Brookdale Senior Living Inc.

Thank you and good morning, everyone. I'd like to welcome you to the fourth quarter and full year 2018 earnings call for Brookdale Senior Living. Joining us today are Cindy Beyer, our President and Chief Executive Officer, and Steve Swain, our Executive Vice President and Chief Financial Officer. I would like to point out that all statements today, which are not historical facts, including our earnings guidance, may be deemed to be forward-looking statements within the meaning of the federal securities laws. These statements are made as of today's date and we expressly disclaim any obligation to update these statements in the future. Actual results and performance may differ materially from forward-looking statements. Certain of the factors that could cause actual results to differ are detailed in the earnings release we issued yesterday, as well as in the reports we file with the SEC from time to time, including the risk factors contained in our annual report on Form 10-K and quarterly reports on Form 10-Q. I direct you to Brookdale Senior Living's earnings release for the full Safe Harbor Statement. Also, please note that during this call, we will present both GAAP and non-GAAP financial measures. For reconciliations of each non-GAAP measure from the most comparable GAAP measure, I direct you to our earnings release and supplemental information, which may be found at brookdale.com forward slash investor and was furnished on an 8K yesterday. With that, I would like to turn the call over to Cindy. Thank you.

Thank you, Kathy. Good morning to all of our shareholders, analysts, and other participants. Welcome to our fourth quarter and year-end 2018 earnings call. This morning, I'll provide a progress update on the strategy, which I introduced in early 2018, as well as our outlook. After we terminated the strategic review in February 2018, We launched our turnaround strategy and successfully executed on business changes that are significant and transformative. We also renewed the focus on our mission and our associates who are so critical to delivering care to our residents. We delivered results within our guidance ranges. Steve will provide the details of our financial results, so let me highlight how our focus on operations laid the foundation for these results. We set the operational foundation with a focus on winning locally, which unified and became the rallying call for the Brookdale team. On a parallel path, we spent an extraordinary, yet necessary, amount of time on our real estate strategy. Last year, we made real estate initiatives a priority to position Brookdale for future success. For our owned portfolio, by year end, we sold assets generating proceeds of $193 million net of debt repayments and transaction costs, and we are nearing completion to sell other communities in line with our $250 million goal. We restructured 89 restrictive leases and moved to more objective change and control provisions. For the managed portfolio, we transitioned numerous communities that were being operated under interim management agreements to new operators. To give perspective, we terminated management agreements or disposed of 131 communities during 2018, with the majority occurring in the fourth quarter. I am proud of what our team accomplished. For the past several years, there has been speculation about whether Brookdale became too big to be successful. So let me be clear. With our recent real estate accomplishments and planned 2019 closings, we are confident that we will be successful with the remaining portfolio. Brookdale is now 22% smaller than it was immediately after the emeritus acquisition was completed. we intentionally reduced our portfolio from over 1,100 to less than 900 communities. With our 2019 plan, we believe that we'll have the optimal portfolio and experienced staff to deliver long-term returns. In 2018, we improved our owned-to-lease portfolio mix, completed significant financing transactions, and did a community-by-community review of capital requirements. In 2019, we expect to finish the vast majority of previously identified community transitions to new operators. This will allow us to celebrate the successes, close the door on the disruption that so much change creates, and continue to sharpen our focus on operations. The board and management team have actively explored many alternatives for enhancing shareholder value. We've conducted numerous reviews over the past several years and consulted different leading real estate investment banking advisors in connection with such reviews. We're committed to continually look at ideas that arise internally and ideas raised by outside advisors or shareholders. Recently, we completed another review to assess the potential of separating all or a portion of a company's real estate from our operations into a new public REIT structure. In the real estate industry, this is commonly referred to as an OPCO-PROPCO transaction. We entered this review with an open mind and with the mandate that we needed to truly understand whether an OPCO-PROPCO transaction would unlock value for our shareholders. Our team performed another comprehensive review, and we were assisted in this regard by an external financial advisor who was recommended by a shareholder who has publicly advocated for a REIT separation transaction. We spent a lot of time and effort on this transaction, and this analysis was based on detailed, confidential information concerning our operations, debt, and lease obligations. In connection with this review, we looked at a range of potential PropCo-OpCo structures, including triple net lease and Radea managed structures. Based on this review, we do not believe that an OpCo-PropCo transaction is advisable to pursue at this time, as it likely wouldn't create additional shareholder value. A separation would result in an operating company with uncertain viability and a single operator prop co, REIT, that is unlikely to trade well due to key structural deficiencies. To provide additional transparency into the analysis, I'd like to share a few of the key considerations we identified during our reviews of the potential op co, prop co transactions. First, you must consider the viability of the potential operating company, factoring in existing third-party lease obligations and any new potential leases with the new PropCo, along with funding of near and long-term CapEx needs. This would certainly create a challenging situation from a cash flow perspective. Second, PropCo's valuations will be influenced by the perceived viability of the OpCo. In addition, you need to consider the subscale size of the PropCo and its initial single operator exposure as well as its higher than usual leverage profile for a region to limit its ability to grow and diversify. You must realistically assess the expected trading value of the PropCo and OpCo entities. All of these issues I just mentioned would create valuation pressure relative to tiers. Third, Depending on the structure of the deal, it is possible that the transaction would be a taxable transaction. Even utilizing our sizable net operating losses along with potentially triggering change of control provisions that could be a substantial burden for the surviving operator. Ultimately, given these and other factors, we simply did not see a path to unlocking value through implementation of this type of transaction at this time. While we will continually assess ways to enhance shareholder value, over the near term, we will remain focused on our strategic priorities. Simply stated, the best way to create shareholder value is through executing our operational turnaround strategy. Our vision is to be the nation's first choice in senior living. The reality is that we are a senior living health care operator that intentionally owns real estate. That being said, we remain committed to evaluating feedback from our shareholders and listening to constructive ideas or perspectives they may have. To this end, I'm pleased with our recent announcement that we are accelerating the pacing of the de-staggering of our Board of Directors. Our Nominating and Corporate Governance Committee and Board voluntarily made this decision after consideration of shareholder feedback we received. Let me turn now to the ongoing operations and briefly talk about our successes in 2018 and expected areas of focus in 2019. In 2018, the senior living industry saw strong macroeconomic headwinds where new community openings outpaced demand. This drove top-line pressure and low unemployment drove higher operating costs. In early 2018, the industry withstood the most severe flu season in the last five years, and there were significant weather-related challenges, including large winter snowstorms, hurricanes, and wildfires. I am very proud of our team's excellence in planning for and executing the logistics of protecting our nation's seniors during these natural disasters. There are thousands of details to ensure that our seniors are safe, comfortable, and have the proper medicines and nutrition to keep their health care regiments intact while continuing to provide engaging resident programming and keeping families informed. I'm incredibly proud of how our team addressed each adversity to keep our residents safe with no attributable deaths during the hurricanes and wildfires, and that despite facing elevated competitive new openings, we reduced controllable move outs. We've made good progress on our priority to attract and retain the best associates. We are on track to complete our three-year plan in 2019. We've seen the benefits of this investment with higher retention of executive directors and health and wellness directors in the communities. In the fourth quarter of 2018, we saw 100 basis point improvement from the third quarter of 2018. This continued our retention rate trend of these two positions above 70% for the past six quarters on a trailing 12-month year-over-year basis. As of year end, we had only 31 open executive director positions. That's just 3% of our nearly 900 communities. Our 2019 focus will be to replicate the executive director and health and wellness director retention successes with our sales directors. We analyzed sales associate turnover, and with this understanding, we are now providing our sales associates with the skills, tools, and dashboards to drive high-quality leads and visits to our communities. With our recent sales realignment, we've improved the span of control of our district sales leaders consistently. allowing them more time to coach sales associates in person. We have the right sales organization strategy and will further support our associates to develop impactful, personal connections with prospects. In the fourth quarter, we refined our plan using customer research to systemically address all phases of a customer experience, from researching, contacting, and visiting our communities to moving in. This has been a large undertaking, including how we message and position the Brookdale brand, communicate the most attractive qualities of each community, promote our resident programming, dining, and clinical care, and package all of this together in our sales messaging to offer customers a compelling point of difference. This is a relationship business, and we are focusing on providing prospects a best-in-class experience. We are ensuring that our operations and sales associates are one cohesive team in guiding customers through all phases of their journey and choosing the right community to meet their needs. No other senior living provider is better suited to do this than Brookdale. Given the strengths of our operations team with execution, we are further aligning sales and operations to drive performance. To achieve this, Last month, the sales organization started reporting to Mary Sue Patchett, our EVP of community operations. The retention rate of the top three leaders brings me to the reason that Brookdale exists, to serve our residents and patients. There's a strong correlation between associate retention and our community's leading indicators. For the full year 2018, we improved three of our four leading indicators. For 2019, our controllable move-out goal is to maintain the strong move-out results we achieved in 2018 as we turn more of the organization's focus on generating move-ins with the sales and marketing action plan I just noted. Turning to our healthcare services segment, previously known as ancillary services, in the fourth quarter, we stabilized our revenue on a sequential basis. In 2018, we shifted our therapy case mix. While this impacted our results, we are now in line with industry mix. We expect our healthcare services business to grow in 2019, in addition to continued growth in our hospice business, where we expect continued strong organic growth in addition to our plan to expand into new markets. Before I turn the call over to Steve, I'd like to provide a few summary comments about this year's expectation. Our 2019 guidance is aligned with the highlights I provided in our third quarter call. The senior housing industry will continue to have headwinds from community openings in 2019, making for a difficult competitive landscape. Yet there are early indications of improvement as new starts continue to fall. Expected 2019 adjusted free cash flow results will be driven by the significant additional community-level CapEx investments. These include major building infrastructure projects, which are necessary to ensure that our communities are in appropriate condition to support our strategy and that we protect the value of our portfolio. This year, we will continue to improve our operations. Now that the real estate restructuring is mostly behind us, We are working to advance the sales cycle, especially related to move-ins, and accelerate our occupancy turnaround. I'll turn the call over to Steve now.

Thank you, Cindy. My remarks today will focus on three primary topics. First, highlights of the fourth quarter and full year 2018 financial results. Second, given the importance of last year's real estate initiatives, I'll provide an update on our progress. And finally, I'll expand on Cindy's comments about our 2019 guidance, starting with a few highlights. We achieved full-year financial results within our 2018 guidance. We saw same community revenue improve on both a year-over-year and sequential quarter basis, driven largely by rate increases. We drove mark-to-market pricing positive in the fourth quarter. This means a new residence rent was greater than an existing residence rate, This positive marked market occurred for all three product lines, independent living, assisted living, and memory care, and shows that our price discipline is working despite strong competition. We saw our independent living occupancy increase to 90%, which was a 50 basis point increase from the third quarter to the fourth quarter and a 110 basis point improvement for the full year. We committed to and executed on our 2018 financing strategy. We paid off the convertible senior notes, lowered the credit facility borrowing costs, and increased flexibility in our capital structure with Freddie Mac financing. And we are nearing completion to achieve our real estate net proceeds goal. These achievements in the first year of our turnaround highlight good progress, especially in the context of industry oversupply and wage pressures. Let me talk in more detail about our real estate initiatives that we announced last year, starting with our owned portfolio. We are nearing completion of our goal of $250 million of proceeds, net of debt repayments, and transaction costs. By the end of 2018, we had closed on community sales, providing net proceeds of $193 million. Specifically, in the fourth quarter, we closed on 19 owned communities, including Battery Park, and a portfolio of 18 communities located across eight states. And we currently have several communities under contract for sale that we expect will close in the first quarter, once customary diligence and closing conditions are completed and satisfied. Turning to the leased portfolio, in the fourth quarter, we completed the remaining HCP 404 Lease terminations of 17 communities originally announced in 2017. Separately, we terminated another lease related to six uneconomic communities. And lastly, for the managed portfolio, during the fourth quarter, we transitioned numerous communities to new operators, mainly related to our previous announcements with HCP and Welltower. In short, our real estate plan was integral to our transformation in 2018. Since the beginning of the fourth quarter of 2017 and through the end of 2018, we disposed of 137 consolidated communities through sales and lease terminations. To put that in perspective, on average, that's one community every three days. In fact, the transitions in the fourth quarter were more than the first three quarters of 2018 combined. To provide context to the financial results, for the fourth quarter 2018 compared to the prior year quarter, these dispositions resulted in $105 million less resident fee revenue and $19 million less adjusted EBITDA, but positively impacted adjusted free cash flow by $6 million. With these significant changes in our portfolio in mind, Fourth quarter 2018 total company reported revenue was $1.1 billion compared to $1.2 billion in the fourth quarter of 2017. This 8% decrease is mainly the result of fewer communities due to asset sales and lease terminations. Moving to senior housing results. Because the execution of our real estate strategy has impacted reported comparability, the best way to analyze the operations is to focus on same community results. Same community fourth quarter revenue improved 0.3% compared to the prior year quarter and improved 0.1% on a sequential basis. Independent living occupancy increased to 90% in the quarter. For assisted living and memory care, oversupply and competitive pressures continue to negatively impact the industry and our occupancy. When compared to prior year quarter, The fourth quarter increase to reported REV PAR was primarily due to dispositions of communities with lower than average REV PAR. The fourth quarter same community REV POR grew nearly 2% over the prior year quarter. This reflects rate increases taken earlier in 2018 and strong price discipline throughout the year and resulted in positive fourth quarter revenue growth in spite of occupancy declines. As mentioned earlier, the fourth quarter mark-to-market pricing was positive. This result was strongly influenced by the early implementation of 2019 market pricing for new residents. In the first quarter, we expected the gap between mark-to-market and in-place rent to close as our in-place rent increases went into effect on January 1, 2019. The higher 2018 resident rates helped support the investment we made in our community associates. Same community compensation expense increased 4.3% for the fourth quarter and 5% for the full year as compared to the respective prior year periods. These increases reflect wage pressure due to a tight labor market plus our intentional above industry investments in key resident facing associates compensation to improve our ability to recruit and retain the best associates in the industry. Our facility operating expense in our same community portfolio increased 5.4% for the fourth quarter and 3.8% for the full year as compared to the same prior year periods. For the year, these increases were due to higher energy, repairs, and insurance costs related to severe weather in the early part of 2018, higher paid referral expense, and normal cost inflation. Primarily as a result of increased investments in our key community leadership and increased facility operating expense, partially offset by slight revenue growth, our same community operating income decreased 8.4% for the fourth quarter and 8.2% for the full year as compared to the respective prior year periods. Moving to our healthcare services segment, previously known as ancillary services. Revenue stabilized on a sequential quarter basis, although it was 2.1% lower on an annual basis. Throughout the year, our case mix shifted to lower rate managed care. While this shift impacted revenue growth, our mix is now in line with the industry average and places us in a better position to implement CMS's proposed industry-wide PDGM in 2020. So even though our patient encounters increased due to our intentional mix shift, our margin decreased. In addition, one byproduct of the large volume of community dispositions is that certain new operators replaced Brookdale's healthcare services soon after a community transitioned. These transitions away from Brookdale had a meaningful impact on our healthcare services performance in 2018. Looking at our hospice business, It continued to grow strongly. Its revenue increased 16% for the fourth quarter and 26% for the full year as compared to the respective prior year periods. From an expense perspective, the primary drivers of this segment's increase in facility operating expense were labor related to increased patient encounters and set of costs associated with consolidating and centralizing the intake functions. In 2019, we expect to see savings from this centralized intake consolidation. For general and administrative expense, we recognized $56 million in the fourth quarter, 5% below the prior year quarter. This is mainly due to the G&A rationalization we made in early 2018. We achieved our annualized G&A savings goal of $25 million prior to normal cost inflation and normalized bonus. We reported fourth quarter adjusted EBITDA of $115 million, excluding transaction and organizational restructuring costs of $3 million. This compares to the fourth quarter 2017 adjusted EBITDA of $149 million, excluding transaction and strategic project costs of $11 million. The key drivers of the lower year-over-year adjusted EBITDA were approximately a $19 million decline related to disposals of communities through asset sales and lease terminations, and $20 million of higher same-community operating expenses. mainly driven by our intentional above-industry investment in community leadership salaries, along with more robust benefits. This was partially offset by a $4 million lower hurricane impact and $4 million in lower G&A. In 2018, we completed three important financing transactions. In the second quarter, we paid off $316 million of convertible senior notes, Then in the fourth quarter, we obtained Freddie Mac mortgage financing and amended and restated our credit facility. The transactions were net neutral to our liquidity but played a key role in providing flexibility in our capital structure while also extending term and diversifying fixed and variable interest exposure. A few key attributes were as follows. We lowered the variable rate by 25 to 50 basis points in our credit facility. expanded the letter of credit supplement, and created new flexibility to remove or substitute assets as collateral in the Freddie Mac facility. Adjusted free cash flow was negative $4.3 million for the fourth quarter compared to negative $11.2 million in the prior year quarter. Beyond the factors I described that impacted adjusted EBITDA, disposition-related interest expense, and lower non-development capex, positively impacted adjusted free cash flow. Our proportionate share of adjusted free cash flow of unconsolidated ventures was $2 million in the fourth quarter of 2018 compared to the prior year quarter of $12 million. Of the $10 million reduction, approximately $8 million was due to lower entrance fee proceeds at our CCRC venture, and $2 million was due to the sale of the equity interest in other ventures. As of December 31, 2018, total liquidity, including the line of credit, was $593 million, an increase of $134 million from September 30. The increase was primarily a result of asset sale proceeds partially offset by lower revolver capacity and paying down additional debt. In December, when the stock market and Brookdale shares were experiencing pressure, we opportunistically purchased approximately $8.5 million of shares at an average price of $6.64 and could again be opportunistic based on future market conditions. We have reasonable debt maturities over the next five years. Of our total debt outstanding, approximately 95% is non-recourse asset-backed mortgage debt. Our balance sheet is well positioned to provide sufficient flexibility as we continue to turn around the business. Turning to 2019 guidance. As noted in yesterday's press release, I want to highlight two changes in 2019 that impact our guidance. First, we adopted the new lease accounting standard effective January 1, 2019. As a result of this adoption, we expect to record an additional $23 million of revenue and an additional $50 million in facility operating expenses generally related to the accounting for resident contracts. This change will result in a one-time decrease of $27 million in 2019 adjusted EBITDA, but with no impact to adjusted free cash flow. The second change is to our definition of adjusted free cash flow. to be more in line with traditional practice. In our current definition of adjusted free cash flow, we adjust cash provided by operations for changes in working capital. Beginning in 2019, we will discontinue the working capital adjustment. While working capital changes are expected to have meaningful volatility by quarter, full-year changes are expected to be neutral to adjusted free cash flow after normalizing for the impact of the new lease accounting standards. I'll now provide details on our 2019 guidance and assumptions. Our full-year outlook reflects the continued execution on our turnaround strategy in context with broader industry macroeconomic headwinds. As Cindy mentioned, industry headwinds continue. However, our internal forecast and NIC show some improvement in the second half. In addition, low unemployment rates will continue to put upward pressure on wage inflation. With this industry backdrop, the guidance we provided in our press release includes the expected impact of previously announced pending or planned dispositions of communities. We expect 2019 adjusted EBITDA, excluding transaction costs, to be in the range of $400 to $425 million. Adjusted pre-cash flow, including transaction costs, to be in the range of negative $80 to negative $100 million. and our proportionate share of unconsolidated ventures to be in the range of $30 to $40 million for adjusted EBITDA and $10 to $20 million for adjusted free cash flow. Excluding the $75 million of incremental 2019 CAPEX that we highlighted last quarter, adjusted free cash flow guidance would have been neutral for the year. The incremental CAPEX spend will be at a high watermark in 2019. As Cindy has already discussed, this investment is necessary. I want to reiterate that our balance sheet is well positioned to provide sufficient flexibility as we continue to turn around the business. I'll share some of the key assumptions underlying our guidance, and we've listed more details in our current investor presentation, which can be found on our website. First, one of the most significant items impacting our outlook is based on our real estate initiatives. In general, successfully closing on the communities currently under contract for sale. Slide 16 in our investor deck is a pro forma view of our 2018 results after reflecting the impact of transactions that are in process. While we will have partial year results for 2019 transactions, the pro forma will help you in understanding our continuing operations. Second, we expect modest revenue growth from our continuing operations. However, because of the impact of dispositions, our consolidated reported revenue will decline. For senior housing, we expect to improve occupancy within the year. This incorporates our assumptions of a less severe flu season. However, the full year average will be slightly down as we don't expect to recapture all of 2018's occupancy loss in 2019. At the same time, we expect to deliver improved rate growth compared to 2018 as we pass through larger in-place rent increases, slightly offset by mark-to-market adjustments throughout the year. In our healthcare services business, we expect performance to improve compared to 2018 when revenue was negatively impacted by a significant case-mix shift to be in line with the industry. We also experienced a negative impact from our large amount of community dispositions. In 2019, the growth will mainly be from our hospice business as we continue to gain scale on our existing licenses and expand markets. We expect our operating margins to remain under pressure during the year from both our top line and facility operating expenses. We expect total labor costs, including benefits, to grow by 5% to 5.5%. This will be the final year of our three-year plan to make above-industry investment in community associates. Over the past two years, we've seen the benefit of these investments with higher retention rates of executive directors and health and wellness directors, along with higher resident satisfaction demonstrated by lower controllable move-outs. We expect our 2019 GNA expenses, excluding transaction costs and non-cash, stock-based compensation to be slightly up compared to 2018. This is based on normalized cost inflation and bonus, partially offset by additional G&A rationalization that we initiated in late 2018. I also want to highlight a few items that will impact our free cash flow. First, we expect lower interest expense and lease amortization combined, primarily from our 2018 real estate transactions and those that occurred or are planned to occur in 2019, somewhat offset by rising interest rate assumptions and lease escalators. Second, we expect our transaction costs to be approximately $10 million in 2019. Third, As I already mentioned, the new lease accounting standard will not have an impact on adjusted free cash flow. The final significant part of our 2019 outlook is related to CapEx. With a disciplined bottoms-up review of our 700-plus communities that Cindy mentioned on our last call, we expect 2019 non-development CapEx to be around $250 million. Again, this CapEx includes a $75 million incremental near-term investment in our communities. We have an aggressive action plan in 2019. However, it is also an exciting time to share in our associates' passion to win locally and invest for future growth in order to drive operating leverage in 2021. I'd now like to turn the call back over to Cindy.