AlerisLife Inc. - Quarter Report: 2008 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2008

 

OR

 

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

 

Commission File Number 001-16817

 

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) (Zip Code)

 

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, or a smaller reporting company.  See the definitions of “large accelerated filed”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

 

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 registrants’ shares of common stock, $0.01 par value outstanding as of May 7, 2008: 31,818,144.

 

 

FIVE STAR QUALITY CARE, INC.

 

FORM 10-Q

 

March 31, 2008

 

INDEX

 

		Page
PART I	Financial Information
Item 1.	Consolidated Financial Statements (unaudited)
	Consolidated Balance Sheet – March 31, 2008 and December 31, 2007	1
	Consolidated Statement of Income – Three Months Ended March 31, 2008 and 2007	2
	Consolidated Statement of Cash Flows – Three Months Ended March 31, 2008 and 2007	3
	Notes to Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	19
Item 4.	Controls and Procedures	20
	Warning Concerning Forward Looking Statements	21
PART II	Other Information
Item 6.	Exhibits	22
	Signatures	23

 

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

(in thousands, except share data)

(unaudited)

 

		March 31, 2008			December 31, 2007
ASSETS
Current assets:
Cash and cash equivalents		$	52,029		$	30,999
Accounts receivable, net of allowance of $5,305 and $4,836 at March 31, 2008 and December 31, 2007, respectively		61,056			58,803
Prepaid expenses		5,096			9,041
Investment securities:
Investments in trading securities		—			61,800
Investments in available for sale securities		7,756			7,455
Restricted cash		6,382			3,655
Restricted investments		4,037			3,946
Other current assets		7,661			7,140
Assets of discontinued operations		2,297			3,178
Total current assets		146,314			186,017
Property and equipment, net		127,505			131,705
Investments in trading securities		71,580			—
Restricted cash		2,788			2,568
Restricted investments		10,790			10,375
Goodwill and other intangible assets		22,595			21,877
Other long term assets		4,898			7,912
		$	386,470		$	360,454
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	27,771		$	19,135
Accrued expenses		19,448			15,222
Accrued compensation and benefits		35,616			30,103
Due to Senior Housing Properties Trust (“Senior Housing”)		14,670			11,242
Mortgage notes payable		184			200
Accrued real estate taxes		5,384			7,352
Security deposit liability		13,291			13,361
Other current liabilities		8,346			7,229
Liabilities of discontinued operations		270			219
Total current liabilities		124,980			104,063
Long term liabilities:
Mortgage notes payable		15,768			15,810
Convertible senior notes		126,500			126,500
Continuing care contracts		3,237			3,159
Other long term liabilities		26,705			24,100
Total long term liabilities		172,210			169,569
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, 31,818,144 shares issued and outstanding at March 31, 2008 and December 31, 2007		318			318
Additional paid-in capital		286,735			286,734
Accumulated deficit		(194,492		)	(196,109		)
Unrealized loss on investments		(3,281		)	(4,121		)
Total shareholders’ equity		89,280			86,822
		$	386,470		$	360,454

 

See accompanying notes.

 

1

 

FIVE STAR QUALITY CARE, INC.

CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share amounts)

(unaudited)

 

		Three months ended March 31,
		2008			2007
Revenues:
Senior living revenue		$	216,927		$	197,222
Hospital revenue		24,744			26,129
Pharmacy revenue		17,206			13,835
Total revenues		258,877			237,186
Operating expenses:
Senior living wages and benefits		109,094			102,092
Other senior living operating expenses		53,421			49,910
Hospital expenses		22,592			23,624
Pharmacy expenses		16,203			13,591
Rent expense		35,444			32,171
General and administrative		11,133			10,059
Depreciation and amortization		3,635			3,151
Total operating expenses		251,522			234,598
Operating income		7,355			2,588
Interest and other income		2,494			1,420
Interest expense		(1,594		)	(1,778		)
Unrealized loss on investments in trading securities		(3,270		)	—
Gain on extinguishment of debt		—			3,557
Income from continuing operations before income taxes		4,985			5,787
Provision for income taxes		566			208
Income from continuing operations		4,419			5,579
Loss from discontinued operations		(2,802		)	(815		)
Net income		$	1,617		$	4,764
Weighted average shares outstanding - basic		31,818			31,684
Weighted average shares outstanding - diluted		41,549			41,415
Basic income per share from:
Continuing operations		$	0.14		$	0.18
Discontinued operations		(0.09		)	(0.03		)
Net income per share		$	0.05		$	0.15
Diluted income per share from:
Continuing operations		$	0.14		$	0.17
Discontinued operations		(0.07		)	(0.02		)
Net income per share		$	0.07		$	0.15

 

See accompanying notes.

 

2

 

FIVE STAR QUALITY CARE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

		Three months ended March 31,
		2008			2007
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	1,617		$	4,764
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization		3,635			3,151
Gain on extinguishment of debt		—			(3,557		)
Loss from discontinued operations		2,802			815
Unrealized loss on investments in trading securities		3,270			—
Provision for losses on receivables, net		469			1,193
Changes in assets and liabilities:
Accounts receivable		(2,431		)	6,388
Prepaid expenses and other assets		6,710			7,311
Investment securities		(13,351		)	9,675
Accounts payable and accrued expenses		9,565			(4,991		)
Accrued compensation and benefits		5,513			7,406
Due to Senior Housing		3,428			384
Other current and long term liabilities		462			113
Cash provided by operating activities		21,689			32,652
Net cash used in discontinued operations		(58		)	(787		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Deposits into restricted cash and investment accounts, net		(2,612		)	(933		)
Acquisition of property and equipment		(17,687		)	(17,745		)
Assumption of senior living communities, net of cash acquired		3,204			—
Proceeds from disposition of property and equipment held for sale		16,552			9,645
Cash used in investing activities		(543		)	(9,033		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of mortgage note payable		(58		)	(22,887		)
Cash used in financing activities		(58		)	(22,887		)
Change in cash and cash equivalents		21,030			(55		)
Cash and cash equivalents at beginning of period		30,999			46,241
Cash and cash equivalents at end of period		$	52,029		$	46,186
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest		$	249		$	715
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of common stock		—			24

 

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, 2007.  In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included.  All material 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 March 31, 2008, we operated 183 senior living communities with 19,666 living units, including 134 primarily independent and assisted living communities with 15,254 living units and 49 nursing homes with 4,412 living units.  Of our 134 primarily independent and assisted living communities, we leased 117 communities with 13,994 living units from Senior Housing, our former parent, and we owned or leased from parties other than Senior Housing 17 communities with 1,260 living units.  We leased 47 of our 49 nursing homes from Senior Housing.  Our 183 communities included 5,605 independent living apartments, 7,846 assisted living suites and 6,215 skilled nursing units.  As of March 31, 2008, we also operated five institutional pharmacies, and two rehabilitation hospitals that we leased from Senior Housing.  Our two rehabilitation hospitals had 321 beds available for inpatient services, three satellite locations, and 19 affiliated outpatient clinics.

 

Note 2. New Accounting Pronouncements

 

In September 2006, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurement”, or SFAS No. 157, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurement.  This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  The adoption of this standard did not have a material impact on our financial position, operations or cash flow.

 

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), “Business Combinations”, or SFAS No. 141(R).  SFAS No. 141(R) establishes principles and requirements for how the acquirer shall recognize and measure in its financial statements the identifiable assets acquired, liabilities assumed, any noncontrolling interest in the acquiree and goodwill acquired in a business combination.  SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008.  We are currently evaluating the effect that the adoption of SFAS No. 141(R) will have on our consolidated financial statements.

 

Note 3. Property and Equipment

 

Property and equipment, at cost, consists of:

 

		March 31, 2008			December 31, 2007
Land		$	7,519		$	7,196
Buildings and improvements		97,610			99,945
Furniture, fixtures and equipment		56,917			55,660
		162,046			162,801
Accumulated depreciation		(34,541		)	(31,096		)
		$	127,505		$	131,705

 

As of March 31, 2008 and December 31, 2007, we had assets classified as held for sale of $23,668 and $25,222, respectively, included in our property and equipment that we intend to sell to Senior Housing as permitted by our leases.

 

4

 

FIVE STAR QUALITY CARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share amounts)

(unaudited)

 

Note 4.  Comprehensive Income

 

Comprehensive income for the three months ended March 31, 2008 and 2007 is summarized below:

 

		Three months ended March 31,
		2008			2007
Net income		$	1,617		$	4,764
Unrealized gain (loss) on investments		840			(43		)
Net comprehensive income		$	2,457		$	4,721

 

Note 5.  Financial Data By Segment

 

Our reportable segments consist of our senior living community business and our rehabilitation hospital business.  In the senior living community segment, we operate independent living and congregate care communities, assisted living communities and nursing homes.  Our rehabilitation hospital segment provides inpatient medical rehabilitation services at two hospital locations and three satellite locations and outpatient medical rehabilitation services at 19 affiliated outpatient clinics.  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 within 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 performance and for decision making purposes.  Segment operating profit excludes interest and other income, interest expense and certain corporate expenses.

 

Our revenues by segment and a reconciliation of segment operating profit to income from continuing operations before income taxes for the quarter ended March 31, 2008 and 2007 are as follows:

 

		Senior Living Communities			Rehabilitation Hospitals			Corporate and Other (1)			Total
Three months ended March 31, 2008
Revenues		$	216,927		$	24,744		$	17,206		$	258,877
Segment expenses:
Operating expenses		162,515			22,592			16,203			201,310
Rent expense		32,794			2,650			—			35,444
Depreciation and amortization		2,440			308			887			3,635
Total segment expenses		197,749			25,550			17,090			240,389
Segment operating profit (loss)		19,178			(806		)	116			18,488
General and administrative expenses (2)		—			—			(11,133		)	(11,133		)
Operating income (loss)		19,178			(806		)	(11,017		)	7,355
Interest and other income		1,283			—			1,211			2,494
Interest expense		(306		)	—			(1,288		)	(1,594		)
Unrealized loss on investments in trading securities		—			—			(3,270		)	(3,270		)
Provision for income taxes		—			—			(566		)	(566		)
Income (loss) from continuing operations		$	20,155		$	(806	)	$	(14,930	)	$	4,419
Total Assets as of March 31, 2008		$	254,556		$	20,821		$	111,093		$	386,470
Three months ended March 31, 2007
Revenues		$	197,222		$	26,129		$	13,835		$	237,186
Segment expenses:
Operating expenses		152,002			23,624			13,591			189,217
Rent expense		29,609			2,562			—			32,171
Depreciation and amortization		2,231			216			704			3,151
Total segment expenses		183,842			26,402			14,295			224,539
Segment operating profit		13,380			(273		)	(460		)	12,647
General and administrative expenses (2)		—			—			(10,059		)	(10,059		)
Operating income (loss)		13,380			(273		)	(10,519		)	2,588
Interest and other income		355			—			1,065			1,420
Interest expense		(537		)	—			(1,241		)	(1,778		)
Gain on extinguishment of debt		3,557			—			—			3,557
Provision for income taxes		—			—			(208		)	(208		)
Income (loss) from continuing operations		$	16,755		$	(273	)	$	(10,903	)	$	5,579
Total Assets as of March 31, 2007		$	261,176		$	18,977		$	67,471		$	347,624

 

5

 

FIVE STAR QUALITY CARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share amounts)

(unaudited)

 

 (1) Corporate and Other includes operations that we do not consider a significant, separately reportable segments 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 affecting home activities.

 

Note 6.  Income Taxes

 

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 income, which will affect our results of operations.  At December 31, 2007, our net operating loss carry forwards, totaling approximately $182,800, will begin to expire in 2023 if unused.

 

For the quarter ended March 31, 2008, we recognized tax expenses of $566, which includes $506 of alternative minimum taxes and certain state taxes that are payable without regard to our tax loss carry forwards. Tax expense also includes $60 related to 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 7.  Earnings Per Share

 

Basic earnings per share for the periods ended March 31, 2008 and 2007 are computed using the weighted average number of shares outstanding during those periods.  Diluted earnings per share for the period ended March 31, 2008 reflect 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 upon conversion of our 3.75% convertible senior notes, or the Notes (See Note 10).  The effect of conversion of our Notes on loss from discontinued operations per share is anti-dilutive for the three months ended March 31, 2008 and March 31, 2007.

 

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:

 

		Three Months Ended March 31,
		2008										2007
		Income				Shares		Per Share				Income				Shares		Per Share
Income from continuing operations		$		4,419		31,818		$		0.14		$		5,579		31,684		$		0.18
Conversion of the Notes		1,239				9,731						1,241				9,731
Diluted earnings from continuing operations		5,658				41,549		$	0.14			6,820				41,415		$	0.17
Diluted loss from discontinued operations		$	(2,802		)	41,549		$	(0.07		)	$	(815		)	41,415		$	(0.02		)

 

6

 

FIVE STAR QUALITY CARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share amounts)

(unaudited)

 

Note 8. Fair Values of Assets and Liabilities

 

As required, we adopted SFAS 157 effective January 1, 2008 for assets and liabilities we measure on a recurring basis.  Although the adoption of SFAS 157 did not materially impact our financial condition, results of operations, or cash flow, we are now required to provide additional disclosures as part of our financial statements.  We measure fair value at the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  SFAS 157 prioritizes the assumptions that market participants would use in pricing the asset or liability, or the inputs, into three broad levels.  This fair value hierarchy gives the highest priority, or Level 1, to quoted prices in active markets for identical assets or liabilities and the lowest priority, or Level 3, to assumptions that are unobservable.  Observable inputs that do not meet the criteria of Level 1, and include quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets and liabilities in markets that are not active, are categorized as Level 2.  Level 3 inputs are those that reflect our own assumptions about the assumptions market participants would use in pricing the asset or liability, based on the best information available in the circumstances.  Valuation techniques for assets and liabilities measured using Level 3 inputs may include methodologies such as the market approach, the income approach or the cost approach, and may use unobservable inputs such as projections, estimates and management’s interpretation of current market data.  These unobservable inputs are only utilized to the extent that observable inputs are not available, or for which it not cost effective for us to obtain.

 

The table below presents the assets and liabilities measured at fair value on a recurring basis at March 31, 2008 categorized by the level of inputs used in the valuation of each asset.

 

Description		Total			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Long lived assets held for sale (1)		$	23,668		$	23,668		$	—		$	—
Investments in trading securities (2)		71,580			—			—			71,580
Investments in available for sale securities (3)		22,583			22,583			—			—
Total assets		$	117,831		$	46,251		$	—		$	71,580

 

(1) Long lived assets held for sale consist of property and equipment we expect to sell to Senior Housing as permitted by our leases and are reported at fair value utilizing Level 1 inputs.  We determined that these asset costs approximate fair value since we have either recently acquired the assets or the assets are part of ongoing construction projects and we expect to sell these assets to Senior Housing at their recorded value.

 

(2) Our investments in trading securities consist of auction rate securities which are primarily bonds issued by various entities to fund student loans pursuant to the Federal Family Education Loan Program.  Due to recent events in the credit markets, auctions for our auction rate securities failed during the first quarter of 2008.  As a result, our auction rate securities are reported at fair value utilizing Level 3 inputs.  We measured fair value of these securities by reference to a statement provided by our securities broker which statement was reportedly calculated with the assistance of a valuation model.  This model reportedly considered, among other items, the collateral underlying the investments, the creditworthiness of the counterparty, the timing of expected future cash flows including possible refinancing of the securities and determination of the appropriate discount rate.  The third party analysis also reportedly included a comparison, when possible, to other observable market data with similar characteristics to our auction rate securities. We reviewed the components of, and calculations made under, our broker’s model.  Due to the declines in fair value for our auction rate securities during the first quarter in 2008, we have recorded an unrealized loss of $3,270.

 

7

 

FIVE STAR QUALITY CARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share amounts)

(unaudited)

 

Prior to April 1, 2008, we classified our auction rate securities as investments in trading securities and recorded the changes in fair value in earnings.  On March 31, 2008, we moved our auction rate securities from current to non-current investments due to our belief that the market for student loan collateralized instruments may take in excess of twelve months to recover.

 

(3) Investments in available for sale securities consist of corporate bonds, preferred securities and variable rate demand obligations and are reported in our balance sheet as current investments in available for sale securities of $7,756, current restricted investments of $4,037 and long term restricted investments of $10,790.  These securities are carried at fair value utilizing Level 1 inputs based on quoted market prices with changes in fair value recorded in other comprehensive income.  When a change in fair value is deemed temporary, we record a corresponding credit or charge to other comprehensive income for any unrealized gains or losses.  If we determine that any future valuation adjustment was other than temporary, we would record a charge to earnings.

 

Based on market conditions, our valuation methodology for investments in trading securities changed.  Accordingly, these securities changed from Level 1 to Level 3 within SFAS 157’s hierarchy since our initial adoption of SFAS 157 at January 1, 2008.  The table below presents the change in fair value measurements that used Level 3 inputs during the period ended March 31, 2008:

 

		Investments in trading securities
Balance, beginning of year		$	—
Transfers into Level 3		74,850
Change in value recognized in earnings		(3,270		)
Balance, end of period		$	71,580

 

Note 9. Line of Credit

 

We have a $40,000 revolving bank line of credit facility for general business purposes, including acquisitions and working capital, which is currently scheduled to expire in May 2009. The amount we are able to borrow at any time is subject to limitation 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; and this facility also places limits on 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 amount which we may borrow under this credit facility may be increased to $80,000.  The termination date of this facility may be extended twice, in each case by twelve months upon our payment of extension fees and other conditions, including lender’s approval. As of March 31, 2008 and May 7, 2008, no amounts were outstanding under this credit facility. As of March 31, 2008 and May 7, 2008 we believe we were and are in compliance with all applicable covenants under this credit facility.  Interest expense and other associated costs related to this facility were $49 and $0 for the three months ended March 31, 2008 and 2007, respectively.

 

Note 10. Mortgages Payable

 

At March 31, 2008, four of our communities were encumbered by five United States Department of Housing and Urban Development, or HUD, insured mortgages totaling $15,952.  The weighted average interest rate on these loans was 6.5%.  Payments of principal and interest are due monthly until maturities at varying dates ranging from June 2035 to July 2043.  These mortgages contain standard HUD mortgage covenants.  We recorded mortgage premiums in connection with some of these HUD mortgages in order to record assumed mortgages at their estimated fair value.  The mortgage premiums are being amortized as a reduction of interest expense until the maturities of the mortgages.  The mortgage premium balance included in the mortgage notes payable as of March 31, 2008 was $759. Mortgage interest expense, net of premium amortization, was $306 and $537 for the three months ended March 31, 2008 and 2007, respectively.

 

8

 

FIVE STAR QUALITY CARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share amounts)

(unaudited)

 

Note 11. Convertible Senior Notes due in 2026

 

In October 2006, we issued $126,500 principal amount of Convertible Senior Notes due in 2026.  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 $1,239 and $1,241 for the three months ended March 31, 2008 and 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 the Notes at anytime after October 20, 2011 and the Note holders may require that we purchase all or a portion of these Notes on each October 15 of 2013, 2016 and 2021.  We issued these Notes pursuant to an indenture which contains various customary covenants.  We believe we are in compliance with all applicable covenants of this indenture.

 

Note 12.  Related Person Transactions

 

We leased 164 of the 183 senior living communities and the two rehabilitation hospitals that we operated on March 31, 2008 from Senior Housing for total annual minimum rent of $152,259.  In addition to the minimum rent, we paid $1,019 and $552 in percentage rent to Senior Housing for the three months ended March 31, 2008 and 2007, respectively.

 

Included in the 164 communities we lease from Senior Housing are 22 senior living communities with 1,743 units which Senior Housing acquired and we began to lease during the first quarter of 2008.  Twenty-one of these communities are assisted living communities (one of which offers some skilled nursing services and one of which offers some independent living services) and one is a continuing care retirement community which offers independent living, assisted living and skilled nursing services.  Our rent payable to Senior Housing for these 22 communities is $21,790 per year, plus future increases calculated as a percentage of the revenue increases for all of these communities after 2009.  We added these communities to our existing lease with Senior Housing which has a term ending in 2020, with renewal options thereafter.

 

During the three months ended March 31, 2008, as permitted by our leases with Senior Housing, we sold to Senior Housing, at cost, $16,552 of improvements made to properties leased from Senior Housing, and our annual rent payable to Senior Housing increased by $1,574.

 

Note 13.  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, in accordance with the terms of our lease with Senior Housing.  In December 2007, we decided to sell one institutional pharmacy located in California and our mail order pharmacy located in Nebraska.  As of March 31, 2008, we have disposed of substantially all of our assets and liabilities related to one of the communities which we expect will be sold.  The assets and liabilities related to the other community and of the two pharmacies that we expect to sell are presented separately in the consolidated balance sheet.  We have reclassified the consolidated statement of income for all periods presented to show the results of operations of the communities and pharmacies which have been sold or are expected to be sold as discontinued.  Below is a summary of the operating results of these discontinued operations included in the financial statements for the three months ended March 31, 2008 and 2007:

 

		Three months ended March 31,
		2008			2007
Revenues		$	2,971		$	3,165
Expenses		(5,773		)	(3,980		)
Net loss		$	(2,802	)	$	(815	)

 

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FIVE STAR QUALITY CARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share amounts)

(unaudited)

 

Note 14.   Guarantor Financial Information

 

Our 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 us, our guarantor subsidiaries and our non-guarantor subsidiaries for all periods presented are stated below:

 

CONDENSED CONSOLIDATING STATEMENT OF INCOME

For the Three Months Ended March 31, 2008

 

		Parent			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Eliminations			Consolidated
Revenues:
Senior living revenue		$	—		$	88,915		$	128,012		$	—		$	216,927
Hospital revenue		—			—			24,744			—			24,744
Pharmacy revenue		—			—			17,206			—			17,206
Total revenues		—			88,915			169,962			—			258,877
Operating expenses:
Senior living wages and benefits		—			37,887			71,207			—			109,094
Other senior living operating expenses		—			21,416			32,005			—			53,421
Hospital expenses		—			—			22,592			—			22,592
Pharmacy expenses		—			—			16,203			—			16,203
Rent expense		—			17,244			18,200			—			35,444
General and administrative		—			—			11,133			—			11,133
Depreciation and amortization		—			1,222			2,413			—			3,635
Total operating expenses		—			77,769			173,753			—			251,522
Operating income (loss)		—			11,146			(3,791		)	—			7,355
Interest and other income		—			—			2,494			—			2,494
Interest expense		—			—			(1,594		)	—			(1,594		)
Unrealized loss on investments in trading securities		—			—			(3,270		)	—			(3,270		)
Equity in earnings of subsidiaries		1,617			—			—			(1,617		)	—
Income (loss) from continuing operations before income taxes		1,617			11,146			(6,161		)	(1,617		)	4,985
Provision for income taxes		—			—			566			—			566
Income (loss) from continuing operations		1,617			11,146			(6,727		)	(1,617		)	4,419
Loss from discontinued operations		—			—			(2,802		)	—			(2,802		)
Net income (loss)		$	1,617		$	11,146		$	(9,529	)	$	(1,617	)	$	1,617

 

CONDENSED CONSOLIDATING STATEMENT OF INCOME

For the Three Months Ended March 31, 2007

 

		Parent			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Eliminations			Consolidated
Revenues:
Senior living revenue		$	—		$	84,041		$	113,181		$	—		$	197,222
Hospital revenue		—			—			26,129			—			26,129
Pharmacy revenue		—			—			13,835			—			13,835
Total revenues		—			84,041			153,145			—			237,186
Operating expenses:
Senior living wages and benefits		—			38,729			63,363			—			102,092
Other senior living operating expenses		—			26,057			23,853			—			49,910
Hospital expenses		—			—			23,624			—			23,624
Pharmacy expenses		—			—			13,591			—			13,591
Rent expense		—			16,624			15,547			—			32,171
General and administrative		—			—			10,059			—			10,059
Depreciation and amortization		—			1,174			1,977			—			3,151
Total operating expenses		—			82,584			152,014			—			234,598
Operating income		—			1,457			1,131			—			2,588
Interest and other income		—			(10		)	1,430			—			1,420
Interest expense		—			—			(1,778		)	—			(1,778		)
Gain on extinguishment of debt		—			—			3,557			—			3,557
Equity in earnings of subsidiaries		4,764			—			—			(4,764		)	—
Income from continuing operations before income taxes		4,764			1,447			4,340			(4,764		)	5,787
Provision for income taxes		—			—			208			—			208
Income from continuing operations		4,764			1,447			4,132			(4,764		)	5,579
Loss from discontinued operations		—			—			(815		)	—			(815		)
Net income		$	4,764		$	1,447		$	3,317		$	(4,764	)	$	4,764

 

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