Ensign Group, Inc Q4 FY2021 Earnings Call

Good day, and thank you for being here. Welcome to The Ensign Group Inc. Fourth Quarter Fiscal Year 2021 Earnings Conference Call. Currently, all participants are in a listen-only mode. After the presentation, there will be a question-and-answer session. Please note that today's conference is being recorded. I would now like to turn the call over to your speaker today, Chad Keetch. Please proceed.

Thank you. Welcome, everyone and thank you for joining us today. We filed our earnings press release yesterday and it is available on the Investor Relations section of our website at ensigngroup.net. A replay of this call will also be available on our website until 5:00 p.m. Pacific on Friday, March 4, 2022. We want to remind any listeners that may be listening to a replay of this call that all statements made are as of today, February 10, 2022, and these statements have not been nor will be updated subsequent to today's call. Also, any forward-looking statements made today are based on management's current expectations, assumptions and beliefs about our business and the environment in which we operate. These statements are subject to risks and uncertainties that could cause our actual results to materially differ from those expressed or implied on today's call. Listeners should not place undue reliance on forward-looking statements and are encouraged to review our SEC filings for a more complete discussion of factors that could impact our results. Except as required by federal securities laws, Ensign and its affiliates do not undertake to publicly update or revise any forward-looking statements where changes arise as a result of new information, future events, changing circumstances or for any other reason. In addition, The Ensign Group Inc. is a holding company with no direct operating assets, employees or revenues. Certain of our wholly owned independent subsidiaries, collectively referred to as the Service Center, provide accounting, payroll, human resources, information technology, legal, risk management and other services to the other operating subsidiaries through contractual relationships with such subsidiaries. In addition, our wholly owned captive insurance subsidiary, which we refer to as the Captive, provides certain claims-made coverage to our operating subsidiaries for general and professional liability, as well as for workers' compensation insurance liabilities. Ensign also owns Standard Bearer Healthcare REIT Inc. which is a captive real estate investment trust that invests in healthcare properties and enters into lease agreements with certain independent subsidiaries of Ensign as well as third-party tenants that are unaffiliated with The Ensign Group Inc. The words Ensign, company, we, our and us refer to the Ensign Group and its consolidated subsidiaries. All of our operating subsidiaries, the Service Center, Standard Bearer Healthcare REIT and the Insurance Captive are operated by separate wholly owned independent companies that have their own management, employees and assets. References herein to the consolidated company and its assets and activities, as well as the use of the terms we, us, our, and similar terms used today are not meant to imply nor should it be construed as meaning that the Ensign Group Inc has direct operating assets, employees or revenue or that any of the subsidiaries are operated by the Ensign Group. Also, we supplement our GAAP reporting with non-GAAP metrics. When viewed together with our GAAP results, we believe that these measures can provide a more complete understanding of our business, but they should not be relied upon to the exclusion of GAAP reports. A GAAP to non-GAAP reconciliation is available in yesterday's press release and is available in our Form 10-Q. And with that, I'll turn the call back over to Barry Port, our CEO.

Thanks, Chad. And again thank you for joining us today. We are pleased to announce yesterday another record quarter. These results demonstrate yet again that our local leaders and their teams continue to be the examples of post-acute excellence as they wade through the evolving landscape in each of their markets. As they've done so, we have again achieved record results in spite of the continued challenges related to the pandemic and the accompanying disruption in their labor markets. Remarkably, despite the impact of the Delta surge in the early part of the quarter and Omicron in the late part of the quarter, we saw continued improvement in occupancy, skilled revenue and managed care revenues. We were particularly pleased that we achieved sequential growth in our overall occupancy for the fourth consecutive quarter and managed care census has grown sequentially six quarters in a row. We were amazed by the commitment of our caregivers and their continued endurance and strength. As evidence of the medical community's confidence in our local operators' clinical capabilities, we saw marked improvement in patient volumes, especially with higher acuity patients, as we saw another sequential increase in Medicare and managed care census of 5.5% and 4.7% in our same-store and transitioning portfolios, respectively. This continued improvement in our admissions trend not only gives us great confidence that we can continue to perform well as the pandemic stubbornly persists in many of our largest markets, but it also shows that we are in an excellent position to see occupancies continue to normalize to pre-pandemic levels over time even while the pandemic continues to impact our operations, our staff and our patients. In spite of the unprecedented challenges, the pandemic has forced us to become stronger and more agile, while allowing us to develop strategic local advantages that will continue to bear fruit even when the pandemic eventually subsides. We continue to work closely with our hospitals, government agencies and managed care partners to care for patients with increasingly demanding medical needs. In doing so, our operations are solidifying their position as providers of choice and are increasingly seen as critical partners in the healthcare continuum as an essential cost-effective setting for these complex patients. Moreover, as the pandemic has continued to put pressure on the labor markets, our operations have discovered new methods for attracting healthcare professionals into our workforce, while also strengthening their ability to retain and develop existing staff as we have focused on being the employer of choice in our communities. While we would never have wanted this pandemic to occur, it has revealed the strength of frontline professionals and caused us to become better clinically and operationally than ever before. We also continue to benefit from sequestration suspension and improved Medicaid funding in certain states. We are grateful that the federal government has extended the state of emergency to April 2022, which keeps in place many of the regulatory and other forms of assistance helpful to patient care. Based on recent COVID trends we anticipate that this additional funding will continue into the second half of this year. But to the extent that COVID trends or political climates change throughout the year, we are confident in our ability to make operational adjustments, take advantage of an attractive acquisition environment and lean on our overall health to continue our path of performance. We are very proud of what we're able to accomplish in 2021, while dealing with so many unusual challenges, but we also know we can still do much better and are excited about the enormous potential within our portfolio as we continue to apply our proven locally driven healthcare model. We are issuing our annual 2022 earnings guidance of $4.01 to $4.13 per diluted share and annual revenue guidance of $2.93 billion to $2.98 billion. The new midpoint of this 2022 earnings guidance represents an increase of 12% over our 2021 results and is 30% higher than our 2020 results. We are excited about the upcoming year and are confident that our teams will continue to manage and innovate through the lingering challenges on the labor front. When we consider the current health of our organization combined with our culture and proven local leadership strategy we are well-positioned to have another outstanding year in 2022.

But before I turn it over to Chad to discuss our growth and real estate efforts, I just want to take a minute to recognize our incredible team members, facility leaders, field resources, clinical partners and service center support staff. I can't emphasize enough how incredibly honored and grateful we are to work alongside them and witness their amazing sacrifice, effort and outcomes. They have taken great care to ease the impact that these last two years have had on our residents and one another. They have focused relentlessly on the safety and well-being of those they serve. Their ownership in serving their communities has blessed the lives of so many. It's absolutely astounding to witness and an honor to be a part of that effort. Thank you Barry. As we announced yesterday as of January 3, 2022, we completed the formation of a new captive REIT, Standard Bearer Healthcare REIT Inc. or Standard Bearer. This new real estate company will enable us to build upon our established real estate investment platform, which is comprised of high-quality assets and very healthy operational fundamentals. We carefully selected the name Standard Bear, which in military tradition is the person that has the honor of carrying the colors. As you all know Ensign means a standard or a flag. Ensign's mission is to raise a flag or to be a symbol of a new higher standard in post-acute care. That mission drives each and every aspect of our organization and is something we care about deeply. Therefore, it is very important for us to ensure that everything the REIT is about is to support that mission. We understand and will always recognize that the true value in our real estate is derived by the loving service provided by our local teams in each location they serve. The real estate while, obviously, an important element of the care we provide only does well if the operations do well. And so Standard Bearer's mission will be to do its part in finding the right opportunities and acquiring those opportunities in a way that supports and sustains the hundreds of Ensign affiliates and other like-minded operators as they seek to provide exceptional post-acute care into the markets they serve. While our real estate strategy has always been an important part of our DNA, we believe this new organizational structure allows us to take the next step with our already thriving real estate business. We've already begun evaluating transactions, which include healthcare properties that will be operated by Ensign affiliates and other third-party operators. We look forward to establishing new partnerships with other outstanding operators and to working together to help further underline the importance of post-acute care providers within the continuum. At the same time, this new strategy will open up new doors to growth that we haven't pursued in the past, allowing us to accelerate Ensign's strategy of acquiring and operating both performing and underperforming operations. As a reminder there are many benefits to our stakeholders in this new organizational structure. In addition to providing us with additional acquisition opportunities Standard Bearer will be able to leverage the knowledge and experience of our exceptional field leaders as they assist the REIT and its efforts to create additional value through real estate investing. Also unlike a transaction that involves a one-time benefit to our stakeholders, the captive REIT and the accompanying periodic valuations will show an ongoing and accurate look at the substantial value of our real estate assets. We are happy to now disclose our real estate portfolio's value as determined by a third-party appraiser in our 10-K with an initial valuation of approximately $1 billion. When compared with the book value of approximately $720 million, which includes the purchase price that we paid at the time of acquisition plus all additional capital improvements, this represents an increase of approximately 40%. Over time, we expect that this continued disclosure will shine a brighter light on the value we have created and will continue to create in these and future assets. In addition, this structure fully preserves the option to do a spin-out or other transactions in the future without duplicating efforts. Most of all by keeping our real estate strategy in-house, we will retain the cultural connection between the real estate business and the most important part of our business, which is obviously the care and service that occurs in these operations on a daily basis. We are always happy to be operators first and the health of each operation will be paramount in every deal we consider. So just to summarize, this new structure gives us more flexibility to grow in new ways without triggering significant capital gains tax and other inefficiencies, provides us with additional flexibility in deployment of capital, and gives us full visibility into the growing value of our real estate. Plus, we are not limiting ourselves in any way to pursue other structures in the future. And just to be clear, we will obviously still continue to grow by leasing new operations. We very much value our relationships with all of our existing and future landlords. Leases have been and will continue to be an essential part of our growth story. For example, during the quarter and since, we added six new operations including two operations in Texas totaling 248 beds, one operation in Idaho with 80 beds, one operation in Arizona with 161 beds, and two operations in California with 218 beds five of which are new long-term triple net leases and one real estate purchase. Just a few months ago, we acquired the real estate for five skilled nursing and assisted living facilities in Arizona, California and Kansas which had previously been operated by Ensign and Pennant Group affiliates for a number of years. As this recent activity illustrates, the ratio between leased and owned will vary depending on the circumstances. When it makes sense and pricing is right we will opportunistically purchase the real estate. When attractive leases come our way, we'll do those too. As we've shown over our 22-year history there will be many opportunities to do both. In total, during the year and since, we've added 20 operations to our organization, and we are very excited about this year. The pipeline for our typical turnarounds, including real estate acquisitions and leases is very strong and improving. We have a dozen new additions that we are working towards closing in the coming months and are seeing a significant increase in the number of opportunities for both leased and owned portfolios. As we mentioned in our release yesterday, we have significant capacity with over $340 million in available capital and very eager capital partners ready to help us grow. And with that, I'll turn the call back over to Barry.

Thanks, Chad. Next we'd like to highlight some examples of the successes our local teams have seen this quarter. While external circumstances have been difficult our partners continue to defy the odds and produce remarkable outcomes clinically, culturally and financially. The pandemic has added complexity to our operational landscape and in some ways it has also reinforced the simple fundamentals that allow operations to be successful regardless of circumstances. These fundamentals such as clinical confidence, stable and consistent leadership, and partnership with health care continuum providers have allowed many of our facilities including Legend West, a skilled nursing facility in San Antonio, Texas to thrive in the midst of unprecedented clinical challenges, reimbursement changes, regulatory oversight, and staffing pressures. Despite the constant pressures throughout 2021, CEO Robert Gray and COO Monica Sanford and the team at Legend West, which has been together for many years have continued to strengthen clinical and financial results quarter-after-quarter. Because of the stability and leadership the team continued to execute a very successful managed care strategy. Working together with local managed care plans, they increase clinical capabilities through specialized training and streamlined processes to meet the needs of both the plans and their patients. At the same time, the Legend West team has relentlessly improved quality metrics and maintained an overall five-star rating from CMS as well as preferred status from multiple managed care networks and the Veterans Administration. As a result, occupancy and revenues have consistently grown quarter-after-quarter and year-after-year. For example during the fourth quarter of 2021, skilled mix increased by 30% compared to the prior year quarter, while managed care patient days increased by 39% in 2021 over prior year. This has led to a 27% improvement in total managed care revenues and contributed to 2021 being the highest EBIT year ever for the facility. These continued improvements by Legend West demonstrate that there will always be a strong demand for top-quality skilled nursing and rehabilitation services. As the pandemic continues, staffing challenges have hit all sectors, but have been particularly difficult for rural health care facilities. However, many of our operations are finding ways to thrive despite the challenges. One example of this is Pinnacle Nursing & Rehabilitation in Price, Utah, a small community in the eastern part of the state where CEO Seth Anderson and COO Lindsey Callahan have led their team staffing efforts in some very innovative ways. Recognizing that the easiest way to successfully staff a facility is to prevent employee turnover, the Pinnacle team has been obsessed with taking care of their existing staff and becoming the employer of choice in the community. This positive culture has not only resulted in staff turnover rates that are less than one-third of the national average, but also has created a pipeline of referrals from employees encouraging their friends and family to join the Pinnacle team. Pinnacle staffing success goes beyond just great culture. The facility has also pioneered in-person and virtual CNA training programs and strategically partnered with the local community college nursing program to ensure a consistent inflow of talented clinicians. As expected, the successful culture at Pinnacle continues to produce exceptional clinical outcomes including a five-star rating overall for quality measures. Similarly, the facility increased revenues, occupancy, and skilled mix throughout 2021 which resulted in a 31% EBIT growth over 2020's record financial performance. Although Pinnacle has been an Ensign affiliate for over a decade, it continues to meaningfully improve year-after-year demonstrating the incredible potential for growth latent in even established same-store operations. We hope that these examples are helpful in illustrating the different levers our local operators have to pull in order to quickly adjust to the needs and the feedback of their health care partners. With that, I'll turn the time over to Suzanne to provide more detail on the company's financial performance and our guidance and then we'll open it up for questions.

Thank you, Barry. Good morning everyone. Detailed financials for the year are contained in our 10-K and press release filed yesterday. Some additional highlights include the following for the year. GAAP diluted earnings per share was $3.42, representing a 12% increase. And adjusted diluted earnings per share was $3.64, an increase of 16%. Consolidated GAAP and adjusted revenues were both $2.6 billion, an increase of 10%. For the quarter, GAAP diluted earnings per share was $0.86, representing a 5% increase and adjusted diluted earnings per share was $0.97, an increase of 21%. Transitioning in same-store occupancy increased by 6.8% and 3% respectively. In addition sequential transitioning and same-store occupancy increased by 1.7% and 40 basis points respectively. Other key metrics as of December 31st include cash and cash equivalents of $262 million, cash flow from operations of $276 million, and $343 million of availability on a revolving line of credit. We continue to de-lever our portfolio achieving a lease-adjusted net debt-to-EBITDA ratio of 2.13 times, a decrease of 0.29 times from last year. We also own 101 assets, 77 of which are unlevered with significant equity value that provide us with even more liquidity. As of the year ended December 31st, 2021 and since, we repurchased 265,000 shares of common stock for $20 million, completing our October 2021 stock repurchase program. We also announced yesterday that the Board approved a new stock repurchase program for 2022 in the amount of $20 million. Given the stock's recent performance, our liquidity, and confidence in near and long-term results, we believe this additional share buyback to be a very wise use of our capital. As we've said before, share buybacks are one of the many levers we have to deploy capital to benefit our shareholders. In mid-January, the public health emergency was extended for another 90 days to April 16th, 2022. With this extension, the federal government will continue to provide various waivers and FMAP funding. As Barry mentioned, we anticipate that this additional funding will continue into the second half of the year. Additionally, it was announced that the suspension of the 2% sequestration would continue through April 1st, 2022 and then would be 1% through June 30th, 2022 after which the full 2% sequestration will be back in place. The suspension has and will continue to have a positive impact on our revenue depending upon how the pandemic affects our Medicare census. We are providing our 2022 annual earnings guidance of $4.01 to $4.13 per diluted share and annual revenue guidance of $2.93 billion to $2.98 billion. The midpoint of this 2022 earnings guidance represents an increase of approximately 12% over our 2021 results and 30% over our 2020 results. Our 2022 guidance is based on diluted weighted average common shares outstanding of approximately $57.3 million; a tax rate of 25%; the inclusion of acquisitions closed in the first half of 2022; the exclusion of losses associated with start-up operations which are not yet stabilized; the inclusion of anticipated Medicare and Medicaid reimbursement rate increases net of provider tax; and with the primary exclusion coming from stock-based compensation. Additionally, other factors that could impact quarterly performance include variations in reimbursement systems delays and changes in state budgets, seasonality in occupancy and skilled mix, the influence of the general economy, census and staffing, the short-term impact of acquisition activities, variations in insurance accruals, surge in COVID-19 and other factors. And with that, I'll turn it back over to Barry.

Thanks Suzanne. We want to again thank you for joining us today and express our appreciation to our stakeholders for their confidence and support. We know that this year will not be without some unique challenges. However, we are encouraged by our operational strength in our core business. But also this new growth lever that we have in the Standard Bearer to help accelerate our mission to change post-acute care. With Ensign operations, as its primary tenant, it's a perfect launching pad to create significant real estate value as we follow our proven model while aligning with others in our industry. As Chad pointed out earlier, we believe that little to no value is being assigned to our real estate by our investors when in fact the value is approximately $1 billion. We're going to grow that value and take advantage of opportunities that we previously would have passed on and leverage our best-in-class field leadership team to help attract and partner with other great providers in our space. Speaking of our talented field leaders, we recognize them for their heroic efforts along with those of our nurses, therapists, and other frontline care providers, who continue to provide an industry-leading example of life-enriching service to our residents, coworkers and communities. We're also appreciative to our colleagues here at the service center who are working tirelessly to support our operations enabling us to succeed in spite of the challenges we faced. Thank you for making us better every day.

Our first question comes from Tao Qiu from Stifel. Your line is now open.

Hey. Good morning. Could you help me understand the building blocks of the 12.5% revenue guidance for 2022 at the midpoint in terms of occupancy outlook rate and skilled mix on the existing portfolio the contribution from recent acquisitions? And in terms of state support, I think you have recognized $75 million of the FMAP funding in 2021. And based on your comments, do you expect half of that level for 2022? Thanks.

Great questions. I'll let Suzanne discuss the revenue aspect of your inquiry. Regarding state support through the FMAP program, our expectation is that this support from the federal government via the states will likely conclude in the latter half of 2022. This estimate is based on the assumption that the state of emergency may be easing. However, should COVID continue to present new variants and outbreaks, that support might persist. Nonetheless, we are anticipating it will likely wrap up sometime this year. In terms of occupancy and skilled mix, we typically observe that during community surges, our occupancy may stall or decrease, while the skilled mix tends to rise as we care for sicker patients. Despite the challenges posed by the Delta and Omicron variants, our overall trend for 2021 indicates a gradual return to pre-COVID occupancy levels, and we expect this trend to carry on into 2022. Suzanne, would you like to add anything?

Yes. I would just say that while we can't predict the future, we have approached this similar to last year by analyzing the census and skilled mix growth in two different scenarios. One scenario assumes a lighter year in terms of COVID impact with an overall increase in census and strong skilled mix, though not as robust as last year. The other scenario considers a year with significant COVID and a high skilled mix but potentially less increase in census. We've analyzed both scenarios to arrive at our overall projections. When looking at acquisition versus organic growth, we find that the majority of the growth is coming from organic sources. Kind of historically looked at the bucket from our skilled nursing at the same-store transition and recently acquired, and have really taken a look back and had the opportunity to grow each one of those buckets in the same-store really in that mid-single digit to high single digit growth transitioning in the mid- to high single-digit growth and then the acquisitions at a double-digit growth. And so with that, huge portion of our revenue coming from that same-store bucket, which is very large, we expect that to continue to enhance and grow.

Yes. That's very helpful. Just looking at the 2021 experience, COVID certainly had an expected impact on the revenue side relative to the initial guidance, while you guys were able to pull ahead on the earnings side. In that context, how should we think about the 2022 guidance? Any lingering impact you are building into the guidance? And what's the level of conservatism in particular in the 2021 experience?

Yes. I mean, I think what you saw and we had this happen in Q4 where we had a really heavy COVID at the very beginning and at the very end you did see the overall revenue come down, but the margins stay up. And I think that that's kind of what we would anticipate. Again, we're really looking to not just focus on that revenue growth but really overall we're concentrating on how we're earning, how we're creating overall earnings and the bottom line. And so I think that's when you think back about our model and look at how we project, really that is our focus is how we actually continue to grow. We're not going to just try to make that revenue number and that revenue target, but really look at the overall. And so I think if we had a lot of surges again of COVID maybe we wouldn't get to the revenue number per sequential, but we would have higher acuity, higher skilled mix, which would result in a stronger earnings margin.

Got you. And one more question on the captive side if I may. I think in 10-Q, you guys called out the Ensign's rental revenue at $54 million plus the $60 million. That's $70 million in terms of year one rental revenue. Does that include a straight-line rent as well?

Yes. So yes, it's not a straight line per se because all of our rents are CPI-based. And with the CPI-based rent, you actually don't straight line that amount. And so we would continue to project that CPI increase if you're looking at how to look at that on a go-forward basis had that CPI actually built up in there.

CPI would cap, they typically have a cap on the 2.5% to 3% typically.

Got you. So it's the same as cash right now. So, just curious on the debt balance, right? On day one, I think the debt to assets is about 25%. Any plan to lever it up as you ramp up investments?

I think your question is on the captive REIT. Would we lever up the captive REIT over time?

That's right.

Yes, absolutely. I mean, as we're looking at acquisitions, you would actually increase that leverage on it. Obviously, you're going to get additional rent stream, but as you do an acquisition through the REIT, then you would have additional leverage that would occur.

Yes. We always talk about sort of our net debt to EBITDA ratio. And we're obviously very cognizant of making sure we stay very healthy and have a lot of room there. And like I said in my prepared remarks, we have eager capital partners that are excited and anxious to help us do that.

Got you. Thank you guys for taking my questions.

Thank you.

Thanks, Tao.

Thank you. Our next question comes from the line of Scott Fidel from Stephens. Your line is now open.

Hi, everyone. Thanks. And first of all, I appreciate the additional disclosures now in the 10-K on the valuation of the real estate assets. A couple of questions for you. And first just interested, Chad, maybe if you want to talk about the conversations that are underway now around deals and sort of the tempo of that. And I know that you already highlighted that you've got at least a dozen operations that look to be in the pipeline to close relative to the near term. I'm just thinking about the bigger picture. I know you've talked about really sort of during the pandemic that a lot of the sellers have had pretty elevated valuation expectations, just given all of the additional relief funding from the pandemic. And just interested in terms of how that sentiment is evolving at this point. Are you starting to see some softening of those expectations and more attractive opportunities starting to open up, or is it still relatively consistent with what you've been telling us about over the last 12, 18 months or so?

Thanks, Scott. It's been interesting to observe that some individuals still maintain high expectations. However, the supply and the increasing number of acquisition opportunities are likely to have a natural effect on this. We've noticed a rise in activity over the past three weeks as we've entered the New Year. As Barry pointed out, there isn't much visibility regarding some of the federal programs that have been in place. Nonetheless, we’ve definitely seen a surge in deals, and we feel that the prices—at least for the ones we're pursuing—have become much more realistic. We're excited about this development.

Got it. For my second question, I wanted to follow up on the state relief funding and how we should incorporate that into our modeling. Last year, I believe you recorded around $75 million in state relief funding. I understand that it's challenging to predict what will happen in 2022, but I am curious about your thoughts. Do you expect this type of revenue to remain fairly consistent in 2022, or do you anticipate a significant drop-off, especially since it seems more weighted toward the first half of the year?

Great question. I think maybe just as a reminder of how we actually even look at those dollars coming in, we really do reflect the every FMAP dollar against a COVID related expense. And so, obviously, the heavier the COVID is in a particular quarter, even with the funding, you're probably going to get a little bit heavier COVID revenue or if COVID experience in a particular quarter is lighter than that COVID revenue would trim down. So just remembering that the revenue isn't recognized until we have a COVID expense. And then when we kind of look through the year, we know it's all the way through April, like we said in the prepared remarks, and what we are hearing and fill, and have built into the guidance is that definitely we go through July based upon everything that's out there. And then kind of teetering off towards the second half of 2022. So they're not as strong, because as we've seen every state has their own way of dealing with FMAP dollars. So it's not this consistent amount that we're getting from every state. But as every state goes through the analysis, they're actually putting money out there, maybe, on a daily basis or putting money out there in lump sum and so, kind of teetering out through that second half of 2022.

Yes, to Suzanne's point, we utilized the COVID-related FMAP funding most heavily in the fourth quarter of last year. We experienced two COVID surges, Omicron and Delta, within a single quarter, which naturally resulted in higher expenses. We are observing Omicron beginning to decline, as reflected in our numbers for both staff and resident cases. Our expectation is that there will still be higher expenses in the first quarter, but we remain hopeful and optimistic that things will begin to improve throughout the year. As that happens, FMAP will eventually phase out, which is expected, and we hope that our reliance on it for COVID-related expenses will also decrease.

Understood. That's helpful. Yeah, because I think there's a perception amongst some investors, I think out there that those FMAP funds, the enhanced funds, have been bolstering margins. And if those go away, you could see some compression in margin. I think it sounds like the point that you're trying to make is that that's more margin neutral because you're booking costs against those revenues. But maybe I just want to give you a chance to address that directly in terms of how those FMAP funds flow through margins and whether there would be any compression or not if those funds were to go away?

And that's a great point Scott and that's precisely why we're pointing out that we're using the funds only to the extent that we have COVID-related expenses. And so again, our assumption is that as a lot of these expenses go away, the need for FMAP will also go away. And so, we're predicting that the pandemic will evolve this year, but again it's really hard to say. Certainly, if it doesn't our expectation is that the government program will continue because I think the intent of the program is to help offset the higher COVID-related expenses. But certainly, we expect to reduce our dependency regardless of whether or not the pandemic persists. Our focus this year is on really kind of returning to fundamentals after having so much time and focus and energy on the kind of the pandemic-related issues that come up both with regulatory and staffing and all the other challenges that come. Our focus is to make sure that we really kind of return to our efficient operating model and have some of the kind of the COVID-related distractions subside.

Understood. And then just one last one for me. If you could talk about what type of wage inflation you're building into the 2022 budget, and how that compared to 2021? And that's it for me. Thanks.

So we're not necessarily prepared with exact numbers on how much wages have gone up. We've indicated in the past that we certainly saw an acceleration of the need for some structural wage increases towards the second half of last year and we expect those to remain in place. Certainly, you can look at kind of our run rate from third and fourth quarter. But even there, our expectation is that we're going to be better at managing our overall labor in spite of higher wages that we see in place. We're seeing some success with that as we again like I mentioned return to a focus on fundamentals.

I would like to point out that we have some natural offsets related to wage inflation. It's true that this year's wage inflation is higher than what we've historically experienced, typically in the low 2% to 3% range, but now we're in the mid-single digits. However, we have offsets that include our overall incentive plans linked to the profitability of each operation and our various markets. A significant factor is the agency amount, which peaked in Q4. We are actively working to reduce this agency amount, and without significant COVID surges, we believe this is achievable due to the additional programs we introduced last year, such as CNA schools and others we've discussed with you.

Agency is a significant issue for us. We are transparent about discussing our agency usage, which accounts for approximately 5% of our overall nursing expenses, notably lower than many of our competitors. However, it remains a considerable cost despite being a small percentage of total labor expenses, and we are actively working to reduce it. Reducing this expense not only enhances patient care but also alleviates a financial burden we aim to diminish. The evidence of our progress is reflected in our hiring acceleration. We have observed a substantial increase in hires over the past two quarters, and we are seeing further positive trends in the first quarter, indicating that we are beginning to see improvement in our staffing situation.

Okay. Great. Very helpful. Thanks.

Thank you. Our next question comes from the line of Ben Hendrix from RBC Capital Markets. Your line is now open.

Hi, thanks. I have a quick question. When discussing the waiver programs and Medicaid, is there anything specific you can mention regarding your assumptions about the Texas Medicaid waiver and the DSRIP program?

Yes. I mean there's nothing unique that we haven't guided in there with regard to that program. I think just for us we've really taken Texas, since that it's going to continue to have the supplemental program that exists there for 2022 in a form that's similar to how it exists today.

We've observed that many providers are excluding it from first quarter guidance but including it in the latter three quarters. Is this the correct way to think about it, or do you plan to keep it included throughout the entire year?

I believe the program you're referring to does not affect us significantly. The program that has the most impact on us is the QIPP program. That is the one that truly affects us the most, and we have managed to keep it flat year-over-year based on the developments within that program as a supplemental provider.

Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Barry Port for closing remarks.

Thanks, Gigi. And we'll go ahead and wrap up our Q&A, and I would like to thank everyone for joining us today.

This concludes today's conference call. Thank you for participating. You may now disconnect.