Alerislife Inc (ALR) 2007 Q2 法說會逐字稿

Good day, everyone, and welcome to the Five Star Quality Care second quarter 2007 financial results conference call. This call is being recorded.

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

Thank you, Abe, 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 includes a 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, August 9, 2007.

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 to 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, I would like to turn the call over to Evrett Benton.

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

Before I begin talking about the second quarter, I'd just like to acknowledge the difficulty we had in properly communicating our first quarter results to the investment community during our call in May. For that communications disconnect, we accept full responsibility. We hope to be able to communicate our results more clearly today and going forward.

That having been said, I'm pleased to report that the second quarter was strong. Net income per share from continuing operations for the second quarter was $0.16 per share basic and $0.15 on a fully diluted basis.

Please note, after excluding the prepayment of a HUD mortgage, net income per share from continuing operations in the second quarter was $0.13 on a fully diluted basis. These results for the second quarter of this year compare on the same basis with $0.08 per share last quarter, and $0.13 per share in the second quarter a year ago after excluding about $90 million of termination fees paid to Sunrise.

One additional clarification. These second quarter 2007 results were negatively impacted by a true-up of certain franchise taxes attributable to prior periods. This true-up amounted to approximately $500,000.

A significant contributing factor to our improving results was an increase in our occupancy, which at the end of the second quarter, had risen to 90.5%. Given all of our efforts, we believe this is a strong improvement over the 89.7% occupancy that we had in mid-May.

Overall, occupancy for the quarter was 89.9% compared with 91% for the same period a year ago. The 89.9% occupancy for the quarter is the average of the daily occupancy for all 91 days in the second quarter.

Looking at these numbers on a resident count basis, we had 16,002 residents on May 9th of 2007. As of yesterday we had 16,130 residents, an increase of about 130 residents.

This increase was achieved by several programs designed to drive traffic to our buildings, including sending additional teams beyond our normal marketing folks out into the communities to help us in our quest to add residents. We never cut rates but there are certain concessions that we offered in communities where census had dropped egregiously.

Presently, if you break out our communities by occupancy, we have 26 communities at 100% occupancy, 50 communities at a 95% to 99% occupancy, 27 communities at 90% to 94% occupancy, 28 communities at an 85% to 89% occupancy, and 32 communities at a 85% occupancy or below. Of these 32, 10 have been operated by Five Star for less than a year, and 15 are skilled nursing facilities in rural areas.

We executed a number of different initiatives in the first half of 2007 to raise occupancy. I'd like to emphasize four.

The three for two blitz initiative. This sales blitz in the spring netted more than 350 sales company-wide. Basically, this was three days of all-out marketing to obtain two new residents per building.

The occupancy bingo program. This initiative at the 10 lowest occupancy communities was a special program that generated a net increase of 40 residents.

The just-one-more program. This initiative was at our IL and AL communities below 90% occupancy and generated a net increase of 79 residents at 19 communities.

And finally, the premier club. This was an initiative for skilled nursing facilities which generated an increase of 38 residents.

Another contributing factor to these second quarter results was rate increases. On a same-store sales basis, the average daily rate increased 5.3% to $140 in the second quarter versus $133 in the same period a year ago. As a reminder, these results include meager increases in Medicare and Medicaid rates.

A third contributing factor was our 3% labor initiative, which we implemented during the second quarter of this year. As we've mentioned to many of you, it's just a name but as a result of the reduction in census, we required the executive and regional directors in our communities who were not at budget to go position by position and remove labor hours. A significant portion of this initiative related to those properties which we took back from Sunrise.

In addition, we've also revamped our labor and agency tracking systems to make them even more robust, and the effect of those enhancements will be seen in the third quarter. The result is that through our labor initiatives in the second quarter, we saved about $0.01per share on our bottom line. We expect the steps that we have taken will have an even greater impact on our third quarter results in the range of an additional $0.01per share.

Now, moving on to the rehabilitation hospitals. As I said when we presented at a recent investor conference, we expected the rehabilitation hospitals to be a drag on our financial results in the second quarter, and that was the case. The substantial portion of this drag was a drop in revenues due to our efforts to become compliant with the 75% rule, and a number of capital improvement projects in process at these hospitals.

We continued to work on the physical plants at our two rehabilitation hospitals. For example, if you visited the New England Rehabilitation Hospital in Woburn, Massachusetts, you'd be hard-pressed to find the main entrance to the building because we have a lot of dirt moving and construction equipment working all over the grounds.

In addition, as many of you know, we have two wings shut down for renovation, one in each hospital. As we complete portions of renovations to the physical plants and integrate the operations of these two hospitals, we expect improvement in their performance in the second half of the year.

One negative note is that in the last few months there have been significant changes with the determination of need process in Massachusetts. The result is that our timeframe for completing our interior renovation plan at these hospitals is now going to be pushed out until 2009.

We're on target with regard to the compliance of the 75% rule, and our census is higher than we took over these operations in October. To quantify things, we need to add about 20 patients from where we are right now.

While the hospitals were a $0.03 per share drag during the second quarter, we are seeing positive signs as we right-size labor and we move to get the hospitals working together in several areas, such as consolidating certain operations and sourcing patients.

Finally, we're aware of several federal legislative initiatives which could impact the 75% rule as well as impact payment terms for certain services provided at our rehabilitation hospitals. While there are both positive and negative aspects for these initiatives, until we have a greater clarity as to the final terms, we're not in a position to give meaningful comment.

On the acquisition front, we recently terminated deals for two properties while in the diligence phase. Upon closer analysis, these two communities were problematic in a few areas and we determined that they would not be immediately accretive.

We still have two communities under contract that are 100% private-pay and over 90% occupied that we expect to close in the fourth quarter. While we know that in the near future we will be back in a growth mode, for the present we're focusing on our existing operations.

Now, let's take a look at our labor costs. Labor costs as a percentage of net revenues from residents remained constant at 51% on a year-over-year and sequential basis.

As we've stated before, while we're always looking for ways to drive this number down, it may fluctuate from quarter-to-quarter. If we keep labor under 52%, we believe this is a good gauge of our continuing ability to control labor costs.

Now, let's look at our institutional pharmacy business. Revenues in our pharmacy business increased 30% to $16.9 million in the second quarter compared to $13 million in the same period last year, and moved up sequentially from $16.2 million last quarter.

Our EBITDA margins in this business improved sequentially to over 3%. This was accomplished in part by moving over 1,000 residents from Five Star and other communities to our pharmacy platform during the quarter.

We currently have over 10,000 customers and we have targeted 1,000 additional residents at our communities that can be transitioned to our pharmacy platform through the remainder of the year. You may recall when we started the year we had approximately 8,500 customers serviced by our pharmacies.

Finally, we anticipate continued margin improvement in our pharmacy business in the third quarter, and remain on target to reach our stated goal of being on a 5% operating margin run rate at the end of 2007.

In the past, we talked about achieving annual revenues of $80 million by year-end. Given the changes in the market, it now looks like we'll be at a revenue run rate of slightly around $75 million per year.

As to our rehabilitation and wellness services business, we've been at it long enough to determine that senior spas work best at large communities or smaller clustered communities creating a large base from which to draw. Since the first quarter we've closed several spas in smaller communities but we're looking to add several new spas at certain of our larger communities by the end of the year.

Now on to some miscellaneous matters. In the first quarter of 2007, we moved two communities to discontinued operations in anticipation of a sale. Because of some regulatory changes on the state level, these assisted living communities were no longer financially viable.

Upon sale, we will receive a reduced rent amount from Senior Housing Properties Trust commensurate with the sales price. In addition, we've just determined to sell an underperforming rural skilled nursing facility and we continue to look closely at several other underperforming facilities.

As we've discussed on past calls, we have been in the process of taking a comprehensive look at our insurance, including workers' compensation, liability, and property. We've just completed a revamping of these programs and expect to save about $0.01 per share per quarter going forward.

Before I turn it call over to Bruce, I'd like to discuss Five Star's stock price at market close yesterday of $6.90. First, we've seriously considered a share buyback program, however, in a volatile market where investors are clearly pulling cash out and until the full impact of various financial concerns are understood, we believe having cash available to deploy gives us an advantage as we look to grow our company. In the long run, we believe this will create greater shareholder value.

Second, a week after our first quarter call, I personally purchased 19,000 shares for an average price of over $7.80 per share. I remain steadfast in my confidence in Five Star as a solid investment.

Recently, the capital markets in general have been under great pressure. Five Star and our peers among the senior living industry have certainly not been immune to the market downturn.

Despite this market downturn, however, fundamentals in the senior living center have not changed. The age 75 to 90 population in the U.S. is in the midst of a 23% growth spurt from 2005 to 2010 that the Census Bureau expects to jump to 46% in the next five-year increment.

Development within the industries remain muted at about 25,000 units annually since the late 1990s. These are strong fundamentals, but more specifically as to Five Star. By any measure, we are undervalued.

Some things to consider. We increased our census from 89.7% at the middle of the quarter to 90.5% at quarter's end. We had a significant initiative to rein in labor costs that has borne fruit.

Our average daily rate, including meager increases in Medicaid and Medicare, has increased in excess of 5% year-over-year on a same-store basis. We've continued to turn around our pharmacy operations. EBITDA growth is strong with a year-over-year increase of 38%.

We generate significant cash flow from our operating activities. In our senior living portfolio, we have had a 9.5% increase in revenues with only an 8.2% increase in our operating expenses, and our G&A at 4.5% of revenues, remains the lowest in the industry. Whenever we've been given an opportunity or a challenge, we've risen to the occasion.

Again, for the communications disconnect that happened in the first quarter, we accept full responsibility, however, all that we do as a company should not be judged on the basis of a one-hour conference call. I firmly believe that we are one of the finest operators in the senior living industry and our financial results for the second quarter would seem to bear that out.

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

Great. Thanks, Evrett.

Let's review the second quarter numbers. Senior living revenues were $200 million for the second quarter, an increase by 9.5% when compared with the second quarter of 2006. This increase was primarily due to revenues from the 11 communities we acquired in the third and fourth quarters of 2006, the one community we acquired in April 2007, and higher per diem charges for residents partially offset by a decrease in occupancy.

All operating expenses for our senior living communities increased by 8.2% in the second quarter to $151.8 million from the second quarter of 2006. This increase in the second quarter was primarily due to the 11 communities we acquired in the third and fourth quarters of 2006, the one community we acquired in April 2007, wage increases, and increased charges from third parties.

Senior living revenues for the communities that we've continuously operated since April 1, 2006, was $191 million for the second quarter, and increased by 4.6% when compared with the second quarter of 2006. This increase was primarily due to higher per diem charges to residents, partially offset by a decrease in occupancy.

Senior living expenses for the communities that we operated continuously since April 1, 2006, was $144.5 million for the second quarter, and increased only by 3.0% when compared with the second quarter of 2006. This increase was primarily due to wage increases and increased charges from third parties.

The management fee to Sunrise was zero in the second quarter of 2007 compared to $2.9 million in the same period a year ago. This expense decreased because of our termination of management agreements in 2005 and 2006.

We now have operated all of the properties previously managed by Sunrise for two full quarters. Sequentially, we have added a 200 basis point improvement in the contribution margin at these 30 communities previously managed by Sunrise while census has remained relatively constant.

G&A expense for the second quarter increased by 36% to $10.9 million from the same period a year ago. The increase in G&A expense primarily results from our acquisition of 11 communities in the third and fourth quarters of 2006 from the 17 communities we began to operate in 2006 that were previously managed for us by Sunrise, and from the rehabilitation hospitals that we began to operate in 2006.

Even with these additional items, G&A expense for the second quarter was still only 4.5% of total revenues, which is up sequentially from 4.2%, but still remains among the lowest in the industry. As we stated on recent conference calls, we anticipated this increase during 2007. We expect this G&A percentage to remain relatively flat.

Rent expense during the second quarter for the communities and hospitals that we lease increased by 23% to $31.9 million from the second quarter of 2006. This rent expense increase is due to the communities and hospitals that we began to lease in 2006, and our payment of additional rent for capital improvements purchased by Senior Housing since January 1, 2006.

You will note in the second quarter of 2007 we incurred $275,000 for federal income taxes. This income tax expense is primarily related to alternative minimum taxes that are payable without regard to our tax loss carry-forwards. We anticipate this amount will be approximately $300,000 per quarter going forward.

For the quarter, we reported net income per share from continuing operations of $0.16 basic and $0.15 fully diluted. Please recognize that excluding the one-time gain on extinguishment of debt, income per share from continuing operations was $0.13 per share on a fully diluted basis.

Excluding the 2006 termination charges paid to Sunrise, EBITDA increased from $6.3 million to $8.7 million, or 38% between the second quarters of 2006 and 2007 respectively.

I would now like to briefly discuss some high-level cash flow metrics. In the second quarter of 2007 we had $15.9 million of cash flow provided by operating activities. In addition, we had $18.4 million of capital expenditures, $15.6 million of that will be reimbursed by Senior Housing in future periods.

In the past, we've discussed the possibility of expanding the unit count at existing communities. There are two projects that we've broken ground on and 12 additional projects that are currently in the planning stages totaling about 200 additional units. We've got a long way to go, but we've certainly started the process.

Moving on to the balance sheet and some or items of note. Cash and cash equivalents were $42.5 million at the end of the second quarter, and we had investments in trading securities of $38.8 million. In this volatile market environment we believe that our cash position strengthens Five Star's ability to efficiently carry out the Company's long-term growth strategy.

In June, we amended our existing $25 million revolving credit facility to increase the maximum borrowing amount to $40 million, and extend the maturity date to May 2009. The annual interest payable under the facility was also reduced from LIBOR plus 150 basis points to LIBOR plus 125 basis points. We think this gives us increased flexibility.

Accounts receivable at the end of the second quarter were $60.9 million. Our days sales outstanding including the rehabilitation hospitals is an industry-leading 22.8 days.

At the end of the second quarter, the market value of our long-term HUD insured mortgage notes was $15.9 million, and we had no amounts outstanding on our $40 million revolving credit facility. We now have $132.8 million of net property and equipment, including 15 properties making up 1,070 independent and assisted living units and 273 skilled nursing beds. Eleven of these 15 properties are unencumbered.

We believe that we are currently in compliance with all material terms of our mortgages, convertible notes, and revolving credit facility.

To sum up, occupancy has recently trended up nicely and we are on our way to returning occupancy to our historical high levels. Our labor initiatives began to bear fruit in the second quarter, and we expect to see an additional contribution to our bottom line in the third quarter.

Our pharmacy operations continue to improve and we have inaugurated a number of initiatives at our rehabilitation hospitals which we know will improve their performance. Finally, we believe that our cash position and strong balance sheet make us continue for long-term growth in the face of present uncertain capital markets.

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

Thank you, Mr. Mackey. Our question-and-answer session is conducted electronically. (OPERATOR INSTRUCTIONS) And we'll go to our first question. This is Liam Burke at Ferris, Baker Watts. Please go ahead.

Good afternoon, Evrett.

Good afternoon. Thanks for joining us, Liam. We're glad you're on the call.

Thank you, Evrett.

If I looked at the expense as a percent of revenue for the newly acquired properties, they're about, I don't know, almost 600, a little over 600 basis points higher than on the existing properties operated for 12 months. Now, I've got to presume that it's an occupancy issue that are driving the lower margins, but is there anything in those new acquired properties that are causing any trouble or can't be fixed with occupancy improvement?

Well, I'll start and then maybe Bruce can amplify it a little bit more on the numbers.

We've always used the analogy, or often, of the passing of the baton and that's usually the case whenever we take over properties. There's usually a dip in all areas and obviously then an increase in certain expense areas.

More particularly, the properties which we've recently taken over, we knew, were to a certain extent troubled, and, therefore, it made sense economically, we knew, though, that most of them would have some sort of a drag. The 600 basis points is right in line because of that, I mean, as a percentage basis, one, they're not making as much money.

Two, a lot of times we're changing out various leadership or other portions of the labor there, and when we do that, you might be paying somebody off. And then three, just to putting in some things that we might otherwise expense. For example, just some of the hardware, software, and just some portions of that we're going to be expensing and so those expenses are going to then rise up early on.

Bruce, anything -- so there's nothing untoward that we --

I think you've hit the big things. I mean I think it takes us a little bit of time to get our labor systems into place until we can gain some knowledge of what's going on in the communities and then make changes accordingly to where we see.

Okay. Thank you.

Thank you.

We'll go next to Donald Hooker at UBS. Please go ahead.

Great. Thanks for taking my call. Good afternoon, everyone.

Good afternoon, Don.

Great.

Let's focus on your pharmacy business. I mean, obviously a good sequential improvement there. Are you done with the software conversions there? Are there more? Can you, you know, where is the margin improvement coming from as you look ahead over the remainder of this year?

Don, it's Bruce.

I think over the coming year, to address the first part of your question, we are a long way into our pharmacy, the Rescot implementation. We've got two more pharmacies where we haven't started it yet but as the new business comes on we are rolling it on, so to put a percentage on it, 85, 90% along done with a little bit more to go.

Most of the margin expansion coming forward from the pharmacy is going to be through the addition of new customers. What you'll see us doing in the third and fourth quarters.

Okay.

And I think I remember from earlier quarters there were some inventory write-offs and receivable write-offs, I guess those are -- there wouldn't be any more of them, or are you still evaluating that?

There are two things that I'll say. One, it just amplifies a little bit on Bruce's point. So that when we took over Expert Care down in Myrtle Beach and then up in the D.C. area, Progress Pharmacy, they both had superior, or they had satisfactory, is the more correct term, software systems. The others didn't have, and so we felt that in addition, those, both of those areas had opportunities for growth in the pharmacy area.

Rescot has proven to be a little bit of a disruptive whenever we start implementing it, and the thought was that we would just move the new clients onto the Rescot system and we'd continue on in their acceptable systems, that once we then brought on all the new stuff, we'd then convert all of their other stuff onto the system. So we actually had planned it that way.

With regard to inventory and AR write-offs, that in part was struggling with the Rescot system and just with a few other things in getting our arms around these things. While, you know, it a, what's that a scalded cat fears even cold water, I hesitate to tell you that it's all completely perfect, but we've put into place significant systems now.

We've got a person that is a controller there, heads that up, and he goes around and makes sure that on a monthly basis we're checking the inventory and what's happening with the AR. And what's happening by virtue of Part D and the PDPs and this whole generic drug system. We're feeling much, much more comfortable, like we've got our arms around it.

And there haven't been issues in the second or the first quarter. Those are really 2006 issues.

Thank you. That's a good point. Not to say that we won't see something crop up, but we certainly are finding them quicker and dealing with them within a month-by-month basis.

So then would you then characterize sort of the trend line from the current, I guess, 3%-plus margin to your goal of 5% as being more stable perhaps?

Absolutely.

Okay. And then I'll ask one other one.

In terms of the rehab hospitals, I may have missed what you said, but in terms of when do you think you'll get that to profitability? You mentioned there was some extensions in your development work there?

We know that we will, during the second half of the year, we should -- we'll break even and that we'll be profitable in the first quarter. We're trying to give you conservative numbers with regard to that. I want to make sure that you recognize we're still high on this. It would be easy to say would you guys take the second look at this.

When we came in, they didn't have time clocks, there was no employee job coding, they had no unit labor programs. The outpatient and satellite accounting programs were really messed up. We had to clean up and refine all of the financial statements. By virtue of that, we identified three non-performing clinics that we've now closed in the third quarter.

We had an unfortunate flood at one of the satellite, inpatient satellite units, we had to shut down the unit for a month. But we had $100,000 worth of agency a month flowing through these things and we eliminated it. We've eliminated agency, the use of temporary help.

The recruiting program was -- it was not satisfactory. We're in the process of moving that around. We're right-sizing labor. We've eliminated or will have eliminated 25 FTEs and in certain instances, significant portions of the leadership teams have been replaced.

We know that we're going to have to go through this. We also know that we're two of the three hospitals in this area that we can glean a higher number of patients that come in and we need to have this place look nicer than they presently look.

We're almost got the outside done, we've spruced up the inside, unfortunately, this change in government has changed up how they look at what's called the determination of need and you can only do so much as far as rehabilitation or remodeling, I should say, a building without going through the process. And that process looks like it's been extended far beyond what we first anticipated and our lawyers had first told us.

That having been said, we're working to open up these two closed wings and have them be one-bed units. We're still moving forward. We're going to get it, this is going to be a very, very nice long-term asset for Five Star.

Excellent. And with regards to the 75% rule, you said you're in compliance. Where are you now?

This, as you know, one, it depends upon where you are from a fiscal year and so Braintree in July, they had to be at 65%, and they are. And at the end of the year, New England has to be at 65% and they're on track now as well.

Okay. And then one last question.

This, Bruce, you mentioned a $500,000 true-up of taxes. I'm not familiar with what that is.

In the second quarter, we had an additional $500,000 of taxes that really related to prior periods so it was kind of a true-up, if you will.

It was state.

Yes, state and franchise taxes, so it kind of flew in our other operating costs, not the federal income line.

And that's a one-time item?

Correct.

Okay. Thank you for your answers.

All right. Thanks for being on the call.

We'll go next to Joel Ray at Davenport. Please go ahead.

Yes, good afternoon guys.

Hey, Joel.

Was wondering, I note that the Company has had some discontinued operations, you're making capital investments in the rehab hospitals, but I also see that on a sequential basis your rent expense declined in the second quarter. Was wondering if we can go into a little more detail, what was behind that and what is the outlook as we start looking over the balance of this year for your rent expense line?

Yes, Joel, it's Bruce.

Rent did go down a little bit but I think Q1 was a little overstated. We had some true-ups in regards to a percentage rent that we took care of in that quarter, so Q2 is probably more of a reflective run rate of what we should be.

Now it's going to go up in Q3 because we had more capital expenditures that were sold to Senior Housing in the quarter, but as far as a base, Q2 is the actual, is a good number.

What type of Cap Ex should we be thinking about for third quarter, fourth quarter, so that we can get a better handle on where that goes for the rent expense?

Well, you saw what we did in the second quarter. I mean, Q3 and four will probably be in line. It's-- we're spending on average 17 and $18 million a quarter right now in Cap Ex. I don't think it's going to be far from the mark.

Okay. Thank you very much.

Not a problem.

We'll go next to Jerry Doctrow at Stifel Nicolaus. Please go ahead.

Thanks. And, again, I commend you guys on the work you're doing on the IR side, better improved communication.

Thanks, Jerry, we appreciate you being on the call, truly.

Let's see, just a couple things, maybe staying on Cap Ex for just a second, Bruce, could you just, two things, I'm trying to clarify. One is sort of Cap Ex that, you know, is really sort of the S&H Cap Ex, if you will, income enhancing Cap Ex, versus kind of maintenance Cap Ex and wanted to just isolate the maintenance Cap Ex and then also sort of clarify, because I think it's enough to make a difference in the quarter.

My sense is that you funded and then have turned it over to S&H sort of right at quarter end, so there's not really a rent increase on say, the $18 million you'll spend, say, in the third quarter here, until really the start of Q4? Can you just kind of clarify those couple of points?

No, that's true. I'll kind of tackle the second question first, I think that's the easier question.

You're right. Actually it could be a few quarters. We generally will sell Cap Ex, if you will, back to Senior Housing when the project's complete. So for example, some of this hospital money that we're putting out will be up for several quarters, if not a year or so before we turn it around and sell it to Senior Housing, so that $18 million that we put out in the second quarter, could be, you know, we'll get some of that back in Q3, Q4, and really into '08, and some of that.

Now, for the first part of the question, kind of what's maintenance Cap Ex versus what's revenue enhancing Cap Ex, our systems are pretty good in that regard. I won't say they're excellent, but probably 75% of that is Cap Ex that is revenue enhancing, help us to drive the rates. And then 25%, somewhere in the range of 3 to $4 million is maintenance Cap Ex.

Okay. All right. That's helpful.

And I think if they're going to be, if you're going to accumulate multiple quarters on the income enhancing Cap Ex, it would help to give us a little schedule of that or anticipated schedule so we can kind of sort it out because it do move the rent and interest line a bit.

Let me just expand just a second on what Bruce said, because I think that first, you're correct, and we'll do that. That's a valid point, Jerry.

Second, $4 million per quarter, which is about 25% on maintenance, that's actually high for the industry. If you think about it, $1,000 per unit, $1,000 per year, that'd be around the $17 million and so that's pretty good.

The second part of that, though, this enhancing stuff, we make sure that it has a financial bottom to it, that we just don't do it because it would make it look nice and so we have to prove it up. Either it is a defensive maneuver or it's an offensive maneuver so that either we know that somebody's coming in and while we're at 98%, the place is looking tired, we nonetheless have to prove it up on that basis that it will allow us to continue on or it's an offensive maneuver.

For example, when you were down and we looked at our properties in the Baltimore area, Ellicott City, we should take you there now, it's just gorgeous, and we've actually moved up several hundred basis points in occupancy. The Aspenwood is likewise, over in Silver Springs, is doing very, very well. And Aspenwood, we put $3 million in and we did a review of, was did that make sense on the increase in rent and it did.

So the things that we're doing are bearing fruit for the most part financially. So while there is going to be an increase in the rent, we don't undertake them if they don't at least on paper show us that they make financial sense. That we not only will have to pay the rent but also it's going to aid us in increasing our revenues.

Okay. Thanks. And then just a couple other things, if I could.

The one -- only thing in the quarter that I think we were scratching our heads about a bit was interest income, because I think when we look at like the average balance which is $80 million or so over the quarter, the interest income was like 14% or something like that, so was there something else going on in the quarter in terms of higher fluctuations or was there something special in terms of these tradable securities? Just because the interest rate, I was trying to understand what's going on in the quarter and also what's the right run rate to assume go-forward?

No, there was nothing untoward in the quarter. In addition to what's in there other than interest income is we have amortization and deferred gains that really relate to old sale leasebacks, but I can't think of anything in the quarter that would have popped it unusually high.

I guess, and, Bruce, maybe to help him on the question, so we believe that's a good run rate. What I think Jerry's after is, is there something that's in there.

Jerry, one of the things that we want to try to show is on both sides, here's something which impacted the quarter one time on a positive nature which was that HUD mortgage, and here's something that impacted it negatively. You personally pointed that out that we could have done a better job on that and so we're trying to do that. And I don't believe -- is our run rate then on the --

I don't think it's anything materially in here.

Okay.

But there's maybe amortizations or something that's other than just straight interest. There definitely is and has been for a while.

And are you picking up extra earnings from, say, just the float, if you will, of something beyond what the average cash balance looks like or --

No, but you also, one thing that does flow in there is our earnings on some of that restricted cash, Jerry.

Okay.

You've got about $20 million related to our captives that might not necessarily be in our operating cash.

Okay.

So you've got that as well to take into account.

Okay. All right. That's helpful. Just one second.

I think the only couple maybe broader things, Evrett, I wanted to just touch on, I mean the great sort of paranoia among the investors these days is sort of the impact of the housing market on seniors housing and I wondered if maybe you can talk to that a bit. I wanted to sort of remind myself whether you've got any entrance-fee communities, and if you can just talk about how you're seeing housing market impact, and maybe give us a little more color on occupancy on the private pays high versus the skilled side?

Mr. Mackey suggested that Jerry Doctrow might have a question on this very subject and so we'll let him start with --

I think I'll just start kind of the second part of your question first, Jerry.

We only have one community that has entrance fees. It's a community in Scottsdale, Arizona. It's actually over 90% occupied and a resident potentially moving in has two choices, they can pay the rent and entrance fee up front or they can go on a straight monthly rent.

Most of them choose the straight monthly rent.

Right. So we really, there's been --

Just a leftover program.

Very minimal impact overall on that community as regards to that. Now, Evrett you want to touch upon the general question overall?

Yes, we've thought about that because we see what others have said. I guess one of the fun things, the reason we gave that sort of litany of programs is because we're pretty proud of the fact that while it looks like others in this industry are flat or maybe even slightly down, we've actually grown our census over the quarter.

We do know this. That people are saying, well, I like it and so when we have that three for two blitz, we actually have a number of sales, but a sale is where you sign up somebody and they say I'll move in October 1, after I get my house sold. And so we are seeing that.

But I think that we're, for our portfolio, the things that were a drag on us were, one, these rural skilled nursing communities that we have and two, just the fact that we were still getting over having 350 more people pass away or be discharged to higher levels of care in the first four months of the year than occurred in the first four months of 2007. And just getting over that took us a while.

That's not to say that it hasn't been harder. When I ask around, people say that, yes, it seems to be a little bit, but I was heartened to see that on one of the first conferences we talked about the fact that we had 20 communities that were at 100% and, look, these things bounce in and out, but as of yesterday, we had 26 that are at 100%. And what we saw were some of these are moving up.

What is a normal number? You know, if you get rid of, of the 32 that are below, 85%, 15 are in rural areas. Ten are properties that we just started, I say just started, we've operated for less than a year, so we know that we're hopeful with regard to that.

That leaves seven. Of those seven we changed out leadership at two of them. Two of them were finishing up some construction and then three are, you know, they're problem properties that have been such for a while and we're just trying to figure it out.

So that having been said, where do we go from here? You know, it'd be easy to wipe out all those bottom ones and say we're at 95%. But I think everyone is going to always have some problem areas, and as we've looked around we've tried to define, is there something that's pervading the market.

And really, Jerry, while there is certainly a, quote, delay, and perhaps it's a little drag by virtue of this housing market, it seems that we're going to be able to continue to move things up. We hope that we'll be back to the 91% by the end of this quarter and if you recall, we actually hit 92% in October.

We still, as Bruce said in his piece, our goal, and we'll be doing another one of these blitzes in September, our goal is to move us back to that 92%. I think it's a fair question that we hopefully will have even greater knowledge about, about three months from now.

Okay.

And then just the last thing, I guess I was trying to understand a little bit, Evrett, I mean you deferred a couple acquisitions, my sense was over the last, maybe year even, you made a number of acquisitions specifically of turnaround properties. It sounds like you're maybe focused more on stabilized stuff now. So I guess I wanted to get a little better understanding of sort of the strategy.

Are you looking to sort of buy certain prototypes, IL versus AL, focus on infilling geographically where you are? Are you going to shift out of some of the, maybe more of the skilled stuff? Just if you can give me kind of a strategy for sort of the particularly acquisition or portfolio as we go forward here?

Right. That's a reasonable question. We still will purchase properties that need to be fixed.

There-- a couple of things. Our good friends at Senior Housing have sourced some stuff but we both felt that it just hasn't fit. If you look at it, several things that we did, it was in response to the challenge which confronted us.

First, we actually closed some of what we call senior spas, our outpatient clinics. Why? Because they just, they were problematic from the standpoint of labor intensive management, time intensive. We also closed several underperforming assets at the hospitals.

We stopped these, several acquisitions, this is actually four, that we've just said no, we're not going to buy. And why? Because we've just been a little bit more judicious right now.

Likewise, we're looking at Royal Hills, our pharmacy on the West Coast, it just hasn't gained traction. We're trying to figure out how we make that good operation work and it's just, and we're trying to figure it out. We're looking at our mail order.

So we're being judicious with regard to several things that were suggested to us by a number of our investors and a number of the good folks in the industry. We're trying to make sure that we get everything ship shape, if you will, and then we'll move forward. We're pretty pleased with where we are right now.

But, look, we're going to grow. That's what we do. We're looking around for opportunities every day. This has given us a great, great opportunity to make sure that the stuff that we operate we're doing it well.

But we'll continue -- I don't believe that we're going to change our profile, but we have been, it's just taken us longer and more capital and more management capital in some of these things so that we're going to be more judicious when we look at it. Bruce, anything?

No, I think the only thing I'd add to that is just in terms of growth, again, we're looking to grow private pay, our independent and assisted living portfolio. We're still pretty hesitant about getting back into skilled nursing although we would look at getting skilled nursing units in a CCRC-type setting, so I think that's the only thing I'd add.

We are a company that will prosper because we grow. We want to make sure that we do it correctly. We're getting in good shape so that we can do that.

We'll next go to Derrick Dagnan at Avondale Partners. Please go ahead.

Thanks. And I wanted to echo on Jerry's comments on improvements in the presentation of the press release.

Thank you, Derrick, appreciate it.

I have a couple questions.

One is just kind of looking at the income statement, the other operating expense, last quarter I kind of talked about other operating expense and it seem that the problem with the quarter had to do with revenue. But if we look at just the dollar value of the other operating expense, it seemed to decline again and it approached kind of the level that you guys posted in the back half, the quarterly level that you posted in the second half of 2006.

And I think you mentioned that that included about $500,000 of one-time tax items. And I just want to know kind of what's going on there that keeps moving this income statement item around?

I think one thing, and, you know, we said it on the past call, we said it on other calls, there is some chopiness. I mean every quarter you have some things that go up and some things that go down. Last quarter there were some items in there that we really didn't highlight probably as good as we should have and we talked about that, really, after the call and in certain presentations.

Several analysts had noted that, too. We had two areas that were one-time hits and we should have told folks about and we didn't. One was with some billing mess ups and another was --

An accrual issue.

An accrual issue on some properties that we took over. We were responsible for payment of bills and we didn't even know we had it. And that's probably what he's looking at.

That's probably the biggest part of it, that's exactly right. The other thing that impacted that a little bit, Derrick, was mostly in regards to our Sunrise community, we trued up some of the bad debt reserves in the first quarter.

Our bad debt reserves we look at as a percentage of aging so as certain buckets move out, they get hit with a higher reserve percentage, if you will. So you saw a little bit of that in the first quarter and then once it's already out there, you don't have to hit anymore. That was another piece of it, but I think we've kind of, what Evrett just said and that is really the explanation.

So other than kind of the one-time items that were in the first quarter, I mean, you feel pretty good about where that expense level is today versus with what happened in the second quarter?

Be in a range, that's correct.

I guess the second question is, if you look at the difference between the same-store average daily rent growth of 2.3% and then the total rate growth of 5.3, I guess the difference there primarily related to some of the sales initiatives items that you did in the quarter?

Well, a big piece of the difference, really, is in the non-same-store, the overall company, we're taking on everything we acquire is in predominantly there were a lot of independent units at a much lesser daily rate than the historical, because the historical had some high skilled nursing daily rates. So that's really why our rates are only going up 2.5, whatever it's percentage on a non-same-store versus the same-store.

We have parsed every one of these. So even if we own it less than a year, we'll look at it and we know that. We're pushing rates in excess of 5, 6% for all of our properties.

It's just what Bruce said. If you take on an independent living place that's at $80 a day when our average rate is $140, obviously, it's going to pull that down. That's all it is.

That's it. Yes.

Okay.

And I guess the last question is, just looking at the cash flow from operations, if I recall, you put up about $32.6 million in the first quarter and then did you say 15.9 in the second quarter?

Correct, yes. That sounds right.

And then your maintenance Cap Ex is somewhere around $17 million a year or so?

Of which we'll get, well, $17 million for the second quarter of which $15 million gets reimbursed by Senior Housing.

He's going maintenance Cap Ex.

I guess exclusive of the reimbursement, I think Jerry talked about it, the maintenance level you said was around 17%?

Yes.

(Inaudible) million?

You're right. That's correct.

So do you think the back half of 2007 you'll see similar cash flow characteristics?

I think you'll see it in the, yes, from the second quarter, yes, there were some timing items that affected our cash flow, made it higher than it usually would be in the first quarter, AR swung, that was a big one, and then we got a large return of an insurance holdback that impacted cash flow. So I would say 2Q would be a much better gauge on our run rate of cash flow.

Regardless, it looks pretty strong. Thank you very much. I'll jump off.

And we'll next to Kevin Ellich at RBC Capital Markets. Please go ahead.

Good afternoon, guys. Thanks for taking the question.

Kevin, we're glad to have you join us.

Thanks, Evrett. Just a quick question.

I think you touched on this before, what is your outlook for expense controls for the remainder of 2007? What programs or initiatives do you have in place and how much do you expect to save?

Okay. Kevin, I'll start. This is Bruce.

I think the first piece I'd like to touch upon is really the insurance. We had a very successful, Evrett called it a revamping of our insurance programs, in the second quarter. We had a new broker that came on board with us in 2007, and we really looked at every line of insurance.

We got some decent savings out of our property insurance, now that's the smallest piece of our insurance, but we still, percentage-wise, it was pretty good.

But in terms of workers' compensation and professional and general liability, Evrett put the number on it, we'll save $0.01per share per quarter really starting in the third quarter. So we think that's a big thing.

And then in terms of the wages and the wages and benefits, we're still tracking that initiative that Evrett really highlighted. We call it our 3% initiative, again, it's just a name, we're not looking to pull 3% of our labor out but we should be getting another $0.01 per quarter from that initiative. We had one in the second quarter and we're well on track to the third quarter.

And then there was a lot of initiatives that Evrett talked about in terms of the hospitals that we're looking at as well, doing some of the same things there, looking at labor and looking at how those two hospitals can really work together because they really are right in the same marketplace.

I'd only say just one other thing. I did talk about enhancements to our systems where we have got a great guy on now whose Kip Kransdorf who handles and oversees our agency and just watches our overtime. That's been very, very beneficial, and I think that you're going to see some more benefits from what he's been able to do on that labor side.

But we, you know, Rosemary Esposito, I've told you time and time again is the expense queen and she, we're going to be able to continue to look at that and move it down. Our G&A, we looked at it very, very hard because we had some real concerns that, look, if we were at 4.2, should we be going to 4.5, and Bruce pointed out that by virtue of everything that we needed in December, we started saying to folks, look, we know that we're going to be moving this up because in order to cover some of the things from a clinical standpoint, from a marketing standpoint, from just running the Company, we had to add some. But I don't think anyone else in the industry is at 4.5%.

Okay. So was that 4.5%, is that a good run rate to use going forward?

Mr. Mackey agrees that it's going to remain flat.

Okay.

And then Bruce, kind of following up on the last two questions, I'm trying to get a good clean free cash flow number. You gave the Cap Ex number of about 17 to $18 million, but regarding what's reimbursed by S&H, how should I think about that?

It's tough to say. I mean, going back and forth, I've definitely kind of gone over that question with other investors. I think some people just take all of that out because at some point it's really -- we're hanging up on the balance sheet and at some point some of it's going to turn in Q3, four and one of next year.

It's up to you. I can't really put too fine an answer on it. But obviously the best answer is you take it all out.

Okay. And then I was just wondering if it's possible to get the current occupancy rate if you guys have that information?

We said, it's 90.5, it's actually, I saw last week it was 90.7 and it's 90.5 right now.

Excellent. Thank you, guys.

Thank you.

We'll go next to George Walsh at Gilford Securities. Please go ahead.

Bruce, earlier in the call you mentioned about the properties that you took over of a 200 basis point improvement there. I guess that's the SRZ properties, if we're talking correctly.

Is there any elaboration you could do on that and the savings that are there? I mean, was it the items you just went through about cost savings or are there additional elements there that you can go into and what was done there and what further improvements you see from those properties?

Let me take that, George. First, thanks for joining us.

I want to make sure that you understand that we have always felt that Sunrise probably, one of the best if not the best operator in the business. They are a company that we always look to.

We had opportunities with regard to insurance that we told you about before, and we also started our own right-sizing by virtue of a number of things on the labor, and so we just wanted to make sure that people understood that we weren't taking these things over and creating a drag. After taking into account the reduction of the management fee, we actually had a 200 basis point improvement.

Okay. Very good.

And I wonder if you could go a little bit more, I don't quite, or what is the impact in terms of, as you're saying with the rehab hospitals, there's certificate of need going out to 2009. Is that revenues you can't generate 'til then or what actually is the impact on that?

We're trying to bring these hospitals, George, into the 21st century and a lot of the projects that we have in place, it's actually it's called a determination of need, you were pretty close.

Okay. Right.

But in the state of Mass., if you spend over a certain dollar limit or you want to put a certain dollar limit into your physical plant, you need to get approval through this determination of need process. So for us to really bring some of these rooms up to where we'd like to see them, we need to go through that process.

Now, we can do the entire outside of the building and get that done, and we can do a lot of cosmetics up on the inside. So that is happening, and as Evrett mentioned, a lot of the outside work is coming to completion, we still have a little bit to go. But getting to the point where we can kind of redo bathrooms inside, electrical and all that other good stuff, we do need to go through that determination of need.

It's almost like --

Whoops. I think you dropped off or we lost George.

Your line is open again, sir. Mr. Walsh, please go ahead.

Yes, so it's more planning and zoning type of approvals?

Yes, but it's, most states have it. It's the Department of Public Health that does it, they want to make sure that monies are spent correctly in the area. They've just extended it out.

So we've got a bunch of bathrooms here that we need to change out. Many of them don't have a shower in them. And just a number -- they're not even ADA-compliant. We're going to do a lot.

It's just to get the whole program and make this so it truly is the juggernaut that we know it can be. It's just going to take us longer. That does not mean that we're not going to be able to attract the patients that we need to get back to profitability.

Okay.

Also, could you just go into the portfolio? You did mention a couple of the rural SNFs and the certain underperforming assets, just how are you feeling on the portfolio now on the divestiture side of possible properties and the underperformers going forward?

I'll start, George.

I mean, we feel very strong about our portfolio. We did talk about, in Evrett's prepared remarks, we had one rural skilled nursing asset that we're looking to sell right now. And we look at some from time to time, as Evrett says, a few are in purgatory and it could get out but it will take us another two for three quarters to make that determination before we do anything additionally. So I wouldn't see any significant moves in any changes in the portfolio.

And that does conclude our question-and-answer session so at this time I'd like to turn the call back to Mr. Benton for any closing comments.

Thank you very much and thank you all for joining us on today's call.

Looking ahead, we'll be presenting at the UBS Healthcare REITS and Operators Conference in New York City on September 17th, we'll give you all an update then. Of course we look forward to speaking with you on our third quarter call in early November.

Thank you. That does conclude the call. We do appreciate your participation. At this time, you may disconnect. Thank you.