Brookdale Senior Living Inc. (NYSE:BKD)
Bank of America Merrill Lynch 2012 Health Care Conference
May 17, 2012 11:40 AM ET
Bill Sheriff – CEO
Ross Roadman – SVP, IR
Kevin Fischbeck – Bank of America Merrill Lynch
It’s my pleasure to introduce Brookdale Senior Living. Brookdale is the largest Senior Living company in the country through its portfolio of assisted living retirement center and continued care retirement center portfolio. The company also has a large and growing ancillary services business.
Presenting today we have Bill Sheriff, CEO and Ross Roadman, Senior Vice President of Investor Relations. And with that, I hand over to Bill.
Thank you Kevin and we do appreciate the opportunity to present today. And as Kevin mentioned, I’ll be sharing the presentation this morning with Ross, our Senior Vice President and Investor Relations.
I want to try to cover the fundamentally, the fundamentals of the business, how that’s trending. Certainly, touch on our particular unique platform and the position that we have in it. So, we’ll touch on our debt maturities balance sheet and where we are there as well as the very actionable growth opportunities that we have. And we will touch in the end just in terms of the management, the depth and breadth of the management team that we enjoy.
As Kevin said, we are the largest Senior Housing provider in the country. We do have a very strong and stable capital structure. And we think we have the absolute leading platform from which to grow this business and produce outstanding outcomes.
Operational standpoint, the first quarter we produced the $0.5 million or $0.48 CFFO per share, did see an occupancy improvement of 60 basis points over the prior year. And the same community revenue grew by 1.6% despite the Medicare cuts, we experienced.
You know, we are about 7 to 8 months into the integration of the Horizon Bay acquisition, which was the acquisition of the ninth largest senior housing manager in the company in terms of bringing our another 16,000 units under management. And we’ll talk a little bit more about the Program Max and the traction initiatives that we are undergoing there.
When you look at Brookdale Senior Living and appreciate the platform that we have and I guess we’re operating 35 states, over 67,000 residents, so 47,000 or 48,000 associates. But we have very strong concentration in markets that are very attractive for the long-term, you know, senior markets. And that some of those markets were the markets that were maybe hit a little bit harder during the deep recession but long-term, our markets that are going to service very well.
As Kevin mentioned, we do operate across the spectrum and we are the only operator who operates at scale across the continuum of products within the senior living field from retirement centers to free-standing assisted living memory care to rental CCRCs, entry fee CCRCs. We do not operate freestanding nursing homes. All the healthcare components are within a continuum of care setting.
On the left hand side, those – the mix of the unit type and our consolidated financials 30% is retirement centers, the 46% of the freestanding memory care and freestanding assisted living is reported under our assisted living segment. And then the CCRCs are split close to half and half between the rental CCRCs and the entry fee CCRCs.
By actual level of care on the left hand side, you see that 9% of our units are the entry fee, independent living units. 36% of actual independent living units and different studies of retirement centers or CCRCs, rental assisted living memory care, the skill nursing. That’s in terms of what we have in total management, the bottom box shows what is in our consolidated, you know, financials.
We are 80% private pay. Medicare is about 15%, Medicaid is 3%, private insurance, which is beginning to grow, is 2%. We developed in urban markets and some rural markets or secondary markets. But we have again, the concentrations and what we refer to as RM2 but major markets where we have some real concentrations and then markets where we have concentration and the full continuum of product offerings with markets and RM3s.
Our ancillary services platform are now up to 42,500 units for therapy and over 37,000 for home health, with this is grown about 5,000 in each of those categories with the initial starting to roll out on Horizon Bay Acquisition.
And on the top right, and again, breaking down the portfolio with the Horizon Bay, which brought in a lot of management, third party management, our third party owned and management business dynamics of 27%, 40% leased and then 33% owned.
Looking at the fundamental demographics, some folks have pointed to the fact that the 80-plus population from 2010 to 2015 is nearly flat. But if you break that down in the way it really affects is that if you look at the 80-plus with incomes less than $50,000 that is decreasing 16.5%. While if you look at the 80-plus with incomes greater than $50,000 that is actually increasing by 34.6%, that’s our ultimate mark.
And really while there is a lot of attention to Baby Boomers, the real generation that we’re beginning to serve and the front end of serving, which also was very significant in terms of basic fundamentals of our business, is called a silent generation. That’s the people who were born between 1925 and 1945. It is the wealthiest generation that our country has ever seen and probably will ever see.
And that bodes incredibly well for our business over the next 10 to 15 years, they benefit from higher pension incomes, retiree health plans, entitlement programs, and there is also a generation then I guess plus was a time of the cycle of life in terms of the ability to generate wealth and retain that having net-worth on average over $500,000. And so those are all very significant for us.
Again, if you look at the 1.9 million units, basically the makeup are our total deal, serving 12 million seniors if you take a 15% penetration rate of 1% increase will absorb half of the vacant units that exist in the industry today. But when you look at the demographics and then you look at the other research that has been produced and is still coming over this last two years and some very recent research reports, there is a growing positive reception and awareness in perspective about senior living on the silent generation and the baby boomers in terms of the perspective.
You put those two things together and while like recession certainly has muted some demand as we start on recovery, as we move further into this, there is every reason to believe that penetration rates will go up in terms of what senior housing – how it’s penetrating that senior market.
At the same time, in terms of supply side, it continues to be constrained and very muted. And you can see that it has continued to go down and when you take the option lessons, when you take the activity that’s going on in terms of the repurposing and reconfiguring of units, and how many units are coming out of basis, the 1.5% really isn’t not to sustain and relative to the growth at all. And that doesn’t seem to appear to really be changing.
So looking at the fundamentals, the field is roughly at 88% and improving in independent living in the first quarter, obviously across the industry, grew more than the assisted living. This is a very, positive sign while independent living had those – the greater declines in the great recession. And assisted living doesn’t have as much total upside because of the smaller buildings, the higher attrition turnover, the friction that exits in terms of what is the optimum occupancy level.
The fact that independent living now is growing and growing further is a good basic fundamental sign, or sign for fundamentals. Pricing is still muted but it is keeping pace with inflation which is a key point. Yes, we've been seeing some very large transactions being generated basically by the large healthcare REIT or companies they’ve been primarily focusing on the class-A properties until this point. But there is going to continue to be consolidation, capital business, the cost of capital is certainly a significant factor but also the operating cost to economics, you know, the economies of scale that are in this both from the corporate level as well as the community level is very significant in this business. And we enjoy tremendous cost advantages versus our peers in that area.
Also, another factor that is beginning to have some affect and will have more affect going forward is what is happening within the whole healthcare reform basis. And again, our population is continuing to age.
The profile of our customer living much longer multiple chronic conditions with physical limitations, living much longer, the aspect of the interface and the connection between the healthcare and the need for healthcare support in the interfacing of that is going to continue to increase. And again for us, we’ll touch on that but we’re in a very good position to our platform. Debt markets continue to evolve, Fannie Mae and Freddie Mac, still very active, very supportive. But you still don’t see much financing being available for new development.
Again, our growth, we have the basic fundamentals of our organic growth and Ross will speak a little bit more to this, are very strong and very positive. And that will come through increasing occupancy as rates and pricing continues to improve as we continue to expand our ancillary services footprint and also expand that with the hospice additions that are going well this year. And also, in pursuing the selective expansion and community REIT position redevelopment projects under Program Max, those are going to be three significant organic growth elements.
We will continue to be a consolidator in the highly fragmented industry, the largest with barely over 3%. And using the strong foundation we have, in the scalable infrastructure, in order to penetrate acquisitions quickly and smoothly, Horizon Bay, the ninth largest which we integrated in a very efficient and very timely basis. And again, the depth and breadth of our management organization is unmatched in our field.
I’ll turn the presentation over at this point to Ross.
Thanks Bill. Diving a little further into those elements of growth, starting with organic growth and the first element, which is the operating performance of our current portfolio. Of course the two key drivers are occupancy and pricing. As Bill said, our occupancy increased 60 basis points year-over-year was actually flat sequentially against Q4 which is actually a good accomplishment given that Q1 is historically, seasonally the lowest of the year.
Kind of a higher perspective on occupancy, our occupancy actually bottomed out around 86% and now it’s approaching back towards 88%. As Bill mentioned, importantly, it’s hard to see on this, but the red line, which is our retirement center segment, which is dominated by independent living, you can see after multiple quarters of pretty steady performance has in the last three quarters started to increase.
On the pricing, we measure that risk, revenue per unit. If you look at what’s going on in the first quarter, we had about 2.5%, increase in our core business. That chart shows the red line includes ancillary and puts and takes of Medicare, which really dived down into the core business and look at the senior housing.
Over the last three quarters the revenue per units increased 2% to 2.5% and that’s higher than the year before where it was increasing 1% to 1.5%. As Bill said, we do have a multi-product strategy. Part of that strategy is to provide supportive services to our residents and our communities. We do that through a number of ways. One we build clinics in our communities that our residents come down and receive rehab services in those clinics.
We also provide home health where our therapists, home health nurses go to our resident units. The key to this u for us is the critical mass that’s created through that multi project strategy. It creates a density of customers that one that allows you to afford and overhead that this business requires, but also for us creates a different cost structure. But we don’t have some of the marketing and travel cost of some of the pure ancillary services providers have.
Our multi product strategy also gives us strategic advantage over – other senior housing operators. We don’t really have that clustering philosophy. This is a business that we start to roll out, through the Acquisition of American Retirement 2006 we rolled it out into the Brookdale portfolio. That rollouts plateaued in 2011, but now as the acquisition of Horizon Bay, it gives us an opportunity to get to another 10,000 units or so.
You can see by the chart, we’re up to 42,500 of our 67,000 units for therapy and little over 37,000 for home health. The home health is really a subset of those therapy units. And our expectation is we can grow therapy another probably 10% to 20%, and try and reach the home health footprint to match the therapy footprint as well.
It is a Medicare business. As Bill said, and we have taken some hits from the reimbursement cuts. But when you think about this business that one, it’s key for our strategy to provide services to our residents but also it’s on a cost structural platform that’s a little different. And the amount of capital that you have to deploy, it’s a really a very attractive economic model for us.
As Bill said, another way to grow this organic growth is to improve your products. And we have been investing on our communities. This chart shows three different buckets of capital expenditures that we report. The bottom blue bars are maintenance CapEx, that’s something we actually subtract from our cash flow metric that we report, it’s about $600 a unit per year. And that really covers unit turns and carpets and you know, window or air-conditioner units.
The second bucket is what we call major projects and EBITDA enhancing, these are more significant refurbishments of communities. And while some of them may be defensive, we do expect a return on many of those. You could see from the gold bars that during the financial crisis, in 2008, 2009 we actually diminished expanding as we were de-leveraging the company putting cash into – lowering our debt. And you could see over the last year and this year, we increased that. Some of it may be differed maintenance but some of it really is preparing those communities for what we believe is a bettering environment.
The third top bar is our corporate systems, corporate spending, some of it on systems, some of it on ancillary build-out. And on the system side, we have a major multi-year initiative to extend electronic medical records into most of our business all the way through assisted living, living in eventually into independent living.
Related to that is our Program Max initiative. And this is where we’re really redeveloping our communities. And we have a portfolio for example retirement centers that have an age of – average age of about 25 years old. Some of the designs need updating, some of the service level mix needs changing. So, some elements of this program are adding new service levels like Alzheimer’s care, expanding service levels that are either undersized or actually pretty successful and you want to expand them or major redevelopment of community repositioning of that community.
As Bill said that program – really we started a couple of years ago really got traction last year. And we have completed eight of those projects. And we have quite a few ongoing right now. It’s our top priority for capital deployment. And we do expect, at least 12% to 15% return on that capital deployed.
The case for consolidation in the industry is pretty compelling. The industry is highly fragmented. The top ten providers have 12% to 15% of the market share. And scale really does matter as we look to integrate regional operators who generally can save 3%, 4%, 5% on the operating margin side, mainly through purchasing of food, insurance health benefits, IT licensers.
On the G&A side, our incremental G&A is probably 3% something like that. But we also have unique advantage that we can also add some revenue through the ancillary services if the situation is right. And that can add anywhere from $75 to $125 per unit per month, depending on how it’s structured. And that’s on top of if you think $1,300 or $1,400 per month, per unit of operating income that we get across our portfolio that’s a pretty significant add.
We did acquire Horizon Bay in September 2006 the integration has gotten very well. The portfolio was a very strong fit. And we found that our platform was able to integrate that acquisition quickly without a lot of disruption and really affirmed our sense that our platform had a lot of capacity to expand.
Our balance sheet has probably never been stronger. Our leverage is – we target around the six times our net debt to adjusted EBITDA. And we’ve been there for a number of quarters it will fluctuate if we got to 6.6 in the first quarter because we acquired some communities and hit our line to do that but we’ll pay that lying down eventually with cash flow. Six times is a level that we’re very comfortable with. It’s almost all totally mortgage debt with strong coverage.
Our interest rate target is 70% fixed, 30% variable and we’re pretty much there. As we look at our maturity schedule, we’ve been lathering it out. We have $300 million we have nothing this year, $300 million next year. But if you think about the company that has $2.5 billion of debt in the matter over 8 to 10 years, we’re sort of into a maintenance mode. That $300 million is on very strong portfolios. We don’t have any large lease terminations coming up any time soon.
As we think about the future, growing demand, limited supply, and operating in financial leverages in our model, just thinking about some of the building block trend, kind of quantifies some of this growth we’re talking about.
The first block is the pricing block. The key to this is managing the unit revenue growth versus the unit cost growth. And there is a relationship to inflation. What’s been going on in the last couple of years, those have been, as Bill said, like in the first quarter, pretty much the same, so we haven’t seen a lot of margin growth. Historically in better times, you can actually see 1% to 1.5% differential. And that really drives the 7% to 8% improvement in operating income.
Looking at occupancy, approaching 88% now, we think we can get to 93%, 94%, in total on the portfolio. Lots of debate internally on actually where that number could go. But just to kind of quantify with our current revenue per unit right now in the size of the portfolio, 1% increase, would drive about $20 million to $21 million of cash flow increase.
We do have entry fee communities, as Bill mentioned. About 4,000 independent living entry fee, units that a little different pricing model where resin pays a larger up-front fee and end up paying a little bit lower monthly service fee. What’s been going on is that that’s a market that is highly sensitive to the housing market. And so, the last couple of years, we haven’t really quite kept up with attrition. And so, we’ve been producing a $25 million to $30 million net cash flow number, when attrition equals turnover that will produce $40 million to $45 million. In addition, there is about $100 million of vacant units that at some point will harvest some of that as well.
We talked a little bit about expansions. Our Program Max, when we first initiated Program Max, we were talking about doing expansion work. As we got into that, we found that actually the low hanging fruit is really the repositioning work. And so a lot of the project that we’ve been doing, some of them have a little bit expansion but really it’s converting service level types to add additional these types of service level and major renovations of the communities that we still expect to 12% to 15% return on that.
But looking on the expansions which we eventually will get to, we think 1,000, adding 1,000 units a year, kind of the jungle math on that is 1,000 units would bring about $16 million CFFO impact. Again on the repositioning, we do expect 12% to 15% return on those.
Finish with the prerequisite management team slide. We are a product of a rollup and very fortunately got the lot of the top management. And, with that broad depth of knowledge of the different product types, lots of experience having gone through some ups and downs in the industry.
With that, we will close.
Kevin Fischbeck – Bank of America Merrill Lynch
Okay. So, maybe I’ll kick-off the Q&A. Obviously you mentioned flat occupancy, sequentially up year-over-year. And your guidance is for 100 basis points occupancy improvement for the year. And how much of that is kind of reliant on the economy behaving and how much of it is achievable to see kind of sit where we are right now?
We feel pretty good about that. The first quarter of course typically is a quarter where you see a little bit of a drop in the occupancy. And actually that was flat sequentially and certainly up from prior year. And you see the positive signs particularly as being indicated in the independent living. We’re beginning to see that across and that’s a very positive sign, the positive signs of exceeding within our entry fee. And the movement within that also is a good positive sign.
For three years in a row, the issues of Europe had hit the second quarter and the consumer confidence at all, and it’s raising its head a little bit again. But we see the reactions are being not as significant in terms of its impact to what’s happening in our markets. So, we feel pretty good about the guidance we give in that regard.
Kevin Fischbeck – Bank of America Merrill Lynch
And how do you guys think about balancing occupancy growth versus pushing rates right now. One of your competitors is talking about focusing more on rates on occupancy and how do you guys think about that?
Well, our view really hasn’t changed and you’ll see and need to see is same moment in the occupancy growth before you will see any real meaningful improvement. So, you already are starting to see a little bit of improvement in pricing. But obviously they are about 80% or so assisted living memory care. Assisted living memory care didn't drop as much during this whole recession as the independent living did. Independent living now, perhaps we’re probably having upside and they have I don’t know what, mix particularly over their markets at all and where they are in terms of balance across that.
So, I think we would view it as compared to our portfolio in our markets. But we would – we still see this is the time for us to drive occupancy as a way even to get to where we do more meaningfully over time move the rates.
Kevin Fischbeck – Bank of America Merrill Lynch
You made a pretty compelling case for acquisitions. It seems like from time to time we’ve seen large acquisitions or steady stream of smaller acquisitions. I mean, how do you think about the opportunities set for 2012, and is it going to be a lumpy Horizon Day type transaction or is it going to be – are you seeing smaller opportunities with maybe steadier stream of that?
It’s certainly hard to predict large ones. But there will be some of that as follows some of the smaller and mid-sized. Overall I would think as we go through the year, we will see some activity. And we’ll cross that spectrum. We think we are in an extraordinarily good position with our platform systems, our capability, I don’t know how they could have demonstrated that more with what we've done with Horizon Bay in that regard.
And we’ve accelerated the whole process of that. We’re even accelerating the process of the rollout of the ancillary services during Horizon Bay. And both in terms of maximizing the results from that and or even though with as you’re going to accelerate that little bit higher, G&A cost of process of it. And the costs or the start-up costs, some elements of those as a result to get through it lot quicker and results will start showing a whole lot more in third and fourth quarter. But also it positions us to have that, if you’re well behind us in terms of what other opportunities may come our way.
Kevin Fischbeck – Bank of America Merrill Lynch
And then you think about the Program Max opportunities, what percentage of your facilities are really prime candidates for these types of programs?
For the Program Max, that probably is maybe 15% and maybe a little bit more. There are some of the prototype design buildings where we’re finding even the small buildings with the addition of about six units or like a slight reconfiguration of the common areas is, producing incredible results. That could increase that percentage more like 40% or 50% in terms of smaller programs.
What has held us back – what we’ve been frustrated about is getting the alignment of with our REIT partners as well as with Fannie and Freddie. And over the last three, four, five months, we think they have cleared commercially all those major hurdle aspect and fundamental understanding alignments and getting agreements with processes and everything. And also, again, you're seeing what Ross shared in the slides that we are beginning to accelerate that. It’s a little frustrating.
We had hoped to be where we are this year, last year and for next year, this year. But we are continuing to see as we’re beating those unlevered return hurdles as we're getting those finished. And as well as getting major lift from the other – just enhancing just basic refurbishment and we’re accelerating that and beginning to see good results from that as well.
Kevin Fischbeck – Bank of America Merrill Lynch
And I think that’s all we have time for. Thank you very much.
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