Diversified Healthcare Trust (DHC) 2006 Q2 法說會逐字稿

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

Thank you, Kelly, 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'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, August 3rd, 2006. The Company undertakes no obligation to revise or publicly release the results of any revisions to the forward-looking statements made in today's conference, 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 and Form 10-Q filed with the Securities and Exchange Commission and in our Q2 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 like to turn the call over to Dave Hegarty.

Thank you, Tim, and good afternoon, everyone. Welcome to our second-quarter 2006 investor conference call. We're very pleased with our second-order results, where revenues were up 5% and FFO per share was up about 3% versus second quarter of 2005. The second quarter FFO includes $320,000 of legal costs associated with HealthSouth litigation.

This was the second quarter that many of the properties leased by to Five Star Quality Care were subject to percentage rent. As a result, for the second quarter, the estimated percentage rent was $1.5 million versus $775,000 for the second quarter of 2005. This is about a $700,000 increase year-over-year. As I mentioned last quarter, all 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 1st, 2006. The remaining one-third of the properties in Five Star's second lease will be subject to percentage rent beginning in 2007 or thereafter.

In addition to the minimum base rent, SNH is entitled to 4% of the growth in revenues at these properties over base year revenues. We have a similar formula in the Sunrise Marriott lease and the Alterra Brookdale lease. All of our other leases have CPI-based or fixed annual bumps in the rent that average 2.5 to 3% per annum. During the quarter, we funded $5.8 million of capital improvements for Five Star. The improvement financings are at increased rental rates of 9 to 10% on the amounts funded. We have three skilled nursing facilities that are currently listed for sale and we expect to sell them during the third quarter for 6 to $8 million. We have recognized the $1.4 million impairment reserve during this quarter related to those assets.

Last quarter, I mentioned we had a 194-unit rental CCRC retirement community under agreement to purchase for 19.1 million. The closing has been delayed due to obtaining lenders consent and is expected to close on August 31st. The initial rent at that property will be 8.5% per annum on the purchase price. We continue to evaluate a number of investment opportunities, most of which are individual properties or small portfolios and I'm optimistic we will complete some of those transactions before the end of the year. Overall, the acquisition environment remains competitive and I expect future transactions to be at 8.25 to 8.5% initial rental rates.

Although we have not announced any blockbuster transactions this quarter, we have been busy on a number of fronts. In June, we redeemed all of our trust preferred securities, which were reflected as junior subordinated debentures on our balance sheet. These debentures had an annual interest rate of 10 1/8% and we funded a redemption using our revolving credit facility. We funded the $5.8 million of capital improvements and expansions and we expect improvement funding to continue at that level or higher for the rest of the year.

We negotiated a new lease with one of our private tenants for a new ten-year term for three senior living properties at $200,000 higher rent with 2% bumps per annum.

Also Five Star, our largest tenant, terminated 10 more management contracts with Sunrise Senior Living effective January 1st, 2006. These contracts [were seen] to the rent due to us so we move into a better priority position from a creditors perspective and the terminations should improve Five Star's operating results since their costs to manage are significantly less than the fee they were being charged by Sunrise. To date, Five Star has terminated 23 of 30 management contracts.

And as an additional benefit to SNH, the credit quality of Five Star has improved significantly over the last 18 months.

Shortly after the quarter end, our Board of Trustees declared a $0.33 per share dividend, which represents a 3.1% increase from the prior dividend level. On a historical basis, this increased rate is the payout ratio from 82% of FFO to 84.6% of FFO for the quarter, which is still a very comfortable and conservative payout ratio. One of the reasons our Board decided to raise the dividend was because the fundamentals of the private pay senior living industry continues to be strong. SNH currently receives 84% of its revenues from facilities that are predominantly private pay.

I would like to present an update on the litigation with HealthSouth and the relicensing of the two rehabilitation hospitals. Five Star continues to pursue the necessary regulatory approvals. However, the Massachusetts Department of Public Health continues to request data for Five Star's application, most of which necessitates cooperation from HealthSouth and is still requiring HealthSouth to sign off on the transfer of the operations to Five Star. We are progressing slowly and the timing continues to be uncertain.

For the second quarter of 2006, we received $1.8 million in cash from HealthSouth, which they represent to be the net cash flows from April 2006 through June 2006. These amounts represent the net cash flow from the operation after paying CapEx and net working capital. The supporting data for the calculations in the amounts due to us provided by HealthSouth appear to be incomplete and contradictory. We've attempted to obtain accurate data and clarifications from HealthSouth but HealthSouth has been unwilling or unable to provide such data.

We are continuing to record only the $725,000 per month or $8.7 million annualized rent, pending the exhaustion of HealthSouth's appeal rights. As of June 30th, we have deferred recognition of $4.1 million of cash received from HealthSouth until these matters are resolved. Since there continues to be ongoing court motions and legal sparring, we expect legal expenses relating to this matter to continue.

As you will notice in this quarter's supplemental, you'll note that we've decided to provide tenant occupancy statistics one quarter in arrears versus the current quarter. We believe this is consistent with the other health-care REITs that do disclose this data or similar type data. Also it's become increasingly more difficult to obtain tenant's data in enough time to allow us to get a full understanding of what has caused changes if any from prior periods. However, I would like to remind you that 97% of our rents come from public traded companies or investment-grade tenants.

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 June 30, 2006 were $41.3 million, which is a $1.7 million increase or 4% over the second quarter of 2005. Rental income increased because of rents from our real estate acquisition since April 1, 2005 totaling $104.8 million, offset by rent reductions resulting from the sale of three properties for $12.5 million during 2005.

Interest expense increased in the second quarter of 2006 versus the second quarter of 2005. This was due to higher interest costs associated with our revolving bank credit facility, offset by a decrease in interest on our senior notes and junior subordinated debentures as a result of our repayment of 52.5 million of our senior notes in January of 2006 and all 28.2 million of our junior subordinated debentures in June 2006.

General and administrative expenses of $3.4 million in the second quarter were up from $3.1 million in the 2005 second quarter. These expenses increased in 2006 due to acquisitions since April 1, 2005 and include $320,000 and $500,000 of HealthSouth litigation costs in the second quarters of 2006 and 2005, respectively.

Income from continuing operations was $12.7 million for the second quarter compared to $14.3 million for the same quarter last year. This represents a 12% decrease in income from continuing operations, which is the result of an impairment of assets charge of 1.4 million related to three properties that are held for sale and a loss on early extinguishment of debt of 1.3 million in connection with our redemption of our junior subordinated debentures. Without these onetime charges, income from continuing operations would have increased 8% year over year. Net income for the second quarter 2006 was the same as income from continuing operations.

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 of 2005 due to our issuance of 3 million shares in December 2005.

In July 2006, we declared a dividend of $0.33 per share, which represents 84.6% of our reported FFO for the second quarter and is approximately equal to the payout ratio for the same period last year. This represents a 3.1% increase in the dividend and only modestly increased the payout ratio from 82% in the prior quarter.

At quarter end, our balance sheet remains solid. We had $1.7 billion of real estate investments, all fee interest, in senior living properties. The average lease term remaining on the portfolio is 11.2 years. Real estate investments increased by $11 million since 2005 year end, which represents improvement financings at Five Star properties.

On the liability side, our real estate investments are partially funded with $562 million of debt as of June 30th, 2006. Our debt is comprised of two senior note issuances due in 2012 and 2015 for $342 million and mortgages and capital leases due mostly in 2012, 2013 for a total of $79 million. In addition, we have a $550 million revolving bank credit facility. At June 30th, we had $141 million outstanding on this facility. Today, we have $135 million outstanding, which leaves us with $415 million of available capacity.

On June 15th, 2006, we redeemed all $28.2 million of our junior subordinated debentures at power plus accrued interest. The interest rate on the debt was 10 1/8% and we funded it using our revolving credit facility.

We recognized a loss on early extinguishment of debt of $1.3 million during the quarter, which was the write off of the unamortized deferred finance fees related to the debentures. At June 30th, 2006, approximately 5% of our total book capital was secured debt. The weighted average interest rate on our secured fixed-rate debt is 6.5%. The weighted average interest rate on our fixed-rate unsecured debt was 8.4%, while the overall weighted average interest rate, including our unsecured revolver, is 7.8%.

At quarter end, debt to total book capitalization was 38.4%. Debt to total market capitalization was 30.4%. For the quarter, our EBITDA to interest coverage ratio was 3.4 times, which is higher than our trend of 3.2 times for the last several years. Currently, we are comfortably within the requirements of our public debt and credit facility covenants.

In summary, SNH has seen the benefits of contractual increases to our rents and additional income from funding our tenant capital improvements. We remain focused on our efforts to transfer management of the two rehabilitation hospitals and recognized substantially increased rent payments. Our acquisition pipeline gives us confidence in our ability to be competitive. These factors, along with continuing strong industry trends, support our Board's decision during the quarter to raise the dividend by over 3% and continue to provide our shareholders with an attractive and secure yield for their investment.

That concludes our prepared remarks. Operator, we're now ready to take questions.

(OPERATOR INSTRUCTIONS). Jerry Doctrow, Stifel Nicolaus.

I just want -- had a couple things. I guess David or John, either one, the 5.8 million CapEx, is that something you're getting current income on or is this part of a longer project that's getting capitalized to --?

No, we are getting rent on that as soon as it is funded.

As soon as it is funded, okay. And you know, you've got two or three swings factors I guess in the quarter. The step-up in the percentage rents, again, just timing on that? Was that effective for the full quarter or you got part of it for this quarter?

That's for the full quarter.

Okay. And obviously the debentures step up and you get rid of the early extinguishment of debt.

The one other thing I wanted to just clarify was, I think you said that the occupancy data is now lagging a quarter and that is true for the rent coverage data as well, because there was some movement around on the, particularly the Five Star rent coverage data and I was just trying to understand what was going on there. But it's all first-quarter numbers but not current quarter numbers?

That's correct.

Okay. And on the movement on the Five Star Sunrise, is that mostly just the change in the management fee being deducted or that's really been taken out of all periods there so that's not an issue?

That's right. The management fees for those 23 contracts are apples to apples across all of the data that's in there.

Okay. And just to come back to one or two other things. Basically, I think you indicated it was $119 million acquisition that's -- the timing is the end of August; is that right?

That's a $19 million.

$19 million, okay. Glad I clarified. And just in terms of percentage rents then and coming back to that, do they sort of vary quarter to quarter or just remind me of sort of, do they step up annually or I'm just trying to think about how we model that in as we go forward?

Yes, it's the current year over the base year amount. So it's going to vary quarter to quarter depending on revenues for that particular quarter over the base year. But it kicks in sort of January 1st.

And then every quarter you look at it so it can bounce around a little bit quarter to quarter?

Right. And then we probably can't recognize it until the end of the year.

Okay, so in the quarter's numbers, you have percentage unrecognized or you really don't have it recognized?

We have it in there for FFO but not for net income.

Okay. So you're recognizing the cash that's received, okay, into FFO. All right. I may come back to you with some detail there, but that's fine. Thanks.

Omotayo Okusanya, UBS.

Could you please talk a little bit about what you're seeing in the acquisitions market at this point, whether it's -- what kind of deal flow you're seeing, whether it's attractive assets?

Yes, we still see plenty of assets on the market. I think some of the larger portfolio transactions -- I have to say that I saw more last year than I am seeing this year. This year, there are a couple of large transactions but by and large, most of what is being evaluated are smaller portfolios. And almost every case or 90% of the cases, they are situations where people are outright selling the properties as well as the business and I rarely come across situations that are true pure sale lease back situations.

Well since our focus is predominantly the private pay sector, well we are seeing a number of independent living, assisted living, CCRC type properties, we occasionally see nursing home transactions. We're not actively chasing them either. So that is one reason why I don't see as many of that type of asset type. Anything --?

Great. Thank you.

Philip Martin, Cantor Fitzgerald.

Just a couple things here. On the acquisition front, you have talked over the last year, everybody really has, about how competitive it is. And some REITs are doing more on the acquisition side than others. But on some of these transactions that are in your pipeline, where you are pretty close or planning to announce something in the next couple of months, what has allowed you to go in and feel that you are going to be the winning bid on these transactions? Or what is it about these transactions that's different at this point?

Well I think a couple of things. One is clearly with interest rates rising, that makes our pricing more competitive and we have a number of transactions. The fact that we are working with an operator to do the transaction, the certainty of the closure, the transactions are not the larger portfolio deals but smaller portfolio transactions. And you know we've sharpened our pencil a little bit. As I mentioned in the presentation, I expect our rental rates to be in the 825 to 8.5% rate. And I just -- we're finding that several more times, we are in the final rounds this year and in some cases I expect that we are the winner.

Is that really more of a function of -- a year ago, it was really all about large portfolio deals and this year, some of the smaller deals are, like you said, your cost of financing is that much less than the competition for those smaller deals?

Somewhat. And I think -- I guess we're -- some of the larger transactions, I believe that everybody is being super aggressive in trying to acquire those so people are willing to go more out on the risk curve than we have been willing to do. And that's less of an issue with the smaller transactions.

Okay, okay, perfect. The other thing, I just missed it at the beginning. The 5.8 million, there's a CapEx that you're funding there?

Yes.

Could you just run through the specifics real quick on that since I'm traveling and my phone actually just went out.

Sure. We have a standing agreement within pretty much all of our leases, where the operator has the option of financing their capital improvements through us or through their own resources. And usually it's particularly for public companies. It's when you factor in depreciation and interest and so on and cost of capital, it's -- our capital is cost-effective.

So these are improvements that are across the board of several of the Five Star properties and we do have a commitment out there to another operator for funding improvements. And these improvements are running -- this quarter, we're funded 5.8 million and the rent goes up by the equivalent amount of what the lease is at traditionally. So right now it's 9 to 10% depending on which particular properties it's part of a pool of.

Got you, okay, so pretty standard. Okay. The last thing, can you give us an update on the Sunrise properties? You know, there's been a little time now where Sunrise has been out of the way and can you talk about the efficiencies gained if any on the operation side, on the margin side, etc., any improvements there just specifically?

I guess first off, I can only comment just at a very high level from my observations. Tomorrow Five Star will be having its conference call and they can comment more specifically on the detail at the properties.

But several -- the management contracts at 10 of the properties were just terminated effective June 1. So we've had no opportunity to really evaluate those results.

The other properties, we are seeing some improvements in the performance of the properties. Occupancies have held up or increased since those management contracts have been terminated. Five Star has freed up a number of capital improvement escrows at those properties for Five Star to utilize where they think best. And so they have been using some of those resources and been formulating plans of significant improvements that they want to do at the properties that have not yet been implemented.

So I think it's still too early to tell but definitely we've seen things moving in the right direction.

Ray Garson, UBS.

Just two quick questions. First I just had to I guess harp on the CapEx investment. I think you also said this is a good run rate going forward, so about 6 million a quarter for what, the next couple quarters? Or I guess from your tenant perspective, what have got and [kind of] got good visibility on at this point?

Well I would say probably at least about this level for the next several quarters into next year. I don't know how far into next year at this point I can foresee. But the plan is to enhance the properties and bring them up to another level, fix any things that management felt should have been dealt with over the past couple years. So there's definitely a concerted effort to spend -- to make improvements to the properties. So I envision quite a while that this will be the pace.

And does that kind of outlook touch on the answer to the question you just talked about, where you said some of the old Sunrise properties in particular maybe have a bit larger projects? Would that be incorporated into that kind of 6 million a quarter run rate? Or would that mean more money potentially from a CapEx perspective?

Well it could mean more but I'm --

Too early to tell?

And this is sort of a more or less a floor of what I expect.

All right. And then just back to the HealthSouth, I guess, situation. Is there any other kind of timelines or any other kind of dates that you can kind of help us out with? Is there anything scheduled with I guess the regulatory authority that is requiring this additional data and sign-off? Or just any sort of incremental update in terms of helping us kind of think about that going forward.

Sure. I mean the HealthSouth situation is a grind, is probably best to describe it. It's continuing to make progress. More information is being provided and there's a dialogue going forward.

Every month, there is a review of what the Public Health Council will consider for licensing and sort of -- and so every month there is more of a push to try to get data provided to them by a certain date. And if they're not satisfied by that date, pretty much there is another three or four weeks before the next deadline and everybody continues to gather that data and try to provide as much as possible. So but I really couldn't tell you if it's next month or three months from now. But that's kind of the timeframe we're trying to really push to make everything happen.

Does it feel like you're going to need a court order to get them to -- because if HealthSouth has to sign off and they say they won't, how do you reconcile that, I guess?

Well, we are -- hopefully, we may have to go back to the court to get further clarification or further help from the courts to make them -- at least agree --. What's interesting is the state basically wants HealthSouth to at least say they convey the properties and that's about all. And it may come down to going back to court to make that happen. But again, there's still dialogues going back and forth and hopefully we will get there.

Okay, but right now, you're just trying to work it out administratively as opposed to any scheduled proceedings; is that right?

That's correct.

(OPERATOR INSTRUCTIONS). Hank Rauch, Liberty Mutual.

Can you talk a little bit about this percentage rent that you're collecting in terms of whether this is a common practice in the industry or not, you know, for the health-care assets? And whether you expect to do this for more of your properties going forward? I know you've got some that are scheduled to start next year but beyond that?

Right. Well percentage rents used to be pretty much globally the norm back in the '80s and '90s and then there was more of a movement toward CPI based or fixed increases. A lot of it is a negotiation depending on the tenants and what their structure is.

For many of the private companies, they prefer to know exactly what their rate increases are. So for them, we would agree to a 2 to 3% fixed annual bumps. For public companies, they obviously don't want to straight-line the rents if they don't have to. So they are more interested in a vague concept which a percentage of rent -- of revenue increases satisfies. You know, an alternative is some people come up with formulas that it's so many -- a CPI but not to exceed a certain amount or different things like that. So I would say probably two-thirds of our leases right now have -- maybe three-quarters of our leases have a percentage formula in it. And probably further transactions to the extent they were Five Star would have a percentage rent. Any other transaction with other operators are to be negotiated.

And at the end of the day, we believe it comes out to more or less the same annual increase, so we are not -- we're somewhat indifferent as to which way it goes.

Okay. And then can you talk a little bit more about the three Smith assets that you are selling and why in fact you are avoiding that market in terms of looking for assets?

As far as making new investments in skilled nursing, we got burnt significantly back in 1999 and 2000. So since then we have had a jaded view of the sector. When we initiate into transactions today, we are envisioning an initial lease term of 15 years plus renewal options with an operator. And it may be different if the operator is a well capitalized company but many of those well capitalized companies aren't looking to do sale leasebacks today. So we're not willing to take the risk of a smaller, less capitalized company entering into a long-term arrangement like that with the belief that at some point in that next 15 years, there has got to be some major rationalization of the health-care system here in the U.S. And they can't continue to raise Medicare, Medicaid rates at the current rates that they do. So we just don't want to take that risk going forward. And we're very comfortable in the private pay side.

As far as those three skilled nursing facilities that we are selling, one is, the numbers didn't work. We saw no expectations they ever will work because it's a high acuity level and predominantly Medicaid funded and the rates didn't cover that type of care. So that in that particular facility, it was methodically being closed down. And the other two properties, you know, there is barely any profit to be made and it's right on the line and we decided that a new operator may be able to make a go of it and those are being sold as ongoing businesses.

Okay, so they're being sold to facilitate a transfer to another operator?

Yes.

Basically. Okay. So your comments about public sector reimbursement, that would lead me to believe that there is some euphoria out there maybe that there might be some hospital assets or other for-profit assets in the market because of the LBO activity at HCA and I guess potential LBO activity from other providers. Are those markets you would avoid like the nursing home assets as well?

Not necessarily but it would depend on the particular situation and structure and the price per unit. Even skilled nursing, if we were comfortable that the price per bed was an acceptable level and it was conservatively structured, we could be okay with that. But we're just finding that those assets are being pursued fairly aggressively also beyond our comfort level. So on the hospital side, you know, we would entertain the transaction on the hospital side depending on the circumstances of it.

So generally speaking then you are focused on senior living, assisted living assets and that's really what you are going to continue to do going forward?

Yes, that's our expectation. We do periodically look at other types of assets that might be triple net leased that might complement our portfolio. But we have obviously not done anything in those areas at this time.

And what sorts of assets are those? Like medical office buildings or --?

Well, medical office buildings that would be triple net leased or other types of health-care related as well as maybe even some non health-care related. But we look at a whole gamut of opportunities.

Sanjay [Ramakrishna], ING Clarion.

With respect to your revolver, you know, obviously it went up this quarter to pay down your junior notes. Do you see yourselves paying that back down in the current quarter or towards the end of the year or are you happy running with this run rate? Thanks.

Well we obviously have plenty of capacity on the revolver so there's no strong need right now to have to take it out, but we are constantly looking at the capital markets and looking at what's available to us. If we don't find anything that's attractive then we're comfortable leaving it where it is.

And then finally with respect to valuations in the current environment, so it seems to me that you would say that where cap rates are on valuations, you still haven't found it to be much more attractive to the point where you would decide more to stay on the sidelines than to be aggressive; would that be correct?

I'll never say never as far as if we saw the right opportunity, we would try to sharpen our pencil and structure it differently. We are very conservative in our underwriting. And I have to say we're not comfortable -- like a lot of the products we see through brokers or through investment bankers have a lot of pro formas in them for what could be done in the next 12 months at the various properties. And we are reluctant to put full weight in those and sometimes that's the difference between us submitting a winning bid versus somebody else because we're not willing to necessarily take that leap of faith.

And that has happened on several occasions over the last couple of years on transactions that we have lost out on.

Another question. With these three facilities for sale, so you had a $1.8 million reserve or write-down for them in the current quarter. So you are saying that you expect or would like to market them for between 6 and 8 million and do you think that would be something that could happen over the course of the year or sooner rather than later? Any timeline on that?

Yes, sooner rather than later. I would expect during the third quarter we will sell those assets and obviously that 6 to 8 million is the net after the impairment reserve that we would expect to receive in proceeds.

Okay, so 6 to 8 million would be -- oh, okay, your net -- would not be a gain.

That's correct, yes, I mean unless amazingly we misjudge the market and somebody comes along and pays more than we thought.

And do you have a dollar value right now on a pipeline of deals that you're actively pursuing at all or is that not even material?

Well if it was material, we would obviously be disclosing it. It is -- we believe we will have a number of smaller handfuls of properties to acquire over the next -- before the year is out.

Philip Martin.

Yes, thank you. Just one more here. Can you -- I think I know the answer to this based on the data you gave, but I know you have control over the operating cash flow at HealthSouth, but can you give us the aggregate amount of I guess received but unrecognized cash that you have from HealthSouth?

Yes, there's about $4.1 million of cash that we have received that we haven't recognized on our income statement.

4.1, okay. Thank you.

Omotayo Okusanya.

My question has actually been answered, so thank you.

Mr. Hegarty, I'll turn things back to you for closing remarks.

All right. Well, I just want to thank you all for joining us today. No particular closing remarks other than have a nice rest of your summer and please join us for the third-quarter conference call. Thank you.

That will conclude today's conference. You may now disconnect and have a pleasant day.