Diversified Healthcare Trust (DHC) 2010 Q1 法說會逐字稿

Good day. And welcome to the Senior Housing Properties Trust first quarter 2010 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 Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you, 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. I would also note that the recording and retransmission of today's conference call is strictly prohibited without prior written consent of SNH.

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, May 4th, 2010. 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, as well as components to calculate AFFO, CAD, or FAD, are available on pages 11 and 14 in our Q1 supplemental operating and financial data package found on our website at www.snhreit.com.

Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our 2010 Form 10-Q, to be filed with the SEC by the end of the day tomorrow. Investors are cautioned to not place undue reliance upon any forward-looking statements.

And with that, I would like to turn the call over to Dave Hegarty.

Great. Thank you, Tim, and good morning, everyone, and thank you for joining us. For the first quarter of 2010, we generated $0.43 per share, funds from operations, which is consistent with consensus expectations. And once again we ended the quarter with a strong balance sheet. SNH continues to be lowly levered with no near-term debt maturities.

Since our last conference call two months ago, things have been quiet on the transaction front. During the quarter, we've funded capital improvements and expansions at our senior living properties, and on April 1st, we closed on an acquisition of a medical office building located in Colorado.

Additionally, subsequent to the quarter, we issued $200 million of senior unsecured notes due in 2020, and have given notice to redeem the $97 million of senior notes due in 2015. Before I get into the details of our portfolio, the acquisition environment, and the outlook, Rick will review our results for the quarter.

Thank you, Dave, and good morning, everyone. Looking first to the income statement, rental income increased by $12.1 million to $80.4 million, or 18% compared to the first quarter of 2009. General and administrative expense increased $750,000, or 16% to $5.5 million, and depreciation expense increased by $3.9 million, or 21% to $22.3 million compared to the first quarter of 2009.

The year-over-year quarterly increase in rental income, G&A and depreciation expense reflects properties acquired since January 2009, partially offset by the sale of four properties in 2009.

Property operating expenses increased by $1.4 million, or 48% to $4.4 million due to our acquisitions of MOBs since January 2009.

Percentage rent revenue from our senior living tenants for the first quarter 2010, increased 19% to $2.5 million versus the first quarter of 2009. The percentage rent revenue now includes the 30 senior living communities acquired in 2008, leased to Five Star Quality Care, and are based on 2009 revenues.

In 2010, 170 of the 190 senior living communities leased to Five Star and all of the Sunrise Senior Living and Brookdale Senior Living communities are on this revenue sharing formula.

Interest expense for the first quarter of 2010 was $7.6 million higher verse the 2009 period, due to the interest and amortization of deferred financing fees relating to our new agency debt with Fannie Mae, offset by lesser amounts outstanding under our revolving credit facility at lower interest rates.

For the first quarter 2010, our FFO was $54.8 million, or $0.43 per share compared to $52.1 million or $0.44 per share for the same period in 2009. In April, we declared a dividend of $0.36 per share, which represents a payout ratio of 84% of our first quarter FFO. During the first quarter, we invested $6.2 million into revenue producing capital improvements. On April 1st, we acquired one medical office building located in Colorado, for $4.5 million. We funded this acquisition using cash on hand and by assuming a mortgage loan totaling $2.5 million with an interest rate of 6.7%. The going-in cap rate on this investment is 9.5%.

At the end of the quarter, we had $58 million outstanding on our revolving credit facility, two series of unsecured senior notes of $322 million in mortgage loans and capital leases totaling $658 million. In April, we sold $200 million of senior unsecured notes with interest at a fixed rate of 6.75% per annum due 2020. A portion of the net proceeds were used to repay the $58 million in borrowings under our revolving credit facility, and we intend to use the remaining net proceeds to fund the redemption of our $97.5 million outstanding 7.875 senior notes due 2015, as well as for general business purposes, including pending and possible future acquisitions. In April, we called all of the outstanding senior notes due 2015 for redemption on May 17th.

FFO for the second quarter will be negatively impacted by $0.01 to $0.02 due to the negative arbitrage of holding excess cash until the 2015 notes are redeemed and the excess proceeds are fully invested.

We currently have $225 million of senior notes due in 2012. Several investors inquired as to why we did not repay these notes, given the high interest rate of 8.625, along with their more near-term maturity. Onerous yield-maintenance penalties on the 2012 notes discouraged us from prepayment. But we will continue to look for opportunities to pre-pay these.

On March 31st, our total debt was approximately $1 billion dollars and our equity was $1.9 billion, for a ratio of debt to total book capital of 36%. On a market basis, our debt to total market capitalization was 27%. After we redeem our senior notes due 2015 in May, our total debt to total book capital will still be 36%.

Other than the 2012 senior notes, 70% of our debt is not due until 2019, or later. Today we have the entire $550 million credit facility available to fund future investments. Our revolving credit facility expires on December 31st, 2010. However, at our option, we can extend the maturity date one year until December 31st, 2011. We continue to monitor banking market conditions, and, at this time, we have not yet made a decision to either pursue a new revolving credit facility this year or exercise our one year extension option.

Now I will turn it back to Dave for discussion about the performance of the portfolio and the investment environment.

Thank you, Rick. As you can hear from Rick's comments, our operating performance was solid, the dividend is well covered, and the balance sheet is well positioned for several years. We all know the sustainability of our operating results is dependent on the quality of the performance of our tenants and their management of the properties we lease to them.

Our existing portfolio continues to perform comfortably in this difficult environment. Our largest tenant, Five Star, reported its earnings yesterday. They reported normalized earnings of $0.09 per share, generated cash flow from operations of approximately $15 million, have their $35 million revolving credit facility completely available, and little capital needs for several years. As a reminder, Five Star will be receiving a net cash increase of approximately $35 million from the UBS Put Right on their option rate securities next month, June 2010.

For the 12 months ended December 31, 2009, the cash flows for all the leased properties we own that Five Star operates, covered the rent obligations by a strong 1.34 times, computed on an EBITDA basis, or a cushion of approximately $60 million. The occupancy for total leases with Five Star have ticked down by 10 basis points for the 12 months ended December 31st, 2009, compared to the 12 months ended September 30th, 2009, while the other two leases have been flat for the same period. But as Five Star reported yesterday, occupancies have stabilized over the past few quarters, and appear to have bottomed out.

The 14 high-end retirement communities we lease to Sunrise also performed well. The rent coverage was 1.4 times, and occupancy averaged 89%. As a reminder, these leases are guaranteed by [MARE] International, and we continue to monitor Sunrise as a company, but the facilities are being operated well and the occupancy and rent coverage are holding up well.

The Brookdale properties continue to be stable with 91% occupancy, and over two times coverage. [Now, smaller] operators continue to perform at about two times coverage as a group. Additionally, the two wellness tenants cover their rental obligations over two times, and they have been surviving the economic downturn remarkably well.

On the medical office building portfolio, occupancy was 96% at December 31st, 2009, for the 56 properties we own, and 97% at March 31, 2010. Most of these properties are long-term lease with strong-credit tenants. But even the multi-tenanted buildings are performing at or better than expected levels. There's been little turnover in medical office suites, but renewal for new leases have approximated rents.

This quarter we had 36,000 square feet of property space come up for renewal, 33,000 square feet was renewed, plus we had new leases for 12,000 square feet. Tenant improvement and leasing commissions for the quarter were only $162,000.

On April 1st, we acquired one medical office building that's a class A surgery center with 14,700 square feet located in Colorado. And it's leased to an A-rated tenant for 10 years on a triple net basis. The purchase price was $4.5 million, as Rick mentioned. The going cap rate in this investment was 9.5%.

As with other sectors of real estate, we are not seeing as many investment opportunities as we had expected. We are seeing several individual assets and small portfolios to consider in both the senior living and medical office property spaces, but many have issues, or, in our opinion, are not worth the debt on the property.

We have a handful of properties that I am optimistic we will acquire in the 8.5 and 9.5 cap rate range. For instance, we have one 55,800 square foot medical office building under agreement for $12.2 million, which is in that cap rate range. We will continue to exercise discipline and not chase transactions for the sake of putting money to work, though.

Subsequent to quarter end, our Board declared a cash dividend of $0.36 per share, which is a payout ratio of 84% of the first quarter's FFO. Our Board evaluates the dividend on a quarterly basis, and the Board considers the dividend to be adequately funded. Based on our current payout ratio, we're generating $35 to $40 million of excess cash flow per year to provide a cushion for the dividend should any operator experience difficulties or any unforeseen needs. This surplus cash flow is currently used to fund improvement financing, make new investments, or prepay debt. We have a solid balance sheet, excellent liquidity, a well-performing portfolio, and are constantly evaluating growth opportunities. Given our size, it's not necessary for us to chase the billion dollar transactions to have a positive impact to the bottom line.

In conclusion, we will continue, as always, to closely monitor the portfolio, seek excellent investment opportunities, while prudently managing our liquidity, and focus on growing cash flow to ultimately increase the dividend.

With that, I'll turn it over for questions.

(Operator Instructions) We'll pause for a moment to assemble our question queue. And our first question comes from Todd Stender with Wells Fargo Securities.

Hi, guys. Good morning.

Good morning.

Good morning.

Just if we could touch on the acquisition you made in April, the MOB in Colorado. You mentioned a cap rate of 9.5%. Is it affiliated -- is the building affiliated with any local health system? And if you could just talk about maybe just some of the lease terms of existing leases.

Sure. That, in that particular case, the tenant is HCA Health One Company. So it's an A-rated credit in that situation. This particular surgery center is leased to one tenant, and it's 10 years left remaining on the lease. We acquired the property with the lease in place. And we also have other leads on some possibilities in that marketplace, so -- and we were not viewing this as a -- normally it's just a standalone transaction. But, and as far as the lease goes, the cap rate we're using is a cap rate of 9.5%. That's over the 10-year lease. Typically starts out about 70 or 80 basis points on a cash basis and increases over the term of the lease.

Okay. Thanks. And I think, just switching gears, at the end of the fourth quarter, I believe there were two assisted living facilities T'd up for sale. Any update on those?

No. They -- they're still available for sale and still listed as such on our financials. One is currently empty and the other one is probably about high 80% occupancy at the moment.

Okay. And last question. Just when you're looking at competition for assets, is it a different competitor in the 15,000 square foot MOB versus say the 50 to 60 thousand square foot MOB?

It is, I believe. We're not going to pursue a number of transactions in that, let's say less than $10 million range. But on occasion one just might make sense. And since we have a full staffed acquisition group and diligence team, it might make sense in certain cases. And I'd say this was more of an exception to the rule.

And the competition, frankly, I'm not totally aware of all of our competition in this particular transaction. I do think that, certainly, the larger healthcare REITs are not pursuing something of this size. I would say if we're running into competition, it's either local people or the healthcare -- Health Trust of America or Grubb and Ellis Healthcare II, as competition.

Okay. Thanks, guys.

Okay.

Thank you.

(Operator Instructions) Our next question comes from Jerry Doctrow with Stifel Nicolaus. Please go ahead.

Thanks. David, just back to clarify one thing you said. So what's the initial cash yield on your MOB acquisition? 9.5, I think what you said was over the lease term.

Right. And that's what would go into the FFO calculation. That's why we use that number. But the initial --

And that includes the straight-line or --

Yes, that's correct. And the initial cap yield in this case would be about an eight, 8.6.

Okay. Okay. And just a couple other things I wanted to follow up on. One is, I wanted to see, and maybe this is in the supplement, I just haven't had a chance to go through. But so how much is the rent you're getting that's related to kind of the revenue bumps now? And I'm trying to think about how we model that go forward, because, as you said, Five Star had some pretty good numbers. I'm just trying to think what kind of growth makes sense to assume go forward.

Well, let's see. For the first quarter this year it was $2.5 million was the percentage rent, and it was with two point --

Last year in the first quarter it was $2.1 million, and increased this quarter to $2.5 million. For the year last year, Jerry, it was $9.1 million. So I don't know if you want to analyze the first quarter would be $10 million.

Okay. And but -- and the deal is it's 4% of their growth in revenue. So if I'm assuming that that $2.5 million is your sort of share, that's a -- I divide that by like 4%, I'm getting a sense of what the revenue base is. And if I'm assuming that revenue's growing 2.5% a year or something, I can sort of calculate it out. Is that kind of the right way to think about it?

Yes, that's correct. That would be a formula-like way of calculating it.

Okay. And 4% it's of -- you've got a 4% of any growth basically?

That's correct.

Okay. Okay. And then I wanted to kind of come back then just to strategy a little bit. I mean, you talked about acquisitions, and I certainly don't think you're alone in not seeing a flood of stuff coming. You're kind of picking up ones and twosies. In terms of what you're looking at these days, a preference for MOBs versus senior housing, given what you're seeing in the acquisition environment, would you change that around at all? I'm just trying to get a little more color. And I know you're trying to do things, you mentioned that the one in Colorado was sort of where you had other properties. Are you trying to build regional concentrations? Just trying to understand strategically maybe what you're thinking about.

Sure. Well, we currently have an acquisition team that their full-time job is to evaluate investment opportunities and present them to us for consideration. So we're completely analyzing any senior housing transaction that we become aware of in the marketplace, as well as any medical office building transactions we become aware of. And there's a filtering process where maybe our valuation comes out where it's not worth the debt or the -- too many issues affiliated with that property that we won't pursue it further, and it sort of sifts out to what is something that we would consider pursuing. And then where it comes down to is how aggressive we want to be on the pricing. And in certain markets we'll be a little more aggressive than others. We're considering both the medical office space as well as the senior housing space. And frankly, I'd say today, at least for the first quarter, we have seen more opportunities on the medical office building side than we have on the senior housing front.

Okay.

It's been pretty quiet on the senior housing front, just, again, onesies and twosies, but not a heck of a lot of portfolios or transactions of substance.

Okay. And are you sort of waiting for broker deals or are you sort of working with maybe Five Star to just look for strategic opportunities as well?

We're doing both. Five Star has its eyes open for opportunities in their local marketplaces, and we also are working with certainly a network of brokers, some national brokers as well as some local finders and so on.

Okay. All right. I think that's all for me. Thanks, David.

You're welcome.

And our next question is from Tayo Okusanya with Jefferies and Company. Please go ahead.

Good morning.

Morning, Tayo.

Morning.

Quick question. In regard -- can you talk a little bit about your outlook for the life sciences piece of your portfolio and what you're seeing in regards to that area?

Well, I mean, it's a relatively small piece of our entire portfolio. And the particular properties have been doing well. As far as new opportunities out there, I cannot say that we've seen a lot of opportunities. Again, an occasional transaction to consider. I think as far as Alexandria and Biomed seem to be the main competition. And I think most of the companies are going with people who are developers who can do a build to suit, and so on. So we clearly don't have that capacity, nor the desire to have that. And so I don't think we're seeing as many transactions as maybe some of the others are seeing. But, because there aren't that many existing assets being traded that are stabilized properties.

Okay. That's helpful. And then could you talk overall about what you're seeing in regards to first quarter trends at your tenants versus the fourth quarter trends that were reported?

Well, let's see. I believe most of them or all of them, at this point, in the senior housing side, have announced their results and discussed their first quarter occupancy levels and so on. And we truly are seeing a stabilization occurring. Five Star has had a bit of an up tick in occupancy in the first quarter. We've seen Brookdale, I believe was down a little bit. And Sunrise was also down for the first quarter. But I do -- but all these movements have been pretty much consistent with the NIC data that just came out on April 29th, where they indicated that overall occupancies have declined a bit, and they are noting that there does seem to be a stabilization going on, where the rate of decline has greatly been reduced. And we're starting to see a, definitely a bottoming out.

And again, there's no, virtually no meaningful new construction going on. So I think it's very much tied into the general economy, the housing market, the unemployment rate, and so on, that's -- and consumer confidence, ultimately, that's going to move the occupancy levels up in a meaningful way.

Sounds good. Thank you.

You're welcome.

Our next question comes from Kevin Ellich with RBC Capital Markets.

Good morning, guys.

Good morning, Kevin.

I'm just wondering, with the pipeline slowing down a little bit, just wondering if there's any other property types that are looking attractive to you guys that you could maybe move into. You indicated that the one acquisition had some ambulatory surgery centers. Have you explored that avenue?

Sure. That is definitely of interest to us. All the property types that, at various points in time, we looked at dialysis centers and ambulatory care centers, all of those related medical office properties are of interest to us. One of the challenges like in the dialysis center is that you -- each location is relatively small and the dollars involved is not that significant. But, so you have to get a meaningful portfolio to be worth your while.

But all of those within the healthcare area are of interest to us, and we're evaluating anything that is -- that offers those types of services. We're not going outside of medical office building and senior housing or healthcare-related properties.

Got you. Okay. And then did you say in the prepared comment that the wellness lifetime fitness centers are doing well? Because I think someone else is having trouble, some issues with their wellness centers.

Ours are continuing to perform well. What we've seen is just that some of the ancillary services, like spa services and personal trainer and so on, have -- that's dropped off a bit. But basic membership and so on is holding up very well. I think we've had a little bit of a slip in coverage, but not a large one. We're still well over two times coverage. So I know one location is undergoing significant renovations right now and stuff like that, so that also can impact coverage a bit.

Okay. And actually, that leads into my last question, guys. The purchase of improvements going forward, it seems kind of low this quarter. I know Five Star indicated yesterday or last night that I think they sold back $6 million of CapEx to you guys. Just wondering what your outlook is on that front and what you guys are budgeting.

Well, that is a lower number than it has been historically. And it is kind of lumpy each quarter as it comes in. But generally what we've seen, certainly on the Five Star front, is that they have back-burnered a few of their expansions that they were expecting to do and just feel that now is not the time that they want to be expanding some of their facilities. But as far as day-to-day CapEx, that's all -- we monitor all of our assets and they're being well-maintained during this period. So from that perspective, we're not concerned. But it is a lower number than it has been.

I think, Kevin, you also asked what are we [pro forming] for that. I would say $35 to $40 million this year. Like Dave said, it used to be $12 to $15 million a quarter, but it might be more to the $35 million range in 2010.

So Q1 really isn't a good run rate to look at? We should definitely bump that up?

We would hope that that would come up in the next few quarters, but.

Got you. Okay. Thanks, Rick. Thanks, guys.

You're welcome.

And our next question's from [Andrew Riu] with Bank of America/Merrill Lynch. Please go a head.

Thank you, and good afternoon.

Hi, Andrew.

When I -- hi. How are you? When I look at your [rank] coverage for your Five Star, the four leases, it looks like lease number one and two continues to improve and lease three and four continues to deteriorate a little bit. Can you talk about what's going on in those four leases and help me understand?

Sure. Well, let's see. Lease number three, that portfolio is comprised mostly of the large rental CCRC-type properties. And the place that they're being affected most by the economy is the independent living component and, to some degree, the skilled nursing component. So that -- that's -- there's a little bit of softness in those two components, while the AL and ALZ components have held up very well and are also part -- a little bit of a seasonal, as far as fourth quarter of '09.

But lease number four, in that particular case, there's 26 properties in that portfolio and there are about six properties that are below one-to-one coverage by a meaningful amount. So if you're to take those six properties out, you'd be at almost 1.4 times coverage. And of those six, three are formerly New Seasons properties that have had some difficulty. Five Star's -- taking them longer to turn them around because they had some regulatory issues when Seasons handed it over to Five Star.

And then there's one major property down in Florida that's undergoing major renovations, and that's like at about 0.65 times coverage. And then there's one or two other just problem properties that they're trying to turn around.

So you boil it down to really six properties are dragging those numbers down considerably.

Okay. Then if I look at the -- if I go and look at the occupancy for your lease number two versus four, for instance, it looks like lease number two has a lower occupancy at 82%, lease number four has a higher occupancy 85%, yet the coverage is higher for lease number two. Is that because -- are you getting a higher rental from those leases? Or like how should I think about that?

Sure. A couple things. One is, lease number two contains the two rehabilitation hospitals --

Okay.

-- and those typically run around an occupancy of about 60%. So that weighs down that number a bit.

Plus the rent on that -- yes, that's exactly right is those two -- we have hospitals who weigh down lease number two. [Plus the size], these are weighted on the annual current rent, and the rent on lease number four isn't as much as lease number two. We have some strong properties on there, on lease number four.

Right, just proportion it down, weighting.

Weighting, yes.

Okay. That makes sense. Then just one last question. As you think about the rest of this year and as you look across your different asset types, where do you see occupancy settling or rather for the different asset types, which asset type do you think will improve the most in occupancy by year end?

Let's see. Well, in the -- you're talking about senior living assets, specifically like independent, assisted, and skilled?

Yes.

I think the -- well, the assisted living is holding up well, and I would think that will continue to improve from here. Again, because this -- the need-driven decision is no new product of consequence coming online and so on. So I think that will show the most noticeable improvement. I think independent living will still be quite awhile for everything to be straightened out and the housing market and so on to improve to have a meaningful impact on increasing the IL component. In fact, a number of operators are looking to find ways to convert their IL units over to assisted living because there's a demand there.

Nursing homes, I think that will be also slow to increase because every state I know of is looking at programs to incentivize people to take care of people at home or find alternative settings. So there's a lot of pressure working against the nursing homes in that sense. Let's see. I mean, the rehab hospitals are probably pretty steady. And the wellness centers and so on and the MOBs, I think all of those should hold up real well. The MOBs, I would expect, I think the healthcare reform should be a further positive for the medical office building front, and I continue to see that improving in occupancy from here.

Great. Thank you.

You're welcome. All right.

This concludes today's question-and-answer session. At this time, I would like to turn the conference back over to Mr. Dave Hegarty. Please go ahead.

All right. Thank you all for joining us today. We will be at the NARE Conference in Chicago in June, and hope to see you there. And we'll look forward to upgrade -- updating you on our progress at the second quarter conference call in August. Thank you. Have a good day.

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