Healthpeak Properties Inc (PEAK) 2003 Q1 法說會逐字稿

Good day and welcome everyone to the Health Care Property Investors first quarter 2003 earnings conference call. Today's call is being recorded. At this time I would like to turn the call over to the Chairman and Chief Executive Officer, Mr. Kenneth Roath. Please go ahead, sir.

Thank you very much. Good morning, everyone. Welcome to our first quarter earnings conference call of Health Care Property Investors. With me today are Jay Flaherty, President and COO of the company, Jim Reynolds, Executive Vice President and Chief Financial Officer of the company, and Ed Henning, General Counsel. At this point Ed Henning will read a statement regarding financial disclosure.

Thank you, Ken. Some of the statements made during this conference call will contain forward-looking statements subject to risks and uncertainties which are described from time to time in press releases and SEC reports filed by the company. Forward-looking statements reflect the company's good faith belief and best judgment based upon current information, but they are not guarantees of future performance.

Projections of earnings and FFO may not be updated until the next announcement of earnings and events prior to the next announcement could render the expectations stale. I'll now turn the meeting back over to Ken.

Thank you, Ed. For the first quarter of 2003 Health Care Property Investors reported earnings today of $47.706 million, or 80 cents a share, up from $43.911 or 77 cents per share a year ago. That is almost a 4% increase year-over-year.

I want to remind people that the first quarter results is always lower and that is due to the SEC Staff Accounting Bulletin 101 that does adjust earnings over the year. Jim Reynolds will explain that in more detail when he gets to discussing the financial statements.

Before that, Jay Flaherty, as most of you now know, who has been brought into the company as President and Chief Operating Officer of the company and is expected to become CEO at the next annual meeting of shareholders of Health Care Property Investors on May 7th of this year, has been with us now for some time. He is going to report on operations of the company.

But before he does that, I would like to say that the succession plan that has been implemented by the company is going extremely well. Jay, with his extensive experience and wealth of knowledge in the healthcare industry, his 19 years in investment banking with Merrill Lynch, he has brought a lot to the company.

He has made a positive impact already on the company. And I think he's going to do an outstanding job going forward. With that I would like to turn over the meeting to Jay.

Thank you, Ken. Good morning and good afternoon respectively, everybody. I'd like to cover three topics today.

Number one. Provide an update on a number of our operators that have been in the news during the past few months.

Number Two. Discuss a number of organizational changes that occurred at the company during the quarter.

And number three. Review the current climate for healthcare real estate and HCP's activity during the first quarter.

Following my comments Jim Reynolds, our Executive Vice President and Chief Financial Officer, will take you through our numbers for the quarter and summarize our recent capital market activity.

Let me begin with a brief update on some of our operators that have made some headline news of late. I'll take them in alphabetical order. Number one, Centennial.

As we disclosed this morning, of our 21 properties in total, 11 are in the process of being transitioned. Six we have transitioned. Five are in the process of being completed. The remaining eight -- of the remaining 10 properties, eight we expect to remain with Centennial and two are in the process of being sold.

We received rents from these properties for each of the three months in the first quarter. In addition, we have received rents for the month of April 2003. We expect that stabilized rents from these 21 properties will be $550,000 per month, representing 61% of the 2002 contracted amount.

This compares with an estimate of $450,000 a month, or 50% of the 2002 level, that we had communicated to you last December. So, we've done a little bit better than we had anticipated. However, I make the final comment that because we are in the bankruptcy courts, the situation remains fluid and we cannot expect full resolution on this topic until later this fall.

Number two, Health South. We own nine in-patient hospitals. Health South was current on all rents for each of the three months in the first quarter. In addition, they are current on their rents for the month of April 2003.

Our nine properties have an average occupancy of 81% for the first quarter. We also know, however, that Health South's board has indicated that the previously reported financial statements from the company cannot be relied upon.

Number three, Sun Health Care. At the beginning of the quarter we had a total of nine properties in total, four of which were leased directly to Sun, two were subleased and three were managed facilities.

All nine of these properties are in the process of being transitioned at this point with stabilized rents expected to be approximately $400,000 per month. That would be down from the 2002 level of $460,000 per month, but slightly better than the estimate we provided earlier this year of $382,000 per month.

So, here again, as was the case in Centennial, we are making good progress. And the results are slightly better than we had previously communicated to the street.

Finally, number four, tenant. Based on the most recent information that we have received, our eight hospitals continue to perform well and enjoy very strong coverage ratios. These properties come up for renewal every five years.

Six of the properties, six of the hospitals whose leases expire in February of 2004 are currently in the six-month renewal window. Within the past five years tenant has renewed the leases on each of these hospitals as they reached the renewal date, and we expect that this will occur again during this renewal window.

Let me add that a number of these situations, particularly the Centennial and the Sun Health Care situations were not the most enjoyable situations to have been able to work through during the quarter. However, the company has made considerable progress and appears as though we will come out a little ahead of our internal expectations.

I did want to acknowledgement the efforts of Art Sunby and Gary Stark. These are our colleagues who have been front and center in leading the negotiations on behalf of HCP. As an aside, I believe that Art and Gary as well as Jim and myself have brought new meaning to the phrase, "let's have a cup of coffee at 8:00 each morning." And their efforts are truly appreciated and I think over time we'll see the benefits accrue to each of the shareholders.

Let me now move to topic two and discuss some organizational changes that took place during the quarter. It might be helpful to have an eight and a half by eleven piece of paper in front of you to kind of follow along with the discussion. I would suggest you take that piece of paper and draw a line across the middle part of the page separating the paper into two halves, top and bottom.

For the purpose of my first comment, if you just focus on the top part of that page and draw two rows, the first row has one box in it, the second row has three boxes in it.

The top row of the box would be the CEO position of the company, and then the second row going left to right, those three boxes would be Senior Vice President of Legal Affairs, our General Counsel, Ed Henning, Senior Vice President of Property Acquisitions, Steve Mulbash, and our Executive Vice President and CFO as well as the Treasury and accounting functions at the company, Jim Reynolds.

That is the organizational structure that we had at the beginning of the quarter. This is a structure that has clearly stood the company well as Ken and his team created a magnificent record of success for the past 17 years. However, I think it's fair to say that the company has outgrown this original structure.

This can be seen most clearly in two respects. One, the existing real estate portfolio, arguably the crown jewels of the company, was reporting in through the accounting department some three levels removed from the Chief Executive Officer.

Two, as the company's footprint grew, both in an absolute sense and across multiple subsectors, via its successful diversification strategy, the current organizational structure acted as a bottleneck with respect to growth initiatives.

Now let me move you to the second half, the bottom half of the page. The same two rows, first row again has a box, one box. However, now on the second row you want to have five boxes.

And I'll take you across the page left to right. The first box remains the Senior Vice President and General Counsel. The next box, the Senior Vice President of Property Acquisitions, Steve Mulbash, we renamed that title Senior Vice President of Property Acquisitions and Dispositions.

The third box is a new spot in the organizational structure called Senior Vice President, Portfolio Management. The fourth box is a new position in the company, Senior Vice President, Business Development.

And the fifth box remains our Executive Vice President and Chief Financial Officer, Jim Reynolds.

So, you've got two new positions in the company. The first of which the Senior Vice President of Portfolio Management and what we've done is moved the existing real estate portfolio out from its previous reporting lines into the accounting department and elevated that position to an executive senior management position. The individual that will take on this position will be charged front and center with managing on a much more active basis our real estate portfolio.

The second new position that's been created, the Senior Vice President of Business Development, will focus the activities externally, those growth opportunities that are focused externally for the company's behalf. I would expect both these two new positions to be filled during the second quarter, the current quarter that we're in of 2003.

I would also add that net head count is actually down from the beginning of the first quarter to where it ended at the end of the first quarter. And while we have now increased the senior management positions by two, it actually represents a net increase of only one as we've eliminated another senior vice president position in the company.

However, much more significantly, going forward we will have five of the six members of senior management focused on all or substantially all of their time and energies on growth initiatives, be they internal or external, for the benefit of the company.

Why all the focus on growth? Let me take you back to the commitment we made in January to both our shareholders and to our Board of Directors. At that time we stopped the penny a quarter dividend increase and set the dividend for 2003 at 83 cents for the quarter and $3.32 for the year, and we committed to reducing our payout ratio.

Following that commitment, a number of reports came out indicating that our dividend was either at risk or apt to be frozen for the foreseeable future. Now, as I calculate things, there are three ways you could go about reducing the payout ratio.

One, we could reduce the dividend. Two, we could hold the dividend constant while increasing our FFO. Or, three, we can increase the dividend while increasing the FFO at a faster pace of growth than the dividend increase.

Let me be very, very clear that your management team is exclusively focused on option number three. Our intent is to grow the dividend while increasing our FFO at an even faster clip than the dividend increase.

As these organizational changes take place during the year, HCP will be well positioned to execute this growth strategy.

Now let me close with some comments about the property activity during the quarter. We have begun to talk during the quarter about our investment triangle as we evaluate decisions relating to our properties, both currently in our portfolio and prospectively in our portfolio.

When we talk about our triangle, maybe I'll take advantage of that piece of paper for one more moment. If you draw a triangle, the top of the triangle is opportunistic, the lower left end point of the triangle is diversification, and the lower right-hand corner of the triangle is a strong balance sheet.

Our investment triangle defines the subset of all opportunities that come into the company that we will pursue. However, just because an opportunity meets with those three criteria, we ultimately may choose to pass on the opportunity because while we're interested in growth we are not interested in growth for growth's sake. Rather, we are interested in profitable growth.

With that framework, we have focused our activities along the following lines. And if I were to limit the discussion for just those situations that we reviewed in the first quarter that were in excess of $50 million apiece, I would make the following comments. One, we entered the quarter with one such situation in our pipeline.

During the quarter, this situation, which was an opportunity emerging from a bankruptcy proceeding, went away as our proposal was topped as that bankruptcy proceeding came to a close.

Two, during the quarter, eight new situations of $50 million or more came to our attention, were analyzed, reviewed and deemed to meet with our investment criteria. Of those eight, one is still pending resolution, one was successfully committed to, and six represent situations where our proposal was either topped from a valuation perspective or we were offered the opportunity to increase our bid and we decided to pass at that time.

General observation here: we are in a little bit more of a seller's market today for healthcare real estate than a buyer's markets.

I think there are two main reasons for this. Part of it is interest rate-driven. You see a similar phenomenon occurring in the market for healthcare real estate today than you've been reading about with respect to residential real estate.

In addition, however, we have also seen some non-traditional healthcare real estate players rotate into the health care real estate space as their own areas of investment have become more challenging. A market like the one I've just described highlights the enormous benefit that HCP's diversified portfolio provides our company.

The four major concentrations of healthcare subsectors, hospitals where we enjoy 25% of our portfolio, nursing homes where we have 24% of our assets, medical office buildings, where we have 20% of our assets, and assisted living and retirement centers where we have approximately 25% of our portfolio deployed, all do very different things at very different times.

Your management team is focused again not on growth for growth's sake, but on long-term profitable growth. And we will remain committed to our investment discipline of opportunism, diversification and a strong balance sheet. With that I'd like to turn it over to Jim Reynolds.

Thank you, Jay. I just wants to reemphasize what Ken was talking about earlier. The FFO per share for the quarter was 80 cents. That's up from 77 cents a year ago or a 4% increase.

Remember that you can't look at our company on a sequential quarter basis because of the effects of SAB 101 where over $5 million in the first quarter were deferred to subsequent quarters in this year. So, nine-cents will be recorded later in the year.

The primary drivers in the year-over-year increase were our very strong acquisitions level in 2002, the returns on those acquisitions offset by the cost of financing the acquisitions, and also the costs of doing longer-term financing. We've now paid down our bank debt and done longer-term financing, and to some extent marginally lower income on the existing portfolio.

We've relooked at our guidance for the year and have not changed it. We remain at the level of guidance of $3.51 to $3.59 for the year. We are now reconciling that in accordance with Reg G to our earnings per share estimate, so you'll see some narrative on that discussion in the earnings release.

Turning to capital markets activity, we raised $200 million in 12-year notes at the end of February in the first quarter at a 6% coupon. This was our best coupon and our longest maturity and just shows you how excellent the financing environment has been.

Our bank line today is only drawn to $83 million and we're incurring about 2% interest on that line. Our dividend reinvestment program is working spectacularly well. We're raising money at an annualized rate of over $100 million a year.

In terms of refinancing possibilities down the road, there is a $134 million preferred, which becomes callable in the fall of this year with an 8.7% coupon. We don't know for sure what we will do with that at this point or when.

And we are in the process of calling our $99 million preferred issue at 8.6%. That will be paid off on May 2nd in the second quarter.

Turning to reimbursement and the nursing home portfolio. As we indicated last quarter we thought because of Medicare reimbursement drops our cash flow coverage would likely drop. And it has dropped from 1.4 to 1.3 times rent after management fees. The drop was caused by the Medicare cuts that we noted, but also because of insurance cost increases and malpractice costs at some of our operators.

Turning to some positive news on that front, the administration has deferred what's commonly known as the Cliff 2 cuts that were scheduled for October of this year, has now deferred them until at least 2005. Separately the therapy caps, which have been deferred once, are now scheduled to go into effect in the third quarter of this year.

On the Medicaid reimbursements for the nursing homes we've had two positive events. In Colorado there is a very significant increase, I think of about $6.50 per patient day. This will be based on a new provider tax. And also, in Massachusetts we should likely see a 1% Medicaid increase. But that is also based on a provider tax there.

So, the provider tax is being used in some states to support higher reimbursement levels. We continue to expect that our overall Medicaid reimbursements for our customers will range from an average of zero flat to up to as much as 2% on average.

In the assisted living retirement portfolio we showed an improvement again this quarter in our cash flow coverage. We're now up to 1.2 after management fees.

We're no longer disclosing our fill up statistics, which last quarter encompassed eight different properties in fill up. That has now dropped to just five properties.

And then I wanted to remind the investors with respect to our American Retirement investment and the $112 million loan that we had with American Retirement, we've continued to record that loan at a 13% accrual rate, which is 4% in excess of the current pay rate but 6%-plus less than the contractual rate.

The reason for the accrual is that there is actually value in the properties. And those values are improving and they exceed our accrued loan receivable.

We would further suggest that investors take a look at American Retirement's earning release and their 10-Q, which will become available in May. And that they look for continued improvement in revenue levels, margins, cash balances and the lack of any significant financial refinancing hurdles for that company in the near term. And with that, I'd like to turn the conversation to any questions. Or back to Ken.

Well that concludes our prepared remarks and at this point, we'd be glad to take questions from callers.

Thank you, gentlemen. The question and answer session will be conducted electronically. If you'd like to ask a question, please do so by pressing the star key followed by the digit 1 on your telephone keypad. Once again, for questions please press star 1. We'll take our first question from Doug Simpson with Merrill Lynch.

Hi. Good morning, everyone. Regarding the $3.51 to $3.59 that you guys have laid out for '03, I was wondering if you could share with us your latest thoughts on what level of acquisitions and are there any expectations -- you know, how do you budget for potential rent reductions going forward as you think about that range?

With respect -- we had not communicated any guidance with respect to acquisition levels for 2004. We think back to our investment triangle, we're opportunistic, we're diversified, we've got a strong balance sheet. I think by definition it's difficult to be opportunistic if, you know, we've got numbers out there that we're trying to reach. So, we have not and will not communicate any guidance with respect to acquisition volumes.

With respect to rent reductions, as Jay already outlined, we're doing better with respect to Centennial and Sun than we expected. So, that will provide some cushion against the budget. And we did have a further cushion in our budgeting process for other rent reductions. So, -- and then the other thing I would say is that we are incurring a fairly high level of costs that are included in GNA that will go away with time on some of our properties in transition. So, there are a number of areas there where we expect to do better.

Okay. And then, Jay, in your comments you had mentioned that some other parties away from the traditional healthcare REITs are entering the market looking at potential healthcare deals. I was just wondering could you talk a little bit about how that affects your strategy, if at all, and have you seen any impact on a day-to-day basis in terms of the volumes or types of deal you're getting to look at as a result of that?

Yeah. I think, by the way, if you wanted to spread the portfolio across those four major concentrations, I would say the overall as I mentioned, were a little bit of a seller's markets. The overall market for healthcare real estate is starting maybe at nursing homes kind of warm to maybe up at the other end of the continuum medical office buildings where I describe it as arguably white hot.

We have seen a number of folks show up for somebody's property that has become available and historically have not played in the healthcare arena. A lot of those folks have been traditionally positioned in the other major real estate categories, office, apartments and the like. It has not changed our strategy one iota. We're going to remain very disciplined. We're not going to chase stuff just to book some acquisitions. We're looking for profitable growth. However, we do remain opportunistic. So, if there's opportunities out there that the present market affords the company, we will evaluate those and may very well take advantage of them.

Okay. Great. Thanks.

We'll take our next question from Rob Stevenson with Morgan Stanley.

Good morning, guys. Just as a follow-up to that last question, Jay, when you're looking at the competitors for assets these days, is a bump up in interest rates going to remove the guys that are winning these bids, or it just basically going to alleviate some of the pressure?

That kind of remains to be seen. I was talking to a couple of folks last week that are much more knowledgeable than I am with respect to the office space and the apartment space, and they indicated that all it would take would be a little built of a settling down in those particular areas and you'd see some of those folks rotate back out of healthcare into those spaces. So, I guess, Rob, the answer to your question may not even be directly a function of interest rates.

I will tell you that traditionally, having gone back and studied this more on the way into the company as opposed to in recent months, our company seems to do better in a little bit of a rising interest rate environment where some of the competition for the properties is not as great. So, that is potential good news that might be out there if and when we were to have a rising interest rate environment.

And you should point out again, trying to stick true to our opportunistic nature, please know that what we did in the first quarter that Jim has just taken you through with respect to trimming out 12 years, we've never gone out that far before. And that transaction was increased in size from 150 to $200 million. We're trying to do all the right things today to take advantage of the current interest rate environment but also be thoughtful going forward and positioning ourselves for what we think will be an changing real estate environment in an increasing interest rate environment.

Okay. I know that it ranges, depending on the asset. But I mean, at present what are the sort of return thresholds that you guys are looking for for acquisitions?

Jim, you want to go through that by sector?

Yeah. On the white hot end, medical office, we've seen transactions low 9s. And then that's, you know, before CAPEX and other things that really bring your returns down. So, it's getting way down there.

On the other end of the spectrum we would expect still to be able to do nursing homes and assisted living in double digit areas, 10.5. We closed some in the first quarter actually over 11. So, that looks good. And I would say that some of the hospital transactions in other areas, you might be able to get double digits, as well.

The only thing I'd add to Jim's comments is, you know, we're continuing to take advantage of what we created here with respect to some very good skills and structuring expertise that I think notwithstanding the environment we're in will stand the company in good stead.

For example in the very sector that we've described as being red hot, or white hot, I guess, we were able to enter into a commitment during the quarter where we're going to get a double digit lease rate in the first year on a collection of five properties master leased to what ends up being a very, very strong credit. So, we may have to work a little harder and look a little longer to find the opportunities, but we remain committed to doing just that. We believe that's what our shareholders are paying us to do.

Okay. And then, Jim, a couple questions on the balance sheet. The redemption of the Series C preferred is being funded partially by the $200 million debt issuance?

Well, no. Legally you're required to refinance that with [INAUDIBLE] securities or junior securities. So, over time we've raised enough stock, in particular I noted how much we were bringing in on the DRIPs. We've raised enough proceeds from stock transactions to pay that off. So, that's the legal requirement there.

Okay. And have you guys had any conversations with the bankers in terms of what you guys could theoretically issue a new series of preferred at today? I mean, is it vastly below the sort of 8.6, 8.7 that the series that you're about to redeem and the series that you could redeem are at?

Yes. I think the rates for us are likely below 8% today, which would be an attractive rate for preferred financing. It's not as attractive, of course, if you compare it to debt rates, but it does look good against our current common stock yield.

Okay. And then lastly, Jim, are there any covenants on the line or any of the debt issuances that restrict dividend pad as a percentage of FFO or anything of that ilk?

No. There are some covenants, but I don't think we get close to any of the covenant restrictions. Certainly not on the senior notes. But not on the bank line, as well.

Okay. Thanks, guys. Appreciate it.

We'll take our next question from Jerry Doctrow with Legg Mason.

A lot of my questions have been answered. I guess one or two things. Just on the coverage on the nursing homes, Jim, I wanted to just be clear whether that was just for the fourth quarter or whether you're going back 12 months or what exactly were those numbers we're getting?

We do trailing 12 months because we find that there are operators that typically have one-time adjustment sometime during their year. So, we're always giving you a trailing 12 months. And I do want to remind you, though, that those are after management fees, and on nursing homes that's a .4 or .5 effect.

Do you have any feel for how much more we would see the drop if we were to just focus on fourth quarter, which is after the Medicare rate dropped in?

I think that indicated a quarter ago, that we thought the drop would be .2. So, there is likely another .1 coming. But on the other hand, we've also had to drop rents as a result of our Centennial and Sun situations. So, those will create improvements in cash flow coverage. Not the way we want to do it, of course. So, I can't tell you exactly where it will wind up. I don't know. But I think those are the various factors that are playing in.

Okay. So, Centennial is in there at the higher rent levels?

Yes.

Okay. Are any other operator issues out there that we ought to be thinking about on the MOB side or anything else? You said you had some contingencies in there. I was just curious whether there's anything that's gonna pop up.

Yeah, I think it's a general contingency. We've taken a look at the -- and that's on the budget, of course, not on the actual numbers. But we've taken a look at all the portfolios and we may have an individual property or two that is creating some headaches for us in one or two sectors. But in terms of portfolio issues, I don't see any on the horizon.

Okay. And just one last thing. On the ACR accruals, can you just maybe walk us through a little bit more of the logic of, you know, how you come to the 13% number? You were starting to talk about equity value and that sort of thing. And I was just --

Yes. Well, we take a look at what the underlying values of the properties are. Remember, our transaction wrapped a mezzanine loan around some first mortgages. And then over and above that we think there is equity value in those properties. And without that equity cushion, we wouldn't accrue additional amounts.

Another aspect, we're actually looking at kind of an appraisal fair market value of those assets to come up with that computation. Additionally what you can look at, though, is that American Retirement is required to pay down those first mortgage loan levels or post deposits equal to an amount -- in an amount that is equal to what we are accruing at this point. So, the equity that will go into those properties through debt reductions is also equal to what we're accruing.

Okay. And then they're actually paying down the first -- this is the first that's ahead of you in an amount equal to what you're accruing?

Yes.

Okay. Great. I thought it was a nice quarter, guys. I don't know why the stock went down, but nice job.

Thank you.

Our next question comes from Howard Capek with UBS Warburg.

Hi. Good morning. Very nice quarter. If you could, Jay or Jim, when you slice your investment pipeline, could you maybe break out any opportunities for more business or expanded business with existing tenants versus brand new tenants?

Um --

Are there any operating companies that, you know, a percentage of your portfolio or pipeline is looking at?

I would say -- this is more kind of a gut feel. I would say I'd probably put it, the majority, certainly, at operators or prospective operators that are not currently in our portfolio. If I had to make a rough guess, I'd say it's maybe three quarters. One quarter, one quarter being opportunities. Maybe one quarter to a third, actually, arising out of folks that we're currently doing business with.

And again, if you think back to the comments I made on the organizational structure, some of that actually was with an eye towards increasing that, whether it's one quarter or one-third, getting that up perhaps to a little higher level. Witness the creation of the new Senior Vice President Portfolio Management position to focus someone's energies on that full-time. So, right now I'd put it kind of, you know, somewhere between two-thirds and three quarters with folks that are not in the current portfolio, a quarter to a third with folks that are. But you may very well see during the course of the year that percentage rise somewhat.

And based on where you are in the process, appreciating no guidance in terms of when investments will close, if we had to guess is it the third quarter where we should look for potential activity?

I'm sorry. I didn't mean to communicate there was no activity in the first quarter. There was a lot.

No, no, I understand. But I mean if there was an opportunity to take numbers up based on investment pipeline, investment activity, is that a second half of the year, fourth quarter?

We're looking at stuff right now that would be -- were it to happen would be quite meaningful. But we're not going to report on that till we actually get it in the door or put it in the end zone. You just can never tell on some of that's situations. There's significant, please, I did not mean to communicate that there's any lack of activity. There's as much activity around here, I think, as we ever have had. It's just that some of that's situations, as we saw on the statistics I went through in the first quarter, it got a little pricey, and we've elected to stand down on some of those situations.

Okay. Thank you.

We'll go next to Ross Nussbaum with Smith Barney.

Hi. A couple of questions. The mezzanine loans that were made in the first quarter, what was the cash flow coverage on that?

We're searching.

I think it was 91% loan to value.

It was 91% loan to value. And we also got some security away from the actual underlying properties. So, we think we're in -- it was a pretty safe transaction for us.

Can you help me understand your thought process in going after these 13% mezz loans as opposed to what you refer to as a double digit yield on just a straight out acquisition?

It's Jay. Let me just make one comment on mezz loans. Mezz loans is not something we're looking to make a primary component of our portfolio. We will look to do that when, as part of an overall, much larger transaction, it facilitates something. I think I'd direct your attention to the way we use that particular form of investment in the ARC transaction. But we're not one off looking to make mezzanine loans. As Jim indicated to you, in this particular situation we significantly -- we got some significant other benefits to the company for making that particular loan.

But that is's nothing we're going to look to do kind of one off going forward.

Okay. I notice that in your new corporate structure you've changed the title of SBC property acquisitions to acquisitions and dispositions. Should we take that to mean that you're planning on increasing your sales activity going forward here?

I would, A, make the observation that that was a very good observation on your part and, B, direct you to the fact that we will remain opportunistic at all times.

Okay. And with respect to Health South, did you make any assumptions in your guidance with respect to what may happen there?

Well, we're watching it. We've kind of -- since we kind of created a hole in our 8:00 coffee schedule each morning with the Centennial and the Sun situations largely being resolved, we kind of got lonely, so we decided to put Health South into that time slot. We are watching that very, very closely using all sorts of means to get perspective as to what's going on with our hospitals.

And away from that, there's not -- I think we've kind of told you everything we know. We are watching it closely. We feel pretty good about what we've got. We feel pretty good about the occupancy. That 81% average occupancy was actually up from the same period of time last year, although I'd point out that a lot of this news on Health South kind of broke late in the first quarter. So, to the extent there was going to be an occupancy impact, one could argue that we really haven't had the time frame to give that its' due. But it clearly has our attention.

Okay. And a final question, and this is probably related to the disposition one. Are you taking a harder look at potentially changing the mix of assets within the portfolio in terms of the risk/reward going forward?

I think that is -- that's a theme that is working its way through. I think that was a large part behind trying to focus on this investment triangle. And clearly look at common on an all-end cost of returns, if you're getting the double digits return. But it's a hypothetical. Turning around the next year and giving some of that back in rent concessions, that's not really a double digit return when you book it. So, you certainly have to risk adjust it, and I think we're spending more time evaluating how we do that.

I will tell you and everybody here absolutely believes it that we're not quite there, but I suspect another quarter or two from now it will become very evident that notwithstanding the pain we went through with Centennial, Centennial may well have been one of the best things that ever happened to this company. It was without a doubt a catalyst for us to rethink some things, take a look at our present organizational structure, take a look at some opportunities perhaps we weren't acting on to the extent we could have. And so, we've learned -- it was a tough lesson to learn, but I think we've learned an awful lot from that situation.

Great. Thank you.

Once again, if you do have a question, please press star 1 on your telephone keypad. Again, that's star 1. We'll go next to Robert Belzer with Prudential Securities.

Hello. A few questions today. During the quarter did you book any security deposits to offset the Sun rental shortfall?

No, we didn't have any letters of credit on those transactions, Robert.

Okay. Then moving on, I noticed that the occupancy in the managed property portfolio went up a percent, but your since then comparison was essentially flat. Can you comment to that trend?

Yeah. And I guess I didn't say that in the past we hadn't excluded our vacant clinic properties in those statistics. And those are discontinued properties. They're now out of those statistics. So, they have changed.

They're out of those statistics and they are held for sale and are actively being marketed.

Yeah. How do you have that lie flat and a change in occupancy or vice versa? We have, you know, mixed changes will increase in the high-priced space in Southern California and decrease in the Midwest where it's lower-priced space and vice versa. And those kinds ever things happen. It doesn't seem to make sense, but when you look at the -- how much more expensive space is in some areas of the country, it does make sense.

Okay. Then moving on to Health South, have they given any indication on any kind of initial intentions to your facilities?

In talking to them, you know, obviously if the $3 billion in unsecured debt gets repaid somehow or partially repaid, they need to do it on the backs of properties that are performing well. And so, the cash flows that are coming off of our properties we believe are going to be valuable to the organization overall. I do think that they view the in-patient rehab leg of their business as the strongest leg. And that's something else that kind of buoys my thinking.

Okay. Then moving on to your acquisitions, and a similar question with regard to your dispositions. If you had to hazard a guess as to the facility type you may acquire this year, what would the mix be on a facility type basis for the year?

We will not comment on that.

Okay. Thanks. I would -- you know, would you have the same policy on the disposition end?

Yeah. Again, that triangle kind of defines everything we do from a property standpoint, whether it's buying properties or selling properties. We're going to be opportunistic, we're going to remain diversified and we're going to have a strong balance sheet. Personally, I'd like to be more opportunistic, more diversified and have an even stronger balance sheet. And I'll leave it at that.

Okay. Thanks. That's all my questions today.

We'll go next to Rich Anderson with Maxcor Financial.

Thank you. With regard to the American Retirement transaction one more time, you mentioned increased equity value as justification for the 13% that you're booking. Could you comment, then, on the return that you are receiving on the $12 million equity investment on that portfolio to further illustrate the increased equity value?

Yeah. Rich, I don't know -- from my perspective, I mean, we had to structure that piece a little differently for some legal reasons. We aren't accruing the excess on that, and that's because we have to follow equity accounting. But we do have the underlying value increases on the same properties. I don't know if that helps you or if I answered the question.

Well, we can talk about it further off-line maybe. Switching gears to the provider tax issue, I think of that as -- it seems like a sort of snazzy way to get Medicare funds through the system. I just wondered if there's been any talk from the point of the federal government, if they've been taking a closer look at the provider tax issue. Is it something that will stand the test of time in your mind?

Well, the provider tax, I agree with you, it is a way to get the federal government to pay a bigger share of the bill. I mean, that's what it's all about. But it has been in existence for a lot of years and a lot of states take a really heavy advantage of it and others take no advantage of it. So, you've got not a very level playing field across the states. But I haven't heard any comments from the federal government on that issue.

Okay. And last question is a quick one. Of the tenant properties, are they all individually leased or is there any cross collateralization there?

They are individually leased, but they are cross-defaulted, if you will.

Okay. Thank you.

And we have a follow-up from Jerry Doctrow with Legg Mason.

Jim, do you have the exact amount of the contingent rent in the quarter? You said about $5 million.

I'm sorry. The SAB 101 deferred rents is about $5.2 million.

One question about tenant just to sort of follow-up, too. I guess my thought was if you were a tenant and you were ever thinking you wanted to buy you guys out, that this would be the time to do it while their valuations of properties may be hurting from the various issues that have been affecting them. Have you had any feedback at all from tenant, or do you think there's any risk of them deciding to buy you out even though they pay you, I guess, they have to pay you some kind of premium?

Jerry, this is Jay. I don't want to comment on tenant's intentions. You should assume that there are significant discussions, as you might expect, with someone who is a significant source of revenue, as tenant is to our company. Those discussions go on constantly. I think most of you are aware of some of the relationships that date back with respect to members of our senior management, members of their senior management in some cases over two decades. I would actually argue the other side of your coin.

Last time I checked, on a continuum of this being a seller's market, real estate, if we put nursing homes, which surprisingly enough are actually holding up reasonably strong in terms of the valuation comps. If medical office buildings was at the other end of the continuum in terms of being white hot, I'd put hospitals not too far from the white hot end of the continuum. So, we do have fair market value mechanisms with respect to the purchase price.

And I would suggest to you that to the extent that tenant wanted to pursue purchasing those hospitals, it would have little to do with their own present financial position and lots to do with the financial performance of those hospitals and the market environment that hospitals currently operate in. And I'll leave it at that.

Do you have -- at the end of the next five years do you go back to market rents, or do you have another role after that where they stay at the same level?

I think there's two more.

Okay. Thanks.

Let me just also add that one of those hospitals that is in the renewal window right now is one of the 14 hospitals that's been targeted for divestiture by tenant. And so, I have every confidence that as those hospital divestitures are completed you will see some very nice benchmarks created with respects to hospital valuation. I think tenant is not surprisingly being quite opportunistic, as well, in terms of, you know, moving forward with that disposition program in the current environment where there's so much demand for good quality performing hospitals.

At this time we're standing by with no further questions. I'll turn the conference back over to you, Mr. Roath, for any additional or closing comments.

Well, that concludes our presentation here today. We thank everyone for attending the conference call and wish you well. Thank you very much.

This does conclude today's conference. We do appreciate your participation. You may now disconnect.