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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 March 31, 2014

 

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)

 

 

Maryland

04-3516029

(State of Incorporation)

(IRS Employer Identification No.)

 

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):

 

 

 

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

(Do not check if a smaller reporting company)

 

 

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 registrants shares of common stock, $.01 par value, outstanding as of December 12, 2014:  48,661,042.

 

 


 

FIVE STAR QUALITY CARE, INC.

 

FORM 10-Q

 

MARCH 31, 2014

 

INDEX

 

 

 

 

PART I 

Financial Information

Page

 

 

 

Item 1. 

Condensed Consolidated Financial Statements (unaudited)

1

 

 

 

 

Condensed Consolidated Balance Sheets – March 31, 2014 and December 31, 2013

1

 

 

 

 

Condensed Consolidated Statements of Operations – Three Months Ended March 31, 2014 and 2013

2

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income (Loss) – Three Months Ended March 31, 2014 and 2013

3

 

 

 

 

Condensed Consolidated Statements of Cash Flows – Three Months Ended March 31, 2014 and 2013

4

 

 

 

 

Notes to Condensed Consolidated Financial Statements

5

 

 

 

Item 2. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

17

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

24

 

 

 

Item 4. 

Controls and Procedures

24

 

 

 

 

Warning Concerning Forward Looking Statements

26

 

 

 

PART II 

Other Information

 

 

 

 

Item 6. 

Exhibits

30

 

 

 

 

Signatures

31

 

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

 

 


 

Part I.   Financial Information

Item 1.  Condensed Consolidated Financial Statements

 

FIVE STAR QUALITY CARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

(unaudited)

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

    

2014

    

2013

 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

21,285 

 

$

23,628 

 

Accounts receivable, net of allowance of $5,081 and $4,281 at March 31, 2014 and December 31, 2013, respectively

 

 

37,566 

 

 

36,940 

 

Due from related persons

 

 

6,091 

 

 

11,659 

 

Investments in available for sale securities, of which $7,739 and $4,690 are restricted as of March 31, 2014 and December 31, 2013, respectively

 

 

22,441 

 

 

19,150 

 

Restricted cash

 

 

3,827 

 

 

9,003 

 

Prepaid and other current assets

 

 

36,576 

 

 

33,799 

 

Assets of discontinued operations

 

 

5,707 

 

 

16,705 

 

Total current assets

 

 

133,493 

 

 

150,884 

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

 

339,222 

 

 

340,276 

 

Equity investment in an investee

 

 

5,835 

 

 

5,913 

 

Restricted cash

 

 

3,668 

 

 

9,795 

 

Restricted investments in available for sale securities

 

 

14,167 

 

 

11,905 

 

Goodwill and other intangible assets

 

 

26,114 

 

 

26,407 

 

Other long term assets

 

 

47,865 

 

 

45,003 

 

 

 

$

570,364 

 

$

590,183 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Revolving credit facility, secured, principally by real estate

 

$

15,000 

 

$

35,000 

 

Accounts payable and accrued expenses

 

 

74,737 

 

 

69,343 

 

Accrued compensation and benefits

 

 

38,274 

 

 

31,888 

 

Due to related persons

 

 

19,801 

 

 

20,587 

 

Mortgage notes payable

 

 

1,177 

 

 

1,159 

 

Accrued real estate taxes

 

 

8,790 

 

 

9,934 

 

Security deposits and current portion of continuing care contracts

 

 

7,443 

 

 

8,025 

 

Other current liabilities

 

 

22,312 

 

 

18,607 

 

Liabilities of discontinued operations

 

 

1,627 

 

 

3,985 

 

Total current liabilities

 

 

189,161 

 

 

198,528 

 

 

 

 

 

 

 

 

 

Long term liabilities:

 

 

 

 

 

 

 

Mortgage notes payable

 

 

36,160 

 

 

36,461 

 

Continuing care contracts

 

 

1,462 

 

 

1,531 

 

Accrued self-insurance obligations

 

 

34,228 

 

 

38,002 

 

Other long term liabilities

 

 

5,400 

 

 

5,283 

 

Total long term liabilities

 

 

77,250 

 

 

81,277 

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

Common stock, $.01 par value: 75,000,000 shares authorized, 48,613,442 shares issued and outstanding at March 31, 2014 and December 31, 2013

 

 

486 

 

 

486 

 

Additional paid in capital

 

 

355,826 

 

 

355,570 

 

Accumulated deficit

 

 

(55,755)

 

 

(48,996)

 

Accumulated other comprehensive income

 

 

3,396 

 

 

3,318 

 

Total shareholders’ equity

 

 

303,953 

 

 

310,378 

 

 

 

$

570,364 

 

$

590,183 

 

See accompanying notes.

 

1


 

FIVE STAR QUALITY CARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

    

2014

    

2013

 

Revenues:

 

 

 

 

 

 

 

Senior living revenue

 

$

271,781 

 

$

269,306 

 

Management fee revenue

 

 

2,425 

 

 

2,302 

 

Reimbursed costs incurred on behalf of managed communities

 

 

54,205 

 

 

52,244 

 

Total revenues

 

 

328,411 

 

 

323,852 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

Senior living wages and benefits

 

 

132,783 

 

 

132,646 

 

Other senior living operating expenses

 

 

72,817 

 

 

65,455 

 

Costs incurred on behalf of managed communities

 

 

54,205 

 

 

52,244 

 

Rent expense

 

 

49,074 

 

 

48,013 

 

General and administrative

 

 

19,748 

 

 

15,456 

 

Depreciation and amortization

 

 

7,276 

 

 

6,370 

 

Total operating expenses

 

 

335,903 

 

 

320,184 

 

 

 

 

 

 

 

 

 

Operating (loss) income

 

 

(7,492)

 

 

3,668 

 

 

 

 

 

 

 

 

 

Interest, dividend and other income

 

 

196 

 

 

197 

 

Interest and other expense

 

 

(1,218)

 

 

(1,456)

 

Gain on sale of available for sale securities reclassified from other comprehensive income

 

 

313 

 

 

87 

 

 

 

 

 

 

 

 

 

(Loss) income from continuing operations before income taxes and equity in (loss) earnings of an investee

 

 

(8,201)

 

 

2,496 

 

Benefit from income taxes

 

 

2,431 

 

 

621 

 

Equity in (loss) earnings of an investee

 

 

(97)

 

 

76 

 

(Loss) income from continuing operations

 

 

(5,867)

 

 

3,193 

 

Loss from discontinued operations

 

 

(892)

 

 

(801)

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(6,759)

 

$

2,392 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding—basic and diluted

 

 

48,002 

 

 

48,234 

 

 

 

 

 

 

 

 

 

Basic and diluted (loss) income per share from:

 

 

 

 

 

 

 

Continuing operations

 

$

(0.12)

 

$

0.07 

 

Discontinued operations

 

 

(0.02)

 

 

(0.02)

 

Net (loss) income per share—basic and diluted

 

$

(0.14)

 

$

0.05 

 

See accompanying notes.

 

 

2


 

FIVE STAR QUALITY CARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

    

2014

    

2013

 

Net (loss) income

 

$

(6,759)

 

$

2,392 

 

Other comprehensive income:

 

 

 

 

 

 

 

Unrealized gain on investments in available for sale securities, net of tax

 

 

253 

 

 

60 

 

Unrealized gain (loss) on equity investment in an investee

 

 

19 

 

 

(8)

 

Less: Realized gain on investments in available for sale securities reclassified and included in net (loss) income, net of tax

 

 

(194)

 

 

(52)

 

Other comprehensive income

 

 

78 

 

 

 —

 

Comprehensive (loss) income

 

$

(6,681)

 

$

2,392 

 

See accompanying notes.

 

 

3


 

FIVE STAR QUALITY CARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

    

2014

    

2013

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net (loss) income

 

$

(6,759)

 

$

2,392 

 

Adjustments to reconcile net (loss) income to cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

7,548 

 

 

6,712 

 

Loss from discontinued operations before income tax

 

 

1,365 

 

 

1,462 

 

Gain on sale of available for sale securities

 

 

(313)

 

 

(87)

 

Equity in loss (earnings) of an investee

 

 

97 

 

 

(76)

 

Stock-based compensation

 

 

256 

 

 

205 

 

Deferred income taxes

 

 

(3,763)

 

 

(3,099)

 

Provision for losses on receivables

 

 

1,234 

 

 

1,439 

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

(1,860)

 

 

(5,189)

 

Prepaid expenses and other assets

 

 

(2,218)

 

 

10,004 

 

Accounts payable and accrued expenses

 

 

4,796 

 

 

(11,699)

 

Accrued compensation and benefits

 

 

6,386 

 

 

2,370 

 

Due to related persons, net

 

 

3,885 

 

 

124 

 

Other current and long term liabilities

 

 

(1,672)

 

 

(2,648)

 

Cash provided by operating activities

 

 

8,982 

 

 

1,910 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Payments into (from) restricted cash and investment accounts, net

 

 

11,303 

 

 

(2,166)

 

Acquisition of property and equipment

 

 

(13,058)

 

 

(11,250)

 

Purchase of available for sale securities

 

 

(9,512)

 

 

(4,882)

 

Proceeds from sale of property and equipment to Senior Housing Properties Trust

 

 

8,614 

 

 

7,522 

 

Proceeds from sale of available for sale securities

 

 

4,336 

 

 

2,409 

 

Cash provided by (used in) investing activities

 

 

1,683 

 

 

(8,367)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Proceeds from borrowings on credit facilities

 

 

 —

 

 

20,000 

 

Repayments of borrowings on credit facilities

 

 

(20,000)

 

 

(20,000)

 

Repayments of mortgage notes payable

 

 

(283)

 

 

(267)

 

Cash used in financing activities

 

 

(20,283)

 

 

(267)

 

 

 

 

 

 

 

 

 

Cash flows from discontinued operations:

 

 

 

 

 

 

 

Net cash provided by (used in) operating activities

 

 

7,275 

 

 

(1,931)

 

Net cash used in investing activities

 

 

 —

 

 

(790)

 

Net cash used in financing activities

 

 

 —

 

 

(37)

 

Net cash flows provided by (used in) discontinued operations

 

 

7,275 

 

 

(2,758)

 

 

 

 

 

 

 

 

 

Change in cash and cash equivalents

 

 

(2,343)

 

 

(9,482)

 

Cash and cash equivalents at beginning of period

 

 

23,628 

 

 

24,638 

 

Cash and cash equivalents at end of period

 

$

21,285 

 

$

15,156 

 

 

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

 

 

Cash paid for interest

 

$

821 

 

$

709 

 

Cash (refunded) paid for income taxes, net

 

$

(21)

 

$

296 

 

 

 

 

 

 

 

 

 

See accompanying notes.

 

 

4


 

Table of Contents

FIVE STAR QUALITY CARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

Note 1.  Basis of Presentation and Organization

General

The accompanying condensed consolidated financial statements of Five Star Quality Care, Inc. and its subsidiaries, which we refer to as we, us or our, are unaudited.  Certain information and disclosures required by U.S. 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, 2013, 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.  Reclassifications have been made to the prior year’s condensed consolidated financial statements to conform to the current year’s presentation.

 

We operate senior living communities, including independent living communities, assisted living communities and skilled nursing facilities, or SNFs.  As of March 31, 2014, we operated 255 senior living communities located in 31 states containing 29,999 living units, including 224 primarily independent and assisted living communities with 27,177 living units and 31 SNFs with 2,822 living units.  As of March 31, 2014, we owned and operated 30 communities (2,946 living units), we leased and operated 181 communities (20,002 living units) and we managed 44 communities (7,051 living units).  These 255 senior living communities included 10,397 independent living apartments, 14,392 assisted living suites and 5,210 skilled nursing units.  The foregoing numbers exclude: (i) 38 living units in one assisted living community that has been temporarily closed for a major renovation; (ii) 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 (iii) six SNFs and three assisted living communities with a total of 619 living units that we lease from Senior Housing Properties Trust or its subsidiaries, or SNH, that are being offered for sale and are classified as discontinued operations.

Revisions to Prior Period Financial Statements

As discussed further in the notes to our financial statements contained in our Annual Report, we identified errors related to our accounts payable and certain other matters that affected previously reported interim periods in 2013. We have revised the prior year’s condensed consolidated financial statements to correct for these errors in the periods in which they occurred.

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 SNH 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 for a reportable segment as prescribed under Financial Accounting Standards Board, or 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 captive insurance company subsidiary, which participates in our workers’ compensation, professional liability and automobile insurance programs, that is organized in the Cayman Islands.

Note 2. Recent Accounting Pronouncements

In August 2014, the FASB issued Accounting Standards Update 2014-15, Presentation of Financial Statements – Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.  The update requires an entity to evaluate whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the

5


 

Table of Contents

FIVE STAR QUALITY CARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

financial statements are available to be issued when applicable) and to provide related footnote disclosures in certain circumstances.  The update is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter with early adoption permitted.  The implementation of this update is not expected to cause any significant changes to our condensed consolidated financial statements.

Note 3. Property and Equipment

Property and equipment consists of the following:

 

 

 

 

 

 

 

 

 

    

March 31,

    

December 31,

 

 

 

2014

 

2013

 

Land

 

$

22,214 

 

$

22,214 

 

Buildings and improvements

 

 

286,772 

 

 

286,467 

 

Furniture, fixtures and equipment

 

 

120,399 

 

 

114,765 

 

Property and equipment, at cost

 

 

429,385 

 

 

423,446 

 

Accumulated depreciation

 

 

(90,163)

 

 

(83,170)

 

Property and equipment, net

 

$

339,222 

 

$

340,276 

 

 

We recorded depreciation expense of $6,993 and $6,084 for the three months ended March 31, 2014 and 2013, respectively, relating to our property and equipment.

 

As of March 31, 2014, we had $7,525 of assets included in our property and equipment associated with certain senior living communities that we lease from SNH that we typically 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. See Note 10.

Note 4. Accumulated Other Comprehensive Income

The following table details the changes in accumulated other comprehensive income, net of tax, for the three months ended March 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

    

Equity Investment in an Investee

    

Investments in Available for Sale Securities

    

 

Accumulated Other Comprehensive Income

Balance at January 1, 2014

 

$

48 

 

$

3,270 

 

$

3,318 

Unrealized gain on investments, net of  tax

 

 

 —

 

 

253 

 

 

253 

Equity interest in an investee’s unrealized gain on investments

 

 

19 

 

 

 —

 

 

19 

Reclassification adjustment:

 

 

 

 

 

 

 

 

 

Realized gain on investments, net of tax

 

 

 —

 

 

(194)

 

 

(194)

Balance at March 31, 2014

 

$

67 

 

$

3,329 

 

 

3,396 

 

Accumulated other comprehensive income represents the unrealized appreciation of our investments, net of tax, and our share of other comprehensive income of Affiliates Insurance Company, or AIC.

Note 5.  Income Taxes

For the three months ended March 31, 2014, we recognized a net tax benefit from continuing operations of $2,431.  We also recognized a tax benefit from discontinued operations of $473.  As of December 31, 2013, our federal net operating loss carry forward, which begins to expire in 2026 if unused, was approximately $81,583. This includes $278 of federal net operating losses that are attributable to unvested stock grants which will be recorded as an increase to additional paid in capital once they are realized in accordance with FASB ASC Topic 718. As of December 31, 2013, our tax credit carry forward, which begins to expire in 2022 if unused, was approximately $15,235.  Our net operating loss carry forwards and tax credit carry forwards are subject to possible audit and adjustments by the Internal Revenue Service. 

 

6


 

Table of Contents

FIVE STAR QUALITY CARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

We maintain a partial valuation allowance against certain deferred tax assets related to impaired investments and certain state net operating loss carry forwards.  When we believe that we will more likely than not realize the benefit of these deferred tax assets, we will record deferred tax assets as an income tax benefit in our condensed consolidated statement of operations, which will affect our results of operations.

Note 6.  Earnings Per Share

We computed basic earnings per common share, or EPS, for the three months ended March 31, 2014 and 2013 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.  For the three months ended March 31, 2013, 1,913 potentially dilutive common shares related to our former convertible senior notes due in 2026, or the Notes,  were not included in the computation of diluted EPS because to do so would have been antidilutive.

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

 

    

Income

    

 

    

Per

    

Income

    

 

    

Per

 

 

 

(loss)

 

Shares

 

Share

 

(loss)

 

Shares

 

Share

 

(Loss) income from continuing operations

 

$

(5,867)

 

48,002 

 

$

(0.12)

 

$

3,193 

 

48,234 

 

$

0.07 

 

Effect of the Notes

 

 

 —

 

 —

 

 

 

 

 

 —

 

 —

 

 

 

 

Diluted (loss) income from continuing operations

 

$

(5,867)

 

48,002 

 

$

(0.12)

 

$

3,193 

 

48,234 

 

$

0.07 

 

Diluted loss from discontinued operations

 

$

(892)

 

48,002 

 

$

(0.02)

 

$

(801)

 

48,234 

 

$

(0.02)

 

 

 

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. 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

 

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Table of Contents

FIVE STAR QUALITY CARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

The tables below present the assets measured at fair value at March 31, 2014 and December 31, 2013 categorized by the level of inputs used in the valuation of each asset.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of March 31, 2014

 

    

 

 

    

Quoted Prices in

    

 

 

    

 

 

 

 

 

 

 

Active Markets

 

Significant Other

 

Significant

 

 

 

 

 

for Identical

 

Observable

 

Unobservable

 

 

 

 

 

Assets

 

Inputs

 

Inputs

Description

 

Total

 

(Level 1)

 

(Level 2)

 

(Level 3)

Cash equivalents(1)

 

$

7,097 

 

$

7,097 

 

$

 

$

Available for sale securities:(2)

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

 

 

 

 

 

 

 

 

 

 

 

Financial services industry

 

 

3,921 

 

 

3,921 

 

 

 

 

REIT industry

 

 

437 

 

 

437 

 

 

 

 

Other

 

 

3,610 

 

 

3,610 

 

 

 

 

Total equity securities

 

 

7,968 

 

 

7,968 

 

 

 

 

Debt securities

 

 

 

 

 

 

 

 

 

 

 

 

International bond fund(3)

 

 

2,352 

 

 

 

 

2,352 

 

 

High yield fund(4)

 

 

2,384 

 

 

 

 

2,384 

 

 

Industrial bonds

 

 

7,797 

 

 

 

 

7,797 

 

 

Government bonds

 

 

7,666 

 

 

5,119 

 

 

2,547 

 

 

Financial bonds

 

 

2,680 

 

 

 

 

2,680 

 

 

Other

 

 

5,761 

 

 

 

 

5,761 

 

 

Total debt securities

 

 

28,640 

 

 

5,119 

 

 

23,521 

 

 

Total available for sale securities

 

 

36,608 

 

 

13,087 

 

 

23,521 

 

 

Total

 

$

43,705 

 

$

20,184 

 

$

23,521 

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2013

 

 

    

 

 

    

Quoted Prices in

    

 

 

    

 

 

    

 

 

 

 

 

Active Markets

 

Significant Other

 

Significant

 

 

 

 

 

 

for Identical

 

Observable

 

Unobservable

 

 

 

 

 

 

Assets

 

Inputs

 

Inputs

 

Description

 

Total

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Cash equivalents(1)

 

$

14,866 

 

$

14,866 

 

$

 

$

 

Available for sale securities:(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial services industry

 

 

3,668 

 

 

3,668 

 

 

 

 

 

REIT industry

 

 

704 

 

 

704 

 

 

 

 

 

Other

 

 

3,875 

 

 

3,875 

 

 

 

 

 

Total equity securities

 

 

8,247 

 

 

8,247 

 

 

 

 

 

Debt securities

 

 

 

 

 

 

 

 

 

 

 

 

 

International bond fund(3)

 

 

2,329 

 

 

 

 

2,329 

 

 

 

High yield fund(4)

 

 

2,309 

 

 

 

 

2,309 

 

 

 

Industrial bonds

 

 

5,234 

 

 

 

 

5,234 

 

 

 

Government bonds

 

 

7,075 

 

 

4,558 

 

 

2,517 

 

 

 

Financial bonds

 

 

1,154 

 

 

 

 

1,154 

 

 

 

Other

 

 

4,706 

 

 

 

 

4,706 

 

 

 

Total debt securities

 

 

22,807 

 

 

4,558 

 

 

18,249 

 

 

 

Total available for sale securities

 

 

31,054 

 

 

12,805 

 

 

18,249 

 

 

 

Total

 

$

45,920 

 

$

27,671 

 

$

18,249 

 

$

 


(1)

Cash equivalents, consisting of money market funds held principally for obligations arising from our self-insurance programs. Cash equivalents are reported on our balance sheet as cash and cash equivalents and current and long term restricted cash.  Cash equivalents include $5,269 and $13,181 of balances that are restricted at March 31, 2014 and December 31, 2013, respectively.

 

(2)

Investments in available for sale securities are reported on our balance sheet as current and long term investments in available for sale securities and are reported at fair value of $22,441 and $14,167, respectively, at March 31, 2014 and $19,150 and $11,905, respectively, at December 31, 2013. Our investments in available for sale securities had amortized costs of $34,585 and $29,127 as of March 31, 2014 and December 31, 2013, respectively, had unrealized gains of $2,193 and $2,185 as of March 31, 2014 and December 31, 2013, respectively, and had unrealized losses of $170 and $257 as of March 31, 2014 and December 31, 2013, respectively. At March 31, 2014, 28 of the securities we hold, with a fair value of

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Table of Contents

FIVE STAR QUALITY CARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

$6,797, have been in a loss position for less than 12 months and 10 of the securities we hold, with a fair value of $1,209, have been in a loss position for greater than 12 months. We do not believe these securities are impaired primarily because they have not been in a loss position for an extended period of time, the financial conditions of the issuers of these securities remain strong with solid fundamentals, or we intend to hold these securities until recovery, and other factors that support our conclusion that the loss is temporary. During the three months ended March 31, 2014 and 2013, we received gross proceeds of $4,336 and $2,409, respectively, in connection with the sales of available for sale securities and recorded gross realized gains totaling $324 and $123, respectively, and gross realized losses totaling $11 and $36, respectively. We record gains and losses on the sales of our available for sale securities using the specific identification method.

 

(3)

The investment strategy of this fund is to invest principally in fixed income securities. The fund invests in such securities or investment vehicles as it considers appropriate to achieve the fund’s investment objective, which is to provide an above average rate of total return while attempting to limit investment risk by investing in a diversified portfolio of U.S. dollar investment grade fixed income securities. There are no unfunded commitments and the investment can be redeemed weekly.

 

(4)

The investment strategy of this fund is to invest principally in fixed income securities. The fund invests in such securities or investment vehicles as it considers appropriate to achieve the fund’s investment objective, which is to provide an above average rate of total return while attempting to limit investment risk by investing in a diversified portfolio of primarily fixed income securities issued by companies with below investment grade ratings. There are no unfunded commitments and the investment can be redeemed weekly.

 

During the three months ended March 31, 2014, 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 three months ended March 31, 2014.

 

The carrying values of accounts receivable and accounts payable approximate fair value as of March 31, 2014 and December 31, 2013.  The carrying value and fair value of our mortgage notes payable were $37,337 and $40,378, respectively, as of March 31, 2014 and $37,620 and $41,113, respectively, as of December 31, 2013, 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.  Because these Level 3 inputs are unobservable, our estimated fair value may differ materially from the actual fair value.  We measured the fair value of our equity investment in AIC, an Indiana insurance company that we owned at March 31, 2014 in equal proportion with each of the other then seven shareholders of that company (see Note 10), categorized in Level 2 of the fair value hierarchy in its entirety, by considering, among other things, the individual assets and liabilities held by AIC, AIC’s overall financial condition and earning trends, and the financial condition and prospects for the insurance industry generally.

 

Non-Recurring Fair Value Measures

 

We evaluate the recoverability of goodwill assets in the fourth quarter of each fiscal year, or more frequently if events or changes in circumstances indicate that goodwill or other intangible assets may be impaired.  As of October 1, 2013, we evaluated our goodwill for impairment and determined that the fair value of our reporting units exceeded their carrying values on that date.  As of March 31, 2014, no events or changes in circumstances had occurred that would trigger the need for an additional impairment review.

 

Goodwill was valued primarily using discounted cash flow models that incorporate assumptions for each reporting units short and long term revenue growth rates, operating margins, and discount rates, which represent our best estimates of current and forecasted market conditions, current cost structure, and the implied rate of return that 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.

  

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 and/or internally developed cash flow models, all of which are considered to be Level 3 fair value measurements.

 

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Table of Contents

FIVE STAR QUALITY CARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

See Note 11 for discussion of fair value measurements related to an acquisition that occurred during the second quarter of 2014.

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.  Borrowings under our Credit Agreement typically bear interest at LIBOR plus a premium of 250 basis points, or 2.66% as of March 31, 2014.  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 Agreement. We may draw, repay and redraw funds under our Credit Agreement until maturity, and no principal repayment is due until maturity.  We made no borrowings under our Credit Agreement during the three months ended March 31, 2014 and 2013.  As of March 31, 2014, we had no amounts outstanding under our Credit Agreement.  We incurred interest expense and other associated costs related to our Credit Agreement of $48 and $152 for the three months ended March 31, 2014 and 2013, respectively.

 

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 certain related collateral. Our Credit Agreement provides for acceleration of payment of all amounts outstanding upon the occurrence and continuation of certain events of default, such as a change of control of us, which includes termination of our business management and shared services agreement, or our business management agreement, with Reit Management & Research LLC, or RMR.

 

We also have a $150,000 secured revolving credit facility, or our Credit Facility, that is available for general business purposes, including acquisitions.  The maturity date of our Credit Facility is April 13, 2015, and, subject to the payment of extension fees and meeting certain other conditions, our Credit Facility includes options for us to extend its stated maturity date for  two consecutive one-year periods.  Borrowings under our Credit Facility typically bear interest at LIBOR plus a premium of 250 basis points, or 2.66% as of March 31, 2014.  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 under our Credit Facility until maturity, and no principal repayment is due until maturity.  The weighted average interest rate for borrowings under our Credit Facility was 2.83% and 4.75% for the three months ended March 31, 2014 and 2013, respectively.  As of March 31, 2014, we had $15,000 outstanding under our Credit Facility.  We incurred interest expense and other associated costs related to our Credit Facility of $593 and $467 for the three months ended March 31, 2014 and 2013, 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 certain related collateral.  Our Credit Facility provides for acceleration of payment of all amounts outstanding upon the occurrence and continuation of certain events of default, such as 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.  Our Credit Agreement and Credit Facility require that we deliver quarterly and annual financial statements within the time periods specified within those agreements.  The lenders under each of our Credit Agreement and Credit Facility have waived until December 31, 2014 any default resulting from our not timely delivering our financial statements for the quarters ended March 31, 2014, June 30, 2014, and September 30, 2014 as required under those agreements.  Our condensed consolidated financial statements for the quarters ended March 31, 2014, June 30, 2014, and September 30, 2014, are being delivered to our lenders contemporaneously with the filing of this Quarterly Report on Form 10-Q and the filing of our Quarterly Reports on

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Table of Contents

FIVE STAR QUALITY CARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

Form 10-Q for the quarters ended June 30, 2014, and September 30, 2014, which are being filed substantially concurrently with this Quarterly Report.

 

In October 2006, we issued $126,500 principal amount of the Notes.  Our net proceeds from this issuance were approximately $122,600.  The Notes bore interest at a rate of 3.75% per annum and were convertible into our common shares at any time.  The conversion rate, which was subject to adjustment, was 76.9231 common shares per $1 principal amount of the Notes, which represented a conversion price of $13.00 per share.  The Notes were guaranteed by certain of our wholly owned subsidiaries.  The Notes were scheduled to mature on October 15, 2026.  We were entitled to prepay the Notes at any time and the holders were entitled to require us to purchase all or a portion of these Notes on each of October 15, 2013, 2016 and 2021 at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus any accrued and unpaid interest.  We periodically repurchased Notes in open market transactions or in privately negotiated transactions, and, on July 8, 2013, we redeemed all of the $24,872 principal amount of the Notes then outstanding at a redemption price equal to the principal amount, plus accrued and unpaid interest.  We incurred interest expense and other associated costs related to the Notes of $245 for the three months ended March 31, 2013.

 

At March 31, 2014, four of our senior living communities were encumbered by mortgage notes with an aggregate outstanding principal balance of $37,337 :  (1) one of our communities was encumbered by a Federal National Mortgage Association, or FNMA, mortgage note and (2) three of our communities were encumbered by Federal Home Loan Mortgage Corporation, or FMCC, mortgage notes.  These mortgages contain FNMA and FMCC, respectively, standard mortgage covenants.  We recorded mortgage premiums in connection with our assumption of the FNMA and FMCC mortgage notes at the time of our acquisitions of the encumbered communities in order to record the assumed mortgage notes at their estimated fair value.  We are amortizing the mortgage premiums as a reduction of interest expense until the maturity of the respective mortgage notes.  The weighted average interest rate on these four notes was 6.90% as of March 31, 2014.  Payments of principal and interest are due monthly under these mortgage notes until maturities at varying dates ranging from June 2023 to September 2032.  We incurred mortgage interest expense, including premium amortization, of $577 and $699 for the three months ended March 31, 2014 and 2013, respectively, and including some interest expense recorded in discontinued operations.  Our mortgages require monthly payments into escrows for taxes, insurance and property replacement funds; withdrawals from these escrows require applicable lender approvals.  As of March 31, 2014, we believe we were in compliance with all applicable covenants under these mortgages.

Note 9. Off Balance Sheet Arrangements

We have pledged certain of our assets, including our accounts receivable with a carrying value, as of March 31, 2014, of $14,268, arising from our operation of 26 properties owned by SNH and leased to us to secure SNH’s borrowings from its lender, FNMA.  As of March 31, 2014, we had no other off balance sheet arrangements that have had or that we expect would be reasonably likely to have a future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

Note 10. Related Person Transactions

We were formerly a 100% owned subsidiary of SNH, SNH is our largest landlord and our largest stockholder and we manage senior living communities for SNH.  In 2001, SNH distributed substantially all of our then outstanding common shares to its shareholders.  As of March 31, 2014, SNH owned 4,235 of our common shares, or approximately 8.7% of our outstanding common shares.  One of our Managing Directors, Mr. Barry Portnoy, is a managing trustee of SNH.  Mr. Barry Portnoy’s son, Mr. Adam Portnoy, also serves as a managing trustee of SNH.

 

As of March 31, 2014, we leased 186 senior living communities (including nine that we have classified as discontinued operations) from SNH.  Under our leases with SNH, we pay SNH minimum rent plus percentage rent based on increases in gross revenues at certain properties.  Our total minimum annual rent payable to SNH as of March 31, 2014 was $190,614, excluding percentage rent.  Our total rent expense (which includes rent for all properties we lease from SNH,

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Table of Contents

FIVE STAR QUALITY CARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

including properties that we have classified as discontinued operations) under all of our leases with SNH, net of lease inducement amortization, was $48,758 and $50,600 for the three months ended March 31, 2014 and 2013, respectively. As of March 31, 2014 and 2013, we had outstanding rent due and payable to SNH of $17,251 and $17,756, respectively.  During the three months ended March 31, 2014, pursuant to the terms of our leases with SNH, we sold $8,614 of improvements made to properties leased from SNH, and, as a result, our annual rent payable to SNH increased by approximately $689.  As of March 31, 2014, our property and equipment included $7,525 for similar improvements we have made to properties we lease from SNH that we typically 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 June 2014, we sold to SNH $8,809 of improvements for an increase in minimum annual rent payable to SNH of $706.  In September 2014, we sold to SNH $6,353 of improvements for an increase in minimum annual rent payable to SNH of $508.

 

We and SNH previously agreed that SNH would offer for sale 11 senior living communities we lease from SNH, which we have classified as discontinued operations.  Our rent payable to SNH is reduced as these sales occur pursuant to terms set in our leases with SNH.  In August 2013, we and SNH sold one of these communities, a SNF located in Missouri with 112 living units, for a sale price of $2,550, and as a result of this sale, our annual minimum rent payable to SNH decreased by $255 in accordance with the terms of the applicable lease.  In January 2014, we and SNH sold one of these communities, an assisted living community located in Texas with 48 assisted living units, for a sale price of $2,400, and as a result of this sale, our annual minimum rent payable to SNH decreased by $210 in accordance with the terms of the applicable lease. In June 2014, we and SNH sold two of these communities, both of which are SNFs located in Wisconsin, with a combined total of 139 living units, for a sale price of $4,500, and as a result of this sale, our annual minimum rent payable to SNH decreased by $450 in accordance with the terms of the applicable lease. In October 2014, we and SNH sold one of these communities, an assisted living community in Virginia with 55 assisted living units, for a sale price of $2,850, and as a result of this sale, our annual minimum rent payable to SNH decreased by $285 in accordance with the terms of the applicable lease.  Also in October 2014, we and SNH sold one assisted living community and one SNF located in Arizona with a combined total of 160 living units, for a sale price of $5,900, and as a result of this sale, our annual minimum rent payable to SNH decreased by $590 in accordance with the terms of the applicable lease. We can provide no assurance that the remaining four senior living communities that we and SNH have agreed to offer for sale will be sold or what the terms of any such sales may provide.

 

Concurrent and in connection with entering into the Villa Valencia Agreement, described below, we and SNH entered into the Fifth Amendment to the Amended and Restated Master Lease Agreement (Lease No. 4), or Lease No. 4. Under this Lease No. 4 amendment, we exercised the first of our existing options under Lease No. 4, extending the term from April 30, 2017 to April 30, 2032, and a third option for us to extend the term of Lease No. 4 from May 1, 2047 to April 30, 2062, was added.

 

As of March 31, 2014, we managed 44 senior living communities for the account of SNH. In connection with these management agreements, we and SNH have entered into four combination agreements, or pooling agreements: three pooling agreements combine our management agreements with SNH for communities that include assisted living units, or the AL Pooling Agreements, and a fourth pooling agreement combines our management agreements with SNH for communities that include only independent living units, or the IL Pooling Agreement. The management agreements that are included in each of our pooling agreements are on substantially similar terms.  Our first AL Pooling Agreement includes 20 identified communities and our second AL Pooling Agreement includes 19 identified communities.  The third AL Pooling Agreement currently includes the management agreement for a community we began managing in November 2013 and two communities we began managing in December 2014.  The IL Pooling Agreement currently includes management agreements for two communities that have only independent living units.  A senior living community in New York and one senior living community in California described below that we manage for SNH are not included in any of our pooling agreements.  Each of the AL Pooling Agreements and the IL Pooling Agreement aggregates the determination of fees and expenses of the various communities that are subject to such pooling agreement,

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Table of Contents

FIVE STAR QUALITY CARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

including determinations of our incentive fees and SNH’s return on its invested capital.  We earned management fees from SNH of $2,425 and $2,295 for the three months ended March 31, 2014 and 2013, respectively.

 

Our second AL Pooling Agreement previously included the management agreement for the assisted living community known as Villa Valencia, which is located in California.  On July 10, 2014, we entered into an agreement with SNH, pursuant to which the management agreement for Villa Valencia was removed from the second AL Pooling Agreement as of July 1, 2014. We expect that the management agreement affecting the Villa Valencia community will not be included in any pooling agreement until after extensive renovations planned at that community are completed.

 

Also on July 10, 2014, we entered into an amendment to the management agreements with SNH that include assisted living units to (i) extend the term of each of the management agreements between us and SNH for Villa Valencia and the 19 assisted living communities currently included in the second AL Pooling Agreement from December 31, 2031 to December 31, 2033 and (ii) extend the term of the management agreement between us and SNH for the senior living community known as Willow Pointe, which is currently included in the third AL Pooling Agreement, from December 31, 2031 to December 31, 2035. On July 10, 2014, we also entered into an amendment to our management agreements with SNH that include only independent living units to extend the term of the management agreements between us and SNH for two independent living communities from December 31, 2031 to December 31, 2032. The term of the 20 management agreements included in the first AL Pooling Agreement were not affected by these amendments and those management agreements expire on December 31, 2031.

 

We manage a portion of a senior living community in New York that is not subject to the requirements of New York healthcare licensing laws, consisting of 199 living units, pursuant to a long term management agreement with SNH.  In order to accommodate certain requirements of New York healthcare licensing laws, SNH subleases another portion of this senior living community that is subject to those requirements, consisting of 111 living units, to an entity, D&R Yonkers LLC, which is owned by SNH’s President and Chief Operating Officer and its Treasurer and Chief Financial Officer.  We manage this portion of the community pursuant to a long term management agreement with D&R Yonkers LLC.

 

We may enter into additional management arrangements with SNH for us to manage senior living communities that SNH may acquire in the future.  We expect that these management arrangements will be pursuant to long term management agreements on terms similar to our existing management agreements and that those agreements may be added to our existing pooling agreements or that we may enter into additional pooling agreements with SNH with respect to these management agreements.

 

RMR provides business management and shared services to us pursuant to our business management agreement.  RMR also provides management services to SNH.  One of our Managing Directors, Mr. Barry Portnoy, is Chairman, majority owner and an employee of RMR.  Mr. Barry Portnoy’s son, Mr. Adam Portnoy, is an owner of RMR and serves as President, Chief Executive Officer and a director of RMR.  Our other Managing Director, Mr. Gerard Martin, is a director of RMR.  Mr. Bruce Mackey, our President and Chief Executive Officer, and Mr. Paul Hoagland, our Treasurer and Chief Financial Officer, are officers of RMR.  RMR provides management services to SNH, SNH’s officers are executive officers of RMR and SNH’s President and Chief Operating Officer serves as a director of RMR.  Our Independent Directors also serve as independent directors or independent trustees of other public companies (but not SNH) to which RMR or its affiliates provide management services.  Mr. Barry Portnoy serves as a managing director or managing trustee of those companies and Mr. Adam Portnoy serves as a managing trustee of a majority of those companies.  In addition, officers of RMR serve as officers of those companies.

 

Pursuant to our business management agreement with RMR, we recognized aggregate business management, administrative and information system service fees of $3,525 and $3,332 for the three months ended March 31, 2014 and 2013, respectively.  These amounts are included in general and administrative expenses in our condensed consolidated

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Table of Contents

FIVE STAR QUALITY CARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

statements of operations.  We also lease our headquarters from an affiliate of RMR for annual rent of approximately $767, which amount is subject to fixed increases.  Our rent expense for our headquarters, which included our utilities and real estate taxes that we are required to pay as additional rent, under this lease, was $355 and $347 for the three months ended March 31, 2014 and 2013, respectively.

 

We, RMR, SNH, and four other companies to which RMR provides management services currently own AIC, an Indiana insurance company.  All of our Directors and most of the trustees and directors of the other AIC shareholders currently serve on the board of directors of AIC.  RMR provides management and administrative services to AIC pursuant to a management and administrative services agreement with AIC.

 

On March 25, 2014, as a result of the removal, without cause, of all of the trustees of Equity Commonwealth (formerly known as CommonWealth REIT), or EQC, EQC underwent a change in control, as defined in the shareholders agreement among us, the other shareholders of AIC and AIC. As a result of that change in control and in accordance with the terms of the shareholders agreement, on May 9, 2014, we and those other shareholders purchased pro rata the AIC shares EQC owned.  Pursuant to that purchase, we purchased 2,857 AIC shares from EQC for $825.  Following these purchases, we and the other remaining six shareholders each owned approximately 14.3% of AIC.

 

In June 2014, we and the other shareholders of AIC renewed our participation in an insurance program arranged by AIC. In connection with that renewal, we purchased a one-year property insurance policy providing $500,000 of coverage with respect to which AIC is a reinsurer of certain coverage amounts.  We paid AIC a premium, including taxes and fees, of approximately $3,901 in connection with that policy, which amount may be adjusted from time to time as we acquire or dispose of properties that are included in the policy.

 

As of March 31, 2014, we have invested $5,209 in AIC since its formation in 2008.  Although we own less than 20% of AIC, we use the equity method to account for this investment because we believe that we have significant influence over AIC because all of our Directors are also directors of AIC.  Our investment in AIC had a carrying value of $5,835 and $5,913 as of March 31, 2014 and December 31, 2013, respectively.  We recognized a loss of $97 and income of $76 related to our investment in AIC for the three months ended March 31, 2014 and 2013, respectively.

 

In June 2014, we, RMR, SNH and three other companies to which RMR provides management services extended our and their combined directors’ and officers’ liability insurance policy through August 31, 2014.  In September 2014, we purchased a two year combined directors and officers insurance policy with RMR and five other companies managed by RMR that provides $10,000 in aggregate primary coverage, including certain errors and omission coverage.  At that time, we also purchased separate additional one year directors and officers liability insurance policies that provide $20,000 of aggregate excess coverage plus $5,000 of excess non-indemnifiable coverage.  The total premium payable by us for these policies purchased in September 2014 was approximately $357

 

Note 11.  Acquisition

 

In May 2014, we acquired a senior living community with 116 living units located in Alabama for approximately $19,914, including the assumption of approximately $13,920 of mortgage debt and the assumption of approximately $68 of net working capital liabilities, but excluding closing costs. This community primarily offers independent and assisted living services that are currently 100% paid by residents from their private resources. We funded this acquisition with cash on hand and borrowings under our Credit Facility. We incurred acquisition related costs of $81 during the second quarter of 2014.  These costs include transaction costs, professional fees and other acquisition related expenses.  The preliminary allocation of the purchase price was based on managements judgment after evaluating several factors, including valuation assessments of tangible and intangible assets and estimates of the fair value of liabilities assumed. The definite lived intangible assets were valued using the income approach and are categorized in Level 3 of the fair value hierarchy.  The valuation of certain tangible assets and liabilities acquired was determined using the cost approach.    

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Table of Contents

FIVE STAR QUALITY CARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

For personal property, we primarily used the cost approach to estimate reproduction or replacement cost.  The fair value of these assets and liabilities are also categorized in Level 3 of the fair value hierarchy.    The following table summarizes the preliminary allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed:

 

 

 

 

 

 

Land

$

1,208 

 

Buildings and improvements

 

17,946 

 

Furniture, fixtures and equipment

 

421 

 

Total property, plant and equipment

 

19,575 

 

 

 

 

 

Intangible assets

 

1,937 

 

Net working capital liabilities assumed

 

(68)

 

Mortgage debt assumed

 

(13,920)

 

Premium on assumed  mortgage debt

 

(1,598)

 

Net cash paid

$

5,926 

 

 

Note 12.  Discontinued Operations

In September 2012, we completed the sale of our pharmacy business to Omnicare, Inc., or Omnicare. In connection with the sale, Omnicare did not acquire the real estate we own associated with one pharmacy located in South Carolina.  In July 2014, we sold this real estate for a sale price of $205.

 

In June 2013, we decided to offer for sale one assisted living community we own with 32 living units.  We are in the process of offering this community for sale. 

 

Please see Note 10 above for a discussion of 11 senior living communities that we lease or had leased from SNH which are included in discontinued operations for all of the periods presented in these condensed consolidated financial statements; two of which had been sold as of March 31, 2014 and five additional of which were sold in June and October 2014.

 

We can provide no assurance that we will be able to sell the senior living community that we are offering for sale, or that we and SNH will be able to sell the senior living communities we lease from SNH that are being offered for sale, or what the terms or timing of any such sales may be.

 

We have reclassified our condensed consolidated balance sheets and condensed consolidated statements of operations for all periods presented to show the financial position and results of operations of our senior living communities, pharmacies and rehabilitation hospitals 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 condensed consolidated financial statements for the three months ended March 31, 2014 and 2013:

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

    

2014

    

2013

Revenues

 

$

7,501 

 

$

42,078 

Expenses

 

 

(8,866)

 

 

(43,540)

Benefit from income taxes

 

 

473 

 

 

661 

Net loss

 

$

(892)

 

$

(801)

 

 

Note 13.  Legal Proceedings and Claims

We have been, are currently, and expect in the future to be involved in claims, lawsuits, and regulatory and other governmental audits, investigations and proceedings arising in the ordinary course of our business, some of which may

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Table of Contents

FIVE STAR QUALITY CARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

involve material amounts.  Also, the defense and resolution of these claims, lawsuits, and regulatory and other governmental audits, investigations and proceedings may require us to incur significant expense.  We account for claims and litigation losses in accordance with ASC Topic 450, Contingencies, or ASC 450. Under ASC 450, loss contingency provisions are recorded for probable and estimable losses at our best estimate of a loss or, when a best estimate cannot be made, at our estimate of the minimum loss. These estimates are often developed prior to knowing the amount of the ultimate loss, require the application of considerable judgment, and are refined as additional information becomes known. Accordingly, we are often initially unable to develop a best estimate of loss and therefore the estimated minimum loss amount, which could be zero, is recorded; then, as information becomes known, the minimum loss amount is updated, as appropriate. Occasionally, a minimum or best estimate amount may be increased or decreased when events result in a changed expectation.

 

In August 2014, in connection with an ongoing and routine compliance audit of medical records, we became aware of certain potential inadequate medical record documentation and other possible failures to comply with appropriate policies at one of our SNFs.  We have commenced an in depth review of these matters that is ongoing.  We have determined that a loss in connection with this matter is reasonably possible, but cannot be reasonably estimated at this time; accordingly, we have not recorded any loss for this matter at this time.  However, such loss could have a material adverse impact on our business, financial condition, and results of operations.

 

 

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

RESULTS OF OPERATIONS

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 SNH 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 FASB 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 captive insurance company subsidiary, which participates in our workers’ compensation, professional liability and automobile insurance programs, that is organized in the Cayman Islands.

Key Statistical Data For the Three Months Ended March 31, 2014 and 2013:

The following tables present a summary of our operations for the three months ended March 31, 2014 and 2013:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

(dollars in thousands, except average monthly rate)

    

2014

    

2013

    

Change

    

%/bps Change

 

Senior living revenue

 

$

271,781 

 

$

269,306 

 

$

2,475 

 

0.9 

%  

Management fee revenue

 

 

2,425 

 

 

2,302 

 

 

123 

 

5.3 

%  

Reimbursed costs incurred on behalf of managed communities

 

 

54,205 

 

 

52,244 

 

 

1,961 

 

3.8 

%  

Total revenue

 

 

328,411 

 

 

323,852 

 

 

4,559 

 

1.4 

%  

Senior living wages and benefits

 

 

(132,783)

 

 

(132,646)

 

 

(137)

 

(0.1)

%  

Other senior living operating expenses

 

 

(72,817)

 

 

(65,455)

 

 

(7,362)

 

(11.2)

%  

Costs incurred on behalf of managed communities

 

 

(54,205)

 

 

(52,244)

 

 

(1,961)

 

(3.8)

%  

Rent expense

 

 

(49,074)

 

 

(48,013)

 

 

(1,061)

 

(2.2)

%  

General and administrative expenses

 

 

(19,748)

 

 

(15,456)

 

 

(4,292)

 

(27.8)

%  

Depreciation and amortization expense

 

 

(7,276)

 

 

(6,370)

 

 

(906)

 

(14.2)

%  

Interest, dividend and other income

 

 

196 

 

 

197 

 

 

(1)

 

(0.5)

%  

Interest and other expense

 

 

(1,218)

 

 

(1,456)

 

 

238 

 

16.3 

%  

Gain on sale of available for sale securities reclassified from other comprehensive income

 

 

313 

 

 

87 

 

 

226 

 

259.8 

%  

Benefit from income taxes

 

 

2,431 

 

 

621 

 

 

1,810 

 

291.5 

%  

Equity in (loss) earnings of an investee

 

 

(97)

 

 

76 

 

 

(173)

 

(227.6)

%  

(Loss) income from continuing operations

 

$

(5,867)

 

$

3,193 

 

$

(9,060)

 

(283.7)

%  

 

 

 

 

 

 

 

 

 

 

 

 

 

Total number of communities (end of period):

 

 

 

 

 

 

 

 

 

 

 

 

Owned and leased communities

 

 

211 

 

 

211 

 

 

 —

 

 —

 

Managed communities

 

 

44 

 

 

39 

 

 

 

12.8 

%  

Number of total communities(1)

 

 

255 

 

 

250 

 

 

 

2.0 

%  

 

 

 

 

 

 

 

 

 

 

 

 

 

Total number of living units (end of period):

 

 

 

 

 

 

 

 

 

 

 

 

Owned and leased living units

 

 

22,948 

 

 

22,948 

 

 

 —

 

 —

 

Managed living units

 

 

7,051 

 

 

6,678 

 

 

373 

 

5.6 

%  

Number of total living units(2)

 

 

29,999 

 

 

29,626 

 

 

373 

 

1.3 

%  

 

 

 

 

 

 

 

 

 

 

 

 

 

Owned and leased communities:

 

 

 

 

 

 

 

 

 

 

 

 

Occupancy %

  

 

85.9 

%  

 

86.3 

%  

 

n/a 

 

(40) bps