Brookdale Senior Living Inc. (BKD) Q2 2017 Earnings Report, Transcript and Summary

Good morning. My name is Jennifer, and I will be your conference operator today. At this time, I would like to welcome everyone to the Brookdale Senior Living Second Quarter 2017 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. And I’d like to turn the conference over to Ross Roadman. Sir, you may begin.

Thank you, Jennifer, and good morning, everyone. I would like to welcome all of you to the second quarter 2017 earnings call for Brookdale Senior Living. Joining us today are Andy Smith, our President and Chief Executive Officer; Cindy Baier, our Chief Financial Officer; and Dan Decker, our Executive Chairman of the Board. I’d like to point out that all statements today, which are not historical facts, including all statements regarding our earnings guidance, may be deemed to be forward-looking statements within the meaning of the federal securities laws. These statements are made as of today’s date and are subject to various risks and uncertainties. Forward-looking statements are not guarantees of future performance. Actual results and performance may differ materially from the estimates or expectations expressed in those statements. Future events could render the forward-looking statements untrue, and we expressly disclaim any obligation to update earlier statements. Certain of the factors that could cause actual results to differ materially from our expectations are detailed in the earnings release we issued yesterday, as well as in the reports we file with the SEC from time to time, including our annual report on Form 10-K and quarterly reports on Form 10-Q. When considering forward-looking statements, you should keep in mind those factors and the other risk factors and cautionary statements in such SEC filings. I direct you to Brookdale Senior Living earnings release for the full Safe Harbor statement. Also please note that during this call, we will present both GAAP and non-GAAP financial measures. I direct you to our earnings release and our supplemental information, which may be found on the Investor Relations page at brookdale.com for important information regarding the company’s use of non-GAAP measures, including the definitions of each of these non-GAAP measures and a reconciliation of each such measure from the most comparable GAAP measure. With that, I would like to turn the call over to Andy. Andy?

Thanks, Ross. Good morning, and thank you for joining us. As always, we appreciate your interest in Brookdale. I’ll make a few comments about the second quarter and discuss our outlook for the remainder of the year. But before I do that, I’d like to ask Dan to make a few comments. Dan?

Thank you, Andy. And good morning to everyone. The second quarter reflected challenges the industry is currently facing as the construction pipeline continues to bring new competition to the market. We are focused on defending our market share, while at the same time, working hard any initiatives that will best position the company for the future. I’d like to take this opportunity to welcome Mark to our board. I’m pleased that we’re able to bring a new highly qualified Independent Director to replace Mark Parrell. I’d now like to comment on our ongoing process to explore options and alternatives available to us to create, enhance shareholder value. We understand that there have been a number of rumors regarding Brookdale in the market and that there has also been a fair amount of speculation in the press regarding our review process, including just recently yesterday. We hope you understand that we simply are not able to comment on market rumors and speculations. That being said, let me assure you that the review process continues to be active and ongoing. Our board, in conjunction with management and our financial and legal advisors, remains hard at work on the ongoing review. As previously indicated, there can be no assurance that this review will result in any specific action or transaction. I wanted to reiterate that no decision has made to enter into transaction at this time and want to confirm that Brookdale will only enter into a transaction or transaction if we can do so under terms that our board concludes are in the best interest of the company and its shareholders. While we are not in a position to answer any questions or say any more than we’ve already said about this subject at this time, rest assured that we may remain committed to transparency and will provide update that we’re able to do so. Andy, I’ll turn it back to you.

Thank you, Dan. Let me turn to my comments about our second quarter performance. As we expected, industry headwinds, particularly from new competition, were challenging in the second quarter. Our operating performance was therefore mixed. Our rate growths in core expense growth were generally consistent with our expectations, but occupancy was softer due to both new competition and elevated move-outs during the first two months of the quarter. Our GAAP rate was up approximately 100 basis points over the second quarter of 2016. Year-to-date, death rates are up 9% over last year, reflecting the effect of this year’s flu season. This difference represents approximately 60 basis points of occupancy. As the quarter progress, we did show the typical seasonal improvement in move-ins. This year we saw move-in improvement in May and June. We saw occupancy start to build in July. We continue to make progress on our portfolio optimization initiatives. During the quarter, we sold two owned communities and terminated the leases on seven communities. We have 14 communities classified as assets held for sale and had agreements to terminate leases on 26 additional communities by the end of this year. Finally, as Cindy will discuss in detail, we are advancing our plan to refinance the majority of our 2018 debt maturities by the end of this year. We have closed several of these refinancing and are actively engaged on the balance of these refinancing transactions. As a result, we are building liquidity in the form of cash and short-term securities, a portion of which will be used to repay the convertible debt in 2018 in cash. Looking at the balance of 2017 and into the first part of 2018. We continue to expect that the competitive landscape for the industry will be difficult. The recent second quarter NIC data evidenced this with a large number of new openings and a corresponding negative impact on industry occupancy. Nevertheless, there were some positive signs in the NIC data as well. Absorption continues to trend up, reaching almost 3% of inventory, evidencing increased demand due to demographics, increased awareness and increased penetration rates. New construction starts remain elevated, but continued to ebb down as financing sources pullback, construction costs increase and markets become saturated. Increasing demand and the reduction in new construction point to a more normalize operating environment in the back half of 2018 and beyond. We saw similar trends in our markets. We had a large number of new competitors opened with 68 new same product competitors opening within a 20-minute drive of our Brookdale community. The better news is that we saw only 41 new projects get started this quarter that will open sometime in the future. That means that we have currently 285 competitive communities opening in the future and that’s down 27 from the first quarter. This means, we will have 364 of our communities facing future new same product competition within 20 minutes. This number has fallen from 464 in the third quarter of 2016. Nevertheless, new openings will remain elevated as new communities exit the development pipeline. We are working diligently to be the most effectively convenient in the phase of these near-term competitive pressures. As I have described before, we are enhancing our revenue management processes and focusing on operating as efficiently as possible. And we are working to put the company in the best financial position with reduced leverage and increased liquidity. But we are also focused on the bigger picture for longer term. Using our strengths, such as size, scaled and operating systems, we are positioning Brookdale to be the leading provider for seniors to have the choice that best fits their needs. This means building out an array of lifestyle choices, the customer see as attractive value propositions as we offered the most choices for high-quality care and quality of life. No one else offers the array of senior living services that we offer. And we have surrounded senior’s housing with our Ancillary Services platform offering home health, outpatient therapy and hospice services. I have talked before about our work on segmentation for our senior housing portfolio. That segmentation creates more differentiated choices to meet the differing needs and desires of our customers, based on factors such as location, price, services, amenities and program. Our operating teams have assessed the entire portfolio and determined the proper market position for each of our communities. As part of the process, we have developed piloted, and on April 1, implemented network selling across many markets. Network selling leverages our SaaS by offering customers multiple choices that only Brookdale can offer. In addition, we are working to improve how we market our portfolio based upon our research and to have customers and their families make the decision for seniors housing. More customers turn to the internet for information to assist in their decision-making process. In fact, 61% of prospects start their search online. And at the same time, a vast majority of them do not have a very good understanding of the cost and the benefits of what they are shopping for. We have bolstered how we use digital media in our marketing to attract prospects, to educate the consumer and to encourage interaction with our senior living advisors and care teams. Importantly, our research engine optimization in terms of ranking and effectiveness for our industry is optimized to the highest level of performance. To support our competitive position, we are continuing to make progress in how we price our services. We have now rolled out our data-driven pricing system to 174 independent living communities. These systems use multiple data points to predict and update rate that will maximize revenue for each partner. Over time, we believe this process change will produce meaningful revenue improvement. And we are the only provider in the senior living industry with an integrated, robust Ancillary Services platform. While our other companies have third-party providers coming into their communities, those providers don’t have the opportunity to build out the interaction with their customers as a single provider. This allows us to focus on expanding services that enrich the lives of our customers and positions Brookdale like no other operator. As the health care landscape continues to evolve, we see having a robust Ancillary Services platform as important in building relationships within the health care community. Finally, I would be remiss if I didn’t mention the focus we have on the people side of our business. We continue to increase the sophistication with which we approach recruitment, compensation, development, roles and responsibilities as well as training. We have a strong team of passionate associates serving our customers, and we’re focused on enhancing their experience. We are pleased that our second quarter 2017 key community leadership turnover improved by 15%, when compared with the second quarter of 2016. I’ll close by saying that our expectations for 2017 are unchanged. We are focused on improving our adjusted EBITDA and adjusted free cash flow. We have made good progress on strengthening the financial position of the company. And while we continue to expect 2017 will be a difficult operating environment, we remain confident in our plans. Now I’ll turn the call over to Cindy for more details on the quarter. Cindy?

Thank you, Andy. And thanks, everyone, for joining us today. I will discuss three topics: our second quarter 2017 results, our refinancing plans for our near-term maturity and our 2017 outlook. Before we get into the details of the quarter, let me set the stage. In addition to our business performance, there are two large items that impacted our financial results: our portfolio optimization initiatives and a large favorable reserve adjustment that we booked last year. And putting our results in the context is important for you to understand these items. First, our portfolio optimization initiative included disposition of lease and owned communities that we chose to dispose off for strategic or economic reasons. As we expected, our portfolio optimization initiative, where we have disposed of 130 communities since the beginning of the second quarter of 2016 dramatically impacted our year-over-year results, as we sacrificed resident fee revenue and adjusted EBITDA to improve our cash flow. On a year-over-year basis, our portfolio optimization initiatives accounted for the entire decline in our Q2 2017 resident fee revenue. We generated $109.9 million less resident fee revenue as a result of the disposition of the 130 communities, since the beginning of the second quarter of 2016. Otherwise, higher rate fully offsets lower occupancy. The portfolio optimization initiatives also significantly reduced adjusted EBITDA. We generated $17.4 million less adjusted EBITDA, as a result of a disposition of the 130 communities, since the beginning of the second quarter 2016. The portfolio optimization impact is inclusive of $3.1 million of increased management fees. Taking into account phase or reduce cost, including capital expenditures and interest expense, adjusted free cash flow of the company was positively impacted by the disposition activity in the second quarter. We generated $4.9 million more in adjusted free cash flow, including management fee as a result of the disposition of the 130 communities, since the beginning of the second quarter 2016. The second large item that impacted our results on a year-over-year basis was the large, favorable general and professional liability insurance reserve adjustments that we booked last year. The year-over-year decrease in favorable insurance reserve adjustments of $9 million also contributed to the adjusted EBITDA decline. As a reminder, the second quarter of 2016 included a benefit from the reversal of reserves established with the Emeritus merger based on the expected cost of historical claim. Let’s turn now to our second quarter business performance. For our senior housing communities, the best way to think about our business is using our same-store results. Our same-store community senior housing revenue was consistent with the second quarter of 2016, as a decline in occupancy was offset by RevPOR growth. We’re always trying to strive the right balance between occupancy and rate to react to the competitive dynamics in our local market. Our second quarter 2017 same-community senior housing operating expenses increased 5.7%, and our same-community operating income decreased by 9.2%, compared to the prior year. Like last quarter, we continue to see labor wage increases, which are partially offsetting our improved productivity. For example, while our Q2 2017 average wage increased 4.2% on a year-over-year basis, we experienced the 3.5% year-over-year increase in salaries and wages. Including benefits like our medical plan expenses and workers’ compensation, we experienced the 4.6% growth in total compensation. This was modestly better than our planned increase of 5.5% to 6%. Again, as we mentioned when we provided our guidance for the year, we benefited from favorable GLPL reserved adjustments last year, and we did not expect these to recur this year. Our same-community portfolio insurance expense increased by $8.5 million on a year-over-year basis, primarily due to the fact that we did not have the benefit of the favorable reserve adjustment that were made in the prior year period. There are two other smaller factors that affected our same-community operating income decline. A $2 million termination payment to our vendor, and higher workers’ compensation cost of $2.8 million. If you exclude the impact of portfolio insurance expense increase, primarily related to the GLPL reserve adjustment, the workers’ compensation increases and the vendor termination payment, our same-community operating income declined 4.5% on a year-over-year basis. Our prior period purchase accounting insurance reserve adjustment will also create tough comparisons in the third and fourth quarters. Needless to say, our results reflect the competition is intense and has been for the last year. We are seeing a lot of competitive openings in our markets and it’s having an impact. We have also seen increased flu-related death rates, which have been noted by the competitors across the industry. These factors of pressured occupancy though our performance is generally in line with industry. Our expense performance is a bit worse, given the large favorable reserve adjustment last year, as well as having push hard on compensation for a few years. The labor market is tight, and we are sometimes challenged by recruiting and retaining the necessary talent, while our total competition costs were increasing. Moving to our Ancillary Services segment. We are in $13.1 million of segment operating income during the second quarter 2017, a $5.9 million decline from the prior year period. The decrease in operating income was a result of a decrease in home health service volume, and lower Medicare reimbursement rate that started on January 1. We are excited to see our continued growth in hospice, which outperformed last year. And we had good cost control, so not enough to offset the home health rate and volume decrease. Our general and administrative expenses performance is good, with a 26% year-over-year reduction. G&A expense of $67.1 million during the quarter, included $600,000 of transaction-related and strategic project costs and $7.2 million of non-cash stock compensation expense. We generated adjusted EBITDA, excluding transaction and strategic project cost, of $164.2 million and generated adjusted free cash flow of $40 million during the second quarter of 2017. Our proportionate share of adjusted free cash flow of unconsolidated venture was $7.9 million, a $1.9 million year-over-year decline. Increased interest expense was partially offset by cash flow from the Blackstone joint venture, which we entered into late in the first quarter of this year. During the second quarter, our joint ventures as a whole has strong rate growth, occupancy declines in line with the industry, expenses in line with budget, and operating income a little below the prior year. We continued our portfolio optimization activity during the second quarter. We began the second quarter of 2017 with 16 communities or 1,508 units cost side assets held for sale. During the second quarter of 2017, we completed the disposition of two of these communities or 236 units. As of June 30, 2017, we had 14 communities or 1,272 units that are classified as assets held for sale. They had a carrying value of $91 million and $60.5 million of associated mortgage debt. This is classified as current on our balance sheets. Additionally, we terminate the leases on seven communities or 710 units during the quarter. We continue to make good progress on our goal of strengthening our balance sheet and our liquidity. First, we are progressing on our plan to refinance our 2018 debt maturities. Remember, the growth of our refinancing plans are to increase liquidity and begin addressing our 2018 maturities, including our convertible bonds, while balancing prepayment penalties and potential increased interest cost with lower risk. This includes refinancing mortgage debt on under levered assets to extend maturities and to build liquidity in the form of cash and short-term securities, a portion of which will be used to repay the converts in 2018 in cash. During the quarter, we obtain a $54.7 million supplemental loan secured by first mortgages on seven communities. The proceeds from this loan for utilized to fund our liquidity needs. Subsequent to the end of the quarter, we completed the refinancing of two existing loan portfolios, secured by first mortgages on 22 communities. The $221.3 million of proceeds from refinancing were utilized to pay out $188.1 million of mortgage debt, which was scheduled to mature in April 2018 and $13.6 million of mortgage debt that was due in January 2021. Other refinancing transactions are in process, and we’ll announce them as they are completed. Our total liquidity continues to increase. It was $546 million on June 30, 2017, compared to $306.3 million on June 30, 2016, compared to the prior quarter, our liquidity increased by $119.3 million. The primary driver for this includes $54.7 million of cash proceeds from a supplemental loan obtained during the period and $40 million of adjusted free cash flow in the second quarter of 2017. Let’s look at our 2017 guidance. For full year 2017, we reaffirm our guidance ranges. Based on our results year-to-date, we are reiterating our full year 2017 guidance for adjusted EBITDA, excluding transaction and strategic private costs to be in the range of $670 million to $710 million. Turning to adjusted free cash flow. Our previously issued guidance for full year 2017 adjusted free cash flow of $140 million to $170 million excluded any impacts of subsequent refinancing and debt modification costs associated with our refinancing plan, as well as excluding costs associated with our ongoing evaluation of options and alternatives to create and enhance shareholder value. And that range remains appropriate guidance. Based on such costs incurred today, and projected for the remainder of 2017, the company expects those costs to be approximately $30 million. We believe the benefit of accelerating our refinancing plan to lower risk by increasing liquidity and beginning to address our 2018 maturities balance, outweighs the debt modification cost, and increased interest cost. Accelerating our refinancing plan creates increased interest cost; it could rebuild liquidity before we can retire the converts of cash. Accordingly, we expect adjusted free cash flow for 2017 will be in the range of $110 million to $140 million including such costs. The actual amounts of such costs associated with our ongoing evaluation of options and alternatives to create and enhance shareholder value, and our refinancing costs are subject to a number of assumptions and may differ significantly from our current projections. We also reiterate our full year 2017 guidance for the company’s proportionate share of adjusted free cash flow of unconsolidated ventures in the range of $25 million to $35 million. The foregoing guidance excludes any potential impact of future acquisition, disposition and portfolio optimization activity other than the pending portfolio optimization transactions described earlier. So to summarize, with our first half performance and our expectations for the remainder of the year, we are still comfortable with our full year guidance ranges. We expected the 2017 would be a difficult competitive environment, especially for our top line. Importantly, we are focused on defending our position in 2017 and putting the company in a better position for 2018. We continue to be focused on the fundamental, which will improve our operational results and strengthen our financial position. Thank you for your attention on this. I’d like to now like to turn the call back to Andy. Andy?

Thanks, Cindy. Our management team is focused to improve our operating performance. We are focused on the overcoming the challenges of increased supply and wage pressures in 2017 and believe that we will be well positioned to return to growth in 2018 and beyond. We’re happy to take your questions now.

[Operator Instructions] Our first question comes from the line of Frank Morgan with RBC Capital Markets.

Good morning. Cindy, if you could touch on that, you mentioned the confidence in the guidance for the rest of the year. I’m just curious could you give us a little bit more color? I think, you mentioned occupancies were actually up in the month of July, but maybe, tell us kind of where that number is, and kind of where you see having to play out the confidence on the top line for the balance of the year? And the secondary question would just be for everyone is on the – you mentioned the number of facilities coming online and new openings out there in the marketplace. What are you specifically doing in those markets? I know, you just mentioned defending your position. But could you give us a little bit more color on specifically, what you’re doing, and maybe, does this new pricing model thing that you’ve rolled out. Does that some kind of the play into that process? I will stop there. Thanks.

Frank, thank you so much for your question. It’s really a good question. If you think about our results for the year, normally we have our seasonal occupancy start to build in May or June. It was a bit later for us this year and starts to build in July. Now we don’t give monthly occupancy. But what I can tell you is that our forecast is based on a normal seasonal pattern for the remainder of the year. So what we would expect to see is, occupancy build in the third quarter. And then normally for us, there is not as much occupancy build in the fourth quarter. It’s generally in the neighborhood of flat. So that’s what we think about occupancy just generally from a normal seasonal pattern. We’re focused very hard on expense controls. I will highlight that our CapEx will have a pretty significant impact on the pacing of our cash flows as we progressed throughout the year. In the first half of the year, you will note that we spent less than half of our annual CapEx guidance. So we’re not changing our non-development CapEx guidance, but what that will mean is that we need to accelerate our CapEx spend in Q3 and Q4. While that won’t change adjusted EBITDA, it will have an impact on our adjusted free cash flow. And then as I mentioned, we’ve got the costs associated with our debt refinancing. Those will impact our adjusted free cash flow in Q3 and Q4. So that’s the big picture. I’ll turn it back over to Andy now, so he can talk about the competitive response.

Yes. Frank, thanks for the question and good morning to you. When we face new competition in markets, there are number of different techniques that we use to combat that new competition. I’ll mention just a few. First and most importantly, we try to protect our people. The folks that are in our communities that are doing the work on the ground, we try to make sure that we retain those folks and that means, we look at compensation, and we look at a lot of different factors to make sure that we protect our people. In the face of new competition, we were very often adjusts our capital expenditure programs to focus more CapEx on those buildings that need to be refreshed, as a new competitors opening in the marketplace. We’ll also adjust the flow of our marketing dollars as appropriate to put more marketing dollars to work, where there is heightened new competition. And so far is our new pricing algorithm program works, that’s with respect to our independent living communities, right now. We will be rolling that program out are at least high living and assisted living, and memory care in 2018. But it’s helpful, because it – in a data-driven way adjust to what’s going on in the marketplace, so that we can deal with new competition quick more quickly and more appropriately. With respect to pricing generally, now aside from the data-driven algorithmic tool, we also adjust our market rates in the assisted living and memory care side of the platform based upon whatever is going on in these local markets that have new competitors opening.

Got you. One final one, I’ll hop. I think, you mentioned a number of divestitures, you got tiered up here. Any thought looking beyond this group, any incremental opportunities that you think you’ll see there and maybe any kind of sense of how many will be talking about? Thanks.

Yes, Frank, we’re not in a position to talk about how many were to get into that level of detail. But it’s fair to say that we have ongoing dialogue with all of our REIT partners or landlords about ways to search for things that are good for them and good for us. Those can include disposition activity or lease terminations. And so we have active and ongoing dialogue around that type of activity. And then, of course, with respect to our owned assets, we are constantly looking at what’s the right way to maximize the platform. But I would say that the primary additional disposition activity – asset optimization activity that we’re doing is around leased assets, as we speak.

Okay. Thank you.

Thanks, Frank.

Your next question comes from the line of Joanna Gajuk with Bank of America.

Good morning. Thank you so much for picking the question. So Cindy, on the $30 million that you highlighted as a impact to adjusted free cash flow. Can you just break it in terms of those two target matters that you’ve outlined around debt, modification and increased cost versus the other cost?

Sure, Joanna. Thank you so much for your question. So the $30 million that we incorporated into our guidance is really roughly $20 million or so debt modification cost that includes the increased interest costs from the fact that we have to borrow money to increase our liquidity before we’re able to retire our converts. And the remaining $10 million is our strategic review cost as well as any additional portfolio optimization cost that we see for the rest of the year.

So we’re pretty much saying that there’s going to be – I guess, increased interest expense, because you will carry that – two, I guess, pieces, but then I guess come June 2018 that’s when you will – I guess buyback your convertible notes, right. So we should expect the interest expense to come down somewhat for that?

That’s correct. Our converts expire in or they mature in June 2018. Just a reminder, they have an interest rate, a coupon rate of 2.75%. But the interest rate that goes to our financial segment is a little higher than that, because of the impact.

Would you be able to quantify that what’s the interest expense impact effective on the P&L?

It’s in the neighborhood of 7%, Joanna.

7%, right. I remember that’s much higher than the coupon. Thank you. And then if I can just squeeze one more on the CapEx although, I appreciate a commentary that the non-development CapEx guidance is unchanged. Any comment between the different pieces in there, in terms of how you tracking on the corporate CapEx versus recurring? And also, outside of this non-development CapEx, I guess, the other piece is probably at Max, where it’s only been trending up like $1 million per quarter, so any view around how much you’re going to spend this year and maybe going forward on that piece – outside of the non-development CapEx? Thank you.

Joanna, another good question. So our development CapEx, which is traditionally what we refer to as Program Max. We brought our guidance down on that like $10 million sort of in this quarter and that’s largely because we’ve been a little bit slower getting out of the gate with some of our REIT partners in terms of getting their agreement to proceed with some of the projects that we think. We still are firm believers in Program Max. We normally get double-digit returns on those projects. And so we’re very anxious to do those, because they help us, respond to the competition and position our markets very effectively in the community. As we think about the components of our CapEx, we’re basically – we understand both our corporate CapEx as well as community CapEx on a year-to-date basis. But we’re still expecting to be within our original guidance ranges on the non-development CapEx.

Great. But then in terms of this Program Max. So you’re saying that there is some slowdown this year but then next year, I guess, that’s when you might expect this $10 million to show up? Is that what you’re trying to say?

Yes. We would hope that, we would increase our development CapEx next year. Again, we see it as a very good use of our proceeds. And so while we’re seeing $30 million to $40 million in 2017, I think in 2018, we would hope that number will be higher.

Great. Thank you.

Thanks, Joanna.

Your next question comes from the line of Chad Vanacore with Stifel.

Hi, good morning.

Hi, Chad.

So how labor cost trended so far. I think you had originally expected to see 5.5%, 6% growth in SWB, but I think you’ve been below that so far. So are you doing a better job of management? Or should we expect some modeling increases in second half?

Hi, Chad. It’s Cindy, again. Good question. So our labor cost as you stated, we did expect 5.5% to 6% for the year. Now what we saw in the second quarter was a 4.6% increase in total compensation cost for the quarter on a same-store basis. Now it’s up from Q1, because we saw our normal mirrored increases to take place in sort of Q2. We haven’t changed our guidance for the remainder of the year. And what I will say is we are continuing to see pressure on our community leader position, particularly in competitive markets, when we are making market adjustments to make sure that we protect our existing people and recruiting when there is turnover. In addition, we’re continuing to see wage pressure on the coast and in the Midwest. But I will say is that we have increased with the productivity that we had on our wages during 2017, while we’ve seen market wage increases, we’ve been more productive within our communities that’s offset part of that increase, but still it’s 5.5% to 6% for the full year.

Okay. And then just thinking about your home health business, the margins were depressed in Q2. Should we expect some recovery in the second half, or this would be run rate for the balance of the year?

We would expect some recovery in the second half of the year. There are a couple of things going on in that business. The Medicare rate reduction will effective on a full year basis. But one of the things that did impact us is the competitive intrusion that we’re overlapping. So if we’re able to sort of build volume, we’ll get better leverage on a business, since the improving margin.

All right, that’s it for me. Thanks.

Thank you, Chad.

Our next question comes from the line of Brian Tanquilut with Jefferies.

It’s Jason Plagman on for Brian. Following up on Frank’s earlier question. Specifically, on the 2018 lease maturities. I believe majority of those have purchase options that are available to you. So just wondering how you are evaluating that optionality as you are closer to those renewals?

Yes. When as we generally speaking, as we approach the maturity of the lease, we’re going to think about whether we wanted to remain with the asset or not, and I will be dependent of course upon the performance of the assets and our outlook for whatever markets those assets are in. Now where we have options to purchase and again, we have two flavors, we have options to purchase the assets at fair market value. Or we have – in some cases, we have the options to purchase at a bargain purchase price. Well, obviously, if we have a bargain purchase price, we would be inclined, again, as a general rule to exercise that option and only asset in control both sides of the equation. Where we had the fair market value purchase option there, of course, we would be acquiring the option at its fair market value. We would generally speaking also be inclined to exercise those fair market value purchase options, because given today’s rate environment in the availability of financing, there is generally speaking that financial arbitrage between what the lease rate is and what we could finance the ownership of the asset at. Those are the general guide lines, Jason.

Okay. And any – as far as the 42, I think, that are purchase options that are coming up next year, how many are – have bargain purchase options?

We have articulated that. Or we’ve given you the detailed in our supplement – I’m sorry, in the investor deck on that.

But we don’t breakout between fair market value and bargain purchase options. My reflection is more than of our fair market value in 2017 and 2018 than bargain purchase.

Okay. That’s helpful. And then, I appreciate the stats around the key employee turnovers on the year-over-year basis. Any color you can provide on shorter-term basis. Trends you’re seeing from Q1 to Q2 or on a shorter-term basis on competition for those key employees?

Well, I say the competition for many of our key employees is intense, people like to hire from Brookdale. That having been said, again as I mentioned, our quarter-over-quarter turnover improved about 15%. And it was roughly the same in the first quarter. So again, we’ve had pretty good experience for the first half of 2017.

Thanks. That’s it for me.

Thank you.

We also have a follow-up question from Joanna Gajuk with Bank of America.

Yes. Thank you. So we have – I was just thinking about ancillary businesses, it’s trying to – I guess there’s been displeasure on the home health side. And there has been this proposal for a home health group smaller model proposed for 2019. Obviously, the industries are going to be – there is going to be a lot of changes between now and when that – eventually but implemented, but nevertheless, does this proposal change in any way if around home health business keeping it and running it, just given that you now already having a pressure there both on volumes and rates?

Yes. I know, with likes to balance of the home health industry, we expect there to be significant dialogue with CMS before that rule is finalized. It also seems to me at least to be countered to where a public policy is heading. And it seems to be – meaning that public policy is generally searching for higher-quality outcomes, but at lower cost settings, which I think home health fits into that. So I expect that the final rule will be different than what has been proposed. And I think we’re in accord with the balance of the industry and saying that. And our long-term view of the Ancillary Services platform is unchanged by virtue of the proposal that CMS has just issued.

There is one thing, I’d like to add to that, Joanna. If you look at the agencies, the guidance provided flat rates for urban providers with a cut for overall providers, all of our agencies with the exception of one of urban providers. And so that’s an important consideration.

Right. And then but on the front, I would expect that – I guess, you don’t have what they will call the admission from institutional setting, but instead all of your admissions are from the community, because I guess – it’s viewed as the – their resident has been at home already, unless I guess, a senior resident is coming. But then on the other side, if you can provide some color in terms of your mix between therapy and nursing visits?

Okay. I hope, I understood your question correctly. If you’re asking what is the mix? The average mix between therapy and nursing for an average Brookdale Home Health episode…

Exactly.

Okay. We’re going to have pretty half proportion of therapy under our current case mix, given the nature of our customers in our home health patients we’re going to have a higher percentage of therapy than just skilled nursing.

Are would you be willing to share with the average like I guess how – in particular they disclose it I say 55% of the episodes have therapy component. I guess, the more half was – you see at – might be a point of our – in terms of the percentage of visits. So I don’t know if there is anything you can provide there.

Joanna, we can follow-up on that. We have not normally broken that out. And it’s going to be different between our resonance that are inside of our walls who are getting home health services as compared to those that out in the general community. But if you’d like to follow-up, we can certainly do that.

Great. Thanks.

Thank you. That’s all.

We have no further questions in queue at this time. And I would like to turn the call back over to presenters.

Thank you all for joining us this morning. We’ll be around today, if you have follow-up questions. And we appreciate again, your interest in Brookdale. Thank you.