Five Star Senior Living Inc.
Q4 2013 Earnings Call Transcript

Published: 18 Sep 2014

[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, September 18, 2014. 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. Now, I would like to turn the call over to Bruce.

[Bruce Mackey:]

Great. Thanks, Kim. Thank you all for joining us on today's call on such short notice. Before turning the call over to Paul to review our fourth quarter and full year 2013 results, I would briefly like to address the link to the audit process for both the restatement and the 2013 10-K. The areas identified as part of the restatement were primarily related to accounting for non-cash income tax items, which tend to be very complex and time-consuming. While we would have preferred to conclude this process more quickly, the period it took is not atypical given the complexity of these issues. In terms of the 10-K, there were three factors which caused us to be very lengthy and labor-intensive process. First, while our typical year-end audit takes approximately four months from start to finish, the year-end audit process was completely put on hold during the restatement, which concluded in April. Second, there has been increased scrutiny of overall public companies, with regards to Sarbanes-Oxley 404 compliance controls. The reality as this is a new world, where public accounting firms are under unprecedented scrutiny and oversight. Items that historically were quick and easy audit no longer are, especially once you have had a restatement. Lastly, and Paul will discuss this in his prepared remarks, during the 2013 10-K audit process, we identified timing issues related to some of our accounts payable and accrued expenses. Historically, our controls around accounts payable were not designed to accrue routine small dollar expenses. However, when your financial statements are open for five months or so at the year-end, you gain perfect clarity into what your actual expenses versus your accrued expenses and estimates should have been. We identified predominantly smaller dollar invoices, primarily at the community level that were not accrued for year-end. We had a similar situation in both, 2012 and 2011. It was concluded that our results from these periods were not materially misstated, however, cumulative effect would have been material to our year-end 2013 results, and as such we revised 2012 and 2011 for these immaterial changes. Let me emphasize, the adjustments were minor and no impact on our cash flows from operating, investing, or financing activities. This last revision to our financial statements took the balance of the summer to complete. That said, we are pleased to have resolved these matters and would like to thank our shareholders and analysts, for their extreme patience. We will continue to work hard to become current with our first and second quarter 2014 filings and do not expect the process to be nearly as time-consuming given that these are quarterly filings. We look forward to fully focusing on running our business and executing on our strategy to provide enhanced shareholder value. With that, I would like to turn the call over to Paul to review the net effect of our restatement and our financial results. Paul?

[Paul Hoagland:]

Thank you, Bruce. Thank you for joining us. First, I would like to take a minute to walk through the net effect of our restatement, which was filed earlier this year on April 15, 2014. In late November 2013, it was determined by Five Star and our auditors that a restatement of certain previously issued financial statements would be required because of inaccuracies primarily with the company's non-cash income tax accounting. The company had identified the issue during the third quarter closing and had brought it to the attention of our auditors and audit committee. As you know, an income tax is the primary reason for restatement and is extremely complicated due to the judgmental considerations within it. The complexities were further increased by the retrospective adjustments needed to all periods for the divestitures of our pharmacy, rehabilitation hospitals, and discontinued communities in recent years as the company has been executing strategic initiatives to increase the overall percentage of private pay revenue. The net impact of correcting the errors in the 2012 10-K/A filing resulted in increase to our shareholders' equity of $6.7 million and $8.1 million at December 31, 2012 and 2011 respectively. Our net income decreased by $1.4 million and increased by $6.6 million, respectively for the same time period. The net income increase over the two years was $5.2 million and was primarily due to the company's prior practice of accounting for deferred state income taxes based on blended state tax rate approach, which until recently was a standard practice. Also as Bruce outlined, and as a result of the delay of our year-end 2013 10-K filing due to the income tax restatement, the company performed a detailed look back analysis for the first five months of 2014 with regards to our accounts payable and accrued expenses. The company processes over 4,000 invoices totaling $265 million annually for its other senior living operating expenses. This is an average of approximately $660 per invoice. The majority of these expenses and accruals originate in the 260 communities that we operate. As Bruce stated, historically our control was focused on accruing larger dollars expense items. Included in our 10-K is the detail which shows a $2 million increase in our 2012 other senior living operating expenses and a $944,000 decrease in our 2011 other senior living operating expenses. Over the two-year period of approximately $500 million in other senior living operating expenses, the net revision is $1.1 million or two-tenths of a point. Going forward, this immaterial amount is now accrued, should not change significantly from period-to-period. Turning to the fourth quarter, senior living revenues were $269.1 million and were flat to the prior year. For the full-year, senior living revenues were just under $1.1 million, an increase of $3 million from last year. Revenue was negatively impacted by the sequestration mandated Medicare payment rate reduction that went into effect April 1, 2013 and a decrease in occupancy, partially offset by increases in our average monthly rates to residents who pay privately for our services. Management fee revenue from the 44 senior living communities we managed was $2.4 million for the quarter. For the full-year, management fee revenues were $9.2 million, an increase of 59%, primarily as a result of the increased communities we took on during the second half of 2012 and in 2013. We have had early success with our managed properties oversight. We are reporting a loss from continuing operations for the fourth quarter of 2013 of $3.3 million or $0.07 per basic and diluted share, partially due to the flat revenue and primarily as a result of increased expenses, many of them which are non-recurring in nature and I will discussed them in a moment. For the full-year 2013, income from continuing operations was $3.4 million or $0.07 per basic and diluted share compared to $10.6 million or $0.23 per basic and diluted share for the year ended December 31, 2012. Senior living wages and benefits for the quarter were $131.4 million and represented 48.8% of senior living revenues. While this is unfavorable to the 47.8% cost in the previous year's fourth quarter, for the full-year, our senior living wages and benefits increased by only 20 basis. During the fourth quarter, higher cost for employee health benefits and workers' compensation claims were the primary causes for the increase. Other senior living operating expenses for the quarter were $67.5 million and unchanged from last year, and for the full-year were $265.8 million, an increase of 1.5%. As a percentage of senior living revenues, our operating expenses during the quarter were 25.1% and unchanged from last year. For the full-year, other senior living operating expenses were 24.7%, up 30 basis points over 2012, a combination of utilities, purchase services for cleaning and professional liability expenses were the primary causes. Fourth quarter general and administrative expenses were $17.7 million. Included in the quarter were $1 million of non-recurring expenses associated with the cost of the restatement. Excluding this one-time non-recurring expense G&A costs were 5.1% of GAAP revenues and 4.8% of total revenues, including our 44 managed properties. G&A for the year was $63.5 million. Excluding the restatement cost, G&A was 4.8% of GAAP revenues and 4.5% of total revenues, including managed properties. Rent expense for the quarter was $48.8 million, which is 18.1% of senior living revenues. For the full-year, rent expense was $193.8 million, which represents 18% of the living revenues, a 30-basis point increase from 2012. Interest expense for the quarter was $1.2 million and depreciation and amortization was $7.3 million. EBITDA, excluding non-recurring items for the quarter was $7.1 million, a decrease of $4.2 million from last year. EBITDA was primarily impacted by $3.5 million of higher cost of employee health benefits and workers' compensation claims, $1.1 million of lost EBITDA due to the poor communities and renovation and Scott will discuss this in a bit. Audit fees of $1 million associated with the restatement and rent increases of $1 million. EBITDAR, excluding non-recurring items for the quarter was $55.9 million versus $59.1 million in the prior year. For the full year, it was $232.6 million versus $234.5 million in the prior year. Now I will review our liquidity, cash flow and selected balance sheet items. Cash used in operating activities quarter was $2.6 million and operating cash flows for the full-year were $35.8 million. During the quarter, we invested $16.5 million of capital into our communities and sold $4.7 million of long-term capital improvements. At December 31, 2013, we had cash and cash equivalents of $23.6 million. At quarter end, we had $340.3 million of net property and equipment, which includes 31 properties directly owned by Five Star, 11 of which are unencumbered by debt. $37.6 million of mortgage notes payable. At year-end, we had $35 million outstanding in our two credit facilities and are currently at $20 million today. We have total borrowing capacity of $175 million. At the end of the quarter, our leverage with 21% of book value and 12% of assets, we believe where compliance with all material terms of our credit, note and mortgage agreement. Now, I would like to turn the call over to Scott, who will walk you through our key operating results and initiatives. Scott?

[Scott Herzig:]

Thank you, Paul. I am pleased to report that we have seen improvement in both, occupancy and rate during the first half of 2014. As of today, total senior living occupancy stands at 86.3%, which is 70 basis points higher than the fourth quarter's average of 85.6%. Total senior living occupancy was 85.8% in the first quarter and 85.7% in the second quarter. Occupancy at our owned independent assisted-living communities was 87.5% in the fourth quarter, 87.4% in the first quarter and improving to 87.6% in the second quarter. Independent assisted-living occupancy at our least communities was 88.7% for the [first] quarter, 80.6% in the first quarter and improved to 88.9% in the second quarter. Total CCRC occupancy was 82.7% for the fourth quarter, improving the 83.6% in the first quarter was 83.1% in the second quarter. Our skilled nursing facilities reported occupancy of 80.9% for the fourth quarter 80.4% in the first quarter and 79.7% in the second quarter. As a reminder, the majority of our freestanding skilled nursing facilities are in small rural markets and continue to struggle to improve occupancy in a difficult operating setting which only supports our strategy of continuing to increase our private pay revenues and limit our dependence on government-funded programs. Finally, our managed occupancy in the fourth quarter was 87.9% improvement to 88.8% in the first quarter and 80.5% in the second quarter. Overall senior living average monthly rates increased 0.5% year-over-year in the fourth quarter, 1.2% in the first quarter of 2014 and a healthy 2.0% in the second quarter of 2014, just back within our targeted range of 2% to 3% year-over-year growth. Looking at our owned and leased communities, average monthly rates were solid and increased 1.9% in the fourth quarter of 2013, 2.0% in the first quarter of 2014 and 2.2% in the second quarter of 2014. We are pleased with the improvements we are seeing in the side of our business in the first half of 2014, I would expect these positive trends to continue. While the restatement and 10-K filing impacted both, Paul and Bruce's time and attention, it is important to note that I along with my teams have not been impacted and had been able to focus 100% on the operations of our business and the rollout of some key initiatives, a few of which I would like to briefly share. First, we completely revamped our sales training program late last year and have conducted intensive mandatory training for every sales team member and ED in the company, which focused on external lead development and effective closing techniques. More than 500 team members participated, making this our largest training project in company's history. Going forward, the new sales training programs is serving as an effective platform for on-boarding new team members and is conducted at the beginning of their Five Star tenure. On top of the rollout of our sales training, we are in the process of overhauling Five Star's digital presence which includes developing a brand-new website along with new web marketing campaigns. Given that 70% of our leads come in through online channels, consistently upgrading our technology initiatives to engage and convert more these leads is critical to our business. All of our sites are currently being rebuilt with improved search engine optimization capabilities. Post-launch later this year, we will be rolling out some new aggressive online marketing campaigns. We believe that once our new sites are optimized, coupled with these campaigns, we will generate superior leads from both, a quantity and quality perspective. Finally, in an effort to further differentiate ourselves from the competition and enhance our dining program, we partnered with an unbelievably talented celebrity chef named Brad Miller, who is the executive chef at the renowned Inn of the Seventh Ray in Los Angeles, and who was a former contestant on Hell's Kitchen among numerous television appearances. To-date, Chef Millers has filmed a series of video demonstration for residents and chefs and added some signature items to all of our menus. Chef Miller is currently in the process of hosting nationwide events for our residents and cooking challenges with our chefs. Not only are these events providing a little inspiration to our already talented chefs, but they are also a fantastic opportunity for us to host referral sources, create positive buzz in our communities and ultimately improve occupancy. Countless studies continue to show that food and dining is a major consideration for seniors and their families when choosing a community and engaging with Chef Miller further helps to differentiate Five Star. Now, turning to our Rehab to Home projects, as you will recall this program converts existing skilled nursing beds in our CCRCs to high and private rehab suites. First, I want to provide an update on the success of our Rehab to Home project in Myrtle Beach, South Carolina. This particular project was slightly different from our completed Rehab to Home projects and that is part of the upgrade to private suites. We also elected to voluntarily exit the South Carolina Medicaid program at this particular community in favor of additional short-term Medicare beds. This project started to open in the middle of last year and is exceeding our expectations. This past March, the memory unit construction was completed at this community as well. Move in activity has been brisk for this unit. As of last week, we already 8% occupied. Last year, we also began two Rehab to Home conversion projects at two of our CCRCs, one in the Scottsdale, Arizona, and one in West Dallas, Wisconsin. Scottsdale property was completed and opened in March of this year is going up as expected. The West Dallas project was a large multi-stage renovation project, which saw first floor opening January and the remaining two floors opened in July. Move in activity has been robust and the local area around the community is excited with the new upscale, short-term rehab options that we can now offer the city of West Dallas. We are continuing to evaluate opportunities to convert units with our other CCRCs throughout the portfolio and will update you on progress on future calls. One last conversion project we mentioned earlier calls, we close converted and repositioned the community in Alabama. This community was recently reopened and is filling up as expected. As we had mentioned previously, we believe that the long-term benefits of closing repositioning and ultimately reopening these communities will far outweigh the short-term losses to our company, occupancy and EBITDA, which we estimate was approximately $1.1 million for the fourth quarter. As a result of our investments, these communities will now be better able to compete with the changing competitive landscapes in their given market. I will now turn the call over to Bruce.

[Bruce Mackey:]

Great. Thank you, Scott. I wanted to moment to talk about our strategic initiatives. We continue to make progress on limiting our exposure to government-funded programs. In the fourth quarter, our revenues derived from residents' private paid sources at our owned and leased communities increased 70 basis points to 76.8% compared to a year ago. While we made substantial progress, our strategy is to drive our percentage of private pay revenues even higher. Over the past 12 months, we continue to reposition our portfolio to support this important initiative. To that end, on December 31st, and ahead of schedule, we announced that we had completed the disposition of our two Greater Boston inpatient rehabilitation hospitals. The rehab hospital results were included in discontinued operations during the second half of 2013. Our annual rent was reduced by $11.5 million, however we are still responsible for approximately $2 million of rent per year going forward which is included in our continuing operations. This transaction is a great long-term move for Five Star given that the Medicare environment changed quite dramatically as we took on the operations in 2006, making it difficult to scale the business and operate with consistent profitability. With the completion of this transaction, Five Star is now 100% focused on operating senior living communities. In addition to the rehab hospital sales, senior housing close on the sale of one skilled nursing community that we leased and operating with a 112 units in August of 2013. One underperforming assisted-living community we leased and operated with 48 units this past January and two skilled facilities we leased and operated with a combined total of 155 units in June. The remaining seven communities, which are primarily skilled nursing facilities are included in discontinued operations and are currently being marketed for sale. Four of the seven communities, with a combined total of 278 units, are currently under agreement to be sold. Although, we expect to sell these communities by the end of 2014, which will strengthen our mix and enable us to focus on our core business of operating private pay, senior living communities in areas where we have a geographic concentration. Recapping our growth in 2013, we begin to manage five senior living communities with a total of 374 units. In August, we began to manage one senior living community with 92 units located in Georgia. In October, we began to manage three senior living communities with a total to 213. That is located in Georgia and in Tennessee. In November, we began to manage one additional senior living community with 68 units located in Wisconsin. All these communities are majority assisted-living, private pay and fit within our geographic footprint of operations. We also renewed and extended a lease for four private pay assisted-living communities with approximate 200 units with HCP, Inc. during the third quarter. These four communities produced positive EBITDA and are located in attractive markets where Five Star has a strong presence. However, as a result of this renewal, our annual rent payable HCP increased by almost $1 million. During the second half of 2013, we recorded about $500,000 of additional rent payable to HCP. These communities still produce over $1 million of EBITDA for Five Star on an annual basis, even take into account the additional rents. In addition, we expect to invest capital in these communities, possibly expand one or more of them. Most importantly, we expect to grow EBITDA from these properties over time. Turning to our more recent acquisition and growth initiatives, in May of 2014, we acquired a senior living community in Dothan, Alabama our own balance sheet for approximately $20 million, which included the assumption of approximately $14 million of mortgage debt and excludes closing costs. This is the first acquisition we have done on our own balance sheet since 2011 and it was funded with cash on hand and borrowings under our revolving credit facility. This community is a perfect fit for Five Star as it is a 100% private pay and it is located where we have a strong geographic presence. The community has a 16 units comprised of independent living, assisted-living and memory care with average monthly rents $3,700 and average occupancy has consistently exceeded 95%. This transaction is expected to increase annual revenue by $4.8 million and contribute approximately $2 million of EBITDA. In July of 2014, Senior Housing entered into an agreement to acquire assisted-living facility in Wisconsin, which we expect to begin managing by the end of year. This community is located in area where Five Star has a strong geographic presence, has 52 units and is a 100% private pay. We expect to remain active in sourcing deals for the remainder of the year and are optimistic that we will continue to expand our private pay portfolio. Although, 2013 had some challenges, we expect to see significant improvements as we progressed through 2014 and beyond, especially given our increasing private pay mix and the revenue producing improvements we are making to several of our communities. Occupancy growth remains one of our highest priorities. Current occupancy of 86.3% is a healthy increase of 70 basis points from our fourth quarter average. Increasing rate is another priority and a very powerful agent of revenue growth. Average monthly rate for the fourth quarter was up 0.5% compared to last year. However, the average monthly rate for owned and leased independent and assisted-living communities increased by 1.9%. Like occupancy, average monthly rate also improved in the first and second quarters and were within our target range of increasing private pay rates between 2%and 3% on an annual basis. Before we open up the call for questions, I would like to provide some color on the first six months of 2014. At this point in the process, we are extremely limited as to what we can discuss. As you can imagine, our accounting and financial reporting department has been entirely focused on issuing our 2013 10-K

[Operator:]

Thank you. (Operator Instructions) Our first question is from Darren Lehrich from Deutsche Bank. Please go ahead.

[Darren Lehrich:]

Hi. Thanks for taking the question. You gave us the spot numbers for occupancy and rate for Q1 and Q2 this year, but I was hoping if you could give us a little color on how occupancy has progressed through the year?

[Bruce Mackey:]

Sure. I mean, it has progressed up. We have seen better metrics in terms of our move-ins, our lead volume was and slightly up, and occupancy has progressed up mostly in our independent assisted-living communities.

[Darren Lehrich:]

Okay. Great. Thanks. Could you give us just a little color on the workers' comp expenses that that have ticked up. Is that an anomaly or is that something that you expect to be higher going forward?

[Paul Hoagland:]

I mean, I don't think we would characterize it as an anomaly. We really did a pretty significant overhaul to the way we administer workers' compensation claims management here in 2011. In 2012 and in early 2013, we were seeing some of the fruits of that from the standpoint of was there reductions, again workers' compensation has, in some cases, an 18-month trail to it. As we entered, the last half of 2013, we saw slight upticks in workers' compensation claims in the fourth quarter of 2013, and they were rolling over slight decreases at the end of 2012. Again, our programs are fully self-insured, self-funded. When you look at whether it is things like the workers' compensation modification factor or the pure premium, which is your actual claims as a percentage of payroll, the company does very well by industry standards, and we will continue to find ways to make improvements.

[Bruce Mackey:]

Maybe other thing that I would add, workers' compensation claims really comes on a frequency and severity and frequency really held I think pretty well. We did see a slight uptick in severity, which we are working to bring back down, but that was another thing that really kind of drove that a little bit as well.

[Darren Lehrich:]

Okay. Thank you.

[Bruce Mackey:]

Yes.

[Operator:]

(Operator Instructions) We will go to Daniel Bernstein with Stifel. Please go ahead.

[Daniel Bernstein:]

Good morning. I hope you can hear me, I am a little under the weather here.

[Bruce Mackey:]

Yes. We hear you.

[Daniel Bernstein:]

Okay. Good. If you expecting, one half '14 EBITDAR a little bit lower than the second half of '13, I assume that you had some issues with expenses on the weather side in the first quarter. If you could talk a little bit more about your expenses in the first half '14 versus the second half '13, if you could.

[Bruce Mackey:]

I really can't get into it too much, Dan, because we haven't really closed those periods down. I mean, you’ve got to take into account we really had to start that process, we had to finish the last process, and we finished it last night at 5

[Daniel Bernstein:]

Okay. Is there a timeframe to complete the 1Q and 2Q quarterly reports or you have a sense of when that might get completed. I assume those are little bit easier than the 10-K.

[Bruce Mackey:]

You are correct. I mean, we are not going through another process. They are easy. There is no timeframe other than saying it is as quick as possible, so we are refocusing all of our efforts to get that done and to get current as quick as possible. I really can't predict right now how long that will take.

[Daniel Bernstein:]

Okay. Are there other assets aside from the seven senior housing assets that you are selling with SNH that you are thinking about disposing at this point or are you mainly done with the calling of the portfolio?

[Paul Hoagland:]

I would say, we never really were done with the calling of the portfolio. We look at it from time-to-time and it is possible that once we are finished with these seven now, we will take a look at and maybe move in some others.

[Daniel Bernstein:]

Okay. On the flipside of that, you did acquire an asset, I guess, it was $19.9 million asset. Are you looking once this financing accounting restatements completed to maybe pick up the pace of acquisitions, once you get free and clear of the accounting restatements, what is the going strategic plan that you really want to concentrate on?

[Bruce Mackey:]

Again, kind of harking back to what I said, our strategic plan is to continue to grow our private payments of properties, and I just said that, you know, that might include calling of some of our existing portfolio. We will continue to work, be it, leasing assets, managing assets, or buying our own balance sheet. This restatement didn't have a huge impact on our ability to acquire properties and do additional management deals. We did that one in Alabama, like you mentioned. We did another four or five at the end of last year. We have got one under our belt, so far this year in the management opportunity, we expect that we very close on the management opportunity, and we still continue to look at all of our priorities. We are very selective in what we take on, but we know we are touring at least probably one or two properties a week across the country and very few make it up to our criteria what we want to take on, but the ones that we do, we are pretty happy with. I can't say that restatement really impacted that too much. It's probably us just being a little bit more selective than maybe some of our competition.

[Daniel Bernstein:]

Do you feel like you need a lot more scale though than what we have now? I mean, Brookdale was sitting at 120,000 units, you are at, what about 3,000 or so. Do you feel like you need to get a lot larger than where you are today?

[Bruce Mackey:]

No. We are the second largest public senior living operator now after Brookdale City. There is a huge span between us. I don't think we need to scale rapidly.

[Daniel Bernstein:]

Okay.

[Bruce Mackey:]

Would I be opposed to it, no, if the right deal came along, but I think we feel pretty good with where we are right now.

[Daniel Bernstein:]

Okay. Yes. I was just trying to understand the pace of the strategic change that you were talking about.

[Paul Hoagland:]

It is really opportunity based, and it is tough to say we are going to go out and want to do 2,000 units next year. Sure, we would like to do it if the right units were there, but again it's opportunity-based.

[Daniel Bernstein:]

Okay. I will hop off. Thanks.

[Operator:]

Thank you. At this time, there are no further questions in queue. Please continue.

[Bruce Mackey:]

We would like to thank you all for joining us today and we look forward to updating you on our first quarter results as soon as it is available. Thank you.

[Operator:]

Thank you. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive TeleConference. You may now disconnect.