Filed pursuant to Rule 424(b)(3)
Registration File No. 333-69846
PROSPECTUS
[LOGO]
SPIN-OFF OF FIVE STAR QUALITY CARE, INC. THROUGH DISTRIBUTION
OF 4,342,170 SHARES OF COMMON STOCK
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We are furnishing this prospectus to the shareholders of Senior Housing
Properties Trust and HRPT Properties Trust, each a Maryland real estate
investment trust. We are currently a 100% owned subsidiary of Senior Housing.
Senior Housing will distribute substantially all of our outstanding common
shares as a special distribution to its shareholders. HRPT Properties owns 29%
of the shares of Senior Housing and will distribute all of our shares that it
receives from Senior Housing to its shareholders.
Shareholders of Senior Housing will receive one of our shares for every 10
Senior Housing common shares owned on December 17, 2001. Shareholders of HRPT
Properties will receive one of our shares for every 100 HRPT Properties common
shares owned on December 17, 2001. These distributions will be made on or about
December 31, 2001.
Our common shares have been approved for listing on the American Stock
Exchange, or AMEX, under the symbol "FVE". Senior Housing's common shares will
continue to trade on the New York Stock Exchange under the symbol "SNH", and
HRPT Properties common shares will continue to trade on the New York Stock
Exchange under the symbol "HRP". This distribution of our common shares is the
first public distribution of our shares. Accordingly, we can provide no
assurance to you as to what the market price of our shares may be.
INVESTMENT IN OUR SHARES INVOLVES RISKS. YOU SHOULD READ CAREFULLY THIS
ENTIRE PROSPECTUS, INCLUDING THE SECTION ENTITLED "RISK FACTORS" THAT BEGINS ON
PAGE 7 OF THIS PROSPECTUS, WHICH DESCRIBES THE MATERIAL RISKS.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful and complete. Any representation to the contrary is a
criminal offense.
The date of this Prospectus is December 6, 2001.
QUESTIONS AND ANSWERS ABOUT THE SPIN-OFF
Q: HOW MANY FIVE STAR COMMON SHARES WILL I RECEIVE?
A: Senior Housing will distribute to you one share of our common stock for
every 10 common shares of Senior Housing you own on the record date; and
HRPT Properties will distribute to you one share of our common stock for
every 100 common shares of HRPT Properties you own on the record date.
Q: WHAT ARE SHARES OF FIVE STAR WORTH?
A: The value of our shares will be determined by their trading price after the
spin-off. We do not know what the trading price will be and we can provide
no assurances as to value.
Q: WHAT WILL SENIOR HOUSING DO AFTER THE SPIN-OFF?
A: Senior Housing will continue to operate as a REIT. Immediately after the
spin-off, Senior Housing will own 86 senior living facilities, including 56
which we will lease. When Senior Housing purchases the Marriott senior
living facilities, it will own 117 senior living facilities, including 87
which we will lease. In the future Senior Housing may purchase additional
senior living facilities and some of these additional facilities may be
leased to us.
Q: WHY IS HRPT PROPERTIES INVOLVED?
A: HRPT Properties owns 29% of Senior Housing. HRPT Properties will receive a
substantial amount of our shares from Senior Housing. If HRPT Properties
does not reduce its ownership of our shares below 10%, both HRPT Properties
and Senior Housing may cease to qualify as real estate investment trusts, or
REITs, under applicable tax rules. Accordingly, HRPT Properties will
distribute all of our shares that it receives.
Q: WHAT WILL HRPT PROPERTIES DO AFTER THE SPIN-OFF?
A: HRPT Properties will continue to be a REIT, principally focused upon
investing and owning office buildings.
Q: WILL THE SPIN-OFF AFFECT MY CASH DISTRIBUTIONS?
A: No. Senior Housing expects to continue quarterly cash distributions of
$0.30/share ($1.20/share per year). HRPT Properties expects to continue
quarterly cash distributions of $0.20/share ($0.80/share per year). We do
not expect to make distributions to our shareholders.
Q: WILL FIVE STAR SHARES BE LISTED ON A STOCK EXCHANGE?
A: Our shares have been approved for listing on the AMEX under the trading
symbol "FVE".
Q: WILL MY SENIOR HOUSING OR HRPT PROPERTIES SHARES CONTINUE TO BE LISTED ON AN
EXCHANGE?
A: Senior Housing's common shares will continue to be listed on the NYSE under
the symbol "SNH". HRPT Properties' common shares will continue to be listed
on the NYSE under the symbol "HRP".
Q: WHAT ARE THE TAX CONSEQUENCES TO ME OF THE SPIN-OFF?
A: The total value of this distribution, as well as your initial tax basis in
our shares, will be determined by the trading price of our common shares at
the time of the spin-off. A portion of this distribution will be taxable to
you as a dividend and the remainder will be a tax-free reduction in your
basis in your Senior Housing or HRPT Properties shares, as applicable.
However, if you have held your Senior Housing or HRPT Properties common
shares, as applicable, for the entire year, we expect you will have little
or no additional taxable dividend for the year as a result of the spin-off
distribution.
Q: WHAT DO I HAVE TO DO TO RECEIVE MY FIVE STAR SHARES?
A: No action by you is required. You do not need to pay any money or surrender
your Senior Housing or HRPT Properties common shares to receive our common
shares. The number of Senior Housing or HRPT Properties common shares you
own will not change. If your Senior Housing or HRPT Properties common shares
are held in a brokerage account, our common shares will be credited to that
account. If you own Senior Housing or HRPT Properties common shares in
certificated form, certificates representing your Five Star common shares
will be mailed to you. No cash distributions will be paid and fractional
shares will be issued as necessary.
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TABLE OF CONTENTS
PAGE
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Summary..................................................... 1
Risk Factors................................................ 7
The Spin-off................................................ 11
Dividend Policy............................................. 15
Capitalization.............................................. 16
The Company................................................. 17
Selected Historical Financial Information................... 33
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 34
Management.................................................. 40
Security Ownership After the Spin-off....................... 45
Certain Relationships....................................... 48
Federal Income Tax Considerations........................... 49
Shares Eligible for Future Sale............................. 59
Description of Capital Stock................................ 59
Material Provisions of Maryland Law, Our Charter and
Bylaws.................................................... 61
Plan of Distribution........................................ 68
Legal Matters............................................... 68
Experts..................................................... 69
Where You Can Find More Information......................... 69
ABOUT THIS PROSPECTUS
You should rely only on the information contained in this prospectus. We
have not, and Senior Housing and HRPT Properties have not, authorized anyone to
provide you with different information. If anyone provides you with different or
inconsistent information, you should not rely on it. We, Senior Housing and HRPT
Properties believe that the information contained in this prospectus is accurate
as of the date on the cover. Changes may occur after that date; and we, Senior
Housing and HRPT Properties may not update this information except as required
by applicable law.
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SUMMARY
REFERENCES IN THIS PROSPECTUS TO "WE", "US", "OUR", THE "COMPANY" OR "FIVE
STAR" MEAN FIVE STAR QUALITY CARE, INC. AND ITS SUBSIDIARIES. REFERENCES IN THIS
PROSPECTUS TO "SENIOR HOUSING" MEAN SENIOR HOUSING PROPERTIES TRUST AND ITS
SUBSIDIARIES. REFERENCES IN THIS PROSPECTUS TO "HRPT PROPERTIES" MEAN HRPT
PROPERTIES TRUST AND ITS SUBSIDIARIES. REFERENCES IN THIS PROSPECTUS TO
"CRESTLINE" MEAN CRESTLINE CAPITAL CORPORATION AND ITS SUBSIDIARIES. REFERENCES
IN THIS PROSPECTUS TO "MARRIOTT" MEAN MARRIOTT SENIOR LIVING SERVICES, INC., AND
ITS SUBSIDIARIES.
THE DISTRIBUTION
Distributing Companies.................... Senior Housing and HRPT Properties. Because HRPT
Properties owns 29% of Senior Housing, HRPT Properties
will receive our shares from Senior Housing. HRPT
Properties will in turn distribute our shares to its
shareholders.
Shares to be Distributed.................. 4,342,170 of our common shares, $.01 par value per
share. Immediately after the spin-off and our merger
with FSQ, Inc. we will have a total of 4,617,170 common
shares outstanding and the distributed shares will
represent 94% of our total common shares outstanding.
Distribution Ratio........................ One of our common shares for every 10 common shares of
Senior Housing owned of record on December 17, 2001. One
of our common shares for every 100 common shares of HRPT
Properties owned of record on December 17, 2001. No cash
distributions will be paid and fractional shares will be
issued as necessary.
No Payment Required....................... No holder of Senior Housing or HRPT Properties common
shares will be required to make any payment, exchange
any shares or to take any other action in order to
receive our common shares.
Record Date............................... The spin-off record date for Senior Housing's and HRPT
Properties' distribution of our shares is December 17,
2001.
Distribution Date......................... The spin-off distribution date will be on or about
December 31, 2001.
Federal Income Tax Consequences........... Our shares distributed to you in the spin-off will be
treated for tax purposes like all other distributions
from Senior Housing or HRPT Properties. The total value
of this distribution, as well as your initial tax basis
in our shares, will be determined by the trading price
of our common shares at the time of the spin-off. A
portion of this distribution will be taxable to you as a
dividend and the remainder will be a tax-free reduction
in your basis in your Senior Housing or HRPT Properties
shares, as applicable. However, if you have held your
Senior Housing or HRPT Properties common shares, as
applicable, for the entire year, we expect you will have
little or no additional taxable dividend for the year as
a result of the spin-off distribution.
1
Background and Reasons for the
Distribution.............................. In July 2000, Senior Housing repossessed or acquired
senior living facilities from former tenants. Senior
Housing contracted with FSQ, Inc. to manage these
properties. Under applicable provisions of the Internal
Revenue Code, or IRC, REITs such as Senior Housing are
not permitted to contract in this manner for facilities
management for extended periods. We will lease 56 of
these facilities from Senior Housing, and after the
spin-off we will acquire FSQ, Inc.
In August 2001, Senior Housing agreed to acquire 31
senior living facilities from Crestline. These senior
living facilities are managed by Marriott under
agreements extending to 2027, plus renewal options
thereafter. Upon the closing of this transaction, we
will lease these 31 facilities from Senior Housing,
assume the rights and obligations under the existing
management agreements with Marriott, and acquire assets
and liabilities relating to the operation of facilities
which Senior Housing cannot assume under IRC REIT rules.
Both Senior Housing and HRPT Properties are REITs. We
were created to lease and operate senior living
facilities which cannot be leased or operated by REITs
under the IRC. HRPT Properties owns 29% of Senior
Housing. Accordingly, when our shares are distributed by
Senior Housing, a substantial number of our shares will
be received by HRPT Properties and then distributed to
its shareholders. Shareholders who continue to own our
shares and their respective shares of Senior Housing or
HRPT Properties will be able to participate in REIT
qualified ownership of real estate in Senior Housing and
HRPT Properties and in our operations of our leased real
estate.
The Crestline transaction is subject to conditions,
including approval by Crestline shareholders and
approval from Marriott under its management agreements.
At this time, we expect that the Crestline transaction
will close in early 2002. However, there can be no
assurance that the Crestline transaction will close, and
the spin-off is not conditioned on the closing of the
Crestline transaction.
Conflicts of Interest..................... We were formed primarily for the benefit of Senior
Housing and not for our own benefit. Our formation
allows Senior Housing to continue to own 56 nursing home
properties that it currently owns and allows Senior
Housing to acquire 31 Marriott facilities in the
Crestline transaction without adverse tax consequences
to Senior Housing. Because we were formed to benefit
Senior Housing, some of our contractual relationships
and the terms of our initial business operations may
provide more benefits to Senior Housing than to us.
2
Further, we are and will be subject to conflicts of
interest, including the following:
- Four of our five directors will also be trustees
of Senior Housing. Initially and for the foreseeable
future, substantially all of our business will be
conducted at properties which we will lease from
Senior Housing.
- Two of our directors, Barry M. Portnoy and Gerard M.
Martin, own 100% of FSQ, Inc. On January 2, 2002,
after the distribution of our shares, we will acquire
FSQ, Inc.
- Messrs. Portnoy and Martin own Reit Management &
Research LLC. Reit Management is the investment
manager to Senior Housing and will also provide
services to us. Also, two of our senior officers will
simultaneously be employed as officers of Reit
Management.
- Messrs. Portnoy and Martin own the premises which
we will lease for our headquarters.
Because of these conflicts of interest, some of our
business may have been, and may in the future be,
conducted on terms which are less favorable to us than
we might have achieved on an arm's length basis.
Distribution Agent, Transfer Agent and
Registrar................................. EquiServe Trust Company, N.A. will be the distribution
agent, transfer agent and registrar for our shares.
Listing................................... There is currently no public market for our shares. Our
shares have been approved for listing on the American
Stock Exchange under the symbol "FVE". We expect trading
will commence on or around the distribution date,
December 31, 2001. The listing of our shares does not
ensure that an active trading market will be available
to you.
RELATED TRANSACTIONS
Merger Transaction........................ Following the spin-off, in exchange for 250,000 of our
common shares, we will acquire all of the capital stock
of FSQ, Inc., the company which currently manages the 56
properties which we will lease from Senior Housing.
Gerard M. Martin and Barry M. Portnoy, Managing Trustees
of Senior Housing and members of our Board of Directors,
together own 100% of FSQ, Inc. The Board of Trustees of
Senior Housing has received an opinion from UBS Warburg
LLC, an internationally recognized investment banking
firm, as to the fairness, from a financial point of
view, to us of the consideration provided for in the
merger. For more detailed discussion of the merger, see
"The Spin-off -- The Merger Transaction".
3
Crestline Transaction..................... Senior Housing has agreed to acquire 31 senior housing
facilities from Crestline. Upon the closing of the
Crestline transaction, we will lease these 31 facilities
from Senior Housing, assume the rights and obligations
under existing management agreements with Marriott and
acquire assets and liabilities related to the operation
of these facilities. For a more detailed discussion of
the Crestline transaction and this lease, see "The
Spin-off -- The Crestline Transaction" and "The Company
-- Our Lease for the Marriott Facilities".
THE COMPANY
General................................... We are a corporation originally formed under Delaware
law in 2000 and reincorporated under Maryland law on
September 20, 2001.
Our principal place of business is 400 Centre Street,
Newton, Massachusetts 02458, and our telephone number is
(617) 796-8387.
Business.................................. We were formed by Senior Housing to lease and operate
senior living facilities, including facilities owned by
Senior Housing. We are not a REIT.
Initially we will lease and operate 56 senior living
facilities which are owned by Senior Housing and
currently managed by FSQ, Inc., which is owned by
Messrs. Portnoy and Martin. These 56 facilities contain
5,125 nursing home beds and 145 independent and assisted
living units. In early 2002, we expect to lease an
additional 31 senior living facilities when they are
acquired by Senior Housing from Crestline. These 31
facilities contain 7,487 living units and are operated
by Marriott under management agreements extending to
2027, plus renewal options thereafter.
In connection with this spin-off transaction, we have
entered into agreements which require us to afford
Senior Housing, HRPT Properties, Hospitality Properties
Trust, a REIT that invests in hotels, or any other
public real estate entity managed by Reit Management,
the opportunity to acquire or finance any real estate
investments of the types in which such entity invests
before we do. Aside from this restriction, we may engage
in any business activity. At present, we expect that our
future business will be focused principally upon
leasing, operating and managing senior living
facilities, possibly including additional facilities
which we will lease from Senior Housing.
Initial Capitalization.................... At the time of the spin-off we will be capitalized with
$50 million of equity consisting of cash and working
capital, primarily operating receivables, net of
operating payables. We will have no funded debt at the
time of the spin-off.
4
Management................................ Prior to completion of the spin-off we expect to have
five Board members, and four of our five Board members
will also be members of Senior Housing's Board of
Trustees. Our chief executive officer and our chief
financial officer are also part time employees of Reit
Management. Reit Management is the investment manager to
Senior Housing, HRPT Properties and Hospitality
Properties. We will enter an agreement with Reit
Management to obtain shared services.
Dividend Policy........................... We do not expect to pay dividends.
Organization and Relationships............ The following chart and table illustrate the ownership
and contractual relationships among us, Senior Housing,
HRPT Properties, Hospitality Properties, FSQ, Inc.,
Crestline and Reit Management which we expect will be
effective upon completion of the spin-off, the FSQ, Inc.
merger, the Crestline transaction and the related
transactions.
[ORGANIZATIONAL CHART]
OWNED OWNERSHIP
SHAREHOLDER ENTITY PERCENTAGE
----------- ------------------------------- ----------
HRPT Properties............................................. Senior Housing 29.5%
HRPT Properties............................................. Hospitality Properties 6.4%
Senior Housing.............................................. HRPT Properties 0.8%
Senior Housing.............................................. Five Star 0.8%
Reit Management and its officers and directors.............. HRPT Properties 1.0%
Reit Management and its officers and directors.............. Hospitality Properties 0.6%
Reit Management and its officers and directors.............. Senior Housing 0.3%
Reit Management and its officers and directors.............. Five Star 6.0%
Messrs. Martin and Portnoy.................................. Reit Management 100.0%
5
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
We have made statements that are not historical facts in this prospectus
that constitute "forward-looking statements" as that term is defined in the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements concern:
- our ability to manage effectively the 56 senior housing facilities which
we will operate;
- our ability to operate as a separate public company;
- the ability of Senior Housing and us to acquire the 31 Marriott senior
housing facilities;
- Marriott's ability to manage effectively the 31 Marriott senior housing
facilities we will lease from Senior Housing;
- the ability of our senior housing facilities to generate cash flow in
excess of our rent obligations to Senior Housing and our other operating
expenses;
- our policies and plans regarding operations, investments, financings and
other matters; and
- our ability to access capital markets or other sources of funds.
Also, whenever we use words such as "believe", "expect", "anticipate",
"estimate" or similar expressions, we are making forward-looking statements.
Forward-looking statements are not guarantees of future performance and involve
risks and uncertainties. Our expected results may not be achieved, and actual
results may differ materially from our expectations. This may be a result of
various factors, including:
- the status of the economy;
- the Crestline transaction not closing;
- compliance with and changes to regulations and payment policies within the
healthcare industry;
- competition within the senior housing and healthcare industries;
- the status of capital markets (including prevailing interest rates) and
our ability to obtain financing; and
- changes in federal, state and local legislation.
Investors should not rely upon forward-looking statements except as
statements of our present intentions and of our present expectations which may
or may not occur.
6
RISK FACTORS
Ownership of our shares will involve various risks. The following is a
summary of the material risks:
THERE IS NO HISTORICAL MARKET FOR OUR SHARES.
We do not know what the trading prices of our shares will be after the
spin-off. There is no historical market for our shares. The distribution of our
shares is not being underwritten by an investment bank or otherwise. Our shares
have been approved for listing on the American Stock Exchange. Until an orderly
trading market develops, the trading prices of our shares may fluctuate
significantly. If no regular trading market develops for our shares, you may not
be able to sell our shares at fair prices.
OUR OPERATING MARGINS ARE NARROW.
Our pro forma total operating revenues for the nine months ended
September 30, 2001, assuming completion of the Crestline transaction, were
$361 million; and our pro forma income before income taxes for the same period
was $309,000. A small percentage decline in our revenues or increase in our
expenses might have a dramatic negative impact upon our pre-tax income or loss.
THE CRESTLINE TRANSACTION MAY NOT CLOSE.
We expect to lease 31 Marriott senior living facilities when they are
acquired by Senior Housing. The operations associated with this lease will
represent over 50% of our total revenues. The closing of the Crestline
transaction is subject to conditions, including approval by Crestline's
shareholders and by Marriott under its management agreements. The closing of the
Crestline transaction is also subject to healthcare regulatory approvals. If the
Crestline transaction is not completed, our actual revenues and income will be
substantially less than the pro forma amounts presented herein.
THE OPERATIONS OF SOME OF OUR FACILITIES ARE DEPENDENT UPON PAYMENTS FROM
MEDICARE AND MEDICAID PROGRAMS.
At some of our facilities, operating revenues are received from the Medicare
and Medicaid programs. On a pro forma basis, assuming completion of the
Crestline transaction, 38% of our total revenues for the nine months ended
September 30, 2001, was derived from these programs. Since 1998, a Medicare
prospective payment system has lowered Medicare rates paid to nursing homes.
Many states have adopted formulas to limit Medicaid rates. As a result, in some
instances Medicare and Medicaid rates no longer cover costs incurred by
operators, including us. Seven of our nursing homes generated operating expenses
in excess of operating revenues for the nine months ended September 30, 2001.
These seven facilities derived $13.3 million, or on average 75%, of their
revenues from Medicare or Medicaid programs during the nine months ended
September 30, 2001. At present there is an active debate within the federal
government and within many state governments between advocates who want to raise
Medicare and Medicaid rates and others who want to retain or lower current
Medicare and Medicaid rates. We cannot predict the outcome of this debate. If we
cannot cover operating costs, our financial condition and results of operations
will be adversely impacted.
OUR FACILITIES AND THEIR OPERATIONS ARE SUBJECT TO COMPLEX REGULATIONS.
Physical characteristics of senior living facilities are mandated by various
governmental authorities. Changes in these regulations may require significant
expenditures. Our leases with Senior Housing require us to maintain our
facilities in compliance with applicable laws. In the future, our facilities may
require significant expenditures to address ongoing required maintenance and
make them attractive to residents. Our available financial resources may be
insufficient to fund these expenditures.
State licensing and Medicare and Medicaid laws also require operators of
senior living facilities to comply with standards governing operations. During
the past three years, the Federal Centers for
7
Medicare and Medicaid Services, or the Federal Centers, have increased their
efforts to enforce Medicare and Medicaid standards and their oversight of state
survey agencies which inspect senior living facilities and investigate
complaints. When deficiencies are identified, sanctions and remedies such as
denials of payment for new Medicare and Medicaid admissions, civil money
penalties, state oversight and loss of Medicare and Medicaid participation may
be imposed. The Federal Centers and the states are increasingly using such
sanctions and remedies when deficiencies, especially those involving findings of
substandard care or repeat violations, are identified. Sanctions and remedies
have been imposed on some of our nursing homes from time to time. For portions
of the nine month period ended September 30, 2001, ten of our properties were
under sanctions and were subjected to more frequent inspections but not to
material financial penalties. As of the date of this prospectus, none of our
properties are subject to sanctions. It is possible that sanctions will be
imposed on us in the future and that such sanctions, if imposed, may have
adverse financial consequences to us.
HEALTHCARE OPERATIONS ARE SUBJECT TO LITIGATION RISKS.
There are various federal and state laws prohibiting fraud by healthcare
providers, including criminal provisions that prohibit filing false claims for
Medicare and Medicaid payments and laws that govern patient referrals. The state
and federal governments seem to be devoting increasing resources to anti-fraud
initiatives against healthcare providers. In some states, advocacy groups have
been created to monitor the quality of care at senior living facilities, and
these groups have brought litigation against operators. Also, in several
instances private litigation by nursing home patients has succeeded in winning
very large damage awards for alleged abuses. The effect of this litigation and
potential litigation has been to increase materially the costs of monitoring and
reporting quality of care compliance. In addition, the cost of medical
malpractice insurance has increased and may continue to increase so long as the
present litigation environment affecting the operations of nursing homes and
other senior living facilities continues.
OUR CREATION AND INITIAL BUSINESS WAS, AND OUR CONTINUING BUSINESS WILL BE,
SUBJECT TO CONFLICTS OF INTEREST WITH SENIOR HOUSING, REIT MANAGEMENT AND
MESSRS. PORTNOY AND MARTIN.
Our creation and initial business was, and our continuing business will be
subject to conflicts of interest, as follows:
- All of our directors were trustees of Senior Housing at the time we were
created.
- Upon completion of the spin-off we expect to have five directors, four of
whom also will be trustees of Senior Housing.
- Our chief executive officer and our chief financial officer are currently
employees of Reit Management, and they will remain part time employees of
Reit Management after the spin-off. Reit Management is the investment
manager for Senior Housing, HRPT Properties and Hospitality Properties,
and we will purchase various services from Reit Management pursuant to a
shared services agreement.
- Two of our directors, Barry M. Portnoy and Gerard M. Martin, are also
Managing Trustees of Senior Housing and of other REITs managed by Reit
Management. Messrs. Portnoy and Martin also own FSQ, Inc., Reit Management
and another entity that leases office space to us.
These conflicts may have caused, and in the future may cause, our business
to be adversely affected, including as follows:
- The leases we will enter with Senior Housing may be on terms less
favorable to us than leases which would have been entered as a result of
arm's length negotiations.
- The terms of our merger with FSQ, Inc., our shared services agreement with
Reit Management or our office lease with an entity owned by
Messrs. Portnoy and Martin may be less favorable to us than we could have
achieved on an arm's length basis; specifically, the consideration we will
pay in the merger of 250,000 of our common shares, our payments of 0.6% of
our total revenues
8
for shared services, equal to $2.9 million on a pro forma basis for the
year ended December 31, 2000 assuming the completion of the Crestline
transaction, or office rent of $531,069 per year may be greater than if
these matters were negotiated with third parties.
- Future business dealings between us and Senior Housing, Reit Management,
Messrs. Portnoy and Martin and their affiliates may be on terms less
favorable to us than we could achieve on an arm's length basis.
- We will have to compete with Senior Housing and Reit Management for the
time and attention of our directors and officers, including
Messrs. Portnoy and Martin.
OUR PROPERTY LEASES WILL BE SUBORDINATED TO SENIOR HOUSING'S DEBTS.
Our leases for some of the Marriott properties which Senior Housing expects
to acquire will be subordinated to mortgages. The leases for all properties
which we lease from Senior Housing may be subordinated to additional
indebtedness Senior Housing incurs. In the event Senior Housing defaults upon
the existing mortgages or future debts to which our leases are subordinated, we
may lose our rights to continue operating the leased properties.
OWNERSHIP LIMITATIONS AND ANTI-TAKEOVER PROVISIONS MAY PREVENT YOU FROM
RECEIVING A TAKEOVER PREMIUM.
Our charter will prohibit any party from owning more than 9.8% of our
outstanding common shares. Our leases with Senior Housing, our shared services
agreement and our transaction agreement also restrict our share ownership and
prohibit any change of control of us. Our charter and bylaws contain other
provisions that may increase the difficulty of acquiring control of us by means
of a tender offer, open market purchases, a proxy fight or otherwise, if the
acquisition is not approved by our Board of Directors. These other anti-takeover
provisions include the following:
- a staggered Board of Directors with separate terms of service for each
class of directors;
- the availability, without a shareholders' vote, of additional shares and
classes of shares that our Board of Directors may authorize and issue on
terms that it determines;
- a 75% shareholder vote required for removal of directors for cause; and
- advance notice procedures with respect to nominations of directors and
shareholder proposals.
For all of these reasons, you may be unable to realize a change of control
premium for the common shares that you receive in the spin-off distribution.
THE SENIOR LIVING INDUSTRY IS HIGHLY COMPETITIVE.
We will compete with numerous other companies which provide senior living
alternatives, including home healthcare companies and other real estate based
service providers. Historically, nursing homes have been somewhat protected from
competition by state requirements of obtaining certificates of need to develop
new facilities; however, these barriers are being eliminated in many states.
Also, there are few barriers to competition for home healthcare or for
independent and assisted living services. Growth in availability of nursing home
alternatives, including assisted living facilities, has and may in the future
have the effect of reducing the occupancy or operating profitability at nursing
homes including those we operate. Many of our existing competitors are larger
and have greater financial resources than us. Accordingly, we cannot provide any
assurances that we will be able to attract a sufficient number of residents to
our facilities or that we will be able to attract employees and keep wages and
other employee costs at levels which will allow us to operate profitably, and we
do not know whether we will be able to grow our business by acquiring additional
operations.
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OUR RELATIONSHIPS WITH SENIOR HOUSING AND WITH REIT MANAGEMENT MAY INHIBIT OUR
ABILITY TO GROW OUR BUSINESS.
In connection with this spin-off we will enter agreements which prohibit us
from acquiring or financing real estate in competition with Senior Housing, HRPT
Properties, Hospitality Properties or other real estate entities managed by Reit
Management, unless those investment opportunities are first offered to Senior
Housing, HRPT Properties, Hospitality Properties or those real estate entities.
Any of these conditions may make it difficult, more expensive or impossible for
us to alter our business growth strategy in the future to include investments in
real estate.
Because of our various relationships with Senior Housing and Reit
Management, competitors of those companies may be unwilling to lease senior
living facilities to us or conduct business with us. Also, because we have
limited ability to incur debt and ownership of more than 9.8% of our shares by a
party is prohibited, we may be unable to finance future growth opportunities.
These circumstances may prevent us from realizing some growth opportunities.
WE HAVE A LIMITED OPERATING HISTORY.
We are a recently formed company, have a limited operating history, and we
have not previously operated as an independent public company. Accordingly, we
may be unable to execute our business plans effectively.
OUR MANAGEMENT TEAM HAS LIMITED EXPERIENCE WORKING TOGETHER.
Our management team has been assembled for less than two years. We do not
have employment agreements with any of our executive officers. Two of our
executive officers and all of our directors have other business interests which
will prevent them from working full time on our business. These conditions may
make it difficult for us to carry out our business plans.
OUR LEASE OF SENIOR HOUSING FACILITIES CREATES RISKS AND LIABILITIES ASSOCIATED
WITH REAL ESTATE.
Our leases require that we pay for and indemnify Senior Housing from all
liabilities associated with the ownership or operation of the facilities we
lease from Senior Housing which arise prior to or during the terms of our
leases. Accordingly, our business will be subject to risks associated with real
estate, including:
- costs associated with uninsured damages, including damages for which
insurance may be unavailable or unavailable on commercially reasonable
terms;
- costs and damages caused by eminent domain takings;
- costs that may be required for maintenance and repair; and
- the need to make expenditures due to changes in laws and other
regulations, including the Americans with Disabilities Act.
THE LEASE OF SENIOR HOUSING FACILITIES CREATES RISKS AND LIABILITIES DUE TO
ENVIRONMENTAL HAZARDS.
Under various laws in the United States, operators of real estate may be
required to investigate and clean up hazardous substances present at their
leased properties, including but not limited to medical waste, mishandled
petroleum products and asbestos containing materials, and may be held liable for
property damage or personal injuries that result from such contamination. These
laws also expose us to the possibility that we become liable to reimburse the
government for damages and costs it incurs in connection with the contamination.
As the owner of real estate leased to us, Senior Housing is also subject to
similar liabilities, and we have agreed to indemnify Senior Housing from costs
it incurs at our leased properties related to environmental hazards which arise
prior to or during the terms of our leases. We can give you no assurance that
environmental liabilities are not present in our operated facilities or that
costs we incur to remediate contamination or the presence of asbestos will not
have a material adverse effect on our business and financial condition.
10
THE SPIN-OFF
KEY DATES
DATE ACTIVITY
---- --------
December 6, 2001..................... PROSPECTUS MAILING DATE. The date the registration statement
of which this prospectus is a part was declared effective by
the SEC. We have mailed this prospectus to you on or about
this date.
December 17, 2001.................... RECORD DATE. Senior Housing common shareholders will receive
one share of our common stock for every 10 Senior Housing
common shares owned of record on this date. Because HRPT
Properties owns 29% of Senior Housing, HRPT Properties will
receive our shares from Senior Housing. Our shares that HRPT
Properties receives from Senior Housing will be distributed
by HRPT Properties to its shareholders. HRPT Properties
common shareholders will receive one share of our common
stock for every 100 HRPT Properties common shares owned of
record on this date. After our declaration of the record
date, a market for our shares may develop before the
distribution date and our shares may begin to trade. A
market that develops for shares that will be issued in the
future is referred to as a "when issued" market. If a "when
issued" market develops for our shares, a market may develop
for the trading of Senior Housing shares and HRPT Properties
shares which do not include the right to receive the
distribution of our shares, which is referred to as a "when
issued/ex dividend" market.
December 31, 2001.................... DISTRIBUTION DATE. 4,342,170 of our common shares will be
delivered to the distribution agent on this date, and the
spin-off will be completed. If you hold Senior Housing or
HRPT Properties common shares in a brokerage account, your
shares of our common stock will be credited to that account.
If you hold Senior Housing or HRPT Properties common shares
in certificated form, a certificate representing your shares
of our common stock will be mailed to you; the mailing
process is expected to take about 30 days. If a "when
issued" and "when issued/ex dividend" market has developed
for our shares and for Senior Housing and HRPT Properties
shares, respectively, it will cease on this date; and
thereafter all those shares will trade in the regular way.
January 2, 2002...................... MERGER DATE. FSQ, Inc. will merge with a subsidiary of ours
on this date. As a result of this merger, FSQ, Inc. will
become a wholly owned subsidiary of ours and Messrs. Portnoy
and Martin will each receive 125,000 of our common shares.
Early in 2002........................ CRESTLINE TRANSACTION DATE. We expect Senior Housing to
acquire 31 Marriott facilities from Crestline on this date.
Simultaneously with this closing, we will lease these 31
Marriott facilities from Senior Housing.
DISTRIBUTION AGENT
The distribution agent for the spin-off will be EquiServe Trust Company,
N.A.
11
LISTING AND TRADING OF OUR SHARES
There is currently no public market for our shares. Our shares have been
approved for listing on the American Stock Exchange, or AMEX, under the symbol
"FVE". A "when issued" market, if one develops, may permit you and others to
trade our shares on the AMEX before the shares are distributed.
Until we have distributed our shares and an orderly trading market develops,
the price of our shares may fluctuate significantly. We expect trading in the
regular way on the AMEX will commence on the trading day following the
distribution date. You should understand that the listing of our shares will not
ensure that an active trading market will be available to you. Many factors will
influence the market price of our shares, including the depth and liquidity of
the market which develops, investor perception of our business and growth
prospects and general market conditions.
BACKGROUND AND REASONS FOR THE SPIN-OFF
In order to maintain its status as a REIT for federal income tax purposes,
in most cases a substantial majority of Senior Housing's revenues must be
derived from real estate rents and mortgage interest.
In July 2000, Senior Housing repossessed or acquired nursing homes from
bankrupt former tenants. These facilities are now managed for Senior Housing's
account by FSQ, Inc. IRC rules applicable to REITs restrict the manner and
period these operations may be conducted and make the profits from these
operations subject to corporate income tax. By completing this spin-off, Senior
Housing will be able to continue indefinitely its ownership of these facilities,
and the rent Senior Housing receives from us may generally be distributed to
Senior Housing shareholders without any corporate federal income tax being paid
by Senior Housing.
In August 2001, Senior Housing agreed to acquire 31 Marriott facilities from
Crestline. The income now realized from these properties is not the type of
income which REITs may receive under applicable IRC rules. By completing this
spin-off and leasing these facilities to us, Senior Housing may remain a REIT
and realize a significant part of the future income from these facilities as
rent without corporate federal tax on income generated from these facilities by
Senior Housing.
We have been formed by Senior Housing to meet Senior Housing's need for a
tenant for the 56 facilities managed by FSQ, Inc. and the 31 Marriott
facilities. We will be able to do so because we will be taxed as a regular
corporation rather than a REIT. Also, in order to acquire the personnel, systems
and assets used in managing the 56 facilities, we have agreed to acquire FSQ,
Inc. on January 2, 2002.
HRPT Properties is a REIT which owns 29% of Senior Housing's shares. When
our shares are distributed by Senior Housing, HRPT Properties will
simultaneously distribute all of our shares that it receives to HRPT Properties
shareholders. HRPT Properties has agreed to make this simultaneous distribution
because doing so will allow HRPT Properties to retain its own REIT status as
well as assist Senior Housing to retain its REIT status.
For a more detailed discussion of the tax provisions applicable to REITs
which underlie this spin-off, see "Federal Income Tax Considerations".
MANNER OF EFFECTING THE SPIN-OFF AND RELATED TRANSACTIONS
To effect the spin-off and related transactions, the following material
actions will occur:
- Senior Housing will capitalize us with $50 million of net assets,
consisting primarily of cash and receivables net of accounts payable
arising from the operations of 56 senior living facilities now managed for
Senior Housing by FSQ, Inc.
12
- Senior Housing will distribute 4,342,170 of our shares to its
shareholders, and retain 25,000 of our shares. Senior Housing shareholders
will receive one of our shares for every 10 common shares of Senior
Housing owned on the record date.
- HRPT Properties will distribute all of our shares it receives to its
shareholders. HRPT Properties shareholders will receive one of our shares
for every 100 common shares of HRPT Properties owned on the record date.
Because Senior Housing owns 1,000,000 common shares of HRPT Properties,
Senior Housing will receive 10,000 additional shares of ours from HRPT
Properties.
- Upon completion of the distribution of our shares by Senior Housing and
HRPT Properties, our lease for the 56 facilities now managed for Senior
Housing by FSQ, Inc. will become effective and our agreement with Senior
Housing to lease the 31 Marriott facilities which Senior Housing has
agreed to purchase from Crestline will become binding.
- On January 2, 2002, we will issue 125,000 of our shares to each of
Messrs. Portnoy and Martin and acquire FSQ, Inc. The now existing
management agreement between FSQ, Inc. and Senior Housing will be
cancelled.
- The lease for the 31 Marriott facilities will be effective when the
Crestline transaction is closed, which we expect to occur in early 2002.
If you hold Senior Housing or HRPT Properties common shares in a brokerage
account, your shares of our common stock will be credited to that account. If
you hold Senior Housing or HRPT Properties common shares in certificated form, a
certificate representing your shares of our common stock will be mailed to you
by the distribution agent; the mailing process is expected to take about
30 days.
No cash distributions will be paid and we will issue fractional shares of
our common stock in connection with the spin-off distribution as necessary.
No holder of common shares of Senior Housing or HRPT Properties is required
to make any payment or exchange any shares in order to receive our common
shares.
THE TRANSACTION AGREEMENT
In order to effect the spin-off and to govern relations after the spin-off,
we will enter a transaction agreement with Senior Housing, HRPT Properties,
Hospitality Properties, FSQ, Inc. and Reit Management. This transaction
agreement has been filed as an exhibit to the registration statement of which
this prospectus is a part. If you want more information about the actions which
have been and will be taken to effect the spin-off or about the agreements among
us, Senior Housing, HRPT Properties, Hospitality Properties, FSQ, Inc. and Reit
Management concerning future relations, you should read the entire transaction
agreement. The material provisions of the transaction agreement are summarized
as follows:
- Senior Housing will capitalize us with net equity of $50 million
consisting primarily of cash and accounts receivable net of accounts
payable arising from the operation of the 56 senior living facilities now
owned by Senior Housing which we will lease.
- On the distribution date Senior Housing will distribute 4,342,170 of our
shares to its shareholders; and HRPT Properties will distribute all of our
shares that it receives as a Senior Housing shareholder to HRPT
Properties' shareholders.
- Our lease for the 56 facilities now owned by Senior Housing will be
effective on the distribution date. See "The Company -- Our Lease for the
56 Facilities".
13
- On January 2, 2002, in order to acquire the personnel, systems and assets
necessary to operate the 56 facilities which we will lease, we will
acquire FSQ, Inc. See "-- The Merger Transaction".
- To retain certain services now provided by Reit Management to FSQ, Inc.,
simultaneously with the FSQ, Inc. merger we will enter a shared services
agreement with Reit Management. See "Management -- Our Shared Services
Agreement with Reit Management".
- When Senior Housing acquires the 31 Marriott facilities from Crestline, we
will lease those facilities from Senior Housing. See "-- The Crestline
Transaction" and "The Company -- Our Lease for the Marriott Facilities".
- Hospitality Properties will provide certain consents to Crestline in order
to facilitate the closing of the Crestline transaction and our lease of
the 31 Marriott facilities.
- We will afford Senior Housing, HRPT Properties, Hospitality Properties or
any other public company for which Reit Management serves as investment
manager the opportunity to acquire or finance any real estate investments
of the types in which they invest before we do.
- We will agree to restrict the ownership of our shares and conduct all of
our business activities in a manner which may prevent a change of control
of us or a sale of a material portion of our assets and does not
jeopardize Senior Housing's or HRPT Properties' status as a REIT. See
"Material Provisions of Maryland Law, Our Charter and
Bylaws -- Restrictions on Share Ownership and Transfer".
- We and Senior Housing will cooperate to file future tax returns including
appropriate allocation of taxable income, expenses and other tax
attributes.
- We will agree to indemnify Senior Housing for liabilities which may arise
relating to our business, operations and the leased facilities, for
periods either before or after the spin-off.
- Senior Housing will pay all of the costs and expenses of the spin-off and
related transactions which may be incurred by the parties to the
transaction agreement.
THE MERGER TRANSACTION
Promptly after completion of the spin-off, one of our subsidiaries will
merge into FSQ, Inc. so that we may acquire the personnel, systems and assets
now used by FSQ, Inc. to manage the 56 facilities which we will lease from
Senior Housing. The merger agreement between FSQ, Inc., one of our subsidiaries
and us has been filed as an exhibit to the registration statement of which this
prospectus is a part. If you want more information about this merger
transaction, you should read the merger agreement. The material terms of the
merger agreement are summarized as follows:
- The merger will be a stock for stock transaction.
- One of our wholly owned subsidiaries will merge into FSQ, Inc.
- As consideration in the merger, we will issue 125,000 shares of our common
stock to each of Messrs. Portnoy and Martin, the current owners of FSQ,
Inc.
- After the merger we will own 100% of FSQ, Inc.
- The merger and related indemnity agreement will contain customary closing
conditions, representations, warranties and indemnities between us and
Messrs. Portnoy and Martin, as owners of FSQ, Inc.
In connection with this merger, the Board of Trustees of Senior Housing has
received the opinion dated December 5, 2001 of UBS Warburg LLC, an
internationally recognized investment banking firm, to the effect that, as of
the date of the opinion and based on and subject to various assumptions,
14
matters considered and limitations described in the opinion, the consideration
provided for in the merger agreement was fair, from a financial point of view,
to us.
THE CRESTLINE TRANSACTION
In August 2001, Senior Housing agreed to purchase all of the outstanding
capital stock of one of Crestline's subsidiaries that owns 31 senior living
facilities which are managed by Marriott. The total purchase price Senior
Housing will pay is $600 million, subject to adjustments. We have agreed with
Senior Housing to assume the rights and obligations of the owner under the
existing management agreements with Marriott and to acquire certain operating
assets and liabilities of these Marriott facilities simultaneously with Senior
Housing's closing with Crestline. On a pro forma basis as of September 30, 2001,
the assets and liabilities are principally composed of accounts receivable of
$8.9 million and accrued operating liabilities of $12.5 million. The net of
these operating assets and liabilities, if any, will be settled between Senior
Housing and us in cash. On a pro forma basis as of September 30, 2001, this cash
amounts to $3.6 million which we would receive from Senior Housing. Also,
simultaneously with this closing we will lease these facilities from Senior
Housing. We expect this transaction to close in early 2002. However, this
transaction is subject to certain conditions, including the following:
- approval by Crestline shareholders;
- consents from Marriott as required under its management agreements;
- consent from certain Crestline lenders to Senior Housing's assuming their
debt and our leasing the properties;
- Crestline's obtaining new mortgage financing which may be assumed by
Senior Housing which is currently expected to be $170 million; and
- various regulatory approvals for the change of ownership for these
facilities from Crestline to Senior Housing and for Senior Housing's
leases to us.
The Crestline transaction may be terminated, in addition to other customary
reasons, by either Crestline or Senior Housing:
- if the closing has not occurred prior to June 30, 2002;
- for regulatory reasons; and
- if Crestline's shareholders do not approve the transaction or if Crestline
accepts an offer to purchase the facilities from a third party other than
Senior Housing.
Under certain termination events, Crestline is required to pay a termination
fee to Senior Housing. If Senior Housing receives this fee, it will pay up to
$7.5 million to us.
A copy of the purchase agreement between Senior Housing and Crestline has
been filed as an exhibit to the registration statement of which this prospectus
is a part. If you want more information about this agreement and the various
conditions to closing you should read this purchase agreement. For more
information about the terms of our prospective lease of these 31 Marriott
facilities, see "The Company -- Our Lease for the Marriott Facilities".
DIVIDEND POLICY
We do not expect to pay dividends in the foreseeable future.
15
CAPITALIZATION
The following table describes our pro forma capitalization as of
September 30, 2001, assuming the capitalization by Senior Housing pursuant to
the transaction agreement and the closing of the FSQ, Inc. merger and as
adjusted for the closing of the Crestline transaction (in 000s):
AS ADJUSTED FOR THE SPIN-OFF,
AS ADJUSTED FOR THE SPIN-OFF FSQ, INC. MERGER AND THE
AND FSQ, INC. MERGER CRESTLINE TRANSACTION
---------------------------- -----------------------------
Debt........................................... $ -- $ --
Common Equity (1).............................. 51,449 51,449
------- -------
Total Capital.................................. $51,449 $51,449
======= =======
------------------------
(1) This table assumes that HRPT Properties will not purchase any of our shares
in order to complete a 1 for 100 distribution to its shareholders. See
"Security Ownership After the Spin-off" and "Plan of Distribution".
16
THE COMPANY
GENERAL
We are a corporation organized under Maryland law. We are in the business of
leasing and operating senior living facilities, including senior apartments,
assisted living facilities, congregate communities and nursing homes. Upon the
completion of the spin-off and the FSQ, Inc. merger, we will lease and operate
56 senior living facilities. Upon completion of the Crestline transaction, we
will lease an additional 31 senior living facilities.
HISTORY
Messrs. Portnoy and Martin have been active in the senior living industry
for over 25 years. In 1986 they organized HRPT Properties as a REIT to invest in
senior living and healthcare related real estate. In the mid-1990s HRPT
Properties began to diversify its investments by purchasing hotels and office
buildings. In 1995 HRPT Properties' hotel subsidiary, Hospitality Properties,
completed an initial public offering, and it now operates as a separate public
company. By the late 1990s the amount of HRPT Properties' office building
investments greatly exceeded its investments in senior living properties; and,
in October 1999, HRPT Properties concentrated its senior living investments in
Senior Housing and a majority interest in Senior Housing was spun-out to HRPT
Properties shareholders. Today, HRPT Properties continues to own 29% of the
common shares of Senior Housing, but HRPT Properties is primarily focused on
owning office buildings.
In July 2000, Senior Housing repossessed or acquired senior living
facilities from two bankrupt former tenants. Under IRC rules applicable to
REITs, Senior Housing was required to engage an independent operating company to
manage the healthcare businesses conducted at their facilities. Messrs. Portnoy
and Martin formed FSQ, Inc. to manage these facilities for Senior Housing.
During the past year, we believe the combined operations at these 56 facilities
have stabilized and improved. Simultaneously with the repossession of these
facilities, Senior Housing foreclosed upon one million HRPT Properties shares
which had been pledged by one of its bankrupt former tenants to secure its
lease.
In August 2001, Senior Housing agreed to acquire 31 senior living facilities
from Crestline for $600 million. The operations at these 31 facilities are
managed by Marriott under management contracts, generally with terms through
2027 plus one five year renewal option. The operating income generated by these
facilities is not REIT qualified income under applicable IRC rules. To complete
the Crestline transaction and remain a REIT, Senior Housing must identify a
taxable entity to lease these facilities.
We are now a 100% owned subsidiary of Senior Housing. Currently, all of the
operations of the 56 facilities are managed by FSQ, Inc. for Senior Housing. We
will enter a lease agreement with Senior Housing for these facilities. This
lease will become effective upon completion of the spin-off. Promptly after
completion of the spin-off, in order to acquire the personnel, systems and
assets now used to manage the 56 facilities which we will lease, we will acquire
FSQ, Inc. Also, we will enter an agreement to lease the 31 Marriott facilities
from Senior Housing when they are acquired by Senior Housing from Crestline.
BUSINESS AND GROWTH STRATEGY
The population of the United States is aging. We expect we may be able to
take advantage of this demographic fact by attracting new residents to, and
retaining existing residents at, our leased facilities. This attraction and
retention will be pursued through a combination of high-quality resident care
services and facilities. Our facilities strategy with regard to our 56 nursing
homes includes correcting maintenance and repairs that had been deferred at
these facilities by their former operators. We also expect to expand our
operations by leasing or managing additional senior living facilities in
conjunction with Senior Housing and independently of Senior Housing.
17
TYPES OF FACILITIES
Upon completion of the spin-off, the FSQ, Inc. merger and the Crestline
transaction, we will lease or manage senior apartments, assisted living
facilities, congregate care communities and nursing homes. Our present business
plan contemplates the leasing and management of these types of senior living
facilities, including some facilities that combine more than one type in a
single building or campus.
SENIOR APARTMENTS. Senior apartments are marketed to residents who are
generally capable of caring for themselves. Residence is usually restricted on
the basis of age. Purpose built facilities may have special function rooms,
concierge services, high levels of security and assistance call systems for
emergency use. Tenants at these facilities who need healthcare or assistance
with the activities of daily living are expected to contract independently for
these services with homemakers or home healthcare companies.
CONGREGATE COMMUNITIES. Independent living properties, or congregate
communities, also provide high levels of privacy to residents and require
residents to be capable of relatively high degrees of independence. Unlike a
senior apartment facility, a congregate community usually bundles several
services as part of a regular monthly charge -- for example, one or two meals
per day in a central dining room, weekly maid service and a social director.
Additional services are generally available from staff employees on a
fee-for-service basis. In some congregate communities, separate parts of the
facility are dedicated to assisted living or nursing services.
ASSISTED LIVING FACILITIES. Assisted living facilities are typically
comprised of one bedroom suites which include private bathrooms and efficiency
kitchens. Services bundled within one charge usually include three meals per day
in a central dining room, daily housekeeping, laundry, medical reminders and
24 hour availability of assistance with the activities of daily living such as
dressing and bathing. Professional nursing and healthcare services are usually
available at the facility on call or at regularly scheduled times. Since the
early 1990s there has been explosive growth in the number of purpose built
assisted living facilities.
NURSING HOMES. Nursing homes generally provide extensive nursing and
healthcare services similar to those available in hospitals, without the high
costs associated with operating theaters, emergency rooms or intensive care
units. A typical purpose built nursing home includes mostly two-bed units with a
separate bathroom in each unit and shared dining and bathing facilities. Some
private rooms are often available for those residents who can afford to pay
higher rates or for patients whose medical conditions require segregation.
Nursing homes are generally staffed by licensed nursing professionals 24 hours
per day.
During the past few years, nursing home operators have faced two significant
business challenges. First, the rapid expansion of the assisted living industry
which started in the early 1990s has attracted a number of residents away from
nursing homes. This was especially significant because the residents who chose
assisted living facilities often previously had been the most profitable
residents in the nursing homes. These residents required a lesser amount of care
and were able to pay higher private rates rather than government rates.
The second major challenge arose as a result of Medicare and Medicaid cost
containment laws, particularly 1997 federal legislation that required the
Medicare program to implement a prospective payment program for various subacute
services provided in nursing homes. Implementation of this Medicare prospective
payment program began on July 1, 1998. Prior to the prospective payment program,
Medicare generally paid nursing home operators based upon audited costs for
services provided. The new prospective payment system sets Medicare rates based
upon government estimated costs of treating specified medical conditions.
Although it is possible that a nursing home may increase its profit if it is
able to provide quality services at below average costs, we believe that the
effect of the new Medicare rate setting methodology has been and will be to
reduce the profitability of Medicare services in nursing homes. This belief is
based upon our observation of the impact of similar Medicare changes that were
implemented for hospitals during the 1980s and the large number of bankruptcies
18
which have occurred in the nursing home industry since the implementation of the
Medicare prospective payment system began.
GOVERNMENT REGULATION AND RATE SETTING
SENIOR APARTMENTS. Generally, government programs do not pay for housing in
senior apartments. Rents are paid from the residents' private resources.
Accordingly, the government regulations that apply to these types of properties
are generally limited to zoning, building and fire codes, Americans with
Disabilities Act requirements and other life safety type regulations applicable
to residential real estate. Government rent subsidies and government assisted
development financing for low income senior housing are exceptions to these
general statements. The development and operation of subsidized senior housing
properties are subject to numerous governmental regulations. While it is
possible that we may lease some subsidized senior apartment facilities, we do
not expect these facilities to be a major part of our future business, and after
the spin-off and the Crestline transaction, we will own no senior apartments
where rent subsidies are applicable.
CONGREGATE COMMUNITIES. Government benefits generally are not available for
services at congregate communities and the resident charges in these facilities
are paid from private resources. However, a number of Federal Supplemental
Security Income program benefits pay housing costs for elderly or disabled
residents to live in these types of residential facilities. The Social Security
Act requires states to certify that they will establish and enforce standards
for any category of group living arrangement in which a significant number of
supplemental security income residents reside or are likely to reside.
Categories of living arrangements which may be subject to these state standards
include congregate communities and assisted living facilities. Because
congregate communities usually offer common dining facilities, in many locations
they are required to obtain licenses applicable to food service establishments
in addition to complying with land use and life safety requirements. In many
states, congregate communities are licensed by state health departments, social
service agencies, or offices on aging with jurisdiction over group residential
facilities for seniors. To the extent that congregate communities maintain units
in which assisted living or nursing services are provided, these units are
subject to applicable state licensing regulations, and if the facilities receive
Medicaid or Medicare funds, to certification standards. In some states,
insurance or consumer protection agencies regulate congregate communities in
which residents pay entrance fees or prepay other costs.
ASSISTED LIVING. According to the National Academy for State Health Policy,
38 states provide or are approved to provide Medicaid payments for residents in
some assisted living facilities under waivers granted by the Federal Centers for
Medicare and Medicaid Services or under Medicaid state plans, and eight other
states are planning some Medicaid funding by requesting waivers implementing
assisted living pilot programs or demonstration projects. Because rates paid to
assisted living facility operators are lower than rates paid to nursing home
operators, some states use Medicaid funding of assisted living as a means of
lowering the cost of services for residents who may not need the higher
intensity of health-related services provided in nursing homes. States that
administer Medicaid programs for assisted living facilities are responsible for
monitoring the services at, and physical conditions of, the participating
properties. Different states apply different standards in these matters, but
generally we believe these monitoring processes are similar to the concerned
states' inspection processes for nursing homes.
In light of the large number of states using Medicaid to purchase services
at assisted living facilities and the growth of assisted living, a majority of
states have adopted licensing standards applicable to assisted living
facilities. According to the National Academy for State Health Policy, 29 states
have licensing statutes or standards specifically using the term "assisted
living". The majority of states have revised their licensing regulations
recently or are reviewing their policies or drafting or revising their
regulations. State regulatory models vary; there is no national consensus on a
definition of assisted living, and no uniform approach by the states to
regulating assisted living facilities. Most state licensing standards apply to
assisted living facilities whether or not they accept Medicaid funding.
19
Also, according to the National Academy for State Health Policy, seven states
require certificates of need from state health planning authorities before new
assisted living facilities may be developed and two states have exempted
assisted living facilities from certificate of need laws. Based on our analysis
of current economic and regulatory trends, we believe that assisted living
facilities that become dependent upon Medicaid payments for a majority of their
revenues may decline in value because Medicaid rates may fail to keep up with
increasing costs. We also believe that assisted living facilities located in
states that adopt certificate of need requirements or otherwise restrict the
development of new assisted living facilities may increase in value because
these limitations upon development may help ensure higher occupancy and higher
non-governmental rates.
Two federal government studies provide background information and make
recommendations regarding the regulation of, and the possibility of increased
governmental funding for, the assisted living industry. The first study, an
April 1999 report by the General Accounting Office to the Senate Special
Committee on Aging on assisted living facilities in four states, found a variety
of residential settings serving a wide range of resident health and care needs.
The General Accounting Office found that consumers often receive insufficient
information to determine whether a particular facility can meet their needs and
that state licensing and oversight approaches vary widely. The General
Accounting Office anticipates that as the states increase the use of Medicaid to
pay for assisted living, federal financing will likewise grow, and these trends
will focus more public attention on the place of assisted living in the
continuum of long-term care and upon state standards and compliance approaches.
The second study, a National Study of Assisted Living for the Frail Elderly, was
funded by the U.S. Department of Health and Human Services Assistant Secretary
for Planning and Evaluation and is expected to result in a report on the effects
of different service and privacy arrangements on resident satisfaction, aging in
place and affordability. In 2001, the Senate Special Committee on Aging held
hearings on assisted living and its role in the continuum of care and on
community-based alternatives to nursing homes. We cannot predict whether these
studies will result in governmental policy changes or new legislation, or what
impact any changes may have. Based upon our analysis of current economic and
regulatory trends, we do not believe that the federal government is likely to
have a material impact upon the current regulatory environment in which the
assisted living industry operates unless it also undertakes expanded funding
obligations, and we do not believe a materially increased financial commitment
from the federal government is presently likely. However, we do anticipate that
assisted living facilities will increasingly be licensed and regulated by the
various states, and that in absence of federal standards, the states' policies
will continue to vary widely.
NURSING HOMES. About 58% of all nursing home revenues in the U.S. in 1999
came from government Medicare and Medicaid programs, including about 47% from
Medicaid programs. Nursing homes are among the most highly regulated businesses
in the country. The federal and state governments regularly monitor the quality
of care provided at nursing homes. State health departments conduct surveys of
resident care and inspect the physical condition of nursing home properties.
These periodic inspections and occasional changes in life safety and physical
plant requirements sometimes require nursing home operators to make significant
capital improvements. These mandated capital improvements have in the past
usually resulted in Medicare and Medicaid rate adjustments, albeit on the basis
of amortization of expenditures over expected useful lives of the improvements.
A new Medicare prospective payment system, often referred to as PPS, began being
phased in for cost reporting years starting on or after July 1, 1998, and will
be completely phased in during 2001. Under this new Medicare payment system,
capital costs are part of the prospective rate and are not facility specific.
This new Medicare payment system and other recent legislative and regulatory
actions with respect to state Medicaid rates are limiting the reimbursement
levels for some nursing home and other eldercare services. At the same time
federal and state enforcement and oversight of nursing homes is increasing,
making licensing and certification of these facilities more rigorous. These
actions have adversely affected the revenues and increased the expenses of many
nursing home operators, including us. The new Medicare payment system was
established by the Balanced Budget Act of 1997, and was intended to reduce the
rate of growth in Medicare payments for skilled nursing facilities. Before the
20
new Medicare payment system, Medicare rates were facility-specific and
cost-based. Under the new Medicare payment system, facilities receive a fixed
payment for each day of care provided to Medicare patients. Each patient is
assigned to one of 44 care groups depending on that patient's medical
characteristics and service needs. Per diem payment rates are based on these
care groups. Medicare payments cover substantially all services provided to
Medicare patients in skilled nursing facilities, including ancillary services
such as rehabilitation therapies. The new Medicare payment system is intended to
provide incentives to providers to furnish only necessary services and to
deliver those services efficiently. During the three-year phase-in period,
Medicare rates for skilled nursing facilities are based on a blend of
facility-specific costs and rates established by the new Medicare payment
system. According to the General Accounting Office, between fiscal year 1998 and
fiscal year 1999, the first full year of the new Medicare payment system
phase-in, the average Medicare payment per day declined by about nine percent.
As of September 30, 2001, all of the facilities that we will lease from Senior
Housing on the distribution date and that participate in the Medicare program
have derived their Medicare revenues under the new payment system rates for at
least six months. The new Medicare payment system rates have been applied to 34
of our 56 leased facilities since January 1, 2001.
Since November 1999, Congress has provided some relief from the impact of
the Balanced Budget Act of 1997. Effective April 1, 2000, the Medicare, Medicaid
and SCHIP Balanced Budget Refinement Act of 1999 temporarily boosted payments
for certain skilled nursing cases by 20 percent and allowed nursing facilities
to transition more rapidly to the federal payment system. This Act also
increased the new Medicare payment rates by four percent for fiscal years 2001
and 2002 and imposed a two-year moratorium on some therapy limitations for
skilled nursing patients covered under Medicare Part B.
In December 2000, the Medicare, Medicaid and SCHIP Benefits Improvement and
Protection Act of 2000 was approved. Effective April 1, 2001, to October 1,
2002, this Act increases the nursing component of the payment rate for each care
group by 16.6%. This Act also increased annual inflation adjustments for fiscal
year 2001, increased rehabilitation care group rates by 6.7%, and maintained the
previously temporary 20% increase in the other care group rates established in
1999.
The Federal Centers for Medicare and Medicaid Services, or the Federal
Centers, have begun to implement an initiative to increase the effectiveness of
Medicare and Medicaid nursing facility survey and enforcement activities. The
Federal Centers' initiative follows a July 1998 General Accounting Office
investigation which found inadequate care in a significant proportion of
California nursing homes and the Federal Centers' July 1998 report to Congress
on the effectiveness of the survey and enforcement system. In 1999, the U.S.
Department of Health and Human Services Office of Inspector General issued
several reports concerning quality of care in nursing homes, and the General
Accounting Office issued reports in 1999 and 2000 which recommended that the
Federal Centers and the states strengthen their compliance and enforcement
practices to better ensure that nursing homes provide adequate care. In 1998,
1999 and 2000, the Senate Special Committee on Aging held hearings on these
issues. The Federal Centers are taking steps to focus more survey and
enforcement efforts on nursing homes with findings of substandard care or repeat
violations of Medicare and Medicaid standards and to identify chain-operated
facilities with patterns of noncompliance. The Federal Centers are increasing
their oversight of state survey agencies and requiring state agencies to use
enforcement sanctions and remedies more promptly when substandard care or repeat
violations are identified, to investigate complaints more promptly, and to
survey facilities more consistently. In addition, the Federal Centers have
adopted regulations expanding federal and state authority to impose civil money
penalties in instances of noncompliance. Medicare survey results for each
nursing home are posted on the internet at http://www.medicare.gov. In 2000, the
Federal Centers issued a report on their study linking nursing staffing levels
with quality of care, and the Federal Centers are assessing the impact that
minimum staffing requirements would have on facility costs and operations.
Federal efforts to target fraud and abuse and violations of anti-kickback laws
and physician referral laws by Medicare and Medicaid providers have also
increased. In March 2000, the U.S. Department of Health and Human Services
Office of Inspector General issued compliance guidelines for nursing facilities,
to assist them
21
in developing voluntary compliance programs to prevent fraud and abuse. Also,
new rules governing the privacy, use and disclosure of individually identified
health information became final in 2001 and will require compliance by 2003,
with civil and criminal sanctions for noncompliance. An adverse determination
concerning any of our licenses or eligibility for Medicare or Medicaid
reimbursement or compliance with applicable federal or state regulations could
negatively affect our financial condition and results of operations.
Most states also limit the number of nursing homes by requiring developers
to obtain certificates of need before new facilities may be built. Even states
such as California and Texas that have eliminated certificate of need laws have
often retained other means of limiting new nursing home development, such as the
use of moratoria, licensing laws or limitations upon participation in the state
Medicaid program. We believe that these governmental limitations generally make
nursing homes more valuable by limiting competition.
A number of legislative proposals that would affect major reforms of the
healthcare system have been introduced in Congress, such as additional Medicare
and Medicaid reforms and cost containment measures. We cannot predict whether
any of these legislative proposals will be adopted or, if adopted, what effect,
if any, these proposals would have on our business.
OUR SENIOR LIVING FACILITIES
Upon completion of the spin-off we will lease and operate 56 senior living
facilities which are owned by Senior Housing. These 56 facilities include 54
nursing homes and two assisted living facilities; four of the nursing homes also
contain some independent living units. These 56 facilities have 5,270 beds or
living units and they are located in 12 states. The following table provides
additional information about these facilities and their current operations:
PERCENT OF
REVENUES
NO. OF BEDS/UNITS FROM
(FUNCTIONALLY MEDICARE/
FACILITY/LOCATION TYPE OF FACILITY AVAILABLE)* OCCUPANCY* REVENUES** MEDICAID**
-------------------------- ----------------- ----------------- ---------- ------------ ----------
1. Phoenix, AZ Nursing Home 119 81.1% $ 4,336,883 78%
2. Yuma, AZ Nursing Home 125 92.6% 5,933,453 80%
3. Yuma, AZ Assisted Living 55 80.5% 577,418 0%
4. Arleta, CA Assisted Living 90 81.1% 1,455,642 0%
5. Lancaster, CA Nursing Home 99 93.0% 4,769,915 70%
6. Stockton, CA Nursing Home 116 96.1% 6,533,247 72%
7. Thousand Oaks, CA Nursing Home 124 92.8% 7,173,189 75%
8. Van Nuys, CA Nursing Home 58 96.3% 2,888,722 81%
9. Canon City, CO Nursing Home/ 133 92.1% 3,634,960 62%
Senior Apartments
10. Cherrelyn, CO Nursing Home 200 89.8% 9,358,669 83%
11. Colorado Springs, CO Nursing Home 100 76.7% 3,934,308 75%
12. Delta, CO Nursing Home 76 86.9% 3,561,334 84%
13. Grand Junction, CO Nursing Home 95 87.2% 4,045,418 64%
14. Grand Junction, CO Nursing Home 82 92.8% 4,110,896 73%
15. Lakewood, CO Nursing Home 125 84.2% 5,707,481 81%
16. New Haven, CT Nursing Home 150 98.0% 9,979,701 94%
17. Waterbury, CT Nursing Home 150 95.4% 10,034,180 93%
18. College Park, GA Nursing Home 99 90.4% 3,152,554 99%
19. Dublin, GA Nursing Home 130 84.9% 3,696,744 97%
20. Glenwood, GA Nursing Home 61 83.3% 1,725,061 94%
21. Marietta, GA Nursing Home 109 84.9% 3,589,047 88%
22. Clarinda, IA Nursing Home 96 61.2% 2,404,946 70%
23. Council Bluffs, IA Nursing Home 62 94.7% 2,403,495 89%
24. Des Moines, IA Nursing Home 85 89.7% 3,931,047 80%
25. Glenwood, IA Nursing Home 116 99.6% 6,700,259 99%
22
PERCENT OF
REVENUES
NO. OF BEDS/UNITS FROM
(FUNCTIONALLY MEDICARE/
FACILITY/LOCATION TYPE OF FACILITY AVAILABLE)* OCCUPANCY* REVENUES** MEDICAID**
-------------------------- ----------------- ----------------- ---------- ------------ ----------
26. Mediapolis, IA Nursing Home 62 88.4% 2,219,393 66%
27. Pacific Junction, IA Nursing Home 12 100.0% 730,684 95%
28. Winterset, IA Nursing Home/ 118 68.7% 2,633,879 49%
Senior Apartments
29. Ellinwood, KS Nursing Home/ 59 92.2% 1,741,190 54%
Senior Apartments
30. Farmington, MI Nursing Home 149 76.3% 10,260,143 75%
31. Howell, MI Nursing Home 172 76.1% 9,854,331 85%
32. Tarkio, MO Nursing Home 76 68.4% 1,970,096 69%
33. Ainsworth, NE Nursing Home 48 88.2% 1,678,222 69%
34. Ashland, NE Nursing Home 101 94.2% 4,413,039 69%
35. Blue Hill, NE Nursing Home 63 86.1% 2,115,889 69%
36. Campbell, NE Nursing Home 45 88.1% 1,592,978 75%
37. Central City, NE Nursing Home 66 93.4% 2,314,880 73%
38. Columbus, NE Nursing Home 48 97.7% 2,085,751 63%
39. Edgar, NE Nursing Home 52 85.4% 1,622,872 65%
40. Exeter, NE Nursing Home 48 88.9% 1,496,107 59%
41. Grand Island, NE Nursing Home 76 97.7% 3,007,170 65%
42. Gretna, NE Nursing Home 63 90.9% 2,466,417 68%
43. Lyons, NE Nursing Home 63 81.6% 1,831,253 58%
44. Milford, NE Nursing Home 54 89.5% 1,937,522 69%
45. Sutherland, NE Nursing Home 62 90.6% 2,320,377 81%
46. Utica, NE Nursing Home 40 95.1% 1,710,904 74%
47. Waverly, NE Nursing Home 50 87.1% 2,037,489 49%
48. Brookfield, WI Nursing Home 226 93.6% 11,581,198 71%
49. Clintonville, WI Nursing Home 100 87.9% 3,366,821 78%
50. Clintonville, WI Nursing Home 61 94.1% 3,196,578 68%
51. Madison, WI Nursing Home 63 72.6% 2,753,580 59%
52. Milwaukee, WI Nursing Home 154 80.5% 6,226,508 82%
53. Pewaukee, WI Nursing Home 160 90.7% 6,916,165 74%
54. Waukesha, WI Nursing Home 105 95.6% 5,082,921 57%
55. Laramie, WY Nursing Home 120 75.7% 4,441,856 70%
56. Worland, WY Nursing Home/ 99 77.2% 3,366,246 72%
Senior Apartments
----- ------ ------------ ---
TOTALS: 5,270 87.1% $224,611,028 76%
beds/ units
------------------------
*/ Based upon functionally available beds/units for the period January 1, 2001,
through September 30, 2001. Total licensed bed/unit capacity is 5,593.
**/ January 1, 2001, through September 30, 2001, annualized.
After it repossessed or acquired the foregoing facilities from bankrupt
former tenants, Senior Housing undertook to correct deferred maintenance which
had been allowed to occur at these facilities by their former tenants. Between
July 2000 and September 2001, $5.7 million was spent by Senior Housing under
this program. We expect this deferred maintenance to be largely completed by the
time of the spin-off; and in the transaction agreement, Senior Housing will
agree to provide us with sufficient cash to fund the estimated costs of certain
projects which remain unfinished at the time of the spin-off without any
adjustment to our rent. During the course of these projects, parts of these
facilities are sometimes closed and these closings can adversely impact
occupancy; however, we believe these projects are necessary for continuing
operations at these facilities and may make the facilities more attractive to
residents.
23
Upon completion of the Crestline transaction we expect to lease an
additional 31 senior living facilities from Senior Housing. These facilities
contain 7,487 living units and are located in 13 states. The following table
provides additional information about these facilities and their current
operations:
PERCENT OF REVENUES
NO. OF ANNUALIZED FROM PRIVATE
FACILITY LOCATION TYPE OF UNITS UNITS OCCUPANCY* REVENUES** PAY SOURCES***
------------------- ------------------ -------- ---------- ------------ -------------------
1. Peoria, AZ Independent Living 155
Assisted Living 79
Nursing Care 57
-----
291 90.4% $ 9,206,164 95.0%
2. Scottsdale, AZ Independent Living 167
Assisted Living 33
Nursing Care 96
-----
296 91.7% 11,328,565 92.8%
3. Tucson, AZ Independent Living 202
Assisted Living 30
Special Care 27
Nursing Care 67
-----
326 95.9% 11,748,561 94.7%
4., 5. San Diego, CA Independent Living 246
(2 properties) Assisted Living 100
Nursing Care 59
-----
405 94.1% 18,369,605 98.5%
6. Newark, DE Independent Living 62
Assisted Living 26
Nursing Care 110
-----
198 97.0% 9,661,986 74.5%
7. Wilmington, DE Independent Living 140
Assisted Living 37
Nursing Care 66
-----
243 96.6% 11,390,174 88.0%
8. Wilmington, DE Independent Living 71
Assisted Living 44
Nursing Care 46
-----
161 94.2% 6,058,991 97.4%
9. Wilmington, DE Independent Living 62
Assisted Living 15
Nursing Care 82
-----
159 92.9% 7,311,724 79.5%
10. Wilmington, DE Assisted Living 51
Special Care 26
Nursing Care 31
-----
108 68.0% 3,065,660 100.0%
11. Coral Springs, FL Independent Living 184
Assisted Living 62
Nursing Care 35
-----
281 90.3% 9,191,159 91.1%
24
PERCENT OF REVENUES
NO. OF ANNUALIZED FROM PRIVATE
FACILITY LOCATION TYPE OF UNITS UNITS OCCUPANCY* REVENUES** PAY SOURCES***
------------------- ------------------ -------- ---------- ------------ -------------------
12. Deerfield Beach, FL Independent Living 198
Assisted Living 33
Nursing Care 60
-----
291 89.0% 10,547,804 78.9%
13. Ft. Lauderdale, FL Assisted Living 109 90.0% 2,102,493 100.0%
14. Ft. Myers, FL Assisted Living 85 89.7% 2,223,621 100.0%
15. Palm Harbor, FL Independent Living 230
Assisted Living 87
-----
317 81.4% 7,156,858 100.0%
16. West Palm Beach, FL Independent Living 276
Assisted Living 64
-----
340 85.0% 7,222,533 100.0%
17. Indianapolis, IN Independent Living 117
Special Care 30
Nursing Care 74
-----
221 93.0% 10,579,381 89.4%
18. Overland Park, KS Independent Living 117
Assisted Living 30
Nursing Care 60
-----
207 94.2% 8,151,923 93.0%
19. Lexington, KY Independent Living 149 93.0% 4,057,754 100.0%
20. Lexington, KY Assisted Living 22
Nursing Care 111
-----
133 94.7% 6,899,220 76.9%
21. Louisville, KY Independent Living 240
Assisted Living 24
Nursing Care 60
-----
324 97.1% 10,566,732 94.5%
22. Winchester, MA Assisted Living 125 98.1% 5,619,342 100.0%
23. Lakewood, NJ Independent Living 217
Assisted Living 108
Special Care 31
Nursing Care 60
-----
416 80.4% 14,999,394 92.3%
24. Albuquerque, NM Independent Living 114
Assisted Living 34
Nursing Care 60
-----
208 98.8% 9,212,891 96.1%
25. Columbus, OH Independent Living 143
Assisted Living 87
Special Care 25
Nursing Care 60
-----
315 91.9% 13,159,571 95.1%
26. Myrtle Beach, SC Assisted Living 60
Special Care 36
Nursing Care 68
-----
164 81.2% 5,618,344 77.4%
25
PERCENT OF REVENUES
NO. OF ANNUALIZED FROM PRIVATE
FACILITY LOCATION TYPE OF UNITS UNITS OCCUPANCY* REVENUES** PAY SOURCES***
------------------- ------------------ -------- ---------- ------------ -------------------
27. Dallas, TX Independent Living 190
Assisted Living 38
Nursing Care 90
-----
318 91.1% 12,740,302 90.3%
28. El Paso, TX Independent Living 123
Special Care 15
Nursing Care 120
-----
258 85.9% 9,589,566 77.7%
29. Houston, TX Independent Living 197
Assisted Living 71
Special Care 60
Nursing Care 87
-----
415 95.9% 17,431,197 95.1%
30. San Antonio, TX Independent Living 151
Assisted Living 30
Special Care 28
Nursing Care 60
-----
269 96.2% 10,747,120 96.3%
31. Woodlands, TX Independent Living 239
Assisted Living 100
Special Care 16
-----
355 91.1% 10,291,170 100.0%
TOTALS: 31 properties Independent Living 3,990
13 states Assisted Living 1,584
Special Care 294
Nursing Care 1,619
----- ----- ------------ ------
7,487 91.1% $276,249,805 91.1%
--------------------------
*/ December 30, 2000, through September 7, 2001.
**/ December 30, 2000, through September 7, 2001, annualized.
***/ December 31, 2000, through August 10, 2001.
26
OUR LEASE FOR THE 56 FACILITIES
Upon completion of the spin-off, our lease for the 56 facilities now owned
by Senior Housing will become effective. One of our subsidiaries will be tenant
to the lease with Senior Housing. A different subsidiary of ours will be tenant
under our lease for the Marriott facilities. We will guarantee our subidiaries'
obligations under the leases. This lease requires us to maintain Senior
Housing's facilities during the lease term and to indemnify Senior Housing for
any liability which may arise during the lease term by reason of ownership and
operation of the properties during or prior to the lease term. The lease has
been filed as an exhibit to the registration statement of which this prospectus
is a part. If you want more information about the lease terms, you should read
the entire lease. The following is a summary of material terms of this lease:
OPERATING COSTS. The lease is a so-called "triple-net" lease which requires
us to pay all costs incurred in the operation of the facilities, including the
costs of personnel, service to residents, insurance and real estate and personal
property taxes.
MINIMUM RENT. The lease requires us to pay minimum rent to Senior Housing
of $7 million per year.
PERCENTAGE RENT. Starting in 2004, the lease requires additional rent with
respect to each lease year in an amount equal to three percent (3%) of net
patient revenues at each leased facility in excess of net patient revenues at
such facility during 2003.
TERM. The lease expires on December 31, 2018.
RENEWAL OPTION. We have the option to renew the lease for all but not less
than all the facilities for one renewal term ending on June 30, 2033, by notice
to Senior Housing on or before June 20, 2015. We may not exercise this renewal
option unless we also exercise our renewal option under our lease for the
Marriott facilities.
RENT DURING RENEWAL TERM. Rent during the renewal term shall be a
continuation of minimum rent and percentage rent payable during the initial
term.
MAINTENANCE AND ALTERATIONS. We are required to maintain, at our expense,
the leased facilities in good order and repair, including structural and
nonstructural components. We may request Senior Housing to fund amounts needed
for repairs and renovations in return for rent adjustments to provide Senior
Housing a return on its investment according to a formula set forth in the
lease. At the end of the lease term, we are required to surrender the leased
facilities in substantially the same condition as existed on the commencement
date of the lease, subject to any permitted alterations and subject to ordinary
wear and tear.
ASSIGNMENT AND SUBLETTING. Senior Housing's consent is generally required
for any direct or indirect assignment or sublease of any of the facilities. In
the event of any assignment or subletting, we will remain liable under the
lease.
ENVIRONMENTAL MATTERS. We are required, at our expense, to remove and
dispose of any hazardous substance at the leased facilities in compliance with
all applicable environmental laws and regulations. We have indemnified Senior
Housing for any liability which may arise as a result of the presence of
hazardous substances at any leased facilities and from any violation or alleged
violation of any applicable environmental law or regulation.
27
INDEMNIFICATION AND INSURANCE. With limited exceptions, we are required to
indemnify Senior Housing from all liabilities which may arise from the ownership
or operation of the facilities. We generally are required to maintain
commercially reasonable insurance. At the outset, that insurance will include
the following types of insurance:
- "all-risk" property insurance, in an amount equal to 100% of the full
replacement cost of the facilities;
- business interruption insurance;
- comprehensive general liability insurance, including bodily injury and
property damage, in amounts as are generally maintained by companies
providing senior living services;
- flood insurance if any facility is located in whole or in part in a flood
plain;
- worker's compensation insurance if required by law; and
- such additional insurance as may be generally maintained by companies
providing senior living services.
The lease requires that Senior Housing be named as an additional insured
under these policies.
DAMAGE, DESTRUCTION OR CONDEMNATION. If any of the leased facilities is
damaged by fire or other casualty or taken for a public use, we are generally
obligated to rebuild unless the facility cannot be restored. If the facility
cannot be restored, Senior Housing will generally receive all insurance or
taking proceeds and we are liable to Senior Housing for the amount of any
deductible or deficiency between the replacement cost and the insurance
proceeds.
EVENTS OF DEFAULT. Events of default under the lease include the following:
- our failure to pay rent or any other sum when due;
- our failure to maintain the insurance required under the lease;
- the occurrence of certain events with respect to our insolvency;
- the institution of a proceeding for our dissolution;
- any person or group of affiliated persons acquiring ownership of more than
9.8% of us without Senior Housing's consent;
- any change in our control or sale of a material portion of our assets
without Senior Housing's consent;
- our default under any lease for the Marriott facilities;
- our default under any indebtedness which gives the holder the right to
accelerate;
- our being declared ineligible to receive reimbursement under Medicare or
Medicaid programs for any of the leased facilities; and
- our failure to perform any terms, covenants or agreements of the lease and
the continuance thereof for a specified period of time after written
notice.
REMEDIES. Upon the occurrence of any event of default, the lease provides
that, among other things, Senior Housing may, to the extent legally permitted:
- accelerate the rent;
- terminate the lease;
- terminate any other lease which we have with Senior Housing;
28
- enter the property and take possession of any and all our personal
property and retain or sell the same at public or private sale; and
- make any payment or perform any act required to be performed by us under
the lease.
We are obligated to reimburse Senior Housing for all costs and expenses
incurred in connection with any exercise of the foregoing remedies.
MANAGEMENT. We may not enter into, amend or modify any management agreement
affecting any leased property without the prior written consent of Senior
Housing.
LEASE SUBORDINATION. Our lease may be subordinated to any mortgages of the
leased properties by Senior Housing.
FINANCING LIMITATIONS; SECURITY. We may not incur debt secured by our
investments in our subsidiary tenants. Further, our tenant subsidiaries are
prohibited from incurring liabilities other than operating liabilities incurred
in the ordinary course of business, those liabilities secured by their
receivables or purchase money debt. We are required to pledge 100% of the equity
interests of our tenant or subtenant subsidiaries to Senior Housing or its
lenders.
OUR LEASE FOR THE MARRIOTT FACILITIES
We expect that Senior Housing will acquire 31 Marriott facilities from
Crestline in early 2002. We will lease these properties from Senior Housing at
the time they are acquired. The material terms of our lease arrangements for
these facilities will be substantially the same as those of our lease for the 56
facilities now owned by Senior Housing, except as follows:
MINIMUM RENT. The lease requires us to pay minimum rent to Senior Housing
of $63 million per year.
PERCENTAGE RENT. Starting in 2003, the lease requires additional rent with
respect to each lease year in an amount equal to five percent (5%) of net
patient revenues at each leased facility in excess of net patient revenues at
such facility during 2002.
FF&E RESERVES. We are required to maintain accounts for capital
replacements and improvements as described below in "--Marriott Management--FF&E
Reserves and Capital Improvements".
TERM. The lease term expires in December 2017.
RENEWAL OPTIONS. We will have two options to renew the lease for all but
not less than all the facilities: the first for 10 years ending in June 2027;
and the second for five years ending in June 2032. We may not exercise these
renewal options unless we have exercised our renewal option under the lease for
the 56 facilities. The first renewal option must be exercised by notice to
Senior Housing two years prior to the expiration of the initial term. The second
renewal option must be exercised by notice to Senior Housing at least 11 months
before the then current term expires.
EVENTS OF DEFAULT. In addition to the events of default described under our
lease for the 56 facilities now owned by Senior Housing, the lease for the
Marriott facilities will include the following events of default:
- our default under any Marriott management agreement; and
- our default under any lease for the 56 facilities now owned by Senior
Housing.
The lease has been filed as an exhibit to the registration statement of
which this prospectus is a part. If you want more information about lease terms,
you should read the entire lease.
29
MARRIOTT MANAGEMENT
The 31 facilities to be acquired by Senior Housing from Crestline are each
subject to a management agreement with Marriott. At the time the lease of these
31 facilities commences, we will assume all of the owner's rights and
responsibilities under these management agreements. The following is a
description of the material terms of the management agreements. If you want more
information about these agreements, you should read the representative form of
management agreement which has been filed as an exhibit to the registration
statement of which this prospectus is a part.
TERM. Generally each of the management agreements has an initial term
expiring in 2027, with one five-year renewal term at Marriott's option.
FACILITY SERVICES. Marriott has responsibility and authority for all
day-to-day operations of the managed facilities, including obtaining and
maintaining all licenses necessary for operations, establishing resident care
policies and procedures, carrying out and supervising all necessary repairs and
maintenance, procuring food, supplies, equipment, furniture and fixtures, and
establishing prices, rates and charges for services provided. Marriott also
recruits, employs and directs all facility based employees, including managerial
employees.
CENTRAL SERVICES. Marriott also furnishes certain central administrative
services, which are provided on a central or regional basis to all senior living
facilities managed by Marriott. Such services include: (i) marketing and public
relations; (ii) human resources program development; (iii) information systems
development and support; and (iv) centralized computer payroll and accounting.
WORKING CAPITAL. We will be required to maintain working capital at each of
the managed facilities at levels consistent with the Marriott senior living
system standard.
FF&E RESERVES AND CAPITAL IMPROVEMENTS. Marriott has established a reserve
account under each management agreement, referred to as an FF&E Reserve, to
cover the expected recurring cost of replacements and renewals to the furniture,
furnishings, fixtures, soft goods, case goods, vehicles and equipment, and for
routine building repairs and maintenance which are normally capitalized. The
FF&E Reserve accounts are funded from the operating revenues of the managed
facilities. The amount of this funding varies somewhat among the managed
facilities; however, for most facilities it is currently set at 2.65% of gross
revenues and is expected to gradually increase thereafter. In the event major
capital improvements are required, or if the amounts set aside in the FF&E
Reserve accounts are inadequate for required repairs, we may be required to fund
such repairs and improvements. Any such funding which we provide increases the
amount of our owner's priority, described below. Also, under our lease we have
the option to request Senior Housing to provide such required funding in return
for rent adjustments to provide Senior Housing a return on its investment
according to a formula set forth in the lease.
FEES. For its facility services, Marriott receives a base fee generally
equal to 5% of the managed facilities' gross revenues, plus an incentive fee
generally equal to 20% of operating profits in excess of owner's priority
amounts, as defined in the agreements. For its central services, Marriott
receives a fee generally equal to 2% of gross revenues. Generally, through the
earlier of (i) the end of the seventh year of the operating agreement or
(ii) the date on which certain performance criteria have been met, payment of up
to one half of this central services fee (i.e., 1% of gross revenues) is
conditional, and is waived if specified annual profit targets are not achieved.
OWNER'S PRIORITY. We will receive the profits of the Marriott managed
facilities on a priority basis before Marriott receives any incentive fees for
facility services or any conditional central services fees. The amount of the
owner's priority for each managed facility is established based upon a specified
rate of return on historical capital investments in these facilities, including
capital investments funded in
30
addition to the FF&E Reserve. For fiscal year 2001, the aggregate amount of
owner's priority for all 31 properties is $69.4 million.
POOLING. Twenty-nine of the facilities are subject to pooling arrangements
whereby the calculation and payment of FF&E Reserves, fees payable to Marriott
and owner's priority for several groups of these 29 facilities are combined.
EVENTS OF DEFAULT. Events of default under the operating agreements
include, among others, certain events relating to the insolvency or bankruptcy
of either party.
TERMINATION. The Marriott management agreements may be terminated as
follows:
- Upon material default, by the non-defaulting party after applicable cure
periods lapse.
- By us, if a specific facility, or a pooled combination of facilities,
fails to achieve specified financial performance; provided, however,
Marriott has the option to avoid financial performance terminations by
making specified payments to us or by temporarily reducing certain of its
fees.
- By us, upon 120 days notice, provided we make a termination payment to
Marriott calculated according to a formula set forth in the agreements.
Our right to exercise termination options under the Marriott management
agreements is subject to approval by Senior Housing under the terms of any lease
for these 31 Marriott facilities.
COMPETITION
The senior living services business is highly competitive. We will compete
with service providers offering different modes of services, such as homemaker
or home healthcare services, as well as other companies providing real estate
facility based services. We believe we will be able to compete successfully for
the following reasons:
- Our merger with FSQ, Inc. and our shared services agreement with Reit
Management may provide us a depth and quality of management which is equal
to or stronger than most other senior living services providers.
- Our historical and continuing relationship with Senior Housing may provide
us opportunities to expand our business by acquiring new leaseholds for
senior living facilities from Senior Housing.
- The senior living services industry has experienced severe financial
distress during the past few years. Many operators of nursing homes and
assisted living facilities have been forced into bankruptcy. As a new
company without any material debt, we do not expect to be burdened with
financial difficulties of the types which currently burden some of these
competitors.
Our management team has been recently assembled within the past two years,
and, although we believe it is highly talented, it does not have extensive
experience working together. We expect we may expand our business with Senior
Housing; however, Senior Housing is not obligated to provide us with
opportunities to lease additional properties. We have no debt, but we do have
large lease obligations, limited financeable assets and only about $50 million
of equity capital; and many of our competitors have greater financial resources
than us. For all of these reasons and others, we cannot provide you any
assurance that we will be able to compete successfully for business in the
senior living industry.
ENVIRONMENTAL MATTERS
Under various federal, state and local laws, ordinances and regulations,
tenants and operators as well as owners of real estate may be required to
investigate and clean up hazardous substances released at a property, and may be
held liable to a governmental entity or to third parties for property damage
31
or personal injuries and for investigation and clean-up costs incurred in
connection with any contamination. Under our leases, we have also agreed to
indemnify Senior Housing for any such liabilities related to the facilities
leased from Senior Housing. In addition, some environmental laws create a lien
on a contaminated site in favor of the government for damages and costs it
incurs in connection with the contamination, which lien may be senior in
priority to our leases. We have reviewed some preliminary environmental surveys
of the properties we will lease upon completion of the spin-off and upon
completion of the Crestline transaction. Based upon that review we do not
believe that any of these properties are subject to any material environmental
contamination. However, no assurances can be given that:
- a prior owner, operator or occupant of our leased properties did not
create a material environmental condition not known to us which might have
been revealed by more in-depth study of the properties; and
- future uses or conditions (including, without limitation, changes in
applicable environmental laws and regulations) will not result in the
imposition of environmental liability upon us.
EMPLOYEES
As of November 1, 2001, we had no employees and FSQ, Inc. had approximately
6,500 employees, including 5,100 full time equivalents. Approximately 763
employees, including 570 full time equivalents, are represented under seven
collective bargaining agreements, all of which have remaining terms of two to
three years. FSQ, Inc. has no other employment agreements and we do not expect
to have any other employment agreements. We believe relations with these union
and non-union employees to be good. After the FSQ, Inc. merger, we will become
the employer of FSQ, Inc.'s employees.
LEGAL PROCEEDINGS
We have a limited operating history and are not currently a party to any
legal proceedings, and we are not aware of any material legal proceeding
affecting our facilities for which we may become liable.
32
SELECTED HISTORICAL FINANCIAL INFORMATION
The following table presents our selected historical financial information
and has been derived from our historical financial statements for the period
from April 27, 2000 (the date we commenced operations), through December 31,
2000, and for the nine months ended September 30, 2001. The following data
should be read in conjunction with our financial statements and the notes
thereto included elsewhere in the prospectus, and "Management's Discussion and
Analysis of Financial Condition and Results of Operations".
PERIOD FROM
APRIL 27, 2000
NINE MONTHS THROUGH
ENDED DECEMBER 31,
SEPTEMBER 30, 2001 2000
------------------ --------------
(DOLLARS IN THOUSANDS)
FIVE STAR QUALITY CARE, INC.
Operating data
Operating revenues....................... $170,681 $ 2,520
Net loss................................. (760) (1,316)
Balance sheet data
Total assets............................. $ 79,876 $54,788
Long term obligations.................... 100 100
The following table presents selected historical financial information of
our two predecessors and has been derived from the historical financial
statements of those predecessors included elsewhere in the prospectus. The
following data should be read in conjunction with the financial statements and
notes thereto entitled Combined Financial Statements of Forty-Two Facilities
acquired by Senior Housing Properties Trust from Integrated Health
Services, Inc. and Combined Financial Statements of Certain Mariner Post-Acute
Network Facilities (Operated by Subsidiaries of Mariner Post-Acute Network)
included elsewhere in the prospectus, and "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Historical Results of
Operations -- Mariner Predecessor" and "Historical Results of
Operations -- Integrated Predecessor". The following table presents the
information from 1996 to 2000 to the extent it was available from the two
predecessor entities.
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2000 1999 1998 1997 1996
-------- --------- -------- -------- --------
(DOLLARS IN THOUSANDS)
INTEGRATED PREDECESSOR
Operating data
Operating revenues................... $135,378 $ 130,333 $140,116 $104,727 $112,805
Net loss............................. (25,252) (126,939) (17,183) (10,432) (1,190)
Balance sheet data
Total assets......................... $ 34,942 $ 61,274 $190,553 $174,954 *
Long term obligations................ -- 17,500 17,751 18,006 *
MARINER PREDECESSOR
Operating data
Operating revenues................... $ 85,325 $ 86,945 $105,486 $107,829 $111,985
Net loss............................. (7,421) (43,804) (7,710) (9,453) *
Balance sheet data
Total assets......................... $ 23,052 $ 17,433 $ 62,502 $ 84,119 $ 36,846
Long term obligations................ 32,091 28,603 33,195 15,498 12,528
------------------------
* Mariner Predecessor and Integrated Predecessor have indicated to us that
certain financial information, some of which relates to periods during which
these operations were conducted by third parties for 1996 is not available.
33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
We were incorporated in April 2000 as a Delaware corporation and
reincorporated in Maryland on September 20, 2001. We were formed as a 100% owned
subsidiary of Senior Housing to operate healthcare facilities owned by Senior
Housing. Effective July 1, 2000, we assumed the operations of healthcare
facilities from two bankrupt former tenants of Senior Housing. At the time we
assumed operations of these facilities, we had not received substantially all of
the required licenses for these facilities. As a result, for the period from
July 1, 2000, through December 31, 2000, we accounted for the operations of
these facilities using the equity method of accounting and we only recorded the
net income from these operations. Since that time, we have obtained all
necessary licenses to operate these facilities, and on January 1, 2001, we began
to consolidate the results of operations of these facilities.
Since we succeeded to substantially all of the business formerly conducted
by subsidiaries or units of two former tenants of Senior Housing, these
subsidiaries and units are considered to be our predecessors. We have included
the financial statements of these predecessors in this prospectus and discuss
their results of operations. Our predecessors' financial statements are
entitled: Certain Mariner Post-Acute Network Facilities (referred to herein as
Mariner Predecessor); and Forty-Two Facilities Acquired by Senior Housing
Properties Trust from Integrated Health Services, Inc. (referred to herein as
Integrated Predecessor).
You should read the following discussion in conjunction with our historical
and pro forma financial statements and the financial statements of our
predecessors included elsewhere in this prospectus.
Our revenues consist primarily of payments for services provided to patients
at our facilities. The payments are either paid for by the patients, their
families or insurers, or by the Medicare and Medicaid programs. The substantial
majority of our historical revenues have been paid by the Medicare and Medicaid
programs. The substantial majority of the revenues associated with the 31
Marriott facilities are paid by the patients, or private pay. On a pro forma
basis, assuming the Crestline transaction closes, for the nine months ended
September 30, 2001, private pay revenues would have represented 61% of our total
revenues. Our expenses consist primarily of wages and benefits of personnel,
food, supplies and other patient care costs, as well as taxes, insurance and
other property related costs.
We will account for our merger with FSQ, Inc. as the termination of a
management contract rather than as a business combination. As a result, at the
closing of the merger, to the extent that the fair value of our common shares
issued in connection with the FSQ, Inc. acquisition exceeds the fair value of
FSQ, Inc.'s assets, we will recognize an expense in an amount equal to that
excess. For this purpose, the fair value of our common shares will be based on
their observable trading prices after the spin-off. As this information is not
now known, we cannot estimate the amount of this expense, if any.
OUR HISTORICAL RESULTS OF OPERATIONS
As described above, we have operated and, until completion of the spin-off
we will operate, as a subsidiary of Senior Housing. Our operations as Senior
Housing's subsidiary differ from our expected future operations as follows:
- Our historical operating business included certain facilities, assets and
activities which we will not own or conduct.
- The principal source of financing for these operating businesses was
intercompany advances from Senior Housing, an entity with financial
resources substantially in excess of ours.
34
We believe that because of these differences, the historical results of
operations described below are not comparable to future operations which we
expect to conduct. Specifically, we will operate only 56 properties for Senior
Housing immediately after the spin-off, and we will not own real estate which
will continue to be owned by Senior Housing. We will lease these facilities from
Senior Housing, and we will conduct our own affairs and incur costs as a
separate public company which may be more or less than the costs incurred by
Senior Housing and allocated to us.
NINE MONTHS ENDED SEPTEMBER 30, 2001, VERSUS 2000
We did not begin to operate the senior living facilities of our predecessors
or generate revenue until July 1, 2000. Therefore, our results for the nine
months ended September 30, 2001, are not comparable to the nine months ended
September 30, 2000.
Revenues for the nine month period ended September 30, 2001, were
$170.7 million. On a combined basis, the two predecessor entities had revenues
of $164.0 million for the nine month period ended September 30, 2000. This
increase was due mainly to an increase in the average daily rate received during
these periods.
Expenses for the nine month period ended September 30, 2001, were
$171.4 million. On a combined basis, the two predecessor entities had expenses
of $171.9 million for the nine month period ended September 30, 2001. The
decrease is due primarily to rent and interest expenses which were included in
the 2000 expenses of our predecessors but were zero in 2001 because, after
Senior Housing's repossessions and foreclosures, rent and interest payments on
the leases and mortgages ceased. This decrease was offset by non-recurring
general and administrative expenses arising from our start up of operations
recorded in 2001 which were zero in 2000.
PERIOD APRIL 27, 2000 (DATE OPERATIONS COMMENCED) THROUGH DECEMBER 31, 2000
This period was our first period of operations and, therefore, there is no
comparable period.
During 2000 we accounted for our investment in these operating businesses
using the equity method of accounting. As a result, the reported revenues
included our equity in earnings of these investees. Revenues for 2000 were
$2.5 million and represent the net amount of net patient revenues in excess of
expenses of these operations for the 2000 period. Net patient revenues at the
operating businesses for the six months ended December 31, 2000, were
$114.5 million and expenses incurred for the period were $111.9 million.
LIQUIDITY AND CAPITAL RESOURCES
On a historical basis our expenditures, including capital expenditures and
for working capital, were provided by Senior Housing, our parent company. We
maintained no financing sources apart from Senior Housing. As of September 30,
2001, Senior Housing had invested $50.3 million in our operations and did not
charge interest on that amount to us.
After the spin-off, our primary source of cash to fund operating expenses,
including rent payable to Senior Housing, will be the patient revenues we
generate at our leased facilities. We believe that this operating revenue will
be sufficient to allow us to meet our ongoing operating expenses, working
capital needs and rent payments to Senior Housing in the short term, or next
12 months, and long term, whether or not we arrange for a line of credit secured
by our receivables, as described below.
Our agreement to purchase shared services from Reit Management will allow us
to defer payments to Reit Management under the shared services agreement if
necessary to make rent payments to Senior Housing. On a pro forma basis,
payments to Reit Management for shared services totaled $2.9 million during the
year ended December 31, 2000.
35
As of the spin-off date, our pro forma assets and liabilities provided by
Senior Housing will include cash, operating accounts receivable and accrued
operating liabilities. On a pro forma basis, assuming the Crestline transaction
does not occur, our cash balance at September 30, 2001, was $28.3 million.
Assuming the Crestline transaction does occur, our pro forma cash balance at
September 30, 2001, was $31.9 million.
As of the spin-off date, on a pro forma basis we will have no debt. Our
principal asset other than cash will be our accounts receivable from residents
at the 56 nursing homes that we will lease from Senior Housing. On a pro forma
basis, these receivables at September 30, 2001, totaled $43.4 million. We have
had preliminary discussions with two financing companies regarding using a
portion of our receivables as collateral for a line of credit, but have not
engaged either of these financing sources in negotiations to date. We expect,
but can provide no assurances, that our receivables will support a line of
credit available to us for general corporate purposes and for business expansion
opportunities.
SEASONALITY
Our business is subject to modest effects of seasonality. During the
calendar fourth quarter holiday periods nursing home patients are sometimes
discharged to join family celebrations and admission decisions are often
deferred. The first quarter of each calendar year usually coincides with
increased illness among nursing home residents which can result in increased
costs or discharges to hospitals. As a result of these factors, nursing home
operations sometimes produce greater earnings in the second and third quarters
of each calendar year and lesser earnings in the first and fourth quarters. This
seasonality is not expected to cause fluctuations in our revenues or operating
cash flow to such an extent that we will have difficulty paying our expenses,
including rent, which do not fluctuate seasonally.
INFLATION AND DEFLATION
Inflation in the past several years in the United States has been modest.
Future inflation might have both positive or negative impacts on our business.
Rising price levels may allow us to increase occupancy charges to residents, but
may also impact our operating costs. Because a portion of our revenues are set
by Medicare and Medicaid formulae, our revenues may change by either more or
less than the rate of change in our expenses. Because a large component of our
expenses will consist of fixed rental obligations to Senior Housing, we may not
be able to fully capitalize on declines in general price levels.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have no obligations for funded debt and as such are not directly affected
by changes in market interest rates. However, as discussed above, we may
negotiate with financing sources for a line of credit secured by some or all of
our receivables. We expect that such a line of credit would bear interest for
funded amounts at floating rates.
We may from time to time consider our exposure to interest rate risks if we
have or expect to have material amounts of floating rate obligations. As a
result of these considerations we may decide to purchase interest rate caps or
other hedging instruments.
36
HISTORICAL RESULTS OF OPERATIONS -- MARINER PREDECESSOR
The Mariner Predecessor conducted operations of 17 facilities leased from
Senior Housing. The operations of the Mariner Predecessor during the period
prior to its acquisition by Senior Housing differs from our expected operations
as follows:
- The business of the Mariner Predecessor was conducted by its then parent,
Mariner Post-Acute Network, an entity with a capital structure, corporate
overhead costs, and operating systems which we expect to be substantially
different than ours.
- During the period of Mariner's operation of this business, significant
writeoffs of goodwill and other long-lived assets of the Mariner
Predecessor occurred and Mariner filed for bankruptcy.
We believe that because of these differences, the historical results of
operations described below are not comparable to future operations which we
expect to conduct. Specifically, the historical operations described below
include: revenues and operating expenses for only 17 facilities, one of which
has since been closed while we expect we will generate revenues and incur
operating expenses at 87 facilities; revenues prior to 1999 which were derived
prior to the completion of the phase-in of the new Medicare prospective payment
system, often referred to as PPS; depreciation expenses which relate to real
estate and amortization expenses which relate to goodwill, while we expect we
will not have substantial depreciable assets; expenses related to allocation of
corporate overhead by the parent of these operations, while we expect to operate
on a stand-alone basis and incur our separate corporate expenses; rent expense
under a lease which has been cancelled; charges for impairments of long-lived
assets of substantial amounts, while we expect we will not have substantial
long-lived assets; and interest expense incurred on debt, while we will have no
debt as of the spin-off date.
YEAR ENDED DECEMBER 31, 2000, VERSUS 1999 -- MARINER PREDECESSOR
Revenues for the year ended December 31, 2000, were $85.3 million. These
revenues represent a decrease of $1.5 million from the revenues in the 1999
period. This decrease is attributable primarily to a slight decrease in
occupancy at the facilities in operation during both periods and by the closing
of one facility.
Expenses for the year ended December 31, 2000, were $92.7 million, a
decrease of $1.6 million over the 1999 period, excluding non-recurring or
unusual charges and write-offs incurred in 1999. This decrease is attributable
primarily to decreases in general and administrative costs and provision for bad
debts and rent, offset by an increase in salary, wages and benefits.
Net loss for the year ended December 31, 2000, was $7.4 million, a decrease
in loss of $36.4 million over the 1999 period. This decrease in loss is
principally attributable to the impact of unusual charges related to the
impairment of long-lived assets in 1999.
YEAR ENDED DECEMBER 31, 1999, VERSUS 1998 -- MARINER PREDECESSOR
Revenues for the year ended December 31, 1999, were $86.9 million. These
revenues represent a decrease of $18.5 million from revenues in the 1998 period.
This decrease is attributable primarily to the detrimental effects of initial
reductions in rates under the new Medicare prospective payment system, or PPS,
for skilled nursing facilities under the federal Medicare program. The per diem
rates under the new Medicare prospective payment system were significantly lower
than the amounts received under the former cost-based system.
Expenses, excluding losses related to the impairment of long-lived assets
aggregating $36.3 million and $8.7 million, in 1999 and 1998, respectively, were
$94.3 million and $103.4 million in 1999 and 1998, respectively. This
$9.1 million decrease is the result of cost cutting measures undertaken to
offset the reductions in Medicare rates.
37
During 1999 and 1998, the Mariner Predecessor incurred losses related to the
impairment of long lived assets of $36.3 million and $8.7 million, respectively.
These charges were a result of write-downs related to goodwill of $30.4 million
and $8.1 million and to property and equipment of $5.9 million and $546,000, in
1999 and 1998, respectively.
Net loss for the year ended December 31, 1999, was $43.8 million, a
$36.1 million increase in loss over the 1998 period. This increase in loss is
attributable to the reduction in net patient revenues and the additional
impairment write-downs discussed above.
HISTORICAL RESULTS OF OPERATIONS -- INTEGRATED PREDECESSOR
The Integrated Predecessor conducted operations of 42 facilities leased from
or mortgaged to Senior Housing. The operations of the Integrated Predecessor
during the period prior to its acquisition by Senior Housing differs from our
expected operations as follows:
- The business of the Integrated Predecessor was conducted by its then
parent, Integrated Health Services, Inc., an entity with a capital
structure, corporate overhead costs, and operating systems which we expect
to be substantially different than ours.
- During the period of Integrated Health Services' operation of the
business, significant write-offs of goodwill and other long-lived assets
of the Integrated Predecessor occurred and Integrated Health Services
filed for bankruptcy.
We believe that because of these differences, the historical results of
operations described below are not comparable to future operations which we
expect to conduct. Specifically, the historical operations described below
include: revenues and operating expenses for only 42 facilities, one of which
has since been closed, while we expect we will generate revenues and incur
operating expenses at 87 facilities; revenues prior to 1999 which were derived
prior to the completion of the phase-in of the new Medicare prospective payment
system; depreciation expenses which relate to real estate and amortization
expenses which relate to intangible assets, while we expect we will not have
substantial depreciable assets; expenses related to property management fees
charged by the parent of the Mariner Predecessor, while we expect to operate on
a stand-alone basis and incur our separate corporate expenses; rent expense
under a lease which has been cancelled; charges for impairments of long-lived
assets of substantial amounts, while we expect we will not have substantial
long-lived assets; and interest expense incurred on debt, while we will have no
debt as of the spin-off date.
YEAR ENDED DECEMBER 31, 2000, VERSUS 1999 -- INTEGRATED PREDECESSOR
Revenues for the year ended December 31, 2000, were $135.4 million. These
revenues represent an increase of $5.1 million over the revenues in the 1999
period. This increase resulted primarily from an increase in Medicaid rates and
an increase in occupancy at the Integrated Predecessor facilities.
Expenses for the year ended December 31, 2000, excluding non-recurring or
unusual charges and write-offs of $16.7 million as discussed in the next
paragraph, were $143.9 million, a decrease of $2.1 million from the 1999 period.
This decrease is attributable primarily to a decrease in rent, depreciation and
amortization at the Integrated Predecessor facilities offset by increased
operating expenses.
During the 2000 period, the Integrated Predecessor incurred unusual charges
related to a loss on settlement of lease and mortgage obligations of
$16.7 million. These charges were a result of the bankruptcy settlement between
Integrated and Senior Housing and represent the carrying value of the tangible
and intangible assets of the facilities conveyed to Senior Housing, less the
debts due Senior Housing which were not paid. During the 1999 period, the
Integrated Predecessor incurred write-offs and unusual charges related to a loss
on impairment of long-lived assets of $120.0 million.
38
Net loss for the year ended December 31, 2000, was $25.3 million, a decrease
of $101.6 million from the net loss of $126.9 million in 1999. This decrease in
loss is attributable the decreases in rent, depreciation and amortization and
the impact of unusual charges discussed above.
YEAR ENDED DECEMBER 31, 1999, VERSUS 1998 -- INTEGRATED PREDECESSOR
Revenues for the year ended December 31, 1999, were $130.3 million. These
revenues represent a decrease of $9.8 million from the revenues in the 1998
period. This decrease is attributable primarily to reduced rates under the new
Medicare prospective payment system, or PPS, for skilled nursing facilities. The
per diem Medicare rates under PPS were significantly lower than the amounts the
facilities received under the former cost-based system.
Expenses for the year ended December 31, 1999, excluding non-recurring or
unusual charges and write-offs aggregating $120.0 million and discussed in the
next paragraph, were $146.0 million, a decrease of $8.4 million from the 1998
period. This decrease is attributable primarily to a decrease in operating
expenses resulting from cost cutting measures undertaken to combat the
reductions in rates under the new Medicare prospective payment system.
During the 1999 period, the Integrated Predecessor incurred unusual charges
related to the impairment of long-lived assets of $120 million. No such charge
occurred in 1998.
Net loss for the year ended December 31, 1999, was $126.9 million, an
increase of $109.7 million over the net loss of $17.2 million in 1998. This
increase in loss is primarily attributable to the impact of unusual charges
discussed above, as well as decreases in net patient revenues and offset
somewhat by decreases in operating expenses.
39
MANAGEMENT
The following sets forth the names, ages and positions of the persons who
will be our directors and executive officers upon completion of the spin-off:
NAME AGE POSITION
---- -------- --------
Barry M. Portnoy................................... 56 Director (term will expire in 2002)
Gerard M. Martin................................... 67 Director (term will expire in 2003)
Bruce M. Gans, M.D................................. 54 Director (term will expire in 2004)
John L. Harrington................................. 65 Director (term will expire in 2002)
Arthur G. Koumantzelis............................. 71 Director (term will expire in 2003)
Evrett W. Benton................................... 53 President, Chief Executive Officer and
Secretary
Rosemary Esposito, RN.............................. 58 Senior Vice President, Chief Operating
Officer
Gretchen A. Holtz, RN.............................. 59 Vice President, Chief Clinical Officer
Maryann Hughes..................................... 54 Vice President, Director of Human Resources
Bruce J. Mackey Jr................................. 31 Treasurer, Chief Financial Officer and
Assistant Secretary
DIRECTORS
BARRY M. PORTNOY has been one of the Managing Trustees of Senior Housing,
HRPT Properties and Hospitality Properties, since each began business in 1999,
1986 and 1995, respectively. Mr. Portnoy is and has been a director and 50%
owner of Reit Management and FSQ, Inc. since each began business in 1986 and
2000, respectively. From 1978 through March 1997, Mr. Portnoy was a partner of
the law firm of Sullivan & Worcester LLP, our counsel, and he was Chairman of
that firm from 1994 through March 1997.
GERARD M. MARTIN has been one of the Managing Trustees of Senior Housing,
HRPT Properties and Hospitality Properties since each began business in 1999,
1986 and 1995, respectively. Mr. Martin is and has been a director and 50% owner
of each of Reit Management and FSQ, Inc. since each began business in 1986 and
2000, respectively.
FUTURE DIRECTORS
Prior to the completion of the spin-off, we expect to appoint the following
individuals to our Board of Directors:
BRUCE M. GANS, M.D. has been Executive Vice President and Chief Medical
Officer at Kessler Rehabilitation Corporation, a provider of healthcare services
headquartered in West Orange, New Jersey, since June 1, 2001. From April 1999 to
May 31, 2001, Dr. Gans was Senior Vice President for Continuing Care and
Chairman of Physical Medicine and Rehabilitation at North Shore Long Island
Jewish Health System, a provider of healthcare services headquartered in New
Hyde Park, New York, and Professor of Physical Medicine and Rehabilitation at
the Albert Einstein College of Medicine in New York City. From 1989 through
March 1999, Dr. Gans was a Professor and Chairman of the Department of Physical
Medicine and Rehabilitation at Wayne State University and a Senior Vice
President of the Detroit Medical Center, both located in Detroit, Michigan.
Dr. Gans was a trustee of HRPT Properties from October 1995 through October 11,
1999. Dr. Gans has been a trustee of Senior Housing since October 12, 1999; and
he will resign that position when the spin-off is completed.
JOHN L. HARRINGTON has been the Chief Executive Officer of the Boston Red
Sox Baseball Club, Executive Director and Trustee of the Yawkey Foundation and a
Trustee of the JRY Trust for over five years. The Yawkey Foundation and JRY
Trust are not-for-profit charitable foundations headquartered in Dedham,
Massachusetts. Mr. Harrington was a trustee of HRPT Properties from 1991 through
40
August 1995 and a trustee of Hospitality Properties and Senior Housing since
those companies became publicly owned in 1995 and 1999, respectively, through
the present.
ARTHUR G. KOUMANTZELIS has been the President and Chief Executive Officer of
Gainesborough Investments LLC, a private investment company, located in
Lexington, Massachusetts since June 1998. Since April 2000, he has served as the
President, Chief Executive Officer and a member of the Board of Directors of
Peponi Investments, LLC, a private company, also located in Lexington,
Massachusetts. In addition, Mr. Koumantzelis has served as Treasurer and has
been a 33% stockholder of Mosaic Communications Group, LLC, a media company,
since December 2000. He is also a Trustee of Milo Trust and Lemoni Trust and a
member of the Board of Directors of Wang Healthcare Information Systems, Inc.;
all of these private companies are headquartered in Massachusetts. From 1990
until February 1998, Mr. Koumantzelis was Senior Vice President and Chief
Financial Officer of Cumberland Farms Inc., a private company headquartered in
Canton, Massachusetts, engaged in the convenience store business and the
distribution and retail sale of gasoline. Mr. Koumantzelis was a trustee of HRPT
Properties from 1992 to 1995, and he has been a trustee of Hospitality
Properties and Senior Housing since they became publicly owned in 1995 and 1999,
respectively, through the present.
EXECUTIVE OFFICERS
EVRETT W. BENTON has been President and Chief Executive Officer of FSQ, Inc.
since it began operations in 2000. From November 1999 until FSQ, Inc. began
operations, Mr. Benton served as a business and legal consultant to Reit
Management and Senior Housing in connection with their negotiations with former
tenants of Senior Housing who filed for bankruptcy. From November 1997 to
November 1999, Mr. Benton was an independent consultant working in the
healthcare and real estate industries. From December 1991 to November 1997,
Mr. Benton was Chief Administrative Officer of and General Counsel to
GranCare, Inc., a publicly owned healthcare services company and a predecessor
to Mariner Post-Acute Network, Inc. Prior to December 1991, Mr. Benton was the
Managing Partner of the Los Angeles office of the law firm of Andrews & Kurth
LLP. Mr. Benton has been a Vice President of Reit Management since
September 2000 and will continue in that office.
ROSEMARY ESPOSITO, RN, has been Senior Vice President and Chief Operating
Officer of FSQ, Inc. since February 2001. Between 1996 and February 2001,
Ms. Esposito was Vice President and Chief Operating Officer of Lenox
Healthcare, Inc., a privately owned nursing home chain headquartered in
Pittsfield, Massachusetts, that filed for Chapter 11 bankruptcy in
November 2000. Prior to 1996, Ms. Esposito held senior management positions with
Berkshire Health Systems, Inc., an acute care medical center and multi-facility,
long-term care company headquartered in Pittsfield, Massachusetts.
GRETCHEN A. HOLTZ, RN, has been Vice President and Chief Clinical Officer of
FSQ, Inc. since May 2000. From 1999 until May 2000, Ms. Holtz was a private
consultant for various healthcare insurance and referral businesses specializing
in elder care services. From 1997 to 1999, Ms. Holtz was Vice President for
Clinical Services at the Frontier Group, Inc., a Boston, Massachusetts based
private company in the nursing home business. From 1994 to 1997, Ms. Holtz was
National Director of Subacute Services for Sun Healthcare Group, Inc., a
publicly owned company which provided healthcare services that filed for
Chapter 11 bankruptcy in October 1999.
MARYANN HUGHES has been Vice President and Director of Human Resources for
FSQ, Inc. since May 2000. Between 1996 and May 2000, Ms. Hughes was Senior Vice
President of Human Resources for Olympus Healthcare Group, Inc., a privately
owned company headquartered in Waltham, Massachusetts in the business of
operating nursing homes and rehabilitation hospitals. From 1994 to 1996,
Ms. Hughes was Senior Vice President of Health Alliance, a partnership of two
acute care hospitals, two nursing homes and other medical services businesses
based in Leominster, Massachusetts.
BRUCE J. MACKEY JR. has been Treasurer and Chief Financial Officer of FSQ,
Inc. since October 2001. From 1997 to July 2000, Mr. Mackey was a Controller of
Reit Management and from
41
July 2000 to October 2001 he was an Assistant Vice President of Reit Management.
From 1992 to 1997, Mr. Mackey was an accountant with the firm of Arthur Andersen
LLP. Mr. Mackey is a certified public accountant. Mr. Mackey was elected a Vice
President of Reit Management in October 2001 and will continue in that office.
COMMITTEES OF THE BOARD OF DIRECTORS
Our Board of Directors will establish three committees when the spin-off is
completed:
- AUDIT COMMITTEE. The audit committee will evaluate the performance of, and
make recommendations to the Board of Directors as to the selection of, our
independent auditors; and it will review our published financial
statements and the adequacy of our internal accounting controls. The
initial members of the audit committee will be Messrs. Gans, Harrington
and Koumantzelis, each of whom will be independent directors as defined by
the AMEX. The audit committee will operate under a written charter which
will be adopted by our Board of Directors and become effective upon the
completion of the spin-off. A copy of the proposed audit committee charter
has been filed as an exhibit to the registration statement of which this
prospectus is a part.
- COMPENSATION COMMITTEE. Our entire Board of Directors will initially serve
as our compensation committee to review the performance and establish the
compensation of our executive officers. The compensation committee will
also serve as the administrator of our stock option and stock incentive
plan described below.
- QUALITY OF CARE COMMITTEE. Our quality of care committee will initially
consist of Dr. Gans and Mr. Martin. The quality of care committee will
periodically meet with our officers and other employees to evaluate the
quality of services provided to residents at our facilities.
COMPENSATION OF DIRECTORS
We will pay each director other than Messrs. Martin and Portnoy an annual
fee of $15,000, plus a fee of $500 for each Board meeting attended. In addition,
each director will automatically receive an annual grant of 1,000 of our common
shares at the first meeting of the Board of Directors following each annual
meeting of shareholders, commencing in 2002. Board members will not be
separately compensated for serving on Board committees; however, we will pay the
Board member serving as chairman of our audit committee an additional annual fee
of $5,000, and the Board member serving as chairman of our quality of care
committee an additional annual fee of $10,000. We will reimburse directors for
reasonable out-of-pocket expenses incurred in attending meetings of the Board of
Directors or Board committees on which they serve. Messrs. Portnoy and Martin
will not receive any cash compensation as directors or as members of Board
committees, but they will receive the annual share grants and they will be
reimbursed for their expenses.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Our entire Board of Directors is expected initially to serve as our
compensation committee. None of our Board members are expected to be our
employee or an employee of any of our subsidiaries.
Two of our directors, Messrs. Portnoy and Martin, are owners, directors and
employees of Reit Management. Messrs. Benton and Mackey, our president and
treasurer, respectively, are also officers, and will be part-time employees, of
Reit Management.
Messrs. Portnoy and Martin, our two current directors, are trustees of
Senior Housing, our landlord. Upon completion of the spin-off and our
appointment of additional directors, all of our directors, other than Dr. Gans,
are expected to continue as trustees of Senior Housing. Messrs. Portnoy, Martin,
Harrington and Koumantzelis are also trustees of Hospitality Properties;
42
Messrs. Portnoy and Martin are also trustees of HRPT Properties; and our
directors to be appointed prior to the spin-off, Messrs. Harrington and
Koumantzelis and Dr. Gans, formerly served as trustees of HRPT Properties. Reit
Management is the investment manager for Senior Housing, Hospitality Properties
and HRPT Properties, and will be a party to a shared services agreement with us.
Messrs. Portnoy and Martin also own the building where we rent space for our
headquarters.
For more information about possible relationships which might impact
compensation decisions see below at "Certain Relationships".
EXECUTIVE COMPENSATION
Our five highest paid executive officers and the amount of their annual cash
compensation at the time of the spin-off are expected to be as follows:
ANNUAL CASH
POSITION COMPENSATION
--------------------------------------- ------------
Evrett W. Benton....................... President, Chief Executive Officer and $420,000
Secretary
Rosemary Esposito, RN.................. Senior Vice President, Chief Operating $225,000
Officer
Gretchen A. Holtz, RN.................. Vice President, Chief Clinical $152,500
Officer
Maryann Hughes......................... Vice President, Director of Human $152,500
Resources
Bruce J. Mackey Jr..................... Treasurer, Chief Financial Officer and $120,000
Assistant Secretary
We have no employment agreements with any of our executive officers.
Messrs. Benton and Mackey are each expected to devote a substantial majority
of their business time to providing services to us as officers and employees. We
also expect Messrs. Benton and Mackey to continue to dedicate some of their
business time to providing services to Reit Management unrelated to us.
Therefore, in addition to receiving compensation paid by us, Reit Management
will pay each of Messrs. Benton and Mackey compensation for their services to
Reit Management. Neither of Messrs. Benton or Mackey have employment agreements
with us, FSQ, Inc. or Reit Management.
Except with respect to incentive share awards under Senior Housing's 1999
Incentive Share Award Plan, neither we nor Senior Housing paid or prior to the
spin-off expect to pay compensation to our executive officers. Their
compensation for services to us and Senior Housing was and is paid by FSQ, Inc.
and Reit Management. In each of 2000 and 2001, Mr. Benton, our president and
chief executive officer, received a grant of 2,000 restricted shares of Senior
Housing, having a value of $17,250 and $26,040, respectively, based upon the
share closing prices for Senior Housing's common shares on the New York Stock
Exchange on the grant dates. At December 31, 2000, the 2,000 incentive shares
granted to Mr. Benton in that year had a value of $18,625, based upon a $9.3125
per share closing price for Senior Housing's common shares on the New York Stock
Exchange on that date. Each share award provided that one-third of the award
vested immediately upon grant and one-third vests on the first and second
anniversaries of the grant. Under Senior Housing's plan, if Mr. Benton ceases to
be an officer or employee of Reit Management during the vesting period, the
Senior Housing common shares which have not yet vested may be repurchased by
Senior Housing for nominal consideration. Vested and unvested common shares
under Senior Housing's plan are entitled to distributions paid by Senior
Housing, including the spin-off distribution described in this prospectus.
43
OUR STOCK OPTION AND STOCK INCENTIVE PLAN
We have adopted the Five Star Quality Care, Inc. 2001 Stock Option and Stock
Incentive Plan (the "Plan"). Under the Plan, we are authorized to grant our
employees, officers, directors and other individuals rendering services to us
and our subsidiaries equity-based awards, including incentive stock options,
nonqualified stock options, common shares, restricted common shares and stock
appreciation rights. The Plan is administered by our Board compensation
committee. The Plan provides that the compensation committee has the authority
to select the participants and determine the terms of the stock options and
other awards granted under the Plan.
An incentive stock option is not transferable by the recipient except by
will or by the laws of descent and distribution. Nonqualified stock options and
other awards are transferable only to the extent provided in the agreement
relating to such option or award. In the event that termination of employment is
due to death or disability, the stock option is exercisable for a maximum of
12 months after such termination. The aggregate number of shares of common stock
which may be issued under the Plan is 650,000. No awards have been made to date
under the Plan and none are expected to be made before the first meeting of the
Board of Directors following the annual meeting of our shareholders in 2002.
If you want more information about this plan you should review the copy of
the Plan which has been filed as an exhibit to the registration statement of
which this prospectus is a part.
OUR SHARED SERVICES AGREEMENT WITH REIT MANAGEMENT
In order that we may have the benefit of certain shared services from Reit
Management, including certain services that Reit Management has historically
provided to FSQ, Inc., we will enter a shared services agreement with Reit
Management. The following is a summary of the material provisions of the shared
services agreement between us and Reit Management. If you want more information,
you should read the entire shared services agreement, which has been filed as an
exhibit to the registration statement of which this prospectus is part.
GENERAL. Under this agreement, Reit Management will provide, or assist us
with, certain services relating to human resources, management information
systems, tax, accounting, property maintenance and repairs, investor relations,
acquisition, business expansion or reduction, capital markets advice, office
support, cash management, SEC compliance and supervision of our relationship
with Marriott.
COMPENSATION TO REIT MANAGEMENT. For Reit Management's services rendered to
us pursuant to the shared services agreement, we will pay Reit Management a fee
equal to 0.6% of our total revenues. The fee will be paid monthly in advance
based upon the prior month's revenues. We will also reimburse Reit Management
for its reasonable out-of-pocket expenses.
SUBORDINATION OF REIT MANAGEMENT FEES TO SENIOR HOUSING RENT. No fees shall
be paid to Reit Management if any rent we owe Senior Housing is past due or if
the fee payment would leave us with insufficient cash, credit facilities or
current accounts receivable to make our next scheduled rent payment under our
leases with Senior Housing. Unpaid fees shall accrue, together with interest at
the prime rate, and will be payable when the condition preventing their payment
is no longer in effect or upon termination of, or the occurrence of certain
events of default by us under, the shared services agreement. The fees due Reit
Management are not subordinated to any of our other obligations.
CONFLICTS OF INTEREST WITH SENIOR HOUSING. We have acknowledged that Reit
Management may continue to serve as the investment manager for Senior Housing
and we have agreed that, regarding issues and in circumstances where there is a
conflict of interest between us and Senior Housing, Reit Management will serve
as the investment manager for Senior Housing and will not be required to
consider our interests.
44
NON-COMPETITION WITH REIT MANAGEMENT. We will afford any public real estate
entity Reit Management manages during the term of the shared services agreement
the opportunity to acquire or finance any real estate investments of the types
in which such entity invests before we do.
TERMINATIONS. The initial term of the agreement expires on December 31,
2002, and it will renew automatically from year to year unless either we or Reit
Management terminate due to default, or provide written notice of termination at
least 90 days prior to the termination date. In addition, if following
completion of the spin-off our full Board of Directors has not ratified the
shared services agreement by January 31, 2002, we may terminate the shared
services agreement effective as of January 31, 2002.
INDEMNIFICATION, DEFAULT AND DAMAGES. We have agreed to indemnify Reit
Management, its owners, directors, officers and employees for any damages,
liabilities, losses or out-of-pocket expenses incurred by them in the course of
performing services other than any such damage, liability or loss resulting from
Reit Management's gross negligence or bad faith. In the event of a termination
because of our default we must pay the fees due Reit Management for the
remainder of the current term. In the event of Reit Management's default, our
remedy is limited to termination of the agreement and we cannot collect damages,
except when Reit Management has taken action willfully and in bad faith.
SECURITY OWNERSHIP AFTER THE SPIN-OFF
GENERAL
As of the date on the cover of this prospectus:
- Senior Housing has 43,421,700 common shares outstanding;
- HRPT Properties owns 12,809,238 common shares of Senior Housing; and
- Senior Housing owns 1,000,000 common shares of HRPT Properties.
We have agreed to issue 125,000 common shares to each of Messrs. Portnoy and
Martin in connection with our acquisition of FSQ, Inc. Messrs. Portnoy and
Martin and entities they control also own some shares of Senior Housing and HRPT
Properties and they will receive some of our shares in those capacities.
The following table sets forth our common share ownership following the
spin-off and the merger with FSQ, Inc. For purposes of the following table, we
have assumed: (1) a distribution ratio of one of our common shares for every 10
Senior Housing common shares and one of our common shares for every 100 HRPT
Properties common shares; and (2) no change in the number of shares of Senior
Housing outstanding, no change in the number of Senior Housing shares owned by
HRPT Properties and no change in the number of HRPT Properties shares owned by
Senior Housing.
OUR
NUMBER OF OUR PERCENTAGE
OWNER COMMON SHARES OWNERSHIP
----- ------------- ----------
Senior Housing shareholders (other than HRPT Properties and
Messrs. Portnoy and Martin)............................... 3,049,005.5 66.0%
HRPT Properties shareholders (other than Senior Housing and
Messrs. Portnoy and Martin)............................... 1,258,420.8 27.2%
Senior Housing.............................................. 35,000 0.8%
HRPT Properties (1)......................................... 0 --
Barry M. Portnoy............................................ 137,371.9 3.0%
Gerard M. Martin............................................ 137,371.9 3.0%
------------------------
(1) HRPT Properties will receive 1,280,923.8 of our shares from Senior Housing
and will distribute one of our shares to its shareholders for every
100 shares of HRPT Properties owned. As of the
45
date on the cover of this prospectus, HRPT Properties has
128,808,747 shares outstanding; however, HRPT Properties has authorized a
share buyback program and may have a lesser number of its shares outstanding
on the spin-off record date. If HRPT Properties has less than
128,092,380 shares outstanding on the spin-off record date, HRPT Properties
will retain our shares which are not distributed to its shareholders. If
HRPT Properties has more than 128,092,380 shares outstanding on the spin-off
record date, we have agreed to sell HRPT Properties up to an additional
10,000 of our shares so that it may complete a distribution of our shares on
the basis of one for one hundred HRPT Properties shares owned. The purchase
price for these shares will be equal to the average of the reported high and
low trading prices in the public market on the day of our spin-off. The
numbers in this table assume that HRPT Properties will have
128,092,380 shares outstanding on the spin-off record date.
We estimate that we may have over 8,000 shareholders of record after giving
effect to the distributions based on the number of record holders of common
shares of Senior Housing and HRPT Properties, respectively, as of December 1,
2001.
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding beneficial
ownership of our common shares following the distribution of our common shares
pursuant to the spin-off by:
- each named executive officer;
- each of our current directors and those individuals we expect to appoint
as directors prior to the spin-off;
- each person known to us to be the beneficial owner of more than 5% of our
common shares; and
- all directors and executive officers as a group.
Information in the following table is based upon public filings relating to
the holders of Senior Housing's and HRPT Properties' common shares. Under
federal securities laws, shareholders are generally required to publicly
disclose their holdings if they beneficially own more than 5% of a company. It
is possible that a shareholder that beneficially owns shares in both Senior
Housing and HRPT Properties may beneficially own more than 5% of our shares
after the spin-off as a result of their combined ownership of Senior Housing and
HRPT Properties. Accordingly, it is possible that we may not be aware of
beneficial owners of more than 5% of our shares after giving effect to the spin-
off.
Unless otherwise noted, the address of each beneficial owner listed on the
table is c/o Five Star Quality Care, Inc., 400 Centre Street, Newton,
Massachusetts 02458, and each beneficial owner has sole voting and investing
power over the shares shown as beneficially owned except to the extent authority
is shared by spouses under applicable law and except as set forth in the
footnotes to the table.
The following table sets forth our common share ownership following the
spin-off. For purposes of the following table, we have assumed: (1) a
distribution ratio of one of our common shares for every 10 Senior Housing
common shares and one of our common shares for every 100 HRPT Properties common
shares; and (2) no change in the number of shares of Senior Housing outstanding,
no change in the number of Senior Housing shares owned by HRPT Properties and no
change in the number of
46
HRPT Properties shares owned by Senior Housing. This table includes our
125,000 shares which will be issued to each of Messrs. Portnoy and Martin in
connection with our merger with FSQ, Inc.
BENEFICIAL OWNERSHIP
---------------------
NUMBER OF
NAME SHARES PERCENT
---- ---------- --------
Barry M. Portnoy(1)......................................... 172,371.9 3.7%
Gerard M. Martin(1)......................................... 172,371.9 3.7%
Bruce M. Gans, M.D.......................................... 190 *
John L. Harrington.......................................... 150 *
Arthur G. Koumantzelis...................................... 225.6 *
Evrett W. Benton............................................ 405 *
All directors and executive officers as a group............. 310,732.6 6.7%
------------------------
* Less than 1%
(1) Mr. Martin is the sole stockholder of a corporation which will own
137,371.9 common shares. Mr. Portnoy is the sole stockholder of a separate
corporation which will own 137,371.9 common shares. Messrs. Martin and
Portnoy are each 50% owners and directors of Reit Management, the investment
manager to Senior Housing. Senior Housing, of which Messrs. Martin and
Portnoy are Managing Trustees, will own 35,000 common shares. Under some
interpretations of applicable law, Messrs. Martin and Portnoy may be deemed
to have beneficial ownership of our shares owned by Senior Housing; however,
Messrs. Martin and Portnoy disclaim beneficial ownership of the common
shares owned by Senior Housing.
47
CERTAIN RELATIONSHIPS
Our creation was, and our continuing business operations will be, subject to
possible conflicts of interest. These conflicts may have caused, and in the
future may cause, our business to be adversely affected. These conflicts and
their possible adverse effects upon us include the following:
- All of the persons expected to serve as our directors following the
spin-off were trustees of Senior Housing at the time we were created, and
four of them will remain trustees of Senior Housing after the spin-off.
Upon completion of the spin-off all of our operating facilities will be
leased from Senior Housing. Upon closing of the Crestline transaction, we
will lease 31 Marriott facilities from Senior Housing. We believe that our
lease terms with Senior Housing are commercially reasonable. Nonetheless,
it is possible that, if these leases were negotiated on an arm's length
basis, the rent and other lease terms might be more favorable to us. We
also believe that our historical and continuing relationships with Senior
Housing will provide us with a competitive advantage in locating business
expansion opportunities. Nonetheless, we will afford Senior Housing, HRPT
Properties and Hospitality Properties the opportunity to acquire or
finance any real estate investments of the type in which Senior Housing,
HRPT Properties and Hospitality Properties, respectively, invests before
we do. Also, future business dealings between Senior Housing and us could
be on less favorable terms than would be possible if there were no
historical or continuing management relationships between Senior Housing
and us.
- Messrs. Portnoy and Martin are two of the five directors we expect to have
following the completion of the spin-off, and they are the Managing
Trustees of Senior Housing. Messrs. Portnoy and Martin formed FSQ, Inc. to
manage properties repossessed by Senior Housing. Upon completion of the
spin-off, we will acquire FSQ, Inc. and Messrs. Portnoy and Martin will
each receive 125,000 of our shares. The Board of Trustees of Senior
Housing has received an opinion dated December 5, 2001 from UBS Warburg
LLC, an internationally recognized investment banking firm, to the effect
that, as of the date of the opinion and based on and subject to various
assumptions, matters considered and limitations described in the opinion,
the consideration provided for in the merger was fair, from a financial
point of view, to us. The terms of this merger have been approved by
Senior Housing's disinterested trustees. Nonetheless, it is possible that,
if this merger were negotiated on an arm's length basis, different terms
more favorable to us might have been achieved.
- Our chief executive officer and our chief financial officer are currently
also officers and employees of Reit Management, and they will remain
officers and part time employees of Reit Management after the spin-off. At
present, we expect that these officers will devote a substantial majority
of their business time to our affairs and the remainder of their business
time to Reit Management's business which is separate from us. The current
compensation which we will pay to these officers reflects our expectation
of their division of business time. Periodically hereafter these
individuals may devote a larger percentage of their time to our or Reit
Management's affairs and the compensation they receive from us may become
disproportionate to their efforts on our behalf. Also, because of this
dual employment arrangement we may have to compete with Reit Management
for the time and attention of these officers.
- Messrs. Portnoy and Martin own Reit Management. Reit Management is the
investment manager for Senior Housing, HRPT Properties and Hospitality
Properties, and has other business interests. After the spin-off, we will
enter a shared services agreement with Reit Management under which Reit
Management will provide certain administrative services to us similar to
the services it now provides to FSQ, Inc. as well as other services which
we may require. Under this shared services agreement, we will pay Reit
Management a fee equal to 0.6% of our total revenues. On a pro forma
basis, assuming completion of the spin-off and the Crestline transaction,
this fee was $2.9 million for the year ended December 31, 2000. We believe
we will receive fair value for the fee paid to Reit Management. The shared
services
48
agreement is terminable upon at least 90 days notice prior to the
expiration date of the then current term. However, despite our beliefs and
this termination provision, equivalent services might be available from
parties other than Reit Management on more favorable terms to us,
including for a lesser fee. Also, the fact that Reit Management has
responsibilities to other entities, including our landlord, Senior
Housing, could create conflicts; and, in the event of such conflicts
between Senior Housing and us, the shared services agreement allows Reit
Management to prefer its responsibilities to Senior Housing. See
"Management -- Our Shared Services Agreement with Reit Management".
- Messrs. Portnoy and Martin own the building in which our headquarters is
located. As a result of our acquisition of FSQ, Inc. we will become
obligated for a lease in this building. This lease expires in 2011 and
requires rent of $531,069 per year, subject to annual increases of $16,093
per year. We believe that the terms of this lease are commercially
reasonable. However, this lease was negotiated at a time when
Messrs. Portnoy and Martin simultaneously owned the building and FSQ,
Inc., and, accordingly, it was not done on an arm's length basis. If the
lease were negotiated on an arm's length basis it is possible that the
lease might have been more favorable to FSQ, Inc., and to us after the
merger, including for a lesser rent.
- Until March 31, 1997, Mr. Portnoy was a partner in the law firm
Sullivan & Worcester LLP, our counsel and counsel to Senior Housing, HRPT
Properties, Hospitality Properties, FSQ, Inc., Reit Management and certain
of their affiliates. Mr. Portnoy has received in 2000 and 2001 payments
from Sullivan & Worcester LLP in respect of his retirement.
FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
In order to maintain its status as a REIT for federal income tax purposes, a
substantial majority of Senior Housing's gross income must generally be derived
from real estate rents and mortgage interest. Thus, the Internal Revenue Code of
1986, as amended, or IRC, imposes strict limits on Senior Housing's ability to
own properties that it or others operate for Senior Housing's own account. Even
in circumstances where Senior Housing is permitted to own properties operated
for its own account, the IRC encourages leasing the properties to one or more
qualified tenants. A qualified tenant is a tenant in whom Senior Housing has at
all times during the taxable year an actual or constructive ownership interest
of less than 10% by vote and by value. In particular, Senior Housing must
generally pay federal corporate income tax on its net income from operated
property, whereas Senior Housing generally does not pay any corporate income tax
on its rental income from qualified tenants that is distributed to shareholders.
With respect to Senior Housing's repossessed properties from former tenants,
the REIT foreclosure property tax rules generally permit Senior Housing to have
those properties operated for its own account only through 2004. Further, during
the period that these properties are operated for Senior Housing's own account,
Senior Housing cannot make improvements to the repossessed properties other than
repairs, and the net income from the repossessed property operations is subject
to corporate income tax. In contrast, Senior Housing's leased properties can
generally be improved without limitation, and rental income from leased
properties that is distributed to shareholders is generally not subject to
corporate income tax. Finally, if and when Senior Housing closes the Crestline
transaction, the IRC REIT qualification rules require Senior Housing to lease
those properties to one or more qualified tenants.
Sullivan & Worcester LLP, Boston, Massachusetts, has rendered a legal
opinion that the discussions in the following summary are accurate in all
material respects and fairly summarize the federal income tax issues of the
spin-off, and the opinions of counsel referred to in this section represent
Sullivan & Worcester LLP's opinions on those subjects. Specifically, subject to
the
49
qualifications and assumptions contained in its opinions and in this prospectus,
Sullivan & Worcester LLP has rendered opinions to the effect that:
- Senior Housing has been organized and has qualified as a REIT under the
IRC for its 1999 and 2000 taxable years, and its current investments and
plan of operation will enable it to continue to meet the requirements for
qualification and taxation as a REIT under the IRC; Senior Housing's
actual qualification as a REIT, however, will depend upon its ability to
meet, and its meeting, through actual annual operating results and
distributions, the various REIT qualification tests imposed under the IRC;
- HRPT Properties has been organized and has qualified as a REIT under the
IRC for its 1987 through 2000 taxable years, and HRPT Properties' current
investments and plan of operation will enable it to continue to meet the
requirements for qualification and taxation as a REIT under the IRC; HRPT
Properties' actual qualification as a REIT, however, will depend upon its
ability to meet, and its meeting, through actual annual operating results
and distributions, the various REIT qualification tests imposed under the
IRC;
- Senior Housing's and HRPT Properties' distributions of our common shares
to shareholders will be treated for federal income tax purposes like other
REIT distributions, as described below; and
- commencing with our 2001 taxable year that begins on the date of the
spin-off, we will be taxed as a subchapter C corporation under the IRC.
These opinions are conditioned upon the assumption that our leases and other
contracts with Senior Housing, our charter and bylaws, the declarations of trust
and bylaws of both Senior Housing and HRPT Properties, and all other legal
documents to which we, Senior Housing or HRPT Properties are or have been a
party, have been and will be complied with by all parties to these documents,
upon the accuracy and completeness of the factual matters described in this
prospectus, and upon representations that we, Senior Housing, and HRPT
Properties have made. The opinions of Sullivan & Worcester LLP are based on the
law as it exists today, but the law may change in the future, possibly with
retroactive effect. Also, an opinion of counsel is not binding on the Internal
Revenue Service or the courts, and the IRS or a court could take a position
different from that expressed by counsel.
The following summary of federal income tax considerations is based on
existing law, and is limited to investors who own our common shares, Senior
Housing common shares, and/or HRPT Properties common shares as investment assets
rather than as inventory or as property used in a trade or business. The summary
does not discuss the particular tax consequences that might be relevant to you
if you are subject to special rules under the federal income tax law, for
example if you are:
- a bank, life insurance company, regulated investment company, or other
financial institution,
- a broker or dealer in securities or foreign currency,
- a person who has a functional currency other than the U.S. dollar,
- a person who acquires our common shares, Senior Housing shares, or HRPT
Properties shares in connection with his employment or other performance
of services,
- a person subject to alternative minimum tax,
- a person who owns our common shares, Senior Housing common shares, or HRPT
Properties common shares as part of a straddle, hedging transaction,
constructive sale transaction, or conversion transaction, or
- except as specifically described in the following summary, a tax-exempt
entity or a foreign person.
The sections of the IRC that govern the federal income tax qualification and
treatment of a REIT and its shareholders are complex. This summary is based on
applicable IRC provisions, related rules and
50
regulations and administrative and judicial interpretations, all of which are
subject to change, possibly with retroactive effect. Future legislative,
judicial, or administrative actions or decisions could affect the accuracy of
statements made in this summary. Neither we, Senior Housing, nor HRPT Properties
has sought a ruling from the IRS with respect to the spin-off, and neither we,
Senior Housing, nor HRPT Properties can assure you that the IRS or a court will
agree with the statements made in this summary. In addition, the following
summary is not exhaustive of all possible tax consequences, and does not discuss
any state, local, or foreign tax consequences. For all these reasons, we urge
you to consult with a tax advisor about the federal income tax and other tax
consequences of your acquisition, ownership and disposition of our common
shares, as well as your acquisition, ownership and disposition of Senior Housing
shares and HRPT Properties shares.
Your federal income tax consequences may differ depending on whether or not
you are a "U.S. person". For purposes of this summary, a U.S. person for federal
income tax purposes is:
- a citizen or resident of the United States, including an alien individual
who is a lawful permanent resident of the United States or meets the
substantial presence residency test under the federal income tax laws,
- a corporation, partnership or other entity treated as a corporation or
partnership for federal income tax purposes, that is created or organized
in or under the laws of the United States, any state thereof or the
District of Columbia, unless otherwise provided by Treasury regulations,
- an estate the income of which is subject to federal income taxation
regardless of its source, or
- a trust if a court within the United States is able to exercise primary
supervision over the administration of the trust and one or more United
States persons have the authority to control all substantial decisions of
the trust, or electing trusts in existence on August 20, 1996 to the
extent provided in Treasury regulations,
whose status as a U.S. person is not overridden by an applicable tax treaty.
Conversely, a "non-U.S. person" is a beneficial owner of our common shares,
Senior Housing common shares, or HRPT Properties common shares who is not a U.S.
person.
FEDERAL INCOME TAX CONSEQUENCES OF THE SPIN-OFF TO SENIOR HOUSING'S AND HRPT
PROPERTIES COMMON SHAREHOLDERS
IN GENERAL. Senior Housing's and HRPT Properties' distribution of our
common shares by spin-off will generally affect each REIT's shareholders in the
same manner as any other distribution of cash or property by a REIT on its
common shares. These tax consequences are summarized below:
- A REIT is generally not subject to tax on its net income to the extent
that net income is distributed to its shareholders.
- Distributions to a REIT's shareholders out of a REIT's current or
accumulated earnings and profits that are not designated by the REIT as
capital gain dividends generally will be taken into account by the REIT's
shareholders as ordinary income dividends. To the extent of a REIT's net
capital gain for the taxable year, the REIT may designate dividends as
capital gain dividends that will be taxable to its shareholders as
long-term capital gain.
- Distributions in excess of a REIT's current and accumulated earnings and
profits will not be taxable to a REIT shareholder to the extent that they
do not exceed the shareholder's adjusted basis in its REIT common shares,
but rather will reduce the adjusted basis in those shares.
- Distributions in excess of a REIT's current and accumulated earnings and
profits that exceed a REIT shareholder's adjusted basis in its REIT common
shares generally will be taxable as capital gain from a deemed sale of
those shares.
- A REIT's earnings and profits for a year will be allocated among each of
the distributions for that year in proportion to the amount of each
distribution.
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- Neither a REIT's ordinary income dividends nor its capital gain dividends
will entitle the REIT's corporate shareholders to any dividends received
deduction.
Accordingly, the spin-off of our common shares will be treated as a
distribution by Senior Housing and HRPT Properties to you in the amount of the
fair market value of the common shares distributed. Senior Housing and HRPT
Properties expect that a portion of this distribution will be taxable to you as
a dividend and a portion will be treated as a tax-free reduction in the adjusted
basis in your REIT shares. You will have a tax basis in our common shares
received in the spin-off equal to their fair market value at the time of the
spin-off, and your holding period in our common shares commences on the day
after the spin-off.
We, Senior Housing and HRPT Properties believe that for all federal income
tax purposes each of our common shares may be properly valued on the
distribution date as the average of the reported high and low trading prices in
the public market on that date, and Senior Housing and HRPT Properties will
perform all tax reporting, including statements supplied to you and to the IRS,
on the basis of this average price, called the distribution price. Because of
the factual nature of the value determinations, Sullivan & Worcester LLP is
unable to render an opinion on the fair market value of our common shares.
As described in more detail below, although the amount and extent to which
Senior Housing and HRPT Properties recognize gains and losses in the spin-off is
not free from doubt, Senior Housing and HRPT Properties expect: (1) to recognize
neither gain nor loss on our and our subsidiaries' properties and other assets;
and (2) to recognize gain but not loss on the distribution of our common shares.
Any gain that Senior Housing and HRPT Properties recognize in the spin-off will
increase their 2001 current earnings and profits, and this will increase the
total amount of their 2001 distributions, including the distribution of our
common shares, that is taxable as a dividend to you. Computing the amount of
these gains and the additional taxable dividend amount is a calculation which
requires some information, including the distribution price for our common
shares at the time of the spin-off, that is not available at this time. Assuming
that you have held your Senior Housing or HRPT Properties common shares, as
applicable, for the entire 2001 calendar year, Senior Housing and HRPT
Properties estimate:
- If the distribution price for our common shares equals pro-forma per share
book value, or $11.14 per share, you will have no additional taxable
dividend as a result of the spin-off.
- You will have little or no additional taxable dividend for distribution
prices up to $13.43 per Five Star share.
- For each $1.00 increase in the distribution price in excess of $13.43, you
will have additional taxable dividends of $0.10 per Senior Housing common
share and $0.01 per HRPT Properties common share.
- The spin-off distribution will not reduce the taxable dividends to you for
the year.
However, a definitive additional taxable dividend computation will not be
possible until after the spin-off.
To the extent Senior Housing and HRPT Properties are able, they intend to
designate a portion of their taxable dividends for the year as capital gain
dividends that generally will be subject to tax at the maximum capital gain
rates of 20% and 25% in the case of Senior Housing and HRPT Properties
noncorporate shareholders.
TAXATION OF TAX-EXEMPT ENTITIES. Tax-exempt entities are generally not
subject to federal income taxation except to the extent of their "unrelated
business taxable income," often referred to as UBTI, as defined in
Section 512(a) of the IRC. As with Senior Housing's and HRPT Properties' other
distributions, the distribution of our common shares to you if you are a
tax-exempt entity should generally not constitute UBTI, provided that you have
not financed the acquisition of your Senior
52
Housing and HRPT Properties common shares with acquisition indebtedness within
the meaning of Section 514 of the IRC. However, if you are a tax-exempt pension
trust, including a so-called 401(k) plan but excluding an individual retirement
account or government pension plan, that owns more than 10% by value of a
pension-held REIT, then you may have to report a portion of the dividends that
you receive from that REIT as UBTI. Although Senior Housing and HRPT Properties
cannot provide complete assurance on this matter, each of Senior Housing and
HRPT Properties believes that it has not been and will not become a pension-held
REIT.
TAXATION OF NON-U.S. PERSONS. If you are a non-U.S. person who holds common
shares in Senior Housing or HRPT Properties, the spin-off of our common shares
will generally be taxable to you in the same manner as any other distribution of
cash or property that Senior Housing or HRPT Properties makes to you. The rules
governing the federal income taxation of non-U.S. persons are complex, and the
following discussion is intended only as a summary of these rules. If you are a
non-U.S. person, you should consult with your own tax advisor to determine the
impact of federal, state, local, and foreign tax laws, including any tax return
filing and other reporting requirements, with respect to the spin-off of our
common shares and your investment in Senior Housing and HRPT Properties common
shares.
You will generally be subject to regular federal income tax in the same
manner as a U.S. person with respect to the spin-off of our common shares and
your investment in Senior Housing or HRPT Properties shares, if this investment
in REIT shares is effectively connected with your conduct of a trade or business
in the United States. In addition, if you are a corporate shareholder of Senior
Housing or HRPT Properties, your income that is effectively connected with a
trade or business in the United States may also be subject to the 30% branch
profits tax under Section 884 of the IRC, which is payable in addition to
regular federal corporate income tax. The balance of this summary addresses only
those non-U.S. persons whose investment in Senior Housing and HRPT Properties
common shares is not effectively connected with the conduct of a trade or
business in the United States.
Neither Senior Housing nor HRPT Properties is at this time designating the
distribution of our common shares as a capital gain dividend that is subject to
35% withholding for non-U.S. persons, and accordingly the 30% or applicable
lower treaty rate withholding will be imposed upon the fair market value of our
common shares that Senior Housing or HRPT Properties distributes to you. Senior
Housing, HRPT Properties or other applicable withholding agents will collect the
amount required to be withheld by reducing to cash for remittance to the IRS a
sufficient portion of our common shares that you would otherwise receive, and
you will bear the brokerage or other costs for this withholding procedure.
Because neither Senior Housing nor HRPT Properties can determine its current and
accumulated earnings and profits until the end of its taxable year, withholding
at the rate of 30% or applicable lower treaty rate will be imposed on the gross
fair market value of our common shares distributed to you. Notwithstanding this
and other withholding on distributions in excess of a REIT's current and
accumulated earnings and profits, these distributions are a nontaxable return of
capital to the extent that they do not exceed your adjusted basis in your common
shares of that REIT, and the nontaxable return of capital will reduce your
adjusted basis in your common shares of that REIT. To the extent that
distributions in excess of the REIT's current and accumulated earnings and
profits exceed your adjusted basis in your common shares of that REIT, the
distributions will give rise to tax liability only if you would otherwise be
subject to tax on any gain from the sale or exchange of your common shares in
that REIT. Your gain from the sale or exchange of your common shares in a REIT
will not be taxable if: (1) the REIT's common shares are "regularly traded"
within the meaning of Treasury regulations under Section 897 of the IRC and you
have at all times during the preceding five years owned 5% or less by value of
that REIT's outstanding common shares, or (2) the REIT is a
"domestically-controlled REIT" within the meaning of Section 897 of the IRC.
Although neither can provide complete assurance on this matter, each of Senior
Housing and HRPT Properties believes that its shares are regularly traded and
that it is a domestically-controlled REIT. You may seek a refund of amounts
withheld on distributions to you in excess of Senior Housing's or HRPT
Properties' current
53
and accumulated earnings and profits, as applicable, provided that you furnish
the required information to the IRS.
Some of Senior Housing's and HRPT Properties' 2001 distributions may be
treated for federal income tax purposes as attributable to dispositions of
United States real property interests. To the extent that a portion of any of
Senior Housing's or HRPT Properties' distributions to you, including the
distribution of our common shares, is attributable to a disposition by Senior
Housing or HRPT Properties of United States real property interests, you will be
subject to tax on this portion as though it were gain effectively connected with
a trade or business conducted in the United States. Accordingly, you will be
taxed on these amounts at the capital gain rates applicable to a U.S. person,
subject to any applicable alternative minimum tax and to a special alternative
minimum tax in the case of nonresident alien individuals; you will be required
to file a United States federal income tax return reporting these amounts, even
if applicable 35% withholding is imposed as described below; and if you are a
corporation, you may owe the 30% branch profits tax under Section 884 of the IRC
in respect of these amounts.
If you are a non-U.S. person, Senior Housing, HRPT Properties and other
applicable withholding agents will be required to withhold from distributions to
you, and to remit to the IRS, 35% of the maximum amount of any distribution that
could be designated as a capital gain dividend by Senior Housing or HRPT
Properties, as applicable. In addition, if either Senior Housing or HRPT
Properties designates any of its prior distributions as capital gain dividends,
then its subsequent distributions up to the amount of the designated prior
distributions will be treated as capital gain dividends for purposes of this 35%
withholding rule. After the close of each of Senior Housing's and HRPT
Properties' 2001 taxable year, each REIT expects to designate to the maximum
extent possible a portion of one or more of its 2001 distributions as capital
gain dividends, and accordingly 35% withholding will be imposed upon its
subsequent distributions to you to that extent.
FEDERAL INCOME TAX CONSEQUENCES OF THE SPIN-OFF TO SENIOR HOUSING
The IRC imposes upon Senior Housing various REIT qualification tests
discussed more fully in Senior Housing's Annual Report on Form 10-K. While
Senior Housing believes that it has operated and will operate in a manner to
satisfy the various REIT qualification tests, counsel has not reviewed and will
not review its compliance with these tests on a continuing basis. The following
discussion summarizes how the spin-off affects Senior Housing's REIT
qualification and taxation issues under the IRC.
IN GENERAL. So long as we and our subsidiaries remain wholly owned direct
or indirect subsidiaries of Senior Housing, we and most all of our subsidiaries
will be qualified REIT subsidiaries under Section 856(i) of the IRC or,
equivalently, noncorporate entities that are taxed as part of Senior Housing
under regulations issued under Section 7701 of the IRC. During these periods we
and these subsidiaries will not be taxpayers separate from Senior Housing for
federal income tax purposes. A few of our subsidiaries are Senior Housing
taxable REIT subsidiaries, with federal income tax filing and payment
obligations that are separate from Senior Housing. Under the transaction
agreement, Senior Housing is generally responsible for our federal income tax
liabilities and filings, as well as those of all our subsidiaries, for the
periods prior to the spin-off.
When we cease to be wholly owned by Senior Housing as a result of the
spin-off, the following will be deemed to have occurred for federal income tax
purposes:
- Immediately preceding the spin-off distribution of our common shares,
Senior Housing disposed of our properties and assets, and the properties
and assets of our subsidiaries, in a tax-free exchange called the deemed
incorporation, in which the aggregate amount Senior Housing realized
equaled the sum of: (1) the fair market value of all our common shares
immediately preceding the spin-off, plus (2) the aggregate amount of
liabilities that are associated with our and our subsidiaries' properties
and assets and that remain our and our subsidiaries'
54
responsibility after the spin-off. For these purposes, the assets and
liabilities of the Senior Housing taxable REIT subsidiaries are ignored,
and instead the stock in the parent taxable REIT subsidiary is treated
like any other asset of ours.
- Immediately after the deemed incorporation, Senior Housing distributed to
its common shareholders, including HRPT Properties, 99% of our common
shares that Senior Housing was treated as having received in the deemed
incorporation.
TAXATION OF THE DISTRIBUTION. The distribution by Senior Housing to its
shareholders of our common shares in the spin-off will be treated in the same
manner as any other distribution of cash or property that Senior Housing may
make. Thus, the distribution of our common shares together with Senior Housing's
other 2001 distributions will entitle Senior Housing to a dividends paid
deduction to the extent of its earnings and profits for the year. In addition,
Senior Housing will recognize gain from the distribution of our common shares
equal to the excess, if any, of the fair market value of our common shares that
Senior Housing distributes, over Senior Housing's tax basis in those shares. In
contrast, Senior Housing will not recognize loss on the distribution even if its
tax basis in our common shares exceeds its fair market value.
Under applicable judicial precedent, it is possible that for federal income
tax purposes the per share fair market value of our common shares Senior Housing
distributes will differ from the average of the reported high and low trading
prices for our common shares in the public market on the date of the spin-off,
called the distribution price. Because of the factual nature of value
determinations, Sullivan & Worcester LLP is unable to render an opinion on the
fair market value of our common shares that Senior Housing will distribute.
However, for purposes of computing any gain that Senior Housing may have on the
distribution of our common shares, we and Senior Housing believe that the fair
market value of our common shares may be computed as the distribution price
multiplied by the number of our common shares distributed. Senior Housing's tax
basis in our common shares distributed is computed as described below.
Any gain that Senior Housing recognizes on the distribution of our common
shares will be qualifying gross income under the 95% gross income test of
Section 856(c) of the IRC, provided that Senior Housing is not treated as
holding our common shares as inventory or other property held primarily for sale
to customers. If any of this gain were characterized as the sale of inventory or
other property held primarily for sale to customers, this would not affect
Senior Housing's ability to satisfy the 95% gross income test, but the
recharacterized gain would be subject to the 100% penalty tax of
Section 857(b)(6) of the IRC. Although Senior Housing can provide no assurance
on this matter, Senior Housing does not believe that it has held our common
shares as inventory or other property held primarily for sale to customers, and
accordingly it believes that its gain, if any, on our distributed common shares
will be short-term capital gain.
Senior Housing's tax basis in the 100% of our common shares that it owns
immediately prior to the spin-off will be equal to, and its tax basis in each
distributed share of our common stock will be the per share value of, the
following sum: (1) Senior Housing's aggregate adjusted tax basis in our
properties and assets, and the properties and assets of our subsidiaries,
immediately prior to the deemed incorporation; minus (2) the aggregate amount of
liabilities that are associated with our properties and assets, and the
properties and assets of our subsidiaries, that remain our and our subsidiaries'
responsibility after the spin-off. For these purposes, the assets and
liabilities of the Senior Housing taxable REIT subsidiaries are ignored, and
instead the stock in the parent taxable REIT subsidiary is treated like any
other asset of ours. Accordingly, Senior Housing expects that its tax basis in
each of our shares that it owns immediately prior to the distribution will be
approximately equal to the distribution price, and may possibly exceed the
distribution price. Under these circumstances, Senior Housing could recognize
some gain but no loss on its distribution of our common shares.
OUR POST SPIN-OFF RELATIONSHIP WITH SENIOR HOUSING. After the distribution
of our common shares, Senior Housing will own 35,000, or less than one percent,
of our common shares. In addition, our
55
leases with Senior Housing, our charter, and the transaction agreement
collectively contain restrictions upon our ownership and provisions that require
us to refrain from taking any actions that may jeopardize Senior Housing's or
HRPT Properties' qualification as REITs under the IRC, including actions which
would result in Senior Housing or HRPT Properties obtaining actual or
constructive ownership of 10% or more of our shares for IRC Section 856(d)
purposes. Accordingly, commencing with its 2002 taxable year, Senior Housing
anticipates that the rental income it receives from us will be "rents from real
property" under Section 856(d) of the IRC, as well as qualifying income under
the 75% and 95% gross income tests of Section 856(c) of the IRC.
FEDERAL INCOME TAX CONSEQUENCES OF THE SPIN-OFF TO HRPT PROPERTIES
The IRC imposes upon HRPT Properties various REIT qualification tests
discussed more fully in HRPT Properties' Annual Report on Form 10-K. While HRPT
Properties believes that it has operated and will operate in a manner to satisfy
the various REIT qualification tests, counsel has not reviewed and will not
review its compliance with these tests on a continuing basis. The following
discussion summarizes how the spin-off affects HRPT Properties' REIT
qualification and taxation issues under the IRC.
HRPT Properties currently owns approximately 29% of the common shares of
Senior Housing. Accordingly, HRPT Properties will receive a substantial number
of our common shares as a distribution from Senior Housing. To the extent of
Senior Housing's allocable earnings and profits, this distribution from Senior
Housing will be a REIT dividend to HRPT Properties that qualifies under the 75%
and 95% gross income tests of Section 856(c) of the IRC. To the extent the
distribution exceeds Senior Housing's allocable earnings and profits, HRPT
Properties will treat the distribution as a tax-free recovery of basis in its
Senior Housing shares.
The distribution by HRPT Properties to its shareholders of our common shares
in the spin-off will be treated in the same manner as any other distribution of
cash or property that HRPT Properties may make. Thus, the distribution of our
common shares together with HRPT Properties' other 2001 distributions will
entitle HRPT Properties to a dividends paid deduction to the extent of its
earnings and profits for the year. In addition, HRPT Properties will recognize
gain from the distribution of our common shares equal to the excess, if any, of
the fair market value of our common shares that HRPT Properties distributes,
over HRPT Properties' tax basis in those shares. In contrast, HRPT Properties
will not recognize loss on the distribution even if its tax basis in our common
shares exceeds its fair market value.
Any gain that HRPT Properties recognizes on the distribution of our common
shares will be qualifying gross income under the 95% gross income test of
Section 856(c) of the IRC, provided that HRPT Properties is not treated as
holding our common shares as inventory or other property held primarily for sale
to customers. If any of this gain were characterized as the sale of inventory or
other property held primarily for sale to customers, this would not affect HRPT
Properties' ability to satisfy the 95% gross income test, but the
recharacterized gain would be subject to the 100% penalty tax of
Section 857(b)(6) of the IRC. Although HRPT Properties can provide no assurance
on this matter, HRPT Properties does not believe that it has held our common
shares as inventory or other property held primarily for sale to customers, and
accordingly it believes that its gain, if any, on our distributed common shares
will be short-term capital gain. Furthermore, as discussed below, HRPT
Properties expects to have no gain on its distribution of our common shares.
HRPT Properties' tax basis in our common shares it distributes will follow
the valuation assumptions that Senior Housing is employing for the Senior
Housing common shareholders, of which HRPT Properties is one: the tax basis in
each of our common shares will equal the average of the reported high and low
trading prices for our common shares in the public market on the date of the
spin-off, called the distribution price. Under applicable judicial precedent, it
is possible that for federal income tax purposes the per share fair market value
of our common shares that HRPT Properties
56
distributes will differ from the distribution price. Because of the factual
nature of value determinations, Sullivan & Worcester LLP is unable to render an
opinion on the fair market value of our common shares that HRPT Properties will
distribute. However, for purposes of computing any gain that HRPT Properties may
have on the distribution of our common shares, we and HRPT Properties believe
that the fair market value of our common shares may be computed as the
distribution price multiplied by the number of shares of our common shares
distributed. Accordingly, HRPT Properties does not expect to have any gain or
loss on its distribution of our common shares.
If Senior Housing as a result of the spin-off recognizes additional gain and
distributes that additional gain as a REIT dividend to its common shareholders,
then HRPT Properties as a Senior Housing common shareholder will receive its pro
rata share of the additional Senior Housing REIT dividend. In addition, if HRPT
Properties' valuation methodologies for our common shares are successfully
challenged by the IRS, then HRPT Properties could have gain on its distribution
of our common shares. In either case, this could correspondingly increase HRPT
Properties' income, distribution requirement, and taxable REIT dividend to its
common shareholders.
FEDERAL INCOME TAXATION OF FIVE STAR AND OUR SHAREHOLDERS
IN GENERAL. We will be taxable as a subchapter C corporation. Accordingly,
we will pay federal income taxes on our income, and not be subject to the
distribution and other requirements applicable to REITs. Under the transaction
agreement, Senior Housing is generally responsible for our federal income tax
liabilities and filings, as well as those of all our subsidiaries, for the
periods prior to the spin-off.
DISTRIBUTIONS ON OUR COMMON SHARES. At the present time, we do not expect
to pay any dividends on our common shares. However, if we do later decide to do
so, your tax consequences would generally be as follows.
If you are a U.S. person, distributions to you on our common shares during
taxable years beginning on or after the spin-off will be treated as ordinary
income dividends to the extent attributable to our current or accumulated
earnings and profits and thereafter as a return of basis to the extent of that
basis, with any excess being treated as gain from a deemed disposition of our
common shares. If you are a corporation, dividends paid to you on our common
shares will generally be eligible for the dividends received deduction, subject
to the limitations of the IRC with respect to the corporate dividends received
deduction.
If you are a non-U.S. person, dividends paid to you will be subject to
withholding of federal income tax at a 30% rate or a lower rate as may be
specified by an applicable income tax treaty. If you are eligible for a reduced
rate of withholding tax pursuant to a tax treaty, you may obtain a refund of any
excess amounts previously withheld by filing an appropriate claim for refund
with the IRS. To claim the benefits on an income tax treaty, you are required to
satisfy the applicable certification requirements, generally by executing an IRS
Form W-8.
DISPOSITIONS OF OUR COMMON SHARES. If you are a U.S. person, you will
generally recognize gain or loss on a disposition of our common shares in an
amount equal to the difference between the amount realized on the disposition
and your adjusted basis in the disposed of common shares. This gain or loss will
be capital gain or loss, and will be long-term capital gain or loss if your
holding period in the disposed of common shares exceeds one year. Special rates
of tax may apply to long-term capital gains recognized by noncorporate U.S.
persons.
If you are a non-U.S. person, you will generally not be subject to United
States federal income tax in respect of gain you recognize on a disposition of
our common shares. However, you may be subject to taxation if you are an
individual who is present in the United States for 183 or more days in the
taxable year of the sale. In addition, you may be subject to taxation if we are
or have been a "United States real property holding corporation" for federal
income tax purposes; however, this taxation will
57
not apply if our stock is "regularly traded" within the meaning of Treasury
regulations under Section 897 of the IRC and you have at all times during the
preceding five years owned 5% or less by value of our common shares. For
corporate non-U.S. persons, taxable gains recognized on a United States real
property holding corporation may also be subject to an additional "branch
profits" tax at a 30% or lower applicable treaty rate. At this time, we do not
believe that we are or will become a "United States real property holding
corporation" for federal income tax purposes, but can provide no assurance in
this regard.
INFORMATION REPORTING AND BACKUP WITHHOLDING
Information reporting and backup withholding may apply to distributions or
proceeds paid to Senior Housing and HRPT Properties shareholders and our
shareholders in the circumstances discussed below. Amounts withheld under backup
withholding are generally not an additional tax and may be refunded or credited
against your federal income tax liability, provided that you furnish the
required information to the IRS. The current backup withholding rate is 30.5%,
but that rate falls to 30% for the calendar years 2002 and 2003, and is
scheduled to gradually decrease to 28% by calendar year 2006.
The spin-off distribution of our common shares is an in-kind distribution to
Senior Housing and HRPT Properties shareholders, and thus Senior Housing, HRPT
Properties, or other applicable withholding agents will have to collect any
applicable backup withholding by reducing to cash for remittance to the IRS a
sufficient portion of our common shares that a Senior Housing shareholder or
HRPT Properties shareholder would otherwise receive, and the recipient
shareholder will bear the brokerage or other costs for this withholding
procedure.
IF YOU ARE A U.S. PERSON. You may be subject to backup withholding when you
receive distributions on, or proceeds upon the sale, exchange, redemption,
retirement or other disposition of, Senior Housing shares, HRPT Properties
shares, or our common shares. Thus, backup withholding may apply to common
shares you receive in the spin-off distribution. In general, you can avoid this
backup withholding if you properly execute under penalties of perjury an IRS
Form W-9 or substantially similar form on which you:
- provide your correct taxpayer identification number, and
- certify that you are exempt from backup withholding because (a) you are a
corporation or come within another enumerated exempt category, (b) you
have not been notified by the IRS that you are subject to backup
withholding or (c) you have been notified by the IRS that you are no
longer subject to backup withholding.
If you have not previously provided and do not provide your correct taxpayer
identification number on the IRS Form W-9 or substantially similar form, you may
be subject to penalties imposed by the IRS and the withholding agent may also
have to withhold a portion of any capital gain distributions paid to you.
Unless you have established on a properly executed IRS Form W-9 or
substantially similar form that you are a corporation or come within another
exempt category, distributions and other payments on Senior Housing shares, HRPT
Properties shares, and our common shares paid to you during the calendar year,
and the amount of tax withheld if any, will be reported to you and to the IRS.
IF YOU ARE A NON-U.S. PERSON. Distributions on Senior Housing shares, HRPT
Properties shares, and our common shares paid to you during each calendar year,
and the amount of tax withheld if any, will generally be reported to you and to
the IRS. This information reporting requirement applies regardless of whether
you were subject to withholding, or whether the withholding was reduced or
eliminated by an applicable tax treaty. Also, distributions and other payments
to you on Senior Housing shares, HRPT Properties shares, or our common shares
may be subject to backup withholding as discussed above, unless you have
properly certified your non-U.S. person status on an IRS Form W-8
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or substantially similar form. Similarly, information reporting and backup
withholding will not apply to proceeds you receive upon the sale, exchange,
redemption, retirement or other disposition of Senior Housing shares, HRPT
Properties shares, or our common shares if you have properly certified your
non-U.S. person status on an IRS Form W-8 or substantially similar form. Even
without having executed an IRS Form W-8 or substantially similar form, however,
in some cases information reporting and backup withholding will not apply to
proceeds that you receive upon the sale, exchange, redemption, retirement or
other disposition of Senior Housing shares, HRPT Properties shares, or our
common shares if you receive those proceeds through a broker's foreign office.
OTHER TAX CONSEQUENCES
You should recognize that our and our shareholders' federal income tax
treatment, as well as Senior Housing's, HRPT Properties' and their respective
shareholders' federal income tax treatment, may be modified by legislative,
judicial, or administrative actions at any time, which actions may be
retroactive in effect. The rules dealing with federal income taxation are
constantly under review by the Congress, the IRS and the Treasury Department,
and statutory changes as well as promulgation of new regulations, revisions to
existing regulations, and revised interpretations of established concepts occur
frequently. No prediction can be made as to the likelihood of passage of new tax
legislation or other provisions either directly or indirectly affecting us,
Senior Housing, HRPT Properties or any of our respective shareholders. Revisions
in federal income tax laws and interpretations of these laws could adversely
affect the tax consequences of an investment in our common shares, Senior
Housing shares, or HRPT Properties shares. We, Senior Housing, and HRPT
Properties, as well as our respective shareholders, may also be subject to state
or local taxation in various state or local jurisdictions, including those in
which we, Senior Housing, HRPT Properties and our respective shareholders
transact business or reside. State and local tax consequences may not be
comparable to the federal income tax consequences discussed above.
SHARES ELIGIBLE FOR FUTURE SALE
Our shares being distributed as part of the spin-off will be freely
transferable, except for shares held by persons that are "affiliates" as defined
in the Securities Act of 1933. The Securities Act of 1933 generally defines
affiliates as individuals or entities that control, are controlled by, or are
under common control with us and may include our officers, directors and
principal shareholders. Shares held by affiliates may only be sold pursuant to
an effective registration statement under the Securities Act of 1933 or
Rule 144 of the Securities Act of 1933. We cannot predict whether substantial
amounts of our shares will be sold in the open market following the
distribution. Sales of substantial amounts of our shares in the public market,
or the perception that substantial sales may occur, could adversely affect their
market price. The 25,000 common shares of ours retained by Senior Housing and
the common shares we will issue to Messrs. Portnoy and Martin as consideration
in our acquisition of FSQ, Inc. will not be registered under the Securities Act
of 1933, and therefore these shares can only be sold pursuant to an effective
registration statement or Rule 144.
DESCRIPTION OF CAPITAL STOCK
The following description of our capital stock and certain provisions of our
charter and bylaws are summaries and are qualified by reference to our charter
and our bylaws. Copies of these documents have been filed as exhibits to the
registration statement of which this prospectus is a part.
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COMMON SHARES
Upon completion of the spin-off and the FSQ, Inc. merger, we will have only
one class of common shares, $.01 par value per share, of which ten million
shares will be authorized and 4,617,170 shares will have been issued. Our
charter provides that our Board of Directors, without any action by the
shareholders, may amend the charter to increase or decrease the number of our
authorized common shares. All of our common shares distributed in the spin-off
and issued in the merger will be duly authorized, fully paid and non-assessable.
The holders of common shares are entitled to one vote for each share held of
record on our books for the election of directors and on all matters submitted
to a vote of shareholders. The holders of common shares are entitled to receive
ratably dividends, if any, when, as and if authorized by our Board of Directors
out of assets legally available therefor, subject to any preferential dividend
rights of any outstanding preferred shares. Upon our dissolution, liquidation or
winding up, the holders of common shares are entitled to receive ratably our net
assets available after the payment of all debts and other liabilities, subject
to the preferential rights of any outstanding preferred shares. Holders of
common shares have no preemptive, subscription, redemption or conversion rights.
The rights, preferences and privileges of holders of common shares are subject
to, and may be adversely affected by, the rights of the holders of shares of any
series of preferred shares that we may designate and issue in the future. Our
charter authorizes our Board of Directors to reclassify any unissued common
shares into other classes or series of stock and to establish the number of
shares in each class or series and to set the preferences, conversion and other
rights, voting powers, restrictions, limitations as to dividends or other
distributions, qualifications or terms or conditions of redemption for each such
class or series. Our charter and our bylaws contain certain provisions that
could have the effect of delaying, deferring or preventing a change in our
control. See "Material Provisions of Maryland Law, Our Charter and Bylaws" below
for a description of these provisions.
PREFERRED SHARES
Upon completion of the spin-off, we will have one million preferred shares
authorized. Our Board of Directors will be authorized, without further vote or
action by the shareholders, to issue from time to time preferred shares in one
or more series and to classify or reclassify any unissued preferred shares and
to reclassify any previously classified but unissued preferred shares of any
series. Prior to issuance of shares of each series, our Board of Directors is
required by Maryland law and our charter to set, subject to the provisions of
our charter regarding the restrictions on transfer of shares, the terms,
preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends or other distributions, qualifications and terms or
conditions of redemption for each such series. Our charter provides that our
Board of Directors, without any action by the shareholders, may amend the
charter to increase or decrease the number of our authorized preferred shares.
The issuance of preferred shares could adversely affect the voting power of
holders of common shares and the likelihood that such holders will receive
dividend payments and payments upon liquidation and could have the effect of
delaying, deferring or preventing a change in control. We believe that the
ability of our Board of Directors to issue one or more series of preferred
shares provides us with flexibility in structuring possible future financings
and acquisitions, and in meeting other corporate needs that may arise.
TRANSFER AGENT AND REGISTRAR
Upon completion of the spin-off, our transfer agent and registrar for the
common shares will be EquiServe Trust Company, N.A.
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MATERIAL PROVISIONS OF MARYLAND LAW, OUR CHARTER AND BYLAWS
We are organized as a Maryland corporation. The following is a summary of
our charter and bylaws that will be in effect on the date of the spin-off and
several provisions of Maryland law. Because it is a summary, it does not contain
all the information that may be important to you. If you want more information,
you should read our entire charter and bylaws, copies of which we have filed as
exhibits to the registration statement of which this prospectus is a part, or
refer to the provisions of applicable Maryland corporate law summarized below.
RESTRICTIONS ON SHARE OWNERSHIP AND TRANSFER
Our charter will restrict the amount of shares that shareholders may own.
These restrictions are intended to assist Senior Housing with REIT compliance
under the IRC, and otherwise to promote our orderly governance. All certificates
representing our shares will bear a legend referring to these restrictions.
Our charter provides that no person or group of persons acting in concert
may own, or be deemed to own by virtue of the attribution provisions of the IRC,
more than 9.8% of the number or value of any class or series of our outstanding
shares of capital stock. Any person who acquires or attempts or intends to
acquire actual or constructive ownership of shares of our capital stock that
will or may violate this 9.8% ownership limitation must give notice immediately
to us and provide us with any other information that we may request.
The ownership limitations in our charter will be effective against all of
our shareholders as of the spin-off distribution date; however, the ownership
limitations will not apply to any person whose ownership exceeds the limitation
solely by reason of receipt of common shares in the distribution on the spin-off
distribution date. With the written consent of Senior Housing, our Board of
Directors may grant an exemption from the ownership limitation if it is
satisfied that: (i) the shareholder's ownership will not cause us or any of our
subsidiaries that are tenants of Senior Housing to be deemed a "related party
tenant" under the IRC rules applicable to REITs; (ii) the shareholder's
ownership will not cause a default under any lease we have outstanding; and
(iii) the shareholder's ownership is otherwise in our interest as determined by
our Board of Directors in the exercise of its business judgment.
If a person attempts a transfer of our shares in violation of the ownership
limitations described above, then that number of shares which would cause the
violation will be automatically transferred to a trust for the exclusive benefit
of one or more charitable beneficiaries designated by us. The prohibited owner
will not acquire any rights in the shares held in trust, will not benefit
economically from ownership of the shares held in trust, will have no rights to
distributions and will not possess any rights to vote the shares held in trust.
This automatic transfer will be deemed to be effective as of the close of
business on the business day prior to the date of the violative transfer.
Within 20 days after receiving notice from us that shares have been
transferred to the trust, the trustee will sell the shares held in the trust to
a person selected by the trustee whose ownership of the shares will not violate
the ownership limitations. Upon this sale, the interest of the charitable
beneficiary in the shares sold will terminate and the trustee will distribute
the net proceeds of the sale to the prohibited owner and to the charitable
beneficiary as follows:
- The prohibited owner will receive the lesser of:
(1) the net price paid by the prohibited owner for the shares or, if the
prohibited owner did not give value for the shares in connection with
the event causing the shares to be held in the trust (e.g., a gift,
devise or other similar transaction), the market price of the shares
on the day of the event causing the shares to be transferred to the
trust; and
(2) the net price received by the trustee from the sale of the shares
held in the trust.
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- Any net sale proceeds in excess of the amount payable to the prohibited
owner shall be paid to the charitable beneficiary.
If, prior to our discovery that shares of our capital stock have been
transferred to the trust, a prohibited owner sells those shares, then:
- those shares will be deemed to have been sold on behalf of the trust; and
- to the extent that the prohibited owner received an amount for those
shares that exceeds the amount that the prohibited owner was entitled to
receive from a sale by the trustee, the prohibited owner must pay the
excess to the trustee upon demand.
Also, shares of capital stock held in the trust will be offered for sale to
us, or our designee, at a price per share equal to the lesser of:
- the price per share in the transaction that resulted in the transfer to
the trust or, in the case of a devise or gift, the market price at the
time of the devise or gift; and
- the market price on the date we or our designee accepts the offer.
We will have the right to accept the offer until the trustee has sold the shares
held in the trust. The net proceeds of the sale to us will be distributed
similar to any other sale by the trustee.
Every owner of 5% or more of any class or series of our shares may be
required to give written notice to us within 30 days after the end of each
taxable year stating the name and address of the owner, the number of shares of
each class and series of our shares which the owner beneficially owns, and a
description of the manner in which those shares are held. In addition, each
shareholder is required to provide us upon demand with any additional
information that we may request in order to assist us and Senior Housing in its
determination of its status as a REIT and to determine and ensure compliance
with the foregoing share ownership limitations.
The restrictions described above will not preclude the settlement of any
transaction entered into through the facilities of the AMEX or any other
national securities exchange or automated inter-dealer quotation system. Our
charter will provide, however, that the fact that the settlement of any
transaction occurs will not negate the effect of any of the foregoing
limitations and any transferee in this kind of transaction will be subject to
all of the provisions and limitations described above.
These ownership limitations could have the effect of delaying, deferring or
preventing a takeover or other transaction in which holders of some, or a
majority, of our common shares might receive a premium for their shares over the
then prevailing market price or which such holders might believe to be otherwise
in their best interest.
POSSIBLE LIABILITY OF SHAREHOLDERS FOR BREACH OF RESTRICTIONS ON OWNERSHIP
Our facility leases and our shared services agreement are terminable by
Senior Housing and Reit Management, respectively, in the event that any
shareholder or group of shareholders acting in concert becomes the owner of more
than 9.8% of our voting stock without Senior Housing's consent. If a breach of
the ownership limitations results in a lease default, the shareholders causing
the default may become liable to us or to our other shareholders for damages.
These damages may be in addition to the loss of beneficial ownership and voting
rights, the transfer to a trust and the forced sale of excess shares described
above. These damages may be for material amounts.
DIRECTORS
Our charter and bylaws provide that our Board of Directors establishes the
number of directors. However, there may not be less than the minimum number
required by Maryland law nor more than seven directors. In the event of a
vacancy, a majority of the remaining directors will fill the vacancy and
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the director elected to fill the vacancy will serve for the remainder of the
full term of the directorship in which the vacancy occurred.
Our charter divides our Board of Directors into three classes. The initial
term of the first class will expire in 2002; the initial term of the second
class will expire in 2003; and the initial term of the third class will expire
in 2004. Beginning in 2002, shareholders will elect directors of each class for
three-year terms upon the expiration of their current terms. Shareholders will
elect only one class of directors each year. There will be no cumulative voting
in the election of directors. Consequently, at each annual meeting of
shareholders, a majority of the votes entitled to be cast will be able to elect
all of the successors of the class of directors whose term expires at that
meeting.
We believe that classification of the board will help to assure the
continuity of our business strategies and policies. However, the classified
board provision could have the effect of making the replacement of incumbent
directors more time consuming and difficult. At least two annual meetings of
shareholders will generally be required to effect a change in a majority of the
Board of Directors.
Our charter provides that a director may be removed only for cause by the
affirmative vote of at least 75% of the shares entitled to vote in the election
of directors. This provision precludes shareholders from removing incumbent
directors unless they can obtain a substantial affirmative vote of shares.
ADVANCE NOTICE OF DIRECTOR NOMINATIONS AND NEW BUSINESS
Our bylaws provide that nominations of persons for election to our Board of
Directors and other business may only be considered at our shareholders meetings
if the nominations or other business are included in the notice of the meeting,
made or proposed by our Board of Directors or made or proposed by a shareholder
who:
- is a shareholder of record at the time of giving notice of the nomination
or the business to be considered;
- is a shareholder of record entitled to vote at the meeting at which the
nomination or business is to be considered;
- is a shareholder of record at the time of the meeting and physically
present in person or by proxy at the meeting to answer questions about the
nomination or business; and
- has complied in all respects with the advance notice provisions for
shareholder nominations and other business set forth in our bylaws.
Under our bylaws, a shareholder's notice of nominations for director or
business to be transacted at an annual meeting of shareholders must be delivered
to our secretary at our principal office not later than the close of business on
the 90th day and not earlier than the close of business on the 120th day prior
to the first anniversary of the date of mailing of our notice for the preceding
year's annual meeting. In the event that the date of mailing of our notice of
the annual meeting is advanced or delayed by more than 30 days from the
anniversary date of the mailing of our notice for the preceding year's annual
meeting, a shareholder's notice must be delivered to us not earlier than the
close of business on the 120th day prior to the mailing of notice of such annual
meeting and not later than the close of business on the later of: (1) the 90th
day prior to the date of mailing of the notice for an annual meeting, or
(2) the 10th day following the day on which we first make a public announcement
of the date of mailing of our notice for such meeting. The public announcement
of a postponement of the mailing of the notice for an annual meeting or of an
adjournment or postponement of an annual meeting to a later date or time will
not commence a new time period for the giving of a shareholder's notice. If the
number of directors to be elected to our Board of Directors at a shareholders
meeting is increased and we make no public announcement of such action or do not
specify the size of the increased Board of Directors at least 100 days prior to
the first anniversary of the date of mailing of
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notice for our preceding year's annual meeting, a shareholder's notice also will
be considered timely, but only with respect to nominees for any new positions
created by such increase, if the notice is delivered to our secretary at our
principal office not later than the close of business on the 10th day following
the day on which such public announcement is made. This provision does not apply
to new directors who are elected by the Board of Directors to fill a vacancy,
including a vacancy created by Board action which increases the number of
directors.
For special meetings of shareholders, our bylaws require a shareholder who
is nominating a person for election to our Board of Directors at a special
meeting at which directors are to be elected to give notice of such nomination
to our secretary at our principal office not earlier than the close of business
on the 120th day prior to such special meeting and not later than the close of
business on the later of: (1) the 90th day prior to such special meeting or
(2) the 10th day following the day on which public announcement is first made of
the date of the special meeting and of the nominees proposed by the directors to
be elected at such meeting. The public announcement of a postponement or
adjournment of a special meeting to a later date or time will not commence a new
time period for the giving of a shareholder's notice as described above.
Any notice from a shareholder of nominations for director or business to be
transacted at a shareholders meeting must be in writing and include the
following:
- as to each person nominated for election or reelection as a director,
(1) the person's name, age, business and residence addresses, (2) the
principal occupation or employment of the person for the past five years,
(3) the class and number of shares beneficially owned or owned of record
by the person and (4) all other information relating to the person that is
required to be disclosed in solicitations of proxies for election of
directors or otherwise required by Regulation 14A under the Securities
Exchange Act of 1934, as amended, together with the nominee's written
consent to being named in the proxy statement as a nominee and to serving
as a director if elected;
- as to other business that the shareholder proposes to bring before the
meeting, a brief description of the business, the reasons for considering
the business and any interest in the business of the shareholder giving
the notice and of the beneficial owner, if any, on whose behalf the
proposal is made; and
- as to the shareholder giving the notice and the beneficial owner, if any,
on whose behalf the nomination or proposal is made, the name and address
of the shareholder and beneficial owner and the class and number of each
class of our shares of capital stock which (s)he or they own beneficially
and of record.
We may request that any shareholder proposing a nominee for election to our
Board of Directors provide, within three business days of such request, written
verification of the accuracy of the information submitted by the shareholder.
MEETINGS OF SHAREHOLDERS
The Board of Directors will determine the place and time of the annual
meeting of shareholders. Special meetings of shareholders may only be called by
the majority of the Board of Directors, the chairman of the Board of Directors,
if any, the president, or, if permitted under Maryland law, upon the written
request of shareholders entitled to cast not less than a majority of all the
votes entitled to be cast at that meeting (or such greater proportion we are
permitted to specify under Maryland law).
LIABILITY AND INDEMNIFICATION OF DIRECTORS AND OFFICERS
Maryland corporate law permits a Maryland corporation to include in its
charter a provision limiting the liability of its directors and officers to the
corporation and its shareholders for money damages except for liability
resulting from (i) actual receipt of an improper benefit or profit in money,
property or services or (ii) acts committed in bad faith or active and
deliberate dishonesty established
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by a final judgment as being material to the cause of action. Our charter
contains such a provision which eliminates such liability to the maximum extent
permitted by Maryland law. In accordance with Maryland corporate law, our
charter authorizes us, to the maximum extent permitted by Maryland law, to
obligate ourselves to indemnify and to pay or reimburse reasonable expenses in
advance of final disposition of a proceeding to (i) any present or former
director or officer or (ii) any individual who, while a director and at our
request, serves or has served another corporation, real estate investment trust,
partnership, joint venture, trust, employee benefit plan or other enterprise
from and against any claim or liability to which he or she may become subject or
which he or she may incur by reason of his or her status as a present or former
director or officer of ours. Our bylaws obligate us, to the maximum extent
permitted by Maryland law, to indemnify and to pay or reimburse reasonable
expenses in advance of final disposition of a proceeding to (a) any present or
former director or officer who is made party to the proceeding by reason of his
service in that capacity or (b) any individual who, while a director, at our
request, serves or has served another corporation, real estate investment trust,
partnership, joint venture, trust, employee benefit plan or any other enterprise
as a director, officer, partner or trustee of such corporation, real estate
investment trust, partnership, joint venture, trust, employee benefit plan or
other enterprise and who is made a party to the proceeding by reason of his
service in that capacity. Our charter and bylaws also permit us to indemnify and
advance expenses to any person who served a predecessor of ours in any of the
capacities described above and to any employee or agent of ours or a predecessor
of ours.
The Maryland corporation statutes require a corporation (unless its charter
provides otherwise, which our charter does not) to indemnify a director or
officer who has been successful, on the merits or otherwise, in the defense of
any proceeding to which he or she is made a party by reason of his or her
service in that capacity. The Maryland corporation statutes permit a corporation
to indemnify its directors and officers, among others, against judgments,
penalties, fines, settlements and reasonable expenses actually incurred by them
in connection with any proceedings to which they may be made a party by reason
of their service in those or other capacities unless it is established that:
- the act or omission of the director or officer was material to the matter
giving rise to the proceedings and (a) was committed in bad faith or
(b) was the result of active and deliberate dishonesty;
- the director or officer actually received an improper personal benefit in
money, property or services; or
- in the case of any criminal proceeding, the director or officer had
reasonable cause to believe that the act or omission was unlawful.
However, under the corporation statutes of Maryland, a Maryland corporation
may not indemnify for an adverse judgment in a suit by or in the right of the
corporation or for a judgment of liability on the basis that personal benefit
was improperly received, unless in either case a court orders indemnification
and then only for expenses. In accordance with Maryland corporate law, our
bylaws require us, as a condition to advancing expenses, to obtain:
- a written affirmation by the director or officer of his or her good faith
belief that he or she has met the standard of conduct necessary for
indemnification by us as authorized by our bylaws; and
- a written statement by or on his or her behalf to repay the amount paid or
reimbursed by us if it shall ultimately be determined that the standard of
conduct was not met.
CHARTER AMENDMENTS AND EXTRAORDINARY TRANSACTIONS
Under Maryland corporate law, a Maryland corporation generally cannot
dissolve, amend its charter, merge, sell all or substantially all of its assets,
engage in a share exchange or engage in similar transactions outside the
ordinary course of business unless the transaction or amendment is declared
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advisable by the board of directors and then approved by the affirmative vote of
stockholders holding at least two-thirds of the shares entitled to vote on the
matter unless a lesser percentage (but not less than a majority of all of the
votes entitled to be cast on the matter) is set forth in the corporation's
charter. Our charter provides for approval of such matters when they are first
declared advisable by our Board of Directors and then approved by the
affirmative vote of stockholders holding a majority of the shares entitled to
vote on the matter (or such lesser proportion, as is permitted by Maryland law).
BYLAW AMENDMENTS
As permitted under Maryland corporate law, our bylaws provide that our Board
of Directors has the exclusive power to amend the bylaws.
BUSINESS COMBINATIONS
The Maryland corporation statutes contain a provision which regulates
business combinations with interested shareholders. Under Maryland corporate
law, business combinations such as mergers, consolidations, share exchanges and
the like between a Maryland corporation and an interested shareholder or an
affiliate of the interested shareholder are prohibited for five years after the
most recent date on which the shareholder becomes an interested shareholder.
Under the statute, the following persons are deemed to be interested
shareholders:
- any person who beneficially owns 10% or more of the voting power of the
corporation's shares of capital stock; or
- an affiliate or associate of the corporation who, at any time within the
two-year period prior to the date in question, was the beneficial owner of
10% or more of the voting power of the then outstanding voting shares of
the corporation.
A person is not an interested shareholder under the statute if the board of
directors approved in advance the transaction by which the person otherwise
would have become an interested shareholder. The board of directors may provide
that its approval is subject to compliance with any terms and conditions
determined by the board of directors.
After the five-year prohibition period has ended, a business combination
between a corporation and an interested shareholder or an affiliate of the
interested shareholder must be recommended by the board of directors of the
corporation and must receive the following shareholder approvals:
- the affirmative vote of at least 80% of the votes entitled to be cast; and
- the affirmative vote of at least two-thirds of the votes entitled to be
cast by holders of shares other than shares held by the interested
shareholder with whom or with whose affiliate the business combination is
to be effected or by an affiliate or associate of the interested
shareholder.
This shareholder approval is not required if the corporation's shareholders
receive the minimum price set forth in the Maryland corporation statute for
their shares of capital stock and the consideration is received in cash or in
the same form as previously paid by the interested shareholder for its shares of
capital stock.
The foregoing provisions of Maryland corporate law do not apply, however, to
business combinations that are approved or exempted by the board of directors of
the corporation prior to the time that the interested shareholder becomes an
interested shareholder. Our Board of Directors has adopted a resolution that any
business combination between us and any other person is exempted from the
provisions of the Maryland corporation statutes described in the preceding
paragraphs, provided that the business combination is first approved by our
Board of Directors, including the approval of a majority of the members of our
Board of Directors who are not affiliates or associates of such person. This
resolution, however, may be altered or repealed in whole or in part at any time.
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CONTROL SHARE ACQUISITIONS
The Maryland corporation statutes contain a provision which provides that
control shares of a Maryland corporation acquired in a control share acquisition
have no voting rights except to the extent that the acquisition is approved by a
vote of two-thirds of the votes entitled to be cast on the matter, excluding
shares of capital stock owned by the acquiror, by employees who are also
directors of the corporation or by officers of the corporation. Control shares
are voting shares of capital stock which, if aggregated with all other shares of
capital stock previously acquired by the acquiror, or in respect of which the
acquiror is able to exercise or direct the exercise of voting power (except
solely by virtue of a revocable proxy), would entitle the acquiror to exercise
voting power in electing directors within one of the following ranges of voting
power:
- one-tenth or more but less than one-third;
- one-third or more but less than a majority; or
- a majority or more of all voting power.
An acquiror must obtain the necessary shareholder approval each time he
acquires control shares in an amount sufficient to cross one of the thresholds
noted above.
Control shares do not include shares which the acquiring person is entitled
to vote as a result of having previously obtained shareholder approval. A
control share acquisition means the acquisition of control shares. There is a
list of exceptions from the definition of control share acquisition.
A person who has made or proposes to make a control share acquisition, upon
satisfaction of the conditions set forth in the statute, including an
undertaking to pay expenses, may compel the board of directors of the
corporation to call a special meeting of shareholders to be held within 50 days
after demand to consider the voting rights of the shares. If no request for a
meeting is made, the corporation may itself present the matter at any
shareholders meeting.
If voting rights are not approved at the meeting or if the acquiring person
does not deliver an acquiring person statement as required by the statute, then
the corporation may redeem any or all of the control shares for fair value
determined as of the date of the last control share acquisition by the acquiror
or of any meeting of shareholders at which the voting rights of those shares are
considered and not approved. The right of the corporation to redeem any or all
of the control shares is subject to conditions and limitations listed in the
statute. The corporation may not redeem shares for which voting rights have
previously been approved. Fair value is determined without regard to the absence
of voting rights for the control shares. If voting rights for control shares are
approved at a shareholders meeting and the acquiror becomes entitled to vote a
majority of the shares entitled to vote, all other shareholders may exercise
appraisal rights. The fair value of the shares as determined for purposes of
these appraisal rights may not be less than the highest price per share paid by
the acquiror in the control share acquisition.
The control share acquisition statute does not apply to the following:
- shares acquired in a merger, consolidation or share exchange if the
corporation is a party to the transaction; or
- acquisitions approved or exempted by a provision in the charter or bylaws
of the corporation adopted before the acquisition of shares.
Our bylaws contain a provision exempting any and all acquisitions by any
person of our shares of capital stock from the control share acquisition
statute. However, this provision may be amended or eliminated at any time in the
future.
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ANTI-TAKEOVER EFFECT OF MARYLAND LAW AND OF OUR CHARTER AND BYLAWS
The following provisions in our charter and bylaws and in Maryland law could
delay or prevent a change in our control:
- the limitation on ownership and acquisition of more than 9.8% of our
shares of capital stock;
- the ability of our Board of Directors, without a shareholders' vote, to
authorize and issue additional shares, including additional classes of
shares with rights defined at the time of issuance;
- the classification of our Board of Directors into classes and the election
of each class for three-year staggered terms;
- the requirement of cause and a 75% vote of shareholders for removal of our
directors;
- the provision that the number of our directors may be fixed only by vote
of our Board of Directors and that a vacancy on our Board of Directors may
be filled by a majority of our remaining directors;
- the advance notice requirements for shareholder nominations for directors
and other proposals; and
- the business combination provisions of Maryland law, if the applicable
resolution of our Board of Directors is rescinded or if our Board of
Directors' approval of a combination is not obtained.
PLAN OF DISTRIBUTION
Our common shares will be distributed by Senior Housing by the declaration
and payment of a dividend to Senior Housing common shareholders. Simultaneously,
HRPT Properties, a 29% shareholder in Senior Housing, will distribute our common
shares received from Senior Housing to the HRPT Properties common shareholders
by declaration and payment of a dividend.
HRPT Properties will receive 1,280,923.8 of our shares from Senior Housing
and will distribute one of our shares to its shareholders for every 100 HRPT
Properties shares owned. As of the date on the cover of this prospectus, HRPT
Properties has 128,808,747 shares outstanding. However, HRPT Properties has
authorized a share buyback program and it may have a lesser number of shares
outstanding on the spin-off record date. If HRPT Properties has less than
128,092,380 shares outstanding on the record date, HRPT Properties will retain
our shares which are not distributed to its shareholders. If HRPT Properties has
more than 128,092,380 shares outstanding on the record date we will sell HRPT
Properties up to an additional 10,000 of our shares so it can complete its one
for 100 distribution; and the price we receive for these shares will be the
average of the reported high and low trading prices in the public market on the
day of the spin-off. Unless otherwise stated, we have assumed throughout this
prospectus that HRPT Properties will not purchase any shares of our common stock
from us.
This distribution is not being underwritten by an investment bank or
otherwise. The purpose of the spin-off is described in the section of this
prospectus entitled "The Spin-off -- Background and Reasons for the Spin-off".
Senior Housing will pay any fees or other expenses incurred in connection with
the listing of our common shares on the American Stock Exchange and the
distributions. We anticipate the aggregate fees and expenses in connection with
the spin-off distribution to be $1,750,000.
LEGAL MATTERS
Sullivan & Worcester LLP will pass upon the validity of our distributed
common shares. As to certain matters of Maryland law, Sullivan & Worcester LLP
will rely upon an opinion of Ballard Spahr Andrews & Ingersoll, LLP. Barry M.
Portnoy, a former partner of the firm of Sullivan & Worcester
68
LLP, is one of our directors, and he is a Managing Trustee of Senior Housing,
HRPT Properties and Hospitality Properties. Mr. Portnoy is also a 50% owner and
a director of Reit Management and FSQ, Inc. Sullivan & Worcester LLP represents
us, Senior Housing, HRPT Properties, Hospitality Properties, FSQ, Inc., Reit
Management and certain of their affiliates.
EXPERTS
The consolidated financial statements of Five Star Quality Care, Inc.
(formerly known as SHOPCO Holdings, Inc.) at December 31, 2000, and for the
period April 27, 2000 (date of commencement of operations) through December 31,
2000, and the combined financial statements and schedule of Certain Mariner
Post-Acute Network Facilities (operated by subsidiaries of Mariner Post-Acute
Network, Inc.) at December 31, 2000 and 1999, and for each of the three years in
the period ended December 31, 2000, appearing in this prospectus and
registration statement have been audited by Ernst & Young, LLP, independent
auditors, as set forth in their reports thereon appearing elsewhere herein, and
are included in reliance upon such reports given on the authority of such firm
as experts in accounting and auditing.
The combined financial statements and schedule of Forty-two Facilities
Acquired by Senior Housing Properties Trust from Integrated Health
Services, Inc. at December 31, 2000 and 1999, and for each of the years in the
three-year period ended December 31, 2000, appearing in this prospectus and
registration statement have been audited by KPMG LLP, independent auditors, as
set forth in their report thereon appearing elsewhere herein, and are included
in reliance upon such report given on the authority of such firm as experts in
accounting and auditing.
The consolidated financial statements of CSL Group, Inc. and Subsidiaries as
Partitioned for Sale to SNH/CSL Properties Trust at December 29, 2000, and
December 31, 1999, and for the years ended December 29, 2000, December 31, 1999,
and January 1, 1999, appearing in this prospectus and registration statement
have been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their report with respect thereto appearing elsewhere herein, and
are included in reliance upon the authority of said firm as experts in
accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form S-1 (including
the exhibits, schedules and any amendments thereto) under the Securities Act of
1933 with respect to the shares being distributed pursuant to this prospectus.
This prospectus is part of this registration statement and does not contain all
of the information set forth in the registration statement. Statements contained
in this prospectus as to the content of any agreement or other document filed as
an exhibit are not necessarily complete, and you should consult a copy of those
contracts or other documents filed as exhibits to the registration statement.
For further information regarding us, please read the registration statement and
the exhibits and schedules thereto.
You may read and copy the registration statement and its exhibits and
schedules or other information on file at the SEC's Public Reference room at 450
Fifth Street, N.W., Washington, D.C. 20549. You can request copies of those
documents upon payment of a duplicating fee to the SEC. When our registration
statement on Form S-1 becomes effective, we will be subject to the reporting
requirements of the Securities Exchange Act of 1934 and the reports, proxy
statements and other information filed by us with the SEC then can be copied at
the SEC's Public Reference Room. Please call the SEC at 1-800-SEC-0330 for
further information on the operation of the public reference room. You can
review our SEC filings and the registration statement by accessing the SEC's
Internet site at http://www.sec.gov.
We intend to furnish to our shareholders annual reports containing financial
statements audited by an independent public accounting firm.
------------------------
69
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
PAGE
--------
FIVE STAR QUALITY CARE, INC. UNAUDITED PRO FORMA FINANCIAL
STATEMENTS
Introduction to Unaudited Pro Forma Financial
Statements.............................................. F-3
Unaudited Pro Forma Consolidated Balance Sheet at
September 30, 2001...................................... F-4
Unaudited Pro Forma Consolidated Statement of Operations
for the year ended
December 31, 2000....................................... F-5
Unaudited Pro Forma Consolidated Statement of Operations
for the nine months
ended September 30, 2001................................ F-6
Notes to Unaudited Pro Forma Consolidated Financial
Statements.............................................. F-7
FIVE STAR QUALITY CARE, INC. HISTORICAL FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheet at September 30, 2001
(unaudited)............................................. F-14
Condensed Consolidated Statements of Operations for the
nine months ended September 30, 2001 and the period
from April 27, 2000 (date of commencement of operations)
through September 30, 2000 (unaudited).................. F-15
Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 2001 and the period
from April 27, 2000 (date of commencement of operations)
through September 30, 2000 (unaudited).................. F-16
Notes to Consolidated Financial Statements (unaudited).... F-17
Report of Independent Auditors............................ F-20
Consolidated Balance Sheet at December 31, 2000........... F-21
Consolidated Statement of Operations for the period
April 27, 2000 (date of commencement of operations)
through December 31, 2000............................... F-22
Consolidated Statement of Shareholder's Equity for the
period April 27, 2000 (date of commencement of
operations) through December 31, 2000................... F-23
Consolidated Statement of Cash Flows for the period
April 27, 2000 (date of commencement of operations)
through December 31, 2000............................... F-24
Notes to Consolidated Financial Statements................ F-25
COMBINED FINANCIAL STATEMENTS OF FORTY-TWO FACILITIES
ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC. (INTEGRATED PREDECESSOR)
Independent Auditors' Report.............................. F-30
Combined Balance Sheets at December 31, 2000 and 1999..... F-31
Combined Statements of Operations for the three years
ended December 31, 2000, 1999 and 1998.................. F-32
Combined Statements of Changes in Net Equity (Deficit) of
Parent Company for the three years ended December 31,
2000, 1999 and 1998..................................... F-33
Combined Statements of Cash Flows for the three years
ended December 31, 2000, 1999 and 1998.................. F-34
Notes to Combined Financial Statements.................... F-35
Schedule II -- Valuation and Qualifying Accounts for the
years ended December 31, 2000, 1999 and 1998............ F-46
F-1
COMBINED FINANCIAL STATEMENTS OF CERTAIN MARINER POST-ACUTE
NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER
POST-ACUTE NETWORK) (MARINER PREDECESSOR)
Report of Independent Auditors............................ F-47
Combined Balance Sheets at December 31, 2000 and 1999..... F-48
Combined Statements of Operations for each of the three
years ended December 31, 2000, 1999 and 1998............ F-49
Combined Statements of Divisional Equity (Deficit) for
each of the three years ended December 31, 2000, 1999
and 1998................................................ F-50
Combined Statements of Cash Flows for each of the three
years ended December 31, 2000, 1999 and 1998............ F-51
Notes To Combined Financial Statements.................... F-52
Schedule II -- Valuation and Qualifying Accounts for the
three years ended December 31, 2000, 1999 and 1998...... F-62
CONSOLIDATED FINANCIAL STATEMENTS OF CSL GROUP, INC. AND
SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES
TRUST
Unaudited Condensed Consolidated Balance Sheet at
September 7, 2001....................................... F-63
Unaudited Condensed Consolidated Statements of Operations
for the thirty-six weeks ended September 7, 2001 and
September 8, 2000....................................... F-64
Unaudited Condensed Consolidated Statements of Cash Flows
for the thirty-six weeks ended September 7, 2001 and
September 8, 2000....................................... F-65
Notes to Unaudited Condensed Consolidated Financial
Statements.............................................. F-66
Report of Independent Public Accountants.................. F-67
Consolidated Balance Sheets at December 29, 2000 and
December 31, 1999....................................... F-68
Consolidated Statements of Operations for the three fiscal
years ended December 29, 2000, December 31, 1999 and
January 1, 1999......................................... F-69
Consolidated Statements of Equity for the three fiscal
years ended December 29, 2000, December 31, 1999 and
January 1, 1999......................................... F-70
Consolidated Statements of Cash Flows for the three fiscal
years ended December 29, 2000, December 31, 1999 and
January 1, 1999......................................... F-71
Notes to Consolidated Financial Statements................ F-72
F-2
FIVE STAR QUALITY CARE, INC.
INTRODUCTION TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS
The unaudited pro forma balance sheet at September 30, 2001, presents the
financial position of Five Star Quality Care, Inc. as if its spin-off from
Senior Housing, its merger with FSQ, Inc. and, separately, the commencement of
its lease of 31 Marriott facilities from Senior Housing had been completed as of
September 30, 2001 as described in the notes thereto. The unaudited pro forma
statements of income for the year ended December 31, 2000, and nine months ended
September 30, 2001, present the results of operations of Five Star Quality Care,
Inc. as if these transactions had been completed as of January 1, 2000 as
described in the notes thereto.
These unaudited pro forma financial statements do not represent our
financial condition or results of operations for any future date or period.
Actual future results may be materially different from pro forma results.
Differences could arise from many factors, including, but not limited to, those
related to our operation as a separate public company, competition in our
business, the impact of changes to rates under Medicare and Medicaid
reimbursement programs, our ability to successfully attract residents to our
facilities, our ability to control operating expenses, our capital structure and
other changes. These unaudited pro forma financial statements should be read in
connection with our and our predecessors' audited and unaudited financial
statements and the related Management's Discussion and Analysis included
elsewhere in this prospectus. The financial statements of the predecessors to
our business included in this prospectus are entitled: Certain Mariner
Post-Acute Network Facilities (referred to herein as Mariner Predecessor); and
Forty-Two Facilities Acquired by Senior Housing Properties Trust from Integrated
Health Services, Inc. (referred to herein as Integrated Predecessor). In
addition, in connection with these unaudited pro forma financial statements, you
should read the financial statements of the 31 Marriott facilities, as owned and
operated by Crestline, which are also included in this prospectus and are
entitled CSL Group, Inc. and Subsidiaries as Partitioned For Sale to SNH/CSL
Properties Trust.
F-3
FIVE STAR QUALITY CARE, INC.
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2001
(DOLLARS IN THOUSANDS)
REORGANIZATION FIVE STAR
AND PRO FORMA
Transaction FSQ, Inc. Crestline INCLUDING
Agreement Merger FIVE STAR Transaction CRESTLINE
FIVE STAR Adjustments Adjustments PRO FORMA Adjustments TRANSACTION
--------- -------------- ----------- ---------- ------------- --------------
(A) (J)
ASSETS
Current assets
Cash............................ $ 7,609 $ 20,677 (B) $ -- $28,286 $ 3,573 $31,859
Accounts receivable, net........ 36,361 (1,850)(C) -- 34,511 8,937 43,448
Prepaid expenses and other...... 1,860 -- -- 1,860 -- 1,860
------- -------- ------ ------- ------- -------
Total current assets.............. 45,830 18,827 -- 64,657 12,510 77,167
Fixed assets, net................. 29,062 (26,022)(D) 1,321 (I) 4,361 -- 4,361
Other assets...................... 4,984 (2,296)(E) 128 (I) 2,816 -- 2,816
------- -------- ------ ------- ------- -------
Total assets...................... $79,876 $ (9,491) $1,449 $71,834 $12,510 $84,344
======= ======== ====== ======= ======= =======
LIABILITIES AND SHAREHOLDERS'
EQUITY
Accounts payable................ $ 6,544 $ -- $ -- $ 6,544 $ -- $ 6,544
Accrued expenses................ 3,675 -- -- 3,675 -- 3,675
Accrued compensation............ 5,894 -- -- 5,894 -- 5,894
Note payable.................... 100 (100)(F) -- -- -- --
Mortgages payable............... 9,100 (9,100)(G) -- -- -- --
Other liabilities............... 4,272 -- -- 4,272 12,510 16,782
------- -------- ------ ------- ------- -------
Total liabilities................. 29,585 (9,200) -- 20,385 12,510 32,895
Shareholders' equity
Common stock, par value $0.01... -- 44 (H) 3 (I) 47 -- 47
Additional paid in capital...... 50,291 (335)(H) 1,446 (I) 51,402 -- 51,402
------- -------- ------ ------- ------- -------
Total shareholders' equity........ 50,291 (291) 1,449 51,449 -- 51,449
------- -------- ------ ------- ------- -------
Total liabilities and
shareholders' equity............ $79,876 $ (9,491) $1,449 $71,834 $12,510 $84,344
======= ======== ====== ======= ======= =======
SEE ACCOMPANYING NOTES.
F-4
FIVE STAR QUALITY CARE, INC.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2000
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SPIN-OFF AND
Mariner Integrated Merger FIVE STAR Crestline
FIVE STAR Predecessor Predecessor Adjustments PRO FORMA Transaction Adjustments
--------- ----------- ----------- ------------ ---------- ----------- -----------
(K) (L) (M) (U)
REVENUES
Net patient
revenues........... $ -- $85,128 $135,378 -- $220,506 $261,923 --
Interest and other
income............. 2,520 197 -- $ (2,520)(N) 197 -- --
------- ------- -------- -------- -------- -------- --------
Total revenues....... 2,520 85,325 135,378 (2,520) 220,703 $261,923 --
------- ------- -------- -------- -------- -------- --------
EXPENSES
Property level
operating costs and
expenses:
Routine............ -- 60,478 125,832 -- 186,310 153,049 --
Ancillary.......... -- 4,077 -- -- 4,077 14,493 --
Depreciation and
amortization....... 317 1,766 889 (2,753)(O) 219 24,083 (24,083)(V)
General and
administrative..... 3,519 4,101 6,084 (1,754)(P) 11,950 17,575 (345)(W)
Rent................. -- 8,748 9,102 (10,850)(Q) 7,000 -- 63,000 (X)
FF&E rent............ -- -- -- -- -- -- 6,794 (Y)
Property taxes and
other.............. -- 13,459 -- -- 13,459 9,263 --
Loss on settlement... -- -- 16,670 (16,670)(R) -- -- --
Interest expense,
net................ -- 117 2,053 (2,170)(S) -- 18,644 (18,644)(Z)
------- ------- -------- -------- -------- -------- --------
Total expenses....... 3,836 92,746 160,630 (34,197) 223,015 237,107 26,722
Income (loss) before
income taxes....... (1,316) (7,421) (25,252) 31,677 (2,312) 24,816 (26,722)
------- ------- -------- -------- -------- -------- --------
Provision (benefit)
for income taxes... -- -- -- (809) (809) 10,175 (10,842)
------- ------- -------- -------- -------- -------- --------
Net income (loss).... $(1,316) $(7,421) $(25,252) $ 32,486 $ (1,503) $ 14,641 $(15,880)
======= ======= ======== ======== ======== ======== ========
Weighted average
shares
outstanding........ 1 -- -- 4,616 (T) 4,617 --
Earnings per share... -- -- -- -- $ (0.33) --
FIVE STAR
PRO FORMA
INCLUDING
CRESTLINE
TRANSACTION
--------------
REVENUES
Net patient
revenues........... $482,429
Interest and other
income............. 197
--------
Total revenues....... $482,626
--------
EXPENSES
Property level
operating costs and
expenses:
Routine............ 339,359
Ancillary.......... 18,570
Depreciation and
amortization....... 219
General and
administrative..... 29,180
Rent................. 70,000
FF&E rent............ 6,794
Property taxes and
other.............. 22,722
Loss on settlement... --
Interest expense,
net................ --
--------
Total expenses....... 486,844
Income (loss) before
income taxes....... (4,218)
--------
Provision (benefit)
for income taxes... (1,476)(AA)
--------
Net income (loss).... $ (2,742)
========
Weighted average
shares
outstanding........ 4,617
Earnings per share... $ (0.59)
SEE ACCOMPANYING NOTES.
F-5
FIVE STAR QUALITY CARE, INC.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR NINE MONTHS ENDED SEPTEMBER 30, 2001
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FIVE STAR
TRANSACTION AND PRO FORMA
MERGER FIVE STAR CRESTLINE INCLUDING
FIVE STAR Adjustments PRO FORMA Transaction Adjustments CRESTLINE
--------- --------------- --------- ----------- ----------- -----------
(K) (U)
Revenues.................... $170,681 $ -- $170,681 $190,608 $ -- $361,289
-------- ------- -------- -------- -------- --------
EXPENSES
Property level operating
costs and expenses:
Routine................... 134,705 -- 134,705 111,274 -- 245,979
Ancillary................. 8,284 -- 8,284 9,206 -- 17,490
Depreciation and
amortization.............. 937 (762)(O) 175 16,717 (16,717)(V) 175
General and
administrative............ 12,710 (2,683)(P) 10,027 13,779 (194)(W) 23,612
Rent........................ -- 5,250 (Q) 5,250 -- 43,615 (X) 48,865
FF&E rent................... -- -- -- -- 3,963 (Y) 3,963
Property taxes and other.... 14,697 -- 14,697 6,199 -- 20,896
Interest expense, net....... 108 (108)(S) -- 13,769 (13,769)(Z) --
-------- ------- -------- -------- -------- --------
Total expenses.............. 171,441 1,697 173,138 170,944 16,898 360,980
-------- ------- -------- -------- -------- --------
Income (loss) before income
taxes..................... (760) (1,697) (2,457) 19,664 (16,898) 309
Provision (benefit) for
income taxes.............. -- (860) (860) 8,062 (7,094) 108(AA)
-------- ------- -------- -------- -------- --------
Net income (loss)........... $ (760) $ (837) $ (1,597) $ 11,602 $ (9,804) $ 201
======== ======= ======== ======== ======== ========
Weighted average shares
outstanding............... 1 4,616 (T) 4,617 4,617
Earnings per share.......... $ (0.35) $ 0.04
SEE ACCOMPANYING NOTES.
F-6
FIVE STAR QUALITY CARE, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
PRO FORMA BALANCE SHEET ADJUSTMENTS
A. Represents the historical results of Five Star Quality Care, Inc.,
formerly known as SHOPCO Holdings, Inc., a subsidiary of Senior Housing.
As of the date of the historical statements and continuing through the
date of this prospectus, none of these actions described in Notes B, C,
D, E, F, G and H below, have been completed, and they are not expected to
be completed until late 2001.
B. In connection with the distribution, Senior Housing will undertake an
internal reorganization. As part of the transaction agreement between
Senior Housing and us which governs the spin-off, Senior Housing is
required to contribute $50 million of equity to us. On a pro forma basis,
cash is expected to be contributed as follows:
Investments and advances from Senior Housing,
September 30, 2001...................................... $ 50,291
Assets retained by Senior Housing:
Accounts receivable (see Note C)........................ (1,850)
Property and equipment, net (see Note D)................ (26,022)
Other assets (see Note E)............................... (2,296)
Mortgages retained by Senior Housing (see Note G)....... 9,100
--------
Net historical assets over liabilities contributed........ 29,223
Total contribution required by Transaction Agreement...... (50,000)
--------
Total additional cash contributed by Senior Housing....... 20,777
Payment of note payable due from us to Senior Housing (see
Note F)................................................. (100)
--------
Net additional cash contributed by Senior Housing......... $ 20,677
========
C. Historically, we have been responsible for the conduct of substantially
all of Senior Housing's affairs related to property repossessions and
foreclosures from two former tenants of Senior Housing. In connection
with certain transition of operations activities, $1,850 is due from
these former tenants as of September 30, 2001. These receivables will be
collected by or transferred to other subsidiaries of Senior Housing prior
to the spin-off date.
D. As part of the internal reorganization, a number of real estate
properties will be transferred to and from other subsidiaries of Senior
Housing prior to the spin-off. These properties were received in
connection with the repossessions and foreclosures from former tenants of
Senior Housing and have a net book value of $26,022 as of September 30,
2001. On the date of the spin-off, substantially all of the facilities
transferred to Senior Housing will be leased by us from Senior Housing
and these real estate properties will remain with Senior Housing.
E. Also in connection with the internal restructuring, miscellaneous other
assets, which total $2,296 as of September 30, 2001 will be transferred
to subsidiaries of Senior Housing by Five Star prior to the spin-off and
remain the property of Senior Housing.
F-7
FIVE STAR QUALITY CARE, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
F. Senior Housing capitalized us at formation in part in exchange for a
note due from us to Senior Housing. We will repay this note prior to the
spin-off in connection with the internal reorganization.
G. We obtained mortgage financing secured by two properties in Michigan. The
real estate securing these mortgages will be retained by, and the
mortgage liability will be transferred to Senior Housing.
H. As discussed in Note B, as part of the spin-off, we will no longer be
wholly owned by Senior Housing. The historical ownership interest of
Senior Housing will be eliminated as a result of the spin-off and
substantially all of our shares will be distributed to shareholders of
Senior Housing. On the distribution date, our shares will have an
aggregate book value of $50,000.
Total outstanding shares of Senior Housing.............. 43,421,700
Spin-off ratio.......................................... 1:10
----------
Total shares distributed................................ 4,342,170
Total shares retained by Senior Housing................. 25,000
----------
Total shares of Five Star outstanding after the spin-off
and just prior to the FSQ, Inc. merger................ 4,367,170
Par value per share..................................... $ 0.01
----------
Par value............................................... $ 44
==========
Common equity contributed to us by Senior Housing....... $ 50,000
Par value............................................... (44)
----------
Additional paid in capital.............................. $ 49,956
==========
I. Our merger agreement with FSQ, Inc. provides that we will issue 250,000
of our shares to effect our acquisition of FSQ, Inc. Because FSQ, Inc.
has no revenue producing activity other than through its management
arrangement with us, we view the merger for accounting purposes as a
termination of a management contract rather than a business combination.
Under this accounting, consideration we pay which is in excess of the
fair value of the assets we acquire in the FSQ, Inc. merger will be
recorded as an expense incurred to terminate a contract on the day of the
merger. The total accounting charge will depend, in part, on the fair
value of the assets acquired and an accounting value of our shares
determined based upon their observable trading prices, which will remain
unknown until the spin-off takes place. For purposes of these pro forma
disclosures, we have assumed an accounting value of our shares equal to
their book value, and we have valued the tangible assets acquired in the
FSQ, Inc. merger based the depreciated cost of those assets which is
estimated to be the fair market value.
F-8
FIVE STAR QUALITY CARE, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
This charge is calculated as follows:
Number of shares issued in the FSQ, Inc. Merger............ 250,000
Multiplied by book value of one of our common shares before
merger................................................... 11.14
-------
Pro forma value of consideration issued in FSQ merger...... $ 2,785
Less: depreciated cost of FSQ, Inc. acquired assets........ (1,449)
-------
Total charge: consideration paid in excess of fair value of
identifiable net assets.................................. $ 1,336
=======
Pursuant to Rule 11-02 of Regulation S-X, this charge has not been
reflected on the face of the pro forma income statement because it is not
expected to recur.
J. We have agreed to lease the 31 Marriott properties from Senior Housing
upon closing of the Crestline transaction. In connection with this lease,
we will acquire receivables due from Marriott as manager of these
facilities of $8,937, and we will assume operating liabilities of $12,510
consisting primarily of refundable resident deposits and liabilities to
provide future services under contracts with residents. The net amount is
required to be settled in cash between us and Senior Housing under the
terms of the transaction agreement:
Operating liabilities assumed.............................. $12,510
Accounts receivable acquired............................... (8,937)
-------
Net cash from Senior Housing............................... $ 3,573
=======
PRO FORMA STATEMENT OF OPERATIONS ADJUSTMENTS
K. Represents the historical results of Five Star Quality Care, Inc.,
formerly known as SHOPCO Holdings, Inc., a subsidiary of Senior Housing,
since the date we began operations on April 27, 2000. During 2000, we
recorded our activities related to the businesses we acquired from
Mariner Predecessor and Integrated Predecessor under the equity method of
accounting. Effective January 1, 2001, when material contingencies
including the transfer of healthcare operating licenses to us was
completed, we consolidated the results of the operations.
L. Represents the operating results, for the 2000 period, for Mariner
Predecessor. During 2000, Mariner Predecessor owned the business of
operating 17 facilities which we acquired through repossession and
foreclosure. These results represent the revenues and expenses of Mariner
Predecessor from January 1, 2000, through December 31, 2000, the last day
that we recorded our activities related to the business we acquired from
Mariner Predecessor on the equity method of accounting (see Notes K and
N). During 2000, we and Mariner closed one facility which will be
transferred to, and not leased by, us from Senior Housing. This closure
had no material impact on our results of operations.
M. Represents the operating results, for the 2000 period, for Integrated
Predecessor. During 2000, Integrated Predecessor owned the business of
operating 42 facilities which we acquired. These results represent the
revenues and expenses of Integrated Predecessor from January 1, 2000,
through December 31, 2000, the last day that we recorded our activities
related to the
F-9
FIVE STAR QUALITY CARE, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
business we acquired from Integrated Predecessor on the equity method of
accounting (see Notes K and N). During 2000, we and Integrated closed two
facilities which will be transferred to and not leased by, us from Senior
Housing. These closed facilities had no material impact on our results of
operations.
SPIN-OFF AND MERGER ADJUSTMENTS
N. Represents the elimination of our equity in the income of the businesses
acquired from Mariner Predecessor and Integrated Predecessor realized in
2000 from the date we began operations on July 1, 2000, through
December 31, 2000.
O. After the spin-off, Senior Housing will retain substantially all of the
real estate and tangible personal property that we currently own (See
Note D). This adjustment represents the elimination of historical
depreciation expense from this real and personal property realized by us
and both of our predecessor entities, and the addition of depreciation
expense related to fixed assets to be acquired by us in the FSQ, Inc.
merger as follows:
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
2000 SEPTEMBER 30, 2001
------------ ------------------
Elimination of historical depreciation
on assets transferred to Senior
Housing net of depreciation on real
estate to be transferred to us...... $ (270) $(902)
Elimination of Mariner Predecessor
depreciation........................ (1,766) --
Elimination of Integrated Predecessor
depreciation........................ (889) --
Addition of FSQ, Inc. depreciation.... 172 140
------- -----
Total adjustment...................... $(2,753) $(762)
======= =====
P. For a portion of the 2000 period, some of the daily business of
operating our facilities was conducted by affiliates of Mariner
Predecessor and Integrated Predecessor. After a transition period, Senior
Housing engaged FSQ, Inc. to manage the facilities for a fee. Because we
will acquire FSQ, Inc. and our management agreement with FSQ, Inc. will
be terminated promptly after the spin-off, we will begin to operate these
facilities directly. Also after the spin-off, we will enter into a shared
services agreement with Reit Management & Research LLC, under
F-10
FIVE STAR QUALITY CARE, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
which we will receive services described elsewhere in this prospectus.
The net adjustment is derived as follows:
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
2000 SEPTEMBER 30, 2001
------------ ------------------
Elimination of management fees
incurred by:
Mariner Predecessor................ $(4,101) $ --
Integrated Predecessor............. (6,084) --
Shared services fee:
Pro forma revenues................. $220,703 $170,681
Contract rate...................... 0.6% 0.6%
-------- --------
1,324 1,024
Elimination of costs related to
Senior Housing's foreclosures of
Mariner and Integrated properties
which are not expected to recur
(1)................................ (3,519) (4,167)
Elimination of management fees paid
to FSQ, Inc. during 2001. Note that
fees paid to FSQ, Inc. are included
in other income in 2000, and
eliminated by Note M. (See
Note M)............................ -- (8,543)
Addition of corporate expenses of
FSQ, Inc., as follows: (2)
Payroll and benefits............. 6,302 5,878
Information technology and other
outside services............... 1,270 1,433
Travel........................... 1,086 684
Legal, accounting and other...... 1,968 1,008
------- --------
Total adjustment..................... $(1,754) $ (2,683)
======= ========
------------------------
(1) These costs represent payments to third parties to convert financial
and patient data previously maintained by Mariner and Integrated to
our systems. This historical data was required prior to our
commencement of operations of the 56 facilities.
(2) During period from July 1, 2000 (the date FSQ operations commenced)
to December 31, 2000, FSQ incurred $3,151 of payroll and other
benefits, $635 of information technology and other outside services,
$523 of travel and $984 of legal, accounting and other expenses.
Information regarding the general and administrative costs incurred
during the period prior to July 1, 2000, by Mariner and Integrated
relating to the 56 facilities which we now operate is not available,
and as a result, the amounts presented in the table above for the
year ended December 31, 2000, represent FSQ's actual costs during
2000, annualized. Amounts for the nine months ended September 30,
2001 represent FSQ, Inc.'s actual costs during that period.
F-11
FIVE STAR QUALITY CARE, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Q. Our agreement to lease 56 facilities currently owned by Senior Housing
requires us to make minimum rent payments of $7 million per annum through
June 30, 2018. During a portion of 2000, Mariner Predecessor and
Integrated Predecessor had rent and mortgage interest obligations (see
Note R) directly with Senior Housing. This adjustment represents the
elimination of historical rent expense and addition of the minimum rent
under our new lease with Senior Housing as follows:
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
2000 SEPTEMBER 30, 2001
------------ ------------------
Elimination of rent incurred by:
Mariner Predecessor................. $ (8,748) $ --
Integrated Predecessor.............. (9,102) --
Addition of new minimum rent to be
paid by us to Senior Housing........ 7,000 5,250
-------- ------
Total adjustment...................... $(10,850) $5,250
======== ======
In addition to minimum rent under this lease, beginning in 2004 we must
make percentage rent payments to Senior Housing in an amount equal to
three percent (3%) of net patient revenues at each leased facility in
excess of net patient revenues at such facility during 2003.
R. Because these unusual charges were incurred by Integrated Predecessor in
its foreclosure settlement with Senior Housing, they are eliminated
because they are not expected to recur.
S. Represents elimination of interest expense of Mariner Predecessor and
Integrated Predecessor on mortgages due to Senior Housing which were
foreclosed by Senior Housing in 2000. See Note Q.
T. Represents our total common shares expected to be outstanding
immediately after the spin-off and the FSQ, Inc. merger.
Total shares distributed in the spin-off prior to the
merger (See Note H)................................... 4,342,170
Total shares retained by Senior Housing................. 25,000
Total shares issued to stockholders of FSQ, Inc. (See
Note I)............................................... 250,000
----------
Total outstanding shares................................ 4,617,170
==========
CRESTLINE TRANSACTION ADJUSTMENTS
U. Represents historical operating revenues and facility operating expenses
for the 31 Marriott facilities, expected to be purchased by Senior
Housing from Crestline and leased to us. The 31 Marriott facilities
results are accounted for on the basis of 13 four-week periods per fiscal
year. Amounts presented as 2000 and related adjustments represent the
period from January 1, 2000, through December 29, 2000, and amounts
presented as 2001 and related adjustments represent the period from
December 30, 2000, through September 7, 2001. General and administrative
expenses include management fees paid to Marriott under the terms of its
management agreements which we will assume. We believe that the terms of
the Marriott management agreements are on market terms consistent with
what is currently
F-12
FIVE STAR QUALITY CARE, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
available for similar arrangements, and, accordingly, no separate value
will be allocated to the contracts.
V. Represents the elimination of historical depreciation and amortization
expense related to the Crestline fixed assets to be acquired and retained
by Senior Housing.
W. Represents the elimination of historically incurred corporate expenses
allocated by Crestline, and the addition of our shared services agreement
fees:
THIRTY-SIX WEEKS
ENDED
YEAR ENDED SEPTEMBER 7,
DECEMBER 31, 2000 2001
----------------- ----------------
Elimination of Crestline corporate
expenses......................... $(1,917) $ (1,338)
Shared services fee:
Pro forma revenues............... $261,923 $190,608
Contract rate.................... 0.6% 0.6%
-------- --------
1,572 1,144
------- --------
Total adjustment................... $ (345) $ (194)
======= ========
X. Our agreement to lease the 31 Marriott facilities expected to be acquired
by Senior Housing requires us to make minimum rent payments of
$63 million per annum which results in adjustments as follows:
THIRTY-SIX
YEAR ENDED WEEKS ENDED
DECEMBER 31, 2000 SEPTEMBER 7, 2001
----------------- ------------------
Total adjustment.................... $63,000 $43,615
In addition to minimum rent under this lease, beginning in 2003 we must
make percentage rent payments to Senior Housing in an amount equal to
five percent (5%) of net patient revenues at each leased facility in
excess of net patient revenues at such facility during 2002.
Y. Represents deposits made into reserves for capital improvements in
accordance with existing management agreements for the 31 Marriott
facilities and which, under our lease with Senior Housing, will be paid
to Senior Housing as additional rent.
Z. Represents the elimination of historical interest expense. In its
acquisition of the 31 Crestline properties, Senior Housing will assume
the debt and the obligation for this expense.
AA. Represents the cumulative tax provision based on all transactions and
merger adjustments, and the lease of the Crestline properties. The pro
forma provision is based on a blended federal and state income tax rate
of 35%.
F-13
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
CONDENSED CONSOLIDATED BALANCE SHEET
(DOLLARS IN THOUSANDS)
SEPTEMBER 30,
2001
--------------
(UNAUDITED)
ASSETS
Cash and cash equivalents................................... $ 7,609
Accounts receivable, net.................................... 36,361
Prepaid expenses............................................ 1,860
-------
45,830
Property and equipment, net................................. 29,062
Other assets................................................ 4,984
-------
$79,876
=======
LIABILITIES AND SHAREHOLDER'S EQUITY
Accounts payable............................................ $ 6,544
Accrued expenses............................................ 3,675
Accrued compensation........................................ 5,894
Note payable................................................ 100
Mortgages payable........................................... 9,100
Other liabilities........................................... 4,272
-------
Total liabilities........................................... 29,585
Commitments and contingencies
Shareholder's equity
Common stock, par value $0.01, 3,000 shares authorized,
1,000 shares issued and outstanding..................... --
Other shareholder's equity................................ 50,291
-------
50,291
-------
$79,876
=======
SEE ACCOMPANYING NOTES.
F-14
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
PERIOD FROM APRIL 27,
2000 (DATE OF
NINE MONTHS ENDED COMMENCEMENT OF OPERATIONS)
SEPTEMBER 30, 2001 THROUGH SEPTEMBER 30, 2000
------------------- ---------------------------
Net revenues:..................................... $170,681 $1,228
Expenses:
Operating expenses.............................. 157,686 --
General and administrative...................... 12,710 870
Interest expense................................ 108 --
Depreciation.................................... 937 158
-------- ------
Total expenses.................................... 171,441 1,028
-------- ------
Net (loss) income................................. $ (760) $ 200
======== ======
SEE ACCOMPANYING NOTES.
F-15
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
PERIOD FROM APRIL 27,
2000 (DATE OF
NINE MONTHS ENDED COMMENCEMENT OF OPERATIONS)
SEPTEMBER 30, 2001 THROUGH SEPTEMBER 30, 2000
------------------- ---------------------------
Cash flows from operating activities:
Net (loss) income................................ $ (760) $ 200
Adjustments to reconcile net income to used in
operating activities:
Depreciation................................... 937 158
Income from facilities operations.............. (1,228)
Changes in assets and liabilities:
Accounts receivable, net..................... 11,232 --
Prepaid expenses............................. (845) --
Other assets................................. (4,833) --
Accounts payable............................. (2,411) --
Accrued expenses............................. (902) --
Accrued compensation......................... 116 --
Other liabilities............................ (5,708) --
------- --------
Cash used in operating activities.............. (3,174) (870)
------- --------
Cash flows from investing activities:
Equipment purchases.............................. (1,861) --
Investment in facilities' operations............. -- (19,792)
------- --------
Cash used for investing activities............. (1,861) (19,792)
------- --------
Cash flows from financing activities:
Proceeds from note payable....................... -- 100
Proceeds from issuance of mortgages.............. 9,100 --
Proceeds from issuance of common stock........... -- 1
(Distributions to) Contribution from Senior
Housing........................................ (3,635) 20,561
------- --------
Cash provided by financing activities............ 5,465 20,662
------- --------
Increase in cash and cash equivalents.............. 430 --
Cash and cash equivalents at beginning of period... -- --
Cash and cash equivalents at facilities'
operations, beginning of period.................. 7,179 --
------- --------
Cash and cash equivalents at end of period......... $ 7,609 $ --
======= ========
Non cash investing and financing activities:
Real estate and related property received........ -- (23,759)
Liabilities assumed by facilities operations..... -- 4,110
SEE ACCOMPANYING NOTES.
F-16
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND BASIS OF PRESENTATION
Five Star Quality Care, Inc. (formerly known as SHOPCO Holdings, Inc.),
together with its subsidiaries ("Five Star"), a subsidiary of Senior Housing
Properties Trust ("Senior Housing"), a Maryland real estate investment trust
(REIT), commenced operations on April 27, 2000 to operate healthcare facilities
owned or mortgaged by Senior Housing. Effective July 1, 2000, Five Star assumed
the operations of healthcare facilities from bankrupt tenants pursuant to
negotiated settlement agreements.
Mariner Post-Acute Network, Inc. ("Mariner"), which previously leased 26
healthcare facilities from Senior Housing, filed for bankruptcy in
January 2000. During 2000, Senior Housing and Mariner reached an agreement that
was approved by the Bankruptcy Court in June 2000. In connection with the
settlement agreement, which was effective July 1, 2000, Five Star assumed
operating responsibility for 17 of the 26 facilities, subject to the receipt of
necessary healthcare licenses. Integrated Health Services, Inc. ("IHS") filed
for bankruptcy in February 2000. In July 2000 the Bankruptcy Court approved a
settlement agreement between Five Star and IHS, whereby subject to the receipt
of necessary healthcare licenses, Senior Housing assumed operating
responsibility for facilities previously leased by IHS, 11 facilities previously
owned by IHS and subject to mortgages with Senior Housing, and nine facilities
which were previously owned by IHS free of debt and conveyed to Five Star,
effective July 1, 2000.
Nine facilities delivered to Senior Housing by IHS in 2000 were not
previously owned or mortgaged to Senior Housing. These facilities were
transferred to Senior Housing by IHS as partial compensation for IHS defaults
under leases and mortgages. Because these facilities were not owned or mortgaged
by Senior Housing, they do not qualify under Internal Revenue Code ("IRC")
provisions for operation by a REIT. To comply with laws applicable to REITs,
these facilities were operated during 2000 by corporations which were 99%
beneficially owned by Five Star and 1% beneficially owned by Senior Housing's
Managing Trustees, Barry M. Portnoy and Gerard M. Martin, who also controlled
100% of the voting power of these corporations (the "Preferred Stock
Corporations"). On January 1, 2001, the laws concerning Senior Housing's ability
to own and operate these facilities changed and Five Star purchased
Messrs. Portnoy and Martin's ownership interests in the Preferred Stock
Corporations at their initial cost.
The consolidated financial statements include the accounts of Five Star. All
intercompany transactions have been eliminated. These interim financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to
Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
considered necessary for a fair presentation have been included. Operating
results for interim periods are not necessarily indicative of the results that
may be expected for the full year.
F-17
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenues are recognized when the related patient services are provided.
Receivables and revenues are stated at amounts estimated to be net realizable
value.
Five Star's investment activities were financed primarily by Senior Housing.
Substantially all amounts invested in or advanced by Five Star do not carry
interest and have no specific repayment terms.
Income generated by the Preferred Stock Corporations and a portion of Five
Star's income from the operation of foreclosure properties are subject to income
taxes. Income taxes have been provided using the liability method in accordance
with the requirements of SFAS No. 109, "Accounting for Income Taxes."
3. INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the deferred tax assets and liabilities as of September 30, 2000 are as follows
(dollars in thousands):
Deferred tax assets (liabilities)
Allowances for doubtful accounts............................ $ 33
Net operating loss carryforward............................. 33
Fixed assets................................................ (19)
----
Net deferred tax assets before valuation allowance.......... 47
Valuation allowance......................................... (47)
----
Net deferred tax assets..................................... $ --
====
A full valuation allowance has been recorded in the accompanying financial
statements to offset the net deferred tax asset because its future realizability
is uncertain.
The reconciliation of the amount computed by applying the statutory Federal
and State income tax rates to income before income taxes to the provision for
income taxes is as follows:
Tax expense at blended statutory rate....................... (35)%
Change in valuation allowance............................... 35 %
---
-- %
===
4. TRANSACTIONS WITH AFFILIATES
Five Star is party to a management arrangement with FSQ, Inc. an affiliate
of Reit Management & Research LLC, the investment manager for Senior Housing,
pursuant to which FSQ, Inc. will manage the facility operations for Five Star.
FSQ, Inc. is paid a fee equal to five percent of net patient revenues at the
facilities. Fees paid to FSQ, Inc. totaled $8.5 million for the nine months
ended September 30, 2001.
F-18
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
5. MORTGAGES PAYABLE
In July 2001, Five Star obtained mortgage financing secured by two
facilities in Michigan for a total of $9.1 million. The mortgages require
interest (4.5% at September 30, 2001) to be paid at prime less a discount. The
mortgages mature in July 2002, but Five Star has an option to extend these
mortgages for an additional 12 months.
6. CONTINGENCIES
Until Five Star received the required licenses and contracts to operate its
facilities, billings for patients were made through Mariner and IHS as
licensees. As of September 30, 2001, approximately $1.9 million of Five Star's
revenue, which was received by IHS and Mariner, is included in accounts
receivable on the consolidated balance sheet. As of October 31, 2001 Five Star
collected all of this receivable.
F-19
REPORT OF INDEPENDENT AUDITORS
To the Trustees and Shareholders of Senior Housing Properties Trust
We have audited the accompanying consolidated balance sheet of Five Star
Quality Care, Inc. (formerly known as SHOPCO Holdings, Inc.) ("Five Star") as of
December 31, 2000, and the related consolidated statements of operations,
shareholder's equity, and cash flows for the period April 27, 2000, (date of
commencement of operations) through December 31, 2000. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Five Star at
December 31, 2000 and the consolidated results of its operations and its cash
flows for the period April 27, 2000 through December 31, 2000 in conformity with
accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
Boston, Massachusetts
March 22, 2001
F-20
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS)
ASSETS
Net investment in facilities' operations.................... $29,046
Property and equipment:
Land...................................................... 2,949
Building and improvements................................. 20,584
Furniture and equipment................................... 2,526
-------
26,059
Less accumulated depreciation............................. (317)
-------
25,742
-------
$54,788
=======
LIABILITIES AND SHAREHOLDER'S EQUITY
Notes payable............................................... $ 100
Commitments and contingencies
Shareholder's equity:
Common stock, par value $0.01, 3,000 shares
authorized, 1,000 shares issued and outstanding......... --
Additional paid-in capital................................ 56,004
Accumulated deficit....................................... (1,316)
-------
Total shareholder's equity.............................. 54,688
-------
$54,788
=======
SEE ACCOMPANYING NOTES.
F-21
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE PERIOD APRIL 27, 2000 (DATE OF COMMENCEMENT OF OPERATIONS) THROUGH
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS)
Income from facilities' operations.......................... $ 2,520
-------
Depreciation................................................ 317
General and administrative.................................. 3,519
-------
3,836
-------
Loss before income taxes.................................... (1,316)
Income taxes................................................ --
-------
Net loss.................................................... $(1,316)
=======
SEE ACCOMPANYING NOTES.
F-22
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
FOR THE PERIOD APRIL 27, 2000 (DATE OF COMMENCEMENT OF OPERATIONS) THROUGH
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS)
ADDITIONAL
NUMBER OF COMMON PAID-IN ACCUMULATED
SHARES STOCK CAPITAL DEFICIT TOTAL
--------- -------- ---------- ----------- --------
Balance at April 27,
2000..................... 1,000 $ -- $ 1 $ -- $ 1
Additional paid-in capital,
net...................... -- -- 56,003 -- 56,003
Net loss................... -- -- -- (1,316) (1,316)
----- ------ ------- ------- -------
Balance at December 31,
2000..................... 1,000 $ -- $56,004 $(1,316) $54,688
===== ====== ======= ======= =======
SEE ACCOMPANYING NOTES.
F-23
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD APRIL 27, 2000 (DATE OF COMMENCEMENT OF OPERATIONS) THROUGH
DECEMBER 31, 2000
(DOLLARS IN THOUSANDS)
Cash flows from operating activities:
Net loss.................................................. $ (1,316)
Adjustments to reconcile net income to cash used for
operating activities:
Depreciation expense.................................... 317
Income from facilities' operations...................... (2,520)
--------
Cash used for operating activities.................... (3,519)
--------
Cash flows from investing activities:
Real estate acquisitions................................ (2,300)
Investment in facilities' operations.................... (38,530)
--------
Cash used for investing activities...................... (40,830)
--------
Cash flows from financing activities:
Proceeds from note payable.................................. 100
Proceeds from issuance of common stock...................... 1
Additional paid-in capital, net............................. 44,248
--------
Cash provided by financing activities..................... 44,349
--------
Change in cash and cash equivalents......................... --
Cash and cash equivalents at beginning of period............ --
--------
Cash and cash equivalents at end of period.................. $ --
========
Non-cash investing and financing activities:
Real estate and related property received................. $(23,759)
Liabilities assumed by facilities' operations............. 12,004
SEE ACCOMPANYING NOTES.
F-24
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
1. ORGANIZATION
Five Star Quality Care, Inc. (formerly known as SHOPCO Holdings, Inc.),
together with its subsidiaries ("Five Star" or the "Company") was organized on
April 27, 2000, and is a wholly owned subsidiary of Senior Housing Properties
Trust ("Senior Housing"), a Maryland real estate investment trust (REIT)
organized on December 16, 1998. Effective July 1, 2000, Five Star assumed the
operations of 49 healthcare facilities from former bankrupt tenants of Senior
Housing pursuant to negotiated settlement agreements.
Mariner Post-Acute Network, Inc. ("Mariner"), which previously leased 26
healthcare facilities from Senior Housing, filed for bankruptcy in
January 2000. During 2000 Senior Housing and Mariner reached an agreement that
was approved by the Bankruptcy Court in June 2000. In connection with the
settlement agreement, which was effective July 1, 2000, Five Star assumed
operating responsibility for 17 of the 26 facilities, subject to the receipt of
necessary healthcare licenses. Integrated Health Services, Inc. ("IHS") filed
for bankruptcy in February 2000. In July 2000 the Bankruptcy Court approved a
settlement agreement between Senior Housing and IHS, whereby subject to the
receipt of necessary healthcare licenses, Five Star assumed operating
responsibility for 22 facilities previously leased by IHS, 11 facilities
previously owned by IHS and subject to mortgages with Senior Housing, and nine
facilities which were previously owned by IHS free of debt and conveyed to Five
Star, effective July 1, 2000.
Nine facilities delivered to Senior Housing by IHS, which were not
previously owned by or mortgaged to Senior Housing, were transferred to Senior
Housing by IHS as partial compensation for its defaults under leases and
mortgages. Because these facilities were not owned or mortgaged by Senior
Housing they do not qualify under Internal Revenue Code, IRC, provisions for
operation by a REIT. To comply with laws applicable to REITs, these facilities
were operated during 2000 by corporations which were 99% beneficially owned by
Five Star and 1% beneficially owned by Senior Housing's Managing Trustees, Barry
M. Portnoy and Gerard M. Martin, who also control 100% of the voting power of
these corporations (the "Preferred Stock Corporations"). Effective January 1,
2001, applicable laws were changed to permit REITs to have voting control of
taxable REIT subsidiaries. Effective January 1, 2001, Messrs. Martin and Portnoy
exchanged their beneficial ownership and voting control of the Preferred Stock
Corporations to Five Star for fair market value, which was deemed to be their
historical investment.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The consolidated financial statements include the
accounts of Five Star. All intercompany transactions have been eliminated.
Minority interest related to the Preferred Stock Corporations is not material
and has not been presented.
The Company is owned by Senior Housing and transactions are presented on
Senior Housing's historical basis. Substantially all of the income from
facilities' operations received by the Company from the former tenants was
deposited in and commingled with Senior Housing's general funds. Senior Housing
provided funds for capital investments and other cash required by the Company.
General and administrative expenses represent costs incurred by Senior Housing
and allocated to the Company on a specific identification basis.
F-25
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The facility operations received from Mariner and IHS are subject to
obtaining licenses from state agencies and entering into payor agreements with
the federal and state governments. The Company had not received substantially
all of the required licenses as of December 31, 2000. As a result, for the
period July 1, 2000, through December 31, 2000, the operations of the facilities
have been accounted for using the equity method of accounting and the net income
from the facilities' operations has been reported as Income from facilities'
operations in the consolidated statement of operations and the capital invested
in the operations by the Company is included in net investment in facilities'
operations in the consolidated balance sheet.
PROPERTY AND EQUIPMENT. Property and equipment is stated at cost.
Depreciation on property and equipment is expensed on a straight-line basis over
the estimated useful lives of up to 40 years for buildings and improvements and
up to 12 years for personal property.
IMPAIRMENT OF LONG LIVED ASSETS. Impairment losses are recognized where
indicators of impairment are present and the undiscounted cash flow estimated to
be generated by the Company's investments is less than the carrying amount of
such investments. The amount of impairment loss is determined by comparing the
carryover amount of the Company's investment to its estimated fair value. No
impairment losses have been recorded.
INCOME TAXES. Income generated by the Preferred Stock Corporations and a
portion of Five Star's income from the operation of foreclosure properties are
subject to income taxes. Income taxes have been provided using the liability
method in accordance with the requirements of SFAS No. 109, "Accounting for
Income Taxes."
USE OF ESTIMATES. Preparation of these financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that may affect the amounts reported in these
financial statements and related notes. The actual results could differ from
these estimates.
3. NET INVESTMENT IN FACILITIES' OPERATIONS
Five Star assumed operating responsibility for its repossessed or acquired
facilities effective July 1, 2000, pending final regulatory approvals, which are
required in the healthcare industry. Five Star entered into management
arrangements with FSQ, Inc. ("FSQ, Inc."), an affiliate of Reit Management &
Research, Inc. ("Reit Management"), the manager of Senior Housing, pursuant to
which FSQ, Inc. will manage the properties for the Company following
relicensing. Mariner and IHS agreed with Five Star and FSQ, Inc. to perform
transition services with respect to the facilities formerly operated by them
until appropriate licenses are received by Five Star and FSQ, Inc.. At
December 31, 2000, all approvals had not been received. Since such approvals
were not received, Five Star reported the net income from these facilities as
Income from facilities' operations in the Consolidated Statement of Operations
for the period ended December 31, 2000. The capital invested in these operations
by Five Star is included in Net investment in facilities' operations in the
Consolidated Balance Sheet at December 31, 2000.
F-26
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
3. NET INVESTMENT IN FACILITIES' OPERATIONS (CONTINUED)
Summary financial data is as follows (dollars in thousands):
JULY 1
THROUGH
DECEMBER 31, DECEMBER 31,
2000 2000
------------- -------------
Current assets................... $55,938 Revenues......................... $114,483
Property and equipment, net...... 2,399 Expenses......................... 111,963
------- --------
Income from facilities'
$58,337 operations..................... $ 2,520
======= ========
Current liabilities.............. $29,291
Net investment in facilities'
operations..................... 29,046
-------
$58,337
=======
4. INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the deferred tax assets and liabilities as of December 31, 2000 are as follows
(dollars in thousands):
Deferred tax assets (liabilities)
Allowances for doubtful accounts............................ $ 65
Net operating loss carryforward............................. 66
Fixed assets................................................ (37)
----
Net deferred tax assets before valuation allowance.......... 94
Valuation allowance......................................... (94)
----
Net deferred tax assets..................................... $ --
====
A full valuation allowance has been recorded in the accompanying financial
statements to offset the net deferred tax asset because its future realizability
is uncertain. At December 31, 2000, Five Star had federal and state net
operating loss carryforwards of $189,000 which may be used to reduce future
income tax liabilities and expires in 2015.
The reconciliation of the amount computed by applying the statutory Federal
and State income tax rates to income before income taxes to the provision for
income taxes is as follows:
Tax expense at blended statutory rate....................... (35)%
Change in valuation allowance............................... 35%
----
--%
====
F-27
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
5. TRANSACTIONS WITH AFFILIATES
Five Star has entered a third party management agreement with FSQ, Inc. to
manage the operations of the facilities. Messrs. Martin and Portnoy, Senior
Housing's Managing Trustees, own FSQ, Inc. Under this management agreement,
during the first 90 days FSQ, Inc. was paid its costs and expenses incurred in
managing the facilities for Five Star and thereafter it is paid a fee equal to
five percent of patient revenues at the managed facilities. During 2000 the fees
paid to FSQ, Inc. by Five Star totaled $5.1 million. This amount includes fees
with respect to all services provided by FSQ, Inc. to Five Star including those
described in this paragraph and in the next two paragraphs.
Prior to July 1, 2000, Senior Housing leased three nursing homes to Advisors
Healthcare Group, Inc. ("AHG"). AHG is owned by Senior Housing's Managing
Trustees, Messrs. Martin and Portnoy. AHG assumed responsibility as the licensee
of these facilities to facilitate a transfer of operations among predecessors of
IHS. Prior to July 1, 2000, IHS managed these facilities and was financially
responsible for the rent due Senior Housing. IHS filed for bankruptcy in
February 2000 and, pursuant to the settlement approved by the IHS Bankruptcy
Court, the IHS management agreements and the AHG leases for these three
facilities were cancelled effective July 1, 2000 and Five Star began operating
these facilities on that date. Since July 1, 2000, FSQ, Inc. has managed these
facilities' operations for Five Star.
During 2000 HRPT Properties Trust, an affiliate of Senior Housing,
foreclosed on a mortgage with a principal balance outstanding of $2.4 million
that went into default. In November 2000 Five Star purchased this assisted
living facility from HRPT Properties for its appraised value of $2.3 million.
FSQ, Inc. has managed this facility since its acquisition by Five Star.
6. COMMITMENTS AND CONTINGENCIES
The settlement agreements entered by Senior Housing with Mariner and IHS
were contingent, in part, upon Five Star obtaining licenses and other government
approvals necessary to operate the affected healthcare facilities. Five Star
applied for all of the required licenses and as of December 31, 2000, the
required licenses for 26 of these facilities had been received. Required
licenses for an additional 22 facilities were received in January 2001 and two
more licenses were received in February 2001. The required licenses for the
remaining seven facilities which are located in one state are pending.
A substantial majority of the revenues at the facilities operated for Five
Star's behalf is received from the Federal Medicare program and from various
state Medicaid programs. Until Five Star received the required licenses to
operate these facilities, billings for these patients were made through Mariner
and IHS as licensees. As of December 31, 2000, approximately $18.2 million
received by IHS and Mariner since July 1, 2000, which is due to Five Star is
included on the Consolidated Balance Sheet as Net investment in facilities'
operations. At March 22, 2001, the receivable balance due from Mariner has been
paid in full and approximately $8.5 million remained due from IHS. Five Star
believes IHS will pay these funds pursuant to its contractual obligation
approved by its Bankruptcy Court. However, IHS remains in bankruptcy proceedings
and its record keeping and payment processing has not been timely.
F-28
FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.)
(A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Applicable provisions of Federal and some state laws allow paying agents for
these Medicare and Medicaid programs to recoup amounts owed by Mariner and IHS
to these programs for historical overpayments from current payments despite the
bankruptcy filings by Mariner and IHS. Also, some state nursing home licensing
agencies have in the past required that a successor nursing home licensee, such
as Five Star, agree to assume financial responsibility for a predecessor
licensee's obligations due to those state Medicaid programs. Five Star has
negotiated agreements with the U.S. Department of Justice and understandings
with several state Medicaid agencies to limit Five Star's liabilities for
obligations of Mariner and IHS to the Federal Medicare and state Medicaid
programs.
F-29
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Senior Housing Properties Trust:
We have audited the accompanying combined balance sheets of the Forty-two
Facilities Acquired by Senior Housing Properties Trust from Integrated Health
Services, Inc. (Acquired Facilities) as described in note 1 as of December 31,
2000 and 1999 and the related statements of operations, changes in net equity
(deficit) of parent company and cash flows for each of the years in the
three-year period ended December 31, 2000. In connection with our audits of the
combined financial statements, we also have audited the financial statement
schedule of valuation and qualifying accounts. These financial statements and
the financial statement schedule are the responsibility of the Acquired
Facilities' management. Our responsibility is to express an opinion on these
financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the combined financial position of the Acquired
Facilities as of December 31, 2000 and 1999 and the results of their operations
and their cash flows for each of the years in the three-year period ended
December 31, 2000 in conformity with accounting principles generally accepted in
the United States of America. Also in our opinion, the related financial
statement schedule, when considered in relation to the basic combined financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
/s/ KPMG LLP
Baltimore, Maryland
September 13, 2001
F-30
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
COMBINED BALANCE SHEETS (NOTE 1)
DECEMBER 31, 2000 AND 1999
(DOLLARS IN THOUSANDS)
2000 1999
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 4,514 1,684
Patient accounts and third-party payor settlements
receivable (note 3)..................................... 29,266 22,624
Other current assets...................................... 576 2,657
------- -------
Total current assets.................................... 34,356 26,965
Property, plant and equipment (note 4)...................... 586 16,199
Intangible assets, net (note 5)............................. -- 18,110
------- -------
$34,942 61,274
======= =======
LIABILITIES AND NET EQUITY (DEFICIT) OF PARENT COMPANY
Current liabilities:
Accounts payable and accrued expenses (note 6)............ $ 9,499 12,891
Current maturities of long-term debt (note 7)............. -- 273
Due to Senior Housing Properties Trust (note 8)........... 27,323 --
------- -------
Total current liabilities............................... 36,822 13,164
Long-term debt, less current maturities (note 7)............ -- 17,500
Commitments and contingencies (notes 11 and 13).............
Net equity (deficit) of Parent Company...................... (1,880) 30,610
------- -------
$34,942 61,274
======= =======
See accompanying notes to financial statements.
F-31
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
COMBINED STATEMENTS OF OPERATIONS (NOTE 1)
YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
2000 1999 1998
-------- -------- --------
Total patient service revenues.............................. $135,378 130,333 140,116
-------- -------- -------
Costs and expenses:
Operating expenses........................................ 131,916 124,732 131,728
Depreciation and amortization............................. 889 4,265 5,043
Rent (note 9)............................................. 9,102 13,191 13,810
Interest, net............................................. 2,053 3,899 3,865
Loss on impairment of long-lived assets (note 12)......... -- 120,007 --
Loss on settlement of lease and mortgage obligations
(note 1)................................................ 16,670 -- --
-------- -------- -------
Total costs and expenses................................ 160,630 266,094 154,446
-------- -------- -------
Loss before income taxes................................ (25,252) (135,761) (14,330)
Federal and state income taxes (benefit) (note 10).......... -- (8,822) 2,853
-------- -------- -------
Net loss................................................ $(25,252) (126,939) (17,183)
======== ======== =======
See accompanying notes to financial statements.
F-32
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
COMBINED STATEMENTS OF CHANGES IN NET EQUITY (DEFICIT) OF PARENT COMPANY
(NOTE 1)
YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
Balance at December 31, 1997................................ $ 139,153
Net contributions from Parent............................... 25,055
Net loss.................................................... (17,183)
---------
Balance at December 31, 1998................................ 147,025
Net contributions from Parent............................... 10,524
Net loss.................................................... (126,939)
---------
Balance at December 31, 1999................................ 30,610
Net contributions from (distributions to) Parent............ (7,238)
Net loss.................................................... (25,252)
---------
Balance at December 31, 2000................................ $ (1,880)
=========
See accompanying notes to financial statements.
F-33
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
COMBINED STATEMENTS OF CASH FLOWS (NOTE 1)
YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
2000 1999 1998
-------- -------- --------
Cash flows from operating activities:
Net loss.................................................. $(25,252) (126,939) (17,183)
Adjustments to reconcile net loss to net cash used by
operating activities:
Loss on impairment of long-lived assets................. -- 120,007 --
Loss on settlement...................................... 16,670 -- --
Deferred income taxes................................... -- (8,822) 2,853
Depreciation and amortization........................... 889 4,265 5,043
Decrease (increase) in patient accounts and third-party
payor settlements receivable.......................... (6,642) 7,540 (8,058)
Increase (decrease) in other current assets............. 2,081 (60) (1,336)
Increase (decrease) in accounts payable................. (3,392) (3,822) 5,066
-------- -------- -------
Net cash used by operating activities................. (15,646) (7,831) (13,615)
-------- -------- -------
Cash flows from investing activities:
Purchases of property, plant and equipment................ (1,472) (3,108) (10,338)
-------- -------- -------
Net cash used by investing activities................. (1,472) (3,108) (10,338)
-------- -------- -------
Cash flows from financing activities:
Repayments of long-term debt.............................. (137) (220) (193)
Net contributions from (distributions to) parent
company................................................. (7,238) 10,524 25,055
Advances from Senior Housing Properties Trust............. 27,323 -- --
-------- -------- -------
Net cash provided by financing activities............. 19,948 10,304 24,862
-------- -------- -------
Increase (decrease) in cash and cash equivalents...... 2,830 (635) 909
Cash and cash equivalents, beginning of period.............. 1,684 2,319 1,410
-------- -------- -------
Cash and cash equivalents, end of period.................... $ 4,514 1,684 2,319
======== ======== =======
See accompanying notes to financial statements.
F-34
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
(1) BACKGROUND AND BASIS OF PRESENTATION
Prior to July 7, 2000, Integrated Health Services, Inc. (IHS or the Parent
Company), through its wholly owned subsidiaries, operated various skilled
nursing facilities with respect to which Senior Housing Properties Trust (SNH)
was owner/lessor or first mortgage lender. In January 2000, IHS ceased making
rent and interest payments on these obligations and subsequently filed for
bankruptcy in February 2000.
On July 7, 2000, effective as of July 1, 2000, the Bankruptcy Court approved
a settlement agreement whereby IHS' lease and mortgage obligations to SNH were
cancelled and IHS conveyed nine nursing homes and one parcel of non-operating
real property to a subsidiary of SNH. As a result, SNH has obtained the
operations of 42 facilities previously operated by IHS (the Acquired
Facilities). IHS managed the Acquired Facilities under a management agreement
with SNH for the period from July 1, 2000 to September 30, 2000.
The Acquired Facilities' financial statements are presented for the purposes
of complying with the Securities and Exchange Commission's rules and regulations
regarding acquired businesses.
The combined financial statements of the Acquired Facilities reflect the
historical accounts of the skilled nursing facilities, including allocations of
general and administrative expenses from the IHS corporate office to the
individual facilities. Such corporate office allocations, calculated as a
percentage of revenue, are based on determinations that management believes to
be reasonable. However, IHS has operated certain other businesses and has
provided certain services to the Acquired Facilities, including financial,
legal, accounting, human resources and information systems services.
Accordingly, expense allocations to the Company may not be representative of
costs of such services to be incurred in the future (see note 11).
The financial statements for periods prior to July 1, 2000 represent the
financial position and results of operations of the Acquired Facilities as
reflected in the accounts of IHS' subsidiaries. Such subsidiaries leased 19
facilities from SNH, owned 11 facilities with respect to which SNH was
mortgagee, and owned, leased or managed 12 other facilities not previously
affiliated with SNH.
The financial statements for the period subsequent to July 1, 2000 represent
the financial position and results of operations of the Acquired Facilities as
described above and give effect to the terms of the aforementioned settlement
agreement. Accordingly, as of July 1, 2000, the accounts of the Acquired
Facilities no longer include the property, plant and equipment and intangible
assets of the facilities conveyed to SNH, related mortgage debt, mortgage
interest, and depreciation and amortization of such facilities. The loss on
settlement represents the carrying value of the tangible and intangible assets
of the facilities conveyed to SNH, less the related mortgage debt.
F-35
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
(1) BACKGROUND AND BASIS OF PRESENTATION (CONTINUED)
The operating results of the Acquired Facilities for the six-month period
ended June 30, 2000 (prior to the settlement agreement) and the six-month period
ended December 31, 2000 are summarized below:
SIX MONTHS SIX MONTHS YEAR
ENDED ENDED ENDED
JUNE 30, DECEMBER 31, DECEMBER 31,
2000 2000 2000
---------- ------------- -------------
Total patient service revenues............ $65,195 70,183 135,378
------- ------- -------
Costs and expenses:
Operating expenses...................... 63,865 68,051 131,916
Depreciation and amortization........... 876 13 889
Rent (note 9)........................... 6,323 2,779 9,102
Interest, net........................... 2,053 -- 2,053
Loss on settlement...................... -- 16,670 16,670
------- ------- -------
Total costs and expenses.............. 73,117 87,513 160,630
------- ------- -------
Loss before income taxes.............. $(7,922) (17,330) (25,252)
======= ======= =======
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) REVENUES
Revenues, primarily patient services revenues related to room and board
charges, ancillary charges and revenues of pharmacy, rehabilitation and
similar service operations, are recorded at established rates and adjusted
for differences between such rates and estimated amounts reimbursable by
third-party payors. As of January 1, 1999, Medicare revenue is recognized
pursuant to the Prospective Payment System (PPS). Under PPS, per diem
federal rates were established for urban and rural areas. Rates are case-mix
adjusted using Resource Utilization Groups. PPS is implemented over a
three-year transition period that blends a facility-specific payment rate
with the federal case-mix adjusted rate.
Estimated settlements under third-party payor retrospective rate setting
programs (primarily Medicare for periods prior to January 1, 1999 and
Medicaid) are accrued in the period that related services are rendered.
Settlements receivable and related revenues under such programs are based on
annual cost reports prepared in accordance with federal and state
regulations, which reports are subject to audit and retroactive adjustment.
In the opinion of management, adequate provision has been made therefor, and
such adjustments in determining final settlements will not have a material
effect on financial position or results of operations.
F-36
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(B) CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid debt instruments with original
maturities of three months or less.
(C) DEPRECIATION AND AMORTIZATION
Property, plant and equipment are recorded at cost. Depreciation and
amortization are provided using the straight-line method over the estimated
useful lives of the related assets, generally 25 years for land
improvements, 10 years for equipment, 40 years for buildings and the term of
the lease for costs of leasehold interests and improvements.
(D) INTANGIBLE ASSETS
Prior to the fourth quarter of 1999, intangible assets of businesses
acquired (primarily goodwill) were amortized by the straight-line method
primarily over 40 years, the period over which such costs were estimated to
be recoverable through operating cash flows. As discussed in note 12,
management of IHS continued to evaluate the impact of the 1997 Balanced
Budget Act (BBA), particularly the impact of the prospective payment system
(PPS), upon future operating results of the facilities. Utilizing IHS'
experience with PPS since January 1, 1999, management performed a
preliminary analysis of such impact in the third quarter of 1999 and a more
comprehensive analysis at December 31, 1999. PPS has had a dramatic negative
impact on the operating results and financial condition of the Acquired
Facilities. The PPS system has significantly reduced the revenues, cash flow
and liquidity of the Acquired Facilities and the long-term care industry in
1999. As a result of the negative impact of the provisions of PPS,
management changed the estimated life of its goodwill to 20 years. This
change has been treated as a change in accounting estimate and is being
recognized prospectively beginning October 1, 1999.
(E) IMPAIRMENT OF LONG-LIVED ASSETS
Management regularly evaluates whether events or changes in
circumstances have occurred that could indicate an impairment in the value
of long-lived assets. If there is an indication that the carrying value of
an asset is not recoverable, management estimates the projected undiscounted
cash flows of the related individual facilities (the lowest level for which
there are identifiable cash flows independent of other groups of assets) to
determine if an impairment loss should be recognized. The amount of
impairment loss is determined by comparing the historical carrying value of
the asset to its estimated fair value. Estimated fair value is determined
through an evaluation of recent financial performance and projected
discounted cash flows of facilities using standard industry valuation
techniques. In addition to consideration of impairment upon the events or
changes in circumstances described above, management regularly evaluates the
remaining lives of its long-lived assets. If estimates are changed, the
carrying value of affected assets is allocated over the remaining lives.
Management performed such an analysis at December 31, 1999 (see
notes 1 (d) and 12).
F-37
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(F) INCOME TAXES
The Acquired Facilities are included in the Parent Company's
consolidated federal income tax return. The income taxes reported in the
Acquired Facilities financial statements are an allocation of income taxes
calculated as if the Acquired Facilities were a separate taxpayer, in
accordance with Statement of Financial Accounting Standards No. 109 (SFAS
No. 109), ACCOUNTING FOR INCOME TAXES.
Deferred income taxes are recognized for the tax consequences of
temporary differences between financial statement carrying amounts and the
related tax bases of assets and liabilities as required by SFAS No. 109.
Such tax effects are measured by applying enacted statutory tax rates
applicable to future years in which the differences are expected to reverse,
and any change in tax rates will be recognized in the period that includes
the date of enactment.
(G) NET EQUITY (DEFICIT) OF PARENT COMPANY
The Parent Company transfers excess cash from and makes working capital
advances and corporate allocations to the Acquired Facilities. These
advances include amounts to fund cash shortfalls, capital expenditures,
advances for accounts payable and amounts paid for employee benefits and
other programs administered by the Parent Company. The resulting net balance
of the aforementioned transactions, the Parent Company's initial investment
in the Acquired Facilities and the cumulative deficit of the Acquired
Facilities is classified as Net Equity (Deficit) of Parent Company in the
accompanying balance sheet.
(H) BUSINESS AND CREDIT CONCENTRATIONS
The Acquired Facilities' patient services are provided through 42
facilities located in 10 states throughout the United States. The Acquired
Facilities generally do not require collateral or other security in
extending credit to patients; however, the Acquired Facilities routinely
obtain assignments of (or are otherwise entitled to receive) benefits
receivable under the health insurance programs, plans or policies of
patients (e.g., Medicare, Medicaid, commercial insurance and managed care
organizations) (see note 3).
(I) USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
(J) RECLASSIFICATION
Certain amounts presented in 1998 and 1999 have been reclassified to
conform with the presentation for 2000.
F-38
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
(3) PATIENT ACCOUNTS AND THIRD-PARTY PAYOR SETTLEMENTS RECEIVABLE
Patient accounts and third-party payor settlements receivable consist of the
following at December 31:
2000 1999
-------- --------
Patient accounts......................................... $ 28,996 $19,396
Third-party payor settlements............................ 13,147 12,194
-------- -------
42,143 31,590
Allowance for doubtful accounts and contractual
adjustments............................................ (12,877) (8,966)
-------- -------
$ 29,266 $22,624
======== =======
Patient accounts receivable and third party payor settlements receivable
from the Federal government (Medicare) were approximately $14,246 and $10,757 at
December 31, 2000 and 1999, respectively. Amounts receivable from various states
(Medicaid) were approximately $17,161 and $16,189 at December 31, 2000 and 1999,
respectively.
(4) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are summarized as follows at December 31:
2000 1999
-------- --------
Land and improvements....................................... $ -- $ 6,306
Buildings and improvements.................................. -- 3,104
Leasehold interests and improvements........................ -- 2,637
Equipment................................................... 598 7,134
---- -------
598 19,181
Less accumulated depreciation and amortization.............. 12 2,982
---- -------
Net property, plant and equipment....................... $586 $16,199
==== =======
(5) INTANGIBLE ASSETS
Intangible assets are summarized as follows at December 31, 1999:
Intangible assets of businesses acquired, primarily
goodwill.................................................. $23,287
Less accumulated amortization............................... (5,177)
-------
Net intangible assets................................... $18,110
=======
Management regularly evaluates whether events or circumstances have occurred
that would indicate an impairment in the carrying value or the life of goodwill.
In accordance with SFAS No. 121,
F-39
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
(5) INTANGIBLE ASSETS (CONTINUED)
if there is an indication that the carrying value of an asset, including
goodwill, is not recoverable, Management estimates the projected undiscounted
cash flows, excluding interest, of the related business unit to determine if an
impairment loss should be recognized. Such impairment loss is determined by
comparing the carrying amount of the asset, including goodwill, to its estimated
fair value. Management performs the impairment analysis at the individual
facility level. See note 12 for information regarding impairment of assets in
the year ended December 31, 1999.
(6) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses are summarized as follows at
December 31:
2000 1999
-------- --------
Accounts payable........................................... $5,105 $ 8,294
Accrued salaries and wages................................. 3,015 3,468
Other accrued expenses..................................... 1,379 1,129
------ -------
$9,499 $12,891
====== =======
(7) LONG-TERM DEBT
Long-term debt is summarized as follows at December 31, 1999:
Mortgages payable in monthly installments of $87, including
interest at rates ranging from 10.3% to 10.86%, due
December 2016............................................. $ 8,687
Mortgages payable in monthly installments of $95, including
interest at 11.5%, due January 2006....................... 9,086
-------
17,773
Less current maturities..................................... 273
-------
Total long-term debt, less current portion.............. $17,500
=======
At December 31, 1999 the aggregate maturities of long-term debt for the five
years ending December 31, 2004 are as follows:
2000........................................................ $ 273
2001........................................................ 304
2002........................................................ 339
2003........................................................ 378
2004........................................................ 421
Thereafter.................................................. 16,058
-------
$17,773
=======
F-40
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
(8) DUE TO SENIOR HOUSING PROPERTIES TRUST (SNH)
Subsequent to July 1, 2000, SNH advanced funds for operating expenses and
working capital of the Acquired Facilities and allocated facility rents. Such
advances bear no interest (see notes 9 and 11).
(9) LEASES
The Acquired Facilities leased equipment under short-term operating leases
having rental costs of approximately $1,146 in 2000, $1,800 in 1999 and $2,214
in 1998. Leases of facilities were terminated in 2000 as discussed in note 1;
however, in accordance with Staff Accounting Bulletin No. 55, "Allocation of
Expenses and Related Disclosure in Financial Statements of Subsidiaries,
Divisions or Lesser Business Components of Another Entity", $2,159 is included
in rent expense for the period subsequent to July 1, 2000, representing an
allocation of the total estimated fair market rental value of the facilities.
The annual fair market rental value has been estimated for a combined group of
facilities, including the Acquired Facilities, and has been allocated based on
the respective total revenues of the facilities.
(10) INCOME TAXES
The Acquired Facilities have been included in the Parent Company's
consolidated federal income tax return. The allocated provision (benefit) for
income taxes on loss before income taxes is summarized as follows at
December 31:
2000 1999 1998
--------- -------- --------
Current................................................. $ -- -- --
Deferred................................................ -- (8,822) 2,853
--------- ------ -----
$ -- (8,822) 2,853
========= ====== =====
The amount computed by applying the Federal corporate tax rate of 35% in
2000, 1999 and 1998 to loss before income taxes is summarized as follows at
December 31:
2000 1999 1998
-------- -------- --------
Income tax computed at statutory rates............. $(8,083) (47,516) (5,016)
State income taxes, net of Federal tax benefit and
nondeductible items.............................. (1,090) (6,724) (666)
Jobs tax credit.................................... (93) (94) (90)
Valuation allowance adjustment..................... 9,266 45,512 8,625
------- ------- ------
$ -- (8,822) 2,853
======= ======= ======
F-41
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
(10) INCOME TAXES (CONTINUED)
Deferred income tax liabilities (assets) at December 31, 2000 and 1999, are
summarized as follows:
2000 1999
-------- --------
Difference in book and tax bases of intangible assets.... $ -- (28,002)
Difference in book and tax bases of fixed assets......... 4 (9,327)
Allowance for doubtful accounts.......................... (5,151) (3,586)
Net operating loss carryforwards......................... (57,979) (13,038)
Job tax credit carryovers................................ (277) (184)
-------- -------
Total before valuation allowance..................... (63,403) (54,137)
-------- -------
Valuation allowance...................................... 63,403 54,137
-------- -------
Net deferred tax liabilities......................... $ -- --
======== =======
(11) OTHER RELATED PARTY TRANSACTIONS
Corporate administrative and general expenses (included in operating
expenses) represent management fees for certain services, including financial,
legal, accounting, human resources and information systems services provided by
the Parent Company. Management fees have been provided at approximately 6% of
total revenues of each facility.
Management fees charged by the Parent Company were $4,311 for the nine
months ended September 30, 2000, $6,254 in 1999 and $7,689 in 1998, and have
been determined based on an allocation of the Parent Company's corporate general
and administrative expenses. Such allocation has been made because specific
identification of expenses is not practicable. Management believes that this
allocation method is reasonable. However, management believes that the Acquired
Facilities' corporate administrative and general expenses on a stand-alone basis
may have been different had the Acquired Facilities operated as an unaffiliated
entity. Management fees charged by SNH were $1,773 for the three months ended
December 31, 2000.
(12) LOSS ON IMPAIRMENT OF LONG-LIVED ASSETS
During the year ended December 31, 1999, the Parent Company continued to
evaluate the impact of the 1997 Balanced Budget Act (BBA), particularly the
impact of the Prospective Payment System (PPS), upon the future operating
results on its facilities. Utilizing the Parent Company's (including the
Acquired Facilities) experience with PPS since January 1, 1999, the Parent
Company performed a preliminary analysis of such impact as of September 30, 1999
and a more comprehensive analysis at December 31, 1999. PPS has had a dramatic
impact on the operating results and financial condition of the Acquired
Facilities. PPS has significantly reduced the revenues, cash flow and liquidity
of the Acquired Facilities and others in the industry in 1999. As a result of
the negative impact of the provisions of PPS, the Acquired Facilities assessed
the impairment of its long-lived assets in accordance with the provisions of
Statement of Financial Accounting Standards (SFAS) No. 121 in 1999. In
F-42
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
(12) LOSS ON IMPAIRMENT OF LONG-LIVED ASSETS (CONTINUED)
accordance with SFAS No. 121, the Acquired Facilities estimated the future cash
flows expected to result from those assets to be held and used.
In estimating the future cash flows for determining whether an asset is
impaired, and if expected future cash flows used in measuring assets are
impaired, the Acquired Facilities grouped the assets at the lowest level for
which there are identifiable cash flows independent of other groups of assets,
which is at the facility level.
After determining the facilities eligible for an impairment charge,
Management determined the estimated fair value of such facilities and compared
such fair value to the carrying values of the related assets. The carrying value
of buildings and improvements, leasehold improvements, equipment and goodwill
exceeded the fair value by $120,007; accordingly, the Acquired Facilities
recognized such amount as a loss on impairment of long-lived assets during the
year ended December 31, 1999.
(13) CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES
The following information is provided in accordance with the AICPA Statement
of Position No. 94-6, DISCLOSURE OF CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES.
The Acquired Facilities and others in the healthcare business are subject to
certain inherent risks, including the following:
- Substantial dependence on revenues derived from reimbursement by the
Federal Medicare and state Medicaid programs which have been drastically
cut in recent years and which entail exposure to various healthcare fraud
statutes;
- Government regulations, government budgetary constraints and proposed
legislative and regulatory changes; and
- Lawsuits alleging malpractice and related claims.
Such inherent risks require the use of certain management estimates in the
preparation of the Acquired Facilities financial statements and it is reasonably
possible that a change in such estimates may occur.
The Acquired Facilities receives payment for a significant portion of
services rendered to patients from the Federal government under Medicare and
from the states in which its facilities and/or services are located under
Medicaid. The Acquired Facilities operations are subject to a variety of
Federal, state and local legal and regulatory risks, including without
limitation the federal Anti-Kickback statute and the federal Ethics in Patient
Referral Act (so-called "Stark Law"), many of which apply to virtually all
companies engaged in the health care services industry. The Anti-Kickback
statute prohibits, among other things, the offer, payment, solicitation or
receipt of any form of remuneration in return for the referral of Medicare and
Medicaid patients. The Stark Law prohibits, with limited exceptions, financial
relationships between ancillary service providers and referring physicians.
Other regulatory risks
F-43
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
(13) CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES (CONTINUED)
assumed by the Acquired Facilities and other companies engaged in the health
care industry are as follows:
- False Claims--"Operation Restore Trust" is a major anti-fraud
demonstration project of the Office of the Inspector General. The primary
purpose for the project is to scrutinize the activities of healthcare
providers which are reimbursed under the Medicare and Medicaid programs.
False claims are prohibited pursuant to criminal and civil statutes and
are punishable by imprisonment and monetary penalties.
- Regulatory Requirement Deficiencies--In the ordinary course of business
health care facilities receive notices of deficiencies for failure to
comply with various regulatory requirements. In some cases, the reviewing
agency may take adverse actions against a facility, including the
imposition of fines, temporary suspension of admission of new patients,
suspension or decertification from participation in the Medicare and
Medicaid programs and, in extreme cases, revocation of a facility's
license.
- Changes in laws and regulations--Changes in laws and regulations could
have a material adverse effect on licensure, eligibility for participation
in government programs, permissable activities, operating costs and the
levels of reimbursement from governmental and other sources.
In response to the aforementioned regulatory risks, the Parent Company
formed a Corporate Compliance Department in 1996 to help identify, prevent and
deter instances of Medicare and Medicaid noncompliance. Although the Parent
Company and the Acquired Facilities strive to manage these regulatory risks,
there can be no assurance that federal and/or state regulatory agencies that
currently have jurisdiction over matters including, without limitation,
Medicare, Medicaid and other government reimbursement programs, will take the
position that the Acquired Facilities business and operations are in compliance
with applicable law or with the standards of such regulatory agencies.
In some cases, violation of such applicable law or regulatory standards by
the Acquired Facilities can carry significant civil and criminal penalties and
can give rise to qui tam litigation. In this connection, the Acquired Facilities
are a defendant in certain actions or the subject of investigations concerning
alleged violations of the False Claims Act or of Medicare regulations. As a
result of the Parent Company's and the Acquired Facilities' financial position,
various agencies of the federal government accelerated efforts to reach a
resolution of all outstanding claims and issues related to the Parent Company's
and the Acquired Facilities' alleged violations of healthcare statutes and
related causes of action. The Parent Company has commenced global settlement
negotiations with the government; however, the Parent Company is unable to
assess fully the merits of the government's monetary claims at this time. In
addition, the Parent Company is unable to determine the amount, if any, that
might relate to the Acquired Facilities.
The BBA, enacted in August 1997, made numerous changes to the Medicare and
Medicaid programs that are significantly affecting the Acquired Facilities. With
respect to Medicare, the BBA provides, among other things, for a prospective
payment system for skilled nursing facilities. As a result,
F-44
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST FROM
INTEGRATED HEALTH SERVICES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
(13) CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES (CONTINUED)
in 1999 the Acquired Facilities bore the cost risk of providing care inasmuch as
they receive specified reimbursement for each treatment regardless of actual
cost. With respect to Medicaid, the BBA repeals the so-called Boren Amendment,
which required state Medicaid programs to reimburse nursing facilities for the
costs that are incurred by efficiently and economically operated providers in
order to meet quality and safety standards. As a result, states now have
considerable flexibility in establishing payment rates and management believes
many states are moving toward a prospective payment type system for skilled
nursing facilities.
The BBA mandates the establishment of a PPS for Medicare skilled nursing
facility services, under which facilities are paid a fixed fee for virtually all
covered services. PPS is being phased in over a four-year period, effective
January 1, 1999 for the Acquired Facilities. During the first three years,
payments will be based on a blend of the facility's historical costs and a
pre-determined federal rate. Thereafter, the per diem rates will be based 100%
on the federal cost rate. Under PPS, each patient's clinical status is evaluated
and placed into a payment category. The patient's payment category dictates the
amount that the provider will receive to care for the patient on a daily basis.
The per diem rate covers (i) all routine inpatient costs currently paid under
Medicare Part A, (ii) certain ancillary and other items and services currently
covered separately under Medicare Part B on a "pass-through" basis, and
(iii) certain capital costs. The Acquired Facilities ability to offer the
ancillary services required by higher acuity patients, such as those in its
subacute care programs to Medicare beneficiaries, in a cost-effective manner
will continue to be critical to the Acquired Facilities services and will affect
the profitability. To date the per diem reimbursement rates have generally been
significantly less than the amount the Acquired Facilities received on a daily
basis under cost based reimbursement, particularly in the case of higher acuity
patients. As a result, PPS has had a material adverse impact on the Acquired
Facilities' results of operations and financial condition (see note 12).
The Acquired Facilities are also subject to malpractice and related claims,
which arise in the normal course of business and which could have a significant
effect on the Acquired Facilities. As a result, the Acquired Facilities maintain
occurrence basis professional and general liability insurance with coverage and
deductibles which management believes to be appropriate.
F-45
FORTY-TWO FACILITIES ACQUIRED BY
SENIOR HOUSING PROPERTIES TRUST
FROM INTEGRATED HEALTH SERVICES, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- ---------- ----------------- ------------- -----------
BALANCE AT ADDITIONS CHARGED
BEGINNING TO OPERATING BALANCE AT
DESCRIPTION OF YEAR ACCOUNTS DEDUCTIONS(1) END OF YEAR
----------- ---------- ----------------- ------------- -----------
Allowance for doubtful accounts:
Year ended December 31, 2000................... $ 8,966 $ 5,001 $(1,090) $12,877
======= ======= ======= =======
Year ended December 31, 1999................... $ 7,016 $ 2,598 $ (648) $ 8,966
======= ======= ======= =======
Year ended December 31, 1998................... $ 1,744 $ 5,537 $ (265) $ 7,016
======= ======= ======= =======
------------------------
(1) Amounts represent bad debt write-offs.
F-46
REPORT OF INDEPENDENT AUDITORS
To the Board of Trustees and Shareholders of
Senior Housing Properties Trust:
We have audited the accompanying combined balance sheets of Certain Mariner
Post-Acute Network Facilities (Operated by subsidiaries of Mariner Post-Acute
Network, Inc.) (the "Facilities"), as defined in Note 1, as of December 31, 2000
and 1999, and the related combined statements of operations, divisional equity
(deficit), and cash flows for each of the three years in the period ended
December 31, 2000. Our audits also included the financial statement schedule
listed in the Index on page F-1. These financial statements and schedule are the
responsibility of the Facilities' management. Our responsibility is to express
an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the combined financial position of Certain Mariner
Post-Acute Network Facilities, as defined in Note 1, at December 31, 2000 and
1999, and the combined results of their operations and their cash flows for each
of the three years in the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
September 19, 2001
Boston, Massachusetts
F-47
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
COMBINED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
DECEMBER 31
-------------------
2000 1999
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 2,508 $ --
Patient receivables, less allowance for doubtful accounts
of $1,834 in 2000 and $1,534 in 1999.................... 7,501 6,888
Other receivables......................................... 3,489 321
Other current assets...................................... 477 226
-------- --------
Total current assets........................................ 13,975 7,435
Property and equipment:
Building improvements..................................... 4,128 3,563
Furniture, fixtures and equipment......................... 635 371
-------- --------
4,763 3,934
Less accumulated depreciation............................. (3,725) (2,425)
-------- --------
1,038 1,509
Goodwill, net............................................... 8,012 8,471
Other assets................................................ 27 18
-------- --------
Total assets................................................ $ 23,052 $ 17,433
======== ========
LIABILITIES AND DIVISIONAL DEFICIT
Current liabilities:
Accounts payable and accrued expenses..................... $ 12,645 $ 9,638
Accrued wages and related liabilities..................... 3,570 3,584
Due to Senior Housing Properties Trust.................... 5,760 --
Current portion of long-term debt......................... -- 919
Current portion of unfavorable lease obligations and other
non-current liabilities................................. 3,673 3,719
-------- --------
Total current liabilities................................... 25,648 17,860
Liabilities subject to compromise........................... 7,111 --
Unfavorable lease obligations and other non-current
liabilities............................................... 24,980 28,603
-------- --------
Total liabilities........................................... 57,739 46,463
Commitments and contingencies
Divisional deficit.......................................... (34,687) (29,030)
-------- --------
Total liabilities and divisional deficit.................... $ 23,052 $ 17,433
======== ========
SEE ACCOMPANYING NOTES.
F-48
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
COMBINED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
2000 1999 1998
-------- -------- --------
Revenues:
Net patient revenues...................................... $85,128 $ 86,643 $105,130
Other..................................................... 197 302 356
------- -------- --------
Total revenues.............................................. 85,325 86,945 105,486
Expenses:
Salaries, wages and benefits.............................. 55,033 50,619 43,582
Nursing, dietary and other supplies....................... 5,445 5,592 4,982
Ancillary services........................................ 4,077 3,848 24,441
Facility general and administrative costs................. 7,205 9,394 8,090
Allocation of corporate overhead.......................... 4,101 4,347 5,274
Insurance................................................. 4,496 4,876 4,267
Rent...................................................... 8,748 9,315 8,241
Depreciation and amortization............................. 1,766 2,027 2,886
Impairment of long-lived assets........................... -- 36,322 8,670
Provision for bad debts................................... 1,758 4,233 1,627
------- -------- --------
Total expenses.............................................. 92,629 130,573 112,060
------- -------- --------
Loss from operations........................................ (7,304) (43,628) (6,574)
Interest expense............................................ (121) (181) (1,138)
Interest income............................................. 4 5 2
------- -------- --------
Loss before income taxes.................................... (7,421) (43,804) (7,710)
Provision for income taxes.................................. -- -- --
------- -------- --------
Net loss.................................................... $(7,421) $(43,804) $ (7,710)
======= ======== ========
SEE ACCOMPANYING NOTES.
F-49
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
COMBINED STATEMENTS OF DIVISIONAL EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS)
Balance at December 31, 1997................................ $ 21,671
Contributions from Parent, net............................ 503
Net loss.................................................. (7,710)
--------
Balance at December 31, 1998................................ 14,464
Contributions from Parent, net............................ 310
Net loss.................................................. (43,804)
--------
Balance at December 31, 1999................................ (29,030)
Contributions from Parent, net............................ 1,764
Net loss.................................................. (7,421)
--------
Balance at December 31, 2000................................ $(34,687)
========
SEE ACCOMPANYING NOTES.
F-50
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
2000 1999 1998
-------- -------- --------
OPERATING ACTIVITIES
Net loss.................................................... $(7,421) $(43,804) $ (7,710)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization........................... 1,766 2,027 2,886
Amortization of unfavorable lease obligations
and other non-current liabilities..................... (3,673) (3,691) (2,248)
Provision for bad debts................................. 1,758 4,233 1,627
Impairment of long-lived assets......................... -- 36,322 8,670
Increase (decrease) in cash arising from changes
in operating assets and liabilities:
Patient receivables..................................... 3,567 2,915 (2,564)
Other receivables....................................... (3,168) 987 2,887
Other assets............................................ (9) (35) 51
Accounts payable and accrued expenses................... 3,007 1,527 111
Accrued wages and related liabilities................... (14) 621 (514)
Due to Senior Housing Properties Trust.................. 5,760 -- --
------- -------- --------
Net cash provided by operating activities................... 1,573 1,102 3,196
------- -------- --------
INVESTING ACTIVITIES
Purchases of property and equipment......................... (829) (1,362) (2,160)
Disposals of property, equipment and other assets........... -- -- 9,971
------- -------- --------
Net cash provided by (used in) investing activities......... (829) (1,362) 7,811
------- -------- --------
FINANCING ACTIVITIES
Capital contributions, net.................................. 1,764 310 503
Repayment of debt........................................... -- -- (11,466)
Repayment of capital lease.................................. -- (50) (44)
------- -------- --------
Net cash provided by (used in) financing activities......... 1,764 260 (11,007)
------- -------- --------
Net increase in cash........................................ 2,508 -- --
Cash at beginning of year................................... -- -- --
------- -------- --------
Cash at end of year......................................... $ 2,508 $ -- $ --
======= ======== ========
SEE ACCOMPANYING NOTES.
F-51
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
NOTES TO COMBINED FINANCIAL STATEMENTS
1. ORGANIZATION
The combined financial statements of Certain Mariner Post-Acute Network
Facilities (the "Facilities") include the accounts of 17 nursing home facilities
and certain related assets and liabilities owned and controlled by Mariner
Post-Acute Network, Inc. ("Mariner" or the "Parent"). The Facilities are owned
by wholly owned subsidiaries of GranCare, Inc. ("GranCare"), a wholly owned
subsidiary of Mariner. The Facilities constitute a division of Mariner and are
not separate legal entities.
Mariner, formerly known as Paragon Health Network, Inc., was formed in
November 1997 through the recapitalization by merger of Living Centers of
America, Inc. ("LCA") with a newly-formed entity owned by certain affiliates of
Apollo Management, L.P. and the subsequent merger of GranCare (the "GranCare
Merger").
Mariner and certain of its respective subsidiaries, including those
subsidiaries operating the Facilities, filed separate voluntary petitions
(collectively, the "Chapter 11 Filings") for relief under Chapter 11 of
Title 11 of the United States Code (the "Bankruptcy Code") with the United
States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court") on
January 18, 2000 (the "Petition Date"). Mariner is presently operating its
business as a debtor-in-possession and is subject to the jurisdiction of the
Bankruptcy Court while a plan of reorganization is formulated. Mariner's and its
subsidiaries' need to seek relief afforded by the Bankruptcy Code is due, in
part, to the significant financial pressure created by the implementation of the
Balanced Budget Act of 1997.
Mariner, through its GranCare subsidiaries, leased the Facilities from a
wholly owned subsidiary of Senior Housing Properties Trust ("SNH"), which
succeeded to the interests of Health and Retirement Properties Trust ("HRPT
Properties"). On May 10, 2000, the Bankruptcy Court approved a settlement
agreement (the "Settlement Agreement") between Mariner, certain of its GranCare
subsidiaries, and subsidiaries of SNH. The Settlement Agreement is effective at
the close of business on June 30, 2000 and is subject to obtaining regulatory
approvals in the states where the Facilities are located. Based upon the terms
of the Settlement Agreement: (a) the Facilities leased by the GranCare
subsidiaries and the related personal property were assigned to subsidiaries of
SNH and (b) Mariner agreed to manage the Facilities transferred to the SNH
during a transition period that was expected to last less than six months. As of
December 31, 2000, the transition period has ended and management of the
Facilities is being performed by SNH.
As specified in the Settlement Agreement, certain assets and liabilities
reflected on the accompanying combined balance sheet as of December 31, 2000
will remain with Mariner including liabilities subject to compromise,
unfavorable lease obligations and goodwill. In connection with the Settlement
Agreement, outstanding indebtedness of the Facilities was terminated (see
Note 8) and Mariner paid SNH at closing approximately $2,335,000 to settle its
obligations for property taxes payable and certain employee accrued liabilities.
The aforementioned transaction has not been reflected in the accompanying
combined financial statements.
The Settlement Agreement is contingent upon SNH obtaining licenses and other
governmental approvals necessary to operate the Facilities. SNH has applied for
all of the required licenses and, as of January 31, 2001, the required licenses
for substantially all of these facilities have been received.
F-52
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying combined financial statements have been prepared on the
basis of accounting principles applicable to going concerns and contemplate the
realization of assets and the settlement of liabilities and commitments in the
normal course of business. The financial statements do not include adjustments,
if any, to reflect the possible future effects on the recoverability and
classification of recorded assets or the amounts and classifications of
liabilities that may result from the outcome of these uncertainties. The
accompanying combined financial statements have also been presented in
conformity with the American Institute of Certified Public Accountants Statement
of Position 90-7, "Financial Reporting of Entities in Reorganization Under the
Bankruptcy Code" ("SOP 90-7"). SOP 90-7 requires the segregation of liabilities
subject to compromise by the Bankruptcy Court as of the Petition Date and
identification of all transactions and events that are directly associated with
the reorganization of the Facilities. Pursuant to SOP 90-7, prepetition
liabilities are reported on the basis of the expected amounts of such allowed
claims, as opposed to the amounts for which those claims may be settled. Under a
confirmed plan of reorganization, those claims may be settled at amounts
substantially less than their allowed amounts.
Substantially all of the patient revenues and other income received by the
Facilities is deposited in and commingled with the Parent's general corporate
funds. Certain cash requirements of the Facilities were paid by the Parent and
were charged directly to the Facilities. General and administrative costs of the
Parent were allocated to the Facilities based upon management's estimate of the
actual costs based upon the Facilities' level of operations. The Parent
maintains insurance policies for the Facilities for workers' compensation,
general and professional liability and employee health and dental insurance (see
Note 9). In the opinion of management, the method for allocating Mariner's
corporate general and administrative and insurance expenses is reasonable. It is
not practicable to estimate additional costs, if any, that would have been
incurred if the Facilities were not controlled by Mariner.
PROPERTY AND EQUIPMENT
Property and equipment is presented at cost. Maintenance and repairs are
charged to operations as incurred and replacements and significant improvements,
which would extend the useful life are capitalized. Depreciation and
amortization are expensed over the estimated useful lives of the assets on a
straight-line basis as follows:
Building improvements....................................... 10 - 15 years
Furniture, fixtures and equipment........................... 3 - 15 years
Depreciation expense related to property and equipment for the years ended
December 31, 2000, 1999 and 1998 was approximately $1,307,000, $880,000, and
$1,212,000, respectively.
GOODWILL
Goodwill represents the excess of acquisition cost over the fair market
value of net assets acquired in the GranCare Merger. Goodwill of approximately
$53,177,000 was recorded at the Facilities and is being amortized on a
straight-line basis over 30 years. Management periodically re-evaluates goodwill
and makes any adjustments, if necessary, whenever events or changes in
circumstances indicate that the
F-53
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
carrying amount may not be recoverable or the estimated useful life has changed.
Accumulated amortization at December 31, 2000 and 1999 was approximately
$1,159,000 and $700,000, respectively. Amortization of goodwill charged to
expense was approximately $459,000, $1,147,000, and $1,674,000 for the years
ended December 31, 2000, 1999 and 1998, respectively.
IMPAIRMENT OF LONG-LIVED ASSETS
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets to be Disposed Of," requires impairment losses
to be recognized for long-lived assets when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by the long-lived
assets are not sufficient to recover the assets' carrying amount. Goodwill is
also evaluated for recoverability by estimating the projected undiscounted cash
flows, excluding interest, of the related business activities.
The impairment loss of long-lived assets, including goodwill, is measured by
comparing the carrying amount of the asset to its fair value with any excess of
the carrying value over the fair value written off. Fair market value is
determined by various valuation techniques including discounted cash flow (see
Note 7).
NON-CURRENT LIABILITIES
Non-current liabilities principally include unfavorable lease obligations
related to facilities acquired in the GranCare Merger. The unfavorable lease
obligations are amortized as a reduction of rent expense over the remaining
lease term.
REVENUE RECOGNITION
Net patient revenue includes patient revenues payable by patients and
amounts reimbursable by third party payors under contracts. Patient revenues
payable by patients are recorded at established billing rates. Patient revenues
to be reimbursed by contracts with third-party payors are recorded at the amount
estimated to be realized under these contractual arrangements. Revenues from
Medicare and Medicaid are generally based on reimbursement of the reasonable
direct and indirect costs of providing services to program participants or, for
the Facilities' cost reporting periods beginning January 1, 1999, determined
under the Prospective Payment System ("PPS"). Management separately estimates
revenues due from each third party with which it has a contractual arrangement
and records anticipated settlements with these parties in the contractual period
during which services were rendered.
The amounts actually reimbursable under Medicare and Medicaid cost
reimbursement programs for periods prior to January 1, 1999 are determined by
filing cost reports that are then subject to audit and retroactive adjustment by
the payor.
Legislative changes to state or federal reimbursement systems may also
retroactively affect recorded revenues. Changes in estimated revenues due in
connection with Medicare and Medicaid may be recorded by management subsequent
to the year of origination and prior to final settlement based on improved
estimates. Such adjustments and final settlements with third party payors are
reflected in operations at the time of the adjustment or settlement. Medicare
revenues represented 21%, 23%, and
F-54
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
38%, and Medicaid revenues represented 55%, 53%, and 43% of net revenues for the
years ended December 31, 2000, 1999 and 1998, respectively. On January 1, 1999,
Mariner transitioned the Facilities to PPS for services to Medicare patients.
Revenue recorded for 1999 consists of the aggregate payments expected from
Medicare for individual claims at the appropriate payment rates, which include
reimbursement for ancillary services.
In April 1995, the Health Care Finance Administration ("HCFA") issued a
memorandum to its Medicare fiscal intermediaries as a guideline to assess costs
incurred by inpatient providers relating to payment of occupational and speech
language pathology services furnished under arrangements that include contracts
between therapy providers and inpatient providers. While not binding on the
fiscal intermediaries, the memorandum suggested certain rates to assist the
fiscal intermediaries in making annual "prudent buyer" assessments of speech and
occupational therapy rates paid by inpatient providers. In addition, HCFA has
promulgated new salary equivalency guidelines effective April 1, 1998, which
updated the then current physical therapy and respiratory therapy rates and
established new guidelines for occupational therapy and speech therapy. These
new payment guidelines were in effect until the Facilities transitioned to PPS,
at which time payment for therapy services were included in the PPS rate. HCFA,
through its intermediaries, is also subjecting physical therapy, occupational
therapy and speech therapy to a heightened level of scrutiny resulting in
increasing audit activity. A majority of the Facilities' provider and
rehabilitation contracts provided for indemnification of the facilities for
potential liabilities in connection with reimbursement for rehabilitation
services. There can be no assurance that actions ultimately taken by HCFA with
regard to reimbursement rates for such therapy services will not materially
adversely affect the Facilities results of operations.
Laws and regulations governing the Medicare and Medicaid programs are
complex and subject to interpretation. Management believes that the Facilities
are in compliance with all applicable laws and regulations, and is not aware of
any pending or threatened investigations involving allegations of potential
wrongdoing. While no such regulatory inquiries have been made, compliance with
such laws and regulations can be subject to future government review and
interpretation as well as significant regulatory action including fines,
penalties, and exclusion from the Medicare and Medicaid programs.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
certain estimates and assumptions that may affect the amounts reported in these
financial statements and related notes. The actual results could differ from
these estimates.
INCOME TAXES
The Parent files a consolidated federal income tax return. Throughout the
years and periods presented herein, the Facilities' operations were included in
the Parent's income tax returns. The income tax provision reported in the
combined financial statements is an allocation of the Parent's total income tax
provision. The Facilities' allocation was determined based on a calculation of
income taxes as if the Facilities were a separate taxpayer, in accordance with
Statement of Financial Accounting
F-55
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Income taxes paid
was zero for all periods presented.
Non-current deferred income taxes arise primarily from timing differences
resulting from the recognition of rent expense for tax and financial reporting
purposes and from the use of accelerated depreciation for tax purposes. Current
deferred income taxes result from timing differences in the recognition of
revenues and expenses for tax and financial reporting purposes which are
expected to reverse within one year.
3. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
On January 18, 2000, Mariner and certain of its respective subsidiaries,
including those subsidiaries operating the Facilities, filed voluntary petitions
for relief under Chapter 11 of the Bankruptcy Code (the "Chapter 11
Proceedings"). Mariner is presently operating its business as a
debtor-in-possession and is subject to the jurisdiction of the Bankruptcy Court
while a plan of reorganization is formulated. As a debtor-in-possession, Mariner
is authorized to operate its business but may not engage in transactions outside
its ordinary course of business without the approval of the Bankruptcy Court.
While the Chapter 11 Proceedings constituted a default under Mariner's and
such subsidiaries' various financing arrangements, Section 362 of the Bankruptcy
Code imposes an automatic stay that generally precludes any creditors and other
interested parties under such arrangements from taking any remedial action in
response to any such resulting default outside of the Chapter 11 Proceedings
with obtaining relief from the automatic stay from the Bankruptcy Court.
On January 19, 2000, Mariner received approval from the Bankruptcy Court to
pay prepetition and postpetition employee wages, salaries, benefits and other
employee obligations. The Bankruptcy Court also approved orders granting
authority to pay prepetition claims of certain critical vendors, utilities and
patient obligations. All other prepetition liabilities at December 31, 2000 are
disclosed in Note 5 as liabilities subject to compromise. The Facilities have
been and intend to continue to pay postpetition claims to all vendors and
providers in the ordinary course of business.
4. GOING CONCERN AND ISSUES AFFECTING LIQUIDITY
The accompanying combined financial statements have been prepared assuming
that the Facilities will continue to operate as a going concern. The Facilities
have violated certain covenants of its loan agreement, have experienced
significant losses and have a working capital deficiency of approximately
$11,673,000 and a divisional deficit of approximately $34,687,000 as of
December 31, 2000. Mariner and certain of its subsidiaries, including those
subsidiaries operating the Facilities, filed voluntary petitions for relief
under Chapter 11 of the Bankruptcy Code. These matters, among others, raise
substantial doubt about the Facilities ability to continue as a going concern.
As described in Note 1, on May 10, 2000 the Bankruptcy Court approved a
settlement agreement between Mariner and SNH whereby the Facilities leased by
Mariner and related personal property were assigned to affiliates of SNH. SNH
agreed to provide working capital to the facilities. The agreement is effective
at the close of business on June 30, 2000 and is subject to obtaining regulatory
approvals in
F-56
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
4. GOING CONCERN AND ISSUES AFFECTING LIQUIDITY (CONTINUED)
the states where the Facilities are located. At December 31, 2000, $5,760,000
had been advanced to the facilities by SNH.
On December 31, 2000, SNH has approximately $173,000,000 available for
borrowing under a $270,000,000 bank credit facility. Management of SNH believes
that the available borrowings under the bank credit facility are sufficient to
provide the necessary working capital to the Facilities for operations
subsequent to the closing of the June 30, 2000 transaction.
5. LIABILITIES SUBJECT TO COMPROMISE
"Liabilities subject to compromise" represents liabilities incurred prior to
the commencement of the Chapter 11 Proceedings. These liabilities, consisting
primarily of long-term debt and certain accounts payable, represent the
Facilities' estimate of known or potential prepetition claims to be resolved in
connection with the Chapter 11 Proceedings. Such claims remain subject to future
adjustments based on negotiations, actions of the Bankruptcy Court, further
developments with respect to disputed claims, future rejection of executory
contracts or unexpired leases, determination as to the value of any collateral
securing claims, treatment under the plan of reorganization and other events.
Payment for these amounts will be established in connection with the plan of
reorganization.
A summary of the principal categories of claims classified as liabilities
subject to compromise at December 31, 2000 is as follows (in thousands):
Accounts payable and accrued expenses....................... $6,223
Long-term debt.............................................. 888
------
$7,111
======
6. IMPAIRMENT OF LONG-LIVED ASSETS
The revenues recorded by the Facilities under PPS are substantially less
than the cost-based reimbursement it received previously. The implementation of
PPS resulted in a greater than expected decline in reimbursement for inpatient
services. Management determined that these revenue declines are other than
temporary and are expected to have a materially adverse effect on future
revenues and cash flow. As a result of such indicators of impairment, in the
third quarter of 1999, a detailed analysis of the Facilities' long-lived assets
and their estimated future cash flows was completed. The analysis resulted in
the identification and measurement of an impairment loss of approximately
$36,322,000.
In the third quarter of 1998, management recorded an impairment charge based
on a detailed analysis of the Facilities' long-lived assets and their estimated
cash flows. The analysis resulted in the identification and measurement of an
impairment loss of approximately $8,670,000 for the Facilities.
Each analysis included management's estimate of the undiscounted cash flows
to be generated by these assets with a comparison to their carrying value. If
the undiscounted future cash flow estimates were less than the carrying value of
the asset then the carrying value was written down to estimated fair value.
Goodwill associated with an impaired asset was included with the carrying value
of that asset in
F-57
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
6. IMPAIRMENT OF LONG-LIVED ASSETS (CONTINUED)
performing both the impairment test and in measuring the amount of impairment
loss related to the asset. Fair value was estimated based on the present value
of future cash flows.
The following is a summary of the impairment losses recognized during 1999
and 1998 by asset category (in thousands):
1999 1998
-------- --------
Goodwill................................................... $30,378 $8,123
Property and equipment..................................... 5,944 547
------- ------
$36,322 $8,670
======= ======
7. DEBT
On December 28, 1990, a mortgage loan agreement was entered into for
$15,000,000 with HRPT Properties, secured by two nursing home facilities'
(Northwest Health Care Center and River Hills West Health Care Center) land,
building and improvements. The interest rate on the note was 11.5%. The loan was
repaid in September 1998 as part of the sale-leaseback transaction discussed in
Note 6.
On March 28, 1992, a loan agreement was entered into with HRPT Properties
for the purpose of funding renovations to the Christopher East facility,
maturing on January 31, 2013. Advances to AMS Properties, Inc. totaled
approximately $883,000 for the years ended December 31, 2000 and 1999. The loan
is interest bearing and principal is payable upon maturity. The interest rate on
the note is 13.75%. The Bankruptcy Proceedings are considered an Event of
Default as defined in the loan agreement. Current portion of long-term debt at
December 31, 1999 includes the principal balance of the note. In consideration
of the terms of the Settlement Agreement, the Christopher East note obligation
was terminated in July 2000. Interest paid was approximately $60,000, $181,000
and $1,252,000 during the years ended December 31, 2000, 1999 and 1998,
respectively.
8. TRANSACTIONS WITH AFFILIATES
Mariner provided various services to the Facilities including, but not
limited to, financial, legal, insurance, information systems, employee benefit
plans and certain administrative services, as required. The combined financial
statements reflect charges for certain corporate general and administrative
expenses from Mariner's corporate office to the Facilities. Such corporate
charges represent allocations based on determinations management believes to be
reasonable (5% of total revenues). Administrative costs charged by Mariner were
approximately $2,133,000, $4,347,000 and $5,274,000 for the years ended
December 31, 2000, 1999 and 1998, respectively. For the year ended December 31,
2000, fees charged by SNH for management services were approximately $1,968,000,
all of which have been paid.
The Facilities participated in the various benefit plans of Mariner,
primarily the profit sharing and 401(k) plans. These plans include matching
provisions for employee contributions to the 401(k) plan. The financial
statements reflect charges for benefits attributable to the Facilities'
employees. Such amounts totaled approximately $108,000, $221,000, and $133,000,
for the years ended December 31, 2000, 1999 and 1998, respectively.
F-58
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
8. TRANSACTIONS WITH AFFILIATES (CONTINUED)
Through March 31, 1998, the Facilities participated in a program for
insurance of workers' compensation risks through a captive insurance subsidiary
of Mariner. Effective March 31, 1998, Mariner purchased a fully-insured workers'
compensation policy with no deductible or retention with a catastrophic policy
in place to cover any loss above $500,000 per occurrence. Additionally, in 1998
Mariner purchased general and professional liability insurance through a third
party. The maximum loss exposure with respect to this policy is $100,000 per
occurrence.
Mariner obtains and provides insurance coverage for health, life and
disability, auto, general liability and workers' compensation through its
self-insurance and outside insurance programs and allocates to the Facilities
based on its estimate of the actual costs incurred on behalf of the Facilities.
Total insurance costs allocated were approximately $2,537,000, $4,876,000 and
$4,267,000 for the years ended December 31, 2000, 1999 and 1998, respectively.
These costs are included in facility general and administrative costs in the
accompanying combined statements of operations.
The Facilities purchased certain therapy services from rehabilitation
subsidiaries of Mariner. These purchases amounted to approximately $0,
$2,955,000 and $3,402,000 for the years ended December 31, 2000, 1999 and 1998,
respectively.
9. COMMITMENTS AND CONTINGENCIES
As discussed in Note 1, the Facilities are party to various agreements
between GranCare and SNH. SNH is the lessor with respect to the Facilities
leased by two subsidiaries of GranCare (the "Tenant Entities") under operating
leases. Pursuant to a Collateral Pledge Agreement dated October 31, 1997,
Mariner provided an unlimited guaranty to SNH, which is secured by a cash
collateral deposit of $15,000,000, the earned interest on which is retained by
SNH. In June 2000, the Facilities ceased payment of rents. As part of the
Settlement Agreement, Mariner was released from its lease obligations.
Rent expense, net of amortization of unfavorable lease obligation, for all
operating leases was approximately $8,748,000, $9,314,000, and $8,241,000 for
the years ended December 31, 2000, 1999 and 1998, respectively.
From time to time, the Facilities have been subject to various legal
proceedings in the ordinary course of business. In the opinion of management,
except as described below, there are currently no proceedings which could
potentially have a material adverse effect on the Facilities' financial position
or results of operations after taking into account the insurance coverage
maintained by Mariner. Although management believes that any of the proceedings
discussed below will not have a material adverse impact on the Facilities if
determined adversely to the Facilities, given the Facilities' current financial
condition, lack of liquidity and the current lack of aggregate limit under
Mariner's current GL/PL insurance policy, settling a large number of cases
within the Company's $1 million self-insured retention limit could have a
material adverse effect on the Facilities.
On August 26, 1996, a class action complaint was asserted against GranCare
in the Denver, Colorado District Court. On March 15, 1998, the Court entered an
Order in which it certified a class action in the matter. On June 10, 1998,
Mariner filed a Motion to Dismiss all claims and Motion for Summary Judgment
Precluding Recovery of Medicaid Funds and these motions were partially granted
F-59
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
by the Court on October 30, 1998. Plaintiffs filed a writ with the Colorado
Supreme Court and an appeal with the Colorado Court of Appeals. The Supreme
Court writ has been denied, the Court of Appeals matter has been briefed and
Oral Argument was set for January 18, 2000. In accordance with the Chapter 11
Proceedings and more particularly, Section 362 of the Bankruptcy Code, this
matter was stayed on January 18, 2000. However, Mariner did agree to limited
relief from the stay in order to allow for certain parts of the appeal to
continue. On January 4, 2001, the Court of Appeals reversed the District Court's
decision. Mariner is currently considering whether to pursue a request for
rehearing and/or appeal to the Colorado Supreme Court. The Company intends to
vigorously contest the remaining allegations of class status.
10. INCOME TAXES
The components of the net deferred tax asset are approximately as follows
(in thousands):
DECEMBER 31
-------------------
2000 1999
-------- --------
Deferred tax assets:
Bad debts............................................. $ 325 $ 598
Amounts related to property and equipment............. 1,681 1,585
Payroll and benefits.................................. 271 620
Unfavorable lease obligations and other liabilities... 11,304 12,736
NOL carryforwards..................................... 11,878 7,205
-------- --------
Total deferred tax assets............................... 25,459 22,744
Less valuation allowance................................ (25,459) (22,744)
-------- --------
Net deferred tax asset.................................. $ -- $ --
======== ========
The Facilities have established a full valuation allowance, which completely
offsets all net deferred tax assets generated from the Facilities' net losses
because its future realizability is uncertain. The net change in the valuation
allowance was an increase of approximately $2,715,000 and $4,789,000 at
December 31, 2000 and 1999, respectively.
F-60
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES (CONTINUED)
The provision for income taxes varies from the amount determined by applying
the Federal statutory rate to pre-tax loss as a result of the following:
YEAR ENDED DECEMBER 31
------------------------------------
2000 1999 1998
-------- -------- --------
Federal statutory income tax rate.................... (34.0)% (34.0)% (34.0)%
Increase (decrease) in taxes resulting from:
State and local taxes, net of federal tax
benefits....................................... (4.7) (1.4) 1.4
Permanent book/tax differences, primarily
resulting from goodwill amortization........... 2.1 0.9 7.4
Impairment of assets............................. -- 23.6 35.8
Change in valuation allowance.................... 36.6 10.9 (10.6)
----- ----- -----
Effective tax rate................................... --% --% --%
===== ===== =====
11. CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Facilities to
concentration of credit risk consist principally of trade receivables. There
have been, and the Facilities expect that there will continue to be, a number of
proposals to limit reimbursement allowable to skilled nursing facilities. Should
the related government agencies suspend or significantly reduce contributions to
the Medicare or Medicaid programs, the Facilities' ability to collect its
receivables would be adversely impacted.
Management believes that the remaining receivable balances from various
payors, including individuals involved in diverse activities, subject to
differing economic conditions, do not represent a concentration of credit risk
to the Facilities. Management continually monitors and adjusts its allowance for
doubtful accounts associated with its receivables.
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Facilities financial instruments include notes payable. Fair values for
fixed rate debt instruments were estimated based on the present value of cash
flows that would be paid on the note over the remaining note term using the
Facilities' current incremental borrowing rate rather than the stated interest
rate on the notes. The fair values of the financial instruments approximate
their carrying values.
F-61
CERTAIN MARINER POST-ACUTE NETWORK FACILITIES
(OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK)
(DEBTOR IN POSSESSION AS OF JANUARY 20, 2000)
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(DOLLARS IN THOUSANDS)
BALANCE AT CHARGED
BEGINNING (CREDITED) TO WRITE-OFFS/ BALANCE AT
DESCRIPTION OF YEAR OPERATIONS RECOVERIES OTHER END OF YEAR
----------- ---------- ------------- ----------- -------- -----------
Year ended December 31, 2000:
Allowance for doubtful accounts:.............. $1,534 $1,758 $(1,458) $ -- $1,834
------ ------ ------- ----- ------
$1,534 $1,758 $(1,458) $ -- $1,834
====== ====== ======= ===== ======
Year ended December 31, 1999:
Allowance for doubtful accounts:.............. $2,927 $4,233 $(5,468) $(158) $1,534
------ ------ ------- ----- ------
$2,927 $4,233 $(5,468) $(158) $1,534
====== ====== ======= ===== ======
Year ended December 31, 1998:
Allowance for doubtful accounts:.............. $1,109 $1,627 $ -- $ 191 $2,927
------ ------ ------- ----- ------
$1,109 $1,627 $ -- $ 191 $2,927
====== ====== ======= ===== ======
F-62
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED, IN THOUSANDS)
SEPTEMBER 7,
2001
-------------
ASSETS
Property and equipment, net................................. $631,644
Due from Marriott Senior Living Services, net............... 8,787
Other assets................................................ 11,000
Cash and cash equivalents................................... 20,107
--------
Total assets............................................ $671,538
========
LIABILITIES AND EQUITY
Debt........................................................ $246,627
Accounts payable and accrued expenses....................... 1,247
Deferred income taxes....................................... 60,882
Other liabilities........................................... 16,057
--------
Total liabilities....................................... 324,813
--------
Equity:
Investments in and advances from parent................... 346,725
--------
Total liabilities and equity............................ $671,538
========
See Notes to Condensed Consolidated Financial Statements.
F-63
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THIRTY-SIX WEEKS ENDED SEPTEMBER 7, 2001 AND SEPTEMBER 8, 2000
(UNAUDITED, IN THOUSANDS)
SEPTEMBER 7, SEPTEMBER 8,
2001 2000
------------- -------------
REVENUES
Routine................................................... $174,154 $164,446
Ancillary................................................. 16,434 16,115
-------- --------
190,588 180,561
Equity in earnings of affiliates.......................... 20 37
-------- --------
Total revenues.......................................... 190,608 180,598
-------- --------
OPERATING COSTS AND EXPENSES
Property-level operating costs and expenses
Routine................................................. 111,274 105,751
Ancillary............................................... 9,206 9,982
Other operating costs and expenses
Depreciation and amortization........................... 16,717 16,591
Management fees......................................... 12,441 11,005
Property taxes and other................................ 6,199 6,654
-------- --------
Total operating costs and expenses.................... 155,837 149,983
-------- --------
OPERATING PROFIT............................................ 34,771 30,615
Corporate expenses.......................................... (1,338) (1,526)
Interest expense............................................ (14,379) (12,582)
Interest income............................................. 610 640
-------- --------
INCOME BEFORE INCOME TAXES.................................. 19,664 17,147
Provision for income taxes.................................. (8,062) (7,030)
-------- --------
INCOME BEFORE EXTRAORDINARY ITEM............................ 11,602 10,117
Gain on early extinguishment of debt, net of tax............ -- 253
-------- --------
NET INCOME.................................................. $ 11,602 $ 10,370
======== ========
See Notes to Condensed Consolidated Financial Statements.
F-64
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THIRTY-SIX WEEKS ENDED SEPTEMBER 7, 2001 AND SEPTEMBER 8, 2000
(UNAUDITED, IN THOUSANDS)
SEPTEMBER 7, SEPTEMBER 8,
2001 2000
------------- -------------
OPERATING ACTIVITIES
Cash provided by operations................................. $23,684 $ 28,518
------- --------
INVESTING ACTIVITIES
Expansions of senior living communities................... -- (3,163)
Other capital expenditures................................ (5,770) (6,434)
Increase in capital improvement reserve................... 5 556
------- --------
Cash used in investing activities........................... (5,765) (9,041)
------- --------
FINANCING ACTIVITIES
Repayments of debt........................................ (2,089) (46,207)
Issuances of debt......................................... -- 92,370
Decrease in financing escrows............................. -- 487
Net advances to parent.................................... (2,399) (66,065)
------- --------
Cash used in financing activities........................... (4,488) (19,415)
------- --------
Increase in cash and cash equivalents....................... 13,431 62
Cash and cash equivalents, beginning of period.............. 6,676 3,006
------- --------
Cash and cash equivalents, end of period.................... $20,107 $ 3,068
======= ========
See Notes to Condensed Consolidated Financial Statements.
F-65
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. On August 9, 2001, Crestline Capital Corporation ("Crestline Capital") and
CSL Group, Inc. ("CSL Group") entered into a stock purchase agreement (the
"Stock Purchase Agreement") with Senior Housing Properties Trust ("SNH") and
SNH/CSL Properties Trust ("SNH/CSL"). Pursuant to the Stock Purchase
Agreement, SNH/CSL would purchase the stock of CSL Group and certain other
subsidiaries of Crestline Capital that compose Crestline Capital's senior
living business (the "Partitioned Business") for $600 million, including the
assumption of approximately $235 million in existing debt. The transaction
is expected to close in the first quarter of 2002 and is subject to a
successful vote by at least two-thirds of Crestline Capital's shareholders,
arranging additional mortgage debt financing for $150 million to
$175 million, obtaining certain consents and customary closing conditions.
These condensed consolidated financial statements include only the assets
and liabilities, along with the results from operations generated from the
Partitioned Business, as described in the Stock Purchase Agreement. The
Partitioned Business is an organizational unit of Crestline Capital and is
not a distinct legal entity. As of September 7, 2001, the Partitioned
Business consisted of the ownership of 31 senior living communities, a
general partnership interest in one senior living community and a second
mortgage note receivable on a senior living community.
The accompanying condensed consolidated financial statements of the
Partitioned Business have been prepared by management without audit. Certain
information and footnote disclosures normally included in financial
statements presented in accordance with generally accepted accounting
principles have been condensed or omitted. Management believes the
disclosures made are adequate to make the information presented not
misleading. However, the condensed consolidated financial statements should
be read in conjunction with the consolidated financial statements and notes
thereto included in the Partitioned Business's audited financial statements
for the fiscal year ended December 29, 2000.
The accompanying unaudited condensed consolidated financial statements
reflect all adjustments (which include only normal and recurring
adjustments) necessary to present fairly the financial position of the
Partitioned Business as of September 7, 2001 and the results of operations
and cash flows for the thirty-six week period ended September 7, 2001. All
significant intercompany accounts and transactions have been eliminated.
Interim results are not necessarily indicative of fiscal year performance
because of the impact of seasonal and short-term variations.
F-66
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Crestline Capital Corporation:
We have audited the accompanying consolidated balance sheets of CSL
Group, Inc. and subsidiaries (a business unit wholly owned by Crestline Capital
Corporation) as partitioned for sale to SNH/CSL Properties Trust (see Note 1) as
of December 29, 2000 and December 31, 1999, and the related consolidated
statements of operations, equity and cash flows for the fiscal years ended
December 29, 2000, December 31, 1999 and January 1, 1999. These consolidated
financial statements are the responsibility of Crestline Capital Corporation's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of CSL
Group, Inc. as partitioned for sale to SNH/CSL Properties Trust, as of
December 29, 2000 and December 31, 1999 and the results of its operations,
equity and its cash flows for the fiscal years ended December 29, 2000,
December 31, 1999 and January 1, 1999, in conformity with accounting principles
generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
Vienna, Virginia
August 31, 2001
F-67
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
CONSOLIDATED BALANCE SHEETS
DECEMBER 29, 2000 AND DECEMBER 31, 1999
(IN THOUSANDS)
2000 1999
-------- --------
ASSETS
Property and equipment, net................................. $643,110 $656,758
Due from Marriott Senior Living Services, net............... 6,106 5,729
Other assets................................................ 12,522 17,246
Cash and cash equivalents................................... 6,676 3,006
-------- --------
Total assets............................................ $668,414 $682,739
======== ========
LIABILITIES AND EQUITY
Debt........................................................ $249,190 $205,629
Accounts payable and accrued expenses....................... 701 1,184
Deferred income taxes....................................... 63,660 61,554
Other liabilities........................................... 17,342 17,240
-------- --------
Total liabilities....................................... 330,893 285,607
-------- --------
Equity:
Investments in and advances to parent..................... 337,521 397,132
-------- --------
Total liabilities and equity............................ $668,414 $682,739
======== ========
See Notes to Consolidated Financial Statements.
F-68
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS
FISCAL YEARS ENDED DECEMBER 29, 2000, DECEMBER 31, 1999 AND JANUARY 1, 1999
(IN THOUSANDS)
2000 1999 1998
-------- -------- --------
REVENUES
Routine................................................... $239,065 $223,794 $213,378
Ancillary................................................. 22,821 22,704 27,899
-------- -------- --------
261,886 246,498 241,277
Equity in earnings of affiliates.......................... 37 92 20
-------- -------- --------
Total revenues.......................................... 261,923 246,590 241,297
-------- -------- --------
OPERATING COSTS AND EXPENSES
Property-level operating costs and expenses
Routine................................................. 153,049 145,778 138,099
Ancillary............................................... 14,493 15,414 21,317
Other operating costs and expenses
Depreciation and amortization........................... 24,083 21,624 22,115
Management fees......................................... 15,658 14,965 13,973
Property taxes and other................................ 9,263 8,549 8,554
Loss on impairment of asset............................. -- 3,522 --
Other................................................... -- 1,650 --
-------- -------- --------
Total operating costs and expenses.................... 216,546 211,502 204,058
-------- -------- --------
OPERATING PROFIT............................................ 45,377 35,088 37,239
Corporate expenses.......................................... (1,917) (2,096) (2,092)
Interest expense............................................ (19,586) (17,061) (22,173)
Interest income............................................. 942 773 2,028
-------- -------- --------
INCOME BEFORE INCOME TAXES AND EXTRAORDINARY ITEM........... 24,816 16,704 15,002
Provision for income taxes.................................. (10,175) (6,849) (6,151)
-------- -------- --------
INCOME BEFORE EXTRAORDINARY ITEM............................ 14,641 9,855 8,851
Gain on early extinguishment of debt, net of taxes.......... 253 -- --
-------- -------- --------
NET INCOME.................................................. $ 14,894 $ 9,855 $ 8,851
======== ======== ========
See Notes to Consolidated Financial Statements.
F-69
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
CONSOLIDATED STATEMENTS OF EQUITY
FISCAL YEARS ENDED DECEMBER 29, 2000, DECEMBER 31, 1999 AND JANUARY 1, 1999
(IN THOUSANDS)
Balance, January 2, 1998.................................... $230,727
Investment from parent, net............................... 159,225
Net income................................................ 8,851
--------
Balance, January 1, 1999.................................... 398,803
Net income................................................ 9,855
Advances to parent, net................................... (11,526)
--------
Balance, December 31, 1999.................................. 397,132
Net income................................................ 14,894
Advances to parent, net................................... (74,505)
--------
Balance, December 29, 2000.................................. $337,521
========
See Notes to Consolidated Financial Statements.
F-70
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
FISCAL YEARS ENDED DECEMBER 29, 2000, DECEMBER 31, 1999 AND JANUARY 1, 1999
(IN THOUSANDS)
2000 1999 1998
-------- -------- --------
OPERATING ACTIVITIES
Net income.................................................. $ 14,894 $ 9,855 $ 8,851
Adjustments to reconcile net income to cash from operations:
Depreciation and amortization............................. 24,083 21,624 22,115
Gain on early extinguishment of debt, net of taxes........ (253) -- --
Loss on impairment of asset............................... -- 3,522 --
Amortization of debt premiums and deferred financing
costs................................................... (710) (1,550) (1,550)
Change in amounts due from Marriott Senior Living
Services................................................ (377) 2,156 (10,934)
Change in other operating accounts........................ 11,867 2,820 (303)
-------- -------- --------
Cash provided by operations................................. 49,504 38,427 18,179
-------- -------- --------
INVESTING ACTIVITIES
Expansions of senior living communities................... (3,204) (18,451) (8,653)
Purchase of minority partnership interest................. -- (7,010) --
Other capital expenditures................................ (10,380) (9,239) (5,567)
Other..................................................... 998 535 (3,432)
-------- -------- --------
Cash used in investing activities........................... (12,586) (34,165) (17,652)
-------- -------- --------
FINANCING ACTIVITIES
Repayments of debt........................................ (47,250) (4,197) (3,608)
Issuances of debt......................................... 92,370 -- --
Net advances to parent.................................... (74,505) (11,526) --
Other..................................................... (3,863) -- (96)
-------- -------- --------
Cash used in financing activities........................... (33,248) (15,723) (3,704)
-------- -------- --------
Increase (decrease) in cash and cash equivalents............ 3,670 (11,461) (3,177)
Cash and cash equivalents, beginning of year................ 3,006 14,467 17,644
-------- -------- --------
Cash and cash equivalents, end of year...................... $ 6,676 $ 3,006 $ 14,467
======== ======== ========
SUPPLEMENTAL INFORMATION--NON-CASH ACTIVITY:
Investments from parent:
Property and equipment.................................. $ -- $ -- $ 20,959
Acquisition of minority interests paid by Crestline
Capital............................................... -- -- 12,963
Debt forgiveness........................................ -- -- 92,195
Debt prepayment paid by Host Marriott................... -- -- 26,405
Other................................................... -- -- 6,703
See Notes to Consolidated Financial Statements.
F-71
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND ORGANIZATION
On June 21, 1997, Crestline Capital Corporation ("Crestline Capital",
formerly known as HMC Senior Living Communities, Inc.), a wholly owned
subsidiary of Host Marriott Corporation ("Host Marriott"), acquired all the
outstanding stock of CSL Group, Inc. and subsidiaries ("CSL Group", formerly
known as Forum Group, Inc. "Forum") from Marriott Senior Living Services, Inc.
("MSLS"), a subsidiary of Marriott International, Inc., pursuant to a stock
purchase agreement dated June 21, 1997. In connection with the acquisition,
Crestline Capital acquired the ownership of 29 senior living communities, and
assigned to MSLS its interest as manager under long-term operating agreements.
Subsequent to Crestline Capital's acquisition of Forum, the Partitioned Business
acquired two additional senior living communities.
On December 29, 1998 (the "Distribution Date"), Crestline Capital became a
publicly traded company when Host Marriott completed its plan of reorganizing
its business operations by spinning-off Crestline Capital to the shareholders of
Host Marriott (the "Distribution"), as part of a series of transactions pursuant
to which Host Marriott elected to be considered a real estate investment trust.
On August 9, 2001, Crestline Capital and CSL Group entered into a stock
purchase agreement (the "Stock Purchase Agreement") with Senior Housing
Properties Trust ("SNH") and SNH/CSL Properties Trust ("SNH/CSL"). Pursuant to
the Stock Purchase Agreement, SNH/CSL would purchase the stock of CSL Group and
certain other subsidiaries of Crestline Capital that compose Crestline Capital's
senior living business (the "Partitioned Business") for $600 million, including
the assumption of approximately $235 million in existing debt. The transaction
is expected to close in the first quarter of 2002 and is subject to a successful
vote by at least two-thirds of Crestline Capital's shareholders, arranging
additional mortgage debt financing for $150 million to $175 million, obtaining
certain consents and customary closing conditions.
These consolidated financial statements include only the assets and
liabilities, along with the results from operations generated from the
Partitioned Business, as described in the Stock Purchase Agreement. The
Partitioned Business is an organizational unit of Crestline Capital and is not a
distinct legal entity. As of December 29, 2000, the Partitioned Business
consisted of the ownership of 31 senior living communities, a general
partnership interest in one senior living community and a second mortgage note
receivable on a senior living community.
The Securities and Exchange Commission, in Staff Accounting Bulletin Number
55 (SAB 55), requires that historical financial statements of a subsidiary,
division, or lesser business component of another entity include certain
expenses incurred by the parent on its behalf. These expenses include officer
and employee salaries, rent or depreciation, advertising, accounting and legal
services, other selling, general and administrative expenses and other such
expenses. Investments and advances from parent represents the net amount of
investments and advances made by Crestline Capital as a result of the
acquisition and operation of the Partitioned Business. These financial
statements include the adjustments necessary to comply with SAB 55.
Through the Distribution Date, the Partitioned Business operated as a wholly
owned business unit of Host Marriott utilizing Host Marriott's employees,
insurance and administrative services since the Partitioned Business had no
employees. Subsequent to the Distribution Date, the Partitioned Business
operated as a wholly-owned business unit of Crestline Capital utilizing
Crestline Capital's employees, insurance and administrative services since the
Partitioned Business had no employees. Periodically, certain operating expenses,
capital expenditures and other cash requirements of the Partitioned
F-72
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ORGANIZATION (CONTINUED)
Business were paid by either Host Marriott or Crestline Capital and charged
directly or allocated to the Partitioned Business. Certain general and
administrative costs of Host Marriott or Crestline Capital were allocated to the
Partitioned Business using a variety of methods, principally including Host
Marriott's or Crestline Capital's specific identification of individual cost
items and otherwise through allocations based upon estimated levels of effort
devoted by its general and administrative departments to individual entities or
relative measures of size of the entities based on assets or revenues. In the
opinion of management, the methods for allocating corporate, general and
administrative expenses and other direct costs are reasonable.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Partitioned Business and its subsidiaries and controlled affiliates. Investments
in affiliates owned 20 percent or more and over which the Partitioned Business
has the ability to exercise significant influence, but does not control, are
accounted for using the equity method. All material intercompany transactions
and balances have been eliminated.
FISCAL YEAR
The Partitioned Business's fiscal year ends on the Friday nearest to
December 31.
REVENUES
Revenues represent operating revenues from senior living communities.
Routine revenues consist of resident fees and health care service revenues,
which are generated primarily from monthly charges for independent and assisted
living apartments and special care center rooms and daily charges for healthcare
beds and are recognized monthly based on the terms of the residents' agreements.
Advance payments received for services are deferred until the services are
provided. Ancillary revenue is generated on a "fee for service" basis for
supplemental items requested by residents and is recognized as the services are
provided.
A portion of revenues from health care services was attributable to patients
whose bills are paid by Medicare or Medicaid under contractual arrangements. For
fiscal year 1998 and earlier, reimbursements under these contractual
arrangements were subject to retroactive adjustments based on agency reviews.
Revenues from health care services in 1998 were generally recorded net of
estimated contractual allowances in the Partitioned Business's consolidated
financial statements. Audits under the reimbursement agreements have generally
been completed through fiscal year 1998 and there were no material audit
adjustments. For fiscal years 1999 and 2000, the Partitioned Business is
generally paid a fixed payment rate for its Medicare and Medicaid services and
therefore, there are no contractual allowances for these fiscal years in the
Partitioned Business's consolidated financial statements.
CASH AND CASH EQUIVALENTS
All highly liquid investments with a maturity of three months or less at
date of purchase are considered cash equivalents.
F-73
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Replacements and improvements
that extend the useful life of property and equipment are capitalized.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, generally 40 years for buildings and three to
10 years for furniture and equipment. Leasehold improvements are amortized over
the shorter of the lease term or the useful lives of the related assets.
In cases where management is holding for sale a particular property,
management assesses impairment based on whether the estimated sales price less
cost of disposal of each individual property to be sold is less than the net
book value. A property is considered to be held for sale when a decision is made
to dispose of the property. Otherwise, impairment is assessed based on whether
it is probable that undiscounted future cash flows from each property will be
less than its net book value. If a property is impaired, its basis is adjusted
to its fair value.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Partitioned Business to
significant concentration of credit risk consist principally of cash and cash
equivalents. The Partitioned Business maintains cash and cash equivalents with
various high credit-quality financial institutions and limits the amount of
credit exposure with any institution.
WORKING CAPITAL
Pursuant to the terms of the senior living operating agreements (see
Note 6), the Partitioned Business is required to provide MSLS with working
capital and supplies to meet the operating needs of the senior living
communities. MSLS converts cash advanced by the Partitioned Business into other
forms of working capital consisting primarily of operating cash, inventories,
resident deposits and trade receivables and payables which are maintained and
controlled by MSLS. Upon the termination of the operating agreements, MSLS is
required to convert working capital and supplies into cash and return it to the
Partitioned Business. As a result of these conditions, the individual components
of working capital and supplies controlled by MSLS are not reflected in the
Partitioned Business's consolidated balance sheets, however, the net working
capital advanced is included in due from Marriott Senior Living Services on the
Partitioned Business's consolidated balance sheets.
DEFERRED REVENUE
Monthly fees deferred for the non-refundable portion of the entry fees are
recorded as deferred revenue and included in other liabilities in the
Partitioned Business's consolidated balance sheets. These amounts are recognized
as revenue as services are performed over the expected term of the residents'
contracts.
LIABILITY FOR FUTURE HEALTH CARE SERVICES
Certain resident and admission agreements at the communities entitled
residents to receive limited amounts of health care up to defined maximums. The
estimated liabilities associated with the health care obligation have been
accrued in other liabilities in the Partitioned Business's consolidated balance
F-74
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
sheets. As of December 29, 2000 and December 31, 1999, the liability totaled
$977,000 and $1,140,000, respectively.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
NEW STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS
During July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations",
SFAS No. 142, "Goodwill and Intangible Assets" and SFAS No. 143, "Accounting for
Asset Retirement Obligations". In the opinion of management the adoption of
these statements will not have a material effect on the Partitioned Business's
consolidated financial statements.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
2000 1999
-------- --------
(IN THOUSANDS)
Land.................................................... $107,425 $107,425
Buildings and leasehold improvements.................... 564,867 560,029
Furniture and equipment................................. 49,292 43,675
-------- --------
721,584 711,129
Less accumulated depreciation and amortization.......... (78,474) (54,371)
-------- --------
$643,110 $656,758
======== ========
In 1999, management determined that one of its senior living communities was
impaired as a result of a deterioration of the community's operating results due
to its size and age and the new supply of communities in its market. A
$3.5 million pre-tax charge was recorded to reduce the net book value of the
property to its fair value.
F-75
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. RESTRICTED CASH
Restricted cash, which is included in other assets on the Partitioned
Business's consolidated balance sheets, consists of the following:
2000 1999
-------- --------
(IN THOUSANDS)
Debt service escrows....................................... $1,137 $ 1,624
Fixed asset escrows........................................ 4,878 5,310
Real estate tax escrows.................................... 1,697 4,092
Insurance escrows.......................................... 64 3,364
------ -------
$7,776 $14,390
====== =======
The debt service, fixed asset, real estate tax and insurance escrows consist
of cash transferred into segregated escrow accounts out of revenues generated by
the senior living communities, pursuant to the secured debt agreements. Funds
from these reserves are periodically disbursed by the collateral agent to pay
for debt service, capital expenditures, insurance premiums and real estate taxes
relating to the secured properties. In addition, the fixed asset escrows also
include cash transferred into segregated escrow accounts pursuant to the senior
living community operating agreements to fund certain capital expenditures at
the senior living communities (see Note 6).
5. LEASES
The Partitioned Business is the lessee under capital and operating leases.
Future minimum annual rental commitments for all non-cancelable leases as of
December 29, 2000 are as follows:
CAPITAL OPERATING
LEASES LEASES
-------- ---------
(IN THOUSANDS)
2001..................................................... $ 1,240 $ 281
2002..................................................... 1,258 281
2003..................................................... 1,477 281
2004..................................................... 1,384 281
2005..................................................... 1,384 281
Thereafter............................................... 8,392 2,205
------- ------
Total minimum lease payments............................. 15,135 $3,610
======
Less amount representing interest........................ (5,293)
-------
Present value of minimum lease payments.................. $ 9,842
=======
The Partitioned Business leases two senior living communities under capital
leases expiring in 2016. Upon the expiration of the lease or anytime prior to
lease expiration, the Partitioned Business has the first right of refusal to
submit a counter offer to any acceptable bona fide offer from a third party
within 30 days of notice from the lessor. If the Partitioned Business fails to
exercise its right of first refusal, then the lessor may proceed with the sale
of the leased property and all assets therein. The assets recorded under capital
leases, which are included in property and equipment on the Partitioned
Business's consolidated balance sheets, were $13.4 million and $14.1 million as
of December 29, 2000
F-76
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. LEASES (CONTINUED)
and December 31, 1999, respectively, net of accumulated amortization of
$3.6 million and $2.4 million, respectively. The amortization for assets
recorded under capital leases is included in depreciation and amortization on
the Partitioned Business's consolidated statements of operations.
The Partitioned Business also has one long-term operating ground lease which
expires in 2013. The operating lease includes three renewal options exercisable
in five-year increments through the year 2028.
Rent expense for fiscal years 2000, 1999 and 1998 was $278,000, $281,000 and
$279,000, respectively.
6. OPERATING AGREEMENTS
The senior living communities are subject to operating agreements which
provide for MSLS to operate the senior living communities, generally for an
initial term of 25 to 30 years with renewal terms subject to certain performance
criteria at the option of MSLS of up to an additional five to ten years. The
operating agreements provide for payment of base management fees equal to five
percent of revenues and incentive management fees equal to 20% of operating
profit (as defined in the operating agreements) over a priority return to the
owner. In the event of early termination of the operating agreements, MSLS will
receive additional fees based on the unexpired term and expected future base and
incentive management fees. The Partitioned Business has the option to terminate
certain, but not all, management agreements if specified performance thresholds
are not satisfied. No operating agreement with respect to a single community is
cross-collateralized or cross-defaulted to any other operating agreement, and
any single operating agreement may be terminated following a default by the
Partitioned Business or MSLS, although such termination will not trigger the
cancellation of any other operating agreement.
Most of the senior living communities are also subject to pooling agreements
whereby for the limited purpose of calculating management fees and exercising
certain termination rights under the operating agreements, the management fees
and rights are considered in the aggregate for the senior living communities in
each pool.
The operating agreements require MSLS to furnish certain services ("Central
Administrative Services") which are generally furnished on a central or regional
basis to other senior living communities in the Marriott retirement community
system. Such services will include the following: (i) marketing and public
relations services; (ii) human resources program development; (iii) information
systems support and development; and (iv) centralized computer payroll and
accounting services. In lieu of reimbursement for such services, MSLS is paid an
amount equal to 2% of revenues. Generally, through the earlier of (i) the end of
the seventh year of the operating agreement or (ii) the date upon which certain
performance criteria have been met, 50% of the Central Administrative services
fee is payable only to the extent that operating profit for the communities
exceeds a priority return to the owner. However, the payment of fees for the
Central Administrative Services were generally waived for the first year of the
operating agreement.
The Partitioned Business is required under the operating agreements to
contribute a percentage of revenues into an interest-bearing reserve account to
cover the cost of (a) certain routine repairs and maintenance to the senior
living communities which are normally capitalized and (b) replacements and
F-77
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. OPERATING AGREEMENTS (CONTINUED)
renewals to the senior living communities' property and improvements. The annual
contribution amount (expressed as a percentage of revenues) generally will be
2.65% through fiscal year 2002, 2.85% for fiscal years 2003 through 2007, and
3.5% thereafter. The amount contributed for fiscal years 2000, 1999 and 1998 was
$6.9 million, $6.4 million and $6.3 million, respectively. The operating
agreements provide that the Partitioned Business shall separately fund the cost
of certain major or non-routine repairs, alterations, improvements, renewals and
replacements to the senior living communities.
7. DEBT
Debt consists of the following as of December 29, 2000 and December 31,
1999:
2000 1999
-------- --------
(IN THOUSANDS)
Mortgage debt secured by eight senior living communities
with $242 million of real estate assets, with an
interest rate of 10.01%, maturing through 2020 (amount
includes debt premium of $13.5 million in 2000 and
$14.1 million in 1999)................................ $131,298 $133,586
Mortgage debt secured by eight senior living communities
with $117 million of real estate assets, with an
interest rate of 9.56%, maturing in July 2005......... 92,370 --
Mortgage debt secured by nine senior living communities
(amount included debt premium of $0.9 million in
1999)................................................. -- 45,097
Revenue bonds with an interest rate of 5.875%, due
2027.................................................. 14,700 14,700
Capital lease obligations............................... 9,842 10,277
Other notes, with an interest rate of 7.5%, maturing
through December 31, 2001............................. 980 1,969
-------- --------
Total debt.......................................... $249,190 $205,629
======== ========
Debt maturities at December 29, 2000, excluding the unamortized debt
premiums of $13.5 million, are as follows (in thousands):
2001........................................................ $ 3,200
2002........................................................ 2,500
2003........................................................ 2,967
2004........................................................ 3,154
2005........................................................ 95,870
Thereafter.................................................. 128,024
--------
$235,715
========
In conjunction with the June 21, 1997 acquisition of Forum, the Partitioned
Business issued $72 million in notes payable to MSLS. Subsequent to the
acquisition, the Partitioned Business issued additional notes payable to MSLS to
finance additional senior living expansion units totaling approximately
$20 million. In the second quarter of 1998, Host Marriott loaned the Partitioned
F-78
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. DEBT (CONTINUED)
Business $92 million to repay the notes payable to MSLS. In the third quarter of
1998, Host Marriott forgave the $92 million note and it was recorded as an
investment in the Partitioned Business. During the first quarter of 1998, Host
Marriott prepaid $26.4 million of the Partitioned Business's mortgage debt. Host
Marriott's prepayment of the debt was recorded as an investment in the
Partitioned Business.
In 2000, the Partitioned Business entered into five loan agreements totaling
$92.4 million secured by mortgages on eight senior living communities. The
non-recourse loans bear interest at the 30-day LIBOR rate plus 275 basis points
(9.56% at December 29, 2000). The loans mature in July 2005 and there is no
principal amortization during the term of the loans. The proceeds of the
financing were used to repay the existing loan secured by the senior living
communities with a principal balance of $43.5 million, which bore interest at
9.93% and had a scheduled maturity of January 1, 2001. In connection with the
prepayment of the existing loan, the Partitioned Business recognized an
extraordinary gain on the early extinguishment of debt of $253,000, net of
income taxes of $175,000.
The indentures governing the mortgages of certain of the Partitioned
Business's senior living communities contain restrictive covenants that, among
other restrictions, (i) require maintenance of segregated cash collection of all
rents for certain of the senior living communities; (ii) require separate cash
reserves for debt service, property improvements, real estate taxes and
insurance; and (iii) limit the ability to incur additional indebtedness, enter
into or cancel leases, enter into certain transactions with affiliates or sell
certain assets. As of December 29, 2000 and December 31, 1999, the Partitioned
Business was in compliance with all debt covenants.
In conjunction with the acquisition of Forum, the Partitioned Business
recorded the debt assumed at its fair value. The Partitioned Business is
amortizing this premium to interest expense over the remaining life of the
related debt. The amortization of this debt premium for fiscal years 2000, 1999
and 1998 was $1.1 million, $1.6 million and $1.6 million, respectively. Cash
paid for interest for fiscal years 2000, 1999 and 1998 totaled $20.8 million,
$18.6 million and $19.8 million, respectively. Deferred financing costs, which
are included in other assets on the Partitioned Business's consolidated balance
sheets, was $3.4 million net of accumulated amortization of $0.4 million as of
December 29, 2000. There was no deferred financing cost in 1999.
8. INCOME TAXES
Total deferred tax assets and liabilities as of December 29, 2000 and
December 31, 1999 were as follows:
2000 1999
-------- --------
(IN THOUSANDS)
Deferred tax assets..................................... $ 17,359 $ 18,596
Deferred tax liabilities................................ (81,019) (80,150)
-------- --------
Net deferred income tax liability..................... $(63,660) $(61,554)
======== ========
F-79
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
The tax effect of each type of temporary difference and carryforward that
gives rise to a significant portion of deferred tax assets and liabilities was
as follows:
2000 1999
-------- --------
(IN THOUSANDS)
Property and equipment.................................. $(80,552) $(77,170)
Debt adjustment to fair value at acquisition............ 5,700 6,160
Net operating losses and other, net..................... 11,192 9,456
-------- --------
Net deferred income tax liability..................... $(63,660) $(61,554)
======== ========
The provision for income taxes for fiscal years 2000, 1999 and 1998 consists
of the following:
2000 1999 1998
-------- -------- --------
(IN THOUSANDS)
Current............................................ $ 8,667 $6,928 $4,781
Deferred........................................... 1,508 (79) 1,370
------- ------ ------
$10,175 $6,849 $6,151
======= ====== ======
A reconciliation of the statutory Federal tax rate to the Partitioned
Business's effective income tax rate for fiscal years 2000, 1999 and 1998 is as
follows:
2000 1999 1998
-------- -------- --------
Statutory federal tax rate.............................. 35.0% 35.0% 35.0%
State income taxes, net of federal tax benefit.......... 6.0 6.0 6.0
---- ---- ----
41.0% 41.0% 41.0%
==== ==== ====
The Partitioned Business was included in the consolidated federal income tax
return of Host Marriott and its affiliates for the period from January 3, 1998
through the Distribution Date, and subsequent to the Distribution Date, the
Partitioned Business was included in the consolidated federal income tax return
of Crestline Capital (collectively, the "Group"). Tax expense was allocated to
the Partitioned Business as a member of the Group based upon the relative
contribution to the Group's consolidated taxable income/loss and changes in
temporary differences. This allocation method results in federal and net state
tax expense allocated for all periods presented that is substantially equal to
the expense that would have been recognized if the Partitioned Business had
filed separate tax returns.
For income tax purposes, the Partitioned Business, through CSL Group, has
net operating loss carryforwards of $8.4 million which expire through 2006.
F-80
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of certain financial liabilities are shown below:
2000 1999
------------------- -------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
(IN THOUSANDS)
Debt, net of capital leases......... $239,348 $243,718 $195,352 $186,705
Valuations for secured debt are determined based on the expected future
payments discounted at risk-adjusted rates. The fair values of other notes are
estimated to be equal to their carrying value. The fair value of all of the
Partitioned Business' other financial assets and liabilities are assumed to
equal their carrying amounts.
In 1999, the Partitioned Business recorded a pre-tax charge of
$1.7 million, which is included in other operating costs and expenses, to fully
reserve a second mortgage note receivable due to uncertainty in the
collectibility of the note.
10. CONTINUING LIFECARE CONTRACTS
Residents at two of the communities are offered continuing care life
contracts that provide reduced monthly rental rates in exchange for significant
security deposits, which become partially or totally non-refundable over time.
At the Pueblo Norte senior living community, two types of continuing care
contracts are currently offered to new residents. One contract provides that 10%
of the resident admission fees is non-refundable upon occupancy. The remaining
90% of the resident admission fees becomes non-refundable at a rate of 1 1/2%
per month over the subsequent 60 months and is amortized over the expected life
of the resident. The second contract type provides that the resident admission
fee is 30% non-refundable and 70% fully refundable. The non-refundable portions
are amortized over the expected life of the resident. The liability for the
refundable portion of the admission fees at December 29, 2000 and December 31,
1999 is $5,161,000 and $4,237,000, respectively, and is included in other
liabilities on the Partitioned Business's consolidated balance sheets. The
non-refundable portion of the admission fees at December 29, 2000 and
December 31, 1999 totaled $2,820,000 and $1,888,000, respectively and is
included in other liabilities on the Partitioned Business's consolidated balance
sheets.
Three other types of continuing care agreements are in effect at Pueblo
Norte with existing residents but are no longer offered to new residents. One
agreement provides that the resident admission fee is 10% non-refundable and 90%
fully refundable. Each resident is entitled to 70 free days of care in the
health center based on a prescribed formula. The second type of agreement
provides that the resident admission fee is 1% refundable and 99%
non-refundable. The non-refundable portion of the resident admission fees are
amortized over the expected life of the resident. The liability at December 29,
2000 and December 31, 1999 for the non-refundable portion of these contracts is
$3,208,000 and $4,131,000, respectively, and is included in other liabilities on
the Partitioned Business's consolidated balance sheets.
At two additional senior living communities, lifecare contracts are in
effect with existing residents, but no longer offered to new residents. The
agreements provide that the resident admission fees are
F-81
CSL GROUP, INC. AND SUBSIDIARIES
AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. CONTINUING LIFECARE CONTRACTS (CONTINUED)
either fully refundable or non-refundable. As of December 29, 2000 and
December 31, 1999, the refundable portion of these contracts was $965,000 in
both years, and the non-refundable portion of these contracts was $618,000 and
$1,428,000, respectively, and are included in other liabilities on the
Partitioned Business's consolidated balance sheets.
11. LITIGATION
On June 15, 1995, the Russell F. Knapp Revocable Trust (the "Plaintiff")
filed a complaint in the United States District Court for the Southern District
of Indiana (the "Indiana Court") against the general partner of one of CSL
Group's subsidiary partnerships, CCC Retirement Partners, LP, formerly Forum
Retirement Partners, LP, ("FRP"), alleging breach of the partnership agreement,
breach of fiduciary duty, fraud, insider trading and civil conspiracy/aiding and
abetting. On February 4, 1998, the Plaintiff, MSLS, the general partner, CSL
Group, Host Marriott and Crestline Capital entered into a Settlement and Release
Agreement (the "Settlement Agreement"), pursuant to which Host Marriott agreed
to purchase, at a price of $4.50 per unit, the partnership units of each limited
partner electing to join in the Settlement Agreement. CSL Group held 79% of the
outstanding limited partner units in the partnership at that time. Host Marriott
and CSL Group also agreed to pay as much as an additional $.75 per unit (the
"Additional Payment") to the settling limited partners (the "Settling
Partners"), under certain conditions, in the event that CSL Group within three
years following the date of settlement initiates a tender offer for the purchase
of units not presently held by CSL Group or the Settling Partners. On
February 5, 1998, the Indiana Court entered an order approving the dismissal of
the Plaintiff's case. In connection with the Settlement Agreement, CSL Group
acquired 2,141,795 limited partner units in 1998 for approximately $9,638,000,
increasing CSL Group's ownership interest in FRP to approximately 93%.
In 1999, CSL Group and FRP completed a merger pursuant to a consent
solicitation whereby the partnership unit holders received the right to receive
cash consideration for each limited partnership unit from CSL Group. In
connection with this merger, CSL Group acquired the remaining limited
partnership units for approximately $6,158,000. Also, CSL Group paid the
Settling Partners an Additional Payment in 1999 of approximately $557,000
pursuant to the merger transaction. As of December 29, 2000, CSL Group had a
liability of $247,000 representing cash consideration for the remaining
untendered FRP limited partnership units. The purchase price of the units for
both transactions approximated fair value, and accordingly, no portion of the
purchase price has been expensed.
F-82
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[LOGO]
SPIN-OFF OF FIVE STAR QUALITY CARE, INC.
THROUGH DISTRIBUTION
OF
4,342,170 SHARES OF COMMON STOCK
---------------------
PROSPECTUS
---------------------
December 6, 2001
Until December 31, 2001 (25 days after the date of this prospectus), all dealers
that effect transactions in these securities may be required to deliver this
prospectus.
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