Brookdale Senior Living - 10-Q quarterly report FY

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For the transition period from _____________ to _____________

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As of November 5, 2007, 101,615,992 shares of the registrant’s common stock, $0.01 par value, were outstanding (excluding unvested restricted shares).

 

See accompanying notes to condensed consolidated financial statements.

See accompanying notes to condensed consolidated financial statements.

See accompanying notes to condensed consolidated financial statements.

Brookdale Senior Living Inc. (“Brookdale” or the “Company”) is a leading owner and operator of senior living facilities throughout the United States.  The Company provides an exceptional living experience through properties that are designed, purpose-built and operated to provide the highest quality service, care and living accommodations for residents.  Currently, the Company owns and operates independent living, assisted living and dementia-care facilities and continuing care retirement centers.

The accompanying unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for quarterly reports on Form 10-Q. In the opinion of management, these financial statements include all adjustments necessary to present fairly the financial position, results of operations and cash flows of the Company as of September 30, 2007, and for all periods presented. The condensed consolidated financial statements are prepared on the accrual basis of accounting. All adjustments made have been of a normal and recurring nature. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The Company believes that the disclosures included are adequate and provide a fair presentation of interim period results. Interim financial statements are not necessarily indicative of the financial position or operating results for an entire year. It is suggested that these interim financial statements be read in conjunction with the audited financial statements and the notes thereto, together with management’s discussion and analysis of financial condition and results of operations, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006, as filed with the Securities and Exchange Commission.

In 2006, the Company adopted EITF 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights, and as a result, consolidated the operations of three limited partnerships controlled by the Company.  In 2006, the Company purchased a facility from one of the limited partnerships and the partnership was liquidated.  In May 2007, the Company purchased another facility from one of the limited partnerships and the partnership was liquidated.  The ownership interest in the remaining limited partnership not owned by the Company has been reflected in the consolidated balance sheets as minority interests.

In determining the allocation of the purchase price of companies and facilities to net tangible and identified intangible assets acquired and liabilities assumed, the Company makes estimates of the fair value of the tangible and intangible assets acquired and liabilities assumed using information obtained as a result of pre-acquisition due diligence, marketing, leasing activities and independent appraisals. The Company allocates the purchase price of facilities to net tangible and identified intangible assets acquired and liabilities assumed based on their fair values in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations.  The determination of fair value involves the use of significant judgment and estimation. The Company determines fair values as follows:

Current assets and current liabilities assumed are valued at carryover basis which approximates fair value.

Property, plant and equipment are valued utilizing discounted cash flow projections that assume certain future revenue and costs, and considers capitalization and discount rates using current market conditions.

The Company allocates a portion of the purchase price to the value of resident leases acquired based on the difference between the facilities valued with existing in-place leases adjusted to market rental rates and the facilities valued with current leases in place based on current contractual terms. Factors management considers in its analysis include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar resident leases. In estimating carrying costs, management includes estimates of lost rentals during the lease-up period and estimated costs to execute similar leases. The value of in-place leases is amortized to expense over the remaining initial term of the respective leases.

Leasehold operating intangibles are valued utilizing discounted cash flow projections that assume certain future revenues and costs over the remaining lease term. The value assigned to leasehold operating intangibles is amortized on a straight-line basis over the lease term.

Facility purchase options are valued at the estimated value of the underlying facility less the cost of the option payment discounted at current market rates.  Management contracts and other acquired contracts are valued at a multiple of management fees and operating income and amortized over the estimated term of the agreement.

Long-term debt assumed is recorded at fair market value based on the current market rates and collateral securing the indebtedness.

Capital lease obligations are valued based on the present value of the minimum lease payments applying a discount rate equal to the Company’s estimated incremental borrowing rate at the date of acquisition.

Deferred entrance fee revenue is valued at the estimated cost of providing services to residents over the terms of the current contracts to provide such services. Refundable entrance fees are valued at cost pursuant to the resident lease plus the resident's share of any appreciation of the facility unit at the date of acquisition, if applicable.

A deferred tax liability is recognized at statutory rates for the difference between the book and tax bases of the acquired assets and liabilities.

The excess of the fair value of liabilities assumed and cash paid over the fair value of assets acquired is allocated to goodwill.

The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Although the Company maintains general liability and professional liability insurance policies for its owned, leased and managed facilities under a master insurance program, the Company’s current policies provide for deductibles of $3.0 million for each claim. As a result, the Company is, in effect, self-insured for most claims. In addition, the Company maintains a self-insured workers compensation program and a self-insured employee medical program for amounts below excess loss coverage amounts, as defined. The Company reviews the adequacy of its accruals related to these liabilities on an ongoing basis, using historical claims, actuarial valuations, third party administrator estimates, consultants, advice from legal counsel and industry data, and adjusts accruals periodically. Estimated costs related to these self-insurance programs are accrued based on known claims and projected claims incurred but not yet reported. Subsequent changes in actual experience are monitored and estimates are updated as information is available.

During the three months ended June 30, 2007, the Company recorded a $4.2 million receivable related to a collateral recovery from an insurance carrier for amounts owed to Alterra Healthcare Corporation, a wholly-owned subsidiary, pursuant to a pre-bankruptcy insurance policy.  Such amount had not previously been recognized by the Company due to the existence of preconfirmation contingencies which were resolved prior to June 30, 2007.  The receivable was recorded as a $3.8 million reduction of general and administrative expense and $0.4 million of interest income in the condensed consolidated statements of operations.  The receivable was collected in full in July 2007.

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. Specifically, the pronouncement prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on the related derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. The interpretation is effective for fiscal years beginning after December 15, 2006.  The Company adopted FIN 48 in the current year.  See note 12 for a discussion of the impact of the adoption of FIN 48.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements.  In February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities("SFAS 159"). SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Both SFAS 157 and SFAS 159 are effective for fiscal years beginning after November 15, 2007. The Company does not believe that the adoption of SFAS 157 and SFAS 159 will materially impact its financial position or results of operations.

On September 17, 2007, the Company’s board of directors declared a quarterly cash dividend of $0.50 per share of common stock, or an aggregate of $51.8 million, for the quarter ended September 30, 2007.  The $0.50 per share dividend was paid on October 12, 2007 to holders of record of the Company’s common stock on September 28, 2007.

Certain prior period amounts have been reclassified to conform to the current financial statement presentation, with no effect on the Company’s consolidated financial position or results of operations.

Compensation expense in connection with grants of restricted stock of $7.1 million and $5.9 million was recorded for the three months ended September 30, 2007 and 2006, respectively, and $26.2 million and $12.6 million of such expense was recorded for the nine months ended September 30, 2007 and 2006, respectively.  All amounts were net of forfeitures estimated at 5% of the shares granted.

On September 15, 2006, the Company entered into Separation and General Release Agreements with two officers that accelerated the vesting provision of a portion of their restricted stock grants upon satisfying certain conditions. As a result of the modification, the previous compensation expense related to these grants was reversed during the year ended December 31, 2006.  The fair value of the stock at the modification date was expensed over the modified service period. The impact of the adjustment was $4.1 million of additional expense for the nine months ended September 30, 2007.

For all awards with graded vesting other than awards with performance-based vesting conditions, the Company records compensation expense for the entire award on a straight-line basis over the requisite service period.  For graded-vesting awards with performance-based vesting conditions, total compensation expense is recognized over the requisite service period for each separately vesting tranche of the award as if the award is, in substance, multiple awards once the performance target is deemed probable of achievement.  Performance goals are evaluated quarterly.  If such goals are not ultimately met or it is not probable the goals will be achieved, no compensation expense is recognized and any previously recognized compensation expense is reversed.  During the current period, the Company reversed approximately $1.4 million of previously recognized compensation expense related to performance-based awards granted in 2007.

Current year grants of restricted shares under the Company’s Omnibus Stock Incentive Plan were as follows ($ in 000’s except for grants and per share amounts):

Following is a summary of changes in the carrying amount of goodwill for the nine months ended September 30, 2007 presented on an operating segment basis ($ in 000’s):

The additions to goodwill primarily related to adjusting the allocation of the purchase price for an acquisition which occurred in the third quarter of fiscal 2006.  The remaining additions resulted from an acquisition completed in the first quarter of 2007.  The adjustments primarily related to the adoption of FIN 48 in the first quarter of 2007 and its impact on acquired entities.

Intangible assets with definite useful lives are amortized over their estimated lives and are tested for impairment whenever indicators of impairment arise. The following is a summary of other intangible assets at September 30, 2007 and December 31, 2006 ($ in 000’s):

Amortization expense related to definite-lived intangible assets for the three and nine months ended September 30, 2007 was $8.9 million and $25.7 million, respectively.

Property, plant, equipment and leasehold intangibles, net consist of the following ($ in 000’s):

Financial results are impacted by the timing, size and number of acquisitions the Company completes in a period. During the nine months ended September 30, 2007, the number of facilities owned or leased by the Company increased by three.  The number of facilities owned or leased was unchanged by the Company’s acquisition of joint venture partner interests, its acquisition of remaining portions of owned facilities and its acquisition of service businesses.   The results of facilities and companies acquired are included in the condensed consolidated financial statements from the effective date of the acquisition.

On January 24, 2007, the Company acquired the interests held by its joint venture partners in a facility located in Flint, Michigan for approximately $3.9 million.  This facility is referred to as the “Flint Facility”.  In connection with the acquisition, the Company obtained $12.6 million of first mortgage financing bearing interest at LIBOR plus 1.15% payable interest only through February 1, 2012 and also entered into interest rate swaps to convert the loan from floating to fixed (note 7).

On February 1, 2007, the Company acquired the skilled nursing portion of a CCRC facility located in Jacksonville, Florida for approximately $6.8 million.  The assisted living and independent living portions of the facility were acquired in 2006 by the Company.  This facility is referred to as the “Atrium SNF”.  In connection with the

acquisition, the Company assumed a first mortgage note secured by the property in the amount of $3.7 million.  The note bears interest at 6.10% with principal and interest payable until maturity on September 1, 2039.

On February 15, 2007, the Company acquired certain home health care assets for approximately $3.0 million.  The purchase price was assigned entirely to goodwill. These operations are referred to as the “Home Health Acquisition”.

On February 28, 2007, the Company acquired a previously leased facility in Richmond Heights, Ohio for approximately $9.5 million.  This facility is referred to as the “Richmond Heights Facility”.

Effective as of April 1, 2007, the Company acquired the leasehold interests of three assisted living facilities located in California for approximately $10.8 million.  These facilities are referred to as the “Chancellor Portfolio”.

On April 4, 2007, the Company purchased the real property underlying an entrance fee continuing care retirement community located in Tampa, Florida for an aggregate purchase price of approximately $51.1 million.  The community consists of independent living retirement apartments, a skilled nursing facility and an assisted living facility.  We previously managed this community pursuant to a cash-flow management agreement and accounted for this community as a capital lease.  These facilities are referred to as the “Freedom Square Portfolio”.

On April 18, 2007, the Company acquired two facilities located in Ohio and North Carolina for approximately $102.0 million.  The facilities were previously operated by the Company under long term operating lease agreements.  These facilities are referred to as the “Saunders Portfolio”.

On May 31, 2007, the Company acquired a facility in Phoenix, Arizona in which we held partnership interests for approximately $15.3 million.  This facility is referred to as “Grand Court Phoenix”.

On July 1, 2007, the Company acquired the skilled nursing portion of a CCRC facility located in Lexington, Kentucky for approximately $7.5 million.  The assisted living and independent living portions of the facility are operated pursuant to an operating lease previously entered into by the Company.  This facility is referred to as the “Darby Facility”.

On August 31, 2007, the Company acquired three facilities located in South Carolina and Oklahoma for approximately $9.8 million.  The facilities were previously operated by the Company under long term operating lease agreements.  These facilities are referred to as the “HCN Portfolio”.

The above acquisitions were accounted for using the purchase method of accounting and the purchase prices were allocated to the associated assets and liabilities based on their estimated fair values.  The Company has made preliminary purchase price allocations for these transactions resulting in approximately $3.4 million of goodwill being recorded in the Retirement Centers/CCRCs segment and anticipates finalizing the purchase price allocations within one year of each respective acquisition date.

Long-term debt, capital leases and financing obligations consist of the following ($ in 000’s):

As of September 30, 2007, the Company had an available secured line of credit of $320.0 million ($70.0 million letter of credit sublimit) and a letter of credit facility of up to $80.0 million.  The line of credit bears interest at the

base rate plus 0.50% or LIBOR plus 1.50%, at the Company’s election.  The Company must also pay a fee equal to 1.50% of the amount of any outstanding letters of credit issued under the facilities.  In connection with entering into the credit facility agreement, the Company paid a commitment fee of 0.50% and is subject to a non-use fee of 0.25% on all unutilized amounts.  On October 10, 2007, the Company amended the credit facility agreement to, among other things, revise certain financial covenants and to address certain administrative matters.  The amended agreement matures on November 15, 2008 subject to extension at the Company’s option for two three-month extension periods and payment of a 0.1875% commitment fee with respect to each extension.  As of September 30, 2007, $231.0 million was drawn on the revolving loan facility and $110.0 million of letters of credit had been issued under the agreements.  The agreements are secured by a pledge of the Company’s tier one subsidiaries and, subject to certain limitations, subsidiaries formed to consummate future acquisitions.  As discussed in note 14, subsequent to September 30, 2007, the Company completed a $140.0 million financing and repaid $49.0 million of existing debt.  Net proceeds from the transaction were used to reduce amounts drawn on the revolving credit facility.  In addition, subsequent to September 30, 2007, the Company obtained $80.3 million of first mortgage financing bearing interest at 6.32%.  Approximately $53.6 million of the proceeds were disbursed at closing, with the remaining $26.7 million to be disbursed in connection with the construction of two new skilled nursing facilities and the renovation of an existing skilled nursing facility.  The net proceeds disbursed at closing were used to pay down amounts drawn against the Company’s revolving credit facility (note 14).

On January 16, 2007 and January 24, 2007, the Company financed a previous acquisition and the Flint Facility with $130.0 million of first mortgage financing bearing interest at LIBOR plus 1.15% payable interest only through February 1, 2012.  The Company also entered into interest rate swaps to convert the loan from floating to fixed.  The loan is secured by 27 previously acquired facilities and the Flint Facility and is partially secured by a $7.4 million letter of credit that will be released upon achievement of certain debt service coverage ratios.

On April 18, 2007, the Company financed a previously acquired facility as well as the Saunders Portfolio with $108.5 million of first mortgage financing bearing interest at LIBOR plus 0.70% payable interest only through August 1, 2012.  The Company has entered into interest rate swaps to convert the loan from floating to fixed.

The financings entered into on January 16, 2007, January 24, 2007 and April 18, 2007 are all part of the same master loan agreement whereby the amounts are secured by all properties under the master agreement.

On July 27, 2007, the Company financed one of its facilities with $30.0 million of first mortgage financing.  The note payable bears interest at 5.65% payable interest only through August 5, 2012 and is secured by the underlying property.  In conjunction with the refinancing, the Company repaid $16.1 million of existing debt.

On August 15, 2007, the Company financed the Freedom Square Portfolio with a $70.0 million note payable.  The note bears interest at 5.77% payable interest only through September 5, 2012 and is secured by the underlying property.

On September 25, 2007, the Company entered into a $41.4 million note payable.  The note bears interest at 6.69% payable interest only through July 2010, matures in July 2012 and is secured by six facilities.

In the normal course of business, the Company uses a variety of financial instruments to manage or hedge interest rate risk. The Company entered into certain interest rate protection and swap agreements to effectively cap or convert floating rate debt to a fixed rate basis, as well as to hedge anticipated future financing transactions. Pursuant to the Company’s hedge agreements, the Company is required to secure its obligation to the counterparty if the fair value liability exceeds a specified threshold.  Cash collateral pledged to the Company’s counterparty was $26.1 million and $41.0 million as of September 30, 2007 and October 31, 2007, respectively.

The Company does not enter into derivative contracts for trading or speculative purposes. Furthermore, the Company has a policy of only entering into contracts with major financial institutions based upon their credit rating and other factors.  Under certain circumstances, the Company may be required to replace a counterparty in the event that the counterparty does not maintain a certain credit rating.

The following table summarizes the Company’s swap instruments at September 30, 2007 ($ in 000’s):

Prior to October 1, 2006, the Company qualified for hedge accounting on designated swap instruments pursuant to SFAS No. 133, Accounting for Derivative Instruments and Certain Hedging Activities, with the effective portion of the change in fair value of the derivative recorded in other comprehensive income and the ineffective portion included in the change in fair value of derivatives and amortization in the statement of operations.

On October 1, 2006, the Company elected to discontinue hedge accounting prospectively for the previously designated swap instruments. Consequently, the net gains and losses accumulated in other comprehensive income at that date of $1.3 million related to the previously designated swap instruments are being amortized to interest expense over the life of the underlying hedged debt payments. In the future, if the underlying hedged debt is extinguished or refinanced, the remaining unamortized gain or loss in accumulated other comprehensive income will be recognized in the statements of operations. Although hedge accounting was discontinued on October 1, 2006, the swap instruments remain outstanding and are carried at fair value in the consolidated balance sheet and the change in fair value beginning October 1, 2006 has been included in the statements of operations.

In April 2007, the Company entered into two separate treasury rate locks for notional amounts of $70.0 million and $50.0 million in anticipation of the Company’s planned future issuance of $120.0 million of fixed-rate debt.  Both rate locks expired in May 2007 and resulted in a cash receipt to the Company of approximately $0.4 million which has been included in the results from operations.

In July 2007, the Company entered into a series of forward starting interest rate swaps in the aggregate notional amount of $553.1 million in anticipation of planned future financing transactions as well as the replacement of certain existing hedges that will be expiring.  The swaps are being carried at fair value in the consolidated balance sheet and the change in fair value is included in the statements of operations.

In connection with the sale of certain facilities to Ventas Realty Limited Partnership (“Ventas”) in 2004, two legal actions have been filed. The first action was filed on September 15, 2005, by current and former limited partners in 36 investing partnerships in the United States District Court for the Eastern District of New York captioned David T. Atkins et al. v. Apollo Real Estate Advisors, L.P., et al. (the “Action”). On March 17, 2006, a third amended complaint was filed in the Action. The third amended complaint is brought on behalf of current and former limited partners in 14 investing partnerships. It names as defendants, among others, the Company, Brookdale Living Communities, Inc. (“BLC”), a subsidiary of the Company, GFB-AS Investors, LLC (“GFB-AS”), a subsidiary of BLC, the general partners of the 14 investing partnerships, which are alleged to be subsidiaries of GFB-AS, Fortress Investment Group (“Fortress”), an affiliate of the Company’s largest stockholder, and R. Stanley Young, the Company’s former Chief Financial Officer. The nine count third amended complaint alleges, among other things, (i) that the defendants converted for their own use the property of the limited partners of 11 partnerships, including through the failure to obtain consents the plaintiffs contend were required for the sale of facilities indirectly owned by those partnerships to Ventas; (ii) that the defendants fraudulently persuaded the limited partners of three partnerships to give up a valuable property right based upon incomplete, false and misleading statements in connection with certain consent solicitations; (iii) that certain defendants, including GFB-AS, the general partners, and the Company’s former Chief Financial Officer, but not including the Company, BLC, or Fortress, committed mail fraud in connection with the sale of facilities indirectly owned by the 14 partnerships at issue in the Action to

Ventas; (iv) that certain defendants, including GFB-AS and the Company’s former Chief Financial Officer, but not including the Company, BLC, the general partners, or Fortress, committed wire fraud in connection with certain communications with plaintiffs in the Action and another investor in a limited partnership; (v) that the defendants, with the exception of the Company, committed substantive violations of the Racketeer Influenced and Corrupt Organizations Act (“RICO”); (vi) that the defendants conspired to violate RICO; (vii) that GFB-AS and the general partners violated the partnership agreements of the 14 investing partnerships; (viii) that GFB-AS, the general partners, and the Company’s former Chief Financial Officer breached fiduciary duties to the plaintiffs; and (ix) that the defendants were unjustly enriched. The plaintiffs have asked for damages in excess of $100.0 million on each of the counts described above, including treble damages for the RICO claims. On April 18, 2006, the Company filed a motion to dismiss the claims with prejudice, which remains pending before the court, and plans to continue to vigorously defend this Action. A putative class action lawsuit was also filed on March 22, 2006, by certain limited partners in four of the same partnerships involved in the Action in the Court of Chancery for the State of Delaware captioned Edith Zimmerman et al. v. GFB-AS Investors, LLC and Brookdale Living Communities, Inc. (the “Second Action”). On November 21, 2006, an amended complaint was filed in the Second Action. The putative class in the Second Action consists only of those limited partners in the four investing partnerships who are not plaintiffs in the Action. The Second Action names as defendants BLC and GFB-AS. The complaint alleges a claim for breach of fiduciary duty arising out of the sale of facilities indirectly owned by the investing partnerships to Ventas and the subsequent lease of those facilities by Ventas to subsidiaries of BLC. The plaintiffs seek, among other relief, an accounting, damages in an unspecified amount, and disgorgement of unspecified amounts by which the defendants were allegedly unjustly enriched. On December 12, 2006, the Company filed an answer denying the claim asserted in the amended complaint and providing affirmative defenses. On December 27, 2006, the plaintiffs moved to certify the Action as a class action. Both the plaintiffs and defendants have served document production requests and the Action is currently in the beginning stages of document discovery. The Company also intends to vigorously defend this Second Action. Because these actions are in an early stage, the Company cannot estimate the possible range of loss, if any.

In addition, the Company has been and is currently involved in other litigation and claims incidental to the conduct of its business which are comparable to other companies in the senior living industry. Certain claims and lawsuits allege large damage amounts and may require significant legal costs to defend and resolve. Similarly, the senior living industry is continuously subject to scrutiny by governmental regulators, which could result in litigation related to regulatory compliance matters. As a result, the Company maintains insurance policies in amounts and with coverage and deductibles the Company believes are adequate, based on the nature and risks of its business, historical experience and industry standards.  Because the Company’s current policies provide for deductibles of $3.0 million for each claim, the Company is, in effect, self-insured for most claims.

A summary of facility lease expense and the impact of straight-line adjustment and amortization of deferred gains are as follows ($ in 000’s):

The following table presents the after-tax components of the Company’s other comprehensive loss for the periods presented ($ in 000’s):

The Company’s effective tax rate for the three months ended September 30, 2007 and 2006 was 37.3% and 31.3%, respectively, and for the nine months ended September 30, 2007 and 2006 was 37.7% and 16.1%, respectively.  The difference between the periods is primarily due to the ability to tax benefit book losses in the first two quarters of 2007 compared to the same period in 2006.  In the third quarter of 2007, the Company adjusted its deferred tax assets as of December 31, 2006, based on the actual tax returns filed.  As a result of filing the returns, the Company has increased its net operating losses by $23.0 million.  Approximately $8.0 million of the increase is related to pre-merger activity and is recorded against goodwill, the remaining $15.0 million is primarily due to additional tax depreciation deducted and is offset in other deferred tax liabilities, and therefore no additional impact on tax expense was recorded in the period.  The Company’s adjusted federal net operating loss at December 31, 2006 was $201.5 million, which is available to offset future taxable income through 2025.  The Company continues to recognize this tax asset on its balance sheet as it is more likely than not to utilize this loss prior to any expiration.  Also as part of filing the returns, the Company adjusted its pre-merger state tax losses and related valuation allowances, impacting goodwill.

The Company adopted the provisions of FIN 48 on January 1, 2007.  The adoption of FIN 48 resulted in a transition adjustment to goodwill of $1.6 million, comprised of $1.4 million in taxes and $0.2 million in interest and penalties.  The adoption impacted goodwill versus retained earnings as the original benefit recorded on these positions was recorded to goodwill in previous purchase accounting transactions.  Interest and penalties related to these tax positions are classified as tax expense in the Company’s financial statements.  Tax returns for all wholly owned subsidiaries for the years 2002 through 2006 are subject to future examination by tax authorities.  In addition, for one wholly owned subsidiary, Alterra Healthcare Corporation, tax returns are open from 1999 through 2001 to the extent of the net operating losses generated during those periods.  The Company has reviewed its FIN 48 position as of September 30, 2007 and has adjusted its reserve for additional interest and some minor changes to its uncertain positions, based on the current returns filed.

Under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, the Company determined that it has four reportable segments based on the way that its chief operating decision makers organize the Company’s business activities for making operating decisions and assessing performance.  The four segments are independent living; assisted living; retirement centers/CCRCs; and management services.

The following table sets forth certain segment financial and operating data ($ in 000’s)

On October 31, 2007, the Company obtained $140.0 million of first mortgage financing bearing interest at 5.84%.  The debt matures on November 1, 2014, subject to extension at the Company’s option.  The loan is secured by 21 of the Company's facilities.  In conjunction with the financing, the Company repaid $49.0 million of existing debt.  The net proceeds from the transaction were used to pay down amounts drawn against the Company’s revolving credit facility (note 7). 

On November 5, 2007, the Company obtained $80.3 million of first mortgage financing bearing interest at 6.32%.  Approximately $53.6 million of the proceeds were disbursed at closing, with the remaining $26.7 million to be disbursed in connection with the construction of two new skilled nursing facilities and the renovation of an existing skilled nursing facility.  The debt matures on August 5, 2012.  The loan is secured by five of the Company’s existing facilities and the two facilities under construction.  The net proceeds disbursed at closing were used to pay down amounts drawn against the Company’s revolving credit facility (note 7).

Certain statements in this Quarterly Report on Form 10-Q and other information we provide from time to time may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Those forward-looking statements include all statements that are not historical statements of fact and those regarding our intent, belief or expectations, including, but not limited to, statements relating to our ability to deploy capital, close accretive transactions, anticipate, manage and address industry trends and their effect on our business, grow dividends, generate growth organically or through acquisitions, achieve operating efficiencies and cost savings, expand our offering of ancillary services (therapy and home health) to additional facilities, expand existing facilities, develop new facilities, secure financing and increase revenues, earnings, Adjusted EBITDA, Cash From Facility Operations, and/or Facility Operating Income (as such terms are defined herein) and add residents and statements relating to our expectations for the performance of our entrance fee communities and our expected levels of expenditures. Words such as “anticipate(s)”, “expect(s)”, “intend(s)”, “plan(s)”, “target(s)”, “project(s)”, “believe(s)”, “will”, “would”, “seek(s)”, “estimate(s)” and similar expressions are intended to identify such forward-looking statements. These statements are based on management’s current expectations and beliefs and are subject to a number of risks and uncertainties that could lead to actual results differing materially from those projected, forecasted or expected. Although we believe that the assumptions underlying the forward-looking statements are reasonable, we can give no assurance that our expectations will be attained. Factors that could cause actual results to differ materially from our expectations include, but are not limited to, our ability to integrate the facilities of American Retirement Corporation (“ARC”) or other acquisitions into our operations; our continued ability to acquire facilities at attractive prices which will generate returns consistent with expectations; the possibility that the facilities that we have recently acquired and will acquire may not generate sufficient additional income to justify their acquisition; possibilities that conditions to closing of certain transactions will not be satisfied; the possibilities that changes in the capital markets, including changes in interest rates and/or credit spreads, or other factors could make financing more expensive or unavailable to us; a decrease in the overall demand for senior housing; general economic conditions and economic conditions in the markets in which we operate; downturns in the real estate markets in the regions where our facilities are located; competitive pressures within the industry and/or markets in which we operate; the creditworthiness of our residents; interest rate fluctuations; licensing risks (including delays in obtaining regulatory approvals); our failure to comply with federal, state and local laws and regulations; our failure to comply with environmental laws; the effect of future legislation or regulatory changes on our operations; and other risks detailed from time to time in our filings with the Securities and Exchange Commission, press releases and other communications, including those set forth under “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2006. Such forward-looking statements speak only as of the date of this Quarterly Report. We expressly disclaim any obligation to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or change in events, conditions or circumstances on which any statement is based.

During the third quarter, we continued to focus on implementing the growth strategy outlined in our most recent Annual Report on Form 10-K.  As previously disclosed, we are focusing on increasing our revenues, cash flows and dividends per share through a combination of: (i) organic growth in our existing operations; (ii) expansion of our ancillary service programs (including therapy and home health services); (iii) selected acquisitions of additional operating companies and facilities; and (iv) expansion of our existing facilities. The following is a brief discussion of our progress during the quarter and nine months ended September 30, 2007.

Our revenues for the quarter ended September 30, 2007 increased to $464.6 million, an increase of $77.6 million, or approximately 20.0%, over the third quarter of 2006.  The increase in revenues was primarily a result of a $281 increase in the average revenue per unit/bed over the prior year quarter, as occupancy remained relatively flat across our portfolio.  The number of acquisitions we completed in the fourth quarter of 2006 and the first nine months of 2007 also contributed to our revenue growth in the current period.  Including the effect of the historical results of the ARC facilities only partially included in our results of operations in the prior-year quarter, same store revenues grew 6.3%.

In addition, we declared a dividend of $0.50 per share for the third quarter, an increase of 25.0% over the $0.40 per share dividend declared for the third quarter of 2006.

During the third quarter, we acquired a skilled nursing facility adjacent to one of our facilities and purchased three facilities that were previously leased by us.  Year-to-date, we have completed expansions at five facilities and had eight expansion projects under construction as of September 30, 2007.  As a result of our acquisition and expansion activity, the number of units we operated as of the end of the third quarter increased to 52,082, an increase of 992 units, or 1.9%, over the same prior year quarter.

We also continued to make progress in expanding our ancillary services programs to additional facilities during the third quarter. For the nine months ended September 30, 2007, we have completed the roll-out of our ancillary services program to over 11,000 additional units.  Although the roll-out of ancillary services has been ahead of our original plan, we have faced some regulatory delays in expanding the home health portion of our business.

We have increased our revenues, cash flows and dividends per share during 2007 and have achieved positive same-store results. Nevertheless, our growth initiatives have been negatively impacted by unfavorable conditions in the housing, credit and financial markets.  For example, we believe that the difficult housing market and general economic uncertainty have caused some potential customers (or their adult children) to delay or reconsider moving into our facilities, thus hindering our ability to increase occupancy above the current 91% level.  In addition, we continue to experience volatility in the entrance fee portion of our business.  Although our third quarter net entrance fees sales increased over the previous quarter, they continued to be negatively impacted by softness in the housing markets in certain of the markets in which we operate (primarily certain areas of Florida and Arizona).  The timing of entrance fee sales is subject to a number of different factors and is also inherently subject to variability (positively or negatively) when measured over the short-term.  We continue to expect entrance fee sales to normalize over the longer term.

The following table sets forth, for the periods indicated, statement of operations items and the amount and percentage of increase or decrease of these items. The results of operations for any particular period are not necessarily indicative of results for any future period. The following data should be read in conjunction with our condensed consolidated financial statements and the notes thereto, which are included herein. Our results reflect the inclusion of acquisitions that occurred during the respective reporting periods.  Refer to our most recent Annual Report on Form 10-K for the year ended December 31, 2006, filed March 16, 2007, and Quarterly Reports on Form 10-Q for the quarters ended March 31, 2007 and June 30, 2007, filed May 8, 2007 and August 8, 2007, respectively, and the notes to our condensed consolidated financial statements included herein for additional information regarding these acquisitions ($ in 000’s):

 

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The increase in resident fees was driven by revenue growth across all business segments.  Resident fees increased over the prior-year third quarter mainly due to the number of acquisitions that we completed during the latter part of 2006 and the first half of 2007, as resident fees from these acquisitions are partially or entirely excluded from the prior period results.  Including the full effect of the historical results of the ARC facilities only partially included in our results of operations in the third quarter of 2006, same store revenues grew 6.3% over the third quarter of 2006.

Independent living revenue increased $12.4 million, or 12.2%, primarily due to an increase in the average monthly revenue per unit/bed at the facilities we operated during both periods.  Occupancy at these same-store facilities remained fairly constant period over period.  Revenue growth was also impacted by the inclusion of facilities acquired during 2006 and 2007, as resident fees from these acquisitions are partially or entirely excluded from the prior period results.

Assisted living revenue increased $22.0 million, or 12.5%, primarily due to the 2006 and 2007 acquisitions.  Additionally, resident fees increased as a result of an increase in the average monthly revenue per unit/bed at the facilities we operated during both periods, partially offset by a slight decrease in occupancy as compared to the same period in the prior-year.

Retirement Centers/CCRCs revenue increased $43.0 million, or 39.9%, primarily due to the acquisition of ARC in the third quarter of 2006 and other 2007 acquisitions.  Additionally, the average monthly revenue per unit/bed increased period over period when including the effect of the historical results of the ARC facilities.

Management fees were comparable period over period as the number of management contracts maintained was fairly consistent during both periods.

Facility operating expense increased over the prior-year same period mainly due to the ARC acquisition as well as other 2006 and 2007 acquisitions.  The increase was primarily due to salaries, wages and benefits.

Independent living operating expenses increased $4.8 million, or 7.9%, primarily due to the 2006 and 2007 acquisitions.  The remaining increase is primarily due to an increase in operating expenses for facilities we operated during both periods, mainly for salaries, wages and benefits.

Assisted living operating expenses increased $19.0 million, or 17.1%, primarily due to increased salaries, wages and benefits resulting from the 2006 acquisitions and additional 2007 acquisitions.

Retirement Centers/CCRC operating expenses increased $26.1 million, or 35.4%, primarily due to the acquisition of ARC during July 2006 and additional 2007 acquisitions.

General and administrative expenses increased $5.5 million, or 18.8%, primarily as a result of an increase in salaries, wages and benefits and an increase in the number of employees in connection with the 2006 acquisition of ARC.  The increase was partially offset by a decreased in non-cash stock based compensation expense.  General and administrative expense as a percentage of total revenue, including revenue generated by the facilities we manage, was 4.7% and 4.8% for the three months ended September 30, 2007 and 2006, respectively, calculated as follows ($ in 000’s):

Lease expense increased by $4.1 million, or 6.4%, primarily due to the 2007 and 2006 acquisitions.  The increase was slightly offset by a decrease in lease expense as a result of the acquisition of certain facilities which were previously leased.  Lease expense includes straight-line rent expense of $6.5 million and $6.1 million for the three months ended September 30, 2007 and 2006, respectively, and is partially offset by $1.1 million of additional deferred gain amortization for both periods.

Total depreciation and amortization expense increased by $18.4 million, or 30.1%, primarily due to the acquisition of ARC as well as other 2006 and 2007 acquisitions.  The increase was partially offset by a decrease in expense for certain resident in-place lease intangibles which were fully depreciated at the end of 2006.

Interest income remained constant period over period.

Interest expense increased $51.1 million, or 158.3%, primarily due to the change in fair value of our interest rate swaps as well as interest expense on additional debt incurred in connection with our acquisitions and refinancings.  During the current quarter, we recognized approximately $43.7 million of interest expense on our interest rate swaps due to unfavorable changes in the LIBOR yield curve which resulted in a change in the fair value of the swaps.  The effective portion of the change in fair value of derivatives was excluded from interest expense and was included in other comprehensive loss for the three months ended September 30, 2006.  On October 1, 2006, we discontinued hedge accounting prospectively.  Changes in fair value of derivatives are now included in interest expense.

Our effective tax rates for the three months ended September 30, 2007 and 2006 were 37.3% and 31.3%, respectively.  The difference between the periods is primarily due to purchase accounting adjustments recorded in 2006, generated in connection with the ARC acquisition.

The following table sets forth, for the periods indicated, statement of operations items and the amount and percentage of increase or decrease of these items. The results of operations for any particular period are not necessarily indicative of results for any future period. The following data should be read in conjunction with our condensed consolidated financial statements and the notes thereto, which are included herein. Our results reflect the inclusion of acquisitions that occurred during the respective reporting periods.  Refer to our Annual Report on Form 10-K for the year ended December 31, 2006, filed March 16, 2007, our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2007 and June 30, 2007, filed May 8, 2007 and August 8, 2007, respectively, and the notes to our condensed consolidated financial statements included herein for additional information regarding these acquisitions ($ in 000’s):