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Executives

Bruce Mackey - President and CEO

Fran Murphy - CFO

Tim Bonang - Director, IR

Analysts

Jerry Doctrow - Stifel Nicolaus

Kevin Ellich - RBC Capital Markets

Joel Ray - Davenport & Company

Sean McMahon - Kennedy Capital

George Walsh - Gilford Securities

Five Star Quality Care, Inc. (FVE) Q1 2009 Earnings Call May 5, 2009 5:00 AM ET

Operator

Good morning, everyone and welcome to the Five Star Quality Care first quarter 2009 earnings results conference call. This call is being recorded.

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

Tim Bonang

Thank you, Sara. Good afternoon, everyone. Joining me on today's call are 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 beliefs and expectations as of today, May 5, 2009. The company undertakes no obligation to revise our publicly release the results of any revisions of the forward-looking statements made in today's conference call, other than through filings with the Securities and Exchange Commission regarding this 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. Investor's are cautioned not to place undue reliance upon any forward-looking statements.

Now, I would like to turn the call over to Bruce Mackey.

Bruce Mackey

Thanks, Tim and thanks everyone for joining us this afternoon. For the three months ended March 31, 2009, net income from continuing operations was $0.78 per basic share and $0.67 per diluted share, compared to net income of $0.14 per basic and diluted share respectively, for the same period last year.

However, both the first quarter of 2009 and 2008 included unusual items. Excluding these items, net income from continuing operations per diluted share was $0.09 in the first quarter of 2009 versus $0.22 in 2008. The 2009 results included several items that in aggregate resulted in a positive impact of $22.2 million or $0.69 per basic share and $0.58 per diluted share respectively.

These items included a $3.5 million unrealized gains on our holdings of auction rate securities, a $2.9 million loss due to the impairment of our investments in certain marketable securities, held by our captive insurance companies; a $25.1 million gain due to early extinguishment of debt and a $3.5 million loss on our UBS put right.

The first quarter of 2008 included a $3.3 million unrealized loss from our holdings of auction rate securities. The primary reason for the decline in net income from continuing operations is the decline in occupancy. Occupancy for the first quarter of 2009 was 86.5%, compared with 89.6% for the same period last year and 87.6% a quarter ago.

Same store occupancy for the first quarter of 2009 was 87.5%, compared with 89.7% for the same period last year and 88% a quarter ago. Same store occupancy as of this past Friday was 87.2%. While occupancy was down, we were still able to push rate and control costs.

Our average daily rate increased 3% year-over-year overall and 5% on a same store basis. On average, Five Star's increased its same store average daily rate by over 4% over the last six quarters. While occupancy is a challenge for all of us in the industry, Five Star maybe different than many of it's peers and that we'll have a community with an occupancy level under 85%, we're offering concessions, but not all out rate reductions.

Often, we are asked about our position on rental concessions. Rental concessions were actually down 15% in the first quarter of 2009 from last quarter. It is our belief that actual rate reductions are dangerous game. Once you provide rate cuts to one resident, the rest will tell you to provide those same cuts to them. We believe it's not only hurts brand integrity, but also creates an unnecessary hurdle of having to raise rates to previous levels, which is a painful process that will take time.

Instead, we are focusing our efforts on our sales force to selling the Five Star difference program. This is our proprietary comprehensive sales training initiatives. The program has two distinct parts.

First, is a basic training which is an intensive two days, face-to-face training program and second, ongoing follow-up training sessions where all participants attend at least two advance sessions per year. When completed, close to 650 Five Star sales and marketing professionals will have attended this intensive training program. The basic training portion of the program should be completed by the end of May.

From a managing perspective, we are beginning to see a uniformity of sales efforts across all of our properties. Our goal is to [repetuate] a unified sales culture within Five Star that will help to increase overall occupancy.

We are also still promoting the Five Star financial solutions program that works in conjunction with the following third-party companies; Elder Life Care, Life Care Funding Group, and A Place for Mom. Our financial solutions program in addition to helping resident stay in our communities, we believe we also help increase the number of people coming through our front doors as well.

Year-to-date versus last year, the trend has been positive. The number of people who apply and receive approval for these programs is increasing. These are small numbers to begin with, but the results are clear. These programs are helping to fund an increased number of participants, pay for senior living services at our communities. We still believe there is plenty of opportunity to drive these preliminary positive results.

In April, we rolled out a new website. I encourage you to visit the site at www.fivestarseniorliving.com. This new site will capitalize on enhanced search engine optimization and will dovetail on the back-end with our lead generation and lead tracking system. We believe this website, overtime, will help us to drive occupancy.

Moving onto other metrics. Wages and benefits as a percent of senior living revenues were 50.8% in the first quarter, up from 50.3% a year ago, and 50.4% last quarter. On a same store basis, wages and benefit as a percent of senior living revenues increased 51.3% from 50.3% last year. These increases are primary result of our decline in occupancy. Going forward is our goal to keep this ratio below 51%.

G&A as a percent of revenues was 4.2% as we still maintain the leanest operations in the industry. We expect this percentage to be in a similar range throughout 2009. In spite of the difficult economic conditions, our core senior living business was profitable in the first quarter. Nearly 85% of our total company revenue comes from this business. Approximately 70% of our senior living revenues are coming from private pay sources.

In the first quarter of 2009, Five Star senior living produced $21.1 million of EBITDAM compared to $20.6 million for the fourth quarter.

Our ancillary businesses, which make up only 15% of our revenues, continue to struggle in the first quarter, but did show some slight improvement from the fourth quarter of 2008.

The rehabilitation hospitals, which accounts for 8% of our total revenues, lost $1 million of EBITDAM during the first quarter. This is an improvement of approximately $60,000 in EBITDAM on a sequential basis.

In the first quarter, we identified a number of opportunities at each hospital to help bring them to profitability. Some of the smaller opportunities are being phased in now and we continue to evaluate larger ones. Some of the opportunities require DON approval and could be several quarters away from being started.

The pharmacy operations, which make up 6% of our total revenues lost $108,000 EBITDAM during the first quarter. This was an improvement of approximately $430,000 in EBITDAM on a sequential basis.

As of the end of March, we were servicing approximately 11,500 customers and have expectations to add almost 1,000 additional customers during the next several quarters.

I would like to note that after the close of the quarter in April, Five Star repurchased and retired an additional $8.5 million par value of our convertible senior notes. The transactions were executed at an average price of 44% of the par value of the notes and at a total cost before crude interest of $3.7 million.

In total, we retired $55 million of convertible senior notes, since the beginning of the year. The remaining $71.5 million of our convertible senior notes could be put to us in October 2013. This redemption reflects 11% of the outstanding senior notes as of March 31, 2009, and was principally financed by drawing our UBS credit facility, as well as, cash on hand.

We will record a one-time $4.5 million gain or $0.14 per share basic on early extinguishment of debt during the second quarter of 2009. As was the case last quarter, the Board and management believe this repurchase to be a good use of capital, providing a 24% return to Five Star and its shareholders. It deleverages our balance sheet and going forward will reduce our diluted share count by approximately 650,000 shares. I think it once again underscores the Board's confidence in Five Star's long-term prospects.

As we told you last quarter, with increasing pressures to our bottom-line appropriate areas of emphasis for senior living operators, or any company for that matter, are mitigating risk, enhancing liquidity, and shoring up balance sheet strength.

I would like to remind you of the ways that Five Star has positioned itself, to withstand a prolong economic downturn. Five Star has no near-term debt maturities for our senior notes or mortgages. The closest maturity we face is in October 2013, when our senior notes can be put to us.

In November 2008, we reached a settlement with UBS concerning our auction rate securities. We have a put right to UBS to sell these securities at their par value of approximately $75 million in June 2010. In December 2008, we extended our $40 million credit facility with Wachovia until May 2010.

We own 22 unencumbered communities with a current net book value of approximately $126 million. Our communities require no entrance fees. This gives potential residents much more financial flexibility in this trying economy.

We have a well-diversified portfolio of communities and in my mind our biggest advantage maybe our cost-controlled culture. As a company, we were born out of adversity, losing money for our first few years of existence. Controlling costs helped us move to profitability in 2004.

In the same spirit and in an effort to mitigate the effects of lower occupancies we have decided to defer our corporate and regional raises historically given on July 1st for six months or until January 1, 2010.

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

Fran Murphy

Thanks, Bruce. Good afternoon, everyone. Our senior living revenues increased $35 million or 16.3% to $252.2 million in the first quarter of 2009, compared with the first quarter of 2008. $33 million of this increase was due to 42 communities we began to operate after January 1st, 2008. Increased per DM charges at our same store facilities, partially offset by a decrease in occupancy at these communities accounts for the remainder of the increase.

Senior living and operating expenses were $190 million in the first quarter, an increase of $27 million or 16.9% from the same period last year. $23 million of this increase was due to the communities we began to operate after January 1st, 2008. Increases in same store expenses particularly for wages and benefits, explains the remainder of this increase.

On our same store basis, senior living revenues were $218 million in the first quarter, an increase of 1.3% from last year, reflecting a 4.9% increase in average daily rates, offset by a 220 basis point decline in occupancy.

Same store senior living expenses were $165 million in the first quarter, an increase of 2.6% from last year, due largely to increases in wages and benefits.

For the first quarter of 2009, our same store operating margins before rent or EBITDARM declined 1% to 24.1% as compared to 2008, while EBITDARM at our new communities was $10 million or 28.9%.

I will now discuss the operating results at our ancillary businesses. First, at our rehabilitation hospitals revenues were flat in the first quarter compared with the first quarter of 2008 were lower occupancy was offset by increased per DM rates.

Hospital expenses increased 1.4% during the first quarter of 2009 and rent was up 5% as a result of additional sales of hospital capital improvements purchased by senior housing since January 01, 2008. Having improved the physical appearance of our hospitals, success of these facilities is dependant on our ability to drive [incentives] and further consolidate the operations between the two hospitals.

At our Institutional Pharmacy business, revenues increased by 6% in the first quarter compared to prior year mainly as a result of adding additional Five Star residents to our customer base. Expenses for the same period increased by 13% due to additional customers and added expenses related to the opening of a consolidated business office, and a satellite office located in Nebraska.

Pharmacy operations were essentially breakeven in the first quarter and we expect them to be slightly profitable for the remainder of the year. We are targeting a 2% to 3% EBITDA margin.

In the first quarter, general and administrative expenses necessary for supporting our corporate and regional operations increased by 12% or $1.3 million from the same period a year ago. Most of this increase was related to added costs necessary to support the communities we began to operate in 2008. As Bruce noted earlier, our G&A expenses were 4.2% of total revenues in the first quarter.

Rent expense increased 24% to $44 million in the first quarter, as compared to the prior year, due mainly to the leasing of new communities in 2008, as well as additional rent expense from the sale of capital improvements to senior housing since January 2008.

Apart from income taxes related to our purchase of convertible senior notes, we expect that taxes in 2009 will be approximately $1.9 million. In the first quarter $330,000 of income taxes were related to the purchase of senior notes.

Before concluding, I would like to spend a few minutes discussing our balance sheet, cash flows, and liquidity. At quarter end, we had unrestricted cash and cash equivalents of $28.4 million, including our UBS put right, auction rate securities and unrestricted investment balance. We have total unrestricted cash and investments of $109.1 million and restricted cash and investment of $19.1 million.

We had no amounts outstanding on our $40 million revolving line of credit with Wachovia and $37.1 million outstanding on our $40 million line with UBS. As of today we still have nothing drawn on our Wachovia line and $40 million drawn on our UBS facility.

Consolidated EBITDA was $7.5 million in the first quarter, compared to $10.9 million last year, after adjusting for the unusual items noted in our press release. And operating cash flow was $23.1 million for the quarter. We made $18.9 million of capital investments during the period and sold $12.7 million of CapEx to senior housing. We anticipate recovering another $10.6 billion in future sales of CapEx to senior housing.

Our day sales outstanding, including the rehabilitation hospitals and pharmacy operations was 21.0 days. At the end of the first quarter, we had $193 million of net profit in equipment, which included 25 properties that were directly owned by Five Star. 22 of these 25 properties are unencumbered by debt. In addition to the lines of credit previously mentioned, we had $80 million of convertible senior notes and $12 million of HUD mortgages outstanding.

As a result of our purchase of convertible senior notes in April, our outstanding balance on these notes is now $71.5 million. We believe that we are in compliance with all material terms of our credit lines, notes and mortgage agreements.

As we have mentioned on past conference calls, our performance in the coming quarters will be greatly influenced by the future occupancy levels that we are able to attain.

Looking forward to the remainder of 2009, we hope to begin to rebuild our occupancy levels as sales and marketing efforts we have undertaken begins to take hold. We believe that Five Star is better positioned for growth and performance today and is sounder financially than it was a year, or possibly even two years ago.

Our debt load has been greatly reduced. Our auction rate securities are expected to be purchased from us in 14 months by UBS, and we have continued to add to and investment and improve our stable refined properties or maintaining cost discipline and achieving profitability in a very difficult environment.

That concludes our prepared remarks, Sara; we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question today will come from Jerry Doctrow with Stifel Nicolaus.

Jerry Doctrow - Stifel Nicolaus

A handful of things and I apologize where I think you actually covered some of this, but it was just gone a little too fast for me. Maintenance CapEx in the quarter, what was that number?

Fran Murphy

Well, Jerry, we had 49% of our $19 million in CapEx spend was on projects of $250,000 or more total value. We had a recovery from sale to senior housing of $12 million.

Jerry Doctrow - Stifel Nicolaus

Okay. Was it $12 million, even I know I heard 12?

Fran Murphy

$12.1 million.

Jerry Doctrow - Stifel Nicolaus

$12.1 million, okay. And then you said, how much you were going to sell to senior for the second quarter, it was 10 point something, I just didn't get the decimal?

Fran Murphy

That's right, it's.

Bruce Mackey

10.6 Jerry.

Jerry Doctrow - Stifel Nicolaus

10.6, okay.

Bruce Mackey

That's just to clarify to be sold in the future, not necessarily the second quarter.

Jerry Doctrow - Stifel Nicolaus

Okay. Sort of switching off a little bit from the numbers, I guess what I wanted to try and do is get a little bit more color Bruce in terms of just occupancy whether it was sort of across the board, whether it's a couple of properties, and I guess I particularly was kind of curious on New Seasons and the Sunwest stuff, how much they are factoring. I guess same store went down as well. But can you give me any color maybe how those two portfolios are performing compared to the rest?

Bruce Mackey

Sure. Both New Seasons and Sunwest are really close to what they are when we took over. Sunwest is actually up, eight residents or maybe even a few. I think New Seasons is actually down, in both groups properties we've really turned the majority of the leadership teams in the buildings. I think Sunwest could be close to 100%, and (inaudible) I think maybe one EDs stayed, but a number of them did decide to leave. So replacing all those EDs at both Sunwest and New Seasons took some time and obviously, you always don't get it right first time, so we've actually, maybe turned one or two them, more than once. That's done.

Our capital plans are in place of all the buildings, I mean I think that's going to be a big driver in some of these communities. I visited almost all of them now at this point, and from the outside that they are good physical plans. They are just a little tired properties, they need new carpets, new [fsne], a paint job on the inside and they'll be a very nice properties and that getting that CapEx work done. It's probably a year to get it all done, maybe a little bit longer and some of [plan seems] like phase them for a year, two year period.

Jerry Doctrow - Stifel Nicolaus

Okay.

Bruce Mackey

I like to answer your other question, anecdotally on occupancy. Some of our communities or areas of countries are doing very well. The Mid-Atlantic Maryland around North Carolina, South Carolina is doing fine. We've seen some pick up in Arizona in Q1, that's to be expected you generally have the [stalwarts] coming down at that time of the period.

Southern California has done okay. We have gotten hit in Florida, pretty significantly year-over-year and Texas is down as well. I think those are two states that have really given us some trouble of late and especially independent living area in those two states.

Jerry Doctrow - Stifel Nicolaus

Okay. That's helpful. Your rent growth, I was just trying to sort of think this too, I think you gave us some parameters. But I know like going forward some of your rent growth is driven by, revenue something maybe kind of CTI base, I don't know if there is force and caps. Could you just have a sense maybe what you're assuming in terms of rent growth, kind of this year and next year or how should we be thinking about it?

Bruce Mackey

When you see rent growth, you mean our rent expense with?

Jerry Doctrow - Stifel Nicolaus

Yeah, your rent expense with any, ignoring sort of new sales of CapEx and all that stuff, I was just kind at the base?

Bruce Mackey

Yeah. Well it's really different for every portfolio and we do break this out in this Q which will be filed later today, if you can see our percentage of rent. So all of our properties that release from senior housing, actually not all, the majority of properties, the New Seasons properties don't have a percentage rate calculation, nor do the hospitals and everything else does and the day shifts vary by property.

And so we will again later in the Q and then you find if you have the number handy, what we pay in percentage rents in the first quarter of 2009. But it was down between Q1 of '09 and where it was in Q1 of '08.

It's got to be a static number throughout most of 2009.

Jerry Doctrow - Stifel Nicolaus

Because it can't go down, whether it could only go to, it does.

Bruce Mackey

It can't go below the base. But don't forget, some of our bases were set in 2003. So percentage revenues in 2008 come down from 2009 and you are looking at a percentage base in 2003. It could come down and we did see that.

Jerry Doctrow - Stifel Nicolaus

Okay. So you are thinking flattish kind of rents go forward or?

Bruce Mackey

Flattish from what we reported in our first quarter.

Operator

Our next question will come from Kevin Ellich with RBC Capital Markets.

Kevin Ellich - RBC Capital Markets

Quick question, just going back to the CapEx I just want to make sure I got this right. So, if we want to think about free cash flow, is it safe to assume that we take $19 million, add back the $12 million. So your maintenance CapEx was really like $7 million?

Fran Murphy

That's the net paid out by Five Star. That's the way we would look at it.

Kevin Ellich - RBC Capital Markets

Okay. So, free cash flow and then you said operating cash is $23 million, so of $16 million of free cash flow. Okay. Excellent, that’s helpful. Going back to the, Bruce, your comments about the rental concessions, I’m just wondering how should we really think about that. If you held concessions flat, due you think occupancy would have been a little bit higher or I guess conversely widely down 15%, what would happen if it was down 50%?

Bruce Mackey

I would expect it to be down 50% rental concessions. We probably would have seen more of a decrease in occupancy. We look at concessions on a market-by-market basis, really property-by-property and try to use them accordingly.

When ones properties get over, certain threshold 90%, we start to take things out of that toolbox for that selected property and convert it when a property drops down below a certain level, we might have to add more things that are available, start building to use to get them back to a level that they were at historically.

Kevin Ellich - RBC Capital Markets

That makes sense. So obviously, with concessions down, that means, it’s more in properties that is has over whatever threshold that is, maybe 90%, is that…

Bruce Mackey

It’s possible. Yes.

Kevin Ellich - RBC Capital Markets

Okay. Thinking about the programs that you guys have in place for recruiting attention whatever, which do you think has had the biggest impact so far and how do you measure that and can you talk at all about the residents that have gone into the Five Star facilities because of these programs?

Bruce Mackey

It’s been very, very small Kevin. None of these problems existed really until late 2008, and we rolled them out in probably, may be January or February of 2009. So I think some residents were talking advantage and just because they heard these other companies and worked on them with their own in the past. So far, I think what might potentially have the biggest impact for us is the VA benefit to A Place for Mom.

We've seen upwards of around 20 maybe potential applications per month being filed with them so far, but now it takes several months for those applications to go through. So as the people are in the application stage right now that will have an impact, it could be three or six months down the road.

We have really to preliminary, like I said these are new programs, we've rolled them out when you need to follow-up some additional work with our communities to make sure that they are using the programs and really selling them to perspective residents. As well as current residents that are having financial difficulties affording our services based on, for whatever reasons, mostly if they lost investment coming in that portfolios.

Kevin Ellich - RBC Capital Markets

So basically and correct me if I'm wrong, but did you say there is kind of maybe a three to six months selling cycle.

Bruce Mackey

Correct. Three to six months application process with the VA benefit, the other ones had selling cycles as well, Life Care Funding Group and Elder Life Care Funding. I wouldn't say this cycle is about long, but there is approval processes and credit things that applicants need to go through.

Kevin Ellich - RBC Capital Markets

Okay. That's helpful. Just going back to the convert repurchases and congratulations again, looks like that was a good investment I think.

Bruce Mackey

Thank you, we do too.

Kevin Ellich - RBC Capital Markets

Looking at the, I have a minor question on the interest expense added back, because of the convert, asset converted method, what portion of the quarter did this fall in? It looks like you did the purchase in January?

Bruce Mackey

That was the initial purchases. We purchased the initial tranche in January, and then we did a second purchase post quarter.

Kevin Ellich - RBC Capital Markets

Right, so the interest now for the convert now was, is it roughly 750,000 per quarter, is that the way to think about it?

Bruce Mackey

3.75%. Right. And with the discount, you’re essentially talking about an effective rate of twice of that and our borrowing rate on the UBS facility is about 2% right now.

Kevin Ellich - RBC Capital Markets

Then with the additional purchase of $8.5 million, the share count should actually go down a little bit more from this quarter, is that correct?

Bruce Mackey

Another 650,000 shares approximately.

Kevin Ellich - RBC Capital Markets

Just going back to the G&A, very low, good job on that front. I was just wondering how sustainable do you think that is? I know you said expected in the same range but are we really looking at 4.2% for the rest of the year?

Bruce Mackey

It's in that range. I think we have always said in the 4.2% to 4.5% range. I think we are very comfortable being in that range, we’ve been there for a number of years and we've worked very hard to keep it in that range. I think the other thing I said we're differing corporate and regional raises that generally would kick in July 1st, for at least six months and that will have an impact as well.

Kevin Ellich - RBC Capital Markets

I hate to ask, just wondering how the employees took the deferral of the raises. Has morale kind of been down because of that or are they okay with it?

Bruce Mackey

For the most part people were okay with it. I think more people understand the circumstances that we are in right now. They see the evening news every night and its generally pretty glum news. When you got unemployment as a result of this economy, we’ve lost 5.1 million jobs, since recession started. I think people are pretty happy to be working here, pretty excited about the prospects they've seen in Five Star. They know we generally do the right thing we will be on for the long-term. So I think the most part, the response I’d have has been favorable.

Kevin Ellich - RBC Capital Markets

Do you think there is any seasonality in the occupancy rate this quarter?

Bruce Mackey

Generally this is one of our tougher quarters. We have seen the improvements take longer. I don’t know if you recall but really two years ago, we didn’t come out of the low point until mid-May or early June and we saw that last year. So, I just want to point that out to people it could take us a little longer than usual if there isn't seasonality, that's going to help us out. It's taking us longer historically than it did a few years ago.

Kevin Ellich - RBC Capital Markets

Okay. And then last question and thanks for taking all the time. I had to ask about the swine flu H1-M1. Have you taken any extra precautions because of that?

Bruce Mackey

We have and it's mostly, we're required with a lot of our skilled nursing units to have pandemic flu policies already put in place. So, it's really breaking out those policies, making sure that people are doing what they are supposed to be doing.

So, reinforcing the things to make sure that the flu is not coming to our buildings, washing your hands and kind of stressing it all these times, but in service reminders. We do have an integral note to our employees, it did come down to swine flu, not at our communities, but just through vacations to Mexico and really just kind of an odd thing that I thought it was interesting.

Operator

(Operator Instructions). Our next question will come from Joel Ray with Davenport & Company.

Joel Ray - Davenport & Company

I was wondering if you might be able to elaborate a little bit about what specifically is involved with your concessions on the rent?

Bruce Mackey

Sure. I mean for the most part our concessions revolve around pre-rent periods. It could be a month or two months, based under two-year commitments. It could also involve around waving a rent increase. So if they do sign a two-year commitment, we'll wave that rent increase for the second year and bake that, into the overall deal.

The last thing it could involve is allowance for moving expenses and that could be renting of a truck etcetera or if they want to do certain things to the unit that aren't standard, upgrade of certain fixtures and things like that. One other thing, it could if we got a community that generally is doing fine occupancy or is starting to come down a little bit, with it's historically charged community fees, that could be a waiving of a community thing.

Joel Ray - Davenport & Company

Okay.

Bruce Mackey

But I think those are probably some of the biggest things.

Joel Ray - Davenport & Company

All right. Let's shift gears a little bit you had talked about the fact that really what we need to do on the rehab hospitals is to built some occupancy.

Bruce Mackey

No question.

Joel Ray - Davenport & Company

You would think that in the first quarter usually seasonally you have a little bit of an uptick and demand for rehab services, given the winter weather. I was wondering what do you think is going on here and what is it that you doing to try to rebuild that?

Bruce Mackey

I think for the most part, unfortunately we were at a national company of rehab hospitals it would probably impact us for being stuck really just in Boston market with these two hospitals. I think we've got a little bit of an over bedded supply in the hospital area around here. Our referrals sources were down significantly in the first quarter, especially in the winter rehab can't pay the rent that we saw a significant reduction at some of knowing rehabs referring hospitals in terms of their overall census, which directly impacted our census.

Some of the things that we're looking combat it are, some of things in terms of CapEx project we talked about, make sure that our hospitals are the referring hospital of choice in these markets. I think one of the other big things, I talked a little bit about in my prepared remarks, is some of the larger opportunities of moving out at some of our bed licenses and taking avenge of opening up additional in-patient satellites around the greater Boston area.

We're looking at a few specific deals right now that I hope to talk about in further quarters, in terms of progressing. These in-patient satellites do make good money for us and have been successfully. We've got three of them right now and we'd like to really increase that. But they do take time. We need to first strike a deal with a host hospital. Second, we need to potentially go through a DON approval and it can take time. And then we need to get the unit up and running.

Fran Murphy

I think it's also worth noting that for a short period of time wings in both of the hospitals were brought to new admissions because of an incident for the norovirus. This came at a pretty busy period of time in the quarter and that hurt us as well.

Joel Ray - Davenport & Company

That's good point, thank you, Fran. And do we have any recourse on the rent that we're paying on these facilities? And what's the global strategy for this business, Bruce? Some of these things can be pretty big distractions to you between the institutional pharmacy and the rehab hospital business. I'm just kind of wondering what can we do to either cut base or cut our expenses so we can least get to breakeven situation on these?

Bruce Mackey

Yeah. Well I think, two parts of the question, one is the rent, what could we do about the rent. It's something we ask F&H on a regular basis, what can we do about the rent? It's a unique position for us. We do have pretty good cash flows at our overall company. It's a negotiation tactic between two independent boards, and those discussions happen from time-to-time and they will continue to happen.

Joel Ray - Davenport & Company

Have we had any results from that on a positive fashion, so far?

Bruce Mackey

Nothing to-date, as of now. We talked about improving our operations, that's obviously ongoing. In terms of dispositions or disposing them, our goal is to not sell them. I'd rather turn them around especially we don't want to sell them at a distress price. Now somebody's come along and offers a what we thought it was a reasonable deal, and something we have to put on the board and consider it theoretically.

Joel Ray - Davenport & Company

I was wondering also, do you have any specific margin targets for these or is just again the goal is at least to get them to breakeven?

Bruce Mackey

I think, in the hospitals the goal is to get them to breakeven. We had margins a few years ago, kind of pre 65 or 70, you know the 60% rule and where we are right now in the business. On the pharmacy side our goals are to still get them back to a 5% margin business.

Joel Ray - Davenport & Company

Lastly, I missed it as Fran mentioned, I was wondering the availability on the $40 million UBS line right now.

Fran Murphy

That’s tapped out right now.

Joel Ray - Davenport & Company

We still have our full availability into our Wachovia line right now, untapped.

Joel Ray - Davenport & Company

I imagine SNH is still very supportive of the company and is not changing any of their thoughts towards the company or the strategies with the company?

Bruce Mackey

I don’t believe so. I think they’ve got their conference call tomorrow and feel free to ask that question to them but none that I see so far.

Operator

Our next question comes from Sean McMahon with Kennedy Capital.

Sean McMahon - Kennedy Capital

Just had a couple things here. One, can you give me how much capital you think is going to be needed on these new facilities that you guys brought onto the portfolio to bring them up to the Five Star quality?

Bruce Mackey

Sure. The rounds kind of 30,000 put numbers, but you’re probably talking over the next two plus year, I talk about doing a phasing of CapEx between New Seasons and Sunwest, probably on the $10 million range.

Sean McMahon - Kennedy Capital

I know you guys are putting some CapEx in the hospitals still, but are there any other major facilities out there where you are going to have to put in that kind of money, let’s say over the next two years or after that are we kind of, I know you are always changing the portfolio, but after that level are we done so to speak, with kind of the base business?

Bruce Mackey

We always look at various projects and when I say it's done, I mean some of the CapEx. The majority of our CapEx going forward are the ones we're just talking about, get the hospitals is still ongoing, those communities that we just acquired.

We've got some additions at Five Star, they are fairly small. We're adding new units on right now. Again we probably maybe have 30 units in the pipeline over the next year and a half period. And then, a project that will be mostly SNH leased properties that we'll be able to sell to them.

Sean McMahon - Kennedy Capital

Okay. Lastly, just on the tax-rate, where do you think you're going to end up there kind of at the end of the year?

Fran Murphy

As I said, we've got about a $1.9 million tax for the convertible notes. The tax is on the convertible note repurchase and in the first quarter the taxes on the note repurchase was $330,000. The $1.9 million kind of comes in lumpy across the year, kind of due to the way GAAP works, Generally Accepted Accounting Principles.

Sean McMahon - Kennedy Capital

Are you able to differ those taxes, I thought there is something in the stimulus bill, on buying the debt back again on that?

Bruce Mackey

Mostly state taxes what we're responsible for, unless it's Massachusetts.

Operator

Our next question will come from George Walsh Jr. with Gilford Securities.

George Walsh - Gilford Securities

Bruce, any comments on the trends in move ins versus move outs in occupancy?

Bruce Mackey

Discharges we're up a little bit quarter-over-quarter and admissions obviously kind of reflected our lower occupancy, quarter-over-quarter on a same store basis. Admits were down, but I would say discharges were definitely higher than admissions. Admits were probably down, maybe 2% or less than 2% overall.

I think the positive, one thing I didn't talk about, when Jerry, asked earlier the traffic we are getting to our communities is still, pretty positive. A number of people [still] to our communities each and every day and I think a lot of them are really kind of waiting for the housing market to come back into play where they can sell their asset.

They want to move into our communities, it's really getting that first piece of that step done and then they want to move in, and that obviously we know obviously takes time in this economy.

George Walsh - Gilford Securities

Anything with the Pittsburgh assisted living facilities that I believe were for sale, any update on that?

Bruce Mackey

No update on those.

George Walsh - Gilford Securities

The other ones I saw with captive insurance, there was a further write-down of about $3 million this quarter. Any comments on the portfolio there and maybe if there is some improvement in the valley in April?

Bruce Mackey

Maybe some slight any improvements in the future gets recorded through other comprehensive income. In fact, all the securities that were paying dividends at year-end are still paying dividends today, and they are all paying at the same levels because these write-downs were really just, most of the lots are already in the comprehensive or in the equity section are merely just being transferred to the balance sheet by the P&L, because of our really time. I think that’s the biggest thing.

Fran Murphy

We're running 12.3% on this portfolio based on the fair market value of it. And we only have $500,000 of unrecognized losses as of quarter end on the portfolio. So we'd like to see this portfolio come back.

Bruce Mackey

The positive George is these are funds that that are for long term claims that I really don’t see coming in. I won't never, but it could be a long time. We don't need the money right now, our capitals are doing fine. We continue to pay for claims out of current cash flow right now. I think one capital that's been established now for potentially 5 or 6 years. We haven't moved money out of that captive, out of the investments at all in that time period.

George Walsh - Gilford Securities

Okay. So, there is no reserved issues as of yet?

Bruce Mackey

Correct.

George Walsh - Gilford Securities

Okay. Now the other was, I saw on the K that you are looking to form a insurance company with some other entities of your RMR company that's there. Can you just elaborate on that a bit and what do you see as the potential cost saving and the timing? And how would that potentially affect the balance sheet in terms of, will there be a transfer of the assets of your balance sheet to this new entity?

Bruce Mackey

Sure. What we are considering just and especially that you might not be aware of it is establishing an insurance company with other RMR managed companies like, HRPT Properties Trust, HPT, SNH and TravelCenters of America and having them write the insurance that's right now written by third-parties. We expect to be able to leverage our portfolio properties for our lines like liability, workers compensation and property insurance, pooled them with those others lines.

One of the larger charges that you'll see in insurance is administrative charges. And we think there is a significant opportunity to really cut off a fair amount of those administrative charges that we'll be paying for insurance and leverage them with these other companies. I think there is also an opportunity to leverage our risk, with the Five Star being some of the higher risk properties with other things as well.

In terms of movement of the balance sheet, it's or where the timing. I don't think anything taking place in terms of writing insurance in 2009. I think most of this is going to be 2010. We've invested some capital to get the insurance company up and running. Five Star own about 16.7% of the insurance company, will account forward under the equity methods. So, we'll be sharing [probating] an income and losses up to that period. And then as we start to write insurance, we'll start to see some of the savings from that going forward.

But I guess, I expect those savings to come in 2010. The savings could be significant, I think, if you look at our success with the other RMR related companies in terms of things that they've done for us, I'll really just point to our G&A as the percent of senior living revenues. We run those one of the leanest operations in the industry for a number of years, because our relationship with RMR, some of that really has borne through and paid off in that area. We expect to potentially see some of those things happen here as well.

George Walsh - Gilford Securities

Okay. So is it something what you think by the end of this year that the insurance company will be established. And then there would be insurance assets that you own now for the captive insurance company and liabilities would be on another balance sheet and redo company's balance sheet?

Bruce Mackey

Possible George, I think that's probably a little bit too early, honestly. And then secondly, we're not fully sure of we're going to be just, maybe writing this on a go forward basis and leave our current captives in place to tail out and tailing out could take five to seven, 10 years. So it's a long-term strategy. It's again cost efficiencies going forward that will pay out over the long-term.

George Walsh - Gilford Securities

Okay. So there might be just new business that goes into the?

Bruce Mackey

It could be, some that we do need to take a look at, correct and that's happening now.

George Walsh - Gilford Securities

Would you guys be running another insurance company at all or that would be third-party individuals, meaning Five Star management.

Bruce Mackey

It would not be Five Star management. Five Star directors will be directors of the insurance company, as would directors of the other RMR related companies.

George Walsh - Gilford Securities

Okay. Just one quick one also the UBS line you mentioned, is 2%. Is that the cost of a line or is there any, is that like a net versus the income from the auction rate securities?

Fran Murphy

Exactly, George. It's with the auction rate securities are yielding right now.

George Walsh - Gilford Securities

Any color on perhaps just with UBS? If something happens to UBS, how does that affect this plot and the agreement or what you do on the line? Relative to that amount outstanding that’s owed to them. So any bit of a worst case scenario, you can just kind of say on UBS versus the line that you have with them?

Bruce Mackey

I think on the worst case scenario right now we have got $40 million outstanding line. UBS has got a put right to them for $75.5 million. I think you effectively look at a say $35.5 million kind of net becoming a long-term asset. We expect to realize that asset in June of 2010. I wanted to overcome that the way auction rate security markets used to operate but there are trading in these securities from time-to-time.

Fran Murphy

I think it's worth noting too that, next quarter we will able to right size our working capital on our balance sheet as we push these related assets and liabilities with UBS line. The ARS securities and the UBS put right to current assets and liabilities and we'll have positive working capital at that time.

Operator

That does conclude the Q&A session for today. I’ll turn the call over to Bruce Mackey.

Bruce Mackey

Thanks to all of you for joining us on today's call. We look forward to updating you on our progress in the future. Bye now.

Operator

That does conclude today's teleconference. Thank you for your participation.

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Source: Five Star Quality Care, Inc. Q1 2009 Earnings Call Transcript
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