Diversified Healthcare Trust (DHC) 2010 Q4 法說會逐字稿

Good afternoon and welcome to the Senior Housing Properties Trust 2010 fourth quarter and year-end 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 afternoon, 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 S & H.

Before we begin today's call, I'd 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 SNH's present beliefs and expectations as of today, February 23rd, 2011. 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 Q4 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 Q4 2011 Form 10-K which we expect to file with the SEC tomorrow. Investors are cautioned not to place undue reliance on any forward-looking statements.

With that I would like to turn the call over to Dave Hegarty.

Thank you, Tim. Good afternoon, everyone. Good morning, wherever you're located, and thank you for joining us. Earlier today we reported funds from operations, or FFO, for the fourth quarter of $0.44 per share which compares favorably to the $0.41 per share we reported for the same period a year ago. And for the year FFO per share was $1.71.

We accomplished a great deal during 2010. Our debt ratings were upgraded to BAA3 by Moody's and our corporate rating was upgraded to BBB minus by Standard & Poor'. We increased our quarterly dividend during third quarter by $0.01 per share, or 2.8%, to $1.48 per share per year. We've really diversified our rental income stream through acquiring Medical office buildings. Today the medical office building portion of our portfolio has grown to 37% of revenues and private senior housing is now at 52% of revenues. Our Five Star concentration is down to 47% of revenues, from 57% at the beginning of 2010.

During the year we made new investments totalling $467 million, consisting of 26 Medical office buildings, and capital improvement funding on our existing senior housing assets. After year-end we made total new investments for approximately $110 million consisting of seven Medical office buildings. Of the $577 million of investments made since January 1, 2010, $470 million was a Medical office billing portfolio transaction, and the other $107 million were other Medical office building acquisitions and capital improvement funding -- financing at our Senior living properties.

Our largest transaction of the year was the acquisition of 27 Medical office buildings from CommonWealth REIT, which we announced in November. These are primarily Class A and B properties with strong credit tenants located across 12 states. We acquired 21 of these properties during the fourth quarter and the remaining six properties in January, so the entire transaction has closed and we were able to fund these investments by accessing both the debt and the equity capital markets.

Our balance sheet remains strong and at year-end our debt only represented 36% of our total book capital, which is in the range of where we've operate historically. Before I get into the details of our portfolio, the acquisition environment and the outlook, Rick will review the annual and quarterly results as well as our acquisitions in more detail.

Thank you, Dave. Good afternoon, everyone. From fourth quarter 2010 we generated fund from operations of $57.2 million, or $0.44 per share, compared to $52.4 million, or $0.41 per share, for the same period in 2009. The dividend paid with respect to the fourth quarter was $0.37 per share, which equals a payout ratio of 84% for the fourth quarter FFO. On a year-over-year basis we were able to grow FFO by $12 million, or 5.8%, increase our annual dividend rate to $1.48 per share and diversify our revenue stream.

From 2009 to 2010 our revenues increased from $297 million with 215 tenants, to $339 million with over 400 tenants. This growth in revenues is due to investments we made in 2010 of $467 million. We invested $435 million in Medical office buildings and $32 million in capital improvements at our Senior living communities. Percentage Rent revenue totalled $10.3 million in 2010 versus $9.1 million in 2009, or a 13% increase year-over-year. In addition to occupancy in rate growth, our percentage rent increased due to 30 Senior living communities we acquired in 2008 based on 2009 revenues.

During the fourth quarter we invested approximately $398 million, comprised of the acquisition of 22 Medical office buildings for $390 million and capital improvement funding to our existing Senior living assets of $8 million. These acquisitions were funded utilizing the proceeds from our equity issuance in December and borrowings from our line of credit. Property operating expenses increased $2.1 million in the fourth quarter of 2010 compared to the same period in 2009. The $4.9 million increase year-over-year is solely the result of Medical office building acquisitions made during 2010.

The annual interest expense for 2010 was $23.6 million higher versus 2009 due to the full-year interest expense and the amortization of deferred financing fees related to our Fannie Mae debt, which we closed in August, 2009, and the sale of $200 million of unsecured senior notes with an interest rate of 6.75% in April 2010. These increases were offset by reduced interest expense related to the redemption of our $97.5 million of our 7.785% unsecured senior notes due 2015 in May 2010, and lesser amounts outstanding on our revolving credit facility and lower interest rates in 2010 versus 2009. In the second quarter of 2010 we recorded a loss on early extinguishment of debt of approximately $2.4 million related to the redemption of the $97.5 million unsecured senior notes due in 2015.

General and administrative expenses for the fourth quarter of 2010 were $5.4 million, or 5.6% of revenues. General and administrative expenses were $2 million higher year-over-year primarily due to new investments. Our G&A costs remain competitive with other Healthcare REITs at 6.4% of revenues for the year, which is down almost 30 basis points from last year.

On a quarterly basis we evaluate our portfolio for impairment in performance, and during the fourth quarter of 2010 we recognized an impairment charge of $4.9 million. During the full year of 2010 we recognized impairment charges of $6 million related to seven under-performing properties, four of which were sold in August 2010. These four skilled nursing facilities sold for $1.5 million, and we recognized a gain of $109,000.

At year-end we had $128 million outstanding on our revolving credit facility, two series of unsecured senior notes totalling $423 million, and mortgage loans and capital leases totalling $654 million. Our total debt was approximately $1.2 billion, and our equity was $2.1 billion, for a ratio of debt to total book capital of 36%. On a market basis, as of December 31, our debt to total market capitalization was 28%.

In January we issued $250 million of five-year unsecured senior notes at 4.3%. The proceeds were used to repay borrowings outstanding under our revolving credit facility and to fund acquisitions. We currently have $225 million of unsecured senior notes due in January of 2012 with a high interest rate of 8.585%. We continue to look for -- continue to look for opportunities to accretively refinance these notes. Today we have essentially the full amounts available to us on our $550 million revolving credit facility to fund future investments. Our credit facility expires on December 31, 2011. If we continue to monitor banking market conditions and expect to refinance of our credit facility prior to its maturity.

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

Thanks, Rick. As Rick described, we had a solid fourth quarter in 2010 and are poised to take advantage of investment opportunities in 2011 and 2012. At this point I'd like to discuss the performance of our major senior living tenants. Our largest tenant, Five Star Quality Care, reported earnings yesterday. As their fourth quarter financials show, they continue to have solid profitability and are well positioned to take advantage of the anticipated rise in occupancy for the industry.

For the 12 months ended December 30, 2010, occupancies across all of our Five Star leases remain flat from the prior quarter, except for lease number one which declined slightly to 87% from 88%. Cash flows for three of the four leases operated by Five Star increased for rental coverage, and overall rental -- overall covered their rental obligations by 1.35 times, on a cushion of approximately $65 million. All coverage ratios presented on EBITDA basis.

Our other tenants outperformed well during the same period, the 14 properties we leased to Sunrise also covered their rental obligations by 1.35 times. Occupancies averaged 90% in their portfolio. Our properties leased to Brookdale are 93% occupied, and covered their rents over two times. The occupancy across our six private operations remain basically flat at 85%. And covered their rents at by more than two times. Our two Wellness center tenants covered their rental obligations over two times as well. The five trailing 12-month periods presented in our Supplemental Package reflect consistent coverage for 2010 and 2009 at about 2.2 times and 2.3 times, respectively. Our Senior living tenants continue to maintain occupancies and cover their rental obligations, our tenants appear well-positioned to improve when the overall economy rebounds.

Now moving on to the Medical office building component of our portfolio. As I mentioned before, in November, 2010, we agreed to acquire 27 Medical office buildings for an aggregate purchase price of $470 million. And during the fourth quarter we acquired 21 of these properties at $374 million, and acquired the remaining six properties in January for $96 million. Also in fourth quarter we acquired one Class A Medical office building located in Conrow, Texas, for $15 million. This property is (inaudible) leased for approximately 14 years to a highly regarded Physicians group with over 100 physicians. We also acquired Biotech lab property in January located outside of Minneapolis, for $14.2 million, with a lease term of approximately eight years. This property is leased to WuXi App Tec, the ninth largest pharmaceutical company in the world.

Since January 1, 2010, we have acquired 33 Medical office buildings for approximately $545 million, with 3.1 million square feet and weighted average lease term of 5.5 years. Today we have 5.9 million square feet of Medical office building space. The occupancy for the Medical office building portfolio remains flat, at 97% quarter-over-quarter for the 82 properties we owned at year-end. Our lease turnover for the next 12 months is only $6.6 million, or less than 2% of our annualized rental income.

In 2010 we funded $32 million of capital improvements at our existing senior living properties. We also have agreements to sell three nursing homes located in Georgia and one assisted living facility located in Pennsylvania, all leased to Five Star for $18.8 million. As Rick mentioned, we sold four skilled nursing facilities in August, 2010, for $1.5 million. These activities decreased our overall skilled nursing exposure to fewer than 50 properties and throughout 2009 to 2010 we have been actively pruning the portfolio to reduce our skilled nursing exposure, and have been more aggressive in pursuing Medical office building acquisitions.

Today we're seeing several individual assets and portfolios to consider. I'm optimistic that we'll make new investments in the 7% to 9% cap rate range. In addition to senior living space, the medical office space, has opened up a new avenue of potential acquisitions. We're confident we will make acquisition in both of those spaces. But, as always, we'll remain a disciplined investor and will not chase non-accretive transactions.

The dividend remains our highest priority. We have a long history of consistently raising the dividend. Our Board evaluates the dividend on a quarterly basis and looks for opportunities to prudently raise it. This was no different in 2010, when our Board raised the dividend during the third quarter by $0.01, to $0.37 per share. Based on current payout ratio of 84%, we're currently generating approximately $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 and prepay debt. This year, we'll be focussing on renewing our revolving credit facility, refinancing our senior notes through January, 2012, and investing in accretive transactions.

With that, now I'll open it up for questions.

(Operator Instructions)

Your first question comes from the line of Jerry Doctrow.

David, a couple of things, big and small. You know, a little -- my sense on acquisitions and maybe acquisition environment, first of all, lot of obviously what you bought was from related parties. There's only a couple of properties that were outside of that. I wanted to get a little more color on -- you're calling everything MOBs, but some of them look like more conventional office buildings. Some of them look like science. I wanted to understand how you're thinking about that market? Then, anymore color on anticipated volume or mix? I think you said you would do it in the 7% to 9% range. That is a fairly wide range for us, but what do you think is a reasonable target?

Sure. Well, as far as medical office buildings, it is a broad definition, and our target is actually properties that are used for biotech labs, or patient care type services. When we did buy some of the CommonWealth REIT properties, those were properties we had a right of first refusal on. And some of those properties are spaces that are leased to, say, Covidien, on a long-term basis. And it's their medical practice group but it is office space. I would say 90% of the space of that portfolio is actual doctors' office practices and so on. At Cedar Sinai Medical, or in the greater Philadelphia area, there's a number of biotech, as well as medical office. So, I would say the only ones that you might consider office, were some of the properties in the CommonWealth transaction.

And biotech is a relatively small percentage of the total at this point?

It is. The biggest investment in the biotech space is the property we bought in La Jolla, California. That is leased to Scripps Research Institute. And that is a very large investment. That's the major piece of our biotech investment. And then we have, I would say we probably have another, maybe, 10 properties or so, that have various lab space within those buildings, but they are much smaller. More in the $7 million to $15 million range per building.

Okay. And then just acquisition environment, any more color you can give us; sense of size, what volume we might see this year?

Yes, well, this year we are seeing a number of transactions in the marketplace. In addition, obviously, we saw the large transactions by our RIDEA structure last year. This year I would say, we probably are evaluating well over a $0.5 billion of investment opportunities in both the senior housing space as well as the medical office space. Some of those I'm pretty optimistic that we're going to be successful in, but at this point we don't have them under firm agreements, so I can't comment on them, yet.

And that is stuff that is away from affiliated parties?

The purchases are from unaffiliated parties.

Okay. And then are -- on the Five Star assets, is all of the stuff that you're selling in 2011 already in held for sale as of 4Q 2010, or some of it moving into held for sale in the first quarter?

We do have a couple of properties, one property that is held for sale moving into 2011. We expect these properties to be sold within -- sometime during the end of the first quarter, beginning of the second quarter.

Okay. And do you know how much? What's the one that is moving in, roughly the size or whatever?

It is not -- these aren't big properties. There's maybe about a $10 million investment property.

Okay. All right. And then last thing for me and I'll jump off. I just wanted to make sure that I'm thinking in the right way about growth in the portfolio. So there's maybe three moving parts, the way I think about it. One is how much of the portfolio as a whole is straight-lined, and, so what actual cash growth you're getting as opposed to straight-lined? And then, where do you see percentage rent going the 2012? I'm trying to get a sense of what the overall growth is going to be in the core portfolio.

Well, just on the senior living assets, pretty much all of that is percentage rent formula driven. And as we saw this year, it had a 13% increase year-over-year, and that's in somewhat of a tough market environment. The coverage ratios and occupancies really haven't moved up that much over the past year. So, most of that growth has been coming from the group of properties that came on line to the percentage rent formula. And so I think there is more upside potential once the occupancies and REITs started moving.

Yes. There were 30 properties that we acquired in 2008 with a base year in 2009 that started contributing in 2010, Jerry. And then we have properties that we acquired in 2009, they now have a base share of 2010 that will be contributing in 2011.

So, it could be better than 13%?

It depends on occupancy and rate growth and how these properties that we brought on, how they do.

Okay. Remind me just the percentages over the base year, what you get?

4% of the revenues in excess to the base year revenues, in Five Star's case 4.5% and on the Sunrise leases.

Okay.

And so there's a couple areas for growth. There is the percentage rent formula. There's -- in the medical office portfolio I would say there's not a heck of a lot of roll over in the next year or two in the medical office. Which actually isn't such a bad thing, because I don't think it's an environment we can really push rates that much, but I do believe that demand is going to increase and we should see rates moving up on the rent renewals. And then we also have capital improvement financings that have been running roughly $10 million a quarter, and we get 8% on the amounts funded as drawn. So there is a couple -- that's all internal stuff.

Then, external, obviously, it depends on the acquisitions, the environment we're seeing. Last year I'd say we saw more in the medical office side of things. In the early part of this year we're seeing more in the senior housing side of the business to consider. And I think there is quite a bit of new product coming on line to consider.

And not so much in development but new sale opportunities?

Yes, correct.

Okay. And on the CapEx, the last couple of quarters it dropped closer to $8 million from $10 million, do you think $10 million a quarter is still a good run rate going forward?

If you recall, a couple of years ago it was about $69 million or $70 million, and then during the economy the last couple of years it probably dropped to more about $8 million to $10 million a quarter. Hopefully in 2011 it will stay there, or maybe increase a little, depending upon the economy, I guess.

There are some decisions being made to start out maybe some expansions, and the rehab hospice that was a big component of the higher dollars years ago. They have refurbished most of the units they intended to, so that should move a little slower, not as big dollar amounts as it was.

Okay. So, maybe $10 million would be a max per quarter?

I would say in this cautionary environment, I know they're holding back a little bit on some expansion, until they feel that the market is really accelerated. Yes, $10 million is a good number for now.

Okay. That's all for me.

Thank you.

(Operator Instructions)

Next we'll go to the line of Jana Gallon.

I was wondering if you could give some color around what's happened to cap rates in the last three months in the MOB or senior housing spaces?

Sure, on the medical office building area I would say that they're pretty much holding at the current level. I think there might be some isolated cases where they could come down for Class A assets that somebody must have. But I think generally they seem to be holding where the initial cash cap rate is in the 7s to low 8s, I would say, depending on the location of where the asset is and the size and things like that. Clearly for portfolio transactions or something that is truly Class A that somebody has to have, they may have to pay a lower cap rate, but that is the exception rather than the rule.

On the senior housing side, I think cap rates have come down. I think any portfolio transaction today, people have to look at the RIDEA structure and look at those cap rates have significantly declined, and so if it's going to be a situation that's a RIDEA format, it is going to have to compare against those. If it's a traditional sale lease-back, I think we're still probably in the 8 to 8.5 cap rate range under those scenarios.

Thank you. And in terms of your underwriting assumptions, has anything changed there, or has that remained the way you've always looked at things?

We've always been very conservative, so we really have not changed our approach on evaluating it. If we believe there is upside potential we may stretch a little, but we're not going to underwrite a transaction on tomorrow's expected results. So, I would say we really haven't changed that much in our underwriting standards.

All right. Thank you very much.

You're welcome.

Your next question comes from the line of Frank Morgan.

Good afternoon. I wanted to touch on all of the refinancing activity you've got coming up between the revolver and those 8.625 notes. I'm just curious it sounds like-- and I'd appreciate your comments about how that can be done. I'm assuming that can be done on an accretive basis in a refi, and any interest and perhaps expanding the size of those facilities or when you go do your refinance? Thank you.

Yes, our unsecured senior notes due on January 2012, is $225 million at 8.625%. Over the next couple quarters we have to evaluate different options on how to refinance it. But I believe, we believe, that it will be an accretive transaction what we do refinance that. Also in the next couple of quarters we'll be talking to the all the banks about refinancing our line of credit, which is due at the end of the year. And today that is at LIBOR plus 80 basis points. So, that will go up, of course, but that's something we'll be looking at in the next couple of quarters.

Just some commentary on the capacity. I think it will depend on the market and what the appetite is in the marketplace and what the pricing structure is. We believe that there is, all the time, more and more interested participating in the revolver. So I would say we're probably going to be at the same or maybe we might consider increasing it a bit. We don't feel we need to double the size or anything like that, but we may consider increasing. And the spread and so on, is a bit volatile but over the course of 2010 the spreads have actually been coming down over the course of a year. So, time has been our ally, in that sense. I think we're thinking more middle to later this year, before dealing with both of these situations, the refinancing of the revolver and refinancing of the debt.

Okay. Thank you.

Next we'll go back to the line of Jerry Doctrow.

And, David, I had to jump off for a second so hopefully somebody has not already asked this. I was curious about how you're thinking about just about overall leverage level. I think candidly we were thinking you were comfortable taking it up into the 40s where most of your peers are. And I think you were at 36%, and Rick maybe even said it come down 28% of book, if I understood him correctly. So, as you go forward, you make acquisitions, should we be thinking of continued equity issuance to sort of keep you closer in that sub-40% debt to book, or should we think about it a little bit higher?

Well, I think we can bring it higher and we're comfortable bringing it higher and again each time we're looking at capital we're evaluating what our best option is at that time. We are going to refinance out that debt issuance. Again, I don't know if today whether that's going to be taken out with debt or equity, probably I would say we would be leaning towards debt right now. And then on the line of credit, clearly -- well, we anticipate utilizing that and running that up somewhat. Right now as we sit we're very well positioned with no capital needs, and our average for the last 10 years has been about 33%. So, we're a little bit above average, but we've run it up to about 44%, probably about five years ago, in that time frame.

Jerry, the 28% I mentioned was on the market capitalization at year-end.

Oh, okay. Sorry, I misunderstood. Dave, just maybe to push you a little bit on this. So, obviously it depends upon marketing conditions, pricing, and that sort of stuff, but assuming you just use debt to do the refinancing, the line gets refinanced, maybe it gets a little bit bigger. I think what I'm hearing you say, let me say it that way, is that we should think about the leverage basically staying just about where it is because your historical has been a little bit lower. It may bounce around little bit quarter to quarter, but we should think about continued equity raise, assuming there is some major acquisitions, to keep the overall ratio about where it is. Does that seem reasonable or --?

Well, very long-term picture, you would probably want to stay more or less around this range. But, again, it's going to depend on what is happening in the marketplace at the time we're raising capital, and it's all driven by the opportunities that we see out there.

Right.

If we had $100 million on the line, probably wouldn't let it sit there. But if we're looking at $500 million of transactions, everybody knows we have to do it pretty much in combination.

Right, right. Thanks.

Thank you.

At this time there are no further questions.

Mr. Hegarty, please continue.

All right. Just thank you all for joining us today. We will be presenting at the Jefferies Global Healthcare Conference in March in New York, and we hope to see some of you there. Have a great afternoon. Thank you.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation, and for using AT&T executive teleconference. You may now disconnect.