Brookdale Senior Living Inc (BKD) 2007 Q3 法說會逐字稿

Good day, and welcome to today's Brookdale Senior Living third quarter earnings conference call. Today's call is being recorded.

For opening remarks and introduction, I would like to turn the call over to Mr. Ross Roadman. Please go ahead.

Thank you, Tina. Good morning, everyone. I'd like to offer all of you to the third quarter 2007 earnings call for Brookdale Senior Living. Joining us today are Bill Doniger, our vice chairman; Mark Schulte, our co-CEO; and Mark Ohlendorf, our co-President and Chief Financial Officer.

Before I turn the call over to Bill, as Tina mentioned, this call is being recorded and the replay number is 888-203-1112 from within the US, or 719-457-0820 from outside the US, and reference the access code 4129480, as recorded in the press release.

This call will also be available via web cast on our website, www.brookdaleliving.com. I'd also like to point out that the statements today which are not historical facts may be deemed forward-looking statements. Actual results may differ materially from the estimates or expectations expressed in those statements. Certain other factors that cause actual results to differ materially from Brookdale Senior Living's expectations are detailed in our SEC report. I direct you to Brookdale Senior Living's earnings release for the full forward-looking statements.

And now, I'd like to turn the call over to Bill Doniger. Bill.

Thanks, Ross. Today, we reported CFFO of $0.43 a share, a 59% increase from the third quarter 2006 reported CFFO of $0.27 a share. From an operating perspective, we continued to exhibit really attractive growth metrics. Same-store NOI for the past 12 months increased 8.8% over the same period a year earlier, and same-store NOI increased 8.2% for the third quarter 2007 over 2006. This organic growth rate, which translates into about 20, 22% cash flow growth, underscores really the strength of our business model.

And with that being said, this year will be below our expectations on two fronts. As we talked about last quarter, entrance fees, while they continue to show improvement, are still going to be below our full-year estimate (inaudible) of about $13 million, which is about $0.13 a share; and, secondly, occupancy. As we -- as you see in the press release, our occupancy has remained flat. We had expected at the beginning of the year for occupancy to end up at around 93%, at 91%, that 2%, I guess 1% is about $0.14 a share. So 2% occupancy adjustment is about $0.20, $0.24, $0.25 a share.

Again, not going backwards, hanging in there pretty well, but not going forward as fast as we thought it would be at the end of the year. Why is that? Really, two reasons. Beginning in early August, as everybody knows, recessionary fears, sub-prime, housing slowdown, all of the following really caused residents to step back with their adult children and delay decisions to move in until they said, "Sell their houses." To us, this is a timing issue. People are deciding to move into a Brookdale facility because there is a need. What they live in their home is not appropriate. And so this is a decision that many people are making, again, because they have to. That being said, it's taking longer for people to move in because they're waiting to sell their houses. And, as everybody knows, that's taking longer, and, in many cases, people are getting less than what they had hoped for.

While it's easy to blame the market, I would say it's not 100% of the reason for not being able to gain the occupancy that we had hoped. Some of it's our fault. We bought a lot of assets. We have a lot of integration activities and it's just taking longer. Again, we're very confident we're going to get there, we just didn't get there when we thought. That being said, we have a lot of good things going on, which Mark Schulte will talk about.

So how do we think about the business going forward? Actually, very optimistically. We grew 8.8% year-over-year on an un-leveraged basis this quarter, in what we would think is a very, very challenging environment. Maybe the way to think about the business is, let's hold occupancy constant at 91%. Let's assume entrance fees don't change from where they are today, again, below historical levels, and we just continue to grow at 8% un-leveraged on an NOI basis. That will generate 20-ish percent free cash flow growth over the next year.

Why do we think we continue to do that in this environment? It's pretty simple. Our residents live in our facilities, for, on average, about three years. Every year they get 4 to 5% annual rate growth -- rate increases and nobody moves out down the block over rate increases. It's not the way the business works. There's a service component. This is not a commodity business. Our expenses grow at about 3.5% annually, and we operate at a 36% margin. That part of the business we feel very, very good about, and we're seeing it even in a very tough environment. Our October numbers are consistent with that as well.

So what you have is 8%-ish NOI growth, low 20s organic cash flow growth, with some material upside. As I said before, we will get back to $44 million in entrance fees, another $0.13 a share. We cannot tell you when that's going to happen because we're operating in a different -- difficult economic environment. Occupancy, we should get to 93% occupancy here. Again, not going to tell you when, but that's another $0.25 a share. And last, expansions. We're doing a fair bit on the expansion, adding another level of care, very need-based-type expansion work. Those numbers start to show up in 2009, so you're not really going to see that in 2008. But if we billed out what we billed out, $500 million in capital, at 15% returns on asset, you get into the $0.25, $0.30 a share in earnings benefits. Again, not really showing up 'til 2009, but that will be there eventually.

Really, to conclude, before I turn it over to Mark Schulte, while we don't love where we are this quarter, we think we have a fantastic growth model and our optimism for the business remains undiminished. At the beginning of the year or the middle of the year, people were worried about over-building. We didn't think that's a risk. We still don't think that's a risk. Actually, in the current environment, I think it even pushes out theoretical building even farther. That, the over-building issue, is something that if it happens in excess capacity, that affects the long-term growth rate of the business. The stuff we're talking about today we view is temporary; can't tell you when it's going to end. But our business remains sound and robust and we're very optimistic about where we're going prospectively.

So with that, I'll turn it over to Mark Schulte.

Thanks, Bill. There's a few things I want to talk about this morning. As Bill talked about, Brookdale's occupancy did not improve as we targeted. Let me talk about some initiatives that we've been working on that we're confident will overcome some of the environmental challenges that we're experiencing. These initiatives are focused on not only attracting new customers, but also addressing the demand that already exists within our resident population.

One of the biggest initiatives of our recent integration has been to coordinate our local marketing and leverage our multiple product offerings in the same market. Internally, we call this initiative major market management, or, for short, we call it M3. Specifically, we now have one group in charge of marketing for all of our locations and product offerings in a particular market where we already have a lot of units. This lets us provide prospective and existing residents with the full range-of-care options, and, particularly those needing a higher level of care. And we do this at different Brookdale facilities in the same local region where they already live, in effect creating a local or a regional CCRC.

By offering more options to residents who typically move to other local operators as their acuity needs change, we are able to re-capture a portion of those move-outs and tap into an existing source to increase occupancy even in a weak economy. Let me give you an example. We have four facilities with 542 units in the Denver area that were 87.5% occupied as of June 30th. We initiated the M3 effort in the third quarter in Denver, and within three months, occupancy at those facilities increased to over 98%, primarily as a result of marketing the higher acuity services at these communities to the outgoing residents from our other nearly 1,200 units in the Denver area.

By the end of this year, we will also have completed our branding initiative at all Brookdale locations, so that our signage, name, advertising, collateral material, come under the Brookdale brand standards easily identifiable for our customers, and support our M3 initiatives in all of our major markets.

In the next few weeks, we're also going to be rolling out a new, more attractive and user friendly website that's designed to utilize the latest technology and to maximize our search engine exposure. This is very important, because the percentage of leads we generate from our website and the Internet now exceeds the number of leads we generate by traditional offline advertising, like print advertising, radio, and other types of media.

Second thing I want to talk about, our expansions initiative has also been planned to take advantage of this local CCRC concept. Our current plan is to expand our portfolio by over 2,000 units over the next three years, with a total construction budget of roughly $500 million. You should see the accretion to earnings begin to show up in 2009.

When we look at doing expansions, we focus on adding like units to existing facilities or to take advantage of excess demand or adding another level of care in a strong market where we already are present and are doing well. For example, we're working on a building that contains 180 assisted living, memory care, and skilled nursing beds as an expansion near one of our large independent living buildings in the Kansas City area. In total, we already have 776 units in the Kansas City area that are substantially full and will act as a referral source for the expansion. We will be translating the demand for the higher acuity services already present in our buildings to this expansion and allow our residents to maintain the high level of care and high quality that they currently experience at Brookdale.

As of September 30th, we had completed five expansions with 213 units, representing approximately $35 million of project costs. Expansions open since the first quarter, with 98 units, were 82% occupied and already earning an approximate 14% run rate un-levered return.

The third thing I want to talk about is our ancillary services. Our ancillary service revenue totaled $29 million for the quarter, up 12.8% from the second quarter. Our growth expectation for ancillary services in the third quarter was impacted by unforeseen delays and obtaining licenses and permits to open licensed home health agencies in several markets. We have the infrastructure and staffing in place to provide these services. The licensing delays are slowing that rollout, which we now expect to happen in the first half of 2008.

And I just want to point out this isn't an instance where, for some reason, we wouldn't qualify for a license. It's that the bureaucratic processing and staffing of these agencies is very low and it's just taking more time to process them.

One last point I want to make about our business is to take a look at the demographic trends that we believe will continue to drive our future growth. At Brookdale, we strongly believe that over the medium to long-term, the needs of an aging population will cause steadily increasing demand for senior living services, regardless of the business environment. The senior segment of the US population has been and will continue to be the fastest growing segment of the population. This growth is driven both by the aging of the baby boomers, as well as significant increases in longevity. Life expectancy in the US has increased from 47 years in 1900, to 68 years in 1950, to 78 today. The joke is that it won't be long before we all live to be 150, but the bad news is that we'll spend the last 50 years in a nursing home.

Today, over 90% of our potential customers do not live in senior living facilities and it's estimated that the number of Americans over 70 who need help with the activities of daily living will grow from roughly 8.5 million in 2000, to 21 million in 2030. And according to a study cited by the National Family Caregivers Association, American businesses can lose as much as $34 billion annually as a result of employees' need to care for loved ones over the age of 50. And on a personal level, these family caregivers also tend to suffer high absentee and out-sized rates of emotional distress.

We believe that the improved quality and acceptance of institutional senior living, as well as the inability of family caregivers to trade work for care giving will increase the penetration of senior living services and, hence, Brookdale's occupancy. To this end, we've recently created several new business development positions, that on a regional and national basis will work with large employers and other institutions to offer elder care counseling and referrals for their employees that are experiencing these difficulties.

In short, we look at these fundamentals as not only getting stronger, but we're very excited on the prospects of Brookdale and the industry as a whole. Our fundamentals, our need-driven customers, our same-store operating growth, our scale, and our superior level of service will continue to serve Brookdale well over the long term.

With that, I'd like to turn things over to our Chief Financial Officer, Mark Ohlendorf.

Brookdale's reported CFFO for the third quarter was $0.43 per share. This does not reflect our recurring run rate cash flow because it includes expenses related to our acquisition in ancillary service initiatives. The net impact on our third quarter results of these items is approximately $0.06 per share.

Included in the integration and startup expenses are integration and acquisition-related expenses of $4 million or $0.04 per share, which are primarily related to systems and process integration, as well as spending on activities to achieve SarbOx compliance at acquired locations. And second, approximately $1.6 million or $0.02 per share of losses and startup expenses related to our various growth initiatives. These include employee training costs for communities that we've acquired within the last year and startup losses related to the rollout of our ancillary service programs.

Not included in these CFFO calculations are approximately $4.1 million or $0.04 per share of amortization related to capital leases and mortgage debt. A table's included in our press release that provides the detail of this debt and lease amortization. The net effect of all these changes is $1.6 million or approximately $0.02 per share.

Our integration activities continue to proceed on plan. In October, we completed the migration of the entire enterprise to common financial, human resources, and purchasing systems. Virtually all of our support departments are now organized on a Brookdale-wide basis. In addition, we've begun to combine our field operating management structure on a geographic basis within seven large operating divisions. This realignment of the field management structure will organize our operations on a geographic market basis, rather than on a product basis.

A few points of clarification as you look at our operating results for the third quarter. In spite of the soft market that Bill spoke about, rates in the quarter, excluding community fee deferrals, averaged $3,639, a 1.8% increase over the second quarter, or an annualized rate of growth of more than 7.3%. Similarly strong revenue metrics can be seen in our same-store results. For the 12 months ended September 2007, compared to the 12 months ended September 2006, revenue grew 7.2%, while occupancy improved a modest 10 basis points between these 12-month periods.

While we targeted occupancy growth of approximately 2% this year, occupancy has been flat and averaged 90.8% in the third quarter. Second, we did experience some increases in our operating costs in the third quarter. Following a relatively temperate second quarter, utility costs increased in the third quarter by around $4.4 million over the second quarter to $20.9 million. This seasonal increase is driven by higher summer cooling costs and, to a lesser extent, higher energy prices.

In addition, we implement annual wage adjustments for a substantial portion of our community level personnel on July 1st. The impact of that wage adjustment totaled approximately $2.9 million in the quarter. These increases are not new to 2007, but have happened at the same time historically as well. However, with no increase in occupancy, higher utility costs and the modestly higher labor costs, the combined effect has been to lower facility operating income on a sequential or quarter basis.

Third, our net entrance fees for the quarter were $9.3 million. This consists of $14.4 million of gross entry fee sales, and $5.1 million of entry fee refunds. You'll see that we've added some tables in the 10-Q this quarter that add some further historical detail on our entry fee results.

And finally, on the liquidity front, we believe that we're well capitalized to execute our business plan over the next two years. As of today, we have approximately $187 million of un-drawn capacity on our corporate line, together with $39 million worth of cash, gives us total liquidity of $226 million. That capital, plus expected financings, should satisfy most of our capital needs over the next two years.

We currently estimate that, assuming we complete all budgeted expansions and refinancings, we may need to raise in the range of $50 million towards the second half of 2009.

I'll now turn it over to the operator for questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question is from Mark Biffert of Goldman Sachs. Please proceed with your question.

Hi, guys. Thanks for the color, Mark, on the utility costs. Another question I have is, of that utilities expense, how much of that do you expect to be recurring, given that we're coming into the winter season and you're going to have additional heating costs as well?

Yes. On a historical basis, our higher utility cost quarters are the third quarter because of cooling costs, and the first quarter because of heating costs. And then the cost moderates somewhat in the other two quarters.

Okay. And when you look at the entrance fees going forward, last quarter you guys had mentioned that you had deposits of about $4 million. I guess my first question is, how much of that $4 million was part of the $14 million you signed, and then, currently, what do you have in terms of deposits going into the next quarter?

The rollover activity is not some data we've got on right -- right in front of us here right now. The $5 million in October -- I think the volume of this activity is relatively consistent with where we were at through the third quarter, perhaps up just a touch. Again, the cycle of closing houses in markets tends to be extending right now.

Yes.

So looking at those deposit levels, even over an immediate 90-day period may be a little bit too short.

Okay. And back to the rent growth. You guys have talked about 5% -- 5 to 6% in terms of rent growth. I mean, do you think that given the occupancy's been relatively flat, that you're going to be able to continue to push rents as we look into '08?

Yes.

Okay. The next question is related to the ancillary revenues business. I noted that the ACR portfolio, the average income per unit dropped from 195 to 183. Can you provide any color on that?

There was a slight decline in the quarter in the part A census in the SNIFs on the CCRCs. So it's primarily a volume-driven change quarter-to-quarter.

So is that --

So it's still --

-- 180 a better number to use to measure income from there?

Well, again, we're forecasting as we roll this business out, in the range of $150 a unit.

Okay.

You know, this clearly will move a little bit from quarter-to-quarter.

Okay. And so in regards to the additional items that you -- or units that you expect to bring online for building up ancillary revenues through your Brookdale legacy portfolio, what do you expect over the remainder of the year in terms of units built out, or having exposure to that?

In terms of continuing to roll this out in the fourth quarter?

Yes.

The rollout plan in the fourth quarter is relatively modest, a few hundred additional units. As you know, we're well ahead of the initial plan we had for this year. So the focus right now is on stabilizing the operations that we've reached.

Okay. And lastly, Bill, if you could, last quarter you kind of went through your math to come up with a recurring run rate for your cash net income -- or cash from facility operations. Can you kind of go through that now, given that you've seen the increase in operating expenses and to where you think that run rate is?

Yes. The way I would try to answer that is, we would not expect a whole lot of growth in the fourth quarter because our run rate or where we thought we were getting to, as I mentioned, on an occupancy basis, was roughly 93%. We're staying closer to 91%. The way our business is run, we grow in occupancy over the end of the year. And so I don't think it's really an expense issue. It's really just an assumption about occupancy and entrance fees, which I told you we kind of view as staying relatively flat.

What you see, though, will be, for instance, our assisted living business -- and Mark can jump in on this -- changed where we raise all of the resident rates at the first of the year. So the big rate increase that will move the numbers materially will be in January, unlike the independent living business, where rates kind of grow annually based upon when people move in. And that bit of change will not -- will basically push the growth into the first quarter versus the fourth quarter. Again, the difference from what we talked about in the summer was really an occupancy-based assumption, which, given the markets, we just are not too optimistic about this part of the year.

So I mean, as we look at your run rate, it's going to come in a little bit shy of the $2 dividend that you guys are paying. How does it affect your decision, the board's decision, on future dividend growth?

Sure. That's a good question. And we obviously have a couple hundred million dollars in liquidity. If you look at our payout ratio since we've gone public, it has come down almost every quarter. And so we're probably at the lowest payout ratio that we have ever been. We've always been forward looking. Our -- the reason for that has been we've been buying a lot of things; as we've bought less, because we don't really need to buy anything at this point to create, what we think, is pretty attractive growth, we obviously are going to be more conservative, if you will, in terms of dividend increases relative to what we think the kind of current growth is and prospective growth. So the payout ratio has gotten a lot tighter, and I would expect it to continue that way. As to more specific than that, obviously, that's a board decision.

Okay. Thanks again.

Our next question is from Kevin Fischbeck of Lehman Brothers. Please proceed with your question.

Okay. Thank you. Good morning. I wanted to clarify a couple of the metrics that you provided. The same-store revenue growth of -- in the actual quarter of 6.3 and operating income of 8.2, do those numbers -- those numbers include the ancillary services; is that correct?

That's correct.

Okay. And does it include the startup losses from ancillary services on the NOI?

Yes, it would.

Okay. All right. And you've -- you talked a little bit about the financing transactions that you completed in the quarter and then I guess subsequent to the quarter. The numbers that you gave about the 187 of un-drawn capacity, if there's $9 million in cash, is that after the most recent transaction closed in the quarter?

It is. That's actually at the close of business yesterday.

Okay. And so the point is, I just want to clarify, I think you said that feel comfortable about your finance position for the next two years, potentially second half of '09, was --

Yes. Kevin, it's Bill. I mean, basically, if you think about our business, we finance our assets at, I don't know, 60-ish percent leverage, and we grow un-leveraged at 8%. So we de-leverage on an asset basis relatively quickly. Given our stock prices, we don't really feel like issuing equity. So what we do is we refinance assets and use that to pay off our line, which is being used, basically, to fund expansions. And so it is -- if we just run out kind of a stabilized number on our portfolio and assume assets that are not prohibited from being refinanced, get refinanced, it's not a lot. We just use that to basically pay down our line. And at the end of, we said kind of the second half of '09, is when we theoretically have about 50 million -- it could be zero, frankly. But just using mathematical numbers and assumptions, that's where we get to. And the line we view as kind of a bridge to our equity. But that's really the plan.

Okay. And then I guess one other clarification. The 20% organic growth, that would include the ancillary service rollout?

That's correct.

Okay. The other thing that I want to go over clarity on it seems like, obviously, you know, you're not doing the same size deals you have the last couple years, but you have announced a couple deals in the last quarter or so. What are you seeing there about the acquisition environment? How are prices, and what are you looking for over the next 12 months?

Again, I think the story in terms of prices is that my guess is prices are going in the direction of a buyer versus a seller, but we're not that focused actually on acquisitions. Again, if we can grow, we -- I don't know. We -- where we're trading today on a free cash flow basis, it's roughly 5-plus percent current free cash flow yield. If we can grow organically, which we believe we can, at 20-ish percent, we talk about a total return of 25% area, we're a pretty big company. And so these small acquisitions are a lot of work. They're not -- they just don't move the meter nearly as much as just filling up the beds that we want to fill up and doing our expansions. So we're not even looking at acquisitions, primarily for that reason. We just don't need to do them to create pretty good growth. That's really the answer to the question.

Okay. Great. Thanks.

Our next question comes from Matt Ripperger of Citigroup. Please proceed with your question.

Hi. Thanks very much. A couple questions. On the CapEx front, can you give a little more detail about the EBITDA enhancing CapEx, which is 20 million in the quarter? And what specifically is that capital going towards? And when we think about protecting that forward, what kind of trend should we assume?

Generally what's going to be in that line, Matt, are two groups of projects. One group of projects are capital projects that we're doing to improve acquired locations. So I think as we've discussed before, when we underwrite an acquisition, we often underwrite as part of our effective cost of the deal, doing some capital spending to reposition the property. So that's one piece of this. And given the volume of acquisitions that occurred in '06, a fair amount of this activity's occurring.

The second group of this relates to doing major projects within the existing portfolio to reposition those assets. Now, that doesn't happen quite as frequently as it does with the acquired locations, but it does happen in the existing portfolio as well. Obviously, we generally wouldn't invest this capital unless we see a yield, which is why we refer to it in that way.

Given that your acquisition pace is decelerating relative to '06, is it fair to assume that your EBITDA enhancing CapEx will materially decline in '08?

It clearly will decline as we go through '08.

And the EBITDA enhancing CapEx is consistent with what your expectations were when you bought these assets in '06?

Yes, it is. That -- the one thing that's probably a little different is, just given the magnitude of acquisition work that was done in '06, it's taking us a little longer to complete the projects than we would like.

Is there any one or two portfolios of properties where the majority of this EBITDA enhancing CapEx is being allocated?

I would say not. I -- it's probably spread across a number of the acquisitions. Obviously, the acquisitions that include assets that are older, you know, were built 12 or 15 years ago, as opposed to five years ago, are going to get more of this capital.

And there's the ACR portfolio, given the newness of those properties is probably not getting much of it.

Correct.

Okay. The second question is, on the ancillary business, you said $29 million in revenues this quarter. And you gave the monthly NOI for the legacy ACR units. Can you give a sense of where you are in terms of the breakout between revenues for home health versus rehab and where you are in terms of revenue per unit or NOI per unit for the Brookdale, Legacy Brookdale units, and how that is projected to ramp up going forward?

We can. Yes. On the ARC side, just to give you a sense of the distribution in the NOI, of the 183 of monthly NOI, about 33 of that comes out of home health in terms of that delivery system; the balance out of therapy. Were you asking about the ramp up in the Brookdale units and how that's --

Yes, what -- are the Legacy Brookdale units generating positive NOI on the (inaudible) business yet?

Well, when we look at the clinics that have been in place, let's say a year, so they've been in place a meaningful period of time, I think the business is tracking where we would have expected. I think where we're at right now, that first year average is in the mid-50s, from an NOI standpoint, and the run rate today is in the low 70s, from an NOI standpoint.

The delay in getting licensure in some of the home health agencies is slowing us down a little bit, because, particularly as we get to the more geographically disbursed Brookdale locations, and in many cases that will be the free-standing assisted living, I think the experience is home health will be a more viable delivery model there. But I think the performance here is pretty much in line with the expectations we had.

And what's the NOI margin at the ACR facilities (inaudible)?

I believe low 30s right now. Well, overall it's mid-30s, I believe, excuse me.

Okay.

Yes, call it 32, 33%.

And in the past you've given a little color about specific regions where you were seeing pockets of weakness, Florida, Arizona, et cetera. Is there any elaboration you could provide on what you're seeing locally?

You're talking about senior housing occupancy?

Senior -- yes, senior housing occupancy and demand trends.

I'm not sure, Mark, that we would spot any significant trends from what we -- differences in the trends from what --

Yes.

-- we have said before.

I think that generally the, you know, the markets we talked about before, obviously the Phoenix area where we have large CCRC presence and some parts of Florida, but it's very difficult to tar a whole geographic area. I mean, we have properties that are doing extraordinarily well in Florida and some that are more affected by weak housing markets. So geographically, we're -- I can't really generalize and say one region of the country is worse than another.

Okay. And what was the -- you have $43 million expense related to change in fair value of derivative. What was that related to?

Well, again, we do not match our hedges. We do not try to qualify for matched hedge accounting. So that is simply the change in the value of the hedges in the quarter. It's a non-cash item. But as interest rates declined in the quarter, that's the accounting impact, the non-cash impact of those hedges, to market, essentially.

Okay. And then the last question I had is, in the entrance fee business, which did show a sequential improvement, is -- does that include the presale of the village units?

That does not.

And how is the presale of that community going?

It's going well. I think we're roughly 60% pre-sold in that project right now.

And you still have not begun construction?

We have not.

Okay. Thank you.

Our next question comes from Ryan Daniels of William Blair. Please proceed with your question.

Yes. Good morning, guys. I had a couple of quick, housekeeping-oriented questions up front. First off, earlier in the year, you guided towards the integration and startup expenses of about $25 million. And if my math is right, it looks like you're at $18 million year-to-date. So I'm curious if you anticipate that that cost is going to spike up in the fourth quarter or if you're just a little bit lower on a run rate basis, and Q4 should be stable with Q3?

It -- well, you're adding together both the capital and the operating piece of this --

Yes.

-- I take it, to get to your number? I think in the fourth quarter, the operating piece is likely to go up because we're much more in the implementation mode, and the capital piece will come down somewhat. We are likely to be under the $25 million number in 2007 standalone.

Okay. And then if we look forward to 2008, I know you guys probably don't want to give a lot of numbers on that right now, but what might that look like as we go into '08? Should that continue to trail off throughout the year or will that just stabilize it at some point and run through the entire year at a given level?

Well, it clearly should trail off as we go through 2008.

Okay. And then I appreciate all the color on the drop in the facility operating income margins due to the labor and the utility costs, that's very helpful. Can you comment on how much of that was offset during the quarter by some of the cost savings you've talked about? I think you had identified about $4 million in cost savings last quarter that you hope to achieve in the back end of the year. Have we seen the impact of that or is a lot of that still going to be seen in the coming quarter or two?

I think, obviously, the $4 million number that we had provided was an estimate at that point.

Yes.

I think we have seen the lion share of that come into the numbers in the third quarter.

Okay. And given that that was an estimate, was it similar to the $4 million, little bit lower? higher? Any --

It was a little bit lower would be the experience.

Okay. And then this is more of a philosophical question. I guess you guys have hit on this a few times, Bill did, in talking about the dividend payment. But do you consider one of the ways to create value here, putting in revenue -- or I'm sorry -- EBITDA enhancing capital in the facilities and then longer term recapitalizing those and cashing out on some of that investment. How do you look at that in terms of using that recapitalization to pay a dividend, maybe above CFFO, versus using that cash to reinvest in new developments or other facilities, just how you guys think internally about that.

I think the way -- I think to answer your question is, we spend capital to -- we bought assets, a fair number of assets we acquired were, we call them 88, 87% occupied, little deferred capital, charging below market rates because they don't look as nice as stuff in town.

Yes.

So we made acquisitions. We assumed -- we put more capital in. And then, obviously improves the quality of the asset, and should be able to charge more and get more people to show up, which will grow NOI.

Yes.

And so we do refinancing to -- once we get assets to stabilize financing, we refinance the assets. That will take excess proceeds out. As I mentioned, we're using capital now basically to fund expansions.

Yes.

And that's what basically -- we could do it two ways. We can issue equity, which we don't really feel like doing.

Right.

Or we could basically use these under-leveraged assets as a way to finance those, and that is our plan.

Okay. That helps clarify it. And then two more quick ones, then I'll hop off. First off, on the -- with the ancillary services kind of being rolled out across your network, are you guys seeing any trends in that actually helping the health of residents, and, in turn, increasing the length of stay? And, in longer term, do you think that's something that could also boost your occupancy, as well as some of the three initiatives you laid out at the start of the call?

Yes. I think I made that point before. But a lot of these ancillary services aren't just simply reactive, like after someone fell and broke their hip, and -- they're proactive to try to keep people from falling or if they're experiencing, in that example, balance problems, you know, we can make it so there isn't a fall.

So, yes, I mean, we're not really able to quantify it at this point. But we would expect that length of stay, for a number of residents, is going to be increased due to the availability of the therapy services.

Okay. Great. Then the last one is just on the licensing delays. Have you -- you probably looked at this. But is there potential where you run into delays in the future to acquire maybe a smaller operator at a fairly cheep investment rate, if you will, to get a license from them, and then roll that out more quickly? Is that something you would consider or --

Excellent question. Yes, it is. I -- we actually have made acquisitions of home health in Florida already.

Yes.

Which, as you know, it's kind of a monopolistic market for those kind of permits.

Right.

And we are, as you said, looking at that in other markets now as well.

Okay. Great. Thanks again, guys.

Our next question comes from Daniel Bernstein of Stifel Nicolaus. Please proceed with your question.

Good morning, gentlemen. When I'm computing average occupied units, just taking the average rate for the quarter and the number of units in the quarter, I get an average occupied units was down just a little bit from Q2. Did you take any units offline for the EBITDA enhancing CapEx or expansion?

We did not. If you're using the units in service that's off the table in the press release and trying to tie that back in to the average rates, there's actually 920 units included in the CCRC total, that are equity homes. So we actually take those out of the total when we calculate the average rate. I'd suspect that may be the difference in your math there.

Okay. And in the cash flow statement, there was a change in future service costs that was an add-back. I'm just trying to figure out what that was and if that was -- where that would be in the income statement?

It's actually not in the income statement. It's a technical change in the valuation of those reserves -- this is very inside baseball -- that was triggered by the refinancing of a CCRC.

So that's not -- it's not in the CFFO or anything like that?

It's not. Part of the future service obligation calculation for a CCRC is effectively based on the book value of the asset and the implied financing around an asset. And we had a refinancing of a CCRC in the quarter.

All my other questions were answered. Thank you.

Our next question comes from Jeff Ungler of Standard and Poor's. Please proceed with your question.

Good morning. Just one quick question. Assuming the occupancy to be -- stay at the current levels for a prolonged period, at what point would you consider scaling back the rollout of the ancillary services assuming you can get the licensing issues worked out.

We would not -- we see the ancillary service business as a tremendous revenue opportunity, which I think it's proven itself out. I mean, the two really aren't connected, you know, whether it's -- in fact, the ancillary service and availability actually enhances occupancy and marketability of these properties.

Okay. Great. Thanks very much.

Our next question comes from Frank Morgan of Jefferies and Company. Please proceed with your question.

Good morning. First question relates to the regulatory delays. Could you specifically tell us what markets you're seeing those or what states you're seeing those delays in?

I think the primary markets that we're working through now are Arizona, Texas, and -- Arizona and Texas I believe are the larger scale markets.

Where you're experiencing the regulatory delays?

Yes. These are cases where we have applied for the licenses and permits and the regulatory approval process has been drawn out.

Okay.

They're either delaying the processing of the application or the inspections. Some of this, to get a little more granular, is more tied to a lot of these state budgets that have cut back their staffing that does these licensing applications. So the work is really piling up for the few people that are there.

Okay. On the subject of ancillaries, I think Mark or somebody answered a question talking about the impact of part A on the ancillary growth. Could you elaborate on that? I didn't quite catch that.

It wasn't really on the ancillary growth, Frank. It's if you look inside the ARC legacy portfolio --

Yes.

-- the NOI per unit from ancillaries changed from roughly 190 a unit last quarter to roughly 180 a unit this quarter. And it was in answer to that question.

So the -- but I thought most of this was part B business. I mean, is there part A business you're doing for nursing homes in local markets that gets rolled into that number? I'm --

No, no. Our own SNIFs on our CCRS, that's our own operation, deliver ancillary services. And the delivery mechanism is our own therapy company.

Okay. So you're delivering part -- you're delivering to your own contract -- to your own patient, you're delivering therapy services to people who are part A patients?

That's right. And because that's such an intensive therapy regimen, when the part A census drops a bit, it does -- it does impact that per unit number.

Okay. All right. So part A census to your own -- okay. All right. And I was wondering, could you quantify the earnings drag related to the new development openings? I mean, it sounds like maybe there isn't that much of one, because they're already at 83%. But how big a number is the drag from the new openings on the expansions? And is there any drag that's associated with therapy staff that you have that may not be able to bill yet because of all these delays?

Well, the answer to the first question, in terms of the net impact of the expansions, there is a negligible impact on earnings in the quarter for those expansions that are open right now.

Okay.

Second question related to the therapy services. Therapy or home health was your question?

I guess -- I guess the delay related to home healthcare, so home health.

Yes, there's a -- there's kind of a holding cost of $10 to $20 thousand a month per location per agency, as those agencies sit in waiting for their licenses. Obviously, the bigger impact here is, we are not getting to the ramp up of profitability after they open, which is substantially greater than $10 or $20 thousand a month.

And remind me again, what is causing that delay in the ramp up?

The delay in the ramp up is because we do not yet have our permits to operate.

Oh, okay. It's not one that's already open. Once it opens and the delay from the time you get opened and licensed until you get to your normal optimal performance, that's not being delayed?

Correct.

Okay. And then finally, just this is more philosophical. Somebody asked this question earlier. They asked about do you think you can raise rates in a flat occupancy environment, and your answer was yes. Could you elaborate on the yes part?

I guess I'm not sure how to elaborate on it, other than to say that as we run the business every day, that's what happens with our rates.

Generally there's a large segment that are on annual agreements. As those agreements turn over, we give those people a 46% (sic) increase. The assisted living, which is on a month-to-month, we continue like all of the other operators, to see good rate growth. And the ability to attract new customers or whatever doesn't really necessarily affect what people are charging in any given market.

Okay. Last one and I'll hop off. Just kind of where were things at the end of the quarter in terms of like say in the month of September, with regard to occupancy and just basic operating trends, and how much of that would maybe carry over into the fourth? Thanks.

Sure. Well, actually, let me fast forward a month, because we've been looking at October results. The trends are modestly positive, I guess -- I guess you would say. Occupancy's clearly holding to growing a little bit, particularly on the assisted living side. No meteoric changes, but things are clearly firm to slightly up.

With that, we'll close. We appreciate your participation and we'll be around for follow-up questions. Thank you very much.

This concludes the conference call. Thank you everyone for joining. You may now disconnect.