LTC Properties Inc (LTC) 2016 Q1 法說會逐字稿

Good morning, and welcome to the LTC Properties First Quarter 2016 Analyst and Investor Conference Call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the conference over to Wendy Simpson, CEO and Chairman. Please go ahead.

Thank you. Good morning, everyone and thank you for joining us today. Last week, we announced our two guest speakers for today's call and I'd like to welcome Dr. Craig Flashner, a Principal of Prestige Healthcare, and Mr. Mark Rockwell, a Principal of Anthem Memory Care. They are joining Pam Kessler, LTC's EVP and CFO; Clint Malin, our EVP and CIO; and me on this call.

Dr. Flashner's company, Prestige Healthcare, is a privately held operating company providing post-acute care, assisted living and independent living services, and other rehabilitative and healthcare services at 68 facilities in seven states. Today, Prestige operates 22 properties in LTC's portfolio.

Mr. Rockwell's company, Anthem Memory Care, is privately held and develops and operates standalone private pay memory care communities. To date, Anthem has developed and opened six communities in three states, including five owned by LTC and has three projects in various stages of development, all with LTC. Just last week, LTC purchased two memory care properties from another operator in Kansas and these will be the first already opened and operating properties that we have done with Anthem.

In the first three months of 2016, Pam, Clint, and I have had the opportunity to meet one-on-one with investors and analysts. And from these meetings, we took away a few recurring questions and possible concerns. Because LTC has a high concentration of non-public operators, investors and analysts may perceive they cannot get a good feel for our individual operators and may view those operators as less sophisticated and not able to effectively respond to the always changing reimbursement and competitive environments.

LTC believes the local regional operator has many advantages over the larger national operator. These operators are dedicated to the states in which they operate and know the regulators, regulations, legislative proposals, licensing requirements and issues, competition, networks and referral sources, labor environment, just to name a few. Also the local regional operator usually can make decisions about costs and revenue streams and effectuate needed operational changes more quickly than the large national provider.

Later during today's call, Dr. Flashner will comment on what Prestige Healthcare does to meet operating challenges, how he sees today's post-acute operating environment and how he views the more immediate future of the post-acute industry. We are of course not in any way denigrating our larger national operators who we continue to highly value and support. We are opening a discussion of our large investment in the local regional operator and why LTC maintains a very positive view of these operators.

Another discussion point in our industry has been a perceived overdevelopment in the private pay sector of assisted living and memory care. Mr. Rockwell's company Anthem Memory Care has been focused on the need for dementia care specific properties. Since its inception in 2008, Mark and his team have strategically selected markets and built dementia care facilities. Mark will discuss how Anthem came to be, why they are in the markets they are in, how they select markets, and how he and his team view the competitive environment.

First though, I'll turn the call over to Pam, who will comment on our productive first quarter. We had success in both acquisitions and financings. After Pam's presentation, Clint will discuss our pipeline and operating statistics. Before I ask Craig and Mark to talk about their companies, I will give you updated guidance and then we will take calls related to LTC's remarks. After the question-and-answer on our remarks is complete, we will begin the industry-specific portion of today's call, followed by a chance for you to ask questions of today's guests. Pam?

Thank you, Wendy. FFO increased 21.1% year-over-year for the first quarter of 2016 to $28.3 million or $0.76 on a fully diluted per share basis. Revenues for the quarter increased 22.6% or $7.1 million year-over-year. The improvement primarily reflects acquisitions, completed development and capital improvement projects, lease amendments, as well as an increase in interest income from mortgage loans resulting from loan originations and the amendment to our Michigan loan. This was partially offset by reduction in revenue from a property sold last December and mortgage loan payoffs.

First quarter interest expense was $6 million, an increase of $2.2 million over the comparable 2015 quarter, due primarily to the sale of senior unsecured notes last year, greater utilization of our line of credit to fund investments and development, partially offset by higher capitalized interest. General and administrative expenses were $4.3 million or $800,000 higher this quarter compared with a year ago. Approximately $600,000 of this increase is due to increased staffing and other costs associated with more investment activity and the remaining $200,000 is due to the timing of certain expenses.

Turning to the balance sheet. During the quarter, we purchased a newly constructed 126-bed skilled nursing center in Texas for $16 million, adding it to a master lease with Fundamental at an initial incremental cash yield of 8.5%. We also sold a 48-unit assisted living community located in Florida for $1.8 million. Last quarter we took an impairment charge on this property writing it down to the sales price net of selling costs; accordingly no gain or loss is recognized related to the sale of this property.

Additionally, we invested $16.6 million in properties under development and capital improvement projects during the first quarter; funded $6.6 million under existing mortgage loans and received $1 million in principal payments and mortgage loan payoffs. Subsequent to March 31, we purchased two memory care communities in Kansas, totaling 120 units for $25 million. Additionally, we acquired a 60-unit memory care community in Kentucky for $14.3 million and originated a $12.3 million mortgage loan secured by two skilled nursing centers in Michigan totaling 216 beds.

During the quarter we borrowed $40.5 million under our line of credit to fund investments and development. Subsequent to March 31, we borrowed $37 million on our line and therefore, we currently have borrowings of $198 million outstanding and $402 million available under our revolver.

During the quarter, we repaid $4.2 million of principal on our senior unsecured notes. Subsequent to March 31, we locked rate under our shelf agreement with Prudential on $37.5 million of senior unsecured notes at 4.15%. These notes will have periodic scheduled principal payments and a 12-year final maturity. We anticipate closing this transaction on or around May 20.

During the quarter we received $14.6 million of net proceeds from the sale of 332,619 shares of common stock under our at-the-market offering program. The weighted average sales price net of commissions was $44 per share. The proceeds were used to fund our investment and development activities.

At the end of the quarter, LTC maintained investment grade metrics with debt to annualized normalized EBITDA of 4.4 times, a normalized annualized fixed charge coverage ratio of 5.1 times and a debt-to-enterprise value of 26.5%. Additionally, we have one of the most conservative debt maturity ladders in the entire REIT universe with long-term debt maturities carefully matched to our free cash flow, thereby virtually eliminating any refinancing risk.

In utilizing debt to fund investments, we have prudently matched our long-lived assets with long-term debt with 10-to 15-year final maturities. We believe our conservative balance sheet management provides us with the best opportunistic approach to financing our company's future growth and creating long-term shareholder value.

I'll now turn the call over to Clint.

Thank you, Pam. Good morning, everyone and thanks for joining us today. Year-to-date, we have completed $63 million of accretive investments. We continue to execute on our investment strategy of deploying capital to acquire newer and more modern assets. The average age of the four properties acquired year-to-date in 2016 is 2.5 years. Two of the transactions closed subsequent to the first quarter were completed with Prestige Healthcare and Anthem. I would like to extend LTC's continued appreciation to both Mark and Craig for their support of LTC as a trusted capital partner.

Currently, we are working on approximately $150 million of off-market transactions split evenly between skilled nursing and private pay assets with approximately 90% of the pipeline representing acquisitions. We continue to evaluate selective development opportunities with our existing operating partners and remain disciplined in our underwriting approach while adding these projects to existing master leases for additional credit enhancement.

As I have mentioned on previous earnings calls, in 2015, we began evaluating opportunities to recycle capital on assets no longer core to our portfolio. Since that time, we have sold two properties, one at the end of 2015 and the other during Q1 of 2016, which Pam just mentioned. In 2016, we will continue to work strategically on recycling capital through selective asset sales to further enhance our portfolio. I will provide updates regarding our capital recycling initiative on subsequent earnings calls.

Turning to our portfolio on a same-store basis for the trailing 12-month period ended Q4 2015. EBITDAR lease coverage for skilled nursing is 2.19 times, assisted living 1.63 times, and range of care 1.71 times. EBITDAR coverage after an allocated management fee of 5% of revenue is 1.59 times for skilled nursing, 1.4 times for assisted living and 1.26 times for range of care.

Compared with the previous quarter, same-store occupancy remains consistent across all property types. Occupancy for the trailing 12-month period ended Q4 2015 is as follows: skilled nursing 79.3, assisted living 86.5, and range of care 85.3. Income from our portfolio continues to be well diversified with approximately 52% of our underlying revenue derived from private pay sources.

Although coverage in our skilled nursing portfolio decreased 5 basis points for the previous quarter, LTC's lease coverage metric for this portfolio remains one of the strongest in the industry. This decrease in coverage is mainly attributable to annual rent escalations and challenges specific to two skilled nursing properties in our portfolio, and not related to any specific shift in reimbursement or managed care penetration. These two properties are included in one of our largest master leases providing us with strong credit enhancement support. EBITDAR coverage for this portfolio on a trailing 12-month basis for Q3 2015 was 1.5 times. One of the properties is on CMS's special focus facility list, resulting from the death of two residents at the facility caused by the actions of another resident, which occurred in mid-2014. The state has denied renewal of the license for this facility. However, our operator has filed an appeal, which has been pending since the licensure expiration date in November 2015. The facility continues to be licensed during the appeal process, and although able to admit residents, local media attention has impacted occupancy dropping from 72% on a trailing 12-month basis in Q4 2014 to 58% on a trailing 12-month basis in Q4 2015.

Our net book value for this property is less than $3 million, which is approximately $15,000 per bed. We continue to stay in close contact with our lessee to monitor the situation. The other property's performance deterioration is a result of challenges relating to implementation of managed Medicaid in late 2014 within the state where the property is located. The transition caused a temporary reduction in occupancy relating to a specific Medicaid waiver program operated by this facility.

Recently, our operator successfully resolve patient placement issues for this Medicaid waiver program and at the end of March 2016 occupancy has returned to the same level prior to implementation of the managed Medicaid programs; we believe this issue is now behind us. However, since we report coverage one quarter in arrears, we anticipate coverage erosion relating to this property will continue for one more quarter.

And to conclude on our portfolio, combined coverage and occupancy metrics for our 37 assisted living communities leased to Brookdale continues to be strong. For the trailing 12-month period ended Q4 2015 EBITDAR coverage after an allocated management fee of 5% of revenues is 1.78 times and occupancy of 88.2%.

Now I'll turn the call back to Wendy.

Thank you, Clint and Pam. With the inclusion of our transactions in the first quarter and those completed so far in the second quarter, acquisitions, financings and ATM use, I'm increasing our guidance, which was $2.95 to $2.99 and raising it to $3.05 to $3.09 for 2016. At the high-end, $3.09 represents a 10% growth from the $2.80 we achieved in 2015. And as Clint discussed, we have opportunities to possibly improve upon that. In the current guidance, we have made some assumptions regarding timing of certain asset sales this year, but we are not including any assumptions of unannounced additional acquisitions, financings or equity issuance.

I'll now turn the call over for some questions about our performance in the first quarter and our views of the year, before we turn the call to the operator. So Austin, if you'd open it up for questions, please.

Sure. We will now begin the question-and-answer session. (Operator Instructions) Rich Anderson, Mizuho Securities.

Thanks. Congratulations on a good quarter. Pam, can you just tell me what the ATM activity was again for the first quarter? I missed that.

Sure. It was -- we received proceeds of $14.6 million from the sale of 332,619 shares and that was a net price of $44 per share.

Okay. Thank you very much. Now, I know we're -- I never got this fully answered, but looking at your skilled coverage on the EBITDAR basis of 1.59 times and in that is the Prestige loan, which was originally, call it 2-ish, now maybe a little bit lower. But, are we thinking about that right, like in terms of the rest of the portfolio that's not in a loan format, would it be significantly below 1.59, just the weighted average kind of math or how should we think about the real estate coverage that -- and the coverage for the real estate that you actually own?

Sure. Rich, this is Clint. Good question. One thing regarding the loan with Prestige that needs to be looked at -- it's a 30-year mortgage, so it has -- it embodies a lot of elements of the lease -- or of a lease, so it is obviously a long-term investment for us. Coverage, as we deployed additional capital on that loan, as we mentioned in the last quarter, the coverage has come down a little bit, which we expected with the funding of that incremental payment as interest going up on that, but the coverage right now for the portfolio, if we took out the Prestige loan we'd be at around 1.5 times coverage within the portfolio, on the skilled portfolio.

Okay. So 1.5, excluding Prestige?

That's correct.

Okay. Thank you for that. And then Wendy, last we spoke, which wasn't long ago, it didn't sound like the acquisition pipeline was going to be as fruitful this year as it was last year for you just in terms of volume of opportunities. But now it's fairly significant increase in guidance based on that, and some sense that you might do some more as the year progresses. Would you say that there's been a change there in that, suddenly things are starting to percolate more in the last month or so?

Yes. We've had a significant success in converting some of the things that we thought were going to be in the pipeline and moved it to the pipeline level where we have an actual LOI, whether they transition into an actual transaction, I don't predict at this point, but yes, it's looking much better for this year than it did the first quarter.

Okay. Great.

Rich, to give you some color on that, these are all off-market transactions that we've been able to source through our relationships. So, in general I would say that marketed activity has probably come down a little bit, but again these are all off-market, which we use our relationships and contacts to fill out the pipeline we have today.

Would you be able to put a dollar figure on this off-market opportunity pipeline?

I provided it in my prepared remarks; it's $160 million in total.

Okay. Sorry I missed that. Okay. All right. Thank you.

Paul Morgan, Canaccord.

Hi. Good morning. Just in terms of the 305 to 309 that you just provided, I might have missed this in terms of what you said about this kind of the balance sheet side of thing. So am I right that there is probably around $200 million or so on the line after your April transactions, and if that's about right, is the 305 to 309 number assuming that just stays on there or is there a kind of terming out or equitization component to the numbers?

It assumes, it's on the line and so the line is not termed out in our assumption.

Okay. And I mean, how do you feel generally about the balance, I mean, it's a little bit higher than kind of what you've carried typically in the past, I mean you've given thoughts over the past few quarters about where you want your leverage to be, and then maybe kind of in particular about where you would want the line balance to be. Is there any kind of additional color there now?

Well we're at $400 million of availability and $200 million drawn on the line, we're comfortable with the line balance, but we will remain opportunistic. You saw us pull down on our Pru shelf, because the rate that we were offered was a great rate for LTC. Spreads have come in from where they were the last time we talked, I think at the beginning of the year.

We were very cautious on possibly terming out the line, because not only were rates higher, but the spreads were considerably higher than they have been historically, as the 10-year crept down and spreads were persistently wide. We did not term out the line, and then recently in the past two weeks, I would say spreads have come in significantly, so we took advantage of that. And that's really how we run the balance sheet is to be opportunistic. So if spreads don't remain low and rates don't move, we possibly could term out more later this year, if rates remain low where they are right now.

Okay. That's helpful. Thanks. And then I think last quarter you talked about kind of looking for some shift in pricing in terms of kind of investments, and obviously the -- kind of all the stocks are in better shape, and I wonder as you look at your pipeline now, whether kind of any of that improvement in cap rates from your perspective is materializing in what you're looking at or whether kind of that's less of an urgent focus now, and it's more to sort of exploring opportunities with kind of organically with your partners at kind of cap rates that might be consistent with where you've been in the past?

Sure. Since these are off-market transactions, we haven't had the cap rates and the evaluations work for us on these transactions, but we have seen slowdowns I mentioned previously, and just deal activity in general. So that could be some price discovery regarding buyers and sellers in the marketplace, given that we've seen a lesser amount of that activity from brokers.

Okay. And then just lastly, anything new on kind of the behavioral side, your sort of initiative to explore kind of more investments there?

We're still interested and we're having conversations and continue to explore the space, and something that we do want to continue to pursue, but we're going to do it slowly and methodically in investing in this space, so something we very much continue to be interested in pursuing.

I mean, you think we could see something this year, and that's going to be based on what you're looking at now?

We're having some discussions, it's possible that we could see something later in the year, it's correct. But that's not in our pipeline right now, but there is something that, I mean, later in the year it's possible could materialize.

Okay. Great. Thanks.

But again, it would be probably a single investment again. We're going to approach this in a methodical and strategic basis and not get ahead of ourselves. So it would be a small investment should we be able to do that.

Okay. All right. Thanks.

Jordan Sadler, KeyBanc.

Thanks. Good morning. Could you characterize, Clint, the pipeline in terms of property versus loan opportunity?

90% was acquisition.

90% is property. Okay.

Asking is it one development and the other acquisition or it's one development, one loan?

There is one development project that would not be -- that would be refund on balance sheet.

What Jordan was asking was, I think was, acquisition or development?

Acquisition or development, I'm sorry. So on development right now, we have 9% of the pipeline that will be development.

But none of the 150 is loans?

Small amount of fees that would be 2% of the -- so very small.

Okay. 2%, small. Okay. And then in terms of -- obviously, you used the ATM during the quarter. One, I am curious sort of the appetite there if that seems to be the most efficient means to sort of raise capital relative to sort of this acquisition pipeline if you think you'd continue to use the ATM here? And two, I didn't catch what the year-end leverage would look like if you sort of modeled it out from here based on your -- what's embedded in your guidance?

Our year-end leverage would be, if you use $47 a share, would be approximately 28.72. Yes, 28.72 debt-to-equity. So, we -- still without assuming any additional ATM shares. So, we'd still be below our 30% average target.

Do you have a debt-to-EBITDA number for that?

It would be under 5 times.

So 5 times, and that's in the range there you want to be -- continue to remain below 5 times or is it 4 to 5?

We're comfortable at 5 times.

But not below, I mean not above rather?

I mean, a little bit above but certainly not up to 6. I know some of our peers run at 6, but I think that's a little high for us considering we tend to be more conservative.

Okay. And the ATM, the only question there I was just, you did 337,000 something shares during the quarter. Post-quarter was how much?

We stopped when we -- we are in a blackout period, so we haven't started using the ATM. If we do this quarter, we haven't started. And indeed, if we do the $150 million of acquisitions, it's not -- it's cheaper to use the ATM, but it's not as efficient. So, we certainly would be looking at different ways of financing if we do all the $150 million.

Okay. Thanks for the color.

You're welcome.

Chad Vanacore, Stifel.

Good morning. This is Seth Canetto on for Chad, how are you guys?

Fine, Seth.

First question just on the updated guidance and more specifically on G&A, as you've added more headcount. What should we be assuming for sort of a quarter run rate for the remaining of the year?

About $4.2 million a quarter.

Okay. So where it came in this quarter?

Yes. I think we're at $4.3 million this quarter, $4.2 million, I mean, we had some timing things. First quarter G&A is always a little bit higher, but I think $4.2 million -- $4.1 million, $4.2 million is probably good for the rest of the year.

All right. Great. And then, the skilled nursing lease coverage, I think has ticked down for a few quarters consecutively now, and I know you guys updated us on two isolated incidents with properties, but do you have any view on how that coverage, should we assume this trend persists going into 1Q, or any updated thoughts there?

Well, right now as I mentioned in my comments that the one building we may see some deterioration on that one building for one more quarter, but right now when looking at what we see, we think that should stabilize. That's where we're at right now.

All right.

And as we continue to buy properties and we underwrite at 1.5 coverage, you would naturally expect the average to trend down as you're adding properties in at 1.5, whereas the legacy portfolio is a little higher than that.

All right. And then I guess in the current environment, and looking at the cap rates, where do you guys see the best investment opportunities and do you think you'll see any behavioral health growth opportunity going forward?

Regarding behavioral health, we talked about that on one of the previous comments that we have been in discussion with somebody and we're looking at a potential opportunity. So it's likely we'll see something on the behavioral health. Regarding the best opportunities for us really it's us being proactive in utilizing our resources to be out in front of operating companies, just try to source off-market transactions, because there is some price discovery disconnect on the acquisition side, whether it's skilled nursing or assisted living.

So it's really trying to find unique off-market opportunities and position ourselves with strong relationships with our existing operating partner --- or continue growing relationship with our existing operating partners and forming new relationship. So, and that's what our pipeline represents and where we're spending our time trying to source investment opportunities.

All right. Great color. Thanks.

Thank you.

This concludes our first question-and-answer session. I will now turn the call back to Wendy Simpson for the second half of the presentation.

Thank you, Austin. At this time I'll ask Dr. Flashner to talk a little bit about Prestige.

Thanks, Wendy. I appreciate the opportunity to be here. Well, I thank LTC for their support. Prestige Healthcare owns and operates 70 facilities in seven states. We focus mostly on skilled nursing but do have a few assisted living and independent living. Our main concentrations are in the states of Tennessee, Ohio, and Michigan.

We're currently the second largest provider of skilled nursing in the state of Michigan. We have an office, our main office is in Louisville, Kentucky, with a satellite office in the suburbs of Detroit.

I think what makes Prestige a little unique is that -- I have a clinical background, I was a surgeon by training, and our CEO Bob Norcross, actually started in skilled nursing facility as a certified nurse's aide when he was 16 years old and worked his way up to be an LPN, RN, and eventually a Director of Nursing.

My background before Prestige Healthcare within skilled nursing dates back to 1994, when I was the Chief Medical Officer and Director of Managed Care for Wingate Healthcare in Massachusetts, outside of Boston, and I also was the Director of Development in that company. We grew from 4 facilities to 22 facilities before I left and formed Prestige, and as I said, we now have 70 facilities in seven states.

Thank you. Mark, would you please talk about Anthem.

Sure. Thank you, Wendy. And thank you for the opportunity to be here. Anthem was established in 2008. Our home office is in Lake Oswego, Oregon. I have two partners, one of whom has extensive experience in operations of 25 years. One of my other partners has in-depth development experience, and my career in real estate developments and healthcare dates back to the 1980s.

We are focused specifically on free-standing memory care. We currently have half a dozen communities open with several more in development. We were attracted to memory care largely because we think it is not only a really large and unmet need, but it's one that's growing, and we felt as though it was an important enough need that we -- it deserved our complete undivided focus. When you say to a family entrust the care of your mother or father to us, that's a pretty heavy moral responsibility. And we felt that the only way we could rise to that level of care was to really make it an undivided emphasis.

Thank you. Craig, what have you done to prepare Prestige for the transition to value-based reimbursement? How are the new reimbursement treatment models, such as bundled payments, ACOs, Medicare Advantage affecting your business?

Well, we actually started back in 2012, making a conscious decision to prepare ourselves for bundled payments, ACOs, et cetera. But by way of history, we are really kind of capitated now anyway back in 1994, we've had many, many reimbursement changes over the last 22 years that I've been in the industry, dating back to 1998, when I know that a lot of the skilled nursing providers and REITs took a major hit on their stock, because everybody thought the world was going to end when PPS came into play.

But the reality is that our view on reimbursement changes most of the time is that there is an -- there's ways to take advantage of different reimbursement methodologies and usually there is something that's changing that could be to our advantage. And the main thing about the change to PPS was it really prepared us for what's going on today. Back before 1998, you were guaranteed a profit, fee-for-service guaranteed everybody a profit but it did fix your margin. So Medicare margins free PPS were actually much lower than they were post-PPS.

And while I know it bothered everybody, and everybody thought the world was going to end, we also realized that that was a big opportunity. So margins went way, way up, we've had numerous reimbursement changes over the last 20 years, surely with obviously, some of the things that have occurred, CMI -- Case Mix Index -- I don't know how familiar everybody is with our industry here, but Case Mix Index has come into play.

Cost reports have changed over the years, the way the methodology is, and we now have quality add-ons in many states. We have some managed Medicaid in states, but really while you'll hear about managed Medicaid, Medicaid is really not managed in any state except New Jersey, because the states still set the rates and anybody can participate.

So back in 2012, the decision we made was that we needed some geographic concentration and coverage. So we actually divested some facilities and we made a conscious effort to acquire within geographic concentration. So right now, if you leave our office in Louisville, Kentucky, and you drive north through Ohio and into the middle portion of Michigan, you can't drive more than 90 minutes without being at one of our facilities. We have 35 facilities in southern Michigan and we cover all the way from the eastern part of the state to the western part of the state and we have 19 facilities in Ohio.

We think that demographics are definitely in our favor as far as an industry goes, and while there's bundling going on in ACOs, and yes, they will bring the length of stays down and they will try not to use skilled nursing facilities as best they can. I think that the demographics say that total Medicare beneficiaries were 47 million in 2010 and projected to be 64 million in 2020. And that's a 35% increase in potential covered lives. So, while there will be a compression of days, there is just that many more obviously beneficiaries.

So, I think it's actually a necessary change, because the reality is if you have 17 million Medicare beneficiaries and we are spending the same amount of money per beneficiary, we'll put the country out of business. So, that doesn't bother us at all. What we've decided to do, as I said, is go geographic concentration.

We also are now the preferred provider for six different systems within the state of Michigan and what we've really focused on myself being a clinician, Bob Norcross, my CEO, being a clinician, is high acuity. If you look back over the history of skilled nursing facilities, since I've been in the industry in 1994, you'll see the shift from really basically warehousing elderly to doing what rehab hospitals did when I trained in medicine in 1980s, which was take care of stroke patients, hips, knees, et cetera, and what I think you're going to see going forward is simply us taking over some of these that are now seen in the LTAC's select rehab hospitals, etcetera.

They're just going to shift down like they always have. So, we have the opportunity there. So, what we've done as a company actually is we've become a high acuity provider. We actually own 65% of all the ventilator beds in skilled nursing facilities in the state of Michigan. We're one of only 20 buildings in the country that has hemodialysis and ventilator care in the same building and it's one of the buildings that we actually own with LTC.

So, what we're seeing is a shift to higher acuity obviously, and I know everybody is worried about this hip, knee replacement program and it only really covers about 30% of the country and only in 67 counties. It's not a big deal and it's a very small volume, but what we're trying to do is position ourselves to be a provider that the preferred provider systems just can't ignore. And I think we've been pretty successful at that. We're on the Board of a couple of the preferred providers. We have managed care contracts with almost every major managed care company in the country and really that's where we've gone.

Thanks, Craig. And you have a view on how big a company you would like to have.

Definitely. I think what's happened over the years is with the shift in acuity it's become necessary to have staff that can take care of those residents and oversee those residents surely from a clinical perspective, regional perspective, and of course from a compliance perspective. We have a very large compliance department in our Company, now that didn't even exist years ago. We have a Chief Compliance Officer, we have another compliance officer. We do triple checks before we bill, et cetera. and I know everybody has heard about all the False Claims Act claims, et cetera, RAC audits.

And really, everybody makes big deal out of a RAC audit, but in theory if you do -- if you're billing appropriately, it doesn't matter if you have a RAC audit. You didn't bill for anything you weren't entitled to bill for. So we've done fine at RAC audits.

But I think that what we've found is that we think the sweet spot is between 90 and 120 facilities and you've seen a lot of the actual public companies including (inaudible) and some of the other ones, pare down from 300, 350 down to that level. We were involved in Extended Care transaction as one of the operators. And Extended Care had 370 facilities, approximately 160 in the United States. They sold their 160 in United States and kept their portfolio in Canada, which gets them into that range. So, I think that you're seeing a lot of the bigger companies come down to that level as well.

Thank you. Mark, would you talk a bit about how you and your team select markets and how you feel about oversupply currently or do you see oversupply in your areas?

Well, there is the risk of oversupply, but first of all, let me address your first question about how we select markets. We are very focused on doing in-depth market studies and we wouldn't, for instance, view a market like Denver as a market, but in fact when we researched that market starting six, seven years ago, we honeycombed it into probably 25 to 30 submarkets, and that's really the way we believe you have to look at any major metropolitan area, because there are supply and need issues in every quadrant of the city and it will vary pretty dramatically.

So, we do -- we start with an in-depth, in-house study to look first at the population, the demographic, the current supply on the ground and calculate what we believe is an unmet need, income adjusted for private pay. And if that looks strong enough and we find a site in that quadrant of the town or the city that we like, we will then refer our study to an out of house third-party to validate what we have done just to make sure that we are not drinking our own Kool-Aid.

And then if it's sufficiently strong, we will move forward in acquiring a site. We really believe that in-depth market study and research to validate the need is an absolute inviolate first step in any kind of an acquisition or development, and so far that has been good for us and we certainly intend to continue in that manner.

In some of the markets that we're in, we're seeing for instance in Denver, there is a continuing supply coming into the market, which is a bit surprising, because, while I think that we're now pretty close to balance, it could get out of balance with some of the -- at least rumored development that's coming, continuing to come.

What we anticipate doing is really focusing on our core strengths, which is strong market brand awareness, reaching out to hospitals, conducting community events and really being recognized in the market as a specialist and an expert in providing top-flight memory care, and that is not to say for a moment that we're not concerned about competition, you always have to be, but we will be the one still standing, because that is our business and that is what we're committed to.

Great. Thank you. Thanks to both of you. I'll now turn the call over to questions from the audience for both Craig and Mark. Austin?

We'll now begin the second question-and-answer session. (Operator Instructions). Michael Carroll, RBC Capital Markets.

Yeah. Thanks. My first question is to Craig regarding the RAC audits. How many audits are actually taking place in your portfolio right now? Are they just starting or are you receiving more I guess letters or is anybody actually doing the information search?

Actually, there was an issue. They didn't even fund the RAC audits for this recent period of time. So, there's not a lot of RAC audits going on right now, I think the last one we had was in 2014. So we're not seeing a lot of activity ourselves.

Okay. So then I guess, have the audits actually started with the announcement that occurred in March?

No. We haven't seen any activity since then.

Okay. And then I guess you said you participated in the BPCI starting in 2012, I mean what model did you participate in?

We didn't participate in a specific model, but we're a preferred provider for a lot of our systems. We actually have supplied the systems with information that they're using to determine how they're going to bundle and how they're going to contract. So, we have two systems that we're jointly supplying information to and working with and they are actually asking the question of us. They're not part of a bundle yet.

Okay, you're actually participating with the hospital systems that are in the bundles, but you yourself are not in one of the bundle programs.

That's correct. They're not bundling with SNFs yet.

And have you noticed any changes from those operators as you participate in the bundle? Are they sending more patients to you as you participate in it?

Well, we're on the board of both of those and we obviously are a preferred provider for them for years now. So, we haven't really seen any increased activity, but we have large activity with them. I would think what's really going to happen, I will address this though. What most people believe and I was meeting with Mark Parkinson recently at our annual meeting and Mark is the President of the AHCA, which is the American Health Care Association, which represents all of the SNFs throughout the country and Mark and I had this conversation. And what's really going to happen, we believe, him and I, is that anybody -- certain companies and once again, the reason I said is, the size becomes an issue as well -- certain companies are just going to be preferred providers and other companies are going to get shut out.

So, if I was making a recommendation to an LTC or any healthcare REIT that is in our space, I would tell them, make sure that they're taking the providers that are going to be in the space that are going to be preferred providers for these guys. Because all that's going to happen is we will see increased volume, there's no doubt.

I mean we're preferred provider, with McLaren, we're on the Board, same with St. John, et cetera. So, we know that McLaren is going to keep us in their system and McLaren is going to pop, knock out probably a third of the facilities that are in their system today. And those are going to be the small mom and pops, the ones who just can't handle acuity, the ones that don't have the geographic coverage and all the things I talked about earlier as to why we set that up starting in 2012.

So, we believe that the actual number of days, the covered lives are projected to go up, the number of SNF days are actually projected to go up even with the bundling, even with the ACOs, but what we believe is that there will be a smaller number of providers that will be sharing in those days.

Rich Anderson, Mizuho Securities.

Thanks for the interesting color to both of you. So, from your business perspective, I think we get the message. But as someone who sees what's going on outside of your specific lines of business, what would you say that the fall-off will be, and I don't know exactly how to ask this question, but is there some stuff that needed -- some companies that needed it to be addressed in terms of how they were going about their practices, their Medicare billing or whatever, and do you have any opinion about that, about your competition and how it'll play out over the long-term?

Yeah. If you're referring to some of the companies that have been in a little bit of trouble recently.

And maybe more that haven't been yet, but may -- from your perspective and not to name names of course but, I'm just curious if this is truly a long-term positive, maybe it is for you, but is it for the industry and that's the kind of perspective --

Well. I think it's absolutely a positive for the industry. If you're asking me if you think -- if I think bundling and if I think that ACOs are positive for the industry, it's not an issue to me of whether it's positive for the industry or negative, it's a necessary place to go.

We provide healthcare. I know you guys like lend money to buildings and say -- you're not into our space, but the reality is guys, that it's necessary to control the overall cost, and I think everybody is so worried about just pulling money out of system, but there's going to be more money in the system, not money pulled out of the system.

AHCA published something recently, in 2010, there were 82 million SNF days -- Medicare SNF days. In 2020, it's projected to be at least 96 million, maybe as high as 105 million. So you're talking about anywhere from a 6% to a 14% increase in actual SNF days. If we kept paying the same amount of money or we didn't get efficient, we'll put everybody out of business.

So it doesn't bother us from a whole industry perspective, anybody that's bothered is just going to get out of the industry, and those are the smaller guys that can't negotiate and don't have some leverage and don't understand. And also you got to remember something about us too. The vendors in our space are not oblivious to what's going on. Pharmacies, I said -- I had dinner the other night with the President of Omnicare Pharmacy, it's owned by CVS.

And Rocky understands, he knows that he's going to have to come down by 8% or 10% to make up the difference. The rehab providers know that, the DME providers know that, and that's what we saw happen back in 1998. Before 1998, when I joined Wingate Healthcare in 1994, they were totally clueless on what their costs were. They said, go contract with managed care companies, you're a physician, go contract with managed care companies.

I said, that's great. How much does it cost you to supply services for a resident for a day? We have no idea. Well then, how much am I supposed to ask the managed care contractor to pay us? So, we had to figure all that out. That wasn't a bad thing, that was a good thing, that was a necessary thing. So I thought, our industry is not going anywhere guys, people are getting old, there's a lot more of them, and they're going to need healthcare and you can't do it at home and what's going to happen is just keep shifting downhill.

And we are focusing on some space and other guys are too, other big companies like ourselves or mid-sized companies, are focused on high acuity for a reason. It gives us pricing power. When we take a ventilator patient from a managed care company that's on dialysis, needs dialysis, I tell them how much they are going to pay us. They don't tell me how much they're going to pay, because they're sitting there in the hospital at $1,600 bucks a day to $2,200 a day, I know that. Knowledge is valuable, knowledge is power, I know how much it costs them.

I can call them up, I did managed care contracting back in 1994 before anybody else was doing it. I know they're paying $2,200 to the hospital and I tell them I'll take them for $1,000. And I know that works for me. So, you are not going to make the same, obviously, margin on every resident, but as long as you have the right population within, you can lose a couple of dollars here and make a lot more there.

So I think a lot of these companies, they have got bright guys, they'll be fine. Everybody is going to be fine in this industry, they're not going anywhere.

What percentage of your Medicare business is orthopedic?

Not that high. I looked at the hips and joints because I knew the question would come up, about 3% on knees and hips.

3%?

Yes, because think of it this way. So my CEO just had both his knees replaced in the last year and a half, he's in his 50s. But let's say you are a 68-year-old person and a buddy of mine he's about 58; he just had his knee replaced. He didn't go to a skilled nursing facility. So all the hips and knees of the 68, the 72-year-old, 75-year-old, the guys that are in our buildings are 80 plus and really 85 plus.

So those are much more medically complex individuals. Those are guys that have had congestive heart failure, respiratory problems, emphysema. We have a big problem now in this country obviously with obesity. We have 400-pound residents. The younger population are the ones that are killing themselves and they are the big obese diabetic patients.

The orthopedic patients that we see in skilled nursing facilities are really just the elderly patients who can't go home right away or can't do outpatient rehab and need to come to our facilities. That's not going to change, because medicine is not going to change -- I shouldn't say that -- medicine will change, obviously technology changes, but in general that's not going to change.

Is there any place in your portfolio where you have even just a little bit of concern that you're not connected properly through relationships or what have you that you might be one of those that will fall by the wayside, as hospitals kind of small down their relationships?

Yes, that's a serious concern, but we've put a huge focus on that. We're making sure that we're in the Humanas of the world and the Aetnas of the world. The other thing is there is a consolidation right now going on within the managed care industry. Aetna, Humana, all those guys, they're merging too. So there's going to be fewer of them.

We're in all those networks. So would you worry about it? There's also a difference remember -- there's a lot of areas in this country still that really don't have high managed care penetration. We have buildings in rural areas, we have buildings in urban areas, and we have buildings in suburbs of urban areas.

We love the suburbs, because we like to network, but in our rural areas really there's such low managed care penetration that they don't really have a lot of choice. In a lot of markets and skilled nursing facilities, you and one other person are the only game in town.

If you go to [Randall] Wisconsin, there's us and one other person, if you go to Ripley, Tennessee, there's us and one other person. So in those managed -- that patient population really isn't just all signing up for managed care, because there's not that kind of penetration.

So, it's really kind of a mixed bag. And we like to own everything, we like to own rural, we like to own urban, we like to own suburban for that exact reason. And you got to hedge your bet and that's why I think that the companies that are going to do okay are the ones that owns 70, 90, 120 buildings, because you're right, you make a great point. If you're going to be an all-or-none phenomena. If you own 5, 4 facilities and you're in one market, it's very risky. If you don't get in that managed care company, if you're in Boston, Massachusetts and you don't get into Harvard Pilgrim and Tufts, you're out of business.

So, we're spreading our risk, you hit it right on the head, that was a great question. But that's why 90 to 120 makes sense, because if we get bumped out of Tennessee, but we're fine in Michigan and Ohio, we're fine. It's the same reason that we believe that we needed that many facilities, and we needed to be in at least three or four states, because over the years, certain states economically are in trouble.

When Tennessee was hurt during the recession, you know what they did, they said okay, we'll look at your cost report, and if you're going to go up, if your rates going to go up $10 a day, we're going to give you a 20% increase on the upside and if it's going to down $10 a day, we're going to give you a 100% decrease on the downside.

So, we got hurt in Tennessee for a few years, we just got a huge rate increase this July 1. Same with Ohio. Ohio rates went down, I'm talking about Medicaid now. Ohio rates had gone down and we just got a big bump effective this July 1, again. So that's why I think it's important also to be in multiple states and not one place. That was a great question.

Okay. Great. Thank you.

Paul Morgan, Canaccord.

Hi. Good morning. And maybe it's for both, but we could maybe start on the Anthem side, there's been a lot of focus on labor costs and the kind of the impact of competition from new developments or higher minimum wages, and I'm just kind of curious how organizations are addressing that challenge, whether it be kind of through retention initiatives or staffing changes or comp structure, and kind of how the impact has been on your margins?

Well. Our biggest concern to start with is finding well-qualified caregivers and while we have seen some upward pressure on wages, it's really not been, at least to date, much more than just inflationary-type pressure, pretty manageable, 2% to 3%, but the bigger concern is really finding and hiring and then training and retaining good help.

And so we are -- that is really our number one focus in 2016, is designing an entire program with just a lot of emphasis around recruitment and training and retention and implementing a bonus program. So, yes, caregiving or hiring and retaining good caregivers is probably our biggest single challenge.

Mark, there is a recognized cost of turnover. So, as the salary levels go up, if you can reduce turnover, you're still going to be better off.

Well, that's exactly right and that's why it's really important in the whole process of analysis to make sure that you're hiring the right person to begin with, because if you raise your wages dramatically, but you didn't hire the right person, you're still going to lose them, they're just not well suited for the job. So what we realized is to balance out not only the optimization of quality care and keeping it affordable, we need to do a better job of identifying the right person than on-boarding them correctly, so that they really understand their job, they don't become demoralized, because we've loaded them up with so much information that they can't process it and then work to retain them. And you're absolutely right, Wendy, as our turnover costs come down, we can then actually reinvest that in higher wages.

Right. And, Craig?

I mean, Mark hit it right on the head. I think our number one concern is employee retention, our number one program that we've got -- that we've implemented in the last year, year-and-half is how to retain our quality employees. When we took over the 33 facilities that we took over out of the extended care portfolio, we actually went through myself and my CEO and we implemented actually wage increases in 23 of the facilities, because we just do market studies and we make sure that we're not underpaying people. That's really one of the major problems. When your $12-an-hour employee and building up the streets, as I'll pay you $12.10, even if you love that building, you're tempted to go. So, we constantly are looking at that. And you're right, Wendy, there is a huge cost to employee turnover, not just in dollars and cents, but really in quality of care. And our main concern in our industry at least on the skilled side is really of quality of care, because I don't care how well you can market a program, if you're not a quality care, the preferred providers are going to know, the hospitals know, the community knows and you'll never keep your buildings occupied and you'll never keep staff.

Thanks. And then just the comment on kind of new development and I think Mark, maybe you're referring to Denver in terms of the level of competition from new projects with sort of -- was balanced and maybe now it could be headed towards sort of a more of a lack of balance. I mean, has it affected kind of the lease up of your kind of your later stage projects in that market and is it kind of changed in all the way you think about entering new markets, and kind of the role barriers to entry or kind of the way you just kind of think about your geographic expansion?

Yes. I think it's fair to say that in Denver it's always concerning, when you see announcements of new development. So, we would never take that anything other than seriously. We believe that -- we have four communities in Denver. The one community that had a bit of a stall out for a short period of time in January and February, I believe and we'll never know the exact amount, but we had a really horrible car accident happen on New Year's Eve, even though we sit back from the street about a 100 feet, believe it or not a car about 60 miles an hour came jumping over the curb and slamming into the front of the building, and thank the good lord, we didn't lose anybody. It took out the entire conference room, which three or four people had just moments before left. So, we were celebrating the fact that there was no loss of life, but on the other hand, when you have the front of your building completely under reconstruction that obviously has an impact on your lease up. That property, which is Greenridge Place in Westminster is now back on track, we're seeing good lease-up activity. As I said, we had some quiet periods in January and February, how much of that was related to the reconstruction, I don't know for sure, but I suspect a fair amount of it was tied to that. Our buildings overall in Denver are doing very well, I certainly would never be complacent, we work diligently every day to market ourselves as one individual in the Colorado market, he was a marketing specialist, has said, which we take as a complement, Anthem has been able to establish strong brand identity in the Denver market. We're not real big, but we do have four communities that surround the Denver market. Yes, I am understandably concerned when I hear about additional announcements of -- I don't know if we're at the peak and we're just now going to see it start to subside. I know that when I was at NECC conference earlier this year, it appeared that overall development may be hitting kind of a cresting point and that we may now be seeing things starting to equalize. We are focusing on a go-forward basis on entering markets where there are higher barriers to entry. One of the other comments has been about the Chicago market and that's where we're also really active. But the way the Chicago market is defined and the way we define it are quite different. When I look at some maps that define the Chicago market, it takes in a very large proportion of Illinois out and including some pretty substantial farming areas, which wouldn't strike me as being Chicago. That in my opinion is where you're seeing a fair amount of development in the Chicago market.

We tend to be close-in in higher barriers to entry markets like Glenn, Huber Ridge, Tinley Park, Lincolnwood, Oakland where frankly finding sites are really, really difficult to come across. So, while that's not any guarantee that we won't face competition, it does at least tend to minimize it.

Karin Ford, MUFG.

What are your return hurdles today and what type of same-store NOI growth are you underwriting when you're looking at new deals?

Are you asking the operators when they're looking at new deals or LTC?

The operators.

If you're looking to add a facility to your portfolio, what type of returns are you looking for?

Well, that's kind of a loaded question to my industry, because of the complexity of some of the programs in the buildings and some the operators we acquire from, we try not to do turnaround buildings that need clinical turnaround, they have clinical issues, but surely buildings that have economic issues, we will try and turnaround if we think we can do something different than the operator, especially in a state like Michigan where we understand cost reports very, very well.

But to answer your question in a specific multiple, our ultimate goal is to be in a facility for 5 to 5.5 multiple of EBITDAR when we're done with what we're doing and that might include a renovation, that might include a bit of a turnaround (inaudible) whatever, but we try and get into our buildings for around 5 multiples when we are done.

Got it.

In our case -- this is Mark speaking for Anthem. The way we tend to evaluate markets is primarily driven by lease coverage and bottom line net operating income. We strive to have a debt coverage somewhere in the north of 1.3 range. We want to make sure that we genuinely believe that we can have a net operating income before taxes in that 9% to 11% range. And as long as we can meet those two tasks we feel pretty comfortable.

Thanks. That's helpful. What are your capital alternatives to the REITs today, and do you see value in doing repeat deals with one capital provider?

Sure. I mean, obviously it's advantageous to do multiple deals with one capital provider. I think the most important thing from our perspective is to be with a capital provider that understands our industry. When you're in the skilled nursing facility industry, there is a lot of nuances and it helps to provide if your capital partner understands that. Now, I'll turn this to the REIT, there's many banks out there that are lending to skilled nursing facilities today, and we do stuff obviously with banks as well as with various REITs.

And is there any change in appetite from the banks, I'm sorry?

Is there a change in appetite? I'd say, right now the appetite is reasonably high, but it changes constantly as you know, I mean, if I called up even to my lenders, I've done eight deals with back in 2010, I probably couldn't have gotten the loan, and I don't take it personally. I just think nobody was really lending, and some of the (inaudible) on the colors, some of the lenders (inaudible). So, I think that right now the appetite is reasonably high. I think the hard thing right now for us is to find deals that make sense. We're very particular, because the last thing we want to do is buy something that is really not additive, as we talked about earlier or we can't get to that 5, 5.5 multiple eventually. So, I think our hardest -- the toughest thing now is finally the deal to make sense. I think if we find a deal in our space that makes economic sense, there's lots of lenders that are interested.

This is Mark speaking. From our standpoint, we really appreciate and value the relationship we have with LTC, and we think that for us in particular at this stage we are in, a repetitive, an ongoing long-term relationship with a trusted capital partner, such as LTC is really optimum and the reason being what's unique for us in our relationship with LTC is not only its size, which is large enough to be financially robust for our needs, but not so big that we have to deal with multiple levels of management and it's not difficult to get a transaction put together and that as we all know in an active and growing market being able to analyze and complete transactions in a fast way, I say fast and no transaction is ever fast, but in a way that is very straightforward and repetitive where you have your documents agreed to, is I think, a strategic advantage for us and because we see the business as an operating business, not a real estate business, it's all about care, we are focused on creating good buildings, but we are not creating them from the standpoint of seeing it as a capital transaction on the real estate side for a future capital event.

It's an interesting question, Karin, because I recall one of our first meetings with Mark and Isaac in this conference room when we were talking about Anthem and starting to build memory care properties and we were so impressed with their focus on the care, they had already developed a prototype, just looking at numbers which was the pro forma of what they -- the industry could be doing and Anthem in particular. I told Mark, I said there is going to come a time in your development if this happens when people are going to be throwing money at you like crazy and we understand that we do not finance with one type of financing vehicle. Craig has more properties than are financed by us. We expect that sometime Anthem -- it's appropriate for Anthem maybe to finance in a different way whether it's to get debt to own their own properties or something, but one of the things that we have with our operators is an understanding of their health is our health. And so if it makes sense for a different capital structure for our operators we are all in support of that.

One of the things that Mark talked about is this relationship we have has really been able to free up your time, just focus on development opportunities, construction operations and not worry about sourcing capital which is going to be a very time consuming process, but it's also taken off recap risk in the portfolio, because if we had pursued a joint venture relationship, there's always that monetization recap event and that's off the table because we provided prominent financing to Anthem that really allows them, gives them a vehicle, they have a business that's ongoing under lease structure where they can invest in their dollars into human capital, technology, really look to other operating business.

Great. And just last one for me, there's been some variation over the years of escalator rates in both skilled nursing and assisted living leases. Do you guys have a view on what the right escalator level is for your business, when you partner with a capital provider?

This is Craig, 0%. (Multiple Speakers). We have actually been doing fixed rates for the first four or five years on our acquisitions. Getting to your point that as we're trying to implement new programs or do some turnarounds or do some capital improvements in these buildings, right now in a portfolio that we did with LTC back in 2013, we're doing $30 million worth of renovations, construction. So, and that's still 2.5 years in. So the first four or five years, we've actually done fixed rates and then we've escalated from there. But obviously, I'll give insight, we can handle at 1.5%, 2% bump increase, but when it starts getting, I think our increase is about 2.25%, when it gets above that it starts really getting out of hand over time. So we've kept those down to 2.25% or 2%.

Well. Speaking for Anthem, of course the flatter they increase the better. It's always, I mean it's certainly understandable from a REIT standpoint that they want to need some kind of an annual adjustment, I think the million dollar question is how do you match that up with inflation expectations. Clearly, if inflation were to remain really, really flat, at some point, we might have some real upward pressure on our lease rate. I think we're all expecting that at some point we're going to see some greater increase in inflation than we maybe have in the past five or six years, but we are comfortable with 2% to 2.25%, and as long as we have reasonable annual adjustments in increase in inflation, we should be able to sustain that.

Thank you very much for the color.

John Kim, BMO.

Thank you, Wendy for hosting this discussion. I think my first question maybe for Dr. Flashner, but I was wondering if your company participates in home health and do you see a cost advantage of home health versus SNF for certain episodes?

That's one space we stayed out of. Actually, my former company when I was with Wingate, we did start a home health agency, but we've decided to really hone in and focus on what we do best, and really what we do best is provide skilled nursing care. That's why we haven't really thought a lot of assisted living and a lot of independent. We bought independent and assisted, when it's kind of come along with our SNF acquisitions, but we don't independently go out and source those and try and acquire those. So, to answer your question, we're not going to do home health, we're going to stay focused on what we're doing to try and grow that. Do I think that some of our days are going down to home health, absolutely I do, but I think some of our days -- some of the days as I mentioned earlier from LTACs and rehab hospitals are coming down to us. There is a finite amount of clinical care that can occur in someone's home. I know everybody is really worried about home health taking over the world. Never going to happen. It just isn't going to happen, because there's really not an efficient delivery system or model for true high acuity individuals. It's great, if you need six hours a day for someone to watch your mom or dad who is 85 and has some dementia issues or whatever, because you can hire somebody in at 12 bucks an hour.

And we talked about this earlier too, the cost of low-end home health aide, et cetera is going up and if these guys keep talking about raising minimum wage to $15 an hour, that's going to be a real issue for them, no doubt it's issue for us as well. But it's not an efficient delivery model, it's not going to be a model that's really going to be taking care of high acuity residents. So we're not too worried about it, because we're focusing on the high acuity side.

Got it, okay. And then my second question is on the star ratings by CMS, do these rating matter to you? Do you think --

Yes, they matter. Well, they don't really matter to me, but they matter to everybody else, so they do. The star rating as you know change almost weekly now for us. It's been ridiculous. They're adding five new categories that they're looking at and a lot of our buildings -- we have buildings that let from five-star down the three-star in the last change and then they changed some again, now they changed some again. It matters only because the managed care companies are saying it matters. And a lot of the managed care companies are saying, if you don't have a three-star building, we won't contract with you. So, it's a big focus of ours(inaudible). We're definitely focused on it. We break it down as to what we need to do building by building to maintain stars, we're above the three-star as a company, most of our buildings are three stars or above, so we don't have an issue with that, you can't contract with the VA unless you're a three-star now. So, it is something to focus on as an issue, but it's hard for the industry, because the government keeps changing what they're measuring and every time they make a change, nobody really knows what the effect is going to be until you run your five-star the next day and then you see if you're going up or down or all around. So, it's hard for everybody, yes, it is important.

So for your one and two-star facility, is this just a matter of increased capital or some facilities ones that you may just (inaudible)?

No, usually, John, it's really about when we take over facilities, we'll take over a number of one and two stars and it's usually the quality measures and it's usually their surveys that they had their healthcare surveys from the states, that CMS does, their annual surveys. And the reason it takes a little bit of time to raise them up is we have the next survey drop-off. So you have to have another annual survey and have the last one drop-off, and sometimes it might take two good annual surveys for you to really get them up to where you want to go. So, it can be a two to three-year process, if you take up a one-star building.

Great. Thank you.

Sure.

Jordan Sadler, KeyBanc.

Thank you. Good afternoon and thanks for everyone taking their time today. Just a follow-up on the CMS star ratings, as a clarification, are you saying -- it's like -- in the end of the answer there you were giving that it does take some time to move a CMS star rating on your portfolio, especially on a one or two, but in general, across a portfolio, you said some -- CMS star ratings moving up and down. Are they more, very gradual to move, how long does it take to move a star rating on an individual facility level?

Jordan, what has happened is, they've changed what they're actually looking as the measure to determine how many stars you have. So, if they say one day, okay, we're now going to look at your how many antidepressant you're using or antipsychotics in your building, but they weren't using that in the star rating before, you don't know where you're going to fall until you look at all your antipsychotics in your buildings and see if that's going to help your star rating or hurt your star rating. So what they have done in the last couple of years is, they added in many new categories like that. Sometimes, the answer is a little complex, but sometimes you can move a building quickly, let's say for example that one of the measurements is your staffing, your nurse staffing. So if you have a building that doesn't have a lot of RNs, and it's well below the average in your area. If you go on higher bunch of RNs, you can move that up fairly quickly. If you had a facility that had a major clinical issue on its annual survey, and got a bunch of high level acuity tags, [I, Js and Gs], then it's going to take a while to move that because you got to have that survey drop-off and that takes a year. So, the answer is, it could be anywhere from a quicker effects to a longer-term effects, it just depends on the building.

And as it relates to, when you talks of the hospitals, not so where you sit on the Board, what are they focused on, I mean, are they focused on the star ratings or are they focused on re-admission rates, are there any hot-buttons that sort of basically effect, how you are managing your portfolio?

Yes. I think they understand that the star ratings and at the end of the world one way or the other because of the variation and the fluctuation, but they're definitely focused on re-admissions, I can tell you that for sure because re-admissions are costly to them, that's probably one of -- that's definitely one of the main focuses. And as they contract and bundle they are going to be focused on how much is really going to cost for you to take care of these particular DRGs. So, when they're discharged, (inaudible) DRG system, and we are not one [rugs], but we're kind of going to go to the DRG system obviously, which is fine because what they're going to say is, okay, we're getting paid to acts and we've got to move him down to here, move him down to here. And they're going to try and skip the next level of acuity obviously as best they can. So, they are focused on that for sure, but here is the other thing, there is a finite dollar cost to take care of somebody in the skilled nursing facility. I don't care if you to be the best provider in the world, but you are not hiring a physical therapist or occupational therapist for a much different cost than anybody else in the marketplace. So if a resident -- if a patient comes in, they really need two hours of therapy. It's going to cost you $60 an hour to do it. It doesn't matter who you are. So, what will happen is, you'll probably see I won't discharge you to see what happened back in the early days of contracting where a lot of providers took contracts on for rates that made no sense whatsoever. And we just set back and said we'll let them go out of business and then will pick up the debris. So what will happen is, [so on a] contract for something that makes no sense (inaudible) because they don't understand what that is and then they won't be able to do it and there won't be a provider for that hospital system very long.

And then one other, I mean you talked about folks who might lose share going forward and moms and pops are often referred to. But at the same time, you're talking about a sweet spot in terms of sizing in the 90 to 120 facility size. So, I am kind of curious who loses more share, is it the moms and pops out there who may or may not be more versatile or have the ability to sort of change, or is it the large corporates?

I think mom and pops are gone. You will not be able to be in the network if you're mom and pop, if you have two buildings, I just don't think that a hospital system that's bundling or a managed care company is going to want to go through the brain damage of contract with somebody that can only supply such a specific niche. Unless you're in the world markets as we talked about earlier, you're the only game in town. They can survive, but I'm talking now in the more urban, suburban settings. I just don't think mom and pops valuable any longer. I think that when I said 90 to a 120 facilities, remember I also said it is important to be in multiple states. So, you are not going to have 90 facilities in one state. We have 35 facilities in Michigan, we're the second largest operator there, there's 440 buildings, we own about 9% of the buildings in Michigan. So there's a finite amount of buildings that you actually want in one state also. But that does give you geographic coverage. I think what you're seeing, as you seeing the national companies kind of come to our philosophy a little bit, as I said earlier and also pairing down, I think (inaudible) is probably down to a 150, 170 build. And I think what they're realizing is, it's really more of a focus, more than anything, Jordan, I think you got to be able to focus on your buildings, and it's hard to focus on 350 buildings, if you're a CEO of a company, and you have 350 buildings and 28 million regionals and Directors of operations and regional clinicians and all that, it's hard enough for our CEO to focus on 70, and that's why we're thinking 90 to a 120 will be his max.

Thank you all for the education.

Todd Stender, Wells Fargo.

Alright. Thanks for taking my question. Very unique conference call, Wendy's. Thanks for setting it up. This is for either gentlemen, whoever wants to give their thoughts or both maybe, can you give your impression of the speed or trajectory of either skilled or senior housing operator consolidation, there's a lot of new regulations, we have been talked about labor costs, new supply, particularly in assisted living, can you just talk about the ability may be smaller operators to navigate on their own or is there increasing pressure do you think to combine with another operator?

There is definitely increasing pressure combined, we don't see so much combination in our industry, the smaller operators usually just sell out truthfully. It's hard for a small operator, we said earlier, our compliance department alone is probably the largest, some small regional operators total management company. So, financial services to build appropriately and make sure you're not make any mistake and do all the things you need to do. It's very difficult. We probably have -- I don't want economy builders, (inaudible) I have, because I want to [shoot] myself. So, it's difficult and even from a clinician perspective, they have to be competitive and they have to compete to higher regionals that can take care of the clinical issues they have and companies like ourselves can pay more money to those regional. So there is no doubt that we're seeing a consolidation, and I think that if you look at the marketplaces over the last 20 years that we're in, I'd say already that the vast majority of the mom and pops are gone. I think that there might be some of the mom and pops became regionals and they may have 10, 15, 20 buildings, but guys that have one, two or three buildings are pretty much out of the business.

Speaking from memory care. I think that there is an advantage to having multiple properties certainly, and in large part due to the whole concept of bringing training and care model to its fullest potential which if you only have a very small number of one, two, three properties, that's pretty difficult to achieve. However, at least from my vantage point, I don't see that in our segment of the healthcare industry that it's necessary to have -- to be really big. We would certainly feel as though given a goal of 25 to 50 properties that that will be a niche, that will be really effective for us, will be big enough to be able to afford all of the professional staffing at the home office that what we need for recruiting, for training, clinical care, et cetera. And I would think -- and this is just speculation on my part, but I would agree with Craig, I think when you start to get about 100 properties, it's going to become pretty unwieldy, but I certainly wouldn't want to see us get to that 50-ish range and I think that will be highly efficient. Even now at closing in on 10 properties, we're starting to see some additional need for corporate staff, which is going to be a little bit rich for us at only 10 properties, it will be a lot more comfortable when we're at 15 or 20, but we certainly don't see the need to be huge in order to be highly competitive.

Great. Thank you very much.

Thank you, and thank you all for attending and I just need to remind you that in order to invest in these two quality operators, you have to buy LTC since they are private. So, thank you all for attending this morning and we look forward to talking to you after the second quarter. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.