Diversified Healthcare Trust (DHC) 2006 Q4 法說會逐字稿

Good day, and welcome to the Senior Housing Properties Trust fourth 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, Matt, and good afternoon everyone. 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, February 28, 2007. 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, which will be filed by tomorrow, 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 afternoon, everyone. As many of you may have seen earlier today we announced the appointment of Rick Doyle as Treasurer and CFO of SNH effective March 15th. Rick will be replacing John Hoadley, who will be leaving us to become the Executive Vice President, Treasurer and CFO of a related company, Travel Centers of America. Travel Centers was recently spun out to shareholders by our sister REIT, Hospitality Properties Trust, and now trades on the American Stock Exchange under the symbol TA. As many of you may know, both SNH and TA are part of a large family of public companies which receive management services from REIT Management and Research,or RMR. One of the many benefits of being managed by RMR is that we get to draw upon a large, deep pool of resources, which would be likely unavailable for SNH as a standalone enterprise. As a result, Rick comes to SNH well seasoned and well prepared for the role of CFO, having held many senior accounting and finance positions at RMR during the last two years.

In addition, Rick has been working closely with both John Hoadley and I during the last six months on SNH matters and is thoroughly up to speed on the company. Prior to joining RMR, Rick was with Sunlight Financial for ten years, holding senior positions in both accounting and finance. Rick also has an MBA and is a Certified Public Accountant. Although Rick will not be officially taking over the duties of CFO until March 15th, following my prepared remarks Rick will be reviewing SNH's fourth quarter and year-end financial results in more detail. And Rick, John and I will be available to answer any questions afterwards. Before I focus on the quarterly results, I just want to say that John has contributed greatly to SNH's growth over the last six years and we wish him well in his new position with TA. At the same time, I'm excited that Rick has agreed to join us. Now let's talk about the performance for the company this past quarter and year ended 2006. We had an excellent 2006 [INAUDIBLE] SNH. Our stock performance for the year was excellent, as we were the best performing senior living REIT at 55% total return and, according to SNL Securities, one of the best of all REITs for 2006.

I'm sure you feel it's all fine and good, but what does the company look like today and for 2007. In order to help you model out the future, we need to discuss the fourth quarter and 2006 annual results first. We were very pleased with the results for the fourth quarter, revenues were up 25% and FFO per share was up about 24% versus the fourth quarter of 2005. However, that's reported revenues and FFO per share and not what should be considered run rate on normal revenues and FFO. The fourth quarter 2006 includes $5.7 million of nonrecurring rental revenues from HealthSouth, as a result of a settlement agreement with them on November 8th. There were also $260,000 of legal costs associated with the HealthSouth litigation versus $600,000 in the fourth quarter of 2005. Without the one-time settlement with HealthSouth and the related legal fees for the quarter, our normal quarter FFO would have been $0.40 per share. For the year we earned $1.57 per share of FFO compared to $1.50 per share in 2005. This amount reflects the HealthSouth settlement in the fourth quarter of $5.7 million and approximately $4.1 million of a loss on early extinguishment of debt settled in cash.

As previously reported, we determined in January, 2007 that a loss on early extinguishment of debt taken in December, 2005 should not have been recorded until the debt was actually paid off on January 9, 2006. And as a consequences, the 2005 results and the first quarter 2006 results had to be restated. This pushed the loss on early extinguishment from a 2000 to 2006. Without the HealthSouth settlement the loss on early extinguishment of debt and the 2006 legal fees related to HealthSouth, somewhat remarkably the net result equals the same $1.57 per share on a normalized basis. Let's turn to the performance of portfolio in a larger picture. The properties in the portfolio continue to perform very well. Occupancies at the properties continue to be generally in the 88% to 93% range and the coverage ratios at the properties range from 1.14 times to well over two times. Our two largest leases with Five Star generated cash flows to cover the rent of 1.5 times. For predominantly private pay properties this is very strong coverage.

As I mentioned on our last call, on October 1st, Five Star took over the operations of the two inpatient rehabilitation hospitals in the Boston area, formally operated by HealthSouth. Five Star began paying us rent at an annual rate of $10.3 million, which is $1.6 million per year higher than what HealthSouth was paying us. Five Star has done on excellent job in taking over the operations and assessing the operational and physical needs of the hospitals. SNH will be providing funds for capital improvements at these hospitals over the next few years and Five Star's rent will increase at roughly our cost to capital. During the fourth quarter of 2006 we acquired $46 million of private pay independent living and assisted living properties and leased them to Five Star at an annual rental rate of a little over 8.25% of the acquisition cost. During the quarter we also funded $7 million of improvements in expansion funding and it earned increased annual rent of approximately 10% on the amount funded. During the quarter we also sold three skilled nursing facilities for $7.9 million and realized a net $21,000 loss on the sale.

For the year we had acquired $107 million of private pay senior living properties at an average annual initial rental rate of 8.29% and an average cost of approximately $80,000 per unit. For the year we funded $25 million of improvements and expansions and sold the three skilled nursing facilities for $7.9 million. In the upcoming year I anticipate most of our acquisitions to be single asset and small portfolio type transactions. In addition, I expect the capital improvement funding will be at greater levels than the last quarter. Results of additional growth from annual rental increases, you will note that our annual straight-line rent is less than $400,000 per year and most of our internal growth is from percentage of revenues growth at the property, so a CPI type increases. For 2006 a percentage of new revenue formula resulted in approximately $2.1 million of increased revenues that fell to the bottom-line, or $0.03 per share. Approximately 35 of the properties in the second Five Star lease commenced participating in the percentage rent formula in 2007, which should provide some additional growth.

We will continue to try to acquire $100 to $200 million of properties annually at rental rates of 7.75% to 8.25% range, as well as opportunistically pursue larger transactions. We evaluate $500 million to $1 billion of investment opportunities each quarter and in this environment several of our competitors had to go out further on the risk curve to close a transaction. We will remain disciplined, which likely points us to small portfolio and one-off transactions. All these activities are designed to grow our cash flow in order to prudently raise the dividends. Over the last year we have raised the quarterly dividend on two occasions by 3%, so that the annualized run rate is $1.36 per share today versus $1.28 per share a year ago, which is a 6.25% increase year-over-year. The payout ratio continues to be a conservative 85% of FFO, using the fourth quarter normalized FFO amount of $0.40 per share. Our board evaluates the dividend on a quarterly basis and has a bias toward raising the dividend when it believes it prudently can. Before we turn the presentation over to Rick Doyle, John Hoadley would like to say a few words.

Thank you, David. I just wanted to take a minute to say that I've greatly enjoyed my time at SNH over the past six years, including the professional associations I've been able to establish. Of course those of you who may be interested in small cap operating companies may still wish to speak to me and I do look forward to that. On a personal note, I would like to take this opportunity to thank Dave Hegarty for his guidance and support over the years. It has been a pleasure working with and leaning from him. Also I want to wish Rick Doyle the best of luck as he takes on his new role. Having worked closely with Rick over the past six months, I know that I'm leaving my post in good hands. That's it. I'm going to turn it over to Rick, who can discuss the fourth quarter and annual results.

Thank you, John. Hello, everyone. I appreciate the opportunity to speak with all of you for the first time. I am very excited about my new position at SNH and I look forward to meeting all of you in the coming months. I would now like to focus on the financial results for the quarter and year ended 2006. As Dave already pointed out, the revenues for the fourth quarter were $55 million, which is a $10.9 million increase or 25% over the fourth quarter of 2005. If you exclude the HealthSouth settlement of $5.7 million, revenues actually increased $5.2 million or 12% year-over-year. Rental income increased because of rents from our new acquisitions of real estate since October 1, 2005, offset by rent reductions resulting from the sale of three properties during 2005 and three properties in the fourth quarter of 2006. Also, percentage rent in the fourth quarter of 2006 was $1.3 million versus $800,000 in the same period in 2005. On an annual basis, this was an increase in percentage rent of $2.1 million, which drops to the bottom-line and increases FFO by almost $0.03 per share.

Interest expense was essentially unchanged for the fourth quarter of 2006 versus the fourth 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 note and junior subordinated debentures, as a result of our repayment of $52.5 million of our senior note in January, 2006 and all $28.2 million of our junior subordinated debentures in June, 2006. General and administrative expenses increased in the fourth quarter of 2006 over the fourth quarter 2005 by $800,000, if you exclude the HealthSouth litigation cost. This was partially a result of the incentive management fee being earned and overall increases in professional fees and public company costs. At quarter end our balance sheet remained solid. We had $1.8 billion of real estate investments, all fees, interest and senior living properties. The average lease term remaining on the portfolio is 11.5 years. Real estate investments increased by $128 million since the 2005 year-end, which represents net new investments of $101 million in improved financings at Five Star properties of $27 million.

Our capital structure remains very strong with a debt to book capital ratio of 35%. During 2006 we improved our capital structure. We redeemed $52.5 million of 7.875% senior notes back in January, 2006. We redeemed all $28.2 million of our 10.125% junior subordinated debentures and issued $126 million of our equity in November of 2006. At year-end we had $112 million outstanding on our $550 million revolving credit facility. In November, 2006 we amended our revolving credit facility to push out the maturity to 2010 and reduced the borrowing cost by 25 basis points. Subsequent to year-end we purchased $20 million of our 8.625% senior notes in the open market and issued 6 million common shares of equity for net proceeds of $151.5 million. As a result of this offering, the company paid off debt with equity at neutral cost. Today we have the entire $550 million available on the revolver for future acquisitions. For the quarter our interest coverage ratio was 3.7 times, which is better than 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 well positioned to grow internally and externally. The capital improvement funding and percentage revenue growth allow us to grow faster than inflation and we expect to be modest acquirers of senior living properties this year. That concludes our prepared remarks. Operator, we are now ready to take questions.

[OPERATOR INSTRUCTIONS] We will go to Jerry Doctrow with Stifel Nicholas.

Good morning, guys, or I guess good afternoon at this point. I had just a couple things, David, and I guess maybe start just about acquisition environment. I wanted to get a little bit more color there. I think you had described it, or Rick had described it, as sort of modest levels of acquisition. You guys have been pretty disciplined, there's been some crazy prices. What do you see it as, and I guess particularly in light of the fact that Five Star has some excess cash right now, what do you see yourself doing this year? Then I also want to get a little more color on the volume of CapEx you might be funding.

The acquisition environment is difficult as it has been all along for the last say year or two. What we're finding is clearly the larger the portfolio the higher the premium that people are willing to pay. And we just can't do transactions at say seven cap rates or lower and so we have to look for transactions that are in the 8% or 8.5% cap rate level. If it's really a nicer asset and we feel we will be a little more agressive on it, we will do that. So as a result the transactions that make sense for us are more the individual facilities or multiple facilities, say less than five facilities being offered by the same seller. And we're finding that when we're acquiring those type of properties, our biggest competition is typically a mom and pop or regional operator and our certainty is closure usually results in people -- the the seller going to us. So that's why I envision that we will continue to buy more one-offs and small transactions.

The 100 million volume is -- 100 to 200 million volume is doable you think, David?

I believe so. I mean, again, it's very difficult to forecast, but we certainly are seeing a number of opportunities to pick up onesies and twosies and the range of individual transactions from a dollar perspective typically range from $5 million, rather, for one property to even $25 million or $30 million for some of the larger retirement communities. So I do believe that it's feasible this year.

And I know you said you're stepping up CapEx, obviously for rehab hospitals and some other stuff as well. Do you have just a sense of what that -- how much you'd be spending over the course of the year?

Well, this past quarter was $7 million or so and I envision that that will go up somewhat to maybe as much as $10 million a quarter. And that is not including the inpatient rehab hospitals. And for those types of improvements, as I mentioned, we're getting typically close to 10% return on.

Okay. And then on the rehab hospitals, did you have a separate number on that and that's being done at cost to capital, right?

Right. Five Star is is formulating different plans for the program. Just to give you some sort of magnitude, I believe it's going to probably come in the neighborhood of $10 to $15 million for the total project for the two hospitals and because Massachusetts is a certificate of need state, it's process you have to go through and it may take two to three years to do all that work.

Okay. That's helpful. Then just a couple details if I could. Hang on. I'm sorry, David, was trying to get background on here. Just one or two things. The interest rate I think was just a little higher than what we talked about. Is this a good sort of run rate for the quarter, was there anything else going then we expected just in terms of interest cost?

Well, interest cost should come down somewhat, because during the quarter -- this first quarter 2007 we raised equity and paid off the revolver to zero and we -- we had redeemed $20 million, we actually bought in the open market $20 million of our 8.625% public debt. So net/net the equity ended up costing about the same as our cost of debt.

I was thinking actually about rate, is there anything else going on in terms of amortization cost or any of that sort of stuff that -- or is that going to stay pretty good at the current rate for the quarter in terms of the amount of debt goes down.

Right, from a rate perspective I envision that to be a pretty stable environment. Obviously judging from various economic reports yesterday and so on I don't know if interest rates are actually headed down or up.

And then just in terms of just general guidance on equity issuance. Obviously you have got the full line, so you could certainly more than fund everything on the line. As you go sort of forward from this point, just your general sort, is there a general sort of rule of thumb about use of equity or whatever, or would you anticipate sort of leveraging back up during the year on the line.

Well, clearly we're sitting on about $15 to $20 million of cash today and the revolver is undrawn. So we will be using the revolver for the foreseeable future for acquisitions. I don't anticipate us accessing the capital markets near term, barring if we were very successful on a large transaction that would change everything somewhat. I would have to evaluate where the markets are at that time.

Okay. Great. Thanks.

Okay, you're welcome.

We will go next to David Tsoupros with Merrill Lynch.

Thank you, good afternoon. I just wanted to ask about the acquisition pipeline. Is there anything that's kind of front burner that you would think get completed here within the first half of the year so you put that cash to use?

Yes, we definitely do have some transactions in the pipeline and they're more of the similar nature of one-offs and a couple properties being sold by the same owner. So I do envision doing business in the -- a fair amount of business in the first half of the year.

Okay. The two rehab hospitals now under Five Star's control, do you just have a sense of maybe in the three months time period is EBITDA covering the pro forma rent for the three months or is that something that's going to ramp up over time?

Well, a couple thoughts on that. One is Five Star has a earnings call tomorrow, so they will provide some more insight onto those hospital operations. But I can tell you that from the indicators I've seen it indicates that the properties do cover the rent and then some currently.

Okay. And just on the three skilled nursing facilities that you sold, what's the, I guess, annualized rent that you're giving up there for those three facilities?

That would be about $790,000, which is about a 10 cap on that, on the proceeds from that sale.

Okay. That's great, thank you.

You're welcome.

[OPERATOR INSTRUCTIONS] We will go next to Omotayo Okusanya with U BS.

Good afternoon, gentlemen. Good quarter. Just a quick follow-up question about the SNF properties that were sold. Could you explain again to me why you ended up booking a loss on them.

Sure. It was actually a -- the transaction costs were enough to throw it into a loss position. We would have had otherwise a modest gain. But those three properties, one is closed and the other two, one was a distressed, marginally distressed situation and the third one was a profitable situation. And they were bundled together to get the best proceeds from the sale. So it very modest. I think we had maybe a couple years ago taken an impairment reserve on one of those properties before. So we felt it was pretty close to net book value we were selling at.

Okay. Great. Thank you.

You're welcome.

We will go next to Phillip Martin with Cantor Fitzgerald.

Good morning, gentlemen, or good afternoon, I should say.

Good morning.

Hi, Phil.

My HealthSouth question was answered, but on your investment opportunities and looking ahead, are you hearing anything from operators or the tenants, your existing tenant base on new developments?

Not -- everybody is looking for it. And there is some going on out there, people trying to figure out how to get into it. I still believe that the demand is significantly outpacing the growth and supply out there. But I'm not seeing much at all in the way of new development, Sunrise is clearly the one who is developing the most, but again it's not widespread that I'm aware of.

Okay. Are you seeing expansion opportunity -- I mean I know you're spending some money on expansions this year, what does that include specifically?

Right. The expansions that we're seeing in our portfolio and what we're hearing about elsewhere are ones of adding, typically, anywhere from say 8 to 20 units say per building. I think at Five Star alone that they are -- have on the drawing board somewhere between 700 and 800 units that they want to add to their properties. And most of that we would be funding the expansion. And we're doing an expansion for a skilled nursing facility up in -- out in California that's about a $4.5 million expansion. That is actually not to add any bed capacity, but to blow out their rehab unit and expand the cafeteria and some of the common areas. So people are looking for ways to expand the existing assets rather than -- .

Develop new ones.

Right.

Okay. Okay. And then on your sale, the skilled nursing sale, how many units did that involve or beds?

Let's see. Off the top of my head I think it's, it would be about 300 units between two of the properties in Connecticut and the other one was closed, so it's not in our bed count.

Okay. How many beds did that include, the one that was closed? Or units?

It was about 120 I think.

About 120.

I think.

Okay. Okay. Thank you very much.

Okay, you're welcome.

At this time we have no further questions. I will turn the call back over to David Hegarty for any additional or closing remarks.

Well, I just want to thank you for joining us this afternoon and have a good day and we will be happy -- if you have any questions you can certainly call us later on. Thank you.

Thank you for your participation, you may now disconnect.