Gen Digital Inc.
Q1 2019 Earnings Call Transcript

Published: 10 May 2019

[Operator:]

Good morning. My name is Tom and I will be your conference operator today. At this time, I would like to welcome everyone to the Genesis Administrative Services (sic) [Genesis Healthcare, Inc.] First Quarter 2019 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the conference over to Lori Mayer, Vice President of Investor Relations. Ma'am, please go ahead.

[Lori Mayer:]

Good morning and thank you for joining us today. We issued our earnings press release last evening. This announcement is available in the Investor Relations section of our website at genesishcc.com. A replay of this call will also be available on our website for one year. Before we begin, I would like to quickly review a few housekeeping matters. First, any forward-looking statements made today are based on management’s current expectations, assumptions and beliefs about our business and the environment in which we operate. These statements are subject to risks and uncertainties that could cause our actual results to materially differ from those expressed or implied on today’s call. Listeners should not place undue reliance on forward-looking statements and are encouraged to review our SEC filings for a more complete discussion of factors that could impact our results. Except as required by federal securities law, Genesis Healthcare and its affiliates do not undertake to publicly update or revise any forward-looking statements or changes that arise as a result from new information, future events, changing circumstances or for any other reason. In addition, any operation we mention today is operated by a separate independent operating subsidiary that is -- that has its own management, employees, and assets. References to the consolidated company and its assets and activities, as well as the use of the terms we, us, our and similar verbiage are not meant to imply that Genesis Healthcare has direct operating assets, employees or revenue or that any of the various operations are operated by the same entity. Our discussion today and the information in our earnings release and in our public filings include references to adjusted EBITDAR, EBITDA, adjusted EBITDA, which are non-GAAP financial measures. We believe the presentation of non-GAAP financial measures provides useful information to investors regarding our results, because these financial measures are useful for trending, analyzing and benchmarking the performance and value of our business, but such non-GAAP financial measures should not be relied upon at the exclusion of GAAP financial measures. Please refer to the company's reasons for non-GAAP financial disclosures and its GAAP to non-GAAP reconciliations contained in today's earnings release. And with that, I'll turn the call over to George Hager, CEO of Genesis Healthcare.

[George Hager:]

Thank you, Lori. Good morning and thank you for joining us today. I would like to make a few brief comments regarding our positive operating performance and our successful transactional activity during the first quarter. I will then turn the call over to Tom DiVittorio, Genesis’ Chief Financial Officer, for more details on our results and other updates. First, I am pleased we were able to build on our recent momentum, with another strong quarter of improving operating trends, earnings growth and the successful execution of our portfolio optimization strategy. Beginning in the back half of 2018, we reported favorable trends with respect to many of the key performance indicators that drive our business; favorable trends that we have not seen since the 2014-2015 timeframe. Our first quarter 2019 results continued these positive trends, showing same-store occupancy growth for the second consecutive quarter and same-store EBITDAR growth for the third consecutive quarter. I would like to highlight very strong same-store EBITDAR growth of 6.5% this quarter versus the prior year quarter. These improving results reflect a more stable census and reimbursement environment, effective cost management, improvement in our therapy and staffing businesses, and the impact of continued portfolio of management activities. Even though we have not highlighted our ancillary divisions in the past, our rehab division GRS and our staffing division career staff, these divisions also showed very strong performance in the quarter. Combined, our ancillary divisions produced EBITDAR growth of 17% from $25.3 million versus $21.6 million in the prior year quarter. I am very optimistic about these two divisions going forward. I'd like to move on to our very successful portfolio optimization activities completed thus far in 2019. As you know, we have been keenly focused on improving the quality of our portfolio over the last two years. We have paid particular retention to exiting markets where we do not have the local market density or meaningful acute care and payer relations -- relationships to effectively compete. During this quarter, we divested, exited or closed the operations of 10 facilities with annual net revenue of $98 million. Subsequent to this quarter end, we have further deliver the balance sheet by selling five owned facilities located in California. And we expect to close on the sale of three additional California owned facilities in the coming months. Also subsequent to the quarter end, Genesis divested two underperforming leased facilities. In aggregate, these 10 facilities generated approximate annual net revenue of $97 million. These divestiture activities reflect our continued efforts to exit non-core markets and to further delever our balance sheet. Beyond these divestitures though, we are prioritizing transactions that increase our real estate state ownership. In the first quarter of 2019, we entered into a partnership to buy back the real estate of 15 facilities historically leased from WELLTOWER. Through this transaction, we were able to acquire a 46% ownership interest in the real estate partnership and also obtained a fixed-price option to purchase the real estate. The new lease we entered into with the partnership also has no rent escalators over the first five years. I want to highlight a couple of key takeaways from this transaction. This transaction is accretive to year-one free cash flow by $3.5 million. Second, we secured a fixed price purchase option that provides us the opportunity to participate in any upside accretion in the real estate value. We have the right to exercise this option after year seven at only a 10% premium to the original acquisition cost. And most importantly, upon exercise of the option, the year-eight fixed charges associated with these 15 assets will decrease by $8 million or 46%. This transaction is a great example of the creative real-estate partnerships that we are looking to execute in the coming months and quarters. Transactions, which will minimize the burden of lease escalator’s, allow us to participate in future real estate appreciation transaction that reduced our overall cost to capital and set the stage for greater facility ownership in the future. As I – to the remainder of 2019, I do expect the positive census and reimbursement trends to continue I expect continued strong performance for our ancillary divisions. We will continue our preparation for our new reimbursement system PDPM. We continue to be optimistic and expect that PDPM will be positive for both patients and providers. And we plan to continue to execute transactions that will strengthen our strategic market concentrations reduce our leverage, reduce our cost of capital, and increase our state ownership. As always, I want to thank our leadership team thousands of nurses CNAs and therapists across the country on another outstanding quarter. With that, I'd like to turn the call over to Tom DiVittorio, our Chief Financial Officer.

[Tom DiVittorio:]

Thanks. George. Good morning everyone. Today, I'll focus my comments on operating results and trends and I will touch on the new lease accounting standards that were effective for us January 1st of this year. Starting with the topline. Revenue in 1Q 2019 of $1.16 billion declined $139.4 million or 10.7% from 1Q 2018. Of this $139 million declined in revenue $119 million is attributed to the impact of divestitures net of acquisitions and $26 million is principally attributed to lower revenue in our rehab services segments following the cancellation of low-margin therapy contracts. These revenue declines were offset by approximately $6 million or 50 basis point of same-store revenue growth in our inpatient services segment the second consecutive quarter of such growth. Adjusted EBITDAR of $148.5 million 1Q 2019 decreased $1.2 million or about 1.4% from 1Q 2018. $11.2 million of this decline in adjusted EBITDAR is from the impact of divestitures net of acquisitions implying same-store adjusted EBITDAR growth of $9.1 million or 6.5%. As George mentioned, this is the third consecutive quarter of same-store adjusted EBITDAR growth. With respect to the earnings margin, our leaner cost structure, improved labor efficiency and successful divestiture strategy expanded adjusted EBITDAR margin in 1Q 2019 to 12.8%. This compares to adjusted EBITDA margins of 11.6% in 1Q 2018 and 12.1% in 1Q 2017. Adjusted EBITDAR less total cash lease payments equaled $40.9 million. This measure grew $1.3 million or 3.2% from 1Q 2018 and exceeded [Indiscernible]. On the topic of wage inflation versus reimbursement rate growth 1Q 2019 wage inflation for non-overtime hours worked by our employee nursing staff grew 2.7% over 1Q 2018. Including overtime hours and agency cost, our all-in-in-nursing wage per worked hour grew 3.3% in 1Q 2019 over 1Q 2018. This is a 20 basis point decline in all in-nursing-wage inflation recorded versus last quarter. This rate of wage inflation is specific to our nursing function where today we see the greatest wage pressure. The nursing function represents about 50% of our workforce. Wage inflation in the other half of our labor force approximated 2%. So in the aggregate, Genesis wage inflation rate in 1Q 2019 was about 2.6%. By comparison, the weighted average reimbursement rate growth we received from our prayers over the same period was about 2.8% or 20 basis points higher than wage inflation, another improving and positive trend for Genesis with two consecutive quarters where reimbursement rate growth outpaced wage inflation. With respect to patient mix and occupancy skilled days mix in 1Q 2019 of 19% decline 110 basis point from the prior year quarter. Of the 110 basis point decline in skills mix, approximately 30 basis points is due to growth in our long-term care census with the remainder due to lower-skilled patient admissions. The average length of stay of Medicare and Medicare advantage skilled patients who are discharged to home remains flat for the fifth consecutive quarter. Operating occupancy in 1Q 2019 of 86.8% increased 190 basis points from the prior year quarter. We estimate that 50 basis points of this increase represents same-store occupancy growth and the remainder represents a change in complexion of Genesis go-forward occupancy levels as we have systematically been divesting underperforming properties having below average level of occupancy. Our 1Q 2019 operating occupancy of 86.8% is a highest occupancy level reported since the second quarter of 2015. Genesis has now reported over six months of year-over-year same-store occupancy growth and this trend has continued thus far in the second quarter of 2019. We remain cautiously optimistic that patient volumes will show sustained strength through the balance of 2019 and beyond. To summarize our operating trends, we remain very encouraged by the improving fundamental drivers of occupancy growth, flattening length of stay, labor efficiency and reimbursement rate growth that better approximates wage inflation. We believe the portfolio of assets under our operation today will continue to produce solid and consistent results. Before we open the line for questions, I just want to touch a little bit on the new lease accounting rules. Effective January 1, 2019, we adopted the new lease Accounting Standards commonly referred to as Topic 842. Topic 842 had a material impact on our GAAP financial statements. We elected to adopt the new rules prospectively therefore historical financial information was not retroactively adjusted for periods prior to January 1, 2019, instead the cumulative effect of initially applying the new rules was recognized as an adjustment to our open and shareholders equity in the first quarter 2019 financials. The adoption resulted in a net increase of about $700 million to a number of long-term asset categories, a $200 million decrease in long-term GAAP-basis lease-related liabilities with the resulting increase to shareholders equity of $900 million. On the first quarter of 2019 income statement, adoption of Topic 842 served to increase GAAP-basis lease expense by $64 million with an offsetting decrease in interest expense of $65 million and a decrease in depreciation expense of $17 million resulting in a net increase to pretax income of approximately $18 million. Adoption of Topic 842 had no impact on our financial covenants or the manner in which the company and its lenders and landlords view the economic performance of Genesis which focuses solely on cash-basis rents. For your reference, our non-GAAP reconciliation tables continue to provide the actual amount of cash basis rents we paid during the reporting period regardless of the accounting treatment or presentation. With that Tom please open the line for questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Chad Vanacore from Stifel. Your line is open.

[Chad Vanacore:]

Thanks and good morning all. So George and Tom occupancy was up pretty substantially, sequentially. What drivers can you point to there that -- that can give you the lift?

[Tom DiVittorio:]

Yes Chad I think what we're finally seeing is what we had hoped we would see over the last several years. And I think first and foremost, I think we've reached the point of equilibrium. We've seen a lot of debts come out of service. We've seen a little tick up. I would say that is more demographically-driven than anything else. The length of stay on the short stay population has stabilized. And I think this industry and clearly Genesis has focused on the importance of growing overall occupancy. So a lot of that occupancy gain relates to a more long-term care chronically ill-oriented patient with let's say, clinical focus like dementia, as we still continue to see obviously a significant amount of capacity -- available capacity in the industry. You've been around long enough that as well as many on this call to know that this industry used to operate in the low 90s as the Genesis for a sustained period of time. And we find ourselves in the 86%, 87% range. There's a lot of capacity here and that opportunity to enjoy the incremental margin from filling that open bed whether it be a long-term care or short-stay patient has still a strong positive impact on the performance of the company. So it's a combination of all those things. We have seen our census; our strong census stay itself through today. And we are gaining confidence that we have truly meet that inflection point and we're looking to see census grow as you move forward.

[Chad Vanacore:]

All right. Then just thinking about rate. Any highlights in the Medicare rate increases upcoming? And then maybe you could share some average Medicare rate increase you expected in 2019 it's still around one-ish percent?

[George Hager:]

Well, Chad we're more optimistic about go-forward Medicaid rates than 1%. And we actually had a very good year-over-year quarter this quarter north of 3% actually. And we've got a couple of states that are important states for us like New Mexico where our provider tax program looks like it's always assured of being implemented, it will require CMS approval. We expect that to be ultimately effective July 1 of this year, it may take a couple of quarters for that to get through CMS and but it will be retroactive. We're seeing some -- look we got some states that are going in the other direction as well or flat. But overall, I think you should be thinking more about 2% or north of 2% on Medicaid rates looking ahead.

[Tom DiVittorio:]

Chad and, obviously, we've gotten a 2.5% Medicare increase effective 10/1, which is a higher Medicare rate increase then we have seen for the last couple of years. And I would also say that I believe that in many state capitals there is increased awareness of the significant chronic underfunding of this industry. And with an improving economy, improving state budgets and tremendous pressure as you see increased facility closures like in states -- states like Massachusetts, you're seeing increasing pressure in the state capitals to try to move towards more responsible funding for this industry.

[Chad Vanacore:]

All right. Then George you expressed optimism on the ancillary services. Just from what I'm looking at rehab revenue per site was down even though efficiency was up. What's the trend there that we should be looking at? And where do you see strength?

[George Hager:]

Yeah, Chad I think first of all, we need PDPM when we think about the motivation for the individual smaller operator and as we've been out in the market, we think PDPM as a change is a focus rehab, may be provide incrementally more incentive to outsource than in-sourced. So we've seen; one, no pressure to providers taking that burden of therapy services and management of the therapy department in house. So we feel that PDPM will be a positive for the industry. We also think that as we think about the fundamentals of PDPM, it really allows the therapy provider to work collaboratively with the skilled nursing provider to look at ways to provide therapy services in a more cost effective basis with really -- without impacting top line and really aligning both outcome opportunities, the patient outcome opportunities and costs in a much more direct way than we can under work for. And lastly as we look at the business and Tom described it, our number of contracts is down and we have intentionally exited contracts that were not profitable contracts for us. And you can't be additive by subtraction and we have done that. We have been intensely focused on improving the operating performance of both divisions, our staffing division which is north of $100 million topline business in and of itself. Our contract therapy division somewhat -- a well-known secret but GRS is the largest contractor provider in the country, significantly larger than its next competitor. And we believe tremendous opportunities to take advantage of the scale we have, the density we have and I think the history we have of strong operating performance with a high level of focus on compliance.

[Chad Vanacore:]

All right. Just one more for me. Any potential gains from value-based payment programs upcoming where we stand as far as Medicare Shared Savings or anything else?

[Tom DiVittorio:]

Chad I'm happy you asked a question. We did not address because the MSSP program did not affect the quarter. But I will say that we are extremely encouraged by what we are seeing there. Just to refresh everyone's memory on Medicare Shared Savings Program unlike bundled payment which was our only retroactive settlement of your gain. The Medicare Shared Savings Program is an annual reset or a reconciliation of your gains. So, we have actually not recognized any gain share for 2018 and overseeing not recognize any gain share for the first quarter of 2019. Based on the results we're seeing, we fully expect that we will see gain share. We are hopeful that that reconciliation will be received somewhere in the June to July timeframe. If it is we will recognize that gain -- which should be viewed as a recurring gain. In the second quarter, if we do not, it will be an event that we recognize in the third quarter. We -- as I said, as we track the results of both the target rates that have been set for us in our ACO by CMS they are higher than our forecast which is a positive. And our costs continue be managed well per member per month in our ACO. Also refresh people's -- everyone's memory we had about 7,000 covered lived under the only-post-acute sponsored ACO in the nation. And we are capitating on a gain share only track almost $200 million of Medicare spend. So, once again, unique asset for us, you're seeing no impact in the first quarter, but fully expect positive impacts either in the second quarter or third quarter of 2019.

[Chad Vanacore:]

All right. Thanks for the update.

[Operator:]

Our next question comes from the line of A.J. Rice from Credit Suisse. Your line is open.

[A.J. Rice:]

Thanks. Hi everybody. George the transaction you did with your REIT partners sounds like an interesting one. Is that -- is there something about that made that available to you? Is there more of a movement toward the favorability of the operator that is going on in REIT world that is worth calling out. What do you see that seems like a little bit of a move to the positive from the operator standpoint and what you're describing?

[George Hager:]

Hey, A. J. I think some of the larger REITs, I think Walter has expressing first to lend lease at some level reduces its exposure to skilled nursing, others have gone in the same direction. Some of our smaller and medium-sized landlords have also expressed similar interest to reduce their exposure to skilled nursing. And I think that is in and of itself is a positive because I think those structures that were originally set at good solid coverage is ultimately with some of the medical cutbacks in 2011 and 2012 resulted in lower fixed-charge coverage and with fixed escalators in a downward trending business created financial difficulty in the industry. So I think the problems date back five years or more, but …

[A.J. Rice:]

Right.

[George Hager:]

… so these REITs and other real estate owners have appreciated the fact that there need to be some level of restructuring of those traditional relationship. So there isn't an interest to sell which is a good thing. I think what facilitates a transaction that we announced and I think I'm glad you focused on because it really is important. It is an example transaction that we will replicate that allows us to effectively own more of our real estate and what facilitates the ability to execute these transactions in addition to the REITs willingness to sell are three things. The per bed values being paid for this industry, despite some of the financial challenges continue to be very, very strong, especially in our core state -- many of our core states, New Jersey, Pennsylvania, Delaware, Maryland, West Virginia, to name a few. So per bed values continued to be solid. Second, the underlying financing ability to finance at low cost non-recourse long-term care types of financing through the heart program or other similar programs provide for the buyers to finance at a much more cost-effective way and as an owner -- as a participant in the real estate partnership with a purchase option is that low-cost financing that we will ultimately inherent when we exercise the purchase option and that's why you see in our transaction when we do exercise, the annual fixed cost just in 15 centers of that transaction reduced our fixed cost by $8 million or 46%. So it's low-cost financing, long-term financing that also facilitates the ability to execute these transactions. And lastly, we obtained the 46% ownership, because we flipped several leased owned interests of several of our assets where the market had commanded very -- as I said very high per bed value. So what this transaction also represents is an ability to internally generate equity on off of our own balance sheet and offers a strong underlying per bed values in many of our core markets.

[A.J. Rice:]

Okay. That's great. Tom, switching gears, you had -- appreciate the comments about the labor wage rates and so forth. I wonder, first of all, is nurses aides and assistance what bucket are you including them in? And I know sometimes, we look at other metrics like turnover rates, vacancy rates whatever. Any comment on how those are trending? I assume they must be trending well, what you are saying about the wages? But I just want to ask.

[Tom DiVittorio:]

Yes, sure. So A. J. we do include the certified nursing assistance in the in the bucket of nursing in the..

[A.J. Rice:]

Wage?

[Tom DiVittorio:]

…inflation statistics that I provided. And in fact we are seeing some, I'll say historically abnormal pressure within that particular population of our labor force, this -- the CNA. Certainly, more so than we seen in recent years. And as far as things like turnover goes, we are seeing actually some very good retention statistics in most of our key leadership positions at the facility level. So just to give you a little bit of perspective there between and I'm looking at 2018 we haven't yet continued in first quarter for 2019, but the retention rates of our key center level leadership which ultimately is going to drive the performance of our buildings that your center executive director, if your nurse executive director have improved by about 4%. So we've got retention levels in the 73% range, which is fairly exceptional in this market.

[A.J. Rice:]

Sure. And then my last one is I know before you guys have talked about $50 million, sort of, cost-saving program. Is there any update on where you stand? I think the target was to get to that by midyear some point any update?

[Tom DiVittorio:]

Yes, A.J. we are -- I would say that we are there now. We sort of…

[A.J. Rice:]

Okay.

[Tom DiVittorio:]

…hit that run rate mark, but just to may be provide a little bit more color when you think about that $50 million number of year that we put out there or $12.5 million now for this run rate period. When you cut through it and you think about the fact that we've since this time last year divested over $0.5 billion of top-line business. A lot of this is just scaling the business the overhead structure down to match the smaller footprint of the business, so actually broken this down a little bit as you think about that $12.5 million. About $5.5 million of that is simply that its rightsizing the overhead structure relative to the underlying operating business. About another $3 million of it, it was also really rightsizing our therapy complement. You've seen utilization of therapy come down as a result of skill mix come down. So if skill mix caseload comes down obviously you’ve got right size the size of your therapy gyms and your staffing complement there. So just to be clear a fair amount of that $12.5 million was really just I would say core operating management relative to what's happening the business on a top line and the rest of it for the most part is what I would call traditional overhead cost. But to answer your first question, we fully realized all of those adjustments.

[A.J. Rice:]

Okay. Great thanks a lot.

[Operator:]

[Operator Instructions] There are no further questions at this time. I would like to turn the conference back to our presenters for any closing remarks.

[George Hager:]

Thank you everyone for joining us this morning. As I think, you've heard, we've a lot of optimism in our voices, as we see a stabilizing and improving business model with a lot of opportunities to really generate internally generate value off the balance sheet and out of our core operating assets, both our skilled nursing center assets and our ancillary assets. So thank for joining us today. And Lori and Tom and myself, are available for questions obviously throughout the day. Thank you again.

[Operator:]

This concludes today's conference call. Thank you for your participation. Have a great day and you may now disconnect.