form10-q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 
Washington, D.C. 20549
 
Form 10-Q

 
T
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

or

 
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____________ to _____________

Commission File Number: 001-32641

BROOKDALE SENIOR LIVING INC.
(Exact name of registrant as specified in its charter)

Delaware
20-3068069
(State or other jurisdiction
of incorporation or organization)
(I.R.S. Employer Identification No.)

  
330 North Wabash Avenue, Suite 1400, Chicago, Illinois
60611
 
(Address of principal executive offices)
(Zip Code)
 

(312) 977-3700
(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  T  No  £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  £
Accelerated filer  T
Non-accelerated filer  £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  £  No  T

As of November 5, 2007, 101,615,992 shares of the registrant’s common stock, $0.01 par value, were outstanding (excluding unvested restricted shares).
 


 



 
PAGE
PART I.   FINANCIAL INFORMATION
 
     
Item 1.   Financial Statements
 
     
   
 
     
   
 
     
   
 
     
 
     
Item 2.
 
 
     
Item 3.
     
Item 4.
     
     
PART II.
OTHER INFORMATION
 
     
Item 1.
     
Item 1A.
     
Item 6.
     
Signatures
 



PART I.   FINANCIAL INFORMATION

Item 1.   Financial Statements
 
BROOKDALE SENIOR LIVING INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except stock amounts)

   
September 30,
2007
   
December 31,
2006
 
Assets
 
(Unaudited)
       
Current assets
           
Cash and cash equivalents
  $
63,059
    $
68,034
 
Cash and investments — restricted
   
93,337
     
61,116
 
Accounts receivable, net
   
66,906
     
58,987
 
Deferred tax asset
   
33,022
     
40,019
 
Prepaid expenses and other current assets, net
   
38,587
     
42,076
 
Total current assets
   
294,911
     
270,232
 
Property, plant, equipment and leasehold intangibles, net
   
3,749,843
     
3,658,788
 
Cash and investments — restricted
   
40,005
     
22,083
 
Goodwill
   
335,729
     
324,750
 
Other intangible assets, net
   
265,972
     
292,448
 
Other assets, net
   
159,293
     
174,154
 
Total assets
  $
4,845,753
    $
4,742,455
 
                 
Liabilities and Stockholders’ Equity
               
Current liabilities
               
Current portion of long-term debt
  $
25,933
    $
20,869
 
Trade accounts payable
   
14,006
     
15,860
 
Accrued expenses
   
166,017
     
155,577
 
Refundable entrance fees
   
200,624
     
198,613
 
Tenant security deposits
   
30,897
     
24,342
 
Deferred revenue and entrance fee revenue
   
43,521
     
47,056
 
Dividends payable
   
51,838
     
46,588
 
Total current liabilities
   
532,836
     
508,905
 
Long-term debt, less current portion
   
1,978,484
     
1,690,570
 
Line of credit
   
231,000
     
163,500
 
Deferred entrance fee revenue
   
73,733
     
70,479
 
Deferred tax liability
   
316,928
     
399,134
 
Deferred liabilities
   
114,189
     
98,673
 
Other liabilities
   
68,594
     
42,581
 
Total liabilities
   
3,315,764
     
2,973,842
 
Minority interests
   
3,624
     
4,601
 
Commitments and contingencies
               
                 
Stockholders’ Equity
               
Preferred stock, $.01 par value, 50,000,000 shares authorized at September 30, 2007 and December 31, 2006; no shares issued and outstanding
   
     
 
Common stock, $.01 par value, 200,000,000 shares authorized at September 30, 2007 and December 31, 2006; 105,004,139 shares and 104,542,648 shares issued and outstanding (including 3,401,808 and 3,282,000 unvested restricted shares), respectively
   
1,050
     
1,045
 
Additional paid-in-capital
   
1,810,460
     
1,934,571
 
Accumulated deficit
    (283,455 )     (170,713 )
Accumulated other comprehensive loss
    (1,690 )     (891 )
Total stockholders’ equity
   
1,526,365
     
1,764,012
 
Total liabilities and stockholders’ equity
  $
4,845,753
    $
4,742,455
 
 
See accompanying notes to condensed consolidated financial statements.
 
3


BROOKDALE SENIOR LIVING INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share data)

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2007
   
2006
   
2007
   
2006
 
Revenue
                       
Resident fees
  $
463,101
    $
385,617
    $
1,365,061
    $
874,495
 
Management fees
   
1,493
     
1,426
     
4,777
     
3,158
 
Total revenue
   
464,594
     
387,043
     
1,369,838
     
877,653
 
                                 
Expense
                               
Facility operating expense (excluding depreciation and amortization of $60,518, $56,866, $187,959 and $109,888, respectively)
   
294,997
     
245,192
     
861,672
     
543,418
 
General and administrative expense (including non-cash stock-based compensation expense of $7,138, $5,852, $26,150 and $12,625, respectively)
   
34,733
     
29,248
     
111,144
     
73,458
 
Facility lease expense
   
67,708
     
63,623
     
203,365
     
155,980
 
Depreciation and amortization
   
79,235
     
60,883
     
234,690
     
114,129
 
Total operating expense
   
476,673
     
398,946
     
1,410,871
     
886,985
 
Loss from operations
    (12,079 )     (11,903 )     (41,033 )     (9,332 )
                                 
Interest income
   
1,695
     
2,032
     
5,077
     
3,709
 
Interest expense
                               
Debt
    (38,472 )     (29,287 )     (107,002 )     (68,521 )
Amortization of deferred financing costs
    (1,151 )     (1,141 )     (4,878 )     (3,179 )
Change in fair value of derivatives and amortization
    (43,731 )     (1,840 )     (30,893 )     (1,422 )
Loss on extinguishment of debt
   
      (1,414 )     (803 )     (2,748 )
Equity in loss of unconsolidated ventures
    (309 )     (1,649 )     (2,362 )     (2,286 )
Other non-operating income
   
     
     
238
     
 
Loss before income taxes
    (94,047 )     (45,202 )     (181,656 )     (83,779 )
Benefit for income taxes
   
35,125
     
14,146
     
68,408
     
13,487
 
Loss before minority interest
    (58,922 )     (31,056 )     (113,248 )     (70,292 )
Minority interest
    (5 )     (89 )    
506
      (438 )
Net loss
  $ (58,927 )   $ (31,145 )   $ (112,742 )   $ (70,730 )
                                 
Basic and diluted loss per share
  $ (0.58 )   $ (0.34 )   $ (1.11 )   $ (0.96 )
                                 
Weighted average shares used in computing basic and diluted loss per share
   
101,564
     
91,640
     
101,463
     
73,999
 
                                 
Dividends declared per share
  $
0.50
    $
0.40
    $
1.45
    $
1.10
 

See accompanying notes to condensed consolidated financial statements.


 
4


BROOKDALE SENIOR LIVING INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)

   
Nine Months Ended
September 30,
 
   
2007
   
2006
 
Cash Flows from Operating Activities
           
Net loss
  $ (112,742 )   $ (70,730 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Non-cash portion of loss on extinguishment of debt
   
     
2,748
 
Depreciation and amortization
   
239,568
     
117,308
 
Minority interest
    (506 )    
438
 
(Gain) loss on sale of assets
    (457 )    
123
 
Equity in loss of unconsolidated ventures
   
2,362
     
2,286
 
Change in future service obligations
   
1,320
     
 
Distributions from unconsolidated ventures from cumulative share of net earnings
   
1,429
     
 
Amortization of deferred gain
    (3,255 )     (3,259 )
Amortization of entrance fees
    (14,222 )     (3,398 )
Proceeds from deferred entrance fee revenue
   
14,315
     
4,329
 
Deferred income tax benefit
    (68,715 )     (14,457 )
Change in deferred lease liability
   
18,815
     
16,622
 
Change in fair value of derivatives and amortization
   
30,893
     
1,422
 
Stock-based compensation
   
26,150
     
12,625
 
Changes in operating assets and liabilities:
               
Accounts receivable, net
    (5,607 )     (24,131 )
Prepaid expenses and other assets, net
    (1,133 )    
1,419
 
Accounts payable and accrued expenses
   
8,368
     
18,665
 
Tenant refundable fees and security deposits
   
5,404
     
2,709
 
Other
    (3,578 )     (11,042 )
Net cash provided by operating activities
   
138,409
     
53,677
 
                 
Cash Flows from Investing Activities
               
Decrease in lease security deposits and lease acquisition deposits, net
   
1,806
     
1,433
 
(Increase) decrease in cash and investments — restricted
    (53,393 )    
18,278
 
Additions to property, plant, equipment and leasehold intangibles, net of related payables
    (113,557 )     (39,580 )
Acquisition of assets, net of related payables and cash received
    (167,621 )     (1,799,115 )
Issuance of notes receivable, net
    (13,714 )     (2,331 )
Investment in unconsolidated ventures
    (1,617 )     (637 )
Distributions received from unconsolidated ventures
   
1,819
     
1,355
 
Net cash used in investing activities
    (346,277 )     (1,820,597 )
                 
Cash Flows from Financing Activities
               
Proceeds from debt
   
395,276
     
739,221
 
Repayment of debt and capital lease obligation
    (54,246 )     (221,616 )
Buyout of capital lease obligation
    (51,114 )    
 
Proceeds from line of credit
   
451,500
     
215,000
 
Repayment of line of credit
    (384,000 )     (215,000 )
Payment of dividends
    (144,990 )     (62,881 )
Payment of financing costs, net of related payables
    (10,248 )     (19,014 )
Other
    (815 )    
 
Refundable entrance fees:
               
Proceeds from refundable entrance fees
   
17,018
     
6,900
 
Refunds of entrance fees
    (15,488 )     (4,540 )
Proceeds from issuance of common stock, net
   
     
1,353,863
 
Costs incurred related to follow-on equity offering
   
      (2,435 )
Net cash provided by financing activities
   
202,893
     
1,789,498
 
Net (decrease) increase in cash and cash equivalents
    (4,975 )    
22,578
 
Cash and cash equivalents at beginning of period
   
68,034
     
77,682
 
Cash and cash equivalents at end of period
  $
63,059
    $
100,260
 

See accompanying notes to condensed consolidated financial statements.

 
5



BROOKDALE SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.  Description of Business

Brookdale Senior Living Inc. (“Brookdale” or the “Company”) is a leading owner and operator of senior living facilities throughout the United States.  The Company provides an exceptional living experience through properties that are designed, purpose-built and operated to provide the highest quality service, care and living accommodations for residents.  Currently, the Company owns and operates independent living, assisted living and dementia-care facilities and continuing care retirement centers.

2.  Summary of Significant Accounting Policies

Basis of Presentation
 
The accompanying unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for quarterly reports on Form 10-Q. In the opinion of management, these financial statements include all adjustments necessary to present fairly the financial position, results of operations and cash flows of the Company as of September 30, 2007, and for all periods presented. The condensed consolidated financial statements are prepared on the accrual basis of accounting. All adjustments made have been of a normal and recurring nature. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The Company believes that the disclosures included are adequate and provide a fair presentation of interim period results. Interim financial statements are not necessarily indicative of the financial position or operating results for an entire year. It is suggested that these interim financial statements be read in conjunction with the audited financial statements and the notes thereto, together with management’s discussion and analysis of financial condition and results of operations, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006, as filed with the Securities and Exchange Commission.
 
In 2006, the Company adopted EITF 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights, and as a result, consolidated the operations of three limited partnerships controlled by the Company.  In 2006, the Company purchased a facility from one of the limited partnerships and the partnership was liquidated.  In May 2007, the Company purchased another facility from one of the limited partnerships and the partnership was liquidated.  The ownership interest in the remaining limited partnership not owned by the Company has been reflected in the consolidated balance sheets as minority interests.

Purchase Accounting

In determining the allocation of the purchase price of companies and facilities to net tangible and identified intangible assets acquired and liabilities assumed, the Company makes estimates of the fair value of the tangible and intangible assets acquired and liabilities assumed using information obtained as a result of pre-acquisition due diligence, marketing, leasing activities and independent appraisals. The Company allocates the purchase price of facilities to net tangible and identified intangible assets acquired and liabilities assumed based on their fair values in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations.  The determination of fair value involves the use of significant judgment and estimation. The Company determines fair values as follows:

Current assets and current liabilities assumed are valued at carryover basis which approximates fair value.

Property, plant and equipment are valued utilizing discounted cash flow projections that assume certain future revenue and costs, and considers capitalization and discount rates using current market conditions.
 
6


The Company allocates a portion of the purchase price to the value of resident leases acquired based on the difference between the facilities valued with existing in-place leases adjusted to market rental rates and the facilities valued with current leases in place based on current contractual terms. Factors management considers in its analysis include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar resident leases. In estimating carrying costs, management includes estimates of lost rentals during the lease-up period and estimated costs to execute similar leases. The value of in-place leases is amortized to expense over the remaining initial term of the respective leases.

Leasehold operating intangibles are valued utilizing discounted cash flow projections that assume certain future revenues and costs over the remaining lease term. The value assigned to leasehold operating intangibles is amortized on a straight-line basis over the lease term.

Facility purchase options are valued at the estimated value of the underlying facility less the cost of the option payment discounted at current market rates.  Management contracts and other acquired contracts are valued at a multiple of management fees and operating income and amortized over the estimated term of the agreement.

Long-term debt assumed is recorded at fair market value based on the current market rates and collateral securing the indebtedness.

Capital lease obligations are valued based on the present value of the minimum lease payments applying a discount rate equal to the Company’s estimated incremental borrowing rate at the date of acquisition.

Deferred entrance fee revenue is valued at the estimated cost of providing services to residents over the terms of the current contracts to provide such services. Refundable entrance fees are valued at cost pursuant to the resident lease plus the resident's share of any appreciation of the facility unit at the date of acquisition, if applicable.

A deferred tax liability is recognized at statutory rates for the difference between the book and tax bases of the acquired assets and liabilities.

The excess of the fair value of liabilities assumed and cash paid over the fair value of assets acquired is allocated to goodwill.

Self-Insurance Liability Accruals

The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Although the Company maintains general liability and professional liability insurance policies for its owned, leased and managed facilities under a master insurance program, the Company’s current policies provide for deductibles of $3.0 million for each claim. As a result, the Company is, in effect, self-insured for most claims. In addition, the Company maintains a self-insured workers compensation program and a self-insured employee medical program for amounts below excess loss coverage amounts, as defined. The Company reviews the adequacy of its accruals related to these liabilities on an ongoing basis, using historical claims, actuarial valuations, third party administrator estimates, consultants, advice from legal counsel and industry data, and adjusts accruals periodically. Estimated costs related to these self-insurance programs are accrued based on known claims and projected claims incurred but not yet reported. Subsequent changes in actual experience are monitored and estimates are updated as information is available.

During the three months ended June 30, 2007, the Company recorded a $4.2 million receivable related to a collateral recovery from an insurance carrier for amounts owed to Alterra Healthcare Corporation, a wholly-owned subsidiary, pursuant to a pre-bankruptcy insurance policy.  Such amount had not previously been recognized by the Company due to the existence of preconfirmation contingencies which were resolved prior to June 30, 2007.  The receivable was recorded as a $3.8 million reduction of general and administrative expense and $0.4 million of interest income in the condensed consolidated statements of operations.  The receivable was collected in full in July 2007.
 
7


New Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. Specifically, the pronouncement prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on the related derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. The interpretation is effective for fiscal years beginning after December 15, 2006.  The Company adopted FIN 48 in the current year.  See note 12 for a discussion of the impact of the adoption of FIN 48.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements.  In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities ("SFAS 159"). SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Both SFAS 157 and SFAS 159 are effective for fiscal years beginning after November 15, 2007. The Company does not believe that the adoption of SFAS 157 and SFAS 159 will materially impact its financial position or results of operations.

Dividends

On September 17, 2007, the Company’s board of directors declared a quarterly cash dividend of $0.50 per share of common stock, or an aggregate of $51.8 million, for the quarter ended September 30, 2007.  The $0.50 per share dividend was paid on October 12, 2007 to holders of record of the Company’s common stock on September 28, 2007.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current financial statement presentation, with no effect on the Company’s consolidated financial position or results of operations.

3.  Stock-Based Compensation

Compensation expense in connection with grants of restricted stock of $7.1 million and $5.9 million was recorded for the three months ended September 30, 2007 and 2006, respectively, and $26.2 million and $12.6 million of such expense was recorded for the nine months ended September 30, 2007 and 2006, respectively.  All amounts were net of forfeitures estimated at 5% of the shares granted.

On September 15, 2006, the Company entered into Separation and General Release Agreements with two officers that accelerated the vesting provision of a portion of their restricted stock grants upon satisfying certain conditions. As a result of the modification, the previous compensation expense related to these grants was reversed during the year ended December 31, 2006.  The fair value of the stock at the modification date was expensed over the modified service period. The impact of the adjustment was $4.1 million of additional expense for the nine months ended September 30, 2007.

For all awards with graded vesting other than awards with performance-based vesting conditions, the Company records compensation expense for the entire award on a straight-line basis over the requisite service period.  For graded-vesting awards with performance-based vesting conditions, total compensation expense is recognized over the requisite service period for each separately vesting tranche of the award as if the award is, in substance, multiple awards once the performance target is deemed probable of achievement.  Performance goals are evaluated quarterly.  If such goals are not ultimately met or it is not probable the goals will be achieved, no compensation expense is recognized and any previously recognized compensation expense is reversed.  During the current period, the Company reversed approximately $1.4 million of previously recognized compensation expense related to performance-based awards granted in 2007.
 
8


Current year grants of restricted shares under the Company’s Omnibus Stock Incentive Plan were as follows ($ in 000’s except for grants and per share amounts):

   
Grants
   
Value Per Share
   
Total Value
 
Three months ended March 31, 2007
   
        53,000
    $
45.02
    $
2,399
 
Three months ended June 30, 2007
   
      544,000
     
45.02 - 46.06
     
25,023
 
Three months ended September 30, 2007
   
        32,000
     
38.96
     
1,250
 

4.  Goodwill and Other Intangible Assets, Net

Following is a summary of changes in the carrying amount of goodwill for the nine months ended September 30, 2007 presented on an operating segment basis ($ in 000’s):
 
   
Independent
Living
   
Assisted
Living
   
Retirement
Centers/CCRCs
   
Total
 
Balance at December 31, 2006
  $
8,118
    $
101,921
    $
214,711
    $
324,750
 
Additions
   
     
     
9,000
     
9,000
 
Adjustments
   
     
862
     
1,117
     
1,979
 
Balance at September 30, 2007
  $
8,118
    $
102,783
    $
224,828
    $
335,729
 

The additions to goodwill primarily related to adjusting the allocation of the purchase price for an acquisition which occurred in the third quarter of fiscal 2006.  The remaining additions resulted from an acquisition completed in the first quarter of 2007.  The adjustments primarily related to the adoption of FIN 48 in the first quarter of 2007 and its impact on acquired entities.

Intangible assets with definite useful lives are amortized over their estimated lives and are tested for impairment whenever indicators of impairment arise. The following is a summary of other intangible assets at September 30, 2007 and December 31, 2006 ($ in 000’s):

   
September 30, 2007
   
December 31, 2006
 
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Net
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Net
 
Facility purchase options
  $
147,682
    $ (1,844 )   $
145,838
    $
147,682
    $
    $
147,682
 
Other intangible assets, net
   
158,041
      (37,907 )    
120,134
     
158,849
      (14,083 )    
144,766
 
Total
  $
305,723
    $ (39,751 )   $
265,972
    $
306,531
    $ (14,083 )   $
292,448
 
 
Amortization expense related to definite-lived intangible assets for the three and nine months ended September 30, 2007 was $8.9 million and $25.7 million, respectively.

5.  Property, Plant, Equipment and Leasehold Intangibles, Net
 
Property, plant, equipment and leasehold intangibles, net consist of the following ($ in 000’s):

   
September 30,
2007
   
December 31,
2006
 
Land
  $
264,679
    $
236,945
 
Buildings and improvements
   
2,635,889
     
2,301,841
 
Furniture and equipment
   
189,050
     
137,583
 
Resident and operating lease intangibles
   
583,532
     
577,547
 
Assets under capital and financing leases
   
511,924
     
654,337
 
     
4,185,074
     
3,908,253
 
Accumulated depreciation and amortization
    (435,231 )     (249,465 )
Property, plant, equipment and leasehold intangibles, net
  $
3,749,843
    $
3,658,788
 

 
9

 
6.  Acquisitions
 
Financial results are impacted by the timing, size and number of acquisitions the Company completes in a period. During the nine months ended September 30, 2007, the number of facilities owned or leased by the Company increased by three.  The number of facilities owned or leased was unchanged by the Company’s acquisition of joint venture partner interests, its acquisition of remaining portions of owned facilities and its acquisition of service businesses.   The results of facilities and companies acquired are included in the condensed consolidated financial statements from the effective date of the acquisition.

Seller
Closing Date
 
Purchase Price,
Excluding
Fees,
Expenses and
Assumption of Debt
($ in millions)
 
Segment
 
McClaren Medical Management, Inc. and FP Flint, LLC
January 24, 2007
  $
3.9
 
Assisted Living
 
American Senior Living of Jacksonville-SNF, LLC
February 1, 2007
   
6.8
 
Retirement Centers/CCRCs
 
1st Choice Home Health, Inc.
February 15, 2007
   
3.0
 
 
Retirement Centers/CCRCs, Assisted Living and Independent Living
 
Health Care Property Investors, Inc.
February 28, 2007
   
9.5
 
Assisted Living
 
Chancellor Health Care of California L.L.C.
April 1, 2007
   
10.8
 
Independent Living
 
Seminole Nursing Pavilion and Seminole Properties
April 4, 2007
   
51.1
 
Retirement Centers/CCRCs
 
Cleveland Retirement Properties, LLC and Countryside ALF, LLC
April 18, 2007
   
102.0
 
Retirement Centers/CCRCs
 
Paradise Retirement Center, L.P.
May 31, 2007
   
15.3
 
Independent Living
 
Darby Square Property, Ltd and Darby Square Services, LLC
July 1, 2007
   
7.5
 
Retirement Centers/CCRCs
 
Health Care REIT, Inc.
August 31, 2007
   
9.8
 
Assisted Living
 
Total
    $
219.7
   

On January 24, 2007, the Company acquired the interests held by its joint venture partners in a facility located in Flint, Michigan for approximately $3.9 million.  This facility is referred to as the “Flint Facility”.  In connection with the acquisition, the Company obtained $12.6 million of first mortgage financing bearing interest at LIBOR plus 1.15% payable interest only through February 1, 2012 and also entered into interest rate swaps to convert the loan from floating to fixed (note 7).

On February 1, 2007, the Company acquired the skilled nursing portion of a CCRC facility located in Jacksonville, Florida for approximately $6.8 million.  The assisted living and independent living portions of the facility were acquired in 2006 by the Company.  This facility is referred to as the “Atrium SNF”.  In connection with the
 
10

 
acquisition, the Company assumed a first mortgage note secured by the property in the amount of $3.7 million.  The note bears interest at 6.10% with principal and interest payable until maturity on September 1, 2039.
 
On February 15, 2007, the Company acquired certain home health care assets for approximately $3.0 million.  The purchase price was assigned entirely to goodwill. These operations are referred to as the “Home Health Acquisition”.

On February 28, 2007, the Company acquired a previously leased facility in Richmond Heights, Ohio for approximately $9.5 million.  This facility is referred to as the “Richmond Heights Facility”.

Effective as of April 1, 2007, the Company acquired the leasehold interests of three assisted living facilities located in California for approximately $10.8 million.  These facilities are referred to as the “Chancellor Portfolio”.

On April 4, 2007, the Company purchased the real property underlying an entrance fee continuing care retirement community located in Tampa, Florida for an aggregate purchase price of approximately $51.1 million.  The community consists of independent living retirement apartments, a skilled nursing facility and an assisted living facility.  We previously managed this community pursuant to a cash-flow management agreement and accounted for this community as a capital lease.  These facilities are referred to as the “Freedom Square Portfolio”.

On April 18, 2007, the Company acquired two facilities located in Ohio and North Carolina for approximately $102.0 million.  The facilities were previously operated by the Company under long term operating lease agreements.  These facilities are referred to as the “Saunders Portfolio”.

On May 31, 2007, the Company acquired a facility in Phoenix, Arizona in which we held partnership interests for approximately $15.3 million.  This facility is referred to as “Grand Court Phoenix”.

On July 1, 2007, the Company acquired the skilled nursing portion of a CCRC facility located in Lexington, Kentucky for approximately $7.5 million.  The assisted living and independent living portions of the facility are operated pursuant to an operating lease previously entered into by the Company.  This facility is referred to as the “Darby Facility”.

On August 31, 2007, the Company acquired three facilities located in South Carolina and Oklahoma for approximately $9.8 million.  The facilities were previously operated by the Company under long term operating lease agreements.  These facilities are referred to as the “HCN Portfolio”.

The above acquisitions were accounted for using the purchase method of accounting and the purchase prices were allocated to the associated assets and liabilities based on their estimated fair values.  The Company has made preliminary purchase price allocations for these transactions resulting in approximately $3.4 million of goodwill being recorded in the Retirement Centers/CCRCs segment and anticipates finalizing the purchase price allocations within one year of each respective acquisition date.

7.  Debt

Long-term Debt, Capital Leases and Financing Obligations

Long-term debt, capital leases and financing obligations consist of the following ($ in 000’s):

   
September 30,
2007
   
December 31,
2006
 
 
Mortgage notes payable due 2008 through 2039; weighted average interest rate of 6.85% in 2007 (weighted average interest rate of 6.98% in 2006)
  $
709,810
    $
490,997
 
 
Mortgages payable due 2009 through 2038; weighted average interest rate of 7.12% in 2007 (weighted average interest rate of 6.57% in 2006)
   
74,555
     
74,571
 

 
11


 
$150,000 Series A notes payable, secured by five facilities, bearing interest at LIBOR plus 0.88% effective August 2006 (3.05% prior to that date), payable in monthly installments of interest only until August 2011 and payable in monthly installments of principal and interest through maturity in August 2013, and secured by a $3.0 million letter of credit
   
150,000
     
150,000
 
 
Mortgages payable due 2012, weighted average interest rate of 5.64% and 5.37% in 2007 and 2006, respectively, payable interest only through July 2010 and payable in monthly installments of principal and interest through maturity in July 2012, secured by the FIT REN portfolio(1)
   
212,407
     
171,000
 
 
Mortgages payable due 2010, bearing interest at LIBOR plus 2.25% effective May 1, 2006 (3.0% prior to that date), payable in monthly installments of interest only until April 2009 and payable in monthly installments of principal and interest through maturity in April 2010, secured by the Fortress CCRC Portfolio(1)
   
105,756
     
105,756
 
 
Variable rate tax-exempt bonds credit-enhanced by Fannie Mae (weighted average interest rates of 5.04% and 4.91% in 2007 and 2006, respectively), due 2032, payable interest only until maturity, secured by the Chambrel portfolio(1)
   
100,841
     
100,841
 
 
Capital and financing lease obligations payable through 2020; weighted average interest rate of 9.18% in 2007 (weighted average interest rate of 8.91% in 2006)
   
302,318
     
371,346
 
 
Mortgage note, bearing interest at a variable rate of LIBOR plus 0.70%, payable interest only through maturity in August 2012; the note is secured by 16 of the Company’s facilities and an $11.5 million guaranty by the Company
   
333,500
     
225,000
 
 
Mezzanine loan payable to Brookdale Senior Housing, LLC joint venture with respect to The Heritage at Gaines Ranch facility, payable to the extent of all available cash flow (as defined)
   
12,739
     
12,739
 
 
Mortgages payable due 2010; interest rate of 7.20%, secured by the limited partnerships consolidated pursuant to EITF 04-5 (weighted average interest rate of 6.81% in 2006)
   
2,491
     
9,189
 
 
Total debt
   
2,004,417
     
1,711,439
 
 
Less current portion of long-term debt
   
25,933
     
20,869
 
 
Total long-term debt
  $
1,978,484
    $
1,690,570
 

________
(1)  
See the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 for a description of the referenced portfolios.

As of September 30, 2007, the Company had an available secured line of credit of $320.0 million ($70.0 million letter of credit sublimit) and a letter of credit facility of up to $80.0 million.  The line of credit bears interest at the
 
12

 
base rate plus 0.50% or LIBOR plus 1.50%, at the Company’s election.  The Company must also pay a fee equal to 1.50% of the amount of any outstanding letters of credit issued under the facilities.  In connection with entering into the credit facility agreement, the Company paid a commitment fee of 0.50% and is subject to a non-use fee of 0.25% on all unutilized amounts.  On October 10, 2007, the Company amended the credit facility agreement to, among other things, revise certain financial covenants and to address certain administrative matters.  The amended agreement matures on November 15, 2008 subject to extension at the Company’s option for two three-month extension periods and payment of a 0.1875% commitment fee with respect to each extension.  As of September 30, 2007, $231.0 million was drawn on the revolving loan facility and $110.0 million of letters of credit had been issued under the agreements.  The agreements are secured by a pledge of the Company’s tier one subsidiaries and, subject to certain limitations, subsidiaries formed to consummate future acquisitions.  As discussed in note 14, subsequent to September 30, 2007, the Company completed a $140.0 million financing and repaid $49.0 million of existing debt.  Net proceeds from the transaction were used to reduce amounts drawn on the revolving credit facility.  In addition, subsequent to September 30, 2007, the Company obtained $80.3 million of first mortgage financing bearing interest at 6.32%.  Approximately $53.6 million of the proceeds were disbursed at closing, with the remaining $26.7 million to be disbursed in connection with the construction of two new skilled nursing facilities and the renovation of an existing skilled nursing facility.  The net proceeds disbursed at closing were used to pay down amounts drawn against the Company’s revolving credit facility (note 14).

On January 16, 2007 and January 24, 2007, the Company financed a previous acquisition and the Flint Facility with $130.0 million of first mortgage financing bearing interest at LIBOR plus 1.15% payable interest only through February 1, 2012.  The Company also entered into interest rate swaps to convert the loan from floating to fixed.  The loan is secured by 27 previously acquired facilities and the Flint Facility and is partially secured by a $7.4 million letter of credit that will be released upon achievement of certain debt service coverage ratios.

On April 18, 2007, the Company financed a previously acquired facility as well as the Saunders Portfolio with $108.5 million of first mortgage financing bearing interest at LIBOR plus 0.70% payable interest only through August 1, 2012.  The Company has entered into interest rate swaps to convert the loan from floating to fixed.

The financings entered into on January 16, 2007, January 24, 2007 and April 18, 2007 are all part of the same master loan agreement whereby the amounts are secured by all properties under the master agreement.

On July 27, 2007, the Company financed one of its facilities with $30.0 million of first mortgage financing.  The note payable bears interest at 5.65% payable interest only through August 5, 2012 and is secured by the underlying property.  In conjunction with the refinancing, the Company repaid $16.1 million of existing debt.

On August 15, 2007, the Company financed the Freedom Square Portfolio with a $70.0 million note payable.  The note bears interest at 5.77% payable interest only through September 5, 2012 and is secured by the underlying property.

On September 25, 2007, the Company entered into a $41.4 million note payable.  The note bears interest at 6.69% payable interest only through July 2010, matures in July 2012 and is secured by six facilities.

In the normal course of business, the Company uses a variety of financial instruments to manage or hedge interest rate risk. The Company entered into certain interest rate protection and swap agreements to effectively cap or convert floating rate debt to a fixed rate basis, as well as to hedge anticipated future financing transactions. Pursuant to the Company’s hedge agreements, the Company is required to secure its obligation to the counterparty if the fair value liability exceeds a specified threshold.  Cash collateral pledged to the Company’s counterparty was $26.1 million and $41.0 million as of September 30, 2007 and October 31, 2007, respectively.

The Company does not enter into derivative contracts for trading or speculative purposes. Furthermore, the Company has a policy of only entering into contracts with major financial institutions based upon their credit rating and other factors.  Under certain circumstances, the Company may be required to replace a counterparty in the event that the counterparty does not maintain a certain credit rating.
 
13

 
The following table summarizes the Company’s swap instruments at September 30, 2007 ($ in 000’s):

Current notional balance
  $
1,729,120
 
Highest possible notional
  $
1,729,120
 
Lowest interest rate
    3.62 %
Highest interest rate
    5.51 %
Average fixed rate
    5.05 %
Earliest maturity date
 
2008
 
Latest maturity date
 
2014
 
Weighted average original maturity
 
5.6 years
 
Estimated asset fair value (included in other assets, net at September 30, 2007)
  $
973
 
Estimated liability fair value (included in other liabilities at September 30, 2007)
  $ (31,172 )

Prior to October 1, 2006, the Company qualified for hedge accounting on designated swap instruments pursuant to SFAS No. 133, Accounting for Derivative Instruments and Certain Hedging Activities, with the effective portion of the change in fair value of the derivative recorded in other comprehensive income and the ineffective portion included in the change in fair value of derivatives and amortization in the statement of operations.

On October 1, 2006, the Company elected to discontinue hedge accounting prospectively for the previously designated swap instruments. Consequently, the net gains and losses accumulated in other comprehensive income at that date of $1.3 million related to the previously designated swap instruments are being amortized to interest expense over the life of the underlying hedged debt payments. In the future, if the underlying hedged debt is extinguished or refinanced, the remaining unamortized gain or loss in accumulated other comprehensive income will be recognized in the statements of operations. Although hedge accounting was discontinued on October 1, 2006, the swap instruments remain outstanding and are carried at fair value in the consolidated balance sheet and the change in fair value beginning October 1, 2006 has been included in the statements of operations.

In April 2007, the Company entered into two separate treasury rate locks for notional amounts of $70.0 million and $50.0 million in anticipation of the Company’s planned future issuance of $120.0 million of fixed-rate debt.  Both rate locks expired in May 2007 and resulted in a cash receipt to the Company of approximately $0.4 million which has been included in the results from operations.

In July 2007, the Company entered into a series of forward starting interest rate swaps in the aggregate notional amount of $553.1 million in anticipation of planned future financing transactions as well as the replacement of certain existing hedges that will be expiring.  The swaps are being carried at fair value in the consolidated balance sheet and the change in fair value is included in the statements of operations.

8.  Legal Proceedings

In connection with the sale of certain facilities to Ventas Realty Limited Partnership (“Ventas”) in 2004, two legal actions have been filed. The first action was filed on September 15, 2005, by current and former limited partners in 36 investing partnerships in the United States District Court for the Eastern District of New York captioned David T. Atkins et al. v. Apollo Real Estate Advisors, L.P., et al. (the “Action”). On March 17, 2006, a third amended complaint was filed in the Action. The third amended complaint is brought on behalf of current and former limited partners in 14 investing partnerships. It names as defendants, among others, the Company, Brookdale Living Communities, Inc. (“BLC”), a subsidiary of the Company, GFB-AS Investors, LLC (“GFB-AS”), a subsidiary of BLC, the general partners of the 14 investing partnerships, which are alleged to be subsidiaries of GFB-AS, Fortress Investment Group (“Fortress”), an affiliate of the Company’s largest stockholder, and R. Stanley Young, the Company’s former Chief Financial Officer. The nine count third amended complaint alleges, among other things, (i) that the defendants converted for their own use the property of the limited partners of 11 partnerships, including through the failure to obtain consents the plaintiffs contend were required for the sale of facilities indirectly owned by those partnerships to Ventas; (ii) that the defendants fraudulently persuaded the limited partners of three partnerships to give up a valuable property right based upon incomplete, false and misleading statements in connection with certain consent solicitations; (iii) that certain defendants, including GFB-AS, the general partners, and the Company’s former Chief Financial Officer, but not including the Company, BLC, or Fortress, committed mail fraud in connection with the sale of facilities indirectly owned by the 14 partnerships at issue in the Action to
 
14

 
Ventas; (iv) that certain defendants, including GFB-AS and the Company’s former Chief Financial Officer, but not including the Company, BLC, the general partners, or Fortress, committed wire fraud in connection with certain communications with plaintiffs in the Action and another investor in a limited partnership; (v) that the defendants, with the exception of the Company, committed substantive violations of the Racketeer Influenced and Corrupt Organizations Act (“RICO”); (vi) that the defendants conspired to violate RICO; (vii) that GFB-AS and the general partners violated the partnership agreements of the 14 investing partnerships; (viii) that GFB-AS, the general partners, and the Company’s former Chief Financial Officer breached fiduciary duties to the plaintiffs; and (ix) that the defendants were unjustly enriched. The plaintiffs have asked for damages in excess of $100.0 million on each of the counts described above, including treble damages for the RICO claims. On April 18, 2006, the Company filed a motion to dismiss the claims with prejudice, which remains pending before the court, and plans to continue to vigorously defend this Action. A putative class action lawsuit was also filed on March 22, 2006, by certain limited partners in four of the same partnerships involved in the Action in the Court of Chancery for the State of Delaware captioned Edith Zimmerman et al. v. GFB-AS Investors, LLC and Brookdale Living Communities, Inc. (the “Second Action”). On November 21, 2006, an amended complaint was filed in the Second Action. The putative class in the Second Action consists only of those limited partners in the four investing partnerships who are not plaintiffs in the Action. The Second Action names as defendants BLC and GFB-AS. The complaint alleges a claim for breach of fiduciary duty arising out of the sale of facilities indirectly owned by the investing partnerships to Ventas and the subsequent lease of those facilities by Ventas to subsidiaries of BLC. The plaintiffs seek, among other relief, an accounting, damages in an unspecified amount, and disgorgement of unspecified amounts by which the defendants were allegedly unjustly enriched. On December 12, 2006, the Company filed an answer denying the claim asserted in the amended complaint and providing affirmative defenses. On December 27, 2006, the plaintiffs moved to certify the Action as a class action. Both the plaintiffs and defendants have served document production requests and the Action is currently in the beginning stages of document discovery. The Company also intends to vigorously defend this Second Action. Because these actions are in an early stage, the Company cannot estimate the possible range of loss, if any.

In addition, the Company has been and is currently involved in other litigation and claims incidental to the conduct of its business which are comparable to other companies in the senior living industry. Certain claims and lawsuits allege large damage amounts and may require significant legal costs to defend and resolve. Similarly, the senior living industry is continuously subject to scrutiny by governmental regulators, which could result in litigation related to regulatory compliance matters. As a result, the Company maintains insurance policies in amounts and with coverage and deductibles the Company believes are adequate, based on the nature and risks of its business, historical experience and industry standards.  Because the Company’s current policies provide for deductibles of $3.0 million for each claim, the Company is, in effect, self-insured for most claims.
 
15

 
9.  Supplemental Disclosure of Cash Flow Information ($ in 000’s)

   
Nine Months Ended
September 30,
 
   
2007
   
2006
 
Supplemental Disclosure of Cash Flow Information:
           
Interest paid
  $
105,759
    $
64,968
 
Income taxes paid
  $
637
    $
335
 
Write-off of deferred costs
  $
    $
5,001
 
                 
Supplemental Schedule of Non-cash Operating, Investing and Financing Activities:
               
Consolidation of limited partnerships pursuant to EITF 04-5 on January 1, 2006:
               
Property, plant, equipment and leasehold intangibles, net
  $
    $
31,645
 
Accounts receivable and other
   
     
1,410
 
Cash and investments-restricted
   
     
1,204
 
Accrued expenses and other
   
      (2,245 )
Tenant refundable fees and security deposits
   
      (177 )
Debt
   
      (19,723 )
Minority interest
   
      (12,114 )
Net
  $
    $
 
De-consolidation of leased development property:
               
Property, plant, equipment and leasehold intangibles, net
  $ (2,978 )   $
 
Debt
   
2,978
     
 
Net
  $
    $
 
Acquisition of assets, net of related payables and cash received, net:
               
Cash and investments-restricted
  $
387
    $
50,059
 
Accounts receivable
   
64
     
25,302
 
Property, plant, equipment and leasehold intangibles, net
   
173,609
     
2,362,413
 
Investment in unconsolidated ventures
    (1,342 )    
 
Goodwill
   
3,395
     
272,422
 
Other intangible assets, net
    (668 )    
306,531
 
Trade accounts payable, accrued expenses and other
    (1,458 )    
 
Debt obligations
    (5,273 )     (291,264 )
Capital and financing lease obligations
   
      (308,855 )
Deferred tax liability
   
      (420,925 )
Minority interest
   
650
     
 
Other, net
    (1,743 )     (196,568 )
Acquisition of assets, net of related payables and cash received
  $
167,621
    $
1,799,115
 

10.  Facility Leases

A summary of facility lease expense and the impact of straight-line adjustment and amortization of deferred gains are as follows ($ in 000’s):

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2007
   
2006
   
2007
   
2006
 
Cash basis payment
  $
62,342
    $
58,585
    $
187,805
    $
142,617
 
Straight-line expense
   
6,451
     
6,124
     
18,815
     
16,622
 
Amortization of deferred gain
    (1,085 )     (1,086 )     (3,255 )     (3,259 )
Facility lease expense
  $
67,708
    $
63,623
    $
203,365
    $
155,980
 
 
 
16

 
11.  Other Comprehensive Loss, Net

The following table presents the after-tax components of the Company’s other comprehensive loss for the periods presented ($ in 000’s):

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2007
   
2006
   
2007
   
2006
 
Net loss
  $ (58,927 )   $ (31,145 )   $ (112,742 )   $ (70,730 )
Unrealized gain on derivatives
   
      (13,261 )    
      (4,070 )
Reclassification of net gains on derivatives into earnings
    (393 )    
      (1,179 )    
 
Amortization of payments from settlement of forward interest swaps
   
94
     
94
     
282
     
282
 
Other
    (134 )    
     
98
     
 
Total comprehensive loss
  $ (59,360 )   $ (44,312 )   $ (113,541 )   $ (74,518 )

12.  Income Taxes

The Company’s effective tax rate for the three months ended September 30, 2007 and 2006 was 37.3% and 31.3%, respectively, and for the nine months ended September 30, 2007 and 2006 was 37.7% and 16.1%, respectively.  The difference between the periods is primarily due to the ability to tax benefit book losses in the first two quarters of 2007 compared to the same period in 2006.  In the third quarter of 2007, the Company adjusted its deferred tax assets as of December 31, 2006, based on the actual tax returns filed.  As a result of filing the returns, the Company has increased its net operating losses by $23.0 million.  Approximately $8.0 million of the increase is related to pre-merger activity and is recorded against goodwill, the remaining $15.0 million is primarily due to additional tax depreciation deducted and is offset in other deferred tax liabilities, and therefore no additional impact on tax expense was recorded in the period.  The Company’s adjusted federal net operating loss at December 31, 2006 was $201.5 million, which is available to offset future taxable income through 2025.  The Company continues to recognize this tax asset on its balance sheet as it is more likely than not to utilize this loss prior to any expiration.  Also as part of filing the returns, the Company adjusted its pre-merger state tax losses and related valuation allowances, impacting goodwill.

The Company adopted the provisions of FIN 48 on January 1, 2007.  The adoption of FIN 48 resulted in a transition adjustment to goodwill of $1.6 million, comprised of $1.4 million in taxes and $0.2 million in interest and penalties.  The adoption impacted goodwill versus retained earnings as the original benefit recorded on these positions was recorded to goodwill in previous purchase accounting transactions.  Interest and penalties related to these tax positions are classified as tax expense in the Company’s financial statements.  Tax returns for all wholly owned subsidiaries for the years 2002 through 2006 are subject to future examination by tax authorities.  In addition, for one wholly owned subsidiary, Alterra Healthcare Corporation, tax returns are open from 1999 through 2001 to the extent of the net operating losses generated during those periods.  The Company has reviewed its FIN 48 position as of September 30, 2007 and has adjusted its reserve for additional interest and some minor changes to its uncertain positions, based on the current returns filed.

13.  Segment Results

Under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, the Company determined that it has four reportable segments based on the way that its chief operating decision makers organize the Company’s business activities for making operating decisions and assessing performance.  The four segments are independent living; assisted living; retirement centers/CCRCs; and management services.

§
Independent Living.   The Company’s independent living facilities are primarily designed for middle to upper income senior citizens age 70 and older who desire an upscale residential environment providing the highest quality of service. The majority of the Company’s independent living facilities consist of both independent living and assisted living units in a single facility, which allows residents to “age-in-place” by providing them with a continuum of senior independent and assisted living services.

 
17


§
Assisted Living.   The Company’s assisted living facilities offer housing and 24-hour assistance with activities of daily life to mid-acuity frail and elderly residents. The Company’s assisted living facilities include both freestanding, multi-story facilities and freestanding, single-story facilities. The Company also operates memory care facilities, which are freestanding assisted living facilities specially designed for residents with Alzheimer's disease and other dementias.

§
Retirement Centers/CCRCs.   The Company’s retirement centers/CCRCs are large communities that offer a variety of living arrangements and services to accommodate all levels of physical ability and health. Most of the Company’s retirement centers/CCRCs have independent living, assisted living and skilled nursing available on one campus, and some also include memory care and Alzheimer's units.

§
Management Services.   The Company’s management services segment includes facilities owned by others and operated by the Company pursuant to management agreements. Under the Company’s management agreements for these facilities, the Company receives management fees as well as reimbursed expenses, which represent the reimbursement of certain expenses the Company incurs on behalf of the owners.

The following table sets forth certain segment financial and operating data ($ in 000’s)

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2007
   
2006
   
2007
   
2006
 
Revenue(1)
                       
Independent Living
  $
114,251
    $
101,816
    $
333,558
    $
288,220
 
Assisted Living
   
197,975
     
175,937
     
588,289
     
434,034
 
Retirement Centers/CCRCs
   
150,875
     
107,864
     
443,214
     
152,241
 
Management Services
   
1,493
     
1,426
     
4,777
     
3,158
 
    $
464,594
    $
387,043
    $
1,369,838
    $
877,653
 
Segment operating income(2)
                               
Independent Living
  $
48,595
    $
40,939
    $
145,594
    $
123,768
 
Assisted Living
   
68,274
     
65,211
     
212,134
     
164,474
 
Retirement Centers/CCRCs
   
51,235
     
34,275
     
145,661
     
42,835
 
Management Services
   
1,045
     
998
     
3,344
     
2,211
 
    $
169,149
    $
141,423
    $
506,733
    $
333,288
 
General and administrative (including non-cash stock-based compensation expense)(3)
  $
34,285
    $
28,820
    $
109,711
    $
72,511
 
Facility lease expense
   
67,708
     
63,623
     
203,365
     
155,980
 
Deprecation and amortization
   
79,235
     
60,883
     
234,690
     
114,129
 
Loss from operations
  $ (12,079 )   $ (11,903 )   $ (41,033 )   $ (9,332 )
                                 
Total Assets
                               
Independent living
                  $
1,149,070
    $
1,177,943
 
Assisted living
                   
1,300,754
     
1,198,495
 
Retirement Centers/CCRCs
                   
2,092,058
     
1,951,078
 
Corporate and Management Services
                   
303,871
     
328,140
 
                    $
4,845,753
    $
4,655,656
 
 
(1)
All revenue is earned from external third parties in the United States.
(2)
Segment operating income is defined as segment revenues less segment operating expenses (excluding depreciation and amortization).
(3)
Net of general and administrative costs allocated to management services reporting segment.

 
18

 
14.  Subsequent Events

On October 31, 2007, the Company obtained $140.0 million of first mortgage financing bearing interest at 5.84%.  The debt matures on November 1, 2014, subject to extension at the Company’s option.  The loan is secured by 21 of the Company's facilities.  In conjunction with the financing, the Company repaid $49.0 million of existing debt.  The net proceeds from the transaction were used to pay down amounts drawn against the Company’s revolving credit facility (note 7). 

On November 5, 2007, the Company obtained $80.3 million of first mortgage financing bearing interest at 6.32%.  Approximately $53.6 million of the proceeds were disbursed at closing, with the remaining $26.7 million to be disbursed in connection with the construction of two new skilled nursing facilities and the renovation of an existing skilled nursing facility.  The debt matures on August 5, 2012.  The loan is secured by five of the Company’s existing facilities and the two facilities under construction.  The net proceeds disbursed at closing were used to pay down amounts drawn against the Company’s revolving credit facility (note 7).

 
19

 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Certain statements in this Quarterly Report on Form 10-Q and other information we provide from time to time may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Those forward-looking statements include all statements that are not historical statements of fact and those regarding our intent, belief or expectations, including, but not limited to, statements relating to our ability to deploy capital, close accretive transactions, anticipate, manage and address industry trends and their effect on our business, grow dividends, generate growth organically or through acquisitions, achieve operating efficiencies and cost savings, expand our offering of ancillary services (therapy and home health) to additional facilities, expand existing facilities, develop new facilities, secure financing and increase revenues, earnings, Adjusted EBITDA, Cash From Facility Operations, and/or Facility Operating Income (as such terms are defined herein) and add residents and statements relating to our expectations for the performance of our entrance fee communities and our expected levels of expenditures. Words such as “anticipate(s)”, “expect(s)”, “intend(s)”, “plan(s)”, “target(s)”, “project(s)”, “believe(s)”, “will”, “would”, “seek(s)”, “estimate(s)” and similar expressions are intended to identify such forward-looking statements. These statements are based on management’s current expectations and beliefs and are subject to a number of risks and uncertainties that could lead to actual results differing materially from those projected, forecasted or expected. Although we believe that the assumptions underlying the forward-looking statements are reasonable, we can give no assurance that our expectations will be attained. Factors that could cause actual results to differ materially from our expectations include, but are not limited to, our ability to integrate the facilities of American Retirement Corporation (“ARC”) or other acquisitions into our operations; our continued ability to acquire facilities at attractive prices which will generate returns consistent with expectations; the possibility that the facilities that we have recently acquired and will acquire may not generate sufficient additional income to justify their acquisition; possibilities that conditions to closing of certain transactions will not be satisfied; the possibilities that changes in the capital markets, including changes in interest rates and/or credit spreads, or other factors could make financing more expensive or unavailable to us; a decrease in the overall demand for senior housing; general economic conditions and economic conditions in the markets in which we operate; downturns in the real estate markets in the regions where our facilities are located; competitive pressures within the industry and/or markets in which we operate; the creditworthiness of our residents; interest rate fluctuations; licensing risks (including delays in obtaining regulatory approvals); our failure to comply with federal, state and local laws and regulations; our failure to comply with environmental laws; the effect of future legislation or regulatory changes on our operations; and other risks detailed from time to time in our filings with the Securities and Exchange Commission, press releases and other communications, including those set forth under “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2006. Such forward-looking statements speak only as of the date of this Quarterly Report. We expressly disclaim any obligation to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or change in events, conditions or circumstances on which any statement is based.

Executive Overview

During the third quarter, we continued to focus on implementing the growth strategy outlined in our most recent Annual Report on Form 10-K.  As previously disclosed, we are focusing on increasing our revenues, cash flows and dividends per share through a combination of: (i) organic growth in our existing operations; (ii) expansion of our ancillary service programs (including therapy and home health services); (iii) selected acquisitions of additional operating companies and facilities; and (iv) expansion of our existing facilities. The following is a brief discussion of our progress during the quarter and nine months ended September 30, 2007.

Our revenues for the quarter ended September 30, 2007 increased to $464.6 million, an increase of $77.6 million, or approximately 20.0%, over the third quarter of 2006.  The increase in revenues was primarily a result of a $281 increase in the average revenue per unit/bed over the prior year quarter, as occupancy remained relatively flat across our portfolio.  The number of acquisitions we completed in the fourth quarter of 2006 and the first nine months of 2007 also contributed to our revenue growth in the current period.  Including the effect of the historical results of the ARC facilities only partially included in our results of operations in the prior-year quarter, same store revenues grew 6.3%.
 
20

 
In addition, we declared a dividend of $0.50 per share for the third quarter, an increase of 25.0% over the $0.40 per share dividend declared for the third quarter of 2006.

During the third quarter, we acquired a skilled nursing facility adjacent to one of our facilities and purchased three facilities that were previously leased by us.  Year-to-date, we have completed expansions at five facilities and had eight expansion projects under construction as of September 30, 2007.  As a result of our acquisition and expansion activity, the number of units we operated as of the end of the third quarter increased to 52,082, an increase of 992 units, or 1.9%, over the same prior year quarter.

We also continued to make progress in expanding our ancillary services programs to additional facilities during the third quarter. For the nine months ended September 30, 2007, we have completed the roll-out of our ancillary services program to over 11,000 additional units.  Although the roll-out of ancillary services has been ahead of our original plan, we have faced some regulatory delays in expanding the home health portion of our business.

We have increased our revenues, cash flows and dividends per share during 2007 and have achieved positive same-store results. Nevertheless, our growth initiatives have been negatively impacted by unfavorable conditions in the housing, credit and financial markets.  For example, we believe that the difficult housing market and general economic uncertainty have caused some potential customers (or their adult children) to delay or reconsider moving into our facilities, thus hindering our ability to increase occupancy above the current 91% level.  In addition, we continue to experience volatility in the entrance fee portion of our business.  Although our third quarter net entrance fees sales increased over the previous quarter, they continued to be negatively impacted by softness in the housing markets in certain of the markets in which we operate (primarily certain areas of Florida and Arizona).  The timing of entrance fee sales is subject to a number of different factors and is also inherently subject to variability (positively or negatively) when measured over the short-term.  We continue to expect entrance fee sales to normalize over the longer term.

Consolidated Results of Operations
Three Months Ended September 30, 2007 and 2006
 
The following table sets forth, for the periods indicated, statement of operations items and the amount and percentage of increase or decrease of these items. The results of operations for any particular period are not necessarily indicative of results for any future period. The following data should be read in conjunction with our condensed consolidated financial statements and the notes thereto, which are included herein. Our results reflect the inclusion of acquisitions that occurred during the respective reporting periods.  Refer to our most recent Annual Report on Form 10-K for the year ended December 31, 2006, filed March 16, 2007, and Quarterly Reports on Form 10-Q for the quarters ended March 31, 2007 and June 30, 2007, filed May 8, 2007 and August 8, 2007, respectively, and the notes to our condensed consolidated financial statements included herein for additional information regarding these acquisitions ($ in 000’s):
 
   
Three Months Ended
September 30,
             
   
2007
   
2006
   
Increase
(Decrease)
   
% Increase
(Decrease)
 
                         
Statement of Operations Data:
                       
Revenue
                       
Resident fees
                       
Independent Living
  $
114,251
    $
101,816
    $
12,435
      12.2 %
Assisted Living
   
197,975
     
175,937
     
22,038
      12.5 %
Retirement Centers/CCRCs
   
150,875
     
107,864
     
43,011
      39.9 %
Total resident fees
   
463,101
     
385,617
     
77,484
      20.1 %
Management fees
   
1,493
     
1,426
     
67
      4.7 %
Total revenue
   
464,594
     
387,043
     
77,551
      20.0 %

 
21

 
 Expense                                
 Facility operating expense                                
Independent Living
   
65,656
     
60,877
     
4,779
      7.9 %
Assisted Living
   
129,701
     
110,726
     
18,975
      17.1 %
Retirement Centers/CCRCs
   
99,640
     
73,589
     
26,051
      35.4 %
Total facility operating expense
   
294,997
     
245,192
     
49,805
      20.3 %
General and administrative expense
   
34,733
     
29,248
     
5,485
      18.8 %
Facility lease expense
   
67,708
     
63,623
     
4,085
      6.4 %
Depreciation and amortization
   
79,235
     
60,883
     
18,352
      30.1 %
Total operating expense
   
476,673
     
398,946
     
77,727
      19.5 %
Loss from operations
    (12,079 )     (11,903 )     (176 )     (1.5 %)
Interest income
   
1,695
     
2,032
      (337 )     (16.6 %)
Interest expense
                               
Debt
    (38,472 )     (29,287 )     (9,185 )     (31.4 %)
Amortization of deferred financing costs
    (1,151 )     (1,141 )     (10 )     (0.9 %)
Change in fair value of derivatives and amortization
    (43,731 )     (1,840 )     (41,891 )     (2,276.7 %)
Loss on extinguishment of debt
   
      (1,414 )    
1,414
      100.0 %
Equity in loss of unconsolidated ventures
    (309 )     (1,649 )    
1,340
      81.3 %
Loss before income taxes
    (94,047 )     (45,202 )     (48,845 )     (108.1 %)
Benefit for income taxes
   
35,125
     
14,146
     
20,979
      148.3 %
Loss before minority interest
    (58,922 )     (31,056 )     (27,866 )     (89.7 %)
Minority interest
    (5 )     (89 )    
84
      94.4 %
Net loss
  $ (58,927 )   $ (31,145 )   $ (27,782 )     (89.2 %)
                                 
Selected Operating and Other Data:
                               
Total number of facilities (at end of period)
   
550
     
545
     
5
      0.9 %
Total units/beds operated(1)
   
52,082
     
51,090
     
992
      1.9 %
Owned/leased facilities units/beds
   
47,553
     
46,566
     
987
      2.1 %
Owned/leased facilities occupancy rate:
                               
Period end
    91.0 %     91.1 %     (0.1 %)     (0.1 %)
Weighted average
    90.8 %     91.1 %     (0.3 %)     (0.3 %)
Average monthly revenue per unit/bed(2)
  $
3,600
    $
3,319
    $
281
      8.5 %
                                 
Selected Segment Operating and Other Data:
                               
Independent Living
                               
Number of facilities (period end)
   
70
     
65
     
5
      7.7 %
Total units/beds(1)
   
12,331
     
11,824
     
507
      4.3 %
Occupancy rate:
                               
Period end
    92.2 %     92.8 %     (0.6 %)     (0.6 %)
Weighted average
    92.5 %     92.7 %     (0.2 %)     (0.2 %)
Average monthly revenue per unit/bed(2)
  $
3,297
    $
3,050
    $
247
      8.1 %
Assisted Living
                               
Number of facilities (period end)
   
409
     
408
     
1
      0.2 %
Total units/beds(1)
   
21,086
     
20,974
     
112
      0.5 %
Occupancy rate:
                               
Period end
    90.1 %     90.4 %     (0.3 %)     (0.3 %)
Weighted average
    90.0 %     90.3 %     (0.3 %)     (0.3 %)
Average monthly revenue per unit/bed(2)
  $
3,465
    $
3,259
    $
206
      6.3 %
Retirement Centers/CCRCs
                               
Number of facilities (period end)
   
48
     
48
     
     
 
Total units/beds(1)
   
14,136
     
13,768
     
368
      2.7 %
Occupancy rate:
                               
Period end
    91.4 %     91.4 %    
     
 
Weighted average
    90.7 %     90.8 %     (0.1 %)     (0.1 %)
Average monthly revenue per unit/bed(2)
  $
4,102
   
$
3,867     $ 235       6.1

 
22


Management Services
                               
Number of facilities (period end)
   
23
     
24
      (1 )     (4.2 )%
Total units/beds(1)
   
4,529
     
4,524
     
5
      0.1 %
Occupancy rate:
                               
Period end
    83.2 %     92.0 %     (8.8 %)     (9.6 %)
Weighted average
    82.9 %     92.1 %     (9.2 %)     (10.0 %)

Selected Entrance Fee Data:
                       
Non-refundable entrance fees sales
  $
5,673
    $
3,716
    $
1,957
      52.66 %
Refundable entrance fees sales
   
8,696
     
4,144
     
4,552
      109.85 %
Total entrance fee receipts
   
14,369
     
7,860
     
6,509
      82.81 %
Refunds
    (5,084 )     (3,529 )     (1,555 )     (44.06 )%
Net entrance fees
  $
9,285
    $
4,331
    $
4,954
      114.38 %
 
__________
 
(1)
Total units/beds operated represent the total units/beds operated as of the end of the period.
 
(2)
Average monthly revenue per unit/bed represents the average of the total monthly revenues, excluding amortization of entrance fees, divided by average occupied units/beds.  Including as revenue community fee receipts deferred under generally accepted accounting principles and excluding amortization of community fees and entrance fees, the average monthly revenue per unit for the three months ended was $3,639 and $3,331, $3,347 and $3,050, $3,525 and $3,259, and $4,099 and $3,916 for Total Units/Beds, Independent Living, Assisted Living and Retirement Centers/CCRCs, respectively.
 
Resident Fees
 
The increase in resident fees was driven by revenue growth across all business segments.  Resident fees increased over the prior-year third quarter mainly due to the number of acquisitions that we completed during the latter part of 2006 and the first half of 2007, as resident fees from these acquisitions are partially or entirely excluded from the prior period results.  Including the full effect of the historical results of the ARC facilities only partially included in our results of operations in the third quarter of 2006, same store revenues grew 6.3% over the third quarter of 2006.

Independent living revenue increased $12.4 million, or 12.2%, primarily due to an increase in the average monthly revenue per unit/bed at the facilities we operated during both periods.  Occupancy at these same-store facilities remained fairly constant period over period.  Revenue growth was also impacted by the inclusion of facilities acquired during 2006 and 2007, as resident fees from these acquisitions are partially or entirely excluded from the prior period results.

Assisted living revenue increased $22.0 million, or 12.5%, primarily due to the 2006 and 2007 acquisitions.  Additionally, resident fees increased as a result of an increase in the average monthly revenue per unit/bed at the facilities we operated during both periods, partially offset by a slight decrease in occupancy as compared to the same period in the prior-year.

Retirement Centers/CCRCs revenue increased $43.0 million, or 39.9%, primarily due to the acquisition of ARC in the third quarter of 2006 and other 2007 acquisitions.  Additionally, the average monthly revenue per unit/bed increased period over period when including the effect of the historical results of the ARC facilities.

Management Fees

Management fees were comparable period over period as the number of management contracts maintained was fairly consistent during both periods.

 
23

 
Facility Operating Expense

Facility operating expense increased over the prior-year same period mainly due to the ARC acquisition as well as other 2006 and 2007 acquisitions.  The increase was primarily due to salaries, wages and benefits.

Independent living operating expenses increased $4.8 million, or 7.9%, primarily due to the 2006 and 2007 acquisitions.  The remaining increase is primarily due to an increase in operating expenses for facilities we operated during both periods, mainly for salaries, wages and benefits.

Assisted living operating expenses increased $19.0 million, or 17.1%, primarily due to increased salaries, wages and benefits resulting from the 2006 acquisitions and additional 2007 acquisitions.

Retirement Centers/CCRC operating expenses increased $26.1 million, or 35.4%, primarily due to the acquisition of ARC during July 2006 and additional 2007 acquisitions.

General and Administrative Expense

General and administrative expenses increased $5.5 million, or 18.8%, primarily as a result of an increase in salaries, wages and benefits and an increase in the number of employees in connection with the 2006 acquisition of ARC.  The increase was partially offset by a decreased in non-cash stock based compensation expense.  General and administrative expense as a percentage of total revenue, including revenue generated by the facilities we manage, was 4.7% and 4.8% for the three months ended September 30, 2007 and 2006, respectively, calculated as follows ($ in 000’s):

   
Three Months Ended
September 30,
 
   
2007
   
2006
 
             
Resident fee revenues
  $
463,101
    $
385,617
 
Resident fee revenues under management