Five Star Quality Care's (FVE) CEO Bruce Mackey on Q2 2016 Results - Earnings Call Transcript

| About: Five Star (FVE)

Five Star Quality Care, Inc. (NYSE:FVE)

Q2 2016 Earnings Conference Call

August 04, 2016 10:00 AM ET

Executives

Brad Shepherd - Director of IR

Bruce Mackey - President and CEO

Rick Doyle - Treasurer and CFO

Scott Herzig - COO

Analysts

Jason Plagman - Jefferies

Operator

Good morning and welcome to the Five Star Quality Care second quarter conference call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.

I would now like to turn the conference over to Brad Shepherd, Director of Investor Relations. Please go ahead, sir.

Brad Shepherd

Thank you. Welcome to Five Star Quality Care’s call covering the second quarter 2016 results. The agenda for today's call includes a presentation by Bruce Mackey, President and CEO; Rick Doyle, Treasurer and CFO and Scott Herzig, Chief Operating Officer. Following this presentation, the management team will open the floor to a question-and-answer session. I would like to note that the transcription, recording and retransmission of today's conference call is strictly prohibited without the prior written consent of Five Star.

Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on Five Star’s present beliefs and expectations as of today, Thursday, August 4, 2016. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission or SEC regarding this reporting period.

Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our filings with the SEC. Investors are cautioned not to place undue reliance upon any forward-looking statements.

I will now turn the call over to Bruce.

Bruce Mackey

Great, thanks, Brad and thanks everyone for joining us on our second quarter earnings call. The second quarter was highlighted by the sale and leaseback transaction with Senior Housing Properties Trust or Senior Housing that had two significantly beneficial components. One that allowed us to recognize and utilize a portion of our owned real estate and which strategically positions our balance sheet and another that is a potential for us to realize additional management fees.

Regarding the sale-leaseback, we consider our owned properties to be a very important part of both our operations and our balance sheet. By completing the sale-leaseback transaction, we are able to realize a portion of those owned property values, which are not being recognized in the public markets and use the proceeds to pay off our revolving credit facility balance.

It is important to note that by executing the sale-leaseback, we are able to maintain the operating economics and potential upside of these properties, while strengthening our credit and repositioning our balance sheet in anticipation of the expiration of our revolver. Rick will talk more about the revolver later.

An equally significant change that occurred during this period, yet received little attention is the amendment to the management agreement allowing us to realize additional management fees from participation in the net operating income at all 63 of the managed communities earlier than under the prior structure. Prior to the amendment, the calculation of net operating income that exceeds the threshold and triggers profit sharing was cumulative, dating back to 2011 and was significantly underwater.

The amendment reset the net operating income threshold to 0, starting July 1, 2016, and modified the calculation to an annual and non-cumulative basis. There were two other pieces of the transaction that were a positive to Five Star. First is the formula for calculating base management fees change from 3% of gross revenues to 5% of gross revenues for the 17 communities we begin to manage after May 1, 2015. The second benefit is that Five Star will start to receive a construction management fee on all managed communities. Both of these changes are effective July 1, 2016.

On the operations front, occupancy continues to be a challenge for us and the industry. However, we are able to maintain expense controls over wage and benefits, increase average monthly rates and continue to decrease our exposure to government payers in the second quarter. I will let Scott talk more about the specifics of operations, but I want to emphasize that we remain diligent on pushing forward the programming and innovation that continues to lead to greater resident satisfaction and will lead to an increased level of referrals, which we believe will lead to higher occupancy in the long term.

On the capital and strategic side of the business, as I mentioned in the first quarter, in April, we closed on older 159-unit skilled nursing facility located in Wisconsin that we leased from Senior Housing. This facility was unprofitable and we expect the closure to have a positive financial impact to Five Star going forward. In the second quarter, we had an approximate $500,000 deficit, related to expenses from the facility. We expect to sell this closed facility later this year and incur minimal expenses from it going forward.

As we talked about in the past, our renovation initiative of ours called, Rehab to Home, converts existing skilled nursing beds in our see CCRCs to high-end private rehab suites. We are targeting younger Medicare eligible patients with shorter rehabilitation stays. Our modern units with amenities coupled with our food and concierge-like services makes us a preferred provider in the markets where we have these units.

We have just about completed our most recent Rehab to Home project in South Carolina and we are waiting to receive the license from the state. This will be the first product type in the market and referral sources are very exciting. We have a project well underway in Indiana and have started two other projects in the second quarter of 2016, one in Ohio and one in Arizona.

On the expansion front, I'm happy to report the 18 unit expansion on an assisted living community in Texas we opened in the first quarter is close to being full. In the second quarter, we opened two additional expansions, a 16 unit expansion of an assisted living and memory care community located in Maryland and a 34-unit expansion at a community in Tennessee. Both of these expansions are in fill-up mode now.

We're still exploring larger projects in Delaware and Tennessee and we will continue to evaluate other expansion opportunities at existing communities as we continually look for ways to take advantage of market opportunities and find growth internally. Additionally, we continue to grow through our third-party management business.

In April and May, we entered into an agreement with Senior Housing to manage two senior living communities, totaling 125 living units. Subsequent to quarter end in July, we entered into a management agreement with senior housing for our senior living community located in Alabama, which has 163 living units. All these communities are maturity private pay and are located in areas where we have a strong geographic presence. These communities should generate annual base management fees of approximately $500,000 for us.

I would now like to turn the call over to Scott Herzig, Five Star’s Chief Operating Officer to talk about operations.

Scott Herzig

Thank you, Bruce. Before discussing our occupancy results, I wanted to first highlight some recent recognition we received surrounding our continued commitment to deliver the highest level of care and service to our seniors. Last month, Five Star was recognized and awarded with 16 quality awards from the American Health Care Association, including four Silver awards. The four communities recognized with these awards are Stratford Court of Palm Harbor and the Court at Palm-Aire, both located in Florida, Central City Care Center located in Nebraska and Van Nuys Healthcare Center located in southern California. We are extremely proud of our teams at these communities and the recognition they received as it highlights our focus as a company on driving and improving quality outcomes across our continuum of care.

Now, turning to occupancy. Total occupancy for the second quarter at our owned and leased senior living communities was 84.3%, down from 85.1%, both sequentially and year-over-year. And occupancy at our managed properties was 86.7% in the second quarter. Although occupancy slipped from last quarter, we are encouraged by the robust number of move-ins that we've seen over the last two months and by a percentage of private pay revenues that was 78.5% and continues to increase on a quarterly basis.

Our focus on the management of private pay communities coupled with our strategic disposition programs has enabled us to consistently drive this percentage higher over the years. As we have said in the past, we will continue to target a total of 2% to 3% for private pay rate growth in 2016. And on the Medicare side, the final ruling from TMS came out last week regarding rates and we are pleased to be seeing a much higher rate increase than we've had in years past.

As the NIC data indicated for the second quarter, occupancy overall for the US markets, and particularly in a few states where we operate has continued to decline. And similar to what NIC has published, nearly 50% of our occupancy decline in the second quarter came from four states, Texas, Indiana, Arizona and Florida. Texas and Florida continue to experience ongoing construction in many areas of those states and has impacted our occupancy, much like it has for other senior living providers.

In Indiana, our decline in occupancy relates to five communities where we are in the process of converting units from independent living to assisted living. These conversions relate to more demand for assisted living in those particular markets and involve changing the existing physical plan to meet state assisted living licensing standards and then obtaining the proper licensing to begin accepting those residents. We anticipate this process to be completed before the end of the year.

Clearly, growing occupancy continues to be our number one priority and we are working tirelessly in this regard. We are continuing to see very positive returns from our focus on driving people to our own company website and away from third-party referral companies like a place Vermont. In fact, sales leads from our website are up 57% year-over-year and move-ins from our own website are up 25% from last year and 7% from last quarter. Our best source of new customers continues to be referrals from our own current residents and we saw an improvement of 10% over last quarter in this regard. The continued growth in referrals from our owned residents clearly indicates a high degree of happiness reflected by our continued focus on providing extraordinary levels of resident satisfaction.

Last quarter, I also spoke about our new efforts to be more dynamic with pricing at some of our communities that have been impacted by new inventory in their market areas. Our goal with this program is to be more proactive and nimble with our pricing in order to better compete with changing market demands. At this time, we have nearly 70 of our communities participating in this program, and we are seeing some positive move-in activity at these communities as a result of being able to address pricing concerns.

Our focus here is really about optimizing price in each market and in some areas, we will see prices going up, and in others, there may be a reduction, but that is really just a part of the overall strategy for these particular buildings. And as we continue to highlight what makes Five Star different and better than any of our competition, we have expanded our industry-leading focus on dining services and have begun to grow our use of the micro’s point of sale system in our dining venues.

Much like you will find in most restaurants and bars across the US, we now have the ability to provide restaurant quality choices and menu items ranging from fine dining options to bistro and gastro pub type cuisine. This new approach to dining offers more choices and flexibility for our residents and allows us to add more high-end healthy choices on the menu and to get better visibility into what our residents want and enjoy when it comes to food.

Turning briefly to our rehab and wellness division, we continue to see this division produce positive returns for Five Star. We now provide outpatient services to 71 independent assisted living centers located in 26 states. We have opened nine of these clinics since the start of 2016 and plan to open another five by the end of this year. And before I turn the call over to Rick, I wanted to highlight another one of our many hallmarks at Five Star and what makes us a different and better employer than our competition and that is our approach to looking from within our organization for our next crop of leaders and executive directors.

Oftentimes, our best and brightest already work for us in the community and are just looking for an opportunity to grow into an Executive Director role and run their own community. Well, at Five Star, we give them that opportunity. We have recently implemented the Rising Star program where we groom, develop and train existing and external candidates into Five Star quality EDs. We have been doing this informally since our inception, but have now formalized the program and look to regularly cycle through multiple candidates on a regular basis to improve our bench strength and continually upgrade the quality of our EDs, which we often say are the difference makers at the community level.

I will now turn the call over to Rick Doyle, our Chief financial Officer.

Rick Doyle

Thank you Scott and good morning everyone. For the second quarter 2016, our senior living revenues were $279 million, an increase of $1.1 million compared to the same period in 2015. The increase primarily relates to the $1 million reversal in revenue reserves regarding the compliance assessment at one of our skilled nursing facilities that we settled in June. Overall, our senior living revenues in the second quarter were slightly higher compared to the same period last year due to the increase on private pay rates, partially offset by decline in occupancy. Our management fee revenues were $2.8 million for the second quarter, an increase of 4.3% compared to the same period last year. The increase in management fee revenues are primarily due to an increase in the number of communities we now manage compared to the same period last year as well as an increase on private pay rates partially offset by decline in occupancy. Senior living wages and benefits for the quarter were $136 million, while 48.7% of senior living revenues. This represents a decrease of approximately $500,000 or 30 basis point decrease compared to the same period in 2015 and flat compared to the first quarter of 2016. The decrease year-over-year primarily relate to decreases in workers compensation and health insurance costs partially offset by annual wage increases and our acquisition of two senior living communities during the fourth quarter of 2015. At 48.7% of revenues senior living wages and benefits were in line with our expectations and remain well controlled.

Other senior living expenses for the second quarter were $71.9 million or 25.8% of senior living revenues. This represents an increase of approximately $690,000 or 1% increase compared to the same period in 2015. The increase is primarily due to the transaction costs incurred related to the sale leaseback transaction in June of approximately $750,000 and an increase in professional and liability insurance expense of approximately $1.3 million, partially offset by a reversal of $500,000 of previously estimated penalties regarding a compliance assessment issue previously disclosed as well as a decrease in other expenses such as food, supplies and utilities expense. As evidenced in our second quarter results, and as we discussed in our first quarter's earnings call, we continue to see progress in our supply chain strategy to move from regional purchases for key business services to national purchasing agreement with strategic partnerships such as waste removal, housekeeping, laundry chemicals as well as food and equipment purchases. This strategy allows us to implement system wide brand standards that we enable our supply chain to leverage our scale and reduce costs while maintaining quality.

General and administrative expenses were $17.6 million for the quarter and were 4.7% of total revenues under management. Our G&A as a percentage of total revenues decreased 30 basis points from the second quarter of 2015. We continue to look for operational synergies to reduce our G&A cost. Rent expense for the quarter was $50.1 million or 18% of senior living revenues. An increase of 10 basis points of senior living revenues compared to the same period last year. Interest expense for the second quarter was $1.5 million and depreciation and amortization was $9.9 million. We expect interest expense to decrease in the second half of 2016 due to the payoff of our credit facility from the proceeds of our sale leaseback transaction in June. Our weighted average interest rate for borrowings under our credit facility during the second quarter of 2016 was 3.1% and we incurred interest expense in other associated costs related to our credit facility of $695,000. We reported a loss from continuing operations of $0.16 per share compared to a loss from continuing operations of $0.07 per share for the same period in 2015.

Net loss for the second quarter 2016 included $3.5 million or $0.07 per share of income tax expense primarily relating to the gain on sale leaseback transaction in June for which Five Star’s available federal net operating loss carry forwards were not applicable. Adjusted EBITDA was $5.9 million for the quarter compared to $7.1 million for the same period last year. During the second quarter of 2016, we experienced in our professional and general liability insurance of approximately $1.3 million relating to an increase in insurance claims. These claims are non-recurring but as past experience has dictated, we can't forecast when claim reserves will increase or decrease. We will continue to monitor our insurance programs to proactively prevent future claims. Also as Bruce mentioned, we had approximately 500,000 from one skilled nursing facility in the second quarter that was closed in April that should have minimal expenses going forward. Adjusted EBITDA was $56.1 million for the quarter compared to $56.8 million for the same period last year.

Now I will review our liquidity, cash flows and selective balance sheet items. At June 30, we had $64.3 million of cash and cash equivalents and $10 million outstanding on our $100 million credit facility at $59.5 million of long-term mortgage notes payable. Subsequent to quarter end, on July 1, we repaid that the remaining $10 million outstanding on our credit facility and today the balance remains zero. As Bruce mentioned earlier, our credit facility expires in April 2017 by using the proceeds from the sale leaseback transactions to bring the credit facility balance to zero, we were able to put ourselves in a stronger position to negotiate as we look to replace this facility over the next couple of quarters. In connection with the sale of seven senior living communities in June 2016, the $29.7 million carrying value of these communities were removed from our balance sheet and $82.6 million gain generated from the sales was deferred and will be amortized as a reduction of rent expense over the initial term of the lease or approximately 12.5 years. At quarter end, we had $351 million of net property and equipment which includes 26 communities directly owned by Five Star, six of which are encumbered by mortgage debt. The weighted average annual interest rate on these mortgages is 6.3% with a weighted average term of approximately seven years and no new maturities prior to June 2018. Cash flows provided by operating activities were $1.7 million of the second quarter 2016; we invested $12.7 million into capital into our communities and sold $6 million of long-term capital improvements. Our leverage was 29% of total book capital and 13% of debt to total assets. We believe that we are in compliance with all material terms of our credit facility and mortgage agreements.

With that I will turn the call back to Bruce for closing remarks.

Bruce Mackey

Thanks Rick, as I said earlier, occupancy continues to be a challenge for us and the entire industry as new competition played a role in the senior housing operating business environment right now. While we are seeing in certain markets as local developers and/or operators come into our markets and undermined pricings to stabilize new communities. We believe that this is not a sustainable business model for them. That is why you’ve heard us and you’ll continue to hear us talking about the Five Star difference, we know that the determining factor for Five Star is to be the operative choice is by providing outstanding quality care and the best in class services such as our industry leading dining experience, our life 360 program, our award-winning memory care services as well as tracking the best employees with our Rising Star program. It is attention to detail that result in Five Star achieving the highest resident satisfaction has a upmost reputation in the industry. We will continue to invest in and grow our existing communities, push our innovative programs and maintain a conservative balance sheet because we are confident of this strategy will enable us to take advantage of opportunities and make us successful in the long term.

I will now turn it back over to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Brian Tanquilut of Jefferies. Please go ahead.

Jason Plagman

Hey guys it’s Jason Plagman on for Brian. The first question, thanks for taking the question, first question, so, thoughts on use of the cash on the balance sheet, when I combine cash and short-term securities there is almost $2 value they’re carrying on the balance sheet, so understand the positioning with the revolver, but just overall thoughts on how you redeploy that or what have you?

Bruce Mackey

I think it is safe to say that we’re looking at a multitude of options, we look at capital allocation on a regular basis, right now I think in the short-term probably the best use of capital is to reinvest on our communities to expand our business, get us back to profitability. After that, like I said, we’ll take a look at it again and evaluate all options.

Jason Plagman

Do you see the potential for additional sale leaseback transactions and just how do you think about or how should investors think about the quality of the remaining 26 owned assets in comparison to the seven that were sold?

Bruce Mackey

That's a great question. Anything is possible, I think in the short-term it's probably unlikely given the fact that we do have a solid cap position but again anything is likely. If I look at the remaining communities I’d say they’re very comparable to the communities that were sold, Scott in his prepared remarks talked about our assets in Indiana. Those are our owned assets that are struggling a little bit and we're repositioning those right now converting them from independent living to assisted living. We expect that will be done by the end of the year and then go through the licensing process, so they’re probably a couple of quarters away from getting that to kind of where the ones that were sold, but I’d say take Indiana out of the mix and the vast majority are very comparable to the ones that were sold.

Jason Plagman

As far as the NOLs and what is the remaining NOL balance after the sale leaseback transaction?

Rick Doyle

Hi Brian, this is Rick. At the end of the quarter we had about $52 million of NOL remaining.

Jason Plagman

And then just one last one from me, CapEx, how should we - what’s your expectations for CapEx spend for the remainder of the year?

Bruce Mackey

It should be comparable with prior quarters, I think this quarter we spend around $30 million for the quarter and we expect to spend that in each of the quarters going forward, maybe a little aggressive to get our communities back to the market conditions and make sure we can grow occupancy, but if you look at I think it will be comparable quarter-over-quarter.

Operator

I'm showing no further questions, I would like to turn the conference back over to Bruce Mackey for any closing remarks.

Bruce Mackey

Great, thank you Dan. I’d like to thank everybody for joining our quarterly earnings call. We look forward to updating you on our future progress. Thank you.

Operator

And ladies and gentlemen the conference has now concluded, thank you for attending today's presentation. You may now disconnect.

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