UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

 

FIVE STAR QUALITY CARE, INC.

(Exact Name of Registrant as Specified in its Charter)

 

400 Centre Street, Newton, Massachusetts 02458

(Address of Principal Executive Offices)

617-796-8387

(Registrant’s Telephone Number Including Area Code)

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

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

Large accelerated filer o  Accelerated filer x   Non-accelerated filer o

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

Number of Common Shares outstanding at August 8, 2007: 31,704,134 shares of common stock, $0.01 par value.

FIVE STAR QUALITY CARE, INC.

FORM 10-Q

JUNE 30, 2007

INDEX

				Page
PART I		Financial Information
Item 1.		Consolidated Financial Statements (unaudited)
		Consolidated Balance Sheet – June 30, 2007 and December 31, 2006		1
		Consolidated Statements of Operations – Three and Six Months Ended June 30, 2007 and 2006		2
		Consolidated Statement of Cash Flows – Six Months Ended June 30, 2007 and 2006		3
		Notes to Consolidated Financial Statements		4
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		23
Item 4.		Controls and Procedures		24
		Warning Concerning Forward Looking Statements		25
PART II		Other Information
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		26
Item 4.		Submission of Matters to a Vote of Security Holders		26
Item 6.		Exhibits		26
		Signatures		27

 

As used herein the terms “we”, “us”, “our” and “Five Star” include Five Star Quality Care, Inc. and its consolidated subsidiaries unless otherwise expressly stated or the context otherwise requires.

Part I.     Financial Information

Item 1.  Consolidated Financial Statements

FIVE STAR QUALITY CARE, INC.

CONSOLIDATED BALANCE SHEET

(dollars in thousands, except share amounts)

		June 30, 2007			December 31, 2006
ASSETS		(unaudited)
Current assets:
Cash and cash equivalents		$	42,486		$	46,241
Accounts receivable, net of allowance of $6,190 and $5,005 at June 30, 2007 and December 31, 2006, respectively		60,877			67,791
Prepaid expenses		8,739			16,112
Investments in trading securities		38,771			50,434
Restricted cash – insurance arrangements		1,849			3,043
Restricted investments – insurance arrangements		4,514			2,448
Restricted cash – other		3,270			4,925
Other current assets		11,320			14,766
Total current assets		171,826			205,760
Property and equipment, net		132,772			114,898
Restricted cash – insurance arrangements		4,713			7,786
Restricted investments – insurance arrangements		11,505			6,262
Restricted cash – other		769			774
Goodwill and other intangible assets		22,477			22,611
Other long term assets		8,404			8,320
		$	352,466		$	366,411
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	18,316		$	22,805
Accrued expenses		26,577			18,825
Accrued compensation and benefits		20,757			19,218
Due to Senior Housing Properties Trust (“SNH”)		10,960			9,988
Mortgage notes payable		155			33,317
Accrued real estate taxes		6,207			6,035
Security deposit liability		14,667			15,097
Other current liabilities		7,983			7,644
Total current liabilities		105,622			132,929
Long term liabilities:
Mortgage notes payable		15,927			11,454
Convertible senior notes		126,500			126,500
Continuing care contracts		3,400			3,649
Other long term liabilities		25,455			24,449
Total long term liabilities		171,282			166,052
Commitments and contingencies
Shareholders’ equity:
Preferred stock, par value $0.01: 1,000,000 shares authorized, none issued		—			—
Common stock, par value $0.01: 50,000,000 shares authorized, 31,704,134 and 31,682,134 shares issued and outstanding at June 30, 2007 and December 31, 2006, respectively		317			316
Additional paid-in capital		286,524			286,344
Accumulated deficit		(210,591		)	(219,435		)
Unrealized (loss) gain on investments		(688		)	205
Total shareholders’ equity		75,562			67,430
		$	352,466		$	366,411

 

See accompanying notes.

1

---

FIVE STAR QUALITY CARE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(dollars in thousands, except per share amounts)

(unaudited)

		Three months ended June 30,						Six months ended June 30,
		2007			2006			2007			2006
Revenues:
Senior living revenue		$	200,024		$	182,649		$	396,525		$	363,437
Hospital revenue		25,873			—			52,643			—
Pharmacy revenue		16,914			12,963			33,162			24,217
Total revenues		242,811			195,612			482,330			387,654
Operating expenses:
Senior living wages and benefits		103,406			94,484			204,872			185,319
Other senior living operating expenses		48,406			45,794			97,875			94,282
Hospital expenses		24,151			—			48,407			—
Pharmacy expenses		16,328			12,305			32,270			22,996
Management fee to Sunrise Senior Living Services, Inc. (“SLS”)		—			2,854			—			6,392
Termination expense for SLS management agreements		—			89,833			—			89,833
Rent expense		31,858			25,846			64,029			51,453
General and administrative		10,887			8,016			20,946			15,238
Depreciation and amortization		3,265			2,289			6,444			4,557
Total operating expenses		238,301			281,421			474,843			470,070
Operating income (loss)		4,510			(85,809		)	7,487			(82,416		)
Interest and other income		1,521			816			2,586			1,140
Interest expense		(1,677		)	(875		)	(3,455		)	(1,633		)
Gain on extinguishment of debt		934			—			4,491			—
Income (loss) from continuing operations before income taxes		5,288			(85,868		)	11,109			(82,909		)
Provision for income taxes		275			—			483			—
Income (loss) from continuing operations		5,013			(85,868		)	10,626			(82,909		)
Loss from discontinued operations		(933		)	(1,323		)	(1,782		)	(2,623		)
Net income (loss)		$	4,080		$	(87,191	)	$	8,844		$	(85,532	)
Weighted average shares outstanding - basic		31,694			30,982			31,689			25,551
Weighted average shares outstanding - diluted		41,425			30,982			41,420			25,551
Basic income (loss) per share from:
Continuing operations		$	0.16		$	(2.78	)	$	0.34		$	(3.25	)
Discontinued operations		(0.03		)	(0.04		)	(0.06		)	(0.10		)
Net income (loss) per share		$	0.13		$	(2.82	)	$	0.28		$	(3.35	)
Diluted income (loss) per share from:
Continuing operations		$	0.15		$	(2.78	)	$	0.32		$	(3.25	)
Discontinued operations		(0.02		)	(0.04		)	(0.04		)	(0.10		)
Net income (loss) per share		$	0.13		$	(2.82	)	$	0.28		$	(3.35	)

 

See accompanying notes.

2

---

FIVE STAR QUALITY CARE, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(dollars in thousands)

(unaudited)

		Six months ended June 30,
		2007			2006
Cash flows from operating activities:
Net income (loss)		$	8,844		$	(85,532	)
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:
Depreciation and amortization		6,444			4,557
Gain on extinguishment of debt		(4,491		)	—
Loss from discontinued operations		1,782			2,623
Provision for bad debt expense, net		1,185			1,334
Changes in assets and liabilities:
Accounts receivable		5,729			(1,550		)
Prepaid expenses and other assets		10,665			(758		)
Investments in trading securities		11,663			(3,859		)
Accounts payable and accrued expenses		3,444			4,021
Accrued compensation and benefits		1,539			(1,766		)
Due to/from SLS		—			(8,076		)
Due to/from SNH		972			11
Other current and long term liabilities		838			424
Cash provided by (used in) operating activities		48,614			(88,571		)
Net cash used in discontinued operations		(1,782		)	(2,623		)
Cash flows from investing activities:
Deposits into restricted cash and investment accounts, net		(2,275		)	(7,642		)
Acquisition of property and equipment		(36,199		)	(20,086		)
Acquisition of senior living community, net of cash acquired		(5,025		)	—
Acquisition of pharmacy, net of cash acquired		—			(3,500		)
Proceeds from disposition of property and equipment held for sale		17,110			11,077
Withdrawals from restricted cash for purchases of property and equipment		—			4,638
Cash used in investing activities		(26,389		)	(15,513		)
Cash flows from financing activities:
Proceeds from issuance of common shares, net		—			114,059
Proceeds from borrowings on revolving credit facility		—			28,000
Repayments of borrowings on revolving credit facility		—			(28,000		)
Proceeds from mortgage note payable		4,559			—
Repayments of mortgage note payable		(28,757		)	(280		)
Cash (used in) provided by financing activities		(24,198		)	113,779
Change in cash and cash equivalents		(3,755		)	7,072
Cash and cash equivalents at beginning of period		46,241			16,376
Cash and cash equivalents at end of period		$	42,486		$	23,448
Supplemental cash flow information:
Cash paid for interest		$	3,063		$	1,354
Non-cash investing and financing activities:
Issuance of common stock		180			43

 

See accompanying notes.

3

FIVE STAR QUALITY CARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share amounts)

(unaudited)

Note 1.  Basis of Presentation and Organization

Certain information and disclosures required by generally accepted accounting principles for complete financial statements have been condensed or omitted.  We believe the disclosures made are adequate to make the information presented not misleading.  However, the accompanying financial statements should be read in conjunction with the financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2006.  In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included.  All intercompany transactions and balances have been eliminated.  Our operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.

As of June 30, 2007, we operated 161 senior living communities containing 18,007 living units, including 112 primarily independent and assisted living communities containing 13,597 living units and 49 nursing homes containing 4,410 living units.  Of our 112 primarily independent and assisted living communities, we leased 95 communities containing 12,330 living units from Senior Housing Properties Trust, or Senior Housing, our former parent, and we owned or leased from parties other than Senior Housing 17 communities containing 1,267 living units.  We leased 47 of our 49 nursing homes from Senior Housing.  Our 161 communities include 5,667 independent living apartments, 6,371 assisted living suites and 5,969 skilled nursing beds.  We also operated six institutional pharmacies, one of which provided mail order pharmaceuticals to the general public, and we operated two rehabilitation hospitals that we leased from Senior Housing.  Our two rehabilitation hospitals contain 342 beds available for inpatient services and 21 affiliated outpatient clinics.

Note 2. Property and Equipment

Property and equipment, at cost, consists of:

		June 30, 2007			December 31, 2006
Land		$	7,195		$	6,685
Buildings and improvements		98,552			82,293
Furniture, fixtures and equipment		54,131			46,685
		159,878			135,663
Accumulated depreciation		(27,106		)	(20,765		)
		$	132,772		$	114,898

 

As of June 30, 2007 and December 31, 2006, we had assets classified as held for sale of $25,127 and $15,478, respectively, included in our property and equipment that we intend to sell to Senior Housing as permitted by our leases.

Note 3. Comprehensive Income (Loss)

Comprehensive income (loss) for the three and six months ended June 30, 2007 and 2006 is summarized below:

		Three months ended June 30,						Six months ended June 30,
		2007			2006			2007			2006
Net income (loss)		$	4,080		$	(87,191	)	$	8,844		$	(85,532	)
Unrealized loss on investments in available for sale securities		(850		)	(336		)	(893		)	(358		)
Comprehensive income (loss)		$	3,230		$	(87,527	)	$	7,951		$	(85,890	)

 

Note 4.  Financial Data By Segment

Our reportable segments consist of our senior living community business and our rehabilitation hospital business that we began to operate in October 2006.  In the senior living community segment, we operate independent living

4

---

and congregate care communities, assisted living communities and nursing homes.  Our rehabilitation hospital segment provides inpatient health rehabilitation services at our two hospital locations and three satellite locations and outpatient health rehabilitation services at 21 locations.  We do not consider our pharmacy operations to be a material, separately reportable segment of our business, but we report our pharmacy revenues and expense as separate items combined with our corporate and other activities.  All of our operations and assets are located in the United States.

We use segment operating profit as an important measure to evaluate our performance and for decision making purposes.  Segment operating profit excludes interest and other income, interest expense and certain corporate expenses.

Our revenues by segment, along with a reconciliation of segment operating profit to income from continuing operations before income taxes for the three and six months ended June 30, 2007 and 2006 are as follows:

		Senior Living Communities			Rehabilitation Hospitals			Corporate and other (1)			Total
Three months ended June 30, 2007
Revenues		$	200,024		$	25,873		$	16,914		$	242,811
Segment expenses:
Operating expenses		151,812			24,151			16,328			192,291
Rent expense		29,296			2,562			—			31,858
Depreciation and amortization		2,289			279			697			3,265
Total segment expenses		183,397			26,992			17,025			227,414
Segment operating profit (loss)		16,627			(1,119		)	(111		)	15,397
General and administrative expenses (2)		—			—			(10,887		)	(10,887		)
Operating income (loss)		16,627			(1,119		)	(10,998		)	4,510
Interest and other income		—			—			1,521			1,521
Interest expense		(432		)	—			(1,245		)	(1,677		)
Gain on extinguishment of debt		934			—			—			934
Provision for income taxes		—			—			(275		)	(275		)
Income (loss) from continuing operations		$	17,129		$	(1,119	)	$	(10,997	)	$	5,013
Total Assets as of June 30, 2007		$	235,382		$	23,821		$	93,263		$	352,466
Three months ended June 30, 2006
Revenues		$	182,649		$	—		$	12,963		$	195,612
Segment expenses:
Operating expenses		140,278			—			12,305			152,583
Management fee to SLS		2,854			—			—			2,854
Termination expense for SLS management agreements		89,833			—			—			89,833
Rent expense		25,846			—			—			25,846
Depreciation and amortization		1,759			—			530			2,289
Total segment expenses		260,570			—			12,835			273,405
Segment operating (loss) profit		(77,921		)	—			128			(77,793		)
General and administrative expenses (2)		—			—			(8,016		)	(8,016		)
Operating loss		(77,921		)	—			(7,888		)	(85,809		)
Interest and other income		—			—			816			816
Interest expense		(867		)	—			(8		)	(875		)
Loss from continuing operations		$	(78,788	)	$	—		$	(7,080	)	$	(85,868	)
Total Assets as of June 30, 2006		$	224,058		$	—		$	28,276		$	252,334

 

5

---

 

Six months ended June 30, 2007
Revenues		$	396,525		$	52,643		$	33,162		$	482,330
Segment expenses:
Operating expenses		302,747			48,407			32,270			383,424
Rent expense		58,898			5,131			—			64,029
Depreciation and amortization		4,500			496			1,448			6,444
Total segment expenses		366,145			54,034			33,718			453,897
Segment operating profit (loss)		30,380			(1,391		)	(556		)	28,433
General and administrative expenses (2)		—			—			(20,946		)	(20,946		)
Operating income (loss)		30,380			(1,391		)	(21,502		)	7,487
Interest and other income		—			—			2,586			2,586
Interest expense		(969		)	—			(2,486		)	(3,455		)
Gain on extinguishment of debt		4,491			—			—			4,491
Provision for income taxes		—			—			(483		)	(483		)
Income (loss) from continuing operations		$	33,902		$	(1,391	)	$	(21,885	)	$	10,626
Six months ended June 30, 2006
Revenues		$	363,437		$	—		$	24,217		$	387,654
Segment expenses:
Operating expenses		279,601			—			22,996			302,597
Management fee to SLS		6,392			—			—			6,392
Termination expense for SLS management agreements		89,833			—			—			89,833
Rent expense		51,453			—			—			51,453
Depreciation and amortization		3,614			—			943			4,557
Total segment expenses		430,893			—			23,939			454,832
Segment operating (loss) profit		(67,456		)	—			278			(67,178		)
General and administrative expenses (2)		—			—			(15,238		)	(15,238		)
Operating loss		(67,456		)	—			(14,960		)	(82,416		)
Interest and other income		—			—			1,140			1,140
Interest expense		(1,510		)	—			(123		)	(1,633		)
Loss from continuing operations		$	(68,966	)	$	—		$	(13,943	)	$	(82,909	)

 

(1) Corporate and Other includes operations that we do not consider a significant, separately reportable segment of our business and income and expenses that are not attributable to a specific segment.

(2) General and administrative expenses are not attributable to a specific segment and include items such as corporate payroll and benefits and outside service expenses.

Note 5.  Income Taxes

In June 2006, the Financial Accounting Standards Board issued Interpretation No. 48 “Accounting for Uncertainty in Income Taxes”, or FIN 48.  FIN 48 prescribes how we should recognize, measure and present in our financial statements uncertain tax positions that have been taken or are expected to be taken in a tax return. Pursuant to FIN 48, we can recognize a tax benefit only if it is “more likely than not” that a particular tax position will be sustained upon examination or audit. To the extent the “more likely than not” standard has been satisfied, the benefit associated with a tax position is measured as the largest amount that has a greater than 50% likelihood of being realized upon settlement.

As required, we adopted FIN 48 effective January 1, 2007 and have concluded the effect is not material to our consolidated financial statements.  Accordingly, we did not record a cumulative effect adjustment related to the adoption of FIN 48.  At the date of adoption, we had $785 in unrecognized tax benefits related to FIN 48 plus significant tax loss carry forwards totaling approximately $202,500 which, if recognized, would favorably affect our

6

---

effective tax rate.  We do not believe that our unrecognized tax benefits related to FIN 48 will change significantly in the next 12 months.

Because we have historically reported losses we do not currently recognize the benefit of all of our deferred tax assets, including tax loss carry forwards that may be used to offset future taxable income.  We will, however, continue to assess our ability to generate sufficient taxable income during future periods in which our deferred tax assets may be realized. When we believe that we will more likely than not recover our deferred tax assets, we will record deferred tax assets as an income tax benefit in the consolidated statement of operations, which will affect our results of operations. Our net operating loss carry forwards begin to expire in 2023, if unused. The tax loss carry forwards and tax returns filed for the 2002 through 2006 tax years are subject to examination by taxing authorities.

For the six months ended June 30, 2007, we recognized tax expenses of $483, which includes $369 of alternative minimum taxes and certain state taxes that are payable without regard to our tax loss carry forwards and $114 of a non cash deferred tax liability arising from the amortization of goodwill for tax purposes but not for book purposes. We may recognize this deferred tax liability as a reduction in the income tax provision if, in some future period, we expense the related items of goodwill for book purposes as the result of its sale, other disposition or impairment.

Note 6.  Earnings Per Share

Basic earnings per share for the periods ended June 30, 2007 and 2006 is computed using the weighted average number of shares outstanding during the periods.  Diluted earnings per share for the period ended June 30, 2007 reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income applicable to common shareholders that would result from the assumed issuance.  The effect of our convertible senior notes on loss from discontinued operations per share is anti-dilutive for the three and six months ended June 30, 2007, respectively.

The following table provides a reconciliation of both net income and the number of common shares used in the computations of diluted earnings per share, or EPS:

		Three Months Ended June 30,
		2007								2006
		Income (loss)			Shares		Per Share			Income  (loss)			Shares		Per Share
Income from continuing operations		$	5,013		31,694		$	0.16		$	(85,868	)	30,982		$	(2.78	)
Effect of convertible senior notes		1,245			9,731					—			—
Amounts used to calculate diluted EPS from continuing operations		6,258			41,425		$	0.15		(85,868		)	30,982		$	(2.78	)
Amounts used to calculate diluted EPS from discontinued operations		$	(933	)	41,425		$	(0.02	)	$	(1,323	)	30,982		$	(0.04	)

 

		Six Months Ended June 30,
		2007								2006
		Income (loss)			Shares		Per Share			Income  (loss)			Shares		Per Share
Income from continuing operations		$	10,626		31,689		$	0.34		$	(82,909	)	25,551		$	(3.25	)
Effect of convertible senior notes		2,486			9,731					—			—
Amounts used to calculate diluted EPS from continuing operations		13,112			41,420		$	0.32		(82,909		)	25,551		$	(3.25	)
Amounts used to calculate diluted EPS from discontinued operations		$	(1,782	)	41,420		$	(0.04	)	$	(2,623	)	25,551		$	(0.10	)

 

7

---

Note 7.  Acquisitions

In April 2007, we acquired a 48 unit assisted living community located in Tennessee for $5,025.  We financed the acquisition by assuming a $4,559 non recourse United States Department of Housing, or HUD, insured mortgage and paying the balance of the purchase price with cash on hand.  The interest rate on the assumed HUD insured mortgage is 7.65%.  We included the results of this community’s operations in our consolidated financial statements from the date of acquisition.  All of the community’s revenues come from residents’ private resources.  We acquired this community to expand our business in high quality senior living operations where residents pay for our services with private resources.

Note 8.  Line of Credit

In June 2007, we amended our revolving line of credit.  The amendment increased the line from $25,000 to $40,000, extended the termination date to May 8, 2009 and reduced the interest rate by 25 basis points.  Our revolving line of credit is available for acquisitions, working capital and general business purposes.  The amount we are able to borrow at any time is subject to limitations based upon qualifying collateral.  We are the borrower under this revolving credit facility and certain of our subsidiaries guarantee our obligations under the facility, which is secured by our and our guarantor subsidiaries’ accounts receivable, deposit accounts and related assets.  The facility contains covenants requiring us to maintain collateral, minimum net worth and certain other financial ratios, limits our ability to incur or assume debt or create liens with respect to certain of our properties and has other customary provisions.  In certain circumstances and subject to available collateral and lender approvals, the maximum amounts which we may draw under this credit facility may be increased to $80,000.  The termination date may be extended twice, in each case by twelve months, subject to lender approval, our payment of extension fees and other conditions.  As of June 30, 2007 and August 8, 2007, no amounts were outstanding under this credit facility.  As of June 30, 2007 and August 8, 2007 we believe we are in compliance with all applicable covenants under this credit facility.   Interest expense and other associated costs related to this facility were $113 and $8 for the three months ended June 30, 2007 and 2006, respectively, and $196 and $123 for the six months ended June 30, 2007 and 2006, respectively.

Note 9.  Mortgages Payable

At June 30, 2007, four of our communities were encumbered by five HUD insured mortgages totaling $16,082.  In February 2007, we prepaid six mortgages that were secured by five of our senior living communities.  We paid $22,923 to retire these six mortgages, which consisted of approximately $22,198 in principal and interest and $725 in prepayment penalties.  Because we had carried these mortgages at a premium to their face value, we recognized a net gain of $3,557 in connection with the early extinguishment of debt.  In April 2007, we prepaid one mortgage that was secured by one of our communities.  We paid $5,944 to retire this mortgage, which consisted of approximately $5,828 in principal and interest and $116 in prepayment penalties.  Because we had carried this mortgage at a premium to its face value, we recognized a net gain of approximately $934 in connection with the early extinguishment of debt.  Mortgage interest expense, including premium amortization, was $319 and $694 for the three months ended June 30, 2007 and 2006, respectively, and $773 and $1,338 for the six months ended June 30, 2007 and 2006, respectively.

As discussed in Note 7, in April 2007, we acquired a 48 unit assisted living community located in Tennessee for $5,025.  We financed the acquisition by assuming a $4,559 non recourse HUD insured mortgage and paying the balance of the purchase price with cash on hand.  The interest rate on the assumed HUD insured mortgage is 7.65%.

Note 10.  Convertible Senior Notes due 2026  

In October 2006, we issued $126,500 principal amount of 3.75% convertible senior notes.  Our net proceeds from this offering were approximately $122,600.  These notes are convertible into our common shares at any time.  The initial conversion rate, which is subject to adjustment, is 76.9231 common shares per $1 principal amount of notes, which represents an initial conversion price of $13.00 per share.  Interest expense and other associated costs on the notes were $1,245 and $2,486 for the three and six months ended June 30, 2007, respectively.  The notes are guaranteed by certain of our domestic wholly owned subsidiaries (see Note 13).  These notes mature on October 15, 2026; we may prepay them at anytime after October 20, 2011 and the note holders may require that we purchase all or a portion of these notes on each of October 15, 2013, October 15, 2016 and October 15, 2021.  We issued these

8

---

notes pursuant to an indenture which contains various customary covenants; we believe we are in compliance with all applicable covenants of the indenture.

Note 11.  Related Party Transactions

We lease 142 of the 161 senior living communities and the two rehabilitation hospitals that we operated on June 30, 2007 from Senior Housing for total annual minimum rent of $126,078.  In addition to the minimum rent, we paid $616 and $377 in percentage rent to Senior Housing for the three months ended June 30, 2007 and 2006, respectively and $1,168 and $670 for the six months ended June 30, 2007 and 2006, respectively.

During the six months ended June 30, 2007, as permitted by our leases with Senior Housing, we sold to Senior Housing, at cost, $17,110 of improvements made to properties leased from Senior Housing, and the annual rent payable to Senior Housing increased by $1,677.

Note 12.  Discontinued Operations

In March 2007, we agreed with Senior Housing that it should sell two assisted living communities in Pennsylvania, which we lease from Senior Housing.  We and Senior Housing are in the process of selling these assisted living communities and, upon their sale, our annual minimum rent payable to Senior Housing will decrease by 9.5% of the net proceeds of the sale to Senior Housing.  As of June 30, 2007, we have disposed of substantially all of our assets and settled all liabilities related to these two communities.  We have reclassified the statement of operations for all periods presented to show the results of operations of the communities which have been sold or are expected to be sold as discontinued.  A summary of the operating results of these discontinued operations included in the financial statements for the three and six months ended June 30, 2007 and 2006 is:

		Three months ended June 30,						Six months ended June 30,
		2007			2006			2007			2006
Revenues		$	779		$	6,351		$	1,531		$	14,213
Expenses		(1,712		)	(7,674		)	(3,313		)	(16,836		)
Net loss		$	(933	)	$	(1,323	)	$	(1,782	)	$	(2,623	)

 

Note 13.  Guarantor Financial Information

Our convertible notes are guaranteed by certain of our domestic wholly owned subsidiaries.  Such guarantees are full, unconditional and joint and several.  Condensed consolidating financial information related to the Company, its guarantor subsidiaries and non-guarantor subsidiaries for all periods presented are as follows:

Consolidating Statement of Operations
For the three months ended June 30, 2007

		Parent			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Eliminations			Consolidated
Revenues:
Senior living revenue		$	—		$	84,988		$	115,036		$	—		$	200,024
Hospital revenue		—			—			25,873			—			25,873
Pharmacy revenue		—						16,914			—			16,914
Total revenues					84,988			157,823			—			242,811
Operating expenses:
Senior living wages and benefits		—			38,242			65,164			—			103,406
Other senior living operating expenses		—			24,536			23,870			—			48,406
Hospital expenses		—			—			24,151			—			24,151
Pharmacy expenses		—			—			16,328			—			16,328
Rent expense		—			16,613			15,245			—			31,858
General and administrative expenses		—			—			10,887			—			10,887

 

9

---

 

Depreciation and amortization		—			1,198			2,067			—			3,265
Total operating expenses		—			80,589			157,712			—			238,301
Operating income		—			4,399			111			—			4,510
Interest and other income		—			—			1,521			—			1,521
Interest expense		—			—			(1,677		)	—			(1,677		)
Gain on extinguishment of debt		—			—			934			—			934
Equity in earnings of subsidiaries		4,080			—			—			(4,080		)	—
Income from continuing operations before income taxes		4,080			4,399			889			(4,080		)	5,288
Provision for income taxes		—			—			275			—			275
Income from continuing operations		4,080			4,399			614			(4,080		)	5,013
Loss from discontinued operations		—			—			(933		)	—			(933		)
Net income		$	4,080		$	4,399		$	(319	)	$	(4,080	)	$	4,080

 

Consolidating Statement of Operations
For the three months ended June 30, 2006

		Parent			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Eliminations			Consolidated
Revenues:
Senior living revenue		$	—		$	82,136		$	100,513		$	—		$	182,649
Pharmacy revenue		—			—			12,963			—			12,963
Total revenues		—			82,136			113,476			—			195,612
Operating expenses:
Senior living wages and benefits		—			35,539			58,945			—			94,484
Other senior living operating expenses		—			24,838			20,956			—			45,794
Pharmacy expenses		—			—			12,305			—			12,305
Management fee to SLS		—			2,854			—			—			2,854
Termination expense for SLS management agreements		—			89,833			—			—			89,833
Rent expense		—			16,202			9,644			—			25,846
General and administrative expenses		—			—			8,016			—			8,016
Depreciation and amortization		—			1,015			1,274			—			2,289
Total operating expenses		—			170,281			111,140			—			281,421
Operating (loss) income		—			(88,145		)	2,336			—			(85,809		)
Interest and other income		—			67			749			—			816
Interest expense		—			(4		)	(871		)	—			(875		)
Equity in earnings of subsidiaries		(87,191		)	—			—			87,191			—
(Loss) income from continuing operations before income taxes		(87,191		)	(88,082		)	2,214			87,191			(85,868		)
Provision for income taxes		—			—			—			—			—
(Loss) income from continuing operations		(87,191		)	(88,082		)	2,214			87,191			(85,868		)
(Loss) income from discontinued operations		—			(25		)	(1,298		)	—			(1,323		)
Net (loss) income		$	(87,191	)	$	(88,107	)	$	916		$	87,191		$	(87,191	)

 

10