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Executives

Timothy Bonang - Vice President, Investor Relations

Bruce Mackey - President and Chief Executive Officer

Paul Hoagland - Treasurer and Chief Financial Officer

Analysts

Daniel Burnstein - Stifel, Nicolaus & Company

Five Star Quality Care, Inc. (FVE) Q1 2012 Earnings Conference Call April 30, 2012 10:00 AM ET

Operator

Good day and welcome to the Five Star Quality Care First Quarter Conference Call. This call is being recorded.

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

Timothy Bonang

Thank you, and good morning, everyone. Joining me on today’s call are Bruce Mackey, Five Star’s President and CEO, and Paul Hoagland, Five Star’s Treasurer and CFO.

The agenda for today’s call includes a presentation by management followed by a question-and-answer session. I would also note that the recording and retransmission of today’s conference call is strictly prohibited without prior written consent of Five Star.

Before we begin, 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 other securities laws. These forward-looking statements are based on Five Star’s present beliefs and expectations as of today, April 30, 2012. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today’s conference call other than through filings with the Securities and Exchange Commission regarding this reporting period.

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

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

Bruce Mackey

Great. Thank you, Tim and thank you everyone for joining us today on our 2012 first quarter earnings call. For the quarter ended March 31, 2012 we reported our 13th consecutive quarter of profitability with net income from continuing operations of $0.02 per basic share and diluted share. Included in our results for the quarter were $500,000 of non-recurring legal expenses which Paul will discuss during his prepared remarks.

Total company revenues were up 12.5% to $346 million and EBITDA was approximately $9 million. 87% of our total company revenues come from our senior living business and 75% of those revenues are derived from residents, private resources.

In the beginning of April we announced that we had closed on a new $150 million revolving credit facility, secured by 15 of our owned communities with 1549 units. Drawings under the facility will be an interest at LIBOR plus a spread of 250 basis points. This is in addition to the current $35 million credit facility we have that matures early next year. The benefit of this new facility is twofold, first, it provides us with much greater financial flexibility and second, it signals to the market and investors the quality of our balance sheet and the value of our owned communities. These 15 communities which were valued by a third party appraiser at $230 million are worth significantly more on a per unit basis than what we pay for them. We own an additional 12 senior living communities with 840 units that are unencumbered by debt. The credit facility is led by Citibank and RBC and has nine participating institutions.

Upon closing, we borrowed $47.5 million for the new facility for two purposes. First, to help repay in full the $38 million bridge loan we had outstanding with senior living properties trust and second to purchase $12.4 million of our convertible senior notes. We purchased these notes at a 3% discount to par and will recognize this gain in the second quarter. We used approximately $3 million of our cash on hand as well.

Compared to last year, our asset pipeline has been relatively slow. As we haven’t seen many opportunities that fit our acquisition strategy which to remind you is focused on stabilized, well run, private pay senior living communities in areas where we have a geographic strength of operations. We will continue to be judicious in our approach to acquisitions and expect to see more opportunities throughout the rest of the year.

With that being said, we don’t have much new acquisition activity to report now. But let me briefly update you on where we stand in terms of previously announced activity. In February, we began to manage a 92-unit senior living community in Alabama which was disclosed on our last earnings call. In March, we began to manage a 252-unit senior living community in South Carolina, which is the last community we have left to manage as part of the large well senior living portfolio. We had two additional communities that we expect to manage during the year. The first, which we have previously disclosed is the last we [ph] senior living community out of the eight we are currently managing with 310 units located in New York that we expect to even begin managing during the second half of the year. The second is an 87-unit senior living community located in Missouri that we expect to begin to manage on behalf of senior housing by the end of the second quarter.

Now I will review some highlights on the quarter. Total senior living occupancy was up slightly on a year-over-year basis but down on a sequential basis. Total senior living occupancy was 85.9%, up 30 basis points from last year but down 30 basis points from last quarter. Overall, same-store occupancy at 85.6% was flat with last year and down 30 basis points from last quarter.

During the quarter, some of our communities experienced the outbreak of the Norwalk virus which clearly impacted occupancy numbers as in normal seasonality. Like we have discussed in prior years, the first quarter tends to be the weakest with regards to occupancy. As of last Friday senior living occupancy was 85.8%.

Recent industry data published by the National Investment Center for the seniors, housing and care industry or NIC showed an increase in sequential and year-over-year occupancy. They noted that this is the eight consecutive quarterly increase in occupancy for the industry. However, they also note that skilled nursing occupancy has been declining for several years and we have certainly experienced a similar trend in that business. Like the industry data shows and as to our results over the last two years show occupancy is on a slow by steady recovery. We do expect this to continue into the rest of 2012 and beyond. The upside potential for the industry and Five Star continues to be compelling.

Taking a look at some of our same-store sales metrics, we had about 5000 admissions during the quarter, which is slightly lower than last year but was offset by huge discharges, all of this mainly driven by skilled nursing. We experienced net positive admissions sequentially driven by skilled nursing as well. Our independent and assisted living admissions and discharges have remained relatively consistent during both periods.

Average daily rate declined 3.8% compared to last year but was up slightly from last quarter. Year-over-year results include the skilled nursing Medicare cuts that went into effect in October 2011. The decline in our rates is mainly due to this loss of revenue. At our private pay independent and assisted living communities, we plan to push rates between 3% and 4% this year which is consistent with last year.

Last quarter we told you about our partnership with Salesforce.com. We are still in the process of implementing our new sales tracking and reporting platform across the company but we now have over 75% of our communities using Salesforce.com, up from 25% last quarter and we still expect to have all of our communities on the system by the end of the second quarter. Also the rollout of our new sales training initiative with cooperate level sales trainees to teach the Five Star way at the community level is almost complete. For the last four months we have trained approximately 450 sales counsels and executive directors. We have also developed program to help ensure this training will be ongoing as well.

Our senior living business continues to perform well. In the first quarter we produced $72 million of EBITDA, this is up from the $70 million of EBITDA we recorded for the first quarter last year and the $71.3 million we reported last quarter.

Moving on to our ancillary businesses. Our relocation hospitals which account for 8% of total revenues generated $2.7 million of EBITDA during the quarter, which is approximately a $1 million increase from last year. Our low inpatient satellite unit opened last week to rate reviews. As an effort taken a few years to accomplish, we are very excited to be in our new location. We have several other initiatives underway to help improve our hospital margins. We have just begun to renovate our traumatic brain injury unit at our Braintree hospital and we are also exploring the possibility of putting in a transitional care unit into our (inaudible) hospital. These efforts are in their early stages and we don’t anticipate completion until sometime in 2013.

The institutional pharmacy operations would make up 5% of total revenues had a disappointing first quarter, losing $129,000 on an EBITDA basis. This is down significantly from $448,000 of EBITDA produced last year and the $357,000 made last quarter. Gross margins were down 9.6% from last year mainly due to the fact that we have a number of drugs that we purchased at brunt prices that were reimbursed at a generic rate. We do expect this to improve going forward.

While our pharmacies financial results are disappointing there are some positives to focus on. First, we had almost 12,700 customers at quarter end, which is the highest number we have ever seen. Second, we did a great job of controlling all other expenses, which were down slightly from last quarter. And last, we are in the process of renegotiating our wholesale provider agreement and expect substantial savings when that is completed sometime during the second quarter.

The first quarter had some very positive developments for our company. First, we confirmed that our owned properties which are on the books for $350 million are well understated from their current fair market value. Second, we greatly increased our financial flexibility by adding $150 million credit facility. And third, our strategy of acquiring private pay communities proved to be successful and largely made up most of the lost EBITDA from the Medicare rate cuts. We are also taking some additional cost cutting measures which Paul will get into in a minute to help to further improve our performance. The most important thing we focus on every day is work on occupancy increases that will bring additional revenues, the majority of which will flow through our bottom line.

At this point, I would give the call over to Paul Hoagland, our Chief Financial Officer.

Paul Hoagland

Thank you, Bruce and good morning everyone and thank you for joining us today. I will now review our year-over-year quarterly financial results for the first quarter of 2012. Senior living revenues were $276 million, up 5.2%. This increase was due primarily to the revenues from 13 communities we acquired or leased since last year which contributed approximately $13 million of revenue. Management fee revenues, which are revenues from the 25 senior living communities we manage were $1.1 million for the quarter and in line with our expectations. We expect to earn $5.5 million in management fees annually from the properties that we currently operate and are scheduled to close on during the year.

Senior living wages and benefits $138 million, or 6.6% increase from last year. $4.2 million of this increase was from the 13 communities we acquired or leased since last year. Total senior living wages and benefits were 50.1% of senior living revenues, an increase of 70 basis points. 30 basis points of this increase was due to labor cost increases and partially attributable to overtime costs associated with the Norwalk virus that some of our communities experienced early in the quarter. 20 basis points was due to an increases in state unemployment insurance taxes and another 20 basis points was due to an increase in employee health benefit expense. However, on a sequential basis, employee health benefit expense was down from the fourth quarter by 40 basis points.

Other senior living operating expenses were $67 million, up 6.3% and represented 24.2% of senior living revenues, a 20 basis point increase from last year. The main drivers of this increase were as follows: $3.2 million from the new communities we acquired or leased since last year, a $700,000 increase in property insurance, a $500,000 increase in market cost, and last $450,000 increase in bed provider fees which were partially reimbursed from Medicaid. Utility expenses were down 20 basis points from last year. However, sequentially it was up 50 basis points due to the normal and anticipated seasonality of utilities.

Turning to our ancillary businesses. Our rehabilitation hospitals generated $2.7 million of EBITDA, which is a 70% improvement over last year. Total hospital revenues were $27 million, up 4.5% compared to last year, primarily due to the higher quality patient case mix. Occupancy for the quarter was 60.4%, a 40 basis point decline from last year and 100 basis point decline from the last quarter. Our institutional pharmacy operations generated $19 million of revenues, down 3.7% from last year. We lost a total of $129,000 of EBITDA during the quarter. We experienced an unfavourable cost of goods sold margin resulting from the continued migration from branded to generic scripts which we do expect to improve during the second quarter. We serviced approximately 12,700 beds at quarter’s end.

Now moving on to other income statement items. General and administrative expenses during the quarter were $15.5 million, up 13% from last year and represented 4.5% of total GAAP revenues. As previously mentioned, our external legal expenses for the quarter were $500,000 higher than in the previous year and associated with one-time non-recurring legal matters. Adjusted for actionable revenues from our managed communities, our G&A was 4.3% for the quarter. Rent expense was $50 million, up 5.7% mainly due to approximately $2 million of additional rent from the six communities we begin to lease during the year. The provision for income tax is $600,000 which is an overall increase as a result of the elimination of our tax evaluation allowance last quarter. Our cash tax rate remains at approximately 11%. Interest expense was $1.4 million, and depreciation and amortization was 6.3 million. All of these items were in line with our expectations and as a result of our growth during 2011.

Now, I would like to review our liquidity, cash flows, and selective balance sheet items. Operating cash flows were approximately $7 million. We invested $13 million of capital into our existing communities and sold approximately $6 million of long term after improvement. At March 31, 2012, we had cash and cash equivalents of $27 million as a subsequent event to our first quarter’s results and on April 13 we closed on a new $150 million revolving credit facility and simultaneously borrowed $47.5 million to help repay our $38 million bridge loan with Senior Housing and to re-purchase $12.4 million of our convertible senior notes at 3% discount to par.

As of today, we have nothing outstanding on our $35 million working capital credit facility. Consolidated EBITDA excluding certain items is $8.9 million compared to $10.8 million last year. We lost approximately $4 million of EBITDA from skilled nursing, Medicare cuts during the fourth quarter. So, we were unable to make up for most of that loss with additional revenues from our new communities we took on last year.

We still have two managed communities left to close on in 2012 which again in total will provide approximately $5.5 million of annual EBITDA from our managed communities that we currently operate and our scheduled to close on. And we have taken additional cost cutting measures to further improve our performances as we go forward. We recently reduced payroll by $2 million annually and we will also be re-aligning certain of our benefits to marry best practices which will save us an additional $1 million annually.

Moving on to our balance sheet. Our accounts receivable management remains strong and as on March 31, 2012, the number of day sales outstanding for our consolidated operations was just under 19 days.

At quarter end we had approximately $354 million of net property and equipment, which includes the 31 properties directly owned by Five Star, 12 of which remain on unencumbered by debt. We had $37 million of convertible senior notes, $39 million of mortgage loans payable and $38 million of outstanding balance on our bridge loan from Senior Housing, previously mentioned subsequent to the quarter’s end we’ve repaid the total balance on the bridge loan with Senior Housing and repurchased $12.4 million of convertible senior notes. At the end of the quarter, our leverage was 40% of book value and 20% of assets. We believe we are in compliance with all materials earned of our credit note and mortgage agreements.

Over the past year, Five Star has made some major changes to strengthen its long term value and viability. We increased our core private pay revenues to 75% of our senior living business and we now operate and manage over 27,000 units a 24% increase, 80% of our units are independent living, assisted living and memory care, virtually all private pay. Having experienced a significantly negative impact from the 11% skilled nursing Medicare rate reduction along with the industry, we’ve made up for most of the estimated $16 to $17 million of lost EBITDA to our growth. We disclosed on a new $150 million revolving credit facility which we will use to continue to increase our private payments.

Our focus on building occupancy and aggressively managing margins will allow us to benefit as our occupancy improves. With that Bruce and I would now like to take your questions. Thank you.

Question-and-Answer Session

Operator

Thank you ladies and gentleman. (Operator Instructions). Your first question will come from Daniel Burnstein at Stifel, Nicolaus & Company. Please go ahead.

Daniel Burnstein - Stifel, Nicolaus & Company

Good morning.

Bruce Mackey

Good morning Dan.

Daniel Burnstein - Stifel, Nicolaus & Company

So, I just want to go over the occupancy quarter-over-quarter, when I isolate the assisted living and independent living, it looks like a drop of about 50 basis points quarter-over-quarter. Can you talk about the impact from the Norwalk virus, whether that occurred early in the quarter and how it affected the averages and maybe what your ending occupancy is or it is just the private pay, Senior Housing?

Bruce Mackey

Sure, I will start with that. It did affect us really early in the quarter. January was definitely the month hardest hit and we are still hit in February and it did carry a little bit in March. To put into somewhat of a perspective, I think we had 35 communities at one point, earlier they had closures at some points basic band of admissions just due to the Norwalk virus. I think it impacted, we calculated about roughly 430 days at the number of communities and the number of days that we couldn’t – but I guess, it’s predominantly in January, got better with February and better in March. I know I would put our overall occupancy as of last week was 85.8 so with that point, we did hit a low point of 85.7 and 85.6 overall got up for about 86, we have been within that 10 to 20 basis points while we averaged the quarter.

Daniel Burnstein - Stifel, Nicolaus & Company

Okay, so the standing occupancy is not just bit higher than the average?

Bruce Mackey

Correct.

Daniel Burnstein - Stifel, Nicolaus & Company

Yeah. And what was the cost again for the quarter, I think Paul went over some of the impact on the expense type.

Bruce Mackey

Well, one thing we did mention was if you are referring to the non-recurring legal expenses in our G&A. We had approximately $500,000 in Q1 associated with various litigation matters that were onetime non-recurring.

Daniel Burnstein - Stifel, Nicolaus & Company

I thought you mentioned something about the Norwalk virus as well.

Bruce Mackey

Well, actually we did obviously talk about it. We’ve not quantified the exact impact although we saw itself manifest not only in occupancy we saw a little bit of an uptick in labor cost as a result of basically overtime because unfortunately the way the virus works is as a community would have it, employees that have it as well are not able to return to work, then the facility itself has to be fully sanitized before it is re-opened for admission. So, there is an in-efficiency in it and again if we don’t obviously broadcast our profitability by month but January was a negative month for us, and February and March were sequentially much better.

Daniel Burnstein - Stifel, Nicolaus & Company

That’s, very helpful. And then you talked about the value of the assets that were encumbered in the quarter, are the unencumbered assets generally similar in quality, if I want to extract like value of the ones you encumbered to the unencumbered ones?

Bruce Mackey

I pay more than half hour, yes Dan, I mean there’s a few in there. You might recall we took a little of those properties from Sunwest. I think we probably paid about $70,000 a unit, I was back in ’08, that was still in the process of getting those up to par with where the rest of assets are, so I’d say than more than half are on par with what we’ve done, and then the others are close but there are two or three that are strivers.

Daniel Burnstein - Stifel, Nicolaus & Company

Okay and then the last question I have is on the acquisition pipeline, you said that it’s been a little slow this year so far, and why would you expect that to ramp up as the year goes, you have any sense of the pipeline or you have any letters of intent out to go ahead and perhaps purchase assets? Just want to understand how you’re thinking about that pipeline though?

Bruce Mackey

Sure. In all lines I just think really the activity from the broker has kind of picked up a little bit over the last month or so, you know which we’ve still not paid to do two right now. We’ve looked at a few deals, but I said the number of deals that kind of fit our strategy has picked up a bit and we’re doing more towards the properties, we’ve signed more CA’s so it does seem to be a little bit busier now than it was back in January, February.

Daniel Burnstein - Stifel, Nicolaus & Company

Do you have a sense of what the dollar volume might be that you’re hoping to close this year?

Bruce Mackey

Realistically, somewhere north of 100 million, but it’s really tough to put a figure on that. And when I say that obviously, taken from our strategy and working with Senior Housing, how much will actually take on our own balance sheet, right now, I don’t know. But we look very hard, but we really, we do would let down to what is really going to meet our strategy and but you pass on most, but there are some things that rise to the top.

Daniel Burnstein - Stifel, Nicolaus & Company

Okay, alright, I appreciate for taking my questions on, I’ll jump off. Thank you.

Bruce Mackey

Okay Dan, no problem.

Operator

And there are no further questions at this time. I’ll turn the call back to Bruce Mackey

Bruce Mackey

Alright, I would like to thank everyone for joining us today. I do understand that some people had some trouble getting into the call before this morning, so we’re sorry about that. And we’ll work with AT&T to ensure that this doesn’t happen in the future. We are planning to attend the Deutsche Bank Healthcare Conference in Boston in May and the Jefferies Global Healthcare Conference in late in June in New York, in June, I’m sorry. We look forward to meeting many of our investors and analysts at either of these events. Thank you again.

Operator

Thank you and that does conclude our conference for today. Thanks for your participation and for using AT&T executive teleconference service. You may now disconnect.

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