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Edited Transcript of ENSG earnings conference call or presentation 7-Feb-19 6:00pm GMT

Q4 2018 Ensign Group Inc Earnings Call

MISSION VIEJO Feb 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Ensign Group Inc earnings conference call or presentation Thursday, February 7, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Chad A. Keetch

The Ensign Group, Inc. - Executive VP & Secretary

* Christopher R. Christensen

The Ensign Group, Inc. - President, CEO & Director

* Suzanne D. Snapper

The Ensign Group, Inc. - CFO

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Conference Call Participants

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* Anton Hie

RBC Capital Markets, LLC, Research Division - Associate

* Chad Christopher Vanacore

Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst

* Dana Rolfson Hambly

Stephens Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to The Ensign Group, Inc. Year-End 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to Chad Keetch, Executive Vice President. You may begin.

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Chad A. Keetch, The Ensign Group, Inc. - Executive VP & Secretary [2]

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Thank you, Sonya. Welcome, everyone, and thank you for joining us today. We filed our earnings press release yesterday. This announcement is available on the Investor Relations section of our website at www.ensigngroup.net.

A replay of this call will also be available on our website until 5:00 p.m. Pacific on Friday, March 1, 2019. We want to remind any listeners that may be listening to a replay of this call that all the statements made are as of today, February 7, 2019, 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 company, 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.

The words Ensign, company, we, our and us refer to The Ensign Group, Inc. and its consolidated subsidiaries. All of our operating subsidiaries, the Service Center and the 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 asset and activities as well as the use of the terms we, us and 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-K.

And with that, I'll turn our call over to Christopher Christensen, our President and CEO. Christopher?

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Christopher R. Christensen, The Ensign Group, Inc. - President, CEO & Director [3]

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Thanks, Chad. Good morning, everyone. We're thrilled to report a record quarter as we achieved our highest adjusted earnings per share in our history. Our GAAP earnings per share for the year was $1.70, an increase of 121% over the prior year and adjusted earnings per share was $1.88, up 34% for the year.

Our GAAP earnings per share for the fourth quarter was $0.48, an increase of 129% from the prior year quarter, and adjusted earnings per share was $0.54, an increase of 35% over the prior year quarter. All of these numbers are record highs.

During the quarter, we experienced a dramatic improvement in our Transitional and Skilled Services segment income of 36% over the prior year and 38% over the prior year quarter. We also experienced positive trends in occupancy with an increase of same-store skilled services occupancy of 63 basis points and transitioning skilled services occupancy of 296 basis points, both over the prior year. As those that have been following us know, we have been working tirelessly on the transition and integration of 148 acquisitions over the last several years in each of our business segments. It often takes several years to truly transform a healthcare operation as the clinical, reputational and cultural transitions take time.

The improvement we've been expecting in many of our operations, especially in Texas and Utah, is now materializing and making a meaningful contribution to our performance.

However, we have many operations and new acquisitions transitioning in same-store operations in all of our geographies that still have tremendous organic upside, even in some of our most mature markets.

As we've stated before, some transitions take more time than others, particularly in newer states. We have several markets that are currently in similar circumstances that Texas and Utah were in a few years ago, but over the period of 20 years with over 300 acquisitions, as we've recently shown in Texas and Utah, our countless leaders have proven this pathway to progress over and over again.

Our other lines of business continue to quietly create significant value. Cornerstone Healthcare, our home health and hospice portfolio grew its segment revenue and income by 20% and 33%, respectively, over the prior year.

Our assisted living and independent living portfolio company grew its segment revenue and adjusted EBITDAR by 11% and 9%, respectively, over the prior year.

Collectively, these 2 business segments now represent 16% of Ensign's consolidated revenue. The income growth of each of these business ventures has achieved is further evidence of our ability to apply our operating principles in several health care services. We expect to see each of these segments grow by acquiring underperforming operations and driving organic growth. As they apply proven Ensign principles, we believe this sometimes forgotten underlying value will become increasingly more difficult to ignore.

We're making progress toward the long-term strategic opportunity involving in our new venture businesses. Just as with our real estate transactions in 2000 -- sorry, just as with our real estate transaction in 2014, our goal has been and will be to ensure that these businesses will benefit our shareholders over the long run.

We continue to methodically add value to our real estate portfolio by improving the operating results in our own operations and by acquiring additional real estate assets.

Since we spun out all but one of our real estate assets to CareTrust REIT in 2014, we've added 169 operations and acquired 72 real estate assets.

We'll continue to focus on creating value through solid operational performance, but we also believe it's important to recognize the growing underlying value in our own real estate, and that there are many options available to us to unlock this value for the benefit of our shareholders.

We're also pleased to provide annual guidance for 2019 with earnings of between $2.17 and $2.26 per diluted share and annual revenue between $2.29 billion and $2.35 billion. Overall, the midpoint of this guidance represents a 19% or $0.36 per share increase from the midpoint of our annual earnings guidance for 2018. As we've often reminded you, our business can be a bit lumpy from quarter to quarter, and we would expect our performance to be more heavily weighted towards the latter half of the year.

We're very excited about the coming year and our guidance demonstrates our optimism for the future. And with that, I'll ask Chad to give us an update on our recent investment activity. Chad?

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Chad A. Keetch, The Ensign Group, Inc. - Executive VP & Secretary [4]

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Thank you, Christopher. During the quarter, we paid a quarterly cash dividend of $0.0475, representing an increase of 5.6% over the prior year. This is the 16th consecutive year we have increased our dividend, which we hope shows our continued confidence in our operating model and our ability to return long-term value to our shareholders.

Also during the quarter and since, the company's operating subsidiaries made the following acquisitions. In November, our affiliate acquired the real estate and operations of Rock Creek of Ottawa, a post-acute care retirement campus with 93 skilled nursing beds, 71 assisted living units and 24 independent living units located in Ottawa, Kansas. This acquisition represents the fourth transition from a nonprofit seller in 2018, demonstrating Ensign's continued success in working with nonprofit operators that are looking to reposition their assets.

Also in November, we acquired the real estate and operations of Creekside Transitional Care and Rehabilitation, a 139-bed skilled nursing and 21-unit assisted living facility located in Meridian, Idaho and Bennett Hills Rehabilitation and Care Center, a 44-bed skilled nursing facility located in Gooding, Idaho.

These acquisitions brought the number of skilled nursing operations in Idaho to 10, further demonstrating our strategy of developing strong clusters in each local health care market. On the senior housing front, our senior living portfolio company acquired the operations of 5 assisted living facilities, including Villa Court Assisted Living and Memory Care, a 53-unit assisted living and 20-unit memory care facility located in Las Vegas, Nevada; Canyon Creek Memory Care, a 52-unit memory care facility located in Temple, Texas; Bridgewater Memory Care, a 52-unit memory care facility in Granbury, Texas; Lakeshore Assisted Living and Memory Care, a 46-unit assisted living and 30-unit memory care community located in Rockwall, Texas; and Windsor County (sic) [Court] Senior Living, a retirement community with 36 independent living units, 16 memory care units and 7 assisted living units located in Weatherford, Texas.

Also during the quarter, Cornerstone Healthcare Inc. acquired the following: Alpha Nursing, a home health agency in Washington; Cornerstone Home Health and Hospice in Utah; and Sequoia Hospice in California. Each of these acquisitions are small agencies that we purchased from small business owners that were looking to exit the space. We continue to see attractive growth opportunities like these, and we'll opportunistically acquire when our leadership talent, geography and pricing align.

Lastly, in January, the company announced that it acquired the real estate and operations of Cedar Health and Rehabilitation, a skilled nursing facility with 120 skilled nursing beds located in Cedar City, Utah. As is the case with all of our acquisition efforts, we pursued these operations because our local leaders saw a pathway to meaningfully impact the quality of health care services delivered to their patients and the resulting occupancy improvements.

These additions bring Ensign's growing portfolio to 189 skilled nursing operations, 24 of which also include assisted living operations, 55 assisted and independent living operations, 23 hospice agencies, 24 home health agencies and 7 home care businesses across 16 states. We also own the real estate at 72 of our 244 health care facilities.

We continue to see a steady flow of acquisition opportunities across all our business segments. These potential transactions come from a variety of sources and different types of sellers, ranging from small operators and nonprofits to regional or large operators that are selling noncore or turnaround assets. Almost all of the transactions we completed in 2018 fit one of these 2 categories and were completed 1, 2 and 3 at a time.

We continue to see several transactions involving financial or real estate buyers trading at overly aggressive cap rates and lease coverages, all of this in the face of news reports indicating that large historically strong operators are defaulting on rents as a result of poorly structured capital market transactions, onerous leases and unhealthy leverage.

We continue to believe the dynamics in our industry, while sometimes challenging, are not nearly as difficult as many are led to believe as a result of these self-imposed challenges that follow creative financial engineering. One of the keys to our success has been to structure our transactions in such a way to ensure the long-term health of the operation. As I reminded you last quarter, our primary constraint to growth is not capital or pipeline, it's the availability of locally-driven clinical and operational leaders. When we evaluate each opportunity, there are many factors we use to evaluate our level of interest, including the availability of locally-driven clinical and operational leaders, the building's reputation and the estimated return. We constantly remind each other to remain disciplined and true to our leadership-driven acquisition strategy.

However, as we saw last quarter, the pipeline for our typical turnaround opportunities and well-priced strategic deals remains strong. We are already working on a handful of transactions that we expect to close in the first and second quarters of this year, and we remain very confident that there are and will be many, many opportunities to be had at right prices. And with that, I'd turn the call back over to Christopher.

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Christopher R. Christensen, The Ensign Group, Inc. - President, CEO & Director [5]

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Thanks, Chad. Before Suzanne runs through the numbers, we'd like to share a few examples that represent some of the vast improvements that have been made over the quarter. As I mentioned earlier, we've been discussing our progress in Texas and Utah. We thought it would be helpful to provide some additional insights into this progress.

Since we completed the Legend acquisition, which was one of our largest single acquisitions, we dedicated a tremendous amount of operational and Service Center leadership to our Texas operations. Each of our leaders accepted this enormous challenge with a laser-like focus on improving clinical outcomes, star ratings, readmissions and operational and leadership fundamentals.

Due to their efforts, revenues in Texas have grown by almost 16% and EBITDAR has expanded by 33% when compared to the prior year.

Legend Oaks Healthcare and Rehab of Kyle, Texas is one of many examples of this transformation. Led by Executive Director, Matthew Fowers, and Director of Nursing, Mary Calderon, the Kyle team has remained relentlessly focused on strengthening clinical systems. As a result of their clinical success, Kyle has improved from a 2-star facility at transition to a 4-star facility, has become a premier post-acute destination and has grown revenue by more than 16%. They've enjoyed a stronger occupancy and skilled mix and EBIT has grown by more than 190% over the prior year. Kyle is one of many examples within the Legend portfolio, but it's also representative of the steady growth that has happened in Texas overall.

We've been encouraged by the growth in managed care relationships in the state of Utah. Our Utah leaders have developed strategic partnerships with the dominant managed care organizations and have been able to grow overall market share. As a result of the narrowing of networks, our operations have been rewarded with higher volumes of skilled census and overall occupancy, resulting in significant growth in revenue and EBITDAR, which have improved by nearly 16% and 20%, respectively, year-over-year.

To highlight this point, St. Joseph's Villa, a skilled nursing and assisted living campus in Salt Lake City, led by CEO, Brent Wilson, and COO, [Shea Pickett], has seen remarkable growth. St. Joseph's has adapted to accommodate all levels of acuity. From long-term care custodial patients to the most complex cases, including ventilator-dependent and acute behavioral patients, St. Joseph's meets almost any medical need in the market.

As a same-store campus, they still managed to grow EBIT by 16.5% over the same quarter last year, all while maintaining a CMS 5-star rating and a reputation as the premier post-acute facility in the Greater Salt Lake area.

Finally, let me highlight one of our favorite stories of 2018.

As much as we talk about clinical being the focus of everything that we do, North Mountain Medical achieved the unthinkable milestone this year. Jason Postl, CEO, and [Jackie Greene], COO, led one of, if not the busiest and most complex subacute operations in the country. With nearly 100% acuity, they see the most challenging and complex medical cases in a skilled nursing setting. Jason, Jackie and their incredible team of caregivers, therapists and other professionals have achieved a perfect zero-deficiency survey for the third year in a row, an unheard of feat for most any facility but an absolutely unthinkable feat for a subacute operation, let alone one as busy as North Mountain Medical.

This achievement cannot be overstated. The level of expertise, leadership and ownership that is required at all levels for this kind of accomplishment must be nearly perfect. We applaud the 5-star rated North Mountain team and express our gratitude and appreciation for the standard they set for our profession.

We fear at times that we bore you with a lengthy description of how our unique facility-centric operating model allows us to be nimble and proactive in the ever-changing post-acute marketplace, but we hope that this quarter finally clarifies why we repeatedly take time to remind ourselves and you of the tremendous power of Ensign's unique leadership structure. We see additional opportunities for improvement in the months ahead as we continue to grow the company and as these leaders continue to improve their operations and prepare for whatever else the future might bring.

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. Suzanne?

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Suzanne D. Snapper, The Ensign Group, Inc. - CFO [6]

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Thank you, Christopher, and good morning, everyone. Detailed financials for the year are contained in our 10-K and press release filed yesterday. Some additional highlights for the year and quarter include the following. Consolidated GAAP net income for the year was $92.4 million, an increase of 128.2% over the prior year. Consolidated adjusted net income for the year was $102.1 million, an increase of 38.3% over the prior year. Consolidated GAAP net income for the fourth quarter was $26.4 million, an increase of 135.2% from the prior year quarter. And adjusted net income was $29.4 million, an increase of 39.5% from the prior year quarter.

On other key metrics, as of December 31, include cash and cash equivalents of $31.1 million and $300 million of availability on our revolving line of credit. As we expected, our lease-adjusted net debt-to-EBITDAR ratio, which was 4.2x at the end of last year decreased in 2018 to 3.77x. And as a reminder, this is after we have invested $568 million in 178 acquisitions since spinning off the REIT. Also, our free cash flow for the year was $155.4 million. These improvements are attributable to growth in our EBITDAR from transitioning in newly acquired operations and enhanced cash collections.

We have prepared -- continued our preparations to implement CMS' payment reform proposal called Patient-Driven Payment Model, or PDPM. We are learning more and more about how this new system will function, and we are confident that with our relentless focus on quality and efficient outcomes will serve us well in a number of new reimbursement systems, including this latest reiteration, which is expected to go into effect on October 1, 2019.

As Christopher mentioned, we announced our guidance for 2019. We are projecting revenue of $2.29 billion to $2.35 billion and adjusted earnings of $2.17 to $2.26 per diluted share. The 2019 guidance is based on diluted weighted average common shares outstanding of approximately 56.7 million, the exclusion of transaction-related costs and amortization costs related to patient-based intangibles, 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, a tax rate of 25%, the exclusion of stock-based compensation and the inclusion of acquisitions closed and anticipated to be closed in the first half of 2019.

Additionally, other factors contributing to our asymmetrical quarters include variation in reimbursement systems, delays and changes in state budgets, seasonality in occupancy and skilled mix, the influence of the general economy on our census and staffing, the short-term impact of our acquisition activities, variations in insurance accruals and other factors.

And with that, I'll turn it back over to Christopher. Christopher?

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Christopher R. Christensen, The Ensign Group, Inc. - President, CEO & Director [7]

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Thanks, Suzanne. Again, I want to thank you for joining us today and express our appreciation to our shareholders for their confidence and support. We deeply appreciate our colleagues in the field and the Service Center for making us better every day. We'll now turn the call over to Sonya if you would, and conduct -- help us to weave our way through the Q&A if you would.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Chad Vanacore of Stifel.

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Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [2]

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So organic occupancy growth improved for 3 consecutive quarters at this point quarter-over-quarter. What are you expecting for 2019? And then what's driving that organic portion of growth? Is that less pressure from payers or referral sources on average length of stay? Or is it volume and demand?

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Christopher R. Christensen, The Ensign Group, Inc. - President, CEO & Director [3]

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Yes, I mean, I think, from our perspective, I think, we expect it to continue, Chad, and I don't know that it's the same everywhere in all of our geographies, but we really feel like it's more about what our leaders are doing because I think we saw the uptick happen more -- happen earlier than it happened industry wide. So obviously, we're biased, Chad, but we feel like it has a lot more to do with our leaders than it does with the marketplace.

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Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [4]

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Okay. And then Christopher, you mentioned a healthy acquisition pipeline. So do you have a targeted spend on M&A? And then what mix of assets are you expecting in here? You're roughly 85% SNF now, but you seem to be growing on the AL, memory and then home health and hospice.

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Christopher R. Christensen, The Ensign Group, Inc. - President, CEO & Director [5]

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Yes, I mean, I want to be helpful to your model. It -- we don't have goals surrounding that ever. We think it keeps us disciplined. It's not just something we say. It's something we believe in strongly, but based on what we see out there, I think that we'll probably grow a little bit faster in home health, hospice and, obviously, the denominator is a lot smaller. So -- but we think on a percentage basis, we'll grow a little bit faster in home health, hospice and assisted living than we will in skilled nursing.

So I would expect -- that number has crept up from 3% several years ago to 16% now. And I think it will continue to creep up, but we'll still grow at a decent pace in skilled nursing based on what we see out there right now. We are seeing prices, they adjust and then we have some people that come and do deals that make very little sense to us, and so they don't stay adjusted as long as they probably could or should. I know I'm not giving you hard numbers, Chad. How can I be more helpful to you?

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Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [6]

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Well, I'll tell you what, I'll skip to the next question. This one will be my last, which I was just thinking about the expansion. You're still skewed to the West. You did curtail it in the East, particularly the Southeast. Are there any regions where you see an abundance of opportunities? Or should we expect you to really focus on the Western markets?

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Christopher R. Christensen, The Ensign Group, Inc. - President, CEO & Director [7]

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I still think we'll focus a lot more on our existing footprint than expansion right now. I mean, you could see us grow in states as we get a little bit healthier, in places like Wisconsin and some of the other Midwestern states that we're in. But we don't have any real plans to expand our footprint wildly in 2019. There's plenty of opportunity in our existing footprint.

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Operator [8]

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And our next question comes from Frank Morgan of RBC Capital Markets.

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Anton Hie, RBC Capital Markets, LLC, Research Division - Associate [9]

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It's Anton Hie on for Frank. Just a couple here. On the acquisitions, obviously, a lot of good opportunities out there, but wanted to ask about kind of the timing of expectations here in the first quarter? And if you can talk a little bit about, for some of the assumptions we might want to make on contribution or anything you can add there on the first half acquisition?

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Chad A. Keetch, The Ensign Group, Inc. - Executive VP & Secretary [10]

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Yes. Thanks, Anton, this is Chad. So we have, I would say, a small handful of deals that are looking strong for Q1. And then we also have sort of a smattering of acquisitions that could happen Q1, but might go into Q2. As you can imagine, there's a whole lot of factors that come into play, even if we have a deal in principle, that could impact the timing of closing. So we're just sort of working through some of that, but I would say the acquisition pace for the first quarter would likely be less than what we had in Q4. And then as Q2 continues, we'll probably pick the pace up a little bit.

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Anton Hie, RBC Capital Markets, LLC, Research Division - Associate [11]

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Okay. And then, I guess, that also builds into the back half of the year being stronger from a quarter-to-quarter sequential performance.

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Suzanne D. Snapper, The Ensign Group, Inc. - CFO [12]

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That's correct. I mean, I think when you think about what kind of acquisitions we typically take on, they're not contributing a lot to the bottom line when we first take them on. So even though we might get that revenue bump in the earlier quarters, really the contribution is going to come in in the back half of the year.

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Anton Hie, RBC Capital Markets, LLC, Research Division - Associate [13]

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Okay. And Suzanne, probably one more for you here on the guidance. I believe you guys had previously said that you would factor in sort of the estimated impacts from PDPM. Just want to confirm that that is in the fourth quarter of '19 guidance?

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Suzanne D. Snapper, The Ensign Group, Inc. - CFO [14]

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Yes, definitely. And I think, we've talked about that a lot, and it has a lot -- when you go through all of the different aspects of PDPM, I think you have a lot of noise out there with regards to how it's going to impact different people and knowing that we're a lot more skewed on the clinical side of the house that we have -- we feel like -- it's really built in there well.

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Anton Hie, RBC Capital Markets, LLC, Research Division - Associate [15]

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Okay. And then one more housekeeping item on the -- it looked like the margins on the -- I mean, obviously, you have good growth in the home health and AL and IL businesses, but the margins came down year-over-year. Anything we could point to on the mechanics there?

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Suzanne D. Snapper, The Ensign Group, Inc. - CFO [16]

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On the -- which business was that?

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Anton Hie, RBC Capital Markets, LLC, Research Division - Associate [17]

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On both Bridgestone and Cornerstone.

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Suzanne D. Snapper, The Ensign Group, Inc. - CFO [18]

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Yes. So on the home -- the Bridgestone, there is actually that impairment charge. So if you're just looking at the quarter, when you take that impairment charge out that we took in the fourth quarter, the margins are actually flat. And so when you look to model that, I wouldn't bill that decrease in decline of improvement in there on a go-forward basis.

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Anton Hie, RBC Capital Markets, LLC, Research Division - Associate [19]

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Okay. And then switching gears. It looks -- certainly great to see the narrow networks are coming through in Utah, kind of, as expected. Can you kind of, I guess, give us -- where are we -- what kind of -- in what inning is that with regards to the narrowing of the networks there and, I guess, the volumes coming through?

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Christopher R. Christensen, The Ensign Group, Inc. - President, CEO & Director [20]

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In what inning did you say?

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Anton Hie, RBC Capital Markets, LLC, Research Division - Associate [21]

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Yes.

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Christopher R. Christensen, The Ensign Group, Inc. - President, CEO & Director [22]

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You do know it's February, right? Are you a basketballer? We're probably in the start of the second quarter. We're still early on. It's much more developed than it was. It did take a lot longer. Anton, I don't know if you were on those calls, but I kept promising that it was going to happen and then it took a lot longer. But there's still a lot more to happen in that particular state, and there's a lot more to happen in many other states. So we're still on the front-end.

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Chad A. Keetch, The Ensign Group, Inc. - Executive VP & Secretary [23]

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I would also add, just seeing that we've acquired another building there in Utah is probably a signal of our confidence that there's some good opportunity for us in that market.

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Operator [24]

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And our next question comes from Dana Hambly of Stephens.

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Dana Rolfson Hambly, Stephens Inc., Research Division - Research Analyst [25]

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Just following up on Utah, you mentioned you bought that building. I think it's only about 50% occupied right now. Is that something you can fold into the narrow network right away? Or is that something you have to build up over time and then it would move into the narrow network?

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Christopher R. Christensen, The Ensign Group, Inc. - President, CEO & Director [26]

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Generally, yes. It depends on what their star rating is, and it depends on how desperately maybe the network needs that geography. But they're pretty good at sticking to their standards. And so in that particular case, star rating isn't as high as we would like it to be, but it's high enough to be included in the network. But we -- in order to ensure that we continue to be part of that network, we need to elevate the star rating and become better there.

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Dana Rolfson Hambly, Stephens Inc., Research Division - Research Analyst [27]

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Okay. All right. And then, I guess, Christopher, staying on the star ratings, going through the K, I may be wrong, but I think the number of facilities with a 4 or 5-star rating actually declined in 2018 by 9 or 10 buildings. Could you just -- one, is that true? And two, I just want to make sure that's not due to a lack of quality, it's more there are some changes to the system.

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Christopher R. Christensen, The Ensign Group, Inc. - President, CEO & Director [28]

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Yes, it's a good question. And it's one we're happy to answer. With the changes in star rating and the -- and how the whole system is calculated and the impact that certain elements of the star rating system have, it's unlike -- not unlike most operators we saw a decline in overall kind of star rating based on how CMS recalculated things and it included staffing components. A lot of that, as we've mentioned before, is not necessarily based on lower staffing standards or anything of that nature, it really has to do with how things are reported up and communicated with CMS.

There is a long lag time associated with how those changes and how things are reported get factored in. And so I think, what you're seeing there is just kind of a lag between when the new system went in place and the changes we're putting in place. Keep in mind, too, there was kind of a freeze in there too. So really no opportunity for us to impact it for several quarters. I think going into this year though, you'll see some changes in that as CMS catches up with how they're bringing in data and how that's being factored in when it comes to overall star ratings.

But as far as quality goes, no, I mean, there's absolutely no change in quality. We're completely confident that our track record is what it has always been, which is we take these underperforming buildings that have challenges, both clinically and culturally, and we steadily and dramatically improve them over time to become what they have been for our portfolio. I mean, it's the reason why we can participate in these narrowing of networks and becoming key providers for these value-based payment contracts and things like that. It's all quality based, right? Star ratings is a piece of that, but it definitely isn't a reflection on overall quality whatsoever.

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Dana Rolfson Hambly, Stephens Inc., Research Division - Research Analyst [29]

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Okay. All right. That's helpful. And on the skilled mix, it looks like the managed care, both as a percent of revenue and as a percent of days, on a same-facility basis was down this quarter, which seems to be kind of in contrast to the way the world is moving, where more people are moving into Medicare Advantage plans. Is this some sort of trend that you're trying to impact? Or is that just kind of how the numbers fell this quarter and nothing more to read into it?

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Suzanne D. Snapper, The Ensign Group, Inc. - CFO [30]

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So if you're looking at same-store, what that is, it's more of a math issue. We just had a lot more growth on -- in the overall Medicaid population, our actual managed care. We actually did grow overall for overall skilled days as a whole on the same store. With regards to the transitioning bucket, we also grew on the managed care overall. Overall skilled slipped a little bit on the transitioning bucket, but that was kind of what we talked about previously with regards to our Kansas operations, where we did have that transition into the Medicaid bucket which increased, but our overall profitability also increased at the same time. So that was on purpose in that particular area. So those should answer both of those bucket questions.

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Dana Rolfson Hambly, Stephens Inc., Research Division - Research Analyst [31]

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Okay. All right. Very helpful. And then on the PDPM, like, hypothetically, if it went live tomorrow, how prepared would you be? Or are you going to need every day up until October 1 to get ready for this?

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Suzanne D. Snapper, The Ensign Group, Inc. - CFO [32]

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I'm -- we're going to use every day. Obviously, I think what that -- I mean, there's a ton of opportunity. We are on the ground running with tons of different pilot programs in some areas to optimize. I think this goes back to the strength that we have, right, of having local leaders in each one of our operations prepare and local clinicians look at and capture both -- all the clinical services that we already provide and making sure that we're actually going to take a count for those today as well as some the changes that we're making -- not changes, but just making sure that we're utilizing therapy appropriately and taking advantage of things that we can utilize today already. So definitely, already making tons of changes in a lot of different areas and then just making sure we're capturing a lot of services that we're already providing.

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Dana Rolfson Hambly, Stephens Inc., Research Division - Research Analyst [33]

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Okay. All right. And a couple of last ones for Suzanne. Operating cash flow was really strong in 2018. Obviously, taxes were lower. Operating -- you had operating growth, but you're getting good cash flow collections. Is that still a legacy of the heavy acquisitions you were doing a couple of years ago? And should we expect that to level out in 2019?

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Suzanne D. Snapper, The Ensign Group, Inc. - CFO [34]

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It's a combination of things. So some of it is a makeup from that lag that we had previously. And then some of it is like the taxes part that's going to continue and some of the better collections that we anticipate continuing, right, because we're on this cycle of getting paid on a routine basis versus previously, where we were a lag from the acquisition and the turnover of the child process. And so we think that it would -- that it will be higher than they have been in '17, but maybe not as high as '18.

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Dana Rolfson Hambly, Stephens Inc., Research Division - Research Analyst [35]

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Okay. And then Suzanne, on the lease accounting change, it doesn't look like it has much of an impact on your income statement anyway. Is that right?

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Suzanne D. Snapper, The Ensign Group, Inc. - CFO [36]

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That's correct. So you're going to see the $1 billion of assets and liabilities put on the balance sheet, and we're projecting about a $700,000 for the entire year impact on the P&L.

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Operator [37]

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And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to Christopher Christensen for any further remarks.

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Christopher R. Christensen, The Ensign Group, Inc. - President, CEO & Director [38]

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Well, I just thank you, everyone. Thanks for your time, and thank you, Sonya, for helping us with this call, and hope everyone has a great day.

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Operator [39]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a good one.