Five Star Senior Living Inc.
Q4 2014 Earnings Call Transcript

Published: 17 Mar 2015

[Operator:]

Good day and welcome to the Five Star Quality Care Conference Call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Director of Investor Relations, Ms. Kimberly Brown. Please go ahead.

[Kimberly Brown:]

Thank you and good morning everyone. Joining me on today’s call are Bruce Mackey, President and CEO; Paul Hoagland, Treasurer and CFO; and Scott Herzig, Chief Operating Officer. The agenda for today’s call includes a presentation by management followed by a question-and-answer session. I would also note that the transcription, recording and retransmission of today’s conference call are strictly prohibited without the 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, March 17, 2015. The company undertakes no obligation to revise or publicly release the results of any revisions 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 statement. 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. Now, I would like to turn the call over to Bruce.

[Bruce Mackey:]

Thanks, Kim, and thanks everyone for joining our earnings call. Before I review our fourth quarter results, I’d like to address two matters which were disclosed in last night’s earnings release that significantly impacted our fourth quarter results. First, during 2014, as a result of a Five Star established compliance program to review medical records related to Medicare billing practices, we discovered potentially inadequate documentation and other issues at one skilled nursing facility. The compliance review was not initiated in response to any specific complaint or allegation, but it was a review of the type that we periodically undertake to test our compliance with applicable Medicare billing rules. As a result of these discoveries, we have made a voluntary disclosure to the U.S. Department of Health and Human Services Office of the Inspector General, or OIG, pursuant to the OIG’s Provider Self-Disclosure Protocol. While the assessment of these matters is ongoing, we have notified the OIG that we expect the investigation and assessment to be completed by mid-May. As of December 31, 2014, we have accrued a revenue reserve of $4.3 million to account for historical Medicare payments we expect to repay and we’ve accrued our expensed compliance costs of $3.6 million, which includes an expected penalty amount and certain costs of the investigation of this matter. I want to reemphasize that this was a routine compliance assessment initiated by Five Star in connection with our own compliance program and not because of any specific compliant or allegation involving any of our communities. I also want to note that as part of our compliance program, Five Star conducted its review at certain other less skilled nursing facilities and determined that the deficiencies identified are isolated to this one skilled nursing facility. The second matter I’d like to address is that we booked income tax expense of $60.9 million, of which $73.3 million is a non-cash income tax charge recorded to establish a full valuation allowance against the future realization of our net deferred tax assets. Paul will discuss the details of this tax charge in a few minutes. I do want to stress that both of these matters are either largely one-time in nature or non-operational. All amounts that we discuss in the remainder of this call will exclude the impact of these matters so that investors will get a more accurate understanding of our core results. Turning to our fourth quarter results, revenue increased 3.6% compared to the fourth quarter last year, primarily due to growth in occupancy and average monthly rates at our independent and assisted living communities. Overall, occupancy increased 50 basis points and we increased rates at our independent and assisted living communities within our target range of 2% to 3%. EBITDA, adjusted for non-recurring items, was $9.2 million, representing a return to a more run rate on a dollar basis after what’s been a challenging 2014 from an expense standpoint. Fourth quarter EBITDA returned to growth and increased 5% quarter over quarter to $58.8 million. In 2015, we expect continued expansion in recurring EBITDA and EBITDAR as a result of our marketing programs, continue to gain traction and fuel occupancy growth, capturing additional rate increases in our communities, keeping routine cost in check and leveraging the synergies gained through acquisitions and expansions. To that end, I’d like to provide a recap of our growth in 2014 which included one acquisition on our own balance sheet and two management deals. In May, we acquired a 100% private pay senior living community in Alabama for approximately $20 million. This acquisition is expected to increase annual revenue by $4.8 million and contribute $2 million of EBITDAR. We now own a total of 31 communities with the goal capacity to do more deals on our own balance sheet. In December, we began to manage two private pay communities in Wisconsin, a state where Five Star already has a strong geographic presence. These communities are 100% private pay and include independent living, assisted living and memory care. I’d like to talk about an additional acquisition we expect to close in our own balance sheet which we are completing due diligence on. This acquisition is comprised of two communities with a combined total of 152 private pay independent living units located in Tennessee for approximately $26 million. Annual revenue is expected to be approximately $3.8 million, with a healthy EBITDAR contribution of approximately $1.9 million. This deal is still in due diligence phase and assuming the process continues to go well, we would expect to close later this year. We plan to remain active in sourcing deals in 2015 and are optimistic that we would continue to expand our private pay portfolio. Currently, we expect our growth to primarily come from acquisitions on our own balance sheet or through management arrangements. At December 31, the percentage of private pay revenues was 77.5%, an increase of 70 basis points compared to the fourth quarter of 2013. Part of our success in driving this percentage higher is due to the disposition program we embarked on more than a year ago. To date, we have sold eight of the 11 communities, the majority of which was skilled nursing facilities and expect to sell the remainder in 2015. 2014 was not a year without its challenges, however, if you look at our core business, we have increased revenue each and every quarter, grow occupancy and rate, initiate marketing programs that are producing results and maintain effective cost control over routine operating expenses. We are optimistic that as we turn the page in 2015 and expect continued expansion in recurring EBITDA and EBITDAR during the year. I would now like to turn the call over to Scott.

[Scott Herzig:]

Thank you, Bruce. First, I’ll review fourth quarter occupancy results and provide a quarter over quarter comparison for each portfolio. With the exception of skilled nursing, we had solid growth across all property types. Total senior living occupancy increased 50 basis points to 86.2%. Occupancy at our owned independent and assisted living communities increased 120 basis points to 88.7%. Independent assisted living occupancy at our leased communities increased 60 basis points to 89.3%. Total CCRC occupancy increased 70 basis points to 83.6%. Our managed occupancy improved 50 basis points to 88.4%. And finally, our skilled nursing facilities reported occupancy of 79.3%, down 160 basis points and caused the biggest drag in our overall occupancy, which is why we continue to execute on our strategy of increasing our private pay revenues and limiting our dependence on government-funded programs. With the exception of our skilled nursing facilities, we made great strides in our occupancy gains during the fourth quarter of 2014. As of last Friday, total senior living occupancy was 85.7%, down since the fourth quarter which is seasonally typical in the first quarter and primarily related to some issues with the flu in both January and February. On a more positive note, we are very encouraged by the move in activity we’ve been seeing so far in the first quarter, which is up 2% over last year. Despite the fact that move in activity has not been enough to offset the move-out, which is primarily due to increased depth of a need for higher level of care, the momentum we’re seeing is expected to bode well for a healthy rebound in occupancy during the second quarter. Turning now to rates, overall senior living average monthly rates increased 1.9% year-over-year in the fourth quarter. Looking at each portfolio, fourth quarter average monthly rates increased 3.2% at our owned senior living communities, increased 2.4% at our leased senior living communities, increased 2.2% at our CCRCs and increased 1.3% at our skilled nursing facilities. We will continue to push rate increases across the company between 2% and 3% throughout 2015. Turning to some of our key sales and marketing initiatives, as I mentioned on our last call, we’ve made significant investments in our digital strategy and I’m pleased to say that phase 1 of this process was completed during the fourth quarter with the launch of our consolidated website featuring improved search engine optimization and a more user friendly interface. Phase 2 is currently in the work and includes live chat functionality, web marketing campaigns, online resident reviews and community floor plans and menus, just to name a few. These tools and content rich enhancements are expected to improve the conversion rates of our website leads and further enhance our presence on the web. On the food and dining front, we extended our partnership with celebrity chef Brad Miller who is committed to working with Five Star again throughout 2015. Chef Miller will continue to host community events and cooking challenges which serve as productive opportunities for us to host referral sources, entertain residents and ultimately improve occupancy. Occupancy at the 10 communities where we hosted events last year experienced significantly higher growth rates than our overall portfolio. Our overall partnership with Chef Brad continues to bear fruit and we have plans to host 15 more community events in 2015. Now turning to our rehab to home projects, as you’ll recall this program converts existing skilled nursing beds in our CCRCs to high-end private rehab suites. As I mentioned on the last call, we have two new projects underway, one is in Kentucky and the other is in South Carolina. On the expansion front, we have two projects in process, one in Texas and the other in Tennessee. These two projects will add a combined total of 50 units split between assisted living and memory care. We currently operate a 100% occupancy at both of these communities and as a result of our expansion investment, they will be better able to accommodate the market demand and significantly drive EBITDAR at these communities. Given the success of these projects, we are actively evaluating additional rehab to home and expansion opportunities throughout our portfolio. I will now turn the call over to Paul.

[Paul Hoagland:]

Thank you, Scott, and thank you for joining us today. I’d like to start with a discussion about the two matters that Bruce has covered in his opening remarks. First, our Q4 results were impacted by the self-disclosed compliance matter that Five Star discovered by its own internal audit and compliance oversight. This resulted in a reduction of $4.3 million of senior living revenues and EBITDAR, specifically within our skilled nursing results. In addition, there was $3.6 million of incurred expenses that are in our senior living other operating expenses in our skilled nursing results. During my prepared remarks today, I will exclude these items from my discussion and analysis, as they are one-time and non-recurring in nature. Second, the company has established a full valuation allowance against its net deferred tax assets. As such, we have recorded increases to our valuation allowance totaling $73.3 million non-cash during the year ended December 31, 2014. As a result of losses primarily due to the compliance matter and recent accounting cost for the 2012 restatement, the company concluded that it expect it to be in a three-year cumulative loss position at the end of the three-year period. While the company has successfully utilized over $130 million of federal net operating losses in the last seven years and used $28 million in 2012 alone, we have recorded this allowance at this time. Our net loss from continuing operations was $70.1 million and $79.4 million for the fourth quarter and full year, respectively, primarily due to this valuation allowance recorded in Q4. For the fourth quarter, senior living revenues increased comparatively by 3.6% to $278.9 million in the fourth quarter of 2014 from $269.1 million in the fourth quarter of 2013. Management fee revenues were $2.5 million and $9.8 million for the fourth quarter and full year, respectively. Senior living wages and benefits for the quarter were $131.1 million, which are 47% of comparative senior living revenues, an improvement of 180 basis points from the fourth quarter 2013. We experienced improvements in virtually all areas of wages and benefits. Employee health insurance costs have returned to average levels versus the higher costs experienced earlier in the year. Other senior living operating expenses when adjusted for the compliance matter were 26.7%, up 160 basis points from the fourth quarter of 2013. As we previously mentioned, the company has experienced an increase in purchase service and has outsourced a portion of its housekeeping expenses. This has helped us reduce wage and benefit costs and we believe has improved the experience of our communities. The company has also experienced higher marketing costs associated with the investments in its initiatives to increase occupancy. And as Scott has mentioned, these investments are paying off given the improving move in activity. General and administrative expenses were $18.2 million for the quarter and increased 3% over the cost incurred in the fourth quarter 2013. While we did incur additional one-time accounting expenses totaling $1.2 million in Q4 as we became current with our 2014 quarterly filings, we’re pleased that we have filed our 2014 10-K in a timely basis. Our accounting expenses in 2015 are expected to return to the levels that the company incurred in 2012. Recurring G&A costs for the full year was $66.5 million or 4.6% of total revenues including our 46 managed properties. Rent expense for the quarter was $49.6 million or 17.8% of comparative senior living revenues and for the full year, it’s 17.9%. It continues to decrease as we acquire properties on our balance sheet and in Q4 of 2014 it decreased 30 basis points was the fourth quarter of 2013. Interest expense was $1.3 million and depreciation and amortization was $8.3 million for the quarter. As we have discussed, EBITDA and EBITDAR were adversely impacted by $7.9 million due to the compliance matter and $1.2 million due to the accounting restatement costs. EBITDA excluding these non-recurring items was $9.2 million for the quarter, an increase of over 30% from last year. And recurring EBITDA was $58.8 million for the quarter. Now I will review our liquidity, cash flow and selected balance sheet items. Cash flow from operating activities was $22.3 million for the full year. For the full year, we invested $49.9 million in capital into our communities and sold $25.8 million of long-term capital improvements. At year-end, we had $21 million of cash and cash equivalents. At year-end, we had $357.2 million of net property and equipment which includes 31 properties directly owned by Five Star, 11 of which are unencumbered by debt. At year-end, we had $35 million outstanding on our two credit facilities and $51.2 million of mortgage notes payable. We are currently at $30 million outstanding, out of our total availability of $175 million. At the end of the quarter, our leverage was 27% of book value and 16% of assets. We believe we are in compliance with all material terms of our credit, note and mortgage agreements. In summary, while 2014 was a challenging year for Five Star, our core business continued to grow and we made good progress at our communities. Our sales and marketing programs are gaining traction as evidenced by our gains in revenue, occupancy and rate throughout the year. In addition, recurring EBITDA and EBITDAR began to return to a more normalized run rate in the fourth quarter and we expect this will continue to grow throughout 2015. With that, Bruce, Scott and I are happy to take your questions. Thank you.

[Operator:]

[Operator Instructions] And our first question comes from the line of Dan Bernstein with Stifel.

[Dan Bernstein:]

Do you have any expectations you can provide on what you think occupancy rate margin could be for 2015 or at least certain, obviously you can’t predict exactly, but what are your internal expectations for how you expect your performance to improve in 2015 over 2014?

[Bruce Mackey:]

No, we expect improvements and as Scott already said in the prepared remarks, we’re seeing some of our initiatives pay off already in 2015 in terms of leads are up, our movements are up year over year so far, unfortunately like a competitors have also publicly announced already that unfortunate move-outs have not kept pace with the move-in to date. But we expect that to turnaround in the second quarter, seasonality plays a big part in that. The [Nic Mountain] is projecting a 50 basis point odd increase, roughly a 50 basis point increase in occupancy; we don’t see why we shouldn’t be able to keep pace with the Nic Mountain.

[Dan Bernstein:]

In terms of rate growth, I guess last year was a little bit under 2% the way I calculate it [indiscernible] housing, is that the expectation for 2015 or do you think you can improve some rate in 2015 over 2014?

[Bruce Mackey:]

I think you are also including our SNF rate growth as well in that amounts. If you look at our private pay rate growth was higher than that and we expect that we should be able to keep pace with what we did in 2014 on our private pay portfolio.

[Dan Bernstein:]

In terms of the impact of the flu, how would you compare this year’s flu season to say the 2012, 2013 flu season that was difficult, are you starting to still – should we expect occupancy to dip further at least on the average side, did into second quarter like it did in 2013 or are you seeing some differences in terms of the move-outs this year versus 2013 period. Just trying to get a sense as whether occupancy is going to dip further in the second quarter and then rebound in the second half, or whether we might be able to get a little bit of a bump in the second quarter?

[Bruce Mackey:]

I think it’s a good question. I think the flu is probably not as prevalent this year as it was two years ago, it’s definitely worse than it was last year and how fast we recover from it remains to be seen. But again, I can point to what we’ve disclosed so far in January and February, movements are up, so we didn’t see that two years ago to the extent we’re seeing it this year. So we expect to recover quicker than we did two years ago.

[Dan Bernstein:]

Two years ago, occupancy bottomed in first month of the second quarter, I believe, right?

[Bruce Mackey:]

Yes.

[Dan Bernstein:]

And then just on the SNF compliance issues, you said it’s just isolated to one property, are you still examining other skilled nursing properties or is it – you’re fairly certain then it’s probably just going to stay isolated to this one property? In other words, is there something that was in your – that could be systemic or was it something isolated to say with ED or whoever the person in charge of recounting their billing in that facility, was responsible for him, just trying to think that whether it’s systemic or something just isolated?

[Bruce Mackey:]

At this time, we believe it’s not systemic, it’s isolated to that one facility, and you mentioned ED, and it’s exactly right. I think we’ve got a good long-term history of compliance and we just had employee at the facility that didn’t follow our policies and procedures. And we conduct a number of reviews on an ongoing basis year after year and again, we think it’s isolated to this one facility at this point in time.

[Operator:]

And we do have a question from the line of Brian Tanquilut with Jefferies.

[Brian Tanquilut:]

First question for you, you kind of framed the guidance, it seems like your expected occupancy to improve over the course of the year in rate and margin at the same time, is that right [indiscernible] how you’d expect the progression over the course of the year?

[Paul Hoagland:]

Little gobbled to some extent, but I think we don’t give guidance as you know, but we do overall we are saying that based on what we’ve seen so far in January and February, and what our internal reports are showing that occupancy – move ins again have gone up, having kept pace with the move-outs, but we think there’s some significant seasonality in that. We know that we’re going to get rate growth at 7% to 8% of our communities in terms of the private pay and it’s going to be in that 2% to 3% range, probably close to the 3% range. We expect that labor and most routine operating costs will remain in check, nothing at this point indicates that what we’ve seen in the past shouldn’t continue in the future.

[Brian Tanquilut:]

And then in your filing, you announced the acquisition of two community areas in Tennessee, if I just, are you seeing the potential impact of that in terms of the cost and the revenues that you’re expecting from those deals?

[Paul Hoagland:]

Yes, give me a second here, on that, it’s two communities, 100% private pay, roughly 150 units, about $26 million, there’ll be some debt assumed with the deal, annual revenues from the two communities will be about $3.8 million with EBITDAR contribution of $1.9 million.

[Brian Tanquilut:]

And then last question from me, you alluded to your digital marketing program in your prepared remarks, are there any metrics that you can give us around that in terms of the contributions that you’ve seen so far or even qualitative comments on how that’s driving occupancy growth?

[Bruce Mackey:]

So far we are seeing some nice activity on the lead generation side. If you look at our leads Q1 so far, we’re up 6% year over year. I think we said our move-ins are up, we just haven’t kept pace with the depths in the move-outs that are really seasonal in nature and related to the flu. We’ve had some good activity with the Chef Brad initiatives that we’ve put out there, we’re getting to be known as the place that provides a high quality food product and people are coming just to experience that. We’ve got a lot of sales trainings that goes on regularly for our buildings, a lot of it is focused on the Medicare side where we’ve got some opportunity to move the needle. So I mean, there’s a lot of programs that we work at regularly to continue to move our occupancy needle.

[Operator:]

And then, at this time for closing remarks, I’d turn the call back over to Mr. Bruce Mackey. Please go ahead, sir.

[Bruce Mackey:]

Great, thank you very much. Well listen, I’d like to thank everybody for joining our call this morning and we look forward to updating you on our future progress.

[Operator:]

And ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using the AT&T Executive Teleconference service. You may now disconnect.