BKD

Brookdale Senior Living Inc. - 10-Q Summary (Q3 2007)

Business Context and Reporting Period

This report covers the quarterly period ended September 30, 2007. Brookdale Senior Living Inc. is a leading owner and operator of senior living facilities in the United States, including independent living, assisted living, dementia-care facilities, and continuing care retirement centers (CCRCs). As of the period end, the company operated 550 facilities with 52,082 units/beds.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 20.0% ($77.6 million) for the quarter and 56.1% ($492.2 million) year-to-date compared to 2006. This growth was driven primarily by acquisitions completed in late 2006 and 2007, particularly the American Retirement Corporation (ARC) acquisition, and an increase in average revenue per unit/bed.
• Net Loss Expansion: Net loss increased significantly, rising 89.2% for the quarter and 59.4% year-to-date. The primary driver was a $43.7 million expense in the quarter (and $30.9 million YTD) related to the change in fair value of interest rate derivatives (swaps) due to unfavorable shifts in the LIBOR yield curve. The company discontinued hedge accounting in October 2006, causing these fair value changes to flow directly into earnings.
• Operating Expenses: Facility operating expenses increased 20.3% for the quarter, largely due to the inclusion of acquired facilities and higher salaries/wages. Depreciation and amortization rose 30.1% due to new assets.
• Occupancy: Overall occupancy remained relatively flat at 91.0% at period end, slightly down from 91.1% in the prior year quarter.

Guidance, Outlook, and Risks

• Management Commentary: Management continues to focus on organic growth, ancillary service expansion (therapy and home health), and selective acquisitions. They noted that difficult housing market conditions and economic uncertainty have hindered occupancy growth above the current 91% level and caused volatility in entrance fee sales, particularly in Florida and Arizona.
• Dividends: The board declared a quarterly cash dividend of $0.50 per share, a 25% increase from the prior year quarter.
• Subsequent Events: Following the period end, the company secured $140.0 million and $80.3 million in new first mortgage financing to pay down its revolving credit facility and fund construction.
• Risks and Contingencies:
  • Derivative Exposure: Significant volatility in earnings due to interest rate swaps carried at fair value.
  • Legal Proceedings: Two active lawsuits regarding the 2004 sale of facilities to Ventas Realty, with plaintiffs seeking damages in excess of $100 million per count. The company cannot estimate the potential loss.
  • Liquidity: The company reported negative working capital of $237.9 million, largely due to the accounting classification of refundable entrance fees ($200.6 million) as current liabilities. Management expects only 9-12% of these to be settled in cash within 12 months.

Investor Verification Checklist

• Derivative Accounting Impact: Verify the sustainability of earnings given the $43.7 million non-cash loss from interest rate swaps in Q3 and the discontinuation of hedge accounting.
• Entrance Fee Volatility: Monitor entrance fee sales trends, as they are sensitive to housing market conditions and impact cash flow from CCRCs.
• Debt Service Coverage: Review the company's ability to service $2.0 billion in debt, particularly with the recent increase in interest expense and the reliance on refinancing.
• Legal Exposure: Assess the potential financial impact of the pending litigation regarding the Ventas facility sales.
• Working Capital Definition: Understand that the reported negative working capital is largely an accounting artifact of refundable entrance fees and does not necessarily indicate immediate liquidity distress.