CareTrust REIT Inc (CTRE) 2016 Q2 法說會逐字稿

Welcome to CareTrust REIT's second-quarter 2016 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 the environment in which it operates. These statements may include projections regarding future financial performance, dividends, acquisitions, investment, returns, financings and 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 a more complete discussion of factors that could impact results as well as any financial or other statistical information required by SEC Regulation G.

In addition, CareTrust supplements its GAAP reporting with non-GAAP metrics such as EBITDA, adjusted EBITDA, FFO, normalized FFO, FAD, and normalize 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 securities laws CareTrust and its affiliates do not undertake to publicly update and revise any forward-looking statements where changes arise as a result of new information, future events, change in circumstances or any other reason.

Listeners are advised that the Company filed its 10-Q and accompanying press release yesterday. Both can be accessed on the Investor Relations section of CareTrust website, www.caretrustreit.com. A replay of this call also be available on the website.

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

Thanks, Ashley, and thanks everyone for being on the call today and good morning. With me are Bill Wagner, our Chief Financial Officer; Dave Sedgwick, our Vice President of Operations, who joins us by phone from our East Coast office; and Mark Lamb, our Director of Investments.

During the second quarter and since, we continued our steady march toward the achievement of our long-term goals for CareTrust. As promised, we put all the funds raised in our $100 million follow-on that came at the end of March to work, closing $82 million of the $97 million in acquisitions we had under contract at that time and adding more. Since April 1, we've deployed over $120 million split about 58/42 between seniors housing and skilled nursing assets, all with the blended going-in yield of 9.1%.

We also expanded our tenant portfolio of 15 distinct operators and did tack-on acquisitions with two of them that strengthened our master leases with those tenants. Even with the $120 million in capital deployment, together with the March offering, we've reduced and held our credit leverage from 5.7 times in February to just over 5 times on a debt to EBITDA basis and about 36% on a debt to enterprise value basis now, which is well within our target ranges of 4.5 to 5.5 times and 30% to 40%, respectively.

This growth has further reduced our tenant concentration with Ensign, our former partners in blue chip principals tenant, from virtually 100% two years ago to about 56% of run rate revenues today. We remain very positive on their capabilities, commitment, and quality. You may have noticed that they reported last week that a few of their newest acquisitions have proved to be more of a challenging turn than expected.

We have seen them overcome similar challenges in the past. They know exactly what to do and they appear to be doing it with a sense of urgency that's always been the hallmark of their high accountability culture and operating model. Most importantly for our investors, we don't expect to see any material weakness in their most mature facilities, which are the ones in our portfolio; and in fact, their preliminary report to us on their Q2 performance indicates the coverage for Ensign portfolio has actually grown from 205 at year-end to 207 at 3/31 and now to 211 at June 30.

With the acquisitions last quarter and since, we've now crossed the $100 million milestone in run rate revenue. In the acquisition pipeline, which is as we predicted went a little soft in Q1 and early Q2, has come surging back. We're seeing a good combination of both portfolios and one-offs that we believe can help us beat last year's capital in the deployment market of $233 million.

We are committed to doing that as long as we can do it with great operators in good markets at yields that give us a superior spread over our weighted average cost of capital. This discipline serves us well to date and we remain committed to building a diversified and well-covered portfolio that will produce solid returns through both good times and bad. This discipline has also allowed us to increase our guidance.

Mark and Dave will fill in more details on all of this momentarily so I will just conclude by telling you that we're excited about our growth and progress to date and we are more optimistic than ever about CareTrust's future. Dave will first briefly address our new operator relationships as well as some broaden industry dynamics and opportunities; then Mark will provide some details on our growth in pipeline and Bill will conclude with the financials. Dave?

Thanks, Greg. Our Q2 deals continue to build on the same foundation and strategy we followed since our start, making smart investments in quality assets with exceptional operators at above average yields. The analytical process obviously goes into great detail but our underwriting discipline always begins and ends with choosing the right operator.

In Q2, we welcomed two new operators to the CareTrust portfolio: Premier Senior Living and Cascadia Healthcare. We look forward to growing with both of these groups. Premier has senior housing operations in five states and their CEO Wayne Kaplan has been a pioneer in assisted living. Cascadia Healthcare is an Idaho-based, up-and-coming skilled nursing company that we know very well.

Owen Hammond and his partners are fellow Ensign Group alumni. They've got the combination of talent and mission and sophistication we look for in new operating companies. That's a combination that is more important now than ever in an always dynamic skilled nursing environment.

Speaking of the environment, some outside observers see skilled nursing ever-evolving reimbursement models as a significant headwind. We don't. Remember, it's not long ago that we were operators ourselves and like the exceptional operators in our portfolio, we see the expansion of managed-care, bundled payments, and other value-based payment systems as positive opportunities to gain market share and distinguish the great providers from the rest.

It's an attempt at meritocracy that is long overdue and it will benefit better providers. Remember also that our primary reason for CMS' efforts to improve efficiencies in post-acute care is to mitigate an expected significant increase of older patients on the healthcare system in the near future. So our overall length of stay may drop; patient volumes will eventually rise.

We believe that the best operators will capture a disproportionate share of the volume, both now and in the increasingly merit-based future. Fortunately, for attentive skilled nursing operators, CMS gives the industry plenty of time to prepare for such changes. For example, CMS recently announced that CJR, the lower extremity joint replacement pilot program that went into effect in limited markets in April, will expand next year to include femoral and hip fractures.

They also announced a new pilot program for cardiac rehab patients to begin next summer. The markets selected for the program expansion haven't been announced yet but this is more than enough time for good operators to get ready. Our operators are prepared for these changes and more.

As our tenants strengthened their clinical programming, whittling down their length of stay, reduced the readmission rates and communicate better up and down the care spectrum, they are gaining market share and seeing overall performance improve. And please note, at the same time that CMS is expanding the value-based payment pilots, they have also announced the 2.4% increase to the Medicare rates for fiscal year 2017, one of the healthiest increases we've seen in years and this also portends good things for good operators.

So to conclude, we're in regular communication with our tenants about what we and they are seeing on the ground in their local markets and even though we happen to do more in the seniors housing side lately, we remain bullish on skilled nursing. Our plan is to continue taking advantage of our size and operating experience to invest in best-in-class operators in both asset classes who are equipped to thrive for years to come.

Mark will now give some color on our pipeline.

Thanks, Dave, and hello, everyone.

After $69 million first quarter that produced several new quality tenant relationships, we followed with $77 million in the second quarter that grew both the portfolio and the tenant roster even further. We have already added another $43 million in Q3, all at a blended going-in yield, including transaction costs of 9.1%.

As Greg mentioned, 58% of the new rental revenue from these investments will come from senior housing assets, with the balance from new skilled nursing investments. You will recall that we raised just over $100 million in a well-received equity follow-on right at the end of Q1.

We have now put all those funds and more to work, even though one of the investments we had pre-announced at that time, a $15 million single asset deal that was part of the $97 million then under contract did not pan out. We like the asset and the operator but ultimately chose not to pursue it due to concerns we unearthed in our property and tenant level due diligence, a reflection of the discipline that Greg just mentioned.

Nevertheless, we've replaced that deal with several others and our growth trajectory continues unabated. For example, in the quarter, we did tack-on deals for a couple of existing tenants, a two-building acquisition in Cincinnati for our operator, Pristine Senior Living and a sale-leaseback with existing tenant Twenty/20 management after it stabilized its facility in Bedford, Virginia, which it acquired a while back from nonprofit.

We then entered two new states, North Carolina and Michigan, picking up a total of six senior housing properties with Premier Senior Living, as Dave just mentioned. Finally, as Dave also mentioned, we pick up a SNF in Boise and leased it to Cascadia and since, we have done another deal with them at just before quarter -- just after quarter and.

As for the pipeline, it continues to fill. Please remember that when we quote our pipeline, we only quote deals that we are actively pursuing which meet our superior yield and coverage underwriting standards that you are accustomed to seeing from us and then only if we have a reasonable level of confidence that we can lock them up and close them.

We normally have around $100 million under serious consideration at any time. As we sit here today, that number is about 20% higher. Like our recent acquisition, the pipe includes a healthy mix of senior housing and SNF assets. While pricing remains aggressive for both skilled nursing and senior housing assets, we continue to find one-off and small to mid-size acquisition opportunities that fit our underwriting criteria, including a higher investment hurdle as we pushed two at the end of 2015.

In addition, we note that some of the large skilled nursing and senior housing operators are turning their portfolios and we believe there may be a few hidden gems in this dispositions that are better suited for best-in-class local and regional operators that we like to work with. So as Greg said, we continue to be optimistic about our chances in closing a few more transactions by year-end and we are starting to load the pipe for early 2017.

For the record, as we speak to today, CareTrust has 149 properties in 20 states and we are actively working with brokers, sellers and operators to source additional opportunities for growth nationwide.

With that, I will hand it to Bill.

Thanks, Mark.

For the quarter, we are pleased to report that normalized FFO grew by 95% over the prior-year quarter to $15.5 million. Normalized FAD grew by 88% to $16.5 million. Normalized FFO per share grew by 6.6% over the prior-year quarter to $0.27; and normalized FAD per share grew by 2.5% to $0.29.

Given our most recent dividend at $0.17 per share, this equates to a payout ratio of 63% on FFO and 59% on FAD which, again, represents one of the best covered dividends in the healthcare REIT sector. In yesterday's press release, we increased our 2016 guidance.

As you recall, our last quarter's guidance included the March equity offering and the projected $97 million of investments then under contract. We ended up closing on $82 million of these investments. We terminated one $15 million deal on diligence and we've added another $43 million since quarter end, all as Mark previously discussed.

We are now projecting normalized FFO per share for 2016 to be between $1.08 and $1.10 and normalized FAD per share to be between $1.15 and $1.17. This guidance includes all investments made today, including the ones closed after quarter and relies on the following assumptions. One, no additional investments nor any further debt or equity issuances this year. Our outstanding balance on a revolving line today is $103 million. Two, no rent escalations for any of the leases that would normally adjust in the last half of the year. Previously, we did not include a bump in Ensign's rent, but on June 1, the rent increased on an annualized basis from $56 million to $56.5 million and our total rental revenues for the year are now projected at approximately $92.2 million.

Three, the improved performance at our three operated independent living facilities which are now projected to do $300,000 in NOI this year. Four, recognition of interest income of approximately $600,000, down from $900,000 in 2015 because the accounting rules limit the amount that we can recognize on one of our preferred equity investments which capped out in the second quarter.

We recently closed on a new $2.2 million preferred equity investment which will bring in about $100,000 in the back half of the year. Five, interest expense of approximately $23.8 million, which includes the $326,000 write-off of deferred financing fees associated with the pay-off of the GE debt less February. In our calculations, we have assumed a LIBOR rate of 1%.

That plus the current grid base LIBOR margin rates of 185 bps on the revolver and 205 bps on the seven-year term loan make up the floating rates on a revolver and term loan. Interest expense also includes roughly $2.3 million of amortization of deferred financing fees.

And six, lastly, G&A continues to be projected at between $9 million and $10 million which equates to just under 10% of total revenues. G&A also includes roughly $1.6 million of amortization of stock [comp]. These amounts do include cost associated with our full-floor implementation as we did trip the market value risk at quarter and we will need to comply with full-floor this year.

As our credit stats on a run-rate basis, as of today, following our Q3 acquisitions, our debt to EBITDA is approximately 5.1 times; leverage is about 36% of enterprise value and our fixed charge coverage ratio is approximately 4.1 times. We also have $5 million in cash on hand.

Lastly, and as Greg mentioned earlier, in addition to the ratings upgrades we got from S&P in March, during the quarter, we also got the anticipated upgrades on both our corporate and bond ratings from Moody's, which obviously helps lower our cost of capital over time.

And with that, turn it back to Greg.

Thanks, Bill. We hope this discussion has been helpful for you. We are grateful for your continued interest and support and we would be happy to answer any questions you might have. Ashley?

(Operator Instructions)

Jordan Sadler, Keybanc Capital Markets.

Hi, guys, this is Jeff Gaston on for Jordan. How are you doing today?

Hey, Jeff.

Hi, my first question is regarding the SNF transaction market. On the Ensign call, their management team was talking about how pricing is getting aggressive and they've had to pull back a little bit. And you mentioned earlier in your prepared remarks that you're seeing some aggressive pricing as well, but can you give a little more color around that, and where you see opportunities?

Sure, this is Mark. We're seeing -- it's really kind of a mixed bag. If you look at geographically, that's probably the best way to look at it, Florida, California, and Mid-Atlantic, Northeast and Northwest are really very, very kind of aggressive. You will find CON states kind of higher barrier-to-entry markets there.

So on a portfolio basis, we're seeing some stuff, and it typically is going to trade at a premium, but there are small, one-off and single-asset sales that are still out there that can be found. It's just a matter of going out and finding them, and figuring out if they hit our underwriting and pricing metrics.

So overall, there is a decent amount in the market. And it is fairly aggressively priced, but there are some gems in there that we have found and think that we will be able to continue to find going forward.

Okay. You said -- I think you mentioned that your pipeline is about $120 million and that it's a healthy mix. Could you give any more color around the mix? Is it 50/50? Weighted a little more towards SNFs or senior housing?

Yes, it's probably slanted a little more, call it 60/40, SNF to senior housing. Obviously, this is a little bit of a moving target since what we quote is transactions that are far enough long that we feel pretty comfortable, and this can change at any time. We've, in the past, seen transactions -- buildings or deals that we've bid on and maybe have lost initially that have come back around. So it's a little bit of a moving target and this is where the snapshot is today.

Okay. Thanks, and I guess one last quick question -- year to date, I think your deals have closed around 9%, 9.1% initial cash yield. I guess in the context of the aggressive pricing, are you seeing deals in that range now? Are you anticipating that comes down a bit? Any color you could provide around that would be helpful.

Jeff, this is Greg. We're still seeing deals that are up in that range. And as we mentioned in our last call, at the end of the year, we pushed our underwriting standards up a little higher than they had been last year. And so that's really what we are looking for and looking at.

The 9.1% you are seeing is probably mostly a reflection of the fact that we've got a larger mix of seniors housing in the portfolio lately than skilled nursing. And I think last year we were closer to 9.3%. But no, to answer your question, we are finding plenty of stuff that's worth looking at, and that we think we can close.

Interestingly, while some of the pricing is aggressive, it seems like there's a lot of sellers out there who are just on fishing expeditions who are throwing out big numbers, seeing what sticks, and we just stick to our discipline. And in some cases, it goes to somebody else and that's okay, and in some cases, it goes to nobody. They just decide to keep them, and in other cases they come down to our price, and we've just seen some of that come down to our price to our benefit, and we expect that to continue.

Awesome. Thanks a lot. That's all I have this morning -- or this afternoon.

Chad Vanacore, Stifel.

Hey, this is Seth Canetto on for Chad. How are you guys?

Good.

First question, I just wanted to get some more color on your larger deals at the end of 2015, beginning of 2016, specifically Pristine and Trillium in Ohio and Iowa. Are those guys performing as expected? Can you give some additional color there?

Yes, this is Dave. Actually just touched base with Rich Mason at Trillium yesterday, and just high-level feedback from him was very, very positive. Their census in Q2 and revenue in Q2 was higher than they were anticipating. It's one of the best Q2s they have experienced since being an operating company, and so we're really happy with how that's going.

And then Pristine, we did the two add-ons in the Cincinnati area, and those are also on track. They are going to do quite a bit of CapEx renovation work in those two buildings, which was always part of the plan when we acquired those, and so that's what they are preparing for there.

Okay. Great. And then just thinking about how you guys look at your relationships with operators, it seems like you have a good mix, but would you rather grow and expand existing relationships, or are you still trying to continue building new ones? How do you guys really view that?

Yes. (multiple speakers) Sorry, Greg. We're looking to do both. This is Dave.

We are still young and small enough to be on the lookout for more great operators in some of the markets where we haven't grown yet. Luckily, some of our operators are enthusiastic about going into new states. But depending on the deal, it might make more sense to enter a new state with an operator who's already there. In some cases, it doesn't make -- it's not that big of a deal if the deal has enough scale where you're basically acquiring the infrastructure.

But yes, we are really looking for both and we have experienced both. We just added two new operators in Q2, and we've also grown with existing operators in Q2, and we expect that to continue to be the case for the foreseeable future.

All right, great. And then when you guys mentioned -- I think you ratcheted up your underwriting criteria a little bit, and in particular, that one deal that you guys terminated. I guess, can you provide any color on what you saw when you did your due diligence that made you want to not complete that deal?

This is Greg. I think we can. Without saying anything I shouldn't say, it really wasn't about the dollars and cents. It came down to a totality of everything. The asset itself needed a little more CapEx than we had anticipated.

The operators -- we actually looked at two different operators, but that one very, very closely, and actually worked very hard to pull them both in. We liked them both, but we did not like their corporate structures or the security that we were going to get for that deal. And so ultimately, we just decided to move on to greener pastures.

All right. Great. And then just one last question -- this is just for my clarification. On the Ensign portfolio coverage, you said there was no impact by the weak Q2 because you guys own their mature assets and they were just having trouble with their new ones; correct?

When they had their -- on their earnings call, and you can go back and listen to it, they indicated that the new acquisitions of which they've done a very substantial number, more than ever in their history, had been a distraction across the whole organization. So when we heard that, we were initially a little bit worried that maybe ours have been impacted. So we went and asked them -- show us where you are.

And we usually get their coverage numbers on a quarter lag. So we would normally be reporting just Q1, which had gone from 205 at the end of the year to 207. But we asked them for Q2, and they were able to generate it, and it's actually gone up to 211 now, which is a pretty solid jump for that portfolio. So even though they may be reporting that there was some distraction and impact beyond the new acquisitions that they are working very diligently on, we not only didn't see it but we saw good performance in the facilities in our portfolio.

All right. Great, that's it for me. Thanks a lot.

You bet.

Jonathan Hughes, Raymond James.

Hey, good afternoon, guys -- or I guess good morning on the West Coast. Question for Greg or Mark -- you mentioned you're on track to surpass last year's $233 million of acquisitions. How should we think about that as we head into 2017?

You said the pipeline is about $120 million, but should we be modeling some monthly dollar amount of acquisitions or, say, a 10% growth in assets each year? Just trying to get some more color there.

Jonathan, it's Greg, and it's so hard to answer that question because the acquisition pipe is so lumpy. We do have a good, solid $120 million worth of stuff we're working on. As we sit here at the beginning of August, it's really hard to tell on some of the larger deals how soon they can close. Small deals we can close a little bit faster, as a rule.

I think we'll make the $233 million. I can't guarantee it. And we could blow right by it, if one of the larger deals we're working on closes.

But I just -- there's no way to tell you exactly how much to model through the rest of this year or for the beginning of next year because we just -- we don't know what will fall and we can't predict when it will fall. But we have been pretty steady, and we are optimistic that we will get those done. And we will do them at the right time, whenever that is for the deal.

Okay. Of the $120 million currently in the pipeline, are most of those the small deals or is there maybe a portfolio deal close to -- closing that you felt comfortable including in there?

There's a big deal in there. And we are not close to closing it.

We've got proposals out. We are in second round on a big deal that we feel that we are optimistic about, and we will just see how that goes. There's other stuff that could come in behind it as well that we are closely tracking.

So it's very fluid at this point, and we're just -- if it makes sense, we will do them. We've got plenty of access to capital. The team is rested and ready, and there's no reason why we can't knock these down if the sellers are willing to do their part.

Okay. And then, last quarter you gave some leverage guidelines, but could you maybe talk a little bit more about the types of debt financing you're looking at, whether it's unsecured private notes, more bank debt or term loans? Obviously, the term loan issuance was a pretty attractive price, but also any color where you think you could price those debt instruments in the current environment would be helpful.

Sure, hi, Jonathan, it's Bill. I think you will continue to see us utilize the line. The line is we have $400 million that we can take it up to.

We also, just in Q2, closed on doing -- we have the ability to issue under an ATM program now. We didn't issue any in the second quarter, but that on the small single, call it, single and double type investments that we are targeting. A mixture of the line, as well as the ATM, would be a good way for us to finance it and keep our leverage stats where we'd like them to be.

Okay. And as far as those one-off acquisitions, would you target say 30/70 debt equity use of line versus the ATM?

Yes, I think those are pretty good right now -- 70 equity; 30 debt.

Okay. And then just one more -- looking at the sensitivity of your skilled nursing operators to Medicare, have you guys looked at this and kind of stress tested the portfolio? I know Ensign is about 30% Medicare for that whole company, but what about the rest of the portfolio in terms of exposure to Medicare?

This is Mark. What I would tell you is, the acquisitions that we did post-spin, most of those SNFs were largely Medicaid. And so the exposure to Medicare is going to be fairly limited. There were maybe one or two that had a little higher of a quality mix census, but for the most part, almost every single acquisition target was 80% plus Medicaid. So they are in the process of building their Medicare census, not seeing a decrease in it.

I'd just add this, Jonathan -- you probably saw the announcement yesterday that we [took down] a four-building portfolio in California Central Valley that's tenanted by a company called Covenant Care that's based here in Orange County. We know those guys fairly well.

We spent about an hour on the phone with them yesterday, and they report that while their length of stay has been steadily dropping through the latest changes in the reimbursement systems, their number of admissions and discharges has increased significantly, and their Medicare days have stayed about the same. And we think that's what we're going to see with the more sophisticated, better quality operators.

We certainly have already seen it with Ensign. We've seen that with Covenant Care, which is about a 50-building operator.

And to the extent we have more Medicare in the portfolio, we have sophisticated operators who know what they're doing, and who will reach out and try and capture market share that way. So we're not doing hard-core analysis around it, but we are asking the questions and we are getting the answers, and they are telling us that they are doing fine.

There's really two things, Jonathan, just to add to that -- this is Dave -- that sort of mitigate the risks that bundled payments and those types of programs present. One is the whole reason these are being introduced, which is the demographics. That, and a narrowing of networks that those programs produce will be -- we'll continue to do what we've already seen at the Ensign group, which is we'll drive more market share to the better providers.

So we feel pretty good about where the Medicare census overall is headed. We have seen projections that show that in spite, even with BPCI initiatives factored in, that because of growing Medicare enrollment, that the Medicare SNF days will continue to grow.

And we're filtering for those -- that sophistication, those capabilities, as we look at and initiate new skilled nursing provider relationships.

And just to beat the dead horse, a lot of our portfolio also is in rural markets, where bundled payment initiatives are not a factor, where CJR is not in play, where the cardiac rehab stuff will probably not take shape anytime soon. And so that also gives those guys extra time to get ready.

Okay. Thanks for all the color, guys. That's it for me. I appreciate it.

Michael Carroll of RBC Capital Markets.

Hey, guys. This is actually George Clark on for Mike. Given that you acquired more senior housing assets than SNFs this quarter, are you kind of shifting your focus more to senior housing? Or were these just good opportunities that you guys took advantage of?

Yes, George, thanks for being on. This is Greg. No, we're not switching our focus. We remain, as ever, asset class-agnostic, and continue to go where we can find the best risk adjusted returns.

It just happens that this quarter we found a fair amount of seniors housing that we really liked. It's mid-market, blue-collar stuff that we think has good, long expected life, and that's what we did.

Next quarter, that could be flipped and we could do largely skilled nursing. In fact, Q3 deals have already included a fair amount of that. So, no change in focus or orientation.

So do you expect to do the 60/40 split going forward? Just mimic the pipeline (multiple speakers) --

We're just going to take it as it comes, and we understand that there are some folks that would very much like to see us diversify that portfolio down and away from skilled nursing to some degree. But remember, we were skilled nursing operators for many, many, many years. And we feel very, very comfortable in that arena, and feel like we can do a very good job of vetting skilled nursing operators, and keeping up with changes in the skilled nursing environment, as we discussed today and making sure that the investments that we do are good, solid, sound investments that will pay the rent.

All right, and then, could you just provide an update of the coverage in your portfolio, typically, at Liberty and maybe provide some color on the covenant coverage ratios?

Yes, I'll just tell you that Liberty, in particular, we closed on October 1. And we did so with full expectation that that portfolio's coverage would dip, as our operator, Pristine, takes that portfolio from what it was, basically pure Medicaid shops that were heavily reliant on the Medicaid skilled work to -- and making it a more modern, high-acuity Medicare, HMO, private focused model.

They are doing that very well, but in order to do that, they have to ramp up staffing. They have to implement new systems. They have to buy -- they have to invest in electronic medical records.

And in doing all that, and so they have -- in terms of their coverage covenant, they basically have a pass for the first year. I talked to Chris Cook at great length on Friday, and we discussed, among other things, his coverage. He is still well above 1.0; I think he's about 1.1. But he's actually doing everything that he promised to do and that we expected him to do and that he needs to do in order to set that portfolio up for good, solid, long-term success.

The rest of our operators -- if you look at the Covenant Care assets, the four assets we just bought on Friday, the going-in coverage on those was roughly [1.85], and we bought leases in place and those are going to be very, very solid for us, and of course, the Ensign coverage continues to decline. So we're pretty happy with where the coverages are.

We expect to give you more color on those coverages on a regular basis as we start to publish supplementals in connection with our quarterly releases. We did a dry run this quarter, and putting one together, just to make sure we had all the bugs worked out and can produce these consistently and deliver a useful -- a user-friendly product. And we feel very good that we expect to be able to start issuing supplementals next quarter that will have all that kind of data in it.

When we do, so you know -- when we report coverages, we -- for the first year after an acquisition, because some of the acquisitions we do, we do re-tenant, and we do expect them to change certain things in the acquisitions even though they are stabilized. We expect to just report the going-in pro forma coverage for the first year until they start producing their own -- until the new tenants start producing their own results. So we will explain all that when the time comes, but in the meantime, everybody's rent is coming in without any problem.

All right. Thanks, guys.

You bet.

(Operator Instructions)

Duncan Brown, Wells Fargo Securities.

Hi, guys. You touched on something I wanted to talk about, about the rural portfolio. I wonder -- I think Dave was talking about it. Can you give us what percentage of your portfolio you would describe as more rural than urban?

We would probably have to get back to you on that, Duncan, and we'd have to make some judgment calls in that. Nothing is really completely out in the sticks, but there are some smaller markets, particularly when you get in the Iowa portion of the portfolio. But we've never actually broken that down and said this is metropolitan, this is rural.

Sure. Well, I guess maybe to phrase it differently -- I'm sorry, Greg. I didn't mean to cut you off.

No problem.

I guess maybe to phrase it differently, I think the comment was that they have more time to implement some of the bundling requirements than the more urban locations. And if you need to get back to us on this, that's fine, but do you have any sense of what percentage of the portfolio that would be that has more time than others? Does that question make sense?

Yes, it does make sense. One way of answering it is just looking at what we currently have that are in CJR markets, and what we have as of, I think, June 1, was we had 27 facilities in eight CJR markets. And so the rest are not, which -- that's a goalpost for you, I guess.

That's perfect. That's helpful.

And then I guess some of this is topical in healthcare these days -- tight labor market. Are any of -- or an increasingly tight labor market -- are you hearing anything from your operators on that front or any trends you could care to highlight?

Yes, we do, starting really just in the last few days we have heard that from our operators. We heard Ensign talk about it on their earnings call, and they outlined, I think it was Arizona, Texas, Idaho, Utah, parts of California, that they were seeing some labor pressures. Trillium is seeing some as well for the first time just this last month. And what that kind of means in terms of dollars and cents is Trillium kind of agreed with how Ensign characterized it on their call, which is that you would normally see about a 1% to 2% increase in labor costs a year, and they would expect that to be slightly more now in those markets where they are feeling it.

Okay. For you all then, the thought process would be still very manageable, even if it's in that 2% to 3% range or 3% to 4% range, just given the coverage ratios?

That's right.

Great, and the last one for me -- on the last call, you gave us some interesting color around the star rating of current portfolio, and I guess I'm curious, the recent acquisitions that you've done, I wonder if you can give us flavor what their star ratings are? And I guess I'm just trying to get a sense of, when you're looking at M&A, how important is that, and how does factor into what you guys are thinking about?

Duncan, this is Greg. Every acquisition we've done in Q2 and Q3 to date -- every SNF acquisition we've done has been three-star or above. That's not to say we wouldn't buy a one or two star. When you get out again in some of those rural markets, star ratings matter far less than they do in more competitive markets. But we are again partnering with operators who understand the system and are maximizing it to their benefit.

Great, thank you.

Paul Morgan, Canaccord.

Hi, good morning. Bill, you mentioned that you don't include rent bumps that haven't yet taken place, in your guidance. Are there any meaningful ones in the second half that aren't being reflected in the range you gave?

Well, all our leases coming up for rent bumps in the second half of the year are CPI-based, and CPI has been so low this year that we just have chosen not to put, call it, a minimum CPI bump in there for anyone.

Okay. So there's nothing that's kind of not being reflected that might roll in, in the second half on a same-store basis?

Well, like the Pristine lease, it's up for renewal on October 1. So that's a $17 million lease, annualized rents, so some small percent on that might matter a little to the numbers, but we just chose not to put it in there.

Okay. And then on the -- I think you said there was $103 million on the line of credit; is that right? Is that the current number?

That's correct, as of today.

Yes, where are you comfortable taking that before you look to term it out or take it down?

I'm very comfortable taking -- putting another $100 million on it, easy. That's only -- that only gets us to $200 million of the $400 million that we have available.

Okay. Great, and then just thinking about your portfolio from a geographic perspective, you talk about moving into new states, and I'm just wondering, as you look across what you've got now and where you would like to be, are there holes that are target markets for you? How much, in terms of -- as you look at acquisition opportunities, is that a consideration versus just tuck-ins in the regions with your existing operators?

I would say, just as we've looked at a couple hundred different deals this year and underwritten, we would love to be in the Mid-Atlantic CON states. We don't currently have a presence up in the Northeast. And then, even to an extent, we would like to grow our footprint in the Northwest. We have two really good operators, one being Cascadia, and the other being Five Oaks, that we would love to kind of grow that footprint even further.

So those are states that we really, really like, or those geographic regions. But as you chase transactions there, the pricing certainly is more aggressive, so we -- if it fits our criteria and it happens to be in one of those states, we would be all over it.

And kind of the flip side of that then is -- are there states where you have less appetite right now, either because of your current exposure or because you just don't find the operating environment very attractive?

Yes, this is Greg. Paul, the answer to that is yes. We have a fairly high concentration in Ohio right now. We're being very careful about looking at adding more there in the near term.

We also have identified a few states where the regulatory or litigation environment is just enough that we are not terribly interested in going there. We haven't completely red-lined them. We see lots of deals there that we don't really -- we haven't really been interested in states like Kentucky, for example.

But most of the rest of the country is wide open for us, and we're looking at deals all over. As Mark mentioned, we have underwritten over 200 deals already year to date, and they keep flowing in.

And just kind of lastly on the SNF side, is there a decent overlap between those more targeted states and what you think might be coming to market from the other REITs, and specifically maybe related to Genesis?

We have seen a little bit of Genesis come to market. The more interesting parts of it were in Ohio, and as I just mentioned, we kind of didn't feel like we had a lot of additional interest or capacity for that state, it being, I think, one of our larger now.

We're waiting for the next wave to come out. We think that they have some outliers in the portfolio that could fit very nicely into some of the portfolios of our existing tenants and others that we know out there who we would like to partner with. So we will look when they come and see how they are.

We don't think that there's anything inherently wrong with a lot of those Genesis facilities. We'd look at them -- we would look at them on a facility-by-facility and market-by-market basis. And if we had an opportunity to re-tenant them, particularly something that, for them, has been difficult to manage because it's just really far from their home base, that's kind of an ideal situation, in our view.

And these would be supplemental to the $120 million you said in your pipeline?

Yes.

Okay.

We're not looking at any -- from there right now.

All right. Perfect. Thanks.

Jonathan Hughes, Raymond James.

Hey, guys. Just had a quick follow-up to Paul's question. It looks like there was a different lease structure between GAAP and cash rent on the $31 million portfolio closed in June. Can you shed any color there?

Yes, you bet. The deal that we did in Michigan with Premier included one facility that was in lease-up mode, and so we gave them a bit of a concession that first, I think it was six months to a year -- I don't have it in front of me -- that in order to give them some room to lease that up. So that's why that's different.

Okay. So that should burn off beginning of next year, and the GAAP and cash will be the same?

That's right, and it's just a one-year, and it does produce a GAAP yield but it varies very slightly from what the actual cash yield will be starting year two.

Yes, I'd probably look at it this way -- in year one, rent is something, in year two it bumps, and then from lease years 3 to 15 it's CPI based. So, the accounting rules require us to straight-line that fixed bump over 15 years. So the GAAP and the cash in year two will be pretty close, but it will still be a little off, so you will see a straight-line adjustment in our FAD number going forward.

Okay. Thanks, guys. I'll follow up offline.

Thank you. I'm not showing any further questions in queue at this time. I'd like to turn the call back over to management for any further remarks.

Thanks, Ashley. Thanks, everybody, for being on today. You know where to find us. If you have any other questions, we welcome your calls, and look forward to seeing you next time we're out on the road. Take care.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may now disconnect. Everyone, have a wonderful day.