Genesis Healthcare, Inc. (NYSE:GEN)
Q3 2016 Earnings Conference Call
November 04, 2016 8:30 AM ET
Lori Mayer – Vice President, Investor Relations
George Hager – Chief Executive Officer
Tom DiVittorio – Senior Vice President and Chief Financial Officer
Frank Morgan – RBC Capital Markets
Chad Vanacore – Stifel Nicolaus
Chris Rigg – Susquehanna Financial Group
A.J. Rice – UBS
Joanna Gajuk – Bank of America
Dana Hambly – Stephens Inc
Good morning and thank you for joining us today. We filed our earnings press release yesterday afternoon. This announcement is available in the investor relations section of our website at GenesisHCC.com. A replay of this call will also be available on our website for one year.
Before we begin, I would like to quickly review 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 from right on today's call.
Listeners should not place undue reliance on forward-looking statements and are encouraged to review our SEC filings for more complete discussion of factors that could impact our results. Acceptance required by federal securities law, Genesis Healthcare and its affiliates do not undertake to publicly update or revise any forward-looking statements or changes that arise as a result from new information, future events, changing circumstances or for any other reason.
In addition, any operation we 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 Genesis Healthcare has direct operating assets, employees or revenue and that any of the various operations are operated by the same entity.
Our discussion today and the information in our earnings release and in our public filings include references to EBITDAR, adjusted EBITDAR and EBITDA, adjusted EBITDA, which are non-GAAP financial measures. We believe the presentation of non-GAAP financial measures provides useful information to investors regarding our results because these financial measures are useful for trending, analyzing and benchmarking the performance and value of our business. But such non-GAAP financial measures should not be relied upon at the exclusion of GAAP financial measures.
Please refer to the company's reasons for non-GAAP financial disclosures and its GAAP to non-GAAP reconciliations contained in today's earnings release. And with that, I'll turn the call over to George Hager, CEO of Genesis Healthcare.
Thank you, Lori. Good morning and thanks for joining us. The third quarter was again another very busy quarter for us at Genesis and we have a lot of exciting developments to discuss. Let me start by focusing on our highly accretive lease transactions, our planned exit of eight mid-western states and progress on our value based purchasing initiative. Then I will turn the call over to Tom DiVittorio for more details on our earnings and balance sheet.
Genesis has been extremely busy this quarter, executing on our strategy to restructure and reposition our business to succeed in the new world of value based purchases. As our healthcare industry continues to evolve, from volume-based fee for service to value-based reimbursement, we have been sharpening our operational and clinical focus to establish best in class -- a best in class track record. And be the partner of choice for healthcare providers and payers. While positioning our portfolio to invest in those markets, that ultimately will produce the best return for Genesis and its shareholders.
Over this past year, we have integrated acquisitions, brought down our cost base, divested noncore assets and improved our balance sheet to create a strong foundation for profitable growth in 2017 and beyond. That work continued this quarter, working very closely with our REIT partners to improve our overall capital structure.
Earlier this week, we announced our intention to enter into new leases for 92 skilled nursing facilities, historically leased from Welltower. The new leases will reduce our prior lease obligation by $440 million through the end of the initial lease term January 2032. These new leases will also lower our fiscal year 2017 rent payment and fixed charges by $10.5 million and $8.1 million respectively.
These new leases will also significantly reduce the burden of rent escalators. Resulting in a better alignment with our organic growth rates. It should be noted that these new leases will be increasingly accretive in the long term. Genesis will continue to operate all 92 facilities pursuant to its new leases and there will be no change in the operations of these facilities. These new leases are clearly a huge win for Genesis. Tom will actually provide more color on these -- on the lease details in a few minutes.
Second, we are continuing -- we are continually reviewing our portfolio in order to identify markets with a strong strategic fit for our organization. Those include markets with high Genesis geographic density, strong hospital partnerships and opportunities to enhance productivity. Today we announced our intention to exit eight mid-western states as part of the strategy to divest facilities in challenging markets where we do not have strong density and where we have not been able to take advantage of our scale.
In order for Genesis to continue to have the capacity to invest and grow, we have made the decision to free up resources for business development in other strategic markets. Our exit from our inpatient business in eight mid-western states is expected to occur in two phases. Phase one includes the divestiture of 18 facilities, 16 owned and two leased in the states of Kansas, Missouri, Nebraska and Iowa. States with challenging operating and labor markets. We have identified a buyer that signed an agreement of sale for these facilities. We are working with the buyer to obtain the regulatory approvals necessary to complete the divestiture, which we expect will occur sometime in the first quarter of 2017.
Phase two of the Midwest divestitures is still in the very early stages. We are still looking to identify a buyer or buyers for 43 inpatient facilities in four states, Kentucky, Indiana, Ohio and Montana. While these markets reflect some of the same industry challenges presented in the phase one market, our decision has also been influenced by the intention of some of our healthcare REIT landlords, to sell portions of their skilled nursing facility real estate portfolio. Including some real estate assets that are currently leased and operated by Genesis Healthcare.
Completion of these transactions will result in the exit from our inpatient business in these four states. It's important to note that neither Genesis Rehab Services nor Genesis Respiratory Services will be exiting any of these states. Currently, Genesis Rehab Services provides rehab therapy to nearly 150 non-Genesis sites in these eight states.
There will be no change in services at these locations at this time. It is, in fact, possible that Genesis Rehab Services and/or Genesis Respiratory Services will continue on as the rehab or respiratory therapy provider after they are sold. But that will be the decision of the new operators.
We are working to ensure a seamless transition in these markets. I and the entire executive management team at Genesis would like to take this opportunity to thank all of the caregivers and leaders in our mid-western states for their commitment to the thousands of seniors they care for every day. And their dedication to Genesis over the last several years.
Finally, we are making meaningful headway in the migration to the value-based world that rewards those organizations that provide better care and better outcomes at a lower cost. We are establishing a best in class track record with hospitals and payers by getting ahead of the curve on these metrics. And I'm excited about our opportunities for gaining market share and generating financial upside for our shareholders as our strategy yields positive results. We expect the promising results of these initiatives will begin to flow through the bottom line next year.
Genesis model three Bundled Payment Care Initiative or BPCI program continues to perform to expectation, generating positive results. In mid-October, Genesis received a reconciliation for the first quarter of 2016. It's important to note that the retrospective settlements under BPCI are approximately two quarters in arrears. This settlement resulting in a $1.8 million positive settlement. as well as an additional $300,000 positive settlement for prior quarters. Thus far, Genesis has received a total of $3.8 million in positive settlement since the beginning of the program.
Furthermore, given our experience and lessons learned under the BPCI program, we remain enthusiastic about our ability to generate savings in the Medicare shared savings program. That our Genesis positioned services subsidiary entered into, effective the beginning of this year. Reconciliations for this program happen on an annual basis retrospectively and are not expected until mid-2017. Currently, Genesis is the only post-acute care provider authorized to participate in this program.
In conclusion, I'm encouraged by our success in repositioning the company for success in a value based world. We believe our increased market focus on areas where we have the greatest geographic density and we can be the provider of choice for acute care hospital systems will create long-term success and value for our Genesis, our hospital partners, our patients, our employees and our shareholders. With that, I'd like to turn the call over to Tom DiVittorio. Tom?
Thanks, George. Good morning, everyone. My comments today will start with a recap of third quarter operating trends, then move to recent financing activities and conclude with guidance.
Starting with census trends. Our overall occupancy and skilled mix remain at levels consistent with our expectations. Operating occupancy in 3Q 2016 of 85.5% declined 50 basis points from the prior year quarter. The lowest quarter over prior year quarter occupancy drop this year.
Equally important to note, 3Q 2016 occupancy dropped only 10 basis points from the sequential quarter despite the historically soft seasonal nature of the September quarter. Our current quarter over prior year quarter skilled patient days decline, also narrowed for the second consecutive reporting period. The percentage of same store average daily skilled patients declined 8.6% in 3Q 2016 versus 3Q 2015. This compares to a 9.5% decline in 2Q 2016 versus 2Q 2015, and a 12% decline in 1Q 2016 versus 1Q 2015.
We have not experienced any new developments or trends with respect to the diversion of skilled patients away from our setting since the first quarter of this year. Nor are we aware of any new CMS mandated programs or new initiatives by upstream hospital partners expected to have a material impact on our skilled census or overall occupancy. Three Q 2016 average length of stay among short-stay skilled patients ran 4% below 3Q 2015, an approximate one-day reduction. This rate of decline also moderated slightly from the last two quarters.
Much of the year over year decline is driven by our own initiatives to reduce skilled patient length of stay where clinically appropriate. As a result of our participation in accountable care and bundled payment programs, we are in a unique position to recapture in future periods some of the current year lost revenue caused by our success managing down episodic costs. We also believe our success in managing down costs and reducing avoidable hospital readmissions will increasingly yield opportunities to gain market share of short-stay skilled patients as acute care hospitals increasingly narrow their discharge panels to fewer post-acute providers.
Now moving to earnings. Adjusted EBITDAR was $172.1 million in 3Q 2016, compared to adjusted EBITDAR of $188.8 million reported in 3Q 2015. It's important to note that about 20% of our current quarter over prior year quarter same-store inpatient EBITDAR decline is attributed to the operations in the eight mid-western states we plan to exit. But these operations only represent about 9% of our patient revenue.
Adjusted EBITDA of $47.8 million in 3Q 2016 met first call consensus estimate and compares to $67.2 million in the prior year quarter. As anticipated, 3Q 2016 includes approximately $5 million of higher same-store professional liability and bad debt expense, which was discussed on our fourth quarter 2015 conference call and reflected in our 2016 guidance. The remaining decline in operating earnings is principally attributed to the year over year reduction in our inpatient skilled census and the impact of all-in labor cost growth, exceeding the rate of reimbursement rate growth.
These headwinds have been partially offset by our initiatives to reduce overhead, aggressively manage controllable costs and the net favorable impact of acquisition growth in excessive divestitures. On the topic of all-in labor costs, in 3Q 2016, wage inflation for non-overtime hours worked by our employed nursing staff grew at a manageable 1.5% over 3Q 2015. We have, however, experienced growth in our use of overtime hours and agency staff, to supplement staffing constraints in certain markets. Including overtime hours and agency costs, our all-in nursing wage costs worked per hour grew 2.4% in 3Q 2016 over 3Q 2015. Still a manageable level of inflation, but lagging the approximate 1.5% weighted average reimbursement rate growth we received from our payers over the same period.
It is typical in our business for reimbursement rate growth to lag behind wage inflation or deflation because both Medicare and Medicaid rates are still greatly influenced by historical costs. As a result, we expect that government reimbursement rates in future periods will better reflect recent growth in the costs of labor. The net Medicare market basket increase of 2.4% effective October 1, 2016, is a much better reflection of more recent experience with inflation and costs and will aid in narrowing this gap in 4Q 2016.
To briefly recap 3Q operating performance and trends. First, our operating and skilled mix -- our operating occupancy and skilled mix continued to show stability, with no new indications or trend involving patient diversion away from our setting. Second, we continue to make excellent progress managing down length of stay and avoidable hospital readmissions. Which have near term negative implications to financial performance but position us to realize incremental gain in 2017 from our value based programs. Lower length of stay and reduced hospital readmissions today will increasingly make our facilities more competitive in their markets, as low-cost quality outcome post-acute providers become more attractive to at-risk up stream providers and payers.
Third, the rising cost of labor is manageable, but in the near term is outpacing reimbursement rate growth particularly so in certain markets. We expect reimbursement rate growth over time will catch up with inflation in our costs. And finally, our focus on reducing overhead, adjusting our cost structure to the currently operating environment and optimizing the performance of our portfolio continues to be a top priority across all of our business lines.
Now turning to recent financing activities and I'll start with cash basis rent. Recurring cash rent in 3Q 2016 grew only $2.8 million over the prior year quarter. This is the lowest rate of current over prior year quarter rent growth in two years and is reflective of our recent divestitures of underperforming leased assets and our recent purchase of five previously leased assets using lower cost mortgage financing. The new lease transactions announced this week will have an even greater impact on year over year rent expense as we look forward to 2017 and beyond.
As George mentioned on Wednesday, we announced that Genesis entered into a new lease with Second Spring Healthcare Investments for 64 skilled nursing facilities previously leased from Welltower. The facilities were historically subject to a 3.4% annual escalator, which was scheduled to decrease to 2.9% effective April 1, 2017.
Under the new lease with Second Spring, initial annual rent is reduced approximately 5% to $103.9 million. And annual escalators will decrease to 1% after year one, 1.5% after year two and 2% thereafter. As part of the transaction, Genesis issued a $51.2 million note to Welltower, maturing in October 2020. And those accrued interest at an all-in rate of 10%, with 3% paid in cash and 7% paid in kind at maturity.
In the second transaction announced on Wednesday, Genesis expects to enter into a new lease in the fourth quarter with a joint venture among Welltower, Cindat Capital Management and Union Life Insurance for 28 facilities currently leased from Welltower. These facilities have also been subject to a 3.4% annual escalator scheduled to decrease to 2.9% effective April 1, 2017.
Under the new lease, the initial annual rent is expected to be reduced approximately 5% to $52.7 million and the annual escalators are expected to decrease to 2%. As part of the transaction, Genesis expects to issue five-year notes, totaling $23.7 million to Welltower, a portion of which is expected to be convertible into common stock at approximately $4 per share. The all-in rate for this loan is also at 10%, with the convertible loans all-in rate at 6%.
These transactions are a huge leap forward in our quest to reduce the near and long term burden of lease escalators. In the near term, year one rent including impact of escalators on the 92 buildings subject to new leases will be $10.5 million lower than the rent we would have incurred under the former lease. The cash paid interest cost of the loans extended by Welltower will offset this rent savings by just $2.4 million. So year one cash paid fixed charges are reduced $8.1 million, improving pro forma fixed charge coverage by 0.02 times. The new lease transactions are also slightly deleveraging on both the funded leverage and in adjusted leverage basis.
To put our lease escalators in greater perspective, Genesis's weighted average rent escalator in 2016 is approximately 3%, which exceeds the current organic growth rate in the business. On a pro forma basis for the recently announced lease transactions and our already scheduled 50 basis points escalator reduction for the remaining Welltower leased assets, our weighted average rent escalator in 2017 is expected to be approximately 1.8%. A meaningful improvement.
In the long term, the accumulated rent savings to Genesis through the January 2032 initial term of the Welltower master lease is $440 million. Offset for the debt service and repayment of the two loans extended by Welltower, the net cash flow savings to the company through January 2032 is approximately $327 million. Assuming no conversion of the convertible component of the loan. A highly accretive outcome for Genesis.
We are very excited about our new relationships with Silver Spring and Cindat. And are appreciative of our partners at Welltower for working hard to find creative win-win strategies that serve the interests of our respective stake holders.
Now, with respect to HUD. We continue to make great progress on the bridge loan refinancing initiative. Year to date, we've closed HUD guaranteed loans totaling $143.1 million. The average fixed interest rate on the completed HUD loans is about 4% with maturities ranging from 30 years to 35 years.
We expect to refinance the remaining real estate bridge loans with lower cost, longer term HUD guaranteed mortgages or other more permanent financing through mid-2017. The HUD refinancing process is taking longer than originally anticipated for a couple of reasons. First and foremost, management has been intensely focused over the past four months with other more immediate opportunities to improve our capital structure.
You will recall at the end of July we refinanced our second lien term loan. We reset financial covenants with all significant credit parties. And we restructured our master lease with Sabra, resulting in significant rent reduction set for 2020 and 2021. And in the last 60 days, our focus turn to the highly accretive lease transactions with Silver Spring and Cindat and our planned exit of the mid-western states.
And second, certain of the real estate bridge loan assets are contemplated for sale in connection with our divestiture strategy. So we put them on hold with respect to the HUD refinancing process. So we expect the majority of the remaining HUD or other bridge loan refinancings to occur now into mid-2017.
So to recap our recent refinancing activities. In the last four months, we have improved the complexion of our debt holders. We resolved near and long term covenant and refinancing risks. We've restructured master leases, resulting in significant near and long term value creation for our stake holders. And we continue to work diligently to reduce our overall cost of debt capital through the HUD program.
And finally, with respect to earnings guidance. The company is reaffirming it's previously published revenue, adjusted EBITDAR and adjusted EBITDA guidance range for fiscal 2016. With that, could you please open the lines for question?
[Operator Instructions] Your first question is from the line of Frank Morgan with RBC Capital Markets.
Good morning. Tom, you comment on a decline on the -- or a deceleration and the decline in occupancy. And I'm curious, could you may be give us a little more color about is that a regional thing or is that in markets where there's less either shared savings or BPI activity?
Well, Frank, I would say, from market to market there are differences in occupancy and skilled mix trends. I would tell you that where we see the greatest drag on both of those measures quite frankly is in some of the markets that we've chosen to divest of. And we're seeing some strength in our core markets on the coast. And now, with respect to BPCI, the most of our BPCI centers -- all of our BPCI centers are in those very core markets around large hospital systems where we're seeing stability, if not some improvement.
And then, speaking of the divestitures, on that second tranche, could you talk about timing? Is it fair to say that you actually can complete that over the course of 2017? Or do you think that takes longer?
You know, Frank, no, it will not take longer than that. We are hopeful that we will be substantially completed by mid-2017. The process is under way and we are soliciting interest as we speak. Obviously, four states and our guess is there will be multiple buyers here, so a little more complicated than the phase one, Kansas, Missouri, Iowa and Nebraska transaction. But I would say we would hope to be substantially completed by mid-2017.
And just from an accounting -- from an accounting perspective, how will you be treating these as you roll into 2017? And then my last question would be how are you thinking about your ability to reduce overhead as you shrink the company and kind of what pace would that take and any thoughts around what that might save? Thank you and I'll hop off.
Right. I'll take the accounting question. We're still reviewing that with our accountants. But it's our strong view that we will treat the mid-western assets and operations as discontinued businesses.
Yes. And Frank, we feel highly confident that when these assets were underwritten with approximately 4% of revenue overhead load on them, we feel highly confident that we'll be able to reduce overhead. These are facilities and markets that have been more complex for us to manage.
They're, obviously, all new markets post sun and skilled for us. There are markets there we don't have the same level of density as we do in many of our core markets on the East and West Coast. So we feel very, very good about the ability to reduce the cost structure.
I will say that even though we have chosen to get out of these markets, Genesis continues to look opportunistically at selected acquisitions in our core markets. We still feel that market based density is critically important to strategy and to the extent we can identify accretive assets in those core markets. We will continue to very selectively look to build our market presence in those principally coastal markets.
Okay. Thank you.
Your next question is from the line of Chad Vanacore with Stifel.
Hi, good morning, team.
Good morning, Chad.
So given your estimate and restructuring that you've announced today, where do you expect fixed charge coverage to be at year end?
Chad, I expect it to be still somewhere around a one to two.
All right. Thanks, Tom. And then in terms of restructuring, you've done a lot of work in a relatively short period but I get there's more to come. So more or less what inning are we in and what do you think could come down the pipes later on?
Yes, I'd say we're still in -- the baseball analogy, I would say probably say third or fourth inning. And there's some very interesting opportunities for us, not the least of which is an option we have received from Welltower to acquire approximately $500 million of our real estate. Obviously, there are challenges there from a capital perspective.
But as we look at the markets and I think one of the encouraging things about the Welltower transaction is there clearly is smart money that has chosen to invest in skilled nursing when you think about the Lindsay Goldberg and Cindat transaction. So we think there are sources of capital that would have an interest in supporting our ability to very accretively from a free cash flow perspective acquire some of our real estate back. So I think that's a major transaction that we will look to pursue.
The value based initiatives, we didn't talk a lot about them in detail but fiscal 2017 is a big year for us. We've talked publicly that if you think about Bundle Payment and we recognize just shy of $4 million of gain share to date, our quarterly settlements have continued to improve with over $2 million per quarter -- or in the third quarter. And that gain share which would annualize in about $8 million is a gain share on roughly $110 million of Medicare spend underlying those 32 BPCI facilities in the program.
Well, the much bigger opportunity for us is the Medicare shared savings program where we are gain sharing one directional. No risk. Gain sharing normally on about $800 million of Medicare spend. I'm not saying it's prudent to extrapolate that by any stretch, but it's a much bigger opportunity for us. So we continue to work diligently in moving our organization and operating in a value-based world.
So a lot more to come in that arena. And we think the Medicare share savings program is leverageable, both internally as well as externally as we take our platform can create significant opportunity for non-Genesis skilled nursing operators as well. So a lot more to come there and we continue to look at some very innovative acute care relationships.
We announced recently a very interesting transaction with one of the dominant acute care systems in one of our major markets southwest, the University of New Mexico Health System. And that is a multifaceted strategic relationship, really focused on driving down episodic costs and providing the hospital great opportunity for increased throughput. They see constraint in bet availability in their system.
So those are anecdotal examples of the thing that we're trying to accomplish. But overtime, those innovative relationships will expand and will become an increasingly important part of the growth strategy for the company.
All right. Thanks, George. So one more for me. What do you think a reasonable average density do you need to be fishing in the market?
Well, that's one because I think they obviously range in how dense the market is. And you could really take a market like Philadelphia and really subdivided by the five counties. It gets that granular.
I think in the range of 10% to 20% market share in the beds, as long as you have the right clinical capabilities from a programming perspective, you need to be multidimensional, you need to have cardiac, orthopedic, pulmonary. And typically, most of our core markets we've diversified into ventilator and dialysis services and joint venture with Faciniad.
So it's not only density, it's the dimension of your clinical programming and the breadth of your clinical programing that's important. But I think in the range of 10% to 20% gives us a meaningful foothold and understanding that this market is still meaningfully fragmented. So typically, a 10% to 20% we are competing for the most part against mom-and-pops in most of our core markets.
All right. That's good color, George. Thanks so much.
Your next question is from the line of Chris Rigg with Susquehanna Financial Group.
Good morning. There are a lot of numbers thrown around earlier in the prepared remarks, just want to make sure I didn't miss anything or at least better understand the second phase of the divestitures. So when we think about $50.4 million of EBITDA, did you disclose or can you disclose the rent level with those facilities? And then more importantly, when we think you're effectively marketing about $50 million of EBITDAR, how does that get split between you and the landlord? Just any color there would be helpful. Thanks.
Chris, a couple things to keep in mind with that $50 million. First, that is really -- although described as EBITDAR, it's really EBITDA RM. So what we haven't yet reflected in both the $50 million or the $4.5 million associated with phase one is any overhead infrastructure that's associated with supporting those operations today.
So, obviously, as we go through that process, there's going to be some incremental effect for the fact that there's overhead costs that will be reduced as a result of no longer supporting those markets. Just haven't provided that level of guidance yet. And then with respect to -- you, of course, because you're trying to come up with sort of an underwritten value for those assets.
It's not unusual to use a 4% or 5% management fee. And we provided you the revenue base of those operations. So I think that may be helpful to you in your modeling.
And then with respect to the rent, we're dealing with not just one but probably four or five different landlords here and each one is a different negotiation. But typically in these transactions, we're able to yield a lease credit based upon the sales price, if it's a sale, of those assets. To the extent they find another operator who leases those buildings, the rent that they then charge to that new tenant becomes our rent credit.
So at this stage, it's a little difficult and we couldn't provide that level of guidance because we're still in the process of negotiating and marketing the assets. But there will be -- there's an overhead reduction to take into account and then there's the lease credit to take in account, really based upon valuation.
A - George Hager]
And also some of these assets relate to our lease structure with Sabra. And we previously announced some restructuring of the Sabra leases. Part of that restructuring related to this portfolio as well.
But once we have a better feel for actual value and the indications of value the portfolio and detailed plan for overhead cost reductions, we will obviously provide that guidance to the street. But we expect these transactions to be leveraging, as well as accretive.
Okay. And then just changing gears completely here. Another post-acute operator, so a different business, but was making mention about seeing a nice uptick in Medicare advantage admissions or patient days and some of the dynamics around that.
Have you guys any material change? I mean, obviously MA is still good growing pretty rapidly. 2016, a little bit slower than the last couple years, but nevertheless still growing. Anything notable there to point out? And can you give us a sense for -- on a patient day basis how MA reimbursement compares to fee for service? Thanks a lot.
Well, as far as volume, Chris, you can see in our KPIs that it's -- of the two elements of skilled sense it's the one that's growing a little bit from the prior year quarter. So 7.2% in the third quarter of last year are Medicare advantage and insurance patient population that 7.3% this year. So we are seeing some growth there despite overall utilization down among -- certainly among our Medicare indemnity patients.
You know, we typically see somewhere in the range of a 10% discount, Medicare fee for service versus Medicare advantage. I think what you may see among other operators out there is a wider gap there. And certainly as we've done diligence on other companies, the disparity between Medicare indemnity rates and what they've negotiated with national contracts which is not as favorable as what we've been able to accomplish.
Perfect. Thanks a lot.
[Operator Instructions] Your next question is from the line of A.J. Rice with UBS.
Thanks. Hi, everybody. Maybe just a couple different questions. On the BPCI benefit, I know you have $1.8 million in Q1 and the prior quarters was $1.3. How should that -- how should we think about that going forward? Will you have additional benefits that will catch up for Q2 through Q4? And this will be somewhat ongoing or how would that work?
Yes. A.J., let's make sure everyone understands. I think it's important to understand. But every quarter we received a settlement for the succeeding quarter. So in the fourth quarter of 2016, we will receive our first settlement for the second quarter of 2016. So we we'll continue to be in arrears, so we will continue to have incurred all the costs in this year but not have recognized the gain.
So the September and December 2016 quarters in 2016, they will not be recognized until 2017. But when you look at the settlement process -- so in the December quarter, not only will we get our first settlement on the second quarter of 2016, we will get our second settlement on the first quarter of 2016. We will get our third settlement on the fourth quarter of 2015. And our fourth and final settlement on the third quarter of 2015.
So every quarter has actually four settlements. What we have found, generally speaking, is those successive settlements have been positive. So you don't really get all of the gains set because even in first settlement.
Now, that varies a little bit. The majority of the settlement happens in your first settlement period. But I think the two important points to note are we've incurred all the costs and we're six months in arrears. Our trend has been very positive and we expect that trend to continue as we learn to operate in a value based environment. And that we will continue to see settlements through 2017 in BPCI and other value based initiatives.
And all we said talk about Medicare shared savings. That is -- an unlike Bundled Payment, BPCI, was just a quarterly settlement, Medicare shared savings is an annual retrospective settlement which we won't expect until mid-2017. And obviously, that is a much, much bigger program. Almost eight times the Medicare spend.
Okay. That's helpful. And then maybe just switching over to the restructured leases. The debt that you're issuing to Welltower, I guess, primarily to the venture, it has some non-cash provisions. Is that set today? How much is going to be non-cash? Or do you have the ability to toggle some of that if you choose? How does that work?
A.J., those provisions are set. So it's -- the 10% all-in rate of which 7% in non-cash, 3% is cash back.
Okay. And then there's no change, it's your discretion or the other. Discretion that's just set for the life of --
Right. And the second note, A.J., is still going to be finalized on the Cindat transaction. A portion of that potentially could be convertible.
At $4 a share, initial conversion price. And we do -- if a piece of that note ends up being converter what was the 3% cash, 3% pick and a $4 conversion price.
Okay. I mean, there's a lot of movie parts here and I know the one transaction's not even done. But if you put that aside, I guess, and you look at the run rate of earnings that you're forecasting for this year. Is there any way to pro forma out where you're at in terms of cash flow and free cash flow run rate pro forma for all these adjustments?
Well, A.J., we've been running at a free cash flow number of around $50 million. So the pre-tax and we're not a taxpayer at this point, the pre-tax accretive nature of the two lease transactions is about $8 million positive to the company.
Okay. All right. And then the last question I had was on the $500 million of option on the real estate. Obviously, I guess, the most attractive option would be to use HUD financing to do that. And this may be obvious to some but I don't know this. Can you use HUD financing to do the purchase? Or do you have to somehow get those assets and then go back to HUD for refinancing?
Typically, what you would do is we would bridge finance. Those purchases, they'd be relatively short-term bridges. These are good, stable property of Genesis. And then we would refinance the bridge debt to HUD. Typically don't use HUD for acquisition financing.
Because it got to what we did, Tom referenced the five assets in the diamond portfolio that we originally acquired the real estate and we did exactly that. We entered into a bridge financing Tom rate in the range of below 5%, bridging into ultimately is a long-term HUD financing.
Okay. All right. That's great. Thanks a lot.
And your next question is from the line of Joanna Gajuk with Bank of America.
Good morning. Thanks for taking the question. Just on the discussion around BPCI payment and sort of RP and I guess you might add some comments that you expect there should be some opportunities for gaining market share based on the positive, I guess, experience that you have in those markets. But is there already any indication that Genesis is, in fact, gaining market share in the nursing home business, I guess? Or at least in those markets where which you are participating in those bundling programs?
I think Joanna, it's anecdotal. But I mean, I reference the University of New Mexico Health System relationship. There are numerous other conversation and arrangements being discussed. In two weeks, a week after next, we will be delivering our first gain share check to one of our hospital partners.
So when we look at BPCI and we talk about those gains, those are net of some gain -- some of that gain that we've shared with our acute care partners. So, I mean, these have very collaborate relationships and, obviously, hospitals looking at discharging downstream, knowing that they're in a network-type program around bundled payment clearly gives us advantage. I would say the -- so there is evidence. It's not evidence that is of the scale that really moves the needle on the company of this scale at this point in time.
Okay. Because what I'm getting at is also in terms of thinking about the margins for that business. I know Q3 is seasonal week of the 12.1 maybe is not a good EBITDAR margin to think about. But even year to date, 12.5% margin. So, where do you see margins in this business in the mid to longer term?
Because also, I guess, the skilled mix continues to be down. Obviously, the decline improved, but so it reached the lowest level we have seen they'll 20% skilled mix. So is there some sort of frame in terms of how you're thinking about Medicare margins for that business?
You know, Joanna, I think it's tough to try of translate the BPCI and the MSSP programs in terms of margin. I mean, you're looking at our third quarter, which is historically seasonally a light quarter. So I think you're -- and very high in terms of non-productive time with vacations and holidays and things like that. So not unusual to see a little bit of margin compression in the third quarter.
But, look, I mean, to give a little bit of perspective on what George has said about the MSSP program, putting BPCI aside for a moment. I mean, if we're successful even at the lowest level achieving our gain share target in that program, we would be sharing a $24 million savings in 2017 with the Medicare programs. So we would yield $12 million. That's sort of the minimum target that we have in that program. And if you take just that --
And you would add to that -- I mean, the increasing trends on BPCI. But if you want to put a number, I'll put a $15 million number improvement in margin, is kind of where we would expect.
I think that's fair. So if you took that over our LTM EBITDAR, you're looking at a 2% margin enhancement in 2017 alone from those two programs.
And, Joanna, I would also say too the margins vary by market. And we are exiting the markets that I think has been most difficult for us because we do not have the density and the presence in those markets, nor do we have the acute care relationships. So, there was logic to our strategic thinking from a market perspective.
So we expect, as Tom said, I think third quarter is seasonally the lowest quarter from a marketing perspective. We are clearly not recognizing -- we are incurring the cost but not recognizing the gains on the value based program. And we do believe that our market based decisions will improve margins.
Great. Thanks for the color.
Your next question from the line of Dana Hambly with Stephens.
Hey, thanks. Good morning. I wonder if you could spend a couple minutes talking about the decline in the average length of stay. Where does that kind of level out? Where do you see it on the fee for service side versus Medicare advantage and is it more dramatic in the BPCI markets than other markets?
Well, without pulling up the data, Dana, I will say there's no question that the length of stay decline is greater in the BPCI markets. There is obviously a very strong incentive there. And so, yes. So the simple answer -- I don't -- I couldn't give you the data point, but there's no question there's lower length of stay, about four days in the BPCI centers. But Tom will address the overall length of stay issue.
Sure. So the length of stay dropped 3Q to 3Q among our Medicare indemnity patients, I mentioned was around 4%. In our 32 BPCI centers, length of stay dropped 14%.
Okay. That's helpful. Remind me, the shared savings, the measurement period is an annual, is that -- is it calendar year or fiscal year?
I'm not -- for us it's calendar year.
We went into the program 1/1/16, so our first settlement will be based on 1/1/16 to 12/31/16.
Okay. So do you have -- I mean, have you been able to kind of internally track your progress? Or is this you just sort of have to wait on the government here?
We get a tremendous -- I mean, one of the reel advantages of being in both BPCI and Medicare shared savings is the access to data. So, we get the data files from the government every month. So we're tracking our performance every month with the government data. So this is not -- we're not flying by the seat of our pants.
We have a lot of data. Now, obviously, it's actuarial data. You know, it's utilization data that has lags in it. So, it really is hard to reach any definitive conclusion. But we have tremendous amount of information that we track very carefully.
Okay. Is it fair to say your confidence level in kind of hitting the minimum savings is pretty high?
Well, I wish I had more experience, Dana, but I mean we're encouraged by what we see today.
Okay. All right. But there's no risk to you, anyway, so there's no --
No doubts on whatsoever.
Right. Okay. Last for me, Tom, I missed the prepared remarks. I think you said in the eight states something about a decline of 20% in the EBITDA. Could you repeat what you had said there?
Yes. The point we were making was that on a year over year basis when we look at those properties that are subject to divestiture, they've contributed 20% of our year over year earnings decline, but they represent only 9% of our revenue.
Okay. That was on a EBITDA basis?
It was on a EBITDAR basis
EBITDAR. Okay. Thanks very much.
There are no further questions at this time. I would now like to turn the call back over to the presenters.
Well, thank you everyone. Obviously, Tom, myself and Lori and team will be here if there are any additional questions. But we appreciate your interest and support of the company. Thank you.
This does conclude today's conference call. You may now disconnect
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