10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

|X|	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period ended June 30, 2004
	or
|_|	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the transition period from  _________ to  ___________
	Commission file number  01-13031

AMERICAN RETIREMENT CORPORATION
(Exact Name of Registrant as Specified in its Charter)

Tennessee	62-1674303
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
111 Westwood Place, Suite 200, Brentwood, TN	37027
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s Telephone Number, Including Area Code:  (615) 221-2250

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  |_|

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  |_|  No  |X|

As of August 11, 2004, 24,609,065 shares of the Registrant’s common stock, $.01 par value, were outstanding.

INDEX

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003 (Unaudited)	2
	Condensed Consolidated Statements of Operations for the Three Months Ended June 30, 2004 and 2003 (Unaudited)	3
	Condensed Consolidated Statements of Operations for the Six Months Ended June 30, 2004 and 2003 (Unaudited)	4
	Condensed Consolidated Statements of Cash  Flows for the Six Months Ended June 30, 2004 and 2003 (Unaudited)	5
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38
Item 4.	Controls and Procedures	39
PART II. OTHER INFORMATION
Item 4.	Submission of Matters to a Vote of Security Holders	40
Item 6.	Exhibits and Reports on Form 8-K	41
Signatures		43

PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements

AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share data)

				June 30, 2004			December 31, 2003
ASSETS
Current assets:
	Cash and cash equivalents			$	18,925		$	17,192
	Assets limited as to use				24,033			20,947
	Accounts receivable, net of allowance for doubtful accounts				15,553			14,902
	Inventory				1,274			1,308
	Prepaid expenses				3,524			3,900
	Deferred income taxes				2,936			2,936
	Assets held-for-sale				1,512			6,426
	Other current assets				10,600			10,989
			Total current assets		78,357			78,600
Assets limited as to use, excluding amounts classified as current					23,366			22,654
Land, buildings and equipment, net of accumulated depreciation					532,765			533,145
Notes receivable					18,745			18,925
Goodwill					36,463			36,463
Leasehold acquisition costs, net of accumulated amortization					30,812			33,207
Other assets					46,090			51,289
			Total assets	$	766,598		$	774,283
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
	Current portion of long-term debt
		Long-term debt		$	11,200		$	10,782
		Lease financing obligations			5,842			5,433
	Debt associated with assets held-for-sale				—			7,000
	Accounts payable				4,679			4,800
	Accrued interest				3,033			3,330
	Accrued payroll and benefits				10,616			10,536
	Accrued property taxes				8,404			10,742
	Other accrued expenses				8,042			8,234
	Other current liabilities				9,109			9,140
			Total current liabilities		60,925			69,997
Long-term debt, excluding current portion
		Long-term debt			246,906			252,906
		Lease financing obligations			93,018			95,414
Refundable portion of entrance fees					78,330			72,980
Deferred entrance fee income					141,946			139,813
Tenant deposits					4,685			4,751
Deferred gains on sale-leaseback transactions					87,703			92,596
Deferred income taxes					5,360			5,360
Other long-term liabilities					21,056			17,774
			Total liabilities		739,929			751,591
Minority interest					21,658			21,885
Commitments and contingencies (See notes)
Shareholders’ equity:
	Preferred stock, no par value; 5,000,000 shares authorized, no shares issued or outstanding				—			—
	Common stock, $.01 par value; 200,000,000 shares authorized, 24,585,990 and 19,670,501 shares issued and outstanding, respectively				246			197
	Additional paid-in capital				162,397			150,896
	Accumulated deficit				(157,632	)		(150,286	)
			Total shareholders’ equity		5,011			807
			Total liabilities and shareholders’ equity	$	766,598		$	774,283

See accompanying notes to condensed consolidated financial statements.

2

AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share data)

			Three months ended June 30,
			2004			2003
Revenues:
	Resident and health care		$	109,110		$	97,378
	Management and development services			515			383
	Reimbursed expenses			524			613
		Total revenues		110,149			98,374
Operating expenses:
	Community operating expenses			74,065			68,898
	General and administrative			6,114			6,837
	Lease expense			15,158			10,366
	Depreciation and amortization			6,547			6,969
	Amortization of leasehold acquisition costs			728			530
	Reimbursed expenses			524			613
		Total operating expenses		103,136			94,213
		Operating income		7,013			4,161
Other income (expense):
	Interest expense			(8,932	)		(14,590	)
	Interest income			669			892
	Gain (loss) on sale of assets			6			79
	Other			(364	)		213
		Other income (expense), net		(8,621	)		(13,406	)
		Loss before income taxes and minority interest		(1,608	)		(9,245	)
Income tax expense				75			64
		Loss before minority interest		(1,683	)		(9,309	)
Minority interest in earnings of consolidated subsidiaries, net of tax				(863	)		(175	)
		Net loss	$	(2,546	)	$	(9,484	)
Basic and diluted loss per share			$	(0.10	)	$	(0.53	)
Weighted average shares used for basic and dilutive loss per share data				24,290			18,051

See accompanying notes to condensed consolidated financial statements.

3

AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share data)

			Six months ended June 30,
			2004			2003
Revenues:
	Resident and health care		$	217,061		$	192,686
	Management and development services			939			833
	Reimbursed expenses			1,292			1,301
		Total revenues		219,292			194,820
Operating expenses:
	Community operating expenses			147,917			137,144
	General and administrative			12,702			12,818
	Lease expense			30,272			20,500
	Depreciation and amortization			13,460			13,800
	Amortization of leasehold acquisition costs			1,446			1,048
	Reimbursed expenses			1,292			1,301
		Total operating expenses		207,089			186,611
		Operating income		12,203			8,209
Other income (expense):
	Interest expense			(18,633	)		(28,907	)
	Interest income			1,271			1,589
	Gain (loss) on sale of assets			111			21
	Other			(253	)		276
		Other income (expense), net		(17,504	)		(27,021	)
		Loss before income taxes and minority interest		(5,301	)		(18,812	)
Income tax expense				220			194
		Loss before minority interest		(5,521	)		(19,006	)
Minority interest in earnings of consolidated subsidiaries, net of tax				(1,825	)		(1,448	)
		Net loss	$	(7,346	)	$	(20,454	)
Basic and diluted loss per share			$	(0.32	)	$	(1.16	)
Weighted average shares used for basic and dilutive loss per share data				22,770			17,697

See accompanying notes to condensed consolidated financial statements.

4

AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)

				Six months ended June 30,
				2004			2003
Cash flows from operating activities:
	Net loss			$	(7,346	)		$	(20,454	)
	Adjustments to reconcile loss from operations to net cash provided by (used by) operations:
		Depreciation and amortization			14,906				14,848
		Amortization of deferred financing costs			1,208				1,001
		Entrance fee items:
			Amortization of deferred entrance fee revenue		(8,745	)			(8,179	)
			Proceeds from entrance fee sales		22,620				17,893
			Refunds of entrance fee terminations		(5,872	)			(7,424	)
		Amortization of deferred gain on sale-leaseback transactions			(5,078	)			(1,681	)
		Minority interest in earnings of consolidated subsidiaries			1,825				1,448
		Losses from unconsolidated joint ventures			220				121
		Gain on sale of assets			(111	)			(21	)
	Changes in assets and liabilities, exclusive of acquisitions and sale-leaseback transactions:
		Accounts receivable			(651	)			(45	)
		Inventory			34				124
		Prepaid expenses			376				1,185
		Other assets			3,928				3,193
		Accounts payable			(121	)			1,076
		Accrued interest			(111	)			133
		Other accrued expenses and other current liabilities			(1,918	)			(1,038	)
		Tenant deposits			(66	)			(170	)
		Other liabilities			3,640				658
Net cash provided by operations					18,738				2,668
Cash flows from investing activities:
		Additions to land, buildings and equipment			(9,572	)			(5,168	)
		Purchase of assets limited as to use, net			(3,798	)			(1,035	)
		Receipts on (issuance of) notes receivable			180				(2,384	)
		Other investing activities			366				983
Net cash used by investing activities					(12,824	)			(7,604	)
Cash flows from financing activities:
		Proceeds from the issuance of long-term debt			43,838				7,617
		Principal payments on long-term debt			(49,239	)			(10,288	)
		Accrual of deferred interest			4,074				6,378
		Distributions to minority interest holders			(2,225	)			(2,206	)
		Principal reductions in master trust liability			(634	)			(720	)
		Accrual of contingent earnouts			—				(594	)
		Expenditures for financing costs			(341	)			(693	)
		Proceeds from the issuance of stock			142				—
		Proceeds from the exercise of stock options			204				—
Net cash used by financing activities					(4,181	)			(506	)

See accompanying notes to condensed consolidated financial statements.

5

AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(UNAUDITED)
(in thousands)

		Six months ended June 30,
		2004		2003
Net increase (decrease) in cash and cash equivalents			1,733		(5,442	)
Cash and cash equivalents at beginning of period			17,192		18,684
Cash and cash equivalents at end of period		$	18,925	$	13,242
Supplemental disclosure of cash flow information:
	Cash paid during the period for interest (including capitalized interest)	$	12,844	$	20,372
	Income taxes paid	$	494	$	298

Supplemental disclosure of non-cash transactions:

During the six months ended June 30, 2004, the Company issued 4,808,898 shares of common stock, par value $0.01 per share, to certain holders of the Company’s 10% Series B Convertible Senior Subordinated Notes (Series B Notes). The holders elected to convert $10.9 million of the convertible debentures to common stock at the conversion price of $2.25 per share. As a result, debt and equity were adjusted as follows:

	2004		2003
Long-term debt	$	10,820	$	—
Common stock		48		—
Additional paid-in capital		10,772		—

During the six months ended June 30, 2003, the Company amended a lease agreement.  Under this amendment, the lease, which had been accounted for as a financing, is now accounted for as an operating lease.  As a result, assets and liabilities decreased as follows:

	2004		2003
Land, building and equipment	$	—	$	4,879
Other assets		—		821
Long-term debt		—		(4,879	)

During the six months ended June 30, 2003 the Company completed certain conditions related to the sale transaction of land in Virginia. The Company received net cash proceeds of $1.2 million in December 2002, and the buyer assumed the related debt. As a result, assets and liabilities decreased as follows:

	2004		2003
Land, building and equipment	$	—	$	13,127
Other current liabilities		—		1,217
Debt associated with assets held-for-sale (current)		—		11,910

See accompanying notes to condensed consolidated financial statements.

6

AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.  Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of American Retirement Corporation (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. These financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K (which was updated on Form 8-K dated June 10, 2004) for the year ended December 31, 2003. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals and other adjustments) considered necessary for a fair presentation have been included. During the six months ended June 30, 2004, the Company determined that three communities previously classified as held-for-sale and accounted for as discontinued operations would no longer be held-for-sale and accordingly, prior period amounts have been restated to include the communities’ activities in continuing operations (see Note 8). In addition, certain other fiscal year 2003 amounts have been reclassified to conform to the fiscal year 2004 presentation (see Note 2). Operating results for the three and six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2004.

2. Principles of Consolidation

The accompanying condensed consolidated financial statements include the financial statements of American Retirement Corporation and its wholly owned and majority owned subsidiaries that manage, own and operate senior living communities. The Company maintains each of its subsidiaries as a separate and distinct legal entity. Absent express contractual provisions or agreements to the contrary, neither the Company nor any of its subsidiaries are liable for, nor are any of their respective assets available to satisfy, the obligations or liabilities of any other subsidiary of the Company. The accounts of limited liability companies, joint ventures and partnerships are consolidated when the Company maintains effective control over such entities’ assets and operations, notwithstanding, in some cases, a lack of majority ownership. During 2003, new accounting literature expanded the circumstances in which the variable interest entities are consolidated. See Note 10. Under this literature, the Company consolidates the communities it manages for others if the Company has the unilateral ability to conduct the ordinary course of business of the subject communities and is the primary beneficiary of the managed entities’ earnings or losses. As a result, beginning in 2004, the Company consolidates the results of a managed community (Freedom Square), and has restated all prior periods presented to conform to this presentation. All significant inter-company balances and transactions are eliminated in consolidation.

3. Segment Information

The Company operates principally in three business segments: (1) retirement centers, (2) free-standing assisted living communities, and (3) management services. The Company currently operates 28 retirement centers, which provide a continuum of care services such as independent living, assisted living and skilled nursing care. Of the 28 retirement centers, the Company owns seven, operates two pursuant to leases classified as financing obligations (which include purchase options), operates 18 pursuant to operating leases and consolidates one variable interest entity, a retirement center that the Company manages (Freedom Square). The Company operates six retirement centers which are entrance fee communities for which the Company receives an upfront fee and provides housing and health care services under various types of entrance fee agreements with residents.

7

The Company currently operates 33 free-standing assisted living communities. Free-standing assisted living communities are generally comprised of stand-alone assisted living communities that are not located on a retirement center campus, most of which also provide some specialized care such as Alzheimer’s and memory enhancement programs. Free-standing assisted living communities are generally much smaller than retirement centers. Of the 33 free-standing assisted living communities operated by the Company, 12 are owned (two in joint ventures), seven are operated pursuant to leases classified as financing obligations, and 14 are operated pursuant to operating leases.

The management services segment includes fees from management agreements for communities owned by others, and fees for other services including development services, and reimbursed expense revenues together with associated expenses. The management services segment does not include any managed communities that the Company consolidates. The Company has five management agreements for retirement centers with third parties. Of the managed communities, two are cooperatives that are owned by their residents and two are owned by not-for-profit sponsors. The remaining managed retirement center is owned by an unaffiliated third party. 

The Company manages and evaluates the performance of its business segments principally based upon segment operating contributions, which the Company defines as revenue from the segment less operating expenses associated with the segment. The following is a summary of total revenues and operating contributions by segment for the three and six months ended June 30, 2004 and 2003, and total assets by segment at June 30, 2004 and December 31, 2003 (in thousands).(1)(2)(3)

			Three Months Ended June 30,				Six Months Ended June 30,
			2004		2003		2004		2003
Revenues
	Retirement centers		$	85,578	$	76,673	$	170,866	$	152,028
	Free-standing assisted living communities			23,532		20,705		46,195		40,658
	Management services (4)			1,039		996		2,231		2,134
		Total revenue	$	110,149	$	98,374	$	219,292	$	194,820
Retirement centers
	Resident and healthcare revenues		$	85,578	$	76,673	$	170,866	$	152,028
	Community operating expense			56,546		52,079		113,337		103,376
		Community operating contribution	$	29,032	$	24,594	$	57,529	$	48,652
Free-standing assisted living communities
	Resident and healthcare revenues		$	23,532	$	20,705	$	46,195	$	40,658
	Community operating expense			17,519		16,819		34,580		33,768
		Community operating contribution	$	6,013	$	3,886	$	11,615	$	6,890
Management services operating contribution			$	515	$	383	$	939	$	833
General and administrative expense			$	6,114	$	6,837	$	12,702	$	12,818
Lease expense				15,158		10,366		30,272		20,500
Depreciation and amortization (3)				7,275		7,499		14,906		14,848
			$	7,013	$	4,161	$	12,203	$	8,209

8

			June 30, 2004		December 31, 2003
Total Assets
	Retirement centers		$	516,860		$	513,905
	Free-standing assisted living communities			202,051			206,489
	Management services			47,687			53,889
		Total	$	766,598		$	774,283

(1)	Segment data does not include any inter-segment transactions or allocated costs.
(2)	On August 25, 2003, the Company acquired a leasehold interest in two retirement centers which had previously been managed by the Company. Subsequent to that date, the amounts have been classified as leased retirement centers.
(3)	During the quarter ended March 31, 2004, the Company determined that three free-standing assisted living communities previously classified as held-for-sale and accounted for as discontinued operations would no longer be held-for-sale. The Company’s 2003 segment data has been restated to include the results of these three free-standing assisted living communities. In addition, the Company’s depreciation expense for the six months ended June 30, 2004 includes $0.5 million of depreciation expense which would have been recognized in prior quarters if the assets had been continuously classified as held-for-use.
(4)	Management services revenue represents the Company’s management services revenue, as well as reimbursed expense revenue.

9

4.  Stock Based Compensation

In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123. SFAS 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosure modifications are included below.

The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including FASB Interpretation (FIN) No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25, to account for its fixed plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123 established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As permitted by SFAS No. 123 and SFAS No. 148, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of these statements. The following table illustrates the effect on net loss if the fair-value-based method had been applied to all outstanding and unvested awards in each period (in thousands except per share data).

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Net loss, as reported		$	(2,546	)	$	(9,484	)	$	(7,346	)	$	(20,454	)
	Deduct total stock-based employee compensation expense determined under fair-value-based method		(255	)		(165	)		(421	)		(326	)
Pro forma net loss		$	(2,801	)	$	(9,649	)	$	(7,767	)	$	(20,780	)
Loss per share:
Basic and diluted - as reported		$	(0.10	)	$	(0.53	)	$	(0.32	)	$	(1.16	)
Basic and diluted - pro forma		$	(0.12	)	$	(0.53	)	$	(0.34	)	$	(1.17	)

10

5. Loss per Share

Basic and diluted loss per share for the three and six months ended June 30, 2004 has been computed on the basis of the weighted average number of shares outstanding. Diluted loss per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.  During the three and six months ended June 30, 2004, there were approximately 1.5 million and 814,000 options to purchase shares of common stock outstanding which had an exercise price below the average market price of the common shares for the corresponding period, respectively. There were no options to purchase shares of common stock outstanding during the three and six months ended June 30, 2003 which had an exercise price below the average market price of the common shares for the corresponding period.

The following options to purchase shares of common stock were outstanding during each of the following periods, but were also not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares for the respective periods and are not included in the diluted earnings per share calculation because of the current and prior period net losses.

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2004		2003		2004		2003
Number of options (in thousands)		746		2,045		1,038		2,076
Weighted-average exercise price	$	4.90	$	4.18	$	4.84	$	4.47

At June 30, 2004, the Company has 2.6 million stock options outstanding. Approximately 0.3 million of these stock options, granted in 1999, have a grant price of $5.00 and expire on October 27, 2004. Based on recent market value of the stock, the Company anticipates a majority of the holders will exercise these options. The exercise of these options, if completed, would result an increase of approximately $1.3 million to cash and shareholders’ equity.

6. Long-term Debt and Other Transactions

A summary of long-term debt as of June 30, 2004 is as follows (in thousands) (See Note 11, Subsequent Events):

	June 30, 2004		December 31, 2003
Mezzanine loan note payable bearing interest at a fixed rate of 19.5%, compounding quarterly. Interest at 9% (increasing 0.55% annually after April 1, 2004) is payable quarterly with principal and unpaid interest due on September 30, 2007. The loan is secured by a security interest in the borrower subsidiary’s ownership interests in certain of its subsidiaries.	$	82,000		$	77,926
Convertible debentures (Series B Notes) bearing interest at a fixed rate of 10.00%. Interest is due semi-annually on April 1 and October 1 through April 1, 2008, at which time all principal is due. On April 1, 2004, the Company elected to redeem the balance of these debentures on April 30, 2004.		—			10,856
Various mortgage notes bearing interest at variable and fixed rates, generally payable monthly with any unpaid principal and interest due between 2004 and 2037. Interest rates at June 30, 2004 range from 3.67% to 9.50%. The loans are secured by certain land, buildings and equipment.		140,838			139,352
Various other long-term debt, generally payable monthly with any unpaid principal and interest due between 2005 and 2015. Variable and fixed interest rates at June 30, 2004 range from 1.07% to 9.625%. The loans are secured by certain land, buildings and equipment.		35,268			42,554
Subtotal debt		258,106			270,688

11

	June 30, 2004		December 31,  2003
Lease financing obligations with principal and interest payable monthly bearing interest at fixed rates ranging from 3.72% to 9.39%, with final payments due between 2006 and 2017. The obligations are secured by certain land, buildings and equipment.(1)		98,860			100,847
Total debt including lease financing obligations		356,966			371,535
Less current portion debt		11,200			10,782
Less current portion of lease financing obligations		5,842			5,433
Less debt associated with assets held-for-sale		—			7,000
Long-term debt, excluding current portion	$	339,924		$	348,320

The aggregate scheduled maturities of long-term debt were as follows (in thousands):

	June 30,  2004
For the twelve months ended	$	17,042
For the twelve months ended June 30, 2006		16,667
For the twelve months ended June 30, 2007		24,649
For the twelve months ended June 30, 2008		104,164
For the twelve months ended June 30, 2009		32,501
Thereafter		161,943
	$	356,966

(1) Approximately $71.3 million of the $98.9 million of lease financing obligations include contingent earn-out provisions which expire between November 2004 and April 2005. The contingent earn-out provisions relate to eight free-standing assisted living communities and were a part of various sale lease-back transactions during 2001 and 2002. As these provisions expire, the Company’s continuing involvement related to the initial sale lease-back transactions will be relieved and will no longer be accounted for as lease financing obligations, but  will be accounted for as operating leases. As a result, lease financing obligations, depreciation expense and interest expense will decrease and operating lease obligations and lease expense will increase. The expected impact (reduction of lease financing obligation) of these expirations, unless otherwised extended, is:

During the three months ended December 31, 2004	$	37.7 million
During the three months ended March 31, 2005	$	9.1 million
During the three months ended June 30, 2005	$	24.5 million
	$	71.3 million

During the six months ended June 30, 2004, the Company refinanced $38.6 of mortgage debt which had a scheduled maturity of April 2005, with a total of $43.1 million of mortgage debt, comprised of a $38.5 million mortgage loan and a $4.6 million mortgage loan. The $38.5 million loan has a seven-year maturity, and is secured by three free-standing assisted living communities. The $4.6 million loan has a two-year maturity and is secured by a fourth free-standing assisted living community. The $38.5 million mortgage debt bears interest at a variable rate with a 5.0% floor, and the $4.6 million mortgage loan bears interest at a variable rate with a floor of 6.5%.  The $38.6 million mortgage debt which was retired had a variable rate with a 6.75% floor.

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On February 12, 2004, the Company announced that it was electing to redeem $4.5 million in principal amount of its Series B Notes and on March 12, 2004, $27,320 was redeemed at a redemption price of 105% (expressed as a percentage of principal amount), plus accrued but unpaid interest to the redemption date. On April 1, 2004, the Company further announced that it was electing to redeem the remaining $2.1 million principal balance of its Series B Notes due 2008 and on April 30, 2004, $8,356 was redeemed at a redemption price of 103.5% (expressed as a percentage of principal amount), plus accrued but unpaid interest to the redemption date. As a result of these two redemption notices, holders of Series B Notes had converted $10.9 million of Series B Notes to 4,808,898 shares of common stock at the conversion price of $2.25 per share, and as of April 30, 2004, no Series B Notes remained outstanding.

In addition, the Company has guaranteed approximately $18.7 million of mortgage debt that is not reflected on the Company’s balance sheet, of which $10.1 million relates to a retirement center which the Company leases and $8.6 million relates to a joint venture which the Company manages.

7.  Liquidity

The Company is highly leveraged with substantial debt and lease obligations. During the past twelve months, the Company reduced its net loss and improved operating results from its retirement center, free-standing assisted living community and management services business segments. For the six months ended June 30, 2003 and 2004, respectively, net cash from operations activities improved to $18.7 million, from $2.7 million, an increase of $16.0 million.

Approximately $265.9 million or 74.5% of the Company’s debt has fixed interest rates, which on a weighted average were 11.0% at June 30, 2004. The remaining $91.1 million or 25.5% of debt has variable interest rates, which on a weighted average basis were 4.8% at June 30, 2004. However, $14.4 million of the variable rate debt agreements contain interest rate floors which allow market interest rates to fluctuate without necessarily changing the Company’s interest rate. Therefore, considering the $76.7 million of variable rate debt without such interest rate floors, each one-percentage point increase in interest rates would increase interest expense for the coming year by approximately $0.8 million.

The Company has scheduled current debt principal payments of $17.0 million and minimum rental obligations of $65.1 million under long-term operating leases due during the twelve months ended June 30, 2005. In addition, as of June 30, 2004, the Company had guaranteed $18.7 million of third-party senior debt in connection with a free-standing assisted living community that the Company manages and a retirement center that the Company leases.

As of June 30, 2004, the Company had approximately $18.9 million in unrestricted cash and cash equivalents and $17.4 million of working capital. The Company believes that its current cash and cash equivalents, expected cash flow from operations, and the proceeds from additional financing transactions or earnouts will be sufficient to fund its operating requirements, ongoing capital expenditure requirements, periodic debt service requirements, and lease obligations during the next twelve months.

In order to meet its future debt maturities and other payment obligations, the Company must continue to improve its cash flow from operations and consummate various refinancing transactions as debt instruments or other obligations mature. There can be no assurance that the Company’s operations will improve as rapidly as anticipated or that the contemplated refinancing transactions can be consummated during the anticipated timeframes. The failure to make its periodic debt and lease payment obligations, or the failure to extend, refinance or repay any of its debt obligations as they become due would have a material adverse effect upon the Company.

A significant amount of the Company’s indebtedness and lease agreements is cross-defaulted. Any non-payment or other default with respect to such obligations (including non-compliance with financial or restrictive covenants) could cause the Company’s lenders or lessors to declare defaults, accelerate payment obligations or foreclose upon the communities securing such indebtedness or exercise their remedies with respect to such communities. Furthermore, because of cross-default and cross-collateralization provisions in most of the Company’s mortgages, debt instruments, and leases, a default by the Company on one of its debt instruments or lease agreements is likely to result in a default or acceleration of many of the Company’s other obligations, which would have a material adverse effect on the Company. Certain of the Company’s debt instruments and leases contain financial and other covenants, typically on specific communities. The Company believes that projected results from operations and cash flows will be sufficient to satisfy these covenants during the next twelve months. However, there can be no assurances that the Company will remain in compliance with those covenants or in the event of future non-compliance that the Company’s creditors will grant amendments or waivers.

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8.  Discontinued Operations

During the quarter ended September 30, 2002, the Company determined that a free-standing assisted living community would be held-for-sale. Subsequently, in the quarter ended March 31, 2003, the Company determined two additional free-standing assisted living communities would also be held-for-sale. During the three months ended March 31, 2004, the Company determined that the three free-standing assisted living communities would no longer be held-for-sale (due to the inability of the potential buyer to close the transaction). Accordingly, the Company’s condensed consolidated statement of operations and statement of cash flows for the three and six months ended June 30, 2003 have been restated to include the operations of these three free-standing assisted living communities in continuing operations (previously shown as discontinued operations).  In addition, during the six months ended June 30, 2004, the Company recorded approximately $0.5 million of depreciation expense which would have been recognized during the period the communities were held-for-sale if the assets been continuously classified as held-for-use.

9.  Commitments and Contingencies

The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. In the opinion of the Company’s management, the ultimate liability with respect to those proceedings and claims will not materially affect the financial position, operations, or liquidity of the Company. The Company maintains commercial insurance on a claims-made basis for medical malpractice, workers’ compensation, and professional liabilities.

Insurance

The delivery of personal and health care services entails an inherent risk of liability. In recent years, participants in the senior living and health care services industry have become subject to an increasing number of lawsuits alleging negligence or related legal theories, many of which involve large claims and result in the incurrence of significant defense costs and significant exposure. The Company currently maintains property, liability and professional medical malpractice insurance policies for the Company’s owned, leased and certain of its managed communities under a master insurance program. 

The Company currently maintains single incident and aggregate liability protection in the amount of $15.0 million for general and professional liability policies (retention levels ranging from $1,000,000 to $5,000,000). The Company believes it has adequately accrued amounts to cover open claims not yet settled and incurred but not reported claims as of June 30, 2004.

The Company has operated under a large deductible workers’ compensation program, with excess loss coverage provided by third party carriers, since July 1995. As of June 30, 2004, the Company’s coverage for workers’ compensation and related programs, excluding Texas, included excess loss coverage of $350,000 per individual claim and approximately $5.2 million in the aggregate. The Company is self-insured for amounts below the excess loss coverage. As of June 30, 2004, the Company provided cash collateralized letters of credit in the aggregate amount of $5.5 million related to this program, which are reflected as assets limited as to use on the Company’s condensed consolidated balance sheet. The Company believes it has adequately accrued amounts to cover open claims not yet settled and incurred but not reported claims as of June 30, 2004. Losses are paid as incurred and estimated losses are accrued on a monthly basis. The Company utilizes a third party administrator to process and pay filed claims. For work-related injuries in Texas, the Company is a non-subscriber under Texas state law, meaning that work-related losses are covered under a defined benefit program outside of the Texas Workers’ Compensation system. The Company carries excess loss coverage of $250,000 per individual under its non-subscriber program. 

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The Company maintains a self-insurance program for employee medical coverage. The Company maintains stop loss insurance coverage of approximately $150,000 per employee and approximately $17.3 million for aggregate calendar 2004 claims.  Estimated costs related to this self-insurance program are accrued based on known claims and projected settlements of unasserted claims incurred but not yet reported to the Company. Subsequent changes in actual experience (including claim costs, claim frequency, and other factors) could result in additional costs to the Company. The Company believes it has adequately accrued amounts to cover open claims not yet settled and incurred but not reported claims as of June 30, 2004.

During the three and six months ended June 30, 2004, the Company expensed $4.0 million and $9.0 million related to premiums, claims and costs for general liability, professional medical malpractice insurance, workers’ compensation, and employee medical insurance related to multiple insurance years, respectively.

Leases

As of June 30, 2004, the Company operated 41 of its senior living communities under long-term leases.  Of the 41 communities, 24 are operated under four master lease agreements, with the remaining communities leased under individual agreements. The Company also leases its corporate offices and is obligated under several ground leases for senior living communities. The primary lease terms vary from four to 22 years.  Certain of the leases provide for renewal and purchase options.  Several of the leases have graduated lease payments which the Company recognizes on a straight-line basis over the term of the leases. Some leases have provisions for contingent lease payments based on revenue levels or other measures. Contingent lease payments are expensed when incurred.

Total lease expense was $15.2 million and $10.4 million for the three months ended June 30, 2004 and 2003, and $30.3 million and $20.5 million for the six months ended June 30, 2004 and 2003, respectively.

Future minimum lease payments at June 30, 2004 are as follows (in thousands): 

Twelve months ended June 30, 2005	$	65,135
Twelve months ended June 30, 2006		66,361
Twelve months ended June 30, 2007		67,619
Twelve months ended June 30, 2008		67,805
Twelve months ended June 30, 2009		68,152
Thereafter		509,068
	$	844,140

Management Agreements

The Company’s management agreements are generally for terms of three to 20 years, but certain of the agreements may be canceled by the owner of the community, without cause, on three to six months’ notice. Pursuant to the management agreements, the Company is generally responsible for providing management personnel, marketing, nursing, resident care and dietary services, accounting and data processing services, and other services for these communities at the owner’s expense and receives a monthly fee for its services based on either a contractually fixed amount, a percentage of revenues or income, or cash flows in excess of operating expenses and certain cash flows of the community.  The Company’s existing management agreements expire at various times through June 2018. 

Regulatory Requirements

Federal and state governments regulate various aspects of the Company’s business.  The development and operation of health care facilities and the provision of health care services are subject to federal, state, and local licensure, certification, and inspection laws that regulate, among other matters, the number of licensed beds, the provision of services, the distribution of pharmaceuticals, billing practices and policies, equipment, staffing (including professional licens­ing), operating policies and procedures, fire prevention measures, environmental matters, and compliance with building and safety codes.  Failure to comply with these laws and regulations could result in the denial of reimbursement, the imposition of fines, temporary suspension of admission of new patients, suspension or decertification from the Medicare programs, restrictions on the ability to acquire new communities or expand existing communities, and, in extreme cases, the revocation of a community’s license or closure of a community.  Management believes the Company was in compliance with such federal and state regulations at June 30, 2004.

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10.  Recent Accounting Pronouncements

In January 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, Consolidation of Variable Interest Entities, which was issued in January 2003. Based upon the Company’s current understanding of the current guidance provided by the FASB, the Company has three variable interest entities in which it holds a significant variable interest:

	Commencement of Operations		Nature of Activity	Ownership (Loss Exposure)		Location	Unit Capacity
Community							IL		L		ME		SNF		Total
Freedom Square		July 1998	Managed	0.0	%	Seminole, Florida		362		103		76		194		735
McLaren Homewood Village		April 2000	Joint Venture	37.5	%	Flint, Michigan		14		71		31		—		116
Village of Homewood		April 1998	Joint Venture	50.0	%	Lady Lake, Florida		—		32		15		—		47
								376		206		122		194		898

For any VIEs that must be consolidated under FIN 46R, the assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with any differences between the net amount added to the balance sheet and any previously recognized interest being recognized as a cumulative effect of an accounting change. The Company reviewed its managed entities and agreements, and has consolidated Freedom Square effective January 1, 2004, as well as for all periods presented.  As a result, the Company’s consolidated balance sheet at December 31, 2003 includes an increase of $59.2 million, respectively, to assets, liabilities and minority interests.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity.  SFAS No. 150 also includes required disclosures for financial instruments within its scope. SFAS 150 was effective for financial instruments entered into or modified after May 31, 2003, and otherwise was effective July 1, 2003. The Company has not entered into any financial instruments within the scope of SFAS 150 since May 31, 2003, nor does it currently hold any significant financial instruments within its scope. Adoption of the standard did not have an impact on the Company’s consolidated financial position, results of operations or cash flows.

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11.  Subsequent Events

Multi-property Sale-Leaseback and Repayment of Mezzanine Loan

On July 15, 2004, the Company completed a multi-property sale-leaseback transaction with Health Care Property Investors, Inc., or HCPI.  In the transaction, the Company sold a substantial majority of its interest in the real property and improvements underlying two retirement centers and one free-standing assisted living community, while retaining a 10% interest in those three communities. The Company also sold to HCPI all of its interest in the real property and improvements underlying one of its other retirement centers.(1) The Company will continue to operate all four of the communities involved in the transaction under a master lease. The proceeds from the transaction were used primarily to repay $18.9 million of mortgage debt and the remaining $82.6 million balance (including accrued interest) of the 19.5% mezzanine loan with HCPI.(2)

In September 2002, the Company entered into the mezzanine loan with HCPI for $112.8 million with a five-year term. At the same time, HCPI also made a $12.2 million equity investment in certain other subsidiaries that functioned solely as passive real estate holding companies owning the real property and improvements of nine retirement centers. HCPI received a 9.8% ownership interest in those subsidiaries as a result of that investment.

In September 2003, the Company partially repaid the mezzanine loan through a separate multi-property transaction with HCPI that resulted in the repayment of $51.8 million of the principal and accrued interest on the mezzanine loan.

The four communities involved in the July 15, 2004 transaction were valued at $153.5 million, as supported by fair market value appraisals. The communities have a combined capacity of 1,353 units, including independent living, assisted living, memory enhancement and skilled nursing units. Two of the communities are located in Florida, one in Kentucky and one in Michigan. As a result of the transaction, the Company will continue to own 10% of the real estate holding companies owning three of the communities. HCPI will own 90% of those holding companies and 100% of the fourth real estate holding company. These four real estate holding companies leased the four communities to the Company pursuant to a master lease.

The master lease agreement has an initial term of ten years, plus three ten year renewal periods at the Company’s option. The initial lease rate will be 8.8% on the $153.5 million value, consisting of a 9% base lease rate on invested equity in the real estate holding companies and a pass-through of the cost of $24.8 million of mortgage debt for two of the real estate holding companies.(3) The lease also contains certain formula-based lease rate escalators. For the three communities in which the Company retained a 10% interest, the Company also retained a formula-based option (transaction value escalated at 3% per annum, compounded annually) to repurchase the real estate, which option is exercisable at the end of the base lease term or any renewal term. The Company also has an earnout provision of up to $0.9 million of additional proceeds on the free-standing assisted living community contingent on achievement of certain operating results at that community.

(1)	Prior to the transaction, the Company held 90.2% and HCPI held 9.8% interests in the real property underlying the three retirement centers and the Company owned a 61% interest in the free-standing assisted living community through a joint venture with unaffiliated parties. After the transaction, the Company retained a 10% interest in the real property and improvements underlying two of the retirement centers and the free-standing assisted living community through its 10% interest in the real estate holding companies that will serve as the lessors for these communities. The Company will continue to operate all four communities as lessee under a master lease.
(2)	The mezzanine loan balance and accrued interest, as of July 15, 2004, was $82.6 million, a $0.6 million increase from $82.0 million at June 30, 2004.
(3)	The $24.8 of mortgage debt was retained by two of the real estate holding companies and will no longer be consolidated on the Company’s balance sheet. The Company’s existing guarantee with respect to $16.8 million of that debt was unchanged and remains in place.

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The master lease will be accounted for as an operating lease for one of the retirement centers and as a lease financing with respect to the other three communities as a result of the continuing 10% ownership interest and other factors. Because of the lease financing treatment for these three communities, the amount of debt on the Company’s balance sheet will remain approximately the same following the transaction. The debt associated with these three new lease financings will be fully amortized over the initial ten-year lease term. No gain or loss is recognized for the three communities with lease financing treatment. For the community being accounted for as an operating lease, the Company will realize a gain of approximately $16.3 million, which will be deferred and amortized over the initial ten-year lease term.

The transaction resulted in the repayment of the remaining $82.6 million balance of the mezzanine loan, including accrued interest, as well as $18.9 million of mortgage debt. The Company intends to use the remaining proceeds for transaction-related costs, taxes on the gain on sale and for general corporate purposes.(4)

As a result of the transaction, during the third quarter of 2004, the Company will write-off $3.4 million of unamortized financing costs relating to the early prepayment of the mezzanine loan and the other debt repaid, and the Company will expense approximately $1.2 million of other transaction related costs. Additionally, the Company will record $6.8 million current tax expense related to the taxable gain on the sale of the Company’s interest in the four communities after full utilization of net operating losses.

The Company also obtained on July 15, 2004 a separate mortgage loan from HCPI in the amount of $5.7 million. Interest is payable monthly at 9%, with the principal balance due in July 2006. The note is secured by mortgages on one of the free-standing assisted living communities, an undeveloped land parcel and a free-standing assisted living community leased to a third party. The proceeds were used to repay $456,000 of debt owed HCPI, and the remainder is available for general corporate purposes.

Restricted Stock

On July 19, 2004, the Company granted certain members of management a total of 440,000 shares of restricted stock. This stock had a $5.95 market value at the date of grant.  These grants will vest ratably over the next three years.

(4)

	(in millions)
Gross transaction value of the four communities		$	153.5
Value of the Company’s retained 10% interests			(10.4	)
Net value of HCPI minority interest (from Sept. 2002)			(6.0	)
Mortgage debt retained by real estate holding companies			(24.8	)
Mezzanine debt repaid, including accrued interest			(82.6	)
Mortgage debt repaid			(18.9	)
Taxes payable			(6.8	)
Cash available for transactions costs and other uses		$	4.0

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

Overview

The senior living industry is experiencing growth as a result of demographic and various other factors.  According to census data, the over age 75 population in the United States is growing much faster than the general population.  We have seen increasing demand for services at both our retirement centers and our free-standing assisted living communities during the past year, and expect that this demand will continue over the next several years. As a general rule, economic factors that affect seniors will have a corresponding impact on the senior living industry. For example, general concerns regarding lower interest rates on savings and uncertainty of investment returns have impacted seniors during the past several years, as well as uncertainties related to world events such as the Iraqi war.  On the other hand, the continuing strength of the home resale market in most areas of the country has been beneficial to seniors, since the equity from the sale of a home is a significant source of funding for senior living care in many cases. In addition, overall economic conditions and general consumer confidence can impact the industry, since many adult children subsidize the cost for care of elderly parents, and share in decisions regarding their care. 

The assisted living industry is maturing and rapidly evolving. The demand for assisted living services increased significantly beginning with the emergence of the industry segment in the mid-1990s. However, the development of new assisted living communities across the country outstripped demand during this period, resulting in oversupply of unit capacity, longer fill up times, price pressures and deep discounting. While this trend continues, the steadily increasing demand for assisted living services, coupled with minimal new development activity, reduced to some extent the oversupply in many of our markets in 2002 and 2003.  As a result, we were able to increase occupancy, and increase rates and reduce promotional discounting for our free-standing assisted living communities during 2003 and the first half of 2004.  We believe that new assisted living development will remain at sustainable levels and, accordingly, expect this trend to continue. The average length of stay in our free-standing assisted living community segment is approximately two years, which represents a challenge and an opportunity for us. We must find a number of new residents to maintain and build occupancy. However, we also have the opportunity to “mark-to-market” if we are able to attract new residents at higher current market rates, replacing prior residents with lower or discounted rates.

Our retirement center segment is a more mature segment of the industry, and has seen demand and price increases in recent years, with new unit capacity entering the market at sustainable levels. Management expects this growth in demand and selling rate increases to continue over the next several years. The average length of stay is much longer in the retirement centers, approximately five years in the rental communities, and approximately ten years in the entrance fee communities. In addition, we believe that many of our retirement centers benefit from significant barriers to entry from competitors, including the significant cost and length of time to develop competitive communities, the difficulty in finding acceptable development sites in the geographical areas in which our retirement centers are located, and the length of time and difficulty in developing strong competitive reputations.

We earn our revenues primarily by providing housing and services to our residents.  Approximately 85% of our revenues come from private pay sources, meaning that residents or their families pay from their own funds (or from the proceeds of their privately funded long-term care policies).  All private pay residents are billed in advance for the next month’s housing and care.  In addition, we receive private pay revenues from the sale of entrance fee contracts at our entrance fee communities. While this cash is received at the time the resident moves in, the non-refundable portion of the entrance fee is primarily recognized as income for financial reporting purposes over the actuarial life of the resident.

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Our most significant expenses are:

• Community operating expenses – Labor and labor related expenses for community associates represent approximately 60% of this line item.  Other significant items in this category are food costs, property taxes, utility costs, marketing costs and insurance.  We increased our marketing expenditures in recent years in response to overcapacity in the assisted living industry and general economic conditions.

• General and administrative – Labor costs also represent the largest component for this category, comprising the home office and regional staff supporting community operations.  Other significant items are liability insurance and related costs, travel, and legal and professional service costs.  In response to higher liability insurance costs and deductibles in recent years, and the inherent liability risk in providing personal and health-related services to seniors, we have significantly increased our staff and resources involved in quality assurance, compliance and risk management.

• Lease expense – Our lease expense has grown significantly over the past two years, as a result of the large number of sale-leaseback transactions completed in connection with various 2002 and 2003 financing transactions. Lease expense will grow significantly as a result of the July 15, 2004 transaction (see below). Our lease expense includes the rent expense for all operating leases, including an accrual for lease escalators in future years (the impact of these future escalators is spread evenly over the lease term for financial reporting purposes). 

• Depreciation and amortization expense – We incur significant depreciation expense on our fixed assets (primarily community buildings and equipment) and amortization expense related primarily to leasehold acquisition costs.

• Interest expense – Our interest expense is comprised of interest on our outstanding debt and lease financing obligations. Interest expense will decrease significantly as a result of the July 15, 2004 transaction (see below).

Results of Operations

Multi-property Sale-Leaseback and Repayment of Mezzanine Loan

On July 15, 2004, we completed a multi-property sale-leaseback transaction with Health Care Property Investors, Inc., or HCPI.  In the transaction, we sold a substantial majority of our interest in the real property and improvements underlying two retirement centers and one free-standing assisted living community, while retaining a 10% interest in those three communities. We also sold to HCPI all of our interest in the real property and improvements underlying one of our other retirement centers. We will continue to operate all four of the communities involved in the transaction under a master lease. The proceeds from the transaction were used primarily to repay $18.9 million of mortgage debt and the remaining $82.6 million (including accrued interest) balance of the 19.5% mezzanine loan with HCPI.  (See Note 11 to the Condensed Consolidated Financial Statements.)

The master lease will be accounted for as an operating lease for one of the retirement centers and as a lease financing with respect to the other three communities as a result of the continuing 10% ownership interest and other factors.  With an operating lease, lease payments (and accruals for lease escalators) are shown as lease expense.  With a lease financing (commonly referred to as capital lease treatment), the leased assets are recorded on the balance sheet, and the lease financing obligation is shown as a component of long-term debt.  The lease financing will impact the income statement in several ways, including the depreciation of the leased asset (generally fully depreciated over the initial lease term), and a portion of each lease payment is considered to be interest expense (with the balance of each lease payment being considered repayment of the lease financing obligation included in long-term debt). Because of the lease financing treatment for these three communities, the amount of debt on our balance sheet will remain approximately the same following the transaction.

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The transaction results in a net decrease of $0.1 million of debt as a result of:

• The repayment of the remaining $82.6 million balance of the mezzanine Loan, including accrued interest.

• The repayment of $18.9 million of mortgage debt.

• A $24.8 million reduction in consolidated mortgage debt on our balance sheet.  This debt was retained by the real estate holding companies, and the lease payments to these holding companies will include a pass through of the periodic principal and interest costs of this debt. Our existing guarantee with respect to $16.8 million of that debt was unchanged and remains in place.

• A new lease financing obligation for the three leases treated as lease financings in the amount of $120.5 million, which will be included in long-term debt.  These lease obligations will be fully amortized over the initial ten-year lease term.

• A new mortgage loan in the amount of $5.7 million.

For the community with the operating lease treatment, we will realize a gain of approximately $16.3 million, which will be deferred and amortized over the initial ten-year lease term. No gain or loss is recognized for the three communities with lease financing treatment.

We expect the transaction to positively impact pre-tax income by approximately $3.0 million per quarter (approximately $12.0 million per year), comprised of the following elements:

• We expect to generate interest savings of approximately $4.5 million per quarter (approximately $18.0 million per year) reflecting significantly reduced cost of debt resulting from the complete repayment of the mezzanine loan and the reduction of first mortgage debt, offset by the interest expense portion of the payments on the three new lease financings.

• Our 10% interest in the real estate holding companies of the three communities will be accounted for using the cost method. Minority interest expense, which prior to the transaction included HCPI’s 9.8% in the subject communities, will be reduced. The net impact of these two items is expected to be a positive increase in pre-tax earnings of approximately $0.5 million per quarter (approximately $2.0 million per year).

• We expect an increase in lease-related expenses of approximately $2.0 million per quarter (approximately $8.0 million per year), which will include:

• Lease expense (on the operating lease) of $0.7 million per quarter, which will be partially offset by the amortization of the $16.3 million of deferred gain of $0.4 million per quarter.

• Increased depreciation of $1.7 million per quarter on the assets of the three lease financing communities.

In addition, during the third quarter of 2004, we will record charges of approximately $11.4 million, which includes:

• The write-off of $3.4 million of unamortized financing costs relating to the early prepayment of the mezzanine loan and the other debt repaid in the transaction.

• Expense of approximately $1.2 million of other transaction related costs.

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• A current tax expense of approximately $6.8 million related to the taxable gain, after full utilization of operating losses, on the sale of our interest in the four communities.

Highlights of Operating Results

The highlights of our 2004 and 2003 results are as follows:

• Our income statements for the three and six months ended June 30, 2004 show significant improvement in operating income versus the prior year periods. However, we continued to incur high costs related to debt service costs and lease obligations, and incurred net losses of $2.5 million and $7.3 million for the three and six months ended June 30, 2004.

• In order to reduce our loss and produce net income in the future, we are focusing primarily on reducing our debt service costs and improving results in our free-standing assisted living community and retirement center segments, while controlling our general and administrative costs.  We must increase occupancy in our free-standing assisted living community segment, and increase revenue per unit through increased rates and reduced discounting, while controlling our operating costs.  We intend to increase ancillary services and revenue per unit in our retirement center segment, increase occupancy at selected communities, and control our operating costs, including labor, insurance and liability related costs.

• Our free-standing assisted living communities increased revenue and community operating contribution, primarily as a result of an 8.1% increase in revenue per unit, as well as an increase in ending occupancy from 81% to 86% during the six months ended June 2003 to June 2004.

• The increased revenue per unit in our free-standing assisted living communities resulted primarily from selling rate increases, reduced discounting, and turnover of units resulting in new residents paying higher current market rates. In addition, current resident agreements allow for annual rate increases. The increased amount of ancillary services, including therapy services, also contributed to the increased revenue per unit.

• Our free-standing assisted living community incremental increase in operating contribution as a percentage of revenue increase was 75% for the three months ended June 30, 2004 versus the three months ended June 30, 2003 and 85% for the six months ended June 30, 2004 versus the six months ended June 30, 2003.

• We are focusing on increasing our free-standing assisted living community operating contribution further primarily by increasing occupancy above the current 86% level, and by increasing revenue per unit through price increases, ancillary services, and turnover of units that are at lower rates. We believe that, absent unforeseen market or pricing pressures, occupancy increases above 86% should produce high incremental community operating contribution margins for this segment. The primary risk to improving occupancy in our free-standing assisted living community portfolio is development of new unit capacity or renewed price discounting by competitors in our markets, which would make it more difficult to fill vacant units and which could result in lower revenue per unit.

• Retirement center community operating contribution increased significantly over the prior year quarter, primarily as a result of increased revenue per unit and occupancy increases.  Revenues were up 11.6% in the quarter ended June 30, 2004 versus the prior year quarter and community operating expenses were up 8.6%, resulting in operating margins increasing from 32.1% to 33.9% for our largest segment. For the six months ended June 30, 2004, revenues were up 12.4% versus the prior year period and community operating expenses were up 9.6%, resulting in operating margins increasing from 32.0% to 33.7% for our largest segment.

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• Revenue per unit increases at our retirement centers resulted primarily from increases in selling rates, increased therapy and ancillary service billings, as well as annual billing rate increases to existing residents (typically 2% to 4% under most resident agreements). In addition, a significant component of the average revenue per unit increase stems from the “mark-to-market” effect of resident turnover. Since monthly rates for new residents (current market selling rates) are generally higher than billing rates for current residents (since annual increases to billing rates are typically capped in resident agreements), turnover typically results in a significantly increased monthly fees for the new resident. This “mark-to-market” increase is generally more significant in entrance fee communities due to much longer average length of stay (approximately ten years).

Segment Results

We operate in three business segments: retirement centers, free-standing assisted living communities, and management services. The following table presents the number, total unit capacity and total ending and average occupancy percentages of our communities by operating segment at June 30, 2004 and 2003.

	Number of Communities / Total Ending Capacity June 30,				Ending Occupancy %/ Ending Occupied Units June 30,						Average Occupancy %/ Average Occupied Units Six Months Ended June 30,
	2004		2003		2004			2003			2004			2003
Retirement centers		28		27		95	%		93	%		94	%		93	%
		8,871		8,579		8,424			8,009			8,380			7,987
Free-standing assisted
living communities		33		33		86	%		81	%		84	%		80	%
		3,002		3,003		2,590			2,427			2,532			2,412
Management services		5		5		93	%		92	%		93	%		90	%
		1,188		1,363		1,111			1,253			1,072			1,228
Total		66		65		93	%		90	%		92	%		90	%
		13,061		12,945		12,125			11,689			11,984			11,627

We measure the performance of our three business segments, in part, based upon the operating contribution produced by these business segments. We compute operating contribution by deducting the operating expenses associated with a segment from the revenues produced by that segment. The following table sets forth certain selected financial and operating data on an operating segment basis(1) (dollars in thousands).

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				Three Months Ended June 30,												Six Months Ended June 30,
				2004			2003			Change			%			2004			2003			Change			%
Revenues:
	Retirement Centers			$	85,578		$	76,673		$	8,905			11.6	%	$	170,866		$	152,028		$	18,838			12.4	%
	Free-standing ALs				23,532			20,705			2,827			13.7	%		46,195			40,658			5,537			13.6	%
	Management Services				1,039			996			43			4.3	%		2,231			2,134			97			4.5	%
		Total revenue		$	110,149		$	98,374		$	11,775			12.0	%	$	219,292		$	194,820		$	24,472			12.6	%
Retirement Centers
	Ending occupied units				8,424			8,009			415			5.2	%		8,424			8,009			415			5.2	%
	Ending occupancy%				95	%		93	%		2	%					95	%		93	%		2	%
	Average occupied units				8,382			7,980			402			5.0	%		8,380			7,987			393			4.9	%
	Average occupancy%				94	%		94	%		0	%					94	%		93	%		1	%
	Revenue per occupied unit (per month)			$	3,403		$	3,203		$	201			6.3	%	$	3,398		$	3,172		$	226			7.1	%
	Operating contribution per unit (per month)				1,155			1,027			127			12.4	%		1,144			1,015			129			12.7	%
	Resident and healthcare revenue				85,578			76,673			8,905			11.6	%		170,866			152,028			18,838			12.4	%
	Community operating expense				56,546			52,079			4,467			8.6	%		113,337			103,376			9,961			9.6	%
		Community operating contribution (2)			29,032			24,594			4,438			18.0	%		57,529			48,652			8,877			18.2	%
		Operating contribution margin (3)			33.9	%		32.1	%		1.8	%		5.8	%		33.7	%		32.0	%		1.7	%		5.2	%
Free-standing assisted living communities
	Ending occupied units (4)				2,456			2,311			145			6.3	%		2,456			2,311			145			6.3	%
	Ending occupancy% (4)				86	%		81	%		5	%					86	%		81	%		5	%
	Average occupied units (4)				2,430			2,298			132			5.7	%		2,408			2,290			118			5.2	%
	Average occupancy% (4)				86	%		81	%		5	%					85	%		81	%		4	%
	Revenue per occupied unit			$	3,228		$	3,003		$	225			7.5	%	$	3,197		$	2,959		$	238			8.1	%
	Operating contribution per unit (per month)				825			564			261			46.3	%		804			501			303			60.4	%
	Resident and healthcare revenue				23,532			20,705			2,827			13.7	%		46,195			40,658			5,537			13.6	%
	Community operating expense				17,519			16,819			700			4.2	%		34,580			33,768			812			2.4	%
			Community operating contribution (2)		6,013			3,886			2,127			54.7	%		11,615			6,890			4,725			68.6	%
			Operating contribution margin (3)		25.6	%		18.8	%		6.8	%		36.1	%		25.1	%		16.9	%		8.2	%		48.4	%
Management services operating contribution (2)				$	515		$	383		$	132			34.5	%	$	939		$	833		$	106			12.7	%
Total segment operating contributions					35,560			28,863			6,697			23.2	%		70,083			56,375			13,708			24.3	%
	As a% of total revenue				32.3	%		29.3	%		2.9	%		10.0	%		32.0	%		28.9	%		3.0	%		10.4	%
General and administrative				$	6,114		$	6,837		$	(723	)		-10.6	%	$	12,702		$	12,818		$	(116	)		-0.9	%
Lease expense					15,158			10,366			4,792			46.2	%		30,272			20,500			9,772			47.7	%
Depreciation and amortization					6,547			6,969			(422	)		-6.1	%		13,460			13,800			(340	)		-2.5	%
Amortization of leasehold costs					728			530			198			37.4	%		1,446			1,048			398			38.0	%
	Operating income			$	7,013		$	4,161		$	2,852			68.5	%	$	12,203		$	8,209		$	3,994			48.7	%

(1)	Selected financial and operating data does not include any inter-segment transactions or allocated costs.
(2)	Segment operating contribution is calculated by subtracting the segment operating expenses from the segment revenues.
(3)	Segment operating contribution margin is calculated by dividing the operating contribution of the segment by the respective segment revenues.
(4)	Excludes two free-standing assisted living communities owned by our company through joint ventures. These joint ventures are not included in the consolidated free-standing  assisted living community segment results since we do not own a majority interest. The net results of these joint ventures are accounted for using the equity method and are included in other income (expense) in our condensed consolidated statement of operations.

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Three Months Ended June 30, 2004 Compared with the Three Months Ended June 30, 2003

Retirement Centers

Revenue - - Retirement center revenues were $85.6 million for the three months ended June 30, 2004, compared to $76.7 million for the three months ended June 30, 2003, an increase of $8.9 million, or 11.6%, which was comprised of:

• $2.5 million increase due to the August 2003 lease of two previously managed communities, which increased revenues by $4.7 million, offset by a $2.2 million decrease in revenues resulting from the September 2003 sale-manageback of a previously owned retirement center.

• $5.4 million from increased revenue per occupied unit.  This increase is made up primarily of selling rate increases and increased ancillary services provided to residents (including a $1.9 million increase in therapy services).  Rate increases include the impact of increased Medicare reimbursement rates for skilled nursing and therapy, the mark-to-market effect from turnover of residents (reselling units at higher current selling rates) and annual increases in monthly service fees from existing residents.  We expect that selling rates to new residents will continue to increase during 2004, subject to market conditions.

• $1.0 million from increased occupancy.  We increased average occupancy in retirement centers by 402 units when comparing the six months ended June 30, 2004 with June 30, 2003.  The 402 increase includes the partial year impact of converting two previously managed retirement centers to a lease during August 2003, offset by a decrease related to the sale-manageback of a retirement center during September 2003, resulting in a net increase in average occupancy of 133 units.  Occupancy of the retirement center segment at June 30, 2004 was 95%. Any occupancy gains above this level should produce significant incremental operating contributions.  We are focused on maintaining this high level of occupancy across the portfolio, and making incremental occupancy gains at selected communities with below average occupancy levels.

Community operating expenses - Retirement center community operating expenses were $56.5 million for the three months ended June 30, 2004, compared to $52.1 million for the three months ended June 30, 2003, an increase of $4.5 million, or 8.6%, which was comprised of:

• $1.6 million increase due to the August 2003 lease of two previously managed communities, which increased expenses by $2.7 million, offset by the September 2003 sale-manageback of a retirement center that was previously owned, which decreased expenses $1.1 million.

• $2.3 million of increased labor and related costs. This increase is primarily a result of wage rate increases for associates and the additional staffing costs, including approximately $0.7 million supporting the growth of the therapy services program. Although wage rates of associates are expected to increase each year, we do not expect significant changes in staffing levels in this segment, other than to support expansions or the growth of ancillary programs such as therapy services. 

• $0.6 million of other year-to-year cost increases.  This includes slight increases in operating expenses such as insurance, utilities, property taxes, marketing, food, ancillary costs and other property related costs.

Community operating contribution - Retirement center operating contribution was $29.0 million for the three months ended June 30, 2004, compared to $24.6 million for the three months ended June 30, 2003, an increase of $4.4 million, or 18.0%.

• The operating contribution margin at June 30, 2003 increased from 32.1% to 33.9% at June 30, 2004, an increase of 1.8%.

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• The increased margin in 2004 primarily relates to continued operational improvements throughout the retirement centers segment resulting from increased occupancy and revenue per occupied unit (including continued growth of the therapy services program), and control of community operating expenses including labor, employee benefits and insurance related costs.

Free-standing Assisted Living Communities

Revenue - Free-standing assisted living community revenues were $23.5 million for the three months ended June 30, 2004, compared to $20.7 million for the three months ended June 30, 2003, an increase of $2.8 million, or 13.7%, which was comprised of:

• $1.9 million from increased revenue per occupied unit. This increase includes the impact of price increases, reduced discounting and promotional allowances, and the mark-to-market effect from turnover of residents (reselling units at higher current rates), and includes $0.3 million related to increased revenues from therapy services.  We will be focused on increasing revenue per occupied unit, subject to market constraints, through price increases, as well as the mark-to-market turnover of residents with prior discounted rates, and an increase in ancillary services such as therapy.

• $0.9 million from increased occupancy.  Occupancy increased from 81% at June 30, 2003 to 86% at June 30, 2004, an increase of 5%.  We are focused on continuing to increase the occupancy in our free-standing assisted living communities, and believe that over the long-term, this segment of the industry should be able to achieve average occupancy levels at or near those achieved in the retirement center segment.  We are focused on increasing our number of move-ins, increasing average length of stay, and expanding our marketing efforts and sales training in order to increase occupancy.

• These amounts exclude the revenue and occupancy for two free-standing assisted living communities owned through unconsolidated joint ventures.

Community operating expenses - Free-standing assisted living community operating expenses were $17.5 million for the three months ended June 30, 2004, compared to $16.8 million for the three months ended June 30, 2003, an increase of $0.7 million or 4.2%, which was comprised of:

• $0.8 million of labor and labor related costs. This increase is primarily a result of wage rate increases for associates and additional staffing costs of approximately $0.3 million supporting the growth of therapy services programs. We do not expect significant increases in staffing levels in this segment as occupancy levels increase over the current 86%, since most communities are nearly fully staffed at current occupancy levels.  However, growth of ancillary revenue programs such as therapy may require additional staff to support incremental activity. As a result of higher recruiting and retention costs of qualified personnel, we expect increased wage rates each year, subject to labor market conditions.

• ($0.1 million) of other net cost decreases.  This includes decreased community overhead costs, insurance costs, marketing expenses (as certain communities reach stabilized occupancy levels), and various other cost decreases.

Community operating contribution - Free-standing assisted living community operating contribution was $6.0 million for the three months ended June 30, 2004, compared to $3.9 million for the three months ended June 30, 2003, an increase of $2.1 million, or 54.7%.

• For the three months ended June 30, 2004 and 2003, respectively, the operating contribution margin increased from 18.8% to 25.6%, an increase of 6.8%.

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• The increased margin primarily relates to strong increases in revenue per occupied unit and some occupancy increases, coupled with control of community operating expenses. The incremental increase in operating contribution as a percentage of revenue increase was 75% for the three months ended June 30, 2004 versus June 30, 2003.

• We believe that, absent unforeseen cost pressures, revenue increases resulting from occupancy increases should continue to produce high incremental community operating contribution margins (as a percentage of sales increase) for this segment.

Management Services.  Management services revenues and operating contribution were $0.5 million for the three months ended June 30, 2004, compared to $0.4 million for the three months ended June 30, 2003, an increase of $0.1 million, or 34.5%. Increase results from the September 2003 sale-manageback of a previously owned retirement center.  During the three months ended March 31, 2004, we consolidated a managed community, Freedom Square (including its revenues and expenses instead of only showing its management fee), in accordance with new accounting literature and have restated all prior periods presented to conform to this presentation.

General and Administrative.  General and administrative expense was $6.1 million for the three months ended June 30, 2004, compared to $6.8 million for the three months ended June 30, 2003, a decrease of $0.7 million, or 10.6%.

• This was primarily a result of decreases in insurance related costs and accruals (including workers compensation and medical programs) of approximately $0.9 million, during the three months ended June 30, 2004 compared to the three months ended June 30, 2003. These decreases were partially offset by approximately $0.2 million of increased audit and information technology service costs.

• General and administrative expense as a percentage of total consolidated revenues decreased to 5.6% for the 2004 period from 7.0% for the 2003 period, a decrease of 1.4%.

• We believe that measuring general and administrative expense as a percentage of total consolidated revenues and combined revenues (including unconsolidated managed revenues) provides insight as to the level of our overhead in relation to our total operating activities (including those that relate to management services). General and administrative expense as a percentage of total combined revenues was 5.0% for the three months ended June 30, 2004 and 2003, respectively, calculated as follows:

		Three Months Ended June 30,
		2004				2003
Total consolidated revenues			$	110,149			$	98,374
Revenues of unconsolidated managed communities				13,668				12,949
Less management fees				515				383
	Total combined revenue		$	123,302			$	110,940
Total general and administrative expense			$	6,114			$	6,837
General and administrative expense as a% of total consolidated revenues				5.6	%			7.0	%
General and administrative expense as a% of total combined revenue				5.0	%			6.2	%

Lease Expense.  Lease expense was $15.2 million for the three months ended June 30, 2004, compared to $10.4 million for the three months ended June 30, 2003, an increase of $4.8 million or 46.2%.

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• As a result of the sale-leaseback and sale-manageback transactions completed in 2003, three additional retirement centers are currently leased (versus owned) properties. Lease expense increased $2.9 million as a result of these transactions completed in 2003.

• Net lease expense for the three months ended June 30, 2004 was $15.2 million, which includes current lease payments of $15.9 million, plus accruals for future lease escalators of $1.7 million, net of the amortization of the deferred gain from prior sale-leasebacks of $2.4 million.

• As of June 30, 2004, we had operating leases for 32 of our communities, including 18 retirement centers and 14 free-standing assisted living communities.

Depreciation and Amortization.  Depreciation and amortization expense was $6.5 million for the three months ended June 30, 2004, compared to $7.0 million for the three months ended June 30, 2003, a decrease of $0.5 million, or 6.1%. The decrease was related to the $92.0 million reduction in depreciable assets resulting from the September 2003 sale-leaseback transactions, offset by additions to depreciable assets during the period.

Amortization of Leasehold Acquisition Costs.  Amortization of leasehold acquisition costs was $0.7 million for the three months ended June 30, 2004, compared to $0.5 million for the three months ended June 30, 2003, an increase of $0.2 million or 37.4%. This increase was related to the August 2003 lease of two retirement centers we previously managed, which increased leasehold acquisition costs by $12.8 million, adjusted by a $0.9 million reduction in prior leasehold acquisition costs, for a net increase of $11.9 million.

Interest Expense.   Interest expense was $8.9 million for the three months ended June 30, 2004, compared to $14.6 million for the three months ended June 30, 2003, a decrease of $5.7 million, or 38.8%.

• As a result of the sale-leaseback transactions completed in September 2003, we repaid $112.8 million of first mortgage debt, and $51.8 million of the mezzanine loan, which accounted for a majority of the decrease in interest expense, as well as the increase in lease expense.

• Interest expense for the second quarter of 2004 was $8.9 million.  This amount includes $3.9 million of interest expense on the mezzanine loan.

Other Income (Expense).  Interest income was $0.7 million for the three months ended June 30, 2004, compared to $0.9 million for the three months ended June 30, 2003, a decrease of $0.2 million, or 25.0%. The decrease in interest income was primarily attributable to reduced amounts of certificates of deposit and notes receivable balances associated with certain terminated leasing transactions, as well as lower interest rates. Assuming rates are consistent, and balance requirements are maintained, interest income in upcoming quarters is expected to be similar to the quarter ended June 30, 2004.

Income Taxes.  The provision for income taxes was an expense of $0.1 million for the three months ended June 30, 2004, and $0.1 million for the three months ended June 30, 2003. These taxes are primarily related to current state taxes. As of June 30, 2004, we have a cumulative valuation allowance against deferred tax assets of approximately $59 million.  As a result of our reported losses in the past several years, we do not meet the “more likely than not” recoverability criteria necessary to currently recognize the benefit of our deferred tax assets, except for those assets which will be recovered through known reversals of deferred tax liabilities.  Accordingly, during the three months ended June 30, 2004, we have recorded valuation allowances against deferred tax assets of approximately $0.9 million.  We will continue to assess our ability to generate sufficient taxable income (from positive earnings and other factors) during future periods in which the deferred tax assets may be utilized.  If in the future, we determine that we meet the “more likely than not” recoverability criteria, we will reduce or eliminate our valuation allowance of approximately $59 million against deferred tax assets at that time, resulting in a significant reduction of tax expense (or recording tax benefit in such period), which will result in a corresponding increase to net income and shareholders’ equity.

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Minority Interest in Earnings of Consolidated Subsidiaries, Net of Tax.  Minority interest in earnings of consolidated subsidiaries, net of tax, was $0.9 million and $0.2 million for the three months ended June 30, 2004 and 2003, respectively. This amount was attributable to the HCPI equity investment made during September 2002, as well as the Freedom Square management agreement consolidated in accordance with new accounting literature. (See Note 10 to the Condensed Consolidated Financial Statements.) The increase in minority interest was attributable to increased lifecare sales for the three months ended June 30, 2004 versus June 30, 2003, at Freedom Square.

Net Loss. We experienced a net loss of $2.5 million, or $0.10 loss per diluted share, for the three months ended June 30, 2004, compared to a net loss of $9.5 million, or $0.53 loss per diluted share, for the three months ended June 30, 2003.

Six Months Ended June 30, 2004 Compared with the Six Months Ended June 30, 2003

Retirement Centers

Revenue - - Retirement center revenues were $170.9 million for the six months ended June 30, 2004, compared to $152.0 million for the six months ended June 30, 2003, an increase of $18.8 million, or 12.4%, which was comprised of:

• $4.9 million increase due to the August 2003 lease of two previously managed communities, which increased revenues by $9.3 million, offset by a $4.4 million decrease in revenues resulting from the September 2003 sale-manageback of a previously owned retirement center.

• $11.6 million from increased revenue per occupied unit.  This increase is made up primarily of selling rate increases and increased ancillary services provided to residents (including a $3.7 million increase in therapy services and $0.9 million increase in entrance fee income).  Rate increases include the impact of increased Medicare reimbursement rates for skilled nursing and therapy, the mark-to-market effect from turnover of residents (reselling units at higher current selling rates) and annual increases in monthly service fees from existing residents.  We expect that selling rates to new residents will continue to increase during 2004, subject to market conditions.

• $2.3 million from increased occupancy.  We increased average occupancy in retirement centers by 393 units when comparing June 30, 2004 with June 30, 2003.  The 393 increase includes the partial year impact of converting two previously managed retirement centers to a lease during August 2003, offset by a decrease related to the sale-manageback of a retirement center during September 2003, resulting in a net increase in average occupancy of 129 units.  Occupancy of the retirement center segment at June 30, 2004 was 95%. Any occupancy gains above this level should produce significant incremental operating contributions.  We are focused on maintaining this high level of occupancy across the portfolio, and making incremental occupancy gains at selected communities with below average occupancy levels.

Community operating expenses - Retirement center community operating expenses were $113.3 million for the six months ended June 30, 2004, compared to $103.4 million for the six months ended June 30, 2003, an increase of $9.9 million, or 9.6%, which was comprised of:

• $3.1 million increase due to the August 2003 lease of two previously managed communities, which increased expenses by $5.3 million, offset by the September 2003 sale-manageback of a retirement center that was previously owned, which decreased expenses $2.2 million.

• $5.7 million of increased labor and related costs. This increase is primarily a result of wage rate increases for associates and the additional staffing costs, including approximately $1.6 million supporting the growth of the therapy services program. Although wage rates of associates are expected to increase each year, we do not expect significant changes in staffing levels in this segment, other than to support expansions or the growth of ancillary programs such as therapy services. 

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• $1.1 million of other year-to-year cost increases.  This includes slight increases in operating expenses such as utilities, property taxes, marketing, food, ancillary costs and other property related costs.

Community operating contribution - Retirement center operating contribution was $57.5 million for the six months ended June 30, 2004, compared to $48.6 million for the six months ended June 30, 2003, an increase of $8.9 million, or 18.2%.

• The operating contribution margin at June 30, 2003 increased from 32.0% to 33.7% at June 30, 2004, an increase of 1.7%.

• The increased margin in 2004 primarily relates to continued operational improvements throughout the retirement centers segment resulting from increased occupancy and revenue per occupied unit (including continued growth of the therapy services program), and control of community operating expenses including labor, employee benefits and insurance related costs.

Free-standing Assisted Living Communities

Revenue - Free-standing assisted living community revenues were $46.2 million for the six months ended June 30, 2004, compared to $40.7 million for the six months ended June 30, 2003, an increase of $5.5 million, or 13.6%, which was comprised of:

• $3.9 million from increased revenue per occupied unit. This increase includes the impact of price increases, reduced discounting and promotional allowances, and the mark-to-market effect from turnover of residents (reselling units at higher current rates), and includes $0.5 million related to increased revenues from therapy services. We will be focused on increasing revenue per occupied unit, subject to market constraints, through price increases, as well as the mark-to-market turnover of residents with prior discounted rates, and an increase in ancillary services such as therapy.

• $1.6 million from increased occupancy.  Occupancy increased from 81% at June 30, 2003 to 86% at June 30, 2004, an increase of 5%.  We are focused on continuing to increase the occupancy in the free-standing assisted living communities, and believes that over the long-term, this segment of the industry should be able to achieve average occupancy levels at or near those achieved in the retirement center segment.  We are focused on increasing our number of move-ins, increasing average length of stay, and expanding our marketing efforts and sales training in order to increase occupancy.

• These amounts exclude the revenue and occupancy for two free-standing assisted living communities owned through unconsolidated joint ventures.

Community operating expenses - Free-standing assisted living community operating expenses were $34.6 million for the six months ended June 30, 2004, compared to $33.8 million for the six months ended June 30, 2003, an increase of $0.8 million or 2.4%, which was comprised of:

• $1.3 million of labor and labor related costs. This increase is primarily a result of wage rate increases for associates and additional staffing costs of approximately $0.5 million supporting the growth of therapy services programs. We do not expect significant increases in staffing levels in this segment as occupancy levels increase over the current 86%, since most communities are nearly fully staffed at current occupancy levels.  However, growth of ancillary revenue programs such as therapy may require additional staff to support incremental activity. As a result of higher recruiting and retention costs of qualified personnel, we expect increased wage rates each year, subject to labor market conditions.

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• ($0.5 million) of other net cost decreases.  This includes decreased community overhead costs, insurance costs, marketing expenses (as certain communities reach stabilized occupancy levels), and various other cost decreases.

Community operating contribution - Free-standing assisted living community operating contribution was $11.6 million for the six months ended June 30, 2004, compared to $6.9 million for the six months ended June 30, 2003, an increase of $4.7 million, or 68.6%.

• For the six months ended June 30, 2004 and 2003, respectively, the operating contribution margin increased from 16.9% to 25.1%, an increase of 8.2%.

• The increased margin primarily relates to strong increases in revenue per occupied unit and some occupancy increases, coupled with control of community operating expenses. The incremental increase in operating contribution as a percentage of revenue increase was 85% for the six months ended June 30, 2004 versus June 30, 2003.

• We believe that, absent unforeseen cost pressures, revenue increases resulting from occupancy increases should continue to produce high incremental community operating contribution margins (as a percentage of sales increase) for this segment.

Management Services.  Management services revenues and operating contribution were $0.9 million for the six months ended June 30, 2004, compared to $0.8 million for the six months ended June 30, 2003, an increase of $0.1 million, or 12.7%. Increase results from the September 2003 sale-manageback of a previously owned retirement center.  During the six months ended June 30, 2004, we consolidated a managed community (Freedom Square) in accordance with new accounting literature and have restated all prior periods presented to conform to this presentation.

General and Administrative.   General and administrative expense was $12.7 million for the six months ended June 30, 2004, compared to $12.8 million for the six months ended June 30, 2003, a decrease of $0.1 million, or 0.9%.

• This was primarily a result of decreases in insurance related costs and accruals (including workers’ compensation and medical programs) of approximately $0.7 million in the 2004 period versus the 2003 period. These decreases were offset by approximately $0.5 million of increased audit and information technology service costs, as well as marketing costs.

• General and administrative expense as a percentage of total consolidated revenues decreased to 5.8% for 2004 from 6.6% for 2003, a decrease of 0.8%.

• We believe that measuring general and administrative expense as a percentage of total consolidated revenues and combined revenues (including unconsolidated managed revenues) provides insight as to the level of our overhead in relation to our total operating activities (including those that relate to management services). General and administrative expense as a percentage of total combined revenues was 5.2% for the six months ended June 30, 2004 and 2003, respectively, calculated as follows:

		Six Months Ended June 30,
		2004				2003
Total consolidated revenues			$	219,292			$	194,820
Revenues of unconsolidated managed communities				25,754				26,045
Less management fees				939				833
	Total combined revenue		$	244,107			$	220,032
Total general and administrative expense			$	12,702			$	12,818
General and administrative expense as a% of total consolidated revenues				5.8	%			6.6	%
General and administrative expense as a% of total combined revenue				5.2	%			5.8	%

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Lease Expense.  Lease expense was $30.3 million for the six months ended June 30, 2004, compared to $20.5 million for the six months ended June 30, 2003, an increase of $9.8 million or 47.7%.

• As a result of the sale-leaseback and sale-manageback transactions completed in 2003, three additional retirement centers are currently leased (versus owned) properties. Lease expense increased $5.8 million as a result of these transactions completed in 2003.

• Net lease expense for the first half of 2004 was $30.3 million, which includes current lease payments of $31.8 million, plus accruals for future lease escalators of $3.5 million, net of the amortization of the deferred gain from prior sale-leasebacks of $5.0 million.

• As of June 30, 2004, we had operating leases for 32 of our communities, including 18 retirement centers and 14 free-standing assisted living communities.

Depreciation and Amortization.  Depreciation and amortization expense was $13.5 million for the six months ended June 30, 2004, compared to $13.8 million for the six months ended June 30, 2003, a decrease of $0.3 million, or 2.5%. The decrease was related to the $92.0 million reduction in depreciable assets resulting from the September 2003 sale-leaseback transactions, offset by additions to depreciable assets during the period, as well as $0.5 million of additional depreciation expensed during the first quarter of 2004, related to assets previously held-for-sale.

Amortization of Leasehold Acquisition Costs.  Amortization of leasehold acquisition costs was $1.4 million for the six months ended June 30, 2004, compared to $1.0 million for the six months ended June 30, 2003, an increase of $0.4 million or 38.0%. This increase was related to the August 2003 lease of two retirement centers we previously managed, which increased leasehold acquisition costs by $12.8 million, adjusted by a $0.9 million reduction in prior leasehold acquisition costs, for a net increase of $11.9 million.

Interest Expense.   Interest expense was $18.6 million for the six months ended June 30, 2004, compared to $28.9 million for the six months ended June 30, 2003, a decrease of $10.3 million, or 35.5%.

• As a result of the sale-leaseback transactions completed in September 2003, we repaid $112.8 million of first mortgage debt, and $51.8 million of the mezzanine loan, which accounted for a majority of the decrease in interest expense, as well as the increase in lease expense.

• Interest expense for the six months ended June 30, 2004 was $18.6 million.  This amount includes $7.8 million of interest expense on the mezzanine loan.

Other Income (Expense).  Interest income was $1.3 million for the six months ended June 30, 2004, compared to $1.6 million for the six months ended June 30, 2003, a decrease of $0.3 million, or 20.0%. The decrease in interest income was primarily attributable to reduced amounts of certificates of deposit and notes receivable balances associated with certain terminated leasing transactions, as well as lower interest rates. Assuming rates are consistent, and balance requirements are maintained, interest income is expected to approximate the June 30, 2004 quarterly amount of $0.7 million.

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Income Taxes.  The provision for income taxes was an expense of $0.2 million for the six months ended June 30, 2004, and $0.2 million for the six months ended June 30, 2003. These taxes are primarily related to current state taxes. As of June 30, 2004, we have a cumulative valuation allowance against deferred tax assets of approximately $59 million.  As a result of our reported losses in the past several years, we do not meet the “more likely than not” recoverability criteria necessary to currently recognize the benefit of our deferred tax assets, except for those assets which will be recovered through known reversals of deferred tax liabilities.  Accordingly, during the six months ended June 30, 2004, we have recorded valuation allowances against deferred tax assets of approximately $2.6 million.  We will continue to assess our ability to generate sufficient taxable income (from positive earnings and other factors) during future periods in which the deferred tax assets may be utilized.  If in the future, we determine that we meet the “more likely than not” recoverability criteria, we will reduce or eliminate our valuation allowance of approximately $59 million against deferred tax assets at that time, resulting in a significant reduction of tax expense (or recording tax benefit in such period), which will result in a corresponding increase to net income and shareholders’ equity.

Minority Interest in Earnings of Consolidated Subsidiaries, Net of Tax.  Minority interest in earnings of consolidated subsidiaries, net of tax, was $1.8 million and $1.4 million for the six months ended June 30, 2004 and 2003, respectively. This amount was attributable to the HCPI equity investment made during September 2002, as well as the Freedom Square management agreement consolidated in accordance with new accounting literature. (See Note 10 to the Condensed Consolidated Financial Statements.) The increase in minority interest was attributable to increased lifecare sales for the six months ended June 30, 2004 versus June 30, 2003, at Freedom Square.

Net Loss. We experienced a net loss of $7.3 million, or $0.32 loss per diluted share, for the six months ended June 30, 2004, compared to a net loss of $20.5 million, or $1.16 loss per diluted share, for the six months ended June 30, 2003.

Liquidity and Capital Resources

Our primary sources of cash from operating activities are the collection of monthly and other billings for providing housing, healthcare services and ancillary services at our communities, the proceeds from the sale of entrance fees and management fees from the communities we manage for third parties. These collections are primarily from residents or their families, with approximately 15% coming from various reimbursement programs (primarily Medicare). The primary uses of cash for our ongoing operations include the payment of community operating expenses, including labor costs and related benefits, general and administrative costs, lease and interest payments, principal payments required under various debt agreements, refunds due upon termination of  entrance fee contracts, working capital requirements, and capital expenditures necessary to maintain our buildings and equipment.

We are highly leveraged and have substantial payment commitments for lease, interest, principal and other payments on outstanding debt and lease obligations. As shown in the Future Cash Commitments table below, we have significant payment obligations during the next five years. These commitments and our plans regarding them are described below:

• Our long-term debt payments include recurring principal amortization and other amounts due each year plus various maturities of mortgages and other loans.

• Long-term debt payments include mortgage debt payments due of $11.2 million in the twelve months ended June 30, 2005, $10.4 million in the twelve months ended June 30, 2006 and $17.9 million in the twelve months ended June 30, 2007. We intend to repay or refinance these amounts as they come due, subject to available funds and market conditions.

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• The long-term debt payments due in the twelve months ended June 30, 2008 include, in addition to other debt payments, the maturity of the remaining $82.0 million of the mezzanine loan, plus deferred interest. This loan was repaid July 15, 2004, in conjunction with a multi-property sale-leaseback transaction. However, because of certain lease financing treatment for three of the four sale-leaseback communities, the amount of debt on the balance sheet will remain approximately the same.

• The long-term debt payments due in the twelve months ended June 30, 2009 include $17.2 million due on notes to certain former joint venture partners, which bear interest at 9.625%.

• As of June 30, 2004, we lease 41 of our communities (32 operating leases and nine leases accounted for as financing obligations) and lease certain equipment. As a result, we incur significant lease payments from these long-term leases. We intend to fund these lease obligations primarily from cash provided by operations.

As of June 30, 2004, we had approximately $18.9 million in unrestricted cash and cash equivalents, and $17.4 million of working capital. We believe that our current cash and cash equivalents, expected cash flow from operations, and the proceeds from additional financing transactions or earnouts will be sufficient to fund our operating requirements, capital expenditure requirements, periodic debt service requirements, and lease obligations during the next twelve months.

Since we are highly leveraged, the cash needs for lease and interest payments and principal payments on outstanding debt will remain high for the foreseeable future and remain a significant cost for our company. In order to meet our liquidity requirements over the longer term, including our debt maturities, we are focusing on:

• Increasing our cash flow from operations - We are focused on increasing our cash flow from operations primarily by increasing our occupancy levels (primarily at our free-standing assisted living communities) and revenue per unit at all communities through periodic selling rate increases and additional services, while controlling operating expenses and maintaining strong entrance fee sales.

• Refinancing certain debt maturities as they come due - Given our high leverage, cash flow from operations will not be sufficient to repay all of our debt maturities in full as they come due. As a result, we will be required to refinance some or all of our maturing debt obligations as they come due. Our ability to do so will be affected by, and dependent upon, our operational results, industry and general economic conditions, and capital market conditions.

• Reducing our cost of capital - During 2002 and 2003, we significantly increased our leverage and average cost of capital (for various debt and lease obligations).  We are continuously exploring opportunities to reduce our leverage and average debt cost by refinancing high cost debt. The July 15, 2004 sale-leaseback transaction will reduce our cost of capital  by replacing the 19.5% mezzanine loan with 9.0% base rate lease agreements.

We do not expect changes in interest rates to have a material effect on income or cash flows in 2004, since 74.5% of our debt has fixed rates. There can be no assurances, however, that interest rates will not significantly change and increase our future debt service costs. As a result of operating losses, we have not incurred significant tax payments in recent years. Although we have generated various operating loss carryforwards in recent years, it is expected that currently taxable gains on the July 15, 2004 sale-leaseback transaction will fully utilize these tax operating loss carryforwards. As a result, we expect to pay approximately $6.8 million of tax during the fourth quarter of 2004, and expect to incur cash tax payments in future quarters as our operating results improve.

As of June 30, 2004, we have a cumulative valuation allowance against deferred tax assets of approximately $59 million.  As a result of our reported losses in the past several years, we do not meet the “more likely than not” recoverability criteria necessary to currently recognize the benefit of our deferred tax assets, except for those assets which will be recovered through known reversals of deferred tax liabilities.  We will continue to assess our ability to generate sufficient taxable income (from positive earnings and other factors) during future periods in which the deferred tax assets may be utilized.  If in the future, we determine that we meet the “more likely than not” recoverability criteria, we will reduce or eliminate our valuation allowance of approximately $59 million against deferred tax assets at that time, resulting in a significant reduction of tax expense (or recording tax benefit in such period), which will result in a corresponding increase to net income and shareholders’ equity.

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We may also consider, from time to time, development or acquisition of additional senior living communities or other assets. Such transactions, if significant, would generally require arrangement of separate leases, mortgages or other financing by us.  We have recently filed a shelf registration (Form S-3) to facilitate future public debt or equity offerings.

A significant amount of our indebtedness and lease agreements is cross-defaulted. Any non-payment or other default with respect to such obligations (including non-compliance with financial or restrictive covenants) could cause our lenders to declare defaults, accelerate payment obligations or foreclose upon the communities securing such indebtedness or exercise their remedies with respect to such communities. Furthermore, because of cross-default and cross-collateralization provisions in most of our mortgages, debt instruments, and leases, a default by us on one of our debt instruments or lease agreements is likely to result in a default or acceleration of many of our other obligations, which would have a material adverse effect on us. Certain of our debt instruments and leases contain financial and other covenants, typically on specific communities. We believe that projected results from operations and cash flows will be sufficient to satisfy these covenants during the next twelve months. However, there can be no assurances that we will remain in compliance with those covenants or in the event of future non-compliance that our creditors will grant amendments or waivers.

We have primarily used a combination of mortgage financing (including the mezzanine loan), lease financing, and convertible debentures to finance our cash needs over the past several years. In the future, subject to our performance and market conditions, we would expect to utilize various types of financing including mortgage financing, lease financing, and public debt or equity offerings as well.

Cash Flow, Investing and Financing Activity

During the six months ended June 30, 2004, we experienced a positive net cash flow of $1.7 million.  Net cash provided by operating activities was $18.7 million, net cash used by investing activities was $12.8 million and net cash used by financing activities was $4.2 million.  Our unrestricted cash balance was $18.9 million as of June 30, 2004, as compared to $17.2 million as of December 31, 2003.  Primarily, cash was provided from improved operating results and strong entrance fee sales, and proceeds from refinancing transactions, while cash was used primarily for debt service and lease obligations, capital expenditures and working capital.

Net cash provided by operating activities increased from $2.7 million for the six months ended June 30, 2003 to $18.7 million for the six months ended June 30, 2004, an improvement of $16.0 million, primarily a result of improved operational results, and increased net cash from entrance fee sales. 

Net cash from entrance fee sales (proceeds from entrance fee sales, less refunds of entrance fee terminations) was $16.7 million for the six months ended June 30, 2004, versus $10.5 million for the six months ended June 30, 2003. The entrance fee sales for both of these periods include the results from Freedom Square. We are focused on maintaining strong entrance fee sales for 2004. In future years, the level of sales may be impacted by the number of available units in our entrance fee communities, which is due in part to average length of stay and unit turnover rates.

We routinely make capital expenditures to maintain or enhance communities under our control. The level of capital spending, primarily for refurbishing apartments and maintaining the quality of community assets, was $8.5 million for the six months ended June 30, 2004. In addition, we incurred approximately $1.1 million during the six months ended June 30, 2004 on capital expenditures related to development activities. Our capital expenditure budget for fiscal 2004 is approximately $18 million. We expect that our spending for maintenance capital spending for the remainder of 2004 will be similar to or slightly increased from levels during the first half of the year. In addition, capital spending on development activities is expected to increase during the remainder of 2004. Any significant development prospects would generally utilize separate mortgage, lease or other financing.

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Net cash used by financing activities was $4.2 million compared with $0.5 million during the six months ended June 30, 2004 and 2003, respectively. During the six months ended June 30, 2004, we received proceeds of $47.9 million from the issuance and refinancing of long-term debt, including the accrual of deferred interest of $4.1 million, made principal payments on our indebtedness of $49.3 million, paid $0.3 million of financing costs and made distributions to minority interest holders of $2.2 million. In connection with certain entrance fee communities, we made principal payments under master trust agreements of $0.6 million. We are focused on reducing our debt service costs.

Future Cash Commitments

The following tables summarize our total contractual obligations and commercial commitments as of June 30, 2004 (amounts in thousands):

	Payments Due by Twelve Months Ended June 30,
	2005			2006			2007			2008			2009			Thereafter
Long-term debt	$	11,200		$	10,385		$	17,904		$	96,919		$	24,796		$	96,902
Lease financing obligations		5,842			6,282			6,745			7,245			7,705			65,041
Operating leases		65,135			66,361			67,619			67,805			68,152			509,068
Future accrued interest on mezzanine loan(1)		—			—			—			35,766			—			—
Total contractual cash obligations	$	82,177		$	83,028		$	92,268		$	207,735		$	100,653		$	671,011
Interest income on notes receivable(2)		(1,084	)		(1,074	)		(1,062	)		(1,054	)		(1,038	)		(19,122	)
Contractual obligations, net	$	81,093		$	81,954		$	91,206		$	206,681		$	99,615		$	651,889

	Amount of Commitment Expiration Per Period
	2005			2006			2007			2008			2009			Thereafter
Guaranties(3)		$	473		$	509		$	8,603		$	383		$	415		$	8,307
Total commercial commitments		$	473		$	509		$	8,603		$	383		$	415		$	8,307

(1)	The mezzanine loan has a cash interest payment rate of 9% per year, which increases after April 2004 by fifty-five basis points each year, plus additional accrued interest (which converts to principal) to its stated interest rate of 19.5% compounding quarterly from June 30, 2004. The amount of interest previously reflected above represents the unpaid interest which we were accruing and compounding quarterly. This loan, $82.0 million at June 30, 2004, was repaid July 15, 2004, in conjunction with a multi-property sale-leaseback transaction.  However, because of certain lease financing treatment for three of the four sale-leaseback communities, the amount of debt on the balance sheet will remain approximately the same.
(2)	A portion of the lease payments noted in the above table is repaid to us as interest income on notes receivable from the lessors.
(3)	Guarantees include mortgage debt related to two communities. The mortgage debt guaranteed by us relates to a retirement center under a long-term operating lease agreement and a free-standing assisted living community joint venture managed by us.

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The sale lease-back transaction completed July 15, 2004 will have a significant impact on our future obligations. (See Note 11 to the Condensed Consolidated Financial Statements.) The following tables summarize our total contractual obligations and commercial commitments as of June 30, 2004 (amounts in thousands), incorporating the impact of the July 15, 2004 transactions:

	Payments Due by Twelve Months Ended June 30,
	2005			2006			2007			2008			2009			Thereafter
Long-term debt(1)	$	9,810		$	9,384		$	19,209		$	5,166		$	19,957		$	73,929
Lease financing obligations(2)		16,123			16,914			17,627			18,546			19,440			130,709
Operating leases		67,384			68,678			70,005			70,262			70,683			522,911
Future accrued interest on mezzanine loan(1)		—			—			—			—			—			—
Total contractual cash obligations	$	93,317		$	94,976		$	106,841		$	93,974		$	110,080		$	727,549
Interest income on notes receivable(3)		(1,084	)		(1,074	)		(1,062	)		(1,054	)		(1,038	)		(19,122	)
Contractual obligations, net	$	92,233		$	93,902		$	105,779		$	92,920		$	109,042		$	708,427

	Amount of Commitment Expiration Per Period
	2005			2006			2007			2008			2009			Thereafter
Guaranties(4)		$	473		$	509		$	8,603		$	383		$	415		$	8,307
Total commercial commitments		$	473		$	509		$	8,603		$	383		$	415		$	8,307

(1)	The mezzanine loan, $82.0 million at June 30, 2004, was repaid July 15, 2004, in conjunction with a multi-property sale-leaseback transaction.  In addition, $18.9 million of mortgage debt was repaid and an additional $24.8 million of mortgage debt is no longer included in long-term debt. This debt is retained by the real estate holding companies, and our lease payments to these holding companies will provide the funds to service this debt in the future (this becomes part of our lease obligation).
(2)	Because of certain lease financing treatment for three of the four sale-leaseback communities, the lease financing obligations amounts above have increased.
(3)	A portion of the lease payments noted in the above table is repaid to us as interest income on notes receivable from the lessors.
(4)	Guarantees include mortgage debt related to two communities. The mortgage debt guaranteed by us relates to a retirement center under a long-term operating lease agreement and a free-standing assisted living community joint venture managed by us.

Critical Accounting Policies

Certain critical accounting policies are complex and involve significant judgments by our management, including the use of estimates and assumptions, which affect the reported amounts of assets, liabilities, revenues and expenses. As a result, changes in these estimates and assumptions could significantly affect our financial position or results of operations. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. The significant and critical accounting policies used in the preparation of our financial statements are more fully described in our Annual Report on Form 10-K for the year ended December 31, 2003 and our consolidated financial statements and the notes thereto.

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Risks Associated with Forward Looking Statements

This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of the federal securities laws, which are intended to be covered by the safe harbors created thereby. Those forward-looking statements include all statements that are not historical statements of fact and those regarding the intent, belief or expectations of us or our management including, but not limited to, all statements concerning our anticipated improvement in operations and anticipated or expected cash flow; our expectations regarding trends in the senior living industry; the discussions of our operating and growth strategy; our liquidity and financing needs; our expectations regarding future entrance fee sales or increasing occupancy at our retirement centers or free-standing assisted living communities; our alternatives for raising additional capital and satisfying our periodic debt and lease obligations; the projections of revenue, income or loss, capital expenditures, interest rates and future operations; and the availability of insurance programs. All forward-looking statements involve risks and uncertainties including, without limitation, (i) the fact that we have generated losses in recent periods, (ii) the risks associated with our financial condition and the fact that we are highly leveraged, (iii) the risk that we will be unable to improve operating results at our free-standing assisted living communities, sell our entrance fee units or increase our cash flow or generate expected levels of cash, (iv) the risk that alternative or replacement financing sources will not be available to us, (v) the risks associated with the adverse market conditions for the senior living industry, (vi) the risk that we will be unable to obtain liability insurance in the future or that the costs associated with such insurance or related losses (including the costs of deductibles) will be prohibitive, (vii) the likelihood of further and tighter governmental regulation, (viii) the risk of adverse changes in governmental reimbursement programs, (ix) the risk of rising interest rates, and (x) the risks and uncertainties set forth under the caption “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2003 (which was updated on Form 8-K dated June 10, 2004) and our other filings with the Securities and Exchange Commission.

Should one or more of those risks materialize, actual results could differ materially from those forecasted or expected. Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of these assumptions could prove to be inaccurate, and therefore, there can be no assurance that the forward-looking statements included in this Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our forecasts, expectations, objectives or plans will be achieved. We undertake no obligation to publicly release any revisions to any forward-looking statements contained herein to reflect events and circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Disclosure About Interest Rate Risk  We are subject to market risk from exposure to changes in interest rates based on our financing, investing, and cash management activities. We utilize a balanced mix of debt maturities along with both fixed-rate and variable-rate debt to manage our exposures to changes in interest rates. For fixed rate debt, changes in interest rates generally affect the fair market value of the debt, but not earnings or cash flows. Conversely, for variable rate debt, changes in interest rates generally do not impact fair market value of the debt, but do affect future earnings and cash flows. We generally cannot prepay fixed rate debt prior to maturity without penalty. Therefore, interest rate risk and changes in fair market value should not have a significant impact on the fixed rate debt until we are required to refinance such debt. We have $91.1 million of variable rate debt at June 30, 2004. However, $14.4 million of the variable rate debt agreements contain interest rate floors which allow market interest rates to fluctuate without necessarily changing our interest rate. Therefore, considering the $76.7 million of variable rate debt without such interest rate floors, each one-percentage point increase in interest rates would result in an increase in interest expense for the coming year of approximately $0.8 million.

In addition, we have entered into an interest rate swap agreement with a major financial institution to manage our exposure. The swap involves the receipt of a fixed interest rate payment in exchange for the payment of a variable rate interest payment without exchanging the notional principal amount. Receipts on the agreement are recorded as a reduction to interest expense. Under the agreement, we receive a fixed rate of 6.87% on the $34.0 million of debt, and pay a floating rate stated by the swap agreement based upon LIBOR and a foreign currency index with a maximum rate of 8.12%.

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We do not expect changes in interest rates to have a material effect on income or cash flows in 2004, since 74.5% of our debt has fixed rates. There can be no assurances, however, that interest rates will not significantly change and increase our future debt service costs. 

Disclosure About Market Exchange Risk  We received notice from the New York Stock Exchange, or the NYSE, in December 2002 that we were below the NYSE’s continued listing requirements relating to total market capitalization of $50 million and minimum shareholders’ equity of $50 million, or alternatively total market capitalization in excess of $100 million. As permitted by the NYSE, we submitted a plan during early 2003 demonstrating how we intended to comply with the continued listing requirements. The NYSE accepted our plan and monitored our progress during the eighteen month period ending June 4, 2004.

On June 7, 2004, we announced that we had received notification from the NYSE that we are now considered a “company in good standing” under the NYSE’s continued listing standards and will be removed from its “Watch List”. The NYSE’s decision comes as a result of our consistent positive performance with respect to our business plan submitted to the NYSE in March 2003, and our satisfaction of the NYSE’s alternate continued listing criteria by achieving $117 million of market capitalization based on the 30 trading days ended June 4, 2004. We will be subject to a 12-month follow-up period to ensure that we remain in compliance with the NYSE’s continued listing standards, and will also be subject to its routine monitoring process.

Item 4.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our chief executive officer and chief financial officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report. Based on that evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures effectively and timely provide them with material information relating to us and our consolidated subsidiaries required to be disclosed in the reports we file or submit under the Exchange Act.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during our fiscal quarter ended June 30, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II.  OTHER INFORMATION

Item 4.  Submission of Matters to a Vote of Security Holders

We held our annual meeting of shareholders on May 19, 2004.  At the annual meeting, our shareholders voted (1) to elect four Class I directors to serve for a term of three years and until their successors are duly elected and qualified, (2) to elect one Class II director to serve for a term of one year and until his successor is duly elected and qualified, and (3) to elect one Class III director to serve for a term of two years and until his successor is duly elected and qualified.

The following table sets forth the number of votes cast for and abstain/withheld with respect to each of the director nominees:

Director Nominee	Class/Term	For	Abstain/Withheld
Christopher J. Coates	Class I - 3 years	22,270,185	18,107
Donald D. Davis	Class I - 3 years	22,270,211	18,081
Daniel K. O’Connell	Class I - 3 years	22,269,911	18,381
Lawrence J. Stuesser	Class I - 3 years	22,270,211	18,081
J. Edward Pearson	Class II - 1 year	22,270,211	18,081
John C. McCauley	Class III - 2 years	22,270,211	18,081

In addition to the foregoing directors, the following table sets forth the other members of our board of directors whose term of office continued after the meeting and the year in which his or her term expires:

Name	Term Expires
Frank M. Bumstead	2005
Nadine C. Smith	2005
John A. Morris, Jr. M.D.	2006
W.E. Sheriff	2006

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Item 6.  Exhibits and Reports on Form 8-K

(a)		Exhibits
	10.1	Fourth Amendment to Master Lease Agreement (Phase I), dated July 15, 2004, between Health Care Property Investors, Inc., a Maryland corporation, Texas HCP Holding, L.P., a Delaware Limited Partnership, ARC Richmond Heights, LLC, a Tennessee limited liability company, ARC Shavano, L.P., a Tennessee limited partnership, ARC Delray Beach, LLC, a Tennessee limited liability company, ARC Victoria, L.P., a Tennessee limited partnership, ARC Carriage Club of Jacksonville, Inc., a Tennessee corporation, ARC Post Oak, L.P., a Tennessee limited partnership, and ARC Boynton Beach, LLC, a Tennessee limited liability company.
	10.2	Third Amendment to Master Lease Agreement (Phase II), dated July 15, 2004, between ARC Richmond Place Real Estate Holdings, LLC, ARC Holland Real Estate Holdings, LLC, ARC Sun City Center Real Estate Holdings, LLC, ARC Lake Seminole Square Real Estate Holdings, LLC, ARC Brandywine Real Estate Holdings, LLC, ARC Richmond Place, Inc., Freedom Village of Holland, Michigan, Freedom Village of Sun City Center, Ltd., Lake Seminole Square Management Company, Inc., Freedom Group-Lake Seminole Square, Inc. and ARC Brandywine, LLC.
	10.3	First Amendment to Master Lease Agreement (Phase III), dated July 15, 2004, between Health Care Property Investors, Inc., a Maryland corporation, Texas HCP Holding, L.P., a Delaware Limited Partnership, Texas HCP Revx, L.P., ARC Richmond Place Real Estate Holdings, LLC, ARC Holland Real Estate Holdings, LLC, ARC Sun City Center Real Estate Holdings, LLC, ARC Labarc Real Estate Holdings, LLC, Fort Austin Limited Partnership, ARC Santa Catalina, Inc., ARC Richmond Place, Inc., Freedom Village of Holland, Michigan, Freedom Village of Sun City Center, Ltd., and Labarc L.P.
	31.1	Certification of W.E. Sheriff pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification of Bryan D. Richardson pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of W.E. Sheriff, Chief Executive Officer of American Retirement Corporation, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of Bryan D. Richardson, Chief Financial Officer of American Retirement Corporation, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b)		Reports on Form 8-K filed during the quarter ended June 30, 2004:
		On May 5, 2004, we furnished to the Securities and Exchange Commission a Current Report on Form 8-K (Items 9 and 12) which contained our press release announcing our first quarter 2004 earnings results.
		On May 5, 2004, we furnished to the Securities and Exchange Commission a Current Report on Form 8-K (Items 9 and 12) which contained supplemental financial information relating to our first quarter 2004 results.
		On June 10, 2004, we filed with the Securities and Exchange Commission a Current Report on Form 8-K (Items 5 and 7) which contained restated consolidated balance sheets as of December 31, 2003 and 2002, restated consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2003 and certain restated selected information and data from our Annual Report on Form 10-K for the fiscal year ending December 31, 2003. Such financial information was restated to consolidate the results of a community we manage in compliance with the Financial Accounting Standards Board Interpretation No. 46(R), Consolidation of Variable Interest Entities, and to include three free-standing assisted living communities as continuing operations.

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Notwithstanding the foregoing, information furnished under Item 9 and Item 12 of our Current Reports on Form 8-K, including the related exhibits, shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934.

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SIGNATURES

          Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	AMERICAN RETIREMENT CORPORATION
Date:  August 11, 2004	By:  /s/ Bryan D. Richardson
		Bryan D. Richardson
		Executive Vice President - Finance and
		Chief Financial Officer (Principal Financial and Accounting Officer)

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EX-10.1

Exhibit 10.1

[Boynton Beach, Florida]
[Delray, Florida]
 [Jacksonville, Florida]
[Cleveland, Ohio]
[Houston, Texas]
[San Antonio, Texas]
[Victoria, Texas]

FOURTH AMENDMENT TO MASTER LEASE
(Phase I)

                    THIS FOURTH AMENDMENT TO MASTER LEASE (PHASE I) (this “Amendment”) is made and entered into as of this ______ day of July, 2004 (the “Effective Date”), by and between HEALTH CARE PROPERTY INVESTORS, INC., a Maryland corporation (“HCP”) and TEXAS HCP HOLDING, L.P., a Delaware limited partnership (collectively, as their interests may appear, “Lessor”), on the one hand, and ARC RICHMOND HEIGHTS, LLC, a Tennessee limited liability company, ARC BOYNTON BEACH, LLC, a Tennessee limited liability company, ARC DELRAY BEACH, LLC, a Tennessee limited liability company, ARC VICTORIA, L.P., a Tennessee limited partnership, ARC CARRIAGE CLUB OF JACKSONVILLE, INC., a Tennessee corporation, ARC SHAVANO, L.P., a Tennessee limited partnership and ARC POST OAK, L.P., a Tennessee limited partnership (collectively and jointly and severally, “Lessee”), on the other hand, and ARCPI HOLDINGS, INC., a Delaware corporation (“Guarantor”).

RECITALS

                    A.        Lessor is the “Lessor” and Lessee is the current “Lessee” pursuant to that certain Master Lease dated March 29, 2002 (the “Original Lease”), as amended by that certain First Amendment to Lease dated September 30, 2002 (the “First Amendment”), that certain Second Amendment to Lease dated February 28, 2003 (the “Second Amendment”) and that certain Third Amendment to Lease dated September 23, 2003 (the “Third Amendment”). The Original Lease, as amended by the First Amendment, Second Amendment and Third Amendment, shall be referred to herein, collectively, as the “Lease.” The Lessee’s obligations under the Lease are guaranteed by Guarantor pursuant to a written Guaranty of Obligations dated as of March 29, 2002 (as the same has been amended and reaffirmed from time to time in accordance with the terms thereof, the “Guaranty”). Lessor, Lessee and certain Affiliates of each are also parties to that certain Forbearance and Limited Waiver Agreement (Regarding Insurance) dated as of January 1, 2004 with respect to the Lease and certain other agreements.

                    B.        The Lease covers the “Leased Property” of four (4) separate assisted living facilities located in Cleveland, Ohio, Delray, Florida, Boynton Beach, Florida and San Antonio, Texas, two (2) separate congregate care facilities located in Houston, Texas, and Jacksonville, Florida, and one (1) mixed congregate care and assisted living facility located in Victoria, Texas, all as more particularly described in the Lease.

                    C.        HCP and Guarantor are also parties to that certain Master Agreement of even date herewith (the “Master Agreement”), pursuant to which HCP and Guarantor have agreed to cause certain transactions to be consummated, including this Amendment, all as more particularly described therein and in the other “Transaction Documents” (as defined in the Master Agreement).

                    D.        In connection with the transactions contemplated by the Master Agreement and the other Transaction Documents, Lessor and Lessee desire to amend the Lease as set forth herein.

                    E.        Capitalized terms used herein and not defined herein shall have the meanings given such terms in the Lease.

AMENDMENT

                    IN CONSIDERATION OF the foregoing recitals, the mutual promises contained herein, and other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Lessor and Lessee hereby agree as follows:

                    1.       Modifications to Certain Provisions of the Lease. Effective as of the Effective Date, the Lease shall be amended and supplemented in the following particulars:

                              (a)     New Definitions. Except as otherwise expressly provided or unless the context otherwise requires, for all purposes of the Lease, as hereby amended, the terms defined in this Section 1(a) shall have the meanings assigned to them as provided below and shall be added to Article II of the Lease to read, in their entireties, as follows:

                              Master Agreement. As defined in the Recitals of this Amendment.

                     Phase III Lease. As defined in the Master Agreement (as the same may be amended, modified and/or amended and restated).

                              (b)     Events of Default. The following is hereby added as a new Section 16.1(w) of the Lease:

                              “(w)   any default beyond any applicable cure periods under the Phase III Lease.”

                              (c)     Financial Statements. Sections 25.1.2(a), (b) and (c) of the Original Lease shall be amended to read, in their entireties, as follows:

                   “(a)     (i) within twenty (20) days after the end of each calendar quarter, unaudited balance sheets and statements of income of Lessee, ARCPI and its consolidated Subsidiaries, and ARC and its consolidated Subsidiaries as of the end of such calendar quarter, (ii) when available, following the end of each calendar quarter, unaudited changes in common stock and other stockholders’ equity and statements of cash flows of ARC and its consolidated Subsidiaries and (iii) within ninety (90) days after the end of Lessee’s, ARCPI’s and ARC’s fiscal years, (A) a copy of the unaudited balance sheets of Lessee, and audited consolidated balance sheets of ARCPI and its consolidated Subsidiaries and ARC and its consolidated Subsidiaries as of the end of such fiscal year, (B) related audited consolidated statements of income, changes in common stock and other stockholders’ equity and statement of cash flows of ARCPI and its consolidated Subsidiaries and ARC and its consolidated Subsidiaries for such fiscal year, and (C) related unaudited statements of income of Lessee, in all cases prepared in accordance with GAAP applied on a basis consistently maintained throughout the period involved (such audited consolidated financial statements of ARC and ARCPI to be certified by nationally recognized certified public accountants);

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                   “(b)     within ninety (90) days after the end of each of Lessee’s, ARCPI’s and ARC’s fiscal years, and together with the annual audit report furnished in accordance with clause (a) above, an Officer’s Certificate stating that to the best of the signer’s knowledge and belief after making due inquiry, Lessee is not in default in the performance or observance of any of the terms of this Lease, or if Lessee shall be in default, specifying all such defaults, the nature thereof, and the steps being taken to remedy the same;

                   “(c)     within thirty (30) days after the end of each of the first twelve (12) months of the Term and the last eighteen (18) months of the Term, all consolidated financial reports that Lessor may reasonably request containing, among other things, detailed statements of income and detailed operational statistics regarding occupancy rates, patient and resident mix and patient and resident rates by type for each Facility; and otherwise within thirty (30) days after the end of each of Lessee’s quarters, all quarterly consolidated financial reports Lessor may reasonably request containing, among other things, detailed statements of income and detailed operational statistics regarding occupancy rates, patient and resident mix and patient and resident rates by type for each Facility;”

                              (d)     Sections 48.1(dd) and (ee). Section 5 of the First Amendment deleted Sections 47.1(dd) and (ee); the references to such sections should have been to Sections 48.1(dd) and (ee).  Sections 48.1(dd) and (ee) are deleted in their entirety. 

                    2.       Consent and Reaffirmation of Guarantor. Guarantor hereby (a) consents to this Amendment, and (b) re-affirms its obligations under the Guaranty and agrees that the same extends to the Lease, as hereby amended.

                    3.       Reaffirmation of Master Lease. Lessor and Lessee hereby acknowledge, agree and reaffirm that the Lease, as hereby amended, is and the parties intend the same for all purposes to be treated as a single, integrated and indivisible agreement. 

                    4.       Governing Law. THIS AMENDMENT WAS NEGOTIATED IN THE STATE OF CALIFORNIA, WHICH STATE THE PARTIES AGREE HAS A SUBSTANTIAL RELATIONSHIP TO THE PARTIES AND TO THE UNDERLYING TRANSACTION EMBODIED HEREBY.  ACCORDINGLY, IN ALL RESPECTS THIS AMENDMENT SHALL BE GOVERNED BY, AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF CALIFORNIA (WITHOUT REGARD OF PRINCIPLES OR CONFLICTS OF LAW) AND ANY APPLICABLE LAWS OF THE UNITED STATES OF AMERICA.

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                    5.       Full Force and Effect; Counterparts; Facsimile Signatures. Except as hereby amended, the Lease shall remain in full force and effect.  This Amendment may be executed in any number of counterparts, all of which shall constitute one and the same instrument.  Telecopied signatures may be used in place of original signatures on this Amendment, and Lessor and Lessee both intend to be bound by the signatures of the telecopied document.

[SIGNATURE PAGE FOLLOWS]

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                    IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the day and year first above written.

WITNESS	“Lessor”
	HEALTH CARE PROPERTY INVESTORS, INC., a Maryland corporation
Witness
	By:
	Title:
Witness
	TEXAS HCP HOLDING, L.P., a Delaware limited partnership
Witness	By:	Texas HCP G.P., INC., a Delaware corporation, its sole General Partner
Witness		By:
		Title:
[Signature pages continue]

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WITNESS	“Lessee”
	ARC RICHMOND HEIGHTS, LLC,      a Tennessee limited liability company
	ARC DELRAY BEACH, LLC,      a Tennessee limited liability company
Witness	ARC BOYNTON BEACH, LLC,      a Tennessee limited liability company
	ARC CARRIAGE CLUB OF JACKSONVILLE,      INC., a Tennessee corporation
Witness
	By:
	Title:
	ARC VICTORIA, L.P., a Tennessee limited partnership
	By:	ARC Homewood Victoria, Inc., a Tennessee corporation, its general partner
Witness
		By:
		Title:
Witness
	ARC POST OAK L.P., a Tennessee limited partnership
Witness	By:	ARC Hampton Post Oak, Inc., a Tennessee corporation, its general partner
		By:
Witness
		Title:
	ARC SHAVANO, L.P., a Tennessee limited partnership
Witness	By:	ARC Shavano Park, Inc., a Tennessee corporation, its general partner
		By:
Witness
		Title:
[Signature pages continue]

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WITNESS	“Guarantor”
	ARCPI HOLDINGS, INC., a Delaware corporation
Witness
	By:
	Title:
Witness

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EX-10.2

Exhibit 10.2

[Seminole, Florida]
[Brandywine, Pennsylvania]

THIRD AMENDMENT TO MASTER LEASE
(Phase II)

                    THIS THIRD AMENDMENT TO MASTER LEASE (PHASE II) (this “Amendment”) is made and entered into as of this ___ day of July, 2004 (the “Effective Date”), by and between ARC Richmond Place Real Estate Holdings, LLC, a Delaware limited liability company (“Richmond RealCo”), ARC Holland Real Estate Holdings, LLC, a Delaware limited liability company (“Holland RealCo”), ARC Sun City Center Real Estate Holdings, LLC, a Delaware limited liability company (“Sun City RealCo”), ARC Lake Seminole Square Real Estate Holdings, LLC, a Delaware limited liability company (“Lake Seminole RealCo”), and ARC Brandywine Real Estate Holdings, LLC, a Delaware limited liability company (“Brandywine RealCo”) (collectively, as their interests may appear, “Lessor”), on the one hand, and ARC Richmond Place, Inc., a Delaware corporation (“Richmond Lessee”), Freedom Village of Holland, Michigan, a Michigan general partnership (“Holland Lessee”), Freedom Village of Sun City Center, Ltd., a Florida limited partnership (“Sun City Lessee”), Lake Seminole Square Management Company, Inc., a Tennessee corporation and Freedom Group-Lake Seminole Square, Inc., a Tennessee corporation (collectively, “Lake Seminole Lessee”), and ARC Brandywine, LLC, a Tennessee limited liability company (“Brandywine Lessee”) (collectively and jointly and severally, “Lessee”), on the other hand, and ARCPI Holdings, Inc., a Delaware corporation (“Guarantor”).

RECITALS

                    A.     Lessor is the current “Lessor” and  Lessee is the current “Lessee” pursuant to that certain Master Lease dated September 30, 2002 together with the Addendum to Master Lease (Entrance Fee Facility) of even date therewith and attached thereto (the “Original Lease”), as amended by that certain First Amendment to Master Lease dated September 23, 2003 (the “First Amendment”) and that certain Second Amendment to Master Lease dated December 31, 2003 (the “Second Amendment”).  The Original Lease, as amended by the First Amendment and Second Amendment, shall be referred to herein, collectively, as the “Lease.”  The Lessee’s obligations under the Lease are guaranteed by Guarantor pursuant to a written Guaranty of Obligations dated as of September 27, 2002 (as the same has been amended and reaffirmed from time to time in accordance with the terms thereof, the “Guaranty”).  Lessor, Lessee and certain Affiliates of each are also parties to that certain Forbearance and Limited Waiver Agreement (Regarding Insurance) dated as of January 1, 2004 with respect to the Lease and certain other agreements.

                    B.     The Original Lease included ARC Santa Catalina Real Estate Holdings, LLC, a Delaware limited liability company (“Santa Catalina RealCo”), Fort Austin Real Estate Holdings, LLC, a Delaware limited liability company (“Fort Austin RealCo”) and Lessor (as defined herein) as the original “Lessor,” and Fort Austin Limited Partnership, a Texas limited partnership (“Fort Austin Lessee”), ARC Santa Catalina, Inc., a Tennessee corporation (“Santa Catalina Lessee”) and Lessee (as defined herein) as the original “Lessee,” and covered in addition to the Seminole Facility, the Brandywine Facility and the Separated Properties (as defined below) four (4) other congregate care retirement centers located in Tucson, Arizona, Denver, Colorado, Austin, Texas, and Ft. Worth, Texas, all as more particularly described in the Original Lease. 

                    C.     Pursuant to the First Amendment, the Tucson Facility, Austin Facility and Ft. Worth Facility were separated from the original Leased Property, and the Lease was terminated with respect to the Denver Facility.  Concurrent therewith, Santa Catalina RealCo and Fort Austin RealCo (collectively, the “Original Phase III Lessor”), as the original “Lessor,” and Fort Austin Lessee and Santa Catalina Lessee (collectively, the “Phase III Lessee”), as “Lessee,” entered into that certain other Master Lease dated September 23, 2003 (the “Phase III Master Lease”) covering the “Leased Property” of the Tucson Facility, Austin Facility and Ft. Worth Facility (collectively, the “Phase III Leased Property”), as more particularly described in the Phase III Master Lease.   The current successor to the Original Phase III Lessor’s interest under the Phase III Master Lease is Health Care Property Investors, Inc., a Maryland corporation (“HCP”), Texas HCP Holding, L.P., a Delaware limited partnership and an Affiliate of HCP (“THCP”) and Texas HCP REVX, L.P., a Delaware limited partnership and an Affiliate of HCP and THCP (“Texas REVX”) (collectively, the “Phase III Lessor”).

                    D.     HCP and Guarantor are the only members of each of the entities comprising the current Lessor under the Lease.  HCP and Guarantor are also parties to that certain Master Agreement of even date herewith (the “Master Agreement”), pursuant to which HCP and Guarantor have agreed to cause certain transactions to be consummated, including this Amendment, all as more particularly described therein and in the other “Transaction Documents” (as defined in the Master Agreement).

                    E.     In connection with the transactions contemplated by the Master Agreement and the other Transaction Documents, Lessor and Lessee desire to execute this Amendment to separate and remove the Lexington Facility, the Holland Facility and the Sun City Facility (collectively, the “Separated Properties”) from the current Leased Property covered by the Lease and to amend the Lease in certain other particulars.  Richmond RealCo, Holland RealCo, and Sun City RealCo (collectively, the “Separated Property Owners”) are the respective fee owners of the Separated Properties and Richmond Lessee, Holland Lessee and Sun City Lessee(collectively, the “Separated Property Operators”) are the respective operators and License Holders for the Separated Properties.  In lieu of executing a New Lease (as defined in Section 31.2 of the Original Lease) in connection with such separation and removal of the Separated Properties from the Leased Property, the Separated Property Owners together with the Phase III Lessor, on the one hand, and the Separated Property Operators together with the Phase III Lessee, on the other hand, and Guarantor are concurrently herewith executing that certain First Amendment to Master Lease (Phase III) of even date herewith (the “Phase III Amendment”) pursuant to which such Separated Properties shall be added to the Phase III Leased Property and the Separated Property Owners and Separated Property Operators shall, respectively, become part of the Phase III Lessor and Phase III Lessee thereunder, all as more particularly set forth in the Phase III Amendment. 

                    F.     Capitalized terms used herein and not defined herein shall have the meanings given such terms in the Lease.

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AMENDMENT

                    IN CONSIDERATION OF the foregoing recitals, the mutual promises contained herein, and other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Lessor and Lessee hereby agree as follows:

          1.       Separated Properties.

                    (a)     Separation of Separated Properties.  Subject to all of the terms and conditions of this Amendment and the Lease, the Separated Properties shall be separated and removed from the Lease upon the Effective Date.  Except as set forth in this Amendment, neither Lessor nor Lessee shall have any further obligations to the other pursuant to the Lease with respect to the Separated Properties subsequent to the Effective Date.

                    (b)     Phase III Master Lease.  Concurrently herewith, the Separated Property Owners together with the Phase III Lessor, on the one hand, and the Separated Property Operators together with the Phase III Lessee, on the other hand, and Guarantor are executing the Phase III Amendment.

          2.      Cessation of Obligations Under Lease and Reservations. 

                    Notwithstanding anything to the contrary herein, the following obligations of Lessee with respect to the Separated Properties shall be reserved and continue subsequent to the Effective Date (as used in Sections 2 and 4 of this Amendment, “Lessee” shall have the meaning given to it under the Lease, without reference to this Amendment):

                    (a)     Lessee agrees to defend, indemnify and hold harmless Lessor from and against any and all liens, claims, costs, losses, expenses, damages, actions and causes of action for which Lessee is responsible under the Lease with respect to the Separated Properties and which accrue or accrued on or before the Effective Date or result from a breach of representation or warranty of Lessee as set forth herein.

                    (b)     Lessee shall remain liable for (i) the cost of any and all Impositions, insurance premiums, utilities charges and other expenses incurred in connection with the operation, maintenance and use of the Separated Properties through and including the Effective Date until full payment thereof and (ii) all Minimum Rent and Additional Rent payable under the Lease through and including the Effective Date (prorating such Minimum Rent and Additional Rent as applicable) until full payment thereof.  Without limiting the foregoing, Lessee shall remain responsible for and shall pay all 2003 assessments for real estate taxes due and payable in 2004, and for all prior years.  Lessee shall also be responsible for and pay its proportionate share of all real estate taxes which are assessed in 2004 and which are due and payable in 2004, based upon the number of days between January 1, 2004 and the Effective Date.

                    (c)     Lessee shall remain responsible for any personal property tax liens assessed against the Separated Properties or any personal property of Lessee therein with a lien date prior to the Effective Date (including all personal property taxes assessed in 2004 which are due and payable in 2005, and for all prior years), irrespective of the date of the billing therefor, and shall indemnify and hold Lessor harmless with respect to any claims for such taxes or resulting from non-payment thereof.

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          3.       Modifications to Certain Provisions of the Lease.  Effective as of the Effective Date, the Lease shall be amended and supplemented in the following particulars:

                    (a)     New Definitions.  Except as otherwise expressly provided or unless the context otherwise requires, for all purposes of the Lease, as hereby amended, the terms defined in this Section 3(a) shall have the meanings assigned to them as provided below and shall be added to Article II of the Lease to read, in their entireties, as follows:

                    Additional Rent Lease Year:  Each period of twelve (12) full calendar months from and after the Effective Date of this Amendment, unless the Effective Date is a day other than the first (1st) day of a calendar month, in which case the first Additional Rent Lease Year shall be the period commencing on the Effective Date of this Amendment and ending on the last day of the twelfth (12th) month following the month in which the Effective Date of this Amendment occurs and each subsequent Additional Rent Lease Year shall be each period of twelve (12) full calendar months after the last day of the prior Additional Rent Lease Year; provided, however, that the last Additional Rent Lease Year during the Term may be a period of less than twelve (12) full calendar months and shall end on the last day of the Term.

                    Additional Rent Quarter:  During each applicable Additional Rent Lease Year, the first three (3) calendar month period commencing on the first (1st) day of such Additional Rent Lease Year and each subsequent three (3) calendar month period within such Additional Rent Lease Year; provided, however, that the last Additional Rent Quarter during the Term may be a period of less than three (3) calendar months and shall end on the last day of the Term.

                    Phase III Master Lease:  As defined in the Recitals of this Amendment.

                    (b)     Amended and Restated Definitions.  The following definitions appearing in Article II of the Original Lease shall be amended and restated, in their entireties, as follows:

                    Base Gross Revenues:  Base Gross Revenues for each Facility shall be the Gross Revenues for such Facility for the period from August 1, 2004 through and including July 31, 2005. 

                    Intangible Property:  All accounts, proceeds of accounts, rents, profits, income or revenues derived from the use of rooms or other space within the Leased Property or the providing of services in or from the Leased Property and all Capital Additions; documents, chattel paper, instruments, contract rights, deposit accounts, general intangibles, commercial tort claims, causes of action, investment property, letter-of-credit rights, letters of credit, money, securities entitlements, now owned or hereafter acquired by Lessee (including any right to any refund of any Impositions and any escrow deposits and reserve accounts required to be maintained in connection with any Entrance Fee Facilities (including any minimum liquid reserves, operating reserves or renewal and replacement reserves) arising from or in connection with Lessee’s operation or use of the Leased Property and all Capital Additions; all licenses and permits now owned or hereinafter acquired by Lessee, which are necessary or desirable for Lessee’s use of the Leased Property and all Capital Additions for the Primary Intended Use, including, if applicable, any certificate of need, certificate of authority or similar certificate; the right to use any trade name or other name associated with the Facility; and any and all third-party provider agreements (including Medicare and Medicaid).

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                    Lessee:  Collectively, and jointly and severally, Lake Seminole Square Management Company, Inc., a Tennessee corporation; Freedom Group-Lake Seminole Square, Inc., a Tennessee corporation; and ARC Brandywine, LLC, a Tennessee limited liability company; provided, however, that it is agreed and understood by all parties hereto that, with respect to each Facility, only the License Holder with respect to such Facility shall be entitled to operate or maintain such Facility, and in no event shall any Lessee other than the applicable License Holder with respect to such Facility be entitled to operate or maintain such Facility or take other actions with respect to such Facility to the extent that such operations or the taking of such actions would violate the licensure requirements or other laws or regulations of any governmental authority with respect to such Facility.  Notwithstanding the foregoing, nothing herein shall affect the joint and several liability of the Lessees.

                    Lessor:  Collectively, as their interests may appear, ARC Lake Seminole Square Real Estate Holdings, LLC, a Delaware limited liability company; and ARC Brandywine Real Estate Holdings, LLC, a Delaware limited liability company; provided, however, that with respect to any matter as it relates to a particular Facility (including, but not limited to, any matter in which Lessor’s consent or approval is required for a particular Facility), as used herein, “Lessor” shall mean only that Lessor which is the fee owner of such Facility.  As of the date hereof, the “Lessor” for each Facility is as set forth on Exhibit H attached hereto.

                    (c)     Deleted Definitions.  The following definitions appearing in Article II of the Original Lease, as well as all or the applicable portion of any provisions directly related thereto, shall be deleted, in their entireties:  “Applicable Percentage,” “Funding Date,” “HCPI Loan Agreement,” “HCPI Loan Documents,” “Incremental Amount,” “Lender,” “Letter of Credit Amount” and “Letter of Credit Date.”

                    (d)     Rent. 

                              (i)      Allocated Minimum Rent. 

                                        (A)     Notwithstanding anything to the contrary in Section 3.1.1 of the Original Lease, subject to any upward adjustments as set forth in Section 3.1.4 of the Original Lease, from and after the Effective Date and continuing through the expiration of the Term, Lessee shall pay monthly “Allocated Base Minimum Rent” for all of the Facilities in the amount as set forth on Exhibit B attached to the Lease, as amended hereby, and incorporated herein by this reference. 

                                        (B)     Section 3.1.2 of the Original Lease shall be deleted in its entirety.

                                        (C)     If the Effective Date shall not be the first (1^st) day of a calendar month, then monthly Allocated Minimum Rent payable for the month in which the Effective Date occurs shall be prorated based upon the monthly Allocated Minimum Rent in effect before and after the Effective Date based upon the number of days for which the different rental amounts apply.

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                              (ii)     Additional Rent. 

                                        (A)     Section 3.1.3 of the Original Lease shall be amended to read, in its entirety, as follows:

                                        “3.1.3     Additional Rent.  In addition to Minimum Rent, Lessee shall, commencing with the first Additional Rent Quarter of the second (2^nd) Additional Rent Lease Year and continuing through the expiration of the Term, pay to Lessor annual Allocated Additional Rent for each Facility in an amount equal to the product of sixteen percent (16%), times the Incremental Gross Revenues for such Facility for such Additional Rent Lease Year; provided, however, that there shall be no Allocated Additional Rent payable with respect to the Brandywine Facility during the Six Year Extended Term, except to the extent included in Fair Market Rental for the Brandywine Facility for such Six Year Extended Term as provided on Exhibit B attached to the Lease, as hereby amended.  Notwithstanding the foregoing, annual Allocated Additional Rent for each Facility for each Additional Rent Lease Year commencing with the third (3^rd) Additional Rent Lease Year shall not be less than the highest annual Allocated Additional Rent payable with respect to such Facility for any prior Additional Rent Lease Year.”

                                        (B)     All Allocated Additional Rent payable under the Lease, as hereby amended, prior to the Effective Date shall be prorated as provided in the Lease. 

                         (e)     Events of Default.  The following shall be added as Section 16.1(w) of the Lease:

                         “(w)     any default beyond any applicable cure periods under the Phase III Master Lease (including any amendments, modifications and/or restatements thereof).”

                         (f)      Financial Statements.  Sections 25.1.2(a), (b) and (c) of the Original Lease shall be amended to read, in their entireties, as follows:

                         “(a)     (i) within twenty (20) days after the end of each calendar quarter, unaudited balance sheets and statements of income of Lessee, ARCPI and its consolidated Subsidiaries, and ARC and its consolidated Subsidiaries as of the end of such calendar quarter, (ii) when available, following the end of each calendar quarter, unaudited changes in common stock and other stockholders’ equity and statements of cash flows of ARC and its consolidated Subsidiaries and (iii) within ninety (90) days after the end of Lessee’s, ARCPI’s and ARC’s fiscal years, (A) a copy of the unaudited balance sheets of Lessee, and audited consolidated balance sheets of ARCPI and its consolidated Subsidiaries and ARC and its consolidated Subsidiaries as of the end of such fiscal year, (B) related audited consolidated statements of income, changes in common stock and other stockholders’ equity and statement of cash flows of ARCPI and its consolidated Subsidiaries and ARC and its consolidated Subsidiaries for such fiscal year, and (C) related unaudited statements of income of Lessee, in all cases prepared in accordance with GAAP applied on a basis consistently maintained throughout the period involved (such audited consolidated financial statements of ARC and ARCPI to be certified by nationally recognized certified public accountants);

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                         “(b)     within ninety (90) days after the end of each of Lessee’s, ARCPI’s and ARC’s fiscal years, and together with the annual audit report furnished in accordance with clause (a) above, an Officer’s Certificate stating that to the best of the signer’s knowledge and belief after making due inquiry, Lessee is not in default in the performance or observance of any of the terms of this Lease, or if Lessee shall be in default, specifying all such defaults, the nature thereof, and the steps being taken to remedy the same;

                         “(c)     within thirty (30) days after the end of each of the first twelve (12) months of the Term and the last eighteen (18) months of the Term, all consolidated financial reports that Lessor may reasonably request containing, among other things, detailed statements of income and detailed operational statistics regarding occupancy rates, patient and resident mix and patient and resident rates by type for each Facility; and otherwise within thirty (30) days after the end of each of Lessee’s quarters, all quarterly consolidated financial reports Lessor may reasonably request containing, among other things, detailed statements of income and detailed operational statistics regarding occupancy rates, patient and resident mix and patient and resident rates by type for each Facility;”

                         (g)     Letter of Credit.  Article XXI of the Lease shall be deleted in its entirety.

                         (h)     Addendum – Maximum Entrance Fee Facility Liabilities.  Notwithstanding anything to the contrary in Section 48.2 of the Addendum attached to the Original Lease, Lessor and Lessee acknowledge and agree that the Maximum Entrance Fee Facility Liabilities for the Lease Year ending September 30, 2004, for each Entrance Fee Facility remaining under the Lease, as hereby amended, shall be as follows:

Seminole Facility:		$	32,396,568
Brandywine Facility:		$	48,897,402
	Total:	$	81,293,970

Lessee represents and warrants that the above amounts do not exceed One Hundred Five Percent (105%) of the sum of (i) the current actual Entrance Fee Facility Liabilities for the applicable Facility as of the Effective Date, plus (ii) the unsold inventory of such Facility as of the Effective Date, at the current market sales price therefor.  For each Lease Year after September 30, 2004, the “Maximum Entrance Fee Facility Liabilities” shall be determined pursuant to the second sentence of the definition of “Maximum Entrance Fee Facility Liabilities” set forth in Section 48.2 of the Addendum.

                      (i)     Exhibits and Schedules.  Exhibits A-4, A-5, and A-6 shall be deleted in their entirety.  Exhibit B shall be amended and restated with the information on Schedule 1 attached hereto.  Exhibit C shall be amended and restated with the information on Schedule 2 attached hereto.  Exhibit D shall be deleted in its entirety.  Exhibit F shall be amended and restated with the information on Schedule 3 attached hereto.  Exhibit G shall be deleted in its entirety.  Exhibit H, as amended and restated with the information contained on Schedule 1 of the Second Amendment, shall be amended and restated with the information on Schedule 4 attached hereto.  Exhibit K shall be amended and restated with the information on Schedule 5 attached hereto.  Exhibit M shall be amended and restated with the information on Schedule 6 attached hereto.  Exhibit N shall be amended and restated with the information on Schedule 7 attached hereto.  Exhibit O shall be deleted in its entirety. 

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                    4.       Release.  Effective as of the Effective Date, the Separated Property Operators shall be released from any duties, obligations and liabilities under the Lease, as hereby amended, as to the balance of the Leased Property (i.e., all Leased Property other than the Separated Properties) first accruing after the Effective Date; provided, however, that the foregoing shall not be construed to release the Separated Property Operators from (a) any duties, obligations and liabilities under the Lease, as hereby amended, or the Phase III Master Lease, as amended by the Phase III Amendment, relating to the Separated Properties (including, without limitation, the duties, obligations and liabilities relating to the Separated Properties resulting pursuant to Section 2 above) or (b) any duties, obligations and liabilities under the Lease, as hereby amended, as to all of the Leased Property, to the extent any such duties, obligations and liabilities relate to the period prior to the Effective Date.

                    5.       Representations and Covenants of Lessee. 

                              Lessee represents, warrants and covenants as follows:

                              (a)     That Lessee shall neither take any action nor fail to take any action the result of which will be the imposition of any liens upon the Separated Properties or the improvements or fixtures thereon or therein or the creation of any claims against Lessor.  It is hereby mutually agreed that this provision is not intended to bestow any benefit upon any person who is not a party to this Amendment.

                              (b)     The Separated Properties and all improvements and fixtures therein are free and clear of any liens, claims or encumbrances created or suffered by, through or under Lessee, or its Affiliates, sublessees or other third parties for whom Lessee is responsible.

                              (c)     Neither Lessor nor Lessee is in default under the Lease, and Lessee does not claim any offsets, credits or defenses against rents or other amounts payable under the Lease or the calculation thereof, nor does Lessee have any other claim against Lessor under the Lease or with respect to the Leased Property.

                    6.       Consent and Reaffirmation of Guarantor.  Guarantor hereby (a) consents to this Amendment, including the separation of the Separated Properties and release of the Separated Property Operators as provided in Section 4 above, and (b) re-affirms its obligations under the Guaranty and agrees that the same extends to the Lease, as hereby amended.

                    7.       Consent of Lessor.  Lessor hereby consents to (a) Lessee entering into, and causing its Affiliates to enter into, each of the Transaction Documents, (b) the consummation of the transactions contemplated thereby in accordance with the terms thereof, and (c) all amendments of the organizational documents of each Lessee that are being executed in connection with the Transaction Documents, copies of which have been delivered to Lessor together with an Officer’s Certificate relating thereto on or prior to the Effective Date of this Amendment.  The parties acknowledge that this Amendment is one of the Transaction Documents contemplated by the Master Agreement.

                    8.       Reaffirmation of Master Lease.  Lessor and Lessee hereby acknowledge, agree and reaffirm that the Lease, as hereby amended, is and the parties intend the same for all purposes to be treated as a single, integrated and indivisible agreement. 

                    9.       Governing Law.  THIS AMENDMENT WAS NEGOTIATED IN THE STATE OF CALIFORNIA, WHICH STATE THE PARTIES AGREE HAS A SUBSTANTIAL RELATIONSHIP TO THE PARTIES AND TO THE UNDERLYING TRANSACTION EMBODIED HEREBY.  ACCORDINGLY, IN ALL RESPECTS THIS AMENDMENT SHALL BE GOVERNED BY, AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF CALIFORNIA (WITHOUT REGARD OF PRINCIPLES OR CONFLICTS OF LAW) AND ANY APPLICABLE LAWS OF THE UNITED STATES OF AMERICA.

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                    10.    Full Force and Effect; Counterparts; Facsimile Signatures.  Except as hereby amended, the Lease shall remain in full force and effect.  In other words, nothing herein shall affect the validity of the Lease or Lessee’s (as the definition of Lessee has been amended hereby) continued obligations thereunder with respect to the Seminole Facility and the Brandywine Facility.  This Amendment may be executed in any number of counterparts, all of which shall constitute one and the same instrument.  Telecopied signatures may be used in place of original signatures on this Amendment, and Lessor and Lessee both intend to be bound by the signatures of the telecopied document.

[SIGNATURE PAGE FOLLOWS]

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                    IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the day and year first above written.

	“Lessor”
	ARC RICHMOND PLACE REAL ESTATE      HOLDINGS, LLC
	ARC HOLLAND REAL ESTATE      HOLDINGS, LLC
	ARC SUN CITY CENTER REAL ESTATE      HOLDINGS, LLC
	ARC LAKE SEMINOLE SQUARE REAL      ESTATE HOLDINGS, LLC
	ARC BRANDYWINE REAL ESTATE      HOLDINGS, LLC
	each, a Delaware limited liability company
WITNESSED:	By:	ARCPI Holdings, Inc., a Delaware corporation, its member
		By:
Witness
		Title:
Witness
WITNESSED:	By:	Health Care Property Investors, Inc., a Maryland corporation, its member
		By:
Witness
		Title:
Witness

[Signature pages continue]

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	“Lessee”
	ARC RICHMOND PLACE, INC., a Delaware      corporation
	LAKE SEMINOLE SQUARE      MANAGEMENT COMPANY, INC., a
	Tennessee corporation
	FREEDOM GROUP-LAKE SEMINOLE      SQUARE, INC., a Tennessee corporation
	ABC BRANDYWINE, LLC, a Tennessee      limited liability company
WITNESSED:
	By:
	Title:
Witness
Witness
	FREEDOM VILLAGE OF HOLLAND,      MICHIGAN, a Michigan general partnership
	FREEDOM VILLAGE OF SUN CITY CENTER,      LTD., a Florida limited partnership
WITNESSED:
	By:	ARC Freedom, LLC, managing partner
		By:
Witness
		Title:
Witness

[Signature pages continue]

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	“Guarantor”
WITNESSED:	ARCPI HOLDINGS, INC., a Delaware corporation
	By:
Witness
	Title:
Witness

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EX-10.3

Exhibit 10.3

[Tucson, Arizona]
[Sun City, Florida - Sun City Facility]
[Sun City, Florida - Homewood Facility]
[Lexington, Kentucky]
[Holland, Michigan]
[Austin, Texas]
[Ft. Worth, Texas]

FIRST AMENDMENT TO MASTER LEASE AND GUARANTY
AND OPTION TO PURCHASE CERTAIN FACILITIES
(Phase III)

                    THIS FIRST AMENDMENT TO MASTER LEASE AND GUARANTY AND OPTION TO PURCHASE CERTAIN FACILITIES (this “Amendment”) is made and entered into as of this ___ day of July, 2004 (the “Effective Date”), by and between HEALTH CARE PROPERTY INVESTORS, INC., a Maryland corporation (“HCP”), TEXAS HCP HOLDING, L.P., a Delaware limited partnership (“Texas HCP”), TEXAS HCP REVX, L.P., a Delaware limited partnership (“Texas REVX”), ARC RICHMOND PLACE REAL ESTATE HOLDINGS, LLC, a Delaware limited liability company (“Richmond RealCo”), ARC HOLLAND REAL ESTATE HOLDINGS, LLC, a Delaware limited liability company (“Holland RealCo”), ARC SUN CITY CENTER REAL ESTATE HOLDINGS, LLC, a Delaware limited liability company (“Sun City RealCo”) and ARC LABARC REAL ESTATE HOLDINGS, LLC, a Delaware limited liability company (“Homewood RealCo”) (collectively, as their interests may appear, “Lessor”), on the one hand, and FORT AUSTIN LIMITED PARTNERSHIP, a Texas limited partnership (“Fort Austin Lessee”), ARC SANTA CATALINA, INC., a Tennessee corporation (“Santa Catalina Lessee”), ARC RICHMOND PLACE, INC., a Delaware corporation (“Richmond Lessee”), FREEDOM VILLAGE OF HOLLAND, MICHIGAN, a Michigan general partnership (“Holland Lessee”), FREEDOM VILLAGE OF SUN CITY CENTER, LTD., a Florida limited partnership (“Sun City Lessee”), and LaBARC, L.P., a Tennessee limited partnership (“Homewood Lessee”) (collectively, and jointly and severally, “Lessee”), on the other hand, and ARCPI HOLDINGS, INC., a Delaware corporation (“Guarantor”).

RECITALS

                    A.      HCP, Texas HCP and Texas REVX are the last and current successor to the interest of the “Lessor,” and Fort Austin Lessee and Santa Catalina Lessee are the current “Lessee,” pursuant to that certain Master Lease dated September 23, 2003 (the “Lease”) between ARC Santa Catalina Real Estate Holdings, LLC, a Delaware limited liability company (“Santa Catalina RealCo”) and Fort Austin Real Estate Holdings, LLC, a Delaware limited liability company (“Fort Austin RealCo”), collectively as the original “Lessor,” and Fort Austin Lessee and Santa Catalina Lessee, as the original “Lessee.”  The Lease covers the “Leased Property” of three (3) separate congregate care retirement centers, located in Tucson, Arizona, Austin, Texas, and Ft. Worth, Texas (the “Initial Facilities”), all as more particularly described in the Lease.  The Lessee’s obligations under the Lease are guaranteed by Guarantor pursuant to a written Guaranty of Obligations dated as of September 23, 2003 (as the same has been amended and reaffirmed from time to time in accordance with the terms thereof, the “Guaranty”).  Lessor, Lessee and certain Affiliates of each are also parties to that certain Forbearance and Limited Waiver Agreement (Regarding Insurance) dated as of January 1, 2004 with respect to the Lease and certain other agreements.

                    B.      HCP and Guarantor are also parties to that certain Master Agreement of even date herewith (the “Master Agreement”), pursuant to which HCP and Guarantor have agreed to cause certain transactions to be consummated, including this Amendment, all as more particularly described therein and in the other “Transaction Documents” (as defined in the Master Agreement”).

                    C.     In connection with the transactions contemplated by the Master Agreement and the other Transaction Documents, Lessor and Lessee desire to execute this Amendment to (i) add Richmond RealCo, Holland RealCo, Sun City RealCo and Homewood RealCo, as their interest may appear, as part of the “Lessor” under the Lease; (ii) add Richmond Lessee, Holland Lessee, Sun City Lessee and Homewood Lessee, jointly and severally, as part of “Lessee” under the Lease; (iii) add to the Leased Property certain real and personal property (A) located in Sun City, Florida, consisting of  26 assisted living facility units, 428 independent living units and 108 skilled nursing beds (the “Sun City Facility”); (B) located in Lexington, Kentucky, consisting of 60 assisted living facility units, 178 independent living units and 20 memory enhanced (Alzheimers) units (the “Lexington Facility”); (C) located in Holland, Michigan, consisting of 74 assisted living facility units, 332 independent living units, 29 memory enhanced (Alzheimers), and 15 skilled nursing beds (the “Holland Facility”); and (D) located in Sun City, Florida, consisting of 60 assisted living units and 28 memory enhanced (Alzheimers) units (the “Homewood Facility” and, together with the Lexington Facility, the Holland Facility and the Sun City Facility, the “Added Facilities”); and (iv) amend the Lease in certain other particulars, in each case effective as of the Effective Date and upon the terms and conditions set forth herein.  A legal description of the Land associated with each Added Facility is attached hereto as Exhibits A-4 through A-7 and incorporated herein by this reference.

                    D.     The Lexington Facility, the Holland Facility and the Sun City Facility are concurrently herewith being removed from that certain Master Lease dated September 30, 2002 (as amended to date, the “Phase II Lease”) between Richmond RealCo, Holland RealCo, Sun City RealCo, ARC Lake Seminole Square Real Estate Holdings, LLC, a Delaware limited liability company, and ARC Brandywine Real Estate Holdings, LLC, a Delaware limited liability company (collectively, the “Phase II Lessor”), collectively as “Lessor,” on the one hand, and Richmond Lessee, Holland Lessee, Sun City Lessee, Lake Seminole Square Management Company, Inc., a Tennessee corporation, Freedom Group-Lake Seminole Square, Inc., a Tennessee corporation, and ARC Brandywine, LLC, a Tennessee limited liability company (collectively, the “Phase II Lessee”), collectively as “Lessee,” on the other hand, pursuant to that certain Third Amendment to Master Lease (Phase II) of even date herewith (the “Phase II Amendment”) between Phase II Lessor, Phase II Lessee, and Guarantor, as “Guarantor.”

                    E.     The Homewood Facility is being concurrently herewith acquired by Homewood RealCo from Homewood Lessee pursuant to that certain Contract of Acquisition dated of even date herewith (the “Homewood Contract of Acquisition”) between Homewood RealCo and Homewood Lessee.

                    F.     Capitalized terms used herein and not defined herein shall have the meanings given such terms in the Lease.

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AMENDMENT

                    IN CONSIDERATION OF the foregoing recitals, the mutual promises contained herein, and other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Lessor and Lessee hereby agree as follows:

                    1.      Leasing of Added Facilities; Removal of the Added Facilities from the Phase II Lease.

                    (a)     Effective as of the Effective Date, Lessor hereby leases to Lessee and Lessee hereby hires from Lessor, the Leased Property of the Added Facilities upon all of the terms and conditions set forth in the Lease, as amended by this Amendment.  All references herein and in the Lease to a “Facility” or “Facilities” shall mean each Facility (as defined in the Lease, i.e. the Initial Facilities) together with the Added Facilities.  

                    (b)     Concurrently herewith, Phase II Lessor, Phase II Lessee and Guarantor are executing the Phase II Amendment.

                    2.      Assumption of Lease Jointly and Severally.  By their signature hereto, effective as of the Effective Date, each of Richmond Lessee, Holland Lessee, Sun City Lessee and Homewood Lessee assumes the obligations of “Lessee” under the Lease, as hereby amended, jointly and severally with each other and with those Persons comprising the original “Lessee.”

                    3.      Modifications to Certain Provisions of the Lease.  Effective as of the Effective Date, the Lease shall be amended and supplemented in the following particulars:

                    (a)     New Definitions.  Except as otherwise expressly provided or unless the context otherwise requires, for all purposes of the Lease, as hereby amended, the terms defined in this Section 3(a) shall have the meanings assigned to them as provided below and shall be added to Article II of the Lease to read, in their entireties, as follows:

                   Added Facilities:  As defined in the Recitals of this Amendment.

                   Addendum:  The Addendum attached to the Lease pursuant to this Amendment, which is incorporated in the Lease and this Amendment by reference.

                   Additional Rent:  The sum of all Allocated Additional Rent for all Facilities payable under this Lease.

                   Adjusted Lease Rate:  For the Holland Facility, the “Adjusted Lease Rate” shall be the ten-year U.S. Treasury Note rate published in the Wall Street Journal three (3) Business Days prior to July 1, 2006 and quoting the rate as of the immediately prior Business Day, but in no event less than Two and One-Half Percent (2.5%), plus 450 basis points; and for the Lexington Facility, the “Adjusted Lease Rate” shall be Nine Percent (9%).

                   Allocated Additional Rent:  With respect to each Facility, the amount of Additional Rent payable under this Lease attributable to such Facility.

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                   Base Gross Revenues:  Base Gross Revenues for each Added Facility shall be the Gross Revenues for such Added Facility for the period from August 1, 2004 through and including July 31, 2005.

                   Cash Flow:  With respect to each Facility, the net income from such Facility, determined on the basis of GAAP applied on a consistent basis (with Entrance Fees (as defined in the Addendum) adjusted to a cash basis), plus the sum of (i) depreciation and amortization expense; (ii) the Allocated Minimum Rent, Allocated Additional Rent and Supplemental Rent for such Facility; plus (iii) management fees for such Facility; less the sum of a management fee allowance of Three Percent (3%) of Gross Revenues for such Facility during the corresponding period.

                   Cash Flow Coverage:  With respect to each Facility, for any period, calculated as of the last day of the period, the ratio of Cash Flow for such Facility attributable to such period to the sum of total Allocated Minimum Rent, Allocated Additional Rent and Supplemental Rent with respect to such Facility payable for such period under this Lease.  For purposes of calculating Cash Flow Coverage for any Facility pursuant to Section 4 of this Amendment, such Cash Flow Coverage shall be calculated as of each Quarter on a historical three (3) Quarter basis (including the Quarter just ended and for which such Cash Flow Coverage is being determined).

                   Earn-Out Amount:  As defined in the Homewood Contract of Acquisition.

                   Earn-Out Payment Date:  The date of payment by Homewood RealCo to Homewood Lessee of an Earn-Out Amount for the Homewood Facility in accordance with the terms of the Homewood Contract of Acquisition.

                   Earn-Out Rate:  For each Earn-Out Payment Date, the “Earn-Out Rate” shall be the ten-year U.S. Treasury Note rate published in the Wall Street Journal three (3) Business Days prior to such Earn-Out Payment Date and quoting the rate as of the immediately prior Business Day, plus 450 basis points.

                   Gross Revenues:  With respect to each Facility, all revenues received or receivable from or by reason of the operation of such Facility or any other use of the Leased Property of such Facility, Lessee’s Personal Property and Capital Additions including all revenues received or receivable for the use of or otherwise attributable to units, rooms, beds and other facilities provided, meals served, services performed (including ancillary services), space or facilities subleased or goods sold on or from the Leased Property and Capital Additions of such Facility and the amortization of Entrance Fees (as defined in the Addendum) related to the Facilities, all determined in accordance with GAAP; provided, however, that Gross Revenues shall not include:

                    (i)     non-operating revenues such as interest income or income from the sale of assets not sold in the ordinary course of business;

                    (ii)     contractual allowances (relating to any period during the Term) for billings not paid by or received from the appropriate governmental agencies or third party providers;

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                    (iii)     all proper patient billing credits and adjustments according to GAAP relating to health care accounting; and

                     (iv)    federal, state or local excise taxes and any tax based upon or measured by such revenues which is added to or made a part of the amount billed to the patient or other recipient of such services or goods, whether included in the billing or stated separately.

                    Gross Revenues for each Lease Year of such Facility shall include all cost report settlement amounts received in or payable during such Lease Year in accordance with GAAP relating to health care accounting, regardless of the year to which such settlement amounts are applicable; provided, however, that to the extent settlement amounts are applicable to years, or portions thereof, prior to the Commencement Date applicable to such Facility, such settlement amounts shall not be included in Gross Revenues for the Lease Year of such Facility in which such settlement amounts are received or paid.  Gross Revenues shall also include (x) the Gross Revenues of any Occupant under a Commercial Occupancy Arrangement (i.e., the Gross Revenues generated from the operations conducted on or from such subleased, licensed or other used or occupied portion of the Leased Property and all Capital Additions of such Facility shall be included directly in the Gross Revenues) if all or any portion of the rent received or receivable by Lessee from or under such Commercial Occupancy Arrangement is based on net income of such Occupant or would otherwise fail to qualify as “rents from real property” within the meaning of Section 856(d) of the Code, or any similar or successor provision thereto (in which event the rent received or receivable by Lessee from or under such Commercial Occupancy Arrangement shall be excluded from Gross Revenues), or (y) the rent received or receivable by Lessee from or under such Commercial Occupancy Arrangement, if no portion of the rent received or receivable by Lessee from or under such Commercial Occupancy Arrangement is based on net income of such Occupant and such rent qualifies as “rents from real property” within the meaning of Section 856(d) of the Code, or any similar or successor provision thereto (in which event the Gross Revenues of such Occupant shall be excluded from Gross Revenues herein).

                    Holland Monthly Supplemental Rent:  (a) For the period from the Commencement Date for the Holland Facility through and including June 30, 2006, the monthly sum of One Hundred Forty-Five Thousand Dollars ($145,000); and (b) commencing July 1, 2006, and continuing for the balance of the Term with respect to the Holland Facility, a monthly amount equal to one-twelfth (1/12th) of the product of (i) Sixteen Million Eight Hundred Sixty-Three Thousand Dollars ($16,863,000), times (ii) the Adjusted Lease Rate for the Holland Facility.

                    Homewood Contract of Acquisition:  As defined in the Recitals of this Amendment.

                    Incremental Gross Revenues:  With respect to each Facility, the positive amount, if any, by which the Gross Revenues for such Facility during the then current Lease Year or partial Lease Year for such Facility exceeds the Base Gross Revenues for such Facility.

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                    Initial Facilities:  As defined in the Recitals of this Amendment.

                    Initial Facility Mortgages:  The Facility Mortgages set forth on Exhibit L attached to this Amendment, together with any amendments, renewals or extensions thereof.

                    Lexington Monthly Supplemental Rent:  (a) For the period from the Commencement Date for the Lexington Facility through and including May 31, 2015 (with such payment for May, 2015, due on or before April 6, 2015), a monthly amount payable in arrears as provided in Section 3.1.3 and computed at the end of each month or partial month equal to the sum of (i) the actual interest payable on the Initial Facility Mortgage loan encumbering the Lexington Facility for the prior month or partial month (prorated for any partial month), plus (ii) one-twelfth (1/12th) of (A) Seventy-Five One-Hundredths Percent (0.75%) of the outstanding principal amount of the Initial Facility Mortgage loan encumbering the Lexington Facility as of the end of such prior month or partial month (prorated for any partial month), (B) the actual annual costs to Richmond RealCo, HCP or its Affiliate to obtain any letter of credit required to be posted to the Initial Facility Mortgagee of the Lexington Facility as security for the obligations owing thereunder, (C) the annual remarketing or similar fees paid in connection with the Initial Facility Mortgage for the Lexington Facility, (D) the annual fees and charges paid to any rating agency or similar organization in connection with rating letter updates on similar requirements in connection with the Initial Facility Mortgage for the Lexington Facility, and (E) the annual trustee fees and charges or any other incidental fees and charges payable on account of the Initial Facility Mortgage for the Lexington Facility, and (b) commencing April 1, 2015, and continuing for the balance of the Term with respect to the Lexington Facility, a monthly amount payable in advance as provided in Section 3.1.3 equal to one-twelfth (1/12th) of the product of (i) Eight Million Ten Thousand Dollars ($8,010,000), times (ii) the Adjusted Lease Rate for the Lexington Facility.

                    Minimum Annual Expenditure:  The following: (a) with respect to the Sun City Facility and Holland Facility, the product of (i) One Thousand Dollars ($1,000.00), times (ii) the number of units in the Sun City Facility and Holland Facility, as applicable; (b) with respect to the Lexington Facility, the product of (i) Seven Hundred Fifty Dollars ($750.00), times (ii) the number of units in the Lexington Facility; and (c) with respect to the Homewood Facility, the product of (i) Five Hundred Dollars ($500.00), times (ii) the number of units in the Homewood Facility.

                    Option Repurchase Price:  With respect to the Leased Property of the Sun City Facility, Homewood Facility and/or Holland Facility, as the case may be, the Minimum Repurchase Price for such Facility, as increased by three percent (3%) per Lease Year, cumulative and compounded, commencing with the expiration of the first Lease Year for such Facility, and upon the expiration of each Lease Year thereafter.

                    Phase II Lease:  As defined in the Recitals of this Amendment.

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                    Qualified Capital Expenditures:  Expenditures capitalized (as opposed to expensed) in accordance with GAAP on the books of Lessee for any of the following:  replacement of furniture, fixtures and equipment, including refrigerators, ranges, major appliances, bathroom fixtures, doors (exterior and interior), central air conditioning and heating systems (including cooling towers, water chilling units, furnaces, boilers and fuel storage tanks) and replacement of siding; roof replacements, including replacements of gutters, downspouts, eaves and soffits; major repairs and replacements of plumbing and sanitary systems; overhaul of elevator systems; repaving, resurfacing and sealcoating of sidewalks, parking lots and driveways; repainting of entire building exterior and normal maintenance and repairs needed to maintain the quality and condition of a Facility in the market in which it operates, but excluding any other “alterations” as defined in Section 10.1.

                    Supplemental Rent:  Collectively, the Holland Monthly Supplemental Rent and the Lexington Monthly Supplemental Rent.

                    (b)     Amended and Restated Definitions.  The following definitions appearing in Article II of the Lease shall be amended and restated, in their entireties, as indicated:

                    Commencement Date:  With respect to the Initial Facilities, September 23, 2003, and with respect to the Added Facilities, the Effective Date of this Amendment. 

                    Facility Mortgagee:  As of the Effective Date, the “Facility Mortgagee” for each Facility shall be as set forth on Exhibit L attached hereto.

                    Impositions (clause (d) only):  “(d) any recording taxes, indebtedness taxes or other taxes imposed with respect to or in connection with any of the Facility Mortgages; provided, however, that any recording taxes, indebtedness taxes or other taxes imposed with respect to or in connection with any of the Initial Facility Mortgages that are Master Trust Documents (as defined in the Addendum) shall be included in this definition of “Impositions”) or” 

                    Intangible Property:  All accounts, proceeds of accounts, rents, profits, income or revenues derived from the use of rooms or other space within the Leased Property or the providing of services in or from the Leased Property and all Capital Additions; documents, chattel paper, instruments, contract rights, deposit accounts, general intangibles, commercial tort claims, causes of action, investment property, letter-of-credit rights, letters of credit, money, securities entitlements, now owned or hereafter acquired by Lessee (including any right to any refund of any Impositions and any escrow deposits and reserve accounts required to be maintained in connection with any Entrance Fee Facilities (as defined in the Addendum) (including any minimum liquid reserves, operating reserves or renewal and replacement reserves) arising from or in connection with Lessee’s operation or use of the Leased Property and all Capital Additions; all licenses and permits now owned or hereinafter acquired by Lessee, which are necessary or desirable for Lessee’s use of the Leased Property and all Capital Additions for the Primary Intended Use, including, if applicable, any certificate of need, certificate of authority or similar certificate; the right to use any trade name or other name associated with the Facility; and any and all third-party provider agreements (including Medicare and Medicaid).

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                    Land:  The real property or properties described in Exhibits A-1 through A-7 attached hereto, and, with respect to each Facility, the Land relating to such Facility.

                    Lessee:  Collectively, and jointly and severally,Fort Austin Limited Partnership, a Texas limited partnership, ARC Santa Catalina, Inc., a Tennessee corporation, ARC Richmond Place, Inc., a Delaware corporation, Freedom Village of Holland, Michigan, a Michigan general partnership, Freedom Village of Sun City Center, Ltd., a Florida limited partnership, and LaBARC, L.P., a Tennessee limited partnership; provided, however, that it is agreed and understood by all parties hereto that, with respect to each Facility, only the License Holder with respect to such Facility shall be entitled to operate or maintain such Facility, and in no event shall any Lessee other than the applicable License Holder with respect to such Facility be entitled to operate or maintain such Facility or take other actions with respect to such Facility to the extent that such operations or the taking of such actions would violate the licensure requirements or other laws or regulations of any governmental authority with respect to such Facility.  Notwithstanding the foregoing, nothing herein shall affect the joint and several liability of the Lessees.

                    Lessor:  Collectively, as their interests may appear, Health Care Property Investors, Inc., a Maryland corporation, Texas HCP Holding, L.P., a Delaware limited partnership, Texas HCP REVX, L.P., a Delaware limited partnership, ARC Richmond Place Real Estate Holdings, LLC, a Delaware limited liability company, ARC Holland Real Estate Holdings, LLC, a Delaware limited liability company, ARC Sun City Center Real Estate Holdings, LLC, a Delaware limited liability company, and ARC LaBARC Real Estate Holdings, LLC, a Delaware limited liability company; provided, however, that with respect to any matter as it relates to a particular Facility (including, but not limited to, any matter in which Lessor’s consent or approval is required for a particular Facility), as used herein, “Lessor” shall mean only that Lessor which is the fee owner of such Facility.  As of the date hereof, the “Lessor” for each Facility is as set forth on Exhibit G attached hereto.

                    Rent:  Collectively, Minimum Rent, Additional Rent, Supplemental Rent, Additional Charges and all other amounts payable under this Lease.

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                    Transfer Consideration:  With respect to any Transfer constituting a Master Sublease (other than a Master Sublease entered into in connection with a Sale of Business), “Transfer Consideration” shall mean Fifty Percent (50%) of the positive remainder, if any, obtained by subtracting (x) the Allocated Minimum Rent, Allocated Additional Rent and Supplemental Rent payable by Lessee under this Lease with respect to such Facility from (y) the Fair Market Rental of such Facility, all determined on a monthly basis, prorating such Fair Market Rental and Allocated Minimum Rent, Allocated Additional Rent and Supplemental Rent, as appropriate, if less than all of such Facility is Master Subleased.  Fifty Percent (50%) of such remainder shall be paid by Lessee to Lessor monthly when the Allocated Minimum Rent, Allocated Additional Rent and Supplemental Rent of such Facility is due; provided, however, that in no event shall the total Transfer Consideration to which Lessor is entitled in connection with any such Master Sublease exceed the total consideration given directly or indirectly (including through one or more intermediaries) to Lessee, to any Controlling Person(s) or to any other Person in exchange for, in connection with, related to or arising out of the transaction(s) as to which such Master Sublease is a part.  With respect to any other Transfer (i.e., a Transfer other than pursuant to a Master Sublease, but including a Master Sublease which is part of a Sale of Business) “Transfer Consideration” shall mean Fifty Percent (50%) of the Leasehold FMV.  Lessee acknowledges and agrees that the terms under which Lessor is entitled to the payment of Transfer Consideration pursuant to this Lease and the amount thereof has been freely negotiated and represents a fair and equitable division with Lessor of the consideration payable in connection with a Transfer taking into account, among other things, Lessor’s investment in the Leased Property, the terms of this Lease and the inherent risks of owning and leasing real property.  As used herein, the term “consideration” shall mean and include money, services, property and other things of value, including payment of costs, cancellation or forgiveness of indebtedness, discounts, rebates, barter and the like.

                              (c)     Deleted Definitions.  The following definitions appearing in Article II of the Lease, as well as all or the applicable portion of any provisions directly related thereto, shall be deleted in their entireties:  “HCPI Loan Agreement,” and “HCPI Loan Documents.”

                              (d)     Rent.  Sections 3.1, 3.2 and 3.3 of the Lease are hereby amended to read, in their entirety, as follows:

“3.1 Rent.  Lessee shall pay to Lessor in lawful money of the United States of America which shall be legal tender for the payment of public and private debts, without offset or deduction, the amounts set forth hereinafter as Minimum Rent, Additional Rent and Supplemental Rent during the Term.  Payments of Minimum Rent, Additional Rent and Supplemental Rent shall be made by wire transfer of funds initiated by Lessee to Lessor’s account or to such other Person as Lessor from time to time may designate in writing.  Lessee shall pay to Lessor Minimum Rent and Supplemental Rent monthly, in advance on or before the sixth (6th) day of each calendar month; provided, however, that prior to April 1, 2015, Lexington Monthly Supplemental Rent shall be payable in arrears on or before the sixth (6th) day of each calendar month for the prior month.  The first monthly payment of Minimum Rent and Supplemental Rent shall be payable on the Commencement Date (prorated as to any partial calendar month at the beginning of the Term), except that the first monthly payment of Lexington Monthly Supplemental Rent shall be payable on the sixth (6th) day of the first calendar month following the Commencement Date for the Lexington Facility.  Additional Rent shall be payable as and when required pursuant to Section 3.2 below.

3.1.1     Allocated Minimum Rent.  Subject to Section 3.1.2 below, the following shall apply:

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	(a)     For the period from the Commencement Date through and including the expiration of the first (1st) Lease Year of Term with respect to the Initial Facilities, Lessee shall pay monthly “Allocated Base Minimum Rent” for all of the Initial Facilities in the amount as set forth on Exhibit B attached hereto and incorporated herein by this reference.
	(b)     For the entire Term (including the Extended Terms, if any) with respect to the Added Facilities, Lessee shall pay monthly “Allocated Base Minimum Rent” for all of the Added Facilities in the amount as set forth on Exhibit B attached hereto and incorporated herein by this reference.
	3.1.2     Allocated Minimum Rent Increases for Initial Facilities and Earn-Out.
	(a)     Commencing upon the expiration of the first (1st) Lease Year of the Term with respect to the Initial Facilities and upon the expiration of each Lease Year thereafter with respect to the Initial Facilities during the applicable Term (including the Extended Terms, if any), the then current monthly “Allocated Minimum Rent” for each Initial Facility shall be adjusted for such ensuing Lease Year to an amount equal to the product of (i) the monthly Allocated Minimum Rent paid or payable for such Initial Facility for the last full month of the immediately prior Lease Year, times (ii) the sum of (x) one (1), plus (y) the applicable Fixed Increase (expressed as a decimal) for such Lease Year.
	(b)     The monthly Allocated Minimum Rent with respect to the Homewood Facility shall be increased from time to time on each Earn-Out Payment Date by an amount equal to one-twelfth (1/12) of the product of (i) the particular Earn-Out Amount paid by Lessor on such Earn-Out Date, times (ii) the then applicable Earn-Out Rate.  Monthly Allocated Minimum Rent payable for the Homewood Facility for any months during which an Earn-Out Payment Date occurs shall be prorated based upon the number of days for which the different rental amounts apply.
	3.1.3     Supplemental Rent.  With respect to the Holland Facility and the Lexington Facility only, for the entire Term (including the Extended Terms, if any), Lessee shall pay monthly the applicable Supplemental Rent for such Facilities; provided, however, that prior to April 1, 2015, Lexington Monthly Supplemental Rent shall be payable in arrears on or before the sixth (6th) day of the calendar month for the prior month.  Commencing April 1, 2015, such Lexington Monthly Supplemental Rent shall be paid in advance on or before the sixth (6th) day of the then current calendar month; provided further, however, that on or before the sixth (6th) day of April, 2015, Lessee shall also pay the last monthly installment payable in arrears for March, 2015.”
“3.2   Additional Rent; Quarterly Calculation and Payment of Additional Rent; Annual Reconciliation.

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              3.2.1    In addition to the Minimum Rent and Supplemental Rent, Lessee shall, commencing with the first (1st) Quarter of the second (2nd) Lease Year of the Fixed Term with respect to the Added Facilities and continuing through the expiration of the Term (including the Extended Terms, if any), pay to Lessor annual “Allocated Additional Rent” with respect to each Added Facility in the amount of Sixteen Percent (16%) of Incremental Gross Revenues for such Added Facility.  Beginning in the third (3rd) Lease Year of the Fixed Term with respect to each Added Facility and continuing through the expiration of the Term (including the Extended Terms, if any), annual Additional Rent for each Added Facility shall be at least equal to the highest annual Additional Rent attributable to such Added Facility for any prior Lease Year.

               3.2.2     Lessee shall calculate and pay Additional Rent for each Added Facility quarterly, in arrears, for the portion of the entire Lease Year, on a cumulative basis, up to the end of the Quarter then most recently ended, less the Additional Rent already paid and attributable to such Lease Year for such Added Facility.  If at the time any calculation on account of Additional Rent is to be made the applicable Gross Revenues for any Added Facility are not yet available, Lessee shall use its best estimate of the applicable Gross Revenues for such Added Facility.  Each quarterly payment of Additional Rent shall be delivered to Lessor, together with an Officer’s Certificate setting forth the calculation thereof, on or before the last Business Day of the calendar month immediately following the end of the corresponding Quarter.

               3.2.3     Within sixty (60) days after the end of each Lease Year, Lessee shall deliver to Lessor an Officer’s Certificate setting forth the Gross Revenues for such Lease Year for each Added Facility.  As soon as practicable following receipt by Lessor of such Certificate, Lessor shall determine the Additional Rent for such Lease Year for each such Added Facility and give Lessee notice of the same together with the calculations upon which the Additional Rent for each such Added Facility was based. If such Additional Rent for any Added Facility exceeds the sum of the quarterly payments of Additional Rent for such Added Facility previously paid by Lessee with respect to such Lease Year, Lessee shall forthwith pay such deficiency to Lessor.  If such Additional Rent for such Lease Year is less than the amount previously paid by Lessee with respect thereto, Lessor shall, at Lessee’s option, either (i) remit to Lessee its check in an amount equal to such difference, or (ii) credit such difference against the quarterly payments of Additional Rent next coming due.

                 3.2.4     Any difference between the annual Additional Rent for any Added Facility for any Lease Year as shown in said Officer’s Certificate and the total amount of quarterly payments for such Lease Year previously paid by Lessee, whether in favor of Lessor or Lessee, shall bear interest at a rate equal to the rate payable on 90-day U.S. Treasury Bills as of the last Business Day of such Lease Year until the amount of such difference shall be paid or otherwise discharged.

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	3.2.5     If the expiration or earlier termination of the Term with respect to an Added Facility is a day other than the last day of a Lease Year, then the amount of the last quarterly installment of Additional Rent for such Added Facility shall be paid pro rata on the basis of the actual number of days in such Lease Year.
	3.2.6     As soon as practicable after the expiration or earlier termination of the Term with respect to an Added Facility, a final reconciliation of Additional Rent with respect to such Added Facility shall be made taking into account, among other relevant adjustments, any unresolved contractual allowances which relate to Gross Revenues for such Added Facility accrued prior to such expiration or termination; provided that if the final reconciliation has not been made within six (6) months of such expiration or termination, then a final reconciliation shall be made at that time based on all available relevant information, including Lessee’s good faith best estimate of the amount of any unresolved contractual allowances.”
“3.3.     Confirmation of Additional Rent.  Lessee shall utilize, or cause to be utilized, an accounting system for the Leased Property and all Capital Additions relating to each Added Facility in accordance with its usual and customary practices and in accordance with GAAP which will accurately record all Gross Revenues for each Added Facility and Lessee shall retain for at least seven (7) years after the expiration of each Lease Year reasonably adequate records conforming to such accounting system showing all Gross Revenues for such Lease Year for each Added Facility.  Lessor, at its own expense except as provided hereinbelow, shall have the right from time to time by its accountants or representatives, to review and/or audit the information set forth in the Officer’s Certificate referred to in Section 3.2 and in connection with such review and/or audit to examine Lessee’s records with respect thereto (including supporting data and sales tax returns) subject to any prohibitions or limitations on disclosure of any such data under applicable law or regulations including any duly enacted “Patients’ Bill of Rights” or similar legislation, or as may be necessary to preserve the confidentiality of the Facility-patient relationship and the physician-patient privilege.  If any such review and/or audit discloses a deficiency in the payment of Additional Rent, Lessee shall forthwith pay to Lessor the amount of the deficiency together with interest thereon at the Overdue Rate compounded monthly from the date when said payment should have been made to the date of payment thereof.  If any such review and/or audit discloses that the Gross Revenues actually received by Lessee for any Lease Year exceed those reported by Lessee by more than Two Percent (2%), Lessee shall pay the costs of such review and/or audit. Any proprietary information obtained by Lessor pursuant to such review and/or audit shall be treated as confidential, except that such information may be used, subject to appropriate confidentiality safeguards, in any litigation or arbitration proceedings between the parties and except further that Lessor may disclose such information to prospective lenders or purchasers.”

                    (e)     Additional Charges.  The phrase “Additional Rent and Supplemental Rent” is hereby added after the phrase “Minimum Rent” in the first sentence of Section 3.4 of the Lease.

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                    (f)     Net Lease.  The phrase “Additional Rent and Supplemental Rent” is hereby added after the phrase “Minimum Rent” in the last sentence of Section 3.6 of the Lease. 

                    (g)     Initial Facility Mortgages. The following is hereby added as a new Section 4.6 of the Lease:

          “4.6     Initial Facility Mortgages.  Notwithstanding anything to the contrary contained in this Lease, during the Term of this Lease, Lessee shall be solely responsible and hereby covenants to fund and maintain any and all impound, escrow or other reserve or similar accounts required under any Initial Facility Mortgage as security for or otherwise relating to any operating expenses of the Facility, including any capital repair or replacement reserves and/or impounds or escrow accounts for Impositions or insurance premiums (each an “Operating Reserve Account”), but excluding any so-called debt service or loan payment sinking funds required under any such Initial Facility Mortgage and excluding any such accounts (or modified requirements with respect to any existing Operating Reserve Account) required by virtue of any amendment to the Initial Facility Mortgages after the date hereof unless (i) Lessee consents in writing to such amendments, which consent shall not be unreasonably withheld, or (ii) such account(s) required by virtue of any such amendment(s) do not materially increase Lessee’s monetary obligations under this Section 4.6.  During the Term of this Lease and provided that no Event of Default shall have occurred and be continuing hereunder, Lessee shall, subject to the terms and conditions of such Operating Reserve Account and the requirements of the Facility Mortgagee(s) under such Initial Facility Mortgages, have access to and the right to apply or use (including for reimbursement) to the same extent of Lessor all monies held in each such Operating Reserve Account for the purposes and subject to the limitations for which such Operating Reserve Account is maintained; Lessor agrees to reasonably cooperate with Lessee in connection therewith.  The right of Lessee to use and apply such Operating Reserve Account monies in accordance with the foregoing shall also apply to any monies currently held or maintained in an Operating Reserve Account as of the date hereof, regardless whether originally funded by Lessor or Lessee.”

                    (h)     Termination with Respect to Fewer than All of the Facilities.  The phrase “Allocated Additional Rent and/or Supplemental Rent, as applicable” is hereby added after the phrase “Allocated Minimum Rent” in clause (b) of Section 5.2 of the Lease.

                    (i)     Events of Default. The following shall be added as a new Section 16.1(v) of the Lease:

                    “(v)     a default shall occur under the Phase II Lease (including any amendments, modifications and/or restatements thereof) where the default is not cured within any applicable grace period set forth therein.”

                    (j)     Damages.  The following shall be added to the end of the second to last paragraph of Section 16.3 of the Lease:

          “For purposes of determining the worth at the time of the award, Additional Rent that would have been payable for the remainder of the Term shall be deemed to be the greater of (y) the same as the Additional Rent for the then current Lease Year or, if not determinable, the immediately preceding Lease Year; and (z) such other amount as Lessor shall demonstrate could reasonably have been earned.”

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                    (k)     Renewal Terms.  Notwithstanding anything to the contrary in Section 19.1 of the Lease, Lessee shall have the right to renew the Lease, as amended hereby, with respect to the Leased Property of the Initial Facilities (as a group) and the Added Facilities (as a group) for three (3) ten (10) year Extended Terms in accordance with the terms of Section 19.1 of the Lease.  Lessee’s right to renew the Lease, as amended hereby, for any applicable Extended Term, however, may not be exercised with respect to the Leased Property of less than all of the Initial Facilities as a group or less than all of the Added Facilities as a group.

                    (l)     Transfer Prohibition.  The phrase “(except in connection with an Initial Facility Mortgage or as provided in Section 48.6 of the Addendum)” is hereby added after the phrase “Lessee’s leasehold estate hereunder” in clause (i) of Section 24.1.1 of the Lease.

                    (m)    Financial Statements.  Sections 25.1.2(a), (b) and (c) of the Lease shall be amended to read, in their entireties, as follows:

                    “(a)     (i) within twenty (20) days after the end of each calendar quarter, unaudited balance sheets and statements of income of Lessee, ARCPI and its consolidated Subsidiaries, and ARC and its consolidated Subsidiaries as of the end of such calendar quarter, (ii) when available, following the end of each calendar quarter, unaudited changes in common stock and other stockholders’ equity and statements of cash flows of ARC and its consolidated Subsidiaries and (iii) within ninety (90) days after the end of Lessee’s, ARCPI’s and ARC’s fiscal years, (A) a copy of the unaudited balance sheets of Lessee, and audited consolidated balance sheets of ARCPI and its consolidated Subsidiaries and ARC and its consolidated Subsidiaries as of the end of such fiscal year, (B) related audited consolidated statements of income, changes in common stock and other stockholders’ equity and statement of cash flows of ARCPI and its consolidated Subsidiaries and ARC and its consolidated Subsidiaries for such fiscal year, and (C) related unaudited statements of income of Lessee, in all cases prepared in accordance with GAAP applied on a basis consistently maintained throughout the period involved (such audited consolidated financial statements of ARC and ARCPI to be certified by nationally recognized certified public accountants);

                    “(b)     within ninety (90) days after the end of each of Lessee’s, ARCPI’s and ARC’s fiscal years, and together with the annual audit report furnished in accordance with clause (a) above, an Officer’s Certificate stating that to the best of the signer’s knowledge and belief after making due inquiry, Lessee is not in default in the performance or observance of any of the terms of this Lease, or if Lessee shall be in default, specifying all such defaults, the nature thereof, and the steps being taken to remedy the same;

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                    “(c)     within thirty (30) days after the end of each of the first twelve (12) months of the Term and the last eighteen (18) months of the Term, all consolidated financial reports that Lessor may reasonably request containing, among other things, detailed statements of income and detailed operational statistics regarding occupancy rates, patient and resident mix and patient and resident rates by type for each Facility; and otherwise within thirty (30) days after the end of each of Lessee’s quarters, all quarterly consolidated financial reports Lessor may reasonably request containing, among other things, detailed statements of income and detailed operational statistics regarding occupancy rates, patient and resident mix and patient and resident rates by type for each Facility;”

                     (n)     New Lease.  The following is hereby added to the end of Section 31.2.1(a) of the Lease: 

           “Any Allocated Additional Rent and/or Supplemental Rent payable for such Separated Property(ies) shall be allocated to such Separated Property(ies) under such New Lease.”

                    (o)     Notices.  Section 33.1 of the Lease is hereby amended to provide for notices to Lessor to be addressed as follows:

If to Lessor:	Health Care Property Investors, Inc.
	3760 Kilroy Airport Way, Suite 300
	Long Beach, California 90806
	Attn:	Legal Department
	Fax:	(562) 733-5200
with a copy to:	Latham & Watkins LLP
	650 Town Center Drive, Suite 2000
	Costa Mesa, California 92626
	Attn:	David C. Meckler, Esq.
	Fax:	(714) 755-8290

                    (p)     Covenants with Respect to Operations and Fundamental Changes of Lessee.  The phrase “except in connection with the Initial Facility Mortgages and the indebtedness secured thereby,” is hereby added at the beginning of Sections 47.1(d) and 47.1(h) of the Lease.  The phrase “except in connection with the Initial Facility Mortgages” is hereby added after the phrase “any other Person” in Section 47.1(s) of the Lease.

                    (q)     Exhibits and Schedules. Exhibits A-4, A-5, A-6 and A-7 attached hereto shall be appended to Exhibit A of the Lease.  Exhibit B shall be amended and restated with the information on Schedule 1 attached hereto.  Exhibit F shall be amended and restated with the information on Schedule 2 attached hereto.  Exhibit G shall be amended and restated with the information on Schedule 3 attached hereto.  Exhibit H shall be amended and restated with the information on Schedule 4 attached hereto.  Exhibit I shall be amended and restated with the information on Schedule 5 attached hereto.  Exhibit J shall be amended and restated with the information on Schedule 6 attached hereto.  Exhibit K and Exhibit L attached hereto shall be appended to and hereafter form part of the Lease, as hereby amended.

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                    (r)     Addendum.  The Addendum attached hereto shall be appended to and hereafter form part of the Lease, as hereby amended.

                    (s)     General Matters Relating to the Commencement Date and Related Matters Affecting the Initial Facilities and Added Facilities.  The parties hereto agree and acknowledge that the effect of having different Commencement Dates with respect to certain Facilities shall be, among other things, that (i) the Lease Year shall be different with respect to those Facilities having different Commencement Dates, and the (ii) the Fixed Term and Extended Terms, if any, shall commence and expire at different times with respect to those Facilities having different Commencement Dates.

          4.       Quarterly Cash Flow Coverage; Cash Security Deposit and Impound Accounts for Added Facilities.

                    (a)     Without in any way limiting Lessee’s obligations under Section 25.1.2 of the Lease, within thirty (30) days of the end of each Quarter during the Term for the Added Facilities, including the first (1st) Quarter of the Fixed Term for the Added Facilities, Lessee shall provide such information to Lessor as necessary for Lessor to ascertain Lessee’s Cash Flow Coverage for such Quarter; provided, however, that for purposes of this Section 4 and the determination of Cash Flow Coverage for all Facilities only, each Quarter for the Initial Facilities shall be deemed to commence and end concurrent with each Quarter for the Added Facilities, notwithstanding that the actual Quarters for the Added Facilities and Initial Facilities may commence and end on different dates.  If for any Quarter, commencing with the expiration of the first Quarter of the Fixed Term for the Added Facilities, the average Cash Flow Coverage for all Facilities (i.e. all Initial Facilities and Added Facilities) is less than 1.1 or if for any two (2) consecutive Quarters the average Cash Flow Coverage for all Facilities is less than 1.2 (in either case, a “Triggering Event”), then Lessee shall immediately deposit with Lessor cash (the “Cash Security Deposit”) as additional security for Lessee’s obligations under the Lease, as hereby amended, in an amount equal to Twenty-Five Percent (25%) of the sum of the aggregate annual (i) Minimum Rent, (ii) Supplemental Rent (to be reasonably estimated by Lessor in the case of Lexington Monthly Supplemental Rent through May 30, 2015) and (iii) Lessor’s reasonable estimate of Additional Rent, in each case for the Added Facilities only.  Lessor shall either keep the Cash Security Deposit in a separate interest-bearing account as may be selected by Lessor from time to time, or may commingle the Cash Security Deposit with its general funds so long as Lessor credits and adds to the Cash Security Deposit each month an amount equal to the interest that would have been earned on the Cash Security Deposit had Lessor invested the same in an interest-bearing account, as reasonably determined by Lessor.  In either case, all earned interest or deemed interest on such Cash Security Deposit shall be added to and become part of the Cash Security Deposit and held and applied by Lessor in accordance with the provisions of this Section 4.  All interest or deemed interest earned on the Cash Security Deposit shall be for the account of Lessee and Lessee shall promptly deliver to Lessor upon request any Internal Revenue Service Form W-9 or such other certification as Lessor may reasonably request in connection with the investment of such Cash Security Deposit.  No notice to Lessee shall be required to enable Lessor to draw upon or apply such Cash Security Deposit.  In the event of a transfer of Lessor’s interest in the Leased Property, Lessor shall transfer the Cash Security Deposit to the transferee and thereupon shall, without any further agreement between the parties, be released by Lessee from all liability therefor, and it is agreed that the provisions hereof shall apply to every transfer or assignment of such Cash Security Deposit to a new Lessor.

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                    (b)     If, at any time after a Triggering Event, the average Cash Flow Coverage for all Facilities for three (3) consecutive Quarters is greater than 1.2, then Lessor shall release to Lessee the Cash Security Deposit.  Any subsequent Triggering Event shall, however, entitle Lessor to require that Lessee again fund such Cash Security Deposit in accordance with the provisions of this Section 4.

                    (c)     Lessor shall have the right to apply all or any portion of the Cash Security Deposit up to its full amount, as applicable, whenever (i) an Event of Default hereunder has occurred, (ii) an event of default beyond applicable periods of notice and cure under any other lease or agreement between Lessor or an Affiliate of Lessor and Lessee or an Affiliate of Lessee or under any other letter of credit, guaranty, mortgage, deed of trust, or other instrument now or hereafter executed by Lessee or an Affiliate of Lessee in favor of Lessor or an Affiliate of Lessor has occurred or (iii) an event or circumstance has occurred which with notice or passage of time, or both, would constitute an Event of Default hereunder or an event of default under any such other lease, agreement, letter of credit, guaranty, mortgage, deed of trust or other instrument, notwithstanding that transmittal of any such notice may be barred by applicable law.  No such application of the Cash Security Deposit shall (A) cure or constitute a waiver of an Event of Default, (B) be deemed to fix or determine the amounts to which Lessor is entitled to recover under the Lease, as hereby amended, or otherwise, or (C) be deemed to limit or waive Lessor’s right to pursue any remedies provided for in the Lease, as hereby amended.  If any portion of the Cash Security Deposit is applied by Lessor, Lessee shall, within two (2) business days after demand by Lessor, cause an amount equal to the amount of Cash Security Deposit previously applied to be paid to Lessor in order to replenish the Cash Security Deposit to the full required amount.

                    (d)     Notwithstanding anything to the contrary in the Lease, as hereby amended, during any period in which Lessee is required to deposit and maintain with Lessor the Cash Security Deposit as provided in this Section 4, regardless whether Lessee has failed to timely pay Impositions, Lessor shall be entitled by written notice to Lessee to require Lessee, for the duration of such same period, to make real estate tax impound deposits pursuant to Section 4.4 of the Lease.

                    (e)     If Lessee is required to fund the Cash Security Deposit or real estate tax impound as provided in this Section 4 and fails to do so within fifteen (15) days after Lessee’s request to do so (the “Deposit Outside Date”), then without limiting or waiving Lessor’s right to pursue any remedies provided for in the Lease, as hereby amended, or at law or equity by reason of Lessee’s failure to perform its obligations under this Section 4, effective on the Deposit Outside Date and continuing for the balance of the Term with respect to the Added Facilities, Monthly Allocated Minimum Rent shall immediately be increased by one-twelfth (1/12th) of the product of (i) One-Half of One Percent (0.50%), times (ii) the Minimum Repurchase Price for each such Added Facility.

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                    (f)     LESSEE WAIVES THE PROVISIONS OF ANY APPLICABLE LAWS NOW IN FORCE OR THAT BECOME IN FORCE AFTER THE EFFECTIVE DATE HEREOF, THAT PROVIDE IN SUBSTANCE THAT LESSOR MAY CLAIM FROM A CASH SECURITY DEPOSIT ONLY THOSE SUMS REASONABLY NECESSARY TO REMEDY DEFAULTS IN THE PAYMENT OF RENT, TO REPAIR DAMAGE CAUSED BY LESSEE, OR TO CLEAN THE LEASED PROPERTY.  LESSOR AND LESSEE AGREE THAT LESSOR MAY, IN ADDITION, CLAIM THOSE SUMS NECESSARY TO COMPENSATE LESSOR FOR ANY OTHER FORESEEABLE OR UNFORESEEABLE ACTUAL LOSS OR DAMAGE CAUSED BY THE ACT OR OMISSION OF LESSEE OR LESSEE’S OFFICERS, AGENTS, EMPLOYEES, INDEPENDENT CONTRACTORS, OR INVITEES, INCLUDING, BUT NOT LIMITED TO THOSE DAMAGES TO WHICH LESSOR IS ENTITLED PURSUANT TO ARTICLE XVI OF THE LEASE.

Lessee’s Initials: __________

                    (g)     If Lessee shall fully and faithfully perform every provision of the Lease, as hereby amended, to be performed by Lessee, upon the expiration of the Term of the Lease, as hereby amended, with respect to the last Facility the Cash Security Deposit shall be applied against any amounts owed by Lessee to Lessor and any balance thereof shall be returned to Lessee (or at Lessor’s option, to the last permitted assignee of Lessee’s interest under the Lease, as hereby amended) within ninety (90) days after the expiration of such Term.

5. Required Maintenance and Capital Expenditures.

                    (a)     Without in any way limiting Lessee’s obligations under Section 9.1 or elsewhere in the Lease, commencing on the Effective Date and continuing through the expiration of the Term (including any Extended Terms) with respect to the Added Facilities, Lessee covenants and agrees to expend each Lease Year the applicable Minimum Annual Expenditure for Qualified Capital Expenditures to improve and maintain each Added Facility.  Within thirty (30) days after the expiration of each Lease Year during the Term with respect to the Added Facilities, Lessee shall deliver to Lessor written evidence reasonably satisfactory to Lessor as to the total actual out-of-pocket costs incurred and paid by Lessee in performing Qualified Capital Expenditures for each Added Facility for the immediately prior Lease Year (excluding, however, any amounts funded from Replacement Reserve Deposits).  If the actual out-of-pocket costs incurred and paid by Lessee (excluding, however, any amounts funded from Replacement Reserve Deposits) in performing Qualified Capital Expenditures for any Added Facility for any Lease Year are less than the Minimum Annual Expenditure, then Lessee shall deposit with Lessor as a repair and replacement deposit with respect to such Added Facility (with respect to any such Added Facility, a “Replacement Reserve Deposit”) such difference.  Lessor shall either keep the Replacement Reserve Deposit in a separate interest-bearing account as may be selected by Lessor from time to time, or may commingle the Replacement Reserve Deposit with its general funds so long as Lessor credits and adds to the Replacement Reserve Deposit each month an amount equal to the interest that would have been earned on the Replacement Reserve Deposit had Lessor invested the same in an interest-bearing account, as reasonably determined by Lessor.  In either case, all earned interest or deemed interest on such Replacement Reserve Deposit shall be added to and become part of the Replacement Reserve Deposit and held and applied by Lessor in accordance with the provisions of this Section 5.  All interest or deemed interest earned on the Replacement Reserve Deposit shall be for the account of Lessee, and Lessee shall promptly deliver to Lessor upon request any Internal Revenue Service Form W-9 or such other certification as Lessor may reasonably request in connection with the investment of such Replacement Reserve Deposit.  The Replacement Reserve Deposits are solely for the protection of Lessor and the Leased Property of each Added Facility and entail no responsibility on Lessor’s part beyond the payment of the respective items for which they are held following receipt of bills, invoices or statements therefor in accordance with the terms of this Section 5 and beyond the allowing of due credit for the sums actually received.  Upon assignment of this Lease by Lessor, any Replacement Reserve Deposits shall be turned over to the assignee and any responsibility of Lessor, as assignor, with respect thereto shall terminate.

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                    (b)     So long as no Event of Default or an event or circumstance has occurred which with notice or passage of time, or both, would constitute an Event of Default under the Lease, as hereby amended, and is continuing, Lessor shall, to the extent of the Replacement Reserve Deposit for an Added Facility, disburse to Lessee the amount incurred and paid by Lessee in performing any Qualified Capital Expenditure for the applicable Added Facility within fifteen (15) days following: (i) the receipt by Lessor of a written request from Lessee for disbursement and a certification by Lessee in form and substance reasonably satisfactory to Lessor that the applicable Qualified Capital Expenditures has been completed; (ii) the delivery to Lessor of paid invoices, receipts or other evidence reasonably satisfactory to Lessor, verifying the cost and payment of performing Qualified Capital Expenditures; and (iii) to the extent applicable, the delivery to Lessor of affidavits, lien waivers or other evidence reasonably satisfactory to Lessor showing that all materialmen, laborers, subcontractors and any other parties who might or could claim statutory or common law liens and are furnishing or have furnished material or labor to the Leased Property of such Added Facility have been (or upon receipt of a sum certain will be) paid all amounts due for labor and materials furnished to the Leased Property of such Added Facility.  Lessor shall not be required to make advances from any Replacement Reserve Deposit more frequently than once in any thirty (30) day period.

                    (c)     Without in any way limiting any right or remedy of Lessor, whether under the Lease, as hereby amended, at law or at equity, if upon the expiration or earlier termination of the Lease Lessor reasonably determines that Lessee has failed to maintain and repair any Added Facility in accordance with the terms of the Lease, as hereby amended, then Lessor shall be entitled to retain and apply any remaining Replacement Reserve Deposits for any Added Facility towards costs of repairing or refurbishing the Leased Property of any Added Facility which has not been maintained or repaired in the condition required by the Lease, as hereby amended, as reasonably determined by Lessor, and the balance, if any, shall be returned to Lessee.

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6. Option to Purchase Certain Added Facilities.

                    (a)     Exercise of Option.  Provided no Event of Default, or event which, with notice or lapse of time or both, would constitute an Event of Default, has occurred and is continuing under the Lease, as hereby amended, Lessor hereby grants to Guarantor the option to purchase at the end of the Fixed Term and each Extended Term, as the case may be, the Leased Property of the Sun City Facility, Homewood Facility and/or Holland Facility at the then Option Repurchase Price for such Facility; provided, however, that Guarantor may only exercise its option to purchase the Sun City Facility and Homewood Facility, if at all, as a group and upon any exercise thereof the purchase transaction therefor shall close simultaneously in accordance with the provisions of this Section 6(a).  Subject to the foregoing, each such option shall be exercised, if at all, upon written notice from Guarantor to Lessor given not earlier than eighteen (18) months and not less than fifteen (15) months prior to the expiration of the Fixed Term or the applicable Extended Term, as the case may be, and concurrently with such notice to Lessor, opening an escrow (the “Escrow”) with and by depositing two and one-half percent (2½%) of the applicable purchase price (the “Opening Deposit”) and a copy of this Amendment, with a national title company reasonably acceptable to Lessor (“Escrow Holder”) and informing Lessor in writing of the establishment of such Escrow along with the Escrow number therefor.  If Guarantor shall not be entitled to exercise such option (e.g., by reason of an Event of Default) or shall be entitled to exercise the same but shall fail to do so within the time and in the manner herein provided, such option shall lapse and thereafter not be exercisable by Guarantor (except that such option shall continue to be effective with respect to the exercise period occurring at the end of each subsequent Extended Term, if any).  Without limiting the foregoing, if Guarantor shall not be entitled to exercise such option or shall be entitled to exercise the same but shall fail to do so within the time and in the manner herein provided, such option shall automatically terminate without further action by either party (except that such option shall continue to be effective with respect to the exercise period occurring at the end of each subsequent Extended Term, if any).  No failure by Lessor to notify Guarantor of any defect in any attempted exercise of the foregoing option shall be deemed a waiver by Lessor of the right to insist upon Guarantor’s exercise of such option in strict accordance with the provisions hereof.  In the event that Guarantor shall properly and timely exercise such option, then such transaction shall be consummated on or within ten (10) days following the expiration of Fixed Term or Extended Term, as applicable (the “Outside Closing Date”).

                    (b)     Damages.

                                   (i)     Liquidated Damages.  IF, FOLLOWING A VALID AND PROPER EXERCISE OF ANY OPTION, GUARANTOR FAILS TO COMPLETE THE PURCHASE OF THE APPLICABLE FACILITY AND SUCH FAILURE CONSTITUTES A BREACH HEREOF, THEN LESSOR, AT ITS OPTION, MAY TERMINATE THE PURCHASE CONTRACT FORMED BY GUARANTOR’S EXERCISE OF SUCH OPTION AND THE ESCROW BY GIVING WRITTEN NOTICE TO GUARANTOR AND ESCROW HOLDER AND, THEREUPON, THE ESCROW SHALL BE CANCELLED, ALL DOCUMENTS SHALL BE RETURNED TO THE RESPECTIVE PARTIES WHO DEPOSITED THE SAME, AND GUARANTOR SHALL PAY ALL TITLE AND ESCROW CANCELLATION CHARGES AND ALL OF LESSOR’S LEGAL FEES AND COSTS.  IN ADDITION, LESSOR AND GUARANTOR AGREE THAT, BASED ON THE CIRCUMSTANCES NOW EXISTING, KNOWN OR UNKNOWN, IT WOULD BE EXCESSIVELY COSTLY AND IMPRACTICABLE TO ESTABLISH LESSOR’S DAMAGES BY REASON OF GUARANTOR’S DEFAULT RESULTING IN A FAILURE OF THE ESCROW TO CLOSE, AND, THEREFORE, LESSOR AND GUARANTOR AGREE THAT IT WOULD BE REASONABLE TO AWARD LESSOR LIQUIDATED DAMAGES IN THE AMOUNT OF THE OPENING DEPOSIT PLUS ANY ACCRUED INTEREST ON THE OPENING DEPOSIT.  BY THEIR RESPECTIVE INITIALS SET FORTH BELOW, LESSOR AND GUARANTOR ACKNOWLEDGE AND AGREE THAT THE OPENING DEPOSIT, PLUS ANY INTEREST ACCRUED ON THE OPENING DEPOSIT, TOGETHER WITH PAYMENT OF LESSOR’S LEGAL FEES AND COSTS, IS REASONABLE AS LIQUIDATED DAMAGES FOR A DEFAULT OF GUARANTOR UNDER THE PURCHASE CONTRACT FORMED BY GUARANTOR’S EXERCISE OF SUCH OPTION THAT RESULTS IN A FAILURE OF THE ESCROW TO CLOSE AND SHALL BE IN LIEU OF ANY OTHER RELIEF, RIGHT OR REMEDY, AT LAW OR IN EQUITY, TO WHICH LESSOR MIGHT OTHERWISE BE ENTITLED BY REASON OF GUARANTOR’S DEFAULT THAT RESULTS IN A FAILURE OF THE ESCROW TO CLOSE, BUT NOTHING CONTAINED HEREIN SHALL LIMIT LESSOR’S RIGHTS AND REMEDIES FOR GUARANTOR’S DEFAULT OCCURRING AFTER THE CLOSE OF ESCROW OR FOR LESSEE’S DEFAULT UNDER THE LEASE, AS HEREBY AMENDED.  ESCROW HOLDER IS HEREBY AUTHORIZED AND INSTRUCTED TO RELEASE THE OPENING DEPOSIT PLUS ACCRUED INTEREST THEREON TO LESSOR UPON THE DELIVERY OF UNILATERAL WRITTEN INSTRUCTIONS THEREOF TO ESCROW HOLDER BY LESSOR, AND ESCROW HOLDER IS HEREBY RELIEVED OF ALL LIABILITY THEREFOR.  IF GUARANTOR WRONGFULLY ATTEMPTS TO INTERFERE WITH THE RELEASE OF ANY SUCH SUMS BY ESCROW HOLDER TO LESSOR, OR WRONGFULLY COMMENCES ANY ACTION AGAINST LESSOR OR THE LEASED PROPERTY ARISING OUT OF THIS ARTICLE, THEN LESSOR SHALL NOT BE LIMITED IN THE AMOUNT OF DAMAGES IT MAY RECOVER FROM GUARANTOR.

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Lessor’s Initials:     __________

Guarantor’s Initials:__________

                                   (ii)     Other Defaults.  A default under any lease or other agreement or instrument, including any purchase contract formed upon exercise of any other option, with or in favor of Lessor or any Affiliate of Lessor and made by or with Guarantor, Lessee or any Affiliate of Lessee where such default is not cured within the applicable time period, if any, shall be deemed a default under this Section 6(b) and the purchase contract formed upon proper exercise by Guarantor of the option herein provided, entitling Lessor, as seller, at its option, to terminate such purchase contract and the Escrow and upon any such termination the Opening Deposit plus all accrued interest thereon shall be paid over to Lessor as provided in Section 6(b)(i) above.

(c) Escrow Provisions.

                                   (i)     Opening of Escrow.  Escrow shall be deemed open when the Opening Deposit and a copy of this Amendment are delivered to Escrow Holder.

                                   (ii)     General and Supplemental Instructions.  Guarantor and Lessor each shall execute, deliver and be bound by such further escrow instructions or other instruments as may be reasonably requested by the other party or by Escrow Holder from time to time, so long as the same are consistent with the provisions of this Section 6.

                                   (iii)     Disposition of Opening Deposit.  Escrow Holder shall hold the Opening Deposit in interest-bearing accounts.  All interest earned on the Opening Deposit shall accrue to Guarantor’s benefit unless Lessor is entitled thereto under Section 6(b)(i).  With full knowledge that Escrow shall not have closed, Guarantor nevertheless agrees to relieve Escrow Holder of all liabilities in making such payment and for any failure to recover said sum in the event that Escrow does not close at anytime thereafter.  The Opening Deposit plus interest thereon shall be (i) applied against the purchase price (as herein determined) if Escrow closes, (ii) returned to Guarantor in full if Escrow does not close for any reason other than Guarantor’s default, or (iii) be paid to Lessor as nonrefundable liquidated damages under Section 6(b)(i), if Escrow fails to close under the provisions of hereof as a result of Guarantor’s default.

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                                   (iv)     Closing Funds.  At least one (1) business day before the Close of Escrow (as hereinafter defined), Escrow Holder shall calculate and Guarantor shall wire cash into Escrow (using wiring instructions reasonably satisfactory to Escrow Holder) in an amount which, when added to the Opening Deposit and all accrued interest shall equal the purchase price for the applicable Facility plus any other sums payable by Guarantor pursuant to the provisions hereof.

                                   (v)     Close of Escrow.  Escrow shall close on the Outside Closing Date.  The term “Close of Escrow” as used in this Section 6 shall mean the time and date that an appropriate deed or other conveyance document conveying Lessor’s entire interest in the applicable Facility, subject to the permitted liens and encumbrances described in Article XVIII of the Lease (which for all purposes shall apply to Guarantor’s purchase of any applicable Facility pursuant to this Section 6), is recorded in appropriate records of the county in which the applicable Facility is located or such earlier date as such deed or conveyance document is deemed delivered to Guarantor in Escrow (as a result of the satisfaction of all conditions to closing and the authorization of the parties).  The Outside Closing Date shall not be extended for any reason.

                                   (vi)     Closing Costs.  The closing costs of consummating the purchase of the applicable Facility shall be paid by Guarantor in the same manner as if Lessee were purchasing such Facility in accordance with Article XVIII of the Lease.

                    (d)     Termination of Lease with Respect to Purchased Facility.  Upon the Close of Escrow, the Lease, as hereby amended, shall be terminated with respect to the purchased Facility (only) in accordance with Section 5.2 of the Lease.

                    (e)     Lessor’s Election of 1031 Exchange.  In the event that Guarantor exercises any option to purchase an applicable Facility as provided in this Section 6, Lessor or HCP may elect to sell such Facility or its interests therein to Guarantor in the form of a simultaneous, tax-deferred forward or reverse exchange pursuant to Section 1031 of the Internal Revenue Code of 1986, as amended (“1031 Exchange”).  In the event that Lessor or HCP shall so elect, Lessor or HCP shall give written notice to Guarantor and Escrow Holder of such election and Guarantor shall fully cooperate with any such 1031 Exchange, including but not limited to executing and delivering additional documents reasonably requested or approved by Lessor or HCP; provided that Guarantor shall not be required to incur any additional costs or liabilities or financial obligation as a consequence of any of the foregoing exchange transactions.

          7.     Entrance Fee Facility Lessee Requirements.  Lessee hereby represents and covenants that, without limiting the requirements of Section 47.1 of the Lease, each Lessee that is the License Holder of an Entrance Fee Facility (as defined in the Addendum) is, and at all times will be, an entity that is treated as a corporation or an association taxable as a corporation for United States federal income tax purposes.

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          8.     Consent of Guarantor and Amendment to Guaranty.  Guarantor hereby (a) consents to this Amendment, the addition of the Added Facilities to the Leased Property, the addition of Richmond RealCo, Sun City RealCo, Holland RealCo and Homewood RealCo as part of “Lessor” under the Lease, as hereby amended, and the addition to and assumption by Richmond Lessee, Sun City Lessee, Holland Lessee and Homewood Lessee of the “Lessee’s” obligations under the Lease, as hereby amended, and (b) re-affirms its obligations under the Guaranty and agrees that such obligations extend to the Lease, as hereby amended.  In addition, Lessor and Guarantor hereby agree that the Guaranty is hereby amended such that the Guaranteed Obligations (as defined in the Guaranty) shall include the payment when due of all costs, expenses, fees and other sums payable by Homewood Lessee and/or Lessee under the Homewood Contract of Acquisition and the full, faithful and prompt performance when due of each and every one of the terms, conditions and covenants to be kept and performed by Homewood Lessee and/or Lessee under the Homewood Contract of Acquisition.

          9.     Consent of Lessor.  Lessor hereby consents to (a) Lessee entering into, and causing its Affiliates to enter into, each of the Transaction Documents, (b) the consummation of the transactions contemplated thereby in accordance with the terms thereof, and (c) all amendments of the organizational documents of each Lessee that are being executed in connection with the Transaction Documents, copies of which have been delivered to Lessor together with an Officer’s Certificate relating thereto on or prior to the Effective Date of this Amendment.  The parties acknowledge that this Amendment is one of the Transaction Documents contemplated by the Master Agreement.

          10.     Reaffirmation of Master Lease.  Lessor and Lessee hereby acknowledge, agree and reaffirm that the Lease, as hereby amended, is and the parties intend the same for all purposes to be treated as a single, integrated and indivisible agreement.  Lessee acknowledges that in order to induce Lessor to lease the Leased Property of each Facility (including the Added Facilities) to Lessee and as a condition thereto, Lessor insisted that the parties execute the Lease, as hereby amended, covering all of the Facilities in a single, integrated and indivisible agreement.

          11.     Governing Law.  THIS AMENDMENT WAS NEGOTIATED IN THE STATE OF CALIFORNIA, WHICH STATE THE PARTIES AGREE HAS A SUBSTANTIAL RELATIONSHIP TO THE PARTIES AND TO THE UNDERLYING TRANSACTION EMBODIED HEREBY.  ACCORDINGLY, IN ALL RESPECTS THIS AMENDMENT SHALL BE GOVERNED BY, AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF CALIFORNIA (WITHOUT REGARD OF PRINCIPLES OR CONFLICTS OF LAW) AND ANY APPLICABLE LAWS OF THE UNITED STATES OF AMERICA.

          12.     Full Force and Effect; Counterparts; Facsimile Signatures.  Except as hereby amended, the Lease shall remain in full force and effect.  This Amendment may be executed in any number of counterparts, all of which shall constitute one and the same instrument.  Telecopied signatures may be used in place of original signatures on this Amendment, and Lessor and Lessee both intend to be bound by the signatures of the telecopied document.

[SIGNATURE PAGE FOLLOWS]

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                    IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the day and year first above written.

	“Lessor”
WITNESSED:	HEALTH CARE PROPERTY INVESTORS, INC., a Maryland corporation
	By:
Witness	Title:
Witness
WITNESSED:	TEXAS HCP HOLDING, L.P., a Delaware limited partnership
	By:		TEXAS HCP G.P., INC., a Delaware corporation, its sole general partner
Witness
			By:
Witness			Title:
WITNESSED:	TEXAS HCP REVX, L.P., a Delaware limited partnership
	By:	TEXAS HCP G.P., INC., a Delaware corporation, its sole general partner
Witness
		By:
Witness		Title:

[Signature pages continue]

24

	ARC RICHMOND PLACE REAL ESTATE
		HOLDINGS, LLC, a Delaware limited liability company
WITNESSED:	By:				Health Care Property Investors, Inc., a
					Maryland corporation, its sole member
				By:
Witness				Title:
Witness
	ARC HOLLAND REAL ESTATE
	HOLDINGS, LLC
	ARC SUN CITY CENTER REAL ESTATE
	HOLDINGS, LLC
	ARC LABARC REAL ESTATE HOLDINGS, LLC each, a Delaware limited liability company
WITNESSED:	By:		Health Care Property Investors, Inc., a
			Maryland corporation, its managing member
			By:
Witness			Title:
Witness

[Signature pages continue]

25

	“Lessee”
WITNESSED:	FORT AUSTIN LIMITED PARTNERSHIP, a Texas limited partnership
	By:		ARC Fort Austin Properties, LLC, its general partner
Witness
Witness			By:
			Title:
	ARC RICHMOND PLACE, INC., a Delaware corporation
WITNESSED:	ARC SANTA CATALINA, INC., a Tennessee corporation
Witness	By:
	Title:
Witness
	FREEDOM VILLAGE OF HOLLAND,       MICHIGAN, a Michigan general partnership
WITNESSED:	FREEDOM VILLAGE OF SUN CITY CENTER,    LTD., a Florida limited partnership
	By:		ARC Freedom, LLC, managing partner
Witness
		By:
		Title:
Witness

[Signature pages continue]

26

	LABARC, L.P., a Tennessee limited partnership
WITNESSED:	By:	ARC Sun City Center, Inc., general partner
			By:
			Title:
Witness
Witness
	“Guarantor”
WITNESSED:	ARCPI HOLDINGS, INC., a Delaware corporation
Witness	By:
	Title:
Witness

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EX-31.1

Exhibit 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, W.E. Sheriff, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of American Retirement Corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
	a)	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
	b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
	c)	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
	a)	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 11, 2004

/s/ W.E. Sheriff

W.E. Sheriff

Chairman, President and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, Bryan D. Richardson, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of American Retirement Corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
	a)	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
	b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
	c)	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
	a)	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 11, 2004

/s/ Bryan D. Richardson

Bryan D. Richardson

Executive Vice President – Finance
and Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of American Retirement Corporation (the “Company”) on Form 10-Q for the period ending June 30, 2004, as filed with the Securities and Exchange Commission on August 11, 2004 (the “Report”), I, W.E. Sheriff, Chairman, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ W.E. Sheriff

W.E. Sheriff

Chairman, President and Chief Executive Officer
August 11, 2004

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of American Retirement Corporation (the “Company”) on Form 10-Q for the period ending June 30, 2004, as filed with the Securities and Exchange Commission on August 11, 2004 (the “Report”), I, Bryan D. Richardson, Executive Vice President – Finance and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Bryan D. Richardson

Bryan D. Richardson

Executive Vice President – Finance and
Chief Financial Officer
August 11, 2004