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Executives

Ross Rodman - Investor Relations

Bill Doniger- Vice Chairman

Mark Schulte - Co-Chief Executive Officer

Mark Ohlendorf - Co-President and Chief Financial Officer

Analysts

Mark Biffert -Goldman Sachs

Kevin Fischbeck -Lehman Brothers

Matt Ripperger - Citigroup

Ryan Daniels - William Blair

Daniel Bernstein- Stifel Nicolaus

Jeff Ungler -Standard & Poor’s

Frank Morgan - Jefferies and Company

Brookdale Senior Living, Inc (BKD) Q3 2007 Earnings Call November 8, 1969 10:00 AM ET

Operator

Good day, and welcome to today's Brookdale Senior LivingThird Quarter Earnings Call. Today's call is being recorded.

For opening remarks and introduction, I would like to turnthe call over to Mr. Ross Rodman. Please go ahead.

Ross Roadman

Thank you, Tina. Good morning, everyone. I'd like to welcomeall of you to the third quarter 2007 earnings call for Brookdale Senior Living.Joining us today are Bill Doniger, our Vice Chairman; Mark Schulte, our Co-CEO;and Mark Ohlendorf, our Co-President and Chief Financial Officer.

Before I turn the call over to Bill, as Tina mentioned thiscall is being recorded and the reply number is 888-203-1112 from within the U.S.,or 719-457-0820 from outside the U.S.,and reference the access code 4129480, as recorded in the press release.

This call will also be available via webcast on our website,www.brookdaleliving.com. I'd also like to point out that the statements today,which are not historical, facts may be deemed forward-looking statements.Actual results may differ materially from the estimates or expectationsexpressed in those statements.

Certain other factors that cause actual results to differmaterially from Brookdale Senior Living's expectations are detailed in our SECreport. I direct you to Brookdale Senior Living's earnings release for the fullforward-looking statements.

And now, I'd like to turn the call over to Bill Doniger.Bill.

Bill Doniger

Thanks, Ross. Today, we reported CFFO of $0.43 a share, a59% increase from the third quarter 2006, reported CFFO of $0.27 a share. Froman operating perspective, we continue to exhibit really attractive growthmetrics.

Same-store NOI for the past 12 months increased 8.8% overthe same period a year earlier and same-store NOI increased 8.2% for the thirdquarter 2007 over 2006. This organic growth rate, which translates into about20%, 22% cash flow growth, underscores really the strength of our businessmodel.

Now, that being said, this year will be below ourexpectations on two fronts. As we talked about last quarter, entrance fees,while they continue to show improvement, are still going to be below ourfull-year estimates near of about $13 million bucks, which is about $0.13 ashare.

And, secondly occupancy as you see in the press release, ouroccupancy has remained flat. We had expected at the beginning of the year foroccupancy to end up at around 93%, at 91%, that 2%, I guess 1% is about $0.14 ashare. So 2% occupancy adjustment is about $0.20, $0.24, $0.25 a share.

Again, not going backwards, hanging in there pretty well,but not going forward as fast as we thought it would be at the end of the year.Why is that? Really, two reasons: Beginning in early August, as everybodyknows, recessionary fears, subprime, housing slowdown, all of the followingreally caused residents to step back with their adult children and delaydecisions to move in until they said, sell their houses. To us, this is a timingissue.

People are deciding to move into a Brookdale facility,because there is a need. What they live in their home is not appropriate, andso this is a decision that many people are making, again, because they have to.That being said, it's taking longer for people to move in, because they'rewaiting to sell their houses, and, as everybody know, that's taking longer, andin many cases people are getting less than what they had hoped for.

While it's easy to blame the market, I would say it's not a 100%of the reason for not being able to gain the occupancy that we had hoped. Someof it's our fault. We bought a lot of assets. We have a lot of integrationactivities and it's just taking longer.

Again, we're very confident we're going to get there; wejust didn't get there when we thought. That being said, we have a lot of goodthings going on, which Mark Schulte will talk about.

So how do we think about the business going forward?Actually, very optimistically, we grew 8.8% year-over-year on an unleveragedbasis this quarter in what we would think is a very, very challengingenvironment. Maybe the way to think about the business is, let's hold occupancyconstant at 91%. Let's assume entrance fees don't change from where they aretoday, again, below historical levels, and we just continue to grow at 8%unleveraged on an NOI basis. That will generate 20ish percent free cash flowgrowth over the next year.

Why do we think we continue to do that in this environment?It's pretty simple. Our residents live in our facilities, for on average aboutthree years. Every year they get 4% to 5% annual rate increases and nobodymoves out down the block over rate increases. It's not the way the businessworks. There's a service component. This is not a commodity business.

Our expenses grow at about 3.5% annually, and we operate ata 36% margin. That part of the business we feel very, very good about and we'reseeing it even in a very tough environment. Our October numbers are consistentwith that as well.

So what you have is 8% NOI growth, low 20s organic cash flowgrowth, with some material upside, as I said before. We will get back to $44million in entrance fees, another $0.13 a share. We cannot tell you when that'sgoing to happen, because we're operating in a difficult economic environment.

Occupancy, we should get to 93% occupancy here. Again, notgoing to tell you when, but that's another $0.25 a share, and last, expansions.We're doing a fair bit on the expansion, adding another level of care, veryneed-based type expansion work. Those numbers start to show up in 2009, soyou're not really going to see that in 2008, but if we billed out what webilled out, $500 million in capital, at 15% returns on asset, you get into the$0.25, $0.30 a share in earnings benefits. Again, not really showing up to 2009,but that will be there eventually.

Really, to conclude, before I turn it over to Mark Schulte,while we don't love where we are this quarter, we think we have a fantasticgrowth model and our optimism for the business remains undiminished. At thebeginning of the year or the middle of the year, people were worried aboutoverbuilding. We didn't think that's a risk. We still don't think that's arisk. Actually, in the current environment I think it even pushes out theoreticalbuilding even farther. That, the overbuilding issue, is something that if ithappens in excess capacity, that affects the long-term growth rate of thebusiness. The stuff we're talking about today we view is temporary; can't tellyou when it's going to end, but our business remains sound and robust and we'revery optimistic about where we're going prospectively

.

So with that, I'll turn it over to Mark Schulte.

Mark Schulte

Thanks, Bill. There are a few things I want to talk aboutthis morning. As Bill talked about, Brookdale's occupancy did not improve as wetargeted. Let me talk about some initiatives that we've been working on thatwe're confident will overcome some of the environmental challenges that we'reexperiencing. These initiatives are focused on not only attracting newcustomers, but also addressing the demand that already exists within ourresident population.

One of the biggest initiatives of our recent integration hasbeen to coordinate our local marketing and leverage our multiple productofferings in the same market. Internally, we call this initiative major marketmanagement, or for short we call it M3. Specifically, we now have one group incharge of marketing for all of our locations and product offerings in aparticular market where we already have a lot of units. This lets us provideprospective and existing residents with the full range-of-care options, and,particularly those needing a higher level of care, and we do this at differentBrookdale facilities in the same local region where they already live, ineffect creating a local or a regional CCRC.

By offering more options to residents who typically move toother local operators, as their acuity needs change, we are able to recapture aportion of those move outs and tap into an existing source to increaseoccupancy even in a weak economy.

Let me give you an example: We have four facilities with 542units in the Denver area that were87.5% occupied as of June 30th. We initiated the M3 effort in the third quarterin Denver, and within three months,occupancy at those facilities increased to over 98%, primarily as a result ofmarketing the higher acuity services, at these communities to the outgoingresidents from our other nearly 1,200 units in the Denverarea.

By the end of this year, we will also have completed ourbranding initiative at all Brookdale locations, so that our signage, name,advertising, collateral material, come under the Brookdale brand standardseasily identifiable for our customers, and support our M3 initiatives in all ofour major markets.

In the next few weeks, we're also going to be rolling out anew, more attractive and user friendly website that's designed to utilize thelatest technology and to maximize our search engine exposure. This is veryimportant, because the percentage of leads we generate from our website and theInternet, now exceeds the number of leads we generate by traditional offlineadvertising, like print advertising, radio, and other types of media.

Second thing I want to talk about, our expansions initiativehas also been planned to take advantage of this local CCRC concept. Our currentplan is to expand our portfolio by over 2,000 units over the next three years,with a total construction budget of roughly $500 million. You should see theaccretion to earnings begin to show up in 2009.

When we look at doing expansions, we focus on adding likeunits to existing facilities or to take advantage of excess demand or addinganother level of care in a strong market where we already are present and aredoing well. For example, we're working on a building that contains 180 assistedliving, memory care, and skilled nursing beds as an expansion near one of ourlarge independent living buildings in the Kansas Cityarea.

In total, we already have 776 units in the Kansas City area that are substantially full and will act asa referral source for the expansion. We will be translating the demand for thehigher acuity services already present in our buildings to this expansion andallow our residents to maintain the high level of care and high quality thatthey currently experience at Brookdale.

As of September 30th, we had completed five expansions with213 units, representing approximately $35 million of project costs. Expansionsopen since the first quarter, with 98 units were 82% occupied and alreadyearning an approximately 14% run rate unlevered return.

The third thing I want to talk about is our ancillaryservices. Our ancillary service revenue totaled $29 million for the quarter, up12.8% from the second quarter. Our growth expectation for ancillary services inthe third quarter was impacted by unforeseen delays and obtaining licenses andpermits to open licensed home health agencies in several markets. We have theinfrastructure and staffing in place to provide these services. The licensingdelays are slowing that rollout, which we now expect to happen in the firsthalf of 2008. And I just want to point out, this isn't an instance where forsome reason, we wouldn't qualify for a license. It's that the bureaucraticprocessing and staffing of these agencies is very low and it's just taking moretime to process them.

One last point I want to make about our business is to takea look at the demographic trends that we believe will continue to drive ourfuture growth. At Brookdale, we strongly believe that over the medium tolong-term, the needs of an aging population will cause steadily increasingdemand for senior living services, regardless of the business environment.

The senior segment of the U.S.population has been, and will continue to be, the fastest growing segment ofthe population. This growth is driven both by the aging of the baby boomers, aswell as significant increases in longevity. Life expectancy in the U.S.has increased from 47 years in 1900 to 68 years in 1950 to 78 today. The jokeis, that it won't be long before we all live to be 150, but the bad news isthat we'll spend the last 50 years in a nursing home.

Today, over 90% of our potential customers do not live insenior living facilities and it's estimated that the number of Americans over70, who need help with the activities of daily living, will grow from roughly$8.5 million in 2000, to $21 million in 2030.

And according to a study cited by the National FamilyCaregivers Association, American businesses can lose as much as $34 billionannually as a result of employee's need to care for loved ones over the age of50. And on a personal level, these family caregivers also tend to suffer highabsentee and outsized rates of emotional distress.

We believe that the improved quality and acceptance ofinstitutional senior living, as well as the inability of family caregivers, totrade work for care giving will increase the penetration of senior livingservices and, hence, Brookdale's occupancy. To this end, we've recently createdseveral new business development positions, that on a regional and nationalbasis will work with large employers and other institutions to offer elder carecounseling and referrals for their employees that are experiencing thesedifficulties.

In short, we look at these fundamentals as not only gettingstronger, but we're very excited on the prospects of Brookdale and the industryas a whole. Our fundamentals, our need-driven customers, our same-storeoperating growth, our scale, and our superior level of service will continue toserve Brookdale well over the long term.

With that, I'd like to turn things over to our ChiefFinancial Officer, Mark Ohlendorf.

Mark Ohlendorf

Brookdale's reported CFFO for the third quarter was $0.43per share. This does not reflect our recurring run rate cash flow, because itincludes expenses related to our acquisition in ancillary service initiatives.The net impact on our third quarter results of these items is approximately $0.06per share. Included in the integration and startup expenses are integration andacquisition related expenses of $4 million or $0.04 per share, which areprimarily related to systems and process integration, as well as spending onactivities to achieve Sarbox compliance at acquired locations.

And second, approximately $1.6 million or $0.02 per share oflosses and startup expenses related to our various growth initiatives. Theseinclude employees training costs for communities that we've acquired within thelast year and startup losses related to the rollout of our ancillary serviceprograms. Not included in these CFFO calculations are approximately $4.1million or $0.04 per share of amortization related to capital leases andmortgage debt. A table is included in our press release that provides thedetail of this debt and lease amortization. The net effect of all these changesis $1.6 million or approximately $0.02 per share.

Our integration activities continue to proceed on plan. InOctober, we completed the migration of the entire enterprise to commonfinancial, human resources, and purchasing systems. Virtually all of oursupport departments are now organized on a Brookdale-wide basis. In addition,we've begun to combine our field operating management structure on a geographicbasis within seven large operating divisions. This realignment of the fieldmanagement structure will organize our operations on a geographic market basis,rather than on a product basis.

A few points of clarification as you look at our operatingresults for the third quarter. In spite of the soft market that Bill spokeabout, rates in the quarter, excluding community fee deferrals, averaged$3,639, a 1.8% increase over the second quarter, or an annualized rate ofgrowth of more than 7.3%. Similarly strong revenue metrics can be seen in oursame-store results. For the 12 months ended September 2007, compared to the 12months ended September 2006, revenue grew 7.2%, while occupancy improved amodest 10 basis points between these 12-month periods. While we targetedoccupancy growth of approximately 2% this year, occupancy has been flat andaveraged 90.8% in the third quarter.

Second, we did experience some increases in our operatingcosts in the third quarter. Following a relatively temperate second quarter,utility costs increased in the third quarter by around $4.4 million over thesecond quarter to $20.9 million. This seasonal increase is driven by highersummer cooling costs and, to a lesser extent, higher energy prices. In addition,we implement annual wage adjustments for a substantial portion of our communitylevel personnel on July 1st. The impact of that wage adjustment totaledapproximately $2.9 million in the quarter.

These increases are not new to 2007, but have happened at thesame time historically as well. However, with no increase in occupancy, higherutility costs and the modestly higher labor costs, the combined effect has beento lower facility operating income on a sequential quarter basis.

Third, our net entrance fees for the quarter were $9.3million. This consists of $14.4 million of gross entry fee sales, and $5.1million of entry fee refunds. You'll see that we've added some tables in the10-Q this quarter that add some further historical detail on our entry fee results.

And finally, on the liquidity front, we believe that we'rewell capitalized to execute our business plan over the next two years. As oftoday, we have approximately $187 million of undrawn capacity on our corporateline, together with $39 million worth of cash, gives us total liquidity of $226million. That capital, plus expected financings, should satisfy most of ourcapital needs over the next two years. We current estimate that assuming wecomplete all budgeted expansions and refinancings, we may need to raise in therange of $50 million towards the second half of 2009.

I'll now turn it over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is from MarkBiffert of Goldman Sachs. Please proceed with your question.

Mark Biffert - Goldman Sachs

Hi, guys. Thanks for the color, Mark, on the utility costs.Another question I have is, of that utilities expense: how much of that do youexpect to be recurring, given that we're coming into the winter season andyou're going to have additional heating costs as well?

Mark Ohlendorf

Yes. On a historical basis, our higher utility cost quartersare the third quarter, because of cooling costs and the first quarter becauseof heating costs. And then the cost moderates somewhat in the other twoquarters.

Mark Biffert -Goldman Sachs

Okay. Andwhen you look at the entrance fees going forward, last quarter you guys hadmentioned that you had deposits of about $4 million. I guess my first question is:how much of that $4 million was part of the $14 million you signed and thencurrently, what do you have in terms of deposits going into the next quarter?

Mark Ohlendorf

The rollover activity is not some data we've got on right infront of us here right now. The $5 million in October, I think, the volume ofthis activity is relatively consistent with where we were at through the thirdquarter, perhaps up just a touch. Again, the cycle of closing houses in marketstends to be expanding right now. So, looking at those deposit levels, even overan immediate 90-day period may be a little bit too short.

Mark Biffert -Goldman Sachs

Okay. Andback to the rent growth. You guys have talked about 5% to 6% in terms of rentgrowth. Do you think that given the occupancy's been relatively flat, thatyou're going to be able to continue to push rents as we look into '08?

Mark Ohlendorf

Yes.

Mark Biffert -Goldman Sachs

Okay. The next question is related to the ancillary revenuesbusiness. I noted that the ACR portfolio, the average income per unit droppedfrom 195 to 183. Can you provide any color on that?

Mark Ohlendorf

There was a slight decline in the quarter in the Part A expensesin the SNFs on the CCRCs. So, it's primarily a volume driven change quarter-to-quarter.

Mark Biffert - Goldman Sachs

So, is that [180] a better number to use to measure incomefrom there?

Mark Ohlendorf

Well, again, we're forecasting as we roll this business out,in the range of $150 a unit.

Mark Biffert -Goldman Sachs

Okay.

Mark Ohlendorf

You know, this clearly will move a little bit fromquarter-to-quarter.

Mark Biffert -Goldman Sachs

Okay. Andso, in regards to the additional items that or units that you expect to bringonline for building up ancillary revenues through your Brookdale legacyportfolio: what do you expect over the remainder of the year in terms of unitsbuilt out or having exposure to that?

Mark Ohlendorf

In terms of: continuing to roll this out in the fourthquarter?

Mark Biffert -Goldman Sachs

Yes.

Mark Ohlendorf

The rollout plan in the fourth quarter is relatively modest,a few hundred additional units. As you know, we're well ahead of the initialplan we had for this year. So, the focus right now is on stabilizing theoperations that we've reached.

Mark Biffert -Goldman Sachs

Okay. Andlastly, Bill, if you could, last quarter you kind of went through your math tocome up with a recurring run rate for your cash net income or cash fromfacility operations. Can you kind of go through that now, given that you'veseen the increase in operating expenses and to where you think that run rateis?

Bill Doniger

Yes. The way I would try to answer that is, we would notexpect a whole lot of growth in the fourth quarter, because our run rate orwhere we thought we were getting to, as I mentioned, on an occupancy basis, wasroughly 93%. We're staying closer to 91%. The way our business is run, we've grownour occupancy over the end of the year. And so I don't think it's really anexpense issue. It's really just an assumption about occupancy and entrancefees, which I told you we kind of view as staying relatively flat.

What you see, though, will be, for instance, our assistedliving business at markets jump in on this; changed where we raised all of theresident rates at the first of the year. So, the big rate increase that willmove the numbers materially will be at January, unlike the independent livingbusiness, where rates kind of grow annually based upon when people move in.

And that bit of change will basically push the growth intothe first quarter versus the fourth quarter. Again, the difference from what wetalked about in the summer was really an occupancy based assumption, whichgiven the markets we just are not too optimistic about this part of the year.

Mark Biffert - Goldman Sachs

So, as we look at your run rate, it's going to come in alittle bit shy of a $2 dividend that you guys are paying. How does it affectyour decision, the Board's decision, on future dividend growth?

Bill Doniger

Sure. That's a good question. And we obviously have a couplehundred million dollars in liquidity. If you look at our payout ratio, sincewe've gone public, it has come down almost every quarter. And so we're probablyat the lowest payout ratio that we've ever been.

We've always been forward looking. The reason for that hasbeen we've been buying a lot of things; as we bought less, because we don'treally need to buy anything at this point to create what we think is prettyattractive growth. We obviously are going to be more conservative, if you will,in terms of dividend increases relative to what we think the kind of currentgrowth is and prospective growth. So, the payout ratio has gotten a lot tighterand I would expect it to continue that way. As to more specific than that,obviously, that's a Board decision.

Mark Biffert -Goldman Sachs

Okay. Thanksagain.

Operator

Our next question is from Kevin Fischbeck of LehmanBrothers. Please proceed with your question.

Kevin Fischbeck - Lehman Brothers

Okay. Thank you. Good morning. I wanted to clarify a coupleof the metrics that you provided. The same-store revenue growth in the actualquarter of 6.3 and operating income of 8.2, those numbers include the ancillaryservices; is that correct?

Mark Ohlendorf

That's correct.

Kevin Fischbeck - Lehman Brothers

Okay. And does it include the startup losses from ancillaryservices on the NOI?

Mark Ohlendorf

Yes, it would.

Kevin Fischbeck - Lehman Brothers

Okay. All right. And you talked a little bit about the financingtransactions that you completed in the quarter and then I guess subsequent tothe quarter. The numbers that you gave about the 187 of undrawn capacity, ifthere's $9 million in cash, is that after the most recent transaction closed inthe quarter?

Mark Ohlendorf

It is. That's actually at the close of business yesterday.

Kevin Fischbeck - Lehman Brothers

Okay. And so the point is, I just want to clarify, I thinkyou said that you feel comfortable about your finance position for the next twoyears, potentially second half of '09, was…?

Bill Doniger

Yes. Kevin, it's Bill. I mean, basically, if you think aboutour business, we finance our assets at, I don't know 60% leverage and we growunleveraged at 8%. So, we deleverage on an asset basis relatively quickly. givenour stock prices, we don't really feel like issuing equity.

So, what we do is we refinance assets and use that to payoff our line, which is being used basically to fund expansions. And so, if wejust run out kind of a stabilized number on our portfolio and assume assetsthat are not prohibited from being refinanced, get refinanced, it's not a lot.We just use that to basically pay down our line.

And at the end of, we said kind of the second half of '09,is when we theoretically have about 50 million; it could be zero, frankly, butjust using mathematical numbers and assumptions that's where we get to. And theline we view is kind of a bridge to our equity. But that's really the plan.

Kevin Fischbeck - Lehman Brothers

Okay. And then, I guess, one other clarification: the 20%organic growth that would include the ancillary service rollout?

Bill Doniger

That's correct.

Kevin Fischbeck - Lehman Brothers

Okay. The other thing that I want to go over clarity on itseems like, obviously, you're not doing the same size deals you have lastcouple years, but you have announced a couple deals in the last quarter or so.What are you seeing there about the acquisition environment? How are prices? Andwhat are you looking for over the next 12 months?

Bill Doniger

Again, I think the story in terms of prices is that my guessis prices are going in the direction of a buyer versus a seller, but we're notthat focused actually on acquisitions. Again, if we can grow, we -- I don'tknow. Where we're trading today on a free cash flow basis, it's roughly in a5-plus percent current free cash flow yield. If we can grow organically, whichwe believe we can, at 20-ish percent, we talk about the total return, 25% area.

We're a pretty big company. And so, these small acquisitionsare a lot of work. They just don't move the meter nearly as much as justfilling up the beds that we want to fill up and doing our expansions. So, we'renot even looking at acquisitions, primarily for that reason. We just don't needto do them to create pretty good growth. That's really the answer to thequestion.

Kevin Fischbeck -Lehman Brothers

Okay, great. Thanks.

Operator

Our next question comes from Matt Ripperger of Citigroup.Please proceed with your question.

Matt Ripperger -Citigroup

Hi. Thanks very much. A couple of questions: On the CapExfront: can you give a little more detail about the EBITDA enhancing CapEx,which is $20 million in the quarter? And what specifically is that capitalgoing towards? And, when we think about projecting that forward, what kind oftrend should we assume?

Mark Ohlendorf

Generally, what's going to be in that line, Matt, are twogroups of projects. One group of projects is the capital projects that we'redoing to improve acquired locations. So, I think as we've discussed before,when we underwrite an acquisition, we often underwrite as part of our effectivecost of the deal, doing some capital spending to reposition the property. Sothat's one piece of this.

And given the volume of acquisitions that occurred in '06, afair amount of this activity is occurring.

The second group of this relates to doing major projectswithin the existing portfolio to reposition those assets. Now, that doesn'thappen quite as frequently as it does with the acquired locations, but it doeshappen in the existing portfolio as well. Obviously, we generally wouldn'tinvest this capital unless we see a yield, which is why we refer to it in thatway.

Matt Ripperger -Citigroup

Given that your acquisition pace is decelerating relative to'06, is it fair to assume that your EBITDA enhancing CapEx will materiallydecline in '08?

Mark Ohlendorf

It clearly will decline as we go through '08.

Matt Ripperger -Citigroup

And the EBITDA enhancing CapEx is consistent with what yourexpectations were when you bought these assets in '06?

Mark Ohlendorf

Yes, it is. That the one thing that's probably a littledifferent is, just given the magnitude of acquisition work that was done in'06, it's taking us a little longer to complete the projects than we wouldlike.

Matt Ripperger -Citigroup

Is there any one or two portfolios of properties where themajority of this EBITDA enhancing CapEx is being allocated?

Mark Ohlendorf

I would say not. It's probably spread across a number of theacquisitions. Obviously, the acquisitions that include assets that are older,were built 12 or 15 years ago, as opposed to five years ago, are going to getmore of this capital.

Matt Ripperger -Citigroup

And there's the ACR portfolio, given the newness of thoseproperties is probably not getting much of it.

Mark Ohlendorf

Correct.

Matt Ripperger -Citigroup

Okay. The second question is: on the ancillary business, yousaid $29 million in revenues this quarter, and you gave the monthly NOI for thelegacy ACR units. Can you give a sense of where you are in terms of thebreakout between revenues for home health versus rehab? And where you are interms of revenue per unit or NOI per unit for the Brookdale, Legacy Brookdaleunits? And how that is projected to ramp up going forward?

Mark Ohlendorf

We can. Yes. On the ARC side, just to give you a sense ofthe distribution in the NOI, of the 183 of monthly NOI, about 33 of that comesout of home health in terms of that delivery system, the balance out oftherapy. Were you asking about the ramp up in the Brookdale units and howthat's…

Matt Ripperger -Citigroup

Yes. Are the Legacy Brookdale units generating positive NOIon the ancillary business yet?

Mark Ohlendorf

Well, when we look at the clinics that have been in place,let's say a year, so they've been in place a meaningful period of time, I thinkthe business is tracking where we would have expected. I think where we're atright now, that first year average is in the mid-50s, from an NOI standpoint,and the run rate today is in the low 70s, from an NOI standpoint.

The delay in getting licensure in some of the home healthagencies is slowing us down a little bit, because particularly, as we get tothe more geographically dispersed Brookdale locations, and in many cases thatwill be the free-standing assisted living. I think, the experience is, homehealth will be a more viable delivery model there. But I think the performancearea is pretty much in line with the expectations we had.

Matt Ripperger -Citigroup

And what's the NOI margin at the ACR facilities perancillary?

Mark Ohlendorf

I believe, low 30s, right now. Well, overall, it's mid-30s,I believe, excuse me.

Matt Ripperger -Citigroup

Okay.

Mark Ohlendorf

Yes. Call it 32%, 33%.

Matt Ripperger -Citigroup

And in the past you've given a little color about specificregions where you were seeing pockets of weakness, Florida,Arizona, etcetera. Is there anyelaboration you could provide on what you're seeing locally?

Mark Ohlendorf

You're talking about senior housing occupancy?

Matt Ripperger -Citigroup

Yes, senior housing occupancy in demand trends.

Mark Ohlendorf

I'm not sure, Mark, that we would spot any significanttrends from what we -- differences in the trends from what we have said before.

Mark Schulte

Yes. I think that generally, the markets we talked aboutbefore, obviously the Phoenix areawhere we have large CCRC presence and some parts of Florida,but it's very difficulty to tar a whole geographic area. I mean, we haveproperties that are doing extraordinarily well in Florida,and some that are more affected by weak housing markets.

So geographically, we're -- I can't really generalize andsay one region of the country is worse than another.

Matt Ripperger -Citigroup

Okay. And what was the $43 million expense related to changein fair value of derivative. What was that related to?

Mark Ohlendorf

Well, again, we do not match our hedges. We do not try toqualify for matched hedge accounting. So that is simply the change in the valueof the hedges in the quarter. It's a non-cash item, but as interest ratesdeclined in the quarter, that's the accounting impact, the non-cash impact ofthose hedges, to mark-to-market, essentially.

Matt Ripperger -Citigroup

Okay. And then the last question I had is: in the entrancefee business, which did show a sequential improvement, does that include thepresale of the village units?

Mark Ohlendorf

That does not.

Matt Ripperger -Citigroup

And how is the presale of that community going?

Mark Ohlendorf

It's going well. I think we're roughly 60% pre-sold in thatproject right now.

Matt Ripperger -Citigroup

And you still have not begun construction?

Mark Ohlendorf

We have not.

Matt Ripperger -Citigroup

Okay. Thank you.

Operator

Our next question comes from Ryan Daniels of William Blair.Please proceed with your question.

Ryan Daniels -William Blair

Yes. Good morning, guys. I had a couple of quick,housekeeping-oriented, questions up front. First off: earlier in the year, youguided towards the integration and startup expenses of about $25 million. And,if my math is right, it looks like you're at $18 million year-to-date. So I'mcurious: if you anticipate that, that cost is going to spike up in the fourthquarter, or if you're just a little bit lower on a run rate basis, and Q4should be stable with Q3?

Mark Ohlendorf

Well, you're adding together both the capital and theoperating piece of this I take it, to get to your number?

Ryan Daniels - William Blair

Yes.

Mark Ohlendorf

I think in the fourth quarter, the operating piece is likelyto go up, because we're much more in the implementation mode, and the capitalpiece will come down somewhat. We are likely to be under the $25 million numberin 2007 standalone.

Ryan Daniels - William Blair

Okay. And then if we look forward to 2008, I know you guysprobably don't want to give a lot of numbers on that right now, but what mightthat look like as we go into '08? Should that continue to trail off throughoutthe year or will that just stabilize it at some point and run through theentire year at a given level?

Mark Ohlendorf

Well, it clearly should trail off as we go through 2008.

Ryan Daniels - William Blair

Okay. And then, I appreciate all the color on the drop in thefacility operating income margins due to the labor and the utility costs,that's very helpful, can you comment on how much of that was offset during thequarter by some of the cost savings you've talked about?

I think you had identified about $4 million in cost savings inlast quarter that you hope to achieve in the back end of the year. Have we seenthe impact of that or is a lot of that still going to be seen in the comingquarter or two?

Mark Ohlendorf

I think, obviously, the $4 million number that we hadprovided was an estimate at that point.

Ryan Daniels - William Blair

Yes.

Mark Ohlendorf

I think we have seen the lion share of that come into thenumbers in the third quarter.

Ryan Daniels - William Blair

Okay. And given that that was an estimate, was it similar tothe $4 million, a little bit lower, higher? Any…

Mark Ohlendorf

It was a little bit lower, would be the experience.

Ryan Daniels - William Blair

Okay. And then this is more of a philosophical question, Iguess you guys have hit on this a few times Bill did, in talking about thedividend payment. But: do you consider one of the ways to create value here,putting in revenue or EBITDA enhancing capital in the facilities and then,longer term, recapitalizing those and cashing out on some of that investment?

How do you look at that in terms of using thatrecapitalization to pay a dividend, maybe above CFFO, versus using that cash toreinvest in new developments or other facilities, just how you guys thinkinternally about that?

Mark Schulte

I think the way, I think to answer your question is, wespend capital to -- we bought assets, a fair number of assets we acquired were,we'll call them 87% occupied, little deferred capital, charging below marketrates because they don't look as nice as stuff in town. So we madeacquisitions. We assumed we put more capital in and then, obviously improvesthe quality of the asset; it should be able to charge more and get more peopleto show up, which will grow NOI.

And so, we do refinancings to once we get access tostabilized financing, we refinance the assets that will take excess proceedsout. As I mentioned, we're using capital now basically to fund expansions. Andthat's what basically we could do it two ways. We can issue equity, which wedon't really feel like doing.

Ryan Daniels - William Blair

All right.

Mark Schulte

Or we could basically use these under-leveraged assets as away to finance those, and that is our plan.

Ryan Daniels - William Blair

Okay. That helps clarify it. And then two more quick ones,then I'll hop off. First off: on the with the ancillary services kind of beingrolled out across your network, are you guys seeing any trends and thatactually helping the health of residents, and, in turn, increasing the lengthof stay? And, in longer term: do you think that's something that could alsoboost your occupancy, as well as some of the three initiatives you laid out atthe start of the call?

Mark Schulte

Yes. I think I made that point before, but a lot of theseancillary services aren't just simply reactive, like after someone fell andbroke their hip, and they're proactive to try to keep people from falling or ifthey're experiencing, in that example, balance problems, we can make it, sothere isn't a fall.

So, yes, I mean that, we're not really able to quantify itat this point, but we would expect that length of stay, for a number ofresidents, it's going to be increased due to the availability of the therapyservices.

Ryan Daniels - William Blair

Okay, great. And then the last one is just on the licensingdelays: You have probably looked at this, but is there potential where you runinto delays in the future to acquire maybe a smaller operator at a fairly cheapinvestment rate if you will, to get a license from them, and then roll that outmore quickly? Is that something you would consider?

Mark Ohlendorf

Excellent question! Yes, it is. We actually have madeacquisitions of home health in Floridaalready, which, as you know, it's kind of a monopolistic market for those kindof permits.

Ryan Daniels - William Blair

Right.

Mark Ohlendorf

And we are, as you said, looking at that in other marketsnow as well.

Ryan Daniels - William Blair

Okay, great. Thanks again, guys.

Operator

Our next question comes from Daniel Bernstein of StifelNicolaus. Please proceed with your question.

Daniel Bernstein - Stifel Nicolaus

Good morning, gentlemen. When I'm computing average occupiedunits, just taking the average rate for the quarter and the number of units inthe quarter, I get an average occupied units was down just a little bit from Q2did you take any units offline for the EBITDA enhancing CapEx or expansion?

Mark Ohlendorf

We did not. If you're using the units in service that's offthe table in the press release and trying to tie that back in to the averagerates, there's actually 920 units included in the CCRC total, that are equityhomes. So we actually take those out of the total when we calculate the averagerate. I'd suspect that may be the difference in your math there.

DanielBernstein - Stifel Nicolaus

Okay. Andin the cash flow statement, there was a change in future service costs that wasan add-back, just trying to figure out what that was and if that was and wherethat would be in the income statement?

Mark Ohlendorf

It's actually not in the income statement. It's a technicalchange in the valuation of those reserves. This is very inside baseball. It wastriggered by the refinancing of a CCRC.

Daniel Bernstein - Stifel Nicolaus

So it's not in the CFFO or anything like that?

Mark Ohlendorf

It's not. Part of the future service obligation calculationfor a CCRC is effectively based on the book value of the asset and the impliedfinancing around an asset, and we had a refinancing of a CCRC in the quarter.

Daniel Bernstein - Stifel Nicolaus

All my other questions were answered. Thank you.

Operator

Our next question comes from Jeff [Ungler] of Standard andPoor's. Please proceed with your question.

Jeff Ungler - Standard & Poor’s

Good morning. Just one quick question: Assuming theoccupancy and efficacy to stay at the current levels for a prolonged period, atwhat point would you consider scaling back the rollout of the ancillaryservices, assuming you get the licensing issues worked out?

Mark Ohlendorf

We would not. We see the ancillary service business as atremendous revenue opportunity, which I think it's proven itself out. I mean,the two really aren't connected, whether it's -- in fact the ancillary serviceand availability actually enhances occupancy and marketability of theseproperties.

Jeff Ungler - Standard & Poor’s

Okay, great. Thanks very much.

Operator

Our next question comes from Frank Morgan of Jefferies andCompany. Please proceed with your question.

Frank Morgan - Jefferies and Company

Good morning. First question relates to the regulatorydelays: Could you specifically tell us what markets you're seeing those or whatstates you're seeing those delays in?

Mark Ohlendorf

I think the primary markets that we're working through now areArizona, Texas-- Arizona and TexasI believe are the larger scale markets.

Frank Morgan - Jefferies and Company

Where you're experiencing the regulatory delays?

Mark Ohlendorf

Yes. These are cases where we have applied for the licensesand permits and the regulatory approval process has been drawn out.

Frank Morgan - Jefferies and Company

Okay.

Mark Schulte

They're either delaying the processing of the application orthe inspections. Some of this should get a little more granular is more tied toa lot of these state budgets that have cut back their staffing that does theselicensing applications. So, the work is really piling up for the few peoplethat are there.

Frank Morgan - Jefferies and Company

Okay. On the subject of ancillaries, I think Mark orsomebody answered a question talking about the impact of part A on theancillary growth. Could you elaborate on that? I didn't quite catch that.

Mark Ohlendorf

It wasn't really on the ancillary growth, Frank. If you lookinside the ARC legacy portfolio, the NOI per unit from ancillary has changedfrom roughly 190 a unit last quarter to roughly 180 a unit this quarter. And itwas an answer to that question.

Frank Morgan - Jefferies and Company

But I thought most of this was part B business. I mean, is yourpart A business you're doing for nursing homes in local markets that getsrolled into that number?

Mark Ohlendorf

No, no. Our owned SNFS on our CCRCs, that's our ownoperation, deliver ancillary services, and the delivery mechanism is our ownedtherapy company.

Frank Morgan - Jefferies and Company

Okay. So, you're delivering part, you're delivering to yourown contract to your own patient, you're delivering therapy services to peoplewho are part A patients?

Mark Ohlendorf

That's right. And because that's such an intensive therapyregiment, when the part A census drops a bit, it does impact that per unitnumber.

Frank Morgan - Jefferies and Company

Okay. Alright, so: part A census to your own. Okay. Alright,and I was wondering: could you quantify the earnings drag related to the newdevelopment openings? I mean, it sounds like maybe there isn't that much ofone, because they're already at 83%, but: how big a number is the drag from thenew openings on the expansions? And: is there any drag that's associated withtherapy staff that you have that you may not be able to bill yet because of allthese delays?

Mark Ohlendorf

Well, the answer to the first question in terms of the netimpact of the expansions, there is a negligible impact on earnings in thequarter for those expansions that are open right now.

Frank Morgan - Jefferies and Company

Okay.

Mark Ohlendorf

Second question related to the therapy services: Therapy orhome health was your question?

Frank Morgan - Jefferies and Company

I guess the delay related to home healthcare, so homehealth.

Mark Ohlendorf

Yes, there's kind of a holding cost of $10,000 to $20,000 amonth per location per agency, as those agencies sit in waiting for theirlicenses. Obviously, the bigger impact here is, we are not getting to the rampup of profitability after they open, which is substantially greater than$10,000 or $20,000 a month.

Frank Morgan - Jefferies and Company

And remind me: what is causing that delay in the ramp up?

Mark Ohlendorf

The delay in the ramp up is because we do not yet have ourpermits to operate.

Frank Morgan - Jefferies and Company

Okay. It's not one that's already open. Once it opens andthe delay from the time you get opened and licensed until you get to yournormal optimal performance, that's not being delayed?

Mark Ohlendorf

Correct.

Frank Morgan - Jefferies and Company

Okay. And then finally: just this is more and more philosophical.Somebody asked this question earlier. They asked about: do you think you canraise rates in a flat occupancy environment? And your answer was: “yes”. Couldyou elaborate on the “yes” part?

Mark Ohlendorf

I guess I'm not sure how to elaborate on it, other than tosay that as we run the business every day, that's what happens with our rates.

Mark Schulte

Generally, there's a large segment that are on annualagreements. If those agreements turn over, we give those people a 46% increase.The assisted living, which is on a month-to-month, we continued like all of theother operators to see good rate growth, and the ability to attract newcustomers or whatever, doesn't really necessarily affect what people arecharging in any given market.

Frank Morgan - Jefferies and Company

Okay. Last one and I'll hop off. Just kind of where werethings at the end of the quarter in terms of, like say in the month ofSeptember, with regard to occupancy and just basic operating trends? And howmuch of that would maybe carry over into the fourth? Thanks.

Mark Ohlendorf

Sure. Well, actually, let me fast-forward a month, becausewe've been looking at October results. The trends are modestly positive, Iguess you would say. Occupancy is clearly holding to growing a little bit,particularly on the assisted living side. No meteoric changes, but things areclearly firm to slightly up.

Bill Doniger

With that, we'll close. We appreciate your participation andwe'll be around for follow-up questions. Thank you very much.

Operator

This concludes the conference call. Thank you everyone forjoining. You may now disconnect.

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Source: Brookdale Senior Living Q3 2007 Earnings Call Transcript
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