UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

For the quarterly period ended September 30, 2007

OR

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)

617-796-8387

(Registrant’s Telephone Number Including Area Code)

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 x  No o

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

Large accelerated filer o  Accelerated filer x   Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o  No x

Number of Common Shares outstanding at November 7, 2007: 31,708,134 shares of common stock, $0.01 par value.

FIVE STAR QUALITY CARE, INC.

FORM 10-Q

September 30, 2007

INDEX

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

Part I.     Financial Information

Item 1. Consolidated Financial Statements

FIVE STAR QUALITY CARE, INC.

CONSOLIDATED BALANCE SHEET

(dollars in thousands, except share amounts)

(unaudited)

See accompanying notes.

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FIVE STAR QUALITY CARE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(dollars in thousands, except per share amounts)

(unaudited)

See accompanying notes.

2

FIVE STAR QUALITY CARE, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(dollars in thousands)

(unaudited)

See accompanying notes.

3

FIVE STAR QUALITY CARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share amounts)

(unaudited)

Note 1.  Basis of Presentation and Organization

Certain information and disclosures required by 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, 2006.  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 have been eliminated.  Our operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.  Reclassifications have been made to the prior year’s financial statements to conform to the current year’s presentation.  Material changes are limited to reclassifying accrued benefits out of other current liabilities and reclassifying available-for-sale securities out of investments in trading securities.  These reclassifications had no effect on net income or shareholders’ equity.

As of September 30, 2007, we operated 161 senior living communities containing 17,911 living units, including 112 primarily independent and assisted living communities containing 13,507 living units and 49 nursing homes containing 4,404 living units.  Of our 112 primarily independent and assisted living communities, we leased 95 communities containing 12,244 living units from Senior Housing Properties Trust, or Senior Housing, our former parent, and we owned or leased from parties other than Senior Housing 17 communities containing 1,263 living units.  We leased 47 of our 49 nursing homes from Senior Housing.  Our 161 communities include 5,627 independent living apartments, 6,235 assisted living suites and 6,049 skilled nursing units.  We also operated six institutional pharmacies, one of which provided mail order pharmaceuticals to the general public, and we operated two rehabilitation hospitals that we leased from Senior Housing.  Our two rehabilitation hospitals have 341 beds available for inpatient services, three satellite locations and 20 outpatient clinics.

Note 2. Property and Equipment

Property and equipment, at cost, consists of:

As of  September 30, 2007 and December 31, 2006, we had assets classified as held for sale of $26,108 and $15,478, respectively, included in our property and equipment, that we intend to sell to Senior Housing as permitted by our leases.

Note 3. Comprehensive Income (Loss)

Comprehensive income (loss) for the three and nine months ended September 30, 2007 and 2006 is summarized below:

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Note 4.  Financial Data By Segment

Our reportable segments consist of our senior living community business and our rehabilitation hospital business that we began to operate in October 2006.   In the senior living community segment, we operate independent living and congregate care communities, assisted living communities and nursing homes.  Our rehabilitation hospital segment provides inpatient health rehabilitation services at our two hospital locations and three satellite locations and outpatient health rehabilitation services at 20 locations.  We do not consider our pharmacy operations to be a material, separately reportable segment of our business but we report our pharmacy revenues and expense as separate items within our corporate and other activities.  All of our operations and assets are located in the United States.

We use segment operating profit as an important measure to evaluate our performance and for decision making purposes.  Segment operating profit excludes interest and other income, interest expense and certain corporate expenses.

Our revenues by segment and a reconciliation of segment operating profit to income from continuing operations before income taxes for the three and nine months ended September 30, 2007 and 2006 are as follows:

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(1) Corporate and Other includes operations that we do not consider significant, separately reportable segments of our business and income and expenses that are not attributable to a specific segment.

(2) General and administrative expenses are not attributable to a specific segment and include items such as corporate payroll and benefits and outside service expenses.

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Note 5.  Income Taxes

In June 2006, the Financial Accounting Standards Board issued Interpretation No. 48 “Accounting for Uncertainty in Income Taxes”, or FIN 48.  FIN 48 prescribes how we should recognize, measure and present in our financial statements uncertain tax positions that have been taken or are expected to be taken in a tax return. Pursuant to FIN 48, we can recognize a tax benefit only if it is “more likely than not” that a particular tax position will be sustained upon examination or audit. To the extent the “more likely than not” standard has been satisfied, the benefit associated with a tax position is measured as the largest amount that has a greater than 50% likelihood of being realized upon settlement.

As required, we adopted FIN 48 effective January 1, 2007 and have concluded the effect is not material to our consolidated financial statements.  Accordingly, we did not record a cumulative effect adjustment related to the adoption of FIN 48.  At the date of adoption, we had $785 in unrecognized tax benefits related to FIN 48 plus significant tax loss carry forwards totaling approximately $201,000 which, if recognized, would favorably affect our effective tax rate.  We do not believe that our unrecognized tax benefits related to FIN 48 will change significantly in the next 12 months.

Because we have historically reported losses, we do not currently recognize the benefit of all of our deferred tax assets, including tax loss carry forwards that may be used to offset future taxable income.  We will, however, continue to assess our ability to generate sufficient taxable income during future periods in which our deferred tax assets may be realized. When we believe that we will more likely than not recover our deferred tax assets, we will record deferred tax assets as an income tax benefit in the consolidated statement of operations, which will affect our results of operations. Our net operating loss carry forwards begin to expire in 2023, if unused.  Our tax loss carry forwards and tax returns filed for the 2002 through 2006 tax years are subject to examination by taxing authorities.

For the nine months ended September 30, 2007, we recognized tax expense of $760, which includes $593 of alternative minimum taxes and certain state taxes that are payable without regard to our tax loss carry forwards and $167 of a non cash deferred tax liability arising from the amortization of goodwill for tax purposes but not for book purposes. We may recognize this deferred tax liability as a reduction in the income tax provision if, in some future period, we expense the related items of goodwill for book purposes as the result of its sale, other disposition or its impairment.

Note 6.  Earnings Per Share

Basic earnings per share for the periods ended September 30, 2007 and 2006 is computed using the weighted average number of shares outstanding during the periods.  Diluted earnings per share for the period ended September 30, 2007 reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income applicable to common shareholders that would result from their assumed issuance.  The effect our convertible senior notes have on loss from discontinued operations per share is anti-dilutive for the three and nine months ended September 30, 2007, respectively.

The following table provides a reconciliation of net income and the number of common shares used in the computations of diluted earnings per share, or EPS:

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Note 7.  Acquisitions

In April 2007, we acquired a 48 unit assisted living community located in Tennessee for $5,025.  We financed the acquisition by assuming a $4,559 non recourse United States Department of Housing, or HUD, insured mortgage and paying the balance of the purchase price with cash on hand.  The interest rate on the assumed HUD insured mortgage is 7.65%.  We included the results of this community’s operations in our consolidated financial statements from the date of acquisition.  All of the community’s revenues come from residents’ private resources.  We acquired this community to expand our business in high quality senior living operations where residents pay for our services with private resources.

Note 8.  Line of Credit

In June 2007, we amended our revolving line of credit.  The amendment increased the line from $25,000 to $40,000, extended the termination date to May 8, 2009 and reduced the interest rate by 25 basis points.  Our revolving line of credit is available for acquisitions, working capital and general business purposes.  The amount we are able to borrow at any time is subject to limitation based upon qualifying collateral.  We are the borrower under this revolving credit facility and certain of our subsidiaries guarantee our obligations under the facility, which is secured by our and our guarantor subsidiaries’ accounts receivable, deposit accounts and related assets.  The facility contains covenants requiring us to maintain collateral, minimum net worth and certain other financial ratios, limits our ability to incur or assume debt or create liens with respect to certain of our properties and has other customary provisions.  In certain circumstances and subject to available collateral and lender approvals, the maximum amounts which we may draw under this credit facility may be increased to $80,000.  The termination date may be extended twice, in each case by twelve months, subject to lender approval, our payment of extension fees and other conditions.  As of September 30, 2007 and November 7, 2007, no amounts were outstanding under this credit facility.  As of September 30, 2007 and November 7, 2007 we believe we are in compliance with all applicable covenants under this credit facility.   Interest expense and other associated costs related to this facility were $0 and $119 for the three months ended September 30, 2007 and 2006, respectively, and $318 and $388 for the nine months ended September 30, 2007 and 2006, respectively.

Note 9.  Mortgages Payable

At September 30, 2007, four of our communities were encumbered by five HUD insured mortgages totaling $16,067.  The weighted average interest rate on these loans was 6.6 %.  Payments of principal and interest are due monthly until maturities at varying dates ranging from June 2035 to July 2043.  These mortgages contain standard HUD mortgage covenants.    We recorded mortgage premiums in connection with some of these HUD mortgages in order to record assumed mortgages at their estimated fair value.  The mortgage premiums are being amortized as a reduction of interest expense until the maturity of the mortgages.  The mortgage premium balance included in mortgage notes payable as of September 30, 2007 was $797.

In February 2007, we prepaid six mortgages that were secured by five of our senior living communities.  We paid $22,923 to retire these six mortgages, which consisted of approximately $22,198 in principal and interest and $725 in prepayment penalties.  Because we had carried these mortgages at a premium to their face value, we recognized a net gain of $3,557 in connection with the early extinguishment of debt.  In April 2007, we prepaid one mortgage that was secured by one of our communities.  We paid $5,944 to retire this mortgage, which consisted of approximately $5,828 in principal and interest and $115 in prepayment penalties.  Because we had carried this mortgage at a premium to its face value, we recognized a net gain of approximately $934 in connection with the early extinguishment of debt.  Mortgage interest expense, including premium amortization, was $226 and $667 for the three months ended September 30, 2007 and 2006, respectively, and $882 and $2,031 for the nine months ended September 30, 2007 and 2006, respectively.

As discussed in Note 7, in April 2007 we acquired a 48 unit assisted living community located in Tennessee for $5,025.  We financed the acquisition by assuming a $4,559 non recourse HUD insured mortgage and paying the balance of the purchase price with cash on hand.  The interest rate on the assumed HUD insured mortgage is 7.65%.

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Note 10. Convertible Senior Notes due 2026

In October 2006, we issued $126,500 principal amount of 3.75% convertible senior notes. Our net proceeds from this offering were approximately $122,600. These notes are convertible into our common shares at any time. The initial conversion rate, which is subject to adjustment, is 76.9231 common shares per $1 principal amount of notes, which represents an initial conversion price of $13.00 per share. Interest expense and other associated costs on the notes were $1,238 and $3,719 for the three and nine months ended September 30, 2007, respectively. The notes are guaranteed by certain of our domestic wholly owned subsidiaries (see Note 13). These notes mature on October 15, 2026; we may prepay them at anytime after October 20, 2011 and the note holders may require that we purchase all or a portion of these notes on each October 15 of 2013, 2016 and 2021. We issued these notes pursuant to an indenture which contains various customary covenants. We believe we are in compliance with all applicable covenants of the indenture.

Note 11. Related Party Transactions

We lease 142 of the 161 senior living communities and the two rehabilitation hospitals that we operated on September 30, 2007 from Senior Housing for total annual minimum rent of $127,594. In addition to the minimum rent, we paid $690 and $244 in percentage rent to Senior Housing for the three months ended September 30, 2007 and 2006, respectively and $1,857 and $876 for the nine months ended September 30, 2007 and 2006, respectively.

During the nine months ended September 30, 2007, as permitted by our leases with Senior Housing, we sold to Senior Housing, at cost, $33,077 of improvements made to properties leased from Senior Housing, and the annual rent payable to Senior Housing increased by $3,194.

Note 12. Discontinued Operations

In March 2007, we agreed with Senior Housing that it should sell two assisted living communities in Pennsylvania, which we lease from Senior Housing.  We and Senior Housing are in the process of selling these assisted living communities and, upon their sale, our annual minimum rent payable to Senior Housing will decrease by 9.5% of the net proceeds of the sale to Senior Housing. As of September 30, 2007, we have disposed of substantially all of our assets and settled all liabilities related to these two communities. We have reclassified the statement of operations for all periods presented to show the results of operations of the communities which have been sold or are expected to be sold as discontinued. A summary of the operating results of these discontinued operations included in the financial statements for the three and nine months ended September 30, 2007 and 2006 is:

Note 13. Guarantor Financial Information

Our convertible notes are guaranteed by certain of our domestic wholly owned subsidiaries. Such guarantees are full, unconditional and joint and several. Condensed consolidating financial information related to the Company, its guarantor subsidiaries and non-guarantor subsidiaries for all periods presented are as follows:

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Consolidating Statement of Operations

For the three months ended September 30, 2007