Gen Digital Inc.
Q1 2018 Earnings Call Transcript

Published: 11 May 2018

[Operator:]

Good morning and I will be your conference operator today. At this time, I would like to welcome everyone to the First Quarter 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions]. Thank you. Ms. Mayer, the floor is yours.

[Lori Mayer:]

Good morning and thank you for joining us today. We issued our earnings press release earlier this morning. 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 mentioned today is operated by a separate independent operating subsidiary 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 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 that the presentation of non-GAAP financial measures provide 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 in 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'm going to focus my comments on three topics

[Tom DiVittorio:]

Thanks, George. Good morning, everyone. Today, I'll focus my comments first on operating results and trends and then on capital structure and balance sheet-related matters. Starting with the top-line. Revenue in 1Q 2018 of $1.3 billion declined $88.1 million or 6.3% from 1Q 2017. It's important to note that approximately $25 million of this reported revenue decline is attributed to our adoption of Accounting Standards Codification topic 606, revenue from contracts with customers that was implemented effective January 1, 2018. If the provisions of topic 606 were applied on a pro forma basis to the prior year quarter ended March 31, 2017, the year-over-year reported revenue decline would have been $64.5 million or 4.7%. Over 70% of this comparable revenue decline is attributed to the impact of divestitures, while the remaining 30% is attributed to lower year-over-year occupancy and skill mix. Adjusted EBITDAR of $150.6 million in 1Q 2018 declined $15.1 million or 9.1% from 1Q 2017. As George covered in his comments, of this $15.1 million decline, $4 million is attributed to the impact of divestitures, an additional $4 million is attributed to higher seasonal costs in 1Q 2018 as compared to 1Q 2017 with remaining $7 million principally attributed to the performance of 16 facilities impacted by various regulatory restrictions during the quarter. With respect to occupancy and mix, operating occupancy in 1Q 2018 of 84.9% declined 70 basis points from the prior year quarter. Skilled days mix in 1Q 2018 of 20.1% declined 50 basis points from the prior year quarter. Within the category of skilled mix days, Medicare mix declined 70 basis points from the prior year quarter, while the insurance category, which largely consists of Managed Medicare days increased 20 basis points. During the first quarter of 2018, we experienced 4.4% decline in skilled patient admissions as compared to the first quarter last year. Within the 4.4% skilled patient admission decline, we experienced a 9% decline in Medicare admissions, offset by a 1% increase in Managed Medicare admissions. Average Medicare and Managed Medicare length of stay for patients discharged to home in the first quarter 2018 was flat compared to the same quarter last year. On the topic of all-in nursing labor costs versus reimbursement rate growth, 1Q 2018 wage inflation for non-over time hours worked by our employed nursing staff grew 2.6% over 1Q 2017. Including overtime hours and agency costs, our all-in nursing wage cost per worked hour grew 2.5% in 1Q 2018 over 1Q 2017. These wage inflation statistics show an improving trend with a 110 basis point reduction in all-in nursing wage growth as compared to the last 2 consecutive quarters. This 2.5% all-in inflation rate continue to exceed the 1.8% weighted average reimbursement rate growth we received from our payers over the same period, but this gap of 70 basis points is the most narrow we have seen since 2Q 2017. To summarize the operating trends in the quarter, although we continue to experience overall occupancy and skilled mix headwinds, we reported favorable movement in several key business drivers. Skilled patient length of stay was stable, nursing wage growth of 2.5% moderated from the past two quarters, reimbursement rate growth of 1.8% was the strongest we have seen in two years, and we generated year-over-year EBITDAR growth in our rehabilitation therapy segment for the first time in seven quarters. Now moving to capital structure and balance sheet-related matters. Restructuring transactions completed in 1Q 2018 with a primary driver of a 9.5% or $11.6 million reduction in cash rents as compared to 1Q 2017. Our LTM March 2018 fixed charge coverage ratio adjusted on a pro forma basis for a full-year of rent and interest reductions and the assumed sale of our Texas assets was approximately 1.2 times, while net funded leverage on the same pro forma basis was 6.1 times. Effective January 1, 2018, we began classifying our Texas inpatient operations as asset held-for-sale. As a consequence, all of our Texas inpatient assets and liabilities have been segregated on the consolidated balance sheet and separately labeled as held-for-sale. We reported negative cash flow from operations in 1Q 2018 of $6.1 million. This use of cash was anticipated and is attributed to over $12 million of transaction costs incurred in the quarter and to the repayment of short-term obligations extended in the fourth quarter of 2017, which allowed us to preserve cash, while we worked through the restructuring transactions. Looking ahead to 2Q 2018 and as in prior years, we expect several states to delay June Medicaid receipts until July. These delays will have no material impact on company, but will serve to reduce reported operating cash flow in 2Q 2018. We expect to report positive operating cash flow in full fiscal 2018. With that, Amanda, please open the line for questions.

[Operator:]

[Operator Instructions]. Your first question comes from the line of Joanna Gajuk from Bank of America. Your line is open, Joanna?

[Joanna Gajuk:]

Good morning. Thank you so much for taking the questions. So I guess on the -- on those couple of numbers you gave in terms of explanation for the year-over-year decline in EBITDAR. So of the $6 million year-over-year decline that you said was related to flu closures of some buildings, but also there is some staffing restrictions and regulatory-imposed restrictions. So can you maybe break those out? How much was flu versus these other restrictions? And also any color you can give us in terms of what these restrictions were about?

[Tom DiVittorio:]

Joanna, the vast majority of these restrictions were in the category of flu and upper GI. So you can assume that virtually all of it was in that category.

[Joanna Gajuk:]

All right. That's good to know. And so the -- on skilled mix, so you're still down year-over-year, but seems maybe -- seems like maybe there is still some stability there because, I guess, these declines are somewhat lower than what you guys experienced in 2017. So any color there? And also I know you talked about on one hand the flu-related closures had a negative impact for you, but was there any benefit to volumes because of the high respiratory issues and maybe more sort of seniors end up in SNF. So is there any color you can give us that would be helpful to?

[Tom DiVittorio:]

Yes, that's a great question, Joanna. We can provide a little bit of color there. Flu is a bit of a double-edged sword. I think when flu cases are moderate as we have seen in some past seasons, I think, you would describe it probably as a net benefit. But the flu season this year was so severe. Beyond just the 16 buildings where it was prolonged and incredibly severe, we had quite a few buildings; in fact almost 100 of our buildings during the quarter were subject to some form of flu-type admission restriction for some period of time during the course of the quarter. And I provided a statistic earlier that our skilled admissions on a year-over-year basis were down 4.4%. But if you look at those -- that subset of buildings, somewhere around 90 buildings, their skilled admissions were down almost double that rate. And so I think it's safe to say that for a fairly significant percentage of our portfolio, flu was net negative in terms of admission flow.

[Joanna Gajuk:]

Great. That's helpful. And if I may, George, I guess, I appreciate the comments you were trying to make in terms of the CMS proposal for the changes in fiscal 2020. So how do you kind of think about -- because, I guess, at the core, the changes is similar to what CMS reports in the prior model in terms of deemphasizing the rehab therapy. So given those changes, how do you think about your third-party rehab services, I mean, you flagged also that actually EBITDA improved this quarter, but are you preparing somewhat for those changes? Or how do you think those changes that will come will impact that part of your business?

[George Hager:]

Yes, Joanna. Obviously, with the new system, the major fundamental change is there is not a direct linkage to the provision of therapy services and your payment rate as there is in the current RUG system today. Also the new system allows, as I mentioned, without great detail, the ability to utilize more cost-efficient modalities, which we believe are at least equal to if not more efficacious than one-on-one therapy. Use of concurrent and group modalities will significantly drive cost structure down. So I think, as far as going forward in our third-party business, no question, we will be approaching all of our customers about changes in the fundamental contractual relationship, but we think there are significant opportunities to reduce cost, preserve margin, but also provide a great opportunity to more effectively manage cost for our third-party customers, and that cost efficiency also will pass through into our own centers as well.

[Joanna Gajuk:]

If I may, the last -- I'm sorry.

[George Hager:]

Fortunately, we have 15 or 16 months before these changes will become effective. So we are -- with the rule being very recently released, we are aggressively reviewing the rule and looking at optimal opportunities to really move our contractual relationships to contracts that might be more cost light in nature than RUG based as they're today.

[Joanna Gajuk:]

Right. I appreciate definitely the comment that there is still enough time to make the changes and prepare for it. But if I may just squeeze the last one. I guess, for Tom on -- I appreciate the comment on the operating cash flow you expect to be positive for the full-year. Any color you can give on the CapEx because there is a lot of, I guess, moving pieces with the divestitures and exit of this?

[Tom DiVittorio:]

Joanna, we're still not providing direct guidance for the year. But I think in George's comments, he mentioned a key point about the divestitures and that we expect that the planned divestitures that we've referenced in the release will be free cash flow neutral. So really virtually no impact to the bottom line with respect to cash associated with these divestitures, but a very significant delevering event given the repayment of about $100 million of debt.

[Operator:]

Your next question comes from the line of Dana Hambly from Stephens. Dana, your line is open.

[Jacob Johnson:]

Hey, thanks. This is Jacob Johnson on for Dana. I guess, first question, your occupancy -- the year-over-year decline in your occupancy ticked up sequentially, you did have to shut down those 16 facilities. Can you quantify the occupancy impact of those facilities being closed?

[Tom DiVittorio:]

Jacob, just to be clear, those facilities were not closed. They were just simply -- new admissions were restricted, while they were working through the level of influenza that was running through the facility. So we have not quantified these individual buildings and what their contribution is to the 70 basis point decline. But I do think the earlier comments that we made about just the overall impact to skilled admissions in more than just the 16 buildings, closer to 90 buildings, the rate of admissions on a year-over-year basis was down double that of the rest of the portfolio. So it had a pretty significant impact on that 70 basis points.

[Jacob Johnson:]

Got it. So this is -- there's some headwind there. I guess, on the announcement of the plan to exit the operations of another 13 leased facilities by July 1. Was this part of your conversations with some of your smaller landlords or something else? And then how are those conversations going with your smaller landlords?

[George Hager:]

Jacob, I'll take that one. This is George Hager. Actually, the 13 are with two of our more significant landlords. Actually, all 13 are with 1 landlord, and we're looking at optimizing and those transactions will have a result of improving coverage on the residual portfolio and our transactions were -- the assets were valued, I would say, very, very highly. And these were principally older assets, and even though they were in our core markets, these 13, they were not core to our strategy in those core markets. And as I said in my formal comments, we will continue to look at the portfolio with our landlords to look at market that we just do not have the right level of density to effectively compete and look to exit and hopefully -- and at least cash flow neutral if not on accretive basis. As far as the discussions with the smaller landlords, they're going well. Obviously, one of -- two of landlords individually often have a significant impact. But I think the smaller landlords have seen what the larger landlords have done in supporting the industry in reflecting the current level of cash flow that the industry can produce. And so we are seeing good response, albeit, selective as we are approaching those landlords when we are nearing natural lease termination dates to work through the residual amounts of our portfolio.

[Jacob Johnson:]

Got it. I guess, moving then to the new real estate loan. I think last quarter you talked about alternatives to HUD financing, looks like you refinanced $73 million of the Welltower loan. Just any more color you can give on these new real estate loans you took on there?

[Tom DiVittorio:]

Yes, Jacob, the lender in this case is our new partner, Midcap. So we were successful, as you know, bringing Midcap into the capital structure as part of the financial restructuring on the ABL side and our partnership with them continues to grow. And so there was a great opportunity for us to refinance at a lower cost of capital. Some of the existing real estate that underlies the Welltower bridge loan. So just a good transactional role for us.

[Jacob Johnson:]

Got it. And then last question from me. On this new PDPM, obviously, the industry is working to respond. Do you have any sense for the industry's preference or -- the answer is for both, but in terms of continuing to ease regulatory burdens associated with the rule? Or do you think there is a chance to maybe push back the implementation of the PDPM?

[George Hager:]

Jacob, I don't think the industry is necessarily going to try to push back the implementation date. I think overall, generally speaking, I think the industry has generally a positive view to the new system. The challenge will be in preparedness of both the industry and CMS to bill and process claims on a new system. We've been through this before, both with the initiation of the RUG system, but also numerous changes within the RUG system. No, I wouldn't compare this to a very radical change that we saw in 1998 when the industry moved from a cost-based system that it operated under for decades to a Prospective Payment System. These are both, obviously, prospectively set rates, just a mechanism on the front-end changes to evaluate the needs of the patient and, therefore, the reimbursement rate. So that was always in the details, but it's an industry that I think has solid vendor support from technology partners like PointClickCare to be prepared to implement a new system. So I don't think there will be aggressive action to push back implementation date.

[Operator:]

[Operator Instructions]. Your next question comes from the line of Chad Vanacore from Stifel. Chad, your line is open.

[Chad Vanacore:]

So I'm going to take off on Jacob's question, take a different path, which is occupancy, it improved a bit sequentially with marginal gain basically over the past three quarters. The normal seasonality portfolio mix, average length of stay or something else and without putting words in mouth, do you think occupancy is stabilizing at these lows?

[Tom DiVittorio:]

So Chad, you're referring -- you're looking at occupancy on a sequential basis?

[Chad Vanacore:]

Right. And understanding that there is normal seasonality there.

[Tom DiVittorio:]

Yes, yes, I'd be a little careful there. I mean, there is always and we certainly expect and did experience a nice lift in the overall admission flow that seasonally is expected. But you're right, I mean, look, I think as we look over the last 8-or-so quarters and when you take maybe a little bit of discount against the issues that we had around flu, which makes it very difficult on occupancy, I would actually say that we are seeing a little bit of a narrowing of that year-over-year gap from quarter-to-quarter in terms of overall occupancy. Are we at the bottom? Tough to say we're at the bottom until we experience a couple of consecutive quarters where on a year-over-year basis, we're flat or slightly up. But the gap does feel to be narrowing.

[Chad Vanacore:]

I understood. Calling it bottom is always an exercise in backward looking. Average length of stay, you'd mentioned something in your prepared remarks about, maybe getting a little bit better. Can you give us more details there?

[Tom DiVittorio:]

Yes, just flat. So when we look at the first quarter this year versus the [indiscernible] straight Medicare patients and Managed Medicare patients, the length of stay is relatively unchanged. And we have been seeing a narrowing there as we look year-over-year each quarter over the last couple of quarters, and again, I'm not prepared to say we hit bottom there either, but it is a data point of interest.

[Chad Vanacore:]

All right. And then skilled mix had a similar trend as occupancy, maybe a little bit better or maybe a little bit better than expected after I had lowered the bar in skilled mix. Is there anything going on there? Just seasonal balance or do you think mix is stabilized around here?

[Tom DiVittorio:]

Well, sequentially, for sure, it's -- you're going to have the seasonal benefits of the March quarter. And we certainly -- you can see that in the sequential trend. But again, very much expected. I'll just go back to flu. Flu can really -- it can bite you as much as it can benefit you, and I would say on balance, this quarter, certainly as compared to the prior year quarter, it probably had a little bit more bite than balance. And that obviously won't recur as we're looking at 2Q as compared to 2Q last year. So we'll see -- I mean, maybe we'll see a little bit of further narrowing of the gap as we close out 2Q.

[Chad Vanacore:]

Okay. Then also in your prepared remarks, you had mentioned all-in nursing wage growth of 2.5% that had been better than a 3-plus-percent. I think we had seen most the last year. How much of that wage growth is due to organic inflation? And how much of that is due to lower use of temporary labor?

[Tom DiVittorio:]

On the -- I would actually say that most of it is on a drop in the use of the temporary labor. I think we've seen more stability in our employee cost per hour and what we've seen in recent times is just this sequential and year-over-year growth in use of agency and overtime. So I think most of the bang we got this quarter was less reliance and [indiscernible] strategies. If you recall, we mentioned last year that the big jump that we saw in nursing wage inflation occurred in the third quarter and much of that was self-imposed. We had -- in many markets where we had staffing constraints had made the effort to increase wages in some of those key markets with the expectation that over time we would see some moderation year-over-year in our reliance on agency and overtime as you improve your retention rates. And I think, we may have seen that in now this first quarter that the investment is starting to yield some return.

[Chad Vanacore:]

All right. Then just one last one for me. G&A looked better than in the quarter. Are there any more saving to be guarded or just could run rate model for the rest of the year?

[George Hager:]

Chad, what you've seen is just the beginning of the opportunity there. We, obviously, need to adjust cost structure for the divestitures. As we look to reduce overhead commensurate with the level of revenue that we divest out, which is a challenge in itself, but I think we've been very successful there, and there are initiatives underway that I think will allow us to even realize greater efficiency in the overhead structure. So I think you'll see more of that to come in subsequent quarters.

[Operator:]

[Operator Instructions]. Your next question comes from the line of Frank Morgan from RBC Capital Markets. Frank, your line is open.

[Frank Morgan:]

Lot of color around the weather and the flu. But I'm just curious, can you give us anything that you're seeing so far? You're actually seeing a bounce back in the second quarter so far. So any color just on admission trends or occupancy bounce back or mix. Any of those -- any color you can give us now since that was clearly sort of a callout and I just want to make sure things are bouncing back to normal.

[George Hager:]

Look, Frank, it's hard to really tell. As Tom said in some of the earlier responses, you have -- the first quarter is seasonally adjusted, typically your highest quarter in skilled census and admission volume. So you're expecting, as you move into the -- into May and into the back end of the second quarter to see some natural decline seasonally adjusted. I will say I think we are seeing a lot of stability around census and admission flow. A lot of these, I'd say, aggressive admission restrictions. Substantially all of them are behind us. So we should see some turnaround in those centers themselves. But it's not to measure kind of bounce back or you're starting to move into a period where you would expect census -- as we move into the second quarter and into the summer month back into the second quarter, it's a natural decline on a seasonal basis. So --

[Frank Morgan:]

Right, yes, but let me ask the question another way. Obviously, with seasonality in demand and just the fact that you came out of this really tough quarter, is it starting to look like a second quarter would normally look? I know -- so kind of forgetting about the first quarter, is it -- do you think it will look more like a normal second quarter with, say, some of these restrictions lifted and some of this -- I guess, I would like a little bit more color on exactly what was that and how many centers and could that alone get you back to looking like a normal second quarter?

[George Hager:]

Look, Frank, we were -- we know that well, and Tom will go on the numbers a bit. But for us, the first quarter, I would tell you from a budget -- internal budgetary perspective and from this pre-consensus, we were pretty much spot on our internal targets, a little ahead of the consensus despite those metrics on flu and on the weather. We did have a -- as I think people who were living in the Mid-Atlantic states in the Northeast, some pretty aggressive winter conditions, which add to a lot of elements of our costs. So we're encouraged by what we see. There are a lot of positive initiatives in place. Census is stable, which is a good thing. And the elements of our cost structure that we began to more aggressively manage that Chad referred to, that we saw in the first quarter, I think you'll see a lot more opportunity on the cost management side in the back nine months of the year. So I would say, yes, we would expect the second quarter to be a normal second quarter, which from an EBITDAR perspective or EBITDA perspective is historically, seasonally adjusted, our highest quarter in a calendar year. Tom, more on the actual numbers on the flu and --

[Frank Morgan:]

Now, my wasn't there, there was a -- so that I understood. You said something about some regulatory restrictions and that might have impacted volumes. Was that just not a -- is that just at the bottom of the list of items? Is it really just all flu? Or any color on regulatory restrictions and how that might just automatically adjust to set back out?

[Tom DiVittorio:]

Yes, Frank. I think most of the regulatory restrictions that we were referring to were illness related, flu, upper GI. There were a few others. I would put those on the bottom of the list and put flu and upper GI, particularly flu, at the top of the list. And look maybe to add a little bit of color to George's comments. If you go back and look at our second quarter last year, we actually had a fairly disappointing second quarter of 2017 in terms of the movement and occupancy. It was a pretty steep slope that we experienced. And look, we're only through the middle of May here. We are obviously not providing guidance. But I think what we're looking at today, you see the normal, what I call the normal slope that George described, which you would expect to see, but at least to-date, we're not seeing the really steep slope that we saw in the full 2Q 2017 last year. I don't know if that answers your question, Frank, but that's the color that we have.

[Frank Morgan:]

Okay now that sounds encouraging. So hopping over to the new proposal for the Patient-Driven Payment Model, understanding that, it sounds like there's going to be some more flexibility with regard to the therapy utilization in concurrent and group, those kind of things. Just curious today, I mean -- correct me if I'm wrong, but don't you already sort of work in that world on the MA side, don't you already have a lot more flexibility there and you can use concurrent and group for MA patients. So just number one is that, is my understanding correct? And then, if it is correct, how does that -- other than just rates being lower on MA, how does that -- have you seen the profitability? Was -- has there been any kind of change in the margin profile by using more of those concurrent and group models?

[George Hager:]

Frank, you're absolutely right that the new system -- the PDPM system, one of the real underlying positives to it is from a care delivery process it aligns with our initiatives that have been in place for some period in how we operationalize especially therapy to the managed patient as required by the payer. But also around some of our initiatives around BPCI and other value-based programming that, obviously, in sense, the most cost-effective means of delivering care, including trying to manage like to stay to its appropriate -- clinically appropriate optimal level. So yes, we have already been operating in an environment. So the operational changes that we would need to make under this new system have already been in place for some time with managed care and other value-based programs. What I think, and those things on the managed care side, Frank, do help in managing incremental -- margin on the managed care, Medicare Advantage patient. But I would argue that Medicare Advantage patient is still less profitable than the Medicare Part A indemnity patients just because the efficiency of therapy cost or the amount of therapy cost, even though it is lower for a managed patient, is not adequate to offset the difference in the premium rate that we have with the majority of our managed care payers that are not RUG based.

[Frank Morgan:]

Got you. And then, I think you called out the impact of those -- the Texas acquisition divestitures. Could you give us any color of just -- I know you don't give guidance, but if you're trying to build a model and sort of think about at least incremental 13 coming out, you have an EBITDAR number and/or rent number you could share with us so that we could kind of try to think about what the run rate is without those in?

[Tom DiVittorio:]

Yes. Frank, in the press release, as it relates to the 13 facilities, we did provide an annualized level of adjusted EBITDA associated with those properties, along with their revenue.

[Frank Morgan:]

Okay and they did have rent there too?

[Tom DiVittorio:]

Yes, we did. There was a $12.2 million annual cash rent component of that that goes away when we divested those 13.

[Operator:]

We have no further questions at this time. I turn the call back to Mr. George Hager.

[George Hager:]

Thank you, everyone. I look forward to talk to you again in a few months. And just so if I could conclude, we do see things approaching a bottom. We have been very, very aggressively managing the portfolio and the cost structure. And we are very encouraged by what we're seeing and look forward to returning to growth in the back half of 2018. Thank you all for joining us this morning.

[Operator:]

Ladies and gentlemen, this does conclude today's conference. You may now disconnect.