Alerislife Inc (ALR) 2006 Q2 法說會逐字稿

Good day and welcome to the Five Star Quality Care second quarter 2006 financial results conference call. [OPERATOR INSTRUCTIONS] At this time for opening remarks and introductions, I would like to turn the conference over to the Manager of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you and good morning everyone. Joining me on today's call are Evrett Benton, President and Chief Executive Officer and Bruce Mackey, Chief Financial Officer. The agenda for today's call includes a presentation by management followed by a question and answer session.

Before we begin today's call I would state that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and the Federal Securities laws. These forward-looking statements are based on Five Star's present beliefs and expectations as of today, August 4th, 2006. The Company undertakes no obligation to revise or publicly release the results of any revisions of the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission regarding this reporting period.

Actual results may differ materially from those projected in these forward-looking statements. Additional information concerning factors that could cause those differences is contained in our form 10-K and 10-Q filed with the Securities and Exchange Commission. Investors are cautioned not to place undue reliance upon any forward-looking statements.

With that, I'd like to turn the call over to Evrett Benton.

Thanks to everyone who is joining us on this Friday morning in August. This morning we reported income from continuing operations of $0.12 per share excluding the effects of an approximately $90 million charge for the termination of management agreements with Sunrise for ten communities that they previously operated for us.

As you will remember from the two previous times that we've terminated management agreements, the GAAP treatment of a contract termination is not handled the same way as an acquisition. The termination of a services contract is accounted for as a one-time expense. In total, since last November we've now terminated 23 management agreements with Sunrise.

Today Sunrise continues to operate seven communities where Five Star is the tenant and Senior Housing Properties Trust is the property owner. But more to the point, and more vital to the interest of our shareholders, is the fact that Five Star now operates more than 95% of our 151 communities where we now have control of the bottom line. This is a substantial improvement from where we were just one year ago.

Once again we were able to accelerate our takeover of properties previously managed by Sunrise. However, this means that we only received one month reduction in the management fee paid to Sunrise during the second quarter. Therefore, when modeling our third quarter, the biggest difference sequentially will be the additional two months' reduction in management fees that we will no longer pay to Sunrise as a result of the most recent terminations.

We're taking the same meticulous approach that served us so well during the transition of the first 13 communities. As of June 1st, we've brought on an additional 2,000 employees and several thousand residents. Our regional directors and other senior management as well as myself have met with employees and residents at all of these communities. With the latest ten communities, we were successful in hiring virtually 100% of the staff, which now brings our total employee base to almost 14,000.

Now as we've said all along, it is our expectation that these ten communities will be incrementally more difficult to integrate. As you may remember, originally we chose the first 12 communities that had the best historical operations and fit cleanly into our regional structure. The net effect is at this time we've created one additional region to aid in operations oversight. As for the remaining seven communities that Sunrise operates, we remain very interested in taking back these operations.

In fact, we had begun negotiations with Sunrise. However, negotiations were put on hold at Sunrise's request until they can resolve their accounting issues. We have been clear that the remaining seven are the most operationally challenged of the original 30 communities.

If you look at the second quarter for these seven, for example, they made $14,000 in April, lost $270,000 in May and lost $436,000 in June. That works out to $0.02 per share impact to our bottom line in the second quarter alone. Given the performance trends that we're seeing, we may be compelled to act sooner rather than later in taking back operations of these seven communities.

Also during the quarter, Senior Housing Properties Trust agreed to sell two skilled nursing facilities that we lease from them and operate in Connecticut. These facilities had been difficult to operate on almost all fronts. Because of the presence of some tough union contracts and a difficult hiring environment, our ability to control labor costs was greatly compromised.

In addition, Medicaid reimbursement rates have not been able to keep pace with our cost increases in Connecticut for several years. The upside for our shareholders is that, by selling these two skilled nursing facilities, we'll stop the bleeding of significant financial losses. In addition upon their sale, our lease payments to senior housing will be reduced by 10% of the net sales proceeds.

I'd now like to give you a brief update on the licensing process for the two rehabilitations hospitals in Massachusetts. We had told you that licensing would be a difficult and painful process. Well, that is most certainly the case. Nonetheless, we've continued to take the steps needed to get licensed, including public hearings, meetings with state officials, and numerous filings of requested documentation. We still expect ultimately to be licensed by the end of this year. So stay tuned.

On the acquisition front, it seems that perhaps the logjam may have broken up just a little in our target area of private-pay independent and assisted living communities. Currently we're in the running for a handful of communities and we're hopeful we will be able to close on some of these before year end. More to come on that front.

We have two other items of note that occurred just after the close of second quarter that further underscored the fact that we have become a stronger company.

First, Five Star was added to the Russell 2000 and 3000 indices in early July. This introduces us to a new group of institutional investors who use the Russell to benchmark their investments. These listings, along with the 31.5 million shares of common stock that we now have outstanding, provide our shareholders with a higher level of liquidity.

Second, we extended the maturity of our $25 million revolving credit facility out to May of 2008. In addition, we were able to reduce the rate of interest paid on drawings from LIBOR plus 250 basis points to LIBOR plus 150 basis points. There's nothing outstanding on the line and under certain circumstances, it can be expanded to $50 million.

Now let's review some of our key metrics. Overall occupancy and same store occupancy in the second quarter were 91%, which are increases over the 90% occupancy we reported for both measures in the same quarter of 2005. Same store occupancy includes those communities we have operated continuously since April 1st of 2005.

Now, moving on to some trends in our other operating statistics. The average daily rate per resident increased by over 6% to $132 in the second quarter of 2006. On a same store basis, the average daily rate is increased by 5% to $129 in the second quarter. The percentage of our revenues that came from residents' private resources was 66% in the second quarter, which is even with last year's second quarter and flat sequentially.

Now let's review our labor costs. Labor costs as a percent of net revenues from residents increased from 50.3% to 51.9% between the second quarters of 2005 and 2006. The year-over-year increase is primarily attributable to high equity labor costs at six assisted living communities we acquired in western Pennsylvania in June of 2005, as well as significant wage pressure and the shortage of nurses and rehabilitation therapists. We will continue to focus on making incremental improvement with regard to our labor costs.

Now let's review our Pharmacy and Rehabilitation businesses. Revenues in our Pharmacy business increased 84% to $13.1 million in the second quarter, compared to $7.1 million in the same period last year. Operating margins of 5% in our Pharmacy business are still below our target of 8%. However, margins significantly improved over our fourth quarter 2005 amounts and also moved up from the first quarter. We're close on one pharmacy acquisition and we are preliminarily reviewing several other opportunities.

In total, our institutional pharmacy business now services over 112 communities with approximately 52 million in annualized revenues.

In addition, we continue the process of moving our own communities into these pharmacies. We still expect that we'll be able to move toward 8% plus operating margins in this business during the second half of 2006. We're also in the process of evaluating strategic alternatives for the mail order portion of this Pharmacy business. Currently, it services about 27,000 people, including about 2,000 of our own employees.

Finally, we've continued on plan in the development of our outpatient Rehabilitation Services business. We've told you that we expect to have outpatient rehabilitation clinics in 40 of our communities by year end. I am pleased to report today that we have 31 up and running.

At this point, I'd like to turn the time over to Bruce Mackey, our Chief Financial Officer.

Great, thanks. Let's review the second quarter numbers. Our net revenues from residents were $183.6 million for the second quarter, an increase by 7% when compared with the second quarter of 2005. This increase was due primarily to revenues from the six communities we acquired in June 2005, higher per diem charges to residents and a 1% increase in occupancy.

I would also note that the 6% increase in same store net revenues from residents for those communities continuously operated since April 1, 2005 was due primarily to 5% higher per diem charges to residents and a 1% increase in occupancy.

Moving on to expenses. Wages and benefits increased by 10% in the second quarter to $95.3 million from the second quarter of 2005. This increase in the second quarter is primarily due to wages and benefits for the six Pennsylvania communities we acquired in June 2005, and wage increases.

Other operating expenses increased by 2% in the second quarter to $45.9 million as compared to the same period in 2005. This increase is primarily the result of other operating expenses of the six communities we acquired in June 2005 and increased charges from third parties. The management fee at Sunrise fell by 49% in the second quarter to $2.9 million from $5.6 million in the same period a year ago. This expense decreased predominantly because of our termination of 12 management agreements in November 2005 and 11 management agreements in February and June 2006.

G&A expense for the first quarter increased by 27% to $7.7 million from the same period a year ago. The increase in G&A expense primarily results from our increased operations from the six communities we acquired in June of 2005 and the 23 communities we began to operate that were previously managed for us by Sunrise.

Even with these additional items, G&A expense for the second quarter was still only 3.9% of total revenues. Rent expense during the second quarter for the communities that we lease increased by 9% to $26.4 million from the second quarter of 2005. This rent expense increase is due to the addition of communities that would be under lease in 2005 and our payment of additional rent for capital improvements purchased by Senior Housing since April 1st, 2005.

Excluding the $90 million termination charge paid to Sunrise, EBITDA would have been $6.1 million for the second quarter -- an increase over 24% from the second quarter 2005.

To reiterate what Evrett had said earlier without the $90 million of charges we would have recorded income per share for continuing operations of $0.12 in the second quarter of 2006. As a reminder, the net loss carryforwards for all the Sunrise termination fees paid since November 2005 now total over $170 million.

It is our expectation that at our present state we will not pay taxes for the next five years. I would also point out that our second quarter earnings per share were impacted by having an additional 11.5 million shares outstanding but not any additional income other than minor investment income from the funds that were raised in our equity offering and one-month reduction in the management fee paid to Sunrise.

Moving on to the balance sheet and some more items of note, cash and cash equivalents were $23.6 million at the end of the second quarter. Accounts receivable at the end of the second quarter were $ 46.3 million. Our days sales outstanding still remain an industry leading 20 days. As a reminder, this was achieved while factoring in that 34% of our revenues for the quarter ended June 30, 2006 received from Medicaid, Medicare programs that generally pay 30 days in arrears.

At the end of the second quarter we had a $102.1 million of net property and equipment. As of today we own 14 properties, five of which are unencumbered. These communities include 12 independent assisted living communities and two skilled nursing facilities.

At the end of the second quarter, the market value of our [high insurance] mortgage note is $45 million. We had no amount outstanding on our $25 million revolving credit facility. We believe that we are currently in compliance with all material covenants of our mortgages and revolving credit facility.

In summary, Five Star is pursuing growth by client private pay, independent and assisted living communities, pushing rates, developing complementary ancillary businesses, getting licenses to operate two rehabilitation hospitals and taking on the operations of communities previously managed for us by Sunrise.

Over the course of the last nine months, we have taken over the operations of 23 communities previously managed by Sunrise, including about 5,000 residents and several thousand employees. As planned, we have successfully maintained the operations of these communities and we are optimistic that we can further improve their performance in the future.

The senior living industry maintains strong fundamentals, including historically low levels of development, favorable demographic trends and rising occupancies. We believe that Five Star's performance, valuation and opportunity relative to our peers warrant serious consideration from both growth and value investors.

That concludes our prepared remarks. Operator, we are now ready to take questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll go first to Jerry Doctrow with Stifel Nicolaus.

Good morning, guys.

Morning.

I had a handful of things. On the two nursing homes that S&H is selling, are those already in discontinued ops or will we actually see a change in continued ops?

No, those are in our discontinued ops for the second quarter.

It looked like the number of units went down from like 17,000 something to like 1681. What was going on there?

Maybe just a little bit more color to amplify that. These are two skilled nursing facilities. They totaled 300 beds. And I don't know how much you know about Connecticut. It's a very, very difficult environment to operate in. We've done reasonably well.

Unfortunately with the start of dramatic increases at the first of the year in some contract terms as well as really no increases in the payment rates, we found it very difficult to continue there. Also Connecticut has used a disproportionate amount of our regional and management expertise. It's just a tough area to work in.

Looking at it, we realize we can use all of those resources, human as well as others, in growing in the areas that make more sense.

Okay.

So that some of the numbers, by virtue of that, once we pull them into discontinued operations, change up.

You know whatever the rent you're paying on those facilities will change. Is it possible when you finally settle up and sell those you're going to see any movement on the rent on continuing because you will have -- they won't sell them for the full amount or something? Or the numbers we're looking at -- you don't think it's going to have any material effect once that sale's done?

No, it should be pretty close to what is in there right now.

I wanted to talk a little bit then of just about CapEx and improvements and those sorts of things. One I just -- do you have a sense of what maintenance CapEx was for the quarter?

We spent several million dollar. Some of that was maintenance CapEx and a lot of that was special projects. The majority of the CapEx in the quarter will be reimbursed by Senior Housing Properties Trust. We did spend probably $2 million on property that we own as well as our pharmacy. A lot of that -- the combination of CapEx and special maintain projects.

If we could maybe just get try and get through the maintenance I'll come back to you after the call. You're obviously spending CapEx from S&H. I think they talked about 5.8 million or something that they had advanced in the quarter. So, is that, I guess, having impact on operations either taking it in its offline or whatever or should we start to expect to be seeing some return on that investment as we kind of go forward? If you can give me a little color on what's going on there.

Thanks. That's actually a very insightful question. First of all, we have a handful of properties where we have significant numbers of their units in -- two in Pennsylvania, for example, we have almost a quarter of their units offline just because of the stuff we're doing. One that you saw in Virginia, we've had to -- we're continuing just bringing that on-line now so you should see some positive.

And several others that we're actually having to sort of go through on a rolling basis and moving folks out. So we are in fact seeing some concerns with regard to that. But it's a normal thing. I think it's a positive thing.

Secondly, I think that we've said in the past that this year we've ginned up a pretty robust system of personnel. Before we only basically had two very strong guys. Now we've got eight people out there. We have a regional system; they call them Area Chief Engineers. It's actually allowed us -- yesterday, for example, Bruce and Rosemary, our COO, spent the bulk of the day with good guys in that area going through all of the CapEx that we're going through and all the things that that means from an operational standpoint, as well.

I think you're going to see two significant points. One, there is an increase in the CapEx, but every one of these substantial projects that are beyond maintenance require financial review and a financial signoff that it makes significant sense. From that then, too, you'll see, we believe, a far better improvement in a number of things in the latter part of this year and the succeeding quarters beyond that.

Maybe if you can come back to us -- I don't know if you can do it this quarter or [get forward], just a sense of -- I mean I like to isolate maintenance CapEx from the stuff from you're spending that's going to produce a return and maybe some sense of a schedule as to how those things are kind of coming on line.

It could move the numbers a bit. I'm just trying to get a better feel for what's going on and the timing of when things might come out.

(multiple speakers)

That's a great point.

I just had a handful of other things. I guess a little bit more on some of the cost items, labor's up. I think Bruce was saying that you see some ability to bring that down. My sense is that your game plan on the Sunrise stuff was to keep labor -- not make labor cuts, sort of as you took those projects over, but as time went on through attrition and that sort of thing, you might have it. Does that factor in at all and is that a place we might see improvement? What do you expect, I guess? Just a little more color in labor costs?

You bet. So I'll do the first part -- the Sunrise part. I think, Bruce, if you could take on some of the labor things.

With regard to Sunrise, we've made sure that we've told everyone that what, in fact, is occurring with regard to that, that we weren't going to change up things until the second half of the year. Whenever you hand off the baton in a relay race like this, one guy is slowing down and the other guy starts from a stop. We wanted to make sure that we didn't have a dip. We haven't had any dip and in many of the metrics we've actually had slight improvement.

At this point, we actually are in the first parts of the initiatives that we're going to put in place. It's all very contributory. We are making sure that everybody is part of it. But there are a number of opportunities there.

So I think that you'll see over the next several quarters some of the things happen there. We've been pretty pleased at everything we've been able to do. You know, I like what Bruce said at the end. It's 5,000 residents, for heaven sakes, and we've brought all those on over the last nine months. In many, many respects, it's been very successful. We appreciated the great job that Sunrise did in many of these things. We bring fortunately or for whatever reason an opportunity to look at it a little bit more comprehensively.

It's been a real positive experience. From here, I think you will see that we're going to have a benefit in, hopefully, all areas that affect those previously Sunrise-managed communities.

I think we've done a very good job managing our labor work force, but we are seeing significant [wage] presses, primarily the inflation, national economy is up overall. Not really reflective just of us, but to everyone.

In addition, the nursing shortage and professional licensing, the staffing shortages also affect that. We're battling two fronts in that regard. We think we're doing a pretty good job managing that. I think there are opportunities to really push a lot of that stuff along potentially to private pay residents in the future. And you know, Medicaid costs (indiscernible) point system there, as well.

Maybe just to amplify on what Bruce has said there, we have annual increases. We've got a pretty darned comprehensive view of what our increases can be. We're seeing some increases in our costs. And because of that, we've inaugurated also a review of every one of the private pay communities with -- this is sort of off schedule, if you will. We'd normally be starting this a little bit later and reviewing what's going on.

It looks like some of this area has heated up just on some anecdotal or empirical evidence. Rosemary and the regionals are -- and along with the folks we've got here -- are looking over what some of the increases may have opportunities for.

Just one or two others. You saw a big improvement in the sort of other expense line. Is that kind of Sunrise-related or is something else going on there? Is that kind of run rate reasonable? I think you dropped 26.5%. Is that percentage of revenue like 25%?

(indiscernible) A lot of that is the insurance cost that we talked about. We think some of it should be maintainable going forward. We'll do our darnedest, that's for sure.

Jerry, what you did see and I don't know it runs exactly through the numbers but what we said is that substantially all of the management fees, certainly on the first ten, we believed we'd be able to pull in without increases. And we've seen that -- excuse me on the first 12. On these 10 we've had to add a [regent]. So you are going to see a - that sort of flow through a little bit more. But overall, we've been able to take those on for very, very little increase in our G&A.

My last one or two, if I could. In G&A, is the run rate just in terms of absolute dollars good for the quarter, or since you, again, you brought on maybe those regional late in the quarter, are we going to see any pickup there in terms of modeling?

You'll probably be a minor pickup in modeling but it won't be that much, maybe 100 to 200,000, in terms of playing it up percentagewise.

Last one and I'll get off. You talked about possibly buying the -- buying out the last seven, talked about CapEx, some other things. So you know, should we be thinking about or worrying about sort of the need to access the capital markets again to raise capital or would you sell off additional communities? How do you see that plan out? Is there something there we should be thinking about?

Thank you for that question. Just maybe a couple of -- a little bit of background on it. First, we believe Sunrise is continuing to do a good job with regard to these seven. I recognize what we just pointed out, that it seems to be some deteriorating numbers with regard to these.

These folks don't know whether they're fish or fowl. We actually get calls from employees and residents alike, asking us when we're going to take it over or have we taken it over. It's just difficult for them.

From that perspective, that is why we said we're looking at it. Sunrise has been kind to talk to us with regard to it. There are several methods. Equity is obviously one of them. But we're a much stronger company at this point. We've have some other opportunities, hopefully.

As you know we've got a number of properties that we can utilize on a sale leaseback with regard to senior housing in addition. We can now access some debt market that we might not have been able to before.

Finally, there is the possibility of seller financing, if you will. So from all of these, we just need to explore the opportunities that are there and hopefully be able to come up with something that benefits Sunrise, as well as benefits us. As far as, let's see -- I think that answers everything.

Yes. Just a little follow-up, if we could. I assume your preferences do anything other than access the capital -- , the equity markets, that would be the last on your list?

That's fair to say, obviously.

Okay, thanks.

Thank you, Jerry.

We'll go next to John Rogers with Ferris Baker Watts.

Good morning.

Good morning, John. Thank you for joining us. Now, Liam is probably out. We were going to say thanks to Liam for joining us. Bring it on.

I'm sitting in for him today. Just a few questions for you. In the Pharmacy segment, how close do you think you can get to your 8% target in the second half of the year?

Well, by year end, we hope to be at 8 or above that. One of the things that's been interesting to us, and I've mentioned it, is the mail order business. We're doing well. It's running very well. But the reality is that it's like an e-commerce concept. People look to the lowest numbers that they can.

And so we're seeing some erosion in just what we can make on margins, and they are substantially below. If you pull that out, you get, very quickly, close to some of the numbers that are there. We're looking at what we really can do. Can we grow this? What can we do with that business? That's going to certainly be part of it.

Bruce, do you have anything additional -- ?

The only thing I wanted to add is, in the Pharmacy business, we always talked about in the pharmacies we required last year we were rolling out a new res cost system, the drug system. And we were converting our own communities on to that pharmacy. So we acquired another pharmacy this year in 2006 in the South Carolina area. We'll be converting that platform over to our software system, as well as rolling those communities on. That will take some time as well. So that will probably structure out to a little bit of 2007 just for the new pharmacy.

This is a work-in-progress. But if you think about it in the fourth quarter we were at zero; contribution margin we're 3.8 %, something like that in the first quarter. Now we're at 5.

As things go up and down on the little business like that, you're going to see it bounce up and down. The neat thing is, we brought on this expert care down in South Carolina. It's added to our capability. We just told you that we think we're close on being able to announce another one that's in that mid-Atlantic area. It allows us the economic synergies that we might not otherwise have. We're looking forward to the benefits that being a little larger can give us.

Okay, great. I think you said the occupancy increased in the Sunrise after you took them over.

Basically remained stable. (multiple speakers)Stable overall.

Were there some problems with occupancy at the time you took it over? Did it drop off?

No, it's been about the same, I'd say. We've had some that have gone up pretty good, some have gone down. Most have stayed the same.

We were very pleased keeping it stable. Usually with an acquisition and we talked about this on past calls, the handling of (indiscernible) to another and there's a chance that at the time that these slow down when you pack up a [ton off]. We didn't really see that in this takeover. Both takeovers, the first 12 we took over in November and what we've done so far in 2006.

Maybe one other thing, John, the revenues and census has never been a concern to us in those communities. So from that perspective, we're pleased that we can continue on with regard to that.

Okay, great. Is it realistic to expect occupancy rates to be over 91% in the future? Or is this a level that you think you're going to continue to operate?

That's a massive blending of three different portfolios or types of product that we've got. And they really are about third, third, third. You've got independent, which is the biggest at, let's say, around 6,500. And then you've got assisted 5,500. And then a little under 5,000 are the skilled. Every one of those has a unique difference with regard to the opportunities and challenges.

Generally speaking, we're lower in our skilled nursing. So once you peel each of those out, we happen to be higher in every segment than we see the industry trends. Without shedding additional properties, you're probably -- can we move up? Yes. How quickly? It's an incremental add-on on a steady basis.

Our goal is to push to 92%. We seem to continue to move it up. Once we hit 92%, then I'll move it to 93.

Okay, great. Thanks a lot.

We'll go next to Carrie Montague with Davenport.

Could you give us an idea of the magnitude of the operating loss that was eliminated with the sale or will be eliminated with the sale of the Connecticut skilled nursing facilities?

Most of that is right in our discontinued operations. I think it was around $1 million for the quarter.

Okay. And then is there any way you could break out the impact of the six western Pennsylvania facilities on the increase in wages and benefits? I know you said that was most of it, but -- .

It was a little harder. Thanks for joining us today. I think from our perspective it's not that -- the problem is you've got an assisted living pay rate and these are a higher acuity assisted living. We had to, we changed around some of the model there with regard to the levels of care, etc., that we're giving. We're sort of giving that right size.

The problem is, you had relative -- it's just that it's a lower increase in your revenues than the increase in your labor. That's all. And that's what happened with regard to those six. The biggest thing that occurred in that metric was we saw some significant inflationary trends, predominantly in nursing and rehabilitation.

And has there been any indication that may have stabilized or is that continuing to pick up in there?

We believe that we're -- we have talked about 52%. If you think in some of the presentations we made, I thought 52% is a number we'd like to see it around and fortunately we saw it drop. It's come back. We believe it's stabilized. But it's what Bruce noted. We are having redoubled efforts with regard to a review of every one of the major points that caused that to move up.

I already did mention it once before but we -- two of those Pennsylvania properties are some of the properties that we are putting significant CapEx into and so we've taken some of those units offline. That might even add to it a little bit in the short term.

Okay, great. Thank you.

Thank you.

We'll go next to Don Hooker with UBS.

Quick question, in your skilled nursing side, what is your typical average per diem for Medicare?

Medicare, we probably averaged per diem around $335.

$335 at this point.

Are you getting -- is it a significant amount of your census in the higher RUGS or is it -- what percentage is --

We've moved it over. I don't have those numbers -- .

(multiple speakers) -- between Q2, Q1.

Ballpark.

I don't think we'd have that to be able to ballpark it. If we had some of the operational guys in here, we would. I'd gladly walk you through that offline. Generally speaking we, one, see it moved up from the second quarter. And two, you've got ro remember that if you look at third quarter numbers of last year and then fourth quarter numbers of last year, there was a big boost in the reimbursement and the payment under that.

And then they changed the RUGS categories and we saw it drop down for our properties in the first quarter. It's now stabilized in the second quarter because we've had guys adding more persons in those higher RUGS categories. The final thing to remember is 66%, two thirds of our revenues, comes from private revenues. Fortunately or unfortunately - fortunately, Medicare is a smaller portion now and we hope to make it even smaller in the future.

One other small fortunate (indiscernible), it appears right now Medicare rates will be increasing about 3% effective October 1st

And then you also indicated you're close to a pharmacy acquisition. Is this going to be in that three to four times EBITDA multiple range?

We've seen it move up a little bit. It's probably four to five times, number one, and number two, it's probably so small you wouldn't need a separate press release on it. But you know, but it's the type of thing that as we add on then we start growing them.

And (multiple speakers) add our own communities to them then it will definitely fall down to that three times multiple.

Then you have to convert to the new software so you'll have that ramp-up in margins?

You bet.

Then let me ask one more and I'll jump off. I guess -- and you talk about this in-house therapy, these in-house rehab therapy centers you're rolling out. I know it's small. Is there some sort of metrics there you think about in terms of revenue per resident? Is there some way to think about as that rolls out and where you see that?

There are several metrics and they help us decide where we're going to roll it out to. A couple of things you should know, obviously the contribution margin or the EBIT - EBITDA[R] is about 30% in this area.

Secondly, while you look at it, you can get to $1500 to $2500 per resident per year. We tend to look at those types of things as to what it looks like. But more importantly, we know the numbers are there if the people are there. So you can't necessarily put this into a 40-unit assisted living place unless you've got a cluster of these around. So we put them into our larger units or we make sure we can draw from other of our communities in the area.

Okay.

Two of the other pieces on that, just so you have some intangibles. We think it's a great marketing tool for our independents and building communities. When they roll in they see we have got a rehab work right in the place with an aquatic pool and therapy and all that other fun stuff.

In addition, it increases our length of stay, which helps some of our independents to live (indiscernible) skilled nursing facilities, potential treatment or out of I believe our own community - might be able to get that done there.

Great. Thanks, guys.

Thanks, Don.

We'll go next to Evan Greenburg with Meadowbrook Capital Management.

Hey, guys. How are you doing?

I think we're doing real good.

That's good, Evrett. I think you are too. I think the street is a little unsettled due to the Sunrise situation. I guess you've got a lot of integration to do. Can you give - do you think things will normalize by next quarter? Or you still think we've got a little bit of work to do?

There's always work to do whenever you bring on this many properties. But as you look at it from our perspective, it is never easy to put it into a 90-day report card. It's best to say -- and I can say this with full confidence -- that all of the things we have said we'd do are in the works and doing well. We've told you in our presentation and in the answers here, some of the things we might have concerns about.

But, overall, things are moving in the right direction. It always takes longer than you would like. Will you see everything fall into place next quarter? Probably not. But you'll see improvement and we will continue to show you the things that are working and tell you about the things that we need to change.

Number two question would have to do with acquisitions. I guess you've got a credit facility and you can probably go get more. Are there still acquisitions out there the size of five and ten at a time or do you think it's going to be more of a one at a time?

We're seeing both, Evan. We're looking at a few portfolios right now that have anywhere from five to 15 communities. But we definitely can (indiscernible) with at least a five number and then we're looking at a lot of one offs. Hopefully, one in the Arizona area.

Thanks a lot.

One other thing. We said it when we -- it looks as if a little bit of the logjam has broken. We've found several and we hope to be able to announce over the next several weeks or a couple months, something that -- a couple of deals that we seem to be right in the thick of it. And as opposed to other times where we couldn't make it to the next round. So, we are hopeful of being able to say some good things in that area.

Yes, I hope that (indiscernible) something to say on these things. Anyway, thanks for your time and I continue to support the stock.

Thank you.

We'll go next to George Walsh with Guilford Securities.

Could you go into a little more background on the rehab hospital situation? You mentioned that earlier. And just how those negotiations and dealing with the state regulatory agencies there?

You bet. I pretty well said it all. We had two very good public hearings. We were basically the only ones there. We put forth for the department all of our qualifications, etc. We have filed literally boxes of information, literally, that they have to go through and look at.

I've had meetings with the Commissioner of the Department of Health, the various folks in licensing, etc. It's just a long and arduous process. We continue to believe that we're going to -- that this will be 2007 business. And from what I can tell in the recent past, we're moving in the right direction. That's not to say it's not easy. It is very long and very arduous and, in many respects, painful.

Well, is it something that requires a level of cooperation from Health South that they're not going to do voluntarily? Or is that the logjam? Or what's the issue as far as that goes?

The logjam, it just takes time. That's the number one thing. We were told it could take us six to nine months. That's the first thing you want to know. Number two, Health South is required under the court judgments to work with us. And they are.

There are a number of things which make it difficult, because the transition is, to a certain extent, forced on Health South. These are significant bureaucracies that we have to work through. It's not unusual and we're working through it.

Okay. And just as far as the skilled nursing facilities in Connecticut, how -- with that situation, how is the portfolio on balance now in skilled nursing?

Well, we've obviously then dropped. We'll now be 48 communities that are skilled and then out of 151 so we've got 103, that 48 or -- . Yes, it depends on how you add because we have two that are on one campus. So we're dropping two out of that portfolio. But they were larger. And I think that you'll see - unfortunately, as you roll through and move things out of continued operations to [disco], then you'll see some things as far as the numbers that change up. It's all a very nice positive.

It should be a significant -- just removing financial losses that we talked about. These communities have taken tremendous amounts of management's time over the last several years. Connecticut's been a very difficult (multiple speakers) offering.

That's the biggest thing.

From almost every area.

We parachute folks in all the time into that, into Connecticut.

Okay. Well, it seems that the issue is, like with the terminations, it's not so much a revenue top line issue but a margin issue for you guys in terms of the improvements. It looks like incrementally, even sequentially you made, on an operating margin basis, you made some improvements there. If that keeps improving incrementally, that's just part of the story here, I would guess.

We know that it's improving, incrementally. I think you're going to see that quarter over quarter over quarter.

Thanks.

We'll go next to J.D. Padgett with the Boston Company.

It looks like just doing the math, a couple [Smiths] or what about $5, $6, $7 million in the quarter in revenue?

Yes. You're right in the range.

And the discontinued adjustment, is the full quarter impact for those?

Correct.

And the other question was just with respect to the seven remaining Sunrise properties. What is your level of confidence once you take over management of those that you can get those operating maybe on a more consistent and profitable basis in line with the rest of the system right now?

You bet. Let's make sure -- because I meant it when I said, these have always been challenged. When Marriott had them and now Sunrise have them. We'll be looking at once we control everything with regard to that, we can look at many options Sunrise might not have been able to have.

Has Sunrise done a worse job? No, they haven't. These are challenged communities. The numbers have always been ours. So at least, we, one, will control the bottom line totally. Hopefully if we can reach some agreement with them. And, two, we'll eliminate the management fees with regard to them. Those are two positives from that perspective. But to think especially with regard to those that you'll see any quick turnaround wouldn't be wise to factor in anything in that area.

The numbers that you shared with us, the profitability. Was that net of the management fee or was that before the management fee?

That's net income. That's - or loss in this instance.

So that includes management fee?

Yes.

I'm trying to remember, but I thought there was some provision with certain traunch of these that if they weren't meeting some performance criteria, there was something that would be more beneficial in the negotiations with you.

That's correct. These seven, I haven't looked at it since we did the offering. But if someone in the trend continues, they would fall into the financial performance termination clauses of the management contracts. We would be able to send termination letters in March of 2007.

But Sunrise had a care provision under the contract. I wouldn't expect we'd get these back with no payments. Sunrise can take a reduction in the management fee for several years. They can make [a May] co-payment. We've still got several years to go before we get these back under that scenario. The metrics would improve just to the function of the reduced management fee or the May co-payment.

Okay. That's -- can you utilize that somewhat in negotiations if you want to accelerate that time line?

Mr. Mackey is a master of authorization.

They are aware of that. Sunrise is good corporate citizens and they're trying to be nice to us. They contacted us. They put it in their press release that they were negotiating with us.

I'm not so certain too, on the relationships on with the Smiths, those are properties that you own that Sunrise is managing?

No, the Smiths, what we call our legacy portfolio, those 50-plus facilities, is how we started out. We lease all of those from Senior Housing Properties Trust. And we manage those, operate them for our own account.

So, Senior Housing is the one that's elected to sell those?

Well, we talked to them. We have to get their approval.

Yes, we need to agree on that.

One point that might be a little bit confusing, we continue to operate those. We are working on -- we went through a sale process and we're working on a sale of those. We're very near to a contract with one party who would take over those operations.

Okay, great. Thanks a lot, guys.

Thank you.

We'll go next to Shawn McMahon with Kennedy Capital.

I was hoping you can maybe quantify the number of units that are offline in Pennsylvania or maybe the total amount of units that you guys are redoing?

I know I can't. I know it varies day to day.

Approximate could be around 50.

Oh, no, it's more than that. But I mean, it's 50 in Pennsylvania.

That's what he asked.

He said and the others.

I'm sorry.

Total units in the Company.

Maybe it's three times that for the total, 150 units.

And you would assume all those would come on line by the end of the year?

Yes. Yes, they should be on line by then. Construction is one of those things that takes twice as long, costs twice as much.

Okay.

And literally it varies day-to-day. Because what happens is, they'll move out the wing or they'll move people over into another wing where there were some empty beds so we didn't necessarily need to change up something. But when they move to the next wing, they have to -- it's more, if you follow.

I can look at the Average Daily Rate and multiply that by 90% and kind of get a year-over-year comp what that should add to next year's numbers?

Yes. But next year, hopefully, we'll roll some more through. We're finding as we are going through every one of those portfolios, especially the properties that we've taken back, that we're going to be doing some substantial work with regards to this.

I believe one of the questions, you guys talked about maybe you were looking into several properties, maybe make an announcement here maybe in the next coming months. Can you maybe talk to me about what the multiples are out there going for properties these days and the max you would pay for one?

Yes. Bruce, you want to talk to that?

I will answer from a slightly different perspective. We generally look at cap rates in terms of our acquisitions. Cap rates that we've mentioned on the calls in the past have come down significantly from what we were doing a year or two ago. I'd say we're in the 9 to 9.5% cap rate, maybe a little bit lower in terms of what we're seeing right now.

That's what we are able to bid on and that's usually because maybe they've got something that's a concern that we believe we can fix. There is still - at sub 8 that we're still, especially if it's a large portfolio, we're seeing that it's definitely sub 8, sub 7, if it's a very nice property. We've been able to pick up some stuff which is a 9, 9.5 maybe slightly sub 9 that we believe that we're going to be able to add to.

From a cost of capital, we can't do a sub 7 cap rate.

We could not.

Okay. I guess going -- you talked about hopefully the hospitals would be an '07 issue. I know the regulatory path is difficult. But would that be early, mid, late kind of --

We said we hope to have [likeness] by the end of this year.

Okay, excuse me. Thank you.

You bet.

All right. I think that's all I had, guys. Thank you.

Thanks for being on.

And we'll take a follow-up question from Jerry Doctrow with Stifel Nicolaus.

What are the rest of the Sunrise things? Where are they? I'm familiar with that portfolio. What's left in the seven?

There's one in South Carolina. There are a couple in Texas. There is -- there's one up in Ohio. There's one down in Florida.

I think one in Delaware.

Two in Delaware. That's it. Delaware, Florida, Ohio, Texas and New Jersey. (multiple speakers) Yes, Delaware and Jersey, those two are right together. It wasn't Delaware, it's Jersey. And the last one was in South Carolina, Myrtle Beach.

When you talk about other options, some of these are things you could conceivably close or get out of or expand?

That's what we mean in that Sunrise wouldn't necessarily have those options.

Right, because of the management contract. There's again no incentive for them to do that. The one thing I wanted to ask, now that operations may be sort of stabilizing here a bit more. Is there seasonality we should be thinking about in terms of particularly some of the operating costs, labor costs? Any sense there that we should give us -- I know in the nursing home business, some quarters are better, some quarters are worse.

There's certainly seasonality. But your question, there's several metrics that are going to play differently. Just a couple of things. And I don't mean to be at all morbid. But unfortunately what you'll see is that people actually live through the wintertime and the season -- they'll go through the holidays and then, because of the winter and because and so after the holidays, people get very sick and tend to pass away. So you'll see that that first quarter can be a little tougher.

As far as rates increasing and stuff, your street rates a lot of times will move ours on in January, new street rates. Those come in at 12 at a time. That's when you'll see those pick up.

The second thing is that, as far as labor is concerned, generally that goes 1/12 of the year. On your hire date, and we do that purposely, on your hire date, you get a review and an increase. But our regional and the senior management comes on. And that happens in the third quarter where we do the reviews with regard to that.

As far as when people come into those communities, more and more and more, we're seeing assisted living. Used to be it was a choice. Assisted living is now becoming a little bit more where an event occurs where they no longer can take care of themselves. They might be an independent or in their home, or living, an event occurs and they move over to usually some medication or whatever.

A lot of that, they wait until the end of the summer and until more in the fall. And so you'll see people coming in more in the fall after the summer vacations are over, etc. It doesn't big enough to show. We can see the trends, but it's not big enough to have some effect - negative or positive - on what your numbers are doing just because there's several other things that are factors in there.

Not something we should worry about so much from a modeling standpoint?

Yes.

Thanks a lot.

You bet. Thanks, Jerry.

And there are no further questions at this time. I'd like to turn the conference back over to you for any additional or closing remarks.

Well, thank you all for joining us today. We're really pleased with what's going on in the Company. We're moving everything in the right direction. We look forward to updating you in our progress in the future. Thanks.

Thank you, everyone. That does conclude today's conference. You may now disconnect.