CareTrust REIT Inc (CTRE) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the CareTrust REIT Second Quarter 2017 Earnings Conference Call. As a reminder, please note that this call is being recorded.

I would now like to turn the conference over to Mr. Josh McLane, CareTrust REIT's General Counsel and Secretary. Please go ahead.

Thank you, Andrew, and good morning. Before we begin, please be 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, financing 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 our 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, during today's call, we will supplement our GAAP reporting with non-GAAP metrics, such as EBITDA, normalized EBITDA, FFO, normalized FFO, FAD and normalized FAD. When viewed together with our GAAP results, we believe these measures can provide a more complete understanding of our business, but they should not be relied upon to the exclusion of GAAP reports.

Except as required by law, CareTrust REIT 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 for any other reason. Listeners are also advised that, yesterday, we filed our Form 10-Q and accompanying press release and our quarterly financial supplement, each of which can be accessed on the Investor Relations section of our website at www.caretrustreit.com. A replay of this call will also be available on the website for a limited period.

At this time, I would like to turn the call over to Greg Stapley, our Chairman and CEO.

Thanks, Josh. Good morning, everybody, and thanks for joining us today. With me are Bill Wagner, our Chief Financial Officer; Dave Sedgwick, our Vice President of Operations, joins us remotely today; Mark Lamb, our Director of Investments; and Eric Gillis, our Director of Asset Management.

On the acquisition front, Q2 was a relatively quiet quarter for us, with $36 million in new investments at an average blended cash yield of 9.3%. Nevertheless, we were very busy laying the groundwork for the second half and for 2018.

So just a few highlights. First, following the execution -- or following the exhaustion of our previous $125 million at-the-market program in March, in May, we set up a new $300 million ATM. Demand for our equity has remained solid, and we raised roughly $64 million in Q2. Going forward, we intend to use the ATM primarily to match fund our smaller deals, which has been a very efficient way for us to manage our leverage while growing earnings per share.

Second, we refinanced our $260 million 5 7/8% senior notes with a new $300 million 5.25% bond issue. Not only did the increased size of the new issue keep our bonds eligible to be included in the widely used Bloomberg Barclays fixed income indices, more importantly, through the issue, we lowered our cost of capital and pushed those maturities out to 8 years.

Third, we monetized a significant asset, our preferred equity interest, in a newly developed AL and memory care in Arvada, Colorado, which was still in stabilization. This allowed us to receive and recognize some significant accrued interest in the quarter as well as realize a sizable gain on the sale. And while our standard practice is to normalize out the benefits of such onetime events when we calculate FFO and other non-GAAP numbers, we still have the cash proceeds to reinvest.

Last and perhaps most importantly, as you might have guessed from our almost $175 million in ATM activities since March, we have been quietly but diligently building our acquisition pipeline for the second half of the year. I'd like the team to tell you more about that, so I'll turn it over to them now starting with Dave.

Thanks, Greg. In Q2, we continued to execute on the strategy you've seen from us from the beginning, stringing together smaller deals from $2 million to around $27 million in size and placing quality local and regional operators into stable and near-stable skilled nursing and seniors housing assets. Each of these deals meets one or more of the goals common to all our acquisitions with our current operators, which include adding tack-on facilities to existing master leases, strengthening lease coverages, providing upside opportunities and expanding their local market share.

Importantly, our Q2 acquisitions again highlight our ability to take noncore assets from larger operators and place them in the hands of local and regional operators who can give those assets the time and attention they need to succeed. We welcome one new operator to the portfolio in the quarter, and we continue to foster relationships nationwide with good operators who have the combination of mission-driven culture and operating sophistication needed to capitalize on the ever-changing operating environment.

On other fronts, we've thus far allocated a modest amount of capital to a new asset development. Our first foray into development was a preferred equity investment in the Denver, Colorado area. Bill will walk you through the numbers, but I'll just say we were pleased to earn 12% interest plus a $3.5 million gain from the $7.5 million investment in just over 2 years. While we don't intend to start self-developing nor do we intend to make new property development a sizable feature of our growth strategy, we will continue to devote a small portion of our activity to helping top-shelf operators strategically develop new assets.

As we discussed on our last earnings call, our asset management team has been focused on our Ohio operator, Pristine Senior Living. We've seen progress in their operations and in their financial performance over the last quarter and into Q3. We remain cautiously optimistic that Pristine will continue on this upward trajectory, and we're monitoring their progress very closely.

We are also watching the other operations of our other tenants and are happy to report that all appear to be performing at or ahead of our expectations.

On the regulatory front, despite the drama in D.C., nothing has significantly changed since our last call. Medicaid is proving to be resilient against attempts to reduce its role in the health care system. Medicare is still delivering a 1% increase in rates for fiscal year '18, although they are proposing tougher penalties for skilled nursing facilities with readmission rates in the bottom 40%. We are constantly interacting with our operators to help them anticipate and prepare for these and other changes at the federal and state levels. Overall, our outlook for the industry remains positive, and we believe that the good skilled nursing and seniors housing operators, like the ones we have on board and the ones we continue to pursue, will not only survive but thrive despite any challenges.

So with that, I'll turn it over to Mark to talk about the acquisition landscape in general and our pipeline in particular.

Thanks, Dave, and hello, everyone. The acquisition market continues to be competitive for both senior housing and skilled nursing assets. Notwithstanding the competition, we've accumulated $106 million in good quality acquisitions year-to-date with great operators.

More importantly, we are seeing a pickup in the volume of opportunities coming across our desks with ad volumes skewed to a slightly higher amount of skilled nursing facilities on the market, ranging from one-offs to midsize portfolios. Active sellers include a fairly steady flow of mom-and-pops who would rather retire than continue to deal with the changes always taking place in regulation and reimbursement. There are also larger operators selling off noncore assets that fall outside their strategic footprints. And of course, you have the big publicly recognized operators who are exiting states and pruning specific assets within their portfolios.

For us, we are encouraged by the number of off-market and narrowly marketed deals we are seeing because we believe they validate our straightforward transactional approach and by operators, for operators philosophy.

Our current acquisition pipeline, which includes both on and off-market deals, significantly exceeds our normal $100 million range. We are currently working on senior housing and skilled nursing deals that if closed would bring in an additional $150 million to $175 million in assets by year-end. As we stated on our last earnings call, some of the transactions have already completed diligence and are merely awaiting licensure from their respective states.

In addition, the current pipeline includes some potential new operators to us as well as new states. Please remember that when we quote our pipe, we only quote deals that we are actively pursuing, which meet the yield and coverage underwriting standards we have in place from time to time and then only if we have a reasonable level of confidence that we can lock them up and close them. In short, we're optimistic about our prospects for the second half of 2017 and are even seeing positive signals for the start of 2018.

And with that, I'll hand it to Bill to discuss the financials.

Thanks, Mark. For the quarter, we are pleased to report that normalized FFO grew by 33% over the prior year quarter to $20.6 million. Normalized FAD grew by 32% to $21.7 million. And although our per share metrics were somewhat muted by the significant equity issuances under our ATM, normalized FFO per share still grew by 3.7% over the prior year quarter to $0.28 and normalized FAD per share grew by 3.5% to $0.30. Given our most recent dividend of $0.185 per share, this equates to a payout ratio of 66% on normalized FFO and 62% on normalized FAD, which again represents one of the best covered dividends in the health care REIT sector.

During the quarter, we refinanced our $260 million 5 7/8% notes due in 2021 with $300 million 5.25% notes due 2025. The excess funds were used to pay down our revolver. In our FFO and FAD reconciliations, we added back $12.5 million, which is made up of a $7.6 million redemption fee, a $4.3 million write-off of deferred financing fees related to the $260 million notes and $592,000 of interest expense representing the 14 days when both note issuances were outstanding.

During the quarter, we also sold a property in which we had a preferred equity investment. As a result of the sale, our initial December 2014 $7.5 million preferred cash investment generated an IRR of 28%. Upon sale, we received $13.5 million in cash represented by our original $7.5 million investment, accrued interest of $2.5 million and an additional cash payment of $3.5 million. The $3.5 million is recorded as a gain on sale on our income statement, and we recognized $1 million of interest income.

As you'll recall from prior quarters, accounting rules limited the amount of interest income that we could recognize on that investment. But with the sale, all previously earned but unrecorded interest was recognized. In our FFO and FAD reconciliations, we reduced normalized FFO and FAD for interest income that related to 2016.

Under our ATM program for the second quarter of 2017, we sold 3.4 million shares at an average price of $18.82, resulting in net proceeds of approximately $63 million. We used the funds to pay for acquisitions closed during the quarter and since and to pay off the remaining revolver balance. Our revolver balance still stands at 0 today.

In yesterday's press release, we revised our 2017 guidance. We now expect net income per share of $0.50 to $0.52, normalized FFO per share of $1.13 to $1.15 and normalized FAD per share of $1.19 to $1.21. This guidance includes all investments and all shares issued under the ATM to date, the weighted average share count of 73 million shares and relies on the following assumptions: one, no additional investments nor any further debt or equity issuances this year; two, no rent escalations for any of our leases beyond those made to date. Total rental revenues for the year, again including only acquisitions announced to date, are projected at approximately $114.9 million. Three, our 3 operated independent living facilities are projected to do about $400,000 in NOI this year; four, interest income of approximately $1.6 million; five, interest expense of approximately $23.6 million. In our calculations, we have assumed a LIBOR rate of 1.25%. That plus the current grid-based LIBOR margin rates of 185 bps on the revolver and 205 bps on the 7-year term loan make up the floating rates on our revolver and term loan. Interest expense also includes roughly $2.1 million of amortization of deferred financing fees; and sixth, we are projecting G&A of between $9.2 million and $10.9 million. Our G&A projection also includes roughly $2.4 million of amortization of stock comp.

As for our credit stats, calculated on a run rate basis as of today, our debt-to-EBITDA is approximately 3.61x, but our net debt-to-EBITDA is approximately 3.39x. Leverage is about 23% of enterprise value and our fixed charge coverage ratio is approximately 5.2x. We also have approximately $25 million of cash on hand.

With that, I'll turn it back to Greg.

Thanks, Bill. As always, we hope this discussion has been helpful to you. We thank you again for your continued interest and support. And with that, we'll be happy to answer questions. Andrew?

(Operator Instructions) And our first question comes from Jonathan Hughes with Raymond James.

Pretty sure I know the answer to these, too, but I think it's important to point out. Are any of your tenants currently near 1x EBITDA or rent coverage or subject to DOJ investigations? I realize half the portfolio is leased to Ensign, so it's really aimed more towards acquisitions over the past few years. And then maybe if you could update us on Pristine and metrics versus last quarter?

Okay, we'll do our best on that, Jonathan. It's Greg. To our knowledge, nobody in the portfolio is undergoing a DOJ investigation. You don't always know that. As an operator, you don't always know when the DOJ is looking at you, but we see no reason to think anybody would be. In terms of Pristine, I think what we said last quarter was that we thought their coverage was hovering around 1x. We believe that coverage has improved month by month. Maybe I'll just give Eric the floor to give you some color on that.

Yes. As you know, we've been working closely with Pristine and have been keeping a close eye on their progress. And really we've been able, along with Pristine, to be able to implement a lot of new programs and strategies. And happy to say that they continue to improve. In fact, they had their best period ever just this last period, and we remain optimistic about the future. And -- but still keeping a close eye on the situation and -- but that situation is improving every month.

Jonathan, was there one more question you asked in there?

Yes, also just Pristine relative to maybe underwriting. I think when you guys bought that portfolio, you were looking for a 1.3 coverage. I mean, is it getting closer to that? Or are we still around maybe the low 1.1 range?

A little early to tell. We -- you're probably right about that. We're watching it. The coverage, we're watching month-to-month. And the operations, we're watching day to day. But they are, as Eric said, on the upswing.

Okay. Thanks for the earlier color on the pipeline. Mark, it sounds like that's up from maybe $100 million or so last quarter. What's in there in terms of asset mix and cap rates? And does that include any portfolio deals?

Yes. So I would say the asset mix is predominantly skilled nursing. Cap rates are ranging from -- obviously, the senior housing component is in the mid to high-8s and the skilled nursing ranges anywhere between the low-9s and the mid-9s.

Okay. And then any portfolio deals in there?

There are -- there's some what we would consider smaller to midsized, 4, 5, 6 asset deals that are mixed in there.

Okay. And then I'll just add one more, and I'll jump off. But Bill, I saw a lot of ATM activity lately at pretty attractive prices. Are these mostly reversed inquiries asking to buy large chunks of stock? Or are they more open market transactions? And how should we think about this going forward in terms of utilization relative to overnights?

It's a combination of both. And as Greg said earlier, as long as our stock price is attractive, we'll use that to match fund some of these smaller deals. But our leverage is currently below our stated goal of 4x to 5x debt-to-EBITDA.

And to tack on to that, Jonathan, you asked about overnight deals. We would still do those to the extent that we had a larger deal or a set of deals that created a larger need than the ATM would normally support.

And our next question comes from Chad Vanacore with Stifel.

All right. So just thinking about your experience so far in your preferred investment in development, should we expect more of that in the future given your experience?

We have a couple of preferred equity investment projects underway in Idaho right now. We anticipate doing another one in Texas with some bed rights that we have down in Harris County over the next couple of years. But as Dave said in his prepared remarks, we don't expect that to be a major component of our growth program.

All right. And then just thinking about the acquisition pace, where are you at the midyear point in comparison to your goals for the year?

We're running a little behind, but acquisition -- deal flow is always a little lumpy. Last year, we got off to a very quick start. This year, we got off to a slower start. But through the year, we think it's all going to even out.

All right. So expect a ramp-up in the second half?

We certainly have been preparing for 1, yes, and are working for 1.

And our next question comes from Jordan Sadler with KeyBanc Capital Markets.

So come back to the pipeline. Reading the press release last night, I thought I might hear a bigger number than even though the $150 million to $175 million based on sort of how you've been laying the groundwork and just some of the commentary in there. Can you maybe elaborate on what the environment looks like beyond maybe that which is under serious consideration? So beyond the $150 million to $175 million, what are you looking at? Because I think you said that the pipeline is the biggest ever and you did one deal not that long ago that was larger than your -- or as large as your whole pipeline is today, so curious.

Yes. So Jordan, this is Mark. I would say kind of in the environment beyond our pipeline, we are seeing more transactions come across. There was kind of a lull over, I would say, kind of April, May, June, and we've started to see a huge pickup in July and over the last week. So we're seeing more deals, and we just continue to underwrite based on our metrics. And a lot of what we have in the pipe is transactions we've been working on since the beginning of the year. And so as you know, with skilled nursing, from the regulatory side, things can happen. And so it's just taken a little bit longer for these deals to get to the point -- get through diligence and then get to licensure. So we feel good with what we have in the pipe. And there is deals coming across every day that we feel pretty good about as we dig into them and underwrite them and present offers on.

Okay, that's helpful. And then the coverage sequentially, I may have missed this because I hopped on a little late, slipped about 5 basis points or so. I'm curious if that is a function of new additions to the portfolio in the quarter over the past year? Or is that a function of deterioration of fundamentals that you're seeing?

No. Actually, I don't think we see any deterioration of fundamentals. If anything, those are strengthening, particularly amongst those tenants about whom we've been most concerned lately, which is not to say there's a lot of those. But we're gratified by the progress that those tenants have made over the past quarter. Remember that when we came out of spinoff 3 years ago, we had one tenant, and the coverage was very, very high and going higher. And so as we continue to grow and layer in new acquisitions at sort of, call it, normal coverages, you're bound to see our overall coverage drop quarter by quarter by quarter. That's completely expected. So we're not too terribly concerned about the coverage at this time.

Okay. And then is that the same on the seniors housing front as it is on skilled nursing? Are you seeing any softness there? Or are you really just largely unaffected by sort of what's going on, on the supply front in that business?

We have one tenant who has stepped into some seniors housing assets fairly recently but have taken just a little bit longer to get to where we want them to be. But overall, they're doing just fine. They're not the only assets we have with them, and the rest of the seniors housing portfolio seems to be doing terrific. So the comment I made earlier was sort of an overall, the whole portfolio comment. But in terms of seniors housing, I think it's doing just fine as well.

And our next question comes from Paul Morgan with Canaccord Genuity.

Greg, you mentioned in your comments about the pipeline kind of laying the groundwork extending into '18, and just kind of wondering given we're several months away still, are these -- is there -- are these structured deals that for whatever reason might take 6 months or more to complete or portfolios -- or is it typical that midyear you'd have stuff that might take that long to transact?

Fair question, Paul. Without tipping our hand too much, I will tell you that the kind of deals that take that kind of time are usually larger portfolio deals that are off-market. And those can just take a little bit of time to work through and to get people aligned on. And so those are the kinds of things that we're seeing for the beginning of -- as we look out that far into the beginning of '18. They're longer shots. They're not in the pipeline number that Mark quoted to you at all. But they do give us a sense of optimism about the beginning of next year, which is about as far as our crystal ball allows us to see.

Okay, that's helpful. And then as you mentioned, you -- the pace of capital raising in the quarter ran a little bit ahead of kind of the investments. And I'm just wondering maybe, Bill, how you're thinking about where your dry powder stands for deals relative to where you want your leverage to be and given the size of your pipeline for the second half.

Yes. Given the -- with the cash on hand and the number that Mark quoted of what's in the pipe that could close, even if we put all of that on the line, the credit stats will still be well within the range that I quoted earlier in the call. So we feel very good from a dry powder standpoint.

Okay. Great. And just real quick, and I'm sorry if I missed this, but did you comment on the impairment in the quarter, what that was related to?

Sure. We had an asset within one of the master leases with Ensign that we knew at the beginning when we spun from Ensign that, that asset would eventually become obsolete. This was the quarter that Ensign wanted to shut it down, so we consented to them shutting it down. And in return, we wrote the property down to 0 because that property is going to be raised and demolished. But the lease that -- the important part of this is that the lease rate under that master lease did not change. So we're getting the same rent going forward, and that property was not earning any money. It was actually negative cash flow, so it actually helps strengthen our collateral.

But they actually took patients from that property and moved them to another one that they had in the same community to strengthen the other property. And we have retained the right to control the bed rights -- the properties in Texas where bed rights have value. And so we've retained that value, which was the remaining value of that asset.

Those were the same bed rights you mentioned earlier on the call about...

No, those are different -- they're actually different ones.

This is the second asset within the Ensign master leases that has closed, but no rent under these master leases have changed.

(Operator Instructions) Our next question comes from John Kim with BMO Capital Markets.

Your annualized rents with Ensign went up 2% this quarter. Can you just remind us, is that a contractual increase under the master lease?

That is not a contractual increase. That is a CPI increase, and it is a CPI not to exceed 2.5%. But I think the increase was around 2%, 2.1%, and it happened in June.

So every year in June?

Every June, it resets.

Okay. But most of your other leases don't have the CPI increase, is that correct?

Most of our leases, almost all have CPI bumps, not contractual fixed.

Got it. Okay. On the impairment this quarter, I guess, it begs the question what happens when this becomes obsolete? And in this case, the answer was there is no use for the asset or the land. I'm just wondering if that was specific to this asset and then also if there are any other assets in your portfolio that has this risk.

We're not aware of any other assets in the portfolio that are nearing the end of their useful lives. Every once in a while, you see one that will do that. But we actually have assets in the portfolio that are nearly 100 years old that are just -- that are kept up and doing very nicely that -- and you can do that with this. In this case, the asset was in a smaller community. There was another -- we have another asset in that same community. It was something we picked up as part of a portfolio transaction back at Ensign several years ago and always knew that this one was -- it was a converted motel. We always knew that this one didn't have long to live and really didn't deserve to be kept up or sustained in that fashion. And so as we went through the decision-making process on its closure, we just saw more value in moving the patients and some of the beds over to the other facility and then closing this one down. As far as any kind of residual value, it was our view when we researched this that the cost of actually preparing the property for sale is essentially scraping the existing facility that couldn't be really used for anything anymore, would exceed the value of the underlying dirt. So we just wrote the thing down, gave the problem to Ensign to fix and kept our rent and our beds where we wanted them.

Okay. And then just a clarification on the deferred -- preferred return. So is it correct that you've already received all the cash as part of this and you're just taking off from FFO what you've already recorded in 2016, is that correct?

Well, we have received all the cash; it closed in May. And in the -- and as part of that, we recorded $900,000-plus of interest income in Q2. Of that $900,000, approximately $500,000 related to 2016 when the accounting rules stopped allowing for us to record that interest income. So it was more of a catch-up. And to just normalize it out, we backed out in our FFO and FAD reconciliations that $500,000. Does that answer your question?

Yes, it does. There's no more cash you're expecting. It already was paid.

No, that one preferred equity investment is now closed out. But as Greg said, we have 2 others outstanding that will accrue interest income the remainder of the year.

I'm showing no further questions at this time. I would now like to turn the call back to Mr. Greg Stapley for any further remarks.

Well, again, thanks, everyone. We appreciate you being on the call today. And we -- if you have any further questions, feel free to give us a ring down here at the office. Take care.

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