Brookdale Senior Living Inc. (NYSE:BKD)
Deutsche Bank AG Health Care Conference Call
May 09, 2012 09:20 am ET
Mark Ohlendorf - Co-President & CFO
Ross Roadman - SVP, IR
Darren Lehrich - Deutsche Bank
Okay good morning everybody. I am Darren Lehrich and I lead DB's healthcare providers' team and happy to introduce Brookdale Senior Living. We are the leading provider of senior living services and have a very innovative ancillary service program offering to the residents as well. Presenting from the company is the Co-President and Chief Financial Officer, Mark Ohlendorf. Also Ross Roadman is on the stage here with us and as you know the Q&A session will follow the short presentation. So I welcome you all to have your questions ready. And those that are on the webcast feel free to use the Yorn application and I can facilitate your questions on the iPad up here. So with that let me turn it over to Mark. Thank you.
Thanks Darren and thanks to Deutsche Bank for having us at the conference this year. I always enjoy coming to Boston. Ross and I will spend just a few minutes here running through our investor presentation. The highlights we will walk you through, Brookdale as you know is a leading industry player and we are in an industry with very favorable supply and demand dynamics. Occupancy is trending up, we just reported our first quarter, we will give you a little summary of our results from the first quarter.
Again as Darren said we have a very unique ancillary service platform which in this climate of healthcare reform and rationalization we think bodes well for our future and our positioning in the market. We have good balance sheet, no near-term debt maturities and significant liquidity, very actionable growth opportunities ahead of us including acquisitions, repositionings and expansions and a very experienced management team.
We reported our first quarter of 2012 last week. Our primary reporting metric is cash flow per share or CFFO. We reported CFFO of $58.5 million or $0.48 a share. Our occupancy year over year was up 60 basis points and same community revenue per unit was up 1.6%. The numbers in the first quarter were impacted by changes in Medicare rates that have occurred October 1st of last year and January 1st of this year. So the first quarter of last year as reported was $0.51. If you adjust for these changes in the Medicare rates, it would have been $0.44. So just over a 10% growth year over year after adjusting for those changes in Medicare rates.
We have been pretty aggressive since we went public in 2005 on the acquisition side. The most recent acquisition we closed was towards the end of 2011 when we acquired the ninth largest of operator of senior housing in the US Horizon Bay. At that point Horizon Bay operated 91 communities with just over 16,000 units. we integrated that acquisition very quickly, actually did the lion share of the backbone system cutovers within a 60-day period. And we are now in the process of rolling out our ancillary services to those communities.
Ross will get into a little more detail on our ancillary service growth opportunities here in a moment. Brookdale has a national footprint, we operate 646 communities in 35 states. We have a capacity to serve about 67000 residents. One of our key business strategies is scale and market in a range of product in market. So you will see that we are the only national senior housing operator that operates a range of senior housing product types. We operate independent living, assisted living, memory care, rental CCRCs and entry fee CCRCs. Again we also have a strong ancillary service platform. The lion share of our ancillary business is outpatient therapy and home health services.
We offer this range of services in a number of markets. We have 18 or 20 markets across the country that we call major markets M2 or M3 markets. Those are markets like Kansas City and Denver, Tampa where we have the full range of product in the market and we are able to take care of customers throughout their period of need and move folks in that market continuum of service. The tables you see here on the top right are mix by a level of care. That's our entire portfolio which includes the assets that we manage. And in the lower right is the mix of our units in our P&L in our consolidated operations.
Again it's a very diversified portfolio. From a revenue standpoint our business is 80% private pay, about 15% of our revenue is from Medicare. Within that we have three primary services we offer that are covered by Medicare, home health, outpatient therapy and we do of a fair amount of rehab in the skilled nursing operations on our CCRC campuses. But 80% of our revenue is private pay. You can see sort of the ownership distribution of our units in the pie chart in the upper right. We manage 27% of our capacity and in many cases we are actually a joint-venture partner in those portfolios.
We own a third of our units and we lease 40% of our units principally from the large national healthcare REITs of whom are I am certain familiar. Of our 67,000 units our ancillary platform serves 42,500 units with outpatient therapy and just over 37,000 units with home health. One of the key parts to our story of course is the long-term supply demand dynamics and ageing demographics in the United States. A very interesting phenomenon in the demographic numbers over the next five years. The most recent census, the 80+ population in the United States was 12 million. Through 2015, that age group is actually forecast to be relatively stable, in terms of the total numbers but in terms of affluence within that age group the 80+ population with the incomes under 50,000 or over 50,000 are projected to changing distribution by almost 1.5 million in the five-year period of time.
Essentially we are beginning to serve what's called the silent generation which were seniors born in 1925 to 1945. This is the wealthiest generation that we have ever had in the United States and likely will ever have. This is the generation that had very significant exposure to defined benefit pension plans, a kind of post-war homeownership. So significant affluence in this demographic and the average net worth here in this age group is over $0.5 million. So while we're not going to see a significant increase in the number of seniors in the near term in the next three or four years, certainly the number of those with a higher level of affluence and therefore a predisposition to the kind of operations we have will increase pretty substantially.
From a supply standpoint during this economic downturn, the number of new units under construction in the United States declined quite a bit. Back in the 2008 timeframe, the number of new units as a percentage of in-place inventory was about 4% that's gradually declined over time. So for the last three quarters it has been 1.5% and those are new construction start numbers as opposed to change in inventory numbers and we are in an industry where some number of units will come out overtime as assets are repositioned and units are combined and so forth, but effectively there is no new capacity coming online.
Financing for any new commercial construction even in a sector like senior housing that's been very vibrant from a financial point of view very, very difficult to finance. So just to kind of paint the picture in terms of recent events across our industry, Nick reports quarterly occupancy data some of you may get that data. Occupancy entry-wide right now about 88%, pricing growth has been somewhat muted though effectively keeping pace with cost inflation. Over the last year to 18 months we have had some very significant consolidation transactions occurring.
As you know the healthcare REITs with RIDEA structures are able now to take exposure to operating income through operating NOI as opposed to triple-net lease income. The healthcare REITs did extremely well during the economic downturn, bulked up their balance sheets and are now taking advantage of that low-cost capital to consolidate particularly in private pay senior housing. Though they're indicating that they are very focused on class A properties and everybody is trying to figure out exactly what that means at this point in time. But clearly market forces are driving a fair amount of consolidation in senior housing.
The cost of capital economies that the REITs enjoy clearly drive consolidation. The operating cost, scale advantages that operators like Brookdale have are also quite significant and those drive consolidation and at the same time the healthcare provider market is reforming. So the notion of having an integrated group of services to offer to chronically old people are increasingly seen by policymakers as part of the answer that we need.
The debt markets continue to evolve, the GSEs, Fannie Mae and Freddie Mack continue to be very active in senior housing although there is a significant lack of financing for new construction. We will now turn to talk a little bit about some of the growth opportunities we have with the company. But just to set the stage for Ross here, again from an organic point of view within our existing portfolio our growth opportunities include year to year organic growth where our cost growth historically has been at a level lower than our unit revenue growth. Second we can we can expand our ancillary service footprint across our portfolio and then we can redevelop and expand locations within our portfolio. Then from an acquisition standpoint, we intend to continue to be a consolidator in a very fragmented industry. We use our scalable infrastructure to quickly integrate those acquisitions and achieve some cost economies and capitalize on the experience that we have in the company as we affect these acquisitions. Let me turn it over to Ross.
Thanks, Mark. Delving into the growth areas in greater detail, starting with organic growth and the first component of that is as Mark said the operating performance of the current portfolio. In the first quarter and the two key drivers are occupancy and pricing. In the first quarter, occupancy was flat with the fourth quarter of 2011, which actually is a good accomplishment given that the first quarter is generally the seasonally lowest quarter that we have for occupancy.
You can see over the last half of 2011, we saw an increase in occupancy, particularly in the independent living dominated retirement segment. That was the first time we'd seen an increase in that segment in a while. Our expectation, we've said, for the remainder of the year is to continue to see an increase in occupancy.
On the pricing front, our price in the quarter went up 1.6%. Excluding the Medicare SNF rate change, it was 2.5%. Our core senior housing business on the pricing, really revenue per unit increase basis, has been running in a 2%, 2.5%. Again, excluding the Medicare rate change, 2%, 2.5% band for the last year. That's up from 1% to 1.5% the year before.
And it continues to be a difficult competitive pricing market, and so our expectation is that it's about the range that we expect for the rest of the year, which is running about the same as what our cost inflation is.
As Mark said, we operate on multi-product strategy and layering supported services, particularly on independent living and assisted living. In skilled nursing, we provide outpatient therapy. We build clinics in our communities that our residents come to for rehab therapy. And then, we also provide home health. We have home health nurses and therapists who go to the resident's units to provide that service.
The key of that is the multi-product strategy, which creates a critical mass density of customers, which allows us, one, to afford the overhead that this business require, but also create some economic viable model on the operating cost side which is a little bit different than some of the operators in that space where we don't have the marketing and travel cost.
We've been rolling this business out since 2006 into the Brookdale portfolio. That growth sort of plateaued in 2011. Then, with the acquisition of Horizon Bay, it introduced about 10,000 more units that we could get to. We're now, as Mark said, up to over 42,000 units in therapy and almost 38,000 in home health, which we expect we can get to that same footprint as therapy.
Horizon Bay units, we in six months have gotten to about half of that 10,000 units. It is a Medicare-based reimbursement model. But for us, while you hate to see your revenue margin go down, we have a very strong economic model that we provide with good margins for that business. Plus, it also leverages our asset base, really bringing in just incremental cash flow.
Another part of organic growth is you can either have the economy help you, you can [act stupider] or you can improve the operating performance of your communities. Related to that is capital expenditures. We reported a number of different buckets of capital expenditures on this chart three.
First is the lower blue bar is just maintenance CapEx, and the turnover is capital replacement. And that's a metric we include in our cash flow metric. The second bar is what we call major projects and EBITDA enhancing projects. That's major refurbishments of communities. We don't included that in our CFFO metric because we expect a return on that. Some of that maybe defensive, but even still we expect a return.
You can see that during the 2008/2009 time period, when we prioritized deleveraging the balance sheet because we squeeze that down. As we go into this year next year, there is some deferred CapEx in that gold bar. But there's also some fairly good refreshment projects going on. The top bar is corporate initiatives. That's mainly systems work and ancillary services, clinic build-out.
The systems work is oriented towards healthcare IT initiative we have. They're going to have electronic medical records spread throughout the company, which we think is important as we go forward in the new healthcare world and interfacing with other healthcare providers. Program Max is our initiative to redevelop our communities.
This is either adding service levels, expanding service levels, or doing a total redevelopment of a community. We have a portfolio, particularly in our retirement center side that's 25 years old. Some of the designs are obsolete. Some of the unit mixes are obsolete. We expect to underwrite a 12% to 15% unlevered return. You can see we've got projects completed, 17 projects underway, and another 19 in approval process.
When we started this, we expected to have a priority on expansion units. But as we've gotten into it, we really actually find that repositioning where we can have the biggest bang for the buck in the shortest amount of time period. If you listen to event house call, they talked about redevelopment of their communities. They're a landlord for us. The health care REITs are all onboard with this.
Mark talked about acquisition, the cases compelling for consolidation, the industry is very fragmented. Top ten have 12% to 13% of the market. There are private equity funds in ownership in this industry, and they will come to demand at some point. As Mark said, we do have tremendous economies of scale.
For us, being the largest region with (inaudible) 3%, 4% improvement in operating margin through savings and purchasing savings, benefits, insurance, Microsoft licenses, things like that. We also have an incremental G&A of about 3% that's also unique to us as we look at acquisition underwriting. Numerous revenue opportunity of the ancillary services platform.
We did acquire Horizon Bay in September of 2011, and we did find that, one, the fit was very strong with our portfolio but we did find that our platform really had capability and competency to acquire and integrate very quickly and has capacity for more as well. We do target a 10% initial levered cash on cash yield on that acquisitions.
Looking at the balance sheet quickly, our balance sheet has never been stronger. We've targeted a net debt to adjusted EBITDA of around 6. It will fluctuate. It went up a little bit in Q1 as we made acquisitions of communities and hit the line of credit to fund that temporarily. But we're around six times and that's our comfort zone.
We've been very active in lettering out our maturities. We have $300 million coming due in 2013. With $2.5 billion worth of debt, we'll as we letter this out, it'll be about the normal debt that we'll have coming out. Our interest rate exposure were 70% fixed, 30% variable, which is about where we're targeting. And we don't have any large lease terms coming up anytime in the near-term.
Looking out forward, where some of these growth drivers can push cash flow, the first element is the box at the top, which is locating at pricing. The key to that is managing the gap between unit, revenue growth and unit cost growth. They are related and are related to inflation. Recently in the last couple of years we have been at the top of box where at the revenue growth and expenses growth have been pretty equal.
In historically and better times, we will get to the bottom of that chart and have a one and half percent gap which produces a 7% or 8% operating income growth. Regarding opportunity on the occupancy side, we are approaching 88%. We can have an internal debate, but we believe that we can get to 93%, 94% in good times. Each one percent of occupancy brings around 20 million or so of incremental cash flow given a fairly high operating leverage in there.
We have an opportunity in our entry fee community. We have almost 4,000 independent living entry fee units. That's the pricing model where people give us a large sum upfront, lower monthly service fee. Dramatically related to the housing market; so for the last five years it's been the most oppressed in our portfolio.
Generally if we were matching sales with attrition, we should be producing $40 million to $45 million net cash flow. We've been running $25 million. This year we think it's going to be $35 million. So there's an opportunity to increase that. Plus we have a large inventory of vacant units where we've seen in the past we've been able to harvest that side of cash flow.
We've talked a little bit about expansions where we look at a jungle math on that. When we get to the 100 units -- 1,000 units where we're producing about $60 million of incremental cash flow. The prerequisite experienced management team, as much as we are the product of a roll-out a number of years ago. One thing about our management team is we manage to keep a lot of the different management folks from the different legacy companies, which has given us a team that's rich in different experiences and different product types.
With that we'll go to questions and answers.
Darren Lehrich - Deutsche Bank
Feel free to raise your hand if you've got a question in the room here. I guess I'll start off with one on occupancy. It's been on sort of a steady climb since it dipped in Q2, if you think about on a year-over-year basis. And I'm just curious to get your thoughts on how you see that developing? Where do you think -- I think you said low 90% is where you think it might get to but where do you think we're going with the occupancy and what do you think is the most important driver that makes that year-over-year improvement even better?
Yep. Our guidance for this year is actually an increased average occupancy in 2012 over 2011 of about 1%, which is a relatively significant increase in occupancy across the portfolio of this size; 650 locations, 67,000 units. Probably the most recent time period we had as a company and as an industry where we had much stronger economic tailwinds would have been back 2005/2006, early into 2007.
In those time periods you saw same store occupancy growth of 1%, 1.5% perhaps. The big difference today is in part because inflation is lower and in part because the economic environment is somewhat disrupted. Rate growth is lower than what you would have seen historically.
Again, as Ross mentioned on the table, what you would have seen in those peak demand periods was unit pricing growth probably a point and half or so above the unit cost growth. Now that was at a fundamentally higher inflation time, you know inflation was probably 4% or so.
So seeing rate growth and 5.5% and 6% range that was pretty significant pricing growth at that time; until we see some more inflation in the economy which who knows when that is, but it doesn’t sound like it’s any time soon, you are probably not going to see rate growth at that level and until we get to a place where the fundamental supply dynamics just get very, very favorable for us and that’s probably when the occupancy for the industry is up in the low 90s at some point.
We try to update our sense occupancy wise pretty regularly, but I think the sense would be, if I grow occupancy by a point here or maybe a point and half here, until we see some real acceleration economically.
Darren Lehrich - Deutsche Bank
And just on the pricing point, how the promotional that could be in this kind of environment and how much do you think that sort of impact roughly 2.5% from this (inaudible)?
Well again, our business is 80% private pay, so the pricing features of what’s going on are today and have always been very retail oriented almost in terms of how the pricing works. A phenomenon we deal within the sales process today and always have is for many seniors and the families creating a decision point, because, remember our customer when they move in is 82, 83, 84 and there's not necessarily in many cases a break line urgency on why its important for mom to move this week or next week, the point of that being, there have always been some pricing promotional features in the sales process simply to create a reason to close.
Now clearly some of those incentives now are being used and have been really for the last three or four years as part of pricing right, so as opposed to the sales process actually changing the pricing in some markets; its not the case in all markets, it is not the case in all product types as you would think its very logically associated with market occupancies and product type occupancies in different markets.
So I mean embedded within our same store rate growth is whatever the effect of discounting and promotions might be, our sense is the magnitude of that. We don't have great measures of that as an industry. We don't have a combined reservation system like you would see in hotels or to some extent in multifamily. So it’s little bit difficult to see exactly what's going on there in terms of the list price versus the net paid price, but our sense is it hasn't really changed a lot for the last two or three years; clearly, a little bit higher than it would have been five years ago but not in a dramatic kind of way.
Again, our customers are with us two or three years, so even if you thought about giving away a month’s rent in that time period which would be a fairly extreme promotion or discount you are talking about, what 3% of the say, so its economically relatively modest. And I think most importantly as you look at our performance and others it’s embedded in our same store rate growth numbers. So unless there's a significant behavior change around pricing or discounting it’s already embedded in what you are seeing.
Darren Lehrich - Deutsche Bank
A question on ancillary services I know it seems some of your competitors mimic your strategy there, are you really trying to cover more and more of your units with therapy and home health services? And then we've seen some of your competitors really go in a different direction by achieving the notion of the ancillary. And part of that rationale occurred is that there are referral sources and if there is something that you might be competing in operating the services; I guess philosophically you've gone in a clear direction, but how do you think about that and what’s the mentality in the other?
That's a good question. There are several that we could actually spend almost all day talking about, provider configurations and a changing healthcare economy, because as you know there's a lot going on right now and initially as the role of cost pressures in Medicare then managed care and now we've got significant reforms going on in the way providers work together.
First of all, we are really the only senior housing company that has enough stay all in enough markets that you can put in place operating network of home health agencies or outpatient therapy clinics. Some of our peers have some markets where they could do that, but first and foremost you need scale in a market to be able to do it, because to do a good job we might put aside the economics for a minute; to do a good job in a market you need a range of therapy types, you need the therapy available in the market on a regular basis. So you need to have some scale to get all that to work.
And then add to that you need an economically viable business model as well. So you need some scale and then you need a number of those markets so that you can create the infrastructure to deliver that service. Home health and outpatient therapy are very distributed businesses. Each of the business units really aren’t that big; it’s pretty efficient from an overhead standpoint for us, because you have got $200 million ancillary business bolted onto a $3 billion senior housing business, so it shares a lot of economies.
But if you go out and look at the G&A levels and the sales and distribution costs, free standing home care companies or therapy companies; it’s a very expensive business to operate. So you’ve get that whole series of issues.
Now on the notion of competing with referral sources and so forth, it’s an interesting situation, particularly when you deal with hospital systems that are very vertically integrated. So the way you deliver those services and how you organize in markets can certainly be different depending on what the other provider configurations are.
In general though, major urban healthcare markets are very large and they are pretty fragmented even as it relates to physicians and hospitals and so forth. So the likelihood that you kind of distant franchise your whole referral base is pretty low by and large.
Darren Lehrich - Deutsche Bank
You talked about dynamics of the REIT and the (inaudible) levels and clearly we’ve seen capital raised over the last couple of years. I think the question I have is, how you think about REIT as a competitive force in your acquisition strategy and what’s that done to valuation and I think how should we be thinking about that over the next couple of years?
Valuations are an interesting topic; we went through a significant round of acquisitions back in 2005 and 2006. In addition to the merger or three operating companies, we acquired 10,000 or 12,000 units; mostly regional portfolios and operating companies and there was a lot of industry-wide consolidation and then cap rates were probably for good solid commercial real estate, decent markets good locations, 7%-ish plus or minus.
Then the housing market crack, the economy went to a downturn and there were advertise changes in cap rates for senior housing where people intuited their cap rates must they have gone up to 9% or 10%, but oddly nobody sold any assets at 9% or 10% cap rates.
Then at the end of 2009 I guess, we had 2010, sorry I am off a year, a big around of consolidation transactions mostly with the REITs buying some large portfolio of assets and surprise, surprise, most of those purchase were done in cap rates right around 7%.
So I don’t think that cap rates as which trades occur have really changed very much for five year. There was a theoretical increase in cap rates, but nobody sold any assets. So I don’t know what that means. Good fundamental returns at that kind of an unlevered yield of 7% or so, one thing that’s fairly difficult to look at different investors admittedly is seller cap rates and buyer cap rates in our industry can be quite different because as Ross pointed out on that slide our local margin structure may improve 3% or 4% when we rollout our purchasing programs, our insurance programs and alike.
Our marginal SG&A cost is 3%, 3.5% of revenue and generally when you look at the economics of a senior housing deal, you are going to include an overhead load of about 5% or so. So the cap rates can be a little bit confusing buyer and seller; as it relates to the REITs clearly they are adding a lot of liquidity in the market, there is lots of transactions out there. At some level we compete with the REITs for the assets, but the REITs need a large operator to buy large portfolios of assets.
So in the short-term partnering with the REITs just seems to be a fair likelihood as we did in some of the Horizon Bay assets, we partnered with [ACP] in a idea of joint venture; you have seen other of those transactions and will likely see more.
Darren Lehrich - Deutsche Bank
I think that (inaudible) for Brookdale.
Thank you all.
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