003 and 2002 remained stable at 94%, while
capacity increased slightly. In addition, the Company manages five Retirement
Centers included in Management Services. These 27 Retirement Centers have
approximately 8,100 units, representing approximately 63% of the total unit
capacity of the Company's communities.
The Company has 31 Free-standing ALs, of which ten are owned and 21 are leased
(seven operated pursuant to lease financing obligations and 14 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 79% as of September 30, 2002 to 83% as of September 30, 2003.
The Management Services segment includes fees from seven management agreements,
including five large Retirement Communities and two Free-standing ALs owned by
others, as well as reimbursed expense revenues together with associated
expenses. These seven Management Service communities have approximately 2,300
units, representing approximately 15% of the total unit capacity of the
Company's communities. Of the seven managed communities, two Retirement Centers
are cooperatives that are owned by their residents and one is owned by a
not-for-profit sponsor. A fourth Retirement Center is owned by an unaffiliated
third party. 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 $8.7 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 $16.9 million first mortgage debt secured by the
land, and certain buildings and equipment at Freedom Square.
22
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 September 30, 2003 and September 30, 2002:
September 30, 2003(1)
---------------------------------------------------------------------------------------
# of Unit Capacity
------------------------------------------------------
Communities IL AL ME SNF Total Occupancy
--------------- -------- ------- ------- ------- --------- -----------
Retirement Centers:
Owned 7 1,728 226 67 223 2,244 94%
Leased 20 3,788 940 170 982 5,880 93%
--------------- -------- ------- ------- ------- --------- -----------
Sub-total 27 5,516 1,166 237 1,205 8,124 94%
--------------- -------- ------- ------- ------- --------- -----------
Free-standing ALs:
Owned 10 61 731 170 - 962 80%
Leased 21 15 1,465 390 - 1,870 84%
--------------- -------- ------- ------- ------- --------- -----------
Sub-total 31 76 2,196 560 - 2,832 83%
--------------- -------- ------- ------- ------- --------- -----------
Management Services:
Retirement Centers 5 1,094 198 147 362 1,801 96%
Free-standing ALs 2 9 103 53 - 165 73%
--------------- -------- ------- ------- ------- --------- -----------
Sub-total 7 1,103 301 200 362 1,966 95%
--------------- -------- ------- ------- ------- --------- -----------
Total 65 6,695 3,663 997 1,567 12,922 91%
=============== ======== ======= ======= ======= ========= ===========
September 30, 2002(2)
---------------------------------------------------------------------------------------
# of Unit Capacity
------------------------------------------------------
Communities IL AL ME SNF Total Occupancy
--------------- -------- ------- ------- ------- --------- -----------
Retirement Centers:
Owned 11 2,430 416 99 476 3,421 94%
Leased 15 2,881 643 111 745 4,380 95%
--------------- -------- ------- ------- ------- --------- -----------
Sub-total 26 5,311 1,059 210 1,221 7,801 94%
--------------- -------- ------- ------- ------- --------- -----------
Free-standing ALs:
Owned 11 61 779 221 - 1,061 72%
Leased 20 15 1,419 336 - 1,770 84%
--------------- -------- ------- ------- ------- --------- -----------
Sub-total 31 76 2,198 557 - 2,831 79%
--------------- -------- ------- ------- ------- --------- -----------
Management Services:
Retirement Centers 6 1,298 285 156 362 2,101 89%
Free-standing ALs 2 15 97 52 - 164 68%
--------------- -------- ------- ------- ------- --------- -----------
Sub-total 8 1,313 382 208 362 2,265 88%
--------------- -------- ------- ------- ------- --------- -----------
Total 65 6,700 3,639 975 1,583 12,897 90%
=============== ======== ======= ======= ======= ========= ===========
(1) On August 25, 2003, the Company acquired a leasehold interest in two
communities which had previously been included in Management Services.
Subsequent to that date, the amounts have been classified as leased
Retirement Centers.
(2) 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 September 30,
2002 information has been restated to conform with the revised
presentation.
Total unit capacity was approximately 12,900 at September 30, 2003 (8,100 in
Retirement Centers, 2,800 in Free-standing ALs and 2,000 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 September 30, 2003 (9,300 in
Retirement Centers, 2,800 in Free-standing ALs and 2,400 in Management
Services). Of the 65 communities the Company operates, the financial statements
for the seven 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.
23
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 nine
months ended September 30, 2003 and 2002 (in thousands).(1)(2)(3)
Three Months Ended
September 30, September 30, $ %
2003 2002 Change Change
------------- -------------------------- ------------
Revenues
Retirement centers $ 70,650 $ 65,666 $ 4,984 7.6%
Free-standing ALs 19,948 17,320 2,628 15.2%
Management services (4) 2,934 1,630 1,304 80.0%
------------- ------------- ------------ ------------
Total revenue $ 93,532 $ 84,616 $ 8,916 10.5%
============= ============= ============ ============
Retirement Centers
Resident and healthcare
revenue $ 70,650 $ 65,666 $ 4,984 7.6%
Community operating
expense 48,505 45,166 3,339 7.4%
------------- ------------- ------------ ------------
Community operating
contribution $ 22,145 $ 20,500 $ 1,645 8.0%
------------- ------------- ------------ ------------
Free-standing ALs
Resident and healthcare
revenue $ 19,948 $ 17,320 $ 2,628 15.2%
Community operating
expense 15,413 15,337 76 0.5%
------------- ------------- ------------ ------------
Community operating
contribution $ 4,535 $ 1,983 $ 2,552 128.7%
============= ============= ============ ============
Management services
Management services $ 1,504 $ 432 $ 1,072 248.1%
Reimbursed expense revenues 1,430 1,198 232 19.4%
Reimbursed expenses 1,430 1,198 (232) (19.4%)
------------ ------------- ------------ ------------
Management services
operating contribution $ 1,504 $ 432 $ 1,072 248.1%
------------ ------------- ------------ ------------
General and administrative
expense $ 6,351 $ 8,637 $ (2,286) (26.5%)
Lease expense (5) 11,884 11,077 807 7.3%
Asset impairments - 2,511 (2,511) (100.0%)
Depreciation and amortization (6) 6,874 5,239 1,635 31.2%
------------ ------------- ------------ ------------
Operating income (loss) $ 3,075 $ (4,549) $ 7,624 167.6%
============ ============= ============ ============
24
Nine Months Ended
September 30, September 30, $ %
2003 2002 Change Change
------------ ----------- ------------ -----------
Revenues
Retirement centers $ 206,583 $ 189,579 $ 17,004 9.0%
Free-standing ALs 58,097 47,889 10,208 21.3%
Management services (4) 7,680 5,002 2,678 53.5%
------------ ----------- ------------ -----------
Total revenue $ 272,360 $ 242,470 $ 29,890 12.3%
============ =========== ============ ===========
Retirement Centers
Resident and healthcare
revenue $ 206,583 $ 189,579 $ 17,004 9.0%
Community operating expense 139,015 127,598 11,417 8.9%
------------ ----------- ------------ -----------
Community operating
contribution $ 67,568 $ 61,981 $ 5,587 9.0%
------------ ----------- ------------ -----------
Free-standing ALs
Resident and healthcare
revenue $ 58,097 $ 47,889 $ 10,208 21.3%
Community operating
expense 46,779 44,096 2,683 6.1%
------------ ----------- ------------ -----------
Community operating
contribution $ 11,318 $ 3,793 $ 7,525 198.4%
------------ ----------- ------------ -----------
Management services
Management services $ 3,278 $ 1,117 $ 2,161 193.5%
Reimbursed expense revenues 4,402 3,885 517 13.3%
Reimbursed expenses 4,402 3,885 (517) (13.3%)
------------ ----------- ------------ -----------
Management services
operating
contribution $ 3,278 $ 1,117 $ 2,161 193.5%
------------ ----------- ------------ -----------
General and administrative
expense $ 19,169 $ 21,061 (1,892) (9.0%)
Lease expense (5) 32,174 61,540 (29,366) (47.7%)
Asset impairments - 2,561 (2,561) (100.0%)
Depreciation and amortization (6) 20,412 25,728 (5,316) (20.7%)
------------ ----------- ------------ -----------
Operating income (loss) $ 10,409 $ (43,999) $ 54,408 123.7%
============ =========== ============ ===========
September 30, December 31, $ %
2003 2002 Change Change
------------- ----------- ----------- -----------
Total Assets:
Retirement Centers $ 449,442 $ 539,764 $ (90,322) (16.7%)
Free-standing ALs 208,562 210,376 (1,814) (0.9%)
Management services 60,807 89,858 (29,051) (32.3%)
------------- ----------- ----------- -----------
Total $ 718,811 $ 839,998 $ (121,187) (14.4%)
============= =========== =========== ===========
25
Unit Occupancy
September 30, June 30 March 31 December 31, September 30,
2003 2003 2003 2002 2002
------------- --------- ---------- ------------- ----------------
Resident Unit Occupancy:
Retirement Centers 94% 93% 94% 94% 94%
Free-standing ALs 83% 81% 81% 80% 79%
Management Services 95% 90% 90% 90% 88%
------------- --------- ---------- ------------- ----------------
Total 91% 90% 90% 91% 90%
============= ========= ========== ============= ================
(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 nine months ended September 30, 2002 and
2003 have been restated to conform with the revised presentation.
(2) On August 25, 2003, the Company acquired a leasehold interest in two
communities which had previously been included in Management Services.
Subsequent to that date, the amounts have been classified as leased
Retirement Centers.
(3) 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 these discontinued
operations.
(4) Management services revenue represents the Company's management
services revenues, as well as reimbursed expense revenues.
(5) Lease expense for the three and nine months ended September 30, 2002
includes $600,000 and $30.8 million, respectively, of additional lease
expense for residual guarantees related to the termination of certain
synthetic leases as part of its 2002 Refinancing Plan.
(6) Depreciation and amortization expense for the nine months ended
September 30, 2002 includes $8.8 million 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 net income of $9.9 million, or $.41 per diluted share, on
total revenues of $93.5 million, as compared with a net loss of $22.6 million,
or $1.30 loss per diluted share, on revenues of $84.6 million for the three
months ended September 30, 2003 and 2002, respectively. The income for the three
months ended September 30, 2003 includes a $23.2 million gain on the sale of a
community. The loss for the three months ended September 30, 2002 includes
$600,000 of additional lease expense resulting from residual value guarantees on
certain terminated synthetic lease transactions. The Company reported a net loss
of $10.6 million, or $0.59 loss per diluted share, on total revenues of $272.4
million, as compared with a net loss of $80.1 million, or $4.63 loss per diluted
share, on revenues of $242.5 million for the nine months ended September 30,
2003 and 2002, respectively. The loss for the nine months ended September 30,
2003 includes a $23.2 million gain on the sale of a community. The loss for the
nine months ended September 30, 2002 includes $30.8 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, reduced
lease charges versus the prior periods, and the $23.2 million gain on sale of a
community.
26
As a result of the net income for the quarter, the Company returned to positive
shareholders' equity as of September 30, 2003. In addition to the gain on sale
of assets recognized during the quarter, as a result of completed transactions,
the Company has deferred gains on sale lease-backs of $95.1 million which will
be recognized over the terms of the leases. Approximately $10 million is
expected to be recognized over the next twelve months.
Three Months Ended September 30, 2003 Compared with the Three Months Ended
September 30, 2002
Revenues. Total revenues were $93.5 million for the three months ended September
30, 2003, compared to $84.6 million for the three months ended September 30,
2002, representing an increase of $8.9 million, or 10.5%. Resident and health
care revenues increased by $7.6 million during the 2003 period. Approximately
$1.7 million related to the August 2003 new leases for of two Retirement Centers
previously managed by the Company, $3.8 million related to increases in average
billable revenue per unit, $1.9 million related to increased revenues from
ancillary services such as therapy and $1.1 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 increased to $1.5 million
and $1.4 million, respectively, and increased as a percentage of total revenue
to 1.6% and 1.5%, respectively, for the three months ended September 30, 2003,
from 0.5% and 1.4%, respectively, for the three months ended September 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 $70.7 million in the
three months ended September 30, 2003, compared to $65.7 million in the three
months ended September 30, 2002, representing an increase of $5.0 million, or
7.6%. Approximately $2.9 million related to increases in average billable
revenue per unit, increased revenues from ancillary services such as therapy of
$1.5 million, and $178,000 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 $19.9 million for the
three months ended September 30, 2003, compared to $17.3 million for the three
months ended September 30, 2002, representing an increase of $2.6 million, or
15.2%. These figures are net of the revenue for three communities held-for-sale,
included as a component of discontinued operations. Approximately $932,000 of
this increase is related to increased occupancy, $910,000 related to increases
in average billable revenue per unit and $696,000 related to increased revenues
from ancillary services such as therapy.
In addition, certain per person annual Medicare reimbursement limits on therapy
services, which had been temporarily suspended, became effective on September 1,
2003. Certain pending legislation may suspend the limits again effective at some
future date. While the Company is currently unable to quantify the impact that
these new rules will have, it is expected that the reimbursement limitations, if
not suspended further, will significantly 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. During the quarter
ended September 30, 2003, the Company's five owned and leased EF Communities
recorded $10.7 million of proceeds from entrance fee sales, including $9.1
million from new sales and $1.6 million from payments received on deferred
entrance fee receivables, and paid refunds as a result of contract terminations
of $4.1 million, resulting in $6.6 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 September 30, 2003, Freedom Square had proceeds from entrance fee sales,
net of refunds paid, of approximately $2.2 million.
Community Operating Expense. Community operating expense increased to $63.9
million in the three months ended September 30, 2003, as compared to $60.5
million in the three months ended September 30, 2002, representing an increase
of $3.4 million, or 5.6%. Over $1.0 million of this increase results from the
August 2003 new leases for of two Retirement Centers previously managed by the
Company. Approximately $1.5 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, $328,000 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,
and $611,000 resulted from additional marketing costs. The remaining increase
results from additional expenses such as insurance, utility, property and food
costs at various communities. Community operating expense as a percentage of
resident and health care revenues decreased to 70.6% from 72.9% for the quarters
ended September 30, 2003 and 2002, respectively.
27
Retirement Center community operating expenses were $48.5 million in the three
months ended September 30, 2003, compared to $45.2 million in the three months
ended September 30, 2002, representing an increase of $3.3 million, or 7.4%.
Approximately $1.0 million of this increase is related to costs associated with
the two new leases for Retirement Centers in August 2003 which were previously
managed by the Company. In addition, increased labor costs related primarily to
industry trends of higher nursing and other costs amounted to $1.4 million. 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 $15.4 million in the
three months ended September 30, 2003 from $15.3 million in the three months
ended September 30, 2002, representing an increase of $76,000 or 0.5%. Labor
costs increased approximately $113,000 and food costs increased approximately
$106,000 related primarily to occupancy increases. In addition, costs associated
with the growth of the therapy services program amounted to $274,000, as well as
additional insurance, utility, and property costs at various communities.
Offsetting these increases is a reduction in marketing expenses of $303,000 as
various communities reach stabilized occupancy, as well as improvements in other
operating expenses.
Segment Operating Contribution. The Company measures the performance of its
three 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 $1.6 million, or 8.0%, to
$22.1 million for the three months ended September 30, 2003 from $20.5 million
for the three months ended September 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 $4.5 million
for the three months ended September 30, 2003, from $1.9 million for the three
months ended September 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 $1.5
million in the three months ended September 30, 2003, attributable to increased
management fees resulting from improved operating results at managed
communities.
General and Administrative. General and administrative expense decreased to $6.4
million for the three months ended September 30, 2003, as compared to $8.6
million for the three months ended September 30, 2002, representing a decrease
of $2.3 million, or 26.5%. This decrease is related to lower consulting and
legal costs incurred as part of the 2002 Refinancing, offset by higher
administrative costs resulting from expanded compliance and regulatory
requirements. General and administrative expense as a percentage of total
consolidated revenues decreased to 6.8% as compared to 10.2% for the three
months ended September 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 its total operating activities (including those that are managed).
General and administrative expense as a percentage of total combined revenues
decreased to 5.7% from 8.2% for the three months ended September 30, 2003 and
2002, respectively, computed as follows:
28
Three Months ended September 30,
--------------------------------
2003 2002
---- ----
Total consolidated revenues $ 93,532 $ 84,616
Revenues of unconsolidated managed
communities 19,669 20,582
Less management fees (1,504) (432)
-------------------------------
Total combined revenue $ 111,697 $ 104,766
===============================
Total general and administrative expense $ 6,351 $ 8,637
===============================
eneral and administrative expense as a %
G of total consolidated revenues 6.8% 10.2%
===============================
General and administrative expense as a %
of total combined revenue 5.7% 8.2%
===============================
Lease Expense. As of September 30, 2003, the Company had operating leases for 32
of its communities, including 16 Retirement Centers and 16 Free-standing ALs.
Lease expense increased $807,000 to $11.9 million for the three months ended
September 30, 2003 from $11.1 million for the three months ended September 30,
2002. This increase was primarily attributable to the additional lease expense
incurred as a result of certain sale-leaseback transactions completed in 2003
and 2002. As a result of the transactions completed during the third quarter of
2003, lease expense is expected to increase in future periods. Based on current
estimates, quarterly lease expense is expected to approach $15 million, net of
$2.5 million of deferred gain amortization.
Depreciation and Amortization. Depreciation and amortization expense increased
to $6.3 million in the three months ended September 30, 2003 from $4.7 million
in the three months ended September 30, 2002, representing an increase of $1.6
million, or 33.0%. The increase was primarily related to increased depreciable
assets during the three months ended September 30, 2003 mainly due to the
addition of assets from the termination of synthetic leases. Note that the $92.0
million reduction in depreciable assets occurred on September 23, 2003. See Note
7.
Amortization of Leasehold Acquisition Costs. Amortization of leasehold
acquisition costs increased $76,000 to $597,000 in the three months ended
September 30, 2003 from $521,000 in the three months ended September 30, 2002.
This increase results from the new leases entered into on August 25, 2003 for
two communities which the Company previously managed for a third party. In
conjunction with this transaction, $13.0 million of leasehold acquisition costs
were incurred, which will be amortized over the 15 year term of the lease.
Other Income (Expense). Interest expense increased to $14.5 million for the
three months ended September 30, 2003 from $11.4 million for the three months
ended September 30, 2002, representing an increase of $3.0 million, or 26.7%.
Approximately $1.0 million of this increase relates to early payment penalties
incurred during the three months ended September 30, 2003, related to first
mortgage debt. The remainder of the 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 15.5% for the
three months ended September 30, 2003 from 13.5% in the three months ended
September 30, 2002. Interest income decreased to $600,000 in the three months
ended September 30, 2003 from $1.0 million in the three months ended September
30, 2002, representing a decrease of $449,000, or 42.8%. 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. Gain of the sale of assets for the three months ended September
30, 2003 was $23.1 million. This gain resulted from the sale of a Retirement
Center. As a result of the refinancing transactions completed during September
2003 and the resulting decrease in debt outstanding, interest expense is
expected to be significantly reduced in future periods. Based on current
estimates, quarterly interest expense is expected to be approximately $9
million.
29
Income Taxes. The provision for income taxes was an expense of $1.4 million and
$100,000 for the three months ended September 30, 2003 and 2002, respectively,
for taxes. The Company has recorded a valuation allowance related to the
deferred tax asset resulting from 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 $671,000 for
the three months ended September 30, 2003. This amount was attributable to the
HCPI Equity Investment made 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
September 30, 2003 and 2002, the Company recorded a loss from discontinued
operations of $254,000 and $6.6 million, respectively, for these three
Free-standing ALs. Based upon the subject purchase prices, the discontinued
operations during the quarter ended September 30, 2002 included $5.9 million of
impairment. The 2002 results of these communities were reclassified to
discontinued operations.
Net Income (Loss). Based upon the factors noted above, the Company experienced
net income of $9.9 million, or $.41 per diluted share, compared to a net loss of
$22.6 million, or $1.30 loss per diluted share, for the three months ended
September 30, 2003 and 2002, respectively. The $.41 income per diluted share for
the three months ended September 30, 2003 was comprised of a $.42 income from
continuing operations and $.01 loss from discontinued operations related to the
three communities held-for-sale. The loss of $1.30 per diluted share for the
three months ended September 30, 2002 was comprised of a $.92 loss from
continuing operations and $.38 loss from discontinued operations.
Nine Months Ended September 30, 2003 Compared with the Nine Months Ended
September 30, 2002
Revenues. Total revenues were $272.4 million for the nine months ended September
30, 2003, compared to $242.5 million for the nine months ended September 30,
2002, representing an increase of $29.9 million, or 12.3%. Resident and health
care revenues increased by $27.2 million during the 2003 period. Approximately
$9.6 million related to increases in average billable revenue per unit and $7.0
million 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 $1.7 million related to
the August 2003 leasehold acquisition of two Retirement Communities. In
addition, $2.2 million is related to revenues from therapy services, as well as
a $2.2 million increase in management services revenues. These increases are
offset by reductions in home health revenues.
Management services revenue and reimbursed expenses increased to $3.3 million
and $4.4 million respectively, and increased as a percentage of total revenue to
1.2% and 1.6%, respectively, in the nine months ended September 30, 2003, from
0.5% and 1.6%, respectively, in the nine months ended September 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 $206.6 million in the
nine months ended September 30, 2003, compared to $189.6 million in the nine
months ended September 30, 2002, representing an increase of $17.0 million, or
9.0%. Approximately $8.2 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, $3.7 million related to increased revenues from
therapy services, $1.0 million related to the new leases in August 2003 for two
Retirement Centers previously managed by the Company and $767,000 related to
increases in occupancy. These increases are offset by reduced home health
revenues.
Free-standing AL resident and health care revenues were $58.1 million in the
nine months ended September 30, 2003, compared to $47.9 million in the nine
months ended September 30, 2002, representing an increase of $10.2 million, or
21.3%. These figures are net of the revenue for three communities held-for-sale
which are included as a component of discontinued operations. Approximately $6.3
million of this increase is related to increased occupancy, $1.6 million related
to increased revenues from therapy services, and $1.4 million related to
increases in average billable revenue per unit. The remaining increase relates
to increased revenues from other ancillary fees and services.
30
In addition, certain per person annual Medicare reimbursement limits on therapy
services, which had been temporarily suspended, became effective on September 1,
2003. Certain pending legislation may suspend the limits again effective at some
future date. While the Company is currently 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. During the end of
2003 and in early 2003, economic conditions and the declining stock market had a
negative effect on the marketing of the Company's EF Communities. These negative
market conditions were 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 has recently
experienced stronger sales and anticipates continued progress during 2003 in the
marketing of its entrance fee units, which should result in higher cash flows
from entrance fee sales. During the nine months ended September 30, 2003, the
Company's five owned and leased EF Communities recorded $25.4 million of
proceeds from entrance fee sales, including $22.7 million from new sales and
$2.7 million from payments received on deferred entrance fee receivables, and
paid refunds as a result of contract terminations of $10.5 million, resulting in
$14.9 million net proceeds from entrance fee sales. During the nine months ended
September 30, 2002, the Company's five owned and leased EF Communities recorded
$18.4 million of proceeds from entrance fee sales, including $16.6 million from
new sales and $1.8 million from payments received on deferred entrance fee
receivables, and paid refunds as a result of contract terminations of $6.6
million, resulting in $11.8 million net proceeds from entrance fee sales.
Therefore, the Company experienced $7.0 million of increased proceeds from
entrance fee sales, including $6.1 million from new sales and $900,000 from
payments received on deferred entrance fees receivable, and paid additional
refunds as a result of contract terminations of $3.9 million, resulting in $3.1
million of additional net proceeds from entrance fee sales, when comparing the
nine month period ended September 30, 2003 and 2002. Approximately $423,000 of
the $3.1 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 nine months ended September 30, 2003,
Freedom Square had proceeds from entrance fee sales, net of refunds paid, of
approximately $3.8 million.
Community Operating Expense. Community operating expense increased to $185.8
million in the nine months ended September 30, 2003, as compared to $171.7
million in the nine months ended September 30, 2002, representing an increase of
$14.1 million, or 8.2%. Approximately $3.3 million of the increase resulted
primarily from additional community expenses as a result of the April 2002
long-term lease (and the resulting consolidation of expenses) of Freedom Plaza
Arizona, as well as the new leases entered into in August 2003 for two
Retirement Centers which the Company previously managed, resulting in $1.0
million of additional expense. In addition, increased labor costs amounted to
$2.8 million related to occupancy increases, and increased costs of nursing
staff. Approximately $1.0 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 $1.5 million and food cost
increases amounted to $570,000. 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 70.2% from 72.3% for the nine months ended September 30, 2003 and
2002, respectively.
31
Retirement Center community operating expenses were $139.0 million in the nine
months ended September 30, 2003, compared to $127.6 million in the nine months
ended September 30, 2002, representing an increase of $11.4 million, or 8.9%.
Approximately $3.3 million of this increase was attributable to the April 1,
2002 long-term lease of Freedom Plaza Arizona, as well as the new leases entered
into in August 2003 for two Retirement Centers which the Company previously
managed, resulting in $1.0 million of additional expense. In addition, increased
labor costs amounted to $1.1 million from increased rates and nursing costs of
qualified personnel. Approximately $991,000 relates to additional marketing
expense and 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 $46.8 million in the
nine months ended September 30, 2003 from $44.1 million in the nine months ended
September 30, 2002, representing an increase of $2.7 million or 6.1%
Approximately $1.8 million of this increase is related to increased labor costs
and $570,000 of increased food costs related primarily to increased occupancy.
In addition, costs associated with the growth of the therapy services program
amounted to $875,000. The remaining variance results from additional expenses
such as insurance, offset by reductions in other expenses. Offsetting these
increases is a reduction in marketing expenses, which were concentrated in the
prior period due to focused fill-up of these communities, of $539,000, as well
as various improvements in other operating expenses.
Segment Operating Contribution. The Company measures the performance of its
three 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 $5.6 million, or 9.0%, to
$67.6 million for the nine months ended September 30, 2003 from $62.0 million
for the nine months ended September 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.
Free-standing AL operating contribution improved by $7.5 million to $11.3
million for the nine months ended September 30, 2003, from $3.8 million for the
nine months ended September 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 $2.2 million to $3.3
million in the nine months ended September 30, 2003, attributable to increased
management fees resulting from improved operating results at managed
communities.
General and Administrative. General and administrative expense decreased to
$19.2 million for the nine months ended September 30, 2003, as compared to $21.1
million for the nine months ended September 30, 2002, representing a decrease of
$1.9 million, or 9.0%. This decrease is related to lower consulting and legal
costs versus costs incurred as part of the 2002 Refinancing, offset by higher
administrative costs resulting from expanded compliance and regulatory
requirements. General and administrative expense as a percentage of total
consolidated revenues decreased to 7.0% as compared to 8.7% for the nine months
ended September 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 its total operating activities (including those that are managed).
General and administrative expense as a percentage of total combined revenues
decreased to 5.8% from 6.9% for the nine months ended September 30, 2003 and
2002, respectively, computed as follows:
32
Nine Months ended September 30,
-------------------------------
2003 2002
---- ----
Total consolidated revenues $ 272,360 $ 242,470
Revenues of unconsolidated managed
communities 61,265 64,636
Less management fees (3,278) (1,117)
------------------------------
Total combined revenue $ 330,347 $ 305,989
==============================
Total general and administrative expense $ 19,169 $ 21,061
==============================
General and administrative expense as a %
of total consolidated revenues 7.0% 8.7%
==============================
General and administrative expense as a %
of total combined revenue 5.8% 6.9%
==============================
Lease Expense. As of September 30, 2003, the Company had operating leases for 32
of its communities, including 16 Retirement Centers and 16 Free-standing ALs.
Lease expense decreased $29.4 million to $32.2 million for the nine months ended
September 30, 2003 from $61.5 million for the nine months ended September 30,
2002. This decrease was attributable to the additional lease expense of $30.8
million recorded during the nine months ended September 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 $7.0 million as a result of
certain sale-leaseback transactions completed in 2003 and 2002.
Depreciation and Amortization. Depreciation and amortization expense increased
to $18.8 million in the nine months ended September 30, 2003 from $15.1 million
in the nine months ended September 30, 2002, representing an increase of $3.7
million, or 24.4%. The increase was primarily related to increased depreciable
assets during the nine months ended September 30, 2003 mainly due to the
addition of assets from the termination of synthetic leases. Note that the
$92.0 million reduction in depreciable assets occurred on September 23, 2003.
See Note 7.
Amortization of Leasehold Acquisition Costs. Amortization of leasehold
acquisition costs decreased $9.0 million to $1.6 million in the nine months
ended September 30, 2003 from $10.6 million in the nine months ended September
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 $41.2 million for the nine
months ended September 30, 2003 from $31.6 million for the nine months ended
September 30, 2002, representing an increase of $9.7 million, or 30.6%. 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 nine months ended September 30, 2003 from 13.0% in
the nine months ended September 30, 2002. Interest income decreased to $2.2
million in the nine months ended September 30, 2003 from $4.0 million in the
nine months ended September 30, 2002, representing a decrease of $1.8 million or
45.6%. 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. Gain of the sale of assets for the nine months ended September 30,
2003 was $23.2 million. This gain resulted from the sale of a Retirement Center.
Income Taxes. The provision for income taxes was an expense of $1.6 million and
$319,000 for the nine months ended September 30, 2003 and 2002, respectively,
for taxes. The Company has recorded a valuation allowance related to the
deferred tax assets resulting from 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 $1.9 million
or the nine months ended September 30, 2003. This amount was attributable to the
HCPI Equity Investment made during September 2002.
33
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 nine months ended
September 30, 2003 and 2002, the Company recorded a loss from discontinued
operations of $1.9 million and $8.0 million, respectively, for these three
Free-standing ALs. The loss recorded for the nine months ended September 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. Based upon the subject purchase prices, the discontinued
operations during the nine months ended September 30, 2002 included $5.9 million
of impairment. 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 $10.6 million, or $.59 loss per diluted share, compared to a net loss of
$80.1 million, or $4.63 loss per diluted share, for the nine months ended
September 30, 2003 and 2002, respectively. The $.59 loss per diluted share for
the nine months ended September 30, 2003 was comprised of a $.49 loss from
continuing operations and $.10 loss from discontinued operations related to the
three communities held-for-sale. The loss of $4.63 per diluted share for the
nine months ended September 30, 2002 was comprised of a $4.17 loss from
continuing operations and $.46 loss from discontinued operations.
Liquidity and Capital Resources
As a result of the completion of the Company's 2002 Refinancing Plan, the
Company is now focused on increasing the operating cash flow of its three
business segments. During the three and nine months ended September 30, 2003,
the Company reduced its net loss and improved operating results from its
Retirement Center and Free-standing AL business segments. The Company is focused
on generating positive cash from operating activities, primarily through
improvements in its operating results. For the nine months ended September 30,
2003, net cash used by continuing operations activities was $978,000.
As of September 30, 2003, the Company had approximately $17.4 million in
unrestricted cash and cash equivalents and $5.0 million of working capital. The
Company has scheduled current debt principal payments of $13.4 million and
minimum rental obligations of $64.2 million under long-term operating leases due
during the twelve months ended September 30, 2004. The Company also has $17.1
million of debt associated with assets held-for-sale, which are classified as
current liabilities (of which only $1.7 million would be due within the next
twelve months by its terms). 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 believes that its current cash and cash equivalents, expected cash
flow from operations, the proceeds from additional financing transactions and
the proceeds of certain 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.
In order to meet its future payment obligations, the Company must 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.
34
Cash Flow
Net cash used by continuing operations was $978,000 for the nine months ended
September 30, 2003, as compared with net cash used of $3.4 million for the nine
months ended September 30, 2002. The Company's cash and cash equivalents totaled
$17.4 million as of September 30, 2003, as compared to $25.0 million as of
September 30, 2002.
Net cash used by investing activities was $1.2 million for the nine months ended
September 30, 2003, as compared with $33.7 million provided for the nine months
ended September 30, 2002. During the nine months ended September 30, 2003, the
Company added $7.4 million to land, buildings and equipment, issued $2.3 million
of notes receivable, and received $8.4 million from the sale of assets and $1.3
million of distributions from joint ventures.
Net cash provided by financing activities was $1.3 million compared with $24.6
million used by financing activities during the nine months ended September 30,
2003 and 2002, respectively. During the nine months ended September 30, 2003 the
Company received proceeds of $16.6 million from the issuance of long-term debt,
including the accrual of deferred interest of $8.9 million, made principal
payments on its indebtedness of $12.1 million, paid $769,000 of financing costs
and made distributions to the minority interest holder of $913,000. In
connection with certain entrance fee communities, the Company made principal
payments under master trust agreements of $1.0 million.
Net cash used by discontinued operations was $27,000 for the nine months ended
September 30, 2003 and $16,000 was provided by discontinued operations for the
nine months ended September 30 2002. Loss from discontinued operations was $1.9
million and $8.0 million for the nine months ended September 30, 2003 and 2002,
respectively.
Financing Activity
On September 23, 2003, the Company completed a multi-property transaction with
HCPI that involved the sale lease-back of three Retirement Centers and the sale
of a fourth Retirement Center. The Company also entered into a long-term
agreement to manage the fourth community for an unaffiliated third party. In
addition, the Company obtained $7.0 million of mortgage financings from HCPI
that are secured by certain land parcels adjoining two of the communities.
The proceeds of the transaction were used to repay $112.8 million of first
mortgage debt on the four Retirement Centers. In addition, after first mortgage
prepayment costs of $1.0 million, a $3.0 million credit for HCPI's existing
minority interest in the properties, and transaction costs, the remaining
proceeds of $51.8 million were used to repay a portion of the HCPI Loan plus
accrued interest. The terms of the HCPI Loan originally did not permit
prepayment until after October 2005, however, the parties amended the agreement
to allow for this transaction and the resulting prepayment.
The four Retirement Centers were valued in the transaction at $163.5 million,
versus their net book value of $72.3 million. As a result of the transaction,
the Company realized gains of $93.1 million. During the third quarter of 2003,
$23.2 million of these gains were recognized related to the sale of the fourth
Retirement Center. The remaining $69.9 million of gains were deferred and will
be recognized over the lease terms. Approximately $66.2 million of the deferred
gains will be recognized over the initial ten year lease terms for the three
Retirement Centers included in the September 2003 HCPI sale lease-back. An
additional $3.7 million of deferred gains will be recognized over the remaining
thirteen years of a Retirement Center lease previously entered into with HCPI
during the first quarter of 2002. As part of the September 2003 transaction,
this prior lease was amended to remove a purchase option related to the land,
building and equipment of this community. The lease was previously accounted for
as a financing, but as a result of the amendment, will now be accounted for as
an operating lease. This lease amendment resulted in a $19.7 million reduction
of land, buildings and equipment and a $24.1 million reduction in debt.
The Company will continue to operate all four Retirement Centers involved in the
September 2003 transaction, two of which are located in Texas, one in Arizona,
and one in Colorado (which will be operated under a management agreement). The
communities have a combined capacity of 1,170 units, including independent
living, assisted living, memory enhancement and skilled nursing units. Three of
the Retirement Centers were leased-back from HCPI under a master lease agreement
with an initial term of ten years, plus two ten year renewal options. The lease
for these three Retirement Centers will be accounted for as an operating lease.
The initial lease rate for these three communities will be 9.5%, with annual
rent increases of 2.75%.
35
The Company additionally agreed to manage the fourth Retirement Center located
in Colorado for an unaffiliated third party under a long term management
agreement. The initial term of the management agreement is ten years, plus two
ten year renewal terms. Under the terms of the management agreement, the Company
will operate the Retirement Center under its existing tradename, and does not
anticipate any change in operations, employees or services. As a result of this
transaction, the Company will report management fee revenue earned under the
management agreement for the Colorado Retirement Center, instead of including
the revenues and expenses of this community as part of its consolidated results.
The Company also entered into a mortgage loan with HCPI in the amount of $7.0
million. Interest is payable monthly at LIBOR plus 3%, with the principal
balance due in September 2005. The Company used the proceeds from this loan in
conjunction with the repayment of the HCPI Loan as described above. The note is
secured by vacant land parcels adjacent to two of the Retirement Centers
included in the sale/lease-back transaction. Since these land parcels are
currently in the process of being sold, the $7.0 million loan is shown as a
current liability, as debt associated with assets held-for-sale (of which $0
would be due within the next twelve months by its terms).
The HCPI Loan balance at September 30, 2003 was $75.9 million, as compared with
$122.1 million at June 30, 2003. The $75.9 million HCPI Loan, and related
interest, if not paid until its September 2007 maturity, will compound to be
approximately $117.7 million, or an additional $41.8 million. The Company is
permitted to repay the HCPI Loan in whole or in part beginning October 2005 and
may redeem the HCPI Equity Investment beginning October 2006. 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 own
five of the Company's Retirement Centers, and the Company will continue to
operate the five 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 on or before the
2007 maturity, and HCPI forecloses upon its collateral, the Company would
realize significant taxable income, which may result in a substantial 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. As a result, the Company has presented
$33.0 million of this debt as long-term and $6.6 million as debt related to
assets held-for-sale on the condensed consolidated financial statements herein,
net of payments made during the three months ended September 30, 2003.
The Company previously had managed two Retirement Centers. The Company had
invested $6.0 million for options to purchase these communities. On August 25,
2003, the options were sold to a third party buyer for $3.0 million and the
third party buyer acquired each of the communities from the original developer.
The buyer simultaneously entered into a long-term lease with a newly formed
entity, owned by the Company and the original developer of the communities. In
order to complete the purchase transaction, the Company agreed on a non-recourse
basis to pay the original developer $11.3 million. The entity, which the Company
consolidates, recorded $10.0 million as debt and will impute interest at prime,
with all amounts due on the $11.3 million note on August 25, 2008. The lease
provides an initial 15 year term, with two 10 year extension options. Proceeds
from the additional funding, if any, will be used first to satisfy the Company's
$11.3 million obligation to the original developer. The Company recorded
leasehold acquisition costs of $13.0 million which consists of the $10.0 million
obligation to the original developer and the balance of the purchase option sold
to the third party buyer. The leasehold acquisition costs are being amortized
over the base term of the leases. The buyer has committed to provide additional
funding to the lessees depending upon the financial performance of the
communities. The Company also acquired an option from the buyer to purchase the
communities in nine years.
During the nine months ended September 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 1,386,024 common
shares, par value $0.01 per share. The average market price of the Company's
common stock outstanding during the three months ended September 30, 2003 was
greater than the $2.25 per share conversion price. At September 30, 2003, the
Series B Notes were convertible into 5,698,204 shares of common stock.
36
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. 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 $41.8 million.
The Company is permitted to repay the HCPI Loan in whole or in part beginning
October 2005 and redeem the HCPI Equity Investment beginning October 2006. 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 five of the Company's Retirement Centers, and the
Company will continue to operate the five 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 would realize significant taxable income, which may
result in a significant 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 nine months ended
September 30, 2003, the Company obtained a financial covenant waiver on a lease
related to a single community. At September 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 could result in a default or
acceleration of certain of the Company's other obligations, which would have a
material adverse effect on the Company.
37
Future Cash Commitments
The following tables summarize the Company's total contractual obligations and
commercial commitments as of September 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) $ 236,404 $ 8,286 $39,020 $ 1,370 $77,371 $ 33,389 $76,968
Debt associated with assets
held-for-sale(1) 17,057 17,057 - - - - -
Lease financing obligations 101,509 5,071 5,578 6,113 6,688 7,287 70,772
Operating leases 884,792 64,210 65,421 66,646 67,902 67,567 553,046
Accrued interest on HCPI Loan(2) 41,836 - - - 41,836 - -
--------------------------------------------------------------------------------------
Total contractual cash
obligations $1,281,598 $ 94,624 $ 110,019 $ 74,129 $193,797 $108,243 $ 700,786
--------------------------------------------------------------------------------------
Interest income on notes
receivable(3) (25,255) (1,094) (1,081) (1,071) (1,060) (1,051) (19,898)
--------------------------------------------------------------------------------------
Contractual obligations, net $1,256,343 $ 93,530 $ 108,938 $73,058 $192,737 $ 107,192 $ 680,888
======================================================================================
Amount of Commitment Expiration Per Period
--------------------------------------------------------------------------------------
Total
Committed Year 1 Year 2 Year 3 Year 4 Year 5 Thereafter
--------- ------ ------ ------ ------ ------ ----------
Guaranties(4) $ 35,965 $1,153 $1,257 $1,369 $9,496 $1,409 $ 21,281
Letter of Credit 7,000 7,000 - - - - -
--------------------------------------------------------------------------------------
Total commercial commitments $ 42,965 $8,153 $1,257 $ 1,369 $9,496 $ 1,409 $ 21,281
======================================================================================
(1) When assets held-for-sale are sold, the Company will use most of the
proceeds to repay mortgage debt and other related payments. Only $1.7
million of the $17.1 million debt associated with the assets held-for-sale
would be due within the next twelve months by its terms (or classified as
current debt).
(2) 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 4 long-term debt amount includes $41.8 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.
(3) 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.
(4) Guarantees include mortgage debt related to four communities. 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 2004 is approximately $14.5 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 alternative financing
sources will not be available to the Company, (vi) the risks associated with the
adverse market conditions for the senior living industry, (vii) 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, (viii) the likelihood of further and tighter governmental
regulation, (ix) the risk of adverse changes in governmental reimbursement
programs (including annual caps on therapy reimbursements), (x) the risk that
the Company will be unable to sell certain assets which are currently
held-for-sale, 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.
38
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 $86.0
million of variable rate debt at September 30, 2003. However, $60.7 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 $25.3 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 $253,000.
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 $34.0 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 $268.8 million, or 75.7% 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.
39
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. Controls and Procedures
American Retirement Corporation's Chief Executive Officer and Chief Financial
Officer have reviewed and evaluated the effectiveness of the Company's
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)
and 15d-15(e)) as of the end of the period covered by this quarterly report.
Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer have concluded that the Company's disclosure controls and procedures
effectively and timely provide them with material information relating to the
Company and its consolidated subsidiaries required to be disclosed in the
reports the Company files or submits under the Exchange Act.
40
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Lease Agreement, dated August 25, 2003, between Alabama Somerby, LLC and CNL Retirement DSL1 Alabama, LP.
10.2 Lease Agreement, dated August 25, 2003, between Alabama Somerby, LLC and CNL Retirement DSL1 Alabama, LP.
10.3 Promissory Note, dated as of August 25, 2003, between Alabama Somerby, LLC and Daniel Senior Living, L.L.C.
10.4 Contract of Acquisition and Agreement to Make Loan, dated as of September 23, 2003, between Health Care Property
Investors, Inc. and ARCPI Holdings, Inc.
10.5 Second Amendment to Loan Agreement, dated as of September 23, 2003, between ARCPI Holdings, Inc. and Health Care
Property Investors, Inc.
10.6 First Amendment to Master Lease Agreement, dated as of September 23, 2003, between Fort Austin Real Estate
Holdings, LLC, ARC Santa
Catalina Real Estate Holdings, LLC, ARC Richmond Place Real Estate Holdings, LLC, ARC Holland Real Estate
Holdings, LLC, ARC Sun City
Center Real Estate Holdings, LLC, ARC Lake Seminole Square Real Estate Holdings, LLC, ARC Brandywine Real Estate
Holdings, LLC, Fort Austin
Limited Partnership, ARC Santa Catalina, Inc., ARC Richmond Place, Inc., Freedom Village of Holland, Michigan,
Freedom Village of Sun City
Center, Ltd., Lake Seminole Square Management Company, Inc., Freedom Group-Lake Seminole Square, Inc. and ARC
Brandywine, LLC.
31.1 Certification of W.E. Sheriff Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Bryan D. Richardson Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of W. E. Sheriff, Chief Executive Officer of American Retirement Corporation, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Bryan D. Richardson Chief Financial Officer of American Retirement Corporation, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Section 1350 Certification of Bryan D. Richardson.
(b) Reports on Form 8-K filed during the quarter ended September 30, 2003:
On August 7, 2003, the Company furnished to the SEC a Form 8-K (Items 7 and
12) containing a press release issued by the Company announcing its second
quarter 2003 earnings results.
On August 7, 2003, the Company furnishsed to the SEC a Form 8-K (Items 7, 9
and 12) containing supplemental financial information relating to the
Company's second quarter 2003 results.
41
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: November 7, 2003 By: /s/ Bryan D. Richardson
-----------------------
Bryan D. Richardson
Executive Vice President-Finance and
Chief Financial Officer (Principal
Financial and Accounting Officer)