Ensign Group Inc (ENSG) 2015 Q4 法說會逐字稿

Good day ladies and gentlemen, welcome to The Ensign Group Incorporated fourth quarter fiscal year 2015 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions). As a reminder, this call is being recorded. I'd now like to introduce your host for today's conference, Chad Keetch, Executive Vice President. You may begin.

Thank you, Cat. Welcome everyone. Thank you for joining us today. We filed our earnings press release yesterday, and this announcement is available on the Investor Relations section of our website at www.Ensigngroup.net. A replay of this call will also be available on our website until 5 PM Pacific on Friday, March 25th, 2016. Before we begin, I have a few housekeeping matters.

First, any forward-looking statements made today are based on management's current expectations, assumptions and beliefs about our business, and the environment in which we operate. These statements are subject to risks and uncertainties that could cause our actual results to materially differ from those expressed or implied on today's call. Listeners should not place undue reliance on forward-looking statements, and are encouraged to review our SEC filings for a more complete discussion of factors that could impact our results. Except as required by Federal Securities Laws, Ensign and its affiliates do not undertake to publicly update or revise any forward-looking statements, where changes arise as a result of new information, future events, changing circumstances, or for any other reason. In addition, any operation 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 the use of terms 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, the real estate subsidiaries, or our captive insurance subsidiary, are operated by the same entity. Also, we supplement our GAAP reporting with non-GAAP 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 to the exclusion of GAAP reports. A GAAP to non-GAAP reconciliation is available in yesterday's press release, and is available on our Form 10-K. And with that, I'll turn the call over to Christopher, our President and CEO. Christopher.

Thanks Chad. Good morning everyone. We're thrilled to report that operating results for the year met Consensus, and our annual earnings guidance which we increased three times during 2015, with adjusted earnings per share of $1.27 for the year. We're also pleased to report that we met our earnings guidance of $0.35 for the fourth quarter as we often remind you our results are not symmetrical from quarter to quarter, especially in periods of significant growth, which is why we do not give quarterly guidance. But we hope you remember that we have been able to project performance fairly accurately on an annual basis.

Our focus is on the long haul, and we are excited to work tirelessly during 2016 to meet or beat our annual guidance yet again. Despite misguided negative reports about our industry, we remain as confident as ever about our ability to set the standard for skilled nursing, and our other post acute service offerings in this changing landscape. 2015 was another record year for Ensign on many fronts. While the year certainly was not without its challenges, our local leaders across the organization were able to drive steady improvements in our same-store operations, while simultaneously transitioning dozens of new operations.

The overall strength inherent in our local approach to healthcare continues to prove itself over and over again, in spite of the fact that there remains ample room for improvement in many of our operations. And as our results from the quarter and this year demonstrate yet again, we continue to have several different growth levers we are able to pull, and those levers are not mutually exclusive. All of this is made possible by each of our local leaders and their teams, and their ability to innovate and adjust in the midst of an ever-changing healthcare environment. As of the end of the year we had 68 operations in the recently acquired bucket, which is the highest number of operations in that category in the organization's history.

While we are pleased with the initial contributions of about 20% of our newly acquired facilities made to our 2015 results, the remaining 80% of our newly acquired operations have yet to contribute in any meaningful way. Our recent growth puts us in an unprecedented position for continued organic improvement in 2016 and beyond, as these recently acquired operations begin to meet their potential, most of which we expect to occur towards the end of 2016. With an incredibly healthy balance sheet, extraordinary growth, and our maturing home health and hospice operations, we're more confident about the organic growth potential than ever. We continue to protect our balance sheet with a conservative adjusted net debt to EBITDA ratio of 3.37 times at quarter end.

And as a result of our discipline, we continue to have flexibility under our newly up-sized revolver line of credit, giving us plenty of dry powder to fund additional growth in 2016 and beyond. And as EBITDAR and cash flow from our newly acquired operations catch up, we're committed to maintain our leverage at conservative levels, even if there are temporary increases as we pursue additional acquisitions that make sense. As always, we remain committed to keeping our cash flow strong, and our debt relatively low as we look to the future. For the 13th consecutive year, we increased our dividend, during the quarter we paid a quarterly cash dividend of $0.04 per share, an increase of 6.7% over the prior year.

We hope this signals our continued confidence in our operating model, and our ability to returning long-term value to our shareholders. We also completed a 2-for-1 split of our outstanding stock, increasing the number of basic outstanding shares to approximately 51.4 million, as of December 31st, 2015. There are several reasons that we decided to take this step, but the primary reasons were to make our shares more affordable for a wider range of investors, and to increase liquidity and trading volumes. Here are some additional highlights.

Our adjusted earnings per share were $1.27 for the year, an increase of 16.4% over the prior year, and $0.35 for the quarter, an increase of 29.6% over the prior year quarter. Again meeting our guidance. Consolidated adjusted net income climbed 31.6% over the prior year to $66.1 million, and 44.7% over the prior year quarter to $18.5 million. Consolidated adjusted EBITDAR was $221.3 million for the year, an increase of 38.8%, and $63.1 million for the quarter, an increase of 43.5%. Same-store revenue for all segments grew by 6.9% over the prior year, and by 7.9% over the prior year quarter. And same-store TSA revenue grew by 6.4% over the prior year, and by 7.5% over the prior year quarter. Same-store skilled revenue mix increased by 115 basis points over the prior year to 52.9%. Cornerstone Healthcare, our home health and hospice subsidiary, grew its revenue by $35.8 million to $90.4 million for the year. An increase of 65.7% over the prior year.

Consolidated revenues for the year were up $314.4 million, or 30.6% over the prior year, to $1.34 billion in consolidated revenues for the quarter were up $96.3 million, or 34.8% over the prior year quarter, to $373.2 million. As we announced yesterday, we are reaffirming our annual guidance for 2016, projecting annual revenue between $1.53 billion and $1.58 billion, and annual earnings per share between $1.43 and $1.50 per diluted share. I also want to be clear that given the number of new operations acquired last year, and mostly late last year, we expect much of the increased performance that we are projecting for 2016 to occur in the latter part of the year, as the transformation process occurs gradually throughout 2016, and as these new acquisitions mature. Before we discuss our financial performance, I'd like to have Chad give some additional detail on the recent growth that's occurred within our organization. Chad.

Thank you Christopher. As Christopher mentioned, 2015 was a record acquisition year for us. During the year we acquired 25 skilled nursing operations, 25 assisted living operations, three home health businesses, three hospice agencies, one home care business, three Urgent Care clinics, and one ancillary service business. As we continued our growth during the fourth quarter and since, with the following additions. In Kansas, the Healthcare Resort of Kansas City, featuring a 70-bed licensed transitional care operation, and 30 private assisted living suites under a long-term lease. In Chandler in Scottsdale, Arizona, Chandler Post Acute and Rehabilitation, 120-bed skilled nursing facility. And Shea Post Acute Rehabilitation Center, 105 skilled nursing facility under a long-term lease. In West Columbia South Carolina, the operations and real estate of Millennium Post Acute Rehabilitation, a 125-bed skilled nursing facility.

In Kansas, the Healthcare Resort of Shawnee Mission, featuring a 101-bed licensed transitional care operation, and 24 private assisted living suites under a long-term lease. In El Cajon, California, the underlying real estate of Somerset Subacute and Rehabilitation, a 46-bed skilled nursing facility that has been operated under a lease arrangement since December 2014. In South Carolina, the operations and real estate of Compass Post Acute Rehabilitation, a 95-bed skilled nursing facility in Conway, Las Colinas Post Acute Rehabilitation, a 99-bed skilled nursing facility in Rock Hill, and Opus Post Acute Rehabilitation, a 100-bed skilled nursing facility in West Columbia. And lastly, in Kansas, the Healthcare Resort of Olathe, featuring a 70-bed licensed transitional care operation and 30 private assisted living suites under a long-term lease.

This brings Ensign's growing portfolio to 187 healthcare operations, 14 hospice agencies, 15 home health agencies, 3 home care businesses, and 17 Urgent Care clinics for a total of 240 independent healthcare operations across 14 states. In addition, we also remind you that Ensign has continued and will continue to purchase real estate assets, while also continuing to selectively enter into long-term leases. And since we spun off certain real estate assets in June of 2014, we have acquired the real estate in 32 of our operations, and have purchase options on 21 of our leased operations. We were very excited to open our second and third healthcare resorts last month. These newly constructed healthcare campuses add an important strategic service offering, and will complement our growing number of healthcare operations in several markets.

These state of the art resorts feature private transitional care beds and private assisted living suites. We expect to open three more such resorts during the first quarter of 2016. With the addition of three healthcare resorts and three additional skilled nursing operations in South Carolina, we continued our expansion in our two newest states, Kansas and South Carolina. As we've described many times in the past, one of the key elements to our locally driven strategy is to organize our operations into geographic clusters. With the latest additions in both states, we are now able to link these operations together. By doing so, our local leadership teams will be able to work shoulder to shoulder to build a strong clinical and financial foundation, from which we can continue to grow in the future.

We continue to see many attractive acquisition opportunities on the horizon and we expect to acquire additional operations and real estate during 2016. We also remind you that our disciplined approach to acquisitions remains consistent, and as a percentage of our organization, our recent growth falls right in line with what we have accomplished historically. And even though we have been and will continue to remain disciplined, as our footprint continues to grow, so does our ability to expand. We continue to be very picky buyers, and will continue to remain true to our locally driven approach to each and every acquisition.

As Christopher mentioned, on February 5th, 2016, Ensign also increased its revolving credit facility by $100 million, to an aggregate of $250 million, $111.8 million of which was drawn as of February 5th, 2016. The amendment reduced the LIBOR based interest rate by 50 basis points, and extended the termination date for our revolving commitment to February 5th, 2021, among other things. This new credit facility further strengthens our long-term capital structure, and together with our operating performance extends our ability to continue expanding our portfolio of healthcare operations. The continued confidence shown by our banking partners is a testament to our solid operating history and our balance sheet, and we look forward to continuing our strategy of disciplined growth.

We remain very excited about the many opportunities we see before us, and continue to believe our unique approach to growth continues to be scalable in both distressed and performing operations. And because of the many acquisitions we've completed, we have the best and most experienced team in the industry, and we get better with each and every transition, as we further refine and improve our process. And with that, I'll hand it back to Christopher.

Thanks Chad. Before Suzanne runs through the numbers, I'd like to offer a few examples of how our front line leaders and their teams continue to the produce record results in a changing operating environment. As those of you that follow our industry know, there's a lot of noise regarding the potential changes to reimbursement models in healthcare, and the varying roles played by hospital systems, physician groups, and managed care organizations. While we expect these models to change and evolve multiple times over the next few years, our focus is to stay abreast of all of the various models, while looking for ways to improve our clinical outcomes and to align our service offerings with the demands of the local healthcare communities we serve. Most of all, by pushing to constantly provide outstanding clinical outcomes, and all of the other moving parts of these complex operations at the same time, our local leaders and their teams strive daily to make their operations the operations of choice in the market they serve.

On the clinical front, we continue to make tremendous progress with the focus on strengthening outcomes and extending our capabilities to care for more complex patients across the post acute continuum. We've continued to direct time and resources into developing outstanding leaders, investing in the best technology, and establishing world-class systems. As a result, we've seen significant improvements in key indicators related to outcomes and satisfaction. In addition, we continue to see steady improvement in our four and five star facilities, in spite of the major overhaul to the CMS star rating methodology in 2015. After excluding new acquisitions in 2015, we saw a 5% increase in the number of our facilities that achieved a four or five star rating in 2015, and a 30% decrease in the number of one star facilities. Remember that most of the operations we acquire are one or two star operations at the time that we acquire them. As with our financial results, there's still much improvement that can be made within our same-store operations.

For example, Broadway Villa post acute, 144-bed skilled nursing operation in Sonoma, California, which had previously carried a two star rating, recently earned a five star rating, due to the extraordinary focus on quality that CEO Eric Olson, and Director of Nursing Janice Diaz established. This kind of progress not only helps us improve our reputation in the markets we serve, but it also allows us to create or enhance the managed care relationships and alternative payment opportunities that are part of our ever-changing landscape. Because of the strides made at Broadway Villa, the operation has seen a marked increase in both total and skilled days in revenue, with total patient days increasing by over 6%, with managed care days increasing by a whopping 179%. As a result of the trust they have earned in the community and with our managed care partners, the operation has been rewarded with increased volumes, resulting in a 14% improvement in total revenue, and a 30% improvement in EBITDAR over last year.

Stories like these are happening across our organization. We're pleased with the progress that we are making with our managed care relationships as they continue to grow their membership in most of our markets. Our local leaders have been determined to become the preferred provider in all our markets, and we are seeing that occur systematically, as we continue to drive superior outcomes. Another example. As a result of their efforts to work together with their managed care providers Montecito Post Acute, a 222-bed skilled nursing facility in Mesa, Arizona, experiences a very high admission volume of approximately 150 patients per month. Over 80% of these admissions are skilled managed care patients, referred as a result of our preferred provider status that CEO Forest Peterson, and COO Marjorie Barsana have helped create. With tightly managed lengths of stay, low return rates to hospitals, superior customer service, and close coordination with the major managed care providers, Montecito fills a leading role for transitional skilled services in the east Phoenix market. Montecito has long been a consistent performer, however, because of these ever-strengthening relationships, they have seen over a 7% improvement in total revenue, and 17% in EBITDAR improvement, both over the same quarter last year. And this is one of our better performing operations.

In addition, while it's still very early, we've seen great success in our participation in alternative payment models, with CMS and managed care organizations. As active participants in both model two and model three of the BPCI demonstration project, we're deepening our relationships with the conveners and hospital groups, and are experiencing tremendous success in driving more efficient management of each bundle of care. For example, at Southland Care Center, 120-bed skilled nursing facility, CEO Tyler Roderickson and COO, Shony Delpillar, are actively participating in several model three bundles. As a result of this participation, they have created such tremendous efficiencies, that they received a revenue enhancement of over 92%, compared to traditional fee for service rates in the applicable patient episodes. This led to a 33.4% increase in Medicare revenue over prior year's quarter.

The spillover from these efficiencies has also generated attention from other payer sources, leading into an increase in skilled mix of 235 basis points, to over 69%. Likewise, they have seen an astounding 25% increase in total EBITDAR, all compared to the fourth quarter of last year. So again, while it's still very, very early, these results are encouraging, and this is an operation that's been part of us for over 16 years. But regardless of which direction the reimbursement system takes, we are very excited about our ability to work within the various frameworks, and are confident that our local approach has us prepared us extremely well to adjust and innovate with all the various players within the payment systems, and the continuum of care. In the end, quality outcomes will be rewarded, and our focus is to become the best provider in each market, and to develop systems and data tracking mechanisms that will allow our performance to shine through.

In summary, we hope that you'll 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. Next I'd like to ask Suzanne to provide more detail on the Company's financial performance. Suzanne.

Thank you Christopher. Good morning everyone. Detailed financials for the fourth quarter and year are contained in the 10-K and press release filed yesterday. Highlights for the quarter and year end December 31st, 2015 as compared to the quarter and year end December 31st, 2014, include record quarterly revenues of $373.2 million, for an increase of 34.8%. Year-to-date same-store TSA revenues increased $53.4 million, or 6.4%. Quarterly same-store TSA revenues increased $16.1 million, or 7.5%. Same-store skilled revenue mix increased 115 basis points over the prior year quarter, to 52.9%. Same-store managed care days increased 10.4% over the prior year, and 9.6% over the prior year quarter. All of which resulted in overall diluted adjusted earnings per share of $1.27 for the year, and $0.35 for the quarter.

Other key metrics include cash and cash equivalents of $41.6 million at December 31st. And $137 million of availability on our newly upsized $250 million revolving line of credit as of February 5th. As those who have followed us and our industry know, after we acquire an operation, we experience a temporary delay in our ability to collect on our Receivables. More specifically, following the transfer of ownership, we undergo a process with Medicare, Medicaid, and managed care agencies to transfer the contract and billing codes to Ensign affiliated accounts.

This process results in delays in the receipt of payments of services provided at our recently acquired operations. As a result, we experience temporary spikes in our Accounts Receivable following each acquisition, while we wait for the paperwork to be completed. This temporary delay in collections result in an increase in our Accounts Receivable, and can result in negative free cash flows, which is consistent with what we'd expect during periods of significant growth.

As Christopher mentioned, we are reaffirming our guidance for 2016. We are projecting revenues of $1.53 billion to $1.58 billion, and adjusted earnings of $1.43 to $1.50 per diluted share. The 2016 guidance is based on diluted weighted average common shares outstanding of approximately $53.3 million. The exclusion of acquisition-related costs and amortization costs related to patient based intangibles, the exclusion of losses associated with the development of new operations and start-up operations which are not yet stabilized, the exclusion of costs related to a new system's implementation for HR, the inclusion of anticipated Medicare and Medicaid reimbursement rates increasing net of provider tax, a tax rate of approximately 38.5%, the exclusion of stock-based compensation, and the inclusion of acquisitions closed to date. Based upon the magnitude of acquisitions in 2015, our expectation will be for much of this growth to be produced in the later half of 2016. Additionally, other factors contribute to our asymmetrical quarters include, variation in reimbursement systems, delays in changes in state budgets, seasonality in occupancy and skilled mix, the influence of the general economy on our census and staffing, the short-term impact of our acquisition activities, variation in insurance accruals related to our self-insurance programs, and other factors. And with that, I'll turn the call back to Christopher. Christopher.

Thanks Suzanne. We want to thank again everyone for joining us today, and express our appreciation to our shareholders for their confidence and support. We're also very appreciative to our colleagues in the field and the service center, for helping us to meet our earnings guidance that have been increased three times during the course of the year, and for making us better every day. I'll turn the time over to Cat for the Q&A portion of the cat.

Thank you. (Operator Instructions). One moment for our questions. Our first question is going to come from the line of Chad Vanacore with Stifel. Your line is open. Please go ahead.

Thanks, and good morning all.

Good morning.

Good morning.

All right. So, Medicaid, one of the things that stood out to me is Medicaid average daily rate jumped quite a bit, sequentially and year-over-year. Was that due to new entries in new states with higher payments, or was that something more one-time, or some retroactive payments in there?

Yes, it's really due to something that changed in California over the course of the last year and a half. California has this program that works really well, if your quality is high. You actually get a little bit less than normal reimbursement throughout the course of the year, and then if your quality hits certain metrics, then you receive not only your money back, but you receive an additional bonus of some sort, additional reimbursement for those qualitative measures. And so that sort of skewed the fourth quarter, but I suppose it skewed it to the negative for the first three quarters, and then skewed it to the positive in the fourth quarter.

All right, Christopher. So is it fair to think first quarter, it will go back down a bit?

Yes. So there are two ways to think of this. One is across the year it's probably pretty accurate. The first quarter will be a little bit higher, as we didn't record all of it because we don't know all of it yet, so the first quarter will reflect some of it. But first quarter will be less than fourth quarter, yes.

Okay. And since we're talking about Medicaid and rates, what are you guys thinking or budgeting for like mid-year rate bumps in most states?

Yes, 1 to 2%.

All right. Thanks, Suzanne. And then just given all your expansions recently, and that they're driven by locally, and put in the hands of local leaders, when you go into new geographies that you're in, say Kansas City or in South Carolina, how is that organized?

Yes, that's a good question. I mean, it depends on the circumstance. It depends on the performance of the operations. Obviously these are newer ones. What we generally do is, we mix extraordinary operators from that market with Ensign people. So that we have the benefit of the Ensign culture and some of the Ensign practices and some of the Ensign, core values, and sort of our way of doing things, with people that know the market very, very well, and hopefully if everything works out the way it should work out, the one side teaches the other side about the market, and obviously the other side teaches the market experts about Ensign. If it's just one facility in a brand new market, we try not to enter markets like that, but when that happens, it's a little more tricky, which is why you've probably seen us in the last three or four markets, enter markets with two to four facilities at the same time.

All right. And then just thinking more on acquisitions, are you seeing new more sizable portfolios, or clusters of facilities coming to market that you might be interested in, or are you still focused on the one to three facilities at a time?

We're focused on both. We're very careful with size. When the acquisition is of a substantial size, and when I say substantial, bigger than three or four, if there are some performers in the portfolio, and we feel like there's a good, at least a decent match with our culture, we'll pursue something like that, but we're still seeking the small onesies and twosies. Unfortunately we've had a couple of larger ones, and that gets lost in translation, because the majority of our acquisitions are still onesies and twosies.

All right. That's it for me. Thanks.

Thanks, Chad.

Thank you. Our next question comes from the line of Frank Morgan with RBC Capital Markets.

Good afternoon. Suzanne, you pulled out a number of issues and items that would be affecting the cadence over the course of 2016. I was wondering if you could maybe go back through those, and give us a little more color, and are there any of those particular, I know there was quite a list, but any ones that you think are more meaningful in terms of the magnitude of impact, the ones that you would be more likely to address, and that would move the needle the quickest to see those results go up?

Are you talking about the list that we always share every quarter? The same list?

Yes.

I was going to say, it's the same list we share every quarter. There's nothing I would say that I'd point out this quarter that's different than the other quarters, other than kind of the introduction of what we talked about, about the size of acquisitions that we had in 2015, and that really is that we expect that to produce more in the later half of 2016. I think that would be the one thing that I would highlight with regards to the list, and the items that I went through. That's going to be a lot more asymmetrical quarters as those produce in the later half of 2016.

So as I recall, your acquisition schedule was maybe a little bit more back end loaded in the second half of 2015, so is it just the magnitude of those coming online is why you're going to see that in the second half? Is that the way to think about it?

Yes, remember frank, the kind of acquisitions that we take, every once in a while we get one that's a performer, but most of the acquisitions we take us a few quarters to get them to a place where they're producing and self-sufficient. And so because, probably, I haven't done the math, but because two-thirds of our acquisitions last year were done in the latter half of the year, it's going to take us well into the second and third quarter before those things are producing what most of our operations produce.

Got you. And in terms of maybe just at a very conceptual level, Suzanne, as we look at the, say the percentage contribution to earnings over the year, do you have any kind of general guidelines you would like to share, like is it kind of 60/40, or is it any kind of distribution without specific numbers, but just in terms of kind of the weighting of how you would get to that guidance number on the year?

Are you asking the contribution of new acquisitions as compared to the rest of the portfolio?

No, no, just in terms of your EPS guidance for the year, if you were to kind of distribute that over the course of the year, is it more like --

That's a good question.

-- in the second half or any guidance there?

Now you're kind of asking --

Quarterly, exactly.

That's a good question. I understand you need to know that to model effectively. I'm sorry, I'm not answering for Suzanne but --

Go for it.

I think that if you were to model it, you would say that, 40% would come -- low 40%s would come in the first half and, high-50%s would come in the second half.

And I would say it's a gradual process so, I mean, as those turn on, it's over time, so we would expect it to build over the year.

Right. Right.

No, no, that's fair and that's actually very helpful. And then --

You almost just got us to give six-month guidance, and I don't want to do that.

But we only give annual guidance, as a reminder.

Understood. Understood. And in terms of, we're in a world where people are obviously concerned about leverage levels, and with all the uncertainties in the world out there, but I'm just curious what are your thoughts about maybe remind everyone, including myself on your sort of tolerance level for leverage, what you're willing to go, and obviously with the stock having pulled back in here, how you think about your buyback? I know you had a program in place but maybe give us your philosophy on leverage tolerance and use of cash? Thanks.

Yes, I think our tolerance has always been for the right acquisitions, we would go into the mid to upper 4 times, but it would be very brief. And we would have to see a path to get back down into the 2s and 3s. And remember obviously most of that is all leaseholds that comprises that debt. Our debt is much lower than that. But I think, we've always said for the right deals, if we could see a path to get back down into the 2 or 3 times rates, or 2 times debt to EBITDAR, we would do it. And we've done that for very brief periods of time. And we've gotten right back down to where we feel more comfortable.

Got you. And in terms of your buyback activity, given where we are?

So, yes, I mean, we have a program in place, and continue to believe that an investment in our stock, especially at these current levels, is a good one. It's just one of many strategies we have to deploy our capital. But I think you'll see us continue to have that be sort of one of the arrows in our quiver.

Got you. Thanks. I'll hop back in the queue.

Thank you, Frank.

Thank you, our next question comes from the line of Ryan Halsted with Wells Fargo. Your line is open. Please go ahead.

Thank you, good morning.

Hi, Ryan.

Christopher, you said in your opening comments, I think you mentioned misguided commentary coming out of the industry, in terms of what maybe some other operators are seeing versus yourselves. I was hoping you could maybe elaborate on that?

Well, I just saw comments about one operator that was then assigned to the entire industry. There's no question that there are changes that have to be made in this environment, in a bundled payment environment, and obviously we're not even in the full bundled payment environment, but it is accelerating. Relationships with managed care organizations, high quality, if you're focusing on the quality of your outcomes, if you're focusing on building relationships with managed care organizations, and I don't mean buddy-buddy relationships, I mean figuring out relationships that make sense for the patient, for the managed care organization, and for you, and you build it in a way where everyone is happy, we're seeing much higher volumes than we've ever seen.

There is a slight drop in the length of stay, and there are some adjustments to reimbursement, but if those relationships are set up the right way, that drop in reimbursement is offset by certain expenses that get picked up by the managed care organizations, and also there are some things that can be adjusted in terms of when you have a higher volume of skilled residents versus the long-term care, your revenues climb, and that's why you've seen our revenues climb the way they've climbed.

If you're managing with the same strategy that you managed with three or four years ago, then I suppose this environment is harmful, but if you've been preparing for this, and seeing all of the signs that many different members of the healthcare community have given to us over time, it actually can be a net positive. And it's something we feel confident about. Are we going to be perfect in it in every single market? Probably not. It will be more difficult in our newer acquisitions. But only because they haven't been prepared prior to our acquisitions. We still feel comfortable that over a short period of time, they will also benefit from this new environment, and we frankly think it's better for all parties.

That's very helpful. So looking forward to the Medicare joint replacement bundle that's going to get started this year, I was hoping you could maybe expand on what are some of the specific initiatives you have in place, and are beginning to execute on ahead of that program?

Yes. Listen, I should have introduced Barry Port who is our COO, and I'm going to let him answer that, Ryan, if you don't mind.

Yes, Ryan, it's a good question. Obviously there's a lot of talk and conjecture about it. As it moves into full swing, we'll see how it goes ultimately, but I can tell you that we have had an unprecedented number of hospitals, physician groups, and other conveners reaching out to us, to establish partnerships on that front. There's certainly some unknown about it. There's certainly some of feeling our way through it that will occur, but again, in the larger context of what we've been doing to prepare for a bundled payment environment, and establishing the model two relationships under the BPCI demonstration projects, and establishing ACR relationships like we have been over the course of the last two years, we've built good, really good relationships with high levels of open communication.

So right now we're in a process of kind of taking what we've prepared for, in terms of systems and approach, and how we help our facilities prepare for the environment, and we're leveraging that with the relationships and making sure that the communication is there, and that we're the players that we need to be as this moves into full swing. We feel confident about it. There is a lot of conjecture about bypassing SNFs, and going to the home and that's all fine and part of the process. At the end of the day though, there will be a place for the right types of patients, and the SNF will be the low cost provider for those patients, and we'll have the relationships that we need to make sure that we care for them properly and in an efficient way.

And I would just add, we've been preparing for this for a long time. It's not just CJR that's led us to prepare for this. It really has to do with kind of high volume of managed care that we've already been taking care of in our population. And the managed care is taking them from the hospitals, guiding them to our facilities, and we've partnered so well with the managed care in almost every single area, that the CJR project is being piloted in. That gives us an additional confidence that we know how to deal with a bundled care project that's run by the hospital, or their convener or a managed care participant, who is helping them walk the hospital through the process. So that's a different additional level that we feel like we have.

That's great. What percentage of your patient days are joint replacement, Medicare joint replacement?

We haven't broken that out, Ryan. It's really kind of hard to say. Especially considering a lot of them are, they have multiple diagnoses, and there's a lot of crossover, so we really don't break that out.

Okay. How about any chance you can frame, what percentage of your overall business is even in an MSA, where the joint replacement program is beginning?

We did figure that out recently, and it's a good number of facilities. I want to say it's somewhere close to 40 of our operations that are in one of those MSAs.

Okay. Maybe my last question, you also talked about, I guess, ramping up efforts to try to attract higher acuity patients, and I think it's come up in the past, but what are some of the things you're doing to, I guess attract this different patient referral, this more downstream patient referral, and is this something you're starting to see pick up recently?

It's not recent, Ryan. It's something that's really been happening over the course of many years now. It's probably, for others or smaller operators, it's a more recent phenomenon, but it's not really a recent phenomenon for us. We've been deep into these relationships for a long time. We've been pushing down length of stay, and improving our care pathways to be more disease-specific, rather than being strong generalists like our industry has traditionally been in the past, to make sure that from day one we've got a specific care plan for very specific diagnoses, to make sure that we care for that patient in a very unique and tailored way, and get them home, or to their next highest level of functioning environment as quickly as possible. So for us, it's really kind of been our business for several years now, and it's just part of the evolution that we feel like we've been a part of for a while.

Okay. Great.

Again, I mean, the biggest part of that Ryan, just is really shouldering the responsibility together with the managed care organizations, and building that partnership. That is where the lion's share of that growth comes from.

Yes. Many of our local operations kind of band together and have joint operations calls with the larger managed care organizations, where they discuss metrics, scorecards, this has kind of been a practice that's been ongoing for us, and been in development with the managed care organizations for quite some time.

Okay. I guess my question was more along the lines of the Medicare regulatory changes that are impacting some of the higher acuity facilities, where they're less, their reimbursement has gone down for the lower acuity stuff. I'm wondering where are those patients going, and could they be treated for within your facilities?

Yes, no, sorry, I misunderstood your question then. That's a good question. That is also something that's been kind of an ongoing evolution for the last year or so, where we see more and more direct admits from the ER for Medicare, fee for service patients, especially ones that are part of ACOs where they bypass that three-day stay qualifying rule, and come straight to us for diseases or diagnoses that are better managed in a post acute environment, rather than the expensive acute environment. So we've seen an uptick in kind of direct admit from the ER for some time, and also shorter term stays in the hospital. We've worked with hospitals to try to establish programs that are more higher acuity based, even kind of in what we call subacute services, where airways and other high intensive kind of wound care issues that sometimes have been, folks have been held in the hospital, that we care for in a kind on a more rapid basis, so they're shorter term stays in the hospital that we can manage in the SNF. We've been seeing that for some time.

All right. Great. I appreciate you taking my questions.

Thanks, Ryan.

Thanks Ryan.

Thank you. Our next question comes from the line of Dana Hambly with Stephens. Your line is open. Please go ahead.

Hey, thank you. Christopher, you're talking about California and Medicaid earlier. Just curious, could you give some examples of some of the quality measures that they're actually measuring in California?

So they would include things like falls, the drug use --

Psychotropic drug use, falls. Skin issues. All kind of the normal quality indicators that CMS already measures. California has adopted those, and then some of their own kind of more unique subset measures of those major categories. Go ahead.

I was just going to ask if you're seeing that in any other states at this point, or is California really the pioneer?

I think California is the pioneer, but we're seeing some other states that are watching it, and want to pattern themselves after California. Again, it does take a little bit of trust because everybody is giving up a little bit of their reimbursement, and then those that meet the higher threshold, they get that pool of money spread amongst the higher performers, and it's a pretty good program, because it obviously penalizes our facilities that aren't doing as well, and it rewards our facilities that are doing extraordinarily well on the key qualitative measures.

Okay. Is it a mandatory program or is it voluntary?

It's mandatory in California.

Okay. Okay. Great. And then Suzanne, on the change in ownership or the transfer in ownership and the drag on the AR, can you just remind me, how long does that typically take for a facility?

Yes, it can take anywhere between nine, the shortest we've ever had it occur is six months, but on average we're closer to a nine to 12-month cycle for everything to get done, and us being fully executed and fully paid on a regular basis for all payers, and then from there it's a little bit more drag until all of the sequential billing gets fully cleared up. So it's a very long drag.

Yes, this is not a new phenomenon for you guys, right?

Yes, it's not new at all. I think everyone just sees it a little bit more in the numbers, because obviously the volume of acquisitions that we had in 2015.

Okay. And then when you're talking with real estate owners that are looking to approach you guys for a long-term lease on a building, what are you comfortable with for initial rent coverages and annual escalators?

That's a great question. We generally love to point to our other arrangements we have with other real estate partners, but typically I would say 1.5 is kind of where we're most comfortable.

Okay.

In terms of escalators, we try to tie it to CPI, and attach caps to the escalators, so that we have a top on how much the rent can increase.

And what is the care trust escalator?

That is a CPI based escalator with a cap of 2.5%.

Cap of 2.5, okay. Last one for me, on capital deployment this year, what would be a good level of CapEx, and then on acquisitions, last year obviously was a banner year. Does the pipeline support that type of activity again this year?

Yes, for the first question you asked, with regards to CapEx we have a budget of about $55 million for the CapEx for 2016.

Okay.

I mean the pipeline certainly is as robust as ever, and consistent with last year. I guess I would say that, we probably have sort of been saying it was a buyer's market for a while. It's maybe even shifting more in that direction now, with just the sheer volume of opportunities that are available. So I think, we expect it to grow, and are going to be as selective as ever and making sure that where it makes sense, that we're ready to fold in additional operations, within our existing portfolio.

Thanks very much.

Thank you.

Thank you. Our next question comes from the line of Natalie Pesque with Wasatch Advisors. Your line is open. Please go ahead.

Hi, thanks for taking my questions. I just want to talk a little bit about the star ratings, and I know relationships and ratings are increasingly important for referrals and growth. I was wondering how is the expected time for newly acquired, like one to two star rated facilities to become that goal of four to five? And I'm sure that differs quite a bit, but just kind of management's expectations and the average that you're seeing?

That's a great question. We are not able to move it from one star to five star in a year, simply because of the way the equation works. But we would expect, if you're at a one or a two star, we would expect over a two to three-year period for it to move up into that four or five star rating. It would take me too long to explain the whole equation, but you get impacted by the prior three years, so if we acquire a facility and it's a one star facility, we still inherit the prior three years until we get to the third year. So it's hard to move the dial significantly in one year, but we can move it all of the way in three years.

Okay. Great. And then can you disclose a percentage of the facilities that you acquired in 2015, what percentage of those are one to two stars?

We don't know that offhand. But we can get back to you if you'd like to have that information.

Okay. Great. Thanks.

It's public information so we can certainly compile it, and get it back to you.

Great. Thanks. And then you talked about this a little bit, about the shift to bundling capitated arrangements, and how that could potentially push home Health Services, or nursing facility services over to home health. I was wondering if you'd just talk a little bit more about that, and talk about what patients are ideal for skilled nursing facilities over home health, and then the overlap of the patients that you're seeing?

Yes, I want to be clear. It's not about, on the joint replacement issue specifically, there might be some that move quicker to home health, but we still on the bundled payment initiative in general, these are care bundles or diagnoses that are the very specifically tailored to care in the skilled nursing environment. And we feel like there probably is some thought to moving as quick as possible to an even lower cost care environment, being the home, than maybe what is being rationally thought through. To be honest with you, I think that the place for skilled nursing care is going to be ever increasing. I find, this is just personal opinion about it, but I find that there is some irrationality about moving the patient as quickly to the home environment as maybe the market is thinking it can.

At the end of the day, you have to do what's right for the patient, and make sure they go home safely. Maybe leaving the hospital quicker and having them triage with us in a very short length of stay, to make sure that the rehab is continued and that they're fully prepared to go home, is going to happen, so we'll see pressure on length of stay. That certainly will happen. And we've seen our length of stay drop year after year for that, addressing that very issue, because patients can get home quicker, and there is more we can do to get them home quicker, but bypassing the SNF altogether, I don't necessarily see a huge phenomenon of that happening as a result of the BPCI demonstration project, or any other bundled payment initiative altogether. So I know it's a very general answer, but it's a pretty detailed issue.

That's great. That's exactly what I was looking for. Thank you for taking my questions.

Thank you.

Thank you.

Thank you. That does conclude today's Q&A portion of the call. You'd like to turn it back over to Christopher Christensen for any closing remarks.

Thank you, Cat. Thanks everyone for joining us today. We appreciate your time.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.