SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2002 [ ] Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission file number 1-13445. CAPITAL SENIOR LIVING CORPORATION --------------------------------- (Exact name of Registrant as specified in its charter) DELAWARE 75-2678809 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 14160 Dallas Parkway, Suite 300, Dallas, Texas 75254 ---------------------------------------------------- (Address of principal executive offices) 972-770-5600 ------------ (Registrant's telephone number, including area code) Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No --- --- As of May 13, 2001, the Registrant had outstanding 19,719,843 shares of its Common Stock, $.01 par value.
CAPITAL SENIOR LIVING CORPORATION INDEX Page Number ------ Part I. Financial Information Item 1. Financial Statements Consolidated Balance Sheets - - March 31, 2002 and December 31, 2001 3 Consolidated Statements of Income - - Three Months Ended March 31, 2002 and 2001 4 Consolidated Statements of Cash Flows - - Three Months Ended March 31, 2002 and 2001 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk 18 Part II. Other Information Item 1. Legal Proceedings 19 Item 6. Exhibits and Reports on Form 8-K 20 Signature 2
PART I. FINANCIAL INFORMATION Item 1. Financial Statements <TABLE> <CAPTION> CAPITAL SENIOR LIVING CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands) March 31, December 31, 2002 2001 ---------------- ---------------- ASSETS (Unaudited) (Audited) <S> <C> <C> Current assets: Cash and cash equivalents........................................... $ 12,323 $ 9,975 Restricted cash..................................................... 2,100 2,100 Accounts receivable, net............................................ 3,337 1,438 Accounts receivable from affiliates................................. 921 366 Interest receivable................................................. 7,323 6,072 Investment in limited partnership................................... 222 5,774 Federal and state income taxes receivable........................... 268 1,145 Deferred taxes...................................................... 2,770 2,770 Prepaid expenses and other.......................................... 369 1,218 ----------- ----------- Total current assets.......................................... 29,633 30,858 Property and equipment, net............................................... 193,288 196,821 Deferred taxes............................................................ 7,440 7,540 Notes receivable from affiliates.......................................... 64,107 59,020 Investments in limited partnerships....................................... 1,856 1,827 Assets held for sale...................................................... 4,924 4,924 Other assets.............................................................. 5,991 7,092 ----------- ----------- Total assets.................................................. $ 307,239 $ 308,082 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable.................................................... $ 3,703 $ 3,040 Accrued expenses.................................................... 3,470 3,363 Current portion of notes payable.................................... 23,643 25,594 Customer deposits................................................... 1,101 1,144 ----------- ----------- Total current liabilities..................................... 31,917 33,141 Deferred income........................................................... 535 507 Deferred income from affiliates........................................... 1,628 1,750 Notes payable, net of current portion..................................... 148,248 149,202 Line of credit............................................................ 7,553 7,553 Minority interest in consolidated partnership............................. 1,997 2,385 Commitments and contingencies Shareholders' equity: Preferred stock, $.01 par value: Authorized shares 15,000,000; no shares issued or outstanding. -- -- Common stock, $.01 par value: Authorized shares 65,000,000; issued and outstanding 19,719,843 and 19,717,347 at March 31, 2002 and December 31, 2001, respectively............................... 197 197 Additional paid-in capital.......................................... 91,941 91,935 Retained earnings................................................... 23,223 21,412 ----------- ----------- Total shareholders' equity.................................... 115,361 113,544 ----------- ----------- Total liabilities and shareholders' equity.................... $ 307,239 $ 308,082 =========== =========== </TABLE> See accompanying notes. 3
<TABLE> <CAPTION> CAPITAL SENIOR LIVING CORPORATION CONSOLIDATED STATEMENTS OF INCOME (in thousands, except earnings per share) Three Months Ended March 31, ---------------------------- 2002 2001 --------------- --------------- (Unaudited) (Unaudited) <S> <C> <C> Revenues: Resident and healthcare revenue................ $ 15,579 $ 16,040 Rental and lease income........................ 37 1,031 Unaffiliated management services revenue....... 366 504 Affiliated management services revenue......... 410 387 Unaffiliated development fees.................. -- 24 Affiliated development fees.................... 183 57 ---------- ----------- Total revenues............................. 16,575 18,043 Expenses: Operating expenses............................. 8,772 9,304 General and administrative expenses............ 3,157 3,114 Depreciation and amortization.................. 1,646 1,743 ---------- ----------- Total expenses............................. 13,575 14,161 ---------- ----------- Income from operations............................... 3,000 3,882 Other income (expense): Interest income................................ 1,429 1,541 Interest expense............................... (2,828) (4,249) Equity in the earnings (losses) of affiliates.. 11 (253) Gain on sale of properties..................... 2,283 -- ---------- ----------- Income before income taxes and minority interest in consolidated partnership....................... 3,895 921 Provision for income taxes........................... (1,124) (262) ---------- ----------- Income before minority interest in consolidated partnership.................................... 2,771 659 Minority interest in consolidated partnership........ (960) (232) ---------- ----------- Net income........................................... $ 1,811 $ 427 ========== =========== Net income per share: Basic.......................................... $ 0.09 $ 0.02 ========= =========== Diluted........................................ $ 0.09 $ 0.02 ========= =========== Weighted average shares outstanding - basic.... 19,718 19,717 ========= =========== Weighted average shares outstanding - diluted.. 20,022 19,717 ========= =========== </TABLE> See accompanying notes. 4
<TABLE> <CAPTION> CAPITAL SENIOR LIVING CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Three Months Ended March 31, ---------------------------- 2002 2001 --------------- ----------------- (Unaudited) (Unaudited) <S> <C> <C> Operating Activities Net income.......................................................... $ 1,811 $ 427 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization................................. 1,646 1,743 Amortization of deferred financing charges.................... 202 234 Gain on sale of assets........................................ (2,283) -- Equity in the (earnings) losses of affiliates................. (11) 253 Minority interest in consolidated partnership................. 960 232 Deferred tax expense.......................................... 100 101 Deferred income............................................... 28 -- Deferred income from affiliates............................... (122) (80) Changes in operating assets and liabilities, net of acquisitions: Accounts receivable....................................... (1,899) 113 Accounts receivable from affiliates....................... (555) (241) Interest receivable....................................... (1,251) (920) Prepaid expenses and other................................ 849 981 Other assets.............................................. -- (383) Accounts payable and accrued expenses..................... 792 (1,208) Federal and state income taxes............................ 879 10 Customer deposits......................................... (153) 13 ----------- ------------ Net cash provided by operating activities........................... 993 1,275 Investing Activities Capital expenditures................................................ (362) (959) Proceeds from the sale of assets.................................... 4,396 -- Advances to affiliates.............................................. (5,105) (3,997) Distribution from limited partnership............................... 5,552 102 ----------- ------------ Net cash provided by (used in) investing activities................. 4,481 (4,854) Financing Activities Repayment of notes payable.......................................... (1,782) (1,508) Proceeds from the issuance of common stock.......................... 4 -- Distributions to minority partners.................................. (1,348) (2,163) ----------- ------------ Net cash used in financing activities............................... (3,126) (3,671) ----------- ------------ Net increase (decrease) in cash and cash equivalents................ 2,348 (7,250) Cash and cash equivalents at beginning of period.................... 9,975 23,975 ----------- ------------ Cash and cash equivalents at end of period.......................... $ 12,323 $ 16,725 =========== ============ Supplemental disclosures: Cash paid during the period for: Interest..................................................... $ 2,606 $ 3,985 =========== ============ Income taxes................................................. $ 381 $ 164 =========== ============ </TABLE> See accompanying notes. 5
CAPITAL SENIOR LIVING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 2002 1. BASIS OF PRESENTATION Capital Senior Living Corporation, a Delaware corporation (the "Company"), was incorporated on October 25, 1996. The accompanying consolidated financial statements include the financial statements of Capital Senior Living Corporation and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. The accompanying consolidated balance sheet, as of December 31, 2001, has been derived from audited consolidated financial statements of the Company for the year ended December 31, 2001, and the accompanying unaudited consolidated financial statements, as of March 31, 2002 and 2001, have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to those rules and regulations. For further information, refer to the financial statements and notes thereto for the year ended December 31, 2001 included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 28, 2002. In the opinion of the Company, the accompanying consolidated financial statements contain all adjustments (all of which were normal recurring accruals) necessary to present fairly the Company's financial position as of March 31, 2002, and results of operations and cash flows for the three months ended March 31, 2002 and 2001. The results of operations for the three months ended March 31, 2002 are not necessarily indicative of the results for the year ending December 31, 2002. In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, "Business Combinations", and No. 142, "Goodwill and Other Intangible Assets", effective for years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets will continue to be amortized over their useful lives. The application of these Statements did not result in a material effect on the Company's net income or financial position. 2. TRANSACTIONS WITH AFFILIATES The Company has entered into development and management agreements with the partnerships set out below (the "Triad Entities") for the development and management of new senior living communities. The Triad Entities own and finance the construction of new senior living communities. These communities are primarily Waterford communities. The development of senior living communities typically involves a substantial commitment of capital over an approximate 12-month construction period, during which time no revenues are generated, followed by an 18 to 24 month lease up period. The Company has an approximate 1% limited partnership interest in each of the Triad Entities and is accounting for these investments under the equity method of accounting based on the provisions of the Triad Entities partnership agreements. The Company has loan commitments to the Triad Entities for construction and pre-marketing expenses, in addition to requirements to fund the Triad Entities' operating deficits through an operating deficit guarantee provided for in its management agreement with the Triad Entities. The Company evaluates the carrying value of these receivables by comparing the cash flows expected from the operations of the Triad Entities to the carrying value of the receivables. These cash flow models consider 6
CAPITAL SENIOR LIVING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) lease-up rates, expected operating costs, debt service requirements and various other factors. The carrying value of the notes receivable from the Triad Entities could be adversely affected by a number of factors including the Triad communities experiencing slower than expected lease-up, lower than expected lease rates, higher than expected operating costs, increases in interest rates, issues involving debt service requirements, general adverse market conditions, other economic factors and changes in accounting guidelines. Management believes that if the assumptions used, which are consistent with our operating experience, in these cash flow models are achieved, the carrying value of the notes receivable are fully recoverable. The following table sets forth, as of March 31, 2002, the capital invested in each of the Triad Entities, information related to loans made by the Company to each Triad Entity and information on deferred income related to each Triad Entity (dollars in thousands): <TABLE> <CAPTION> Notes Receivable Deferred Income ----------------------------------------------------------------------------------------- Operating Development/ Capital Committed Interest Note Deficit Management Entity Investment Amount Rate Maturity Balance Funding Interest Fees ------ ---------- --------- -------- -------- ------- --------- -------- -------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Triad Senior Living I, L.P. $ -- $ -- 8.0% -- $ -- $13,217 $111 $ 356 (Triad I) Triad Senior Living II, L.P. Sept. 25, (Triad II) -- 15,000 8.0% 2003 15,000 2,937 166 173 Triad Senior Living III, L.P. Feb. 8, (Triad III) -- 15,000 8.0% 2004 15,000 5,176 160 336 Triad Senior Living IV, L.P. Dec. 30, (Triad IV) -- 10,000 8.0% 2003 9,345 -- 145 118 Triad Senior Living V, L.P. June 30, (Triad V) -- 10,000 8.0% 2004 3,432 -- 28 28 </TABLE> The Company typically receives a development fee of 4% of project costs, as well as reimbursement of expenses and overhead not to exceed 4% of project costs. These fees are recorded over the term of the development project on a basis approximating the percentage of completion method. In addition, when the properties become operational, the Company typically receives management fees in an amount equal to the greater of 5% of gross revenues or $5,000 per month per community, plus overhead expenses. The Company has the option, but not the obligation, to purchase the partnership interests of the other parties in Triad Entities for an amount equal to the amount paid for the partnership interest by the other partners, plus a noncompounded return of 12% per annum except for Triad I. In addition, each Triad Entity except Triad I provides the Company with an option, but not the obligation, to purchase the community developed by the applicable partnership upon their completion for an amount equal to the fair market value (based on a third-party appraisal but not less than hard and soft costs and lease-up costs) of the community. The Company has the option to purchase the Triad I communities for an amount specified in the partnership agreement. The Company has made no determination as to whether it will exercise any of these purchase options. Deferred interest income is being amortized into income over the life of the loan commitment that the Company has with each of the Triad Entities. Deferred development and management fee income are being amortized into income over the expected remaining life of the Triad partnerships. 7
CAPITAL SENIOR LIVING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Each of the Triad Entities finances the development of new communities through a combination of equity funding, traditional construction loans and permanent financing with institutional lenders secured by first liens on the communities and unsecured loans from the Company. The Company loans may be prepaid without penalty. The financings from institutional lenders are secured by first liens on the communities, as well as assignment to the lenders of the construction contracts and the development and management agreements with the Company. Each development and management agreement assigned to an institutional lender is also guaranteed by the Company and those guarantees are also assigned to the lenders. In most cases, the management agreements contain an obligation of the Company to fund operating deficits to the Triad Entities if the other financing sources of the Triad Entities have been fully utilized. These operating deficit funding obligations are guaranteed by the Company and include making loans to fund debt service obligations to the Triad Entities' lenders. Amounts funded to date under these operating deficit agreements are disclosed in the table above. The Company expects to be required to fund additional amounts under these operating deficit agreements in the future. Set forth below is information on the construction loan facilities entered into by each of the Triad Entities as of March 31, 2002 (dollars in thousands): <TABLE> <CAPTION> Loan Facilities to Triads ------------------------------------------------------ Amount Entity Commitment Outstanding Type Lender ------------------------ ---------- ----------- ---- --------------- <S> <C> <C> <C> <C> <C> Triad I $50,000 $49,287 take-out GMAC Triad II $26,900 $26,774 mini-perm Key Corporate Capital, Inc. Triad III $56,300 $56,270 mini-perm Guaranty Bank Triad IV $18,600 $15,651 construction; Compass Bank mini-perm Triad V $ 8,903 $ 8,660 mini-perm Bank of America </TABLE> During 2001, Triad V was notified by the lender of its failure to comply with certain terms of its loan agreement with the lender. The lender, however, expressed its intention to work with Triad V and the lender and Triad V subsequently signed a new loan agreement in April 2002. Summary financial information regarding the results of operations of the Triad Entities for the three months ending March 31, 2002 and 2001 is as follows (in thousands): 2002 2001 ---------- ---------- Net revenue...................... $ 5,677 $ 3,223 Net loss......................... (5,240) (6,496) The Company formed a joint venture ("BRE/CSL") with Blackstone Real Estate Advisors ("Blackstone") in December 2001, and the joint venture will seek to acquire in excess of $200 million of senior housing properties. BRE/CSL is owned 90% by Blackstone and 10% by the Company. Pursuant to the terms of the joint venture, each of the Company and Blackstone must approve any acquisitions made by the joint venture. Each party must also contribute its pro rata portion of the costs of any acquisition. The joint venture currently owns one community, The Amberleigh at Woodside Farms ("Amberleigh"), a 394 resident capacity independent living facility. In connection with the acquisition of Amberleigh by BRE/CSL, the Company contributed $1.8 million to the joint venture. Subsequent to the end of the first quarter of 2002, BRE/CSL 8
CAPITAL SENIOR LIVING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) obtained permanent financing for the Amberleigh community and the Company recovered $1.4 million of its contribution to the joint venture. In addition, the Company has entered into a contribution agreement to contribute four of its senior living communities to BRE/CSL. The Company manages the Amberleigh community and will manage other communities once owned by BRE/CSL under long-term management contracts. 3. NET INCOME PER SHARE Basic net income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share considers the dilutive effect of outstanding options calculated using the treasury stock method. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except for per share amounts): Three Months Ended March 31, -------------------------- 2002 2001 ------------ ------------- Net income $ 1,811 $ 427 Weighted average shares outstanding - 19,718 19,717 basic Effect of dilutive securities: Employee stock options 304 -- ----------- ----------- Weighted average shares outstanding - 20,022 19,717 diluted =========== =========== Basic earnings per share $ 0.09 $ 0.02 =========== ============ Diluted earnings per share $ 0.09 $ 0.02 =========== ============ Options to purchase 0.8 million shares of common stock at prices ranging from $4.14 to $13.50 per share were not included in the computation of diluted earnings per share because the average daily price of the common stock during the first quarter of fiscal 2002 did not exceed the exercise price of the options, and therefore, the effect would not be dilutive. For the first quarter of fiscal 2001, options to purchase 1.0 million shares of common stock at prices ranging from $3.63 to $13.50 per share were not included in the computation of diluted earnings per share because the average daily price of the common stock did not exceed the exercise price of the options, and therefore, the effect would not be dilutive. On January 31, 2002, the Company granted options to certain employees, to purchase 58,000 shares of the Company's common stock at an exercise price of $4.14. In addition, the Company issued 396 and 2,100 shares of common stock on February 12, 2002 and on March 5, 2002, respectively, pursuant to the exercise of stock options by certain employees of the Company. 4. CONTINGENCIES On or about October 23, 1998, Robert Lewis filed a putative class action complaint on behalf of certain holders of assignee interests (the "Assignee Interests") in NHP Retirement Housing Partners I Limited Partnership ("NHP") in the Delaware Court of Chancery, Civil Action No. 16725 (the "Delaware Action") against NHP, the general partner of NHP ("General Partner"), the Company and Capital Senior Living Properties 2-NHPCT, Inc. (collectively, the "Defendants"). Mr. Lewis purchased ninety Assignee Interests in NHP in February 1993 for $180. The complaint alleges, among other things, that the Defendants breached, or aided and abetted a breach of, the express and implied terms of the NHP Partnership Agreement in connection with the sale of four properties by NHP to Capital Senior Living Properties 2-NHPCT, Inc in September 1998 (the "1998 Transaction"). The complaint seeks, among other relief, rescission of the 1998 9
CAPITAL SENIOR LIVING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Transaction and unspecified damages. On July 9, 1999, the Defendants filed a motion to dismiss the case. Subsequently, the plaintiff amended his complaint adding allegations challenging the terms of the sale in December 2001 of the Amberleigh retirement facility to BRE/CSL. On January 31, 2002, the parties to the Delaware Action entered into a Memorandum of Understanding providing for the settlement of the Delaware Action subject to certain terms and conditions, including the filing of an amended complaint and receipt of the approval of the Court of Chancery. The proposed settlement contemplates the creation of a settlement fund in the amount of approximately $0.8 million, of which NHP will contribute approximately $0.3 million, the amount of the deductible of NHP's directors and officers' liability insurance policy at the time the Delaware Action was filed (the "D&O Policy"). Virtually all of the balance of the settlement fund will be contributed by the various insurance brokers and agents, and their insurers, in connection with the resolution of certain claims for coverage under the D&O Policy. The settlement contribution of the Company and its affiliates will be $43,000. If approved by the Court of Chancery, the settlement fund, less any award of attorney's fees for plaintiff's counsel approved by the court, will be distributed to a class of Assignee Holders of NHP. On December 6, 2001, Leonard Kalmenson filed a motion to intervene in the Delaware Action on the behalf of a putative class of holders of Pension Notes of NHP in the event the Court of Chancery determines that the claims asserted in the Delaware Action are derivative in nature. The Complaint in Intervention filed by Mr. Kalmenson names as defendants the Defendants in the Delaware Action as well as Retirement Associates, Inc., the sole stockholder of the General Partner of NHP, and various current and former directors of the General Partner. The Complaint in Intervention essentially alleges, among other things, a variety of claims challenging the 1998 Transaction and a claim for breach of contract relating to the failure of NHP to pay the full amount of principal and interest owed on the Pension Notes on their maturity date. NHP and the Company believe that the allegations asserted by Mr. Kalmenson are without merit and that his motion to intervene is moot in view of the proposed settlement of the Delaware Action. The Company is unable at this time to estimate any liability related to this claim, if any. On January 16, 2002, the Company filed a claim with the American Arbitration Association seeking reimbursement of certain health care expenses, as well as severance compensation from Buckner Retirement Services, Inc. ("Buckner") pursuant to a management agreement between the parties. Buckner has filed an answer and a counterclaim in this arbitration and proceedings are continuing. The Company has other pending claims incurred in the normal course of business, that, in the opinion of management, based on the advice of legal counsel, will not have a material effect on the financial statements of the Company. 5. MANAGEMENT AGREEMENTS On February 28, 2002, ILM Senior Living II, Inc. ("ILM II") notified the Company that it had entered into an agreement to sell the five communities managed by the Company and would, therefore, be terminating the management agreement for these five communities effective April 1, 2002. As of April 1, 2002, the Company no longer manages these communities. On March 1, 2002, affiliates of LCOR Incorporated ("LCOR") notified the Company of its intent to terminate the LCOR Management Agreements, effective May 31, 2002, as a result of the Company not funding certain alleged operating deficits, which the Company could optionally fund under the LCOR Management Agreements. The Company has notified LCOR that the Company believes this termination was without cause. 10
CAPITAL SENIOR LIVING CORPORATION Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following discussion and analysis addresses (i) the Company's results of operations for the three months ended March 31, 2002 and 2001, respectively, and (ii) liquidity and capital resources of the Company and should be read in conjunction with the Company's consolidated financial statements contained elsewhere in this report. The Company is one of the largest operators of senior living communities in the United States in terms of resident capacity. The Company's operating strategy is to provide high quality senior living services at an affordable price to its residents, while achieving and sustaining a strong, competitive position within its chosen markets, as well as to continue to enhance the performance of its operations. The Company provides a wide array of senior living services to the elderly at its communities, including independent living, assisted living (with special programs and living units at some of its communities for residents with Alzheimer's and other forms of dementia), skilled nursing and home care services. The Company generates revenue from a variety of sources. For the three months ended March 31, 2002, the Company's revenue was derived as follows: 94.0% from the operation of 18 owned senior living communities that are operated by the Company; 0.2% from lease rentals for triple net leases; 4.7% from management fees arising from management services provided for 19 affiliate owned senior living communities and 10 third party owned senior living communities and 1.1% derived from development fees earned for managing the development and construction of new senior living communities for the Triad Entities. The Company believes that the factors affecting the financial performance of communities managed under contracts with third parties do not vary substantially from the factors affecting the performance of owned and leased communities, although there are different business risks associated with these activities. The Company's third-party management fees are primarily based on a percentage of gross revenues. As a result, the cash flows and profitability of such contracts to the Company are more dependent on the revenues generated by such communities and less dependent on net cash flow than for owned communities. Further, the Company is not responsible for capital investments in managed communities. While the management contracts are generally terminable only for cause, in certain cases the contracts can be terminated upon the sale of a community, subject to the Company's rights to offer to purchase such community. The Company's current management contracts expire on various dates through January 2012 and provide for management fees based generally upon rates that vary by contract from 4% of net revenues to 5% of net revenues. In addition, certain of the contracts provide for supplemental incentive fees that vary by contract based upon the financial performance of the managed community. The Company's development fees are generally based upon a percentage of construction cost and are earned over the period commencing with the initial development activities and ending with the opening of the community. The Company, through its ownership in Healthcare Properties, L.P. ("HCP"), leased two properties under triple net leases both of which were sold during the first quarter of 2002. After the sale of these properties, HCP owns one community that is currently classified as held for sale. The Company formed the BRE/CSL joint venture with Blackstone in December 2001, and the joint venture will seek to acquire in excess of $200 million of senior housing properties. BRE/CSL is owned 90% 11
CAPITAL SENIOR LIVING CORPORATION MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) by Blackstone and 10% by the Company. Pursuant to the terms of the joint venture, each of the Company and Blackstone must approve any acquisitions made by the joint venture. Each party must also contribute its pro rata portion of the costs of any acquisition. The joint venture currently owns one community, The Amberleigh at Woodside Farms, a 394 resident capacity independent living facility. In connection with the acquisition of Amberleigh by BRE/CSL, the Company contributed $1.8 million to the joint venture. Subsequent to the end of the first quarter of 2002, BRE/CSL obtained permanent financing for the Amberleigh community and the Company recovered $1.4 million of its contribution to the joint venture. In addition, the Company has entered into a contribution agreement to contribute four of its senior living communities to BRE/CSL. The Company manages the Amberleigh community and will manage other communities once owned by BRE/CSL under long-term management contracts. The Company's development fees are generally based upon a percentage of construction costs and are earned over the period commencing with the initial development activities and ending with the opening of the community. The Company completed the development and opened two communities for the Triad IV, one on January 2, 2002 and the other subsequent to the end of the first quarter of 2002 on May 1, 2002. The Company manages these communities for the Triad Entities under long-term management contracts. 12
CAPITAL SENIOR LIVING CORPORATION MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Results of Operations The following table sets forth for the periods indicated, selected statements of income data in thousands of dollars and expressed as a percentage of total revenues. <TABLE> <CAPTION> Three Months Ended March 31, ---------------------------------------- 2002 2001 ------------------ -------------------- $ % $ % ---------- --------- --------- --------- <S> <C> <C> <C> <C> <C> Revenues: Resident and healthcare revenue.. $ 15,579 94.0 $ 16,040 88.9 Rental and lease income.......... 37 0.2 1,031 5.7 Unaffiliated management service revenue..................... 366 2.2 504 2.8 Affiliated management service revenue....................... 410 2.5 387 2.2 Unaffiliated development fees.... -- 0.0 24 0.1 Affiliated development fees...... 183 1.1 57 0.3 --------- --------- --------- -------- Total revenue.................... 16,575 100.0 18,043 100.0 Expenses: Operating expenses............... 8,772 52.9 9,304 51.6 General and administrative expenses 3,157 19.1 3,114 17.2 Depreciation and amortization.... 1,646 9.9 1,743 9.7 --------- -------- -------- -------- Total expenses.............. 13,575 81.9 14,161 78.5 --------- -------- -------- -------- Income from operations ............... 3,000 18.1 3,882 21.5 Other income (expense): Interest income.................. 1,429 8.6 1,541 8.5 Interest expense................. (2,828) (17.0) (4,249) (23.5) Equity in the losses of affiliates 11 (0.0) (253) (1.4) Gain on sales of assets.......... 2,283 13.8 -- -- --------- -------- -------- -------- Income before income taxes and minority interest in consolidated partnership........................ 3,895 23.5 921 5.1 Provision for income taxes............ (1,124) (6.8) (262) (1.4) --------- -------- -------- -------- Income before minority interest in consolidated partnership.......... 2,771 16.7 659 3.7 Minority interest in consolidated partnership....................... (960) (5.8) (232) (1.3) --------- -------- -------- -------- Net income............................ $ 1,811 10.9 $ 427 2.4 ========= ======== ======== ======== </TABLE> Three Months Ended March 31, 2002 Compared to the Three Months Ended March 31, 2001 Revenues. Total revenues were $16.6 million in the three months ended March 31, 2002 compared to $18.0 million for the three months ended March 31, 2001, representing a decrease of approximately $1.5 million or 8.1%. This decrease in revenue is primarily the result of a $0.5 million decrease in resident and healthcare revenue and a decrease of $1.0 million in rental and lease income. The decrease in resident and healthcare revenue reflects the loss of revenue from the Cambridge community of $1.5 million, which was sold in August 2001 offset by an overall increase in revenue at the Company's other communities of $1.0 million. The decease in rental and lease income results from the expiration of the HealthSouth master lease on four communities owned by HCP and the sale by HCP of its two remaining communities that were previously leased to third parties. HCP continues to own one community, which is currently held for sale. 13
CAPITAL SENIOR LIVING CORPORATION MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Management services revenue decreased by $0.1 million primarily as a result of the termination of the Company's management contracts with Buckner. The increase in development fees revenue reflects an increase in fees received from the Triad Entities. Expenses. Total expenses were $13.6 million in the first quarter of fiscal 2002 compared to $14.2 million in the first quarter of fiscal 2001, representing a decrease of $0.6 million or 4.1%. This decrease is primarily due to a $0.5 million decrease in operating expenses and a decrease $0.1 million in depreciation and amortization related to the sale of the Cambridge community in August 2001. Other income and expense. Interest expense decreased $1.4 million to $2.8 million in the first quarter of 2002 compared to $4.2 million in the first quarter of 2001. This 33.4% decrease in interest expense is the result of lower interest rates on the Company's variable rate loans and slightly lower debt outstanding in the current year. Interest income represents interest earned on loans the Company has made to the Triad Entities along with interest earned on the Company's investment in the NHP Pension Notes. Interest income decreased as a result of the NHP Pension Notes being redeemed in January 2002. Gain on sale of assets reflects the sale of two communities by HCP for net proceeds of $4.4 million, which resulted in the recognition of a $2.3 million gain on sale. Equity in the earnings of affiliates represents the Company's share of the earnings and losses from the Company's investments in BRE/CSL and the Triad Entities. Provision for income taxes. Provision for income taxes in the first quarter of fiscal 2002 was $1.1 million or 38.3% of taxable income, compared to $0.3 million or 38.0% of taxable income in the comparable quarter for 2001. The effective tax rates for the first quarter of 2002 and 2001 differ from the statutory tax rates because of state income taxes and permanent tax differences. Minority interest. Minority interest increased $0.7 million primarily due to the sale of two HCP communities in fiscal 2002 offset by a decrease in net operating income in HCP in the first quarter of fiscal 2002 compared to the same period in fiscal 2001. The sale of the two HCP communities increased minority interest in fiscal 2002 by approximately $1.0 million. Net income. As a result of the foregoing factors, net income increased $1.4 million to $1.8 million for the three months ended March 31, 2002, as compared to $0.4 million for the three months ended March 31, 2001. Liquidity and Capital Resources In addition to approximately $12.3 million of cash balances on hand as of March 31, 2002, the Company's principal source of liquidity is expected to be cash flows from operations, proceeds from the sale of noncore assets, and cash flows from BRE/CSL. Of the $12.3 million in cash balances, $2.8 million relates to cash held by HCP. The Company expects its available cash and cash flows from operations, proceeds from the sale of assets, and cash flows from BRE/CSL to be sufficient to fund its short-term working capital requirements. The Company's long-term capital requirements, primarily for acquisitions, the payment of operating deficit guarantees, development, and other corporate initiatives, will be dependent on its ability to access additional funds through joint ventures and the debt and/or equity markets. There can be no assurance that the Company will continue to generate cash flows at or above current levels or that the Company will be able to obtain the capital necessary to meet the Company's long-term capital requirements. The Company had net cash provided by operating activities of $1.0 million and $1.3 million in the first three months of fiscal 2002 and 2001, respectively. In the first three months of fiscal 2002, the net cash provided 14
CAPITAL SENIOR LIVING CORPORATION MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) by operating activities was primarily derived from net income of $1.8 million, net non-cash charges of $0.5 million, a decrease in prepaid and other expenses of $0.8 million, an increase in accounts payable and accrued expenses of $0.8 million and a decrease in federal and state income taxes receivable of $0.9 million offset by an increase in accounts receivable of $2.5 million and an increase in interest receivable of $1.3 million. In the first quarter of 2001, the net cash provided by operating activities was primarily derived from net income of $0.4 million, net non-cash charges of $2.5 million, a decrease in prepaid and other expenses of $1.0 million offset by an increase in interest receivable of $1.0 million, a decrease in accounts payable and accrued expenses of $1.2 million and other working capital charges of $0.5 million. The Company had net cash provided by investing activities of $4.5 million in the first quarter of 2002 compared to net cash used in investing activities of $4.9 million in the first quarter of 2001. In the first quarter of 2002, the net cash provided by investing activities resulted from net proceeds of $4.4 million from the sale of two communities, proceeds of $5.6 million from the NHP Pension Note redemption offset by advances to the Triad Entities of $5.1 million and capital expenditures of $0.4 million. In the first three months of fiscal 2001, net cash used in investing activities was primarily derived from advances to affiliates of $4.0 million, capital expenditures of $1.0 million offset by distributions from limited partnerships of $0.1 million. The Company had net cash used in financing activities of $3.1 million and $3.7 million in first quarter of fiscal 2002 and 2001, respectively. Net cash used in financing activities in the first three months of fiscal 2002 resulted primarily from repayment of notes payable of $1.8 million and distribution to minority partners of $1.3 million. Net cash used in financing activities in the first three months of fiscal 2001 resulted from repayment of notes payable of $1.5 million and distribution to minority partners of $2.2 million. The Company derives the benefits and bears the risks attendant to the communities it owns. The cash flows and profitability of owned communities depends on the operating results of such communities and are subject to certain risks of ownership, including the need for capital expenditures, financing and other risks such as those relating to environmental matters. The Company, through its ownership in HCP, leased two properties under triple net leases both of which were sold during the first quarter of 2002. On January 1, 2002, HCP sold its Hearthstone community for net proceeds of $2.7 million after the payment of settlement costs, resulting in a gain of $1.8 million. On February 28, 2002, HCP sold its Trinity Hills community for net proceeds of $1.7 million after the payment of settlement costs, resulting in a gain of $0.5 million. After the sale of these properties, HCP owns one community that is currently classified as held for sale. The cash flows and profitability of the Company's third-party management fees are dependent upon the revenues and profitability of the communities managed. While the management contracts are generally terminable only for cause, in certain cases contracts can be terminated upon the sale of a community, subject to the Company's rights to offer to purchase such community. On February 28, 2002, ILM II notified the Company that it had entered into an agreement to sell the five communities managed by the Company and would, therefore, be terminating the management agreement for these five communities effective April 1, 2002. As of April 1, 2002, the Company no longer manages these communities. On March 1, 2002, LCOR notified the Company of its intent to terminate the LCOR Management Agreements, effective May 31, 2002, as a result of the Company not funding certain alleged operating 15
CAPITAL SENIOR LIVING CORPORATION MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) deficits, which the Company could optionally fund under the LCOR Management Agreements. The Company has notified LCOR that the Company believes this termination was without cause. The Company has entered into development and management agreements with the Triad Entities for the development and management of new senior living communities. The Triad Entities own and finance the construction of new senior living communities. These communities are primarily Waterford communities. The development of senior living communities typically involves a substantial commitment of capital over an approximate 12-month construction period, during which time no revenues are generated, followed by an 18 to 24 month lease up period. The Company has an approximate 1% limited partnership interest in each of the Triad Entities and is accounting for these investments under the equity method of accounting based on the provisions of the Triad Entities partnership agreements. The Company has loan commitments to the Triad Entities for construction and pre-marketing expenses, in addition to requirements to fund the Triad Entities' operating deficits through an operating deficit guarantee provided for in its management agreement with the Triad Entities. The Company evaluates the carrying value of these receivables by comparing the cash flows expected from the operations of the Triad Entities to the carrying value of the receivables. These cash flow models consider lease-up rates, expected operating costs, debt service requirements and various other factors. The carrying value of the notes receivable from the Triad Entities could be adversely affected by a number of factors including the Triad communities experiencing slower than expected lease-up, lower than expected lease rates, higher than expected operating costs, increases in interest rates, issues involving debt service requirements, general adverse market conditions, other economic factors and changes in accounting guidelines. Management believes that if the assumptions used, which are consistent with our operating experience, in these cash flow models are achieved, the carrying value of the notes receivable are fully recoverable. The following table sets forth, as of March 31, 2002, the capital invested in each of the Triad Entities, information related to loans made by the Company to each Triad Entity and information on deferred income related to each Triad Entity (dollars in thousands): <TABLE> <CAPTION> Notes Receivable Deferred Income ------------------------------------------------------------ -------------------- Operating Development/ Capital Committed Interest Note Deficit Management Entity Investment Amount Rate Maturity Balance Funding Interest Fees ------ ---------- --------- -------- -------- ------- --------- -------- ----------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Triad I $ -- $ -- 8.0% -- $ -- $13,217 $111 $ 356 Triad II -- 15,000 8.0% Sept. 25, 15,000 2,937 166 173 2003 Triad III -- 15,000 8.0% Feb. 8, 15,000 5,176 160 336 2004 Triad IV -- 10,000 8.0% Dec 30, 9,345 -- 145 118 2003 Triad V -- 10,000 8.0% June 30, 3,432 -- 28 28 2004 </TABLE> The Company typically receives a development fee of 4% of project costs, as well as reimbursement of expenses and overhead not to exceed 4% of project costs. These fees are recorded over the term of the development project on a basis approximating the percentage of completion method. In addition, when the properties become operational, the Company typically receives management fees in an amount equal to the 16
CAPITAL SENIOR LIVING CORPORATION MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) greater of 5% of gross revenues or $5,000 per month per community, plus overhead expenses. The Company has the option, but not the obligation, to purchase the partnership interests of the other parties in Triad Entities for an amount equal to the amount paid for the partnership interest by the other partners, plus a noncompounded return of 12% per annum except for Triad I. In addition, each Triad Entity except Triad I provides the Company with an option, but not the obligation, to purchase the community developed by the applicable partnership upon their completion for an amount equal to the fair market value (based on a third-party appraisal but not less than hard and soft costs and lease-up costs) of the community. The Company has the option to purchase the Triad I communities for an amount specified in the partnership agreement. The Company has made no determination as to whether it will exercise any of these purchase options. Deferred interest income is being amortized into income over the life of the loan commitment that the Company has with each of the Triad Entities. Deferred development and management fee income are being amortized into income over the expected remaining life of the Triad partnerships. Each of the Triad Entities finances the development of new communities through a combination of equity funding, traditional construction loans and permanent financing with institutional lenders secured by first liens on the communities and unsecured loans from the Company. The Company loans may be prepaid without penalty. The financings from institutional lenders are secured by first liens on the communities, as well as assignment to the lenders of the construction contracts and the development and management agreements with the Company. Each development and management agreement assigned to an institutional lender is also guaranteed by the Company and those guarantees are also assigned to the lenders. In most cases, the management agreements contain an obligation of the Company to fund operating deficits to the Triad Entities if the other financing sources of the Triad Entities have been fully utilized. These operating deficit funding obligations are guaranteed by the Company and include making loans to fund debt service obligations to the Triad Entities' lenders. Amounts funded to date under these operating deficit agreements are disclosed in the table above. The Company expects to be required to fund additional amounts under these operating deficit agreements in the future. Set forth below is information on the construction loan facilities entered into by each of the Triad Entities as of March 31, 2002 (in thousands): <TABLE> <CAPTION> Loan Facilities to Triads ------------------------------------------------------ Amount Entity Commitment Outstanding Type Lender ------------------------- ---------- ----------- ---------- --------------- <S> <C> <C> <C> <C> <C> Triad I $50,000 $49,287 take-out GMAC Triad II $26,900 $26,774 mini-perm Key Corporate Capital, Inc. Triad III $56,300 $56,270 mini-perm Guaranty Bank Triad IV $18,600 $15,651 construction; Compass Bank mini-perm Triad V $ 8,903 $ 8,660 mini-perm Bank of America </TABLE> During 2001, Triad V was notified by the lender of its failure to comply with certain terms of its loan agreement with the lender. The lender, however, expressed its intention to work with Triad V and the lender and Triad V subsequently signed a new loan agreement in April 2002. 17
CAPITAL SENIOR LIVING CORPORATION MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Summary financial information regarding the results of operations of the Triad Entities for the three months ending March 31, 2002 and 2001 is as follows (in thousands): 2002 2001 -------- -------- Net revenue...................... $ 5,677 $ 3,223 Net loss......................... (5,240) (6,496) Forward-Looking Statements Certain information contained in this report constitutes "Forward-Looking Statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which can be identified by the use of forward-looking terminology such as "may," "will," "expect," "anticipate," "estimate" or "continue" or the negative thereof or other variations thereon or comparable terminology. The Company cautions readers that forward-looking statements, including, without limitation, those relating to the Company's future business prospects, revenues, working capital, liquidity, capital needs, interest costs and income, are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements, due to several important factors herein identified, among others, and their risks and factors identified from time to time in the Company's reports filed with the Securities and Exchange Commission. Item 3. QUANTITATIVE AND QUALIITATIVE DISCLOSURES ABOUT MARKET RISK. The Company's primary market risk is exposure to changes in interest rates on debt instruments. As of March 31, 2002 the Company had $179.4 million in outstanding debt comprised of various fixed and variable rate debt instruments of $52.6 million and $126.8 million, respectively. Changes in interest rates would affect the fair market value of the Company's fixed rate debt instruments but would not have an impact on the Company's earnings or cash flows. Fluctuations in interest rates on the Company's variable rate debt instruments, which are tied to either the LIBOR or the prime rate, would affect the Company's earnings and cash flows but would not affect the fair market value of the variable rate debt. For each percentage point change in interest rates the Company's annual interest expense would increase by approximately $1.3 million based on its current outstanding variable debt. In addition, an increase in interest rates could result in operating deficit obligations, relating to the Triad Entities, that could require funding by the Company. 18
CAPITAL SENIOR LIVING CORPORATION PART II. OTHER INFORMATION PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS On or about October 23, 1998, Robert Lewis filed a putative class action complaint on behalf of certain holders of assignee interests (the "Assignee Interests") in NHP in the Delaware Court of Chancery, Civil Action No. 16725 (the "Delaware Action") against NHP, the general partner of NHP ("General Partner"), the Company and Capital Senior Living Properties 2-NHPCT, Inc. (collectively, the "Defendants"). Mr. Lewis purchased ninety Assignee Interests in NHP in February 1993 for $180. The complaint alleges, among other things, that the Defendants breached, or aided and abetted a breach of, the express and implied terms of the NHP Partnership Agreement in connection with the sale of four properties by NHP to Capital Senior Living Properties 2-NHPCT, Inc in September 1998 (the "1998 Transaction"). The complaint seeks, among other relief, rescission of the 1998 Transaction and unspecified damages. On July 9, 1999, the Defendants filed a motion to dismiss the case. Subsequently, the plaintiff amended his complaint adding allegations challenging the terms of the sale in December 2001 of the Amberleigh retirement facility to BRE/CSL. On January 31, 2002, the parties to the Delaware Action entered into a Memorandum of Understanding providing for the settlement of the Delaware Action subject to certain terms and conditions, including the filing of an amended complaint and receipt of the approval of the Court of Chancery. The proposed settlement contemplates the creation of a settlement fund in the amount of approximately $0.8 million, of which NHP will contribute approximately $0.3 million, the amount of the deductible of NHP's directors and officers' liability insurance policy at the time the Delaware Action was filed (the "D&O Policy"). Virtually all of the balance of the settlement fund will be contributed by the various insurance brokers and agents, and their insurers, in connection with the resolution of certain claims for coverage under the D&O Policy. The settlement contribution of the Company and its affiliates will be $43,000. If approved by the Court of Chancery, the settlement fund, less any award of attorney's fees for plaintiff's counsel approved by the court, will be distributed to a class of Assignee Holders of NHP. On December 6, 2001, Leonard Kalmenson filed a motion to intervene in the Delaware Action on the behalf of a putative class of holders of Pension Notes of NHP in the event the Court of Chancery determines that the claims asserted in the Delaware Action are derivative in nature. The Complaint in Intervention filed by Mr. Kalmenson names as defendants the Defendants in the Delaware Action as well as Retirement Associates, Inc., the sole stockholder of the General Partner of NHP, and various current and former directors of the General Partner. The Complaint in Intervention essentially alleges, among other things, a variety of claims challenging the 1998 Transaction and a claim for breach of contract relating to the failure of NHP to pay the full amount of principal and interest owed on the Pension Notes on their maturity date. NHP and the Company believe that the allegations asserted by Mr. Kalmenson are without merit and that his motion to intervene is moot in view of the proposed settlement of the Delaware Action. The Company is unable at this time to estimate any liability related to this claim, if any. On January 16, 2002, the Company filed a claim with the American Arbitration Association seeking reimbursement of certain health care expenses, as well as severance compensation from Buckner pursuant to a management agreement between the parties. Buckner has filed an answer and a counterclaim in this arbitration and proceedings are continuing. The Company has other pending claims incurred in the normal course of business, that, in the opinion of management, based on the advice of legal counsel, will not have a material effect on the financial statements of the Company. 19
CAPITAL SENIOR LIVING CORPORATION PART II. OTHER INFORMATION Item 2. CHANGES IN SECURITIES (and use of proceeds) Not Applicable Item 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable Item 5. OTHER INFORMATION Not Applicable Item 6. EXHIBITS AND REPORTS ON FORM 8-K (A) Exhibits: Not Applicable (B) Reports on Form 8-K Not Applicable 20
CAPITAL SENIOR LIVING CORPORATION March 31, 2002 Signature Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Capital Senior Living Corporation (Registrant) By: /s/ Ralph A. Beattie --------------------------- Ralph A. Beattie Executive Vice President and Chief Financial Officer (Principal Financial Officer and Duly Authorized Officer) Date: May 13, 2002 21