Alerislife Inc (ALR) 2008 Q3 法說會逐字稿

Good day everyone and welcome to Five Star Quality Care Second Quarter 2008 Earnings Results Conference Call. This call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the conference over to the Director of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you and good afternoon everyone. Joining me on today's call are Bruce Mackey, Five Star's President and CEO, and Fran Murphy, Five Star's CFO.

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, November 5th, 2008.

The company undertakes no obligation to revise or publicly release the revision to any of the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission regarding this reporting period.

Actual results may differ materially from those projected in these forward-looking statements. Additional information concerning factors that could cause those differences is contained in our filings with the SEC.

Investors are cautioned not to place undue reliance on any forward-looking statements.

And with that, I would like to turn the call over to Bruce Mackey.

Thanks, Tim and thanks to everyone for joining us this afternoon. I would like to review our third quarter results as reported on our news release, issued after the market closed today.

Net loss per share from continuing operations for the third quarter of 2008 was $0.05, basic and diluted, compared to net income of $0.27 and $0.24, basic and diluted respectively, for the same period last year.

The third quarter had a number of unusual items. First, there was an unrealized loss of $1.7 million or $0.04 per fully diluted share as a result of our holdings in auction-rate securities.

Second, we recorded a loss of $3 million, or $0.07 per fully diluted share, due to recording a permanent impairment on some of our marketable securities. This impairment was attributable to losses in investments of financially related companies, including Fannie Mae, Lehman and AIG. These investments were held by our captive insurance companies. And third, there was a $743,000, or $0.02 per fully diluted share, gain on early extinguishment of debt.

Without the effects of unusual items in the quarter, net income per share from continuing operations was $0.08 per share, fully diluted.

I would also note that, excluding unusual items, in both 2007 and 2008 nine-month periods, fully diluted earnings per share have increased from $0.44 per share last year to $0.45 per share this year. In addition, our third quarter was negatively impacted by higher than expected utility costs and lower interest income.

Together, these items had an impact of $0.05 per fully diluted share when compared with that second quarter of 2008. Additionally, our pharmacy business was negatively impacted by an adjustment of $1.3 million or $0.03 per fully diluted share, primarily related to an adjustment to our contractual allowance that was taken in the third quarter of 2008. Taking these additional items into account, I believe, brings our results more in line with previous quarters.

The third quarter was a very big quarter for us related to acquisitions. We acquired three senior-living communities with 278 units and began leasing 17 senior-living communities with 1,279 units. Twelve of these communities are assisted living communities, and eight are independent living communities.

In addition to the 10 new senior communities we talked about on the second quarter conference call, we added two communities in Alabama and eight in Indiana.

Post-quarter-end, we closed on what we consider to be a trophy asset, MeadowWood, in Bloomington, Indiana. This is one of the top senior-living communities in the country. It is located on 50 acres and is adjacent to Indiana University, which has the third largest alumni organization in the United States. It was recently ranked by America Online as the number one senior living community in the country and was also cited in the Wall Street Journal on September 13th as an ideal retirement community.

I would now like to update you on our holdings of auction-rate securities. There was an event that took place subsequent to quarter-end.

In October, UBS provided us with a prospectus and settlement agreement. Under the terms of the agreement, UBS will repurchase at cost our investments in auction-rate securities at our request between the period of June 30th, 2010 and July 2nd, 2012. UBS has also agreed to provide us with liquidity under a no net cost loan program, which provides for, among other things, borrowing up to 75% of the market value of our auction-rate securities.

Acceptance of this offer also requires us to release all claims we may have against UBS arising from their marketing the auction-rate securities to us. We are currently evaluating this offer and discussing with UBS alternative arrangements regarding the no-net-cost loan program. The UBS offer expires on November 14th, 2008. If we are able to reach an agreement with UBS, we will be reevaluating the losses we previously recognized related to our auction rate securities in the fourth quarter.

Through the end of the third quarter, we have recognized $6.1 million in losses or $0.15 per fully diluted share.

To reiterate from prior calls, Five Star's long-term business plan is very straightforward. On the highest level, we plan to take advantage of our proven ability as an operator of senior living communities to meet the needs of the expanding population in the United States.

We are primarily focused on increasing the private pay portion of our core business, both organically and through acquisitions. We will achieve this growth while maintaining solid operating metrics. In addition, we are striving to improve the performance of our complementary ancillary businesses.

Our main areas of focus in our core senior-living business are to, one, improve occupancy. Two, increase same store average daily rate. Three, control labor costs. And four, maintain low G&A.

I will now review our third quarter performance in each of these areas.

Occupancy, which is currently our biggest challenge, is also the most difficult thing for us to control. Occupancy for the third quarter of 2008 was 88.2% compared with 90.4% in the third quarter of 2007 and 88.6% a quarter ago. On a same-store basis, occupancy for the third quarter of 2008 was 88.5%, compared with 90.8% last year and 88.7% a quarter ago. As of last Friday, overall occupancy was 88.4%. Same store occupancy as of last Friday was 88.5%.

Any kind of discussion on our future occupancy is going to trend towards is really discussion about the economy at this point. As I speak with other operators in the industry, the phrase I keep hearing is, we are holding our breath. If there's a long-term recession in the U.S., the impact is going to be felt by all companies, not just senior living.

To date, though, we have seen nothing material in the way of move outs related to the financial crisis. We have also seen little change on bad debt expense on a same store basis.

On last quarter's call, we spoke of our sales blitz. The blitz provided a good lead base that we will be able to build upon. Additionally, it provides the impetus for our 60 basis point improvement in occupancy from our low-point in the middle of July to last Friday. Also, for the first time in seven quarters, the quarter showed more admissions than discharges at our same-store communities.

On a same-store basis, admissions were up 2% from the third quarter of 2007 to the third quarter of 2008. We believe this is a result of the efforts of our staff in part to not only promote this blitz, but other sales and marketing initiatives we're aggressively pursuing at Five Star.

As a side note, we saw an increase in the lease of our new tracking software, as a result of the blitz, which we expect to be ongoing behavior that will enable us to better manage our sales process. As we reported on the Q2 call, we continue to move forward with other initiatives, including a new retail focused website, an AL Wizard, which helps us track levels of care for our residents more accurately and closer to real time. We expect both of these systems to help generate revenues for us in 2009.

I'd now like to move to another metric, average daily rate, which is an area where we have some control over. On a same-store basis, our average daily rate increased by more than 5% from $137 to $144. This increase reflects our ability to continue to push the rates for our private-pay residents in spite of the general occupancy and economic challenges we are facing.

As of right now, we are projecting a private-pay rate increase just under 50% for 2009.

As we told you on last quarter's call, the 3.4% rate hike to the Medicare market basket will benefit Five Star. The increase will mean an additional $4.5 million, or $0.11 per fully diluted share, annually to Five Star, beginning on October 1st, 2008.

On the Medicaid front, most states have finalized their upcoming rates. We seem to be in line with the situation of prior years of some states being up, some states being down, and the net result is about a 2% rate increase, like we received in prior years. This is particularly positive, given the shape of most states' budgets.

Moving on to wages and benefits. Wages and benefits as a percent of C revenues were 50.0% in the third quarter of 2008 compared to 49.4% a year ago, but well within our stated range. This is also up slightly from the 48.9% we reported in the second quarter. This is an area that we control and watch very closely. While we have performed well on this metric, we are not resting on our laurels, particularly given the occupancy challenges that our industry faces. Our community labor costs are reviewed daily and as census changes, we adjust labor costs accordingly.

We continue to maintain good control of our G&A. Our G&A as a percent of revenues was 4.2% in the third quarter 2008, which is down from the 4.4% we reported in the same quarter a year ago.

Last quarter we told you we expected this to be in the 4.5% range, so this was a solid result. However, we still think that we will trend towards -- we will trend closer towards the 4.5% range over the next several quarters.

Moving on to our ancillary businesses. I'd like to start with our rehabilitation hospitals. Revenues decreased 5.6% in the third quarter to $23.9 million due to lower patient revenues. More specifically, a decrease in reimbursement rates from Medicare.

EBITDA margins for the third quarter were approximately 7%. Frankly, it's a very competitive environment for rehabilitation hospitals in the Boston area right now. An illustration of this is that [Kindridge] just closed an [L-tech] hospital in Braintree, that is very close to one of our rehabilitation hospitals.

We are anticipating that this may eliminate some competition in the area. In addition, we view this hospital closing as an opportunity for us to buttress our staff.

We stated in the past that the CapEx work that's currently underway at both hospitals is going to be critical to helping us increase census. Our interior renovations at both hospitals should have the first ones completed in mid-December. This is slightly ahead of schedule from our last report.

Moving over to our pharmacy business, revenues increased 8% to $16.8 million in the third quarter compared to $15.6 million in the same period last year. Our EBITDA margin, however, was negatively impacted by a $1.3 million adjustment, primarily related to adjusting our contractual allowance. Without this adjustment, our margin in the third quarter would have been 3.9%.

Excluding the pharmacy to be sold, we have approximately 11,325 customers, a slight decrease from last quarter, which was due to the loss of a large third-party customer. In addition, we experienced some licensing issues, which prevented us from adding as many new Five Star customers as we'd hoped. Most of these licensing issues have been resolved and we believe we can add about 2,000 customers over the next several quarters. The majority of these new customers will come from Five Star communities.

On a positive note, related to our pharmacy business, we finalized a new wholesaling agreement, effective November 1st, which should generate savings of $500,000 annually. It's our goal that with the addition of new customers to our pharmacy platform, this new wholesaling agreement and several other initiatives we have in place in our pharmacy business, that our EBITDA margins will improve over the next several quarters.

While we dedicate some time speaking to these ancillary lines of business, we'd like to remind investors that our ancillary businesses represent approximately 15% of Five Star's overall revenues and less than 4% of EBITDARM. These amounts are based on the results of the nine months ended September 30th, 2008.

Moving back to our senior-living communities, as we told you last quarter, we are adjusting our senior living product mix slightly. We are in the process of converting about 100 units of independent living to assisted living and independent and assisted living to Alzheimer units. Also, we have about 172 new units in the process of being built. These are in some form of construction -- development, from either permitting to full-blown construction.

Now I want to provide you with an update on the Sunrise litigation. In October, Sunrise filed a motion to dismiss our lawsuit and we recently filed our opposition to that motion. We spent approximately $150,000 related to this litigation during the third quarter. Since we last spoke to you in early August, there has been a lot of bad news in the economy, including a complete sell-off in the stock market. This sell off has led to irrational evaluations, both in the markets and the senior living industry and placed little or no value on operational performance, property owned, cash position or financial flexibility.

To date, investors' thinking has yet to focus on the companies that are best positioned to withstand a potential long-term recession. Such a recession will be challenging, but we think Five Star is well positioned to not only survive, but to thrive. Our strong balance sheet and lack of near-term debt maturities gives us the flexibility to adjust to a challenging market environment. Our proven ability to increase same store average daily rate and control labor and G&A costs will serve us well. And our private pay focus, with primarily a needs driven product offering, we believe, will serve us well in trying economic times.

If we're in as sold a position as we feel we are and as undervalued as we believe ourselves to be, some of you might be asking why not buy back your own stock? In this unprecedented credit crisis that we're currently experiencing, right now the position of management and the Board is that preservation of capital is most important. In these uncertain times, we know that making acquisitions is, for us, like putting money in the bank, which can be readily refinanced.

If we buy back shares, we can't turn around and sell them if, for some untold reason, we need to access the capital. As market conditions and other factors change, management and the Board will continue to review this issue.

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

Thanks, Bruce. Good afternoon everyone. Senior living revenues were $241 million in the third quarter of 2008, an increase of 18% compared with the same period a year ago. This increase was primarily due to additional revenue generated by communities we began to operate in 2008, higher rates partially offset by a decrease in occupancy at our existing communities explains the rest of this increase.

Operating expenses at our communities were $182 million in the third quarter, an increase of 20% when compared with 2007. This increase was primarily due to the addition of new communities in 2008.

Regarding expenses, I would note that we have targeted some areas for potential savings in the near term. First, we recently negotiated an agreement with AT&T, which provides us with annual savings of about $700,000 for each of the next three years while delivering a more robust product offering to our communities.

Second, we are close to completing negotiations on a new long-term care pharmacy agreement, covering those areas that our wholly owned pharmacies do not service. We expect that this agreement will save us several hundred thousands of dollars per year. We continue to pursue a number of other cost savings initiatives that we expect to be approved shortly, including our work with several utility consultants, aimed at reducing utility costs, by entering into group purchasing arrangements and/or futures contracts.

On a same store or comparable basis, senior living revenues in the third quarter increased by 2.9% to $209 million compared with the same period a year ago. This increase reflects a 5.3% improvement in rates, offset by a 190 basis point decline in occupancy.

Same store senior living expenses in the third quarter increased by 5.5% to $160 million when compared with 2007. This was largely due to increases in workers' compensation, therapy service and utilities expenses.

Our hospital revenues were down 5.6% in the third quarter, as compared with 2007. 2.2% of this decline was due to the closing of several unprofitable outpatient clinics, with the remainder relating to lower census. The 1.1% decrease in hospital expenses for the third quarter was primarily due to reduction in labor and benefit expenses, as well as the closing of clinics.

As Bruce mentioned earlier, our pharmacy sales increased by 8% in the third quarter versus the same period a year ago. This was primarily the result of adding new customers from both our existing senior living and third-party operated communities. On a sequential basis, pharmacy sales decreased by 8% as compared to the second quarter of 2008.

Excluding the impact of the contractual allowance adjustment of 1.3 million taken in the third quarter of 2008, including an adjustment for the timing of these charges on a pro forma basis throughout 2008, pharmacy sales actually increased by 16% over the same period a year ago and decreased by 0.6% sequentially, largely as a result of a loss of a large third-party customer we spoke about earlier.

Our corporate and regional overhead, or G&A, necessary for supporting our operations increased by 11% to $11.9 million in the third quarter from the same period a year ago. This increase was primarily due to additional regional support necessitated by the 39 communities that we began to operate in 2008.

As Bruce noted earlier, our G&A expenses were just 4.2% of total revenues in the third quarter, consistent with our results in the second quarter. These expense levels remain the lowest in the industry.

Rent expense during the third quarter increased by 28% to $42 million from the second quarter of 2007 due to the communities that we began to lease in 2008 and additional rent for capital improvements purchased by Senior Housing since October 2007. Including our most recent acquisitions, our annualized rent expense is approximately $173 million.

Consolidated EBITDA was $6.6 million after adjusting for the unusual items noted in our press release. Cash provided from continuing operations was $22.6 million in the third quarter. During the third quarter, we had $16.2 million of capital expenditures. Of that amount, we anticipate recovering a total of $12.5 million through future sales to Senior Housing. During the quarter, we also purchased three senior living communities for $21.4 million and received a net lease inducement credit of $7.6 million.

Now turning to the balance sheet and some more items of note. Cash and cash equivalents, as of September 30th, was $40 million. This is a $6 million reduction from our cash position at June 30th and is primarily due to the generation of operating cash flow, offset by the acquisition of the three senior living communities in receipt of the lease inducement credit that I just mentioned.

Accounts receivable at the end of the third quarter was $58 million. Our days sales outstanding, including the rehabilitation hospitals and the pharmacy operations is an industry leading 22.7 days. At the end of the third quarter, we had $152 million net property and equipment, which included 18 properties, comprised of 1,303 independent and assisted living units and 271 skilled nursing beds that were directly owned by Five Star.

15 of these 18 properties are unencumbered by debt. Our balance of property and equipment also includes $27 million of assets that we intend to sell to Senior Housing, as committed by our leases. Our long-term liabilities at September 30th included $127 million of convertible notes and $12 million of HUD mortgages. We had no amount outstanding on our $40 million revolving credit facility. We believe that we are currently in compliance with all material terms of our mortgages, convertible notes and revolving credit facility.

To review, despite the general economic challenges we faced, the operating metrics in our core senior living business, including occupancy, rate, and cost controls, remain solid in the third quarter. Our performance in the coming quarters will be greatly influenced by the future occupancy levels we are able to attain.

Looking forward to the fourth quarter, given the difficult environment, our goal is to maintain and increase occupancy levels through the various activities and initiatives on the corporate and community levels that Bruce outlined in detail earlier. In addition to the recent increase in our Medicare reimbursement rates, we will work to increase private pay rates where we can to offset our increased costs of labor, food and energy.

We believe that our management team has the ability to drive census and revenue in these very difficult market conditions. At the same time, we will work to control rising costs by operating even more efficiently than we have in the past. We continue to generate positive free cash flow and have access to several sources of liquidity, necessary to fuel our growth. Our operating leverage leaves us well positioned to significantly expand our operating earnings once macroeconomic conditions return to normal levels.

That concludes our prepared remarks. We are now ready to take some questions.

(OPERATOR INSTRUCTIONS) We'll have our first question from Derrick Dagnan at Avondale Partners.

Good afternoon. I wanted to drill down on this contractual allowance, if you don't mind, on the pharmacy business. Just going back and looking at the revenue performance of this business over the last several quarters, I don't remember experiencing -- you guys experiencing this large of a contractual allowance. And I would just like to get a little bit more color on that, on, I guess, the relative size of that allowance and what happened.

Sure, Derrick. This is Fran. We haven't reported on the contractual in the past. This is primarily related to our billings and our Medicare Part D. During the quarter, we experienced some unusually high contractual charges that were ultimately determined to be about $260,000 in excess of what should have been recorded.

As we dug into it, we concluded that we needed to book an adjustment of 993,000 to properly state these reserves. This is all related to prior periods.

So there's the 260 and then on top of that was 990 for prior periods?

That's right. We pro formaed out the impact to each of the quarters throughout 2008.

Okay. Okay. And I guess, could you give us a little color on some of the recent acquisitions you announced, information on maybe occupancy levels or daily rates? And if you're not willing to give us the specific numbers, maybe just relative to your existing business? Is it lower than existing business or higher?

I mean most -- if you look, they're all independent living. A fair amount are independent living. Occupancy level at most of these properties is significantly higher than our same store communities. Two in Alabama, the eight in Indiana and the one we just referenced in Bloomington are all stabilized communities, all have occupancies, on average in excess of 90%. And the ones in Alabama and Indiana, the average daily rate is probably less than our overall same store IL-AL portfolio. And the one in Bloomington, Indiana is probably on par or even slightly higher. They do have a skilled nurses component there, so that will be a little bit higher than the other ones.

Okay. I'll hope out and let others ask questions. Thank you.

All right. Sounds good, Derrick. Thank you.

We'll have our next question from Joel Ray, Davenport.

Good afternoon, folks.

Good afternoon, Joel.

Hi. I was wondering, your overall expenses, wages and benefits, for the senior living site, did pop up some to 50% in the quarter.

Yes.

Do you perceive that some of that is arising from the recent additions of the properties this year?

No. Primarily it's related to, on the benefits side, mostly workers' compensation reserves. We had a slight up tick in the third quarter.

That's right. In the third quarter of 2007, we experience a very favorable reduction this expense due to better experience and this comparison hurt the current quarter.

Right. That really robbed us of a few pennies of earnings.

Yes.

What do you think is an appropriate ratio to be focusing on going forward? Are there one-time catch-ups that occurred here? Or should we be -- ?

It's going to be in this range, Joel. I mean, I think I'm going back probably 2 or 3 quarters now, but we always have our stated goals. I mean, the 51, 52% range. I think last quarter, we really said we'd drop that down to be below 51%. So we were happy being at 50.0%.

Right.

To be in this range going forward.

Okay. And if anything, you might come up with TAT is what you're saying? The longer term goal is 51, 52%?

No, no. It was 51, 52%.

Oh, I apologize.

Yes, we pulled that down to -- our goal is to be under that 51% range now.

Okay. Let's also think a little bit more about the opportunities that you see with the pharmacy business. It sounds like you had some near term challenges vis-a-vis these -- going back on the contractuals.

Yes.

Can we go and start getting these contracts in place? Can we go and start getting more capacity in? Because this part of your business, while it's a small portion, is a little bit of a ball-and-chain around our neck. It seems like it continues to come up a bit short. And I was wondering where do you see you taking this business?

Well, I -- just taking a little reference to the ball around the -- ball-and-chain around the neck, it's done close to our stated goal. I mean, we always said we wanted to be in the 5% range, albeit we are at 4% pro forma to those adjustments that Fran talked about.

Adding new customers to the pharmacy is something that you have to do very carefully. It's generally something that has to be done by a licensed pharmacy technician or a pharmacist themselves, they can do it one patient at a time. We generally don't like to rush new business onto the pharmacy, given the challenges that can occur.

I did mention that we had some licensing issues as well. We were trying to execute and open up a new satellite location in Delaware, and that took probably about a quarter or maybe even a little bit longer than we would have liked to get done. That satellite is now open. We expect to, I wouldn't say rush, to add new customers, but I did reference in the prepared remarks, we look to add about 2,000 customers over the next several quarters. I'm guessing that's about three quarters worth of work for us to take on.

Okay. I'm just writing this down. And lastly, I know you had mentioned you don't anticipate the company buying back shares. I was wondering what about insiders? Can we expect maybe some of you folks to step up and put a few bucks in? Because that certainly would be a positive sign for the investment community and existing investors that, again, putting your money where your mouth is.

Yes, no. I don't disagree with that statement. I can only speak for myself. It's something I've looked at in the past. I'll continue to evaluate going forward. I really can't speak to -- about if I am and when I'm going to purchase. But also there's generally a very short period in which I can purchase, given insider information that I generally have.

But I will look to do that in the future.

Great. And lastly, can you tell me what your thoughts are as far as resolution with the litigation with Sunrise? What do you think the timing is to get all of that kind of wrapped up?

It could take several years. Just -- we'll go through these next couple of motions, we'll see where that leads us to and if this is to be a full-blown litigation, I -- just -- on the professional liability side, I'm dealing with the litigation now from 2001. So it can be a several year process.

And can you refresh me on what it is that's involved with this suit?

Sure. We issued a press release in, I think it was, the middle of August. Yes, August 11th. And it primarily relates to historical insurance reserves that we believe were overcharged to us by Sunrise.

Okay.

And Sunrise issued public statements in 2007 and maybe even in 2008 referencing refunds that they had made related to overcharging customers in the time period that we had a community that was managed by Sunrise.

So we believe some of these refunds were in fact owed to us.

Very good. Well thanks very much.

Great, Joel. Thank you.

Thank you.

(OPERATOR INSTRUCTIONS) We'll go next to Donald Hooker, UBS.

Hey, good afternoon.

Hey, Don.

Hey. Great. Did you all mention what your free cash flow was? I'm sorry if I missed it. Maybe you could break that down, cash flow from operations and CapEx?

We had $22 million of CapEx -- of operating cash flow and a net $2 million of CapEx expenditure. We also had $20 million -- $21 million of purchases of senior housing communities and less a credit of $7 million.

Got you. And you, earlier, just one of your comments at the utilities and interest income had a $0.05 negative impact, I think I heard you say. Is that predominantly the utilities?

Predominantly utilities, yes.

And I assume that's, obviously, reversed. Or I mean, just think guessing when utilities -- ?

Our expectation, that will come down significantly in the third quarter.

Okay. And then I'll ask one more and then jump off. Just out of curiosity, I mean you have a number of -- you have assisted living and independent living properties. Is it -- how -- have they been performing differently? Has assisted living been more resilient? Or has there been not much difference, in your view?

I wouldn't say the -- our experience over the last year or so is for the most part, assisted living's been easier.

Yes.

Getting new people in the door than independent living. But I wouldn't say it's changed materially over the last several quarters. Independent living's been more difficult and it is still more difficult today.

Okay. Let me ask one more actually and I'll let you go. And in terms of the hospital, maybe you can just update us kind of if you have a vision as to when that might break even in the years out?

It's really dependent upon driving occupancy related to our new construction. We expect the construction to be done at both hospitals in the month of December. So I think really the first full quarter of 2009 will give us an indication of how that goes.

Okay. Okay. Well thanks. Thanks for the -- thanks for your time.

No problem. Thank you.

Thank you.

We'll have our next question from Jerry Doctrow, Stifel Nicolaus.

Hello. A couple of things. I think I just wanted to clarify, with the 2 million, 2 million was really maintenance CapEx?

No. 2 million was the net expenditure after reimbursement from senior housing.

Okay.

And, Jerry, what that really represents, that's CapEx on properties owned directly by Five Star.

Okay.

And on some items that we don't sell to Senior Housing.

Okay. And earlier you had said, I'm just trying to reconcile this stuff, you -- I thought you had said that 16.2 million of CapEx, was that the quarter? And then 12.5 million of that to -- will be done by -- will be sold -- future sales, S&H?

That's right. Of that $16 million, 12 million will be eventually reimbursed to us by Senior Housing. It will be sold to Senior Housing.

16.2 and then 12 even? Or 12.5 of it?

It's -- I -- it's just over 12.

Okay.

But that was 14 million in the third quarter.

And we sold 14.4 in the third quarter.

So -- right. Okay.

And then, Jim's just -- if you were just trying to limit it to maintenance CapEx, which I assume was included in those numbers, there's sort of a mix of -- a mix of income enhancing stuff and perhaps regular stuff. Is there a -- do you have just a maintenance CapEx number that you're using, as we use it to get kind of cash flow?

Well, Jerry, I thought about this question over the last quarter and I wanted to find a way to come back and respond to you. Yes, the same one the last time around. And what I've done is taken a look at what our spend is and if I look at the projects we spend money on, and characterize them by size and look at any project over $500,000, which I consider to be a significant project, about a third of our CapEx spending in the third quarter, a third of that 16 million, was spent on projects that exceeded $500,000 in total costs.

Okay. And so basically everything under that would be kind of maintenance in your view?

Yes. I'll -- but it may include some large things.

Yes.

That wouldn't need to be replaced for long periods of time. We often replace call systems, for instance, which probably don't get swapped out any more than 7 or 10 years. But I would say that those are maintenance items in this business.

Okay. Okay. So if I'm running about two-thirds of that 16 million, that's kind of the right number for maintenance?

Yes.

Okay. Okay. And then I think, again, you touched on a couple of these things. But unencumbered assets, and again, this is probably on the balance sheet, but it might not be sort of a real market value. Do you have a sense in, just in terms of, what amount of unencumbered real estate, if you wanted to sort of lever up with some agency debt, how much capacity, roughly, you've got available?

Well I think just the number of units, Jerry, we have right now, we've got -- Fran mentioned how many communities we actually own, in terms of the number of units. You've got like 1,700 ball park, Fran, of independent living and then another 270 of assisted living?

That's right.

So putting a fair market value on a per unit basis of those properties and I think I might have misquoted -- yes, 1,300, I'm sorry.

Okay.

Of owned IL-AL.

Yes.

All of them, fairly stabilized assets. I know we're still working on the three new seasoned assets, which are not stabilized. Those are in there as well. But the majority of the ones, like I said, are all stabilized assets.

Okay. And it was 1,300 IL and 270 AL. Is that -- ?

271.

Oh, it's 1,300 IL-AL.

Okay.

And 270 skilled nursing.

270 SNF. Okay.

You've got it.

Okay. Okay. And we could put a number on that. Okay.

And there was this tax provision that was kind of like a positive add-back or something. Could we just -- what was that all about?

There were some true-up credits that we recognized in the quarter. We were able to offset all of our federal expenses because of a provision that changed the way AMT is calculated. So we got back our 2007 AMT costs as well as what we had charged this year.

And that's a one-time basically item. So going forward, you would be, again, going back to being kind of a normal taxpayer? Or do you have a sense of what the rate would be going forward?

Yes, I think going forward, we do expect that to trend back to something more historical, less the AMT going forward.

Okay. Okay. And then just the last thing, and people touched on this, but I mean it sounds like from what you're talking about, you're working very hard obviously to deal with occupancy and rates and all the other stuff you sort of went through. And I guess -- you talked about the stock, so we won't go there, but in terms of just the one thing that you haven't really touched on that I think I continue to wonder about and some of the investors wonder about, is you've got these two businesses, pharmacy and rehab, that are clearly not core to your operations. And the margins you're talking about are dramatically lower than some of the big companies that are starting to put up good results in those areas. So why wouldn't you think strategically about exiting institutional pharmacy and why wouldn't you think strategically about exiting rehab? Whether it's selling it to one of the large not-for-profits in the Boston area or selling it to one of the specialized operators? Because it's clearly a tough business. You're not -- it's not your core business and I just don't understand why you sort of seem so wedded to this -- those two business lines?

Yes, well let me speak first to the institutional pharmacy business. I do wan to point out, and I've pointed this out in the past, we got into this business to provide a better service to our patients and residents that we serve. If Omnicare or some other provider is in our building, and for whatever reason there's a pharmacy issue, it's our issue. It affects our residents, our patients, we're the one that has to deal with it.

And we saw that in the past. That's really why we got into the pharmacy business. Albeit, it doesn't make as much as we would have liked, in the past we got into it, we always thought it was going to be an 8 to 10% margin business. Years ago, we dropped that down significantly. But it does make money for us. We haven't paid a lot for these assets. We've generally bought them under the radar screen from Omnicare. And we've built up a business over time.

We've got about 2,000 customers left to add to the business, but as we grow, that might go up. We want to finish adding those customers to the plan, to the platform rather. See where that gets us. And at that time, perhaps we'll consider selling it. The Board has looked at that in the past. I wouldn't say that will be taken off the table in the future.

I'll point out the same thing on the hospital side. I think our intent, again, is to finish the CapEx work, and if it doesn't pay out, it's something that we'll have to take a look at.

And so is -- and is there sort of a time line for each of those? I mean, is 2009 sort of the expectation for both of those things being finished? Or -- and you'd reevaluate or --

I think potentially on both -- that's a possibility. Obviously I don't think right now is the right time to sell anything in this market. But it's, again, adding the 2,000 customers takes us several quarters and we get there. We'd like to have a quarter of -- to look at the results. It's probably end of 2009, early 2010.

Because I think -- I mean, from my perspective, the credit crisis sort of works both ways. I mean, there'll -- opportunities to buy core assets at much more accretive -- much more attractive prices, probably, presents itself and it just -- again, I continue to think strategically, refocusing on the core would make a lot of sense. So -- and I guess, well, I mean, we've -- you talked about it, it's something you'll consider, but it's probably a year off. And so --

Correct. And it's something we have considered in the past.

Okay. Okay. Thanks.

Okay. Thank you, Jerry.

Thanks, Jerry.

We'll have our next question from Sean McMahon, Kennedy Capital.

Hi, Bruce, how are you?

Hi, Sean.

Can you maybe help me out on one -- the acquisitions you guys did this quarter on the average pay back for a property?

I'm not sure I necessarily understand the question?

Well, what's your IRR you're looking for on a property today?

Well, I mean, don't -- most of the properties that we've purchased are that Five Star bought directly, are undervalued. And when we say undervalued, we bought them for about, I think, net 45, $50,000 a unit after taking into account the money that we got from the lease inducement and then other than that, we're buying properties mostly sale lease backs to Senior Housing. So, again, we're not putting any money in. We're actually generally getting money out on the networking capital basis.

So on that -- I mean, is that on a cap rate? Or how should I think about that? Or even if we take the facility that you did buy this quarter, how long should you -- how long or what's your IRR hurdle rate for buying a property?

Overall, generally, we're looking at the 18 to 20% range. It's going to take some time. Especially in these -- in this market.

Okay.

That's on the acquisitions that we've done. So to stabilize that, it's like I said, for the most part we're pulling money out the day we acquire something. Because it generally is a negative working capital situation.

Okay. So an 18 to 20% IRR is kind of what I should be thinking about when you look at a project though?

Yes.

Okay. So if I look at the cash flow here, 22 million, I back out the $12 million for CapEx, is that fair for routine CapEx? Is that fair?

It's going to be high. That's high.

Okay. What is the routine CapEx then?

Well, I mean, this quarter it was a net 2 million. So you get the 22 million and then a net two this quarter.

Okay. So help me to understand, I mean you could technically buy the company then, all the stock that's out there in the next 2.5 quarters, but yet we're looking to buy properties that could take us 4 to 5 years. So why are we not buying back the stock today and why are we buying property?

Well I mean, we're not buying -- I mean, I'll go back to my prepared remarks. We want to make sure we've got liquidity on hand to run this company for the long term.

Yet you're buying property.

We are buying property that we can readily refinance. Don't forget, we've got a lease to Senior Housing as well as our other sources of liquidity out in the marketplace.

Okay. That's not the question though. Why are we even buying property when we can buy the whole company back for less than -- in less than 2.5 quarters?

I don't think we'd be able to buy the whole company back in less than 2.5 quarters based on our cash flow. I mean, the stock price is obviously going to drive up significantly the day we --

Well, you're at 53 million today, you threw off 20 million, or what you're telling me, in free cash flow. Where -- what am I missing here?

The numbers you have are correct.

Okay. So you can technically buy the company back in the next 2 to 3 quarters, but we're buying property that will take us 4 to 5 years?

Based on the stock price today. But like I said, I think the day we announce the stock buy-back, if it's anything significant, the stock's going to go up significantly.

But why are we not doing that? That's kind of my point. Why are we even out there buying property today when we can buy the company back for significantly better return?

We're not doing that in today's market because we don't know when we'll have access to capital in the future. That might change. Two quarters from now, it might change next quarter. I don't know. But right now, the decision's all under our capital. And we'll fly it towards properties.

Well, you tell me that, but then you bought three properties. Correct?

I just told you that we're buying properties. Yes. We are not putting capital -- we are putting capital into buying properties.

Okay. So you're -- that's my point. So you're saying we're going to hold onto our capital for better ideas out there, but we're buying property when the stock's significant undervalued. I just don't get that. Help me understand that delta.

We can go back and forth and talk about this and I don't know if we'll ever agree on this right now.

Well, I'm just trying to say, if you're looking to put to the highest return, that would be buying the stock back, not property. Is that fair?

At today's stock price, correct.

Okay. So from now on, I mean, should we assume that management and the Board's going to look at buying stock back instead of property? How should I think about that?

Sean McMahon: No. For the short term, you should assume that management's going to take money and buy properties.

Even though it's at a lower return?

It's a lower return, but given today's credit crisis, I mean, we don't know when our next access to capital's going to come. And if we run into problems a year down the road, two years down the road from now, the liquidity hasn't come back to the marketplace, we're going to wish we hadn't bought stock back when we can refinance properties.

Okay. I guess we'll just have to agree that we're not seeing eye to eye, that the stock is a better return today, but we're going to still buy properties. Anyway, my next question to you is with all the challenges you are facing with your portfolio today, why are we even buying properties today? Why not try to fix what we have and then maybe come back to the market?

Well I think we're in a solid position with what we have. I mean, if you really kind of look at the numbers, I think we're reporting pretty good metrics and buying stabilized properties that we're doing well with.

So on pharmacy here, I mean, do you feel like everything's working out well there then?

I didn't say it was on pharmacies, I said it was on properties. On pharmacy, talked about our margins are a little lower than we'd like. We've got customers to add, as Jerry and I just went into, over the next several quarters.

All right. Well, lastly, I just would like you and the Board to hear me say that we think that this is completely a bad strategy and you should be buying back stock at this level, aggressively. Thank you for your time.

Okay. Thank you.

Thank you.

We'll go next to George Walsh, Guildford Securities.

Bruce, could you review the auction rate settlement offer again in terms of the three components there?

Sure. There is a -- there's an agreement that we have the right to potentially put our option rate securities to UBS between June 2010 and July 2012. With that agreement, there is available to us a no-net-cost loan program, but we also have to release any claims that we may have against UBS in regards to their marketing these auction-rate securities to us. I really think those are the three components.

Okay. And does that mean you can put it to them? Is it all of it at any point starting on June 30th, 2010 or are there increments to that?

No, it's all of it at June 30th, 2010. It's [at par].

Okay. Until 2012. And the no-net-cost loan, is that something that would start immediately between now and the first offer? Or until you -- how does that work in terms of the availability of the no-net loan?

It would star right away. Again, that's probably the one item that we're still negotiating with UBS.

Okay. And so theoretically -- okay. And the other thing, this offer is good until November 14th?

Correct.

All right. Are you going -- you're talking about it, so I would guess you're certainly leaning towards it.

The other is obviously if that's accepted, there would be a reevaluation on the losses. Are they -- do you have -- have you done any review or that would take those back to par, where you got them, which I think was about 74 million or so?

It's funny. Yes. Effectively, that's probably how it works. You almost have to bifurcate it. The auction rate securities will still trade. And then they might trade down. They might trade up. But we have a put right that we can place a value on. It's almost a derivative. And we get to value that. And that would offset, probably, most of the losses.

Okay. So it would be "mark-to-market" and then the value of the put?

Correct. Exactly.

Okay. The 3 million loan -- the $3 million loan impairment on the loss to the marketable securities. That was out of the captive insurance?

Yes.

Okay. And how is that portfolio looking now in the captive insurance company? I mean, you kind of had some of the, unfortunately, some of the three companies that got hit over the last couple of months. How is the balance of that portfolio?

I mean, I think the balance of the portfolio, it's still in companies that are significantly down. We still have unrealized losses related to that portfolio. You can see them right now in our balance sheet. And -- but as of right now, we don't expect to take any future losses. That could change. But most of the securities that are preferred investments, they're all still paying dividends, we all -- we expect all of the companies to continue to pay the dividends and -- but it's on that -- will get looked at in the future and does get evaluated by our auditors at year-end.

Okay. So was the increase in the workmans' comp related to the insurance write down or were there were there actually more workmans' comp events that you had to increase your reserve?

No, our workers' comp costs have been very stable. What we were up against was a very big quarter a year ago.

Okay. When you do have these write downs in the insurance, do you have to put up more reserves to cover?

That's something we have to evaluate. As of right now, no. No. We've been significantly overfunded in our (inaudible) for quite some time.

Okay. Okay. You're overfunded into that point. Okay. And the discontinued operations charge.

Yes.

I may have missed what exactly was involved there. Is that discontinued operations that are still a problem? Or are these discontinued operations that have been sold?

Yes, we really didn't speak to our discontinued operations, but I'll go into it. We still have two properties in Pennsylvania that we're working on selling as well as our mail order pharmacy and a small institutional pharmacy out in California. We've got negotiations really in almost all lines of those business that are in some points along the way towards finally disposing of them. But nothing to report on right now that's finalized.

Okay. And I guess the other side is, Bruce, which you spoke to. Obviously a large issue here is that we're dealing with a recession. And if we take the market valuation, your price like there -- they're having a problem with you guys as a going concern, although obviously they're doing that to a lot of companies, but you guys are -- even with the cash on the balance sheet now, I think you have 60% of cash and if you get some type of settlement going with these auction rates, it's -- you're probably below cash. If you put a value on that loan.

It's just astounding to me, I guess, the valuation. And the discount to book value. I think that's 60% of book. And you spoke to it a bit, but is there any amplification you can give to the idea? Because people are extremely concerned about the viability of companies, obviously, going forward into this recession. And I just wonder if you can amplify things as far as your ability to work through a difficult recession, even if there are times where you are break even or unprofitable, but to survive through that, through your balance sheet and through partners like Senior Housing or others?

Yes, George, I appreciate the question. I think we -- it's a relatively small sized balance sheet, but I think it's a very, very solid balance sheet, especially compared to our competitors. I mean, you mentioned how much cash we have. We hopefully will have access to some of the investments in our auction rate securities. We still have an untapped line of credit as well as, we believe, over $100 million of property and equipment that we could refinance with our partners, Senior Housing, or with another company. Or put debt up. So I think we will be well positioned to, and I said in my prepared remarks, really to not only survive, but thrive during this time. I think there will be a lot of opportunities and we're looking to take advantage of them.

Great. Is there anything else operationally that you feel are further issues going forward? I mean, is it really just a matter of the depth of the recession people are worrying about and occupancy and what that can do on a cash flow basis? I mean, you -- there are things that come up on a quarterly basis. The auction rates were obviously a negative development, but it looks like there could be some resolution there. But you have the captive insurance, there's some -- you had to take a hit on it there. It's -- it's tough to always come up and think with things. I try to examine them and come up with an analysis, but are there any other issues that could affect you going forward as an operating company?

Yes, we look at a number of things all the time. And there'll be things out there. How tough will this recession be? It's really anyone's guess on how that's going to impact the senior living industry.

Right now though, through October, and October was a pretty rough month, it didn't hit us too bad. And it didn't really hit us that bad in the third quarter, albeit, most of the bad news really came out in October and we still saw some decent activity, both on the move end as well as adjusting our rates for the upcoming year.

I mean, a lot of those notifications went out during the month of October and are being put into place. They're not effective until January 1st, 2009, but people know about them.

Okay.

So I think we will be well positioned moving into 2009.

Okay. And I appreciate -- oh, if you come with some type of settlement on the auction-rates, there would be some type of news release regarding that as a material event?

Yes, no question.

All right. Very good. Okay.

Thank you, George.

Thank you, Bruce.

That's all the time we have for questions. I'll turn the conference back over to Mr. Bruce Mackey for additional or closing remarks.

Great. Thank you all for joining us on today's call. We look forward to updating you on our progress in the future. Thanks.

That concludes today's conference. You may disconnect at this time. We do appreciate your participation.