AlerisLife Inc. - Quarter Report: 2015 September (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON,  DC 20549 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2015

 

or

 

☐ 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)

 

 

(Registrant’s Telephone Number, Including Area Code):  617-796-8387

 

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 ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “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 ☐  No ☒

 

Number of registrant’s shares of common stock, $.01 par value, outstanding as of November 5, 2015:  49,035,915. 

 

 

FIVE STAR QUALITY CARE, INC.

 

FORM 10-Q

 

SEPTEMBER 30, 2015

 

INDEX

 

 

References in this Quarterly Report on Form 10-Q to “we”, “us” or “our” include Five Star Quality Care, Inc. and its consolidated subsidiaries unless otherwise expressly stated or the context indicates otherwise.

 

 

Part I.   Financial Information

Item 1.  Condensed Consolidated Financial Statements

 

FIVE STAR QUALITY CARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

See accompanying notes.

FIVE STAR QUALITY CARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

See accompanying notes.

 

 

FIVE STAR QUALITY CARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

 

See accompanying notes.

 

 

FIVE STAR QUALITY CARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

See accompanying notes.

 

Note 1.  Basis of Presentation and Organization

General

The accompanying condensed consolidated financial statements of Five Star Quality Care, Inc. and its subsidiaries, or we, us or our, are unaudited.  Certain information and disclosures required by U.S. generally accepted accounting principles, or GAAP, 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, 2014, or our Annual Report.  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 with or among our consolidated subsidiaries have been eliminated.  Our operating results for interim periods are not necessarily indicative of the results that may be expected for the full year. 

 

We operate senior living communities, including independent living communities, assisted living communities and skilled nursing facilities, or SNFs.  As of September 30, 2015, we operated 272 senior living communities located in 32 states with 31,310 living units, including 241 primarily independent and assisted living communities with 28,503 living units and 31 SNFs with 2,807 living units.  As of September 30, 2015, we owned and operated 31 communities (3,064 living units), we leased and operated 181 communities (20,035 living units) and we managed 60 communities (8,211 living units).  Our 272 senior living communities, as of September 30, 2015, included 10,626 independent living apartments, 15,500 assisted living suites and 5,184 skilled nursing units.  The foregoing numbers exclude: (i) one assisted living community with 32 living units that we own which is being offered for sale and is classified as a discontinued operation; and (ii) one SNF with 116 living units that we lease from Senior Housing Properties Trust or its subsidiaries, or SNH, that is being offered for sale and is classified as a discontinued operation.

Segment Information

We have two operating segments: senior living communities and rehabilitation and wellness. In the senior living community segment, we operate for our own account or manage for the account of third parties independent living communities, assisted living communities and SNFs that are subject to centralized oversight and provide housing and services to elderly residents. Our rehabilitation and wellness operating segment does not meet any of the quantitative thresholds of a reportable segment as prescribed under Financial Accounting Standards Board, or the FASB, Accounting Standards Codification TM, or ASC, Topic 280, and therefore we have determined that our business is comprised of one reportable segment, senior living. All of our operations and assets are located in the United States, except for the operations of our Cayman Islands organized captive insurance company subsidiary, which participates in our workers’ compensation, professional general liability and automobile insurance programs.

Note 2. Recent Accounting Pronouncements

In April 2015, the FASB issued Accounting Standards Update, or ASU, 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires debt issuance costs to be presented in the balance sheet as a direct deduction from the associated debt liability. In August 2015, the FASB clarified the previous ASU and issued ASU No. 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements – Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting, which addresses the presentation of debt issuance costs related to line of credit arrangements.  These updates are effective for interim and annual reporting periods beginning after December 15, 2015 and require retrospective application.  Debt issuance costs related to line of credit arrangements will remain classified as assets in accordance with ASU No. 2015-15.  The implementation of these updates is not expected to have a material impact on our condensed consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which outlines a comprehensive model for entities to use in accounting for revenue arising from contracts with customers.  This ASU clarifies the principles for recognizing revenue by, among other things, removing inconsistencies in revenue

requirements, improving comparability of revenue recognition practices across entities and industries and providing improved disclosure requirements. In July 2015, the FASB approved a one year deferral of the effective date for this ASU to interim and annual reporting periods beginning after December 15, 2017; however, early adoption at the original effective date is still permitted. We are currently evaluating the impact that the adoption of this ASU will have on our condensed consolidated financial statements.

 

In September 2015, the FASB issued ASU No. 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, which eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. Instead, acquirers must recognize measurement-period adjustments during the period in which they determine the amounts, including the effect on earnings of any amounts that would have been recorded in previous periods if the accounting had been completed at the acquisition date. This update is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted.  The implementation of this update is not expected to have a material impact on our condensed consolidated financial statements.

Note 3. Property and Equipment

Property and equipment consists of the following:

 

We recorded depreciation expense relating to our property and equipment of $8,406 and $7,504 for the three months ended September 30, 2015 and 2014, respectively, and $24,384 and $21,787 for the nine months ended September 30, 2015 and 2014, respectively.

 

We review the carrying value of long lived assets, excluding goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If there is an indication that the carrying value of an asset is not recoverable, we determine the amount of impairment loss, if any, by comparing the historical carrying value of the asset to its estimated fair value. We determine estimated fair value based on input from market participants, our experience selling similar assets, market conditions and internally developed cash flow models that our assets or asset groups are expected to generate. As a result of our long lived assets impairment review, excluding goodwill, we recorded $145 and $589 of impairment charges to our long lived assets in continuing operations, excluding goodwill, for the three and nine months ended September 30, 2015 and 2014, respectively.

 

As of September 30, 2015, we had $13,271 of assets included in our property and equipment that we expect to request that SNH purchase from us for an increase in future rent; however, we are not obligated to make these sales and SNH is not obligated to fund such amounts.

 

In November 2015, we acquired two independent living communities with 68 and 84 living units, respectively, located in Tennessee for an aggregate purchase price of approximately $26,000,  excluding closing costs.  We funded this acquisition with cash on hand and by assuming approximately $17,310 of mortgage debt. The purchase price allocation for this acquisition will be performed during the fourth quarter.

Note 4. Accumulated Other Comprehensive Income

The following table details the changes in accumulated other comprehensive income, net of tax, for the nine months ended September 30, 2015:

 

Accumulated other comprehensive income represents the unrealized gains and losses of our investments, net of tax, and our share of other comprehensive income (loss) of Affiliates Insurance Company, or AIC.

 

Note 5.  Income Taxes

For the nine months ended  September 30, 2015, we recognized income tax expense from our continuing operations of $348.  We did not recognize any income tax expense or benefit from our discontinued operations for that period.  As of December 31, 2014, our federal net operating loss carry forwards, which are scheduled to begin expiring in 2026 if unused, were approximately $112,182 and our tax credit carry forwards, which begin expiring in 2022 if unused, were approximately $17,191.  We have an additional $333 of federal net operating loss carry forwards not included in the $112,182, that are attributable to unvested stock grants which will be recorded as an increase to additional paid in capital after they are realized in accordance with FASB ASC Topic 718,  Compensation – Stock Compensation. Our net operating loss carry forwards and tax credit carry forwards are subject to possible audits and adjustments by the Internal Revenue Service. 

During the year ended December 31, 2014, we determined it was more likely than not that our net deferred tax assets would not be realized and concluded that a full valuation allowance was required. In the future, if we believe that we will more likely than not realize the benefit of these deferred tax assets, we will adjust our valuation allowance and recognize an income tax benefit in our results of operations.

Note 6.  Earnings Per Share

We computed basic earnings per common share, or EPS, for the three and nine months ended September 30, 2015 and 2014 using the weighted average number of shares of our common stock, $.01 par value per share, or our common shares, outstanding during the periods.  Diluted EPS reflects the more dilutive earnings per common share amount calculated using the two class method or the treasury stock method.    The effect of our unvested restricted shares for the three and nine months ended September 30, 2015 and 2014 was not included in the calculation of diluted EPS because to do so would have been antidilutive.   

 

The following table provides a reconciliation of loss from continuing operations and loss from discontinued operations and the number of common shares used in the computations of diluted EPS:

 

 

 

 

 

 

Note 7.  Fair Values of Assets and Liabilities

Our assets recorded at fair value have been categorized based upon a fair value hierarchy in accordance with FASB ASC Topic 820, Fair Value Measurements and Disclosures. We apply the following fair value hierarchy, which prioritizes the inputs used to measure fair value into three levels.

 

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access at the measurement date.

 

Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets and quoted prices in inactive markets.

 

Level 3 inputs are unobservable inputs for the asset or liability in which there is little, if any, market activity for the asset or liability at the measurement date.

 

Recurring Fair Value Measures

 

The tables below present the assets measured at fair value at September 30, 2015 and December 31, 2014 categorized by the level of inputs used in the valuation of each asset.

 

 

 

 

---

 

 

 

 

During the nine months ended September 30, 2015, we did not change the type of inputs used to determine the fair value of any of our assets and liabilities that we measure at fair value.  Accordingly, there were no transfers of assets or liabilities between levels of the fair value hierarchy during the nine months ended September 30, 2015.

 

The carrying values of accounts receivable and accounts payable approximate fair value as of September 30, 2015 and December 31, 2014.  The carrying value and fair value of our mortgage notes payable were $44,324 and $47,915, respectively, as of September 30, 2015 and $51,159 and $56,099, respectively, as of December 31, 2014, and are categorized in Level 3 of the fair value hierarchy in their entirety.  We estimate the fair values of our mortgage notes payable by using discounted cash flow analyses and currently prevailing market terms as of the measurement date. 

 

Non-Recurring Fair Value Measures

 

We review the carrying value of long lived assets, excluding goodwill, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable. See Note 3 for more information regarding fair value measurements related to impairments of our long lived assets, excluding goodwill.

 

We evaluate the recoverability of goodwill in the fourth quarter of each fiscal year, or more frequently if events or changes in circumstances indicate that goodwill may be impaired.  As part of the preparation of our 2015 third quarter financial statements, we conducted an interim assessment of goodwill which resulted in our recording a non-cash charge for goodwill impairment of $25,344 for the 2015 third quarter.    Goodwill was valued primarily using discounted cash flow models that incorporate assumptions for short and long term revenue growth rates, operating margins and discount rates, which represent our best estimates of current and forecasted market conditions, our current cost structure, and the implied rate of return that our management believes a market participant would require for an investment in a company having similar risks and business characteristics to the reporting unit being assessed, all of which are considered to be Level 3 fair value  measurements. See Note 13 for further information regarding our interim goodwill assessment, the fair value measurements used in this analysis and the non-cash charge for goodwill impairment we recorded for the 2015 third quarter.

 

The fair value of assets held for sale is determined based on the use of appraisals, input from market participants, our experience selling similar assets or internally developed cash flow models, all of which are considered to be Level 3 fair value measurements.

 

Note 8.  Indebtedness

We have a $25,000 revolving secured line of credit, or our Credit Agreement, that is available for general business purposes, including acquisitions.  The maturity date of our Credit Agreement is March 18, 2016.  Our Credit Agreement requires interest at a rate of LIBOR plus a premium of 250 basis points, or 2.70% per annum as of September 30, 2015.  We are also required to pay a quarterly commitment fee of 0.35% per annum on the unused part of our borrowing availability under the Credit Agreement. We may draw, repay and redraw funds until maturity, and no principal repayment is due until maturity.  We made no borrowings under our Credit Agreement during either of the nine months

ended September 30, 2015 or 2014 and, as of September 30, 2015, we had no amounts outstanding under our Credit Agreement.  We incurred interest expense and other associated costs related to our Credit Agreement of $48 for each of the three months ended September 30, 2015 and 2014, and $144 for each of the nine months ended September 30, 2015 and 2014.

 

We are the borrower under our Credit Agreement and certain of our subsidiaries guarantee our obligations under our Credit Agreement, which is secured by our and our guarantor subsidiaries’ accounts receivable and related collateral. Our Credit Agreement provides for acceleration of payment of all amounts outstanding upon the occurrence and continuation of certain events of default, including a change of control of us, which includes termination of our business management agreement with The RMR Group LLC (formerly known as Reit Management & Research LLC), or RMR LLC.

 

We also have a $150,000 secured revolving credit facility, or our Credit Facility, that is available for general business purposes, including acquisitions.  In April 2015, we exercised our option to extend the maturity date of our Credit Facility to April 13, 2016; we paid a fee of $300 in connection with this extension. Subject to the payment of an extension fee and meeting certain other conditions, we have the option to further extend the maturity date of our Credit Facility to April 13, 2017.  Our Credit Facility requires interest at a rate of LIBOR plus a premium of 250 basis points, or 2.70% per annum as of September 30, 2015.  We are also required to pay a quarterly commitment fee of 0.35% per annum on the unused part of our borrowing availability under our Credit Facility. We may draw, repay and redraw funds until maturity, and no principal repayment is due until maturity.  The weighted average annual interest rate for borrowings under our Credit Facility was 2.81% and 2.76% for the nine months ended September 30, 2015 and 2014, respectively.  As of September 30, 2015, we had $35,000 outstanding under our Credit Facility.  We incurred interest expense and other associated costs related to our Credit Facility of $450 and $552 for the three months ended September 30, 2015 and 2014, respectively, and $1,462 and $1,687 for the nine months ended September 30, 2015 and 2014, respectively.

 

We are the borrower under our Credit Facility, and certain of our subsidiaries guarantee our obligations under our Credit Facility, which is secured by real estate mortgages on 15 senior living communities with 1,549 living units owned by our guarantor subsidiaries and our guarantor subsidiaries’ accounts receivable and related collateral.  Our Credit Facility provides for acceleration of payment of all amounts outstanding upon the occurrence and continuation of certain events of default, including a change of control of us.

 

Our Credit Agreement and our Credit Facility contain a number of financial and other covenants, including covenants that restrict our ability to incur indebtedness or to pay dividends or make other distributions under certain circumstances and require us to maintain financial ratios and a minimum net worth.  On March 13, 2015, we and the lenders under our Credit Agreement entered into Amendment No. 3 to the Credit and Security Agreement, which amended the defined term for EBITDA set forth in the Credit Agreement by excluding from the calculation of EBITDA certain costs associated with Medicare compliance deficiencies and made certain changes to the representations and warranties in the Credit Agreement to except certain failures to comply with Medicare billing, recordkeeping, reporting and related practices from events which may otherwise cause our default.

 

At September 30, 2015, four of our senior living communities were encumbered by mortgages with an aggregate outstanding principal balance of $44,324:  (1) two of our communities were encumbered by Federal National Mortgage Association, or FNMA, mortgages and (2) two of our communities were encumbered by Federal Home Loan Mortgage Corporation, or FMCC, mortgages.  These mortgages contain FNMA and FMCC standard mortgage covenants, respectively.  We recorded a mortgage premium in connection with our assumption of the FNMA and FMCC mortgages as part of our acquisitions of the encumbered communities in order to record the assumed mortgages at their estimated fair value.  We are amortizing the mortgage premiums as a reduction of interest expense until the maturity of the respective mortgages.  The weighted average annual interest rate on these four mortgages was 6.48% as of September 30, 2015.  Payments of principal and interest are due monthly under these mortgages until maturities at varying dates ranging from June 2018 to September 2032.  We incurred mortgage interest expense, including premium amortization, of