Diversified Healthcare Trust (DHC) 2006 Q3 法說會逐字稿

Good day and welcome to the Senior Housing Properties Trust third quarter 2006 earnings results conference call. This 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, Cindy, and good morning 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 this 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, November 9, 2006. The Company undertakes no obligation to revise or publicly released the results of any revisions of 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 those factors that could cause those differences is contained in our Form 10-K and Form 10-Q filed with the Securities and Exchange Commission. 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 morning everyone and welcome to our third quarter 2006 investor conference call. For those of you I had planned to meet with in San Francisco, please accept my apologies.

The most exciting news for SNH at this time is our -- last night's announcement that we reached a settlement regarding our litigation with HealthSouth Corporation. This settlement does not affect third-quarter results, but we will recognize $5.7 million or $0.08 per share of nonrecurring rental income in the fourth quarter.

I would like to first focus though on the third quarter results and address the HealthSouth settlement later in this call. We're very pleased with the results for the third quarter. Revenues were up 5% and FFO per share was up about 3% versus the third quarter of 2005. The third quarter of 2006 FFO includes $700,000 of legal costs associated with the HealthSouth litigation versus $350,000 in the third quarter of 2005. As we had pointed out on prior calls, in addition to the minimum base rent on the [five style leases], SNH is entitled to 4% of growth in revenues at these properties over a base year. This was the third quarter that many as the properties leased at Five Star were subject to percentage rent. 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 to 2.5% to 3% per annum.

For the third quarter, the estimated percentage rent was $1.3 million versus approximately $800,000 for the third quarter of 2005, just a $500,000 increase year-over-year. On a year-to-date basis, the percentage rent for 2006 was $4 million versus $2.4 million for 2005. Keep in mind that each quarter's percentage rent is estimated and at year end, the percentage rent is trued-up based on audited numbers. As a result, the numbers can fluctuate somewhat on a quarter-to-quarter basis.

On the investment front, it has been productive few months for us. During the quarter, we acquired five senior living properties for $61.5 million and funded $5.7 million in improvement financings at our properties. Subsequent to the end of the quarter, we closed on the acquisition of another five private payer assisted living communities for $42.6 million, as well as closed on the sale of two skilled nursing facilities for net proceeds of $6 million. Since the beginning of the year, we have acquired 10 properties for about $105 million, plus we've funded about $17 million of capital improvement financings at our properties. We continue to evaluate a number of investment opportunities, most of which are individual properties or small portfolios and we're optimistic that we'll complete some of these transactions before the end of the year. Overall, the acquisition environment remains competitive and we expect future transactions to be at the 8 to 8.5% initial rental rates.

With regards to our portfolio metrics, occupancies declined from the March quarter slightly in all categories, including independent living, assisted living and skilled nursing facilities. We do not believe this is the beginning of a trend, just a pause. In some cases, the difference is just due to rounding.

The two areas that have decreased that's worth noting are the skilled nursing facilities in Five Star's portfolio which had a decrease of a couple of percentage points in occupancy and the Brookdale portfolio of assisted living facilities, which decreased from 90% in the March quarter to 86% in the June quarter. The decrease at Five Star was a result of declines in occupancies at two skilled nursing facilities that were being prepared for sale, as well as units closed for renovation during the quarter.

With regards to the Brookdale portfolio, occupancy declined because one property was closed during the quarter as a result of storm damage.

Despite these decreases, the cash flow coverage of the rent of our tenants is still very strong at 1.2 times to over 2 times the rent for each lease. The master lease with Five Star had a decline from 1.49 to 1.35 from the March quarter to the June quarter. This was primarily due to the decline in occupancies at the skilled nursing properties and the communities undergoing renovations which I just discussed. The sale of two underperforming nursing homes after the end of the quarter should improve coverage of this lease in the future.

I would also like to bring your attention to this morning that Five Star announced it has terminated the last remaining management agreements with Sunrise. As a result, the coverage ratio for the Five Star/Sunrise lease should improve in the future.

Shortly after the quarter end, our Board of Trustees declared a $0.33 per share dividend, which is consistent with the prior quarter dividend level. On a historical basis, the payout ratio is 85% of FFO for the quarter, which is still a very comfortable and conservative payout ratio. This represents a cushion of approximately $15 million to $16 million per year to protect the dividends.

As I mentioned earlier, we reached a settlement with HealthSouth in the last 24 hours. This settlement puts an end to a significant distraction and substantial legal costs over the last few years. As part of the settlement, HealthSouth's lease was reinstated until September 30, 2006, and the rent was increased back to January 2002. As a result, yesterday, HealthSouth paid us $3.35 million, which represents the total amount due for back rent, and we will recognize the $3.5 million, plus $2.2 million of payments previously received that have not been recognized, for a total of $5.7 million, or $0.08 per share, as nonrecurring rental income in the fourth quarter.

Even though litigation costs related to this matter should cease in the future, we will still report some legal and related fees in the fourth quarter. At this time, we cannot quantify the exact amount of those costs for the fourth quarter. As a result, or as a reminder rather, Five Star leased these two hospitals as of October 1, 2006, at annual rent of $1.6 million, more than we have been recording in the past.

And now I will 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 September 30, 2006 were $42.3 million, which is a $2 million increase, or 5%, over the third quarter of 2005. Rental income increased because of rents from our $144.7 million of real estate acquisitions since July 1, 2005, offset by rent reductions resulting from the sale of three properties for $12.5 million in December, 2005.

Interest and other income decreased $400,000 from the 2005 quarter as a result of a prepaid mortgage loan that occurred in August 2005.

Interest expense was essentially unchanged in the third quarter of 2006 versus the third quarter 2005. We had higher interest costs associated with our revolving bank credit facility due to increased amounts outstanding on the revolver and an increase in LIBOR rates. The increase in interest costs was offset by our repayment of $52.5 million of our senior notes in January 2006 and all 28.2 million of our junior subordinated debentures in June 2006.

General and administrative expenses of $4.1 million in the third quarter were up by $800,000 from the 2005 quarter. These expenses increased in 2006 due to acquisitions since July 1, 2005, and include $700,000 and $350,000 of HealthSouth litigation costs in the third quarters of 2006 and 2005, respectively.

Income from continuing operations and net income were $15.4 million for the third quarter compared to $14.1 million for the same quarter last year, which represents a 9% increase. 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 3.25 million shares in December 2005.

At quarter end, our balance sheet remains solid. We had $1.8 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 $81 million since the 2005 year end, which represents new investments of $64 million and improvement financings at Five Star properties of $17 million.

On the liability side, our real estate investments are partially funded at $642 million of debt as of September 30, 2006. Our debt is comprised of two senior note issuances due in 2012 and 2015 to $342 million and mortgages and capital leases that mature between 2012 and 2027 for a total of $79 million.

In addition, we have a $550 million revolving bank credit facility. At September 30, we had $222 million outstanding on this credit facility. As of today, we have $225 million outstanding, which leaves us with $325 million of available capacity.

At September 30, 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 is 8.4%, while the overall weighted average interest rate, including our unsecured revolver, is 7.5%. At quarter end, debt to total book capitalization was 41.8%. Debt to total capital market capitalization was 29.5%. For the quarter, our EBITDA to interest coverage ratio was 3.3 times, which is consistent with our trend over the last several years. Currently, we are comfortably within the requirements of our public debt and credit facility covenants.

In summary, SNH is seeing the benefits of contractual increases to our rents and additional income from acquisitions and funding of our tenants' capital improvements. We also remain focused to grow cash flows through new investments in the private pay sector. Finally, we're very pleased that we have favorably concluded our litigation with HealthSouth.

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

(Operator Instructions). Jerry Doctrow, Stifel Nicolaus.

Good morning. Actually, it's Eric Gommel standing in for Jerry. Just a couple of questions. Can you just again discuss the acquisitions in fourth quarter? I think we -- in our model, we look at -- we currently have about a $31.2 million in acquisitions, and then we are expecting $50 million in acquisitions in 2007. I'm just curious what your prospects -- what prospects look like for '07, and I think just clarify again what you have already done in fourth quarter and what the rest of the quarter is shaping up as?

Our position on acquisition has been that we don't really give guidance going forward for acquisitions. We have typically told people $100 million to $200 million is our targeted objective, because, given the size of our Company, that is what -- we can to $100 million of deals, and that moves the needle on our cash flow and allows us to increase the dividend and so on. But the reality is we chase a number of the smaller deals, as well as several of the larger deals, and it's very unpredictable what our odds are of succeeding in some of those bids. So in essence, for 2007, your guess is as good as mine since I was I was trying to quantify it.

As far as this year, we have required about $105 million in total and we hope to close some of them a little bit earlier in the year than we had, but we've closed the transaction in September 1st for $61.5 million. Then the other $31.5 million has occurred right on October 1, or within the first couple of weeks thereafter.

It's $42.5 million.

So we were at about $105 million for the year, plus all the improvement in financings and other things that we have been doing.

So, again, our focus is pure private-pay properties. I say pure, but there might be a CCRC with a skilled nursing component that has some Medicare money or maybe some Medicaid money, but that's a component of a larger picture. And all of these properties, all except for one, we have required this year, has historical cash flows that exceed the rank going into deal, and that one property is a property down in Naples that was bought back on September 1st that we know it's a diamond in the rough and we feel confident putting some money into it, it will perform very well going forward.

And my last question, our understanding is, on October 1, Five Star took over managing the rehab hospitals, the HealthSouth hospitals, and rent jumped on that date. Can you just confirm that? And then, do you expect to invest additional cash into these properties for CapEx and such, and how do you guys see that as impacting rent going forward?

The rent did go up on October 1st by $1.6 million per year for the property, so you can calculate that into the fourth quarter. We envision that, right now, they are doing some lighter improvements to the properties, more cosmetic -- and improve the curb appeal, and then they intend to go back in with a more comprehensive significant capital improvement program for two rehab hospitals. I envision that we will fund the improvements, probably it won't be until 2007, the bigger dollar ones, and when we fund them, I would expect our rent to go up by approximately 10% on the amounts funded.

Great, thanks.

Rick Murray, Raymond James.

Two questions. One, what do you think the anticipated improvement in coverage will be from the termination of the remaining Sunrise contracts?

Well, if you were to take the June quarter, which is in our supplemental, that is at 1.33 times in the supplemental. That, if you were to recalculate it, just pointing out the management fees, the number would be 1.51 times. And that's without -- obviously, Five Star will have some overhead cost (Inaudible - background noise) do a number of things to improve the operations at the property.

The other question I had was, you're obviously at this point looking at selling off a couple of underperforming SNF assets. Is there any thought going forward to further pruning the exposure to nursing homes?

Our current intention is more one-off properties and not the large transaction like the one that was done by HCP. We're not -- or that HCP is planning on doing. So we don't have a current plan to do a major exit of the sector.

Okay, great. Thanks.

David Supros, Merrill Lynch.

Just to get a sense on those two rehab hospitals. I guess what is the EBITDA run rate of those hospitals? I know you don't give out coverage, but is there an expectation there?

Well, historically, unfortunately, the only numbers we have had available to us to date have been the numbers generated by HealthSouth through September 30th, and we don't know how much we can rely on those numbers. And so we don't have good data going forward yet. Clearly, we believe that there's opportunities there and that the cash flow today covers the rent. How much, I would not want to estimate right now because we're still trying to find out the answer to that.

Okay, but there's an assumption that it's not close to one, because increasing the rent by, whatever, $1.6 million, so there's either the assumption that they're being undermanaged or that the coverage, even based on those numbers, well exceeds one times?

That is correct. It's some or both of what you just said.

Okay. And then on the capital improvement funding, you actually mentioned that -- it sounds like you get sort of a lease rate of 10% on the improvements you make at that rehab hospital. Is that right, basically?

Yes.

And then looking forward, it seems like you're consistently doing about $6 million a quarter of improvements across the portfolio. Is that a good run rate to think about? And what is the lease rates on those improvements?

You could -- it's a good run rate because I expect it to continue at least at that level for the next couple of years probably. The lease rate, it depends on the actual property and what its initial rental rate was set at when we funded the property. But probably for your calculations, I think you'd be pretty -- materially close, if you use 10%.

Okay, that's great. Thank you very much.

Omotayo Okusanya, UBS.

Dave, I just wanted to confirm that for future acquisitions, you expect the cap rates to come down, so do you use a 8.5 to 9 or 8 to 8.5?

Yes, I mentioned in the presentation, 8 to 8.5 is our current parameters that we envision. Whether we can -- even if it's a Class A asset, whether even 8% does it, is questionable. But if we feel that it's a highly desirable asset, we will be in that range for that type of situation, versus more bread-and-butter type properties, we are more likely to be the 8.25. 8.5 maybe at other times, but -- so I just gave that range of between 8 and 8.5.

Great. Thanks, Dave, good quarter.

(Operator Instructions). [Asa Qadri], [Schroeder].

A couple of questions. I saw there was an increase in your revolver debt. Was that used for the building acquisition?

That is correct.

In the future, are you going to use primarily your revolver, or what are your views on the (indiscernible) property?

Historically, we have use the revolver to close acquisitions in sort of the near-term, and then once the revolver level got to a certain amount, there's no set number of what that amount is. We have $550 million of capacity, so we have about $325 million of availability today. But generally, we're in -- looking at the capital markets to see what our opportunities are to then take that revolver down.

At this time, it appears we have no further questions. I would like to turn the conference back over to David Hegarty for any additional or closing remarks.

Thank you, everyone, for joining me. I would like to just also point out that we will be presenting at the Merrill Lynch Health Care Services conference in late November, and the Wachovia Global Real Estate Securities conference in early December in New York -- both of those are in New York. And we look forward to seeing you there and hopefully having a chance to catch up and talk there. Thank you.

Thank you. That does conclude today's conference. You may disconnect at this time.