combined with deteriorating conditions in the general economy were major factors in the decline in private pay occupancy in 2008. We believe that the decline in private pay occupancy in 2008 resulted from a combination of factors, including:
§ private pay residents who left our residences because they could no longer rollover from private pay into Medicaid programs;

§ residents' inability to obtain necessary funds from the sale of their homes or from other investments; and

§ the increased ability and willingness of other family members to provide care at home.

The impact of these factors is referred to in this report as the "Private Pay Impact". In the event general economic conditions fail to improve, we believe these negative occupancy and revenue trends may continue.
Average private pay occupancy in 2008 on an overall basis increased by 230 units over 2007. The increase resulted from the addition of 481 occupied private pay units in the CaraVita Acquisition and 47 occupied private pay units representing 85 occupied units for the first 201 days of 2007 from the July 20, 2007 acquisition of a newly built residence in Dubuque, Iowa (the "Dubuque Acquisition"), partially offset by a reduction of a total of 298 private pay occupied units in our same residence portfolio and in the CaraVita and Dubuque Acquisitions since their respective dates of acquisition.
As a result of the Medicaid Impact, Private Pay Impact, and CaraVita and Dubuque Acquisitions, the average occupancy for all of our residences was 68.9%, 79.1% and 85.0% in 2008, 2007 and 2006, respectively, and the percentage of our revenues from private pay sources was 91.7%, 85.0% and 79.0%, respectively. We believe that reducing the number of units available for residents who pay through Medicaid programs is a necessary part of our long-term strategy to improve the overall revenue base. Our overall average revenue per occupied unit day in 2008, 2007 and 2006 was $102.24, $94.19 and $87.06, respectively. Business Strategies
We plan to grow our revenue and operating income by:
§ increasing the overall size and attractiveness of our portfolio by building additional capacity and refurbishing existing residences and by making acquisitions;

§ increasing our occupancy rate and the percentage of revenue derived from private pay sources; and

§ applying operating efficiencies achievable from owning a large number of assisted living residences.

Increasing the overall size and attractiveness of our portfolio by building additional capacity and refurbishing existing residences and by making acquisitions
In February 2007, we announced plans to add a total of 400 units to our existing owned buildings. By the end of 2008, we had completed, licensed, and begun accepting new residents in approximately 80 of these units. Construction continues on the remaining expansion units. Weather issues, primarily related to heavy rains and flooding in the Midwest, hurricanes in the Texas and Louisiana regions, obtaining regulatory approvals and other unforeseen circumstances have resulted in timing delays. As of the date of this report, we are targeting completion of 170 units in the first quarter of 2009, 100 in the second quarter, 25 units in the third quarter and the remaining 25 in the fourth quarter of 2009. We expended $22.2 million through December 31, 2008, and expect to spend an additional $27.8 million in 2009 related to this expansion program. Cost estimates remain consistent with our original estimates of $125,000 per unit. This unit cost includes the addition of common areas such as media rooms, family gathering areas and exercise facilities. Our process of selecting buildings for expansion consisted of identifying what we believe to be our best performing buildings as determined by factors such as occupancy, strength of the local management team, private pay mix, and demographic trends for the area. We expect to continue to evaluate our portfolio of properties for potential expansion opportunities but have no immediate plans to add additional units to existing buildings.
In 2008 we temporarily closed, refurbished and reopened two residences in Arizona consisting of 98 units. In addition, in 2008 we temporarily closed a 50 unit residence in Texas which we plan to begin refurbishing in early 2009. We expect to temporarily close and refurbish three residences consisting of 109 units in Oregon in early 2009. We expect these projects to take six to nine months to complete and that it will take the residences approximately twelve additional months to stabilize occupancy. We believe refurbishment projects are necessary where markets have strong growth potential and our existing residence needs to be upgraded and repositioned in the market. We expect to spend approximately $200,000 to $400,000 on each of these projects. We may temporarily close and refurbish other residences from time to time.

We intend to continue to grow our portfolio of residences by making selective acquisitions in markets with favorable private pay demographics. In November 2006, we acquired a fully tenanted private pay 40 unit assisted living residence in Escanaba, Michigan at a cost of approximately $4.6 million. This residence is included in our current expansion program. On July 20, 2007, we completed the Dubuque Acquisition, the acquisition of a newly constructed 185 unit assisted/independent living residence in Dubuque, Iowa at a cost of approximately $24.4 million. Effective January 1, 2008, we completed the CaraVita Acquisition, the acquisition of the operations of eight leased assisted living residences with a total of 541 units for a purchase price including expenses of $14.8 million. The residences, five of which are located in Georgia and one in each of South Carolina, Alabama and Florida, were occupied with 481 private pay residents at the time of acquisition. The lease has an initial term expiring in March 2015 with three five-year renewal options.
Because of the size of our operations and the depth of our experience in the senior living industry, we believe we are able to effectively identify and maximize cost efficiencies and expand our portfolio by investing in attractive assets in our target communities. Additional regional, divisional and corporate costs associated with our growth are anticipated to be proportionate to current operating levels. Acquiring additional properties can require significant outlays of cash. Our ability to make future acquisitions may be limited by general economic conditions affecting credit markets. See "Future Liquidity and Capital Resources" below.
Increasing our occupancy rate and the percentage of revenue derived from private pay sources
One of our strategies is to increase the number of residents in our residences who are private pay, both by filling existing vacancies with private pay residents and by gradually decreasing the number of units that are available for residents who rely on Medicaid. We use a focused sales and marketing effort designed to increase demand for our services among private pay residents and to establish ALC as the provider of choice for residents who value wellness and quality of care.
We plan to continue to improve our payer mix by increasing the size of our private pay population. Specifically, from November 2006 through December 31, 2008, we increased the number of units available to private pay residents by exiting Medicaid contracts at 44 of our residences and reaching an agreement with the state of Oregon to gradually reduce the number of units available to Medicaid residents through attrition. In limited circumstances we may be required to allow residents who are private pay to remain in the residence if they later convert to Medicaid. We plan to continue to focus on moving private pay residents into our residences.
We consider improvement in payer mix an important part of our long-term strategy to improve the overall revenue base. To the extent we have not been able to immediately fill vacancies created by the exit of Medicaid residents with private pay residents, the reduction in the number of units occupied by Medicaid residents has significantly contributed to overall occupancy and revenue reductions. If general economic conditions fail to improve, our ability to fill vacant units with private pay residents may continue to be difficult and the negative occupancy and revenue trends may continue. However, as the proportion of population in our residences who pay through Medicaid programs trends closer to zero, the impact on our revenues and operating income from additional attrition in the number of our Medicaid residents will diminish. Applying operating efficiencies achievable from owning a large number of assisted living residences
The senior living industry, and specifically the independent living and assisted living segments, are large and fragmented and characterized by many small and regional operators. According to figures available from the American Seniors Housing Association, the top five operators of senior living residences measured by total resident capacity service less than 14% of total capacity. We plan to leverage the efficiencies of scale we have achieved through the consolidated purchasing power of our residences, our standardized operating model, and our centralized financial and management functions to lower costs at residences we may acquire.
The remainder of this Management's Discussion and Analysis of Financial Condition and Results of Operations is organized as follows:
§ Basis of Presentation of Historical Consolidated Financial Statements.
This section provides an overview of our historical assisted living operations and the basis of presentation for our historical consolidated financial statements.

§ Business Overview. This section provides a general financial description of our business, including the sources and composition of our revenues and operating expenses. In addition, this section outlines the key performance indicators that we use to monitor and manage our business and to anticipate future trends.

§ Consolidated Results of Operations. This section provides an analysis of our results of operations for the year ended December 31, 2008 compared to the year ended December 31, 2007 and for the year ended December 31, 2007 compared to the year ended December 31, 2006.

§ Liquidity and Capital Resources. This section provides a discussion of our liquidity and capital resources as of December 31, 2008, and our expected future cash needs.

§ Critical Accounting Policies. This section discusses accounting policies which we consider to be critical to obtain an understanding of our consolidated financial statements because their application on the part of management requires significant judgment and reliance on estimations of matters that are inherently uncertain.

In addition to our core business, ALC holds share investments in Omnicare, Inc. a publicly traded corporation in the United States, BAM Investments Corporation, a Canadian publicly traded company, and MedX Health Corporation, a Canadian publicly traded corporation, and cash or other investments in Pearson Indemnity Company Ltd. ("Pearson"), our wholly owned Bermuda based captive insurance company formed primarily to provide self insured general and professional liability coverage.
Basis of Presentation of Historical Consolidated Financial Statements Effective upon the Separation, the ownership structure of the entities changed and as such became consolidated. All references in this report to ALC financial statements, both pre- and post-Separation Date, are referred to as "consolidated" as opposed to "combined." For periods prior to the Separation Date the historical consolidated financial and other data in this report have been prepared to include all of Extendicare's assisted living business in the United States, consisting of:
§ 177 assisted living residences operated by ALC since the time of the ALC Purchase;

§ the assisted living residences operated by EHSI through the Separation Date, which consisted of 32 residences operated by EHSI at December 31, 2005;

§ three assisted living residences that were constructed and owned by EHSI (two of which were operated by ALC) during 2005;

§ Pearson since its formation;

§ the Escanaba residence since its acquisition on November 1, 2006.

Prior to the Separation, operations were terminated at four of the EHSI residences and were presented as discontinued operations. At the Separation Date, the historical financial statements included 209 residences (two of which remained with EHSI).
After the Separation Date, historical consolidated financial and other data include Pearson, 178 assisted living residences operated by ALC (including the Escanaba residence), 29 residences purchased from EHSI, one residence acquired by ALC in July 2007 and eight leased residences acquired by ALC in January 2008, from and after their respective dates of acquisition. As of the date of this report, ALC operated a total of 216 residences.
The historical consolidated financial and other operating data prior to the Separation Date do not contain data related to certain assets and operations that were transferred to ALC such as share investments in Omnicare, BAM, and MedX, or cash and other investments in Pearson, and do include certain assets and operations that were not transferred to ALC in connection with the Separation such as certain EHSI properties that did not fit the targeted portfolio profile or were not readily separable from EHSI's operations. The differences between the historical consolidated financial data and financial data for the assets and the operations transferred in the Separation are immaterial in 2006.
The following is a description of significant events that occurred to our assisted living business since January 2005 and how those events affected the basis of presentation of historical consolidated financial statements:
§ On January 31, 2005, all of the outstanding capital stock of ALC, which had a portfolio of 177 assisted living residences (6,838 units) in 14 states at the time, 122 of which were owned and 55 of which were leased, was acquired by EHSI.

§ During 2005, EHSI completed construction projects that resulted in increased capacity at five assisted living residences (96 units), opened a newly constructed assisted living residence in Wisconsin (60 units), and closed one assisted living residence in Washington (12 units). In addition, EHSI completed construction on two new assisted living residences (90 units) in Ohio and Indiana that were opened and operated by ALC. As a result, as of December 31, 2005, ALC operated 179 residences, two of which were owned by EHSI, and EHSI operated 32 residences, for a consolidated operation of 211 residences (8,673 units) in 17 states.

§ Between January 1, 2006, and the Separation Date, EHSI closed an assisted living residence (60 units) in Texas and disposed of the property. It also closed an assisted living residence in Oregon (45 units) and discontinued operations at an assisted living residence (63 units) in Washington for which the underlying lease had expired. EHSI also completed construction projects that increased capacity (37 units) at two assisted living residences. On November 1, 2006, ALC completed the acquisition of an assisted living residence (40 units) in Escanaba, Michigan. As a result, as of the Separation Date, ALC operated 180 residences, two of which were owned by EHSI, and EHSI operated 29 residences, for a consolidated operation of 209 residences (8,530 units) in 17 states.

§ On the Separation Date Extendicare transferred 29 of the 31 properties previously owned by EHSI to ALC. As of the Separation Date, ALC operated a total of 207 residences (8,302 units) in 17 states.

§ On July 20, 2007, we completed the acquisition of a newly constructed 185 unit assisted/independent living residence in Dubuque, Iowa at a purchase price including all fees and expenses of approximately $24.4 million. At the time of purchase, the residence was approximately 47% occupied with all private pay residents.

§ Effective January 1, 2008, we completed the CaraVita Acquisition, consisting of eight leased assisted living residences with a total of 541 units for a purchase price including expenses of $14.8 million. The residences, five of which are located in Georgia and one in each of South Carolina, Alabama and Florida, were occupied with 481 private pay residents at the time of acquisition. The lease has an initial term expiring in March 2015 with three five-year renewal options.

Since the ALC Purchase, ALC has purchased certain accounting, human resources and information technology services from EHSI. For periods subsequent to March 31, 2005 through the Separation Date, charges related to the consolidated ALC and EHSI operations for accounting, human resources, information technology and certain other administrative services have been allocated based upon estimated incremental cost to support the consolidated operations. Stock options to acquire Extendicare shares granted to ALC senior management have been charged to general and administrative expenses, based upon the number of options granted and the share price for the periods reflected. Interest charges prior to the Separation Date have been allocated based upon:
§ any ALC specific facility-based debt instruments in place with the applicable interest charges;

§ interest incurred by EHSI on the replacement of ALC debt prior to the ALC Purchase;

§ for residences owned by EHSI, based upon the assisted living residences' historic cost and average borrowing rates of EHSI for those periods; or

§ for debt incurred under EHSI's line of credit in connection with the ALC Purchase, the interest incurred on the average balance of the line of credit and EHSI's average interest rate on the line of credit.

Interest charges after the Separation Date are based upon ALC's actual outstanding debt.
In addition, all assets and liabilities associated with the assisted living operations of Extendicare since January 31, 2005, have been reflected in the historical audited consolidated financial statements.
For purposes of the audited consolidated financial statements, residences that were sold or closed have been reported as discontinued operations. Business Overview
Revenues
We generate revenue from private pay and Medicaid sources. For the years ended December 31, 2008, 2007 and 2006, approximately 91.7%, 85.0% and 79.0%, respectively, of our revenues were generated from private pay sources. Residents are

charged an accommodation fee that is based on the type of accommodation they occupy and a service fee that is based upon their assessed level of care. We generally offer studio, one-bedroom and two-bedroom accommodations. The accommodation fee is based on prevailing market rates of similar assisted living accommodations. The service fee is based upon periodic assessments, which include input of the resident and the resident's physician and family and establish the additional hours of care and service provided to the resident. We offer various levels of care for assisted living residents who require less or more frequent and intensive care or supervision. For the years ended December 31, 2008, 2007 and 2006 approximately 78%, 79% and 82%, respectively, of our private pay revenue was derived from accommodation fees with the balance derived from service fees. Both the accommodation and level of care service fees are charged on a per day basis, pursuant to residency agreements with month-to-month terms.
Medicaid rates are generally lower than rates earned from private payers. Therefore, we consider our private pay mix an important performance indicator.
Although we intend to continue to reduce the number of units occupied by residents paying through Medicaid, as of December 31, 2008, we provided assisted living services to Medicaid funded residents at 75 of the residences we operate. Medicaid programs in each state determine the revenue rates for accommodations and levels of care. The basis of the Medicaid rates varies by state and in certain states is subject to negotiation. Residence Operations Expenses
For all continuing residences, as defined below, residence operations expense percentages consisted of the following:

                                              2008      2007      2006
                    Wage and benefit costs      61 %      61 %      62 %
                    Property related costs      21        20        19
                    Other operating costs       18        19        19

                    Total                      100 %     100 %     100 %

The largest component of our residence operations expense consist of wages and benefits and property related costs which include utilities, property taxes, and building maintenance related costs. Other operating costs include food, advertising, insurance, and other operational costs related to providing services to our residents. Wage and benefit costs are generally variable (with the exception of minimum staffing requirements as provided from state to state) and can be adjusted with changes in census. Property related costs are generally fixed while other operating costs are a mix of fixed (i.e. insurance) and variable costs (i.e. food).
General and Administrative Costs
As a result of the Separation, as of the Separation Date, we required services and incurred additional costs associated with being a public company. In addition, certain other general and administrative costs that had been shared with Extendicare since the ALC Purchase were re-established after completion of the Separation. Certain of these costs were in place as of the Separation Date; however, since the Separation Date, we have incurred additional annual public company costs relating to:
§ board of director fees;

§ Sarbanes-Oxley compliance;

§ hiring additional members of the management team;

§ stock registration and listing fees;

§ other general and administrative costs for reporting and compliance;

§ quarterly and annual filings;

§ transfer agent fees;

§ public relations; and

§ directors' and officers' liability insurance.

Subsequent to the ALC Purchase, certain general and administrative services were provided to us by Extendicare. Extendicare's incremental costs, and, in the case of information technologies, the price that Extendicare's related company, Virtual Care Provider Inc. ("VCPI"), sells services to external clients, have been charged to us since the Separation. Some services previously provided . . .