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Executives

Paul Hoagland – Treasurer and CFO

Bruce Mackey – President and CEO

Analysts

Louis Friend – UBS Investment Bank

Five Star Quality Care, Inc. (FVE) UBS Global Healthcare Services Conference Transcript February 7, 2012 4:00 PM ET

Louis Friend – UBS Investment Bank

Good afternoon. And thank you for coming to the 2012 UBS Global Healthcare Services Conference. My name is Louis Friend, and I’ll be your host for this session. I’d like to introduce Paul Hoagland, Treasurer and CFO; and Bruce Mackey, President and CEO of Five Star Quality Care. Following the presentation there will be a breakout session in the Broadway Room. Thank you.

Bruce Mackey

Great. Thank you, Louis. Five Star is a strong and growing force in the senior living industry. We operate 245 senior living communities with about 27,000 living units. According to data that was released last year by the American Senior Housing Association, Five Star is the sixth largest operator of senior living units in the United States.

I think the pie charts here on the slide help to tell our story. Looking at the pie chart on the left, as you can see 86% of our total company revenues come from senior living business, skilled nursing at 17% and independent and assisted living at 69%, only 14% of our revenues come from our pharmacies and rehab hospital business.

Moving to the pie chart in the middle, 73% of our senior living revenues come from residence private resources, when Five Star began operations over decade ago that was 21%, since coming public Five Star has a focused on acquiring high-end independent senior living communities for the majority of revenues are paid for with residence private resources. We significantly decrease substantially from Medicaid and Medicare over the last decade. And then the chart in the right shows our revenues by state. We currently operate in 30 states and no state makes up more than 10% of our total senior living revenue.

By many measures Five Star makes a strong case as a solid investment opportunity. With the national platform of senior living communities, as of year end we operated 245 properties in 30 states with 27,000 living units.

We generate annual revenues in excess of $1.3 billion and we employee over 25,000 people. Our communities are predominantly private pay. Our properties are not dependent upon government sources, Medicaid and Medicare and that’s been a hallmark to Five Star to coming public decade ago.

Demographics are clearly in our favor, demand is really strong and new supply will be extremely limited over the next several years. Five Star is a great operator, we are the only company among the four largest public senior living operators has been profitable over the last eight quarters. We’ve achieved this by pushing rate and maintaining very tight expense controls, Paul will detail that in a little bit.

And last, but certainly not least, Five Star is a consolidator in this market. We closed on several deals last year that made 2011 a pretty exciting year for us on the acquisition front. We took on about 40 communities, almost 5000 units that are almost all private pay.

Five Star offers an [excellent] solution for seniors. At year end we operated 207 independent and assisted living communities. We also operated 38 skilled nursing facilities. Our communities range from large to small and from high-end to moderate. The average number of community units per community is 107 and our average monthly rent is $4,500.

The chart on the right shows our breakdown of units by type, we’re about 30% independent living, 50% assisted living and 20% skilled nursing. About 2000 of our AL units offer Alzheimer or dimension care also above 35% of our skilled nursing units, I mean, continuing care retirement communities or CCRCs. CCRC is a campus like setting, that is independent living, assisted living and skilled nursing, all in one property.

As you can see from the photo at the bottom of the page here, we operate some high-end communities. The photo on the left is the shot of the community is the café that we operate at Minnesota, the middle shot of the property at the inside entrance of one of our communities that we operate in Naples and then the photo on the right is continuing care retirement community that we operate on the East Coast of Florida.

Five Star is a large national footprint. We operate properties in 30 states. Our independent and assisted living communities are organized in three divisions and each division has five regions. We also have one division at overseas our skilled nursing services.

Five Star’s capacity to take on additional communities without need to add additional resources, we did that in 2000 when we took on 40 communities, we plugged in an existing regions without really adding incrementally much overhead.

We’ve build a very scalable infrastructure in our home office, about Five Star to take on additional communities again without need additional resources in our home office, as you will see in a minute that Five Star’s general administrative cost of the lost among all our peers.

The senior living industry an exciting industry right now and have lot of potential for investors over the next several years. For us the senior living market is a large and fragmented market. The top 10 public and private operators controlled above 25% of the units in 2011. Five Star has been and will continue to be a consolidator in this fragmented market.

Demand is clearly in our favor, the 85 and above age demographic is one of the fastest growing segments of the U.S. population. We focused on that 85 and above demographic because that’s above the average age or resident upon moving. And the chart in the bottom of the slide here shows the supply in this moving industry.

What is shown on the chart our new construction starts for independent and assisted living units in the country. Five Star essentially shutdown in the second half of 2008 and haven’t really recovered any meaningful amount since then.

In 2006, Five Star began operating two rehabilitation hospitals in the Boston area. The two hospitals among the premiere rehab hospital in New England and have annual revenues in excess of $100 million.

We also operate five institutional pharmacies. At the end of the third quarter, our pharmacy serviced 247 communities, about 12,200 customers and generated annual revenues of about $80 million. Even though our pharmacy business is a very small part of Five Star, like I said, it makes up about 6% of our overall revenues, it actually ranks as one of the top 10 long-term care pharmacies in the country.

These next couple of slides shows some communities that we’ve taken on in 2011. The first community, the community that we took over in Chesapeake, Virginia, it’s a 172 unit independent living community. We now have 12 independent senior living communities in Virginia with about 1050 units, having scale in areas like that to be very beneficial at Five Star. We closed on this community in the second quarter of 2011.

This is a 120 unit community, an assisted living community that we manage, located in North Carolina. In total we operate 20 communities in North Carolina with almost 1800 units. I mentioned, we closed this community in the second quarter of 2011 and this is a little bit different for us that’s when we started getting involved with managed communities and we are now a manager of communities as well.

We paid a base management fee of 3% on these properties of the revenues and then have an opportunity to earn 35% of the cash flow in excess of 8% prior return. The benefit of the management relates to the Five Star, first of all, we don’t invest any capital on that, second, we have very little down size were paid off the revenues on top side and third, we also control who the community uses for ancillary services. So if the community falls in the footprint of our rehab wellness division or our pharmacy division, we can make that change as manager and Five Star will capture all the incoming income from those changes.

This is another community right here that we are going to manage 2011 as well, it’s a 200-unit almost brand new community located in Georgia. We now operate just under 1000 units in the State of Georgia.

This is community is the community that Five Star actually acquired on our own balance sheet on May 1st, it’s located in Prescott, Arizona. It’s a high-end, beautiful private pay community that has 10 acres of land on it available for expansion. We have a number of owned communities that have that capacity.

In September, Senior Housing Properties Trust now they are acquiring nine high-end rental communities from Vi senior living. Vi was formerly known as Classic Residence by Hyatt. Five Star began to manage eight of these communities on behalf Senior Housing under long-term management agreement at the end of December. We’ll start to manage the ninth sometime during this year. The nine communities in total have 2,226 living units and are 100% private pay. All the properties are located in areas that easily fit Five Star’s existing geographic footprint.

This is one of those nine communities. As you can see it’s a beautiful 214 unit community in Boca Raton, Florida. I’d like to say [reason that it got] really high-end. The community is actually located from us 5 miles away from existing Five Star location in Florida. Today we operate 18 communities in Florida with about 3250 units.

And this last one here is another community that was formerly managed by Vi now by Five Star. It’s a 337 community located in Chevy Chase, Maryland. It’s actually located in one of congratulant golf course right outside the District of DC. We operate 11 communities in Maryland with almost 1300 units.

And now I’ll bring Paul Hoagland, our Chief Financial Officer, Paul will discuss our financials, some of our key metric and our business plans. Paul?

Paul Hoagland

Thank you, Bruce, and thank you for joining us this afternoon. I’d like to share with you some of our business strategies and some of the metrics of the company. Our strategy is really simple, is to grow occupancy, obviously, that’s a key metric within the senior living business.

As we ended the third, our overall blended occupancy was 86%, before the recession, our occupancy was as high as 92%, every one point of occupancy is worth $10 million in revenue, which approximately is probably 60% to 70% of that would flow through.

Looking at our independent living and assisted living occupancy, we’ve seen some slight improvement, third quarter we were up 30 basis points over last year same quarter and more significantly we were up 90 basis points of the second quarter.

Increasing rate, an important piece of our strategy, we continue to be able to be rewarded with good rate increases and we saw a 2.8% rate increase in Q3 and over the last nine quarters have seen rate increases in excess of 3%, which outpaces the competitive set, really we think for two reasons, reason one is, we invest heavily in our communities, we invest on average over $50 million a year in the upgrading of our facilities and secondly, we are good operators.

We also operate efficiently from the standpoint of cost controls, our G&A remains at the lowest of the industry at 4.4%, and our senior living wages and benefits, which are roughly half of our costs have seen a 130 basis point reduction over the last two years. And then our other operating expenses which are 24.9% have seen a net reduction of 40 basis points, so we’ll see details of that in a moment.

And our growth strategy to continue to grow through lease and properties with long-term leases, managing properties through the REIT structure which was just recently conceived in the second quarter of 2011.

And then lastly, purchasing properties on our own balance sheet, this past year we did two transactions on our own balance sheet for a total of $150 million, and we continue to have ample firepower on our balance sheet to continue go forward with this strategy.

Looking at the industry-wide occupancy, it is leveled off and then flat in the last few years, and basically parallel how Five Star has been operating as well. And if you look at Five Star and I think what’s important to notice here as if you look back in the year 2009, our occupancy for the four quarters averaged 86.5%, also in those four quarters our EBITDA averaged $6.5 million.

Looking at 2010, our occupancy continued to decline slightly by 100 basis points at 85.5%. But having said that, our EBITDA increased to $10.5 million and that’s not acquisition driven, that’s a function of continuing defined opportunities within our P&L, and carrying-forward into the year 2011 occupancy again at the same level, but EBITDA has increased over $11 million a quarter.

If you look at our rental growth, again, we continue to be able to be rewarded with good rate growth. The blue line represents Five Star. We have outpaced the competitive set on average.

And then looking cost controls, wages and benefits, you can see that in 2011, we’ve made a 50 basis point improvement in reduction from 2010, which was an 80 basis point reduction from the previous year. Again, focusing on labor efficiency through controls and metrics grids, as well as watching all of our benefit expenditures.

Other operating expense, although, we’ve seen a slight uptick this year, primarily in some of the insurance areas, it still over the last two year has been net 40 basis point reduction, and we are always looking for opportunities from the standpoint of expense, be it utilities which were down year-on-year by 20 basis points, because of improvements we’ve made or even food in the face of heavy food inflation we found opportunities to actually reduce that by 10 basis point in the year 2011.

And then lastly, our overhead expenses, again, we are able to really leverage the company very efficiently at this point with very modest increments to our overhead.

If you look at the profitability of Five Star, we are perhaps one of the few that remains profitable in all the downturn and headwinds come out us with regards to occupancy. And you can see in the bottom from the standpoint of EBITDA, the EBITDA performance continues to gain momentum.

Recent financial performance third quarter, company’s revenues were $329 million versus $304 million, key drivers in that change are rate, 13 new communities that we picked up during the third quarter of 2011, as well as the managed contracts that we’ve assumed.

EBITDA relatively flat, but I would do want to add that in the third quarter of 2011 because of when acquisitions came online within the quarter, which was very deep in the third quarter, we estimate we would pick up in the incremental $1.5 million of EBITDA have those acquisitions been in the third quarter for the full quarter. You can see resulting income in EPS as well and you also can see that our shares outstanding increase as we did offering in June.

Strong balance sheet, company is very conservatively run, but still have ample firepower to go forward, we finished the quarter with $41 million of cash on our balance sheet, account receivable at $59 million, but we run 19 days outstanding. So, again, we keep tight control on that.

If you look at our liabilities, we’ve got $37 million in convertible debt, which is due in 2013 and then we’ve got $38 million of long-term debt associated with acquisitions we made in 2011. And then lastly, a $48 million bridge loan, which is due in the summer of 2012 to Senior Housing Properties Trust used to help us facilitate the acquisitions.

In closing, we feel that Five Star represents a good investment opportunity. Certainly, the supply and demand within Senior Housing, as well as the aging of America favors our model. We also feel that our abilities to operate the business very efficiently allows us to be the beneficiary of increased occupancy and flow through as the market will come back, it’s not a function of will occupancy, it’s more when occupancy comes back, and as the tide flows, we’ll certainly get our fair share of that upside.

So, with that, we’d like to throw it open to any questions that you might have for Bruce and I. Thank you.

Bruce Mackey

Have any question here or in the breakout. We’ve got about six, seven minutes here. If you don’t have question right now, we can go to the breakout room.

Question-and-Answer Session

Unidentified Analyst

(Inaudible)

Bruce Mackey

I didn’t fully, some of our increase memory services, what was the first part?

Unidentified Analyst

(Inaudible)

Bruce Mackey

Sure. I’ve mentioned in the remarks that we --- about 2000 maybe a little bit more than that right now of our assisted living units offer dimensional and memory care, we’ve actually bring, the program is called Bridge to Rediscovery, and it’s been an industry award winning program within Five Star, about 80 of our communities right now have that program in place, and we do have the ability to expand that to the number of other communities or actually grow those communities, grow those programs in our other communities. So definitely an opportunity that we have within Five Star and some of them we’ve been taking advantage over the last several years. All right.

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