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Executives

Tim Bonang - Director, Investor Relations

Bruce Mackey - President, Chief Executive Officer and Secretary

Fran Murphy - Chief Financial Officer and Assistant Secretary

Analysts

Derrick Dagnan - Avondale Partners

Joel Ray – Davenport & Co.

Donald Hooker - UBS

Jerry Doctrow - Stifel Nicolaus

John McMahon – Kennedy Capital

George Walsh

Five Star Quality Care, Inc. (FVE) Q3 2008 Earnings Call November 5, 2008 5:00 PM ET

Operator

Good day everyone and welcome to the Five Star Quality Care third quarter 2008 earnings results conference call. This call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the conference over to the Director of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Tim Bonang

Thank you and good afternoon, everyone. Joining me on today's call are Mr. Bruce Mackey, Five Star's President and Chief Executive Officer and Fran Murphy, Five Star's Chief Financial Officer.

The agenda for today's call includes a presentation by management followed by a question-and-answer session. Before we begin today's call, I would like to state that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Federal Securities Laws.

These forward-looking statements are based on Five Star's present lease and expectations as of today, November 5, 2008. The Company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call, other than through filings with the Securities and Exchange Commission regarding missed reporting period.

Actual results may differ materially from those projected in these forward-looking statements. Additional information concerning factors that could cause those differences is contained in our filings with the SEC. Investors are cautioned not to place undue reliance on any forward-looking statements.

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

Bruce Mackey

Thanks, Tim and thanks to everyone for joining us this afternoon.

I would like to view our third quarter results as reported on news release issued after market close today.

Net loss per share from continuing operations for the third quarter of 2008 was $0.05 basic and diluted compared to net income of $0.27 and $0.24 basic and diluted respectively for the same period last year. The third quarter had a number of unusual items. First, it was an unrealized loss of $1.7 million or $0.04 per fully diluted share as the result of our holdings in auction rate securities. Second, we recorded a loss of $3 million or $0.07 per fully diluted share due to recording a permanent impairment on some of our marketable securities. This impairment was attributable to losses and investments of financial related companies including Fannie Mae, Lehman, and AIG. These investments were held by our captive insurance companies. And third, it was $743,000 or $0.02 per fully diluted share gain on early extinguishment of debt. Without the effects of neutral items in the quarter net income per share from continuing operations with $0.08 per share fully diluted.

I would also note that excluding unusual items in both 2007 and 2008 nine month periods fully diluted earnings per share have increased from $0.44 per share last year to $0.45 per share this year.

In addition, our third quarter was negatively impacted by higher than expecting utility cost and lower interest income. Together, these items had an impact of $0.05 per fully diluted share when computed that second quarter of 2008.

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

The third quarter was a very big quarter for us related to acquisitions. We acquired three senior living communities with 278 units and began leasing 17 senior living communities with 1,279 units. Twelve of these communities are assisted living communities and 8 are independent living communities. In addition to the 10 new senior living communities we talked about on the second quarter conference call, we added two communities in Alabama and eight in Indiana. Cost quarter end, we closed on what we considered to be a trophy asset, Meadowood in Bloomington, Indiana. This is one of the top senior living communities in the country. It is located on 50 hectares and it is adjacent to Indiana University, which is the third largest alumni organization in the United States.

It was recently ranks by America online as the number one senior living community in the country and was also cited in the Wall Street journal on September 13th as an ideal retirement community.

I would now like to update you on holdings of auction rate securities. There was a event that took place subsequent to quarter end. In October, UBS provided us with a perspective and settlement agreement. Under the terms of agreement, UBS will repurchase at cost our investment in auction rate securities at our request between the periods of June 30, 2010 and July 2, 2012.

UBS has also agreed to provide us with liquidity under no net cost loan program, which provide for among other things, borrowing up to 75% of the market value of our auction rate securities.

Acceptance of this offer also required us to reach all claims we may have as UBS arising from their marketing the auction rate securities to us. We are currently evaluating this offer and discussing with UBS alternative arrangements regarding a no net cost loan program. The UBS offer expires on November 14, 2008. If we are able to reach agreement with UBS, we will be reevaluating the losses we previously recognized with the auction rate securities in the fourth quarter. At the end of the third quarter, we have recognized $6.1 million in losses or $0.15 per fully diluted share.

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

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

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

I will now review our third quarter performance in each of these areas. Occupancy, which is currently our biggest challenge, is also the most difficult thing for us to control. Occupancy for the third quarter of 2008 was 88.2% compared with 90.4% in the third quarter of 2007 and 88.6% a quarter ago. On a same store basis, occupancy for the third quarter of 2008 was 88.5%, compared with 90.8% last year and 88.7% a quarter ago.

As of last Friday, overall occupancy was 88.4%, same store occupancy as of last Friday was 88.5%. Anytime the discussion on our future occupancy is going to trend towards is really discussion about the economy at this point. As I speak with other operator in the industry before they comparing us we are holding our breath. If there is a long term we session in the US, the impact was then felt by the all companies not just senior living. To date though, we have seen nothing material in a way of move outs related to the financial crisis. We have also seen a little change and bad at expense of a same store basis.

On last quarter’s call, we spoke of our sales split. The blitz provides a good lead based that we will be able to build upon. Additionally, it provides the impetus for a 60 basis point improvement in occupancy from a low point in middle of July, the last Friday. Also for the first time in seven quarters, the third quarter showed more admissions than discharges at our same store communities. On a same store basis admissions were up 2% from the third quarter of 2007 to the third quarter of 2008. We believe that is the results of the effort of our staff impart to not only promote this blitz but on the sales and marketing initiatives we are aggressively pursuing at Five Star.

As I note, we start increased in this by new lead tracking software as a result of the blitz, which we expected to be ongoing behavior that will enable us to better manage ourselves practice.

As we put on the Q2 call, we continue to move forward other initiatives including a new retail focus website and AL Wizard which help us track levels of care for our residents more accurately in closer to real time. We expect both of these systems to help generate revenues for us in 2009.

I would now like to move to another metric, average daily rate which is an area where we have some control over. On a same store basis, our average daily rate increased by more than 5% from $137 to $144. This increase reflects our ability to continue push the rates for our private-pay residents in spite of the general occupancy and economic challenges we are facing. As of right now, we are projecting a private-pay rate increase just under 5% for 2009.

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

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

Moving on to wages and benefits, wages and benefits as a percent of senior revenues were 50.0% in the third quarter of 2008 compared to 49.4% a year ago but well with then are stated range. This is also slightly from a 48.9% we reported in the second quarter. This is an area that we can control and watch very closely. While we have performed well on this metric, we are not resting on our laurels, particularly given the occupancy challenges that our industry faces.

Our community labor costs are reviewed daily and add some changes we adjust labor cost accordingly. We continue to maintain goo control of our G&A. Our G&A as a percent of revenues was 4.2% in the third quarter of 2008 which is down from the 4.4% we reported in the same quarter a year ago. Last quarter, we told you we expect this has been in the 4.5% range, so this was a solid result. However, we still think that we will trend toward, we will think closer towards to 4.5% range over the next several quarters.

Moving on to our ancillary businesses, I would like to start with our rehabilitation hospitals. Revenues decreased 5.6% in the third quarter, the $23.9 million to the lower patient revenues more specifically a decrease in reimbursement rate from Medicare. EBITDA margins for the third quarter were approximately 7%. Frankly, it is a very competitive environment for rehabilitation hospitals in the Boston area right now. In illustration of this is that [11.54] closed a hospital in [11.56] that is very close to one of our rehabilitation hospitals.

We are anticipating that this may eliminate some competition in the area. In addition, we view this hospital closing as an opportunity for us to butcher our staff. We stated in the past that the CapEx work that is currently underway at both hospitals is going to be critical to helping us increase census. Our interior renovations at both hospitals should have the firstlings completed in mid-December. This is slightly scheduled from our last report.

Moving over to our pharmacy business, revenues increased 8% to $16.8 million in the third quarter compared to $15.6 million in the same period last year. Our EBITDA margin level was negatively impacted by $1.3 million adjustment primarily related to adjusting our contractual allowance. Without this adjustment, our margin in the third quarter would have been 3.9%. Excluding the pharmacy to be sold, we have approximately 11,325 customers a slight decreased from last quarter, which was due to the loss of a large third-party customer. In addition, we experienced some licensing issues which prevent us from adding as many new contract customers as we hoped. Mostly, licensing issues have been resolve and we believe we can add about 2000 customers over the next several quarters. The majority of these new customers will come from Five Star communities.

On a positive note, related to our pharmacy business we finalized a new wholesale agreement effective November 1 which regenerate savings of $500,000 annually. It is our goal that with the addition of new customers to our pharmacy platform this new wholesale agreement and several other initiatives we have emplaced in our pharmacy business that our EBITDA margins will improve over the next several quarters. While we dedicate sometimes speak into this ancillary line of business, we like to remind investors that our ancillary businesses represent approximately 15% of Five Star's overall revenues and less than 4% of EBITDA. These amounts are based on the results from the nine months ended September 30, 2008.

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

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

Today, investors are thinking to adjust the focus on a Company’s that our best physicians to stand the potential long term recession. Such recession will be challenging that we think Five Star as well positioned that not only survive but deprive. Our strong balance sheet and lack of midterm debt maturities give us the flexibility to adjust to a challenging market environment. Our proven ability to increase same store average daily rate in control labor, NG&A cost will serve as well. And our private-pay focus but primarily a need driven product operating, we believe will serve as well in trying economic times. If we are in solid position as we feel we are and is under vial as we believe ourselves to be. Some might be asking, why not buyback on your stock? And it is unprecedented credit crisis that we are currently experiencing right now the position of management and the Board is the preservation of capital is most important and in uncertain times we know that making acquisitions is for us like putting money in the bank, which can be really refinance. If we buyback shares, we cannot turn around and sell them if for some untold reason we need to access our capital. As market conditions and other stock exchange, management and the board will continue to review this issue.

At this point I would like to turn it over to Fran Murphy, our Chief Financial Officer.

Francis Murphy

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

Operating expenses at our communities were $182 million in the third quarter, an increase of 20% when compared with 2007. This increase was primarily due to the addition of new communities in 2008. Regarding expenses, I would note that we have targeted some areas for potential savings in the near term. First, we recently negotiated and agreement with AT&T, which provides us with annual savings of about $700,000 for each of the next three years of delivering a more robust product offerings to our community.

Second, we are close to completing negotiations on a new long term care pharmacy agreement. Having those areas that are probably on pharmacists did not service. We expect that this agreement will save us several hundred thousands of dollars per year. We continue to pursue a number of other cost savings initiatives that we expect to be approved shortly, including our work with several utility consultants and the reducing utility costs by entering as a group purchasing arrangements and or future’s contracts.

On a same-store or comparable basis, senior living revenues in the third quarter increased by 2.9% to $209 million compared with the same period a year ago. This increase reflects to 5.3% improvement in rates, offset by a 130 basis point decline in occupancy.

Same-store senior living expenses in the third quarter increased 5.5% to $160 million when compared with 2007. This was largely do to increases in work based compensation therapy service and utility’s expenses.

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

As Bruce mentioned earlier, our pharmacy sales increased by 8% in the third quarter versus the same period a year ago. This was primarily the result of adding new customers from both our existing senior living and third party operated communities. On a sequential basis, pharmacy sales decreased by 8% as compared to the second quarter of 2008, excluding the impact of the contractual allowance adjustment of $1.3 million in the third quarter of 2008 including an adjustment for the timing of these charges on a pro forma basis throughout 2008.

Pharmacy sales actually increased by 16% over the same period a year ago and decreased by 0.6% sequentially largely as a result from a loss of a large third part customer, we spoke about earlier.

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

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

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

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

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

Accounts receivable at the end of the third quarter was $58 million. Our day sales outstanding including the rehabilitation hospitals and pharmacy operations, is an industry leading 22.7 days.

At the end of the third quarter, we had $152 million of net property and equipment, which included 18 properties comprised of 1303 independents and assisted living units and 271 skilled nursing beds that were directly owned by Five Star. Fifteen of these 18 properties are unencumbered by debt. On the balance of property and equipment also includes $27 million of asset that we intend to sell a senior housing as permitted by our leases.

Our long-term liabilities at September 30 include $127 million of convertible notes and $12 million of HUD mortgages. We had no amounts outstanding on our $40 million revolving credit facility. We believe that we are currently in compliance with all material terms of our mortgages, convertible notes and revolving credit facility.

To review despite the general economic challenges that we face. The operating metrics in our core senior living business including occupancy, rate, and cost controls remained solid in the third quarter.

Our performance in the coming quarters will be greatly influenced by the future occupancy levels we are able to attain. Looking forward to the fourth quarter even the difficult environment, our goal is to maintain and increase occupancy levels to the various activities and initiatives. On a cooperating community levels that Bruce outlined in detail earlier. In addition to the recent increased in our Medicare reimbursement rates we will work to increased private pay rates or we can to offset our increased costs of labor, food and energy.

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

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

Question-and-answer session

Operator

(Operator Instructions). Your first question comes from Derrick Dagnan – Avondale Partners.

Derrick Dagnan – Avondale Partners, LLC

Good afternoon. I wonder if your balance is like contractual allowance if you do not mind on the pharmacy business, just go and back and looking at the revenue performances of this business over last several quarters. I do not remember, you guys, experiencing this large of contractual allowance and I just like to get a little color on that on the relative sides of that allowance and what happen.

Francis Murphy

Sure, this is Fran. We had not reported on the contractual in the past. This is primarily related to our buildings under Medicare party. During the quarter we experienced some unusually high contractual charges that were ultimately determined to be about $260,000 in excess of what should had been recorded. As we [dag] into a week, we concluded that we needed to book in adjustment of 993,000 to property we state these reserves. This is all related to the prior periods.

Derrick Dagnan – Avondale Partners, LLC

So the 260 in that, on top of that was 990 for prior period?

Francis Murphy

That is right. We pro forma the impact each of the quarters throughout 2008.

Derrick Dagnan – Avondale Partners, LLC

Okay. I guess, could you give us a little color on the recent acquisitions you announced information on, maybe occupancy levels or daily rates if you are not willing to give us the specific numbers maybe just related to your existing business that was lower than existing business or higher.

Francis Murphy

No, I mean most, if you look they are all independent in the senior living. Our independent living, occupancy level that mostly properties are significantly higher than our same store communities, two in Alabama, the eight in Indiana and the one we just record in Bloomington are all stabilized communities, all have occupancies, on average in excess of 90% and the one in Alabama and Indiana, the average daily rate is probably less than our overall same store [IAL] portfolio and the one in Bloomington, Indiana is probably on par and even slightly higher. They do have a skill nursing component there. So that that will be a little bit higher than the other one.

Derrick Dagnan – Avondale Partners, LLC

Okay, I will hop on and let others ask question. Thank you.

Francis Murphy

Thank you Derrick, thank you.

Operator

Your next question comes from Joel Ray – Davenport.

Joel Ray – Davenport & Co.

I was wondering your overall expenses, wages and benefits for the single living side did pop up some to 50% in the quarter. Do you pursue that some of that is arising from the recent editions of properties this year?

Bruce Mackey

No, primarily it is related to a benefit side. Mostly work based compensation reserves. We had slight uptake in the third quarter.

Francis Murphy

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

Bruce Mackey

Right, that is really [robust] of the few pending in earnings.

Joel Ray – Davenport & Co.

Yes, what do think is it appropriate ratio to be focusing on going forward? Are there one time catch up should occurred here?

Bruce Mackey

It is going to be ranged, Joel, and I think I am going back probably two or three quarters and I will be always aware, I state the goal is in the 51%, 52% range. I think last quarter we really said we dropped that down to be below 51%. We were happy being a 50.0% in this range going forward.

Joel Ray – Davenport & Co.

Okay. And if anything we might come up with [time] that is what you are saying since the longer term goals 31%, 52%.

Bruce Mackey

No, no. It was 51%, 52%.

Joel Ray – Davenport & Co.

Okay, I apologize.

Bruce Mackey

Yes, we pulled that down our goals to be on that 51% range now.

Joel Ray – Davenport & Co.

Okay. Let us all think a little bit more about the opportunities you have see with the pharmacy business. It sounds like you have some near term challenges based of this come back on the contractual, can we go and start getting these contracts in place? Can we go and start giving more capacity? Because this is part of your business while the small portion is a little bit ball and chain around our neck, it is continues to come up a bit short. And I was wondering, where do you see you taking this business?

Bruce Mackey

I just take a little reference to the ball and chain around the neck, it is done close to our stated goal and we will always to be in the 5% range, albeit we are 4% pro forma that Francis talk about. Adding new customers to the pharmacy is something you have to do very carefully, it is generally something that has to be done by license pharmacy technician or pharmaceutical that can deal with one patient at a time. We generally do not like to rash new business on to the pharmacy given challenges that can occur. I did mention that we have some licensing issues as well. We will trying execute and open up a new satellite locate in Delaware and that took probably about a quarter or a little bit longer and we would like be it done. At satellite is now open, we expect to, I would not say rush to add new customers but it reference in the prepared remarks. We look to add about 2000 customers over the next several quarters. I am guessing that is about three quarters what work has take on.

Joel Ray – Davenport & Co.

Okay. I am just writing this down and lastly, I know you have mentioned you do not anticipate the Company buying back shares. I was wondering what about insiders, can we expect maybe some of new folks to step up and put off you back because that is slightly be a positive sign for the investment community and existing investors that again putting money on new office.

Francis Murphy

No, I do not disagree with that statement. I can only speak to myself that I have looked at in the past for continuing evaluate going forward. I really cannot speak to about, if I am going to purchase but, also generally other [short period] was I cannot purchase given in front information I generally have. But I will look to that in the future.

Joel Ray – Davenport & Co.

All right, and lastly, can you tell what your thoughts are as far as resolution with the litigation with Sunrise. What if the timing is to get all of that kind of wrapped up?

Bruce Mackey

It could take several years. We will go to the next couple of motions. We will see what that leases do. And if this is to be full blown litigation just on the [professional] liability right now from 2001. So it could be a several year process.

Joel Ray – Davenport & Co.

Can you refresh me on what it is that is involved with issues?

Bruce Mackey

Sure, we issued a press release and I am thinking it was August 11. It primarily release to historical insurance reserves that we believe we overcharge to at [five] Sunrise.

Joel Ray – Davenport & Co.

Okay.

Bruce Mackey

And Sunrise issued public statements in 2007 and maybe in 2008 repressing refunds the day made related to overcharging customers in the time period that we had committed that will manage by Sunrise. So we believe some of these refunds were in fact linked to us.

Joel Ray – Davenport & Co.

Very good, well, thanks very much.

Operator

(Operator Instructions). Your next question comes from Donald Hooker – UBS.

Don Hooker – UBS

Great, could you have mention with your free cash flow was I am sorry if I mistake. Maybe can break that down cash flow from operations and CapEx.

Francis Murphy

We had $22 million of operating cash flow and net, $2 million of CapEx. We will say a $21 million of purchases of senior. Housing communities are less than, accredit of $7 million.

Don Hooker – UBS

I got it. And you earlier just when your comments that the utilities and interest income had a $0.05 negative impact, I think I heard you say that. Was that predominantly the utilities?

Francis Murphy

Predominantly I will tell you, yes.

Don Hooker – UBS

And I would assume that is obviously reversed or I mean I am just guessing when…

Francis Murphy

Oh yes, but in case that will come down significantly in the third quarter.

Don Hooker – UBS

Okay and then just one and I will jump off, just a curiosity, we have a number of seats that are living and independent living properties, has they been performing differently as the system would have been more resilient or is there has been not much difference in your view?

Francis Murphy

I would not say our experience over the last year are so [17.59] but to the most part, they said the living has been easier. We are getting new people in the door in independent living but I would not say exchange materially over the last several quarters. Independently has been more difficult and it is still more difficult today.

Don Hooker – UBS

Okay, let me ask one more and I will let you go. In terms of the hospital, maybe you could just update us kind of you have given the vision as to now might be breakeven and the years out.

Francis Murphy

It is really dependent upon driving occupancy. It is really toward the new construction. We expect the construction is being done at both hospitals in the month of December but I think really the first full quarter of 2009 will be the communication of how that goes.

Operator

Your next question comes from the line of Jerry Doctrow - Stifel Nicolaus.

Jerry Doctrow - Stifel Nicolaus

Couple of things. I think I just want to clarify, with the $2 million completely was really maintenance CapEx?

Francis Murphy

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

Bruce Mackey

And Jerry that really add CapEx on properties owned directly by five star and on some items that we do not sell the senior housing.

Jerry Doctrow - Stifel Nicolaus

Okay and earlier you would say, I will just try to reconcile this up. You had said $16.2 million of CapEx, was that the quarter and then $12.5 million of that will be future sales S&H?

Francis Murphy

That is right. That $16 million, $12 million will be eventually reimbursed to us by senior housing.

Jerry Doctrow - Stifel Nicolaus

The $16.2 and then $12 even? Or 12.5?

Francis Murphy

It is just over 12.

Bruce Mackey

But that was $14 in the third quarter.

Francis Murphy

And we saw a $14.4 in the third quarter.

Jerry Doctrow - Stifel Nicolaus

Right, okay. In terms of just, if you were actually just trying to limit it to maintenance CapEx as I seen included in those numbers, sort of a mix of income enhancing stuff and perhaps regular stuffs is there a, do you have just the maintenance CapEx that you are using to get, kind of cash flow?

Francis Murphy

Well Jerry, I though about this question over the last quarter and one of the final way to come back and respond to you. Yes, it is summoned last time around. What I have done is taken a look out what our spend is and if I look at the project we spend money on and calculates them by size and look at any project over $500,000, which I considered to be a significant project. About a third of our CapEx spending in the quarter, a third of that $16 million was spent on projects that exceeded $500,000 in total cost.

Jerry Doctrow - Stifel Nicolaus

And so basically, everything under that would be, kind of, maintenance in your review.

Bruce Mackey

Yes, but it may include some large spends, but that would not needed to be replaced for period of time. We often replace call systems for instance, which probably do not get swapped out anymore than several 10 years. But, I would say that those are maintenance items in this business.

Jerry Doctrow - Stifel Nicolaus

So, if I am running about two thirds of that $16 million that is kind of the right number for maintenance?

Bruce Mackey

Yes.

Jerry Doctrow - Stifel Nicolaus

And then, I think you get any touch in a couple of these things, but I mean, converge assets and again, these is probably on the balance sheet but it might have been sort of a real market value. Do you have a sense in just terms of what amount of unencumbered real state if you want to lever out with some agency debt? How much capacity roughly you got available.

Bruce Mackey

I think you know, just the number of units, Jerry, we have right now, we have got, for a mention, how many communities we have actually own, in terms of the number of units. You got 1700 ball part frame of independent living and another 270 of senior living, including a fair market value in a per unit basis of those probably and I think, I might have excluded 1300, I am sorry of owned IAL. All of them fairly stabilize data, I know we are still working on the three new seasons assets which are not stabilized, those are in there as well. But the majority of the other one is they are all stabilized assets.

Jerry Doctrow - Stifel Nicolaus

And it was 1300 IAL and 270 AL..

Bruce Mackey

But it is 1300 IAL and 270 skilled nursing.

Jerry Doctrow - Stifel Nicolaus

And we could put number on that. There was this tax probation that was kind of like a positive add back or something. What was that all about?

Bruce Mackey

They were some through our credits that we recognize in the quarter. We were able to offset all of our federal expenses because of the provision that changed away AMT is calculated. We got that, our 2007 AMT, as well as what we have charged this year.

Jerry Doctrow - Stifel Nicolaus

And that is a one time base of the item? So, going forward to you would be again going back to be in kind of a normal tax payer or do you have the sense what the rate would be go forward?

Bruce Mackey

Yes, I think going forward. We do expect that the transaction is something more historical, like the AMT going forward.

Jerry Doctrow - Stifel Nicolaus

And then, just the way I see in it, I get peoples touch in this, but in sounds like for which I am back to working very hard, obviously it would, occupancy in rates and all the other stuff you sort of went through. You talk about the stock, so we would not go there. In terms of just, the one thing that you have not really touched on that I think I get to know, wonder about some of the other investors, wonder about if you got this two businesses, pharmacy and rehab that are clearly not core to your operations and the margins you are talking about are dramatically lower than some of the big companies that are starting to put up good results in those areas. So, why would not you thing strategically about exiting institutional pharmacy and why would not you think strategically about exiting rehab? Whether selling it to one of the large on for profits in the Boston area or sell it to one of the specialized operators because it is really a tough business. It is not your core business and I just want to understand why you sort of seemed too welded to this two business lines?

Francis Murphy

Let me speak first for the institutional pharmacy business. I do want to point I point out in the past. We got into this business to provide a better service to our patients in residence that we serve. If Omnicare or some other provider is in our building and for whatever reason that a pharmacy issue, it is our issue. It affects our residence, our patients whether one that I can deal with it and we saw that in the past. That is really why got into the pharmacy business. It does not make as much as we would have liked. On the past, we are always talking about an 8% to 10% margin business year that we have dropped that down significantly. But, it does make money for us. We have not paid a lot with assets. We have generally bought them under the [2548] from Omnicare, and we have build up a business over time.

We have got about 2,000 customers left at the business, but as we grow, that might go up. We want to finish adding those customers to the platform. See what that gets us and at that time, perhaps, we will consider selling it. The board had looked that up in the past and I would not say that would take off of the table on the future. I will put up the same on the hospital side. I think, our intend again is to stay the CapEx works. If it does not help, that is something that I will have to look at.

Jerry Doctrow - Stifel Nicolaus

So, in this, sort of a time line for each of those, it is 2009 sort of expectation for both of these things being finished and you evaluate or –

Francis Murphy

Yes, I think potentially on both, that as a possibility. As I have said, I do not think right now is the right time to sell anything in this market. But again, if adding the 2,000 customers takes a several quarters and we get there. We would like to have in a quarter to look at the results. It is probably end of 2009 or 2010.

Jerry Doctrow - Stifel Nicolaus

Because for me, in my perspective, the credit crisis is it works both ways, there are opportunities to buy core assets and much more attractive price is probably presents itself. I continue to strategically refocusing on the core would make a lot of sense. I guess, you have talked about it, it is something that you will consider but it is probably a year off.

Bruce Mackey

And it is something happens to learn about.

Operator

Your next question comes from [John McMahon – Kennedy Capital]

John McMahon – Kennedy Capital

Can you maybe help me out on one of the acquisition you guys did this quarter on the average payback for a property?

Bruce Mackey

I am not sure I understand the question.

John McMahon – Kennedy Capital

What is your [IR] you are looking for on a property today?

Francis Murphy

Most of the properties that we purchase that by some bought directly are under value and when I say undervalue we have bought them for about, I think net 45,000 to 50,000 per unit, actually taken into account the money that we got from lease inducement. In other than that, we are buying properties mostly sale lease back to senior housing. So again, we are not putting money in, we actually get money out on the network and capital basis.

John McMahon – Kennedy Capital

On that, is that like on the Cap rate or how shall I think about that? Or even if we take the facility that you did buy this quarter, how long or what is your IR overall rate for buying a property?

Francis Murphy

Well overall generally, we will going to be 18 to 20% range. It is going to take some time especially in this market. That was on the acquisition that we have done. To stabilize that, just like I said in the most part, we are pulling money out on the day we acquire something because it is generally it is a negative working capital situation.

John McMahon – Kennedy Capital

Okay. So in 18 to 20% IR is kind of what I should be thinking about when you look at the project though?

Francis Murphy

Yes.

John McMahon – Kennedy Capital

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

Francis Murphy

It is going to be high.

John McMahon – Kennedy Capital

What is the routine CapEx in?

Francis Murphy

For this quarter, with the net $2 million, at this point $2 million, and then the net too this quarter.

John McMahon – Kennedy Capital

Help me understand, you could technically buy the company than all the stock that is out there in the next two and a half quarters or you are looking to buy properties that could take us four to five years. So, why are we not buying back the stock today, and why are we buying property?

Francis Murphy

I will just go back to my prepared remarks. We want to make sure we got liquidity on hand to run this company for the long term.

John McMahon – Kennedy Capital

But yet, you are buying property.

Francis Murphy

We are, that we can be readily be financed, it got to be a relationship with senior housing. As well as other source of liquidity on the market place.

John McMahon – Kennedy Capital

That is not the question. Why are we even buying property, when we can buy the whole company back in less than two and a half quarters?

Francis Murphy

I do not think we can buy the whole company back in less than 2 and a half quarters based on our cash flow. Stock buyback is going to drive up significantly.

John McMahon – Kennedy Capital

Well, you are at $53 million today. You threw out $20 million where you telling me in free cash flow. What am I missing here?

Francis Murphy

That the number you have is correct.

John McMahon – Kennedy Capital

So, you can technically buy the company back in the next two to three quarter, but we are buying property that will take us four to five years?

Francis Murphy

Based on the stock price today, but I guess, the day we announce the stock buyback of any significance. We are talking about it significantly.

John McMahon – Kennedy Capital

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

Francis Murphy

We do not doing that in today market because we do not know when we would have access to capital in the future.

That might change two quarters and not might change next quarter. I do not know. That is right now the decision is to hold on to our capital than apply it to as properties.

John McMahon – Kennedy Capital

You are telling me that, the thing you bought three properties. Correct?

Francis Murphy

I just told you that we are buying properties. Yes, we are putting capital into buying properties.

John McMahon – Kennedy Capital

That is my point. So, you are saying, we are going to hold on our capital for better ideas out there, but we are buying property when the stock significantly undervalued.

I just do not get that. Help me understand that better.

Francis Murphy

We can go back and forth and talk about this and I do not know if we will ever agree on this right now.

John McMahon – Kennedy Capital

Well, I am just trying to say, if you are looking to put to the highest return that would be buying the stock back in our property.

Francis Murphy

At today’s stock price, correct.

John McMahon – Kennedy Capital

So, from now on, should we assume that manager and the Board is going to look at buying the stock back and start a property? How should I thing about that?

Francis Murphy

For the short term, you should assume that management take money and buy property.

John McMahon – Kennedy Capital

Even though it has a lower return?

Bruce Mackey

It has a lower return, but given today’s credit crisis, we do not know when the next access to capital will come.

If we run into problems, a year down the rope now to get on the rope now, and if no liquidity has not gone back to the market place, we are going to wish we have not bought that when we can find as properties.

John McMahon – Kennedy Capital

I guess, we will just have to agree that we are not seeing eye to eye that the stock has a better return today but we are still going to buy property today.

My next question to you is, with all the challenges you are facing with your portfolio today, why are we even buying properties today? Why not try to fix what we have and then maybe comeback to the market?

Bruce Mackey

I think we are doing a this all position of what we have. If we really have looked at the numbers, I think we are putting pretty good metrics that we are buying stabilized properties that we are doing well.

John McMahon – Kennedy Capital

So, on pharmacy here, you feel like everything is working out okay there then?

Bruce Mackey

I did not say on pharmacy, I said along properties. On pharmacy I talked that our margins are a little low than we would like. We got customers to add as Jerry and I just went to over the next couple quarters.

John McMahon – Kennedy Capital

Lastly, I just would like to you and the boards to hear of me say that we think that this is completely a bad strategy. You should be buying back stock at this level aggressively.

Operator

Your next question comes from [George Walsh] – [33:30] Securities

George Walsh

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

Bruce Mackey

There is a, it is an agreement that we a right to essentially put our auction securities to UBS, between June 2010 and July 2012. With that agreement that is available to us, a no net cost loan program, but we also has to release any claims that we may have against UBS in regards to their marketing of this auction rate securities to us. I think those are the three components.

George Walsh

Does that mean you can put it to them, is it all of it? At any point starting in June 3, 2010, or is there an increment to that?

Bruce Mackey

No. It is all of it at June 30th, 2010.

George Walsh

Okay, till 2012.

The no net cost loan, is that something that would start immediately between now and the first offer or till you, how does that work in terms of availability that no net loan?

Bruce Mackey

It would start right away. Again, that is probably the one I am still negotiating with UBS.

George Walsh

So, theoretically, in the other thing and this offer is good till November 14?

Bruce Mackey

Correct.

George Walsh

When you are going, you are talking about it so I would guess you sort of leaning towards it.

The other is, obviously if that is accepted, there would be a reevaluation on the laws. Would they view, have you done any review on that would take those back to part or you got more strategies about $74 million or so?

Bruce Mackey

Though it is funny, yes, effectively that is probably that is how it works, you just have to fabricate it. The auction security will still trade and then they might trade down, they might trade up, but we have a put right that we can place the value on. It is almost in [3535] and we got to value that and that would offset probably most of the losses.

George Walsh

So the mark to "mark-to-market" and then to value of the put.

Bruce Mackey

Correct, exactly.

George Walsh

The $3 million impairment on the mark to market securities. That was the out in the captive insurance?

Bruce Mackey

Yes.

George Walsh

And how was that portfolio looking down on the captive insurance company? You kind of foresees still in the free companies that got hit over the last couple months. How is the balance for that portfolio?

Bruce Mackey

I did the balance to the portfolio. It is still in company that is significantly down. We still have unrealized losses related to that portfolio, you can see right into our balance sheet. But as of right now, we do not expect to take any future losses. That could change, the most of the securities than in preferred investments. They are all still paying give ins, we all expect all of it pay the dividends and if I am not, we will get looked at in the future and they will get evaluated by around of the year end.

George Walsh

So with the increase in the workman comp reserve related to the insurance right there, or were there actually more work has come advance that you have to increase your reserve.

Bruce Mackey

Our work has cut cost has been very stable, what we were up against was a very good quarter a year ago.

George Walsh

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

Bruce Mackey

It is something we have to evaluate as of right now. No, we have initially over funded our CapEx of quite sometime.

George Walsh

The discontinued operation charge, I may have missed exactly what was involved there. Is that discontinued operations that are still a problem or this discontinued operations had have been sold.

Bruce Mackey

We really to our discontinued operations, but I will go into. We still have two properties in Pennsylvania that were working on selling as well as our [37:47] on the pharmacy in a small institutional pharmacy in California.

We got negotiations really almost lined to that business that in some points along the way to is finally disposing of them, but not going to report on right now that is finalized.

George Walsh

I guess the other side is Bruce, which you spoke to, I mean honestly a large issue here is that we are dealing with the recession and if we take the market valuation, your price like they are having a problem that you guys is a going concern. Although obviously they are doing that for lot of companies, even with the cash on the balance sheet now, I think you are 60% of cash and if your get some comp resettlement going with this auction rate, if probably below cash, if you put a value on that no net loan.

It is just astounding to me, I guess evaluation and discount the book value to give 60% of book.

You spoke to it a bit, but there are any amplification you can give to the idea, because people are extremely concerned about the variability of companies obviously going forward into this recession. I just want if you could amplify things as far as your ability to work to a difficult recession, even there are a time where you will break even or unprofitable? But to survive through that, your balance sheet and two partners like senior housing or others.

Francis Murphy

Well George, I appreciate the question. I think us, if we wrote a small side balance sheet but I think it is a very, tall balance sheet, especially compared to our competitors. Even mention how much cash we have, we hopeful to have access to some of the investments and on auction securities, which we still have an untapped line of credit as well as we believe in all over a $100 million of property equipment that we could refinance with our partners in senior housing or with another company or put down on them. So, I think we will be well positioned to, I said in my prepared remark to not only survive or to thrive during the summer because there will be going to be lot of opportunities and we will look in taking advantage in them.

George Walsh

Is there anything else operationally that you feel a further issues going forward, I mean, is it really just a matter the depth of recession people are worrying about and occupancy and what that can do on the cash flow basis.

There are things that come up in the quarterly basis to bid the auction rate where obviously a negative development but it looks like there could be some resolution there. But, you have the captive insurance. You have to take the hit on that there. It is tough to always come up and think with things, I try to examine and come up with an analysis. Are there any issues that could affect you going forward as an operating company?

Francis Murphy

No. We look at a number of things all the time and there will be things out there, it is how tough the recession be, it is really, if anyone get and hard of an impact of [4458] in car industry. Right now, they will go through October and October is a pretty rough month. It did not hit us too bad. It did not really hit that bad in third quarter albeit most of the bad news really came on October, and we still saw some decent activity both on the move ends, as well as adjusting our rates to the out coming year. A lot of those notifications went out during the month of October and are being putted in a place that is not affected till January 1st, 2009, but people know about it. We will be well positioned moving into 2009.

George Walsh

I presume would be, if you come to some type of settlement on the auction rate, would there be some type news release regarding that as an material event?

Executive

Yes, no question.

Operator

That is all the time we have for question, I will turn the conference back over to Mr. Bruce Mackey for additional or closing remarks.

Bruce Mackey

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

Operator

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

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