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Diversicare Healthcare Services (NASDAQ:DVCR)

Q2 2013 Earnings Call

August 09, 2013 8:00 am ET

Executives

Kelly J. Gill - Chief Executive Officer, President and Director

James Reed McKnight - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Secretary

Analysts

Dana Hambly - Stephens Inc., Research Division

Operator

Good morning, and welcome to the Diversicare Healthcare Services Second Quarter Conference Call. Today's call is being recorded.

I would like to remind everyone that in addition to historical information, certain comments made during this conference call will be forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. And these statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. You are encouraged to review the risk factors and forward-looking statement disclosures the company has provided in its annual report on Form 10-K for the fiscal year ended December 31, 2012, as well as in its other public filings with the Securities and Exchange Commission.

During today's call, references may be made to non-GAAP financial measures. Investors are encouraged to review those non-GAAP financial measures and reconciliation of those measures to the comparable GAAP results in our press release furnished under Form 8-K.

I would now like to turn the call over to Kelly Gill, President and Chief Executive Officer.

Kelly J. Gill

Good morning. Thank you, operator, and thanks to all of you for joining our call today. Also with me is Jay McKnight, our Chief Financial Officer who will provide us some financial detail later in the call.

We spent an incredibly busy second quarter and first half in 2013, so I'd like to move quickly to the transactions we announced last week and discuss how they fit into our strategic plans then go through our Q2 operating results. And we will review the number of moving parts in those results as they relate to our portfolio management.

First, as I hope you all saw last week at the beginning of August, we announced that we're planning to exit the state of Arkansas through the cooperative termination of 11 leased facilities with Omega Health Investors. This exit also coincides with our assumption of operations at 5 additional facilities located in other states. We believe this combination of transaction is a testament to the execution of our strategic plan and on our demonstrated ability to cultivate new business through acquisition and assumption of long-term leases. To illustrate this form further, while we embarked upon our strategic plan in the fall of 2010, our portfolio consisted of 46 facilities in 8 states, 12 of which were in Arkansas. Once these recently announced transactions are completed, our portfolio will consist of 47 facilities in 9 states. Inclusive of these transactions, we will have completed 6 separate acquisition transactions through a combination of fee-simple purchases and long-term leases, resulting in the addition of 13 new facilities into our portfolio and the entrance into 2 new states.

Before continuing with the rest of our discussion on it this morning, I would like to take a moment to comment on our exit from Arkansas a bit further. First of all, this was a difficult decision to make from a sentimental standpoint. We've operated in the state for over 20 years, and our facilities there are staffed with and managed by an incredible group of dedicated caregivers committed to providing high-quality services to our patients and residents. However, our professional liability loss rates remained high and ultimately drove our decision to exit the state. I want to publicly thank our amazing group of health care professionals for their many contributions over the past few decades. I also want to thank Omega for their support in identifying a new operator who will assume these leases. We expect to finalize their departure from Arkansas around the beginning of September, and as Jay will discuss, we'll classify our operations in the state as discontinued going forward.

As I mentioned, it has been much easier to consider such a significant divestiture because we have been so active on the acquisition front. Also contained in the announcement last week, we initiated operations on a new facility in Louisville, Kentucky, which we have named Diversicare of Seneca Place. This is an 107-bed skilled nursing facility located in close proximity to the Highlands facility we acquired through the assumption of a lease last September. Having 2 quality facilities in this market greatly enhances our marketing efforts, and we expect to enjoy certain synergies by having the ability to develop a coordinated care delivery model supported by multiple facilities.

We also included in our announcement last week that we plan to assume operations of 4 additional facilities in Ohio and Indiana from Catholic Health Partners. We're honored to undertake such a transaction with CHP, and I look forward to continuing the dedication to quality that exists in those facilities today. One final important point on this transaction is that the Indiana facility is located directly across the river from Louisville and is well within the market service area of the city. As such, it will be our third facility within our outstanding Louisville market cluster of coordinated care.

Backing up a bit, if you look at the broader body of the transactions we've either completed or announced thus far this year, I think you can get a clearer picture of the achievement of the goals I have discussed in the past by adding new facilities to our portfolio, deepening and expanding our geographical footprint and improving our risk profile. From a top line standpoint, on those assets, combined revenues we have acquired or will acquire through these acquisitions, including our Kansas acquisitions, are roughly equal to those of the 11 Arkansas facilities we are exiting. Geographically speaking, we are pleased to enter 2 new space, Kansas and Indiana. And with the balance of the CHP properties, we are pleased to expand on our current market presence in Ohio.

Now with respect to our second quarter operating results, clearly, there a lot of moving parts here, especially given how much our revenue base will change during the second half of this year. That said, this is clearly a challenging period particularly related to professional liability expenses and utilization trend. We certainly recognize the impact of these challenges, but I'll also point out that the contribution from our acquired facilities certainly helped to mitigate that impact in the second quarter. And looking forward, both the acquisitions we just announced in our planned exit from Arkansas should help to address these challenges in the future.

From a reported standpoint, we generated revenues of $83 million in the second quarter, up 9.1% year-over-year, reflecting 2-month contribution from the Kansas acquisition, our Highlands acquisition last fall and continuing census draw from 2 new health care facilities in 2012 as they continue to ramp up occupancy.

As you'll see on our recorded statistics, the quarter was one of the most difficult we've seen in a number of years from a payor mix standpoint. While occupancy and mix generally see a modest seasonal decline from Q1 to Q2, this seasonal trend was much more pronounced this year, not only for us but industry-wide, which we believe is reflective of the weak hospital discharge volume you've probably seen in quarters among publicly traded hospital companies. Additionally, the effect of the Medicare rate cuts imposed by sequestration along with the cuts in the rates for Part B therapy services are additional factors affecting our quarterly and year-over-year comparisons. From a company-specific standpoint, though, we continue to generate positive operating leverage as we add new facilities to the portfolio, enough though to enable us to maintain our facility-level margin on a year-over-year basis despite these challenges. More specifically, this quarter had a $473,000 negative impact on our Medicare revenue from sequestration and $239,000 from Part B therapy services. Even including this impact, as well as the broader sense of trends I touched on, our facility level operating margin remains stable at 21.2% this quarter, unchanged from last year, which demonstrates our continued effective management and facility-level cost not associated with the provision of direct patient care. Additionally, I'll point out that we incurred roughly $440,000 in start-up costs associated with Kansas, which were classified as G&A expense. Excluding these costs, G&A declined slightly as a percent of revenue year-over-year.

Finally, I'll touch on our professional liability expense, which you'll see showed a sequential increase from an already high level in Q1. Jay will also discuss some of our details of our PL expenses, but I want to be sure to brand this topic correctly as it relates to our planned Arkansas transaction. As most of you will hopefully understand, while we will cease operations in the state during the third quarter, we will most likely continue to incur PL expenses for some time related to open cases and any potential new matters that are filed related to our former operations. However, following the completion of the Arkansas transaction, any PL expense related to that state will be classified within discontinued operations.

Overall, without discounting some of the operating challenges we faced this quarter, I'm still very proud of the ability of our team to continue to significantly change the profile of Diversicare through the effective use of our platform, to achieve growth through acquisitions, targeted divestitures and improved operating leverage in the face of reimbursement cuts while maintaining our focus on making continuing improvement in the quality of care we provide for our patients and residents.

With that, I want to turn the call over to Jay to go through the financial details.

James Reed McKnight

Thanks, Kelly. At first, I'm going to walk through the drivers of our revenue in comparison to the second quarter of last year and then I'll discuss the adjustment items we reported for this year's second quarter to bridge our reported EBITDA, net income and earnings per share to our adjusted metrics. You'll find in yesterday's press release, tables reconciling non-GAAP financial measures to their closest GAAP measurement.

At the top line, reported revenue for the quarter was $82.7 million, an increase of $6.9 million or 9.1% from the second quarter of last year. The primary driver of this increase was the contribution of revenues from the 3 facilities we opened or acquired during 2012 and 2-month contribution from the 5 Kansas facilities we acquired during the second quarter of this year. Also contributing to growth in the quarter were increases in our Medicaid and Managed Care rates. Our Medicaid -- Medicare rates were roughly flat year-over-year due to sequestration. Modestly lower occupancy and skilled mix partially offset other growth drivers.

Compared to the $6.9 million increase in revenue, our facility level operating expense increased by $5.4 million versus the second quarter of 2012, resulting in facility level operating profit before professional liability expense of $17.6 million for an increase of 9%. This equated to 21.2% of revenue unchanged from last year. The revenue reduction resulting from sequestration that Kelly mentioned totaled roughly $712,000 during the quarter. For those at the facility level, our G&A expense rose to $7 million from $6.1 million. Roughly $440,000 of this increase relates to the cost of acquisitions. Excluding this cost, G&A expense declined slightly as a percent of revenue to 7.9% from 8%.

On an adjusted basis, which excludes start-up costs related to 2 newly opened facilities, acquisition-related expenses and debt retirement costs associated with our refinancing, our EBITDA for the quarter was $400,000 compared to $2.8 million in the second quarter of 2012. As Kelly noted, the primary driver for this decline was roughly $2.3 million increase of professional liability expense versus the second quarter of 2012.

For the quarter, net income attributable to shareholders was a negative $2.3 million or a loss of $0.39 per share compared to a negative $0.5 million or a loss of $0.09 per share in the year ago period. On an adjusted basis, we reported a net loss of $1.5 million or $0.26 per share compared to net income of $200,000 or $0.03 per share in 2012.

At the end of the June quarter, our balance sheet reflected cash of $4 million compared to $5.9 million at the end of 2012, and total working capital of $12.3 million compared to $15.7 million.

Related to the announced Arkansas transaction, after the transaction is closed, we will provide further financial information on Form 8-K with the SEC. As Kelly mentioned, Arkansas operating results for all periods presented will be reclassified as discontinued operations. As a result and as soon as the transaction closes as expected during the third quarter, we will report financials for the first half of 2013 compared to the first half of 2012 with Arkansas removed from continuing operations, and we'll do so as well for all periods going forward.

At this time, I'll turn the call back over to Kelly.

Kelly J. Gill

Thanks, Jay. So to recap our progress on our strategic portfolio management efforts, inclusive of these recent announcements, we are showing clear traction in developing our acquisition pipeline. Our integration of new facilities has gone better than expected, thanks to the investments we've made in our operating platform. We've completed acquisition and deal pipes [ph] across the array of opportunities available to us; made progress to exit a troublesome state; and finally, diversified our portfolio with the addition of facilities in 2 new states.

Through the transactions we've completed or announced over the past 12 months, we've changed the profile of nearly a full quarter of our consolidated revenues, which we believe will have positive implications on our top line growth potential, demonstrated improvements in our operating leverage and risk profile for some time in the future. I also believe the steps we've taken further enhances the Diversicare brand. We've been an active player in the acquisition marketplace, and we've had the honor of building upon our agreed [ph] relationships, [indiscernible] high-quality operators such as CHP to assume operations of their facility, and doing so while remaining focused on our strong commitment to quality care, without which none of the rest would be possible.

We will continue to execute on our priority strategic portfolio growth, investments in our facilities and improvement in our high-quality patient care. I believe the steps we've taken thus far demonstrates the quality of outcome of these priorities, and I'm optimistic about not only the benefits we'll get from these steps but also from further such steps in the future.

We have over 6,000 employees and caregivers within our organization, and I'm very mindful and thankful that our progress is every bit is a result of their incredible dedication and work ethic to this truly transformational period for Diversicare.

With that, operator, we'd like to open the call up for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Dana Hambly with Stephens.

Dana Hambly - Stephens Inc., Research Division

Just a question, Kelly, on the skilled mix, down -- sequentially down year-over-year, I appreciate what is going on in the industry and the hospital sense is down. I'm just trying to get a sense if -- I'm just looking at the Medicare per diems were down pretty good sequentially and I understand sequestration and Part B. I'm just trying to figure out, has the actual acuity changed at all? Or are you seeing a higher acuity patient, lower acuity patient, anything there?

Kelly J. Gill

Great question, Dana, and thanks for joining the call this morning. As we're saying, through the effect of -- what we're seeing is this market phenomenon here. Our rates -- our Medicare rates are holding fairly steady despite the rate cuts, which is a fairly good indication of ongoing acuity of our patients. And so with that, I would say that we feel good that we're continuing to see the same high-quality or high-caliber acuity of patients. We're just not seeing them in the same numbers.

Dana Hambly - Stephens Inc., Research Division

Okay, that's fair. And on the Managed Care piece, I know that's a pretty small piece of the business, but at least give a sense of how the negotiations are going there with respect to rate.

Kelly J. Gill

The -- a fair number of our contracts still follow suit as a rough base reimbursement model. And we feel good about -- on the rate side that's again reflective of the acuity of our patients. We feel that we're continuing to see appropriate high quality -- high-acuity patients. But the trend of Managed Care referral is just following the broader trend in the market. And so the volume is down, but we're still seeing high-quality -- or high-acuity patients.

Dana Hambly - Stephens Inc., Research Division

Okay. And then on the new facilities joining the portfolio or the skilled mix, occupancy rates, are they pretty comparable to where the existing portfolio is?

Kelly J. Gill

Yes. We're not releasing those numbers today while we're excited about the potential of those facilities. Once we actually complete those transactions, we will provide more specific information on those. But I would share that we do have good excitement about the facilities that they operate today and what we'll do in the future for them.

Dana Hambly - Stephens Inc., Research Division

Okay. And last one for me, I think I know the answer but I'll ask anyway. The professional liability expense, if you don't want to get a percentage, is it fair to assume that the lion's share of that is related to the Arkansas facilities?

James Reed McKnight

Dana, it's Jay. Obviously, a significant portion of it is related to the Arkansas facilities. We're looking forward to being able to share a lot about the financial performance of Arkansas and the continuing operations. You have to be able to close during the next few weeks.

Operator

Now our next question comes from Will Feder [ph] with Woodmont [ph].

Unknown Analyst

Maybe this is another way to ask the last question, I understand you don't want to get into too much. But of the 51 outstanding cases on file, how many of those are related to Arkansas?

Kelly J. Gill

That's a really good question. We don't break down the cases in the different matters. It fluctuates from period to period depending on when different matters are filed, when they're settled, et cetera. So that information, as far as breaking it down between regions, isn't something that we have historically provided. I'll follow through with our attorneys, and if there's anything we can say about that, we'll look to do that in detail.

Unknown Analyst

And then on the acquisition revenues, I appreciate you breaking out the Kansas facility in your press release. And you -- I think you said you have $3.9 million of revenues for 2 months. Just given the size of that transaction, can you tell us how August occupancy -- are things -- you said the integration is going better than expected. Are the things in Kansas still trending up, down, stable? What would be your characterization?

Kelly J. Gill

Yes. Obviously, we're extremely excited about the Kansas portfolio. Again, were not ready to go into the occupancy of the region. We did disclose that information about revenue. We want to give the readers some information there. It was about $3.9 million. There hasn't been any fundamental or material change as it relates to August. And we're looking forward to having that facility on long term in the second half of the year --

Unknown Analyst

And that's regions, excuse me.

Kelly J. Gill

And as far as the integration is concerned, we're -- I think I even commented on the last call that we're pleased that given the characteristics of our platform that the region is completely integrated onto our platform within all of our operating systems, including EMR. And so from that standpoint, those -- all of those efforts are behind us. And therefore, our operations team is able to focus exclusively on developing our care services and our sales efforts.

Operator

I am currently showing no questions at this time. I will now turn the call back over to Kelly Gill for closing remarks.

Kelly J. Gill

Okay, thank you, operator. We'll go ahead and conclude our call today. I want to thank all of you for joining in our call, and we look forward to talking to you next quarter. Thank you.

Operator

Thank you, ladies and gentlemen. That does conclude today's conference. You may all disconnect, and have a wonderful day.

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