Diversified Healthcare Trust (DHC) 2007 Q2 法說會逐字稿

Good day, and welcome to the Senior Housing Properties Trust second quarter 2007 financial 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, Laurie, and good afternoon, everyone. Joining me on today's call are David Hegarty, President and Chief Operating Officer and Rick Doyle, 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, July 30, 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, or SEC, regarding this reporting period.

In addition, this call may contain non-GAAP numbers including funds from operations, or FFO. A reconciliation of FFO to net income is available in our supplemental package found in the Investor Relations section of the Company's Web site. 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-Q, which will be filed later today and 2006 Form 10-K filed with the SEC as well as in our Q2 supplemental operating and financial data found on our Web site 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.

The second quarter of 2007 was solid, but uneventful, which given the conditions of the capital markets recently may not be a bad thing. The main points are that the revenues increased year-over-year by 8.9% and funds from operations on per share basis increased 5.1% to $0.41 per share.

For sell side analysts who follow us estimated $0.41per share to $0.42 per share of FFO for the quarter and we came out on the low end of that range. Although there were many contributing factors, the main reason is that we did not do any acquisitions in the quarter. Our other lesser factors included additional G&A expenses and lower percentage rent than anticipated.

As in our previous calls, Rick will discuss the specifics of our operating results and I will discuss the acquisition environment, our tenants' performance, and trends in the industry. Being one of the first healthcare REITs to report this quarters results, you'll have to wait to compare our results with other.

As I said, during the quarter we did not sell or acquire or sell any assets. We actually had three properties under agreement in the first quarter for almost $20 million, however, one of these was terminated during the diligence period by Five Star, our proposed tenant.

We, however, do have two assisted living facilities with 112 units under agreement to purchase for $14.1 million. The communities are 100% private pay and approximately 98% occupied.

The properties have HUD financing that we would assume and we're going through the approval process now. We expect the acquisition to close in the third quarter and at that time the properties will be added to the master lease with Five Star and rent will be increased by $1.1 million, or 8% on the purchase price.

While purchasing properties from smaller operators provides opportunities, one of the risks is that the financial reporting systems lack sophistication and often they operate on a shoestring budget with minimal employee benefits, by use in various supply vendors. In these cases, it can be determined that operating results are overstated, or, once brought up to a public company's operating standards, the operations may lose money after rent.

During the quarter we also funded $7.5 million of capital improvement funding which generated an increase in rent equal to approximately 10% of the amount funded. Year-to-date we have funded $17.1 million of capital improvements.

We continue to evaluate several investment opportunities and I'm still optimistic that we'll acquire over $100 million of investments this year. Given the volatility of the capital markets today, both equity and debt, SNH is in an excellent position to grow.

Our leverage is only 26% of our total book capital. We're sitting on approximately $25 million of cash and have a $550 million revolving credit facility immediately available. We have no significant debt maturing for another six years. This positioning may provide us with the opportunity to capitalize on situations that are not available to others without access to capital.

The portfolio continues to perform well. For the first quarter of 2007, most of the publicly traded senior living operators noticed the dip in occupancy of probably 50 basis points, 200 basis points.

Five Star was no exception and that affected the coverage ratio somewhat at our properties. Coverage ratios are still at a comfortable level and at industry conferences in May and June, Five Star reported that occupancy levels have been steadily increasing.

Our two rehabilitation hospitals leased to Five Star have a much more volatile cash flow than senior living assets due to the shorter lengths of stay and an active program to reposition and improve the hospitals. At the end of the first quarter Five Star's coverage on the two hospitals moved to slightly below one times.

Five Star has been performing a significant amount of construction at the properties, which is disruptive, has been implementing new programs and managing the occupancy to be in compliance with the various phase-ins of the 75% Medicare reimbursement rules.

With regard to the other operators in the portfolio, the coverage at the New Seasons portfolio has bounced back to over one times, which is more in line with historical results and the prior quarter drop should be considered an aberration. Brookdale remains at over two times coverage, Genesis down a little but at still at 2.3 times coverage, and the other smaller private operators are performing at an acceptable level.

As most of you know, our second largest tenant, Sunrise Senior Living, announced it has hired an investment banker to help it explore strategic alternatives. As an owner, we are looking at our consent rights in different scenarios, but we feel adequately protected by virtue of the fact that these leases are guaranteed by Marion International, which is an invest-grade rated company. Along with everyone else in the industry, we'll be monitoring the situation closely.

Before I turn things over to Rick, I'd like to first discuss our first six months of 2007 financial results relative to SNH's stock price performance. Since January 1st when our stock price opened at approximately $24.50 a share, we have raised the dividend, paid down high priced debt, strengthened the balance sheet with an equity issuance, and increased six-month FFO by 10% on a year-over-year basis.

Through our conservative financial approach, we're in a position of strength in terms of financing potential acquisitions. As Rick will discuss, we have plenty of ready capital, we'll continue to pursue transactions large and small and in the interim, we have good sources of internal growth, a low payout ratio, and room to grow it.

Thank you, Dave.

As Dave mentioned, we had strong growth in our revenues in FFO year-over-year. Revenues grew by $3.7 million, or 8.9% from the second quarter 2006 to the second quarter 2007. This was primarily due to approximately $145 million of acquisitions in improvement financings and increased rent at the two rehabilitation hospitals in other properties subject to CPI increases in rent.

For FFO purposes we have recognized $1.7 million of percentage rent in the current quarter versus $1.5 million a year ago. Interest expense decreased from $11.5 million to $9.2 million year-over-year, primarily due to reduced leverage levels.

During the current quarter, we did not borrow on our revolving credit facility and actually have been using operating cash to fund the improvement financings, therefore, we had zero outstanding on our $550 million revolving credit facility and approximately $25 million of cash on hand.

General and administrative expenses were at $3.4 million and slightly higher than the 2006 quarter and $267,000 lower than the first quarter of 2007.

After the quarter end the board of trustees declared a dividend of $0.34 per share. This represents a payout of approximately 83% of the FFO per share. On an annual basis there is a $23.4 million cushion between FFO in the dividend level.

In closing, while we are disappointed with the year-to-date drop in SNH's stock price, we believe that this downturn is not reflected of any concern that investors have with SNH specifically, but are more the result of outflows from the REIT sector over the past few months.

There are a number of factors that we feel make SNH an attractive investment. First, SNH has long-term leases with strong credit quality tenants. 97% of our portfolios leased to public companies are investment-grade rated tenants.

Second, 85% of our revenues come from properties that are more than 80% private pay. This payor mix is among the best all healthcare REITs and somewhat insulates SNH from the government-funded programs.

Third, SNH has a conservative financial structure with debt to total book capital of 26%. In addition, with an untapped $550 million line and $25 million in cash on the balance sheet, SNH is well positioned to pursue accretive acquisitions, even in this fickle market environment.

Fourth, SNH has a low dividend payout ratio of 83%. This is more than enough cushion to cover the dividend.

And finally, these factors, combined with the current dividend yield of nearly 8%, make SNH a compelling investment for value and income investors.

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

(OPERATOR INSTRUCTIONS) We'll go first to Chris Pike with Merrill Lynch.

Hey, guys, how you doing?

Good, Chris.

Sounds like you're doing everything well, everything you can do except for buying your stock back. So I know you kind of talked about it last quarter.

Seems to us you're trading close to a 10% implied cap at this point given that property out there is selling still probably 6 or 7s. What's stopping you guys from going out there and buying your own stock back?

Well, a few things. One is right now the stock price has taken a significant dip for us as well as all across the REIT industry and we don't know if this is where things are settling out or if this is just a volatile phenomenon. So I don't think based upon short-term fluctuations of price that we should make a decision on buybacks.

But also, we view that when you have capital and others don't creates the most opportunities for you to invest in new opportunities. And for us to do a meaningful buyback, we would have to lever up the Company, reduce our capital available for future growth and we're criticized enough as it is from the rating agencies as well as the public markets about being too small a company to start with. So there's a lot of considerations.

O know that recently there was an article in the Journal about buyback programs and I think for the most part, concluded that for the short-term it provides a bump to the stock price. People can exit but for long-term, it doesn't necessarily leave the Company in a longer-term better position.

I can certainly understand that except it doesn't seem like you guys are moving that quickly in terms of acquisition velocity. So is that, are we to imply at this point that there's maybe portfolio acquisitions coming down the pipe? Or the current level of velocity in terms of the acquisition side, that is going to start to dissipate and we're going to start to see more deals being struck from you guys? That's implicit in your comments, right?

Sure. We have been looking at a number of transactions and some we've just missed by small amounts, come in second. And I think with the tightening of the capital markets and so on that we're a dependable closer on transactions now, and hopefully the cap rates will adjust to now make our price.

We're going to keep our price the same and hopefully the cap rates will adjust such that it now becomes very competitive and with the ability to close that I would hope that our success rate on winning bids will accelerate.

Okay. Thanks a lot, Dave.

Okay. You're welcome.

We'll go next to Jerry Doctrow with Stifel Nicolaus.

Hello, all.

Hi, Jerry.

Hey, Jerry.

Had a couple different things. I guess I wanted to just start a little bit more on sort of acquisitions.

Basically I think you said, David, of course, the revenue was the issue this quarter. So basically there were two -- I just kind of wanted to go back through the deal. First of all, there were two [AL] properties, $14.1 and with an 8% yield that you're talking about getting?

That's correct. And those are encumbered by HUD loans and we, frankly, thought that they would have -- a transaction probably would have closed by this call.

And, but the HUD process is such that it's very cumbersome and if there's any question marks or hiccups in the process, you get set back weeks or months, and so that process has just gotten dragged out and that's why we're expecting to close in the third quarter.

Okay.

And you feel fairly good about that? So it's something we should be counting on, do you think?

Yes, yes. We're very optimistic it's all going to ultimately get through it just takes longer than you expect.

Okay.

And those are acquisitions with Five Star. Are you looking at anything that's non-Five Star-related or are they still the focus of your, [full] focus of your acquisitions?

I'd say most of the transactions are still with Five Star. We are looking at other transactions, (inaudible) not with Five Star, but I think probably the most likely success rate is probably still with Five Star.

Okay.

And have you seen -- you allude to this and I think I agree with you it's happening -- cap rates or at least people being more rational about their bids. Any sign that that's actually happening yet or it's just something you're expecting?

Well, it is a little too early to tell because, frankly, I haven't seen that many deals closing in the last month, let's say. And it's really not the deals that are closing are ones that where probably the bid was won a couple of months ago, it's really transactions that are in the market today and I think we're being invited to the second round more often.

I do believe our ability to close is being weighed more heavily than it was. People before if you had a noticeably higher price, then people are willing to take the risk that they could wait an extra month or two to get their credit approval to get the loan and so on, and it almost seemed like it was a matter of a sure thing, whereas now, from some brokers I'm talking to they're saying that's not necessarily the case today, people are more concerned about deals closing.

So that's got to have an affect on cap rates a bit. And so, I guess I have not seen any specifics, but that's what I'm expecting and that's what the evidence is starting to suggest.

Okay.

And then, just on percentage rent, could you just kind of remind us -- I think all the percentage rent is coming from Five Star. What's that relationship and should we -- what's sort of our range of possibilities as we go forward here?

Right. Well, actually, Jerry, the bulk of the percentage rent that we recognized today is coming from Sunrise.

Okay.

And Five Star is sort of rapidly catching up with Sunrise as far as their amount of percentage rent contributing relative to the rest of the group.

The way it works is that in the case of Sunrise, it is, we receive 4.5% of the growth in revenues at the properties. The base year for those 14 properties was set back in 1994 and so as those properties improved, there's no ceiling on it. There is a floor equal to last year's number and so we just get 4.5 growth in revenue in those properties. And those represent probably about 60% of the total amount of percentage rent that we currently get.

Okay.

Then the balance is mostly Five Star, although there's some from Brookdale, too. Five Star it's 4% of the growth in revenues and it depends on when the exact closing of the transaction occurred.

Like if we closed on a deal today, chances are next year would become a base year for percentage rent. And then the year after would be when we'd start to receive some percentage rent.

Okay.

Like I said, about $1.7 million was the percentage rent in this quarter. It's tough to tell to give you much guidance on it but we do expect a penny or two per year coming from that percentage rent and it drops to the bottom line.

Okay. All right. That's helpful. Thanks. And if I could just shift gears a little bit here.

I think the investors I've been talking to have been nervous about impact to the housing market (particularly) on entrance fee communities and IL. Can you give us a sense of how much entrance fee stuff you've got in your portfolio and, again, if you've seen any impact even -- why you haven't released currently quartered, any impact from the declining housing market on leasing or entrance fee receipts.

Right. Well, we only have two communities in the whole portfolio that are, have an entry fee program and we really haven't seen that much at all of an impact at those two properties.

Now, generally speaking, though, those are the properties that get affected the most just because people have to come up with a large down payment and typically that's coming out of their sale of their home or it's a substantial part of their assets, and they don't want to have one part of their assets tied in a home and another part of their assets tied up in an endowment fund at a retirement community.

So what we have found is that the most influential factor is really confidence level, consumer confidence level out there amongst the seniors and whether they feel confident that they can move into a facility and that their portfolio will allow them to stay at that facility for the rest of their lives and they don't have to move again or anything else.

And on the independent living facilities, I have not seen that much, and it's very localized. There are certain markets where we've seen a little bit of an impact like down in Florida a bit of an impact. But on the independent living, it's a choice that people make to move into those settings and so they can delay it a bit more.

Down in the assisted living is a need-driven decision. They may be able to delay it for a month or two, but not long and then they have to make that move.

I think right now probably with the -- what's happening with the stock markets and capital markets that are shaking confidence a little bit. And I think we're seeing a little bit of a backup, but not widespread.

Okay. Is it something you're worry about go-forward or not really?

No, I think it's something that will fix itself like there's a pause, but it's just meaning that the demand is being pent up and that it's going to flow again. So I'm not particular worried at all about the go-forward.

The fundamentals are still great in the industry. Development is still very, very modest and the demand continues to increase.

Okay. Last thing I have and I'll jump off.

Just in the existing portfolio, I think you kind of alluded to sales earlier. Are there properties that are actually being considered for sale and is there something that should be thinking about for our modeling there?

I know there are a handful maybe in that last batch from Sunrise that Five Star took. But anything out there that we should be thinking about?

No, once in a while there is some pruning going on and it's usually one or two underperforming skilled nursing facility or underperforming assisted living facility.

I think out in Five Star currently is marketing two facilities in the Pittsburgh area and should they reach an acceptable price that they presented to us and we review it and approve the sale. So I can envision maybe over the rest of the year there might be, say, two or three assets sold that are underperforming. But that would be it.

Okay. Okay. I'll jump off. Thanks.

(OPERATOR INSTRUCTIONS) We'll go next to Michael Salinsky with RBC Capital Markets.

Good afternoon, guys.

Hi, Mike.

In your prepared comments you mentioned that you were still fairly upbeat about closing on about $100 million of acquisitions. Now you've got the $14.1 million you're talking about closing in the third quarter. Can you give us a sense of what the pipeline looks at like right now as well as the timing of that?

Well, the ones that are under active purchase and sale agreement, we've mentioned the $14.1 million. We have various letters of intent out there that I'm optimistic that they will be executed and we'll be able to have transactions.

All I can point to is I don't want to get into forecasting specifics for acquisitions, but last year, we had $145 million of acquisitions in a year. Just about all of it occurred August 31st, October 1st, and early November.

So I guess during the year, we have a track record of being late starters, but closing strong during the final part of the year. And like I say, I'm optimistic that we will consummate at least $100 million this year.

Okay.

Secondly then, assuming cap rates -- there's no major change in cap rates in the intermediate term here, what's your ability to seek growth through other avenues ala the Five Star capital improvement agreements you have there? Can you up that beyond the $10 million that you've kind of talked about before per quarter?

Well, no, I think, I mean at least for now probably for the rest of this year the $10 million per quarter is probably a good average. There are some projects that they're funding until they get complete and then they'll flip it to us and we'll be lumpy like the first quarter we have $10 million, in the second quarter about $7.5 million.

But we don't really control that. There's another operator that we have a commitment out there to fund and we're waiting for them to draw on it but that would be later this year. It's about a $4.5 million funding.

All the other operators do have the option. For instance at the Brookdale properties, they're doing some expansions and so on but they have determined that they would just fund that out of their operating cash.

And finally in your prepared comments as well, you mentioned that percentage rents came in a little bit lower than you had expected. Was there any particular reason or was it just a seasonality thing?

I believe it's a little bit of seasonality. Occupancy's dipped a bit so that has a direct relationship to the percentage rent.

I think a lot of it, too, is based on estimates and at the end of the day, it's an annual calculation. So the quarterly amounts will fluctuate and this time, this quarter I think we wanted to stay conservative in it. But at least it was $1.7 million for the quarter so that should probably be viewed as sort of a minimum run rate.

Okay. Thanks, guys.

Okay.

And we'll go next to Philip Martin with Cantor Fitzgerald.

Good afternoon.

Hi, Philip.

A couple things. Let's see.

On the acquisition front, are you more enthused now than you were last year at this time?

Yes, I would say so. Primarily because of the way the capital markets are and the position we're in right now.

To an extent on the, well, let me go one place first. With the smaller operators that you generally tend to focus on or concentrate on, are you seeing yourselves having more negotiating leverage with them, especially even on the leasing side in terms of discussing percentage rents, et cetera?

Well, --

I know you're obviously viewed as a very good closer here, especially in this environment but is it spilling over into leasing structures et cetera?

Well, we really have not had to get into those negotiations lately because our transactions for a while have been with Five Star. There's a master lease already set up and established so it's just folding that into the master lease.

With other operators, it's challenging enough to meet an acceptable price and so on. I don't think we still have to be competitive with rates and often it's being competitive for what the operator thinks the market is today.

I think the market is running away from them a bit. But there has to be a little bit of history passed before the operators believe it. I'm hoping we can do some sale leasebacks with other operators but they're going to have to feel comfortable that the market has adjusted before they're willing to do deals with us at 8 or 8.25%.

Do you get the feeling that some of these discussions you're having with potential new operators are going to come to that point through the end of the year here?

I think by -- before the end of the year, yes. Over the next couple of weeks, I don't expect so.

Okay.

Who are you losing deals to? I mean the deals where you've come in second, who are you losing those to?

Well, a couple to other healthcare REITs but a lot of other times like we have lost a couple to Brookdale even this year. And we -- other ones tend to be regional operators using the Merrill Lynch and the GE Healthcare finance type of capital.

So it's -- whenever -- if it's one-off or two-off property deal if we're at all competitive, we typically win because we're competing against other more mom and pop and local operators. The larger deals, let's say the 20 to $75 million deals, those we've lost a couple to a couple other healthcare REITs and we've lost a couple to Brookdale.

Are you losing transactions because you're forcing Five Star down some of these operators? Or where you wanted to have Five Star come in and operate these properties? Have they become at all a hindrance?

No. I think to some degree we've expressed that maybe we could get to put a little more money on the table if it was Five Star just because of security of structuring it. But if it's not them, we've said, well, you have to show us that you have adequate capitalization or be willing to put up a security deposit of six months to a year or a good guarantee that's very strong. And we're finding that our competitors are not requiring as stringent requirements.

Okay.

We may be able to put the equal pricing on the table, but we're also losing it on just the restrictions we put on it.

And when you look you're. I mean that goes to my next question. When you look at your overall portfolio here, what's the average, the average security deposit covers how many months?

In most cases -- in some cases six months, some cases a year. Let's see, we have a year, well, we have the Marion International guarantee, we have the IBC guarantee, we have a Brookdale guarantee, we have Genesis guarantee in addition with about a three-month security deposit. Our smaller operators, one has six months the others have a year security deposit. So we have something from everybody pretty much.

So the portfolio in general six to 12 months on average?

Correct.

Okay. Okay.

I mean it's, obviously, everybody takes different business strategies and we view ourselves mostly as a financial institution evaluating people on credit worthiness and the ability to operate the facilities. And there are, and some of our competition take a different approach and underwrite the operator. And feel that they've kind of, they're the only one to take the risk that if something should fail that they have other backstops to turn the properties over to.

And size affects things too because as a $2 billion or $1.8 billion REIT, I'm reporting transactions that are relatively small, but I end up going into more detail than normal I'd have to talk about whereas several of our competitors are a couple billion dollars larger. They can do a number of these transactions or adjust the rent with tenants and so on but never have to talk about it, and that's one of the disadvantages to our size.

Okay. Well, yes, it's the good and the bad.

Now on the operating front, again, I know you answered this a little bit early to some extent, but at the operating level, same-store growth, your ability, the ability of the operators to raise rents, that's still strong?

Yes. What you typically find is that amongst the portfolio of, amongst a company's portfolio, there'll always be a half dozen properties or something that holds the overall statistics down.

But in those, all those other properties, they're typically running north of 90% occupancy level and able to push rates 4 to 6%, maybe even 7% on the tenants and get those increases and most of that translates into good earnings for the bottom line. But it seems like you spend so much more time on those six problem properties than you do on the rest of the portfolio.

And my last question.

In terms of development opportunities within your existing portfolio or opportunities that are coming up in discussions with, you know, discussions that are ongoing here with potential new operators, are you seeing more of that at all?

Yes. Many of the transactions we look at have a development aspect to it that either people want to be compensated it for today or they want to structure a longer-term arrangement for future development and so on.

We're not a development company and we're willing to fund expansions or maybe in a small development but we often run into a pricing valuation problem when a fair amount of development is a component of the acquisition. So we are coming across that. Again, it's not widespread and it's not, we're not talking major development going on, it's usually to add a wing or add an IL campus to the AL [sniff] that they have, things of that nature.

Okay. Okay. Thank you very much.

Okay. You're welcome.

There are no other questions. At this point, I'll turn it back over to Mr. Hegarty for any additional or closing comments.

Well, thank you all for joining us this afternoon. And looking at the schedule ahead, it looks like we'll be at, presenting at a UBS Healthcare REITs and Operators conference in New York on September 17th. And of course there'll be a fair amount of other opportunities to get together in November.

And we look forward to you on the next conference call. Thanks a lot. Take care.

And this does conclude today's conference. Thank you for participating. You may now disconnect.