UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
___X___ Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 2003
Commission file number 01-13031
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 of (I.R.S. Employer
Incorporation or Organization) Identification No.)
111 Westwood Place, Suite 200, Brentwood, TN 37027
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (615) 221-2250
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
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Common Stock, par value $.01 per share NYSE
Series A Preferred Stock Purchase Rights NYSE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes ___ No _X_
The aggregate market value of common stock held by non-affiliates of the
registrant as of June 30, 2003, the last business day of the registrant's most
recently completed second fiscal quarter, was approximately $39.3 million. The
market value calculation was determined using a per share price of $2.10, the
price at which the common stock was last sold on the New York Stock Exchange on
such date. For purposes of this calculation, shares held by non-affiliates
excludes only those shares beneficially owned by officers, directors, and
shareholders owning 10% or more of the outstanding common stock (and, in each
case, their immediate family members and affiliates).
As of March 5, 2004, 21,827,264 shares of the registrant's common stock were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for use in connection with the
Annual Meeting of Shareholders to be held on May 19, 2004 are incorporated by
reference into Part III, items 10, 11, 12, 13 and 14 of this Form 10-K.
CONTENTS:
Page
PART I
Item 1. Business 3
Item 2. Properties 15
Item 3. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security Holders 18
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 18
Item 6. Selected Financial Data 18
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 20
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 45
Item 8. Financial Statements and Supplementary Data 46
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 75
Item 9A. Controls and Procedures 75
PART III
Item 10. Directors and Executive Officers of the Registrant 76
Item 11. Executive Compensation 76
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters 76
Item 13. Certain Relationships and Related Transactions 76
Item 14. Principal Accountant Fees and Services 76
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 77
2
PART I
Item 1. Business
The Company
American Retirement Corporation (collectively with its wholly-owned and majority
owned subsidiaries, the "Company"), established in 1978, is one of the ten
largest operators of senior living communities in the United States. The Company
is a senior living and health care services provider offering a broad range of
care and services to seniors, including independent living, assisted living,
skilled nursing and therapy services. The senior living industry is a growing
and highly fragmented industry. The Company believes it is one of the few
national operators providing a range of service offerings and price levels
across multiple communities. The Company currently operates 65 senior living
communities in 14 states, with an aggregate unit capacity of approximately
12,900 units and resident capacity of approximately 14,500. The Company owns 19
communities, leases 41 communities, and manages five communities pursuant to
management agreements.
The Company believes it is a leading operator of independent living communities,
continuing care retirement communities ("CCRCs"), and free-standing assisted
living communities ("Free-standing ALs"). The Company has also developed
specialized care programs for residents with Alzheimer's and other forms of
dementia and provides therapy services to many of its residents. The Company's
operating philosophy was inspired by the vision of its founders, Dr. Thomas F.
Frist, Sr. and Jack C. Massey, to enhance the lives of seniors by striving to
provide the highest quality of care and services in well-operated communities
designed to improve and protect the quality of life, independence, personal
freedom, privacy, spirit, and dignity of its residents.
Operating Segments
The Company operates in three distinct business segments: Retirement
Centers, Free-standing ALs, and Management Services.
Retirement Centers - The Company operates large CCRCs and independent living
communities ("Retirement Centers") that provide an array of services, including
independent living, assisted living, Alzheimer's and skilled nursing care.
Retirement Centers are large, often campus style or high-rise settings with an
average unit capacity of approximately 300 units. These communities generally
maintain high and consistent occupancy levels, many with waiting lists of
prospective residents. The Company's Retirement Centers are the largest segment
of the Company's business and comprise 27 of the 65 communities that the Company
operates, with unit capacity of approximately 8,100, representing approximately
63% of the total unit capacity of the Company's communities. At both December
31, 2003 and 2002, the Company's Retirement Centers had an occupancy rate of
94%.
Free-standing ALs - The Company's Free-standing ALs provide specialized assisted
living care to residents in a comfortable residential atmosphere. Most of the
Free-standing ALs provide specialized care such as Alzheimer's, memory
enhancement and other dementia programs. These communities are designed to
provide care in a home-like setting, which the Company believes residents prefer
as opposed to the more clinical or institutional settings offered by some other
providers. Free-standing ALs are much smaller than Retirement Centers and have
an average unit capacity of 91 units. At each of its Free-standing ALs, the
Company provides personalized care plans for each resident, extensive activity
programs, and access to therapy or other services as needed. Most of the
Company's Free-standing ALs were developed and opened during 1999 and 2000, in
response to the emergence of the assisted living segment of the senior living
industry in the mid-1990s. While the assisted living segment of the industry has
grown rapidly during the past decade, it has also suffered from adverse market
conditions, including significant overdevelopment and overcapacity in most
markets, resulting in longer than anticipated fill-up periods, price discounting
and price pressures. The adverse overcapacity conditions and price pressures
improved in many markets during 2003, and the Company expects these conditions
to continue to improve in 2004 in many markets. The Company operates 33
Free-standing ALs, with unit capacity of approximately 3,000, representing
approximately 23% of the total unit capacity of the Company's communities.
Seventeen of these Free-standing ALs are still in the fill-up stage and have not
yet reached stabilized occupancy levels (i.e., 90% or greater occupancy).
Excluding two communities owned through non-consolidated joint ventures and
three communities which are designated as held-for-sale, the 28 Free-standing
ALs included in this segment had occupancy rates of 84% and 81% at December 31,
2003 and 2002, respectively.
3
Management Services - The Company also operates five large Retirement Centers
owned by others under multi-year management agreements ("Management Services").
Under its management agreements, the Company receives management fees as well as
reimbursed expense revenues which reimburse associated expenses the Company
incurs on behalf of the owners. Two of these communities are Retirement Center
cooperatives that are owned by their residents, and one of these is a Retirement
Center owned by a not-for-profit sponsor. A fourth Retirement Center is owned by
an unaffiliated third party. The Company's remaining management agreement
relates to the Freedom Square Retirement Center ("Freedom Square"), a 735-unit
entrance fee Community, which the Company manages pursuant to a long-term
management contract. These five communities have approximately 1,800 units,
representing approximately 14% of the total unit capacity of the Company's
communities.
Operating results from these segments are discussed further in Management's
Discussion and Analysis of Financial Condition and Results of Operations and
Note 19 to the Company's consolidated financial statements.
Care and Services Programs
The Company provides a wide array of senior living and health care services at
its communities, including independent living, assisted living and memory
enhanced services (with special programs and living units for residents with
Alzheimer's and other forms of dementia), skilled nursing services, and therapy
services. By offering a variety of services and involving the active
participation of the resident, resident's family and medical consultants, the
Company is able to customize its service plans to meet the specific needs and
desires of each resident. As a result, the Company believes that it is able to
maximize resident satisfaction and avoid the high cost of delivering all
services to every resident without regard to need, preference, or choice.
Independent Living Services
The Company provides independent living services to seniors who do not yet need
assistance or support with the activities of daily life ("ADLs"), but who prefer
the physical and psychological comfort of a residential community for seniors
that offers health care and other services. Independent living services provided
by the Company include daily meals and dining programs, transportation, social
and recreational activities, laundry, housekeeping, security, and health care
monitoring. The Company employs health care professionals to foster the wellness
of its residents by offering health screenings, ongoing dietary, exercise and
fitness classes, and chronic disease management (such as diabetes with blood
glucose monitoring). Subject to applicable government regulation, personal care
and medical services are available to independent living residents. The
Company's residency agreements with its independent living residents (other than
entrance fee contracts) are generally for a term of one year (terminable by the
resident upon 30 to 60 days written notice), although most residents remain for
many years. The agreements generally provide for increases in billing rates each
year (subject to specified ceilings at certain communities). Residents are also
billed monthly for ancillary services utilized over and above those included in
their recurring monthly service fees. These revenues are generally paid from
private pay sources and are recognized monthly when the services are provided.
Assisted Living and Memory Enhanced Services
Residents who receive the Company's assisted living services generally need
assistance with some or all ADLs, but do not require the more acute medical care
provided in a typical nursing home environment. Upon admission, each assisted
living resident is assessed, in consultation with the resident, the resident's
family and medical consultants, to determine his or her health status, including
functional abilities and need for personal care services. Each resident also
completes a lifestyles assessment to determine the resident's preferences. From
these assessments, a care plan is developed in an effort to ensure that the
specific needs and preferences of each resident are satisfied to the extent
possible. Each resident's care plan is reviewed periodically to determine when a
change in care is needed.
4
The Company has adopted a philosophy of assisted living care with the goal of
allowing a resident to maintain a dignified, independent lifestyle. Residents
and their families are encouraged to be partners in their care and to take as
much responsibility for the resident's well being as possible. The basic types
of assisted living services offered by the Company include:
-- Personal Care Services - which include assistance with ADLs such as
ambulation, bathing, dressing, eating, grooming, personal hygiene,
monitoring or assistance with medications, and confusion management;
-- Support Services - such as meals, assistance with social and
recreational activities, laundry services, general housekeeping,
maintenance services and transportation services; and
-- Special Care Services - such as the Company's "Arbors" memory
enhancement programs and other specialized services to care for
residents with Alzheimer's and other forms of dementia in a
comfortable, homelike setting.
The Company maintains programs and special "Arbors" units at most of its
assisted living communities for residents with Alzheimer's and other forms of
dementia. These programs provide the attention, care, and services to help those
residents maintain a higher quality of life. Specialized services include
assistance with activities of daily living, behavior management, and a
lifeskills-based activity program, the goal being to provide a normalized
environment that supports residents' remaining functional abilities. These
special units are located in a separate area of the communities and have their
own dining and lounge facilities, and specially trained staff.
Agreements for the Company's assisted living services are month to month and
provide for annual or other periodic increases to the monthly service fees.
Monthly service fees are based on size of unit selected, additional services
provided, and level of care required. Specialized units for those with
Alzheimer's or other forms of dementia have higher billing rates to cover the
increased staffing and program costs associated with these services. These
revenues, generally from private pay sources, are recognized as revenue on a
monthly basis when the services are provided.
Skilled Nursing
Within its Retirement Center campuses, the Company operates seventeen skilled
nursing centers providing traditional skilled nursing care by registered nurses,
licensed practical nurses, and certified nursing aides. The Company also offers
a range of therapy rehabilitation services in these communities. Therapy
services are typically rendered immediately after, or in lieu of, acute
hospitalization in order to treat specific medical conditions. The Company's
skilled nursing services are primarily utilized by the Company's independent and
assisted living residents who occupy the skilled nursing centers at the
Company's Retirement Centers on a temporary or long-term basis. However, the
Company also provides skilled nursing services to those admitted from outside
the Retirement Center for temporary stays following hospitalization or other
health issues, some of which also become long-term residents of the Retirement
Center. These skilled nursing services are provided to the individuals on a
daily fee basis, with additional charges for specialized equipment, therapy,
medications or medical supplies in many cases. These services are paid for
primarily by private pay sources, long-term care insurance, and under the
Medicare, and in some cases Medicaid, programs. Daily rates are revised
periodically in response to cost changes and market conditions. These daily
revenues are recognized when the services are provided.
Therapy Services
The Company historically contracted with independent third parties to provide
therapy services to its residents. Beginning in 2000, the Company began
administering therapy services itself and greatly expanded its in-house therapy
programs. The Company currently provides a range of therapy services to its
independent living, assisted living, and skilled nursing residents. The therapy
services provided by the Company include physical, occupational, and speech
therapy services. The Company believes that by providing these in-house therapy
services, it is able to maintain a consistent, high level of care to its
residents, provide a closer relationship between the therapist and the resident,
and provide many continuing education opportunities for residents and their
families through health fairs, seminars, and other consultative interactions. In
addition, programs focused on wellness and physical fitness allow residents to
maintain maximum independence. These services may be reimbursed under Medicare
or paid directly by residents from private pay sources and revenues are
recognized as services are provided.
5
Managed Communities
The Company's management agreements with third-parties have terms of three to
twenty years and require the Company to provide a wide range of services. The
Company may be responsible for providing all employees, and all marketing and
operations services at the community. In other agreements, the Company may
provide management personnel only, and more limited services including
assistance with marketing, finance and other operations. In each case, the costs
of owning and operating the community are the responsibility of the owner. In
most cases, the Company receives a monthly fee for its services based either on
a contractually fixed amount or a percentage of revenues or income. The
Company's existing management agreements expire at various times through June
2018, but certain agreements may be canceled by the owner of the community,
without cause, on three to six months' written notice.
Entrance Fee Agreements
Six of the Company's Retirement Centers (four owned, one leased and one managed)
are CCRC's that provide housing and health care services through entrance fee
agreements with residents (the "EF Communities"). In addition, the Company
manages two other Retirement Centers utilizing entrance fees, but does not
receive the economics of the entrance fee sales for these communities. Under
these agreements, residents pay an entrance fee, typically $100,000 to $400,000
or more, upon initial occupancy of a unit. The amount of the entrance fee varies
depending upon the type and size of the dwelling unit selected, the resident's
lifecare benefit election and other variables.
Under the entrance fee agreements, generally a portion of the entrance fee is
refundable to the resident or the resident's estate upon termination of the
entrance fee contract. The entrance fee agreements typically contain contractual
provisions reducing the percentage of the original entrance fee that is
refundable to the resident over time. In a relatively short period of time
(generally two to four years), the refundable portion of the entrance fee is
reduced to a fixed minimum percentage. However, for accounting purposes,
entrance fee revenues are recognized over a longer period based on actuarial
projections. The non-refundable portion of the fee is recorded as deferred
entrance fee income and is amortized into revenue using the straight-line method
over the estimated remaining life expectancy of the resident, based upon
actuarial projections. The refundable amount of the entrance fee is a long-term
liability and is recorded by the Company as refundable portion of entrance fees,
until termination of the agreement.
These entrance fee agreements include limited lifecare benefits which are
typically: (a) a certain number of free days in the community's skilled nursing
center during the resident's lifetime; (b) a discounted rate for such services;
or (c) a combination of the two. The limited lifecare benefit also varies based
upon the extent to which the resident's entrance fee is refundable.
At certain of its EF Communities, the Company offers an entrance fee program
that allows the resident to participate in the appreciation in the value of the
resident's unit (the "Partner Plan"). Under the Partner Plan, the entrance fee
is refundable to the resident or the resident's estate only upon the sale of the
unit to a succeeding resident unless otherwise required by applicable state law.
Typically, Partner Plan residents receive priority access to assisted living and
skilled nursing services, but no discounted or other lifecare benefits. The
resident shares in a specified percentage, typically 50%, of any appreciation in
the entrance fee paid by the succeeding resident. The entrance fees payable
under the Partner Plan are recorded by the Company as refundable entrance fees
and are amortized into revenue using the straight-line method over the remaining
life of the building.
The residents under all of the Company's entrance fee agreements also pay a
monthly service fee, which entitles them to the use of certain amenities and
certain services. As a result of paying an entrance fee upfront, the monthly fee
will be less than fees at a comparable rental community. Residents may also
elect to obtain additional services, which are billed on a monthly basis or as
the services are provided. The Company recognizes these additional fees as
revenue on a monthly basis when these services are provided.
6
Business Operations
Management Structure
Each of the Retirement Centers is managed by an Executive Director, with various
department heads responsible for functional areas such as assisted living,
activities, dining services, maintenance, human resources and finance. Within
the Retirement Centers, healthcare professionals manage the assisted living and
memory enhanced programs, as well as wellness and other programs. For those
communities with health centers providing skilled nursing services, licensed
professionals also manage those services and direct the nursing staff.
Each of the Free-standing ALs is managed by a Residence Manager whose primary
focus is resident care. These communities receive daily administrative central
support for operations, care planning, clinical assessments, quality assurance,
accounting and finance, human resources, dining and maintenance. By providing
strong program management and administrative support from the home office and at
the regional level, the staff at the Free-standing ALs can focus on the care of
the residents and interaction with their families or other caregivers.
The Retirement Centers and Free-standing ALs report to regional operation vice
presidents. These regional vice presidents and their staff regularly visit the
communities, providing inspection of the communities, staff development and
training, financial and program reviews, regulatory and compliance support, and
quality assurance reviews.
The home office provides central support to the communities in various areas,
including information technology, human resources, training, accounting,
finance, internal audit, insurance and risk management, legal, development,
sales and marketing, dining services, therapy services, operations and program
support, and national purchasing programs. Home office staff also provide
support for budgeting, financial analysis and strategic planning. In addition,
quality assurance and risk management staff review and monitor key safety and
quality measurements, train community staff, and visit communities regularly for
regulatory and other compliance programs. Human resource programs are developed
for staff training and retention in the communities, and are implemented by the
home office and regional staff.
The Company believes that, through its regional and home office staff, it is
able to provide strong support in each functional area on a cost effective
basis, which provides an advantage over many other smaller or local competitors.
In addition, by providing daily administrative support to its Free-standing ALs,
the company believes that its community staff are able to stay focused on
resident care and provide a higher level of service to the residents and their
families.
Marketing
Each community has an on-site marketing director, and additional marketing staff
based on its size. These community based marketing personnel are involved in
daily activities with prospective residents and key referral sources including
current residents and their families. Home office and regional marketing
directors assist each community in developing, implementing and monitoring their
detailed marketing plan. The marketing plans include goals for lead generation,
wait lists, referrals, community outreach, awareness events, prospect follow-up,
and monthly move-ins. Competitive analyses are also updated regularly. Home
office marketing staff provide coordination and monitoring of these marketing
plans, development of pricing strategies and overall marketing plans, assistance
with creative media, collection and analysis of data measuring effectiveness of
promotions, advertising, and lead sources, and selection and training of
regional and community staff. The Company believes that this locally based
marketing approach, coupled with strong regional and central monitoring and
support, provides an advantage over many smaller or regional competitors.
Feedback and Quality Assurance
The Company solicits regular feedback from its residents, their families, and
its employees through various satisfaction surveys. The Company also regularly
performs quality assurance reviews by community, regional and home office staff,
in addition to being subject to surveys and reviews by various local, state and
federal regulatory agencies. The Company believes that each of these activities
provides important feedback, which can be used by management to maintain high
levels of safety and quality, and to continue to look for opportunities to
improve its procedures and programs.
7
Senior Living Industry
The senior living industry is highly fragmented and characterized by numerous
local and regional operators. The Company is one of a limited number of national
competitors that provide a broad range of community locations and service level
offerings at varying price levels. The industry has seen significant growth in
recent years and has been marked by the emergence of the assisted living segment
in the mid-1990s.
The Company believes that a number of trends will contribute to the growth in
the senior living industry. The primary market for senior living services is
individuals age 75 and older. According to U.S. Census data, this group is one
of the fastest growing segments of the United States population and is expected
to more that double between the years 2000 and 2030. The population of seniors
age 85 and over has also increased in recent years, and is expected to continue
to grow. As a result of these expected demographic trends, the Company expects
an increase in the demand for senior living services in future years.
The Company believes the senior living industry has been and will continue to be
impacted by several other trends. The use of long-term care insurance is
increasing among current and future seniors as a means of planning for the costs
of senior living services. In addition, as a result of increased mobility in
society, reduction of average family size, and increased number of two-wage
earner couples, more seniors are looking for alternatives outside the family for
their care. Many seniors have shown an increasing preference for communities
that allow them to "age in place" in a residential setting, which provides them
maximum independence and quality of life in contrast to more institutional or
clinical settings. The emergence of the assisted living segment of the industry
in the mid-1990s is a prime example of this trend.
Competition
The senior living and health care services industry is highly competitive and
the Company expects that providers within the industry will continue to be
competitive in the future. During the second half of the 1990s, a large number
of assisted living units were developed across the country, including in many of
the Company's markets. This additional capacity increased the time required to
fill assisted living units in most markets and resulted in significant pricing
pressures in those markets. The Company believes that the primary competitive
factors in the senior living and health care services industry are: (i)
reputation for and commitment to a high quality of care; (ii) quality of support
services offered; (iii) price of services; (iv) physical appearance and
amenities associated with the communities; and (v) location. The Company
competes with other companies providing independent living, assisted living,
skilled nursing, and other similar service and care alternatives, many of whom
may have greater financial resources than the Company.
The senior living industry is highly fragmented and characterized by many local
or regional operators. The Company is one of a limited number of national
competitors that operate a large number of communities in multiple locations,
and that provide a broad range of senior living services at varying price
levels. The Company's size allows it to centralize administrative functions that
give the decentralized managerial operations cost-efficient support. The Company
believes it has a reputation as a leader in the industry and as a provider of
high quality services.
The Company also competes with other health care businesses with respect to
attracting and retaining nurses, technicians, aides, and other high quality
professional and non-professional employees and managers. The market for these
professionals has become very competitive, with resulting pressure on salaries
and compensation levels. However, the Company believes it is able to attract and
retain quality managers through its reputation, culture, organizational
stability, and competitive compensation.
Business Strategy
The Company's business strategy is to provide high-quality services to seniors
at affordable prices, maintain strong competitive positions in each of its
markets, and to enhance the value of its communities by expanding services and
improving operating results. The Company is implementing this business strategy
primarily through the following steps.
8
Improve Community Operating Results:
The primary areas on which the Company is focusing in order to improve its
operating results are:
-- Free-standing AL occupancy gains and increased revenue per unit - The
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Free-standing AL segment occupancy was 84% at December 31, 2003. The
Company is focusing on increasing the occupancy in these communities
and completing the fill-up of several of these communities. Revenue
per unit in this segment was $3,101 (per month) during the fourth
quarter of 2003, an increase of 8.6% over the fourth quarter of the
prior year. Subject to market and other conditions, the Company
expects that revenue per unit will increase over the next year as a
result of price increases, reduced price discounting, and the
"mark-to-market" effect of resident turnover as residents with lower
rates are replaced by those paying higher current market rates. The
Company expects that further occupancy increases will not require
significant incremental cost increases, and therefore will result in
high incremental operating margins.
-- Increase Retirement Center margins - The Company expects to continue
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to improve operating results at its Retirement Centers through a
combination of selling rate increases, increased revenues from
ancillary services (such as therapy services), incremental occupancy
increases and control of operating expenses. During 2003, the average
monthly revenue per occupied unit for the Retirement Centers increased
by 5.1%, driven by increased ancillary services revenue and increased
revenue from new residents paying higher monthly fees. Although the
Retirement Center segment had an overall occupancy rate of 94% at
December 31, 2003, the Company is focusing on filling several recent
expansions and increasing occupancy at selected communities (excluding
the four communities with the lowest occupancy, the overall occupancy
of the remaining communities is 96%). During 2003, the Retirement
Centers increased revenue by 9%, expenses by 7% and operating margin
by 13%.
-- Maintain strong entrance fee sales - The Company is focusing on
-------------------------------------
maintaining strong entrance fee sales activity. When a resident of an
EF Community vacates his or her independent living unit, the community
re-sells the unit to a new resident. When the former resident leaves
the community, he or she (or their estate) receives a refund, which is
typically a percentage of the initial entrance fee that he or she
paid. Consequently, the turnover of residents results in new entrance
fee sales (at higher current prices) and refunds to the former
residents equal to a percentage (typically 50%) of the original
entrance fee. As a result, the sale of entrance fee units at current
sales prices provides significant cash flows to the Company. In
addition, as new residents enter the EF Communities at current market
selling rates for monthly fees, the Company generates additional
revenues at the same level of occupancy. The Company's six EF
Communities have 3,010 total units, of which 2,066 are independent
living. The current aggregate occupancy of the independent living
units within the EF Communities is 95%, and the 105 independent living
units available for sale at December 31, 2003 represent approximately
$16.7 million of potential sales, based upon current entrance fee
prices.
-- Control operating expenses - The Company continues to focus on
----------------------------
managing its operating costs through active management and use of
information systems. In addition, the Company will continue to focus
on its overhead costs for savings opportunities in areas such as
telecommunications, utilities and staffing.
-- Excel at marketing and sales - The Company believes that it has a
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strong sales and marketing effort in each of its operating segments.
It will continue to focus on this area through careful recruitment,
ongoing training, strong systems support, and innovative incentive
rewards for its staff.
Improve Costs of Capital and Decrease Leverage:
As a result of financing obligations incurred for the Free-standing AL
development program begun in the late 1990s, and the slower fill up of these new
communities stemming from market overdevelopment and other adverse market
conditions, the Company entered 2002 with over $370 million of current debt
maturities. In order to refinance these maturities, the Company executed
mortgage refinancings, a series of sale-leaseback transactions (many on assisted
living properties still in fill up stage), an exchange offer for the Company's
2002 debentures, and a high interest rate mezzanine loan and related equity
investment (the "2002 Refinancing Plan"). As a result of the 2002 Refinancing
Plan, the Company satisfied its current debt obligations but also incurred a
substantial diminution in its book equity and a significant increase in its
fixed lease and debt payments as a result of its high leverage.
9
As a result of the 2002 Refinancing Plan, the Company incurred approximately
$113 million of debt with a 19.5% interest rate (the "Mezzanine Loan") and
received a related $12 million equity investment in certain of its subsidiaries.
The Company completed a sale lease-back transaction in September 2003 which
resulted in the repayment of approximately $52 million of the Mezzanine Loan,
and also resulted in a $93 million gain on sale, $23 million of which was
recognized immediately and the balance of which will be amortized into income
over the ten year life of the lease. As of December 31, 2003, the outstanding
balance of the Mezzanine Loan and accrued interest was approximately $78
million.
The Company will continue to explore opportunities to refinance the Mezzanine
Loan (which matures September 2007) at the earliest opportunity, including any
opportunity to prepay it beginning in September 2005, when full prepayment
without penalty is permitted (or sooner if agreed to by the lender, which cannot
be assured). The Company will also explore opportunities to reduce its overall
cost of capital through refinancings of other higher interest rate debt and
leases, including its 10% Series B Convertible Senior Subordinated Notes due
April 1, 2008 ("the Series B Notes"). The Series B Notes are convertible into
shares of the Company's common stock at a conversion price of $2.25 at the
option of the holders. As of December 31, 2003, approximately $5.1 million of
the Series B Notes had been converted into shares of the Company's stock. In
February 2004, the Company issued a notice of partial redemption on an
additional $4.5 million of the Series B Notes, and will look for opportunities
to effect the conversion or redemption of additional Series B Notes as
conditions permit. The Company is also continually exploring various ways to
refinance its assets with lower cost mortgage capital, particularly where
improving economics of selected communities would result in lower costs of
capital.
Risk Management
The delivery of personal and health care services entails an inherent risk of
liability, and in recent years, participants in the senior living and health
care services industry have become subject to an increasing number of lawsuits,
many of which involve significant defense costs and significant claims exposure.
The Company recognizes this challenging environment, and has responded in recent
years by allocating significant resources to quality assurance and risk
management areas, including hiring and developing significant in-house expertise
focusing on these areas. Since this challenging environment is expected to
continue for the foreseeable future, management believes that the expertise the
Company has developed may provide a competitive advantage over smaller
competitors unable to devote similar efforts and resources in this area.
People
As a service oriented business with high labor requirements, the Company will
continue to focus on attracting and retaining high quality personnel to ensure
it is delivering high quality services in a cost effective manor. In order to be
successful in its effort, the Company has dedicated in-house recruiters to find
the right people, programs designed to improve retention of associates, and
training programs to ensure its associates are trained to excel in their roles.
Systems
The Company has developed certain proprietary systems to provide its managers
with timely access to the information necessary to manage and control pricing
levels, unit inventory levels, and the turnover and retention of employees. In
addition, these systems collect information regarding effectiveness of
promotions, advertising and lead sources for analysis by management. The Company
believes that these systems provide strategic value in managing its business.
Growth
The Company expects the results from its current portfolio will grow over the
next several years through increased occupancy, rate increases and the growth of
ancillary services. Additionally, the Company expects to produce growth through
added capacity and additional services. Capacity additions would come through
expansions at current communities (of which 11 have expansion possibilities),
acquisitions of Retirement Centers or Free-standing AL's in selected markets, or
development of new Retirement Centers. The Company will also continue to build
ancillary services that it can offer its residents, such as therapy, medical
supplies, hospice care, and telecom services.
10
Government Regulation
The Company is subject to various federal, state and local regulations, which
are frequently revised. While such requirements vary by state, they typically
regulate, among other matters, the number of licensed beds, provision of
services, staffing levels, professional licensing, distribution of
pharmaceuticals, billing practices, equipment, operating procedures, fire
prevention measures, environmental matters, and compliance with building and
safety codes. The Company's communities are also subject to various zoning
restrictions, local building codes, and other ordinances, such as fire safety
codes. Certain states require a certificate of need review in order to provide
certain services. Currently, the operation of independent living and assisted
living residences are subject to limited federal and state laws. However, such
regulation has increased in recent years. The Company believes that such
regulation will continue to increase in the future, including the evolution of
the regulation of the assisted living industry.
The Company's skilled nursing centers and home health agencies are subject to
Federal certification requirements in order to participate in the Medicare and
Medicaid programs. Approximately 11.8%, 10.5%, and 8.5% of the Company's total
revenues for the years ended December 31, 2003, 2002, and 2001, respectively,
were attributable to Medicare, including Medicare-related private co-insurance,
and Medicaid. These reimbursement programs are subject to extensive regulation
and frequent change, which may be beneficial or detrimental to the Company.
Certain per person annual limits on therapy services, which were temporarily
effective beginning in September 2003 and would have had an adverse effect in
the Company's therapy services business, have recently been deferred until 2005.
If re-initiated, those limits could negatively affect the Company's therapy
services business.
In addition, there are various Federal and state laws prohibiting other types of
fraud and abuse by health care providers, including criminal and civil
provisions that prohibit filing false claims or making false statements to
receive payment or certification under Medicare or Medicaid and failing to
refund overpayments or improper payments. Violation of these laws can result in
loss of licensure, civil and criminal penalties, and exclusion of health care
providers or suppliers from participation in Medicare, Medicaid, and other state
and Federal reimbursement programs.
The Company's EF Communities are subject to regulation by certain state
departments of insurance and various state agencies, and must meet various
guidelines and disclosure requirements.
Many of the Company's communities are subject to periodic survey or inspection
by governmental authorities. From time to time in the ordinary course of
business, one or more of the Company's communities may be cited for operating or
other deficiencies by regulatory authorities. Although most inspection
deficiencies can be resolved through a plan of correction, the regulatory agency
may have the right to levy fines, impose conditions on operating licenses,
suspend licenses, or propose other sanctions for the facility.
There are currently numerous legislative and regulatory initiatives at the state
and Federal levels addressing patient privacy concerns. In particular, final
regulations regarding privacy and standards and code sets were issued for the
Health Insurance Portability and Accountability Act of 1996 ("HIPAA"). These
regulations restrict how health care providers use and disclose individually
identifiable health information and grant patients certain rights related to
their health information. Final HIPAA security regulations become effective in
April 2005 and govern the security of individually identifiable health
information that is electronically maintained or transmitted. Failure to comply
with the privacy, security or transaction standard regulations enacted under
HIPAA could result in civil and criminal penalties. Management does not expect
costs incurred, or costs to be incurred in order to comply with HIPAA to have a
material impact on the Company's operating results.
11
Insurance
The delivery of personal and health care services entails an inherent risk of
liability. In recent years, participants in the senior living and health care
services industry have become subject to an increasing number of lawsuits
alleging negligence or related legal theories, many of which involve large
claims and result in the incurrence of significant exposure and defense costs.
As a result, the Company has significantly increased the staff and resources
involved in quality assurance, compliance and risk management. 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 in recent years and the
premiums and deductibles associated with such insurance have risen substantially
in recent years.
During 2003, the Company's general and professional liability policy premiums
were lower than 2002, but deductibles were higher (retention levels range from
$1,000,000 to $5,000,000). The Company currently maintains single incident and
aggregate liability protection in the amount of $15.0 million. During the years
ended December 31, 2003 and 2002, the Company expensed $5.5 million and $5.7
million, respectively, of general liability, and professional medical
malpractice insurance premiums, claims, and costs related to multiple insurance
years. Additionally, the Company has accrued amounts to cover open claims not
yet settled and incurred but not reported claims as of December 31, 2003.
The Company has operated under a large deductible workers' compensation program,
with excess loss coverage provided by third party carriers, since July 1995. As
of December 31, 2003, the Company's coverage for workers' compensation and
related programs, excluding Texas, include excess loss coverage of $350,000 per
individual claim and approximately $7.25 million in the aggregate. The Company
is self-insured for amounts below the excess loss coverage. As of December 31,
2003, the Company provided cash collateralized letters of credit in the
aggregate amount of $6.5 million related to this program, which is reflected as
assets limited as to use on the Company's balance sheet. During the years ended
December 31, 2003 and 2002, the Company expensed $4.8 million and $4.4 million,
respectively, of workers' compensation premiums, claims and costs related to
multiple insurance years. The Company has accrued amounts to cover open claims
not yet settled and incurred but not reported claims as of December 31, 2003.
For work-related injuries in Texas, the Company is a non-subscriber under Texas
state law, meaning that work-related losses are covered under a defined benefit
program outside of the Texas Workers' Compensation system. Losses are paid as
incurred and estimated losses are accrued on a monthly basis. The Company
utilizes a third party administrator to process and pay filed claims.
On January 1, 2002, the Company initiated a self-insurance program for employee
medical coverage. The Company maintains stop-loss insurance coverage of
approximately $150,000 per employee and approximately $18.9 million for
aggregate calendar 2003 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. During the year ended
December 31, 2003, the Company expensed $10.1 million of employee medical
insurance claims and costs. The Company has accrued amounts to cover open claims
not yet settled and incurred but not reported claims as of December 31, 2003.
There can be no assurance that a claim in excess of the Company's insurance
coverage limits will not arise. A claim against the Company not covered by, or
in excess of, the Company's coverage limits could have a material adverse effect
upon the Company. Furthermore, there can be no assurance that the Company will
be able to obtain liability insurance in the future or that, if such insurance
is available, it will be available on acceptable terms.
Employees
The Company employs approximately 8,700 persons. As of December 31, 2003, an
aggregate of approximately 75 employees at one Free-standing AL were represented
by a labor union. In addition, an aggregate of approximately 70 employees at
another Free-standing AL voted for a union in 2002, but to date, no contract has
been signed. The Company believes that its relationship with its employees is
good.
12
Executive Officers
The following table sets forth certain information concerning the executive
officers of the Company.
Name Age Position
----------------- ------------ -------------------------------------------------------------------------------
W. E. Sheriff 61 Chairman, Chief Executive Officer and President
Gregory B. Richard 50 Executive Vice President and Chief Operating Officer
Bryan D. Richardson 45 Executive Vice President - Finance and Chief Financial Officer
George T. Hicks 46 Executive Vice President - Finance and Internal Audit, Secretary and Treasurer
H. Todd Kaestner 48 Executive Vice President - Corporate Development
James T. Money 54 Executive Vice President - Sales and Marketing
Terry L. Frisby 53 Senior Vice President - Human Resources/Corporate Culture and Compliance
Ross C. Roadman 53 Senior Vice President - Strategic Planning and Investor Relations
W.E. Sheriff has served as Chairman and Chief Executive Officer of the Company
and its predecessors since April 1984 and as President since 2003. From 1973 to
1984, Mr. Sheriff served in various capacities for Ryder System, Inc., including
as President and Chief Executive Officer of its Truckstops of America division.
Mr. Sheriff also serves on the boards of various educational and charitable
organizations and in varying capacities with several trade organizations.
Gregory B. Richard has served as Executive Vice President and Chief Operating
Officer since January 2003 and previously served as Executive Vice President -
Community Operations since January 2000. Mr. Richard was formerly with a
pediatric practice management company from May 1997 to May 1999, serving as
President and Chief Executive Officer from October 1997 to May 1999. Prior to
this Mr. Richard was with Rehability Corporation, a publicly traded outpatient
physical rehabilitation service provider, from July 1986 to October 1996,
serving as Senior Vice President of Operations and Chief Operating Officer from
September 1992 to October 1996.
Bryan D. Richardson has served as Executive Vice President - Finance and Chief
Financial Officer since April 2003 and previously served as Senior Vice
President - Finance since April 2000. Mr. Richardson was formerly with a
national graphic arts company from 1984 to 1999 serving in various capacities,
including Senior Vice President of Finance of a digital prepress division from
May 1994 to October 1999, and Senior Vice President of Finance and Chief
Financial Officer from 1989 to 1994.
George T. Hicks has served as Executive Vice President - Finance and Internal
Audit, Secretary and Treasurer since September 1993. Mr. Hicks has served in
various capacities for the Company's predecessors since 1985, including Chief
Financial Officer from September 1993 to April 2003 and Vice President - Finance
and Treasurer from November 1989 to September 1993.
H. Todd Kaestner has served as Executive Vice President - Corporate Development
since September 1993. Mr. Kaestner has served in various capacities for the
Company's predecessors since 1985, including Vice President - Development from
1988 to 1993 and Chief Financial Officer from 1985 to 1988.
James T. Money has served as Executive Vice President - Sales and Marketing
since September 1993. Mr. Money has served in various capacities for the
Company's predecessors since 1978, including Vice President - Development from
1985 to 1993.
Terry L. Frisby has served as Senior Vice President - Human Resources/Corporate
Culture and Compliance since January 1999. Mr. Frisby served as Vice President -
Corporate Culture and Compliance from July 1998 to January 1999. Prior to this
Mr. Frisby was principal of a healthcare consulting business located in
Nashville, Tennessee, from 1988 to 1998. Mr. Frisby serves on the Executive
Council for Human Resources with the Assisted Living Federation of America.
13
Ross C. Roadman has served as Senior Vice President - Strategic Planning and
Investor Relations since May 1999. Previously, Mr. Roadman served in various
capacities, since 1980, at Ryder System, Inc., including as Group Director of
Investor and Community Relations, Assistant Treasurer, Division Controller, and
Director of Planning. Before joining Ryder, he held positions with Ernst & Young
and the International Monetary Fund. He serves on the boards of several
educational and charitable organizations as well as being active in various
professional organizations.
Available Information
The Company's Internet web site is http://www.arclp.com. The Company makes
available free of charge through its website the Company's Annual Reports on
Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and
amendments to those reports as soon as reasonably practicable after it
electronically files or furnishes such materials to the Securities and Exchange
Commission. Information contained on the Company's website is not part of this
report.
The Company has also adopted a code of ethics that applies to the Company's
principal executive officer, principal financial officer, principal accounting
officer or controller and persons performing similar functions. A copy of such
code is available on the Company's website.
14
Item 2. Properties
The table below sets forth certain information with respect to the senior living
communities currently operated by the Company.
Retirement Centers Unit Capacity(1)
-----------------------------------------
Commencement
Community Location IL AL ME SN Total of Operations(2)
--------- --------- ----------------------------------------- ----------------
Owned(3):
Freedom Plaza Sun City Center Sun City Center, FL 428 26 - 108 562 Jul-98
Freedom Village Brandywine Glenmore, PA 292 15 18 47 372 Jun-00
Freedom Village Holland Holland, MI 330 21 29 68 448 Jul-98
Homewood at Corpus Christi Corpus Christi, TX 60 30 - - 90 May-97
Lake Seminole Square Seminole, FL 306 33 - - 339 Jul-98
Richmond Place Lexington, KY 177 54 20 - 251 Apr-95
Wilora Lake Lodge Charlotte, NC 135 47 - - 182 Dec-97
----- ----- ----- ----- -----
Subtotal 1,728 226 67 223 2,244
Leased:
Broadway Plaza(4) Ft. Worth, TX 214 40 - 122 376 Apr-92
Carriage Club of Charlotte(5) Charlotte, NC 276 63 34 42 415 May-96
Carriage Club of Jacksonville(6) Jacksonville, FL 238 60 - - 298 May-96
Freedom Plaza Arizona(7) Peoria, AZ 348 - 42 164 554 Jul-98
Freedom Plaza Care Center(8) Peoria, AZ - 44 - 128 172 Jul-01
The Hampton at Post Oak(6) Houston, TX 149 39 - 56 244 Oct-94
Heritage Club(9) Denver, CO 200 35 - - 235 Feb-95
Heritage Club at Greenwood
Village(10) Denver, CO - 75 15 90 180 Nov-99
Holley Court Terrace(11) Oak Park, IL 161 18 - 179 Jul-93
Homewood at Victoria(12) Victoria, TX 59 30 - 89 May-97
Imperial Plaza(13) Richmond, VA 758 148 - - 906 Oct-97
Oakhurst Towers(14) Denver, CO 171 - - - 171 Feb-99
Parklane West(15) San Antonio, TX - 17 - 124 141 Jan-00
Park Regency(15) Chandler, AZ 120 26 16 66 228 Sep-98
Santa Catalina Villas(4) Tucson, AZ 162 70 15 42 289 Jun-94
Somerby at Jones Farm(16) Huntsville, AL 137 48 - - 185 Apr-99
Somerby at University Park(16) Birmingham, AL 238 82 28 - 348 Apr-99
The Summit at Westlake Hills(4) Austin, TX 149 30 - 90 269 Apr-92
Trinity Towers(15) Corpus Christi, TX 197 62 20 75 354 Jan-90
Westlake Village (17) Cleveland, OH 211 53 - - 264 Oct-94
----- ----- ----- ----- -----
Subtotal 3,788 940 170 999 5,897
----- ----- ----- ----- -----
Total Retirement Centers 5,516 1,166 237 1,222 8,141
===== ===== ===== ===== =====
15
Free-standing Assisted Living
Unit Capacity(1)
-----------------------------------------
Commencement
Community Location IL AL ME SN Total of Operations(2)
--------- --------- ----------------------------------------- ----------------
Owned(3):
---------
Bahia Oaks Lodge Sarasota, FL - 92 - - 92 Jun-98
Broadway Plaza at Westover Hills Ft. Worth, TX - 74 17 - 91 Feb-01
Freedom Inn at Scottsdale Scottsdale, AZ - 94 25 - 119 Mar-01
Homewood at Air Force Village San Antonio, TX - 39 - - 39 Nov-00
Homewood at Castle Hills San Antonio, TX 22 58 17 - 97 Feb-01
Homewood at Deane Hill Knoxville, TN 26 52 29 - 107 Oct-98
Homewood at Rockefeller Gardens Cleveland, OH 37 68 34 - 139 Dec-99
Homewood at Sun City Center(18) Sun City Center, FL - 60 31 - 91 Aug-99
Homewood at Tarpon Springs Tarpon Springs, FL - 64 - - 64 Aug-97
McLaren Homewood Village(19) Flint, MI 14 66 38 - 118 Apr-00
Summit at Northwest Hills Austin, TX - 106 16 - 122 Aug-00
Village of Homewood(20) Lady Lake, FL - 32 15 - 47 Apr-98
----- ----- ----- ----- -----
Subtotal 99 805 222 - 1,126
Leased:
------
Hampton at Cypress Station(21) Houston, TX - 81 19 - 100 Feb-99
Hampton at Pearland(15) Houston, TX 15 55 17 - 87 Feb-00
Hampton at Pinegate(15) Houston, TX - 80 16 - 96 May-00
Hampton at Spring Shadows(15) Houston, TX - 54 16 - 70 May-99
Hampton at Willowbrook(15) Houston, TX - 54 18 - 72 Jun-99
Hampton at Shadowlake(15) Houston, TX - 80 19 - 99 Apr-99
Heritage Club at Aurora(22) Aurora, CO - 80 17 - 97 Jun-99
Heritage Club at Lakewood(22) Lakewood, CO - 78 17 - 95 Apr-00
Homewood at Bay Pines(22) St Petersburg, FL - 80 - - 80 Jul-99
Homewood at Boca Raton(10) Boca Raton, FL - 60 18 - 78 Oct-00
Homewood at Boynton Beach(23) Boynton Beach, FL - 79 18 - 97 Jan-00
Homewood at Brookmont Terrace(24) Nashville, TN - 62 33 - 95 May-00
Homewood at Cleveland Park(22) Greenville, SC - 75 17 - 92 Aug-00
Homewood at Coconut Creek(10) Coconut Creek, FL - 81 18 - 99 Feb-00
Homewood at Countryside(22) Safety Harbor, FL - 59 25 - 84 Oct-99
Homewood at Delray Beach(23) Delray Beach, FL - 52 33 - 85 Oct-00
Homewood at Lakeway(15) Austin, TX - 66 15 - 81 Sep-00
Homewood at Naples(22) Naples, FL - 76 24 - 100 Sep-00
Homewood at Pecan Park(10) Fort Worth, TX - 80 17 - 97 Aug-00
Homewood at Richmond Heights(23) Cleveland, OH - 78 17 - 95 Feb-00
Homewood at Shavano Park(6) San Antonio, TX - 62 17 - 79 Jun-00
----- ----- ----- ----- -----
Subtotal 15 1,472 391 - 1,878
----- ----- ----- ----- -----
Total Free-standing ALs 114 2,277 613 - 3,004
----- ----- ----- ----- -----
16
Management Services: (25)
Unit Capacity(1)
-----------------------------------------
Commencement
Community Location IL AL ME SN Total of Operations(2)
--------- --------- ----------------------------------------- ----------------
Burcham Hills East Lansing, MI 85 52 54 133 324 Nov-78
Freedom Square(26) Seminole, FL 362 103 76 194 735 Jul-98
Glenview at Pelican Bay Naples, FL 118 - - 35 153 Jul-98
Parkplace(27) Denver, CO 176 43 17 - 236 Oct-94
The Towers San Antonio, TX 353 - - - 353 Oct-94
----- ----- ----- ----- -----
Subtotal 1,094 198 147 362 1,801
----- ----- ----- ----- -----
Grand Total 6,724 3,641 997 1,584 12,946
===== ===== ===== ===== =====
-----------------------
(1) Current unit capacity by care level and type: independent living residences
(IL), assisted living residences (AL), memory enhanced (ME), and skilled
nursing beds (SN).
(2) Indicates the date on which the Company acquired each of its owned and
leased communities, or commenced operating its managed communities. The
Company operated certain of its communities pursuant to management
agreements prior to acquiring the communities.
(3) The Company's owned communities are subject to mortgage liens or serve as
collateral for various financing arrangements. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity
and Capital Resources."
(4) Leased pursuant to a master operating lease expiring September 23, 2013,
with renewal options for up to two additional ten-year terms.
(5) Leased pursuant to an operating lease expiring December 31, 2016, with
renewal options for up to two additional five-year terms.
(6) Leased pursuant to a master operating lease expiring March 31, 2017, with
renewal options for up to two additional ten-year terms.
(7) Leased pursuant to an operating lease expiring July 2018, with renewal
options for up to two additional ten-year terms.
(8) The community is owned by Maybrook Realty, Inc., of which W.E. Sheriff, the
Company's chairman and chief executive officer owns 50%. Leased pursuant to
a term of nine years and six months, expiring December 31, 2010, with a
renewal option of ten years. The Company also has an option to purchase the
community at a predetermined price.
(9) Leased pursuant to a master operating lease expiring June 30, 2012, which
provides for certain purchase options and therefore is recorded as lease
financing obligations. In addition, the lease includes renewal options for
up to five additional ten-year terms.
(10) Leased pursuant to an operating lease expiring March 31, 2017, which
provides for a contingent earn-out and therefore is recorded as lease
financing obligations. In addition, the lease includes renewal options for
up to two additional five-year terms.
(11) Leased pursuant to an operating lease expiring February 28, 2017, with
renewal options for up to two additional five-year terms.
(12) Leased pursuant to an operating lease expiring July 2011, with renewal
options for up to two additional ten-year terms.
(13) Leased pursuant to an operating lease expiring October 2017, with a
seven-year renewal option. The Company also has an option to purchase the
community at the expiration of the lease term.
(14) Leased pursuant to a 14-year operating lease expiring February 2013 from a
managed entity. The Company also has an option to purchase the community at
the expiration of the lease term.
(15) Leased pursuant to a master operating lease expiring June 30, 2014, with
renewal options for up to four additional ten-year terms.
(16) Leased pursuant to an operating lease expiring August 25, 2018, with
renewal options for up to two additional ten-year terms.
(17) During 2000, the Company sold the property and subsequently leased the
property back from the buyer. Leased pursuant to a seven-year operating
lease expiring December 31, 2007, with two renewal options of 13 and ten
years. The sale lease-back agreement also includes a right of first refusal
for the Company.
(18) Owned by a joint venture in which the Company owns a 50% interest.
(19) Owned by a joint venture in which the Company owns a 37.5% interest.
(20) Owned by a joint venture in which the Company owns a 50% interest.
(21) Leased pursuant to an operating lease expiring April 1, 2012, with renewal
options for up to three additional five-year terms.
(22) Leased pursuant to a master operating lease expiring June 30, 2012, with
renewal options for up to four additional ten-year terms.
(23) Leased pursuant to a master operating lease expiring March 31, 2017, which
provides for certain purchase options or contingent earn-outs and therefore
is recorded as lease financing obligations. In addition, the lease includes
renewal options for up to two additional ten-year terms.
(24) Leased pursuant to an operating lease expiring October 31, 2017, which
provides for a contingent earn-out and therefore is recorded as lease
financing obligations. In addition, the lease includes renewal options for
up to two additional five-year terms.
(25) Except as noted, the Company's management agreements are generally for
terms of five to ten years, but may be canceled by the owner of the
community, without cause, on three to six months written 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 reports, and other
services for these communities at the owner's expense and receives a
monthly fee for its services based either on a contractually fixed amount
or percentage of revenues or income plus reimbursement for certain
expenses.
(26) Operated pursuant to a management agreement with a 20-year term, with two
renewal options for additional ten-year terms, that provides for a
management fee equal to all cash received by the community in excess of
operating expenses, refunds of entry fees, capital expenditure reserves,
debt service, and certain payments to the community's owner. The Company
has an option to purchase the community at a predetermined price and
guarantees the communities long-term debt.
(27) Operated pursuant to a management agreement with a ten-year term, with two
renewal options for additional ten-year terms.
17
Item 3. Legal Proceedings
The ownership of property and provision of services related to the senior living
industry entails an inherent risk of liability. Although the Company is engaged
in routine litigation incidental to its business, there is no legal proceeding
to which the Company is a party, which, in the opinion of management, will have
a material adverse effect upon the Company's financial condition, results of
operations, or liquidity. The Company and a community managed by the Company
recently received a request for information from the United States Department of
Justice for information relating to certain Medicare reimbursements, relating to
a civil complaint filed by an individual. It is the Company's understanding that
the inquiry relates to a third party that provided services at the community
from 1995 until late 1999 (this community has been managed by the Company since
mid-1998). The Company is currently unable to determine whether such action will
be pursued by the Department of Justice or the potential outcome or liability to
the Company of any such action. The Company carries liability insurance against
certain types of claims that management believes meets industry standards. The
Company believes that these liabilities have been adequately accrued for as of
December 31, 2003. See "Business - Insurance." There can be no assurance that
the Company will continue to maintain such insurance, or that any future legal
proceedings (including any related judgments, settlements or costs) will not
have a material adverse effect on the Company's financial condition, liquidity,
or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock trades on the New York Stock Exchange under the
symbol "ACR." The following table sets forth, for the periods indicated, the
high and low sales prices for the Company's Common Stock as reported on the
NYSE.
Year Ended December 31, 2003 High Low
---------------------------- --------- -----------
First Quarter $3.000 $1.500
Second Quarter 2.250 1.500
Third Quarter 3.400 1.960
Fourth Quarter 3.600 2.960
Year Ended December 31, 2002 High Low
---------------------------- --------- -----------
First Quarter $2.800 $1.000
Second Quarter 3.140 1.700
Third Quarter 2.600 1.600
Fourth Quarter 2.020 1.300
As of March 1, 2004, there were approximately 484 shareholders of record and
approximately 2,227 persons or entities holding Common Stock in nominee name.
It is the current policy of the Company's Board of Directors to retain all
future earnings to repay debt obligations. Accordingly, the Company does not
anticipate declaring or paying cash dividends on the Common Stock in the
foreseeable future. The payment of cash dividends in the future will be at the
sole discretion of the Company's Board of Directors and will depend on, among
other things, the Company's earnings, operations, capital requirements,
financial condition, restrictions in then existing financing agreements, and
other factors deemed relevant by the Board of Directors. However, certain
financing agreements currently prohibit the payment of cash dividends on our
common stock.
The Company did not sell any securities during the year ended December 31, 2003
without registration under the Securities Act of 1933, as amended.
Item 6. Selected Financial Data
The selected financial data presented below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and notes thereto included
elsewhere in this report(1).
18
Years Ended December 31,
--------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Operating and Other Data: (in thousands, except per share data)
Communities (At end of period):
Retirement Centers 27 26 25 25 22
Free-standing ALs 33 33 32 18 7
Managed 5 6 8 20 24
- - - -- --
Total communities 65 65 65 63 53
Unit capacity (At end of period):
Retirement Centers 8,141 7,800 7,246 7,279 6,438
Free-standing ALs 3,004 2,997 2,906 1,461 497
Managed 1,801 2,092 2,624 4,144 4,993
----- ----- ----- ----- -----
Total capacity 12,946 12,889 12,776 12,884 11,928
Occupancy rate (At end of period):
Retirement Centers 94% 94% 94% 93% 93%
Free-standing ALs 83% 80% 63% 51% 63%
Managed 97% 92% 90% 85% 77%
--- --- --- --- ---
Occupancy rate 92% 91% 86% 86% 85%
Statement of Operations Data:
Total revenues $368,096 $328,634 $263,520 $212,785 $184,021
Retirement Center revenues 279,329 255,562 224,703 192,363 158,299
Free-standing AL revenues 78,491 66,067 29,217 8,442 6,293
Community operating expenses 248,846 233,460 179,718 138,670 105,978
Operating margin(2) 30% 27% 29% 31% 36%
General and administrative 25,410 26,720 29,297 19,420 15,020
Lease expense
Operating lease expense 47,095 35,748 16,917 12,040 11,333
Synthetic lease expense - 35,821 18,450 6,227 1,652
Amortization of leasehold acquisition
costs
Leasehold amortization - operating 2,421 2,094 1,272 409 188
Leasehold amortization - synthetic - 9,089 708 46 3
Interest expense 50,437 46,325 38,422 36,517 23,668
Net (loss) income $(17,314) $ (94,757) $ (34,922) $ (5,846) $ 2,052
Basic (loss) earnings per share $ (0.95) $ (5.48) $ (2.03) $ (0.34) $ 0.12
Weighted average basic shares outstanding 18,278 17,294 17,206 17,086 17,129
Diluted (loss) earnings per share $ (0.95) $ (5.48) $ (2.03) $ (0.34) $ 0.12
Weighted average diluted shares outstanding 18,278 17,294 17,206 17,086 17,177
At December 31,
--------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(in thousands)
Balance Sheet Data:
Cash and cash equivalents $16,706 $ 18,244 $ 19,334 $ 19,850 $ 21,881
Working capital (deficit) 11,199 15,725 (368,453) 14,280 23,590
Land, buildings and equipment, net 464,888 578,804 525,174 473,062 431,560
Total assets 715,035 839,998 850,191 792,480 740,411
Convertible Debt 10,856 15,956 137,980 137,980 137,980
Long-term debt, including current portion 343,839 524,695 424,145 345,710 298,008
Refundable portion of entrance fees 62,231 59,609 46,309 44,739 43,386
Deferred entrance fee income 122,389 118,498 51,211 52,765 51,606
Deferred gain on sale lease-back 92,596 27,622 13,055 16,122 3,168
transactions
Shareholders' equity 807 12,907 107,548 141,957 148,168
(1) Effective January 1, 2002, the Company changed its method of accounting for
goodwill in accordance with Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangible Assets" and impairment of
long-lived assets and discontinued operations in accordance with SFAS No.
144 "Accounting for the Impairment or Disposal of Long-Lived Assets."
(2) Operating margin is calculated by subtracting Community Operating Expenses
from the sum of Retirement Center and Free-standing AL revenues ("Community
Revenues"), and dividing the result by the Community Revenues.
19
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
The senior living industry is experiencing growth as a result of demographic and
various other factors. According to census data, the over age 75 population in
the United States is growing much faster than the general population. The
Company has seen increasing demand for services at both its Retirement Centers
and Free-standing ALs during the past year, and expects that this demand will
continue over the next several years. As a general rule, economic factors that
affect seniors will have a corresponding impact on the senior living industry.
For example, general concerns regarding lower interest rates on savings and
uncertainty of investment returns have impacted seniors during the past several
years, as well as uncertainties related to world events such as the Iraqi war.
On the other hand, the continuing strength of the home resale market in most
areas of the country has been beneficial to seniors, since the equity from the
sale of a home is a significant source of funding for senior living care in many
cases. In addition, overall economic conditions and general consumer confidence
can impact the industry, since many adult children subsidize the cost for care
of elderly parents, and share in decisions regarding their care.
The assisted living industry is maturing and rapidly evolving. The demand for
assisted living services increased significantly beginning with the emergence of
the industry segment in the mid-1990s. However, the development of new assisted
living communities across the country outstripped demand during this period,
resulting in oversupply of unit capacity, longer fill up times, price pressures
and deep discounting. While this trend continues, the demand for assisted living
services, coupled with minimal new development activity, reduced to some extent
the oversupply in many of the Company's markets in 2002 and 2003. As a result,
the Company was able to increase occupancy and increase rates and reduce
promotional discounting for its Free-standing ALs during 2003. The Company
believes that new assisted living development will remain at sustainable levels
and accordingly, this trend will continue. The average length of stay in the
Free-standing AL segment is approximately two years, which represents a
challenge and an opportunity for the Company. The Company must find a number of
new residents to maintain and build occupancy. However, it also has the
opportunity to "mark-to-market" if it is able to attract new residents at higher
current market rates, replacing those prior residents that had lower or
discounted rates.
The Retirement Center segment is a more mature segment of the industry, and has
seen demand and price increases in recent years, with new unit capacity entering
the market at sustainable levels. Management expects this growth in demand and
selling rate increases to continue over the next several years. The average
length of stay is much longer in the Retirement Centers, approximately five
years in the rental communities, and approximately 12 years in the EF
Communities. In addition, the Company believes that many of its Retirement
Centers benefit from significant barriers to entry from competitors, including
the significant cost and length of time to develop competitive communities, the
difficulty in finding acceptable development sites in the geographical areas in
which the Company's Retirement Centers are located, and the length of time and
difficulty in developing strong competing reputations.
The Company earns its revenues primarily by providing housing and services to
its residents. Approximately 88% of its revenues come from private pay sources,
meaning that residents or their families pay from their own funds (or from the
proceeds of their long-term care policies). All private pay residents are billed
in advance for the next month's housing and care. In addition, the Company
receives revenues from the sale of entrance fee contracts at the Company's EF
Communities. While this cash is received at the time the resident moves in, the
non-refundable portion of the entrance fee is primarily recognized as income for
financial reporting purposes over the actuarial life of the resident.
The Company's most significant expenses are:
-- Community operating expenses - Labor and labor related expenses for
community associates are approximately 60% of this line item. Other
significant items in this category are food costs, property taxes,
utility costs, marketing costs and insurance. The Company increased
its marketing expenditures in recent years in response to overcapacity
in the assisted living industry, and in response to general economic
conditions during 2002 and early 2003.
-- General and administrative - Labor costs are also the largest
component for this category, comprising the home office and regional
staff supporting the communities. Other significant items are
liability insurance and related costs, travel, and legal and
professional services. In response to higher liability insurance costs
and deductibles in recent years, and the inherent liability risk in
providing personal and health-related services to seniors, the Company
has significantly increased its staff and resources involved in
quality assurance, compliance and risk management.
20
-- Lease expense - The Company's lease expense has grown significantly
--------------
over the past two years, as a result of the large number of
sale-leaseback transactions completed in connection with the 2002
Refinancing Plan, as well as various 2003 transactions. The Company's
lease expense includes the rent expense for all operating leases, plus
an accrual for lease escalators in future years (the impact of these
future escalators is spread evenly over the lease term for financial
reporting purposes).
-- Depreciation and amortization expense - The Company incurs significant
-------------------------------------
depreciation expense on its fixed assets (primarily community
buildings and equipment) and amortization expense related primarily to
leasehold acquisition costs.
-- Interest expense - The Company's interest expense is comprised of
-----------------
interest on its outstanding debt and capital leases. The interest
expense includes both the current cash portion (9.0%) and the accrued
but deferred portion (10.5%) of the 19.5% interest under the Mezzanine
Loan.
Results of Operations
The Company's results of operations in recent years should be considered in
light of the following factors, some of which are likely to influence the
Company's future operating results and financial outlook:
-- Prior to the late 1990s, the Company exclusively owned and operated
Retirement Centers.
-- The Company's expansion into the assisted living market during the
late 1990s (with most of its Free-standing ALs opening during 1999 and
2000) resulted in large amounts of new debt and lease financing. While
the assisted living market grew rapidly during this period, an
oversupply of new units caused slower than anticipated fill up times
for these communities, at lower than anticipated prices. Consequently,
many of the Free-standing ALs incurred large start-up losses beginning
in 2000, and have taken longer than anticipated to reach stabilized
occupancy levels. Seventeen of the Free-standing ALs have not yet
reached stabilized occupancy. As a result, the Company's Free-standing
AL portfolio consumed the majority of the Company's available cash
over the past several years.
-- The Company had over $370 million of current debt maturities during
2002, which was largely associated with the development and financing
of the Free-standing ALs, which were maturing at a time when the
Free-standing ALs were still filling up and producing weak operating
results. In addition, the assisted living industry in general, was in
a weakened financial condition and many providers were insolvent. As a
result, the Company had diminished access to mortgage refinancings and
other capital sources during this period.
-- The Company completed the 2002 Refinancing Plan which included
mortgage refinancings, a series of sale-leaseback transactions
(predominately on assisted living properties still in fill up stage),
an exchange offer for its maturing convertible debentures and the
Mezzanine Loan.
-- Many of these financing transactions resulted in large gains or losses
to the Company. While the losses immediately reduced the Company's
reported equity, approximately $93 million of gains on various
sale-leaseback transactions have been deferred and will be recognized
over the terms of the subject leases.
-- Although the Company satisfied its 2003 current debt maturities
through the 2002 Refinancing Plan, the Company remains highly
leveraged with substantial debt and lease obligations. The Company
incurred additional debt and lease obligations and most of them at
increased interest rates, including the 19.5% interest rate (9% paid
currently) on the Mezzanine Loan.
21
-- The completion of the 2002 Refinancing Plan, however, allowed the
Company to focus on improving operating results and taking advantage
of opportunities as they arise to reduce its cost of capital and its
leverage. The Retirement Centers are the Company's largest segment and
provide most of the community operating contribution. This segment has
experienced significant increases in revenue and community operating
contribution during the past three years, which the Company expects to
continue.
-- While the Free-standing AL segment produced a positive community
operating contribution for 2002, and greatly increased operating
contribution for 2003. The Company expects this trend to continue so
long as market conditions remain stable.
Segment Results
The Company operates in three business segments: Retirement Centers,
Free-standing ALs, and Management Services.
The following table presents the number, total unit capacity and total ending
and average occupancy percentages of the Company's communities by operating
segment at December 31, 2003, 2002 and 2001.
Number of Communities/ Ending Occupancy % / Average Occupancy% /
Total Ending Ending Occupied Average Occupied
Capacity Units Units
December 31, December 31, Year ended December 31,
--------------------- --------------------- ---------------------
2003 2002 2001 2003 2002 2001 2003 2002 2001
Retirement
Centers 27 26 25 94% 94% 94% 94% 94% 94%
8,141 7,800 7,246 7,683 7,343 6,829 7,430 7,143 6,799
Free-standing
ALs 33 33 32 83% 80% 63% 81% 73% 59%
3,004 2,997 2,906 2,483 2,395 1,831 2,434 2,171 1,060
Management
Services 5 6 8 97% 92% 90% 93% 89% 83%
1,801 2,092 2,624 1,741 1,920 2,351 1,840 2,056 3,094
--------------------- --------------------- ---------------------
Total 65 65 65 92% 91% 86% 91% 88% 85%
12,946 12,889 12,776 11,907 11,658 11,011 11,704 11,370 10,953
===================== ===================== =====================
The Company measures the performance of its three business segments, in
part, based upon the operating contribution produced by these business segments.
The Company computes operating contribution by deducting the operating expenses
associated with a segment from the revenues produced by that segment. The
following table sets forth certain selected financial and operating data on an
operating segment basis(1) (dollars in thousands).
22
Years Ended December 31, 2003 vs. 2002 2002 vs. 2001
--------------------------- ---------------- ----------------
2003 2002 2001 Change % Change %
---- ---- ---- -------- ------- --------- ------
Revenues:
Retirement Centers $ 279,329 $ 255,562 $ 224,703 $ 23,767 9.3% $ 30,859 13.7%
Free-standing ALs (2) 78,491 66,067 29,217 12,424 18.8% 36,850 126.1%
Management Services 10,276 7,005 9,600 3,271 46.7% (2,595) (27.0%)
--------------------------- ---------------- ----------------
Total revenue $ 368,096 $ 328,634 $ 263,520 $ 39,462 12.0% $65,114 24.7%
=========================== ================ ================
Retirement Centers
Ending occupied units 7,683 7,343 6,829 340 4.6% 514 7.5%
Ending occupancy % 94% 94% 94% 0% 0%
Average occupied units 7,430 7,143 6,799 287 4.0% 344 5.1%
Average occupancy % 94% 94% 94% 0% 0%
Revenue per occupied unit (per month) $ 3,133 $ 2,981 $ 2,754 $ 151 5.1% $ 227 8.3%
Operating contribution per unit (per month) 1,040 955 949 85 8.9% 6 0.6%
Resident and healthcare revenue 279,329 255,562 224,703 23,767 9.3% 30,859 13.7%
Community operating expense 186,628 173,689 147,238 12,939 7.4% 26,451 18.0%
--------------------------- ---------------- ----------------
Community operating contribution (3) 92,701 81,873 77,465 10,828 13.2% 4,408 5.7%
--------------------------- ---------------- ----------------
Operating contribution margin (4) 33.2% 32.0% 34.5% 1.2% 3.6% (2.4%) (7.1%)
Free-standing ALs
Ending occupied units (5) 2,201 2,122 1,792 79 3.7% 330 18.4%
Ending occupancy % (5) 84% 81% 63% 3% 18%
Average occupied units (5) 2,150 1,934 904 216 11.2% 1,030 113.9%
Average occupancy % (5) 82% 74% 54% 8% 20%
Revenue per occupied unit $ 3,042 $ 2,847 $ 2,693 $ 196 6.9% $ 153 5.7%
Operating contribution (loss) per
unit (per month) 631 271 (301) 359 132.5% 572 190.2%
Resident and healthcare revenue 78,491 66,067 29,217 12,424 18.8% 36,850 126.1%
Community operating expense 62,218 59,771 32,480 2,447 4.1% 27,291 84.0%
--------------------------- ---------------- ----------------
Community operating contribution (loss) (3) 16,273 6,296 (3,263) 9,977 158.5% 9,559 NM
--------------------------- ---------------- ----------------
Operating contribution (loss) margin (4) 20.7% 9.5% (11.2%) 11.2% 117.6% (20.7%) NM
--------------------------- ---------------- ----------------
Management services operating contribution $ 4,771 $ 1,959 $ 2,296 $ 2,812 143.5% $ (337) (14.7%)
--------------------------- ---------------- ----------------
Total segment operating contributions 113,745 90,128 76,498 23,617 26.2% 13,630 17.8%
As a % of total revenue 30.9% 27.4% 29.0% 3.5% 12.7% (1.6%) (5.5%)
General and administrative $ 25,410 $ 26,720 $ 29,297 $ (1,310) (4.9%) $ (2,577) (8.8%)
Lease expense 47,095 71,569 35,367 (24,474) (34.2%) 36,202 102.4%
Depreciation and amortization 24,265 21,255 19,737 3,010 14.2% 1,518 7.7%
Amortization of leasehold costs 2,421 11,183 1,980 (8,762) (78.4%) 9,203 464.8%
Asset impairment - 4,011 6,343 (4,011) (100.0%) (2,332) (36.8%)
--------------------------- ---------------- ----------------
Operating income (loss) $ 14,554 $ (44,610)$ (16,226) $ 59,164 NM $ (28,384) NM
=========================== ================ ================
(1) Selected financial and operating data does not include any inter-segment transations or allocated costs.
(2) Freestanding AL revenues represent the Company's consolidated revenues for the period throughout the year the communities were
owned or leased. The Company acquired leasehold interests of 12 Free-standing ALs during 2001, of which ten were acquired as of
December 31, 2001. The results of these communities are reflected in the Company's income statement from the date of
acquisition and therefore, do not reflect a full year of operations until 2002.
(3) Segment Operating Contribution is calculated by subtracting the segment operating expenses from the segment revenues.
(4) Segment Operating Contribution Margin is calculated by dividing the operating contribution of the segment by the respective
segment revenues.
(5) Excludes two Free-standing ALs owned by the Company through joint ventures. These joint ventures are not included in the
consolidated Free-standing AL segment results since the Company does not own a majority interest. The net results of these joint
ventures are accounted for using the equity method and are included in Other income (expense) in the consolidated statement
of operations. Also excludes three communities which are designated as held-for-sale. See note 9 to the consolidated
financial statements.
NM Not Meaningful
23
Year Ended December 31, 2003 Compared with the Year Ended December 31, 2002
The highlights of the Company's 2003 results of operations are as follows:
-- The Free-standing ALs increased revenue and community operating
contribution, primarily as a result of a 6.9% increase in revenue per
unit, as well as an increase in occupancy from 81% to 84% during the
period from December 2002 to December 2003.
-- The increased revenue per unit in Free-standing ALs resulted primarily
from selling rate increases, reduced discounting, and turnover of
units resulting in new residents paying higher current market rates.
In addition, current resident agreements contain annual rate increases
(typically 2% to 4%). The increased amount of ancillary services
including therapy services, has also contributed to the increased
revenue per unit.
-- The Free-standing AL incremental increase in operating contribution as
a percentage of revenue increase was 80% for 2003 versus 2002.
-- While Free-standing AL results improved significantly, the
Free-standing AL portfolio must continue to increase its operating
contribution margin in order for the Company to service its future
debt service obligations and return to profitability. The Company is
focusing on increasing the Free-standing AL community operating
contribution further primarily by increasing occupancy above the
current 84% level, and by increasing revenue per unit through price
increases, ancillary services, and turnover of units that are at lower
rates. The Company believes that, absent unforeseen market or pricing
pressures, occupancy increases above 84% should produce high
incremental community operating contribution margins for this segment.
The primary risk to improving occupancy in the Free-standing AL
portfolio is development of new unit capacity or renewed price
discounting by competitors in the Company's markets, which would make
it more difficult to fill vacant units and which could result in lower
revenue per unit.
-- Retirement Center community operating contribution increased
significantly over the prior year, primarily as a result of increased
revenue per unit and occupancy increases. Revenues were up 9.3% in
2003 versus the prior year, community operating expenses were up 7.4%,
resulting in operating margins increasing from 32.0% to 33.2%, for the
Company's largest segment.
-- Revenue per unit increases at the Retirement Centers are primarily a
result of increases to selling rates, increased therapy and ancillary
service billings, as well as annual billing rate increases to existing
residents (typically 2%-4% under most resident agreements). In
addition, a significant component of the average revenue per unit
increase is the "mark-to-market" effect as a result of resident
turnover. Since monthly rates for new residents (current market
"selling rates") are generally higher than billing rates to current
residents (since annual increases to billing rates are typically
capped in resident agreements), turnover typically results in a
significantly increased monthly fee as a unit is rented to a new
resident. This mark-to-market increase is generally more significant
in EF Communities due to much longer average length of stay (12
years).
-- The operating contribution from the Management Services segment
increased primarily as a result of improved results at Freedom Square,
the Company's largest managed community.
-- In September 2003, the Company completed a refinancing transaction
that resulted in the repayment of approximately 40% of the Mezzanine
Loan, reducing the balance at December 31, 2003 to $77.9 million. As a
result, the Company replaced a portion of the Mezzanine Loan with
lower cost, longer term leases, reducing the Company's overall cost of
capital and partially addressing 2007 debt maturities.
-- While the Company's 2003 income statement shows significant
improvement in operating income versus the prior year, the Company
continues to incur high costs related to interest and lease
obligations, and incurred a net loss of $17.3 million, despite $23.2
million of gains on the sale of certain properties.
-- During the fourth quarter of 2003 the Company reported a net loss of
$6.7 million, which was not affected by any significant gain on the
sale of properties.
24
-- In order to reduce its loss and produce net income in the future, the
Company is focusing primarily on reducing its debt service costs and
improving results in its Free-standing AL and Retirement Center
segments, while controlling its general and administrative costs. The
Company must increase occupancy in its Free-standing AL segment, and
increase revenue per unit through increased rates and reduced
discounting, while controlling its operating costs. The Company
intends to increase ancillary services and revenue per unit in its
Retirement Center segment, increase occupancy at selected communities,
and control its operating costs, including labor, insurance and
liability related costs.
Retirement Centers
Revenue - Retirement Center revenues were $279.3 million for the year ended
December 31, 2003, compared to $255.6 million for the year ended December 31,
2002, an increase of $23.8 million, or 9.3%, which was comprised of:
-- $15.1 million from increased revenue per occupied unit. This increase
is made up primarily of selling rate increases and increased ancillary
services provided to residents (including a $4.7 million increase in
therapy services). Rate increases include the impact of increased
Medicare reimbursement rates for skilled nursing and therapy, the
mark-to-market effect from turnover of residents (reselling these
units at higher current selling rates) and annual increases in monthly
service fees from existing residents. The Company expects selling
rates to new residents will continue to increase during 2004, subject
to market conditions.
-- $9.0 million from increased occupancy. The year to year increase in
average occupancy was 287 units. This included the partial year impact
of converting two Alabama (Somerby) communities, which were previously
managed, to a lease during August 2003, and the change of the
Parkplace community from owned to managed during September 2003.
Occupancy of the segment at December 31, 2003 was 94%. Any occupancy
gains above this level should produce significant incremental
operating contributions. The Company is focused on maintaining this
high level of occupancy across the portfolio, and making incremental
occupancy gains at three communities with recent expansions not yet
filled (65 units remain unfilled at these three communities at
December 31, 2003) and at selected other communities with below
average occupancy levels.
-- ($0.3) million of other net decreases, which is primarily a $1.1
million decrease from divestitures of certain home health agencies,
partially offset by other increases.
Community operating expenses - Retirement Center community operating
expenses were $186.6 million for the year ended December 31, 2003, compared to
$173.7 million for the year ended December 31, 2002, an increase of $12.9
million, or 7.4%, which was comprised of:
-- $7.3 million of labor and related costs. This increase is primarily a
result of wage rate increases for associates, as well as approximately
600 additional employees, and the additional staffing costs of
approximately $1.8 million supporting the growth of the therapy
services programs. The Company does not expect significant changes in
staffing levels in this segment, other than to support expansions or
the growth of ancillary programs such as therapy. Wage rates of
associates are expected to increase each year, subject to market
conditions.
-- $1.2 million of increased marketing costs. This increase is a result
of expansions at three communities, and additional marketing staff and
other expenditures at selected communities.
-- $1.1 million of increased utility costs, including significant
increases incurred at various communities in Texas.
-- $3.3 million of other year to year cost increases. This includes
increases in insurance, food, property taxes, and other property
related costs.
Community operating contribution - Retirement Center operating contribution
was $92.7 million for the year ended December 31, 2003, compared to $81.9
million for the year ended December 31, 2002, an increase of $10.8 million, or
13.2%.
-- The operating contribution margin increased from 32.0% in 2002, to
33.2% in 2003, an increase of 1.2%. The 2001 margin of 34.5% decreased
during 2002 primarily as a result of larger increases in labor and
employee benefit costs, as well as increased insurance and liability
related costs.
-- The increased margin in 2003 primarily relates to continued
operational improvements throughout the Retirement Centers segment
resulting from increased occupancy and revenue per occupied unit
(including continued growth of the therapy services program), and
control of community operating expenses including labor, employee
benefits and insurance related costs.
25
Free-standing ALs
Revenue - Free-standing AL revenues were $78.5 million for the year ended
December 31, 2003, compared to $66.1 million for the year ended December 31,
2002, an increase of $12.4 million, or 18.8%, which was comprised of:
-- $5.5 million from increased revenue per occupied unit. This increase
includes the impact of price increases, reduced discounting and
promotional allowances, and the mark-to-market effect from turnover of
residents (reselling these units at higher current rates), and
includes $1.7 million related to increased revenues from therapy
services. The Company will be focused on increasing revenue per
occupied unit, subject to market constraints, through price increases,
as well as the mark-to-market turnover of residents with prior
discounted rates, and an increase in ancillary services such as
therapy.
-- $6.9 million from increased occupancy. Occupancy increased from 81% at
December 31, 2002 to 84% at December 31, 2002, an increase of 3%. The
Company is focused on continuing to increase the occupancy in the
Free-standing AL communities, and believes that over the long-term,
this segment of the industry should be able to achieve average
occupancy levels at or near those achieved in the Retirement Center
segment. The Company is focused on increasing its number of move-ins,
increasing average length of stay, and expanding its marketing efforts
and sales training in order to increase occupancy.
-- These amounts are net of the revenue and occupancy for three
communities held-for-sale, which are included as a component of
discontinued operations and two Free-standing ALs owned through
unconsolidated joint ventures.
Community operating expenses - Free-standing AL community operating
expenses were $62.2 million for the year ended December 31, 2003, compared to
$59.8 million for the year ended December 31, 2002, an increase of $2.4 million
or 4.1%, which was comprised of:
-- $3.0 million of labor and labor related costs. This increase is
primarily a result of wage rate increases for associates and
additional staffing costs of approximately $1.0 million supporting the
growth of the therapy services programs. The Company does not expect
significant increases in staffing levels in this segment if occupancy
levels increase over the current 84%, since most communities are
nearly fully staffed at current occupancy levels and accordingly,
additional occupancies will not result in a significant staffing need
for the Company. However, growth of ancillary revenue programs such as
therapy may require additional staff to support incremental activity.
Higher recruiting and retention costs of qualified personnel increase
expectations that of increased wage rates each year, subject to labor
market conditions.
-- $0.6 million of food costs, primarily as a result of increased
occupancy. Food costs will continue to increase in relation to
occupancy.
-- ($1.2) million of other net cost decreases. This includes decreased
marketing expenses (as certain communities reach stabilized occupancy
levels), and various other cost decreases.
Community operating contribution - Free-standing AL operating contribution was
$16.3 million for the year ended December 31, 2003, compared to $6.3 million for
the year ended December 31, 2002, an increase of $10.0 million, or 159%.
-- The operating contribution margin increased from 9.5% in 2002, to
20.7% in 2003, an increase of 11.2%.
-- The increased margin in 2003 primarily relates to strong increases in
revenue per occupied unit and some occupancy increases, coupled with
control of community operating expenses. The incremental increase in
operating contribution as a percentage of revenue increase was 80% for
2003 versus 2002.
-- The Company believes that, absent unforeseen cost pressures, revenue
increases resulting from occupancy increases should produce high
incremental community operating contribution margins (as a percentage
of sales increase) for this segment.
Management Services Management services revenues and operating contribution were
$4.8 million for the year ended December 31, 2003, compared to $2.0 million for
the year ended December 31, 2002, an increase of $2.8 million, or 144%. The
increase is primarily related to improved operating results at Freedom Square, a
managed community in Florida.
General and Administrative. General and administrative expense was $25.4 million
for the year ended December 31, 2003, compared to $26.7 million for the year
ended December 31, 2002, a decrease of $1.3 million, or 4.9%.
-- This decrease is related to lower consulting and legal costs versus
costs incurred during 2002 related to consummation of the transactions
comprising the 2002 Refinancing Plan, offset by higher administrative
costs resulting from expanded compliance and regulatory requirements.
-- The Company's accruals for costs under its self-insured medical plan
was reduced in 2003 versus 2002, which was partially offset by
increased accruals for liability and workers compensation claims.
-- General and administrative expense as a percentage of total
consolidated revenues decreased to 6.9% for 2003 from 8.1% for 2002, a
decrease of 1.2%.
26
-- The Company believes that measuring general and administrative expense
as a percentage of total consolidated revenues and combined revenues
(including unconsolidated managed revenues) provides insight as to the
level of the Company's overhead in relation to its total operating
activities (including those that relate to management services).
General and administrative expense as a percentage of total combined
revenues decreased to 5.7% from 6.5% for the year ended December 31,
2003 and 2002, respectively, calculated as follows:
Year ended December 31,
--------------------------
2003 2002
---- ----
Total consolidated revenues $ 368,096 $ 328,634
Revenues of unconsolidated managed
communities 80,970 85,253
Less management fees (4,771) (1,959)
--------------------------
Total combined revenue $ 444,295 $ 411,928
==========================
Total general and administrative expense $ 25,410 $ 26,720
==============================
General and administrative expense as a %
of total consolidated revenues 6.9% 8.1%
==============================
General and administrative expense as a %
of total combined revenue 5.7% 6.5%
==============================
Lease Expense. Lease expense was $47.1 million for the year ended December 31,
2003, compared to $71.6 million for the year ended December 31, 2002, a decrease
of $24.5 million or 34%.
-- This decrease was primarily attributable to the additional lease
expense of $30.8 million recorded during the year ended December 31,
2002, related to residual value guarantees for the termination of
certain synthetic leases on various communities. As of December 31,
2002, the Company no longer operated any of its communities under
synthetic lease structures.
-- Excluding the synthetic lease expense, lease expense increased $6.3
million as a result of certain sale-leaseback transactions completed
in 2003 and 2002.
-- As a result of the sale-leaseback transactions completed in September
2003, three additional Retirement Centers are now leased (versus
owned) properties.
-- Net lease expense for the fourth quarter of 2003 was $14.9 million,
which includes current lease payments of $16.2 million, plus accruals
for future lease escalators of $1.2 million, net of the amortization
of the deferred gain from prior sale-leasebacks of $2.5 million.
-- Absent any additional refinancing or transactional activity, net lease
expense is expected to continue during the upcoming year at a level
similar to the fourth quarter of 2003 ($14.9 million).
-- As of December 31, 2003, the Company had operating leases for 32 of
its communities, including 18 Retirement Centers and 14 Free-standing
ALs.
Depreciation and Amortization. Depreciation and amortization expense was
$24.3 million for the year ended December 31, 2003, compared to $21.3 million
for the year ended December 31, 2002, an increase of $3.0 million, or 14.2%. The
increase was primarily related to increased depreciable assets during the second
half of 2002 mainly due to the addition of assets from leasehold acquisitions,
offset by the $92.0 million reduction in depreciable assets from the September
23, 2003 transactions. Assuming asset balances are maintained, depreciation and
amortization expense is expected to average amounts similar to the fourth
quarter of 2003, which was $5.5 million.
Amortization of Leasehold Acquisition Costs. Amortization of leasehold
acquisition costs was $2.4 million for the year ended December 31, 2003,
compared to $11.2 million for the year ended December 31, 2002, a decrease of
$8.8 million. The 2002 amortization costs included $8.8 million of accelerated
amortization of leasehold acquisition costs related to the termination of
synthetic leases.
27
Interest Expense. Interest expense was $50.4 million for the year ended
December 31, 2003, compared to $46.3 million for the year ended December 31,
2002, an increase of $4.1 million, or 8.9%.
-- This increase was primarily attributable to higher average cost of
debt as a result of various refinancing transactions completed during
2002.
-- These amounts include the deferred interest on the HCPI loan
(Mezzanine Loan) completed in September 2002, which is not paid until
maturity. This Mezzanine Loan impacts all of 2003, but only the fourth
quarter of 2002.
-- As a result of the transactions completed September 23, 2003, the
Company repaid $112.8 million of first mortgage debt, and $51.8
million of the Mezzanine Loan.
-- At December 31, 2003, the Mezzanine Loan balance was $77.9 million.
The Mezzanine Loan matures September 2007, with the possibility of
prepayment (without penalty) beginning in September 2005.
-- Interest expense for the fourth quarter of 2003 was $9.2 million. This
amount includes $3.8 million of interest expense on the Mezzanine Loan
(of which $2.0 is deferred and paid at maturity).
-- Absent any additional refinancing, transactional activity, or increase
in the interest rates of variable rate debt, interest expense is
expected to continue during the upcoming year at levels slightly below
the fourth quarter of 2003.
Other Income (Expense).
-- Gain of the sale of assets for the year ended December 31, 2003 was
$23.2 million. This gain resulted primarily from the sale of a
Retirement Center during September 2003. See Note 10 to the
consolidated financial statements.
-- Interest income was $2.7 million for the year ended December 31, 2003,
compared to $4.9 million for the year ended December 31, 2002, a
decrease of $2.2 million, or 45%. The decrease in interest income was
primarily attributable to reduced amounts of certificates of deposit
and notes receivable balances associated with certain terminated
leasing transactions, as well as lower interest rates. Assuming rates
are consistent, and balance requirements are maintained, interest
income is expected to average amounts similar to the fourth quarter
2003 amount of $489,000.
Income Taxes. The provision for income taxes was an expense of $2.7 million for
the year ended December 31, 2003, and $487,000 for the year ended December 31,
2002, an increase of $2.2 million. These taxes are largely the result of gains
recognized with the September 2003 sale and sale lease-back transactions. The
Company has recorded a valuation allowance against federal and state net
operating loss carryovers as well as other deferred tax assets. This valuation
allowance is based on the uncertainty that the value of certain deferred tax
assets will be realized.
Minority Interest in Earnings of Consolidated Subsidiaries, Net of Tax. Minority
interest in earnings of consolidated subsidiaries, net of tax, was $2.4 million
for the year ended December 31, 2003. This amount was attributable to the HCPI
Equity Investment made during September 2002.
Discontinued Operations. During the quarter ended December 31, 2002, the Company
determined that a Free-standing AL would be held-for-sale. During 2003, the
Company determined that two additional Free-standing ALs would be held-for-sale.
The Company is involved in negotiations related to these three communities,
which are subject to various contingencies. If the sales are completed, the
Company will use the majority of the proceeds to repay mortgage debt. For the
years ended December 31, 2003 and 2002, the Company recorded a loss from
discontinued operations of $2.1 million and $8.4 million, respectively, for
these three Free-standing ALs. The loss recorded for the year ended December 31,
2003 includes a loss of $821,000 resulting from the write-off of a contingent
earnout recorded as part of a 2002 sale-leaseback transaction related to one of
the Free-standing ALs. Based upon the anticipated purchase prices, the
discontinued operations during the year ended December 31, 2002 included $5.9
million of impairment. The 2002 results of these three communities were
reclassified to discontinued operations.
Net Loss. The Company experienced a net loss of $17.3 million, or $.95 loss per
diluted share for the year ended December 31, 2003, compared to a net loss of
$94.8 million, or $5.48 loss per diluted share, for the year ended December 31,
2002. The 2003 net loss is net of a gain on sale of assets of $23.2 million. The
2002 net loss includes the impact of various charges related to the completion
of the 2002 Refinancing Plan.
28
Year Ended December 31, 2002 Compared with the Year Ended December 31, 2001
Highlights of the Company's 2002 results are as follows:
-- The Free-standing ALs progressed from a negative to a positive segment
operating contribution in 2002, and increased their occupancy from 63%
at December 31, 2001 to 81% at December 31, 2002. Although the segment
achieved large occupancy gains, significant pricing pressure and
significant promotional incentives resulted in low rental rates.
-- The Retirement Centers experienced increased labor costs, including
nursing wages, increased insurance and liability related costs, and
increased employee benefit costs (primarily medical).
-- General and administrative costs include both the benefit of favorable
rulings on prior Medicare accruals, and increased costs related to
employee medical and the refinancing transactions.
-- The Company had over $370 million of debt maturing during 2002, at a
time when the Free-standing ALs were still filling up and were still
producing weak operating results. These maturities included
convertible debentures that, as a result of various factors, were not
converted to equity as had been originally anticipated.
-- The Company completed a 2002 Refinancing Plan that included mortgage
refinancings, a series of sale-leaseback transactions (predominately
on assisted living properties still in fill up stage), an exchange
offer on maturing debentures, and a high interest rate Mezzanine Loan.
These transactions resulted in high leverage, and significantly
increased interest and lease expense.
-- The 2002 results include several significant items related to the
various refinancing transactions, including $30.8 million of
additional lease expense, $8.8 million of additional amortization of
leasehold costs, and $3.1 million of general and administrative costs.
In addition, $4.0 million of asset impairments were recorded during
2002.
Retirement Centers
Revenue - Retirement Center revenues were $255.6 million for the year ended
December 31, 2002, compared to $224.7 million for the year ended December 31,
2001, an increase of $30.9 million, or 13.7%, which was comprised of:
-- $21.4 million from increased revenue per occupied unit. This increase
is made up primarily of selling rate increases and increased ancillary
services provided to residents (including a $4.2 million increase in
therapy services). Rate increases include the impact of increased
Medicare reimbursement rates for skilled nursing and therapy, the
mark-to-market effect from turnover of residents (reselling these
units at higher current selling rates) and annual increases in monthly
service fees from existing residents. The year to year increase in
average occupancy was 344 units. Occupancy of the segment at December
31, 2002 was 94%.
-- $11.3 million from increased occupancy resulting from the April 2002
and July 2001 long-term leases of Freedom Plaza Arizona and Freedom
Plaza Care Center, respectively.
-- ($1.8) million of other net decreases is primarily the reduction in
home health services, as well as increased promotions/incentives given
to new residents during 2002.
Community operating expenses - Retirement Center community operating expenses
were $173.7 million for the year ended December 31, 2002, compared to $147.2
million for the year ended December 31, 2001, an increase of $26.5 million, or
18.0%, which was comprised of:
-- $12.6 million of labor and related costs. This increase is primarily a
result of wage rate increases for associates and additional staffing
costs of approximately $3.1 million supporting the growth of the
therapy services programs.
-- $10.0 million from cost related to increased occupancy resulting from
the April 2002 and July 2001 long-term leases of Freedom Plaza Arizona
and Freedom Plaza Care Center, respectively.
-- $1.1 million of increased marketing costs. This increase is a result
of additional marketing staff and other expenditures at selected
communities, primarily in response to general economic conditions in
the market.
-- $2.8 million of other year to year cost increases. This includes
increases in insurance, food, property taxes, and other property
related costs.
29
Community operating contribution - Retirement Center operating contribution
was $81.9 million for the year ended December 31, 2002, compared to $77.5
million for the year ended December 31, 2001, an increase of $4.4 million, or
5.7%.
-- The operating contribution margin decreased from 34.5% in 2001, to
32.0% in 2002, a decrease of 2.5%. This decreased margin is primarily
the result of larger increases in labor and employee benefit costs, as
well as increased insurance and liability related costs. The addition
of Freedom Plaza Arizona and increased ancillary services also reduced
the operating contribution margin.
Free-standing ALs Revenue - Free-standing AL revenues were $66.1 million
for the year ended December 31, 2002, compared to $29.2 million for the year
ended December 31, 2001, an increase of $36.9 million, or 126%, which was
comprised of:
-- $21.1 million from additional revenues. During 2001, the Company
acquired 12 leasehold interests in Free-standing ALs, ten of which
were acquired on December 31, 2001. Therefore, 2002 includes an entire
year of revenues for these 12 communities.
-- $15.8 million from increased occupancy and revenue per occupied unit.
Occupancy increased from 63% at December 31, 2001 to 81% at December
31, 2002, an increase of 18%, resulting in an average of 1,934 units
occupied, versus 904 in 2001. This increase includes the impact of
price increases, reduced discounting and promotional allowances, and
the turnover of residents (reselling these units at higher current
rates), and includes $2.8 million related to increased revenues from
therapy services.
-- These amounts are net of the revenue for three communities that were
classified as held-for-sale which are included as a component of
discontinued operations and two Free-standing ALs owned through
unconsolidated joint ventures.
Community operating expenses - Free-standing AL community operating expenses
were $59.8 million for the year ended December 31, 2002, compared to $32.5
million for the year ended December 31, 2001, an increase of $27.3 million or
84%, which was comprised of:
-- $19.4 million of labor and related costs. This increase was primarily
a result of wage rate increases for associates and additional staffing
costs, including approximately $1.4 million supporting the growth of
the therapy services programs.
-- $2.6 million of food costs, primarily as a result of increased
occupancy.
-- $5.3 million of other year to year cost increases. This includes
property tax increases of $1.4 million, utility increases of $1.2
million, as well as other property related costs.
Community operating contribution - Free-standing AL operating contribution was
$6.3 million for the year ended December 31, 2002, compared to a loss of ($3.3)
million for the year ended December 31, 2001, an increase of $9.6 million.
-- The operating contribution margin increased from negative (11.2%) in
2001, to 9.5% in 2002, an increase of 20.7%.
-- The increased margin in 2002 primarily relates to strong increases in
occupancy and some increases in revenue per occupied unit, coupled
with increased community operating expenses during the fill-up stage.
Management Services. Management services revenues and operating contribution
were $2.0 million for the year ended December 31, 2002, compared to $2.3 million
for the year ended December 31, 2001, a decrease of $0.3 million, or 14.7%. The
decrease is primarily related to lower entrance fee sales of units during the
first half of 2002, which reduces the formula-based management fees at Freedom
Square, a managed community in Florida, and a decrease in the number of other
managed communities from eight at December 31, 2001 to six at December 31, 2002.
General and Administrative. General and administrative expense was $26.7 million
for the year ended December 31, 2002, compared to $29.3 million for the year
ended December 31, 2001, a decrease of $2.6 million, or 8.8%.
-- ($6.3) million year to year decrease in expense for Medicare
reimbursement assessments. During the year ended December 31, 2001,
$3.6 million was accrued for an assessment related to 1998 Medicare
reimbursements at a community managed by the Company, and bad debt
provisions for various assessments received on prior year home health
reimbursements. During 2002, as a result of several favorable rulings,
these accruals were reduced by $2.7 million, resulting in
approximately $6.3 million of year-to-year decrease in general and
administrative expense.
-- $3.8 million of increased accruals for self-insured employee medical
coverage plan.
-- $3.1 million of various costs related to the 2002 Refinancing Plan.
-- $2.1 million decrease in workers' compensation and general and
professional liability expense.
-- General and administrative expense as a percentage of total
consolidated revenues decreased to 8.1% compared to 11.1%, a decrease
of 3.0%
30
-- Corporate general and administrative expense as a percentage of total
combined revenues (including those that are managed) decreased to 6.5%
compared to 7.8% for the years ended December 31, 2002 and 2001,
respectively, calculated as follows:
Year ended December 31,
----------------------
2002 2001
---- ----
Total consolidated revenues $ 328,634 $ 263,520
Revenues of unconsolidated managed
communities 85,253 112,073
Less management fees (1,959) (2,296)
------------------------
Total combined revenue $ 411,928 $ 373,297
========================
Total general and administrative expense $ 26,720 $ 29,297
========================
General and administrative expense as a %
of total consolidated revenues 8.1% 11.1%
========================
General and administrative expense as a %
of total combined revenue 6.5% 7.8%
========================
Lease Expense. Lease expense was $71.6 million for the year ended December
31, 2002, compared to $35.4 million for the year ended December 31, 2001, an
increase of $36.2 million, or 102%.
-- Lease expense (excluding synthetic leases) was $35.1 million for the
year ended December 31, 2002, compared to $17.4 million for the year
ended December 31, 2001, an increase of $17.7 million, or 102%. This
increase was primarily attributable to 11 additional leases entered
into by the Company during 2001 and 2002, consisting primarily of
three Retirement Center leases, which increased lease expense $10.1
million, and the acquisition of leasehold interests in eight
Free-standing AL communities, which increased lease expense by $7.6
million.
-- As of December 31, 2002, the Company no longer operated any of its
communities under synthetic lease structures. Synthetic lease expense
was $36.5 million for the year ended December 31, 2002, compared to
$18.0 million for the year ended December 31, 2001, an increase of
$18.5 million.
-- Of the total $36.5 million of synthetic lease expense for the year
ended December 31, 2002, $9.0 million related to Retirement Centers
and $27.5 million related to Free-standing ALs.
-- Of the total $36.5 million of synthetic lease expense for the year
ended December 31, 2002, $30.8 million resulted from losses from
sale-leaseback transactions recorded as residual value guarantee
amounts, of which $7.6 million related to Retirement Centers and $23.2
million related to Free-standing ALs.
Depreciation and Amortization. Depreciation and amortization expense was
$21.3 million for the year ended December 31, 2002, compared to $19.7 million
for the year ended December 31, 2001, an increase of $1.5 million, or 7.7%. The
increase was primarily related to the increase in depreciable assets of
approximately $53.6 million, offset by the decrease in amortization of goodwill
of $1.0 million which is no longer amortized pursuant to the Company's adoption
of FASB No. 142. These additional assets relate primarily to the acquisition of
communities (including the December 31, 2002 acquisition of Freedom Village
Brandywine), including leasehold interests, and expansion of communities since
December 31, 2001, as well as ongoing capital expenditures.
Amortization of Leasehold Acquisition Costs. Amortization of leasehold
acquisition costs was $11.2 million for the year ended December 31, 2002,
compared to $2.0 million for the year ended December 31, 2001, an increase of
$9.2 million. As a result of transactions completed during 2002, which resulted
in a shorter than expected remaining life of various leases, the Company
accelerated the amortization of leasehold acquisition costs and recorded
additional amortization costs of $8.8 million during 2002.
Asset Impairments. During the year ended December 31, 2002, the Company
recorded $4.0 million in charges related to delayed or discontinued development
and certain financing transactions.
31
Interest Expense. Interest expense was $46.3 million for the year ended December
31, 2002, compared to $38.4 million for the year ended December 31, 2001, an
increase of $7.9 million, or 20.6%. This increase was primarily attributable to
a higher average amount of indebtedness (prior to certain refinancing
transactions) during the year ended December 31, 2002, as well as higher
interest rates. The Company completed an extensive refinancing plan during 2002
in order to satisfy various 2002 debt maturities.
Other Income (Expense).
-- Interest income was $4.9 million in the year ended December 31, 2002,
compared to $10.5 million for the year ended December 31, 2001, a
decrease of $5.6 million, or 53.6%. 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 terminated leasing transactions and management
agreements.
-- Equity in loss of Managed SPE Communities (representing the losses
that the Company funded for operating deficits at certain managed
communities which exceeded specified limits) decreased from $5.0
million in the year ended December 31, 2001 to $0 in the year ended
December 31, 2002. The Company had no further Managed SPE Communities
after December 31, 2001.
-- Loss on sale of assets was $1.8 million during 2002, primarily related
to the sale of a Free-standing AL in Florida.
Income Taxes. The provision for income taxes was a $487,000 expense for the year
ended December 31, 2002, compared to a $11.8 million benefit for the year ended
December 31, 2001. The Company has recorded a valuation allowance against
federal and state net operating loss carryovers as well as other deferred tax
assets. This valuation allowance is based on the uncertainty that the value of
certain deferred tax assets will be realized.
Minority Interest in Earnings of Consolidated Subsidiaries, Net of Tax. Minority
interest in earnings of consolidated subsidiaries, net of tax, for 2002 and
2001, respectively, was $597,000 and $92,000, representing an increase of
$505,000. The increase was primarily attributable to the HCPI Equity Investment.
Discontinued Operations. During the quarter ended December 31, 2002, the Company
determined that a Free-standing AL would be held-for-sale. During 2003, the
Company determined two additional Free-standing ALs would also be held-for-sale.
Based upon an estimated sale price, the Company recorded a $5.9 million
impairment charge and $2.5 million of net loss for the year ended December 31,
2002, in discontinued operations. The results of operations for the year ended
December 31, 2001 has not been reclassified to discontinued operations within
the accompanying consolidated financial statements based on the overall
insignificance of these results.
Net Loss. The Company experienced a net loss of $94.8 million, or $5.48 loss per
diluted share for the year ended December 31, 2002, compared to a net loss of
$34.9 million, or $2.03 loss per diluted share, for the year ended December 31,
2001. The 2002 net loss includes the impact of various charges related to the
completion of the 2002 Refinancing Plan.
32
Quarterly Results
The following table presents certain quarterly operating results for each of the
Company's last eight fiscal quarters, derived from the Company's unaudited
financial statements. The Company believes that all necessary adjustments have
been included in the amounts stated below to present fairly the quarterly
results when read in conjunction with the Consolidated Financial Statements.
Results of operations for any particular quarter are not necessarily indicative
of results of operations for a full year or predictive of future periods.
2003 Quarter Ended
-------------------------------------------------- Year Ended
Mar 31 June 30 Sept 30(1) Dec 31 Dec 31, 2003
------ ------- ------- ------ ------------
(dollar amounts in thousands, except share data)
Statement of Operations Data:
Total revenues $ 88,204 $ 90,624 $ 93,532 $95,736 $ 368,096
Net loss (10,970) (9,484) 9,880 (6,740) (17,314)
Loss per share:
Basic ($ 0.63) ($ 0.53) $ 0.53 ($ 0.36) ($ 0.95)
Weighted average basic shares
outstanding 17,343 18,051 18,739 18,962 18,278
Diluted ($ 0.63) ($ 0.53) $ 0.41 ($ 0.36) ($ 0.95)
Weighted average diluted shares
outstanding 17,343 18,051 24,578 18,962 18,278
--------------------------------------------------
2002 Quarter Ended
-------------------------------------------------- Year Ended
Mar 31(2) June 30(3) Sept 30(4) Dec 31(5) Dec 31, 2002
---------- ---------- ---------- --------- ------------
(dollar amounts in thousands, except share data)
Statement of Operations Data:
Total revenues $ 76,046 $ 81,808 $ 84,616 $86,164 $ 328,634
Net loss (38,071) (19,418) (22,569) (14,699) (94,757)
Loss per share:
Basic ($ 2.20) ($ 1.12) ($ 1.30) ($ 0.85) ($ 5.48)
Weighted average basic shares
outstanding 17,277 17,277 17,310 17,310 17,294
Diluted ($ 2.20) ($ 1.12) ($ 1.30) ($ 0.85) ($ 5.48)
Weighted average diluted shares
outstanding 17,277 17,277 17,310 17,310 17,294
(1) During the quarter ended September 30, 2003, the Company recorded $23.2
million of gain on sale related to the sale of a Retirement Center. See
Note 10 to the Consolidated Financial Statements.
(2) During the quarter ended March 31, 2002, the Company recorded $23.2 million
of lease expense related to residual value guarantee losses for synthetic
leases the Company terminated during 2002 and $6.5 million related to
accelerated amortization of leasehold acquisition costs from the early
termination of these leases.
(3) During the quarter ended June 30, 2002, the Company recorded $7.0 million
of lease expense related to residual value guarantee losses for synthetic
leases the Company terminated during 2002 and $2.3 million related to
accelerated amortization of leasehold acquisition costs from the early
termination of these leases.
(4) During the quarter ended September 30, 2002, the Company recorded $2.5
million in losses related to two land parcels due to development delays and
one property determined to be held-for-sale, as well as a $1.9 million loss
related to the sale of a pre-stable Free-standing AL. The Company also
recorded a $1.7 million increase in its self-insurance reserves and also
recognized $1.4 million of transaction costs during the quarter related to
the 2002 Refinancing Plan.
(5) During the quarter ended December 31, 2002, the Company recorded $1.5
million in impairment losses related to certain land parcel developments.
Liquidity and Capital Resources
The Company's primary sources of cash from its operating activities are the
collection of monthly and other billings for providing housing, healthcare
services and ancillary services at its communities, the proceeds from the sale
of entrance fees and management fees from the communities it manages for third
parties. These collections are primarily from residents or their families, with
approximately 11.8% coming from various reimbursement programs (primarily
Medicare). The primary uses of cash for the Company's ongoing operations include
the payment of community operating expenses, including labor costs and related
benefits, general and administrative costs, lease and interest payments,
principal payments required under various debt agreements, refunds due as
residents terminate entrance fee contracts, working capital requirements, and
capital expenditures necessary to maintain the Company's buildings and
equipment.
33
As a result of the 2002 Refinancing Plan, although the Company satisfied all its
debt maturing in 2002, the Company remains highly leveraged with substantial
debt and lease obligations. The Company incurred additional debt and lease
obligations and most of them at increased interest rates, including the
Mezzanine Loan which carries a 19.5% interest rate (9% paid currently).
The Company is highly leveraged and has substantial payment commitments for
lease, interest, principal and other payments on outstanding debt and lease
obligations. As shown in the Future Cash Commitments table below, the Company
has significant payment obligations during the next five years. These
commitments and the Company's plans regarding them are described below:
-- The Company's long term debt payments include recurring principal
amortization and other amounts due each year plus various maturities of
mortgages and other loans.
-- Long term debt payments include mortgage debt payments due of $8.8 million
in 2004, $10.8 million in 2005 and $5.3 million in 2006. The Company
intends to repay or refinance these amounts as they come due, subject to
available funds and market conditions.
-- The 2007 long term debt payments include, in addition to other debt
payments, the maturity of the remaining $77.9 million of the Mezzanine
Loan, plus the deferred interest described below. This loan may be prepaid
without penalty beginning in September 2005. The Company previously
negotiated and prepaid $51.8 million on this loan during September 2003.
Since the Mezzanine Loan accrues interest at 19.5%, the Company is focused
on refinancing it at its earliest opportunity, if acceptable refinancing
alternatives are available. These alternatives may include sale-leaseback
or sale manage-back transactions, mortgage financing, or other
alternatives. Refinancing this loan prior to September 2005 would require
permission from the lender, of which there can be no assurance.
-- Future accrued interest on Mezzanine Loan represents the future accrual of
interest on the Mezzanine Loan. Of the 19.5% interest on the loan, the
Company currently pays 9.0%, with 10.5% accrued but deferred until maturity
or prepayments. It is the Company's plan to refinance this amount as part
of the refinancing of the underlying principal on this loan as described
above. The balance of the interest accrued from December 31, 2003 until the
September 2007 maturity is $39.8 million. The balance as of September 2005,
the beginning of the period when prepayment of the loan is permitted, is
$15.8 million.
-- The 2008 long term debt payments include $13.7 million due on notes to
certain former joint venture partners. The 2008 payments also include $10.9
million of Series B Notes, which are convertible into shares of common
stock of the Company at $2.25 per share. During 2003, $5.1 million of these
notes were retired through such conversions. In addition, the Company
issued a notice of redemption during March 2004 for $4.5 million of the
Series B Notes. The Company will pay the notes so redeemed in March 2004
from its cash on hand or from funds from operations. However, based on
recent prices for the Company's stock, the Company anticipates that most
holders will exercise their conversion rights prior to redemption. The
Company may issue additional redemption notices in the future for the
remaining Series B Notes.
-- Lease financing obligations and Operating Leases - As of December 31, 2003,
the Company leases 41 of its communities and leases certain equipment. As a
result, the Company incurs significant lease payments from these long-term
leases. The Company intends to fund these lease obligations primarily from
cash provided by operations.
-- Debt associated with assets held-for-sale of $16.4 million is mortgage debt
that will be repaid from sale proceeds of the related properties
held-for-sale.
34
As of December 31, 2003, the Company had approximately $16.7 million in
unrestricted cash and cash equivalents, and $11.2 million of working capital.
The Company believes that its current cash and cash equivalents, expected cash
flow from operations, the proceeds from the sale of certain assets currently
held-for-sale, and the proceeds from additional financing transactions or
earnouts will be sufficient to fund its operating requirements, capital
expenditure requirements, periodic debt service requirements, and lease
obligations during the next twelve months.
Since the Company is highly leveraged, the cash needs for lease and interest
payments, and principal payments on outstanding debt will remain very high for
the foreseeable future and be a significant burden on the Company. In order to
meet its liquidity requirements over the longer term, including its debt
maturities, the Company is focusing on:
-- Increasing its cash flow from operations - The current level of cash
generated by operations will not be sufficient to meet the future debt
service levels of the Company. The Company is focused on increasing its
cash flow from operations primarily by increasing its occupancy levels
(primarily at its Free-standing AL communities) and revenue per unit at all
communities through periodic selling rate increases and additional
services, while controlling operating expenses and maintaining strong
entrance fee sales.
-- Refinancing certain debt maturities as they come due - It will be very
important that the operational results of the Company, industry and
economic conditions, and capital market conditions enable the Company to
refinance various debt maturities as they come due in future years. Given
the high leverage of the Company, cash flow from operations will not be
sufficient to repay all of the Company's debt maturities in full as they
come due.
-- Reducing its cost of capital - As a result of the completion of the 2002
Refinancing Plan the Company significantly increased its leverage and
average cost of capital (for various debt and lease obligations). The
Company is continuously exploring opportunities to reduce its leverage and
average debt cost by refinancing high cost debt, including the high cost
Mezzanine Loan.
Although approximately 75% of the Company's debt currently has fixed rates,
given the Company's significant leverage, increases in interest rates could
materially increase its future debt service costs. As a result of operating
losses, the Company has not incurred significant tax payments in recent years.
Although the Company has operating loss carryforwards at December 31, 2003,
future operational results and transactional activity could result in tax
liabilities in future years.
The Company may also consider, from time to time, development or acquisition of
additional senior living communities or other assets. Such transactions, if
significant, would generally require arrangement of separate leases, mortgages
or other financing by the Company.
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 covenants)
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 many of the Company's other obligations, which would have a
material adverse effect on the Company. Certain of the Company's loans and
leases contain financial and other covenants. The Company believes that
projected results from operations and cash flows will be sufficient to satisfy
these covenants during fiscal 2004. However, there can be no assurances that the
Company will remain in compliance with those covenants or that the Company's
creditors will grant amendments or waivers in the event of future
non-compliance.
The Company has primarily used a combination of mortgage financing (including
the Mezzanine Loan), lease financing, and convertible debentures to finance its
cash needs over the past several years. In the future, subject to Company
performance and market conditions, the Company would expect to utilize various
types of financing including mortgage financing, lease financing, and may
consider public debt or equity offerings as well.
35
Cash Flow, Investing and Financing Activity
During 2003, the Company experienced a negative net cash flow of $1.5 million.
Net cash used by operating activities was $0.8 million, net cash used by
investing activities was $3.7 million and net cash provided by financing
activities was $2.9 million. The Company's unrestricted cash balance was $16.7
million as of December 31, 2003, as compared to $18.2 million as of December 31,
2002. Primarily, cash was provided from improved operating results and strong
entrance fee sales, proceeds from refinancing transactions and asset sales,
while cash was used primarily for debt service and lease obligations, working
capital and capital expenditures.
Net cash used by operating activities decreased from $6.2 million for 2002 to
$0.8 million for 2003, primarily a result of improving continuing operational
results, and increased net cash from entrance fee sales. The Company completed a
refinancing transaction in September 2003, in order to reduce the balance of its
highest cost debt, the Mezzanine Loan, and reduce its overall cost of capital.
This transaction is further described in Note 10 to the consolidated financial
statements.
During 2002, the Company experienced a negative net cash flow of $1.1 million.
Net cash used by operating activities was $6.2 million for 2002, net cash
provided by investing activities was $9.3 million and net cash used by financing
activities was $4.2 million. The Company's unrestricted cash balance was $18.2
million as of December 31, 2002, as compared to $19.3 million as of December 31,
2001. Primarily, cash was provided from the positive cash flow from the
Retirement Centers, refinancing activities and sales of assets, while cash was
used for start-up losses of the Company's Free-standing ALs during the fill-up
stage.
During 2001, the Company experienced a negative net cash flow of $516,000. Net
cash provided by operating activities was $3.2 million, net cash used by
investing activities was $24.1 million and net cash provided by financing
activities was $20.5 million. The Company's unrestricted cash balance was $19.3
million as of December 31, 2001, as compared to $19.9 million as of December 31,
2000. Primarily, cash was provided from the positive cash flow from the
Retirement Centers, refinancing activities and sales of assets, while cash was
used to fund the start-up losses of the Company's Free-standing ALs during the
fill-up stage.
The level of capital spending, primarily for refurbishing apartments and
maintaining the quality of community assets, was $10.8 million for 2003, and is
expected to increase during 2004 as a result of additional community maintenance
projects. The Company routinely makes capital expenditures to maintain or
enhance communities under its control. The Company's capital expenditure budget
for fiscal 2004 is approximately $17 million.
Net cash from entrance fee sales (proceeds from entrance fee sales, less refunds
of entrance fee terminations) was $22.0 million for 2003, $16.8 million for
2002, and $7.7 million for 2001. These increases are primarily from an increased
number of entrance fee units sold and from the addition of Freedom Plaza Arizona
(an EF Community) beginning in April 2002. The Company will be focused on
maintaining strong entrance fee sales for 2004. In future years, the level of
sales may be impacted by the number of available units in the Company's EF
Communities, which is due in part to average length of stay and unit turnover
rates.
36
Future Cash Commitments
The following tables summarize the Company's total contractual obligations and
commercial commitments as of December 31, 2003 (amounts in thousands):
Payments Due by Period
---------------------------------------------------------------------------
2004 2005 2006 2007 2008 Thereafter
---- ---- ---- ---- ---- ----------
Long-term debt $ 8,775 $10,772 $ 5,257 $91,970 $ 40,043 $ 80,599
Debt associated with assets
held-for-sale(1) 16,432 - - - - -
Lease financing obligations 5,433 5,941 6,325 6,864 7,467 68,817
Operating leases 64,497 65,698 66,940 68,223 67,364 542,596
Future accrued interest on Mezzanine
Loan(2) - - - 39,840 - -
--------------------------------------------------------------------------
Total contractual cash obligations $ 95,137 $ 82,411 $ 78,522 $206,897 $114,874 $ 692,012
--------------------------------------------------------------------------
Interest income on notes receivable(3) (1,092) (1,079) (1,068) (1,057) (1,047) (19,638)
--------------------------------------------------------------------------
Contractual obligations, net $94,045 $ 81,332 $77,454 $ 205,840 $ 113,827 $ 672,374
==========================================================================
Amount of Commitment Expiration Per Period
---------------------------------------------------------------------------
2004 2005 2006 2007 2008 Thereafter
---- ---- ---- ---- ---- ----------
Line of Credit $7,000 - - - - -
Guaranties(4) $1,183 $1,284 $9,553 $1,322 $1,440 $ 20,903
--------------------------------------------------------------------------
Total commercial commitments $ 8,183 $1,284 $ 9,553 $1,322 $ 1,440 $ 20,903
==========================================================================
(1) Since this debt is associated with assets held-for-sale, the debt is
classified as current liabilities. However, only $1.3 million is due within
the next twelve months by its contractual terms.
(2) The Mezzanine Loan matures on September 30, 2007 and has a cash interest
payment rate of 9% per year, which increases after April 2004 by fifty-five
basis points each year, plus additional accrued interest (which converts to
principal) to its stated interest rate of 19.5% compounding quarterly. The
amount of interest reflected above represents the unpaid interest which the
Company will be accruing and compounding quarterly from December 31, 2003
until its September 30, 2007 maturity, unless paid-off earlier.
(3) A portion of the lease payments noted in the above table is repaid to the
Company as interest income on notes receivable from the lessors.
(4) Guarantees include mortgage debt related to four communities. The mortgage
debt guaranteed by the Company relates to two Retirement Centers under a
long-term management agreement and a long-term operating lease agreement
and the Company's two joint ventures.
Critical Accounting Policies
Certain critical accounting policies are complex and involve significant
judgments by the Company's 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 Note 2 to the Consolidated Financial Statements.
37
Revenue Recognition and Assumptions at Entrance Fee Communities
The Company's six EF Communities provide housing and healthcare services through
entrance fee agreements with residents. Under certain of these agreements,
residents pay an entrance fee upon entering into the contract and are
contractually guaranteed certain limited lifecare benefits. The recognition of
entrance fee revenue requires the use of various actuarial estimates. The
Company recognizes this revenue by recording the nonrefundable portion of the
residents' entrance fees as deferred entrance fee income and amortizing it into
revenue using the straight-line method over the estimated remaining life
expectancy of each resident or couple. The Company periodically assesses the
reasonableness of its mortality tables and other actuarial assumptions.
Self-Insurance Liability Accruals
The Company is subject to various legal proceedings and claims that arise in the
ordinary course of its business. The Company maintains property, general
liability and professional malpractice insurance policies for the Company's
owned, leased and certain of its managed communities under a master insurance
program. The Company's general and professional liability policy provides for
loss coverage at amounts ranging from $1 million to $5 million. In addition, the
Company operates under a large deductible workers compensation program with
excess loss coverage of $350,000 per individual claim and approximately $7.25
million in the aggregate. The Company is self-insured for amounts below these
excess loss coverage amounts. The Company reviews the adequacy of its accruals
related to general and professional liability and workers' compensation claims
on an ongoing basis, using historical claims, third party administrator
estimates, advice from legal counsel and industry loss development factors, and
adjusts accruals periodically. Changes in fact patterns or industry development
factors could have a significant impact on the required accrual levels. On
January 1, 2002, the Company became self-insured for employee medical coverage.
Estimated costs related to these self-insurance programs are accrued based on
known claims and projected claims incurred but not reported.
Allowance for Doubtful Accounts
The Company reports accounts receivable, net of an allowance for doubtful
accounts, to represent its estimate of the amount that ultimately will be
realized in cash. The allowance for doubtful accounts was $2.3 million and $2.4
million as of December 31, 2003 and 2002, respectively. The Company reviews the
adequacy of its allowance for doubtful accounts on an ongoing basis, using
historical payment trends, write-off experience, analyses of receivable
portfolios by payor source and aging of receivables, as well as a review of
specific accounts, and makes adjustments to the allowance as necessary. Changes
in legislation or economic conditions could have an impact on the collection of
existing receivable balances or future allowance considerations.
During 2003 and 2002, 11.8% and 10.5%, respectively, of the Company's resident
and health care revenues were derived from services covered by various
third-party payor programs, including Medicare and Medicaid. Billings for
services under third-party payor programs are recorded net of estimated
retroactive adjustments under reimbursement programs. Retroactive adjustments
are accrued on an estimated basis in the period the related services are
rendered and adjusted in future periods or as final settlements are determined.
The Company accrues contractual or cost related adjustments from Medicare or
Medicaid when assessed (without regard to when the assessment is paid or
withheld), even if the Company has not agreed to or is appealing the assessment.
Based upon final settlements with third-party payor programs, subsequent
positive or negative adjustments to these accrued amounts are recorded in net
revenues upon final settlement during the year of service, or in general and
administrative expense upon final settlement subsequent to the year of service.
Leasehold Acquisition Costs
At December 31, 2003 and 2002, the Company had $33.2 million and $22.9
million, respectively, of leasehold acquisition costs. The terms of the
leasehold interests range from June 2011 to August 2018. Leasehold acquisition
costs are amortized principally on a straight-line basis over the remaining
contractual or expected life of the related lease agreements. Accumulated
amortization for the years ended December 31, 2003 and 2002 was $6.5 million and
$4.2 million, respectively. Amortization expense for the years ended December
31, 2003 and 2002 was $2.4 million and $11.2 million, respectively. During the
fourth quarter of 2001, the Company determined that it intended to exercise its
termination rights under its fourteen synthetic leases during 2002. Accordingly,
the Company accelerated the amortization of the leasehold acquisition costs for
these communities over the expected lease termination date, resulting in $8.8
million of accelerated leasehold amortization expense for the year ended
December 31, 2002. The Company assesses the leasehold acquisition costs for
impairment based upon the amount of estimated undiscounted future cash flows
from the communities over the remaining lease terms.
38
Lease Classification
As of December 31, 2003, the Company operated 41 of its senior living
communities under long-term leases. Certain of these leases provide for various
additional lease payments, as well as renewal options. The Company, as the
lessee, makes a determination with respect to each of these leases whether they
should be accounted for as operating leases or lease financing obligations. The
Company bases its classification criteria on estimates regarding the fair value
of the leased community, minimum lease payments, the Company's effective cost of
funds, the economic life of the community and certain other terms in the lease
agreements. Sale lease-back transactions are recorded as financings when the
transactions include a form of continuing involvement, such as purchase options
or contingent earn-outs. Sale lease-back transactions recorded as financings
result in maintaining the land, building and equipment on the Company's balance
sheet as well as recording debt equal to the net cash proceeds received.
Long-lived Assets and Goodwill
As of December 31, 2003, the Company's long-lived assets were comprised
primarily of $464.9 million of land, buildings and equipment and $33.2 million
of leasehold acquisition costs. In accounting for the Company's long-lived
assets, other than goodwill and other intangible assets, the Company applies the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. Beginning
January 1, 2002, the Company accounted for goodwill and other intangible assets
under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. As
of December 31, 2003, the Company had $36.5 million of goodwill.
The determination and measurement of an impairment loss under these accounting
standards requires the significant use of judgment and estimates. The
determination of fair value of these assets utilizes cash flow projections that
assume certain future revenue and cost levels, assumed discount rates based upon
current market conditions and other valuation factors, all of which involve the
use of significant judgment and estimation. For the year ended December 31,
2002, the Company recorded $4.0 million of asset impairments related to
long-lived assets, all of which are classified as held-for-sale at December 31,
2002. Future events may indicate differences from management's judgments and
estimates which could, in turn, result in increased impairment. Future events
that may result in increased impairment charges include increases in interest
rates, which would impact discount rates, lower than projected occupancy rates
and changes in the cost structure of existing communities.
Purchase Options
Purchase options to acquire property are recorded at their cost and, upon
exercise, are applied to the cost of the property at the time of acquisition.
Nonrefundable purchase options are expensed when they expire or when the Company
determines it is no longer probable that the property will be acquired. The
Company currently has purchase options related to two communities with an
aggregate recorded value of $11.4 million. Based upon variable termination
clauses dependent upon occupancy, an option with a recorded value of $10.4
million will expire in October 2017 and an option with a recorded value of $1.0
million will expire in December 2012. The Company intends to exercise these
purchase options. If the Company determined at some future time that it no
longer intended to exercise these options, that it will transfer them for other
consideration, or that their value was impaired, a loss would be recorded at
that time.
39
Recognition of Contingent Earn-outs
During 2002 and 2001, as part of eight sale lease-back transactions with a third
party buyer, the Company recognized losses on sale of assets of $918,000, net of
estimated contingent earn-outs of $5.6 million (out of a maximum of $15.7
million). The earn-out provisions of the lease agreements specify certain
criteria that must be met to receive the earn-out consideration. Based upon its
review of the earn-out criteria, the Company believes that these estimated
amounts are realizable, however, actual results may differ from these estimates
under different assumptions or conditions. Management periodically assesses the
recoverability of the recorded balances and adjusts the carrying amount to its
revised estimate with a corresponding increase or decrease to interest expense.
Recent Accounting Pronouncements
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities, which addresses how a
business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, which was issued in January 2003.
Based upon the Company's current understanding of the current guidance provided
by the FASB, the Company has three variable interest entities with which it
holds a significant variable interest.
For any VIEs that must be consolidated under FIN 46R, the assets, liabilities
and noncontrolling interests of the VIE initially would be measured at their
carrying amounts with any differences between the net amount added to the
balance sheet and any previously recognized interest being recognized as a
cumulative effect of an accounting change. The Company is in the process of
reviewing its managed entities and agreements, and will consolidate any managed
entities in accordance with the then current consolidation literature beginning
January 1, 2004. At this time, it is anticipated that the Company will
consolidate Freedom Square effective January 1, 2004 and the effect on the
Company's consolidated balance sheet would be an increase of approximately $59.2
million to assets, liabilities and minority interests.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS 150
establishes standards for the classification and measurements of certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 also includes required disclosures for financial instruments within its
scope. SFAS 150 was effective for financial instruments entered into or modified
after May 31, 2003, and otherwise was effective July 1, 2003. The Company has
not entered into any financial instruments within the scope of SFAS 150 since
May 31, 2003, nor does it currently hold any significant financial instruments
within its scope. Adoption of the standard did not have an impact on the
Company's consolidated financial position, results of operations or cash flows.
Off-Balance Sheet Arrangements - Managed Communities
The Company manages five Retirement Centers for third parties which are included
in the Management Services operating segment. Of the managed communities, two
are cooperatives that are owned by their residents, one is owned by a
not-for-profit sponsor and one is owned by a non-related third party. The
Company's remaining management agreement relates to the Freedom Square
Retirement Center ("Freedom Square"), which the Company operates pursuant to a
long-term management contract. The initial term of the management contract has
16 years remaining, and there is an additional extension term of 20 years,
exercisable at the Company's option. Freedom Square is a 735 unit entrance fee
community and the Company earns a management fee pursuant to the Freedom Square
management contract that is equal to all of the cash flow generated by the
community, including entrance fee sales proceeds, that is in excess of its
operating costs, capital expenditures, mortgage payment and a fixed $3.0 million
annual distribution to the owner, which escalates 3% annually. The Company has
guaranteed the $16.8 million first mortgage debt secured by the land, and
certain buildings and equipment at Freedom Square.
40
Two free-standing assisted living residences are non-consolidated and owned by
joint ventures. ARC owns 50% of one of the joint ventures and 37.5% of the other
and has joined with its venture partners in guaranteeing $8.7 million of first
mortgage debt secured by one of the joint venture assets.
Related Party Transactions
The Company places an emphasis on identifying transactions with parties known to
be related to ensure that terms of any transactions are equal to the terms that
clearly independent third parties would have negotiated in similar transactions.
Management believes that each of the Company's related party transactions were
consummated on terms no more favorable to the related parties than in arm's
length transactions.
W.E. Sheriff, the Company's chairman, chief executive officer and president,
owns 50% of Maybrook Realty, Inc., which owns Freedom Plaza Care Center (FPCC),
a 128-bed nursing and 44-bed assisted living center and approximately 7,000
square feet of office space subleased to a third party, in Peoria, Arizona.
Freedom Plaza Care Center is on the campus of the Freedom Plaza of Arizona, a
community that the Company leases and operates. Maybrook Realty acquired Freedom
Plaza Care Center on September 30, 1999 from its former owner. The Company
managed FPCC from October 1999 until June 2001 and, upon completion of an
expansion, the Company entered into a long-term operating lease for FPCC. The
lease term expires in December 2015, and provides the Company one five-year
renewal option and an option to acquire FPCC at an agreed upon amount. The
Company also served as the developer of the expansion of FPCC and recognized
$46,875 of development fee in 2001. Total lease payments during 2003, 2002 and
2001 under this lease were $2.1 million, $2.1 million and $1.1 million,
respectively. For 2003, the Company recorded approximately $800,000 of net
income from FPCC.
During 2001 and 2000, the Company acquired leasehold interests in six
Free-standing ALs owned by affiliates of John Morris, a director of the Company.
The Company issued a $7.6 million, 9.58% fixed interest only note, due October
1, 2008. This note, and certain similar notes, are secured by the Company's
interest in a Retirement Center located in Richmond, Virginia and a
Free-standing AL in San Antonio, Texas. The terms of this note and its related
security instruments are identical to those issued to certain unaffiliated
entities in connection with the simultaneous acquisition of certain other
communities.
Impact of Inflation
Inflation could affect the Company's future revenues and results of operations
because of, among other things, the Company's dependence on senior residents,
many of whom rely primarily on fixed incomes to pay for the Company's services.
As a result, during inflationary periods, the Company may not be able to
increase resident service fees to account fully for increased operating
expenses. In structuring its fees, the Company attempts to anticipate inflation
levels, but there can be no assurance that the Company will be able to
anticipate fully or otherwise respond to any future inflationary pressures.
Risks Associated with Forward Looking Statements
This Form 10-K contains certain forward-looking statements within the meaning of
the federal securities laws, which are intended to be covered by the safe
harbors created thereby. Those forward-looking statements include all statements
that are not historical statements of fact and those regarding the intent,
belief or expectations of the Company or its management including, but not
limited to, all statements concerning the Company's anticipated improvement in
operations and anticipated or expected cash flow; the Company's expectations
regarding trends in the senior living industry; the discussions of the Company's
operating and growth strategy; the Company's liquidity and financing needs; the
Company's expectations regarding future entry fee sales or increasing occupancy
at its Retirement Centers or Free-standing ALs; the Company's alternatives for
raising additional capital and satisfying its periodic debt and lease
obligations; the projections of revenue, income or loss, capital expenditures,
and future operations; and the availability of insurance programs. All
forward-looking statements involve risks and uncertainties including, without
limitation, the risks and uncertainties described in this report under the
caption "Risk Factors."
41
Should one or more of those 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-K 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.
Risk Factors
Substantial Debt and Operating Lease Obligations
The Company is highly leveraged with a substantial amount of debt and lease
obligations. The cash needs for lease and interest payments, and principal
payments on outstanding debt will remain very high for the foreseeable future
and be a significant burden on the Company. At December 31, 2003, the Company
had long-term debt, including current portion and debt associated with assets
held-for-sale, of $354.7 million and was obligated to pay minimum rental
obligations in 2003 of approximately $64.5 million under long-term operating
leases. The Company has current scheduled debt principal payments for 2004 of
$14.2 million, as well as $16.4 million of debt associated with assets
held-for-sale (of which only $1.3 million is due within the next twelve months
by its terms), plus substantial payments due under its lease obligations. For
the year ended December 31, 2003, the Company's net cash provided by continuing
operations was negative. There can be no assurance that the Company will be able
to generate sufficient cash flows from operations to meet required interest,
principal, and lease payments in future periods.
Certain of the Company's current debt agreements and leases contain various
financial and other restrictive covenants, which may restrict the Company's
flexibility in operating its business. Any payment or other default with respect
to such obligations could cause lenders to cease funding and accelerate payment
obligations or to foreclose upon the communities securing such indebtedness or,
in the case of an operating lease, could terminate the lease, with a consequent
loss of income and asset value to the Company. While the Company endeavors to
comply with all financial covenant requirements, there can be no assurance that
the Company's creditors will grant amendments or waivers in the event of
non-compliance. Furthermore, because of cross-default and
cross-collateralization provisions in certain of the Company's mortgages, debt
instruments, and leases, a default by the Company on one of its payment
obligations could result in default or acceleration of several of the Company's
other obligations. Failure to remain in compliance with its financial covenants
could have a material adverse impact on the Company.
Ability to Refinance Debt Obligations
Given the high leverage of the Company, cash flow from continuing operations
will not be sufficient to repay all debt maturities in full as they come due.
The Company will need the ability to refinance certain debt maturities as they
come due. The ability for the Company to refinance debt obligations may be
impacted by its operational results, industry and economic conditions, capital
market conditions, and other factors that may not be in the Company's control.
The inability of the Company to refinance various debt maturities as they come
due in future years could have a material adverse impact on the Company and its
financial condition.
Ability to Increase Cash Flow From Operations
The Company has experienced significant losses from operations during the past
several years, and must increase its cash flow from operations in order to meet
its future debt and lease payment obligations. These increases are contingent on
the Company's ability to increase its occupancy (especially in its Free-standing
AL communities), and to increase its revenue per unit through rate increases and
additional fees and services. The Free-standing AL segment of the senior living
industry experienced significant overcapacity and price discounting between 2000
and 2002, and the Company experienced significant losses associated with the
fill-up of its Free-standing ALs (most of which began operations during 1999 and
2000) during this time. Increasing cash flow from operations will also be
contingent on the Company's ability to derive significant entrance fee sales
each year through the remarketing of available units at its EF Communities, and
to maintain and increase the price level of these units. Cash flow from
continuing operations may also be impacted by increases in the Company's
operating and overhead costs, many of which are beyond the Company's control,
unless these increases can be recovered through rate increases. In addition,
changes in amounts reimbursed under programs such as Medicare and Medicaid may
have an adverse impact on the Company in the future. There can be no assurance
that the Company will be able to increase occupancy, increase cash through
entrance fee sales, raise billing rates, and control its costs in order to
increase its cash flow from operations.
42
Liability Insurance and Risks of Liability Claims
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 liability and professional
liability insurance for the nursing and assisted living industry has declined
dramatically and the premiums and deductibles associated with such insurance has
risen substantially in recent years. In addition, the Company maintains programs
for worker compensation and employee medical coverage which are partially
self-insured.
There can be no assurance that the current level of accruals will be adequate to
cover the actual liabilities that may be incurred by the Company. There can be
no assurance that a claim in excess of the Company's insurance coverage limits
will not arise. A claim against the Company not covered by, or in excess of, the
Company's coverage limits could have a material adverse effect upon the Company.
Furthermore, there can be no assurance that the Company will be able to obtain
adequate liability insurance in the future or that, if such insurance is
available, it will be available on acceptable terms.
Community Management, Staffing, and Labor Costs
The Company competes with other providers of senior living and health care
services with respect to attracting and retaining qualified management personnel
responsible for the day-to-day operations of each of the Company's communities
and skilled technical personnel responsible for providing resident care. In
certain markets, a shortage of nurses or trained personnel has required the
Company to enhance its wage and benefits package in order to compete in the
hiring and retention of such personnel or to hire more expensive temporary
personnel. The Company will also be heavily dependent on the available labor
pool of semi-skilled and unskilled employees in each of the markets in which it
operates. The Company has experienced a competitive labor market, periodic
shortages of qualified workers in certain markets, and increasing wage rates for
many of these employees. The Company cannot be sure its labor costs will not
increase, or that, if they do increase, they can be matched by corresponding
increases in rates charged to residents. If the Company is unable to attract and
retain qualified management and staff personnel, control its labor costs, or
pass on increased labor costs to residents through rate increases, the Company's
business, financial condition, and results of operations would be adversely
affected.
Exposure to Rising Interest Rates
Future indebtedness, from commercial banks or otherwise, and lease obligations,
including those related to REIT facilities, are expected to be based on interest
rates prevailing at the time such debt and lease arrangements are obtained. As
of December 31, 2003, the Company had $267.5 million of fixed rate debt
outstanding. The Company has $87.2 million of rate debt at December 31, 2003.
However, $59.0 million of the variable rate debt agreements contain interest
rate floors which allow market interest rates to fluctuate without necessarily
changing the Company's interest rate. Therefore, considering the $28.2 million
of variable rate debt without such interest rate floors, each one-percentage
point increase in interest rates would result in an increase in interest expense
for the coming year of approximately $282,000. Increases in prevailing interest
rates would increase the Company's interest or lease payment obligations and
could have a material adverse effect on the Company's business, financial
condition, and results of operations.
43
Loss of Key Officers
The Company relies upon the services of its executive officers. The loss of some
of our executive officers and the inability to attract and retain qualified
management personnel could affect our ability to manage our business and could
adversely affect the Company's business, financial condition and results of
operations.
Termination of Residency Agreements
The Company's residency agreements with its independent living residents (other
than entrance fee contracts) are generally for a term of one year (terminable by
the resident upon 30 to 60 days written notice). Although most residents remain
for many years, the Company does not contract with residents for longer periods
of time. If a large number of residents elected to terminate their resident
agreements at or around the same time, then Company revenues and earnings could
be adversely affected.
Dependence on Attracting Residents with Sufficient Resources to Pay
Approximately 88.2% of the Company's total revenues for 2003 were attributable
to private pay sources. The Company expects to continue to rely primarily on the
ability of residents to pay for the Company's services from their personal or
family financial resources and long-term care insurance. Future economic or
investment market conditions or other circumstances that adversely affect the
ability of seniors to pay for the Company's services could have a material
adverse effect on the Company's business, financial condition, and results of
operations.
Risks Associated With Lifecare Benefits
Six of the communities operated by the Company are lifecare EF Communities that
offer residents a limited lifecare benefit. Residents of these communities pay
an upfront entrance fee upon occupancy, of which a portion is generally
refundable, with an additional monthly service fee while living in the
community. This limited lifecare benefit is typically (a) a certain number of
free days in the community's health center during the resident's lifetime, (b) a
discounted rate for such services, or (c) a combination of the two. The lifecare
benefit varies based upon the extent to which the resident's entrance fee is
refundable. The pricing of entrance fees, refundability provisions, monthly
service fees, and lifecare benefits are determined from actuarial projections of
the expected morbidity and mortality of the resident population. In the event
the entrance fees and monthly service payments established for the communities
are not sufficient to cover the cost of lifecare benefits granted to residents,
the results of operations and financial condition of the communities would be
adversely affected.
Residents of the Company's EF Communities are guaranteed a living unit and
nursing care at the community during their lifetime, even if the resident
exhausts his or her financial resources and becomes unable to satisfy his or her
obligations to the community. In addition, in the event a resident requires
nursing care and there is insufficient capacity for the resident in the nursing
facility at the community where the resident lives, the community must contract
with a third party to provide such care. Although the Company screens potential
residents to ensure that they have adequate assets, income, and reimbursements
from government programs and third parties to pay their obligations to the
communities during their lifetime, there can be no assurance that such assets,
income, and reimbursements will be sufficient in all cases. If insufficient, the
Company has rights of set-off against the refundable portions of the residents'
deposits, and would also seek available reimbursement under Medicaid or other
available programs. To the extent that the financial resources of some of the
residents are not sufficient to pay for the cost of facilities and services
provided to them, or in the event that the communities must pay third parties to
provide nursing care to residents of the communities, the Company's results of
operations and financial condition would be adversely affected.
Risks of Operations in Concentrated Geographic Areas
Part of the Company's business strategy is to own, lease or manage senior living
communities in concentrated geographic service areas. The Company has a large
concentration of communities in Florida, Texas, Arizona and Colorado, among
other areas. Accordingly, the Company's operating results may be adversely
affected by various regional and local factors, including economic conditions,
real estate market conditions, competitive conditions, and applicable laws and
regulations.
44
Government Regulation and the Burdens of Compliance
Federal and state governments regulate various aspects of the Company's
business. The development and operation of senior living communities and the
provision of health care services are subject to federal, state, and local
licensure, certification, and inspection laws. Failure to comply with these laws
and regulations could result in the denial of reimbursement, the imposition of
fines, temporary suspension of admission of new patients, restrictions on
operating or marketing entrance fee communities, suspension or decertification
from Medicare, Medicaid, or other state or Federal reimbursement programs,
restrictions on the Company's ability to acquire new communities or expand
existing communities, or revocation of a community's license. There can be no
assurance that the Company will not be subject to penalties in the future, or
that federal, state, or local governments will not impose restrictions on the
Company's activities that could materially adversely affect the Company's
business, financial condition, or results of operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Disclosure About Interest Rate Risk The Company is subject to market risk from
exposure to changes in interest rates based on its financing, investing, and
cash management activities. The Company utilizes a balanced mix of debt
maturities along with both fixed-rate and variable-rate debt to manage its
exposures to changes in interest rates. For fixed rate debt, changes in interest
rates generally affect the fair market value of the debt, but not earnings or
cash flows. Conversely, for variable rate debt, changes in interest rates
generally do not impact fair market value of the debt, but do affect the future
earnings and cash flows. The Company generally does not prepay fixed rate debt
prior to maturity without penalty. Therefore, interest rate risk and changes in
fair market value should not have a significant impact on the fixed rate debt
until the Company is required to refinance such debt. The Company has $87.2
million of variable rate debt at December 31, 2003. However, $59.0 million of
the variable rate debt agreements contain interest rate floors which allow
market interest rates to fluctuate without necessarily changing the Company's
interest rate. Therefore, considering the $28.2 million of variable rate debt
without such interest rate floors, each one-percentage point increase in
interest rates would result in an increase in interest expense for the coming
year of approximately $282,000.
The Company does not expect changes in interest rates to have a material effect
on income or cash flows in 2004, since 75.4% 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. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources."
In addition, 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. Under
the agreement, the Company receives a fixed rate of 6.87% on the $34.0 million
of debt, and pays a floating rate stated by the swap agreement based upon LIBOR
and a foreign currency index with a maximum rate of 8.12%.
Disclosure About Market Exchange Risk The Company received notice from the New
York Stock Exchange ("NYSE") in December 2002 that it was below the NYSE's
continued listing requirements relating to total market capitalization of $50
million and minimum shareholder's equity of $50 million. As permitted by the
NYSE, the Company submitted a plan during early 2003 demonstrating how the
Company intends to comply with the continued listing requirements. The NYSE
accepted the Company's plan and is monitoring the Company's progress during the
eighteen month period ending June 2004. In addition, the NYSE has recently
amended its continued listing requirements to increase the required market
capitalization and minimum shareholder's equity from $50 million each to $75
million each. If the Company's common stock is not eligible for trading on the
NYSE, the liquidity and value of its common stock could be adversely affected.
Should the Company's shares cease to be traded on the NYSE, the Company believes
an alternative trading market will be available for its common stock. If the
Company's common stock were not listed or quoted on another market or exchange,
trading in the Company's common stock would be conducted in the over-the-counter
market on an electronic bulletin board established for unlisted securities. As a
result, an investor would find it more difficult to trade, or to obtain accurate
quotations for the price of, the Company's common stock. If the Company is not
able to have its common stock listed or quoted on another acceptable market or
exchange, the liquidity and value of its common stock would be adversely
affected.
45
Item 8. Financial Statements and Supplementary Data
Index to Financial Statements
Independent Auditors' Report 47
Consolidated Balance Sheets --- December 31, 2003 and 2002 48
Consolidated Statements of Operations --- Years ended
December 31, 2003, 2002 and 2001 49
Consolidated Statements of Shareholders' Equity --- Years ended
December 31, 2003, 2002 and 2001 51
Consolidated Statements of Cash Flows --- Years ended
December 31, 2003, 2002 and 2001 52
Notes to Consolidated Financial Statements 54
Financial Statement Schedules 83
Schedule II - Valuation and Qualifying Accounts
Schedule IV - Mortgage Loans on Real Estate
All other schedules omitted are not required, inapplicable or the
information required is furnished in the financial statements or notes
therein.
46
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
American Retirement Corporation:
We have audited the accompanying consolidated balance sheets of American
Retirement Corporation and subsidiaries as of December 31, 2003 and 2002
and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the years in the three-year period
ended December 31, 2003. In connection with our audits of the
consolidated financial statements, we have also audited financial
statement Schedule II - Valuation and Qualifying Accounts and financial
statement Schedule IV - Mortgage Loans on Real Estate as of December 31,
2003 and for each of the years in the three-year period ended December
31, 2003. These consolidated financial statements and financial statement
schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedules based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
American Retirement Corporation and subsidiaries as of December 31, 2003
and 2002 and the results of their operations and their cash flows for
each of the years in the three-year period ended December 31, 2003, in
conformity with accounting principles generally accepted in the United
States of America. Also, in our opinion, the related financial statement
schedules, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
As discussed in note 2 to the consolidated financial statements,
effective January 1, 2002, the Company changed its method of
accounting for goodwill in accordance with Statement of Financial
Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets" and impairment of long-lived assets and discontinued operations
in accordance with SFAS No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets."
/s/ KPMG LLP
Nashville, Tennessee
March 4, 2004
47
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data) December 31
-------------------
2003 2002
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $16,706 $18,244
Assets limited as to use 16,551 17,359
Accounts receivable, net of allowance for
doubtful accounts 13,518 12,523
Inventory 1,219 1,378
Prepaid expenses 3,789 3,903
Deferred income taxes 2,936 3,028
Assets held-for-sale 20,176 34,071
Other current assets 10,961 6,680
--------- ---------
Total current assets 85,856 97,186
Assets limited as to use, excluding amounts
classified as current 22,655 21,701
Land, buildings and equipment, net 464,888 578,804
Notes receivable 18,925 19,176
Goodwill 36,463 36,463
Leasehold acquisition costs, net of accumulated
amortization 33,207 22,861
Other assets 53,041 63,807
--------- ---------
Total assets $715,035 $839,998
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $14,208 $13,526
Debt associated with assets held-for-sale 16,432 20,246
Accounts payable 4,102 5,187
Accrued interest 3,268 4,620
Accrued payroll and benefits 9,724 7,652
Accrued property taxes 10,571 9,917
Other accrued expenses 7,605 8,164
Other current liabilities 8,747 12,149
--------- ---------
Total current liabilities 74,657 81,461
Long-term debt, excluding current portion 324,055 506,879
Refundable portion of entrance fees 62,231 59,609
Deferred entrance fee income 122,389 118,498
Tenant deposits 4,624 4,898
Deferred gains on sale-leaseback transactions 92,596 27,622
Deferred income taxes 5,360 3,806
Other long-term liabilities 17,452 11,717
--------- ---------
Total liabilities 703,364 814,490
--------- ---------
Minority interest 10,864 12,601
Commitments and contingencies (See notes)
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares
authorized, no shares issued or outstanding - -
Common stock, $.01 par value; 200,000,000 shares
authorized, 19,670,501 and 17,341,191 shares
issued and outstanding, respectively 197 173
Additional paid-in capital 150,896 145,706
Accumulated deficit (150,286) (132,972)
--------- ---------
Total shareholders' equity 807 12,907
--------- ---------
Total liabilities and shareholders' equity $715,035 $839,998
========= =========
See accompanying notes to the consolidated financial statements
48
AMERICAN RETIREMENT CORPORATION AND
SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Years ended December 31,
-----------------------------
2003 2002 2001
--------- --------- ---------
Revenues:
Resident and health care $357,820 $321,629 $253,920
Management and development services 4,771 1,959 2,296
Reimbursed expenses 5,505 5,046 7,304
--------- --------- ---------
Total revenues 368,096 328,634 263,520
Operating expenses:
Community operating expenses 248,846 233,460 179,718
General and administrative 25,410 26,720 29,297
Lease expense 47,095 71,569 35,367
Depreciation and amortization 24,265 21,255 19,737
Amortization of leasehold acquisition
costs 2,421 11,183 1,980
Asset impairments - 4,011 6,343
Reimbursed expenses 5,505 5,046 7,304
--------- --------- ---------
Total operating expenses 353,542 373,244 279,746
--------- --------- ---------
Operating income (loss) 14,554 (44,610) (16,226)
Other income (expense):
Interest expense (50,437) (46,325) (38,422)
Interest income 2,653 4,888 10,540
Gain (loss) on sale of assets 23,152 (1,814) (1,005)
Equity in losses of managed special
purpose entity communities - - (5,029)
Lease income 324 2,627 2,852
Other (422) (4) 623
--------- --------- ---------
Other expense, net (24,730) (40,628) (30,441)
--------- --------- ---------
Loss from continuing operations
before income taxes, minority
interest and discontinued operations (10,176) (85,238) (46,667)
Income tax expense (benefit) 2,661 487 (11,837)
--------- --------- ---------
Loss from continuing operations
before minority interest and
discontinued operations (12,837) (85,725) (34,830)
Minority interest in earnings of
consolidated subsidiaries, net of tax (2,427) (597) (92)
--------- --------- ---------
Loss from continuing operations
before discontinued operations (15,264) (86,322) (34,922)
Discontinued operations, net of tax (2,050) (8,435) -
--------- --------- ---------
Net loss $(17,314) $(94,757) $(34,922)
========= ========= =========
See accompanying notes to the consolidated financial statements
49
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - CONTINUED
(in thousands, except share data)
Years ended December 31,
-----------------------
2003 2002 2001
------- ------- -------
Basic loss per share:
Basic loss per share from continuing
operations $(0.84) $(4.99) $(2.03)
Loss from discontinued operations, net of tax (0.11) (0.49) -
------- ------- -------
Basic loss per share $(0.95) $(5.48) $(2.03)
======= ======= =======
Diluted loss per share:
Diluted loss per share from continuing
operations $(0.84) $(4.99) $(2.03)
Loss from discontinued operations, net of tax (0.11) (0.49) -
------- ------- -------
Diluted loss per share $(0.95) $(5.48) $(2.03)
======= ======= =======
Weighted average shares used for basic loss
per share data 18,278 17,294 17,206
Effect of dilutive common stock options - - -
------- ------- -------
Weighted average shares used for diluted loss
per share data 18,278 17,294 17,206
======= ======= =======
See accompanying notes to the consolidated financial statements
50
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
Common stock Additional Total
----------------- paid-in Accumulated shareholders'
Shares Amount capital deficit equity
------------------------------------------------------
Balance at December
31, 2000 17,065,395 $171 $145,079 $(3,293) $141,957
Net loss - - - (34,922) (34,922)
Issuance of common
stock pursuant to
employee stock
purchase plan 60,718 1 143 - 144
Issuance of common
stock to fund
employer 401k
contribution 138,907 1 333 - 334
Issuance of common
stock pursuant to
stock options
exercised 11,500 - 35 - 35
---------------------------------------------------
Balance at December
31, 2001 17,276,520 $173 $145,590 $(38,215) $107,548
---------------------------------------------------
Net loss - - - (94,757) (94,757)
Issuance of common
stock pursuant to
employee stock
purchase plan 64,671 - 116 - 116
---------------------------------------------------
Balance at December
31, 2002 17,341,191 $173 $145,706 $(132,972) $12,907
---------------------------------------------------
Net loss - - - (17,314) (17,314)
Issuance of common
stock pursuant to
employee stock
purchase plan 62,793 1 111 - 112
Issuance of common
stock for conversion
of convertible
debentures 2,266,517 23 5,079 - 5,102
---------------------------------------------------
Balance at December
31, 2003 19,670,501 $197 $150,896 $(150,286) $807
===================================================
See accompanying notes to the consolidated financial statements
51
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years ended December 31,
-----------------------------
2003 2002 2001
--------- --------- ---------
Cash flows from operating activities:
Net loss $(17,314) $(94,757) $(34,922)
Loss from discontinued operations 2,050 8,435 -
--------- --------- ---------
Loss from continuing operations (15,264) (86,322) (34,922)
Adjustments to reconcile loss from
continuing operations to net
cash and cash equivalents (used)
provided by operating activities:
Depreciation and amortization 26,686 32,438 21,717
Amortization of deferred financing costs 2,259 2,665 2,683
Residual value guarantee loss, included
in lease expense - 30,793 7,854
Asset impairments - 4,011 6,343
Entrance fee items:
Amortization of deferred entrance fee
revenue (13,295) (12,392) (10,598)
Proceeds from entrance fee sales 35,132 26,187 14,946
Refunds of entrance fee terminations (13,159) (9,365) (7,250)
Deferred income tax benefit 1,645 (17) (11,773)
Amortization of deferred gain on sale-
leaseback transactions (4,960) (3,398) (2,367)
Minority interest in earnings of
consolidated subsidiaries 2,427 597 92
Losses (gains) from unconsolidated
joint ventures 478 582 (14)
(Gain) loss on sale of assets (23,152) 1,814 1,005
Issuance of stock to employee 401k plan - - 334
Changes in assets and liabilities,
exclusive of acquisitions and sale
leaseback transactions:
Accounts receivable 337 (1,321) 5,797
Inventory 157 (59) (57)
Prepaid expenses 53 (649) 80
Other assets (4,463) 2,068 4,165
Accounts payable (525) (2,776) (442)
Accrued interest 414 1,036 (396)
Other accrued expenses and other current
liabilities (213) 10,178 3,649
Tenant deposits (276) (1,144) (659)
Deferred lease liability 4,741 2,993 173
Other liabilities 170 (4,141) 2,799
--------- --------- ---------
Net cash and cash equivalents (used)
provided by continuing operating
activities (808) (6,222) 3,159
Cash flows from investing activities:
Additions to land, buildings and
equipment (10,807) (34,203) (56,282)
Proceeds from the sale of assets 8,405 25,048 28,526
(Purchase of) proceeds from assets
limited as to use, net (1,620) 22,234 (4,229)
Receipts from (issuance of) notes
receivable, net 251 (1,818) 9,081
Other investing activities 112 (1,281) (1,231)
Expenditures for leasehold acquisitions,
net of cash received - (612) -
-------- --------- ---------
Net cash (used) provided by investing
activities (3,659) 9,368 (24,135)
See accompanying notes to the consolidated financial statements
52
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(in thousands)
Years ended December 31,
---------------------------
2003 2002 2001
-------- --------- --------
Cash flows from financing activities:
Proceeds from the issuance of long-term
debt $ 9,612 $278,892 $54,024
Principal payments on long-term debt (14,399) (284,623) (30,029)
Accrual of deferred interest 11,651 2,971 -
Proceeds from equity investment, net of
distributions (1,123) 12,004 -
Principal reductions in master trust
liability (1,356) (1,447) (1,092)
Accrual of contingent earnouts (594) (3,560) -
Expenditures for financing costs (978) (8,597) (2,622)
Other financing costs 112 116 179
-------- --------- --------
Net cash provided (used) by financing
activities 2,925 (4,244) 20,460
-------- --------- --------
Net cash and cash equivalents used by
continuing operations (1,542) (1,098) (516)
Net cash and cash equivalents provided by
discontinued operations 4 8 -
-------- --------- --------
Net decrease in cash and cash equivalents (1,538) (1,090) (516)
Cash and cash equivalents at beginning of
year 18,244 19,334 19,850
-------- --------- --------
Cash and cash equivalents at end of year $16,706 $ 18,244 $19,334
======== ========= ========
Supplemental disclosure of cash flow
information:
------------------------------------------
Cash paid during the year for interest
(including capitalized interest) $38,870 $ 36,665 $35,829
======== ========= ========
Income taxes paid $ 1,324 $ 241 $ 65
======== ========= ========
Supplemental disclosure of non-cash transactions:
------------------------------------------------
During the year ended December 31, 2003, the Company issued 2,266,517
shares of common stock, par value $0.01 per share to certain holders of the
Company's 10% Series B Convertible Senior Subordinated Notes (Series B Notes).
The holders elected to convert $5.1 million of the convertible debentures to
common stock at the conversion price of $2.25 per share. As a result, debt and
equity changed as follows:
Years ended December 31,
---------------------------
2003 2002 2001
-------- --------- --------
Long-term debt $(5,102) $ - $ -
Common stock 23 - -
Additional paid-in capital 5,079 - -
During the respective years, the Company acquired/(sold) certain
communities, entered into and amended certain lease agreements, and sold a land
parcel in Virginia. In conjunction with these transactions, assets and
liabilites increased/(decreased) as follows:
Years ended December 31,
---------------------------
2003 2002 2001
-------- --------- --------
Leasehold acquisition costs $ - $ - $19,329
Land, buildings and other assets (18,006) 202,165 1,430
Other assets (821) (99,106) 9,532
Current liabilities (13,127) 54,196 12,918
Long-term debt (4,879) 48,863 17,373
During the year ended December 31, 2001 the Company funded its 401(k)
contribution with 138,907 shares of its common stock at a fair market value of
$334,000.
During the year ended December 31, 2001, the Company acquired the leasehold
interests in 12 communities the Company had previously managed. The liabilities
assumed exceeded the assets acquired by $19.2 million, which was recorded as
leasehold acquistion costs and is being amortized over the life of the leases or
the expected life of the leases, whichever is shorter.
See accompanying notes to the consolidated financial statements
53
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Organization and Presentation
The accompanying financial statements as of and for the years ended December 31,
2003, 2002 and 2001 include the consolidated financial statements of American
Retirement Corporation ("ARC") and its wholly-owned and majority owned
subsidiaries (ARC and such subsidiaries being collectively referred to as the
"Company") that manage, own and operate senior living communities. The Company
maintains each of its subsidiaries as a separate and distinct legal entity.
Absent express contractual provisions or agreements to the contrary, neither the
Company nor any of its subsidiaries are liable for, nor are any of their
respective assets available to satisfy, the obligations or liabilities of any
other subsidiary or the Company. The accounts of limited liability companies,
joint ventures and partnerships are consolidated when the Company maintains
effective control over such entities' assets and operations, notwithstanding, in
some cases, a lack of majority ownership. During 2003, new accounting literature
expanded the prior interpretations regarding consolidation of variable interest
entities. See Note 2. Under this literature, the Company would consolidate any
communities it manages for others if the Company has the unilateral ability to
conduct the ordinary course of business of the subject communities and is the
primary beneficiary of the managed entities earnings or losses. The Company
plans to complete its review of these entities and agreements, and will
consolidate any managed entities in accordance with the then current
consolidation literature. All significant inter-company balances and
transactions have been eliminated in consolidation.
(2) Summary of Significant Accounting Policies and Practices
The Company principally provides housing, health care, and other related
services to senior residents through the operation and management of senior
living communities located throughout the United States. The communities provide
a combination of independent living, assisted living and skilled nursing
services. The following is a summary of the Company's significant accounting
policies.
(a) Use of Estimates and Assumptions: The preparation of the consolidated
financial statements requires management to make estimates and assumptions
relating to the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses
during the period. Significant items subject to such estimates and
assumptions include the carrying amount of land, buildings and equipment,
leasehold acquisition costs and goodwill; valuation allowances for
receivables and deferred income tax assets; actuarial life expectations of
residents; and obligations related to employee benefits and general
liability claims. Actual results could differ from those estimates.
(b) Recognition of Revenue: The Company provides residents with housing and
health care services through various types of agreements. The Company also
receives fees for managing senior living communities owned by others.
The majority of the Company's communities provide housing and health care
services through annually renewable agreements with the residents. Under
these agreements, residents are billed monthly fees for housing and
additional services, which are recognized as revenue under these agreements
on a monthly basis as the services are provided to its residents.
Management services revenue is recorded monthly as services and
administrative support under management agreements are provided to the
owners and lessees of the subject communities. Such revenues are determined
by an agreed formula set forth in the applicable management agreement
(e.g., a specified percentage of revenues, income or cash flows of the
managed community, or a negotiated fee per the management agreement).
Certain communities provide housing and health care services under various
types of entrance fee agreements with residents (EF Communities). These
agreements require new independent living residents to pay an upfront
entrance fee, and may obligate the Company to provide a limited healthcare
benefit in the form of future assisted living or skilled nursing housing
and services during the life of the resident. These benefits generally take
the form of reduced monthly or daily rates for assisted living or skilled
nursing services, or a certain number of days of these services are allowed
at no additional cost during each quarter or year. Each new entrance fee
resident must meet certain asset and income criteria as part of these
lifecare agreements.
54
Generally, a portion of the entrance fee is refundable to the resident or
the resident's estate upon termination of the agreement. The refundable
amount is recorded by the Company as refundable portion of entrance fees, a
long-term liability, until termination of the agreement. The remainder of
the entrance fee is recorded as deferred entrance fee income and is
amortized into revenue using the straight-line method over the estimated
remaining life expectancy of the resident, based upon actuarial
projections. Additionally, under these agreements the residents pay a
monthly service fee, which entitles them to the use of certain amenities
and certain services. Residents may also elect to obtain additional
services, which are also billed on a monthly basis, as the services are
provided. The Company recognizes these additional fees as revenue on a
monthly basis when earned.
Certain communities also provide services under a type of an entrance fee
agreement whereby the entrance fee is fully refundable to the resident or
the resident's estate contingent upon the occupation of the unit by the
next resident, unless otherwise required by applicable state law. In this
situation, the resident also shares in a percentage, typically 50%, of any
appreciation in the entrance fee paid by the succeeding resident, but
receives no healthcare benefit. This contingent refund is paid to the
preceding resident only upon occupancy of the unit by a new, succeeding
resident. Because these refunds are contingent and only payable out of
subsequent entrance fee proceeds, these entrance fees are classified on the
Company's consolidated balance sheet as deferred entrance fee income.
Because these units can be reoccupied during the remaining life of the
building and the Company's obligations continue as long as the unit can be
reoccupied, these refunds are amortized into revenue on a straight-line
basis over the remaining life of the building. In the unusual event that
the new resident's entrance fee is less than the previous resident's
entrance fee, the Company immediately recognizes the entire shortfall as a
loss during the current period. Additionally, under these agreements the
residents pay a monthly service fee, which entitles them to the use of
certain amenities and certain services. These residents may also elect to
obtain additional services, which are billed on a monthly basis, as the
services are provided. The Company recognizes these additional fees as
revenue on a monthly basis when earned. If residents terminate these
agreements, they are required to continue to pay their monthly service fee
for the lesser of a specified time period (typically one year) or until the
relevant unit is reoccupied.
Resident and health care revenues are reported at the estimated net
realizable amounts from residents, third-party payors, and others for
services rendered, including estimated retroactive adjustments under
reimbursement agreements with third-party payors.
(c) Cash and Cash Equivalents: For purposes of the Consolidated Statements of
Cash Flows, the Company considers highly liquid debt investments with
original maturities of three months or less to be cash equivalents.
(d) Assets Limited as to Use: Assets limited as to use are classified as held
to maturity and include assets held by lenders under loan agreements in
escrow for property taxes and property improvements, operating reserves
required by certain state licensing authorities and certificates of
deposit, held as collateral for letters of credit or in conjunction with
leasing activity and insurance requirements, as well as resident deposits.
A decline in the fair value of any held-to-maturity security below cost
that is deemed to be other than temporary results in an impairment in
carrying amount to fair value. The impairment is charged to earnings and a
new cost basis for the security is established. Premiums and discounts are
amortized or accreted over the life of the related held-to-maturity
security as an adjustment to yield using the effective interest method.
Dividend and interest income are recognized when earned.
(e) Accounts Receivable: Accounts receivable are reported at the invoiced
amount. The allowance for doubtful accounts is the Company's best estimate
of the amount of probable credit losses in the Company's existing accounts
receivable. The Company determines the allowance based on historical
write-off experience and actual resident information. The Company reviews
its allowance for doubtful accounts monthly. Past due balances over certain
days (dependent on payor type) and over a specified amount are reviewed
individually for collectibility. All other balances are reviewed on a
pooled basis by payor type. Account balances are charged off against the
allowance after all means of collection have been exhausted and the
potential for recovery is considered remote.
(f) Inventory: Inventory consists of supplies and is stated at the lower of
cost (first-in, first-out) or market.
55
(g) Assets Held-for-Sale: Assets held-for-sale are reported at the lower of the
carrying amount or fair value less costs to sell. Upon classification as
held-for-sale, depreciation on depreciable assets ceases.
(h) Land, Buildings, and Equipment: Land, buildings, and equipment are recorded
at cost and include interest capitalized on long-term construction projects
during the construction period, as well as other costs directly related to
the acquisition, development, and construction of the communities.
Depreciation and amortization are computed using the straight-line method
over the estimated useful lives of the related assets. Buildings and
improvements are depreciated over 15 to 40 years, and furniture, fixtures
and equipment are depreciated over three to seven years. Leasehold
improvements are amortized over the shorter of their useful life or
remaining base lease term. Construction in progress includes costs incurred
related to the development, construction or remodeling of senior living
communities. If a project is abandoned or delayed, any costs previously
capitalized are measured for impairment and expensed accordingly.
(i) Purchase Options: Purchase options to acquire property are recorded at
their cost and, upon exercise, are applied to the cost of the property at
the time of acquisition. Nonrefundable purchase options are expensed when
they expire or when the Company determines it is no longer probable that
the property will be acquired. If the Company determined at some future
time that it no longer intended to exercise these options, that it will
transfer them for other consideration, or that their value was impaired, a
loss would be recorded at that time.
(j) Notes Receivable: Notes receivable are recorded at cost, less any related
allowance for impaired notes receivable. Impairment losses are included in
the allowance for doubtful accounts through a charge to bad debt expense.
Management considers a note to be impaired when it is probable that the
Company will be unable to collect all amounts due according to the
contractual terms of the note agreement.
(k) Goodwill: Goodwill represents the excess of costs over fair value of assets
of businesses acquired. In July 2001, the FASB 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 December 31, 2003 and 2002, the Company had $36.5 million
of goodwill. Amortization expense related to goodwill was approximately
$1.0 million for the year ended December 31, 2001, or $0.06 per dilutive
share. The Company adopted SFAS No. 142 on January 1, 2002.
With the adoption of SFAS No. 142, the Company reassessed the useful lives
and residual values of all intangible assets acquired in purchase business
combinations, and determined that no amortization period adjustments were
required. In addition, the Company did not identify any intangible assets
with indefinite useful lives, other than goodwill. The transitional
provisions of SFAS No. 142 required the Company to perform an assessment of
whether there was an indication that goodwill was impaired as of the date
of adoption. To accomplish this, the Company identified its reporting units
and determined the carrying value of each reporting unit by assigning the
assets and liabilities, including the existing goodwill and intangible
assets, to those reporting units as of the date of adoption. For purposes
of allocating and evaluating goodwill and intangible assets, the Company
considers Retirement Centers and Free-standing ALs as its reporting units.
All recorded goodwill as of the date of adoption was attributable to the
Retirement Center reporting unit. To the extent a reporting unit's carrying
amount exceeded its fair value, an indication existed that the reporting
unit's goodwill may be impaired and the Company was required to perform the
second step of the transitional impairment test. The Company completed step
one of the initial impairment provisions of SFAS No. 142 and determined
that the fair value of its Retirement Center reporting unit exceeded its
net book value at January 1, 2002, thus indicating goodwill was not
impaired. The required annual impairment assessment was performed during
the fourth quarters of 2002 and 2003 which resulted in no indication of
impairment.
(l) Leasehold Acquisition Costs: Leasehold acquisition costs consist primarily
of costs incurred in conjunction with entering into certain new leases and
for costs incurred for the acquisition of lease rights from previously
managed special purpose entity communities. These costs provide the Company
the opportunity to lease the communities. Leasehold acquisition costs are
amortized principally on a straight-line basis over the remaining
contractual or expected life of the related lease agreements if shorter.
56
(m) Other Assets: Other assets consist primarily of security deposits,
unexercised nonrefundable purchase options, deferred financing costs, costs
of acquiring lifecare contracts, deferred entrance fee receivables,
advances to managed entities, contingent earn-outs and investments in joint
ventures. Deferred financing costs are amortized using the straight-line
method over the terms of the related debt agreements. Costs of acquiring
initial lifecare contracts are amortized over the life expectancy of the
initial residents of a lifecare community. Nonrefundable purchase options
to acquire property are recorded at their cost and, upon exercise, are
applied to the cost of the property acquired. Nonrefundable purchase
options are expensed when they expire or earlier, if management determines
it is no longer probable that the property will be acquired. Contingent
earn-outs represent management's estimate of additional sale proceeds to be
received from the counterparty in certain sale lease-back transactions
which were accounted for as financing transactions. Management periodically
assesses the recoverability of the recorded balances of contingent
earn-outs for these contingent earn-outs and adjusts the carrying amount to
its revised estimate with a corresponding increase or decrease to interest
expense.
(n) Investments In Joint Ventures: Investments in joint ventures includes the
Company's 37% and 50% investments in joint ventures that own two Free
Standing ALs, which the Company accounts for under the equity method. The
Company recognizes an impairment loss when there is a loss in the value in
the equity method investment which is deemed to be an other-than-temporary
decline.
(o) Advances to Managed Communities: Advances to Managed Communities includes
the Company's working capital advances to a Retirement Center managed by
the Company. At December 31, 2003 and 2002, the Company's advances to
managed entities was approximately $1.8 million and $1.5 million,
respectively. The amounts are non-interest bearing and due on demand. The
Company does not intend to demand repayment, unless sufficient operating
cash exists at the Retirement Center. Such assets are reflected in Other
Assets on the accompanying consolidated balance sheets.
(p) Debt Associated with Assets Held-for-Sale: Debt associated with assets
held-for-sale is presented as current, as this debt will be assumed by the
buyer or paid from sale proceeds. However, over the next twelve months,
only $1.3 million of the $16.4 million of debt associated with assets
held-for-sale at December 31, 2003 is contractually due.
(q) Lease Classification: The Company, as the lessee, makes a determination
with respect to each of these leases whether they should be accounted for
as operating leases or lease financing obligations. The Company bases its
classification criteria on estimates regarding the fair value of the leased
community, minimum lease payments, the Company's effective cost of funds,
the economic life of the community and certain other terms in the lease
agreements. Sale lease-back transactions are recorded as financings when
the transactions include a form of continuing involvement, such as purchase
options or contingent earn-outs. Sale lease-back transactions recorded as
financings result in maintaining the land, building and equipment on the
Company's balance sheet as well as recording debt equal to the net cash
proceeds received.
(r) Other Liabilities: The Company periodically reviews the adequacy of its
accruals related to general and professional liability, workers'
compensation, employee medical claims and other claims on an ongoing basis,
using historical claims, third party administrator estimates, advice from
legal counsel and industry loss development factors.
(s) Obligation to Provide Future Services: Under the terms of certain entrance
fee contracts, the Company is obligated to provide future lifecare services
to its residents. The Company, through the use of external advisors,
periodically calculates the present value of the net cost of future
services and use of facilities and compares that amount with the present
value of future resident cash inflows. If the present value of the net cost
of future services and use of facilities exceeds discounted future cash
inflows, a liability will be recorded with a corresponding charge to
income. As of December 31, 2003 and 2002, the Company did not have a
liability associated with its obligation to provide future services and use
of facilities.
(t) Income Taxes: Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are recorded using enacted tax rates
expected to apply to taxable income in the year in which those temporary
differences are expected to be recovered or settled. A valuation allowance
is recorded to adjust net deferred tax assets to the amount which
management believes will more likely than not be recoverable. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date.
57
(u) Loss per Share: Basic loss per share ("EPS") is computed by dividing net
loss (numerator) by the weighted average number of common shares
outstanding (denominator). The denominator used in computing diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock or resulted in the issuance of common stock that then shared in the
earnings of the Company. Due to the net losses in 2003, 2002 and 2001 no
common stock equivalents were considered in the computation of diluted EPS,
including the effect from assumed conversion of the 10% Series B
Convertible Senior Subordinated Notes Due 2008 (the "Series B Notes").
(v) Stock-Based Compensation: In December 2002, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of FASB Statement No. 123. SFAS 148 amends SFAS
No. 123, Accounting for Stock-Based Compensation, to provide alternative
methods of transition for a voluntary change to the fair value method of
accounting for stock-based employee compensation. In addition, this
Statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements.
Certain of the disclosure modifications are included below.
The Company applies the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations including FASB
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation, an interpretation of APB Opinion No. 25, to account for its
fixed plan stock options. Under this method, compensation expense is
recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. SFAS No. 123 established
accounting and disclosure requirements using a fair-value-based method of
accounting for stock-based employee compensation plans. As permitted by
SFAS No. 123 and SFAS No. 148, the Company has elected to continue to apply
the intrinsic-value-based method of accounting described above, and has
adopted only the disclosure requirements of these statements. The following
table illustrates the effect on net loss if the fair-value-based method had
been applied to all outstanding and unvested awards in each period.
Years Ended December 31,
2003 2002 2001
------------- ------------ ------------
Net loss, as reported $ (17,314) $ (94,757) $ (34,922)
Deduct total stock-based employee compensation expense
determined under fair-value-based method, net of tax (557) (1,763) (1,769)
------------- ------------ ------------
Pro forma net loss $ (17,871) $ (96,520) $ (36,691)
============= ============ ============
Loss per share:
Basic-as reported $ (0.95) $ (5.48) $ (2.03)
Basic-pro forma $ (0.98) $ (5.58) $ (2.13)
Diluted-as reported $ (0.95) $ (5.48) $ (2.03)
Diluted-pro forma $ (0.98) $ (5.58) $ (2.13)
(w) Fair Value of Financial Instruments: The carrying amount of cash and cash
equivalents approximates fair value because of the short-term nature of
these accounts and because amounts are invested in accounts earning market
rates of interest. The carrying value of assets limited as to use, accounts
receivable, debt associated with assets held-for-sale and accounts payable
approximate their fair values because of the short-term nature of these
accounts. The carrying value of notes receivable and debt approximates fair
value as the interest rates approximate the current rates available to the
Company. The interest rate swap is carried at fair value.
(x) Derivative Financial Instruments: The Company recognizes all derivatives as
either assets or liabilities, measured at fair value, in the consolidated
balance sheets. The accounting for changes in the fair value (i.e., gains
or losses) of a derivative instrument depends on whether it has been
designated and qualifies as part of a hedging relationship and, if so, on
the reason for holding it.
58
At December 31, 2003 and 2002, the Company's derivative financial
instruments consisted of one interest rate swap agreement as a hedge
against changes in the fair value of certain debt liabilities. The notional
amount of the agreement is $34.8 million and matures on July 1, 2008. Under
the terms of the agreement, the Company receives a fixed rate payment of
6.87% on the $34.8 million of debt, but pays a floating rate stated by the
swap agreement based on LIBOR and a foreign currency index, with a maximum
rate of 8.12%. The fair value of the remaining interest rate swap as of
December 31, 2003 and 2002 was a $1.3 million and a $1.5 million liability,
respectively, which is being amortized over the life of specified debt
instruments as a yield adjustment. Subsequent changes in the fair values of
the interest rate swap is recorded in earnings.
(y) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of:
Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying
amount of an asset to future undiscounted net cash flows expected to be
generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is the amount by which the carrying amount of
the assets exceeds the fair value of the assets. Assets to be disposed of
are separately presented on the balance sheet as held-for-sale and reported
at the lower of the carrying amount or fair value less the costs to sell,
and are no longer depreciated. The assets and liabilities of a disposal
group classified as held-for-sale are presented separately in the
appropriate asset and liability section of the balance sheet.
(z) Comprehensive Loss: During 2003, 2002 and 2001, the Company's only
component of comprehensive loss was net loss.
(aa) Segment Disclosures: The Company operates in three reportable business
segments, Retirement Centers, Free-standing ALs and Management Services.
(bb) Reclassifications: Certain 2002 and 2001 amounts have been reclassified to
conform with the 2003 presentation.
(cc) Recent Issued Accounting Standards:
In December 2003, the FASB issued FASB Interpretation No. 46 (revised
December 2003), Consolidation of Variable Interest Entities, which
addresses how a business enterprise should evaluate whether it has a
controlling financial interest in an entity through means other than voting
rights and accordingly should consolidate the entity. FIN 46R replaces FASB
Interpretation No. 46, Consolidation of Variable Interest Entities, which
was issued in January 2003. Based upon the Company's current understanding
of the current guidance provided by the FASB, the Company has three
variable interest entities with which it holds a significant variable
interest:
Commencement Nature of Ownership Unit Capacity
Community of Operations Activity (Loss Exposure) Location IL AL MI SNF Total
--------- ------------- -------- --------------- -------- ---- ---- ---- ----- -----
Freedom Square July 1998 Managed 0.0% Seminole, 362 103 76 194 735
Florida
McLaren
Homewood Village April 2000 Joint Venture 37.5% Flint, Michigan 14 66 38 - 118
Village of
Homewood April 1998 Joint Venture 50.0% Lady Lake, - 32 15 - 47
Florida ----- ----- ----- ------ -------
376 201 129 194 900
===== ===== ===== ====== =======
For any VIEs that must be consolidated under FIN 46R, the assets,
liabilities and noncontrolling interests of the VIE initially would be
measured at their carrying amounts with any differences between the
net amount added to the balance sheet and any previously recognized
interest being recognized as a cumulative effect of an accounting
change. The Company is in the process of reviewing its managed
entities and agreements, and will consolidate any managed entities in
accordance with the then current consolidation literature beginning
January 1, 2004. At this time, it is anticipated that the Company will
consolidate Freedom Square effective January 1, 2004 and the effect on
the Company's consolidated balance sheet would be an increase of
approximately $59.2 million to assets, liabilities and minority
interests.
59
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS 150
establishes standards for the classification and measurements of certain
financial instruments with characteristics of both liabilities and equity.
SFAS No. 150 also includes required disclosures for financial instruments
within its scope. SFAS 150 was effective for financial instruments entered
into or modified after May 31, 2003, and otherwise was effective July 1,
2003. The Company has not entered into any financial instruments within the
scope of SFAS 150 since May 31, 2003, nor does it currently hold any
significant financial instruments within its scope. Adoption of the
standard did not have an impact on the Company's consolidated financial
position, results of operations or cash flows.
(3) Asset Impairments and Other Losses
During the years ended December 31, 2002 and 2001 the Company recorded $4.0
million and $6.3 million, respectively, of asset impairments related to delayed
or discontinued developments. The 2002 and 2001 impairments related to five land
parcels and a land purchase agreement. During 2003, the Company sold two of the
land parcels. The three remaining parcels with a net carrying value of $5.6
million at December 31, 2003, are held-for-sale. The land purchase agreement
will be used for the development of a senior living community through a joint
venture with an unaffiliated entity. Architectural, engineering, legal and other
costs which the Company has incurred, amount to a net carrying value of $2.6
million at December 31, 2003. Although zoning for the project has been approved,
the project has been delayed while the Company appeals certain restrictions
contained in the zoning approval. The Company intends to pursue these appeals
vigorously and believes it will ultimately be successful in amending the zoning
restrictions and securing financing (through joint venture or other
arrangements) to acquire and develop the property, but there can be no assurance
in that regard.
(4) Discontinued Operations
During the quarter ended September 30, 2002, the Company determined that a
Free-standing AL would be held-for-sale. During 2003, the Company determined
that two additional Free-standing ALs would be held-for-sale. The Company is
involved in negotiation relating to these three communities, which are subject
to various contingencies. If the sales are completed (of which there can be no
assurance), the Company will use most of the proceeds to repay mortgage debt and
other related payments. The 2002 amounts have been restated to include all three
Free-standing ALs in discontinued operations. For the years ended December 31,
2003 and 2002, the Company recorded a loss from discontinued operations of $2.1
million and $8.4 million, respectively, for these three Free-standing ALs. The
loss recorded for the year ended December 31, 2003 includes a loss of $821,000
resulting from the write-off of a contingent earnout recorded as part of a first
quarter 2003 amendment to a sale-leaseback transaction of a Free-standing AL
originally consummated during 2002 (see note 9). Based upon the anticipated
purchase prices, the discontinued operations during the year ended December 31,
2002 included $5.9 million of asset impairments.
(5) Assets Held-for-Sale
The Company had $20.2 million and $34.1 million of assets classified as
held-for-sale at December 31, 2003 and 2002, respectively. At December 31, 2003,
these assets consist of approximately $13.8 million related to three
Free-standing ALs held-for-sale, $5.6 million related to three land parcels
which were originally purchased for development and $800,000 of other assets.
Debt associated with assets held-for-sale at December 31, 2003 was $16.4
million, which is classified as a current liability (of which only $1.3 million
is due over the next twelve months by its contractual terms). See note 10.
60
(6) Assets Limited as to Use
The composition of assets limited as to use at December 31, 2003 and 2002 is as
follows (in thousands):
2003 2002
---- ----
Held by trustee under agreement:
Certificates of deposit $ 15,240 $ 21,195
Cash and other short-term investments 23,966 17,865
----------- -----------
39,206 39,060
Less long-term investments 22,655 21,701
----------- -----------
Short-term investments $ 16,551 $ 17,359
============ ===========
The certificates of deposit are pledged to a variety of parties for various
reasons such as state requirements (primarily for entrance fee communities),
collateral for various self-insurance programs, and collateral to support the
Company's lease obligations. The Company receives and recognizes the interest
income earned on these certificates of deposit.
(7) Land, Buildings, and Equipment
A summary of land, buildings, and equipment is as follows (in thousands):
2003 2002
---- ----
Land and improvements $ 15,369 $ 15,233
Land leased to others 19,690 31,516
Land held for development 3,667 3,667
Buildings and improvements 441,614 549,724
Furniture, fixtures, and equipment 38,122 44,092
Leasehold improvements 9,456 7,425
------------ -------------
527,918 651,657
Less accumulated depreciation (66,238) (76,770)
Construction in progress 3,208 3,917
------------ -------------
Total $ 464,888 $ 578,804
============ =============
Depreciation expense was $23.8 million, $20.4 million, and $17.7 million for the
years ended December 31, 2003, 2002, and 2001, respectively. The Company
capitalized $15,000 and $861,000 of interest costs during 2002 and 2001,
respectively.
(8) Notes Receivable
These are primarily loans to lessors of retirement communities that are being
leased by the Company. The notes receivable generally earn interest at fixed
rates ranging from 3% to 6%. Interest and principal are due monthly based on a
35 year amortization. The notes receivable mature from October 2006 through June
2038 and are secured by the related communities.
61
(9) Other Assets
Other assets at December 31, 2003 and 2002 consist of the following (in
thousands):
2003 2002
---- ----
Security deposits $ 9,145 $ 8,780
Nonrefundable purchase options 11,350 17,376
Costs of acquiring lifecare contracts, net 2,086 2,417
Deferred entrance fee receivables 6,377 7,353
Deferred financing costs, net 5,543 7,968
Contingent earn-outs 5,259 5,585
Advances to managed entities 1,830 1,483
Investments in and advances to joint ventures 1,149 2,111
Other 10,302 10,734
---------- ---------
Total $ 53,041 $ 63,807
========== =========
Summary unaudited financial information of the Company's two joint ventures
(each own one Free-standing AL community) as of and for the years ended December
31, 2003 and 2002 follows (in thousands):
2003 2002
---- ----
Current assets $ 326 $ 415
Land, buildings and equipment, net 13,130 13,533
Other assets 241 414
---------- ---------
Total assets $ 13,697 $ 14,362
========== =========
Current liabilities $ 4,123 $ 2,992
Long-term liabilities 12,425 12,126
---------- ---------
Total liabilities 16,548 15,118
---------- ---------
Partners' equity (2,851) (756)
---------- ---------
Total liabilities and partners' equity $ 13,697 $ 14,362
========== =========
Revenues $ 4,245 $ 3,894
Net loss (1,236) (1,469)
========== =========
As noted above, the Company had $1.1 million and $2.1 million of investments in
and advances to the two joint ventures at December 31, 2003 and 2002,
respectively. For the years ended December 31, 2003 and 2002, respectively, the
Company recognized $484,000 and $582,000 of net losses related to these two
unconsolidated joint ventures.
62
(10) Long-term Debt and Other Transactions
A summary of long-term debt is as follows (in thousands):
December 31, December 31,
2003 2002
------------------- -----------------
Note payable bearing interest at a fixed rate of 19.5%, compounding quarterly
("Mezzanine Loan"). Interest at 9% (increasing 0.55% annually after April 1,
2004) is payable quarterly with principal and unpaid interest due on September
30, 2007. The loan is secured by a security interest in the borrower
subsidiary's ownership interests in certain of its subsidiaries. $ 77,926 $ 115,721
Convertible debentures (Series B Notes) bearing interest at a fixed rate of
10.00%. Interest is due semi-annually on April 1 and October 1 through April 1,
2008, at which time all principal is due. 10,856 15,956
Various mortgage notes bearing interest at variable and fixed rates, generally
payable monthly with any unpaid principal and interest due between 2004 and
2037. Interest rates at December 31, 2003 range from 3.67% to 9.50%. The loans
are secured by certain land, buildings and equipment. 122,512 240,549
Lease financing obligations with principal and interest payable monthly bearing
interest at fixed rates ranging from 3.72% - 9.39%, with final payments due
between 2006 and 2017. The obligations are secured by certain land, buildings
and equipment. 100,275 128,575
Various other long-term debt, generally payable monthly with any unpaid
principal and interest due between 2004 and 2015. Variable and fixed rate
interest rates at December 31, 2003 range from 1.20% to 11.12%. The loans are
secured by certain land, buildings and equipment. 43,126 39,850
------------------- -----------------
Total long-term debt 354,695 540,651
Less current portion 14,208 13,526
Less debt associated with assets held-for-sale 16,432 20,246
------------------- -----------------
Long-term debt, excluding current portion $ 324,055 $ 506,879
=================== =================
The aggregate scheduled maturities of long-term debt were as follows (in
thousands):
December 31,
2003
--------------------
2004 $ 14,208
2004, debt associated with assets held-for-sale 16,432
2005 16,713
2006 11,582
2007 98,834
2008 47,510
Thereafter 149,416
--------------------
$354,695
====================
63
In addition to the scheduled maturities of long-term debt, the Company will be
required to pay all accrued but unpaid interest on the Mezzanine Loan up to
maturity or earlier repayment. This balance will increase each year as another
year of interest is accrued but unpaid, plus the compounding of interest on
amounts previously accrued. Unless paid earlier, the accrued interest on the
Mezzanine Loan at maturity (September 2007) will be approximately $41.8 million.
The accrued interest at September 30, 2005, when the Mezzanine Loan permits
prepayment, will be approximately $15.8 million.
During the year ended December 31, 2003, the Company entered into various
financing transactions, which are described below.
September 2003 Transaction:
On September 23, 2003, the Company completed a multi-property transaction with
HCPI that involved the sale lease-back of three Retirement Centers and the sale
of a fourth Retirement Center. The Company also entered into a long-term
agreement to manage the fourth community for an unaffiliated third party. The
proceeds of the transaction were used to repay $112.8 million of first mortgage
debt on the four Retirement Centers. In addition, after first mortgage
prepayment costs of $1.0 million, a $3.0 million credit for existing minority
interest in the properties, and transaction costs, the remaining proceeds of
$51.8 million were used to repay a portion of the principal and accrued interest
on the Mezzanine Loan.
The four Retirement Centers were valued in the transaction at $163.5 million,
versus their net book value of $72.3 million. As a result of the transaction,
the Company realized gains of $93.1 million. During 2003 $23.2 million of these
gains were recognized related to the sale of the fourth Retirement Center. Gains
of $69.9 million were deferred and will be recognized over the lease terms.
Approximately $66.2 million of the deferred gains will be recognized over the
initial ten year lease terms for the three Retirement Centers included in the
September 2003 sale lease-back. An additional $3.7 million of deferred gain will
be recognized over the remaining thirteen years of a Retirement Center lease
previously entered into with HCPI during the first quarter of 2002. As part of
the September 2003 transaction, this prior lease was amended to remove a
purchase option related to the land, buildings and equipment of this community.
The lease was previously accounted for as a financing, but as a result of the
amendment, to remove the purchase option, this lease is currently accounted for
as an operating lease. The removal of the option resulted in the $19.7 million
reduction of land, buildings and equipment and a $24.1 million reduction in
debt.
The Company continues to operate all four Retirement Centers involved in the
September 2003 transaction. Three of the Retirement Centers were leased-back
under a master lease agreement with an initial term of ten years, plus two ten
year renewal options. The lease for these three Retirement Centers will be
accounted for as an operating lease. The initial lease rate for these three
communities is 9.5%, with annual rent increases of 2.75%. The Company
additionally agreed to manage the fourth Retirement Center for an unaffiliated
third party under a long-term management agreement. The initial term of the
management agreement is ten years, plus two ten year renewal terms. As a result
of this transaction, the Company has reported management fee revenue earned
under the management agreement for the Retirement Center, instead of including
the revenues and expenses of this community as part of its consolidated fourth
quarter results.
Recapitalization of Two Managed Communities:
In August 2003, the Company recapitalized two retirement centers that it had
previously managed. The Company had invested $6.0 million for options to
purchase these communities. On August 25, 2003, the options were sold to a third
party buyer for $3.0 million and the third party buyer acquired each of the
communities from the original developer. The buyer simultaneously entered into a
long-term lease with a newly formed entity, owned by the Company and the
original developer of the communities. In order to complete the purchase
transaction, the Company agreed on a non-recourse basis to pay the original
developer $11.3 million to purchase its interest in the entity. The entity,
which the Company consolidates, recorded $10.0 million as debt and will impute
interest at prime, with all amounts due on the $11.3 million note on August 25,
2008. Upon payment of the $11.3 million note, the Company will own 100% of this
entity. The lease provides an initial 15 year term, with two ten year extension
options. Proceeds from the additional funding, if any, will be used first to
satisfy the Company's $11.3 million obligation to the original developer. The
Company recorded leasehold acquisition costs of $13.0 million which consists of
the $10.0 million obligation to the original developer and the balance of the
purchase option sold to the third party buyer. The leasehold acquisition costs
are being amortized over the base term of the leases. The buyer has committed to
provide additional funding to the lessees depending upon the financial
performance of the communities. The Company also acquired an option from the
buyer to purchase the communities in nine years.
64
Sale Lease-back Transactions:
On February 28, 2003 the Company sold a Free-standing AL in Florida for $6.5
million. The sale agreement contains certain formula-based earnout provisions
which may provide for up to $1.1 million of additional sales proceeds to the
Company based on future performance. The Company contemporaneously leased the
property back from the buyer. As a result of the contingent earnout provision,
this Free-standing AL lease is classified as a financing transaction and the
Company recorded $6.5 million of lease obligation as debt, bearing interest at
8.76%. This community was added to a master lease agreement which the Company
entered into on March 28, 2002, which previously included three Retirement
Centers and three Free-standing ALs. The amended lease is a 15 year lease
(approximately 13 years remaining) with two ten-year renewal options. The
Company has the right of first refusal to repurchase the leased communities. As
a result of this lease amendment, the Company is no longer eligible for a
contingent earnout of one of these communities that is currently held-for-sale,
resulting in a $821,000 write-off and conversion from financing to operating
lease treatment for this community.
(11) Liquidity
As a result of the completion of several refinancings and sale lease-back
transactions during 2002, the Company is highly leveraged with substantial debt
and lease obligations. During the year ended December 31, 2003, the Company
reduced its net loss and improved operating results from its Retirement Center,
Free-standing AL and Management Services business segments. The Company is
focused on generating positive cash flow from operating activities, primarily
through improvements in its operating results. For the years ended December 31,
2003 and 2002, respectively, net cash used by continuing operations activities
improved from $6.2 million to $808,000.
Total debt has decreased $186.0 million from $540.7 million to $354.7 million
for the years ended December 31, 2002 and 2003, respectively. Approximately
$267.5 million or 75.4% of the Company's debt has fixed interest rates, which on
a weighted average were 10.8% at December 31, 2003. The remaining $87.2 million
or 24.6% of debt has variable interest rates, which on a weighted average were
6.0% at December 31, 2003.
The Company has scheduled current debt principal payments of $14.2 million and
minimum rental obligations of $64.5 million under long-term operating leases due
during the twelve months ended December 31, 2004. The Company also has $16.4
million of debt associated with assets held-for-sale, which are classified as
current liabilities (of which only $1.3 million is due within the next twelve
months by its contractual terms). When assets held-for-sale are sold, the
Company will use most of the proceeds to repay mortgage debt and other related
payments. In addition, as of December 31, 2004, the Company had guaranteed $35.7
million of third-party senior debt in connection with four communities that the
Company manages, leases, or owns through joint ventures.
As of December 31, 2003, the Company had approximately $16.7 million in
unrestricted cash and cash equivalents and $11.2 million of working capital. The
Company's consolidated cash flows from operations, while improved, were negative
for the year ended December 31, 2003 and were not sufficient to meet future debt
and lease obligations. However, the Company believes that its current cash and
cash equivalents, expected cash flow from operations, the proceeds from
additional financing transactions and the proceeds of certain assets currently
held-for-sale will be sufficient to fund its operating requirements, capital
expenditure requirements, periodic debt service requirements, and lease
obligations during 2004.
In order to meet its future payment obligations, the Company must continue to
improve its cash flow from operations, complete the disposition of certain of
the assets currently held-for-sale, and consummate various financing
transactions. There can be no assurance that the Company's operations will
improve as rapidly as anticipated or that the contemplated asset disposition and
refinancing transactions can be consummated during the anticipated timeframes.
The failure to make its periodic debt and lease payment obligations, or the
failure to extend, refinance or repay any of its debt obligations as they become
due would have a material adverse effect upon the Company.
Certain of the Company's current debt and lease agreements contain various
financial and other restrictive covenants, which may restrict the Company's
flexibility in operating its business. The Company believes that projected
results from operations and cash flows will be sufficient to satisfy these
covenants during 2004. However, there can be no assurances that the Company will
remain in compliance with those covenants or that the Company's creditors will
grant amendments or waivers in the event of future non-compliance. Furthermore,
because of cross-default and cross-collateralization provisions in many of the
Company's mortgages, debt instruments, and leases, a default by the Company on
one of its payment obligations could result in default or acceleration of many
of the Company's other obligations. Failure to remain in compliance with its
financial covenants, any non-payment, or other default with respect to such
obligations 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, which could have a
material adverse impact on the Company.
65
(12) Refundable Entrance Fees and Deferred Entrance Fee Income
Entrance fees related to the residency and care agreements entered into with
residents are received at the time of occupancy. The nonrefundable portion of
the fee is reported as deferred entrance fees and amortized into income over the
actuarially determined life expectancy of each resident. The refundable portion
of the entrance fee is reported as refundable portion of entrance fees and is
not amortized. Entrance fees that are fully refundable to the resident upon
occupation of the unit by the next resident are recorded as deferred entrance
fee income and amortized into revenue over the remaining life of the building.
Certain entrance fee agreements provide for declining refundable fees based upon
the resident's length of stay. Residency and care agreements may be terminated
by residents at any time for any reason with 30 days notice. At termination, the
refundable amount is paid to the resident or resident's estate. Payments of such
refunds are charged against the resident's deferred entrance fees and refundable
portion of entrance fees, and any gain or loss is included in resident and
health care services revenue.
Under certain of the Company's residency and health care agreements for its
lifecare communities residents entered into a Master Trust Agreement whereby
amounts were paid by the resident into a trust account. These funds were then
made available to the related communities in the form of a non-interest bearing
loan to provide permanent financing for the related communities and are
collateralized by the land, buildings and equipment at the community. As of
December 31, 2003, the remaining obligation under the Master Trust Agreements is
$37.4 million and is payable monthly based on a 40-year amortization of each
resident's balance. The current installment due in 2004, and annually for the
subsequent five-year period, is approximately $1.4 million. The annual
obligation is reduced as individual residency agreements terminate.
Upon termination of the resident's occupancy, the resident or the resident's
estate receives a payment of the remaining loan balance from the trust and pays
a lifecare fee to the community based on a formula in the residency and health
care agreement, not to exceed a specified percentage of the resident's original
amount paid to the trust. This lifecare fee is amortized by the Company into
revenue on a straight-line basis over the estimated life expectancy of the
resident beginning with the date of occupancy by the resident. The amortization
of the lifecare fees is included in resident and health care revenue in the
consolidated statement of operations. At December 31, 2003 and 2002, the Company
had accrued $6.4 million and $7.4 million, respectively, as deferred entrance
fee receivables which is included as a component of other assets. The Company
reports the long-term obligation under the Master Trust Agreements as a
refundable portion of entrance fees and deferred entrance fee income based on
the applicable residency agreements.
The balances at December 31, 2003 and 2002, respectively (in thousands) were:
Other Residency
Master Trust Agreements Total
------------------- ------------------- ----------------
At December 31, 2003:
Other current liabilities $ 1,356 $ --- $ 1,356
Refundable portion of entrance fees 15,045 47,186 62,231
Deferred entrance fee income 20,963 101,426 122,389
-------- --------- ---------
$ 37,364 $ 148,612 $ 185,976
========= ========= =========
Other Residency
Master Trust Agreements Total
------------------- ------------------- ----------------
At December 31, 2002:
Other current liabilities $ 1,522 $ --- $ 1,522
Refundable portion of entrance fees 17,215 42,394 59,609
Deferred entrance fee income 25,397 93,101 118,498
--------- --------- ---------
$ 44,134 $ 135,495 $ 179,629
========= ========= =========
66
(13) Shareholders' Equity
The Company is authorized to establish and issue, from time to time, up to 5
million shares of no par value preferred stock, in one or more series, with such
dividend rights, dividend rate, conversion rights, voting rights, rights and
terms of redemption (including sinking fund provisions), redemption price or
prices, and liquidation preference as authorized by the Board of Directors. At
December 31, 2003 and 2002, no preferred shares had been issued.
On November 18, 1998, the Company's Board of Directors adopted a Shareholders'
Rights Plan (the "Rights Plan") to protect the interests of the Company's
shareholders if the Company is confronted with coercive or unfair takeover
tactics by third parties. Pursuant to the Rights Plan, a dividend of one Right
for each outstanding share of the Company's Common Stock was issued to
shareholders of record on December 7, 1998. Under certain conditions, each Right
may be exercised to purchase one one-hundredth of a share of Series A Preferred
Stock at an exercise price of $86.25 per Right. Each Right will become
exercisable following the tenth day after a person's or group's acquisition of,
or commencement of a tender or exchange offer for 15% or more of the Company's
Common Stock. If a person or group acquires 15% or more of the Company's Common
Stock, each right will entitle its holder (other than the person or group whose
action has triggered the exercisability of the Rights) to purchase common stock
of either the Company or the acquiring company (depending on the form of the
transaction) having a value of twice the exercise price of the Rights. The
Rights will also become exercisable in the event of certain mergers or asset
sales involving more than 50% of the Company's assets or earning power. The
Rights may be redeemed prior to becoming exercisable, subject to approval by the
Company's Board of Directors, for $0.001 per Right. The Rights expire on
November 18, 2008. The Company has reserved 2,000,000 shares of Series A
Preferred Stock for issuance upon exercise of the Rights.
The Series B Notes are convertible into shares of the Company's common stock at
any time prior to their April 1, 2008 maturity, at the option of the holder, at
the conversion price of $2.25 per share. The Company has the option to pay up to
2% interest per year through the issuance of additional Series B Notes, rather
than in cash. The Series B Notes are redeemable, in whole or in part, at the
Company's option, at any time, at a premium starting at 105% of the principal
amount, declining to 100% of the principal amount during the term of the Series
B Notes. During the year ended December 31, 2003, holders of Series B Notes
elected to convert $5.1 million of the $16.0 million of convertible debentures
to common stock at the conversion price of $2.25 per share. As a result, the
Company issued 2,266,517 shares of common stock. The average market price of the
Company's common stock outstanding during the three and twelve months ended
December 31, 2003 was greater than the $2.25 per share conversion price. At
December 31, 2003, the remaining Series B Notes were convertible into 4,824,817
shares of common stock.
(14) Stock-Based Compensation
Stock Option Plan
In 1997, the Company adopted a stock incentive plan (the "1997 Plan") providing
for the grant of stock options, stock appreciation rights, restricted stock,
and/or other stock-based awards. Pursuant to the 1997 Plan, as amended, 15% of
the outstanding common stock, or 2,950,575 shares of common stock at December
31, 2003, have been reserved and are available for issuance. The option exercise
price and vesting provisions of such options are fixed when options are granted.
The options generally expire ten years from the date of grant and vest over a
three-year period. The weighted average fair value of options granted during
2003, 2002 and 2001 was $1.02, $0.95, and $1.15, respectively.
67
A summary of the Company's stock option activity, and related information for
the years ended December 31, 2003, 2002 and 2001, respectively, is presented
below (shares in thousands):
Average Exercise
Options Shares Price
--------------------------------------------------------------
Outstanding at December 31, 2000 760 $ 7.52
--------------------------------------------------------------
Granted 1,602 3.16
Exercised (12) 3.10
Forfeited (191) 7.07
--------------------------------------------------------------
Outstanding at December 31, 2001 2,159 $ 4.83
--------------------------------------------------------------
Granted 85 2.22
Exercised - -
Forfeited (117) 4.78
--------------------------------------------------------------
Outstanding at December 31, 2002 2,127 $ 4.73
--------------------------------------------------------------
Granted 156 2.20
Exercised - -
Forfeited (220) 9.83
--------------------------------------------------------------
Outstanding at December 31, 2003 2,063 $ 3.99
==============================================================
The following table summarizes information about stock options outstanding
at December 31, 2003 (shares in thousands):
Weighted Average Average
Number Exercise
Range of Exercise Prices Outstanding Contractual Life (Years) Price
-------------------------- --------------- -------------------------- -----------
$ 1.650 - 3.050 290 8.68 $ 2.35
$ 3.100 - 3.100 975 7.01 3.10
$ 3.110 - 4.950 308 7.71 3.37
$ 5.000 - 5.000 303 1.15 5.00
$ 5.010 - 18.813 187 2.64 10.54
-------------------------- --------------- -------------------------- -----------
$ 1.650 - 18.813 2,063 6.09 $ 3.99
-------------------------- --------------- -------------------------- -----------
There were exercisable options to purchase an aggregate of 1,738,000 shares at
an average exercise price of $4.25 per share as of December 31, 2003.
The following table summarizes information about stock options outstanding at
December 31, 2002 (shares in thousands):
Number Weighted Average Average Exercise
Range of Exercise Prices Outstanding Contractual Life (Years) Price
-------------------------- --------------- -------------------------- -----------
$ 1.650 - 3.050 146 8.95 $ 2.55
-------------------------- --------------- -------------------------- -----------
$ 3.100 - 3.100 1,010 8.01 3.10
-------------------------- --------------- -------------------------- -----------
$ 3.140 - 4.950 326 8.67 3.37
-------------------------- --------------- -------------------------- -----------
$ 5.000 - 5.000 343 2.11 5.00
-------------------------- --------------- -------------------------- -----------
$ 5.010 - 18.813 302 4.26 12.35
-------------------------- --------------- -------------------------- -----------
$ 1.650 - 18.813 2,127 6.69 $ 4.73
-------------------------- --------------- -------------------------- -----------
There were exercisable options to purchase an aggregate of 1,435,000 shares at
an average exercise price of $4.73 per share as of December 31, 2002.
In accordance with SFAS No. 123 and SFAS No. 148, pro forma information
regarding net loss and loss per share as disclosed in note 1(v) has been
determined by the Company using the "Black-Scholes" option pricing model with
the following weighted average assumptions for the years ended December 31,
2003, 2002 and 2001, respectively: 1.16%, 1.64% and 5.20% risk-free interest
rate, 0% dividend yield, 69.6%, 64.3% and 59.9% volatility rate, and an expected
life of the options equal to the remaining vesting period.
68
Stock Purchase Plan
In 1997, the Company adopted an employee stock purchase plan ("ESPP") pursuant
to which an aggregate of 449,782 shares remain authorized and available for
issuance to employees at December 31, 2003. Under the ESPP, employees, including
executive officers, who have been employed by the Company continuously for at
least 90 days are eligible, subject to certain limitations, as of the first day
of any option period (January 1 through June 30, or July 1 through December 31)
(an "Option Period") to contribute on an after-tax basis up to 15% of their base
pay per pay period through payroll deductions and/or a single lump sum
contribution per Option Period to be used to purchase shares of common stock. On
the last trading day of each Option Period (the "Exercise Date"), the amount
contributed by each participant over the course of the Option Period will be
used to purchase shares of common stock at a purchase price per share equal to
the lesser of (a) 85% of the closing market price of the common stock on the
Exercise Date; or (b) 85% of the closing market price of the common stock on the
first trading date of such Option Period. The ESPP is intended to qualify for
favorable tax treatment under Section 423 of the Internal Revenue Code (Code).
During 2003, 2002 and 2001, respectively, 62,793, 64,671 and 60,718 shares were
issued pursuant to the ESPP at an average purchase price of $1.77, $1.83 and
$2.37 per share, respectively.
(15) Executive Officer Incentive Compensation Plans
During 2003 the Board of Directors modified the incentive compensation programs
for its senior officers, which reduced the annual incentive opportunity for this
group, and added a program that provides an additional incentive opportunity
under a multi-year program. During the period beginning in 2003 and ending in
2007, the senior officer group can earn an additional incentive bonuses upon
achieving certain specified goals regarding improvements in the Company's
capital structure. The maximum payout under the multi-year plan would be
approximately $2.2 million if all targets are met, a net increase of
approximately $1.1 million during this period versus the prior incentive terms.
This amount would be paid out during the quarter following the time the
objective is met. The additional bonuses require the approval of the Company's
Board of Directors prior to payment.
(16) Retirement Plans
Employees of the Company participate in a savings plan (the "401(k) Plan") which
is qualified under Sections 401 (a) and 401(k) of the Code. To be eligible, an
employee must have been employed by the Company for at least three months. The
401(k) Plan permits employees to make voluntary contributions up to specified
limits. The Company matches 1% of participant contributions, up to 2% of the
participant's monthly compensation. In addition, the Company may make
discretionary contributions up to 2% of the participant's quarterly
compensation. The Company may also contribute an additional amount determined in
its sole judgment. The Company funded its contributions with the issuance of
stock during 2000 and 2001, contributing 72,493 shares and 138,907 shares,
respectively. In 2003 and 2002, the Company funded its contributions with cash
totaling approximately $416,000 and $485,000, respectively.
The Company maintains a non-qualified deferred compensation plan (the "162
Plan") which allows employees who are "highly compensated" under IRS guidelines
to make after-tax contributions to an investment account established in such
employees' name. Additional contributions may be made by the Company at its
discretion. All contributions to the 162 Plan are subject to the claims of the
Company's creditors. Approximately 78 employees are eligible to participate in
the 162 Plan. No contributions were made to the 162 Plan in 2003, 2002 or 2001.
(17) Income Taxes
Total income tax expense (benefit) for the years ended December 31, 2003, 2002,
and 2001 were attributable to the following (in thousands):
Years Ended December 31,
-------------------------------------
2003 2002 2001
----------- ----------- -----------
Loss from continuing operations $2,661 $487 ($11,837)
Minority interest in losses of
consolidated subsidiaries -- -- (49)
Extraordinary item -- -- (155)
----------- ----------- -----------
Total income tax expense(benefit) $2,661 $ 487 ($12,041)
=========== =========== ===========
69
The income tax expense (benefit), attributable to loss from continuing
operations before income taxes and minority interest consists of the following
(in thousands):
Years Ended December 31,
--------------------------------------------
2003 2002 2001
------------ ------------ -----------
U.S. Federal:
Current $ 552 $ -- ($327)
Deferred -- -- (11,310)
------------ ------------ -----------
Total U.S. Federal 552 -- (11,637)
------------ ------------ -----------
Years Ended December 31,
--------------------------------------------
2003 2002 2001
------------ ------------ -----------
State:
Current 464 479 263
Deferred 1,645 8 (463)
------------ ------------ -----------
Total State 2,109 487 (200)
------------ ------------ -----------
Total $ 2,661 $ 487 ($ 11,837)
============ ============ ===========
The tax effect of temporary differences that give rise to significant portions
of the deferred tax assets and liabilities at December 31, 2003 and 2002 are
presented below (in thousands):
2003 2002
------- -------
Deferred tax assets:
Federal and state operating loss carryforwards $10,122 $24,449
AMT credit carryforward 701 149
Deferred gains on sale lease-back transactions 35,344 11,240
Accrued expenses not deductible for tax 5,169 4,702
Intangible assets 6,474 --
Asset impairment charges and other losses 2,296 7,466
Deferred entrance fee revenue 19,047 19,096
Deferred rent 3,018 --
Other 2,266 3,255
-------- --------
Total gross deferred tax assets 84,437 70,357
Less valuation allowance (56,471) (47,934)
-------- --------
Total deferred tax assets, net of valuation allowance 27,966 22,423
Deferred tax liabilities:
Buildings and equipment 27,806 21,580
Intangible assets -- 833
Other 2,584 789
-------- --------
Total gross deferred tax liabilities 30,390 23,202
-------- --------
Net deferred tax liability ($2,424) ($ 779)
======== ========
The following table summarizes the significant differences between the U.S.
Federal statutory tax rate and the Company's effective tax rate for financial
statement purposes on loss from continuing operations before income taxes,
minority interest and discontinued operations:
2003 2002 2001
----- ----- ----
Statutory tax rate 35.0% 35.0% 35.0%
Difference in book and tax goodwill
amortization expense 0% 0% (0.3%)
State income taxes, net of Federal benefit (13.5%) (0.5%) 0.3%
Non-deductible expenses and other items (0.7%) (0.1%) (0.1%)
Change in valuation allowance (47.0%) (34.9%) (9.4%)
------- ------- -------
Total (26.2%) (0.5%) 25.5%
======= ======= =======
70
At December 31, 2003, the Company had unused federal net operating loss (NOL)
carryforwards of approximately $14 million for regular tax purposes and $10
million for alternative minimum tax, which expire in 2021 through 2022. As of
December 31, 2003 the Company had alternative minimum tax credit carryforwards
of approximately $701,000.
As of December 31, 2003, the Company carried a valuation allowance against
deferred tax assets in the amount of $56.5 million. The net change in the total
valuation allowance for the years ended December 31, 2003 and 2002 was an
increase of $8.5 million and $6.8, respectively. In assessing the realizability
of deferred tax assets, management considers whether it is more likely than not
that some portion or all of the deferred tax assets will be realized. The
ultimate realization of deferred tax assets related to deductible temporary
differences is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. The ultimate
realization of deferred tax assets related to net operating loss carryforwards
and tax credit carryforwards is dependent upon the generation of future taxable
income prior to the expiration of the carryforwards. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income,
and tax planning strategies in making this assessment. Based upon the level of
cumulative and projected future taxable income over the period in which the
Company can utilize the certain deferred tax assets, management has determined
that a valuation allowance in the amount of $56.5 million should be recorded
against federal and state net operating loss carryovers, and other deferred tax
assets.
(18) Leasehold Acquisitions
At December 31, 2003 and 2002, the Company had $33.2 million and $22.9
million, respectively, of leasehold acquisition costs. The terms of the subject
leases range from June 2012 to August 2018. Leasehold acquisition costs are
amortized principally on a straight-line basis over the remaining contractual or
expected life of the related lease agreements (generally ten to 15 years, or, if
shorter, the expected life of the lease). Accumulated amortization for the years
ended December 31, 2003 and 2002 was $6.5 million and $4.2 million,
respectively. Amortization expense for the years ended December 31, 2003 and
2002 was $2.4 million and $11.2 million, respectively. During the fourth quarter
of 2001, the Company determined that it intended to exercise its termination
rights under its fourteen synthetic leases during 2002. Accordingly, the Company
accelerated the amortization of the leasehold acquisition costs for these
communities over the expected lease termination date, resulting in $8.8 million
of accelerated leasehold amortization expense for the year ended December 31,
2002. The Company assesses the leasehold acquisition costs for impairment based
upon the amount of estimated undiscounted future cash flows over the remaining
lease terms.
(19) Industry Segment Information
The Company has significant operations principally in three business segments:
(1) Retirement Centers (2) Free-Standing ALs and (3) Management Services.
Retirement Centers represent 27 of the Company's senior living communities at
which the Company provides a continuum of care services such as, independent
living, assisted living and skilled nursing care. The Company currently operates
33 Free-Standing ALs. Free-standing ALs are generally comprised of stand-alone
assisted living communities that are not located on a Retirement Center campus,
which also provide specialized care such as Alzheimer's and memory enhancement
programs. Free-standing ALs are generally much smaller than Retirement Centers.
The Management Services segment includes fees from management agreements for
communities owned by others, and reimbursed expense revenues together with
associated expenses. The Company has five management agreements with third
parties relating to five Retirement Centers.
71
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The following table sets forth
certain segment financial and operating data(1) (in thousands).
Years Ended December 31,
---------------------------------------
2003 2002 2001
------------ ------------ ------------
Revenues:
Retirement Centers $ 279,329 $ 255,562 $ 224,703
Free-standing ALs(2) 78,491 66,067 29,217
Management Services (2)(4) 10,276 7,005 9,600
------------ ------------ ------------
Total $ 368,096 $ 328,634 $ 263,520
============ ============ ============
Segment operating income: (3)
Retirement Centers $ 92,701 $ 81,873 $ 77,465
Free-standing ALs 16,273 6,296 (3,263)
Management Services 4,771 1,959 2,296
------------ ------------ ------------
Total $ 113,745 $ 90,128 $ 76,498
============ ============ ============
General and administrative 25,410 26,720 29,297
Lease expense 47,095 71,569 35,367
Depreciation and amortization 24,265 21,255 19,737
Amortization of leasehold acquisition costs 2,421 11,183 1,980
Asset impairments -- 4,011 6,343
------------ ------------ ------------
Operating income (loss) $ 14,554 $ (44,610) $ (16,226)
============ ============ ============
At December 31,
---------------------------------------
2003 2002 2001
------------ ------------ ------------
Total Assets:
Retirement Centers $ 454,049 $ 539,764 $ 511,468
Free-standing ALs 206,489 210,376 239,333
Management Services 54,497 89,858 99,390
------------ ------------ ------------
Total $ 715,035 $ 839,998 $ 850,191
============ ============ ============
(1) Segment financial and operating data does not include any inter-segment
transactions or allocated costs.
(2) Free-standing AL revenues represent the Company's consolidated revenues
for the period throughout the year the communities were owned or
leased. The Company acquired leasehold interests of 12 Free-standing
ALs during 2001, including leasehold interests in ten acquired as of
December 31, 2001. The results of these communities are reflected in
the Company's income statement from the date of acquisition and,
therefore, do not reflect a full year of operations until 2002.
(3) Segment Operating Income is defined as segment earnings less segment
operating expenses.
(4) Management Services represent the Company's management fee revenues,
as well as reimbursed expenses of $5.5 million, $5.0 million and $7.3
million, respectively for the years ended December 31, 2003, 2002 and
2001.
(20) 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 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.
During 2003, the Company's general and professional liability policy premiums
were lower than 2002, but deductibles were higher, (retention levels ranging
from $1,000,000 to $5,000,000). The Company currently maintains single incident
and aggregate liability protection in the amount of $15.0 million. During the
years ended December 31, 2003 and 2002, the Company expensed $5.5 million and
$5.7 million, respectively, of general liability, and professional medical
malpractice insurance premiums, claims, and costs related to multiple insurance
years. Additionally, the Company has accrued amounts to cover open claims not
yet settled and incurred but not reported claims as of December 31, 2003.
The Company has operated under a large deductible workers' compensation program,
with excess loss coverage provided by third party carriers, since July 1995. As
of December 31, 2003, the Company's coverage for workers' compensation and
related programs, excluding Texas, included excess loss coverage of $350,000 per
individual claim and approximately $7.25 million in the aggregate. The Company
is self-insured for amounts below the excess loss coverage. As of December 31,
2003, the Company provided cash collateralized letters of credit in the
aggregate amount of $6.5 million related to this program, which is reflected as
assets limited as to use on the Company's consolidated balance sheet. During the
years ended December 31, 2003 and 2002, the Company expensed $4.8 million and
$4.4 million, respectively, of workers' compensation premiums, claims, and
costs related to multiple insurance years. The Company has accrued amounts to
cover open claims not yet settled and incurred but not reported claims as of
December 31, 2003. For work-related injuries in Texas, the Company is a
non-subscriber under Texas state law, meaning that work-related losses are
covered under a defined benefit program outside of the Texas Workers'
Compensation system. Losses are paid as incurred and estimated losses are
accrued on a monthly basis. The Company utilizes a third party administrator to
process and pay filed claims.
On January 1, 2002, the Company initiated a self-insurance program for employee
medical coverage. The Company maintains stop loss insurance coverage of
approximately $150,000 per employee and approximately $18.9 million for
aggregate calendar 2003 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. During the year ended
December 31, 2003, the Company has expensed $10.1 million of employee medical
insurance claims and costs. The Company has accrued amounts to cover open claims
not yet settled and incurred but not reported claims as of December 31, 2003.
Leases
As of December 31, 2003, the Company operated 41 of its senior living
communities under long-term leases. Of the 41 communities, 24 are operated under
four master lease agreements, with the remaining communities leased under
individual agreements. The Company also leases its corporate offices and is
obligated under several ground leases for senior living communities. The
remaining base lease terms vary from four to 22 years. Certain of the leases
provide for renewal and purchase options. Several of the leases have graduated
lease payments which the Company recognizes on a straight-line basis over the
term of the leases. Some leases have provisions for contingent lease payments
based on occupancy levels or other measures. Contingent lease payments are
expensed when incurred.
During 2003, the Company entered into lease agreements for five Retirement
Centers. Three of the Retirement Centers were previously owned and two
previously managed by the Company. These transactions will result in increased
annual lease expense of approximately $20 million, offset by $69.9 million of
deferred gain, of which approximately $6.9 million will be recognized annually.
See note 10.
Total lease expense was $47.1 million, $71.6 million and $35.4 million for 2003,
2002, and 2001, respectively. Lease expense for 2002 and 2001 includes residual
value guarantee losses of $30.8 million and $7.9 million, respectively.
Future minimum lease payments at December 31, 2003 are as follows
(in thousands):
2004 $ 64,497
2005 65,698
2006 66,940
2007 68,223
2008 67,364
Thereafter 542,596
------------------
$ 875,318
==================
Management Agreements
The Company's management agreements are generally for terms of three to 20
years, but certain of the 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 owner's expense and receives a monthly fee for its services
based on either a contractually fixed amount, a percentage of revenues or
income, or cash flows in excess of operating expenses and certain cash flows of
the community. The Company's existing management agreements expire at various
times through June 2018.
In connection with the execution of certain management contracts, the Company
assumed a debt guarantee on the mortgage debt of one of the managed communities.
At December 31, 2003, $16.8 million was outstanding under the debt agreement. In
addition, the Company has additional guaranteed mortgage debt of approximately
$18.9 million of which $10.2 million relates to a Retirement Center which the
Company leases, and $8.7 million relates to a joint ventures which the Company
manages.
Regulatory Requirements
Federal and state governments regulate various aspects of the Company's
business. The development and operation of health care facilities and the
provision of health care services are subject to federal, state, and local
licensure, certification, and inspection laws that regulate, among other
matters, the number of licensed beds, the provision of services, the
distribution of pharmaceuticals, billing practices and policies, equipment,
staffing (including professional licensing), operating policies and procedures,
fire prevention measures, environmental matters, and compliance with building
and safety codes. Failure to comply with these laws and regulations could result
in the denial of reimbursement, the imposition of fines, temporary suspension of
admission of new patients, suspension or decertification from the Medicare
programs, restrictions on the ability to acquire new communities or expand
existing communities, and, in extreme cases, the revocation of a community's
license or closure of a community. Management believes the Company was in
compliance with such federal and state regulations at December 31, 2002.
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 expired effective October 1, 2002, but were
largely offset by the October 1, 2003 rate increases. In addition, certain per
person annual limits on therapy services, which were effective September through
December 2003, but have now been placed on moratorium for two years. Such limits
are not expected to have a significant impact on the Company.
(21) Related Party Transactions
W.E. Sheriff, the Company's chairman and chief executive officer, owns 50% of
Maybrook Realty, Inc., which owns Freedom Plaza Care Center (FPCC), a 128-bed
nursing and 44-bed assisted living center and approximately 7,000 square feet of
office space subleased to a third party, in Peoria, Arizona. From October 1999
until June 2001, the Company managed FPCC pursuant to its management agreement
for the Freedom Plaza CCRC in Peoria, Arizona. The Company also served as the
developer of an expansion of FPCC, which was completed July 2001. Pursuant to
the terms of its development agreement with Maybrook, the Company received a
development fee of $46,875 in 2001. Effective July 1, 2001, the Company entered
into a long-term operating lease for FPCC in substitution of the prior
management arrangement. The lease term expires in December 2015, and provides
the Company one five-year renewal option and an option to acquire FPCC at an
agreed upon amount. As part of this transaction, the Company acquired certain
assets and liabilities from the previous lessee of the community. The assets
acquired exceeded the liabilities assumed by $903,000, which was recorded as
deferred lease costs and will be amortized over the life of the lease. Total
lease payments during 2003, 2002 and 2001 under this lease were $2.1 million,
$2.1 million and $1.1 million, respectively.
During 2001 and 2000, the Company acquired leasehold interests in six
Free-standing ALs owned by affiliates of John Morris, a director of the Company.
The Company issued a $7.6 million, 9.63% fixed interest only note, due October
1, 2008. This note, and certain similar notes, are secured by the Company's
interest in a Retirement Center located in Richmond, Virginia and a
Free-standing AL in San Antonio, Texas. The terms of this note and its related
security instruments are identical to those issued to certain unaffiliated
entities in connection with the simultaneous acquisition of certain other
communities.
(22) Subsequent Events
The Series B Notes are convertible into shares of the Company's common stock at
any time prior to their April 1, 2008 maturity, at the option of the holder, at
a conversion price of $2.25 per share. On February 12, 2004, the Company
announced that it was electing to redeem $4.5 million in principal amount of its
10% Series B Notes Due 2008. The Series B Notes selected by the Trustee will be
redeemed on March 12, 2004 at a redemption price of 105% (expressed as a
percentage of principal amount), plus accrued but unpaid interest to the
redemption date. Subsequent to December 31, 2003, as of March 5, 2004, holders
of Series B Notes elected to convert $4.8 million of the $10.9 million
outstanding at December 31, 2003 of convertible debentures to 2,139,113 shares
of common stock at the conversion price of $2.25 per share. As of March 4, 2004,
$6.0 million of the Series B Notes remained outstanding.
On March 4, 2004, the Company refinanced $38.6 of mortgage debt which had a
scheduled maturity of April 2005, with a total of $43.1 million of mortgage
debt. A loan of $38.4 million with a seven year maturity is secured by three
Free-standing ALs and a second loan with a two year maturity for $4.7 million is
secured by a fourth Free-standing AL which is currently held-for-sale. The $38.4
million mortgage debt bears interest at a variable rate with a 5% floor, the
$4.7 million bears interest at a variable rate with a floor of 6.5%, while the
$38.6 million of mortgage debt which was replaced had a variable rate with a
6.75% floor.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
American Retirement Corporation's Chief Executive Officer and Chief Financial
Officer have reviewed and evaluated the effectiveness of the Company's
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)
and 15d-15(e)) as of the end of the period covered by this annual report. Based
on that evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that the Company's disclosure controls and procedures effectively and
timely provide them with material information relating to the Company and its
consolidated subsidiaries required to be disclosed in the reports the Company
files or submits under the Exchange Act.
Changes in Internal Control Over Financial Reporting
There were no changes in the Company's internal control over financial reporting
during the Company's fiscal quarter ended December 31, 2003 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this item is incorporated herein by reference to the
Company's definitive proxy statement for its Annual Meeting of Shareholders to
be held May 19, 2004 to be filed with the Securities and Exchange Commission
(the "SEC") under the captions "Election of Directors," "Corporate Governance"
and "Section 16(a) Beneficial Ownership Reporting Compliance." Pursuant to
General Instruction G(3), certain information concerning the executive officers
of the Company is included in Part I of this report under the caption "Executive
Officers."
Item 11. Executive Compensation
The information required by this item is incorporated herein by reference to the
section entitled "Executive Compensation" in the Company's definitive proxy
statement for its Annual Meeting of Shareholders to be held May 19, 2004 to be
filed with the SEC.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The information required by this item is incorporated herein by reference to the
sections entitled "Security Ownership of Management and Certain Beneficial
Owners" and "Executive Compensation" in the Company's definitive proxy statement
for its Annual Meeting of Shareholders to be held May 19, 2004 to be filed with
the SEC.
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated herein by reference to the
section entitled "Certain Transactions" in the Company's definitive proxy
statement for its Annual Meeting of Shareholders to be held May 19, 2004 to be
filed with the SEC.
Item 14. Principal Accountant Fees and Services
The information required by this item is incorporated herein by reference to the
section entitled "Fees Billed to the Company by KPMG LLP During 2003 and 2002"
in the Company's definitive proxy statement for its Annual Meeting of
Shareholders to be held May 19, 2004 to be filed with the SEC.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form
8-K
Item 15. (a)(1) Financial Statements: See Item 8
(2) Financial Statement Schedules: See Item 8
(3) Exhibits required by item 601 of Regulation S-K are as follows:
Exhibit
Number Description
--------- -----------
3.1 Charter of the Registrant (restated electronically for SEC
filing purposes only)(1)
3.2 Bylaws of the Registrant, as amended(2)
4.1 Specimen Common Stock certificate(3)
4.2 Article 8 of the Registrant's Charter (included in Exhibit
3.1)
4.3 Rights Agreement, dated November 18, 1998, between American
Retirement Corporation and American Stock Transfer and Trust
Company(4)
4.4 Indenture, dated September 26, 2002, between the Company and
U.S. Bank National Association, as Trustee, relating to the
Company's 5 3/4% Series A Senior Subordinated Notes Due
2002(5)
4.5 Indenture, dated September 26, 2002, between the Company and
U.S. Bank National Association, as Trustee, relating to the
Company's 10% Series B Convertible Senior Subordinated Notes
Due 2008(5)
10.1 American Retirement Corporation 1997 Stock Incentive Plan, as
amended(6)
10.2 American Retirement Corporation Employee Stock Purchase
Plan(3)
10.3 First Amendment to Employee Stock Purchase Plan(7)
10.4 Second Amendment to Employee Stock Purchase Plan(8)
10.5 Third Amendment to Employee Stock Purchase Plan
10.6 American Retirement Corporation 401(k) Plan and Trust Adoption
Agreement(6)
10.7 Amendment No. 1 to American Retirement Corporation 401(k) Plan
10.8 Officers' Incentive Compensation Plan(3)
10.9 American Retirement Corporation Supplemental Executive
Retirement Plan
10.10 Lease and Security Agreement, dated January 2, 1997, by and
between Nationwide Health Properties, Inc. and American
Retirement Communities, L.P.(9)
10.11 Lease and Security Agreement, dated January 2, 1997, by and
between N.H. Texas Properties Limited Partnership and Trinity
Towers Limited Partnership(9)
10.12 Letter of Intent, dated February 24, 1997, by Nationwide
Health Properties, Inc. to American Retirement Corporation(3)
10.13 Deed of Lease, dated as of October 23, 1997, between Daniel
U.S. Properties Limited Partnership, as Lessor, and ARC
Imperial Plaza, Inc., as Lessee(7)
10.14 Financing and Security Agreement, dated June 8, 1999, by and
among ARC Capital Corporation II and Bank United, as Agent(10)
10.15 Loan Commitment, dated July 30, 1999, among American
Retirement Corporation and Guaranty Federal Bank, F.S.B.(10)
10.16 Term Sheet, dated May 28, 1999, among Health Care REIT, Inc.
and American Retirement Corporation(10)
10.17 Construction Loan Agreement, dated March 17, 2000 between
Freedom Village of Sun City Center, Ltd. and Suntrust Bank,
Tampa Bay(11)
10.18 Real Estate Mortgage and Security Agreement, dated May 8,
2000, between Lake Seminole Square Management Company, Inc.,
Freedom Group-Lake Seminole Square, Inc. and Aid Association
for Lutherans(11)
10.19 Construction Loan Agreement, dated September 28, 2000 between
ARC Scottsdale, LLC and Guaranty Federal Bank, F.S.B.(12)
10.20 First Amendment to Amended and Restated Financing and Security
Agreement(12)
10.21 First Amendment to Amended and Restated Guaranty of Payment
Agreement(12)
10.22 Lease Agreement by and between Cleveland Retirement
Properties, LLC, and ARC Westlake Village, Inc., dated
December 18, 2000(13)
10.23 Executive Change in Control Severance Benefits Plan(14)
10.24 Operating Lease, dated July 1, 2001, between Maybrook Realty,
Inc. and ARC HDV, LLC(6)
10.25 Master Lease and Security Agreement, dated July 31, 2001,
between ARC Pinegate, L.P., ARC Pearland, L.P., American
Retirement Corporation, Trinity Towers, L.P., ARC Lakeway,
L.P., ARC Spring Shadow, L.P., Nationwide Health Properties,
Inc. and NH Texas Properties, L.P.(6)
10.26 Real Estate Purchase and Sale Contract, dated November 9,
2001, between CNL Retirement Corp and American Retirement
Corporation(15)
10.27 Deed of Trust Note, dated December 3, 2001, between Highland
Mortgage Company and ARC Wilora Lake, Inc.(15)
10.28 Promissory Note, dated January 1, 2002, between SIRROM
Partners and C/M Corporation15 10.29Lease Agreement by and
between Countryside ALF, LLC and ARCLP - Charlotte, LLC, dated
January 1, 2002(16)
10.30 Lease Agreement by and between CNL Retirement - AM Illinois
L.P. and ARC Holley Court, LLC, dated February 11, 2002(16)
10.31 Lease Agreement by and between CNL Retirement - AM Colorado
L.P. and ARC Greenwood Village, Inc., dated March 21, 2002(16)
10.32 First Amendment to Master Lease and Security Agreement, dated
February 7, 2002(16)
10.33 Master Lease Agreement, dated March 29, 2002, between ARC
Shavano, L.P., ARC Richmond Heights, LLC, ARC Delray Beach,
LLC, ARC Victoria, L.P., ARC Carriage Club of Jacksonville,
Inc., ARC Post Oak, L.P. and Health Care Property Investors
Inc. (16)
10.34 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(17)
10.35 Lease Agreement by and between Freedom Plaza Limited
Partnership, an Arizona Limited Partnership, and American
Retirement Corporation, a Tennessee Corporation, dated April
1, 2002(17)
10.36 Promissory Note dated April 1, 2002, between Freedom Plaza
Limited Partnership, an Arizona Limited Partnership, and
American Retirement Corporation, a Tennessee Corporation(17)
10.37 Promissory Note dated July 1, 2002, between GMAC Commercial
Mortgage Corporation, a California Corporation (as Lender),
and ARC Santa Catalina Real Estate Holdings, LLC, a Delaware
Corporation(5)
10.38 Master Lease Agreement (Pool I), dated July 9, 2002, between
ARC Pinegate, L.P., ARC Pearland, L.P., Trinity Towers, L.P.,
ARC Lakeway, L.P., ARC Spring Shadow, L.P., ARC Shadowlake,
L.P., ARC Willowbrook, L.P., ARC Park Regency, Inc., ARC
Parklane, Inc., Nationwide Health Properties, Inc., and
NH Texas Properties L.P.(5)
10.39 Master Lease Agreement (Pool II), dated July 9, 2002,
between American Retirement Corporation, ARC Naples, LLC,
ARC Aurora, LLC, ARC Lakewood, LLC, ARC Heritage Club, Inc.,
ARC Countryside, LLC, ARC Cleveland Park, LLC, Nationwide
Health Properties, Inc., and MLD Delaware Trust(5)
10.40 Amended and Restated Loan Agreement, dated as of September 30,
2002, between ARCPI Holdings, Inc. and Health Care Property
Investors, Inc.(5)
10.41 Master Lease Agreement, dated as of September 30, 2002,
between Fort Austin Real Estate Holdings, LLC, ARC Santa
Catalina Real Estate Holdings, LLC, ARC Richmond Place Real
Estate Holdings, LLC, ARC Holland Real Estate Holdings, LLC,
ARC Sun City Center Real Estate Holdings, LLC, ARC Lake
Seminole Square Real Estate Holdings, LLC, ARC Brandywine Real
Estate Holdings, LLC, Fort Austin Limited Partnership, ARC
Santa Catalina, Inc., ARC Richmond Place, Inc., Freedom
Village of Holland, Michigan, Freedom Village of Sun City
Center, Ltd., Lake Seminole Square Management Company, Inc.,
Freedom Group-Lake Seminole Square, Inc. and ARC
Brandywine, LLC(5)
10.42 Loan Agreement, dated as of August 14, 2002, between ARCPI
Holdings, Inc. and Health Care Property Investors, Inc.(18)
10.43 Contribution Agreement, dated August 14, 2002, between ARCPI
Holdings, Inc., Fort Austin Limited Partnership, ARC Santa
Catalina, Inc., ARC Richmond Place, Inc., Freedom Village of
Holland, Michigan, Freedom Village of Sun City Center, Ltd.,
Lake Seminole Square Management Company, Inc., Freedom
Group-Lake Seminole Square, Inc., ARC Brandywine, LLC and
Health Care Property Investors, Inc.(18)
10.44 Promissory Note dated December 17, 2002, between GMAC
Commercial Mortgage Corporation, a California Corporation
(as Lender), and ARC Sun City Center Real Estate Holdings,
LLC, a Delaware Corporation(1)
10.45 Second Amendment to Master Lease Agreement (Phase I), dated
February 28, 2003, between Health Care Property Investors,
Inc., a Maryland corporation, Texas HCP Holding, L.P., a
Delaware Limited Partnership, ARC Richmond Heights, LLC, a
Tennessee limited liability company, ARC Shavano, L.P., a
Tennessee limited partnership, ARC Delray Beach, LLC, a
Tennessee limited liability company, ARC Victoria, L.P., a
Tennessee limited partnership, ARC Carriage Club of
Jacksonville, Inc., a Tennessee
corporation, ARC Post Oak, L.P., a Tennessee limited
partnership, and ARC Boynton Beach, LLC, a Tennessee
limited liability company(19)
10.46 Lease Agreement, dated August 25, 2003, between Alabama
Somerby, LLC and CNL Retirement DSL1 Alabama, LP.(20)
10.47 Lease Agreement, dated August 25, 2003, between Alabama
Somerby, LLC and CNL Retirement DSL1 Alabama, LP.(20)
10.48 Promissory Note, dated as of August 25, 2003, between
Alabama Somerby, LLC and Daniel Senior Living, L.L.C.(20)
10.49 Contract of Acquisition and Agreement to Make Loan, dated as
of September 23, 2003, between Health Care Property
Investors, Inc. and ARCPI Holdings, Inc.(20)
10.50 Second Amendment to Loan Agreement, dated as of September
23, 2003, between ARCPI Holdings, Inc. and Health Care
Property Investors, Inc.(20)
10.51 First Amendment to Master Lease Agreement, dated as of
September 23, 2003, between Fort Austin Real Estate
Holdings, LLC, ARC Santa Catalina Real Estate Holdings, LLC,
ARC Richmond Place Real Estate Holdings, LLC, ARC Holland
Real Estate Holdings, LLC, ARC Sun City Center Real Estate
Holdings, LLC, ARC Lake Seminole Square Real Estate
Holdings, LLC, ARC Brandywine Real Estate Holdings, LLC,
Fort Austin Limited Partnership, ARC Santa Catalina, Inc.,
ARC Richmond Place, Inc., Freedom Village of Holland,
Michigan, Freedom Village of Sun City Center, Ltd., Lake
Seminole Square Management Company, Inc., Freedom Group-Lake
Seminole Square, Inc. and ARC Brandywine, LLC.(20)
21 Subsidiaries of the Registrant
23 Consent of KPMG LLP
31.1 Certification of W.E. Sheriff pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Bryan D. Richardson pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of W.E. Sheriff pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Bryan D. Richardson pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
--------------
1 Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 2002.
2 Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1998.
3 Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (Registration No. 333-23197).
4 Incorporated by reference to the Registrant's Current Report on Form 8-K,
dated November 24, 1998.
5 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 2002.
6 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 2001.
7 Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1997.
8 Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Registration No 333-106669).
9 Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (Registration No. 333-34339).
10 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1999.
11 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2000.
12 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 2000.
13 Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 2000.
14 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2001.
15 Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 2001.
16 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2002.
17 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2002.
18 Incorporated by reference to the Registrant's Current Report on Form 8-K
dated August 15, 2002.
19 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2003.
20 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 2003.
(b) Reports on Form 8-K.
On October 8, 2003, the Company filed with the SEC a Form 8-K (Item
2) reporting that the Company had completed a multi-property
transaction that involved the sale lease-back of three Retirement
Centers and the sale of a fourth Retirement Center. The Company also
reported that it had entered into a long-term agreement to manage the
fourth community for an unaffiliated third party and had obtained
mortgage financings that are secured by certain land parcels
adjoining two of the communities.
On November 6, 2003, the Company furnished to the SEC a Form 8-K
(Items 7 and 12) containing a press release issued by the Company
announcing its third quarter 2003 earnings results.
On November 6, 2003, the Company furnished to the SEC a Form 8-K
(Items 7, 9 and 12) containing supplemental financial information
relating to the Company's third quarter 2003 results.
Notwithstanding the foregoing, information furnished under Item 9 and
Item 12 of our Current Reports on Form 8-K, including the related
exhibits, shall not be deemed to be filed for purposes of Section 18
of the Securities Exchange Act of 1934.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
March 8, 2004 By: /s/ W.E. Sheriff
---------------------------------------
W.E. Sheriff
Chairman, Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
/s/ W.E. Sheriff Chairman, March 8, 2004
--------------------------------- Chief Executive Officer
W.E. Sheriff and President
(Principal Executive Officer)
/s/ Bryan D. Richardson Executive Vice President - March 8, 2004
--------------------------------- Finance and Chief Financial
Bryan D. Richardson Officer (Principal Financial
and Accounting Officer)
/s/ Frank M. Bumstead Director March 8, 2004
---------------------------------
Frank M. Bumstead
/s/ Christopher J. Coates Director March 8, 2004
---------------------------------
Christopher J. Coates
Director March -, 2004
---------------------------------
Donald D. Davis
/s/ John C. McCauley Director March 8, 2004
---------------------------------
John C. McCauley
/s/ John A. Morris, Jr., M.D. Director March 8, 2004
---------------------------------
John A. Morris, Jr., M.D.
/s/ Daniel K. O'Connell Director March 8, 2004
---------------------------------
Daniel K. O'Connell
/s/ J. Edward Pearson Director March 8, 2004
---------------------------------
J. Edward Pearson
/s/ Nadine C. Smith Director March 8, 2004
---------------------------------
Nadine C. Smith
/s/ Lawrence J. Stuesser Director March 8, 2004
---------------------------------
Lawrence J. Stuesser
American Retirement Corporation
Schedule II - Valuation and Qualifying Accounts
Additions
----------------------------
Balance at Charged to Charged to Balance at
Beginning of costs and other End of
Description Period expenses accounts Deductions Period
--------------------------------------------------------------------------------------------------------
Allowance for Doubtful Accounts
Year ended December 31, 2001 $ 1,352 $ 1,460 $ - $ (127) $ 2,685
=========================================================================
Year ended December 31, 2002 $ 2,685 $ 661 $ - $ (923) $ 2,423
=========================================================================
Year ended December 31, 2003 $ 2,423 $ 492 $ - $ (652) $ 2,263
=========================================================================
Deferred Tax Valuation Account
Year ended December 31, 2001 $ 8,717 $ 7,511 $ - $ - $ 16,228
=========================================================================
Year ended December 31, 2002 $ 16,228 $ 31,706 $ - $ - $ 47,934
=========================================================================
Year ended December 31, 2003 $ 47,934 $ 8,537 $ - $ - $ 56,471
=========================================================================
Reserve for Contractual loss
Year ended December 31, 2001 $ 811 $ 443 $ - $ (467) $ 787
=========================================================================
Year ended December 31, 2002 $ 787 $ - $ - $ (90) $ 697
=========================================================================
Year ended December 31, 2003 $ 697 $ - $ - $ (21) $ 676
=========================================================================
See accompanying independent auditors' report.
American Retirement Corporation
Schedule IV - Mortgage Loans on Real Estate
Principal amount
Final Periodic Carrying of loans subject
Interest Maturity Payment Face amount amount of to delinquent
Description Rate Date Terms Prior of mortgages(2) principal or
liens mortgages interest
---------------------------------------------------------------------------------------------------------
First mortgage loan 5.90% 1-Jun-38 (1) - 18,283 18,283 -
---------------------------------------------------
$ - $ 18,283 $ 18,283 $ -
===================================================
(1) Principal payment based upon a June 1, 2038 amortization schedule with
outstanding principal due at maturity.
(2) The carrying amount of the mortgage for federal income tax purposes is
$18,283.
----------
Balance at December 31, 2000 $ 88,505
==========
Additions during period:
New mortgage loans 6,285
Deductions during period:
Collections of principal (14,633)
Write offs of impaired
loans (652)
---------------------
Balance at December 31, 2001 $ 79,505
==========
Additions during period:
New mortgage loans 18,548
Deductions during period:
Collections of principal (109)
Other(3) (79,505)
---------------------
Balance at December 31, 2002 $ 18,439
==========
Collections of principal (156)
----------
Balance at December 31, 2003 $ 18,283
==========
(3) Principal payment based upon forgiveness of note receivables in exchange
for termination of certain leases.
See accompanying independent auditors' report.
Exhibit 21
Subsidiaries of the Registrant
1. Alabama Somerby, LLC, a Delaware limited liability company
2. ARC Air Force Village, L.P., a Tennessee limited partnership
3. ARC Aurora, LLC, a Tennessee limited liability company
4. ARC Bahia Oaks, Inc., a Tennessee corporation
5. ARC Boca Raton, Inc., a Tennessee corporation
6. ARC Boynton Beach, LLC, a Tennessee limited liability company
7. ARC Brandywine, LLC, a Tennessee limited liability company
8. ARC Brandywine Real Estate Holdings, LLC, a Delaware limited liability
company
9. ARC Brookmont Terrace, Inc., a Tennessee corporation
10. ARC Carriage Club of Jacksonville, Inc., a Tennessee corporation
11. ARC Castle Hills, L.P., a Tennessee limited partnership
12. ARC Charlotte, Inc., a Tennessee corporation
13. ARC Cleveland Heights, LLC, a Tennessee limited liability company
14. ARC Cleveland Park, LLC, a Tennessee limited liability company
15. ARC Coconut Creek, LLC, a Tennessee limited liability company
16. ARC Coconut Creek Management, Inc., a Tennessee corporation
17. ARC Corpus Christi, LLC, a Tennessee limited liability company
18. ARC Countryside, LLC, a Tennessee limited liability company
19. ARC Creative Marketing, LLC, a Tennessee limited liability company
20. ARC Cypress Station, L.P., a Tennessee limited partnership
21. ARC Deane Hill, LLC, a Tennessee limited liability company
22. ARC Delray Beach, LLC, a Tennessee limited liability company
23. ARC Flint, Inc., a Tennessee corporation
24. ARC Fort Austin Properties, LLC, a Tennessee limited liability company
25. ARC Freedom, LLC, a Tennessee limited liability company
26. ARC Greenwood Village, Inc., a Tennessee corporation
27. ARC Hampton Post Oak, Inc., a Tennessee corporation
28. ARC HDV, LLC, a Tennessee limited liability company
29. ARC Heritage Club, Inc., a Tennessee corporation
30. ARC Holland, Inc., a Tennessee corporation
31. ARC Holland Real Estate Holdings, LLC, a Delaware limited liability
company
32. ARC Holley Court, LLC, a Tennessee limited liability company
33. ARC Holley Court Management, Inc., a Tennessee corporation
34. ARC Homewood Corpus Christi, L.P., a Tennessee limited partnership
35. ARC Homewood Victoria, Inc., a Tennessee corporation
36. ARC Imperial Plaza, Inc., a Tennessee corporation
37. ARC Imperial Services, Inc., a Tennessee corporation
38. ARC Lady Lake, Inc., a Tennessee corporation
39. ARC Lake Seminole Square Real Estate Holdings, LLC, a Delaware limited
liability company
40. ARC Lakeway, L.P., a Tennessee limited partnership
41. ARC Lakewood, LLC, a Tennessee limited liability company
42. ARC LifeMed, Inc., a Tennessee corporation
43. ARC Lowry, LLC, a Tennessee limited liability company
44. ARCLP-Charlotte, LLC, a Tennessee limited liability company
45. ARC LP Holdings, LLC, a Tennessee limited liability company
46. A.R.C. Management Corporation, a Tennessee corporation
47. ARC Management, LLC, a Tennessee limited liability company
48. ARC Naples, LLC, a Tennessee limited liability company
49. ARC Northwest Hills, L.P., a Tennessee limited partnership
50. ARC Oakhurst, Inc., a Tennessee corporation
51. ARC Parklane, Inc., a Tennessee corporation
52. ARC Park Regency, Inc., a Tennessee corporation
53. ARC Partners II, Inc., a Tennessee corporation
54. ARC Pearland, L.P., a Tennessee limited partnership
55. ARC Pecan Park, L.P., a Tennessee limited partnership
56. ARC Pecan Park/Padgett, Inc., a Tennessee corporation
57. ARC Peoria, LLC, a Tennessee limited liability company
58. ARCPI Holdings, Inc., a Delaware corporation
59. ARC Pinegate, L.P., a Tennessee limited partnership
60. ARC Post Oak, L.P., a Tennessee limited partnership
61. ARC Richmond Heights, LLC, a Tennessee limited liability company
62. ARC Richmond Place, Inc., a Delaware corporation
63. ARC Richmond Place Real Estate Holdings, LLC, a Delaware limited
liability company
64. ARC Rossmoor, Inc., a Tennessee corporation
65. ARC Santa Catalina, Inc., a Tennessee corporation
66. ARC SCC, Inc., a Tennessee corporation
67. ARC Scottsdale, LLC, a Tennessee limited liability company
68. ARC Shadowlake, L.P., a Tennessee limited partnership
69. ARC Shavano, L.P., a Tennessee limited partnership
70. ARC Shavano Park, Inc., a Tennessee corporation
71. ARC Somerby Holdings, Inc., a Tennessee corporation
72. ARC Spring Shadow, L.P., a Tennessee limited partnership
73. ARC Sun City Center, Inc., a Tennessee corporation
74. ARC Sun City Center Real Estate Holdings, LLC, a Delaware limited
liability company
75. ARC Sun City Golf Course, Inc., a Tennessee corporation
76. ARC Tarpon Springs, Inc., a Tennessee corporation
77. ARC Tennessee GP, Inc., a Tennessee corporation
78. ARC Therapy Services, LLC, a Tennessee limited liability company
79. ARC Victoria, L.P., a Tennessee limited partnership
80. ARC Westlake Village, Inc., a Tennessee corporation
81. ARC Westover Hills, L.P., a Tennessee limited partnership
82. ARC Willowbrook, L.P., a Tennessee limited partnership
83. ARC Wilora Assisted Living, LLC, a Tennessee limited liability company
84. ARC Wilora Lake, Inc., a Tennessee corporation
85. Assisted Care of the Villages, a Florida general partnership
86. Flint Michigan Retirement Housing L.L.C., a Michigan limited liability
company
87. Fort Austin Limited Partnership, a Texas limited partnership
88. Freedom Group-Lake Seminole Square, Inc., a Tennessee corporation
89. Freedom Group-Naples Management Company, Inc., a Tennessee corporation
90. Freedom Village of Holland, Michigan, a Michigan general partnership
91. Freedom Village of Sun City Center, Ltd., a Florida limited partnership
92. Homewood at Brookmont Terrace, LLC, a Tennessee limited liability
company
93. LaBarc, L.P., a Tennessee limited partnership
94. Lake Seminole Square Management Company, Inc., a Tennessee corporation
95. LifeMed, LLC, a Delaware limited liability company
96. Plaza Professional Pharmacy, Inc., a Virginia corporation
97. Trinity Towers Limited Partnership, a Tennessee limited partnership
Exhibit 23
ACCOUNTANTS' CONSENT
The Board of Directors
American Retirement Corporation
We consent to incorporation by reference in the Registration Statement Nos.
333-28657, 333-66821, 333-40162, 333-94747 and 333-106669 on Form S-8 of
American Retirement Corporation of our report dated March 4, 2004, relating to
the consolidated balance sheets of American Retirement Corporation and
subsidiaries as of December 31, 2003 and 2002, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
years in the three-year period ended December 31, 2003, and all related
schedules, which report appears in the December 31, 2003 annual report on Form
10-K of American Retirement Corporation.
As discussed in note 2 to the consolidated financial statements, effective
January 1, 2002, the Company changed its method of accounting for goodwill in
accordance with Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Other Intangible Assets" and impairment of long-lived assets and
discounted operations in accordance with SFAS No. 144 "Accounting for the
Impairment of Disposal of Long-Lived Assets."
/s/ KPMG LLP
Nashville, Tennessee
March 8, 2004
Exhibit 31.1
CERTIFICATION
I, W.E. Sheriff, certify that:
1. I have reviewed this Annual Report on Form 10-K of American
Retirement Corporation;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present
in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for,
the periods presented in this report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)), for the registrant and have:
a) designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
c) disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during
the registrant's fourth fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's auditors
and the audit committee of the registrant's board of directors
(or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the
registrant's ability to record, process, summarize and report
financial information; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: March 8, 2004
/s/ W.E. Sheriff
-----------------------------------------------
W.E. Sheriff
Chairman, Chief Executive Officer and President
Exhibit 31.2
CERTIFICATION
I, Bryan D. Richardson, certify that:
1. I have reviewed this Annual Report on Form 10-K of American
Retirement Corporation;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present
in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for,
the periods presented in this report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)), for the registrant and have:
a) designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
c) disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during
the registrant's fourth fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting;
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's auditors
and the audit committee of the registrant's board of directors
(or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the
registrant's ability to record, process, summarize and report
financial information; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: March 8, 2004
/s/ Bryan D. Richardson
--------------------------------------
Bryan D. Richardson
Executive Vice President - Finance and
Chief Financial Officer
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of American Retirement Corporation (the
"Company") on Form 10-K for the year ending December 31, 2003, as filed with the
Securities and Exchange Commission on March 8, 2004 (the "Report"), I, W.E.
Sheriff, Chairman, Chief Executive Officer and President of the Company,
certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ W.E. Sheriff
-----------------------------------------------------------
W.E. Sheriff
Chairman, Chief Executive Officer and President
March 8, 2004
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of American Retirement Corporation (the
"Company") on Form 10-K for the year ending December 31, 2003, as filed with the
Securities and Exchange Commission on March 8, 2004 (the "Report"), I, Bryan D.
Richardson, Executive Vice President - Finance and Chief Financial Officer of
the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ Bryan D. Richardson
------------------------------------------------
Bryan D. Richardson
Executive Vice President - Finance and
Chief Financial Officer
March 8, 2004