0001159281-18-000034.txt : 20181114 0001159281-18-000034.hdr.sgml : 20181114 20181114144635 ACCESSION NUMBER: 0001159281-18-000034 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 55 CONFORMED PERIOD OF REPORT: 20180930 FILED AS OF DATE: 20181114 DATE AS OF CHANGE: 20181114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIVE STAR SENIOR LIVING INC. CENTRAL INDEX KEY: 0001159281 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SKILLED NURSING CARE FACILITIES [8051] IRS NUMBER: 043516029 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-16817 FILM NUMBER: 181182865 BUSINESS ADDRESS: STREET 1: 400 CENTRE STREET CITY: NEWTON STATE: MA ZIP: 02458 BUSINESS PHONE: (617) 796 8387 MAIL ADDRESS: STREET 1: 400 CENTRE STREET CITY: NEWTON STATE: MA ZIP: 02458 FORMER COMPANY: FORMER CONFORMED NAME: FIVE STAR QUALITY CARE, INC. DATE OF NAME CHANGE: 20161006 FORMER COMPANY: FORMER CONFORMED NAME: FIVE STAR QUALITY CARE INC DATE OF NAME CHANGE: 20010918 10-Q 1 a9302018-10qxdocument.htm 10-Q Document


 
 
 
 
 

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, 2018  
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number 1-16817
FIVE STAR SENIOR LIVING 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 every Interactive Data File required to be submitted 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 such files).     
Yes  ☒ No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. 
 
 
Large accelerated filer ☐
Accelerated filer ☐
Non-accelerated filer ☒
Smaller reporting company ☒
 
Emerging growth company ☐
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.☐

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 9, 2018:  50,568,224.  
 
 
 
 
 




FIVE STAR SENIOR LIVING INC.
FORM 10-Q
SEPTEMBER 30, 2018
INDEX
 
Page
 
 
 
 
 
 
 
 
References in this Quarterly Report on Form 10-Q to the Company, Five Star, we, us or our include Five Star Senior Living 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 SENIOR LIVING INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
 
 
September 30, 2018
 
December 31, 2017
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
13,128

 
$
26,255

Accounts receivable, net of allowance of $4,478 and $3,572 at September 30, 2018 and December 31, 2017, respectively
 
36,860

 
38,673

Due from related persons
 
6,062

 
4,774

Investments, of which $6,008 and $7,310 are restricted at September 30, 2018 and December 31, 2017, respectively
 
21,175

 
22,524

Restricted cash
 
20,123

 
20,747

Prepaid expenses and other current assets
 
26,870

 
25,132

Assets held for sale
 

 
59,080

Total current assets
 
124,218

 
197,185

 
 
 
 
 
Property and equipment, net
 
244,748

 
251,504

Equity investment of an investee
 
9,157

 
8,185

Restricted cash
 
1,538

 
1,476

Restricted investments
 
8,753

 
10,758

Other long term assets
 
6,211

 
6,800

Total assets
 
$
394,625

 
$
475,908

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

 
$

Accounts payable and accrued expenses
 
70,419

 
74,734

Accrued compensation and benefits
 
45,057

 
37,893

Due to related persons
 
18,757

 
18,683

Mortgage notes payable
 
333

 
316

Accrued real estate taxes
 
16,430

 
11,801

Security deposits and current portion of continuing care contracts
 
3,573

 
4,073

Other current liabilities
 
39,187

 
36,361

Liabilities held for sale
 

 
34,781

Total current liabilities
 
193,756

 
218,642

 
 
 
 
 
Long term liabilities:
 
 
 
 
Mortgage notes payable
 
7,620

 
7,872

Accrued self insurance obligations
 
32,248

 
33,082

Deferred gain on sale and leaseback transaction
 
61,130

 
66,087

Other long term liabilities
 
4,903

 
5,231

Total long term liabilities
 
105,901

 
112,272

 
 
 
 
 
Commitments and contingencies
 

 

 
 
 
 
 
Shareholders’ equity:
 
 
 
 
Common stock, par value $.01: 75,000,000 shares authorized, 50,579,744 and 50,524,424 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively
 
506

 
505

Additional paid in capital
 
361,595

 
360,942

Accumulated deficit
 
(268,967
)
 
(220,489
)
Accumulated other comprehensive income
 
1,834

 
4,036

Total shareholders’ equity
 
94,968

 
144,994

 
 
$
394,625

 
$
475,908

See accompanying notes.

1


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


 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
 
Senior living revenue
 
$
272,701

 
$
279,654

 
$
818,108

 
$
842,938

Management fee revenue
 
4,009

 
3,414

 
11,408

 
10,531

Reimbursed costs incurred on behalf of managed communities
 
72,200

 
64,033

 
208,009

 
194,346

Total revenues
 
348,910

 
347,101

 
1,037,525

 
1,047,815

 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
Senior living wages and benefits
 
142,035

 
138,255

 
418,917

 
413,196

Other senior living operating expenses
 
76,761

 
71,218

 
226,302

 
219,060

Costs incurred on behalf of managed communities
 
72,200

 
64,033

 
208,009

 
194,346

Rent expense
 
52,282

 
51,779

 
156,640

 
154,524

General and administrative expenses
 
18,965

 
17,851

 
57,405

 
56,733

Depreciation and amortization expense
 
9,137

 
9,753

 
26,974

 
29,040

Loss (gain) on sale of senior living communities
 
62

 

 
(7,131
)
 

Long lived asset impairment
 

 
142

 
365

 
528

Total operating expenses
 
371,442

 
353,031

 
1,087,481

 
1,067,427

 
 
 
 
 
 
 
 
 
Operating loss
 
(22,532
)
 
(5,930
)
 
(49,956
)
 
(19,612
)
 
 
 
 
 
 
 
 
 
Interest, dividend and other income
 
192

 
167

 
577

 
559

Interest and other expense
 
(466
)
 
(1,139
)
 
(1,773
)
 
(3,200
)
Gain on early extinguishment of debt
 

 
143

 

 
143

Unrealized gain on equity investments
 
133

 

 
127

 

Realized gain (loss) on sale of debt and equity investments, net of tax
 
2

 
70

 
(8
)
 
351

 
 
 
 
 
 
 
 
 
Loss before income taxes and equity in earnings of an investee
 
(22,671
)
 
(6,689
)
 
(51,033
)
 
(21,759
)
Benefit (provision) for income taxes
 
263

 
55

 
(274
)
 
1,330

Equity in earnings of an investee, net of tax
 
826

 
31

 
882

 
533

Net loss
 
$
(21,582
)
 
$
(6,603
)
 
$
(50,425
)
 
$
(19,896
)
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding—basic and diluted
 
49,682

 
49,242

 
49,643

 
49,199

 
 
 
 
 
 
 
 
 
Net loss per share—basic and diluted
 
$
(0.43
)
 
$
(0.13
)
 
$
(1.02
)
 
$
(0.40
)
 
See accompanying notes.


2


FIVE STAR SENIOR LIVING INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
(unaudited)


 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Net loss
$
(21,582
)
 
$
(6,603
)
 
$
(50,425
)
 
$
(19,896
)
Other comprehensive income:
 
 
 
 
 
 
 
Unrealized gain (loss) on investments, net of tax
3

 
145

 
(437
)
 
504

Equity in unrealized gain of an investee, net of tax
173

 
116

 
90

 
296

Realized loss (gain) on investments reclassified and included in net loss, net of tax
25

 
(70
)
 
92

 
(351
)
Other comprehensive income
201

 
191

 
(255
)
 
449

Comprehensive loss
$
(21,381
)
 
$
(6,412
)
 
$
(50,680
)
 
$
(19,447
)
See accompanying notes.


3


FIVE STAR SENIOR LIVING INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)


 
 
Nine Months Ended September 30,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(50,425
)
 
$
(19,896
)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
 
 
 
 
Depreciation and amortization expense
 
26,974

 
29,040

Gain on sale of senior living communities
 
(7,131
)
 

Gain on early extinguishment of debt
 

 
(166
)
Unrealized gain on equity investments
 
(127
)
 

Realized loss (gain) on sale of debt and equity investments
 
8

 
(351
)
Loss on disposal of property and equipment
 
263

 
202

Long lived asset impairment
 
365

 
528

Equity in earnings of an investee, net of tax
 
(882
)
 
(533
)
Stock based compensation
 
654

 
784

Provision for losses on receivables
 
3,694

 
3,632

Amortization of deferred gain on sale and leaseback transaction
 
(4,957
)
 
(4,956
)
Other noncash expense (income) adjustments, net
 
279

 
325

Changes in assets and liabilities:
 
 
 
 

Accounts receivable
 
(1,881
)
 
(2,797
)
Prepaid expenses and other assets
 
(1,715
)
 
(8,853
)
Accounts payable and accrued expenses
 
(2,491
)
 
3,821

Accrued compensation and benefits
 
7,164

 
8,613

Due from related persons, net
 
(1,670
)
 
9,131

Other current and long term liabilities
 
5,879

 
6,642

Cash (used in) provided by operating activities
 
(25,999
)
 
25,166

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Acquisition of property and equipment
 
(36,941
)
 
(55,049
)
Purchases of investments
 
(3,239
)
 
(10,895
)
Proceeds from sale of property and equipment
 
14,749

 
30,698

Proceeds from sale of land
 

 
750

Proceeds from sale of communities
 
31,819

 

Proceeds from sale of investments
 
6,349

 
15,681

Cash provided by (used in) investing activities
 
12,737

 
(18,815
)
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Proceeds from borrowings on revolving credit facility
 
25,000

 
40,000

Repayments of borrowings on revolving credit facility
 
(25,000
)
 
(35,000
)
Repayments of mortgage notes payable
 
(427
)
 
(14,111
)
Prepayment fees on early extinguishment of debt
 

 
(132
)
Payment of deferred financing fees
 

 
(1,889
)
Cash used in financing activities
 
(427
)
 
(11,132
)
 
 
 
 
 
Cash flows from discontinued operations:
 
 
 
 
Net cash provided by operating activities
 

 
1,003

Net cash flows provided by discontinued operations
 

 
1,003

 
 
 
 
 
Change in cash and cash equivalents and restricted cash
 
(13,689
)
 
(3,778
)
Cash and cash equivalents and restricted cash at beginning of period
 
48,478

 
33,576

Cash and cash equivalents and restricted cash at end of period
 
$
34,789

 
$
29,798

 
 
 
 
 
Reconciliation of cash and cash equivalents and restricted cash:
 
 
 
 
Cash and cash equivalents
 
$
13,128

 
$
8,706

Restricted cash
 
21,661

 
21,092

Cash and cash equivalents and restricted cash at end of period
 
$
34,789

 
$
29,798

 
 
 
 
 
Supplemental cash flow information:
 
 
 
 
Cash paid for interest
 
$
1,195

 
$
2,913

Cash paid for income taxes, net
 
$
338

 
$
275

 
 
 
 
 
Non-cash activities:
 
 
 
 
Real estate sale
 
$
33,364

 
$

Mortgage notes assumed by purchaser in real estate sale
 
$
33,364

 
$

See accompanying notes.

4


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)



Note 1.  Basis of Presentation and Organization

General

The accompanying condensed consolidated financial statements of Five Star Senior Living 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, 2017, 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, 2018, we operated 283 senior living communities located in 32 states with 31,805 living units, including 254 primarily independent and assisted living communities with 29,300 living units and 29 SNFs with 2,505 living units. As of September 30, 2018, we owned and operated 20 of these senior living communities (2,108 living units), we leased and operated 188 of these senior living communities (20,182 living units) and we managed 75 of these senior living communities (9,515 living units). Our 283 senior living communities, as of September 30, 2018, included 10,741 independent living apartments, 16,292 assisted living suites and 4,772 SNF units. The foregoing numbers exclude living units categorized as out of service.  

Going Concern

On January 1, 2016, we adopted Financial Accounting Standards Board, or FASB, Accounting Standards Update, or ASU, No. 2014-15, Presentation of Financial Statements-Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which requires us to evaluate, as of each reporting period, whether there are conditions or events that raise substantial doubt about our ability to continue as a going concern within one year after the date that our financial statements are issued and to provide related disclosures in certain circumstances.

The accompanying condensed consolidated financial statements have been prepared on the basis that we will continue as a going concern, which accordingly assumes, among other things, the realization of assets and the satisfaction of liabilities in the ordinary course of business. We face increased competition across the senior living industry, including in specific markets in which we operate senior living communities. Medical advances and healthcare services also allow some potential residents to defer the time when they require the special services available at our communities. In addition, low unemployment in the United States combined with a competitive labor market within our industry are increasing our employment costs. These challenges are currently negatively impacting our revenues, expenses, cash flows and results from operations, and we expect these challenges to continue at least through 2019. At September 30, 2018, we have an accumulated deficit of $268,967 and have incurred operating losses in each of the last three years. These conditions raise substantial doubt about our ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Based on our cash balance at September 30, 2018 and projected cash needs for the next 12 months, our management believes that we will need to increase our revenues, reduce our costs and/or pursue other transactions to be able to continue to fund our operating and capital requirements and meet our debt covenant obligations. See Note 8 for more information regarding our indebtedness and covenants. We will need to raise the additional funds by: (i) increasing occupancy and/or rates we charge at our senior living communities, (ii) reducing our costs, (iii) increasing our revenues from other services we provide, such as rehabilitation, home health or other services, (iv) engaging in additional sale and leaseback or manageback transactions, (v) selling assets, including senior living communities we own, (vi) obtaining mortgage financing for our owned senior living communities, (vii) obtaining additional debt financing, such as term debt and/or a new credit facility, and/or (viii) issuing other debt or equity securities. We cannot be sure that we will be able to obtain any such additional funds by any of the foregoing or other means, and any such funds we may obtain may not be sufficient. If we are unable to obtain sufficient funds, we may be unable to continue as a going concern.

5


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)



Segment Information

We have two operating segments: (i) senior living community and (ii) 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. In the rehabilitation and wellness operating segment, we provide therapy services, including physical, occupational, speech and other specialized therapy services, in the inpatient setting and in outpatient clinics. We have determined that our two operating segments meet the aggregation criteria as prescribed under FASB Accounting Standards CodificationTM, or ASC, Topic 280, Segment Reporting, and we have therefore determined that our business is comprised of one reportable segment, senior living. All of our operations and assets are located in the United States, except for the operations of our Cayman Islands organized captive insurance company subsidiary, which participates in our workers’ compensation, professional and general liability and certain automobile insurance programs.

Note 2. Summary of Significant Accounting Policies

Revenue Recognition

On January 1, 2018, we adopted FASB ASC Topic 606, Revenue from Contracts with Customers, or ASC Topic 606, under the modified retrospective approach applied to certain contracts which were not completed as of December 31, 2017 using the practical expedient in paragraph 606-10-10-4 that allows for the use of a portfolio approach, because we have determined that the effect of applying the guidance to our portfolios of contracts within the scope of ASC Topic 606 on our consolidated financial statements would not differ materially from applying the guidance to each individual contract within the respective portfolio or our performance obligations within that portfolio. This approach will also be used for future contract modifications, if any. The five step model defined by ASC Topic 606 requires us to: (1) identify our contracts with customers, (2) identify our performance obligations under those contracts, (3) determine the transaction prices of those contracts, (4) allocate the transaction prices to our performance obligations in those contracts and (5) recognize revenue when each performance obligation under those contracts is satisfied. Revenue is recognized when promised goods or services are transferred to the customer in an amount that reflects the consideration expected in exchange for those goods or services. Our adoption of ASC Topic 606 did not result in an adjustment to our retained earnings and did not have a material impact on the amount and timing of our revenue recognition for the three and nine months ended September 30, 2018.

A substantial portion of our revenue relates to contracts with residents for housing services that are generally short term in nature and fall under FASB ASC Topic 840, Leases, or ASC Topic 840, which are specifically excluded from the scope of ASC Topic 606. Our contracts with residents and other customers that are within the scope of ASC Topic 606 are also generally short term in nature. We have determined that services performed under those contracts are considered one performance obligation in accordance with ASC Topic 606 as such services are regarded a series of distinct events with the same timing and pattern of transfer to the resident or customer. Revenue is recognized for those contracts when our performance obligation is satisfied by transferring control of the service provided to the resident or customer, which is generally when the services are provided over time.

Senior Living Revenue. Resident fees at our independent living and assisted living communities consist of regular monthly charges for basic housing and support services and fees for additional requested services, such as assisted living services, personalized health services and ancillary services. Fees are specified in our agreements with residents, which are generally short term (30 days to one year), with regular monthly charges billed in advance. Funds received from residents in advance of services being provided are not material to our consolidated financial statements. Some of our senior living communities require payment of an entrance fee in advance of a resident moving into the community; substantially all of these community fees are non-refundable and are initially recorded as deferred revenue and included in other current liabilities in our consolidated balance sheets. These deferred amounts then are amortized on a straight line basis into revenue over the term of the resident agreement. Revenue recorded and deferred in connection with community fees is not material to our consolidated financial statements. A substantial portion of our senior living revenue related to housing services falls under ASC Topic 840, and is recorded on a straight line basis over the term of the resident agreement. Revenue for additional requested services is recognized in accordance with ASC Topic 606 and measured based on the consideration specified in the resident agreement and is recorded when the services are provided.


6


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


In our SNFs and certain of our independent and assisted living communities where we provide SNF services, we are paid fixed daily rates from governmental and contracted third party payers, and we charge a predetermined fixed daily rate for private pay residents. These fixed daily rates and certain other fees are billed monthly in arrears. Although there are complex regulatory compliance rules governing fixed daily rates, we have no episodic payments or capitation arrangements. We currently use the “most likely amount” technique to estimate revenue in accordance with ASC Topic 606, although rates are generally known and considered fixed prior to services being performed, whether included in the resident agreement or contracted with governmental or third party payers. Rate adjustments from Medicare or Medicaid are recorded when known (without regard to when the assessment is paid or withheld), and subsequent adjustments to these amounts are recorded in revenues when known. Billings under certain of these programs are subject to audit and possible retroactive adjustment, and related revenue is recorded at the amount we ultimately expect to receive, which is inclusive of the estimated retroactive adjustments or refunds, if any, under reimbursement programs. Retroactive adjustments are recorded on an estimated basis in the period the related services are rendered and adjusted in future periods or as final settlements are determined. Revenue is recognized when performance obligations are satisfied by transferring control of the service provided to the resident, which is generally when services are provided over the duration of care. We derived approximately 23.1% and 22.6% of our senior living revenues for the three months ended September 30, 2018 and 2017, respectively, and 23.2% and 22.9% for the nine months ended September 30, 2018 and 2017, respectively, from payments under Medicare and Medicaid programs.

Management Fee Revenue and Reimbursed Costs Incurred on Behalf of Managed Communities. We manage senior living communities for the account of Senior Housing Properties Trust, or, together with its subsidiaries, SNH, pursuant to long term management agreements which provide for periodic management fee payments to us and reimbursement for our direct costs and expenses related to such communities. Management fees are determined by an agreed upon percentage of gross revenues (as defined) and recognized in accordance with ASC Topic 606 in the same period that we provide the management services to SNH, generally monthly. FASB ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which we adopted effective January 1, 2018, 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. Where we are the primary obligor and therefore control the transfer of the goods and services with respect to any such operating expenses incurred in connection with the management of these communities, we recognize revenue when the goods have been delivered or the service has been rendered and we are due to be reimbursed from SNH. Such revenue is included in reimbursed costs incurred on behalf of managed communities in our consolidated statements of operations. The related costs are included in costs incurred on behalf of managed communities in our consolidated statements of operations. Amounts due from SNH related to management fees and reimbursed costs incurred on behalf of managed communities are included in due from related persons in our consolidated balance sheets.

The following table presents revenue disaggregated by type of contract and payer:

 
 
Three Months Ended September 30, 2018
 
Nine Months Ended September 30, 2018
Leasing revenue (1)
 
162,397

 
486,279

Revenue from contracts with customers:
 
 
 
 
Medicare and Medicaid programs (1)
 
62,982

 
190,138

Additional requested services, and private pay and other third party payer SNF services (1)
 
47,322

 
141,691

Management fee revenue
 
4,009

 
11,408

Reimbursed costs incurred on behalf of managed communities
 
72,200

 
208,009

 
 
186,513

 
551,246

Total revenues
 
348,910

 
1,037,525


(1)
Included in senior living revenue in our consolidated statements of operations.

Recent Accounting Pronouncements

On January 1, 2018, we adopted FASB 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. Prior to our adoption of this ASU, we recorded changes in the fair value of our equity investments through other comprehensive income. Pursuant to this ASU, these changes will now be recorded through earnings. We adopted this ASU using the cumulative effect adjustment method and

7


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


recorded an adjustment of $1,107 on January 1, 2018 to accumulated other comprehensive income and accumulated deficit in our consolidated balance sheets. Affiliates Insurance Company, or AIC, a private company in which we have an equity investment, chose to early adopt this ASU during the second quarter of 2018, and therefore we recorded a cumulative effect adjustment of $840 to accumulated other comprehensive income and accumulated deficit in our consolidated balance sheets to reflect our share of AIC's adjustment to its equity investments. See Note 11 for more information regarding our arrangements with AIC.

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. 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. Additionally, real estate sales are within the scope of ASU No. 2014-09, as amended by ASU No. 2017-05, Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets. Under these ASUs, income recognition for real estate sales is primarily based on the transfer of control of the real estate rather than the continuing involvement in the real estate under the current guidance. As a result, more of our transactions may qualify as real estate sales and we may be required to recognize gains or losses sooner. We adopted these ASUs on January 1, 2018 using the modified retrospective approach. The adoption of these ASUs did not result in any adjustment to our initial retained earnings and did not result in any significant change to the amount and timing of our revenue recognition. The adoption of these ASUs did result in expanded disclosures related to the nature, amount, timing and uncertainty of our revenue and cash flows arising from our contracts with customers that are included within the scope of these ASUs. See also the discussion above under “Revenue Recognition” for more information regarding the impact of these ASUs on our consolidated financial statements.

On January 1, 2018, we adopted FASB ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which clarifies how entities present and classify certain cash receipts and cash payments in the statement of cash flows. The adoption of this ASU did not have a material impact on our consolidated financial statements.

On January 1, 2018, we adopted FASB ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires that the reconciliation of the beginning-of-period and end-of-period amounts presented in the statement of cash flows include restricted cash and restricted cash equivalents. We adopted this ASU retrospectively to all periods presented in our consolidated statement of cash flows. Pursuant to this ASU, in the event restricted cash is presented separately from cash and cash equivalents in the balance sheets, entities are required to reconcile the amounts presented in the statement of cash flows to the amounts presented in the balance sheet and to disclose information about the nature of the restrictions. We have presented our consolidated statement of cash flows to reconcile both cash and cash equivalents and restricted cash and restricted cash equivalents and have provided a reconciliation to the amounts presented in our consolidated statements of cash flows to the amounts presented in our consolidated balance sheets.

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). This ASU 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. This ASU also changes the accounting for sale and leaseback transactions, such as our sale and leaseback transaction with SNH in June 2016, and any associated deferred gain. Additionally, this ASU 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. This ASU is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which works to improve on certain aspects of ASU No. 2016-02 identified by stakeholders as problematic or difficult to implement, including the adoption method. ASU No. 2018-11 provides for a transition method option, allowing entities to recognize a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption, rather than restating comparative periods being presented. ASU No. 2018-11 also provides lessors with a practical expedient, by class of underlying asset, not to separate non-lease components from the associated lease component if certain conditions are met. In addition, ASU No. 2018-11 clarifies which ASC Topic (Topic 842 or Topic 606) applies for the combined component. Specifically, if the non-lease components associated with the lease component are the predominant component of the combined component, an entity should account for the combined component

8


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


in accordance with ASC Topic 606. Otherwise, the entity should account for the combined component as an operating lease in accordance with ASC Topic 842. We expect to elect this practical expedient provided to lessors and will recognize revenue under our resident agreements based upon the predominant component. We will adopt these ASUs as required effective January 1, 2019 utilizing the modified retrospective transition method with no adjustments to comparative periods presented in accordance with ASU No. 2018-11. While we are continuing to assess the potential impact that the adoption of these ASUs may have on our consolidated financial statements, we believe the adoption of these ASUs will have a material impact on our consolidated balance sheets due to the recognition of lease rights and obligations as assets and liabilities, and any previously unrecognized right of use assets will need to be reviewed for impairment effective January 1, 2019. While the adoption of these ASUs will not affect the rent we pay, we expect the rent expense amounts presented in our consolidated statements of operations and comprehensive loss to change materially due to changes in how we will account for our deferred gain on our sale and leaseback transaction described above.
 
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 requires reflection of 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 that the adoption of this ASU will have on our consolidated financial statements.

In March 2017, the FASB issued ASU No. 2017-08, Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20), which shortens the amortization period for certain callable debt securities held at a premium. Specifically, this ASU requires the premium to be amortized to the earliest call date. This ASU does not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. This ASU is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. We are currently assessing the potential impact that the adoption of this ASU will have on our consolidated financial statements.

In February 2018, the FASB issued ASU No. 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220), which permits an entity to reclassify the tax effects that remain recorded within other comprehensive income to retained earnings as a result of tax reform legislation that became effective in December 2017. This ASU is effective for reporting periods beginning after December 15, 2018. We are currently assessing the potential impact that the adoption of this ASU will have on our consolidated financial statements.

In June 2018, the FASB issued ASU No. 2018-07, Compensation—Stock Compensation (Topic 718), which expands the scope of Topic 718 to include share based payment transactions for acquiring goods and services from non-employees. This ASU is effective for reporting periods beginning after December 15, 2018. We are currently assessing the potential impact that the adoption of this ASU will have on our consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820), which modifies certain disclosure requirements in Topic 820, such as the removal of the need to disclose the amount of and reason for transfers between Level 1 and Level 2 of the fair value hierarchy, and several changes related to Level 3 fair value measurements. This ASU is effective for reporting periods beginning after December 15, 2019. We are currently assessing the potential impact that the adoption of this ASU will have on our consolidated financial statements.

In August 2018, the FASB also issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal Use Software (Subtopic 350-40), which aligns the requirements for capitalizing implementation costs incurred in a cloud computing hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal use software. This ASU is effective for reporting periods beginning after December 15, 2019. We are currently assessing the potential impact that the adoption of this ASU will have on our consolidated financial statements.


9


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


Note 3. Property and Equipment

Property and equipment consists of the following:
 
 
September 30, 2018
 
December 31, 2017
Land
 
$
16,383

 
$
16,383

Buildings and improvements
 
207,379

 
211,812

Furniture, fixtures and equipment
 
232,252

 
208,262

Property and equipment, at cost
 
456,014

 
436,457

Accumulated depreciation
 
(211,266
)
 
(184,953
)
Property and equipment, net
 
$
244,748

 
$
251,504

 
We recorded depreciation expense relating to our property and equipment of $9,117 and $9,732 for the three months ended September 30, 2018 and 2017, respectively, and $26,915 and $28,863 for the nine months ended September 30, 2018 and 2017, 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 impairment charges to certain of our long lived assets of $0 and $365 for the three and nine months ended September 30, 2018, respectively, and $142 and $528 for the three and nine months ended September 30, 2017, respectively.

As of September 30, 2018 and December 31, 2017, we had $0 and $59,080, respectively, of net property and equipment classified as held for sale and presented separately in our consolidated balance sheets. See Note 9 for more information regarding our communities that we had classified as held for sale.
 
As of September 30, 2018, we had $987 of assets related to our leased senior living communities included in our property and equipment that we expect to request SNH to purchase from us for an increase in future rent; however, SNH is not obligated to purchase such amounts. See Note 9 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, 2018:
 
 
Equity
Investment of an
Investee
 
Investments
 
Accumulated
Other
Comprehensive
Income
Balance at January 1, 2018
 
$
642

 
$
3,394

 
$
4,036

Cumulative effect of reclassification of unrealized gain on equity investments in connection with the adoption of FASB ASU No. 2016-01
 
(840
)
 
(1,107
)
 
(1,947
)
Unrealized loss on investments, net of tax
 

 
(437
)
 
(437
)
Equity in unrealized gain of an investee, net of tax
 
90

 

 
90

Realized loss on investments reclassified and included in net loss, net of tax
 

 
92

 
92

Balance at September 30, 2018
 
$
(108
)
 
$
1,942

 
$
1,834

 
Accumulated other comprehensive income represents the unrealized gains and losses of our debt investments, net of tax, and our share of other comprehensive income of AIC. See Note 11 for more information regarding our arrangements with AIC.


10


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


Note 5.  Income Taxes

We recognized a benefit for income taxes of $263 and $55 for the three months ended September 30, 2018 and 2017, respectively. We recognized a provision for income taxes of $274 for the nine months ended September 30, 2018 and a benefit for income taxes of $1,330 for the nine months ended September 30, 2017. The benefit for income taxes for the three months ended September 30, 2018 and the provision for income taxes for the nine months ended September 30, 2018 relate to our state income taxes. The benefit for income taxes for the three months ended September 30, 2017 is due primarily to intra-period tax allocation benefits related to the unrealized gains on our debt and equity investments and the benefit for income taxes for the nine months ended September 30, 2017 is due primarily to our monetization of alternative minimum tax credits during the second quarter of 2017.

We previously determined it was more likely than not that a majority of our net deferred tax assets would not be realized and concluded that a valuation allowance was required, which eliminated the majority 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, 2018 and 2017 using the weighted average number of shares of our common stock, $.01 par value per share, or our common shares, outstanding during the periods.  When applicable, 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, 2018 and 2017 had 1,207,928 and 1,053,305, respectively, and the nine months ended September 30, 2018 and 2017 had 1,239,628 and 1,031,793, 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. 

Note 7.  Fair Values of Assets and Liabilities

Our assets recorded at fair value have been categorized based on 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.


11


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


Recurring Fair Value Measures

The tables below present the assets measured at fair value at September 30, 2018 and December 31, 2017 categorized by the level of inputs used in the valuation of each asset.
 
 
As of September 30, 2018
 
 
 
 
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)
 
$
24,191

 
$
24,191

 
$

 
$

Investments:
 
 
 
 
 
 
 
 
Equity investments(2)
 
 
 
 
 
 
 
 
Financial services industry
 
2,000

 
2,000

 

 

REIT industry
 
115

 
115

 

 

Other
 
4,112

 
4,112

 

 

Total equity investments
 
6,227

 
6,227

 

 

Debt investments:(3)
 
 
 
 
 
 
 
 
International bond fund(4)
 
2,503

 

 
2,503

 

High yield fund(5)
 
2,812

 

 
2,812

 

Industrial bonds
 
2,042

 

 
2,042

 

Technology bonds
 
2,371

 

 
2,371

 

Government bonds
 
10,159

 
10,159

 

 

Energy bonds
 
590

 

 
590

 

Financial bonds
 
1,459

 

 
1,459

 

Other
 
1,765

 

 
1,765

 

Total debt investments
 
23,701

 
10,159

 
13,542

 

Total investments
 
29,928

 
16,386

 
13,542

 

Total
 
$
54,119

 
$
40,577

 
$
13,542

 
$

 

12


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


 
 
As of December 31, 2017
 
 
 
 
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)
 
$
23,578

 
$
23,578

 
 
 
 
Investments:
 
 
 
 
 
 
 
 
Equity investments(2)
 
 
 
 
 
 
 
 
Financial services industry
 
2,199

 
2,199

 

 

REIT industry
 
145

 
145

 

 

Other
 
4,094

 
4,094

 

 

Total equity investments
 
6,438

 
6,438

 

 

Debt investments(3)
 
 
 
 
 
 
 
 
International bond fund(4)
 
2,511

 

 
2,511

 

High yield fund(5)
 
2,744

 

 
2,744

 

Industrial bonds
 
2,017

 

 
2,017

 

Technology bonds
 
2,972

 

 
2,972

 

Government bonds
 
10,707

 
10,610

 
97

 

Energy bonds
 
1,216

 

 
1,216

 

Financial bonds
 
1,423

 

 
1,423

 

Other
 
3,254

 

 
3,254

 

Total debt investments
 
26,844

 
10,610

 
16,234

 

Total investments
 
33,282

 
17,048

 
16,234

 

Total
 
$
56,860

 
$
40,626

 
$
16,234

 
$

 
 
(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 $20,480 and $20,316 of balances that are restricted at September 30, 2018 and December 31, 2017, respectively.
(2)
The fair value of our equity investments is readily determinable. During the nine months ended September 30, 2018 and 2017, we received gross proceeds of $697 and $3,083, respectively, in connection with the sales of equity investments and recorded gross realized gains totaling $92 and $360, respectively, and gross realized losses totaling $5 and $145, respectively.
 
(3)
As of September 30, 2018, our debt investments, which are classified as available for sale, had a fair value of $23,701 with an amortized cost of $22,788; the difference between the fair value and amortized cost amounts resulted from unrealized gains of $1,352, net of unrealized losses of $439. As of December 31, 2017, our debt investments had a fair value of $26,844 with an amortized cost of $25,589; the difference between the fair value and amortized cost amounts resulted from unrealized gains of $1,401, net of unrealized losses of $146. Debt investments include $14,768 and $18,068 of balances that are restricted as of September 30, 2018 and December 31, 2017, respectively. At September 30, 2018, 37 of the securities we hold, with a fair value of $8,932, have been in a loss position for less than 12 months and 28 of the investments we hold, with a fair value of $8,748, have been in a loss position for greater than 12 months. We do not believe these investments 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 investments remain strong with solid fundamentals, or we intend to hold these investments until recovery, and other factors that support our conclusion that the loss is temporary. During the nine months ended September 30, 2018 and 2017, we received gross proceeds of $5,652 and $12,598, respectively, in connection with the sales of debt investments and recorded gross realized gains totaling $9 and $167, respectively, and gross realized losses totaling $104 and $31, respectively. We record gains and losses on the sales of these investments using the specific identification method.

(4)
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.
 
(5)
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, 2018, 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, 2018.

13


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


 
The carrying value of accounts receivable and accounts payable approximates fair value as of September 30, 2018 and December 31, 2017.  The carrying value and fair value of our mortgage notes payable were $7,953 and $8,937, respectively, as of September 30, 2018 and $8,188 and $9,617, respectively, as of December 31, 2017, 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. The carrying value and fair value of our mortgage notes payable as of December 31, 2017 excludes $34,781 of mortgage notes payable categorized as held for sale and presented separately in our condensed consolidated balance sheets. See Note 9 for more information regarding our communities classified as held for sale.

Non-Recurring Fair Value Measures
 
We review the carrying value of our long lived assets, including our property and equipment and other intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable. See Note 3 for more information regarding fair value measurements related to impairments of our long lived assets we recorded.
 
Note 8.  Indebtedness

We previously had a $100,000 secured revolving credit facility, or our prior credit facility, which was scheduled to mature in April 2017. In February 2017, we replaced our prior credit facility with a new $100,000 secured revolving credit facility, or our credit facility, with terms substantially similar to those of our prior credit facility. We paid fees of $1,889 in 2017 in connection with the closing of our credit facility, which fees were deferred and are being amortized over the initial term of our credit facility. Our credit facility is available for general business purposes, including acquisitions, provides for issuance of letters of credit and matures in February 2020. Subject to our payment of extension fees and meeting other conditions, we have options to extend the stated maturity date of our credit facility for two, one year periods. We are required to pay interest at a rate based on, at our option, LIBOR or a base rate, plus a premium, or 4.61% and 6.75%, respectively, per annum as of September 30, 2018, on outstanding borrowings under our credit facility. We are also required to pay a quarterly commitment fee of 0.35% per annum on the unused part of the available borrowings under our credit facility. We can borrow, repay and re-borrow funds available until maturity, and no principal repayment is due until maturity. The weighted average annual interest rate for borrowings under our credit facility was 6.51% and 5.61% for the nine months ended September 30, 2018 and 2017, respectively. We incurred aggregate interest expense and other associated costs related to our credit facilities of $329 and $358 for the three months ended September 30, 2018 and 2017, respectively, and $864 and $848 for the nine months ended September 30, 2018 and 2017, respectively.

Our credit facility is secured by real estate mortgages on 10 senior living communities with a combined 1,219 living units owned by certain of our subsidiaries that guarantee our obligations under our credit facility. Our credit facility is also secured by these subsidiaries’ accounts receivable and related collateral. 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 communities securing our obligations under our credit facility. Accordingly, the maximum 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 under our credit facility upon the occurrence and continuation of certain events of default, including a change of control of us, as defined. The agreement governing our credit facility, or our credit agreement, 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 to our stockholders in certain circumstances, and requires us to maintain financial ratios and a minimum net worth.

The lenders under our credit facility have waived for the period of six fiscal quarters commencing with the quarter ended March 31, 2018 and ending with the quarter ending June 30, 2019, or the waiver period, any default resulting from our non-compliance with the leverage and fixed charge coverage ratio covenants contained in our credit agreement. In connection with this waiver, we agreed that, if at any time during the waiver period we are in non-compliance with either the leverage covenant or the fixed charge coverage ratio covenant (before giving effect to the waiver), the maximum amount available to be drawn under our credit facility (giving effect to applicable borrowing base conditions) less the aggregate outstanding extensions of credit under the credit facility will not be less than approximately $33,333. We have also agreed not to declare or pay any dividends, purchase, redeem, retire, defease or otherwise acquire for value any shares of our capital stock, return any capital to our stockholders or distribute any obligations, securities or other assets to our stockholders if we are not in compliance with the leverage covenant or the fixed charge coverage ratio covenant (before giving effect to the waiver) at the time of such action.

14


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


 
At September 30, 2018, we had seven irrevocable standby letters of credit outstanding, totaling $25,216. In June 2018, we increased, from $17,800 to $22,700, one of these letters of credit which secures our workers' compensation insurance program, and this letter of credit is currently collateralized by approximately $17,885 of cash equivalents and $6,247 of debt and equity investments. This letter of credit currently matures in June 2019, at which time we expect to renew it for an amount then required for our workers' compensation insurance program. At September 30, 2018, the cash equivalents collateralizing this letter of credit, including accumulated interest, were classified as short term restricted cash in our condensed consolidated balance sheets, and the debt and equity investments collateralizing this letter of credit are classified as short term investments in our condensed consolidated balance sheets. The remaining six irrevocable standby letters of credit outstanding at September 30, 2018, totaling $2,516, secure certain of our other obligations. These letters of credit were scheduled to mature between October 2018 and September 2019 at September 30, 2018 and are required to be renewed annually. The letter of credit scheduled to mature in October 2018 was renewed for an additional year prior to its maturity. Our obligations under these six letters of credit are issued under our credit facility. As of September 30, 2018, we had these six letters of credit, totaling $2,516, issued and outstanding under our credit facility, and, after giving effect to the waiver described above, $52,811 available for borrowing under our credit facility.

At September 30, 2018, one of our senior living communities was encumbered by a mortgage. This mortgage contains standard mortgage covenants. We recorded a mortgage discount in connection with the assumption of this mortgage as part of our acquisition of the community secured by this mortgage in order to record this mortgage at its estimated fair value. We amortize this mortgage discount as an increase in interest expense until the maturity of this mortgage. This mortgage requires payments of principal and interest monthly until maturity. The following table is a summary of this mortgage as of September 30, 2018:
Balance as of
 
Contractual Stated
 
Effective
 
 
 
Monthly
 
 
September 30, 2018
 
Interest Rate
 
Interest Rate
 
Maturity Date
 
Payment
 
Lender Type
 
 
 
 
 
 
 
 
 
 
 
$
8,239
 
(1) 
6.20
%
 
6.70
%
 
September 2032
 
$
72
 
 
Federal Home Loan Mortgage Corporation

(1)
Contractual principal payment excluding unamortized discount and debt issuance costs of $286.

We incurred mortgage interest expense, net of discount amortization, of $137 and $781 for the three months ended September 30, 2018 and 2017, respectively, and $909 and $2,352 for the nine months ended September 30, 2018 and 2017, respectively. This mortgage requires monthly payments into escrows for taxes, insurance and property replacement funds; certain withdrawals from these escrows require Federal Home Loan Mortgage Corporation approval.
In February 2018, in connection with the sale of one of our senior living communities to SNH, SNH assumed a Federal National Mortgage Association mortgage that had a principal balance of $16,776 and required interest at the contracted rate of 6.64% per annum. In connection with SNH's assumption of this debt, we recorded a gain of $543, which amount is included in gain on sale of senior living communities in our condensed consolidated statements of operations.

In June 2018, in connection with the sale of two of our senior living communities to SNH, SNH assumed a commercial lender mortgage that had a principal balance of $16,588 and required interest at the contracted rate of 5.75% per annum. In connection with SNH's assumption of this debt, we recorded a gain of $638, which amount is included in gain on sale of senior living communities in our condensed consolidated statements of operations.

As of September 30, 2018, we believe we were in compliance with all applicable covenants under our mortgage debt and, giving effect to the waiver discussed above, our credit facility.
 
Note 9. Leases and Management Agreements with SNH
    
Senior Living Communities Leased from SNH. We are SNH’s largest tenant and SNH is our largest landlord. As of September 30, 2018 and 2017, we leased 184 and 185 senior living communities from SNH, respectively. We lease senior living communities from SNH pursuant to five leases with SNH. Our total annual rent payable to SNH as of September 30, 2018 and 2017 was $207,504 and $206,297, respectively, excluding percentage rent based on increases in gross revenues at certain communities. Our total rent expense 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 in June 2016 described below, was $51,541 and $51,056 for the three months ended September 30, 2018 and 2017, respectively, and $154,425 and $152,358

15


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


for the nine months ended September 30, 2018 and 2017, respectively, which amounts included estimated percentage rent of $1,387 and $1,353 for the three months ended September 30, 2018 and 2017, respectively, and $4,068 and $4,190 for the nine months ended September 30, 2018 and 2017, respectively. As of September 30, 2018 and December 31, 2017, we had outstanding rent due and payable to SNH of $18,642 and $18,555, respectively, which amounts are included in due to related persons in our condensed consolidated balance sheets.

Pursuant to the terms of our leases with SNH, for the nine months ended September 30, 2018 and 2017, we sold to SNH $14,749 and $30,698, respectively, of improvements to communities leased from SNH. As a result, the annual rent payable by us to SNH increased by approximately $1,177 and $2,464 as of September 30, 2018 and 2017, respectively. As of September 30, 2018, our property and equipment included $987 for similar improvements to communities leased from SNH that we expect to request SNH to purchase from us for an increase in future rent; however, SNH is not obligated to purchase these improvements.

In June 2016, we entered an agreement with SNH pursuant to which, on June 29, 2016, we sold seven senior living communities to SNH for an aggregate purchase price of $112,350, and SNH simultaneously leased these communities back to us under a new long term lease agreement. Under the new lease, we are required to pay SNH initial annual rent of $8,426, plus percentage rent beginning in 2018.

In accordance with FASB ASC Topic 840, Leases, the June 2016 sale and leaseback transaction qualifies for sale-leaseback accounting. Accordingly, the gain generated from the sale of $82,644 was deferred and is being amortized as a reduction of rent expense over the initial term of the lease. As of September 30, 2018 and December 31, 2017, the short term portion of the deferred gain in the amount of $6,609 is presented in other current liabilities in our condensed consolidated balance sheets, and the long term portion is presented separately in our condensed consolidated balance sheets.

In June 2018, we and SNH sold to a third party one SNF, which was previously leased to us, located in California with 97 living units for a sales price of approximately $6,500, excluding closing costs. We recorded a loss of $62 and $102 for the three and nine months ended September 30, 2018, respectively, as a result of this sale, which loss is included in loss (gain) on sale of senior living communities in our condensed consolidated statements of operations. This community, while leased by us, generated a loss from operations before income taxes of $24 and $358 for the three months ended September 30, 2018 and 2017, respectively, and $283 and $461 for the nine months ended September 30, 2018 and 2017, respectively, excluding the loss on sale of the community. Pursuant to the terms of our lease with SNH, as a result of this sale, our annual rent payable to SNH decreased by 10% of the net proceeds that SNH received from this sale, in accordance with the terms of the applicable lease.

Also in June 2018, SNH acquired an additional living unit at a senior living community we lease from SNH located in Florida which was added to the lease for that senior living community, and, as a result of this acquisition, our annual rent payable to SNH increased by $14 in accordance with the terms of such lease.

Senior Living Communities Managed for the Account of SNH and its Related Entities. As of September 30, 2018 and 2017, we managed 75 and 68 senior living communities, respectively, for the account of SNH. We earned base management fees of $3,597 and $3,199 from the senior living communities we managed for the account of SNH for the three months ended September 30, 2018 and 2017, respectively, and $10,486 and $9,708 for the nine months ended September 30, 2018 and 2017, respectively. In addition, we earned fees for our management of capital expenditure projects at the communities we managed for the account of SNH of $344 and $128 for the three months ended September 30, 2018 and 2017, respectively, and $714 and $628 for the nine months ended September 30, 2018 and 2017, respectively. These amounts are included in management fee revenue in our condensed consolidated statements of operations.

In November 2017, we entered a transaction agreement with SNH, or the transaction agreement, pursuant to which in December 2017, January 2018, February 2018 and June 2018 we sold to, and began managing for the account of, SNH a total of six senior living communities and, concurrently with those sales, we and SNH entered management agreements for each of these senior living communities and two new pooling agreements with terms substantially similar to our other management and pooling agreements with SNH.

In accordance with FASB ASC Topic 360, Property, Plant and Equipment, or ASC 360, these six senior living communities met the conditions to be classified as held for sale in November 2017. These six senior living communities, while owned by us, generated income (loss) from operations before income taxes of $(14) and $806 for the three months ended September 30, 2018

16


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


and 2017, respectively, and $137 and $2,075 for the nine months ended September 30, 2018 and 2017, respectively, excluding the gain on sale of the communities. These amounts are included in our condensed consolidated statements of operations.

In December 2017, we sold two of the six senior living communities described above for an aggregate sales price of $39,150. These two senior living communities had an aggregate carrying value of $29,444, net of mortgage debt and discount of $2,303. In accordance with ASC 360, these two transactions qualify as real estate sales and the gains on these transactions were recognized immediately in accordance with the full accrual method as a result of our lack of continuing involvement in the ownership of the senior living communities after completing these sales. The carrying value of these senior living communities was not included in our condensed consolidated balance sheet as of December 31, 2017.

In January and February 2018, we sold two additional senior living communities described above for an aggregate sales price of $41,917. These two senior living communities had an aggregate carrying value of $19,425, net of mortgage debt and premiums of $17,356, of which the principal amount of $16,776 was assumed by SNH. These transactions are accounted for in accordance with ASU No. 2014-09, in particular ASC Topic 610 and related ASUs, effective with the adoption of these new ASUs on January 1, 2018. Under these new ASUs, the income recognition for real estate sales is largely based on the transfer of control rather than continuing involvement in the ownership of the real estate. We recorded a gain of $5,684 for the three months ended March 31, 2018 as a result of the sale of these two senior living communities, which gain is included in loss (gain) on sale of senior living communities in our condensed consolidated statements of operations.

In June 2018, we sold the remaining two senior living communities described above for an aggregate sales price of $23,300. These two senior living communities had an aggregate carrying value of $5,163, net of mortgage debt and premiums of $17,226, of which the principal amount of $16,588 was assumed by SNH. These transactions are accounted for in accordance with ASU No. 2014-09, in particular ASC Topic 610 and related ASUs, effective with our adoption of these new ASUs on January 1, 2018. We recorded a gain of $1,549 for the three months ended June 30, 2018 as a result of the sale of these two senior living communities, which gain is included in loss (gain) on sale of senior living communities in our condensed consolidated statements of operations.

In June 2018, we began managing for the account of SNH, pursuant to a management agreement and our existing Pooling Agreement No. 12 with SNH, as amended and restated, a senior living community SNH owns located in California with 98 living units. Pursuant to the terms of the management and pooling agreements with respect to this senior living community, we will earn a management fee equal to 5% of the gross revenues realized at this community plus reimbursement for our direct costs and expenses related to our operation of this community, as well as an annual incentive fee equal to 20% of the annual net operating income of this community remaining after SNH realizes an annual minimum return of $1,000 plus 7% of its invested capital for this community in excess of $500 made after the date we began managing this community, and SNH’s annual minimum return for this community will not be used in determining whether or not there is a priority return shortfall, as defined, under the pooling agreement until 2019.

In November 2018, we began managing for the account of SNH, pursuant to a management agreement with SNH, a senior living community SNH owns located in Colorado with 238 living units. Pursuant to the terms of the management agreement with respect to this senior living community, we will earn a management fee equal to 5% of the gross revenues realized at this community plus reimbursement for our direct costs and expenses related to our operation of this community, as well as an annual incentive fee equal to 20% of the annual net operating income of this community remaining after SNH realizes an annual minimum return of $1,500 plus 7% of its invested capital for this community made after the date we began managing this community. We and SNH both have the option to terminate the management agreement with respect to this community as of December 31, 2019.

We also provide certain other services to residents at some of the senior living communities we manage for SNH, such as rehabilitation services. At senior living communities we manage for the account of SNH where we provide rehabilitation services on an outpatient basis, the residents, third party payers or government programs pay us for those rehabilitation services. At senior living communities we manage for the account of SNH where we provide both inpatient and outpatient rehabilitation services, SNH generally pays us for these services and charges for such services are included in amounts charged to residents, third party payers or government programs. We earned revenues of $1,584 and $1,841 for the three months ended September 30, 2018 and 2017, respectively, and $4,944 and $5,709 for the nine months ended September 30, 2018 and 2017, respectively, for rehabilitation services we provided at senior living communities we manage for the account of SNH and that are payable by SNH. These amounts are included in senior living revenue in our condensed consolidated statements of operations.

17


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)



In order to accommodate certain requirements of New York healthcare licensing laws, a part of the senior living community SNH owns, and we manage, located in Yonkers, New York is subleased by a subsidiary of SNH to D&R Yonkers LLC. As of September 30, 2018, D&R Yonkers LLC was owned by our Executive Vice President, Chief Financial Officer and Treasurer and by SNH’s former president and chief operating officer. We count the part of this senior living community that we manage for D&R Yonkers LLC and the part of this senior living community that we manage for the account of SNH as one senior living community. We earned management fees of $68 and $87 for the three months ended September 30, 2018 and 2017, respectively, and $208 and $195 for the nine months ended September 30, 2018 and 2017, respectively, under this management arrangement with D&R Yonkers LLC, which amounts are included in management fee revenue in our condensed consolidated statements of operations.

Note 10. Business Management Agreement with RMR LLC

The RMR Group LLC, or RMR LLC, provides us certain services that we require to operate our business and which relate to various aspects of our business. RMR LLC provides these services pursuant to a business management agreement.

Pursuant to our business management agreement with RMR LLC, we recognized business management fees of $2,258 and $2,264 for the three months ended September 30, 2018 and 2017, respectively, and $6,771 and $6,817 for the nine months ended September 30, 2018 and 2017, respectively. In addition, we are responsible for our share of RMR LLC’s costs for providing our internal audit function. The amounts recognized as expense for internal audit costs were $61 and $72 for the three months ended September 30, 2018 and 2017, respectively, and $184 and $207 for the nine months ended September 30, 2018 and 2017, respectively, which amounts are included in general and administrative expenses in our condensed consolidated statements of operations.

Note 11. Related Person Transactions

We have relationships and historical and continuing transactions with SNH, RMR LLC, ABP Trust, AIC and others related to them, including other companies to which RMR LLC or its subsidiaries provide management services and which have trustees, directors and officers who are also our Directors or officers.

SNH. SNH is currently one of our largest stockholders, owning, as of September 30, 2018, 4,235,000 of our common shares, or approximately 8.4% of our outstanding common shares. We lease from, and manage for the account of, SNH a majority of the senior living communities we operate. RMR LLC provides management services to both us and SNH and Adam D. Portnoy, one of our Managing Directors, also serves as a managing trustee of SNH. See Notes 9 and 10 for more information regarding our relationships, agreements and transactions with SNH and certain parties related to it and us.

RMR LLC. We have an agreement with RMR LLC to provide management services to us. See Note 10 for more information regarding our management agreement with RMR LLC.

ABP Trust. A subsidiary of ABP Trust is our largest stockholder, owning, as of September 30, 2018, 17,999,999 of our common shares, or approximately 35.6% of our outstanding common shares. Adam D. Portnoy, one of our Managing Directors, is the sole trustee, an officer and the controlling shareholder of ABP Trust, which is the controlling shareholder of The RMR Group Inc., or RMR Inc.; RMR Inc. is the managing member of RMR LLC.

We lease our headquarters from another subsidiary of ABP Trust. Our rent expense for our headquarters, including utilities and real estate taxes that we pay as additional rent, was $420 and $416 for the three months ended September 30, 2018 and 2017, respectively, and $1,299 and $1,212 for the nine months ended September 30, 2018 and 2017, respectively.

AIC. We, ABP Trust, SNH and four other companies to which RMR LLC provides management services currently own AIC, an Indiana insurance company, 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 $3,144 in connection with the renewal of this insurance program for the policy year ending June 30, 2019, 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, 2018 and December 31, 2017, our investment in AIC had a carrying value of $9,157 and $8,185, respectively. These amounts are presented as equity investment of an investee in our condensed consolidated balance sheets. We

18


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


recognized income related to our investment in AIC, which amounts are presented as equity in earnings of an investee in our condensed consolidated statements of operations. Our other comprehensive income includes our proportionate part of unrealized gains (losses) on securities that are owned by AIC related to our investment in AIC.

For further information about these and other such relationships and certain other related person transactions, refer to our Annual Report.

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 government 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 government audits, investigations and proceedings may require us to incur significant expense. We account for claims and litigation losses in accordance with FASB ASC Topic 450, Contingencies, or ASC Topic 450. Under ASC Topic 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. A minimum or best estimate amount may be increased or decreased when events result in a changed expectation.

As previously disclosed, in July 2017, as a result of our compliance program to review records related to our Medicare billing practices, we became aware of certain potential 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 compliance with applicable Medicare billing rules. As a result of these discoveries, we have made a voluntary disclosure of deficiencies to the U.S. Department of Health and Human Services Office of the Inspector General, or the OIG, pursuant to the OIG's Provider Self-Disclosure Protocol. We submitted supplemental disclosures to the OIG in December 2017 and March 2018. At December 31, 2017, we accrued an estimated revenue reserve of $888 for historical Medicare payments we received and expect to repay as a result of these deficiencies, which amount we reduced to $759 in March 2018. The entire $759 reserve remained accrued and unpaid at September 30, 2018. In addition, at December 31, 2017, we recorded an aggregate $658 expense for additional costs we incurred as a result of this matter, including estimated OIG imposed penalties, which amount we reduced to $594 in March 2018, and thereafter recorded an additional expense of $55, $20 and $12 for further costs related to this matter for the three months ended March 31, 2018, June 30, 2018 and September 30, 2018, respectively. Our total costs incurred related to this matter at September 30, 2018, excluding revenue reserves, was $681, $559 of which remained accrued and unpaid at September 30, 2018.

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, or the Arizona litigation matter. 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 with the plaintiff, $7,250 was paid to the plaintiff, of which $3,021 was paid by our then liability insurer and the balance by us. We recorded a $4,229 charge for the year ended December 31, 2015 for the net settlement amount we paid. In September 2017, pursuant to an agreement we entered with our former liability insurer to settle litigation we had commenced against it, our former liability insurer paid us an additional $800 related to our settlement of the Arizona litigation matter and we recorded a decrease to other senior living operating expenses in our condensed consolidated statements of operations consistent with the classification of the original charge.

Note 13.  Employee Benefit Plans

Employee 401(k) Plan. We have an employee savings plan, or our 401(k) Plan, under the provisions of Section 401(k) of the Internal Revenue Code, or the IRC. All of our employees are eligible to participate in our 401(k) Plan and are entitled upon termination or retirement to receive their vested portion of our 401(k) Plan assets. We match up to a certain amount of employee contributions. We also pay certain expenses related to our 401(k) Plan. Our contributions and related expenses for our 401(k) Plan were $332 and $322 for the three months ended September 30, 2018 and 2017, respectively, of which $292 and

19


FIVE STAR SENIOR LIVING INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands, except per share amounts)
(unaudited)


$288, respectively, was recorded in senior living wages and benefits and of which $40 and $34, respectively, was recorded in general and administrative expenses in our condensed consolidated statements of operations. Our contributions and related expenses for our 401(k) Plan were $1,003 and $1,085 for the nine months ended September 30, 2018 and 2017, respectively, of which $879 and $943, respectively, was recorded in senior living wages and benefits and of which $124 and $142, respectively, was recorded in general and administrative expenses in our condensed consolidated statements of operations.
Non-Qualified Deferred Compensation Plan. In May 2018, our board of directors adopted a non-qualified deferred compensation plan, or our Deferred Compensation Plan, which we began offering to certain of our employees, including our executive officers, in August 2018. Participation in our Deferred Compensation Plan is limited to a group of highly compensated employees holding the position of administrator or director or a position above such levels, which group includes our named executive officers. Our Deferred Compensation Plan is an unfunded and unsecured deferred compensation arrangement. A participant may, on a pre-tax basis, elect to defer base salary and bonus up to the maximum percentages for such deferrals as described in our Deferred Compensation Plan. We may also, at our discretion, match deferrals made under our Deferred Compensation Plan, subject to a vesting schedule. Compensation deferred under our Deferred Compensation Plan was recorded in accounts payable and accrued expenses in our condensed consolidated balance sheets as of September 30, 2018. Expenses related to such deferred compensation were recorded in senior living wages and benefits and general and administrative expenses in our condensed consolidated statements of operations. Compensation deferred under our Deferred Compensation Plan was not material to our condensed consolidated balance sheets as of September 30, 2018 or our condensed consolidated statements of operations for three and nine months ended September 30, 2018.

20



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

We believe that the primary market for senior living services is individuals age 80 and older, and, according to U.S. Census data, that group is projected to be among the fastest growing age cohort in the United States over the next 20 years. Also, as a result of medical advances, seniors are living longer. Due to these demographic trends, we expect the demand for senior living services to increase in future years.
    
Despite this trend, future economic downturns, softness in the U.S. housing market, higher levels of unemployment among our residents' and potential residents' family members, lower levels of consumer confidence, stock market volatility and/or changes in demographics could adversely affect the ability of seniors to afford our resident charges. Prospective residents who plan to use the proceeds from the sale of their homes to cover the cost of senior living services seem to be especially affected by cyclical factors affecting the housing market. 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. Although many of the services that we provide to residents are needs driven, some prospective residents may be deferring decisions to relocate to senior living communities in light of economic circumstances, among other reasons.

For the past few years, low capital costs appear to have encouraged increased senior living development, particularly in areas where existing senior living communities have historically experienced high occupancies. This has resulted in a significant number of new senior living communities being developed in recent years, although there are indications that the rate of newly started development has recently declined. The development activity has increased competitive pressures on us, particularly in certain geographic markets where we own, lease and manage senior living communities, and we expect these challenges to continue for at least the next few years. As recently developed senior living communities begin operations, we expect to have continuing challenges to maintain or increase occupancies and charges at our senior living communities. These challenges are currently negatively impacting our revenues, cash flows and results from operations and we expect these challenges to continue at least through 2019.

Another factor which appears to be negatively affecting us and our industry is that the same medical advances and healthcare services that are extending lives and periods of occupancy at senior living communities are also allowing some potential residents to defer the time when they require the special services available at our communities. We do not currently believe that the increased stays that may result from medical advances and healthcare services will be completely offset by deferred entry, but we think this factor may be contributing to occupancy declines at this time.

In addition, low unemployment in the United States combined with a competitive labor market that are increasing our employment costs, including salaries, wages and benefits, such as health care benefit coverage, for our employees, will increase our operating expenses and may negatively impact our financial results.

The senior living and healthcare industries are subject to extensive and frequently changing federal, state and local laws and regulations. These laws and regulations vary by jurisdiction but may address, among other things, licensure, personnel training, staffing ratios, types and quality of medical care, physical facility requirements, government healthcare program participation, the definition of "fraud and abuse", payment rates for resident services and confidentiality of patient records. We incur significant costs to comply with these laws and regulations and these laws and regulations may result in our having to repay payments we received for services we provided and to pay penalties, fines and interest, which amounts can be significant. See Note 12 to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report. For further information regarding government regulations and reimbursements, including possible changes and related legislative and other reform efforts, see "—Our Revenues" in Part I, Item 2 of this Quarterly Report.


21


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



RESULTS OF OPERATIONS

We have two operating segments: (i) senior living community and (ii) 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. In the rehabilitation and wellness operating segment, we provide therapy services, including physical, occupational, speech and other specialized therapy services, in the inpatient setting and in outpatient clinics. We have determined that our two operating segments meet the aggregation criteria as prescribed under FASB ASC Topic 280, Segment Reporting, and we have therefore determined that our business is comprised of one reportable segment, senior living. All of our operations and assets are located in the United States, except for the operations of our Cayman Islands organized captive insurance company subsidiary, which participates in our workers’ compensation, professional and general liability and certain automobile insurance programs.
In November 2017, we entered the transaction agreement with SNH pursuant to which we agreed to sell six senior living communities to SNH for $104.4 million, including SNH’s assumption of approximately $33.5 million of mortgage debt principal secured by certain of these senior living communities, and excluding closing costs. In December 2017, January 2018, February 2018 and June 2018, we sold to, and began managing for the account of, SNH two of these senior living communities located in Alabama and Indiana, one of these senior living communities located in Tennessee, one of these senior living communities located in Arizona and two of these senior living communities located in Tennessee, respectively, and concurrently with those sales, we and SNH entered management agreements for each of these senior living communities and two new pooling arrangements with SNH. For more information regarding our leases and management agreements and other transactions with SNH, see Note 9 to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report.

22


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



Key Statistical Data For the Three Months Ended September 30, 2018 and 2017:
The following tables present a summary of our operations for the three months ended September 30, 2018 and 2017:
 
 
Three Months Ended September 30,
 
(dollars in thousands, except average monthly rate)
 
2018
 
2017
 
Change
 
%/bps
Change
 
Senior living revenue
 
$
272,701

 
$
279,654

 
$
(6,953
)
 
(2.5
)%
 
Management fee revenue
 
4,009

 
3,414

 
595

 
17.4
 %
 
Reimbursed costs incurred on behalf of managed communities
 
72,200

 
64,033

 
8,167

 
12.8
 %
 
Total revenues
 
348,910

 
347,101

 
1,809

 
0.5
 %
 
Senior living wages and benefits
 
(142,035
)
 
(138,255
)
 
3,780

 
2.7
 %
 
Other senior living operating expenses
 
(76,761
)
 
(71,218
)
 
5,543

 
7.8
 %
 
Costs incurred on behalf of managed communities
 
(72,200
)
 
(64,033
)
 
8,167

 
12.8
 %
 
Rent expense
 
(52,282
)
 
(51,779
)
 
503

 
1.0
 %
 
General and administrative expenses
 
(18,965
)
 
(17,851
)
 
1,114

 
6.2
 %
 
Depreciation and amortization expense
 
(9,137
)
 
(9,753
)
 
(616
)
 
(6.3
)%
 
Loss on sale of senior living communities
 
(62
)
 

 
(62
)
 
(100.0
)%
 
Long lived asset impairment
 

 
(142
)
 
(142
)
 
(100.0
)%
 
Interest, dividend and other income
 
192

 
167

 
25

 
15.0
 %
 
Interest and other expense
 
(466
)
 
(1,139
)
 
(673
)
 
(59.1
)%
 
Unrealized gain on equity investments
 
133

 

 
(133
)
 
100.0
 %
 
Gain on early extinguishment of debt
 

 
143

 
(143
)
 
(100.0
)%
 
Realized gain on sale of debt and equity investment, net of tax
 
2

 
70

 
(68
)
 
(97.1
)%
 
Benefit for income taxes
 
263

 
55

 
208

 
378.2
 %
 
Equity in earnings of an investee, net of tax
 
826

 
31

 
795

 
2,564.5
 %
 
Net loss
 
$
(21,582
)
 
$
(6,603
)
 
$
(14,979
)
 
(226.9
)%
 
Total number of communities (end of period):
 
 
 
 
 
 
 
 
 
Owned and leased communities
 
208

 
215

 
(7
)
 
(3.3
)%
 
Managed communities
 
75

 
68

 
7

 
10.3
 %
 
Number of total communities
 
283

 
283

 

 
 %
 
Total number of living units (end of period):
 
 
 
 
 
 
 
 
 
Owned and leased living units (1)
 
22,290

 
23,005

 
(715
)
 
(3.1
)%
 
Managed living units (1)
 
9,515

 
8,807

 
708

 
8.0
 %
 
Number of total living units (1)
 
31,805

 
31,812

 
(7
)
 
 %
 
 
 
 
 
 
 
 
 
 
 
Owned and leased communities:
 
 
 
 
 
 
 
 
 
Occupancy % (1)
 
82.0
%
 
83.0
%
 
n/a 

 
(100
)
bps
Average monthly rate (2)
 
$
4,701

 
$
4,648

 
$
53

 
1.1
 %
 
Percent of senior living revenue from Medicaid
 
12.6
%
 
12.3
%
 
n/a 

 
30

bps
Percent of senior living revenue from Medicare
 
10.5
%
 
10.3
%
 
n/a 

 
20

bps
Percent of senior living revenue from private and other sources
 
76.9
%
 
77.4
%
 
n/a 

 
(50
)
bps
 
 
(1) Includes only living units categorized as in service. As a result, the number of living units may change from period to period for reasons other than the acquisition or disposition of senior living communities.
(2) Average monthly rate is calculated by taking the average daily rate, which is defined as total operating revenues for senior living services divided by occupied units during the period, and multiplying it by 30 days.

23


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



Comparable communities (senior living communities that we have operated continuously since July 1, 2017):
 
 
Three Months Ended September 30,
 
(dollars in thousands, except average monthly rate)
 
2018
 
2017
 
Change
 
%/bps
Change
 
Senior living revenue
 
$
271,421

 
$
272,378

 
$
(957
)
 
(0.4
)%
 
Management fee revenue
 
3,331

 
3,287

 
44

 
1.3
 %
 
Senior living wages and benefits
 
141,125

 
135,146

 
(5,979
)
 
4.4
 %
 
Other senior living operating expenses
 
76,585

 
68,992

 
(7,593
)
 
11.0
 %
 
Total number of communities (end of period):
 
 
 
 
 
 
 
 
 
Owned and leased communities
 
208

 
208

 

 
 %
 
Managed communities
 
68

 
68

 

 
 %
 
Number of total communities
 
276

 
276

 

 
 %
 
Total number of living units (end of period):
 
 
 
 
 
 
 
 
 
Owned and leased living units (1)
 
22,290

 
22,313

 
(23
)
 
(0.1
)%
 
Managed living units (1)
 
8,818

 
8,807

 
11

 
0.1
 %
 
Number of total living units (1)
 
31,108

 
31,120

 
(12
)
 
 %
 
 
 
 
 
 
 
 
 
 
 
Owned and leased communities (1):
 
 
 
 
 
 
 
 
 
Occupancy % (1)
 
82.0
%
 
82.8
%
 
n/a 

 
(80
)
bps
Average monthly rate (2)
 
$
4,701

 
$
4,677

 
$
24

 
0.5
 %
 
Percent of senior living revenue from Medicaid
 
12.7
%
 
12.3
%
 
n/a 

 
40

bps
Percent of senior living revenue from Medicare
 
10.2
%
 
10.2
%
 
n/a 

 

bps
Percent of senior living revenue from private and other sources
 
77.1
%
 
77.5
%
 
n/a 

 
(40
)
bps
 
 

(1) Includes only living units categorized as in service. As a result, the number of living units may change from period to period for reasons other than the acquisition or disposition of senior living communities.
(2) Average monthly rate is calculated by taking the average daily rate, which is defined as total operating revenues for senior living services divided by occupied units during the period, and multiplying it by 30 days.
Three Months Ended September 30, 2018 Compared to Three Months Ended September 30, 2017
The following is a discussion of our operating results for the three months ended September 30, 2018 compared to the three months ended September 30, 2017.

Senior living revenue. Senior living revenue for the three months ended September 30, 2018 decreased approximately 2.5% compared to the same period in 2017 primarily due to the sale of two senior living communities during the fourth quarter of 2017 and five senior living communities during the first half of 2018 and a decrease in occupancy, partially offset by an increase in revenues from ancillary services, such as rehabilitation and wellness services. The 0.4% decrease in senior living revenue at the communities that we have operated continuously since July 1, 2017 was primarily due to a decrease in occupancy.
 
Management fee revenue. Management fee revenue increased by 17.4% for the three months ended September 30, 2018 compared to the same period in 2017 primarily due to an increase in the number of managed communities from 68 to 75.

Reimbursed costs incurred on behalf of managed communities. Reimbursed costs incurred on behalf of managed communities increased by 12.8% for the three months ended September 30, 2018 compared to the same period in 2017 primarily due to an increase in the number of managed communities from 68 to 75.
 
Senior living wages and benefits. Senior living wages and benefits increased by 2.7% for the three months ended September 30, 2018 compared to the same period in 2017 primarily due to an increase in overtime expenses and annual wage increases, partially offset by the sale of two senior living communities during the fourth quarter of 2017 and five senior living communities during the first half of 2018. The 4.4% increase in senior living wages and benefits at the communities that we have operated continuously since July 1, 2017 was primarily due to an increase in overtime expenses and annual wage increases.
 
Other senior living operating expenses. Other senior living operating expenses, which include utilities, housekeeping, dietary, repairs and maintenance, insurance and community level administrative costs, increased by 7.8% for the three months ended September 30, 2018 compared to the same period in 2017 primarily due to an increase in repairs and maintenance and certain consulting and other purchased services expenses, partially offset by the sale of two senior living communities during the fourth

24


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



quarter of 2017 and five senior living communities during the first half of 2018 and a decrease in professional and general liability insurance expenses. The 11.0% increase in other senior living operating expenses at the communities that we have operated continuously since July 1, 2017 was primarily due to an increase in repairs and maintenance and certain consulting and other purchased services expenses, partially offset by a decrease in professional and general liability insurance expenses.

Rent expense. Rent expense increased by 1.0% for the three months ended September 30, 2018 compared to the same period in 2017 primarily due to additional rent related to senior living community capital improvements we sold to SNH since January 1, 2017 pursuant to our leases with SNH. 

General and administrative expenses. General and administrative expenses increased by 6.2% for the three months ended September 30, 2018 compared to the same period in 2017 primarily due to an increase in expenses for certain consulting and other purchased services during the third quarter of 2018.
 
Depreciation and amortization expense. Depreciation and amortization expense decreased by 6.3% for the three months ended September 30, 2018 compared to the same period in 2017 primarily due to the sale of two senior living communities during the fourth quarter of 2017 and five senior living communities during the first half of 2018, partially offset by capital expenditures we made at our owned and leased communities (net of our sales of capital improvements to SNH at our leased communities).

Loss on sale of senior living communities. A loss on sale of senior living communities of $0.1 million was recorded primarily in connection with the sale of one senior living community to a third party in June 2018.

Long lived asset impairment. For the three months ended September 30, 2017, we recorded non-cash charges for long lived asset impairment of $0.1 million to reduce the carrying value of certain of our long lived assets to their estimated fair values.
 
Interest, dividend and other income. Interest, dividend and other income increased by 15.0% for the three months ended September 30, 2018 compared to the same period in 2017 primarily due to higher investable cash and cash equivalents balances.
 
Interest and other expense. Interest and other expense decreased by 59.1% for the three months ended September 30, 2018 compared to the same period in 2017 primarily due to the prepayment of one mortgage note in September 2017 and another mortgage note in December 2017 and SNH's assumption of one mortgage note in February 2018 and another mortgage note in June 2018 in connection with our sale of three senior living communities to SNH pursuant to the transaction agreement.

Unrealized gain on equity investments. Unrealized gain on equity investments represents our unrealized gain on our equity investments held at September 30, 2018 in accordance with new GAAP standards effective January 1, 2018.

Gain on early extinguishment of debt. In September 2017, we prepaid a mortgage note and recorded a gain of $0.1 million, net of unamortized premiums and a prepayment penalty equal to 1% of the principal prepaid.

Realized gain on sale of debt and equity investments, net of tax. Realized gain on sale of debt and equity investments represents our realized gain on investments, net of applicable taxes. 

Benefit for income taxes. For the three months ended September 30, 2018 and 2017, we recognized a benefit for income taxes of $0.3 million and $0.1 million, respectively. The benefit for income taxes for the three months ended September 30, 2018 is related to our state income taxes. The benefit for income taxes for the three months ended September 30, 2017 is primarily due to intra-period tax allocation benefits related to the unrealized gains on our debt and equity investments.
 
Equity in earnings of an investee, net of tax. Equity in earnings of an investee represents our proportionate share of earnings from AIC.


25


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



Key Statistical Data For the Nine Months Ended September 30, 2018 and 2017:
The following tables present a summary of our operations for the nine months ended September 30, 2018 and 2017:
 
 
Nine Months Ended September 30,
 
(dollars in thousands, except average monthly rate)
 
2018
 
2017
 
Change
 
%/bps
Change
 
Senior living revenue
 
$
818,108

 
$
842,938

 
$
(24,830
)
 
(2.9
)%
 
Management fee revenue
 
11,408

 
10,531

 
877

 
8.3
 %
 
Reimbursed costs incurred on behalf of managed communities
 
208,009

 
194,346

 
13,663

 
7.0
 %
 
Total revenues
 
1,037,525

 
1,047,815

 
(10,290
)
 
(1.0
)%
 
Senior living wages and benefits
 
(418,917
)
 
(413,196
)
 
5,721

 
1.4
 %
 
Other senior living operating expenses
 
(226,302
)
 
(219,060
)
 
7,242

 
3.3
 %
 
Costs incurred on behalf of managed communities
 
(208,009
)
 
(194,346
)
 
13,663

 
7.0
 %
 
Rent expense
 
(156,640
)
 
(154,524
)
 
2,116

 
1.4
 %
 
General and administrative expenses
 
(57,405
)
 
(56,733
)
 
672

 
1.2
 %
 
Depreciation and amortization expense
 
(26,974
)
 
(29,040
)
 
(2,066
)
 
(7.1
)%
 
Gain on sale of senior living communities
 
7,131

 

 
7,131

 
100.0
 %
 
Long lived asset impairment
 
(365
)
 
(528
)
 
(163
)
 
(30.9
)%
 
Interest, dividend and other income
 
577

 
559

 
18

 
3.2
 %
 
Interest and other expense
 
(1,773
)
 
(3,200
)
 
(1,427
)
 
(44.6
)%
 
Unrealized gain on equity investments
 
127

 

 
127

 
100.0
 %
 
Gain on early extinguishment of debt
 

 
143

 
(143
)
 
(100.0
)%
 
Realized (loss) gain on sale of debt and equity investment, net of tax
 
(8
)
 
351

 
(359
)
 
(102.3
)%
 
(Provision) benefit for income taxes
 
(274
)
 
1,330

 
1,604

 
120.6
 %
 
Equity in earnings of an investee, net of tax
 
882

 
533

 
349

 
65.5
 %
 
Net loss
 
$
(50,425
)
 
$
(19,896
)
 
$
(30,529
)
 
(153.4
)%
 
Total number of communities (end of period):
 
 
 
 
 
 
 
 
 
Owned and leased communities
 
208

 
215

 
(7
)
 
(3.3
)%
 
Managed communities
 
75

 
68

 
7

 
10.3
 %
 
Number of total communities
 
283

 
283

 

 
 %
 
Total number of living units (end of period):
 
 
 
 
 
 
 
 
 
Owned and leased living units (2)
 
22,290

 
23,005

 
(715
)
 
(3.1
)%
 
Managed living units (2)
 
9,515

 
8,807

 
708

 
8.0
 %
 
Number of total living units (2)
 
31,805

 
31,812

 
(7
)
 
 %
 
 
 
 
 
 
 
 
 
 
 
Owned and leased communities:
 
 
 
 
 
 
 
 
 
Occupancy % (1) (2)
 
81.7
%
 
83.2
%
 
n/a 

 
(150
)
bps
Average monthly rate (1) (3)
 
$
4,735

 
$
4,706

 
$
29

 
0.6
 %
 
Percent of senior living revenue from Medicaid
 
12.3
%
 
11.7
%
 
n/a 

 
60

bps
Percent of senior living revenue from Medicare
 
10.9
%
 
11.2
%
 
n/a 

 
(30
)
bps
Percent of senior living revenue from private and other sources
 
76.8
%
 
77.1
%
 
n/a 

 
(30
)
bps
 
 
(1) Occupancy and average monthly rate for the nine months ended September 30, 2018 include data for the senior living communities that were sold to SNH during such period as owned until the time of sale and as managed from the time of sale through the end of such period.
(2) Includes only living units categorized as in service. As a result, the number of living units may change from period to period for reasons other than the acquisition or disposition of senior living communities.
(3) Average monthly rate is calculated by taking the average daily rate, which is defined as total operating revenues for senior living services divided by occupied units during the period, and multiplying it by 30 days.

26


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



Comparable communities (senior living communities that we have operated continuously since January 1, 2017):
 
 
Nine Months Ended September 30,
 
(dollars in thousands, except average monthly rate)
 
2018
 
2017
 
Change
 
%/bps
Change
 
Senior living revenue
 
$
807,598

 
$
820,384

 
$
(12,786
)
 
(1.6
)%
 
Management fee revenue
 
9,957

 
9,904

 
53

 
0.5
 %
 
Senior living wages and benefits
 
412,653

 
403,426

 
(9,227
)
 
2.3
 %
 
Other senior living operating expenses
 
223,892

 
212,868

 
(11,024
)
 
5.2
 %