Ladies and gentlemen, thank you for standing by, and welcome to the Pennant Group Third Quarter 2019 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions].

I would now like to hand the conference over to Chief Investment Officer, Derek Bunker. .

Thank you, Andrew, and welcome, everyone. Thank you for joining us today. Here with me today, I have Danny Walker, our CEO and President; Jen Freeman, our CFO; and John Gochnour, our COO..

Before we begin, I have a few housekeeping matters. We filed our earnings press release and 10-Q yesterday. This announcement is available on the Investor Relations section of our website, www.pennantgroup.com. A replay of this call will also be available on our website until 5 p.m. Mountain Time on Friday, December 13, 2019..

We want to remind anyone that may be listening to a replay of this call that all the statements made are as of today, November 13, 2019, and these statements have not been nor will they 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, Pennant and its affiliates do not undertake to publicly update or revise any forward-looking statements or when changes arise as a result of new information, future events, changing circumstances or for any other reason..

In addition, the Pennant 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.

The words Pennant, company, we, our and us refer to the Pennant Group, Inc. and its consolidated subsidiaries. All of our operating subsidiaries and the service center are operated by separate, wholly owned independent companies that have their own management, employees and assets.

References herein to the consolidated company and its assets and activities as well as 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 Pennant Group, Inc.

has direct operating assets, employees or revenue or that any of the subsidiaries are operated by the Pennant 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 10-Q..

And with that, I'll turn the call over to Danny Walker, our CEO.

Danny?.

Thanks, Derek. Good morning, everyone. We're thrilled to welcome you to the Pennant Group's very first earnings call. I would like to start first by thanking the many Pennant team members for the significant focus, effort and commitment it took to successfully complete the spinoff from Ensign.

We'd also like to extend our appreciation to our partners at Ensign, who have entrusted us with this opportunity to continue to grow alongside them as a publicly traded company with unique opportunities for growth afforded by the Ensign Pennant Care Continuum. We're thrilled to have 2 healthy public companies for investors to work with..

Finally, we also want to acknowledge the external advisers, third-party landlords, government agencies and others who have played a role in the transaction. We're grateful for your efforts and appreciate each one of you..

a vibrant Home Health and Hospice company and a healthy Senior Living business, coupled with a strong balance sheet and a healthy beginning lease coverage ratio as a result of the spinoff..

Our Home Health and Hospice business continues to produce excellent top and bottom line results and is primed for even more growth..

Our Senior Living company is composed of operations that were hand-selected for their strategic potential. This portfolio is relatively new to us, with approximately 70% of its operations acquired within the last 5 years.

And as these communities mature, we believe this business is poised to generate solid returns in the near and long term in spite of what some believe to be industry headwinds..

Our third quarter results were strong and offer us a great starting point for our future growth. During the quarter, we generated revenue of $88.4 million and combined adjusted EBITDAR of $15 million.

Our Home Health and Hospice business increased revenue by $11.3 million or 26% and adjusted segment EBITDAR from operations by approximately 15%, each over the prior year quarter..

In our Senior Living business, revenue increased $4.1 million or 14% and adjusted segment EBITDAR from operations increased 70 basis points each over the prior year quarter. Today, we are pleased to present our full year 2020 annual guidance.

For the full year 2020, we anticipate annual revenue of $376 million to $386 million and adjusted earnings per share of $0.53 to $0.58 per diluted share. The midpoint of our earnings per share guidance represents an increase of 24.7% over the midpoint of our full year spin-adjusted 2019 guidance.

Jen will give more detail on our guidance a little bit later..

Now turning to the health of our operations. As Ensign has repeatedly done, we find it helpful to frame the progress happening across our organization by sharing specific examples of how our local teams are driving clinical and operational results. These examples help highlight the untapped potential throughout our portfolio.

While we only highlight a few operations each quarter, there are dozens of stories like these unfolding across the organization. As new operations join as a result of our acquisition efforts, the cycle of growth exemplified by these stories unfolds again and again, giving us confidence in our ability to drive long-term shareholder value..

In the fall of 2017, we acquired a home health and hospice agency called Excell Home Health and Home Care & Hospice, located in Oklahoma City, Oklahoma.

Led by Executive Director Spencer Nolen; and Director of Clinical Services, [ Christina Tel ], Excell's talented clinical team has improved their clinical outcomes and star rating and reduced rehospitalization rates.

These improvements have led to a participation in key [ narrowed ] networks and admissions have increased in both home health and hospice. Cumulatively, this volume helped improve top line revenue by 8.5% over the prior year quarter.

Excell has grown even more quickly on the bottom line, with earnings increasing by over 73% over the prior year quarter.

Since our model is built on ownership and peer accountability, as our local leaders work hand-in-hand with our resources to capture greater market share and thoughtfully manage costs, these recently acquired operations will drive sustained long-term earnings growth..

While we continue to grow our newer acquisitions like Excel, our entrepreneurial model also continues to drive improvement in our more mature operations. For example, Zion's Way Home Health & Hospice in St. George, Utah has been part of our organization since 2012.

From the first full quarter of operations following our acquisition until the third quarter of 2018, the agency produced a revenue CAGR of approximately 24%.

Under the leadership of Cortney Mathews and CCO Trevor Rowland, in the third quarter of 2019, Zion's Way further increased revenue by more than 22% and increased earnings by more than 41% all over the prior year quarter and on top of 6 years of equally impressive financial growth.

While producing stellar financial results, Zion's Way has continued to methodically improve its clinical outcomes evidenced by a CMS star rating of 4.5 stars..

Zion's Way is just 1 example of the continued organic growth opportunity present in our mature operations as local CEOs and clinical leaders strategically expand their market share and service area on the foundation of world-class systems, coupled with a strong balance sheet..

Our localized approach is at the heart of our preparation for the implementation of PDGM. Throughout 2019, cross-disciplinary teams have worked closely to identify and share best practices, data and tools to prepare for PDGM.

Armed with this information, our local leaders and resources are training clinical staff and evaluating internal processes and making changes necessary to ensure optimal clinical and financial results upon implementation.

In light of this preparation and our -- and the improved behavioral adjustment expectations in the final rule, we are currently projecting that PDGM will have a modest positive impact on our Medicare home health revenue in 2020 of between 1.5% and 2%.

We also expect the phase-out of the RAP and the transition to 30-day periods of payment may create additional acquisition opportunities as local owner-operators experience reimbursement disruption and seek to entrust their legacy to us so their teams can have the experiences like those I have outlined at Excell and Zion's Way..

This playbook of ownership-minded local leaders developing and growing 1 operation at a time is having a similar impact in our Senior Living business. One example is The Grove Assisted & Independent Living in Riverside, California.

Led by Executive Director [ Briana Boyd ]; and Wellness Director, [ Beto Gonzales ], The Grove has established clinically driven resident retention programs, allowing more residents to age in place. As a result, the gross occupancy increased to 88% which represented a 16% increase over the prior year quarter.

As occupancy and length of stay have increased, The Grove saw earnings growth of 118% over the prior year quarter. The Grove is one of many success stories unfolding throughout our senior living company.

We are excited for the growth in 2020 that will be realized as local teams unlock the potential of our senior living operations, many of which are still relatively early in the process of transitioning into what we are seeing in our more mature operations..

With that, I'll turn it over to Derek to give us an update on our recent investment activity.

Derek?.

Thank you, Danny. Despite the demands of completing the spinoff, we continued to execute a number of acquisitions throughout the year.

We are committed to remaining disciplined when it comes to capital allocation, prioritizing the preparation of our local leaders to step in and lead new operations so we will continue to be selective as we underwrite new strategic opportunities..

Our model is built to scale, and we have a strong pipeline that we believe will continue to expand as we digest the acquisition year-to-date. The pace and size of our transactions depend primarily on the strength and size of our leadership pipeline and the health of our existing operations. We're also very thoughtful when entering new states..

During the quarter, we completed the acquisition of Agape Hospice, an agency providing services in Tucson, Arizona; and Mainplace Senior Living, a 91-unit senior living community located in Orange, California.

Our acquisitions in the first half of the year include hospice agencies in Austin and Houston, Texas; a home health and hospice agency based in Milwaukee, Wisconsin; and a home health and hospice agency in San Antonio, Texas in addition to the others announced throughout the year.

In total, we have acquired 11 operations year-to-date, bringing our total operations count at year-end to 115..

Our access to capital and balance sheet strength position us for further growth. In connection with the spinoff, we entered into a new credit facility that provides a $75 million revolving line of credit.

In addition, our overall rent coverage ratio stands at a strong 1.6x, primarily the result of Ensign's efforts to ensure the spinoff resulted in 2 healthy companies.

As part of those efforts, we entered into a new master lease agreement with Ensign for the lease of 29 senior living communities and they're willing and able to partner on future senior living acquisitions by taking on real estate and associated costs, allowing us to allocate more cash to other opportunities.

This is just one of many exciting aspects of the Ensign Pennant Care Continuum, and we look forward to working closely with them as well as with other current and potential landlord partners as we continue to grow..

Armed with substantial dry powder from our cash flows, a new revolver and a solid lease profile, we are excited to continue and even accelerate our acquisition strategy in 2020. Our history is built on organic and inorganic growth.

We remained very active this year, notwithstanding the heavy work involved in completing the spinoff, and we expect even more growth as we go forward from here..

With that, I'll hand it over to Jen to provide more detail on the company's financial performance and guidance.

Jen?.

Thank you, Derek, and good morning, everyone. Detailed financials for the quarter are contained in our 10-Q and press release filed yesterday..

adjusted GAAP income of $4.4 million and combined adjusted EBITDA of $6.5 million. We also want to point out that we have made a few adjustments between our GAAP and non-GAAP numbers, and approximately 92% of those adjustments relate to the removal of costs related to the spinoff transaction and share-based compensation.

Other key metrics include year-to-date cash generated from operations is $12.2 million, a lease-adjusted net debt to adjusted EBITDA ratio of 4.89x, we paid down $8 million of our revolver since quarter end and $52 million is available on our line of credit..

In addition, we are providing full year 2019 revenue guidance of $339 million to $340 million and adjusted earnings per share guidance of $0.55 to $0.56 per diluted share. The guidance is based upon diluted weighted average common shares outstanding of approximately 29.0 million..

An effective tax rate of 25.2%, with the primary exclusions coming from transaction-related costs related to the spinoff, stock-based compensation, and the effect of net income attributable to noncontrolling interests and the inclusion of acquisitions closed to date..

Consistent with the pro forma financials presented in our Form 10 information statement, we have also adjusted our full year 2019 earnings guidance to account for certain spin-related items in order to provide a more helpful year-over-year comparison to our full year 2020 guidance.

We anticipate full year spinoff-adjusted 2019 earnings per share to be $0.44 to $0.45 per diluted share. Our full year spinoff-adjusted 2019 guidance assumes annualized fourth quarter 2019 rent and interest expense..

We have also provided 2020 guidance with annual adjusted earnings per share of $0.53 to $0.58 per diluted share and annual revenue of $376 million to $386 million. The midpoint of our earnings guidance represents an increase of 24.7% over the mid-year of our full year spin-adjusted 2019 earnings per share guidance.

The 2020 guidance is based upon diluted weighted average common shares outstanding of approximately 29.3 million, an effective tax rate of 25.2%, the inclusion of acquisitions expected to close in the fourth quarter of 2019, the exclusion of acquisition-related costs, the exclusion of expenses associated with duplicate services provided during the transaction services period, and the exclusion of stock-based compensation..

the short-term impact of our acquisition activities; seasonality in occupancy or census; variation and changes in reimbursement systems; the influence of the general economy on our census and staffing; and delays and changes in state or federal budgets..

And with that, I'll turn the call over to Danny.

Danny?.

Thank you, Jen. We, again, just want to express our gratitude to Ensign for the solid foundation and starting point with which we've been entrusted. We hope all will take note of our track record of growth and that you will see the exciting growth potential in our young, budding portfolio of home health, hospice and senior living businesses.

We look forward to sharing more specific examples in future calls on how we're unlocking and driving long-term shareholder value throughout our portfolio..

We want to thank you again for joining us today and express our appreciation to our shareholders for their confidence and support. We're also appreciative of our colleagues in the field, service -- and service center for making us better every day.

As we look to conclude 2019, we are confident that their dedication to and application of our core operating principles will be what makes us -- makes the rest of this year and beyond successful..

We will now turn to the Q&A portion of our call. As Derek mentioned earlier, we are here with our COO, John Gochnour, who is also available for questions..

Andrew, can you please instruct the audience on the Q&A procedure?.

[Operator Instructions] And we have a question from the line of Frank Morgan with RBC Capital Markets. .

I guess staying on the subject to the guidance, I appreciate the general framework there.

But as you think about the guidance, is there anything that you would highlight to us that might be critical to achieving those results? Is there any one particular or just a couple of things that you would specifically call out would be the key elements to achieving that guidance?.

Yes. Great question, Frank. So really, it's a matter of us executing on our standard playbook as we have a number of new acquisitions in the -- that we've done in the last 12 months. And we need to continue to see those acquisitions materialize and result in the kind of growth we normally see during that first period of operations.

We also need to -- and that applies to both our home health and hospice acquisitions. So there's been a number of them as well as these senior living acquisitions that took place in the fourth quarter of 2017 and -- fourth quarter of 2018, sorry..

And then we need to execute on our implementation of PDGM effectively. Like I said, we expect it to be less of a challenge for us.

Even with an internal positive projection for how it's going to affect us, there's a lot of change that, that results in, and we need to make sure that we stay focused on our core operations and we help our local teams navigate that massive change effectively.

We feel very good about our preparation, we feel very confident in what we'll be able to do.

But these kinds of changes in the payment model and the payment system will affect not just our operators, but the physician groups that we work with and hospital systems, everybody involved in submitting those and preparing those claims for home health services. So those are really kind of the 3 big items that I think about. .

And then, I guess, on the subject of PDGM, a lot of talk from other -- of your peers about the ability to offset there, most of them saying, hey, we think that we can mitigate a good chunk of the headwind in that 4-plus percent range, we can offset that through revenue.

And then from a cost perspective, we think that, that would be -- might serve as an upside over the -- over the next several quarters after it's implemented.

Is that kind of how you think about it as well?.

Yes. Yes, that's exactly. And we're looking at every lever and each of our operations has a different profile when it comes to PDGM and which levers they're going to need to focus on. And so we're prepared on both the revenue side, the quoting side of things as well as the cost front. And we see opportunities in all of those areas.

We're encouraged by it. We feel like we're as well positioned as we could be, and actually look forward to it..

Our hope and expectation is that other small providers that are trying to navigate those waters will look to our experience with bringing on operators that have a really solid clinical reputation, the heart that you would want to see in a home health and hospice business and want to see that legacy preserved and developed like these examples I've shared earlier.

So we're excited for the growth potential that, that represents both with our organic operations as well as the possibility of new acquisitions. .

And I guess, staying on that subject of M&A, the opportunity that may present.

Is most of what you're seeing is -- is it similar to what we always thought with Ensign, where a lot of those opportunities that you're seeing are more sort of within existing markets?.

And I guess the follow-on question to that would be just you did reference this -- your Ensign Pennant Care Continuum in the context of being a good capital partner with you, but I know one of the other things was a discussion about the lack of referral flows to date between the Ensign facilities and the Pennant's.

I think something like less than 10% of your home health care referrals actually come from the Ensign side, despite some really good overlaps.

So do you see that increase -- actually there's a separate question, do you still see a near-term opportunity to increase the penetration there? And then are you seeing those acquisition opportunities in your existing markets?.

Yes. Great question. You'll note that our hospice acquisition in Tucson was right in our existing markets. The 2 we did in Texas were also in those existing markets. We continue to see opportunities in the existing states that we're in.

We will continue to, in a very disciplined way, evaluate opportunities to enter new states as those opportunities present themselves. And we feel good about our preparation for that. Our leadership pipeline is continuing to develop.

And we have a good number of leaders that are in the training process and ready to step in and help these acquisitions thrive..

On your question about the EPCC and that referral relationship with Ensign, yes, we continue to approach it exactly the same way, which is we -- arm's length, and we expect to earn that business.

We have seen extraordinary progress in that regard and look forward to seeing each of these submarkets, continue to develop those relationships so that they become a more vibrant solution to hospital systems and other payers in those local markets.

We're seeing an increase in the collaboration between Ensign operators and Pennant operators with a renewed focus on how those relationships can be mutually beneficial. And the EPCC activities that we have engaged in continue to lay a really solid foundation for what we believe we can accomplish in the future. .

[Operator Instructions] And we have a follow-up question from Frank Morgan from RBC Capital Markets. .

So I guess, you've touched on this a little bit. But in terms of the -- with what you're seeing now, is the M&A market overall -- clearly, you've got the opportunity to pursue home health care and hospice, but also senior living.

Given what you've seen at least since -- now that you're freestanding, any change in thought about priorities or preference of growth between those 2 segments?.

Yes. Our priorities and preferences are always going to be an outgrowth of where we have strength in our existing operations. Where our pieces of our organization are healthy, clinically, financially and culturally, those groups are going to be encouraged to grow.

On the macro environment, there continues to be more opportunities on the senior living side than we're willing and able to try to take. And so we're very selective in a very, very frothy market. There's just plenty of opportunities there..

On the home health side, we're anticipating that there will be some of this disruption and we're well prepared and excited about that. We continue to evaluate meaningful opportunities in that vein..

On the hospice front, multiples have been a little bit compressed on that front.

So we've again looked for strategic opportunities in our existing markets where we can get deals done that are a win-win for us and the sellers that are involved that tend to have a focus on preserving the identity and the legacy of a hospice that's built in the community, a meaningful reputation and presents meaningful opportunities as we couple that hospice with additional resources, better systems and the opportunity to be supported with a balance sheet that can drive growth in ways that they hadn't previously been able to.

.

Got you. And I guess, on the senior living side of the business, a lot of questions from investors about the industry overall and how close we are to an inflection point, given all the supply that's coming into the marketplace.

So I'd just be curious about what's your sort of overall assessment of the senior living sector right now? And do you think we're getting close to an inflection point? And how does that affect your overall appetite for that? And then I'll hop off. .

Yes. Great. So first and foremost, we view the Senior Living business as an opportunity for us to distinguish ourselves as an operator that pulls the right levers and establishes the right culture and supports each community in the way that needs to be supported, so that they can achieve results regardless of the macro environment.

And so it's with that in mind that we're looking for meaningful opportunities to step in to communities that can be transformed through our leadership model. And so we don't view ourselves as necessarily beholden to those kinds of pressures in order to succeed or fail.

So when there's industry -- what might be referred to as industry headwinds, we feel like we can operate effectively within that environment and our track record shows that. And when there happens to be an inflection point and there's tailwinds in the industry, that just makes our operating success a little bit easier.

But for us, the view of senior living is that there's an opportunity to be a true culture-driven, local decision making-driven operator that can outpace any of the headwinds that exist.

As long as we're disciplined on the real estate cost side of things and that we are focused on that middle-income segment of the market, where there's still plenty of demand..

So I'm probably not the best -- I'm not as -- we generally aren't as concerned about whether we're meeting an inflection point or how closely that's going to be. We're not holding our breath. We see the demographics, we see the data that is available through NIC and other places.

And based on that information, it does appear that an inflection point is in the near future. But for our purposes and how we view the opportunity and how we're expending funds and working to build an Ensign. You'll recall that when Ensign started in the skilled nursing space, it was -- that industry was in very, very difficult shape on all fronts.

And we feel like our playbook in the senior housing space is very, very well set up for exactly the kind of operating environment we have. And if and when an inflection point comes, it will just complement our core efforts. But we don't view it as a critical piece of our success or failure going forward. .

Got you. Maybe one -- I promise this is my last one, maybe for Jen. Just thinking about balance sheet strategy, I mean, you're -- because your average -- your leverage level is going to be a little higher than, say, a pure-play home health where leverage is usually averaging just about 1x EBITDA.

So how do you think about your strategy for managing the balance sheet in terms of optimizing -- leveraging to optimize your business? Just any thoughts around that would be appreciated. .

Thank you, Frank. When I think about our balance sheet, our goal is to maintain a healthy balance sheet. And we will continue to opportunistically acquire as opportunities come on the market.

I think when we're thinking about what the balance sheet leverages that we would be comfortable with, right now, we're at 0.95 as a net debt-to-EBITDA ratio, adjusted EBITDA ratio. And we probably would be comfortable at no more than around 2 -- 2x. .

Thank you. And I'm showing no further questions at this time..

I will now turn the call back over to CEO, Danny Walker, for closing remarks. .

Thank you, Andrew..

We'd just like to thank everyone again for joining us today, and we wish you all a happy thanksgiving, and we look forward to talking to you again soon. .

Ladies and gentlemen, this concludes today's conference call. Thank you for participating, and you may now disconnect..