Diversified Healthcare Trust (DHC) 2009 Q2 法說會逐字稿

Good day and welcome to the Senior Housing Properties Trust second-quarter 2009 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 Director of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you, Jolene, and good morning, everyone. Joining me on today's call are David Hegarty, President and Chief Operating Officer, and Rick Doyle, Chief Financial Officer. 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, August 7, 2009. 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 call other than through filings with the Securities and Exchange Commission 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 as well as components to calculate AFFO, CAD, or FAD are available on pages 11 and 14 in our supplemental operating and financial data package found in the investor relations section of the Company's website, located at www.snhreit.com. 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 2008 Form 10-K and second-quarter Form 10-Q to be filed with the Securities and Exchange Commission by the end of the day on Monday as well as in our Q2 supplemental operating and financial data. Investors are cautioned not to place undue reliance on 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. Well, I consider these exciting and positive times for SNH and our shareholders. We just completed an excellent quarter. We increased the dividend, raised $513 million of long-term debt at attractive rates in this environment, remained lowly levered, and are considering some excellent investment opportunities.

In addition, in late June SNH was elevated to the Russell 1000 Index. Since the second quarter of 2009, we generated $0.44 per share of funds from operations and based on these results and the outlook for SNH, our Board of Trustees recently raised the quarterly dividend to $0.36 per share. This dividend represents a conservative 82% payout ratio of our funds from operations. SNH continues to have a strong balance sheet with low leverage. Today our entire $550 million credit facility is available to utilize and we have no near-term debt maturities until 2012.

The most exciting news is that we closed on the Fannie Mae financing of almost $513 million earlier this week on very attractive terms. I will delve into the details of this financing and the impact in a short while, but first, however, I would like Rick to report on the second-quarter results in our balance sheet.

Thank you, Dave, and good morning, everyone. This morning we reported FFO of $0.44 per share for the second quarter of 2009, which compares very favorably to $0.41 per share for the second quarter of 2008. This represents per share growth of 7.3% year-over-year despite 20 million more shares outstanding.

Revenues for the second quarter were $69 million, which is a 30% growth over the same quarter last year. The main reason our revenues increased from the second quarter of 2008 was due to the $557 million of acquisitions made since July 1, 2008. Many of those acquisitions were medical office buildings with gross leases.

For the second quarter, percentage rent was $2.4 million versus $2.3 million for the same period last year. These percentage revenues are not included in our GAAP revenues until the fourth quarter, but are calculated to determine FFO.

Operating expenses increased by $3.1 million for the second quarter 2009 versus the 2008 quarter as a result of $435 million of our medical office buildings acquired since June of 2008. During the second quarter of 2008, we only owned the first few medical office buildings for one month. Today, these expenses are all tracking as originally budgeted.

Interest expense increased from $9.8 million to $10.7 million as a result of greater amounts outstanding on our credit facility and the assumption of $61 million of mortgage loans with the acquisitions of eight senior living communities and two medical office buildings in the third quarter of 2008.

General and administrative expenses increased by $700,000 year-over-year, primarily due to the $641 million of acquisitions since June 1 of 2008. Our G&A remains one of the lowest in the industry at 7.5% of revenues.

During the second quarter, we acquired two multi-tenanted medical office buildings in the mid-Atlantic area from HRPT for $50.8 million. As a result of new accounting pronouncement known as Statement of Financial Accounting Standards number 141(R), which became effective in January 2009, we now expense acquisition costs such as legal costs, brokerage fees, title insurance, at transfer taxes, third-party inspection costs, in Other transaction costs. For the quarter ended June 30, 2009, we incurred $1.3 million of acquisition costs primarily transfer taxes related to the $50.8 million of medical office buildings acquired in the quarter.

Historically these costs would have been capitalized and depreciated over the life of the assets. Since depreciation expense is added back to calculate FFO, we have taken the position that these one-time acquisition costs should also be added back to calculate FFO, and you will see that broken out in our FFO calculation.

We also funded $11.5 million improvement financing in the second quarter for properties operated by Five Star. To date, we have funded $24.2 million of improvement funding for the six months ended June 30, 2009. At June 30, we had a very strong balance sheet. Our debt consisted of two senior unsecured notes totaling $322 million, mortgage debt and capital leases totaling $150 million and $235 million outstanding on our $550 million revolver.

This week in connection with the secured financing with Fannie Mae, we repaid the balance on the revolver. We also closed yesterday on three biotech buildings as part of the HRP transaction for $116 million. These three buildings are leased until 2019 to Scripps Research Institute and are located in La Jolla, California. To date, we have acquired 43 of the 47 properties we agreed to acquire from HRP.

As of today, we still have over $150 million of cash available to invest in our revolver completely available to us. There are four remaining medical office buildings leased to Oklahoma City Clinics which we hope to acquire later in the third quarter from HRP for $29 million, which will complete the whole HRP medical office transaction.

We also have one senior living property under agreement to acquire for $21 million, which we intend to lease to Five Star. Of course this acquisition is subject to diligence and may or may not occur.

Until the excess proceeds of the Fannie Mae financing are reinvested, we expect to incur significant negative arbitrage. SNH continues to have one of the best balance sheets in the REIT industry. After the Fannie Mae financing, our debt to gross book value of our real estate assets are only 34%. Our secured debt to total assets is only 23% and our EBITDA coverage to debt service is only 3.5 times.

Dave will now discuss how we will invest the funds for Fannie Mae financing as well as the performance of our portfolio.

Thanks, Rick. Fundamentally, our portfolio of properties continues to hold up very well in this difficult economic environment. As I will explain in a moment, Five Star leases had to be realigned in conjunction with the Fannie Mae financing such that the 28 properties encumbered by Fannie Mae loans were put into one new lease. This created a need to balance the remaining properties and the remaining leases.

The statistics in the supplemental package have been presented on the new composition. Lease number one now contains 80 properties, of which 21 are standalone nursing homes and 59 are seasoned senior living properties. Lease number two contains 50 properties, of which 25 are nursing homes, 23 are senior living properties, plus the two rehabilitation hospitals. Lease number three contains the 28 senior living communities secured by Fannie Mae mortgages and lease number four contains 25 properties, of which five are nursing homes and 20 are senior living properties. The fourth lease contains seven of the former New Seasons properties which are still under turn around mode.

Occupancies in the portfolio for the March quarter are generally down slightly across the portfolio versus the December quarter, with the nursing homes and independent living being impacted the most while the need-driven assisted-living and Alzheimer's care segments are generally up a bit. This is also consistent with what operators have been reporting recently. Occupancy as you know, is only part of the story and operators are adjusting their way of doing business by either raising rates or lowering rates in some cases and implementing cost controls.

As a result, we feel that rent coverage ratios should be the focus. And sequentially coverage ratios improved for the quarter ended March 31 versus the December 31 quarter. Except for lease number four with Five Star and a few of the private operator leases, that holds true. The Five Star leases cover from 1.12 times to 1.63 times coverage. Keep in mind we don't look at these leases on an individual basis given that all four are guaranteed by Five Star. So in the aggregate, the coverage ratio would be 1.34 times. So you can see Five Star is covering its rental obligations well.

The Sunrise properties have had an improvement in coverage from the December quarter to the March quarter to 1.45 times coverage, which is fairly strong. Brookdale continues to be strong at over 2.2 times coverage and the private operators have a combined 1.8 times coverage.

Finally, the 10 wellness centers cover their rental obligations at 2.27 times coverage, which continues to be very strong. Life Time Fitness, one of these tenants, reported an excellent second quarter and since then their stock price has almost doubled.

Earlier this week we announced the successful completion of a $513 million secured loan under the Fannie Mae program and our appreciation goes out to the folks at Fannie Mae, Citibank, and numerous lawyers for completing this large, very complex financing. It is the third largest loan ever completed by Fannie Mae in the senior housing space. The terms are significantly more attractive than we could obtain in the public market.

The loan is for 10 years with $0.60 fixed-rate and 40% floating rate. The blended initial interest rate is 6.6% per annum. The loan could not have been consummated without significant cooperation and concessions by Five Star. During diligence, Five Star personnel had to produce a tremendous amount of operating data, provide numerous site inspections and regulatory information. To accommodate Fannie Mae's financing requirements, Five Star had to obtain releases of collateral from their lender so they can be pledged to Fannie Mae. SNH had to acquire all the personal property at the properties that Five Star owned and Five Star has to relicense all 28 properties, obtain new provider agreements in the name of the new sole purpose subsidiary and grant Fannie Mae an interest in those operating assets.

So SNH has paid Five Star $18.6 million to acquire all the personal property owned by Five Star at these properties and receive 3.2 million common shares of Five Star to replenish permanent loss of liquidity. The net book value of personal property we acquired was $8.7 million and the value of the Five Star shares on the date of closing was $8.9 million. So if you are doing the math, one way to view it would be that we paid $1 million of additional money to Five Star to compensate them for their assistance.

Now in addition, SNH agreed to lower the rents at the lease containing the two rehabilitation hospitals by $2 million per year for the remaining lease term of 17 years. Of course SNH will pay any third-party costs incurred by Five Star to consummate this transaction and to relicense the properties.

The rent concession to Five Star in essence adds 40 basis points to the cost of the loan and it still remains attractively priced. This loan of approximately $513 million is less than 55% loan to value on assets that have a cost basis of $607 million and they were appraised at almost $1 billion.

SNH continues to own 165 senior living communities which are not encumbered by secured mortgage debt. In addition, SNH will continue to own two rehabilitation hospitals, 10 wellness centers, and 40 medical office buildings that have an aggregate historical cost of $650 million. Only four of these properties are encumbered by mortgages which total $25 million.

As Rick mentioned, we used $235 million of the proceeds to pay down the revolver. Yesterday we accelerated and acquired the three biotech laboratory buildings in La Jolla, California for $116 million that will lease to Scripps Research Institute until 2019. All that remains are four off-campus clinics totaling $29 million leased to Oklahoma City Clinics until 2016 and we hope to acquire these by quarter end.

The acquisition environment is very slow on the senior housing side and still fairly robust on the medical office side. As Rick mentioned, we do have one large senior living community under agreement to purchase for $21 million. Senior Housing owners are still reluctant to sell unless they have some pressure from a lender or an investor who needs liquidity. We still see several one-off properties for sale and occasionally a portfolio.

And healthcare systems, developers, and physicians continue to look at ways to monetize their real estate and we continue to see numerous investments to consider on that side. Having a tremendous amount of capital clearly attracts sellers to us.

In summary, we are very well positioned beyond the offensive and not the defense. Our Board raised the dividend this past quarter to reflect the solid performance and positive outlook for the Company.

In the face of uncertain backdrop, SNH continued to perform very well in the first and second quarters. Our prudent decision making during the acquisition frenzy that gripped our industry a few years ago places us in an enviable position of having a strong balance sheet, low leverage, and no near-term debt maturities. This combination strongly positions us to ride out the economic storm and operate from a position of strength moving forward.

Now that completes our prepared remarks, but Rick and I would be happy to answer any questions you have.

(Operator Instructions) Mark Biffert, Oppenheimer.

Good morning, guys. Dave, I was wondering if you could talk a little bit more about the loan. You had mentioned that you had paid -- the incremental amount that you paid was about $1 million, but from what I'm reading -- maybe I misunderstood this -- but it says that you also gave a discount of the two rehab hospitals of about $2 million a year in rental revenues. Was that part of the agreement as well?

Yes, that's correct. Part of -- there are two pieces to the discussion. One was the fact that we had to acquire the personal property of the -- that relate to these particular properties from Five Star that they had acquired over the years. And then there were costs incurred naturally as part of getting up to the point of closing. And so basically the $1 million was partly to compensate for them for that aspect of it.

Then the $2 million is to recognize the fact that on an ongoing basis, they are going to have to provide quite a bit of operating data to Fannie Mae as well as cooperate with property tours and so on. So you are correct that those are the two essentially consent fees or components that were extra consideration.

Okay, and then in terms of the realignments of the leases, what was the minimum coverage that Fannie was trying to obtain on the properties?

The NOI coverage was at 1.7 times and on the lease coverage or the rent coverage would be 1.2 times by property or 1.35 times on a portfolio as a whole.

No, but I mean was Fannie saying that they had to meet a 1.5 times coverage in order for them to do the note and that's why you realigned everything into that one portfolio to obtain that level?

No, that is not why. Fannie did require us to take these 28 properties and put them into one lease. In these properties, these 28 properties were spread out with the four different leases that we had previously to this transaction. So we had to take those 28 properties and just realign our leases and put those 28 into one lease and while we did that, we realigned the other three leases of Five Star. So now we still have four leases, but one would be specifically for Fannie Mae.

Okay, okay, and then on the senior housing asset that you guys are looking to close on, what was the cost per unit on that?

Outlook -- we have only one that we have under agreement and that, the cost per unit is about $120,000 a unit.

Okay. And was that all AL -- ALZ?

It is a combination of IL, AL, ALZ, and some skilled nursing beds.

Okay. And the coverage, do you know what the coverage was on that?

Well, we expect to go in at about a 1.3 times coverage.

Okay, who was the previous operator?

I am not at liberty to disclose at this point. We're still in the middle of diligence right now, so until we have closed on it, then I can discuss it with you.

Lastly, did you guys look at the unsecured market in terms of potential opportunities?

Yes. We are constantly monitoring the unsecured market and obviously this financing has been in the works for about eight months, really. So the market has changed over the course of time and obviously of recent, it has significantly improved. Now still given -- one of the things we saw through about it too was in the unsecured markets, we believe we would only be able to do a transaction of the size of $200 million to $250 million. So we would not be able to get $500 million at a reasonable price.

Then secondly, people have been whispering rates that they think we could get and until recently, it's been probably north of 10, but recently they are talking in the 9s. So again, we are not investment-grade rated. We are on the cusp. So the deals you are seeing in the market place, a, we would be looking at seven- or 10-year deals and some of the deals out there are five-year deals. But also, I think Duke recently did a deal, a 10-year deal, and that was in the 8s and they are BBB rated. So we would be clearly still in the 9s. So this is still a much better deal for us. It doesn't preclude us from doing some other debt financing later.

Yes, do you have a pretty good pipeline given the cash that you have on your balance sheet now? I think you said $150 million. Are there significant assets in the senior housing or what sectors are you seeing the best opportunities?

Frankly, we are seeing the best opportunities in the medical office side. We are seeing some opportunities and we are pretty optimistic that we will have a couple transactions on the senior housing space. But also, we have a number of situations that we are pretty optimistic, too, on the medical office side. And frankly, I think we are more likely to spend more of the proceeds on the medical office side than we are in the senior housing, and it's primarily because of the volume and lack of capital for that side.

Okay, great. Thanks.

[David Ellich], RBC Capital Markets.

Thanks, it's actually Kevin Ellich. Good morning, guys. Just a follow-up on the Fannie Mae financing. So if I understand it correctly, it was -- the two rehab hospitals where you guys gave the lease concession, that was really driven by Fannie or -- because these two properties weren't involved in the financing, right?

That's correct. No, the decision to apply it to the Fannie Mae lease was really mostly Five Star's request. We are relatively indifferent because when we look at the whole group of leases and Five Star is a credit on these, so it somewhat was irrelevant to us, although it is in our interest a little bit to have it go to the rehab hospitals too, given they've been struggling with those.

Okay, got it. And I hopped on the call late and I don't know if you had broken out with the loan. I see part of it is fixed and part is floating. Did you break that out?

Yes, 60% is fixed and 40% is floating.. The floating has a cap of 3% above where it is when we closed -- or where it was when we closed.

Got it.

[If] LIBOR goes up, that's the maximum exposure we have. On a blended basis, that means overall it will be a [7.798] (multiple speakers) max.

Okay, that's helpful, Dave. Thanks. And then going back to some of the past acquisitions, if my memory is correct, you guys did some senior living properties in the Northeast that were kind of underperforming assets. Just wondering how those are doing now?

I'm sorry, I don't recall anything we did in the Northeast. What we have is there is the properties that are in the greater Philadelphia area that we took back from New Seasons and Five Star took over the operations of those. And those needed to be turned around. And then Five Star did its own acquisition in the Southeast with some properties that needed to be turned around.

Yes, actually the ones in Philly are the ones that I was starting out, Dave. Sorry. How are those doing now?

A little better. They've still got a ways to go. They are -- it's interesting. Certain properties are doing just fine but it's a very competitive market rate there and the rates -- it's very difficult to raise the rates. Of those, there were 10 properties that we had with New Seasons, three Five Star bought and operates themselves and those are the more problematic properties of the 10. And of our seven, there's still a couple in there that need to be turned around a lot more.

Okay and then just going back to the pipeline now that you have a little bit -- some more capital, is there anything else on the horizon that you guys are interested in or looking at or are you just content to kind of sit on that for a little while?

No, given the negative arbitrage on this cash, we are definitely incentivised to put it to work in good investments going forward. And as quick as we can. Now we have obviously put $150 million, $160 million into the biotech properties right away. We have $29 million of medical office buildings that are left on the HRP deal. That should close by the end of the quarter, we believe.

And then we have the $21 million senior living property under agreement. We have definitely several other transactions that we are considering and we don't have under agreement, but we're pretty far along in evaluating and pretty optimistic. I really can't give you much more certainty of that, but I would certainly hope within the next few months that we will have put this money to work.

Got it. And then, when I think about the HRP transaction, I believe there was a contingency on a number of their properties. Is that included in your pipeline with HRP or are you guys still considering that?

No, when we had done the deal back then we obtained a right of first refusal on 45 other properties of theirs, but that's all it is.

Got it. Thanks, guys.

(Operator Instructions) Jerry Doctrow, Stifel Nicolaus.

Good morning, it's actually Dan Bernstein. Most of my questions are answered. I guess what we are trying to understand a little better is how a couple years you're thinking about positioning the Company in terms of property type. You were at 17% MOBs now, obviously going up in the third quarter. So how is the Company going to look a couple of years down the road?

Dan, in some ways you are looking -- your guess is as good as mine in a way because realistically our desire is to grow more into the medical office building space. We -- but we evaluate both the medical office and the senior housing property type and I do believe as soon as capital comes back into the markets, that's flowing freely, it's going to continue to be a very competitive environment particularly in the senior housing space. And then at some point a few years down the road, we would have some development starting up again and so on in the senior housing. And I do see opportunities there, but I don't see that that's going to be where most of our investing dollars will go. You know, I don't know that I can provide any more clarity on that.

Are you looking at the hospital space at all? I mean you have the one rehab that hasn't I guess performed spectacularly. Are there opportunities outside of senior housing and MOBs that you might consider?

You know, in the right circumstances, I guess we'd consider hospitals. We're not at the moment looking at hospitals. We do want to stay within the healthcare spectrum, so maybe -- we've got -- we've done a little bit of biotech. We've done some single clinics and we've done some multi-tenanted medical office buildings. So that gives us a pretty broad array to further invest in.

And maybe one thing about the whole healthcare spectrum, as time goes on there is constant refinement of the spectrum. And so like LTACs didn't really exist until several years ago, skilled nursing has become much different than it was before. In fact, become so heavily focused on rehab and stuff that long-term care is very unprofitable and very tough to set up. So I think we will continue to refine that spectrum and try to focus on different spots where we can.

Okay and I was just trying to better understand the taking back of the shares from Five Star. Could you just go through that again, on the rationale for doing that.

Sure, well in the -- as you recall, the process was that independent directors of Five Star and the independent trustees of Senior Housing negotiated the terms of the transaction. And one of the sticking points of Five Star's was that they were relinquishing quite a bit of potential borrowing capacity on their line of credit and so it became how do they get compensated for that? Should there be a permanent loan by HRP -- I mean by SNH -- I'm sorry. And SNH, we don't want to have a permanent loan out there to them and so it got thrown in while what else -- what could we get for the cash? And that's where the discussion ultimately arose where stock became a component.

And then after seeing how this whole transaction was we believe we will end up benefiting them because of the rent concession and so one, we believe that Five Star has some upside potential and we want to share in that. So we are already -- have a vested interest in how Five Star performs and the reality is if Five Star was trading at $20 a share in a rock solid balance sheet, that would benefit us, SNH, even if not directly by additional rent or anything we'd get from it. But SNH would be perceived stronger and better, and so we think that too the stronger they are, the stronger we are. We both have a vested interest in them.

And the intention is not to hold the shares long-term?

It is. I couldn't tell you five years down the road, 10 years, who knows? But currently at the time of this transaction, the Board has no intention of settling those shares.

I also just wanted to make sure that the yield on the properties that you're buying in the third quarter for the MOBs, that still 7.3 or is that going to be higher towards the 7.7 that -- the MOBs you purchased in the first and second quarter?

Well, as time has gone on, any upticks in the CPI or fixed increases have kicked in and so on, so they are a bit higher. The cash would still end up being around that 7.3.

Okay, I think that's all the properties I have. Thank you. That's all the questions I have. Thank you.

At this time, I would like to turn the call over to David Hegarty for any additional or closing comments.

Thank you very much and Rick and I plan to be at the NIC conference in Chicago and R.W. Baird and UBS conferences in New York in September. And so we hope to meet all of you at one of those events and have a great day and a great weekend. Thank you.

This does conclude today's teleconference. Thank you for your participation.