CareTrust REIT Inc (CTRE) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the CareTrust REIT third-quarter 2015 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session, and instructions will be given at that time. (Operator Instructions) As a reminder, this conference call may be recorded.

Welcome to the CareTrust REIT's third quarter 2015 quarterly earnings call. Listeners are advised that any forward-looking statements made on today's call are based on management's current expectations, assumptions and beliefs about CareTrust's business and environment in which it operates. These statements may include projections regarding future financial performance, dividends, acquisitions, investments, returns and financings and all other matters, all of which are subject to risks and uncertainties that could cause actual results to materially differ from those expressed or implied here.

Listeners should not place undue reliance on forward-looking statements and are encouraged to review the Company's SEC filings for more -- for a more complete discussion of factors that could impact results, as well as any financial or other fiscal information required by SEC Regulation G.

In addition, CareTrust will supplement its GAAP reporting with non-GAAP metrics such as EBITDA, adjusted EBITDA, FFO, normalized FFO, FAD and normalized FAD. When viewed together with its GAAP results, the Company believes that these measures can provide a more complete understanding of its business, but they should not be relied upon to the exclusion of GAAP reports, except as required by federal security laws. CareTrust and its affiliates do not undertake to publicly update or revise any forward-looking statements where changes arise as a result of new information, future events, changing circumstances, or any other reason.

Listeners are also advised that the Company filed its 10-Q for the third quarter and accompanying press release yesterday. Both can be accessed on the Investors Relations section of CareTrust's website at www.caretrustreit.com. A replay of this call will be also available on the website.

At this time, I would like to hand the call over to Mr. Greg Stapley, CareTrust's Chairman and CEO.

Thank you, Nicole. Good morning, everyone, and thank you for joining us today. With me are Bill Wagner, our Chief Financial Officer; Dave Sedgwick, our Vice President of Operations, who is joining by phone from our Baltimore office; and Mark Lamb, our Director of Investments.

Q3 was a very busy and really important quarter for CareTrust. The flywheel we have been steadily pushing on since our spinoff last year finally started to gain some real momentum, producing some transformative results. I am pleased to report that these results have catapulted us toward our long-term goals well ahead of schedule, placing us in a position of real strength for the coming year.

First and foremost, our By Operators, For Operators business approach is yielding fruit in the form of a steady stream of top-flight healthcare and seniors housing operators who want to grow their businesses with us. Great operators are an important key to our health and success and during Q3 we were gratified to initiate three outstanding new tenant relationships, one of which has already resulted in a tack-on acquisition.

Notably, we are working on deals right now that will expand almost all our existing tenant relationships, and happily, several of those prospective deals have been brought to us by the tenants themselves. These tenants, in combination with the new tenant relationships that we are continually cultivating, have us underwriting and executing on what has become a solid stream of small- to medium-sized acquisition opportunities, all of which moved the dot quite nicely for us. The going in cash yields on our Q3 investments, for example, all of which were in the $10 million apiece, were over 8.4% for the seniors housing assets and over 9.5% for the SNF asset. These individual properties in small portfolios remain our primary focus as they tend to generate above market returns that will help us continue our steady march towards the leverage, yield and liquidity metrics that we believe will position us for very efficient growth in the near future and maximize shareholder value over time.

I am also pleased to report that, immediately following Q3, we completed a large portfolio acquisition, picking up the 14-facility Liberty Nursing Centers portfolio in Ohio. This $177 million acquisition not only grew our revenue and carries a going in cash yield of over 9.5%, it also gives a compelling backdrop to tell our story to both current and new investors by way of our first follow-on stock offering.

Because CareTrust was born as a spinoff, we never really had an IPO. So this was our first real foray into the equity capital markets.

I am pleased to report that our first follow-on is now behind us, and we were able to get it done in a difficult market while adding a whole new group of very good institutional investors. Best of all, the Liberty deal enabled us to add another high quality, growth-focused tenant in pristine senior living, whom we are very excited about.

With the new tenant relationships and investments we have made since our spinoff, we are now generating over $80 million in annual run rate rental revenue, which represents a 44% increase from the $56 million in rental revenue we started with just 17 months ago.

We are also very excited to be reporting on our financing activity during the quarter, which helped fund these acquisitions and position us well for future growth. But I will let Bill cover that, as well as our continued progress toward improving our credit profile in just a moment.

The last thing I would like to mention before handing the time over to Bill is the buildout of our team. In less than 18 months, we have built a small but highly capable and close knit management team that has grown together, is firing on all cylinders, and is working now with a diverse group of operators, brokers and other key industry players to grow CareTrust.

This year, we added a couple of additional team members to keep pace with our growing portfolio and pipeline, and we are getting closer to steady-state staffing. In 2016, we expect to add two to three additional employees, which will keep our regular G&A at around 10% of revenue for the year. From that point on, we expect the benefit from the scalability of our model and see G&A start to decrease as a percentage of revenue over time.

With that, I will turn it over to Bill. Bill?

Thanks, Greg. There were a couple of unusual items in the quarter that we have highlighted before, but I want to mention them again.

For the quarter, we are pleased to report that normalized FFO grew by 5.1% over the prior year quarter to $7.7 million, and normalized FAD grew by 10.4% to $8.7 million. However, partly because of the gap in time between the follow-on offering and the new revenue from the resulting acquisition, which came at the beginning of Q4, on a weighted average per share basis, our normalized FFO was $0.20 per share and normalized FAD was $0.22 per share.

In addition, please recall in making any per share comparisons to last year, that the share counts in Q3 of 2014 did not take into account the dilutive effects of the then pending purging distribution, which was made in mid-December of last year.

Interest expense for the quarter was also up slightly to $7.2 million, but I should point out that $1.2 million of that was related to the one-time write-off of deferred financing fees in connection with the refinancing of our secured revolver.

In addition, because we hit key incentive targets for the year, we increased our accrual for incentive compensation, which also impacted the quarter. These items were accounted for in developing and publishing our updated guidance for 2015, which we put out in early September.

Reiterating that guidance, we are projecting 2015 normalized FFO per share of approximately $0.92 and normalized FAD per share of approximately $1.02, all subject to the assumptions and qualifications we previously articulated in connection with that guidance. We expect to update our previously released 2016 guidance and provide a little more color on the coming year when we release our final results for 2015.

As Greg mentioned, the quarter was a really busy and transformative one for CareTrust. We were very happy to replace our $150 million secured revolving credit facility with a new $300 million unsecured revolving credit facility, which carries an accordion feature allowing for the additional $200 million of borrowing capacity, subject to certain customary terms and conditions.

We also completed the follow-on offering of 16.3 million shares of common stock that Greg referenced, which generated roughly $163 million in net proceeds. This brought a run rate net debt to EBITDA ratio down from 6.8 times to approximately 5.2 times today and cut leverage to 42% of enterprise value.

Following the offering, Moody's and Standard & Poor's both changed their respective credit outlooks on CareTrust public debt from stable to positive. As for other credit statistics, our fixed charge coverage ratio has increased to approximately 3.3 times, up from 2.6 times. Gross assets are now just over $800 million, and our effective leverage is just under 50%.

Lastly, we have reduced our single tenant concentration at Ensign from 84% to 67% on run rate revenues. Although I must always remind you that we are very bullish on them as an operator and a tenant, and we continue to love their 2 times lease coverage. Each of these credit metrics now exceeds the what could change our rating up hurdles in the credit opinion we received from Moody's last year. Because we funded the Liberty acquisition primarily with equity and given the additional capacity under our new unsecured credit facility, we have tremendous run rate to fund our growth in 2016.

One last point to go along with Greg's comments about our team. While we are committed to keeping G&A at around 10% of annual revenue in the short term and trending downward from there, it is possible that our growth in 2016 will require us to comply with Section 404(b) of the Sarbanes-Oxley Act, which would require additional consulting and audit fees and, depending on our rate of growth, could slightly delay our trend downward or even increase overhead in the short term. We anticipate having a clearer picture of the likelihood and magnitude of SOX impact, if any, after next quarter, and we will provide another update at that time.

And, with that, I will turn it back to Greg.

Thanks, Bill. To wrap up, we are excited about the trajectory we are on. We have a solid and growing rent stream, an enviable portfolio with true best-in-class tenants and abundant opportunities to grow. We hope this discussion has been helpful. We're obviously excited about our both near- and long-term prospects, and we are grateful for your continued interest and support.

And, with that, we will be happy to answer questions. Nicole?

(Operator Instructions) Paul Morgan, Canaccord.

As you look at your -- what's in your pipeline right now, how should we think about the mix between skilled and private pay senior housing? And then, as you look at the private pay side, in light of the supply risk that so many people are focused on, how do you approach it geographically? I mean, as you redline metro areas, are you taking in kind of much more sub market and asset specific?

Hey, Paul. I would say, looking out the pipe right now, we have a couple hundred million in the pipeline as we sit here today, half of which we are focused on and feel pretty good about in terms of execution.

Your question on ALF versus SNF or senior housing versus SNF, it is about 60/40 senior housing to SNF at this point. But, as you know, it can change pretty rapidly.

In terms of the private pay, we are looking -- with the deals we have, 8% start rate -- north of 8% start rate, most of the deals are kind of in that sweet spot from a monthly rate perspective. So we are not targeting the high-end market. We are targeting kind of that Courtyard by Marriott model. So I think we feel pretty good about the supply risk from that perspective, just because it is the affordable model that folks can meet on a monthly basis. So we are not looking for the $8000 to $10,000 kind of Sunrise/Brookdale model. It is kind of the more economical price point.

Paul, this is Greg. To address your geography question, we shouldn't really redline any areas, although there's a few areas that we are pretty cautious about. If you're talking about skilled nursing deals, we are concerned about the timing of payments of skilled nursing providers in states like Illinois, for example. But by and large, the country is wide open, and we are looking all over for the new deals.

We are particularly -- as you probably already know, we are particularly interested in secondary markets. Some of the places that are unloved by some of the bigger competitors and that are not terribly hard to get to, and we feel like we can get some really good, solid risk-adjusted returns by going an hour or two away from the big, big major metros. And we like that.

Great. Thanks. And then, another question just on the SNF side, what are your operators thinking about the bundled payments initiatives and the pilot studies for next year? I mean, the market is concerned about the impact on margins. And do you think that this is a catalyst for further industry consolidation? Does it change the way you underwrite new operators that you are looking at doing business with? How are you approaching the shifts in the reimbursement structure?

This is Greg. I think that is three questions. So I will do my best to get them all answered. Backwards, maybe. First, no, we don't change the way that we have been analyzing and underwriting our operators because we have always looked for operators who are smart, sophisticated and nimble. Not necessarily big, but sophisticated. If you look at the folks we added in the third quarter -- for example, Trillium SNF operator we added in the third quarter -- these guys came out of senior living. They know what they are doing. They are very sophisticated. If you look at Pristine, which we added right at the end of the third quarter, beginning of the fourth quarter, also this team highly sophisticated came out of one of the big, very good high-end operators in Indiana. And they are doing a terrific job out there.

So that is what we've always look for. So we don't need to change our approach in identifying good, solid quality operators.

Second, if I remember now what else you asked, bundled payments. BPCI, other bundled payment initiatives, these things have been around for a while. We're starting to see the first reports on pilot programs coming in. And I think our operators -- and this is the reason we look for sophisticated operators, is that they are able to adjust pretty quickly and efficiently to any changes in the reimbursement landscape. For example, there has long been a shift underway for Medicare to Medicare Advantage. There has long been a shift underway to more and more HMO payer patients. And our operators, we identify operators who have been very, very good, historically, in interfacing with the arbiters of those payment systems and taking good care of their patients.

I would love to just refer you over to Ensign's, who is our biggest tenant. Their earnings call from a few days ago, where they talked about the fact that they are involved in both Model 2 and Model 3 BPCI programs and doing very well in them. Length of stays dropping. They have always had lower length of stays to begin with. Quality outcomes are improving. Costs, I think if you read the Lewin report from last February, costs are not necessarily dropping, but I think it is probably still too early to tell how that is going to play out over time.

But we are very cognizant of that. Our operators are very cognizant of these bundled payment systems and other things that may be coming down the pipe, whether it is site neutral payments, other episodic payments systems Pay-for-performance proposals have been around forever. The ACLs, which are now getting more mature, others -- and there is substantial overlap between all of those. But it is something that we are watching very carefully.

Did I answer all your questions?

Yes, I think so. I will just tack on one kind of follow-up to that. Does it change at all the way you kind of looked at it pro forma EBITDAR coverage when you're looking at a SNF investment? Do you look for any extra cushion or not necessarily?

I think it probably doesn't because our expectation is that whatever the current performance is, that any changes that are made, they are going to take advantage of and probably do better with than by way of capturing more occupancy market share being more efficient in the selection of the patients that they have coming in, which a good operator can do. And it is really not just about what is coming in on the top line. It is what is going out on the bottom line. And as these payment systems shift toward more bundled payments, there is going to be better discussions about what the appropriate setting for delivery, in particular carriers, and a huge part of that discussion is going to be for the SNF operator, for example, is, is that patient going to be profitable for me. And that is nothing new for SNF operators in our portfolio and across the country who, if they are paying attention to their business, have always asked that question before they admitted any patient.

Jonathan Hughes, Raymond James.

Congrats on the quarter and congrats on the spin out. Just wanted to ask, I know your revenue exposure to Ensign has dropped significantly after the Liberty deal that you mentioned earlier. Curious as to what your long-term target exposure to Ensign, given you guys do love their -- love them as an operator. Just curious where you see that going over the next several years.

Jonathan, thanks for the question. We have been real clear from the beginning that our long-term objective for all of our tenants is to have no tenant who is over -- no tenant concentration over 20% of rental revenues, and that is certainly true for Ensign. That is a bittersweet thing for us because we think very well of those guys. We don't think there is a better operator in the country. They are -- if you had to pick one operator to have in your portfolio, they would be the one any REIT would pick.

But, that said, we understand that the market would love for us to diversify our tenant base, and so we are doing that and doing our best to grow with other rate tenants who follow similar models and have similar levels of sophistication.

Okay. Do you often find yourself bidding against them for properties? I think I saw they acquired something like 40 assets -- SNFs and senior housing facilities this year. Just curious if you see them going after the same properties.

Not very often, surprisingly. There have been a couple of instances where we have tripped over each other, but we are separate and independent, and we have kept a pretty good wall between us so that we don't always know when we might be competing against them for an asset. But we don't generally look for the same kind of classes that they are looking for. Ensign has done very well historically, and I can only say this -- not having been there for almost 18 months, I don't profess to have any expertise on what their current state is, what their current approach is.

But, historically, Ensign, when I was there, was buying mostly distressed assets, turnaround opportunities. They are very opportunistic buyers and have been extremely good at that. And I think they continue to do that to a large degree, if not entirely. By contrast, if you are looking for more stabilized assets, we love assets that are stable, but have some upside left in them for our incoming operators or sale-leaseback partners. But, by and large, it is really two different kind of assets that we and they are looking at.

Okay. And then, switching gears a little, looking at the dividend going forward, obviously it is very well covered today. What is your expectation to grow this in the coming years?

Hey, Jonathan. It is Bill. Yes, over the coming years, we would expect to grow the dividend as we grow our FFO and FAD. But changing the payout ratio over the short-term will probably keep it around where it is, which is most conservative in the sector because we just find that we can redeploy that and create greater shareholder value over time by investing in our pipeline.

Yes. Totally agree. Just was curious to hear your thoughts there. And then, one more and I will jump off. As you grow over the next several years, do you have any plans to maybe provide more disclosure in your earnings releases or maybe even a quarterly supplement?

Yes. I would look to -- last year, we completed our first investments in Q4. So this upcoming Q4 we will have all those new investments in the portfolio for over 12 months. So I think around Q1 is when we will start doing a supplement.

Okay. That would be great. Very helpful.

Chad Vanacore, Stifel.

So I apologize if I missed this. You were talking about coverage before. Can you give us what your Ensign coverage and your portfolio coverage is?

The Ensign portfolio for the 12 months ending 6/30 is 2.0 times, and the rest of the portfolio is at above our underwriting levels for each of the deals that we did. I don't have a blended, call it, weighted average coverage today.

All right. And then, you were describing your pipeline as well. And I apologize if I missed this, but as far as single assets versus small portfolios, what is the mix there, and what is the mix of new operators versus existing that you are evaluating?

Just looking at the portfolio. This is Greg. The mix of new operators, there is probably one, two, just kind of looking at this. There are a couple of new operators in the mix, so a lot of it is going to existing operators right now.

What was the other question, Chad?

Oh, just a mix of single assets versus small portfolios that you are evaluating?

Well, a lot of it is single assets, but there are some small portfolios in there, too.

All right. Then, you also mentioned in your comments about changing G&A. How should we think about a run rate G&A going forward on a dollar basis?

Between 10% and 11% of total revenue.

Michael Carroll, RBC Capital.

Hey, Greg. Can you give us an update on the Liberty portfolio transition? Is Pristine up and running with operations on those assets?

Yes, those guys were really well positioned to hit the ground running when they took the thing over. I had a long conversation with Chris Cook earlier in the week. Just got an update from him. And they are doing really well. They have hit a few bumps, as you always do, but nothing they didn't anticipate and have just run right over everything. I really am very happy and optimistic about their prospects.

They have only been in now for just over a month. One of the big hurdles that they were going to have was getting their licenses approved by the state, which comes a little bit after you take over and their Medicaid payments floating back, which comes well after or sometimes up to 90 days after the transition. And it looks like they may have those Medicaid approvals here in the next week or so. So that is just a real coup for them.

So they are healthy. They are happy. They are working hard. They are well. And I don't mind telling you that we are working on a tack-on already for them.

Okay. And then, how long does it really take for them to start implementing their own operational efficiencies into those assets?

Well, I think that is a really complex question. Maybe I should let David or Mark weigh in on that because -- Dave, can you answer that?

Sure. It is a complex question because there is a lot of levers, both from the top line and expense wise. This portfolio, though, was pretty well run on a cost basis. So luckily, they don't have to come in and right-size departments and cause cultural trauma at the facility level with cutting staff or anything like that. If anything, they are going to be adding some resources that were absent before. And those resources come mostly on their support structure level with expertise and technology, marketing, rehab, nursing and finance as well.

So that -- those efforts to improve those -- the overall operations and the top-line performance are underway. I think we will start seeing results of that soon. In the first two or three months, we should start to see skilled census start to tick up just a touch, which, the way this portfolio has been operated in the past, just a very modest tickup in skilled census or even a little bit of Medicaid census will have a significant impact to the lease coverage there.

Okay. Great. Thanks. And then, I guess last question. Maybe, Greg, can you describe what percentage of properties within the current investment pipeline would require you to bring in a new replacement operator? And are those mostly skilled nursing facilities, or do you have some of those for the senior housing communities, too?

Let me just count up. It is about 80% new operators in the high percentage deals that we are looking at. What was the other question?

Are those mostly skilled nursing facilities where you are placing operators, or do you have some of those first in the senior housing communities, too?

Senior housing as well. Mark said before that the current high percentage portion of the pipeline is about 60/40 seniors housing and skilled nursing, and the one operator that we have who would be a sale leaseback operator is the same operator staying in is -- represents about a third of the seniors housing portfolio.

Jordan Sadler, KeyBanc.

First one is just on senior housing. Could you maybe talk a little bit how you are thinking about the supply that we are seeing in the space and whether or not -- or how you judge the potential impact?

Yes. There is a lot of chatter about the supply issue, and if you look at the deals that we have done, these are assisted living that are in secondary markets, but that are also, like Mark alluded to, more on the high quality, yet affordable, housing option. And what we see on the new supply coming online is really -- the bulk of it is in the high price point area.

And so being both in secondary markets but also being in that more affordable price point, the new competition really doesn't affect the occupancy of our assisted livings, particularly the ones that we have done recently and the ones that we continue to target going forward.

When you are looking at new supply, what type of range or radius do you look at relative to the properties you are looking at and your underwriting?

It really depends on the individual location. Because if you are in a more rural market, that might be a 15 mile radius. But if you are in a more dense populated place, that might be more of a five-mile radius, really depending on the different factors of the location. In some cases, there is a freeway 1 mile away and nobody crosses that freeway. Or a river, something like that. But those are each kind of general radius points that we would keep in mind, depending on how dense the population is.

That's helpful. And then, one for you, Bill. Just curious, I might have missed this on sort of overall liquidity, how you are thinking about it, and just maybe the ability to lean on credit to finance your investments in 2016.

Yes. So we just put these $300 million in secured revolver in place, and to fund the Liberty deal, we drew down about $45 million and used the proceeds from the equity offering to finalize that. But we have got $45 million on -- drawn on that unsecured. We have got another $150 million plus of availability today. And then, for every asset that we purchase, we will get about 60% credit to increase that borrowing capacity. So I think we have more than enough to, from a revolver standpoint, get through 2016.

Having just finished the equity offering, the lockup has expired. So we will probably be looking at an ATM option as well.

Okay. And as it relates to G&A, you mentioned potential SOX impact, 404(b). Can you quantify or give us a range of what something like that might go for? Is it like $1 million or $2 million annually? Is that about the right way to think of it?

Not for us. I think it would be something -- maybe even half of that. But we will have some startup costs in the first year of implementation, just call it implementation costs to get everything documented the way it needs to be, and then you will have an ongoing run rate increase. But for a company like us and how simple we are, I wouldn't expect in the year of implementation to be more than $500,000.

Okay. Last one for you is just on the GECC mortgage that you have got an option to repay in January. Can you shed some light on that? Thoughts?

Yes. Well, we are just starting the process now, kind of looking at our options. We were out at [NICK] a few weeks ago, and there were a lot of HUD lenders there that would love to take a look at it. We could throw it into our line and free up a lot of -- even more availability under our line. I think the outlook on it is positive. I think we will see a decrease in interest expense on either of those options.

Yes, remember, Jordan, that it is not prepayable until January 31, and it is not actually due until June 2017. So we do have some optionality in terms of how we time and what we do with that.

And how would you think about that, Greg, in terms of now versus -- and I forget the structure? Is it do you have to do it now or in 2017? Or -- when I say now, I mean January 31. Is it January 31 or 2017 or at any time between January 31 and 2017, and how would you think about it?

And then we can do it any time after January 31. And GE, soon to be Capital One, would love to roll that over for us. But we think that it needs to be done sooner than later because of the interest rate on half of that debt is fairly high, and we would love to capture the interest savings by going to one of the other alternatives?

Do you have to do the whole thing?

No.

You could just do the half that is high?

Yes, but it doesn't make sense to do the half because we are not getting credit for the asset value, then?

Okay. I got it. And you would look to do something with term -- some more term?

Well, I think one alternative would be to take those assets to HUD where we could get something around a 4% 35-year fixed rate on them, which would be nice to put them away that way. But that is not the only alternative we are looking at, and there is some brain damage associated with that alternative.

So, as Bill said, we are just starting the conversation about how we would want to deal with that, and there is a lot of ground to cover between here and that decision.

(Operator Instructions) Duncan Brown, Wells Fargo.

Just two for me. Forgive me if I missed this. A numbers question. Bill, the write-off of deferred financing fees, $1.2 million, where is that embedded on the income statement?

It is in interest expense.

It is in interest expense.

Yes.

Okay. Thank you. And then, just post the equity offering, your leverage is down 5.2 times. You mentioned using a revolver for M&A going forward and then also considering an ATM. How should we think about the leverage -- longer-term leverage target and how high you are willing to take it over the intermediate term?

Well, I think we have always said that we like our leverage to be around 30% to 40% of debt to enterprise value, and our fixed charge coverage ratio between 3 and 4 on our debt to EBITDA between 4 and 5 times. But we are not looking to get there all in one jump. It will be a gradual glide to get there. So I can see us using, especially given where the equity markets are today, probably utilizing our line predominantly to fund this next wave of investments that we hope to make.

Thank you and I am showing no further questions at this time. I would like to hand the call back over to management for any closing remarks.

Well, thanks, everybody. We really appreciate you being on the call. If any of you have questions, I think most of you know where to reach us, and we are happy to continue any conversations. Thanks, again.

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Have a great day, everyone.