Diversified Healthcare Trust (DHC) 2015 Q2 法說會逐字稿

Good afternoon, everyone, and welcome to the Senior Housing Properties Trust second quarter financial results conference call. All participants will be in a listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please also note that today's event is being recorded.

At this time, I'd like to turn the conference call over to Ms. Kim Brown, Director of Investor Relations. Ma'am, please go ahead.

Thank you, and good afternoon, everyone. Joining me on today's call are David Hegarty, President and Chief Operating Officer; and Rick Doyle, Treasurer and Chief Financial Officer.

Today's call includes a presentation by management, followed by a question-and-answer session. I would also note that the transcription, recording and retransmission of today's conference call are strictly prohibited without the prior written consent of Senior Housing. Before we begin, 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 other securities laws. These forward-looking statements are based upon Senior Housing's present beliefs and expectations as of today, August 6, 2015.

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. In addition, this call may contain non-GAAP numbers, including normalized funds from operations or normalized FFO and cash-based net operating income or cash NOI. A reconciliation of these non-GAAP figures to net income and the components to calculate AFFO, CAD or FAD are available in our supplemental operating and financial data package found on our website 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 filings with the SEC. Investors are cautioned not to place undue reliance upon any forward-looking statements. Now, I would like to turn the call over to Dave.

Right. Thank you, Kim and good afternoon everyone, and thank you for joining us on today's second quarter earnings call. Earlier this morning, we were pleased to report normalized funds from operations or normalized FFO of $0.45 per share for the second quarter, up almost 5% compared to the same period last year, and in line with consensus. This is the third straight quarter that SNH has posted 5% year-over-year growth in normalized FFO on a per share basis.

I'd like to review the results of our various business segments and our acquisition investment activities and then, Rick will discuss our financial information in more detail.

Our triple net leased senior living properties, which represented 40% of our second quarter NOI, continue to perform very well, and in line with our expectations as same-store rental income increased 1.8% year-over-year. This increase is primarily due to revenue-producing capital improvements made in our properties over the past year. Within the triple net senior living portfolio, our individual operators also continued to perform very well. Five Star's 180 leased communities has a combined occupancy of 84.7% and rent coverage of a solid 1.2 times for the 12 months ended March 31, 2015, which is consistent with our healthcare peers coverage for senior living properties. The four properties we leased to Sunrise Senior Living had occupancy of 92.5% and coverage of 2.0 times. The 18 properties we leased to Brookdale Senior Living had occupancy of 93.7% and rental coverage of 2.7 times. Our other triple net leased senior living properties leased to the private regional operators had occupancy of 85% and rental coverage of 2.0 times.

As you can see, our leases are well covered, and we're pleased with the performance of our operators. We're also pleased to note that in connection with the CNL transaction. We've added six new relationships into our triple net leased senior living portfolio.

And moving on to the managed senior living portfolio, during the quarter, we acquired 19 properties, 14 of which we hired Five Star to manage and five are managed by a third-party operator in the southeast.

At June 30, we had a total of 65 managed properties with 8,500 units, generating over $22 million of NOI during the quarter, which represents approximately 14% of total company NOI. At our 44 same-store communities, the NOI grew by 1.4% year-over-year and same-store margins were essentially flat at 23%.

Our same-store revenue results were primarily driven by an average monthly rate increase of 2.4%, offset by a decline in occupancy. The increase in rates and service revenue more than offset the decline in occupancy as net revenues increased 1.7% or $1.3 million. Same-store occupancy declined [30] basis points sequentially and 90 basis points year-over-year to 87.6%. The sequential decline was in line with industry trends and primarily due to the impact of the flu, which extended into the second quarter. We also experienced a 1.8% increase in property operating expenses, primarily due to increased repairs and maintenance, including unit turnover cost that we expensed as well as marketing costs related to promotional activities at certain communities.

Turning to our medical office buildings, at June 30, our MOB segment was comprised of 121 properties with 145 buildings. We had over 11.3 million square feet, generating quarterly NOI of $66 million, representing approximately 43% of total company NOI. Overall occupancy was an industry-leading 96.4%. At our 96 same-store medical office building properties, our NOI for the second quarter decreased approximately 2% compared to the same period last year to $35.2 million, a decrease of approximately $800,000.

Our rental income increased modestly by $100,000 year-over-year and the decrease in NOI relates primarily to an increase in expenses that are non-escalatable to our tenants during the quarter. Non-escalatable expenses include items like legal fees non-routine, repairs and maintenance, and increased payroll costs. We continue to see positive leasing activities during the first half of the year of which the benefit won't take effect until later this year and is expected to improve our same-store quarterly results in the second half of 2015. A strong occupancy of 96.4% represents occupied and committed space as evidenced by lease agreements.

Moving on to our acquisition and investment activities. In the second quarter, we announced the transaction involving our manager, Reit Management & Research or RMR when we acquired a 17% economic interest in our manager in exchange for $60.7 million. We also amended our management agreement with RMR to extend the term for 20 years. As part of the purchase of RMR, we issued 2.3 million shares of SNH valued at $46.8 million and the remainder of the purchase price was paid in cash. The shares, we issued are subject to 10-year lock-up agreement by the historical owners of RMR.

As part of this transaction, we've agreed to distribute half of the RMR shares to our shareholders as a special dividend and RMR has agreed to facilitate this distribution by filing a registration statement with the SEC by seeking a listing on a National Stock Exchange. We currently expect to complete the distribution of RMR shares for our shareholders by year-end 2015 but we cannot distribute the shares until the RMR registration statement is declared effective by the SEC.

We believe this investment on manager was made at a compelling price and this transaction benefits SNH and the shareholders. Specifically, we believe this transaction further aligns the interests of RMR management, ourselves and our shareholders, provides greater transparency into our manager, and allows us to continue benefiting from the low-cost management structure.

On May 1, we closed on the acquisition of 37 of the 38 private pay senior living communities from CNL Lifestyle Properties for approximately $763 million. There's one remaining lease community that will be acquired for $27 million, when all the closing conditions are satisfied.

As a reminder, the 38 Class A communities have approximately 3,500 units, one third of which are independent living and two-thirds are assisted living and memory care and the majority of which were built in the last 10 years.

On May 1, we assumed 18 leases, which have a combined coverage ratio in excess of 1.2 times and a weighted average remaining lease term of approximately 10 years. We converted one management agreement into a long-term 15-year lease, bringing the total number of leased communities in the transaction to 19. In terms of the managed communities, we've assumed the agreements with one private operator to manage five communities and engaged Five Star to manage the remaining 14 communities. Since May 1, Five Star has re-branded the communities, retained key personnel and started a rollout program, which both improves residents' quality of life as well as attracts new residents. In addition, we believe there are expansion opportunities at some of these communities. And over the next couple of quarters, and as is typical with these acquisitions, we would expect some volatility during the transition of managed properties. However, we still expect the CNL transaction to achieve a return in excess of 7%.

Also in May, we acquired a newly-constructed private pay senior living community with 40 independent living units in Georgia for approximately $9.8 million. This building shares the campus with the community we own that offers both assisted living and memory care, thus providing a full suite of services. The new construction is filling up nicely and the entire campus is managed by Five Star. We would expect this property to be stabilized from an occupancy standpoint during 2016. And then subsequent to quarter-end in July, we agreed to acquire another private pay community with 84 assisted living and memory care units in Georgia for approximately $18 million. This transaction is a sale-leaseback with an existing private operator, and we expect this acquisition to close prior to year-end.

We're pleased with our year-to-date acquisition activities and we expect to remain very selective and disciplined through the remainder of the year, given that cap rates continue to be compressed across the healthcare spectrum. Our focus is on broadening our relationships with existing operators, seeking internal growth opportunities, including expansions and renovations at our communities and other opportunities to enhance investment returns.

With that, I'll turn it over to Rick to provide a more detailed discussion of our financial results.

Thank you, Dave, and good afternoon everyone. For the second quarter of 2015, we generated normalized FFO of $106.8 million, up 23% from $86.6 million in the second quarter of last year. On a per share basis, normalized FFO for the quarter increased 4.7% to $0.45 per share compared to the same period of last year. Rental income for the quarter increased $28 million to $156 million. The increase is primarily due to external growth from investments in 25 medical office buildings and from the 18 leased CNL senior living communities we acquired on May 1, offset by reduction in rental income due to the sale of six senior living facilities since April 1, 2014. Looking at our managed senior living portfolio, residents fees and services revenues from our 65 managed properties increased over [15%] to $92 million compared to the second quarter of last year. The increase primarily relates to acquiring 21 managed senior living communities since April 1, 2014 and an increase in the average monthly rental rate. Property operating expenses increased 17% in the second quarter to $94 million compared to the same period last year due to external growth from acquisitions as we added 21 managed senior living communities and 25 MOBs to our portfolio since April 1, 2014.

General and administrative expenses for the quarter were $11.7 million compared to $9.6 million for the same period last year. The increase primarily relates to the property acquisitions, offset by the dispositions since April 1, 2014. At 4.7% of quarterly revenues, SNH continues to maintain a G&A expense as a percentage of revenues at or below its healthcare peers.

Interest expense increased 11% to $38 million this quarter compared to the same period of last year, primarily as a result of issuing $650 million of senior unsecured notes in April 2014 and our $350 million term loan, which closed in May of 2014, as well as the assumption of approximately $185 million of mortgage debt, encumbering 19 properties with a weighted average interest rate of 4.6% since April 1, 2014, offset by the repayment of secured debt encumbering 13 properties with the total principal balance of $134 million in a weighted average interest rate of 5.9% over the past year.

During the second quarter of 2015, we repaid mortgage notes encumbering seven properties with an aggregate $30.6 million in a weighted average interest rate of over 5.5% and recognized a loss of approximately $39,000 on early extinguishment of debt in the second quarter. At the end of April, we sold the MOB classified and discontinued operations for $1.5 million. For the second quarter of 2015, we reported a loss from discontinued operations from this MOB of $109,000 compared to income from discontinued operations of $741,000 in the second quarter of 2014, a differential of approximately $850,000 year-over-year, which we include in our calculation of normalized FFO.

In the third quarter, we do not expect to record a loss from discontinued operations. Subsequent to quarter-end, we sold two leased skilled nursing facilities that were classified as held for sale, and currently we have one remaining leased facility classified as held for sale, which we expect to sell in 2015. Moving to the balance sheet. During the quarter, we closed our $772 million of acquisitions and invested $4.8 million into revenue-producing capital improvements at our leased senior living communities. During the quarter, we also spent $4.9 million on MOB tenant improvements and leasing costs.

These costs can vary significantly quarter-to-quarter, depending on when we execute certain leases in the characteristics of those leases such as the multiple lease terms in the amount of square footage.

Our recurring capital expenditures for the quarter included $1.3 million at our medical office buildings and $2.8 million at our managed senior living communities. We also incurred approximately $4.3 million of development and redevelopment capital expenditures, primarily at our managed senior living communities.

At June 30, we had $52 million of cash on hand, $615 million outstanding on our revolving credit facility and $1.7 billion of senior unsecured notes, $730 million of secured debt and capital leases and a $350 million unsecured term loan. SNH's balance sheet and liquidity remains strong and in line with our peers with total debt to gross book value of real estate assets of approximately 47% and adjusted EBITDA to interest expense at 3.8 times.

On May 1, we closed on the majority of the CNL acquisition for approximately $763 million, which included the assumption of approximately $139 million of secured debt with a weighted average rate of 4.4%.

We used cash on hand in our revolver to close the CNL acquisition. The revolver currently has $585 million outstanding and as previously discussed, we expect to pay it down with debt financing. For the foreseeable future, we will focus our efforts on internal growth by funding expansions, improving and expanding our operations in the managed portfolio and greater expense controls for our senior living and MOB properties, and continue to look for opportunities to repay secured debt at lower rates whenever possible.

With that Dave and I are happy to take your questions.

Juan Sanabria, Bank of America Merrill Lynch.

Hi everyone [Josh Duggar] in line with Juan Sanabria. My question relates to your acquisition pipeline. I was wondering, what you guys are looking at for the rest of the year and what's the mix? Is it a more portfolio deals or single assets and what kind of a pricing are you expecting for future acquisitions?

Well, the acquisition environment is pretty hot and competitive, and we definitely see a lot of product to consider. But we've conscientiously made the decision, we are not going to chase a lot of transactions out there that are trading in the (inaudible) cap rates. So I envision, we will be first focused on trying to expand our relationships internally by looking at expanding existing communities. We have I think five different operators doing expansions right now. And for those expansions, we typically can earn at least an 8% return on those investments. And then we've individual assets that we're investing in periodically and those will tend to be 7.5%, 8% cap rates generally. But we are not going to -- pursuing portfolios or really chasing some of the transactions out there. So, as I expect to be modest for the rest of 2015 for acquisitions or new investments.

Got it, thanks. That's it for us. Thank you.

Tayo Okusanya, Jefferies.

Hi good afternoon, gentlemen. I just wanted to talk a little bit about the transaction with RMR. I mean you made some valid points about why you felt this was the right thing to do but I think one thing people are still struggling with this idea that RMR still gets this huge [10-1] voting majority on all the issues. I mean why would not just you but all the other healthcare REIT agreed to just let them still have this outstanding huge amount of voting rights on all matters. And how is that fair to shareholders who you are going to be distributing the stock to?

I think one thing RMR is in the process of filing a registration statement, so I am limited to what I could say anyways but I think for people who have expressed an interest in is having the transparency and an interest in the participation of RMR and frankly we have a very complex organizational structure, so it would be very difficult to slip things up or to exactly do a certain type of transaction. So I think this was one way to achieve a number of goals, maybe not a 100% of what everybody wanted but I think it does provide the element of interest and provides the insight into RMR and its participation and their performance.

Yes, but it still creates a situation where even with the shares that I own I barely have a voice at the table because they get this 10-1 voting majority on all matters. So they are getting the cash there but yet I still -- if I'm displeased with anything I still don't have enough of a voice to really create real change.

Well, it's really participating in the economic performance of them and having the insight. It's not necessarily having an ability to change things at our mind. That's the transaction negotiated between the trustees and RMR and consultation with the various advisors involved.

Okay, that's okay. Let's now move on to the next topic then. Just from a balance sheet perspective and capital markets perspective, you guys are all set with all the financing you need for all your deals, correct?

Correct, we have the capacity and we're still looking at different options for paying down some of the outstanding borrowings on the revolver but frankly I think given that we're not pursuing a very large pipeline to begin with, we are more than satisfied.

But in regards to staying down the line, are you kind of looking at a combination of debt and equity or is it primarily equity you want to use to kind of maintain decent leverage ratios or are you willing to kind of swap it out debt for longer-term debt.

Yes like we have said Tayo, we will pay down this on a long-term debt financing. We now look at all options on debt, including bank debt, secured debt and we'll continue to monitor the unsecured notes market. But today, we will not pay, we would definitely not pay, nor raising any equity to pay down the funds on that credit facility.

Okay. That's helpful. Just one more from me, and I'll get off. Dave, again just given what's happened with the stock, again, down, just last a quarter of its value year-to-date, it's trading at a huge discount to NAV, what do you think investors are really concerned about in regards to the company? And then two, would you guys also consider a stock buyback, just kind of given this large valuation disconnect?

Sure. As far as the stock buyback that is on the table for us to consider, including certain asset sales and other things we'll evaluate. As far as the stock price itself, we're clearly not pleased at all with the performance. And really speculation I mean -- there is a question for the RMR transaction, but that's not materially dollar-wise significant. People are afraid that interest rates are going to significantly move up. Everything I've heard is if they do move up, it's going to be modest and still something for later in the year but I guess I turn it back to you and talk with investors and if there is anything that you think that -- also talking on the stock price, we would be interested in hearing about it but we're very pleased with the revenues and so on of our MOBs and our senior living, and we have tempered our growth plans for not chasing portfolios and so on.

I think we should -- we can definitely talk a little bit more about this offline, but I yield the floor to the next person.

Okay thank you.

(Operator Instructions) Daniel Bernstein, Stifel.

Good afternoon. Could you remind me how the RMR fees are tied to the stock price? I know you made some changes last year, probably this year, last year about that. I just wondered if you could just remind me how that works?

With the new business management agreements that are all now -- it's all paid in cash, full 100% of it's paid in cash, Dan and the fees are paid based off 50 basis points of investments or that's the low of 50 basis points are investments or the market value -- total market value of the company.

Okay. And then also just -- I will just reemphasize what Tayo said I think buying back stock here would be very, very beneficial given where the stock price relative to discount NAVs, if you are considering that, are you thinking about -- would you think about doing that with increased leverage or would that just be from asset sales in the smaller way? I am just trying to ascertain your real propensities to do something like this.

We definitely have looked at the pricing considering stock buyback program. We have often looked at different asset sales and very modestly sold assets, but we definitely would look at tying effective two together granted on a short-term basis, the revolver is available to do something. But I think a long-term solution would be selling some assets to buyback stocks. It's on the table and certainly we have to consider that seriously.

Has there been any consideration of re-splitting out the stock the company between -- the two companies such as MOBs and Senior Housing to be in a specific trading there versus or it's just not?

It is not very actively discussed internally, there is no current plan.

Okay. Just on seniors housing just to get into the more meat of what might drive earnings in the company. Are you seeing any wage inflation in terms of staffing in the seniors housing side of the business? A little bit about that maybe out there and how are you thinking about rate growth in your seniors housing relative to expense growth, just broadly?

Sure. Well, generally we've not seen much in the way of wage pressure and obviously, there is the greater picture of people calling for the rise in minimum wage across the country, so that eventually could impact the space. But within our portfolio, we're not seeing a meaningful impact or concern about rising wages. Now, with regards to rate increases, we had 2.4% net rent growth this quarter and that's always weighted average or average because down in Florida where our properties are all in excess of 90% occupancy and we're able push through 4% to 6% rate increases. But I would say like our weakest market like the Arizona market and where we are not going to be able to push rates much at all. So, net-net, it's averaging out to about 2.5% rate increases.

And then just one last question. Is there any structural impediments to rolling Five Star back up, and you have taken your assets and moving it into a right structure or restructure, that's again -- asking if there is any internal discussion effort is there any structural impediments to doing, as a potential acquisition or growth for the company. Just trying to -- they have some owned assets, trying to think about whether there is any impediments to rolling them back up?

No, I think we still have to go through our [shareholders as always] I think that just the economics will all have to work. But there's nothing structural.

Okay. I'll hop-off. Thanks a lot.

Okay. You're welcome. Have a good day.

And ladies and gentlemen, at this time, I'm showing no additional questions. I would like to turn the conference call back over to management for any closing remarks.

Now, we appreciate you all joining us today and we look forward to seeing many of you at the upcoming fall conferences. Thank you and have a good day.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.