The Ensign Group's (ENSG) CEO Christopher Christensen on Q4 2015 Results - Earnings Call Transcript

| About: The Ensign (ENSG)

The Ensign Group, Inc. (NASDAQ:ENSG)

Q4 2015 Earnings Conference Call

February 11, 2016 01:00 PM ET

Executives

Chad Keetch - EVP

Christopher Christensen - President and CEO

Suzanne Snapper - CFO

Barry Port - COO

Analysts

Chad Vanacore - Stifel

Frank Morgan - RBC Capital Markets

Ryan Halsted - Wells Fargo

Dana Hambly - Stephens

Natalie Pesque - Wasatch Advisors

Operator

Good day, ladies and gentlemen and 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 would now like to introduce your host for today's conference, Chad Keetch, Executive Vice President. You may begin.

Chad Keetch

Thank you, Tat, [ph], and welcome everyone. And 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 05:00 PM Pacific on Friday, March 25, 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 the 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 subsidiaries 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 on upon 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?

Christopher Christensen

Thanks, Chad and good morning everyone. We’re thrilled to report that operating results for the year met consensuses, 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 and estimates trickle from quarter to quarter especially in periods of significant growth, which is why we do not give quarterly guidance. But we hope to remember that have been able to project performance fairly accurately on an annual basis. Our focus in 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 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 challenges, our local leaders across the organization were able to drive steady improvements in our same stores 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're pleased with the initial contribution 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 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 on our newly upsized revolver line of credit, giving us plenty of dry powder to fund additional growth in 2016 and beyond. And as EBITDAR and our 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 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 return long-term value to our shareholders. We also completed a two-for-one split of our outstanding stock, increasing the number of basic outstanding shares to approximately 51.4 million as of December 31, 2015. There are several reasons that we decided to take the step, but the primary reasons were to make our shares more affordable for a wider range of investors and increased 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% of 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, and consolidated revenues for the year were up $314.4 million or 30.6% over the prior year to $1.34 billion and 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 later part of the year as the transformation process occurs gradually throughout 2016 and 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?

Chad Keetch

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, 3 home health businesses, 3 hospice agencies, 1 home care business, 3 urgent care clinics and 1 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 and Scottsdale, Arizona, Chandler Post Acute and Rehabilitation a 120 bed skilled nursing operation and Shea Post Acute Rehabilitation Center, a 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 the Kansas, the Healthcare Resort of Shawnee Mission, between 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 bring 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 the three healthcare resorts, and three additional scale 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 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’ve 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 5, 2016, Ensign also increased its revolving credit facility by 100 million to an aggregate of $250 million, a $111.8 million of which was drawn as of February 5, 2016. The amendment reduced the LIBOR-based interest rate by 50 basis points and extended the termination date for our revolving commitment to February 5, 2021, among other things. This is 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 strong balance sheet, and we look forward to continuing our strategy of disciplined growth. We've 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 will hand it back to Christopher.

Christopher Christensen

Thanks, Chad. Before Suzanne runs through the numbers, I'd like to offer a few examples of how our frontline leaders and their teams continue to produce record results in a changing operating environment. As those of you that follow our industry know, there is a lot of noise regarding the potential changes to reimbursement models and healthcare in the varying roles played by hospital systems, physician groups and manage 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 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 pursuing 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 a focus on strengthening outcomes and extending our capabilities to care for more complex patients across the post-acute continuum. We continue to direct time and resources into developing outstanding leaders, investing in the best technology and establishing world class systems. As a result, we're seeing 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 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, and 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 is still much improvement that can be made within our same store operations. For example, Broadway Villa Post Acute, a 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 Wilson and Director of Nursing Janice Diaz established. This kind of progress not only helps us improve our reputation in the market 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 strives made at Broadway Villa, the operation has seen marked increase in both total and skill days in revenue, with total patient days increasing by over 6%, with managed care days increasing by 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 the 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 so they continue to grow their membership in most of our markets. Our local leaders have been determined to becoming the preferred provider in 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 the managed care providers, Montecito Post Acute, a 222 bed skilled nursing facility in Mesa, Arizona experiences a very high admission volume of approximately a 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, Forrest Peterson and COO, [Marjorie Barsona] [ph] have helped create. With tightly managed length of stay, low return rates to hospital's superior customer service and close coordination with the major manage 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 of 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 and alternative payment models with CMS and managed care organizations, as active participants in both model 2, and model 3 of BPCI demonstration project. We're deepening our relationships with the conveners and hospital groups and our experiencing tremendous success in driving more efficient management of each bundle of care.

For example, at Southern Care Center a 120 bed skilled nursing facility, CEO, Tyler Albrechtsen and COO [Shoni Del-Pilar] [ph] are actively participating in several model 3 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, but still over from these efficiencies has also generated attention from other pair of sources, leading into an increasing 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 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 will see as we do the clear path to success that lies ahead, and why we are enthusiastic about our future and our prospects for Ensign's continued growth and performance.

Next, I'd like to ask Suzanne to provide more detail on the Company's financial performance. Suzanne?

Suzanne Snapper

Thank you, Christopher and good morning everyone. Detailed financials for the fourth quarter and the year are contained in the 10-K and press release filed yesterday. Highlights for the quarter and year end December 31, 2015, as compared to the quarter and year end December 31, 2014 include record quarterly revenues of $373.2 million or 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 sales 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 nearly upsized $250 million revolving line of credit as of February 5th. Of those who have followed us and our industry now, 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 an [affiliate] account. 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 where we wait for the paperwork to be completed. This temporary delay in collections results in an increase in our account receivable and can result in negative free cash flows, which is consistent with what we would expect during periods of significant growth. As Christopher mentioned, we are reaffirming our guidance for 2016. We are projecting revenues at $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 patients based intangible, the exclusion of losses associated with the development of new operations and startup operations which are not yet stabilized, the exclusion of costs related to a new system 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 this much of this growth to be produced in the latter half of 2016.

Additionally, other factors contribute to asymmetrical quarters include variation in reimbursement systems, delays and 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 program and other factors.

And with that, I’ll turn the call back to Christopher. Christopher?

Christopher Christensen

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 appreciative of our colleagues in the field and the service center for helping us to meet our earnings guidance that has been increased three times during the course of the year, and for making us better every day. I guess I'll turn the time over to Tat [ph] for Q&A portion of the call.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question is going to come from the line of Chad Vanacore with Stifel. Your line is open. Please go ahead.

Chad Vanacore

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

Christopher Christensen

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

Chad Vanacore

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

Christopher Christensen

Yes. So there's two ways to think of this. So the two way 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 first quarter will reflect some of it, but first quarter will be less than fourth quarter. Yes.

Chad Vanacore

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

Suzanne Snapper

Yes, 1% to 3%.

Chad Vanacore

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 to the geographies that you’re in, Kansas City or in South Carolina, how is that organized?

Christopher Christensen

Yes, that's a good question. It depends on the circumstances. It depends on the performance of the operations. Obviously these are newer ones. So 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 random 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.

Chad Vanacore

All right. And then just maybe more on acquisitions. Are you seeing any more sizeable portfolios or clusters of facilities come to market, that you might be interested in or are you still focused on the one to three facilities at a time?

Christopher Christensen

We’re focused on both. We’re very careful with size. When the acquisition is of a substantial size, and what's actually substantial, bigger than three or four, if there is some performers in the portfolio, and we feel like there is a good -- at least a decent match with our culture, we’ll pursue something like that. But we’re still seeking the small ones even to that. 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.

Operator

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

Frank Morgan

Suzanne called 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 bit more color and is our opinion of those particular -- I don’t know quite the risk, but anyone that you think are more meaningful in terms of the magnitude of the impact or ones that you would be more likely in duress and that would move the needle the quickest to see those results go up?

Christopher Christensen

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

Frank Morgan

Yes.

Suzanne Snapper

It’s the same list that we share every quarter. There's nothing that has I would say that I'll point out this quarter that difference in 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, that we expect that produce more in the latter half of 2016. I think that that would be the one thing that I would highlight with regards to the list and items that I went through. So it’s going to be a lot more symmetrical quarter as those produce in the latter half of ’16.

Frank Morgan

So as I recall, your acquisition schedule was maybe a little bit more back end loaded in the second half of ’15. So it’s 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?

Christopher Christensen

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, take us a few quarters to get them to 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 second and third quarter before those things are producing what most of our operations produce.

Frank Morgan

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

Christopher Christensen

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

Frank Morgan

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

Christopher Christensen

Oh, that’s a [indiscernible] question.

Frank Morgan

In the second half or any guidance there

Christopher Christensen

[Indiscernible] I understand you need to know that to model effectively. I think that -- I'm sorry. I'm not answering for Suzanne

Suzanne Snapper

It's okay, go for it.

Christopher Christensen

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

Suzanne Snapper

And I would say, it's a gradual process. We are [indiscernible] over time. So we would expect it to build over the years.

Frank Morgan

That's fair, that's actually very helpful and then

Christopher Christensen

[Indiscernible]

Suzanne Snapper

But we only give annual guidance as a remainder.

Frank Morgan

I understood. In the firms of -- we're in a world where people are obviously concerned about leverage and levels and with all the uncertainties in the world out there, but I'm just curious of your thoughts about, maybe you remind everyone, and stay up on your sort of tolerance level for leverage, how much you're willing going to go. And then obviously with the stock heaving pullback in here, how do you think about your buyback? I know you have a program in place, but just maybe give us your philosophy on leverage, tolerance and use of cash.

Christopher Christensen

Yes, I think our tolerance has always been for the right acquisitions we would go into the mid to upper four times, but it would be very brief, and we would have to see a path to get that down into the twos and threes. And remember obviously this is -- most of that is all leasehold that comprises that debt, or 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 two or three times rates or two times ….

Suzanne Snapper

Net debt to EBITDA

Christopher Christensen

Net debt to EBITDA, sorry -- we would do it, and we've done that for very brief periods of time, and we've gone right back down to where we feel more comfortable

Frank Morgan

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

Christopher Christensen

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

Operator

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

Ryan Halsted

Christopher, you said that 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.

Christopher Christensen

Well, I just saw some comments about one operator that was then assigned to the entire industry. There is 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 bundle payment environment. But it is -- it's accelerating. Relationships with managed care organizations, high quality, if you're focusing on the quality of your outcomes, if you are focusing on building relationships with managed care organizations, I don't just mean buddy-buddy relations. I mean, figuring out relationships that make sense for the patient, for the managed care organization and for you, and you are building in a way where everyone is happy. We are 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 setup 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 that they've climbed. If you are managing with the same strategy that you've managed with three or four years ago, then I suppose this environment is harmful. But if you've been preparing for this, and seen 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 within 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.

Ryan Halsted

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 can maybe expand on what are some of the specific initiatives you have in place and are beginning to execute on ahead of that program?

Christopher Christensen

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.

Barry Port

Yes, Ryan, it's a good question. Obviously there is a lot of a talk and conjecture about -- 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 is certainly some unknown about it. There is certainly some -- some feeling our way through it that will occur. But again in the larger context of what we've been doing to prepare for a bundle payment environment, and in establishing the model to relationships under the BPCI demonstration projects, and establishing ACL relationships like we have been over the course of last few years, we've built 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 in the SNF, and we'll be the low cost provider for those patients and we'll have the relationships that we need to, to make sure that we care for them properly and in an efficient way.

Suzanne Snapper

Yes, 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 the high volume of managed care that we've already been taking care, and our population, and there's a demand 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 and that gives us an additional confidence that we know how can deal with a bundled care project that's run by the hospital or their corporate, their convener or a managed care participant who is helping them walk the hospital through the process. And that's a different additional level that we feel we have.

Ryan Halsted

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

Christopher Christensen

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 is a lot of crossovers. So we really don't that break that out.

Ryan Halsted

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

Christopher Christensen

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.

Ryan Halsted

Okay. And 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 to attract this different patient referral, this more I guess downstream patient referral and is this something you're starting to see pick up recently?

Christopher Christensen

It's not recent Ryan. It's something really been happening over the course of the years now. It's probably -- for others or smaller operators is a more recent phenomenon, but it's not really a recent phenomenon for us. We have 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 generalist 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 its just part of the evolution that we feel like we've been a part of for a while.

Barry Port

Yes, I mean the biggest part of that Ryan, just so you know 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.

Christopher Christensen

Yes. Many of our local operations kind of band together, have joint operations with the larger managed care organizations where they discuss metrics, score cards. This has kind of been a practice that's being ongoing for us and been in development within [indiscernible] care organizations for quite some time.

Ryan Halsted

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 there less -- the 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?

Christopher Christensen

Sorry, I misunderstood your question. That’s a good question. That is also something that's kind of an ongoing evolution for the last year. So we see more and more directed mix from the ER for Medicare deeper 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 up-tick in kind of directed net 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 the, what we call sub-acute services or airways and other high intensive kind of room care issues that sometimes have been -- folks have been held in the hospital that we care for on a kind of more rapid basis. So they are shorter term stays in a hospital that we can manage in the SNF. We’ve been seeing that for some time.

Operator

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

Dana Hambly

Chris, you were talking about California and Medicaid earlier? Just curious, you gave some examples of some of the quality measures, that they’re actually measuring in California?

Suzanne Snapper

So they would include things like spas and drugging use.

Christopher Christensen

[indiscernible] drug use, 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.

Dana Hambly

Okay. And going to different attributes, you’ve seen that in any other city at this point or is California really the pioneer?

Christopher Christensen

Yes. I think California is the pioneer, but we’re seeing some other states that are watching it and want to pattern themselves back to California. Again it takes -- 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.

Dana Hambly

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

Christopher Christensen

It’s mandatory.

Dana Hambly

Okay, okay. Very good. And then Suzanne, on the change in ownership or the transfer in ownerships and the drag on the [indiscernible], could you just remind me how long did that typically take for your facility?

Suzanne Snapper

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 9 to 12-month cycle for everything to get done. And that's being fully executed and fully paid on a regular basis for all pairs. And then from there is a little bit more dredged until all the sequential billing gets fully clear of that. So it’s a very long drag.

Dana Hambly

Yes, this is my new phenomenon through periodically.

Suzanne Snapper

Yes. 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 have in 2015.

Dana Hambly

Okay. And then you are talking with real estate owners that are looking to impress you guys for a long-term lease on a building, what are you comfortable enough for initial rent coverages and any escalators [ph]?

Christopher Christensen

That’s a great question. We generally -- we love the points of our -- to our other arrangements we have at other real estate partners. But typically I would say 1.5 is kind of where we're most comparable.

Dana Hambly

Okay. And…

Christopher Christensen

In terms of escalators. We try to tie-up the CPI and attach taps to the escalators so that we have a top on how much the rent can increase.

Dana Hambly

You look with characterize [ph] escalators?

Christopher Christensen

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

Dana Hambly

Capital is 2.5, okay. And last one for me, just on capital deployment this year, what would be a good level of CapEx. And then on acquisitions, last year obviously was a bare year. Would the pipeline support that type of activity again this year?

Suzanne Snapper

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

Dana Hambly

Okay.

Christopher Christensen

I mean, the pipeline certainly is as robust as ever and consistent with last year. I guess, I would say that we probably -- we've sort of been saying it was a buyers' 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 to grow and are going to be as selective as ever and making sure that making sure that where it makes sense, that we're ready to pull then additional operations within our existing portfolio.

Operator

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

Natalie Pesque

I just wanted 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 long is the expected time for newly acquired, like one to two-star rating facilities to become a 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

Christopher Christensen

That's a great question. We're not able to move it from one star to five star in a year, simply because of the way of the equation works. But we would expect, if you were 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 the way in three years

Natalie Pesque

Okay, great and then on can you disclose the percentage of the facilities that you acquired in 2015, what percentage of those were one to two stars?

Christopher Christensen

We don't know that offhand but we can get back to you if you like to have that information. It's public information. So we can certainly compile it and get it back to you.

Natalie Pesque

Great, thanks and then you had talked about -- a little bit about the shift bundling [indiscernible] arrangements and how that could potentially push on home health services or nursing facility services over to home health and I was wondering if you could just talk a little bit more about that and kind of what patients are ideal for skilled nursing facilities over home health and then the overlap of the patients that you're seeing

Christopher Christensen

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 bundle payment initiative in general, these are care bundles or diagnosis that are 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 is 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, addressing that very issue, because patients can get home quicker, and there is more we can do to get them home quicker. But bypassing this 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.

Operator

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

Christopher Christensen

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

Operator

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.

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