Omega Healthcare Investors Inc (OHI) 2011 Q2 法說會逐字稿

Good morning, and welcome to the Omega Healthcare Investors Second Quarter Earnings for 2011 Conference Call. (Operator Instructions) I would now like to turn the conference to Michelle Reiber. Please go ahead.

Thank you, and good morning. Comments made during this conference call that are not historical facts may be forward-looking statements, such as statements regarding our financial and FFO projections, dividend policy, portfolio restructuring, rent payments, financial condition or prospects of our operators, contemplated acquisitions and our business and portfolio outlook, generally. These forward-looking statements involve risks and uncertainties which may cause actual results to differ materially. Please see our press releases and our filings with the Securities and Exchange Commission, including, without limitation, our most recent report on Form 10-K which identified specific factors that may cause actual results or events to differ materially from those described in forward-looking statements.

During the call today, we will refer to some non-GAAP financial measures, such as FFO, adjusted FFO, and EBITDA. Reconciliations of these non-GAAP measures to the most comparable measure under generally-accepted accounting principles, as well as an explanation of the usefulness of the non-GAAP measures, are available under the Financial Information section of our website at www.OmegaHealthcare.com, and in the case of FFO and adjusted FFO, in our press release issued today.

I will now turn the call over to CEO, Taylor Pickett.

Thanks, Michelle. Good morning, and thank you for joining our Second Quarter 2011 Earnings Conference Call.

Adjusted FFO for the second quarter is $0.47 per share, up 27% from the second quarter 2010. We increased our quarterly [dividend] to $0.40, which is a dividend payout ratio of 85% of adjusted FFO.

We increased the low end of our 2011 adjusted FFO guidance from $1.80 per share to $1.82 per share, while leaving the high end unchanged at $1.86 per share. This guidance continues to assume $150 million in acquisitions during 2011.

On June 15, we executed an agreement to enter into a master lease with a subsidiary of Genesis Healthcare for the 11 facilities currently leased by FC/SCH. This was originally a 15-facility lease. In the first quarter, the four underperforming Connecticut facilities were taken over by the State of Connecticut. The remaining 11 facilities in Massachusetts, New Hampshire, Rhode Island, Vermont and West Virginia, continue to perform well.

We're pleased with the prospect of having a direct (technical difficulty) relationship with Genesis, and note that the Genesis parent guarantee will significantly improve the overall portfolio of credit.

On July 29, the Centers for Medicare and Medicaid Services issued a final rule updating the 2012 Medicare Skilled Nursing Facility payment rates. The effective date is October 1, 2011. The rule includes a significant reduction in the nursing component case mix index for the 23 RUGs IV rehab categories. The overall estimated effect is an 11.1% decrease in total Medicare reimbursement. During the last two quarters, our operators have had improved cash flow and rent coverages as a result of RUGs IV.

The final rule for 2002 will reduce rent coverage ratios back to pre-RUGs IV levels, and possibly a bit more due to increased therapy costs. (technical difficulty) coverage ratios in more detail later in our prepared comments.

Bob Stephenson, our Chief Financial Officer, will now review our second quarter financial results.

Thank you Taylor, and good morning. Our reportable FFO on a diluted basis was $42.6 million, or $0.42 per share for the quarter, as compared to $29.7 million, or $0.32 per diluted share, in the second quarter of 2010.

Our adjusted FFO was $48.4 million, or $0.47 per share for the quarter, and excludes a $4.1 million provision for uncollectable accounts receivable related to the restructure of the FC/SCH and Genesis transactions which Taylor discussed, $1.5 million of non-cash, stock-based compensation expense, and it also excludes a $225,000 net loss associated with the runoff expenses from our former owned and operated asset.

Operating revenue for the quarter, when excluding owned and operated nursing home revenues, was $72.6 million versus $55.8 million for the second quarter of 2010. The increase was primarily a result of $17 million of revenue associated with the capital source acquisitions completed in June of 2010, incremental revenue associated with capital improvements made to our facilities throughout 2010 and 2011, and mortgage interest from new mortgages placed in the fourth quarter of 2010. These were partially offset by the decrease in other investment income recorded in the second quarter of 2010 related to securities that were purchased and sold in the first two quarters of 2010.

The $72.6 million of revenue for the quarter was composed of $68.1 million of cash revenue, and $4.5 million of non-cash revenue. Operating expenses for the second quarter of 2011, when excluding nursing home expenses, provision for uncollectable accounts receivable, and stock-based compensation expense, increased by $8.5 million as compared to the second quarter of 2010. The increase was primarily the result of additional depreciation expense associated with approximately $630 million of capital source assets acquired in June of 2010, as well as additional G&A primarily related to the acquisitions.

We believe our 2011 G&A should be approximately $14 million, assuming no extraordinary transactions or unusual events. Interest expense for the quarter, when excluding refinancing costs and non-cash deferred financing costs, was $20.1 million versus $14.7 million for the same period in 2010. The $5.4 million increase in interest expense resulted from financings relating to the capital source acquisitions and by us taking advantage of favorable borrowing rates in the fourth quarter of 2010.

Turning to the balance sheet, in March 2011, we redeemed all of our 8.375% Series D Cumulative Redeemable Preferred Stock, valued at $108.5 million. As a result of the preferred redemption, in the first quarter of 2011, we recorded a $3.5 million charge to net income available to common stockholders to write off issuance costs associated with the Preferred D stock. During the six-month period ended June 30, 2011, under our equity shelf program, also known as a continuous equity program or at-the-market program, we sold 1.4 million shares of new common stock generating net cash proceeds of $31.5 million.

Under our dividend reinvestment and common stock purchase plan, we issued 1.9 million shares of our common stock, generating net cash proceeds of $40.7 million. At June 30, 2011, we had approximately $2.7 billion of gross assets. On the liability side of the balance sheet, we had $1.2 billion of debt and we had $267 million available on our $320 million revolving credit facility.

Today, we have approximately $300 million in combined invested cash and credit facility availability. We also have $40 million of shares available to issue under our equity shelf program.

For the three months ended June 30, 2011, our adjusted total debt to adjusted annualized EBITDA was 4.3 times, and our adjusted fixed charge coverage ratio was 3.3 times. I will now turn the call over to Dan Booth, our Chief Operating Officer.

Thank you Bob, and good morning. As of June 30, 2011, Omega had a core asset portfolio of 398 facilities distributed among 50 third-party operators located within 35 states. Operator coverage ratios continued to increase during the first quarter of 2011 due in large part to the implementation of RUGs IV, effective October 1, 2010.

Trailing 12-month operator EBITDARM coverage was 2.2 times for the period ended March 31, compared to 2.1 times for the period ended December 31. Trailing 12-month operator EBITDAR coverage for the period ended March 31 was 1.8 times, compared to 1.7 times for the period ended December 31, 2010.

From a historical perspective, Omega's operator coverage ratios have never been higher. That being said, the recent announcement by CMS of an 11.1% cut to Medicare rates, as well as a change in methodology for rehab services, will put pressure on our operators' profitability, and therefore, our coverage ratios.

As I indicated, the current trailing 12-month EBITDAR coverage ratio was 1.8 as of March 31. These numbers include six months of results with RUGs IV. Looking only at the period in which RUGs IV was in effect, the operator EBITDAR coverage ratio was 1.9 times for the six months ended March 31, 2011.

In an effort to gauge the impact of the rate cuts on our operators' performance, Omega has run a sensitivity analysis using our operators' last six months reported results as a baseline. While not specific to individual operators, an 11.1% cut has the effect of reducing our consolidated operator coverages from 1.9 times as of March 31, 2011, to 1.53 times.

It is important to note that our consolidated operator coverage ratio pre-RUGs IV was 1.6 times as of 9/30/2010. By comparison, the coverage ratios for the period ended June 30, 2010, and March 31, 2010, was similarly 1.6 times for both periods respectively.

Given these facts, Omega feels that the ultimate impact on operator coverages will be relatively modest when compared to pre-RUGs IV implementation.

Turning to our major tenants specifically, our top 10 operators represent approximately 74% of Omega's total contractual revenue with the remaining 40 tenants representing the other 26%. Of the top 10 operators, nine are expected to have coverage ratios in excess of 1.3 times, after applying an 11.1% cut to their Medicare revenue.

Recognize that this cut does not give any benefit to our operators' cost-cutting efforts, including changes to reduced therapy services, cost-cutting from third party vendors, or otherwise. Only one tenant falls below 1.35 times, but still remains above 1-to-1. However, it is important to note that when compared to our other top-10 operators, this tenant saw only modest Medicare rate increases during the six months ended March 31, 2011, predominantly because they switched therapy providers effective October 1, 2010.

As a result, they did not experience the unintended increase in Medicare rates that the proposed 11.1% cut is intended to cure. And hence, we expect their Medicare rate cut to be less than that experienced by many of our other top-10 providers.

Furthermore, this tenant's coverages are currently hampered by a significant CapEx program, whereby numerous beds have been taken out of service to allow for expansion, private rooms, physical upgrades, improved therapy space, and overall physical plant improvements.

In summary, while the 11.1% Medicare cut was not in line with the expectations of the industry, we believe that the net effect on operator coverages will be modest when compared to prior period results before the implementation of RUGs IV.

Turning to new investments, Omega continues to see a healthy pipeline of acquisition opportunities. While the recent announcement by CMS (technical difficulty) Medicare rates will affect operator performance as indicated, we also expect the announcement to temper what had become a very aggressive seller's market. As Bob mentioned, as of today, Omega has $300 million in cash and/or availability to fund new investments.

Thanks, Dan. We will now open the call up for questions.

(Operator Instructions) Our first question comes from Jerry Doctrow at Stifel Nicolaus.

Good morning. It's actually Dan Bernstein filling in for Jerry.

Morning, Dan.

The 11.1% cut is out there, but we haven't really gotten a good sense of what the assessment changes and technical changes are going to impact the SNFs. Have you spoken to any of your operators about those changes, and what the negative impact might be from some of the technical and assessment changes there?

We have talked to our operators, and it's complicated, and really there is nobody out there who's willing to put a number on it. Our sense is that it's some order of magnitude that's not extremely big and probably is subject to some mitigation. So, in our analysis, we took the 11.1% and did a mathematical calculation. As we said, we excluded any type of [cost-cutting] that might occur to limit the impact on our operators. And so, we kind of look at that and say, there will be efficiencies in cost-cutting that will offset the effect of group therapy, and it'll also offset the effect of the evaluation process.

What would your sense be, that it's like another 1% additional cut, or 2%? I mean, how should investors think about -- what the potential range might be, even if it's not an exact number? I mean.

I think order of magnitude --

How that should be put?

Order of magnitude, that's probably fair, and I think that's why you can look at it and say -- we haven't tried to model expense cutting either, we think there's sufficient mitigation where taking the 11.1% as a proxy is probably a fair way to do the analysis for now.

Okay. And just to be clear, the analysis that you've done going from 1.9 coverage to 1.53, that's an EBITDAR coverage?

EBITDAR, correct.

Before CapEx?

Before CapEx.

Before CapEx. And just in terms of the pipeline itself, obviously if you think back in the last decade, I think cap rates have been pretty stable in skilled nursing, up until the megadeals that we've seen in the last 12 months. Should we expect cap rates to really go back to where they were before, based on this cut? What, I guess what are your expectations for new investment yields going forward, post-cut?

I think this was a wake-up call, and I think that you will see cap rates go back to normal.

Okay.

I think the market will gain some realism, based upon this.

Have you seen -- I know it's only been a week, or less than a week, but have you seen any changes in your pipeline or in your negotiations with folks that you're looking to acquire properties from? What has been the reaction from those folks at this point?

I think what we've done in the last few days is dealing with our existing portfolio, and sensitizing our current portfolio. We haven't had a lot of ongoing conversations with people out in the market trying to sell right now. I think everything sort of went on hold for a few days.

But the only comment I'd add to that is, we've always under -- in our current pipeline, our underwriting has always eliminated RUGs IV from a coverage perspective and otherwise. So, to the extent that we have stuff in the pipeline that's active, that looks like it could come to a close, is really not a negotiation process there because we've always looked at RUGs IV as temporary.

Okay. I'll jump off and let somebody else ask, thank you.

Your next question comes from Todd Stender at Wells Fargo.

Hi, thanks, guys. Just looking at the terms of your leases in general, what are your obligations for providing capital expenditure funding? And then part two to that, what's your tenants' ability to either defer CapEx or are they -- any portion of that is discretionary?

We have no obligation to fund CapEx. These are pure triple-net, and the operators are required to fund CapEx. There's usually a minimum, 350 to 450 a bed, but typically you see much more spent. And really, there is no opportunity to defer CapEx because of the checks and balances. Not only our physical plant walkthroughs, but the annual state surveys which typically pick up CapEx issues. So, the deferral is -- there's a minimum required amount to be spent that can't be deferred, and you have the checks and balances of what we do and what the state does.

What would you say are some reasonable numbers to just wrap around how much CapEx per bed would your tenants be spending?

You know, it varies. Most of our contractual arrangements are between 400 and 500 per bed, but most of our tenants spend probably close to double that. I would like to add that we do have some contractual arrangements on CapEx. It's not embedded in the lease, it's because of a specific project. So, for some, a number of our tenants where they're undergoing major renovations or rehabs, and/or additions, in those cases we do commit dollars.

Okay, thanks, and thank you again for the clarity on your coverage ratios after the cut. Is there any way you could put some numbers, maybe some categories, around say 10% of the portfolios between a 1 and a 1.25 coverage, and say you know, some percentage is in excess of 2 times? Is there any way to kind of gauge where we are around those averages?

The percentage of the portfolio that's less than 1.25 times is small. It's a handful of operators that have credit stories. Operators where we have parent guarantees with very substantial balance sheets, or turnarounds that are in process that we can project.

So, in terms of true at-risk rent streams, it's virtually non, even post this analysis.

And then on the other side of that, do you have any of -- we've seen some of the competition of talking about three to four times, from some of their larger tenants. Anything in that realm of maybe even over two times?

We have a couple that touch up near 2, in the top 10, but it's right at that 2, 2.2 level.

Okay, thank you. And then, you raised the dividend recently. How far out do you look when you determine what level you can raise to? And can that payout be impacted by this Medicare cut?

We have a full expectation of receiving rent from all of our operators, which means we'll maintain our current adjusted FFO level, which means we'll retain our dividend. Obviously, we would look forward if we thought there was an impairment on our rent, and think about our dividend. We raised it, looking forward at our current pro forma coverages, and we feel comfortable that that's going to be maintained.

Okay, thanks. And just last question, you kind of touched on this in your prepared remarks. Just looking at initial lease yields and maybe how the CMS decision has impacted those, with the cost of debt in general being low and spreads are probably pretty attractive, now. Can you just give us some numbers of maybe what some initial lease yields, maybe a range of what you can expect going forward?

You know, I think historically we've always targeted the 10% and north yields. I think that we've seen in 2011, pressure to come underneath that. But, we haven't come in underneath that significantly. We might dip down as low as -- I don't want to telegraph this to the world, but you know, 9.75%. There are some special deals that might be outside of the SNF range that could command lower yields, but I mean, that's kind of what we're looking at today.

Yes, I think the typical deal is back in the 10% cash-on-cash type deal, and for the right type of asset with the right operator, you still may see rates go below that. But I don't think a lot below that, you know. 9.75% might be a rate we'd underwrite to. On the flip side, I don't think you'll see 10.5%, either.

Okay, thanks, guys.

Thank you.

Our next question comes from Tayo Okusanya at Jefferies.

Yes, good morning Taylor.

Morning, Tayo.

Question. So, the coverage ratios that you talked about, do those also include any potential impact from Medicaid cuts as well? Is that purely just running the 11.1% Medicare cut through?

Yes, we decided that we would just make a clean mathematical calculation, because you'd have to fold in the effect of group therapy and the assessment (technical difficulty) to try to offset that with cost cuts. It just -- it seemed like an exercise that frankly we wouldn't get it right, and our operators are going to need time to get there, but we also thought it was fairly conservative. But, to answer your specific question, it's just the 11.1% for Medicare. We haven't folded in any Medicaid.

But just given that some states are having such fairly large Medicaid cuts, I'm sure you must have done some assessment around that just to make you feel comfortable with your commentary about no real risk at your tenants, right?

Absolutely.

Okay. Could you give us a sense of the additional impact from Medicaid cuts?

Yes, I mean, the two big states that have affected us are Florida and Ohio. And Florida had a revenue cut, but it was offset by reduction in required nursing hours. As we run the net effect of the Florida Medicaid change through our portfolio, it's about 3%. And the comment I would make there is, if we look at our Florida coverages, they're above the average coverages we've talked about today, sort of across the board. So, that type of net cut in Florida doesn't have, I mean, that would bring the Florida portfolio sort of in line with the 1.5 times coverage range.

Ohio is the other big state that had a big cut, there's a 6% cut to revenue with no real offsetting expense items specifically within the rate system. However, I will note that Ohio is a cost-based system that's gone now to a price-based system, basically a PPS-type system. And there are a lot of cost-cutting opportunities in Ohio, so that analysis is a little bit more complicated. We have two fairly sizeable operators with concentrations in Ohio, and we've had detailed discussions with both. We think there are a lot of cost opportunities to offset the effect in Ohio where again we won't have any issues in terms of being paid rent.

Okay. That's helpful. When you talk to your tenants in general about cost-cutting opportunities, you had one of your colleagues at Sun Health basically say they could probably offset about a third of the impact of the Medicare cuts via taking out costs. Would you say that's applicable to most of your tenants as well, or no?

Well, you're referring to Sun, and obviously that's a big company with the infrastructure of a big company. So I'm not -- I know that Bill was hesitant to go into the specific details. But, there certainly are opportunities, as a lot of our operators have developed enhanced programs to bring Medicare patients into the system. There's always opportunities to look at those enhanced programs and see where there are efficiencies. Whether it's labor efficiencies or otherwise. Dan, do you have any other thoughts, then?

No, I mean, I think 30% sounds high, but we haven't gotten more specifics from our operators at this point. Obviously, they have talked about a little bit more detail and where they can find some of those cost savings, but it's what you would think. It's labor, it's part overhead, it's a little bit of vendors, it's a mix of everything.

I will note that Sun's about a $2 billion revenue type company, and so, $20 million is 1%. So, I think for all of our operators, if you said -- go find 1% of cuts, they probably can.

Okay, that's helpful. And I guess the last question, on the reworking of the Genesis master lease, just walk off a little bit about what the provision for uncollectable accounts, how's that, how that came about?

Oh, the $4.1 million?

Yes.

Sure, Bob, why don't you walk through that?

Yes, hey Tayo. Basically, when we switched from the one operator, FC/SCH to Genesis, we were required to write off operator-related assets that were put in place back in 2008 when we took on the -- when that portfolio went from a bankruptcy state to (technical difficulty) at that time, and $1 million of it was straight-line rent, or a rent holiday that we gave them back then. The other $3 million was a lease inducement, but again, that's operator-related assets. They're non-cash-related, both items.

Okay, great, take care, thank you.

Thanks, Tayo.

(Operator Instructions) Our next question comes from John Roberts at Hilliard Lyons.

Morning. Most of my questions have been answered, but just a couple of more strategic type questions. On the dividend, obviously you've been pretty aggressively increasing it. Are you going to sit back and sort of wait before you even think about what you're going to do with the dividend going forward? Given the uncertainty that this presents?

Well, the aggressive increase really is the reflection of FFO growth. We've maintained a dividend payout and ratio or range of 80% to 85%. So, I think the answer to the question is, if our FFO continues to improve, the only reason we would not stay in the 80% to 85% range is something that we see that we're not aware of today. And, so I don't want to -- to be clear, we've maintained that range and we feel comfortable with it today, and unless something comes up that we haven't seen yet, we would continue to maintain that range.

Okay, so any uncertainty that the cuts engender, are going to really take you off of that strategy?

I don't think so, because we think we've wrapped our arms, for the most part, around the cuts. You know, you have the edges which are group therapy, the assessment process, and then what cost cutting our operators can do to mitigate, but our sense is that those are not -- none of that is significant enough to change our overall assessment that our coverages are still strong.

Very good. Secondly, another strategic question. You've been pretty quiet on the acquisition front. Has that been more a function of just trying to integrate the larger acquisitions you've made over the past year or so, or is it a function of seeing the uncertainty that the CMS issue presented and now that you've got some clarity on that, maybe you go back and look at a little bit more aggressively on the acquisition front?

Well, and the third option I'd throw out there or the third item is pricing, and Dan mentioned it. We were seeing price expectations which didn't fit into our underwriting box, and I think that with the certainty we're going to see pricing get back to what we would call more or less normal. And so, the couple of things that we have in our pipeline, we have operators who are pretty sophisticated, who (technical difficulty) the way we looked at the world, which was the rates as they were in 2011 weren't going to last.

Great, okay, thanks, guys.

Okay.

Our next question comes from Jerry Doctrow with Stifel Nicolaus.

Hi, it's Dan. I have just one quick follow-up question. The lease coverage sensitivity that you were talking about, is that also taking into account I guess future lease bumps in the next 12 months? I know your lease bumps aren't that aggressive, but are those factored in as well in that 1.5 number that you were giving out?

No, Dan, they weren't. They were just, we used the [drawing] six months as of March 31st as a baseline, and used that, that EBITDAR number and those rents.

Okay, thanks. That's all I need, thank you.

Okay.

(Operator Instructions) This concludes our question-and-answer session. I would like to turn the conference back over to Taylor Pickett for any closing remarks.

Thanks, Amy. Thank you for joining the call. Bob Stephenson will be available for any follow-up questions.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.