Gen Digital Inc.
Q1 2015 Earnings Call Transcript

Published: 8 May 2015

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the First Quarter 2015 Earnings Conference 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]. I will now turn the conference over to Ms. Lori Mayer, Vice President of Investor Relations. Please go ahead, ma'am.

[Lori Mayer:]

Good morning and thank you for joining us today. We filed our earnings press release yesterday afternoon. This announcement is available in the Investors section of our web site at www.genesishcc.com. A replay of this call will also be available on our web site 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 I encourage you to review our SEC filings for a more complete discussion of factors that could impact our results. Except as required by Federal Securities laws, 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 over any other reasons. In addition, any operation we mention 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 activity, 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. Furthermore, we supplement our GAAP reporting with non-GAAP net metrics. When viewed together with our GAAP results, we believe that these measures can provide a more complete understanding of our business, but they should not be relied upon at the exclusion of GAAP report. A GAAP to non-GAAP reconciliation is available in today's press release. To facilitate comparison before and after February 2015, the February 2015 combination with Skilled Healthcare, we have also provided certain non-GAAP financial information on the basis assuming the combination of Skilled Healthcare and Genesis HealthCare occur at the beginning of each reporting period. This data is labeled pro forma. Also when we reference earnings per share, we are always referring to diluted earnings per share. And with that, I will 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 begin today's call with a brief overview of our results, and provide and update on a number of operational and strategic initiatives. Then I will turn the call over to Tom DiVittorio, Genesis HealthCare's Chief Financial Officer to discuss our financial results and our deleveraging activities in greater detail. I am pleased to report that we had a very strong first quarter, in virtually every area of focus we have discussed publicly. In the first quarter, on a pro forma basis, we reported EBITDAR of $185.4 million, EBITDA of $66.2 million and earnings per share of $0.07. I am extremely proud of our performance, our progress, as a result of the entire team's laser focus on managing the fundamentals of the business. Routine operating expenses were well managed across all segments. The legacy Skilled Healthcare businesses performed very well, despite distractions of the integration activity. The legacy Genesis inpatient segment posted 90 basis points of year-over-year skilled mix census growth. A full one-third of this increase was generated by our first eight power-backed rehabilitation centers. And our expense reduction initiatives realized $6.5 million in the quarter, of the $30 million to $40 million of annual reductions we began implementing in the prior year fourth quarter. The Skilled Healthcare integration is on track. Thus far, there have been no surprises, and we are very impressed with the skilled operation leaders. We still remain confident in our $25 million synergy estimate, with approximately $13 million expected in 2015. We estimate that we realized about $1 million of those synergies in the first quarter, and we expect to see accelerated synergy realization in the second quarter. We also had great success in the quarter on the business development front. First, we opened our second power-backed rehabilitation facility in the Denver, Colorado market during the quarter. This is a brand new state-of-the-art facility with 99 beds. We also acquired a traditional 140 bed skilled nursing facility in San Antonio, Texas, and we acquired two power-backed living facilities in Texas in May. Genesis intends to convert the two power-backed living facilities to the power-backed rehabilitation brand over the next several months. Including these three new facilities, Genesis now operates 11 power-backed rehabilitation facilities across five states, with one additional facility under construction in New Jersey. We will continue to evaluate other key markets, for additional power-backed opportunities. Second, our rehabilitation segment signed 120 new therapy contracts with four key customers, and we expect to complete a 24 outpatient site acquisition in July. We expect these contracts to contribute an additional $10 million in annual EBITDA, which has already been contemplated in our guidance. And finally, we are making great progress in our deleveraging activities, including agreements with our REIT partners, which Tom will discuss in a moment. Before I turn the call over, I would like to comment on our rehab initiatives in China. This is a small, but exciting venture for Genesis, and the first time we have entered the international marketplace. With 300 million over the age of 60, and virtually no post-acute rehabilitative care infrastructure in place, we believe there is significant market potential in China. To put this in some perspective today, China currently has only 14,000 therapists, that's one therapist for every 100,000 people on average. As a comparison, the United States has one therapist for every 1,700 people. As one of the largest providers of post-acute care in the United States, we are well suited and honored to participate in the development of the post-acute care continuum in China. Today, our activities and milestones in China include, receiving the first of its kind, wholly-owned foreign entity healthcare services license in China, to operate a wellness center in Phoenix City' Zengcheng, China, that we call Vitality Center. This site is open and in startup phase. Additionally, in the third quarter of this year, we expect to open a second site in Qinhuangdao, which is an inpatient rehabilitation facility. And separately in April, we signed a memorandum of understanding to enter into a joint venture agreement, with the BangEr Orthopedic Hospital Group, to open post-acute inpatient and outpatient rehab facilities, within each of its 11 orthopedic hospitals in China. We expect to have five sites open by the end of 2015. And last, we are in the process of building and developing on the ground, management infrastructure at the local level in China. Tremendous progress has been made in a short period of time, in our rehab services leadership, led by Dan Hirschfeld, is to be commended for their innovation and efforts. Let me perfectly clear about our intentions and expectations in China; one, we will approach our activities in China in a cautious, deliberate, and disciplined manner. Two, our committed capital will remain relatively small for the foreseeable future, and our investment strategy will be capital efficient, with a focus on joint venture structures. And three, our top priority is, and always be our core U.S. operations. Accordingly, we are developing management infrastructure locally in China, to ensure the continued focus on our domestic operations. Let me also be clear, the market should not expect any positive cash flow generated by these activities in 2015, and likely well into 2016. We will keep you apprised of our activities and progress in China. With that, I would like to turn the call over to Tom DiVittorio, our Chief Financial Officer.

[Tom DiVittorio:]

Thanks George and good morning. Before I comment on the quarter, I want to emphasize that the Skilled combination occurred on February 2nd, 2015, so the GAAP income statement, cash flows and all of the key performance indicators in the release for the current year quarter, include just two months of legacy Skilled Healthcare and three months of legacy Genesis HealthCare. The prior year quarter only reflects the results, and the key performance indicators of legacy Genesis. In my comments however, I will be referencing non-GAAP financial results on a pro forma basis, is that the combination was fully recognized in the current and prior year quarters, which we believe is the most useful barometer of our overall performance. Our GAAP to non-GAAP reconciliations in the release are expanded, to bring Skilled HealthCare's precombination financial results in, for all periods. With that as a backdrop, revenue grew 70 basis points on a base of $1.4 billion, this year's quarter versus last. Top line growth was impacted 60 basis points, by the divestiture of two underperforming facilities and 110 basis points from reduced revenue in our rehabilitation therapy segment, principally due to the loss of 50 therapy contracts occurring late in the fourth quarter of 2014. Both elements of reduced revenue were anticipated and included in our 2015 annual guidance. The two divested facilities historically produced breakeven EBITDAR, so their divestiture will be accretive to cash flow, as we successfully reduced annualized rent expense $2.8 million following the divestitures. The loss business in our therapy segment will be more than made up by the 120 new contract sites and the 24 outpatient rehab site acquisition, expected to commence July 1st. We remain confident in our full year 2015 revenue guidance growth rate of approximately 3%. Looking now to earnings; our adjusted EBITDAR Of $185.4 million grew 6.5%, and adjusted EBITDA of $66.2 million grew 11.6% over the prior year. The quality of our earnings growth is reflected in EBITDAR margin expansion of 70 basis points to 13.2% and EBITDA margin expansion of 40 basis points to 4.7%. Strong earnings growth was fueled by outstanding operating performance in our inpatient segment. The realization of $6.5 million from our planned expense reductions, and $1 million of Skilled transaction synergies. This growth was offset by the anticipated decline in rehab segment earnings, principally due to the loss contracts previously mentioned. Therapist efficiency of 69% showed good improvement from the fourth quarter, closing the gap to within 100 basis points of our prior year quarter performance. We continue to work hard and remain focused on our labor management practices in this segment, and across all lines of business. As you analyze Genesis' performance in the current quarter relative to our annual guidance, it's important to consider some seasonal aspects of our business and the timing of several earnings growth initiatives. The most notable seasonal factor impacting our first quarter is the resetting of payroll tax limits. We estimate payroll related tax expenses are nearly $10 million higher in the first quarter than they will be in the average quarter of this fiscal year. With respect to earnings growth, there are three activities we expect will generate incremental earnings growth in the next three quarters. First, as previously reported, we expect to realize $30 million to $40 million of year-over-year expense reductions in 2015, that were identified in the fourth quarter of last year, and implemented by the end of the first quarter of this year. We realized $6.5 million of these expense reductions in the first quarter, and expect incremental realization next quarter. Second, we are on track to realize $13 million of the $25 million baseline synergies identified in the skilled combination. Given the timing of the transaction, we realized just $1 million of synergies this quarter, but expect accelerated synergy realization beginning next quarter. And last, new business growth in the rehab segment will ramp up in the second half of the year, from the previously mentioned contract starts and the outpatient acquisition. Moving now to guidance; we are reaffirming with confidence, our 2015 pro forma adjusted EBITDAR of $755 million to $770 million, and pro forma adjusted EBITDA of $268 million to $283 million. With respect to earnings per share, we are adjusting our guidance down $0.05 on either side of the range to $0.29 on the low end and $0.34 on the high end. The adjustment is specific to the skilled combination acquisition accounting and reflects refinement to our initial estimates of non-cash depreciation, amortization expense, related to higher than expected allocation of value to certain identifiable intangible assets. This change in estimate impacted our current quarter EPS by $0.01. We are also reaffirming our 2015 recurring free cash flow guidance of approximately $70 million, the components of which are detailed in the text of the earnings release. Now turning to the balance sheet and cash flow; cash at March 31 this year was $95.7 million, and total net debt was $898 million. This level of net debt at the midpoint of our 2015 guidance implies 3.25 times net funded leverage, and 6.3 times lease adjusted net leverage. Our GAAP operating cash flow was impacted by the Skilled Healthcare transaction costs, excluding funded transaction costs, our operating cash flow was approximately $27 million in the first quarter of this year. Let me conclude with an update on our capital strengthening initiatives. We are very focused in making great progress on multiple fronts, to reduce fixed charges, increase facility ownership, pay down debt, and reduce our overall cost of capital. During the first quarter, Genesis sold a non-core minority interest in a provider of diagnostic laboratory services in hospice care for cash of $26 million, resulting in an $8 million book gain. The company also sold an office building acquired in the Sun transaction for cash of $1.2 million. Proceeds from these transactions were used to repay revolving credit facility debt, providing us additional capacity to support our other capital strengthening objectives. We will continue to strategically monetize non-core assets, and either redeploy the capital to investments, providing greater return to shareholders, or to repay our most expensive debt. We are actively evaluating other non-core asset sales, that we expect to execute over the next six to 12 months. We will keep you apprised of our progress. Regarding transactions with REITs, over the course of the first quarter, we engaged in constructive and collaborative discussions and agreements with our major REIT partners, culminating in a series of planned facility acquisitions, divestitures, closures and rent-free payments. The transactions currently contemplate 21 facility acquisitions and 12 facility divestitures or closures. In the aggregate, those transactions contemplate nearly $300 million of invested capital, which will be financed with a combination of proceeds from mortgage financing, preferably HUD, non-core asset sales, and other capital raising activities as necessary. The transactions will close in stages, principally in 2016. To-date we have divested two facilities and made rent prepayments, that together reduced annual rents by $4.7 million. On a full run rate basis, and including our ongoing initiative to refinance our real estate bridge loan with HUD financing, these transactions will have a meaningful strengthening effect to Genesis. Specifically, annual rents that would otherwise escalate about 3% per year, will decline by $35 million. After-tax free cash flow will improve $25 million to $30 million per year, but nearly a 40% increase in free cash flow off the midpoint of our 2015 guidance. Facility ownership will expand from 15% to 20%, and our fixed charge coverage ratio will improve by more than 0.1 times. We appreciate the value and support received from our major REIT partners, and look forward to closing these transactions in the coming quarters. Finally, we expect to hear from HUD in the next few weeks regarding our requests for approval to refinance the company's $360 million real estate bridge loan, with HUD guaranteed financing. Refinancing would reduce our annual interest costs $14 million. We also hope to expand or approve borrowing capacity with HUD, an additional $350 million to $400 million to finance future facility acquisitions, including those with our REIT partners. Let me conclude by echoing George's comments, how pleased we are with the start to 2015. We made excellent progress executing against our operations and strategic objectives, and we will build on the positive momentum, to drive growth and improve our capital structure. Thank you for joining the call today. And Crystal, if you could please open the line for questions now.

[Operator:]

[Operator Instructions]. Your first question comes from the line of Joanna Gajuk with Bank of America.

[Joanna Gajuk:]

Thank you. Thanks for the color around same store Skilled mix on legacy Genesis. Is there a way for you to talk about what happened at the legacy Skilled portfolio, in terms of Skilled mix or any other metrics, that would help us, if you would, what happened there?

[George Hager:]

Sure. The legacy Skilled businesses, Skilled mix, improved, Joanna, by about 50 basis points, first quarter this year versus last. Genesis is about 90 basis points. So on a blended basis, somewhere in the 60 to 70 basis point improvement on both companies combined.

[Joanna Gajuk:]

Great. That's helpful. And also, any color you can give in terms of the segment margin? I mean, I assumed that the rehab business, because of the contract clauses, maybe impacted there. But anything you can tell us about the statement on a comparable basis, the margin there?

[George Hager:]

Sure. And again, you will find a little bit of segment data of course in our 10-Q. Of course, it gets a little difficult, because again that's going to provide just Genesis in the prior year and Skilled for two months in the current year. But as we do our own internal pro forming of the business, what we saw in the quarter, Joanna, in the inpatient segment on a pro forma basis, was about call it 100 basis points of margin expansion, in the inpatient business, and about 50 basis points of margin contraction in the rehab business, principally generated by those loss contracts and being about 100 basis points below on our efficiency number this year versus last.

[Joanna Gajuk:]

Great. Thanks.

[George Hager:]

You're welcome.

[Joanna Gajuk:]

And lastly if I can, on the proposals [ph] that you're expecting the approval here in a couple of weeks, is that right?

[George Hager:]

Yeah. That's the best information that we have. The guidance that we were given is that it would take about 90 days to get an approval for a request of our size, and 90 days would bring us to just the end of May or perhaps the first week of June.

[Joanna Gajuk:]

All right. So this approval that you have outstanding there, or the requests, is that already for the higher amount that you refer to, or first, you need to get first approval, and then you are going to ask fro an increase in that?

[George Hager:]

Its for the larger amount, but our focus clearly on our priority, is to get approval for the first 360 that we need to refinance the bridge loan.

[Tom DiVittorio:]

But the request itself is for the larger capacity.

[Joanna Gajuk:]

All right. Great. Thank you. I will go back to the line. Thanks.

[George Hager:]

You're welcome.

[Operator:]

Your next question comes from the line of Frank Morgan with RBC Capital Markets.

[Frank Morgan:]

Good morning. On that subject of margins in the contract therapy business, what would you -- you said it was a 50 basis point degradation. What is that number in absolute terms and of the base of the contracts you're bringing, about 120 in the second half. Is there any reason why the margin profile would be different there, and where should we put those margins?

[Tom DiVittorio:]

Well the margin in the first quarter, seasonally in our rehab business, is typically going to be pretty strong Frank, and its just under 11% in the quarter, and there is no reason to think that -- I mean, the new business that we are bringing on, would arguably be at a higher margin than that, because there is not nearly the level of overhead we would need to take on -- to bring on 120 incremental contracts. But we have provided you guidance on the earnings potential of those -- that new business, that $10 million annually.

[Frank Morgan:]

Right. And these outpatient rehab clinics, you will just -- those are running similar margins, is that sort of a 10% to 12% margin kind of business?

[Tom DiVittorio:]

Yes Frank.

[Frank Morgan:]

Okay. And then, in terms of -- you obviously divested a couple of facilities, and you're talking about some potential more in an opportunity to back a lot of your assets that are currently leased. Over the long term, beyond this group, where do you think you ultimately could end up, in terms of your ownership of your asset base?

[Tom DiVittorio:]

We have talked about a goal of getting into the 30% to 35% range, obviously the base is pretty big here. So getting there is not going to happen overnight. But as we look at continued M&A opportunities and we continue to be very active on that front, especially continue to be focused on existing core markets, which include some of those new markets that we expanded into with both the Sun and Skilled mergers out west, such as Denver, now some of the Texas marketplaces, San Antonio, Dallas specifically, continue to look at opportunities in California as well. So we will continue to be active on the M&A front, and hopefully, we will be able to -- in those M&A activities, acquire the real estate as well, and finance in a more traditional way to continue to increase our ownership percentage. But 30% to 35% is the target we have set for ourselves.

[Frank Morgan:]

Okay. One more then I will hop, just maybe give us your assessment of the reimbursement outlook? Obviously you had proposed rules come out for Medicare on SNFs, but maybe also, just a little bit on the Medicaid outlook in terms of some of your important states? Thanks.

[Tom DiVittorio:]

The guidance that we gave at the outset of the year was 1.7% weighted average Medicaid rate growth across our states. We still feel really good about that level of growth. We are obviously monitoring state budget activities very closely, and there are some pushes and pulls along the way. But we still feel very good about our 1.7% target. And on the Medicare front, obviously, we are thrilled about the permanent Doc Fix, clearly something that was a surprise for us, and a pleasant one at that, and the proposed rule that 1.4%; we had projected 1.7%. Of course, we were a little disappointed by the forecast there, but we are only about 30 basis points off of where we had originally projected, and that's about $1 million a quarter. So the first million will ht us in the fourth quarter, that's certainly something we can manage through, and we are just happy to have the visibility, and not having been blindsided by any surprises.

[George Hager:]

I'd say, with the Doc Fix, behind us and now the post-rule for 2016 out there, it’s a good deal of -- I won't use the word visibility, put clarity in reimbursement, stability in reimbursement that takes us out, virtually through the end of 2016 at this point.

[Frank Morgan:]

Okay. Thank you very much.

[Operator:]

[Operator Instructions]. Your next question comes from the line of Dana Nentin with Deutsche Bank.

[Dana Nentin:]

Hi, good morning. Thanks for taking the question. Just going back to the international expansion into China, can you just, I guess describe the opportunity there, your plans to grow that business more to see yourself moving outside of China, and maybe what the reimbursement landscape looks like there?

[George Hager:]

Well as far as moving outside china, we don't have any plans at this point at all, and as I mentioned in my comments, our investment in China will be very limited until we can validate with certainty, that there is an opportunity to invest in China and grow at a level of margin -- the level of return that meets our expectation. We are also very focused on making sure that any efforts in China will not distract our key operating executives in the rehab division from the core business. So establishing infrastructure there, local infrastructure, is a high priority. I don't see it expanding outside of China at this point. As I said, our investment will be limited and will be principally focused on, I would say, selling our intellectual property more than investing capital in China. That country has very-very limited rehab infrastructure. We have received very warm reception in China, in multiple parts of the country. As you can imagine, it’s a huge geographic area, with extraordinarily dense population in many markets, and we see opportunity there. But once again, we will look to see that our models and our rehab programs can be provided a level of profitability that meets our expectations.

[Dana Nentin:]

Okay, great. And then just going back -- I believe you guys had about three facilities in the bundle payment initiative that you're going to move to the testing phase. I guess, can you -- I know its still early, but can you provide any color on, to the extent to which you guys are testing in those facilities, DRGs and what not, if you chose a convener there?

[George Hager:]

We will be our own convener. So we do not need a third party, and do not anticipate bringing in a third party, with respect to our bundled payment program. As you said, we did put three facilities in, April 1st. We will look potentially to expand that, effective July 1. We are monitoring those facilities, the performance under the program. As you said, its very-very early on. Right now, though, everything that we are seeing, is meeting our expectations, and really we see opportunity in looking at ways to really improve outcome at lower cost points under this program, and we continue to participate. Once again, there is a little bit of a black box there, not having gone to the first reconciliation on our bundled payment program for our three facilities within [ph] April. Most likely, won't happen until the end of the fourth quarter or early in the first quarter of 2016. So its one that -- once again, we will be cautious, but we are learning and we do see opportunity to improve outcome at lower cost points under the program.

[Dana Nentin:]

Okay, great. Thanks a lot.

[Operator:]

At this time, there are no further questions in queue. Mr. Hager?

[George Hager:]

Thanks everyone for joining us this morning, and we are excited about the start for 2015 and continuing to see a lot of opportunity in front of us, as we look ahead to the rest of 2015 and into 2016. Thank you, everyone.

[Operator:]

This concludes today's conference call. You may now disconnect.