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Executives

Will Council – President and Chief Executive Officer

Glynn Riddle – Chief Financial Officer

Analysts

Derrick Dagnan – Avondale Partners LLC

Nick Milivis – Private Investor

Evan Greenberg – Meadowbrook Capital Management

Bryan Verona – Vanadian Capital

Simon Silatras – Harbourside Capital Management

Advocat Inc. (AVCA) Q2 2008 Earnings Call August 7, 2008 10:00 AM ET

Operator

Good morning, and welcome to the Advocat second quarter conference call. Today’s call is being recorded. I would like to remind everyone that in addition to historical information, certain comments made during this conference call will be forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Such statements may be identified by words such as anticipate, believe, estimate, expect, intend, predict, hope, or similar expressions. These forward-looking statements reflect our current views with respect to future events and present our estimates and assumptions only as of the date of this report.

Actual results could differ materially from those contemplated by the forward-looking statements made in this conference call. In addition to any assumptions and other factors referred to specifically in connection with such statements, other factors, many of which are beyond our ability to control or predict, could cause our actual results to differ materially from the results expressed or implied in any forward-looking statements including, but not limited to, our ability to successfully construct and operate the Paris, Texas replacement facility; changes in governmental reimbursements, government regulation, and healthcare reform; the increase cost of borrowing under our credit agreement; the ability to control ultimate professional liability costs; the accuracy of our estimate of our anticipated professional liability expense; our ability to control costs; changes to our valuation allowance for deferred tax assets; changes in our occupancy rates in our facilities; the impact of future licensing surveys; the outcome of regulatory proceedings alleging violations of laws and regulations governing quality of care or violations of other laws and regulations applicable to our business; the effects of changing economic in competitive condition; changes in anticipated revenue and cost growth; changes in the anticipated refills of operations of the Company; the effect of changes in accounting policies, as well as other risks factors detailed in the Company’s Securities and Exchange Commission filing.

The Company has provided additional information in its annual report on Form 10-K for the fiscal year ended December 31, 2007, as well as in other filings with the Securities and Exchange Commission, which readers are encouraged to review for further disclosure of other factors.

These assumptions may not materialize to the extent assumed and, risks and uncertainties may cause actual result to be different from anticipated results. We cannot guarantee any future operating result, activity, or performance, or achievement.

I would now like to turn the call over to Will Council, the President and Chief Executive Officer. Please proceed, sir.

Will Council

Good morning. Thank you, Jen. Yesterday, we issued a press release announcing second quarter 2008 result. Many of the measurements for tracking the operations of the business were positive for the second quarter.

One soft indicator was the occupancy rate on a same-center basis which was 77.7% versus 78.6% last year and 78.3% for the first quarter of 2008. We believe this decline in census may be due to in part of the late-arriving and short flu season this year. We also believe the weakening economy may be prompting families to delay admissions because of the cost of their portions of nursing home care.

We are also dealing with the continuing challenges in integrating the Texas acquisition and changing the culture. We have made additional management changes and intensified training to raise the level of closures on referrals. We will further address the Texas issues later in the call.

The significant highlights for Advocat in quarter two 2008 include revenues increased 27.9% compared to the second quarter 2007. Net income from continuing operations in 2008 was $700,000 compared to $4.3 million in 2007. Diluted earnings per share from continuing operations were $0.11 in 2008 compared to $0.68 in 2007. Funds from operations were $2.7 million in 2008 compared to $3.6 million in 2007. Same center Medicare census was 14.6% of total census in the second quarter of 2008 compared to 14.3% in the second quarter of 2007, an increase of 30 basis points.

Our average Medicare rate was 9.3% higher in the second quarter of 2008 than the same quarter last year on a same-center basis. Our average Medicaid rate increased 4.4% in 2008 compared to 2007 on a same-center basis. In all, it was a profitable quarter for the Company with encouraging growth in patient acuity. However, there are some opportunities for us to improve our operating performance at a number of facilities, particularly in Texas.

I will discuss this further shortly, but at this point, I will turn the discussion over to Glynn Riddle, our Chief Financial Officer to review the second quarter financial results.

Glynn Riddle

Thank you, Will. We issued a press release yesterday covering the 2008 second quarter results and filed our quarterly report on Form 10-Q. At previously disclosed, we completed the acquisition of leasehold interests in operations of seven skilled nursing facilities in Texas, the SMSA acquisition, in August 2007. And in the fourth quarter of 2007, we entered into a lease for an additional facility in Paris, Texas. We refer to the SMSA facilities and the new lease Paris, Texas facility collectively as the new Texas facilities.

For the second quarter of 2008, revenues increased to $70.8 million from $55.4 million in 2007. Revenues related to the new Texas facilities were $12.5 million. Same-center patient revenues excluding the effects of the new Texas facilities increase $2.9 million or 5.2%. The increased in same-center revenues is due primarily to Medicare rate increases, increased Medicaid rates in certain states, and increased private pay and manage care rates and census, partially offset by the effects of lower Medicaid census.

The average rate of occupancy at our nursing centers was 74.6% in 2008 compared to 78.6% in 2007. On the same-center basis, nursing center occupancy was 77.7% in 2008 compared to 78.6% in 2007 and 78.3% in the first quarter of 2008.

Our Medicare revenue was 32.1% of total patient revenue for 2008 compared to 31.4% in 2007. On a same-center basis, Medicare revenue was 32.4% of total patient revenues in 2008 compared to 31.4% in 2007. As a percent of total census, Medicare days were 13.9% of total in 2008 and 14.3% in 2007. On a same-center basis, Medicare days increased to 14.6% in 2008 compared to 14.3% in 2007, an increase of 30 basis points. This level represents an increase from the 14% level that we experienced in the first quarter of 2008.

The Company’s average rate per day for Medicare Part A patients increased to $380.01 in 2008 and $344.48 in 2007. On a same-center basis, the average Medicare rate increased to $376.50 in 2008 from $334.48 in 2007 or 9.3%. As a result of increases in Medicare rates due to annual inflation adjustments and the acuity level of our patients as indicated by the RUG level scores, which were higher in 2008 than in 2007. The average rate per day for Medicaid patients increased to $138.05 in 2008 compared to $137.75 in 2007. On a same-center basis, the average Medicaid rate increase $143.85 in 2008 compared to $137.75 in 2007, an increase to 4.4% as a result of increasing patient acuity levels and other rate increase in certain states.

Operating expense increased to $56 million in 2008 from $41.9 million in 2007. Operating expense related to the new Texas facilities was $11.6 million. Same-center operating expense increased to $44.4 million in 2008 from $41.9 million in 2007. The largest component of operating expense is wages, which increased to $33.3 million in 2008 from $25.1 million in 2007. Wages related to the new Texas facilities were approximately $7.1 million. Same-center wages increased approximately $1 million or 4.1%.

Regular merit and inflationary increases for our personnel were approximately 4.6% for the second quarter representing an increase from the 3.5% to 3.8% increases we have seen in the last several quarters. We have experienced strong competition for nurses, therapists and line staff in several markets. These cost increases were partially offset by lower labor costs associated with decreases in census.

Worker’s compensation insurance expense was approximately $400,000 higher in 2008 compared to 2007. We had better than expected claims experienced in 2007 when we were covered by variable rate policies that allowed us to reduce the cost that cut worker’s compensation insurance based on our actual experience.

Our coverage in 2008 was primarily related to fixed-premium policies. Our operating costs were also impacted by higher food and energy costs. Food costs were approximately $100,000 higher on a same-center basis, an increase in expense per patient day of about 8%. Utility costs were about $100,000 higher or about 10%. Lease expense increased $5.7 million in 2008 from $4.6 million in 2007. Lease expense related to the new Texas facilities was $1 million in 2008, remaining increase in lease expense of $100,000 results from rent increases for lessor funded property renovations.

Professional liability in 2008 was an expense of $1.4 million compared to a benefit of approximately $3.4 million in 2007, an increase in expense to $4.8 million. The benefit last year was the result of reductions in the accrual for prior year claims. Our cash expenditures for professional liability costs were approximately $1.9 million in 2008 compared to approximately $1.1 million in 2007. The increase in cash expenditures results from settlements we announced last quarter for professional liability cases totaling $4.8 million to be paid from April, 2008 through January, 2009. Professional liability cash expenditures fluctuate from year to year.

General and administrative expenses increased to $4.6 million in 2008 compared to $4.2 million in 2007. General and administrative expense related to the new Texas facilities was approximately $200,000. Compensation costs increased by $300,000 for normal merit and inflationary increases and for new positions added to improve marketing, operating and financial controls. These increases were offset by a decrease in incentive compensation expense of $200,000. Our incentive compensation plan is based predominantly on achieving budgeted levels of net operating income adjusted for the non cash impact of professional liability expense.

The remaining increase in G&A expense is due to higher travel costs of $100,000 which were primarily due to higher facilities support costs. The provision for income taxes was[Author ID1: at Wed Sep 24 13:18:00 2008

]taxes were[Author ID1: at Wed Sep 24 13:18:00 2008

] $500,000 in 2008 an effective rate of 41.6% compared to approximately $2.7 million in 2007, an effective rate of 3.8%.

Now, I would like to comment further on the results for the new Texas facilities. Since there is no prior year comp for these facilities, I will compare the results for the second quarter of 2008 to those for the first quarter of 2008. For the second quarter of 2008, revenues for the new Texas facilities decreased to $12.5 million from $12.9 million in first quarter of 2008. The decrease in revenues is due primarily to a decrease in Medicare census partially offset by the effects of higher Medicaid and managed care census

The average rate of occupancy at new Texas nursing centers was 64.9% in both the second and the first quarter of 2008. As the percent of total census, Medicare census was 11% of total in the second quarter compared to 13.3% in the first quarter representing a decrease of approximately 21 patients per day, a $700,000 reduction in quarterly revenue.

Operating expense for the Texas facility increased to $11.6 million in the second quarter compared to $11.3 million in the first quarter. Wages were approximately $300,000 higher in the second quarter. We had additional labor costs of approximately $400,000 related to additional staffing in housekeeping, dietary and laundry areas, as we completed the elimination of an outsourcing contract for these services. This increase was offset by a reduction of other operating expenses related to be elimination of the outsourcing agreements.

Health insurance costs were approximately $200,000 higher. We were self-insured for the first $150,000 of costs per claim and these costs can vary significantly from period to period.

This time I would like to focus on the funds provided from operations or cash flow. We believe this is a valuable concept for following the Company's performance that shows cash provided from operations and eliminate the effects of actuarial assumptions and reflects actual cash effect to professional liability expense. It excludes non cash charges related to stock-based compensation, as well as the effect of non cash deferred income taxes. The computation of funds from operations is summarized in our press release. For the second quarter of 2008, funds from operations decreased to $2.7 million compared to $3.6 million for the second quarter of 2007, primarily due to lower operating income and the increased cash payment for professional liability costs.

Cash payments for professional liability costs were approximately $700,000 higher in the second quarter of 2008 than in the second quarter of 2007. As we announced last quarter, we entered into settlements for professional liability cases totaling $4.8 million take quarterly from April, 2008 through January, 2009. The payment this quarter under those settlements was approximately $1.3 million after insurance proceeds, and will be $1.4 million in the third quarter of 2008, $1.1 million in the fourth quarter of 2008, and $1 million in first quarter of 2009.

The new Texas facilities generated a deficit in funds from operations of approximately $200,000 for the second quarter of 2008 compared to positive funds from operations of $400,000 in the first quarter of 2008. There is one item I would like to point out from the balance sheet. During the second quarter, we receive a notice from CMS for a Medicare assessment from 1997 for one of the new Texas centers. The total amount of the payment requested by CMS as of June 30, 2008 is approximately $1.4 million including accrued interest of approximately $800,000.

The original overpayment liability appears to be a routine cost report adjustment and was initially assessed by CMS in 1999 and 2000. However, CMS apparently made no effort to collect this overpayment from the appropriate operator until earlier this year. In our acquisition of the new Texas centers, we acquired Medicare provider numbers and agreements, which meant we could be held accountable for past liabilities associated with those provider numbers. We conducted normal due diligence to investigate cost report liabilities that might be outstanding, however, given the age of this alleged overpayment and the fact that it related to periods well prior to the period during which our seller operated the building, this alleged liability was not uncovered.

We intend to seek relief for this assessment from CMS and to take action to force the previous owners of the facility to pay any liability due. Given the uncertainty of these efforts and the costs involved, we recorded the liability of $1 million in the second quarter of 2008 for our estimate of liability for this assessment and its defense costs. This accrual resulted in an increase in the acquired leasehold interest in tangible assets.

Now, I would like to turn the call back over to Will.

Will Council

Thanks, Glynn. Our focus for the second half of 2008 is to continue executing our strategic plan and enhance our focus on facility that had a difficult second quarter. Key initiatives include continuing the facility renovation projects, improving our quality census including increased Medicare, improving our patient acuity mix, cost containment, pursuit of acquisitions and other strategic growth opportunities and a redoubling of our efforts to return the new Texas facilities to the financial performance they experienced before they entered Chapter 11.

With respect to our facility improvement project, I would like to provide you with an update on our progress.

As of June, 2008, we have completed renovation projects at eight facilities in the last couple of years. We currently have three renovation projects under way with two completions expected in the third quarter and a third completion in early 2009. Two of these projects are being funded under our capital improvement arrangement with out landlord which we expect to exhaust with these projects. We have elected to fund the project costs in excess of the capital improvement arrangements as well as a third project, with internally generated cash flow.

The renovation projects provide a complete floor-to-ceiling rehab and dramatically improve the presentation and marketability of a nursing center. Financial information for the eight renovated facilities that were completed before the start of the second quarter is included in our press release. Most of the projects are performing as we would expect on a combined basis for all eight facilities occupancy increase to 69.2% in the second quarter of 2008 compared to 63.2% for the 12 months prior to renovation. On a combined basis for all eight facilities, Medicare census as a percent of total census increased to 13.8% compared to 13.1% prior to the renovation.

We think there is still room for further improvement at a couple of the projects by refining their specific marketing plan. In all the renovation projects have delivered excellent internal growth providing great return on investment. It should be noted that this information is for one quarter only and that the facilities are at different stages in the life cycle of renovation.

This time, I would like to talk about the second quarter performance of our Texas facilities. Glynn spoke about the new Texas facilities. We obviously had a disappointing quarter with certain of these buildings. We have conducted a comprehensive operations review of those facilities and have implemented specific procedures to improve operations.

Let me describe the findings of that review and our plans to address identified weaknesses. We had leadership turnover. During the first six months of 2008, we experienced higher than normal turnover in certain Texas leadership positions including regional management and nursing center administrator, director of nursing and marketing coordinator. This impacted census Medicare utilization in overall performance. A protracted survey process at one building affected our ability to effectively market the building and also to make significant changes and operating strategies that deal with declining census.

We had to appeal the State’s determination that we had not corrected one-sided deficiency. We prevailed in that process; however, the four months process resulted in our facility average daily census declining by 11 patients per day including the decline of nine Medicare patients per day. We have identified centers that had lower than normal referral conversion that is the conversion of the referral to an admission.

Finally, we identified facilities that simply were not following our staffing guidelines in the face of declining census. As a result of our reviews, we developed facility-specific action plans that are geared towards improving census and Medicare utilization and controlling costs as appropriate. These action plans address the specific problems noted at each facility and identified specific targets and measurement metrics.

In addition, the plans are specific with respect to which employees have responsibility for performance. I believe these action plans are appropriate and will result an improvement at these facilities.

This time I would like to talk about acquisition and development activities. As we announced last quarter, the State of West Virginia has approved our application for the construction of a new facility. We are currently developing bid specifications and expect to bid this project during the third quarter. Assuming satisfactory completion of financing arrangements, we expect construction to begin during the fourth quarter and to take approximately twelve months to complete. Glynn also discussed the new lease of the skilled nursing facility in Paris, Texas.

In November, 2007, we agreed with Omega to operate this facility on a short-term basis while we evaluated the possibility of a rebuild of this facility. In March, 2008, we entered into an amendment to our master lease with Omega to provide for the construction and lease of the new facility. On the completion of the construction of the replacement facility, the existing building will be closed and the single facility lease terminated.

Under the terms of the lease amendment, we will supervise the construction of the facility and Omega will provide funding for the first $7 million in costs. Rent will commence upon the completion of the project, but no later than August, 2009. Once construction is completed, annual rent will be equal to 10.25% of the total cost of the replacement facility including direct costs of construction, carrying costs during the construction period, furnishings and equipment, land cost and the value of the related skilled nursing facility license. The total cost for the replacement facility was originally expected to be approximately $7 million and it is currently expected to be approximately $7.9 million.

We will bear all costs in excess of the original costs of $7 million. We are currently in negotiations with Omega to bear an increased amount of these costs; however, no assurance can be given that these negotiations will be successful. We continue to look for other acquisition candidates or development opportunities that fit our profile and market objectives. Our primary focus is on facilities that fit within our footprint and that will be accretive to our financial results.

We will certainly considered groups of facilities that are not within our footprint. For those, we would need an adequate numbers of centers to support the necessary regional overhead. I would like to provide some additional information with respect to the amendment of our shareholders’ rights plan. Our rights plan was last amended in 2005 when our share price was approximately $5 at a term through 2010. As a result of the approaching expiration of the current agreement and because of the share price for the Company has change, our Board of Directors elected to amend the plan. The plan has amended extends the expiration to August 2018, sets the exercise price at $50 per share and add an exchange feature to the plan.

The exchange feature gives the Board of Directors the option of exchanging each right for one share of the Company’s stock. This provision is intended to avoid requiring right holders to pay cash to exercise their right and to alleviate any uncertainty as to whether holders will exercise their right.

Finally, I would like to comment on the reimbursement outlook. Last week, under significant congressional pressure, CMS published the final rule with respect to skilled-nursing Medicare rate and abandoned their efforts to cut rates by 3.3% for fiscal 2009. CMS also announced that the final market basket adjustment would be approximately 3.4% slightly higher than the originally announced market basket of 3.1%. Based on our patient RUG distribution over the last twelve months, we expect that the impact on our facilities will be an increase of approximately 3.6% effective October 1, 2008. Any change in our patient RUG distributions could result in variations from this expected increase. With respect to our expected Medicaid rate, we have benefited from good Medicaid rate increases in recent periods, with a 4.4% increased in Medicaid rate in the second quarter of 2008 compared to the same period in 2007.

Our states generally have June 30 or August 31 fiscal year ends and rate adjustment typically occur on July 1st of September 1st. Rate increases have not been finalized in all of our states for the states that have published third quarter rate adjustment we are seeing state average rate increases of 0.5% to 1.9% for our facilities as compared to the rate we experienced in the second quarter of 2008.

In summary we had a profitable quarter. We continue to grow. We improved Medicare utilization in our same-store centers. We continue to improve our Medicare rate with higher acuity patient and quickly identified and address the operating issues that will result in better performance. We got good news on the federal Medicare rate beginning October 1st.

At this point I would ask Jen to open the call up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator's instruction) And our first question comes from Derrick Dagnan with Avondale Partners.

Derrick Dagnan – Avondale Partners LLC

Good morning.

Will Council

Hello, Derrick.

Derrick Dagnan – Avondale Partners LLC

I want to ask a question on that employee turnover at the facility level on Texas. Do you believe that some of the turnover is related to competitors hiring away some of your talent? Or, is it more that you kind of put the bad or wrong people in the job in the first place?

Will Council

Derrick, it is really a combination of both. About half of the turnover we have experienced have been people that resigned and moved on to something else. And about half have been people that we identified as having weaknesses or identified as being folks that would not follow our prescribed procedures and so we elected to make a move. We feel good about the management we have in place today. It has taken us a while to get a good team assembled, but we feel good about it and feel like they are going to be very helpful as we move forward and try to improve those operations.

Derrick Dagnan – Avondale Partners LLC

Okay. And with the management turnover just the instability there, is there any reason why you are concerned about any issues with professional liability because of a lack of oversight or any issues like that?

Will Council

No. I am not concerned about that. The turnover has affected our marketing efforts outside the facility which generally speaking comes after we had taken care of the patient. So, when you sort of have turnover there, the marketing effort drops off. But taking care of the patient does not. The responsibilities in the facility are well identified and folks know what they are responsible for doing irrespective of whether the administrator or the DON is there. I do not expect it to have an impact on our professional liability exposure in Texas. One factor that does help in the State of Texas with respect to professional liability is there is an effective tort reform legislation there that provides a cap on damages.

Derrick Dagnan – Avondale Partners LLC

Okay. I will ask you a couple of more then jump back in the queue. When you look at the inflation pressures you saw in, I guess, across your entire business, on the food and utility side, is there anything you can do there to control that? Or are you doing anything or is that something we should kind of expect for the remainder of 2008?

Will Council

It is a good question, Derrick. With respect to utilities, there is not a whole lot we can do. Our patients have the right to be comfortable in their home, and so we have got to turn the air conditioner on and provide the level of comfort that they are accustomed to. So, certainly, there is little that we can do about that. With respect to the food costs, yes, we work very hard to manage our food costs and have routinely for many, many years and have an excellent program in place. We have recently switched food vendors that happened during really the mid to late part of the first quarter and I think was effective for most of the second quarter.

We did that primarily based on a service that we expected to get from the new vendor. There was a small expected savings that would result from that. But that was not the reason for the change and did not expect that savings to be material perhaps, is offset the inflationary effect somewhat, you can very definitely put a control on your food costs, but we still have to provide an appropriate level of nourishment and appropriate tasting and presenting food for our patients. And so we do that routinely and know that there is not a lot of opportunity to control the inflationary effects there. A lot of that extra cost, though, is in the form of fuel surcharges, which theoretically will go away if the fuel costs comeback down.

Derrick Dagnan – Avondale Partners LLC

Okay, and I will ask some more if I can.

Will Council

Sure

Derrick Dagnan – Avondale Partners LLC

On the rice plan, so I guess the way it is going to work now is for every right you could and exchange that for a share and that would be a new cost to the shareholder. Is that true?

Will Council

That is correct.

Derrick Dagnan – Avondale Partners LLC

Okay, what about the number of rights? Is there a fix number there?

Will Council

There is. I will be honest, Derrick, I do not know the exact formula. One thing to keep in mind about the rights plan, it is designed to give the Board of Directors flexibility in dealing with potentially hostile situations. The ability to dilute the hostile party is significant leverage in forcing the hostile party to deal with all shareholders in an equitable fashion. To my knowledge, no company has ever actually used the rights plan. The existence of the rights plan alone is enough to give the necessary leverage. The plan allows shareholders to receive shares that effectively dilute any potentially hostile party. The exercise price is for the actual right, with the number of shares per right determined at the time the plan is utilized.

Derrick Dagnan – Avondale Partners LLC

Okay. And on that plan, was that something that went through the Board, was that something that was, I guess, general agreement or unanimous approval?

Will Council

Yes.

Derrick Dagnan – Avondale Partners LLC

Okay. Alright, that is all. Thanks.

Will Council

Good day.

Operator

The next question is on Nick Milivis, a private investor.

Nick Milivis - Private Investor

Hi guys.

Will Council

Hi, Nick.

Nick Milivis - Private Investor

The $1.4 million you talked about as far as from the Texas facilities, the CMS number, is that reflected anywhere in the income statement?

Will Council

It is not reflected on the income statement. Under acquisition purchase accounting, liabilities that are uncovered within the year of an acquisition day are reflected as additional purchase price. And so, that is how that was reflected.

Nick Milivis - Private Investor

Okay, and on the rights plan, was this done in anticipation, knowing that the market was going to react negatively to the earnings?

Will Council

No, it was done simply because we realized that the existing rights plan we had was set for expiration in a couple years and it is generally good practice to periodically refreshen that plan, also to make our plan consistent with most of the rights plan in the marketplace today. We added the exchange feature that is a feature that most new plans or amended plans adopt and include in their plan.

Nick Milivis - Private Investor

Are you guys aware of anyone who is, that expressed an interest in doing some actions that are possible against the company?

Will Council

No.

Nick Milivis - Private Investor

Good. Alright, thanks.

Will Council

Thank you.

Operator

The next question is from Evan Greenberg with Meadowbrook Capital Management.

Evan Greenberg - Meadowbrook Capital Management

Yes, I wanted to get an idea on the, you talked about same revenue centers. What the FFO was ex Texas and what Texas' contribution or lack thereof was?

Glynn Riddle

Texas, one of the comments we made during this call this morning is Texas would actually a negative FFO for the quarter of about $200,000. The reported number would have been about $200,000 higher this quarter without Texas.

Will Council

Well and I think more relevantly, last quarter, it was a $400,000 positive contributor. So, the swing from Q1 to Q2 related to Texas was $600,000. The other large swing in funds from operations was an increase in professional liability, cash outlay and net increase as a result of the settlements that we announced with the first quarter conference call.

Evan Greenberg - Meadowbrook Capital Management

Okay, so other than that, it seems the FFO would have been close to flat due to the increase labor cost but operations continue to be sound at the overall facilities ex what you have to do in Texas now. I guess it is one of the reasons why the acquisition came so cheap. It is too cheap for a reason.

Will Council

Well, it certainly appears that way. We still feel good about what we got there. We think we got the team in place and we are working very hard to bring it around.

Evan Greenberg - Meadowbrook Capital Management

So, am I right in my comment in terms of the operations being fundamentally, basically in sound shape outside of Texas?

Will Council

That is correct, yes. We feel good about the operations for the quarter outside of Texas.

Evan Greenberg - Meadowbrook Capital Management

And the FFO would have been flat has not been for a lot of increased labor cost and food cost, or slightly higher?

Glynn Riddle

At that time, it would have been stronger without the higher, there were inflationary pressures and is well pointed out. There was a also a drag from Texas due to an increase in professional liability under the settlement that we announced last quarter which was a little bit front end loaded. The payments in the first couple of quarters are a little bit higher than the last couple of quarters.

Evan Greenberg - Meadowbrook Capital Management

Alright, thanks a lot.

Will Council

Thank you.

Operator

(Operator's instruction) The next question is from Bryan Verona with Vanadian Capital.

Bryan Verona - Vanadian Capital

Hey, guys. Couple of questions, with respect to renovations anticipated to be completed in the third quarter of this year, what was the drag during the second quarter from those properties?

Will Council

I do not think we are prepared to speak to them specifically on a quarterly basis for a couple of reasons. One, we do not have it in front of us and two, we generally do not describe to that level a detail for single facility. I can tell you that those facilities are in the final stages of the renovation which typically means well let me back up just a little bit. We start the renovation usually in an isolated wing and we sort of work our way around isolating the work as best as we can from the central core of the facility and then the very final thing that we do is finish the central core of the building and that is the most disruptive point in the renovation and both of the project in the second quarter were at that stage of the renovation.

So, we do believe that we have some decline in census at least relative to where we wanted to be in those buildings related to that sort of disruption going on in the central core of the building. Both of those buildings are at the point where the interior work is going to be finishing up probably this month or early in September and then we will be working on some exterior work to get on finalized but the internal disruption should be over very soon.

Bryan Verona - Vanadian Capital

But regardless in the second quarter, I mean to normalize the impact, would you suggest it was significant relative to the single facility operation for the full, whole operations with disruption?

Will Council

It was important to the single facilities operations whether it was significant or not. I do not know, I am not sure how to define that for a single facility. Certainly, we were disappointed in the census numbers of those two buildings for the quarter but understand the reason for it and certainly expect it to do better once we get the renovation finished.

Bryan Verona - Vanadian Capital

Okay. Next question as it relate to the survey issue in the Texas facility my back of the envelope calculations a reduction of nine Medicare patients and two I was just assuming Medicaid and the order of $350,000 of loss revenue assuming they were gone the entire quarter, is that kind of, again I am trying to normalize what was ultimately a weak occupancy quarter for you guys.

Will Council

That can be on or below, Bryan. That is about right. I think you have quantified the total for the new Texas facility, the total for new Texas was down about 21 and in that range, in that 21 patients works about a $700,000 draft in Medicare revenue.

Bryan Verona - Vanadian Capital

Got it. Okay, so that is about right. Again, you would characterize the survey issue as now resolved and that being a loss of one third of that or call $350,000 approximately or half as one time in nature, correct, which would made the Texas cash flow from operations probably pretty flat.

Will Council

The building that had the survey issue was not one of the new Texas facilities. The Texas region building but it was one of the eight new Texas homes. Yes, I would agree we do believe that does survey issues are behind, that they are behind this. They are resolved and that building should be in a situation to start making improvements now.

Bryan Verona - Vanadian Capital

Okay, good and last question is can you quantify what 3.6% increase is as of October '08 on new Medicare census from the CMS updated guidelines that plays through?

Will Council

Sure, we estimated that that monthly increase in revenue at our current patient mix is about a $200,000 increase in revenue from that.

Bryan Verona - Vanadian Capital

Thank you very much.

Will Council

Thank you, Bryan.

Operator

Your next question is from Simon Silatras with Harbourside Capital Management.

Simon Silatras - Harbourside Capital Management

Hey, guys. How are you doing?

Will Council

Good, how are you, Simon?

Simon Silatras - Harbourside Capital Management

Doing well. My first question is related to the Texas facility. I want to get understanding of now from what you are saying it is due to management turnover and just kind of lower occupancy and lower Medicare mix, lower Medicare census, pardon. How long before you see those issues working through now that you have defined the problem and have a plan to fix it? What are you looking for in terms of timeframe?

Will Council

Well, each facility has a specific target that we have asked them to meet; specific measurement points along the way, specific action plans, specific…it is a very specific plan. Everybody is working very hard to achieve those plans. We tend to shy away from the business of trying to project when exactly it is going to happen but we do feel good about the plan we developed. We feel good about the people that are executing the plan and we feel like we are going to recover from this quarter.

Simon Silatras - Harbourside Capital Management

Great, I understand. I guess I am trying to deal and maybe you have touched on this before, I understand it is with the facility specifics but if you look at all the facilities probably speaking, I mean I am just trying to understand, it is hard to imagine that there is not some point in the future although that not be strictly defined that you have a view of when you see these things working themselves through.

Will Council

Well, we certainly do. It is just we tend to shy away from addressing that in such a public forum.

Simon Silatras - Harbourside Capital Management

Okay. Next question I have is on just the lower occupancy in the same store building, in the same centers. Why is that lower?

Will Council

We think it is a combination of things. A, we do believe that the weakening economy is having some impact on some of our facilities folks that even someone that has only a minimal pinch and are only a small social security check has to contribute those funds towards their care in a Medicaid setting and if those folks are staying in an extended household with other people that are used to getting those funds to help the cost in the household, I think sometimes people stay in the household for a little while longer than they should given their healthcare in order to continue to take advantage of those funds.

We also had a very late arriving flu season and it also went at being very short and so we got a very, very late kick from the flu and I think it was so short that it did not extended into the second quarter. I think those are the main reasons, our focus more than on total census continues to be on the quality level of our census and that is Medicare and some of the Medicare advantage work that we do and some of the manage care that we do. Those continue to get our focus as well as private thing.

Simon Silatras - Harbourside Capital Management

Okay, thanks. Good bye for now.

Will Council

Thank you.

Operator

(Operator's instruction) If there are no more questions in queue, I will turn the call back to management for any closing remarks.

Will Council

Jen, thank you very much. There is not anyone in the queue at this time so we are going to conclude the call. Thank you for the opportunity to communicate with our shareholders and we look forward to further communication.

Operator

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a good day.

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Source: Advocat Inc. Q2 2008 Earnings Call Transcript

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