UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
- -------------------------------------------------------------------------------
FORM 10-Q
- -------------------------------------------------------------------------------
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999.
( ) 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)
FOR THE QUARTER ENDED JUNE 30, 1999
WASHINGTON 91-1605464
(State or other jurisdiction of (I.R.S Employer
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
As of August 6, 1999, there were 10,489,450 shares of the Registrant's Common
Stock, par value $.0001, outstanding.
EMERITUS CORPORATION
Index
Part I. Financial Information
PAGE NO.
--------
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of December 31, 1998 and
June 30, 1999 (unaudited)........................................... 1
Condensed Consolidated Statements of Operation for the Three Months
and Six Months Ended June 30, 1998 and 1999 (unaudited)............. 2
Condensed Consolidated Statements of Comprehensive Operations for
the Three Months and Six Months ended June 30, 1998 and 1999
(unaudited)......................................................... 3
Condensed Consolidated Statements of Cash Flows for the Six Months
ended June 30, 1998 and 1999 (unaudited)............................ 4
Notes to Condensed Consolidated Financial Statements................ 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................... 6
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......... 13
Part II. Other Information
Item 1. Legal Proceedings................................................... 14
Item 4. Submission of Matters to a Vote of Security Holders................. 14
Item 6. Exhibits............................................................ 15
Signatures.......................................................... 16
Note: Items 2, 3 and 5 of Part II are omitted because they are not
applicable.
EMERITUS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31, 1998 and June 30, 1999
(In thousands, except share data)
ASSETS
June 30,
December 31, 1999
1998 (unaudited)
------------ -----------
Current Assets:
Cash and cash equivalents ....................... $ 11,442 $ 6,077
Short-term investments .......................... 4,491 2,894
Trade accounts receivable, net .................. 2,235 2,324
Other receivables ............................... 5,944 10,452
Prepaid expenses and other current assets ....... 7,879 6,383
Property held for sale .......................... 3,661 7,235
-------- --------
Total current assets .................... 35,652 35,365
-------- --------
Property and equipment, net ....................... 128,659 120,859
Property held for development ..................... 1,855 2,001
Notes receivable from and investments in
affiliates....................................... 10,247 8,602
Restricted deposits, less current portion ......... 6,271 2,846
Other assets, net ................................. 10,186 9,480
-------- --------
Total assets ............................ $192,870 $179,153
======== ========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities:
Short-term borrowings ........................... $ 5,000 $ 8,500
Current portion of long-term debt ............... 7,591 7,150
Margin loan on short-term investments ........... 2,324 1,647
Trade accounts payable .......................... 7,115 3,945
Accrued employee compensation and benefits ...... 3,386 3,767
Other current liabilities ....................... 11,213 9,798
-------- --------
Total current liabilities ............... 36,629 34,807
-------- --------
Deferred rent ..................................... 4,352 1,326
Deferred gain on sale of communities .............. 19,483 18,946
Convertible debentures ............................ 32,000 32,000
Long-term debt, less current portion .............. 119,674 119,665
Other long-term liabilities ....................... 786 349
-------- --------
Total liabilities ....................... 212,924 207,093
-------- --------
Minority interests ................................ 910 692
Redeemable preferred stock ........................ 25,000 25,000
Shareholders' Deficit:
Common stock, $.0001 par value. Authorized
40,000,000 shares; issued and Outstanding
10,484,050 and 10,489,450 shares at
December 31, 1998 and June 30, 1999,
respectively .................................. 1 1
Additional paid-in capital ...................... 38,995 39,035
Accumulated other comprehensive loss ............ (4,420) (6,048)
Accumulated deficit ............................. (80,540) (86,620)
-------- --------
Total shareholders' deficit ............. (45,964) (53,632)
-------- --------
Total liabilities and shareholders'
deficit .............................. $192,870 $179,153
======== ========
See accompanying Notes to Condensed Consolidated Financial
Statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations.
1
EMERITUS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months and Six Months Ended June 30, 1998 and 1999
(unaudited)
(In thousands, except per share data)
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1998 1999 1998 1999
-------- -------- -------- --------
Revenues:
Community revenue .............................. $ 36,765 $ 27,191 $ 71,506 $ 60,671
Management fees ................................ 249 1,693 310 2,392
-------- -------- -------- --------
Total operating revenues ............... 37,014 28,884 71,816 63,063
-------- -------- -------- --------
Expenses:
Community operations ........................... 27,339 17,688 53,048 39,340
General and administrative ..................... 3,277 3,527 6,478 7,039
Depreciation and amortization .................. 1,331 1,403 2,898 2,868
Rent ........................................... 10,434 5,733 20,734 13,318
-------- -------- -------- --------
Total operating expenses ............... 42,381 28,351 83,158 62,565
-------- -------- -------- --------
Income (loss) from operations .......... (5,367) 533 (11,342) 498
-------- -------- -------- --------
Other income (expense):
Interest expense, net .......................... (3,721) (3,163) (6,499) (6,388)
Other, net ..................................... 1,888 622 2,216 926
-------- -------- -------- --------
Net other expense ...................... (1,833) (2,541) (4,283) (5,462)
-------- -------- -------- --------
Loss before extraordinary item and cumulative
effect of change in accounting principle ...... (7,200) (2,008) (15,625) (4,964)
Extraordinary item-loss on early extinguishment of
debt ........................................... (767) -- (767) --
Cumulative effect of change in accounting
principle ...................................... -- -- (1,320) --
-------- -------- -------- --------
Net loss ............................... $ (7,967) $ (2,008) $(17,712) $ (4,964)
======== ======== ======== ========
Preferred stock dividends ........................ 561 561 1,116 1,116
-------- -------- -------- --------
Net loss to common shareholders ........ $ (8,528) $ (2,569) $(18,828) $ (6,080)
======== ======== ======== ========
Loss per common share - basic and diluted:
Loss before extraordinary item and cumulative
effect of change in accounting principle ...... $ (0.74) $ (0.24) $ (1.58) $ (0.58)
Extraordinary item ............................... (0.07) -- (0.07) --
Cumulative effect of change in accounting
principle ..................................... -- -- (0.13) --
-------- -------- -------- --------
Loss per common share ............................ $ (0.81) $ (0.24) $ (1.78) $ (0.58)
======== ======== ======== ========
Weighted average number of common shares
outstanding - basic and diluted ............... 10,483 10,488 10,558 10,486
======== ======== ======== ========
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 COMPREHENSIVE OPERATIONS
Three Months and Six Months Ended June 30, 1998 and 1999
(unaudited)
(In thousands)
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1998 1999 1998 1999
-------- -------- -------- --------
Net loss ................................................ $ (7,967) $ (2,008) $(17,712) $ (4,964)
Other comprehensive loss:
Foreign currency translation adjustments ........... (8) 15 (6) 20
Unrealized losses on investment securities:
Unrealized holding losses arising during
the period ................................... (1,042) (181) (3,395) (1,648)
Reclassification adjustment for gains included in
net loss ..................................... (9) -- (459) --
-------- -------- -------- --------
Total other comprehensive loss ............ (1,059) (166) (3,860) (1,628)
-------- -------- -------- --------
Comprehensive loss ...................................... $ (9,026) $ (2,174) $(21,572) $ (6,592)
======== ======== ======== ========
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
Six Months Ended June 30, 1998 and 1999
(unaudited)
(In thousands)
1998 1999
-------- --------
Net cash used in operating activities (including changes in all operating assets and
liabilities) .................................................................. $(13,123) $ (8,230)
-------- --------
Cash flows from investing activities:
Acquisition of property and equipment ............................................ (9,013) (1,655)
Acquisition of property held for development ..................................... (1,674) (146)
Proceeds from sale of property and equipment ..................................... 10,427 3,767
Purchase of investment securities ................................................ (208) (50)
Sale of investment securities .................................................... 5,421 --
Construction advances - leased communities ....................................... 7,697 10,801
Construction expenditures - leased communities ................................... (5,832) (11,643)
Advances to affiliates ........................................................... (2,244) (254)
Acquisition of interest in affiliates ............................................ (3,520) --
-------- --------
Net cash provided by investing activities ................................ 1,054 820
-------- --------
Cash flows from financing activities:
Increase in restricted deposits .................................................. (450) (269)
Proceeds from short-term borrowings .............................................. 5,221 3,500
Repayment of short-term borrowings, including margin loan ........................ (5,138) (677)
Debt issue and other financing costs ............................................. (2,135) (79)
Proceeds from long-term borrowings ............................................... 84,741 --
Repayment of long-term borrowings ................................................ (60,634) (450)
Repurchase of common stock ....................................................... (5,406) --
-------- --------
Net cash provided by financing activities ................................ 16,199 2,025
-------- --------
Effect of exchange rate changes on cash .......................................... (6) 20
Net increase (decrease) in cash and cash equivalents ..................... 4,124 (5,365)
Cash and cash equivalents at the beginning of the period ........................... 17,537 11,442
-------- --------
Cash and cash equivalents at the end of the period ................................. $ 21,661 $ 6,077
======== ========
Supplemental disclosure of cash flow information -- cash paid during the period
for interest ................................................................... $ 6,489 $ 6,195
======== ========
Noncash investing and financing activities:
Transfer of property and equipment to property held for sale ..................... $ -- $ 6,012
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
BASIS OF PRESENTATION
The unaudited interim financial information furnished herein, in the opinion of
management, reflects all adjustments which are necessary to state fairly the
consolidated financial position, results of operations, comprehensive
operations, and cash flows of Emeritus Corporation, (the "Company") as of June
30, 1999 and for the three and six months ended June 30, 1998 and 1999. The
Company presumes that users of the interim financial information herein have
read or have access to the Company's 1998 audited consolidated financial
statements and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained in the 1998 Form 10-K filed March 31, 1999 by
the Company under the Securities Act of 1934. Accordingly, footnotes and other
disclosures which would substantially duplicate the disclosures in Form 10-K
have been omitted. The financial information herein is not necessarily
representative of a full year's operations.
PROPERTY HELD FOR SALE
The Company currently has four communities being held for sale.
MANAGEMENT FEES
Management fee revenues are derived from the management by the Company of 60
communities as of June 30, 1999 under management contracts which typically
provide for management fees ranging from 5% to 7% of gross revenues. These
agreements have terms ranging from two to five years, but may be renewed at the
expiration of the term. The Company has options and rights of first refusal to
acquire 40 and three of these managed communities, respectively.
LOSS PER SHARE
Loss per common share on a dilutive basis has been calculated without
consideration of 3,869,322 and 4,254,122 common shares at June 30, 1998 and
1999, respectively, related to outstanding options, warrants, convertible
debentures and convertible preferred stock because the inclusion of such common
stock equivalents would be anti-dilutive.
SALES OF COMMUNITIES
In March 1999, the Company completed the disposition of its leasehold interests
in 17 communities, consisting of 16 currently operational communities previously
leased by the Company from Meditrust Corporation, a health care REIT,
("Meditrust") as well as one development community to a related entity.
Additionally, the Company will dispose of its leasehold interests in four
development communities (together with the 17 communities above known as the
"Emeritrust II communities") to the related entity, upon completion of their
development. The combined purchase price for the Emeritrust II communities will
approximate $123 million. As of March 31, 1999, Emeritus has received net
proceeds of $3.7 million in conjunction with this transaction. The Company will
continue to operate the Emeritrust II communities pursuant to a three year
management contract and will receive management fees of 5% of revenues currently
payable as well as 2% of revenues which is contingent upon the communities
achieving positive cash flows. The management agreement provides the Company an
option to purchase the 21 Emeritrust II communities at a formula price. The
management agreement further stipulates a cash shortfall funding requirement
by the Company to the extent that the five development communities generate
cash deficiencies in excess of individually specified amounts per community,
ranging from $400,000 to $500,000. Previously deferred gains on communities
which are the subject of this transaction collectively totaling approximately
$5.7 million are continuing to be deferred given the continuing financial
involvement of the Company stipulated in the management agreement.
5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
We are one of the largest and most experienced national providers of
assisted living residential communities. Assisted living communities provide a
residential housing alternative for senior citizens who need help with the
activities of daily living, with an emphasis on personal care services.
Until 1999, our revenues were derived primarily from rents and service fees
charged to residents of our communities. With the consummation of Emeritrust II
and with the previous repositioning of 25 communities which closed on December
31, 1998, some of our revenues are shifting to management fees earned on
operating assisted living communities, which should approximate $5.9 million
during 1999. For the six months ended June 30, 1998 and 1999, we generated total
operating revenues of $71.8 million and $63.0 million, respectively, including
$2.4 million in management fees for the six months ended June 30, 1999. For the
six months ended June 30, 1998 and 1999, we incurred losses of $15.6 million and
$4.9 million (excluding preferred dividends, and a charge related to the
cumulative effect of a change in accounting principle as well as an
extraordinary item related to the extinguishment of debt in 1998), respectively.
For the three months ended June 30, 1998 and 1999, we generated total operating
revenues of $37.0 million and $28.9 million, respectively, including $1.7
million in management fees for the three months ended June 30, 1999. For the
three months ended June 30, 1998 and 1999, we incurred losses of $7.2 million
and $2.0 million (excluding preferred stock dividends and an extraordinary item
related to the extinguishment of debt in 1998), respectively. Our loss before
extraordinary item and cumulative effect of change in accounting principle
decreased $948,000 from $3.0 million for the quarter ended March 31, 1999 to
$2.0 million for the quarter ended June 30, 1999.
During 1998, we adopted an operating strategy focused on increasing occupancy
throughout our communities, reducing acquisition and development and
disposing of select communities that had been operating at a loss. Occupancy
across our total portfolio at June 30, 1999 increased by 4.5 percentage
points to 78.7% compared to 74.2% at June 30, 1998. In addition, average
second quarter occupancy increased by 5.7 percentage points to 77.5% for 1999
compared to 71.8% for 1998. We have significantly reduced our acquisition and
development activities, acquiring 35 and 7 communities in 1996 and 1997,
respectively, and none in 1998 and the first six months of 1999. In addition,
we opened 10, 20 and 11 development communities in 1996, 1997 and 1998,
respectively, as well as six additional ones during the six months ended June
30, 1999. We believe that slowing our acquisition and development activities
has enabled us to use our resources more efficiently and increase our focus
on community operations. During the six months ended June 30, 1998, we
disposed of three communities operating at a loss. During the six months
ended June 30, 1999 we disposed of our leasehold interests in 18 communities,
consisting of 16 operating communities and two development communities. We
currently retain a management interest in these 18 facilities through three
year management contracts as well options to purchase.
For the remaining part of 1999, we will stay primarily focused on increasing
occupancy throughout our communities, consistent with 1998. In addition, we will
be devoting attention to the generation of alternative sources of resident fee
revenue as well the containment of operating costs to continue improving our
margins.
Our losses to date result from a number of factors. These factors include,
but are not limited to: the development of 50 and acquisition of 69 assisted
living communities since inception that incurred operating losses during the
initial 12 to 24 month rent-up phase; initially lower levels of occupancy at
the Company's communities than originally anticipated; financing costs
arising from sale/leaseback transactions and mortgage financing; refinancing
transactions at proportionately higher levels of debt; and increased
administrative and corporate expenses to facilitate the Company's growth.
6
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (Continued)
The following table sets forth a summary of our community interests.
As of December 31, As of December 31, As of June 30,
1997 1998 1999
------------------ ------------------ ------------------
Buildings Units Buildings Units Buildings Units
------------------ ------------------ ------------------
Owned 19 2,099 15 1,492 15 1,492
Leased 76 6,124 52 3,937 40 3,185
Managed/Admin Services 4 327 38 3,734 60 5,350
Joint Venture/Partnership 1 140 8 809 4 489
------------------ ------------------ ------------------
Sub Total 100 8,690 113 9,972 119 10,516
Percentage Increase (2) 41% 47% 13% 15% 5% 5%
Development Communities (1) 26 2,483 21 2,029 15 1,502
Minority Interest (Alert Care) 22 1,248 21 1,203 21 1,203
------------------ ------------------ ------------------
Total 148 12,421 155 13,204 155 13,221
------------------ ------------------ ------------------
Percentage Increase (2) 20% 22% 5% 6% - % - %
(1) Of these 15 developments communities, we are developing three that
we expect to sell upon completion and manage pursuant to management
contracts with the purchaser, we are developed three in joint
ventures with third parties, and the remaining nine are being
developed by third parties but will be managed by us upon
completion.
(2) The percentage increase indicates the change from the preceding
December 31.
At August 6, 1999, we held ownership, leasehold or management interests in 121
residential communities consisting of approximately 10,700 units with the
capacity of approximately 12,300 residents, located in 29 states. Of the 121
residential communities, 20 and 11 are development communities that we opened
during 1997 and 1998, respectively. Additionally, we opened six development
communities in the six months ended June 30, 1999. We jointly own, have a
leasehold interest in, management interest in or have acquired an option to
purchase development sites for 13 new assisted living communities. Of these
development communities, we are scheduled to open nine during the remainder of
1999 and the remaining four in 2000. As of August 6, 1999, we lease 41 of our
residential communities, typically from a financial institution such as a Real
Estate Investment Trust ("REIT"), own 15 communities, manage or provide
administrative services for 61 communities and have a partnership or joint
venture interest in four communities. Additionally, we hold a minority interest
of 31.3% in Alert Care, an Ontario, Canada-based owner and operator of 21
assisted living communities consisting of approximately 1,200 units with a
capacity of approximately 1,300 residents. Assuming the completion of the 1999
development communities and including our interest in Alert Care, we will own,
lease, have an ownership or partnership or joint interest in or manage 151
residential communities in 29 states, Canada and Japan, consisting of an
aggregate of 12,900 units with a capacity of approximately 14,500 residents. We
cannot guarantee, however, that the communities under development will be
completed on schedule and will not be affected by construction delays, the
effects of government regulations or other factors beyond our control.
We are exploring international development and acquisition possibilities in
Canada and Japan. Our investment in Alert Care in Ontario, Canada represents a
significant initial investment in the assisted living industry in Canada. We
have also entered into a joint venture with Sanyo Electric Company, Ltd. of
Osaka, Japan to provide assisted living services in Japan. Our first
assisted living community in Japan is under construction and is anticipated to
open by the end of 1999. This community will be among the first assisted living
communities in Japan to offer private apartments on a month-to-month rental.
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (Continued)
RESULTS OF OPERATIONS
The following table presents certain items of our consolidated statements of
operations as a percentage of total revenues and the percentage change of the
underlying dollar amounts from period to period.
Period to Period
Percentage Increase (Decrease)
Percentage of Revenues Three Months Six Months
Three Months Ended Six Months Ended Ended Ended
June 30, June 30, June 30, June 30,
------------------ ----------------- ------------------------
1998 1999 1998 1999 1998-1999 1998-1999
----- ----- ----- ----- --------- ---------
Total operating revenues .................. 100.0% 100.0% 100.0% 100.0% (22.0)% (12.2)%
Expenses:
Community operations ................. 73.9 61.2 73.9 62.4 (35.3) (25.8)
General and administrative ........... 8.8 12.2 9.0 11.2 7.6 8.7
Depreciation and amortization ........ 3.6 4.9 4.0 4.5 5.4 (1.0)
Rent ................................. 28.2 19.9 28.9 21.1 (45.1) (35.8)
----- ----- ----- ----- ------ ------
Total operating expenses ......... 114.5 98.2 115.8 99.2 (33.1) (24.8)
----- ----- ----- ----- ------ ------
Income (loss) from operations .... (14.5) 1.8 (15.8) 0.8 (109.9) (104.4)
----- ----- ----- ----- ------ ------
Other income (expense):
Interest expense, net ................ (10.0) (11.0) (9.1) (10.1) (15.0) (1.7)
Other, net ........................... 5.1 2.2 3.1 1.4 (67.1) (58.2)
----- ----- ----- ----- ------ ------
Net other expense ................ (4.9) (8.8) (6.0) (8.7) 38.6 27.5
Loss before extraordinary item
and cumulative effect of change
in accounting principle ........ (19.4) (7.0) (21.8) (7.9) (72.1) (68.2)
Extraordinary item-loss on early
extinguishment of debt ................. (2.1) -- (1.1) -- (100.0) (100.0)
Cumulative effect of change in
accounting principle ................... -- -- (1.8) -- -- (100.0)
----- ----- ----- ----- ------ ------
Net loss ........................ (21.5)% (7.0)% (24.7)% (7.9)% (74.8)% (72.0)%
===== ===== ===== ===== ====== ======
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998
TOTAL OPERATING REVENUES: Total operating revenues for the six months ended
June 30, 1999 decreased 12.2% or $8.8 million from the comparable period in
1998. At December 31, 1998 and at March 31, 1999, we transferred our
interests in a total of 41 owned and leased communities to others but
continued to manage them under three year management agreements with rights
of first refusal or options to reacquire them in the future. As a result, we
now receive management fees from these communities rather than the revenues
arising from their operations. For the first six months of 1998, these
communities were responsible for $23.5 million in revenue while generating
$1.3 million in management fees for the same period in 1999. This decrease in
revenue was partially offset, however, by generally increasing levels of
occupancy throughout our consolidated communities. Average occupancy of the
59 communities we own and lease in the first six months of 1999 rose to 86%
compared to 72% for the 96 owned and leased communities in the equivalent
1998 period, an increase of 14 percentage points.
8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (Continued)
COMMUNITY OPERATIONS: Community operating expenses for the six months ended
June 30, 1999 decreased 25.8% or $13.7 million from the comparable period in
1998 to $39.3 million. This reduction is primarily the result of the transfer
of 41 of our previously leased and owned communities to management
agreements, as discussed in "Total Operating Revenues" above. These
communities were responsible for $18.4 million of community operating
expenses as owned and leased communities in the first six months of 1998;
because 25 and 16 were managed communities during the first six months and
second quarter of 1999, respectively, we were no longer responsible for their
operating expenses. This decrease was partially offset, however, by increased
variable costs resulting from the significant occupancy gains in our
communities in 1998 and by increased sales and marketing costs. Our community
operating margin, which we compute as community revenues less community
operating expenses, has increased to 35.2% for the six months ended June 30,
1999 compared to 25.8% for the six months ended June 30, 1998. This
improvement is, in part, because the 41 communities that we transferred to
management agreements generally experienced lower margins than our
communities as a whole and, in part, because of cost control measures that we
instituted in 1998 that affected our remaining owned and leased communities.
GENERAL AND ADMINISTRATIVE: As a percentage of total operating revenues,
general and administrative (G&A) expenses increased to 11.2% for the six
months ended June 30, 1999 as compared to 9.0% for the six months ended June
30, 1998. The increase of G&A costs as a percentage of revenues is due, in
part, to the shift from community revenues to management fees in the transfer
of the 41 communities referred to above. Overall, G&A costs increased
approximately $561,000 primarily due to greater personnel costs to support
the increasing number of communities.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization for the six
months ended June 30, 1999 were $2.9 million, or 4.5% of total operating
revenues, compared to $2.9 million, or 4.0% of total operating revenues for
the comparable period in 1998.
RENT: Rent expense for the six months ended June 30, 1999 was $13.3 million,
representing a decrease of $7.4 million, or 35.8% from the comparable period
in 1998. The decrease is primarily attributable to the transfer of 36 of our
previously leased operating communities to management agreements as discussed
above. These communities accounted for $8.1 million in rent expense for the
six months ended June 30, 1998. We leased an average of 44 communities for the
six months ended June 30, 1999, compared to an average of 77 for the six
months ended June 30, 1998. Rent as a percentage of revenues was 28.9% and
21.1% for the six months ended June 30, 1998 and 1999, respectively.
INTEREST EXPENSE, NET: Net interest expense for the six months ended June 30,
1999 was $6.4 million, or 10.1% of total operating revenues, compared to $6.5
million, or 9.1% of total operating revenues for the comparable period in
1998. The change in percentage of revenue is primarily the result of our
decrease in revenues from the transfer of 41 of our communities as discussed
above.
OTHER, NET: Other, net, for the six months ended June 30, 1999 decreased $1.3
million from the comparable period in 1998. The decrease is primarily
attributable to a gain on the sale of securities and a gain on the disposition
of three of our communities during the six months ended June 30, 1998.
EXTRAORDINARY ITEM: We recognized an extraordinary loss of approximately
$767,000 for the period ended June 30, 1998, resulting from the write-off of
loan fees and other related costs in conjunction with the refinancing of 10 of
our mortgage-financed communities.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE: During the six month period
ended June 30, 1998, we recorded a cumulative effect of a change in accounting
principle of $1.3 million relating to the early adoption of SOP 98-5 which
requires that costs of start-up activities and organization costs be expensed as
incurred. We did not incur such a charge for the six months ended June 30, 1999.
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (Continued)
THREE MONTHS ENDED JUNE 30, 1999 COMPARED TO THREE MONTHS ENDED JUNE 30, 1998
TOTAL OPERATING REVENUES: Total operating revenues for the three months ended
June 30, 1999 decreased 22.0% or $8.1 million from the comparable period in
1998. At December 31, 1998 and at March 31, 1999, we transferred our
interests in a total of 41 owned and leased communities to others but
continued to manage them under three year management agreements with rights
of first refusal or options to reacquire them in the future. As a result, we
now receive management fees from these communities rather than the revenues
arising from their operations. For the three months ended June 30, 1998,
these communities were responsible for $12.1 million in revenue while
generating $914,000 in management fees for the same period in 1999. This
decrease in revenue was partially offset, however, by generally increasing
levels of occupancy throughout our consolidated communities. Average
occupancy of the 59 communities we own and lease in the three months ended
June 30, 1999 rose to 86% compared to 72% for the 96 owned and leased
communities in the equivalent 1998 period, an increase of 14 percentage
points.
COMMUNITY OPERATIONS: Community operating expenses for the three months ended
June 30, 1999 decreased 35.3% or $9.7 million from the comparable period in
1998 to $17.7 million. This reduction is the result of the transfer of 41 of
our previously leased and owned communities to management agreements, as
discussed in "Total Operating Revenues" above. These communities were
responsible for $9.6 million of community operating expenses as owned and
leased communities in the three months ended June 30, 1998; because they were
managed communities during the second quarter of 1999, we were no longer
responsible for their operating expenses. Our community operating margin,
which we compute as community revenues less community operating expenses, has
increased to 34.9% for the three months ended June 30, 1999 compared to 25.6%
for the three months ended June 30, 1998. This improvement is, in part,
because the 41 communities that we transferred to management agreements
generally experienced lower margins than our communities as a whole and, in
part, because of cost control measures that we instituted in 1998 that
affected our remaining owned and leased communities.
GENERAL AND ADMINISTRATIVE: As a percentage of total operating revenues,
general and administrative (G&A) expenses increased to 12.2% for the three
months ended June 30, 1999 as compared to 8.8% recorded for the three months
ended June 30, 1998. The increase of G&A costs as a percentage of revenues is
due, in part, to the shift from community revenues to management fees in the
transfer of the 41 communities referred to above. Overall, G&A costs
increased approximately $250,000 primarily due to greater personnel costs to
support the increasing number of communities.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization for the three
months ended June 30, 1999 were $1.4 million, or 4.9% of total operating
revenues, compared to $1.3 million, or 3.6% of total operating revenues for
the comparable period in 1998. The increase of depreciation and amortization
as a percentage of revenues is due, in part, to the shift from community
revenues to management fees in the transfer of the 41 communities referred to
above.
RENT: Rent expense for the three months ended June 30, 1999 was $5.7 million,
representing a decrease of $4.7 million, or 45.1% from the comparable period
in 1998. The decrease is primarily attributable to the transfer of 36 of our
previously leased operating communities to management agreements as discussed
above. These communities accounted for $3.9 million in rent expense for the
three months ended June 30, 1998. We leased an average of 37 communities for
the three months ended June 30, 1999, compared to an average of 78 for the
three months ended June 30, 1998. Rent as a percentage of revenues was 28.2%
and 19.9% for the three months ended June 30, 1998 and 1999, respectively.
INTEREST EXPENSE, NET: Net interest expense for the three months ended June
30, 1999 was $3.2 million, or 11.0% of total operating revenues, compared to
$3.7 million, or 10.0% of total operating revenues for the comparable period
in 1998. The change in percentage of revenue is primarily the result of our
decrease in revenues from the transfer of 41 of our communities as discussed
above.
OTHER, NET: Other, net, for the three months ended June 30, 1999 decreased $1.3
million from the comparable period in 1998. The decrease is primarily
attributable to a gain on the sale of securities and a gain on the disposition
of three of our communities realized during the three months ended June 30,
1998.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (Continued)
EXTRAORDINARY ITEM: We recognized an extraordinary loss of approximately
$767,000 for the period ended June 30, 1998, resulting from the write-off of
loan fees and other related costs in conjunction with the refinancing of 10 of
our mortgage-financed communities.
SAME COMMUNITY COMPARISON
We operated 53 of our communities during both three month periods ended June
30, 1998 and 1999. These communities do not include the 41 owned or leased
communities that we transferred to managed communities during 1998 and the
first quarter of 1999. The following table sets forth a comparison of these
same communities' results of operations, excluding corporate overhead, for
the three months ended June 30, 1998 and 1999.
Three Months Ended June 30,
(In thousands)
Dollar Percentage
1998 1999 Change Change
-------- -------- -------- ----------
Revenue .......................... $ 21,344 $ 24,288 $ 2,944 13.8 %
-------- -------- -------- ------
Expenses:
Community operating expense ... 14,010 15,276 1,266 9.0
Depreciation and amortization.. 855 1,014 159 18.6
Rent .......................... 5,682 5,454 (228) (4.0)
-------- -------- -------- ------
Total operating expenses .... 20,547 21,744 1,197 5.8
-------- -------- -------- ------
Income from operations ...... 797 2,544 1,747 219.3
-------- -------- -------- ------
Other income (expense):
Interest expense, net ......... (2,007) (1,947) 60 3.0
Other income .................. 155 20 (135) (87.4)
-------- -------- -------- ------
Net other expense .......... (1,852) (1,927) (75) (4.0)
-------- -------- -------- ------
Net income (loss) ................ $ (1,055) $ 617 $ 1,672 (158.4)%
======== ======== ======== ======
The same communities represented $24.3 million or 84% of our total operating
revenue for the three months ended June 30, 1999. Same community revenues
increased by $2.9 million or 13.8% for the three months ended June 30, 1999 from
the comparable period in 1998. The increase in revenue is attributable primarily
to monthly rate increases, as measured by revenue per occupied unit, due to an
expanded range of services offered at the communities. Same community average
revenue per unit increased from $1,869 per month for the three months ended June
30, 1998 to $2,092 per month for the three months ended June 30, 1999. During
the three months ended June 30, 1999, average occupancy also experienced a
slight increase to 86% compared to average occupancy of 84% the three months
ended June 30, 1998. During the three months ended June 30, 1999, we recorded
net income of $617,000 compared to a net loss of $1.1 million for the three
months ended June 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
For the six months ended June 30, 1999, net cash used in operating activities
was $8.2 million compared to $13.1 million for the comparable period in the
prior year. The primary component of this use of cash was the net loss of $5.0
million and $17.7 million recorded in the six months ended June 30, 1999 and
1998, respectively.
Net cash provided by investing activities amounted to $820,000 for the six
months ended June 30, 1999, stemming primarily from proceeds from our March
31, 1999 transfer of 17 leased communities of $3.2 million as well as
proceeds on the sale of our office park of $500,000. This inflow of cash was
offset in part by acquisitions of property and equipment of $1.7 million as
well as an excess of $800,000 of construction expenditures on leased
communities over construction advances for the same six month period. Net
cash provided by investing activities for the six months ended June 30, 1998
was $1.1 million, primarily resulting from the proceeds from the disposition
of three communities offset by the acquisitions of property held for
development and property and equipment.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (Continued)
For the six months ended June 30, 1999, net cash provided by financing
activities was $2.0 million which is primarily the result of proceeds from
short-term borrowings. For the six months ended June 30, 1998, net cash
provided by financing activities was $16.2 million, reflecting the
refinancing of 10 existing assisted living communities for $73.2 million and
the repayment of existing debt of $60.3 million.
At June 30, 1999, we had $5.0 million outstanding on our unsecured revolving
account with our primary banking institution. This account, which bears
interest at the prime rate and expires in November 1999, is guaranteed by our
principal shareholder.
We have been, and expect to continue to be, dependent on third-party financing
for our cash needs in connection with operating losses as well as with our
acquisition and development of communities. There can be no assurance that
financing for these requirements will be available to the Company on acceptable
terms. Moreover, to the extent the Company acquires communities that do not
generate positive cash flow, the Company may have to seek additional capital or
borrowings for working capital and liquidity purposes.
IMPACT OF INFLATION
To date, we have not been significantly impacted by inflation. Inflation could,
however, affect our future revenues and operating income due to our dependence
on our senior resident population, most of whom rely on relatively fixed incomes
to pay for our services. The monthly charges for the 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.
IMPACT OF YEAR 2000
GENERAL
We developed a plan to modify our information technology to address "Year 2000"
problems. The concerns surrounding the Year 2000 are the result of computer
programs being written using two digits rather than four to define the
applicable year. Programs that employ time-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could cause
system errors or failures.
PLAN
Our plan is comprised of three components including assessment of: a) the
IT infrastructure (hardware and systems software other than application
software); b) application software; and c) third party suppliers/vendors. We
began our work on the Plan in the fourth quarter of 1998 by taking inventory of
Year 2000 problems in the areas of IT infrastructure as well as application
software. In addition, we prioritized the items based on their materiality to
our operations. No material items have been noted to date. We started contacting
our third party suppliers/vendors during the second quarter of 1999 to determine
the status of their Year 2000 compliance. For each component, we will address
Year 2000 problems in six phases: 1) taking inventory of Year 2000 problems; 2)
assigning priorities to identified items; 3) assessing materiality of items to
the Company's operations; 4) replacing/repairing material non-compliant items;
5) testing material items; and 6) designing and implementing business
continuation plans. Material items are those we believe to have a risk that may
affect revenue or may cause a discontinuation of operations. We estimate a
completion date of September 30, 1999.
COSTS
We do not expect the project and its cost to be material to our operations or
financial position. We do not expect our total internal remediation cost to
exceed $50,000, of which we have spent approximately $20,000.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (Continued)
RISKS
The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, normal business activities or operations. Such
failures could materially affect our results of operations, liquidity, and
financial condition. We are unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on our results of
operations, liquidity or financial condition due, in part, to uncertainty
regarding compliance by third parties. We expect our plan to significantly
reduce the Company's level of uncertainty regarding the Year 2000 problem,
however, particularly compliance and readiness of our third-party
suppliers/vendors. We believe that, with the completion of our plan as
scheduled, the possibility of significant interruptions of normal operations
will be reduced and, therefore, we have not deemed a contingency plan necessary
to date.
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 the Company's actual
future experience involving any one or more of such matters and subject areas
relating to demand, pricing, competition, construction, licensing, permitting,
construction delays on new developments contractual and licensure, and other
delays on the disposition of assisted living communities in the Company's
portfolio, and the ability of the Company to continue managing its costs while
maintaining high occupancy rates and market rate assisted living charges in its
assisted living communities. The Company has attempted to identify, in context,
certain of the factors that they currently believe may cause actual future
experience and results to differ from the Company's current expectations
regarding the relevant matter or subject area. These and other risks and
uncertainties are detailed in the Company's reports filed with the Securities
and Exchange Commission, including the Company's Annual Reports on Form 10-K and
Quarterly Reports on Form 10-Q.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our results of operations are affected by changes in interest rates as a
result of its short- and long-term borrowings. We manage this risk by
obtaining fixed rate borrowings when possible. At June 30, 1999, our variable
rate borrowings totaled $97.3 million. If market interest rates average 2%
more in 1999 than they did in 1998, our interest expense would increase and
loss before taxes would increase by $1.9 million. These amounts are
determined by considering the impact of hypothetical interest rates on our
outstanding variable rate borrowings as of June 30, 1999 and does not
consider changes in the actual level of borrowings which may occur subsequent
to June 30, 1999. This analysis also does not consider the effects of the
reduced level of overall economic activity that could exist in such an
environment nor does it consider likely actions that management could take
with respect to our financial structure to mitigate the exposure to such a
change.
We are also exposed to equity price risk on our investments, including a
margin account having a loan balance of $1.6 million as of June 30, 1999. This
margin account is secured by marketable securities we hold with a current
market value of $2.9 million at June 30, 1999. These investments are generally
in companies in the health care sector. We typically do not attempt to reduce
or eliminate our market exposure on these securities. The decrease in the fair
value of our short-term available-for-sale securities compared to the December
31, 1998 value reflects the decrease in the dollar value of our securities
holdings, the majority of which represents unrealized market depreciation.
13
PART II OTHER INFORMATION
Item 1: LEGAL PROCEEDINGS
On April 24, 1998, we commenced a lawsuit against ARV Assisted Living Inc.
in Superior Court of the State of California for the County of Orange
alleging that share purchases on January 16, 1998 by Prometheus Assisted Living
LLC triggered the so-called flip-in feature of ARV's poison pill.
Prometheus is an investment vehicle controlled by Lazard Freres Real Estate
Investors L.L.C. We brought the suit in April 1998 as a result of ARV's
failure to issue freely tradeable rights under its poison pill to us and ARV's
other shareholders, other than Prometheus.
On July 1, 1999, the Superior Court issued a decision upholding our claim that
the investment vehicle controlled by Lazard triggered ARV's poison pill. The
Court agreed with us that share purchases by Prometheus in January 1998 caused
Prometheus to exceed the permitted ownership level under ARV's poison pill,
thereby triggering our right to purchase additional shares in ARV at a 50%
discount to the then-market price of ARV's stock. The Court ordered ARV to pay
us $5.4 million in damages, plus our legal costs. The Court awarded us damages
based upon the in-the-money value of the rights at the time they should have
been issued to us and the other public shareholders of ARV.
Items 2 and 3 are not applicable.
Item 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our annual meeting of shareholders on May 19, 1999. The following
summarizes all matters voted on at the meeting:
(a) To elect two directors into Class III of the Company's Board of
Directors for a three year term.
Votes Cast
-------------------------------
Nominee For Against Withheld
------------------- --------- ---------- ----------
Daniel R. Baty 9,297,713 - 27,951
William E. Colson 9,297,416 - 28,248
(b) To approve an amendment to the Company's 1995 Stock Incentive
Compensation Plan to increase the number of shares available for
issuance pursuant to the plan from 1,450,000 shares to 1,850,000.
FOR AGAINST ABSTAIN NON-VOTES
--- ------- ------- ---------
8,401,448 885,159 38,957 1,161,486
(c) To ratify the appointment of KPMG LLP as the Company's independent
public accountant's for the fiscal year 1999.
FOR AGAINST ABSTAIN NON-VOTES
--- ------- ------- ---------
9,297,802 15,617 12,245 1,161,386
14
PART II OTHER INFORMATION (cont'd)
Item 5 is not applicable.
Item 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
- ------ -----------
27.1 FINANCIAL DATA SCHEDULE
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the six months ended June 30, 1999.
15
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: August 6, 1999
EMERITUS CORPORATION
(Registrant)
---------------------------------------------------
Kelly J. Price, Vice President, Finance, Chief
Financial Officer and Principal Accounting Officer
16