UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 10-Q/A
(AMENDMENT NO. 1)
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT 1934
For the quarterly period ended September 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-14012
EMERITUS CORPORATION
(Exact name of registrant as specified in its charter)
WASHINGTON 91-1605464
(State or other jurisdiction (I.R.S Employer
of incorporation or organization) Identification No.)
3131 Elliott Avenue, Suite 500
Seattle, WA 98121
(Address of principal executive offices)
(206) 298-2909
(Registrant's telephone number, including area code)
____________________________
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). [ ] Yes [X] No
As of October 31, 2003, there were 10,263,063 shares of the Registrant's Common
Stock, par value $.0001, outstanding.
Pursuant to this Form 10-Q/A, the registrant amends "Part I Financial
Information, Item 1. Financial Statements" and "Item 2. Management's Discussion
and Analysis of Financial Condition and Results of Operations" ("MD&A") in its
Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2003,
to correct a table showing contractual obligations in the note to the Condensed
Consolidated Financial Statements entitled "Liquidity" on page 16 of this report
and an identical table in the MD&A entitled "Liquidity and Capital Resources" on
page 31 of this report. No other changes were made to the Quarterly Report on
Form 10-Q for the quarterly period ended September 30, 2003.
EMERITUS CORPORATION
INDEX
Part I. Financial Information
Page No.
--------
Item 1. Financial Statements: . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Condensed Consolidated Balance Sheets as of September 30, 2003, and
December 31, 2002. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Condensed Consolidated Statements of Operations for the Three
Months and Nine Months ended September 30, 2003 and 2002. .. .. . . . . . . . 3
Condensed Consolidated Statements of Cash Flows for the Nine
Months ended September 30, 2003 and 2002 . . . . . . . . . . . . . . . . . . . 4
Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . . 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations . . . .. . . . . . . . . . . . .. . . . .. . . . . . . . . . . 17
Part II. Other Information
Note: Items 1 through 5 of Part II are omitted because they are not
applicable.
Item 6. Exhibits and Reports on Form 8-K . . . .. . . . .. . . . . . . . . . . 33
Signature. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
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1
EMERITUS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(In thousands, except share data)
ASSETS
September 30, December 31,
2003 2002
--------------- --------------
Current Assets:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,791 $ 6,960
Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 2,759
Trade accounts receivable, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,276 1,662
Other receivables. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,341 3,645
Prepaid expenses and other current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . 8,829 5,217
--------------- --------------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,237 20,243
--------------- --------------
Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94,491 119,583
Property held for development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,254 1,254
Notes receivable from and investments in affiliates . . . . . . . . . . . . . . . . . . . . . . 2,469 6,358
Restricted deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,613 5,555
Lease acquisition costs, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,054 6,081
Other assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,221 3,759
--------------- --------------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 152,339 $ 162,833
=============== ==============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities:
Current portion of long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,161 $ 3,604
Trade accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,404 3,108
Accrued employee compensation and benefits . . . . . . . . . . . . . . . . . . . . . . . . . . 6,133 5,355
Accrued interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,430 1,737
Accrued real estate taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,793 2,463
Accrued dividends on preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,578 13,457
Other accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,279 9,080
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,750 2,884
Other current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,590 5,040
--------------- --------------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,118 46,728
--------------- --------------
Long-term debt, less current portion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114,648 119,887
Convertible debentures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,000 32,000
Deferred gain on sale of communities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,069 20,324
Deferred rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282 2,508
Other long-term liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 530 894
--------------- --------------
Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229,647 222,341
--------------- --------------
Minority interests. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 558
Redeemable preferred stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 25,000
Commitments and contingencies
Shareholders' Deficit:
Preferred stock, $.0001 par value. Authorized 70,000 shares; issued and outstanding
34,486 and 33,473 at September 30, 2003, and December 31, 2002, respectively. . . . . . . . - -
Common stock, $.0001 par value. Authorized 40,000,000 shares; issued and outstanding
10,251,975 and 10,247,226 shares at September 30, 2003, and December 31, 2002, respectively 1 1
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71,326 68,944
Accumulated other comprehensive gain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 1,247
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (148,635) (155,258)
--------------- --------------
Total shareholders' deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (77,308) (85,066)
--------------- --------------
Total liabilities and shareholders' deficit. . . . . . . . . . . . . . . . . . . . . . . . . . $ 152,339 $ 162,833
=============== ==============
See accompanying Notes to Condensed Consolidated Financial Statements
and Management's Discussion and Analysis
of Financial Condition and Results of Operations
2
EMERITUS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(In thousands, except per share data)
Three Months ended Nine Months ended
September 30, September 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Revenues:
Community revenue. . . . . . . . . . . . . . . . $ 46,702 $ 32,226 $ 134,949 $ 94,640
Other service fees . . . . . . . . . . . . . . . 1,131 1,149 3,165 3,244
Management fees. . . . . . . . . . . . . . . . . 2,376 2,662 8,671 8,313
------------- ------------- ------------- -------------
Total operating revenues . . . . . . . . 50,209 36,037 146,785 106,197
------------- ------------- ------------- -------------
Expenses:
Community operations . . . . . . . . . . . . . . 32,056 21,474 90,486 63,120
General and administrative . . . . . . . . . . . 6,151 5,385 17,366 15,175
Depreciation and amortization. . . . . . . . . . 1,799 1,653 5,486 5,179
Facility lease expense . . . . . . . . . . . . . 9,767 7,282 27,697 21,420
------------- ------------- ------------- -------------
Total operating expenses . . . . . . . . 49,773 35,794 141,035 104,894
------------- ------------- ------------- -------------
Income from operations . . . . . . . . . 436 243 5,750 1,303
Other income (expense):
Interest income. . . . . . . . . . . . . . . . . 172 46 500 268
Interest expense . . . . . . . . . . . . . . . . (3,311) (2,838) (9,813) (8,616)
Other, net . . . . . . . . . . . . . . . . . . . 97 (153) 1,537 (894)
------------- ------------- ------------- -------------
Net other expense. . . . . . . . . . . . (3,042) (2,945) (7,776) (9,242)
------------- ------------- ------------- -------------
Net loss before income taxes. . . . . . (2,606) (2,702) (2,026) (7,939)
Provision for income taxes . . . . . . . (576) - (576) -
------------- ------------- ------------- -------------
Net loss . . . . . . . . . . . . . . . . (3,182) (2,702) (2,602) (7,939)
Preferred stock dividends. . . . . . . . . . . . . (1,464) (1,777) (5,240) (5,506)
Gain on repurchase of Series A preferred stock . . 14,465 - 14,465 -
------------- ------------- ------------- -------------
Net income (loss) to common shareholders $ 9,819 $ (4,479) $ 6,623 $ (13,445)
============= ============= ============= =============
Income (loss) per common share:
Basic. . . . . . . . . . . . . . . . . . . . . $ 0.96 $ (0.44) $ 0.65 $ (1.32)
============= ============= ============= =============
Diluted. . . . . . . . . . . . . . . . . . . . $ 0.63 $ (0.44) $ 0.59 $ (1.32)
============= ============= ============= =============
Weighted average common shares outstanding:
Basic. . . . . . . . . . . . . . . . . . . . . 10,252 10,215 10,249 10,204
============= ============= ============= =============
Diluted. . . . . . . . . . . . . . . . . . . . 18,687 10,215 11,311 10,204
============= ============= ============= =============
See accompanying Notes to Condensed Consolidated Financial Statements
and Management's Discussion and Analysis
of Financial Condition and Results of Operations
3
EMERITUS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(In thousands)
Nine Months Ended September 30,
------------------------------------
2003 2002
----------------- -----------------
Cash flows from operating activities:
Net loss . . . . . . . . . . . . . . . . . . . . . . . $ (2,602) $ (7,939)
Adjustments to reconcile net loss to
net cash provided by (used in) operating activities:
Minority interests . . . . . . . . . . . . . . . . . . . . . 152 141
Depreciation and amortization. . . . . . . . . . . . . . . . 5,486 5,179
Amortization of deferred gain. . . . . . . . . . . . . . . . (387) (244)
Loss on sale of properties . . . . . . . . . . . . . . . . . - 515
Impairment of long-lived asset . . . . . . . . . . . . . . . 950 -
Gain on sale of investment securities. . . . . . . . . . . . (1,437) -
Write down of lease acquisition costs. . . . . . . . . . . . 25 191
Write off of deferred gain . . . . . . . . . . . . . . . . . - 243
Changes in operating assets and liabilities. . . . . . . . . (1,275) 850
----------------- -----------------
Net cash provided by (used in) operating activities. . 912 (1,064)
----------------- -----------------
Cash flows from investing activities:
Acquisition of property and equipment. . . . . . . . . . . . . (2,013) (11,763)
Purchase of minority partner interest. . . . . . . . . . . . . (2,500) (3,070)
Sale of property and equipment . . . . . . . . . . . . . . . . 44,800 25,010
Proceeds from sale of investment securities. . . . . . . . . . 2,949 -
Management and lease acquisition costs . . . . . . . . . . . . (12,140) (1,602)
Advances to affiliates and other managed communities . . . . . (190) (603)
Proceeds from sales of interest in affiliates. . . . . . . . . - 750
Investment in affiliates . . . . . . . . . . . . . . . . . . . (137) (94)
Distributions to minority partners . . . . . . . . . . . . . . (250) (500)
----------------- -----------------
Net cash provided by investing activities. . . . . . . 30,519 8,128
----------------- -----------------
Cash flows from financing activities:
Proceeds from sale of stock under employee stock purchase plan - 57
Increase in restricted deposits. . . . . . . . . . . . . . . . (58) (35)
Repayment of short-term borrowings . . . . . . . . . . . . . . (1,993) (1,733)
Debt issue and other financing costs . . . . . . . . . . . . . (283) (1,424)
Repurchase of Series A preferred stock . . . . . . . . . . . . (20,516) -
Proceeds from long-term borrowings . . . . . . . . . . . . . . 19,600 46,818
Repayment of long-term borrowings. . . . . . . . . . . . . . . (24,350) (53,097)
----------------- -----------------
Net cash used in financing activities. . . . . . . . . (27,600) (9,414)
----------------- -----------------
Net increase (decrease) in cash and cash equivalents . 3,831 (2,350)
Cash and cash equivalents at the beginning of the period . . . . 6,960 9,811
----------------- -----------------
Cash and cash equivalents at the end of the period . . . . . . . $ 10,791 $ 7,461
================= =================
Supplemental disclosure of cash flow information -
cash paid during the period for interest . . . . . . . . . . $ 10,120 $ 10,220
Noncash investing and financing activities:
Unrealized holding gains in investment securities. . . . . . . $ - $ 1,020
Accrued and in-kind preferred stock dividends. . . . . . . . . $ 5,240 $ 5,506
Gain on repurchase of Series A preferred stock . . . . . . . . $ 14,465 $ -
Common stock warrants issued . . . . . . . . . . . . . . . . . $ 1,358 $ -
See accompanying Notes to Condensed Consolidated Financial Statements
and Management's Discussion and Analysis
of Financial Condition and Results of Operations
4
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of condensed consolidated financial statements requires Emeritus
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, Emeritus evaluates its estimates,
including those related to resident programs and incentives, bad debts,
investments, intangible assets, income taxes, restructuring, long-term service
contracts, contingencies, self-insured retention, insurance deductibles, health
insurance, and litigation. Emeritus bases its estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
Emeritus believes the following critical accounting policies are most
significant to the judgments and estimates used in the preparation of its
condensed consolidated financial statements. Revisions in such estimates are
charged to income in the period in which the facts that give rise to the
revision become known.
* For commercial general liability and professional liability insurance,
Emeritus uses a captive insurance structure essentially to self-fund its
primary layer of insurance. This policy is claims-made based and covers
losses and liabilities associated with general and professional liability.
The primary layer has per occurrence and aggregate limits. Within that
primary layer is a self-insured retention, which also has a per occurrence
and aggregate limit. The Company also has an excess policy, which applies
to claims in excess of the primary layer on a per occurrence basis. Losses
within the primary layer, which include the self-insured retention, are
accrued based upon actuarial estimates of the aggregate liability for
claims incurred.
* For health insurance, Emeritus self-insures up to a certain level for each
occurrence above which a catastrophic insurance policy covers any
additional costs. Health insurance expense is accrued based upon
historical experience of the aggregate liability for claims incurred. If
these estimates are insufficient, additional charges may be required.
* For workers' compensation insurance for insured states (excluding Texas
and compulsory State Funds), the Company is on an incurred loss,
retrospective insurance policy, retroactively adjusted, upward or
downward, based upon total incurred loss experience. The premium charged
by the insurance underwriter is based upon a standard rate determined by
the underwriter to cover, amongst other things, estimated losses and other
fixed costs. The difference between the premium charged and the actuarial
based estimate of costs, which is expensed on a monthly basis, is carried
as an asset on the balance sheet. After the end of the policy year, the
insurance company conducts an audit and adjusts the total premium based
upon the actual payroll and actual incurred loss for the policy year. Any
premium adjustment for the differences between estimated and actual
payroll and estimated and actual losses will first be applied to the
accrued asset and then as an adjustment to workers' compensation expense
at the time such adjustment is determined. There is a reasonable
expectation that the incurred loss adjustment will be downward, resulting
in a premium refund. The incurred loss adjustment is limited to 50% of the
standard premium with the initial adjustment six months after policy
expiration on December 31, 2003, and annually thereafter. For work-related
injuries in Texas, the Company is a non-subscriber, 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
..
5
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(unaudited)
* Emeritus maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its residents to make required payments.
If the financial condition of Emeritus's residents were to deteriorate,
resulting in an impairment of their ability to make payments, additional
charges may be required.
* Emeritus records a valuation allowance to reduce its deferred tax assets
to the amount that is more likely than not to be realized, which at this
time shows a net asset valuation of zero. Emeritus has considered future
taxable income and ongoing prudent and feasible tax planning strategies in
assessing the need for the valuation allowance. However, in the event
Emeritus were to determine that it would be able to realize its deferred
tax assets in the future in excess of its net recorded amount, an
adjustment to the deferred tax asset would increase income in the period
such determination was made.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 requires the Company to record the fair value of an
asset retirement obligation as a liability in the period in which it incurs a
legal obligation associated with the retirement of tangible long-lived assets
that result from the acquisition, construction, development, and/or normal use
of the assets. The Company also records a corresponding asset that is
depreciated over the life of the asset. Subsequent to the initial measurement of
the asset retirement obligation, the obligation will be adjusted at the end of
each period to reflect the passage of time and changes in the estimated future
cash flows underlying the obligation. The Company adopted SFAS No. 143 on
January 1, 2003. Adoption did not have an impact on the Company's financial
condition and results of operations.
In April 2002, the FASB issued SFAS No.145, Rescission of FASB Statements No. 4,
44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS
No. 145 amends existing guidance on reporting gains and losses on the
extinguishment of debt to prohibit the classification of the gain or loss as
extraordinary, as the use of such extinguishments have become part of the risk
management strategy of many companies. SFAS No. 145 also amends SFAS No. 13 to
require sale-leaseback accounting for certain lease modifications that have
economic effects similar to sale-leaseback transactions. The provisions of the
Statement related to the rescission of Statement No. 4 are applied in fiscal
years beginning after May 15, 2002. The provisions of the Statement related to
Statement No. 13 were effective for transactions occurring after May 15, 2002,
with early application encouraged. The Company adopted SFAS No. 145 in the
fourth quarter of 2002.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others, an interpretation of FASB Statements No. 5, 57, and 107
and a rescission of FASB Interpretation No. 34. This Interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees issued. The Interpretation
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002. The
disclosure requirements are effective for financial statements of interim or
annual periods ending after December 15, 2002. Adoption did not have an impact
on the Company's financial condition and results of operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123. This Statement amends FASB Statement 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
Statement No. 123 to require prominent disclosures in both annual and interim
financial statements. Certain of the disclosure modifications are required for
fiscal years ending after December 15, 2002, and are included in the notes to
these condensed consolidated financial statements.
6
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(unaudited)
In January 2003, the FASB issued Interpretation No. 46 (FIN No. 46),
"Consolidation of Variable Interest Entities." This Interpretation addresses
consolidation by business enterprises of variable interest entities (VIE's). A
VIE is subject to the consolidation provisions of FIN No. 46 if it cannot
support its financial activities without additional subordinated financial
support from third parties or its equity investors lack any one of the following
characteristics: the ability to make decisions about its activities through
voting rights, the obligation to absorb losses of the entity if they occur, or
the right to receive residual returns of the entity if they occur. FIN No. 46
requires a VIE to be consolidated by its primary beneficiary. The primary
beneficiary is the party that holds the variable interests that expose it to a
majority of the entity's expected losses and/or residual returns. For purposes
of determining a primary beneficiary, all related party interests must be
combined with the actual interests of the Company in the VIE. The application
of this Interpretation is immediate for VIE's created or altered after January
31, 2003, and is effective at the end of the first interim or annual period
ending after December 15, 2003, for variable interest entities that existed
prior to February 1, 2003.
The Company is evaluating the impact of FIN No. 46 on all its current related
party management agreements including those more fully discussed in the
Company's December 31, 2002, Annual Report on Form 10-K, under Item 13 "CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS," under sections denoted as "Emeritrust
Transactions" and "Baty Transactions" as well as other management agreements and
other arrangements with potential VIE's. Implementation of FIN No. 46 would
have more likely than not resulted in consolidation of both the Emeritrust I and
Emeritrust II communities and possibly some of the other entities discussed in
the referenced sections. However, these relationships have been modified such
that they are not believed to be VIE's under FIN No. 46. The Emeritrust II
communities are leased as of September 30, 2003, and the operating results are
now consolidated.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. For public
enterprises, such as the Company, this statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. Management has determined that no financial instruments of the Company
are covered by this pronouncement.
BASIS OF PRESENTATION
The unaudited interim financial information furnished herein, in the opinion of
the Company's management, reflects all adjustments, consisting of only normally
recurring adjustments, which are necessary to state fairly the condensed
consolidated financial position, results of operations, and cash flows of
Emeritus as of September 30, 2003, and for the three and nine months ended
September 30, 2003 and 2002. The results of operations for the period ended
September 30, 2003, are not necessarily indicative of the operating results for
the full year. The Company presumes that those reading this interim financial
information have read or have access to its 2002 audited consolidated financial
statements and Management's Discussion and Analysis of Financial Condition and
Results of Operations that are contained in the 2002 Form 10-K filed March 28,
2003. Therefore, the Company has omitted footnotes and other disclosures
herein, which are disclosed in the Form 10-K.
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7
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(unaudited)
STOCK-BASED COMPENSATION
The Company applies APB Opinion No. 25, Accounting for Stock Issued to Employees
and related interpretations in measuring compensation costs for its stock option
plans. The Company discloses pro forma net income (loss) and net income (loss)
per share as if compensation cost had been determined consistent with Statement
of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation.
Had compensation costs for the Company's stock option plan been determined
pursuant to SFAS 123, the Company's pro forma net income (loss) and pro forma
net income (loss) per share would have been as follows:
Three Months ended Nine Months ended
September 30, September 30,
------------------------------- --------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- --------------
(In thousands, except per share data)
Net income (loss) to common shareholders:
As reported. . . . . . . . . . . . . . . . . . . . . . . . $ 9,819 $ (4,479) $ 6,623 $ (13,445)
Add: Stock-based employee compensation expense
included in reported net income (loss) . . . . . . . . . - - - -
Deduct: Stock-based employee compensation
determined under fair value based method for all awards. (129) (62) (594) (522)
--------------- --------------- --------------- ---------------
Pro forma. . . . . . . . . . . . . . . . . . . . . . . . . $ 9,690 $ (4,541) $ 6,029 $ (13,967)
=============== =============== =============== ===============
Net income (loss) per common share:
As reported - Basic. . . . . . . . . . . . . . . . . . . . $ 0.96 $ (0.44) $ 0.65 $ (1.32)
=============== =============== =============== ===============
Pro forma - Basic. . . . . . . . . . . . . . . . . . . . . $ 0.95 $ (0.44) $ 0.59 $ (1.37)
=============== =============== =============== ===============
As reported - Diluted. . . . . . . . . . . . . . . . . . . $ 0.63 $ (0.44) $ 0.59 $ (1.32)
=============== =============== =============== ===============
Pro forma - Diluted. . . . . . . . . . . . . . . . . . . . $ 0.57 $ (0.44) $ 0.53 $ (1.37)
=============== =============== =============== ===============
We estimate the fair value of our options using the Black-Scholes option value
model, which is one of several methods that can be used to estimate option
values. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. Option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. Our
options have characteristics significantly different from those of traded
options, and changes in the subjective input assumptions can materially affect
the fair value estimates. The fair value of options granted and employee
purchase plan shares were estimated at the date of grant using the following
weighted average assumptions:
Three Months Nine Months
Ended Ended
September 30, September 30,
------------- ----------------------------
2003 2002 2003 2002
----- ----- ------------- -------------
Expected life from vest date (in years) 4 4 4 4
Risk-free interest rate . . . . . . . . 1.96% 4.3% 1.96%- 4.3% 2.9%- 4.3%
Volatility. . . . . . . . . . . . . . . 90.0% 90.4% 89.3% - 91.1% 90.4%-93.3%
Dividend yield. . . . . . . . . . . . . - - - -
Weighted average fair value (per share) $2.33 $1.24 $2.55 $2.00
8
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(unaudited)
GAINS ON INVESTMENT SECURITIES
On April 23, 2003, ARV announced that, at a special meeting held on that date,
its shareholders voted to approve the Agreement and Plan of Merger, dated as of
January 3, 2003, between ARV and Prometheus Assisted Living LLC ("Prometheus").
ARV further announced that the merger transaction closed and trading of the ARV
stock on the American Stock Exchange ceased on April 23, 2003. Under the terms
of the merger, shares of ARV's stock held by shareholders other than Prometheus
and its affiliates were converted into the right to receive merger consideration
of $3.90 per share, without interest. On April 25, 2003, the Company received
approximately $2.9 million in exchange for its 755,884 shares of ARV common
stock in which it had a carrying value of approximately $1.5 million, thus
recognizing a gain of approximately $1.4 million, which is included in "Other,
net" in the Company's Condensed Consolidated Statements of Operations and a
reduction in "Accumulated other comprehensive gain" in the Company's Condensed
Consolidated Balance Sheets.
EMERITRUST TRANSACTIONS
As of July 1, 2003, the Company held interests in 45 communities referred to as
the Emeritrust communities, including 24 Emeritrust I communities, 16 Emeritrust
II Operating communities, and five Emeritrust II Development communities, under
management agreements. In August 2003, the Emeritrust I investors sold a
building in Casper, Wyoming, reducing the number of Emeritrust I communities
under management from 24 to 23. The Company does not recognize management fees
on the Emeritrust communities as revenue in its condensed consolidated financial
statements to the extent that it is funding the cash operating losses that
include them, although the amounts of the funding obligation each year include
management fees earned by Emeritus under the management agreements.
Correspondingly, the Company recognizes the funding obligation under the
agreement, less the applicable management fees, as an expense in its condensed
consolidated financial statements under the category "Other, net". Conversely,
if the applicable management fees exceed the funding obligation, the Company
recognizes the management fees less the funding obligation as management fee
revenue in its condensed consolidated financial statements.
The management agreements and related options to purchase these communities
expired June 30, 2003 (except that management agreements with respect to five
communities were to continue until December 31, 2003). Because the Company was
not in a position to exercise the options to acquire the communities prior to
expiration, it was in discussions with the owners of the communities and their
lenders to extend the management agreements and related purchase options. On
July 2, 2003, the Company executed an initial extension of its management
agreement with respect to the Emeritrust II communities. The management and
purchase option agreements related to the Emeritrust II communities were amended
to expire October 1, 2003, which allowed the owners of the communities, their
lenders, and the Company to consider a longer-term agreement. On September 30,
2003, the Company acquired the leasehold interests of the 21 Emeritrust II
communities. The Company facilitated the purchase of these communities by a real
estate investment trust for a cash purchase price of $118.6 million and issued,
or agreed to issue, to the seller warrants to purchase 500,000 shares of the
Company's common stock. The Company financed the cash purchase price through a
real estate investment trust with a combination of lease and mortgage financing
in the aggregate amount of $121.5 million, which is described below under "21
Building Lease Acquisition and Debt Consolidation." The warrants expire
September 30, 2008, and have an exercise price of $7.60 (subject to certain
adjustments). The holders have limited registration rights. The Company included
the fair value of these warrants, totaling approximately $1.4 million, as lease
acquisition costs and will amortize them over the life of the lease.
The Company continued to operate under the existing operating structure of the
Emeritrust I communities on a day-to-day basis pending renegotiation of the
terms of financing, management, and purchase option agreements. In the third
quarter of 2003, the Company executed a short-term extension of the management
agreement from June 30, 2003, to January 2, 2004, and the Company's purchase
option was terminated. As a result of recent sales or transfers of communities,
it is likely that the number of Emeritrust I communities will have reduced from
24 to 21 communities. The interest rate on the underlying mortgage financing
was
9
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(unaudited)
increased, effective July 1, 2003, which has the effect of decreasing the
portion of the management fee that is dependent on 50% of the cash flow of the
communities. Because of the decrease in the number of managed communities and
the reduction in cash flow, the Company anticipates that management fees earned
on the Emeritrust I communities will decline. The Company has also been
indemnified against any funding obligations it may have under the extended
management agreement by certain of the Emeritrust I investors, including Mr.
Baty. The management agreement related to the Emeritrust I communities was
further extended from January 2, 2004, to September 30, 2005. This longer-term
extension of the management contract excludes any funding obligation, excludes a
purchase option, and may be terminated by either party on 90 days notice.
Subject to the lender's consent, the investor group may transfer one community
in Grand Terrace, California, to an entity owned or controlled by Mr. Baty
subject to mortgage financing of $3.2 million, the amount of the underlying
mortgage financing allocated to this community. If the transfer occurs, Mr.
Baty will lease the community to the Company under a 10-year lease with a fair
value rental rate of (i) debt service (including interest and principal)
computed on a $4.2 million base amount, the Emeritrust I mortgage interest rate
and a 25 year amortization, and (ii) 50% of cash flow (after accounting for
assumed management fees and capital expenditures). The base amount represents
the principal amount of Emeritrust I mortgage debt allocated to this community
and a portion of the debt reductions funded by Mr. Baty.
In connection with these management arrangements, Mr. Baty entered into an
agreement with the investor group pursuant to which he guaranteed to the
investor group (i) on or before September 30, 2005, the repayment of its
invested capital together with a 6% rate of return, compounded annually, (less
any cash distributions received) and (ii) the funding of operating deficits
related to the Emeritrust I communities. Under these arrangements, Mr. Baty
would also assume responsibility for the underlying GMAC debt. Mr. Baty secured
these obligations through a pledge of unrelated partnership interests and
capital stock. The prior agreements under which the investor group could
require Mr. Baty to purchase up to 12 communities were terminated.
Additional information relating to the Emeritrust transactions is set forth in
the Company's Form 8-K filed October 14, 2003.
For the three months and nine months ended September 30, 2003 and 2002, the
total gross management fees earned, management fees recognized, and funding
obligations accrued for all Emeritrust communities are shown in the tables below
(In thousands):
Management Fees Earned:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- Increase ---------------------------- Increase
Communities 2003 2002 (Decrease) 2003 2002 (Decrease)
- ------------------------- ------------- ------------- -------------- ------------- ------------- --------------
Emeritrust I. . . . . . . $ 510 $ 511 $ (1) $ 2,346 $ 1,611 $ 735
Emeritrust II Operating . 493 486 7 1,479 1,451 28
Emeritrust II Development 176 183 (7) 540 579 (39)
------------- ------------- -------------- ------------- ------------- --------------
Total . . . . . . . . . . $ 1,179 $ 1,180 $ (1) $ 4,365 $ 3,641 $ 724
============= ============= ============== ============= ============= ==============
Management Fees Recognized:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- Increase ---------------------------- Increase
Communities 2003 2002 (Decrease) 2003 2002 (Decrease)
- ------------------------- ------------- ------------- -------------- ------------- ------------- --------------
Emeritrust I. . . . . . . $ 510 $ 349 $ 161 $ 2,335 $ 1,449 $ 886
Emeritrust II Operating . 493 486 7 1,479 1,451 28
Emeritrust II Development 172 170 2 525 529 (4)
------------- ------------- -------------- ------------- ------------- --------------
Total . . . . . . . . . . $ 1,175 $ 1,005 $ 170 $ 4,339 $ 3,429 $ 910
============= ============= ============== ============= ============= ==============
10
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(unaudited)
Funding Obligations Accrued:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- Increase ---------------------------- Increase
Communities 2003 2002 (Decrease) 2003 2002 (Decrease)
- ------------------------- ------------- ------------- -------------- ------------- ------------- --------------
Emeritrust I. . . . . . . $ - $ 162 $ (162) $ 11 $ 162 $ (151)
Emeritrust II Development 4 2 2 (16) 123 (139)
------------- ------------- -------------- -------------- ------------- --------------
Total . . . . . . . . . . $ 4 $ 164 $ (160) $ (5) $ 285 $ (290)
============= ============= ============== ============== ============= ==============
ACCRUED DIVIDENDS ON PREFERRED STOCK
In a two-tranche transaction that closed on July 31, 2003, and August 28, 2003,
the Company repurchased all of its outstanding shares of Series A Preferred
Stock (the "Series A Stock") for an aggregate purchase price of $20.5 million,
of which approximately $516,000 is due to transaction related expenses. The
Series A Stock had a face value of $25.0 million. In addition, the holder of
the Series A Stock agreed to forego approximately $10.1 million in accrued and
unpaid dividends on the Series A Stock. The Company financed the first tranche
through a previously announced lease transaction involving three communities in
which the Company raised $10.2 million, discussed below in "Other Transactions".
The second tranche was primarily financed through $7.5 million of mortgage debt
with a real estate investment trust and proceeds from a sale-leaseback
transaction involving four buildings, also discussed below in "Other
Transactions". The mortgage debt is secured by the seven properties discussed
above. The Company recognized a one-time gain of approximately $14.5 million,
net of transaction costs, related to the repurchase of the Series A Stock, which
reduced retained deficit and is shown as a separate line item on the Condensed
Consolidated Statements of Operations in arriving at "Net income (loss) to
common shareholders".
Since the third quarter of 2000, the Company has accrued its obligation to pay
cash dividends to the Series B preferred shareholders, which amounted to
approximately $7.6 million at September 30, 2003, including all penalties for
non-payment. Since the Company had not paid these dividends for more than six
consecutive quarters, under the Designation of Rights and Preferences of the
Series B preferred stock in the Company's Articles of Incorporation, the Series
B preferred shareholders may designate one director in addition to the other
directors that they are entitled to designate under the shareholders' agreement.
As of January 1, 2002, the Series B preferred shareholders became entitled to
designate an additional director under the Articles, but thus far have chosen
not to do so.
Series B preferred dividends are to be paid in cash and in additional shares of
Series B preferred shares. As of September 30, 2003, an additional 4,486 Series
B preferred shares had been issued as paid-in-kind dividends for all periods
prior to the third quarter of 2003. As of October 1, 2003, an additional 344
shares of Series B preferred stock were issued as paid-in-kind dividends for the
third quarter of 2003.
EIGHT BUILDING ACQUISITION
On May 1, 2003, the Company entered into a lease agreement with certain
affiliates of a real estate investment trust, for eight assisted living
communities (the "Eight Properties") in four states containing an aggregate of
489 units.
The lease is for an initial 10-year period with three 5-year extensions and
includes an opportunity for the Company to acquire the Eight Properties anytime
during the second year for $42.2 million and a purchase option in the third year
at a 3% premium over the original purchase option price. In addition, the lease
gives the Company the right of first refusal to purchase any of the properties
if the owner decides to sell. The lease is a net lease, with base rental
approximating $3.45 million annually with a lease escalator at the end of the
first and second lease years based on a percentage of increased operating
revenues, with an aggregate annual cap of $275,000, and lease escalators each
year thereafter based on increases in the consumer price index. The real estate
investment trust has agreed to fund up to $500,000 for capital
11
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(unaudited)
expenditure requirements. The capital expenditures funded by the real estate
investment trust will increase the basis and purchase option and carry a 10%
lease rate.
The real estate investment trust also loaned $600,000 to the Company for general
working capital purposes and for capital and other improvements to the Eight
Properties. This loan has a 10-year term with no extensions, bearing interest
at 10% annually with monthly interest-only payments. In addition, if the
Company exercises its purchase option at any time on any of the Eight
Properties, the pro rata principal portion of the loan will become due at the
time the closing of the sale of such facility occurs.
The Eight Properties in this acquisition are purpose-built assisted living
communities in which the Company plans to offer both assisted and memory loss
services to select communities.
21 BUILDING LEASE ACQUISITION AND DEBT CONSOLIDATION
On September 30, 2003, the Company entered into a master operating lease
agreement to lease 21 assisted living communities previously managed as the
Emeritrust II communities (the "21 Properties"). The agreement is an amended
master operating lease agreement (the "Master Lease") with certain affiliates of
a real estate investment trust. The Master Lease relates to four communities
from a March 2002 lease transaction and the 21 Emeritrust II communities for a
total of 25 communities.
The Master Lease is for an initial 15-year period with one 15-year renewal. In
addition, the lease gives the Company the right of first refusal to purchase any
of the 21 Properties if the owner decides to sell. The lease is a net lease,
with base rent approximating $14.7 million annually with certain lease
escalators.
The real estate investment trust also provided financing secured by the
Company's leasehold mortgage in the 21 Properties of $11.5 million to the
Company in connection with the Emeritrust II communities transaction.
Additionally, the real estate investment trust and the Company agreed to
consolidate this new debt with the $6.8 million in outstanding debt from the
March 2002 transaction referenced above and the $7.5 million debt from the
Series A Stock repurchase described above, which closed in August 2003, all as
further discussed below in "Other Transactions". The new consolidated loan of
$25.8 million matures on June 30, 2007, and bears an initial interest rate of
12.13% per annum with periodic increases up to 13%. The new note requires
monthly interest-only payments in the first year, interest and principal
starting in the second year, and a balloon principal payment at maturity.
Additional principal reductions may occur, at the Company's option, through the
increase in the amount of the lease financing based on the portfolio achieving
certain coverage ratios.
OTHER TRANSACTIONS
In July 2003, the Company entered into a transaction involving three leased,
purpose-built assisted living communities located in Louisville, Kentucky;
Auburn, Massachusetts; and Rocky Hill, Connecticut, wherein the three leases
with the Company were transferred to a new lessor. The Company received
approximately $10.2 million in cash proceeds recognizing a gain of approximately
$8.5 million, of which $2.2 million of deferred rent was reclassified as
deferred gains, all of which was deferred and will be amortized over the
remaining life of the leases. As part of the transaction, approximately $4.4
million in notes and interest receivable related to the three facilities was
retired.
Effective July 1, 2003, the Company ceased managing 12 Regent Assisted Living
communities. On August 1, 2003, the Company ceased managing an additional
Regent Assisted Living community.
In August of 2003, a real estate investment trust provided mortgage financing
for $7.5 million. The mortgage loan had a 36 month term and required
interest-only payments and bore an initial interest rate of 12% per annum with
periodic increases. This mortgage loan was subsequently consolidated with other
then outstanding and newly issued debt as discussed above in "21 Building Lease
Acquisition and Debt Consolidation".
On September 30, 2003, wholly owned subsidiaries of the Company, established
pursuant to financing requirements, which owned three buildings and jointly
owned one building, participated with a real estate
12
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(unaudited)
investment trust in the sale-leasebacks of four buildings, and the leasehold
assets continue to be owned by the subsidiaries and are not available to satisfy
debts or obligations of the consolidated Company. The four buildings are
purpose-built assisted living communities located in Manassas, Virginia;
Kirkland, Washington; Chelmsford, Massachusetts; and Ridgeland, Mississippi. The
jointly owned building was 50% owned by the Company's subsidiary and 50% owned
by an unrelated third party. The Company purchased the unrelated third party's
interest for $2.5 million. The consideration for the transaction was paid by the
real estate investment trust by assuming the underlying debt on the facilities
and paying cash consideration to the Company. The Company received approximately
$6.6 million in cash proceeds. As a result of this transaction, the Company
recognized a gain of $9.9 million, which will be deferred over the term of the
new operating leases.
Effective October 1, 2003, the Company ceased managing two communities located
in Tacoma, Washington, and Coeur d'Alene, Idaho.
HORIZON BAY TRANSACTIONS
On September 30, 2003, the Company entered into an agreement to lease eight
communities that the Company was then managing for a series of entities, which
are owned or controlled by Dan Baty ("Baty entities"). These transactions are
subject to the transfer of applicable licenses and the receipt of lender and
landlord approvals, which the Company expects to occur within 90 days.
Under the terms of the agreement between the Company and the Baty entities, the
Company has agreed to assume the existing leases relating to seven of the
facilities, which are leased by the Baty entities. In lieu of acquiring the
remaining community and assuming the existing mortgage financing, the Company
has agreed, subject to securing necessary lender and licensure approvals, to
enter into an agreement to lease the community from the applicable Baty entity
for a term of 10 years, with rent equal to the debt service on the mortgage
indebtedness (including interest and principal) plus 25% of cash flow (after
accounting for assumed management fees and capital expenditures). The debt
which is secured by this community may be cross-collateralized by Mr. Baty with
an Emeritrust I community that Mr. Baty has agreed to acquire and lease to the
Company, as described above in "Emeritrust Transactions". Annual rent relating
to the eight communities is estimated at $3.7 million, plus annual rent
escalators based upon changes in the consumer price level index. The Company
will pay the Baty entities approximately $65,000, which represented their cash
investment plus 9% per annum, as provided in the original agreement related to
the management of these communities between Emeritus and the Baty entities.
Under the new agreement, obligations previously existing to fund operating
losses do not continue. As a result, the Company may incur operating losses
that will not be reimbursed.
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13
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(unaudited)
INCOME (LOSS) PER SHARE
The capital structure of Emeritus includes convertible debentures, and
redeemable and non-redeemable convertible preferred stock, common stock
warrants, and stock options. Basic net income (loss) per share is computed
based on weighted average shares outstanding and excludes any potential
dilution. Diluted net income (loss) per share is computed based on the weighted
average number of shares outstanding plus dilutive potential common shares.
Options and warrants are included under the "treasury stock method" to the
extent they are dilutive. Certain shares issuable upon the exercise of stock
options and warrants and conversion of convertible debentures and preferred
stock have been excluded from the computation because the effect of their
inclusion would be anti-dilutive. The following table summarizes those that are
excluded in each period because they are anti-dilutive (in thousands):
Three Months ended Nine Months ended
September 30, September 30,
-------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Convertible Debentures. - 1,455 1,455 1,455
Options . . . . . . . . 31 1,763 31 1,763
Warrants. . . . . . . . - 1,000 - 1,000
Series A Preferred (1). - 1,374 1,145 1,374
Series B Preferred. . . - 4,590 4,714 4,590
------------ ------------ ------------ ------------
31 10,182 7,345 10,182
============ ============ ============ ============
(1) Repurchased in July and August 2003.
Dilutive potential common shares and adjustments to net income (loss) to common
shareholders arising under the assumed conversion into common stock of the
convertible debentures, Series A redeemable convertible preferred, and Series B
convertible preferred stock are included under the "if-converted method".
The following table summarizes the computation of basic and diluted net income
(loss) per common share amounts presented in the accompanying condensed
consolidated statements of operations (in thousands, except per share amounts):
Three Months ended Nine Months ended
September 30, September 30,
----------------------------- -----------------------------
2003 2002 2003 2002
------------- -------------- ------------- --------------
Basic:
Numerator for basic net income (loss) per share:
Net income (loss) to common shareholders . . . . . . $ 9,819 $ (4,479) $ 6,623 $ (13,445)
============= ============== ============= ==============
Denominator for basic net income (loss) per share:
Weighted average number of common shares outstanding. 10,252 10,215 10,249 10,204
============= ============== ============= ==============
Basic net income (loss) per share. . . . . . . . . . . . $ 0.96 $ (0.44) $ 0.65 $ (1.32)
============= ============== ============= ==============
Diluted:
Numerator for diluted net income (loss) per share:
Net income (loss) to common shareholders . . . . . . $ 9,819 $ (4,479) $ 6,623 $ (13,445)
Assumed conversion of convertible debentures . . . . 500 - - -
Assumed conversion of Series A preferred stock . . . 476 - - -
Assumed conversion of Series B preferred stock . . . 988 - - -
------------- -------------- ------------- --------------
$ 11,783 $ (4,479) $ 6,623 $ (13,445)
============= ============== ============= ==============
14
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(unaudited)
Three Months ended Nine Months ended
September 30, September 30,
----------------------------- -----------------------------
2003 2002 2003 2002
------------- -------------- ------------- --------------
Denominator for diluted net income (loss) per share:
Weighted average number of common shares outstanding $ 10,252 $ 10,215 $ 10,249 $ 10,204
Assumed exercise of options and warrants . . . . . . 1,517 - 1,062 -
Assumed conversion of convertible debentures . . . . 1,455 - - -
Assumed conversion of Series A preferred stock . . . 687 - - -
Assumed conversion of Series B preferred stock . . . 4,776 - - -
------------- -------------- ------------- --------------
$ 18,687 $ 10,215 $ 11,311 $ 10,204
============= ============== ============= ==============
Diluted net income (loss) per share. . . . . . . . . . . $ 0.63 $ (0.44) $ 0.59 $ (1.32)
============= ============== ============= ==============
OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) includes the following transactions for the
three-month and nine-month periods ended September 30, 2003 and 2002,
respectively:
Three Months ended Nine Months ended
September 30, September 30,
-------------------------------- --------------------------------
(In thousands)
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Net income (loss) to common shareholders. $ 9,819 $ (4,479) $ 6,623 $ (13,445)
Other comprehensive income:
Unrealized holding gains
on investment securities. . . . - 771 (1,247) 1,020
-------------- --------------- --------------- ---------------
Comprehensive income (loss) . . . . . . . $ 9,819 $ (3,708) $ 5,376 $ (12,425)
============== =============== =============== ===============
LIQUIDITY
The Company has incurred significant operating losses since its inception and
has a working capital deficit of $19.9 million, although $5.8 million represents
deferred revenue and $7.6 million of preferred dividends is due only if declared
by the Company's board of directors. At times in the past, the Company has been
dependent upon third party financing or disposition of assets to fund
operations. If such transactions are necessary in the future, Emeritus cannot
guarantee that they will be available on a timely basis, on terms attractive to
the Company, or at all.
Throughout 2002 and continuing in the first quarter of 2003, the Company
refinanced substantially all of its debt obligations, extending the maturities
of such financings to dates in 2005 or thereafter, at which time the Company
will need to refinance or otherwise repay the obligations. Many of the
Company's debt instruments and leases contain "cross-default" provisions
pursuant to which a default under one obligation can cause a default under one
or more other obligations to the same lender or lessor. Such cross-default
provisions affect 12 owned assisted living properties and 97 properties operated
under leases. Accordingly, any event of default could cause a material adverse
effect on the Company's financial condition if such debt or leases are
cross-defaulted. At September 30, 2003, the Company complied with all such
covenants.
Management believes that the Company will be able to sustain positive operating
cash flow at least through September 30, 2004, and will have adequate cash for
all necessary investing and financing activities including required debt service
and capital expenditures.
15
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(unaudited)
The following table summarizes the Company's contractual obligations at
September 30, 2003 (In thousands):
Payments Due by Period
-----------------------------------------------------
Less than After 5
Contractual Obligations Total 1 year 1-3 years 4-5 years years
--------- --------- --------- --------- ---------
Long-Term Debt, including current portion $ 117,809 $ 3,161 $ 17,059 $ 97,434 $ 155
Operating Leases. . . . . . . . . . . . . $ 610,447 $ 48,119 $ 103,549 $ 359,988 $ 98,791
OTHER EVENTS
Alterra Healthcare Corporation ("Alterra"), a national assisted living company
headquartered in Milwaukee, Wisconsin, filed a voluntary Chapter 11 bankruptcy
petition on January 22, 2003. On April 10, 2003, the Bankruptcy Court approved
bidding procedures establishing a process for Alterra to seek and select a
transaction to address its capital and liquidity needs upon completion of its
bankruptcy reorganization by selling its capital stock or assets.
The Company previously announced its intent to acquire Alterra through a joint
venture entity controlled by Emeritus. The Company has renegotiated the terms
of the joint venture with its partners under which an affiliate of Fortress
Investment Group LLC, which was to contribute $1.5 million of equity and $62.5
million of debt, will now contribute $49 million of equity and $15 million of
debt and have the right to appoint a majority of the directors of the
reorganized Alterra. The Company's investment in Alterra will be $7.0 million,
excluding any transaction costs. The transaction continues to be conditioned
on, among other things, confirmation of Alterra's Chapter 11 Plan of
Reorganization and the receipt of regulatory approvals, and is still expected to
close in the fourth quarter of this year.
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16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Emeritus is a Washington corporation organized by Daniel R. Baty and two other
founders in 1993. In November 1995, we completed our initial public offering
and began our expansion strategy.
Through 1998, we focused on rapidly expanding our operations in order to
assemble a portfolio of assisted living communities with a critical mass of
capacity. We pursued an aggressive acquisition and development strategy during
that time, acquiring 35 and developing 10 communities in 1996, acquiring seven
and developing 20 communities in 1997, and developing five communities in 1998.
During 1999 and continuing through 2001, we substantially reduced our pace of
acquisition and development activities to concentrate our efforts on improving
the performance of our existing facilities. During 2002 and the first three
quarters of 2003, we have resumed pursuing, on a selective basis, management
contracts and acquisition opportunities, which we believe will be beneficial to
us.
In our consolidated portfolio, we had an increase in average monthly revenue per
occupied unit to $2,765 for the first three quarters of 2003 from $2,535 for the
first three quarters of 2002, primarily brought about by our rate enhancement
program. This represents an average revenue increase of $230 per month per
occupied unit, or 9.1%. The average occupancy rate decreased to 77.1% for the
first three quarters of 2003 from 81.8% for the first three quarters of 2002.
However, the year-to-year comparison of these results is skewed by the impact of
the 24 building lease acquisition in the fourth quarter of 2002 and the 8
building lease acquisition in the second quarter of 2003. The table below shows
the results exclusive of these acquisitions:
Nine months ended September 30,
-------------------------------------------------------------
2003 2002
--------------------------------------------- --------------
A B C D E
Recent (A without B) (C-D)
Consolidated Lease Consolidated Increase
Portfolio Acquisitions Portfolio (Decrease)
-------------- ------------- -------------- -------------- ---------------
Average monthly revenue
per occupied unit . . $ 2,765 $ 2,981 $ 2,703 $ 2,535 $ 168
============== ============== ============== ============== ==============
Average occupancy rate. 77.1% 65.1% 81.4% 81.8% (0.4%)
============== ============== ============== ============== ==============
In our total operated portfolio, which includes managed communities, we had an
increase in average monthly revenue per occupied unit to $2,681 for the first
three quarters of 2003 from $2,532 for the first three quarters of 2002,
primarily brought about by our rate enhancement program. This represents an
average revenue increase of $149 per month per occupied unit, or 5.9%. The
average occupancy rate decreased to 78.8% for the first three quarters of 2003
from 81.1% for the first three quarters of 2002. However, the year-to-year
comparison of these results is skewed by the impact of the 24 building lease
acquisition in the fourth quarter of 2002 and the 8 building lease acquisition
in the second quarter of 2003. The table below shows the results exclusive of
these acquisitions:
Nine months ended September 30,
-------------------------------------------------------------
2003 2002
--------------------------------------------- --------------
A B C D E
Total Recent (A without B) Total (C-D)
Operated Lease Operated Increase
Portfolio Acquisitions Portfolio (Decrease)
-------------- ------------- -------------- -------------- ---------------
Average monthly revenue
per occupied unit . . $ 2,681 $ 2,981 $ 2,646 $ 2,532 $ 114
============== ============== ============== ============== ==============
Average occupancy rate. 78.8% 65.1% 80.7% 81.1% (0.4%)
============== ============== ============== ============== ==============
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
While our focus during the upcoming year will be to continue evaluating other
acquisition opportunities, we also intend to concentrate on integration of
existing and pending acquisitions. We are interested in opportunities that have
neutral capitalization requirements, enhance or expand existing offerings, and
offer upside potential.
The following table sets forth a summary of our property interests:
As of September 30, As of December 31, As of September 30,
2003 2002 2002
---------------------- ---------------------- ----------------------
Buildings Units Buildings Units Buildings Units
---------- ---------- ---------- ---------- ---------- ----------
Owned (1) . . . . . . . . . . . . . . . 14 1,458 17 1,687 17 1,687
Leased (1). . . . . . . . . . . . . . . 100 7,640 67 5,279 43 3,628
Managed/Admin Services (2). . . . . . . 54 5,206 94 8,577 93 8,505
Joint Venture/Partnership . . . . . . . 1 140 2 219 3 333
---------- ---------- ---------- ---------- ---------- ----------
Operated Portfolio . . . . . . . . 169 14,444 180 15,762 156 14,153
Percentage increase (decrease) (3) (6.1%) (8.4%) 35.3% 28.7% 17.3% 15.6%
- --------
(1) Included in our consolidated portfolio of communities.
(2) Buildings managed decreased due to termination of 13 Regent management
contracts and the 21 Emeritrust II communities, which are leased as of
September 30, 2003.
(3) The percentage increase (decrease) indicates the change from the prior
year, or, in the case of September 30, 2003 and 2002, from the end of the
prior year.
We rely primarily on our residents' ability to pay our charges for services from
their own or familial resources and expect that we will do so for the
foreseeable future. Although care in an assisted living community is typically
less expensive than in a skilled nursing facility, we believe that generally
only seniors with income or assets meeting or exceeding the regional median can
afford to reside in our communities. Therefore, inflation or other
circumstances that adversely affect seniors' ability to pay for assisted living
services could have an adverse effect on our business. All sources of
resident-related revenue other than residents' private resources constitute less
than 10% of our total revenues.
We have incurred net losses since our inception, and as of September 30, 2003,
we had an accumulated deficit of approximately $148.6 million. These losses
resulted from a number of factors, including:
* occupancy levels at our communities that were lower for longer periods
than we originally anticipated;
* financing costs that we incurred as a result of multiple financing and
refinancing transactions; and
* administrative and corporate expenses that we increased to facilitate our
growth and maintain operations.
During 1998, we decided to reduce acquisition and development activities and
dispose of select communities that had been operating at a loss. We believe
that slowing our acquisition and development activities enabled us to use our
resources more efficiently and increase our focus on enhancing community
operations. In 2002 and through the third quarter of 2003, along with a focus
on operations, we selectively acquired additional communities and new management
contracts.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
EMERITRUST TRANSACTIONS
As of July 1, 2003, we held interests in 45 communities referred to as the
Emeritrust communities, including 24 Emeritrust I communities, 16 Emeritrust II
Operating communities and five Emeritrust II Development communities, under
management agreements. In August 2003, the Emeritrust I investors sold a
building in Casper, Wyoming, reducing the number of Emeritrust I communities
under management from 24 to 23. We do not recognize management fees on the
Emeritrust communities as revenue in our condensed consolidated financial
statements to the extent that we are funding the cash operating losses that
include them, although the amounts of the funding obligation each year include
management fees earned by us under the management agreements. Correspondingly,
we recognize the funding obligation under the agreement, less the applicable
management fees, as an expense in our condensed consolidated financial
statements under the category "Other, net". Conversely, if the applicable
management fees exceed the funding obligation, we recognize the management fees
less the funding obligation as management fee revenue in our condensed
consolidated financial statements.
The management agreements and related options to purchase these communities
expired June 30, 2003 (except that management agreements with respect to five
communities were to continue until December 31, 2003). Because we were not in a
position to exercise the options to acquire the communities prior to expiration,
we were in discussions with the owners of the communities and their lenders to
extend the management agreements and related purchase options. On July 2, 2003,
we executed an initial extension of the management agreement with respect to the
Emeritrust II communities. The management and purchase option agreement related
to the Emeritrust II communities were amended to expire October 1, 2003, which
allowed us, the owners of the communities, and their lenders to consider a
longer-term agreement. On September 30, 2003, we acquired the leasehold
interests of the 21 Emeritrust II communities. We facilitated the purchase of
these communities by a real estate investment trust for a cash purchase price of
$118.6 million and issued, or agreed to issue, to the seller warrants to
purchase 500,000 shares of our common stock. We financed the cash purchase price
through a real estate investment trust with a combination of lease and mortgage
financing in the aggregate amount of $121.5 million, which is described below
under "21 Building Lease Acquisition and Debt Consolidation." The warrants
expire September 30, 2008, and have an exercise price of $7.60 (subject to
certain adjustments). The holders have limited registration rights. We included
the fair value of these warrants, totaling approximately $1.4 million, as lease
acquisition costs and will amortize them over the life of the lease.
We continued to operate under the existing operating structure of the Emeritrust
I communities on a day-to-day basis pending renegotiation of the terms of
financing, management, and purchase option agreements. In the third quarter of
2003, we executed a short-term extension of the management agreement from June
30, 2003, to January 2, 2004, and our purchase option was terminated. As a
result of recent sales or transfers of communities, it is likely that the number
of Emeritrust I communities will have reduced from 24 to 21 communities. The
interest rate on the underlying mortgage financing was increased, effective July
1, 2003, which has the effect of decreasing the portion of the management fee
that is dependent on 50% of the cash flow of the communities. Because of the
decrease in the number of managed communities and the reduction in cash flow, we
anticipate that management fees earned on the Emeritrust I communities will
decline. We have also been indemnified against any funding obligations we may
have under the extended management agreement by certain of the Emeritrust I
investors, including Mr. Baty. The management agreement related to the
Emeritrust I communities was further extended from January 2, 2004, to September
30, 2005. This longer-term extension of the management contract excludes any
funding obligation, excludes a purchase option, and may be terminated by either
party on 90 days notice. Subject to the lender's consent, the investor group
may transfer one community in Grand Terrace, California, to an entity owned or
controlled by Mr. Baty subject to mortgage financing of $3.2 million, the amount
of the underlying mortgage financing allocated to this community. If the
transfer occurs, Mr. Baty will lease the community to us under a 10-year lease
with a fair value rental rate of (i) debt service (including interest and
principal) computed on a $4.2 million base amount, the Emeritrust I mortgage
interest rate and a 25 year amortization, and (ii) 50% of cash flow (after
accounting for assumed management fees and capital expenditures). The base
amount represents the principal amount of Emeritrust I mortgage debt allocated
to this community and a portion of the debt reductions funded by Mr. Baty.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
In connection with these management arrangements, Mr. Baty entered into an
agreement with the investor group pursuant to which he guaranteed to the
investor group (i) on or before September 30, 2005, the repayment of its
invested capital together with a 6% rate of return, compounded annually, (less
any cash distributions received) and (ii) the funding of operating deficits
related to the Emeritrust I communities. Under these arrangements, Mr. Baty
would also assume responsibility for the underlying GMAC debt. Mr. Baty secured
these obligations through a pledge of unrelated partnership interests and
capital stock. The prior agreements under which the investor group could
require Mr. Baty to purchase up to 12 communities were terminated.
Additional information relating to the Emeritrust transactions is set forth in
our Form 8-K filed October 14, 2003.
For the three months and nine months ended September 30, 2003 and 2002, the
total gross management fees earned, management fees recognized, and funding
obligations accrued for all Emeritrust communities are shown in the tables below
(In thousands):
Management Fees Earned:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- Increase ---------------------------- Increase
Communities 2003 2002 (Decrease) 2003 2002 (Decrease)
- ------------------------- ------------- ------------- -------------- ------------- ------------- --------------
Emeritrust I. . . . . . . $ 510 $ 511 $ (1) $ 2,346 $ 1,611 $ 735
Emeritrust II Operating . 493 486 7 1,479 1,451 28
Emeritrust II Development 176 183 (7) 540 579 (39)
------------- ------------- -------------- ------------- ------------- --------------
Total . . . . . . . . . . $ 1,179 $ 1,180 $ (1) $ 4,365 $ 3,641 $ 724
============= ============= ============== ============= ============= ==============
Management Fees Recognized:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- Increase ---------------------------- Increase
Communities 2003 2002 (Decrease) 2003 2002 (Decrease)
- ------------------------- ------------- ------------- -------------- ------------- ------------- --------------
Emeritrust I. . . . . . . $ 510 $ 349 $ 161 $ 2,335 $ 1,449 $ 886
Emeritrust II Operating . 493 486 7 1,479 1,451 28
Emeritrust II Development 172 170 2 525 529 (4)
------------- ------------- -------------- ------------- ------------- --------------
Total . . . . . . . . . . $ 1,175 $ 1,005 $ 170 $ 4,339 $ 3,429 $ 910
============= ============= ============== ============= ============= ==============
Funding Obligations Accrued:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- Increase ---------------------------- Increase
Communities 2003 2002 (Decrease) 2003 2002 (Decrease)
- ------------------------- ------------- ------------- -------------- ------------- ------------- --------------
Emeritrust I. . . . . . . $ - $ 162 $ (162) $ 11 $ 162 $ (151)
Emeritrust II Development 4 2 2 (16) 123 (139)
------------- ------------- -------------- -------------- ------------- --------------
Total . . . . . . . . . . $ 4 $ 164 $ (160) $ (5) $ 285 $ (290)
============= ============= ============== ============== ============= ==============
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
SERIES A PREFERRED STOCK
In a two-tranche transaction that closed on July 31, 2003, and August 28, 2003,
we repurchased all the outstanding shares of our Series A Preferred Stock (the
"Series A Stock") for an aggregate purchase price of $20.5 million, of which
approximately $516,000 is due to transaction related expenses. The Series A
Stock had a face value of $25.0 million. In addition, the holder of the Series
A Stock agreed to forego approximately $10.1 million in accrued and unpaid
dividends. We financed the first tranche through a previously announced lease
transaction involving three communities in which we raised $10.2 million,
discussed below in "Other Transactions". The second tranche was primarily
financed through $7.5 million of secured mortgage debt with a real estate
investment trust and proceeds from a sale-leaseback transaction involving four
buildings, also discussed below in "Other Transactions". The mortgage debt is
secured by the seven properties discussed above. We recognized a one-time gain
of approximately $14.5 million, net of transaction costs, related to the
repurchase of the Series A Stock, which reduced retained deficit and is shown as
a separate line item on the Condensed Consolidated Statements of Operations in
arriving at "Net income (loss) to common shareholders".
EIGHT BUILDING ACQUISITION
On May 1, 2003, we entered into a lease agreement with certain affiliates of a
real estate investment trust, for eight assisted living communities (the "Eight
Properties") in four states containing an aggregate of 489 units.
The lease is for an initial 10-year period with three 5-year extensions and
includes an opportunity for us to acquire the Eight Properties anytime during
the second year for $42.2 million and a purchase option in the third year at a
3% premium over the original purchase option price. In addition, the lease
gives us the right of first refusal to purchase any of the properties if the
owner decides to sell. The lease is a net lease, with base rental approximating
$3.45 million annually with a lease escalator at the end of the first and second
lease years based on a percentage of increased operating revenues, with an
aggregate annual cap of $275,000, and lease escalators each year thereafter
based on increases in the consumer price index. The real estate investment
trust has agreed to fund up to $500,000 for capital expenditure requirements.
The capital expenditures funded by the real estate investment trust will
increase the basis and purchase option and carry a 10% lease rate.
The real estate investment trust also loaned $600,000 to us for general working
capital purposes and for capital and other improvements to the Eight Properties.
This loan has a 10-year term with no extensions, bearing interest at 10%
annually with monthly interest-only payments. In addition, if we exercise our
purchase option at any time on any of the Eight Properties, the pro rata
principal portion of the loan will become due at the time the closing of such
facility occurs.
The Eight Properties in this acquisition are purpose-built assisted living
communities in which we plan to offer both assisted and memory loss services to
select communities.
21 BUILDING LEASE ACQUISITION AND DEBT CONSOLIDATION
On September 30, 2003, we entered into a master operating lease agreement to
lease 21 assisted living communities previously managed as the Emeritrust II
communities (the "21 Properties"). The agreement is an amended master operating
lease agreement (the "Master Lease") with certain affiliates of a real estate
investment trust. The Master Lease relates to four communities from a March
2002 lease transaction and the 21 Emeritrust II communities for a total of 25
communities.
The Master Lease is for an initial 15-year period with one 15-year renewal. In
addition, the lease gives us the right of first refusal to purchase any of the
21 Properties if the owner decides to sell. The lease is a net lease, with base
rent approximating $14.7 million annually with certain lease escalators.
The real estate investment trust also provided financing secured by our
leasehold mortgage in the 21 Properties of $11.5 million in connection with the
Emeritrust II communities transaction. Additionally, the real estate investment
trust agreed to consolidate this new debt with the $6.8 million in outstanding
debt
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
from the March 2002 transaction referenced above and the $7.5 million debt from
the Series A Stock repurchase described above, which closed in August 2003, all
as further discussed below in "Other Transactions". The new consolidated loan of
$25.8 million matures on June 30, 2007, and bears an initial interest rate of
12.13% per annum with periodic increases up to 13%. The new note requires
monthly interest-only payments in the first year, interest and principal
starting in the second year, and a balloon principal payment at maturity.
Additional principal reductions may occur, at our option, through the increase
in the amount of the lease financing based on the portfolio achieving certain
coverage ratios.
OTHER TRANSACTIONS
In July 2003, we entered into a transaction involving three leased,
purpose-built assisted living communities located in Louisville, Kentucky;
Auburn, Massachusetts; and Rocky Hill, Connecticut, wherein the three leases
with us were transferred to a new lessor. We received approximately $10.2
million in cash proceeds and recognized a gain of approximately $8.5 million, of
which $2.2 million of deferred rent was reclassified as deferred gains, all of
which was deferred and will be amortized over the remaining life of the leases.
As part of the transaction, approximately $4.4 million in notes and interest
receivable related to the three facilities was retired.
Effective July 1, 2003, we ceased managing 12 Regent Assisted Living
communities. On August 1, 2003, we ceased managing an additional Regent
Assisted Living community.
In August of 2003, a real estate investment trust provided mortgage financing
for $7.5 million. The mortgage loan had a 36 month term and required
interest-only payments and bore an initial interest rate of 12% per annum with
periodic increases. This mortgage loan was subsequently consolidated with other
then outstanding and newly issued debt as discussed above in "21 Building Lease
Acquisition and Debt Consolidation".
On September 30, 2003, our wholly owned subsidiaries, established pursuant to
financing requirements, which owned three buildings and jointly owned one
building, participated with a real estate investment trust in the
sale-leasebacks of four buildings, and the leasehold assets continue to be owned
by the subsidiaries and are not available to satisfy debts or obligations of the
consolidated Company. The four buildings are purpose-built assisted living
communities located in Manassas, Virginia; Kirkland, Washington; Chelmsford,
Massachusetts; and Ridgeland, Mississippi. The jointly owned building was 50%
owned by our subsidiary and 50% owned by an unrelated third party. We purchased
the unrelated third party interest for $2.5 million. The consideration for the
transaction was paid by the real estate investment trust by assuming the
underlying debt on the facilities and paying cash consideration to us. We
received approximately $6.6 million in cash proceeds. As a result of this
transaction, we recognized a gain of $9.9 million, which will be deferred over
the term of the new operating leases.
Effective October 1, 2003, we ceased managing two communities located in Tacoma,
Washington, and Coeur d'Alene, Idaho.
HORIZON BAY TRANSACTIONS
On September 30, 2003, we entered into an agreement to lease eight communities
that we were then managing for a series of entities, which are owned or
controlled by Dan Baty ("Baty entities"). These transactions are subject to the
transfer of applicable licenses and receipt of lender and landlord approvals,
which we expect to occur within 90 days.
Under the terms of the agreement between us and the Baty entities, we have
agreed to assume the existing leases relating to seven of the facilities, which
are leased by the Baty entities. In lieu of acquiring the remaining community
and assuming the existing mortgage financing, we have agreed, subject to
securing necessary lender and licensure approvals, to enter into an agreement to
lease the community from the applicable Baty entity for a term of 10 years, with
rent equal to the debt service on the mortgage indebtedness (including interest
and principal) plus 25% of cash flow (after accounting for assumed management
fees and capital expenditures). The debt which is secured by this community may
be cross-collateralized by Mr. Baty with an Emeritrust I community that Mr. Baty
has agreed to acquire and lease to us, as described above in "Emeritrust
Transactions". Annual rent relating to the eight communities is
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
estimated at $3.7 million, plus annual rent escalators based upon changes in the
consumer price level index. We will pay the Baty entities approximately $65,000,
which represented their cash investment plus 9% per annum, as provided in the
original agreement related to the management of these communities between us and
the Baty entities. Under the new agreement, obligations previously existing to
fund operating losses do not continue. As a result, we may incur operating
losses that will not be reimbursed.
OTHER EVENTS
Alterra Healthcare Corporation ("Alterra"), a national assisted living company
headquartered in Milwaukee, Wisconsin, filed a voluntary Chapter 11 bankruptcy
petition on January 22, 2003. On April 10, 2003, the Bankruptcy Court approved
bidding procedures establishing a process for Alterra to seek and select a
transaction to address its capital and liquidity needs upon completion of its
bankruptcy reorganization by selling its capital stock or assets.
We previously announced our intent to acquire Alterra through a joint venture
entity controlled by us. We have renegotiated the terms of the joint venture
with its partners under which an affiliate of Fortress Investment Group LLC,
which was to contribute $1.5 million of equity and $62.5 million of debt, will
now contribute $49 million of equity and $15 million of debt and have the right
to appoint a majority of the directors of the reorganized Alterra. Our
investment in Alterra will be $7.0 million, excluding any transaction costs.
The transaction continues to be conditioned on, among other things, confirmation
of Alterra's Chapter 11 Plan of Reorganization and the receipt of regulatory
approvals, and is still expected to close in the fourth quarter of this year.
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23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
RESULTS OF OPERATIONS
Critical Accounting Policies and Estimates.
Management's discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these condensed consolidated financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates, including those related to resident programs and incentives, bad
debts, investments, intangible assets, income taxes, restructuring, long-term
service contracts, contingencies, self-insured retention, insurance deductibles,
health insurance, and litigation. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We believe the following critical accounting policies are most significant to
the judgments and estimates used in the preparation of our condensed
consolidated financial statements. Revisions in such estimates are charged to
income in the period in which the facts that give rise to the revision become
known.
* For commercial general liability and professional liability insurance, we
use a captive insurance structure essentially to self-fund our primary
layer of insurance. This policy is claims-made based and covers losses and
liabilities associated with general and professional liability. The
primary layer has per occurrence and aggregate limits. Within that primary
layer is a self-insured retention, which also has a per occurrence and
aggregate limit. We also have an excess policy, which applies to claims in
excess of the primary layer on a per occurrence basis. Losses within the
primary layer, which include the self-insured retention, are accrued based
upon actuarial estimates of the aggregate liability for claims incurred.
* For health insurance, we self-insure up to a certain level for each
occurrence above which a catastrophic insurance policy covers any
additional costs. Health insurance expense is accrued based upon
historical experience of the aggregate liability for claims incurred. If
these estimates are insufficient, additional charges may be required.
* For workers' compensation insurance for insured states (excluding Texas
and compulsory State Funds), we are on an incurred loss, retrospective
insurance policy, retroactively adjusted, upward or downward, based upon
total incurred loss experience. The premium charged by the insurance
underwriter is based upon a standard rate determined by the underwriter to
cover, amongst other things, estimated losses and other fixed costs. The
difference between the premium charged and the actuarial based estimate of
costs, which is expensed on a monthly basis, is carried as an asset on the
balance sheet. After the end of the policy year, the insurance company
conducts an audit and adjusts the total premium based upon the actual
payroll and actual incurred loss for the policy year. Any premium
adjustment for the differences between estimated and actual payroll and
estimated and actual losses will first be applied to the accrued asset and
then as an adjustment to workers' compensation expense at the time such
adjustment is determined. There is a reasonable expectation that the
incurred loss adjustment will be downward, resulting in a premium refund.
The incurred loss adjustment is limited to 50% of the standard premium
with the initial adjustment six months after policy expiration on December
31, 2003, and annually thereafter. For work-related injuries in Texas, we
are a non-subscriber, 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.
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
* We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our residents to make required payments.
If the financial condition of our residents were to deteriorate, resulting
in an impairment of their ability to make payments, additional allowances
may be required.
* We record a valuation allowance to reduce our deferred tax assets to the
amount that is more likely than not to be realized, which at this time
shows a net asset valuation of zero. We have considered future taxable
income and ongoing prudent and feasible tax planning strategies in
assessing the need for a valuation allowance. However, in the event we
were to determine that we would be able to realize our deferred tax assets
in the future in excess of our net recorded amount, an adjustment to the
deferred tax asset would increase income in the period we made such
determination.
COMMON-SIZE INCOME STATEMENTS AND PERIOD-TO-PERIOD PERCENTAGE CHANGE
The following table sets forth, for the periods indicated, certain items from
our Condensed Consolidated Statements of Operations as a percentage of total
revenues and the percentage change of the dollar amounts from period to period.
Period-to-Period
Percentage
Increase
(Decrease)
Percentage of Revenues ----------------------------
---------------------------------------------------------- Three Months Nine Months
Three Months ended Nine Months Ended ended ended
September 30, September 30, September 30, September 30,
---------------------------- ---------------------------- ------------- -------------
2003 2002 2003 2002 2003-2002 2003-2002
------------- ------------- ------------- ------------- ------------- -------------
Revenues. . . . . . . . . . . . . . 100.0% 100.0% 100.0% 100.0% 39.3% 38.2%
Expenses:
Community operations . . . . . 63.8 59.6 61.6 59.4 49.3 43.4
General and administrative . . 12.3 14.9 11.8 14.3 14.2 14.4
Depreciation and amortization. 3.6 4.6 3.7 4.9 8.8 5.9
Facility lease expense . . . . 19.4 20.2 18.9 20.2 34.1 29.3
------------- ------------- ------------- ------------- ------------- -------------
Total operating expenses . 99.1 99.3 96.0 98.8 39.1 34.5
------------- ------------- ------------- ------------- ------------- -------------
Income from operations. . . . . . . 0.9 0.7 4.0 1.2 79.4 341.3
Other income (expense)
Interest income. . . . . . . . 0.3 0.1 0.3 0.3 273.9 86.6
Interest expense . . . . . . . (6.6) (7.9) (6.7) (8.2) 16.7 13.9
Other, net . . . . . . . . . . 0.2 (0.4) 1.0 (0.8) N/A N/A
------------- ------------- ------------- ------------- ------------- -------------
Net other expense. . . . . (6.1) (8.2) (5.4) (8.7) 3.3 (15.9)
------------- ------------- ------------- ------------- ------------- -------------
Net loss . . . . . . . . . (5.2%) (7.5%) (1.4%) (7.5%) N/A N/A
============= ============= ============= ============= ============= =============
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25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Comparison of the three months ended September 30, 2003 and 2002
- --------------------------------------------------------------------------
Total Operating Revenues: Total operating revenues for the three months ended
September 30, 2003, increased by $14.2 million to $50.2 million from $36.0
million for the comparable period in 2002, or 39.3%.
Community revenue increased by approximately $14.5 million in the three months
ended September 30, 2003, compared to the three months ended September 30, 2002.
This increase is primarily due to additional revenue related to a 24 building
lease acquisition in the fourth quarter of 2002 and an 8 building lease
acquisition in the second quarter of 2003. These acquired communities, which
represent revenue of approximately $12.4 million, were included in our
consolidated portfolio in the third quarter of 2003, but were not included in
the comparable quarter of 2002. The remaining increase in revenue is attributed
to the net effect of an increase in average monthly revenue per unit, a decrease
in the occupancy rate, and a reduction in management fee income. Average
monthly revenue per unit (excluding the acquisition impact, which was favorable
by $67) was $2,714 for the third quarter of 2003 compared to $2,554 for the
comparable quarter of 2002, an increase of approximately 6.3%. The occupancy
rate for the three months ended September 30, 2003, decreased 5.0% to 77.3% from
82.3% primarily from the repositioning of the above mentioned acquired
communities. The occupancy rate excluding the acquisition impact, which was
unfavorable by 4.8 percentage points, decreased 0.2 percentage points from the
prior year quarter.
Management fee income decreased by approximately $286,000 to $2.4 million from
$2.7 million for the three months ended September 30, 2003, and 2002,
respectively. This decrease is primarily due to termination of 13 Regent
managed communities in July and August of 2003 as discussed in "Other
Transactions". Regent related management fee income recognized for the three
months ended September 30, 2003, was approximately $32,000 compared to $371,000
for the three months ended September 30, 2002.
Community Operations: Community operating expenses for the three months ended
September 30, 2003, increased by $10.5 million to $32.1 million from $21.5
million in the third quarter of 2003, or 49.3%. The change was primarily due to
a 24 building lease acquisition in the fourth quarter of 2002 and an 8 building
lease acquisition in the second quarter of 2003. These acquired communities,
which approximates $10.1 million of expense, were included in our consolidated
portfolio in the third quarter of 2003, but were not included in the comparable
quarter of 2002. Additionally, in August 2003, we recognized an impairment loss
on one community in Scottsdale, Arizona, of $950,000. The increases
attributable to the two lease acquisitions and impairment loss are partially
offset by improvements in insurance, bad debt expense, and other operating
expenses. Our insurance expense improved mainly due to a change in our
professional and general liability insurance structure, which is essentially a
captive insurance policy, and a change in our health insurance policies,
resulting in lower expected costs in 2003 compared to 2002. Community operating
expenses as a percentage of total operating revenue increased to 63.8% in the
third quarter of 2003 from 59.6% in the third quarter of 2002, inclusive of the
impairment loss that occurred in August 2003.
General and Administrative: General and administrative (G&A) expenses for the
three months ended September 30, 2003, increased $766,000 to $6.2 million from
$5.4 million for the comparable period in 2002, or 14.2%. As a percentage of
total operating revenues, G&A expenses decreased to 12.3% for the three months
ended September 30, 2003, compared to 14.9% for the three months ended September
30, 2002. G&A expenses increased primarily due to increases in the number of
employees and normal increases in employee salaries. An increase in total
communities managed or leased through additional contracts for the three months
ended September 30, 2003, compared to the three months ended September 30, 2002,
and an expansion of program offerings, has led to some added employees. Since a
significant number of the communities we operate are managed rather than owned
or leased, G&A expense as a percentage of operating revenues for all
communities, including managed communities, may be more meaningful for
industry-wide comparisons. G&A as a percentage of operating revenues for all
communities increased to 6.6% from 6.2% for the three months ended September 30,
2003 and 2002, respectively, due in part to not replacing the lost revenue from
the termination of Regent contracts with new agreements during the quarter.
26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Depreciation and Amortization: Depreciation and amortization for the three
months ended September 30, 2003, was $1.8 million compared to $1.7 million for
the comparable period in 2002. In 2003, depreciation and amortization
represents 3.6% of total operating revenues, compared to 4.6% for the comparable
period in 2002. This decrease as a percentage of revenue is primarily due to
increased revenue.
Facility Lease Expense: Facility lease expense for the three months ended
September 30, 2003, was $9.8 million compared to $7.3 million for the comparable
period of 2002, representing an increase of $2.5 million, or 34.1%. This
increase is primarily due to the 24 building lease acquisition in the fourth
quarter of 2002 and an 8 building lease acquisition in the second quarter of
2003. We leased 100 communities as of September 30, 2003 (including 21
community leases entered into on September 30, 2003), compared to 43 leased
communities as of September 30, 2002. The additional facility lease expense
related to the acquired communities approximates $2.3 million. Facility lease
expense as a percentage of revenues was 19.4% for the three months ended
September 30, 2003, and 20.2% for the three months ended September 30, 2002.
Interest Income: Interest income for the three months ended September 30, 2003,
was $172,000 versus $46,000 for the comparable period of 2002. This increase is
primarily attributable to a higher return on certain restricted deposits related
to a sale-leaseback transaction in the fourth quarter of 2002.
Interest Expense: Interest expense for the three months ended September 30,
2003, was $3.3 million compared to $2.8 million for the comparable period of
2002. This increase of $473,000, or 16.7%, is primarily attributable to the
additional secured mortgage financing related to the 21 Properties acquisition
discussed above in "21 Building Lease Acquisition and Debt Consolidation". As a
percentage of total operating revenues, interest expense decreased to 6.6% from
7.9% for the three months ended September 30, 2003 and 2002, respectively.
Other, net: Other, net for the three months ended September 30, 2003, was
income of approximately $97,000 compared to expense of $153,000 for the
comparable period in 2002. The net change of $250,000 is due to amortization of
deferred gains related to three communities.
Income taxes. Income taxes are due primarily because of gains on sale-leaseback
transactions involving several communities in the third quarter of 2003, which
have been deferred for accounting purposes. We believe that we will be required
to pay an alternative minimum income tax for 2003 on our federal income tax
return and in certain states that have alternative minimum income tax
provisions. Net operating loss carry-forwards will be used to offset 90% of
projected 2003 taxable income, but an alternative minimum tax liability is still
expected on the remaining income.
Preferred dividends: For the three months ended September 30, 2003 and 2002, the
preferred dividends were approximately $1.5 million and $1.8 million,
respectively. The primary reason for the decrease is the repurchase of the
Series A preferred shares in July and August 2003 as discussed above under
"Series A Preferred Stock". Since we have not paid the Series B preferred
dividends for six consecutive quarters, under the Designation of Rights and
Preferences of the Series B preferred stock in our Articles of Incorporation,
the Series B preferred shareholders may designate one director in addition to
the other directors that they are entitled to designate under the shareholders'
agreement. As of January 1, 2002, the Series B preferred shareholders became
entitled to designate an additional director under the Articles, but thus far
have chosen not to do so.
[The rest of this page is intentionally left blank]
27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Comparison of the nine months ended September 30, 2003 and 2002
- -------------------------------------------------------------------------
Total Operating Revenues: Total operating revenues for the nine months ended
September 30, 2003, increased by $40.6 million to $146.8 million from $106.2
million for the comparable period in 2002, or 38.2%.
Community revenue increased by approximately $40.3 million in the nine months
ended September 30, 2003, compared to the nine months ended September 30, 2002.
This increase is primarily due to additional revenue related to a 24 building
lease acquisition in the fourth quarter of 2002 and an 8 building lease
acquisition in the second quarter of 2003. These acquired communities, which
represent revenue of approximately $33.3 million, were included in our
consolidated portfolio in the first three quarters of 2003, but were not
included in the comparable quarters of 2002. The remaining increase in revenue
is attributed to the net effect of an increase in average monthly revenue per
unit, a decrease in the occupancy rate, and a reduction in management fee
income. Average monthly revenue per unit (excluding the acquisition impact,
which was favorable by $62) was $2,703 for the first three quarters of 2003
compared to $2,535 for the comparable quarters of 2002, an increase of
approximately 6.6%. The occupancy rate for the nine months ended September 30,
2003, decreased 4.7% to 77.1%from 81.8% primarily from the repositioning of the
above mentioned acquired communities. The occupancy rate excluding the
acquisition impact, which was unfavorable by 4.3 percentage points, decreased
0.4 percentage points from the first three quarters of the prior year.
Management fee income increased by approximately $358,000 to $8.7 million from
$8.3 million for the nine months ended September 30, 2003, and 2002,
respectively. This increase is primarily due to the Horizon Bay managed
portfolio, which was initiated in May of 2002. Consequently, we recognized five
months of revenue in the nine months ended September 30, 2002, of approximately
$339,000 compared to $569,000 for the nine months ended September 30, 2003. The
remaining increase is attributable to the net effect of improved operating
performance of other managed communities and the termination of 13 Regent
managed communities in July and August of 2003 as discussed in "Other
Transactions". Regent related management fee income recognized for the nine
months ended September 30, 2003, was approximately $664,000 compared to $1.1
million for the nine months ended September 30, 2002.
Community Operations: Community operating expenses for the nine months ended
September 30, 2003, increased by $27.4 million to $90.5 million from $63.1
million in the first three quarters of 2003, or 43.4%. The change was primarily
due to a 24 building lease acquisition in the fourth quarter of 2002 and an 8
building lease acquisition in the second quarter of 2003. These acquired
communities, which approximates $26.8 million of expense, were included in our
consolidated portfolio in the first three quarters of 2003, but were not
included in the comparable quarters of 2002. Additionally, in August 2003, we
recognized an impairment loss on one community in Scottsdale, Arizona, of
$950,000. Community operating expenses as a percentage of total operating
revenue increased to 61.6% in the first three quarters of 2003 from 59.4% in the
first three quarters of 2002, inclusive of the impairment loss that occurred in
August 2003.
General and Administrative: General and administrative (G&A) expenses for the
nine months ended September 30, 2003, increased $2.2 million to $17.4 million
from $15.2 million for the comparable period in 2002, or 14.4%. As a percentage
of total operating revenues, G&A expenses decreased to 11.8% for the nine months
ended September 30, 2003, compared to 14.3% for the nine months ended September
30, 2002. G&A expenses increased primarily due to increases in the number of
employees and normal increases in employee salaries, as well as, insurance costs
related to directors and officers. An increase in total communities managed or
leased through additional contracts for the nine months ended September 30,
2003, compared to the nine months ended September 30, 2002, and an expansion of
program offerings, has led to some added employees. Since a significant number
of the communities we operate are managed rather than owned or leased, G&A
expense as a percentage of operating revenues for all communities, including
managed communities, may be more meaningful for industry-wide comparisons. G&A
as a percentage of operating revenues for all communities was 6.0% for both the
nine-month periods ended September 30, 2003 and 2002.
28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Depreciation and Amortization: Depreciation and amortization for the nine
months ended September 30, 2003, was $5.5 million compared to $5.2 million for
the comparable period in 2002. In 2003, depreciation and amortization
represents 3.7% of total operating revenues, compared to 4.9% for the comparable
period in 2002. This decrease as a percentage of revenue is primarily due to
increased revenue.
Facility Lease Expense: Facility lease expense for the nine months ended
September 30, 2003, was $27.7 million compared to $21.4 million for the
comparable period of 2002, representing an increase of $6.3 million, or 29.3%.
This increase is primarily due to the 24 building lease acquisition in the
fourth quarter of 2002 and the 8 building lease acquisition in the second
quarter of 2003. We leased 100 communities as of September 30, 2003 (including
21 community leases entered into on September 30, 2003), compared to 43 leased
communities as of September 30, 2002. The additional facility lease expense
related to the acquired communities approximates $5.8 million for the first
three quarters of 2003. The balance of the increase was attributable to
variable rent escalation provisions in existing leases. Facility lease expense
as a percentage of revenues was 18.9% for the nine months ended September 30,
2003, and 20.2% for the nine months ended September 30, 2002.
Interest Income: Interest income for the nine months ended September 30, 2003,
was $500,000 versus $268,000 for the comparable period of 2002. This increase
is primarily attributable to a higher return on certain restricted deposits
related to a sale-leaseback transaction in the fourth quarter of 2002.
Interest Expense: Interest expense for the nine months ended September 30,
2003, was $9.8 million compared to $8.6 million for the comparable period of
2002. This increase of $1.2 million, or 13.9%, is primarily attributable to the
repurchase of a previously leased community in the third quarter of 2002, a
refinance transaction related to 11 communities in December 2002, a refinance
transaction in January of 2003, additional debt related to the Series A
preferred stock repurchase, and 21 building acquisition in the third quarter of
2003, all of which constitutes an increase of approximately $1.4 million. This
increase is partially offset by a sale-leaseback transaction in the second
quarter of 2002, which replaced interest expense with lease expense of
approximately $206,000. As a percentage of total operating revenues, interest
expense decreased to 6.7% from 8.2% for the nine months ended September 30, 2003
and 2002, respectively.
Other, net: Other, net for the nine months ended September 30, 2003, was income
of $1.5 million compared to expense of $894,000 for the comparable period in
2002. The net change of $2.4 million is primarily comprised of the following
items: In April 2003, we recognized a gain on the acceptance of ARV's tender
offer on our investment in ARV Assisted Living common stock of approximately
$1.4 million. During the first three quarters of 2002, we repurchased a related
party's economic interest in a 172-unit community resulting in an expense of
$158,000 and we completed the sale-leaseback of two communities and re-lease of
two additional communities resulting in an expense of $372,000, for a combined
impact of $530,000. The remaining difference is primarily attributable to
amortization of deferred gains related to six communities.
Income taxes. Income taxes are due primarily because of gains on sale-leaseback
transactions involving several communities in the third quarter of 2003, which
have been deferred for accounting purposes. We believe that we will be required
to pay an alternative minimum income tax for 2003 on our federal income tax
return and in certain states that have alternative minimum income tax
provisions. Net operating loss carry-forwards will be used to offset 90% of
projected 2003 taxable income, but an alternative minimum tax liability is still
expected on the remaining income.
Preferred dividends: For the nine months ended September 30, 2003 and 2002, the
preferred dividends were approximately $5.2 million and $5.5 million,
respectively. The primary reason for the decrease is the repurchase of the
Series A preferred shares in July and August 2003 as discussed above under
"Series A Preferred Stock". Since we have not paid the Series B preferred
dividends for six consecutive quarters, under the Designation of Rights and
Preferences of the Series B preferred stock in our Articles of Incorporation,
the Series B preferred shareholders may designate one director in addition to
the other directors that they are entitled to designate under the shareholders'
agreement. As of January 1, 2002, the Series B preferred shareholders became
entitled to designate an additional director under the Articles, but thus far
have chosen not to do so.
29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Same Community Comparison
We operated 59 communities on a comparable basis during both the three months
ended September 30, 2003 and 2002. The following table sets forth a comparison
of same community results of operations, excluding general and administrative
expenses, for the three months ended September 30, 2003 and 2002.
Three Months ended September 30,
(In thousands)
----------------------------------------------------
Dollar % Change
2003 2002 Change Fav/(Unfav)
------------ ------------ --------- -------------
Revenue . . . . . . . . . . . . . . . . . . $ 34,369 $ 32,918 $ 1,451 4.4%
Community operating expenses. . . . . . . . (20,674) (21,214) 540 2.5
------------ ------------ -------- -------------
Community operating income. . . . . . . 13,695 11,704 1,991 17.0
Depreciation & amortization . . . . . . . . (1,527) (1,462) (65) (4.4)
Facility lease expense. . . . . . . . . . . (6,998) (7,029) 31 0.4
------------ ------------ -------- -------------
Operating income. . . . . . . . . . . . 5,170 3,213 1,957 60.9
Interest expense, net . . . . . . . . . . . (2,574) (2,260) (314) (13.9)
------------ ------------ -------- -------------
Operating income after interest expense $ 2,596 $ 953 $ 1,643 172.4%
============ ============ ======== =============
The same communities represented $34.4 million or 68.5% of our total revenue of
$50.2 million for the third quarter of 2003. Same community revenues increased
by $1.5 million or 4.4% for the quarter ended September 30, 2003, from the
comparable period in 2002. This increase is due to higher average revenue per
unit while the occupancy percentage remained flat. Average revenue per occupied
unit increased by $149 per month or 5.8% for the three months ended September
30, 2003 as compared to the three months ended September 30, 2002. Average
occupancy remained relatively unchanged at approximately 82.6% in the third
quarter of 2003 and 82.5% in the third quarter of 2002.
Community operating expenses decreased approximately $540,000 due to a
combination of factors: the decrease in operating expenses was primarily due to
reduced personnel expenses and other employee costs of $195,000, combined with
decreases in liability insurance of $168,000, and other operating expense
categories of approximately $177,000. Occupancy expenses, consisting of
facility lease expense, depreciation and amortization, and interest expense
combined, increased approximately $348,000 as a result of the net effect of a
refinancing transaction related to 11 buildings in December of 2002, and
variable rent escalation related to other communities, partially offset by lower
interest rates. For the quarter ended September 30, 2003, net income increased
to $2.6 million from $953,000 for the comparable period of 2002.
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended September 30, 2003, net cash provided by operating
activities was $912,000 compared to $1.1 million used in operating activities
for the comparable period in the prior year. The primary components of
operating cash provided by operating activities were depreciation and
amortization of $5.5 million and an adjustment for an impairment loss on one
community of $950,000, partially offset by the net loss of $2.6 million, the
adjustment of $1.4 million for the gain on the sale of investment securities,
amortization of deferred gain of $387,000, and the net increase in other
operating assets and liabilities of $1.3 million. The primary components of
operating cash used in operating activities for the nine months ended September
30, 2002, were the net loss of $7.9 million, partially offset by depreciation
and amortization of $5.2 million, loss on sale of properties of $515,000, write
off of deferred gain of $243,000, and the net decrease in other operating assets
and liabilities of $850,000.
Net cash provided by investing activities amounted to $30.5 million for the nine
months ended September 30, 2003, and was comprised primarily of proceeds from
the sale of property and equipment of approximately $44.8 million and proceeds
from the sale of investment securities of approximately $2.9 million, partially
offset by an increase in management and lease acquisition costs of $12.1
million, purchases of approximately $2.0 million of various property and
equipment, purchase of minority partner
30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
interest of $2.5 million, and distributions to minority partners of $250,000.
Net cash provided by investing activities amounted to $8.1 million for the nine
months ended September 30, 2002, and was comprised primarily of proceeds of
approximately $25.0 million related to the sale of two buildings, proceeds from
sales of interest in affiliates of $750,000, partially offset by the purchase of
property and equipment of $11.8 million, the purchase of minority interests in
two buildings for approximately $3.1 million, additional lease acquisition costs
of $1.6 million, advances to third parties and affiliates of $603,000, and
distributions to minority partners of $500,000.
For the nine months ended September 30, 2003, net cash used in financing
activities was $27.6 million, primarily from the repurchase of Series A
preferred stock for $20.5 million, of which approximately $516,000 was
transaction related expenses, long-term debt repayments of $24.4 million, and
short-term debt repayments of $2.0 million, which include debt repayments
related to a January 2003 refinancing transaction. Also related to that
refinancing transaction, approximately $283,000 relates to debt issuance and
other financing costs. These uses of cash were partially offset by proceeds
from long-term borrowings of approximately $19.6 million. For the nine months
ended September 30, 2002, net cash used in financing activities was $9.4
million, primarily from the repayment of long-term borrowings of $53.1 million
related to the sale, minority interest purchase, and lease transactions related
to two communities in the second quarter of 2002, repayment of short-term
borrowings of $1.7 million, and other financing costs of $1.4 million, partially
offset by the proceeds of long-term borrowings of $46.8 million.
We have incurred significant operating losses since our inception and have a
working capital deficit of $19.9 million, although $5.8 million represents
deferred revenues and $7.6 million of preferred cash dividends is only due if
declared by our board of directors. At times in the past, we have been
dependent upon third party financing or disposition of assets to fund
operations. If such transactions are necessary in the future, we cannot
guarantee that they will be available on a timely basis, on terms attractive to
us, or at all.
Throughout 2002 and continuing in the first quarter of 2003, we refinanced
substantially all of our debt obligations, extending the maturities of such
financings to dates in 2005 or thereafter, at which time we will need to
refinance or otherwise repay the obligations. Many of our debt instruments and
leases contain "cross-default" provisions pursuant to which a default under one
obligation can cause a default under one or more other obligations to the same
lender or lessor. Such cross-default provisions affect 12 owned assisted living
properties and 97 operated under leases. Accordingly, any event of default
could cause a material adverse effect on our financial condition if such debt or
leases are cross-defaulted. At September 30, 2003, we complied with all such
covenants.
Management believes that we will be able to sustain positive operating cash flow
at least through September 30, 2004, and will have adequate cash for all
necessary investing and financing activities including required debt service and
capital expenditures.
The following table summarizes our contractual obligations at September 30, 2003
(In thousands):
Payments Due by Period
-----------------------------------------------------
Less than After 5
Contractual Obligations Total 1 year 1-3 years 4-5 years years
--------- --------- --------- --------- ---------
Long-Term Debt, including current portion $ 117,809 $ 3,161 $ 17,059 $ 97,434 $ 155
Operating Leases. . . . . . . . . . . . . $ 610,447 $ 48,119 $ 103,549 $ 359,988 $ 98,791
IMPACT OF INFLATION
To date, inflation has not had a significant impact on Emeritus. However,
inflation could affect our future revenues and operating income due to our
dependence on the senior resident population, most of whom rely on relatively
fixed incomes to pay for our services. The monthly charges for a resident's
unit and assisted living services are influenced by the location of the
community and local competition. Our ability to increase revenues in proportion
to increased operating expenses may be limited. We typically do not rely to a
significant extent on governmental reimbursement programs. In pricing our
services, we attempt to anticipate inflation levels, but there can be no
assurance that we will be able to respond to inflationary pressures in the
future.
31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
FORWARD-LOOKING STATEMENTS
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995: A number of the matters and subject areas discussed in this report that
are not historical or current facts deal with potential future circumstances,
operations, and prospects. The discussion of such matters and subject areas is
qualified by the inherent risks and uncertainties surrounding future
expectations generally, and also may materially differ from our actual future
experience as a result of such factors as: the effects of competition and
economic conditions on the occupancy levels in our communities; our ability
under current market conditions to maintain and increase our resident charges in
accordance with rate enhancement programs without adversely affecting occupancy
levels; increases in interest rates that would increase costs as a result of
variable rate debt; our ability to control community operation expenses,
including insurance and utility costs, without adversely affecting the level of
occupancy and the level of resident charges; our ability to generate cash flow
sufficient to service our debt and other fixed payment requirements; our ability
to find sources of financing and capital on satisfactory terms to meet our cash
requirements to the extent that they are not met by operations; and our
continued management of the Emeritrust I communities beyond January 2, 2004,
when our management agreements for those communities could be terminated on
short-term notice. While we believe that these arrangements will be extended,
we cannot guarantee that these discussions will be successful or, if the
arrangements are extended, what the terms will be. If we are unsuccessful, we
could lose the management fee revenue from these communities. We have attempted
to identify, in context, certain of the factors that we currently believe may
cause actual future experience and results to differ from our current
expectations regarding the relevant matter or subject area. These and other
risks and uncertainties are detailed in our reports filed with the Securities
and Exchange Commission (SEC), including our Annual Reports on Form 10-K and
Quarterly Reports on Form 10-Q.
[The rest of this page is intentionally left blank]
32
PART II. OTHER INFORMATION
ITEMS 1 THROUGH 5 ARE NOT APPLICABLE.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Footnote
Number Description Number
- --------- ---------------------------------------------------------------------------------------------------- -----------
31.1. . . Certification of Periodic Reports
31.1.1. . Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 for Daniel R. Baty dated November 10, 2003. (1)
31.1.2. . Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 for Raymond R. Brandstrom dated November 10, 2003. (1)
32.1. . . Certification of Periodic Reports
32.1.1. . Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 for Daniel R. Baty dated November 7, 2003. (2)
32.1.2. . Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 for Raymond R. Brandstrom dated November 7, 2003. (2)
32.1.3. . Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 for Daniel R. Baty dated November 10, 2003. (2)
32.1.4. . Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 for Raymond R. Brandstrom dated November 10, 2003. (2)
(1) Filed herewith
(2) Furnished herewith
(b) Reports on Form 8-K.
None
33
SIGNATURE
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.
Dated: November 10, 2003
EMERITUS CORPORATION
(Registrant)
/s/ Raymond R. Brandstrom
-----------------------------------------
Raymond R. Brandstrom, Vice President
of Finance, Chief Financial Officer, and
Secretary
34