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 June 30, 2015

 

or

 

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

 

Commission File Number 001-16817

FIVE STAR QUALITY CARE, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

400 Centre Street, Newton, Massachusetts 02458

(Address of Principal Executive Offices) (Zip Code)

 

 

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

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒  No ☐

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

Yes ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐  No ☒

 

Number of registrant’s shares of common stock, $.01 par value, outstanding as of August 7, 2015:  49,046,115. 

 

 

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FIVE STAR QUALITY CARE, INC.

 

FORM 10-Q

 

JUNE 30, 2015

 

INDEX

 

 

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

 

 

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Part I.   Financial Information

Item 1.  Condensed Consolidated Financial Statements

 

FIVE STAR QUALITY CARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

See accompanying notes.

 

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FIVE STAR QUALITY CARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

See accompanying notes.

 

 

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FIVE STAR QUALITY CARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

 

See accompanying notes.

 

 

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FIVE STAR QUALITY CARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

See accompanying notes.

 

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Note 1.  Basis of Presentation and Organization

General

The accompanying condensed consolidated financial statements of Five Star Quality Care, Inc. and its subsidiaries, or we, us or our, are unaudited.  Certain information and disclosures required by U.S. generally accepted accounting principles for complete financial statements have been condensed or omitted.  We believe the disclosures made are adequate to make the information presented not misleading.  However, the accompanying financial statements should be read in conjunction with the financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2014, or our Annual Report.  In the opinion of our management, all adjustments, which include only normal recurring adjustments, considered necessary for a fair presentation have been included.  All intercompany transactions and balances with or among our consolidated subsidiaries have been eliminated.  Our operating results for interim periods are not necessarily indicative of the results that may be expected for the full year. 

 

We operate senior living communities, including independent living communities, assisted living communities and skilled nursing facilities, or SNFs.  As of June 30, 2015, we operated 272 senior living communities located in 32 states with 31,267 living units, including 241 primarily independent and assisted living communities with 28,460 living units and 31 SNFs with 2,807 living units.  As of June 30, 2015, we owned and operated 31 communities (3,064 living units), we leased and operated 181 communities (20,035 living units) and we managed 60 communities (8,168 living units).  Our 272 senior living communities, as of June 30, 2015, included 10,626 independent living apartments, 15,457 assisted living suites and 5,184 skilled nursing units.  The foregoing numbers exclude: (i) one assisted living community with 32 living units that we own which is being offered for sale and is classified as a discontinued operation; and (ii) three SNFs with a total of 167 living units that we lease from Senior Housing Properties Trust or its subsidiaries, or SNH, that are being offered for sale and are classified as discontinued operations.

Segment Information

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

Note 2. Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update, or ASU, No. 2014‑09, Revenue from Contracts with Customers,  which outlines a comprehensive model for entities to use in accounting for revenue arising from contracts with customers.  This ASU clarifies the principles for recognizing revenue by, among other things, removing inconsistencies in revenue requirements, improving comparability of revenue recognition practices across entities and industries and providing improved disclosure requirements. In July 2015, the FASB approved a one year deferral of the effective date for this ASU to interim and annual reporting periods beginning after December 15, 2017; however, early adoption at the original effective date is still permitted.  We are currently evaluating the impact that the adoption of this ASU will have on our consolidated financial statements.

 

In May 2015, the FASB issued ASU No. 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent), which excludes investments measured at net asset value, as a practical expedient for fair value, from the fair value hierarchy. This ASU is effective for interim and annual reporting periods beginning after December 15, 2015, and requires retrospective application, with early adoption permitted. The

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implementation of this ASU is not expected to have a material impact to the disclosures in our consolidated financial statements.

Note 3. Property and Equipment

Property and equipment consists of the following:

 

We recorded depreciation expense relating to our property and equipment of $8,110 and $7,290 for the three months ended June 30, 2015 and 2014, respectively, and $15,978 and $14,283 for the six months ended June 30, 2015 and 2014, 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. We did not record impairment charges to any of our long lived assets in continuing operations for the three and six months ended June 30, 2015 or 2014.

 

As of June 30, 2015, we had $8,205 of assets included in our property and equipment that we expect to request that SNH purchase from us for an increase in future rent; however, we are not obligated to make these sales and SNH is not obligated to fund such amounts.

 

In March 2015, we entered into an agreement to acquire two independent living communities with 68 and 84 living units, respectively, located in Tennessee for an aggregate purchase price of approximately $26,000, including the assumption of approximately $17,000 of mortgage debt. We expect to fund this acquisition with cash on hand and borrowings under our secured revolving credit facility. We currently expect this transaction to close during 2015. However, this acquisition is subject to various conditions; accordingly, we can provide no assurance that we will acquire these communities, that the acquisition will not be delayed or that the terms of this acquisition will not change.

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Note 4. Accumulated Other Comprehensive Income

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

 

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

Note 5.  Income Taxes

For the six months ended  June 30, 2015, we recognized tax expense from our continuing operations of $584; we did not recognize any tax expense or benefit from our discontinued operations. As of December 31, 2014, our federal net operating loss carry forwards, which are scheduled to begin expiring in 2026 if unused, were approximately $112,182 and our tax credit carry forwards, which begin expiring in 2022 if unused, were approximately $17,191.  We have an additional $333 of federal net operating loss carry forwards not included in the $112,182, that are attributable to unvested stock grants which will be recorded as an increase to additional paid in capital after they are realized in accordance with FASB ASC Topic 718. Our net operating loss carry forwards and tax credit carry forwards are subject to possible audits and adjustments by the Internal Revenue Service. 

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

Note 6.  Earnings Per Share

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

 

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

 

 

 

 

 

 

 

 

Note 7.  Fair Values of Assets and Liabilities

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

 

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

 

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

 

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

 

Recurring Fair Value Measures

 

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

 

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

 

The carrying values of accounts receivable and accounts payable approximate fair value as of June 30, 2015 and December 31, 2014.  The carrying value and fair value of our mortgage notes payable were $44,662 and $48,199, respectively, as of June 30, 2015 and $51,159 and $56,099, respectively, as of December 31, 2014, and are categorized in Level 3 of the fair value hierarchy in their entirety.  We estimate the fair values of our mortgage notes payable by using discounted cash flow analyses and currently prevailing market terms as of the measurement date. 

 

Non-Recurring Fair Value Measures

 

We review the carrying value of long lived assets 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 a discussion of fair value measurements related to impairments of our long lived assets.

 

We evaluate the recoverability of goodwill or other intangible assets in the fourth quarter of each fiscal year, or more frequently if events or changes in circumstances indicate that goodwill or other intangible assets may be impaired.  As of October 1, 2014, we evaluated our goodwill for impairment and determined that the fair value of our reporting units exceeded their carrying values on that date.  As of June 30, 2015, no events or changes in circumstances had occurred since October 1, 2014 that would trigger the need for an additional impairment review.

 

Goodwill was valued primarily using discounted cash flow models that incorporate assumptions for each reporting unit’s short and long term revenue growth rates, operating margins, and discount rates, which represent our best estimates of current and forecasted market conditions, current cost structure, and the implied rate of return that management believes a market participant would require for an investment in a company having similar risks and business characteristics to the reporting unit being assessed.

  

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

 

Note 8.  Indebtedness

We have a $25,000 revolving secured line of credit, or our Credit Agreement, that is available for general business purposes, including acquisitions.  The maturity date of our Credit Agreement is March 18, 2016.  Borrowings under our Credit Agreement typically bear interest at LIBOR plus a premium of 250 basis points, or 2.69% as of June 30, 2015.  We are also required to pay a quarterly commitment fee of 0.35% per annum on the unused part of our borrowing availability under the Credit Agreement. We may draw, repay and redraw funds until maturity, and no principal repayment is due until maturity.  We made no borrowings under our Credit Agreement during either of the six months

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ended June 30, 2015 and 2014 and, as of June 30, 2015, we had no amounts outstanding under our Credit Agreement.  We incurred interest expense and other associated costs related to our Credit Agreement of $48 for each of the three months ended June 30, 2015 and 2014, and $96 for each of the six months ended June 30, 2015 and 2014.

 

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

 

We also have a $150,000 secured revolving credit facility, or our Credit Facility, that is available for general business purposes, including acquisitions.  In April 2015, we exercised our option to extend the maturity date of our Credit Facility to April 13, 2016; we paid a fee of $300 in connection with this extension. Subject to the payment of an extension fee and meeting certain other conditions, we have the option to further extend the maturity date of our Credit Facility to April 13, 2017.  Borrowings under our Credit Facility typically bear interest at LIBOR plus a premium of 250 basis points, or 2.69% as of June 30, 2015.  We are also required to pay a quarterly commitment fee of 0.35% per annum on the unused part of our borrowing availability under our Credit Facility. We may draw, repay and redraw funds until maturity, and no principal repayment is due until maturity.  The weighted average interest rate for borrowings under our Credit Facility was 2.74% and 2.79% for the six months ended June 30, 2015 and 2014, respectively.  As of June 30, 2015, we had $35,000 outstanding under our Credit Facility.  We incurred interest expense and other associated costs related to our Credit Facility of $404 and $542 for the three months ended June 30, 2015 and 2014, respectively, and $1,013 and $1,135 for the six months ended June 30, 2015 and 2014, respectively.

 

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

 

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

 

At June 30, 2015, four of our senior living communities were encumbered by mortgage notes with an aggregate outstanding principal balance of $44,662: (1) two of our communities were encumbered by Federal National Mortgage Association, or FNMA, mortgage notes and (2) two of our communities were encumbered by Federal Home Loan Mortgage Corporation, or FMCC, mortgage notes.  These mortgages contain FNMA and FMCC standard mortgage covenants, respectively.  We recorded a mortgage premium in connection with our assumption of the FNMA and FMCC mortgage notes as part of our acquisitions of the encumbered communities in order to record the assumed mortgage notes at their estimated fair value.  We are amortizing the mortgage premiums as a reduction of interest expense until the maturity of the respective mortgage notes.  The weighted average interest rate on these four notes was 6.48% as of June 30, 2015.  Payments of principal and interest are due monthly under these mortgage notes until maturities at varying dates ranging from June 2018 to September 2032.  We incurred mortgage interest expense, including premium amortization, of $683 and $671 for the three months ended June 30, 2015 and 2014, respectively, and $1,381 and $1,248 for the six months ended June 30, 2015 and 2014, respectively.  Our mortgages require monthly payments into escrows

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for taxes, insurance and property replacement funds; withdrawals from these escrows require applicable FNMA and FMCC approvals.

 

In June 2015, we prepaid a mortgage note that had a principal balance of $4,873 and required interest at the contracted rate of 8.99% per annum. In connection with this repayment, we recorded a gain of $692 on early extinguishment of debt, net of unamortized premiums and a 1% prepayment penalty, in the second quarter of 2015.

 

As of June 30, 2015, we believe we were in compliance with all applicable covenants under our Credit Agreement, Credit Facility and mortgages.

 

See Note 3 for information regarding mortgage debt we expect to assume in connection with our pending acquisition of two independent living communities.

 

Note 9. Off Balance Sheet Arrangements

We have pledged our accounts receivable and certain other assets, with a carrying value, as of June 30, 2015, of $13,742, arising from our operation of 26 properties owned by SNH and leased to us to secure SNH’s borrowings from its lender, FNMA.  As of June 30, 2015, we had no other off balance sheet arrangements that have had or that we expect would be reasonably likely to have a future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

Note 10. Related Person Transactions

We have relationships and historical and continuing transactions with SNH, RMR LLC and others related to them, including other companies to which RMR LLC provides management services and which have directors, trustees and officers who are also directors or officers of us or RMR LLC. For further information about these and other such relationships and certain other related person transactions, please refer to our Annual Report.

 

SNH: We were formerly a 100% owned subsidiary of SNH until SNH spun us out to its shareholders in 2001. As of June 30, 2015, SNH owned 4,235,000 of our common shares, representing approximately 8.6% of our outstanding common shares, and SNH is our largest shareholder.

 

As of June 30, 2015, we leased 180 senior living communities from SNH.  Our total minimum annual rent payable to SNH as of June 30, 2015 and 2014 was $191,397 and $190,867, respectively,  excluding percentage rent.  Our total rent expense under our leases with SNH, net of lease inducement amortization, was $48,973 and $48,822 for the three months ended June 30, 2015 and 2014, respectively, and $97,915 and $97,581 for the six months ended June 30, 2015 and 2014, respectively, which amounts included estimated percentage rent of $1,393 and $1,403 for the three months ended June 30, 2015 and 2014, respectively, and $2,824 and $2,819 for of the six months ended June 30, 2015 and 2014, respectively. As of June 30, 2015 and December 31, 2014, we had outstanding rent due and payable to SNH of $17,286 and $17,310, respectively.  During the six months ended June 30, 2015 and 2014, pursuant to the terms of our leases with SNH, we sold $8,902 and $17,423, respectively, of improvements made to properties leased from SNH, and, as a result, our annual rent payable to SNH increased by approximately $717 and $1,395, respectively. As of June 30, 2015, our property and equipment included $8,205 for similar improvements we have made to properties we lease from SNH that we typically request that SNH purchase from us for an increase in future rent; however, we are not obligated to make these sales and SNH is not obligated to fund such amounts. 

 

In February 2015, SNH acquired a land parcel adjacent to a senior living community we lease from SNH for $490.  This property was added to the lease for that senior living community and our annual rent payable to SNH increased by $39 as a result.

 

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In February 2015, we and SNH sold a vacant assisted living community located in Pennsylvania for $250, and as a result of this sale, our annual minimum rent payable to SNH decreased by $23 in accordance with the terms of the applicable lease.

 

In July 2015, we and SNH sold a SNF located in Iowa with 12 living units for $155, and as a result of this sale, our annual minimum rent payable to SNH decreased by $16 in accordance with the terms of the applicable lease.

 

In August 2015, we and SNH sold a SNF located in Wisconsin with 39 living units for $850, and as a result of this sale, our annual minimum rent payable to SNH decreased by $85 in accordance with the terms of the applicable lease.

 

As of June 30, 2015, we managed 60 senior living communities for SNH; as of June 30, 2014, we managed 44 senior living communities for SNH. Pursuant to these management agreements with SNH, we earned management fees of $2,699 and $2,433 for the three months ended June 30, 2015 and 2014, respectively, and $5,222 and $4,858 for the six months ended June 30, 2015 and 2014, respectively.

 

In May 2015, we began managing pursuant to 14 separate management agreements 14 senior living communities that SNH acquired at that time. The economic terms of these management agreements are substantially similar to our other management agreements with SNH for senior living communities including assisted living units.

 

Also in May 2015, SNH acquired a senior living community with 40 private pay independent living units located in Georgia.  This senior living community is adjacent to another community that we manage for SNH.  The operations of this community and the community already managed are conducted as a single integrated community under the same management agreement.

 

Pursuant to our management agreement with D&R Yonkers LLC, we earned management fees of  $54 and $59 for the three months ended June 30, 2015 and 2014, respectively, and $108 and $119 for the six months ended June 30, 2015 and 2014, respectively. SNH’s executive officers are the principals of D&R Yonkers LLC, which was established in order to accommodate certain state licensing requirements.

 

RMR LLC:  Pursuant to our business management agreement with RMR LLC, we recognized business management fees of $2,142 and $2,134, and information system service charges of $0 and $1,384,  for the three months ended June 30, 2015 and 2014, respectively, and business management fees of $4,269 and $4,140, and information system service charges of $0 and $2,903, for the six months ended June 30, 2015 and 2014, respectively.  These amounts are included in general and administrative expenses in our condensed consolidated statements of operations.    

 

On March 16, 2015, we and RMR LLC entered into an amended and restated business management agreement, which was approved by our Compensation Committee, comprised solely of our Independent Directors.  As amended, RMR LLC may terminate the business management agreement upon 120 days’ written notice, and we continue to have the right to terminate the business management agreement upon 60 days’ written notice, subject to approval by a majority vote of our Independent Directors.  As amended, if we terminate or do not renew the business management agreement other than for cause, as defined, we are obligated to pay RMR LLC a termination fee equal to 2.875 times the sum of the annual base management fee and the annual internal audit services expense, which amounts are based on averages during the 24 consecutive calendar months prior to the date of notice of termination or nonrenewal.  If we terminate for cause, as defined, no termination fee is payable.  Also, as amended, RMR LLC agrees to provide certain transition services to us for 120 days following termination by us or notice of termination by RMR LLC.  

 

Our rent expense for our headquarters that we lease from an affiliate of Reit Management & Research Trust, or RMR Trust, was $436 and $317 for the three months ended June 30, 2015 and 2014, respectively, and $847 and $672 for the six months ended June 30, 2015 and 2014, respectively. RMR Trust is an owner of RMR LLC, our manager.

 

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AIC:  As of June 30, 2015, our investment in AIC had a carrying value of $6,904.  We recognized income of $23 and $118 related to our investment in AIC for the three months ended June 30, 2015 and 2014, respectively, and $95 and $21 for the six months ended June 30, 2015 and 2014, respectively. Our other comprehensive (loss) income includes unrealized (losses) gains on securities held for sale which are owned by AIC of $(64) and $22 for the three months ended June 30, 2015 and 2014, respectively, and $(19) and $41 for the six months ended June 30, 2015 and 2014, respectively.

 

In June 2015, we and the other shareholders of AIC renewed our participation in an insurance program arranged by AIC.  In connection with that renewal, we purchased a three year combined property insurance policy providing $500,000 of coverage annually with the premium to be paid annually and a one year combined policy providing terrorism coverage of $200,000 for our properties. We currently expect to pay aggregate annual premiums, including taxes and fees, of approximately $4,067 in connection with these policies for the policy year ending June 30, 2016, which amount may be adjusted from time to time as we acquire and dispose of properties that are included in this insurance program.

 

 

Note 11.  Discontinued Operations

In June 2013, we decided to offer for sale one assisted living community we own with 32 living units.  We are in the process of offering this community for sale. As of June 30, 2015, we had three senior living communities that we leased from SNH which were being offered for sale and included in our discontinued operations. Please see Note 10 for a discussion of the sale of two of these senior living communities in discontinued operations subsequent to June 30, 2015. We can provide no assurance that we will be able to sell the senior living community that we are offering for sale, or that we and SNH will be able to sell the remaining senior living community that we lease from SNH that is being offered for sale, or what the terms or timing of any sales may be.

 

We have reclassified our condensed consolidated balance sheets and condensed consolidated statements of operations for all periods presented to show the financial position and results of operations of our senior living communities that have been sold or are expected to be sold as discontinued.  Below is a summary of the operating results of these discontinued operations included in the condensed consolidated financial statements for the three and six months ended June 30, 2015 and 2014:

 

 

 

 

Note 12.  Legal Proceedings and Claims

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

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As previously disclosed, as a result of our compliance program to review medical records related to our Medicare billing practices, during 2014 we discovered potentially inadequate documentation and other issues at one of our leased SNFs.  This compliance review was not initiated in response to any specific complaint or allegation, but was a review of the type that we periodically undertake to test our own compliance with applicable Medicare billing rules.  As a result of these discoveries, in February 2015, we made a voluntary disclosure of deficiencies to the United States Department of Health and Human Services Office of the Inspector General, or the OIG, pursuant to the OIG’s Provider Self-Disclosure Protocol.  We completed our investigation and assessment of these matters and submitted a final supplemental disclosure to the OIG in May 2015. At December 31, 2014, we had accrued a revenue reserve of $4,333 for historical Medicare repayments that we expect to repay as a result of these deficiencies.  For the quarter ended March 31, 2015, this revenue reserve was increased by $2,400 so it now totals $6,733.  In addition, we have recorded expense for additional costs we incurred or expect to incur, including OIG imposed penalties, as a result of this matter totaling $3,606 for the year ending December 31, 2014, and $1,856 and $4,161 for the three and six months ending June 30, 2015, respectively, of which $5,070 remains accrued and not paid at June 30, 2015. As part of the OIG’s Self-Disclosure Protocol, we expect that the OIG will review and evaluate our investigation and assessment of these deficiencies.  The OIG may not agree with our assessment and also may require additional investigation and assessment of these deficiencies and additional deficiencies may be discovered as a result, which could increase our liability to the OIG and other costs. Potential losses associated with any such disagreement or with such additional investigation and assessment and/or additional compliance deficiencies are reasonably possible but cannot be reasonably estimated at this time.

 

We are defendants in a lawsuit filed in the Superior Court of Maricopa County, Arizona by the estate of a former resident of a senior living community operated by us. The complaint asserts 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 $19.2 million, which consisted of $2.5 million for pain and suffering and the remainder in punitive damages. Although we cannot predict the ultimate outcome of this claim, we believe the jury’s verdicts were wrong and the result of significant trial error.  We intend to vigorously pursue our position in post trial motions, and, if those motions are unsuccessful, on appeal. In accordance with ASC 450, we have determined that losses beyond costs already incurred in defending the lawsuit are not probable at this time and it is not possible to reasonably estimate any such liability for this case, and therefore, we have not recorded a reserve for this matter.