Alerislife Inc (ALR) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Five Star Quality Care Third Quarter 2006 Earnings Results Conference Call. This call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to the Manager of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you, Erika.

Good afternoon, 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 is the presentation by management, followed by a question-and-answer session.

Before we begin today's call, I would like to state that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and federal securities laws. These forward-looking statements are based on Five Star's present beliefs and expectations as of today, November 9, 2006.

The Company undertakes no obligation to revise or publicly release the results of any revision to 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.

And with that complete, I'd like to turn the call over to Evrett Benton.

Thanks, Tim, and thanks to everyone for joining us this afternoon.

Today, Five Star reported income from continuing operations for the third quarter of $0.18 per share. This compares with income from continuing operations in the second quarter of $0.12 per share, excluding $89.8 million of termination fees paid to Sunrise. This $0.06-per-share increase came from a combination of reduced management fees paid to Sunrise, growth in our business, and improved operating efficiencies.

I'll go into more detail regarding the third quarter results in a moment, but before that, I want to discuss several events that have occurred following the close of the quarter.

First, earlier today, we announced an agreement to terminate the last remaining seven management agreements from Sunrise for a one-time payment of approximately $40 million. We're scheduled to take over operations at these communities on December 1, and we will report these termination fees as an expense in the fourth quarter.

With the termination of these last remaining management agreements, we've completed a process that started about 18 months ago to take over the operations of communities managed by Sunrise. In total, we paid Sunrise $216 million to take over operations of 30 communities. Going forward, Sunrise will no longer manage any communities on our behalf.

As a reminder, taking back the operations of these seven communities from Sunrise will eliminate a little more than $5.5 million of annual management fees paid to Sunrise. For the entire 30 communities we've taken back during the last 18 months, we've eliminated in excess of $20 million of annual management fees from our income statement, and additional [cost] savings may also be found in the future by reducing insurance and labor expenses at these communities.

With regard to the 23 communities we've previously taken over, the operations continue to show improvement. Unfortunately, these last seven communities, which we anticipate taking over on December 1, may be a bit more challenging. Historically, these seven communities have been the weakest-performing of the group.

The second event that occurred after the quarter ended involved taking over the operations of two rehabilitation hospitals in the Boston area on October 1. While this transfer was effective in the fourth quarter, a large amount of the work took place in the third quarter. Taking the necessary steps to ensure a smooth transition took a lot of planning in the execution on the part of many great people throughout our organization.

I'm very pleased to report that we've been very well received by the employees of these two hospitals, with over 99.9% of the personnel at both hospitals remaining on Five Star's payroll after the transition.

As we've discussed in the past, Five Star will retain all of the cash flows at these hospitals after paying approximately $10.3 million of annual rent to our landlord, Senior Housing Properties Trust.

We've only been operating these hospitals for a little over a month, and we'll have more information about their operations after we've been operating them for a full quarter.

One item we can report now is that we've earmarked about $5 million to be spent over the next several quarters for capital improvements at these hospitals.

Also, after the end of the quarter, in October, we completed an offering of convertible senior notes due in 2026, raising net proceeds of almost $123 million. These notes have a low coupon of 3.75% per annum and a conversion price of $13 per share.

Proceeds from this offering were used to pay the $40 million of termination fees to Sunrise for the remaining seven management agreements and to cover about $30 million of short-term working capital needs and transition costs associated with the takeover of the two rehabilitation hospitals. The remaining capital from this offering may be used for future acquisitions of senior living communities and institutional pharmacies.

Finally, since our last call, we've had a fair amount of acquisition-related activities. Working with Senior Housing, we've agreed to lease 10 new communities across the United States.

We previously issued a press release in September regarding five assisted living and independent living communities located in California, Kentucky, Illinois, and Florida, totaling 783 units. Substantially, all revenues are paid from residents' private resources, and the average census was about 83% at the time of takeover.

Through integration of operations and capital improvements, we anticipate operating improvements with these properties.

Next, in four different acquisitions, we acquired five additional communities -- two in Savannah, Georgia, two in Mississippi near Memphis, Tennessee, and one in Kentucky. These communities are substantially all private pay and total 433 units.

Also today, we completed a $2 million acquisition of a small institutional pharmacy located in Maryland near our nation's capital.

Finally, we're pleased to announce that on November 1, we completed the divestiture of two skilled nursing facilities located in Connecticut. For 2006, these Connecticut operations made up substantially all of the losses from our discontinued operations.

Now, let's review some of the key operating metrics regarding the third quarter.

Overall occupancy and same-store occupancy in the third quarter were 91%, which is flat with the 91% occupancy we reported for both measures in the same quarter of 2005. Same-store occupancy includes those communities we've operated continuously since July 1 of 2005.

The average daily rate per resident increased by over 1% to $127 in the third quarter of 2006 compared to the same period last year. On a same-store basis, the more relevant metric, the average daily rate increased 4% to $132 in the third quarter.

The percentage of our revenues that came from residents' private resources was 66% in the third quarter, which is down slightly from 67% in last year's third quarter and flat sequentially.

Now, let's take a look at our labor costs. Labor costs as a percentage of net revenues from residents decreased slightly from 51.9% to 51.8% between the third quarters of 2005 and 2006 and down a like amount from the second quarter.

Now, let's review our pharmacy and rehabilitation businesses.

Revenues in our pharmacy business increased 39% to $14.3 million in the third quarter, compared to $10.3 million in the same period last year. Operating margins of 1% in our pharmacy business are still significantly below our target of 8%.

Basically, this quarter, we've taken reserves to cover possible write-offs for receivables attributable to prior years and antiquated accounting systems in place at the time of our various acquisitions. While these numbers might seem disheartening, we believe that our operations are progressing in a positive manner, and we anticipate correcting all of these concerns in short order.

On a positive note, all six of these pharmacies have total annual revenues of over $60 million and service over 177 communities. In addition, we now have the opportunity of servicing over 35 additional Five Star communities.

Finally, we have continued on plan in the development of our outpatient rehabilitation services business. We have told you that we expect to have outpatient rehabilitation clinics in 40 of our communities by the end of 2006. I am pleased to report that today we have 35 up and running. In addition, there are 20 outpatient clinics associated with our two rehabilitation hospitals, bringing our total number of outpatient clinics to 55.

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

Great. Thanks, Evrett.

Let's review the third quarter numbers.

Our net revenues from residents were $187.6 million for the third quarter and increased by 6% when compared with the third quarter of 2005. This increase is primarily due to revenues from the five communities we acquired in September 2006 and higher per diem charges to residents. I would also note that the 5% increase in same-store net revenues from residents for those communities continuously operated since July 1, 2005 is due primarily to higher per diem charges for residents.

Moving on to expenses --

Wages and benefits increased by 6% in the third quarter and $97.1 million from the third quarter of 2005. This increase in the third quarter is primarily due to wages and benefits at the five communities we acquired September 2006 and wage increases.

Other operating expenses decreased by 2% in the third quarter to $45 million as compared to the same period in 2005. This decrease was primarily the result of a decrease in insurance costs at the communities historically managed for us by Sunrise, offset by some increased charges from third parties.

The management fee to Sunrise fell by 300% in the third quarter to $1.4 million from [$5.7] million in the same period a year ago. This expense decreased predominantly because of our termination of 12 management agreements in November 2005, one agreement in 2006, and 10 agreements in June 2006.

Upon the termination of these last seven remaining Sunrise management agreements later this quarter, we will no longer pay Sunrise any management fees in the future.

G&A expense for the third quarter increased by 29% to $8.4 million from the same period a year ago. The increase in G&A expense primarily results from the 23 communities we began to operate that were previously operated for us by Sunrise and the five communities we acquired September 2006.

Rent expense during the third quarter for the communities that we lease increased by 10% to $27.1 million from the third quarter of 2005. This rent expense increase is due to the communities that would be in a lease in 2005 and 2006 and our payment of additional rent for capital improvements purchased by Senior Housing since July 1, 2005.

EBITDA, excluding Sunrise termination fees and asset impairment charges, increased from $3 million to $8.7 million, or almost 200% between the third quarters of 2005 and 2006, respectively.

Moving on to the balance sheet and some more items of note --

Cash and cash equivalents were $23.3 million at the end of the third quarter.

Accounts receivable at the end of the third quarter were $50.4 million.

Our days sales outstanding still remain industry leading, 24 days. This increase from the prior quarters is due to the one-time holding of all Medicare funds for a period of nine days in the course of the Federal Deficit Reduction Act. The days sales outstanding should return to historical low levels in the fourth quarter.

As a reminder, this low level was achieved while factoring in at 34% of our revenues for the quarter ended September 30, 2006 received from Medicare/Medicaid programs that generally pay 30 days in arrears.

At the end of the third quarter, we had $108.3 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.

As of the end of the third quarter, the market value of our HUD-insured mortgage notes is $44.3 million, and we had no amounts 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 continuing to acquire private-pay independent assisted living communities; increasing rental rates and other charges; developing complementary ancillary businesses; improving the operations of the two recently acquired rehabilitation hospitals; and taking on the operations of communities previously managed for us by Sunrise.

Over the course of the last 12 months, we have taken on over operations of over 33 communities, including 23 previously managed by Sunrise, as well as two rehabilitation hospitals, which in total, service over 7,000 residents and patients. 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.

Two final points --

We are pleased to have announced today that we completed the termination of all Sunrise management agreements; and second, we are now well positioned for growth with excess cash available for possible future acquisitions.

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

Thank you, sir. [OPERATOR INSTRUCTIONS]

We'll take our first question from Frank Morgan of Jefferies and Co.

Good afternoon, and it looks like a pretty good quarter here.

A couple of things I wanted to talk with you about today on the rehab hospital side. Can you give us some details on where those assets are right now in terms of their compliance with the 75% rule and just give us some comments there?

And then, secondly, I noticed you had -- did you, by chance, put another nursing home into discontinued ops? There was something a little confusing in one of the footnotes, and I was just trying to figure out has anything new been added to that?

Okay. Frank, thank you so much for joining us. I appreciate those two questions. Maybe I'll just take that second one first.

We don't have any other properties in discontinued operations, and we don't anticipate putting any others in there. A while ago, we stopped operations at a property in Milwaukee, and that made -- that has some residual holding costs.

Yes, and that's exactly what the footnote refers to, Frank.

Yes.

And so --

It's been in there for a while.

Yes, since last year.

Secondly, we're actually reasonably pleased with what we're seeing at the rehab hospitals thus far. You can understand that having just taken them over on October 1, that there are many things that we have to do. But, first of all, both hospitals are basically at the 60% level at this point. We anticipate a number of things that we're doing which will allow us to meet the criteria in '07 and then in '08. But we've been very pleased. We've worked very hard, and we've put together a number of meetings and get-togethers and dinners and planning sessions and budgeting, and it's been very, very positive what we found. And generally speaking, I think that you're going to see us view these as a fairly favorable asset.

It's interesting that when we took over, we were a little disappointed in where the census levels were, and we've been able to move them up, a nice pick-up just in the last 40 days, so we're pretty happy about that.

I got you. And then I know there was some discussion about implementing your IT systems. Has that gone fairly smoothly?

You know, it's like birthing a baby. Many times you just wonder whether you're going to get it done. I think some of our guys were working literally 20 hours a day. We put a vanilla system in place --

To start.

-- to start in the first couple of weeks, and then we continued to add on. And I think as of last week, we'd finally taken over the lab work. HealthSouth was kind enough to allow us to keep open some of the software and the systems which would allow us to do the things. Bruce, any additional --

I think the other thing I'd add is we've rolled out over 500 computers and over 100 printers to the two hospitals, and we did that in relatively short time, so it's been fairly busy, along with the other acquisitions that we've been running, as well, so it's -- I think it's gone very well. We do have some things to add to the systems, but it's nothing that we need HealthSouth from; it's just really working on the clinical and the billing system, but we're right on schedule with where we wanted to be. In fact, I'd like to say we're a little bit ahead of schedule. I think it's gone very well.

Yes.

I guess on the subject there, do you -- are there any -- this was a fairly clean quarter. Are there any kind of special charges or any kind of unusual items that you think flow through in the fourth quarter, or will it be --

Well, we'll have one item which we think is a positive. We'll be terminating the remainder of the seven management contracts, Frank. So you'll see a termination expense of 40 million in the fourth quarter. That's the only thing that comes to mind.

Okay. All right. Looks like a good quarter. Thanks.

Thank you, Frank, too.

Thank you.

Our next question comes from Jerry Doctrow of Stifel Nicolaus.

Hi there.

Hey, Jerry. Thanks for being on the call.

Sure. Let's see, a handful of things. I think, Evrett, I wanted to get a little more color. Below the surface in the numbers, I think, compared to what we were looking at, revenue is down a little bit, expenses were down more, which allowed you to sort of beat the numbers. And I know you're constantly sort of - or you're doing a fair amount of improvements and that sort of thing. I guess I was wondering if you could speak a little bit to the revenue numbers. I think -- I don't think that's just discontinued ops; I think it might be something else. Wanted to get some clarity there. You know, is it stuff you're taking offline?

And then on the expense lines, I was curious as to whether you think some of those levels hold or we'll see some movement maybe [inaudible] in relationship to revenue.

Okay. Thanks, Jerry.

Just, first, with regard to revenue, there is nothing untoward that's happening. We've -- actually, if you recall, quarter over quarter, there's -- I think in the third quarter we did -- had a slight dip in census in some of the properties, but it held. It held. We thought it was moving up, and then it held around 91%. And think about this. We had -- it's been flat, if you will, in Medicare, and so if -- when we looked at our Medicare numbers, they actually skew it just down just ever so slightly, and so that might be what you're seeing, just because of some of the things that were happening in there. And -- but generally speaking, when we talk about the fact on a same-store basis we went up in our rates, for example, 4%, remember, that's on a completely blended basis. So our Medicare, which is still a sizable amount of this portfolio, was flat, 0 increase, Medicaid went up 2%, and the entire portfolio, if you will, on a blended basis went up 4%. And so just looking back, it was almost a 6% increase for the independent and assisted living, the private pay. So we're pretty happy with regard to what we're seeing with regard to that.

In addition, we've continued to do two things in that area.

One, we have centralized and automated the system by which we roll out the rate increases, and we've refined our -- the methods by which we define what rate increases should be.

Secondly, we've added two persons that are heading up our levels-of-care review, and so there's sort of an audit with regard to that -- an audit with regard to that. So from our perspective, we think that next year, you'll see some fun stuff on that side. So we're actually pleased with where the revenues are going, from that perspective, at least as we presently view it.

As far as the expenses are concerned, we know that you and others were concerned last quarter when we had what seemed to be a jump in the numbers. We said it was because it was just -- we had some wage reviews. We certainly have continued pressure with regard to the clinical aspects, professional nursing, and rehabilitation. But we also said that we thought that we would keep it under 52%. As we've looked at it, it continues to be around that level, and we're pleased to see that we dropped 10 basis points. It's going to be around that, and so people have asked us where do they model it. At present -- at present, we believe that where you're seeing it, that 52% level and slightly under may be -- may be where to put it.

Bruce, any thoughts on some of these things?

I think the only thing I'd add to that, Jerry, is the wage prices that we still continue to see for professional staff and the wage and benefits still -- I mean something that we fight against every day. I think we're doing a very good in maintaining that, but with the shortages out there on the professional staff -- also seeing that in the rehab side, as well -- it poses a challenge.

It looked like because the same-store ADR was up higher than your overall, that some of the new stuff coming online might have had a little bit lower average daily rate. Is that --

Clearly, Jerry. Just cutting to the chase with regard to the question, obviously, if you've got Medicare of 330-some dollars a day in your existing legacy portfolio, as well as the higher rate, although much, much lower margins on the skilled nursing of 140, $150 a day, if you're bringing on independent --

I'd say probably half the units would be brought on --

Are independent.

-- as independent.

So they're going to actually have a lower rate.

Yes.

And so, unfortunately, it's hard to have an apples-to-apples, and that's why we showed those same-store sales.

And if we think about the 10 that you're bringing online, you know, the ones you fairly recently acquired, is a reasonable sort of ADR assumption on those, is it sort of this 127-kind of level is reasonable or it could be lower than that?

It's lower than that because the bulk of those are, in fact, independent.

Okay.

So, yes.

So like one -- it's north of 100? 110? 115? 1--

Oh, yes.

Yes, but you know, I'd hate to put a fine --

I'm just trying to get a ballpark.

Ballpark, I think you're in the range.

Okay. Okay. And just one or more, if I could. On the pharmacy, obviously, 1% margin is not great. I mean how much of a bounce-back, I mean, as we go into fourth quarter is it reasonable to get? I know 8% is your target. We had it kind of bouncing back close to that level by year-end. With the -- eliminating the one-time charges and stuff, I mean what's a reasonable run rate on that?

Yes. We recognize that -- we knew that that -- that we should have significant concerns in the area. I want to assure folks that it's -- and I used this earlier with somebody. It's a little like making sausage. You don't necessarily want to see it.

These are six different little bitty disparate operations that we brought on, and I don't mean to disparage anybody, but the reality is that, to a certain extent, these people keep their books in shoeboxes. And so when we take them over, there are things that we need to clean up. But as you do that, we see that we're moving toward the 8%. It's probably fair to say that we're in the 4 to 5% range for the fourth quarter just in what we see. But that's because, again, we're continuing to work with what we want to do with the mail order business --

Getting our latest acquisition under our belts.

Yes, getting that latest acquisition, which we just did today. In addition, there are concerns with regard to the switchover to the [res cot]. We're trying to redo how we switch these over. It's just been slow, laborious, and expensive, and so we're trying to work through how we get these all -- once you get them out in the system, the several that are on the system, it's very nice. But all of it is just taking time.

The reality is what I think we said when we were on this last road show, by the start of 2008, we and -- our goal -- our goal is to be at something like $100 million run rate. That might seem a little bit high right now, but also, once you reach that, the economies of scale and the organization tend to start clicking in, and really, we're seeing that when we have these in our communities, people appreciate that. "Ah, this is a Five Star pharmacy." That becomes a real bonus. Not to say the folks that don't -- that do the work for us now aren't good, but the reality is that this is still a work-in-progress. We will tell you if we think it were bad, and it isn't right now. There's still some stuff that we have to work through, and we're on top of it.

Bruce, do you have anything --

I think the only thing I just want to point out, I mean you mentioned that the goal might be -- sound unrealistic, but I just want to point out to the listeners where we were two years ago. We were at zero in revenues back in September of 2003, of course, in three years ago now. And I think we've done a very good job getting that to where we are right now.

Okay. And I guess the last thing is just in terms of spending the rest of the cash that you've got in terms of growth. I think you mentioned in a very general way that you would use it potentially for acquisitions and that sort of thing. And I guess in addition to what you've got, you'll have -- some of the working capital that might be coming back over time. Acquisitions pending -- would you be funding them yourself or funding stuff with the reader? How quickly should we think about pulling that cash?

Jerry, you're being very kind. I'll harken back to the -- to our conference call three months ago. We looked at this, and you asked would we be issuing equity, and I said it would probably be our last resort, or perhaps in prompting, I said something like that. We looked at a number of alternatives, and I want to make sure that we can answer that.

We could finally get some unsecured debt, and they offered it to us at 10%. We started looking around. We knew that if we had the cash ready, that in our discussions with Sunrise -- and they've been very kind to us -- that it would allow us to perhaps do this thing a little bit faster than we'd previously anticipated and that we might be able to just move it and get it done, just as we had shown today. And so we -- looking around, we realized that could we get something together, and this became the best alternative.

Now, think about it. That's a pretty dog-gone low interest rate. And if, in fact, we had equity to issue it, $13 a share, in all candor, I'd have to say that I don't think people would be discouraged with regard to it. I'm going to answer your question, but I want to make sure that you understand just one thing.

Our view for the Company and for our long-term shareholders was that in 2007, we would do better if we had the funds from this offering than if we did not. Now, I recognize that it resonated very well with investors, and when we looked, people were clamoring. We actually had orders of $300 million. And so we pushed it and down to, and the underwriters determined that it would be best to issue it at the 126 million, 123 net, if you will.

So when we looked at that, we realized that it would give us the opportunity to, one, take care of Sunrise; two, take care of these -- the working capital and transition cost needs; and at that point, things were seeming to work out with the rehab hospitals, but we didn't necessarily appreciate that, and better safe than sorry. And so -- and then, three, if we had any extra, we would strengthen ourselves and be able to go out and do acquisitions, either on our own or, probably more correctly, in conjunction with Senior Housing.

Now, the 10 which we just took over were obviously already in the works by the time that we put this offering together, and so we've continued on with that. You'll see in the future that we used this cash in a judicious manner, but we're going to get it out quickly rather than on to it. Bruce has done a good job of finding some places to put it, so we actually -- it's a fun little arbitrage, and maybe, Bruce, you could talk about where it sits with regard to dilution or things like that as we see it.

Sure, just real basic. On a basic EPS, it's obviously an accretive deal. We're investing the funds north of 5%, paying 3-3/4. On a fully diluted, taking into account the dilution of a share, this is about 9.7 million shares, it works out to just about neutral on an EPS level. And obviously you factor in the Sunrise that we just did today, and the deal starts to make sense.

Yes, it does strengthen us. We're not going to be -- hopefully, we won't be stupid with regard to these funds, Jerry, and we are going to use these funds for acquisitions where we become the "owner."

And if you look back at a couple of deals, when we had the opportunity and had equity, we did blended deals, where we did sale leasebacks with Senior Housing, we acquired properties outright, and we assumed some debt on some properties. So, overall, I think that you'll, hopefully -- hopefully, you'll be pleased with how we handle these funds.

Okay. I'm hopeful, too, but let me jump off and let someone else ask a question.

Thanks, Jerry.

[OPERATOR INSTRUCTIONS]

And next, we'll hear from Liam Burke of Ferris, Baker and Watts.

Evrett, how are you tonight?

Liam, we're happy to have you back on. We -- you were gone that last one or the couple of times, and we're just happy that you're back. Thank you for joining us.

Well, thanks, Everett. It's always good to be here.

Outpatient hospitals, you're up to 55. I know the revenue delineation is not as clear as you would on pharmacy, but what number do you have to get to where it actually starts moving the needle rather than becoming just an additional add-on for some of your assisted living?

You bet. Let me just -- so you mean outpatient rehab --

Rehab, that's right.

-- clinics, outpatient clinics. And we personally have 55 now. Twenty of those are associated with these two hospitals, and they don't generally do independent billing. They literally bill through the license of the hospital, so let's just take those out for a second.

Right.

But the reality is what you're talking about is that even with a reimbursement cap, that you get about $150 per month per resident that you can add on, and the contribution margin, the percentage margin, if you will, approaches 30% so that to the extent we can put them in any sizable number of our communities, it really is a nice add-on. But as we said in the past, it really has several things. It allows these folks to stay there longer. It's a nice little selling thing, and it's a profit center on its own.

Now, you make a good point. Where -- how does it move the needle? It moves the needle just a little bit on the bottom line, if you will, but because of those other things, it adds some real positive benefits to what we can offer, and they're a good company that's now part of Brookdale American Retirement Corporation. They did this. We'd actually been doing it elsewhere, and they've shown how they do it, and we're, to a certain extent, paralleling that model. We think that it works fairly well.

Great. And, Bruce, you mentioned $5 million needs to be invested in the two rehab hospitals. Do you have any other larger capital projects slated for the end of '06 or any time in '07?

We've got several, Liam. At various of our communities, we're doing a lot of rehab. For example, we've got one down in Florida that we just took back from Sunrise, we're putting several million dollars into. Actually, one of the communities that we just announced today is also down in Florida. We'll put several million dollars into it. Most of these, though, have revenue payback associated with it, and we think the hospitals do, in all honesty, as well, so we think it's going to be excellent deployment of our capital.

So it would be about --

[Inaudible].

-- 10 million in '07 over and above your normal capital expenditure?

With the hospitals, I'd say 5 million maybe, maybe 5 million over.

Okay.

I mean right now -- we'll click on about $10 million of capital a quarter right now. I think you'll see that for the next several quarters, probably well into 2007.

You know, there's one point I want to make that -- with regard to the lease on the two rehab hospitals, we're going to fund that, and that's probably phase one. It will take at least a year to put that stuff out, but we're looking at other things to raise this. But Senior Housing has been kind enough, as we work through the lease, to give us the funds necessary for the remodeling and improvement of those two hospitals at their cost of capital. So as the "rent increases," if you will, it would only be the same amount which -- probably less than it would otherwise cost us. So it's a real positive in helping us to bring these hospitals up to a class A-plus standard.

And, Liam, just to clarify, the CapEx numbers that I threw out, that includes the amounts that Sunrise Senior Housing [Rental] will reimburse us. So I don't want you to --

No, no, not that I -- I get that part.

Yes, okay.

Okay. Thanks a lot, Bruce. Thanks, Evrett.

Thank you.

Thank you.

Our next question comes from Joel Ray of Davenport Brokerage.

Good afternoon, guys.

Well, Joel --

Congratulations.

-- it's -- well, thank you. It's a pleasure to hear your voice. You had that wonderful Miss Montague in there before, but we're happy to have you now joining us.

Well, I'm happy to be able to cover you. Was wondering if you might be able to expand upon the seven Sunrise-managed facilities that we saw announced fold in today? If you have already discussed that, I apologize. I got on the call a couple minutes late. But I'm wondering about the timing of that particular fold-in.

Secondly, the terms seem to be a bit lower than what I would have expected. I congratulate you at the $40 million because I had thought it might be running higher.

And I was wondering, operationally, as we bring those in, are they at least at breakeven so they won't be diluting our earnings? Obviously, I know we're saving a management fee, but I was hoping you could expand upon that a bit.

And then the second question unrelated. Seems like the acquisition opportunities are actually increasing and the pace is picking up a bit. Was wondering if you might be able to address that a bit?

Okay, Joel, I'm going to try to handle most of the first question, and then I'll pass it over to Evrett for the second.

But the Sunrise, the timing is going to be December 1. We just really reached a deal with them last night, signed it all up today, this morning, issued the press release.

Yes.

Timing will take them over 12/1. We'll eliminate a little more than $5.5 million a year of management fees. The seven right now are -- what they did in the third quarter is pretty much on track with what they did in the second quarter, so by eliminating the management fees, I mean it will bring them back to profitability, and hopefully, we'd be able to bring the things that we think we can bear on them, like the reduction in insurance costs. We hope there will be some operating efficiencies in terms of labor reductions, etcetera, in that regard.

Contractually, the payment -- the termination fee is a lot less than the contractual rate. I do want to turn it over to Evrett, but believe me, that was one deal we really walked back and forth with Sunrise on in trying to get that.

And just very quickly, though, too, these numbers have always been in our numbers, Joel. So, really, these have been -- I think I said at the start that they're going to be challenging, and they've always been the worst performers, the weakest, if you will.

Correct.

And so but their numbers have always run through, so there's not going to necessarily be a change.

Other than the reduction of the management --

Yes.

Right.

But Sunrise -- everybody from inception of these seven properties has had difficulty. The very first Builders' Forum and then Marriott, Sunrise, and so you can't -- these are just difficult properties. But by taking them over, we have many then opportunities. We can change out things that might -- the products offered there. We can put them in discontinued operations, close them or sell them, etcetera, by virtue of the fact that we control them, and it's not just a manager.

With regard to the price, though, I just want to say that, remember, because these are under-performing facilities, there were certain rights, that Bruce has enumerated several times, that we would have after the close of the year.

Correct.

And Sunrise saw that, and so it's not -- you know, I wish we were "great" negotiators. We're not. This was a fair deal because of the status of the properties, and they were kind enough to help us to work through it and recognize that this was good for us, as well as for them, and that 2007 just makes sense, that, look, let's just split this out and be able to move on down the road. It was always difficult for them, especially with these remaining seven, that we would talk about them losing money. They'd lost a little bit more this quarter than they lost last quarter. And in addition, we're literally getting calls from residents and from employees there. They didn't know whether they were fish or fowl. And so this --

Some thought they were already taken over, in all honesty.

Yes, and so this straightens that up. It was -- my hat's off to Sunrise. They were kind to help us to get to the -- get this over the goal line with regard to it.

As far as -- you're actually correct on the second question, what are we seeing. If you look back, other than the Sunrise stuff, which we've had sort of an exclusive right, if you will, for about a year, we didn't bring anything on, not --

That's right.

-- that we didn't look at things, but Bruce and I and the guys here look at every significant deal, and we bid on every one of them, and we just couldn't make them work. And so all of a sudden, we started getting second place -- excuse me, getting in the second round and then winding up and bringing them on. A couple of them are troubled, but we looked at them and said, "What can we do to take these to the next level?" And so we're pretty happy about that.

We're seeing a significant increase in the number of properties which were offered at a level which is better than we saw in -- from mid-'05 to mid-'06. It's as simple as that.

Very good.

Thanks.

Congratulations.

Thank you, Joel.

Thanks, Joel.

Our next question comes from Sean McMahon of Kennedy Capital Management.

Hi, guys. Nice quarter.

Well thank you, Sean. Thanks for being on the call.

Just have one question that will elaborate on the last caller on the acquisition market. Can you maybe just give me a little bit more color on what you're seeing prices out there go for some units, and are you being chosen, or are you looking -- I mean what are you looking for? Are you looking up -- at a fixer-upper, so to speak, with low occupancy? Are you looking for triple-A standing? Can you maybe just walk me through what you're looking at and what the prices are?

I think to start, John, we're looking at pretty much everything you said. We're looking at some fixer-uppers. We're looking at some triple-As. And of the 10 we closed, I'd say two were fixer-uppers, most are very nice properties, there's a few Class-As in there.

Pricing -- you know, we've been paying around or a little under $100,000 a unit. We also look -- oh, probably a little bit more -- at a cap rate philosophy, and I think we're really getting deals between and 8 and 9% right now. And I think that compares favorably with a lot of the deals. We really -- Evrett alluded to it, but we weren't making second rounds, and we were getting priced out between that 8 to 9% range.

Okay. And can you maybe just help me understand the other operating expense line where at the beginning of this year, you're almost at $50 million. Now, you're kind of looking at 45 -- 44, 45 million. Where -- is that all insurance, or what is that -- what's that reduction there? How did that come down?

A large portion of that came down to the discontinued operations. As things moved to discontinued operations, they fell out of that.

Okay, okay. All right. And that's it. Thanks, guys.

Thank you, Sean.

Thank you.

Our next question comes from J.D. Padgett of the Boston Co.

Hi, guys. A couple questions. One, the 10 properties that you've brought on recently were the five that you got from Senior Housing and then another three that we saw in the press releases recently just recently, or are those different?

Well, there are 10 altogether --

Right.

-- and so, let's see. We had a press release on the five that we took on in September.

Okay.

We had a press release on the three we took on in October.

Okay.

And then we just did another two in --

And we just did two more at the start of November.

Were those outright acquisitions, or are those similar type --

Those were leases --

Okay.

-- of -- they were already in the works. They'd been in there for a long time. One was in Kentucky, and there was an additional one --

In Savannah.

-- in Savannah.

Were those from the Senior Housing portfolio, or those were other transactions that you did separately?

We leased them from Senior Housing.

Yes.

Okay. And are there more properties within their portfolio that you could pursue?

Well, that was -- they acquired them, and we leased them on the same day.

Okay.

So we worked in conjunction with them for the acquisition.

Okay.

They were more our financing partner is the way we looked at it.

Exactly. [David Haggerty] would source them. He did a lot of the work on it, but we would use our folks. We'd go out there and look at it, and we'd make a separate analysis from an operating standpoint and -- as to what we thought would work.

So would that be the way we could pursue some additional M&A in the future in conjunction with Senior Housing then?

No question. I mean it's one of the -- success of our strategy the last couple years, but as I've alluded to now, I think with our own funds from the convertible debt offering that we can add to that, so you'll see a blended strategy.

Yes.

Okay, so no preference one way or another teaming up with them or doing it on your own?

Well, you know --

[Inaudible] deal.

Yes, yes. It's going to be a deal-by-deal review. We haven't had the opportunity in the past to have cash to do these types of things. The offerings, the equity offerings we did, the cash literally, for the most pat, went to pay off Sunrise, and so now we're seeing some of these opportunities, and we're growing into it. But I'm grateful for the partnership, if you will, that we've forged with Senior Housing. They allowed us to become by various measures the fifth largest operator of senior living communities in the industry.

And the -- when we look at the P&L in the fourth quarter, how will the new rehab hospitals impact that in terms of revenue pick-up and any margin implications?

Talk about revenue pick-up first. I mean we approximate it's going to be around 25 million in the fourth quarter.

In terms of margins, we're probably in the teens somewhere. Whereabouts, we're still trying to figure that out, and we're working right now through that.

That's on what basis, EBITDA, EBITDAR?

EBITDARM.

EBITDAR?

EBITDARM, before rent and management costs.

Okay.

We expect what -- we've told people historically that we expect the fourth quarter, because we'll have some start-up costs and really going to learn the hospitals, to be flat in the fourth quarter and then go up from there.

Flat from the margin perspective?

Correct, yes.

Okay. And then go up to the mid -- go up to the teens over time?

Yes, it's just that we're -- well, obviously think about it there -- if there are a fair number of expenses and just transition costs that we're flowing through.

Okay. And then a couple other quick ones. How will you record earnings now with a convert out there? Do you do it on an as-converted basis or--?

Correct, yes. I mean we'll report earnings, both basic and fully diluted, the fully diluted EPS, assuming -- you won't see it in the fourth quarter because we're showing a loss, but starting in 2007, it will back out the interest expense and then show the dilution of the shares.

Okay. And I guess the final question is -- I think that actually does it for me. Thank you.

Great. Thank you.

Thank you.

Now, we'll turn to [Michael Casser] of SIO Capital.

Hi. Thank you. A couple of quick questions. First, you had mentioned that in getting ready to take over the rehab hospitals and some of the acquisitions that you did, that there was a fair amount of managerial activity and attention. Can you quantify the costs that might be in your SG&A lines that went into getting ready to take over some of these properties?

Can't quantify it exactly, but I would say there's several hundred thousand dollars, you know, 2 to $300,000 of costs associated with that.

Great. And you also had mentioned --

That's out of pocket. You can imagine that we -- we had guys moving cots into their offices.

Yes, exactly, as well, you know, our own time, which is already in there.

Yes, I can imagine. You had also mentioned that there were some write-offs in the pharmacy business in the quarter?

Yes.

Can you quantify those?

Also several hundred thousand.

Several hundred thousand dollars.

And those are write-offs that you would not [occur] -- that you would not expect to see on an ongoing basis, correct?

That's correct.

So would it be correct to think that even in the past quarter on a normalized basis, that the pharmacies were operating --

Well, you know, one of the guys asked that. I don't know. Was that Jerry that asked that? We think in the fourth quarter -- look, look. We -- this is truly a work in progress. We think in the fourth quarter, we're hoping for about 4 to 5%.

Great. Thank you very much.

You bet.

Thank you.

Thanks for being on the call.

Now, we'll hear from [Vincent Maulay] of [Laquins] Capital.

Hi, guys. Just a few questions. First, on the facilities you're taking over, what are the escalators?

On the escalators, Vince?

On the eight -- the ones that -- not the hospitals, but the [inaudible].

Yes, these 10 you're talking about?

The escalators are just like they were in the past. We pay 4% over the increase in a base year. Base year for everything we've taken over so far is going to be 2007, and there are no escalators in the rehab hospitals at all. It's a flat 10.3 throughout its entirety.

Okay. Secondly, what's the -- what's going to be the size of the NOL at the end of the year with you guys buying these on December 1?

Around $210 million.

Gross?

Correct.

Okay. And then just, lastly, just -- I want to make sure -- I'll just follow up on the last question. The G&A jumping from 8.3 -- jumping to 8.3 from 7.7, was that all HealthSouth in its entirety, taking over the HealthSouth facilities?

No. I mean we've added to our management structure in terms of people just like running the 23 communities we've taken over from Sunrise, the communities that we've just taken on, the 10 that we've talked about.

But as a percentage --

Oh, as a percentage, well, yes, we're still at 4.1%, Vince.

Yes.

And you'll see that's probably one of the lowest you'll see in this industry.

Yes, yes, especially when you look at it. I recognize we've got several different pieces to our business, but just look at anybody that's purely in the ILAL business, and you'll see that we're right at the lowest that there is.

And just -- I want to quantify the cost of doing this plus the pharmacy write-offs. Is that close to $1 million of additional expense that either one time it's in nature or isn't covered by revenue?

I'd take a little bit less than that.

So it's a higher-quality quarter than you're telling us about?

No, I can see where Vincent was going. Don't add that to the next quarter, Vincent. We're -- one, we're -- we've still got a lot of work to do on the rehab hospitals. Two, whenever we take over anything, we're going to have to -- and so we've taken over these seven. We're going to be spending funds. There's always something in there. I wouldn't be slapping a million bucks onto the fourth quarter, big guy.

But I appreciate what you're saying. Look, we're pretty proud of the quarter. We've said always that we don't necessarily go on a 90-day report card. We've tried to scrub it down and do what's there, but over the year and over the long term, we have produced what we said we're going to produce, and we'll continue to do that.

I appreciate what you need to do. That would probably be -- I don't know that you'd end up with the right numbers, yes.

Okay, and just real quick. You talked about EBITDARM margins on the hospitals that you're taking over, but you don't have any management fees, so those are actually EBITDAR. Is that correct in thinking about that?

Well, when you say management fees --

Yes, G&A. Some of the G&A would go into that.

Yes, yes, there's going to be an increase in G&A.

Okay. Well, thank you.

You bet. Thanks, Vincent, for joining us.

Our next question comes from [George Walsh] of [Gilford Securities].

Hey, Evrett. How are you doing?

Great. Thanks for coming on, George.

Just a question regarding the sale of the Connecticut S&F facilities. Do you anticipate any write-downs on that with the quarter?

I think we've taken the bulk of it in the third quarter, George. I mean there might be something coming up in the fourth quarter --

Yes, well [inaudible] --

-- but I wouldn't think it's going to be significant.

-- October. So here's what happens whenever you do this, whenever you do this. Number one, you've got to maintain the same clinical levels, the same personnel that are there. But, number two, people start leaving. They get worried about it, and so that's why your losses increase. It took us a little longer to get rid of this than we would've liked, so you're going to see those losses in October --

Yes, also, you've got one month of operations in October, so --

Yes.

-- so you [inaudible] that one month.

Exactly.

But in terms of asset write-downs, I think most of that's been taken care of.

Absolutely. Bruce is absolutely correct.

Okay, so just one month of that. Can we kind of prorate it versus what happened this last quarter?

No, because we had write-downs in all the equipment and other things that we just pulled off, right, Bruce?

Correct. I mean it's going to be several hundred thousand dollars.

Yes.

Okay. And --

Yes, easily.

Okay. If I understood correctly -- did I hear that right? When he was talking about the rehab hospitals, I thought you mentioned -- are you on a $30 million CapEx program there? Did I hear that correctly?

No, you didn't. That was all on CapEx.

Okay.

We expect over the next 18 months maybe to spend about $5 million on these two hospitals.

Okay, very good. And I saw today that the other announcement was that Senior Housing did their settlement with HealthSouth. Does that accrue any benefits to you as far as the rehab hospitals are concerned anyway, or that's just their own issue?

No, it did accrue a little bit of a benefit to us. As part of the settlement, some of the transaction costs and transition costs will be picked up. Funds will be provided to us by HealthSouth as a result of that. Still trying to quantify -- I mean what the --

We're trying to work through --

-- ultimate benefit will be.

The reality is that what it does is it clears up some things with regard to just the operational side. It's not really that significant, if you will, from our perspective. I'm happy for Senior Housing and really happy for HealthSouth. I think, overall, it's just that we can now move on with those hospitals, and they can move on with their lives.

Okay. And are you now comfortable with the balance of the [Sniff] portfolio that you have?

Oh, absolutely. You know, it's pretty well stabilized. The margins are steady. If you've got costs that go up on the clinical side and you're only getting a 2 or 3% pick-up on the Medicaid and Medicare, you see a "minor erosion," but the reality is that that's a stabilized portfolio. It gives us the opportunity of having a large labor base that we do a lot of things with.

The whole clinical aspect -- we've got a great clinical department here because of that. Our whole labor initiative's come about because Rosemary Esposito was able to put into place, our COO, some -- four proprietary systems that worked off of labor that we had in those places. We are able to be better operators because of that portfolio, and it's stabilized, and it makes money. We're happy with it.

Okay, good. Given what we're talking about here and what will be involved in the fourth quarter with the termination fees and the other things we've been talking about, do you anticipate that 2007 should be a pretty clean year in terms of -- you seem pretty satisfied now with the [Sniff] portfolio. There might be some issues, it seems, with some of the last facilities you're going to be taking over with -- versus Sunrise, but do you feel we'll have pretty much a pretty clean view of the operations for 2007?

We do. I mean we're very happy that the termination fees will be behind us and we won't be seeing that on a go-forward basis. We do hope to add some acquisitions to the mix, so I don't think it's going to be -- hopefully, it will still be a noisy year from that point of view, but --

It will be a joyful noise, as they say.

Right, right. Okay, thank you very much.

Thank you.

Thank you.

Our next question comes from [David Basile] of Janney Montgomery Scott.

Hi, guys.

Hey.

Hey, David. How're we doing?

Good, real good. Most of my questions have been asked, but I want to go back to labor costs. Labor costs of 51.9 declined into 51.8. Is that a stable level that we should look forward to here, or should we be looking at increasing that in our models?

If you're going to increase it in the model, we've always targeted 52%, so we're pleased that we're under it, but if it got up to 52, would it surprise us and alarm us? Not really.

Okay. In terms of your staffing needs, both at the headquarters and then operations, are there any significant challenges there?

I think it's always a challenge finding good people in terms of accounting or MIS, rehab therapists, professional nurses, etcetera. But we have -- one of the things we set up a few years ago was a recruiting department internally, and we think we get the job done.

I've known you guys for several years now, and you kind of have been running this very thinly, if I could say that. What are we going to add here? What should we expect?

Well, I wish I were thin. You know, I continue to need to go on a diet, actually.

But the reality is that we're presently reviewing the operational structure -- the organizational structure, I should say, and while we think that there is going to be a pick-up in the G&A line because of that, it's something that we believe that will benefit us in the long term.

And as a percentage of our revenues, we think it should be fairly well in line with historical levels. You know, it might be up a little bit because those Sunrise revenues are already in our operations.

Yes.

But when you take into account the hospitals, we think we should continue to maintain one of the lowest G&L levels in the industry.

Yes, I think Bruce is absolutely correct. I want to make sure that when you look at this, you see that we're -- we are pretty lean. We always tell folks that when the maid comes and she says she's not going to do windows, well, I always tell people, "I'll do windows. I'll do the floors. I'll answer the phone. We'll do what's necessary." I've been so grateful for our folks because that's the mentality and sort of the character that has been instilled, and I think that, generally speaking, everybody can be pleased and happy with the work that we're doing. Not to say after a while, it can get a little bit tough, and we're looking to make sure that we strengthen the bulk, and the officers of the Company, all four of us, are looking at what we need to do so that we bring on folks and make the structure so that it's workable.

If you look just before -- about this this time last year, about this time four -- five years ago, excuse me, we were about a fourth the size that we are now. And we, generally speaking, have been running it with about the same level. We've just added more [inaudible] --

Exactly right. I mean it just --

-- four more regions.

So this SG&A for management, that 4.1%, what should I really be looking for there? What's a more normalized number?

You know, I think it's going to take us two quarters to figure that out, in all honesty, David.

Yes.

I don't think it's going to go up significantly from where it's at right now. It might go up a little bit, but I don't think we'll let it get out of line.

Well, I think I've been with you for three years. I think I could wait two more quarters.

Thank you.

All right. Thanks. Good quarter.

Thank you.

Ladies and gentlemen, that is all the time we have for questions. I'd like to turn things back over to Mr. Evrett Benton for any closing or additional comments.

Well, thank you all for joining us on today's call. We, as always, look forward to updating you on our progress in the future. Bye bye.