CareTrust REIT Inc (CTRE) 2018 Q1 法說會逐字稿

Welcome to CareTrust REIT's Q1 2018 Earnings Call. Please note that this call is being recorded.

Before we begin, please be advised that any forward-looking statements made on today's call are based on manager's (sic) [management's] current expectations, assumptions and beliefs about CareTrust REIT's business and the 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 exposed -- expressed or implied herein. Listeners should not place undue reliance on forward-looking statements and are encouraged to review CareTrust'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. During the call, the company will reference non-GAAP metrics such as EBITDA, normalized EBITDA, FFO, normalized FFO, FAD and normalized FAD. When viewed together with its GAAP results, the company believes these measures can provide a more complete understanding of its business but cautions that 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, change in circumstances or for any other reason. Listeners are also advised that CareTrust yesterday filed its Form 10-Q and accompanying press release and its quarterly financial supplement, each of which can be accessed on its Investor Relations section of CareTrust's website at www.caretrustreit.com. A replay of this call will also be available on the website for a limited period. Management on this call this morning includes Bill Wagner, Chief Financial Officer; Dave Sedgwick, Vice President of Operations; Mark Lamb, Director of Investments; and Eric Gillis, Director of Asset Management.

And I would now like to turn to call over to Greg Stapley, CareTrust REIT's Chairman and CEO.

Thank you, Sarah. Good morning, and welcome, everyone. It's been a busy year so far here at CareTrust. We've completed $47 million in acquisitions, increased our dividend by more than 10%, welcomed 3 new tenants into the fold and completed the retenanting of a number of great assets. We are increasing our guidance, and after resolving a couple of tenant issues, we are again turning our full attention to the business of getting back on the growth trajectory that we've been accustomed to.

Retenanting any operating health care asset in an orderly matter is always a significant challenge. But in the case of Pristine and OnPointe, we did so without delay, maintaining both the value of the assets and the integrity of the rent stream in the process. Among other things, it was our team's deep understanding of skilled nursing in general and our close familiarity with day-to-day operations with these facilities specifically that allowed us to transition the operations quickly and smoothly.

In the case of the last 9 Pristine assets, we placed those into the hands of Trio Healthcare and Hillstone Healthcare, 2 separate operators about whom we're very excited. I'll let Dave discuss these promising new operator relationships in a minute.

With respect to the 2 assets formerly leased to OnPointe, the decision to retenant could have gone either way. You'll recall that we purchased those assets mid-last year with the OnPointe leases in place. The buildings were new, well-located and doing well in lease-up, and they were extremely well-priced. In addition, we were pleased to have OnPointe in CareTrust's fold, even though we knew that they were facing some challenges in their organization, which might eventually affect our 2 assets. So we evaluated that risk against the value of the deal, prepared for it and went in eyes wide open.

Recently, as a result of those continuing challenges, we had the opportunity to open a conversation with OnPointe about the long-term relationship. Based on those conversations, we agreed that the best course was to transfer the operations to other operators, and that transition was completed on May 1. We placed the 2 properties into our existing master leases with Providence and Eduro, doing so without any rent leakage. These are very nice and very recent vintage assets. In fact, the Albuquerque asset is so nice, we put it on the cover of our supplemental this quarter. And both operators are excited to have them.

As I noted, the transitions went smoothly, in large part due to OnPointe's professionalism and cooperation, and we look forward to possibly reopening the conversation with them in the future. As we close the chapter on the Pristine experience, you might guess and you would be correct that we've done some serious self-examination around our vetting process for new operators. There have been plenty of takeaways, which we have used to expand and sharpen our underwriting processes that Dave and Mark will discuss in a minute. We've also applied what we've learned as we continue building our unique brand of asset management. Perhaps most importantly, we have proven our ability to address occasional tenant difficulties swiftly and productively and to bring you solid solutions, not just problems. So we look forward now to a bright 2018 and beyond and pledge to continue making solid investments with top flight operators at superior returns.

With that, Dave will address our operator relationships and some broader industry developments, then Mark will provide details on our growth and pipeline, and Bill will conclude with the financials. Dave?

Thanks, Greg, and good morning. One of the happy byproducts of transitioning the remaining Ohio portfolio to Trio and Hillstone is a significant upgrade in operating capabilities, not only for these facilities, but also for future growth opportunities with these great operators.

So let me just take a second to introduce you to them. Trio Healthcare currently operates 19 skilled nursing and seniors housing facilities in Virginia and Ohio. Trio's name is a nod to the 3 cofounders: David Rubenstein, CEO; Boyd Gentry, CFO; and Melissa Green, Chief Clinical Officer, who, combined, have several decades of broad and deep industry experience. They know how to combine big company systems with the granular, hands-on touch, and they're committed to creating a vibrant culture of compassion and accountability. We look forward to seeing Trio realize the untapped potential in the 7 central Ohio facilities they took over.

Hillstone operate its 22 facilities across Ohio and is headed by Paul Bergsten, a longtime Ohio operator. Paul is well-known and well-respected throughout the state for running high-performing, caring and efficient facilities, many of which are run as predominantly Medicaid facilities. Paul knows these markets very well and has been warmly received by the staff, several of whom have worked with him in the past. Hillstone is growing and in demand because they understand the business and have a proven track record.

So both companies scored very well on our operator scorecard, and both moved quickly with us to take over operations by May 1. We're confident that the lease coverage for this part of the portfolio will be much stronger 12 months from now.

As for the prior transition in Ohio, you'll recall that Trillium took over operations at 7 Southern Ohio facilities on December 1 and has been doing terrific job with the operations there. They immediately captured significant cost savings from implementing the fundamentals of expense management and are now running efficiently. We expect its census to decline as it has while Trillium negotiated new contracts with local health plans and sought a Medicaid waiver for its senior housing units. That contracting was largely completed last week. Those units are now filling with a waitlist, and we anticipate a steady ramp in their SNF census and skilled mix as well.

All 3 of these outstanding operators as well as the 2 that took over the former OnPointe operations scored very well on our proprietary operator scorecard, which has become a key element of our underwriting process. The scorecard includes over 100 different data points, ranging from traditional credit metrics, staff turnover and other objective measures, to things like culture, the management team's battle experience and other soft or subjective measures that we know from our own operating backgrounds they make a huge difference in an operator's profitability and long-term success.

As Mark will discuss in a moment, we've used this scorecard to ferret out some interesting information about potential operators that would never be picked up in a traditional underwriting process. And we've used that data to do a much better job of matching operators to the right kinds of assets and opportunities. In addition, our asset management team continues to use them to periodically rescore and reevaluate our existing tenants to be sure nothing pops up that might portend problems down the road.

Finally, on a broader note, the industry received welcome news last week. First, CMS confirmed a 2.4% increase to the Medicare rates, the largest net annual rate increase in years. Second, CMS announced progress in changing the Medicare reimbursement model from the current volume-based program referred to as RUG, to a model called Patient Driven Payment Model or PDPM. PDPM is the new name for the previously proposed RCS 1 model that we had enthusiastically supported. This model removes arbitrary thresholds from minutes of a therapy required for setting rates and allows more flexibility to operators -- sorry, so operators can provide care more efficiently. Like with RCS 1, we're enthused by these proposed changes that are now scheduled for October 2019.

And with that, I'll hand it over to Mark to talk about the pipeline. Mark?

Thanks, Dave, and hello, everyone. Q1 was another solid quarter for us as we invested $47.4 million in 2 separate transactions at a blended initial cash yield of 9%.

With the Metron portfolio in Michigan, we added a very solid new operator and 5 well-run sale leaseback assets to our portfolio. And we hope to grow again with them before long. We also added a very nice Montana skilled nursing facility to our master lease with Eduro Healthcare. And they appear to be doing very well right out of the gate.

We also disposed of 1 small set of assets, our Cross assisted living portfolio in Idaho for $13 million. We bought those assets back in 2014 for $12 million with the expectation that the relationship would grow. Cross informed us last year that their priorities had changed and they did not intend to grow further. So we sold the assets back to them at a nice profit and we expect to redeploy the proceeds into higher-yielding investments.

In the current environment, we may continue to look at opportunities to recycle small amounts of capital. But the driving factor in that disposition decision was the investment in small size and static tenant relationship.

Our enhanced underwriting process to which Greg and Dave both alluded has required us to work harder to find deals and vet operators, but it's absolutely worth the extra effort. As one example, this enhanced discipline caused us to cancel a large deal we had under contract just a few months ago in which we would have bought assets with leases and an operator in place. We liked the assets well enough. And from a pure real estate and finance standpoint, the deal looked like a winner. But the operator could not meet our new, more detailed operator criteria, and we, accordingly, pulled out. It's not often that you get near immediate validation on a no-go decision like that. But all of that operator's assets in several states, although not the ones we had under contract, have recently been placed in receivership. Our operator scorecard was key in dodging a possible bullet.

On the new deal front, at present, overall volume of deals that are attractive to us continues to lag previous years. Although there appears to be a pick up recently in marketed senior housing deals, we view most of that end of the market as overheated, overpriced and overbuilt. Nevertheless, we continue to screen those deals for that hidden gem. And in the meantime, most of the opportunities we are seeing are a combination of mom-and-pop and not-for-profit SNFs looking to exit the business as well as small to midsized and larger portfolios that need repositioning and are no longer strategic to the operators and/or their landlords.

We are also hearing that more inventory is being prepared to come to the market in the second half of the year, so we are cautiously optimistic that deal flow will pick up, especially on the skilled nursing side where we see better returns and a brighter future.

As we sit here today, our pipeline has grown from last quarter and is currently in the $75 million to $100 million range. The current pipeline includes both on- and off-market skilled nursing and senior housing deals, with the majority of the pipeline made up of skilled nursing facilities.

The current pipeline provides us with opportunities to partner with a few new operators that we are really looking forward to growing with, while also adding assets to existing operating partners that are thriving in the ever-changing reimbursement environment in which we find ourselves today. 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.

And now I'll turn it over to Bill to discuss the financials.

Thanks, Mark. For the quarter, we are pleased to report that normalized FFO grew by 25% over the prior year quarter to $24.1 million, and normalized FAD grew by 22% to $24.9 million.

Normalized FFO per share grew by 10% over the prior year quarter to $0.32, and normalized FAD per share also grew by 10% to $0.33. Given our most recent dividend at $0.205 per share, this equates to a payout ratio of 64% on FFO and 62% on FAD, which again represents one of the best covered dividends in the health care REIT sector.

Before I go on to guidance, let me update you with respect to the accounting for Pristine. As Greg discussed, we have transitioned Pristine out of the remaining 9 assets and put in 2 new tenants at cash rents approximating what Pristine was paying. Pristine paid their rent through March 31, and we expect to collect April rent as we collect through all of the outstanding accounts receivable on Pristine's books after collections have paid off Pristine's working capital line.

After collecting through and paying April rent, remaining collections will go to pay any 2018 expenses such as property taxes and back taxes that Pristine does not pay. After that, any remaining cash collections will be used to reverse the reserve that we took in the fourth quarter of 2017.

In our guidance for 2018, we are assuming that cash collections on the outstanding AR from Pristine will cover April rent and any 2018 expenses that Pristine does not pay. But we are not reversing any reserve previously taken, although we do believe that a portion of the reserve may ultimately be reversed.

In yesterday's press release, we increased our 2018 annual guidance range for normalized FFO per share by $0.01 on both the low and the high end of our range to $1.26 to $1.28. We also increased our guidance for normalized FAD per share to $1.32 to $1.34. This guidance includes all investments made today, a diluted weighted average share count of 75.9 million shares and also relies on the following assumptions: one, no additional investments nor any further debt or equity issuances this year; two, CPI rent escalations of 2%. Our total rental revenues for the year, again, including only acquisitions made today, are projected at approximately $137 million and includes approximately $1.2 million of straight-line rent; three, our independent living facilities are projected to do about $400,000 in NOI this year; four, interest income of approximately $1.3 million; five, interest expense of approximately $29.4 million. In our calculations, we have assumed a LIBOR rate of 2%. 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 interest rates on our revolver and term loan. Interest expense also includes roughly $2 million of amortization of deferred financing fees; and sixth, we're projecting G&A of approximately $12.4 million to $13.3 million. Our G&A projection also includes roughly $3.8 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 4.5x. Leverage is about 35% of enterprise value, and our fixed charge coverage ratio is approximately 4.8x. We also have $17 million of cash on hand today.

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

Thanks, Bill. To sum up, I'm proud of the way the team has tackled our recent challenges and pleased to have those challenges behind us. We are optimistic about our future and the future of the skilled nursing and seniors housing industries and look forward to continuing to grow CareTrust in an intelligent and measured way. We hope this discussion has been helpful. We thank you again for your continued support.

And with that, we'll be happy to answer any questions. Sarah?

(Operator Instructions) Our first question comes from Jordan Sadler with KeyBanc Capital.

First question is regarding the underwriting model that you're using today. Have you gone back and reunderwritten the existing tenant base outside of the couple you've reinstalled here using the new model?

Yes. So Jordan, this is Dave. So the operator scorecard that we use has about 100 data points on it, captures things from the really objective corporate credit things, the operating margins, the systems that they use and more soft subjective things as well, like the background of the leaders, their financial sophistication, their sophistication with the new trends on bundled payments and the data-driven approach that's needed. So we cover a lot of ground. And then, we've handed that off to asset management, and what they do is they take that and then they actually enhance it with more information that we have. So we have done that for all of our operators. It's an evolving process. Asset management is continually adding more things as we find more data points to add to it.

But presumably, you've run all the existing operators -- or your asset management is running the existing operators through the model and they pass the test?

They do. And yes, and yes. And the reason that's so helpful is, for example, as we've done the OnPointe change and we're able to look at our existing operators and decide very quickly who is the best fit, who is not just the best fit for this asset, but who is prepared as we look at their whole operation to move quickly and who fits those operations. That's how we landed on Eduro and Providence.

Okay. And then, as it relates to -- I mean, along the same lines, I presume you feel you're out of the woods as it relates to tenant issues at this point. I think, OnPointe marks the third tenant in the portfolio with whom you've had some kind of challenges or you've now swapped out. So I'm curious what the watch list looks like today, if anything.

Well, I think, 2 of us will take that one, Jordan. This is Greg. First, I just want to remind everybody that the OnPointe situation was very different from the others that we've had, because we knew that there might eventually be an issue there. We priced the deal based in part upon that, and then, we had a chance to prepare for them and work with them as they managed their way through some separate challenges that we knew they were having. So we don't really count that one with the other 2. But we take full responsibility for the other 2. And then, I'll ask Dave to take the second half of your question.

Yes. So just looking at the portfolio as a whole, right now, we feel really good about it. And we'll obviously be paying close attention to the transition-building. And as we have in the past, we'd let you know if there are any operators that we feel are at risk to making a rent payment. And as of today, there aren't any.

Okay. And then, last one, I guess. Maybe again for you, Dave, I'd be interested in sort of your take on CMS' latest iteration and including sort of the RCS 1 rollout and how you think that'll impact underwriting?

Yes. So ever since RCS 1 came out, we saw that as a real positive for the better operators. It's going to give -- and PDPM has been lauded by everybody that I've heard so far as an improved version of RCS 1 because it gives -- it cuts down some of the reporting requirements and continues to give operators more flexibility in terms of how they deliver therapy. So we expect that there's going to be some cost savings and, in some cases, material cost savings on the therapy side, which is a major expense as operators can be more efficient in the delivery of the needed care. And therapy is certainly not going away. It will always be an integral part of the delivery of care for these patients. But not having the arbitrary thresholds of minutes that are required gives the flexibility to operators to just be much more efficient. So yes, we see it as an overall plus for the better, more sophisticated operators. And we -- not much more to say than that.

Our next question comes from Jonathan Hughes with Raymond James.

Congrats on the transitions. I know you're happy to have those behind you. So just sticking with those transitions, can you give us any color as to the progress that Trio and Hillstone have made thus far? I realize it's only been 7 or 8 days. And then, maybe an update on the Trillium, Pristine facilities, how that's trended since the transition?

Yes, so from a Trio and Hillstone perspective, we -- this is Eric, Jonathan. I was out there in Ohio last week with the transition teams and have been impressed by the way that they've handled the transition. The employees have been -- have received them with open arms. And the clinical leader, which is Melissa, which is part of that Trio group, has been in all the buildings and has, from a clinical standpoint, has really truly built a good, solid base and foundation starting that process with all the directors of nursing and operators there. So we feel really, really comfortable about the transition. We continue to stay close with those operators and continue to communicate on a weekly basis with them as to what they are doing and how they're transitioning the portfolio. But we're very excited on how they're doing that. As regards to Trillium, Trillium is -- kind of reiterating Dave's point in his prepared comments, during any transition, there's a high likelihood of a different census as the new operator negotiates contracts, health plans and including this Medicare waiver program -- sorry, Medicaid waiver program with assisted living. The vast majority of those contracts have now been signed. The Medicaid waiver was signed last Friday. And so as of that last week, a lot of those have been signed and we are expecting and seeing the census continue to steadily ramp up. Now just to give you a little more color on that, in Middletown, which is one of the SNF campuses that has assisted living, they have a waitlist for their Medicaid waiver in assisted living of [12] people. So that's an instant impact to the bottom line there. And so we were expecting to see more things like that occur with Trillium. But we're excited. They really have been -- have done well with their cost control and really managing labor well. So we're excited about the future for Trillium.

Okay. That's great. And then maybe one for Mark. You mentioned a deal that the scorecard effectively helped you avoid an investment that recently went into receivership, which is great, but will that scorecard extend the pace of future investments and slow the deployment of capital?

Yes. I think it's helped us identify operators earlier to kind of bring into kind of the bench before we look to acquire buildings. So I don't think it's going to change the pace. I think it demands that we do a little bit more work upfront in terms of vetting operators before we, one, make the determination to place a building or a set of buildings with that operator. And so it also helps us with our existing operator bench to kind of know who has the bandwidth, who has coverage. So I think, in many ways, it just helps us kind of take a deeper dive and truly understand the best fit for that particular opportunity that's in front of us.

Yes. Okay. And then, earlier, you mentioned the pipe has mostly scaled. Is that a reflection of the higher cost of capital today versus last year? Or is that simply just that there are more opportunities out there in that space right now?

I think, we are seeing a little more bandwidth with our existing operator bench and the ability to grow with them on the SNF side at this point. I think the -- although volume is down, we are still seeing some very interesting opportunities that we think can be accretive, not only to us, but accretive to coverage for -- and cash flow to our tenants. And so we're SNF operators from our old days and the transactions that we are seeing we -- and that we are chasing, we're excited about. We think once we bring them into the portfolio, we'll do very well for our tenants and for our coverage.

Okay. And then, just one more if I may. I don't want to leave Bill out. But leverage is within target ranges. Just wondering if you could talk a little bit more about the balance on your line, any plans to term that out, maybe where you keep your price debt today, and then also how you think about your cost of equity to current share price?

Yes. So talking about terming out the debt on our balance sheet right now, we've got $200 million on the line, and we've got that $100 million, 7-year term loan that is prepayable without penalty today. We could term it out via the high-yield market that we tapped last year. We've looked at both 8- and 10-year tenors, both are which a little more expensive than what we've issued at last year. So those are opportunities. We've also got the ATM out there. And given our share price today, we're feeling a lot better today than we were yesterday and the weeks leading up to this announcement regarding the cost of our equity.

So it's fair to think that, I mean, you guys could start pulling that lever here over the next couple of weeks at this $15 share price?

Jonathan, this is Greg. As Bill says, it just feels a heck of a lot better than it did a week ago. But we've always been very careful about being disciplined on -- particularly on the equity front and doing our best to match fund our equity raises to our acquisitions. It needs a lot of power in the math behind that discipline. And so we will tend to lean that way. On the debt side, I think there's an ongoing conversation here that we're going to have to do something with pretty soon. Getting the transitions of these facilities behind us has been a very significant and time-consuming thing, as you might imagine. And so we're now, with the conclusion of this call today, we'll be pivoting toward some of those things.

(Operator Instructions) Our next question comes from Michael Carroll with RBC Capital Markets.

Greg, can you talk a little bit about the investment markets today? I know that you're kind of indicating today and previously that some deal volumes are a little bit lighter right now. What does the investment pipeline looks like? And are you more apt to pursue relationships or relationship-type deals today than you were, say, 2 years ago when you had really big activity going on?

That's a great question, Mike. We -- the pipeline, as Mark indicated, seems to be a little bit thin. We've talked about that for a couple of quarters now that deal volume just seems to be down overall, and we continue to see that. Although we are starting to hear rumblings as we get out and talk across the industry about a lot of pent-up supply that could be coming out in the second half. So we're cautiously optimistic about that and looking forward to seeing some new deals. And I think, just having our other issues behind us and the chance for more of us to look harder and beat the bushes a little more for those things should be beneficial to begin with. So as far as relationship deals, we've always been relationship acquirers. For us, it's always been about who's the operator first. You've probably heard me say it before, but there are few assets that are so bad that a great operator can't turn around, and no assets that are so good that a trained monkey can run them. And so we are always looking at operators. That's why the new operator scorecard has become so, so important to us. It's how it helped us dodge a big bullet last year when we thought maybe we were going to step into a group of assets with significant investment but just couldn't get comfortable with who the operator was. And it's how we will continue to function even more in the future than we have in the past. Does that answer your question?

No -- yes, it does. Can you talk a little bit about the pent-up demand that you expect to occur in the second half? What's the reason why those sellers are on the sideline and why will they come to the market in the second half of this year?

Well, I think, everybody would probably have their own opinion or reason for that. The one that's been offered to us that seems the most plausible is that the whole industry had kind of a rough -- hit kind of a rough patch in the past year, and a lot of sellers that would -- that might otherwise be coming to market now need a little extra time to sort of clean up their operations, clean up their P&Ls and recover some of the value that might have been lost through the choppy waters of 2017. And so that makes sense, and I think we see good things on the horizon for operators. And so that should free up some of the deal flow.

And do you see operators that just completely want to exit the business maybe because of all the changes that they're seeing, maybe the growth in Medicare Advantage is getting just more complex that they would rather kind of cash out than kind of pursue and evolve in this environment?

Yes. I mean, we've been doing this for a long, long time, long before we spun off from our former partners at Ensign. And there's always been a steady flow of small mom-and-pop, small regionals, sort of legacy operators, second-, third-generation families who have just kind of hit the wall and say, "Look, it's getting more complicated." Because it is getting more complicated all the time and requires a higher level of sophistication and a constant willingness to evolve and grow that not everybody is up for. And so that provided a steady stream of opportunities for us over the years.

And has that become more apparent recently? Or is it just kind of the same as it was 1 to 2 years ago?

No, same old, same old.

We have no further questions at this time. I would now like to turn the call over to Greg Stapley for any further remarks.

Thanks, everybody. We really appreciate you being on the call and your support today. If you have any other questions, most of you know where to find us, and we're always happy to see you and to visit with you. So take care, and we'll talk to you next quarter.

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