Ensign Group Inc (ENSG) 2013 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to The Ensign Group, Inc. third quarter fiscal 2013 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session, and instructions will be given at that time. (Operator Instructions). I would now like to introduce your host for today's program, Mr. Greg Stapley, Executive Vice President. Please go ahead.

Thanks Jonathan. Welcome everyone, and thank you for being on the call today. We filed our 10-Q and Company press release yesterday, in addition we filed a Form 10 an 8-K, and an 8-A in separate press releases, addressing our plan to separate our healthcare business and our real estate businesses into two distinct publicly-traded companies, which we will discuss in more detail today.

All of these disclosures are available on the Investor Relations section of our website at www.EnsignGroup.net. A replay of this call will also be available there until 5.00 PM Pacific Time on Friday, November 29, 2013. As you know, we always start our calls with a few housekeeping matters. First, any forward-looking statements made today are based on management's current expectations, assumptions, and beliefs about our business and the environment in which we operate. Those statements are subject to risks and uncertainties that could cause our actual results to materially differ from those expressed or implied on the call.

Listeners should not place undue reliance on forward-looking statements, and are encouraged to review our SEC filings for a more complete discussion of factors that could impact our results. Except as required by Federal Securities laws, Ensign and its affiliates do not undertake to publicly update or revise any forward-looking statements, where changes arise result of new information, future events, change of circumstances, or for any other reason. In addition, any Ensign business we may mention today is operated by a separate independent operating subsidiary that has its own management, employees, and assets. References to the consolidated company and its assets, as well as the use of such terms like we, us, our, and similar verbiage, are not meant to imply that The Ensign Group Inc. has direct operating assets, employees, or revenue, or that any of the various operations, the service center, the real estate subsidiaries, or our captive insurance subsidiaries are operated by the same entity.

Also we supplement our GAAP reporting with non-GAAP metrics. When viewed together with the GAAP results we believe that these measures can provide a more complete understanding of our business, but they should not be relied upon to the exclusion of GAAP reports. A GAAP to non-GAAP reconciliation is available in yesterday's press release and in the Q.

Lastly, before we start the call we are pleased to report that we finalized our settlement with the Department of Justice and the OIG, fully and finally resolving the DOJ investigation which has been ongoing since 2006. In connection with the settlement on October 1, 2013 we signed a five year corporate integrity agreement. As you know, in order to fulfill our obligation under the CIA we have been making significant enhancements to our internal compliance program, we also paid the settlement amount of $48 million in Q4. For the record, Ensign has denied engaging in any illegal conduct, and agreed to the settlement without any admission of wrong doing in order to resolve the matter, and avoid the uncertainty and expense of protracted litigation. We are glad to have that behind us, and do not expect to mention it any longer on these calls.

With that, I will turn it over to Christopher Christensen, our President and CEO, to get things started. Christopher.

Thanks Greg. Good morning everyone. Despite several challenges in the first half of the year, we didn't revise our annual guidance last quarter as we expected to see many improvements in the third quarter, and especially in the fourth quarter. However some of those challenges dragged into the third quarter, and were augmented to some degree by the distractions of crafting the spinoff transaction we announced yesterday. Efforts to push the DOJ settlement over the finish line preparations to comply with our corporate integrity agreement, and of course the short-term drag on earnings created by our significant growth earlier this year. In addition, most of the Medicaid rate adjustments we were expected to receive in the third quarter will not actually be received until the fourth quarter.

As a result of these challenges we have adjusted our annual guidance for 2013. We are pleased to report that we see a reversal in some of the setbacks from earlier this year, as many of projected improvements we discussed in August, actually began to take effect late in the third quarter, and early this quarter. We expect that these improvements will continue through the fourth quarter and into 2014. As those of you who have been following us for many years know, this fourth quarter surge is typical for us, as we almost always see the best occupancy and skill mix increases, as well as the effect of rate increases in the last three months of the year.

We made a significant announcement yesterday about our plan to separate our healthcare business and our real estate business into two separate and independent publicly-traded companies, Ensign and CareTrust REIT. This process has taken intensive organizational effort over the past many months, and as some of you will remember, the last time we experienced a temporary flattening in the results was in the midst of the disruption we experienced during the quarters leading up to our IPO in 2007. The short-term leveling in our previously consistent and steady performance ramp was followed by tremendous growth in almost every performance metric in 2008 and 2009. As with the IPO in 2007 we believe the long-term value creation from the strategic transaction will more than make up for any near term flattening.

More importantly, we are confident that the unique way we are doing it will further strengthen our ability to pursue our proven operating strategy for many years to come, and leaves us in a position to repeat the same steady and consistent performance we achieved following our IPO beginning immediately. On our current operating front, we see many positive developments and opportunities on the horizon. For example, since 2011 we have acquired 37 skilled nursing and assisted living operations, as well as 8 home health, 6 hospice agencies, and 6 urgent care operations. Nine of these acquisitions came in the second and third quarters alone. These acquisitions were made in the face of reimbursement cuts, program changes, and other near term hurdles.

As we have often reminded you, whenever we have seen an unusual surge in growth over a short period of time, we naturally expect a temporary hit to our short-term earnings. Extra costs include normal transition and startup losses at few of the facilities, as well as the significant cost of deploying numerous resource personnel and others to the four corners of the Company for extended periods, and the distractions that go with having them away from their own operations. However as we see these facilities transition, we expect to see an improvement in our long-term organic growth and performance in 2014.

We are also pleased to report that our budding home health hospice and urgent care businesses are also beginning to mature. And we expect our investment to start producing significant returns in 2014. While we have experienced some challenges in our home health and hospice collections, we have made improvements in the third quarter, and believe that our steady efforts to establish these new services, as well as progress in the transitioning newly-acquired facilities are beginning to pay off. And that we will see dramatic improvements in these operations in 2014 and beyond. You will recall that our guidance assumes an average 1% Medicaid rate increase net of provider taxes, and we still believe it will come within this year. But it will almost all come in the fourth quarter. In addition to this year's 1.3% net increase in Medicare rates took effect on October 1.

Also during the quarter our newly-developed Sloans Lake Rehab and Care Center, a 42-bed all-private Medicare skilled nursing facility located just west of downtown Denver, achieved an EBITDAR margin for the quarter of 21.8% in only the second full quarter since completing its Medicare certification, with 91.1% occupancy, and 100% skilled mix revenue. We are pursuing a similar strategy in other key markets, creating an additional lever the Company can pull in the near future.

In summary, we continue to have many levers we can pull as we continue making the improvements we need to make to finish 2013 well, and set up 2014 to resume our ramp. We will discuss some of those tools and the challenges they can address later in our report. We hope that you will see as we do the clear path to success that lies ahead, and why we are enthusiastic about our future and our prospects for Ensign's continued growth and performance.

First I will have Greg discuss our recent growth. Greg.

Thanks Christopher. After acquiring 8 skilled nursing and assisted living facilities in Q2, we added an additional skilled nursing facility in Seattle in Q3. We are seeing increased acquisition opportunities at present, and expect to complete additional facility acquisitions before year end. During the quarter our home health and hospice operators continued to reinforced our operational foundation, strengthening systems, processes, and personnel prior to taking on any new acquisitions. To date we have acquired or developed nine home health, seven hospice agencies, and likewise see no abatement in the number of opportunities in that space. We expect to resume the growth of those operations as our existing base there matures.

Our fledgling urgent care centers, Immediate Clinic purchased an existing urgent care clinic in Seattle, Washington, all of our urgent care centers up to this quarter have been developed denovo, which can be time consuming and expensive during the start-up period. The addition of this established clinic adds significant additional firepower to ourSeattle cluster, improving our critical mass in what we believe to be an underserved market for retail urgent care centers. To date we opened or acquired six urgent care clinics, all in the greater Seattle market, with a seventh location there currently being built out. This new growth has brought our total senior housing and in patient care portfolio to 119 facilities in 11 states, with 11,124 skilled beds, 1,603 assisted living units, and 477 independent living units in operation. Of the 119 properties that we operate, 96 are Ensign-owned, and 75 of those are owned free of mortgage debt.

And with that, I will hand it back to Christopher.

Thanks Greg. As we mentioned in previous calls, our consistent success is achieved through the aggregate effect of dozens of small victories across the organization. Similarly, our earnings decline has resulted from a number of small challenges rather than any one factor. I would be remiss if I did not recognize our outstanding field leaders who are working tirelessly on all fronts to identify and overcome these weaknesses wherever they occur, and tell you that we believe we are starting to see their efforts bear fruit. Just to mention a few of the recent challenges which create great opportunities for future performance are the following. First, executing the strategic separation of our real estate and healthcare operations has required significant effort from our leadership team.

We designed the transaction to leave both resulting companies in positions of great strength, and we look to the lessons we learned following our IPO, which again was followed by tremendous growth in almost every category of performance in 2008 and 2009, to achieve and even exceed those results in 2014 and beyond. The costs and organizational effort associated with implementing the terms of the corporate integrity agreement exceeded expectations, especially with respect to implementing compliance programs in our smaller service offerings, each of which have unique needs. However we believe these efforts will help us to be more profitable, as we improve clinical and claims processing systems and are able to bill and keep more of our earned revenues. Third, the second quarter was an enormous quarter on the acquisition front, and we experienced larger than usual startup losses at a few of the facilities, as well as the significant costs of deploying numerous resource personnel to the four corners of the Company to transition the newly-acquired operations. As discussed above, we believe the short-term weakness in operating results at our newly-acquired and transitioning facilities, also represents an improvement in our long-term organic growth prospects in those facilities.

Next, we continue to experience significant costs associated with the ramp-up of the home health and hospice agencies, and although on a smaller scale, our urgent care and mobile X-ray services. Although these operations did not contribute as expected to our earnings in 2013, we see significant upside and with a few adjustments we expect our returns on those investments to improve dramatically in 2014. Next we did not receive most of the state Medicaid increases that we expected in the third quarter. However, we expect these benefits to arrive in this quarter in addition to the 1.3% net increase in Medicare rates announced in the second quarter took effect on October 1.

Our healthcare costs increased again in the quarter by $1 million dollars over our projected costs. The increases were unexpected, and we believe that we have made the adjustments in our insurance program to prevent this problem from recurring in 2014. Lastly, consolidated occupancy of 77.4% was significantly impacted by the group of 42 transitioning and newly-acquired facilities averaging occupancy of 70.5%. 64.5% average occupancy in the 17 newly-acquired facilities alone, representing the addition of substantial organic upside to the Company's portfolio.

All of these things and other things combined to impact the quarter, but in each case we see both short-term improvements and long-term opportunities. We are especially pleased to report significant improvements in compliance and quality of care across the organization, and as always we would remind you that compliance and quality outcomes are precursors to outstanding financial performance. But you don't have to take our word for it. The number of Ensign facilities sporting four and five star ratings has grown by 24%, from 46 to 57 of our 106 skilled nursing operations just since January. And remember, most of our acquisitions were one and two star operations when first acquired. In fact, we are very proud to report that six of our facilities achieved zero deficiency surveys so far this year.

For example, at Park Avenue Health and Rehab Center in Tucson, Arizona, CEO Ellen Cote and Director of Nursing Sheila Summey, who is also a COO, have completely transformed the clinical reputation of what was once a CMS special focus facility. As a result of their most recent perfect Department of Health survey, they have solidified their transformation pushing from one star status to achieving CMS' highest five star rating. As a result, Park Avenue's revenue is up 730 basis points, and their EBIT has improved by almost 9.8% over last year's quarter.

Also in Arizona, Bella Vita Health and Rehabilitation Center of Glendale, led by CEO Doug Haney and Director of Nursing and COO, Rena Castro, likewise achieved a perfect Department of Health survey, for an unprecedented second year in a row. Doug, Rena, and their team have leveraged their unblemished survey record, along with their well-regarded clinical programs, and expanded behavioral health service offerings to propel that facility to new heights. Revenues have climbed over 13%. Net income before taxes soared by 34%, and occupancy improved by 317 basis points. So I will say it again, financial results follow clinical performance, period.

We are also happy to report that some of our more significant renovation projects which have been particularly disruptive to the operations and our operating results have been completed, with a few still remaining. One we have mentioned before is Grand Terrace Rehab and Healthcare in McAllen, Texas, where CEO Brett Jones and Director of Nursing and COO, Eva Therate, have successfully introduced or reintroduced their facility to the market, following some damaging flooding that closed down entire wings for many months. With renovations behind them, they have soared past historic performance levels increasing revenues by 14%, EBIT by 25%, and skilled mix by almost 38%.

So although the quarter's overall results were not what we expect, we have always taken the long view of our business, and we are very encouraged by the recent progress and significant opportunities we are seeing. We see no reason why we cannot reap the benefits of all of our hard work over the last few months and years, and we have put in place a solid foundation for making our growth pay dividends in the fourth quarter, and in 2014 and beyond.

And with that I will hand it over to Suzanne to provide more detail on the Company's financial performance. Suzanne.

Thank you Christopher. Good morning everyone. Detailed financials for the quarter are contained in our Q and press release filed yesterday. As Christopher noted, operating results in the quarter were impacted by a number of unusual factors that we included in our adjusted results. Including management's time and focus devoted to the separation of our healthcare and real estate businesses, the ramp-up to meet our compliance obligations under the CIA, the deferral of some expected Medicaid increases, a spike in healthcare costs, difficulties in our home health and hospice services, and continued softness in occupancy with a slight decline in the year-over-year occupancy in our same store bucket of 26 basis points. Which is offset by an increase in skilled mix of 58 basis points, and an increase in same-store managed care days of 15.4%, and a growth in our sub-acute days of 5.6%.

As for other key data points as September 30, cash and cash equivalents were $46 million. Net cash from operations was $57.1 million. And free cash flow for the trailing 12-months ended September 30, 2013 was $53.6 million. As always we provide a reconciliation of GAAP to non-GAAP results in yesterday's release.

Although as Christopher indicated we have many reasons to be positive about the fourth quarter, which is when we historically have our best occupancy and mix, and the efforts of rate increases finally kick in, we have reduced our annual guidance for 2013 to $900 million to $915 million in revenue, with $2.56 to $2.72 in diluted adjusted earnings per share. These projections are based on diluted weighted average common shares outstanding of approximately 22.5 million,mo additional acquisitions or disposals beyond those made to date, the exclusion of acquisition-related costs and amortization costs related to intangible assets acquired, the exclusion of start-up losses at newly-created operations, the exclusion of expenses related to the DOJ matter, exclusion of expenses related to the separation of the healthcare and real estate businesses, a tax rate at our historical average of approximately 38.5%, and including Medicare reimbursement rate increases net of provider tax.

In giving you these numbers, I would like to remind you again that our business can be lumpy from quarter to quarter. This is largely attributable to, variations in reimbursement systems, delays and changes in state budgets, seasonality and occupancy and skilled mix, the influence of the general economy on our census and staffing, the short term impact of our acquisition activities, and other factors.

We will be happy to answer any specific questions you might have later in the call, and now I will turn it back over to Christopher. Christopher.

Thanks Suzanne. Although we have already touched on the announcement we made yesterday regarding our plan to separate our healthcare business and our real estate business into two separate publicly-traded companies, we would like to spend an additional few minutes to explain our vision and purpose in pursuing this strategy. First, we want to be very clear that our first and most pressing priority from the beginning of our discussions has been to ensure that when the dust settles the separation would result in two very healthy companies.

This priority has been our guiding principal throughout this process. Unlike other transactions that have occurred in our industry, which on their surface may seem similar, we have taken great care in structuring a transaction that would safeguard our ability to provide the highest quality healthcare services, while also finding a way to share the tremendous value we have created in our real estate with our partners and shareholders, now and over time. As we described in our announcement and public filings, one of the many distinguishing factors between our transaction and similar transactions is the fact that based on a very recent ruling issued by the IRS, our separation can be accomplished tax free. We have requested a private letter ruling from the IRS to confirm that we can separate the two businesses without incurring a tax liability, which based on our significant assets and retained earnings will be beneficial to our shareholders.

Additionally we are pursuing this transaction from a position of strength, and not one of necessity. The health of our balance sheet, our strong cash flow, favorable market conditions and the tax free nature of the transaction allowed us to establish capital structures for both companies that leave each not only quite healthy, but with plenty of runway for both near term and long-term growth. Ensign will continue executing our existing business model and growth strategy, which will still include the purchase of real estate assets, and the potential for significant value creation that comes with them, just as we always have.

Other unique aspects of the separation from Ensign's perspective include a healthy initial rent coverage ratio at 1.85 times facility level EBITDAR, leaving ample cash flow to fund future growth. A healthy balance sheet with the lowest leverage in our peer group, and zero funded debt on the date of the spinoff. A healthy cash account on the balance sheet, the amount of which will be determined based on the number of acquisitions we complete between now and the effective date of the spin. Availability of a revolving line of credit which can be used to fund working capital needs, and to aggressively pursue our growth strategy, and retention of all of the Company's leadership team, except for Greg Stapley who will become the Chief Executive Officer of CareTrust.

In addition to continuing our same growth strategy, Ensign expects to benefit from CareTrust's ability to close on larger portfolio transactions, that historically have been difficult for Ensign to pursue. As you know, Ensign's operating model relies on a cluster system, pursuant to which local leaders in specific geographies support each other, in order to produce industry leading operating results. Furthermore, Ensign's growth strategy has relied heavily on availability of Ensign-trained leaders, and our growth in both existing and new markets has sometimes been affected by the unavailability of sufficient leaders. In contrast, CareTrust will have the flexible to carry the Ensign banner into many new geographies, without facing the operational considerations with which Ensign is confronted as a health care operator.

For example, CareTrust will be able to partner with multiple operators, including Ensign, to pursue larger portfolio transactions, as a result we expect this new platform to help us acquire facilities that we may not have been able to pursue as one company. These are just some highlights, and only a few of many other reasons that we have decided to pursue this transaction. We are excited for the opportunity we will have to add an additional platform to extend Ensign's' mission of setting a new standard of care in the skilled nursing and assisted living industries.

With that, I will turn the time over to Greg, to discuss some of the details of this transaction from the real estate company's perspective. Greg.

Thanks Christopher. I would refer you to our public filings, including the Investor Presentation included with our press release yesterday for a more complete description of the mechanics of the transaction, and I would just take a minute to add a few brief thoughts regarding our vision for CareTrust REIT. As a real estate investment company, CareTrust intends to expand into new geographies, branch out into different asset classes, diversify its tenant base, and reduce its financing costs. Following the separation, CareTrust will have the flexible to choose which markets, asset classes, and prospective tenants to pursue, based solely on the acquisition parameters associated with the real estate business.

We expect CareTrust as a healthcare-oriented REIT, to not only pursue skilled nursing, assisted living, and independent living properties, but also to potentially diversify or eventually diversify into different property classes, such as medical office buildings, long-term acute care hospitals, and in-patient rehabilitation facilities. CareTrust may also engage in an expanded range of real estate related business activities, such as the provision of mortgage financing and development financing. As Christopher mentioned, our primary focus has been on establishing two very healthy platforms from which we can continue to pursue our mission.

Some of the highlights from CareTrust's perspective include, an initial lease coverage ratio of approximately 1.85 times, which readily supports our projected initial rent stream of about $59 million per year from the Ensign master leases alone. Also a starting capital structure that provides ample cash and liquidity at inception. The potential for improved access to more lower cost capital. And the opportunity to start with an outstanding portfolio of assets, a solid rental stream, and the opportunity to establish a stable dividend, and grow it as CareTrust grows and executes its business plan.

As you know, healthcare companies are subject to unique regulatory litigation and reimbursement risks, and generally have higher costs of capital, and trade at lower earnings multiples than real estate companies. In contrast with its triple net leases CareTrust will primarily be subject only to simple premises liability risks, and the credit risks associated with its tenants. As CareTrust diversifies both its tenant pool and its asset base, we expect its risk profile and cost of capital to improve.

Finally, our biggest advantage will be our relationship with Ensign. Throughout my 14 years with Ensign, I have been personally and gratefully approached by a number of REITs and other prospective landlords, who have been anxious to establish a landlord/tenant relationship with Ensign, as one of the industry's premier operating companies. CareTrust will inherit as its first tenant, the best-of-the-best. Ensign's strong track record or operating performance and its industry-leading management team will provide CareTrust with a solid foundation, on which to build into the future.

We hope this discussion has been helpful. As always, we want to conclude by thanking our outstanding partners in the field, at the service center, and across the organization, for their continued efforts to make Ensign the best Company in the healthcare industry. We would also like to thank our shareholders again, for your support and confidence as well. Jonathan, would you please instruct the audience on the question and answer procedure?

Certainly. (Operator Instructions). Our first question from the line of Rob Mains from Stifel. Your question, please.

Thanks. Good morning.

Good morning, Rob.

A couple of questions on the operations, first you mentioned the home health and hospice ramp-up costs. That occurs in situations where you are buying a license, then and filling in the business underneath it? Is that a fair assessment of that?

There were several acquisitions that we made that were really just starting, and so they were practically the same thing. Their volume was so small that it was almost like starting with a new. Plus there are just are some complications as you change from one organization to the next in the billing process.

Okay. I understand that. And then the 42 transitioning, and of that subset the 17 newly-acquired, how many of those are going to wind up with CareTrust?

Say that again, Rob?

The 42 transitioning facilities, how many of those will be with CareTrust, versus the ones that you already leased?

By which bucket is Loie in?

It is in the transition.

We haven't broken those out by what is owned and what is leased. I think they are mostly owned, Rob. I can't think of any we have leased.

The number is probably in the 95% range. I mean there are probably only one or two that are not. We haven't looked at it in buckets yet.

Okay. And then when you look at growth going forward, obviously part of the Ensign story has been successful M&A. How will the growth be done in concert with CareTrust, because on one hand I assume you want to be able to continue growing Ensign, you mentioned about how this improves your financial flexibility, but at the same time CareTrust wants to diversify?

Listen, there are actually two answers to the question, Rob. First, Ensign will continue to grow the exact same way it has always grown, it has always had good free cash flow, it has always had goodcredit facilities and plenty of cash on the books with which to do whatever it wanted to do. Mostly we do the one-off deals, and try and absorb them fairly quickly, and that is just not going to change.

What this will do, the way that CareTrust will be involved in that, is when we see large portfolios and we see these now, but sometimes it is too much for Ensign to swallow all at once. CareTrust will be able to go out and work with Ensign and other operators, to take down whole portfolios and divide them up amongst a pool of tenants, including Ensign. We think it is advantageous to Ensign both ways. While yes, we do at CareTrust, we are going to be very, very focused on diversifying the tenant base, we are not running away from Ensign at all. Quite the opposite. They are still the best operator in the industry.

Hello?

Ladies and gentlemen. Please remain on your line. Your conference call will resume momentarily. Once again, please remain on the line. Your conference call will resume momentarily.

I think we just had an electrical service interruption here or something, but our phone died. We are back on. Rob, are you still there?

I am still here.

Where was I in my answer when the phone died?

Just explaining the meaning of life, and now we just all lost it. No, I think you had gone through the explanation of how both companies would grow. So the takeaway that we should have is that Ensign as a tenant of CareTrust, we can expect it to grow, but you are going to grow with other tenants as well?

Yes. We will grow with other tenants, and they will grow without CareTrust. I want you to be real clear on both of the growth strategies, there will be great opportunities on both sides of the ledger. This just opens up a whole new world for them, for CareTrust, for everybody.

Last question then for CareTrust. You are going to own assets that obviously Ensign knows, you know well from Ensign, the transitioning ones are ones that I would say typically you don't see a lot of healthcare REITs owning. The question would be, when you look at comparing yourselves to others out there, how do you position CareTrust compared to some of the other REITs, in terms of what the portfolio is going to consist of, in terms of the assets and where they are in their development? And that is my last question.

Thanks Rob. Look, I would tell you two things. First, when we say we are going to diversify our asset classes or asset base, we do mean that. We mean that while Ensign has historically done about 80% to 90% of our acquisitions in sort of the distressed asset space, CareTrust is not going to be pursuing that parameter solely. We will be look at performing assets, we will be looking at other kinds of assets, we will be really opening up a whole new set of opportunities.

That said, with the history that we have, and the operator background and orientation that we have, we will be able to look at assets that the others don't want, and see whether or not there might be a diamond in the rough there, as we have done historically and consistently here at Ensign. That is what we do. We are out there looking at 15 or 20 assets or opportunities for every single one we do. And we know how to identify the ones that can be turned, and the people that can turn them. So we hope to partner with other operators who are oriented in the same direction as Ensign. We are happy to share Ensign's secret sauce with them on the turnaround front, and we will be able to go forward and do deals that really are under the radar of others. I don't want you to think the portfolio is just going to be distressed assets. It is not now, and it won't be then.

Okay, great. Thank you.

Rob, also the answer to your other question, it is 40 out of the 42. Because one is a leasehold, and one we are retaining.

Great. Thank you.

Thank you. Our next question from the line of Ryan Halsted from Wells Fargo. Your question please.

Good morning.

Good morning.

One quick one as a follow-up to the past question. How about on the other side of the equation, the operations, will Ensign be able to benefit from some of those new asset classes, I mean how will they be pursuing I guess their strategy of operating skilled nursing facilities, beyond the traditional one?

I think we will continue to pursue related businesses as they make sense. The CareTrust REIT could open up some of those avenues. We obviously aren't going to get crazy and just jump into something because CareTrust REIT bought something and makes sense for us to lease it, or be a part of it. If it doesn't make sense with our passions and with our mission, then we won't be doing it. Certainly there will be, I think the biggest advantage is the fact that when there is a big deal out there, we can take the part that we really like, and they can find other operators for the rest of that deal, which is a little more difficult to execute right now.

That is a perfect segue into sort of explaining that some of the portfolios aren't necessarily big, or outside of Ensign's geographic footprint. But we don't do, for example, LTACs. And when you see a portfolio that is like six facilities, two of which are LTACs, that is something that CareTrust can do by partnering with an LTAC operator, and giving Ensign or somebody else the other four. We think it is beneficial on all sides.

Okay. And then on the deal specifics, I guess to start, could you give the value of the real estate, I guess as you are implying on the yield on the leases?

I will let Suzanne give you the breakdown.

What we have disclosed so far is just the historical book value. I think if you look through the Form 10, the historical book value as of June 30th is $445 million. And then if you get a yield implied, based upon the projected first year revenue stream of $59 million, I think it gets you to about 12% on the yield reply.

A little higher. Obviously that is not the way we think about this spend, but we will think about yield on straight up acquisitions in the future.

Okay. And then with I guess you talked a little bit about the leverage of the operating company post the spin. Could you just clarify how you anticipate or how you will go about, I guess, delevering the operating company? And I guess along those same lines you talked a little bit about the cash account specifically, that it looked like barring any significant, well, assuming there could be significant or more transactions going forward, that might have implications on the cash accounts between the two companies. But I guess my question would be, is assuming no deal is going forward, how do you see cash sort of split between the two?

Well, as the deal stands right now we expect and this can change, but we expect to issue about a $350 million bond at the time through CareTrust at the time of the spin. Use the proceeds from that to pay off debt, to basically capitalize both balance sheets, to position both companies with plenty of ramp for the coming year's worth of acquisitions. Beyond that, we haven'treally published proforma numbers, and as you correctly note, we do have some acquisitions on the horizon that could affect that. They could affect the amount of the bond if we do a number of them. We could upsize that if we want to, or depending on where we want those assets to land, we may allocate cash one way or another toward either company. That is as much as we can predict right now.

Okay.

If I could say that we are working with a great bank group who is really supportive, and we have talked to them a lot about what it is going to look like, and the commitments that they are going to be able to make.

Glad you are in good hands. I guess as far as the corporate integrity agreement. Just curious,I know you talked about some of the initial expenses, but now that you have a month under your belt under the corporate integrity agreement, I guess you had outlined about $2.5 million of expenses. Can we expect more quarterly expense going forward, or was the compliance costs you highlighted in the third quarter the extent of it?

No, I think that a lot of those expenses obviously will continue well into the future. I think they peak in frankly I think they peak between the third, fourth and first quarter of next year, because of all of the extra work that has to go into doing certain trainings with the existing staff. And then obviously we continue to do so with all of the new staff, and then we do it again each year. But the stuff that has to be done every year is not as rigorous as what has to be done the first time. I would say that we are at the peak of those costs, but that the peak will continue through the fourth and some of the first quarter, just the beginning of the first quarter. And then some of those costs will drop off quite a bit.

Any sort of initial thoughts so far, as you have been operating under it? I know it is still early, I know you highlighted some of the compliance highlights, but any sort of other takeaways we should come away with on how it is going so far?

I think it has been healthy for the organization. I mean there are, some of the things that you deal with when you introduce new computer systems to an organization, I guess the country knows something about that now. But it is, we have a few IT stuff, but it is nothing unusual. And it has been good for the organization.

Okay, great. Thank you.

Thank you. Our next question comes from the line of Dana Hambly from Stephens. Your question, please.

Thanks. Good morning. A question for the operating company going forward, just trying to think about your thinking on pursuing new deals, obviously historically you have been preferred to buy, as opposed to lease financing. When you go back into the market, has that thinking changed at all?

No. We are still happy to take leaseholds when we have landlords that don't want to sell, but we still prefer to buy.

Okay. And now that you guys have been out of the market for most the second half of this year, are you seeing, I think that you mentioned this earlier, is there pent-up demand that you can put that facility to use pretty quickly?

Yes.

Okay.

We have seen a better environment in the last few weeks than we have seen in the last two or three months, so we are pretty excited about that.

Good to hear. I know this has probably been in the works for a while now. Could you just speak, I know the last skilled nursing spin, the reimbursement timing was pretty unfortunate. Could you just talk to how you feel generally about the Medicare and Medicaid reimbursement environment, if that had any, weighed in at all on the timing of this?

No, it had nothing to do with the decision. I know you didn't ask this question, but the environment actually is better. It looks better than it has for the last two or three years. But it had nothing to do with the decision.

Okay. Just final one for me. I know it is small, but what is the purpose of the REIT owning and operating the three independent living facilities?

That is one of the nuances of tax law. In order to effectuate this tax respin, and as we understand it, we are only the second ones in the country probably by the time we get it done, who will have done this. But in order for the company to do this on a tax free basis, we had to have not one but two active trader businesses, that have been, that the Company has had for a long time, and we have the three standalone independent livings, that we could identify as a good solid potential second active trader business, and so those are going with us. They will live inside the REIT. They will not be dropped into a TRS, at least not initially, and the revenue from them is relatively small, and probably matches the expenses pretty closely. It is about $2.5 million actually.

Okay.

They run just slightly better than breakeven.

Okay. Thank you.

Thank you.

Thank you. (Operator Instructions). This does conclude the question and answer session of today's program. I would like to hand the program back to management for any further remarks.

Thank you, Jonathan. We appreciate everybody spending the time on the call with us, and we appreciate everybody's support and trust, and all of the work that has gone into creating this. So thanks for spending this time with us.

Thank you ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.