The following tables present an overview of our portfolio for the quarters ended March 31, 2004 and 2003:
Total revenues from residents for the three months ended March 31, 2004 were $148.0 million, an increase of 5% over revenues from residents of $141.6 million for the three months ended March 31, 2003. This increase is due primarily to higher per diem charges to residents and three additional communities that we began to operate on May 30, 2003 somewhat offset by a decrease in occupancy. Revenues from residents at the communities we operated continuously since January 1, 2003, were $147.1 million and $141.6 million, for the three months ended March 31, 2004 and March 31, 2003, respectively, an increase of 4%. This increase is due primarily to higher per diem charges to residents somewhat offset by a decrease in occupancy. About 40% of our revenues from residents in the three months ended March 31, 2004 and 2003 were received from Medicare and Medicaid. Revenues from our pharmacy, which was acquired in September 2003, were $2.2 million for the three months ended March 31, 2004.
Interest and other income increased by $1.3 million in three months ended March 31, 2004 to $1.4 million compared to $75,000 in the three months ended March 31, 2003 due to our settlement with Marriott and MSLS. On January 7, 2004, we and Senior Housing settled the pending litigation with Marriott and MSLS. Under the terms of the settlement we and Senior Housing, and Marriott and MSLS, agreed to dismiss all claims and counterclaims asserted in the litigation. Also under the terms of the settlement, Marriott paid to us and Senior Housing $1,250 each.
Expenses for the three months ended March 31, 2004 were $150.5 million, an increase of 5% over expenses of $143.6 million for the three months ended March 31, 2003. Our wages and benefits costs increased from $77.6 million to $81.4 million, or 5%, primarily due to wage increases as well as wages related to three communities we began to operate on May 30, 2003 and the pharmacy we acquired in September 2003. Other operating expenses, which include utilities, housekeeping, dietary, maintenance, insurance and community level administrative costs, increased $814,000 to $38.1 million, or 2%, primarily as a result of increased charges from third parties, our lease of three additional properties on May 30, 2003 and our pharmacy acquisition in September 2003. Management fees related to the 30 communities managed for us by SLS for the three months ended March 31, 2004 and 2003, were $4.6 million and $4.3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
million, respectively. The increase in fees at these 30 communities are based upon contractual calculations of fees based primarily upon increased revenues. Rent expense to Senior Housing increased from $19.0 million to $20.1 million, or 6%, primarily due to the addition of three communities we began to lease since May 2003, and additional rent for capital improvements at properties we lease that were funded by Senior Housing in 2003. Community level operating expenses related to the communities we operated throughout the three months ended March 31, 2004 and March 31, 2003 were $116.7 million and $114.9 million, respectively, an increase of 2%. This increase is primarily due to wage increases.
Our general and administrative expenses for the three months ended March 31, 2004 were $5.1 million, an increase of 19% over expenses for the three months ended March 31, 2003 of $4.3 million, primarily due to costs resulting from our increased operations and to legal costs incurred in connection with our litigation with Marriott and MSLS and other matters.
Depreciation expense for the three months ended March 31, 2004 was $973,000 an increase of 19% over depreciation expense of $819,000 for the three months ended March 31, 2003. The increase is primarily attributable to our purchase of furniture and fixtures related to the 30 communities which SLS began to manage in the second half of 2003 offset by our sale of six communities in the second half of 2003 as well as our sale of previously capitalized improvements to Senior Housing at some of our communities.
Loss from discontinued operations for the three months ended March 31, 2004 was $451,000, an increase of $103,000 over the loss for the three months ended March 31, 2003. This increase is primarily the result of closing costs and losses in the first quarter of 2004 at one assisted living community that was managed by SLS.
As a result of the factors described above, our net income for the three months ended March 31, 2004 was $507,000 compared to a loss of $2.3 million for the three months ended March 31, 2003. Our net income per share for the three months ended March 31, 2004 was $0.06 compared to a loss per share of $0.27 for the three months ended March 31, 2003.
LIQUIDITY AND CAPITAL RESOURCES
Our total current assets at March 31, 2004, were $65.7 million compared to $59.7 million at December 31, 2003. At March 31, 2004, we had cash and cash equivalents of $22.0 million.
Our total current liabilities were $49.5 million at March 31, 2004 compared to $58.1 million at December 31, 2003. This decrease was due primarily to our repayment of amounts outstanding under our revolving credit facility and the payment of amounts due to SLS during the quarter ended March 31, 2004.
Currently, we lease 98 communities from Senior Housing under two leases. Our leases with Senior Housing require us to pay a total of $82.0 million of minimum rent annually. Percentage rent on the leases begins in 2006. At May 10, 2004, we believe we were in compliance with the terms of these leases.
In accordance with our leases with Senior Housing, Senior Housing will reimburse funds spent on capital improvements to our leased facilities. We have expended $3.2 million on capital improvements made to these leased facilities for which we anticipate Senior Housing reimbursing us in the second quarter of 2004. When Senior Housing provides such funds to us, our rent payable to Senior Housing will increase in accordance with the terms of these leases.
Our primary source of cash to fund operating expenses, including rent and routine capital expenditures, is our revenues from services to residents at our communities. At some of our communities, operating revenues for nursing home services are received from the Medicare and Medicaid programs. Through March 31, 2004, 40% of our total revenues were derived from these programs. Medicare and Medicaid revenues were earned primarily from the 51 nursing home communities we lease from Senior Housing. Since 1998, a Medicare prospective payment system has generally lowered Medicare rates paid to senior living communities including many of those that we operate. In October 2002, temporary increases in Medicare payment rates expired. In October 2003, Medicare rates increased by approximately 6%. Our Medicare revenues totaled $22.2 million and $19.1 million during the three months ended March 31, 2004
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
and 2003, respectively. Our Medicaid revenues totaled $37.7 million and $36.7 million during the three months ended March 31, 2004 and 2003, respectively. Some of the states in which we operate have not raised rates by amounts sufficient to offset increasing costs or are expected to reduce Medicaid funding. The magnitude of the potential combined Medicare and Medicaid rate reductions cannot currently be estimated, but it may be material and may affect our future results of operations. Further Medicare and Medicaid rate declines may have a dramatic negative impact on our revenues and may produce losses.
We expect recent increases in the costs of insurance, especially tort liability insurance, workers compensation and employee health insurance, which are affecting the senior living industry, will continue to have a material adverse impact upon our future results of operations. As discussed in Note 7 to our financial statements, a failure by IHS, HHS or the State of Connecticut to make payments that we believe are due to us would have a material adverse impact upon our future financial results. Also, we believe Marriott’s sale of MSLS to Sunrise has had, and may continue to have, an adverse impact on our financial results and increase our working capital requirements.
Our revolving credit facility limits our ability to incur debt as more fully described below. The terms of our leases with Senior Housing contain provisions whereby our rights under these agreements may be cancelled by Senior Housing upon the acquisition by any person or group of more than 9.8% of our voting stock, and upon other change of control events. These leases also limit our ability to create, incur, assume or guarantee indebtedness.
As is further discussed below in “Related Party Transactions,” on March 1, 2004, Senior Housing purchased from us one independent and assisted living community with 229 units located in Maryland. The purchase price was $24.1 million, the appraised value of the property. The sale resulted in a gain of $1.4 million which will be recognized over the term of our lease of this community.
During 2003, Senior Housing agreed to sell us two nursing homes in Michigan that we leased from Senior Housing. The purchase price is $10.5 million, the appraised value of the properties. These two properties are leased from Senior Housing on a combined basis with 65 other properties. Under the terms of our lease with Senior Housing, upon consummation of the sale, the annual rent payable under the combined lease will be reduced by 10% of the net proceeds that we receive from the sale. On April 19, 2004, we purchased one of these properties from Senior Housing for $5.9 million. We financed this acquisition with proceeds we received from a new HUD insured mortgage and by using cash on hand. We expect the second sale to occur later in 2004 and we intend to finance the second sale with proceeds that we receive from a second HUD insured mortgage and with available cash.
Despite the commitments, contingencies and limitations described above, we believe that a combination of our efforts to increase revenues and contain costs, our ability to borrow on our revolving credit facility, our ability to sell to Senior Housing certain capital improvements made to communities leased from Senior Housing and the possibility of sales or financings of our owned communities will be sufficient to meet our working capital needs, operating expenses, rent payments to Senior Housing, debt service and capital expenditures for the next 12 months and the foreseeable future.
Debt Instruments and Covenants
In October 2002, we entered into a revolving credit facility. The interest rate on borrowings on this facility is LIBOR plus a spread. The maximum amount available under this facility is $12.5 million, and borrowings are subject to limitations based upon qualifying collateral. The facility is available for acquisitions, working capital and general business purposes. The facility contains covenants and events of default requiring the maintenance of collateral, minimum net worth and certain other financial ratios, among other customary provisions. In certain circumstances, and subject to available collateral and lender approvals, the maximum amounts that we may draw under this credit agreement may be increased to $25.0 million. As of March 31, 2004, no amounts were outstanding under the facility. At May 10, 2004, we believe we were in compliance with all applicable covenants under this revolving credit agreement and no amounts are outstanding.
In connection with our October 2002 acquisition of a community, we assumed two HUD insured mortgages totaling approximately $15.7 million. In December 2003, we prepaid one $9.3 million mortgage. In March 2004, the second $6.4 million mortgage was prepaid.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Seasonality
Our business is subject to modest effects of seasonality. During the calendar fourth quarter holiday periods nursing home and assisted living residents are sometimes discharged to join family celebrations and admission decisions are often deferred. The first quarter of each calendar year usually coincides with increased illness among nursing home and assisted living residents which can result in increased costs or discharges to hospitals. As a result of these factors, nursing home and assisted living operations sometimes produce greater earnings in the second and third quarters of a calendar year and lesser earnings in the first and fourth quarters. We do not believe that this seasonality will cause fluctuations in our revenues or operating cash flow to such an extent that we will have difficulty paying our expenses, including rent, which do not fluctuate seasonally.
Related Party Transactions
On March 1, 2004, Senior Housing purchased from us one independent and assisted living community with 229 units located in Maryland. The purchase price was $24.1 million, the appraised value of the property. Simultaneous with this purchase, our existing leases with Senior Housing were modified as follows:
| | • | | the lease for 53 nursing homes and the lease for 13 independent and assisted living communities were combined into one lease and the property acquired on March 1, 2004 was added to this combined lease; |
| | • | | the combined lease expiration date was changed to December 31, 2020 from December 31, 2018 and 2019 for the separate leases; |
| | • | | our minimum rent for the combined lease of 53 nursing homes and 14 independent living communities was increased by $2.41 million per year; |
| | • | | for all of our leases with Senior Housing, the amount of additional rent to be paid to Senior Housing was changed to 4% of the increase in revenues at the leased properties beginning in 2006. Prior to the lease combination, the percentage and the beginning time period for the nursing home lease and the independent and assisted living community lease was 3% and 2004 and 4% and 2005, respectively. |
All other lease terms remain substantially unchanged.
As discussed above in “Liquidity and Capital Resources,” on April 19, 2004, we purchased one property from Senior Housing for its appraised value of $5.9 million that was previously leased to us. We financed this transaction with proceeds we received from a new HUD insured mortgage in the amount of $5.0 million and by using cash on hand. We have an agreement to purchase one additional property from Senior Housing and also expect to finance this transaction with proceeds from a second HUD insured mortgage and by using cash on hand.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to risks associated with market changes in interest rates. We manage our exposure to this market risk through our monitoring of available financing alternatives. Our strategy to manage exposure to changes in interest rates is unchanged since December 31, 2003. However, our exposure to fluctuations in interest rates may increase in the future if we incur debt to fund acquisitions or otherwise. As of May 10, 2004, we have no commercial paper, derivatives, swaps, hedges, joint ventures or partnerships.
Item 4. Controls and Procedures
As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and with the participation of our President and Chief Executive Officer and our Treasurer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934. Based upon that evaluation, our President and Chief Executive Officer and our Treasurer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.
There have been no significant changes in our internal controls over financial reporting during the quarter ended March 31, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, including any corrective actions with regard to significant deficiencies and material weaknesses.
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WARNING CONCERNING FORWARD LOOKING STATEMENTS
THIS QUARTERLY REPORT ON FORM 10-Q AND OUR ANNUAL REPORT ON FORM 10-K, REFERRED TO HEREIN, CONTAIN FORWARD LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND FEDERAL SECURITIES LAWS. THESE STATEMENTS REGARD OUR INTENT, BELIEF OR EXPECTATIONS, OR THE INTENT, BELIEF OR EXPECTATIONS OF OUR DIRECTORS AND OFFICERS, BUT THEY ARE NOT GUARANTEED TO OCCUR. FOR EXAMPLE:
| | • | | INCREASES IN INSURANCE COSTS AND IN INSURANCE RESERVE CALCULATIONS MAY HAVE A GREATER ADVERSE IMPACT ON OUR BUSINESS THAN WE CURRENTLY ANTICIPATE; |
| | • | | WE MAY BE UNABLE TO CARRY OUT OUR BUSINESS PLAN TO EXPAND OUR OPERATIONS OF COMMUNITIES WHERE RESIDENTS PAY FOR SERVICES WITH PRIVATE RESOURCES BECAUSE WE ARE UNABLE TO LOCATE SUCH EXPANSION OPPORTUNITIES AT PRICES WE ARE WILLING OR ABLE TO PAY; |
| | • | | WE MAY BE UNABLE TO COLLECT ACCOUNTS RECEIVABLE WHICH WE BELIEVE ARE DUE FROM IHS, FROM HHS, OR FROM THE STATE OF CONNECTICUT MEDICAID PROGRAM; |
| | • | | THE SALE OF MSLS BY MARRIOTT TO SUNRISE SEEMS TO HAVE ADVERSELY AFFECTED THE OPERATIONS OF THE SENIOR LIVING COMMUNITIES WHICH SLS NOW MANAGES FOR OUR ACCOUNT. THE REVENUES AT THESE COMMUNITIES MAY DECLINE, THE EXPENSES AT THESE COMMUNITIES MAY INCREASE AND OUR INCOME FROM THESE COMMUNITIES MAY DECLINE; AND |
| | • | | WE MAY BE UNABLE TO COMPLETE OUR PURCHASE OF THE FACILITY LOCATED IN MICHIGAN FROM SENIOR HOUSING. |
ALSO, WHENEVER WE USE WORDS SUCH AS “BELIEVE”, “EXPECT”, “ANTICIPATE”, “INTEND”, “PLAN”, “ESTIMATE”, “PREDICT” OR SIMILAR EXPRESSIONS, WE ARE MAKING FORWARD LOOKING STATEMENTS. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTAINED IN OR IMPLIED BY THESE FORWARD LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS. SUCH FACTORS INCLUDE, WITHOUT LIMITATION THOSE DESCRIBED ABOVE AND:
| | • | | CHANGES IN THE ECONOMY AND THE CAPITAL MARKETS (INCLUDING PREVAILING INTEREST RATES); |
| | • | | COMPLIANCE WITH AND CHANGES TO REGULATIONS AND PAYMENT POLICIES WITHIN THE SENIOR HOUSING AND HEALTHCARE INDUSTRIES; |
| | • | | CHANGES IN OUR FINANCING TERMS; |
| | • | | COMPETITION WITHIN THE SENIOR HOUSING AND HEALTHCARE INDUSTRIES; AND |
| | • | | CHANGES IN FEDERAL, STATE AND LOCAL LEGISLATION. |
FORWARD LOOKING STATEMENTS IN THIS QUARTERLY REPORT ON FORM 10-Q AND IN OUR ANNUAL REPORT ON FORM 10-K MAY IMPLY THAT WE EXPECT TO OPERATE PROFITABLY IN THE FUTURE. HOWEVER, WE MAY BE UNABLE TO OPERATE PROFITABLY FOR THE REASONS SET FORTH ABOVE OR FOR OTHER REASONS. ALTHOUGH WE BELIEVE OUR LIQUIDITY AND CAPITAL RESOURCES ARE SUFFICIENT TO MEET OUR BUSINESS NEEDS FOR THE NEXT 12 MONTHS, IN FACT THEY MIGHT NOT BE SUFFICIENT FOR US TO CONTINUE IN BUSINESS. AN INVESTMENT IN OUR SECURITIES INVOLVES A HIGH DEGREE OF RISK OF LOSS, AND INVESTORS SHOULD NOT PLACE UNDUE RELIANCE UPON FORWARD LOOKING STATEMENTS WHICH IMPLY OTHERWISE.
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Part II. Other Information
Item 1. Legal Proceedings
During 2002, about the time Marriott determined to sell MSLS to Sunrise, we and Senior Housing became involved in litigation with Marriott International and MSLS which has been previously described in our 2002 and 2003 Annual Reports on Form 10-K and our quarterly reports on Form 10-Q for the quarters ended March 31, 2003, June 30, 2003 and September 30, 2003. On January 7, 2004, we and Senior Housing settled our pending litigation with Marriott and MSLS. Under the terms of the settlement we and Senior Housing, and Marriott and MSLS, agreed to dismiss all claims and counterclaims asserted in the litigation. Also under the terms of the settlement, Marriott paid to us and Senior Housing $1.25 million each. The settlement was a compromise of the parties’ disputes entered into to avoid the expense and inconvenience of litigation and neither we or Senior Housing, nor Marriott or MSLS, has admitted any liability, violation of law or wrongdoing in connection with the matters in the litigation. We believe the settlement settles all of our litigation with Marriott. This settlement does not affect our or Senior Housing’s rights vis-à-vis Sunrise or SLS which arise by reason of events after Sunrise purchased MSLS.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
On March 10, 2004, our board of directors adopted a shareholder protection rights plan, or the Plan, pursuant to which our board of directors created a class of authorized but unissued junior participating preferred stock, par value $.01 per share, and declared a dividend of one preferred stock purchase right for each of our outstanding shares of common stock of beneficial interest. The terms of the junior participating preferred stock and the Plan are described in our Current Report on Form 8-K dated March 10, 2004, which is hereby incorporated herein by reference.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
3.2 Composite copy of Amended and Restated Bylaws of the Registrant. (Incorporated by reference to the Company’s Current Report on Form 8-K dated March 10, 2004.)
3.3 Articles Supplementary.(Incorporated by reference to the Company's Form 8A dated March 19, 2004.)
3.4 Certificate of Correction dated March 19, 2004.(Filed herewith.)
4.1 Rights Agreement, dated as of March 10, 2004, by and between the Company and EquiServe Trust Company, N.A.(Incorporated by reference to the Company’s Current Report on Form 8-K dated March 10, 2004.)
10.1 Second Amendment to Amended Master Lease Agreement, dated March 1, 2004, by and among certain affiliates of Senior Housing Properties Trust, as Landlord, and FS Tenant Holding Company Trust and FS Tenant Pool III Trust, collectively as Tenant.(Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.)
10.2 Amended and Restated Lease Agreement, dated March 1, 2004, by and among certain affiliates of Senior Housing Properties Trust, as Landlord, and Five Star Quality Care Trust, as Tenant. (Incorporated by reference to the Company’s Current Report on Form 8-K dated March 1, 2004.)
10.3 Amendment No. 2 to Shared Services Agreement, dated as of March 10, 2004, by and between the Company and Reit Management & Research LLC. (Incorporated by reference to the Company’s Current Report on Form 8-K dated March 10, 2004.)
10.4 Purchase and Sale Agreement, dated March 1, 2004, by and among Ellicott City Land I, LLC and Ellicott City Land II, LLC, collectively as Sellers and SNH CHS Properties Trust, as Purchaser. (Incorporated by reference to the Company’s Current Report on Form 8-K dated March 1, 2004.)
10.5 Form of Indemnification Agreement. (Incorporated by reference to the Company’s Current Report on Form 8-K dated March 10, 2004.)
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10.6 Partial Termination and Amendment of Lease dated as of April 19, 2004, by and among certain subsidiaries of Senior Housing Properties Trust and the Company.(Filed herewith.)
10.7 Amended and Restated Purchase and Sale Agreement dated as of April 19, 2004, by and between SPT-Michigan Trust and Five Star Quality Care-Howell, LLC.(Filed herewith.)
10.8 Mortgage dated as of April 19, 2004, between Five Star Quality Care-Howell, LLC and Love Funding Corporation.(Filed herewith.)
31.1 Certification required by Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.(Filed herewith.)
31.2 Certification required by Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.(Filed herewith.)
32.1 Certification required by 18 U.S.C. Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).(Furnished herewith.)
(b) Reports on Form 8-K:
Current Report on Form 8-K dated March 1, 2004, filing information regarding the sale of an independent and assisted living facility to a subsidiary of Senior Housing and the amendment of our leases with Senior Housing (Items 2 and 7).
Current Report on Form 8-K dated March 10, 2004, filing information with respect to the adoption of a shareholder protection rights plan and filing various exhibits (Items 5 and 7).
Current Report on Form 8-K dated March 26, 2004, furnishing our press release containing our results of operations and financial condition for the quarter and year ended December 31, 2003 (Items 7 and 12).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | FIVE STAR QUALITY CARE, INC.
By: /s/ Evrett W. Benton
Evrett W. Benton
President and Chief Executive Officer
Dated: May 10, 2004
By: /s/ Bruce J. Mackey Jr.
Bruce J. Mackey Jr.
Treasurer and Chief Financial Officer
Dated: May 10, 2004 |
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