Good day, and thank you for standing by. Welcome to the Pennant Group Second Quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speakers presentation there will be a question and answer session. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to Kirk Cheney, Corporate Secretary. Please begin..

Thank you, Norma. Welcome, everyone, and thank you for joining us today. Here with me today, I have Brent Guerisoli, our CEO; John Gochnour, our President and COO; and Lynette Walbom, our CFO. 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 at www.pennantgroup.com. A replay of this call will also be available on our website until 5:00 p.m. Mountain on August 8, 2024.

We want to remind anyone who may be listening to a replay of this call that all statements are made as of today, August 9, 2023, and these statements have not been nor will they be updated after 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, et and its affiliates do not undertake to publicly update or revise any forward-looking statements where changes arise as a result of new information, future events, changing circumstances or for any other reasons.

In addition, the Pennant Group incorporated as a holding company with no direct operating assets, employees or revenues.

Certain of our independent subsidiaries, collectively referred to as the service center, provide accounting, payroll, human resources, information technology, legal, risk management and other services to the 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 independent companies that we -- 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, 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 will turn the call over to Brent Guerisoli, our CEO.

Brent?.

leadership development, top and bottom line growth, clinical excellence and employee experience. As a result, we've generated significant growth in all business lines, improved margins, reduced turnover and achieve strong clinical outcomes, keeping us on track with 2023 earnings guidance.

Senior Living segment made a remarkable progress in the quarter. As our segment adjusted EBITDAR increased 33.2% over the prior year quarter and 14.1% sequentially, and segment adjusted EBITDA increased 277.4% over the prior year quarter to 58.5% sequentially.

The Senior Living results demonstrates the power of our model and the importance of local leadership with strong cluster support. The cluster support, we mean peer support, which enhances leadership development and execution at the local level. The turnaround in this business truly is a leadership story.

In 2021, our Senior Living business was at a nadir as many of our local leaders struggle to embrace and harness the power of our unique operating model. One by one, new leaders were added, existing leaders transformed, clusters rebuilt and collectively, we deepened our commitment to our core values and our operating model.

Now, the segment has entrepreneurial local leaders to function like owners and strong clusters, which thrive on peer accountability. The Senior Living business now has a deep bench of current and future leaders and contribute meaningfully to our earnings.

We are also trying to grow thoughtfully and opportunistically and to further unlock the latent potential that has existed in this platform since our spin-off in 2019. Our model continues to demonstrate its effectiveness in our Home Health and Hospice segment as well.

Last quarter, we discussed the census pressures we experienced to begin the year and the reduction in our home health Medicare reimbursement rate. Despite these headwinds, our home health and hospice segment adjusted EBITDA increased $1.2 million or 9.2% over the prior quarter, and segment adjusted EBITDA margin improved 70 basis points.

We are pleased with this progress and also see opportunity to continue to build momentum. With that said, let me take a moment to comment on the home health proposed rule.

We are disappointed in CMS' aggressive pets to home health reimbursement, which contrasts with its more nuanced treatment of other post-acute care services and risks dramatically reducing access to critical care in the most cost-effective health care setting as providers are still facing staffing pressures and rising costs.

Together with partners throughout the industry, we look forward to working with CMS and the legislative branch to pursue solutions that work better for beneficiaries and providers. Our commitment to leadership development remains our top priority.

As we discussed last quarter, we are diligently focused on developing a robust pipeline of exceptional leaders will make us better and drive our future growth. We have made tremendous progress in these efforts and our leadership bench in both business lines is as strong as it's ever been.

We are also on the way to achieving our goal of developing 100 local CEOs as well as dramatically increasing the total number of C-level leaders over the next several years.

As we explained last quarter, to earn the title of CEO, our leaders must not only achieve extraordinary clinical outcomes, culture and growth but also drive significant financial improvement in their operations.

Progress in this key initiative is essential and will be the foundation upon which our growth and success will thrive for many years to come. While we are pleased with this progress in each of the 5 key initiatives, we remain laser-focused on driving bottom line improvement.

We know that entrepreneurial leaders who exercise discipline and diligence in their operations, and deliver exceptional results in all types of macroeconomic cycles and rate environments. Many of our local leaders are doing just that, and their efforts are showing in the bottom line.

In Q2, our adjusted EBITDA margin improved on a consolidated basis to 7.8% from 6.6%, a 120 basis point increase over the prior year quarter and a 140 basis point increase sequentially. We are encouraged by the overall improvement that we recognize there remains significant upside opportunity.

We continue to appropriately drive bottom line improvement but carefully managing utilization staff productivity, optimizing service line and reimbursement mix and urgently addressing underperforming operations.

Finally, we are excited to see movement on the acquisition front as we have completed multiple transactions in both segments in the first half of the year. With the growth of our leadership bench and a robust pipeline of attractive acquisitions, we are poised to unlock the potential of our future leaders through our disciplined growth strategy.

With that, I'll turn the call over to John to provide more detail on our second quarter operational results..

Thank you, Brent, and good morning, everyone. We are pleased to report solid performance with existing untapped potential in both operating segments. Our Home Health and Hospice business experienced significant, growth with revenue of $95 million, an increase of $9.7 million or 11.3% over the prior year quarter.

Our census progress was highlighted by robust growth in our hospice programs, where revenue increased 18.3%, admissions grew 9.6% and average daily census increased 9.1%, each over the prior year quarter.

Our home health business also continued its steady growth as home health revenue increased 5.4% and Medicare home health admissions grew 3.6%, and total home health admissions improved 3.8% each over the prior year quarter. Segment adjusted EBITDA of $14.4 million decreased by $0.1 million or 1% over the prior year quarter.

This decrease is a result of calculated investment in additional segment-level leadership to accelerate growth and continued but abating margin pressure from labor and cost increases.

In addition, the negative reimbursement impact of the home health final rule and the reimplementation of sequestration together had a negative impact of approximately $1.1 million. We have started to see the benefits of our investment in leadership in the growth described above and in sequential margin improvement over the prior quarter.

Home health and hospice adjusted EBITDA margin improved to 15.5%, a 70 basis point increase and segment adjusted EBITDA improved $1.2 million or 9.2%, each sequentially over the first quarter.

Our focus on clinical outcomes continues to yield strong results with hospitalization rates, star ratings and hospice quality composite scores significantly above national and community averages. In Q2, our percentage of home health agencies with a star rating above 4, increased to 80% versus 77% in the prior quarter.

Strong clinical outcomes drive growth by enhancing our ability to enter and deepen preferred provider relationships with acute care systems and other key referral sources and positions us to see positive adjustments to our home health revenue through CMS' home health value-based purchasing program.

In addition, our clinical performance has resulted in opportunities to renegotiate contract rates with existing payer partners that more accurately reflect the cost of providing care and to establish new relationships with managed care payers who see our excellent clinical outcomes, geographic diversity and effective and efficient care delivery as a necessary part of their provider networks.

We are just now beginning to experience the impact of these efforts as our managed care visits are up 5.1% and revenue per visit is up 4.9%, each over the prior year quarter.

As we've done on the operations side, we will continue to invest in clinical leadership and improve systems to support our local leaders and clusters in driving extraordinary outcomes.

On the regulatory front, CMS released the 2024 Hospice Final Rule, which included a final payment update of 3.1% and will result in an estimated 2.8% increase in reimbursement per day for us.

In late July, CMS also issued the 2024 Proposed Home Health Rule, which applies a net 5.1% total permanent behavioral adjustment for all payments, offset by a market basket update of 2.7% and yield a proposed aggregate net reduction of 2.2% in Medicare fee-for-service payments in 2024.

These behavioral adjustments are in addition to the adjustments contained in last year's final rule. The home health cuts in the proposed rule, combined with the significant increase in costs we've experienced over the last few years, risk reducing access to quality services and create significant uncertainty for providers in our industry.

While another disruption to the industry is unwise and unwelcome, Pennant began in and has thrived through periods of difficulty much like today, thanks to the scalability of our locally led operating model, strong and flexible balance sheet and opportunistic approach to acquisitive growth.

Even as we work closely with industry partners to change the rule, we will thoughtfully prepare for the potential impact should it be finalized. Much like the change to reimbursement with PDGM, we are confident in our ability to pull the right levers and continue to create long-term value even in an ever-changing reimbursement environment.

As Brent described at the beginning of this call, our Senior Living business has undergone a remarkable transformation over the last 2 years and we see it continuing to build momentum throughout the remainder of 2023.

Our local leaders and dedicated resource partners continue to push on every facet of the business, which is showing in the financial results. Senior Living segment revenue of $37.3 million is up 20.3% over the prior year quarter and 5.3% sequentially.

As our leaders grew revenue and rigorously managed costs in Q2 and Senior living adjusted EBITDA margin increased to 9.8% from 6.5%, a 330 basis point increase over the prior quarter, and segment adjusted EBITDA increased 58.5% sequentially and 277.4% over the prior year quarter.

The pieces are in place for this ramp to continue as same-store occupancy nears pre-pandemic levels at 79.6%, up 240 basis points over the prior year quarter and average revenue per occupied room is up 13.2% over the prior year quarter.

We also continue to make important investments in our finance, IT and other service center teams to support our growth. Throughout 2023, our leaders have carefully managed these investments that correspond with our revenue growth, allowing us to achieve improved scale in our adjusted G&A expense.

In Q2, adjusted G&A as a percentage of revenue was 6.1%, down from 6.8% in Q2 of '22 and below our internal target. While G&A will fluctuate with the needs of the organization, we are pleased that our leaders have applied the same rigor in the service center that we expect in the field to outperform our internal targets.

During the quarter, we continued to execute on our long-term growth strategy by acquiring 2 strategically attractive operations within our existing footprint. In May, we acquired Benefit Home Health Care and Benefit By Your Side, a home health and home care agency located in Colorado Springs, Colorado.

This acquisition complements our existing footprint in Denver and Southwest Colorado, deepening our Colorado continuum. In June, we acquired Bluebird Health, a home health hospice and home care provider in the Boise, Idaho market. Bluebird is a critical part of the Treasure Valley health care ecosystem.

Bluebird Health's deep community relationships make it a strategic acquisition in a core operating market, it shares with our service center, existing home health and hospice operations and a recently acquired assisted living operation.

With our cash flow from operations continuing to improve, as Lynette will describe, plenty of dry powder in our revolver and a robust flow of meaningful acquisition opportunities in both segments, we see significant opportunity for growth. As we have stated before, our growth is not the result of arbitrary goals for capital deployment.

We focus first on the who, making sure that we have the right operational and clinical leadership to make an impact on a new community or market. With the growth of our leadership pipeline, we are well positioned to step into new operations and successfully improve that clinical, cultural and financial results.

While our pipeline for new acquisitions is more robust than it has been in several years, we will remain extremely disciplined in our capital allocation, prioritizing investments where we have healthy clusters and markets or opportunities for strategic partnerships at pricing that makes sense for the long-term health of our organization.

With that, I'll hand it over to Lynette for a review of the financials.

Lynette?.

Thank you, John, and good morning, everyone. Detailed financial results for the 3 months ended June 30, 2023, are contained in our 10-Q and press release filed yesterday. For the quarter ended June 30, 2023, we reported total GAAP revenue of $132.3 million, an increase of $16 million or 13.7% over the prior year quarter.

We also reported GAAP diluted earnings per share of $0.09, a 200% increase over the prior year quarter and non-GAAP diluted earnings per share of $0.18, a 28.6% increase over the prior year quarter. These results are consistent with our full year 2023 guidance, which we are reaffirming at this time.

Key metrics for the 3 months ended June 30, 2023, include; $60.5 million outstanding on our $150 million revolving line of credit and $2.8 million in cash on hand at quarter end. We ended Q2 with a 1.57 times net debt to adjusted EBITDA leverage ratio and cash flows provided from operations of $6.5 million for the quarter.

We expect cash flow from operations to remain healthy throughout 2023, which reflects robust organic revenue growth, solid cash collections and continued bottom line improvement. Our strong operating cash flows enable us to respond opportunistically to potential acquisitions while maintaining a healthy balance sheet.

Since joining the organization, I have seen how the focus on developing entrepreneurial local leaders has driven significant change in both top line and margin performance in both segments.

In addition, the culture that our leaders infused in their operations has been a driver for change in reducing turnover, improving employee satisfaction and producing strong clinical outcomes. I'd like to hand it back to Brent to highlight some of our local leaders that exemplify this culture and strong operational performance.

Brent?.

Thanks, Lynette. It's my pleasure to spotlight a few leaders and teams in our organization who have achieved exceptional results. At Citrus Hills assisted living in Orange, California, Executive Director and future CEO, [Itsi Barbaguire]; and Wellness Director and future CWO, [Yaya Garcia], have driven impressive growth and success.

And stepping into their roles in 2022, Itsy and Yaya, have established a culture of clinical excellence and resident satisfaction and has resulted in Citrus Hill's occupancy increasing from 74.2% in Q2 2022 and to 96.7% in Q2 2023.

As the community increasingly turns to Citrus Hills as a trusted provider of assisted living service, the financial performance is followed with a 2.5 times increase in revenue and an incredible 46.5 times increase in EBITDAR over the prior year quarter.

In the Bay Area, CEO, Jordan Baker; and newly appointed CCO, Vanessa Alcaraz, have established Sequoia Home Health and Hospice as a provider and employer of choice in their local market. Since becoming the Executive Director at Sequoia in early 2019, Jordan has led a remarkable 7 times improvement in revenue and 221 times improvement in earnings.

In addition, current revenue grew 36.3% and earnings grew 72.6% over the prior year quarter. At the same time, Sequoia has demonstrated strong clinical results with the real-time home health Star rating of 5 stars.

Sequoia's people are the foundation of its consistent performance and a part of that success is in the continued development and elevation of key leaders from within the operation. All of this growth in development comes while enjoying one of the highest employee satisfaction scores in the company.

Both of these stories are tremendous examples of the power of our leadership model at work. We are grateful to these leaders for owning and leading their operations in a way that benefits patients, residents, employees and community partners. With that, we'll open it up for questions.

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

[Operator Instructions] The first question comes from the line of Raj Kumar with Stephens..

This is Raj on for Scott Fidel. Just wanted to kind of go through senior living. Could you talk to how much rate elastic upside there is given the sequential rate bump, we saw a sequential decline in total occupancy? So overall, we saw industry level and peer occupancy increase sequentially.

So just kind of wanted to parse out what was like the key drivers when it came to Pennant's operations given the slight sequential occupancy down trend in the quarter..

Yes. And I think when you're referencing sequential occupancy down, you're referencing the overall. And when we look at it from a same-store standpoint, our overall occupancy has actually increased. I think we referenced 79.6%. So from that standpoint, we're seeing growth in occupancy continue over time.

And in addition to that, we have also implemented rate changes across most of our platform. And while I think there's a little more sensitivity to rate increases versus what we saw over the last two years, we haven't seen significant attrition that has come from that.

So we're pretty confident that as we continue to drive those rate levels back to levels that are probably appropriate to cover the cost of the services that we're providing that we can see those occupancy gains maintain at the pace that they're going now.

So I mean, from that standpoint, I think overall, we're pretty optimistic that we can drive our occupancy levels back to where we were and perhaps above the levels that we were at pre pandemic. And I would just add this, too, Raj.

I mean, we've mentioned this in the past, but a big part of our efforts around leadership development is not just on the overall operating leadership, but also in our ability to build and grow marketing and sales talent and create a better path in each of our buildings. And so that's also leading to a lot of the occupancy gains.

So in many ways, we approach things very differently now than we did 2 or 3 years ago. And so we're seeing the benefit of that as well.

Our investment in marketing, our investment in sales and just the overall product as we've invested in each of our buildings to put something in place where we can be proud of and be a critical part of the communities we serve in..

Okay. Great. And then I kind of wanted to focus on M&A.

As you kind of look towards the future within the next couple of quarters, and now that we have the proposed home health rate, how are valuations settling out? I mean, are there still high or are sale expectations still high? Or what's like the availability of assets now since we have more visibility into the rates from a performance standpoint?.

Yes. Raj, that's a great question. What we're seeing is exciting. And I think that is we're seeing more opportunities come to market in the valuation zone that we feel comfortable pursuing in our disciplined acquisition strategy.

And so primarily, you're seeing home health, but you're also seeing hospice multiples kind of return to more normalized rates. And that's really helpful.

What we saw the last time we experienced significant home health reimbursement challenges in the mid 2010 to 2017, we sort of had this opportunity where we were able to acquire assets at favorable valuations that really built the platform we have now.

And so we're seeing people -- and it's taking a little bit for sellers to get comfortable that what they had before isn't worth the same amount as it was but their financials tell that story. And so they're becoming more comfortable with that. And we see a number of attractive opportunities coming to the table.

We'll continue to evaluate as we work through the proposed rule and into the final rule, what the actual impact is going to be. and we're continuing to pursue acquisition opportunities in all 3 areas. We feel like valuations on the senior living side are coming a little bit better into focus. Valuations on hospice are becoming more realistic.

And with home health, certainly, the impact of the final rule coupled with last year's -- the impact of last year's final rule, is really creating some unique opportunities for us..

And then a quick follow-up on hospice. I think you guys called out that your impact on the final rate would be a 2.8% increase.

So when we think about the originally issued guidance back earlier this year, how does that fair against what you had baked into that guidance versus what we have now?.

So you're absolutely right. We estimate about a 2.8% impact on our revenue per day from that home health final rule. And so that will affect our revenue in the fourth quarter. We do have baked into the guidance of modest increase but that increase is a little bit higher than that.

And so we do think it will be a net positive as we seek to meet and exceed our commitments for this year..

And the next question comes from the line of Ben Hendrix with RBC Capital Markets..

I appreciate all the comments on the local leadership model.

And I was just wondering, can you give us an idea of what inning we're in with your local leadership strategy? And is there a margin target that we should think about as you get closer to achieving the optimal leadership profile for each of your clusters?.

Yes. So I'll let Lynette answer the question on margin. But I guess I would put it this way. In terms of developing the program, we put a lot of time and effort at the beginning of the year to really build out this robust program.

So just in the -- from a program development standpoint where you asked an inning, so we're probably halfway through that or maybe a little bit further. We made some good progress there. In terms of like the overall development of the leaders, this is a multiyear. I mean, this is going to go on forever because it's what our focus is.

We're a leadership company. And so from that standpoint, we're seeing really strong returns. The talent that's coming into the organization is incredible.

But we shared two examples, recognizing Sequoia and Citrus Hill's two incredible leaders, one that was already internal to the organization and developed through the program, another that joined us a couple of years ago that stepped in and has really changed us.

And so the impact of these leaders coming in really is over multiple years and is incredible increase, right? So from that standpoint, I think right now, we want to get to 100 CEOs, but in the next several years, once we hit that number, we're going to get to 200 and beyond that, right? And so that's our model for growth for the future.

So from that standpoint, we're still at the beginning stages because we're just now really hitting our stride in bringing those leaders in..

And on the margin front, really the target that we're looking at from a margin for home health and hospice in the long term is an 18% margin. And then on the senior living side, getting our margin up to about 15%. So that's where we're looking for those long-term targets on margin..

And Ben, we'll just emphasize margin is always going to be lumpy in our business and in our strategic model, the way that we approach things we're buying underperforming assets and that can pull our margin down. And then as those assets kind of fully integrated into our model and we get a CEO in place, we see that outperformance going forward.

And so I think those targets are hopefully helpful to the modeling, but we will always expect some lumpiness as we acquire these underperforming assets and then turn them into real resources and solutions in that community..

Yes. And maybe just to add a little bit more color to tie those two things together, right? Our investment in leadership and improvement in margin we're seeing it now on the senior living side, right, we're seeing this pretty significant ramp in margin improvement and overall bottom line improvement.

It's because we invested not only in the local leaders, the local EDs and future CEOs, but also in each of the markets, there is a team that helps to develop those leaders and to look for acquisition opportunities. And so some of that investment, it just takes time for that to pay off. And John alluded to this in the script.

But we're also seeing that, especially acutely on the home health and hospice side, we strategically made a decision to invest in a number of additional market leaders and building those teams so that we can grow. We can invest in new leaders at the local level, and we can grow strategically from an acquisition an expansion standpoint.

So some of the pressure that we're feeling right now is a result of those investments that we made at the beginning of the year. And as the year goes on and as time goes on, those will just pay off because those investments will become less and less a percentage of the overall revenue that we bring in..

I'm currently showing no further questions at this time. I'd like to turn the conference back over to Mr. Brent Guerisoli for closing remarks..

Okay. Well, thank you, Norma, and thank you, everyone, for joining us today, and we hope you have a great rest of your day..

Ladies and gentlemen, thank you for your participation in today's conference. You may now disconnect. Everyone, have a wonderful day..