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 June 30, 2002
( ) 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
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AMERICAN RETIREMENT CORPORATION
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(Exact name of Registrant as specified in its charter)
Tennessee 62-1674303
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(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
111 Westwood Place, Suite 200, Brentwood, TN 37027
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(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 August 14, 2002, there were 17,310,209 shares of the Registrant's common
stock, $.01 par value, outstanding.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page
Condensed Consolidated Balance Sheets as of
June 30, 2002 and December 31, 2001...............................................3
Condensed Consolidated Statements of
Operations for the Three Months Ended
June 30, 2002 and 2001 ...........................................................4
Condensed Consolidated Statements of
Operations for the Six Months Ended
June 30, 2002 and 2001 ...........................................................5
Condensed Consolidated Statements of Cash
Flows for the Six Months Ended June 30,
2002 and 2001 ....................................................................6
Notes to Condensed Consolidated Financial Statements .............................8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations................................... 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk ..................... 43
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................ 44
Signatures ................................................................................ 45
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share data)
June 30, 2002 December 31, 2001
------------- --------------------
ASSETS
Current assets:
Cash and cash equivalents $ 12,250 $ 19,334
Assets limited as to use 16,102 10,122
Accounts receivable, net of allowance for doubtful accounts 14,030 11,447
Inventory 1,349 1,249
Prepaid expenses 3,122 3,016
Deferred income taxes 1,285 1,285
Other current assets 3,620 5,799
------------ ------------
Total current assets 51,758 52,252
Assets limited as to use, excluding amounts classified as current 59,550 68,618
Land, buildings and equipment, net 498,823 525,174
Notes receivable 55,403 84,537
Goodwill, net 36,463 36,463
Leasehold acquisition costs, net 23,929 33,484
Other assets 65,501 49,663
------------ ------------
Total assets $ 791,427 $ 850,191
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt, including
convertible subordinated debentures $ 165,355 $ 371,667
Accounts payable 4,961 7,919
Accrued interest 3,134 3,584
Accrued payroll and benefits 5,309 4,838
Accrued property taxes 7,732 7,998
Other accrued expenses 6,401 9,926
Other current liabilities 22,650 17,436
------------ ------------
Total current liabilities 215,542 423,368
Long-term debt, excluding current portion 349,399 190,458
Refundable portion of life estate fees 56,393 46,309
Deferred life estate income 68,742 51,211
Tenant deposits 5,410 6,016
Deferred gain on sale-leaseback transactions 29,193 13,055
Deferred income taxes 1,970 2,055
Other long-term liabilities 14,652 10,171
------------ ------------
Total liabilities 741,301 742,643
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,
17,310,209 and 17,276,520 shares issued and outstanding, respectively 173 173
Additional paid-in capital 145,657 145,590
Accumulated deficit (95,704) (38,215)
------------ ------------
Total shareholders' equity 50,126 107,548
------------ ------------
Total liabilities and shareholders' equity $ 791,427 $ 850,191
============ ============
See accompanying notes to condensed consolidated financial statements
3
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except share data)
Three Months Ended June 30,
-------------------------------------
2002 2001
----------------- -----------------
Revenues:
Resident and health care $ 80,787 $ 62,405
Management services 620 964
Reimbursable out-of-pockets 1,236 1,729
----------------- -----------------
Total revenues 82,643 65,098
Operating expenses:
Community operating expenses 59,010 43,615
General and administrative 6,554 6,756
Lease expense, net 18,098 6,700
Depreciation and amortization 5,510 4,799
Amortization of leasehold acquisition costs 2,994 396
Reimbursable out-of-pockets 1,236 1,729
----------------- -----------------
Total operating expenses 93,402 63,995
----------------- -----------------
Operating (loss) income (10,759) 1,103
Other income (expense):
Interest expense (9,969) (9,293)
Interest income 1,268 2,969
Loss on sale of assets (27) (303)
Equity in losses of managed special purpose entity communities - (972)
Other 191 510
----------------- -----------------
Other expense, net (8,537) (7,089)
----------------- -----------------
Loss from continuing operations before income taxes,
minority interest, and extraordinary item (19,296) (5,986)
Income tax expense (benefit) 122 (1,952)
----------------- -----------------
Loss from continuing operations before minority
interest and extraordinary item (19,418) (4,034)
Minority interest in losses of consolidated subsidiaries, net of tax - 4
----------------- -----------------
Loss from continuing operations before extraordinary item (19,418) (4,030)
Extraordinary loss on extinguishment of debt, net of tax - (576)
----------------- -----------------
Net loss $ (19,418) $ (4,606)
================= =================
Basic loss per share:
Basic loss per share before extraordinary item $ (1.12) $ (0.23)
Extraordinary loss, net of tax - (0.03)
----------------- -----------------
Basic loss per share $ (1.12) $ (0.27)
================= =================
Diluted loss per share:
Diluted loss per share before extraordinary item $ (1.12) $ (0.23)
Extraordinary loss, net of tax - (0.03)
----------------- -----------------
Diluted loss per share $ (1.12) $ (0.27)
================= =================
Weighted average shares used for basic loss per share data 17,277 17,200
Effect of dilutive common stock options - -
----------------- -----------------
Weighted average shares used for diluted loss per share data 17,277 17,200
================= =================
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)
Six Months Ended June 30,
--------------------------------------
2002 2001
----------------- -----------------
Revenues:
Resident and health care $ 156,040 $ 122,077
Management and development services 685 1,673
Reimbursable out-of-pockets 2,687 3,400
----------------- -----------------
Total revenues 159,412 127,150
Operating expenses:
Community operating expenses 112,987 85,404
General and administrative 12,474 11,750
Lease expense, net 51,063 13,451
Depreciation and amortization 10,532 9,526
Amortization of leasehold acquisition costs 10,116 761
Reimbursable out-of-pockets 2,687 3,400
----------------- -----------------
Total operating expenses 199,859 124,292
----------------- -----------------
Operating (loss) income (40,447) 2,858
Other income (expense):
Interest expense (19,694) (18,519)
Interest income 2,928 6,153
Loss on sale of assets (53) (122)
Equity in losses of managed special purpose entity communities - (1,938)
Other 752 1,023
----------------- -----------------
Other expense, net (16,067) (13,403)
----------------- -----------------
Loss from continuing operations before income taxes,
minority interest, and extraordinary item (56,514) (10,545)
Income tax expense (benefit) 219 (3,398)
----------------- -----------------
Loss from continuing operations before minority
interest and extraordinary item (56,733) (7,147)
Minority interest in earnings of consolidated subsidiaries, net of tax - (96)
----------------- -----------------
Loss from continuing operations before extraordinary item (56,733) (7,243)
Extraordinary loss on extinguishment of debt, net of tax (756) (181)
----------------- -----------------
Net loss $ (57,489) $ (7,424)
================= =================
Basic loss per share:
Basic loss per share before extraordinary item $ (3.28) $ (0.42)
Extraordinary loss, net of tax (0.04) (0.01)
----------------- -----------------
Basic loss per share $ (3.33) $ (0.43)
================= =================
Diluted loss per share:
Diluted loss per share before extraordinary item $ (3.28) $ (0.42)
Extraordinary loss, net of tax (0.04) (0.01)
----------------- -----------------
Diluted loss per share $ (3.33) $ (0.43)
================= =================
Weighted average shares used for basic loss per share data 17,277 17,167
Effect of dilutive common stock options - -
----------------- -----------------
Weighted average shares used for diluted loss per share data 17,277 17,167
================= =================
See accompanying notes to the condensed consolidated financial statements.
5
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
Six Months Ended June 30,
----------------------------------------------
2002 2001
-------------------- ---------------------
Cash flows from operating activities:
Net loss $ (57,489) $ (7,424)
Extraordinary loss on extinguishment of debt, net of tax 756 181
-------------------- ---------------------
Loss from continuing operations (56,733) (7,243)
Adjustments to reconcile loss from continuing operations to net
cash and cash equivalents used by operating activities:
Depreciation and amortization 20,648 10,287
Amortization of deferred entrance fee revenue (5,675) (5,206)
Amortization of deferred financing costs 1,658 1,262
Residual value guarantee lease costs 30,279 -
Advances to joint ventures - (1,512)
Proceeds from life estate sales, net of refunds 6,258 5,372
Deferred income tax benefit (85) (3,091)
Amortization of deferred gain on sale-leaseback transactions (1,641) (1,310)
Minority interest in earnings of consolidated subsidiaries - 96
Losses (gains) from unconsolidated joint ventures 279 (14)
Loss on sale of assets 53 122
Issuance of stock to employee 401k plan - 333
Changes in assets and liabilities:
Accounts receivable (1,592) 41
Inventory (30) (60)
Prepaid expenses 71 1,291
Other assets 5,809 3,860
Accounts payable (3,344) (4,732)
Accrued expenses and other current liabilities (5,332) 1,407
Tenant deposits (632) (346)
Other liabilities 1,880 (588)
-------------------- ---------------------
Net cash and cash equivalents used by operating activities (8,129) (31)
Cash flows from investing activities:
Additions to land, buildings and equipment (13,133) (11,408)
Purchase of assets limited as to use (7,677) (2,864)
(Issuance of) receipts from notes receivable (8,641) 2,090
Proceeds from the sale of assets 92,113 7,708
Other investing activities (2,235) 308
-------------------- ---------------------
Net cash provided (used) by investing activities 60,427 (4,166)
See accompanying notes to condensed consolidated financial statements
6
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(UNAUDITED)
(in thousands)
Six Months Ended June 30,
----------------------------------------------
2002 2001
--------------------- ---------------------
Cash flows from financing activities:
Proceeds from issuance of stock through employee stock purchase plan 67 84
Proceeds from the issuance of long-term debt 189,381 21,745
Principal payments on long-term debt (236,752) (7,444)
Purchase of convertible debentures - (4,029)
Principal reductions in master trust liability (3,109) (3,092)
Expenditures for contingent earnouts (5,294) (567)
Expenditures for financing costs (3,675) -
--------------- ---------------------
Net cash (used) provided by financing activities (59,382) 6,697
--------------- ---------------------
Net (decrease) increase in cash and cash equivalents (7,084) 2,500
--------------- ---------------------
Cash and cash equivalents at beginning of period 19,334 19,850
--------------- ---------------------
Cash and cash equivalents at end of period $ 12,250 $ 22,350
=============== =====================
Supplemental disclosure of cash flow information:
Cash paid during the period for interest (including capitalized interest) $ 17,003 $ 18,400
=============== =====================
Income taxes paid (received) $ 330 $ (1,533)
=============== =====================
Supplemental disclosure of non-cash transactions:
During the quarter ended June 30, 2002, the Company terminated a management
agreement and entered into a long-term operating lease. Under the terms of the
lease, the Company acquired the following assets and assumed the following
liabilities:
Accounts receivable $ 991 $ -
Other current assets 441 -
Note receivable 18,756 -
Other assets 11,651 -
Other current liabilities 1,527 -
Refundable portion of life estate fees 11,348 -
Deferred life estate income 16,335 -
Other long-term liabilities 2,629 -
During the six months ended June 30, 2002, the Company terminated five operating
leases, and acquired $69.3 million of land, buildings and equipment in exchange
for $58.1 million of notes receivable and $11.2 million of certificates of
deposit (included in assets whose use is limited), previously securing these
leases. In conjunction with the transactions, assets and liabilities changed as
follows:
Notes receivable $ (58,110) $ -
Assets limited as to use (11,176) -
Land, buildings and equipment 44,313 -
Other current liabilities 24,973 -
During the six months ended June 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.
See accompanying notes to condensed 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 2001 amounts have been reclassified to conform to the fiscal year 2002
presentation. Operating results for the three and six months ended June 30, 2002
are not necessarily indicative of the results that may be expected for the
entire year ending December 31, 2002. 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, 2001.
2. LIQUIDITY AND REFINANCING PLAN
The Company has a substantial amount of debt and lease obligations maturing
during 2002, comprised primarily of $132.9 million of its 5 3/4% Convertible
Subordinated Debentures Due October 1, 2002 (the "Debentures"). The Company has
scheduled debt maturities during the 12 months ended June 30, 2003 of $165.4
million, which includes $32.5 million of periodic mortgage debt payments and
$132.9 million of Debentures. As a result of these current maturities, the
Company had a net working capital deficit of $163.8 million as of June 30, 2002.
As of June 30, 2002, the Company also had minimum rental obligations of $50.3
million under long-term operating leases due during the twelve months ended June
30, 2003. In addition, as of June 30, 2002, the Company had guaranteed $93.1
million of third-party senior debt in connection with a community that the
Company manages, the Company's joint ventures and certain of the Company's lease
financings. The Company and certain of its lenders and lessors also agreed to
amendments or waivers of various financial covenants as of June 30, 2002. As of
June 30, 2002, the Company had approximately $12.3 million in unrestricted cash
and cash equivalents. The Company currently does not generate sufficient cash
flow to meet its debt and lease payment obligations. The Company expects that
its cash flow from operations will improve, and, accordingly, expects that its
current cash and cash equivalents, expected cash flow from operations, and the
proceeds from certain recently completed financings will be sufficient to fund
its operating requirements, its capital expenditure requirements and its
periodic debt service requirements through June 30, 2003. However, the Company's
current cash balances and internally generated cash (including the proceeds from
recently completed financings) will not be sufficient to satisfy its scheduled
debt maturities in 2002.
In order to satisfy or extend the Company's debt and lease payment obligations
and to address its net working capital deficit, the Company considered a number
of financing and capital raising alternatives and developed a refinancing plan
in consultation with its investment banking advisor and its legal counsel and
through discussions with its lenders and other third parties (the "Refinancing
Plan"). The Refinancing Plan included extensions of existing debt maturities,
refinancings of existing mortgage facilities, new mortgage financings, and sale
lease-back arrangements. Pursuant to the Refinancing Plan, since November 2001,
the Company has consummated sale lease-back transactions relating to 16
communities and various other refinancing and capital raising transactions,
which in the aggregate generated gross proceeds of approximately $362.0 million.
The Company used approximately $327.2 million of the proceeds to repay related
debt and to fund reserve and escrow requirements related to these transactions.
The Company used the remaining $34.8 million of proceeds to pay transaction
costs associated with the Refinancing Plan and for working capital. As a result
of the Refinancing Plan, the Company has extended the maturity of substantially
all of its debt arrangements, other than the Debentures, to January 2004 or
later.
The Debentures are the Company's only material remaining outstanding debt
obligation maturing during the next 12 months. In order to address the maturity
of the Debentures, during March of 2002, the Company entered into a non-binding
commitment letter with Health Care Property Investors, Inc. ("HCPI"), a real
estate investment trust, relating to a proposed $125 million financing
transaction. On August 14, 2002, the Company entered into a binding
8
loan agreement with HCPI (the "HCPI Loan Agreement") pursuant to which HCPI has
agreed to loan one of the Company's subsidiaries $112.8 million (the "HCPI
Loan"). The Company also contemporaneously entered into a binding securities
purchase agreement with HCPI (the "HCPI Investment Agreement") under which HCPI
has agreed to make a $12.2 million equity investment in certain other
subsidiaries of the Company (the "HCPI Equity Investment"). The HCPI Loan and
the HCPI Equity Investment are collectively referred to as the "HCPI
Transactions."
HCPI's obligation to consummate the HCPI Transactions is subject to a number of
conditions and contingencies. Those conditions include the requirement that the
Company successfully complete an exchange offer with the holders of the
outstanding Debentures (the "Exchange Offer"), pursuant to which the Company
will exchange for each $1,000 principal amount of outstanding Debentures and
accrued interest thereon (i) $839 principal amount of the Company's new 5 3/4%
Series A Senior Subordinated Notes Due September 30, 2002 (the "Series A
Notes"), (ii) $190 principal amount of the Company's new 10% Series B Senior
Subordinated Notes Due September 30, 2009 (the "Series B Notes"), and (iii) 13
warrants, each warrant to purchase one share of the Company's common stock at an
exercise price of $3.50 per share and with an expiration date of September 30,
2009 (the "Warrants"). With respect to the Exchange Offer, HCPI is also
requiring that the Company receive the valid tender of at least 75% of the
outstanding principal amount of the Debentures (approximately $99.7 million) to
provide the Company with additional cash on hand to meet its on-going liquidity
requirements. The Series A Notes and the Series B Notes will be unsecured and
subordinated to all of the Company's existing and future indebtedness and
capital lease obligations, but they will rank senior to the Debentures. The
Company has the option to pay up to 2% interest per year on the Series B Notes
through the issuance of additional Series B Notes rather than in cash. The
Company initiated the Exchange Offer on August 14, 2002, and anticipates that,
if successful, it will be consummated during September 2002.
The HCPI Loan will mature five years after initial funding, and will have a
stated interest rate of 19.5%; however, the Company will only be required to pay
in cash 9% interest per year until April 2004. Thereafter, the cash interest
payment rate will increase each year by fifty-five basis points. The cash
portion of interest will be payable quarterly, with any unpaid interest accruing
and compounding quarterly. The $112.8 million principal balance and all accrued
interest will be payable at the maturity of the loan. The Company will be
permitted to repay the loan at any time after three years from the date of
initial funding.
The $12.2 million HCPI Equity Investment will be made in return for a 9.8%
ownership interest in certain subsidiaries of the Company's subsidiary that is
the borrower under the HCPI Loan (the "Real Estate Companies"). The Real Estate
Companies function solely as passive real estate holding companies owning the
real property and improvements of nine of the Company's large retirement
communities. These retirement communities are leased to, and operated by, other
operating subsidiaries of the borrower subsidiary in which HCPI will have no
interest. During the term of its investment in each Real Estate Company, HCPI
and the borrower subsidiary will have mutual decision making authority with
respect to the Real Estate Companies. HCPI will have the right to receive
certain preferred distributions from any cash generated by the Real Estate
Companies. The borrower subsidiary will have the right to repurchase HCPI's
minority interest in the Real Estate Companies for one year beginning four years
after closing. HCPI will have the right to purchase the borrower subsidiary's
interests in the Real Estate Companies beginning five years after closing.
The HCPI Loan will be non-recourse and will be secured by a first-priority
security interest in the borrower subsidiary's 90.2% ownership interests in the
Real Estate Companies, and in certain cash reserve accounts. Since the HCPI Loan
is non-recourse, if the borrower subsidiary defaults or fails to repay the loan
at maturity, HCPI's only claim against that subsidiary will be to exercise its
security interests and, absent fraud or certain other customary events of
malfeasance, neither the Company nor any of its subsidiaries will have any
further obligation to repay the HCPI Loan. Accordingly, even in the event of
default by the borrower subsidiary, the operating subsidiaries will continue to
operate these communities under a lease, which has an initial term of 15 years,
commencing at the date of funding of the loan, and two ten-year extensions that
are exercisable at the Company's option.
The HCPI Loan Agreement contains numerous affirmative, negative and financial
covenants. In addition, under the HCPI Loan Agreement, HCPI's obligation to make
the HCPI Loan is subject to customary and usual conditions and certain other
conditions and requirements. Those conditions include, among others, the
following:
9
o the loan must be funded by September 30, 2002;
o the Company must complete the Exchange Offer on the terms
currently contemplated and the holders of the Debentures must
validly tender at least 75% of the outstanding principal
amount, or approximately $99.7 million, of the Debentures;
o operating results must be within budget and the Company must
meet certain liquidity and financial tests relating to the
Company and to the nine retirement communities owned by the
Real Estate Companies; and
o no material adverse change shall have occurred with respect to
the nine retirement communities, the borrower subsidiary or
the Company.
HCPI's obligation to make the $12.2 million HCPI Equity Investment in the Real
Estate Companies is also subject to substantially similar conditions.
In the event the Exchange Offer is successful and the Company receives the valid
tender of at least 75% of the aggregate principal amount of the outstanding
Debentures, the Company expects that it will be able to satisfy the other
conditions in the HCPI Loan Agreement and in the HCPI Investment Agreement and
close those transactions on or before September 30, 2002. The Company
anticipates that it will receive net proceeds of approximately $119.8 million
from the HCPI Transactions after paying approximately $5.2 million of
transaction costs associated with those transactions and the Exchange Offer.
However, the success of the Exchange Offer and the Company's ability to satisfy
HCPI's other conditions and close the HCPI Transactions are subject to a number
of uncertainties and depend upon a number of factors, many of which are beyond
the Company's control. Accordingly, there can be no assurance that the Company
can successfully complete the Exchange Offer as required by HCPI or satisfy the
other conditions required by HCPI and consummate the HCPI Loan or obtain the
HCPI Equity Investment.
The Company will use the net proceeds of the HCPI Transactions, together with
cash on hand, to repay first the principal amount of and accrued interest on the
Series A Notes when they mature on September 30, 2002 and then the principal
amount of and interest on the remaining Debentures when they mature on October
1, 2002. If the holders of the Debentures do not validly tender at least 75% of
the aggregate principal amount of the Debentures on the terms currently
contemplated and the Company does not consummate the HCPI Transactions, the
Company will be forced to seek other financing alternatives. At the present
time, the Company does not have any alternative sources of financing that would
provide it with sufficient funds to repay the Series A Notes and the Debentures
at maturity. As a result of the Company's current financial condition and the
fact that substantially all of the Company's properties are fully encumbered by
mortgage or lease financings, the Company does not believe it would be able to
obtain such alternative financing prior to the maturity of the Series A Notes
and the Debentures. The Company also does not believe that it would be able to
sell its properties in the time or at values necessary to raise sufficient cash
to satisfy the Series A Notes and the Debentures at maturity. In addition, a
sale of the Company's assets could have adverse tax consequences to the Company.
If the Company is unable to consummate the HCPI Transactions by September 30,
2002 and repay the principal of and interest on the Series A Notes, the Company
will be in default under approximately $137.3 million of mortgage indebtedness
and under the indenture governing the Series A Notes. In addition, because of
cross-default and cross-collateralization provisions in many of the Company's
other debt instruments and leases, those defaults are likely to result in a
default and acceleration of substantially all of the Company's other debt and
lease obligations, including the Series B Notes and the Debentures. As of June
30, 2002, the Company had approximately $381.8 million of senior secured debt
and capital lease obligations, $132.9 million of Debentures and approximately
$50.3 million of annual lease obligations. In addition, as of June 30, 2002, the
Company had guaranteed $93.1 million of third-party senior debt in connection
with a community that the Company manages, the Company's joint ventures and
certain of the Company's lease financings. As a result, a default under the
indentures governing the Series A Notes, the Series B Notes and the Debentures
and the Company's other debt and lease obligations would have a material adverse
effect upon the Company and could make it necessary for the Company to seek
protection from its creditors under federal bankruptcy laws.
10
In the event that the Company successfully consummates the Exchange Offer and
the HCPI Transactions, it will remain highly leveraged with a substantial amount
of debt and lease obligations, and will have increased interest and lease
expenses. The Company, however, expects that its cash flow from operations will
improve, and, accordingly, expects that its current cash and cash equivalents,
expected cash flow from operations, and the proceeds from successful completion
of the refinancing plan will be sufficient to fund its operating requirements,
its capital expenditure requirements, its periodic debt service requirements and
its lease obligations during the next twelve months.
3. EARNINGS PER SHARE
Basic loss per share for the three and six months ended June 30, 2002 has been
computed on the basis of the weighted average number of shares outstanding.
During the three months ended June 30, 2002, there were 3,000 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
six months ended June 30, 2002, and therefore were not included in the
computation of diluted earnings per share. Note that for the six months ended
June 30, 2002, there were no options to purchase shares of common stock
outstanding which had an exercise price below the average market price of the
common shares.
The 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 also not included in the computation of
diluted earnings per share because the options' exercise price was greater than
the average market price of the common shares for the respective periods and,
therefore, the effect would be anti-dilutive.
Three Months Six Months
Ended June 30, Ended June 30,
-------------- -------------- -------------- -------------
2002 2001 2002 2001
-------------- -------------- -------------- -------------
Average number of options (in thousands) 2,108 829 2,124 809
Weighted-average exercise price $ 4.83 $ 7.86 $ 4.83 $ 8.11
4. LONG TERM DEBT AND OTHER FINANCING TRANSACTIONS
On January 1, 2002, the Company completed a sale lease-back of a retirement
center in North Carolina for $45.0 million. The lessor assumed $34.8 million of
debt associated with the property, resulting in an assumption penalty of
$348,000, coupled with $50,000 of unamortized financing costs, which the Company
has recorded as an extraordinary loss. The lease agreement has an initial term
of 15 years with two five-year renewal options and a right of first refusal to
repurchase the community. The Company recorded a gain of $11.7 million on the
sale, which is being amortized over the term of the lease. In conjunction with
this sale, on January 1, 2002, the Company acquired a Free-standing assisted
living community ("Free-standing AL") in Florida for $7.1 million, which it had
previously managed for the buyer of the North Carolina community. The Company
funded this acquisition by assuming a $4.7 million mortgage note bearing
interest at a floating rate of 5.63% at March 31, 2002. Interest is due monthly
with remaining principal and unpaid interest due December 31, 2002. The note is
secured by certain land, buildings, and equipment.
On January 25, 2002, the Company amended two loan agreements with aggregate
outstanding indebtedness of $7.2 million. The amendment extends the due dates of
the agreements to December 31, 2002, requires additional monthly principal
payments of $60,000, and a $1.0 million cash collateral deposit. In connection
with the amendment, the Company agreed to, among other things, (1) retire or
refinance approximately $92.3 million of
11
indebtedness on or before July 1, 2002, so as to mature no earlier than December
1, 2003 and (2) retire or refinance the $132.9 million outstanding principal
amount of its Debentures on or before September 1, 2002 so as to mature no
earlier than October 1, 2004. Failure to accomplish the retirement or
refinancing of this debt could result in the acceleration of the outstanding
indebtedness. On July 11, 2002, this debt was paid off in conjunction with the
sale leasebacks of the respective properties. See notes 2 and 10.
On February 12, 2002, the Company sold a Free-standing AL in Florida for $9.7
million. The Company contemporaneously leased the property back from the buyer
under a 15-year lease agreement with two five-year renewal options and a right
of first refusal to repurchase the community. The Company used a portion of the
sale proceeds to repay $8.6 million of debt associated with the property. The
sale agreement contains certain formula-based earnout provisions which may
provide additional sales proceeds to the Company based on future performance. As
a result of the contingent earn-out provisions, for financial reporting
purposes, this transaction was recorded as a financing transaction and the
Company recorded $9.7 million of lease obligation as debt, bearing interest of
7.55%. The Company recorded a $1.4 million loss as a result of this transaction.
For financial reporting purposes, these losses are considered residual value
guarantee amounts under the previous leases terminated in connection with the
sale lease-back transaction and have been fully recognized as lease expense.
On February 12, 2002, the Company sold for $18.5 million a retirement center in
Illinois. The Company used a majority of the sale proceeds to repay $12.9
million of debt associated with the property. The Company contemporaneously
leased the property back from the buyer under a 15-year lease agreement with two
five-year renewal options, and has the right of first refusal to repurchase the
community. The Company recorded a gain of $5.3 million on the sale, which is
being amortized on a straight-line basis over the term of the lease.
On March 22, 2002, the Company sold a Free-standing AL in Colorado, for $17.9
million. The Company contemporaneously leased the property back from the buyer
under a 15-year lease agreement with two five-year renewal options and a right
of first refusal to repurchase the community. The Company used a portion of the
sale proceeds to repay $16.3 million of debt associated with the property,
resulting in the Company expensing $259,000 of unamortized financing cost as an
extraordinary item. The sale agreement contains certain formula-based earnout
provisions which may provide additional sales proceeds to the Company based on
future performance. As a result of the contingent earn-out provisions, for
financial reporting purposes, this transaction was recorded as a financing
transaction and the Company recorded $17.9 million of lease obligation as debt,
bearing interest of 7.46%. The Company recorded a $5.8 million loss as a result
of this transaction. For financial reporting purposes, these losses are
considered residual value guarantee amounts under the previous leases terminated
in connection with the sale lease-back transaction and have been fully
recognized as lease expense.
On March 28, 2002, the Company sold two retirement centers and three
Free-standing ALs for $73.2 million. The Company used a portion of the proceeds
to repay $55.2 million of debt, resulting in the Company expensing $99,000 of
unamortized financing cost as an extraordinary item. The Company
contemporaneously leased the properties back from the buyer under a 15-year
lease agreement with two ten-year renewal options. The sale agreements for the
three Free-standing ALs contain certain formula-based earnout provisions which
may provide additional sales proceeds to the Company based on future
performance. As a result of the contingent earn-out provisions, for financial
reporting purposes, the Free-standing AL transactions were recorded as financing
transactions and the Company recorded $18.2 million of lease obligation as debt,
bearing interest of 9.37%. The Company recorded a $17.8 million loss as a result
of the sale of these three AL's. For financial reporting purposes, these losses
are considered residual value guarantee amounts under the previous leases
terminated in connection with the sale lease-back transaction and have been
fully recognized as lease expense. One of the retirement center leases is
recorded as a capital lease and the Company recorded $25.0 million of lease
obligation as debt, bearing interest of 8.27%. The other retirement center lease
is being accounted for as an operating lease, since the sale agreement for this
community did not contain a contingent earnout provision or other continuing
involvement provisions. The Company recorded a gain of $697,000 on the sale of
this retirement center, which is being amortized on a straight-line basis over
the term of the lease. The Company has an option to acquire the retirement
center that has been accounted for as a capital lease after March 28, 2006,
subject to certain conditions.
12
On May 31, 2002, the Company replaced two mortgage notes maturing December 31,
2002 totaling $82.7 million with a $95.7 million mortgage note with the same
lender which matures May 31, 2005. The Company applied the provisions of EITF
96-19, "Debtor's Accounting for a Modification or Exchange of Debt Instruments"
in determining the treatment of costs incurred related to the exchange of debt
instruments. As such, the commitment fee of $957,000 which, along with $128,000
of unamortized financing costs on the previous notes, will be amortized as a
yield adjustment over the term of the new mortgage note, while $972,000 of legal
and investment advisor fees are recorded in general and administrative expense.
The new mortgage debt has a fixed and variable interest component, principal and
interest is due monthly, based on a 25-year amortization, and remaining
principal and unpaid interest is due May 31, 2005, with two one-year renewal
options. The fixed rate component converts to a variable rate on January 1,
2003. The Company purchased an interest rate cap agreement for $789,000, which
limits the Company's variable interest expense if 30-day LIBOR exceeds 5.8% over
the term of the mortgage. The Company has designated the cap as a cashflow
hedge. As such, any changes in the fair value of the cap while 30-day LIBOR does
not exceed 5.8% is recognized as interest expense during the current period. The
fair value of the cap was $584,000 at June 30, 2002. In connection with the
debt, in the event that on or before September 30, 2002, either the Debentures
have not been retired or the Company has not provided to the Lender evidence
that the Company holds an amount of unrestricted cash sufficient to retire the
Debentures, the Company would be in default and the lender could exercise its
contractual remedies, including the acceleration of the loan. The note is
secured by certain land, buildings, and equipment and contains cross-default
provisions.
As a result of completed and anticipated transactions under the Refinancing
Plan, the Company has recorded losses from sale lease-back transactions of $7.9
million during the quarter ended December 31, 2001, $23.2 million during the
quarter ended March 31, 2002, and $7.0 million during the quarter ended June 30,
2002, bringing the total loss on these sale lease-back transactions to $38.1
million. For financial reporting purposes, these losses are considered residual
value guarantee amounts under the previous leases terminated in connection with
the sale lease-back transactions and have been fully recognized as lease
expense. The Company does not expect to incur any additional residual value
guarantee amounts.
In addition, due to the shorter than expected remaining life of the previous
leases terminated in connection with the sale lease-back transactions, the
Company accelerated the amortization of leasehold acquisition costs beginning in
the fourth quarter of 2001. As a result of this acceleration, the Company
recorded additional amortization costs of $472,000 during the quarter ended
December 31, 2001, $6.5 million during the quarter ended March 31, 2002, and
$2.3 million during the quarter ended June 30, 2002, bringing the total amount
of accelerated amortization related to these sale lease-back transactions to
$9.3 million.
Effective as of June 30, 2002, the Company obtained waivers under various
financing and lease agreements with respect to certain of its financial
covenants. In connection with a $95.7 million mortgage note, in the event that
on or before September 30, 2002, either the Debentures have not been retired or
the Company has not provided to the Lender evidence that the Company holds an
amount of unrestricted cash sufficient to retire the Debentures, the Company
would be in default and the lender could exercise its contractual remedies,
including the acceleration of the loan. See note 2.
The Company announced, during the quarter ended March 31, 2000, that its Board
of Directors had authorized the repurchase, from time to time, of up to $30.0
million of its Debentures. During the six months ended June 30, 2001, the
Company purchased $3.3 million of the Debentures, resulting in an extraordinary
gain on extinguishment of debt, net of tax, of $395,000. The Company has
initiated the Exchange Offer with respect to the Debentures, and no longer
expects to purchase any of the Debentures on the open market.
5. ASSET IMPAIRMENTS AND CONTRACTUAL LOSSES
During the quarter ended December 31, 1999, the Company abandoned five
development projects. The Company has sold three of the five land parcels
associated with the abandoned projects, and intends to continue marketing the
remaining two land parcels during the remainder of 2002. The remaining two land
parcels are classified as held for
13
sale and are included in other assets. The net carrying amount of these assets
was $2.7 million at June 30, 2002. The Company will continue to evaluate the
land parcels for impairment.
6. ACQUISITION AND OTHER TRANSACTIONS
On January 1, 2002, the Company acquired a Free-standing AL community in Florida
for $7.1 million. The Company funded this acquisition by assuming a $4.7 million
mortgage note. The community has 83 units, of which 57 are assisted living and
26 are memory enhanced. See note 4.
The Company previously managed a senior living community in Arizona under a
long-term management agreement with a third party owner. The owner of the
community agreed to terminate the existing management agreement and to enter
into a long-term lease with the Company upon the Arizona Department of
Insurance's (DOI) approval of the Company as the "provider" (as defined by the
applicable Arizona statutes) at the Community. On April 1, 2002, the Department
approved the application of the Company as the provider at the Community and the
Company contemporaneously terminated the management agreement and leased the
property from the owner for an initial term of approximately 16 years (the
remainder of the original management agreement), with two 10-year renewal
options. In addition to the payments for the lease of the facility, the Company
is responsible for making payments under the existing ground lease as well as
debt service payments on the $10.6 million mortgage debt associated with the
community which the Company guarantees. As a result of this lease transaction,
the Company and the community are in compliance with all requirements under
Arizona DOI regulations effectively remedying the owner's previous
non-compliance. As a result of this operating lease, consolidated community
operating results will increase and management service fees will decrease.
Upon the execution of the lease agreement, the Company acquired the working
capital assets, assumed the working capital liabilities and assumed
approximately $27.0 million of resident contract liabilities. The Company
received a $18.3 million, 6% note receivable from the lessor as compensation for
the assumption of the resident contract liabilities, the value of which
approximates the tax basis of the resident contract liabilities. Monthly
payments of $104,000 are required under the terms of the note receivable. At the
termination of the lease agreement, the resident liabilities revert to the
lessor. Any excess of the tax basis of the resident liabilities above the note
receivable balance at the termination of the lease will be repaid by the Company
through the issuance of a note payable bearing interest at 6%.
7. SEGMENT INFORMATION
The Company has significant operations principally in two industry segments: (1)
retirement centers and (2) Free-standing ALs. Retirement centers represent 31 of
the Company's senior living communities and provide a continuum of care services
such as independent living, assisted living and skilled nursing care. The
Company currently operates 34 Free-standing ALs. Free-standing ALs are generally
comprised of stand-alone assisted living communities that are not located on a
retirement center campus, some 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 in part based upon EBITDAR, which is
defined as earnings before net interest expense, income tax expense (benefit),
depreciation, amortization, rent, and other special charges related to asset
impairment and other losses, equity in loss of special purpose entities, 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 six months ended June 30, 2002 and 2001 (in thousands).(1)(2)(3)
14
THREE MONTHS ENDED
JUNE 30, JUNE 30, $ %
2002 2001 CHANGE CHANGE
---- ---- ------- ------
Revenues:
Retirement centers $ 61,877 $ 53,511 $ 8,366 15.6%
Free-standing ALs 18,910 8,894 10,016 112.6%
Corporate/other 1,856 2,693 (837) (31.1%)
----------------------------------------------------
Total $ 82,643 $ 65,098 $ 17,545 27.0%
====================================================
NOI / Community EBITDAR:
Retirement centers $ 20,473 $ 18,956 $ 1,517 8.0%
Free-standing ALs 1,665 (162) 1,827 1127.8%
Corporate/other (6,295) (5,796) (499) (8.6%)
----------------------------------------------------
Net operating income 21.9%
15,843 12,998 2,845
Lease expense (4) 18,098 6,700 11,398 170.1%
Depreciation and amortization(5) 8,504 5,195 3,309 63.7%
----------------------------------------------------
Operating (loss)
income $ (10,759) $ 1,103 $ (11,862) (1075.4%)
====================================================
SIX MONTHS ENDED
JUNE 30, JUNE 30, $ %
2002 2001 CHANGE CHANGE
---- ---- ------- ------
Revenues:
Retirement centers $ 119,493 $ 105,749 $ 13,744 13.0%
Free-standing ALs 36,547 16,328 20,219 123.8%
Corporate/other 3,372 5,074 (1,702) (33.5%)
----------------------------------------------------
Total $ 159,412 $ 127,151 $ 32,261 25.4%
====================================================
NOI / Community EBITDAR:
Retirement centers $ 41,184 $ 38,327 $ 2,857 7.5%
Free-standing ALs 2,614 (962) 3,576 371.7%
Corporate/other (12,534) (10,769) (1,765) (16.4%)
----------------------------------------------------
Net operating income 31,264 26,596 4,668 17.6%
Lease expense (4) 51,063 13,451 37,612 279.6%
Depreciation and amortization(5) 20,648 10,287 10,361 100.7%
----------------------------------------------------
Operating (loss)
income $ (40,447) $ 2,858 $ (43,305) (1515.2%)
====================================================
TOTAL ASSETS
JUNE 30, DECEMBER 31, $ %
2002 2001 CHANGE CHANGE
---- ---- ------- ------
Total Assets:
Retirement centers $ 470,231 $ 509,732 $ (39,501) (7.8%)
Free-standing ALs 221,643 241,069 (19,426) (8.1%)
Corporate/other 99,553 99,390 163 0.0%
----------------------------------------------------
Total $ 791,427 $ 850,191 $ (58,764) (6.9%)
====================================================
(1) Segment data does not include any inter-segment transactions or
allocated costs.
(2) 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 impairments and other losses, equity in loss of communities that
are managed by the Company and owned by special purpose entities, other
income (expense), minority interest, and extraordinary items. While NOI
and EBITDAR are not GAAP measurements, the Company believes they are
relevant in analyzing its operating results.
(3) Corporate/other revenues represent the Company's development and
management fee revenues. Corporate/Other NOI includes operating
expenses related to corporate operations, including human resources,
financial services, and information systems, as well as senior living
network and assisted living management costs.
(4) Includes $7.0 million and $30.2 million of additional lease expense for
the three and six months ended June 30, 2002 as a result of sale
lease-back transactions. See note 4 to the condensed consolidated
financial statements.
15
(5) Includes $2.3 million and $ 8.8 million of additional amortization
expense for the three and six months ended June 30, 2002 as a result of
sale lease-back transactions. See note 4 to the condensed consolidated
financial statements.
8. COMMITMENTS AND CONTINGENCIES
The Company is subject to various legal proceedings and claims that 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. The
Company maintains commercial insurance on a claims-made basis for medical
malpractice and professional liabilities.
Insurance
The Company has operated under a workers' compensation self-insurance program
with excess loss coverage provided by third party carriers since July 1995.
During July 2002, the Company renewed its self-insurance for workers'
compensation claims with excess loss coverage of $350,000 per individual claim
and approximately $7.25 million in the aggregate. The Company currently provides
letters of credit in the aggregate amount of $3.5 million related to this
program. The letters of credit are collateralized by cash. The Company utilizes
a third party administrator to process and pay filed claims. The Company has
accrued amounts to cover open claims not yet settled and incurred but not
reported claims as of June 30, 2002, which management believes are adequate.
The delivery of personal and health care services entails an inherent risk of
liability. In recent years, participants in the senior living and health care
services industry have become subject to an increasing number of lawsuits
alleging negligence or related legal theories, many of which involve large
claims and result in the incurrence of significant defense costs and significant
exposure. The Company currently maintains property, liability, and professional
medical malpractice insurance policies for the Company's owned, leased and
certain of its managed communities under a master insurance program. The number
of insurance companies willing to provide general and professional liability
insurance for the nursing and assisted living industry has declined dramatically
and the premiums and deductibles associated with such insurance have risen
substantially in recent years.
The Company's previous liability policies expired on July 1, 2001, and the
Company was able to obtain an extended policy through December 2001 only by
paying significantly higher premiums and agreeing to higher deductibles (ranging
from $200,000 to $3,000,000). As a result, in the third quarter of 2001, the
Company began incurring significantly higher costs for premiums and accruals for
potential liability claims. As part of this renewal process, four incidents were
excluded from policy coverage. To date, the Company believes one of these
incidents may result in liability exposure to the Company, and the Company has
established an accrual for this claim as of June 30, 2002. The Company renewed
this liability policy effective January 1, 2002, expiring December 31, 2002,
paying increased premiums and continuing the foregoing deductible program. The
Company also has underlying and umbrella excess liability protection policies in
the amount of up to $25.0 million in the aggregate.
On January 1, 2002, the Company became self-insured for employee medical
coverage. The Company maintains stop loss insurance coverage of $150,000 per
employee and approximately $17.7 million for aggregate claims. Estimated costs
related to these self-insurance programs are accrued based on known claims and
projected settlements of unasserted claims incurred but not yet reported to the
Company. Subsequent changes in actual experience (including claim costs, claim
frequency, and other factors) could result in additional costs to the Company.
Leases
As of June 30, 2002, the Company operated 38 of its senior living communities
under long-term leases. Of the 38 communities, 11 are operated under a master
lease agreement, with the remaining communities leased under individual
agreements. The Company also leases its corporate offices and is obligated under
a ground lease for a senior living community purchased during 2001. The
remaining base lease terms vary from five to 22 years. Certain of the leases
provide for renewal and purchase options.
16
Synthetic Leases
At June 30, 2002, the Company operated nine of its leased senior living
communities under leases which are treated as operating leases for financial
reporting purposes and financing leases for income tax purposes (synthetic
leases). As of June 30, 2002, the Company had approximately $80.6 million of
assets related to the nine communities being operated under synthetic leases
(including $31.1 million of notes receivable, $37.4 million of security deposits
and $7.4 million of land). At June 30, 2002, the Company was a guarantor on
$54.0 million of the $57.6 million of third party lessor debt and had $31.1
million of notes receivable from the lessors. These leases provide the Company
with termination rights whereby the Company can terminate the leases and acquire
the property at predetermined amounts in exchange for assuming the lessors'
debt, forgiving the notes receivable from the lessor, and repaying the lessors'
equity. The Company may also elect to terminate the leases and remarket the
properties on behalf of the lessors. If the net sales proceeds from a leased
property are an amount higher than the lessors' costs, such excess is paid to
the Company. If the net sales proceeds are less than the lessors' costs, the
Company is obligated, under residual value guarantees, to pay to the lessors any
shortfall, not to exceed approximately 85% of the lessors' original cost of the
properties. At June 30, 2002, the Company's residual value guarantees under
these nine leases aggregated $162.8 million. These residual value guaranties
represent an off-balance sheet contingent liability, for which the Company does
not believe it has any significant exposure for additional cash costs. In order
to simplify its financial structure, and as a condition of certain elements of
its Refinancing Plan, the Company will terminate these nine leases during the
third quarter of 2002. Upon the termination of these leases, the Company will
become the owner of each community for financial reporting purposes. See notes 4
and 10.
Other
A portion of the Company's skilled nursing revenues are attributable to
reimbursements under Medicare. Certain temporary rate add-ons for the Company's
skilled nursing reimbursement rates under the Prospective Payment System are set
to expire as of October 1, 2002, unless extended by Congress. It is uncertain at
this time, whether any extension of these add-ons or some portion of the add-on
reimbursement rates will be approved. Failure to extend the current rate for
add-on services or a reduction in the current rates would negatively impact
future revenues of the Company.
9. NEW ACCOUNTING PRONOUNCEMENTS
On July 30, 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards Statement No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities" (SFAS No. 146). The standard
replaces EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)" and requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. SFAS 146 is
effective prospectively to exit or disposal activities initiated after December
31, 2002.
In November 2001, the Emerging Issues Task Force reached a consensus on Issue
01-14, "Income Statement Characterization of Reimbursements Received for 'Out-of
Pocket' Expenses Incurred" ("EITF 01-14"), which became effective on January 1,
2002. Under EITF 01-14, certain reimbursements received for out-of-pocket
expenses incurred as part of its management agreements should be characterized
as revenue and the associated costs be included as operating expenses in the
income statement. Upon adoption of EITF 01-14, comparative financial statements
for prior periods should be reclassified to comply with the current
presentation. The Company typically incurs various expenses which may include
payroll, insurance and benefit related cost and other management related costs
in association with its managed communities. Such costs are billed to and
reimbursed by the owners of the respective communities. The Company implemented
EITF 01-14 beginning with the quarter ended June 30, 2002 and as required, has
also reclassified comparative financial information for the three and six months
ended June 30, 2002. The implementation of EITF 01-14 resulted only in the equal
gross up of revenues and expenses and did not have any impact on net earnings in
any reported period. The effect of the reclassifications made by the Company
pursuant to EITF No. 01-14 was to increase total revenues and total operating
expenses by $1.2 million and $1.7 million and $2.7 million and $3.4 million for
the three and six months ended June 30, 2002 and 2001, respectively.
17
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 141 addresses financial accounting and reporting for business
combinations requiring the use of the purchase method of accounting and
reporting for goodwill and other intangible assets requiring 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 SFAS No. 142. SFAS No. 142 requires intangible assets with
definite useful lives be amortized over their respective useful life to their
estimated residual values, and reviewed for impairment. As of June 30, 2002, the
Company had $36.5 million of goodwill. Amortization expense related to goodwill
was approximately $500,000 for the six months ended June 30, 2001, or $0.03 per
dilutive share. The Company adopted SFAS No. 142 on January 1, 2002.
Accordingly, effective January 1, 2002, the Company no longer amortizes
goodwill. Goodwill amortization expense for the three and six months ended June
30, 2001 was $250,000 and $500,000, respectively. Goodwill amortization expense
was $0, $486,000 and $1.0 million for the years ended 1997, 1998, and 1999
through 2001, respectively. Basic and diluted earnings per share, excluding the
impact of prior periods' goodwill amortization expense, are as follows:
Three Six
Year Ended December 31, ----- ----
----------------------------------------- Months Ended
1997 1998 1999 2000 2001 June 30, 2001
---- ---- ---- ---- ---- -------------
Basic earnings (loss) per share from
continuing operations before
extraordinary item and cumulative
effect of change accounting
principle $0.71 $0.18 $ (0.28) $(1.97) $(0.22) $(0.39)
Basic EPS $0.53 $0.18 $(0.28) $(1.97) $(0.26) $(0.40)
Pro forma basic earnings
per share before extraordinary
item available for distribution
to partners and shareholders $0.36
Basic earnings (loss) per share from
continuing operations before
extraordinary item and cumulative
effect of change in accounting
principle $0.70 $0.18 $(0.28) $(1.97) $(0.22) $(0.39)
Diluted EPS $0.53 $0.18 $(0.28) $(1.97) $(0.26) $(0.40)
Pro forma diluted earnings
per share before extraordinary
item available for distribution
to partners and shareholders $0.35
With the adoption of SFAS No. 142, the Company has reassessed the useful lives
and residual values of all intangible assets acquired in purchase business
combinations, and has determined that no amortization period adjustments are
required. As of June 30, 2002, the Company has not identified any intangible
assets with indefinite useful lives, other than goodwill.
The transitional provisions of SFAS No. 142 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
18
adoption. For purposes of allocating and evaluating goodwill and intangible
assets, the Company considers retirement centers and Free-standing AL's as its
reporting units. All recorded goodwill as of the date of adoption was
attributable to the retirement centers reporting unit. The Company has up to six
months from the date of 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. The Company has completed
step one and believes that its goodwill is not impaired.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which supersedes both SFAS No. 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 No. 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 APB Opinion No. 30). SFAS No. 144 retains the fundamental provisions in SFAS
No. 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 SFAS No. 121. For
example, SFAS No. 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. SFAS No. 144
retains the basic provisions of APB Opinion No. 30 on how to present
discontinued operations in the income statement but broadens that presentation
to include a component of an entity (rather than a segment of a business).
Unlike SFAS No. 121, an impairment assessment under SFAS No. 144 will never
result in a write-down of goodwill. Rather, goodwill is evaluated for impairment
under SFAS No. 142.
The Company adopted SFAS No. 144 on January 1, 2002. The adoption had no
material impact on the Company's current year financial statements because the
impairment assessment under SFAS No. 144 is largely unchanged from SFAS No. 121.
10. SUBSEQUENT EVENTS
On July 1, 2002 the Company replaced $18.8 million of mortgage debt due August
31, 2002 with a $18.5 million mortgage note bearing interest at the greater of
7.25% or 4% above one-month LIBOR. Principal and interest are due monthly with
remaining principal and unpaid interest due July 1, 2007. The Company purchased
an interest rate cap agreement for $106,000, which would limit the Company's
interest expense if one-month LIBOR should exceed 6.5% during the term of the
mortgage. The Company used the proceeds from the replacement mortgage note to
repay the remaining $18.5 million balance outstanding under the Company's $95
million revolving credit facility and in the process, terminated a synthetic
lease and became the owner of the previously leased assets including $12.8
million of property and equipment. The $18.8 million note is secured by certain
land, buildings, and equipment affiliated with a community in Arizona. The
community has 344 units, of which 217 are independent living, 70 are assisted
living, 15 are memory enhanced and 42 are skilled nursing.
On July 11, 2002 the Company terminated synthetic leases on two communities in
South Carolina and Arizona and the Company became the owner of each community.
The termination of the synthetic leases facilitated the Company simultaneously
selling and leasing-back these communities and certain others on the same date
(see below). The Company did not incur any cash costs in connection with the
termination of the synthetic leases other than transaction costs.
On July 11, 2002 the Company sold for $56.5 million three retirement centers in
Arizona, Colorado, and Texas and two Free-standing ALs in South Carolina and
Florida. The Company used a portion of the sale proceeds to repay debt
associated with the properties. The Company contemporaneously leased these
properties back from the buyer. The leases are classified as operating leases,
with the exception that one of the retirement center leases is recorded as a
capital lease and the Company recorded $30.1 million of lease obligation as debt
in connection with the retirement center lease. Note that this lease agreement
additionally includes other communities previously leased by the Company to the
lessor.
19
On July 11, 2002 the Company modified the February 7, 2002 master lease
agreement which included 11 communities, one Retirement Center and ten
Free-standing ALs, into two new master lease agreements (Pool I and Pool II).
The Pool I lease agreement includes one Retirement Center and six Free-standing
ALs from the original lease, as well as two additional Retirement Centers from
the July 11, 2002 sale. The Pool II lease agreement includes four Free-standing
ALs from the original lease, as well as one Retirement Centers and two
Free-standing ALs from the July 11, 2002 sale leaseback transaction. Pool I is a
12-year lease with four ten-year renewal options and the Company has the right
of first refusal to repurchase the communities. Pool II is a 10-year lease with
four ten-year renewal options and the Company has the right of first refusal to
repurchase the communities. These master leases will be treated as operating
leases for financial reporting purposes.
On July 18, 2002, the Company refinanced $25.7 million of mortgage debt on three
communities and two land parcels. Under the terms of the new mortgage debt
agreements, previous maturities ranging from 2002 to 2006 were amended to 2004
and certain financial covenants were eliminated or amended. Measurement of the
modified covenants begins on September 30, 2002.
On July 26, 2002, the Company terminated synthetic leases on three Free-standing
AL's in Texas and the Company became the owner of each community. The Company
did not incur any cash costs in connection with the termination of the synthetic
leases other than transaction costs. Simultaneously, the Company extended and
modified an existing $11.0 million mortgage note and refinanced $33.7 million of
mortgage debt on the three communities which the Company previously leased under
synthetic leases and for which the Company was guarantor. The original
maturities were extended to 2004, and certain existing financial covenants were
amended, the measurement of which begins on September 30, 2002. Interest on the
notes increased from 6.75% to 7.25%. In connection with the extended and
modified notes, in the event that the Company does not repay the Debentures on
or before October 1, 2002, or extend such Debentures to a date no earlier than
2004, the Company would be in default and the Lender could exercise its
contractual remedies, including all amounts due being payable on demand.
On August 2, 2002, the Company determined that assets acquired in 2001 as part
of a like-kind exchange, specifically land in Virginia and land and buildings
associated with the equity interests in a single member limited liability
company that the Company acquired during 2001, would be placed for sale. The
value of the land and buildings, net of accumulated depreciation, as of June 30,
2002, is $29.2 million. As of June 30, 2002, the Company had a $12.0 million
non-recourse mortgage loan bearing interest at 7.43% with principal due monthly,
and a maturity date of January 2024 and a $15.1 million non-recourse mortgage
loan, with interest at 8.41% and principal and interest due monthly, and a
maturity date of September 2005, respectively, related to these assets. The
Company acquired the various land parcels subject to lease agreements that
provide annual rental payments of $980,000 through February 23, 2023 and $1.3
million through March 7, 2022, respectively. The Company has no reason to
believe the sale prices for these assets will be below the net book value,
however, the Company will continue to evaluate the land parcels and buildings
for impairment.
On August 14, 2002, as part of the Refinancing Plan, the Company initiated an
Exchange Offer seeking to exchange up to $126.0 million of the Debentures. On
August 14, 2002, the Company also entered into the HCPI Loan Agreement pursuant
to which HCPI has agreed to make the HCPI Loan to one of the Company's
subsidiaries in the amount of $112.8 million. The Company also contemporaneously
entered into the HCPI Investment Agreement under which HCPI has agreed to make
the $12.2 million HCPI Equity Investment in certain other subsidiaries of the
Company. See note 2.
20
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 June 30, 2002, the Company operated 65 senior living communities,
consisting of 31 large continuing care retirement communities and independent
living communities ("Retirement Centers") and 34 Free-standing ALs in 14 states
with an aggregate capacity for approximately 11,200 and 3,200 residents,
respectively. The Company owns 21 communities, leases 38 communities pursuant to
long-term leases, and manages six communities pursuant to management agreements.
Of its Retirement Centers, the Company owns 12, leases 13, and manages six. Of
its Free-standing ALs, the Company owns nine and leases 25. During the three
months ended June 30, 2002 and 2001, the Company's Retirement Centers and
Free-standing ALs generated 76.6% and 23.4%, and 85.8% and 14.2%, respectively,
of resident and healthcare revenues. During the six months ended June 30, 2002
and 2001, the Company's Retirement Centers and Free-standing ALs generated 76.6%
and 23.4%, and 86.6% and 13.4%, respectively, of resident and healthcare
revenues.
The Company's long-term strategy is to develop and operate multiple communities
within a major metropolitan region in order to create a Senior Living Network
that provides a continuum of housing and care for seniors. 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.
CRITICAL ACCOUNTING POLICIES
Certain critical accounting policies are complex and involve significant
judgments by management, including the use of estimates and assumptions, which
affect the reported amounts of assets, liabilities, revenues and expenses. As a
result, changes in these estimates and assumptions could significantly affect
the Company's financial position or results of operations. The Company bases its
estimates on historical experience and on various other assumptions that it
believes to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities.
Actual results may differ from these estimates under different assumptions or
conditions. The significant accounting policies used in the preparation of the
Company's financial statements are more fully described in the Company's Annual
Report on Form 10-K for the year ended December 31, 2001 and the Company's
consolidated financial statements and the notes thereto.
SYNTHETIC LEASE COMMUNITIES
As of December 31, 2001, the Company operated 14 of its communities (two
Retirement Centers and 12 Free-standing ALs) under an operating lease structure
commonly referred to as a synthetic lease. During the fourth quarter of 2001,
the Company determined that in order to simplify its financial structure, and as
a condition of certain elements of its Refinancing Plan, it would terminate all
synthetic leases during 2002. Upon the termination of these synthetic leases,
the Company will become the owner of each community for financial reporting
purposes. The Company will not incur any cash costs in connection with the
termination of the synthetic leases other than transaction costs. As of June 30,
2002,
21
the Company had completed the termination of five of these 14 synthetic leases.
The Company operated nine of its communities (two Retirement Centers and seven
Free-standing ALs) under synthetic leases and subsequently completed the
termination of six additional synthetic leases. The Company expects to terminate
the three remaining synthetic leases during the third quarter of 2002. Upon
completion of these three transactions, the Company will not have any remaining
synthetic leases.
The Company has substantial investments in these synthetic lease communities in
the form of land, security deposits (certificates of deposit and treasury bills)
and loans to the lessors (notes receivable). The Company has pledged security
deposits to the lessors to secure its obligations under the synthetic lease
agreements. As of June 30, 2002, the Company had approximately $80.6 million of
assets related to the nine communities being operated under synthetic leases
(including $31.1 million of notes receivable, $37.4 million of security deposits
and $7.4 million of land). The Company owns the land under seven of these
synthetic lease communities, and leases such land to the lessors under long-term
operating leases.
As of June 30, 2002, of the third party mortgage debt secured by the synthetic
lease assets, the Company is the borrower of approximately $5.6 million of
mortgage loans, which is debt recorded on the Company's condensed consolidated
balance sheets. As of June 30, 2002, the Company is the guarantor of
approximately $54.0 million of third party mortgage debt associated with these
synthetic leases which were made directly to the lessors and therefore are not
recorded on the Company's condensed consolidated balance sheet. This
nonconsolidated debt is secured by the synthetic lease assets, and is
cross-defaulted with a portion of the Company's consolidated debt.
SALE LEASE-BACK TRANSACTIONS
The table below summarizes the sale lease-back transactions that the Company
completed during the six months ended June 30, 2002 into two categories. The
first six communities presented are accounted for as capital leases as a result
of contingent earnout agreements or conditional purchase options. The remaining
three communities presented are accounted for as operating leases.
INCREASE IN REDUCTION NEW CAPITAL
LAND, BUILDINGS IN NOTES LEASE TRANSACTION
2002 COMMUNITY PROCEEDS AND EQUIPMENT RECEIVABLE OBLIGATION(2) LOSSES(3)
--------------- ------------------------------- ---- ---------- ---------------- ------------ ------------ ------------
(in thousands)
February 12 Free-standing AL in Florida (1) $ 9,687 9,687 (8,559) (9,687) 1,381
March 22 Free-standing AL in Colorado (1) 17,865 17,865 (20,012) (17,865) 5,817
March 28 Three (3) Free-standing ALs (1) 18,200 18,200 (29,537) (18,200) 17,786
March 28 Retirement Center in Texas 25,000 25,000 - (25,000) -
---------- ---------------- ------------ ------------ ------------
$70,752 70,752 (58,108) (70,752) 24,984
========== ================ ============ ============ ============
REDUCTION IN DEFERRED
LAND, BUILDINGS REDUCTION TRANSACTION
2002 COMMUNITY PROCEEDS AND EQUIPMENT IN DEBT GAINS
--------------- ------------------------------- ---- ---------- ---------------- ------------ ------------
(in thousands)
Retirement Center in North
January 1 Carolina $ 45,000 (32,802) 34,780 11,758
February 12 Retirement Center in Illinois 18,469 (12,669) 12,933 5,268
March 28 Retirement Center in Florida 30,000 (28,387) 19,538 697
---------- ---------------- ------------ ------------
$ 93,469 (73,858) 67,251 17,723
========== ================ ============ ============
(1) In conjunction with the Refinancing Plan, the Company determined during
the fourth quarter of 2001 to terminate all of the synthetic leases and
subsequently enter into sale lease-back transactions with respect to
eight of the fourteen synthetic lease communities during the first and
second quarters of 2002. As of June 30, 2002, the Company had completed
five of the eight synthetic lease termination and sale lease-back
transactions. These transactions raised gross proceeds of $45.8
million, net of $1.3 million of transaction costs.
(2) For financial reporting purposes, these capital lease obligations are
included in debt.
(3) The determination of transaction losses assumes $5.3 million of
estimated earnout payments.
As a result of the completed and anticipated transactions under the Refinancing
Plan, the Company has recorded losses from sale lease-back transactions of $7.9
million during the quarter ended December 31, 2001, $23.2 million during the
quarter ended March 31, 2002, and $7.0 million during the quarter ended June 30,
2002, bringing the total loss on these sale lease-back transactions to $38.1
million ($30.2 million for the six months ended June 30, 2002). For financial
reporting purposes, these losses are considered residual value guarantee amounts
and have been fully recognized as lease expense. See note 4 to the condensed
consolidated financial statements.
22
In addition, because the Company's sale lease-back transactions resulted in the
early termination of certain existing synthetic leaseholds, the Company
accelerated the amortization of leasehold acquisition costs beginning in the
fourth quarter of 2001. As a result of this acceleration, the Company recorded
additional amortization costs of $472,000 during the quarter ended December 31,
2001, $6.5 million during the quarter ended March 31, 2002, and $2.3 million of
additional amortization during the quarter ended June 30, 2002, bringing the
total amount of accelerated amortization related to these sale lease-back
transactions to $9.3 million ($8.8 million for the six months ended June 30,
2002).
The Company has not incurred, and does not expect to incur, any cash costs other
than transaction costs in connection with these transactions. Given the
long-term nature of the lease-back arrangements, the Company views these
transactions as long term financings. As such, the Company believes that
although sale lease-back accounting rules require the recognition of a loss in
the amount of the difference between the sales prices and the Company's cost
basis in the assets (including the leasehold acquisition costs of its synthetic
leases), the Company will continue to derive economic benefits from the assets
in the form of future payments under the earn-out provisions in excess of the
amounts currently included in the sales price, as well as from any improvement
in operating results as the communities increase occupancy and performance.
RESULTS OF OPERATIONS
The Company reported a net loss of $19.4 million, or $1.12 loss per diluted
share, on total revenues of $82.6 million, as compared with net loss of $4.6
million, or $0.27 loss per diluted share, on revenues of $65.1 million for the
three months ended June 30, 2002 and 2001, respectively. The loss of $1.12 per
dilutive share for the three months ended June 30, 2002 was entirely comprised
of a loss from continuing operations. The Company reported a net loss of $57.5
million, or $3.33 loss per diluted share, on total revenues of $159.4 million,
as compared with net loss of $7.4 million, or $0.43 loss per diluted share, on
revenues of $127.2 million for the six months ended June 30, 2002 and 2001,
respectively. The loss of $3.33 per dilutive share for the six months ended June
30, 2002 was comprised of a $3.28 loss from continuing operations, plus a $0.04
loss from the extinguishment of debt. Included in the loss from continuing
operations for the three and six months ended June 30, 2002 is approximately
$7.0 million and $30.2 million, respectively, of additional lease expense
resulting from losses on certain sale lease-back transactions, and approximately
$2.3 million and $8.8 million, respectively, of accelerated leasehold
acquisition cost amortization from these transactions. See notes 4 and 8 to the
condensed consolidated financial statements.
REVENUES
The Company's revenues from continuing operations are comprised of resident and
health care revenues, which includes revenues from the Company's owned and
leased communities and management and development services revenues, which
include fees, net of reimbursements, for the development, marketing, and
management of communities owned by third parties. The following table sets forth
each of the components of the Company's revenues as a percentage of the total
revenues for the three and six months ended 2002 and 2001:
23
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2002 2001 2002 2001
Resident and health care revenues:
Monthly service fees and ancillary revenues from
independent and assisted living residents 72.4% 74.0% 72.8% 73.7%
Per diem charges from skilled nursing and 23.1% 19.3% 22.9% 19.5%
therapy services
Amortization of non-refundable entrance fees(1) 2.3% 2.6% 2.2% 2.8%
Management and development services 0.7% 1.5% 0.4% 1.3%
Reimbursable out-of-pockets 1.5% 2.6% 1.7% 2.7%
------------ ------------ ------------- -----------
Total revenues 100.0% 100.0% 100.0% 100.0%
============ ============ ============= ===========
(1) Amortized over each resident's actuarially determined life expectancy
(or building life for contingent refunds).
The Company's management agreements are generally for terms of three to 20
years, but certain of such agreements may be canceled by the owner of the
community, without cause, on three to six months notice. Pursuant to the
management agreements, the Company is generally responsible for providing
management personnel, marketing, nursing, resident care and dietary services,
accounting and data processing services, and other services for these
communities at the owners' expense, and receives a monthly fee for its services
based either on a contractually fixed amount or a percentage of revenues or
income. One of the Company's management agreements is for a community with
aggregate resident capacity for approximately 900 residents and has a 20-year
term, with approximately 16 years remaining, with two ten-year renewals, as well
as a purchase option. The management fee for this agreement is equal to all cash
received in excess of operating and financing expenses and certain cash payments
to the owner of the community. The Company's existing management agreements
expire at various times through June 2018. See note 6 to the condensed
consolidated financial statements.
SEGMENT RESULTS
The Company's operations are divided into two segments: (1) Retirement Centers
and (2) Free-standing ALs.
The Retirement Centers are generally comprised of the Company's continuing care
retirement centers and lifecare communities and its independent living
communities, including those at which assisted living and/or nursing services
are provided. The Retirement Centers are established communities with strong
reputations within their respective markets, and generally maintain high and
consistent occupancy levels, most with waiting lists of prospective residents.
The Company's Retirement Centers form the core segment of the Company's business
and comprise 31 of the 65 communities that the Company operates, with capacity
for approximately 11,200 residents, representing approximately 78% of the total
resident capacity of the Company's communities. At June 30, 2002 and 2001, the
Company's Retirement Centers had occupancy rates of 92% and 93%, respectively.
The Company has also developed and acquired a number of Free-standing ALs, most
of which began operations during 1999 and 2000. Free-standing ALs are much
smaller than Retirement Centers and generally are stand-alone communities that
are not located on a Retirement Center campus. Most Free-standing ALs provide
specialized care such as Alzheimer's, memory enhancement and other dementia
programs. During the last several years and continuing through 2002, the
Free-standing AL market has suffered from adverse market conditions, including
significant overcapacity in most markets, longer than anticipated fill-up
periods, price discounting and price pressures. The Company expects these
conditions to continue for the intermediate term. Although the Company ceased
development of additional Free-standing ALs in late 1999, many that were already
in development were opened during 2000 and early 2001. The Company's community
operating results include only the Free-standing ALs that the Company owns or
leases. The number of Free-standing ALs included in the Company's consolidated
24
operations grew from 22 at June 30, 2001 to 34 at June 30, 2002 as a result of
acquisitions of Free-standing ALs and leasehold interests of various communities
that were managed by the Company and owned by special purpose entities which
were owned by third parties ("Managed SPE Communities"), including leasehold
interests in ten Managed SPE Communities acquired as of December 31, 2001.
The Company operates 34 Free-standing ALs, with capacity for approximately 3,200
residents, representing approximately 22% of the total resident capacity of the
Company's communities. Many of these Free-standing ALs are in the fill-up stage.
At June 30, 2002 and 2001, the Company's Free-standing ALs had occupancy rates
of 74% and 58%, respectively.
The Company evaluates its performance in part based upon EBITDAR, which is
defined as earnings before net interest expense, income tax expense,
depreciation, amortization, rent, and other special charges related to asset
impairment and other losses, equity in loss of managed special purpose entities,
other income (expense), minority interest, and extraordinary items. As a result
of increased occupancy, the Company's Free-standing ALs generated positive
community EBITDAR since the fourth quarter of 2001. On an operating income
basis, however, they are still generating losses after lease, amortization and
depreciation expense.
The following is a summary of total revenues, EBITDAR, and total assets by
segment for the three and six months ended June 30, 2002 and 2001 (in
thousands).(1)(2)(3)
THREE MONTHS ENDED
JUNE 30, JUNE 30, $ %
2002 2001 CHANGE CHANGE
---- ---- ------- ------
Revenues:
Retirement centers $ 61,877 $ 53,511 $ 8,366 15.6%
Free-standing ALs 18,910 8,894 10,016 112.6%
Corporate/other 1,856 2,693 (837) (31.1%)
-----------------------------------------------------
Total $ 82,643 $ 65,098 $ 17,545 27.0%
=====================================================
NOI / Community EBITDAR:
Retirement centers $ 20,473 $ 18,956 $ 1,517 8.0%
Free-standing ALs 1,665 (162) 1,827 1127.8%
Corporate/other (6,295) (5,796) (499) (8.6%)
-----------------------------------------------------
Net operating income 21.9%
15,843 12,998 2,845
Lease expense (4) 18,098 6,700 11,398 170.1%
Depreciation and amortization(5) 8,504 5,195 3,309 63.7%
------------------------------------------------------
Operating income $ (10,759) $ 1,103 $ (11,862) (1075.4%)
======================================================
SIX MONTHS ENDED
JUNE 30, JUNE 30, $ %
2002 2001 CHANGE CHANGE
---- ---- ------- ------
Revenues:
Retirement centers $ 119,493 $ 105,749 $ 13,744 13.0%
Free-standing ALs 36,547 16,328 20,219 123.8%
Corporate/other 3,372 5,074 (1,702) (33.5%)
--------------------------------------------------------
Total $ 159,412 $ 127,151 $ 32,261 25.4%
========================================================
25
JUNE 30, JUNE 30, $ %
2002 2001 CHANGE CHANGE
---- ---- ------- ------
NOI / Community EBITDAR:
Retirement centers $ 41,184 $ 38,327 $ 2,857 7.5%
Free-standing ALs 2,614 (962) 3,576 371.7%
Corporate/other (12,534) (10,769) (1,765) (16.4%)
---------------------------------------------------
Net operating income 31,264 26,596 4,668 17.6%
Lease expense (4) 50,063 13,451 37,612 279.6%
Depreciation and amortization(5) 20,648 10,287 10,361 100.7%
----------------------------------------------------
Operating (loss)
income $ (40,447) $ 2,858 $ (43,305) (1515.2%)
====================================================
TOTAL ASSETS
JUNE 30, DECEMBER 31, $ %
2002 2001 CHANGE CHANGE
---- ---- -- ------- ------
Total Assets:
Retirement centers $ 470,231 $ 509,732 $ (39,501) (7.8%)
Free-standing ALs 221,643 241,069 (19,426) (8.1%)
Corporate/other 99,553 99,390 163 0.0%
--------------------------------------------------------
Total $ 791,427 $ 850,191 $ (58,764) (6.9%)
========================================================
(1) Segment data does not include any inter-segment transactions or
allocated costs.
(2) 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 impairments and other losses, equity in loss of communities that
are managed by the Company and owned by special purpose entities, other
income (expense), minority interest, and extraordinary items. While NOI
and EBITDAR are not GAAP measurements, the Company believes it is
relevant in analyzing its operating results.
(3) Corporate/Other revenues represent the Company's development and
management fee revenues. Corporate/Other NOI includes operating
expenses related to corporate operations, including human resources,
financial services, and information systems, as well as senior living
network and assisted living management costs.
(4) Includes $7.0 million and $30.2 million of additional lease expense for
the three and six months ended June 30, 2002 as a result of sale
lease-back transactions. See note 4 to the condensed consolidated
financial statements.
(5) Includes $2.3 million and $8.8 million of additional amortization
expense for the three and six months ended June 30, 2002 as a result of
sale lease-back transactions. See note 4 to the condensed consolidated
financial statements.
PRO FORMA SEGMENT RESULTS:
The following table presents, on a pro forma basis, quarterly community results
on a segment basis for each of the Company's last six fiscal quarters (2002 and
2001), assuming that all communities currently owned or leased were consolidated
for the entire period. As a result, the operating results for 25 Retirement
Centers and 34 Free-standing ALs owned or leased as of June 30, 2002, are
included for all quarters shown. This information is presented in order to show
the historical results of the communities that currently make up each segment
(many of which were not consolidated in some or all quarters shown). Communities
managed as of June 30, 2002, communities sold during these periods, not
subsequently leased-back, and unconsolidated joint ventures are excluded from
all quarters shown. While this pro forma information is not presented in
accordance with accounting principles generally accepted in the United States of
America, the Company believes such information is useful in evaluating the
Company's performance. The pro forma results of any particular quarter are not
necessarily indicative of results of operations for a full year or predictive of
future periods. All dollar amounts are in thousands.
26
2001 Quarter Ended Year Ended 2002 Quarter Ended
--------------------------------------- -----------------------
March 31 June Sept Dec 31 Dec 31, March 31 June 30
---------- ------ ------ -------- -------- ---------- ---------
30 30 2001
--- --- ----
Retirement Centers
Revenues $55,692 $58,205 $58,696 $59,536 $232,129 $61,761 $61,877
Community EBITDAR 18,864 19,818 18,743 19,371 76,796 21,576 20,473
Free-standing ALs
Revenues 11,927 13,716 15,160 16,465 57,268 17,637 18,910
Community EBITDAR (1,769) (473) (86) 648 (1,680) 949 1,665
This pro forma table shows the significant trends in each of the two business
segments. Retirement Center revenues have grown primarily as a result of price
increases for new residents, increased occupancy and the fill up of expansions
at certain communities, growth of therapy services and the expansion of other
service offerings. These revenue increases, as well as control of expenses and
recoupment of expense increases through rate increases to current residents,
have resulted in increases in community EBITDAR from the Retirement Centers.
During 1999 and 2000, the Company opened many new Free-standing AL communities
which added significant unit capacity to the Company's portfolio of
Free-standing ALs. Free-standing AL revenues have increased primarily as a
result of increased occupancy as Free-standing AL communities fill-up.
Free-standing AL revenues have also increased as a result of selective price
increases and growth of ancillary revenues. As the Free-standing AL communities
continue to fill, the Company expects community EBITDAR to increase.
THREE MONTHS ENDED JUNE 30, 2002 COMPARED WITH THE THREE MONTHS ENDED JUNE 30,
2001
Revenues. Total revenues were $82.6 million in the quarter ended June 30, 2002,
compared to $65.1 million in the quarter ended June 30, 2001, representing an
increase of $17.5 million, or 27.0%. Resident and health care revenues increased
by $18.4 million, management and development services revenue decreased by
$344,000 during the 2002 period, and reimbursable out-of-pocket revenues
decreased $493,000. The increases in resident and health care revenues resulted
primarily from an increase of: (a) approximately $6.5 million as a result of the
increase in the number of Free-standing ALs included in the Company's
consolidated operations, as well as $2.8 million related to the continued
fill-up of these communities, (b) $3.5 million and $1.8 million related to the
April 2002 and July 2001 long-term leases of Freedom Plaza Arizona and Freedom
Plaza Care Center, respectively, (c) an increase of $1.8 million in revenue from
therapy services, (d) $704,000 attributable to increased capacity as a result of
Retirement Center expansions and (e) $2.1 million related increased average
occupancy and additional entrance fee revenues. The offsetting decrease relates
to the July 1, 2001 sale of Rossmoor Regency, which had $1.2 million in total
revenues for the three months ended June 30, 2001.
Management and development services revenue and reimbursable out-of-pocket
revenues decreased by $344,000 and $493,000 and decreased as a percentage of
total revenue to 0.7% and 1.5% in the quarter ended June 30, 2002 from 1.5% and
2.6% in the quarter ended June 30, 2001, respectively. The decrease is primarily
related to the reduction in managed communities, decreased management fees at
certain properties as a result of lower sales of new units, which reduces the
formula-based management fees, as well as the decrease in the number of managed
communities from 20 at June 30, 2001 to six at June 30, 2002, including Freedom
Plaza Arizona and Freedom Plaza Care Center.
Retirement Center resident and health care revenues were $61.9 million in the
quarter ended June 30, 2002, compared to $53.5 million in the quarter ended June
30, 2001, representing an increase of $8.4 million, or 15.6%. This increase
resulted primarily from additional revenues as a result of the long-term lease,
and consolidation of Freedom Plaza Arizona and Freedom Plaza Care Center,
increased capacity related to expansions and increased
27
therapy services provided by the Company during 2002. Retirement Center resident
and health care revenues were also positively affected by increased average
occupancy and additional entrance fee revenues.
Free-standing AL resident and health care revenues increased from $8.9 million
in the quarter ended June 30, 2001 to $18.9 million in the quarter ended June
30, 2002. This increase is largely related to the increase in the number of
Free-standing ALs included in the Company's consolidated operations from 22 to
34 communities, as well as increased occupancy at these communities.
Community Operating Expense. Community operating expense increased to $59.0
million in the quarter ended June 30, 2002, as compared to $43.6 million in the
quarter ended June 30, 2001, representing an increase of $15.4 million, or
35.3%. The increase in community operating expense was primarily attributable to
communities acquired or leased during 2001 and expansions. Additionally, the
increase was the result of increased labor, insurance, utility, property and
marketing costs at various new communities, as well as costs associated with the
expansion of therapy services to additional communities during 2001 and 2002.
Community operating expense as a percentage of resident and health care revenues
increased to 73.0% from 69.9% for the quarters ended June 30, 2002 and 2001,
respectively, primarily attributable to the acquisition of leasehold interests
in various Managed SPE Communities during the second half of 2001 which are in
the fill-up stage. The Company expects community operating expense to remain at
greater than historical levels as a percentage of resident and health care
revenues as the Free-standing ALs acquired during 2001 complete the fill-up
stage.
Retirement Center operating expenses were $41.4 million in the quarter ended
June 30, 2002, compared to $34.6 million in the quarter ended June 30, 2001,
representing an increase of $6.8 million, or 19.7%. Approximately $3.1 and $1.8
million of this increase was attributable to the April 1, 2002 and July 1, 2001
long-term lease of Freedom Plaza Arizona and Freedom Plaza Care Center,
respectively. In addition, the expansions at several Retirement Centers
increased operating expenses by $630,000. Finally, $926,000 of the increase
related to expenses associated with increased therapy services during the
quarter ended June 30, 2002. The remaining increase relates primarily to
increased average occupancies resulting in increased Retirement Center operating
expenses.
Free-standing AL operating expenses increased from $9.1 million in the quarter
ended June 30, 2001 to $17.2 million in the quarter ended June 30, 2002. This
increase is largely related to the increase in the number of Free-standing ALs
included in the Company's consolidated operations from 22 to 34 communities, as
well as increased occupancy at these communities.
General and Administrative. General and administrative expense decreased to $6.5
million for the quarter ended June 30, 2002, as compared to $6.8 million for the
quarter ended June 30, 2001, representing a decrease of $202,000, or 3.0%. This
decrease is primarily attributable to additional accruals in the prior period
for general and professional liability claims, workers' compensation, and other
insurance related accruals, resulting from general conditions in the insurance
markets and changes in the Company's insurance program at that time. General and
administrative expense as a percentage of total revenues decreased to 7.9%
compared to 10.4% for the quarters ended June 30, 2002 and 2001, respectively.
EBITDAR (Community NOI). EBITDAR increased $2.8 million from $13.0 million in
the quarter ended June 30, 2001 to $15.8 million in the quarter ended June 30,
2002 as further described below.
Retirement Center EBITDAR increased $1.5 million, or 8.0%, from $19.0 million
for the quarter ended June 30, 2001 to $20.5 million for the quarter ended June
30, 2002. This increase primarily relates to the April 2002 and July 2001
addition of the long-term leases of Freedom Plaza Arizona 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.
Free-standing AL EBITDAR improved by $1.8 million from a $162,000 loss in the
quarter ended June 30, 2001, to $1.7 million of income in the quarter ended June
30, 2002, primarily as a result of increased occupancy at these communities.
28
Other EBITDAR losses increased $499,000 to $6.3 million in the quarter ended
June 30, 2002 resulting from $972,000 of legal and consulting costs affiliated
with the exchange of a debt instrument, as well as the $344,000 reduction in
management and development fees. These costs were offset by approximately
$198,000 of reductions in bad debt expense and $684,000 of reductions in general
liability and other insurance accruals in the prior period. The remaining
increase relates to additional costs associated with therapy services,
marketing, corporate operations, human resources, financial services and
overhead, and increased senior living network and assisted living management
costs.
Lease Expense. As of June 30, 2002, the Company had operating leases for 38 of
its communities, including 13 Retirement Centers and 25 Free-standing ALs. Lease
expense increased $11.4 million from $6.7 million for the quarter ended June 30,
2001 to $18.1 million for the quarter ended June 30, 2002. Lease expense
(excluding synthetic leases) increased to $9.1 million for the quarter ended
June 30, 2002, as compared to $4.0 million for the quarter ended June 30, 2001,
representing an increase of $5.1 million. This increase was attributable to 15
additional leases entered into by the Company during 2001 and 2002, consisting
of five Retirement Center leases which increased lease expense $3.4 million, and
the acquisition of leasehold interests in ten Free-standing AL communities,
which increased lease expense $1.7 million.
As of June 30, 2002, the Company operated nine of its communities, including two
Retirement Centers and seven Free-standing ALs, under operating lease structures
commonly referred to as synthetic leases. Synthetic lease expense increased to
$9.0 million for the quarter ended June 30, 2002, as compared to $2.7 million
for the quarter ended June 30, 2001, representing an increase of $6.3 million.
Of the total $9.0 million of synthetic lease expense for the quarter ended June
30, 2002, $2.1 million related to Retirement Centers and $6.9 million related to
Free-standing ALs. Of the total $9.0 million of synthetic lease expense for the
quarter ended June 30, 2002, $7.0 million resulted from residual value guarantee
amounts related to losses on sale leaseback transactions, of which $1.7 million
related to Retirement Centers and $5.3 million related to Free-standing ALs.
As a result of completed and anticipated transactions under the Refinancing
Plan, the Company has recorded losses from sale lease-back transactions of $7.9
million during the quarter ended December 31, 2001 and $23.2 million during the
quarter ended March 31, 2002, and $7.0 million for the quarter ended June 30,
2002, bringing the total loss on these sale lease-back transactions to
approximately $38.1 million. For financial reporting purposes, these losses are
considered residual value guarantee amounts and have been fully recognized as
lease expense.
Depreciation and Amortization. Depreciation and amortization expense increased
to $5.5 million in the quarter ended June 30, 2002 from $4.8 million in the
quarter ended June 30, 2001, representing an increase of $711,000, or 14.8%. The
increase was primarily related to the increase in depreciable assets of
approximately $19.7 million. These assets relate primarily to the acquisition of
communities, including leasehold interests, and expansion of communities since
June 30, 2001, as well as ongoing capital expenditures.
Amortization of Leasehold Acquisition Costs. Amortization of leasehold
acquisition costs increased $2.6 million from $396,000 in the quarter ended June
30, 2001 to $3.0 million in the quarter ended June 30, 2002. During the fourth
quarter of 2001, the Company determined that in order to simplify its financial
structure, and as a condition of certain elements of its Refinancing Plan, it
would exercise its termination rights under its synthetic leases during 2002. As
a result of the completed and anticipated transactions under the Refinancing
Plan, which would result in a shorter than expected remaining life of various
leases, the Company accelerated the amortization of leasehold acquisition costs
beginning in the fourth quarter of 2001. As a result of this acceleration, the
Company recorded additional amortization costs of $472,000 during the quarter
ended December 31, 2001, $6.5 million during the quarter ended March 31, 2002,
and $2.3 million of additional amortization during June 30, 2002, bringing the
total amount of accelerated amortization related to these sale lease-back
transactions to $9.3 million. The remaining portion of this increase relates to
the acquisition of twelve leasehold interests in Free-standing ALs during 2001.
Other Income (Expense). Interest expense increased to $10.0 million in the
quarter ended June 30, 2002 from $9.3 million in the quarter ended June 30,
2001, representing an increase of $676,000, or 7.3%. Although total indebtedness
has decreased slightly to $514.8 million from $520.2 million at June 30, 2002
and June 30, 2001, respectively, this increase was primarily attributable to a
higher average amount of indebtedness, prior to certain
29
refinancing transactions, during the six months ended June 30, 2002, as well as
higher interest rates. Interest expense, as a percentage of total revenues,
decreased to 12.1% for the quarter ended June 30, 2002 from 14.3% in the quarter
ended June 30, 2001. Considering certain financings expected to be completed in
the refinancing plan, the Company expects interest expense to continue at
greater than historical levels as a percentage of total revenues. Interest
income decreased to $1.3 million in the quarter ended June 30, 2002 from $3.0
million in the quarter ended June 30, 2001, representing a decrease of $1.7
million, or 57.3%. The decrease in interest income was primarily attributable to
lower income generated from the reduced amount of certificates of deposit and
notes receivable balances associated with certain leasing transactions and
management agreements. Equity in loss of Managed SPE Communities (representing
the losses that the Company funded when operating deficits at the Managed SPE
Communities exceeded specified limits) decreased from $972,000 in the quarter
ended June 30, 2001 to $0 in the quarter ended June 30, 2002. The Company had no
further Managed SPE Communities after December 31, 2001.
Income Tax Benefit. The provision for income taxes was a $122,000 expense,
compared to a $2.0 million benefit for the quarters ended June 30, 2002 and
2001, respectively. The Company has applied a full valuation allowance against
its net operating carryforwards.
Net Loss. Based upon the factors noted above, the Company experienced a net loss
of $19.4 million, or $1.12 loss per dilutive share, compared to a net loss of
$4.6 million, or $0.27 loss per dilutive share, for the quarters ended June 30,
2002 and 2001, respectively. The $1.12 loss per dilutive share for the quarter
ended June 30, 2002 was comprised of a $1.12 loss from operations. The loss of
$0.27 per dilutive share for the quarter ended June 30, 2001 was comprised of a
$0.23 loss from operations and a $0.03 loss from the extinguishment of debt.
SIX MONTHS ENDED JUNE 30, 2002 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2001
Revenues. Total revenues were $159.4 million in the six months ended June 30,
2002, compared to $127.2 million in the six months ended June 30, 2001,
representing an increase of $32.3 million, or 25.4%. Resident and health care
revenues increased by $34.0 million, management and development services revenue
decreased by $988,000, and reimbursable out-of-pocket revenues decreased
$713,000 during the 2002 period. The increases in resident and health care
revenues resulted primarily from an increase of: (a) approximately $12.7 million
as a result of the increase in the number of Free-standing ALs included in the
Company's consolidated operations, as well as $6.1 million related to the
continued fill-up of these communities, (b) $3.5 million and $3.5 million
related to the April 2002 and July 2001 long-term leases of Freedom Plaza
Arizona and Freedom Plaza Care Center, respectively, (c) an increase of $3.4
million in revenue from therapy services, and (d) $1.4 million attributable to
increased capacity as a result of Retirement Center expansions. The remaining
increase relates primarily to increased average occupancy and additional
entrance fee revenues.
Management and development services and reimbursable out-of-pocket revenue
decreased by $988,000 and $713,000 and decreased as a percentage of total
revenue to 0.4% and 1.7% in the six months ended June 30, 2002 from 1.3% and
2.7% in the six months ended June 30, 2001. The decrease is primarily related to
the reduction in managed communities, decreased management fees at certain
properties as a result of lower sales of new units, which reduces the
formula-based management fees, as well as the decrease in the number of managed
communities from 20 at June 30, 2001 to six at June 30, 2002, including Freedom
Plaza Arizona and Freedom Plaza Care Center.
Retirement Center resident and health care revenues were $119.5 million in the
six months ended June 30, 2002, compared to $105.8 million in the six months
ended June 30, 2001, representing an increase of $13.8 million, or 13.0%. This
increase resulted primarily from additional revenues as a result of the
long-term lease, therefore now consolidated, Freedom Plaza Arizona and Freedom
Plaza Care Center, increased capacity related to expansions and increased
therapy services provided by the Company during 2002. Retirement Center resident
and health care revenues were also positively affected by increased average
occupancy and additional entrance fee revenues.
Free-standing AL resident and health care revenues increased from $16.3 million
in the six months ended June 30, 2001 to $36.5 million in the six months ended
June 30, 2002. This increase is largely related to the increase in the number of
Free-standing ALs included in the Company's consolidated operations from 22 to
34 communities, as well as increased occupancy at these communities.
30
Community Operating Expense. Community operating expense increased to $113.0
million in the six months ended June 30, 2002, as compared to $85.4 million in
the six months ended June 30, 2001, representing an increase of $27.6 million,
or 32.3%. The increase in community operating expense was primarily attributable
to communities acquired or leased during 2001 and expansions. Additionally, the
increase was the result of increased labor, insurance, utility, property and
marketing costs at various new communities, as well as costs associated with the
expansion of therapy services to additional communities during 2001 and 2002.
Community operating expense as a percentage of resident and health care revenues
increased to 72.4% from 70.0% for the quarters ended June 30, 2002 and 2001,
respectively, primarily attributable to the acquisition of leasehold interests
in various Managed SPE Communities during the second half of 2001 which are in
the fill-up stage. The Company expects community operating expense to remain at
greater than historical levels as a percentage of resident and health care
revenues as the Free-standing ALs acquired during 2001 complete the fill-up
stage.
Retirement Center operating expenses were $78.3 million in the six months ended
June 30, 2002, compared to $67.4 million in the six months ended June 30, 2001,
representing an increase of $10.9 million, or 16.2%. Approximately $3.1 and $3.5
million of this increase was attributable to the April 1, 2002 and July 1, 2001
long-term lease of Freedom Plaza Arizona and Freedom Plaza Care Center,
respectively. In addition, the expansions at several Retirement Centers
increased operating expenses by $1.4 million. Finally, $1.8 million of the
increase related to expenses associated with increased therapy services during
the six months ended June 30, 2002. The remaining increase relates primarily to
increased average occupancies resulting in increased Retirement Center operating
expenses.
Free-standing AL operating expenses increased from $17.3 million in the six
months ended June 30, 2001 to $33.9 million in the six months ended June 30,
2002. This increase is largely related to the increase in the number of
Free-standing ALs included in the Company's consolidated operations from 22 to
34 communities, as well as increased occupancy at these communities.
General and Administrative. General and administrative expense decreased to
$12.5 million for the six months ended June 30, 2002, as compared to $11.8
million for the six months ended June 30, 2001, representing an increase of
$724,000, or 6.2%. This increase is primarily attributable to legal and
consulting costs affiliated with the exchange of a debt instrument, offset by
additional accruals in the prior period for general and professional liability
claims, workers' compensation, and other insurance related accruals, resulting
from general conditions in the insurance markets and changes in the Company's
insurance program at that time. General and administrative expense as a
percentage of total revenues decreased to 7.8% compared to 9.2% for the six
month periods ended June 30, 2002 and 2001, respectively.
EBITDAR (Community NOI). EBITDAR increased $4.7 million from $26.6 million
profit in the six months ended June 30, 2001 to $31.3 million loss in the six
months ended June 30, 2002 as further described below.
Retirement Center EBITDAR increased $2.9 million, or 7.5%, from $38.3 million
for the six months ended June 30, 2001 to $41.2 million for the six months ended
June 30, 2002. This increase primarily relates to the April 2002 and July 2001
addition of the long-term leases of Freedom Plaza Arizona 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.
Free-standing AL EBITDAR improved by $3.6 million from a $962,000 loss in the
six months ended June 30, 2001, to $2.6 million of income in the six months
ended June 30, 2002, primarily as a result of increased occupancy at these
communities.
Other EBITDAR losses increased by $1.8 million to $12.5 million in the six
months ended June 30, 2002 resulting from the $988,000 reduction in management
and development fees and $972,000 of legal and consulting costs affiliated with
the exchange of a debt instrument.
31
Lease Expense. As of June 30, 2002, the Company had operating leases for 38 of
its communities, including 13 Retirement Centers and 25 Free-standing ALs. Lease
expense increased $37.6 million from $13.5 million for the six months ended June
30, 2001 to $51.1 million for the six months ended June 30, 2002. Lease expense
(excluding synthetic leases) increased to $15.9 million for the six months ended
June 30, 2002, as compared to $7.6 million for the six months ended June 30,
2001, representing an increase of $8.4 million. This increase was attributable
to 15 additional leases entered into by the Company during 2001 and 2002,
consisting of five Retirement Center leases which increased lease expense $5.0
million, and the acquisition of leasehold interests in ten Free-standing AL
communities, which increased lease expense $3.4 million.
As of June 30, 2002, the Company operated nine of its communities, including two
Retirement Centers and seven Free-standing ALs, under operating lease structures
commonly referred to as synthetic leases. Synthetic lease expense increased to
$35.1 million for the six months ended June 30, 2002, as compared to $5.9
million for the six months ended June 30, 2001, representing an increase of
$29.2 million. Of the total $35.1 million of synthetic lease expense for the six
months ended June 30, 2002, $4.3 million related to Retirement Centers and $30.8
million related to Free-standing ALs. Of the total $35.1 million of synthetic
lease expense for the six months ended June 30, 2002, $30.2 million resulted
from residual value guarantee amounts related to losses on sale lease-back
transactions, of which $3.4 million related to Retirement Centers and $26.8
million related to Free-standing ALs.
As a result of completed and anticipated transactions under the Refinancing
Plan, the Company has recorded losses from sale lease-back transactions of $7.9
million during the three months ended December 31, 2001, $23.2 million during
the three months ended March 31, 2002, and $7.0 million for the three months
ended June 30, 2002, bringing the total loss on these sale lease-back
transactions to approximately $38.1 million. For financial reporting purposes,
these losses are considered residual value guarantee amounts and have been fully
recognized as lease expense.
Depreciation and Amortization. Depreciation and amortization expense increased
to $10.5 million in the six months ended June 30, 2002 from $9.5 million in the
six months ended June 30, 2001, representing an increase of $1.0 million, or
10.6%. The increase was primarily related to the increase in depreciable assets
of approximately $19.7 million. These assets relate primarily to the acquisition
of communities, including leasehold interests, and expansion of communities
since June 30, 2001, as well as ongoing capital expenditures.
Amortization of Leasehold Acquisition Costs. Amortization of leasehold
acquisition costs increased $9.4 million from $761,000 in the six months ended
June 30, 2001 to $10.1 million in the six months ended June 30, 2002. During the
fourth quarter of 2001, the Company determined that in order to simplify its
financial structure, and as a condition of certain elements of its Refinancing
Plan, it would exercise its termination rights under its synthetic leases during
2002. As a result of the completed and anticipated transactions under the
Refinancing Plan, which would result in a shorter than expected remaining life
of various leases, the Company accelerated the amortization of leasehold
acquisition costs beginning in the fourth quarter of 2001. As a result of this
acceleration, the Company recorded additional amortization costs of $472,000
during the three months ended December 31, 2001, $6.5 million during the three
months ended March 31, 2002, and $2.3 million of amortization during the three
months ended June 30, 2002, bringing the total amount of accelerated
amortization related to these sale lease-back transactions to $9.3 million. The
remaining portion of this increase relates to the acquisition of twelve
leasehold interests in Free-standing ALs during 2001.
Other Income (Expense). Interest expense increased to $19.7 million in the six
months ended June 30, 2002 from $18.5 million in the six months ended June 30,
2001, representing an increase of $1.2 million, or 6.3%. This increase was
primarily attributable to a higher average amount of indebtedness, prior to
certain refinancing transactions, during the six months ended June 30, 2002, as
well as higher interest rates. Interest expense, as a percentage of total
revenues, decreased to 12.4% for the six months ended June 30, 2002 from 14.6%
in the six months ended June 30, 2001. Considering certain financings expected
to be completed in the refinancing plan, the Company expects interest expense to
continue at greater than historical levels as a percentage of total revenues.
Interest income decreased to $2.9 million in the six months ended June 30, 2002
from $6.1 million in the six months ended June 30, 2001, representing a decrease
of $3.2 million, or 52.4%. The decrease in interest income was primarily
attributable to lower income generated from the reduced amount of certificates
of deposit and notes receivable balances associated with certain leasing
transactions and management agreements. Equity in loss of
32
Managed SPE Communities (representing the losses that the Company funded when
operating deficits at the Managed SPE Communities exceeded specified limits)
decreased from $1.9 million in the six months ended June 30, 2001 to $0 in the
six months ended June 30, 2002. The Company had no further Managed SPE
Communities after December 31, 2001.
Income Tax Benefit. The provision for income taxes was a $219,000 expense,
compared to a $3.4 million benefit for the six months ended June 30, 2002 and
2001, respectively. The Company has applied a full valuation allowance against
its net operating carryforwards.
Extraordinary Loss. During the six months ended June 30, 2002, the Company
repaid a term note to a bank in connection with the sale of its Carriage Club
Charlotte community, resulting in a prepayment penalty of $348,000. In addition,
the Company expensed the unamortized portions of financing costs, totaling
$408,000 related to the sale lease-backs of Holley Court Terrace and Hampton at
Post Oak. The Company recorded $756,000 or a $0.04 loss per dilutive share, net
of income taxes, as an extraordinary loss on the extinguishment of debt.
Net Loss. Based upon the factors noted above, the Company experienced a net loss
of $57.5 million, or $3.33 loss per dilutive share, compared to a net loss of
$7.4 million, or $0.43 loss per dilutive share, for the six months ended June
30, 2002 and 2001, respectively. The $3.33 loss per dilutive share for the six
months ended June 30, 2002 was comprised of a $3.28 loss from operations and a
$0.04 loss from the Company's extinguishment of debt. The loss of $0.43 per
dilutive share for the six months ended June 30, 2001 was comprised of a $0.42
loss from operations and a $0.01 loss from the extinguishment of debt.
LIQUIDITY AND CAPITAL RESOURCES
Refinancing Plan
The Company has a substantial amount of debt and lease obligations maturing
during 2002, comprised primarily of $132.9 million of its Debentures. The
Company has scheduled debt maturities during the 12 months ended June 30, 2003
of $165.4 million, which includes $32.5 million of periodic mortgage debt
payments and $132.9 million of Debentures. As a result of these current
maturities, the Company had a net working capital deficit of $163.8 million as
of June 30, 2002. As of June 30, 2002, the Company also had minimum rental
obligations of $50.3 million under long-term operating leases due during the 12
months ended June 30, 2003. In addition, as of June 30, 2002, the Company had
guaranteed $93.1 million of third-party senior debt in connection with a
community that the Company manages, the Company's joint ventures and certain of
the Company's lease financings. In addition, the Company and certain of its
lenders and lessors agreed to amendments or waivers of various financial
covenants as of June 30, 2002. As of June 30, 2002, the Company had
approximately $12.3 million in unrestricted cash and cash equivalents. The
Company currently does not generate sufficient cash flow to meet its debt and
lease payment obligations. The Company expects that its cash flow from
operations will improve, and, accordingly, expects that its current cash and
cash equivalents, expected cash flow from operations, and the proceeds from
certain recently completed financings will be sufficient to fund its operating
requirements, its capital expenditure requirements and its periodic debt service
requirements during 2002. However, the Company's current cash balances and
internally generated cash (including the proceeds from recently completed
financings) will not be sufficient to satisfy its scheduled debt maturities in
2002.
In order to satisfy or extend the Company's debt and lease payment obligations
and to address its net working capital deficit, the Company considered a number
of financing and capital raising alternatives and developed the Refinancing Plan
in consultation with its investment banking advisor and its legal counsel and
through discussions with its lenders and other third parties. The Refinancing
Plan included extensions of existing debt maturities, refinancings of existing
mortgage facilities, new mortgage financings, and sale lease-back arrangements.
Pursuant to the Refinancing Plan, since November 2001, the Company has
consummated sale lease-back transactions relating to 16 communities and various
other refinancing and capital raising transactions, which in the aggregate
generated gross proceeds of approximately $362.0 million. The Company used
approximately $327.2 million of the proceeds to repay related debt and to fund
reserve and escrow requirements related to these transactions. The Company used
the remaining $34.8 million of proceeds to pay transaction costs associated with
the Refinancing Plan and for
33
working capital. As a result of the Refinancing Plan, the Company has extended
the maturity of substantially all of its debt arrangements, other than the
Debentures, to January 2004 or later.
The Debentures are the Company's only material remaining outstanding debt
obligation maturing during the next 12 months. In order to address the maturity
of the Debentures, during March of 2002, the Company entered into a non-binding
commitment letter with HCPI relating to a proposed $125.0 million financing
transaction. On August 14, 2002, the Company entered into the HCPI Loan
Agreement pursuant to which HCPI has agreed to make the HCPI Loan to one of the
Company's subsidiaries in the amount of $112.8 million. The Company also
contemporaneously entered into the HCPI Investment Agreement under which HCPI
has agreed to make the $12.2 million HCPI Equity Investment in certain other
subsidiaries of the Company.
Exchange Offer
HCPI's obligation to consummate the HCPI Transactions is subject to a number of
conditions and contingencies. Those conditions include the requirement that the
Company successfully complete the Exchange Offer with the holders of the
outstanding Debentures. Under the Exchange Offer, the Company will exchange for
each $1,000 principal amount of outstanding Debentures and accrued interest
thereon (i) $839 principal amount of the Company's new 5 3/4% Series A Notes,
(ii) $190 principal amount of the Company's new 10% Series B Notes, and (iii) 13
Warrants, each Warrant to purchase one share of the Company's common stock at an
exercise price of $3.50 per share and with an expiration date of September 30,
2009. With respect to the Exchange Offer, HCPI is also requiring that the
Company receive the valid tender of at least 75% of the outstanding principal
amount of the Debentures (approximately $99.7 million) to provide the Company
with additional cash on hand to meet its on-going liquidity requirements. The
Series A Notes and the Series B Notes will be unsecured and subordinated to all
of the Company's existing and future indebtedness and capital lease obligations,
but they will rank senior to the Debentures. The Company has the option to pay
up to 2% interest per year on the Series B Notes through the issuance of
additional Series B Notes rather than in cash. The Company is seeking to
exchange up to $126.0 million of the Debentures in the Exchange Offer, but the
Exchange Offer is not conditioned upon the tender of any minimum amount of
Debentures and the Company intends to accept all Debentures tendered, regardless
of whether the HCPI Transactions are consummated. The Company initiated the
Exchange Offer on August 14, 2002, and anticipates that, if successful, it will
be consummated during September 2002.
HCPI Transactions
The HCPI Loan will mature five years after initial funding, and will have a
stated interest rate of 19.5%; however, the Company will only be required to pay
in cash 9% interest per year until April 2004. Thereafter, the cash interest
payment rate will increase each year by fifty-five basis points. Interest only
at the cash rate will be payable quarterly, with any unpaid interest accruing
and compounding quarterly. The $112.8 million principal balance and all accrued
interest will be payable at the maturity of the loan. The Company will be
permitted to repay the loan at any time after three years from the date of
initial funding.
The HCPI Equity Investment will be made in return for a 9.8% ownership interest
in the Real Estate Companies. The Real Estate Companies function solely as
passive real estate holding companies owning the real property and improvements
of nine of the Company's large retirement communities. These retirement
communities are leased to, and operated by, other operating subsidiaries of the
borrower subsidiary in which HCPI will have no interest. During the term of its
investment in each Real Estate Company, HCPI and the borrower subsidiary will
have mutual decision making authority with respect to the Real Estate Companies.
HCPI will have the right to receive certain preferred distributions from any
cash generated by the Real Estate Companies. The borrower subsidiary will have
the right to repurchase HCPI's minority interest in the Real Estate Companies
for one year beginning four years after closing. HCPI will have the right to
purchase the borrower subsidiary's interests in the Real Estate Companies
beginning five years after closing.
The HCPI Loan will be non-recourse and will be secured by a first-priority
security interest in the borrower subsidiary's 90.2% ownership interests in the
Real Estate Companies, and in certain cash reserve accounts. Since the HCPI Loan
is non-recourse, if the borrower subsidiary defaults or fails to repay the loan
at maturity, HCPI's only claim against that subsidiary will be to exercise its
security interests and, absent fraud or certain other
34
customary events of malfeasance, neither the Company nor any of its subsidiaries
will have any further obligation to repay the HCPI Loan. Accordingly, even in
the event of default by the borrower subsidiary, the operating subsidiaries will
continue to operate these communities under a lease, which has an initial term
of 15 years, commencing at the date of funding of the loan, and two ten-year
extensions exercisable at our option.
The HCPI Loan Agreement contains numerous affirmative, negative and financial
covenants. In addition, under the HCPI Loan Agreement, HCPI's obligation to make
the HCPI Loan is subject to customary and usual conditions and certain other
conditions and requirements. Those conditions include, among others, the
following:
o the loan must be funded by September 30, 2002;
o the Company must complete the Exchange Offer on the terms
currently contemplated and the holders of the Debentures must
validly tender at least 75% of the outstanding principal
amount, or approximately $99.7 million, of the Debentures;
o operating results must be within budget and the Company must
meet certain liquidity and financial tests relating to the
Company and to the nine retirement communities owned by the
Real Estate Companies; and
o no material adverse change shall have occurred with respect to
the nine retirement communities, the borrower subsidiary or
the Company.
HCPI's obligation to make the $12.2 million HCPI Equity Investment in the Real
Estate Companies is also subject to substantially similar conditions.
In the event the Exchange Offer is successful and the Company receives the valid
tender of at least 75% of the aggregate principal amount of the outstanding
Debentures, the Company expects that it will be able to satisfy the other
conditions in the HCPI Loan Agreement and in the HCPI Investment Agreement and
close those transactions on or before September 30, 2002. The Company
anticipates that it will receive net proceeds of approximately $119.8 million
from the HCPI Transactions after paying approximately $5.2 million of
transaction costs associated with those transactions and the Exchange Offer.
However, the success of the Exchange Offer and the Company's ability to satisfy
HCPI's other conditions and consummate the HCPI Transactions are subject to a
number of uncertainties and depend upon a number of factors, many of which are
beyond the Company's control. Accordingly, there can be no assurance that the
Company can successfully complete the Exchange Offer as required by HCPI or
satisfy the other conditions required by HCPI and consummate the HCPI Loan or
obtain the HCPI Equity Investment.
The Company will use the net proceeds of the HCPI Transactions, together with
cash on hand, to repay first the principal amount of and accrued interest on the
Series A Notes when they mature on September 30, 2002 and then the principal
amount of and interest on the remaining Debentures when they mature on October
1, 2002. If the holders of the Debentures do not validly tender at least 75% of
the aggregate principal amount of the Debentures on the terms currently
contemplated and the Company does not consummate the HCPI Transactions, the
Company will be forced to seek other financing alternatives. At the present
time, the Company does not have any alternative sources of financing that would
provide it with sufficient funds to repay the Series A Notes and the Debentures
at maturity. As a result of the Company's current financial condition and the
fact that substantially all of the Company's properties are fully encumbered by
mortgage or lease financings, the Company does not believe it would be able to
obtain such alternative financing prior to the maturity of the Series A Notes
and the Debentures. The Company also does not believe that it would be able to
sell its properties in the time or at values necessary to raise sufficient cash
to satisfy the Series A Notes and the Debentures at maturity. In addition, a
sale of the Company's assets could have adverse tax consequences to the Company.
If the Company is unable to consummate the HCPI Transactions by September 30,
2002 and repay the principal of and interest on the Series A Notes, the Company
will be in default under approximately $137.3 million of mortgage indebtedness
and under the indenture governing the Series A Notes. In addition, because of
cross-default and cross-collateralization provisions in many of the Company's
other debt instruments and leases, those defaults are likely to
35
result in a default and acceleration of substantially all of the Company's other
debt and lease obligations, including the Series B Notes and the Debentures. As
of June 30, 2002, the Company had approximately $381.8 million of senior secured
debt and capital lease obligations, $132.9 million of Debentures and
approximately $50.3 million of annual lease obligations. In addition, as of June
30, 2002, the Company had guaranteed $93.1 million of third-party senior debt in
connection with a community that the Company manages, the Company's joint
ventures and certain of the Company's lease financings. As a result, a default
under the indenture governing the Series A Notes, the Series B Notes and the
Debentures and the Company's other debt and lease obligations would have a
material adverse effect upon the Company and could make it necessary for the
Company to seek protection from its creditors under federal bankruptcy laws.
In the event that the Company successfully consummates the Exchange Offer and
the HCPI Transactions, it will remain highly leveraged with a substantial amount
of debt and lease obligations, and will have increased interest and lease
expenses. The Company, however, expects that its cash flow from operations will
improve, and, accordingly, expects that its current cash and cash equivalents,
expected cash flow from operations, and the proceeds from successful completion
of the Refinancing Plan (including the HCPI Transactions and the Exchange Offer)
will be sufficient to fund its operating requirements, its capital expenditure
requirements, its periodic debt service requirements and its lease obligations
during the next twelve months.
Cash flow
Net cash used by operating activities was $8.1 million for the six months ended
June 30, 2002, as compared with $31,000 used for the six months ended June 30,
2001. The Company's cash and cash equivalents totaled $12.3 million as of June
30, 2002, as compared to $19.3 million as of December 31, 2001.
Net cash provided by investing activities was $60.4 million for the six months
ended June 30, 2002, as compared with $4.2 million used for the six months ended
June 30, 2001. During the six months ended June 30, 2002, the Company received
$92.1 million from sales of assets, purchased assets limited as to use of $7.7
million, added $13.1 million to land, building and equipment, issued $8.6
million of notes receivable, and made $1.9 million in security deposits.
Net cash used by financing activities was $59.4 million compared with $6.7
million provided by financing activities during the six months ended June 30,
2002 and 2001, respectively. During the six months ended June 30, 2002, the
Company borrowed $189.4 million under long-term debt arrangements, made
principal payments on its indebtedness of $236.8 million, recorded $5.3 million
of contingent earnouts, and paid $3.7 million of financing costs. In connection
with certain lifecare communities, the Company made principal payments and
refunds under master trust agreements of $3.1 million.
Liquidity
The Company currently does not generate sufficient cash flow to meet its debt
and lease payment obligations. The Company expects that its cash flow from
operations will improve, and, accordingly, expects that its current cash and
cash equivalents, expected cash flow from operations, and the proceeds from
certain recently completed financings will be sufficient to fund its operating
requirements, its capital expenditure requirements and its periodic debt service
requirements through June 30, 2003. However, the Company's current cash balances
and internally generated cash (including the proceeds from recently completed
financings) will not be sufficient to satisfy its scheduled debt maturities in
2002. Accordingly, the Company's ability to satisfy its maturing obligations in
2002 will depend primarily upon its ability to successfully complete the
Exchange Offer on the terms required by HCPI and to consummate the HCPI Loan and
the HCPI Equity Investment.
Many of the Company's credit and other agreements contain restrictive covenants
that include, among other things, the maintenance of prescribed debt service
coverage, liquidity, capital expenditure reserves and occupancy levels. In
addition, certain of these agreements require that the Company raise a
prescribed amount of capital and provide evidence of sufficient capacity to pay
off the Debentures prior to their maturity. Effective as of June 30, 2002, the
Company and certain of its lenders agreed to waivers relating to certain
financial covenants in order to allow the
36
Company to remain in compliance. As part of its Refinancing Plan, the Company
has renegotiated most of its financial covenants to levels that it believes it
can satisfy for the forseeable future. Included in the renegotiated financial
covenants related to approximately $137.3 million of mortgage indebtedness are
covenants that require the Company to successfully retire or extend the
Debentures. There can be no assurances, however, that the Company will remain in
compliance with those covenants or that the Company's creditors will grant
further amendments or waivers in the event of future non-compliance. Failure to
remain in compliance with those covenants would have a material adverse impact
on the Company, and would result in a default under a substantial majority of
the Company's indebtedness and other obligations, and could result in an
acceleration of the maturity of those obligations.
A significant amount of the Company's indebtedness and lease agreements is
cross-defaulted. Any non-payment or other default with respect to such
obligations (including non-compliance with a financial or restrictive covenant)
could cause the Company's 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 most of the Company's
mortgages, debt instruments, and leases, a default by the Company on one of its
debt instruments or lease agreements is likely to result in a default or
acceleration of substantially all of the Company's other obligations, which
would have a material adverse effect on the Company.
While the Company anticipates completing the Refinancing Plan and consummating
the Exchange Offer, the HCPI Loan and the HCPI Equity Investment on or before
September 30, 2002, there can be no assurances that the Company will be able to
do so or that the Company will be able to satisfy its maturing obligations
(including the Debentures). The Company's ability to consummate the Exchange
Offer and the HCPI Transactions depends upon a number of factors, many of which
are beyond the Company's control. These factors include the satisfaction of
conditions relating to the HCPI Transactions (including a successful completion
of the Exchange Offer on the terms required by HCPI), the Company's financial
condition and operating performance, the financial strength of the Company's
assets, the requirement for regulatory approvals and other approvals and
consents, general economic conditions, general conditions in the credit markets,
the condition of the senior living industry, and other factors.
The failure to consummate the Exchange Offer on the terms required by HCPI or to
consummate the HCPI Transactions will have a material adverse effect on the
Company and could make it necessary for the Company to seek protection from its
creditors under federal bankruptcy laws.
The Company's financial condition could adversely effect the Company's ability
to retain existing residents, attract prospective residents and maintain
customary terms of payment from its vendors, which could have a material adverse
effect on the Company's operating results and liquidity and could adversely
effect the Company's ability to consummate the Refinancing Plan and the HCPI
Transactions. The Company believes that, if the Exchange Offer and the HPCI
Transactions are consummated as currently planned, the HCPI Transactions will
generate sufficient net proceeds to satisfy the scheduled debt maturities during
2002.
In the event that the Company successfully consummates the HCPI Loan and HCPI
Equity Investment, it will continue to be highly leveraged, and will have
substantial debt and lease obligations, and will have increased interest and
lease expenses. The Company will incur substantial costs in connection with the
consummation of the Refinancing Plan, the Exchange Offer, the HCPI Loan and the
HCPI Equity Investment. As a part of the Refinancing Plan, the Company has
consummated sale lease-back transactions relating to 16 communities and various
other refinancing and capital raising transactions, generating gross proceeds of
approximately $362.0 million. As part of these extensions and refinancings, the
Company has replaced a significant amount of mortgage debt with higher cost
leases, increasing the Company's annual debt and lease payments by approximately
$14.4 million. In addition, the interest costs under the HCPI Loan and the
Series B Notes are significantly higher than the interest cost of the
Debentures. Assuming that the Company completes the Exchange Offer and exchanges
$99.7 million principal amount of the Debentures in the Exchange Offer and that
the Company elects to pay 2% interest on the Series B Notes through the issuance
of additional Series B Notes rather than in cash, the Company's annual interest
payments would increase by approximately $4.0 million. In addition, the Company
would accrue an additional $12.5 million of interest expense, that is not
currently payable, pursuant to the HCPI Loan and the Series B Notes.
37
Financing Activity
During the six months ended June 30, 2002, the Company entered into various
financing transactions.
On January 1, 2002, the Company completed a sale lease-back of a retirement
center in North Carolina for $45.0 million. The lessor assumed $34.8 million of
debt associated with the property, resulting in an assumption penalty of
$348,000, coupled with $50,000 of unamortized financing costs, which the Company
has recorded as an extraordinary loss. The lease agreement has an initial term
of 15 years with two five-year renewal options and a right of first refusal to
repurchase the community. The Company recorded a gain of $11.7 million on the
sale, which is being amortized over the term of the lease. In conjunction with
this sale, on January 1, 2002, the Company acquired a Free-standing AL in
Florida for $7.1 million, which it had previously managed for the buyer of the
Retirement Center located in North Carolina. The Company funded this acquisition
by assuming a $4.7 million mortgage note bearing interest at a floating rate of
5.63% at March 31, 2002. Interest is due monthly with remaining principal and
unpaid interest due December 31, 2002. The note is secured by certain land,
buildings, and equipment.
On January 25, 2002, the Company amended two loan agreements with aggregate
outstanding indebtedness of $7.2 million. The amendment extends the due dates of
the agreements to December 31, 2002, requires additional monthly principal
payments of $60,000, and a $1.0 million cash collateral deposit. In connection
with the amendment, the Company agreed to, among other things, (1) retire or
refinance approximately $92.3 million of indebtedness on or before July 1, 2002,
so as to mature no earlier than December 1, 2003 and (2) retire or refinance the
$132.9 million outstanding principal amount of its Debentures on or before
September 1, 2002 so as to mature no earlier than October 1, 2004. Failure to
accomplish the retirement or refinancing of this debt could result in the
acceleration of the outstanding indebtedness. On July 11, 2002, this debt was
paid off in conjunction with the sale leasebacks of the respective properties.
See notes 2 and 10 to the condensed consolidated financial statements.
On February 12, 2002, the Company sold a Free-standing AL in Florida for $9.7
million. The Company contemporaneously leased the property back from the buyer
under a 15-year lease agreement with two five-year renewal options and a right
of first refusal to repurchase the community. The Company used a portion of the
sale proceeds to repay $8.6 million of debt associated with the property. The
sale agreement contains certain formula-based earnout provisions which may
provide additional sales proceeds to the Company based on future performance. As
a result of the contingent earn-out provisions, for financial reporting
purposes, this transaction was recorded as a financing transaction and the
Company recorded $9.7 million of lease obligation as debt, bearing interest of
7.55%. The Company recorded a $1.4 million loss as a result of this transaction.
For financial reporting purposes, these losses are considered residual value
guarantee amounts under the previous leases terminated in connection with the
sale lease-back transaction and have been fully recognized as lease expense.
On February 12, 2002, the Company sold for $18.5 million a retirement center in
Illinois. The Company used a majority of the sale proceeds to repay $12.9
million of debt associated with the property, resulting in the Company expensing
$259,000 of unamortized financing cost as an extraordinary item. The Company
contemporaneously leased the property back from the buyer under a 15-year lease
agreement with two five-year renewal options, and has the right of first refusal
to repurchase the community. The Company recorded a gain of $5.3 million on the
sale, which is being amortized on a straight-line basis over the term of the
lease.
On March 22, 2002, the Company sold a Free-standing AL in Colorado, for $17.9
million. The Company contemporaneously leased the property back from the buyer
under a 15-year lease agreement with two five-year renewal options and a right
of first refusal to repurchase the community. The Company used a portion of the
sale proceeds to repay $16.3 million of debt associated with the property,
resulting in the Company expensing $259,000 of unamortized financing cost as an
extraordinary item. The sale agreement contains certain formula-based earnout
provisions which may provide additional sales proceeds to the Company based on
future performance. As a result of the contingent earn-out provisions, for
financial reporting purposes, this transaction was recorded as a financing
transaction and the Company recorded $17.9 million of lease obligation as debt,
bearing interest of 7.46%. The Company recorded a $5.8 million loss as a result
of this transaction. For financial reporting purposes, these losses are
38
considered residual value guarantee amounts under the previous leases terminated
in connection with the sale lease-back transaction and have been fully
recognized as lease expense.
On March 28, 2002, the Company sold two retirement centers and three
Free-standing ALs for $73.2 million. The Company used a portion of the proceeds
to repay $55.2 million of debt, resulting in the Company expensing $99,000 of
unamortized financing cost as an extraordinary item. The Company
contemporaneously leased the properties back from the buyer under a 15-year
lease agreement with two ten-year renewal options. The sale agreements for the
three Free-standing ALs contain certain formula-based earnout provisions which
may provide additional sales proceeds to the Company based on future
performance. As a result of the contingent earn-out provisions, for financial
reporting purposes, the Free-standing AL transactions were recorded as financing
transactions and the Company recorded $18.2 million of lease obligation as debt,
bearing interest of 9.37%. The Company recorded a $17.8 million loss as a result
of the sale of these three AL's. For financial reporting purposes, these losses
are considered residual value guarantee amounts under the previous leases
terminated in connection with the sale lease-back transaction and have been
fully recognized as lease expense. One of the retirement center leases is
recorded as a capital lease and the Company recorded $25.0 million of lease
obligation as debt, bearing interest of 8.27%. The other retirement center lease
is being accounted for as an operating lease, since the sale agreement for this
community did not contain a contingent earnout provision or other continuing
involvement provisions. The Company recorded a gain of $697,000 on the sale of
this retirement center, which is being amortized on a straight-line basis over
the term of the lease. The Company has an option to acquire the retirement
center that has been accounted for as a capital lease after March 28, 2006,
subject to certain conditions.
On May 31, 2002, the Company replaced two mortgage notes maturing December 31,
2002 totaling $82.7 million with a $95.7 million mortgage note with the same
lender which matures May 31, 2005. The Company applied the provisions of EITF
96-19, "Debtor's Accounting for a Modification or Exchange of Debt Instruments"
in determining the treatment of costs incurred related to the exchange of debt
instruments. As such, the commitment fee of $957,000 which, along with $128,000
of unamortized financing costs on the previous notes, will be amortized as a
yield adjustment over the term of the new mortgage note, while $972,000 of legal
and investment advisor fees are recorded in general and administrative expense.
The new mortgage debt has a fixed and variable interest component, principal and
interest due monthly, based on a 25-year amortization, and remaining principal
and unpaid interest due May 31, 2005, with two one-year renewal options. The
fixed rate component converts to a variable rate on January 1, 2003. The Company
purchased an interest rate cap agreement for $789,000, which would limit the
Company's variable interest expense if one-month LIBOR should exceed 5.8% over
the term of the mortgage. The Company has designated the cap as a cashflow
hedge. As such, any changes in the fair value of the cap while 30-day LIBOR does
not exceed 5.8% is recognized as interest expense during the current period. The
fair value of the cap was $584,000 at June 30, 2002. In connection with the
debt, in the event that on or before September 30, 2002, either the Debentures
have not been retired or the Company has not provided to the Lender evidence
that the Company holds an amount of unrestricted cash sufficient to retire the
Debentures, the Company would be in default and the Lender could exercise its
contractual remedies, including all amounts due being payable on demand. The
note is secured by certain land, buildings, and equipment, and contains
cross-default provisions.
As a result of completed and anticipated transactions under the Refinancing
Plan, the Company has recorded losses from sale lease-back transactions of $7.9
million during the quarter ended December 31, 2001, $23.2 million during the
quarter ended March 31, 2002, and $7.0 million during the quarter ended June 30,
2002, bringing the total loss on these sale lease-back transactions to $38.1
million. For financial reporting purposes, these losses are considered residual
value guarantee amounts under the previous leases terminated in connection with
the sale lease-back transactions and have been fully recognized as lease
expense. See note 4.
In addition, due to the shorter than expected remaining life of the previous
leases terminated in connection with the sale lease-back transactions, the
Company accelerated the amortization of leasehold acquisition costs beginning in
the fourth quarter of 2001. As a result of this acceleration, the Company
recorded additional amortization costs of $472,000 during the quarter ended
December 31, 2001, $6.5 million during the quarter ended March 31, 2002, and
$2.3 million during the quarter ended June 30, 2002, bringing the total amount
of accelerated amortization related to these sale lease-back transactions to
$9.3 million.
39
Effective as of June 30, 2002, the Company obtained waivers under various
financing agreements with respect to certain of its financial covenants. See
note 2 to the condensed consolidated financial statements.
The Company announced, during the quarter ended March 31, 2000, that its Board
of Directors had authorized the repurchase, from time to time, of up to $30.0
million of its Debentures. During the six months ended June 30, 2001, the
Company purchased $3.3 million of the Debentures, resulting in an extraordinary
gain on extinguishment of debt, net of tax, of $395,000. The Company has
initiated the Exchange Offer with respect to the Debentures and no longer
expects to purchase any of the Debentures on the open market.
FUTURE CASH COMMITMENTS
The following tables summarize the Company's total contractual obligations and
commercial commitments as of June 30, 2002 (amounts in thousands). This
information only reflects the effect of those elements of the Company's
Refinancing Plan that have been completed as of June 30, 2002, and does not
include the impact of remaining transactions contemplated in the Refinancing
Plan that were not yet completed as of that date:
40
Payments Due by Period
---------------------------------------------------------------------------
Less than 1 - 3 4 - 5 After 5
Total 1 year years years Years
----- ------ ----- ----- -----
Long-term debt $ 423,751 $ 162,663 $ 141,786 $ 36,700 $82,602
Capital lease obligations 91,003 2,692 5,622 7,328 75,361
Operating leases 425,071 50,256 106,277 101,979 166,559
Lease payments that apply to debt(1) (54,010) (54,010) -- -- --
Interest income on notes receivable
and security deposits(2) (5,992) (501) (2,943) (1,376) (1,172)
===========================================================================
Total contractual cash obligations (3) $ 879,823 $ 161,100 $ 250,742 $ 144,631 $ 323,350
===========================================================================
(1) Approximately $54.0 million of the $93.1 million of guaranteed mortgage
debt is associated with seven of the nine synthetic leases remaining at
June 30, 2002. As such, these lease payments are included within both
operating leases and guaranties listed in the table below.
(2) A portion of the lease payments noted in the above table are repaid to
the Company as interest income on notes receivable from lessors.
(3) See note 2 to the condensed consolidated financial statements related
to the Company's plans regarding the 2002 obligations. These amounts do
not include the impact of the remaining transactions contemplated in
the Refinancing Plan that were not yet completed as of June 30, 2002,
nor do they reflect cash requirements for certain debt that is
accelerated if the refinancing plan is not consummated.
Amount of Commitment Expiration Per Period
-------------------------------------------------------------------------
Total
Amounts Less than 1 - 3 4 - 5 After 5
Committed 1 year years years Years
Guaranties(1) $ 93,092 9,540 39,079 11,623 32,850
-------------------------------------------------------------------------
Total commercial commitments $ 93,092 $ 9,540 $ 39,079 $ 11,623 $ 32,850
=========================================================================
(1) Guaranties include mortgage debt related to 11 communities (four Retirement
Centers, five Free-standing ALs, and two joint ventures). Approximately
$54.0 million of the $93.1 million is associated with seven of the 14
synthetic leases the Company determined during the fourth quarter of 2001
to terminate. The remaining mortgage debt guaranteed by the Company relates
to two Retirement Centers under a long-term management agreement and a
long-term operating lease agreement and the Company's two joint ventures.
These amounts do not include the Company's residual value guaranties under
the remaining nine synthetic leases which were $162.8 million as of June
30, 2002.
The Company routinely makes capital expenditures to maintain or enhance
communities under its control. The Company's capital expenditure budget for
fiscal 2002 is approximately $14.7 million.
RISKS ASSOCIATED WITH FORWARD LOOKING STATEMENTS
This Form 10-Q contains certain forward-looking statements within the meaning of
the federal securities laws, which are intended to be covered by the safe
harbors created thereby. Those forward-looking statements include all statements
that are not historical statements of fact and those regarding the intent,
belief or expectations of the Company or its management including, but not
limited to, all statements concerning the Company's expectations regarding the
HCPI Loan, the HCPI Equity Investment and the Exchange Offer; the Company's
anticipated improvement in operations and anticipated or expected cashflow; 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 Company's alternatives for raising additional capital and
satisfying its maturing obligations; the
41
projections of revenue, income or loss, capital expenditures, and future
operations; and the availability of insurance programs. Investors are cautioned
that all forward-looking statements involve risks and uncertainties including,
without limitation, (i) the possibility that the Company will be unable to
consummate the Exchange Offer on the terms required by HCPI, (ii) the
possibility that the Company will be unable to satisfy the other conditions to
the HCPI Loan Agreement or the HCPI Equity Investment Agreement or that such
agreements may be amended or modified or that the Company will be unable to
obtain the HCPI Loan or HCPI Equity Investment, (iii) the possibility of future
defaults under the Company's debt and lease agreements (including the
Debentures), (iv) the risks associated with the Company's financial condition
and the fact that the Company is highly leveraged, (v) the risk that the Company
will be unable to reduce the operating losses at its Free-standing ALs or
increase its cash flow or generate expected levels of cash, (vi) the risks
associated with the adverse market conditions for the senior living industry,
(vii) the risk that the Company will be unable to obtain liability insurance in
the future or that the costs associated with such insurance (including the costs
of deductibles) will be prohibitive, (viii) the likelihood of further and
tighter governmental regulation, 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, 2001 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.
42
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 an interest
rate swap agreement with a major financial institution to manage its exposure.
The swap involves the receipt of a fixed interest rate payment in exchange for
the payment of a variable rate interest payment without exchanging the notional
principal amount. Receipts on the agreement are recorded as a reduction to
interest expense. At June 30, 2002, the Company's outstanding notional amount of
its existing swap agreement was $34.8 million maturing July 1, 2008. Under the
agreement the Company receives a fixed rate of 6.87% and pays floating rates
based upon LIBOR and a foreign currency index with a maximum rate through July
1, 2002 of 8.12%.
The Company has also entered into an interest rate cap agreement on a $95.7
million mortgage note to limit the Company's interest rate exposure. Under the
terms of the interest rate cap agreement, the Company receives payments from the
counterparty if one-month LIBOR exceeds 5.8% over the term of the mortgage. The
Company does not expect changes in interest rates to have a material effect on
income or cash flows in 2002, since 64.6% 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.
As a part of its Refinancing Plan, the Company has consummated sale lease-back
transactions relating to 16 communities and various other refinancing and
capital raising transactions, generating gross proceeds of approximately $362.0
million. As part of these extensions and refinancings, the Company has replaced
a significant amount of mortgage debt with higher cost leases, increasing the
Company's annual debt and lease payments by approximately $14.4 million. In
addition, the interest costs under the HCPI Loan and the Series B Notes are
significantly higher than the interest cost of the Debentures. Assuming that the
Company completes the Exchange Offer and exchanges $99.7 million principal
amount of the Debentures in the Exchange Offer and that the Company elects to
pay 2% interest on the Series B Notes through the issuance of additional Series
B Notes rather than in cash, the Company's annual interest and lease costs would
increase by approximately $4.0 million. In addition, the Company would accrue an
additional $12.5 million of interest expense, that is not currently payable,
pursuant to the HCPI Loan and the Series B Notes.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
10.1 Loan Agreement Among Fort Austin Real Estate Holdings, LLC, as
Borrower, Fort Austin Limited Partnership, as Operating Lessee, and
General Electric Capital Corporation, as Lender, dated May 15, 2002
10.2 Lease Agreement by and between Freedom Plaza Limited Partnership, an
Arizona Limited Partnership, and American Retirement Corporation, a
Tennessee Corporation, dated April 1, 2002
10.3 Promissory Note dated April 1, 2002, between Freedom Plaza Limited
Partnership, an Arizona Limited Partnership, and American Retirement
Corporation, a Tennessee Corporation
99.1 Certification of W.E. Sheriff Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification of George T. Hicks Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
b. Reports on Form 8-K
On May 16, 2002, the Company furnished to the SEC a Form 8-K disclosing for
purposes of Regulation FD supplemental financial information relating to
the Company's first quarter ended March 31, 2002.
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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: August 14, 2002 By: /s/ George T. Hicks
-------------------
George T. Hicks
Executive Vice President-Finance, Chief
Financial Officer, Secretary and Treasurer
(Principal Financial and Accounting Officer)
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