Diversified Healthcare Trust
Q1 2016 Earnings Call Transcript

Published: 5 May 2016

[Operator:]

Welcome to the Senior Housing Properties Trust First Quarter 2016 Financial Results Conference Call. [Operator Instructions]. Now, I would like to turn the conference over to Mr. Brad Shepherd. Go ahead, sir.

[Brad Shepherd:]

Thank you and good morning, everyone. Joining me on today's call are David Hegarty, President and Chief Operating Officer; and Rick Siedel, Chief Financial Officer and Treasurer. Today's call includes a presentation by management, followed by a question-and-answer session. I would like to note that transcription, recording and retransmission of today's conference call is strictly prohibited without the prior written consent of Senior Housing. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based upon Senior Housing's present beliefs and expectations as of today, Thursday, May 5, 2016. The Company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call, other than through filings with the Securities and Exchange Commission or SEC. In addition, this call may contain non-GAAP numbers, including normalized funds from operation or normalized FFO and cash-based net operating income or cash NOI. A reconciliation of these non-GAAP figures to net income and the components to calculate AFFO, CAD or FAD are available in our supplemental operating and financial data package found in our website at www.snhreit.com. Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that would cause those differences is contained in our filings with the SEC. Investors are cautioned not to place undue reliance upon any forward-looking statements. I would now like to turn the call over to Dave.

[David Hegarty:]

Thank you, Brad; and good morning, everyone and thank you for joining us on today's first quarter earnings call. For those of you who have not yet had the opportunity to meet Brad, he's our new Director of Investor Relations and we're pleased to have him join us today. Earlier this morning, we reported normalized funds from operations or normalized FFO, of $0.48 per share for the first quarter, an increase of 6.7% year-over-year. This was achieved through strong operating results across all sectors and attractive financing activities during the quarter. In the first quarter, we continue to focus on adding value through internal growth, more efficient operations and improving our financial flexibility. Highlights of this quarter were that we grew normalized FFO per share year over year by 6.7%, grew consolidated same-property cash NOI by 1.7% year-over-year with growth in all three operating segments, achieved same-store NOI growth in our managed senior living portfolio of 3.3% year-over-year, continued to lead the healthcare REIT sector with a 97% private pay portfolio, skilled nursing facilities that are dependent upon government programs account for less than 3% of our portfolio. We maintained our normalized FFO payout ratio at 81%, acquired the previously announced $23 million medical office building in Minneapolis and subsequent to quarter-end acquired a private pay senior living community in Georgia for $8.4 million which was previously disclosed and a 183,000 square foot life-size MOB in Florida for $45 million. And finally, we converted $250 million of floating rate revolver debt to 30-year fixed-rate debt at attractive pricing. Our carefully constructed portfolio continued to illustrate our strategy of owning well-diversified private pay focused healthcare assets. In the first quarter, 41% of our NOI was attributed to triple net leased senior living communities, 41% to medical office buildings and 15% to managed senior living communities. At the end of the first quarter, our triple net leased senior living portfolio consisted of 231 communities generating quarterly NOI of $65 million, a 17.5% increase over the prior year. These communities continue to perform very well with same-store NOI increasing 1.6% year-over-year. Within the triple net senior living portfolio, our largest operating partner, Five Star, leases 177 communities. These communities had combined occupancy of 84.3% and rent coverage of 1.23 times for the 12 months ended December 31, 2015. Although occupancy in this portfolio declined in the aggregate, by 50 basis points, coverage ratios have remained consistently strong. The four communities we leased to Sunrise Senior Living had occupancy of 90.6% and rental coverage of 1.9 times. The 18 communities we leased to Brookdale Senior Living had occupancy of 89.3% and rental coverage of 2.8 times. The 32 communities leased to 13 private regional operators had average occupancy of 86.3% and rental coverage of 1.28 times. The coverage ratios of our leases remain very strong overall. We've seen occupancies impacted on the margin, mainly by new competition, but the operators comfortably cover their rental obligations due to us. At the end of the first quarter, our MOB portfolio was comprised of 122 properties with total 11.4 million square feet generating quarterly NOI of $66 million, a 5.7% increase over the prior year. Overall, occupancy at the end of the first quarter at our MOB portfolio was a strong 95.8%, modestly lower than the prior quarter end and the prior year quarter. Occupancy in the same-store MOB portfolio decreased 50 basis points to 94.8% in the first quarter. However, NOI increased by 1.2% on a GAAP basis and 1.4% on a cash basis compared to the prior year. Although same-store occupancy experienced a modest decline, rental income increased almost $1.8 million. The increase in rental income relates primarily to the increase in rental rates, escalation income and parking income. We had $1.1 million of increased expenses, primarily due to increased real estate taxes, most of which are escalatable. We also benefited from lower operating costs, primarily lower snow removal, utilities and insurance costs. At the end of the first quarter, our managed senior living portfolio consisted of 65 communities generating quarterly NOI of $25 million, a 21.5% increase over the prior year. Although we spent a considerable amount of time to discuss the performance of this portfolio, I want to remind you that it represents only 15% of our NOI. On a same-store basis, NOI on our managed senior living communities grew 3.3% year-over-year and same-store margins increased 60 basis points to 25.2% from 24.6% last year. These communities generated a $680,000 increase in revenue which is primarily driven by an average monthly rate increase of 1.2%, offset by a 90 basis point decline in occupancy. As noted on our last earnings call, approximately 20% of our communities have a property opening up in their market, but will strive to maintain market share by investing capital in our communities containing quality professionals and maintaining a preferred status as a provider of choice in our markets. Our operators have done a great job providing high-quality services for our residents, while also maintaining appropriate cost controls. Turning to the acquisition and disposition activities, as mentioned on our last call, in February, we acquired a 128,000 square foot MOB in the Minneapolis area for $22.7 million. This multi-tenanted property is anchored by a Minneapolis-based high-investment grade healthcare system. We also mentioned on our last call that we had a senior living facility under agreement in Georgia for $8.4 million. That transaction closed this past week and yesterday, we acquired a 183,000 square foot life-size MOB in Florida for $45 million in a sale leaseback transaction with Nanotherapeutics, an existing life science tenant of ours. Nanotherapeutics will use the facility and its capabilities to produce medical countermeasure products for the Department of Defense and to attract commercial customers in need of contract development and manufacturing for a variety of biopharmaceutical products. In March, we sold a land parcel previously classified as held for sale for $700,000 excluding closing cost and entered into an agreement to sell one skilled nursing facility for approximately $9.5 million. This skilled nursing facility and one MOB are classified as held for sale as of March 31, 2016. We had a very strong start to 2016 and continue to be pleased with the performance and quality of our portfolio. We remain disciplined in regards to capital deployment as cap rates generally remain compressed across the healthcare sector with significant private equity seeking investments in the space. In the near term, we will continue our focus on enhancing internal growth, very selectively making investments in pruning the portfolio while maintaining a strong balance sheet. Now, I would like to turn it over to Rick to provide a more detailed discussion of our financial results for the quarter.

[Rick Siedel:]

Thank you, Dave and good morning, everyone. 2016 is off to a good start with normalized FFO up 15% compared to last year to $112.9 million or $0.48 on a per share basis. We declared a $0.39 per share cash dividend in April, resulting in a normalized FFO payout ratio of 81.3%. Rental income for the quarter increased $15.6 million from the first quarter of last year to $161.4 million. This increase is primarily due to growth from our acquisitions of 24 medical office buildings and 20 triple net leased senior living communities since January 1, 2015. This increase is partially offset by reductions in rental income from the sale of four triple net leased senior living communities, primarily skilled nursing facilities and one MOB during the same period. On a same store basis, rental income increased $2.6 million or 2% compared to Q1 of 2015. This increase is primarily attributable to investments we've made in certain of our triple net leased senior living communities, along with increased rental rates and escalation income from our MOBs. Resident fees and services revenues from our 65 managed senior living communities increased 17% compared to the first quarter of 2015 to $97 million. This increase is primarily attributable to our acquisition of 20 managed senior living communities since January 1, 2015. As Dave mentioned, on a same-store basis, our managed senior living communities were able to increase average monthly rates by 1.2% to more than offset a modest decline in occupancy. Property operating expenses from our MOBs and managed senior living communities increased 14.2% in the first quarter to $97.9 million compared to the same period last year, due to the acquisitions I just mentioned. On a same store basis, similar to last quarter, we saw increases in operating expenses at our MOBs, primarily real estate taxes and slight decreases at our managed senior living communities compared to the year-ago period. We're pleased that our managed senior living community operators have been able to control costs through strategic purchasing initiatives to more than offset various cost pressures in our portfolio. We have also benefited from reduced costs related to a milder winter and reduced insurance costs. General and administrative expenses increased $289,000 or 2.7% to $10.9 million this quarter compared to the same period last year. Within G&A expense, our expense related to business management fees decreased by $0.5 million compared to last year despite growth in our portfolio. The business management fees continued to be calculated based on our market capitalization instead of our historical cost which reduced the fees by a little over $900,000 in the first quarter. This savings was offset by increases in legal and accounting fees along with other costs of being a public company. At 4.2% of revenue for the quarter, SNH benefits from the efficiencies of our structure and continues to run lower G&A expenses than many of our peers. We recorded non-cash impairment charges totaling $7.4 million in the first quarter of 2016. $4.4 million of these charges were to write off acquired intangible assets associated with two triple net leased senior living communities acquired in 2015 that we have transitioned or are currently working to transition to a TRS or REIT deal structure. The remainder of our impairment charges, about $3 million, relates to writing down a medical office building and an adjacent land parcel to fair value, less estimated cost of sale based on what we were seeing in the market. Interest expense increased 9% to $39 million this quarter compared to the first quarter of 2015. The increase was primarily a result of increased borrowings on the revolver, the $200 million term loan in September, 2015, the $250 million of 30-year senior notes issued in February 2016 and the mortgages we assumed in connection with our 2015 acquisitions. These increases were partially offset by the repayments of $250 million of our senior notes and $135 million of mortgages that had encumbered 11 of our properties. We did not recognize any dividend income from our investment in RMR during the first quarter, but RMR did declare a cash dividend in April 2016. We expect dividend income to run at approximately $2.6 million annually or $650,000 per quarter beginning in the second quarter. This will amount to just under $2 million for the balance of 2016. During the quarter, we acquired one MOB for $22.7 million and subsequent to quarter end, we acquired the senior living community in Georgia for $8.4 million and the life science MOB for $45 million. The senior living community opened in January 2015 and the life science MOB was completed in April 2016. The weighted average cash cap rate for these three acquisitions was just over 11%. So we're discovering unique opportunities to acquire first-class assets at attractive returns. In addition, we continually seek high-return investments in our existing portfolio. We invested $8.5 million into revenue-producing capital improvements at our triple net leased senior living communities and $1.2 million on MOB tenant improvements and leasing costs. The timing of tenant improvements and leasing costs can be volatile as it relates to volume of leasing activity and tie-in activity. Our recurring capital expenditures for the quarter included $2 million at our MOBs and $3.6 million at our managed senior living communities. We also spent $6.5 million on development and redevelopment capital projects with approximately two-thirds of it in our managed senior living communities and one-third in our MOBs. These significant modernization or renovation projects are intended to give our properties a competitive edge in their market. On the disposition front, we completed the sale of a land parcel during the quarter and we continue to work to sell certain other assets, including the MOB we have classified as held for sale and selective skilled nursing facilities in order to focus our portfolio on private pay assets. During the quarter, we entered into an agreement to sell one more of our remaining 41 skilled nursing facilities for $9.5 million. This potential sale that we expect to close in the second quarter would further reduce our exposure to skilled nursing which is already less than 3% of our NOI for the first quarter. At March 31, 2016, we had $39 million of cash on hand and $439 million available on our $1 billion revolver. In the first quarter, we issued $250 million of 30-year senior notes and used the proceeds to reduce the amount outstanding on our revolver. This transaction increased our total weighted average debt maturity to 8 years from 6.3 years in the prior quarter, while only increasing our weighted average interest by 30 basis points. Subsequent to the end of the first quarter, we repaid another mortgage for $18 million that encumbered one of our properties and in the third quarter, we expect to prepay mortgages totaling $93 million that encumbered three of our properties with an average interest rate near 6%. Our total debt to gross book value of real estate assets was 43.7% and debt to adjusted EBITDA was 5.7 times at the end of the first quarter. Given the quality of our portfolio, we're comfortable with our leverage ratios where they are and believe we still have some flexibility to take on a modest amount of additional debt. The SNH portfolio continues to perform well and is complemented by a strong balance sheet with no meaningful debt maturities for the near future. We will continue to focus our efforts on internal growth by funding expansions and improvements and managing the portfolio to generate strong operating results from our senior living and MOB properties. With that, Dave and I are happy to take your questions.

[Operator:]

[Operator Instructions]. Our first question comes from Mr. Vikram Malhotra, Morgan Stanley.

[Landon Park:]

This is Landon Park on for Vikram. So yes, just to start off, just running through the segments, I mean occupancy in each of the segments is struggling year-over-year for each of them. How are you guys thinking that's going to progress going forward and is this a bottom or will you expect those declines to continue?

[Rick Siedel:]

And as far as across all segments, I mean we really have three segments and the MOB front is holding pretty steady around 95%, 96% occupancy and that's been very consistent. I don't see that changing all that much. With regards to the senior living side, we have obviously independent living, assisted living and skilled and within those various categories, independent seems to be holding very steady, if you were to look at our portfolio, the majority of our portfolio is independent living and then assisted living. Assisted living is feeling the impact of the new supply and a lot of dynamics in the industry with -- there is a revolving door with many of the Executive Director positions or the department heads as everybody is trying to find good qualified health in the industry and we've been very successful at retaining a majority, a substantial majority of them, so I think that is still sliding a bit from an occupancy perspective, memory care in particular is the area that's the weakest. Skilled nursing has been on a very slow decline. I think we're selling off a number of our skilled nursing facilities over the course of time, but I think the industry as a whole has been hovering around 80% occupancy, but I think that's going to continue to modestly decline our occupancy.

[David Hegarty:]

Right. I think the only thing I would add is that I mentioned it briefly on the last earnings call, but our major operating partner on the managed senior living side was making a conscious effort to try to wean the system off of third-party referrals and trying to shift towards more organic referrals, some resident referrals that result in long goings of stay, more profitability and higher satisfaction for everyone involved. So there is some element of that changeover having a slight decrease in occupancy along with some supply concerns and stuff like that, but for the most part, we're confident with where the portfolio is and where it's going.

[Rick Siedel:]

However, I will point out, yesterday, Five Star had their earnings call and they commented that January and February were one of the weakest months in years; yet, the March month was fantastic with a lot of new admissions and so on. So, hopefully, some of these changes that they are making over there will see an uptick going forward.

[Landon Park:]

Okay. And I guess, just following up on the senior housing side, you mentioned supply, obviously, are you able to provide maybe some sort of the spread between supply impacted properties and the properties that are really seeing a supply impact, where the non-supply impacted properties flat or up or, what's the difference here?

[Rick Siedel:]

They've been mostly I would say, flat I'd say for that reason. We have certain like properties of Florida to date really have not been impacted by new supply all that much and those properties are pretty much all north of 90% occupancy and they've stayed there. On our last call, we mentioned that about 20% of our portfolio has a new property that has opened recently or will open within a five-mile radius of our properties and so people are doing what they can to be best prepared for that. So, I would say 20% is really at risk of exposure to potential softening in the near term, but the rest of the portfolio seems to be holding pretty steady.

[Landon Park:]

Okay. And then, just one last one on the acquisitions you guys have announced, can you give us any more details on the MOBs? I mean how much of those are leased directly to the health system and maybe locations and the differences between the buildings and on the life science one, just how you are able to -- I guess, what the process was there and how you were able to get such a high yield on that asset?

[Rick Siedel:]

Sure. Well, as you know, we didn't do a heck of a lot of acquisitions recently and that's likely to be our mode of operations going forward for a while, but like the property in Minnesota, in the Minneapolis area, it's predominantly north shore -- North Memorial Health Care System that is the major tenant there and then there are several other doctor groups and this North Memorial is approximately 50% of that occupancy and then it's other doctor groups and then some commercial tenants within those three buildings, it's three buildings in total. And then, the other medical office building is the one in Florida that you mentioned, that is a very unique situation because we own a biotechnology park called Progress Center that is a lot of upstock biotech companies from the University of Florida, Gainesville campus and what the park does is the university has a C program where they get programs started and then often C Groups they started to grow they moved to our progress center park and then we'll own substantial amount land around that this particular situation was in existing tenants in our portfolio that kept growing and growing and they did a special project with the Department of Defense to build this state-of-the-art manufacturing facility and research facility for predominantly four contracts with the Department of Defense and because of that relationship. And because we have the background in that area of biotechnology, we were able to negotiate a transaction with them, that's a sale leaseback for the campus and essentially Department of Defense in their contracts will reimburse for a lot of the rent expense and so on. So we've basically paid for the hard costs for that building. It's a very unique situation?

[Landon Park:]

So you helped fund the costs of the buildout? Is that what you are saying?

[Rick Siedel:]

The takeout of that.

[Landon Park:]

I see. Okay. And so it sounds like that's sort of a mixed-use building. its manufacturing as well as office?

[Rick Siedel:]

Right there, while is not really office there is some office general administrative space, but it's really specialized lab space and manufacturing capability once roll it out from the lab.

[Landon Park:]

So are there any concerns about because of reusability of that type of assets should, that and it's relatively newer company I guess. Should there be any issues, I guess.

[Rick Siedel:]

I mean, the Company has been around in for long term contract with the U.S. government. So we feel very confident that they will be there for a good while and as where is located adjacent to our park and we hope to do other transactions like that. So it's very specialized but it offers a lot and in our investment on a per square foot basis, it's around $250 per foot. So we're not stretching from that perspective for lab space. So very comfortable with the relationship and going forward.

[Landon Park:]

So what's this right between lab and manufacturing, I guess?

[Rick Siedel:]

I would say the lab is substantial, but 60% lab space and I would say about 30% manufacturing and the balance would just be R&D in general office.

[Operator:]

Our next question comes from Michael Carroll, RBC Capital Markets.

[George Davis:]

This is actually George on for Mike. I was wondering the coverage ratio is on the 13 private pay senior living communities dropped pretty meaningfully during the quarter, could you provide some color on that?

[Rick Siedel:]

Yes, there are a couple of things; one, the coverage that's presented in our supplemental, for those is not same-store. So, you do see the impact of the CNL transaction that we did last year, where those properties came in somewhere around 1.2% coverage. So, they did drag it down a little bit, but then just taking that a step further, the impairment charge is largely related to two of those particular assets, where the tenants ran into a little bit of trouble and coverage wasn't there. We're in the process of -- well, the coverage dropped. I mean, it's still covering rent, but it's dropped. So, we're in the process of transitioning both of those properties over to our TRS or REIT deal structure and we have two other buildings, we believe they're good buildings where we're confident with the right operator, we'll get them back to where they need to be, but it did result in decreased coverage that you see here and also the impairment charges, we wrote off the intangible assets associated with the acquired leases in place.

[George Davis:]

And then, given where leverage is right now, what's your acquisition outlook? Are you comfortable pushing a little higher, just it completes a couple of our investments or--?

[Rick Siedel:]

I think it's going to depend. I mean obviously, we're conscious of cost to capital and everything else and we said we weren't going to do anything drastic and we expected the portfolio to largely look similar to where it started for the year. But then, when you look at the acquisitions that we've done, they're pretty compelling. I mean the cash cap rate was over 11% for those. So, it's pretty hard to ignore those. So, when there is good opportunities that makes sense, we're going to do it, even if it does tick the leverage up a little bit, but again, we weren't looking to do anything drastic there and I don't think we have.

[David Hegarty:]

No. And we've been looking for opportunities to sell off some assets. We've been in the market exploring, selling some or many of our skilled nursing facilities as well as a handful of other properties that are in the back office building area. So, we're going to be very modest consumers of capital and raising of capital.

[George Davis:]

All right, that leads well into my next question, are you thinking about doing any meaningful dispositions, kind of to match potential acquisitions or kind of delever the balance sheet, anything about doing a little bigger than what you announced this quarter or are you kind of comfortable doing those smaller one-off deals?

[Rick Siedel:]

Well, it is very lumpy. So, we would sell a lot more at the right pricing and we've said many times that we expect to exit the skilled nursing sector over the course of time. So, I do think it hopefully will be a bit more meaningful in the next several quarters.

[Operator:]

[Operator Instructions]. Our next question comes from Jonathan Hughes, Raymond James.

[Jonathan Hughes:]

Could you just -- I know you touched on the virtual MOB earlier, thanks for the color on that. Obviously, it's a unique asset. Maybe why didn't they just ask for more money? I mean it's a great deal for you guys, but it seems like they left a lot of money on the table?

[David Hegarty:]

Well, it's a very unique situation and we do know that there was a limited marketing process for it. And as you know, this is a fairly high-profile investment because the governor has been there on a couple occasions for ribbon cutting and other events connected with this and seize it as a future growth opportunity for that area or Florida. So, in our case, we believe that it is unique and we have the presence there and we can support them for expansion. So, I think it's a combination of a relationship and I've taken the time to understand the nuances of their business and the contracts that they have with the U.S. government and so on.

[Jonathan Hughes:]

Are there any similar opportunities like this in the future, maybe with that same tenant and in the same Life Science Park?

[David Hegarty:]

We certainly hope so. They are not going to come along every day, but as you know, the biotech industry is one where we'll have startups, many of them run out of cash first or they become successful and then ultimately, probably get acquired or will and come public and so we do own a significant amount of acreage around the park and do have it on the table that we would do build-to-suits or acquire properties upon completion. So we do hope this further opportunity.

[Jonathan Hughes:]

Okay. We will have to check it out this fall, I'm up at some Gator Games [ph] but turning to the impairment, this included some component of the transition from a triple net to a REIT deal structure and some senior housing assets. Was the entire $7 million related to that or some related to the land partial sale? I'm sorry if I missed that earlier.

[David Hegarty:]

No, it's about of the whole charge, about $4.4 million is related to writing off the intangibles on two tenants that defaulted on triple net leases that were in the process of transitioning over to TRS. Then, there is about $3 million of charges related to writing down an MOB in that land parcel down to what we're seeing in the market.

[Jonathan Hughes:]

Okay. Are there any other assets on your watch list?

[David Hegarty:]

Sorry, what's that?

[Jonathan Hughes:]

I mean, do you have any other assets that are trending that way or potentially on your watch list for maybe similar transitions from triple net to REIT deal?

[Rick Siedel:]

No, I would say certainly not on the triple net leased assets. I think we're very comfortable with everything else in the portfolio. And no, I think MOBs are in very good shape too. So I don't really expect anything, any impairments.

[Jonathan Hughes:]

Okay. And then, just one more, looking at the asset sales, you did one in the quarter and have another $9.5 million expected. Have there been more aggressive internal discussions to recycle capital, maybe even selling some of your the bottom, take 10% of your MOB portfolio, given the strong demand environment you just mentioned?

[Rick Siedel:]

Well, we've continued to monitor the portfolio and look for opportunities to sell certain assets. And as I said, we've specifically targeted skilled nursing. We have looking at the few of the other senior living properties potentially and some of the medical office buildings. But we haven't set a specific target and I think just mode of operations have typically been we would tell you in hindsight that we felt something as opposed to forecasting of what we will sell and we also look for opportunities for joint ventures or other opportunities to realize the value at a number of our assets.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. David Hegarty for any closing remarks.

[David Hegarty:]

Thank you for joining us today and we certainly hope to meet up with a number of you at the upcoming NAREIT meeting in June and the BofA Conference at Las Vegas where we will be presenting. Thank you.

[Operator:]

The conference has now concluded. Thank you attending today's presentation. You may now disconnect.