DHC (2019 - Q1)

Good morning, and welcome to the Senior Housing Properties Trust First Quarter 2019 Financial Results Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Michael Carroll [ph] Director, Investor Relations. Please go ahead. Unidenti

Thank you. Welcome to Senior Housing Properties Trust call covering the first quarter and 2019 results. Joining me on today's call are Jennifer Francis, President and Chief Operating Officer; and Rick Siedel, Chief Financial Officer and Treasurer. Today's call includes a presentation by management followed by a question-and-answer session. I would like to note that the transcription, recording and retransmission of today's conference call are strictly prohibited without the prior written consent of Senior Housing. 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, Thursday, May 9, 2019. 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 basis net operating income or cash basis NOI. Reconciliations of net income attributable to common shareholders to these non-GAAP figures and the components to calculate AFFO, CAD or FAD are available on our 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 filings within the SEC. Investors are cautioned not to place undue reliance upon any forward-looking statements. Now, I'd like to turn the call over to Jennifer.

Thank you, Michael. Good morning, everyone. On our fourth quarter earnings call, we commented that we believe 2019 was going to be a transitional year for SNH, and we still believe that is the case. Since then, we have announced the restructuring of our business arrangements with Five Star, reset the dividend and are laser focused on executing on our disposition strategy to both reduce our financial leverage and transform our portfolio to best position SNH for the future. To an aggressive disposition plan and active asset management of our senior living, medical office and life science real estate. We are excited to improve SNH's portfolio into one that will produce value, strong returns and growth for our shareholders as the demand in the U.S. for healthcare services and healthcare-related products grows. The first quarter's results represent a mix of stability from our MOB portfolio and transition in our senior living triple-net lease portfolio. Earlier this morning, we reported an 8.6% decrease in consolidated same-property cash basis NOI in the first quarter compared to the same quarter last year. This decrease was primarily the result of the $12.8 million reduction in rent from Five Star for February and March discussed on our April 2 call. Excluding the triple-net leased senior living communities, same-property cash basis NOI was flat compared to the same quarter last year. Same-property cash basis NOI in our MOB segment increased 80 basis points in the first quarter compared to the same quarter last year, driven by a 4.2% increase in our life science properties, mainly the result of the base rent increase in our triple-net leased 1 million square foot property in the Seaport District of Boston. This 15-year lease that commenced in 2013 has an 8% increase every 5 years, one of which took effect on January 1, 2019. This increase was offset by a tenant vacating a 94,000 square-foot building located in Fremont, California at the year-end. The property is located in the San Francisco Bay Area, a strong life science R&D market. We have had good leasing activity at the property and believe that we will lease the building with a meaningful roll up in rent. Our 2.7% decrease in same-property cash basis NOI in our medical office portfolio and the corresponding 190 basis point decrease in same-property medical office occupancy is the result of a 140,000 square-foot tenant vacating the property in the Minneapolis market in the fourth quarter. This building has been repositioned into a multitenant building, and we are currently in discussions with several prospects. We generated strong leasing results during the quarter with close to 500,000 square feet of new and renewal leases executed with a weighted average lease term of 8.5 years and tenant improvements and leasing costs of $3.40 per square foot per lease year. We have a very strong leasing team that does a great job getting ahead of renewals and leasing vacancies when we get the space back. Last quarter, I mentioned that we would be marketing for sales, the 13 buildings containing 360,000 square feet in Central Massachusetts leased to the Reliant Medical Group, whose lease expires at end of May. In March, we sold one of these buildings and the remaining 12 are under agreement for sale, scheduled to close following the expiration of the lease. We've also previously discussed the rebuilding 160,000 square foot life science property located in the Torrey Pines submarket of San Diego that has been vacated at the end of next month. We're excited about our prospects for these buildings as they sit in one of the top life science markets in the country. We are now nearing completion of planning and permitting for the buildings potential redevelopment and are actively marketing them for lease. Our managed senior living portfolio same-property occupancy increased 50 basis points and residence fees and service revenue increased $1.3 million or 1.2% compared to the same quarter last year. Same-property cash basis NOI was down, however, due to increased operating expenses. The main contributor to the increase was salaries and wages, which were up 3.2% on a same-property basis. As we've said, one of the biggest challenges in senior living is wage pressure across all employee types and fierce competition for quality leadership. To address this, Five Star has increased its commitment to the company's team members. Part of this commitment focuses on recognition through both promotion and compensation, which contributed to the senior living salaries and wage expense increase in the first quarter. This commitment, which we see as a much-needed strategic move, is already having a noticeable impact. Yesterday, Five Star reported that employee turnover companywide was 35% in March, down from 68% a year ago and 57% in January. High employee turnover in the past led to the increased use of costly contract labor. Five Star hopes to eliminate third-party labor entirely and replace it with a higher quality permanent workforce. We support Five Star's investment and its workforce and believe this will lead to better services to residents and ultimately increased occupancy and rent growth. Our triple-net leased senior living portfolio had rent coverage of 1.06x for the year ended December 31, 2018. This includes 0.99x coverage from the Five Star leases, which would have been 1.55x coverage based on the new reduced rent resulting from the transaction agreement announced in April. We will continue to report the coverage of these leases until they are transitioned to the new management agreements, which we expect to happen on January 1, 2020. Excluding Five Star, the rent coverage was 1.42x. Finally, I'd like to give an update on our dispositions. On our April 2 conference call, we mentioned that we expect to sell properties valued at up to $900 million by the end of 2019 to reach our target leverage. We have a list of disposition properties finalized, the makeup of which is weighted toward underperforming senior living communities and noncore properties in our MOB segment, and are in the process of engaging brokers on each property or portfolio. There is abundant capital in both the medical office and senior living acquisitions markets, and we feel comfortable that our pricing and timing goals are obtainable. In the first quarter, we sold two MOBs. And at the end of the quarter, we had 10 MOBs and 20 skilled nursing facilities under agreement to sell. Subsequent to the end of the quarter, we sold three of those skilled nursing facilities, and we entered into agreements to sell an additional three MOBs. I will now turn the call over to Rick to provide further discussion on our financial results for the quarter.

Thank you, Jennifer, and good morning, everyone. I'll be discussing some of the first quarter financial highlights beyond what Jennifer just covered. Normalized FFO for the first quarter of 2019 was $88.2 million or $0.37 per share, which was down $0.08 per share compared to the same quarter last year. $0.07 of the decrease in normalized FFO came from our triple-net senior living communities, mainly due to the reduction in Five Star's rent in the first quarter. In April, we declared a $0.15 per share dividend for the second quarter of 2019. The normalized FFO payout ratio for the first quarter based on the new dividend was approximately 40%. As we stated on our last call, this dividend is based on a target payout ratio of approximately 80% of projected cash available for distribution after the conversion of leased communities and after selling assets to meet our leverage target. General and administrative expenses decreased approximately $15.3 million or almost 61% for the first quarter compared to last year, as a result of our lower stock price and total shareholder return compared to the Healthcare REIT Index during the quarter. We believe this demonstrates the strong alignment of interests between RMR and SNH's shareholders as the reduced market capitalization driven by the reduced stock price in March translated to an annualized run rate of $10.4 million of lost revenues for RMR. In April 2019, the run rate of lost revenues for RMR increased to $13.6 million per year as SNH's shares traded lower. In the first quarter, we spent $28.6 million on capital expenditures, of which $13.4 million was considered recurring and included tenant improvements and leasing costs at our MOBs and building improvements at both our MOBs and managed senior living communities. The remaining portion of our capital expenditures $15.1 million, was spent on development and redevelopment capital projects. Our MOB redevelopment CapEx of $6 million is related to two projects. A repositioning of 130,000 square foot medical office buildings located in the heart of Washington D.C.'s Central Business District and the conversion of the building in Minneapolis that Jennifer mentioned earlier, from a single tenant to multitenant building. Much of the managed senior living redevelopment CapEx in the first quarter was spent at the 91 unit independent living expansion at our community in Loudon, Tennessee. Our team is pre-leased nearly 80% of these units and construction is expected to be completed by the end of the summer. Moving to our balance sheet. We ended the first quarter with $39.9 million of cash on hand and $225 million outstanding on our revolving credit facility. Subsequent to quarter end, we redeemed $400 million of 3.25% senior notes using cash on hand and borrowings under our revolving credit facility. Additionally, we gave notice of our intention to prepay approximately $42.2 million of secured debt encumbering four senior living communities during the second quarter. As of March 31, our reported debt-to-adjusted EBITDAR was 6.7x and debt-to-gross assets was 43.3%. As I mentioned on our April 2 call, we expect our debt-to-adjusted EBITDAR to climb, to just above 7x in the middle of 2019 as a result of the reduced rent from our Five Star lease senior living communities. In order to reduce debt-to-adjusted EBITDAR following the transaction to 6x or lower, we plan to complete our disposition program by the end of the year. That concludes our prepared remarks. Operator, please open up the line for questions.

[Operator Instructions]. The first question comes from Drew Babin of Baird.

This is Alex on for Drew. We were hoping for a little more detail on - that your potential redevelopment plans at Scripps base as well as your general expectations for that potential mark-to-market when that's vacated later this year. It sounds like you're seeing strong demand. So what does that market look like today?

The market's quite strong. There was actually a report that was generated this morning from Jones line [ph] saying that, that market rents are approaching $5 a foot a month as they talk in California so $60 net rents. It's a very strong market. We are, as I said in my prepared remarks, we're completing our planning and permitting stage right now and are actively marketing the building. This is a complete redevelopment that we're planning. And so this building - this tenant just came off of a 20-year lease, and there's really not as strong Class B market, which is what these buildings now are because of the length of the prior lease. And so to reposition it as a Class A space, we're working - we're looking to really demo the building to slab and steel, a complete - not a complete demo because we're keeping the footprint of the existing three buildings in place so that we can maximize the grandfather density in that market. It's tough to - we've been able to build the buildings that we have now. So it's a big project, but it's such a great market. We feel pretty good about it. We're expecting close to double-digit returns when it's all said and done cash-on-cash.

Great. Now that's a lot of great color. So I got a helpful color there. And one other one from me. After announced sales, it look like you have got 18 skilled nursing facilities left in your portfolio, are all of these currently being marketed or slated for disposition? And generally, how do you think we should go about valuing these sales given their negative EBITDA? Just looking for some of your insight there.

Yes. We're marketing and selling all of our standalone skilled nursing. And so are very far along in the process of that. Some of these are really underperforming and struggling assets. So it's not - certainly not a cap rate play, but there is a lot of capital in the market for both skilled nursing and senior living. So I think we're going to be very successful in the disposition of the assets. We feel pretty comfortable that we'll complete the disposition pretty quickly.

The next question is from Bryan Maher of B. Riley FBR.

So we noticed with your release and a couple of the others in the senior living space, an uptick in occupancy in the first quarter. Can you give us a little bit more color on what you're seeing there? Is there a turn in the market? Is there a stabilization? What's going on there? And do you expect it to continue for the balance of the year?

Well, I think the reality is a turn in market, in the most recent report that was released by Nick. New construction starts have continued to slow, they've been talking about that, I think, now for five quarters. Absorption in senior living was at its highest this quarter since 2007 - highest first quarter, sorry, since 2007, slightly lower the last quarter, but that's pretty typical for the fourth versus first quarter. And inventory growth has slowed, it's interesting that the number of units delivered was less than the number of units absorbed for the first time since 2016. So across the market, things are, we say that we're balancing along the bottom, but I think things are starting to look up.

Okay. And then on the Five Star, changes scheduled for January 1 of 2020, got a little bit of mix read on that and maybe it's just me. But is there any chance that, that gets delayed at all? Is there anything going on with the Five Star transaction that would give us pause that it doesn't fully take place January 1?

No. We feel pretty comfortable that it will take place. There's a lot to do between now and then. There's a lot of licensing that needs to take place, getting SNH licensed. But I think that we feel pretty comfortable that it will go as expected.

The next question comes from Michael Carroll of RBC Capital Markets.

Yes. Jennifer, can you talk a little bit about these sales that you just completed? I guess, specifically, with the skilled nursing facilities sales. How much EBITDAR were those assets generating? I'm assuming that Five Star previously leased all those assets?

Yes. They did for the assets that have closed. These were struggling communities, as I said. So I think that we had negative EBITDAR for these communities.

How much - how negative were they? And then was that for the ones that closed and also the ones that - or have - that you agreed to [indiscernible]?

The one under our agreement currently generally have had negative EBITDAR as well. There is a portfolio being marketed right now that does generate some EBITDA, but we are confident the pricing will be better on those. As Jennifer said, they - the current - the properties that have been sold already weren't really cap rate plays. They were trying to maximize, kind of, per unit pricing and really looking for somebody to come in and redevelop some of the properties and think they could run it better. So we're hoping future pricing is still in line with our overall guidance of somewhere around seven cap or maybe a little below. But some of the earlier properties were already being marketed separate from the disposition plans. So they're more one-off.

So I just want to get this clear and make sure I'm hearing this correctly. You said the EBITDAR was negative or the EBITDA was negative?

EBITDA without the R was negative for sure, if you have rent. EBITDAR was negative for a number of these properties.

Okay. And then the - how many of the assets that you're marking for sale right now are underperforming Senior Housing assets? And I think, Jennifer, in your prepared remarks, you said that a good portion of them were. I guess, how should we think about that? And how much, I guess, EBITDAR were they generating that we can kind of model out and figure out what the unexpected dilution will be from the Five Star transition on Jan 1?

I think that the disposition plan has about - it's about 60-40 senior living to noncore MOB. I don't know that I have the breakdown. It's about $900 million an asset. So I don't - probably can't talk individually about each asset.

Yes. Mike, I think, the easiest way to back into it is to take our dividend rate, and we've said that, that is an 80% CAD payout ratio on future CAD after conversion and after asset sale. So I think that's probably as much guidance as we'd want to give on it until these properties are under agreement.

Okay. And then can you talk a little bit about who were the interested parties in buying those assets? I guess, how far along are you with marketing, I guess, the $900 million in total?

We've compiled the list. We see broker opinions or values on all of them. We are conducting broker interviews over the next few days and then we'll hit the market with them. So we're not in discussions with any buyers right now, though we have a lot of excited brokers because they're - they know that the market is good for these assets.

There's been a number of inbound calls.

Yes, certainly.

So there's certainly demand in market.

The next question is from Todd Stender with Wells Fargo.

Rick, probably just backup on the leverage piece, you mentioned obviously the expected drop in EBITDA, which is going to push your debt-to-EBITDA metric up. But what - how are you addressing that denominator? What are you doing for debt paydowns? We saw some pretty cheap coupons being paid off so far this year and some mortgages, but what can we expect more of the debt paydown piece?

We did. I think we did have the bond maturity of $400 million to $300 million quarter notes of that was due earlier this month. We paid that off with the revolver. So it's slightly dilutive, but more or less a push. We are moving forward, paying off of mortgage that encumbers four of our senior living communities. And then we really don't have any maturities until next year. So the proceeds that we generate will be used to pay down the revolving credit facility. And to the extent, we have extra proceeds, we have the ability to pay down the existing term loans.

Okay. And then, I guess, switching gears to MOBs, how should we look at the same-store pool? The NOI trended positive, but on a cash basis it did go negative. Any color specifically on that nuance there?

Yes. We had some single tenant buildings vacate in the last quarter of 2018. We're seeing rents grow, but we've got to get those buildings released that's really causing the drop.

Okay. And then in life science, just as a reminder there was an - was there an outsize rent bump, I guess, from Vertex in Q1? What helped life science?

Yes. There was. Their rent bumped 8% on January 1.

The next question is from Vikram Malhotra of Morgan Stanley.

Just sort of on the planned sales, sort of broke it up and gave the number by MOB and the skilled. I'm just sort of wondering when you talk about MOB and noncore, can you just talk about, especially for the MOB, as you look to the portfolio, what in your mind sort of made these noncore? Can you give us a broad sense just of pricing given our robust MOB pricing has been recently?

I think that for us noncore is a geographic noncore, specifically. And so its markets that we don't feel complement our portfolio well.

Okay. And then just any sort of range you can give? Or just sense of where you sort of are seeing preliminary cap rates?

Yes. I mean, the portfolio, overall, we think - we were thinking it would - in total, would be at around seven cap, but we think that based on the BOVs that cap rates is going to tighten up a bit. And it'll be a bit lower.

And that seven for MOB or the whole thing?

It's for the whole thing, but I think we could use that number on the MOBs and maybe slightly lower on the MOBs.

Okay. And then, I guess, just, you talked about the potential improvement you're seeing, in which you noted Nick data, we've seen this in some of our peers as well. Can you sort of just talk about your expectations on conversion? What are you sort of baking in, in terms of just high level? How you're thinking about different components, occupancy, rent growth and expenses?

I think the main story there, as we've modeled it is expenses, in particular wage pressures been the number one headlines in the Senior Housing space. And we're pleased to see that Five Star is making investments in its human capital and workforce. We completely agree with those moves, and we're excited to see them execute on that. So that's probably the most significant driver of change. We've generally modeled revenue flattish, but are hoping to outperform. Again, we're pleased that we've seen some growth in occupancy over the portfolio of the last three quarters. The revenue management system has increased rates a bit. We're hopeful that as the demographics provide a bit of a tailwind, we should be in good shape. As Jennifer said, we still believe Senior Housing is, at or near the bottom or skipping along the bottom, and we're hopeful to capitalize on that as the market turns a bit.

Okay. That's helpful. And then just last one, I wanted to clarify the conversion in early 2020. In the press release, can you just remind us, it says or January 2021 if extended on the transaction agreement, can you just remind us under what conditions that gets extended?

That is in there kind of as a worst case scenario. We fully expect to be ready to transition on 1/1/20. The reason that, that when your extension is available, it's just from a tax perspective. You can't own more than generally 10% of a tenant in any given year. And you can't have more than 35% of an independent contractor, who operates your TRS or RIDEA properties. So we're looking for an all or nothing conversion, and we still believe that we'll be able to do it but the contracts were written in a way that in the event, there was some reason to delay, Five Star still going concern for another year, while we work through any kinks. But we really expect it to go as expected on 1/1/20.

This concludes our question-and-answer session. I would like to turn the conference back over to Jennifer Francis for closing remarks.

Thank you, and thank you for joining us on our first quarter earnings call. We've several events coming up, including the Bank of America Merrill Lynch Healthcare Conference in Las Vegas next week, and we'll be New York with Wells Fargo Research the following week. We look forward to seeing many of you at these events. Thank you.

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