Regional Health Properties, Inc.
Q3 2014 Earnings Call Transcript

Published: 13 Nov 2014

[Operator:]

Good day, and welcome to the AdCare Health Systems Inc. Third Quarter 2014 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the call over to Brett Maas of Hayden IR.

[Brett Maas:]

Thank you, and good day. Joining me on the call today are Bill McBride, AdCare's Chief Executive Officer and President; Sheryl Wolf, AdCare's Controller and Chief Accounting Officer. I'd also like to mention, this call is being simulcast on the company's website at www.adcarehealth.com. I'm now going to read forward-looking statements. Any forward-looking statements made today are based on management current expectations, assumptions and beliefs about AdCare's business and the environment in which the company operates. These statements are subject to risks and uncertainties that could cause AdCare's actual results to materially differ from those expressed or implied on this call. Listeners should not place undue reliance on forward-looking statements and are encouraged to review AdCare's SEC filings for a more complete discussions of the factors that could impact AdCare's results. Except as required by federal securities laws, AdCare does not undertake to publicly update or revise any forward-looking statements, which where changes arise as a result of new information, future events, changing circumstances or for any other reason. In addition, any AdCare facility or business the company may mention today is operated by a separate independent operating subsidiary that has its own management, employees and assets. References to the consolidated company and its assets and activities, as well as the use of terms like we, us, our and similar verbiage are not meant to imply that AdCare Health Systems Inc. has direct operating assets, employees or revenue or that any of the operations are operated by the same entity. Also AdCare supplemented GAAP reporting with non-GAAP metrics, such as adjusted EBITDA and EBITDAR when reviewing together with AdCare's GAAP results, these measures can provide a more complete understanding of AdCare's businesses. They should not be relied upon to the exclusion of GAAP financial measures. A reconciliation of these measures to GAAP is available in today's press release. After management concludes their remarks, they will respond to questions regarding the presentation. Now I would be turn the call over to President and Chief Executive Officer of AdCare, Mr. Bill McBride. Bill, please go ahead.

[William McBride:]

Thanks, Brad. Good morning, and thanks to everyone for joining us today for what's my first earnings call with AdCare. As most of you know, I stepped into the role of Chief Executive Officer and President, a month ago following the board's decision to significantly change the operating model of the company. Prior to joining the company, I carefully reviewed and evaluated the strategy. It's one I've executed before, and I want to start the call by saying that I believe this strategy is the best way to maximize value for shareholders, which is ultimately why I accepted the position as CEO. I'm confident my experience will be valuable at the company as I lead the evolution of our company from an owner-operator to a lease holding company. The new strategy of converting the company to a lease holding company is the best way to improve cash flow, achieve more predictable financial results and eventually, enable the company to return cash to shareholders through a regular dividend. At inception, the plan called for the execution of a number of key action items, that we're making good progress towards these items to achieve the outcomes as articulated in the plan. The first step was to hold a special Meeting of Shareholders to gain approval for certain leasing transactions, which has been completed. On October 14, the board convened a Special Shareholders Meeting where our shareholders overwhelmingly approved certain leasing transactions for properties in the state of Georgia. The approval also effectively authorized the company to pursue the strategic plan to transition to a healthcare property holding and leasing company and out of the day-to-day operations of healthcare facilities. The second action item essential to the plan is the negotiation and execution of lease agreements with health care operators for all 37 properties in the portfolio. To date, we've entered into agreements to lease 14 of our 37 facilities. As of today, 6 of these 14 lease agreements have received the requisite approvals and are completely in effect. This includes 2 lease facilities in Georgia, which became effective on November 1, as well as 4 Georgia subleases. The remaining 8 of the 14 negotiated agreements includes 4 facilities in Ohio and 1 in Georgia, which are now pending HUD approval and 2 Alabama leases, which we're currently awaiting regulatory approval. We expect these 2 Alabama lease agreements will receive the necessary approvals and will be fully effective by the end of 2014. I want to take a minute to explain the subtle yet important difference between entering a lease agreement and the lease becoming fully effective. We've been working diligently to identify potential lessees for all of our properties then negotiate terms and execute those leases. As part of this process, these fully negotiated and lease agreements are also subject to certain approvals, often with each agreement requiring approval by different regulatory government or financial entities. In most cases, the party to the underlying financing agreement for the property varies from property to property. This required separate industry discussions with each bank to gain their approval, which can often extend the time to fully and completely affect the lease agreement. It is important to note that we have different lenders for the majority of our facility, so each approval discussion is unique and the timing can vary. In addition, certain new lease agreements are subject to approval by the United States Department of Housing and Urban Development or other regulatory bodies, which can also extend the time to fully and completely affect the lease agreement. Finally, in some states, approval is needed from state regulators. This approval can take some time to secure. For example, it takes between 6 and 9 months in Oklahoma to gain licensure. We are working aggressively to expedite this process, but we have limited control over the timing, especially as it relates to state regulators in the state where that approval is applicable. The facilities that have HUD loans will generally take 60 to 90 days after an application is submitted to get a financing approval of the new operator. While we're working through each transaction to satisfy the individual approval requirements, these external influences will keep the company from moving as quickly as was originally expected. But the process is continuing and we expect these approvals will be obtained. It's simply a matter of timing and we're working diligently to get these approvals. Turning back to our expectations for leasing the remaining properties. With 14 of the 37 either leased or fully transitioned to the new operating model or pending approval, we currently expect the majority of the remaining 23 facilities to be leased subject to approvals by the end of the first quarter of 2015. The third action item under our strategic plan includes reducing interest in overhead expense. To that end, the company has completed the refinancing of 4 facilities with HUD loans, which raised additional working capital and will reduce interest expense. Additionally, since the commencement of the plan, the company has been able to significantly reduce its corporate overhead costs by approximately $2,700,000 on an annual basis. We expect to continue to reduce overhead over the next several quarters as we lease facilities. To further the reductions in overhead, the Board of Directors approved yesterday a reduction in its compensation expense, which should total approximately $500,000 for the year of 2015. One of the key components of our new strategic plan is the return of cash to our shareholders, which leads me to the fourth action item, the institution of a quarterly cash dividend. We continue to expect the transformation of our operations to leases and the reduction of overhead and interest expense will increase cash flow and position the company to begin payment of a dividend on the common stock. The board remains committed to the payment of a common stock dividend and will move expeditiously to declare one once we've obtained complete lease agreements for the majority of our facilities. It is our goal, as identified in the strategic plan, to pay a $0.05 dividend in the common stock in the first quarter of 2015. We'll have more to say on the timing of the dividend declaration as we continue to work on executing additional lease agreements. And finally, the last action under the strategic plan is to potentially grow and diversify the existing portfolio of properties over time by acquiring additional properties in different markets. And based on my experience in growing LTC properties, REIT I worked out in many years and cofounded, I believe there will be ample opportunities to selectively grow our asset base. And with such a small balance sheet, it will not take a large number of acquisitions to allow the company to significantly grow its FFO. Turning next to our financial result. For the quarter, our financial results are those of a company in transition, with certain properties still being managed under the operator model and others being managed under our new leasing and holding company model. For the quarter's results, I'd like to turn the call over to Sheryl Wolf, our Senior Vice President, Controller and Chief Accounting Officer.

[Sheryl Wolf:]

Thank you, Bill, and good morning, everyone. I will review our financial results for the third quarter of the 2014. During the quarter, revenue was up 6.4% to $57.1 million, compared to the third quarter of 2013 of $53.6 million. Operating income was approximately $1.2 million, compared to operating income of approximately $1.5 million to the third quarter of 2013. The third quarter of 2014 includes a nonrecurring charge of approximately $1.5 million related to salary continuation and separation costs of approximately $1.5 million and approximately $400,000 related to a separation agreement with an officer of the company since the strategic transition was announced. The nonrecurring charge during the quarter was partially offset by a reduction in our fixed cost. As always, cost reduction will continue to be a priority. Within our operating expenses, general and administrative expenses decreased approximately $1 million year-over-year as the result in the decrease in salaries, wages, employee benefits, contract services, travel expenses and accounting and auditing fees. As a percentage of total revenue, G&A expenses decreased from 8.5% from the third quarter of 2013 to 6.3% for the third quarter of 2014. As we continue this strategic transition, we expect a continued reduction in our fixed cost. However, investors should expect some nonrecurring charges, such as severance charges, other costs associated with termination of contracts or obligations within the existing operations of the facilities and also higher costs related to our upcoming full year-end audit. These are normal expenses related to a strategic transition of this magnitude, but are primarily nonoperating costs. Interest expense for the quarter was approximately $2.6 million, compared to $3.2 million in the third quarter of 2013. The decrease was primarily due to the holders of the company's subordinated convertible promissory notes due August 2014's conversion of approximately $4.8 million of principal and accrued and unpaid interest to outstanding shares of company common stock, as well as the payment of the remaining outstanding principal amount of $4.0 million for the 2011 subordinated convertible promissory notes due March 2014. Adjusted EBITDAR was up 20.2% to $6.5 million, compared to the prior year period of $5.4 million. The adjusted EBITDAR margin for the third quarter of 2014 was 11.5%, compared to 10.2% in the third quarter of 2013. A reconciliation of this metric to our GAAP numbers is available in the press release we distributed today. Moving to review our balance sheet. Cash and cash equivalents at September 30, 2014, totaled $12.9 million as compared to $19.4 million at December 31, 2013. Total restricted cash and investments at September 30, 2014, totaled $8.7 million as compared to $15.4 million at December 31, 2013. Total debt at the end of the third quarter of this year was $151.3 million, compared to $160.3 million at December 31, 2013. The Board of Directors declared a quarterly dividend of $0.68 per share on the company's 10.875% Series A Cumulative Redeemable Preferred Stock, which is paid on September 30, 2014, to holders of record at the close of business on September 19, 2014. The Series A Preferred Stock is listed on NYSE market LLC and trades underneath the symbol ADK.PA. I would now like to turn back over to Bill to provide a summary.

[William McBride:]

Thanks, Sheryl. I'd like to also point out or reiterate improvement in our performance this quarter, particularly EBITDA for the 3 months ending September 30, 2014, with $6.5 million versus $5.3 million the prior quarter and $5.4 million the same quarter a year ago. This represents the excellent efforts by the entire AdCare operations team, which to me is particularly noteworthy since it occurred during a time of significant change at AdCare. The improving operating results on EBITDA should greatly enhance our ability to obtain maximum value on our lease agreements for our remaining properties. I'm very proud of the work of the AdCare team thus far, and I commend everyone on their exceptional professionalism in the time of transition. In summary, I'd like to leave you with some key takeaways from our call today as they relate to the execution of our new strategic plan. First, we are making good progress in leasing our operations with 14 lease agreements already in place. The values of those leases assigned to date or the rental income are inline with those identified in the company's strategic plan. Second, approval constraints, which are largely out of our control, will impact the speed of transformation of the operators, and we want to be prudent in our efforts to lease the remaining buildings to maximize value. Third, we are making substantial progress in lowering our overhead expenses and interest expense. Fourth, as we continue to execute this transition, we are seeing stable to improving facility level performance and EBITDA, which will allow us to complete these lease agreements with obtaining maximum value going forward. Finally, the execution of a sufficient number of lease agreements is critical to us adopting our new dividend policy. Our goal remains the same, to pay a $0.05 dividend in the first quarter. I'm extremely confident about where we're headed. We're making good progress toward the implementation of the strategic plan, and I think the benefits are starting to materialize in our reported financial results. So at this time, I'd like to ask our operator to open up the call for your questions.

[Operator:]

[Operator Instructions] And we'll take our first question from Chris Sansone for Sansone Partners.

[Christopher R. Sansone:]

I'm looking at the presentation where you provide the potential $0.40 annualized dividend in 2016. And I guess I'm just kind of curious, what sort of Skilled Mix does that assume? And then maybe can you just explain, are there opportunities for AdCare if an operator comes in and is able to improve the Skilled Mix and is that the way these deals are structured, will you guys then be able to benefit from those increases in profitability?

[William McBride:]

As far as the Skill Mix, so the operators will take over the properties under lease. So the mix of the residents going forward really in large part, they will drive that mix, we're at that point, receiving rental income. We have upside on those leases, restructuring those leases typical to what all of the other healthcare public Health Care REIT operators do. I mean, I've done a number of those deals while at LTC. And what you typically see are triple net leases, 5 or 10 years in duration with escalators every year, typically 2% escalators each year. In AdCare's case, because we feel a number of these properties have some significant upside beyond what they're performing at today, we're doing 5-year leases that have renewal options at the end of 5 years as a package, cross collateralized, cross defaulted, renew one, renew them all in the package with the greater of FMV are 2% escalators between year 5 and year 6. So we have the 2% escalators built in very typical of a REIT and we then also have an FMV escalator after year 5, so that if the facility's performing significantly better in 5 years than it's performing today, we could capture some of that additional revenue. So the FFO coming off of those leases is what will drive our ability to pay the dividend, not necessarily tied directly to the patient mix at those facilities. Does that answer your question?

[Christopher R. Sansone:]

Yes. And are the lease agreements being structured with purchase options being given to the operators?

[William McBride:]

No.

[Christopher R. Sansone:]

Okay. And with respect to the operators and the operators that you're choosing, can you give us a sense for, is there 1 or 2 main operators? Or kind of what sort of operator risk are we anticipating?

[William McBride:]

We -- there will be a number of different operators. We are not doing one-off properties or two-off deals though. We are doing groups of properties so far in the 4 or 5, 6 range, we're doing -- we're working on a package right now would involve 10 facilities as a package to 1 operator. These are operators that are already obviously, operating a number of properties that we know, based on previous history or have connections with, are familiar with the regulatory environment in those particular states and have had success operating properties in those individual locations. From a REIT perspective going forward, you want to have a mix of operator diversity and obviously, state diversity. And so you don't, while on 1 hand, you'd like to have 1 or 2 operators having the majority of properties, there's a risk with that. So it's kind of a balance. So I see us ending up probably with somewhere around 6 to 10 operators that are ultimately going to be operating all of our properties. Each one with a package, and each one of those packages having cross default, cross collateral and cross renewal provisions.

[Operator:]

We'll take our next question from [indiscernible] Ryan with Saber Capital.

[Unknown Analyst:]

I know we had the chance to meet previously, but let me take this on an open to welcome you to the AdCare family. One just quick question particularly, noted the results from third quarter as you had mentioned we're fairly strong. And one of the risks, obviously, with the transition being a little longer than initially anticipated is what happens at these facilities, making sure that they continue to perform. So you hit the pro forma balance sheet that you had put out there earlier. Can you give us just some anecdotal or qualitative data points as to how things has progressed since the end of Q3, October and maybe partially through November, if you have that available?

[William McBride:]

I'm very pleased with the performance of the operations. When I came on board, I got to say, one of my most pressing concerns was the amount of time that had already passed since the strategic plan had been announced and the facilities were getting leased, concerned that operations would continue to perform effectively, profitably and regulatory have good results. I'm happy to report that, obviously, you can see what happened in the third quarter, they did a magnificent job in that environment. So far from what I've seen, into the fourth quarter, things are going reasonably well or reasonably consistent with the results in the third quarter, census seems to be stable to actually slightly up, expenses seemed reasonably in line. So -- and the regulatory environment is pretty much consistent with the third quarter. So I'm very happy with the results. And obviously, that makes our job a heck of a lot easier as we go out and look at perspective tenants in this facilities to say, hey, here's what these already doing, they're already doing quite well, and it gives us a lot more negotiating power. And it also gives us a lot of options for multiple tenants on some of these buildings.

[Operator:]

[Operator Instructions] And we will take our next question from Gentry Klein with Cetus Capital.

[Gentry S. Klein:]

Bill, just want to commend you, the management team and all the employees for doing a great job as we undergo this transition. As you mentioned numerous times, the quarter looked great in terms of all of the core metrics, revenue, EBITDAR, occupancy, Skilled Mix. And you touched on this a couple of times, but tying back to that pro forma snapshot that was put together a couple of months ago of pro forma revenues of $26.8 million, given the -- given how the quarter's been progressing and your view for the go forward, how are you tracking towards that number? Do you still feel confident in achieving that $26.8 million? Given the recent trends, is there a potential for upside on that number?

[William McBride:]

I'm confident, I mean, with the deals that we've already done and the negotiations that we have to date and our undertaking basically as we speak or today even, we are tracking on that number or slightly better.

[Operator:]

And we will take a follow-up question from Chris Sansone with Sansone Partners.

[Christopher R. Sansone:]

Bill, 2 more. I guess, one is when you look at the capital structure today and your cost of funds, your preferred is yielding 10% and I guess, the implied yield on the common stock when the 2016 is also around 10%. How do you think about raising additional equity capital to do future deals on skilled nursing side when the cap rates on those deals are yielding lower than your cost of funds?

[William McBride:]

Well, I think that basically what happens is you raise some equity capital and then lever that capital as you go forward as a REIT, or you use a lot -- you raise some equity capital and utilize that with a line of credit to lever that equity capital. So it's not strictly your FFO cost on an equity side that would drive the deals to going forward. Also once we get to that point where we're just a leasing company, our overhead levels are going to remain relatively fixed as we add properties on. So you could do deals at 9% and 10% and still be accretive to FFO at that point in time, because of that factor. So when you looked at what some of the competitive REITs were doing out there in the marketplace, I mean, there's still a lot of smaller deals, not the large, high profile, multi-facility deals, but the smaller 3, 4, 5 facility deals that are still done at rates approaching 10% in this marketplace.

[Christopher R. Sansone:]

Right. And then my last question is the preferred -- it's a redeemable preferred, so is there an opportunity there? Or are you guys thinking about redeeming the preferred and maybe [indiscernible] refinancing that would lower costs in funds?

[William McBride:]

Is convertible preferred, is that what you're talking about? Our convertible preferred, yes. So our intention and our hope next year is that convertible preferreds would convert to common stock. And that's our plan, if not, we will look for other ways to refinance them.

[Christopher R. Sansone:]

Okay. And that's the -- on the balance sheet of 23 million, 7 50, of redemption amount we're looking at?

[Sheryl Wolf:]

I think he's talking about preferred instead of [indiscernible].

[William McBride:]

You're talking about the preferred stock?

[Christopher R. Sansone:]

Yes.

[William McBride:]

Okay. The preferred stock is redeemable, if that's what you're asking.

[Christopher R. Sansone:]

Yes. And does the company have an opportunity to redeem that or refinance that? I guess, it's a 10% cost of funds preferred and maybe higher than what other preferreds might be trading in your industry.

[William McBride:]

We do have an option. I mean, it's redeemable, but I think that's something that the company, over time, would look at as it lowers its cost to capital to see whether it makes sense to take that out with some other instruments.

[Operator:]

We'll take our next question from Andy crozers[ph] with Bagley Security.

[Unknown Analyst:]

Could you explain the big drop in cash from year-end about $10 million? And also in the latest quarter, you had $1.2 million of loss on extinguishment of debt. And do you we expect to have further losses as you transition these properties from or the company's on the debt or prepay before the maturity date?

[William McBride:]

Sheryl, do you want to answer that about the $1.2 million?

[Sheryl Wolf:]

Sure. The $1.2 million related to the convertible debt that transpired during 2014 and going forward, in regards to the loss on extinguishment of debt relating to the 2014 subordinated convertible promissory note in the 2012, 7.5 convertible, I don't foresee any additional extinguishment of debt in regards to those converts. In regards to your question relating to the cash flow or the reduction in regards to cash and cash equivalents. During the 9 months ended, we've actually, of course, had repayments on notes payable as well as repayment on our convertible debt. We paid out dividends on preferred stock as well as used it in regards to working capital needs.

[Unknown Analyst:]

And why was there such a drop in the income from operations from the June quarter to -- from, I guess, the prior March quarter?

[William McBride:]

On June to March, we -- I mean, the operations, as I look at it, it's from an EBITDAR point of view. The operations in the third quarter, which is what I'll comment on, performed much better than the third quarter in the previous year or the previous quarter.

[Sheryl Wolf:]

And also to, in regards to second quarter, we had $1.3 million of salary retirement and continuation cost during the second quarter of 2014.

[William McBride:]

I mean, there are going to be, as we mentioned in the call, there are going to be certain charges such as that, that the company is going to incur as it transitions out being a operating company to being a lease holding company. Those charges are one-time in nature as we wind down the operations of the business. Will not be on an ongoing basis going forward. We have factored those into the liquidity models for the company as we look out into next year in order to make sure that we have adequate cash in order to transition the company during that period of time.

[Unknown Analyst:]

Do you anticipate all of those being out of the way by year-end?

[William McBride:]

I believe that the majority of them will, but there could be some additional charges, as we said in the press release and in the speech that we expect to be completely signed all the leases by the end of the first quarter of 2015. And we would expect that any and all of those charges to the extent that there are anymore, would be realized by that time.

[Operator:]

[Operator Instructions] And we will take our next question from Chris Doucet with Doucet Asset Management.

[Christopher Leonce Doucet:]

A couple of questions. I guess, Sheryl, I think this question is probably for you. The company has $21 million of bullet maturities due in February of 2015. I know that on previous calls, you mentioned that the company was trying to refinance those through HUD loans. Can you give us to status of those bullet maturities?

[William McBride:]

I mean, I can address that probably better, Chris. The company -- we're in negotiations right now on the best way to refinance that debt. There are already a number of options that we have to do that. We're trying to figure out the best strategy. Obviously, getting HUD loans on those properties is the most cost-effective way to finance those things on a long-term basis. We are close on the submittal to HUD on a number of those -- on 2 of those properties were close to submittal on to HUD. The other 3, we expect to submit to HUD over the next quarter. We're in negotiations to get bridge loans to basically take those properties out until such time that the HUD loans are completed. We expect to have those refinancings done, or commitments for those refinancings by the end of the year.

[Christopher Leonce Doucet:]

Okay. And can you give me the status of the VIE, the River Chase village?

[William McBride:]

That property is still listed for sale with a broker. And as of yet, we have no pending transaction.

[Operator:]

That does conclude our question-and-answer session for today. At this time, I will turn the conference back to management for any additional or closing remarks.

[Christopher F. Brogdon:]

Well thanks to everyone for joining us today. And I look forward to updating you on our progress during the next conference call as we continue to execute the strategic plan for the company. Good day, everyone.

[Operator:]

Thank you for your participation. That does conclude today's call.