Diversified Healthcare Trust (DHC) 2005 Q4 法說會逐字稿

Thank you for standing by and welcome to today's Senior Housing Properties Trust fourth quarter 2005 earnings conference call. This call is being recorded. Now at this time I would like to turn the conference over to the Manager of Investor Relations, Tim Bonang. Mr. Bonang, please go ahead.

Thank you. Good afternoon, everyone. Joining me on today's call are David Hegarty, President and Chief Operating Officer, and John Hoadley, Chief Financial Officer. The agenda for today's call includes a presentation by management followed by a question and answer session. Before we begin today's call, I'd like to state that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Federal Securities laws. These forward-looking statements are based on Senior Housing's present beliefs and expectations as of today, February 7, 2006.

The Company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission regarding this reporting period. Actual results may differ materially from those projected in these forward-looking statements. Additional information concerning factors that could cause those differences is contained in our Forms 10-K and 10-Q filed with the Securities and Exchange Commission and in our Q4 supplemental operating and financial data found on our website at www.SNHREIT.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. And with that, I would now like to turn the call over to Dave Hegarty.

Thank you, Tim, and good afternoon, everyone. Welcome to our fourth quarter and year end 2005 investor conference call. The fourth quarter reflected continuing positive trends in our tenants occupancy and coverage ratios as well as some positive developments within the portfolio including our litigation with HealthSouth. First our funds from operations, or FFO for the fourth quarter decreased to $22.2 million or $0.32 per share from $24.4 million or $0.38 per share in the same period in 2004. The current quarter includes a number of one time events. One of which significantly affected FFO for the quarter.

In December, we excised an option to redeem high cost debt with a small equity issuance resulting in a loss and early extinguishment of debt of $5.2 million. $4.1million of this loss was a cash premium paid to the bondholders and $1.1 million was a write-off of related, deferred financing fees and we've included only the cash portion of this loss in the calculation of FFO. Excluding this one time item, FFO for the quarter would have been $26.3 million or $0.38 per share. Also included in the fourth quarter FFO were $600,000 of legal expenses related to our litigation with HealthSouth. I will provide you further details on the HealthSouth litigation in a few minutes.

For the year 2005, FFO was $99.3 million or $1.44 per share compared to 94.8 million or $1.50 per share for 2004. Excluding the one time item mentioned earlier, FFO for the year would have been $103.4 million or $1.50 per share and in 2005 the legal expenses related to the HealthSouth litigation was $1.850 million. We are continuing to see improving fundamentals at the portfolio of properties. Generally we've seen occupancy levels continue to improve year-over-year and sequentially. Occupancies have stayed flat or increased over all segments of our portfolio. Our independent living portfolio occupancy increased to 92% in the fourth quarter compared to 91% during the prior quarter, and 92% for the same quarter a year ago. Our assisted living portfolio improved to 91% occupancy in the fourth quarter from 90% in the third quarter, and 82% for the comparable quarter in 2004. Occupancy in all our skilled nursing facilities was 90% in the fourth quarter, which is the same as the third quarter and 1% better than the fourth quarter of 2004.

Occupancies also improved across the board by tenant and lease. In our largest lease occupancies increased from 92% to 93% from the third quarter to the fourth quarter of 2005. This portfolio of 30 properties is leased to Five Star Care and until November 1, 2005, all 30 properties were managed by Sunrise Senior Living. On November 1, Five Star terminated the Sunrise management agreements for 12 properties and assumed direct operational control of these properties. In our second largest lease also with Five Star occupancy increased to 91% in the fourth quarter versus 90% in the third quarter and 88% in the fourth quarter of 2004. The 14 properties leased to Sunrise with the Marriott International guarantee expands that increase in occupancy to 92% in the fourth quarter from 90% in the third quarter. The properties leased to Alterra Healthcare and Genesis Healthcare also had 2 to 300 basis points sequential increase in occupancy in the fourth quarter compared to the third quarter. And the rest of the portfolio is largely unchanged in the fourth quarter.

Commencing in 2006, the majority of properties leased to Five Star will be paying additional rent equal to 4% of the growth in net revenues at the properties over the net revenues in 2005. Alterra and Sunrise pay additional rent based on a similar formula, while most of the other leases have fixed increases or CPI based increased. Generally the private pay a percentage of revenues, did not significantly change from historical levels, they continue to be in excess of 80% at most properties. The healthy coverage ratios experienced in the third quarter have continued into the fourth quarter. The coverage of the rent in our largest lease with Five Star which represents $64 million of annual rent was 1.25 times for the fourth quarter. This compares very favorably to the 1.11 times coverage ratio that we reported in the third quarter for this lease.

As you may recall, at the start of fourth quarter all the properties in this lease were managed by Sunrise Senior Living and management fee was senior to our rent. On November 1, Five Star terminated the management contracts of 12 of the properties and the management fee has been eliminated at these communities. Effective February 1, 2006, Five Star also terminated a contract for one more property. As a result of Five Star's termination of Sunrise management contracts, S&H's coverage ratios have improved significantly in the fourth quarter because the rent moves to a priority position over any Five Star management costs. For meaningful comparison purposes the coverage ratios in the supplemental package reflect the termination of the 13 contracts as if they have been eliminated for all periods presented. That way the coverage ratios are on an apples-to-apples basis.

The next largest lease is with Five Star also, but it's comprised of 106 properties that they operate directly. Rent coverage for the fourth quarter for this lease was approximately 1.8 times, roughly the same as the third quarter and slightly higher than the fourth quarter of 2004. If acquisitions have been made added to the master lease the statistics for all periods presented in the supplemental have been recalculated as if these properties were in the lease for all periods presented. The coverage ratios for lease with Alterra and the lease with Genesis experienced notable improvements in coverage to approximately two times or better. The remaining leases had essentially the same coverage for the fourth quarter as they did for the third quarter.

During the year, Senior Housing acquired ten properties for $82 million and added them to a master lease with Five Star. We also funded $15 million of capital improvements and sold three properties all of which were leased to Five Star and were included as part of a master lease with them. The net brand adjustment was an increase of $7.1 million per year in rent. Also during the quarter Genesis excised a lease renewal for its property for ten years on the same rent terms. As of today we have no significant lease expirations until 2013. The most significant development in the quarter has been a series of positive rulings by the Massachusetts courts in the HealthSouth litigation. As announced in September, the Massachusetts Superior Court ruled that the lease was validly terminated back on October 26, 2004. We then needed to obtain a court order to enforce a yield up provision in the lease that requires the tenant to manage the properties for the landlord's account until a new qualified tenant can replace them and to cooperate in the lease licensing process for a successor tenant.

During this period, the cash flows of the properties less the management fee had to be remitted to us as the landlord. In January we announced the same court ruled that HealthSouth is required to pay us the operating profits of the hospitals retroactive to October 26, 2004, less a 5% of revenues management fee. And cooperate with the landlord to transition the property to a new tenant. The court has also ruled we're entitled to reimbursement of our legal fees. Since then, HealthSouth has filed a notice of appeal of the court's decisions and as of today HealthSouth's motions for a stay of the court's decisions during the appeal process have been denied by both the Trial Court and the Appeals Court. During the pendency of these disputes, HealthSouth continued to pay us a disputed rent amount of $725,000 per month. In addition on February 3, 2006, HealthSouth paid us an additional $4.6 million which they represented to be the excess cash flow due from November 1, 2004, to December 31, 2005. We were currently in the process of reviewing HealthSouth's calculations of these amounts due to us and we may claim additional amounts. Furthermore, we do not expect to recognize any of this additional cash flow until HealthSouth exhausts all of its appeal rights.

Given the uncertainty of the legal process, we cannot assure you that the amounts we will actually -- what amounts we will actually receive or the consequences of their continuing appeals. There is another lawsuit pending against HealthSouth for the period January 2002, until October 2004 for rental averages but that's been on hold pending the outcome of this first case.

During the quarter, we executed a small overnight equity offering and we issued 3.25 million common shares for net proceeds of $58 million which were used to redeem $52.5 million of senior unsecured notes during 2015 which carried a coupon of 7 and 7/8ths plus a $4.1 million redemption premium. The option to redeem this debt with equity expired in early 2006, so time was running out if we wanted to exercise this option. Other than the one time charge for early extinguishment of debt, the run rate affect on FFO is essentially neutral yet improves our balance sheet. In connection with this equity offering, HRPT Properties Trust, our shareholder sold 950,000 shares and it currently holds 7.7 million shares which is 10.7% of our outstanding shares. HRPT has publicly stated that it does not intend to sell these shares in S&H in the open market.

As I mentioned in the last several conference calls and presentations, I feel the greatest challenge to S&H is to how make accretive acquisitions in the current market environment. In 2005, we acquired ten properties for $82 million at an average going cap rate of 9%. We have the financial capacity to make a significant amount of investments but it is challenging to compete with the tremendous amount of capital available out there. With the rise in short term rates, weak financing may be more competitive in 2006.

Although it's been a difficult market to make acquisitions, we have benefited from this environment with the sale of properties at attractive valuations. In 2005 we sold three properties for $13 million and recognized a book gain of $5.9 million. There's considerable anxiety about the Medicare and Medicaid programs and budget proposals for 2006 and 2007. I would like to remind investors that roughly 85% of our rents come from private pay facilities. For investors who may be concerned about the impact of proposed changes in long term care acute hospitals, or LTAC's there is no impact on S&H since we don't have any in our portfolio. We continue to focus on properties that are not dependent on government funding. Another topic of interest for investors is our dividend level. Soon after the end of the fourth quarter we declared a dividend of $0.32 per share which represents 84% of our FFO for the quarter excluding the one time redemption charge. Our board considers the dividend level on a quarterly basis and they're currently comfortable with this payout ratio. We believe our dividend provides an attractive secure yield to existing and potential shareholders with the possibility for future growth. Now, I'll turn the presentation over to John Hoadley, our CFO to discuss the quarter's financial results in more detail.

Thank you, Dave. The revenues for the quarter ended December 31, 2005 were $44.1 million which is $3.4 million increase or 8.3% over 2004 revenues for the comparable period. Rental income increased because of the full impact of rents from our real estate acquisitions totaling $23o million made since October 1, 2004. Interest expense increased due to our assumption of $48.8 million of debt in connection with the LifeTrust America acquisition during the fourth quarter of 2004 and higher interest costs associated with our revolving bank credit facility. Our weighted average balance outstanding and interest rate under our revolving bank credit facility was $62 million and 4.8% and $45 million and 3% for the three months ended December 31, 2005 and 2004 respectively.

As you can see, our short term borrowing rates increased by 180 basis points as a result of the rate increases by the Federal Reserve Bank during this time period which was offset somewhat by the reduction in our borrowing spread when we refinanced our revolving bank credit facility at the end of July 2005. General and administrative expenses increased in the fourth quarter of 2005 by $351,000 over 2004. However, general and administrative expenses included $600,000 of HealthSouth litigation costs in the fourth quarter of 2005. The fourth quarter of 2004 had $200,000 of costs related to the HealthSouth litigation. Excluding litigation costs general and administrative expenses were unchanged for the fourth quarter 2005 versus the fourth quarter 2004.

During the quarter, two older unprofitable assisted living facilities leased to Five Star were closed and sold for a book gain of $5.2 million. In addition, the skilled nursing facility that has been unprofitable is in the process of being closed and is expected to be sold in early 2006. An impairment charge related to this asset to be sold, the $1.8 million was recorded in the fourth quarter. Net income was $15.7 million for the fourth quarter compared to $16.5 million for the same quarter last year. This 5% year-over-year decrease in net income was attributable to changes in revenues and expenses including the one time items in the fourth quarter such as the charges for impairment of assets of $1.8 million and loss on early extinguishment of debt of $5.2 million offset by the gain on sale of properties of $5.2 million.

The weighted average number of common shares outstanding was 69.4 million in this quarter as compared with 64.3 million for the fourth quarter of 2004. At December 31, 2005, the outstanding shares were 71,812,227. In January 2006, we declared a dividend of $0.32 per share which represent 100% of our reported FFO for the quarter but 84% of FFO without the one time cash portion of the loss on the early redemption of debt.

On the asset side of the balance sheet, all of our investments are currently fee interest in senior living properties. Real estate investments increased by a net $85 million since 2004 year end, which represent the acquisition of ten properties, plus improvement financing since the beginning of the year less the sale of one nursing home in May and two assists living facilities in December. During the fourth quarter, 2005, we made $4 million of improvement financings at a 10% yield. And in October, we entered a sale lease-back transaction with Five Star for six assisted living facilities for $58 million. The average lease term remaining on our entire portfolio is 11.7 years. None of our revenues come up for renewal in the next five years.

On the liability side, our real estate investments are partially funded with $550 million of debt as of December 31, 2005. Our debt was comprised of two senior note issuances due in 2012 and 2015 for $395 million. Junior subordinated debentures totaling $28 billion due in 2041. Mortgages and capital leases due mostly in 2012 and 2013 for a total of $70 million and our revolving credit facility.

In January, we redeemed 52.5 million of senior notes using the proceeds from the equity issuance in December. The junior subordinated debentures have a coupon of 10 and 8% and can be prepaid at par beginning in June, 2006. Only 5% of our total capital is secured debt. The weighted average interest rate on our secured fix rate debt is 6.7%. The weighted average interest rate on our fixed rate unsecured debt was 7.8% while the overall weighted average industry including our unsecured revolver is 7.4%.

At year end, our balance sheet remained very solid. We had $1.7 billion of real estate investments, all fee interest. Debt-to-total book capitalization was 38%. Debt-to-total market capitalization was 31%. At December 31, 2005, we had $64 million outstanding in our credit facility. In January, we borrowed 39 million to partially fund the bond redemption. As of today we have $103 million outstanding in our credit facility which leaves us with $447 million of available capacity. In the fourth quarter, our EBITDA to interest coverage ratio was 3.2 times which is consistent with our trends for the last several years. We are also currently comfortably within the requirements of our public debt covenants.

To sum up, the positive trends that we have seen with tenant metrics throughout 2005 has continued in the fourth quarter. Five Star has taken additional steps in its development as a leader in the senior healthcare industry and we are pleased with the positive developments with the HealthSouth litigations. We believe that S&H's long term leases with strong tenants may be unequaled in the industry. 97% of S&H's rents come from publicly traded companies or investment grade tenants. Furthermore, our solid balance sheet, attractive dividend yields, and low payout ratio are appealing to long term investors. That concludes our prepared remarks. Operator, we are now ready to take questions.

[OPERATOR INSTRUCTIONS] Our first question will come from David Tsoupros with Merrill Lynch.

Just a question on HealthSouth. How long do you expect to be in this transition period where you are looking for a new operator?

Well, the process right now is that they are -- they still have an appeal on the stay and they are providing us numbers. We don't know how long that process is going to stay to get the final clearance on the stay. I think that might be couple -- maybe a couple weeks and then to decide how we are going to go about all the -- replacing the operator and so on could take a couple of months. At least anyways.

So there are no candidates potentially that you have been talking to that might come in here and be willing to operate those facilities?

Sure. We have been talking to five different candidates over the last couple of months to just keep a rapport and keep in touch with the situation. But it will come down to who can be licensed in Massachusetts because it's a certificate in each state and also who can give the best economics to us on the rental rate and so on.

That's great. Then another question, with the Medicare reimbursement changes for different types of providers, do you see it as an opportunity to maybe increase your exposure to Medicare? Could you be willing to provide financing through sale leasebacks to operators that may not be able to find financing by other means because of changes?

Possibly. The market seems to be indicating that nobody is reluctant to finance health care companies, even with some of the stuff going on in the marketplace with the -- as far as reimbursement. Maybe that will change. We look at all kinds of opportunities. We are focused again predominantly on private pay. And almost exclusively on private pay facilities. So I would not expect much opportunity for us -- I wouldn't rule out if there is an opportunity that we wouldn't be in there evaluating it and seeing if we can finance it.

Great. Thanks a lot.

Our next question will come from John Wallace with Stifel Nicolaus.

Good afternoon.

Hi, John.

My question is about diversifications. Obviously you have a pretty good relationship with Five Star. Have you thought about diversifying into other tenants or can we expect more transitions just with this Five Star Sunrise managed contract buyback?

Well, we clearly would like to do more investing with other tenants. They -- obviously a lot of relationships other REITs have with certain operators and so we clearly just have the strongest relationship with Five Star. But, for instance, a transaction that occurred -- a transaction in Pittsburgh that occurred earlier this year, we had told the brokerage firm that was handling the transaction that there were three operators that if any one of them won the bid on this, we would back them up to a certain dollar amount. And so it so happened that Five Star was the winning bidder. But we were willing to go with any of the other two operators should they have won it. So we are trying to make inroads with others but the reality is that we did $85 million of acquisitions this year and it was due to our relationship with Five Star. So it's a benefit from the perspective of seeing more opportunities and growth potential. It is a negative as far as concentration but Five Star continues to get stronger and be a major player in the industry. I think we are comfortable with doing business with them, too.

And would you see yields coming down? Am I reading between the lines right to think that yields could be a little bit lower if you are focusing on IOAL in 2006?

Yes, that's probably true. We have to be competitive. We -- the transaction we closed during the year did have a 9% rental rate on it. But that's above market today. So I think for the REIT market it's between 8 and 8.5% tends to be where the market seems to be.

Okay. Thank you.

[OPERATOR INSTRUCTIONS] We will next go to Sanjay Ramakushna with ING Clarion Capital.

I have a few questions for you. First, housekeeping, you said your current revolver balance most recently is 103 million.

That's correct.

And of that 103 million you drew 37 million additional which went towards the call back, right?

That's correct. What happened was we did the equity issuance in December and we used the proceeds to pay down the line until the redemption, we had to give a 30 day notice.

And then for the total $52.5 million, the remaining would come off the balance sheet or just off the revolver?

No, it came off the balance sheet. We had about 14 million or so.

So as of today right now you have how much cash on your balance sheet?

It's probably down around 2, 3 million.

So looking at your curved revolver balance, it's higher than it's been in a little bit and you have your debentures that you can redeem at par this June. Have you thought about doing another senior notes issue or given how the market has been very accommodating for near invest grade REITs like yourself?

Well, like you said, with the balance at $100 million and we have the redemption that we can do, the call we can do in June, to the extent we saw an opportunity to finance those out we would certainly take it but we are in the fortunate position right now that we don't really have to.

So what you are saying is in terms of a capital structure strategy you would rather draw down on the revolver to redeem those notes if you so choose to versus do an add-on or another notes offering?

Yes, that's right unless we saw something in the market that we couldn't resist.

Going back to what you had talked about before with the whole CMS 2007 impact, you said there would be no impact, but how about in terms of the impact it would have from Five Star in and of itself? Are -- have you noticed any rumblings or anything like that in the marketplace at all?

Well, I guess I can only comment to the extent that I can think it affects the portfolio maybe. But as far as the rules that are being proposed, the -- first of all there is no ALTCs in the portfolio so there would be no impact on that front. On the Medicare front there is talk of keeping the step up market increase flat for October of 2006. So that would hurt -- probably hurt them a little bit, but not affect our coverage ratios that much due to us. And there's a therapy cap which is still in the works that they anticipate to be some exemptions to go above the cap in complex cases and so on. So it's really complicated, but I don't think there is any significant change or impact on the coverage ratios due to us.

And finally, pro forma for Five Star taking over the remaining amount of leases that they agreed to take over, what would you say is their aggregate concentration -- your revenue concentration from Five Star as of now?

Well, I think everybody still counts it as a Five Star concentration because it's a lease to them even though Sunrise manages those remaining properties.

62%.

62% rent comes from Five Star properties.

Thank you very much.

You're welcome.

Our next question comes from Hank Roush with Liberty Mutual.

Good afternoon. Could you give me an update on what the total legal costs you have spent to date on the HealthSouth case are?

Yes, it's $2.3 million to date. 1.850 million in 2005.

And so -- at this point, the expected recovery is that amount and obviously you are continuing to have some expenses plus some sort of earnings amount from the period of time, but then you go back, you said there is another case from a prior period that's pending. Will that also be resolved? Or will that continue on once this current case is taken care of?

Well, it's possible -- that's moving very slow and I guess we just have to determine -- there's a significant amount of money at stake so we probably would continue to pursue it. It just, -- I don't know if at some point we'll try to sell the things or make some tradeoff or something like that to make this transition smoother with HealthSouth. We have to leave that door open.

That case it's in a different court. So it definitely won't be decided with what's going on right now.

Okay. And I assume you are aware of the corporate restructuring or balance sheet restructuring that they are in the process of doing at the moment.

Yes, we are aware of that.

And they should have a lot of money I guess to help pay whatever they owe you. Good luck.

Thank you.

Our next question comes from Ray Garson with UBS.

Thanks. Not to keep focusing on the HealthSouth element, but you said you received -- I think the number you said was like $4.6 million which was HealthSouth's estimate as to the profits that they owed you. When did you get that money again?

Friday.

You got the money on Friday. And they remain current on the rent during the appeal in addition to that?

They had continued to make payments, that 725,000 a month they made through January.

And then moving out with respect to just kind of the acquisition outlook, understand how the yields are coming down on the private pay set. Are you guys looking at broadening the asset class, to maybe acute care hospitals or other kind of things, medical office buildings or other things to just try to look for other opportunities? Are you still focused on your core base here?

We are continuing to focus on our core base here to try to make some acquisitions happen. We do look at other health care related assets if they are in the marketplace, we do consider them, but I guess we bid on situations here and there. But our chances of success are limited. And we will periodically consider other types of triple net leased assets or something like that that fit with our business here.

Okay. Directionally, Dave, are you seeing more stuff come to market that -- how would you describe kind of the pipeline I guess? It sounds like it's pretty slim pickings for the yield that you all are targeting.

Well, it's really picked up again at late January, a lot of transactions have come back -- have come to the market. So I would say the activity level has picked up a good amount. And it is challenging and I think certainly for top notch class A senior living communities the cap rates probably would be very difficult to win the bid in a weak format because we have to make a return on our investment and the operator has to have a return on their -- on the leases from the get-go, too.

Okay. Thanks.

Okay, you're welcome.

And we have a follow-up from Sanjay Ramakushna, again, ING Clarion Capital.

Just one quick follow-up question guys. Are you comfortable where your revolver balance is right now? Is that like a steady state you are comfortable staying at? Or do you see yourselves opportunistically paying that down, at least in the first half of the year?

I would say opportunistic is the right word. If we see an attractive financing or something like that, we would seriously consider that.

But you do plan on keeping it at around the 103 or $100 million level in the near term?

Maybe.

As I said before, we feel comfortable with having the balance where it is, but if we saw something that was attractive enough then we would be fine with paying it down as well.

Okay. Thank you.

And there are no further questions at this time. I would like to turn the conference back to Dave Hegarty for any additional or closing remarks.

Thank you. Thank you everyone for joining us this afternoon. Senior Housing Properties Trust will be presenting at the UBS Global Healthcare Services conference in New York on Monday and we're scheduled to present to the Credit Suisse real estate conference in New York in early April. We look forward to seeing you at one of these events and speaking with you at the first quarter 2006 conference call. Have a good day.