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Skilled Healthcare Group, Inc. (NYSE:SKH)

Q1 2009 Earnings Call

May 5, 2009 01:00 pm ET

Executives

Boyd W. Hendrickson - Chairman and Chief Executive Officer

Devasis Ghose - Chief Financial Officer

Jose C. Lynch - President, Chief Operating Officer

Mark Wortley - Chief Executive Officer of Ancillary Services

Roland G. Rapp - Chief Administrative Officer, General Counsel

Analysts

Frank Morgan - RBC Capital Markets

Brendan Strong - Barclays Capital

Donald Hooker - UBS

Brian Siu - Sidoti & Co.

Robert Mains - Morgan Keegan & Co.

Gary Taylor - Citi

Eric Gommel - Stifel Nicolaus

Andreas Dirnagl - Stephens Inc.

Operator

Good day ladies and gentlemen and welcome to the first quarter 2009 Skilled Healthcare Group Incorporated earnings conference call. My name is Kameshia and I will be your coordinator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to your host for today’s call, Mr. Roland Rapp, General Counsel and Chief Administrator Officer.

Roland G. Rapp

Good morning everyone. I’d like to welcome you to Skilled Healthcare’s quarterly earnings conference call and introduce our presenters, Boyd Hendrickson, Chairman and Chief Executive Officer and Dev Ghose, Chief Financial Officer.

Before we begin, I'd like to note that certain statements and information that we discuss this morning may be deemed to be forward-looking statements including but not limited to guidance for our 2009 financial performance. These statements include statements relating to our objectives, plans and strategies as well as statements other than statements of historical facts that address activities, events, or developments that we expect or anticipate will occur in the future.

Any forward-looking statements discussed on this call are made as of the date of this call and Skilled Healthcare undertakes no duty to update or revise any such statements. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties. Important factors that could cause actual results, developments, and business decisions to differ materially from our forward-looking statements are described in our filings with the Securities and Exchange Commission.

Additionally, as we discuss performance, we will be referring to EBITDA, adjusted EBITDA, and adjusted EBITDAR, which we use as measures of performance but are not considered as measures of financial performance under generally accepted accounting principles. Adjusted EBITDA includes the loss on the disposal of assets in 2009. Adjusted EBITDAR is adjusted EBITDA excluding rent, cost of revenue. Therefore, please see reconciliations included in our earnings release issued this morning, which can be located on the investor relations section of our website at www.skilledhealthcaregroup.com.

With the exception of EBITDA, adjusted EBITDA and adjusted EBITDAR, this report and our discussion today are presented on a consolidated basis under generally accepted accounting principles and as such references to the company, Skilled Healthcare Group, Skilled Healthcare, “us”, “we” “our” refer to Skilled Healthcare Group, Inc. and each of its consolidated subsidiaries.

I will now turn the call over to Boyd Hendrickson, Chairman and Chief Executive Officer.

Boyd W. Hendrickson

Good morning everyone. We are pleased to have you on the call today. The year 2009 thus far has encompassed several accomplishments that we’re pleased to discuss with you today. Additionally, while it is difficult to forecast the outcome of the current and the future reimbursement proposal, we continue to remain focused on building the company for the long-term. This means that our top priority remains centered around high quality patient care, the prudent use of cash and investment, employee training, and expense control to closely resemble change in revenue. Our actions in the first quarter reiterate this philosophy as well. As a result, in the first quarter we achieved revenue growth of nearly 5% year-over-year and earnings per share growth of 26% during that same period, all in a very challenging environment.

In addition, the company has executed on several key initiatives so far in 2009 that we’re confident will continue to drive future growth. First, we’re very excited about the extension of our $135 million revolving line of credit for an additional 2 years while maintaining a low interest rate spreads at our choice of either LIBOR plus 275 basis points or prime plus 175. The revolver is previously scheduled to mature in June 2010. After June 15, 2010, the revolver will have a total capacity of $124 million, and in today’s challenging capital environment, we believe this to be a significant accomplishment and a statement of confidence from our lenders. In addition, we believe that the extension will provide sufficient liquidity as we continue to execute our gross strategy.

Another milestone was the opening of our state of the art 136-bed skilled nursing facility, The Dallas Center of Rehabilitation in March. This facility included a 68-bed Express Recovery Units and a 4000 square foot rehabilitation gym among many other amenities. We believe the facility raises the bar in skilled nursing care and look forward to sharing it with all of those of you who are scheduled to attend our Investor Day on June 3rd in Dallas.

In addition, as previously mentioned, we have commenced construction on a second facility which is located next to several downtown Fort Worth Acute Care Hospitals. This facility will be similar to our new Dallas facility and is being built in accordance with nationally recognized standards for Green certification.

In April we acquired a 74-bed skilled nursing facility for $1.7 million as we expanded our regional presence into Iowa, our seventh state. This facility is expected to improve its metrics upon the remodeling efforts and implementation of operational and service improvement initiatives.

Also, in April we opened a new 41-bed assisted living facility in Tonganoxie, a suburb of Kansas City bringing the total number of ALFs to 22. Including the Dallas Center of Rehabilitation, we now operate 77 skilled nursing facilities combined with our assisted living facilities we own an industry leading 74% of all of our properties. We continue to feel strongly about owning our facilities as it provides additional operational and financial flexibility, economies to scale, and a hedge against rent escalation associated with the lease building.

And last but not the least, we welcome Kelly Gill who became president of our Ancillary Services Company on May 1st.

We continue to expand our Express Recovery Units as planned. During the first quarter 2009, we added two new specialty ERUs, our Pulmonary Advantage Units, and one new ERU. We also expanded two others for a total of 190 additional ERU beds in the first quarter. This now brings our total number of Express Recovery Units to 52 and annual growth rate of 53% over the first quarter of 2008, and the total number of ERU beds to approximately 1830, an increase of 68% year-over-year. ERU beds now represent over 20% of our total SNF available beds. Furthermore, the 52 units are located in 47 different facilities which means that over 60% of all of our SNFs now have an Express Recovery Unit.

For the first quarter of 2009, our facilities with an ERU had combined skill match mix which is defined as the number of Medicare plus managed care days as the percentage of total of 27.1 versus 18% for those without an ERU. Additionally, in the first quarter, our facilities with an Express Recovery Unit had a combined adjusted EBITDA margin of 370 basis points higher than those without an ERU.

Our occupancy rate in facilities with an ERU was 460 basis points higher than those without an ERU. For the remainder of 2009, we expect to open an additional 10 new Express Recovery Units and expand 7 other units for a total of approximately 300 more ERU beds. At the end of the year, we expect to have a total of 62 ERUs with 2164 dedicated beds, a 27% and 32% increase over 2008 respectively.

Turning to our key operating statistics, our skilled nursing occupancy measured of available skilled beds is 84.7 for the first quarter of 2009, up 20 basis points compared to 84.5 in the fourth quarter of 2008. Occupancy was 85.4 in the first quarter of last year. In addition, our skilled mix was 24.3 in the first quarter of 2009, up 100 basis points from 23.3 during the fourth quarter of 2008. This measure is above industry average and a testament to our focus on the high acuity model.

Skilled mix was 225.7 in the first quarter of 2008. Our quality mix defined as the amount of non-Medicaid revenue as a percentage of total revenue was 69.1 in the first quarter of 2009, up 130 basis points compared to 67.8 in the fourth quarter of 2008, quality mix of 69.3 in the same quarter a year ago.

Another key operating statistics is the percentage of patients in the upper nine Medicare RUG categories. For the first quarter of 2009, our upper nine RUG category utilization was 41.9%, up 180 basis points since compared to 40.1 in the fourth quarter of 2008. RUG utilization was 40.7 in the first quarter of last year.

Now, I’d like to turn the call over to Dev Ghose, Chief Financial Officer to talk about the company’s financial results in more detail.

Devasis Ghose

Good morning. Before I discuss our first quarter 2009 results, I want to expand on our discussion of extending the revolving line of credit for another 2 years. We are delighted to maintain current interest rates given the recent capital market environment. In order to achieve this as you know, we paid upfront fees and expenses of nearly $8 million. On the US GAAP rules, these costs are amortizable over the 38-month term of the debt so the ratable charge on 2009 is approximately $0.03 per share assuming a 40% tax rate.

Moving on to first quarter results, we continue to report our operations in two segments; the larger segment, long-term care services includes the operation of skilled nursing and assisted living facilities that represent approximately 84% and 3% of revenue respectively in the first quarter of 2009. Our ancillary services segment includes our third party rehabilitation therapy and hospice businesses that represent approximately 10% and 3% of revenue over the same period.

For the first quarter of 2009, revenue was $189.5 million, an increase of $8.8 million or 4.8% over the same period last year. Adjusted EBITDA was $30.6 million, an increase of $2.1 million or 7.3% from the first quarter of 2008.

Revenue in our long-term care services segment increased by $6.7 million or 4.2% to $165.5 million for the first quarter of 2009 from $158.8 million in the same quarter last year. Approximately $3.6 million of increase in long-term care service revenues resulted from healthcare facilities acquired or commencing operations after January 1, 2008. The remainder of the increase representing same-store growth was due to 5.2% improvement in patient per diem rates offset by a 70 basis point decrease in SNF occupancy.

Revenue in our ancillary services segment increased $2 million or 9.2% to $23.9 million in the first quarter of 2009 compared to $21.9 million in the equivalent prior period. During the first quarter, Hallmark, our rehabilitation services company achieved higher EBITDAR margins by effectively managing expenses through higher productivity levels. In addition, our hospice business increased revenue over 28% compared to the same period a year ago.

Net income for the first quarter of 2009 was $10.9 million, an increase of $2.5 million or 30% compared to net income of $8.4 million for the first quarter of 2008. Earnings per diluted share in the first quarter of 2009 were at a record level of $0.29 per share, up 26% compared to earnings of $0.23 per share to the same period in 2008.

In addition to organic growth in the first quarter, earnings also benefited from a slightly lower tax rate and significantly lower interest expenses year-over-year. Also, in the first quarter 2009 insurance PLGL expense was left in that in 2008 as the 2008 expense had included increased reserves on certain streams in the amount of approximately $.13 million.

Our adjusted EBITDA margin increased 30 basis points from the first quarter of 2008 to 18.5% in the first quarter of 2009. Our adjusted EBITDA margin also increased, it was 40 basis points higher than the first quarter of 2008 to 16.2% in the same period this year.

While our margins increased during the first quarter compared to the same prior period, we saw increased revenue due to our Kansas acquisition and higher per patient day rates, reductions in general liability and worker’s compensation reserves of approximately $1.4 million, interest expense of approximately $1.6 million primarily from a decrease of 130 basis points in our average borrowing rates and reduced tax expense of 400,000 due to a statute closure and finally from increased cost controls. These were offset by slightly lower total occupancy rates as discussed earlier.

Turning to our statement of cash flows during the 3 months ended March 31, 2009, we invested $4.9 million in developments and Express Recovery Units and $5.5 million in routine CapEx. With cash flows from operating activities at $8 million, we were able to fund a majority of our capital expenditures through internal sources which is important as it provides greater flexibility to us in 2009. Our days sales outstanding was 57 days at March 31, 2009 compared to 56 days as of December 31, 2008.

Moving on to long-term debt, as of March 31, 2009, we had $479 million in aggregate debt outstanding consistent of approximately $130 million of our 11% senior subordinate notes, $250 million of first lien senior secured term loan, and $93 million outstanding under our $135 million revolving credit facility, and finally, capital lease was another debt of approximately $6 million.

In addition, we had $5 million in outstanding lines of credit against our revolving credit facility leaving approximately $37 million of additional borrowing capacity under our revolver at the end of the first quarter.

As previously mentioned, we extended the maturity of the revolving credit loan and thus we don’t have any significant debt maturing for the next 3 years. Both our revolver and our term loan are now due in June 2012 and our 11% senior subordinate notes are due in January 2014.

Nearly half our total debt of approximately $230 million is currently fixed rate. Our debt today has a weighted average remaining duration of 3.6 years, and at the end of the first quarter, our leverage ratio defined under a senior lending agreement was 4.0 times and our interest coverage ratio was 3.6 times, well within our debt covenants.

And finally, with regard to our guidance for 2009, we are maintaining our existing 2009 guidance that was provided in conjunction with our 2008 earnings results and stated in the 2008 year end conference call.

With that, I’d like to turn the call back to Boyd.

Boyd W. Hendrickson

In closing, I’d like to note that we’re very excited about our execution of key initiatives summarized today and look forward to continuing to build our company to align our services to meet the future long-term care and rehabilitation needs. While the economic environment has changed over the last year, the strong fundamentals of our company have not. We remain focused on our top priorities, providing high quality patient care and building long-term value for our shareholders, and I would also like to re-invite anyone that would like to come to our Investor Day on June 3rd that will be held in Dallas and everybody will be given the opportunity of going through our new building there and hopefully, time allowing, one of our other properties in the immediate area.

Now, before we open it up to Q&A, I’d like to let everyone know that our management group will be available for Q&A besides Dev and I, are Jose Lynch, the President and Chief Operating Officer of the company, Mark Wortley, Executive Vice President, Kelly Gill, the President of our Ancillary Services Segment, and Roland Rapp our General Counsel.

With that operator, we’re ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Frank Morgan - RBC Capital Markets.

Frank Morgan - RBC Capital Markets

A couple of questions here, first on the roll-out of your Express Recovery Units the balance of the year, I believe you said you have 10 that you will be rolling out, could you maybe elaborate a little bit more on the timing of that, is that fairly equally weighted or is it back-end loaded; and then on the same point, in terms of the start-up cost related to this new Dallas facility, could you help walk us through how you see that unfolds and I’m assuming that’s already built into your guidance, but could you just tell us a little bit more about that?

Jose C. Lynch

The 13 total recovery units in ’09 was pretty well spread evenly throughout the quarter; so we have 3 in the first quarter, 2 in the second quarter, 4 in four, that’s just the prediction and we’re hopeful we don’t have any delays; sometimes we see the third quarter push into the fourth with some of our California units; and then in regards to the Dallas question, yes, the losses are built into our guidance; we were modeling right around the $6 million range and a little bit over the break-even EBITDA by year end ’09.

Frank Morgan - RBC Capital Markets

Okay, and then totally unrelated to that, the notion of the roll-out of these racks, I know you’ve had a little bit of experience with that in the past, but could you maybe talk to us a little bit more about what your plans are in terms of implementing and getting ready for this being implemented on a nationwide basis?

Jose C. Lynch

We actually allocated about a little over $1 million in the budget just to get ahead of it, just having experienced with it. So, we have a new Denials Department that is focused very heavily on professionals to be able to write a PL in that; so, we’ve learned a lot through the demonstration project and we’re really well geared up with probably the staff ranging around 10 to 15 right now targeted on working existing racks from when we were hit mostly in California and then what’s to happen going forward.

Operator

Your next question comes from the line of Brendan Strong - Barclays Capital.

Brendan Strong - Barclays Capital

I now your reiterating guidance here, but I’m just curious about some of the components if any of those may change a bit, and in particular, when you provided guidance, you had said that you were expecting full market basket increase in the fourth quarter, so I’m wondering if, as your reiterating guidance, what you’re assuming around the fourth quarter?

Boyd W. Hendrickson

Brendan, first of all, we only put out annual guidance; in our current guidance that contemplates the 2.8% increase in Medicare rate coming in October and compare that to the proposed regulation that would contemplate a net cut of 1.2; if the proposed Medicare regulation were enacted, it would have the effect of reducing EPS by approximately $0.04 a share after tax for that fourth quarter of 2009. When we’re doing annual guidance, we felt there were two things out there, #1, we don’t have clear visibility yet on what will happen ultimately in the quarter; I think we’re looking at probably the worst thing that could happen and there’s a probability that that could get better. The other thing that will have more visibility as we get into the third quarter will be our Medicaid rate increases. I think that when we put out the initial guidance, our Medicaid rates we had budgeted for a 2% overall increase and we would like to see more before those come in before we really do anything about changing our current guidance. We have put into the guidance the effect of the refinancing cost that Dev talked about, the $8 million.

Brendan Strong - Barclays Capital

And then, how are you thinking about, obviously you guys get a high percentage of your cases in the upper nine RUGs, so no changes in 2010, but how are you thinking about the potential for those changes in 2011; whether it’s at risk or you not too concerned about it, any thoughts?

Devasis Ghose

It’s still early looking at the fiscal 2011 program, it’s real early to figure out what the rates are going to be in all the categories and obviously the rehab rates were cut, the nursing rates were added; there is obviously some impact by the look-back going away where we benefit by treating patients all at once with IVs and trachestomy care and rehab all at once, now with the RUGs changing it looks like the proposal is going back the way it used to be which is going backwards from where they were trying to have IRF and LTAC patients coming to SNF. So, it’s way too early even to comment on that. Based on the way it looks today we’d see fewer patients in the upper nine and we’d see more patients in the rehab and the new RUG category. So, without knowing the rates and from what they’re saying it being budget neutral, we’re assuming that there’d be no impact.

Boyd W. Hendrickson

The real thing to reiterate would be that the proposed changes are revenue neutral and it would be anybody’s guess after that.

Operator

Your next question comes from the line of Donald Hooker - UBS.

Donald Hooker - UBS

Following up on the guidance; I don’t know if I’m looking at this wrong, but it seemed like your interest expense was a lot lower, as you mentioned rates have come down; what is your assumption; should we just run rate that for year, or how do we think about that in terms of getting to your EPS guidance?

Devasis Ghose

As Boyd mentioned, we’re keeping guidance level with what we gave out; obviously some components with change as you get actual results versus what we budgeted.

Donald Hooker - UBS

So, the interest expense, it wouldn’t go up for any reason?

Devasis Ghose

The interest expense will go up for the $0.03 that I talked about for refinancing. In general, interest costs have been lower than the LIBOR curve would have projected before; that’s all I can share with you on variable rate interest.

Boyd W. Hendrickson

What we told when we gave our guidance out is that we just took the LIBOR curve and modeled it forward.

Donald Hooker - UBS

The margin differentials for the Express Recovery Units I thought was interesting, it was very wide; it seemed like it got wider than in some prior periods. Is there a way to think about it, I guess that looks really good; is there a way to think about that going forward, where ultimately will that settle up?

Jose C. Lynch

They’re still just looking attractive as ever, they’re generating that much more skill mix which is generating all the margin. So, I think we’re just continuing along the same pace of opening new ones and keeping along with our model and opening our arms to the highest acuity patients which is not going to change over the next 10 years. We’re just staying on course with our managed care model; take the sicker patients as soon as you can, and I don’t think that we’re really going to change course. I think we see those margins staying relatively stable. The key is not in keeping our occupancy levels up in those units as well our total occupancy, not just managing skill mix.

Donald Hooker - UBS

You mentioned that there were a couple of these other nursing homes you’re building, if I recall, Garland and Fort Worth, in terms of the construction CapEx that’s going to go into that, how does that play out over the next year or so and when do those patients start kicking into your P&L?

Jose C. Lynch

Right now our projection is the two SNFs; you know Dallas has opened and you know Tonganoxie has opened, that opened just this week; so the assisted living projection is that we’ll probably break even this year on that particular; was about just under $500,000, and then Fort Worth and Garland combined will be; the start date for Forth Worth will be right around somewhere between Q2 and Q3 2010, Garland will be more so than likely Q4 2010; the CapEx on those two will be $29 million to $30 million, and then at maturity they’ll both do about $5.5 million EBITDA. Typically our startup models have been where we break even EBITDA after about 6 months of operation, and the EBITDA margin annualized for those projects is somewhere between 6% and 9% EBITDA.

Boyd W. Hendrickson

That would be $29 million for both of them.

Operator

Your next question comes from the line of Brian Siu - Sidoti & Co.

Brian Siu - Sidoti & Co.

Just a quick question on Medicare rates; the percentage days was down 17% year-over-year, about 130 basis points, but the percentage in the upper nine was substantially higher; is there any correlation we should draw there?

Jose C. Lynch

The rate piece of it is strong from that perspective, so 496 over 461 on a daily rate, upper nines is there, all the rehab categories are striking well. The difference in the drop on the percentages related to volume and our volume of incoming new admits and re-admits over Q1’08. Q1’08 was probably one of the best quarters in history the company in regards to that. So when you look at skilled census, the three components would be new admissions coming in the door, readmissions from the hospital, and then our length of stay. Our length of stay was flat, the biggest portion of the drop was a lower new admission volume, that was about 90% of the problem. We were down in new admissions volume by about 7.6%. That was the biggest portion of the drop related to the Medicare job.

Operator

Your next question comes from the line of Robert Mains - Morgan Keegan & Co.

Robert Mains - Morgan Keegan & Co.

If I can proceed on that last question there; generally speaking if you roll out more EIUs, considering the shorter length of stay, will that have a dampening effect on occupancy improvement or do you think that occupancy can still move up from where it is now?

Jose C. Lynch

I think we have a lot of opportunity in total occupancy. I think over time the way the 2011 road looks today, our lengths of stay can go up just based on how they do it, but over time we’ll see lengths of stay continue to probably trickle down over time, I think that’s just what we’ll see as we are now a place for sicker and sicker patients and some that rehab and go home. So, I think we do have a lot of opportunity for the total occupancy still in the company left.

Robert Mains - Morgan Keegan & Co.

So, when you look at the quarter’s occupancy, you didn’t typically get as much for fourth quarter to first quarter, you said that there were a few admissions coming from the hospital; is that something competitive, is it something going on in terms of the economy; what do you think was the reason for that?

Jose C. Lynch

My comparison on the new admits was over Q1’08, but we had a nice in Q1’09 over Q4’08, we jumped by about 80 or so skill patients, and so we had a nice pop in new admissions from the fourth quarter to the first quarter and readmission; so they both jumped around 7% or 8% over the fourth quarter. We saw a lot of different stuff going on as we typically do not quite like we saw it in the first quarter ’08, but where we had more of the clinically complex rather than coming in with some flu and respiratory stuff. So, that was most of the pick up over Q4’08, which is not quite as aggressive as it was in Q1’08.

Robert Mains - Morgan Keegan & Co.

A question on the Medicaid rates, I remember last quarter there was a little bit of a catch-up in there; the rate that you had this quarter, is that the rate that assuming there’s going to be a 2% that it would be off of?

Jose C. Lynch

That rate is pretty much all in; there’s not anything inflated in there. So, I think most of it’s right off that rate, the 144 or 145.

Robert Mains - Morgan Keegan & Co.

Similarly Dev, last couple of quarters there have been some insurance adjustments or bad debt adjustments have been falling through the income statement; I gather there were none of them this quarter?

Devasis Ghose

That’s correct.

Robert Mains - Morgan Keegan & Co.

Could you elaborate what was the reason you gave a sense on the tax rate during the quarter?

Devasis Ghose

Just a minor adjustment of $400,000 because of a statute closure.

Robert Mains - Morgan Keegan & Co.

So the $39.5 that you originally gave in guidance will still be the right one to use for the year?

Devasis Ghose

If you’re keeping guidance level.

Robert Mains - Morgan Keegan & Co.

Let me be the third person to ask this question the same way; in the guidance you said that you are including the effect of the new line, the $0.03?

Devasis Ghose

As I said when you amortize the cost over the period of the renewal or the remaining duration of that set, the effect of that on 2009 is approximately $0.03 per share.

Robert Mains - Morgan Keegan & Co.

So if you dip a line at the beginning of May that’s $0.03 over an 8-month period effectively?

Devasis Ghose

If you take $8 million divided by 38 and then 60% of that, run it out, I think you get to just a little it under $0.03 a share.

Robert Mains - Morgan Keegan & Co.

Fair enough, and then that new expense is going to reside on the interest expense line?

Devasis Ghose

Under US GAAP, part of the borrowing costs, and they have the same treatment really as interest expense.

Robert Mains - Morgan Keegan & Co.

Right, which is non-cash.

Operator

Your next question comes from the line of Gary Taylor - Citi.

Gary Taylor - Citi

A couple of detailed questions already got answered. So, I am going to go straight to the harder ones unfortunately. I guess there’s some optimism with respect to where RUG4 could turn up for you. To state the obvious, with the stock trading at 8 times earnings, the market is obviously worried about what Obama has got on his budget for post-acute bundle, maybe, what’s in RUG4. So, the first question is, what are your thoughts on bundle; obviously a lot of people have commented about very onerous implementation issues; how realistic do you think that is if that’s something you’ll really end up facing?

Jose C. Lynch

We don’t think it’s real realistic, but I think everyone will stay there; the perfect company for it, but I think we’ve focused so long on managed care and that program plays out well with our company in the event that it goes out; I don’t think the acute hospitals are capable of managing that program and I think it would be a potential mess, but I think we’re just somewhat focused on acute hospital relationships and how we work with that program, I think it would play out well for us. Ultimately it would turn into a managed care program. I think the IRFs and the LTACs might get hurt pretty big by the bundling.

Boyd W. Hendrickson

I think that we’ll get more information on that Gary probably sometime in the middle part of June and then we’ll have more to go on, but when you really think about it, if you’re going to bundle, like Jose alluded to, the conceptual managed care, and if they are the gatekeeper there’s the person that is controlling money and they probably didn’t want to put the patient to the level of care where they can get the appropriate outcome at the lowest cost. We really don’t have enough information or a whole lot of information on that right now.

Gary Taylor - Citi

So your expectation of the June timeframe, just seeing something in a house-bill basically?

Boyd W. Hendrickson

Yes, something where people begin to talk about it. They aren’t even looking at implementation until at the earlier some of it phased in; 2012 through 2015, and then the full benefit I don’t think comes until 2018.

Devasis Ghose

Really all it does is it just puts pressure on our outcomes today and focusing on that. People ask questions about length of stay and ultimately the system turns into managed care, we’re going to have to get patient in and out more quickly into home.

Gary Taylor - Citi

Just switching over to RUG4 and I appreciate that you don’t have a group or was some of the MDS and ADL changes, you might not even be able to run that today if you had one, and I appreciate the thought that overall it’s designed to be budget neutral, which it is, but is it really plausible as it’s laid out now that it could be budget neutral to your company because of the movement of days that they’re trying to force out of those higher nine RUGs.

Jose C. Lynch

It’s really hard to answer that question without seeing the rates. A lot of it depends on where those rates come in, that’s really the ultimate, and then of course a lot of it has to do with does the mindset change in regards to how a patient is treated from where it is today; hopefully not, but do you see with less services patients, initially do you potentially see an uptick in length of stay possibly. Hopefully not and hopefully the system continues to push through getting patients some center. If you look at that context, Gary when they went in with the nine new higher RUG categories, if you look at it 12 months after that, in our company why our average length of stay really did drop about 5 days, and here again depending on whether you’re going to discontinue some of the dual treatment, they could potentially go back up. I think you’ll get enough information and enough clarity prior to the implementation of whatever so that you’re going to be able to adapt and change your model to make it work and to make it fit like we’ve been able to do right from the beginning of our movement with the Express Recovery Unit and developing our capability and ability to deal with the higher acuity patients. We’ll get it even with the same patient; maybe we deal with them in a little different way.

Gary Taylor - Citi

I guess we’re so accustomed to seeing how those large chains do so well targeting particularly these 9 extensive rehab RUGs and the higher gross dollar profit associated with those days; anything that would attempt or at least propose moving some days out of those categories, it’s just worrisome, but I guess I appreciate we don’t have all the answers today and you think there’s still some flexibility just in terms of the cost side and to manage your profitability regardless of what they throw at you, I guess what I’m hearing is right?

Boyd W. Hendrickson

Yes, I think that the one unique ability that our company has been able to have and the things we kind of build our footprint and our reputation on has been our ability; we had the foresight prior to the nine new higher RUGs coming out and it began developing the ERU units; we started developing those in late 2003 and 2004 knowing that whatever happened going forward and in the future would deal with higher acuity patients; now that we’ve got that developed and we found that we do have the ability, we’ll work very diligently between now and when the final rules come out to know what contains within them, and maybe we change the way we operate our ERU units a little bit; I don’t know what it would be, we just don’t have the visibility now, but I think that the one thing that we do have as a company is the fact that we do have the ability to be adaptable and we’re kind of fleet on foot and I think that we’ll be able to manage through it very well.

Gary Taylor - Citi

My last question on this, and I appreciate the answers, there’s some chatter at one of your other companies I talked to that CMS might release a RUG for a group or to at least let you be able to analyze what the new rule could potentially do to you, do you have any thought on the timeframe of when you might have that and when you might be in a position to just kind of talk to the street about what that looks like?

Boyd W. Hendrickson

We have no idea.

Operator

Your next question comes from the line of Eric Gommel - Stifel Nicolaus.

Eric Gommel - Stifel Nicolaus

I just had one question, on your available beds in service at the end of the period, is that expected to fluctuate much for the rest of the year?

Boyd W. Hendrickson

Not much, we’re about right around 96% of licensed beds available. The only change would be the way that we show the Dallas Center being empty, but for the most part it was around 96%.

Eric Gommel - Stifel Nicolaus

So, you’re excluding the Dallas stuff in that number?

Jose C. Lynch

Partially, and will be going into operation right at the end of the quarter.

Boyd W. Hendrickson

We opened a floor but we didn’t open the second floor.

Eric Gommel - Stifel Nicolaus

Okay, so then maybe the assumption would be you’d open it over the quarter or maybe over the year?

Jose C. Lynch

Yes, those two floors we’ll probably open in about a couple of months.

Operator

Your next question comes from the line of Andreas Dirnagl - Stephens Inc.

Andreas Dirnagl - Stephens Inc.

Most of my questions have been answered, but I did want to just sort of get one bit of clarification, I’m sorry I can’t remember what Boyd or Jose who were talking about the potential impact of the proposed 1.2% cut on the fourth quarter, what that would do to EPS, I think I heard correctly that negative 1.2 would be about a $0.04 impact, is that correct?

Jose C. Lynch

You’re correct, and very mind of fact that if Medicaid and everything remained constant and we didn’t do anything at all to take anything out of cost, it would be a $0.04 impact.

Andreas Dirnagl - Stephens Inc.

And that delta is off of what you had been projecting which you call a full market update and was an absolute of about 2.8%?

Jose C. Lynch

Yes, that’s correct, that’s what we gave in our guidance, we said 2.8% increase in Medicare is what we projected for 2009 coming in the fourth quarter and instead of that 2.8% positive impact, we got 1.2% negative impact that delta after-tax is $0.04 a share.

Andreas Dirnagl - Stephens Inc.

And then a final question, I’m assuming that should be a pretty linear relationship, so in other words, every 100 basis points below that 2.8% that you were estimating costs you about a penny or quarter, is that correct?

Boyd W. Hendrickson

Correct.

Operator

At this time, we have no questions in queue. I will now turn the call back over to Mr. Boyd Hendrickson for closing remarks.

Boyd W. Hendrickson

Thank you everyone for joining on the call, and once again, I would reiterate that if you haven’t scheduled that you’re going to be at our June 3rd investor meeting, if you wanted to contact Shelly Hubbard here at the corporate office while she could arrange all the detailed information. Thank you for joining on the call.

Operator

Thank you for your participation in today’s conference. This concludes the presentation.

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Source: Skilled Healthcare Group, Inc., Q1 2009 Earnings Call Transcript

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