Brookdale Senior Living Inc (BKD) 2018 Q4 法說會逐字稿

Thank you, and good morning, everyone. I'd like to welcome you to the Fourth Quarter and Full Year 2018 Earnings Call for Brookdale Senior Living.

Joining us today are: Cindy Baier, our President and Chief Executive Officer; and Steve Swain, our Executive Vice President and Chief Financial Officer.

I would like to point out that all statements today which are not historical facts, including our earnings guidance, may be deemed to be forward-looking statements within the meaning of the federal securities laws. These statements are made as of today's date, and we expressly disclaim any obligation to update these statements in the future.

Actual results and performance may differ materially from forward-looking statements. Certain of the factors that could cause actual results to differ are detailed in the earnings release we issued yesterday as well as in the reports we file with the SEC from time to time, including the risk factors contained in our annual report on Form 10-K and quarterly reports on Form 10-Q. I direct you to Brookdale Senior Living's earnings release for the full Safe Harbor statement.

Also, please note that during this call, we will present both GAAP and non-GAAP financial measures. For reconciliations of each non-GAAP measure from the most comparable GAAP measure, I direct you to our earnings release and supplemental information, which may be found at brookdale.com/investor and was furnished on an 8-K yesterday.

With that, I would like to turn the call over to Cindy.

Thank you, Kathy. Good morning to all of our shareholders, analysts and other participants. Welcome to our fourth quarter and year-end 2018 earnings call. This morning, I'll provide a progress update on the strategy, which I introduced in early 2018 as well as our outlook. After we terminated the strategic review in February 2018, we launched our turnaround strategy and successfully executed on business changes that are significant and transformative. We also renewed the focus on our mission and our associates, who are so critical to delivering care to our residents. We delivered results within our guidance ranges.

Steve will provide the details of our financial results, so let me highlight how our focus on operations laid the foundation for these results. We set the operational foundation with a focus on winning locally, which unified and became the rallying call for the Brookdale team. On a parallel path, we spent an extraordinary yet necessary amount of time on our real estate strategy. Last year, we made real estate initiatives a priority, to position Brookdale for future success. For our owned portfolio, by year-end, we sold assets generating proceeds of $193 million net of debt repayments and transaction costs, and we are nearing completion to sell other communities, in line with our $250 million goal. We restructured 89 restrictive leases and moved to more objective change in control provisions.

For the managed portfolio, we transitioned numerous communities that were being operated under interim management agreements to new operators. To give perspective, we terminated management agreements or disposed of 131 communities during 2018, with the majority occurring in the fourth quarter. I am proud of what our team accomplished.

For the past several years, there has been speculation about whether Brookdale became too big to be successful. So let me be clear: with our recent real estate accomplishments and planned 2019 closings, we are confident that we will be successful with the remaining portfolio. Brookdale is now 22% smaller than it was immediately after the Emeritus acquisition was completed. We intentionally reduced our portfolio from over 1100 to less than 900 communities. With our 2019 plan, we believe that we'll have the optimal portfolio and experienced staff to deliver long-term returns.

In 2018, we improved our owned to leased portfolio mix, completed significant financing transactions and did a community-by-community review of capital requirements. In 2019, we expect to finish the vast majority of previously identified community transitions to new operators. This will allow us to celebrate the successes, close the door on the disruption that so much change creates and continue to sharpen our focus on operations. The board and management team have actively explored many alternatives for enhancing shareholder value. We've conducted numerous reviews over the past several years and consulted different leading real estate investment banking advisors in connection with such reviews. We are committed to continually to look at ideas that arise internally and ideas raised by outside advisors or shareholders.

Recently, we completed another review to assess the potential of separating all or a portion of the company's real estate from our operations into a new public REIT structure. In the real estate industry, this is commonly referred to as an opco-propco transaction. We entered this review with an open mind and with a mandate that we needed to truly understand whether an opco-propco transaction would unlock value for our shareholders. Our team performed another comprehensive review, and we were assisted in this regard by an external financial advisor who was recommended by a shareholder who has publicly advocated for a REIT separation transaction. We spent a lot of time and effort on this transaction, and this analysis was based on detailed confidential information concerning our operations, debt and lease obligations. In connection with this review, we looked at a range of potential propco-opco structures, including triple-net lease and RIDEA-managed structures. Based on this review, we do not believe that an opco-propco transaction is advisable to pursue at this time, as it likely wouldn't create additional shareholder value. A separation would result in an operating company with uncertain viability and a single-operator propco REIT that is unlikely to trade well, due to key structural deficiencies.

To provide additional transparency into the analysis, I'd like to share a few of the key considerations we identified during our reviews of the potential opco-propco transactions. First, you must consider the viability of the potential operating company, factoring in existing third-party lease obligations and any new potential leases with the new propco, along with funding of near- and long-term CapEx needs. This would certainly create a challenging situation from a cash flow perspective.

Second, propco's valuations will be influenced by the perceived viability of the opco. In addition, you need to consider the subscale size of the propco and its initial single-operator exposure as well as its higher-than-usual leverage profile for a REIT

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will limit its ability to grow and diversify. You must realistically assess the expected trading value of the propco and opco entities. All of these issues I just mentioned would create valuation pressure relative to peers.

Third, depending on the structure of the deal, it is possible that the transaction would be a taxable transaction even utilizing our sizable net operating losses, along with potentially triggering change of control provisions that could be a substantial burden for the surviving operator. Ultimately, given these and other factors, we simply did not see a path to unlocking value through implementation of this type of transaction at this time. While we will continually assess ways to enhance shareholder value, over the near term we will remain focused on our strategic priorities.

Simply [stated], the best way to create shareholder value is through executing our operational turnaround strategy. Our vision is to be the nation's first choice in senior living. The reality is that we are a senior living, healthcare operator that intentionally owns real estate. That being said, we remain committed to evaluating feedback from our shareholders and listening to constructive ideas or perspectives they may have. To this end, I'm pleased with our recent announcement that we are accelerating the pacing of a destaggering of our board of directors. Our nominating and corporate governance committee and board voluntarily made this decision after consideration of shareholder feedback we received.

Let me turn now to the ongoing operations and briefly talk about our successes in 2018 and expected areas of focus in 2019. In 2018, the senior living industry saw strong macroeconomic headwinds, where new community openings outpaced demand. This drove top line pressure, and low unemployment drove higher operating costs.

In early 2018, the industry withstood the most severe flu season in the last 5 years, and there were significant weather-related challenges, including large winter snow storms, hurricanes and wildfires. I am very proud of our teams' excellence in planning for and executing the logistics of protecting our nation's seniors during these natural disasters. There are thousands of details to ensure that our seniors are safe, comfortable, and have the proper medicines and nutrition to keep their healthcare regimens intact while continuing to provide engaging resident programming and keeping families informed.

I'm incredibly proud of how our team addressed each adversity to keep our residents safe, with no attributable deaths during the hurricanes and wildfires, and that despite facing elevated, competitive new openings, we reduced controllable move-outs.

We've made good progress on our priority to attract and retain the best associates. We are on track to complete our 3-year plan in 2019. We've seen the benefits of this investment with higher retention of Executive Directors and Health & Wellness Directors in the communities. In the fourth quarter 2018, we saw a 100 basis point improvement from the third quarter of 2018. This continued our retention rate trend of these 2 positions above 70% for the past 6 quarters on a trailing 12-month year-over-year basis. As of year-end, we had only 31 open Executive Director positions; that's just 3% of our nearly 900 communities. Our 2019 focus will be to replicate the Executive Director and Health & Wellness Director retention successes with our Sales Directors. We analyzed sales associate turnover, and with this understanding, we are now providing our sales associates with the skill, tools and dashboards to drive high-quality leads and visits to our communities.

With our recent sales realignment, we've improved the span of control of our district sales leaders, allowing them more time to coach sales associates in person. We have the right sales organization strategy and will further support our associates to develop impactful, personal connections of prospects.

In the fourth quarter, we refined our plan using customer research to systemically address all phases of the customer experience, from researching, contacting and visiting our communities to moving in. This has been a large undertaking, including how we message and position the Brookdale brand. Communicate the most attractive qualities of each community, promote our resident programming, dining and critical care, and package all of this together in our sales messaging, to offer customers a compelling point of difference. This is a relationship business, and we are focusing on providing prospects a best-in-class experience. We are ensuring that our operations and sales associates are one cohesive team in guiding customers through all phases of their journey and choosing the right community to meet their needs. No other senior living provider is better suited to do this than Brookdale.

Given the strength of our operations team with execution, we are further aligning sales and operations to drive performance. To achieve this, last month the sales organization started reporting to Mary Sue Patchett, our EVP of community operations. The retention rates of the top 3 leaders brings me to the reason that Brookdale exists: to serve our residents and patients. There's a strong correlation between associate retention and our community's leading indicators.

For the full year 2018, we improved 3 of our 4 leading indicators. For 2019, our controllable move-out goal is to maintain the strong move-out results we achieved in 2018 as we turn more of the organization's focus on generating move-ins with the sales and marketing action plans I just noted.

Turning to our Healthcare Services segment -- previously known as Ancillary Services. In the fourth quarter we stabilized our revenue on a sequential basis. In 2018, we shifted our therapy case mix. While this impacted our results, we are now in line with industry mix. We expect our Healthcare Services business to grow in 2019, in addition to continued growth in our hospice business, where we expect continued strong organic growth in addition to our plan to expand into new markets.

Before I turn the call over to Steve, I'd like to provide a few summary comments about this year's expectations. Our 2019 guidance is aligned with the highlights I provided in our third quarter call. The senior housing industry will continue to have headwinds from community openings in 2019, making for a difficult competitive landscape. Yet there are early indications of improvement as new starts continue to fall. Expected 2019 adjusted free cash flow results will be driven by the significant additional community-level CapEx investments. These include major building infrastructure projects, which are necessary to ensure that our communities are in appropriate condition to support our strategy and that we protect the value of our portfolio. This year, we will continue to improve our operations. Now that the real estate restructuring is mostly behind us, we are working to advance the sales cycle, especially related to move-ins, and accelerate our occupancy turnaround. I'll turn the call over to Steve now.

Thanks, Cindy. My remarks today will focus on 3 primary topics: first, highlights of the fourth quarter and full year 2018 financial results; second, given the importance of last year's real estate initiatives, I'll provide an update on our progress; and finally, I'll expand on Cindy's comments about our 2019 guidance.

Starting with a few highlights. We achieved a full year financial results within our 2018 guidance. We saw same-community revenue improved on both a year-over-year and sequential quarter basis, driven largely by rate increases. We drove mark-to-market pricing positive in the fourth quarter. This means a new resident's rent was greater than an existing resident's rate. This positive mark-to-market occurred for all 3 product lines -- Independent Living, Assisted Living and Memory Care -- and shows that our price discipline is working, despite strong competition. We saw our Independent Living occupancy increase to 90%, which was a 50 basis point increase from the third quarter to the fourth quarter and a 110 basis points improvement for the full year. We committed to and executed on our 2018 financing strategy. We paid off the convertible senior notes, lowered the credit facility borrowing costs and increased flexibility in our capital structure with Freddie Mac financing. And we are nearing completion to achieve our real estate net proceeds goal. These achievements in the first year of our turnaround highlight good progress, especially in the context of industry oversupply and wage pressures.

Let me talk in more detail about our real estate initiatives that we announced last year, starting with our owned portfolio. We are nearing completion of our goal of $250 million of proceeds, net of debt repayments and transaction costs. By the end of 2018, we had closed on community sales providing net proceeds of $193 million. Specifically, in the fourth quarter we closed on 19 owned communities, including Battery Park, and a portfolio of 18 communities located across 8 states, and we currently have several communities under contract for sale that we expect will close in the first quarter, once customary diligence and closing conditions are completed and satisfied.

Turning to the leased portfolio. In the fourth quarter, we completed the remaining HCP lease terminations of 17 communities originally announced in 2017. Separately, we terminated another lease related to 6 uneconomic communities. And lastly, for the managed portfolio, during the fourth quarter, we transitioned numerous communities to new operators, mainly related to our previous announcements with HCP and Welltower. In short, our real estate plan was integral to our transformation in 2018.

Since the beginning of the fourth quarter of 2017 and through the end of 2018, we disposed of 137 consolidated communities through sales and lease terminations. To put that in perspective, on average that's 1 community every 3 days. In fact, the transitions in the fourth quarter were more than the first 3 quarters of 2018 combined.

To provide context to the financial results, for the fourth quarter 2018 compared to the prior year quarter, these dispositions resulted in $105 million less resident fee revenue and $19 million less adjusted EBITDA, but positively impacted adjusted free cash flow by $6 million. With these significant changes in our portfolio in mind, fourth quarter 2018 total company reported revenue was $1.1 billion, compared to $1.2 billion in the fourth quarter of 2017. This 8% decrease is mainly the result of fewer communities, due to asset sales and lease terminations.

Moving to Senior Housing results. Because the execution of our real estate strategy has impacted reported comparability, the best way to analyze the operations is to focus on same-community results. Same-community fourth quarter revenue improved 0.3% compared to the prior year quarter, and improved 0.1% on a sequential basis. Independent Living occupancy increased to 90% in the quarter. For Assisted Living and Memory Care, oversupply and competitive pressures continued to negatively impact the industry and our occupancy. When compared to prior year quarter, the fourth quarter increase to reported RevPAR was primarily due to dispositions of communities with lower-than-average RevPAR. The fourth quarter same-community RevPOR grew nearly 2% over the prior year quarter. This reflects rate increases taken earlier in 2018 and strong price discipline throughout the year, and resulted in positive fourth quarter revenue growth in spite of occupancy declines.

As mentioned earlier, the fourth quarter mark-to-market pricing was positive. This result was strongly influenced by the early implementation of 2019 market pricing for new residents. In the first quarter, we expect the gap between mark-to-market and in-place rent to close, as our in-place rent increases went into effect on January 1, 2019.

The higher 2018 resident rates helped support the investment we made in our community associates. Same-community compensation expense increased 4.3% for the fourth quarter and 5% for the full year as compared to the respective prior year periods. These increases reflects wage pressure due to a tight labor market plus our intentional above-industry investments in key resident-facing associates' compensation to improve our ability to recruit and retain the best associates in the industry.

Our facility operating expense and our same-community portfolio increased 5.4% for the fourth quarter and 3.8% for the full year as compared to the same prior year periods. For the year, these increases were due to higher energy, repairs and insurance costs related to severe weather in the early part of 2018, higher-pace referral expense and normal cost inflation. Primarily as a result of increased investments in our key community leadership and increased facility operating expense, partially offset by slight revenue growth, our same-community operating income decreased to 8.4% for the fourth quarter and 8.2% for the full year as compared to the respective prior year periods.

Moving to our Healthcare Services segment, previously known as Ancillary Services. Revenue stabilized on a sequential quarter basis, although it was 2.1% lower on an annual basis. Throughout the year, our case mix shifted to lower-rate managed care. While this shift impacted revenue growth, our mix is now in line with the industry average and places us in a better position to implement CMS's proposed industry-wide PDGM in 2020. So, even though our patient encounters increased due to our intentional mix shift, our margin decreased.

In addition, one byproduct of the large volume of community dispositions is that certain new operators replaced Brookdale's Healthcare Services soon after a community transitioned. These transitions away from Brookdale had a meaningful impact on our Healthcare Services performance in 2018.

Looking at our hospice business, it continued to grow strongly. Its revenue increased 16% for the fourth quarter and 26% for the full year as compared to the respective prior year periods. From an expense perspective, the primary drivers of this segment's increase in facility-operating expense were labor, related to increased patient encounters and setup costs associated with consolidating and centralizing the intake functions. In 2019, we expect to see savings from this centralized intake consolidation. For our general and administrative expense, we recognized $56 million in the fourth quarter, 5% below the prior year quarter. This is mainly due to the G&A rationalization we made in early 2018. We achieved our annualized G&A savings goal of $25 million, prior to normal cost inflation and normalized bonus.

We reported fourth quarter adjusted EBITDA of $115 million, excluding transaction and organizational restructuring costs of $3 million. This compares to the fourth quarter 2017 adjusted EBITDA of $149 million, excluding transaction and strategic project cost of $11 million. The key drivers of the lower year-over-year adjusted EBITDA were approximately a $19 million decline related to the disposals of communities through asset sales and lease terminations and $20 million of higher same-community operating expenses, mainly driven by our intentional above-industry investment in community leadership salaries, along with more robust benefits. This was partially offset by a $4 million lower hurricane impact and $4 million in lower G&A.

In 2018, we completed 3 important financing transactions. In the second quarter, we paid off $316 million of convertible senior notes. Then, in the fourth quarter, we obtained Freddie Mac mortgage financing and amended and restated our credit facility. The transactions were net neutral to our liquidity, but played a key role in providing flexibility in our capital structure while also extending term and diversifying fixed and variable interest exposure.

A few key attributes were as follows: we lowered the variable rate by 25 to 50 basis points in our credit facility, expanded the letter of credit supplement and created new flexibility to remove or substitute assets as collateral in the Freddie Mac facility. Adjusted free cash flow was negative $4.3 million for the fourth quarter, compared to negative $11.2 million in the prior year quarter. Beyond the factors I described that impacted adjusted EBITDA, disposition-related interest expense and lower nondevelopment CapEx positively impacted adjusted free cash flow. Our proportionate share of adjusted free cash flow of unconsolidated ventures was $2 million in the fourth quarter 2018, compared to the prior year quarter of $12 million. Of the $10 million reduction, approximately $8 million was due to lower entrance fee proceeds at our CCRC venture and $2 million was due to the sale of the equity interest in other ventures.

As of December 31, 2018, total liquidity, including the line of credit, was $593 million, an increase of $134 million from September 30. The increase was primarily a result of asset sale proceeds, partially offset by lower revolver capacity and paying down additional debt. In December, when the stock market and Brookdale shares were experiencing pressure, we opportunistically purchased approximately $8.5 million of shares at an average price of $6.64, and could again be opportunistic based on the future market conditions. We have reasonable debt maturities over the next 5 years. Of our total debt outstanding, approximately 95% is nonrecourse asset-backed mortgage debt. Our balance sheet is well positioned to provide sufficient flexibility as we continue to turn around the business.

Turning to 2019 guidance. As noted in yesterday's press release, I want to highlight 2 changes in 2019 that impact our guidance. First, we adopted the new lease accounting standard, effective January 1, 2019. As a result of this adoption, we expect to record an additional $23 million of revenue and an additional $50 million in facility operating expenses, generally related to the accounting for resident contracts. This change will result in a onetime decrease of $27 million in 2019 adjusted EBITDA but with no impact to adjusted free cash flow. The second change is to our definition of adjusted free cash flow, to be more in line with traditional practice. In our current definition of adjusted free cash flow, we adjust cash provided by operations for changes in working capital. Beginning in 2019, we will discontinue the working capital adjustment. While working capital changes are expected to have meaningful volatility by quarter, full year changes are expected to be neutral to adjusted free cash flow after normalizing for the impact of the new lease accounting standard.

I'll now provide details on our 2019 guidance and assumptions. Our full year outlook reflects the continued execution on our turnaround strategy, in context with broader industry macroeconomic headwinds. As Cindy mentioned, industry headwinds continue, however, our internal forecast and NIC show some improvement in the second half. In addition, low unemployment rates will continue to put upward pressure on wage inflation. With this industry backdrop, the guidance we provided in our press release includes the expected impact of previously announced pending or planned dispositions of communities.

We expect 2019 adjusted EBITDA excluding transaction costs to be in the range of $400 million to $425 million; adjusted free cash flow, including transaction costs, to be in the range of negative $80 million to negative $100 million; and our proportionate share of unconsolidated ventures to be in the range of $30 million to $40 million for adjusted EBITDA, and $10 million to $20 million for adjusted free cash flow. Excluding the $75 million of incremental 2019 CapEx that we highlighted last quarter, adjusted free cash flow guidance would have been neutral for the year. The incremental CapEx spend will be at a high watermark in 2019. As Cindy has already discussed, this investment is necessary. I want to reiterate that our balance sheet is well positioned to provide sufficient flexibility as we continue to turn around the business.

I'll share some of the key assumptions underlying our guidance, and we've listed more details in our current investor presentation, which can be found on our website.

First, one of the most significant items impacting our outlook is based on our real estate initiatives, in general, successfully closing on the communities currently under contract for sale. Slide 16 in our investor deck is a pro forma view of our 2018 results after reflecting the impact of transactions that are in process. While we will have partial year results for 2019 transactions, the pro forma will help you in understanding our continuing operations.

Second, we expect modest revenue growth from our continuing operations. However, because of the impact of dispositions, our consolidated reported revenue will decline. For senior housing, we expect to improve occupancy within the year. This incorporates our assumptions of a less severe flu season. However, the full year average will be slightly down as we don't expect to recapture all of 2018's occupancy loss in 2019. At the same time, we expect to deliver improved rate growth compared to 2018 as we pass through larger in-place rent increases, slightly offset by mark-to-market adjustments throughout the year.

In our Healthcare Services business, we expect performance to improve compared to 2018, when revenue was negatively impacted by a significant case mix shift, to be in line with the industry. We also experienced a negative impact from our large amount of community dispositions.

In 2019, the growth will mainly be from our hospice business, as we continue to gain scale on our existing licenses and expand markets. We expect our operating margins to remain under pressure during the year from both our top line and facility operating expenses. We expect total labor cost, including benefits, to grow by 5% to 5.5%. This will be the final year of our 3-year plan to make above-industry investment in community associates.

Over the past 2 years we've seen the benefit of these investments, with higher retention rates of Executive Directors and Health & Wellness Directors along with higher resident satisfaction, demonstrated by lower controllable move-outs. We expect our 2019 G&A expenses, excluding transaction costs and noncash stock-based compensation, to be slightly up compared to 2018. This is based on normalized cost inflation and bonus, partially offset by additional G&A rationalization that we initiated in late 2018.

I also wanted to highlight a few items that will impact our free cash flow: first, we expect to lower interest expense and lease amortization combined, primarily from our 2018 real estate transactions and those that occurred or are planned to occur in 2019, somewhat offset by rising interest rate assumptions and lease escalators; second, we expect our transaction costs to be approximately $10 million in 2019; third, as I already mentioned, the new lease accounting standard will not have an impact on adjusted free cash flow.

The final significant part of our 2019 outlook is related to CapEx. With the disciplined bottoms-up review of our 700-plus communities that Cindy mentioned on our last call, we expect 2019 nondevelopment CapEx to be around $250 million. Again, this CapEx includes a $75 million incremental near-term investment in our communities. We have an aggressive action plan in 2019; however, it is also an exciting time to share in our associates' passion to win locally and invest for future growth in order to drive operating leverage in 2021.

I would now like to turn the call back over to Cindy.

Thank you, Steve. I want our shareholders to know that we are in a strong position, and we are also seeing positive data points in the industry. Recently, NIC reported an improved forecast, with Independent Living occupancy projected to flatten and Assisted Living annual inventory growth and absorption to intersect in 2019. We believe in the positive trend in Senior Housing as the crest of the Silver Wave is approaching. We are committed to the multiyear roadmap I introduced in February 2018, and we are committed to our turnaround strategy.

Let me close by saying that we are the leader, and we always aspire to be the nation's first choice in senior living. We have an unwavering commitment to our residents, patients and their families, and we are proud to serve America's seniors.

Steve and I are happy to answer questions now. Operator, please open the line for questions.

(Operator Instructions)

As the operator is polling for questions, Steve will address one question that we received overnight.

Yes. Thanks, Cindy. The question is regarding run rate EBITDA growth. To estimate run rate EBITDA growth, you could start with fourth quarter pro forma, the pro forma number found on Page 15 of the investor deck. The fourth quarter pro forma reflects, among other things, the most recent occupancy rate and expense levels. Annualized fourth quarter adjusted EBITDA of $107 million gets you $427 million.

Due to lease accounting adoption, adjusted EBITDA will decline $27 million, which nets to $400 million. $400 million is the start of our adjusted EBITDA guidance range. Then, add your assumptions for rate increase, occupancy, timing of community dispositions and other factors in our guidance page. The middle of our 2019 guidance, or $412.5 million, equates to approximately 3% run rate growth in adjusted EBITDA.

We are now ready for our first caller.

And your first question comes from the line of Jason Plagman of Jefferies.

And thanks for that last clarification. That was going to be my first question about the core EBITDA. And -- but that was very helpful. So digging in the detail, I know you don't guide quarterly, but anything that we should keep in mind as far as the cadence of EBITDA throughout 2019 from -- as we flow through the year?

Yes. Thanks for the question. The EBITDA cadence should be -- should mirror prior years. So I think that's a good start point. As far as free cash flow, I want to remind you that there will be some variability in the free cash flow, as we're including working capital in our numbers this year. And I -- looking at historical numbers, the first quarter is generally a use of cash. The last year for instance, it was a $30 million use of cash.

Okay. That's helpful. And then can -- as far as the CapEx program, can you just describe what some of the major type of projects you're undertaking there? And then do you expect any operational disruption or income statement impact in 2019 from those projects?

Jason, thanks for the question. This is Cindy. So our major projects really include end-of-life projects like roofs, pavement, HVAC, water heaters. We've got to the building integrity around exterior paint, the building envelope and the skin, windows, doors, plumbing and drainage. We've got life safety, including nurse call systems, fire suppression, that sort of thing. And then we do have some resident enhancement, which is landscaping, walls and fences as well as exterior lighting. That gets added to some apartment refurbs, and that's partially offset by lower corporate CapEx. Now, we have a plan to capitalize on the fact that we're investing our -- in our communities, and a "pardon our dust" campaign is coming. Usually what happens when you invest CapEx in your communities is that you improve associate retention rate. And actually, it's something that's exciting for both the residents and new prospects. And so we're hoping that we can capitalize on our CapEx.

Okay, that's helpful. And then last one for me. I know this will be in the 10-K, but you commented on the NOLs as part of the strategic review. Can you -- where do those stand today? I know that several years ago Brookdale was on a trajectory to become a cash taxpayer within a few years. But I guess that's been delayed?

The -- over the planning period, a multiyear planning period of about 3 years, we don't foresee needing to use our NOLs.

And then just the absolute level of the NOLs as of the year -- end of year?

It's a little over $1 billion.

Your next question comes from the line of Chad Vanacore of Stifel.

Just looking at -- just looking at your leased portfolio, you saw a sequential improvement in occupancy. But then comparing that to the owned and managed assets that had sequential declines in occupancy from last quarter. So was that leased portfolio -- was that primarily related to HCP lease terminations? By shedding some of the low occupancy assets, you improved overall? Or is there something else going on there?

So essentially, the HCP lease portfolio does have something to do with it, but it really relates primarily to the competitive economic condition around the communities.

All right. So in some of those communities, you're actually seeing a lightening of competition?

So if you look at our investor presentation, you'll see that in Q4 our starts were elevated around our communities. There's no question that that had an impact on occupancy as well as the retention rate of our sales directors. We saw some turnover in sales directors that was attributable to competitive activity. And so the good news is that we do see the industry's supply pipeline decreasing. And we've got line of sight into Brookdale's supply pipeline based on our proprietary analysis, and we think that near the end of 2019, new opens around our communities will improve.

Okay. So you've had a busy year in terms of dispositions, restructuring. I think you mentioned 137 communities. How much more is assumed in 2019 guidance? And what's reasonable timeline? And then one ancillary question is you say adjusted guidance is roughly up 3% or so, how much of dispositions affect that guidance, one way or another?

So let me start with the big picture and then Steve can kind of jump in. As I look at our portfolio restructuring, we certainly have the 13 assets that are included in assets held for sale. In our agreements with both Ventas and Welltower last year, we had the ability to slightly prune those portfolios. We have reached an initial set of assets that we would like Ventas to market, and they are working on marketing those. That's likely coming in the back half of the year, given the time to do the marketing and transition. So I don't see massive changes in our portfolio other than the exit of the interim management agreement structures. As you know, when we terminated leases last year, we took over management of the communities until the landlords could find a new operator, and that's something that we would expect to happen more in the first half of the year than the second. Steve, do you want to add anything to that?

That's right, Cindy. The -- and you can also see the assets held for sale, the impact on our P&L. So that's on Page 15, is Column C. And although it has a fair amount of revenue impact, when you get down to EBITDA, it's relatively de minimis on our total EBITDA number for the company.

Your next question comes from the line of Josh Raskin of Nephron Research.

I guess the question really is, we've gone through over the last couple of years of attempting to sell, or strategic alternatives and all that sort of stuff. Obviously, nothing came of that, and now it sounds like there was this whole opco-propco analysis with external advisors and doesn't sound like that's actually a value-enhancing strategy. So it really comes down to operations at this point. And I guess one thing I don't get is, I don't feel a sense of urgency on cost controls. We're still hearing about bonuses and investments, and I think G&A was actually going to be up on a same-store basis in 2019. And so I'm just curious, what am I missing here? Because I can't imagine that's the case, there has to be some sort of offsetting factors. So maybe a little bit on the G&A, and how you guys are thinking about these investments and when the payoff starts to come?

So Josh, let me start. So we are very focused on cost control. Let me start with G&A first. We cut $25 million of G&A in our 2018 plan, and we made the adjustments to G&A at the end of the year. We did another reduction in force, and that's largely behind us, which will benefit sort of 2017 -- or 2019. But it is important to recognize that people have a compensation package that includes a bonus and base compensation. Those bonuses did not fully pay in 2018. We have high expectations, and we want to make sure that we're paying for performance. So when we budget for 2019, we are baking in a full bonus into our guidance. Now if we don't deliver our numbers, our G&A will come down because we will not pay a bonus.

Now the second thing that you need to remember is in our communities, our communities have a very high fixed-cost structure, and think about the investments that you need to run a community, there's a step function. When you shrink occupancy below a certain level, you can't cut costs. You still need to operate your community 24/7. You still need to have nursing on staff. You still need to serve 3 meals a day in your dining room. And so when we improve revenue and -- when we improve occupancy, which we will, there is roughly a $20 million improvement to both adjusted EBITDA and adjusted free cash flow from the improvement in occupancy. To the extent that we're able to drive rate faster than our cost, then that's a $25 million improvement in both adjusted EBITDA and adjusted free cash flow. That's why we're so very focused on the competition around our communities, putting the plan in place to deal with that competition and making sure that we have the right associates in our community.

One thing you may not realize is, because we have to have people on staff, if we have too much turnover, we have to go to overtime and contract labor because we cannot leave our residents without a nurse on staff, and we have to serve 3 meals a day. So believe me, we are focused on cost control, but we have to invest to turn around the business because underinvestment has hurt our occupancy and hurt the growth profile of our business.

I certainly understand the idea of fixed-cost business and staffing ratios, et cetera. So I certainly appreciate that. I guess that kind of leads into a second question of mine, which is around the competition. We're hearing some of the healthcare REITs have made some commentary around potential -- I wouldn't call it -- well, some have said even inflections in the market, not calling it a trend yet, but you were seeing slightly better results kind of industry-wide. So -- and I understand the AL-IL mix relative to the industry, et cetera. But do you think there are other factors as to why Brookdale's seeing more of a lag? Why is the competition still so pervasive in your specific markets relative to what we're hearing from some of the larger REITs?

So let me start by saying I agree with what the REITs are saying. They're absolutely right about an improving competitive environment. If you look at our Independent Living business, we were over 90% occupied in the fourth quarter. That's a sequential improvement as well as a year-over-year improvement.

It's important to note that our consolidated results are reflected by an even higher concentration of AL and Memory Care than our managed communities, all the communities that we manage, including our owned and leased. So what we are seeing is in the primary markets, there's still a lot of competition. Our secondary markets are improving, and we are seeing improved results as a result of that. So we believe that if you look at the comparable, we're doing quite well. And that is why we are so confident by continuing on the path that we laid out and making the investments that we need to make to compete effectively, we are going to drive value for our shareholders.

Got it. Got it. And then third just for me, and I apologize for all the questions, but one -- and sort of off-topic, more sort of long-term positive opportunities. We saw an interesting announcement from a couple of senior housing providers that are sort of coming together with a company that's helping them to put together a Medicare Advantage plan. And to me that's sort of the ultimate move in kind of taking risk or bundled payments.

And you guys have this big Ancillary Services business; obviously, it hasn't been doing very well. Are you thinking about more dramatic opportunities to take advantage again, now that you've kind of set your real estate, you're not selling the company. You've got this captive audience, in my opinion, of seniors. And are you guys thinking about different types of opportunities in, I guess, Healthcare Services, what used to be Ancillary?

Absolutely, absolutely. So if you go back to what I said in February of 2018, the first thing that we have to do is to get our existing portfolio to where we have a right to win. We have to improve the operations in those communities and then we have to deliver additional products and services to the residents in those communities.

Medicare Advantage is one potential opportunity for us, whether we do a plan on our own or whether we partner with a third party. It's services that our residents need, and it's gaining traction sort of in the United States. So as you see us go through 2019, you'll see us be more vocal about the long-term things that we can add to our business to drive incremental profit, cash flow and value to our shareholders.

Your next question comes from the line of Joanna Gajuk of Bank of America.

So 2 questions here on the CapEx, right? So the $250 million, that's of net -- I mean, that's net of the REIT funding? Correct?

That is correct. Thank you, Joanna.

And then you plan to use, essentially, the proceeds, the $190 million you already received, I guess, to fund it, correct?

So the $193 million, consider our cash balance. I view cash as fungible. But it is fair to say that a portion of that will fund the CapEx investments that we're making that are critically necessary for our communities to operate effectively.

Right. And then, so the way I'm thinking about it, is the $75 million sort of increase in '19 versus '18 enough? Should we expect the $250 million kind of level CapEx for '19 to come down in 2020?

So that's a good question, Joanna. We see sort of an increase between 2018 and 2019. We think 2020 will come down from 2019. 2019 will be a high water mark, but we do not think that -- or that 2020 will be less then 2018. So think of it as between 2018 and 2019, and that's where we think 2020 will come in.

Okay, that makes sense. And then the other item in the guidance, you talked about the labor costs outlook for this line item to grow 5% to 7.5% in '19 after it was up 5%. I understand you're making these investments, but is there a way for us to glean into what actually is included in there? I mean, what's the kind of underlying labor cost inflation in your markets, i.e., if you exclude these incremental investments, what's the kind of run rate growth? Or is there even a way to think about it that way?

I think it's fair to say that normal wage inflation is in that 2.5% to 3%, and that is something that is not terribly different. We've got some markets that are much higher than that, and we've got some market that are lower. And there are a few components that are really going into our wage increases, some is wage rates, some is better benefits. And then of course, you've got to look at the labor that we have per resident day.

All right. If I may squeeze the last question on the Ancillary Services or the Healthcare Services segment. So obviously margins were weakened, I guess you're making some investments there. But how do -- should we think about the margins for 2019 and then beyond? So it sounds like you made some changes already to the home health business ahead of the PDGM in 2020. But even with that, do you think you already have the right mix, given how the reimbursement would change or you think there's going to be incremental pressure to margins in 2020?

So the good news is that with the changes that we made to our business in 2018, we're in line with the industry as it relates to nursing and therapy ratios. Where we still have to focus for 2020 is in the level of services that we provide. And so as you look at a new payment model, there's no question it'll having an impact on revenue, but we expect to reduce costs by a similar amount so that we keep our margin dollars consistent. And so you'll see us continue to look at how to compete effectively and adjust our business to capitalize on the opportunities that come from that.

And your next question comes from the line of Frank Morgan of RBC.

It's Anton Hie on for Frank. A lot of mine have been addressed, but I wanted to come back and get a bit of clarification on at least 2 items here. The -- I was hoping you could -- you mentioned you think quarterly EBITDA cadence will be similar to 2018 and -- but referencing back to the assumptions built into the guidance that occupancy improves throughout the year, could you just help square that up? Is the occupancy improving throughout the year, is that just sort of on the normal progression of occupancy? Or is that suggesting that maybe we see some of the environment improving as some of these construction deliveries slow down throughout the year?

Yes, thanks for your question. The occupancy assumptions that we assumed in the 2019 forecast follow the trends we've seen over the past couple of years. So some pressure in the first quarter and then grows throughout the rest of the year. So that would lead you to a better EBITDA as you go throughout the year. Just remember that in the first quarter, January 1 is when we had our rate increase for our in-place residents. So that will be a tailwind there.

But it is fair to say that you do the rate increases in January 1 and then there's a little bit of mark-to-market that goes throughout the rest of the year. We were positive in Q4 because we pulled our rate increases forward. But as you think about sort of how that affects the year, normally you do see rate deteriorate a little bit during the year as a result of new residents coming in.

How was the reception to pulling those rate increases forward a bit?

We do it pretty much every year. Now the difference with this year's rate increase is that they were larger than normal. And so we were very happy that we were able to sustain a good rate. We believe that if we protect that rate, that will be the most important thing to drive value, and we haven't really seen an increase in resident attrition as a result of higher-than-normal rate increases. Now I think that our residents understand that we have to pay to have the right staffing in their communities and to get the right associates. We've actually had residents say, "Pay our people more." And so as we explain the reasons for the rate increase, they tend to understand. And as you would expect, because we are large and we're the industry's leader, we had a comprehensive program to train all of our Executive Directors on how to communicate with residents about the rate increase and to explain the rationale for the rate increase they received as why -- as well as why it was necessary for us as a company to do. And that happened very well, I think.

Okay. And then, Steve offering the EBITDA kind of run rate. I mean, obviously, that's top of the mind for everybody with '19 being another sort of rebuilding year, if you will. So -- but we kind of start with the $400-ish million jumping-off point from the fourth quarter pro forma annualized. But I think once we add back -- I mean, am I right? The $27 million is a onetime issue from the lease accounting adjustment, then we add back in kind of the unconsolidated ventures. Is it unreasonable to think $475 million is a reasonable sort of run rate stepping into 2020 and to grow from there?

When you add the -- when you add both the consolidated and the JV, that's above the top of our -- $425 million and $40 million are the top ends of our guidance ranges.

But it's fair to say that the $27 million hit will happen only in 2019, so that will not recur in 2020. So it's appropriate to add that to your model as you think about what 2020 looks like.

2020 and beyond, correct.

Okay, great. Thank you, And then one final one, and you touched on it a little bit earlier, but can you talk about what you're seeing in some of the secondary markets where construction deliveries are stopping or slowing considerably, kind of what you're seeing in your communities there?

You can see that we are improving in the secondary markets, and we have in a slide in our investor presentation.

Page 11.

Page 11. That shows the secondary markets and kind of some of the occupancy trends relative to the primary markets. So that's something that you can dig into in great detail.

And your next question comes from the line of Dana Hambly of Stephens.

Cindy, you talked about this year being a big focus on the move-ins, and just looking at one of your slides, I think the leads in the fourth quarter were stable, first visits up a little bit, move-ins down a little bit, but was 2018 a year of discovery on becoming more efficient on converting leads to move-ins? Or is 2019 going to be where you start to pay more -- not pay more attention, but you start to learn more about becoming more efficient there.

I think we had a lot of learnings in 2018, and we're very happy that we've got the strategy right in terms of how to grow move-ins. It's fair to say that in the fourth quarter we suffered from turnover due to competition from our sales directors, and we also saw our lead flow from our large aggregator decline a bit. And our large aggregators tend to convert much more quickly, albeit at a lower rate. And so that affected our move-ins in the fourth quarter.

Now I think that I'm really excited about the realignment of sales under Mary Sue Patchett. Sales will still report to Sales, which I think is critically important, but what our Operations team is amazing at is execution. So we've got the strategy right. Now we'll add execution. We will add additional coaching and mentoring for our new sales associates, because we know that our first year sales associates, it takes them a while to become proficient. So we are adding additional training. We are adding additional support and certification so that they can get it right.

We've also been a little bit more proscriptive on how you sell the value of Brookdale at each of the different product types. To that, they can add the local focus of why their local community is best, but having a little bit more support from the corporate folks about why our Memory Care is industry-leading -- we have better programs than anyone else; why AL is better than other competitors -- because of the size and scale that Brookdale offers. So we're pretty excited about what we're going to do with move-ins in 2019.

Okay. And then you -- Cindy, you mentioned the aggregator, is that a permanent move or is that something you experimented with in the fourth quarter?

It wasn't a move by Brookdale as much as it was of the leads that we saw coming in from the aggregator. So it's a private company, so we don't necessarily know what they saw in the aggregate. All we know is that the leads that they sent Brookdale were lower. And as you would expect, we've got an action plan to make sure that we are getting more than our fair share of leads, and then once we get those leads, we convert faster than anyone else. And we make them happy, new Brookdale residents.

Okay. And then there was -- I think in one of your pages on the shareholder value creation, there was a note in there about technology investments that would enhance the resident experience and lower costs. I don't know. Can you shed any light on that or is that top secret?

It's not necessarily top secret, but we continually look at ways to use technology to help our residents, and it can be anything from monitoring to -- monitoring slips, trips and falls -- to just making sure that they have WiFi that is robust enough, so they can communicate with their family and friends and with loved ones.

Let me also add, one of the things that I'm excited about is the rollout of our electronic residency agreement. We've been working on this for quite some time now, and we've tested it in some of our communities, and it's going really well. Our new resident bills -- it's a pain point in the industry because they're complicated. By allowing us to capture data electronically as the resident signs the residency agreement, that will improve resident satisfaction by improving the quality of that first bill and making sure that it's right. So that's just one example of what we're doing to make sure that we're focused on delighting our residents and really improving customer service as well as improving costs.

Is that rolled out or are you just starting to roll that out now?

The pilot has been successful, and we are working on rollout plans for 2019. So I'm pushing the teams very hard, and they are going to be as aggressive as they can about getting it into our communities.

Okay, alright. Last for me. I appreciate all the color on the CapEx, there's a lot of questions there. And so we have -- obviously, know 2019 and have an idea of 2020. But just longer-term, how do you think about just maintenance CapEx or community CapEx on a per unit level? I think it's run around $2,000 in 2017 and 2018, obviously, bumping up the next couple of years. But longer term, what's the right number to think about?

Yes, I think it's likely above that $1,800 that we talked about previously but below sort of what we're spending in 2019. I don't want to get much more granular than that. We will come out with additional information as time passes. But that's definitely a thumbnail on what you can expect.

And Cindy, I'll turn over to you for closing remarks.

We are now in -- one year into the execution of our turnaround plan, and we're pleased with the posted results in line with our guidance range. As we reflect on the improvements that were made and we have continued to make in our business, along with signs for improvement in supply and demand, everything that we have seen to this point affirms our belief in our strategy.

Over the last year, we made great progress to restructure leases and optimize our portfolio, and we focused our team on a few key operational initiatives, and they are starting to show success. As evidenced by our controllable move-out experience, we're very confident that our sales and operational initiatives for 2019 will only help to further the progress of our turnaround. We are also seeing evidence that the supply-demand equation will improve within the next year, and we are excited about the tremendous demographic tailwind that is coming over the next few years.

Healthcare spending will only continue to increase, and we will play an important role, both within the senior housing and healthcare. With a combination of our industry-leading position, our plan to win locally and the silver wave approaching, we firmly believe that we will be well positioned to drive operating leverage and create significant value for our shareholders. Thank you for joining us this morning.

Operator, that ends the call.

Thank you so much, presenters. Have a great day.