SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(X) Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the quarterly period ended September 30, 2002
( ) Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from _______ to _______.
Commission file number 01-13031
---------
AMERICAN RETIREMENT CORPORATION
-------------------------------
(Exact name of Registrant as specified in its charter)
Tennessee 62-1674303
--------- ----------
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
111 Westwood Place, Suite 200, Brentwood, TN 37027
-------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(615) 221-2250
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
As of November 14, 2002, there were 17,310,209 shares of the Registrant's common
stock, $.01 par value, outstanding.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page
Condensed Consolidated Balance Sheets as of
September 30, 2002 and December 31, 2001..........................................3
Condensed Consolidated Statements of
Operations for the Three Months Ended
September 30, 2002 and 2001 ......................................................4
Condensed Consolidated Statements of
Operations for the Nine Months Ended
September 30, 2002 and 2001 ......................................................5
Condensed Consolidated Statements of Cash
Flows for the Nine Months Ended September 30,
2002 and 2001 ....................................................................6
Notes to Condensed Consolidated Financial Statements .............................8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations................................... 22
Item 3. Quantitative and Qualitative Disclosures About Market Risk ..................... 40
Item 4. Controls and Procedures ....................................................... 41
PART II. OTHER INFORMATION
Item 2. Change in Securities and Use of Proceeds........................................ 41
Item 6. Exhibits and Reports on Form 8-K................................................ 42
Signatures ................................................................................ 44
2
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share data)
September 30, 2002 December 31, 2001
------------------ ------------------
ASSETS
Current assets:
Cash and cash equivalents $ 24,997 $ 19,334
Assets limited as to use 16,863 10,122
Accounts receivable, net of allowance for doubtful accounts 13,196 11,447
Inventory 1,289 1,249
Prepaid expenses 3,609 3,016
Deferred income taxes 1,285 1,285
Assets held-for-sale 51,357 2,663
Other current assets 5,162 5,799
--------- ---------
Total current assets 117,758 54,915
Assets limited as to use, excluding amounts classified as current 27,091 68,618
Land, buildings and equipment, net 570,890 525,174
Notes receivable 20,722 84,537
Goodwill, net 36,463 36,463
Leasehold acquisition costs, net 23,417 33,484
Other assets 63,845 47,000
--------- ---------
Total assets $ 860,186 $ 850,191
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 13,965 $ 371,667
Debt associated with assets held-for-sale 35,829 --
Accounts payable 6,267 7,919
Accrued interest 1,876 3,584
Accrued payroll and benefits 6,930 4,838
Accrued property taxes 9,470 7,998
Other accrued expenses 9,650 9,926
Other current liabilities 10,499 17,436
--------- ---------
Total current liabilities 94,486 423,368
Long-term debt, excluding current portion 483,451 190,458
Convertible debentures 15,956 --
Refundable portion of life estate fees 58,515 46,309
Deferred life estate income 118,249 51,211
Tenant deposits 5,093 6,016
Deferred gain on sale-leaseback transactions 28,323 13,055
Deferred income taxes 2,055 2,055
Other long-term liabilities 14,251 10,171
--------- ---------
Total liabilities 820,379 742,643
Minority interest 12,250 --
Commitments and contingencies (See notes)
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares authorized, no
shares issued or outstanding -- --
Common stock, $.01 par value; 200,000,000 shares authorized,
17,310,209 and 17,276,520 shares issued and outstanding, respectively 173 173
Additional paid-in capital 145,657 145,590
Accumulated deficit (118,273) (38,215)
--------- ---------
Total shareholders' equity 27,557 107,548
--------- ---------
Total liabilities and shareholders' equity $ 860,186 $ 850,191
========= =========
3
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except share data)
Three Months Ended September 30,
---------------------------------
2002 2001
-------- --------
Revenues:
Resident and health care $ 83,916 $ 64,820
Management services 432 1,231
Reimbursed expenses 1,198 1,396
-------- --------
Total revenues 85,546 67,447
Operating expenses:
Community operating expenses 62,542 46,516
General and administrative 7,664 6,412
Lease expense, net 11,168 7,217
Depreciation and amortization 4,897 4,953
Amortization of leasehold acquisition costs 521 379
Asset impairments 2,511 --
Reimbursed expenses 1,198 1,396
-------- --------
Total operating expenses 90,501 66,873
-------- --------
Operating (loss) income (4,955) 574
Other income (expense):
Interest expense (11,727) (9,537)
Interest income 1,049 2,448
Loss on sale of assets (1,885) (59)
Equity in losses of managed special purpose entity communities -- (1,014)
Other 916 832
-------- --------
Other expense, net (11,647) (7,330)
-------- --------
Loss from continuing operations before income taxes,
minority interest, discontinued operations and extraordinary item (16,602) (6,756)
Income tax expense (benefit) 100 (2,311)
-------- --------
Loss from continuing operations before minority
interest discontinued operations and extraordinary item (16,702) (4,445)
Minority interest in losses of consolidated subsidiaries, net of tax -- 1
-------- --------
Loss from continuing operations before discontinued operations
extraordinary item (16,702) (4,444)
Discontinued operations, net of tax (5,867) --
-------- --------
Loss from operations before extraordinary item (22,569) (4,444)
Extraordinary gain on extinguishment of debt, net of tax -- 3
-------- --------
Net loss $(22,569) $ (4,441)
======== ========
Basic loss per share:
Basic loss per share before extraordinary item $ (0.96) $ (0.26)
Discontinued operations, net of tax (0.34) --
Extraordinary loss, net of tax -- --
-------- --------
Basic loss per share $ (1.30) $ (0.26)
======== ========
Diluted loss per share:
Diluted loss per share before extraordinary item $ (0.96) $ (0.26)
Discontinued operations, net of tax (0.34) --
Extraordinary loss, net of tax -- --
-------- --------
Diluted loss per share $ (1.30) $ (0.26)
======== ========
Weighted average shares used for basic loss per share data 17,310 17,239
Effect of dilutive common stock options -- --
-------- --------
Weighted average shares used for diluted loss per share data 17,310 17,239
======== ========
4
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share data)
Nine Months Ended September 30,
----------------------------------
2002 2001
--------- ---------
Revenues:
Resident and health care $ 239,956 $ 186,897
Management and development services 1,117 2,904
Reimbursed expenses 3,885 4,797
--------- ---------
Total revenues 244,958 194,598
Operating expenses:
Community operating expenses 175,529 131,920
General and administrative 20,088 18,162
Lease expense, net 62,231 20,668
Depreciation and amortization 15,384 14,479
Amortization of leasehold acquisition costs 10,682 1,140
Asset impairments 2,561 --
Reimbursed expenses 3,885 4,797
--------- ---------
Total operating expenses 290,360 191,166
--------- ---------
Operating (loss) income (45,402) 3,432
Other income (expense):
Interest expense (31,421) (28,056)
Interest income 3,977 8,601
Loss on sale of assets (1,938) (181)
Equity in losses of managed special purpose entity communities -- (2,952)
Other 1,668 1,855
--------- ---------
Other expense, net (27,714) (20,733)
--------- ---------
Loss from continuing operations before income taxes, minority interest
discontinued operations, and extraordinary item (73,116) (17,301)
Income tax expense (benefit) 319 (5,709)
--------- ---------
Loss from continuing operations before minority interest,
discontinued operations and extraordinary item (73,435) (11,592)
Minority interest in earnings of consolidated subsidiaries, net of tax -- (94)
--------- ---------
Loss from continuing operations before discontinued operations
and extraordinary items (73,435) (11,686)
Discontinued operations, net of tax (5,867) --
--------- ---------
Loss from operations before extraordinary item (79,302) (11,686)
Extraordinary loss on extinguishment of debt, net of tax (756) (178)
--------- ---------
Net loss $ (80,058) $ (11,864)
========= =========
Basic loss per share:
Basic loss per share before extraordinary item $ (4.25) $ (0.68)
Discontinued operations, net of tax (0.34) --
Extraordinary loss, net of tax (0.04) (0.01)
--------- ---------
Basic loss per share $ (4.63) $ (0.69)
========= =========
Diluted loss per share:
Diluted loss per share before extraordinary item $ (4.25) $ (0.68)
Discontinued operations, net of tax (0.34) --
Extraordinary loss, net of tax (0.04) (0.01)
--------- ---------
Diluted loss per share $ (4.63) $ (0.69)
========= =========
Weighted average shares used for basic loss per share data 17,288 17,192
Effect of dilutive common stock options -- --
--------- ---------
Weighted average shares used for diluted loss per share data 17,288 17,192
========= =========
5
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
Nine Months Ended September 30,
-------------------------------
2002 2001
-------- --------
Cash flows from operating activities:
Net loss $(80,058) $(11,864)
Extraordinary loss on extinguishment of debt, net of tax 756 178
-------- --------
Loss from continuing operations (79,302) (11,686)
Adjustments to reconcile loss from continuing operations to net
cash and cash equivalents used by operating activities:
Depreciation and aamortization 26,066 15,619
Amortization of deferred financing costs 2,114 1,938
Residual value guarantee lease costs 30,793 --
Asset impairments 2,561 --
Amortization of deferred entrance fee revenue (9,044) (7,480)
Proceeds from entrance fee sales, net of refunds 13,502 8,560
Advances to joint ventures -- (1,512)
Deferred income tac benefit (108) (5,415)
Amortization of deferred gain on sale-leaseback transactions (3,045) (2,509)
Minority interest in earningss of consolidated subsidiaries -- 94
Losses (gains) from unconsolidated joint ventures 445 (14)
Loss on sale of assets 1,938 181
Issuance of stock to employee 401k plan -- 333
Changes in assets and liabilities:
Accounts receivable (758) (977)
Inventory 30 (75)
Prepaid expenses (416) (203)
Other assets 1,323 1,262
Accounts payable (1,718) (1,949)
Accrued expenses and other current liabilities 8,536 8,550
Tenant deposits (949) (22)
Other liabilities 1,480 1,018
-------- --------
Net cash and cash equivalents (used) provided by continuing operations (6,552) 5,713
Net cash and cash equivalents provided by discontinued operations 5,867 --
-------- --------
Net cash and cash equivalents (used) provided by opereating activities (685) 5,713
Cash flows from investing activities:
Additions to land, buildings and equipment (14,664) (13,325)
Proceeds from (purchase of) assets limited as to use 22,728 (5,439)
Issuance of notes receivable (3,364) (2,167)
Proceeds from the sale of assets 25,396 7,708
Expenditures for leasehold acquisitions, net of cash received (615) (5)
Other investing activities (923) 804
-------- --------
Net cash provided (used) by investing activities 28,558 (12,424)
6
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(UNAUDITED)
(in thousands)
Nine Months Ended September 30,
---------------------------------
2002 2001
--------- --------
Cash flows from financing activities:
Proceeds from the issuance of long-term debt 219,349 21,744
Principal payments on long-term debt (237,646) (8,781)
Proceeds from equity investment 12,250 --
Purchase of convertible debentures -- (4,029)
Principal reductions in master trust liability (4,566) (4,035)
Accrual of contingent earnouts (3,560) --
Expenditures for financing costs (8,104) (1,116)
Other financing costs 67 104
--------- --------
Net cash (used) provided by financing activities (22,210) 3,887
--------- --------
Net increase (decrease) in cash and cash equivalents 5,663 (2,824)
--------- --------
Cash and cash equivalents at beginning of period 19,334 19,850
--------- --------
Cash and cash equivalents at end of period $ 24,997 $ 17,026
========= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest (including capitalized interest) $ 29,156 $ 25,134
========= ========
Income taxes paid (received) $ 179 $ (1,520)
========= ========
Supplemental disclosure of non-cash transactions:
During the nine months ended September 30, 2002, the Company terminated a
management agreement and entered into a long-term operating lease. Under the
terms of the lease, the Company acquired the following assets and assumed the
following liabilities:
Accounts receivable $ 991 $ --
Other current assets 441 --
Note receivable 18,756 --
Other assets 11,651 --
Other current liabilities 1,527 --
Refundable portion of life estate fees 11,348 --
Deferred life estate income 16,335 --
Other long-term liabilities 2,629 --
During the nine months ended September 30, 2002, the Company terminated 13
operating leases, and acquired $187.0 million of land, buildings, and equipment
in exchange for $88.6 million of notes receivable and $36.7 million of treasury
bills and certificates of deposit (included in assets whose use is limited), and
the assumption of $47.7 million of entrance fee liabilities and $45.6 million of
debt. In conjunction with the transactions, assets and liabilities changed as
follows (increase (decrease)):
Notes receivable $ (88,610) $ -
Assets limited as to use (36,654) -
Land, buildings and equipment 187,016 -
Other current liabilities (31,513) -
Entrance fee liabilities 47,710 -
Long-term debt 45,555 -
During the nine months ended September 30, 2001, the Company funded its 401(k)
contribution with 81,788 shares of its common stock at a fair market value of
approximately $333,000.
7
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
American Retirement Corporation (the "Company") have been prepared in accordance
with accounting principles generally accepted in the United States of America
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. These financial statements should be read in
conjunction with the consolidated financial statements and the notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2001. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States of
America for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals and other adjustments, such
as impairments) considered necessary for a fair presentation have been included.
Certain fiscal year 2001 amounts have been reclassified to conform to the fiscal
year 2002 presentation. Operating results for the three and nine months ended
September 30, 2002 are not necessarily indicative of the results that may be
expected for the entire year ending December 31, 2002.
2. LIQUIDITY AND COMPLETION OF REFINANCING PLAN
During the later part of 2001, the Company developed a refinancing plan (the
"Refinancing Plan") to address its debt and lease obligations maturing during
2002, comprised primarily of $132.9 million of its 5-3/4% Convertible
Subordinated Debentures due October 1, 2002 (the "Old Debentures"). Since
November 2001, the Company has consummated sale lease-back transactions relating
to 16 communities and various other refinancing and capital raising
transactions. In addition, on September 30, 2002, the Company completed the
Refinancing Plan and repaid the Old Debentures primarily through the completion
of the HCPI Transactions and the Exchange Offer described below.
On August 14, 2002, the Company entered into a loan agreement with Health Care
Property Investors, Inc. ("HCPI"), a real estate investment trust, pursuant to
which HCPI agreed to loan one of the Company's subsidiaries $112.8 million (the
"HCPI Loan"). The Company also contemporaneously entered into a contribution
agreement with HCPI (the "HCPI Investment Agreement") under which HCPI agreed to
make a $12.2 million equity investment in certain other subsidiaries of the
Company (the "HCPI Equity Investment"). The HCPI Loan and the HCPI Equity
Investment are collectively referred to as the "HCPI Transactions."
HCPI's obligation to consummate the HCPI Transactions was subject to a number of
conditions and contingencies, including the requirement that the Company
successfully complete an exchange offer with the holders of the Old Debentures
(the "Exchange Offer"). On September 26, 2002, the Company completed the
Exchange Offer by exchanging $99.8 million aggregate principal amount of its Old
Debentures for approximately $86.8 million aggregate principal amount of the
Company's new 5 3/4% Series A Senior Subordinated Notes Due September 30, 2002
(the "Series A Notes") and approximately $16.0 million aggregate principal
amount of its new 10% Series B Convertible Senior Subordinated Notes Due April
1, 2008 (the "Series B Notes"). For each $1,000 principal amount of Old
Debentures exchanged, the Company issued $869 principal amount Series A Notes
and $160 principal amount of Series B Notes. Following completion of the
Exchange Offer, approximately $33.1 million aggregate principal amount of Old
Debentures were outstanding. The Series A Notes and the Series B Notes are
unsecured and subordinated to all of the Company's existing and future
indebtedness and capital lease obligations. Interest on the Series B Notes is
due semiannually. The Company has the option to pay up to 2% interest per year
on the Series B Notes through the issuance of additional Series B Notes rather
than in cash. The Company's Series B can be convertible at any time into shares
of the Company's common stock at a conversion price of $2.25 per share at the
option of the holder.
On September 30, 2002 the Company completed the HCPI Transactions, which
generated approximately $119.8 million of net proceeds, after paying
approximately $5.2 million of transaction costs, which were used to repay the
$86.8 million of Series A Notes and the $33.1 million of Old Debentures that
were not exchanged in the Exchange Offer. Approximately $4.3 million of the
transaction costs have been capitalized and will be amortized over a five year
period.
8
The HCPI Loan matures on September 30, 2007 and has a cash interest payment rate
of 9% per year, plus additional accrued interest (which converts to principal)
to its stated interest rate of 19.5%. The Company will only be required to pay
in cash 9% interest per year until April 2004. Thereafter, the cash interest
payment rate will increase each year by fifty-five basis points. The cash
portion of interest will be payable quarterly, with any unpaid interest accruing
and compounding quarterly. The Company will be permitted to repay the loan in
whole or in part at any time after September 30, 2005. The $112.8 million
principal balance and all accrued interest will be payable at the maturity of
the loan.
The $12.2 million HCPI Equity Investment was made in return for a 9.8% ownership
interest in certain subsidiaries (the "Real Estate Companies") of the Company's
subsidiary that is the borrower under the HCPI Loan. The Real Estate Companies
function solely as passive real estate holding companies owning the real
property and improvements of nine of the Company's large retirement communities.
These retirement communities are leased to, and operated by, other operating
subsidiaries of the borrower subsidiary in which HCPI has no interest. During
the term of its investment in each Real Estate Company, HCPI and the borrower
subsidiary will have mutual decision making authority with respect to the Real
Estate Companies. HCPI has the right to receive certain preferred distributions
from any cash generated by the Real Estate Companies. The borrower subsidiary
has the right to repurchase HCPI's minority interest in the Real Estate
Companies for one year beginning September 30, 2006. HCPI has the right to
purchase the borrower subsidiary's interests in the Real Estate Companies
beginning September 30, 2007.
The HCPI Loan is primarily non-recourse and secured by a first-priority security
interest in the borrower subsidiary's 90.2% ownership interests in the Real
Estate Companies, and in certain cash reserve accounts. Since the HCPI Loan is
primarily non-recourse, if the borrower subsidiary defaults or fails to repay
the loan at maturity, HCPI's initial claim against that subsidiary, absent fraud
or certain other customary events of malfeasance, will be to exercise its
security interests and the foreclosure does not fully satisfy the HCPI Loan, the
borrower subsidiary's personal liability for the remainder of the HCPI Loan is
limited to an amount equal to the equity value of one of its retirement
communities (approximately $112.8 million as of September 30, 2002). In any
event following a default under the HCPI Loan, the operating subsidiaries will
continue to operate these communities under a master lease, which has an initial
term of 15 years, commencing September 30, 2002, with the Company having two
ten-year extensions that are exercisable at its option.
In addition, pursuant to the Refinancing Plan, since November 2001, the Company
consummated sale lease-back transactions relating to 16 communities and various
other refinancing and capital raising transactions, which in the aggregate
generated gross proceeds of approximately $362.0 million. The Company used
approximately $327.2 million of the proceeds to repay related debt and to fund
reserve and escrow requirements related to these transactions. The Company used
the remaining $34.8 million of proceeds to pay transaction costs associated with
the Refinancing Plan and for working capital. As a result of the completion of
the Refinancing Plan, the Company has extended the maturity of substantially all
of its debt arrangements to January 2004 or later. The Company and the lessor of
one community agreed to a waiver related to various financial covenants as of
September 30, 2002. In addition, as of September 30, 2002, the Company had
guaranteed $40.3 million of third-party senior debt in connection with a
community that the Company manages, a community that the Company leases, and the
Company's two joint ventures.
Although the Company has successfully completed the Refinancing Plan, it remains
highly leveraged with a substantial amount of debt and lease obligations, and
has increased interest and lease costs. As part of these extensions and
refinancings, the Company has replaced a significant amount of mortgage debt
with debt having higher interest rates or higher lease costs, increasing the
Company's estimated annual debt and lease payments by approximately $14.4
million. In addition, the interest costs under the HCPI Loan and the Series B
Notes are significantly higher than the interest cost of the Old Debentures.
Assuming that the Company elects to pay 2% of the interest on the Series B Notes
through the issuance of additional Series B Notes rather than cash, the HCPI
loan and Series B Note annual interest payments would be higher than the
corresponding interest payments under the Old Debentures by approximately $3.8
million per year. In addition, the Company will accrue additional interest
expense that is not currently payable, pursuant to the HCPI Loan and the Series
B Notes, which will be approximately $13.0 million for the next twelve months.
The Company has scheduled current debt payments of $14.0 million and minimum
rental obligations of $44.1 million under long-term operating leases due during
the twelve months ended September 30, 2003. As of September
9
30, 2002, the Company had approximately $25.0 million in unrestricted cash and
cash equivalents and $23.3 million of working capital. The Company's current
level of cash flow from operations is not sufficient to meet its future debt and
lease payment obligations. However, the Company expects that its cash flow from
operations will continue to improve, and, accordingly, expects that its current
cash and cash equivalents, expected cash flow from operations, the proceeds from
additional financing transactions, and the proceeds from the sale of assets
currently held for sale should be sufficient to fund operating requirements,
capital expenditure requirements and periodic debt service requirements and
lease obligations during the next twelve months.
3. EARNINGS PER SHARE
Basic loss per share for the three and nine months ended September 30, 2002 has
been computed on the basis of the weighted average number of shares outstanding.
During the three and nine months ended September 30, 2002, there were 6,355 and
2,165 options, respectively, to purchase shares of common stock outstanding
which had an exercise price below the average market price of the common shares
for the corresponding periods. Such options were anti-dilutive because the
Company incurred a loss from continuing operations for the three and nine months
ended September 30, 2002, and therefore were not included in the computation of
diluted earnings per share.
The following options to purchase shares of common stock were outstanding during
each of the following periods, but were also not included in the computation of
diluted earnings per share because the options' exercise price was greater than
the average market price of the common shares for the respective periods and,
therefore, the effect would be anti-dilutive.
Three Months Nine Months
Ended September 30, Ended September 30,
-------------- -------------- -------------- -------------
2002 2001 2002 2001
-------------- -------------- -------------- -------------
Average number of options (in thousands) 2,113 823 2,120 805
Weighted-average exercise price $ 4.80 $ 7.76 $ 4.82 $ 8.03
Basic earnings per share excludes dilution and is computed by dividing income
available to common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock, or if restricted shares of common
stock were to become fully vested.
The Old Debentures due October 1, 2002 outstanding during the periods presented
were not included in the computation of diluted earnings per share because the
conversion price of $24.00 per share was greater than the average market price
of the common shares for the respective periods and, therefore, the effect would
be anti-dilutive.
The average market price of the Company's common stock outstanding during the
nine months ended September 30, 2002 was greater than the $2.25 per share
conversion price 10% Series B Notes. However, the common shares were not
included in the computation of diluted earnings per share for the three or nine
months ended September 30, 2002 because the Company had a loss from continuing
operations and therefore, the effect would be anti-dilutive. At September 30,
2002, the Series B Notes were convertible into 7,091,342 shares of common stock.
4. LONG TERM DEBT AND OTHER FINANCING TRANSACTIONS
The completion of the Refinancing Plan made significant changes in the Company's
long-term debt. The following information is presented to show the various
changes that have occurred since December 31, 2001. The Company's long-term debt
at September 30, 2002 and December 31, 2001 is presented below (in thousands):
10
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
Note payable bearing interest at a fixed rate of 19.5%
Interest at 9% (increasing 0.55% annually after April 1, 2004) of the 19.5%
fixed interest is payable quarterly with principal and unpaid interest due on
September 30, 2007. The loan is secured by a first-priority security interest in
the borrower subsidiary's ownership interests $112,750 $ --
Mortgage note payable bearing interest at a fixed rate of 8.2%. Interest is due
monthly with principal and unpaid interest due at maturity on May 31, 2005. The
loan is secured by certain land, buildings, equipment,
and assignment of rents and leases 62,020 62,330
Mortgage note payable bearing interest at the rate of LIBOR plus one hundred
basis points (7.25% at September 30, 2002). Interest and principal is payable
monthly and the loan matures on March 31, 2017. The loan is
secured by certain land and buildings 41,744 --
Mortgage note payable bearing interest at the greater of LIBOR plus 3.95% or
6.75% (6.75% at September 30, 2002). Interest and principal is payable monthly
and the loan matures on May 1, 2005. The loan is secured by
certain land and buildings 33,204 --
Note payable bearing interest at a fixed rate of 3.13%. Interest and principal
of $279,994 is due monthly with final payment due on July 31, 2012. The note is
secured
by certain land, buildings, equipment 30,534 --
Mortgage note payable bearing interest at fixed rate of 7.55%. Interest and
principal of $244,400 is due monthly with remaining principal and unpaid
interest due February 28, 2017. The note is secured by certain
land, buildings, and equipment 27,224 --
Note payable bearing interest at a fixed rate equal to 8.27%. Interest and
principal of $218,750 is due monthly with final payment due March 31, 2017. The
note is
secured by certain land, buildings, equipment 24,734 --
Mortgage note payable bearing interest at fixed rate of 7.93%. Interest and
principal of $172,975 is due monthly with remaining principal and unpaid
interest due November 1, 2006. The note is secured by certain land,
buildings, and equipment 19,823 20,171
Mortgage note payable bearing interest at the rate of 4% plus the greater of
LIBOR or 3.25% (7.25% at September 30, 2002). Interest and principal is payable
monthly and the loan matures on July 1, 2007. The loan is
secured by certain land and buildings 18,460 --
11
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
Note payable bearing interest at a fixed rate of 9.37%. Interest and principal
of $170,625 is due monthly with final payment due on March 31, 2017. The note is
secured by certain land, buildings, equipment 18,040 --
Mortgage note payable bearing interest at a fixed rate of 8.50%. Principal and
interest of $144,956 is due monthly with remaining principal and unpaid interest
due on December 10, 2024. The note is secured by certain land, buildings,
equipment, and assignment of rents and leases 17,359 17,550
Note payable bearing interest at fixed rate of 9.575%, interest is due monthly
with principal and unpaid interest due on October 1, 2008. The note is secured
by the Company's interest in certain land, buildings, equipment 17,239 17,239
Convertible debentures bearing interest at a fixed rate of 10.00%. Interest is
due semi-annually on April 1 and October 1 through April 1, 2008, at which time
all principal is due 15,956 --
Mortgage note payable bearing interest at a fixed rate of 8.41%. Principal and
interest of $110,223 is due monthly with remaining principal and unpaid interest
due on September 7, 2005. The note is secured by certain land, buildings,
equipment, and assignment of rents and leases 15,129 15,160
Mortgage note payable bearing interest at a fixed rate of 7.43%. Principal and
interest of $80,864 is due monthly with remaining principal and unpaid interest due
on January 10, 2024. The note is secured by certain land, buildings, equipment,
and assignment of rents and leases 11,993 11,939
Mortgage note payable bearing interest at a fixed rate of 9.50%. Principal and
interest of $104,844 is due monthly with remaining principal and unpaid interest
due on June 10, 2025. The note is secured by certain land,
buildings, equipment, and assignment of rents and leases 11,705 11,810
Mortgage note payable bearing interest at a fixed rate of 6.50%. Principal and
interest of $64,524 is due monthly with remaining principal and unpaid interest
due on January 1, 2037. The note is secured by certain land, buildings,
equipment, and assignment of rents and leases 10,625 10,680
12
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
Mortgage note payable bearing interest at a floating rate equal to two hundred
twenty-five basis points in excess of the LIBOR rate recalculated each month
(8.00% at September 30, 2002). Interest is due monthly with principal due at
maturity on January 1, 2004. The loan is secured by certain land and buildings 9,512 11,037
Convertible debentures bearing interest at a fixed rate of 5.75%. Interest is
due semi-annually on April 1 and October 1 through October 1, 2002, at which
time all principal is due -- 132,930
Term loan bearing interest at the rate of LIBOR plus three hundred basis points
(6.75% at December 31, 2001). Interest only is payable monthly and the loan
matures on November 2, 2002. The note is secured by certain land, buildings,
equipment, and assignment of
rents and leases -- 81,645
Mortgage note payable bearing interest at a fixed rate of 6.87%. Principal and
interest of $262,747 is due monthly with remaining principal and unpaid interest
due on July 31, 2008. The note is secured by certain land,
buildings, equipment, and assignment of rents and leases -- 33,061
Mortgage note payable bearing interest at a floating rate equal to three hundred
basis points in excess of the LIBOR rate (5.28% at December 31, 2001). Interest
and principal, amortized over 25 years, is due monthly with balloon maturity on
April 1, 2003. The loan is secured by certain land, buildings, equipment, and
assignment of rents and leases -- 22,752
Revolving line of credit in the amount of $50.0 million bearing interest at the
rate of LIBOR plus one hundred seventy-five basis points (4.19% at December 31,
2001). Interest only is payable monthly and the loan matures on December 31,
2002. The loan is secured by certain land
and buildings -- 20,409
Mortgage note payable bearing interest at a floating rate equal to three hundred
twenty-five basis points in excess of LIBOR rate (5.12% at December 31, 2001)
Interest and principal, amortized over 25 years, is due monthly with balloon
maturity on July 1, 2002. The loan is secured by certain land buildings, equipment -- 17,078
13
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
Mortgage note payable bearing interest at floating rate equal to three hundred
fifty basis points in excess of the LIBOR rate (6.27% at December 31, 2001)
Interest and principal is due monthly with remaining principal and unpaid
interest due October 1, 2003. The note is secured by certain land, buildings,
and equipment -- 12,965
Various mortgage notes payable, generally payable
monthly with interest rates ranging from 4.31% to 10.25% 40,025 41,206
Other long-term debt, generally payable monthly with
interest rates ranging from 3.25% to 8.12% 10,654 21,315
Capital leases 525 794
Total long-term debt 549,201 562,125
Less current portion 13,965 371,667
Less debt associated with assets held for sale 35,829 --
Long-term debt, excluding current portion $499,407 $190,458
The aggregate scheduled maturities of long-term debt were as follows (in
thousands):
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
Year 1 $ 13,965 $371,667
Year 1, debt associated with assets held for sale 35,829 --
Year 2 68,961 36,770
Year 3 103,027 7,537
Year 4 7,432 16,739
Year 5 142,469 1,938
Thereafter 177,518 127,474
$549,201 $562,125
In addition to the scheduled maturities of long-term debt, the Company will be
required to pay all accrued but unpaid interest on the HCPI Loan and Series B
Notes (assuming the Company elects to defer 2% of this interest) at their
maturity or earlier repayment. The HCPI Loan and Series B Notes accrued
interest for the upcoming four quarters will be approximately $13.0 million.
This balance will increase each year as another year of interest is accrued but
unpaid, plus the compounding of interest on amounts previously accrued.
During the three months ended September 30, 2002, the Company entered into
various financing transactions, which are described below and included within
the summary set forth above.
On July 1, 2002 the Company replaced $18.8 million of mortgage debt related to
two communities due August 31, 2002 with an $18.5 million mortgage note bearing
interest at the greater of 7.25% or 4% above 30-day LIBOR. Principal and
interest are due monthly with remaining principal and unpaid interest due July
1, 2007. The Company purchased an interest rate cap agreement with a notional
amount of $18.5 million for a fee of $106,000, which would limit the Company's
interest expense if 30-day LIBOR should exceed 6.5% during the term of the
mortgage. The Company used the proceeds from the replacement mortgage note to
repay the remaining $18.8 million balance outstanding under the Company's $95
million revolving credit facility and in the process, terminated a synthetic
lease and became the owner of the previously leased assets including $12.3
million of property and equipment. The $18.5 million note is secured by certain
land, buildings, and equipment affiliated with a community in Arizona. The
community has 289 units, of which 162 are independent living, 70 are assisted
living, 15 are memory enhanced and 42 are skilled nursing.
14
On July 11, 2002 the Company terminated synthetic leases on two communities in
South Carolina and Arizona and the Company became the owner of each community.
The termination of the synthetic leases facilitated the Company simultaneously
selling and leasing-back these communities and certain others on the same date
(see below). The Company did not incur any cash costs in connection with the
termination of the synthetic leases other than transaction costs.
On July 11, 2002 the Company sold for $56.5 million three retirement centers in
Arizona, Colorado, and Texas and two Free-standing ALs in South Carolina and
Florida. The Company used a portion of the sale proceeds to repay debt
associated with the properties. The Company contemporaneously leased these
properties back from the buyer under a master lease agreement. The leases are
classified as operating leases, with the exception of the retirement center in
Colorado which, due to a purchase option, is recorded as a capital lease.
Accordingly, the Company recorded $30.1 million of the Colorado lease obligation
as debt. In addition, the Company recorded $1.9 million of loss on sale related
to the Florida Free-standing AL. Note that this lease agreement additionally
includes other communities previously leased by the Company from the lessor.
On July 11, 2002 the Company modified the February 7, 2002 master lease
agreement which included 11 communities, one Retirement Center and ten
Free-standing ALs, into two new master lease agreements (Pool I and Pool II).
The Pool I lease agreement includes one Retirement Center and six Free-standing
ALs from the original lease, as well as two additional Retirement Centers from
the July 11, 2002 sale discussed above. The Pool II lease agreement includes
four Free-standing ALs from the original lease, as well as one Retirement Center
and two Free-standing ALs from the July 11, 2002 sale leaseback transaction
discussed above. Pool I is a 12-year lease with four ten-year renewal options
and the Company has the right of first refusal to repurchase the communities.
Pool II is a 10-year lease with four ten-year renewal options and the Company
has the right of first refusal to repurchase the communities. These master
leases will be treated as operating leases for financial reporting purposes,
with the exception of the retirement community in Colorado as noted above.
On July 18, 2002, the Company refinanced $25.7 million of mortgage debt on three
communities and two land parcels. Under the terms of the new mortgage debt
agreements, previous maturities ranging from 2002 to 2006 were amended to 2004
and certain financial covenants were eliminated or amended. Measurement of the
modified covenants began on September 30, 2002.
On July 26, 2002, the Company terminated synthetic leases on three Free-standing
AL's in Texas and the Company became the owner of each community, resulting in
an aggregate increase of property and equipment of $42.2 million and the
assumption of $31.0 of mortgage debt. The Company did not incur any cash costs
in connection with the termination of the synthetic leases other than
transaction costs. Simultaneously, the Company extended and modified an existing
$11.0 million mortgage note and refinanced $33.7 million of mortgage debt on
these three communities. The original maturities were extended to 2004, and
certain existing financial covenants were amended, the measurement of which
began on September 30, 2002. Interest on the notes increased from 6.75% to
7.25%.
On September 30, 2002, the Company completed the Exchange Offer, as well as the
HCPI Transactions (see note 2).
As a result of completed and anticipated transactions under the Refinancing
Plan, the Company has expensed losses from 11 of 16 sale lease-back transactions
of $30.8 million for the nine months ended September 30, 2002, including $0.6
million during the quarter ended September 30, 2002, $7.0 million during the
quarter ended June 30, 2002, and $23.2 million during the quarter ended March
31, 2002. In addition, the Company recorded losses of $7.9 million during the
quarter ended December 31, 2001 bringing the total losses on the sale lease-back
Refinancing Plan transactions to $38.7 million. For financial reporting
purposes, these losses are considered residual value guarantee amounts
associated with prior leases that were terminated as pre-conditions to the sale
lease-back transactions and have been fully recognized as lease expense. The
Company does not expect to incur any additional residual value guarantee losses.
Note that the Company has recorded deferred gains of $17.0 million on the other
5 of 16 sale-leaseback transactions, which is being amortized over the 15 year
term of the lease, increasing the Company's deferred gain on sale lease-back
transactions to $28.3 million.
In addition, due to the shorter than expected remaining life of the prior leases
terminated in connection with the sale lease-back transactions, the Company
accelerated the amortization of leasehold acquisition costs beginning in the
15
fourth quarter of 2001. As a result of this acceleration, the Company recorded
additional amortization costs of $472,000 during the quarter ended December 31,
2001, $6.5 million during the quarter ended March 31, 2002, and $2.3 million
during the quarter ended June 30, 2002, bringing the total amount of accelerated
amortization related to these sale lease-back transactions to $9.3 million, $8.8
million of which was recognized during the nine months ended September 30, 2002.
During the three months ended September 30, 2002 the Company terminated
synthetic leases on six communities in Texas, Florida, Ohio and Pennsylvania and
the Company became the owner of each community. The Company did not incur any
cash costs in connection with the termination of these synthetic leases other
than transaction costs, but acquired $142.6 million of fixed assets, in return
for $30.5 million of notes receivable and $25.5 million of restricted assets,
and assumed $47.7 million of entrance fee liabilities and $45.6 million of
long-term debt.
Effective as of September 30, 2002, the Company obtained a waiver of certain
financial covenants under one Free-standing AL's lease agreement. See note 2.
5. ASSET IMPAIRMENTS AND CONTRACTUAL LOSSES
During the nine months ended September 30, 2002, the Company recorded $2.6
million of impairment related delayed or discontinued developments and financing
transactions, as discussed below.
The Company has two parcels of land upon which senior living communities were to
be expanded. Each project was in the early stage of development, with activity
in process consisting primarily of zoning permits, completing architectural
drawings and site testing. To date, each of these projects has been subject to
various delays. During the third quarter of 2002, the Company further delayed
the development and completion of each of these projects. As a result of these
additional delays related to the various projects and the completion of the
Refinancing Plan, the Company has recorded a charge of approximately $2.0
million during the quarter ended September 30, 2002, related to various
development costs previously incurred on these two projects, resulting in a
reduction in their net carrying value from $10.6 million to $8.6 million. The
two land parcels are classified as assets held for sale at September 30, 2002.
In late August 2002, the Company determined that assets acquired in 2001 as part
of a like-kind exchange, specifically land in Virginia and land and buildings
associated with the equity interests in a single member limited liability
company that the Company acquired during 2001, would be placed for sale. The
value of the land and buildings as of September 30, 2002, net of accumulated
depreciation, is $28.0 million. As of September 30, 2002, the Company has a
$12.0 million non-recourse mortgage loan bearing interest at 7.43% with
principal due monthly, and a maturity date of January 2024 and a $15.1 million
non-recourse mortgage loan, with interest at 8.41% and principal and interest
due monthly, and a maturity date of September 2005, respectively, related to
these assets. The Company acquired the various land parcels subject to lease
agreements that provide annual rental payments of $980,000 through February 23,
2023 and $1.3 million through March 7, 2022, respectively. These assets and
liabilities were classified as held for sale as of September 30, 2002. The
Company has evaluated the estimated sales prices of the land parcels and
buildings for impairment and recorded $537,000 of impairment during the quarter
ended September 30, 2002. The Company will continue to evaluate the land parcels
and buildings for impairment. The results of operations for these assets and
liabilities classified as held for sale for both the current year and
comparative prior periods have not been reclassified to discontinued operations
within the accompanying condensed consolidated financial statements based on the
overall insignificance of these results to the Company.
6. DISCONTINUED OPERATIONS
During the quarter ended September 30, 2002, the Company determined that assets
acquired through the termination of a synthetic lease on a Free-standing AL
would be held for sale. The Company expects to sell the community for $9.5
million. As part of the sales agreement, the Company will pay off its related
mortgage debt. Based upon this purchase price, the Company has recorded $5.9
million of impairment as discontinued operations during the quarter ended
September 30, 2002 and classified the assets and liabilities as held for sale.
The results of operations for these assets and liabilities classified as held
for sale for both the current year and comparative prior periods have not been
reclassified to discontinued operations within the accompanying condensed
consolidated financial statements based on the overall insignificance of these
results to the Company.
16
7. SEGMENT INFORMATION
The Company has significant operations principally in two industry segments: (1)
Retirement Centers and (2) Free-standing ALs. Retirement Centers represent 31 of
the Company's senior living communities and provide a continuum of care services
such as independent living, assisted living and skilled nursing care.
Free-standing ALs represent 34 of the Company's senior living communities and
primarily provide assisted living and specialized care such as Alzheimer's and
memory enhancement programs in Free-standing ALs averaging approximately 90
units.
The Company evaluates its performance in part based upon EBITDAR, which is
defined as earnings before net interest expense, income tax expense (benefit),
depreciation, amortization, rent, and charges related to asset impairments,
equity in losses of managed special purpose entity communities, other income
(expense), minority interest, and extraordinary items. The following is a
summary of total revenues, EBITDAR, operating (loss) income and total assets by
segment for the three and nine months ended September 30, 2002 and 2001 (in
thousands).(1)(2)(3)
THREE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30 $ %
2002 2001 CHANGE CHANGE
------------ ----------- -------- -------
Revenues:
Retirement Centers $ 63,390 $ 54,893 $ 8,497 15.48%
Free-standing ALs 20,526 9,927 10,599 106.77%
Corporate/Other 1,630 2,627 (997) (37.95%)
-------- -------- -------- -------
Total $ 85,546 67,447 $ 18,099 26.83%
======== ======== ======== =======
EBITDAR $ 14,142 $ 13,123 $ 1,019 7.77%
Net Operating Income (Loss):
Retirement Centers $ 20,392 $ 18,309 $ 2,083 11.38%
Free-standing ALs 2,379 (158) 2,537 1605.70%
Corporate/Other(3) (11,140) (5,028) (6,122) (121.56%)
-------- -------- -------- -------
Net Operating Income $ 11,631 $ 13,123 $ (1,492) (11.37%)
Lease expense (4) 11,168 7,217 3,951 54.75%
Depreciation and Amortization (5) 5,418 5,332 86 1.61%
-------- -------- -------- -------
Operating income $ (4,955) $ 574 $ (5,529) (963.24%)
======== ======== ======== =======
NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30 $ %
2002 2001 CHANGE CHANGE
------------ ----------- -------- -------
Revenues:
Retirement Centers $ 182,883 $ 160,642 $ 22,241 13.85%
Free-standing ALs 57,073 26,255 30,818 117.38%
Corporate/Other 5,002 7,701 (2,699) (35.05%)
--------- --------- -------- -------
Total $ 244,958 $ 194,598 $ 50,360 25.88%
========= ========= ======== =======
EBITDAR $ 45,456 $ 39,719 $ 5,737 14.44%
Net Operating Income (Loss):
Retirement Centers $ 61,576 $ 56,636 $ 4,940 8.72%
Free-standing ALs 4,993 (1,120) 6,113 545.80%
Corporate/Other(3) (23,674) (15,797) (7,877) (49.87%)
--------- --------- -------- -------
Net Operating Income $ 42,895 $ 39,719 $ (3,176) (8.00%)
Lease expense (4) 62,231 20,668 41,563 201.10%
Depreciation and Amortization (5) 26,066 15,619 10,447 66.89%
--------- --------- -------- -------
Operating income $ (45,402) $ 3,432 $(48,834) (1422.90%)
========= ========= ======== =======
17
SEPTEMBER 30 DECEMBER 31, $ %
2002 2001 CHANGE CHANGE
------------ ------------ -------- -----
Total Assets:
Retirement Centers $546,908 $509,732 $ 37,176 7.29%
Free-standing ALs 217,594 241,069 (23,475) (9.74%)
Corporate/Other 95,684 99,390 (3,706) (3.73%)
-------- -------- -------- ----
Total $860,186 $850,191 $ 9,995 1.18%
======== ======== ======== ====
(1) Segment data does not include any inter-segment transactions or
allocated costs.
(2) EBITDAR, is defined as earnings before net interest expense, income tax
expense (benefit), depreciation, amortization, rent, asset impairments,
equity in losses of communities that are managed by the Company and
owned by special purpose entities, other income (expense), minority
interest, and extraordinary items. While EBITDAR is not GAAP
measurements, the Company believes it is relevant in analyzing its
operating results.
(3) Corporate/other revenues represent the Company's development and
management fee revenues. Corporate/Other NOI includes operating
expenses related to corporate operations, including human resources,
financial services, and information systems, as well as senior living
network and assisted living management costs. Increases in
Corporate/Other expenses result from increases in insurance related
accruals, including self-insured employee medical coverage, general and
professional liability claims, workers' compensation costs, as well as
substantial costs related to the Refinancing Plan.
(4) Includes $600,000 and $30.8 million of additional lease expense for the
three and nine months ended September 30, 2002 as a result of sale
lease-back transactions. See note 4 to the condensed consolidated
financial statements.
(5) Includes $8.8 million of additional amortization expense for the nine
months ended September 30, 2002 as a result of sale lease-back
transactions. There was no additional amortization expense related to
sale lease-back transactions for the three months ended September 30,
2002. See note 4 to the condensed consolidated financial statements.
8. COMMITMENTS AND CONTINGENCIES
The Company is subject to various legal proceedings and claims that arise in the
ordinary course of its business. In the opinion of management, the ultimate
liability with respect to those proceedings and claims will not materially
affect the financial position, operations, or liquidity of the Company. The
Company maintains commercial insurance on a claims-made basis for medical
malpractice and professional liabilities.
Insurance
The delivery of personal and health care services entails an inherent risk of
liability. In recent years, participants in the senior living and health care
services industry have become subject to an increasing number of lawsuits
alleging negligence or related legal theories, many of which involve large
claims and result in the incurrence of significant defense costs and significant
exposure. As a result, the Company has significantly increased the staff and
resources involved in quality assurance, compliance, and risk management. The
Company currently maintains property, liability, and professional medical
malpractice insurance policies for the Company's owned, leased and certain of
its managed communities under a master insurance program. The number of
insurance companies willing to provide general and professional liability
insurance for the nursing and assisted living industry has declined dramatically
and the premiums and deductibles associated with such insurance have risen
substantially in recent years.
The Company renewed its liability policy effective January 1, 2002, expiring
December 31, 2002, paying increased premiums and continuing the high deductible
levels (ranging from $200,000 to $3,000,000). The Company also has underlying
and umbrella excess liability protection policies in the amount of up to $25.0
million in the aggregate. During the nine months ended September 30, 2002, the
Company paid $385,000 of property, liability, and professional medical
malpractice insurance claims. Additionally, the Company has accrued amounts to
cover open claims not yet settled and incurred but not reported claims as of
September 30, 2002 of $4.8 million, which management believes are adequate.
The Company has operated under a workers' compensation self-insurance program
with excess loss coverage provided by third party carriers since July 1995.
During July 2002, the Company renewed its self-insurance for workers'
compensation claims with excess loss coverage of $350,000 per individual claim
and approximately $7.25 million in the aggregate. The Company currently provides
letters of credit in the aggregate amount of $4.1 million related to this
program, which is reflected as assets limited as to use on the balance sheet.
The Company utilizes a third party administrator to process and pay filed
claims. During the nine months ended September 30, 2002, the
18
Company has paid $2.1 million of workers' compensation claims. The Company has
accrued amounts to cover open claims not yet settled and incurred but not
reported claims as of September 30, 2002 of $3.6 million, which management
believes are adequate.
On January 1, 2002, the Company became self-insured for employee medical
coverage. The Company maintains stop loss insurance coverage of approximately
$150,000 per employee and approximately $17.7 million for aggregate calendar
2002 claims. Estimated costs related to these self-insurance programs are
accrued based on known claims and projected settlements of unasserted claims
incurred but not yet reported to the Company. Subsequent changes in actual
experience (including claim costs, claim frequency, and other factors) could
result in additional costs to the Company. During the nine months ended
September 30, 2002, the Company has paid $7.2 million of employee medical
insurance claims. The Company has accrued amounts to cover open claims not yet
settled and incurred but not reported claims as of September 30, 2002 of $2.9
million, which management believes are adequate.
Leases
As of September 30, 2002, the Company operated 35 of its senior living
communities under long-term leases. Of the 35 communities, 16 are operated under
a master lease agreement, with the remaining communities leased under individual
agreements. The Company also leases its corporate offices and is obligated under
a ground lease for a senior living community purchased during 2001. The
remaining base lease terms vary from five to 22 years. Certain of the leases
provide for renewal and purchase options.
Synthetic Leases
At September 30, 2002, the Company operated a single Free-standing AL under a
lease which is treated as an operating lease for financial reporting purposes
and a financing lease for income tax purposes (synthetic lease). As of September
30, 2002, the Company had approximately $8.7 million of assets related to the
community being operated under a synthetic lease (including $5.4 million of
security deposits and $3.3 million of land). The Company did not guarantee the
$3.3 million of third party lessor debt associated with the community. This
lease provides the Company with termination rights whereby the Company can
terminate the lease and acquire the property at predetermined amounts in
exchange for assuming the lessors' debt and repaying the lessors' equity.
Effective November 1, 2002, the Company terminated its final synthetic lease and
became the owner of the community for financial reporting purposes. As a result,
the Company's property, plant and equipment will increase by $8.7 million and
debt will increase $3.3 million. The Company did not incur any cash costs in
connection with the termination of the synthetic leases other than transaction
costs. See notes 4 and 10.
Other
A portion of the Company's skilled nursing revenues are attributable to
reimbursements under Medicare. Certain temporary rate add-ons for the Company's
skilled nursing reimbursement rates under the Prospective Payment System expired
October 1, 2002. It is uncertain at this time whether any extension of these
add-ons or some portion of the add-on reimbursement rates will be approved by
Congress. Failure to extend the current rate add-ons will negatively impact
future revenues of the Company, beginning with the fourth quarter of calendar
2002, by approximately $400,000 per quarter. In addition, certain per person
annual limits on therapy services, which have been temporarily suspended, will
become effective again on January 1, 2003, unless Congress takes additional
action before that date. Such limits are not expected to have a significant
impact on the Company.
9. NEW ACCOUNTING PRONOUNCEMENTS
On July 30, 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards Statement No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities" (SFAS No. 146). The standard
replaces Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)" and requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of a commitment to an exit or disposal
plan. Examples of costs covered by the standard include lease termination costs
and certain employee severance costs that are associated with a
19
restructuring, discontinued operation, plant closing, or other exit or disposal
activity. SFAS 146 is effective prospectively to exit or disposal activities
initiated after December 31, 2002.
In November 2001, the EITF reached a consensus on Issue 01-14, "Income Statement
Characterization of Reimbursements Received for `Out-of Pocket' Expenses
Incurred" ("EITF 01-14"), which became effective on January 1, 2002. Under EITF
01-14, certain reimbursements received for out-of-pocket expenses incurred as
part of its management agreements should be characterized as revenue and the
associated costs be included as operating expenses in the income statement. Upon
adoption of EITF 01-14, comparative financial statements for prior periods
should be reclassified to comply with the current presentation. The Company
typically incurs various expenses which may include payroll, insurance and
benefit related cost and other management related costs in association with its
managed communities. Such costs are billed to and reimbursed by the owners of
the respective communities. The Company implemented EITF 01-14 during the
quarter ended June 30, 2002 and as required, has also reclassified comparative
prior period financial information. The implementation of EITF 01-14 resulted
only in the equal gross up of revenues and expenses and did not have any impact
on the net loss in any reported period. The effect of the adoption of EITF 01-14
by the Company was to increase total revenues and total operating expenses by
$1.2 million and $1.4 million and $3.8 million and $4.8 million for the three
and nine months ended September 30, 2002 and 2001, respectively.
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 141 addresses financial accounting and reporting for business
combinations requiring the use of the purchase method of accounting and
reporting for goodwill and other intangible assets requiring that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 requires intangible assets with
definite useful lives be amortized over their respective useful life to their
estimated residual values, and reviewed for impairment. As of September 30,
2002, the Company had $36.5 million of goodwill. Amortization expense related to
goodwill was approximately $757,000 for the nine months ended September 30,
2001, or $0.04 per dilutive share. The Company adopted SFAS No. 142 on January
1, 2002. Accordingly, effective January 1, 2002, the Company no longer amortizes
goodwill. Goodwill amortization expense for the three and nine months ended
September 30, 2001 was $252,000 and $757,000, respectively. Goodwill
amortization expense was $0, $486,000 and $1.0 million for the years ended 1997,
1998, and 1999 through 2001, respectively. Basic and diluted earnings per share,
excluding the impact of prior periods' goodwill amortization expense, are as
follows:
Three Nine
Year Ended December 31, ----- -----
---------------------------------------- Months Ended
1997 1998 1999 2000 2001 September 30, 2001
---- ---- ---- ---- ---- ------------------
Basic earnings (loss) per share from continuing
operations before extraordinary item and
cumulative effect of change accounting principle $0.71 $0.18 $(0.28) $(1.97) $(0.24) $(0.63)
Basic earnings per share $0.53 $0.18 $(0.28) $(1.97) $(0.24) $(0.65)
Pro forma basic earnings per share before
extraordinary item available for distribution
to partners and shareholders $0.36
Diluted earnings (loss) per share from continuing
operations before extraordinary item and
cumulative effect of change in accounting principle $0.70 $0.18 $(0.28) $(1.97) $(0.24) $(0.63)
Diluted earnings per share $0.53 $0.18 $(0.28) $(1.97) $(0.24) $(0.65)
Pro forma diluted earnings per share before
extraordinary item available for distribution
to partners and shareholders $0.35
With the adoption of SFAS No. 142, the Company has reassessed the useful lives
and residual values of all intangible assets acquired in purchase business
combinations, and has determined that no amortization period
20
adjustments are required. As of September 30, 2002, the Company has not
identified any intangible assets with indefinite useful lives, other than
goodwill.
The transitional provisions of SFAS No. 142 require the Company to perform an
assessment of whether there is an indication that goodwill is impaired as of
the date of adoption. To accomplish this, the Company must identify its
reporting units and determine the carrying value of each reporting unit by
assigning the assets and liabilities, including the existing goodwill and
intangible assets, to those reporting units as of the date of adoption. For
purposes of allocating and evaluating goodwill and intangible assets, the
Company considers retirement centers and Free-standing AL's as its reporting
units. All recorded goodwill as of the date of adoption was attributable to the
retirement centers reporting unit. The Company has up to six months from the
date of adoption to determine the fair value of each reporting unit and compare
it to the reporting unit's carrying amount. To the extent a reporting unit's
carrying amount exceeds its fair value, an indication exists that the reporting
unit's goodwill may be impaired and the Company must perform the second step of
the transitional impairment test. The Company has completed step one and
determined that the fair value of its reporting units exceeded the net book
value, thus indicating goodwill is not impaired. Accordingly, the Company has
not performed the second step. The required annual impairment assessment will
be performed during the fourth quarter of 2002.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which supersedes both SFAS No. 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30,
Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions, for the disposal of a segment of a business (as
previously defined in APB Opinion No. 30). SFAS No. 144 retains the fundamental
provisions in SFAS No. 121 for recognizing and measuring impairment losses on
long-lived assets held for use and long-lived assets to be disposed of by sale,
while also resolving significant implementation issues associated with SFAS No.
121. For example, SFAS No. 144 provides guidance on how a long-lived asset that
is used as part of a group should be evaluated for impairment, establishes
criteria for when a long-lived asset is held for sale, and prescribes the
accounting for a long-lived asset that will be disposed of other than by sale.
SFAS No. 144 retains the basic provisions of APB Opinion No. 30 on how to
present discontinued operations in the income statement but broadens that
presentation to include a component of an entity (rather than a segment of a
business). Unlike SFAS No. 121, an impairment assessment under SFAS No. 144
will never result in a write-down of goodwill. Rather, goodwill is evaluated
for impairment under SFAS No. 142.
The Company adopted SFAS No. 144 on January 1, 2002. The adoption had no
material impact on the Company's current year financial statements because the
impairment assessment under SFAS No. 144 is largely unchanged from SFAS No.
121.
10. SUBSEQUENT EVENTS
On November 1, 2002 the Company sold for $8.9 million a Free-standing AL in
Tennessee. The Company used a portion of the sales proceeds to repay debt
associated with the property. The Company contemporaneously leased this
property back from the buyer. The Company also entered into a contingent
earn-out agreement with respect to this community pursuant to which the Company
may receive up to $1.8 million, depending upon the future performance of the
community. For financial reporting purposes, this transaction was recorded as a
financing transaction, resulting in the recording of $10.1 million of future
lease obligations as debt.
Effective November 1, 2002 the Company terminated its final remaining synthetic
lease on a Free-standing AL community in Florida and the Company became the
owner of the community for financial reporting purposes. The Company did not
incur any cash costs in connection with the termination other than transaction
costs.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
American Retirement Corporation is a national senior living and health care
services provider offering a broad range of care and services to seniors within
a residential setting. The range of the Company's services include independent
living ("IL"), assisted living ("AL"), memory enhancement services, with
special programs and living units for residents with Alzheimer's and other
forms of dementia ("ME") and skilled nursing ("SNF") services. The Company's
operations are divided into two segments: (1) Retirement Centers and (2)
Free-standing assisted living residences ("Free-standing AL's").
The Retirement Centers are well-established communities with strong reputations
within their respective markets, and generally maintain high and consistent
occupancy levels, most with waiting lists of prospective residents. The
Retirement Centers are of two basic types: (i) continuing care retirement
communities ("CCRC's") that provide a full continuum of IL, AL, and SNF
services; and (ii) congregate living communities which offer IL and AL, but do
not provide SNF services. The majority of the Company's Retirement Centers
operate under a monthly service fee pricing structure (the "MSF Retirement
Centers".) In addition, six of the Company's CCRC's are entrance fee
communities (the "EF Communities"), which provide housing and health care
services through limited lifecare contracts and entrance fee agreements with
residents. Under these agreements, in addition to monthly service fees, at
initial occupancy the residents also pay entrance fees that average
approximately $158,000 per independent living unit.
The Company's Retirement Centers form the core segment of the Company's
business and comprise 31 of the 65 communities that the Company operates or
manages, with approximately 9,700 units, representing approximately 75% of the
total unit capacity of the Company's communities (including Freedom Square, a
736 unit EF Community that the Company operates under a long-term management
contract that functions economically like a lease). At both September 30, 2002
and 2001, the Company's Retirement Centers had occupancy rates of 93%.
The Company's Free-standing ALs provide specialized assisted living care to
residents in a comfortable residential atmosphere. Free-standing ALs are much
smaller than Retirement Centers and are stand-alone communities that are not
located on a Retirement Center campus. Due to their smaller size, they provide
a very personal interaction with the resident and their family. They provide
personalized care plans for each resident, extensive activity programs, and
access to therapy or other services as needed. Most of the Free-standing ALs
also provide specialized care such as alzheimer's, memory enhancement and other
dementia programs. The Company's portfolio of Free-standing AL's is currently
in the process of completing its fill-up stage, and the average occupancy of
its Free-standing AL's increased from 62.0% as of September 30, 2001 to 79.5%
as of September 30, 2002.
The Company developed and acquired a number of Free-standing ALs, most of which
began operations during 1999 and 2000. Although the Company ceased to initiate
new development of Free-standing ALs as of late 1999, it completed a number of
AL's that were already in development and opened them during 2000 and early
2001. The Company's community operating results include Free-standing ALs that
the Company owns or leases, excluding two joint ventures. The number of
Free-standing ALs included in the Company's consolidated operations grew from
23 at September 30, 2001 to 34 at September 30, 2002 as a result of
acquisitions of Free-standing ALs and leasehold interests of various
communities that were managed by the Company and owned by special purpose
entities ("Managed SPE Communities"), including leasehold interests in 11
Managed SPE Communities acquired as of December 31, 2001.
The tables below segregate the Company's portfolio of communities by business
segment, listing the number of communities owned, leased or managed within each
segment, and the unit capacity and occupancy as of September 30, 2002 and
December 31, 2001.
22
SEPTEMBER 30, 2002
---------------------------------------------------------------------------------------
# OF IL AL ME SNF TOTAL
COMMUNITIES UNITS UNITS UNITS UNITS UNITS OCCUPANCY
--------------- ------- ------- -------- -------- -------- -----------
Retirement Centers:
Owned 11 2,430 416 99 476 3,421 93.9%
Leased 14 2,881 568 96 655 4,200 94.9%
Managed 6 1,298 285 156 362 2,101 89.5%
-- ----- ----- --- ----- ----- -----
Sub-total 31 6,609 1,269 351 1,493 9,722 93.4%
-- ----- ----- --- ----- ----- -----
Free-standing ALs:
Owned 13 76 876 273 - 1,225 71.6%
Leased 21 15 1,494 351 90 1,950 84.5%
Managed - - - - - - -
-- ----- ----- --- ----- ----- -----
Sub-total 34 91 2,370 624 90 3,175 79.5%
-- ----- ----- --- ----- ----- -----
Total 65 6,700 3,639 975 1,583 12,897 90.0%
== ===== ===== === ===== ====== ====
DECEMBER 31, 2001
---------------------------------------------------------------------------------------
# OF IL AL ME SNF TOTAL
COMMUNITIES UNITS UNITS UNITS UNITS UNITS OCCUPANCY
--------------- ------- ------- -------- -------- -------- -----------
Retirement Centers:
Owned 16 3,157 621 119 656 4,553 93.7%
Leased 8 1,801 358 38 316 2,513 94.9%
Managed 7 1,529 295 194 524 2,542 89.8%
-- ----- ----- --- ----- ----- -----
Sub-total 31 6,487 1,274 351 1,496 9,608 93.0%
-- ----- ----- --- ----- ----- -----
Free-standing ALs:
Owned 8 41 469 170 - 680 59.9%
Leased 25 57 1,838 421 90 2,406 66.1%
Managed 1 - 57 25 - 82 82.9%
-- ----- ----- --- ----- ----- -----
Sub-total 34 98 2,364 616 90 3,168 65.2%
-- ----- ----- --- ----- ----- -----
Total 65 6,585 3,638 967 1,586 12,776 86.1%
== ====== ===== === ===== ====== =====
Total resident capacity, which includes an estimate of double occupancy within
a single unit, typically by married couples in independent living units, was
approximately 14,500 at September 30, 2002 (11,300 in Retirement Centers and
3,200 in Free-standing ALs), and approximately 14,300 as of December 31, 2001
(11,100 in Retirement Centers and 3,200 in Free-standing ALs).
CRITICAL ACCOUNTING POLICIES
Certain critical accounting policies are complex and involve significant
judgments by management, including the use of estimates and assumptions, which
affect the reported amounts of assets, liabilities, revenues and expenses. As a
result, changes in these estimates and assumptions could significantly affect
the Company's financial position or results of operations. The Company bases
its estimates on historical experience and on various other assumptions that it
believes to be reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and
liabilities. Actual results may differ from these estimates under different
assumptions or conditions. The significant and critical accounting policies
used in the preparation of the Company's financial statements are more fully
described in the Company's Annual Report on Form 10-K for the year ended
December 31, 2001 and the Company's consolidated financial statements and the
notes thereto.
STRATEGY
The Company acquired most of its MSF Retirement Centers between 1990 and 1996.
The Company was able to acquire many of these at below historical cost because
they had not met the initial development projections of their
23
respective developers. The Company's MSF Retirement Centers now sustain an
aggregate occupancy level of 94.8%. The Company also acquired its EF
Communities, all of which were developed by Freedom Group, Inc., which the
Company acquired in July 1998. The Company developed the majority of its
Free-standing AL's, most of which were opened between 1999 and 2000. The
Company incurred approximately $360 million of costs in the development and/or
acquisition of its Free-standing AL business segment, a significant portion of
which was financed by the proceeds of short term construction debt and by the
proceeds of the 1997 issuance of $138 million of subordinated bonds (the Old
Debentures - see Note 2 to the condensed consolidated financial statements)
that were due in October 2002. The Company developed and acquired its portfolio
of Free-standing AL's at a time in which the assisted living industry was
experiencing a building boom that resulted in significant overcapacity.
Consequently, its Free-standing AL's have not achieved aggregate stabilized
occupancy as quickly as anticipated, and the Company entered the year 2002 with
approximately $371.7 million of current debt maturities at a time when its
Free-standing AL's were not yet operating at levels originally anticipated by
the Company.
The Company responded to the large amount of debt maturing in 2002 by
developing and executing the Refinancing Plan (see Note 2 to the condensed
consolidated financial statements). The plan consisted of a series of
refinancings and sale-leasebacks of both Retirement Centers and Free-standing
AL's. As a result of completing the Refinancing Plan, the Company has extended
the maturity of substantially all of its debt arrangements to January 2004 or
later, and is now devoting its full attention to increasing the operating cash
flow of its two business segments. The Company's strategies for improving its
operating cash flow include the following steps:
Retirement Center Occupancy and Margin Increases:
The Company's Retirement Centers, which represent approximately 75% of its
total unit capacity, are well-established communities with strong reputations
within their respective markets. They generally sustain high occupancy levels
and most maintain waiting lists of prospective residents. At both September 30,
2002 and 2001, the Company's Retirement Centers had occupancy rates of 93%.
Over one-half of the Retirement Centers currently have occupancies that are in
excess of 96%, and the company believes that it will be able to increase the
occupancy levels of the remaining Retirement Centers above that level as well.
Therefore, despite the current high level of Retirement Center occupancy, the
Company expects to achieve improved operating results from its Retirement
Centers through incremental occupancy increases, control of operating expenses,
and increased revenues from ancillary services (such as therapy) and selective
price increases.
Increased Entrance Fee Sales:
The Company's six EF Communities have 3,188 total units, of which 2,074 are
independent living. Based upon current entrance fee prices, the estimated sales
price for these 2,074 units (including both occupied and vacant units) is
approximately $330 million. The current aggregate occupancy of the EF
Communities is 90.5%, and the 174 independent living apartments available for
sale at September 30, 2002 represent approximately $27.0 million of the total
$330 million, based upon current entrance fee prices. The entrance fee paid by
residents who enter EF Communities represents a significant financial
investment. Accordingly, the events of September 11, 2001 and the declining
stock market have had a more pronounced, negative effect on the marketing of the
Company's EF Communities than on its MSF Retirement Centers. Furthermore, the
Company's significant debt obligations maturing in 2002 had a more negative
impact on the marketing of the EF Communities during 2001 and 2002 than on the
marketing of the MSF Retirement Centers. With the completion of the Refinancing
Plan, the Company anticipates significant progress in the marketing of its
entrance fee apartments, resulting in higher cash flows from entrance fee sales.
Increased Cash Flow from Maturing EF Communities:
The majority of the Company's six EF Communities were opened in the early
1990's. As entrance fee communities mature, the annual turnover of residents
increases, typically at a rate of approximately 1% per year, until turnover
stabilizes at a rate of approximately 12-15% per year. As a resident of an
entrance fee community vacates his or her independent apartment, (often to move
to AL or SNF), the community re-sells the apartment to a new resident. When the
former resident leaves the community, he or she (or their estate) receives a
refund which is typically a percentage of the initial entrance fee that he or
she paid. Consequently, the turnover of residents results in new entrance fee
sales and partial entrance fee refunds. As the Company's EF communities mature,
resident turnover increases and this turnover produces an increasing stream of
cash flow generated by the sale and refund of entrance fees.
24
In addition, there typically is a gap between the monthly service fee billing
rates paid by a current resident and the current market rate payable by a new
resident. As new residents enter the Retirement Centers at current market
rates, replacing former residents at lower billing rates, the Company is able
to generate additional revenues, even at the same level of occupancy. This
phenomenon is more pronounced at the Company's six EF Communities than it is at
the MSF Retirement Centers, and represents a significant source of improved
economics as the Company's EF Communities continue to mature and reach
stabilized levels of resident turnover.
Improved Results from Free-standing ALs:
The Company's Free-standing AL's, which represent approximately 25% of the
Company's total unit capacity, are in the latter stages of fill-up. The
Free-standing AL marketplace continues to suffer from adverse market conditions
primarily related to overcapacity and lack of product familiarity. These
conditions have contributed to longer than anticipated fill-up periods, price
discounting and competition for experienced staff. The Company's Free-standing
ALs are experiencing steady occupancy gains having increased from an aggregate
occupancy of 65.2% at December 31, 2001 to 79.5% as of September 30, 2002. The
early stages of fill-up for any Free-standing AL produce operating losses as a
result of high fixed costs and limited revenues associated with low levels of
occupancy. At occupancy levels between 70-80% the Company's Free-standing ALs
incur all of the fixed and most of the variable costs required to operate at
full occupancy. Therefore, as occupancy moves from 80% to 90% or better, the
Company expects its operating margins to improve significantly. Furthermore,
there has been a substantial reduction in new freestanding AL development over
the last few years, and as product familiarity and market demand come back into
balance with supply, the Company expects that price discounting will be a less
significant factor in the economics of assisted living. Accordingly, the
Company expects its future Free-standing AL operating margins to benefit from
higher occupancy, lower marketing costs associated with stabilized census, the
expiration of existing incentive pricing arrangements, and higher pricing
generally.
Because of the effects of price discounting in the current assisted living
marketplace, the process of achieving an optimal operating margin is often
two-stage. A Free-standing AL completes the first stage when it attains and
maintains an occupancy level of 90% or better. The second stage in the process
entails increasing selling prices to new residents so that over a 1 to 3 year
period, discounted rates are replaced undiscounted rates.
Control of Operating Expenses:
The Company has focused on reducing certain costs, such as contract labor, and
control of its insurance and liability costs, through extensive quality
assurance and risk management efforts. In addition, the Company will be
carefully reviewing its overhead and administrative costs for savings
opportunities.
SEGMENT RESULTS
The Company evaluates its performance in part based upon EBITDAR, which it
defines as earnings before net interest expense, income tax expense (benefit),
depreciation, amortization, rent, and other charges related to asset
impairments, equity in losses of managed special purpose entity communities,
other income (expense), minority interest, and extraordinary items. As a result
of increased occupancy, the Company's Free-standing ALs generated positive
quarterly community EBITDAR since the fourth quarter of 2001. On an operating
income basis, however, they are still generating losses after interest, lease,
amortization and depreciation expense.
The following is a summary of total revenues, EBITDAR operating income (loss),
and total assets by segment for the three and nine months ended September 30,
2002 and 2001 (in thousands).(1)(2)(3)
THREE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30 $ %
2002 2001 CHANGE CHANGE
---- ---- ------- ------
Revenues:
Retirement Centers $ 63,390 $ 54,893 $ 8,497 15.48%
Free-standing ALs 20,526 9,927 10,599 106.77%
Corporate/Other 1,630 2,627 (997) (37.95)%
---------- ----------- --------- -------
Total $ 85,546 67,447 $ 18,099 26.83%
========== =========== ========= =======
EBITDAR $ 14,142 $ 13,123 $ 1,019 7.77%
25
Net Operating (Loss) Income:
Retirement Centers $ 20,392 $ 18,309 $ 2,083 11.38%
Free-standing ALs 2,379 (158) 2,537 1605.70%
Corporate/Other(3) (11,140) (5,028) (6,112) (121.56)%
---------- ----------- --------- --------
Net Operating Income $ 11,631 $ 13,123 $ (1,492) (11.37)%
Lease expense (4) 11,168 7,217 3,951 54.75%
Depreciation and Amortization(5) 5,418 5,332 86 1.61%
---------- ----------- --------- ---------
Operating (loss) income $ (4,955) $ 574 $ (5,529) (963.24)%
========== =========== ========= =========
NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30 $ %
2002 2001 CHANGE CHANGE
------------ ------------ --------- -------
Revenues:
Retirement Centers $ 182,883 $ 160,642 $ 22,241 13.85%
Free-standing ALs 57,073 26,255 30,818 117.38%
Corporate/Other 5,002 7,701 (2,699) (35.05)%
------------ ------------ --------- ---------
Total $ 244,958 $ 194,598 $ 50,360 25.88%
=========== =========== ========= =========
EBITDAR $ 45,456 $ 39,719 $ 5,737 14.44%
Net Operating (Loss) Income:
Retirement Centers $ 61,576 $ 56,636 $ 4,940 8.72%
Free-standing ALs 4,993 (1,120) 6,113 545.80%
Corporate/Other(3) (23,674) (15,797) (7,877) (49.87)%
------------ ------------ --------- ---------
Net Operating Income $ 42,895 $ 39,719 $ 3,176 8.00%
Lease expense (4) 62,231 20,668 41,563 201.10%
Depreciation and Amortization
(5) 26,066 15,619 10,447 66.89%
------------ ------------ --------- ---------
Operating (loss) income $ (45,402) $ 3,432 $ (48,834) (1422.90%)
=========== =========== ========= =========
TOTAL ASSETS
SEPTEMBER 30 DECEMBER 31, $ %
2002 2001 CHANGE CHANGE
------------ ------------ -------- -------
Total Assets:
Retirement Centers $546,908 509,732 $ 37,176 7.30%
Free-standing ALs 217,594 241,069 (23,475) (9.74%)
Corporate/Other 95,684 99,390 (3,706) (3.73%)
-------- ------- -------- ----
Total $860,186 850,191 $ 9,995 1.18%
======== ======= ======== ====
UNIT OCCUPANCY
SEPTEMBER 30 DECEMBER 31, %
2002 2001 CHANGE
------------ ------------ ------
Resident Unit Occupancy:
Retirement Centers 93.4% 93.0% 0.4%
Free-standing ALs 79.5% 65.2% 14.3%
---- ---- ----
Total 90.0% 86.1% 3.9%
==== ==== ====
(1) Segment data does not include any inter-segment transactions or
allocated costs.
(2) EBITDAR, is defined as earnings before net interest expense, income tax
expense (benefit), depreciation, amortization, rent, asset impairments,
equity in losses of communities that are managed by the Company and
owned by special purpose entities, other income (expense), minority
interest, and extraordinary items. While EBITDAR is not a GAAP
measurements, the Company believes they are relevant in analyzing its
operating results. (3) Corporate/other revenues represent the
Company's development and management fee revenues. Corporate/Other NOI
includes operating expenses related to corporate operations, including
human resources, financial services, and information systems, as well
as senior living network and assisted living management costs.
Increases in
26
Corporate/Other expenses result from increases in insurance related
accruals, including self-insured employee medical coverage, general
and professional liability claims, workers' compensation costs, as
well as substantial costs related to the Refinancing Plan.
(4) Includes $600,000 and $30.8 million of additional lease expense for
the three and nine months ended September 30, 2002 as a result of sale
lease-back transactions. See note 4 to the condensed consolidated
financial statements.
(5) Includes $8.8 million of additional amortization expense for the nine
months ended September 30, 2002 as a result of sale lease-back
transactions. There was no additional amortization expense related to
sale lease-back transactions for the three months ended September 30,
2002. See note 4 to the condensed consolidated financial statements.
The Company has expensed approximately $49.9 million in losses in the last 12
months related to 11 of the 16 sale-leaseback transactions completed pursuant
to the Refinancing Plan. These losses are a result of the Company entering
long-term leases on pre-stabilized Free-standing ALs that have lease bases that
are at below the historical cost of development or acquisition of the subject
community. The Company has recorded deferred gains of $17.0 million on the 5 of
16 sale-leaseback transactions, which is being amortized over the 15 year term
of the lease, increasing the Company's deferred gain on sale lease-back
transactions to $28.3 million. The positive aspect of these transactions is
that the subsequent lease payments are calculated using these lower lease
bases. This results in a significant opportunity to generate cash flow in
excess of the lease payments once the communities reach economic stability.
Moreover, several of the sale-leaseback transactions include earn-out
provisions whereby the Company may obtain additional cash proceeds in the
amount of up to $14.0 million between June 2003 and May 2005, contingent upon
the economic performance of the sale-leaseback communities. Furthermore, two of
the Retirement Center sale-leaseback transactions include purchase options that
allow the company to re-acquire the assets for a fixed return contingent upon
the economic performance of other assets that were sold and leased back
contemporaneously.
PRO FORMA SEGMENT RESULTS:
The following table presents, on a pro forma basis, quarterly community results
on a segment basis for each of the Company's last seven fiscal quarters (2002
and 2001), assuming that all communities currently owned or leased were
consolidated for the entire period. The operating results for 25 Retirement
Centers and 32 Free-standing ALs owned or leased as of September 30, 2002, are
included for all quarters shown. This information is presented in order to show
the historical results of the communities that currently make up each segment
(many of which were not consolidated in some or all quarters shown).
Communities managed as of September 30, 2002, communities sold during these
periods which were not subsequently leased-back, and unconsolidated joint
ventures are excluded from all quarters shown. While this pro forma information
is not presented in accordance with accounting principles generally accepted in
the United States of America, the Company believes such information is useful
in evaluating the Company's performance. The pro forma results of any
particular quarter are not necessarily indicative of results of operations for
a full year or predictive of future periods. All dollar amounts are in
thousands.
Retirement Centers:
2001 Quarter Ended 2002 Quarter Ended
------------------------------------- Year Ended -------------------------------
March 31 June 30 Sept 30 Dec 31 Dec 31, 2001 March 31 June 30 Sept 30
---------------------------------------------------------------------------------------------------------------
Revenues $55,692 $58,205 $58,696 $59,536 $232,129 $61,761 $61,877 $63,390
---------------------------------------------------------------------------------------------------------------
EBITDAR 18,864 19,818 18,743 19,371 76,796 21,576 20,473 20,392
---------------------------------------------------------------------------------------------------------------
Operating Margin 33.9% 34.0% 31.9% 32.5% 33.1% 34.9% 33.1% 32.2%
---------------------------------------------------------------------------------------------------------------
Ending Unit
Occupancy 93.2% 92.8% 93.3% 93.4% 93.4% 93.3% 93.2% 94.5%
---------------------------------------------------------------------------------------------------------------
Monthly Revenue $2,626 $ 2,740 $ 2,747 $ 2,787 $2,717 $2,904 $ 2,907 $2,935
per Occupied Unit
---------------------------------------------------------------------------------------------------------------
Retirement Center revenues have grown primarily as a result of price increases
for new residents, increased occupancy and the fill up of expansions at certain
communities, growth of therapy services and the expansion of other service
offerings. These revenue increases, as well as control of expenses and
recoupment of expense increases through rate increases to current residents,
have resulted in increases in community EBITDAR from the Retirement Centers.
27
The Company's six EF Communities provide housing and health care services
through limited lifecare contracts and entrance fee agreements with residents.
Under these agreements, residents pay an entrance fee upon entering into a
limited lifecare contract. The Company recognizes revenue by recording the
nonrefundable portion of the residents' entrance fee as amortization of
deferred entrance fee revenue using the straight-line method over the actuarial
determined remaining life expectancy of each resident or couple. The EF
Communities represent 24.7% of the Retirement Center unit capacity and 21.9%,
24.5%, and 16.9% of Retirement Center revenues, operating expense and EBITDAR,
for the nine months ended September 30, 2002, respectively. Continued increases
in occupancy at these EF Communities represent a key component of the Company's
strategy of improving operating and profit margins, as well as cash flows. The
Company believes that the level of entry fee sales in these communities has been
diminished by the recent uncertainty surrounding the Refinancing Plan. With the
completion of the Refinancing Plan, the Company believes it can reduce the
vacant units (174 at September 30, 2002), increasing proceeds from entrance fee
sales, net of refunds.
Free-standing ALs:
2001 Quarter Ended 2002 Quarter Ended
--------------------------------------- Year Ended ----------------------------------
March 31 June 30 Sept 30 Dec 31 Dec 31, 2001 March 31 June 30 Sept 30
---------------------------------------------------------------------------------------------------------------
Revenues $ 11,927 $13,716 $ 15,160 $ 16,465 $ 57,268 $ 17,637 $ 18,910 $ 20,526
---------------------------------------------------------------------------------------------------------------
EBITDAR (1,769) (473) (86) 648 (1,680) 949 1,665 2,379
---------------------------------------------------------------------------------------------------------------
Operating Margin (14.8)% (3.4)% (0.6)% 3.9% (2.9)% 5.4% 8.8% 11.6%
---------------------------------------------------------------------------------------------------------------
Ending Unit
Occupancy 52.7% 58.1% 62.3% 65.3% 65.3% 69.1% 74.5% 80.1%
---------------------------------------------------------------------------------------------------------------
Monthly Revenue $ 2,552 $ 2,643 $ 2,712 $ 2,803 $2,437 $2,827 $2,813 $2,835
per Occupied Unit
---------------------------------------------------------------------------------------------------------------
The Company opened substantially all of its Free-standing AL communities
between 1999 and 2000. Free-standing ALs average 93 units and provide
specialized care such as Alzheimer's, memory enhancement and other dementia
programs. Free-standing AL revenues have increased primarily as a result of
increased occupancy. Free-standing AL revenues have also increased as a result
of selective price increases and growth of ancillary revenues. As the
Free-standing AL communities continue to experience improved occupancy, the
Company expects community EBITDAR to increase.
SYNTHETIC LEASE COMMUNITIES
As of December 31, 2001, the Company operated 14 of its communities (two
Retirement Centers and 12 Free-standing ALs) under a lease which is treated as
an operating lease for financing reporting purposes and a financing lease for
income tax purposes, commonly referred to as a synthetic lease. During the
fourth quarter of 2001, the Company determined that in order to simplify its
financial structure, and as a condition of certain elements of its Refinancing
Plan, it would terminate all synthetic leases during 2002. The Company's
synthetic leases were structured such that upon the termination of these
synthetic leases, the Company became the owner of each community. The Company
did not incur any cash costs in connection with the termination of the
synthetic leases other than transaction costs.
At September 30, 2002, the Company operated only one senior living community
under a synthetic lease. As of September 30, 2002, the Company had approximately
$8.7 million of assets related to the community being operated under a synthetic
lease (including $5.4 million of assets limited as to use and $3.3 million of
land). This lease provided the Company with termination rights whereby the
Company could terminate the lease and acquire the property at predetermined
amounts. Effective November 1, 2002, the Company terminated the synthetic lease
and became the owner of the community for financial reporting purposes. The
Company did not incur any cash costs in connection with the termination of this
synthetic lease other than transaction costs. See notes 4 and 9 to the Condensed
Consolidated Financial Statements.
28
OFF-BALANCE SHEET ASSETS - LEASED AND MANAGED COMMUNITIES
The Company previously operated several communities pursuant to synthetic
leases and operated certain communities under management agreements with third
party SPE owners. In 2001, the Company determined to eliminate its synthetic
lease and managed SPE programs in order to simplify its capital structure.
Effective November 1, 2002, the Company has acquired all of the operating
assets previously subject to synthetic lease arrangements.
As of September 30, 2002, the Company operates 31 Retirement Centers and 34
Free-standing ALs. Of the 31 Retirement Centers, the Company owns 11, operates
two pursuant to capital leases (which include purchase options) and 12 pursuant
to operating leases. The Company manages six Retirement Centers for third
parties and has invested $6.0 million in purchase options for two of the six
managed communities. Of the remaining four managed communities, two are
cooperatives that are owned by their residents and one is owned by a
not-for-profit sponsor. The Company's final management agreement relates to the
Freedom Square Retirement Center ("Freedom Square"), which the Company operates
pursuant to a long-term management contract. The initial term of the management
contract has 16 years remaining, and there is an additional extension term of
20 years, exercisable at the Company's option. Freedom Square is a 736 unit
Entrance Fee community and the Company earns a management fee pursuant to the
Freedom Square management contract that is equal to all of the cash flow
generated by the community that is in excess of its operating costs, capital
expenditures, mortgage payment and a stated $3.0 million annual distribution to
the owner, which escalates 3% annually. The Company has guaranteed the $17.6
million first mortgage debt secured by the land, buildings and equipment at
Freedom Square.
Of the 34 Free-standing ALs operated by the Company as of September 30, 2002,
13 were owned, seven were operated pursuant to capital leases, 13 were operated
pursuant to operating leases, and one was operated under a synthetic lease. The
Company terminated the synthetic lease effective November 1, 2002 and took
ownership of the asset. The two remaining free-standing assisted living
residences are owned by joint ventures. ARC owns 50% of one of the joint
ventures and 37.5% of the other and has joined with its venture partners in
guaranteeing $12.1 million of first mortgage debt secured by the two joint
venture assets.
SALE LEASE-BACK TRANSACTIONS
As a result of the completed and anticipated transactions under the Refinancing
Plan, the Company has recorded losses related to 11 of 16 sale lease-back
transactions of $30.8 million for the nine months ended September 30, 2002,
including $0.6 million during the quarter ended September 30, 2002, $7.0
million during the quarter ended June 30, 2002, and $23.2 million during the
quarter ended March 31, 2002. In addition, during 2001, the Company recorded
losses of $7.9 million during the quarter ended December 31, 2001 bringing the
total loss on the sale lease-back Refinancing Plan transactions to $38.7
million. For financial reporting purposes, these losses are considered residual
value guarantee amounts and have been fully recognized as lease expense. The
Company does not expect to incur any additional residual value guarantee
amounts. In addition, the Company has recorded deferred gains of $17.0 million
on the 5 of 16 sale-leaseback transactions, which is being amortized over the
15 year term of the lease, increasing the Company's deferred gain on sale
lease-back transactions to $28.3 million. See note 4 to the condensed
consolidated financial statements.
In addition, because the Company's sale lease-back transactions resulted in the
early termination of certain existing synthetic leases, the Company accelerated
the amortization of leasehold acquisition costs beginning in the fourth quarter
of 2001. As a result of this acceleration, the Company recorded additional
amortization costs of $472,000 during the quarter ended December 31, 2001, $6.5
million during the quarter ended March 31, 2002, and $2.3 million of additional
amortization during the quarter ended June 30, 2002, bringing the total amount
of accelerated amortization related to these sale lease-back transactions to
$9.3 million, of which $8.8 million was recognized during the nine months ended
September 30, 2002.
The Company did not incur any cash costs other than transaction costs in
connection with these transactions. Given the long-term nature of the
lease-back arrangements, the Company views these transactions as long-term
financings. As such, the Company believes that although sale lease-back
accounting rules require the recognition of a loss in the amount of the
difference between the sales prices and the Company's cost basis in the assets
(including the leasehold acquisition costs of its synthetic leases), the
Company will continue to derive economic benefits from the assets in the
29
form of future payments under the earn-out provisions in excess of the amounts
currently included in the sales price, as well as from any improvement in
operating results as the communities increase occupancy and performance. In
addition, the $30.8 million and $8.8 million incurred during the nine months
ended September 30, 2002 related to sale lease-back losses and leasehold
acquisition cost amortization, or $39.6 million, is reflective of non-cash
costs which are not indicative of costs going forward and are a significant
portion of the current year reduction in equity.
RESULTS OF OPERATIONS
The Company reported a net loss of $22.6 million, or $1.30 loss per diluted
share, on total revenues of $85.5 million, as compared with net loss of $4.4
million, or $0.26 loss per diluted share, on revenues of $67.4 million for the
three months ended September 30, 2002 and 2001, respectively. The 2002 loss is
comprised of $5.9 million of impairment as discontinued operations, $2.5 million
of asset impairment charges, $1.9 million of loss on sale of assets, $1.7
million of increased insurance related accruals, and $1.4 million of refinancing
costs. The remaining loss relates to operating losses from certain of the
Company's Free-standing ALs resulting from the continued fill-up of these
communities. The Company reported a net loss of $80.1 million, or $4.63 loss per
diluted share, on total revenues of $245.0 million, as compared with a net loss
of $11.9 million, or $0.69 loss per diluted share, on revenues of $194.6 million
for the nine months ended September 30, 2002 and 2001, respectively. The 2002
loss is comprised of $30.8 million of additional lease expense resulting from
losses on certain sale lease-back transactions and accelerated leasehold
acquisition cost amortization from these transactions, $8.8 million of
accelerated leasehold acquisition cost amortization, $5.9 million of impairment
as discontinued operations, $2.6 million of asset impairment, $2.3 million of
increased insurance related accruals, $1.9 million of loss on sale of assets,
and $1.4 million of refinancing costs. The remaining loss relates to operating
losses from certain of the Company's Free-standing ALs resulting from the
continued fill-up of these communities. The loss of $4.63 per dilutive share for
the nine months ended September 30, 2002 was comprised of a $4.59 loss from
continuing operations, plus a $0.04 loss from the extinguishment of debt. See
notes 4 and 8 to the Condensed Consolidated Financial Statements.
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED WITH THE THREE MONTHS ENDED
SEPTEMBER 30, 2001
Revenues. Total revenues were $85.5 million in the quarter ended September 30,
2002, compared to $67.4 million in the quarter ended September 30, 2001,
representing an increase of $18.1 million, or 26.8%. Resident and health care
revenues increased by $19.1 million, management services revenue decreased by
$800,000, and reimbursement of out-of-pocket expenses decreased $200,000. The
increases in resident and health care revenues resulted primarily from an
increase of: (a) approximately $7.1 million as a result of the increase in the
number of Free-standing ALs included in the Company's consolidated operations,
as well as $2.7 million related to the continued fill-up of these communities,
(b) $3.6 million and $300,000 related to the April, 2002 and July, 2001
long-term leases of Freedom Plaza Arizona and Freedom Plaza Care Center,
respectively, (c) an increase of $1.6 million in revenue from therapy services,
(d) $774,000 attributable to increased capacity as a result of Retirement
Center expansions and (e) $3.0 million related increased average occupancy and
additional entrance fee revenues.
Management and development services revenue and reimbursement of out-of-pocket
expenses decreased by $800,000 and $200,000, respectively, and decreased as a
percentage of total revenue to 0.5% and 1.4% in the quarter ended September 30,
2002 from 1.8% and 2.1% in the quarter ended September 30, 2001, respectively.
The decrease is primarily related to the decreased management fees at certain
properties as a result of lower entrance fee sales of units, which reduces the
formula-based management fees, as well as the decrease in the number of managed
communities from 17 at September 30, 2001 to six at September 30, 2002.
Retirement Center resident and health care revenues were $63.4 million in the
quarter ended September 30, 2002, compared to $54.9 million in the quarter
ended September 30, 2001, representing an increase of $8.5 million, or 15.5%.
This increase resulted primarily from additional revenues as a result of the
long-term lease, and consolidation of Freedom Plaza Arizona and Freedom Plaza
Care Center, increased capacity related to expansions and increased therapy
services provided by the Company during 2002. Retirement Center resident and
health care revenues were also positively affected by increased average
occupancy and additional entrance fee revenues.
Free-standing AL resident and health care revenues increased from $9.9 million
in the quarter ended September 30, 2001 to $20.5 million in the quarter ended
September 30, 2002. This increase is largely related to the increase in the
number of Free-standing ALs included in the Company's consolidated operations
from 23 to 34 communities, as well as increased occupancy at these communities.
Community Operating Expense. Community operating expense increased to $62.5
million in the quarter ended September 30, 2002, as compared to $46.5 million
in the quarter ended September 30, 2001, representing an increase of $16.0
million, or 34.5%. The increase in community operating expense was primarily
attributable to communities acquired or leased during 2001 and expansions.
Additionally, the increase was the result of increased labor, insurance,
utility, property and marketing costs at various new communities, as well as
costs associated with the expansion of therapy services to additional
communities during 2001 and 2002. Community operating expense as a percentage
of resident and health care revenues increased to 74.5% from 71.8% for the
quarters ended September 30, 2002 and 2001, respectively, primarily
attributable to the acquisition of leasehold interests in various Managed SPE
Communities during the second half of 2001 which are in the fill-up stage. The
Company expects community operating expense to begin to decrease below
historical levels as a percentage of resident and health care revenues as the
Free-standing ALs acquired during 2001 continue the fill-up stage.
Retirement Center operating expenses were $43.0 million in the quarter ended
September 30, 2002, compared to $36.6 million in the quarter ended September
30, 2001, representing an increase of $6.4 million, or 17.5%. Approximately
$3.3 million and $300,000 of this increase was attributable to the April 1,
2002 and July 1, 2001 long-term lease of Freedom Plaza Arizona and Freedom
Plaza Care Center, respectively. In addition, the expansions at several
Retirement Centers increased operating expenses by $500,000. Finally, $823,000
of the increase related to expenses associated with the growth of the therapy
services program during the quarter ended September 30, 2002. The remaining
increase relates primarily to increased average occupancies resulting in
increased Retirement Center operating expenses.
Free-standing AL operating expenses increased from $10.1 million in the quarter
ended September 30, 2001 to $18.1 million in the quarter ended September 30,
2002. This increase is largely related to the increase in the number of
Free-standing ALs included in the Company's consolidated operations from 23 to
34 communities, as well as increased occupancy at these communities.
30
Community Operating Expense. Community operating expense increased to $62.5
million in the quarter ended September 30, 2002, as compared to $46.5 million in
the quarter ended September 30, 2001, representing an increase of $16.0 million,
or 34.5%. The increase in community operating expense was primarily attributable
to communities acquired or leased during 2001 and expansions. Additionally, the
increase was the result of increased labor, insurance, utility, property and
marketing costs at various new communities, as well as costs
associated with the expansion of therapy services to additional communities
during 2001 and 2002. Community operating expense as a percentage of resident
and health care revenues increased to 74.5% from 71.8% for the quarters ended
September 30, 2002 and 2001, respectively, primarily attributable to the
acquisition of leasehold interests in various Managed SPE Communities during the
second half of 2001 which are in the fill-up stage. The Company expects
community operating expense to begin to decrease below historical levels as a
percentage of resident and health care revenues as the Free-standing ALs
acquired during 2001 continue the fill-up stage.
Retirement Center operating expenses were $43.0 million in the quarter ended
September 30, 2002, compared to $36.6 million in the quarter ended September 30,
2001, representing an increase of $6.4 million, or 17.5%. Approximately $3.3
million and $300,000 of this increase was attributable to the April 1, 2002 and
July 1, 2001 long-term lease of Freedom Plaza Arizona and Freedom Plaza Care
Center, respectively. In addition, the expansions at several Retirement Centers
increased operating expenses by $500,000. Finally, $823,000 of the increase
related to expenses associated with the growth of the therapy services program
during the quarter ended September 30, 2002. The remaining increase relates
primarily to increased average occupancies resulting in increased Retirement
Center operating expenses.
Free-standing AL operating expenses increased from $10.1 million in the quarter
ended September 30, 2001 to $18.1 million in the quarter ended September 30,
2002. This increase is largely related to the increase in the number of
Free-standing ALs included in the Company's consolidated operations from 23 to
34 communities, as well as increased occupancy at these communities.
General and Administrative. General and administrative expense increased to $7.7
million for the quarter ended September 30, 2002, as compared to $6.4 million
for the quarter ended September 30, 2001, representing an increase of $1.3
million, or 19.5%. This increase is primarily attributable to additional
accruals during the quarter for insurance related accruals amounting to $1.7
million, including self-insured employee medical coverage of $1.4 million, and
$475,000 of general and professional liability claims, offset by a reduction of
$180,000 in workers' compensation costs. In addition, during the quarter, the
Company incurred various costs related to the Refinancing Plan amounting to $1.4
million, including $958,000 of consultant costs and $410,000 of legal costs. The
Company does not expect to incur similar costs in the fourth quarter. These
increases are offset by costs incurred during the three months ended September
30, 2001, resulting in a $1.5 million reduction in bad debt expense and a
$212,000 reduction in severance costs. General and administrative expense as a
percentage of total revenues decreased to 9.0% compared to 9.5% for the quarters
ended September 30, 2002 and 2001, respectively. The Company anticipates that
general and administrative expense as a percentage of total revenues will
continue to be at levels less than prior periods.
EBITDAR (Community NOI). EBITDAR increased $1.0 million from $13.1 million in
the quarter ended September 30, 2001 to $14.1 million in the quarter ended
September 30, 2002 as further described below.
Retirement Center EBITDAR increased $2.1 million, or 11.4%, from $18.3 million
for the quarter ended September 30, 2001 to $20.4 million for the quarter ended
September 30, 2002. This increase primarily relates to the April 2002 and July
2001 addition of the long-term leases of Freedom Plaza Arizona and Freedom Plaza
Care Center, as well as continued operational improvement throughout the
Retirement Centers, resulting from stabilized occupancy and increased capacity
through expansions, rate increases, and improved control of community-level
overhead expense.
Free-standing AL EBITDAR improved by $2.5 million from a $158,000 loss in the
quarter ended September 30, 2001, to $2.4 million of income in the quarter ended
September 30, 2002, primarily as a result of increased occupancy at these
communities.
31
Other EBITDAR losses increased $3.6 million to $8.6 million in the quarter ended
September 30, 2002 resulting from $2.2 million of additional insurance related
accruals (related to self-insured employee medical coverage, general and
professional liability claims and workers' compensation), $1.4 million of legal
and consulting costs affiliated with the Refinancing Plan, as well as the
$800,000 reduction in management services revenue. These increases are offset by
the prior period equity in losses of special purpose entities of $1.0 million.
The remaining increase relates to additional costs associated with therapy
services, marketing and other operating costs.
Lease Expense. As of September 30, 2002, the Company had operating leases for 35
of its communities, including 14 Retirement Centers and 21 Free-standing ALs.
Lease expense increased $4.0 million from $7.2 million for the quarter ended
September 30, 2001 to $11.2 million for the quarter ended September 30, 2002.
Lease expense (excluding synthetic leases) increased to $9.9 million for the
quarter ended September 30, 2002, as compared to $4.2 million for the quarter
ended September 30, 2001, representing an increase of $5.7 million. This
increase was attributable to 12 additional leases entered into by the Company
during 2001 and 2002, consisting of five Retirement Center leases which
increased lease expense $3.1 million, and the acquisition of leasehold interests
in seven Free-standing AL communities, which increased lease expense $1.3
million.
As of September 30, 2002, the Company operated only one of its Free-standing ALs
under a synthetic lease structure. Synthetic lease expense decreased to $1.3
million for the quarter ended September 30, 2002, as compared to $3.0 million
for the quarter ended September 30, 2001, representing a decrease of $1.7
million. This decrease relates to the Company's decision during the fourth
quarter of 2001, that in order to simplify its financial structure, it would
terminate all synthetic leases during 2002. Of the total $1.3 million of
synthetic lease expense for the quarter ended September 30, 2002, $151,000
related to Retirement Centers and $1.1 million related to Free-standing ALs. Of
the total $1.3 million of synthetic lease expense for the quarter ended
September 30, 2002, $515,000 resulted from residual value guarantee amounts
related to losses on sale-leaseback transactions. Effective November 1, 2002,
the Company has terminated all of its synthetic leases.
As a result of completed and anticipated transactions under the Refinancing
Plan, the Company has recorded losses from sale lease-back transactions of $0.6
million for the quarter ended September 30, 2002. For financial reporting
purposes, these losses are considered residual value guarantee amounts and have
been fully recognized as lease expense.
Depreciation and Amortization. Depreciation and amortization expense decreased
slightly to $4.9 million in the quarter ended September 30, 2002 from $5.0
million in the quarter ended September 30, 2001, representing a decrease of
$56,000, or 1.1%. The decrease was primarily related to the various sale
lease-back transactions of communities subsequent to September 30, 2001, offset
by the increase in depreciable assets of approximately $77.0 million (note that
$70.2 million of this increase relates to the September 30, 2002 termination of
a synthetic lease, therefore no depreciation expense on these assets was
included during the quarter ended September 30, 2002).
Amortization of Leasehold Acquisition Costs. Amortization of leasehold
acquisition costs increased $142,000 from $379,000 in the quarter ended
September 30, 2001 to $521,000 in the quarter ended September 30, 2002. This
increase relates to the acquisition of twelve leasehold interests in
Free-standing ALs during 2001.
Asset Impairment. During the quarter ended September 30, 2002, the Company
recorded $2.5 million in charges related to delayed or discontinued development
and financing transactions. The Company will continue to evaluate these assets
for impairment. See note 5 to the Condensed Consolidated Financial Statements.
Other Income (Expense). Interest expense increased to $11.7 million in the
quarter ended September 30, 2002 from $9.5 million in the quarter ended
September 30, 2001, representing an increase of $2.2 million, or 23.0%. Total
indebtedness has increased to $549.2 million from $532.0 million at September
30, 2002 and September 30, 2001, respectively, this increase was primarily
attributable to a higher average amount of indebtedness (prior to certain
refinancing transactions), during the nine months ended September 30, 2002, as
well as higher interest rates. Interest expense, as a percentage of total
revenues, decreased to 13.7% for the quarter ended September 30, 2002 from 14.1%
in the quarter ended September 30, 2001. As a result of certain financings
completed under the Refinancing Plan, the Company expects interest expense to
increase, and accordingly, exceed historical levels as a percentage of total
revenues. Interest income decreased to $1.0 million in the quarter ended
September 30, 2002 from $2.4 million in the quarter ended September 30, 2001,
representing a decrease of $1.4 million, or 57.1%. The
32
decrease in interest income was primarily attributable to lower income generated
from the reduced amount of certificates of deposit and notes receivable balances
associated with certain leasing transactions and management agreements. Equity
in loss of Managed SPE Communities (representing the losses that the Company
funded when operating deficits at the Managed SPE Communities exceeded specified
limits) decreased from $1.0 million in the quarter ended September 30, 2001 to
$0 in the quarter ended September 30, 2002. The Company had no further Managed
SPE Communities after December 31, 2001.
Income Taxes. The provision for income taxes was a $100,000 expense, compared to
a $2.3 million benefit for the quarters ended September 30, 2002 and 2001,
respectively. The Company has applied a full deferred tax asset valuation
allowance related to its available net operating carryforwards.
Discontinued Operations. During the three months ended September 30, 2002, the
Company determined that assets acquired through the termination of a synthetic
lease on a Free-standing AL would be held for sale. The Company expects to sell
the community for $9.5 million. Based upon this purchase price, the Company has
recorded $5.9 million of impairment as discontinued operations. The results of
operations for both the current year and comparative prior periods have not been
reclassified to discontinued operations within the accompanying condensed
consolidated financial statements based on the overall insignificance of these
results to the Company.
Net Loss. Based upon the factors noted above, the Company experienced a net loss
of $22.6 million, or $1.30 loss per dilutive share, compared to a net loss of
$4.4 million, or $0.26 loss per dilutive share, for the quarters ended September
30, 2002 and 2001, respectively. The $1.30 loss per dilutive share for the three
months ended September 30, 2002 was comprised of a $0.96 loss from operations
and a $0.34 loss from the Company's discontinued operations related to the
impairment of a community held-for-sale. The $1.30 loss and $0.26 loss per
dilutive share for the quarters ended September 30, 2002 and 2001, respectively,
were entirely comprised of losses from operations.
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED WITH THE NINE MONTHS ENDED
SEPTEMBER 30, 2001
Revenues. Total revenues were $245.0 million in the nine months ended September
30, 2002, compared to $194.6 million in the nine months ended September 30,
2001, representing an increase of $50.4 million, or 25.9%. Resident and health
care revenues increased by $53.1 million, management and development services
revenue decreased by $1.8 million, and reimbursement of out-of-pocket expenses
decreased $912,000 during the 2002 period. The increases in resident and health
care revenues resulted primarily from an increase of: (a) approximately $19.7
million as a result of the increase in the number of Free-standing ALs included
in the Company's consolidated operations, as well as $9.7 million related to the
continued fill-up of these communities, (b) $7.1 million and $3.8 million
related to the April 2002 and July 2001 long-term leases of Freedom Plaza
Arizona and Freedom Plaza Care Center, respectively, (c) an increase of $8.1
million in revenue from therapy services, and (d) $2.2 million attributable to
increased capacity as a result of Retirement Center expansions. These increases
are offset by revenue decreases of $2.7 million related to the July 2001 sale of
a California Retirement Center. The remaining increase relates primarily to
increased average occupancy and additional entrance fee revenues.
Management and development services and reimbursement of out-of-pocket expenses
decreased by $1.8 million and $912,000 and decreased as a percentage of total
revenue to 0.5% and 1.6% in the nine months ended September 30, 2002, from 1.5%
and 2.5% in the nine months ended September 30, 2001. The decrease is primarily
related to decreased management fees at certain properties as a result of lower
entrance fee sales of units, which reduces the formula-based management fees, as
well as the decrease in the number of managed communities from 17 at September
30, 2001 to six at September 30, 2002.
Retirement Center resident and health care revenues were $182.9 million in the
nine months ended September 30, 2002, compared to $160.6 million in the nine
months ended September 30, 2001, representing an increase of $22.2 million, or
13.8%. This increase resulted primarily from additional revenues as a result of
the long-term lease (and the resulting consolidation of revenues) of Freedom
Plaza Arizona and Freedom Plaza Care Center, increased capacity related to
expansions and increased therapy services provided by the Company during 2002.
Retirement Center resident and health care revenues were also positively
affected by increased average occupancy and additional entrance fee revenues.
Free-standing AL resident and health care revenues increased from $26.3 million
in the nine months ended September 30, 2001 to $57.1 million in the nine months
ended September 30, 2002. This increase is largely related to the increase in
the number of Free-standing ALs included in the Company's consolidated
operations from 23 to 34 communities, as well as increased occupancy at these
communities.
Community Operating Expense. Community operating expense increased to $175.5
million in the nine months ended September 30, 2002, as compared to $131.9
million in the nine months ended September 30, 2001, representing an increase of
$43.6 million, or 33.1%. The increase in community operating expense was
primarily attributable to communities acquired or leased during 2001 and
expansions. Additionally, the increase was the result of increased labor,
insurance, utility, property and marketing costs at various new communities, as
well as costs
33
associated with the expansion of therapy services to additional communities
during 2001 and 2002. Community operating expense as a percentage of resident
and health care revenues increased to 73.2% from 70.6% for the quarters ended
September 30, 2002 and 2001, respectively, primarily attributable to the
acquisition of leasehold interests in various Managed SPE Communities during the
second half of 2001 which are in the fill-up stage. The Company expects
community operating expense to remain at greater than historical levels as a
percentage of resident and health care revenues as the Free-standing ALs
acquired during 2001 continue the fill-up stage.
Retirement Center operating expenses were $121.3 million in the nine months
ended September 30, 2002, compared to $104.0 million in the nine months ended
September 30, 2001, representing an increase of $17.3 million, or 16.6%.
Approximately $6.4 and $3.9 million of this increase was attributable to the
April 1, 2002 and July 1, 2001 long-term lease of Freedom Plaza Arizona and
Freedom Plaza Care Center, respectively. In addition, the expansion at a
Retirement Center increased operating expenses by $1.9 million. Finally, $2.6
million of the increase related to expenses associated with the growth of the
therapy services program during the nine months ended September 30, 2002. The
remaining increase relates primarily to increased average occupancies resulting
in increased Retirement Center operating expenses.
Free-standing AL operating expenses increased from $27.4 million in the nine
months ended September 30, 2001 to $52.1 million in the nine months ended
September 30, 2002. This increase is largely related to the increase in the
number of Free-standing ALs included in the Company's consolidated operations
from 23 to 34 communities, as well as increased occupancy at these communities.
General and Administrative. General and administrative expense increased to
$20.1 million for the nine months ended September 30, 2002, as compared to $18.2
million for the nine months ended September 30, 2001, representing an increase
of $1.9 million, or 10.6%. This increase is primarily attributable to additional
accruals during the nine months ended September 30, 2002 for insurance related
accruals amounting to $2.3 million, including self-insured employee medical
coverage of $1.3 million, $477,000 of general and professional liability claims,
and $475,000 in workers' compensation costs. Also, during the nine months ended,
the Company incurred various costs related to the refinancing plan amounting to
$1.4 million, including $963,000 of consultant costs and $460,000 of legal
costs. The Company does not expect to incur similar costs in the fourth quarter.
Additionally, during the nine months ended September 30, 2002, the Company
incurred approximately $411,000 of additional administrative wages resulting
from industry staffing and retention pressures. These increases are offset by
costs incurred during the nine months ended September 30, 2001, resulting in a
$2.1 million reduction in bad debt expense and a $212,000 reduction in severance
costs. General and administrative expense as a percentage of total revenues
decreased to 8.2% compared to 9.3% for the nine month periods ended September
30, 2002 and 2001, respectively. The Company anticipates that general and
administrative expense as a percentage of total revenues will continue to be at
levels less than prior periods.
EBITDAR (Community NOI). EBITDAR increased $5.7 million from $39.7 million
profit in the nine months ended September 30, 2001 to $45.5 million profit in
the nine months ended September 30, 2002 as further described below.
Retirement Center EBITDAR increased $4.9 million, or 8.7%, from $56.6 million
for the nine months ended September 30, 2001 to $61.6 million for the nine
months ended September 30, 2002. This increase primarily relates to the April
2002 and July 2001 addition of the long-term leases of Freedom Plaza Arizona and
Freedom Plaza Care Center, as well as continued operational improvement
throughout the Retirement Centers, resulting from stabilized occupancy and
increased capacity through expansions, rate increases, and improved control of
community-level overhead expense.
Free-standing AL EBITDAR improved by $6.1 million from a $1.1 million loss in
the nine months ended September 30, 2001, to $5.0 million of income in the nine
months ended September 30, 2002, primarily as a result of increased occupancy at
these communities.
Other EBITDAR losses increased by $5.3 million to $21.1 million in the nine
months ended September 30, 2002 resulting from the $4.0 million of additional
insurance related accruals (related to self-insured employee medical coverage,
general and professional liability claims and workers' compensation), $2.4
million of legal and consulting costs affiliated with the Refinancing Plan, as
well as the $1.0 million reduction in management and development
34
fees. These increases are offset by the decrease of $2.1 million related to
prior year bad debt expense. The remaining increase relates to additional costs
associated with therapy services, marketing, corporate operations, human
resources, financial services and overhead, and increased senior living network
and assisted living management costs.
Lease Expense. As of September 30, 2002, the Company had operating leases for 35
of its communities, including 14 Retirement Centers and 21 Free-standing ALs.
Lease expense increased $41.6 million from $20.7 million for the nine months
ended September 30, 2001 to $62.2 million for the nine months ended September
30, 2002. Lease expense (excluding synthetic leases) increased to $25.9 million
for the nine months ended September 30, 2002, as compared to $11.3 million for
the nine months ended September 30, 2001, representing an increase of $14.5
million. This increase was primarily attributable to 12 additional leases
entered into by the Company during 2001 and 2002, consisting of five Retirement
Center leases which increased lease expense $8.1 million, and the acquisition of
leasehold interests in seven Free-standing AL communities, which increased lease
expense $4.7 million.
As of September 30, 2002, the Company operated only one of its Free-standing ALs
under a synthetic lease structure. Synthetic lease expense increased to $36.4
million for the nine months ended September 30, 2002, as compared to $9.3
million for the nine months ended September 30, 2001, representing an increase
of $27.0 million. Of the total $36.4 million of synthetic lease expense for the
nine months ended September 30, 2002, $4.5 million related to Retirement Centers
and $31.9 million related to Free-standing ALs. Of the total $36.4 million of
synthetic lease expense for the nine months ended September 30, 2002, $30.8
million resulted from residual value guarantee amounts related to losses on sale
lease-back transactions, of which $3.4 million related to Retirement Centers and
$27.4 million related to Free-standing ALs. Effective November 1, 2002, the
Company has terminated all of its synthetic leases.
As a result of completed and anticipated transactions under the Refinancing
Plan, the Company has recorded losses from sale lease-back transactions of $30.8
million for the nine months ended September 30, 2002. For financial reporting
purposes, these losses are considered residual value guarantee amounts and have
been fully recognized as lease expense.
Depreciation and Amortization. Depreciation and amortization expense increased
to $15.4 million in the nine months ended September 30, 2002 from $14.5 million
in the nine months ended September 30, 2001, representing an increase of
$905,000, or 6.3%. The increase was primarily related to the increase in
depreciable assets of approximately $77.0 million (note that $70.2 million of
this increase relates to the September 30, 2002 termination of a synthetic
lease, i.e. no depreciation expense was recognized on these assets during the
nine months ended September 30, 2002), offset by the decrease in amortization of
goodwill of $757,000. These assets relate primarily to the acquisition of
communities, including leasehold interests, and expansion of communities since
September 30, 2001, as well as ongoing capital expenditures.
Amortization of Leasehold Acquisition Costs. Amortization of leasehold
acquisition costs increased $9.5 million from $1.1 million in the nine months
ended September 30, 2001 to $10.7 million in the nine months ended September 30,
2002. As a result of the completed and anticipated transactions under the
Refinancing Plan, which would result in a shorter than expected remaining life
of various leases, the Company accelerated the amortization of leasehold
acquisition costs and recorded additional amortization costs of $8.8 million
related to the nine months ended September 30, 2002. The remaining portion of
this increase relates to the acquisition of twelve leasehold interests in
Free-standing ALs during 2001.
Asset Impairments. During the nine months ended September 30, 2002, the Company
recorded $2.6 million in charges related to delayed or discontinued development
and financing transactions. The Company will continue to evaluate these assets
for impairment. See note 5 to the Condensed Consolidated Financial Statements.
Other Income (Expense). Interest expense increased to $31.4 million in the nine
months ended September 30, 2002 from $28.1 million in the nine months ended
September 30, 2001, representing an increase of $3.4 million, or 12.0%. This
increase was primarily attributable to a higher average amount of indebtedness
(prior to certain refinancing transactions), during the nine months ended
September 30, 2002, as well as higher interest rates. Interest expense, as a
percentage of total revenues, decreased to 12.8% for the nine months ended
September 30, 2002 from 14.4 % in the nine months ended September 30, 2001. As a
result of certain financings completed under the
35
refinancing plan, the Company expects interest expense to increase and,
accordingly, exceed historical levels as a percentage of total revenues.
Interest income decreased to $4.0 million in the nine months ended September 30,
2002 from $8.6 million in the nine months ended September 30, 2001, representing
a decrease of $4.6 million, or 53.8%. The decrease in interest income was
primarily attributable to lower income generated from the reduced amount of
certificates of deposit and notes receivable balances associated with certain
leasing transactions and management agreements. Equity in loss of Managed SPE
Communities (representing the losses that the Company funded when operating
deficits at the Managed SPE Communities exceeded specified limits) decreased
from $3.0 million in the nine months ended September 30, 2001 to $0 in the nine
months ended September 30, 2002. The Company had no further Managed SPE
Communities after December 31, 2001. In addition, $1.9 million of additional
expense related to losses on sales of assets (primarily related to the sale of a
Free-standing AL in Florida).
Income Taxes. The provision for income taxes was a $319,000 expense, compared to
a $5.7 million benefit for the nine months ended September 30, 2002 and 2001,
respectively. The Company has applied a full deferred tax asset valuation
allowance related to its available net operating carryforwards.
Discontinued Operations. During the nine months ended September 30, 2002, the
Company determined that assets acquired through the termination of a synthetic
lease on a Free-standing AL would be held for sale. The Company expects to
sell the community for $9.5 million. Based upon this purchase price, the
Company has recorded $5.9 million of impairment as discontinued operations. The
results of operations for both the current year and comparative prior periods
have not been reclassified to discontinued operations within the accompanying
condensed consolidated financial statements based on the overall insignificance
of these results to the Company.
Extraordinary Loss. During the nine months ended September 30, 2002, the Company
repaid a term note to a bank in connection with the sale of its Carriage Club
Charlotte community, resulting in a prepayment penalty of $348,000. In addition,
the Company expensed the unamortized portions of financing costs, totaling
$408,000 related to the sale lease-backs of two Retirement Centers located in
Illinois and Texas. The Company recorded $756,000 or a $0.04 loss per dilutive
share, net of income taxes, as an extraordinary loss on the extinguishment of
debt.
Net Loss. Based upon the factors noted above, the Company experienced a net loss
of $80.1 million, or $4.63 loss per dilutive share, compared to a net loss of
$11.9 million, or $0.69 loss per dilutive share, for the nine months ended
September 30, 2002 and 2001, respectively. The $4.63 loss per dilutive share for
the nine months ended September 30, 2002 was comprised of a $4.25 loss from
operations, $0.34 loss from discontinued operations related to the impairment of
a community held-for-sale, and a $0.04 loss from the Company's extinguishment of
debt. The loss of $0.69 per dilutive share for the nine months ended September
30, 2001 was comprised of a $0.68 loss from operations and a $0.01 loss from the
extinguishment of debt.
LIQUIDITY AND CAPITAL RESOURCES
During the latter part of 2001, the Company developed a Refinancing Plan to
address its debt and lease obligations maturing during 2002, comprised primarily
of $132.9 million of its Old Debentures due October 1, 2002. On September 30,
2002, the Company completed the Refinancing Plan and repaid the Old Debentures
primarily through the completion of the HCPI Transactions and the Exchange
Offer. As a result of successfully completing its Refinancing Plan, the Company
reduced its current maturities of long term debt from $371.7 million at December
31, 2001 to $14.0 million at September 30, 2002. See Note 2 to the Condensed
Consolidated Financial Statements.
In addition, pursuant to the Refinancing Plan, since November 2001, the Company
has consummated sale lease-back transactions relating to 16 communities and
various other refinancing and capital raising transactions, which in the
aggregate generated gross proceeds of approximately $362.0 million. The Company
used approximately $327.2 million of the proceeds to repay related debt and to
fund reserve and escrow requirements related to these transactions. The Company
used the remaining $34.8 million of proceeds to pay transaction costs associated
with the Refinancing Plan and for working capital. As a result of the
Refinancing Plan, the Company has extended the maturity of substantially all of
its debt arrangements to January 2004 or later. As part of these extensions and
refinancings, the Company has replaced a significant amount of mortgage debt
with higher cost debt and leases, increasing the Company's annual debt and lease
payments by approximately $14.4 million. In addition, the interest costs under
the HCPI Loan and the Series B Notes are significantly higher than the interest
cost of the Debentures. Assuming that the Company elects to pay 2% of the
interest on the Series B Notes through the issuance of additional Series B Notes
rather than cash, the HCPI loan and Series B Note interest payments would be
higher than the corresponding interest payments under the Old Debentures by
approximately $3.8 million. In addition, the Company will accrue additional
interest expense that is not currently payable, pursuant to the HCPI Loan and
the Series B Notes, which will be approximately $13.0 million for the next
twelve months.
Many of the Company's credit and other agreements contain restrictive covenants
that include, among other things, the maintenance of prescribed debt service
coverage, liquidity, capital expenditure reserves and occupancy levels.
Effective as of September 30, 2002, the Company and the lessor of one
Free-standing AL agreed to a waiver relating
36
to certain financial covenants in order to allow the Company to remain in
compliance. Except for the covenants in this lease, the Company has renegotiated
its financial covenants to levels that it believes it can satisfy for the
foreseeable future. There can be no assurances, however, that the Company will
remain in compliance with those covenants or that the Company's creditors will
grant further amendments or waivers in the event of future non-compliance.
Failure to remain in compliance with those covenants would have a material
adverse impact on the Company, and would result in a default under a substantial
majority of the Company's indebtedness and other obligations, and could result
in an acceleration of the maturity of those obligations.
A significant amount of the Company's indebtedness and lease agreements is
cross-defaulted. Any non-payment or other default with respect to such
obligations (including non-compliance with a financial or restrictive covenant)
could cause the Company's lenders to declare defaults, accelerate payment
obligations or foreclose upon the communities securing such indebtedness or
exercise their remedies with respect to such communities. Furthermore, because
of cross-default and cross-collateralization provisions in most of the Company's
mortgages, debt instruments, and leases, a default by the Company on one of its
debt instruments or lease agreements is likely to result in a default or
acceleration of substantially all of the Company's other obligations, which
would have a material adverse effect on the Company.
In addition, the complexity of the Company's Refinancing Plan and the HCPI
Transactions, together with the Company's financial condition could adversely
effect the Company's ability to retain existing residents, attract prospective
residents, selling entry fee units and maintain customary terms of payment from
its vendors, which could have a material adverse effect on the Company's
operating results and liquidity.
Although the Company has successfully consummated the Exchange Offer, the HCPI
Transactions and various other refinancings, it remains highly leveraged with a
substantial amount of debt and lease obligations, and has increased interest and
lease expenses. The Company had scheduled debt payments of $14.0 million and
minimum rental obligations of $44.1 million under long-term operating leases due
during the twelve months ended September 30, 2003. In addition, as of September
30, 2002, the Company had guaranteed $40.3 million of third-party senior debt in
connection with four communities that the Company manages, leases, or owns
through a joint venture.
As of September 30, 2002, the Company had approximately $25.0 million in
unrestricted cash and cash equivalents and $23.3 million of working capital. The
Company's current level of cash flow from operations is not sufficient to meet
its future debt and lease payment obligations. The Company's free cash flow
during the third quarter was approximately negative $3.5 million. For purposes
of this determination, the Company defines Free Cash Flow as EBITDAR minus cash
payments related to lease payments, interest expense and scheduled reductions of
indebtedness and capital expenditures. The EBITDAR used in the determination of
Free Cash Flow is adjusted by 1) subtracting the amortization of deferred
entrance fee revenue and adding the proceeds of entrance fee sales, net of
refunds, 2) subtracting transactions costs recorded in G&A related to the
completion of the Refinancing Plan, and 3) subtracting additions to reserves for
insurance recorded in G&A. The Company expects that its cash flow from
operations will continue to improve, and, accordingly, expects that its current
cash and cash equivalents, expected cash flow from operations, the proceeds from
additional financing transactions and the proceeds of assets currently held for
sale will be sufficient to fund its operating requirements, its capital
expenditure requirements and its periodic debt service requirements and its
lease obligations during the next twelve months.
Cash flow
Net cash used by operating activities was $685,000 for the nine months ended
September 30, 2002, as compared with $5.7 million for the nine months ended
September 30, 2001. The Company's cash and cash equivalents totaled $25.0
million as of September 30, 2002, as compared to $19.3 million as of December
31, 2001.
Net cash provided by investing activities was $28.6 million for the nine months
ended September 30, 2002, as compared with $12.4 million used for the nine
months ended September 30, 2001. During the nine months ended September 30,
2002, the Company received $25.4 million and $22.7 million from sales of assets
and assets limited as to use, respectively, added $14.7 million to land,
building and equipment, issued $3.4 million of notes receivable, and received
$923,000 in security deposits.
Net cash used by financing activities was $22.2 million compared with $3.9
million provided by financing activities during the nine months ended September
30, 2002 and 2001, respectively. During the nine months ended September 30,
2002, the Company borrowed $219.3 million and $12.3 million under long-term debt
and minority interest contribution arrangements, made principal payments on its
indebtedness of $237.6 million, recorded $3.6 million of contingent earnouts,
and paid $8.1 million of financing costs. In connection with certain lifecare
communities, the Company made principal payments and refunds under master trust
agreements of $4.6 million.
37
Financing Activity and the HCPI Transactions
During the three months ended September 30, 2002, the Company entered into
various financing transactions. These transactions are described in Note 4 to
the Condensed Consolidated Financial Statements.
The HCPI Transactions, described more fully in Note 2 to the Condensed
Consolidated Financial Statements, represent the most significant component of
the Company's third quarter financing activity. The Company is permitted to
repay the HCPI Note in whole or in part after three years and redeem the HCPI
Equity Investment after four years. In the event that the Company does not repay
the HCPI Note at maturity in 2007, HCPI may foreclose upon the Company's
ownership interests in the Real Estate Companies that currently own nine of the
Company's Retirement Centers, and the Company will continue to operate the nine
communities pursuant to a long term lease with an initial term of 15 years, and
two ten year renewal options. The Company intends to repay, subject to available
funds, the HCPI Note at the end of three years and repurchase the HCPI Equity
Investment at the end of four years. However, if the Company does not repay the
HCPI Note and repurchase the HCPI Equity Investment at the end of five years,
and HCPI forecloses upon its collateral, the Company will realize significant
taxable income, which may exceed, substantially, the Company's net operating
loss carryforward resulting in a significant net liability to the Company.
The following table presents selected operating information at September 30,
2002, for the nine communities that are included in the HCPI Transactions:
THREE MONTHS NINE MONTHS
# OF UNIT ENDED ENDED MORTGAGE
COMMUNITIES CAPACITY ADJUSTED EBITDAR DEBT
----------- -------- ------------------------- --------
(IN THOUSANDS)
Monthly Service Fee Communities 5 1,428 $ 5,447 $ 15,477 $126,799
EF Communities 4 1,722 4,243 14,053 43,381
------- -------
EBITDAR(1) 9,690 29,530
------- -------
Proceeds from entrance fee sales, net 5,700 10,596
of refunds
Amortization of deferred entrance fee
revenue (2,740) (7,730)
--- ----- ------- ------- --------
9 3,150 $12,650 $32,396 $170,180
=== ===== ======= ======= ========
(1) EBITDAR is defined as earnings before net interest expense, income tax
expense (benefit), depreciation, amortization, rent, and charges
related to asset impairments, equity in losses of managed special
purpose entity communities, other income (expense), minority interest,
and extraordinary items.
FUTURE CASH COMMITMENTS
The following tables summarize the Company's total contractual obligations and
commercial commitments as of September 30, 2002 (amounts in thousands):
38
Payments Due by Period
------------------------------------------------------------------------------
Less than 1 - 3 4 - 5 After 5
Total 1 year years years Years
----------- -------- --------- --------- ---------
Long-term debt $ 392,491 $ 8,999 $ 161,166 $ 136,486 $ 85,840
Debt associated with assets held for sale 35,829 35,829 -- -- --
Capital lease obligations 120,881 4,966 10,822 13,415 91,678
Operating leases 623,270 44,128 90,391 93,139 395,612
Accrued interest on HCPI Loan(1) 90,626 -- -- 90,626 --
Interest income on notes receivable(2) (26,355) (1,101) (2,176) (2,130) (20,948)
----------- -------- --------- --------- ---------
Total contractual cash obligations $ 1,236,742 $ 92,821 $ 290,203 $ 331,536 $ 552,182
=========== ======== ========= ========= =========
(1) The HCPI Loan matures on September 30, 2007 and has a cash interest
payment rate of 9% per year, plus additional accrued interest (which
converts to principal) to its stated interest rate of 19.5%. The amount
interest above represents the unpaid interest which the Company will be
accruing and compounding quarterly until its September 30, 2007
maturity.
(2) A portion of the lease payments noted in the above table are repaid to
the Company as interest income on notes receivable from lessors.
Amount of Commitment Expiration Per Period
--------------------------------------------------------------
Total
Amounts Less than 1 - 3 4 - 5 After 5
Committed 1 year years years Years
--------- --------- ------ ------- -------
Guaranties(1) $40,293 $1,132 $5,606 $10,864 $22,691
------- ------ ------ ------- -------
Total commercial commitments $40,293 $1,132 $5,606 $10,864 $22,691
======= ====== ====== ======= =======
(1) Guaranties include mortgage debt related to four communities. The
mortgage debt guaranteed by the Company relates to two Retirement
Centers under a long-term management agreement and a long-term
operating lease agreement and the Company's two joint ventures.
The Company routinely makes capital expenditures to maintain or enhance
communities under its control. The Company's capital expenditure budget for
fiscal 2003 is approximately $14.2 million.
RISKS ASSOCIATED WITH FORWARD LOOKING STATEMENTS
This Form 10-Q contains certain forward-looking statements within the meaning of
the federal securities laws, which are intended to be covered by the safe
harbors created thereby. Those forward-looking statements include all statements
that are not historical statements of fact and those regarding the intent,
belief or expectations of the Company or its management including, but not
limited to, all statements concerning the Company's anticipated improvement in
operations and anticipated or expected cashflow; the discussions of the
Company's operating and growth strategy; the Company's liquidity and financing
needs; the Company's expectations regarding future entry fee sales or increasing
occupancy at its Retirement Centers or Free-standing ALs; the Company's
alternatives for raising additional capital and satisfying its periodic debt and
lease obligations; the projections of revenue, income or loss, capital
expenditures, and future operations; and the availability of insurance programs.
All forward-looking statements involve risks and uncertainties including,
without limitation, (i) the fact that the Company's cashflow does not currently
cover its obligations (ii) the possibility of future defaults under the
Company's debt and lease agreements, (iii) the risks associated with the
Company's financial condition and the fact that the Company is highly leveraged,
(iv) the risk that the Company will be unable to reduce the operating losses at
its Free-standing ALs , sell its entry fee units or increase its cash flow or
generate expected levels of cash, (v) the risk that alternative financing
sources will not be available to the Company; (vi) the risk that the Company
will be unable to sell the assets that it currently has held for sale; (vii) the
risks associated with the adverse market conditions for the senior living
industry, (viii) the risk that the Company will be unable to obtain liability
insurance in the future or that the costs associated
39
with such insurance (including the costs of deductibles) will be prohibitive,
(ix) the likelihood of further and tighter governmental regulation, and (x) the
risks and uncertainties set forth under the caption "Risk Factors" in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001
and the Company's other filings with the Securities and Exchange Commission.
Should one or more of these risks materialize, actual results could differ
materially from those forecasted or expected. Although the Company believes that
the assumptions underlying the forward-looking statements contained herein are
reasonable, any of these assumptions could prove to be inaccurate, and
therefore, there can be no assurance that the forward-looking statements
included in this Form 10-Q will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking statements included
herein, the inclusion of such information should not be regarded as a
representation by the Company or any other person that the forecasts,
expectations, objectives or plans of the Company will be achieved. The Company
undertakes no obligation to publicly release any revisions to any
forward-looking statements contained herein to reflect events and circumstances
occurring after the date hereof or to reflect the occurrence of unanticipated
events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Disclosure About Interest Rate Risk. The Company is subject to market risk from
exposure to changes in interest rates based on its financing, investing, and
cash management activities. The Company utilizes a balanced mix of debt
maturities along with both fixed-rate and variable-rate debt to manage its
exposures to changes in interest rates. The Company has entered into an interest
rate swap agreement with a major financial institution to manage its exposure.
The swap involves the receipt of a fixed interest rate payment in exchange for
the payment of a variable rate interest payment without exchanging the notional
principal amount. Receipts on the agreement are recorded as a reduction to
interest expense. At September 30, 2002, the Company's outstanding notional
amount of its existing swap agreement was $34.8 million maturing July 1, 2008.
Under the agreement the Company receives a fixed rate of 6.87% and pays floating
rates based upon LIBOR and a foreign currency index with a maximum rate through
July 1, 2002 of 8.12%.
The Company has also entered into two interest rate cap agreements on $33.2
million and $18.5 million mortgage notes to limit the Company's interest rate
exposure. Under the terms of the interest rate cap agreements, the Company
receives payments from the counterparty if 30-day LIBOR exceeds 5.8% over the
term of each mortgage. The Company does not expect changes in interest rates to
have a material effect on income or cash flows in 2002, since 76.2% of the
Company's debt has fixed rates. There can be no assurances, however, that
interest rates will not significantly change and materially affect the Company.
As a part of our Refinancing Plan, the Company consummated sale lease-back
transactions relating to 16 communities and various other refinancing and
capital raising transactions, generating gross proceeds of approximately $362.0
million. As part of these extensions and refinancings, the Company has replaced
a significant amount of mortgage debt with higher cost leases, increasing the
Company's annual debt and lease payments by approximately $14.4 million. In
addition, the interest costs under the HCPI Loan and the Series B Notes are
significantly higher than the interest cost of the Old Debentures. Assuming that
the Company elects to pay 2% of the interest on the Series B Notes through the
issuance of additional Series B Notes rather than cash, HCPI loan and Series B
Note interest payments would be higher than the corresponding interest payments
under the Old Debentures by approximately $3.8 million. In addition, the Company
will accrue additional interest expense that is not currently payable, pursuant
to the HCPI Loan and the Series B Notes, which will be approximately $13.0
million for the next twelve months.
40
Disclosure About Market Exchange Risk The Company's common stock is listed on
the New York Stock Exchange (NYSE). To remain listed on NYSE, the Company must
meet the NYSE's listing maintenance standards and abide by the NYSE's rules. If
the Company fails to meet the other NYSE standards, including minimum
stockholders equity of $50 million or minimum market capitalization of $50
million, or if the price of the Company's common stock falls below $1.00 per
share for an extended period, the Company's common stock could be delisted from
the NYSE.
If the Company's common stock is delisted, the Company would likely seek to list
its common stock on the Nasdaq National Market, if available. Listing or
quotation on such market or exchange could reduce the liquidity for the
Company's common stock. If the Company's common stock were not listed or quoted
on another market or exchange, trading in the Company's common stock would be
conducted in the over-the-counter market on an electronic bulletin board
established for unlisted securities. As a result, an investor would find it more
difficult to trade, or to obtain accurate quotations for the price of, the
Company's common stock. In addition, delisting from the NYSE and failure to
obtain listing or quotation on such other market or exchange could subject the
Company's common stock to so-called "penny stock" rules. These rules impose
additional sales practice and market-making requirements on broker-dealers who
sell and/or make a market in such securities. Consequently, if the Company's
common stock is delisted from the NYSE and the Company fails to obtain listing
or quotation on another market or exchange, broker-dealers may be less willing
or able to sell and/or make a market in the Company's common stock and
purchasers of the Company's common stock may have more difficulty selling such
common stock in the secondary market. In either case, the market liquidity of
the Company's common stock would decline.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's management,
including the Company's chief executive officer and chief financial officer, the
Company conducted an evaluation of its disclosure controls and procedures, as
such term is defined under Rule 13a-14(c) promulgated under the Securities
Exchange Act of 1934, as amended, within 90 days of the filing date of this
report. Based on this evaluation, the principal executive officer and principal
accounting officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information required to be
included in the Company's periodic reports.
There have been no significant changes (including corrective actions with regard
to significant deficiencies or material weaknesses) in the Company's internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation referenced in paragraph (a) above.
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On September 26, 2002, the Company issued $86.8 million aggregate principal
amount of its 5 3/4% Series A Senior Subordinated Notes Due 2002 and $16.0
million aggregate principal amount of its 10% Series B Convertible Senior
Subordinated Notes Due 2008 in exchange for $99.8 million aggregate principal
amount of its outstanding 5 3/4% Convertible Subordinated Debentures Due 2002.
The Exchange Offer was exempt from the registration requirements of the
Securities Act of 1933 pursuant to Section 3(a)(9) of the Securities Act, which
exempts exchanges of securities solely between an issuer and its security
holders. The Company's 10% Series B Convertible Senior Subordinated Notes are
convertible into shares of the Company's common stock at a conversion price of
$2.25 per share.
41
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
4.1 Indenture, dated September 26, 2002, between the Company and U.S. Bank National Association, as Trustee, relating to
the Company's 5 3/4% Series A Senior Subordinated Notes Due 2002
4.2 Indenture, dated September 26, 2002, between the Company and U.S. Bank National Association, as Trustee, relating to
the Company's 10% Series B Convertible Senior Subordinated Notes Due 2008
10.1 Promissory Note dated July 1, 2002, between GMAC Commercial Loan Corporation, a California Corporation (as Lender), and
ARC Santa Catalina Real Estate Holdings, LLC, a Delaware Corporation
10.2 Master Lease Agreement (Pool I), dated July 9, 2002, between ARC Pinegate, L.P., ARC Pearland, L.P., Trinity Towers,
L.P., ARC Lakeway, L.P., ARC Spring Shadow, L.P., ARC Shadowlake, L.P., ARC Willowbrook, L.P., ARC Park Regency, Inc.,
ARC Parklane, Inc. Nationwide Health Properties, Inc., and NH Texas Properties L.P.
10.3 Master Lease Agreement (Pool II), dated July 9, 2002, between American Retirement Corporation, Inc., ARC Naples, LLC,
ARC Aurora, LLC, ARC Lakewood, LLC, ARC Heritage Club, Inc., ARC Countryside, LLC, ARC Cleveland Park, LLC, Nationwide
Health Properties, Inc., and MLD Delaware Trust
10.4 Amended and Restated Loan Agreement, dated as of September 30, 2002, between ARCPI Holdings, Inc. and Health Care
Property Investors, Inc.
10.5 Master Lease Agreement, dated as of September 30, 2002, between Fort Austin Real Estate Holdings, LLC, ARC Santa
Catalina Real Estate Holdings, LLC, ARC Richmond Place Real Estate Holdings, LLC, ARC Holland Real Estate Holdings,
LLC, ARC Sun City Center Real Estate Holdings, LLC, ARC Lake Seminole Square Real Estate Holdings, LLC, ARC Brandywine
Real Estate Holdings, LLC, Fort Austin Limited Partnership, ARC Santa Catalina, Inc., ARC Richmond Place, Inc., Freedom
Village of Holland, Michigan, Freedom Village of Sun City Center, Ltd., Lake Seminole Square Management Company, Inc.,
Freedom Group-Lake Seminole Square, Inc. and ARC Brandywine, LLC
10.6 Loan Agreement, dated as of August 14, 2002, between ARCPI Holdings, Inc. and Health Care Property Investors, Inc.
(Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated August 15, 2002)
10.7 Contribution Agreement, dated August 14, 2002, between ARCPI Holdings, Inc., Fort Austin Limited Partnership, ARC Santa
Catalina, Inc., ARC Richmond Place, Inc., Freedom Village of Holland, Michigan, Freedom Village of Sun City Center,
Ltd., Lake Seminole Square Management Company, Inc., Freedom Group-Lake Seminole Square, Inc., ARC Brandywine, LLC and
Health Care Property Investors, Inc. (Incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form
8-K filed with the Commission on August 15, 2002)
99.1 Certification of W.E. Sheriff Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Certification of George T. Hicks Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
b. Reports on Form 8-K
On August 15, 2002, the Company furnished to the SEC a Form 8-K
disclosing for purposes of Regulation FD supplemental financial
information relating to the Company's second quarter ended June 30,
2002.
On August 15, 2002, the Company furnished to the SEC a Form 8-K
disclosing for purposes of Regulation FD the terms of an exchange offer
for its 5-3/4% Convertible Subordinated Debentures due October 1, 2002
and a $125 million refinancing plan.
42
On August 29, 2002, the Company furnished to the SEC a Form 8-K
disclosing for purposes of Regulation FD supplemental pro forma
information regarding a $125 million loan agreement.
On September 12, 2002, the Company furnished to the SEC a Form 8-K
disclosing for purposes of Regulation FD amended terms of a $125
million refinancing plan.
On September 26, 2002, the Company furnished to the SEC a Form 8-K
disclosing for purposes of Regulation FD the completion of the
Company's exchange offer for its 5-3/4% Convertible Subordinated
Debentures due October 1, 2002.
On October 1, 2002, the Company furnished to the SEC a Form 8-K
disclosing for purposes of Regulation FD the completion of the
Company's $125 million refinancing plan.
43
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AMERICAN RETIREMENT CORPORATION
Date: November 14, 2002 By: /s/ George T. Hicks
----------------------------------------
George T. Hicks
Executive Vice President-Finance,
Chief Financial Officer, Secretary and
Treasurer (Principal Financial and
Accounting Officer)
44
CERTIFICATION
I, W.E. Sheriff, certify that:
1. I have reviewed this quarterly report on Form 10-Q of American
Retirement Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 14, 2002
/s/ W.E. Sheriff
-----------------------------------------------
W.E. Sheriff
Chairman and Chief Executive Officer
45
CERTIFICATION
I, George T. Hicks, certify that:
1. I have reviewed this quarterly report on Form 10-Q of American
Retirement Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 14, 2002
/s/ George T. Hicks
--------------------------------------------
George T. Hicks
Chief Financial Officer, Secretary and Treasurer
46