SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 For the quarterly period ended
September 30, 2001
[ ] 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 (I.R.S. Employer
of Incorporation or Organization) Identification No.)
111 Westwood Place, Suite 200, Brentwood, TN 37027
-------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(615) 221-2250
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
As of November 9, 2001, there were 17,247,576 shares of the Registrant's common
stock, $.01 par value, outstanding.
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 2001 and December 31, 2000........................3
Condensed Consolidated Statements of
Operations for the Three Months Ended
September 30, 2001 and 2000 ....................................4
Condensed Consolidated Statements of
Operations for the Nine Months Ended
September 30, 2001 and 2000 ....................................5
Condensed Consolidated Statements of Cash
Flows for the Nine Months Ended September 30,
2001 and 2000 ..................................................6
Notes to Condensed Consolidated Financial Statements ...........8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations................. 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk ... 31
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.............................. 31
Signatures ............................................................ 32
2
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,
2001 2000
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 17,026 $ 19,850
Assets limited as to use 7,398 5,181
Accounts receivable, net 17,842 15,772
Inventory 1,200 1,079
Prepaid expenses 3,126 2,906
Deferred income taxes 332 332
Other current assets 5,599 5,608
--------- ---------
Total current assets 52,523 50,728
Assets limited as to use, excluding amounts classified as current 72,552 73,785
Land, buildings and equipment, net 513,050 473,062
Notes receivable 95,574 90,707
Goodwill, net 36,715 37,503
Leasehold acquisition costs, net 15,248 16,103
Other assets 45,703 50,592
--------- ---------
Total assets $ 831,365 $ 792,480
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 38,579 $ 7,449
Accounts payable 5,989 7,502
Accrued expenses 23,236 16,256
Other current liabilities 7,949 5,241
--------- ---------
Total current liabilities 75,753 36,448
Long-term debt, excluding current portion 360,464 338,261
Convertible subordinated debentures 132,930 137,980
Refundable portion of life estate fees 43,640 44,739
Deferred life estate income 53,305 52,765
Tenant deposits 6,626 6,612
Deferred gain on sale-leaseback transactions 13,613 16,122
Deferred income taxes 7,085 13,079
Other long-term liabilities 8,242 4,517
--------- ---------
Total liabilities 701,658 650,523
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,
17,236,076 and 17,036,695 shares issued and outstanding,
respectively 172 170
Additional paid-in capital 145,516 145,080
Accumulated deficit (15,156) (3,293)
Accumulated other comprehensive loss, net (825) --
--------- ---------
Total shareholders' equity 129,707 141,957
--------- ---------
Total liabilities and shareholders' equity $ 831,365 $ 792,480
========= =========
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,
--------------------
2001 2000
-------- --------
Revenues:
Resident and health care $ 64,820 $ 52,359
Management and development services 1,231 1,073
-------- --------
Total revenues 66,051 53,432
Operating expenses:
Community operating expenses 46,516 36,936
General and administrative 6,412 4,722
Lease expense, net 7,217 4,979
Depreciation and amortization 5,332 4,547
-------- --------
Total operating expenses 65,477 51,184
-------- --------
Operating income 574 2,248
Other income (expense):
Interest expense (9,537) (9,768)
Interest income 2,448 3,660
Gain (loss) on sale of assets (59) 265
Equity in losses of managed special purpose entity
communities (1,014) (589)
Other 832 876
-------- --------
Other expense, net (7,330) (5,556)
-------- --------
Loss from continuing operations before income taxes,
minority interest, and extraordinary item (6,756) (3,308)
Income tax benefit (2,311) (1,098)
-------- --------
Loss from continuing operations before minority
interest and extraordinary item (4,445) (2,210)
Minority interest in losses of consolidated subsidiaries,
net of tax 1 468
-------- --------
Loss from continuing operations before
extraordinary item (4,444) (1,742)
Extraordinary gain (loss) on extinguishment of debt,
net of tax 3 (124)
-------- --------
Net loss $ (4,441) $ (1,866)
======== ========
Basic loss per share:
Basic loss per share before extraordinary item $ (0.26) $ (0.10)
Extraordinary gain (loss), net of tax -- (0.01)
-------- --------
Basic loss per share $ (0.26) $ (0.11)
======== ========
Diluted loss per share:
Diluted loss per share before extraordinary item $ (0.26) $ (0.10)
Extraordinary gain (loss), net of tax -- (0.01)
-------- --------
Diluted loss per share $ (0.26) $ (0.11)
======== ========
Weighted average shares used for basic loss per share data 17,239 17,024
Effect of dilutive common stock options -- --
-------- --------
Weighted average shares used for diluted loss per share data 17,239 17,024
======== ========
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,
----------------------
2001 2000
--------- ---------
Revenues:
Resident and health care $ 186,897 $ 145,372
Management and development services 2,904 3,599
--------- ---------
Total revenues 189,801 148,971
Operating expenses:
Community operating expenses 131,920 99,458
General and administrative 18,162 13,381
Lease expense, net 20,668 12,597
Depreciation and amortization 15,619 12,589
--------- ---------
Total operating expenses 186,369 138,025
--------- ---------
Operating income 3,432 10,946
Other income (expense):
Interest expense (28,056) (26,473)
Interest income 8,601 11,173
(Loss) gain on sale of assets (181) 260
Equity in losses of managed special purpose entity
communities (2,952) (589)
Other 1,855 732
--------- ---------
Other expense, net (20,733) (14,897)
--------- ---------
Loss from continuing operations before income taxes,
minority interest, and extraordinary item (17,301) (3,951)
Income tax benefit (5,709) (1,334)
--------- ---------
Loss from continuing operations before minority
interest and extraordinary item (11,592) (2,617)
Minority interest in (earnings) losses of consolidated
subsidiaries, net of tax (94) 967
--------- ---------
Loss from continuing operations before
extraordinary item (11,686) (1,650)
Extraordinary loss on extinguishment of debt, net of tax (178) (124)
--------- ---------
Net loss $ (11,864) $ (1,774)
========= =========
Basic loss per share:
Basic loss per share before extraordinary item $ (0.68) $ (0.10)
Extraordinary loss, net of tax (0.01) (0.01)
--------- ---------
Basic loss per share $ (0.69) $ (0.10)
========= =========
Diluted loss per share:
Diluted loss per share before extraordinary item $ (0.68) $ (0.10)
Extraordinary loss, net of tax (0.01) (0.01)
--------- ---------
Diluted loss per share $ (0.69) $ (0.10)
========= =========
Weighted average shares used for basic loss per share data 17,192 17,102
Effect of dilutive common stock options -- --
--------- ---------
Weighted average shares used for diluted loss per share data 17,192 17,102
========= =========
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,
--------------------
2001 2000
-------- --------
Cash flows from operating activities:
Net loss $(11,864) $ (1,774)
Extraordinary loss on extinguishment of debt, net of tax 178 124
-------- --------
Loss from continuing operations (11,686) (1,650)
Adjustments to reconcile loss from continuing operations to net
cash and cash equivalents provided by operating activities:
Depreciation and amortization 15,619 12,589
Amortization of deferred entrance fee revenue (7,480) (5,037)
Amortization of deferred financing costs 1,938 1,542
Advances to joint ventures (1,512) --
Proceeds from terminated lifecare contract 2,355 1,767
Proceeds from life estate sales, net of refunds 6,205 5,864
Deferred income tax benefit (5,415) (866)
Amortization of deferred gain on sale-leaseback transactions (2,509) (340)
Minority interest in earnings (losses) of consolidated subsidiaries 94 (967)
(Income) losses from unconsolidated joint ventures (14) 411
(Loss) gain on sale of assets 181 (260)
Issuance of stock to defined contribution plan 333 --
Changes in assets and liabilities, net of effects from acquisitions:
Accounts receivable (977) 846
Inventory (75) 68
Prepaid expenses (203) (1,678)
Other assets 1,262 (3,088)
Accounts payable (1,949) 14
Accrued expenses and other current liabilities 8,550 (949)
Tenant deposits (22) 64
Other liabilities 1,018 (1,658)
-------- --------
Net cash and cash equivalents provided by operating activities 5,713 6,672
Cash flows from investing activities:
Additions to land, buildings and equipment (13,325) (34,592)
Expenditures for acquisitions, net of cash received -- (6,082)
Advances for development projects, net -- (1,254)
Investments in joint ventures -- (75)
Contributions from minority owners -- 522
Proceeds from the sale of assets 7,708 265
Other investing activities 804 2,787
Expenditures for leasehold acquisitions, net of cash received (5) (9,651)
Purchase of assets limited as to use, net (5,439) (8,311)
Issuance of notes receivable (2,167) (5,892)
-------- --------
Net cash used by investing activities (12,424) (62,283)
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,
--------------------
2001 2000
-------- --------
Cash flows from financing activities:
Proceeds from the issuance of long-term debt 21,744 86,935
Principal payments on long-term debt (8,781) (23,319)
Purchase of convertible debentures (4,029) --
Principal reductions in master trust liability (4,035) (1,847)
Expenditures for financing costs (1,116) (1,769)
Other financing costs 104 (639)
-------- --------
Net cash provided by financing activities 3,887 59,361
-------- --------
Net (decrease) increase in cash and cash equivalents (2,824) 3,750
-------- --------
Cash and cash equivalents at beginning of period 19,850 21,881
-------- --------
Cash and cash equivalents at end of period $ 17,026 $ 25,631
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest (including capitalized interest) $ 25,134 $ 24,208
======== ========
Income taxes (refunded) paid $ (1,520) $ 211
======== ========
Supplemental disclosure of non-cash transactions:
During the respective periods, the Company acquired certain communities and
entered into certain lease transactions. In conjunction with the
transactions, assets and liabilities were assumed as follows:
Current assets $ -- $ 939
Land, buildings and other assets -- 14,202
Current liabilities -- 1,108
Long-term debt -- 7,925
Other liabilities -- 26
======== ========
During the nine months ended September 30, 2001, the Company funded its 401(k)
contribution with 81,788 shares of its common stock at a fair market value of
approximately $333,000.
During the nine months ended September 30, 2001, the Company entered into a
long-term operating lease and acquired certain assets and liabilities from the
previous lessee. The assets acquired exceeded the liabilities assumed by
$903,000, which will be amortized over the life of the lease.
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. 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)
considered necessary for a fair presentation have been included. Certain fiscal
year 2000 amounts have been reclassified to conform to the fiscal year 2001
presentation. Operating results for the three and nine months ended September
30, 2001 are not necessarily indicative of the results that may be expected for
the entire year ending December 31, 2001. 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, 2000.
2. LIQUIDITY
The Company is highly leveraged and has a substantial amount of debt and lease
obligations. At September 30, 2001, the scheduled debt maturities during the
fifteen months ended December 31, 2002 totaled $348.9 million, including $216.0
million of mortgage debt and $132.9 million of 5 3/4% Convertible Subordinated
Debentures due October 2002. In addition, as of September 30, 2001, the Company
had negative working capital of $23.9 million, as a result of $38.6 million of
debt classified as a current liability. The Company expects that its current
cash and cash equivalents, expected cash flow from operations, and the proceeds
from certain anticipated financings will be sufficient to fund its operating
requirements, including its pre-stabilization losses, its capital expenditure
requirements and its ordinary course, periodic debt service requirements, during
the remainder of 2001 and 2002. The Company's internally generated cash will not
be sufficient to satisfy all of its obligations that mature in 2002 or its
scheduled principal reductions in 2002. The Company's ability to satisfy its
maturing obligations will depend primarily upon its ability to refinance,
extend, or obtain new credit arrangements and to issue privately placed equity
or equity linked securities. The Company is also examining other alternatives
for raising capital, including the selective disposition of certain communities,
the sale-leaseback or monetization of certain communities, and the exchange of
its 5 3/4% Convertible Subordinated Debentures for other securities of the
Company. The Company has engaged in and anticipates continuing discussions with
its existing lenders and other third parties regarding these alternatives. The
terms of any such transactions may impose significant burdens on the Company and
are likely to be substantially dilutive to the Company's existing shareholders.
There can be no assurances that the Company will be able to consummate any of
these transactions or that it will be able to refinance, extend or obtain new
debt or equity financing necessary to satisfy its periodic or maturing
obligations. Failure to satisfy these maturing obligations or to meet its
operating or debt service requirements would have a material adverse effect on
the Company.
Certain of the Company's credit agreements contain restrictive covenants that
include, among other things, the maintenance of minimum tangible net worth,
prescribed debt service coverage, liquidity, capital expenditure reserves and
occupancy levels. Effective as of September 30, 2001, the Company and certain of
its lenders and lessors agreed to amendments or waivers relating to several of
these financial covenants in order to allow the Company to remain in compliance
therewith. Effective as of September 30 2001, the Company extended the maturity
date of its $100.0 million mortgage loan facility from August 1, 2002 to
November 1, 2002. The debt outstanding under this facility is classified in
accordance with its revised stated maturity schedule; however, if the maturity
of this facility is not further extended beyond November 1, 2002, this debt will
be classified as a current liability in the fourth quarter of 2001, which will
have a material adverse effect on the Company's working capital position. At
September 30, 2001, $92.3 million was outstanding under this credit facility. In
connection with previous amendments to the $100.0 million
8
mortgage loan facility and certain of the Company's credit agreements, the
Company agreed to, among other things, (i) convert the facility to a term loan
from a revolving line-of-credit, (ii) make a $10.0 million principal reduction
by May 1, 2002, (iii) increase the interest rate margin of the facility, (iv)
provide a capital formation plan requiring that the Company raise $30.0 million
of capital by January 31, 2002, (v) provide evidence of sufficient capacity to
payoff its 5 3/4% Convertible Subordinated Debentures by July 1, 2002, and (vi)
include certain new and amended financial covenants.
Future compliance with the Company's financial covenants is largely dependent
upon improvements in the operations of the Company's free-standing assisted
living communities ("Free-standing ALs") and upon the Company's ability to raise
capital to make required debt reductions. Improvements in the Company's
operations and its ability to raise capital are subject to various factors such
as the Company's financial position, general economic conditions, credit market
conditions, interest rate levels, competition for residents, increases in
operating costs and various other factors, most of which are beyond the
Company's control. There can be no assurances that the Company will remain in
compliance with its financial covenants or obtain amendments or waivers related
to these covenants. If the Company fails to meet its financial covenants, unless
amended or waived, the Company's lenders will have the right to declare
defaults, accelerate repayment of the debt and exercise their legal remedies
(including foreclosure actions), which would have a material adverse effect on
the Company. There can be no assurance that the Company's lenders will grant
additional waivers or amendments in the future.
A significant amount of the Company's indebtedness is cross-defaulted. Any
non-payment, other default with respect to such obligations, or failure to
comply with the financial or other covenants of the debt agreements could cause
lenders to declare defaults, accelerate payment obligations or foreclose upon
the communities securing the indebtedness. Further, because of the cross-default
and cross collateralization provisions in certain of the Company's mortgages,
debt instruments and leases, a default by the Company under one of its credit or
lease agreements is likely to result in a default or acceleration of
substantially all of the Company's other obligations, which would have a
material adverse effect on the Company.
The Company's ability to obtain new credit facilities, to sell communities, or
to consummate any of the debt or equity financing alternatives being considered
depends upon a number of factors, many of which are beyond the Company's
control. These factors include the Company's financial condition and operating
performance, the financial strength of the assets to be sold or leveraged,
general economic conditions, general conditions in the credit markets, the
condition of the senior living industry, mortgage interest rates, the Company's
equity in any particular community and other factors. The Company's efforts will
be adversely affected by the condition of the assisted living market in general,
the insolvency or weakened financial conditions of many assisted living
competitors, a reduced number of lenders willing to finance assisted living or
retirement companies, the substantial fill-up costs associated with the
Company's Free-standing ALs and the fact that the Company is highly leveraged.
3. EARNINGS PER SHARE
Basic loss per share for the three and nine months ended September 30, 2001 and
2000 have been computed on the basis of the weighted average number of shares
outstanding. The weighted average number of shares outstanding for diluted
earnings per share includes dilutive common stock equivalents, which consist of
in-the-money stock options. During the three and nine months ended September 30,
2001, there were 1,187,086 and 1,194,447 options to purchase shares of common
stock outstanding which had an exercise price below the average market price of
the common shares. Such options were anti-dilutive because the Company incurred
a loss from continuing operations for the three and nine months ended September
30, 2001, and therefore were not included in the computation of diluted earnings
per share.
On January 4, 2001, the Company granted options to purchase approximately
1,120,000 shares of common stock. These options were granted with an exercise
price of $3.10, the fair value of the shares at the date of grant. These grants
are one-third vested after six months, 12 months and 24 months, and have a ten
year term.
9
The Company's 5 3/4% Convertible Subordinated Debentures outstanding during the
periods presented were not included in the computation of diluted earnings per
share because the conversion price of $24.00 per share was greater than the
average market price of the common shares for the respective periods and,
therefore, the effect would be anti-dilutive.
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.
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
------------------ -----------------
Average number of options (in thousands) 823 313 805 1,272
Weighted-average exercise price $ 7.76 $ 12.06 $ 8.03 $ 15.46
4. LONG TERM DEBT
During the nine months ended September 30, 2001, the Company entered into
various financing commitments including a secured term loan from a mortgage
lender in the amount of $17.3 million, with interest payable at LIBOR plus 3%.
Interest and principal are payable monthly, based on a twenty-five year
amortization schedule, with all remaining balances due in July 2002. The Company
used a portion of the proceeds from the loan to refinance a portion of a term
note to a capital corporation, repaying the outstanding amount of $3.5 million.
Effective as of September 30, 2001, the Company amended and obtained waivers for
various financing agreements in order to, among other things, maintain
compliance with its debt covenants, including its senior term loan, of which
$92.3 million was outstanding as of September 30, 2001. This amendment resulted
in the extension of the August 1, 2002 maturity to November 1, 2002 and amended
certain financial covenants. See Note 2 to the Condensed Consolidated Financial
Statements.
On September 26, 2001, the Company acquired a community located in Oakpark,
Illinois. The Company entered into a mortgage note with a commercial mortgage
lender in the amount of $13.0 million, with interest payable at a grid-based
pricing of LIBOR plus 2.6% to 3.5%. Interest and principle are payable monthly,
with the note maturing on October 1, 2003. The note is secured by the land and
building of the community. The Company previously leased this community.
On December 18, 2000, the Company sold a community located in Westlake, Ohio for
$26.0 million and contemporaneously leased the property back from the buyer. The
Company used a portion of the proceeds from the sale to repay $17.0 million of a
$50.0 million revolving line of credit. During the nine months ended September
30, 2001, the Company completed two like-kind exchange transactions which
deferred the taxable gain resulting from the Westlake transaction. In connection
with the first like-kind exchange, the Company purchased land in Virginia and
assumed a $12.1 million non-recourse mortgage loan bearing interest at 7.43%
with principal due monthly and a maturity date of January 2024. The Company
acquired the land subject to a lease that provides annual rental payments of
$980,000 through February 23, 2023. In the second like-kind exchange, the
Company purchased all of the equity interests in a single member limited
liability company that owned various parcels of land and buildings recorded at
$2.3 million and building improvements recorded at $4.8 million, and assumed a
$15.2 million non-recourse mortgage loan, with interest at 8.41% and principal
and interest due monthly, and a maturity date of September 2005. The various
land parcels are subject to leases that provide annual rental payments of $1.3
million through March 7, 2022.
10
The Company announced, during the quarter ended March 31, 2000, that the Board
of Directors had authorized the repurchase, from time to time, of up to $30.0
million of its 5 3/4% Convertible Subordinated Debentures. The timing and amount
of purchases of these debentures will depend upon prevailing market conditions,
availability of capital, alternative uses of capital and other factors. During
the nine months ended September 30, 2001, the Company purchased $5.1 million of
the 5 3/4% Convertible Subordinated Debentures, resulting in an extraordinary
gain on extinguishment of debt, net of tax, of $694,000. Additional purchases of
the 5 3/4% Convertible Subordinated Debentures, if any, are likely to be made
primarily in the open market.
5. ASSET IMPAIRMENTS AND CONTRACTUAL LOSSES
During the quarter ended December 31, 1999, the Company abandoned certain
development projects and recorded charges of approximately $6.7 million for
contractual losses and other costs. The Company made cash payments of $5.9
million in 2000 and $464,000 during the nine months ended September 30, 2001
related to these costs. An accrual of $348,000 remains at September 30, 2001.
The Company will continue to evaluate the adequacy of the remaining accrual. The
Company has sold two of the five land parcels associated with the abandoned
projects, and intends to continue marketing the remaining three land parcels
during 2001.
6. LEASEHOLD ACQUISITIONS AND SPECIAL PURPOSE ENTITIES (SPE)
The Company has entered into various transactions with third parties for the
development and operation of certain Free-standing ALs. The Company generally
has owned the land to be developed and entered into long-term ground leases with
special purpose entities, typically a subsidiary of a bank (the Owner). The
Owner has entered into a construction loan agreement with a lender, and those
construction loans have been guaranteed by the Company. The Company has pledged
to the Owners certificates of deposit as collateral to support the Owner's
equity contribution commitment. At September 30, 2001 and December 31, 2000, the
Company had pledged certificates of deposit and other investments in the
aggregate of $46.2 million and $45.4 million, respectively, which are classified
as non-current assets limited as to use. The Company receives the interest
income earned on these certificates of deposit.
The Owners of these Free-standing ALs leased the properties to various unrelated
SPEs (the Lessee) under operating leases. The Company contemporaneously entered
into management agreements with the lessees to manage the operations of the
communities ("Managed SPE Communities"). The management agreements provide for
the payment of management fees to the Company based on a percentage of each
communities' gross revenues and certain related agreements require the Company
to fund the Lessee's operating deficits above specified amounts. In certain
instances these thresholds have been exceeded and, as a result, the Company
recorded $2,952,000 of operating deficits during the nine months ended September
30, 2001 and $589,000 of operating deficits during the nine months ended
September 30, 2000 as Equity in Losses of Managed Special Purpose Entity
Communities on the accompanying Statements of Operations. The Company expects
that it will continue to incur additional operating deficit costs during the
remainder of 2001 and into 2002 and that these amounts may increase as deficits
exceed specified amounts at certain Managed SPE Communities. The management
agreements also provide the Company with purchase options or rights of first
refusal to assume the lessee's leasehold interests in the leases at a formula
price.
During the nine months ended September 30, 2001, the Company acquired two
leasehold interests in Managed SPE Communities from affiliates of John Morris, a
director of the Company. In conjunction with these transactions, the Company
acquired certain assets and assumed certain liabilities. The assets and
liabilities were recorded at cost. At September 30, 2001, approximately $73,000
was due to the Company from other SPE affiliates of John Morris in connection
with other Managed SPE Communities.
At September 30, 2001, the Company was operating ten Managed SPE Communities
leased by various lessees, four of which are leased by an affiliate of John
Morris. The Company currently is in negotiations
11
and expects to acquire certain, and perhaps all, of the leasehold interests, in
these ten Managed SPE Communities during 2001 and 2002. If all are acquired, the
Company estimates the combined purchase price would be approximately $20.0
million, although the amount of the purchase price, the terms of payment and the
other terms of any such acquisition are not yet finalized. As a result of past
and future leasehold acquisitions of Managed SPE Communities, the Company
expects to incur significant operating losses until the communities achieve
break-even occupancy levels. If the Company does not acquire the leasehold
interests in Managed SPE Communities, it remains responsible for funding future
operating losses above specified limits.
7. ACQUISITIONS AND OTHER TRANSACTIONS
On September 30, 2001, the Company acquired the remaining joint venture interest
in a Free-standing assisted living community in Nashville, Tennessee for
$300,000. The community has 96 total units, of which 62 are assisted living and
34 are memory enhanced.
On September 26, 2001, the Company acquired for $13.2 million, a retirement
center in Oak Park, Illinois, which the Company had previously leased. The
community has 193 total independent living units. The Company funded this
acquisition by entering into a $13.0 million mortgage note.
W.E. Sheriff, the Company's chairman and chief executive officer, owns 50% of
Maybrook Realty, Inc., which owns a 128-bed nursing center, Freedom Plaza Care
Center (FPCC) in Peoria, Arizona. During the six months ended June 30, 2001,
FPCC opened a 47 unit assisted living expansion which is currently 50% occupied.
On July 1, 2001, the Company entered into a long-term operating lease for FPCC.
Prior to July 1, 2001, the Company had been operating FPCC pursuant to a
management agreement. The Company entered into a series of agreements with
Maybrook Realty, Inc. to lease and operate the retirement community. As part of
this transaction, the Company acquired certain assets and liabilities from the
previous lessee of the community. The assets acquired exceeded the liabilities
assumed by $903,000, which will be amortized over the life of the lease.
During the nine months ended September 30, 2001, the Company completed two
like-kind exchange transactions which deferred the taxable gain resulting from
the sale of a community located in Westlake, Ohio. In connection with the first
like-kind exchange, the Company purchased land in Virginia, assuming a $12.1
million non-recourse mortgage loan. The Company acquired the land subject to a
lease that provides annual rental payments of $980,000 through February 23,
2023. In the second like-kind exchange, the Company purchased all of the equity
interests in a single member limited liability company that owned various
parcels of land and buildings recorded at $2.3 million and building improvements
recorded at $4.8 million, and assumed a $15.2 million non-recourse mortgage
loan. The various land parcels are subject to leases that provide annual rental
payments of $1.3 million through March 7, 2022.
During 2001, the Company acquired from various SPEs the assets and leasehold
interests of two Managed SPE Communities. The Company also assumed certain
liabilities in connection with these acquisitions. The assets and liabilities
were recorded at cost. Both of these leasehold interests were acquired from a
SPE that is affiliated with John Morris, a director of the Company. The Company
manages four additional Free-standing ALs leased by affiliates of John Morris.
In addition, the Company has advanced amounts for certain costs of these Managed
SPE communities affiliated with Dr. Morris. At September 30, 2001, approximately
$73,000 was due to the Company from these affiliates. Such amounts are expected
to be reimbursed through the future acquisition of the leasehold interests of
these affiliates.
8. SALE OF COMMUNITY
During the nine months ended September 30, 2001, the Company sold its leasehold
interest in its only California community, Rossmoor Regency. This leasehold
interest was acquired by the Company in May 1998 as part of the Company's Senior
Living Network strategy. However, during the year ended December 31, 1999, the
Company discontinued its assisted living development and acquisition program
prior to
12
acquiring or developing communities complementary to Rossmoor Regency. The
Company sold its leasehold interest in the community for an aggregate price of
$21.5 million. The Company used a majority of the sale proceeds to $15.6 million
of debt associated with the property, resulting in an early payment penalty of
$875,000, net of tax. In addition, the Company recognized a $694,000 loss on the
sale of assets.
9. SEGMENT INFORMATION
The Company has significant operations in two segments: (1) Retirement Centers
and (2) Free-Standing ALs. The Company has 31 Retirement Centers which provide a
continuum of care services such as independent living, assisted living and
skilled nursing care on an integrated campus. The Company currently operates 34
Free-Standing ALs. Free-standing ALs are generally stand-alone assisted living
communities that are not located on a Retirement Center campus, certain of which
also provide some skilled nursing and/or specialized care such as Alzheimer's
and memory enhancement programs. Free-standing ALs are generally much smaller
than Retirement Centers.
The Company evaluates its performance on the basis of EBITDAR, which is defined
as earnings before net interest expense, income tax expense, depreciation,
amortization, rent, equity in losses of Managed SPEs, other income (expense),
minority interest, and extraordinary items. The following is a summary of total
revenues, EBITDAR, and total assets by segment for the three and nine months
ended September 30, 2001 and 2000 (in thousands). (1)(2)(3)
THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, $ %
2001 2000 CHANGE CHANGE
--------- --------- -------- -----
Revenues:
Retirement Centers $ 54,893 $ 48,699 $ 6,194 12.72%
Free-standing ALs 9,927 3,660 6,267 171.23%
Corporate/Other 1,231 1,073 158 14.73%
--------------------------------------------------------
Total $ 66,051 $ 53,432 $ 12,619 23.62%
========================================================
NOI/Community EBITDAR:
Retirement Centers $ 18,309 $ 16,547 $ 1,762 10.65%
Free-standing ALs (158) (1,132) 974 -86.04%
Corporate/Other (5,028) (3,641) (1,387) 38.09%
--------------------------------------------------------
Net Operating Income $ 13,123 $ 11,774 $ 1,349 11.46%
Lease expense 7,217 4,979 2,238 44.95%
Depreciation and Amortization 5,332 4,547 785 17.26%
--------------------------------------------------------
Operating income $ 574 $ 2,248 $ (1,674) -74.47%
========================================================
13
NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, $ %
2001 2000 CHANGE CHANGE
--------- --------- -------- -----
Revenues:
Retirement Centers $ 160,642 $ 137,031 $ 23,611 17.23%
Free-standing ALs 26,255 8,340 17,915 214.81%
Corporate/Other 2,904 3,600 (696) -19.33%
--------------------------------------------------------
Total $ 189,801 $ 148,971 $ 40,830 27.41%
========================================================
NOI/Community EBITDAR:
Retirement Centers $ 56,636 $ 47,656 $ 8,980 18.84%
Free-standing ALs (1,120) (1,735) 615 -35.45%
Corporate/Other (15,797) (9,789) (6,008) 61.38%
--------------------------------------------------------
Net Operating Income $ 39,719 $ 36,132 $ 3,588 9.93%
Lease expense 20,668 12,597 8,071 64.07%
Depreciation and Amortization 15,619 12,589 3,030 24.07%
--------------------------------------------------------
Operating income $ 3,432 $ 10,946 $ (7,514) -68.65%
========================================================
TOTAL ASSETS
SEPTEMBER 30, DECEMBER 30, $ %
2001 2000 CHANGE CHANGE
--------- --------- -------- -----
Total Assets:
Retirement Centers $ 451,878 $ 445,020 $ 6,858 1.54%
Free-standing ALs 68,233 368,266 (33) -0.05%
Corporate/Other 310,537 279,194 31,343 11.23%
--------------------------------------------------------
Total $ 830,648 $ 792,480 $ 38,168 4.82%
========================================================
(1) Segment data does not include any inter-segment transactions or
allocated costs.
(2) All prior period data has been reclassified to conform to the new
segment alignment.
(3) Net Operating Income ("NOI"), or Community EBITDAR is defined as
earnings before net interest expense, income tax expense (benefit),
depreciation, amortization, rent, and other special charges related to
asset write-offs and write-downs, equity in loss of Managed SPE
Communities, other income (expense), minority interest, and
extraordinary items.
10. COMMITMENTS AND CONTINGENCIES
The Company is subject to various legal proceedings and claims which arise in
the ordinary course of its business. In the opinion of management, the ultimate
liability with respect to those proceedings and claims will not materially
affect the financial position, operations, or liquidity of the Company.
On July 1, 2001, the Company renewed its commercial insurance for various risks
including medical malpractice liabilities on a claims-incurred basis with a new
provider. The change from its prior year claims-made policy to a claims-incurred
policy resulted in an additional premium of $1.2 million to cover the claims
incurred but not reported in the previous insurance year. This payment was
expensed during the three months ended June 30, 2001. During the three months
ended September 30, 2001, the Company became aware of several irregularities and
inappropriate activities related to the claims-incurred program, leading
management to question the existence, integrity and viability of the new
program. Consequently, the Company was compelled to obtain replacement coverage
from its previous provider on a claims-made basis. This replacement coverage
expires on December 31, 2001, and the Company is currently in discussions to
extend this policy through calendar year 2002. The replacement claims-made
coverage eliminated the need for the $1.2 million claims-incurred insurance
premium. However, the Company has established additional accruals as a result of
uncertainties associated with certain claims incurred prior to obtaining
replacement coverage and higher deductibles under the replacement coverage. In
addition, the Company has
14
accrued for and commenced litigation related to $525,000 of unrecovered premiums
related to the July 1, 2001 claims-incurred policy. The Company intends to
pursue its legal remedies vigorously. For the three months ended September 30,
2001, the impact of the change back to the original insurance provider and the
resulting increase in general and professional liability accruals was
approximately $160,000 of reduced G&A Expense.
As a result of flooding in the Houston area during June 2001, the Company
sustained significant flood and water damage at one of its Free-standing AL
communities, and minor damage at several other communities. Approximately 60
residents from the significantly damaged community have been temporarily
relocated to several of the other communities operated by the Company in the
Houston area. The Company anticipates that repair work will take six months or
more, at which time residents will be able to move back into the community. The
Company expects that its insurance policies will cover substantially all costs
incurred in connection with this flood, including property damage, business
interruption and incidental additional expenses. The Company has recorded a
charge of $100,000 during the nine months ended September 30, 2001 for its
insurance deductible cost, and recorded $2.8 million as an insurance claim
receivable as of September 30, 2001, primarily related to repair of physical
property.
The Company manages a senior living community in Peoria, Arizona under a
long-term management agreement with a third party owner. The Arizona Department
of Insurance ("Arizona DOI") has notified the owner that the owner is not
currently in compliance with a net worth requirement imposed by Arizona law.
While compliance with this net worth requirement is technically the
responsibility of the owner, in order to facilitate discussions with the Arizona
DOI, the Company has provided the Department with a guaranty relating to the
financial performance of the community, and has submitted to the Arizona DOI an
application for the Company to enter into a lease of the community. The
Department has tentatively indicated that the proposed lease will result in the
community's compliance with the applicable Arizona statute. There can be no
assurance that the Arizona DOI will ultimately approve the proposed lease or
that State of Arizona will not enforce the law strictly. A violation of this net
worth requirement may, among other things, allow the Arizona DOI to take steps
to appoint a receiver for the community.
During 1999, the Company entered into a land purchase agreement for a parcel of
land in Boston, Massachusetts for $14.5 million, to be used for the development
of a senior living community. In connection with the development of this
project, the Company has agreed to enter into a joint venture relationship with
an unaffiliated entity. Closing of the purchase agreement is dependent upon
various zoning, land use and other approvals. The Company has incurred and
capitalized architectural, engineering, legal, and other costs to date amounting
to $2.5 million as part of the development of this project. If satisfactory
zoning and land use approvals are not received or if the Company is not able to
secure equity and debt financing to acquire and develop the property, the
Company could have to consider various options, including sale or assignment of
its rights, modification of the project scope, or abandonment of its interest in
the project which could result in a write-off of these costs. The Company
believes it will ultimately be successful in receiving these approvals and
securing financing to acquire and develop the property, but there can be no
assurance in that regard, nor can there be any assurance that these delays will
not adversely effect the feasibility of, or the Company's willingness to
complete the project.
The Company discovered during 1999 that its property in Knoxville, Tennessee had
several significant construction or design deficiencies that resulted in, among
other things, inadequate water and condensation drainage and control. As a
result of these construction issues, the Company moved certain residents and
initiated various inspections, air quality tests, and other procedures. The
Company also involved its outside counsel and its insurance carrier in these
issues. The Company recorded certain impairment charges related to this
property, and others, during the quarter ended December 31, 1999. During the
nine months ended September 30, 2001, the Company received net settlement
proceeds of $1,000,000 for repairs and improvements necessary to correct the
deficiencies in the property. The Company is not able to determine to what
extent these issues will result in a negative impact on the results of this
community or additional liabilities and costs to the Company.
15
11. NEW ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued Statement 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS 144), which supersedes both SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" and the accounting and reporting provisions of APB Opinion 30,
"Reporting the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," for the disposal of a segment of a business (as
previously defined in that Opinion). Statement 144 retains the fundamental
provisions in Statement 121 for recognizing and measuring impairment losses on
long-lived assets held for use and long-lived assets to be disposed of by sale,
while also resolving significant implementation issues associated with Statement
121. For example, Statement 144 provides guidance on how a long-lived asset that
is used as part of a group should be evaluated for impairment, establishes
criteria for when a long-lived asset is held for sale, and prescribes the
accounting for a long-lived asset that will be disposed of other than by sale.
Statement 144 retains the basic provisions of Opinion 30 on how to present
discontinued operations in the income statement but broadens the presentation to
include a component of an entity (rather than a segment of a business). Unlike
Statement 121, an impairment assessment under Statement 144 will never result in
a write-down of goodwill. Rather, goodwill is evaluated for impairment under
Statement 142, "Goodwill and Other Intangible Assets."
The Company is required to adopt Statement 144 no later than the year beginning
after December 15, 2001, and plans to adopt its provisions for the quarter
ending March 31, 2002. Management does not expect the adoption of Statement 144
for long-lived assets held for use to have a material impact on the Company's
financial statements because the impairment assessment under Statement 144 is
largely unchanged from Statement 121. The provisions of the Statement for assets
held for sale or other disposals generally are required to be applied
prospectively after the adoption date to newly initiated disposal activities.
Therefore, management cannot determine the potential effects that adoption of
Statement 144 will have on the Company's financial statements.
In July 2001, the FASB issued Statement 143, "Accounting for Asset Retirement
Obligations" (SFAS 143). The Company is required to record the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred. When the liability is initially recorded, the Company will capitalize
a cost by increasing the carrying amount of the related long-lived asset. Over
time, the liability is accreted to its present value each period, and the
capitalized cost is depreciated over the useful life of the related asset. Upon
settlement of the liability, the Company either will settle the obligation for
its recorded amount or will incur a gain or loss upon settlement. The standard
is effective for fiscal years beginning after June 15, 2002, with earlier
adoption permitted. The Company does not expect the adoption of this standard to
have a material effect on the Company's revenue, operating results or liquidity.
In July 2001, the FASB issued Statement 141, "Business Combinations" (SFAS 141),
and Statement 142, "Goodwill and Other Intangible Assets" (SFAS 142). Statement
141 requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 as well as all purchase method
business combinations completed after June 30, 2001. Statement 141 also
specifies criteria intangible assets acquired in a purchase method business
combinations completed after June 20, 2001. Statement 141 also specifies
criteria intangible assets acquired in a purchase method business combination
must meet to be recognized and reported apart from goodwill, noting that any
purchase price allocable to an assembled workforce may not be accounted for
separately. Statement 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement 142.
Statement 142 will also require that intangible assets with estimable useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviews for impairment in accordance with FAS
Statement 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of."
The Company is required to adopt the provisions of SFAS 141 immediately, except
with regard to business combinations initiated prior to July 1, 2001, which it
expects to account for the pooling-of-interests
16
method, and Statement 142 effective January 1, 2002. Furthermore, goodwill and
intangible assets determined to have an indefinite useful life acquired in a
purchase business combination completed after June 30, 2001, but before
Statement 142 is adopted in full will not be amortized, but will continue to be
evaluated for impairment in accordance with the appropriate pre-Statement 142
accounting literature. Goodwill and intangible assets acquired in business
combinations completed before July 1, 2001 will continue to be amortized and
tested for impairment in accordance with the appropriate pre-Statement 142
accounting requirements prior to the adoption of Statement 142.
Statement 141 will require upon adoption of Statement 142, that the Company
evaluate its existing intangible assets and goodwill that were acquired in a
prior purchase business combination, and to make any necessary reclassifications
in order to conform with the new criteria in Statement 141 for recognition apart
from goodwill. Upon adoption of Statement 142, the Company will be required to
reassess the useful lives and residual values of all intangible assets acquired,
and make any necessary amortization period adjustments by the end of the first
interim period after adoption. In addition, to the extent an intangible asset is
identified as having an indefinite useful life, the Company will be required to
test the intangible asset for impairment in accordance with the provisions of
Statement 142 within the first interim period. Any impairment loss will be
measured as of the date of adoption and recognized as the cumulative effect of a
change in accounting principle in the first interim period.
In connection with Statement 142's transitional goodwill impairment evaluation,
the Statement will require the Company to perform an assessment of whether there
is an indication that goodwill is impaired as of the date of adoption. To
accomplish this, the Company must identify its reporting units and determine the
carrying value of each reporting unit by assigning the assets and liabilities,
including the existing goodwill and intangible assets, to those reporting units
as of the date of adoption. The Company will then have up to six months from the
date of the adoption to determine the fair value of each reporting unit and
compare it to the reporting unit's carrying amount. To the extent a reporting
unit's carrying amount exceeds its fair value, an indication exists that the
reporting unit's goodwill may be impaired and the Company must perform the
second step of the transitional impairment test. In the second step, the Company
must compare the implied fair value of the reporting unit's goodwill, determined
by allocating the reporting unit's fair value to all of its assets (recognized
and unrecognized) and liabilities in a manner similar to a purchase price
allocation in accordance with Statement 141, to its carrying amount, both of
which would be measured as of the date of adoption. This second step is required
to be completed as soon as possible, but no later than the end of the year of
adoption. Any transitional impairment loss will be recognized as the cumulative
effect of a change in accounting principle in the Company's statement of
earnings.
The Company expects to have $36.5 million of unamortized goodwill as of January
1, 2002, which will be subject to the transition provisions of SFAS 141 and 142.
Amortization expense related to goodwill was approximately $1.0 million and
$757,000 for the year ended December 31, 2000 and the nine months ended
September 30, 2001, respectively. Because of the extensive effort needed to
comply with adopting Statements 141 and 142, it is not practicable to reasonably
estimate the impact of adopting these Statements on the Company's financial
statements at the date of this report, including whether it will be required to
recognize any transitional impairment losses as the cumulative effect of a
change in accounting principle.
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards (SFAS 133), "Accounting for Derivative Instruments and Hedging
Activities." SFAS 133 established reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts. Under SFAS 133, the Company recognizes all derivatives as either
assets or liabilities, measured at fair value, in the consolidated balance
sheet.
The accounting for changes in the fair value (i.e., gains or losses) of a
derivative instrument depends on whether it has been designated and qualifies as
part of a hedging relationship and, if so, on the reason for holding it. If
certain conditions are met, entities may elect to designate a derivative
instrument as a hedge of exposures to changes in fair values, cash flows, or
foreign currencies. If the hedged exposure is a cash
17
flow exposure, the effective portion of the gain or loss on the derivative
instrument is reported initially as a component of other comprehensive income
(outside earnings) and subsequently reclassified into earnings when the
forecasted transaction affects earnings. Any amounts excluded from the
assessment of hedge effectiveness as well as the ineffective portion of the gain
or loss is reported in earnings immediately. During 1999 and 2000, the Company
entered into two interest rate swap agreements.
12. SUBSEQUENT EVENTS
On November 9, 2001, the Company sold two pre-stable Free-standing ALs: a 79
unit community located in Boca Raton, Florida for $10.8 million and a 97 unit
community located in Arlington, Texas for $12.1 million, which resulted in a
$3.1 million loss, during the fourth quarter. The Company contemporaneously
leased both properties back from the buyer for terms of 15 years, with two
additional five year extensions available. The lease agreements include earn-out
provisions in the third year of the leases which may permit the Company to
increase the sale price by up to $4.6 million, based upon improved performance.
The Company used a portion of the proceeds from the sales to repay $7.4 million
of mortgage debt and $9.3 million of the $100 million mortgage loan facility,
respectively. In conjunction with the leases, the Company has rights of first
refusal to purchase the communities.
On September 30, 2001, $92.3 million was outstanding on the amended senior
mortgage facility. On November 9, 2001, the Company paid $9.2 million of
principal on the $100 million mortgage loan facility. On October 24, 2001, the
Company additionally paid $1.4 million of principal on the $100 million mortgage
loan facility. These two payments satisfy the requirement agreed to by the
Company in the June 30, 2001 amendment, to pay $10.0 million in principal on or
before May 1, 2002.
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. As of September 30, 2001, the Company operated 65 senior living
communities, consisting of 31 Retirement Centers and 34 Free-standing ALs in 14
states with an aggregate capacity for approximately 11,000 and 3,200 residents,
respectively. The Company owns 23 communities, leases 24 communities pursuant to
long-term leases, and manages 18 communities pursuant to management agreements.
Of its Retirement Centers, the Company owns 15, leases nine, and manages seven.
Of its Free-standing ALs, the Company owns eight, leases 15, and manages 11. As
of September 30, 2001, the Company's owned communities had a stabilized
occupancy rate of 86%, its leased communities had a stabilized occupancy rate of
68%, and its managed communities had a stabilized occupancy rate of 82%. The
Company considers a community or expansion thereof to be stabilized if it has
either been open and owned at least 12 months, or has achieved 95% occupancy.
Stabilized communities also include any managed communities that have been open
at least 12 months.
The Company's long-term strategy is to develop and operate Senior Living
Networks in major metropolitan regions. During the nine months ended September
30, 2001 and 2000, the Company's Retirement Centers and Free-standing ALs
generated 86.0% and 14.0%, respectively, and 94.3% and 5.7%, respectively, of
resident and healthcare revenues, respectively. Many of the Free-standing ALs
are located within the same major metropolitan regions as the Retirement Centers
and function as satellites to those Retirement Center hubs in order to form
Senior Living Networks and expand the continuum of housing and care into the
market. The Company believes that this hub and satellite approach produces
management efficiencies and market penetration by offering a range of senior
living arrangements at various price levels.
During the late 1990s and continuing through 2001, the assisted living market
suffered from adverse market conditions including significant overcapacity in
most markets, longer fill-up periods, price
18
discounting and price pressures, and increasing labor and insurance costs. The
Company expects these trends and conditions to continue for the intermediate
term. As a result, the Company ceased its development of new Free-standing ALs
in late 1999 in order to focus on improving the performance of its existing
Retirement Centers, filling its Free-standing ALs, increasing the Company's
cashflow and strengthening the Company's balance sheet.
The Company reported a net loss of $11.9 million, or $0.69 loss per diluted
share, on total revenues of $189.8 million, as compared with net loss of $1.8
million, or $0.10 loss per diluted share, on revenues of $149.0 million for the
nine months ended September 30, 2001 and 2000, respectively. The loss of $0.69
per dilutive share for the nine months ended September 30, 2001 was comprised of
a $0.68 loss from operations, plus a $0.01 loss from the extinguishment of debt.
RESULTS OF OPERATIONS
The Company's total revenues from continuing operations are comprised of (i)
resident and health care revenues and (ii) management and development services
revenues, which include fees, net of reimbursements, for the development,
marketing, and management of communities owned by third parties. The Company's
resident and health care revenues are derived from three principal sources: (i)
monthly service fees from independent and assisted living residents and
ancillary revenues from various sources including therapy, representing 79.2%
and 81.5% of total resident and health care revenues for the three months ended
September 30, 2001 and 2000, respectively, and 80.0% and 82.1% of total resident
and health care revenues for the nine months ended September 30, 2001 and 2000,
respectively; (ii) revenues from skilled nursing patients, representing 18.6%
and 15.8% of total resident and health care revenues for the three months ended
September 30, 2001 and 2000, respectively, and 17.4% and 15.7% of total resident
and health care revenues for the nine months ended September 30, 2001 and 2000,
respectively; and (iii) the amortization of non-refundable entrance fees over
each resident's actuarially determined life expectancy (or building life for
contingent refunds), representing 2.2% and 2.7% of total resident and health
care revenues for the three months ended September 30, 2001 and 2000,
respectively, and 2.7% and 2.2% of total resident and health care revenues for
the nine months ended September 30, 2001 and 2000, respectively. Approximately
92% and 95% of the Company's total revenues for both the three and nine months
ended September 30, 2001 and 2000, respectively, were attributable to private
pay sources, with the balance attributable to Medicare, including
Medicare-related private co-insurance, and Medicaid.
The Company's operating expenses are comprised, in general, of (i) community
operating expense, which includes all operating expenses of the Company's owned
or leased communities; (ii) lease expense; (iii) general and administrative
expense, which includes all corporate office overhead; and (iv) depreciation and
amortization expense.
The Company's operations are divided into two segments: (1) Retirement Centers
and (2) Free-standing ALs. The 31 Retirement Centers are large retirement
communities that provide some or all of independent living, assisted living and
skilled nursing care. A substantial majority of the Retirement Centers are
stabilized, including recent expansions, and averaged 93% occupancy during the
three and nine months ended September 30, 2001. The portfolio of Free-standing
ALs operated by the Company has increased to 34 (eight owned, 15 leased, and 11
managed communities, ten of which are Managed SPE Communities) at September 30,
2001. The operations of the managed communities are not included in the
Company's financial statements, although losses that exceed specified levels are
included in Equity in Losses of Managed Special Purpose Entity Communities. The
consolidated number of Free-standing AL Communities is 23. Substantially all of
the consolidated Free-standing ALs and the Managed SPE Communities are in the
fill-up stage. The Company has been and continues to be focused on increasing
and maintaining occupancy and controlling operating margins in all communities.
19
THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2000
Revenues Total revenues were $66.1 million compared to $53.4 million for the
three months ended September 30, 2001 and 2000, respectively, representing an
increase of $12.6 million, or 23.6%. Resident and health care revenues increased
by $12.5 million, and management and development services revenue increased by
$158,000 during the period. This increase related to: (a) approximately $6.5
million was attributable to revenues derived from Free-standing AL leasehold
interests acquired after September 30, 2000, (b) $2.0 million was attributable
to the long-term lease of Freedom Plaza Care Center, (c) $1.6 million was
attributable to growth in therapy services, and (d) $848,000 was attributable to
the November 2000 expansion at Freedom Plaza Sun City Center. The remaining
increase relates to increased average occupancy and additional entrance fee
revenues. Management and development services revenue increased slightly, but
decreased as a percentage of total revenue to 1.9% from 2.0%. The increase in
management and development services revenues resulted from higher sales of new
units, which increases the formula-based management fees, while the decrease in
management and development services revenue as a percentage of total revenue is
primarily related to the substantial growth in resident and health care
revenues.
For all of its communities, the Company had a stabilized occupancy rate of 89%
compared to 92% as of September 30, 2001 and 2000, respectively, and had a total
occupancy rate of 85% and 83% as of September 30, 2001 and 2000, respectively. A
community or expansion is defined as stabilized if it has either been open and
owned at least 12 months, or has achieved 95% occupancy. The reduction in
stabilized occupancy rate results from four additional Free-standing ALs being
considered as stable during the period as a result of being open and owned over
12 months. The Company anticipates that the fill-up of the Free-standing ALs
will occur over the next 12 to 24 months. The increase in total occupancy rate
is primarily due to the continued improvement in occupancy at the Free-standing
AL communities.
Retirement Center resident and health care revenues for the three months ended
September 30, 2001 were $54.9 million, compared to $48.7 million for the three
months ended September 30, 2000, representing an increase of $6.2 million, or
12.7%. This increase was primarily attributable to the July 1, 2001 long-term
lease of Freedom Plaza Care Center and the November 2000 expansion of Freedom
Plaza Sun City Center, resulting in increased resident and health care revenues
of $2.0 million and $848,000, respectively. In addition, $1.4 million of the
increase in Retirement Center revenues resulted from increased therapy services
provided by the Company. The remaining increase was primarily attributable to
increased average occupancy. Free-standing AL community resident and health care
revenues increased from $3.7 million to $9.9 million for the three months ended
September 30, 2000 and 2001, respectively. This increase is largely related to
the fill-up and increased occupancy of these communities during the year, as
well as the increase in the number of consolidated Free-standing AL communities
from 20 to 23.
Community Operating Expense Community operating expense increased to $46.5
million compared to $36.9 million for the three months ended September 30, 2001
and 2000, respectively, representing an increase of $9.6 million, or 25.9%. The
increase in community operating expense was primarily attributable to
communities acquired or leased after September 30, 2000 and expenses from
expansions. Additionally, this increase is the result of higher labor,
insurance, utility, facility and marketing costs at new communities, as well as
costs associated with the expansion of therapy services now provided at 12
communities. Community operating expense as a percentage of resident and health
care revenues increased to 71.8% from 70.5% for the three months ended September
30, 2001 and 2000, respectively. The increase in community operating expense as
a percentage of resident and health care revenues is primarily attributable to
the acquisition of leasehold interests in various Free-standing ALs that were
Managed SPE Communities during the second half of 2000, which are in the fill-up
stage. The Company anticipates that the fill-up of these communities will occur
over the next 12 to 24 months. The Company expects community operating expense
to remain at greater than historical levels as a percentage of resident and
health care revenues because the Company anticipates acquiring additional
leasehold interests in Managed SPE Communities.
20
Retirement Center operating expenses were $36.6 million, compared to $32.2
million for the three months ended September 30, 2001 and 2000, respectively,
representing an increase of $4.4 million, or 13.8%. This increase was primarily
attributable to the July 1, 2001 long-term lease of Freedom Plaza Care Center,
resulting in increased operating expenses of $1.6 million. The November 2000
opening of the Freedom Plaza Sun City Center expansion added $993,000 in
community operating expense. In addition, $687,000 of the increase in Retirement
Center operating expenses related to increased therapy services. The remaining
increase relates primarily to increased average occupancies resulting in
increased Retirement Center operating expenses. Free-standing AL operating
expenses increased to $10.1 million from $4.8 million for the three months ended
September 30, 2001 and 2000, respectively. This increase is largely related to
the fill-up and increased occupancy of these communities during the year, as
well as the increase in the number of consolidated Free-standing AL communities
from 20 to 23.
General and Administrative General and administrative expense increased to $6.4
million compared to $4.7 million for the three months ended September 30, 2001
and 2000, respectively, representing an increase of $1.7 million, or 35.8%.
Approximately $898,000 relates to bad debt provisions incurred in conjunction
with prior year home health receivables. In addition, $525,000 of the increase
relates to unrecovered premiums related to the July 1, 2001 claims-incurred
policy. The remaining increase reflects increases in overhead support costs
associated with the Free-standing ALs in various geographic areas, as well as
increases in salaries and benefits associated with the operation of an increased
number of communities, as well as severance costs. General and administrative
expense as a percentage of total revenues increased to 9.7% compared to 8.8% for
the three months ended September 30, 2001 and 2000, respectively.
EBITDAR (Community NOI) Retirement Center EBITDAR increased $1.8 million, or
10.7%, to $18.3 million from $16.5 million for the three months ended September
30, 2001 and 2000, respectively. This increase primarily relates to the July 1,
2001 long-term lease of Freedom Plaza Care Center, the November 2000 opening of
the Sun City expansion, as well as continued operational improvement throughout
the Retirement Centers, resulting from stabilized occupancy and increased
capacity through expansions, rate increases, and improved control of
community-level overhead expense. Consolidated Free-standing AL EBITDAR
increased by $974,000, to a $158,000 loss from a $1.1 million loss for the three
months ended September 30, 2001 and 2000, respectively. The 2001 loss resulted
from the majority of these Free-standing ALs communities being in the fill-up
stage. The Company expects to continue to incur losses during this fill-up
stage. Other EBITDAR decreased by $1.4 million to a $5.0 million loss from a
$3.6 million loss for the three months ended September 30, 2001 and 2000,
respectively. This decrease in Other EBITDAR resulted from additional general
liability and bad debt provisions, severance costs, and additional costs
associated with corporate operations, human resources, financial services and
overhead, as well as increased senior living network and assisted living
management costs.
Lease Expense Lease expense increased to $7.2 million compared to $5.0 million
for the three months ended September 30, 2001 and 2000, respectively,
representing an increase of $2.2 million, or 44.9%. This increase was
attributable to nine leases entered into after September 30, 2000, consisting of
two Retirement Center leases, Freedom Plaza Care Center and Westlake Village,
increasing lease expense, $517,000 and $96,000 respectively, and seven
Free-standing AL leases increasing lease expense $2.3 million. These increases
are offset by the sale of Rossmoor, reducing lease expense $523,000. As of
September 30, 2001, the Company had synthetic and operating leases for 24 of its
communities, including nine Retirement Centers and 15 Free-standing ALs, of
which 11 are synthetic leases. Accordingly, of the total $7.2 million lease
expense for the three months ended September 30, 2001, $3.4 million related to
Retirement Centers and $3.8 million related to Free-standing ALs.
Depreciation and Amortization Depreciation and amortization expense increased
to $5.3 million from $4.5 million for the three months ended September 30, 2001
and 2000, respectively, representing an increase of $785,000, or 17.3%. The
increase was primarily related to the increase in depreciable assets of
approximately $41.0 million since October 1, 2000. These assets relate
primarily to the opening or
21
acquisition of communities, including leasehold interests, the properties
acquired as part of a series of like-kind exchanges associated with the
sale-leaseback of one of the Company's communities in Ohio, and expansion of
communities since September 30, 2000, as well as ongoing capital expenditures.
For the current quarter, $286,000, $383,000, and $116,000 of the $785,000
depreciation and amortization increase resulted from Retirement Centers,
Free-standing ALs, and Other, respectively.
Other Income (Expense) Interest expense decreased to $9.5 million from $9.8
million for the three months ended September 30, 2001 and 2000, respectively,
representing a decrease of $231,000, or 2.4%. The decrease in interest expense
was primarily attributable to the fact that over 44% of the Company's debt bore
interest at variable rates; the Company's weighted average variable interest
rate has decreased from 8.7% to 6.5% for the three months ended September 30,
2001 and 2000, respectively. Interest expense, as a percentage of total
revenues, decreased to 14.4% from 18.3% for the three months ended September 30,
2001 and 2000, respectively. Interest income decreased to $2.4 million from $3.7
million for the three months ended September 30, 2001 and 2000, respectively,
representing a decrease of $1.2 million, or 33.1%. The decrease in interest
income was primarily attributable to lower income generated from reduced
interest rates on certificates of deposit and notes receivable balances
associated with certain leasing transactions and management agreements. Equity
in Losses of Managed SPE Communities increased to $1.0 million from $589,000 for
the three months ended September 30, 2001 and 2000, respectively. The increase
in Equity in Losses of Managed SPE Communities relates to the significant
fill-up losses that the Company is obligated to fund when operating deficits at
Managed SPE Communities exceed specified limits.
Income Tax Benefit The provision for income taxes was a $2.3 million benefit
compared to a $1.1 million benefit for the three months ended September 30, 2001
and 2000, respectively. The Company's effective tax rate was 34.2% and 33.2% for
the three months ended September 30, 2001 and 2000, respectively.
Minority Interest in Losses of Consolidated Subsidiaries, Net of Tax Minority
interest in losses of a consolidated subsidiary, net of tax, for the three
months ended September 30, 2001 and 2000, respectively, was $1,000 and $468,000,
representing a decrease of $467,000. The decrease was primarily attributable to
a revised partner loss allocation formula for a subsidiary, in which the Company
agreed to consolidate all losses until the contribution percentages were
reflective of the partners capital account balances. The Company acquired this
partnership interest on September 30, 2001 for $300,000.
Net Loss Based upon the factors noted above, the Company experienced a net loss
of $4.4 million, or $0.26 loss per dilutive share, compared to a net loss of
$1.9 million, or $0.11 loss per dilutive share, for the three months ended
September 30, 2001 and 2000, respectively. The loss of $0.26 per dilutive share
for the three months ended September 30, 2001, was comprised from loss from
operations of $0.26. The loss of $0.11 per dilutive share for the three months
ended September 30, 2000, was comprised from loss from operations of $0.10, as
well as a $0.01 loss from the extinguishment of debt.
NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2000
Revenues Total revenues were $189.8 million compared to $149.0 million for the
nine months ended September 30, 2001 and 2000, respectively, representing an
increase of $40.8 million, or 27.4%. Resident and health care revenues increased
by $41.5 million, and management and development services revenue decreased by
$695,000 during the period. The increase in resident and health care revenues
related to: (a) approximately $17.9 million attributable to revenues derived
from Free-standing AL leasehold interests acquired after September 30, 2000, (b)
$2.0 million and $6.7 million attributable to long-term leases of Freedom Plaza
Care Center and Freedom Village Brandywine, (c) $3.8 million attributable to
growth in therapy services, and (d) $2.6 million attributable to the November
2000 expansion at Freedom Plaza Sun City Center. The remaining increase relates
to increased average occupancy and additional entrance fee revenues. Management
and development services revenue decreased as a percentage of total revenue to
1.5% from 2.4%, as of September 30, 2001 and 2000, respectively. The decrease in
management and
22
development services revenue is primarily related to a decrease in development
fees, as well as decreased management fees at certain properties as a result of
lower sales of new units, which reduces the formula-based management fees. In
late 1999, the Company discontinued new development of Free-standing ALs, for
which the Company received development fees.
For all of its communities, the Company had a stabilized occupancy rate of 89%
compared to 92% as of September 30, 2001 and 2000, respectively, and had a total
occupancy rate of 85% and 83% as of September 30, 2001 and 2000, respectively. A
community or expansion is defined as stabilized if it has either been open and
owned at least 12 months, or has achieved 95% occupancy. The reduction in
stabilized occupancy rate results from four additional Free-standing ALs being
considered as stable during the period, as a result of being open and owned over
12 months. The Company anticipates that the fill-up of these Free-standing ALs
will occur over the next 12 to 24 months. The increase in total occupancy rate
is primarily due to the continued improvement in occupancy at the Free-standing
AL communities.
Retirement Center resident and health care revenues were $160.6 million,
compared to $137.0 million for the nine months ended September 30, 2001 and
2000, respectively, representing an increase of $23.6 million, or 17.2%. The May
26, 2000 long-term lease of Freedom Village Brandywine increased resident and
health care revenues by $6.7 million. The July 1, 2001 long-term lease of
Freedom Plaza Care Center increased resident and health care revenues by $2.0
million. In addition, the November 2000 expansion at Freedom Plaza Sun City
Center increased revenues by $2.6 million. Also, $3.3 million of the increase in
Retirement Center revenues resulted from increased therapy services provided by
the Company. The remaining increase relates to increased average occupancy and
additional entrance fee revenues. Free-standing AL community resident and health
care revenues increased from $8.3 million to $26.3 million for the nine months
ended September 30, 2000 and 2001, respectively. This increase is largely
related to the fill-up and increased occupancy of these communities during the
year, as well as the increase in the number of consolidated Free-standing AL
communities from 20 to 23.
Community Operating Expense Community operating expense increased to $131.9
million compared to $99.5 million for the nine months ended September 30, 2001
and 2000, respectively, representing an increase of $32.5 million, or 32.6%. The
increase in community operating expenses was primarily attributable to expenses
from expansions and communities acquired or leased after September 30, 2000.
Additionally, this increase is the result of higher labor, insurance, utility,
facility and marketing costs at new communities, as well as costs associated
with the expansion of therapy services now provided at 12 communities. Community
operating expense as a percentage of resident and health care revenues increased
to 70.6% from 68.4% for the nine months ended September 30, 2001 and 2000,
respectively. The increase in community operating expense as a percentage of
resident and health care revenues is primarily attributable to the acquisition
of leasehold interests in various Free-standing ALs that were Managed SPE
Communities during the second half of 2000, of which many are in the fill-up
stage. The Company anticipates that the fill-up of these communities will occur
over the next 12 to 24 months. The Company expects community operating expense
to remain at greater than historical levels as a percentage of resident and
health care revenues because the Company anticipates acquiring additional
leasehold interests in Managed SPE Communities.
Retirement Center operating expenses were $104.0 million, compared to $89.4
million for the nine months ended September 30, 2001 and 2000, respectively,
representing an increase of $14.6 million, or 16.3%. Approximately $3.9 million
of this increase was attributable to the May 26, 2000 long-term lease of Freedom
Village Brandywine. Approximately $1.6 million of this increase was attributable
to the July 1, 2001 long-term lease of Freedom Plaza Care Center. In addition,
the November 2000 expansion at Freedom Plaza Sun City Center increased operating
expenses by $2.3 million. Finally, $1.5 million of the increase in Retirement
Center operating expenses related to increased therapy services. The remaining
increase relates primarily to increased average occupancies resulting in
increased Retirement Center operating expenses. Free-standing AL operating
expenses increased to $27.4 million from $10.1 million for the nine months ended
September 30, 2001 and 2000, respectively. This increase is largely related to
the
23
fill-up and increased occupancy of these communities during the year, as well as
the increase in the number of consolidated Free-standing AL communities from 20
to 23.
General and Administrative General and administrative expense increased to
$18.2 million compared to $13.4 million for the nine months ended September 30,
2001 and 2000, respectively, representing an increase of $4.8 million, or 35.7%.
Over $1.5 million of this increase relates to additional reserves for workers
compensation and general and professional liability claims, as well as the
$525,000 of unrecovered premiums related to the July 1, 2001 claims-incurred
policy. In addition, approximately $1.2 million relates to bad debt provisions
incurred in conjunction with prior year home health receivables. The remaining
increase reflects increases in overhead support costs associated with the
Free-standing ALs in various geographic areas, as well as increases in salaries
and benefits associated with the operation of an increased number of
communities. General and administrative expense as a percentage of total
revenues increased to 9.6% compared to 9.0% for the nine months ended September
30, 2001 and 2000, respectively.
EBITDAR (Community NOI) Retirement Center EBITDAR increased $8.9 million, or
18.8%, to $56.6 million from $47.7 million for the nine months ended September
30, 2001 and 2000, respectively. This increase primarily relates to the
additions of the long-term leases of Freedom Village Brandywine and Freedom
Plaza Care Center, as well as continued operational improvement throughout the
Retirement Centers, resulting from stabilized occupancy and increased capacity
through expansions, rate increases, and improved control of community-level
overhead expense. Consolidated Free-standing AL EBITDAR increased by $615,000,
to a $1.1 million loss from a $1.7 million loss for the nine months ended
September 30, 2001 and 2000, respectively. The 2001 reduction in loss resulted
from the improved occupancy in consolidated Free-standing ALs. Other EBITDAR
decreased by $6.0 million to a $15.8 million loss resulting from: (a) $1.8
million related to bad debt charges incurred in conjunction with home health and
trade receivables, (b) approximately $2.0 million related to general liability
and workers compensation claim provisions, and (c) a $695,000 reduction in
management and development fees. The remaining decrease relates to additional
costs associated with therapy costs, marketing, corporate operations, human
resources, financial services and overhead, and increased senior living network
and assisted living management costs.
Lease Expense Lease expense increased to $20.7 million compared to $12.6
million for the nine months ended September 30, 2001 and 2000, respectively,
representing an increase of $8.1 million, or 64.1%. This increase was
attributable to nine leases entered into after September 30, 2000, consisting of
two Retirement Center leases, Freedom Plaza Care Center and Westlake Village,
increasing lease expense, $517,000 and $287,000 respectively, and seven
Free-standing AL leases increasing lease expense $7.5 million. These increases
are offset by the sale of Rossmoor, reducing lease expense $683,000. As of
September 30, 2001, the Company had synthetic and operating leases for 24 of its
communities, including nine Retirement Centers and 15 Free-standing ALs, of
which 11 are synthetic leases. Accordingly, of the total $20.7 million lease
expense for the nine months ended September 30, 2001, $10.3 million related to
Retirement Centers and $10.4 million related to Free-standing ALs.
Depreciation and Amortization Depreciation and amortization expense increased
to $15.6 million from $12.6 million for the nine months ended September 30, 2001
and 2000, respectively, representing an increase of $3.0 million, or 24.1%. The
increase was primarily related to the increase in depreciable assets of
approximately $41.0 million since October 1, 2000. These assets relate primarily
to the opening or acquisition of communities, including leasehold interests, the
properties acquired as part of a series of like-kind exchanges associated with
the sale-leaseback of one of the Company's communities in Ohio, and expansion of
communities since September 30, 2000, as well as ongoing capital expenditures.
For the nine months ended September 30, 2001, $10.5 million of the total $15.6
million depreciation and amortization resulted from Retirement Centers.
Other Income (Expense) Interest expense increased to $28.1 million from $26.5
million for the nine months ended September 30, 2001 and 2000, respectively,
representing an increase of $1.6 million, or
24
6.0%. The increase in interest expense was primarily attributable to additional
indebtedness of $47.6 million incurred in connection with acquisitions and
development activity. This increase is offset by the fact that over 44% of the
Company's debt interest at variable rates, with the weighted average variable
interest rate decreasing from 8.7% to 6.5%, for the nine months ended September
30, 2001 and 2000, respectively. Interest expense, as a percentage of total
revenues, decreased to 14.8% from 17.8% for the nine months ended September 30,
2001 and 2000, respectively. Interest income decreased to $8.6 million from
$11.2 million for the nine months ended September 30, 2001 and 2000,
respectively, representing a decrease of $2.6 million, or 23.0%. The decrease in
interest income was primarily attributable to lower income generated from a
reduced amount of certificates of deposit and notes receivable balances
associated with certain leasing transactions and management agreements. Equity
in Losses of Managed SPE Communities increased to $3.0 million from $589,000 for
the nine months ended September 30, 2001 and 2000, respectively. The increase in
Equity in Losses of Managed SPE Communities relates to the significant fill-up
losses that the Company is obligated to fund when operating deficits at Managed
SPE Communities exceed specified limits.
Income Tax Benefit The provision for income taxes was a $5.7 million benefit
compared to a $1.3 million benefit for the nine months ended September 30, 2001
and 2000, respectively. The Company's effective tax rate was 33.0% and 33.8% for
the nine months ended September 30, 2001 and 2000, respectively.
Minority Interest in Losses (Earnings) of Consolidated Subsidiaries, Net of Tax
Minority interest in losses (earnings) of one consolidated subsidiary, net of
tax, for the nine months ended September 30, 2001 and 2000, respectively, was
$94,000 in income, and $967,000 of losses, representing a decrease of $1.1
million. The decrease was primarily attributable to a negotiated revised partner
loss allocation system for a subsidiary in which the Company agreed to
consolidate all losses until the contribution percentages were reflective of the
capital account balance. The Company acquired this partner interest on September
30, 2001 for $300,000.
Extraordinary Loss on Extinguishment of Debt, Net of Tax During the nine months
ended September 30, 2001, the Company purchased $5.1 million of its 5 3/4%
Convertible Debenture Bonds at 78% of their face value, for a total cost of $4.0
million, resulting in an extraordinary gain on extinguishment of debt, net of
tax, of $694,000, or $0.04 gain per dilutive share. Offsetting this gain, during
the period ended September 30, 2001, the Company repaid a term note to a bank in
connection with the sale of its community in California. As part of this
transaction, the Company incurred a prepayment penalty of $875,000, or $0.05
loss per dilutive share, net of income taxes, which was recorded as an
extraordinary loss on the extinguishment of debt. The purchase of bonds and
repayment of the term note resulted in a net extraordinary loss of $178,000, or
$0.01 loss per dilutive share.
Net Loss Based upon the factors noted above, the Company experienced a net loss
of $11.9 million, or $0.69 loss per dilutive share, compared to a net loss of
$1.8 million, or $0.10 per dilutive share, for the nine months ended September
30, 2001 and 2000, respectively. The $0.69 loss per dilutive share for the nine
months ended September 30, 2001 loss of was comprised of a $0.68 loss from
operations, as well as a $0.01 loss from the extinguishment of debt. The loss of
$0.10 per dilutive share for the nine months ended September 30, 2000, was
comprised from loss from operations of $0.10, as well as a $0.01 loss from the
extinguishment of debt.
LIQUIDITY AND CAPITAL RESOURCES
Cash flow
Net cash provided by operating activities was $5.7 million for the nine months
ended September 30, 2001, as compared with $6.7 million for the nine months
ended September 30, 2000. The Company's cash and cash equivalents totaled $17.0
million as of September 30, 2001, as compared to $25.6 million as of September
30, 2000.
25
Net cash used by investing activities was $12.4 million for the nine months
ended September 30, 2001, as compared with $62.3 million for the nine months
ended September 30, 2000. During the nine months ended September 30, 2001, the
Company made additions to land, buildings, and equipment, including construction
activity, of $13.3 million. The Company received $7.7 million from sales of
assets, issued notes receivable of $2.2 million, and purchased assets limited as
to use of $5.4 million.
Net cash provided by financing activities was $3.9 million compared with $59.4
million for the nine months ended September 30, 2001 and 2000, respectively.
During the nine months ended September 30, 2001, the Company borrowed $21.7
million under long-term debt arrangements, made principal payments on its
indebtedness of $8.8 million, purchased debentures totaling $4.0 million and
paid $1.1 million of financing costs. In connection with certain lifecare
communities, the Company made principal payments and refunds under master trust
agreements of $4.0 million.
Financing Activity
During the nine months ended September 30, 2001, the Company entered into
various financing commitments including a secured term loan from a mortgage
lender in the amount of $17.3 million, with interest payable at LIBOR plus 3%.
Interest and principal are payable monthly, based on a twenty-five year
amortization schedule, with all remaining balances due in July 2002. The Company
used a portion of the proceeds from the loan to refinance a portion of a term
note to a capital corporation, repaying the outstanding amount of $3.5 million.
Effective as of September 30, 2001, the Company amended various financing
agreements in order to, among other things, maintain compliance with its debt
covenants, including its senior term loan, of which $92.3 million was
outstanding as of September 30, 2001. This amendment resulted in the extension
of the August 1, 2002 maturity to November 1, 2002 and amended certain financial
covenants. See Note 2 to the Condensed Consolidated Financial Statements.
On September 26, 2001, the Company acquired a community, located in Oakpark,
Illinois. The Company entered into a mortgage note with a commercial mortgage
lender in the amount of $13.0 million, with interest payable at a grid-based
pricing of LIBOR plus 2.6% to 3.5%. Interest and principle are payable monthly,
with the note maturing on October 1, 2003. The note is secured by the land and
building of the community. The Company previously leased this community.
On December 18, 2000, the Company sold a community located in Westlake, Ohio for
$26.0 million and contemporaneously leased the property back from the buyer. The
Company used a portion of the proceeds from the sale to repay $17.0 million of a
$50.0 million revolving line of credit. During the nine months ended September
30, 2001, the Company completed two like-kind exchange transactions which
deferred the taxable gain resulting from the Westlake transaction. In connection
with the first like-kind exchange, the Company purchased land in Virginia and
assumed a $12.1 million non-recourse mortgage loan bearing interest at 7.43%
with principal due monthly and a maturity date of January 2024. The Company
acquired the land subject to a lease that provides annual rental payments of
$980,000 through February 23, 2023. In the second like-kind exchange, the
Company purchased all of the equity interests in a single member limited
liability company that owned various parcels of land and buildings recorded at
$2.3 million and building improvements recorded at $4.8 million, and assumed a
$15.2 million non-recourse mortgage loan, with interest at 8.41% and principal
and interest due monthly, and a maturity date of September 2005. The various
land parcels are subject to leases that provide annual rental payments of $1.3
million through March 7, 2022.
The Company announced, during the quarter ended March 31, 2000, that the Board
of Directors had authorized the repurchase, from time to time, of up to $30.0
million of its 5 3/4% Convertible Subordinated Debentures. The timing and amount
of purchases of these debentures will depend upon prevailing market conditions,
availability of capital, alternative uses of capital and other factors. During
the nine months
26
ended September 30, 2001, the Company purchased $5.1 million of the 5 3/4%
Convertible Subordinated Debentures, resulting in an extraordinary gain on
extinguishment of debt, net of tax, of $694,000. Additional purchases of the
5 3/4% Convertible Subordinated Debentures, if any, are likely to be made
primarily in the open market.
During 1999, the Company entered into a land purchase agreement for a parcel of
land in Boston, Massachusetts for $14.5 million, to be used for the development
of a senior living community. In connection with the development of this
project, the Company has agreed to enter into a joint venture relationship with
an unaffiliated entity. Closing of this purchase agreement is dependent upon
various zoning, land use and other approvals. The Company has incurred and
capitalized architectural, engineering, legal, and other costs to date amounting
to $2.5 million as part of the development of this project. If satisfactory
zoning and land use approvals are not received or if the Company is not able to
secure equity and debt financing to acquire and develop the property, the
Company could have to consider various options, including sale or assignment of
its rights, modification of the project scope, or abandonment of its interest in
the project which could result in a write-off of these costs. The Company
believes it will ultimately be successful in receiving these approvals and
securing financing to acquire and develop the property, but there can be no
assurance in that regard, nor can there be any assurance that these delays will
not adversely effect the feasibility of, or the Company's willingness to
complete the project.
Free-standing ALs and Managed SPE Communities
The Company owns, leases, or manages a total of 34 Free-standing ALs.
Substantially all of the Company's Free-standing ALs, including all of the
Managed SPE Communities, are in the fill-up stage. As a result, the Company
expects its Free-standing AL portfolio (both consolidated Free-standing ALs and
Managed SPE Communities) to continue to incur substantial losses throughout 2001
and 2002. For the three months ended December 31, 2000, March 31, 2001, June 30,
2001, and September 30, 2001, Free-standing AL Pre-tax Losses (defined as
Free-standing AL operating income, including Equity in Losses of Managed Special
Purpose Entity Communities, plus lease and interest costs directly allocable to
Free-standing ALs, but excluding general and administrative costs) were $5.1
million, $5.6 million, $5.2 million and $5.0 million, respectively.
The Company's consolidated results include and will continue to include
increased losses from Free-standing ALs in 2001 versus 2000, as a result of a
full year of activity in 2001 for these communities opened during 2000, an
increased number of Free-standing ALs which are included in consolidated results
(as a result of acquiring various communities and leasehold interests during
2000 and 2001), and increased Equity in Losses of Managed SPE Communities (as
cumulative operating costs exceed the limits for which the SPEs are
responsible). However, the Company believes that the losses incurred in
connection with its Free-standing AL portfolio will decrease each successive
quarter, primarily as a result of increased occupancy at these communities.
The Company has options to purchase or has rights of first refusal to acquire
the leasehold interests in ten Managed SPE Communities, but is under no
obligation to purchase these communities. The Company acquired two leasehold
interests during the nine months ended September 30, 2001 from affiliates of
John Morris, a director of the Company. The Company is in discussions with the
various SPEs to acquire some or all of the remaining ten Managed SPE Communities
that are currently managed by the Company. If offered and accepted, the Company
anticipates acquiring certain, and perhaps all, of those leasehold interests in
Managed SPE Communities during 2001 and 2002. If all are acquired, the Company
estimates that the combined purchase price would be approximately $20.0 million,
although the purchase price, terms of payment, and other terms are not yet
finalized. The timing of these leasehold acquisitions will depend on a variety
of factors, including prevailing market conditions, the Company's financing
plans, the availability of capital, alternative uses of capital, general
economic conditions and the results of negotiations with the SPEs. If the
Company does not acquire these leasehold interests, the Company remains
responsible for funding future operating losses to the extent that such losses
exceed specified
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limits. The Company expects that it will be required to fund significant Managed
SPE operating deficits during the remainder of 2001 and 2002.
Liquidity
The Company has historically financed its activities with long-term mortgage
borrowings, term and revolving credit facilities, cash flows from operations,
and prior to 1999, net proceeds from public offerings of debt and equity. At
September 30, 2001, the Company had $531.3 million of indebtedness outstanding,
including $132.9 million of 5 3/4% Convertible Subordinated Debentures, with
fixed maturities ranging from November 2001 to April 2028. As of September 30,
2001, approximately 55.9% of the Company's indebtedness bore interest at fixed
rates, with a weighted average interest rate of 7.05%. The Company's variable
rate indebtedness carried a weighted average rate of 6.49% as of September 30,
2001. As of September 30, 2001, the Company had negative working capital of
$23.9 million.
Certain of the Company's credit agreements contain restrictive covenants that
include, among other things, the maintenance of minimum tangible net worth,
prescribed debt service coverage, liquidity, capital expenditure reserves and
occupancy levels. Effective as of September 30, 2001, the Company and certain of
its lenders and lessors agreed to amendments or waivers relating to several of
these financial covenants in order to allow the Company to remain in compliance
therewith. In addition, the Company extended the maturity date of its senior
term loan from August 1, 2002 to November 1, 2002. At September 30, 2001, $92.3
million was outstanding under this credit facility. In connection with the June
30, 2001 extension, the Company agreed to, among other things, (i) convert the
facility to a term loan from a revolving line-of-credit, (ii) make a $10.0
million principal reduction by May 1, 2002, (iii) increase the interest rate
margin of the facility, (iv) provide a capital formation plan requiring that the
Company raise $30.0 million of capital by January 31, 2002, (v) provide evidence
of sufficient capacity to payoff its 5 3/4% Convertible Subordinated Debentures
by July 1, 2002, and (vi) include certain new and amended financial covenants.
The Company's compliance with its financial covenants is dependent, among other
things, upon improvements in the operations of the Company's Free-standing ALs
and the Company's ability to raise capital to meet covenants requiring debt
reductions. There can be no assurances that the Company will remain in
compliance with those financial covenants or that its lenders will grant further
amendments in the event of such non-compliance. Failure to remain in compliance
with its financial covenants would have a material adverse impact on the
Company, and would likely result in a default or an acceleration of a
substantial majority of the Company's indebtedness and other obligations.
Most of the Company's owned communities are subject to mortgages. Each of the
Company's debt agreements contains restrictive covenants that generally relate
to the use, operation, and disposition of the communities that serve as
collateral for the subject indebtedness, and prohibit the further encumbrance of
such community or communities without the consent of the applicable lender. The
Company does not believe the covenants relating to the use, operation, and
disposition of its communities materially limit its operations.
A significant amount of the Company's indebtedness is cross-defaulted. Any
non-payment or other default with respect to such obligations (including
non-compliance with a financial covenant) could cause lenders 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 and cross-collateralization
provisions in certain of the Company's mortgages, debt instruments, and leases,
a default by the Company on one of its debt instruments is likely to result in a
default or acceleration of substantially all of the Company's other obligations,
which would have a material adverse effect on the Company.
The Company is highly leveraged and has a substantial amount of debt and lease
obligations. At September 30, 2001, the scheduled debt maturities during the
fifteen months ended December 31, 2002 total $348.9 million, including $216.0
million of mortgage debt and $132.9 million of 5 3/4% Convertible Subordinated
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Debentures. The maturing mortgage debt includes the Company's amended senior
mortgage facility, of which $92.3 million was outstanding as of September 30,
2001, $10.0 million of which is due on May 1, 2002 with the balance being due on
November 1, 2002. The $132.9 million of 5 3/4% Convertible Subordinated
Debentures matures on October 1, 2002. The Company must repay or refinance all
of these obligations as they mature in order to avoid being in default
thereunder.
The Company expects that its current cash and cash equivalents, expected cash
flow from operations, and the proceeds from certain anticipated financings will
be sufficient to fund its operating requirements, including its
pre-stabilization losses, its capital expenditure requirements and its periodic
debt service requirements, during 2001 and 2002. The Company's internally
generated cash will not be sufficient to satisfy the mortgage debt that matures
in 2002 or its scheduled principal reductions in 2002. Accordingly, the
Company's ability to refinance its maturing mortgage debt obligations and to
make its scheduled principal reductions will depend, primarily upon its ability
to renew existing credit facilities and arrangements, to obtain new credit
facilities or other financing arrangements, or to issue privately placed equity
or equity linked securities. The Company has engaged in, and anticipates
continuing, discussions with its existing lenders and other third parties
regarding the refinancing of the Company's maturing indebtedness. There can be
no assurances, however, that the Company will successfully negotiate and obtain
adequate new credit facilities or extensions of its existing credit facilities,
and if such financing is available, that the terms of any such financing will
not impose significant burdens on the Company or be dilutive to the Company's
existing shareholders. If the Company has not successfully extended or renewed
the $92.3 million senior mortgage facility beyond the current maturity of
November 1, 2002, this amount will be classified as a current liability in the
fourth quarter of 2001, which will have a material adverse effect upon its
working capital position.
The Company's internally generated cash flow will also not be sufficient to
satisfy the Convertible Subordinated Debentures at their maturity in October
2002. The Company has engaged an investment advisor and is considering various
capital raising and other alternatives to satisfy the Company's obligations in
connection with the 5 3/4% Convertible Subordinated Debentures and its maturing
mortgage debt. These alternatives include generating cash from incremental
leverage on the Company's stabilized assets, the selective disposition or sale
of certain communities, the sale-leaseback or monetization of certain
communities, the issuance of equity or equity linked securities in privately
negotiated transactions, the exchange of the 5 3/4% Convertible Subordinated
Debentures for other securities of the Company, and combinations of all of these
alternatives. The terms of any such transactions may impose significant burdens
on the Company and are likely to be substantially dilutive to the Company's
existing shareholders. There can be no assurance that any of these alternatives
will be available to the Company, or that any available terms will be acceptable
to the Company. Consequently, there can be no assurance that the Company will be
able to refinance, extend, exchange or otherwise satisfy its obligations with
respect to the 5 3/4% Convertible Subordinated Debentures prior to their
maturity or classification as a current liability. The failure to repay the
5 3/4% Convertible Subordinated Debentures will have a material adverse effect
upon the Company.
The Company's ability to obtain new credit facilities, to sell communities, or
to consummate any of the debt or equity financing alternatives being considered
depends upon a number of factors, many of which are beyond the Company's
control. These factors include the Company's financial condition and operating
performance, the financial strength of the assets to be sold or leveraged,
general economic conditions, general conditions in the credit markets, the
condition of the senior living industry, mortgage interest rates, the Company's
equity in any particular community and other factors. The Company's efforts will
be adversely affected by the condition of the assisted living market in general,
the insolvency or weakened financial conditions of many assisted living
competitors, a reduced number of lenders willing to finance assisted living or
retirement companies, the substantial fill-up costs associated with the
Company's Free-standing ALs and the fact that the Company is highly leveraged.
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Insurance
The provision 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. The Company
currently maintains property, liability, and professional medical malpractice
insurance policies for the Company's owned and certain of its managed
communities under a master insurance program. The number of insurance companies
willing to provide general liability and professional malpractice liability
insurance for the nursing and assisted living industry has declined
dramatically. The Company's previous liability policies expired on July 1, 2001,
and, in order to renew its liability coverage, the Company was required to pay
significantly higher premiums and deductibles and agree to a policy expiring
December 31, 2001. As a result, beginning in the third quarter of 2001, the
Company began incurring higher costs for premiums and reserves for potential
liability claims. The Company also has underlying and umbrella excess liability
protection policies in the amount of at least $15.0 million in the aggregate.
There can be no assurance that a claim in excess of the Company's insurance will
not arise. A claim against the Company not covered by, or in excess of, the
Company's insurance could have a material adverse effect upon the Company. In
addition, the Company's insurance policies must be renewed December 31, 2001.
There can be no assurance that the Company will be able to obtain liability
insurance in the future or that, if such insurance is available, it will be
available on acceptable terms.
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: the Company's anticipated or expected cashflow; the Company's
anticipated financings; the discussions of the Company's operating and growth
strategy (including its development plans and possible dispositions); the
Company's liquidity and financing needs; the alternatives that the Company is
considering for raising additional capital and satisfying its maturing
obligations; the projections of revenue, income or loss, capital expenditures,
and, future operations; and the availability of new insurance programs.
Investors are cautioned that all forward-looking statements involve risks and
uncertainties including, without limitation, (i) the possibility of future
defaults under the Company's debt and lease agreements (including the Company's
inability to meet financial covenants or satisfy these obligations at their
maturity), (ii) the risks associated with the Company's financial condition and
the fact that the Company is highly leveraged, (iii) the risk that the Company
will be unable to close anticipated financings, obtain new credit facilities,
raise additional capital or consummate any of the capital raising alternatives
that the Company is contemplating, (iv) the risk that the Company will not
generate expected levels of cash or will be unable to reduce the operating
losses at its Free-standing ALs, (v) the risks associated with the adverse
market conditions for the senior living industry, (vi) 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, (vii) the likelihood of further and tighter governmental
regulation, and (viii) 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, 2000 and the Company's other filings with the Securities and
Exchange Commission. 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.
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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. The Company has entered into two
interest rate swap agreements with a major financial institution to manage its
exposure. The Company does not expect changes in interest rates to have a
material effect on income or cash flows in 2001 or 2002, since 56% 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.
Additionally, the Company anticipates refinancing and/or renegotiating certain
debt in 2001 and 2002, which could result in higher interest rates in the
future. There can be no assurance, however, that the Company will be able to
refinance and/or renegotiate any of its indebtedness.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
10.1 American Retirement Corporation 401(k) Plan and Trust and
Adoption Agreement
10.2 1997 Stock Incentive Plan, as amended
10.3 Third Amendment to Amended and Restated Financing and Security
Agreement, dated September 30, 2001 between Washington Mutual
Bank, FA and ARC Capital Corporation II
10.4 Loan Agreement, dated September 26, 2001, between ARC Holley
Court Terrace, LLC and GMAC Commercial Mortgage Corporation.
10.5 Operating Lease, dated July 1, 2001, between Maybrook Realty,
Inc. and ARC HDV, LLC.
10.6 Master Lease and Security Agreement, dated July 31, 2001,
between ARC Pinegate, L.P., ARC Pearland, L.P., American
Retirement Corporation, Trinity Towers, L.P., ARC Lakeway,
L.P., ARC Spring Shadow, L.P., Nationwide Health Properties,
Inc. and NH Texas Properties, L.P.
b. Reports on Form 8-K
On August 14, 2001, the Company furnished to the SEC a Form 8-K
disclosing for purposes of Regulation FD supplemental financial
information relating to the Company's second quarter ended June 30,
2001.
On September 4, 2001, the Company furnished to the SEC a Form 8-K
disclosing for purposes of Regulation FD the issuance by the Company of
a press release announcing that it had modified its liability insurance
program.
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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 14, 2001 By: /s/ George T. Hicks
-----------------------------------
George T. Hicks
Executive Vice President
and Chief Financial Officer
(principal financial and
accounting officer)
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