Earnings Transcript for RHE - Q2 Fiscal Year 2016

Executives: Bill McBride – CEO Allan Rimland – CFO Brett Maas – IR

Analysts: John Cantone – Cantone Research Larry Raiman - LDR Capital Management Chris Doucet - Doucet Asset management

Operator: Good day everyone and welcome to the AdCare Health Systems Inc. Second Quarter 2016 Earnings Call. Today’s conference is being recorded. And at this time, I would like to turn the conference over to Mr. Brett Maas. Please go ahead.

Brett Maas: Thank you and good day. Joining me on the call today are Bill McBride, AdCare’s Chairman and Chief Executive Officer; Allan Rimland, AdCare’s President and Chief Financial Officer; and Clinton Cain, AdCare’s Senior Vice President and Chief Accounting Officer. I would also like to mention this call is being simulcast on the company’s website at www.adcarehealth.com. Forward-looking statements. Any forward-looking statements made today are based on management’s current expectations, assumptions and beliefs about AdCare’s business and the environment in which the company operates. These statements are subject to risks and uncertainties that could cause AdCare’s actual results to materially differ from those expressed or implied on this call. Listeners should not place undue reliance on forward-looking statements and are encouraged to review AdCare’s SEC filings for a more complete discussion of factors that could impact AdCare’s results. Except as required by Federal Securities Laws, AdCare does 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. After management concludes their remarks, they will respond to questions. Now, I’d like to turn the call over to Chairman and Chief Executive Officer of AdCare, Bill McBride. Please go ahead, Bill.

Bill McBride : Thanks, Brett. Good morning and thanks to everyone for joining us today. I’d like to make a few general comments before turning the call over to Allan to report the financial results for the quarter. AdCare is beginning to see the benefits of its transition from an operator of skilled nursing facilities to a property holding and leasing company, as evidenced by a return this quarter to positive cash flow from operations. We made progress in our efforts to increase the value of our facilities by further aligning ourselves with strong operators and continuing to work with our existing operators to look for opportunities to invest in our facilities. These investments will enhance the performance of the facilities, which will continue to improve our coverage ratio. The review of strategic alternatives by our board using Stifel as our advisor is ongoing and our continued efforts to further increase the value of our properties and our balance sheet will maximize those results. During the second quarter, we continued negotiations with Skyline Healthcare for their purchase of nine of our Arkansas facilities, which they began operating at the beginning of the second quarter. As you may recall, Skyline exercised its option to purchase the facilities for $55 million. By mutual agreement, the closing date of the sale was extended from August 1 to August 31. In connection with the extension, Skyline waived all conditions to the completion of the sale and our indemnification obligations under the Master Lease were completely eliminated. Skyline also agreed to provide evidence of financing by August 10, which they have done. Total consideration for the sale is $55 million, $52 million in cash and closing with the balance evidenced by a promissory note. After repayment of the mortgage debt associated with these properties, we expect to net approximately $25 million in proceeds, $22 million in cash and a $3 million, 10% note to be repaid in two years. Deployment of the net proceeds has yet to be determined, but is being evaluated in concert with the board's review of strategic alternatives. I might add that Skyline has already begun making improvements to the operating performance of these facilities, which the company would record benefit from in the unlikely event that Skyline does not exercise its purchase option. Turning to an update on our Georgia facilities. As you may recall, three of our Georgia facilities have transitioned from New Beginnings to Peach Healthcare Group. New Beginnings was a poorly managed, thinly capitalized entity that the company had subleased three of its Georgia facilities to in 2012. Following New Beginnings’ filing for bankruptcy protection, which was expected earlier this year, we signed a Master Lease Agreement with Peach Health, a well-respected operator in Georgia with significant experience in recertifying facilities. Operations on our Savannah Beach facility transferred in July. We're working closely with Peach to finalize recertification plans for the two other Georgia facilities, Jeffersonville and Oceanside, which will involve investing capital in both facilities to bring them up to operational and physical plant standards. This process is well underway in Jeffersonville and will begin very shortly on Oceanside. We are optimistic that the two facilities will be recertified by CMS by the end of the fourth quarter 2016. We are expecting significant improvement in our operators in the third quarter, as both our Ohio and Georgia facilities receive significant Medicaid rate increases, effective July 1, 2015. Additionally, DMS has released the new Medicare rates, which will increase by 2.4%, effective October 1. We have recently began discussions with our tenant in our two Oklahoma facilities to look at programs available in the Oklahoma City marketplace. These programs could significantly increase the performance of these two facilities and their coverage ratios in future quarters. While we have been focused on assisting our operators continue to improve their performance, we have looked at all ways to operate the company at the lowest possible overhead cost. As a result, general and administrative expenses were significantly lower in the second quarter, as a result of planned headcount reductions and other cost reductions. We expect these costs to continue to be reduced as we wind down our remaining legacy businesses and look for other areas to negotiate cost reduction. Additionally, we have also completed the sale of all of our non-core assets. We had previously identified approximately $1.4 million of non-core real estate assets, primarily office buildings and a parcel of excess land that were no longer necessary to support our business. Finally, we recently subleased our Buckhead offices, which will further reduce costs in subsequent quarters. However, one of our remaining legacy operation issues involves professional liability lawsuits. Unfortunately the company recently has seen an increase in the number of such liability lawsuits. This development may continue to affect our profitability in future periods. Finally, from a strategic perspective, the board engaged Stifel a few months ago as its financial advisor in its review of strategic alternatives for the company. We are pleased with the progress so far conducted by Stifel. It has been extensive, with no limits placed on the outcome by management or the board. When that process is complete, we expect to have a further announcement. That process is still underway and we will not answer questions related to such review on this call. With that, I'll now turn the call over to Allan Rimland, our President and CFO.

Allan Rimland: Thank you, Bill and good morning everyone. Before reviewing our financial results, I wanted to review our operating metrics of our portfolio for the quarter. For the three months ending June 30, 2016, our occupancy rate was approximately 81.9%. The skilled mix was 12.3% and our rent coverage before and after management fee was 1.3 times and 0.9 times respectively. The metrics were similar on a sequential quarter basis. These metrics exclude Arkansas facilities which are subject to a pending sale and three of our Georgia facilities, previously operated by New Beginnings. I would also note that our coverage ratios do not reflect the benefits of the recent Ohio Medicaid rebasing and Georgia Medicaid rate increases Bill alluded to earlier. In addition, Bill addressed preliminary plans for our two Oklahoma facilities. The most recent operations transfer as well as the weakest performers in our portfolio. As a reminder, the presentation of our second quarter and year to date financial results includes the reclassification of our operating results that were transferred to discontinued operation in the prior year’s period. Comparative periods are not indicative of our financial performance given our change in business model. Revenues in the second quarter were $7.2 million. We recognize our revenues in accordance with GAAP, which for most leases on a straight line rent accrual basis. However, rent revenues for nine facilities in Arkansas are recorded on a cash basis due to the pending sale of facilities to Skyline. And three facilities in Georgia are also recorded on a cash basis due to the bankruptcy proceedings related to New Beginnings. We began recognizing rental revenue for our Savannah Beach facility in July, when Peach began operating the facility and expect to recognize rental revenue for our Jeffersonville and Oceanside facilities when the facilities are recertified by CMS in the coming months. General and administrative expenses were $2.0 million for the quarter of 2016, inclusive of $240,000 in stock-based compensation. I would also note that G&A includes approximately $125,000 in expense related into our facility management business. G&A declined 17% compared to the second quarter of 2015. The decrease in G&A was primarily driven by a decrease in employee compensation, contract services and IT related expense, partially offset by increases in legal, insurance and accounting, some of which are more non-recurring in nature. To give you some additional insights into the drivers behind our G&A reductions, our total headcount has been reduced from 21 at the end of 2015 to 14 currently, excluding six professionals dedicated to our facility management business. Our core headcount to be expected to be eight to nine professionals for our ongoing business, plus a few contracted employees necessary to wind down legacy issues. In addition, we continue to expect additional reductions in G&A in the next few months from lower non-compensation related expenses. Depreciation and amortization declined in the second quarter of 2016 to $1.3 million compared to $1.8 million in the year ago quarter, and $1.7 million in the prior quarter. This decrease was due primarily to the Arkansas facilities being classified as assets held sale. Interest expense declined from $2.3 million in the second quarter of 2015 to $1.8 million in the second quarter of 2016, as a result of lower debt balances through netting restricted cash against certain mortgage loans, principal amortization and debt repayment. Our loss from discontinued operations net of tax was $3.8 million for the current quarter as compared to $1.5 million for the prior year period. The loss was primarily due to increased reserves for professional and general liability claims, as well as higher bad debt expense related to legacy patient accounts receivable. Net loss attributed to AdCare common stockholders for the quarter was $6.8 million compared to $6.5 million for the second quarter of 2015, or $0.34 and $0.33 basic and diluted loss per share respectively. Now, for a view of our year to date financials. Revenues for the first 6 months were $14.2 million compared to $6 million in the year ago period. The increase in revenues was driven by an increase in rental revenues, reflecting our transition to a healthcare property holding in leasing company. General administrative expense were $4.7 million for the first half of 2016, inclusive of $720,000 stock-based compensation. G&A declined 21% or $1.2 million compared to the first 6 months of 2015. Interest expense decreased from $4.8 million in the first half of 2015 to $3.6 million in the first half of 2016. Net loss attributed to common stockholders for the first 6 months of 2016 was $10.5 million, compared to $12.2 million for the first 6 months of 2015 or $0.53 and $0.63 loss for basic and dilute shares respectfully. Turning to a review of our balance sheet. Cash and cash equivalents at June 30, 2016 totaled $2.3 million dollars compared to $2.7 million at year end. Restricted cash in June 30, 2016 totaled $5.0 million compared to $12.7 million at year end. The large decrease in restricted cash is due to moving a portion of restricted cash through assets held for sale, as these announced serve as cash collateral for mortgages on our Arkansas facilities subject to sale. In addition, we have netted some restricted cash to be used as cash collateral against mortgage loans to reduce outstanding loan balances. Total debt outstanding at June 30, 2016 was $116 million compared to $122.8 million at year end, including liabilities of disposal group held for sale of $32.2 million and $958,000 and net of $2.3 million and $2.7 million of deferred financing cost respectively. Also, you will see further progress in reducing our legacy related operating working capital accounts, namely accounts receivable, pre-pay, accounts payable and accrued expenses. We expect further reductions in such accounts over the next few months as we continue to wind down legacy business related issues. Our operational progress was reflected in our financial results, with G&A expensive again low in the quarter, deleveraging of our balance sheet and positive cash flow. We look forward to continuing these trends throughout the remainder of 2016. I will now turn the call back over to Bill.

Bill McBride : Thanks Allan. I'm pleased with the progress we've made this quarter in re-leasing our 3 New Beginnings property, the continued reduction of general and administrative expenses and other initiatives and investment which we believe will further improve the operations which will enhance our coverage ratio. Obviously, the results of our strategic review may have a significant impact on the direction of the company, as well as dictate how and where we will reinvest the proceeds from the sale of the Arkansas facilities to Skyline if completed. This would obviously impact the company's financial guidance as well. We are finalizing that process as expeditiously as possible while still looking to fully evaluate all proposals to maximize shareholder value. We look forward to updating you as that process is completed, and we’ll provide updated guidance at that time as well. I’d like to open it up for questions now.

Operator: Thank you. [Operator Instructions]. We’ll go first to John Cantone with Cantone Research.

John Cantone: Hi, good morning guys. 2 questions. First one will be if you heard anything about Skyline’s financing, if they came through, if they showed you proof of financing from their bank regarding the purchase of the 9 facilities?

Bill McBride: As we said in the press release, as well as in the speech, we have seen proof of financial wherewithal to close that deal.

John Cantone: Oh good. Secondly, has there been any discussion about reinstituting the dividend the common shareholders?

Bill McBride: I think that would be something that we would address as we come out with a conclusion from the review of our strategic review. And then based on the direction of the company, it’s always been mine and I believe Allan and I are firmly aligned on this, that the dividend relative to the common shares ought to be in some proportion to the FAD or funds available for distribution for the company. Obviously with the results of the strategic review be determined as well as the closing of Skyline, that would impact that. And so when those two -- when we have further clarity on those 2 points then we would address that issue.

John Cantone: Okay. Thank you very much.

Operator: We’ll go next to Larry Raiman with LDR Capital.

Larry Raiman: Thank you. Nice progress in the quarter. Just a quick, 2 quick questions. One, now that you've seen proof of the skyline financing, are there any other contingencies that are being worked through between now and the end of the month? And then the second question is regarding the strategic review. Can you give any indication to the marketplace with regard to the particular timeline that you're working within after which you would say okay gang, this is make or break and let's make it happen or not? Thank you.

Bill McBride: In regard to the first question, as far as the Skyline closing, part of the negotiations in granting them the 30 day extension was that they removed all contingencies relative to close. There weren’t a lot even before that, but there were certain contingencies relating to title and environmental. They completed those reviews and released all contingencies on the deal. So there are none. In regards to the question on the strategic review, the company is pushing Stifel as quickly as possible to wrap up the strategic review. At the same token though, we want to make sure that we look at it further and fully explore any and all alternatives out there to the company. This isn't a process that you want to do frequently. So when you do it, you want to make sure it's complete, it's extensive, and it looks at any and all possibilities. So while we are pushing them, we are also balancing that with making that process be complete. I don't have a specific timeline other than I can say we know Arkansas -- we expect that Arkansas will be closing soon. The company will need to make decisions regarding the reinvestment of the proceeds from the Arkansas sale, that those proceeds and how we invest those proceeds will be driven by those strategic options, so to the extent that there's certain directions that the company may want to take with other firms et cetera, they would need to step up and make a final decision on both sides so that we can reinvest those proceeds in accordance with what they would like to do. So there is some internal pressure, but at the same token we want to finish this process completely and fully and explore all alternatives.

Larry Raiman: Thank you. Good luck.

Operator: [Operator Instructions]. We’ll go next to Chris Doucet with Doucet Asset management.

Chris Doucet: Good morning guys. Bill, can you speak to how long it will take to get back to the $1 million in G&A per quarter that you talked about a year ago?

Bill McBride: Yes Chris. We’re rapidly getting there in terms of all other areas, expect for really legal, accounting and certain other non-recurring charges. We’re continuing to work on those areas. We hope that towards the end of this year, third to fourth quarter, we would be there on a run rate basis, at the 4 million dollar level. We were impacted by this quarter by the New Beginnings bankruptcy for example and the legal expenses and such associated with that. Obviously that was on a non-recurring basis and wasn’t expected nor budgeted by us. I would expect by the end of the year on a run rate basis we’ll be at that level. Obviously we have the additional costs from the management business in the Ohio property that’s included in our G&A. Allan, would you want to comment further on that?

Allan Rimland: Obviously as we said in our script earlier that approximately $0.5 million of G&A expense related is in our UBMC business. We look at our G&A in really 2 buckets or 3 buckets. One is stock-based comp which is obviously is non-cash and that mostly relates to initial grants. We typically look at cash-based comp as well as the non-compensation top. As I alluded to earlier, we watch the headcount like a hawk. We also are really transitioning where there’s probably 3 or 4 individuals that wind down this year, mostly focusing on Legacy operations. There we would meet our goal of compensation of $1.5 million to $1.6 million area. We’re probably at the $1.8 million area right now. The hardest part to really assess and really reduce is the non-comp related expenses. Legal, we are watching very closely. Some of those expense were non-recurring over the last 6 months. Again I think we feel good about that, but we revisit every month and I would say even over the last month, I’ve probably chopped out on an annualized basis $300,000 to $330,000 worth of expense. We feel good about the end of the year target and a lot of it is just legacy or cost related to legacy operations.

Chris Doucet: Then can you please speak to the company’s path back to profitability and maybe an associated timeline?

Bill McBride: So basically if you look at the quarter the 3 months ending June 30, 2016, REITs really look at this from an FFO point of view from operations. If you look at income from operations, we were at $553,000. Add that to depreciation of $1.3 million you get almost $1.9 million. Our interest expense was $1.7 million. So we were actually positive cash flow from our core REIT business for that quarter. Now, the revenues, the rental revenues for the third quarter of almost $6.9 million, obviously we’re impacted by a couple of things to the negative. That was the New Beginnings facilities are not on line and once online they will generate about $275,000 roughly a quarter of additional rental revenue. The Skyline facilities are on a cash rent basis. So when you add those 2 items back in on a go-forward basis, then you would end up getting pretty close to our run rate that we had originally had out there of about $30 million on an annualized basis for revenue. From a pure REIT point of view in our core continuing business, we have already returned to profitability. We expect that will increase as those other properties come online, number 1 and number 2, it will further increase as we continue to reduce the general and administrative expenses. We had $2.1 million for the quarter. There was a couple of areas like legal and accounting that we’re working on very diligently to reduce. Those are a big part of our budget. Some of those are a little bit controllable relating to say audit and accounting fees. Some of those are a little bit non-controllable in the sense that if an issue comes up like a New Beginnings or some tenant issue, they’re non-controllable, but we’re still doing our best to cut all of those costs down and get that G&A number down to that $4 million run rate number that we talked about.

Chris Doucet: Okay. Good answers. Thank you.

Allan Rimland: Just one additional point, Chris just on the accounting. Obviously we’re always looking at the accounting cost give the size of the business, but we book accounting fees or invoices when received and obviously given the audit at year end, most of those fees are front end loaded in terms of the beginning part of the year. You won’t be seeing those type of expenses in the back half of the year. So an example, if you were to annualize either the first three months, the first six months, it’s way below what we expect to pay for the full year.

Chris Doucet: Thanks guys. I’ll step back in the queue.

Operator: This does conclude today’s question-and-answer session. I would like to turn the call back over to management for any closing remarks.

Bill McBride: Okay, no additional questions then.

Allan Rimland: Bill, could you just hold on one second? The queue may be reforming. Why don’t we just wait a few seconds?

Bill McBride: Okay.

Operator: [Operator instructions].

Allan Rimland: There’s no one in the queue, Bill.

Bill McBride: All right, thanks to everyone for joining us today and we look forward to updating you on our progress, including the results of our strategic view as soon as possible and we’ll have a conference call again at that time. Thanks again.

Operator: This does conclude today’s conference call. Thank you for your participation. You may now disconnect.