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Executives

Mark W. Ohlendorf - Co-President, Chief Financial Officer and Principal Accounting Officer

Analysts

Bryan Sekino - Barclays Capital, Research Division

Brookdale Senior Living Inc. (BKD) Barclays Global Healthcare Conference March 12, 2013 3:15 PM ET

Bryan Sekino - Barclays Capital, Research Division

Okay. Thanks, and good afternoon. We're very excited to host Brookdale now, one of the newest additions to our health care facilities coverage universe. With us today is Mark Ohlendorf, the company's Co-President and CFO, as well as Ross Roadman. So before we begin the presentation, as you've probably seen with some of the previous presentations, we've been doing the audience response questions. So basically, we have 7 questions that we're using for every company in our coverage universe. So if you use the handheld device in front of you, we can go through them. This will take 1.5 minutes to get through each of the questions.

So first, do you believe health reform will be a positive for the company in 2014? So from 1, very negative; up to 5, very positive. How do you think senior housing for Brookdale will be impacted for reform?

[Voting]

Bryan Sekino - Barclays Capital, Research Division

So neutral. That seems to be a common theme we've had today. Next question, we can move to the next question, it doesn't necessarily pertain. We can move to the next question as well. Okay, so how would you like to see Brookdale deploy capital in 2013? Through M&A, repurchases shares, issue a dividend, repay debt or invest in the core business?

[Voting]

Bryan Sekino - Barclays Capital, Research Division

Invest in the core business. Certainly, with senior housing and Project Max (sic) [Program Max], that's something we'll be talking about. The next question, do you think the company will grow maybe, we'll say, CFFO, in 2014? Either yes or no.

[Voting]

Bryan Sekino - Barclays Capital, Research Division

Yes. Very definitively there. And then the next question. Do you currently own shares in Brookdale?

[Voting]

Bryan Sekino - Barclays Capital, Research Division

So, the -- we're 88% no. So that's an opportunity we have here. And then the last question, what is your current bias on the stock? Either positive, neutral or negative.

[Voting]

Bryan Sekino - Barclays Capital, Research Division

And fairly neutral, slight positive bias, with 25%. So perhaps, just to get started, would you like to give an overview on the company, and then maybe talk about the strategy with senior housing moving forward?

Mark W. Ohlendorf

Sure. Brookdale is the country's largest operator of private pay senior housing. We operate 67,000 units, 650 locations in 35 states. We employ 48,000 associates. The company is unique in that we're the only multi-product operator of senior housing. We operate freestanding Assisted Living, Memory Care, Independent Living or what we refer to as Retirement Centers, and CCRCs at scale, and also have, at scale, Ancillary Services business, where we provide Outpatient Therapy and home care, primarily to residents within our communities, but also in the general market. The company is largely a roll up of 4 major operating companies that's occurred over several years, and we've also acquired about 12,000 units of operations from a number of primarily regional operators across the country, and integrated that into a very large and powerful senior housing platform. Our revenue is 80% private pay, 15% of our revenue is from Medicare. About 9% of the 15% relates to our ancillary service businesses, Outpatient Therapy and home care.

Question-and-Answer Session

Bryan Sekino - Barclays Capital, Research Division

A good way to start. So given your scale advantage in senior housing, certainly a very fragmented marketplace, what advantages do you think the national marketing campaign would have for the company?

Mark W. Ohlendorf

We're actually working through, and have been for the last couple of years, working on a branding campaign, and a branding strategy for the business. If you've had an opportunity to look in your local markets or nationally, at some of the sort of image presentation of senior housing companies, you'd find that they're not particularly distinctive. In fact, early on in our branding research work, we took the collateral material for a dozen senior housing companies and blanked out the names and spread them out on our board table, and we couldn't find our own collateral material, much less those from some of the other national companies. So there's what we refer to as kind of a sea of sameness right now. At the same time, the buying process for senior housing is a very difficult one for families. Typically, it's triggered because something has happened in the family to a senior. So it creates what's really kind of a guilt reaction in the family. Because people don't feel that they've planned ahead appropriately. So in the branding strategy, we're developing, we intend to position Brookdale as a solutions provider for families and residents. And in some of the advertising campaigns, try to stimulate the discussion in the family around what would you do if something happened with your loved ones. So it will be very interesting to see how it unfolds.

Bryan Sekino - Barclays Capital, Research Division

Sure. And then, could you talk a little bit about some of the trends that you're seeing in the marketplace right now? Certainly with an aging population, demographic trends work in your favor. What are you seeing from a supply and demand perspective?

Mark W. Ohlendorf

From a supply standpoint, we have an industry trade group that surveys activity in the top 100 MSAs in the U.S. So on a percentage of industry basis, that's a little bit over 1/3 of the U.S. senior housing industry. New construction in those markets totals about 2% of existing inventory. So very modest new construction growth. Quite likely, if we were able to get the information outside those top 100 MSAs, the inventory growth rate would be somewhat higher than that. New construction in our industry, within some reasonable range, is probably more of a positive than a negative. That's primarily because the unit cost and the unit economics on new construction require that we charge fairly high rates. And for those of you that are accustomed to thinking of the world on a real estate basis, think about new construction costs, $200,000 or $250,000 a unit. In our own experience, we've seen costs more in the $250,000 unit range. Folks will generally require an underwriting yield of 11%, 12%, 13%, to take the risk of new construction. The business is a 35% to 45% gross margin business. You'll assume a vacancy rate of 5% or 10% in your underwriting math. So if you do all that math, you'll that find you need to charge $6,000, $7,000, $8,000 a month of rent on that new location. There certainly are markets where that's possible, but across the whole Brookdale portfolio, our average revenue for the senior housing part of our business is about $3,700 a month. And in fact, we're a fairly high service intensity provider. So we're packaging a fair amount in that rate. So a lot of our peers would actually have rates somewhat below that. So it's certainly possible to get new construction to work. But the likelihood that folks are going to begin some national de novo development campaign would seem pretty remote.

Bryan Sekino - Barclays Capital, Research Division

Sure. So the past few quarters we've seen favorable trends on the occupancy side of the equation. At what point do you think the company can start to push price a little bit harder?

Mark W. Ohlendorf

We're actually beginning some acceleration in the pricing growth. I think one thing that's important to bear in mind here is private pay senior housing takes care of roughly 15% of the 12 million or so people in the U.S. that are over age 80. So our penetration into that age group, as an industry, is roughly 15%. There's a similar number of seniors in Skilled Nursing, traditional community based Skilled Nursing, and the other 70% of people over 80 are at home, which can mean a lot of things. But the important part of that discussion is we don't take care of 100% of the target population, if you will. So there are substitutes and substitute effects in what we do. And pricing certainly comes into bear as it relates to that. Our service is predominantly private paid on -- privately paid on the senior housing side. So pricing growth has historically had some relationship to cost growth overall in the market, inflation, if you will. So we saw very strong pricing growth before the recession back '05, '06. Pricing growth got as high -- same-store pricing growth, got as high as 6%, 6.5% in that time period. But that was a point in time where inflation was also 4.5% or 5%. So we tend to think about how high pricing growth can get in the context of the delta, if you will, between cost growth and rate growth. And if that delta gets to 1.5%, maybe 2%, that's pretty heady pricing growth. So if we're in a world today where inflation is, let's say, 2.5%, that would mean that pretty full pricing growth is going to be in the 4%, 4.5% range. Our fourth quarter same-store pricing growth was 2.8%. So clearly, there's some room to go. But perhaps, not as much as one might think, given some of the historical performance.

Bryan Sekino - Barclays Capital, Research Division

Thinking about capital deployment, what are the company's priorities in the short-term? Does that change with some of the management transition that we've seen? And can you talk a little bit about Project Max?

Mark W. Ohlendorf

Sure. Well -- our general capital deployment strategy is unlikely to change with Andy becoming CEO. Andy has been with the company for 6 years, and part of his responsibilities with the company was organizing our strategic planning process. So I think he's a firm believer with our strategic direction at this point. Capital deployment for us involves a number of possibilities. We have a large portfolio of commercial real estate, and we're in a sector that is very fragmented. As large as Brookdale is, we're order of magnitude 4% of the U.S. market. In an industry where economies of scale are pretty compelling from a number's point of view. But to answer your question, a lot of our capital deployment in the short-term, putting aside acquisition opportunities, which are hard to count on as you develop a strategy, a lot of our capital deployment is oriented into the portfolio. This year, we're going to do 110 or 120 full facility refurbishments, where we go into that common areas of the location and update everything. We actually underwrite those projects for yield because we expect to see a lift, both from an occupancy and a pricing standpoint, although the mix of that may vary a little bit by market-to-market. So that's a fairly significant investment. Typically, we would expect to refurbish our locations every 10 or 12 years, perhaps 11 to 13 years. But this year, we're going to refurbish about 20% of our consolidated portfolio. So that's clearly a substantial investment. We started investing more aggressively in refurbishment in 2010; 2011, a higher level of investment; 2012, higher level of investment. We're seeing the returns from that as we look forward to 2013, so we think it's a good investment. The other investment we do in the portfolio is what we call Program Max, and that's where there's really 2 big work streams there. One is where we reposition communities, and typically communities we're repositioning are retirement centers or big Independent Living buildings that were built in the second half of the '70s or first half of the '80s, where the physical assets were built for a different customer than we're taking care of today. Many of those locations are Independent Living-only locations, and it's very valuable to customers in today's market where they see a community that offers a range of service. So we'll convert some number of units to Assisted Living, some number of units to Memory Care, but the retirement center Program Max projects tend to be conversions and expansions of product offerings, kind of the within the existing walls, if you will. The other part of Program Max is where we expand locations. We have a large portfolio of freestanding Assisted Living communities, they were generally built in the second half of the '90s. Lots of different models there, but they tend to be smaller locations, 40, 50, 60 units. So the most common Program Max investment there is to expand a location, make it bigger, and in making it bigger, add a service at the location that we lack on a market basis. So the most common expansion for the last few years has been Memory Care, freestanding dementia care. So what we'll often do is take a smaller Assisted Living community, add Memory Care, at the same time, add space for ancillary services and other outpatient opportunities, and update the building to contemporary standards. So it sounds a little bit boring, but we can deploy hundreds of millions of dollars back into our portfolio, and we're seeing returns on Program Max in the low to mid-teens, unlevered, so it's a very high yielding deployment of capital.

Bryan Sekino - Barclays Capital, Research Division

Now you touched on a little bit earlier, the ancillary services that you provide in the portfolio. And just curious, can you talk about the innovative senior care strategy? And then, in addition to how you're looking to deploy that to people that are outside of your portfolio here.

Mark W. Ohlendorf

Sure. Brookdale again is unique in that we have an ancillary services platform. We branded, ISC, innovative senior care. It's actually a separate operating group within our company because it's a very different business. It's a predominantly Medicare-reimbursed business, where the balance of our business is predominantly private pay. We employ roughly 4,000 therapists in ISC, in the home care business, the Outpatient Therapy business. And ISC also manages the therapy portion of our skilled nursing operation as part of what they do. Our view is the best approach to local markets is to develop scale in the markets and range of service in the markets. So ISC is both a financial lift for us from a performance standpoint. Order of magnitude, this year, ISC will generate about $200 million of revenue, about $50 million of NOI, kind of pre-overhead NOI, and the overhead for ISC is 8% to 9% of revenue. So net of overhead, it's contributing $20 million, $25 million a year of cash flow. But even beyond the financial contribution that ISC makes, it's a significant differentiator for us in terms of how we can position ourselves in markets. Because we can position ourselves as a one-stop shop for people, which is very helpful from a competitive point of view. So in our 67,000-unit portfolio, ISC is situated to provide Outpatient Therapy in about 50,000 of those units and to provide home health in about 45,000 of those units. Again, those are the Medicare-reimbursed, rehab-type services. We also offer private pay home care services in our communities, but we consider that to be part of the operation of the community, so we don't report it as part of ISC, it's included within the segment that the community would relate to. We have started with home care, Medicare home care in particular, following our discharges out of our skilled nursing communities back home, if you will. We discharge about 19,000 people a year from our portfolio of Skilled Nursing locations. So a natural outgrowth of the ISC strategy is to simply follow those folks back home when they need home care. We do some general community home care as well. We're in the process of rolling out a hospice business across the company. We're early in that process right now. We're active in 5 markets with hospice and another half a dozen markets or so should start operations this year. Been on the private pay home care side, which again, we've done so far just within our communities. We're beginning some pilots this year to take that service outside the walls, if you will, into the general market. At any moment in time, we have at Brookdale, a lead bank of potential sales leads of around 250,000. And again, we discharge about 19,000 people a year from our Skilled Nursing locations. So we have a very large pipeline of potential customers for private pay home care. The question -- well, there's many questions we're trying to sort through in our pile of work, probably the most important of which is whether we're somehow cannibalizing our own sales pipeline by entering the private pay home care business. So, we'll know in another year or so as we complete some of that experimentation. But on its face, it would seem to be a pretty good opportunity.

Mark W. Ohlendorf

And similar to that, thinking about discharges and also certainly with reform, there's a lot of interest in ACOs and potentially sort of interaction between Skilled Nursing and senior housing and where there could be opportunities around that. How do you think Brookdale is into that equation? Did you start doing any work on that?

Mark W. Ohlendorf

We have. And in fact, together with some academic medical centers and some universities, we're in a group that received an innovation grant from CMS. And we're the only senior housing company that even applied for a grant. There's a fairly competitive process, I think, there are roughly 30,000 applications for 50 or 60 grants. And we're in a group that got one of those grants. The purpose of our grant to study, at this point, and we're just halfway through the first year of a 3-year study, is to take a look at different things that we might do that impact hospital readmission rates, in particular. And the initial part of the study was focused around skilled nursing, and how we can impact readmission rates for hospital discharges that go to skilled nursing. But it's become fairly clear that there's opportunities to impact that. Everybody discharged from a hospital doesn't go to Skilled Nursing. Some go to Assisted Living, some go to Independent Living, some go home. So we're also trying to work through in the study to demonstrate some of the benefits of senior housing on curbing readmission rates to hospitals in that context as well. So it's a fairly early process. Particularly in the case of Brookdale, we've got a pretty good set of tools because in the scale markets where we have skilled nursing, Assisted Living, home care, Outpatient Therapy, we've got a fairly integrated set of tools to bring to bear. Now it's all about the work of demonstrating the effect of that on the system more broadly.

Bryan Sekino - Barclays Capital, Research Division

Got you. Switching topics. As we think about the operational benefit that you think you can drive in the core business and certainly with scale, maybe how acquisitions can play into that. What additional opportunities do you think you can drive in OpEx?

Mark W. Ohlendorf

You know, the company is essentially a roll up. So we got to do a study on ourselves as we've gotten bigger in terms of what some of the scale economies are. And every acquisition opportunity is somewhat different, so it's hard to generalize. But on average, we've seen a local community, cost savings that impact margins by 3%, as much as 4%. So those are pretty substantial cost savings in a business with a 35% margin. We buy food and other supplies much more efficiently than local operators. Insurance and benefit costs, our insurance costs will not uncommonly be half of what a seller's insurance cost would be. Some of the risk management savings relate to how we buy things. More of the risk management savings relate to how we operate. The best way to have low insurance cost is not have any losses. So probably, 3% or so at the local level. Then at the corporate level, well, we just acquired Horizon Bay at the end of 2011. It's a large management company, managed and operated 16,000 units. We integrated that company in about 6 months in our marginal cost to manage as we added the Horizon Bay communities was about 3% of revenue. Our overall overhead for senior housing, we kind of split ISC and senior housing, the senior housing part of our business is about 4.5% of revenue, in terms of overhead, but then the marginal cost is obviously less than that. And in the case of Horizon Bay was about 3. When people look at senior housing assets economically, they'll generally burden the local operation with 5% to 6% as overhead management fee, G&A charge, however you want to look at it, so compared to the general assumption we're advantaged there by another 2% or 3%. So they're pretty substantial differences from a cost standpoint.

Bryan Sekino - Barclays Capital, Research Division

Got you. And then maybe just as we're wrapping up on time here. Is there any specific message that you would like to leave investors with? And what are you most excited about in the near-term?

Mark W. Ohlendorf

Well, it's an interesting time for us because many of the questions that everybody's sorting through right now is, what's the new normal? We're dealing with an economic recovery now that's clearly different than anything we've ever seen before. But as we've started to see the recovery for the last couple of years, the business has begun to improve from a performance point of view. Occupancy's ticking up, rate growth is improving, NOI growth is coming back. So we feel like we've been through a challenging period as is everybody else. But from a financial point of view and from a product point of view, we think that the company's very well-positioned for the next several years.

Bryan Sekino - Barclays Capital, Research Division

Okay. Thanks again. For those of you that would like to join us, we'll be having the breakout session in Point Sienna 3, just down the hallway.

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