Diversified Healthcare Trust (DHC) 2006 Q1 法說會逐字稿

Good day, everyone, and welcome to the Senior Housing Properties Trust first quarter 2006 earnings results conference call. [OPERATOR INSTRUCTIONS] Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Manager of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you, Lisa and 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 would 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, May 2, 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 Form 10-K filed with the Securities and Exchange Commission and in our Q1 supplemental operating and financial data found on our website at www.SNHREIT.com. I would note we currently expect to file the first quarter Form 10-Q with the Securities and Exchange Commission by the end of this week.

Investors are cautioned not to place undue reliance upon any forward-looking statements. And with that, I would like to turn the call over to Dave Hegarty.

Thank you, Tim. And good afternoon, everyone, and welcome to our first quarter 2006 investor conference call. We are very pleased with the first-quarter results. Revenues were up 5%, funds from operations or FFO were up 8.8%, and FFO per share was up 5.4% versus the first quarter of 2005. Results for the quarter do not include any one-time events but they do include $390,000 of legal costs associated with the HealthSouth litigation.

This was the first quarter that many of the properties leased to Five Star Quality Care were subject to percentage rent. And as a result the first -- for the first quarter, the estimated percentage rent was $1.26 million versus $815,000 for the first quarter of 2005. This was an increase of $445,000 year over year.

All of the 30 retirement properties in our largest lease and approximately two thirds of the properties in our second lease with Five Star are subject to the percentage rent formula effective January 1, 2006. The remaining one third of the properties in Five Star's second lease will be subject to percentage rent beginning in 2007.

In addition to its minimum-based rent, S&H is entitled to 4% of the growth in revenues at this property over base year revenues. With the similar formula in the Sunrise Marriott lease and the Alterra Brookedale lease, all of our other leases have CPI base or fixed annual bumps in the rent that average 2.5% to 3% per annum.

During the quarter, we did not sell any properties and we funded $5.3 million of capital improvements to Five Star and have committed to funding up to $4.5 million of expansion financing for another tenant. The improvement financings are at an increased rental rate of 9.5% to 10% on the amounts funded. I'd like to present an update of the litigation with HealthSouth and the relicensing of the two rehabilitation hospitals.

Five Star's is pursuing a the necessary regulatory approvals. However, the Massachusetts health department has made a preliminary determination that a written agreement from HealthSouth is necessary to process a license application. And we advised our [inaudible] the authorities to reconsider their determination.

During 2006, we received 6 million in cash from HealthSouth, which they represent to be the net cash flows from -- for October 2004 through March 2006, above the rent they have paid us through January 2006. We discussed in our prior call that $5.3 million of these payments were received in early February. These amounts represent net cash flow from the operations after paying for CapEx and networking capital. Supporting data for the calculations of the amounts due to us provided by HealthSouth appear to be incomplete and contradictory and we have attempted to obtain accurate data and clarifications from HealthSouth but HealthSouth has been unwilling or unable to provide such data.

And we are continuing to record only the $725,000 per month or $8.7 million of annualized rent pending the exhaustion of HealthSouth's appeal rights. Since there continues to be ongoing court motions and legal sparring, we expect legal expenses relating to this matter to continue. During the quarter, our largest shareholder and former parent HRPT Properties Trust, sold its remaining interest in our company.

HRPT owned 7.7 million shares of S&H, and 4 million shares of another HRPT's former subsidiaries, Hospitality's Properties Trust and liquidated their position in both companies in order to fund their real estate investments. Periodically investors have had a concern about the shares being an overhang on SNH's stock and this transaction eliminated that concern. The demand for the shares significantly exceeded the shares available to be sold and the stock traded up for the first few days after the transaction.

Now, the occupancy levels and coverage ratios at all of our properties have remained strong although sequentially quarter to quarter some of the ratios have decreased. Occupancies for the independent living properties are up from the prior year and quarter to 93%, assisted living continued strong at 91%, which is the same as last quarter, and up significantly from a year ago. Nursing home occupancies also were up for the quarter to 92%, versus 90% last quarter and 88% a year ago.

The tenant occupancies were the same as last quarter, except new seasons increased to 85% from 80% and the private companies were up to 90% from 88%. In the fourth quarter of 2005, Five Star terminated the management contracts on 13 properties and assumed the operations of these properties.

In March, Five Star issued $120 million of common equity and exercised termination options for 10 more Sunrise Management contracts and Five Star will take over the operations at those properties and management fees that were seeing into our rent will no longer exist. And when our supplementary reporting package all rent coverage ratios have been presented without the management fees paid to Sunrise, that relates to the 23 properties with Five Star's terminated the management contract. We have presented the ratios in this management to provide a more meaningful presentation to investors on an apples-to-apples basis. On this basis, the coverage ratios declined in 2005 and have picked up in the first quarter of 2006 -- 2006 to 1.33 times.

Furthermore, this compares very favorably with the actual coverage ratio of 1.14 times reported for this lease in the first quarter of 2005 before Five Star terminated any management contracts. The rent coverage ratio of a second lease, which includes 106 properties leased to Five Star declined from about 1.8 times during most of 2005 to 1.5 times in the first quarter of 2006. This decrease in coverage was largely the result of a decline in operating performance and certain of Five Star's nursing homes included in the lease.

The rest of our portfolio is doing well with excellent coverage of the rent and the seasons coverage was picked up to 1.16 times, the Genesis property's off a little but it fluctuates quarter to quarter and the private company's coverage is off due to one of the nursing homes having a loss for the quarter. All of our tenants are current in their rent obligations to us. Now, the acquisition environment remains competitive, we are still seeing a large number of properties to acquire, they are not chasing overpriced assets or troubled situation. And during the quarter, we reviewed over $0.5 billion of properties for sale, and I'm optimistic we will succeed on some of our bids.

In fact as of today we have 194 unit rentals continuing care retirement community under agreement, to be purchased for $19.1 million, and this agreement is subject to diligence and may or may not close and if we acquire this property we will discuss it in more detail in the future. During the remainder of the year, I also expect we will fund approximately $20 million of additional capital improvements and expansions at our existing properties.

In addition, we currently have one skilled nursing facility for sale, which we hope to sell in the second quarter. I will now turn the presentation over to John Hoadley, our CFO, to discuss the quarterly financial results in more detail.

Thank you, Dave. The revenues for the quarter ended March 31, 2006 for $41.2 million, which is a $1.9 million increase or 5% over the first quarter of 2005. Rental income increased because of the full impact of rents from our real estate acquisitions totaling $97 million, made since January 1, 2005, net of three property sales that occurred in 2005. Interest expense increased in the first quarter of 2006 versus the first quarter of 2005 due to higher amounts outstanding on our revolver and increasing short-term interest rates.

General administrative expenses of $3.4 million in the first quarter were essentially unchanged from the 2005 first quarter. General administrative expenses include $390,000 of HealthSouth litigation costs in the first quarter of 2006 while the first quarter of 2005 had $400,000 of costs. Net income was $15.7 million for the first quarter, compared to $13.9 million for the same quarter last year. This represents a 13% increase in net income. The weighted average number of common shares outstanding was 71.8 million in this quarter as compared with 68.5 million for the prior quarter 2005, due to our issuance of 3 million shares in December 2005.

There was no change in the outstanding shares during the first quarter of 2006. In April 2006, we declared a dividend of $0.32 per share which represents 82% of our reported FFO for the quarter, which is an improvement from the 86% payout ratio recorded for the same period last year. At quarter end, our balance sheet remains solid. We have $1.7 billion of real estate investments, all fee interest and senior living properties.

The average lease term remaining on the portfolio is 11.5 years. Real estate investments increased by $5.3 million since 2005 year-end, which represents improvement financings of Five Star properties. On the liability side, our real estate investments are partially funded with $550 million of debt as of March 31, 2006. Our debt is comprised of two senior note issuance due in 2012 and 2015 for $343 million, junior subordinated debentures totaling $28 million due in 2041 and mortgages and capital leases due mostly in 2012, 2013, for a total of $70 million.

In addition, we have a $550 million revolving bank credit facility. At March 31, we had $106 million outstanding on this credit facility. Today we have $98 million outstanding which leaves us with $452 million of available capacity. In January, we regained $52.5 million of senior notes, using the proceeds of the equity issuance in December. Our junior subordinated debentures have a coupon of 10% and 8% and can be prepaid at par beginning June of 2006. Approximately 5% of our total book capital is secured debt.

The weighted average interest rate on our secured fixed rate debt is 6.4%. The weighted average interest rate on our fixed rate unsecured debt was 8.5%, while the overall weighted average interest rate including our unsecured revolver was 7.7%. Debt to total book capitalization was 37% and debt to total market capitalization was 30%.

For the quarter, our EBITDA interest coverage ratio is 3.4 times, which is higher than our trends for the last several years which have typically turned at above 3.2 times, historically. We are also currently comfortable within the requirements of our public debt and credit facility covenants. We believe that SNH's long-term leases with strong tenants may be unequaled in the industry. 97% of SNH's rents come from publicly traded companies or investment grade tenants.

Furthermore, our solid balance sheet, attractive dividend yield and low payout ratio are appealing long-term investors. That concludes our prepared remarks. Operator, we are now ready to take questions.

Thank you. Today's question-and-answer session will be conducted electronically. [OPERATOR INSTRUCTIONS] We'll go first to David Supras with Merrill Lynch.

Good morning and thanks. To what extent did you compete against CNL for acquisition -- potential acquisitions? And does that change your outlook in terms of acquiring Senior Housing Properties?

Hi, David. As far as competing against CNL, we really didn't compete with them that often. The -- CNL, had a number of strategic relationships and those transactions were not particularly widely marketed but we interestingly enough did not come head to head with them that often on acquisition opportunities.

Okay. And it sounds like from HTP's call that they would be divesting maybe even potentially some of the Senior Housing Properties from the CNL portfolio. That's something that you'd consider looking at or looked at in the past?

Well, we would certainly be interested in looking at some of the properties that HTP would be offering. And if -- I guess will depend on exactly what the situation is. If they're underperforming assets that need to be turned around or certain characteristics like that, I think we'd have trouble with it, but you know, we will be interested in looking at those.

So you would be less interested in turnaround properties then?

That is correct.

Okay. All right. Thanks.

Okay.

We'll take our next question from Jerry Doctrow with Stifel Nicolas.

Hi, good afternoon.

Hi, Jerry.

I'm actually going to ask about something other than the HTP - CNL deal.

Tough act to follow.

Right. Right. Even worse for Ventose, I think this morning. Let's see. I guess there are a couple things I wanted to understand a little bit better and I think we've got some of this built into the model but wanted to make sure. On the -- the growth in rents and sort of this revenue participation, which I kind of knew about, but wanted to just go over. You added sort of $445,000 in rent in -- in the quarter, is that what I understood? And then can you just walk me through sort of how it's going to play out over the course of the year? And I also just wanted to understand how that factored into the -- the decline in coverage, how much it was that and how much it was property performance?

Well, obviously it does factor somewhat into the coverage ratios because the rent has gone up.

Right.

But I would say that increase of 445,000 is spread over multiple tenants so it's not all Five Star. The Sunrise properties, some with Alterra. I think the main thing is between the two leases, the properties that are in the first lease, they increased in coverage from the last quarter. Like a 20 basis point increase in coverage at that -- on that lease significantly would exceed say a 20% or a 30% -- 30 basis point decrease in the other lease, just because the relative rent is much higher in the first lease than the second lease.

Okay.

But , there are certainly a couple of nursing homes that are affected with the new refinement and a couple are underperforming relative to the portfolio. So I think those affected the numbers and whether they're one time or not we don't know yet.

Okay. And in terms of just thinking about the rent increases going forward from a modeling perspective, you're resetting sort of every quarter or every year, or how -- how does that work in terms of just your revenue participation? Just to make sure I've got that kind of built in correctly.

Yes. It's an annual calculation. And we do quarterly estimates and the tenants actually pay us on a quarterly estimate basis. And then it gets trued up at year-end.

Okay.

From an accounting perspective, the published income statements, the accounting rules did not permit you to include percentage rent until it's 100% earned. So like the revenue growth of 5% is dereported GAAP rent and does not include that $445,000 increase.

Oh.

And -- now, in fourth quarter typically 100% of that percentage rent would drop into the GAAP reported numbers.

Okay.

But we have an adjustment in our supplemental package when we back out the first three quarters so that we have a sort of a normalized percentage rent estimate.

Okay.

Per quarter.

Per quarter. I'll go take a look at the -- the supplement. Let's see. I think there are one or two other things. The HealthSouth thing, does the written agreement for HealthSouth you think essentially give them sort of a block on the whole transaction so they could indeed just keep operating the facilities, or are you going to have to compromise with them in terms of financial terms to get it, just give me a little more color there because that's a new development as far as I understand.

It is a new development. And I guess I am uncertain as to how it will affect the negotiations going forward. As I mentioned, we are -- we've asked the state health department to reconsider it. And since we have a court order and other documents that indicate that HealthSouth doesn't have a right to be there and they should not be in a position to negotiate a purchase and sale agreement. We've told -- asked them to consider that move and we have not heard a response yet.

Okay. And any sense -- I mean I know you were sort of expecting us to take most of the year, which it sounds like it probably will. Any sense as to when you might get any response from them? Is this -- kind of they have a monthly cycle or something or --

No. Ongoing discussions with trying to push us along and keep the dialogue going to come to a resolution.

Okay. And if you would also then just -- there's some differences here in terms of cash received and that sort of thing. In terms of just the rental line, sort of from HealthSouth, is that going to be stable, or is it just going to bounce around quarter to quarter depending on what their actual performance are, if you can give me a little sense there.

In terms of what we actually record.

Yeah. What's in your numbers.

What's in there is the 2.2 million, which was the -- the rental rate under the disputed lease and really what that -- where that comes out is because the appeal process have been exhausted. So until that fact changes -- I mean obviously the fact's changing all the time so other facts could impact it, but until that -- that's one in particular that needs to resolve itself before we consider booking any additional income or cash flow. So until then we'll just continue to defer.

And even like on a fad you're not then adding back the actual cash received, is that right?

That's correct. I mean there is a second piece where we're trying to -- we've been asking questions about the numbers that we've been provided and they're still trying to get responses to those as well.

Okay. But you're basically taking a pretty conservative accounting. You're not considering anything more than the old contractual.

Correct.

Okay. And my last thing, which I hate to go back now to HTP, but what does it suggest to you, David, about the value of your portfolio and is potential sale of SNH something that you guys logically need to consider given the cap rates that were paid, which I think HTP talked about being 6.35% on current and maybe 6.8% on projected '07's your thoughts on -- if somebody showed up and offered you that kind of cap rate, what you guys would do?

Well, we would have to take it seriously and consider it at the board level. And we're always quarterly evaluating the market out there and what our investment opportunities are and what the best situation would be for us. I think we clearly have attractive assets that we have been accumulating over the last several years and I don't obviously feel that necessarily the stock price reflects that. And obviously we would have to take -- put on our fiduciary duties and evaluate the opportunity.

And what's your percentage right now private pay versus skilled and other stuff?

Based on -- we look at it pretty much as a percentage of rent.

Yes, yes.

And about 85%.

That's right.

Okay. And I mean I probably am a little unfair but just given that cap rate and you've got north of 7% even just dividend yield. I mean it doesn't it suggest that it might even begin a process, or is that -- to solicit offers or --

You're right, it's unfair.

All right. I'll let you off the hook on that one, but --

Revised --

Yes. It's -- impressive price, so -- okay. Thanks a lot.

Thank you.

THE OPERATOR: We'll go next to Bill Grant with Morgan Stanley.

Hello, David.

Yes, hi, BG.

How's it going? Look, you spent the last several calls just talking about how difficult the acquisition environment is. Clearly, SNH has followed through with the strong pricing discipline and you've pursued acquisitions and as you've stayed on the sidelines. In addition, the Company has such strong credit stats and you said on previous calls I believe that it would be challenging for SNH to achieve an investment grade credit rating given the current concentration problems for the conversation. The previous company was talking about the C NL, I think HTP basically purchased the portfolio encumbered externally managed senior living assets at a cap rate that implies mid 20s share price for S & H. That's clearly a huge gap versus where the stock trades today but rather than just keep harping on this I guess my question is, In the context of the environment you're facing, what action is the Company considering to help the stock price reflect the intrinsic value SNH portfolio including not only a process but just something you can't control immediately, meaningful share buyback program? Thank you.

Thanks for the question. Well, you know, we're always evaluating what our options are in the best use of capital for us. And frankly, we -- I guess we're reluctant to use the line of credit or debt as a source of capital to do a buyback program at one of the biggest complaints about our company is that we're relatively small and every time we've talked to the rate agencies, one of the concerns has been our relative size and they keep -- the bar keeps getting raised on what it would take to become investment grade rated and I believe that for us to reduce our equity base would certainly hurt us from even being considered further for that. Periodically we do sell off selected assets but usually those are ones that have -- are either nursing homes or have some issues that we don't want to continue to own the properties. But we will discuss it at our upcoming board meeting about what other alternatives we should consider. Next question?

We'll go next to Rick Murray with Raymond James.

Hey, good afternoon, guys.

Hi, Rick.

Hi, Rick.

I was curious. I just wanted to make sure I heard you right. In the quarter you guys said you funded 5 million of CapEx, is that right?

That's correct.

With an additional 20 million over the remainder of the year, is that correct?

Yes. We estimate maybe 5 -- 15 million to Five Star-related properties and we've committed another 4.5 million to another tenant.

Okay. I mean I guess I was just curious. Maybe you can help me understand how Five Star gets into a position where they're paying you percentage rents but are unable to fund the CapEx?

They're not unable to fund the CapEx. In fact, they're sitting on over $100 million of cash today. So it just makes logical sense for the -- this is the type of CapEx that is carpets, furniture, new addition to existing structures. So logically those capital expenditures should go with the properties that are being leased from us. They have the option of using their own cash to fund that. Then they have to record the depreciation over the remaining lease life that they have. And so from an earnings perspective it hurts them and it's just a better matching of cash with the -- with the properties. We are not -- obviously, they own another approximately 25 or so properties that they are funding their own CapEx on. We're not funding any of that. So it's purely a matching of assets that we lease to them.

Okay. And how much CapEx did you fund for them last year?

I would say roughly 15 to 20 million.

I think it was around 15 or 16, yes.

Okay. Thanks.

We'll go next to Ray Garson with UBS.

Hi. It's Chad [Vinacore] for Ray Garson. We were just wondering what kind of yield you were expecting on the incremental CapEx you're investing in and what properties you are investing in?

Well, the predominant -- the majority of the capital expenditures are being made on the assisted living and independent living side. And obviously as I mentioned mostly Five Star Properties, but the rates are a function of what's in the -- the base yield of the initial lease that was done with them. So on certain -- most properties it's around 10%. Some of the properties could be 9%, but -- so on average it works out to 9.5 to 10%.

Thank you.

Okay.

And once again, that's star one if you'd like to ask a question. We'll go next to Sanjay [Ramnachris] with ING Clarion capital.

Hi, guys, thanks for taking my call. Talking about this $19.1 million potential transaction. I presume you're defunding that right off of your revolver?

Yes. Some of it involves our -- probably about a little more than two thirds of it is an assumption of debt and the balance is cash on hand -- on the revolver.

And looking at the revolver balance as well as your junior debt, do you see yourself moving towards refinancing some of the junior debt towards the end of the year as it comes up for prepay pretty soon?

Yes. Certainly once -- once we get to a certain level we're always willing to evaluate the markets at that time to see what our alternatives are. Of course we're in a good position in that we have plenty of capacity on the revolver so if we didn't like what we saw, we'd be willing to let it ride a little longer.

Uh-huh. Okay. Great. Well, thanks very much.

And we'll go next to Paul Puryear with Raymond James.

Yes, thanks. Just to clarify Rick's question earlier. Are you saying the properties are able to fund the CapEx and pay percentage rent but Five Star chooses not to do that, but property by property they can fund their own CapEx?

That is correct.

Okay. Great. Thanks.

And gentlemen at this time we have no more questions in the queue. I'd like to turn the conference back to Mr. Hegarty for concluding remarks.

Thank you, everyone, for joining us this afternoon. We'll be presenting at the Bear Stearns credit conference in New York on May 17, and a schedule to present the [NAREIT] investors conference in early June and we hope to see many of you there and catch up with you there. Thanks a lot and have a good day.

Ladies and gentlemen, we thank you for joining us today. You may disconnect your phone lines at this time.