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EX-99.2 - EX-99.2 - FIVE STAR SENIOR LIVING INC.exhibit992.htm
EX-32.1 - EX-32.1 - FIVE STAR SENIOR LIVING INC.exhibit321.htm
EX-31.2 - EX-31.2 - FIVE STAR SENIOR LIVING INC.exhibit312.htm
EX-31.1 - EX-31.1 - FIVE STAR SENIOR LIVING INC.exhibit311.htm
EX-10.2 - EX-10.2 - FIVE STAR SENIOR LIVING INC.exhibit102.htm


 
 
 
 
 

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, 2016
 
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 or Other Jurisdiction of Incorporation or Organization)
(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 registrant’s shares of common stock, $.01 par value, outstanding as of November 2, 2016:  49,512,651.  
 
 
 
 
 




FIVE STAR QUALITY CARE, INC.
FORM 10-Q
SEPTEMBER 30, 2016
INDEX
 
Page
 
 
 
 
 
 
 
 
References in this Quarterly Report on Form 10-Q to the Company, Five Star, 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)
 
 
September 30, 2016
 
December 31, 2015
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
43,174

 
$
14,672

Accounts receivable, net of allowance of $3,696 and $3,592 at September 30, 2016 and December 31, 2015, respectively
 
38,040

 
37,829

Due from related persons
 
8,961

 
9,731

Investments in available for sale securities, of which $10,553 and $11,471 are restricted at September 30, 2016 and December 31, 2015, respectively
 
25,801

 
26,417

Restricted cash
 
11,168

 
3,301

Prepaid expenses and other current assets
 
20,135

 
19,138

Assets of discontinued operations
 
567

 
981

Total current assets
 
147,846

 
112,069

 
 
 
 
 
Property and equipment, net
 
352,561

 
383,858

Equity investment of an investee
 
7,110

 
6,827

Restricted cash
 
1,787

 
2,821

Restricted investments in available for sale securities
 
18,511

 
23,166

Other long term assets
 
2,861

 
3,029

 
 
$
530,676

 
$
531,770

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Revolving credit facility
 
$

 
$
50,000

Accounts payable and accrued expenses
 
70,858

 
93,205

Accrued compensation and benefits
 
40,768

 
32,127

Due to related persons
 
18,338

 
17,870

Mortgage notes payable
 
1,878

 
1,807

Accrued real estate taxes
 
16,030

 
12,207

Security deposits and current portion of continuing care contracts
 
5,568

 
6,129

Other current liabilities
 
33,461

 
30,399

Liabilities of discontinued operations
 
8

 
176

Total current liabilities
 
186,909

 
243,920

 
 
 
 
 
Long term liabilities:
 
 
 
 
Mortgage notes payable
 
58,978

 
60,396

Continuing care contracts
 
1,068

 
1,267

Accrued self insurance obligations
 
35,636

 
37,588

Deferred gain on sale and leaseback transaction with Senior Housing Properties Trust
 
74,347

 

Other long term liabilities
 
3,648

 
4,147

Total long term liabilities
 
173,677

 
103,398

 
 
 
 
 
Commitments and contingencies
 

 

 
 
 
 
 
Shareholders’ equity:
 
 
 
 
Common stock, par value $.01: 75,000,000 shares authorized, 49,519,051 and 49,476,611 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively
 
495

 
494

Additional paid in capital
 
359,413

 
358,665

Accumulated deficit
 
(193,808
)
 
(177,622
)
Accumulated other comprehensive income
 
3,990

 
2,915

Total shareholders’ equity
 
170,090

 
184,452

 
 
$
530,676

 
$
531,770

See accompanying notes.

1


FIVE STAR QUALITY CARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)


 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
 
Senior living revenue
 
$
277,410

 
$
279,685

 
$
836,523

 
$
832,793

Management fee revenue
 
3,336

 
2,717

 
8,955

 
7,939

Reimbursed costs incurred on behalf of managed communities
 
63,965

 
62,170

 
186,378

 
180,082

Total revenues
 
344,711

 
344,572

 
1,031,856

 
1,020,814

 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
Senior living wages and benefits
 
137,190

 
135,133

 
408,886

 
404,737

Other senior living operating expenses
 
70,890

 
72,637

 
212,565

 
216,107

Costs incurred on behalf of managed communities
 
63,965

 
62,170

 
186,378

 
180,082

Rent expense
 
50,625

 
49,730

 
150,837

 
149,015

General and administrative expenses
 
18,542

 
16,587

 
54,218

 
52,750

Depreciation and amortization expense
 
9,398

 
8,419

 
28,847

 
24,637

Goodwill impairment
 

 
25,344

 

 
25,344

Long lived asset impairment
 
196

 
145

 
502

 
145

Total operating expenses
 
350,806

 
370,165

 
1,042,233

 
1,052,817

 
 
 
 
 
 
 
 
 
Operating loss
 
(6,095
)
 
(25,593
)
 
(10,377
)
 
(32,003
)
 
 
 
 
 
 
 
 
 
Interest, dividend and other income
 
237

 
238

 
766

 
701

Interest and other expense
 
(945
)
 
(1,106
)
 
(3,957
)
 
(3,597
)
Gain on early extinguishment of debt
 

 

 

 
692

Gain on sale of available for sale securities reclassified from accumulated other comprehensive income
 
12

 

 
247

 
38

 
 
 
 
 
 
 
 
 
Loss from continuing operations before income taxes and equity in earnings (losses) of an investee
 
(6,791
)
 
(26,461
)
 
(13,321
)
 
(34,169
)
Benefit from (provision for) income taxes
 
934

 
236

 
(2,841
)
 
(348
)
Equity in earnings (losses) of an investee
 
13

 
(25
)
 
107

 
70

Loss from continuing operations
 
(5,844
)
 
(26,250
)
 
(16,055
)
 
(34,447
)
Loss from discontinued operations
 
(53
)
 
(1,238
)
 
(131
)
 
(2,253
)
 
 
 
 
 
 
 
 
 
Net loss
 
$
(5,897
)
 
$
(27,488
)
 
$
(16,186
)
 
$
(36,700
)
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding—basic and diluted
 
48,846

 
48,427

 
48,817

 
48,397

 
 
 
 
 
 
 
 
 
Basic and diluted loss per share from:
 
 

 
 

 
 
 
 
Continuing operations
 
$
(0.12
)
 
$
(0.54
)
 
$
(0.33
)
 
$
(0.71
)
Discontinued operations
 

 
(0.03
)
 

 
(0.05
)
Net loss per share—basic and diluted
 
$
(0.12
)
 
$
(0.57
)
 
$
(0.33
)
 
$
(0.76
)
 
See accompanying notes.


2


FIVE STAR QUALITY CARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
(unaudited)


 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Net loss
$
(5,897
)
 
$
(27,488
)
 
$
(16,186
)
 
$
(36,700
)
Other comprehensive income (loss):
 

 
 

 
 

 
 

Unrealized gain (loss) on investments in available for sale securities, net of tax benefit (expense) of $162,  $0, $(383) and $0, respectively
321

 
(311
)
 
1,147

 
(437
)
Equity in unrealized gain (loss) of an investee
80

 
(72
)
 
175

 
(91
)
Realized gain on investments in available for sale securities reclassified and included in net loss, net of tax
(12
)
 

 
(247
)
 
(38
)
Other comprehensive income (loss)
389

 
(383
)
 
1,075

 
(566
)
Comprehensive loss
$
(5,508
)
 
$
(27,871
)
 
$
(15,111
)
 
$
(37,266
)
See accompanying notes.


3


FIVE STAR QUALITY CARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)


 
 
Nine Months Ended September 30,
 
 
2016
 
2015
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(16,186
)
 
$
(36,700
)
Adjustments to reconcile net loss to cash (used in) provided by operating activities:
 
 
 
 
Depreciation and amortization expense
 
28,847

 
24,637

Gain on early extinguishment of debt
 

 
(742
)
Loss from discontinued operations
 
131

 
2,253

Gain on sale of available for sale securities reclassified from accumulated other comprehensive income
 
(247
)
 
(38
)
Loss on disposal of property and equipment
 
70

 
98

Goodwill impairment
 

 
25,344

Long lived asset impairment
 
502

 
145

Equity in earnings of an investee
 
(107
)
 
(70
)
Stock based compensation
 
749

 
948

Provision for losses on receivables
 
2,598

 
3,520

Amortization of deferred gain on sale and leaseback transaction with Senior Housing Properties Trust
 
(1,688
)
 

Other noncash (income) expense adjustments, net
 
(375
)
 
409

Changes in assets and liabilities:
 
 
 
 

Accounts receivable
 
(2,809
)
 
(2,689
)
Prepaid expenses and other assets
 
(2,314
)
 
(1,962
)
Accounts payable and accrued expenses
 
(22,297
)
 
330

Accrued compensation and benefits
 
8,641

 
9,917

Due to/from related persons, net
 
222

 
1,026

Other current and long term liabilities
 
(2,716
)
 
9,278

Cash (used in) provided by operating activities
 
(6,979
)
 
35,704

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Increase in restricted cash and investment accounts, net
 
(6,833
)
 
(417
)
Acquisition of property and equipment
 
(40,825
)
 
(40,867
)
Purchase of intangible assets
 

 
(191
)
Purchases of available for sale securities
 
(6,780
)
 
(10,717
)
Proceeds from sale of property and equipment to Senior Housing Properties Trust
 
15,180

 
16,425

Proceeds from sale and  leaseback transaction with Senior Housing Properties Trust
 
112,350

 

Proceeds from sale of available for sale securities
 
13,508

 
6,469

Cash provided by (used in) investing activities
 
86,600

 
(29,298
)
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Proceeds from borrowings on revolving credit facility
 
25,000

 
20,000

Repayments of borrowings on revolving credit facility
 
(75,000
)
 
(20,000
)
Repayments of mortgage notes payable
 
(934
)
 
(5,732
)
Payment of deferred financing fees
 
(300
)
 
(300
)
Cash used in financing activities
 
(51,234
)
 
(6,032
)
 
 
 
 
 
Cash flows from discontinued operations:
 
 
 
 
Net cash provided by (used in) operating activities
 
130

 
(1,512
)
Net cash used in investing activities
 
(15
)
 
(24
)
Net cash flows provided by (used in) discontinued operations
 
115

 
(1,536
)
 
 
 
 
 
Change in cash and cash equivalents
 
28,502

 
(1,162
)
Cash and cash equivalents at beginning of period
 
14,672

 
20,988

Cash and cash equivalents at end of period
 
$
43,174

 
$
19,826

 
 
 
 
 
Supplemental cash flow information:
 
 
 
 
Cash paid for interest
 
$
3,920

 
$
3,078

Cash paid for income taxes, net
 
$
2,657

 
$
805

See accompanying notes.

4


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except 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, 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, 2015, 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. Certain reclassifications have been made to the prior years’ 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 September 30, 2016, we operated 276 senior living communities located in 32 states with 31,349 living units, including 246 primarily independent and assisted living communities with 28,748 living units and 30 SNFs with 2,601 living units.  As of September 30, 2016, we owned and operated 26 communities (2,703 living units), we leased and operated 187 communities (20,244 living units) and we managed 63 communities (8,402 living units).  Our 276 senior living communities, as of September 30, 2016, included 10,663 independent living apartments, 15,742 assisted living suites and 4,944 skilled nursing beds. The foregoing numbers exclude living units categorized as out of service.  
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 others 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 , or ASC, Topic 280, Segment Reporting, 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 and professional and general liability insurance programs.
Note 2. Recent Accounting Pronouncements
In December 2015, we early adopted FASB Accounting Standards Update, or ASU, No. 2015-17, Balance Sheet Classification of Deferred Taxes, which requires that deferred tax assets and liabilities be classified as noncurrent in a consolidated balance sheet rather than the former presentation of separating deferred tax assets and liabilities into current and noncurrent amounts. We adopted this ASU using prospective application. Since we have recognized a full deferred tax valuation allowance since 2014 and our deferred tax assets and liabilities net to zero, the implementation of this ASU did not have a material impact on our consolidated financial statements.
On January 1, 2016, we adopted FASB ASU No. 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, and 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. The implementation of ASU No. 2015-03 did not have a material impact on our condensed consolidated financial statements.  The adoption of ASU No. 2015-15 did not result in any changes in the classification of capitalized debt issuance costs related to our secured revolving credit facility.
On January 1, 2016, we adopted FASB 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. The implementation of this ASU did not have a material impact on our condensed consolidated financial statements.

5


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
(unaudited)


In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which changes how entities measure certain equity investments and present changes in the fair value of financial liabilities measured under the fair value option that are attributable to their own credit. This ASU is effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted subject to certain conditions. Currently, changes in fair value of these investments are recorded through other comprehensive income. Under this ASU, these changes will be recorded through earnings. We are continuing to evaluate this ASU, but we expect the implementation of this ASU will affect available for sale equity investments that we hold.
 
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). ASU No. 2016-02 requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight line basis over the term of the lease. A lessee is also required to record a right of use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales type leases, direct financing leases and operating leases. ASU No. 2016-02 is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. We are currently assessing the potential impact the adoption of ASU No. 2016-02 will have on our condensed consolidated financial statements.
 
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718), which identifies areas for simplification involving several aspects of accounting for share based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows.  ASU No. 2016-09 is effective for reporting periods beginning after December 15, 2016. We are currently assessing the potential impact the adoption of ASU No. 2016-09 will have on our condensed consolidated financial statements.
 
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), 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. In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarifies how an entity should identify the unit of accounting for the principal versus agent evaluation and how it should apply the control principle to certain types of arrangements, such as service transactions. We are currently evaluating the impact that the adoption of these ASUs will have on our condensed consolidated financial statements.
 
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326), which requires a financial asset or a group of financial assets measured at amortized cost basis, to be presented at the net amount expected to be collected. This ASU eliminates the probable initial recognition threshold and instead reflects an entity’s current estimate of all expected credit losses. In addition, this ASU amends the current available for sale security other-than-temporary impairment model for debt securities. The length of time that the fair value of an available for sale debt security has been below the amortized cost will no longer impact the determination of whether a credit loss exists and credit losses will now be limited to the difference between a security’s amortized cost basis and its fair value. This ASU is effective for reporting periods beginning after December 15, 2019. We are currently assessing the potential impact the adoption of ASU No. 2016-13 will have on our condensed consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows. ASU No. 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are currently assessing the potential impact the adoption of ASU No. 2016-15 will have on our condensed consolidated financial statements.



6


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
(unaudited)


Note 3. Property and Equipment
Property and equipment consists of the following:
 
 
September 30, 2016
 
December 31, 2015
Land
 
$
22,261

 
$
25,410

Buildings and improvements
 
303,260

 
338,522

Furniture, fixtures and equipment
 
185,654

 
165,497

Property and equipment, at cost
 
511,175

 
529,429

Accumulated depreciation
 
(158,614
)
 
(145,571
)
Property and equipment, net
 
$
352,561

 
$
383,858

 
We recorded depreciation expense relating to our property and equipment of $9,147 and $8,406 for the three months ended September 30, 2016 and 2015, respectively, and $27,290 and $24,384 for the nine months ended September 30, 2016 and 2015, respectively.
 
We review the carrying value of long lived assets 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, and we consider these estimates to be a Level 3 fair value measurement. As a result of our long lived assets impairment review, we recorded $196 and $145 of impairment charges to certain of our long lived assets in continuing operations for the three months ended September 30, 2016 and 2015, respectively, and $502 and $145 for the nine months ended September 30, 2016 and 2015, respectively.
 
As of September 30, 2016, we had $7,017 of assets related to our leased senior living communities included in our property and equipment that we currently expect to request that Senior Housing Properties Trust, or, together with its subsidiaries, SNH, purchase from us for an increase in future rent; however, SNH is not obligated to purchase such amounts. Please see Note 10 for more information regarding our leases and other arrangements with SNH.

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, 2016:
 
 
Equity
Investment of an
Investee
 
Investments in
Available for Sale
Securities
 
Accumulated
Other
Comprehensive
Income
Balance at January 1, 2016
 
$
30

 
$
2,885

 
$
2,915

Unrealized gain on investments, net of  tax of $0, $383 and $383, respectively
 

 
1,147

 
1,147

Equity in unrealized gain of an investee
 
175

 

 
175

Reclassification adjustment:
 
 
 
 
 
 
Realized gain on investments, net of tax
 

 
(247
)
 
(247
)
Balance at September 30, 2016
 
$
205

 
$
3,785

 
$
3,990

 
Accumulated other comprehensive income represents the unrealized gains and losses 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 September 30, 2016, we recognized income tax benefits from continuing operations of $934 primarily due to a reduction of previously accrued estimated state tax expense resulting from our June 2016 sale and leaseback

7


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
(unaudited)


transaction with SNH. For the nine months ended September 30, 2016, we recognized a provision for income taxes from continuing operations of $2,841, which consists of current state tax expense of $3,224 related primarily to the gain on sale for tax purposes associated with our June 2016 sale and leaseback transaction with SNH, net of federal and state intraperiod tax allocation benefits totaling $383 related to the unrealized gains on our available for sale securities.  We have not recognized any federal income tax expense attributable to federal taxable income because in the three and nine months ended September 30, 2016, such income and expense were offset by our federal net operating loss carry forwards and tax credit carry forwards.  We did not recognize any income tax expense or benefit from our discontinued operations for any period presented.
 
As of September 30, 2016, after reduction for the amounts utilized to offset federal taxable income in the nine months ended September 30, 2016, our federal net operating loss carry forwards, which are scheduled to begin expiring in 2026 if unused, were approximately $54,407, and our tax credit carry forwards, which begin expiring in 2027 if unused, were approximately $18,975.  Our federal net operating loss carry forwards and tax credit carry forwards are subject to possible audit and adjustment 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, which eliminated the amount of our net deferred tax assets recorded in our consolidated balance sheets.  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, which may affect our results of operations.

Note 6.  Earnings Per Share
We calculated basic earnings per common share, or EPS, for the three and nine months ended September 30, 2016 and 2015 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 three months ended September 30, 2016 and 2015 had 821,180 and 541,018, respectively, and the nine months ended September 30, 2016 and 2015 had 898,009 and 591,367, respectively, of potentially dilutive restricted unvested common shares that were 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 calculations of diluted EPS:
 
 
Three Months Ended September 30,
 
2016
 
2015
 
Income
 
 
 
Per
 
Income
 
 
 
Per
 
(loss)
 
Shares
 
Share
 
(loss)
 
Shares
 
Share
Loss from continuing operations
 
$
(5,844
)
 
48,846

 
$
(0.12
)
 
$
(26,250
)
 
48,427

 
$
(0.54
)
Dilutive effect of unvested restricted shares
 

 

 
 
 

 

 
 
Diluted loss from continuing operations
 
$
(5,844
)
 
48,846

 
$
(0.12
)
 
$
(26,250
)
 
48,427

 
$
(0.54
)
Diluted loss from discontinued operations
 
$
(53
)
 
48,846

 
$

 
$
(1,238
)
 
48,427

 
$
(0.03
)

 
 
Nine Months Ended September 30,
 
2016
 
2015
 
Income
 
 
 
Per
 
Income
 
 
 
Per
 
(loss)
 
Shares
 
Share
 
(loss)
 
Shares
 
Share
Loss from continuing operations
 
$
(16,055
)
 
48,817

 
$
(0.33
)
 
$
(34,447
)
 
48,397

 
$
(0.71
)
Dilutive effect of unvested restricted shares
 

 

 
 
 

 

 
 
Diluted loss from continuing operations
 
$
(16,055
)
 
48,817

 
$
(0.33
)
 
$
(34,447
)
 
48,397

 
$
(0.71
)
Diluted loss from discontinued operations
 
$
(131
)
 
48,817

 
$

 
$
(2,253
)
 
48,397

 
$
(0.05
)
 


8


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
(unaudited)


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, 2016 and December 31, 2015 categorized by the level of inputs used in the valuation of each asset.
 
 
As of September 30, 2016
 
 
 
 
Quoted Prices in
Active Markets
for Identical
 Assets
 
Significant 
Other
Observable
 Observable
Inputs
 
Significant
Unobservable 
Inputs
Description
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Cash equivalents(1)
 
$
12,961

 
$
12,961

 
$

 
$

Available for sale securities:(2)
 
 
 
 
 
 
 
 
Equity securities
 
 
 
 
 
 
 
 
Financial services industry
 
3,099

 

 
3,099

 

REIT industry
 
349

 

 
349

 

Other
 
4,706

 

 
4,706

 

Total equity securities
 
8,154

 

 
8,154

 

Debt securities
 
 
 
 
 
 
 
 
International bond fund(3)
 
2,482

 

 
2,482

 

High yield fund(4)
 
2,545

 

 
2,545

 

Industrial bonds
 
6,565

 

 
6,565

 

Government bonds
 
11,218

 
7,078

 
4,140

 

Financial bonds
 
2,312

 

 
2,312

 

Other
 
11,036

 

 
11,036

 

Total debt securities
 
36,158

 
7,078

 
29,080

 

Total available for sale securities
 
44,312

 
7,078

 
37,234

 

Total
 
$
57,273

 
$
20,039

 
$
37,234

 
$


9


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
(unaudited)


 
 
 
As of December 31, 2015
 
 
 
 
Quoted Prices in
Active Markets
for Identical
Assets
 
Significant 
Other
Observable
Inputs
 
Significant
 Unobservable
Inputs
Description
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Cash equivalents(1)
 
5,936

 
5,936

 
 
 
 
Available for sale securities:(2)
 
 
 
 
 
 
 
 
Equity securities
 
 
 
 
 
 
 
 
Financial services industry
 
3,746

 
3,746

 

 

REIT industry
 
270

 
270

 

 

Other
 
3,807

 
3,807

 

 

Total equity securities
 
7,823

 
7,823

 

 

Debt securities
 
 
 
 
 
 
 
 
International bond fund(3)
 
2,399

 

 
2,399

 

High yield fund(4)
 
2,245

 

 
2,245

 

Industrial bonds
 
6,007

 

 
6,007

 

Government bonds
 
16,612

 
8,661

 
7,951

 

Financial bonds
 
3,157

 

 
3,157

 

Other
 
11,340

 

 
11,340

 

Total debt securities
 
41,760

 
8,661

 
33,099

 

Total available for sale securities
 
49,583

 
16,484

 
33,099

 

Total
 
$
55,519

 
$
22,420

 
$
33,099

 
$

 
 
(1)
Cash equivalents consist of short term, highly liquid investments and money market funds held principally for obligations arising from our self insurance programs. Cash equivalents are reported in our condensed consolidated balance sheets as cash and cash equivalents and current and long term restricted cash.  Cash equivalents include $10,607 and $4,027 of balances that are restricted at September 30, 2016 and December 31, 2015, respectively.
 
(2)
As of September 30, 2016, our investments in available for sale securities had a fair value of $44,312 with an amortized cost of $41,486; the difference between the fair value and amortized cost amounts resulted from unrealized gains of $3,074, net of unrealized losses of $248. As of December 31, 2015, our investments in our available for sale securities had a fair value of $49,583 with an amortized cost of $48,040; the difference between the fair value and amortized cost amounts resulted from unrealized gains of $2,113, net of unrealized losses of $570. At September 30, 2016, 16 of the securities we hold, with a fair value of $4,272, have been in a loss position for less than 12 months and 10 of the securities we hold, with a fair value of $1,325, 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 what we believe to be extended periods of time, the financial conditions of the issuers of these securities remain strong and exhibit solid fundamentals, we intend to hold these securities until recovery, and other factors that support our conclusion that the loss is temporary. During the nine months ended September 30, 2016 and 2015, we received gross proceeds of $13,508 and $6,469, respectively, in connection with the sales of available for sale securities and recorded gross realized gains totaling $423 and $41, respectively, and gross realized losses totaling $176 and $3, 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 issued by non-U.S. issuers. 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 nine months ended September 30, 2016, 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, 2016.
 
The carrying values of accounts receivable and accounts payable approximate fair value as of September 30, 2016 and December 31, 2015.  The carrying value and fair value of our mortgage notes payable were $60,856 and $66,394, respectively, as of September 30, 2016 and $62,203 and $65,999, respectively, as of December 31, 2015, and are categorized in Level 3 of

10


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
(unaudited)


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 for impairment whenever events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable. Please see Note 3 for more information regarding fair value measurements related to impairments of our long lived assets in continuing operations.
 
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. Please see Note 11 for more information regarding impairments of our assets held for sale.
 
Note 8.  Indebtedness
We have a $100,000 secured revolving credit facility, or our Credit Facility, that is available for general business purposes, including acquisitions. In April 2016, we extended the maturity date of our Credit Facility to April 13, 2017, and we paid a fee of $300 in connection with this extension.  We are required to pay interest at an annual rate of LIBOR plus a premium of 250 basis points, or 3.03% as of September 30, 2016, on borrowings under our Credit Facility.  We are also required to pay a quarterly fee of 0.35% per annum on the unused part of 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 3.31% and 2.81% for the nine months ended September 30, 2016 and 2015, respectively.  As of September 30, 2016, we had no borrowings outstanding and $87,671 available to borrow under our Credit Facility. We incurred interest expense and other associated costs related to our Credit Facility of $144 and $450 for the three months ended September 30, 2016 and 2015, respectively, and $1,476 and $1,462 for the nine months ended September 30, 2016 and 2015, 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 10 senior living communities with 1,178 living units owned by our guarantor subsidiaries and our guarantor subsidiaries’ accounts receivable and related collateral. In connection with our June 2016 sale and leaseback transaction with SNH, we reduced the aggregate commitments under our Credit Facility from $150,000 to $100,000 because, as part of that transaction, we sold to SNH five senior living communities that had been collateral under our Credit Facility prior to the sale. The amount of available borrowings under our Credit Facility is subject to our having qualified collateral, which is primarily based on the value of the properties securing our obligations under our Credit Facility. Accordingly, the availability of borrowings under our Credit Facility at any time may be less than $100,000.  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, as defined.  Our Credit Facility contains 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 October 17, 2016, ABP Trust and certain related parties requested the consent and waiver of the required lenders under our Credit Facility of any default or event of default resulting from their acquisition of more than 35% of the combined voting power of all our voting interests, which consent and waiver was obtained on October 21, 2016. Please see Note 10 for more information regarding the consent and waiver.
 
We previously had a $25,000 secured revolving line of credit that matured on March 18, 2016, which we determined not to extend or replace. We had no borrowings outstanding under this facility during either the nine months ended September 30, 2016 or 2015. We incurred associated costs related to this facility of $0 and $48 for the three months ended September 30, 2016 and 2015, respectively, and $45 and $144 for the nine months ended September 30, 2016 and 2015, respectively.
 
In June 2016, we initiated a so-called “step up” letter of credit for $11,700 as security for our workers’ compensation insurance program collateralized by approximately $8,000 in cash equivalents. This letter of credit matures in June 2017. We are required to increase the collateral under this letter of credit quarterly so that the stated amount of $11,700 is met by March 2017. The cash collateral is classified as short term restricted cash in our condensed consolidated balance sheet at September 30, 2016. At September 30, 2016, we had seven other irrevocable standby letters of credit outstanding, totaling $1,296, which secure certain of our other obligations. These letters of credit currently mature between May 2017 and September 2017 but are renewed annually. Our obligations under these letters of credit are secured by cash or cash equivalents.

11


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
(unaudited)



At September 30, 2016, six of our senior living communities were encumbered by mortgages with a carrying value of $60,856: (1) two of our communities were encumbered by Federal National Mortgage Association, or FNMA, mortgages; (2) two of our communities were encumbered by Federal Home Loan Mortgage Corporation, or FMCC, mortgages; and (3) two of our communities was encumbered by a mortgage from a commercial lender.  These mortgages contain standard mortgage covenants.  We recorded mortgage premiums in connection with our assumption of certain of these 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 mortgages was 6.27% as of September 30, 2016.  Payments of principal and interest are due monthly under these mortgages until the maturities at varying dates ranging from June 2018 to September 2032.  We incurred mortgage interest expense, including premium amortization, of $806 and $607 for the three months ended September 30, 2016 and 2015, respectively, and $2,425 and $1,988 for the nine months ended September 30, 2016 and 2015, respectively. Our mortgage debts require monthly payments into escrows for taxes, insurance and property replacement funds; certain withdrawals from escrows for our FNMA and FMCC mortgages require applicable FNMA and FMCC approval.
As of September 30, 2016, we believe we were in compliance with all applicable covenants under our Credit Facility and mortgage debts.
 
Note 9. Off Balance Sheet Arrangements
We have pledged our accounts receivable and certain other assets, with a carrying value as of September 30, 2016, of $15,144, arising from our operation of 25 communities owned by SNH and leased to us to secure SNH’s borrowings from its lender, FNMA.  As of September 30, 2016, we had no other off balance sheet arrangements that have had or that we expect would be reasonably likely to have a 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 have relationships and historical and continuing transactions with SNH, The RMR Group LLC, or RMR LLC, ABP Trust and others related to them, including other companies to which RMR LLC provides management services and which have trustees, directors and officers who are also our Directors or officers. For further information about these and other such relationships and certain other related person transactions, please refer to our Annual Report.
SNH: We were a 100% owned subsidiary of SNH until SNH distributed our common shares to its shareholders in 2001. As of September 30, 2016, SNH owned 4,235,000 of our common shares, or approximately 8.6% of our outstanding common shares.  SNH is currently our largest stockholder. We are SNH’s largest tenant and we manage certain senior living communities owned by SNH.
On June 29, 2016, we entered into a transaction agreement, or the Transaction Agreement, and related agreements, or, collectively, the Transaction Documents, with SNH.  Pursuant to the Transaction Documents, among other things, on June 29, 2016, we and SNH completed a sale and leaseback transaction with respect to certain senior living communities we owned and amended the pooling arrangements related to our management of certain of the senior living communities we manage for the account of SNH.  Significant terms of the Transaction Documents are summarized below.
Pursuant to the Transaction Agreement, SNH purchased seven senior living communities we owned for an aggregate purchase price of $112,350, and we and SNH simultaneously entered into a new long term lease agreement, or the New Lease, whereby SNH has leased those seven senior living communities to us. 
Pursuant to the New Lease, we are required to pay SNH initial annual rent of $8,426, plus, beginning in 2018, percentage rent equal to 4% of the amount by which gross revenues, as defined in the New Lease, of each community exceeds gross revenues of such community in 2017.  The initial term of the New Lease expires on December 31, 2028, subject to our options to extend the term of the New Lease for two consecutive 15-year terms. Pursuant to the New Lease, we may request that SNH purchase certain improvements to the communities in return for rent increases in accordance with the formula specified in the New Lease; however, SNH is not obligated to purchase such improvements and we are not required to sell them to SNH.  Pursuant to the Transaction Agreement, SNH has the right, in connection with a financing or other capital raising transaction by it, to reassign one or more of the

12


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
(unaudited)


communities covered by the New Lease to another existing or new long term lease agreement between us and SNH.  Other terms of the New Lease are substantially similar to those of our other four preexisting long term leases with SNH, such terms being described in our Annual Report, which descriptions are incorporated herein by reference. 
Pursuant to the Transaction Agreement, our three then existing pooling agreements with SNH that combined for certain purposes certain of our management agreements with SNH for senior living communities that include assisted living units, or AL Management Agreements, were terminated, and we entered into 10 new pooling agreements with SNH, or the New Pooling Agreements.  Nine of the New Pooling Agreements combine six AL Management Agreements and one of the New Pooling Agreements currently combines five AL Management Agreements.  Each New Pooling Agreement combines various calculations of revenues and expenses from the operations of the applicable communities covered by each New Pooling Agreement. 
Pursuant to the New Pooling Agreements, the AL Management Agreements covered by each New Pooling Agreement generally provide us with a management fee equal to either 3% or 5% of the gross revenues realized at such communities plus reimbursement for our direct costs and expenses related to such communities, as well as an annual incentive fee equal to either 35% or 20% of the annual net operating income of such communities remaining after SNH realizes an annual minimum return equal to either 8% or 7% of its invested capital, or, in the case of nine communities, a specified amount plus 7% of SNH’s invested capital since December 31, 2015.  The calculations of our fees and of SNH’s annual minimum return related to any AL Management Agreement that became effective before May 2015 and had been pooled under one of the previously existing pooling agreements are generally the same as they were under the previously existing pooling agreements.  However, with respect to certain communities, SNH’s annual minimum return was reduced to 7%, and also, with respect to the nine communities referenced above, SNH’s annual minimum return was reset as of 2016 to specified amounts.  With regard to AL Management Agreements that became effective from and after May 2015, the management fee was changed to 5%, rather than the prior 3%, of the gross revenues realized at the applicable community, and the incentive fee was changed to 20%, rather than the prior 35%, of the annual net operating income of the applicable community remaining, in all cases after SNH realizes its requisite annual minimum return.  Pursuant to the New Pooling Agreements, SNH will pay us a fee for our management of capital expenditure projects equal to 3% of amounts funded by SNH.
The terms of the AL Management Agreements covered by the New Pooling Agreements expire between 2030 and 2039 and are subject to automatic renewals, unless earlier terminated or timely notices of nonrenewal are delivered.  The right that we and SNH each had under the AL Management Agreements that became effective from and after May 1, 2015 to terminate each such AL Management Agreement as of December 31, 2016 was eliminated pursuant to the applicable New Pooling Agreement.  We have a limited right under the AL Management Agreements to require underperforming communities to be sold, and SNH has the right to terminate all the AL Management Agreements subject to a New Pooling Agreement if it does not receive its annual minimum return under such New Pooling Agreement in each of three consecutive years, commencing with calendar year 2016, subject to certain cure rights that we have. 
The New Pooling Agreements collectively combine all AL Management Agreements except for the management agreement related to one assisted living community located in New York and the management agreement related to one assisted living community located in California, and, other than as described below, the terms of those management agreements were not amended as part of the transactions implemented by the Transaction Documents.  The terms of our existing pooling agreement with SNH that combines our management agreements with SNH for senior living communities that include only independent living units, and the terms of those management agreements, also were not amended as part of the transactions implemented by the Transaction Documents.
Pursuant to the Transaction Agreement, we and SNH amended the management agreement for one California community so that the calculation of SNH’s annual minimum return under that agreement is fixed at $3,610 plus 7% of any amount funded by SNH for capital expenditures at this community since December 31, 2015.
Because of the continuing relationships between us and SNH, the terms of the Transaction Documents were negotiated and approved by special committees of our Board of Directors and SNH’s board of trustees composed solely of our Independent Directors and SNH’s independent trustees who are not also Directors or trustees of the other party, which committees were represented by separate counsel.

13


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
(unaudited)


In accordance with FASB ASC Topic 840, Leases, the sale and leaseback transaction with SNH described above qualifies for sale-leaseback accounting and we have classified the New Lease as an operating lease.  Accordingly, the carrying value of the senior living communities we sold to SNH of $29,706 was removed from our condensed consolidated balance sheets during the second quarter of 2016, and the gain generated from the sale of $82,644 was deferred and will be amortized as a reduction of rent expense over the initial term of the New Lease.  As of September 30, 2016, the short term part of the deferred gain in the amount of $6,609 is presented in other current liabilities in our condensed consolidated balance sheet, and the long term part of $74,347 is presented separately in our condensed consolidated balance sheet.  We incurred transaction costs of approximately $750 in connection with the sale of the senior living communities to SNH, which amount was expensed in full during the three months ended June 30, 2016.
In September 2016, SNH acquired for $130 an additional living unit at a senior living community located in Florida that we lease from SNH. This living unit was added to the applicable lease and our annual rent payable to SNH increased by $10 in accordance with the terms of that lease.
In September 2016, we and SNH sold a vacant SNF located in Wisconsin that we leased from SNH for $248, and as a result of this sale, our annual rent payable to SNH decreased by $25 in accordance with the terms of the applicable lease.
As of September 30, 2016 and 2015, we leased 183 and 178 senior living communities from SNH, respectively. Our total annual rent payable to SNH as of September 30, 2016 and 2015 was $202,253 and $191,839, respectively, excluding percentage rent.  Our total rent expense (which includes rent for all communities we lease from SNH, including communities that we have classified as discontinued operations) under all of our leases with SNH, net of lease inducement amortization and the amortization of the deferred gain associated with the sale and leaseback transaction with SNH described above, was $49,904 and $49,025 for the three months ended September 30, 2016 and 2015 , respectively, and $148,675 and $146,941 for the nine months ended September 30, 2016 and 2015, respectively, which amounts included estimated percentage rent of $1,364 and $1,371 for the three months ended September 30, 2016 and 2015, respectively, and $4,219 and $4,194 for the nine months ended September 30, 2016 and 2015, respectively.  As of September 30, 2016 and December 31, 2015, we had outstanding rent due and payable to SNH of $18,198 and $17,497, respectively, which are presented in due to related persons in our condensed consolidated balance sheets. 
 
Pursuant to the terms of our leases with SNH, we sold $3,470 and $7,523 for the three months ended September 30, 2016 and 2015, respectively, and $15,180 and $16,425 for the nine months ended September 30, 2016 and 2015, respectively, of improvements to communities leased from SNH. As a result, the annual rent payable by us to SNH increased by approximately $279 and $604 for the three months ended September 30, 2016 and 2015, respectively, and $1,219 and $1,322 for the nine months ended September 30, 2016 and 2015, respectively. As of September 30, 2016, our property and equipment included $7,017 for similar improvements to communities leased from SNH that we expected to request SNH to purchase from us for an increase in future rent; however, SNH is not obligated to purchase these improvements.
Also in September 2016, SNH agreed to acquire two senior living communities with a combined 126 living units located in Illinois for $18,600, excluding closing costs. If these communities are acquired, we expect that we will lease these communities from SNH under one of our existing master leases with SNH. These acquisitions are subject to various conditions; accordingly, we cannot be sure that SNH will complete these acquisitions and that we will lease them, that the acquisitions and lease arrangements will not be delayed or that the terms will not change.

During the nine months ended September 30, 2016, we began managing for the account of SNH three senior living communities SNH owns with an aggregate 288 living units. The terms under which we are managing these senior living communities are described above.
As of September 30, 2016 and 2015, we managed 63 and 60 senior living communities for the account of SNH, respectively. We earned management fees from SNH of $3,070 and $2,717 for the three months ended September 30, 2016 and 2015, respectively, and $8,689 and $7,939 for the nine months ended September 30, 2016 and 2015, respectively. In addition, we earned fees for our management of capital expenditure projects at the communities we managed for the account of SNH of $266 for the three and nine months ended September 30, 2016, which amount is included in management fee revenue in our condensed consolidated statement of operations.

In October 2016, SNH entered into an agreement to sell a former memory care building at an assisted living community in Florida that we have historically managed for the account of SNH. If this sale is completed, we expect that our management

14


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
(unaudited)


agreement with SNH for this community will be terminated. This sale is subject to various conditions; accordingly, we cannot be sure that SNH will complete the sale.

In October 2016, we agreed to manage four senior living communities SNH owns with approximately 350 living units. We will manage these senior living communities pursuant to management agreements that will be added to an existing or new pooling agreement with terms consistent with the AL Management Agreements that became effective from and after May 2015 as described above. Our assumption of the management of these communities is subject to conditions and we cannot be sure that those conditions will be satisfied.
 
D&R Yonkers LLC:  In order to accommodate certain requirements of New York licensing laws, a part of one of the senior living communities owned by SNH that we manage is subleased by a subsidiary of SNH to D&R Yonkers LLC, and D&R Yonkers LLC is owned by SNH’s president and chief operating officer and our Chief Financial Officer and Treasurer. Pursuant to our management agreement with D&R Yonkers LLC, we earned management fees of $65 and $45 for the three months ended September 30, 2016 and 2015, respectively, and $194 and $153 for the nine months ended September 30, 2016 and 2015, respectively.
 
RMR LLC:  Pursuant to our business management agreement with RMR LLC, we recognized business management fees of $2,229 and $2,241, for the three months ended September 30, 2016 and 2015, respectively, and $6,715 and $6,511 for the nine months ended September 30, 2016 and 2015, respectively. These amounts are included in general and administrative expenses in our condensed consolidated statements of operations. 
 
We have historically awarded share grants to certain RMR LLC employees under our equity compensation plans.  In addition, under our business management agreement we reimburse RMR LLC for our allocable costs for internal audit services.  The amounts recognized as expense for share grants to RMR LLC employees and internal audit costs were $55 and $50 for the three months ended September 30, 2016 and 2015, respectively, and $261 and $351 for the nine months ended September 30, 2016 and 2015, respectively; these amounts are included in general and administrative expenses in our condensed consolidated statements of operations.
ABP Trust:  We lease our headquarters from a subsidiary of ABP Trust, which is the indirect controlling shareholder of RMR LLC and which is owned in part by one of our Managing Directors. Our rent expense for our headquarters was $420 and $400 for the three months ended September 30, 2016 and 2015, respectively, and $1,372 and $1,247 for the nine months ended September 30, 2016 and 2015, respectively. 
On October 6, 2016, a subsidiary of ABP Trust, or the Purchaser, commenced a partial tender offer, or the Offer, for up to 10,000,000 of our common shares at a price of $3.00 per share. On October 27, 2016, the Purchaser amended the Offer to increase the number of our common shares it is offering to purchase from 10,000,000 to 18,000,000. In connection with the Offer, on October 2, 2016, we entered into a Consent, Standstill, Registration Rights and Lock-Up Agreement, or the Consent Agreement, with the Purchaser, ABP Trust, Adam D. Portnoy and Barry M. Portnoy, or the Requesting Parties. Pursuant to the Consent Agreement, among other things, we granted the Requesting Parties and certain related persons exceptions to the ownership restrictions set forth in our charter and, for the purposes of the restrictions on transfers of our common shares set forth in our bylaws and applicable provisions of Maryland law, approved the Requesting Parties’ acquisition up to 18,000,000 of our common shares. The Consent Agreement provided certain conditions to the granting of those exceptions and approvals, including that the Requesting Parties obtain the written consent of SNH to our granting of the exceptions to the ownership restrictions set forth in our charter and a waiver of any default under our leases, management and other agreements with SNH arising or resulting from the Offer and that, if required, the Requesting Parties obtain a written waiver from the required lenders under our Credit Facility of any default or event of default thereunder arising or resulting from the acquisition by the Requesting Parties of 35% or more of the combined voting power of all our voting interests, for the benefit of us and the Requesting Parties, or the Lender Consent. The Requesting Parties obtained such consent and waiver from SNH, to which we are a beneficiary, on October 2, 2016. On October 17, 2016, the Requesting Parties requested the Lender Consent and, in connection with this request, on October 21, 2016, we entered into a letter agreement with the Requesting Parties pursuant to which they confirmed their agreement to reimburse us for all of our out-of-pocket fees and expenses reasonably incurred in connection with such request and acknowledged that the Lender Consent does not vary any terms or conditions of the Consent Agreement. Also on October 21, 2016, the required lenders granted the Lender Consent. The Consent Agreement also included standstill and lock-up provisions for our benefit related to the common shares acquired by the Requesting Parties, as further described in the Consent Agreement. Because of the continuing relationships among us and ABP Trust and its affiliates, the

15


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
(unaudited)


terms of the Consent Agreement were negotiated and approved by a special committee of our Board composed solely of our Independent Directors and also were approved by the Independent Directors and our Board (with Barry M. Portnoy abstaining), voting separately. For additional information regarding the Offer and the Consent Agreement and related matters, please refer to our Solicitation/Recommendation Statement on Schedule 14D-9 filed with the SEC on October 6, 2016, as amended by Amendment No. 1 to Schedule 14D-9 filed with the SEC on October 28, 2016, or the Schedule 14D-9, and to our Current Reports on Form 8-K dated October 2, 2016 and October 17, 2016 filed with the SEC on October 6, 2016 and October 27, 2016, respectively.
AIC:  We and six other companies to which RMR LLC provides management services each own AIC in equal amounts. We and the other AIC shareholders participate in a combined property insurance program arranged and reinsured in part by AIC. We paid aggregate annual premiums, including taxes and fees, of approximately $4,595 in connection with this insurance program for the policy year ending June 30, 2017, which amount may be adjusted from time to time as we acquire and dispose of properties that are included in this insurance program.
As of September 30, 2016 and December 31, 2015, our investment in AIC had a carrying value of $7,110 and $6,827, respectively. These amounts are presented as an equity investment on our condensed consolidated balance sheets. We recognized income (loss) of $13 and $(25) related to our investment in AIC for the three months ended September 30, 2016 and 2015, respectively, and $107 and $70 for the nine months ended September 30, 2016 and 2015, respectively. Our other comprehensive income (loss) includes our proportionate part of unrealized gains (losses) on securities which are owned by AIC of $80 and $(72) for the three months ended September 30, 2016 and 2015, respectively, and $175 and $(91) for the nine months ended September 30, 2016 and 2015, respectively.

Directors’ and Officers’ Liability Insurance: We, The RMR Group Inc., RMR LLC and certain companies to which RMR LLC provides management services participate in a combined directors’ and officers’ liability insurance policy. In September 2016, we participated in a one year extension of this combined directors’ and officers’ insurance policy through September 2018. Our premium for this policy extension was approximately $79.

Note 11.  Discontinued Operations
In September 2016, we sold an assisted living community we owned with 32 living units located in Alabama for $225, excluding closing costs. As of September 30, 2016, we have no senior living communities classified as held for sale. We recorded long lived asset impairment charges of $325 for the three months ended March 31, 2016, to reduce the carrying value of this community to its estimated fair value, less costs to sell. During the three months ended June 30, 2016, in accordance with FASB ASC 360, Property, Plant and Equipment, we recorded a gain to increase the carrying value of this community based on an increase in the estimated fair value of this community, less costs to sell. Below is a summary of the operating results of our discontinued operations included in the condensed consolidated financial statements for the three and nine months ended September 30, 2016 and 2015:
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Revenues
 
$
90

 
$
335

 
$
478

 
$
4,021

Expenses
 
(143
)
 
(876
)
 
(497
)
 
(5,577
)
Impairment on discontinued assets
 

 
(697
)
 
(112
)
 
(697
)
Loss from discontinued operations
 
$
(53
)
 
$
(1,238
)
 
$
(131
)
 
$
(2,253
)
 
Note 12.  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 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 claim and litigation losses in accordance with FASB 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

16


FIVE STAR QUALITY CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
(unaudited)


develop a best estimate of loss and therefore the estimated minimum loss amount, which could be zero, is recorded; and then, as information becomes known, the minimum loss amount is updated, as appropriate. A minimum or best estimate amount may be increased or decreased when events result in a changed expectation.
 
As previously disclosed, as a result of our compliance program to review medical records related to our Medicare billing practices, during 2014 we discovered potentially inadequate documentation and other issues at one of our leased SNFs. This compliance review was not initiated in response to any specific complaint or allegation, but was a review of the type that we periodically undertake to test our own compliance with applicable Medicare billing rules. As a result of these discoveries, in February 2015, we made a voluntary disclosure of deficiencies to the United States Department of Health and Human Services Office of the Inspector General, or the OIG, pursuant to the OIG’s Provider Self-Disclosure Protocol. We completed our investigation and assessment of these matters and submitted a final supplemental disclosure to the OIG in May 2015. In June 2016, we settled this matter with the OIG and agreed to pay approximately $8,600 in exchange for a customary release but did not admit any liability.

We previously accrued a total liability of $10,100 related to this matter, all of which was accrued at December 31, 2015 and $0 and $3,600 of which we recognized as a revenue reserve or expense during the three and nine months ended September 2015, respectively.  As a result of the accrued liability exceeding the final settlement amount, we recorded an increase to earnings in our results of operations for the three months ended June 30, 2016 of approximately $1,500.  Of the total increase to earnings, $1,000 was recorded as an increase to senior living revenue and $500 as a decrease to other senior living operating expenses in our condensed consolidated statements of operations consistent with the classification of the original charge.
 
We were defendants in a lawsuit filed in the Superior Court of Maricopa County, Arizona by the estate of a former resident of a senior living community operated by us. The complaint asserted claims against us for pain and suffering as a result of improper treatment constituting violations of the Arizona Adult Protective Services Act and wrongful death. In May 2015, the jury rendered a decision in our favor on the wrongful death claim, and against us on the remaining claims, returning verdicts awarding damages of approximately $19,200, which consisted of $2,500 for pain and suffering and the remainder in punitive damages. In March 2016, pursuant to a settlement agreement we entered into with the plaintiff, $7,250 was paid to the plaintiff, of which $3,021 was paid by our liability insurer and the balance by us. We believe our liability insurer may be financially responsible for more than $3,021 and we are seeking additional payments from our liability insurer; however, we cannot predict the outcome of our on-going negotiations or potential future litigation with our liability insurer. As a result, we recorded a $4,229 charge during the three months ended December 31, 2015, which was included in other senior living operating expenses in our consolidated statements of operations.

Note 13.  Subsequent Event
In October 2016, we entered into an agreement to acquire an assisted living community with 63 living units located in Illinois for $7,900. We expect to fund this acquisition with cash on hand. We currently expect this transaction to close in 2016; however, this acquisition is subject to various conditions; accordingly, we cannot be sure that we will acquire this community, that the acquisition will not be delayed or that the terms of this acquisition will not change.

17



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

The following discussion should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q, or this Quarterly Report, and with our Annual Report.

GENERAL INDUSTRY TRENDS
During the past several years, weak economic conditions in many markets throughout the country have negatively affected many businesses within our industry and others. These conditions have resulted in, among other things, a decrease in our senior living communities’ occupancy, and it is unclear when these conditions may materially improve. Although many of the services that we provide to residents of our senior living communities are needs driven, some prospective residents may be deferring decisions to relocate to senior living communities in light of current economic circumstances.  In recent years, economic indicators reflect an improving housing market; however, it is unclear how sustainable the improvements will be and whether any such improvements will result in any increased demand for our services.  For the past two to three years, low capital costs appear to have encouraged increased senior living development, particularly in certain higher demand markets.  As the recently developed senior living communities begin operations, we expect to experience continuing challenges in maintaining or increasing occupancy at our senior living communities.

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 others 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, Segment Reporting, 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 and professional and general liability insurance programs.

18


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



Key Statistical Data For the Three Months Ended September 30, 2016 and 2015:
The following tables present a summary of our operations for the three months ended September 30, 2016 and 2015:
 
 
Three Months Ended September 30,
 
(dollars in thousands, except average monthly rate)
 
2016
 
2015
 
Change
 
%/bps
Change
 
Senior living revenue
 
$
277,410

 
$
279,685

 
$
(2,275
)
 
(0.8
)%
 
Management fee revenue
 
3,336

 
2,717

 
619

 
22.8
 %
 
Reimbursed costs incurred on behalf of managed communities
 
63,965

 
62,170

 
1,795

 
2.9
 %
 
Total revenues
 
344,711

 
344,572

 
139

 
 %
 
Senior living wages and benefits
 
(137,190
)
 
(135,133
)
 
(2,057
)
 
(1.5
)%
 
Other senior living operating expenses
 
(70,890
)
 
(72,637
)
 
1,747

 
2.4
 %
 
Costs incurred on behalf of managed communities
 
(63,965
)
 
(62,170
)
 
(1,795
)
 
(2.9
)%
 
Rent expense
 
(50,625
)
 
(49,730
)
 
(895
)
 
(1.8
)%
 
General and administrative expenses
 
(18,542
)
 
(16,587
)
 
(1,955
)
 
(11.8
)%
 
Depreciation and amortization expense
 
(9,398
)
 
(8,419
)
 
(979
)
 
(11.6
)%
 
Goodwill impairment
 

 
(25,344
)
 
25,344

 
100.0
 %
 
Long lived asset impairment
 
(196
)
 
(145
)
 
(51
)
 
(35.2
)%
 
Interest, dividend and other income
 
237

 
238

 
(1
)
 
(0.4
)%
 
Interest and other expense
 
(945
)
 
(1,106
)
 
161

 
14.6
 %
 
Gain on sale of available for sale securities reclassified from accumulated other comprehensive income (loss)
 
12

 

 
12

 
100.0
 %
 
Benefit from income taxes
 
934

 
236

 
698

 
(295.8
)%
 
Equity in earnings (losses) of an investee
 
13

 
(25
)
 
38

 
(152.0
)%
 
Loss from continuing operations
 
$
(5,844
)
 
$
(26,250
)
 
$
20,406

 
77.7
 %
 
Total number of communities (end of period):
 
 
 
 
 
 
 
 
 
Owned and leased communities(1)
 
213

 
212

 
1

 
0.5
 %
 
Managed communities
 
63

 
60

 
3

 
5.0
 %
 
Number of total communities(1)
 
276

 
272

 
4

 
1.5
 %
 
Total number of living units (end of period):
 
 
 
 
 
 
 
 
 
Owned and leased living units (1)(2)
 
22,947

 
23,099

 
(152
)
 
(0.7
)%
 
Managed living units (2)
 
8,402

 
8,211

 
191

 
2.3
 %
 
Number of total living units (1)(2)
 
31,349

 
31,310

 
39

 
0.1
 %
 
Owned and leased communities (1):
 
 
 
 
 
 
 
 
 
Occupancy %(2)
 
83.8
%
 
85.0
%
 
n/a 

 
(120
)
bps
Average monthly rate(3)
 
$
4,608

 
$
4,567

 
$
41

 
0.9
 %
 
Percent of senior living revenue from Medicaid
 
11.5
%
 
11.4
%
 
n/a 

 
10

bps
Percent of senior living revenue from Medicare
 
9.9
%
 
10.6
%
 
n/a 

 
(70
)
bps
Percent of senior living revenue from private and other sources
 
78.6
%
 
78.0
%
 
n/a 

 
60

bps
 
 
(1) Excludes those senior living communities that we have classified as discontinued operations.
(2) For the three months ended September 30, 2016, the calculation of occupancy includes only living units categorized as in service; occupancy calculations for periods prior to 2016 included certain living units categorized as out of service.
(3) Average monthly rate is calculated by taking the average daily rate, which is defined as total operating revenues divided by occupied units during the period, and multiplying it by 30 days.

19


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



Comparable communities (senior living communities that we have owned, leased or managed and operated continuously since July 1, 2015):
 
 
Three Months Ended September 30,
 
(dollars in thousands, except average monthly rate)
 
2016
 
2015
 
Change
 
%/bps
Change
 
Senior living revenue
 
$
276,357

 
$
278,010

 
$
(1,653
)
 
(0.6
)%
 
Management fee revenue
 
2,964

 
2,717

 
247

 
9.1
 %
 
Senior living wages and benefits
 
(136,932
)
 
(133,946
)
 
(2,986
)
 
(2.2
)%
 
Other senior living operating expenses
 
(70,639
)
 
(72,090
)
 
1,451

 
2.0
 %
 
Total number of communities (end of period):
 
 
 
 
 
 
 
 
 
Owned and leased communities(1)
 
211

 
211

 

 
 %
 
Managed communities
 
60

 
60

 

 
 %
 
Number of total communities(1)
 
271

 
271

 

 
 %
 
Total number of living units (end of period):
 
 
 
 
 
 
 
 
 
Owned and leased living units (1)(2)
 
22,796

 
22,940

 
(144
)
 
(0.6
)%
 
Managed living units (2)
 
8,101

 
8,211

 
(110
)
 
(1.3
)%
 
Number of total living units (1)(2)
 
30,897

 
31,151

 
(254
)
 
(0.8
)%
 
Owned and leased communities (1):
 
 
 
 
 
 
 
 
 
Occupancy %(2)
 
83.7
%
 
85.2
%
 
n/a 

 
(150
)
bps
Average monthly rate(3)
 
$
4,625

 
$
4,562

 
$
63

 
1.4
 %
 
Percent of senior living revenue from Medicaid
 
11.6
%
 
11.1
%
 
n/a 

 
50

bps
Percent of senior living revenue from Medicare
 
9.9
%
 
10.6
%
 
n/a 

 
(70
)
bps
Percent of senior living revenue from private and other sources
 
78.5
%
 
78.3
%
 
n/a 

 
20

bps
 
 

(1) Excludes those senior living communities that we have classified as discontinued operations.
(2) For the three months ended September 30, 2016, the calculation of occupancy includes only living units categorized as in service; occupancy calculations for periods prior to 2016 included certain living units categorized as out of service.
(3) Average monthly rate is calculated by taking the average daily rate, which is defined as total operating revenues divided by occupied units during the period, and multiplying it by 30 days.
Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015
Our senior living revenue decreased by 0.8% for the three months ended September 30, 2016 compared to the same period in 2015 primarily due to a decrease in occupancy, partially offset by an increase in average monthly rates to residents who pay privately for services.
 
Our management fee revenue increased by 22.8% for the three months ended September 30, 2016 compared to the same period in 2015 primarily due to an increase in the base management fee to 5% from 3% under our management agreements with SNH for certain senior living communities and additional fees for the management of capital expenditure projects by us at the senior living communities we manage for the account of SNH, each of which became effective as of July 1, 2016, an increase in the number of managed communities from 60 to 63 and an increase in average monthly rates to private pay residents, partially offset by a decrease in occupancy at our comparable managed communities.

Our reimbursed costs incurred on behalf of managed communities increased by 2.9% for the three months ended September 30, 2016 compared to the same period in 2015 primarily due to an increase in the number of managed communities from 60 to 63.
 
Our senior living wages and benefits increased by 1.5% for the three months ended September 30, 2016 compared to the same period in 2015 primarily due to annual wage increases, increases in employee health insurance costs and our acquisition of two senior living communities during the fourth quarter of 2015.
 
Our other senior living operating expenses, which include utilities, housekeeping, dietary, maintenance, insurance and community level administrative costs, decreased by 2.4% for the three months ended September 30, 2016 compared to the same period in 2015 primarily due to professional fees and other costs recorded in the 2015 period related to our Medicare compliance assessment at one of our SNFs, or the Compliance Assessment, partially offset by an increase in professional and general liability insurance expense.

Our rent expense increased by 1.8% for the three months ended September 30, 2016 compared to the same period in 2015 primarily due to additional rent related to senior living community capital improvements we sold to SNH since January 1, 2015 pursuant to our leases with SNH and an increase in the number of leased communities as a result of our June 2016 sale and

20


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



leaseback transaction, partially offset by rent reductions as a result of the sale of certain communities that we leased from SNH during 2015 and 2016.
 
Our general and administrative expenses increased by 11.8% for the three months ended September 30, 2016 compared to the same period in 2015 primarily due to increases in certain corporate wages and benefits, transaction costs relating to our acquisition and disposition activities, purchased services and professional fees.
 
Our depreciation and amortization expense increased by 11.6% for the three months ended September 30, 2016 compared to the same period in 2015 primarily due to our acquisition of two senior living communities during the fourth quarter of 2015 and capital expenditures (net of our sales of capital improvements to SNH), including depreciation costs related to our purchase of furniture and fixtures for owned senior living communities.

For the three months ended September 30, 2015, we recorded a non-cash charge for goodwill impairment of $25.3 million to write down the goodwill in our senior living reporting unit to its implied fair value.

For the three months ended September 30, 2016 and 2015 we recorded non-cash charges for long lived asset impairment of $0.2 million and $0.1 million, respectively, to reduce the carrying value of certain of our long lived assets to their estimated fair values.
 
Our interest, dividend and other income decreased by 0.4% for the three months ended September 30, 2016 compared to the same period in 2015 primarily due to lower investable cash and cash equivalents balances.
 
Our interest and other expense decreased by 14.6% for the three months ended September 30, 2016 compared to the same period in 2015 primarily due to the repayment of all of the outstanding borrowings under our Credit Facility with proceeds from our June 2016 sale and leaseback transaction, partially offset by the assumption of a mortgage note in connection with our acquisition of two senior living communities during the fourth quarter of 2015.
 
Gain on sale of available for sale securities reclassified from accumulated other comprehensive income represents our realized gain on investments.
 
For the three months ended September 30, 2016 and 2015, we recognized income tax benefits from continuing operations of $0.9 million and $0.2 million, respectively. The benefits for income taxes increased primarily due to a reduction of estimated state tax expense resulting primarily from our June 2016 sale and leaseback transaction with SNH.  For more information about our taxes, please see Note 5 to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report.
 
Equity in earnings of an investee represents our proportionate share of earnings from AIC.
Discontinued operations:
We recorded a loss from discontinued operations for the three months ended September 30, 2016 of $0.1 million compared to a loss of $1.2 million for the same period in 2015. We did not recognize any income tax expense or benefit from our discontinued operations for the three months ended September 30, 2016 or 2015.  The losses in both periods were primarily due to losses incurred at assisted living communities and SNFs that we have sold.


21


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



Key Statistical Data For the Nine Months Ended September 30, 2016 and 2015:
The following tables present a summary of our operations for the nine months ended September 30, 2016 and 2015:
(dollars in thousands, except average monthly rate)
 
Nine Months Ended September 30,
 
 
 
2016
 
2015
 
Change
 
%/bps
Change
 
Senior living revenue
 
$
836,523

 
$
832,793

 
$
3,730

 
0.4
 %
 
Management fee revenue
 
8,955

 
7,939

 
1,016

 
12.8
 %
 
Reimbursed costs incurred on behalf of managed communities
 
186,378

 
180,082

 
6,296

 
3.5
 %
 
Total revenues
 
1,031,856

 
1,020,814

 
11,042

 
1.1
 %
 
Senior living wages and benefits
 
(408,886
)
 
(404,737
)
 
(4,149
)
 
(1.0
)%
 
Other senior living operating expenses
 
(212,565
)
 
(216,107
)
 
3,542

 
1.6
 %
 
Costs incurred on behalf of managed communities
 
(186,378
)
 
(180,082
)
 
(6,296
)
 
(3.5
)%
 
Rent expense
 
(150,837
)
 
(149,015
)
 
(1,822
)
 
(1.2
)%
 
General and administrative expenses
 
(54,218
)
 
(52,750
)
 
(1,468
)
 
(2.8
)%
 
Depreciation and amortization expense
 
(28,847
)
 
(24,637
)
 
(4,210
)
 
(17.1
)%
 
Goodwill impairment
 

 
(25,344
)
 
25,344

 
100.0
 %
 
Long lived asset impairment
 
(502
)
 
(145
)
 
(357
)
 
(246.2
)%
 
Interest, dividend and other income
 
766

 
701

 
65

 
9.3
 %
 
Interest and other expense
 
(3,957
)
 
(3,597
)
 
(360
)
 
(10.0
)%
 
Gain on early extinguishment of debt
 

 
692

 
(692
)
 
(100.0
)%
 
Gain on sale of available for sale securities reclassified from accumulated other comprehensive income
 
247

 
38

 
209

 
550.0
 %
 
Provision for income taxes
 
(2,841
)
 
(348
)
 
(2,493
)
 
(716.4
)%
 
Equity in earnings of an investee
 
107

 
70

 
37

 
52.9
 %
 
Loss from continuing operations
 
$
(16,055
)
 
$
(34,447
)
 
$
18,392

 
53.4
 %
 
Total number of communities (end of period):
 
 
 
 
 
 
 
 
 
Owned and leased communities(1)
 
213

 
212

 
1

 
0.5
 %
 
Managed communities
 
63

 
60

 
3

 
5.0
 %
 
Number of total communities(1)
 
276

 
272

 
4

 
1.5
 %
 
Total number of living units (end of period):
 
 
 
 
 
 
 
 
 
Owned and leased living units (1)(2)
 
22,947

 
23,099

 
(152
)
 
(0.7
)%
 
Managed living units (2)
 
8,402

 
8,211

 
191

 
2.3
 %
 
Number of total living units (1)(2)
 
31,349

 
31,310

 
39

 
0.1
 %
 
Owned and leased communities (1):
 
 

 
 

 
 

 
 

 
Occupancy %(2)
 
84.4
%
 
85.2
%
 
n/a 

 
(80
)
bps
Average monthly rate(3)
 
$
4,640

 
$
4,594

 
$
46

 
1.0
 %
 
Percent of senior living revenue from Medicaid
 
11.5
%
 
11.1
%
 
n/a 

 
40

bps
Percent of senior living revenue from Medicare
 
10.1
%
 
11.3
%
 
n/a 

 
(120
)
bps
Percent of senior living revenue from private and other sources
 
78.4
%
 
77.6
%
 
n/a 

 
80

bps
 
 

(1) Excludes those senior living communities that we have classified as discontinued operations.
(2) For the nine months ended September 30, 2016, the calculation of occupancy includes only living units categorized as in service; occupancy calculations for periods prior to 2016 included certain living units categorized as out of service.
(3) Average monthly rate is calculated by taking the average daily rate, which is defined as total operating revenues divided by occupied units during the period, and multiplying it by 30 days.


22


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



Comparable communities (senior living communities that we have owned, leased or managed and operated continuously since January 1, 2015):
 
 
 
Nine Months Ended September 30,
 
(dollars in thousands, except average monthly rate)