Ensign Group Inc (ENSG) 2013 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to The Ensign Group, Incorporatedsecond quarter fiscal year 2013 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will have a question-and-answer session, and instructions will follow at that time. (Operator Instructions). As a reminder, today's conference is being recorded. I would now like to turn the conference over to your host for today, Mr. Greg Stapley, Executive Vice President. Sir, you may begin.

Thank you Mary. Welcome everyone. Thank you for joining us today. We filed our 10-Q and a Company press release yesterday. Both are available on the Investor Relations section of our website at www.ensigngroup.net. A replay of this call will also be available there until 5.00 PM Pacific on Friday August 23, 2013.

As you know, we always open with 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. They could cause our actual results to materially differ from those expressed or implied on the 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 laws, Ensign does not undertake to publicly update or revise any forward-looking statements for changes that arise as a result of new information, future events, changing circumstances, or for any other reason.

In addition, any Ensign business we may 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 activities, as well as use of terms such as we, us, our, and similar verbiage are not meant to imply that The Ensign Group Inc. has direct operating assets, employees, or revenue, or that any of the various operations, the service center, or our captive insurance subsidiaries are operated by the same entity.

Also we supplement our GAAP reporting with non-GAAP metrics. When viewed get 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 to the exclusion of GAAP reports. A GAAP to non-GAAP reconciliation is available in yesterday's press release, and in the Q.

Finally, just a quick update on the DOJ civil investigation, and we hope that it is the last one of these we will give you. As you know, without admitting any wrongdoing, we have tentatively agreed to settle the matter, in order to avoid the uncertainty and expense of litigation. The paperwork now is nearly complete, and we now expect to sign the Corporate Integrity Agreement, or the CIA, and remit the settlement amount some time in the third quarter.

Preparations to fully comply with the terms of the CIA, including significant enhancements to our internal compliance program have continued in earnest throughout the quarter. Many of the ongoing costs for these changes are reflected in our second quarter results, and we expect that monitoring the expenses, interest expense, and other associated costs, will be incurred starting in Q3. Naturally, we caution that until the tentative settlement becomes final, there can be no guarantee that these matters will ultimately be resolved. The more complete discussions of the matter contained in yesterday's 10-Q and prior files with the US Securities and Exchange Commission should be consulted for additional disclosures and details.

With that, I will turn the call over to Christopher Christensen, our President and CEO, to get started. Christopher?

Thanks Greg. Good morning everyone. Long time followers of the Company will recall that in every earnings call to date, we have reminded our listeners that our business can be a bit unpredictable. We use the word lumpy from quarter to quarter. The second quarter was just such a quarter, and highlights why it is so difficult for us and those who follow us to predict short term results at any given point in time. However, Ensign Group's long-term business has been highly predictable over our 6.5 year history as a public company, and even well before that. We have been able to consistently achieve our annual goals, even in the face of reimbursement cuts, program changes, and other near term hurdles for us and the industry.

Even though the second quarter was among the most challenging we have had in a long time, we are optimistic that we can reassure our shareholders and friends that Ensign remains on track to achieve our previously-announced annual guidance. We expect to see the lion's share of that remaining performance in the fourth quarter. This fourth quarter surge is typical for us, as we almost always see our best occupancy and skill mix increases, as well as the effect of rate increases, which will be unusually beneficial this year in the last three months of the year.

As most of you know, our consistent success is seldom the product of any one thing, but rather reflects the aggregate effect of dozens of small victories across the organization. Likewise, our earnings decline this quarter has resulted from a number of small deficiencies rather than any one big downturn or headwind. We believe these challenges are mostly manageable over time, and our outstanding field leaders are fully engaged on all fronts to identify and overcome weakness wherever it occurs. Because of them, we remain confident that Ensign's future both near term and long is very bright.

In addition to our operators and their care teams, which will always be the brightest of our bright spots, we see other positive developments on the horizon that we believe will help us lift our business past the current industry-wide declines in occupancy and skilled mix. For example, the recently announced 1.3% net increase in Medicare rates will begin on October 1st. We have also had good news on the Medicaid front in several our larger states, with our largest states California and Texas, both announcing significant increases later in the year.

Several other states where we operate are issuing positive rate announcements as well. But these increases are still on the come, as last year's state budget problems in many of our states have caused our net Medicaid rates to be not just flat, but down through the first three quarters of the year. I think most realize this, but to see our Medicaid rates accurately, it is essential to view them net, of offsetting bed debt, bed tax increases in most states.

For example this year in California, our largest state, the state announced a Medicaid rate increase, but the effect of the accompanying provider tax increase was much more than the increase, resulting in a net decline. You will recall that our guidance assumes on average 1% Medicaid rate increases, net of provider taxes, and we still believe we will get it within this year, but that it will almost all come in the fourth quarter. This news aside, we continue to have many levers we can pull to achieve our operating objectives this year. We will discuss some of those and the challenges they can address later in our report. We hope that you will see as we do the clear path to success that lies ahead. And why we are enthusiastic about our future, and our prospects for Ensign's continued growth and performance.

But first, I would like to have Greg briefly discuss our recent growth. Greg?

Thanks, Christopher. It was an unusually busy quarter on the acquisition front, with nine new facilities added to the portfolioin Q2 and since. We also finalized disposition of our Doctors Express franchise business early in the quarter.

The nine facilities we have acquired include six skilled nursing facilities in Texas, Nebraska, and Washington, and three assisted living properties in Utah, California, and Washington. We are excited about the prospects for these facilities, but like most of our acquisitions, some of these will require time and energy before they move into the black. While we expect most of them to be mildly accretive for the year, we recognize that doing this many acquisitions all at once will always have a negative impact in the short term. This is true not just because the acquired operations themselves take some time to turn around, but also because the acquisition process usually takes something of a toll on our existing operations. As leaders across our organization are temporarily retasked to help initiate and shorten those turnarounds. But as we have proven time and again, it is worth the sacrifice in the short run, in order to acquire the tremendous long-term organic upside that these acquisitions represent to make those sacrifices.

This new growth has brought our total senior housing and inpatient care portfolio to 119 facilities in 11 states, with 11,137 skilled beds, 1,603 assisted living units, and 477 independent living units all in operation. Of the 119 properties we operate, 96 of them are Ensign-owned, and 75 of those are owned free of mortgage debt. On other fronts, our home health and hospice operators took a much-needed breather from their recent acquisition pace during the quarter, as we indicated they would last quarter. That break will likely continue for the foreseeable future as they stop to strengthen systems processes and personnel, and continue to digest their recent acquisitions. To date, we have acquired or developed nine home health and seven hospice agencies, and for the record, we see no abatement in the number of opportunities in that space, and we can expect to continue growing those businesses as our existing base matures.

In addition, even though we sold our Doctors Express franchise business on favorable terms during the quarter, we do remain committed to our non-franchised urgent care business, Immediate Clinic. Immediate Clinic has five open and operating clinics, all in the greater Seattle market, with more locations in the pipeline. As we predicted previously, some expected start-up losses in these new businesses negatively impacted the first half of the year. But we still anticipate that these pilot locations will start becoming accretive later in the second half.

We continue to see compelling opportunities to spread the Ensign operating philosophy across the country, and we have additional acquisition growth and diversification prospects in the pipeline. We continue to generate strong free cash flow that can be used to fund growth. In addition, the majority of our $150 million revolving credit line remains available, and we have tremendous untapped equity in our real estate portfolio, as well as a very strong balance sheet, all of which we can leverage to act as additional growth capital as needed. With that, I will hand it back over to Christopher.

Thanks Greg. As I mentioned earlier, the quarter's challenges did not stem from any one thing. Including in our adjusted quarterly results are the following. Our healthcare costs spiked quite significantly in the quarter. More than $1.1 million over our projected costs. That spike was not expected and we are pleased to report that those costs are not continuing at the same elevated levels as they, have already dropped back to normal levels in June and July.

Next thing is sequestration reduced revenue by nearly $1.8 million, but that was expected and it will be offset to a large degree in the fourth quarter by the October 1st Medicare increase that was announced last month. Some significant costs associated with the acquisition and transition of the home, health and hospice business, approximately $1 million in the quarter were also unexpected, but those costs have been absorb and are not expected to recur.

In addition, we like the rest of the industry saw some marked softness in occupancy and especially skilled mix in our same store, which was only partially offset by a nice tick upward in managed care days. We are happy to note that both occupancy and skilled mix trended up in July. And of course, our compliance costs increased, but those increases were planned and expected, and will continue to increase throughout the remainder of the year. All of these things and others combined to impact the quarter, but with the exception of the compliance program costs, they appear to be one-time expenses, and we are expecting meaningful Medicaid increases in addition to the Medicare increase before the end of the year, with the bulk of the benefits coming in the fourth quarter.

Also as Greg mentioned, we had an enormous quarter on the acquisition front, but the usually-hidden short-term costs of transitioning a higher than usual number of distressed assets in the quarter, naturally took a bite out of earnings. Those costs included normal start-up losses at a few of the facilities, as well as the significant hard costs of deploying numerous resource personnel and others to the four corners of the Company for extended periods, in an effort to decrease the turnaround time at these newly-acquired operations. In addition, there were intangible but real costs of having many of our best operational leaders temporarily spending time away from the day-to-day and their own operations. We saw a few key operations suffer short-term performance declines as well.

All of this added up to two things. First, some short-term weakness in operating results that you are seeing now, and second, the improvement of our long-term projects or prospects for organic growth and performance, which we expect you will see in the future. Just by way of illustration, that organic upside is evident in the many differences between our newly-acquired and same store buckets, which differ in both skilled mix and occupancy by 16 and 20 percentage points respectively. As you know, making these Ensign-style acquisitions is a key element of our business model, and it is one reason why we can say that we still expect to achieve our annual guidance by year end. There were other reasons as well with plenty of positive news in the quarter, for example, last year, we began a concerted program to move all of our facilities into the four and five star categories under CMS five star rating program.

We are pleased to report significant improvements in compliance and quality of care across the organization, and as we always remind you, compliance and quality outcomes are precursors to outstanding financial performance. We are also pleased to report concrete results with a number of Ensign facilities sporting four and five star ratings, growing by 20% from 46 to 55 operations since January. And remember that many of the acquisitions we make are one and two star operations at the time that we acquire them. We have also spent the past year focusing heavily on an intensive effort to enhance our managed care contracting team and focus on managed care admissions. This quarter, we are pleased to report that our same store managed care days were up 882 basis points, and same store managed care revenues was up over 1,000 basis points. We value these managed care relationships, and we plan to continue growing this business.

With this foundation in place, we have recently added an intensive business development program to our focus. Business development necessarily took a bit of a back seat to other efforts at a lot of facilities, while we worked hard on the clinical compliance and five-star improvements. Now our new business development initiative will leverage those clinical and regulatory improvements over time to drive future increases in occupancy and skilled mix. In the spirit of full disclosure, we expected to start this program sooner and move it faster. But it is underway now, and we are expecting it to produce results in this year. Some facilities have already started seeing positive results from these efforts, and I will just mention three examples, as we believe these are just the first of many.

At Pacific Care Center in Little Hoquiam, Washington, CEO, Spencer Burton, with Director of Nursing and COO, Julie Wakefield, and Director of Rehab Services, Scott Hollander, have opened a new outpatient therapy program and a new wound care program, and used them and other clinical enhancements to extend their marketing radius to a number of neighboring communities. As a result, Pacific Care's skilled days are up 21%, and their revenue is up 650 basis points, and their EBIT has jumped almost 58% over last year's quarter.

At Glenwood Care Center in Oxnard, California, CEO, Dave Merkley, together with Director of Nursing and COO, Sheryl Santos, and Director of Rehab, Sashin Basha, have aggressively marketed their outstanding survey record, their newly installed advanced therapy technologies, and their status as the area's top five-star facility. Among other things, these efforts allowed them to secure an important contract with the new County-operated managed care system, to provide maintenance and quality of life therapy to long-term care residents. As a facility of choice in their area, Glenwood's skilled mix revenue is up 540 basis points to 70.7%. Their revenue is up over 800 basis points, and their EBIT has jumped almost 35% over last year's extraordinary quarter.

Finally, at St. Joseph's Villa, our continuing care campus in Salt Lake City, Utah, which is a four-star facility and still improving, CEO, Brad Albrechtsen, and Director of Nursing, Shaylene Pikay, have expanded their gero psych unit, and established a new sub-acute unit, changes that have enhanced St. Joseph's reputation as a premiere high acuity healthcare provider in the Salt Lake metro area. Community response has been gratifying, allowing them to grow their skilled mix revenue by nearly 800 basis points to 41.7%. Increase their post-acute revenue by 11%, and improve their EBITDAR in post-acute operations by 178% over last year.

So although the quarter's results by themselves were not what we like to see, we have always taken the long view of our business. We are very encouraged by the stories and many other exciting developments underway across the organization. We have grown at a much faster pace than usual this quarter, and we believe we have put in place a solid foundation for making the growth pay dividends later this year.

With that, I will hand it to Suzanne to provide another detail on the Company's financial performance, and then we will open it up for questions. Suzanne?

Thanks Christopher. Good morning everyone. Detailed financials for the quarter are contained in our 10-Q and press release filed yesterday. We are pleased to report that after completing one of the most aggressive quarters of acquisitions in our history, and after accounting for the $48 million settlement payment we expect to deliver to the government later in Q2 (Sic-see press release "Q3"), we believe that Ensign still has the cleanest balance sheet in the industry. If that payment were made today, our net debt to EBITDAR ratio would stand at 2.39 times, which was in advertently reported as 2.85times in yesterday's press release. If you remember our history, growth pattern, and business model, we typically see spikes in the ratio immediately following acquisitions, and then see that ratio float down over time as the new acquisitions add more and more EBITDAR to our operating results.

As Christopher noted, operating results in the quarter were impacted by a number of one-time factors,that we actually included in our adjusted results. Including a spike in healthcare costs, difficulties in fast-growing home health and hospice services, and of course, a drop in occupancy and skilled mix,all of which we already see turning around in July. We believe that part of the decline in the skilled mix tracks back to the increase by some hospitals, and their use of observation stays, rather than qualifying in-patient stays, which prevents patients from coming back to the hospital with Medicare eligibility. We are pleased to see CMS recognize that observation stays can be overused, and apparently taking positive steps to address the problem. For our part, we are educating our local leaders and their care and billing personnel, so that they can verify payer sources more closely. Even if the patient has already been in the facility.

As for other key data points on June 30th, cash and cash equivalents were $27.5 million. Net cash from operations was $26.6 million. And free cash flow for the trailing12-months ended June 30 was $47.7 million. As well we provided a reconciliation of GAAP to non-GAAP results in yesterday's release. As you saw from the financials, comparisons to the second quarter of 2012 which was clearly an outstanding quarter were difficult. With an adjusted consolidated EBITDA margin of 15.3%, adjusted consolidated EBITDAR margin of 16.7%, and adjusted non-GAAP earnings of $0.61.

In our frequently uneven business model, Q2 of 2012 happened to be unusually good. And Q2 of 2013 happened to be unusually difficult, perhaps making the earnings delta look a little more daunting this quarter than it really is. However, as Greg and Christopher both indicated, we have many reasons to be positive about the second half of the year, and particularly the fourth quarter, which is when we historically have our best occupancy and mix, and the effect of rate increases finally kick in. And we have reaffirmed that our annual guidance for 2013 is $915 million to $931 million revenues, with $2.72 to $2.81 in diluted adjusted earnings per share. This represents an average growth rate and earnings per share of almost 15% a year since 2009.

These projections are based on diluted weighted average common shares outstanding of approximately 22.5 million. No additional acquisition or disposals beyond those made to date. Exclusion of acquisition-related costs, and amortization costs related to intangible assets acquired, exclusion of start-up losses at newly-created operations, exclusion of expenses and accruals related to the DOJ matter, tax rates at our historical average of 38.5%, the effective sequestration followed by an offsetting Medicare net market basket increase in October 2013, and include anticipated Medicaid reimbursement rate increases net of provider tax.

In giving you these numbers, I would like to remind you again that our business can be a bit lumpy from quarter to quarter. This is largely attributable to the variation in reimbursement systems, delays and changes in state budgets, seasonality and occupancy and skilled mix, the influence of the general economy on census and staffing, and the short-term impact of our acquisition activities and other factors.

We will be happy to any specific questions you have later in the call. Now I will turn it back over to Christopher to wrap up. Christopher?

Thanks Suzanne. Thanks to everyone who has been on the call. We hope this discussion has been helpful. As always, I want to conclude by thanking our outstanding partners, in the field, at the service center, and across the organization, for their continued efforts to make Ensign the best Company in the healthcare industry. We would also like to thank our shareholders again for your support and your confidence.

Mary, can you please instruct everyone on the call on the Q&A procedure?

Certainly. (Operator Instructions). A moment while we wait for questions to queue. We have a question from Rob Mains from Stifel. Your line is open.

Thanks. Good morning out there.

Hi, Rob.

I just want to clarify one comment about expectation for the remainder of the year. On Medicaid. Christopher, you had said that Medicaid would be down through the first three quarters of the year. That is on a sequential basis, right? Because it is up year-over-year.

I know it looks like that. One of the reasons I wish I had time to explain was the net Medicaid rate, because the gross Medicaid rate looks like it is up, but there is an accompanying, it is called many different things, quality fee, bed tax, lots of things that takes a positive rate adjustment on the revenue front, but makes it a net negative after you add in the expense that is on a different line.

Okay. Right. So what you were referring to was like a net of provider type tax type quarter?

That is correct.

Got it. Then Ihad a question about M&A since it was a real busy quarter. Are you seeing more or less competition for deals? It seems that since the last time you reported a quarter, we have seen capital costs go up. The REITs are talking about, the private REITs that are becoming, or non public REITs that have been more active in pursuing deals, but I don't know whether they are pursuing the ones you would necessarily pursue. Kind of a sense of the competitive market for deals?

Rob, this is Greg. I think your sense is good that indeed we do see more competition, even though some of the big, big REITs announced that they are stepping away from the skilled nursing space, there are others who are backfilling and providing liquidity to smaller companies that want to do some of those performing asset deals. At the higher end of the market, the more performing end of the market, we are seeing a little more competition for those assets. But those are not the assets we typically look for. About 80% to 90% of our deals are the distressed asset deals. We don't see a lot of variability in either demand or pricing for those kind of assets. The pipeline for those is fairly steady and as you can see we are getting deals done.

Okay. And then last question for me for now, you gave the numbers that are helpful on how much of the portfolio you own. What is your view of lease assumption as a way to grow the asset base?

We have done that before, Rob. We don't have any problem with doing lease assumption, as long as we feel like value is there. And it all makes a lot of sense.

Okay.

Leasing, it is just another form of financing and we're perfectly comfortable with it, if that is the opportunity before us.

Got it. Thank you very much.

Thank you.

Thank you. (Operator Instructions). Our next question comes from Ryan Halsted from Wells Fargo. Your line is open.

Hi. Good morning.

Good morning, Ryan.

So just sticking with the acquisition environment, I was just curious how you guys are viewing, looked like you did a decent number of deals in the assisted living space. So I am just curious how you guys are looking at your pipeline going forward as far as those types of assets, as well as, what are your views, or what is your pipeline on the home health and hospice front as well?

The assisted living that we have acquired lately are doing fairly well. In some respects, they are harder turns than the skilled nursing facility, take a little longer to build. But we like that business and we are optimistic about it. We have actually grown it at probably a more aggressive rate lately, or the past year and a half to two years than even the skilled portfolio. So you will see us in assisted for a long time. And that will continue to grow. The pipeline for it is pretty robust. We have got some good opportunities out there, and there are sort of different tiers in the assisted living business. There is your A facilities, and then there are some B and C facilities.

Similar to our opportunistic strategy on the skilled nursing side, we like to find sort of C level, beaten down, distressed assisted living facilities, and then clean them up, to that very nice B level, where middle, upper middle class folks can afford to live, and really receive good service.

And on the home, health and hospice, our pipeline may not be enormous right now, but the pipeline available is extraordinary. But I think you will see is slow down a little bit as we absorb what we have already acquired. We have grown at a very rapid pace. Even though home, health and hospice still represents a very small part of our overall organization, it has grown quickly, and right now, we are as I said, absorbing all of it. We are going to take advantage of all of the organic growth opportunities that remain in the many agencies that we have, and then I think you will see us grow, I don't want to say a time exactly, but in another few quarters, you will see us grow again.

Okay, great. You commented about the lease assumptions, how about as far as owning the real estate?How are you thinking about acquisitions, and do you approach that as maybe being able to expand on your owned properties, and then just as far as broader, your views on sort of the value of your own portfolio as a whole?

We really like to own properties and most of the transactions and acquisitions we do, we do own. But in the early days, we didn't have the cast to do it. Since about mid-2004, we have not had to borrow money to do a transaction ever. They are cash buys. We usually have cash on hand, and can finance and reload that fund at a later date. So it removes a lot of the transaction friction, it allows us to buy up a lot of the properties that we operate but again as I mentioned earlier, we are not adverse to leasing. If that is the opportunity before us and the numbers work.

Okay. Lastly, cash flow was a little below what I was expecting. It looked like there was maybe some pressure on collections. If you could just clarify or provide any more color on that?

It was a little bit slower in collections. We did add one DSO this quarter. And then a little bit more on, that was the majority of it. Just a little bit slower on the collections side with one DSO added.

Okay. So nothing, I mean nothing abnormal?

Correct. Nothing abnormal at all.

Remember, Ryan, when we have a slew of acquisitions, which we have had over the first half the year, our DSO tends to go up, because we are not able to collect on a lot of these facilities for many, many months.

The other thing to couple that with is that with the California payment, they held the last couple of payments so that pushed into July, and I think you see some other California operators have that same thing, where we had a big payment in July instead of June, so it looks a little bit worse at the end of June than it would typically.

Okay. That is very helpful. Thank you.

Thank you. I would like to turn the conference back to Mr. Christopher Christensen for closing remarks.

Thank you Mary. I appreciate it. Again, I just want to thank all of our partners out there for the extraordinary progress we have made on the clinical front, and on the qualitative front. We know that it is going to bode well for us in the future. I also want to thank everyone who has joined us today on the call. Thank you Mary.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may all disconnect at this time.