Ensign Group, Inc Q2 FY2023 Earnings Call

Good day, and thank you for standing by and welcome to Ensign Group Incorporated Second Quarter Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Chad Keetch, Chief Investment Officer. Please go ahead.

Thank you, operator, and welcome everyone. 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 PM Pacific on Friday, August 25, 2023. We want to remind any listeners that may be listening to a replay of this call that all statements made are as of today, July 28, 2023, 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, 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, referred to as the Insurance Captive, provides certain claims made coverage to our operating companies 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. The words Ensign, company, we, our, and us refer to Ensign Group, Inc., 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 use of the words we, us, our, and similar terms may be used today are not meant to imply, nor should it be construed as meaning that Ensign Group has direct operating assets, employees, or revenue, or that any of the subsidiaries are operated by 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 over to Barry Port, our CEO. Barry?

Thanks, Chad, and thank you everyone for joining us today. We are very happy with the record results we reported this quarter as our local leaders and their teams achieved excellent clinical and financial results, even when the operating environment continues to present challenges. During the quarter, we saw continued improvement in occupancy, skilled revenue, skilled days, and managed care revenues, which is particularly impressive given persistent labor market pressures and the return of more typical seasonality. As we anticipated in our last report, we saw fewer admissions in the second quarter, which is typical in the summer months as seasonal factors impact patient flow. However, our occupancy performance remains strong with same store occupancy of 78.5% as of the end of the quarter, which was an increase of 3.97% over the prior year quarter. We are confident that we are on a path to reach and eventually exceed our pre-COVID same store occupancy of 80.1% as we move into the higher admission months of fall and winter. In addition, we may never have seen as much potential to drive organic growth across our portfolio than we do right now. There are so many opportunities in front of us to improve labor and drive occupancy and skilled mix as we continue to successfully transition 45 recently acquired operations. We are very excited to see our local field and Service Center partners share and apply best practices as they respond to the significant labor market challenges. As they instill our customer second culture into each operation, we have seen and will continue to see lower turnover and less usage of third-party nursing agencies, which again improved for the six months in a row as of June 30th. We also see the enormous growth opportunities in same store occupancy in enhancing our ability to care for skilled patients in a way that best serves each unique healthcare market. During the quarter, our same store operations grew skilled mix revenue and skilled mix days by 8.8% and 5.6%, respectively, over the prior year quarter. We also continue to build stronger relationships with our managed care partners due to the better coordination of care, increased capabilities, and strong clinical outcomes. As a result, we saw increased volume in our same store and transitioning combined managed care census and managed care revenue, which increased during the quarter by 8.2% and 12.2%, respectively, over the prior year. As we indicated last quarter, we continue to see that our skilled mix for both revenue and census remains elevated when compared to pre-COVID levels, showing just how important high quality post-acute services are within the continuum of care. We continue to demonstrate our ability to find, transition, and improve our recently acquired operations. We are encouraged to see our ability to transition new operations continue to improve with each and every acquisition both in larger and smaller deals. Because we’ve demonstrated a track record for successfully transitioning operations throughout our history, we sometimes worry that we underemphasize how truly remarkable these transformations are. The process each operation goes through to achieve the clinical and financial results we expect is so complex and varies so much building-by-building; it's difficult to describe unless you have seen it close-up. But this is where our local approach really shines. With the support of local cluster and Service Center experts, each leadership team is empowered to implement the changes their operation demands, down to every aspect of clinical offerings and expense management. So, when we see these results in many of these operations across a diverse set of locations, all in a relatively short period of time, it shows that we are learning and improving each time we grow. We expect some of these operations to face some transitional growth pains during the year, including some pressures on occupancy that are typical during the summer months, but we can't wait to see how these operations continue to contribute to our results as they mature, and we look forward to many more like them in the near and long-term future. Due to our solid skilled mix and occupancy growth as well as continued strength from our recent acquisitions, we are increasing and narrowing our annual 2023 earnings guidance between $4.70 and $4.78 per diluted share, up from $4.64 to $4.77 per diluted share. This new midpoint of our 2023 earnings guidance represents an increase of 14.5% over our 2022 results and is 30.2% higher than our 2021 results. We are also raising our annual revenue guidance to between $3.69 billion and $3.73 billion, up from our previous guidance of $3.68 billion to $3.73 billion. This increased guidance comes on top of the enormous growth we experienced in the last few years. To put this performance in perspective, since we spun out The Pennant Group in 2019, we have seen adjusted EPS grow by 166% with a compound annual growth rate of 27.7%. This performance is not due to some large events or a single transformative transaction, but instead as a result of consistent growth and performance quarter-after-quarter that comes from following proven Ensign principles. We are excited about the upcoming year and confident that our partners will continue to manage and innovate through all the lingering challenges on the labor front. All of these results we have discussed today are only made possible by the relentless efforts of our leaders, caregivers and their continued endurance and strength, all while many of them were helping transition 45 recently acquired operations. We look forward to even more clinical and financial success during the remainder of the year as our focus is following and protecting the operational principles that got us here. Now, I'll ask Chad to provide some additional insights regarding our recent growth. Chad?

Thank you, Barry. After adding 19 operations last quarter, we took some much needed time to continue to work together with our new teams and all 45 of our newly acquired operations as they continue to adopt Ensign's cultural principles. We couldn’t be more excited about the organic growth potential within our existing portfolio, as our new acquisitions are already contributing to our results, in many cases ahead of schedule. As a result of skilled services expansions in the first half of 2023, occupancy and skilled mix days for the skilled nursing operations in the recently acquired bucket was 77.2% and 28%, respectively, for the quarter. For those that have been following us for years, this is a very impressive starting point from which to build. However, when compared to our same store occupancy and skilled mixed days of 78.5% and 32.3%, respectively, there is enormous upside in each of these operations as they continue to transform into same store caliber operations. As we evaluate the horizon for new deals, we are well down the road on several opportunities, and assuming everything goes as planned, we expect to announce a handful of new acquisitions in the very near future. The pipeline has been steady over the summer and we expect more opportunities to arise in the fall as we approach the end of the year. The past few years have been very difficult for skilled nursing operators and we see evidence of that in the low occupancy and high utilization of third-party nursing agencies, and the poor clinical and financial health of the facilities we have recently acquired. As a result, we still expect that there will be lots of opportunities that will arise. However, as we always remind you, we do not set arbitrary growth goals and we’ll remain true to our disciplined acquisition strategy, only growing when we have the right leaders in place and the pricing is right. We continue to look at opportunities in new states, but as we've said before, entering new states is challenging and can often take time to gain the trust of the local healthcare community. With the success, we continue to enjoy in South Carolina, we hope that we'll be able to continue to build Ensign’s footprint in nearby southern states. That said, we will always place the highest priority on growth opportunities within our existing footprint. As we carefully select our acquisition targets, we prioritize those that give us exposure to new markets and states we already operate in, and those that enhance our service offerings and markets we've been in for years. Our real estate investment trust, Standard Bearer, continues to evaluate a steady flow of deal opportunities that would potentially include leases with several unaffiliated tenants in addition to providing opportunities for Ensign affiliated operations. In fact, we expect to announce just such a transaction in the coming weeks. However, we also want to remind you that we are being very careful not to dilute the health of our current portfolio in the name of diversification. As potential transactions cross our desks, we are first focused on the fundamental principles that have led to Ensign’s success, including ensuring that the operator has a fantastic leadership team and that the purchase price will result in a rent payment that will ensure a healthy operation over both the near and long term. We are committed to those principles and are in no hurry to diversify our billion-dollar portfolio that we've spent years building just for the sake of growth. As of the end of the quarter, Standard Bearer, which is comprised of 103 owned assets, generated rental revenue of $19.9 million for the quarter, of which $16.1 million was derived from Ensign affiliated operations. Also for the quarter, Standard Bearer produced $13.3 million in FFO and have an EBITDAR to rent coverage ratio of 2.4 times. And with that, I will turn the call to Spencer, our COO to add more color around our operations. Spencer?

Thank you, Chad, and hello everyone. As Barry and Chad just noted, acquisitions represent an extremely important part of our operational strategy. This is particularly true right now, as we are absorbing 45 facilities that were acquired over the last 12 months. While many of these new facilities are following the typical multi-year turnaround process to reach their potential, we've been pleased to see quicker than average contributions that some of our recent acquisitions are making, clinically and financially. One great example of this is Fairmont Rehab Hospital, located in Lodi, California. This 59-bed skilled nursing and rehab center had a good reputation in the community prior to transition. Thanks in part to the leadership of longtime Executive Director, Randy Tu and Director of Nursing, Jennibeth Devera. Despite their prior history of success, Randy and Jennibeth truly embraced the cluster model, as well as the sophisticated tools and data that our organization provides to help affiliated operations succeed at the day-to-day fundamentals. As a result, over the past five months, the Fairmount team has already made a meaningful EBIT contribution. In addition, they've successfully eliminated third-party nursing agencies and reduced overall nursing labor expenses, while simultaneously growing revenues, occupancy, and skilled mix, all this while maintaining a CMS 5-star overall rating, as well as a 5-star rating for health inspections and quality measures. However, with the focus and excitement that surrounds new transitions, it's important that we don't overlook the greatest contributor to our ongoing success, consistent year-over-year improvement in our same store operations. One exceptional example of this is Beacon Hill Rehabilitation, located in Longview, Washington. This CMS 5-star rated 67-bed skilled operation is led by CEO, Steve Ross and COO, Amanda Ogden. It was acquired in 2014, and after transitioning has been able to achieve five straight years of financial improvement while serving as Longview’s facility of choice. Despite years of high performance, Beacon Hill grew revenues by 13% in the second quarter compared to the prior year quarter; even more impressive year-to-date, EBIT is trending 47% ahead of last year through the first half of the year. More than just focusing on their own success, though, the leadership team at Beacon Hill has led the cluster model and found ways to improve the results of the other 12 facilities in the Washington market. One particularly impressive example of this is how Beacon eliminated their own reliance on third-party nursing agencies late in 2022, and then reached out to share ideas and pushed the other facilities in their market to do the same. The result is that since April 1st of this year, none of the 13 affiliated facilities in the state of Washington has used even a single shift of agency nursing labor. While there are more incredible success stories than can possibly be shared, we hope that these two examples demonstrate the synergistic mix of newly acquired and same store contributions that have allowed us to continue to achieve record results, even in today's challenging environment. And 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 up for some questions. Suzanne?

Thank you, Spencer, and good morning, everyone. Detailed financials for the quarter are contained in our 10-Q and press release filed yesterday. Some additional highlights for the quarter include the following: GAAP diluted earnings per share was $1.12, an increase of 10.9%. Adjusted diluted earnings per share was $1.16, an increase of 14.9%. Consolidated GAAP revenues and adjusted revenues were both $921.3 million, an increase of 25.8%. GAAP net income was $64 million, an increase of 10.9%. And adjusted net income was $66.3 million, an increase of 15.4%. Other key metrics as of June 30, 2023 include cash and cash equivalents of $420 million, cash flow from operations of $168.1 million, and $593 million of availability on our revolving line of credit. During the quarter, we paid a quarterly cash dividend of $0.0575 per share. We also deleveraged our portfolio achieving lease adjusted net debt-to-EBITDA ratio of 2 times, which is a decrease from last year of 2.03 times and is particularly impressive given the amount of growth we have taken on over the last year. As of today, we have no updates from the federal government on the anticipated federal minimum staffing rule. However, since our last quarter, we have continued to receive good news on reimbursement that has provided some extra clarity about the remainder of the year. Starting in October of this year, we expect the federal net Medicare rate to increase by a healthy 3.5%. At the state level, most of the states we operate in have already adjusted their reimbursement to offset some of the reimbursement linked to the public health emergency that ended in May. For example, key states like Texas announced some encouraging changes to their rates. The combination of a positive rate environment and a slowing of inflation in some of our biggest costs, including labor, will add to the operational momentum we continue to generate as we focus relentlessly on fundamentals. As Barry mentioned, we are increasing and narrowing our annual 2023 earnings guidance to between $4.70 to $4.78 per diluted share, up from $4.64 to $4.77 per diluted share. We are also raising our annual revenue guidance to between $3.69 billion and $3.73 billion. We have evaluated multiple scenarios, and based on the strength in our performance and the positive momentum we've seen in operations and strong skilled mix as well as some additional strength in Medicaid and managed care programs, we are confident that we can meet this guidance. Our 2023 guidance is based on diluted weighted average common shares outstanding of approximately 57.7 million, a tax rate of 25%, the inclusion of acquisitions closed in 2023, the inclusion of management's expectations for Medicare and Medicaid reimbursement rates 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, the return of seasonality in occupancy and skilled mix, the influence of the general economy, census and staffing, the short-term impact of acquisition activities, variations in reinsurance accruals and other factors. And with that, I'll turn it back over to Barry.

Thanks, Suzanne. As we conclude, it's essential for us to recognize our incredible team members, facility leaders, field resources, clinical partners, and service center teams who contribute to these record-setting results. Reflecting on the challenges our partners continue to face, we are constantly impressed by their remarkable resilience as they support one another in new and innovative ways. We are truly honored and grateful to work alongside each of them. Their dedication has deeply impacted many lives, including our own. We are optimistic about our future because of these incredible partners, and we have complete confidence in them and the culture they have created together. We'll now move to the Q&A portion of our call. Operator, could you please explain the Q&A procedure to the audience?

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

Great. Hi. Thanks everyone. Good afternoon. First question, just given the unusual size of the acquisition with the North American portfolio, I thought it would be helpful if you maybe you can walk us through how the integration has been proceeding on that portfolio and how the margins in particular have been trending there relative to your expectations in the second half and then how you see that setting up for continued performance in the back half of the year?

I appreciate the question. It has been an important focus for us to ensure that we get the cultural integration right. Whenever we acquire a larger portfolio of facilities, our main concern is about making sure that these new partners feel like an essential part of our organization, understand our operational principles and core values, and share our vision for the future. We have implemented some unique strategies during this transition that have been very beneficial. Our leaders had early access to the North American partners, allowing them to spend time together before the transition to help them learn and adapt to the necessary changes. Additionally, we introduced new tools and operational processes that proved helpful in ensuring a smoother transition than we anticipated. While we faced some significant initial challenges, such as high nursing agency rates and other operational adjustments, as well as lower occupancy compared to our other California operations, we quickly overcame many of those hurdles. Although we are not yet where we need to be with these operations, the transition has been effective. We have witnessed a faster path toward viability and profitability at each operation than expected, to the extent that they are all contributing now. The good news is there is still substantial potential for improvement, with excellent leaders already in place, including highly experienced clinical leaders in every building. Having strong operational and clinical leaders, along with supportive partners, creates a good formula for success in one of our strongest states. The leadership experience around these North American buildings has been very effective in helping these leaders feel valued within our organization.

My second question is about the EBITDA margins. In the first half of the year, you reported 11.3% in the first quarter and 11.2% in the second quarter on an adjusted basis. There are several factors to consider, such as the winding down of FMAP and the integration of the North American property. As we approach the second half of the year, we are still anticipating the minimum staffing rule, which will take effect later on, and you've noted some rate increases. While I understand you don't provide quarterly guidance, could you share your thoughts on the expected trend in margins for the third and fourth quarters, especially considering the return of normal seasonality in the business?

Yes. I'll begin, and then Barry can provide additional details. Historically, our strongest quarter is Q4, while Q2 and Q3 are typically weaker. During COVID, we didn't see the usual seasonality. However, we are observing some signs of seasonality returning towards the end of June and expect this trend to continue as we adapt to post-COVID conditions. We have consistently achieved better margins in the fourth quarter compared to Q3. Regarding other developments affecting the numbers, we recently made a North American acquisition that Barry mentioned. We are assessing our EBITDA in relation to EBITDAR, ensuring we account for the full rent calculation associated with these new acquisitions, many of which are leases. Our EBITDAR has shown consistent performance quarter-over-quarter. So, I think that's the situation.

Yes. I believe there are several factors that support our optimism for potential margin expansion towards the end of the year. We continue to make significant progress in our agency operations, as reflected in a steady decline in those numbers for about six months, or two full quarters. Additionally, our skilled mix has improved greatly since before the pandemic, presenting ongoing opportunities. We also maintain strong relationships with our managed care partners, and our field leaders have become increasingly skilled at providing high-quality, high-acuity services that attract more complex patients. Typically, we observe greater growth in skilled mix and sicker patients toward the end of the year. These factors together are likely to contribute to higher margins in the latter part of the year.

Okay, understood. I have one more question regarding the minimum staffing rule, which everyone has been anticipating for some time. I'm curious if there are any proactive steps you plan to take from an operations standpoint in light of this, or if you prefer to wait for the final proposal and then make adjustments as needed. Additionally, in relation to M&A discussions, how much has the uncertainty around this rule impacted your position or that of potential sellers in seeking clarity, or is it not a major concern as you proceed with M&A discussions? That's all from me. Thanks a lot.

Addressing the last part of that question first. It's interesting how sellers tend to ignore any potentiality of any factor that has some kind of a headwind effect. So, that's always funny to us that are you seeing something, we're not seeing. So, but that said, yes, there's a lot we're doing, I would say, on the government relations front. We're very active with our association. We've spent time visiting DC at their request and with folks they want us to meet with, and also providing comments and feedback. We will engage with our association on a pretty aggressive letter writing campaign to both ahead of and behind any release of the proposed rule around federal staffing. We know that proposed staffing rule will be coming. We don't think it will probably be out for another month or so. But what I can tell you that we're doing organizationally is really not reacting much to what we don't know. What we have been focused on is making sure that we continue to be the best employer we can be. We have had an intense focus for the last year and a half on being the employer of choice to make sure our retention efforts are exceptional that we're sharing best practices around how to improve on our culture and our principles that we believe deeply in that we hope make us the place where healthcare workers want to be. So, a lot of discussion around turnover, best practices around orientation and attracting talent and developing new employees by having schools and other programs to attract talent. Those have been in place, absent a federal staffing minimum rule and will continue to be in place post, just in line with what our cultural principles lead us to. The labor challenges really have put all these things at a bigger spotlight for us and really helped us to want to continue on this path of just being better. Whenever the federal staffing minimum rule is, we will address it, and we will deal with it as we have with any other headwind or challenge that has been put in our way before. We're not necessarily looking forward to it, but that's the nature of our industry, and I think if there is an organization that can and will adapt, we'll be able to do it. The other last comment I'll make about that, Scott, is that even when the rule comes out, there's going to be a pretty long comment period around what that rule looks like before it becomes final, that will take many, many months. So it will certainly lead us into the next year. And I think the one thing that we've been giving some clarity on that could change is that there's probably going to be a longer lead time as far as the implementation of the federal staffing rule, as you could imagine. So, again, this is all conjecture. We try not to spend too much time on it, but that's what we know.

I'll just add to the second part of your question there, Scott. Certainly, as Barry was saying, I mean the deals that we're seeing now, sellers and brokers are saying, "Hey, let's build in some minimum staffing into our pro formas for sure. But all that said, I certainly think that will create some disruption in the market that will generate an enormous amount of opportunity for us. Our strategy will remain the same, however, which is to pay prices that are reflective of reality. And as we do that, we're confident that the growth engine that we have will continue to run, and we'll have lots of opportunity to do that.

And our next question comes from the line of Ben Hendrix with RBC Capital Markets. Your line is now open.

Hey. Thanks, guys. A quick question on the guidance. I appreciate the commentary about watching EBITDAR. So, I was wondering if you could give us a little idea on the ramp in lease expense you expect through the back half of the year. And then, where you would expect lease expense to end the year on a run-rate basis? Thanks.

Yes. For the most part, we did not have any additional acquisitions in the third quarter and our second quarter, so the lease amount has a base. Most of our leases have caps slightly above 3%. Having about half of that already accounted for, with some expected in the second half, is a reasonable way to consider the lease expense number.

Thank you. We're noticing increased headlines from health systems regarding the adoption of skilled home care. I'm curious about how you perceive this trend in your markets. Additionally, I believe you were in talks with one healthcare system about a potential in-home strategy. I'd like to understand how that is progressing.

Yes. I mean, I think one major comment or kind of one principal comment I would make about that is that I think any shift of patients that we might have from kind of their current setting to a home setting is a really, really tiny percentage. Our focus is on getting our patients out of our setting and into the home setting to the extent that they're eligible for that transition or capable of it as quickly as possible. That said, there are some things that I think we are looking at that can be done to make that transition better and even look at different strategies and partnerships with physician groups and have a strategy around that successful transition. We've recently partnered with and invested in a group that is focused on this for a high-risk, high-needs population in the San Diego market. We're exploring that partnership and the synergies we can have with that group and seeing how we can expand it. But again, I think we're still talking about a really, really tiny part of our current and future business. And while there's a lot of discussion around this, I think any major shifts that have taken place have already happened. Remember, we started a home health and hospice company and eventually spun it out. We know that business really well. We know the home setting well. But I don't think we see any massive dynamics that would drastically change our business model in the future; more just nuanced market-by-market strategies for maybe high-risk patient populations.

Thank you. I'm currently showing no further questions at this time. I'd like to turn the call back over to Mr. Barry Port for closing remarks.

Thank you. And we look forward to a great year and appreciate everyone's support and for being on the call today.

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.