Emeritus 10-Q 2010
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended September 30, 2010
Commission file number 1-14012
(Exact name of registrant as specified in its charter)
3131 Elliott Avenue, Suite 500, Seattle, WA 98121
(Address of principal executive offices)
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer o Accelerated filer þ Non-accelerated filer o Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of November 1, 2010, there were 39,543,532 shares of the Registrant’s Common Stock, par value $0.0001, outstanding.
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CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
See accompanying Notes to Condensed Consolidated Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
See accompanying Notes to Condensed Consolidated Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying Notes to Condensed Consolidated Financial Statements
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(In thousands, except share data)
See accompanying Notes to Condensed Consolidated Financial Statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2010
Emeritus Corporation is an assisted living, Alzheimer’s and dementia care service provider that operates residential style communities located throughout the United States. Through these communities, we provide a residential housing alternative for senior citizens who need help with the activities of daily living, with an emphasis on assisted living and personal care services. As of September 30, 2010, the Company owned 163 communities and leased 115 communities. These 278 communities comprise the communities included in the condensed consolidated financial statements.
We also provide management services to independent and related-party owners of assisted living communities. As of September 30, 2010, we managed 174 communities, of which 159 are owned by joint ventures in which the Company has a financial interest. Management agreements typically provide for fees of 5% to 6% of gross or collected revenues.
Emeritus has one operating segment, which is assisted living and related services.
Unless the context otherwise requires, the terms the “Company,” “we,” “us,” “our,” or similar terms and “Emeritus” refer to Emeritus Corporation, together with its consolidated subsidiaries.
The preparation of condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to resident move-in fees, bad debts, investments, intangible assets, impairment of long-lived assets and goodwill, income taxes, contingencies, self-insured retention, insurance deductibles, health insurance, inputs to the Black-Scholes option pricing model, and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe that certain critical accounting policies are most significant to the judgments and estimates used in the preparation of our condensed consolidated financial statements. We record revisions to such estimates in the period in which the facts that give rise to the revision become known. A detailed discussion of our significant accounting policies and the use of estimates is contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009, which was filed with the Securities and Exchange Commission (“SEC”) on March 15, 2010.
Basis of Presentation
The unaudited condensed consolidated financial statements reflect all adjustments that are, in our opinion, necessary to state fairly the Company’s financial position, results of operations, and cash flows as of September 30, 2010 and for all periods presented. Except as otherwise disclosed in these Notes, such adjustments are of a normal, recurring nature. The Company’s results of operations for the period ended September 30, 2010 are not necessarily indicative of the results of operations that it may achieve for the full year ending December 31, 2010. We presume that readers of this interim financial information in this Quarterly Report on Form 10-Q have read or have access to the Company’s 2009 audited Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009. Therefore, we have omitted certain footnotes and other disclosures that are disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009.
Reclassifications and Revisions
We recast the 2009 financial information so that the basis of presentation is consistent with that of the 2010 financial information. Specifically, in the fourth quarter of 2009, the Company’s Board of Directors approved the sale of one community and, as a result, we reclassified the results of operations for this community as discontinued operations for all periods presented. Additionally, during the fourth quarter of 2009, we took five communities classified as held for sale (with net assets totaling $28.9 million) off the market and reclassified them as held and used in property and equipment. As a result, we reclassified the results of operations for these communities from discontinued operations to continuing operations for all periods presented.
We have three equity incentive plans: the Amended and Restated 2006 Equity Incentive Plan (the “2006 Plan”), the Amended and Restated Stock Option Plan for Non-employee Directors (the “Directors Plan”) and the 1995 Stock Incentive Plan (the “1995 Plan”). Employees may also participate in our 2009 Employee Stock Purchase Plan (the “2009 ESP Plan”). We record compensation expense based on fair value for all stock-based awards, which amounted to approximately $1.5 million and $1.2 million for the three months ended September 30, 2010 and 2009, respectively, and approximately $4.5 million and $3.3 million for the nine months ended September 30, 2010 and 2009, respectively.
Stock Incentive Plans
The following table summarizes our stock option activity for the nine months ended September 30, 2010:
The following is a description of various transactions that affected the comparability of the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
Sunwest Joint Venture
In January 2010, we entered into a joint venture agreement with BRE/SW Member LLC, an affiliate of Blackstone Real Estate Advisors VI, L.P (“Blackstone”) and an entity controlled by Daniel R. Baty, the Company’s Chairman and Co-Chief Executive Officer (“Columbia Pacific”) (the “Joint Venture Agreement”), pursuant to which the Company, Blackstone and Columbia Pacific formed a joint venture that operates under the name of BRE/SW Portfolio LLC (the “Sunwest JV”). The initial purpose of the Sunwest JV is to acquire a portfolio of communities (the “Properties”) formerly operated by an Oregon limited liability company (“Sunwest”).
On January 15, 2010, the Joint Venture entered into a purchase and sale agreement with Sunwest to acquire the Properties. On May 17, 2010, the U.S. District Court for the District of Oregon (the “Court”) approved the purchase and sale agreement, as amended (the “Purchase Agreement”), and on July 13, 2010, the Court confirmed Sunwest’s plan of reorganization.
On August 5, 2010 and September 1, 2010, the Sunwest JV closed on the purchase of 132 Properties and eight Properties, respectively. The purchase of an additional four Properties, three of which we are managing for Sunwest, are deferred until finalization of consents with lenders and other matters. The aggregate unadjusted purchase price for the 144 Properties is approximately $1.3 billion and the consideration included (i) approximately $285.0 million in a combination of cash and membership interests in the Sunwest JV and (ii) the assumption by the Sunwest JV of secured debt and other liabilities of approximately $980.2 million. The Company paid cash at closing of $19.0 million for its initial capital contribution and will be required to make an additional contribution of approximately $2.0 million over the next two years.
Pursuant to the Purchase Agreement, among other things, existing Sunwest investors (the “Investors”) had the option to either (1) sell their ownership interests in one or more Properties for cash or (2) exchange their ownership interests in the Properties for indirect equity interests in the Sunwest JV. Investors choosing the second option contributed their interests in the Properties (the “Contributed Interests”) to a newly formed entity owned entirely by such Investors (the “Rollover Member”). The Rollover Member immediately further contributed the Contributed Interests to the Sunwest JV in exchange for, at the election of the Investors, preferred equity interests or common equity interests in the Sunwest JV. As of September 30, 2010, common equity interests held by the Rollover Member amounted to approximately 15.9% of the initial equity of the Sunwest JV. The initial equity interests in the Sunwest JV of Blackstone, Columbia Pacific and Emeritus were 67.3%, 11.0% and 5.8%, respectively. We expect that the equity interests in the Sunwest JV of the members will change slightly over time as the Sunwest JV completes the deferred transactions, the final Rollover Member amounts are determined, and additional anticipated funding for capital expenditures is completed. The Joint Venture Agreement provides that Blackstone has final authority with respect to all major decisions regarding the Sunwest JV, including final approval of operating and capital budgets.
The Joint Venture Agreement provides for cash distributions from the Sunwest JV to the members in accordance with their ownership interests; however, the Company is entitled to distributions at increasing levels in excess of its ownership percentage if certain Sunwest JV performance criteria are achieved. The Joint Venture Agreement also provides that in the event Blackstone desires to sell a specified portion of the Properties, all of the Properties or its membership interest in the Sunwest JV, we will have the right of first opportunity to purchase such Properties or membership interest, as applicable.
The 144 Properties included in the purchase are comprised of approximately 11,769 units and are similar in operating characteristics to our existing portfolio of senior living communities.
As contemplated by the Purchase Agreement, the Company entered into management agreements with the Sunwest
JV to manage the portfolio of communities for a fee equal to 5.0% of gross collected revenues. As of September 30, 2010, five of the communities owned by the Sunwest JV were managed by third parties. We are accounting for the Sunwest JV as an unconsolidated equity method investee in the Company’s consolidated financial statements.
2010 Emeritus at Marlton Crossing Lease
In September 2010, we purchased a 110-unit assisted living community located in New Jersey and simultaneously entered into a sale-leaseback agreement with affiliates of HCP, Inc. (“HCP”). The lease expires in September 2020 and we have two ten-year renewal options available. The initial annual base rent is approximately $1.2 million with annual scheduled increases. We are accounting for this lease as a financing lease and recorded property and equipment of $13.7 million, a resident contract intangible asset of $930,000 and a financing lease obligation of $14.7 million. We expensed transaction costs of approximately $189,000.
2010 HCP, Inc. Lease
In May 2010, we entered into an agreement with HCP for the lease of four senior living communities (collectively, the “HCP Lease”). The communities, located in Illinois and Texas, consist of 400 assisted living units and 152 skilled nursing units.
The HCP Lease has an initial term of 10 years, commencing on June 1, 2010, with two available extension options of ten years each at our election. We have the option to purchase the properties upon the expiration of the first extended term. The purchase option price is calculated at the greater of (i) fair market value, as defined, or (ii) $101.2 million, plus any capital addition costs funded by HCP, increased on each lease anniversary date by the greater of (a) 2.5% or (b) the lesser of the applicable increase in the consumer price index (“CPI”) or 5.0%.
The annual minimum lease payments are fixed for the first five years of the lease term at approximately $8.5 million, $9.1 million, $9.6 million, $10.2 million, and $10.7 million for the first through fifth years, respectively, excluding any additional rent related to capital addition costs funded by HCP. We are accounting for this lease as an operating lease.
2010 Eastover Lease
In February 2010, we purchased an 88-unit assisted living community located in North Carolina and simultaneously entered into a sale-leaseback agreement. The lease expires in November 2018 and there are two ten-year renewal options available. The initial annual base rent is approximately $793,000 with annual scheduled increases. We are accounting for this lease as a financing lease and recorded property and equipment for $8.3 million, a resident contact intangible asset of $600,000 and a financing lease obligation of $8.9 million. We expensed transaction costs of approximately $185,000.
2010 National Health Investors, Inc. Lease
In January 2010, the Company entered into an agreement to lease eight communities from National Health Investors, Inc. The communities are comprised of 336 units. The term of the agreement is 15 years with two five-year renewal options available. The initial annual base rent is $3.4 million with annual scheduled increases. We are accounting for these leases as capital leases and therefore recorded a capital lease asset and obligation in the aggregate amount of $37.5 million.
2009 Trace Point Acquisition
In October 2009, we purchased Trace Pointe, a 100-unit assisted living and memory care community that we previously managed for Columbia Pacific. The purchase price was $15.8 million, of which we financed $12.1 million with mortgage debt and $2.0 million with an unsecured note payable to an affiliate of Mr. Baty, with the balance paid in cash.
2009 Courtyard at Merced Acquisition
In October 2009, we purchased Courtyard at Merced, an 83-unit assisted living and memory care community from Ventas Realty, LP (“Ventas”) that we previously operated under a management contract. The purchase price was
$6.3 million and was financed with a three-year first mortgage note from Ventas for $5.0 million, with the balance paid in cash.
2009 College Park Acquisition
In June 2009, we purchased College Park, an 85-unit assisted living community that we previously managed for Columbia Pacific. The purchase price was $10.6 million, of which $7.8 million was financed with mortgage debt and $1.2 million was financed with an unsecured note payable to an affiliate of Mr. Baty with the balance of the purchase price paid in cash.
2009 Northdale Lease Agreement
In January 2009, we entered into an agreement to lease an 84-unit assisted living community. The lease term is ten years with two ten-year renewal options available. The initial annual minimum rent is approximately $600,000 (less abatements in the first year of $300,000) with fixed annual increases of 3.0%. We are accounting for this lease as an operating lease.
2009 New Development
In January 2009, we opened a newly constructed community in Urbandale, Iowa. This 38-unit memory care community had a development cost of $6.6 million and was funded by $5.5 million of short-term construction debt due in July 2010. We repaid this debt in full as of June 30, 2010.
In 2003, we sold four communities to Health Care REIT, Inc. (“HCN”) and leased them back. The sale did not qualify for sale-leaseback accounting because of the Company’s continuing involvement in the form of a guarantee of the underlying mortgage debt, which was assumed by HCN in the sale. Therefore, we recorded the sale proceeds of $34.6 million as a financing lease obligation and continued to report the real estate and equipment as owned assets.
HCN paid the mortgage obligations in June 2009 and the Company’s guarantee terminated. Therefore, we recorded the sale and we now account for each of the four leases as capital leases. As a result, in June 2009, we recorded a net increase in property and equipment of $968,000, a net decrease in capital lease and financing obligations of $4.1 million, an increase in deferred gains of $5.2 million and a decrease in deferred rent of $129,000.
In September 2010, we entered into an amendment to a credit agreement related to $19.5 million of mortgage debt secured by three communities. Under the terms of the amended credit agreement, we prepaid $5.0 million of the principal balance and terminated the related interest rate swap contract. The interest rate on the debt, which was effectively fixed at 6.35% with the swap, was changed to a variable rate equal to the 90-day London Interbank Offered Rate (“LIBOR”) plus 4.25%. All other terms of the credit agreement remained unchanged.
In August 2010, we paid off the outstanding balance of a mortgage loan in the amount of $2.8 million. The interest rate on the loan was 10.54% and it was due to mature in January 2011.
On July 9, 2010, we entered into an agreement to extend the maturity date on an existing $50.0 million loan with HCN (the “HCN Note”). The HCN Note, originally due July 1, 2011, was extended to July 1, 2014. The current interest rate of 8.5% will increase by 0.15% on each anniversary date beginning July 1, 2011. Monthly payments of interest only are due through June 1, 2011, with additional principal payments of $200,000 per month due July 1, 2011 and each month thereafter until maturity. In the event the Company issues securities with net proceeds to the Company in excess of $150.0 million, then such excess proceeds must be used to reduce the principal balance on the HCN Note. In addition, if the Company makes any principal payments on its $51.4 million of loans with Nationwide Health Properties, Inc., then the Company must make a like payment on the HCN Note.
Revolving Line of Credit
The Company is party to a credit agreement with Wells Fargo Bank, N.A. (“Wells Fargo”), which provides a $25.0 million unsecured revolving line of credit. The line of credit was extended to June 30, 2011. The line of credit allows the Company to obtain letters of credit from the lender, if the undrawn amount of any outstanding letters of credit (and any borrowings outstanding under the credit agreement) does not exceed $25.0 million. The interest rate on the line of credit is our choice of either (a) a fluctuating rate equal to the daily one-month LIBOR plus 2.50% or (b) a fixed rate for a 30-day term equal to the one-month LIBOR plus 2.25%, payable monthly. We pay a commitment fee of 0.25% on the average daily unused amount of the line of credit, payable quarterly. In addition, Wells Fargo requires the Company to pay fees equal to 1.0% of the face amount of every letter of credit issued as well as the negotiation fees on each letter. We must maintain a zero balance on advances for 30 consecutive days during each fiscal year and a fixed charge coverage ratio of 1.1 to 1.0. In addition, we must maintain liquid assets (cash, cash equivalents and/or publicly traded marketable securities) with an aggregate fair value of at least $10.0 million in excess of the outstanding balance at any time under the line of credit. There were no outstanding borrowings under the line of credit as of September 30, 2010.
The Company’s lease and loan agreements generally include customary provisions related to: (i) restrictions on cash dividends, investments, and borrowings; (ii) cash held in escrow for real estate taxes, insurance and building maintenance; (iii) financial reporting requirements; and (iv) events of default. Certain loan agreements require the maintenance of debt service coverage or other financial ratios and specify minimum required annual capital expenditures at the related communities. Many of the Company’s lease and debt instruments contain “cross-default” provisions pursuant to which a default under one obligation can cause a default under one or more other obligations to the same lender or property owner. Such cross-default provisions affect the majority of the Company’s properties. Accordingly, an event of default could cause a material adverse effect on the Company’s financial condition if such debts/leases are cross-defaulted. As of September 30, 2010, the Company was in violation of certain financial and occupancy covenants in one debt agreement. We have obtained a waiver from the lender and, as such, the Company was in compliance as of September 30, 2010. We have classified this loan, which matures in May 2011, as current in the condensed consolidated balance sheet as of September 30, 2010. In October 2010, we entered into an agreement to amend the financial and occupancy covenants in one other debt agreement for the quarterly reporting periods beginning September 30, 2010 through September 30, 2011. As a result of this amendment, the Company was in compliance as of September 30, 2010.
In the normal course of business, the Company’s financial results are exposed to the effect of interest rate changes, so we may limit these risks by following risk management policies and procedures, including the use of derivatives. To address exposure to interest rates, we may use interest rate swap agreements to fix the rate on debt based on floating-rate indices and to manage the cost of borrowing obligations.
Prior to September 2010, Emeritus was a party to an interest rate swap with a notional amount of $19.6 million. The swap effectively converted the interest rate on the related mortgage debt from a floating rate to fixed rate, thus mitigating the impact of interest rate changes on future interest expense. In September 2010, the mortgage debt was modified and the swap contract was terminated. We paid $1.6 million to the counterparty to the swap to terminate our obligation, which was recorded as a reduction in the fair value (liability) of the swap. Emeritus was a party to a second interest rate swap, with a notional amount of $12.4 million, that expired on January 1, 2010.
Hedges that we report at fair value and present on the balance sheet could be characterized as either cash flow hedges or fair value hedges. We considered the Company’s interest rate swaps to be cash flow hedges as they address the risk associated with future cash flows of debt transactions. We did not designate the interest rate swaps as hedging instruments; therefore, we recognized the gain or loss resulting from the change in the estimated fair value of the swaps in current earnings during the period of change.
We compute basic net loss per share based on weighted average shares outstanding and exclude any potential dilution. We reported a consolidated net loss in each of the periods presented. As a result, we have excluded shares issuable upon the exercise of stock options from the computation as their effect was antidilutive. Stock options excluded in each period were as follows (in thousands):
The following table summarizes the comprehensive loss for the periods indicated (in thousands):
The following table sets forth amounts attributable to Emeritus Corporation common shareholders, excluding losses attributable to the noncontrolling interest (in thousands):
The following table shows the net losses for discontinued operations:
In the third quarter of 2010, we finalized an agreement to sell one of our communities. Accordingly, we recorded an impairment charge of $559,000. Loss from discontinued operations for the nine months ended September 30, 2010, amounting to $1.7 million, also includes losses from one community we sold in January 2010 and one community we sold in June 2010. Loss from discontinued operations for the 2009 periods includes impairment charges of $1.2 million on the communities we sold in January 2010 and January 2009. Revenues and expenses related to these communities were not material to the condensed consolidated statements of operations for the three and nine months ended September 30, 2010 and 2009.
As of September 30, 2010, the Company has a working capital deficit of $53.6 million. The Company is able to operate in the position of a working capital deficit because we often convert our revenues to cash more quickly than we are required to pay the corresponding obligations incurred to generate those revenues. This can result in a low level of current assets to the extent we have used cash for business development expenses or to pay down long-term liabilities. Additionally, the working capital deficit includes the following non-cash items: an $18.0 million deferred tax asset and, as part of current liabilities, $30.6 million of deferred revenue and unearned rental income. We do not expect the level of current liabilities to change from period to period in such a way as to require the use of significant cash in excess of normal requirements, except for $71.1 million in final payments of principal on long-term debt maturing in 2011, of which $26.1 million is included in current portion of long-term debt as of September 30, 2010.
In the nine months ended September 30, 2010 and 2009, we reported net cash provided by operating activities of $60.5 million and $55.1 million, respectively, in the Company’s condensed consolidated statements of cash flows. However, net cash provided by operating activities has not always been sufficient to pay all of the Company’s long-term obligations and we have been dependent upon third-party financing or disposition of assets to fund operations. We cannot guarantee that, if necessary in the future, such transactions will be available on a timely basis or at all, or on terms attractive to us.
Since 2008, we have refinanced and extended the terms of a substantial amount of the Company’s existing debt obligations, extending the maturities of such financings to dates in 2011 through 2019. Final payments of principal on long-term debt maturing in 2011 amounts to $71.1 million and is expected to be repaid or refinanced. Many of the Company's debt instruments and leases contain “cross-default” provisions pursuant to which a default under one obligation can cause a default under one or more other obligations to the same lender or lessor. Such cross-default provisions affect the majority of the Company’s properties. Accordingly, any event of default could cause a material adverse effect on the Company's financial condition if such debt or leases are cross-defaulted. As of September 30, 2010, the Company was in violation of certain financial and occupancy covenants in one debt agreement. We have obtained a waiver from the lender and, as such, the Company was in compliance as of September 30, 2010. We have classified this loan, which matures in May 2011, as current in the condensed consolidated balance sheet as of September 30, 2010. In October 2010, we entered into an agreement to amend the financial and occupancy covenants in one other debt agreement for the quarterly reporting periods beginning September 30, 2010 through September 30, 2011. As a result of this amendment, the Company was in compliance as of September 30, 2010.
We believe the Company will be able to generate sufficient cash flows to support its operating activities and will have adequate sources of cash for all necessary investing and financing activities, including required debt service and capital expenditures, for at least the next twelve months.
The following table presents information about the Company’s assets measured at fair value on a recurring basis as of September 30, 2010, and indicates the fair value hierarchy of the valuation techniques we have utilized to determine such fair value (in thousands):
In general, fair values determined by Level 1 inputs utilize quoted prices in active markets for identical assets or liabilities that we have the ability to access.
Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability.
Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and we consider many factors specific to the asset or liability.
The Company has financial instruments other than investment securities consisting of cash and cash equivalents, trade accounts receivable, other receivables, tax and maintenance escrows, workers’ compensation collateral accounts, accounts payable, and long-term debt. The fair value of these financial instruments as of September 30, 2010 and December 31, 2009, based on their short-term nature or current market indicators, such as prevailing interest rates, approximates their carrying value with the exception of the following (in thousands):
We estimated the fair value of debt obligations using discounted cash flows based on the Company’s assumed incremental borrowing rate of 8.0% for unsecured borrowings and 6.6% for secured borrowings.
Impairment of Long-Lived Assets
The following table presents information about the Company’s assets and liabilities measured at fair value on a nonrecurring basis as of September 30, 2010 and indicates the fair value hierarchy of the valuation techniques we have utilized to determine such fair value (in thousands):
In the nine months ended September 30, 2010, we sold, for a net price of $2.6 million, a long-lived asset held for
sale with a carrying amount of $2.8 million resulting in a loss of $162,000, which was included in “Other, net” for the period. This asset represents the sale, in July 2010, of an executive’s former house that we purchased in the second quarter of 2009 in connection the executive’s required relocation to Seattle following the Company’s merger with Summerville Senior Living, Inc. (“Summerville”) in 2007. In addition, we recorded an impairment charge of $559,000 related to one community that we sold in November 2010, which is included in “Loss from discontinued operations” in the condensed consolidated statement of operations and described in Note 9, Discontinued Operations.
In the nine months ended September 30, 2009, we recorded impairment losses totaling $3.0 million, comprised of $1.2 million related to five communities that were previously held for sale, $1.2 million related to two communities that we sold (Note 9, Discontinued Operations), and $623,000 related to the aforementioned executive’s former house. We determined the fair value of these properties based on preliminary offers from prospective purchasers.
Our income tax accruals include liabilities for unrecognized tax benefits, including penalties and interest, which we recorded in connection with the Summerville merger. These liabilities, which total $2.6 million, are included in “Other long-term liabilities” and are the result of uncertainty surrounding the deductibility of certain items included in the Summerville tax returns for periods prior to the merger.
Effective October 12, 2010, we entered into two master leases with affiliates of HCP to lease 27 senior living communities. The communities are located in 13 states and consist of approximately 3,239 units, comprised of 2,021 assisted living, 631 memory care, 450 skilled nursing and 137 independent living units.
The lease agreements have an initial term of 15 years, commencing on November 1, 2010, with two available extension options of 10 years each. One of the lease agreements also contains a purchase option on 10 of the communities, exercisable beginning in year 11 and extending through the remaining term of the lease. The purchase option price for the 10 communities is the greater of (i) $140.0 million or (ii) the fair market value of such communities, as determined by appraisal on the date of exercise, less any shared appreciation amount as specified in the leases.
The annual minimum rent on the communities, subject to certain adjustments with respect to one facility, is fixed during the first five years at $31.0 million, $34.5 million, $41.0 million, $46.0 million, and $51.0 million, respectively, excluding any additional rent related to capital additions funded by HCP. Thereafter, annual minimum rent increases annually by the greater of the CPI or 3.0%. Minimum rent on the first year of each extension period is the greater of (i) the fair market rent, not to exceed 106% of the prior lease year rent, or (ii) the minimum rent for the prior lease year increased by the greater of CPI or 3.0%.
We will account for these leases as capital leases.
Weston Group Purchase Agreement
On October 21, 2010, the Company entered into a purchase agreement (the “Purchase Agreement”) with Randall Weston and Weston Group, Inc. (together the “Weston Parties”) to purchase the assets of the Weston Parties and their related entities that provide rehabilitative care and contract rehabilitation services and Medicare certified durable medical equipment products to the senior living industry (the “Rehabilitation Business”).
Under the terms of the Purchase Agreement, the Company will acquire all right, title and interest in and to all of the assets used in the Rehabilitation Business, including a 51% ownership interest in Weston Group, Inc.'s wholly owned subsidiary, Mobility Rehabilitation Products LLC, a durable medical equipment supplier (the “Acquired Assets”). The Acquired Assets will be transferred to Weston Rehabilitation and Ancillary Services LLC, a wholly owned subsidiary of Emeritus (“Weston Rehabilitation”). The purchase price for the Acquired Assets will be $18.0
million, plus or minus the amount by which the closing net working capital of Weston Rehabilitation exceeds or falls below $6.0 million. The purchase consideration will be in the form of a promissory note payable to Mr. Weston in the amount of $5.0 million (the “Note”) with the balance paid in cash. Following the completion of the transaction, Mr. Weston will serve as President of Weston Rehabilitation.
The Purchase Agreement includes several customary closing conditions and we expect the transaction to be completed in early 2011.
On November 1, 2010, we sold one community in Florida for approximately $3.0 million, net of selling costs. As a result, we recorded an impairment charge of $559,000 for the three and nine months ended September 30, 2010, which is included in “Loss from discontinued operations” in the condensed consolidated statements of operations and described in Note 9, Discontinued Operations.
On November 1, 2010, the Company entered into agreements with Nationwide Health Properties, Inc. (“NHP”) to amend the terms of two loans payable to NHP (the “Notes”). A note payable to NHP in the amount of $21.4 million was amended to extend the maturity date from March 31, 2012 to March 31, 2017. A note payable to NHP in the amount of $30.0 million was amended to extend the maturity date from April 1, 2012 to March 31, 2017.
The interest rate each of the Notes is 8.50%, increasing annually on the anniversary date by 0.15%. Monthly payments on the Notes are interest only, with the unpaid principal balance due at maturity.
Community Mortgage Refinance
On November 1, 2010, Batus LLC, the Company’s joint venture with Mr. Baty, entered into an agreement with KeyCorp Real Estate Capital Markets, Inc. to refinance the mortgage debt on one of its communities, having an outstanding principal balance of $5.8 million (the “Original Loan”), with proceeds from a new Fannie Mae mortgage loan (the “Fannie Mae Loan”). The principal balance of the Fannie Mae Loan is $4.5 million and it has a ten-year term. The interest rate is fixed at 5.38%. The Fannie Mae Loan is scheduled to be repaid in equal monthly payments of principal and interest based on a 30-year amortization period. Emeritus and Mr. Baty each paid 50% of the closing costs and the principal paydown on the Original Loan.
This report contains “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,” “future,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “seek,” “should,” “target,” 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 prove to be inaccurate. Please carefully review Item 1A—Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2009 for important factors that could cause the Company’s actual results to differ materially from the forward-looking statements included in this report and those that we present elsewhere 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. 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 the Company’s quarterly reports on Form 10-Q and current reports on Form 8-K.
A summary of activity in the first nine months of 2010 compared to the equivalent period in 2009 is as follows:
Additionally, in January 2010, the Company entered into the Sunwest JV with Blackstone and Columbia Pacific. As of September 30, 2010, the Sunwest JV had acquired 140 Properties previously operated by Sunwest with an additional four Properties deferred until a later date, of which three Properties we currently manage for Sunwest. The communities formerly owned by Sunwest that were acquired by the Sunwest JV are similar in operating characteristics to the Company’s existing portfolio of senior living communities. We entered into management agreements with the Sunwest JV to manage the portfolio of communities for a fee equal to 5.0% of gross collected revenues. For additional information regarding the acquisition of the Properties by the Sunwest JV, see Note 4, Acquisitions and Other Significant Transactions—Sunwest Joint Venture, in Notes to Condensed Consolidated Financial Statements.
For the third quarter of 2010, the net loss attributable to our common shareholders was $13.7 million compared to $16.0 million in the 2009 period. Operating income from continuing operations, which excludes interest, equity earnings/losses, and other non-operating items, increased by $2.9 million to $14.4 million in the third quarter of 2010 compared to $11.5 million in the same quarter in 2009. Total operating revenues increased to $250.0 million in the current quarter from $225.8 million in the prior year period.
Two of the important factors affecting the Company’s financial results are the rates we charge our residents and the occupancy levels we achieve in the Company’s communities. We rely primarily on our residents’ ability to pay the Company’s charges for services from their own or from their families’ 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, in general, only seniors with income or assets meeting or exceeding the regional median can afford to reside in the Company’s 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 utilize the average monthly revenue per occupied 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 utilize 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 the Company’s consolidated portfolio, which includes the communities we own and lease, as well as for the Company’s total operating portfolio, which includes all of the communities we manage.
In the Company’s consolidated portfolio, the average monthly revenue per occupied unit increased to $3,833 in the current quarter from $3,649 in the third quarter of 2009. The change from 2009 to 2010 represents an increase of $184 per occupied unit, or 5.0%. This average rate increase reflects a combination of factors, including local market conditions, competition, changes in level of required care provided to residents, acquisitions, and inflationary adjustments and resident mix.
In the Company’s consolidated portfolio, the average occupancy rate remained constant at 87.1% in both the third quarter of 2010 and 2009 despite the continued general economic fluctuation and future uncertainty. We continue to evaluate the factors of rate and occupancy to find the optimum balance in each community.
We also earn management fee revenues by managing certain communities for third parties, including communities owned by the Sunwest JV and other joint ventures in which we have an ownership interest. We charge fees based on a percentage of community revenues.
Since Emeritus Corporation’s inception in 1993, it has incurred cumulative operating losses totaling approximately $456.2 million as of September 30, 2010. We believe that these losses have resulted from our early and continuing emphasis on expansion, financing costs arising from multiple financing and refinancing transactions related to this expansion, administrative and corporate expenses that we incur as the scope and complexity of the Company has grown, the impact in the early years on many of the Company’s leases from capital and financing lease treatments, and occupancy rates remaining lower for longer periods than we anticipated. While we have generally realized growth in both the Company’s occupancy and average monthly rates, we anticipate continued net operating losses in the near term but expect to continue to generate positive cash flows from operations. Our current emphasis is on maximizing cash flows and containing costs as we work toward improvements in occupancy and average rates, selective growth, and changes in the Company’s capital structure, such as acquisition of leased properties and refinancing of existing debt.
The following table sets forth a summary of the Company’s property interests:
(1) We account for 82 of the 115 leased communities as operating leases and the remaining 33 as capital or financing leases. We do not include the assets and liabilities of the 82 operating lease communities on our condensed consolidated balance sheets.
(2) The percentage increase indicates the change from December 31 of the preceding year.
The Company’s total operated portfolio as of September 30, 2010 consists of the following unit types:
The units taken out of service represent rooms that we have converted to alternative uses, such as additional office space, and are not available for immediate occupancy. We exclude the units taken out of service from the calculation of the average occupancy rate. We place these units back into service as demand dictates.
In recent periods, we entered into a number of transactions that affected the number of communities the Company owns and leases, its financing arrangements, and its capital structure. These transactions are summarized below. For details on significant transactions that affected the comparability of the financial statements included in this Quarterly Report on Form 10-Q, see Note 4, Acquisitions and Other Significant Transactions, in Notes to Condensed Consolidated Financial Statements.
The following table shows the changes in the Company’s building portfolio from December 31, 2008 through September 30, 2010, including those transactions previously described:
(1) The totals have been adjusted to combine facilities on certain community campuses.
(2) Of the 132 Sunwest JV communities purchased by the Sunwest JV on August 5, 2010, five of those communities were managed by third parties as of September 30, 2010.
Statements of Operations as a Percentage of Total Operating Revenues and Period-to-Period Percentage Change
The following table sets forth, for the periods indicated, certain items from the Company’s condensed consolidated statements of operations as a percentage of total revenues and the percentage change in the dollar amounts from period to period.