Emeritus 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2007.
Commission file number 1-14012
(Exact name of registrant as specified in its charter)
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007
3131 Elliott Avenue, Suite 500, Seattle, WA 98121
(Address of principal executive offices)
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
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), (2) and has been subject to such filing requirements for the past 90 days. Yes xNo o
Indicate by check mark that there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K contained in this form, and no disclosure will be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the Registrant is a SHELL COMPANY (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
Aggregate market value of common voting stock held by non-affiliates of the registrant as of June 30, 2007, was $171,379,346.
Aggregate market value of common voting stock held by non-affiliates of the registrant as of February 29, 2008, was $437,278,406.
As of February 29, 2008, 39,038,181 shares of the Registrant’s Common Stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
The information required by Part III of Form 10-K (items 10-14) is incorporated herein by reference to the Registrant’s definitive Proxy Statement to be filed on or before April 30, 2008.
Our disclosure and analysis in this report, in other disclosures incorporated by reference herein, and in some of our other public statements contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. This Act provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. In some cases, you can identify forward-looking statements by terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “should” or “will,” or the negative of those terms, or comparable terminology. Some of the forward-looking statements included in this report and documents incorporated by reference and in some of our other public statements relate to, among other things:
Any or all of our forward-looking statements in this report and in any other public statements we make may turn out to be inaccurate. Please review carefully Item 1A-Risk Factors of this report for important factors that could cause our actual results to differ materially from the forward-looking statements included in this report and presented elsewhere by our management from time to time. Incorrect assumptions we might make and known or unknown risks and uncertainties may affect the accuracy of our forward-looking statements. Forward-looking statements reflect our current expectations or forecasts of future events or results and are inherently uncertain, and accordingly, you should not place undue reliance on forward-looking statements.
Although we believe that the expectations and forecasts reflected in the forward-looking statements are reasonable, we cannot guarantee future results, performance, or achievements. Consequently, no forward-looking statement can be guaranteed and future events and actual or suggested results may differ materially. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events, or otherwise. You are advised, however, to consult any further disclosures we make in our quarterly reports on Form 10-Q and current reports on Form 8-K.
Emeritus Corporation was founded in 1993 and is one of the largest and most experienced national operators of assisted living and Alzheimer’s care residential communities in the United States. Our communities provide a residential housing alternative for senior citizens who need help with the activities of daily living, but do not require the constant skilled nursing services provided in skilled nursing facilities.
On September 1, 2007, we completed our acquisition of Summerville Senior Living, Inc., which we sometimes refer to as "Summerville", a San Ramon, California-based operator of 81 communities comprising 7,935 units in 13 states, which provided independent living, assisted living, and Alzheimer’s and dementia-related services to seniors. We sometimes refer to this transaction as the "Summerville acquisition". As a result of the Summerville acquisition, Summerville became our wholly-owned subsidiary and retained the brand name in the operation of its communities. Granger Cobb, President and CEO of Summerville, assumed the titles of President and Co-CEO of Emeritus. Pursuant to the terms of the merger agreement and a shareholder agreement, Mr. Cobb and a representative designated by the Apollo Real Estate Investment Funds III and IV, which we sometimes refer to as the "Apollo Funds" were appointed to our board of directors upon consummation of the transaction.
As of December 31, 2007, we operated, or had an interest in, 287 assisted living communities, consisting of approximately 24,680 units with a capacity for 29,522 residents. Our facilities are located in 37 states and include 107 communities that we own, 147 communities that we lease, and 33 communities that we manage, including 23 in which we hold joint venture interests. As of December 31, 2007, our consolidated facilities were 88.0% occupied. In 2007, we generated approximately 89.0% of our revenues from private pay residents, which limits our exposure to government reimbursement risk, and our average monthly revenue per occupied unit was $3,235.
We have 178 communities that offer Alzheimer’s and dementia care services with approximately 3,941 units in a mix of both free-standing facilities and as part of our standard assisted living facilities. We believe the need for Alzheimer’s and dementia care will continue to increase in the future. Today, there are an estimated 24 million people in the world with some form of dementia and 4.6 million new cases are diagnosed each year. In addition, the number of Americans diagnosed with Alzheimer’s disease has doubled since 1980. By 2050 the number of individuals in the United States with dementia is expected to increase from 4.5 million to above 11.3 million. Dementia care residents typically have declines in certain mental functions that prevent them from performing activities of daily living, such as dressing and feeding themselves.
Our portfolio of communities is highlighted by relatively new, high quality facilities that offer a significant number of amenities to our residents and which allows us to operate efficiently. Of our 287 communities, 180 have been built or opened since January 1, 1996. In addition, we have significantly upgraded many of our older communities to enhance their appearance and made improvements to kitchens, nurse call systems, dining and recreation areas, landscaping, and electronic systems, including data transmission.
We strive to provide a wide variety of supportive living services in a professionally managed environment that allows our residents to maintain dignity and independence. Our residents are typically unable to live independently, but do not require the intensive care provided in skilled nursing facilities. Under our approach, seniors reside in a private or semi-private residential unit for a monthly fee based in part on each resident’s individual service needs. We believe our residential assisted living and Alzheimer’s and related dementia care communities allow seniors to maintain a more independent lifestyle than is possible in the institutional environment of skilled nursing facilities, while also providing peace of mind knowing that staff are available should the need arise. In addition, we believe that our services, including assisting residents with activities of daily living, such as medication management, bathing, dressing, personal hygiene, and grooming, are attractive to seniors who are inadequately served by independent living facilities.
We are focused on increasing our revenues and cash flows through a combination of initiatives:
· continue to increase occupancy to stabilized levels.
By executing these growth initiatives, we have witnessed a consistent improvement in our revenues as evidenced by our increase in revenue per unit from $2,957 in 2005 to $3,100 in 2006 and to $3,235 in 2007. In addition, our average occupancy increased from 84.5% in 2005 to 85.3% in 2006 and to 86.7% in 2007.
In 2007, our initiatives to enhance revenues produced the following successful results:
The Assisted Living and Alzheimer’s and Related Dementia Care Industry
We believe that the assisted living and Alzheimer’s and related dementia care industry is the preferred residential alternative for seniors who cannot live independently due to physical or cognitive frailties but who do not require the more intensive medical attention provided by a skilled nursing facility.
Generally, assisted living provides housing and 24-hour personal support services designed to assist seniors with the activities of daily living, which include bathing, eating, personal hygiene, grooming, medication reminders, ambulating, and dressing. Certain assisted living facilities may offer higher levels of personal assistance for residents with Alzheimer’s disease or other forms of dementia, based in part on local regulations, in addition to our free-standing Alzheimer’s and related dementia care facilities.
We believe that assisted living communities will continue to be one of the fastest growing choices for senior care due to a number of factors, including:
We compete with other assisted living communities located in the areas where we operate. These communities are operated by individuals, local and regional businesses, and larger operators of regional and national groups of communities, including public companies similar to us. We believe that we have the following competitive strengths:
We believe that there is a significant demand for alternative long-term care services that are well-positioned between the limited services offered by independent living facilities and the higher-level medical and institutional care offered by skilled nursing facilities. Our goal is to continue as a national leader in the assisted living segment of the long-term care industry through the following strategy:
Our assisted living communities offer residents a full range of services based on individual resident needs in a supportive “home-like” environment. By offering a full range of services, we can accommodate residents' needs. The services that we provide to our residents are designed to respond to their individual needs and to improve their quality of life.
Service Revenue Sources
We rely primarily on our residents’ ability to pay our charges for services from their own or family resources and expect that we will do so for the foreseeable future. Although care in an assisted living community is typically less expensive than in a skilled nursing facility, we believe that generally only seniors with income or assets meeting or exceeding the regional median can afford to reside in our communities.
As third-party reimbursement programs and other forms of payment continue to grow, we will participate in these alternative forms of payment, depending on the level of reimbursement provided in relation to the level of care provided. We also believe that private long-term care insurance will increasingly become a revenue source in the future, although it is currently small. All sources of revenue other than residents’ private resources constituted less than 11.0% of our total revenues in 2007.
We provide management services to independent and related-party owners of assisted living communities. We managed 33 and 32 communities at December 31, 2007 and 2006, respectively. Of the 33 managed communities, 23 are owned by joint ventures in which we have an interest, three are owned by a third party, and seven are owned by entities in which Mr. Baty has an interest. Agreements typically provide for fees between 5% and 6% of gross revenues, although a few have fees based on occupancy that approximate 5% of gross revenues. Terms typically range from two to five years and may be renewed or renegotiated at the expiration of the term. However, our management agreements with Blackstone JV have a one-year term and are automatically renewed on 30-day successive periods at the end of the initial one-year term.
From the beginning of 2003 through 2007, we have decreased the number of our managed communities from 95 to 33 primarily by acquiring and leasing these communities. Management fees were approximately $4.4 million for 2007 and $1.9 million in 2006, compared to $2.0 million in 2005. Management fees increased by $2.5 million in the year ended December 31, 2007, primarily due to the net 23 management agreements added from the Blackstone JV since December 2006, partially offset by the two-community net reduction in other management agreements from January 1, 2006, through December 31, 2007.
As of December 31, 2007, we operated, or had an interest in, 287 assisted living communities, consisting of approximately 24,680 units with a capacity for 29,522 residents. Our facilities are located in 37 states. The following table summarizes our portfolio of communities as of December 31, 2007.
Marketing and Referral Relationships
Our operating strategy is designed to integrate our assisted living communities into the continuum of healthcare services offered in the geographic markets in which we operate. One objective of this strategy is to enable residents who require additional healthcare services to benefit from our relationships with local hospitals, physicians, home healthcare agencies, and skilled nursing facilities in order to obtain the most appropriate level of care. Thus, we seek to establish relationships with local hospitals, through joint marketing efforts where appropriate, and home healthcare agencies, alliances with visiting nurses associations and, on a more limited basis, priority transfer agreements with local, high-quality skilled nursing facilities. In addition to benefiting residents, the implementation of this operating strategy has strengthened and expanded our network of referral sources.
We have an ongoing quality assurance process that occurs in each of our communities. Our program is designed to achieve resident and family member satisfaction with the care and services we provide. Quality assurance audits of care and operational systems are done on an ongoing basis using the Comprehensive Process Review (CPR) auditing tool. The CPR audit tool was developed by the quality and risk management team in collaboration with other departments in the community, regional, and divisional levels. All areas of community operations and care systems are reviewed and evaluated using this comprehensive process. The audit includes an inspection of the community that evaluates three major areas: quality of care, quality of life, and community practices and behavior. Other continuous quality improvement measures include our customer satisfaction and employee satisfaction surveys and feedback from residents and family members on a regular basis to monitor their perception of the quality of services provided to residents through our Ethics First compliance program.
Our communities have established on-going resident and/or family meetings through care conferences and/or family night meetings. Feedback, recommendations, and suggestions to improve overall quality performance of the community are obtained from the resident, responsible party, and staff. The CPR, Ethics First compliance program, resident care conferences, and family night meetings are significant components of our continuous quality improvement program. These processes are used to benchmark our ongoing efforts to improve quality, enhance customer satisfaction, and minimize risk exposure.
We employ an integrated structure of management, financial systems, and controls to maximize operating efficiency and contain costs. In addition, we have developed the internal procedures, policies, and standards we believe are necessary for effective operation and management of our assisted living communities. We have recruited seasoned key employees with years of experience in the long-term care services field and believe we have assembled the administrative, operational, and financial personnel who will enable us to continue to manage our operating strategies effectively.
Our Chief Operating Officer leads a vice presidential group that consists of six divisions. An operational vice president heads each division in a collaborative team system that includes a vice president of sales and marketing and a vice president of quality service and risk management. Each divisional team oversees several operating regions headed by a regional director of operations, who provides management support services for each of the communities in his/her respective region, along with the respective regional director of quality service and risk management and regional director of sales and marketing. An on-site executive director supervises day-to-day community operations, and in certain jurisdictions, must satisfy various licensing requirements. We provide management support services to each of our residential communities, including establishing operating systems and standards, recruiting, training, and financial and accounting services.
We have centralized finance and other operational support functions at our headquarters in Seattle, Washington, in order to allow community-based personnel to focus on resident care. The Seattle office establishes policies and procedures applicable to the entire company, oversees our financial and marketing functions, manages our acquisition and development activities, and provides our overall strategic direction.
We use a blend of centralized and decentralized accounting and computer systems that link each community with our headquarters. Through these systems, we are able to monitor occupancy rates and operating costs and distribute financial and operating information to appropriate levels of management in a cost efficient manner. We believe that our data systems are adequate for current operating needs and provide the flexibility to meet the requirements of our operations without disruption or significant modification to existing systems beyond 2008. We use high quality hardware and operating systems from current and proven technologies to support our technology infrastructure.
The number of assisted living communities continues to grow in the United States. We anticipate that our source of competition will come from local, regional, and national assisted living companies that operate, manage, and develop residences within the geographic area in which we operate, as well as retirement facilities and communities, home healthcare agencies, not-for-profit or charitable operators and, to a lesser extent, skilled nursing facilities and convalescent centers. We believe that quality of service, reputation, community location, physical appearance, and price will be significant competitive factors.
Federal, state, and local authorities heavily regulate the healthcare industry. Regulations change frequently, and sometimes require us to make changes in our operations. We cannot predict to what extent legislative or regulatory initiatives will be enacted or adopted or what effect any initiative would have on our business and operating results. Changes in applicable laws and new interpretations of existing laws can significantly affect our operations, as well as our revenues and expenses. Our residential communities are subject to varying degrees of regulation and licensing by local and state health and social service agencies and other regulatory authorities. In addition, federal, state, and local officials are increasingly focusing their efforts on enforcement of these laws.
In several of the states in which we operate or intend to operate, we are prohibited from providing senior care services or expanding existing services without first obtaining the appropriate licenses such as a Certificate of Need. Senior living facilities may also be subject to state and/or local building, zoning, fire, and food service codes and must be in compliance with these local codes before licensing or certification may be granted. Assisted living facilities are subject to periodic surveys or inspections by governmental authorities to assess and assure compliance with regulatory requirements. Such unannounced surveys occur annually or bi-annually, or may occur following a state’s receipt of a complaint about the community. As a result of any such inspection, authorities may allege that the senior living community has not complied with all applicable regulatory requirements. Typically, assisted living communities then have the opportunity to correct alleged deficiencies by implementing a plan of correction, but the reviewing agency typically has the authority to take further action against a licensed or certified facility. Authorities may enforce compliance through imposition of fines, imposition of a provisional or conditional license, suspension or revocation of a license, suspension or denial of admissions, loss of certification as a provider under federal health care programs, or imposition of other sanctions. From time to time, in the ordinary course of business, we receive deficiency reports from state regulatory bodies resulting from such inspections or surveys.
We are also subject to certain federal and state laws that regulate financial arrangements by health care providers, such as the Health Insurance Portability and Accountability Act of 1996, or HIPAA, the Federal Anti-Kickback Law and the False Claims Act. The Federal Anti-Kickback Law makes it unlawful for any person to offer or pay (or to solicit or receive) any remuneration directly or indirectly, overtly or covertly, in cash or in kind for referring or recommending for purchase any item or service which is eligible for payment under the Medicare or Medicaid programs. Authorities have interpreted this statute very broadly to apply to many practices and relationships between health care providers and sources of patient referral. If an entity were to violate the Anti-Kickback Law, it may face criminal penalties and civil sanctions, including fines and possible exclusion from government programs such as Medicare and Medicaid. In addition, with respect to our participation in federal health care reimbursement programs, the government or private individuals acting on behalf of the government may bring an action under the False Claims Act alleging that a health care provider has defrauded the government and seek treble damages for false claims and the payment of additional monetary civil penalties. The False Claims Act allows a private individual with knowledge of fraud to bring a claim on behalf of the federal government and earn a percentage of the federal government’s recovery. Many states have enacted similar anti-kickback and false claims laws that may have a broad impact on providers and their payor sources. We are also subject to federal and state laws designed to protect the confidentiality of patient health information. The U.S. Department of Health and Human Services (HHS) has issued rules pursuant to HIPAA relating to the privacy of such information. In addition, many states have confidentiality laws, which in some cases may exceed the federal standard. We have adopted procedures for the proper use and disclosure of residents’ health information in compliance with the relevant state and federal laws, including HIPAA. Although these requirements affect the manner in which we handle health data and communicate with payors at communities, the cost of compliance does not have a material adverse effect on our business, financial condition, or results of operations. The federal and state laws governing assisted living are various and complex. While we endeavor to comply with all laws that regulate the licensure and operation of our communities, it is difficult to predict how our business could be affected if it were subject to an action alleging such violations.
At December 31, 2007, we had approximately 16,205 employees, including 11,869 full-time employees, of which 324 were employed at our corporate headquarters and regional offices. This is an increase of 6,105 employees compared to December 31, 2006. This substantial increase in employees is primarily due to our September 1, 2007, acquisition of Summerville, which had approximately 4,900 employees at the time of the acquisition. Of our 16,205 employees, 1,915 were employed in our managed communities, including 1,220 full-time employees. As of December 31, 2007, none of our employees are represented by a labor union. On July 30, 2007, we were advised that a matter before the National Labor Relations Board about one of our Florida communities had been dismissed. We had approximately 48 employees represented at one time by the union at this Florida community. Our last bargaining session with the union took place on February 13, 2007. Subsequently, we received evidence establishing that the union, in fact, no longer represented a majority of our employees that were the subject of the collective bargaining. Based upon this evidence, and in accordance with applicable law, we withdrew recognition of the union and terminated bargaining. We believe that our relationship with our employees is satisfactory.
Although we believe that we are able to employ sufficiently skilled personnel to staff the communities we operate or manage, a shortage of skilled personnel, particularly in nursing, in any of the geographic areas in which we operate could adversely affect our ability to recruit and retain qualified employees and to control our operating expenses.
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments thereto, filed with the Securities and Exchange Commission (SEC) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder are made available free of charge on our web site (www.emeritus.com) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our web site is not being incorporated herein. These reports may also be obtained at the SEC's Public Reference Room at 100 F Street, NE Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains a web site at www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including Emeritus.
Our business, results of operations, and financial condition are subject to many risks, including, but not limited to, those set forth below:
We have incurred losses since we began doing business, except for 2005, and may continue to incur losses for the foreseeable future. We organized and began operations in July 1993 and have operated at a loss since we began doing business, except for 2005. For 2007, 2006, and 2005, we recorded, before preferred dividends, a loss of $48.7 million, a loss of $14.6 million, and income of $12.3 million, respectively. Our net income in 2005 includes a gain on the sale of our investment in Alterra Healthcare Corporation (Alterra) of $55.4 million. Without this gain, we would have incurred a loss in 2005. We believe that the historically aggressive growth of our portfolio through acquisitions and developments and related financing activities, as well as our inability (along with much of the assisted living industry) to increase occupancy rates at our communities, were among the causes of these losses. To date, at many of our communities, we have generally been able to stabilize occupancy and rate structures to levels that have resulted in positive cash
flow from operations, but not earnings. Our ongoing operations may not become profitable in line with our current expectations or may not become profitable at all.
We may fail to realize the anticipated synergies, cost savings and other benefits expected from the Summerville acquisition, which could adversely affect the value of our common stock in the future. The Summerville acquisition involved the integration of two companies that had previously operated independently. We entered into the merger agreement with Summerville with the expectation that the transaction would combine Summerville’s business with our business and create opportunities to achieve cost synergies and other benefits from operating the combined business.
The value of our common stock in the future may be affected by the ability to achieve the benefits expected to result from consummation of the Summerville acquisition. Achieving the benefits of the transaction will depend in part upon meeting the challenges inherent in the successful combination of two business enterprises of the size and scope of our business and Summerville and the possible resulting diversion of management attention for an extended period of time. There can be no assurance that such challenges will be met and that such diversion will not negatively impact our operations following the transaction. Although we expect significant benefits, such as increased cost savings, to result from the transaction, there can be no assurance that we will fully realize these anticipated benefits.
If we cannot generate sufficient cash flow to cover required interest, principal and lease payments, we risk defaults on our debt agreements and leases. At December 31, 2007, we had total debt of $744.7 million, with minimum annual principal payments of $33.1 million due in 2008 (including $10.5 million principal amount of 6.25% convertible subordinated debentures due July 1, 2008), and were obligated under both long-term operating and capital leases requiring minimum annual cash lease payments of $126.1 million in 2008. In addition, we will have approximately $101.5 million and $40.5 million in principal amount of debt repayment obligations that become due in 2009 and 2010, respectively. If we are unable to generate sufficient cash flow to make such payments as required and are unable to renegotiate payments or obtain additional equity or debt financing, a lender could foreclose on our communities secured by the respective indebtedness or, in the case of a lease, could terminate our lease, resulting in loss of income and asset value. In some cases, our indebtedness is secured by a particular community and a pledge of our interests in a subsidiary entity that owns that community. In the event of a default, a lender could avoid judicial procedures required to foreclose on real property by foreclosing on our pledge instead, thus accelerating its acquisition of that community. Furthermore, because of cross-default and cross-collateralization provisions in certain of our mortgage and sale-leaseback agreements, if we default on one of our payment obligations, we could adversely affect a significant number of our communities.
Because we are highly leveraged, we may not be able to respond to changing business and economic conditions or continue with selected acquisitions. A substantial portion of our future cash flow will be devoted to debt service and lease payments. In the past, we have frequently been dependent on third-party financing and disposition of assets to fund these obligations in full and we may be required to do so in the future. In addition, we are periodically required to refinance these obligations as they mature. Our long-term debt including convertible debentures was $744.7 million at December 31, 2007, and our obligations under long-term operating and capital leases were $1.6 billion at December 31, 2007. These circumstances could reduce our flexibility and ability to respond to our business needs, including changing business and financial conditions such as increasing interest rates and opportunities to expand our business through selected acquisitions.
We may be unable to increase or stabilize our occupancy rates at levels that would result in positive earnings. In previous years, we have been unable to increase our occupancy to levels that would result in net income on a sustained basis. Our historical losses have resulted, in part, from occupancy levels that were lower than anticipated when we acquired or developed our communities. While our occupancy levels have increased each year since 2004, during the three years prior to that, occupancy levels declined, excluding the
effects of acquired communities. Our occupancy levels may not continue to increase and may never reach levels necessary to achieve net income.
We may not find additional funding through public or private financing on acceptable terms. We may not find adequate equity, debt, or sale-leaseback financing when we need it or on terms acceptable to us. This could affect our ability to finance our operations or refinance our properties to avoid the consequences of default and foreclosure under our existing financing as described elsewhere. In addition, if we raise additional funds by issuing equity securities, our shareholders may experience dilution in their investment.
If we fail to comply with financial covenants contained in our debt instruments, our lenders may accelerate the related debt. From time to time, we have failed to comply with certain covenants in our financing and lease agreements relating generally to matters such as cash flow, debt and lease coverage ratios, and certain other performance standards. Currently, we do not comply with certain covenants relating to portfolio and facility-level cash flow to base rent coverage ratios under certain leases with one of our significant lessors, for which we have obtained waivers until January 2009. In the future, we may be unable to comply with these or other covenants. If we fail to comply with any of these requirements and are not able to obtain waivers, our lenders could accelerate the related indebtedness so that it becomes due and payable prior to its stated due date, and/or the lessors could terminate lease agreements. We may be unable to repay or refinance this debt if it becomes due.
We self-insure many of the liabilities we face. In recent years, participants in the long-term-care industry have faced an increasing number of lawsuits alleging negligence, malpractice, or other related legal theories. Many of these suits involve large claims and significant legal costs. We expect we will occasionally face such suits because of the nature of our business. We are responsible for the full loss of any professional liability claims. We also carry conventional commercial general liability insurance. Claims against us, regardless of their merit or eventual outcome, may also undermine our ability to attract residents or expand our business and would require management to devote time to matters unrelated to the operation of our business. Except on a very limited basis, we currently do not carry professional liability insurance and, although we review our liability insurance annually, we may not be able to obtain third-party liability insurance coverage in the future or, if available, on acceptable terms.
We face risks associated with selective acquisitions. We intend to continue to seek selective acquisition opportunities. However, we may not succeed in identifying any future acquisition opportunities or completing any identified acquisitions. The acquisition of communities presents a number of risks. Existing communities available for acquisition may frequently serve or target different market segments than those we presently serve. It may be necessary in these cases to reposition and renovate acquired communities or turn over the existing resident population to achieve a resident care level and income profile that is consistent with our objectives. In the past, these obstacles have delayed the achievement of acceptable occupancy levels and increased operating and capital expenditures. As a consequence, we currently plan to target assisted living communities with established operations, which could reduce the number of acquisitions we can complete and increase the expected cost. Even in these acquisitions, however, we may need to make staff and operating management personnel changes to successfully integrate acquired communities into our existing operations. We may not succeed in repositioning acquired communities or in effecting any necessary operational or structural changes and improvements on a timely basis. We also may face unforeseen liabilities attributable to the prior operator of the acquired communities, against whom we may have little or no recourse.
If we are unable to expand our facilities in accordance with our plans, our anticipated revenues and results of operations could be adversely affected. We are currently working on projects that will expand several of our existing communities over the next several years. We are also developing certain new senior living facilities. These projects are in various stages of development and are subject to a number of factors over which we have little or no control. Such factors include the necessity of arranging separate mortgage loans or other financings to provide the capital required to complete these projects; difficulties or delays in
obtaining zoning, land use, building, occupancy, licensing, certificate of need and other required governmental permits and approvals; failure to complete construction of the projects on budget and on schedule; failure of third-party contractors and subcontractors to perform under their contracts; shortages of labor or materials that could delay projects or make them more expensive; adverse weather conditions that could delay completion of projects; increased costs resulting from general economic conditions or increases in the cost of materials; and increased costs as a result of changes in laws and regulations.
We cannot assure you that we will elect to undertake or complete all of our proposed expansion and development projects, or that we will not experience delays in completing those projects. In addition, we may incur substantial costs prior to achieving stabilized occupancy for each such project and cannot assure you that these costs will not be greater than we have anticipated. We also cannot assure you that any of our development projects will be economically successful. Our failure to achieve our expansion and development plans could adversely impact our growth objectives and our anticipated revenues and results of operations.
We expect competition in our industry to increase, which could cause our occupancy rates and resident fees to decline. The long-term care industry is highly competitive, and given the relatively low barriers to entry and continuing health care cost containment pressures, we expect that our industry will become increasingly competitive in the future. We believe that market saturation in some locales could have an adverse effect on our communities and their ability to reach and maintain stabilized occupancy levels. Moreover, the senior housing services industry has been subject to pressures that have resulted in the consolidation of many small, local operations into larger regional and national multi-facility operations. We compete with other companies providing assisted living services as well as numerous other companies providing similar service and care alternatives, such as home healthcare agencies, independent living facilities, retirement communities, and skilled nursing facilities. We expect that competition from new market entrants will increase as assisted living residences receive increased market awareness and more states decide to include assisted living services in their Medicaid programs. Many of these competitors may have substantially greater financial resources than we do. Increased competition may limit our ability to attract or retain residents or maintain our existing rate structures. This could lead to lower occupancy rates or lower rate structures in our communities.
If development of new assisted living facilities outpaces demand, we may experience decreased occupancy, depressed margins, and diminished operating results. We believe that some assisted living markets have become or are on the verge of becoming overbuilt. The barriers to entry in the assisted living industry are not substantial. Consequently, the development of new assisted living facilities could outpace demand. Overbuilding in the markets in which we operate could thus cause us to experience decreased occupancy and depressed margins and could otherwise adversely affect our operating results.
Market forces could undermine our efforts to attract seniors with sufficient resources. We rely on the ability of our residents to pay our fees from their own or family financial resources. Generally, only seniors with income or assets meeting or exceeding the comparable median in the region where our assisted living communities are located can afford our fees. Inflation or other circumstances may undermine the ability of seniors to pay for our services. If we encounter difficulty in attracting seniors with adequate resources to pay for our services, our occupancy rates may decline.
Our labor costs may increase and may not be matched by corresponding increases in rates we charge to our residents. We compete with other providers of assisted living services and long-term care in attracting and retaining qualified and skilled personnel. We depend on our ability to attract and retain management personnel responsible for the day-to-day operations of each of our communities. If we are unable to attract or retain qualified community management personnel, our results of operations may suffer. In addition, possible shortages of nurses or trained personnel may require us to enhance our wage and benefits packages to compete in the hiring and retention of personnel. We also depend on the available labor pool of semi-skilled and unskilled employees in each of the markets in which we operate. As a result of these and other
factors, our labor costs may increase and may not be matched by corresponding increases in rates we charge to our residents.
Some of our facilities generate infectious medical waste due to the illness or physical condition of the residents, including, for example, blood-soaked bandages, swabs, and other medical waste products, and incontinence products of those residents diagnosed with an infectious disease. The management of infectious medical waste, including handling, storage, transportation, treatment, and disposal, is subject to regulation under various laws, including federal and state environmental laws. These environmental laws set forth the management requirements, as well as permit, record-keeping, notice, and reporting obligations. Each of our facilities has an agreement with a waste management company for the proper disposal of all infectious medical waste. Any finding that we are not in compliance with these environmental laws could adversely affect our business and financial condition. While we are not aware of any non-compliance with environmental laws related to infectious medical waste at any of our properties, these environmental laws are amended from time to time and we cannot predict when and to what extent liability may arise. In addition, because these environmental laws vary from state to state, expansion of our operations to states where we do not currently operate may subject us to additional restrictions on the manner in which we operate our facilities.
Our chief executive officer, Daniel R. Baty, has personal interests that may conflict with ours due to his interest in Columbia-Pacific Group, Inc. Mr. Baty is the principal owner of Columbia-Pacific Group, Inc., a private company engaged in the development and operation of senior housing, assisted living communities, and hospitals in India and other parts of Asia. Columbia-Pacific and affiliated partnerships also own assisted living communities, Alzheimer’s and dementia care facilities, and independent living facilities in the United States, some of which we manage under various management agreements. These financial interests and management and financing responsibilities of Mr. Baty with respect to Columbia-Pacific and their affiliated partnerships could present conflicts of interest with us, including potential competition for residents in markets where both companies operate and competing demands for the time and efforts of Mr. Baty.
Some of our recent transactions and the operations of certain communities that we manage are supported financially by Mr. Baty with limited guarantees and through his direct and indirect ownership of such communities; we would be unable to benefit from these transactions and managed communities without this support. We currently manage seven communities owned by entities controlled by Mr. Baty. Mr. Baty was also the guarantor of a portion of our obligations under a 24-community lease with an entity in which Mr. Baty has an ownership interest. We acquired these properties in February 2007 in a transaction in which the entity affiliated with Mr. Baty provided us with financing in the amount of $18 million for two years, which financing was paid off in July 2007. In 2004, he personally guaranteed $3 million of our obligations under a long-term lease with Health Care Property Investors, Inc., an independent REIT, which terminated with the purchase of these communities in August 2007. Also in 2004, Mr. Baty guaranteed our obligations under a long-term lease relating to 20 communities. As part of this arrangement, which continues to be in effect for 18 of the communities, he shares in 50% of the positive cash flow (as defined) and is responsible for 50% of the cash deficiency for these communities. We believe that we would have been unable to take advantage of these transactions and management opportunities without Mr. Baty’s individual and financial support. The ongoing administration of these transactions, however, could be adversely affected by these continuing relationships because our interests and those of Mr. Baty may not be congruent at all times. In addition, we cannot guarantee that such support will be available in the future.
We may be unable to attract and retain key management personnel. We depend upon, and will continue to depend upon, the services of Mr. Baty. Mr. Baty has financial interests and management responsibilities with respect to Columbia-Pacific and its related partnerships that require a considerable amount of Mr. Baty’s time. As a result, he does not devote his full time and efforts to Emeritus. The loss of Mr. Baty’s services, or those of Mr. Cobb, could adversely affect our business and our results of operations. We also may be unable to attract and retain other qualified executive personnel critical to the success of our business.
Our costs of compliance with government regulations may significantly increase in the future. Federal, state, and local authorities heavily regulate the healthcare industry. Regulations change frequently, and sometimes require us to make expensive changes in our operations. A number of legislative and regulatory initiatives relating to long-term care are proposed or under study at both the federal and state levels that, if enacted or adopted, could adversely affect our business and operating results. We cannot predict to what extent legislative or regulatory initiatives will be enacted or adopted or what effect any initiative would have on our business and operating results. Changes in applicable laws and new interpretations of existing laws can significantly affect our operations, as well as our revenues, particularly those from governmental sources, and our expenses. These laws and regulatory requirements could affect our ability to expand into new markets and to expand our services and facilities in existing markets. In addition, if any of our presently licensed facilities operates outside of its licensing authority, it may be subject to penalties, including closure of the facility. Our residential communities are subject to varying degrees of regulation and licensing by local and state health and social service agencies and other regulatory authorities. Federal, state, and local governments occasionally conduct unannounced investigations, audits, and reviews to determine whether violations of applicable rules and regulations exist. Devoting management and staff time and legal resources to such investigations, as well as any material violation by us that is discovered in any such investigation, audit, or review, could strain our resources and affect our profitability. In addition, regulatory oversight of construction efforts associated with refurbishment could cause us to lose residents and disrupt community operations. While these regulations and licensing requirements often vary significantly from state to state, they typically include:
We may be unable to satisfy all regulations and requirements or to acquire and maintain any required licenses on a cost-effective basis. Failure to comply with applicable requirements could lead to enforcement action that can materially and adversely affect business and revenues. Loss, suspension or modification of a license may also cause us to default under our leases and/or trigger cross-defaults.
We are also subject to federal and state regulations regarding government funded public assistance that prohibit certain business practices and relationships. Because we accept residents who receive financial assistance from governmental sources for their assisted living services, we are subject to federal and state regulations that prohibit certain business practices and relationships. Failure to comply with these regulations could prevent reimbursement for our healthcare services under Medicaid or similar state reimbursement programs. Our failure to comply with such regulations also could result in fines and the suspension or inability to renew our operating licenses. Acceptance of federal or state funds could subject us to potential false claims actions or whistleblower claims.
We also cannot predict the effect of the healthcare industry trend toward managed care on the assisted living marketplace. Managed care, an arrangement whereby service and care providers agree to sell specifically defined services to public or private payers in an effort to achieve more efficiency with respect to utilization and cost, is not currently a significant factor in the assisted living marketplace. However, managed care plans sponsored by insurance companies or health maintenance organizations (HMOs) may in the future negatively affect pricing and the range of services provided in the assisted living marketplace.
We face possible environmental liabilities at each of our properties. Under various federal, state, and local environmental laws, ordinances, and regulations, a current or previous owner or operator of real property may be held liable for the costs of removal or remediation of certain hazardous or toxic substances, including asbestos-containing materials that could be located on, in, or under its property. These laws and regulations often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of the hazardous or toxic substances. We could face substantial costs of any required remediation or removal of these substances, and our liability typically is not limited under applicable laws and regulations. Our liability could exceed our properties’ value or the value of our assets. We may be unable to sell or rent our properties, or borrow using our properties as collateral, if any of these substances are present or if we fail to remediate them properly. Under these laws and regulations, if we arrange for the disposal of hazardous or toxic substances such as asbestos-containing materials at a disposal site, we also may be liable for the costs of the removal or destruction of the hazardous or toxic substances at the disposal site. In addition to liability for these costs, we could be liable for governmental fines and injuries to persons or properties.
In addition to the risks described above, investing in our common stock involves the following risks:
We may experience volatility in the market price of our common stock due to the lower trading volume and lower public ownership of our common stock. The market price of our common stock has fluctuated significantly in the past and is likely to continue to be highly volatile. In particular, the volatility of our shares is influenced by lower trading volume and lower public ownership relative to several other publicly-held competitors. For example, our closing stock price has ranged from $21.00 per share to $39.23 per share during fiscal 2007. Because 49.4% of our outstanding shares were owned by affiliates as of February 29, 2008, our stock is relatively less liquid and therefore more susceptible to large price fluctuations.
Many factors could cause the market price of our common stock to significantly rise and fall. In addition to the matters discussed in other risk factors discussed in this filing, some of the reasons for the fluctuations in our stock price could be:
In addition, the stock market has recently experienced significant price and volume fluctuations. These fluctuations are often unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of our common stock. When the market price of a company’s stock drops significantly, shareholders often institute securities class action litigation against that company. Any litigation against us could cause us to incur substantial costs, divert the time and attention of our management and other resources, or otherwise harm our business.
Insiders have substantial control over us and are able to influence corporate matters. Under the terms of a shareholders agreement entered into in connection with the Summerville acquisition, a representative of each of the Baty shareholders, the Saratoga shareholders and the Apollo shareholders has been elected or appointed to our board of directors. Our directors and executive officers and their affiliates, including the Baty shareholders, the Saratoga shareholders and the Apollo shareholders, own, in the aggregate, approximately 49.4% of our outstanding common stock as of February 29, 2008. As a result, these shareholders are able to exercise significant influence over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or its assets. This concentration of ownership could limit a shareholder’s ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us.
Future sales of shares by existing shareholders could cause our stock price to decline. Based on shares outstanding as of February 29, 2008, we have outstanding approximately 39,038,181 shares of common stock, of which 19,287,576 outstanding shares are beneficially owned by our executive officers, directors, and affiliates controlled by them.
The shares received by the Apollo shareholders in the Summerville acquisition are eligible for sale in the public market beginning September 1, 2008, subject to volume limitations under Rule 144 under the Securities Act of 1933, as amended. However, pursuant to a registration rights agreement we entered into with the Apollo shareholders, the Saratoga shareholders, the Baty shareholders, and Mr. Granger Cobb, we have agreed to register shares of common stock beneficially owned by these persons under certain circumstances. In particular, we filed a shelf registration statement, which was declared effective by the SEC on January 16, 2008, to permit public resale of 4,859,008 shares beneficially owned by Apollo shareholders, and 1,800,000 shares beneficially owned by certain Saratoga shareholders. Pursuant to this registration statement, these shareholders will be able to publicly resell the identified Emeritus shares without restriction. Moreover, if one or more parties to the registration rights agreement exercise their rights with respect to the shares they own, additional shares may become eligible for public resale without restriction.
As of December 31, 2007, options for a total of 2,166,575 shares of common stock were outstanding under our equity incentive plans, of which options for a total of 1,034,761 shares were then exercisable. All of the shares issuable on exercise of such vested options are eligible for sale in the public market. If our executive officers, directors, or significant shareholders sell, or indicate an intention to sell, substantial amounts of our common stock in the public market, the trading price of our common stock could decline.
If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline. The trading market for our common stock may depend in part on any research and reports that securities or industry analysts publish about us or our business. We currently have limited research coverage by securities and industry analysts. Lack of research coverage could negatively impact the market for our common stock. In the event additional securities or industry analysts do initiate coverage of our company and one or more of these analysts
downgrade our stock or publish inaccurate or unfavorable research about our business, our stock price would likely decline.
Antitakeover provisions of Washington law, our articles of incorporation and our bylaws may prevent or delay an acquisition of us that shareholders may consider favorable or may prevent or delay attempts to replace or remove our board of directors. Our articles of incorporation and bylaws contain provisions, such as the right of our directors to issue preferred stock from time to time with voting, economic and other rights superior to those of our common stock without the consent of our shareholders, and prohibitions on cumulative voting in the election of directors, all of which could make it more difficult for a third party to acquire us without the consent of our board of directors. In addition, our articles of incorporation provide for our board of directors to be divided into three classes serving staggered terms of three years each, permit removal of directors only for cause by the holders of not less than two-thirds of the shares entitled to elect the director whose removal is sought, and require two-thirds shareholder approval of certain matters, including business combination transactions not approved by our incumbent board and the amendment of our bylaws. Furthermore, our bylaws require advance notice of shareholder proposals and nominations and impose restrictions on the persons who may call special shareholder meetings. In addition, Chapter 23B.19 of the Washington Business Corporation Act prohibits certain business combinations between us and certain significant shareholders unless certain conditions are met. These provisions may have the effect of delaying or preventing a change of control of our company even if this change of control would benefit our shareholders.
Our assisted living communities generally consist of one-story to three-story buildings and include common dining and social areas. Of our operating communities, 178 offer memory loss services, 25 offer some independent living services and three are operated as skilled nursing facilities. The table below summarizes information regarding our current operating communities as of December 31, 2007.
Our executive offices are located in Seattle, Washington, where we lease approximately 40,000 square feet of space. Our lease agreement runs for a term of 10 years, expiring July 2016.
From time to time, we are subject to lawsuits and other matters in the normal course of business, including claims related to general and professional liability. Accruals for these claims are based upon actuarial and/or estimated exposure, taking into account self-insured retention or deductibles, as applicable. While we cannot predict the results with certainty, except as noted below, we do not believe that any liability from any such lawsuits or other matters will have a material effect on our financial position, results of operations, or liquidity.
In February 2005, a San Antonio, Texas, jury found one of our assisted living communities negligent in the care of a resident. The jury awarded a verdict against us in the amount of $1.5 million in compensatory damages and $18.0 million in punitive damages. We appealed the verdict but recorded a liability accrual of $18.7 million in the fourth quarter of 2004 and accrued interest of $766,000 on the unpaid judgment at the rate of 5% per annum during 2005. In March 2006, we settled the action for $5.6 million. In the first quarter of 2006, we reduced the accrued interest by $766,000 and the liability accrual recorded in 2004 by $12.2 million.
In March 2006, the Texas attorney general’s office began an inquiry into compliance with certain Medicaid regulations at six of our communities in Texas that participate in the Community Based Alternative program of the Texas Department of Aging and Disability. Participation in the program requires eligible rooms to have an area equipped with a sink, refrigerator, cooking appliance, adequate space for food preparation, and storage space for utensils and supplies. An audit by the department revealed that some of the rooms used for residents in the program did not have some or all of those items. We addressed the State's concerns raised in the audits and all rooms were equipped with the above regulatory requirements as of April 2006, at a cost of approximately $618,000.
The Texas attorney general’s office originally sought $6.6 million related to the compliance issue, which equates to three times the total amount of all payments made to us by the State of Texas since the inception of our Medicaid contract, plus interest and attorney fees. We took the position with the State that all services for which Medicaid lawfully paid us were provided to the program residents despite the absence of some of the kitchen items and therefore, recovery of the total of all payments made to us was unjustified. As a result of continuing settlement discussions with the Texas attorney general’s office, we settled the claim for approximately $1.9 million in August 2007.
Emeritus did not submit any matter to a vote of its security holders during the fourth quarter of its fiscal year ended December 31, 2007.
The following table presents certain information about our executive officers.
Daniel R. Baty, one of the Emeritus founders, has served as its Chief Executive Officer and as a director since its inception in 1993 and became Chairman of the Board in April 1995. Mr. Baty also has served as the Chairman of the Board of Holiday Retirement Corporation since 1987 and served as its Chief Executive Officer from 1991 through September 1997. Since 1984, Mr. Baty has also served as Chairman of the Board of Columbia Pacific Group, Inc. and, since 1986, as Chairman of the Board of Columbia Pacific Management, Inc. Both of these companies are wholly owned by Mr. Baty and are engaged in developing independent living facilities and providing consulting services for that market. Upon completion of our acquisition of Summerville, Mr. Baty’s title changed to Chairman of the Board and Co-Chief Executive Officer. Mr. Baty is the father of Stanley L. Baty, a current director of our company.
Granger Cobb has 21 years of senior management experience in the senior residential, assisted living, and skilled nursing industries. He served as President, Chief Executive Officer, and a director of Summerville, since 2000. Mr. Cobb joined Summerville in 1998 with its acquisition of Cobbco, Inc., a California-based assisted living company founded by Mr. Cobb in 1989. Mr. Cobb is active in several industry associations and has served on the boards of the Assisted Living Federation of America (ALFA), the National Investment Center for the Seniors Housing & Care Industry (NIC), and the political action committees for ALFA and the California Assisted Living Association (CALA). Mr. Cobb became our Co-Chief Executive Officer, President, and a member of our board of directors upon completion of our acquisition of Summerville.
Raymond R. Brandstrom, one of the Emeritus founders, has served as a director since its inception in 1993. From 1993 to March 1999, Mr. Brandstrom also served as Emeritus’s President and Chief Operating Officer. In March 2000, Mr. Brandstrom was elected Vice President of Finance, Chief Financial Officer and Secretary of Emeritus. From May 1992 to October 1996, Mr. Brandstrom served as President of Columbia Pacific Group, Inc. and Columbia Pacific Management, Inc. From May 1992 to May 1997, Mr. Brandstrom served as Vice President and Treasurer of Columbia Winery, a company previously affiliated with Mr. Baty that is engaged in the production and sale of table wines. Upon completion of our acquisition of Summerville, Mr. Brandstrom became our Executive Vice President-Finance.
Justin Hutchens joined Emeritus in September of 2007 as part of the merger with Summerville. Mr. Hutchens was appointed to Senior Vice-President of Operations for Summerville in November of 2003. He
joined Summerville in 2001 as a Regional Director of Operations. Prior to joining Summerville, Mr. Hutchens had a multi-site management background in the areas of marketing and operations in the senior housing and long-term care arena. He has management oversight experience with hundreds of skilled nursing and assisted living communities starting in 1994. Mr. Hutchens is the chair of the Operational Excellence Advisory Panel for the Assisted Living Federation of America (ALFA) and the past chair and current member of the COO roundtable for ALFA. Mr. Hutchens became our Executive Vice President and Chief Operating Officer upon completion of our acquisition of Summerville.
Melanie Werdel served as Senior Vice President, Administration for Summerville, overseeing corporate compliance, licensing standards and requirements and Summerville’s overall risk management and operational policies and procedures. Prior to joining Summerville in 1998, she served as the Vice President of Administration for Cobbco, Inc., a California-based assisted living and skilled nursing company founded by Mr. Cobb. Ms. Werdel has over 14 years of long-term care management experience and serves as the immediate past Board Chair of the California Assisted Living Association (CALA). She is the sister of Mr. Cobb. Ms. Werdel became our Executive Vice President-Administration upon completion of our acquisition of Summerville.
Budgie Amparo is a registered nurse with a master’s degree in nursing, and has 20 years of combined healthcare experience in nursing education, acute care, skilled nursing, and assisted living. Mr. Amparo joined Summerville in 2002 as Vice President of Quality and Risk Management. Prior to joining Summerville, Mr. Amparo worked for Kaiser Permanente and for Mariner Post-Acute Network in a variety of positions. Mr. Amparo is a member of the clinical round table executives with ALFA and he was recently selected to be a member of the 2008 Board of Examiners with American Health Care Association (AHCA) and National Center for Assisted Living (NCAL) National Quality Awards. Mr. Amparo became our Senior Vice President-Quality and Risk Management upon completion of our acquisition of Summerville.
John Cincotta has 17 years of experience in the healthcare industry, including five years in skilled nursing and 10 years in assisted living. Mr. Cincotta joined us in 1997 and served as our National Director of Sales and Marketing. Mr. Cincotta became our Senior Vice President-Sales and Marketing upon completion of our acquisition of Summerville.
Jim L. Hanson joined Emeritus in April 2000 and served as our Director of Financial Services. Prior to joining Emeritus, Mr. Hanson held various accounting, financial, and administrative positions spanning a 21 year career with Pepsico. Mr. Hanson became our Senior Vice President-Financial Services and Controller upon completion of our acquisition of Summerville.
Eric Mendelsohn joined Emeritus as Director of Real Estate and Legal Affairs in February of 2006 and is currently responsible for the acquisition, development and financing of new and existing Emeritus buildings. Mr. Mendelsohn has 20 years of experience in real estate and related financing and is a member of the bar in both Washington State and Florida. Prior to joining Emeritus he served as a Transaction Officer for the University of Washington where he managed the acquisition, leasing and financing of healthcare properties for the School of Medicine as well as other property needs for University clients. Mr. Mendelsohn became our Senior Vice President of Corporate Development upon completion of our acquisition of Summerville.
Martin D. Roffe joined Emeritus as Director of Financial Planning in March 1998, and was promoted to Vice President of Financial Planning in October 1999. Mr. Roffe has 33 years of experience in the acute care, long-term care, and senior housing industries. Prior to joining Emeritus, from May 1987 until February 1996, Mr. Roffe served as Vice President of Financial Planning for The Hillhaven Corporation, where he also held the previous positions of Sr. Application Analyst and Director of Financial Planning. The Hillhaven Corporation operated nursing centers, pharmacies, and retirement housing communities. Upon completion of our acquisition of Summerville, Mr. Roffe became our Senior Vice President-Financial Planning.
Leo Watterson is a certified public accountant and joined Emeritus as Director of Corporate Accounting in February 2005. Upon completion of our acquisition of Summerville, he became our Vice President-Corporate Accounting and Chief Accounting Officer. Mr. Watterson has over 28 years experience in the long-term care and senior housing industries. Prior to joining Emeritus, Mr. Watterson spent four years in public accounting with a focus on audits of healthcare entities, served 12 years with The Hillhaven Corporation, an operator of long-term care facilities, pharmacies, and retirement housing communities, and nine years as Vice President of Finance with Sun Healthcare Group, another operator of long-term care facilities, pharmacies, and retirement housing communities.
Our common stock has been traded on the American Stock Exchange under the symbol “ESC” since November 21, 1995, the date of our initial public offering. The following table sets forth for the periods indicated the high and low closing prices for our common stock as reported on AMEX.
As of February 29, 2008, we had 128 holders of record of our common stock.
We have never declared or paid any dividends on our common stock, and expect to retain any future earnings to finance the operation and expansion of our business. Future dividend payments will depend on our results of operations, financial condition, capital expenditure plans, and other obligations and will be at the sole discretion of our Board of Directors. Certain of our existing leases and lending arrangements contain provisions that restrict our ability to pay dividends, and it is anticipated that the terms of future leases and debt financing arrangements may contain similar restrictions. Therefore, we do not anticipate paying any cash dividends on our common stock in the foreseeable future.
The following graph compares the cumulative total return on shares of our common stock with the cumulative total return of the S&P Smallcap 600 Index, AMEX Composite Index, and a customized peer group selected by us for the period beginning on December 31, 2002, and ending on December 31, 2007. In making this comparison, we have assumed an investment of $100 in shares of the Company's common stock, S&P Smallcap 600 Index, AMEX Composite Index, and the peer group, with all dividends reinvested. Stock price performance shown below for the common stock is historical and not necessarily indicative of future price performance.
Given the relative volatility of the assisted living industry, we revise our peer group from time to time to include companies that have entered the assisted living market. As the industry begins to mature and consolidate, we remove certain companies previously included in our peer group as they are acquired or as their focus of services shifts away from the assisted living residences. Our peer group currently consists of Brookdale Senior Living, Inc., Capital Senior Living Corp., Five Star Quality Care, Inc., and Sunrise Senior Living, Inc.
Securities Authorized for Issuance Under Equity Compensation Plans
The information called for by this Item is contained in Item 12 – Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Sales of Unregistered Securities; Repurchase of Securities
We did not make any sales of unregistered securities or repurchases of securities during the three months ended December 31, 2007.
The selected data presented below under the captions "Consolidated Statements of Operations Data" and "Consolidated Balance Sheet Data" for, and as of the end of, each of the years in the five-year period ended December 31, 2007, are derived from the consolidated financial statements of Emeritus Corporation. The consolidated balance sheets as of December 31, 2007 and 2006, and consolidated statements of operations for each of the years in the three-year period ended December 31, 2007, are included elsewhere in this document.
(1) Includes the operating results of Summerville for the period subsequent to the merger on September 1, 2007. In light of the merger with Summerville, the consolidated statement of operations data for the year ended December 31, 2007, are not indicative of future results.
(1) Includes the impact of the Summerville acquisition for the period subsequent to the merger on September 1, 2007.
Emeritus Corporation is a Washington corporation founded by Daniel R. Baty and two other long-time associates in 1993. Mr. Baty is chairman of our board of directors, co-chief executive officer, and one of our largest shareholders. He is also a party to a number of agreements with us and is referred to frequently in discussions of the business. In November 1995, we completed our initial public offering.
From 1995 through 1999, we expanded rapidly through acquisition and internal development and by December 31, 1999, operated 129 assisted living communities with 11,726 units. We believe, however, that during this expansion, the assisted living industry became over-built, creating an environment characterized by sluggish or falling occupancy and market resistance to rate increases. As a result, in 2000 we began an increased focus first on raising our occupancy and later on rate development, operating efficiencies, and cost controls. This focus has continued throughout 2007.
We believe the operating environment of the assisted living industry has been improving over the past several years resulting in occupancy gains and increases in the average monthly rate. These operating improvements have also resulted in greater access to capital. We believe these dynamics have resulted in the consolidation of smaller local and regional operators into the larger national operators, and anticipate this consolidation of the industry will continue. Because of these circumstances, we have been able to complete several acquisitions or leases in the last few years, although at a slower pace in 2005 and 2006, and at an increased rate in 2007. Although opportunities for further expansion have been available over the past few years, we have been selective in our growth as we have seen a sharp increase in market prices. On September 1, 2007, we acquired Summerville Senior Living, Inc. (Summerville), which operated 81 communities comprising 7,935 units in 13 states, providing independent living, assisted living, and Alzheimer’s and dementia-related services to seniors. See “Significant Transactions—Summerville Acquisition” below.
In recent years we focused on internal growth through expansion of existing properties and construction of new communities. This focus continued through 2007. We currently have expansion projects in eight of our communities and will continue to look at other expansion opportunities where the market conditions are favorable. In addition, we have several development projects in various stages of completion in several locations.
From the beginning of 2003 through December 31, 2007, we have increased our owned and leased communities by 89 and 80, respectively, for a net increase in our consolidated portfolio of 169. In addition, we have decreased our number of managed communities by 62, thereby increasing our total operated portfolio by 107 communities. Those communities we own and lease, and which are included in our consolidated portfolio, increased from 85 at the beginning of 2003 to 254 at December 31, 2007, reflecting both our increasing confidence in the assisted living industry and the availability of capital.
In 2008, we expect to continue our focus on increasing occupancy and rates, as well as reviewing acquisition opportunities that meet our criteria.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
The following table sets forth a summary of our property interests.
Two of the important factors affecting our financial results are the rates we charge our residents and the occupancy levels we achieve in our communities. We rely primarily on our residents' ability to pay our charges for services from their own or family resources and expect that we will do so for the foreseeable future. Although care in an assisted living community is typically less expensive than in a skilled nursing facility, we believe that generally only seniors with income or assets meeting or exceeding the regional median can afford to reside in our communities. In this context, we must be sensitive to our residents' financial circumstances and remain aware that rates and occupancy are interrelated.
In evaluating the rate component, we generally rely on the average monthly revenue per unit, computed by dividing the total operating revenue for a particular period by the average number of occupied units for the same period. In evaluating the occupancy component, we generally rely on an average occupancy rate, computed by dividing the average units occupied during a particular period by the average number of units available during the period. We evaluate these and other operating components for our consolidated portfolio, which includes the communities we own and lease, and our operating portfolio, which also includes the communities we manage.
In our consolidated portfolio, our average monthly revenue per unit increased from $2,957 to $3,100 and to $3,235 in 2005, 2006, and 2007, respectively. The change from 2006 to 2007 represents an increase of $135, or 4.4% and from 2005 to 2006, an increase of $143, or 4.8%. Although Summerville’s portfolio had a higher average monthly revenue per unit than Emeritus’s portfolio, the impact of Summerville was insignificant on the overall average increase in 2007 since they have only been a part of the consolidated group for four months.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
In our consolidated portfolio, our average occupancy rate in 2005 was 84.5% and increased to 85.3% and 86.7% in 2006 and 2007, respectively. We believe that this increase in occupancy rates reflects industry-wide factors, such as the declining supply of vacant units, as well as our own actions and policies. Summerville has a higher average occupancy rate than Emeritus, but as noted above, its impact is slight on the overall increase because it has only been a part of the portfolio for four months. We continue to evaluate the factors of rate and occupancy to find the optimum balance in each community, as witnessed by the increase in occupancy rates and average monthly revenue per unit from 2003 through 2007.
Since our inception in 1993, we have incurred cumulative operating losses totaling approximately $255.8 million as of December 31, 2007. We believe that these losses have resulted from our early emphasis on expansion, financing costs arising from multiple financing and refinancing transactions related to this expansion, administrative and corporate expenses that we incurred in anticipation of further expansion and increased emphasis on risk management and financial reporting controls, the impact in the early years on many of our leases from capital and financing lease treatments, and occupancy rates remaining lower for longer periods than we anticipated. While we have realized growth in both our occupancy and average monthly rates, we anticipate continued losses in the near term until such time as our occupancy stabilizes. Our current emphasis is on maximization of cash flows as we work toward improvements in occupancy and average rates, selective growth, and changes in our capital structure, such as acquisition of leased properties and refinancing of existing high-rate debt.
From 2005 through 2007, and continuing into 2008, we entered into a number of transactions that affected the number of communities we own, lease, and manage; our financing arrangements; and our capital structure. These transactions are summarized below.
On September 1, 2007, we acquired all of the outstanding stock of Summerville through a merger of our wholly-owned acquisition subsidiary with Summerville. Under the terms of the merger agreement, a total of 8,392,656 shares of our common stock were issued: (i) to the Apollo Funds, two real estate funds managed by Apollo Real Estate Advisors, in satisfaction of certain loans from such entities, (ii) to certain employees of Summerville in satisfaction of certain incentive compensation arrangements, and (iii) to the stockholders of Summerville, including the Apollo Funds.
Summerville was a San Ramon, California-based operator of 81 communities comprising 7,935 units in 13 states, which provided independent living, assisted living, and Alzheimer’s and dementia-related services to seniors. Upon completion of the merger, Summerville became our wholly-owned subsidiary and retained the brand name in the operation of its communities.
Subsequent to the merger and at December 31, 2007, we operated 287 communities in 37 states comprising 24,680 units with a capacity for 29,522 residents.
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Summerville Purchase Price
The purchase price of Summerville is detailed in the table below. The common stock issued in the transaction was valued at a price of $32.57 per share based on the average trading price over a five-day period, including two days before and two days after the public announcement of the merger on March 29, 2007.
Allocation of the Purchase Price
Under the purchase method of accounting, the total estimated purchase price was allocated to Summerville’s net tangible and intangible assets based on their estimated fair values as of September 1, 2007, the closing date of the transaction. The excess of the purchase price over the estimated fair value of the net tangible and intangible assets was recorded as goodwill.
Based upon the consideration paid and assumptions regarding valuation of acquired assets and assumed liabilities, the preliminary purchase price allocation is as follows:
(1) Includes $4.5 million of estimated Federal, state, and local tax liabilities that are reimbursable under an indemnity agreement with the former shareholders of Summerville. Any changes upon finalization of the taxes could result in a change to goodwill.
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Pro Forma Statements of Operations (Unaudited)
The following table details the effect on net loss and net loss per share had the merger between us and Summerville occurred at the beginning of the period presented, (in thousands except per share amounts):
2007 HCPI Communities Purchased
In March 2007, we completed the purchase of seven communities consisting of 453 units located in South Carolina for approximately $28.9 million, including transaction costs. We had operated these facilities as assisted living and dementia care communities for seniors.
The seven acquired properties were part of master lease agreement dated September 18, 2002, between Health Care Property Investors, Inc. (HCPI), and us. As a result of this asset purchase transaction, the master lease was amended to remove the purchased communities effective March 26, 2007. The amendment also provided for the return of approximately $4.5 million in cash security deposits held by HCPI. The cash security deposits were credited against the purchase price for the seven acquired properties. We accounted for this master lease as an operating lease.
Capmark Finance, Inc. (Capmark) provided variable rate mortgage financing of $23.6 million pursuant to a loan agreement dated March 26, 2007, by and among our affiliated entities and Capmark Bank. Under this Capmark loan facility, the variable rate loan has a term of three years and bears interest at 290 basis points over the London Interbank Offered Rate (LIBOR), adjusted monthly. The interest rate on December 31, 2007, was 8.125%. Monthly interest-only payments are required for the first year and, thereafter, monthly payments of principal and interest are based on a 25-year amortization period. The balance is due in full in April 2010. This facility is secured by all real, personal, and intangible assets used in the operation of the acquired communities. The loan may be repaid at any time upon written notice, if no events of default are continuing. We paid a 1.0% loan fee at closing and will be required to pay a 2.0% exit fee upon full payment of the loans, unless the loans are refinanced with Capmark. The loan agreement requires maintenance of a debt service coverage ratio, an aggregate minimum occupancy percentage, and payment of annual capital expenditures of at least $300 per unit.
In June 2007, we entered into a definitive agreement to acquire a total of 40 additional communities from HCPI. After the original announcement, we added another community to the purchased portfolio for a total of 41 communities, consisting of 3,732 units located in 17 states. Of the 41 communities, we had leased 33 and Summerville had leased eight of the communities.
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In August 2007, we completed the acquisition of the 41 communities from HCPI. We leased 33 of these communities from HCPI under a master lease dated September 18, 2002, as amended. We had accounted for 23 of the 33 communities as operating leases and 10 as financing leases prior to the acquisition. The annual base rent for our 33 communities was approximately $25.0 million as of the closing date. As a result of this transaction, the HCPI master lease was terminated. Upon termination of the financing leases for the 10 communities, the difference between the carrying amount of the leased assets and the lease obligation was recorded as an adjustment to the carrying amount of the assets purchased, which represents a reduction of approximately $27.6 million to the cost basis of the purchased assets. In addition, upon termination of the 23 operating leases, the cumulative straight-line lease accrual was recorded as an adjustment to the carrying amount of the assets purchased, which represents a reduction of approximately $1.6 million to the cost basis of the purchased assets.
Summerville continued to operate the eight communities under its existing leases until we completed our acquisition of Summerville in September 2007. The annual base rent for the eight Summerville communities was approximately $4.7 million.
The acquisition of the 41 properties discussed above was partially financed by affiliates of Capmark and other participants (Fannie Mae) through fixed rate mortgage debt of $226.9 million at an annual interest rate of 6.305% for a term of 10 years, and variable rate mortgage debt of $76.0 million at a rate of 30-day LIBOR plus 1.7% (approximately 7.0% at December 31, 2007) for a term of two years, plus a one-year extension option, pursuant to a series of Loan Agreements dated August 15, 2007, by and among our affiliates and Capmark. Monthly interest-only payments on the fixed rate loan are due for the first three years and thereafter, monthly payments of principal and interest will be based on a 30-year amortization schedule. The balance on the fixed rate loan is due in full in September 2017. Monthly interest-only payments on the variable rate loan are due over the term of the loan. The balance on the variable rate loan is due in full in September 2009, with a one-year extension option available. The indebtedness outstanding under the Capmark loans may be accelerated under customary circumstances, including payment defaults. The fixed rate loan is secured by all real, personal, and intangible assets used in the operation of 29 communities, and the variable rate loan is secured by all real, personal, and intangible assets used in the operation of 12 communities.
2007 HRT Communities Purchased
In March 2007, we purchased 12 communities consisting of 786 units located in five states for a price of $100.2 million, including transaction costs. We had leased four of these communities from Healthcare Realty Trust (HRT) since May 2002 and eight since May 2003. We had accounted for the four leases as capital leases and the eight leases as operating leases. As a result of this transaction, the HRT leases were terminated. Upon termination of the four capital leases, the difference between the carrying amount of the leased assets and the lease obligation was recorded as an adjustment to the carrying amount of the assets purchased, which represented a $3.5 million reduction to the cost basis of the purchased assets. Capmark Finance, Inc. provided fixed rate senior mortgage financing of $88.0 million at 6.515% per annum and second mortgage financing of $13.6 million at a variable rate equal to the LIBOR rate plus 325 basis points. The second mortgage of $13.6 million was repaid in July 2007. The senior mortgage has a term of five years, with a 1% exit fee if the debt is paid off or refinanced by anyone except Capmark, and monthly interest-only payments for three years and, thereafter, monthly payments of principal and interest based on a 25-year amortization, with the remaining balance due in full in April 2012. The total Capmark loan commitment of $101.6 million was used to pay the purchase price, transaction and financing costs, and to retire a $600,000 loan, as described below.
At the time of closing, we had approximately $32.8 million in loans outstanding with HRT, of which $11.4 million was secured by the leases on the 12 communities described above. Of the $11.4 million, $10.8 related to a loan from HRT to enable us to pay the accumulated dividends due upon conversion of our Series
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B Convertible Preferred Stock in June 2005. As part of the our purchase of the 12 communities, the $10.8 million loan was acquired from HRT by Mr. Baty on similar terms and conditions as the original loan, and the remaining $600,000 was paid off at closing. The $10.8 million loan from Mr. Baty was repaid in July 2007.
2007 Fretus Communities Purchased
In February 2007, we purchased 24 communities consisting of 1,651 units located in six states for a price of $143.5 million, including transaction costs. We had leased these communities from Fretus Investors LLC (Fretus) since October 2002. All leases had been accounted for as operating leases. As a result of this transaction, the Fretus lease was terminated. Capmark provided fixed rate mortgage financing of $132.0 million and variable rate mortgage financing of $8.0 million. The variable rate loan of $8.0 million was repaid in July 2007. The fixed rate component has a term of five years and bears interest at 6.55% per annum, with a 1% exit fee payable if the debt is paid off or refinanced by anyone except Capmark, with monthly interest-only payments for two years and thereafter, monthly payments of principal and interest based on a 25-year amortization. The remaining balance is due in full in February 2012. The variable rate component has a term of three years and interest at 30-day LIBOR plus 1.8%. Fretus was a private investment joint venture between Fremont Realty Capital, which held a 65% interest, and a Baty-related entity, which held a 35% minority interest. Mr. Baty held a 16% indirect interest in the minority entity, personally guaranteed $3.0 million of the Fretus mortgage debt covering the communities and controlled the administrative member of Fretus. In conjunction with this transaction, the Baty-related entity provided $18.0 million in short-term financing to us, of which approximately $5.1 million, was used to fund the balance of the purchase price and the balance was used for general business purposes. The short-term debt was due in February 2009, accrued interest at 9.0% per annum, and was repaid in July 2007.
2007 HC REIT Purchase
In August 2007, we closed on the acquisition of three Florida communities consisting of 431 units. The final purchase price was $25.0 million, including transaction costs. We had leased these communities from Health Care REIT, Inc. and affiliates under two different master leases dated September 30, 2003, and September 30, 2004. The leases were accounted for as capital leases. The annual base rent for the three communities was approximately $2.5 million as of the closing date. As a result of this asset purchase transaction, the master leases were modified to remove the communities from these leases. Upon termination of the capital lease for the three communities, the difference between the carrying amount of the leased assets and the lease obligation was recorded as an adjustment to the carrying amount of the assets purchased, which represents a reduction of approximately $3.2 million to the cost basis of the purchased assets.
An affiliate of General Electric Capital Corporation (GECC) provided variable rate mortgage financing of approximately $19.6 million pursuant to a Credit Agreement dated August 6, 2007, by and among our affiliates and GECC. The variable rate mortgage has a term of five years with interest at 30-day LIBOR plus 1.5%, which was 6.725% at December 31, 2007. Monthly interest-only payments are due for the first three years and thereafter, monthly payments of principal and interest will be based on a 25-year amortization schedule. The balance on the loan is due in full in August 2012. The indebtedness outstanding under the GECC loan may be accelerated under customary circumstances, including payment defaults, and is secured by all real, personal, and intangible assets used in the operation of the three communities.
2007 Wegman Purchase
In August 2007, we completed the acquisition of nine communities that we had formerly leased, consisting of 711 units located in the State of New York, for an aggregate purchase price of $89.0 million including transaction costs. Upon termination of the operating lease for the nine communities, the cumulative straight-line lease accrual was recorded as an adjustment to the carrying amount of the assets purchased, which represents a reduction of approximately $2.3 million to the cost basis of the purchased assets.
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The transaction was financed by a $67.8 million Fannie Mae insured loan with Red Mortgage Capital, Inc. The loan term is 84 months, with interest only for the first 24 months at a fixed rate of 6.185%, and matures on September 1, 2014. Principal and interest payments for the remaining term of the loan are based on a 30-year amortization schedule. We have the right, upon advanced notice to the lender, to prepay the entire amount of the loan, all accrued interest, loan costs, and prepayment premium.
The allocation of the purchase price for the acquisitions discussed above was based in part on property appraisals. Aggregate purchase cost allocations, related financings, and other balance sheet adjustments were as follows (in thousands):
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In July 2007, we completed the public offering of 11,000,000 shares of our common stock, of which 10,500,000 shares were sold by us and 500,000 shares were sold by certain selling shareholders. We received net proceeds of approximately $305.4 million after issuance costs.
In July 2007, the underwriters of the public offering exercised, in part, their over-allotment option relating to the offering. As a result, we sold an additional 800,800 shares of common stock in the offering. The sale of shares pursuant to the over-allotment options was closed on August 2, 2007, and we received net proceeds of $23.2 million after issuance costs.
2006 Blackstone Joint Venture
We hold a 19.0% interest in Blackstone JV, a joint venture with Blackstone Real Property Group (Blackstone) that acquired a portfolio of 21 properties in December 2006. Blackstone JV acquired three additional properties in 2007. The portfolio currently consists of 23 assisted living and dementia care communities and one skilled nursing facility with a total of 1,890 units.
We are the administrative member of the Blackstone JV and responsible for day-to-day operations. Blackstone holds the remaining 81.0% interest in the Blackstone JV and has final authority with respect to all major decisions of the joint venture, including final approval of operating and capital budgets. We are prohibited from selling our Blackstone JV interest without Blackstone’s consent. Pursuant to a management agreement with Blackstone JV, we manage 24 of the assisted living properties for a fee equal to 5.0% of gross revenues collected.
We account for our investment in the Blackstone JV under the equity method of accounting. For the year ended December 31, 2007, we recorded equity losses of approximately $2.9 million and management fee income of approximately $2.9 million. For the year ended December 31, 2006, we recorded equity losses of approximately $104,000 and management fee income of approximately $166,000.
As a part of a 2003 transaction in which we leased a separate group of Emeritrust communities that we had managed since 1999, we issued seven-year warrants to purchase 500,000 shares of our common stock at an exercise price of $7.60 per share to the owners of the communities, which included Mr. Baty. Warrants to purchase 400,000 shares were exercised in February 2006 and we received proceeds of $3.0 million. In March 2006, we issued 69,169 shares to the holders pursuant to a net exercise of the warrants for the remaining 100,000 shares.
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2004 Lease Transaction
In April 2004, we completed the lease of 17 of a group of 23 communities, including nine stand-alone dementia care facilities, with four of the remaining six communities leased later in 2004 and the final two communities leased in 2005. Of the communities, 13 were formerly owned by entities in which Mr. Baty had financial interests; of which 12 of these communities had been managed by us prior to the lease. The nine stand-alone dementia care facilities were formerly owned by entities controlled by JEA Senior Living (JEA), an independent third party, although Mr. Baty had non-controlling financial interests in the entities.
The communities were acquired by a REIT and leased to us under a 15-year lease, with three five-year renewal options. The initial lease payment was approximately $16.1 million per year, with annual lease inflators based on the change in the consumer price index, not to exceed an annual ceiling. This transaction also provided for an earn-out arrangement for payment to the JEA entities of up to $2.0 million based on improvements in the net operating income of the dementia care facilities during the three years following closing.
We also entered into a three-year agreement for JEA to manage the nine dementia care facilities. The agreement provided for a management fee of 5% of revenues and a termination fee of $100,000 per year for the 10 years following termination of the agreement.
In September 2006, we entered into an agreement for the early termination of the management agreement and the earn-out arrangement. The management agreement was terminated September 30, 2006, which was six months early. In lieu of the 10-year termination fee, we paid JEA a lump sum of $594,000. Based on performance of the communities, we paid the full $2.0 million earn-out payment in September 2006.
Other 2005-2007 Community Acquisitions
In December 2005, we purchased three communities located in Arkansas, with a capacity of 253 units, for a price of $17.8 million. We financed $15.9 million of the purchase price with GECC mortgage financing that matures in December 2012, with no prepayment right, bears interest at 6.95% per annum and provides for monthly payments based on a 25-year amortization.
In July 2006, we purchased a 101-unit community we formerly managed for $11.0 million from an entity in which Mr. Baty had a 50% financial interest. We financed $8.0 million of the purchase price with GECC mortgage financing that matures in June 2013, with no prepayment right, bears interest at 7.229% per annum, and provides for monthly payments based on a 25-year amortization.
The GECC mortgage loans are cross-collateralized.
In July 2007, we entered into a long-term lease for an 89-unit assisted living community in Ohio. The lease term is 12 years, expiring in July 2019, with one ten-year renewal option available. The initial annual lease payment is approximately $1.1 million, with annual increases based on the greater of 3% or the change in CPI.
In December 2007, we purchased a 106-unit assisted living community located in Ohio for a price of $12.9 million. We financed $12.4 million of the purchase price with Key Bank. The loan matures in January, 2010, with interest-only payments at 225 basis points over the 30 day LIBOR (7.48% at December 31, 2007) and two optional one-year extensions.
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Senior Med Transaction
We owned a 9.5% indirect interest in Senior Med, a pharmacy services provider. In April 2007, we received written notice from Walgreens, the majority owner of the entity that owns Senior Med, that it had exercised its purchase option rights. The transaction closed on May 31, 2007. We received approximately $8.8 million in cash for our equity share of the business and recorded a gain of approximately $7.7 million. We have no further ownership interest in Senior Med.
Exclusive of the equity gain mentioned in the previous paragraph, we had equity losses of $328,000 and $713,000 for the years ended December 31, 2007 and 2006, respectively, which is included in the line item entitled “Equity gains (losses) in unconsolidated joint ventures.”
Exercise of Common Stock Warrants
On March 6, 2006, we issued 829,597 shares of common stock pursuant to the exercise of warrants for the purchase of 1.0 million common shares. The shares were purchased by the holders of the warrants pursuant to a “net exercise” provision of the warrants in which 170,403 shares subject to the warrants were used to pay the exercise price of $4.2 million. No cash proceeds were received from this transaction.
In February 2007, we offered to pay a cash incentive to debenture holders if they elected to convert their debentures into common stock by giving written notice by March 8, 2007. The incentive payment was equal to the amount of interest that the holders would have received if the debentures were held to the maturity date of July 1, 2008.
Of the $26.6 million principal amount of debentures outstanding, holders of $16.1 million principal amount converted their debentures into 732,725 shares of common stock at the debentures’ stated conversion rate of $22.00 per share. Of the debentures converted into common stock, $15.8 million principal amount was owned by entities controlled by Mr. Baty. On April 16, 2007, we paid the incentive fee of $1.3 million in connection with this conversion, which amount would have otherwise been paid in three installments on July 1, 2007, January 1, 2008, and July 1, 2008, if the debentures were held to maturity. The incentive payment was expensed to “Other, net” in the consolidated statement of operations in the first quarter of 2007.
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The following table summarizes the property transactions described above: