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spk01: Good day and welcome to the Sonita Senior Living third quarter 2022 earnings conference call. Today's conference is being recorded. All statements today which are not historical facts 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 the company expressly disclaims any obligation to update these statements in the future. Actual results and performance may differ materially from forward-looking statements. Certain of these factors that could cause extra results to differ are detailed in the earnings release the company issued earlier today, as well as the reports the company files with the SEC from time to time, including the risk factors contained in the annual report on Form 10-K and quarterly reports on Form 10-Q. Please see today's press release for the full Safe Harbor Statement, which may be found at www.sonitaseniorliving.com forward slash investor relations, and was furnished in an 8K filing this morning. Also, please note that during this call, the company will present non-GAAP financial measures. For reconciliations of each non-GAAP measure from the most comparable GAAP measure, please also see today's press release. At this time, I'd like to turn the call over to Sonita Senior Living President and Chief Executive Officer Brandon Rebar.
spk00: Thank you, Doug. Good afternoon and welcome to our third quarter 2022 earnings call. I'm joined this afternoon by Kevin Dietz, our Chief Financial Officer. We are changing our approach to our earnings call starting this quarter and we'll be referencing our publicly available third quarter investor presentation as we discuss our strategic priorities, operating results for the quarter, and ongoing performance expectations. You can find our latest presentation at sanitaseniorliving.com in the investor relations section if you would like to follow along. I'll open my comments by once again thanking our incredible team members who provide care and services throughout each of the communities we operate. While we have seen improvement in the overall health landscape with the reduced severity of COVID, the operating environment continues to require dedicated, compassionate, and innovative leadership teams at the local level. Stability in the caregiver and resident services roles in our communities remains fundamental to our operating approach. It's our belief that strength and stability in local and regional teams will define successful senior living operators during this recovery cycle and beyond, and have crafted our go-forward strategy with that premise as the foundation. On slide four of the presentation, we have highlighted a few of our recent accomplishments, beginning on the people front. Leadership retention has never been stronger, with only 14 open positions across more than 330 local and regional leadership roles. Coupled with recent alignment changes, I'm confident we have the leadership strength to deliver on our key growth initiatives moving forward. I'm also pleased with the early returns on capital investments within our portfolio this year and look forward to completion of our community refresh projects by early next year. These projects have delivered significant occupancy and margin recovery in recent months and represent a key component of 2023 growth. The performance of our memory care product, Magnolia Trails, also deserves recognition. Memory care revenue has grown 13.5% year over year, driven by occupancy improvement of nearly 800 basis points and rate increases exceeding 5% in the 31 communities with a memory care offering. In November of last year, we recapitalized and rebranded Sunita with a commitment to investing in specific areas to position the business for long-term growth. Those investments in strengthening our balance sheet Completing offensive capital investment projects in our existing portfolio and investing in our people and resident programming will be complete in the near term, and we have set aggressive margin recovery expectations for 2023. Coupled with the evaluation of accretive management arrangements with real estate partners and value-add acquisitions in markets consistent with our current portfolio, we have multiple strategic paths to create value for our current and future investors. My expectations for 2023 include significant REV4 and margin improvement, driven by heightened employee engagement, continued high-value care and services for our residents, and consistent operational excellence. Kevin will expand further on the key drivers for margin improvement in his comments. Turning to slide five, we delivered our sixth consecutive quarter of sequential revenue and occupancy growth and reached an important milestone in September. achieving pre-pandemic occupancy ahead of our year-end timeline. Adjusted NOI increased slightly when removing one-time grant revenue from Q2, but remains below our expectations. Following the leadership transition in late Q3, we implemented significant changes to our approach on rates. I am confident the combination of high-quality resident programming, capital improvements to refresh our physical plants, and occupancy rates exceeding 80% across more than three-quarters of our portfolio will support accelerated growth in our market rates in 2023. Finally, corporate G&A as a percentage of revenue must be reduced to achieve positive cash flow on a run rate basis. The combination of continued revenue growth and a right-sized support team will drive further improvement on this front moving forward. I'll now turn it over to Kevin for discussion of the financial results.
spk03: Thanks, Brandon. I'll be picking back up on slide five for those following along in the deck. Despite a continued challenging operating environment, the company realized a six straight quarter of both occupancy and revenue growth. With a strong foundation of continually improving revenues, we were able to increase our operational focus on more sophisticated labor management practices, in addition to the company's recently implemented rate initiatives. This is particularly relevant for a third of our portfolio, which is enjoying occupancy above 94% and a stabilized in-place workforce. We are also encouraged to see the continued accretive impact from both recently and soon-to-be completed renovation projects, which includes our repositioned Magnolia Trails communities. Diving into the margin headwinds a little deeper, contract labor played a significant role in flat quarter-over-quarter operating margin, with a $400,000 increase from the previous quarter. The quarterly increase was largely driven by 10 communities, which have struggled as a result of acute local community factors, including a nursing shortage in several of our Ohio communities and local wage wars in a few limited communities. We believe that our operational leaders have mitigated these factors with targeted action plans and are pleased with the October trends. We expect a material decrease in Q4, assuming current trending continues. On a macro basis, Though average wages continue to increase during the quarter, the percentage increase is flattening relative to the prior 12 months' experience. Also, net hires increased 7.9 percent and 3.6 percent since year end and Q2, respectively. Finally, our number of open community leadership positions decreased from 33 associates to 14 associates during the quarter. We believe these trends are all strong indicators of community workforce stability and will allow us to greatly reduce our reliance on contract labor for quarters to come. In addition to the impact on labor expense, we also believe that our workplace stability is foundational to executing on the recently deployed strategic operating initiatives. These initiatives include a heightened focus on purchasing compliance through the GPO we rolled out in August and the recently established formal rate setting structure. On the former, we recognized an 8.5% decrease in total food costs from August to September. On the latter, given the new structure and rolling calendar of resident lease expiries, we are expecting a corresponding but responsible rate lift in quarters to come. Moving on to page six, we wanted to illustrate the impact on margin by addressing the potential movement on our most significant KPIs. Starting with a baseline of the Q3 results, we identified the incremental impact and margin for occupancy, rate, and contract labor reduction. Again, this slide does not reflect management's plan, but it's merely illustrative. We believe the upward trend of occupancy over the last six quarters, as illustrated on page 8, is strong evidence that the industry recovery in Sunita's own portfolio continue to have room for growth. For the month of September, 19 communities had occupancies above 94%. Conversely, nine communities had occupancies below 72%. We believe the combination of recent capital investments and our focused sales efforts will return these communities to pre-pandemic levels. We used an incremental margin of 65% for each 100 basis points of occupancy growth, understanding that the lower occupied communities will need to incur more operating expenses than the stabilized communities. Turning to REV4, we believe that as a result of the company's revamped design of its rate setting function and qualified sales incentive plan, we are well positioned to capture our share of responsible rate increases, which wholly flows to the bottom line and pushes incremental margin up faster than any other KPI. Contract labor. As discussed on the last few slides, contract labor continues to be an area of high importance for the company's margin profile. Flipping to page seven, we can see the impact of our discretionary capital projects on our performance, measured from the point of project completion. With another nine community renovations nearing project end, we believe similar lift is realistic in the next nine to 12 months. Our projected discretionary spend on all these communities is $9.5 million. Touching quickly on page eight, there is a strong overlap between the company's owned assets and high-performing MSAs. supporting the ability to execute on the KPIs identified on slide six. Moving to page nine and circling back on occupancy, we've seen an 820 basis point increase in weighted average occupancy since the low point of the pandemic. As of the end of Q3, we have achieved pre-pandemic levels for occupancy, one of the company's goals heading into the year. As mentioned a few slides back, we believe our tailored initiatives on underperforming communities will continue to move our weighted average occupancy up. These plans include repositioning of communities with our successful Magnolia Trails memory care program, stabilizing community leadership teams, and investing capital refresh dollars to compete with newer product types in local markets, all of which are underway. Now, moving ahead to slide 10, we will display our debt composition. In the face of a rising interest rate environment, approximately 80% of our borrowings on communities are fixed rate at an average rate of 4.6%. We were in compliance with all financial covenants required under our mortgages as more fully described in the 10Q to be filed later today. Our communities that are capitalized under floating rate debt continue to outperform underwriting expectations. Finally, we have four communities that are currently unlevered. Before turning the presentation over to Brandon for closing remarks on the last couple slides, I wanted to briefly address the uses of cash from last year's recapitalization on page 11. Nearly half of the net proceeds were used to pay off near-term maturities to provide the company with the runway needed to participate in the macro industry recovery, and more importantly, execute on the company's own strategic growth plans. The company used approximately $12 million to grow its strong MSA density with the acquisition of two Indiana communities, which have seen occupancy increases of 1,700 basis points since onboarding in Q1. Beyond recurring capital needs, the company has already deployed $6 million out of a projected $9.5 million for refresh projects and selected markets that should help yield accretive returns during and beyond the recovery period. We believe the foundational initiatives laid over the last 12 months will yield significant increases to our already positive operating cash profile. Back over to you on slide 12, Brandon.
spk00: Thanks, Kevin. Let's spend a few minutes revisiting the primary growth opportunities in the fourth quarter and 2023. First and foremost, we remain focused on achieving the upside performance potential within our organic portfolio at our improved occupancy levels. On the expansion front, We see two primary opportunities for growth in 2023. We are currently evaluating strategic management arrangements with institutional real estate owners for acquisition portfolios. Sunita's interest and ability to invest alongside our ownership partners, in addition to our track record of improving challenged assets, have generated consistent interest on this front. Finally, the prolonged operating challenges of the senior living operating environment, coupled with rising financing costs, will likely produce additional investment opportunities in 2023. We will remain active in evaluating and pursuing accretive investments in our existing and predetermined expansion markets. Turning to slide 13, I'll conclude today's presentation by introducing our strategic pillars, team, value, and operational excellence. We believe best-in-class execution in these areas is key to delivering continued improvement in the business. Emphasizing these three areas creates a differentiated experience for our residents, families, and team members, and will deliver strong operating results within current and future CENITA communities. Doug, please open the line for additional questions.
spk01: Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. If you'd like to ask a question, you may press star 1 on your telephone keypad. A confirmation tone will indicate your line is in a question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from the line of Steven Valliquette with Barclays. Please proceed with your question.
spk02: Great, thanks. Good morning, guys. Thanks for taking the question. Yeah, I guess as far as the, hey, good morning. As far as the in-place resident rates for 2023, I didn't hear any sort of quantification of the expected rate, but I guess I'm just curious if you are able to quantify what the range would be. But also, you know, should we expect it to accelerate versus the trend in 22? And I guess the other question that's kind of intertwined with that is how should we think about that in the context of how much your op-ex would grow year over year? Do you expect the, you know, Rev4 to outpace the operating expense? per occupied room as far as another source of margin expansion over and above the occupancy gains. So we'll start with that. Thanks.
spk00: Yeah, thank you, Steve. I would say that we have seen ongoing increases throughout this year. If you just look between Q1, 2, and 3 in our in-place rent increases at the resident level. As a reminder, we do our increases on the resident's anniversary date, so it's not a one-time increase. And we have seen those rates increasing from in the 4% range in the first quarter to now, you know, in the high fives and low sixes as we, you know, reach the end of the third quarter. So we will continue to push forward on that. We believe that what we've done from an investment perspective, both in the resident programming as well as the physical plant improvements, does justify the higher in-place rent increases. over and beyond what we're hearing just in terms of inflation across the entire economy. So we would expect that those increases will be higher in 2023. And we also, our goal, you know, given what Kevin talked about, the opportunity to manage operating expenses, especially on the labor front, to, you know, remain below what we're shooting for for the in-place and overall market rates on the top line. in order to generate our margin improvement at 25%.
spk02: Okay, got it. Okay, and then slide six is useful as far as just being able to show some of the operating leverage, some of the various components. On the contract labor piece you have there, what is the raw dollar amount of just annualized contract labor costs across the community portfolio right now, just to give us some context around that? you know, that every $1 million reduction. But, you know, what's the baseline gross dollar on it, just roughly, just to give us a sense?
spk03: Yeah, so it's the $7.5 million in the top left corner, and that is simply Q3 annualized, multiplied by four. And so we use that same number in the table in the bottom right to show how that number sensitizes over varying levels of contract labor dollar decrease.
spk02: Okay, that is the baseline. Got it. Okay. Final quick question. You alluded to the more sophisticated labor management practices. Is there a chance you could just provide just a little bit more color on some of the framework around that just so we can all better understand what goes into that? That'd be helpful. Thanks.
spk00: Yeah, I'd say there's two major components to it. And this goes beyond just the basic blocking and tackling of the positive net hires that Kevin referenced that we've seen throughout the last couple of quarters. that really provides stability in the overall workforce. One is sharing of staff in the markets where we have significant density. We have begun doing that in the later part of this year and are seeing benefits from avoiding the more premium cost of overtime and third party contract labor utilization. So we would expect to further expand that in our portfolio. And then the other component is the use of flexible and part-time in order to really ensure, again, that we're optimized for the services that our residents need and not just thinking about our labor as a fully fixed component of the P&L. And then I'd also say that as we have achieved the occupancy levels that we're at pre-pandemic, we now have the opportunity to see greater flow through without the need to add additional labor hours because we've reached kind of right just below that 85% mark that ultimately gives you a lot more operating flexibility in running the business without adding labor.
spk02: Okay, got it. Okay, maybe a final quick question. As far as any sort of formal 2023 guidance, are you in a position now with the company and, you know, a decent amount of stabilization post the – the worst of the pandemic to potentially get more formal guidance for 2023, maybe on the next earnings call? Or is that still you're kind of just living quarter by quarter as far as some of the trends within the company? Just curious to get your thoughts on that. That'll be the final question. Thanks.
spk00: Yeah, I'd say that we would like to be in a position to do that. At this point in time, we're just looking at kind of quarter over quarter trends and assuming that the environment begins to stabilize a bit more in 2023, then the company would be in position to get back to providing guidance. I think we're still in an environment where there's a fair number of moving pieces, but our goal would be to get there next year. And also just to continue providing the framework similar to what Kevin provided around the levers to increasing margins and how we're doing on each of those fronts going forward.
spk02: Okay, excellent. Okay, that's it for me. Thanks.
spk01: Thank you, Steve. If there are no further questions in the queue, I'd like to hand the call back to management for closing remarks.
spk00: Thank you, Doug. This concludes today's conference. Thank you all for participating, and we wish everyone a happy and healthy holiday season.
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