10-K 1 tenk.txt 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the year ended December 31, 2002 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from ____ to ____ Commission File No. 001-13807 ElderTrust (Exact name of registrant as specified in its charter) Maryland 23-2932973 (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) Number) 2711 Centerville Road, Suite 108, Wilmington, DE 19808 (Address of principal executive offices) (Zip Code) (302) 993-1022 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of Each Class on which registered ------------------------ ----------------------- Common shares of beneficial interest New York Stock Exchange $.01 par value per share Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ ] No [X] Aggregate market value of common shares held by non-affiliates computed by reference to the price at which the common shares were last sold as of June 28, 2002 (the last business day of the registrant's most recently completed second fiscal quarter): $42,687,508 As of February 28, 2003, there were 7,592,477 total common shares outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's definitive proxy statement for the annual shareholders' meeting to be held on May 23, 2003 are incorporated by reference into Part III of this Form 10-K. ELDERTRUST 2002 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS
Page ---- Cautionary Statements Regarding Forward-Looking Statements 1 PART I Item 1. Business 1 Item 2. Properties 36 Item 3. Legal Proceedings 39 Item 4. Submission of Matters to a Vote of Security Holders 39 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 39 Item 6. Selected Financial Data 39 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 43 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 57 Item 8. Financial Statements and Supplementary Data 59 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 85 PART III Item 10. Directors and Executive Officers of the Registrant 86 Item 11. Executive Compensation 86 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters 86 Item 13. Certain Relationships and Related Transactions 86 Item 14. Controls and Procedures 86 PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 87 SIGNATURES 88 CERTIFICATION 89 EXHIBIT INDEX 90
i Cautionary Statements Regarding Forward-Looking Statements This Form 10-K contains certain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934 with respect to results of operations and businesses of ElderTrust and its consolidated subsidiaries (collectively, "ElderTrust" or the "Company"). All statements, other than statements of historical facts, included in this Form 10-K, are forward-looking statements within the meaning of the Securities Act and the Exchange Act. In general, these statements are identified by the use of forward-looking words or phrases, including "intended," "will," "should," "could," "may," "continues," "continued," "estimate," "estimated," "expects," "expected," "believes," "anticipates," and "anticipated" or the negative or variations thereof or similar terminology. Because forward-looking statements involve risks and uncertainties, the Company's actual results could differ materially from those expressed or implied by these forward-looking statements. The statements set forth under the caption "Business - Risk Factors" and elsewhere in this Form 10-K, including statements contained in "Business" concerning the ability of subsidiaries of Genesis Health Ventures, Inc. ("Genesis"), the Company's principal tenant, and entities in which it has made equity investments ("Genesis Equity Investees") to continue to make lease payments to the Company, the Company's ability to extend or restructure a mortgage loan totaling $14.9 million, the maturity date of which has been extended until April 10, 2003, government regulation and the impact of Medicare and Medicaid reimbursement programs on the Company's lessees, certain statements contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" concerning the Company's ability to meet its liquidity needs and other statements contained herein regarding matters that are not historical facts identify important factors with respect to these forward-looking statements that could cause actual results to differ materially from those in these forward-looking statements. These forward-looking statements represent the Company's judgment as of the date of this Form 10-K. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct. All subsequent written and oral forward-looking statements attributable to the Company are expressly qualified in their entirety by the cautionary statements. The Company disclaims, however, any intent or obligation to update its forward-looking statements. PART I ITEM 1. BUSINESS General The Company is a self-managed and self-administered real estate investment trust ("REIT") that invests principally in senior housing and other healthcare facilities, primarily skilled nursing facilities, assisted and independent living facilities (or "senior living centers") and medical office and other buildings. The Company is the general partner of, and conducts all of its operations through, ElderTrust Operating Limited Partnership (the "Operating Partnership"). At December 31, 2002, the Company owned a 96.2% interest in the Operating Partnership. 1 The Company's consolidated assets consist primarily of the assets of the Operating Partnership and its consolidated subsidiaries. At December 31, 2002, the Company's consolidated assets primarily consisted of a diversified portfolio of 32 healthcare properties with an aggregate value of $283.0 million. The portfolio consists of eleven assisted living facilities, fifteen skilled nursing facilities, seven of which are leased by the Company, two independent living facilities and four medical office and other buildings. Skilled nursing facilities and senior living centers comprised approximately 93% of the Company's consolidated assets at December 31, 2002. Approximately 86% of the Company's consolidated assets at December 31, 2002 consisted of properties leased to or managed by subsidiaries of Genesis or Genesis Equity Investees. Revenues recorded by the Company in connection with these leases aggregated $18.3 million in 2002. As a result of these relationships with Genesis, the Company's revenues and ability to meet its obligations depend, in significant part, upon the ability of Genesis and Genesis Equity Investees to meet their lease obligations. Genesis emerged from bankruptcy in October 2001. Any failure of these entities to continue their operations and/or to continue to make lease payments to the Company could have a significant adverse impact on the Company's operations and cash flows due to the significant portion of our properties leased to such entities. 2002 Developments Developments in 2002 include the following: Guidance Line On August 30, 2002, the Company entered into a new 18-month credit agreement with Wachovia Bank ("Guidance Line"). Funds provided under the Guidance Line of approximately $3.1 million were used to pay off ElderTrust's prior Bank Credit Facility provided by German American Capital Corporation, an affiliate of Deutsche Bank, and to pay certain transaction and other costs. The amounts outstanding under the Guidance Line bear interest at a floating rate of 3.25% over LIBOR, or 4.67% at December 31, 2002. On January 27, 2003, the Company paid approximately $3.1 million to Wachovia Bank to pay-off the outstanding balance under the Guidance Line. The Company currently has borrowing capacity of up to $7.5 million under the Guidance Line, subject to lender approval and borrowing base limitations. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," for additional information. 2 Consolidation of Significant Off-Balance Sheet Investments During September 2002, the Company acquired, or obtained options to acquire, from D. Lee McCreary, Jr., ElderTrust's President and Chief Executive Officer, the controlling 1% ownership interests in three entities that hold leasehold and purchase option rights to seven skilled nursing facilities and that own one assisted living facility and one independent living facility. The Company had owned a non-controlling 99% interest in these entities since 1998. The Company previously accounted for its investment in these entities under the equity method. As of September 30, 2002, the Company consolidated the respective balance sheets of ET Sub-Meridian Limited Partnership, L.L.P. ("Meridian"), ET Sub-Cabot Park, L.L.C. ("Cabot") and ET Sub-Cleveland Circle, L.L.C. ("Cleveland"), with the Company's other operations. The results of operations of these entities are consolidated into the Company's statement of operations beginning October 1, 2002. As a result of this transaction, the Company's total assets, debt, investments in unconsolidated entities, rental revenue, interest, depreciation expense and equity in losses of unconsolidated entities changed significantly, however, net income was not materially changed. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," for additional information. New Dividend Policy In December 2002, the Company stated that it intends to resume regularly quarterly distributions to holders of its common shares and that the initial distribution is expected to be declared in mid-April, 2003. The Company estimated that, based upon its current estimate of operations and cash requirements, the annual per share distribution will be $0.64 per share, or $0.16 per quarter. Recent Developments Mortgage Loan Maturities The Company had three non-recourse mortgage loans secured by four properties with an aggregate principal balance of $30.0 million that matured in December 2002. The Company announced in November 2002 that the maturity date of one loan, secured by the Lopatcong property, had been extended until December 1, 2004. In February 2003, the lender also extended a $4.6 million mortgage loan secured by the Wayne property to December 1, 2004. In connection with the extension, the Company made a $1.1 million payment and reduced the balance outstanding from $4.6 million to $3.5 million. The lender has extended the maturity date of the remaining mortgage loan of $14.9 million, which is secured by the Harston Hall and Pennsburg properties, until April 10, 2003 to allow the time for the lender and the Company to negotiate a resolution of this loan. Based upon conversations with the lender, several alternatives are available to satisfy the Company's obligation under this loan which may include, among other alternatives, a further extension as a cash flow mortgage, sale or a title transfer via a "deed in lieu of foreclosure" transaction. See "Item 7. Management's Discussion and Analysis of Results of Operations--Liquidity and Capital Resources," for additional information. 3 Possible Spin-Off by Genesis of its Eldercare Business In February 2003, Genesis announced that its Board of Directors had approved the spin-off of its ElderCare business. This business includes our tenants that are currently owned, in whole or in part, by Genesis, as well as Genesis' other senior housing asset-based businesses. Under our lease terms, any assignment of the leases to a party in which Genesis has no ownership interest would require our consent, which may not be unreasonably withheld. If the leases are assigned with our consent, the Genesis guarantee would be eliminated. However, we would be entitled to obtain guarantees from other parties in control of the tenant. Conversely, if the leases are assigned without our consent, the Genesis guarantee would remain in effect. We believe that the transaction proposed by Genesis may constitute an assignment of the leases. As a result, the transaction may require our consent should Genesis desire to eliminate its obligations under its guarantees. In determining whether to provide our consent, we intend to evaluate the current and expected operating performance of the leased properties and determine the need for, and availability of, substitute credit enhancements. The spin-off is expected to be completed during the latter part of 2003. To date, Genesis has not provided us with any financial information regarding the proposed spin-off nor has Genesis requested to be released from its guarantees, although we expect that they will do so. Investments Investment Policies At December 31, 2002, the Company's investments consisted primarily of senior housing and other healthcare facilities leased to operators under long-term operating leases. Operating leases are normally secured by the underlying real estate, guarantees and/or cash deposits. As of December 31, 2002, cash deposits aggregating approximately $5.4 million were held by the Company as security for operating leases. In addition, the leases are generally cross-defaulted with any other leases or other agreements between the operator or any affiliate of the operator and the Company, which were entered into at the time the leases were executed. The Company's operating leases include fixed and minimum rent leases, which normally include annual rate increases, and, in the case of one of our assisted and independent living facilities, percentage rent leases. Percentage rent leases generally require rents based upon a fixed percentage of facility revenues throughout the lease term. See "Business - Investments - Properties - Operating Leases." 4 There are no limitations on the amount or percentage of the Company's total assets that may be invested in any one property. Additionally, no limits have been set on the concentration of investments in any one location, operator or facility type. The Board of Trustees may change the investment policies and activities of the Company at any time without a vote of shareholders. There can be no assurance that the Company's investment objectives will be realized. See "Business - Risk Factors." Investment Portfolio The Company's consolidated investments in real estate properties at December 31, 2002 are reflected in the following table:
--------------------------------------------------------------------------------------------------------------------------------- Percentage Number Number Investment Number Investments of of of per Number of of Type of Facility (1) Portfolio Facilities Beds (2) Bed (3) Operators (4) States (5) --------------------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Assisted Living Facilities $ 111,121 32.6% 11 999 $ 111 2 2 Independent Living Facilities 22,732 6.7 2 172 132 2 2 Skilled Nursing Facilities 191,604 56.3 15 2,393 80 3 3 Medical Office and Other Buildings 14,910 4.4 4 - - 3 3 ----------------------------------------------- Total Properties $ 340,367 100.0% 32 3,564 ===============================================
-------------------------------------------------------------------------------- (1) Includes investments in real estate properties aggregating $328.1 million, before reductions for accumulated depreciation of $44.9 million and credit enhancements on several owned properties which aggregated $12.3 million. Credit enhancements consisted of $6.3 million in bond and operating reserve funds required in connection with outstanding debt issues on five facilities, security deposits of $5.4 million on various facilities and mortgage escrow accounts of $0.6 million. The Company owns leasehold interests in seven skilled nursing facilities. The remaining interests are fee interests. (2) Based upon the number of private and semi-private beds/units currently in service. (3) Investment per Bed was computed by using the respective facility investment amount divided by number of beds/units currently in service for each respective facility. (4) Genesis or Genesis Equity Investees manages 28 of the properties under management agreements with the tenants. See "Dependence on Genesis" and "Item 2 - Properties." 5 (5) The Company has investments in properties located in five states, occupied by six different tenants not including the medical office building tenants. Properties Assisted Living Facilities Assisted living facilities provide services to aid in activities of daily living, such as bathing, meals, security, transportation, recreation, medication supervision and limited therapeutic programs. More intensive medical needs of the resident are often met within assisted living facilities by home health providers, close coordination with the resident's physician and skilled nursing facilities. Independent Living Facilities Independent living facilities offer specially designed residential units for active and ambulatory elderly residents and provide various ancillary services. These facilities offer residents an opportunity for an independent lifestyle with a range of social and health services. Skilled Nursing Facilities Skilled nursing facilities provide inpatient skilled nursing and custodial services as well as rehabilitative, restorative and transitional medical services. In some instances, nursing facilities supplement hospital care by providing specialized care for medically complex patients whose conditions require intense medical and therapeutic services, but who are medically stable enough to have these services provided in facilities that are less expensive than acute care hospitals. Medical Office and Other Buildings The medical office and other buildings provide office space primarily to practicing physicians and other healthcare professionals, principally in connection with services rendered by these physicians at an adjacent acute care or long-term facility. Operating Leases Each of the Company's skilled nursing and senior housing facilities, which includes the land (if owned), buildings, improvements and related rights, is leased to an operator pursuant to a long-term lease. These leases (or subleases in the case of seven skilled nursing facilities in which the Company has leasehold interests) generally have remaining terms of 5 to 9 years and contain one or more five to ten-year renewal options. Two of these leases provide for rents based on a specified percentage of facility operating revenues with no required minimum rent ("percentage rent leases"). Other leases provide for base rent, increasing each year by the lesser of 5% of the increase in facility revenues for the immediately preceding year or one-half of the percentage increase in the Consumer Price Index for the immediately preceding year ("minimum rent leases"). Both types of leases are triple net leases that require the lessees to pay all operating expenses, taxes, insurance, maintenance and other costs, including a portion of capitalized expenditures. The base rents for the renewal periods are generally fixed rents set at a spread above the Treasury yield for the corresponding period. The remaining leases ("fixed rent leases") are with tenants in the medical office and other buildings and provide for specified annual rents, subject to annual increases in some of the leases. Generally, these leases are for a five-year period. 6 Dependence on Genesis At December 31, 2002, the Company had the following investments in real estate properties managed by Genesis or Genesis Equity Investees:
Genesis (1) Genesis Equity Investees (2) Number of Investment Number of Investment Properties Amount Properties Amount ---------- ---------- ---------- ---------- (dollars in thousands) ElderTrust 20 $174,108 8 $88,315
(1) Represents Genesis and its consolidated subsidiaries. (2) Represents entities in which Genesis accounts for its investment using the equity method of accounting. At December 31, 2002, the Company leased or subleased nineteen properties to subsidiaries of Genesis under percentage and minimum rent leases, each for an initial ten-year period with two five-year renewals. The Company received lease payments totaling $10.2 million in 2002 on properties leased to or managed by subsidiaries of Genesis. The initial terms of these leases expire as follows: five leases with aggregate 2002 rent of $ 4.1 million expire in January 2008, one lease with 2002 rent of $0.6 million expires in March 2008, seven leases with aggregate 2002 rent of $2.6 million expire in September 2008, one lease with 2002 rent of $0.4 million expires in January 2010, one lease with aggregate 2002 rent of $0.8 million expires in June 2008, three leases with aggregate 2002 rent of $0.8 million expire in January 2011 and one lease with 2002 rent of $0.8 million expires in January 2018. Genesis has guaranteed the lease payments on substantially all of these leases. Genesis also leased space under a fixed rent lease in one medical office building with aggregate 2002 rent of $ 0.1 million. This lease terminated on January 31, 2003. Additionally, Genesis managed one property leased by the Company to an unrelated third party. At December 31, 2002 the Company also leased or subleased eight properties under minimum rent leases to Genesis Equity Investees. The Company received lease payments totaling $8.1 million in 2002 from these Genesis Equity Investees. The initial terms of these leases expire as follows: three leases with aggregate 2002 rent of $2.6 million expire in November 2008, one lease with 2002 rent of $1.2 expires in March 2009 and four leases with aggregate 2002 rent of $4.3 million expire in January 2010. Genesis has guaranteed the lease payments on the leases that expire in November 2008 and November 2009. 7 Reimbursement Health Care Reform The healthcare industry is subject to extensive federal, state and local regulation. The Company is affected by government regulation of the healthcare industry in that the Company receives rent from lessees and the Company's additional rents are generally based on its lessees' gross revenue from operations. The underlying value of certain of the Company's facilities depends on the revenue that a facility is able to generate. Aggressive efforts by health insurers and governmental agencies to limit the cost of healthcare services and to reduce utilization of hospital and other healthcare facilities may further reduce revenues or slow revenue growth from these healthcare facilities and shift or reduce utilization. In recent years, a number of laws have been enacted that have effected major changes in the healthcare system, both nationally and at the state level. The Balanced Budget Act of 1997 (the "Balanced Budget Act"), signed into law on August 5, 1997, sought to achieve a balanced federal budget by, among other things, significantly reducing federal spending on the Medicare and Medicaid programs. The Medicare Balanced Budget Refinement Act (the "Refinement Act"), signed into law in November 1999, made certain amendments to the Medicare reimbursement reductions resulting from the Balanced Budget Act. The Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000 ("BIPA"), signed into law on December 21, 2000, made additional amendments to the Medicare reimbursement reductions from the Balanced Budget Act. The Company anticipates that Congress and state legislatures will continue to review and assess alternative healthcare delivery and payment systems and will continue to propose and adopt legislation effecting fundamental changes in these systems. Changes in the applicable laws or new interpretations of existing laws may have a dramatic effect on the definition of permissible or impermissible activities, the relative cost of doing business, and the methods and amounts of payments for medical care by both governmental and other payers. Medicare and Medicaid Reimbursement The Company's lessees who operate skilled nursing facilities are reimbursed by the Medicare and Medicaid programs for their products and services. As a whole, the legislative changes since 1997 have reduced reimbursement payments under these programs, which have resulted in lower lease coverage ratios on the skilled nursing facilities leased by the Company to its tenants. Also, the Company's lessees may experience increases in time periods between submission of Medicare and Medicaid program claims and receipt of payments due to increased regulatory action and governmental budgetary constraints. Since Medicaid programs are funded by both the states and the federal government, the amount of payments can be affected by changes at either the state or federal level. There is no assurance that payments under these programs will remain at levels comparable to present levels or be sufficient to cover costs allocable to these patients. Both Medicare and Medicaid payments are generally below retail rates for lessee-operated facilities. Increasingly, states have introduced managed care contracting techniques in the administration of Medicaid programs. Medicare has also increased its utilization of managed care contracting for providing services to Medicare beneficiaries. Such mechanisms could have the impact of reducing utilization of and reimbursement to the Company's lessees. 8 Impact of Balanced Budget Act and Medicare Balanced Budget Refinement Act, and Medicare Benefits Improvement and Protection Act The Balanced Budget Act mandated establishment of the Prospective Payment System ("PPS") for Medicare skilled nursing facilities under which such facilities are paid a federal per diem rate for most covered nursing facility services. Under PPS, operators of skilled nursing facilities are no longer assured of receiving reimbursement adequate to cover the costs of operating the facilities. Pursuant to the Balanced Budget Act, PPS began to be phased in for skilled nursing facilities commencing with cost reporting periods beginning on or after July 1, 1998. Under PPS, reimbursement rates were initially based on a blend of a facility's historic reimbursement rate and a newly prescribed federal per diem rate, which resulted in significantly reduced reimbursement rates for many operators of skilled nursing facilities, including Genesis. In subsequent periods, and for facilities first receiving payments for Medicare services on or after October 1, 1995, the federal per diem rate is used without regard to historic reimbursement levels. The Federal per diem rate is increased each year by a skilled nursing facility market basket percentage change. By statue, the increase is equal to the pertinent percentage change minus 0.5 percentage points in 2003 and equal to the pertinent percentage change in subsequent years. The Refinement Act addresses certain reductions in Medicare reimbursement resulting from the Balanced Budget Act. Under the Refinement Act, the federal per diem rate established under PPS was increased by 20% for 15 categories of Medicare patients in skilled nursing facilities starting April 1, 2000 and continuing until the later of October 1, 2000 or changes to PPS are made to better account for patients in such categories which has yet to occur (although this provision has been superseded by a subsequent law described below). The statute requires that federal rates for all categories be increased by 4% in fiscal years 2001 and 2002 only. For cost reporting periods beginning on or after January 1, 2000, skilled nursing facilities may elect to receive Medicare payments based 100% on the federal per diem rate rather than partially on a federal per diem rate and partially on a pre-PPS facility specific rate. Certain services (such as prostheses and chemotherapy drugs) for skilled nursing facility patients are being paid by Medicare in addition to the PPS per diem amounts which began April 1, 2000. The caps on rehabilitation therapy services required by the Balanced Budget Act have been suspended for 2000 and 2001. 9 At the state level, the Balanced Budget Act also repealed rules which required Medicaid payments to nursing facilities to be "reasonable and adequate" to cover the costs of efficiently and economically operated facilities. Under the Balanced Budget Act, states must now use a public notice and comment process for determining Medicaid rates, rate methodology and justifications. On December 21, 2000, BIPA ("Benefits Improvement and Protection Act") was signed into law. This legislation required Medicare to increase the nursing component of the rates by approximately 16.7% for the period from April 1, 2001 through September 30, 2002. In addition, BIPA eliminated a 1% reduction in the update formula for payment rates for federal fiscal year 2001. The legislation also changed the 20% add-on to 3 of the 15 rehabilitation Resource Utilization Groups (RUG) categories to a 6.7% add-on to all 14 rehabilitation RUG categories effective for services furnished from April 1, 2001, until the date that certain RUG refinements are made. These refinements have not been made. In addition, BIPA revised the consolidated billing requirements to the Balanced Budget Act to limit these requirements to skilled nursing facility residents in a Medicare Part A stay and to therapy services provided in a Part A or Part B stay. The moratorium on the $1,500 therapy caps was extended through calendar year 2002. Under authority of the Health Insurance Portability and Accountability Act (HIPAA) of 1996, the U.S. Department of Health and Human Services has promulgated regulations establishing standards for protection of personally identifiable health information, and certain related rules on standard transaction data sets and data security. The compliance date for the privacy regulations is April 14, 2002. Like other healthcare operators, the Company's lessees will be required to incur significant expense in coming into compliance with the various HIPAA regulations, and will be subject to criminal fines and penalties if they violate the rules. Any failure by the Company's lessees to comply with such requirements could have a material adverse effect on the Company. The Pennsylvania Medicaid programs impose limitations on the amount of reimbursement available for capital-related costs, such as depreciation, interest and rental expenses, following a change of ownership, including a sale and leaseback transaction. The Pennsylvania Medicaid program bases capital-related costs for new owners (including rent paid by lessees) on the appraised depreciated replacement cost of the facility to the prior owner as determined by the Pennsylvania Department of Public Welfare. Other states may have similar restrictions on capital related cost reimbursement. There can be no assurance that reimbursement of the costs of the Company's skilled nursing facilities under current or future reimbursement methodologies will be adequate to cover the rental payments owed to the Company by the lessees of these properties. 10 The Company does not employ Medicaid and Medicare reimbursement specialists and must rely on its lessees to monitor and comply with all reporting requirements and to ensure appropriate payments are being received. PPS has negatively impacted many operators in the skilled nursing industry, including Genesis. There can be no assurances that the Company's lessees will not be further negatively impacted by the provisions or interpretations of the Balanced Budget Act, including PPS, the Refinement Act, BIPA, or by future changes in regulations or interpretations of such regulations. See "Business - Government Regulation" and "Business - Risk Factors." Government Regulation The long-term care segment of the healthcare industry is highly regulated. Operators of skilled nursing facilities are subject to federal, state and local laws relating to the delivery and adequacy of medical care, distribution of pharmaceuticals, equipment, personnel, operating policies, fire prevention, rate-setting, compliance with building and safety codes and environmental laws. Operators of skilled nursing facilities also are subject to periodic inspections by governmental and other authorities to assure continued compliance with various standards, the continued licensing of the facility under state law, certification under the Medicare and Medicaid programs and the ability to participate in other third party payment programs. Many states have adopted Certificate of Need or similar laws which generally require that the appropriate state agency approve certain acquisitions of skilled nursing facilities and determine that a need exists for certain bed additions, new services and capital expenditures or other changes prior to beds and/or new services being added or capital expenditures being undertaken. The failure to obtain or maintain any required regulatory approvals or licenses could prevent an operator from offering services or adversely affect its ability to receive reimbursement for services and could result in the denial of reimbursement, temporary suspension of admission of new patients, suspension or decertification from the Medicaid or Medicare program, restrictions on the ability to acquire new facilities or expand existing facilities and, in extreme cases, revocation of the facility's license or closure of a facility. Federal laws also impose civil and criminal penalties for the submission of false or fraudulent claims, including nursing home bills and cost reports, to Medicare or Medicaid. There can be no assurance that lessees of the Company's skilled nursing facilities or the provision of services and supplies by such lessees will meet or continue to meet the requirements for participation in the Medicaid or Medicare programs or state regulatory authorities or that regulatory authorities will not adopt changes or new interpretations of existing regulations that would adversely affect the ability of lessees to make rental payments to the Company. Although not currently regulated at the federal level (except under laws of general applicability to businesses, such as work place safety and income tax requirements), assisted living facilities are increasingly becoming subject to more stringent regulation and licensing by state and local health and social service agencies and other regulatory authorities. In general, these assisted living requirements address, among other things: personnel education, training and records, facility services, including administration of medication, assistance with self-administration of medication and limited nursing services, monitoring of wellness, physical plant inspections, furnishing of resident units, food and housekeeping services, emergency evacuation plans, and resident rights and responsibilities, including in certain states the right to receive certain healthcare services from providers of a resident's choice. In several states, assisted living facilities also require a certificate of need before the facility can be opened or expanded or before it can reduce its resident capacity or make other significant capital expenditures. Some of the Company's properties are licensed to provide independent living services, which generally involve lower levels of resident assistance. Like skilled nursing facilities and other healthcare facilities, assisted living facilities are subject to periodic inspection by government authorities. 11 In most states, assisted living facilities, as well as skilled nursing and other healthcare facilities, are subject to state or local building code, fire code and food service licensure or certification requirements. Any failure by the Company's lessees to meet applicable regulatory requirements may result in the imposition of fines, imposition of a provisional or conditional license or suspension or revocation of a license or other sanctions or adverse consequences, including delays in opening or expanding a facility. Any failure by the Company's lessees to comply with such requirements could have a material adverse effect on the Company. Healthcare operators also are subject to federal and state anti-remuneration laws and regulations, such as the Federal Health Care Programs' anti-kickback law, which govern certain financial arrangements among healthcare providers and others who may be in a position to refer or recommend patients to such providers. These laws prohibit, among other things, the offer, payment, solicitation or receipt of any form of remuneration in return for the referral of Federal Health Care Program patients (including Medicare and Medicaid) or the purchasing, leasing, ordering (or arranging for or recommending the purchase, lease or order) of any goods, facilities, services or items for which payment can be made under a Federal Health Care Program. A violation of the Federal anti-kickback law or any other anti-remuneration law could result in the loss of eligibility to participate in Medicare or Medicaid, or in civil or criminal penalties. The potential for issues to arise under this law may be increased under a provision of the Balanced Budget Act which, as currently implemented, requires skilled nursing facilities to purchase and bill for services of ancillary care providers treating some of their Medicare residents. The federal government, private insurers and various state enforcement agencies have increased their scrutiny of providers, business practices and claims in an effort to identify and prosecute fraudulent and abusive practices. In addition, an increasing number of enforcement cases against health care providers, including cases alleging deficiencies in the quality of care, are being brought by private individual "whistleblowers" under the "qui tam" provisions of the Federal Civil False Claims Act. Competitors, employees of healthcare providers and others are incentivized to bring such claims because they share in any monetary recovery. The federal government has also issued fraud alerts concerning nursing services, double billings, home health services and the provision of medical supplies to nursing facilities, and a model compliance plan referencing numerous areas of business operation that it recommends be made the subject of specific policies and procedures that nursing homes implement and enforce. Accordingly, these areas may come under closer scrutiny by the government or by "qui tam" plaintiffs. Possible sanctions for violation of any of these restrictions or prohibitions include loss of licensure or eligibility to participate in reimbursement programs and civil and criminal penalties. State laws vary from state to state, are often vague and have seldom been interpreted by the courts or regulatory agencies. There can be no assurance that these federal and state laws will ultimately be interpreted in a manner consistent with the practices of the Company's lessees. The costs of complying with these laws, and/or defending against any allegations of non-compliance that might be brought, could be significant, and could negatively impact the ability of the Company's lessees to meet their financial obligations to the Company. 12 Taxation General A corporation, trust or association meeting certain requirements may elect to be treated as a REIT for federal income tax purposes. The Company believes that, commencing with its taxable period ended December 31, 1998, it has been organized and operated in a manner so as to qualify for taxation as a REIT under Sections 856 to 860, inclusive, of the Internal Revenue Code of 1986, as amended. To qualify as a REIT, the Company must satisfy a variety of complex organizational and operating requirements each year, including share ownership tests and percentage tests relating to the sources of its gross income, the nature of its assets and the distribution of its income. The Company intends to operate in such a manner as to continue qualifying as a REIT for federal income tax purposes in future periods, but no assurance can be given that the Company has operated or will continue to operate in such a manner so as to qualify or remain qualified as a REIT. Generally, for each taxable year during which the Company qualifies as a REIT, it will not be taxed on the portion of its taxable income (including capital gains) that is distributed to shareholders. This treatment substantially eliminates the "double taxation" (at the corporate and shareholder levels) that generally results from investment in a regular corporation. However, the Company will be subject to federal income tax under certain circumstances as discussed below. To qualify as a REIT, the Company is required to distribute to its shareholders each year at least 90% of its REIT taxable income, computed without regard to the dividends paid deduction and any net capital gain. REIT taxable income is the otherwise taxable income of the REIT subject to adjustments, including a deduction for dividends paid. 13 During 2000, the Company recorded significant bad debt expenses due to the Genesis bankruptcy filing related to loans and properties under lease and, as a result, recognized a net loss for financial reporting purposes. For federal income tax purposes, these losses were recognized in 2001 as required under applicable income tax rules. Based on the amount of these losses, the Company does not believe it would have to make any distributions to its shareholders until at least mid-2003 for REIT qualification purposes. When recognized for federal income tax purposes, these losses will reduce the amount otherwise required by the Company to be distributed to meet REIT requirements. Should these losses when recognized exceed REIT taxable income computed without regard to these losses, any excess loss ("NOL") amount may be carried forward for deduction in the succeeding year. A NOL of a REIT in any given year may be carried forward until utilized but over no more than 20 years. REIT taxable loss before reduction for the dividends paid deduction reported for 2001, the last year for which an income tax return has been prepared, was $10.6 million. NOL deductions may be subject to various limitations. The general limitation is that the deduction is limited to the current year's regular taxable income computed without regard to the loss deduction. For alternative minimum tax purposes, the general limitation is equal to 90% of the current year's alternative minimum taxable income computed without regard to the loss deduction. The applicable REIT distribution percentage requirement is applied against the greater of regular or alternative minimum taxable income. Other limitations include, but are not limited to, those imposed for a greater than 50% ownership change among the Company's 5% and greater owners during a test period, which is generally a three year period ending on each date there is a change in the ownership of Company stock held by a 5% or greater owner. The Company will be taxed at regular ordinary and capital gain corporate rates on any undistributed REIT taxable income. The Company may elect to treat any undistributed net capital gains as having been distributed to the shareholders. These "designated" undistributed net capital gains will be included by the Company's shareholders in income as long-term capital gain. The tax paid by the Company on those gains will be allocated among the shareholders and may be claimed as a credit on their tax returns. The shareholders will receive an increase in the basis of their shares in the Company equal to the difference between the capital gain income and the tax credit allocated to them. Under certain circumstances, the Company may be subject to the "alternative minimum tax" on its items of tax preference. The highest corporate tax rate is currently 39%. Subject to certain limitations, the Company will also be subject to an additional tax equal to 100% of the net income, if any, derived from prohibited transactions. A prohibited transaction is defined as a sale or disposition of inventory-type property or property held by the Company primarily for sale to customers in the ordinary course of its trade or business, which is not property acquired on foreclosure. 14 The Company will be subject to tax at the highest corporate rate on its net income from "foreclosure property", regardless of the amount of its distributions, but the income would qualify under the REIT gross income tests. The highest corporate tax rate is currently 39%. The Company may elect to treat any real property it acquires by foreclosure after a default on a lease of, or on a loan secured by, the real property as foreclosure property if certain conditions are satisfied. With a valid election, the Company is permitted to derive revenues directly from the ownership of such property (rather than deriving rental revenues pursuant to the lease of such property) until the end of the third taxable year after the year of acquisition (subject to an extension of up to a total of six years at the IRS' discretion) so long as an independent contractor (which might but not necessarily in all circumstances include Genesis or its affiliates) operates the property within 90 days after the property is acquired. A tenant of the Company may qualify as an independent contractor for purposes of the foreclosure property rules if the property that is leased to the independent contractor is a "qualified health care property" and was under lease to the independent contractor or a third party at the time that the Company acquired the foreclosure property. If the property had been under lease to a third party, then the tenant could qualify as an independent contractor only if under the subsequent lease of the property to the tenant, the Company receives a substantially similar or lesser benefit in comparison to the prior lease. Similar rules would apply to treat as foreclosure property "qualified health care property" acquired by the Company as the result of the termination of a lease of such property except that such property would constitute foreclosure property until the close of the second taxable year following the year in which it was acquired, or for up to a total of four years if an extension is granted by the IRS. If the Company should fail to distribute during each calendar year at least the sum of (a) 85% of its REIT ordinary income for such year, (b) 90% of its REIT capital gain net income for such year and (c) any undistributed taxable income from prior periods, the Company would be subject to a 4% excise tax on the excess of such required distribution over the amounts actually distributed. If the Company should fail to satisfy the 75% gross income test or the 90% gross income test that apply to REITs, but has nonetheless maintained its qualification as a REIT because certain other requirements have been met, it will be subject to a 100% tax on an amount equal to the greater of either (a) the amount by which 75% of the Company's gross income exceeds the amount qualifying under the 75% test for the taxable year, or (b) the amount by which 90% of the Company's gross income exceeds the amount of the Company's gross income qualifying for the 90% test, multiplied in either case by a fraction intended to reflect the Company's profitability. In addition, if a taxable REIT subsidiary ("TRS") pays interest or another amount to the Company that exceeds the amount that would generally be paid to an unrelated party in an arm's length transaction, the Company generally will be subject to an excise tax equal to 100% of such excess. Generally, a TRS is an entity taxable as a corporation in which a REIT owns an equity interest that, together with the REIT, elects treatment as a TRS and that does not operate either a healthcare or lodging facility or provide rights to any brand name under which a healthcare or lodging facility is operated. A TRS is not subject to the general asset tests applicable to the ownership of securities by a REIT (although not more than 20% of the value of the REIT's assets may be represented by securities of one or more TRS's). The Company's subsidiaries, ET Capital Corp. and ET Capital Corp. II, Inc., elected, together with the Company, to be treated as a TRS of the Company effective January 1, 2001. 15 Finally, notwithstanding the Company's status as a REIT, the Company may have to pay certain state or local income taxes because not all states and localities treat REITs the same as they are treated for federal income tax purposes, and will be subject to other state and local taxes resulting from the Operating Partnership's operations and asset ownership. ET Capital is subject to federal, state and local income taxes at regular corporate rates and, accordingly, will have less cash available to distribute to its shareholders, including the Company. Failure To Qualify as a REIT While the Company intends to operate so as to qualify as a real estate investment trust under the Tax Code, if in any taxable year the Company fails to qualify, and certain relief provisions do not apply, its taxable income would be subject to tax (including any alternative minimum tax) at regular corporate rates. If that occurred, the Company might have to dispose of a significant amount of its assets or incur a significant amount of debt in order to pay the resulting federal income tax. Further distributions to its shareholders would not be deductible by the Company nor would they be required to be made. Distributions out of the Company's current or accumulated earnings and profits would be taxable to the Company's shareholders as dividends but, subject to certain limitations, could be eligible for the dividends received deduction for corporations. No portion of any distribution would be eligible for designation as a capital gain dividend. Further, the Company would no longer be deemed to pass through its "designated" undistributed capital gains and the related tax paid by the Company. Unless entitled to relief under specific statutory provisions, the Company also would be disqualified from taxation as a REIT for the four taxable years following the year during which qualification was lost. The foregoing is only a summary of some of the significant federal income tax considerations affecting the Company and is qualified in its entirety by reference to the applicable provisions of the Internal Revenue Code, the rules and regulations promulgated thereunder, and the administrative and judicial interpretations thereof. Shareholders of the Company are urged to consult their own tax advisors as to the effects of these rules and regulations on them. In particular, foreign shareholders should consult with their tax advisors concerning the tax consequences of ownership of shares in the Company, including the possibility that distributions with respect to the shares will be subject to federal income tax withholding. 16 For additional information on taxes, see the Company's Form 8-K filed on March 28, 2003. Competition The Company competes with other healthcare REITs, real estate partnerships, healthcare providers and other investors, including but not limited to banks and insurance companies, in the acquisition, leasing and financing of healthcare facilities. Many of these investors may have greater resources than the Company. Genesis and other lessees operate properties that the Company competes, on a local and regional basis, with operators of other facilities that provide comparable services. Operators compete for residents based on quality of care, reputation, physical appearance of facilities, services offered, family preferences, physicians, staff and price. In general, regulatory and other barriers to competitive entry in the assisted living industry are not substantial. The development of new assisted living facilities has outpaced the demand for these facilities in certain of the Company's markets. This oversupply of facilities has caused operators of some of our facilities to experience decreased occupancy, depressed margins and lower operating results, which has adversely affected their ability to make lease payments to the Company. Employees As of December 31, 2002, the Company employed six full-time employees. Internet Website ElderTrust's internet website can be found at www.eldertrust.com. ElderTrust makes available, free of charge, on our website, access to the Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after such material is filed, or furnished, to the Securities and Exchange Commission. RISK FACTORS Set forth below are the risks that we believe are material to investors who purchase or own our common shares of beneficial interest or units of limited partnership interest in the Operating Partnership, which are redeemable by the holder on a one-for-one basis for common shares or their cash equivalent, at our election. As used herein, all references to "we," "us" or "our" mean ElderTrust and its consolidated subsidiaries unless the context otherwise requires. We rely to a substantial degree upon contractual obligations in the form of leases with subsidiaries of Genesis and other entities in which Genesis has an equity ownership interest the primary source of our revenues and for our ability to meet our corporate obligations 17 Approximately 86% of our consolidated assets at December 31, 2002 consisted of real estate properties leased to or managed by subsidiaries of Genesis or Genesis Equity Investees, under agreements as manager or tenant. We recorded revenues in connection with these leases aggregating $18.3 million during 2002. As a result of these relationships, the Company's revenues and ability to meet its obligations depend, in significant part, upon the ability of subsidiaries of Genesis and Genesis Equity Investees to meet their lease obligations. Genesis emerged from bankruptcy in October 2001. Any failure of subsidiaries of Genesis or Genesis Equity Investees to continue their operations and/or to continue to make lease payments to the Company could have a significant adverse impact on our operations and cash flows due to the significant portion of our properties leased to Genesis and the Genesis Equity Investees. The proposed spin-off by Genesis of its Eldercare business may increase the credit risk of substantially all of our leased properties. The Company currently leases 27 properties to Genesis subsidiaries that are guaranteed, in whole or in part, by Genesis. In February 2003, Genesis announced that its Board of Directors had approved the spin-off of its ElderCare business. This business includes our tenants that are currently owned, in whole or in part, by Genesis, as well as Genesis' other senior housing asset-based businesses. The operating performance of the Company's skilled nursing and assisted living assets affected by the proposed transaction have, on an overall basis, declined over the past several years due to various factors. These factors include, among others, net reductions in Medicare reimbursement, increased operating costs and competition. Under our lease terms, any assignment of the leases to a party in which Genesis has no ownership interest would require our consent. Such consent may not be unreasonably withheld. If the leases are assigned with our consent, the Genesis guarantee would be eliminated. However, we would be entitled to obtain guarantees from other parties in control of the tenant. Conversely, if the leases are assigned without our consent, the Genesis guarantee would remain in effect. We believe that the transaction proposed by Genesis may constitute an assignment of the leases. As a result, the transaction may require our consent should Genesis desire to eliminate its obligations under its guarantees. In determining whether to provide our consent, we intend to evaluate the current and expected operating performance of the leased properties and determine the need for, and availability of, substitute credit enhancements. The spin-off is expected to be completed during the latter part of 2003. To date, Genesis has not provided us with any financial information regarding the proposed spin-off nor has Genesis requested to be released from its guarantees although we expect that it will do so. No assurance can be given that the credit risk inherent in the current lease and guarantee agreements will not increase as a result of the proposed spin-off. 18 Rising interest rates could adversely affect our cash flow because of variable rate debt At December 31, 2002, the Company had $3.1 million of variable rate indebtedness outstanding under the Guidance Line. The Company's Guidance Line bears interest at a floating rate 3.25% over LIBOR (4.67% at December 31, 2002), any future borrowings would be subject to risk related to increases in interest rates. On January 27, 2003, the Company paid $3.1 million to Wachovia Bank to pay off the balance due under the Guidance Line. As of January 31, 2003, the Company has $7.5 million available for future borrowings under the Guidance Line, subject to lender approval and borrowing base limitations. In addition, we have variable rate mortgages of $30.0 million at December 31, 2002, with an interest rate of one-month LIBOR plus 300 basis points (4.44% at December 31, 2002). Assuming the variable rate mortgage balances outstanding at December 31, 2002 of $30.0 million remains constant, each one percentage point increase in interest rates from 4.44% at December 31, 2002 would result in an increase in interest expense of approximately $300,000. Also, we may borrow additional money with variable interest rates in the future. Any increase in interest rates will adversely affect our cash flow and our ability to make distributions to our shareholders. Our degree of leverage could limit our ability to obtain additional financing and adversely affect our cash flow As of December 31, 2002, our debt to book capitalization ratio, which we calculate as total debt as a percentage of total debt plus the book equity attributed to our outstanding common shares and outstanding partnership units, was approximately 71.2%. We do not have a stated policy limiting the amount of debt that we may incur. If we increase our leverage it could pose risks to our shareholders, including that: o our debt service costs or requirements may increase, which could adversely affect our cash flow and, consequently, the amount available for distribution to our shareholders; o the risk that we will default on our indebtedness may increase; o we may be unable to obtain additional financing in the future to fund working capital, capital expenditures, acquisitions or other general corporate expenses, or our ability to obtain such financing on satisfactory terms may be impaired; and o we may be more vulnerable to a downturn in our business or the economy generally. We depend upon external sources of capital To qualify as a REIT, we must distribute to our shareholders each year at least 90% of our net taxable income, excluding any net capital gain. Because of these distribution requirements, it is not likely that we will be able to fund future capital needs, including those for acquisitions, from income from operations. We, therefore, rely on third party sources of capital which may or may not be available on favorable terms or at all. Our access to third party sources of capital depends on a number of things, including the market's perception of our growth potential and our current and potential future earnings. Moreover, additional equity offerings may result in substantial dilution of security holders' interests, and additional debt financing may substantially increase our leverage. 19 Our ability to grow will be significantly limited until the capital and credit markets improve The current economic recession, combined with the net reduction in Medicare reimbursement levels during and after 1998, which resulted in a significant curtailment of the willingness of banks to extend loans secured by healthcare-related real estate, has adversely impacted the debt and equity markets for healthcare-related companies. The Company depends on these markets to fund its long-term liquidity needs. The Company's ability to access the capital and credit markets will likely be significantly limited until such time as these markets improve. The Company does not have sufficient cash flow to repay indebtedness if its creditors require immediate repayment of these amounts or if the collateral underlying these amounts is insufficient to cover the outstanding balances. Operators of our skilled nursing facilities rely on government and other third party reimbursement to make lease payments to us A significant portion of the revenues derived from the fifteen skilled nursing facilities owned by us or in which we have leasehold interests is attributable to government reimbursement under Medicare and Medicaid to operators of these facilities. The changes in these programs have had a material adverse effect on the revenues derived by the operators of the skilled nursing facilities leased from us. Healthcare facilities also have experienced increasing pressures from private payers attempting to control healthcare costs that in some instances have reduced reimbursement to levels approaching that of government payers. We can make no assurance that future actions by governmental or other third party payers will not result in further reductions in reimbursement levels, or that future reimbursements from any payer will be sufficient to cover the costs of the facilities' operations. If reimbursement levels do not cover lease payments, the possibility exists that one or more of our lessees could default on their leases to us. The Company may be unable to find other lessees upon the expiration of its leases There can be no assurance that the Company will be able to locate suitable lessees for its properties upon the expiration of its leases or, if the Company is successful in locating such operators, that the rental payments from the new operators would not be significantly less than the existing rental payments. 20 We experience ongoing competition from and conflicts with Genesis Our facilities, whether or not operated by Genesis, compete with facilities owned and operated by Genesis in some markets. As a result, Genesis has a conflict of interest due to its ownership of competing facilities and its operation and management of a substantial portion of the facilities we own. Because the percentage rent leases with Genesis provide for lower operating margins for Genesis than minimum rent leases with Genesis, Genesis may also have a conflict of interest to the extent that it is involved in the placement of private pay residents with acuity levels equally suited to an assisted living facility or a skilled nursing facility. Holders of units of limited partnership interest in the Operating Partnership have different interests than shareholders and may exercise their voting rights in the Operating Partnership in a manner that conflicts with the interests of shareholders As the sole general partner of the Operating Partnership, we have fiduciary obligations to the other limited partners in the Operating Partnership, the discharge of which may conflict with the interests of our shareholders. In addition, those persons holding beneficial interests in units of limited partnership interest in the Operating Partnership, including Michael Walker, have the right, as limited partners, to vote on amendments to the partnership agreement of the Operating Partnership, most of which require approval by a majority in interest of the limited partners, including ElderTrust, and such individuals may exercise their voting rights in a manner that conflicts with the interests of our shareholders. Additionally, if we prepay or refinance debt securing some of our properties or sell properties, Mr. Walker and other holders of units of limited partnership interest in the Operating Partnership may incur adverse tax consequences which are different from the tax consequences to us and our shareholders. Consequently, persons holding directly or indirectly units of limited partnership interest, including Mr. Walker, may have different objectives regarding the appropriate timing of such actions. While we have the exclusive authority as general partner under the partnership agreement to determine whether, when and on what terms to prepay or refinance debt or to sell a property, any of these actions would require the approval of our Board of Trustees. As Chairman of the Board of ElderTrust, Mr. Walker has substantial influence with respect to any of these actions, and could exercise his influence in a manner inconsistent with the interests of some, or a majority, of ElderTrust's shareholders. Healthcare industry regulation may adversely affect the operations of our lessees and their ability to make lease payments to us 21 Any failure by our lessees to comply with applicable government regulations could adversely affect their ability to make lease payments to us. The long-term care segment of the healthcare industry is highly regulated. Operators of skilled nursing facilities are subject to regulation under various federal, state and local laws, including those relating to: o delivery and adequacy of medical care; o distribution of pharmaceuticals; o equipment utilized in their facilities; o personnel; o operating policies; o fire prevention; o rate-setting; o compliance with building and safety codes; o compliance with environmental laws; o periodic inspection by governmental and other authorities to ensure compliance with various standards; o licensing of facilities under state law; o protecting the privacy and security of personally identifiable health information; o certification for participation under the Federal Health Care Program, including Medicare and Medicaid; and o ability to participate in other third party payment programs. In addition, many states have adopted certificate of need or similar laws which generally require that the appropriate state agency approve acquisitions of skilled nursing facilities and determine that a need exists for certain bed additions, new services, capital expenditures or other changes. The failure to obtain or maintain any required regulatory approvals or licenses could prevent an operator of one or more of our facilities from offering services or adversely affect its ability to receive reimbursement for services. It also could result in the denial of reimbursement, temporary suspension of admission of new patients, suspension or decertification from a Federal Health Care Program, restrictions on the ability to expand existing facilities and, in extreme cases, revocation of the facility's license or closure of a facility. Federal law also imposes civil and criminal penalties for submission of false or fraudulent claims, including nursing home bills and cost reports, to Medicare or Medicaid. There can be no assurance that our lessees will meet or continue to meet the requirements for participation in the Medicaid or Medicare programs or of state licensing authorities. Nor can there be any assurance that regulatory authorities will not adopt changes or new interpretations of existing regulations that would adversely affect the ability of our lessees to make their lease payments to us. 22 Although not currently regulated at the federal level, except under laws generally applicable to businesses, assisted living facilities are increasingly becoming subject to more stringent regulation and licensing by state and local health and social service agencies and other regulatory authorities. In general, these assisted living requirements address: o personnel education; o training and records; o facility services, including administration of medication, assistance with self-administration of medication and the provision of limited nursing services; o monitoring of wellness; o physical plant inspections; o furnishing of resident units; o food and housekeeping services; o emergency evacuation plans; and o resident rights and responsibilities, including in certain states the right to receive certain healthcare services from providers of a resident's choice. In several states, assisted living facilities also require a certificate of need before the facility can be opened, expand or reduce its resident capacity or make significant capital expenditures. Several of our properties are licensed to provide independent living services, which generally involve lower levels of resident assistance. Like skilled nursing facilities and other healthcare facilities, assisted living facilities are subject to periodic inspections by government authorities. In most states, assisted living facilities, as well as skilled nursing and other healthcare facilities, also are subject to state or local building code, fire code and food service licensure or certification requirements. Any failure by our lessees to meet applicable regulatory requirements may result in the imposition of fines, imposition of a provisional or conditional license or suspension or revocation of a license or other sanctions or adverse consequences, including delays in opening or expanding a facility. Any failure by our lessees to comply with these requirements could have a material adverse effect on their ability to make lease payments to us. 23 Operators of our facilities also must comply with federal and state fraud and abuse laws Healthcare operators also are subject to federal and state anti-remuneration laws and regulations, such as the Federal Health Care Program anti-kickback law. These laws govern financial arrangements among healthcare providers and others that may be in a position to refer or recommend patients to providers. These laws prohibit, among other things, the offer, payment, solicitation or receipt of any form of remuneration in return for the referral of Federal Health Care Program patients or for purchasing, leasing, ordering (or arranging for or recommending the purchase, lease or order) of any goods, facilities, services or items for which payment can be made under a Federal Health Care Program. A violation of the federal anti-kickback law could result in the loss of eligibility to participate in Medicare or Medicaid or in civil or criminal penalties. The federal government, private insurers and various state enforcement agencies have increased their scrutiny of providers, business practices and claims in an effort to identify and prosecute fraudulent and abusive practices. Operators of skilled nursing facilities are also subject to state and federal laws prohibiting the submission of "false" or "fraudulent" claims. One of these laws, the Federal False Claims Act, can be enforced by a private individual "whistleblowers" in a "qui tam" case, and an increasing number of such cases, including cases alleging deficiencies in the quality of care, are being brought in the health care field. In addition, the federal government has issued fraud alerts concerning nursing services, double billing, home health services and the provision of medical supplies to nursing facilities, and a model compliance plan referencing numerous areas of business operation that it recommends be made the subject of specific policies and procedures that nursing homes implement and enforce. Accordingly, these areas have come under closer scrutiny by the government. Further, some states restrict certain business corporations from providing, or holding themselves out as a provider of, medical care. Sanctions for violation of any of these laws can include loss of licensure or eligibility to participate in reimbursement programs and civil and criminal penalties. State laws vary from state to state, are often vague and have seldom been interpreted by the courts or regulatory agencies. There can be no assurance that these federal and state laws will ultimately be interpreted in a manner consistent with the practices of our lessees. The costs of complying with these laws, and/or defending against any allegations of non-compliance that might be brought, could be significant, and could negatively impact the ability of our lessees to meet their financial obligations to us. We may encounter delays in substituting lessees or operators because the facility licenses are held by our lessees and not by us A loss of license or Medicare/Medicaid certification or default by one or more of our lessees could result in us having to obtain another lessee or substitute operator for the affected facility or facilities. Because the facility licenses for our properties are held by our lessees and not by us and because under the REIT tax rules we would have to find a new "unrelated" lessee to operate the properties following a default, we may encounter delays in exercising our remedies under the leases made by us or substituting a new lessee or operator in the event of any loss of licensure or Medical/Medicaid certification by a prior lessee or operator or a default by the operator of one or more of our facilities. 24 Transfers of healthcare facilities require regulatory approvals and alternative uses of healthcare facilities are limited Because transfers of operations of healthcare facilities are subject to regulatory approvals not required for transfers of other types of commercial operations and other types of real estate, there may be delays in transferring operations of our facilities to successor lessees or we may be prohibited from transferring operations to a successor lessee. In addition, substantially all of our properties are special purpose facilities that may not be easily adapted to non-healthcare related uses. Proximity to hospitals and other healthcare facilities may affect our ability to renew leases and attract new lessees in the event of relocation or closure of a hospital or other healthcare facility Many of our assisted living facilities, skilled nursing facilities and medical office buildings are in close proximity to one or more hospitals. The relocation or closure of a hospital could make our assisted living facilities, skilled nursing facilities or medical office buildings in the affected area less desirable and affect our ability to renew leases and attract new tenants. Because real estate investments are illiquid, we may not be able to sell properties when appropriate Real estate investments generally cannot be sold quickly. We may not be able to vary our portfolio promptly in response to economic or other conditions. This inability to respond to changes in the performance of our investments could adversely affect our ability to service debt and make distributions to our shareholders. In addition, there are limitations under the federal income tax laws applicable to REITs that may limit our ability to recognize the full economic benefit from a sale of our assets. Lack of industry diversification subjects us to the risks associated with investments in a single industry While we are authorized to invest in various types of income-producing real estate, our current strategy is to acquire and hold, as long-term investments, only healthcare-related properties. Consequently, we currently do not have any significant non-healthcare related real estate assets, and, therefore, are subject to the risks associated with investments in a single industry. 25 Competition in the marketplace could adversely affect the ability of our lessees to make lease payments to us Lessees operating our owned properties compete on a local and regional basis with operators of other facilities that provide comparable services. Operators compete for residents based on a number of factors, including but not limited to quality of care, reputation, range and type of services offered, staffing and price. There can be no assurance that operators of our facilities will be able to compete effectively. If they are unable to do so, their ability to make lease payments to us could be adversely affected. Overbuilding in the assisted living industry has resulted in decreased occupancy, depressed margins and lower operating results for operators of some of our assisted living facilities In general, regulatory and other barriers to competitive entry in the assisted living industry are not substantial. In certain of our markets, the development of new assisted living facilities has outpaced the demand for these facilities. This oversupply of facilities has caused operators of some of our facilities to experience decreased occupancy, depressed margins and lower operating results, which has adversely affected their ability to make lease payments to the Company and could do so in the future. Assisted living revenues are derived from private pay sources Assisted living services currently are not generally reimbursable under government reimbursement programs, such as Medicare and Medicaid. Accordingly, substantially all of the revenues derived by operators of the assisted living facilities owned by us come from private pay sources consisting of income or assets of residents or their family members. In general, because of the cost associated with building new facilities and the staffing and other costs of providing the assisted living services at those facilities, only seniors with income or assets meeting or exceeding the comparable median in the region where the facilities are located can afford to pay the daily resident fees. An unexpectedly high resident turnover rate could adversely affect the revenues derived by operators of our assisted living facilities, which could adversely affect their ability to make lease payments to us State regulations governing assisted living facilities require written resident agreements with each resident. These regulations also require that each resident have the right to terminate the resident agreement for any reason on reasonable notice. Consistent with these regulations, the resident agreements entered into with operators of our assisted living facilities allow residents to terminate the agreement on 30 days' notice. Thus, operators of our assisted living facilities cannot contract with residents to stay for longer periods of time, unlike typical apartment leasing arrangements that involve lease agreements with specified leasing periods of up to one year or longer. If a large number of residents elected to terminate their resident agreements at or around the same time, then the revenues derived by the operator of the facility could be adversely affected, which, in turn, would adversely affect the ability of the operator to make lease payments to us. In addition, the advanced age of assisted living residents means that resident turnover in assisted living facilities may be less predictable. 26 New acquisitions may fail to perform as expected Assuming we are able to obtain capital on commercially reasonable terms, we intend to continue to acquire assisted and independent living facilities, skilled nursing facilities and medical office and other buildings. Newly acquired properties may fail to perform as expected, which could adversely affect our earnings and distributions to our shareholders. Some potential losses may not be covered by insurance We require our lessees to secure and maintain, comprehensive liability and property insurance that covers the Company, as well as the lessees on all of our properties. Some types of losses, however, either may be uninsurable or too expensive to insure against. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a property, as well as the anticipated future revenue from the property. In such an event, we might nevertheless remain obligated for any mortgage debt or other financial obligations related to the property. We cannot assure shareholders that material losses in excess of insurance proceeds will not occur in the future. Our failure to comply with tax-exempt bond requirements for our Highgate and Woodbridge facilities could result in termination of the tax-exempt status or acceleration of the bonds Our indebtedness at December 31, 2002 includes approximately $19.3 million of tax-exempt bonds used to finance our Highgate and Woodbridge assisted living facilities. The bonds are subject to various requirements under the Internal Revenue Code. In addition, the bonds impose requirements on the operation of the facilities, including a requirement that at least 20% of the rental units in the facilities are occupied by tenants whose adjusted gross family income does not exceed 50% of the median gross income for the relevant geographic area. If our lessees do not comply with these requirements, the tax-exempt status of the bonds could be terminated or the bonds could be accelerated. In the event of such a termination or acceleration, our interest in the relevant property would be subordinate to the interests of the bondholder. Provisions of our declaration of trust and bylaws and Maryland law could inhibit changes in control 27 Various provisions of our declaration of trust and bylaws and Maryland law may delay or prevent a change in control or other transactions that could provide our shareholders with a premium over the then-prevailing market price of their shares or which might otherwise be in the best interest of our shareholders. These provisions of our declaration of trust and bylaws include: o a classified Board of Trustees with the trustees divided into three classes with terms of three years each; o that the number of trustees may not be less than three nor more than nine, with the number of trustees fixed within this range by action of the Board of Trustees; o the authority of the Board of Trustees to fill vacancies for the remainder of the term of the class in which the vacancy occurred; o that trustees may be removed only for cause upon the affirmative vote of shareholders holding at least a majority of the shares entitled to be cast in an election of trustees; o the authority of the Board of Trustees to issue preferred shares of beneficial interest in one or more series without shareholder approval; o the exclusive authority of the Board of Trustees to amend the bylaws; o an advance notice bylaw requiring advance notice of shareholder nominations for trustee or new business proposals; o that special meetings of shareholders may be called only by the chairman, the president or at least one-third of the Board of Trustees; o a requirement of a vote of shareholders of not less than two-thirds of all the votes entitled to be cast on the matter to approve amendments to provisions of the declaration of trust that have an anti-takeover effect; and o the ownership limit described below which is primarily intended to satisfy requirements under the Internal Revenue Code for qualification as a REIT. Maryland law also provides protection for Maryland real estate investment trusts against unsolicited takeovers by protecting the Board of Trustees with regard to actions taken in a takeover context. Maryland law provides that the duties of trustees will not require them to (a) accept, recommend, or respond to any proposal by a person seeking to acquire control, (b) authorize the real estate investment trust to redeem any rights under, modify, or render inapplicable a shareholder rights plan, (c) make a determination under the Maryland Business Combination Statute or the Maryland Control Share Acquisition Statute, or (d) act or fail to act solely because of the effect the act or failure to act may have on an acquisition or potential acquisition of control or the amount or type of consideration that may be offered or paid to shareholders in an acquisition. Maryland law also establishes a presumption that an act of a trustee satisfies the required standard of care. In addition, an act of a trustee relating to or affecting an acquisition or a potential acquisition of control is not subject under Maryland law to a higher duty or greater scrutiny than is applied to any other act of a trustee. Maryland law also provides that the duty of a trustee is only enforceable by the trust or in the right of the trust. A shareholder suit to enforce the duty of a trustee, therefore, can only be brought derivatively. 28 Maryland law also expressly codifies the authority of a Maryland real estate investment trust to include in its charter a provision that allows the Board of Trustees to consider the effect of a potential acquisition of control on shareholders, employees, suppliers, customers, creditors and communities in which offices or other establishments of the trust are located. Our declaration of trust does not include a provision of this type. Maryland law also provides, however, that the inclusion or omission of this type of provision in the declaration of trust of a Maryland real estate investment trust does not create an inference concerning factors that may be considered by the Board of Trustees regarding a potential acquisition of control. This law may allow the Board of Trustees to reject an acquisition proposal even though the proposal was in the best interests of our shareholders. We also are subject to Maryland Business Combination Statute Provisions of Maryland law prohibit specified "business combinations" between a Maryland real estate investment trust and any person or entity who beneficially owns ten percent or more of the voting power of its outstanding shares, or any affiliate of the ten percent owner, for five years. Thereafter, the business combination must be approved by (a) 80% of the outstanding voting shares and (b) two-thirds of the outstanding voting shares, other than shares held by the ten percent owner, unless specified statutory conditions are met. A business combination that is approved any time before the ten- percent owner acquires his or her shares is not subject to these special voting requirements. We have not "opted out" of these provisions and, accordingly, we are subject to them. Our Board of Trustees has adopted a shareholder rights plan that could discourage a third party from making a proposal to acquire us In 1999, our Board of Trustees adopted a shareholder rights plan, which may discourage a third party from making a proposal to acquire us. Under the shareholder rights plan, preferred share purchase rights, which are attached to our common shares, generally will be triggered and become exercisable upon the acquisition of 15% or more of our outstanding common shares, or the commencement of a tender offer seeking at least that amount, unless our Board of Trustees amends the plan or redeems the rights. If triggered, these rights would entitle our common shareholders other than the acquirer whose rights would be voided to purchase our common shares, and possibly the common stock of the acquirer, at a price equal to one-half of the market value of our common shares. 29 We have a share ownership limit primarily for REIT tax purposes To qualify and maintain qualification as a REIT for federal income tax purposes, not more than 50% in value of our outstanding common shares of beneficial interest may be owned, directly or indirectly, by five or fewer individuals, as defined in the Internal Revenue Code to include certain entities. In addition, in order for rent paid by the Company's tenants to qualify for purposes of the gross income tests applicable to REITs, no tenant (including Genesis) nor any person who constructively owns 10% or more of the outstanding shares of Genesis or any other tenant may own actually or constructively 10% or more, in value or voting rights, of our outstanding shares of beneficial interest. Primarily to facilitate compliance with these requirements, our declaration of trust prohibits ownership, directly or by virtue of the attribution provisions of the Tax Code, by any single shareholder of more than 8.6% of the issued and outstanding common shares and generally prohibits the ownership, directly or by virtue of these attribution rules, by any single shareholder of more than 9.9% of any class or series of preferred shares of beneficial interest. We refer to this as the "ownership limit." The federal tax laws include complex share ownership rules that apply in determining whether a shareholder exceeds the ownership limit. These rules may cause a shareholder to be treated as owning the shares of a number of related shareholders. Absent any such exemption or waiver by the Board of Trustees, shares acquired or held in violation of the ownership limit will be transferred to a trust for the exclusive benefit of a designated charitable beneficiary, and the shareholder's rights to distributions and to vote would terminate. Also, the ownership limit could delay or prevent a change in control and, therefore, could adversely affect our shareholders' ability to realize a premium over the then-prevailing market price for their shares. Our failure to qualify as a REIT would cause us to be taxed as a corporation We believe that we were organized and operated in a manner so as to qualify as a REIT under the Internal Revenue Code, commencing with our taxable year ended December 31, 1998. While the Company intends to operate so as to qualify as a real estate investment trust under the Internal Revenue Code, we can give no assurance, however, that we currently qualify or will maintain our qualification as a REIT. Qualification as a REIT involves the satisfaction of numerous requirements, some on an annual and some on a quarterly basis, established under highly technical and complex Internal Revenue Code provisions for which there are only limited judicial and administrative interpretations, and involves the determination of various factual matters and circumstances not entirely within our control. The complexity of these provisions and of the applicable U.S. Treasury regulations is greater in the case of a REIT that holds its assets in partnership form. We can make no assurances that legislation, new regulations, administrative interpretations or court decisions will not significantly change the tax laws with respect to our qualification as a REIT or the federal income tax consequences of our qualification as a REIT. 30 If we fail to qualify as a REIT, we will be subject to federal and state income tax, including any alternative qualification as a REIT, on our taxable income at regular corporate rates. If that occurred, the Company might have to dispose of a significant amount of its assets or incur a significant amount of debt in order to pay the resulting federal income tax. Further distributions to its shareholders would not be deductible by the Company nor would they be required to be made. Moreover, unless entitled to statutory relief, we will be disqualified from treatment as a REIT for the four taxable years following the year in which REIT qualification is lost. If we failed to qualify as a REIT, our net income available for investment or distribution to our shareholders would be significantly reduced because of the additional tax liability to us for the years involved. We might have to dispose of a significant amount of our assets or incur a significant amount of debt in order to pay the resulting federal or state income tax. In addition, distributions to our shareholders would no longer be required to be made by us. Our failure to qualify as a REIT could reduce materially the value of our common stock and would cause any distributions to shareholders that otherwise would have been subject to tax as capital gain dividends to be taxable as ordinary income to the extent of our current and accumulated earnings and profits. However, subject to limitations under the Internal Revenue Code, corporate distributions may be eligible for the dividends received deduction with respect to our distributions. Our failure to qualify as a REIT also would cause an event of default under our Credit Facility and other indebtedness. To qualify as a REIT, we currently are required to distribute to our shareholders with respect to each year at least 90% of our taxable income, excluding net capital gain. In addition, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions made by us with respect to the calendar year are less than the sum of 85% of our ordinary income and 95% of our capital gain net income for that year and any undistributed taxable income from prior periods. We intend to make distributions to our shareholders to the extent necessary to comply with the distribution requirement and to avoid the nondeductible excise tax and will rely for this purpose on distributions from the Operating Partnership. Special considerations apply to us because of the nature of our assets The manner in which we derive income from the assisted and independent living facilities and skilled nursing facilities we own is governed by special considerations in satisfying the requirements for REIT qualification. Because we would not qualify as a REIT if we directly operated an assisted or independent living facility or a skilled nursing facility, we lease such facilities to a healthcare provider, such as a subsidiary of Genesis, which operates the facilities. To qualify as a REIT, we must satisfy two gross income tests, under which specified percentages of our gross income must be passive income, like rent. For the rent paid pursuant to the leases, which constitutes substantially all of our gross income, to qualify for purposes of the gross income tests, the leases must be respected as true leases for federal income tax purposes and not be treated as service contracts, joint ventures or some other type of arrangement. In addition, our lessees, including the subsidiaries of Genesis that lease some of our properties, must not be regarded as "related party tenants," as defined in the Internal Revenue Code. We believe that the leases will be respected as true leases for federal income tax purposes. There can be no assurance, however, that the IRS will agree with this view. We also believe that our lessees are not "related party tenants." If the leases were not respected as true leases for federal income tax purposes or if our lessees were regarded as "related party tenants," we would not be able to satisfy either of the two gross income tests applicable to REITs and we would lose our REIT status. See "Risk Factors--Our failure to qualify as a REIT would cause us to be taxed as a corporation" above. 31 In the event the leases expire and are not renewed, we will have to find a new lessee that is not related to us to lease and operate the properties in order to continue to qualify as a REIT. We are able to elect to treat property acquired as a result of an expired lease as foreclosure property if certain conditions are satisfied. With a valid election, we would be permitted to derive revenues directly from the ownership of such property rather than deriving rental revenues attributable to the lease of such property until the end of the second taxable year following the year of the lease termination (subject to an extension of up to an additional four years, if granted by the IRS) but only if an independent contractor begins to operate the property within 90 days after the lease is terminated. The net income from the foreclosure property would be subject to tax at the maximum corporate rate, but the income would qualify under the REIT gross income tests. In the event of a default on a lease of an assisted or independent living facility or skilled nursing facility, to maintain our REIT qualification, we would either have to immediately lease the property to a lessee that is not related to us, or make a foreclosure election and engage a new healthcare provider. Although with a valid election, we would be permitted to operate the facility for 90 days after taking possession of the facility pursuant to applicable U.S. Treasury regulations without jeopardizing our REIT status, the fact that the facility licenses are held by our lessees may preclude us from doing so under applicable healthcare regulatory requirements. The REIT requirements and applicable healthcare regulatory requirements could deter us from exercising our remedies in the event of a default even though such exercise otherwise would be in our best interests. As a REIT, we are subject to limitations on our ownership of debt and equity securities Subject to certain exceptions, including the one discussed in this paragraph, a REIT is generally prohibited from owning securities in any one issuer if the value of those securities exceeds 5% of the value of the REIT's total assets or the securities owned by the REIT represent more than 10% of the issuer's outstanding voting securities or more than 10% of the value of the issuer's outstanding securities. A REIT is permitted to own securities of a subsidiary in an amount that exceeds the 5% value test and the 10% vote or value test if the subsidiary elects to be a "taxable REIT subsidiary", which is taxable as a corporation. However, a REIT may not own securities of taxable REIT subsidiaries that represent in the aggregate more than 20% of the value of the REIT's total assets. While we believe that we have satisfied these limitations on the ownership of securities during each of the taxable years that each such limitation applied to us, given the highly complex nature of the rules governing REIT's (which complexity is exacerbated when a REIT owns its properties through partnerships, as we do) and the ongoing importance of actual determinations, we cannot provide any assurance that the Internal Revenue Service would not disagree with our determinations. 32 We pay some taxes Even if we qualify as a REIT, we are required to pay certain federal, state and local taxes on our income and property. ET Capital Corp., in which we have a 95% nonvoting equity interest, also is subject to federal, state and local taxes on its net income. In addition, as a taxable REIT subsidiary, ET Capital Corp. is subject to special rules that may result in increased taxes. Several Internal Revenue Code provisions ensure that a taxable REIT subsidiary is subject to an appropriate level of federal income taxation. For example, a taxable REIT subsidiary is limited in its ability to deduct interest payments made to an affiliated REIT. In addition, the REIT has to pay a 100% penalty tax on some payments that it receives if the economic arrangements between the REIT and the taxable REIT subsidiary are not comparable to similar arrangements between unrelated parties. Various factors have affected and are likely to continue to affect our common share price Various factors have affected and are likely to continue to affect our common share price, including: o our financial performance and our dependence on Genesis as the primary operator of our facilities; o the financial performance of Genesis and other lessees of our facilities; o the market prices of other healthcare REITs and the attractiveness of their equity securities in comparison to other equity securities, including securities issued by other real estate-based companies; and o general stock and bond market conditions. Our common share price is affected by changes in our earnings and cash distributions 33 We believe that the market value of a REIT's equity securities is based primarily upon the market's perception of the REIT's growth potential and its current and potential future cash distributions, and is secondarily based upon the real estate market value of the underlying assets. For that reason, our shares may trade at prices that are higher or lower than the net asset value per share. To the extent we retain operating cash flow for investment purposes, working capital reserves or other purposes, these retained funds, while increasing the value of our underlying assets, may not correspondingly increase the market price of our shares. Our failure to meet the market's expectations with regard to future earnings and cash distributions also would likely adversely affect the market price of our common shares. Legislative or regulatory tax changes may adversely affect our share price The federal income tax laws governing REIT's and other corporations or the administrative interpretations of those laws may be amended at any time. Any new laws or interpretations may take effect retroactively and could adversely affect our stock price. On January 7, 2003, the Bush Administration released a proposal intended to eliminate one level of the "double taxation" that is currently imposed on corporate income for regular C corporations by excluding corporate dividends from an individual's taxable income to the extent that corporate income tax has been paid on the earnings from which the dividends are paid. REIT's currently are tax-advantaged relative to regular C corporations because they are not subject to corporate-level federal income tax on income that they distribute to shareholders, but shareholders do include REIT dividends in taxable income. The tax treatment of REIT's generally would not be affected by the Bush Administration's proposal in its current form, except that a REIT that receives dividends from a C corporation that have been subject to corporate income tax could distribute or retain those amounts without a second tax being imposed on the REIT or its shareholders. The Bush Administration's proposal, if enacted, could cause individual investors to view stocks of regular C corporations as more attractive relative to stocks of REITs than is the case currently because part or all of the dividends on the stocks of the regular C corporation would be exempt from tax for the individual. It is not possible to predict whether in fact this change in relative perceived value will occur or whether, if it occurs, what the impact will be on the value of our stock. In any event, there can be no assurance regarding whether the Bush Administration's proposal ultimately will be enacted or the form in which it might in fact be enacted. Shares available for future sale could adversely affect the market price of our common shares At December 31, 2002, 295,560 units of limited partnership interest in the Operating Partnership are owned by minority interests. These units are redeemable by the holder for cash or, at our election, common shares, subject to certain limitations. In addition, we have reserved a total of 779,340 common shares for issuance pursuant to our 1998 share option and incentive plan, of which 595,814 are exercisable share options as of December 31, 2002. The Company also has reserved a total of 350,000 common shares for issuance pursuant to our 1999 share option and incentive plan, of which 56,388 are exercisable share options as of December 31, 2002. We cannot predict the effect that future sales of any of these common shares, or the perception that such sales could occur, will have on the market prices of our outstanding common shares. 34 Environmental problems are possible and can be costly Federal, state and local laws and regulations relating to the protection of the environment may require a current or previous owner or operator of real estate to investigate and clean up hazardous or toxic substances or petroleum product releases at the property. If unidentified environmental problems arise, we may have to make substantial payments, which could adversely affect our cash flow and our ability to make distributions to our shareholders because: o we or the operator may have to pay a governmental entity or third parties for property damage and for investigation and clean-up costs incurred by them in connection with the contamination; o environmental laws typically impose clean-up responsibility and liability without regard to whether the owner or operator knew or caused the presence of the contaminants; o even if more than one person may have been responsible for the contamination, each person covered by the environmental laws may be held responsible for all of the clean-up costs incurred; and o third parties may sue the owner or operator of a site for damages and costs resulting from environmental contamination emanating from that site. Environmental laws also govern the presence, maintenance and removal of asbestos. These laws require (1) that owners or operators of buildings containing asbestos properly manage and maintain the asbestos, (2) that they notify and train those who may come into contact with asbestos and (3) that they undertake special precautions, including removal or other abatement, if asbestos would be disturbed during renovation or demolition of a building. These laws may impose fines and penalties on building owners or operators who fail to comply with these requirements and may allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos fibers. Independent environmental consultants have conducted or updated environmental assessments at the properties in which we have an interest. These assessments included a visual inspection of the properties and the surrounding areas, an examination of current and historical uses of the properties and the surrounding areas and a review of relevant state, federal and historical documents. Where appropriate, on a property by property basis, these consultants conducted additional testing, including sampling for: asbestos, lead in drinking water, soil contamination where underground storage tanks are or were located or where other past site usage creates a potential for site impact and for contamination in groundwater. 35 These environmental assessments have not revealed any environmental liabilities at the properties that we believe would have a material adverse effect on our business, financial condition, revenues or earnings. Asbestos is present at some of our buildings. The environmental consultants have not recommended removal or encapsulation of the asbestos, except in connection with the construction, remodeling, renovation or demolition of a building. For some of our properties, the environmental assessments also note potential offsite sources of contamination such as underground storage tanks. Additionally, for some of our properties, the environmental assessments note previous uses, such as the former presence of underground storage tanks, and in these cases, documented underground storage tanks subject to regulatory requirements were either removed, replaced or otherwise brought into compliance. Failure of operators to comply with environmental laws regarding the use and disposal of hazardous substances and infectious medical wastes could adversely affect their ability to make lease payments to us The operation of healthcare facilities also involves the handling, use, storage, transportation, disposal and/or discharge of hazardous, infectious, toxic, radioactive, flammable and other hazardous materials, wastes, pollutants or contaminants. These activities may result in: o damage to individuals, property or the environment; o interruption of operations and increases in costs; o legal liability, damages, injunctions or fines; o investigations, administrative proceedings, penalties or other governmental agency actions; and o costs that are not covered by insurance. We can make no assurance that our lessees will not incur liability in connection with the use and disposal of hazardous substances and infectious medical waste, which could have a material adverse effect on their ability to make lease payments to us. ITEM 2. PROPERTIES The following table sets forth certain information comprising the Company's investments in owned real estate property as of December 31, 2002. At December 31, 2002, the Company's properties were encumbered by mortgage loans, bonds and capital lease obligations aggregating $194.4 million and bearing interest at a weighted average rate of 6.75%. These mortgage loans mature from April 2003 through September 2025. See Note 8 to the Company's Consolidated Financial Statements included in this Form 10-K for additional information. 36
Number of Annualized Property State Beds (3) Investment (4) Rental Income (5) ---------------------------------- -------- ------------ ---------------- ------------------- (dollar amounts in thousands) Assisted Living Facilities: Heritage Woods * (1) MA 126 $12,667 $1,084 Berkshire * (1) PA 75 4,791 278 Lehigh * (1) PA 75 4,265 201 Sanatoga * (1) PA 85 3,707 327 Willowbrook * (1) PA 56 6,584 300 Riverview Ridge (1) PA 105 6,700 625 Woodbridge PA 90 11,964 984 Highgate at Paoli Pointe (1) PA 85 13,793 1,253 Heritage at North Andover (1) MA 97 12,141 1,201 Heritage at Vernon Court (1) MA 115 19,126 1,780 Heritage at Cleveland Circle (1) MA 90 15,383 1,517 ------- -------- ------- Total Assisted Living 999 111,121 9,550 ------- -------- ------- Independent Living Facilities: Cabot Park (1) MA 100 18,558 1,717 Pleasant View (1) NH 72 4,174 385 ------- -------- ------- Total Independent Living 172 22,732 2,102 ------- -------- ------- Skilled Nursing Facilities: Rittenhouse CC * (1) PA 183 10,089 831 Lopatcong CC (1) NJ 153 15,141 1,310 Wayne NRC (2) PA 118 8,470 836 Belvedere NRC (1) PA 147 12,538 640 Phillipsburg CC * (1) NJ 60 2,637 181 Chapel NRC (1) PA 240 12,305 1,729 Harston Hall NCH (1) PA 196 5,716 853 Pennsburg Manor NRC (1) PA 120 11,571 1,164 La Plata (1) MD 149 13,328 1,198 Voorhees (1) NJ 190 17,725 1,600 Corsica Hills (1) MD 162 14,507 1,306 Heritage Center (1) MD 181 19,441 1,757 Multi Med (1) MD 120 5,714 501 Severna Park (1) MD 141 18,691 1,689 Westfield Center (1) NJ 233 23,731 2,150 ------- -------- ------- Total Skilled Nursing 2,393 191,604 17,745 ------- -------- ------- Medical Office and Other Buildings: Professional Office Building I PA 4,708 797 DCMH Medical Office Building PA 8,445 1,672 Salisbury Medical Office Bldg. (1) MD 1,132 16 Lacey Branch Office Building NJ 625 65 ------- -------- ------- Total Medical Office and Other 14,910 2,550 ------- -------- ------- Total Properties: 3,564 $340,367 $31,947 ------- -------- -------
37 * Represent properties included in the Company's borrowing base for the Guidance Line and pledged as collateral. (1) Represent properties that are leased to and/or managed by Genesis or Genesis Equity Investees. Genesis has guaranteed these leases. See "Dependence on Genesis." Heritage at North Andover has a one year rent guarantee, Heritage at Vernon Court, Heritage at Cleveland Circle and Cabot Park each have a 2 year rent guarantee. (2) Represents property managed by Genesis but leased by an unrelated third party. See "Dependence on Genesis." (3) Based upon the number of private and semi-private beds in service at December 31, 2002. (4) Includes investments in real estate properties aggregating $328.1 million, before reductions for accumulated depreciation of $44.9 includes credit enhancements on several properties aggregating $12.3 million. Credit enhancements include bond and operating reserve funds aggregating $6.3 million, security deposits of $5.4 million and mortgage escrow accounts of $0.6 million. (5) Reflects contract rate of annual base rent under fixed and minimum rent leases and estimated rent under percentage rent leases assuming rental income for these properties consistent with 2002. The Company holds a fee interest in each of its properties except for leasehold interests in the Professional Office Building I, La Plata, Vorhees, Corsica Hills, Heritage Center, Multi Med, Severna Park, Westfield Center and DCMH Medical Office Building in which the Company owns a condominium unit. Each of the Company's skilled nursing and senior housing facilities, which includes the land (if owned), buildings, improvements and related rights, are leased principally to healthcare providers pursuant to long-term triple net leases. The leases generally have remaining terms of 5 to 9 years and contain multiple five to ten-year renewal options. These properties are leased principally under percentage and minimum rent leases. These lessees are required to insure, repair, rebuild and maintain the leased properties. The leases with tenants in the medical office and other buildings are generally fixed rent leases, which provide for specified annual rents, subject to annual increases in some of the leases. Generally, these leases are for a five-year period. Some of the lessees are required to insure, repair, rebuild and maintain the leased properties. The Company believes that its leased properties are adequately insured under insurance policies maintained by the lessees. See "Business - Investments - Owned Property - Operating Leases." 38 ITEM 3. LEGAL PROCEEDINGS None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The following table sets forth the high and low sales prices of the Company's common stock on the New York Stock Exchange for the periods indicated. There were no distributions made during these periods. At March 21, 2003, there were approximately 69 holders on record of the Company's common shares.
Quarter Ended High Low ----------------- ------- ------ December 31, 2002 $7.90 $6.06 September 30, 2002 8.00 6.16 June 30, 2002 8.46 7.75 March 31, 2002 8.49 7.55 December 31, 2001 $8.85 $6.83 September 30, 2001 7.50 5.00 June 30, 2001 5.19 3.45 March 31, 2001 3.75 2.38
On December 4, 2002, the Company issued a press release addressing its dividend distribution policy. The Company stated that it intends to resume regular quarterly distributions to the holders of its common shares and that the initial distribution is expected to be declared in mid-April, 2003. The Company estimates that, based upon its current estimate of operations and cash requirements, the per share distribution will be $0.64 per year, or $0.16 per quarter. To qualify as a REIT, the Company must distribute with respect to each year at least 90% of its taxable income, excluding any net capital gain, to its shareholders. ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial data is derived from the consolidated financial statements of the Company. The 2002 data include the consolidation of three entities that hold leasehold and purchase option rights to seven skilled nursing facilities and that own one assisted living facility and one independent living facility. The Company previously accounted for its investment in these properties under the equity method. As a result of the consolidation of these entities, the Company's total assets, debt, investments in unconsolidated entities, rental revenue, interest, depreciation expense and equity in losses of unconsolidated entities as of and for the year ended December 31, 2002 changed significantly. The following data should be read together with the Company's consolidated financial statements and related notes, and the other financial information included in this Form 10-K, including "Management's Discussion and Analysis of Financial Condition and Results of Operations." 39
2002 2001 2000 1999 1998 ------------------------------------------------------------- (in thousands, except per share data) Operating Data: Revenues $25,329 $25,416 $ 26,368 $ 27,950 $21,033 Expenses: Property expenses 1,289 1,181 1,063 1,076 940 Interest expense 10,167 11,634 13,911 13,106 6,256 Depreciation and amortization 7,117 5,634 5,806 5,745 4,421 General and administrative, separation agreement and start-up expenses 2,452 3,220 3,592 5,404 4,648 Loss on impairment of long-lived assets 2,119 450 5,306 - - Bad debt expense - 116 9,522 - - ------------------------------------------------------------- Total expenses 23,144 22,235 39,200 25,331 16,265 ------------------------------------------------------------- Equity in losses of unconsolidated entities, net (1,364) (2,590) (10,010) (2,482) (648) Minority interest (53) (42) 1,530 (15) (265) ------------------------------------------------------------- Net income (loss) from continuing operations before extraordinary item 768 549 (21,312) 122 3,855 Income (loss) from discontinued operations (262) (25) (18) 58 118 ------------------------------------------------------------- Net income (loss) before extraordinary item 506 524 (21,330) 180 3,973 Extraordinary item, net of minority interest - - - (1,210) - ------------------------------------------------------------- Net income (loss) $ 506 $ 524 ($21,330) ($ 1,030) $ 3,973 ============================================================= Per share information: Basic net income (loss) per share: -------------------------------------- Weighted average common shares outstanding 7,401 7,184 7,119 7,198 7,369 ------------------------------------------------------------- Net income (loss) per share from continuing operations $0.10 $0.07 ($3.00) $0.02 $0.52 Net income (loss) per share on discontinued operations ($0.03) - - $0.01 $0.02 Net loss per share on extraordinary item - - - ($0.17) - Net income (loss) per share $0.07 $0.07 ($3.00) ($0.14) $0.54 Diluted net income (loss) per share: ----------------------------------------- Weighted average common shares outstanding 7,708 7,442 7,119 7,198 7,369 ------------------------------------------------------------- Net income (loss) per share from continuing operations $ 0.10 $ 0.07 ($3.00) $ 0.02 $ 0.52 Net income (loss) per share on discontinued operations (0.03) - - $ 0.01 $ 0.02 Net loss per share on extraordinary item - - - ($0.17) - Net income (loss) per share $ 0.07 $ 0.07 ($3.00) ($0.14) $ 0.54 ------------------------------------------------------------- Distributions per share $ 0.00 $ 0.00 $ 0.60 $ 1.46 $ 0.97 =============================================================
40
December 31, December 31, December 31, December 31, December 31, 2002 2001 2000 1999 1998 ----------------------------------------------------------------------------- (in thousands) Balance Sheet Data: Real estate properties, net $282,983 $166,660 $149,804 $171,681 $176,129 Real estate loans receivable, net - - 41,559 48,646 47,899 Guidance Line/Bank Credit Facility 3,067 7,174 38,720 39,670 90,204 Mortgages, bonds, lease and notes payable 209,740 107,715 108,947 110,084 53,728 Total liabilities 220,562 119,916 152,931 155,053 149,162 Total shareholders' equity 82,744 80,998 80,099 103,440 113,296 Other Data: Cash flow provided by operating activities 10,671 11,101 7,430 16,727 13,742 Cash flow provided by (used in) investing activities 761 20,887 (256) (4,855) (205,402) Cash flow provided by (used in) financing activities (6,710) (32,417) (7,674) (10,539) 193,932
The following is a summary of capital expenditures for the periods presented:
------------------------------------------------------------------- 2002 2001 2000 1999 1998 ------------------------------------------------------------------- (in thousands) Recurring capital expenditures: Corporate / Administrative $ 205 $ - $ 8 $ 36 $ 5 Capital improvements 28 30 - 5 238 ------------------------------------------------------------------- 233 30 8 41 243 ------------------------------------------------------------------- Major renovations 300 111 126 1,289 - ------------------------------------------------------------------- Total capital expenditures $ 533 $ 141 $ 134 $ 1,330 $ 243 ===================================================================
Recurring capital expenditures include those expenditures made in the normal course of operations for corporate/administrative items and for routine improvements to the Company's existing properties. 41 Major renovations include those expenditures which are larger in scope than recurring capital expenditures both in dollar value and time to complete and generally enhance the marketability and revenue producing capacity of the property. The following table presents the Company's Funds from Operations for the periods presented:
2002 2001 2000 1999 (1) 1998 (1) ------------------------------------------------------------------ (in thousands) Funds from Operations: Net income (loss) $ 506 $ 524 ($21,330) ($1,030) $3,973 Minority interest 53 42 (1,530) (67) 273 Minority interest from discontinued operations (12) (1) (1) - - ------------------------------------------------------------------ Net income (loss) before minority interest 547 565 (22,861) (1,097) 4,246 Adjustments to derive funds from operations: Add: Depreciation and amortization: Consolidated entities 7,119 5,660 5,976 5,963 4,664 Unconsolidated entities 3,367 4,488 4,489 4,492 1,243 Impairment charges on real estate properties 2,434 450 5,306 - - Extraordinary loss on debt extinguishment - - - 1,296 - ------------------------------------------------------------------ Funds from Operations before allocation to minority interest 13,467 11,163 (7,090) 10,654 10,153 Funds from Operations allocable to minority interest (602) (584) 470 (715) (635) ------------------------------------------------------------------ Funds from Operations attributable to the common shareholders $12,865 $10,579 ($6,620) $ 9,939 $9,518 ------------------------------------------------------------------
(1) The White Paper on Funds from Operations approved by the Board of Governors of NAREIT in October, 1999 defines Funds from Operations as net income (loss), computed in accordance with generally accepted accounting principles, excluding gains (or losses) from sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect funds from operations on the same basis. The Company believes that Funds from Operations is helpful to investors as a measure of the performance of an equity REIT because, along with cash flow from operating activities, financing activities and investing activities, it provides investors with an indication of the ability of the Company to incur and service debt, to make capital expenditures and to fund other cash needs. The Company computes Funds from Operations using standards established by NAREIT which may not be comparable to Funds from Operations reported by other REITs that do not define the term using the current NAREIT definition or that interpret the current NAREIT definition differently than the Company. Funds from Operations does not represent cash generated from operating activities using generally accepted accounting principles and should not be considered as an alternative to net income as an indication of the Company's financial performance, or to cash flow from operating activities as a measure of the Company's liquidity, nor is it indicative of funds available to fund the Company's cash needs, including its ability to make cash distributions. Effective January 1, 2000, Funds from Operations includes both recurring and non-recurring results of operations, except those results defined as "extraordinary items" under generally accepted accounting principles and gains and losses from sales of depreciable operating property. For comparative purposes, Funds from Operations for periods prior to 2000 have been restated to conform to the new definition of Funds from Operations. 42 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The Company is a self-managed and self-administered real estate investment trust ("REIT") that invests principally in senior housing and other healthcare facilities, primarily skilled nursing facilities, assisted and independent living facilities (or "senior living centers") and medical office and other buildings. The Company is the general partner of, and conducts all of its operations through, ElderTrust Operating Limited Partnership (the "Operating Partnership"). At December 31, 2002, the Company owned a 96.2% interest in the Operating Partnership. The Company's consolidated assets consist primarily of the assets of the Operating Partnership and its consolidated subsidiaries. At December 31, 2002, the Company's consolidated assets primarily consisted of a diversified portfolio of 32 healthcare properties with a net book value of $283.0 million. The portfolio consists of eleven assisted living facilities, fifteen skilled nursing facilities (seven of which are leased by the Company), two independent living facility and four medical office and other buildings. Senior living centers comprised approximately 96% of the Company's consolidated assets at December 31, 2002. Approximately 86% of the Company's consolidated assets at December 31, 2002 consisted of real estate properties leased to or managed by subsidiaries of Genesis or entities in which it has made equity investments ("Genesis Equity Investees"), which are leased or subleased to the prior owners or third parties. Revenues recorded by the Company in connection with these leases aggregated $18.3 million in 2002. As a result of these relationships with Genesis, the Company's revenues and ability to meet its obligations depend, in significant part, upon the ability of Genesis and Genesis Equity Investees to meet their lease obligations. Genesis emerged from bankruptcy in October 2001. Any failure of these entities to continue their operations and/or to continue to make lease payments to the Company could have a significant adverse impact on the Company's operations and cash flows due to the significant portion of our properties leased to such entities. Possible Spin-Off by Genesis of its Eldercare Business In February 2003, Genesis announced that its Board of Directors had approved the spin-off of its ElderCare business. This business includes our tenants that are currently owned, in whole or in part, by Genesis, as well as Genesis' other senior housing asset-based businesses. Under our lease terms, any assignment of the leases to a party in which Genesis has no ownership interest would require our consent. Such consent may not be unreasonably withheld. If the leases are assigned with our consent, the Genesis guarantee would be eliminated. However, we would be entitled to obtain guarantees from other parties in control of the tenant. Conversely, if the leases are assigned without our consent, the Genesis guarantee would remain in effect. We believe that the transaction proposed by Genesis may constitute an assignment of the leases. As a result, the transaction may require our consent should Genesis desire to eliminate its obligations under its guarantees. In determining whether to provide our consent, we intend to evaluate the current and expected operating performance of the leased properties and determine the need for, and availability of, substitute credit enhancements. The spin-off is expected to be completed during the latter part of 2003. To date, Genesis has not provided us with any financial information regarding the proposed spin-off nor has Genesis requested to be released from its guarantees although we expect that it will do so. 43 Critical Accounting Policies 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 vary from those estimates. The Company's critical accounting policies are as follows: Impairment of Long-Lived Assets The Company reviews its long-lived assets for impairment under criteria set forth under accounting principles generally accepted in the United States of America. These criteria require that a review be performed whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Once circumstances require a review the asset is tested to determine if it is impaired. An asset is impaired if the carrying amount of an asset is greater than the future net cash flows, measured on an absolute basis, expected to be generated by the asset. If the asset is impaired, the Company records an impairment charge equal to the asset's carrying amount over its estimated fair value. Discontinued Operations When management intends to dispose of a property and meets other criteria set forth under accounting principles generally accepted in the United States of America, the Company classifies the operating results of properties it intends to dispose of as discontinued operations. At that time, the Company performs an analysis of the property's cash flows and records any adjustment necessary to reduce the carrying value to the properties fair value less cost to sell. Revenue Recognition The Company's real estate assets are leased to operators primarily through long-term triple-net leases. These leases generally take the form of percentage, minimum or fixed rents. Lease payments are recognized as revenue when earned, based on the provisions of the underlying leases. The Company reports base rental revenue on these leases using the straight-line method over the terms of the respective leases. The Company records an unbilled rent receivable or payable representing the amount that the straight-line rental revenue exceeds or reduces the rent currently collectible under the lease agreements. Investments in Unconsolidated Entities The Company has several investments in entities in which the controlling voting interests were owned by Mr. D. Lee McCreary, Jr., the Company's President, Chief Executive Officer and Chief Financial Officer. The Company uses the equity method to account for investments in subsidaries in which it does not have a controlling interest. The Company determines its ability to control these entities based upon its percentage of the voting interest. The Company evaluates its ability to control periodically and upon changes in ownership of the subsidiaries. During 2002 the Company acquired a controlling interest in three of these investments. 44 Results of Operations Year ended December 31, 2002 compared to the year ended December 31, 2001 General During September 2002, the Company acquired, or obtained options to acquire, from the Company's President and Chief Executive Officer the controlling 1% ownership interests in three entities, ET Sub Meridian Limited Partnership, LLP, ("Meridian"), ET Sub-Cabot Park, LLC, ("Cabot") and ET Sub-Cleveland Circle, LLC, ("Cleveland"), that hold leasehold and purchase option rights to seven skilled nursing facilities and that own one assisted living facility and one independent living facility. During the option period, Mr. McCreary has surrendered operational control to the Company. The Company owned a 99% non-controlling interest in these entities since 1998. The Company previously accounted for its investment in these entities under the equity method. As of September 30, 2002, the Company consolidated the respective balance sheets of Meridian, Cabot and Cleveland with the Company's other operations. The results of operations of these entities are consolidated into the Company's consolidated statement of operations beginning October 1, 2002. As a result of this transaction, the Company's total assets, debt, investments in unconsolidated entities, rental revenue, interest, depreciation expense and equity in losses of unconsolidated entities changed significantly, however, net income was not materially changed. See Note 6 to the Company's Consolidated Financial Statements for supplemental pro forma results of operations as if the consolidation had been completed as of the beginning of the periods presented. 45 Revenues Rental revenues were $21.9 million for 2002 as compared to $18.6 million for 2001. Rental revenues attributable to Genesis and Genesis Equity Investees totaled $18.3 million, or 72% of total rental revenues, for 2002 compared to $14.8 million, or 79% of total revenues for 2001. The increase in rental revenues in 2002 is primarily due to the consolidation of Meridian, Cabot and Cleveland beginning in the fourth quarter of 2002. Interest income was $0.3 million for 2002 as compared to $2.7 million for 2001. This decrease was a result of repayments of real estate loan receivables made to the Company during 2001. Interest from investments in unconsolidated equity investees was $2.9 million for 2002 as compared to $3.9 million for 2001. This decrease is primarily due to the consolidation of Meridian, Cabot and Cleveland beginning in the fourth quarter of 2002. Approximately $2.4 million of interest income was recorded on loans made to Meridian, Cabot and Cleveland during 2002. These amounts will no longer be recognized in subsequent periods due to the elimination of these receivables following the consolidation of Meridian, Cabot and Cleveland as of September 30, 2002. Expenses Property operating expenses principally relate to medical office buildings, which are subject to leases that do not require the lessees to pay all property operating expenses. Property operating expenses for these properties were $1.3 million for 2002 compared to $1.2 million for 2001. Property operating expenses as a percentage of medical office building rental revenues decreased to 39.6% for 2002 from 41.4% for 2001. Interest expense, which includes amortization of deferred financing costs of $0.5 million, was $10.2 million for 2002 as compared to $11.6 million, including amortization of deferred financing costs of $0.7 million for 2001. The decrease of $1.4 million is due to lower LIBOR rates during 2002. The weighted average interest rate on outstanding third party debt decreased from 7.1% at December 31, 2001 to 6.8% at December 31, 2002. The Company's interest rate on the Guidance Line was 4.67% at December 31, 2002 compared to the rate on its Bank Credit Facility of 5.44% at December 31, 2001 on the Bank Credit Facility. Total debt increased from $114.9 million at December 31, 2001 to $212.8 million at December 31, 2002. This increase in debt is primarily the result of the consolidation of Meridian, Cabot and Cleveland beginning September 30, 2002. 46 Depreciation and amortization was approximately $7.1 million for 2002 compared to $5.6 million for 2001. This increase is primarily due to the consolidation of Meridian, Cabot and Cleveland beginning in the fourth quarter of 2002. General and administrative expense was approximately $2.5 million for 2002 compared to $3.2 million for 2001. This reduction is primarily due to a decrease in legal fees of approximately $0.9 million due to completion of the Genesis lease and loan restructuring transactions in January 2001 and the execution of the amended lease agreements. Loss on impairment of long-lived assets was $2.1 million for 2002 and $0.5 million for 2001. This increase is due principally to the $2.1 million asset impairment charge recorded by the Company on its Harston Hall property that, along with the Pennsbury property, secure a $14.9 million mortgage loan that matures on April 10, 2003. The impairment charge was recorded due to changes in the expected holding period of the property. Equity in Losses of Unconsolidated Subsidiaries Equity in losses of unconsolidated subsidiaries decreased principally due to the consolidation of Meridian, Cabot and Cleveland beginning in the fourth quarter of 2002. Loss from Discontinued Operations The Salisbury Medical Office Building, located in Salisbury, Maryland, was classified as held for sale in June 2002. After adjusting for an impairment charge of $315,000, the property has a net carrying value of $926,000 as of December 31, 2002. The loss from discontinued operations for 2002 was $262,000 as compared to a net loss of $25,000 for the corresponding period in 2001. The increase is due to the recording of the impairment charge in 2002. The Company sold the Salisbury Medical Office Building at a purchase price of approximately $1.0 million, the proceeds were used to payoff the $1.0 million in debt secured by the property. Year ended December 31, 2001 compared to the year ended December 31, 2000 Revenues Rental revenues were $18.6 million for 2001 as compared to $18.4 million for 2000. Rental revenues attributable to Genesis and Genesis Equity Investees totaled $14.8 million, or 79% of total rental revenues, for 2001 compared to $14.8 million, or 80% of total revenues for 2000. Interest income was $2.7 million for 2001 as compared to $4.5 million, net of amortization of deferred loan costs of $145,000 for 2000, a 40.2% decrease. This decrease is due to the repayment of the underlying loans by the borrowers during 2001. 47 Interest income from investments in unconsolidated equity investees was $3.9 million for 2001 as compared to $3.3 million for 2000. This represents a 20.5% increase over the prior year which is primarily due to the interest payments received by the Company related to a $8.5 million note receivable from Meridian, an unconsolidated subsidiary of the Company. This note receivable was transferred to the Company in January 2001 as part of the Genesis restructuring. Expenses Property operating expenses principally relate to medical office buildings, which are subject to leases that do not require the lessees to pay all property operating expenses. Property operating expenses for these properties were $1.2 million for 2001 compared to $1.1 million for 2000. Property operating expenses as a percentage of medical office building rental revenues increased to 43.5% for 2001 from 38.2% for 2000. Interest expense, which includes amortization of deferred financing costs of $0.7 million, was $11.6 million for 2001 as compared to $13.9 million, including amortization of deferred financing costs of $0.6 million for 2000. The decrease of $2.3 million is due to lower LIBOR rates and lower third party debt balances outstanding. The weighted average interest rate on outstanding third party debt decreased from 8.5% at December 31, 2000 to 7.1% at December 31, 2001. The Company's interest rate on the Bank Credit Facility was 5.44% at December 31, 2001 compared to 9.63% at December 31, 2000. Depreciation and amortization was approximately $5.6 million for 2001 compared to $5.8 million for 2000. This decrease is primarily due to the Woodbridge property being held for sale during 2001. During the held for sale period the property was not depreciated, as required under SFAS No. 121,"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of". General and administrative expense was approximately $3.2 million for 2001 compared to $3.6 million for 2000. This decrease is primarily due to decreased compensation for officers of approximately $0.2 million, a decrease of $0.7 million in connection with expenses related to property due diligence transactions offset, in part, by an increase in legal expenses of approximately $0.6 million relating to the Genesis and Multicare lease and loan restructuring transactions that took place in January 2001 following Genesis' June 2000 chapter 11 bankruptcy filing and the resolution of the Woodbridge property new lease agreement. Bad debt expense was $0.1 million for 2001 and $9.5 million for 2000. The bad debt expense recorded in 2000 resulted from impairment charges recorded on real estate loans receivable of $7.1 million, investments in and advances to unconsolidated entities of $1.4 million and a note receivable from a former officer of the Company of $990,000. Loss on impairment of long-lived assets was $0.5 million for 2001 and $5.3 million for 2000. The loss on impairment of long-lived assets recorded in 2000 resulted primarily from fair market value adjustments on real estate properties held for sale at December 31, 2000. 48 Equity in Losses of Unconsolidated Subsidiaries The net losses recorded by the Company for its investment in unconsolidated subsidiaries were $2.6 million for 2001 and $10.0 million for 2000. The net decrease in net equity in losses of unconsolidated subsidiaries is primarily due to the Company recording its share of a bad debt expense of $7.8 million recorded by ET Capital during 2000. See Note 6 to the Company's Consolidated Financial Statements for additional information. Liquidity and Capital Resources During August 2002, the Company entered into a new, 18-month credit agreement with Wachovia Bank. The more significant terms of the new Guidance Line are: * 18-month term; * recourse loan secured by all properties not otherwise securing other loans; * borrowings up to $7.5 million in the aggregate upon lender approval, subject to borrowing base limits; * quarterly principal payments of $500,000; * interest calculated at 325 basis points over LIBOR, which was elected by the Company, or an alternate rate of Wachovia Bank prime plus 0.5%, at borrower's election; and * distributions to shareholders limited to 90% of funds from operations. The amounts outstanding under the Guidance Line bear interest at a floating rate of 3.25% over LIBOR, or 4.67% at December 31, 2002. As noted previously, on January 27, 2003, the Company paid approximately $3.1 million to Wachovia Bank to pay-off the outstanding balance under the Guidance Line. Cash provided by operating activities was $10.7 million for 2002 as compared to $11.1 million for 2001. Net cash provided by operating activities for 2002 is comprised of net income adjusted for non cash items of $12.0 million offset by changes in assets and liabilities of $1.3 million. Net cash provided by operating activities was $11.1 million for 2001 as compared to $7.5 million for 2000. This increase in cash of $3.6 million is comprised of the following (a) an increase in net income of $21.8 million offset, in part, by (b), the net decrease in bad debt of $9.4 million, (c) the net decrease in loss on impairment of long-lived assets of $4.9 million, (d) the net decrease in minority interest and equity in losses from unconsolidated entities of $5.8 million, (e) the net decrease in depreciation and amortization of $0.2 million and (f) increased by the net change in operating assets and liabilities of $2.1 million. Net cash provided by investing activities was $0.8 million for 2002 compared to $20.9 million for 2001. Net cash provided by investing activities for the year ended December 31, 2001 included $21.7 million received in principal payments on loans receivable offset, in part, by a $0.8 million net increase in deposits and restricted cash and $0.1 million in capital expenditures. 49 Net cash provided by investing activities was $20.9 million for 2001 compared to net cash used in investing activities of $0.3 million for 2000. Net cash provided by investing activities for the year ended December 31, 2001 included (a) $21.7 million received in principal payments on loans receivable, (b) $0.2 million in proceeds from affiliates offset by (c) $0.8 million net increase in deposits and restricted cash. Net cash used in financing activities was $6.7 million for 2002 compared to $32.4 million for 2001. The decrease in net cash used was due to a net decrease of $27.0 million related to payments on the Company's Bank Credit Facility and the Company's Guidance Line offset, in part, by the increase in payments on mortgages payable of $0.6 million. Net cash used in financing activities was $32.4 million for 2001 compared to $7.7 million for 2000. The net cash used in financing activities for 2001 principally included $31.4 million in payments on the Credit Facility and $1.2 million in payments on mortgages. Net cash used in financing activities for 2000 included (a) $0.8 million in payments of deferred financing fees, (b) $1.0 million in payments on the Credit Facility, (c) $1.1 million in payments on mortgages payable, (d) $4.6 million in distributions to shareholders and minority interests and (e) $0.2 million related to the purchase of partnership units. The Company's working capital deficit was $14.3 million and $49.6 million at December 31, 2002 and 2001, respectively. The decrease in the working capital deficit at December 31, 2002 compared to 2001 was primarily due to the inclusion in current liabilities, at December 31, 2001, of three mortgages with unpaid principal balances totaling $14.8 million which were in default based on technical requirements in the leases and two mortgages secured by three properties with unpaid principal balances totaling $25.1 million that matured originally in December 2002. The Company has not received notice of default or acceleration on these loans. Therefore the Company does not consider them to be a current liability. See Note 8 of the Company's Consolidated Financial Statements for additional information. The 2002 working capital deficit also includes the $2.0 million current portion of the $3.1 million outstanding balance with the Guidance Line at December 31, 2002, which was required to be repaid by August 31, 2003. As discussed above, on January 27, 2003, the Company paid $3.1 million to Wachovia Bank to pay off the balance due under the Guidance Line. As of January 31, 2003, the Company has, $7.5 million available for future borrowings under the Guidance Line, subject to lender approval and borrowing limitations. Cash and cash equivalents were $7.4 million and $2.7 million at December 31, 2002 and December 31, 2001, respectively. The Company's management believes that available cash and cash equivalents should be sufficient to satisfy the Company's short-term working capital needs. Of the $7.4 million in cash at December 31, 2002, $3.1 million was used to pay off the Guidance Line on January 27, 2003. The Company had three non-recourse mortgage loans secured by four properties with an aggregate principal balance of $30 million that matured in December 2002. The Company announced in November 2002 that the maturity date of one loan, secured by the Lopatcong property, had been extended until December 1, 2004. In February 2003, the lender also extended a $4.6 million mortgage loan secured by the Wayne property to December 1, 2004. In connection with the extension, the Company made a $1.1 million payment and reduced the balance outstanding from $4.6 million to $3.5 million. The lender has extended the maturity date of the remaining mortgage loan of $14.9 million, which is secured by the Harston Hall and Pennsburg properties, until April 10, 2003 to allow time for the lender and the Company to negotiate a resolution of this loan. If the maturity date of this mortgage is not extended by the lender and the lender foreclosed on these properties securing the mortgages, the Company would lose the properties and the revenues it derives from the properties. Based upon conversations with the lender, several alternatives appear to be available to satisfy the Company's obligation under the loan, which may include, among other alternatives, a further extension as a cash flow mortgage, sale or a title transfer via a "deed in lieu of foreclosure" transaction. At December 31, 2002, the Harston Hall and Pennsburg properties had a net book value of $13.8 million. During 2002, the Company derived $2.0 million of revenue and net income of $0.5 million from the properties. 50 As of December 31, 2002, the Company had shareholders' equity of $82.7 million and Guidance Line borrowings, capital lease obligations and mortgages, bonds and notes payable, aggregating $212.8 million, which represents a debt to equity ratio of 2.57 to 1. This is an increase from 1.42 to 1 at December 31, 2001. This increase is primarily due to a net increase in mortgages payable and capital lease obligations of $99.1 million resulting from the consolidation of Meridian, Cabot and Cleveland. On December 4, 2002, the Company issued a press release addressing the dividend distribution policy. The Company stated that it intends to resume regular quarterly distributions to the holders of its common shares and that the initial distribution is expected to be declared in mid-April, 2003. The Company estimates that, based upon its current estimate of operations and cash requirements, the per share distribution will be $0.64 per year, or $0.16 per quarter. Distributions by the Company are at the discretion of its Board of Trustees. At December 31, 2002, the Company's third party indebtedness of $209.0 million consisted of $33.1 million in variable rate debt and $175.9 million in fixed rate debt. The weighted average annual interest rate on this debt was 6.82% at December 31, 2002. Based on interest rates at December 31, 2002, annual debt service requirements related to this debt approximate $14.5 million. Future increases in interest rates, as well as any defaults by tenants on their leases, could adversely affect the Company's cash flow and its ability to pay its obligations. Facilities owned by the Company and leased to tenants under percentage and minimum rent triple net leases require the lessee to pay substantially all expenses associated with the operation of such facilities. Facilities owned by the Company and subject to percentage and minimum rent leases represent approximately 87% of the Company's revenues at December 31, 2002. As a result of these arrangements, the Company does not believe it will be responsible for significant expenses in connection with the facilities during the terms of the leases. However, there can be no assurance the Company will not be responsible for significant expenses of its leased properties in the event one or more of its lessees default on their leases with the Company. During 2000, the Company recorded significant bad debt expenses due to the Genesis bankruptcy filing related to loans and properties under lease and, as a result, recognized a net loss for financial reporting purposes. For federal income tax purposes, these losses totaling approximately $13.5 million were recorded in 2001 as required under applicable income tax rules. These losses will reduce the amount otherwise required by the Company to be distributed to meet REIT requirements. 51 Contractual Obligations and Commercial Commitments The following table represents the Company's contractual obligations as of December 31, 2002 (amounts in thousands):
Payments due by period: -------------------------------------------------------------- Less than 1 to 2 3 to 4 5 years Contractual Obligations: Total 1 year years years and after ---------------------------------------------------------------------------------------------------------- Long-term debt $209,740 $18,671 $23,570 $9,439 $ 158,060 Guidance Line (1) 3,067 2,000 1,067 Operating leases 817 163 168 173 313 -------------------------------------------------------------- Total contractual obligations $213,624 $20,834 $24,805 $ 9,612 $ 158,373 ==============================================================
(1) On January 27, 2003, the Company paid approximately $3.1 million to Wachovia Bank to pay off the Guidance Line. See Item 7A. "Qualitative and Qualitative Disclosures About Market Risk", and Note 8 of the Company's Consolidated Financial Statements for additional information. As of December 31, 2002 the Company's commercial commitments consisted of the following: The Company provided two letters of credit aggregating $1.0 million in connection with the Woodbridge and Highgate bond documents. At December 31, 2002, the Company's total assets increased to $306.8 million from $205.6 million at December 31, 2001. This increase is primarily due to the consolidation of Meridian, Cabot and Cleveland as of September 30, 2002. The Company owns the leasehold and purchase option rights to seven skilled nursing facilities located in Maryland and New Jersey. The seven skilled nursing facilities are subleased to subsidiaries of Genesis. Genesis has guaranteed the subleases. The purchase options are exercisable in September 2008 for a cash exercise price of $66.5 million. In connection with its acquisition of a 99% interest in Meridian in 1998, the Company agreed to indemnify the property owners for any loss of deferral of tax benefits prior to August 31, 2008 due to a default under a sublease or if a cure of a default by the Genesis subsidiary leasing the facilities resulted in a taxable event to the owners. The Company also agreed to indemnify Genesis for any amounts expended by Genesis under the back-up indemnity provided by Genesis to the current owners for the same loss. The Company's maximum remaining exposure under these indemnity agreements is $9.1 million. Additionally, the Company entered into an agreement in 1998 with respect to Cabot, Cleveland, Vernon Court and Heritage Andover (collectively, the "NDNE properties") that allow all deductions for depreciation and low income housing tax credits ("LIHTC") on the NDNE properties to be allocated to the holders of the class C (LIHTC) units of limited partnership interest of the Operating Partnership through 2012. The agreement further states that, in the event that prior to December 31, 2012, the Operating Partnership either disposes of all or any portion of its interests in the NDNE properties or takes any other action with respect to the NDNE properties that causes the qualified basis to be less than the amount thereof on the date of purchase and solely by reason of such disposition or other action all or any part of the LIHTC's actually allowed to the holders of the class C (LIHTC) units are subject to recapture pursuant to Section 42(j) of the Internal Revenue Code, the Operating Partnership shall pay to such holders of the class C (LIHTC) units cash in an amount equal to the "credit recapture amount", if any, payable by the holders of the class C (LIHTC) units solely as the result of such disposition or other action. The Operating Partnership also covenants that in the event that prior to December 31, 2013, the Operating Partnership either disposes of all or any portion of the Operating Partnership's interest in the NDNE properties or takes any other action with respect to the NDNE properties that causes the holders of the class C (LIHTC) units to have to recognize a "recapture" of all or any portion of the Depreciation deductions that have been specially allocated to them, the Operating Partnership will pay to the holders of the class C (LIHTC) units cash in an amount equal to the excess of (a) 38% of such depreciation deductions that are required to be recaptured solely as the result of such disposition or other action over (b) the discounted present value of such amount, discounted from December 31, 2013 to the last day of the calendar year in which depreciation deductions are recaptured. 52 Financial Covenants The Guidance Line contains various financial and other covenants, including, but not limited to, minimum fixed charge ratio, minimum tangible net worth, a total leverage ratio and minimum interest coverage ratio. Certain of the Company's other indebtedness also contains various financial and other covenants. At December 31, 2002, the Company was in compliance with these requirements. The following table sets forth the material financial covenants to which we are subject under the Guidance Line and our other indebtedness, and the degree to which we complied with those covenants as of December 31, 2002:
Financial Covenant Required Ratio/Test Actual Ratio/Test --------------------------------------------------------------------------------------------------- Minimum tangible net worth $75.0 million $86.2 million Total leverage ratio Less than 65% 54.8% Minimum interest coverage ratio Greater than 1.75 2.20 Minimum fixed charge ratio Greater than 1.50 1.58 EBITDA to interest expense (1) Greater than 1.60 1.98
(1) This EBITDA interest coverage ratio increases to 1.80:1 for 2003 and to 1.90:1 after June 30, 2004. 53 Funds from Operations The following table presents the Company's Funds from Operations for the years ended December 31, 2002, 2001 and 2000:
2002 2001 2000 ---------------------------------------- (in thousands) Funds from Operations (1): Net income (loss) $ 506 $ 524 ($21,330) Minority interest 53 42 (1,530) Minority interest from discontinued operations (12) (1) (1) ---------------------------------------- Net income (loss) before minority interest 547 565 (22,861) Adjustments to derive Funds from Operations: Add: Depreciation and amortization: Consolidated entities 7,119 5,660 5,976 Unconsolidated entities 3,367 4,488 4,489 Impairment charges on real estate properties 2,434 450 5,306 ---------------------------------------- Funds from Operations before allocation to minority interest 13,467 11,163 (7,090) Funds from Operations allocable to minority interest (602) (584) 470 ---------------------------------------- Funds from Operations attributable to the common shareholders $12,865 $10,579 ($6,620) ---------------------------------------- Other Data: Cash flow provided by operating activities $10,671 $11,101 $7,430 ---------------------------------------- Cash flow provided by (used in) investing activities $ 761 $20,887 $ (256) ---------------------------------------- Cash flow used in financing activities ($6,710) ($32,417) ($7,674) ----------------------------------------
(1) For information on the definition of Funds from Operations, see footnote 1 to the Funds from Operations table under "Selected Financial Data." 54 Impact of Inflation Earnings of the Company are primarily from long-term investments with fixed interest rates and fixed and percentage rental streams. These investments are mainly financed with a combination of equity, long-term mortgages and borrowings under the revolving lines of credit. During inflationary periods, which generally are accompanied by rising interest rates, the Company's ability to grow may be adversely affected because the yield on new investments may increase at a slower rate than new borrowing costs. Recent Accounting Pronouncements See the Company's Consolidated Financial Statements and related notes for information relating to the impact on the Company of new accounting pronouncements. Summary Condensed Consolidated Financial Data of Genesis As leases with Genesis represent a significant portion of the Company's consolidated assets and revenues, the Company has included certain summary condensed consolidated financial data of Genesis for the periods discussed below. The summary condensed consolidated financial data of Genesis was taken from Genesis' annual report on Form 10-K for the year ended September 30, 2002 and from Genesis' quarterly report on Form 10-Q for the quarter ended December 31, 2002 as filed with the Securities and Exchange Commission (the "Commission") under the Securities Exchange Act of 1934, as amended, (the "Exchange Act"). Genesis is subject to the information filing requirements of the Exchange Act, and in accordance therewith, is obligated to file periodic reports, proxy statements and other information with the Commission relating to its business, financial condition and other matters. Such reports, proxy statements and other information may be inspected at the offices of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and should also be available at the following Regional Offices of the Commission: 7 World Trade Center, New York, N.Y. 10048, and 500 West Madison Street, Suite 1400, Chicago, IL 60661. The SEC also maintains an Internet web site that contains reports, proxy statements and other information regarding issuers, like Genesis, that file electronically with the SEC. The address of that site is http://www.sec.gov. 55 The following table sets forth certain summary condensed consolidated financial data for Genesis as of and for the quarter ended December 31, 2002 and the years ended September 30, 2002 and 2001.
For the quarter ended For the years ended December 31, September 30, --------------------------------------- 2002 2002 2001 --------------------------------------- (in thousands except per share data) --------------------------------------- Successor Successor Successor --------------------------------------- Net revenues $669,511 $2,623,679 $2,452,171 Operating income before debt restructuring, reorganization costs and capital and other costs (1) 63,346 253,166 126,460 Debt restructuring and reorganization costs - 4,270 1,083,407 Loss on sale of assets - - 540 Depreciation and amortization 16,671 63,102 104,394 Lease expense 7,162 27,716 35,011 Interest expense, net 11,405 47,963 118,552 -------------------------------------- Income (loss) before income taxes, equity in net income (loss) of unconsolidated affiliates, minority interest, extraordinary items and discontinued 28,108 110,115 (1,215,444) operations Income tax expense 10,961 32,463 - -------------------------------------- Income (loss) before equity in net income (loss) of unconsolidated affiliates, minority interest and extraordinary items 17,147 77,652 (1,215,444) Minority interest (1,115) (2,838) 23,456 Equity in income (loss) of unconsolidated affiliates 147 1,579 (10,213) Preferred stock dividends (683) (2,599) (45,623) Loss from discontinued operations, net of taxes (3,559) (3,627) (15,085) Extraordinary items, net of tax - - 1,509,918 -------------------------------------- Net income applicable to common shareholders $ 11,937 $ 70,167 $ 247,009 ======================================
56
For the quarter ended For the years ended December 31, September 30, --------------------------------------- 2002 2002 2001 --------------------------------------- (in thousands except per share data) --------------------------------------- Successor Successor Successor --------------------------------------- Per common share data: Basic: Income (loss) from continuing operations $ 0.37 $ 1.79 ($25.65) Net (loss) from discontinued operations (0.09) (0.09) (0.31) Extraordinary item - - 31.04 Net income $ 0.29 $ 1.70 $5.08 Weighted average shares of common stock and equivalents 41,458 41,226 48,641 Diluted: Income (loss) from continuing operations $ 0.37 $ 1.76 ($25.65) Net (loss) from discontinued operations (0.08) (0.08) (0.31) Extraordinary item - - 31.04 Net income $ 0.29 $ 1.68 $5.08 Weighted average shares of common stock and equivalents 43,712 43,351 48,641
(1) Capital costs include depreciation, amortization, lease expense and interest expense.
December 31, September 30, September 30, 2002 2002 2001 ------------- ------------------- ------------- (dollars in thousands) Successor Successor Predecessor Balance Sheet Data Working capital $416,223 $ 449,006 $ 282,016 Total assets 1,961,961 1,989,495 1,839,220 Long-term debt 613,377 648,939 603,268 Shareholders' equity 927,530 914,123 834,858
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's bonds payable and most of the Company's mortgages payable bear interest at fixed rates. The Company is exposed to market risks related to fluctuations in interest rates on its guidance line and variable rate mortgages. The Company utilizes interest rate cap provisions within its debt agreements to limit the impact that interest rate fluctuations have on its variable rate mortgages. The Company does not utilize interest rate swaps, forward or option contracts on foreign currencies or commodities, or any other type of derivative financial instruments. For fixed rate debt, changes in interest rates generally affect the fair market value of the underlying indebtedness, but not earnings or cash flows. The Company generally cannot prepay fixed rate debt prior to maturity without premium. Therefore, interest rate risk and changes in fair market value should not have a significant impact on the fixed rate debt until the Company would be required to refinance such debt. The maturity schedule for the Company's fixed rate mortgages, note and bonds payable is as follows (in thousands): 57
2003 $ 3,458 2004 3,706 2005 3,986 2006 4,284 2007 4,119 Thereafter 91,048 ------- $110,601 ========
At December 31, 2002, the fair value of the Company's fixed rate mortgages and bonds payable is approximately $116.0 million. For variable rate debt, changes in interest rates generally do not impact fair market value, but do affect future earnings and cash flows. At December 31, 2002, the fair value of the Company's variable rate debt approximates its carrying value of $33.1 million. The weighted average interest rate on borrowings outstanding under the Guidance Line and variable rate mortgages was 4.44% at December 31, 2002. Assuming the variable rate mortgage balances outstanding at December 31, 2002 of $30.0 million remains constant, each one percentage point increase in interest rates from 4.44% at December 31, 2002 would result in an increase in interest expense for the coming year of approximately $300,000. Amounts outstanding under the Guidance Line bear interest at a rate of 3.25% over LIBOR. Variable-rate mortgages bear interest at 3.00% over one-month LIBOR. The Company may borrow additional money with variable interest rates in the future. Increases in interest rates, therefore, would result in increases in interest expenses, which could adversely affect the Company's cash flow and its ability to pay its obligations and make distributions to shareholders at current levels. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." 58 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Independent Auditors' Report The Board of Trustees and Shareholders ElderTrust: We have audited the accompanying consolidated balance sheets of ElderTrust and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 2002. In connection with our audits of the consolidated financial statements, we have also audited the financial statement Schedule III as listed in the index as Item 15(a)(ii). These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of ElderTrust and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in Note 2, the Company adopted Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets in 2002. /s/ KPMG LLP McLean, Virginia January 27, 2003, except as to Note 8, which is as of March 13, 2003 59 ELDERTRUST CONSOLIDATED BALANCE SHEETS December 31, 2002 and 2001 (in thousands, except share and per share amounts)
2002 2001 ------------------------- ASSETS Assets: Real estate properties, at cost $306,553 $169,078 Less - accumulated depreciation (44,921) (19,745) Land 20,425 17,327 ------------------------- Net real estate properties 282,057 166,660 Property held for sale 926 - Cash and cash equivalents 7,398 2,676 Restricted cash 11,259 9,245 Accounts receivable, net of allowance of $16 and $340, respectively 119 386 Accounts receivable from unconsolidated entities 65 1,552 Prepaid expenses 613 403 Investment in and advances to unconsolidated entities, net of allowance of $1,292 and $1,405, respectively 3,187 24,033 Other assets, net of accumulated amortization and depreciation of $1,128 and $2,817, respectively 1,151 600 ------------------------- Total assets $306,775 $205,555 ========================= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Guidance line / Bank credit facility $3,067 $7,174 Accounts payable and accrued expenses 1,441 1,024 Accounts payable to unconsolidated entities 47 11 Mortgages, note and bonds payable, including a mortgage on a property held for sale of $1,022, and capital lease obligations 205,896 106,773 Notes payable to unconsolidated entities 3,844 942 Other liabilities 6,267 3,992 ------------------------- Total liabilities 220,562 119,916 ------------------------- Minority interest 3,469 4,641 Shareholders' equity: Preferred shares, $.01 par value; 20,000,000 shares authorized; none outstanding - - Common shares, $.01 par value; 100,000,000 shares authorized; 7,540,142 and 7,336,331 issued and outstanding, respectively 75 73 Capital in excess of par value 121,988 120,750 Deficit (39,319) (39,825) ------------------------- Total shareholders' equity 82,744 80,998 ------------------------- Total liabilities and shareholders' equity $306,775 $205,555 =========================
The accompanying notes to consolidated financial statements are an integral part of these statements. 60 ELDERTRUST CONSOLIDATED STATEMENTS OF OPERATIONS Years ended December 31, 2002, 2001 and 2000 (in thousands, except per share amounts)
2002 2001 2000 ------- ------- ------- Revenues: Rental revenues $21,906 $18,593 $18,437 Interest, net of amortization of deferred loan origination costs 290 2,715 4,542 Interest from unconsolidated equity investees 2,888 3,920 3,252 Other income 245 188 137 ------- ------- ------- Total revenues 25,329 25,416 26,368 ------- ------- ------- Expenses: Property operating expenses 1,289 1,181 1,063 Interest expense, including amortization of deferred finance costs 10,167 11,634 13,911 Depreciation and amortization 7,117 5,634 5,806 General and administrative 2,452 3,220 3,592 Bad debt expense - 116 9,522 Loss on impairment of long-lived assets 2,119 450 5,306 ------- ------- ------- Total expenses 23,144 22,235 39,200 ------- ------- ------- Net income (loss) before equity in losses of unconsolidated entities, minority interest and discontinued operations 2,185 3,181 (12,832) Equity in losses of unconsolidated entities, net (1,364) (2,590) (10,010) Minority interest (53) (42) 1,530 ------- ------- ------- Net income (loss) from continuing operations 768 549 (21,312) Loss from discontinued operations (262) (25) (18) ------- ------- ------- Net income (loss) $506 $524 ($21,330) ======= ======= ======= Basic weighted average number of common shares outstanding 7,401 7,184 7,119 ------- ------- ------- Net income (loss) per share from continuing operations - basic $0.10 $0.07 ($3.00) Net loss on discontinued operations ($0.03) - - Net income (loss) per share - basic $0.07 $0.07 ($3.00) Diluted weighted average number of common shares Outstanding 7,708 7,442 7,119 ------- ------- ------- Net income (loss) per share from continuing operations- diluted $0.07 ($3.00) $0.10 Net loss on discontinued operations ($0.03) - - Net income (loss) per share - diluted $0.07 $0.07 ($3.00)
The accompanying notes to consolidated financial statements are an integral part of these statements. 61 ELDERTRUST CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years ended December 31, 2002, 2001, and 2000 (in thousands)
Note Capital In Receivable Total Shares Common Excess of From Former Shareholders' Outstanding Shares Par Value Deficit Officer Equity ------------------------------------------------------------------------------------- Balances at December 31, 1999 7,119 71 119,106 (14,747) (990) 103,440 Purchase of partnership units - - 1,271 - - 1,271 Net loss - - - (21,330) - (21,330) Distributions - - - (4,272) - (4,272) Bad debt allowance on loan from former officer - - - - 990 990 ------------------------------------------------------------------------------------- Balances at December 31, 2000 7,119 71 120,377 (40,349) - 80,099 Purchase of partnership units - - 38 - - 38 Net income - - - 524 - 524 Share options exercised 217 2 170 - - 172 Share warrants issued - - 165 - - 165 ------------------------------------------------------------------------------------- Balances at December 31, 2001 7,336 73 120,750 (39,825) - 80,998 Redeemed partnership units 95 1 1,193 - - 1,194 Net income - - - 506 - 506 Share options exercised 18 - 45 - - 45 Share warrants exercised 91 1 - - - 1 ------------------------------------------------------------------------------------- Balances at December 31, 2002 7,540 $ 75 $121,988 ($39,319) $ - $82,744 =====================================================================================
The accompanying notes to consolidated financial statements are an integral part of these statements. 62 ELDERTRUST CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 2002, 2001 and 2000 (in thousands)
2002 2001 2000 ------- -------- ------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) from continuing operations $ 768 $ 549 ($21,312) Adjustments to reconcile to net cash provided by operating activities: Depreciation and amortization 7,684 6,360 6,569 Bad debt expense - 116 9,522 Loss on impairment of long-lived assets 2,434 450 5,306 Minority interest and equity in losses from unconsolidated entities 1,405 2,642 8,480 Deferred lease costs (154) - - Discontinued operations (254) (9) 8 Net changes in assets and liabilities: Accounts receivable and prepaid expenses (677) 1,206 (1,244) Accounts payable and accrued expenses 406 (589) 77 Other (946) 376 24 ------- -------- ------- Net cash provided by operating activities 10,666 11,101 7,430 ------- -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of controlling partnership interest 410 - - Capital expenditures (533) (141) (134) Proceeds from collection on advances to unconsolidated entities 705 195 1,536 Payments received on real estate loans receivable - 21,697 - Net increase in reserve funds and deposits - restricted cash 179 (834) (1,658) Other - (30) - ------- -------- ------- Net cash provided by (used in) investing activities 761 20,887 (256) ------- -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Deferred finance costs (525) - (797) Borrowings under guidance line 3,067 - - Payments under credit facility (7,370) (31,352) (950) Payments on mortgages payable (1,784) (1,146) (1,061) Purchase of partnership units - (18) (203) Distributions to shareholders - - (4,272) Distributions to minority interests (3) - (327) Stock options exercised 45 172 - Other (135) (73) (64) ------- -------- ------- Net cash used in financing activities (6,705) (32,417) (7,674) ------- -------- ------- Net increase (decrease) in cash and cash equivalents 4,722 (429) (500) Cash and cash equivalents, beginning of year 2,676 3,105 3,605 ------- -------- ------- Cash and cash equivalents, end of year $ 7,398 $ 2,676 $ 3,105 ======= ======== =======
The accompanying notes to consolidated financial statements are an integral part of these statements. 63 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 1. Organization and Operations ElderTrust was formed in the State of Maryland in 1997 and began operations upon the completion of its initial public offering in January 1998. ElderTrust elected to be taxed as a real estate investment trust beginning for its year ended December 31, 1998. At December 31, 2002 and 2001, ElderTrust's total assets consisted primarily of a 96.2% and 94.9% interest in ElderTrust Operating Limited Partnership (the "Operating Partnership"), and its wholly-owned subsidiaries and controlled partnerships (collectively, "ElderTrust", "We" or the "Company"), respectively. At December 31, 2002 and 2001, the Company's consolidated assets primarily consisted of a diversified portfolio of 32 and 23 healthcare properties, respectively, consisting primarily of assisted living and skilled nursing facilities which are leased back to the prior owners or other third parties. At December 31, 2001, the Company's consolidated assets also included (a) a 99% non-voting limited partnership interest in an unconsolidated entity (ET Sub Meridian Limited Partnership, LLP, "Meridian") which holds leasehold and purchase option rights for seven skilled nursing facilities and (b) a 99% non-voting limited member interest in two other unconsolidated entities (ET Sub-Cabot Park, LLC, "Cabot") which owns an independent living facility and (ET Sub-Cleveland Circle, LLC, "Cleveland") which owns an assisted living facility. Since September 30, 2002, the Company has consolidated the respective balance sheets of Meridian, Cabot and Cleveland and their results of operations. See Note 6 of the Company's consolidated financial statements for additional information. Approximately 86% and 71% of the Company's consolidated assets at December 31, 2002 and 2001, respectively, consisted of real estate properties leased to or managed by Genesis Health Ventures, Inc. or its consolidated subsidiaries (unless the context otherwise requires, collectively, "Genesis") or entities in which Genesis accounts for its investment using the equity method of accounting ("Genesis Equity Investees"). As such, the Company's consolidated revenues and ability to make expected distributions to shareholders depends, in significant part, upon the revenues derived from Genesis. See Note 5 for additional information. Michael Walker, ElderTrust's Chairman of the Board of Trustees, served as Chief Executive Officer of Genesis from 1985 until May 2002 and as Chairman of the Board of Genesis from 1985 until October 2002. Basis of Presentation The consolidated financial statements of ElderTrust include all the accounts of ElderTrust, the Operating Partnership, and the Operating Partnership's wholly owned and controlled subsidiaries. Intercompany balances and transactions have been eliminated. Meridian, Cabot and Cleveland's results of operations have been consolidated beginning October 1, 2002. Certain other amounts included in the consolidated financial statements for prior periods have been reclassified for comparative purposes to conform to the presentation for 2002. 64 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) 2. Summary of Significant Accounting Policies 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 vary from those estimates. Cash and Cash Equivalents The Company considers all short-term, highly liquid investments that are readily convertible to cash and have an original maturity of three months or less at the time of purchase to be cash equivalents. Restricted Cash Restricted cash represents bond and operating reserve funds required in connection with outstanding debt issues, security deposits, letters of credit and mortgage escrow accounts. Real Estate Properties Real estate properties are recorded at cost. Acquisition costs and transaction fees, including legal fees, title insurance, transfer taxes, external due diligence costs and market interest rate adjustments on assumed debt directly related to each property are capitalized as a cost of the respective property. The cost of real estate properties acquired is allocated between land and buildings and improvements based upon estimated market values at the time of acquisition. Depreciation is provided for on a straight-line basis over an estimated composite useful life of twenty-eight and one-half years for buildings and improvements. We classify the properties we are actively marketing as held for sale once all of the following conditions are met: o our board has approved the sale, and o we have a fully executed agreement with a qualified buyer which provides for no significant outstanding or continuing obligations with the property after sale. We carry properties held for sale at the lower of their carrying values or estimated fair values less costs to sell. We cease depreciation at the time the asset is classified as held for sale. We segregate the held for sale properties on our consolidated balance sheet. Accounting Pronouncements In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," which amended SFAS No. 123 "Accounting for Stock-Based Compensation." The new standard provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Additionally, the statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in the annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement is effective for financial statements for fiscal years ending after December 15, 2002. In compliance with SFAS No. 123, ElderTrust has elected to continue to follow the intrinsic value method in accounting for stock-based employee compensation arrangement as defined by Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, and has made the applicable disclosures in Note 10 to the consolidated financial statements required by SFAS No. 148. 65 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) In January 2003, the FASB issued FASB Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities", an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements". FIN 46 explains how to identify variable interest entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. The interpretation requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. FIN No. 46 is effective immediately for variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. The Interpretation applies in the first fiscal year or interim period beginning after June 15, 2003 to variable interest entities in which an enterprise holds a variable interest that is acquired before February 1, 2003. ElderTrust does not anticipate that the adoption of FIN No. 46 will have a material effect on its financial position or results of operations. Impairment of Long-Lived Assets The Company reviews its long-lived assets, which includes real estate properties, and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. We adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," on January 1, 2002. SFAS No. 144 requires the current and prior period operating results of any asset that has been classified as held for sale or has been disposed of on or after January 1, 2002, including any gain or loss recognized, to be recorded as discontinued operations. Deferred Financing Costs Deferred financing costs are incurred in the process of acquiring financing for the Company. The Company amortizes these costs over the term of the respective loan using a method that approximates the interest method. Income Taxes The Company has been organized and operated in a manner so as to qualify for taxation as a real estate investment trust ("REIT") under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. As a result, the Company generally will not be subject to income tax on its taxable income at corporate rates to the extent it distributes with respect to each year 90% of its taxable income, excluding net capital gain, to its shareholders and complies with certain other requirements (although the Company will pay tax to the extend of any taxable income that it retains even if it qualifies as a REIT). The Company intends to continue to qualify as a REIT, and, in light of the Company's net operating losses described below, no provision has been made for federal income taxes for the Company in the accompanying financial statements. 66 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) Leases and Rental Income Real estate properties are leased to operators primarily on a long-term triple net-lease basis. Two of these leases provide for rents based on a specific percentage of facility operating revenues with no required minimum rent ("percentage rent leases"). Other leases provide for base rent, increasing each year by the lesser of 5% of the increase in facility revenues for the immediately preceding year or one-half of the percentage increase in the Consumer Price Index for the immediately preceding year ("minimum rent leases"). Both types of leases are triple net-leases that require the lessees to pay all operating expenses, taxes, insurance, maintenance and other costs, including a portion of capitalized expenditures. The remaining leases ("fixed rent leases") are with tenants in the medical office and other buildings and provide for specific annual rents, subject to annual increases in some of the leases. Generally, lease payments are recognized as revenue in accordance with lease terms. Certain of the leases provide for scheduled annual rent increases. The Company reports base rental revenue on these leases using the straight-line method over the terms of the respective leases. The Company records an unbilled rent receivable or payable representing the amount that the straight-line rental revenue exceeds or reduces the rent currently collectible under the lease agreements. Share Option Plans The Company applies the intrinsic value-based method of accounting prescribed by the Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, in accounting for its fixed plan share options. As such, compensation expense would be recorded only if the current market price of the underlying shares on the date of grant exceeded the exercise price. No compensation expense has been recognized for options granted under the 1998 and 1999 Share Option and Incentive Plans as the Company adopted the disclosure-only provisions of SFAS No. 123, "Stock Based Compensation." Under SFAS No. 123, compensation expense of $108,000, $88,000 and $114,000 would have been recorded in 2002, 2001 and 2000, respectively, for the 1998 and 1999 Plans based upon the fair value of the option awards. 67 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) Pro forma net income (loss) and net income (loss) per share would have been as follows: 2002 2001 2000 ----------------------------- Net income (loss), as reported $ 506 $ 524 ($ 21,330) Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects 108 88 114 Proforma net income (loss) 398 436 (21,444) Net income (loss) per share, as reported - basic and diluted $ 0.07 $ 0.07 ($3.00) Pro forma net income(loss) per share - basic and diluted $ 0.05 $ 0.06 ($3.01) Investments in Unconsolidated Entities The Company has an investment in ET Capital Corp., an entity in which the controlling voting interest is owned by Mr. D. Lee McCreary, Jr., the Company's President, Chief Executive Officer and Chief Financial Officer. As a result, the Company accounts for this investment using the equity method of accounting. 68 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) Net Income/(Loss) per Share Basic net income/(loss) per share is calculated by dividing net income by the weighted average number of common shares outstanding. Diluted net income/(loss) per share is calculated by dividing net income/(loss) by the addition of weighted average common shares outstanding and common share equivalents, if dilutive. Segment Reporting The Company is a real estate investment trust whose primary objective is to invest in healthcare facilities. The Company has one reportable segment, investments in healthcare facilities. 3. Discontinued Operations Under Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the Company is required to reclassify from continuing operations to discontinued operations, the results of operations from any property that is disposed of or is classified as held for sale and where the company will not have significant continuing involvement. The following represents the Summary of results of operations of the Salisbury Medical Office Building which has been classified as held for sale at December 31, 2002 and the classification of the results as to discontinued operations.
Year Ended December 31, 2002 2001 2000 ---------------------------------------------- (amounts in thousands) Rental revenue $ 182 $ 168 $ 164 Other income 62 46 53 ---------------------------------------------- Total revenue 244 214 217 Interest expense 93 93 96 Depreciation and amortization 19 45 44 Property operating expense 56 69 65 General and administrative 34 33 31 Loss on impairment of asset 315 - - ---------------------------------------------- Total expenses 517 240 236 ---------------------------------------------- Loss before minority interest (273) (26) (19) Minority interest 11 1 1 ---------------------------------------------- Loss from discontinued operations ($262) ($25) ($18) ==============================================
69 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) On March 7, 2003, the Company sold the Salisbury Medical Office Building to an unrelated third party and received approximately $1.0 million. The funds were used to repay the mortgage securing the property. 4. Real Estate Investments As of December 31, 2002, the Company had investments in 32 real estate properties located in five states. The properties include eleven assisted living facilities, and two independent living facilities with a total of 1,171 beds, fifteen skilled nursing facilities with a total of 2,393 beds, and four medical office and other buildings. The Company leases its assisted living, independent living and skilled nursing properties to operators pursuant to long-term triple net leases. At December 31, 2002, future minimum lease payments receivable are as follows (dollars in thousands): 2003 $31,947 2004 32,138 2005 31,040 2006 30,617 2007 30,011 Thereafter 43,229 -------- $198,982 ======== 5. Concentration of Risk Revenues recorded by the Company under leases with and loans to Genesis or Genesis Equity Investees were approximately $18.3 million, $16.1 million and $17.9 million in 2002, 2001 and 2000, respectively. All loans were repaid in 2001. The Company's equity in net losses of unconsolidated entities (see Note 6) derived from arrangements with Genesis or Genesis Equity Investees totaled approximately $1.5 million, $2.3 million and $2.8 million in 2002, 2001 and 2000, respectively. The Company did not have any equity in net losses of unconsolidated entities derived from arrangements with Genesis or Genesis Equity Investees subsequent to October 1, 2002. The Company's consolidated revenues depends in significant part, upon the revenues derived from Genesis. 6. Investments in Unconsolidated Entities During September 2002, the Company acquired, or obtained options to acquire (collectively, the "Acquisition"), from D. Lee McCreary, Jr., ElderTrust's President and Chief Executive Officer, the controlling 1% ownership interests in entities that hold leasehold and purchase option rights to seven skilled nursing and that own one assisted living facility and one independent living facility. The Company has owned a non-controlling 99% interest in these entities since 1998. The seven skilled nursing facilities are subleased to an affiliate of Genesis, the Company's principal tenant, for an initial ten-year period with a ten-year renewal exercisable by the tenant. Genesis has guaranteed the subleases. Purchase options totaling $66.5 million are exercisable in September 2008. The independent and assisted living facilities are also leased to an affiliate of Genesis and Genesis has guaranteed the lease payments. 70 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) Under the terms of the Acquisition, the Company acquired Mr. McCreary's interest in the general partnership of Meridian, which holds leasehold and purchase option rights to seven skilled nursing facilities, and options to acquire his managing member interests in Cabot, and Cleveland for approximately $85,000. Cabot and Cleveland own a single independent living and assisted living facility, respectively. The options, which the Company intends to exercise upon receipt of lender approval, are exercisable for a combined additional price of approximately $17,000. Mr. McCreary has agreed to transfer operational and managerial control of Cabot and Cleveland to the Company during the option period. The purchase prices for Mr. McCreary's interests in the skilled nursing, independent and assisted living facilities were determined based upon the estimated fair market value of the interests acquired. Prior to the Acquisition, the Company accounted for its investment in these properties under the equity method. As of December 31, 2002, the Company has consolidated the balance sheets of Meridian, Cabot and Cleveland with the Company's other operations. The results of operations of Meridian, Cabot and Cleveland are consolidated in the Company's consolidated statement of income beginning October 1, 2002. Supplemental unaudited pro forma results of operations for 2002 and 2001 as if the acquisition had been completed at the beginning of the years presented is as follows: 2002 2001 ----------------------------- Revenues $ 32,897 $ 35,437 Expenses 32,216 34,542 Income from continuing operations 753 526 Loss from discontinued operations (262) (25) Net income 491 501 Earnings per share - basic $0.07 $0.07 Earnings per share - diluted $0.06 $0.07 71 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) The following is a summary of the Company's investment in and advances to unconsolidated entities accounted for by the equity method of accounting. As of December 31, (dollars in thousands): 2002 2001 ----------------------------- ET Capital Corp. $ 3,187 $ 3,162 ET Sub-Meridian, LLP - 18,564 ET Sub-Cabot Park, LLC - 1,305 ET Sub-Cleveland Circle, LLC - 1,002 ----------------------------- $ 3,187 $ 24,033 ============================= After giving effect to the Acquisition, the Company has one remaining unconsolidated investment, ET Capital Corp. The Company has a nonvoting 95% equity interest in ET Capital Corp. Mr. McCreary owns the voting 5% equity interest. Summary unaudited financial information as of and for the year ended December 31, 2002 for ET Capital Corp. is as follows (dollars in thousands): Balance Sheet ------------- Current assets $ 290 Notes receivable(1) 3,845 Total assets 4,135 Current liabilities 290 Long-term debt(1) 8,772 Total liabilities 9,062 Deficit (4,927) (1) Represents amounts due to/from ElderTrust. Income Statement ---------------- Interest income 1,874 Interest expense 488 Bad debt expense 1,308 Net income 131 Percent ownership 95% 72 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) In May 2001, ET Capital was named as a third party defendant in a complaint filed against Genesis. This lawsuit was settled on December 31, 2002. Under the settlement terms, ET Capital received $250,000 and was released from any claims under the lawsuit in exchange for forgiving notes totaling $7.8 million plus accrued interest. ET Capital Corp. fully reserved against these loans in 2000. Summary unaudited financial information for 2001 and 2000 for unconsolidated entities accounted for by the equity method during those years is as follows (dollars in thousands): As of and for the year ended December 31, 2001
ET ET Sub- ET Sub-Meridian, ET Capital Cabot Sub-Cleveland LLP Corp. Park, LLC Circle, LLC Total -------------- ---------- --------- ------------- --------- Current assets $ 984 $ 171 $ 147 $ 223 $ 1,525 Real estate properties (1) 99,522 - 15,996 13,205 128,723 Notes receivable - 4,116 - - 4,116 Other assets - - 542 513 1,055 Total assets 100,506 4,287 16,685 13,941 135,419 Current liabilities 2,181 325 601 661 3,768 Long-term debt (2) 104,186 9,019 16,492 13,211 142,908 Total liabilities 108,094 9,344 17,362 14,098 148,898 Total deficit (7,588) (5,058) (677) (157) (13,480) Rental revenue 9,883 - 1,669 1,477 13,029 Interest income 67 2,152 23 22 2,264 Interest expense 8,331 768 1,349 1,028 11,476 Bad debt expense 47 1,552 - - 1,599 Depreciation/amortization 3,512 - 560 462 4,534 Net loss (2,013) (343) (251) (24) (2,631) Change in long-term debt (1,195) (228) (225) (302) (1,950) Percent ownership 99% 95% 99% 99%
73 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) As of and for the year ended December 31, 2000
ET ET Sub- ET Sub-Meridian, ET Capital Cabot Sub-Cleveland LLP Corp. Park, LLC Circle, LLC Total -------------- ---------- --------- ------------- -------- Current assets $ 1,598 $ 131 $ 54 $ 77 $ 1,860 Real estate properties (1) 103,034 - 16,555 13,667 133,256 Notes receivable - 4,354 - - 4,354 Other assets - 270 535 505 1,310 Total assets 104,632 4,755 17,144 14,249 140,780 Current liabilities 3,118 223 585 643 4,569 Long-term debt (2) 105,381 9,247 16,717 13,513 144,858 Total liabilities 110,207 9,469 17,571 14,381 151,628 Total deficit (5,575) (4,715) (426) (132) (10,848) Rental revenue 9,800 - 1,644 1,453 12,897 Interest income 28 890 38 36 992 Interest expense 8,736 726 1,377 1,056 11,895 Bad debt expense - 7,800 - - 7,800 Depreciation/amortization 3,513 118 560 462 4,653 Net loss (2,485) (7,587) (285) (60) (10,417) Change in long-term debt (1,538) (177) (203) (278) (2,196) Percent ownership 99% 95% 99% 99%
(1) Includes properties under capital lease. (2) Includes capital lease obligations. In connection with ET Sub-Meridian's acquisition of seven skilled nursing facilities from Genesis, the Company agreed to indemnify the property owners for any loss of deferral of tax benefits prior to August 31, 2008 due to a default under a sublease or if a cure of a default by the Genesis subsidiary leasing the facilities resulted in a taxable event to the owners. The Company also agreed to indemnify Genesis for any amounts expended by Genesis under the back-up indemnity provided by Genesis to the current owners for the same loss. 74 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) 7. Guidance Line / Bank Credit Facility On August 30, 2002, ElderTrust entered into the Guidance Line. Funds provided under this agreement to the borrower, ElderTrust Operating Limited Partnership (the "Operating Partnership"), of approximately $3.1 million were used to pay off the existing credit facility, and to pay certain transaction and other costs. ElderTrust has guaranteed the Guidance Line. The previous Bank Credit Facility had an outstanding balance of $7.2 million at December 31, 2001 and a floating interest rate of 3.25% over one-month LIBOR, or 5.125% at August 29, 2002. The amounts outstanding under the Guidance Line bear interest at a floating rate of 3.25% over LIBOR, or 4.67% at December 31, 2002. At December 31, 2002, the properties securing the Guidance Line had an aggregate net book value of $38.6 million. During the quarter and twelve months ended December 31, 2002, the Company derived $0.8 million and $3.2 million, respectively, of revenues from these properties. On January 27, 2003 the Company paid $3.1 million to Wachovia Bank to pay off the balance due under the Guidance Line. As of January 27, 2003, the Company has $7.5 million available to borrow, subject to lender approval and borrowing base limitations. 8. Mortgages, Bonds, Note Payable and Capital Lease Obligations The following is a summary of mortgages, bonds payable and capital lease obligations at December 31, 2002 and 2001 (dollars in thousands):
Effective Balance at Balance at Interest Maturity December 31, December 31, Property Rate Date 2002 2001 ----------------------------------------- ------------ ------------ -------------------------------- DCMH Medical Office Building (a) 8.35% 11/2009 $5,638 $5,717 Cabot Park (b) 5.80% 1/2037 12,630 - Cleveland Circle (b) 5.80% 10/2025 10,926 - Professional Office Building I (a) 8.35% 11/2009 2,485 2,520 Meridian capital lease (b) 7.06% 9/2008 *** 65,295 - Meridian note payable (b) 7.06% 9/2008 11,524 - Pleasant View (a) 8.26% 10/2009 3,743 3,796 Salisbury Medical Office Building (a) 8.16% 10/2009 1,007 1,022 Heritage at North Andover (a) 8.26% 10/2009 8,417 8,537 The Woodbridge Bonds due 2005 7.81% * 9/2005 472 610 Bonds due 2025 7.81% * 9/2025 9,411 9,440 Belvedere NRC/ Chapel NRC (a) 8.46% 10/2009 18,238 18,490 Highgate at Paoli Pointe Series A Bonds 7.81% * 1/2024 9,424 9,589 Riverview Ridge (a) 7.81% * 1/2020 2,673 2,742 Vernon Court (a) 5.80% * 5/2025 13,540 13,828 Lacey Branch Office Building 7.81% * 10/2022 473 482 LIBOR Wayne NRC (a) +3.00% 12/2004 ** 4,600 4,600 Pennsburg Manor NRC/ Harston Hall LIBOR NCH (a) +3.00% 4/2003 ** 14,900 14,900 LIBOR Lopatcong Care Center (a) +3.00% 12/2004 ** 10,500 10,500 ------------------------ Total $205,896 $106,773 ========================
75 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) (a) The repayment of principal and interest on these loans is non-recourse to ElderTrust. (b) Meridian, Cabot and Cleveland were not consolidated as December 31, 2001. * The stated interest rates on these mortgages are higher than the effective interest rates because they were adjusted to market rates when the loans were acquired by the Company. ** The Company had three non-recourse mortgage loans secured by four properties with an aggregate principal balance of $30 million that matured in December 2002. The Company announced in November 2002 that the maturity date of one loan, secured by the Lapatcong property, had been extended until December 1, 2004. In February 2003, the lender also extended a $4.6 million mortgage loan secured by the Wayne property to December 1, 2004. In connection with the extension, the Company made a $1.1 million payment on March 31, 2003 and reduced the balance outstanding from $4.6 million to $3.5 million. The lender has extended the maturity date of the remaining mortgage loan of $14.9 million, which is secured by the Harston Hall and Pennsburg properties, until April 10, 2003 to allow time for the lender and the Company to negotiate a resolution of this loan. If the maturity date of this mortgage is not extended by the lender and the lender foreclosed on these properties securing the mortgages, the Company would lose the properties and the revenues it derives from the properties. Based upon conversations with the lender, several alternatives are available to satisfy the Company's obligation under the loan which may include, among other alternatives, a further extension as a cash flow mortgage, sale or a title transfer via a "deed in lieu of foreclosure" transaction. At December 31, 2002, the Harston Hall and Pennsburg properties had a net book value of $13.8 million. During 2002, the Company derived $2.0 million of revenue and net income of $0.5 million from the properties. The repayment of principal and interest on these mortgage loans is non-recourse to ElderTrust. *** The following is a schedule by years of future minimum lease payments under capital leases together with the present value of the minimum lease payments as of December 31, 2002 (dollars in thousands): 2003 $ 4,245 2004 4,245 2005 4,245 2006 4,245 2007 4,245 Thereafter 70,447 --------- Total minimum lease payments 91,672 Less: amount representing interest at 7.06% per annum 26,377 --------- Present value of future minimum lease payments $ 65,295 ========= The Company's weighted average effective interest rate on mortgages and bonds payable was 6.75% and 8.09% at December 31, 2002 and 2001, respectively. Scheduled principal payments and bond sinking fund requirements are as follows: (dollars in thousands) 2003 $ 18,358 2004 18,806 2005 3,986 2006 4,285 2007 4,119 Thereafter 91,047 --------- $ 140,601 ========= 76 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) 9. Operating Lease The Company leases its corporate office space from a third party under an operating lease, which expires on September 30, 2007. Under the lease agreement, the Company pays base rent plus its portion of real estate taxes, common area maintenance and operation for the building based upon the ratio of square footage of the leased premises to the square footage of the building. Future minimum rental payments are as follows (dollars in thousands): 2003 $ 163 2004 168 2005 173 2006 178 2007 136 ----- Total $ 818 ===== 10. Share Option and Incentive Plans and Other Retirement Arrangements The Company established the 1998 share option and incentive plan (the "1998 Plan") for the purpose of attracting and retaining key executive officers and employees, as well as non-employee trustees. A total of 779,340 common shares were reserved for and have been issued under the 1998 Plan as of December 31, 2002. At the time of the Company's initial public offering in January 1998, the Company granted options with respect to 504,000 common shares to officers, employees and trustees. The exercise price for such options is the Offering price of $18.00. The term of such options is ten years from the date of grant. Of these options, 150,000 vested immediately, 322,500 vest ratably over three years from the date of grant and 31,500 vest ratably over five years from date of grant. Additional options with respect to 7,500 and 25,000 common shares were granted to a trustee and officer of the Company, respectively, during 1998 at an exercise price of $17.75 and $15.125 per share, respectively. These options vest ratably over three and five years respectively, and terminate ten years from the date of grant. Additional options of 231,500 were granted during 1999 to a key executive officer and employees of the Company at exercise prices ranging from $5.31 to $6.69 per share. These options vest over three to four years and terminate ten years from the date of grant or three month's after termination of employment. During 1999, options of 307,500 were cancelled upon the resignations of a former executive officer and a trustee. Additional options of 323,840 were granted under the 1998 plan during 2000 to a key executive officer and employees of the Company at exercise prices ranging from $0.75 to $2.75 per share. Of these options, 108,612 vested immediately, 215,228 vest over two years from the date of grant and terminate ten years from the date of grant or three month's after termination of employment. Additionally, during 2000, 15,000 options were cancelled upon the resignations of two former trustees. During 2002, options of 6,667 were cancelled upon the resignation of a former executive officer. No common shares are available for future grant or award under the 1998 plan. 77 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) During 1999, the Company established the 1999 share option and incentive plan (the "1999 Plan") for the purpose of encouraging and enabling the officers, employees, non-employee trustees and other key persons of the Company to acquire a proprietary interest in the Company. A total of 350,000 common shares were reserved for issuance under the 1999 Plan. Options of 43,000 were granted during 2001 from the 1999 Plan to the executive officers and trustees of the Company at exercise prices ranging from $3.50 to $4.18 per share. Of these options, 8,000 vested immediately and the remaining 35,000 vest ratably on each of the annual anniversaries for the next three years and terminate ten years from the date of grant or three month's after termination of employment. Options of 85,500 were granted during 2002 from the 1999 Plan to the executive officers, trustees and employees of the Company at an exercise price of $7.90 per share. Of these options 8,000 vested immediately and the remaining 77,500 vest ratably on each of the annual anniversaries for the next three years and terminate ten years from the date of grant or three month's after termination of employment. At December 31, 2002, 129,340 common shares are available for award. The following summarizes the activity in the 1998 and 1999 Plans for the years ended December 31, 2002, 2001 and 2000:
2002 2001 2000 ---------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise 1998 Plan and 1999 Plan Shares Price Shares Price Shares Price ---------------------------------------------------------------------------------------------------------------------------- Options outstanding, beginning of year 697,169 $ 7.85 871,500 $ 6.47 460,500 $ 12.06 Options granted 85,500 7.90 43,000 4.08 426,000 0.82 Options exercised (18,333) 2.46 (217,331) 0.79 - - Options forfeited (6,667) 4.18 - - (15,000) 18.00 ---------------------------------------------------------------------------- Options outstanding, end of year 757,669 $ 8.24 697,169 $ 7.85 871,500 $ 6.47 ============================================================================ Options exercisable, end of year 652,202 $ 8.23 424,934 $ 10.64 355,833 $ 8.24 ============================================================================ Weighted average fair value of options granted during the year (calculated as of the grant date): $ 6.60 $ 2.17 $ 0.28
Information regarding stock options outstanding and exercisable under the 1998 and 1999 Plans as of December 31, 2002 is as follows:
Exercise Price Range $0.75-$2.75 $3.50-$5.31 $6.69-$7.90 $15.13-$18.00 ---------------------------------------------------------------------- Options outstanding at December 31, 2002: Shares 195,669 62,500 285,500 214,000 Weighted average exercise price $0.79 $4.70 $7.05 $17.66 Weighted average remaining contractual life 7.7 years 5.0 years 7.6 years 5.1 years Options exercisable at December 31, 2002: Shares 195,669 45,833 208,000 202,700 Weighted average exercise price $0.79 $4.89 $6.73 $17.72
78 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) The fair value determination was calculated using the Black-Scholes option-pricing model to value all stock options granted in 2002, 2001 and 2000 using the following assumptions:
2002 2001 2000 ------------------------------------------- Weighted average risk free interest rate 5.58% 5.4% 6.1% Expected volatility 81.27% 85.7% 75.7% Expected dividend yield 7.34% 7.34% 7.71% Weighted average expected life of options 2.80 years 3.50 years 3.55 years
The Company has established a defined contribution retirement plan covering all eligible employees. Under this plan, eligible employees may make contributions up to the Internal Revenue Service maximum, and the Company is required to make certain minimum contributions. Company contributions to this Plan were $24,000 in 2002, $24,000 in 2001 and $16,000 in 2000. 11. Shareholder's Rights Plan On October 13, 1999, the Company adopted a Shareholder Rights Plan (the "Rights Plan"). The Rights Plan is designed to deter coercive and unfair hostile takeover tactics. Under the Rights Plan, the Company authorized and declared a distribution of one right for each of its outstanding common shares held on the record date of October 29, 1999. Each right upon the occurrence of certain events (a "triggering event") entitles the holder to purchase from the Company one one-thousandth of a Series A Junior Participating Preferred Share, $.01 par value per share, of the Company (which is intended to be the economic equivalent of one common share) at an initial purchase price of $35. The rights are neither exercisable nor traded separately from the common shares unless a triggering event occurs and will expire on October 13, 2009, unless exchanged or redeemed earlier. The rights will be exercisable only if a person or group in the future becomes the beneficial owner of 15% or more of the common shares of the Company, or announces a tender or exchange offer which, if consummated, would result in that person or group owning at least 15% of the common shares, subject to certain exceptions. The Company generally may redeem the rights for $0.0005 per right at any time until ten days following the public disclosure that the 15% position has been met. A total of 16,000 preferred shares are reserved for issuance under the rights. 12. Taxes The Company believes that, commencing with its taxable period ended December 31, 1998, it has been organized and operated in a manner so as to qualify for taxation as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. As a result, the Company generally will not be subject to income tax on its taxable income at corporate rates to the extent it distributes annually at least 90% of its taxable income, excluding net capital gain, to its shareholders and complies with certain other requirements (although the Company will pay tax to the extent of any taxable income that it retains, even if it qualifies as a REIT). The Company intends to continue to qualify as a REIT and, in light of the Company's net operating losses described below, no provision has been made for income taxes in the accompanying consolidated financial statements. 79 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) The following table reconciles net income under accounting principles generally accepted in the United States of America ("GAAP"), to taxable income for the years ended December 31, (dollars in thousands):
Estimated 2002 2001 2000 -------------------------------------- GAAP net income (loss) $ 506 $ 524 ($21,330) Less: GAAP net income of taxable REIT subsidiaries included above 125 (326) (6,838) -------------------------------------- GAAP net income for REIT operations (1) 381 850 (14,492) Add: book depreciation and amortization 6,755 5,293 5,550 Less: tax depreciation and amortization (6,697) (5,831) (7,222) bad debt expense - tax 28 (15,438) 9,972 impairment losses - tax 2,341 423 4,639 other book/tax differences, net 2,615 4,091 4,608 net operating loss utilized (5,423) - - -------------------------------------- Adjusted taxable income subject to 90% dividend requirement $ - ($10,612) $ 3,055 ======================================
(1) All adjustments to GAAP net income from REIT operations are net of amounts attributable to minority interest and taxable REIT subsidiaries. During 2000, the Company recorded significant bad debt expenses due to the Genesis bankruptcy filing related to loans and properties under lease and, as a result, recognized a net loss for financial reporting purposes. For federal income tax purposes, these losses were recorded in 2001 as required under applicable income tax rules. When recognized for federal income tax purposes, these losses reduce the amount otherwise required by the Company to be distributed to meet REIT requirements. Should these losses, when recognized exceed REIT taxable income computed without regard to these losses, any excess loss ("NOL") amount may be carried forward for deduction in the succeeding year. The estimated NOL carry forward at December 31, 2002 is approximately $7.1 million. 80 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) The following is a reconciliation of the Company's dividends paid deduction for the years ended December 31 (dollars in thousands):
2002 2001 2000 ----------------------------------------------- Cash dividends paid $ - $ - $ 4,272 Less: portion designated capital gains - - - ----------------------------------------------- Dividends paid deduction $ - $ - $ 4,272 ===============================================
13. Distributions The Company must distribute at least 90% of its taxable income, excluding net capital gain, in order to continue to qualify as a REIT. Distributions in a given year may exceed the Company's earnings and profits due to non-cash expenses such as depreciation and amortization. Per share distributions on the Company's common shares include the following categories for income tax purposes: 2002 2001 2000 ----------------------------------------------- Ordinary income $ - $ - $ 0.5508 Capital gains - - - Return of capital - - 0.0492 ----------------------------------------------- $ - $ - $ 0.6000 =============================================== Effective for the quarter ended September 30, 2000, the Company suspended the payment of cash distributions to its shareholders. No distributions were made for the years ended December 31, 2002 and 2001. On December 4, 2002, the Company issued a press release addressing the dividend distribution policy. The Company stated that it intends to resume regular quarterly distributions to the holders of its common shares and that the initial distribution is expected to be declared in mid-April, 2003. The Company estimates that, based upon its current estimate of operations and cash requirements, the per share distribution will be $0.64 per year, or $0.16 per quarter. Distributions by the Company are at the discretion of its Board of Trustees. 81 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) 14. Earnings (Loss) Per Share The following table sets forth the computation of basic and diluted earnings (loss) per share (in thousands, except per share data):
Income (loss) per share - basic: 2002 2001 2000 --------------------------------------------------------------------------------------------------- Net income (loss) $506 $524 ($21,330) Weighted average common shares outstanding 7,401 7,184 7,119 ======================================= Net income (loss) per share from continuing operations $0.10 $0.07 ($3.00) Net loss on discontinued operations ($0.03) - - Basic net income (loss) per share $0.07 $0.07 ($3.00) Income (loss) per share - diluted: -------------------------------------------------------- Net income (loss) $506 $524 ($21,330) Weighted average common shares outstanding 7,401 7,184 7,119 Dilutive common stock equivalents - stock options and warrants 307 258 - --------------------------------------- Total weighted average number of diluted shares 7,708 7,442 7,119 ======================================= Net income (loss) per share from continuing operations $0.10 $0.07 ($3.00) Net loss on discontinued operations ($0.03) - - Diluted net income (loss) per share $0.07 $0.07 ($3.00)
Units of ElderTrust Operating Limited Partnership are not included in the determination of weighted average common shares outstanding for purposes of computing diluted income per share since they are antidilutive. 15. Disclosure About Fair Value of Financial Instruments The carrying amount of cash and cash equivalents, restricted cash and accounts receivable approximates fair value based on the short-term nature of these investments. The carrying amounts of the Company's Guidance Line and variable rate mortgages payable at December 31, 2002 and 2001 approximate fair value because the borrowings are at variable interest rates. The fair value of the Company's fixed rate notes payable, mortgages and bonds payable at December 31, 2002 and 2001 is estimated using discounted cash flow analysis and the Company's current incremental borrowing rates for similar types of borrowing arrangements. The fair value of the Company's fixed rate mortgages, bonds and note payable at December 31, 2002 is approximatly $116.0 million. 82 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) 16. Quarterly Financial Information (Unaudited) The following quarterly financial data summarize the unaudited quarterly results from continuing operations for the years ended December 31, 2002 and 2001 (in thousands, except per share amounts):
Quarter ended ------------------------------------------------------------------- December 31, (1) September 30, June 30, March 31, ------------------------------------------------------------------- 2002 -------------------------------------------- Revenues from continuing operations $ 8,199 $ 5,661 $ 5,635 $ 5,834 Income (loss) from continuing operations (1,084) 671 576 605 Net income (loss) (1,131) 685 342 610 Net income (loss) per share from continuing operations - basic (0.15) 0.09 0.08 0.08 Net income (loss) per share from continuing operations - diluted (0.15) 0.09 0.08 0.08 (1) Includes impairment charge of $0.3 million. Quarter ended ------------------------------------------------------------------- December 31, September 30, June 30, March 31, (1) ------------------------------------------------------------------- 2001 -------------------------------------------- Revenues from continuing operations $ 6,336 $ 6,326 $ 6,366 $ 6,388 Net income (loss) from continuing operations 719 424 331 (925) Net income (loss) 717 418 320 (931) Net income (loss) per share from continuing operations - basic 0.09 0.06 0.05 (0.13) Net income (loss) per share from continuing operations - diluted 0.09 0.06 0.04 (0.13) (1) Includes impairment charge of $0.5 million.
83 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) The following table reconciles previously issued quarterly information to the quarterly information presented above as a result of discontinued operations for the quarter ended March 31, (in thousands): 2002 2001 ------------------------ Previously stated revenues $ 5,899 $ 6,441 Revenue from discontinued operations 65 53 ------------------------ Revenue 5,834 6,388 Net income (loss) from continuing operations 610 (931) ------------------------ Income (loss) from discontinued operations (5) 6 Net income (loss) $ 605 ($ 925) ======================== The quarters ended June 30, September 30, and December 31, 2002 were stated showing discontinued operations. Therefore, no reconciliation is needed. 17. Related Party Transactions During September, 2002, the Company acquired, or obtained options to acquire, from D. Lee McCreary, Jr., ElderTrust's President and Chief Executive Officer, the controlling 1% ownership interests in three entities that hold leasehold and purchase option rights to seven skilled nursing and that own one independent living and one assisted living facility. Under the terms of the acquisition, the Company acquired Mr. McCreary's interests for approximately $85,000. The options, which the Company intends to exercise upon receipt of lender approval, are exercisable for a combined additional price of approximately $17,000. The purchase prices for Mr. McCreary's interests in the skilled nursing facilities, independent and assisted living facilities were determined based upon the estimated fair market value of the interests acquired. See note 6 for additional information. Michael Walker, ElderTrust's Chairman of the Board of Trustees, served as Chief Executive Officer of Genesis from 1985 until May 2002 and as Chairman of the Board of Genesis from 1985 until October 2002. At December 31, 2002, Mr. Walker beneficially owned approximately 8.1% of the common shares of ElderTrust. 18. Minority Interest The Company owned approximately 96.2% and 94.9% of the Operating Partnership, at December 31, 2002 and 2001, respectively. The ownership interest is represented by 7,540,142 and 7,242,265 units owned as of December 31, 2002 and 2001, respectively. The remaining ownership interests include interests owned directly or indirectly by trustees and officers of the Company and Genesis totaling 295,560 units. 84 ELDERTRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000 (Continued) Subject to certain limitations in the Operating Partnership Agreement the limited partners that hold units in the Operating Partnership have the right to require the redemption of their units at any time ("Unit Redemption Rights"). The Operating Partnership's obligation with respect to the Unit Redemption Rights is that the limited partner will receive cash from the Operating Partnership in an amount equal to the market value of the units to be redeemed. However, in lieu of the Operating Partnership acquiring the units for cash, the Company has the right to elect to acquire the units directly from the limited partner, either for cash or common shares of ElderTrust at the Company's discretion. 19. Supplemental Cash Flow Information: Supplemental cash flow information for the years ended December 31, 2002, 2001 and 2000 is as follows (amounts in thousands):
2002 2001 2000 ----------------------------------- Non-cash investing and financing activities; Assets and liabilities consolidated as a result of the acquisition of controlling interests in Meridian, Cabot and Cleveland: Real estate assets $125,498 $ - $ - Restricted cash 2,193 - - Investments (18,973) - - Other assets (1,676) - - Real estate mortgage debt and debt (103,945) - - Other liabilities (3,114) - - Minority interest 17 - - Conversion of operating partnership units to common stock $ 1,195 - - Acquisition of real estate properties at fair value in exchange for notes receivable - $ 12,650 - Cash paid for interest $ 9,734 $ 11,353 $13,324
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 85 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is incorporated herein by reference to the information under the heading "Election of Trustees" in the Company's proxy statement to be filed with respect to the 2003 annual meeting of shareholders (the "Proxy Statement"). ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated herein by reference to the information under the heading "Executive Compensation and Other Information" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by this Item is incorporated herein by reference to the information under the heading "Securities Owned by Management and Principal Shareholders" and "Equity Compensation Plan Information" in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated herein by reference to the information under the heading "Certain Relationships and Related Transactions" in the Proxy Statement. ITEM 14. CONTROLS AND PROCEDURES. Our principal executive officer and principal financial officer, D. Lee McCreary, Jr., evaluated, within 90 days prior to the filing of this Form 10-K, the effectiveness of the design and operations of our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. As a result of this evaluation, Mr. McCreary concluded that, as of such date, the design and operation of our disclosure controls and procedures were effective. Since the date of evaluation of our disclosure controls and procedures by Mr. McCreary described above, there have been no significant changes in our internal control or in other factors that could significantly affect our disclosure controls and procedures. 86 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are included in Part II, Item 8 of this report: (1) Financial Statements: Page Number ----------- Independent Auditors' Report 59 Consolidated Balance Sheets as of December 31, 2002 and 2001 60 Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000 61 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2002, 2001 and 2000 62 Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000 63 Notes to Consolidated Financial Statements 64 (2) The following Financial Statement Schedule is included in Item 15 (d): Schedule III - Real Estate and Accumulated Depreciation All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (3) Exhibits: The exhibits filed with this report are listed in the exhibit index on page 90. (b) Current Reports on Form 8-K: During the fourth quarter ended December 31, 2002, the Company filed two Form 8-K's as follows: Date of Event Items Reported/Financial Statements Filed ------------- ----------------------------------------- September 25, 2002 Item 2. Acquisition or Disposition of Assets Item 7. Financial Statements and Exhibits (furnishing required historical financial statements for ET Sub-Meridian Limited Partnership, L.L.P., ET Sub-Cabot Park, L.L.C. and ET Sub-Cleveland Circle, L.L.C. and pro forma financial information) December 4, 2002 Item 9. Regulation FD Disclosure (c) Exhibits: The exhibits listed in Item 15(a)(3) above are filed with this Form 10-K. (d) Financial Statement Schedules: Financial statement schedules are included on pages S-1 through S-3.
87 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 28, 2003. ElderTrust -------------------------------- Registrant By: /s/ D. Lee McCreary, Jr. -------------------------------------------- President, Chief Executive Officer and Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 28, 2003. By: /s/ D. Lee McCreary, Jr. ------------------------------------------------------- D. Lee McCreary, Jr. President, Chief Executive Officer, Chief Financial Officer and Trustee (Principal Executive, Financial and Accounting Officer) By: /s/ Michael R. Walker ------------------------------------------------------- Michael R. Walker Chairman of the Board By: /s/ Rodman W. Moorhead, III ------------------------------------------------------- Rodman W. Moorhead, III Trustee By: /s/ John G. Foos ------------------------------------------------------- John G. Foos Trustee By: /s/ Harold L. Zuber, Jr. ------------------------------------------------------- Harold L. Zuber, Jr. Trustee 88 CERTIFICATION I, D. Lee McCreary, Jr., certify that: 1. I have reviewed this annual report on Form 10-K of ElderTrust; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for the periods presented in this annual report; 4. I am responsible for establishing and maintaining the disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report my conclusions about the effectiveness of the disclosure control and procedures based on my evaluation as of the Evaluation Date; 5. I have disclosed, based on my most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operations of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weakness in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control; and 6. I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of my most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. March 28, 2003 /s/ D. Lee McCreary, Jr. ----------------------------------------- D. Lee McCreary, Jr. President, Chief Executive Officer and Chief Financial Officer Principal Executive Officer and Principal Financial Officer) 89 EXHIBIT INDEX Exhibit No. Description (a) 2.1 Assignment of Partnership Interest and Second Amendment to Agreement of Limited Partnership of ET Sub-Meridian Limited Partnership, L.L.P. dated September 25, 2002, by and among Toughkenamon, LLC, ElderTrust Operating Limited Partnership and ET Meridian General Partner, L.L.C. (a) 2.2 Option Agreement, dated as of September 25, 2002, by and between D. Lee McCreary, Jr. and ElderTrust Operating Limited Partnership relating to interest in and to Cabot ALF, L.L.C. (a) 2.3 Option Agreement, dated as of September 25, 2002, by and between D. Lee McCreary, Jr. and ElderTrust Operating Limited Partnership relating to interest in and to Cleveland ALF, L.L.C. (b) 3.1 Amended and Restated Declaration of Trust of the Company 3.2 Articles Supplementary of the Company (b) 3.3 Amended and Restated Bylaws of the Company (c) 4.1 Form of Rights Agreement between ElderTrust and First Union National Bank, as Rights Agent (d) 4.2 Articles Supplementary for Classifying and Designating Series A Junior Participating Preferred Shares (b) 10.1.1 Second Amended and Restated Agreement of Limited Partnership of ElderTrust Operating Limited Partnership (e) 10.1.2 Certificate of Designation for Class C (LIHTC) Units of ElderTrust Operating Limited Partnership (d) 10.1.3 Second Amendment to Second Amended and Restated Agreement of Limited Partnership of ElderTrust Operating Limited Partnership (b) 10.2 Registration Rights Agreement between the Company and the persons named therein (b) 10.3 1998 Share Option and Incentive Plan * (d) 10.4 1999 Share Option and Incentive Plan * (b) 10.5 Non-Competition Agreement between the Company and Michael R. Walker* (f) 10.6 Form of Minimum Rent Lease between the Operating Partnership and Genesis (f) 10.7 Form of Percentage Rent Lease between the Operating Partnership and Genesis (g) 10.8 Master Agreement with Genesis (g) 10.9 Master Agreement with The Multicare Companies, Inc. (h) 10.10 Bank Credit Facility dated August 30, 2002 by and among ElderTrust, ElderTrust Operating Limited Partnership and Wachovia Bank National Association (a) 10.11 Lease Agreement, dated as of November 30, 1993, by and between Heritage Associates Limited Partnership and MHC Acquisition Corporation (a) 10.12 Amendment No. 1 to Lease Agreement, dated as of August 1, 1994, by and between Heritage Associates Limited Partnership and Meridian Healthcare, Inc. (a) 10.13 Amendment No. 2 to Lease Agreement, dated as of August 1, 1994, by and between Heritage Associates Limited Partnership and Meridian Healthcare, Inc. (a) 10.14 Amendment No. 3 to Lease Agreement, dated as of September 3, 1998, by and between Heritage Associates Limited Partnership and ET Sub-Meridian Limited Partnership, L.L.P. 90 (a) 10.15 Assignment of Lease Agreement, dated as of September 3, 1998, by and between Heritage Associates Limited Partnership and ET Sub-Meridian Limited Partnership, L.L.P. (a) 10.16 Schedule of Omitted Meridian Lease Agreements (a) 10.17 Purchase Option, dated as of November 30, 1993, by and among the sellers identified therein, Heritage Associates Limited Partnership and MHC Acquisition Corporation (a) 10.18 First Amendment to Option Agreement, dated September 3, 1998, by and among the sellers identified therein, Heritage Meridian Limited Partnership and MHC Acquisition Corporation (a) 10.19 Assignment of Option Agreement, dated September 3, 1998, between Meridian Healthcare, Inc. and ET Sub-Meridian Limited Partnership, L.L.P. (a) 10.20 Schedule of Omitted Meridian Purchase Options (a) 10.21 Sublease Agreement, dated September 3, 1998, by and between ET Sub-Meridian Limited Partnership, L.L.P., as Landlord, and Meridian Healthcare, Inc., as Tenant (a) 10.22 Schedule of Omitted Meridian Sublease Agreements (i) 10.23 Indemnification Agreement dated September 3, 1998 in favor of the persons and entities listed on Exhibit B thereto (i) 10.24 Indemnification Consent and Acknowledgment Agreement dated September 3, 1998 between the Operating Partnership and Genesis (i) 10.25 Guarantee Agreement dated September 3, 1998 between the Operating Partnership and ET Sub-Meridian (d) 10.26 Option Agreement by and between D. Lee McCreary, Jr. and the Operating Partnership to purchase Mr. McCreary's controlling ownership interest in ET-Sub Vernon Court, L.L.C. (d) 10.27 Employment Agreement between the Company and D. Lee McCreary, Jr. dated as of October 13, 1999* (j) 10.28 Separation Agreement and Release entered into as of June 7, 2002 by and between ElderTrust and John H. Haas* 11.1 Computation of basic and diluted earnings per share 21.1 Subsidiaries of the Registrant 23.1 Consent of Independent Auditors ------------- * Represents management contract or compensatory plan. (a) Incorporated herein by reference to the Company's Form 8-K filed on October 10, 2002. (b) Incorporated by reference to the Company's Form 10-K for the year ended December 31, 1997. (c) Incorporated by reference to the Company's Form 8-K filed on October 20, 1999. (d) Incorporated by reference to the Company's Form 10-K for the year ended December 31, 1999. (e) Incorporated by reference to the Company's Form 10-Q for the quarter ended March 31, 1999. (f) Incorporated by reference to the Company's Form S-11 Registration Statement (No. 333-37451). (g) Incorporated by reference to the Company's Form 8-K filed on December 11, 2000. (h) Incorporated by reference to the Company's Form 8-K filed on August 30, 2002. (i) Incorporated by reference to the Company's Form 8-K filed on September 18, 1998. (j) Incorporate by reference to the Company's Form 10-Q for the quarter ended June 30, 2002. 91 ELDERTRUST SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 2002 (dollars in thousands)
Initial Cost to Company Cost Gross Amount Carried at Close of Period ----------------------- Capitalized ------------------------------------------ Buildings Subsequent and to Buildings and Accum. Description Encumbrances Land Improvements Acquisition Land Improvements Total(1) Deprec.(2) --------------------------------------------------------------------------------------------------------------------- Assisted Living Facilities: Agawam, MA $ - (3) $1,249 $11,243 $ - $1,249 $11,243 $12,492 $1,940 Clark's Summit, PA - (3) 645 5,802 18 645 5,820 6,465 1,004 Wilkes-Barre, PA 2,742 662 5,932 - 654 5,932 6,586 989 Paoli, PA 9,589 1,128 10,079 208 1,152 10,287 11,439 1,775 Macungie, PA - (3) 420 3,780 - 420 3,780 4,200 254 Reading, PA - (3) 470 4,230 - 470 4,230 4,700 284 Pottstown, PA - (3) 360 3,240 - 360 3,240 3,600 218 Kimberton, PA 10,050 (6) 1,239 10,834 10 970 8,763 9,733 412 North Andover, MA 8,537 1,194 10,729 3 1,194 10,732 11,926 1,538 Newton, MA 13,829 1,793 16,091 5 1,793 16,096 17,889 2,307 Brookline, MA 10,926 1,468 13,217 - 1,469 13,161 14,630 1,886 ------------ ------------------------------- -------------------------------- ----------- Subtotal 55,673 10,628 95,177 244 10,376 93,284 103,660 12,607 ------------ ------------------------------- -------------------------------- ----------- Independent Living Facility: Newton, MA 12,630 1,772 15,945 - 1,772 15,950 17,722 2,286 Concord, NH 3,796 407 3,667 - 407 3,667 4,074 633 ------------ ------------------------------- -------------------------------- ----------- Subtotal 16,426 2,179 19,612 - 2,179 19,617 21,796 2,919 ------------ ------------------------------- -------------------------------- ----------- Skilled Nursing Facilities: Philadelphia, PA - (3) 985 8,821 1 1,135 8,821 9,956 1,522 Lopatcong, NJ 10,500 1,490 13,406 - 1,490 13,406 14,896 2,313 Phillipsburg, NJ - (3) 679 6,110 10 230 2,312 2,542 170 Wayne, PA 4,600 662 5,921 1,761 662 7,682 8,344 1,217 Chester, PA 18,489 (4) 1,187 10,670 - 1,187 10,670 11,857 1,841 Philadelphia, PA - (4) 1,230 11,074 1 1,230 11,075 12,305 1,910 Flourtown, PA 14,900 (5) 784 7,052 - 784 4,933 5,717 1,216 Pennsburg, PA - (5) 1,091 9,813 51 1,091 9,864 10,955 1,701 La Plata, MD 9,208 1,306 11,751 4 1,306 11,778 13,084 1,788 Voorhees, NJ 12,173 1,745 15,669 6 1,745 15,736 17,481 2,388 Centerville, MD 10,033 1,424 12,809 5 1,424 12,840 14,264 1,949 Dundalk, MD 13,484 1,916 17,241 6 1,916 17,281 19,197 2,622 Towson, MD 3,883 546 4,912 2 546 4,924 5,470 748 Severna Park, MD 12,958 1,841 16,567 6 1,841 16,606 18,447 2,520 Westfield, NJ 16,484 2,345 21,092 8 2,345 21,142 23,487 3,209 ------------ ------------------------------- -------------------------------- ----------- Subtotal 126,712 19,231 172,908 1,861 18,932 169,070 188,002 27,114 ------------ ------------------------------- -------------------------------- -----------
Orig. Construct./ Date Description Renovation Date Acquired --------------------------------------------------------------- Assisted Living Facilities: Agawam, MA 1997 Jan-98 Clark's Summit, PA 1996 Jan-98 Wilkes-Barre, PA 1993 Mar-98 Paoli, PA 1995 Jan-98 Macungie, PA 1997 Jan-01 Reading, PA 1997 Jan-01 Pottstown, PA 1998 Jan-01 Kimberton, PA 1996 Jan-98 North Andover, MA 1995 Dec-98 Newton, MA 1905/1995 Dec-98 Brookline, MA 1995 Dec-98 Subtotal Independent Living Facility: Newton, MA 1996 Dec-98 Concord, NH 1926 Jan-98 Subtotal Skilled Nursing Facilities: Philadelphia, PA 1930/1993/2000 Jan-98 Lopatcong, NJ 1984/1992 Jan-98 Phillipsburg, NJ 1930/1993 Jan-98 Wayne, PA 1920/1999 Jan-98 Chester, PA 1960/1983 Jan-98 Philadelphia, PA 1973 Jan-98 Flourtown, PA 1977/1991 Jan-98 Pennsburg, PA 1982 Jan-98 La Plata, MD 1983 Sept-98 Voorhees, NJ 1986/1988 Sept-98 Centerville, MD 1977/1983/1991 Sept-98 Dundalk, MD 1981 Sept-98 Towson, MD 1972-1973 Sept-98 Severna Park, MD 1982 Sept-98 Westfield, NJ 1970/1980/1994 Sept-98 Subtotal
S-1 ELDERTRUST SCHEDULE III (continued) REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 2002 (dollars in thousands)
Initial Cost to Company Cost Gross Amount Carried at Close of Period ----------------------- Capitalized ------------------------------------------ Buildings Subsequent and to Buildings and Accum. Description Encumbrances Land Improvements Acquisition Land Improvements Total(1) Deprec.(2) --------------------------------------------------------------------------------------------------------------------- Medical Office and Other Buildings: Upland, PA 2,520 - 4,383 129 - 4,610 4,610 771 Drexel Hill, PA 5,717 - 8,132 86 - 8,285 8,285 1,413 Forked River, NJ 482 62 563 - 62 563 625 97 ------------ ------------------------------- -------------------------------- ----------- Subtotal 8,719 62 13,078 215 62 13,458 13,520 2,281 ------------ ------------------------------- -------------------------------- ----------- ------------ ------------------------------- -------------------------------- ----------- Total Operating $207,530 $32,100 $300,775 $2,320 $31,549 $295,429 $326,978 $44,921 ============ =============================== ================================ =========== Orig. Construct./ Date Description Renovation Date Acquired --------------------------------------------------------------- Medical Office and Other Buildings: Upland, PA 1977 Jan-98 Drexel Hill, PA 1984/1997 Feb-98 Forked River, NJ 1996 Jan-98 Subtotal Total Operating
(1) The aggregate cost for Federal income tax purposes is $216,699. (2) Depreciation expense is calculated using a 28.5 year composite life for both building and equipment. (3) Encumbered by the Guidance Line in the aggregate amount of $3.1 million. (4)&(5) This is a single note which covers both properties. (6) This property was classified as held for sale prior to November 1, 2001. The asset value and accumulated depreciation have been adjusted according to SFAS 144. See "Item 2 - Properties" Properties Held for Sale at December 31, 2002:
Initial Cost to Company Cost Gross Amount Carried at Close of Period ----------------------- Capitalized ------------------------------------------ Buildings Subsequent and to Buildings and Accum. Description Encumbrances Land Improvements Acquisition Land Improvements Total(1) Deprec.(2) --------------------------------------------------------------------------------------------------------------------- Medical Office Building: Salisbury, MD $ 1,022 $135 $1,212 $ 75 $142 $973 $1,115 $189 ----------- -------------------------------- -------------------------------- ----------- Asset Held for Sale $ 1,022 $135 $1,212 $ 75 $142 $973 $1,115 $189 =========== ================================ ================================ =========== Orig. Construct./ Date Description Renovation Date Acquired --------------------------------------------------------------- Medical Office Building: Salisbury, MD 1984 Jan-98 Asset Held for Sale
S-2 The following represents a roll forward of the balance of real estate properties and related accumulated depreciation from January 1, 1999 to December 31, 2002:
Accumulated Cost Basis Depreciation ------------ -------------- Balance at December 31, 1999 $ 181,861 $ 10,180 Additions/(reductions) during period: Assets held for sale written down to fair value (5,932) (626) Assets held for sale reclassed on balance sheet (12,666) (1,301) Improvements 626 66 Real estate properties depreciation for the period - 5,766 --------- -------- Balance at December 31, 2000 (1) $ 163,889 $ 14,085 Additions during period: Acquisitions (2) 12,650 362 Asset previously held for sale (3) 9,695 59 Improvements 171 75 Real estate properties depreciation for the period - 5,164 --------- -------- Balance at December 31, 2001 $ 186,405 $ 19,745 Additions during period: Assets written down to fair value (2,119) - Assets held for sale reclassed on balance sheet (1,115) (189) Assets held for sale written down to fair value (315) - Acquisition of property through the consolidation of Meridian, Cabot and Cleveland 143,782 18,260 Improvements 340 81 Real estate properties depreciation for the period - 7,024 --------- -------- Balance at December 31, 2002 $ 326,978 $ 44,921 ========= ========
(1) Balance does not reflect assets held for sale. Assets held for sale are disclosed separately on the Balance Sheet. (2) Represents three assisted living properties and land on one additional property acquired through the debt restructuring with Genesis on January 31, 2001. (3) Represents the Woodbridge property located in Kimberton, PA. This asset was reclassified from held for sale on November 1, 2001. S-3