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Sabra Health Care REIT, Inc. (NASDAQ:SBRA)

Q1 2013 Earnings Conference Call

May 2, 2013; 01:00 p.m. ET

Executives

Rick Matros - Chairman & Chief Executive Officer

Harold Andrews - Chief Financial Officer

Talya Nevo-Hacohen - Chief Investment Officer

Analysts

Michael Carroll - RBC Capital

Rob Mains - Stifel Nicolaus

Emmanuel Korchman - Citi

David Schiffmann - Jefferies & Co.

Operator

Good day ladies and gentlemen, and welcome the Sabra Health Care REIT Inc. announces first quarter 2013 earnings conference call. This call is being recorded.

I would now like to turn the call over to Talya Nevo-Hacohen, Chief Investment Officer. Please go ahead Ms. Nevo.

Talya Nevo-Hacohen

Thank you very much. Before we begin, I want to remind you that we will be making forward-looking statements in our comments and in response your questions concerning our business strategies and expectations for growth opportunities, expectations regarding our acquisition plans, and expectations regarding our future results of operations.

These forward-looking statements are based on management’s current expectations and are subject to risks and uncertainties that could cause actual results to differ materially, including the risks listed in our Form 10-Q to be filed with the SEC, as well as in our earnings press release included as Exhibit 99.1 to the Form 8-K we furnished with the SEC yesterday.

We undertake no obligation to update our forward-looking statements to reflect subsequent events or circumstances and you should not assume later in the quarter that the comments we make today are still valid.

In addition, references will be made during this call to non-GAAP financial results. Investors are encouraged to review these non-GAAP financial measures, as well as the explanations and reconciliation’s of these measures to the comparable GAAP results included at the end of our earnings press release and the supplemental information materials included as exhibits 99.1 and 99.2 respectively to the Form 8-K we furnished to the SEC yesterday. These materials can also be accessed in the Investor Relations section of our website at www.sabrahealth.com.

And with that, let me turn the call over to Rick Matros, Chairman and CEO of Sabra Health Care REIT.

Rick Matros

Thanks Talya and hello everyone and thanks for joining our call today. We had a productive first quarter. We realized significant growth in revenues, net income, FFO and AFFO of 35%, 108%, 44% and 13% respectively.

We made a $12.8 million mortgage investment with a fixed rate of 9% annually. It includes an option to purchase a 48-unit memory care facility with New Dawn. This is our second facility with New Dawn, our first development deal with New Dawn and you should expect to see announcements on the official development deals with New Dawn on a go forward basis. They may come in one at a time or it maybe in the context of a pipeline, but in any way we’ll be seeing more development deals with our New Dawn team.

We also entered into two preferred equity investments, earned up to $7.6 million with an option to purchase a new 141-bed skilled nursing facility upon stabilization. We funded $4.6 million to date. This provides for an annual 15% preferred rate of return. This is another deal for us with the Meridian Team and we expect additional development deals with them as well, and as with New Dawn are working on a development pipeline deal with them.

We also completed a preferred equity offering that netted were $138.4 million of proceeds to the company, and implemented a $100 million ATM program, although given the amount of liquidity on hand, we will not activate it until necessary.

We reaffirm our previously issued guidance and continue to expect our 2013 investments to be in the $150 million to $200 million range. We expect our focus to remain on the expansion of our asset base in to Senior Housing, although you can still expect to see us close skilled nursing facilities deals as well. We also expect that most of our development projects will be assisted living and memory care facilities.

Our current pipeline stands at approximately $250 million, with 65% of it being in senior housing. We had a slow start to the year, and the slow start was pretty typical of the first quarter, but it extended a little bit longer than we anticipated. That activity has improved recently and although the pipeline size is about the same size that we reported in the last quarter, the quality of potential asset deals within that pipeline has improved quite a bit over the past four weeks.

Occupancy was stable to the portfolio of 87.9%, skilled mix came in at 36.5%, which is down from 38.6% from the first quarter 2012; however, that was a smaller decrease than previous quarters in 2012, but we are starting to feel like that’s bottomed out, maybe stabilizing a little bit more finally.

In terms of coverage, our portfolio EBITDARM and EBITDAR coverage for the three months ending March 2013 came in at 1.73 and 1.30 respectively, versus 1.87 and 1.41 for the first quarter ending March 2012. Skilled coverage came in at 1.73 and 1.26 versus 1.80 and 1.31. The 12 months trailing coverage numbers for 2012 included nine months of pre-CMS cuts, which accounts for the difference in coverage.

If we were to go back to our fourth quarter numbers and present them as facility base, so no Sun guarantee, and you’ll recall that prior to the Genesis, the completion of the Genesis Sun merger, we presented the numbers at the Sun guarantee.

So if we were to go back to those fourth quarter numbers, which were still one month in arrears, the trailing 12 coverage would be flat sequentially. Our first quarter coverage would be slightly down on skilled nursing coverage from 134 to 126, but that was essentially due to the fact that with our fourth quarter still being one month in arrears, September was included in those numbers and not December.

December is typically a tougher month with the holidays and we saw that in occupancy. Occupancy in December was 1.4% lower than occupancy in September, which again is pretty typical, although skilled mix was flat. At any rate we view facility level coverage as stable and expect the fixed charge coverage to naturally improve as synergies from the Genesis Sun merger are realized.

CMS as you may have seen, also just been out of the market has an increase of 1.4%, which will be effective this coming October. That will certainly help coverage as well.

From a Medicaid perspective, we expect to see Medicaid rates flat to slightly positive on a consolidated basis. So no downside there, and again to summarize in terms of how we are reporting differently now and how we’ll get into more detail, but where historically we were reporting a month in arrears to accommodate Genesis’s need to get its financials when they can get them to us on a timely and accurate basis, we’ll now be reporting a quarter in arrears.

And with that, I’ll turn the call over to Harold Andrews.

Harold Andrews

Thank you Rick and thanks everybody for joining the call this morning. For the three months ending March 31, 2013 we recorded revenues of $32 million compared to $23.7 million for the first quarter of 2012, an increase of 35%. As of March 31, 2013, 63.2% of our revenue was derived from our leases to subsidiaries of Genesis and 82.3% of our portfolio revenue was derived from skilled nursing related assets.

FFO for the three months ended March 31, 2013 was $17.5 million or $0.46 per diluted common share, compared to $11.7 million or $0.32 per diluted common share for the first quarter of 2012, an increase of 43.8% on a per share basis.

The FFO which excludes from FFO acquisition pursuit costs and certain non-cash revenues and expenses was $16.6 million or $0.43 per diluted common share, compared to $14 million or $0.38 per diluted common share for the first quarter of 2012, a 13.2% increase on a per share basis.

Net income attributable to common stockholders was $9.3 million or $0.25 per diluted common share for the quarter, compared to $4.4 million or $0.12 per diluted common share for the first quarter of 2012.

GMA cost for the three months ended March 31, 2013 totaled $4.7 million and includes stock based compensation expense of $2.5 million, and acquisition pursuit costs of $0.2 million.

Excluding these non-cashed and transactional related costs, G&A costs were 6.4% of total revenues for the three months ended March 31, 2013, down from 6.9% in the first quarter of 2012.

Recurring cash G&A costs were up $0.4 million, compared to Q1, 2012 from $1.6 million to $2.0 million, primarily related to payroll cost increases as we hired two employees subsequent to the first quarter of 2012.

Interest expense for the three months ended March 31, 2013 totaled $10 million compared to $7.7 million in the first quarter of 2012, and included amortization of the differed financing costs of $0.8 million in the first quarter of 2013 and $0.6 million in the first quarter of 2012. This increase in interest expense was primarily related to the increase in our senior notes outstanding of $105.5 million period over period in the borrowings under the revolver proportion of the first quarter of 2013.

Based on debt outstanding at the end of the quarter, we have a 6.8% weighted average interest rate, compared to 7.24% as of March 31, 2012. This reduction is a result of our continued efforts to take advantage of the low interest rate environment by refinancing certain mortgage indebtedness, along with the issuance of the additional borrowings during 2012 at an attractive rate.

We will continue these efforts as reflected by the payoff of the $7.3 million, 9.4% mortgage note subsequent to March 31, 2013. This payoff was executed at the expiration of a significant pre-payment penalty associated with the loan.

During the quarter ended March 31, 2013, we recorded an adjustment to an asset purchase earn out liability, which was recorded in the fourth quarter of 2012, resulting in other income of $0.5 million. In addition, we incurred a preferred stock dividend of $0.3 million associated with the issuance 5.75 million shares of preferred stock on March 21, 2013.

Looking at the balance sheet and statement of cash flows, our investment activity during the quarter consisted of the mortgage loan investment of $12.8 million and a preferred equity investment of $4.6 million. These transactions were funded with available cash. In addition, we sold one asset identified as Held for Sale at December 31, 2012 for $2.2 million, resulting in no gain or loss on sale.

Cash flows from operations totaled $21.6 million for the three months ended March 31, 2013, compared to $16.5 million for the first quarter of 2012, an increase of 31.2%. Cash and cash equivalents increase by $36.5 million during the quarter to $53.6 million as of March 31, 2013.

This increase in cash was primarily due to cash flows from operations, and the net proceeds provided by the issuance of the 5.75 million shares of seven and eight preferred equity during the quarter, which after paying down $92.5 million of outstanding borrowings on the revolver, provided cash of $46.5 million. In addition, we paid a quarterly dividend totaling $12.7 million or $0.34 per share during the quarter.

After the pay down of the revolver with proceeds from the preferred equity offering, we have total liquidity of $247.5 million. This liquidity, along with cash flows from operations subsequent to quarter end is available to fund our $0.34 per share dividend to common shareholders and our $2 million preferred dividend, both to be paid on May 31, 2013, along with ongoing operations and future acquisitions.

We were in compliance with all of our debt covenants under our senior notes indenture and secured revolving line of credit as of March 31, 2013. Our key metrics continue to improve, particularly this quarter due to the preferred stock issuance. Those metrics are as follows based on the defined terms in our credit agreements.

Consolidated leverage ratio, 3.74 times; consolidated fixed charge ratio of 2.62 times, and minimum interest coverage ratio of 3.65 times. Total debt to asset value, 38% and secured debt to asset value, 12%. Our un-encumbered asset value to unsecured debt was at 206%.

As we’ve stated before, we don’t believe that any of the covenants in our indenture or amended credit agreement will limit in any significant manner, our ability to deploy our available liquidity to support our acquisition strategy.

In addition to the issuance of a preferred equity during the quarter, we also entered into a sales agreement to sell shares of our common stock from time to time, having an aggregate gross proceeds of up to $100 million, through the aftermarket or ATM offering program.

This program will allow us to efficiently and economically manage our goal of funding future acquisitions with an appropriate balance of debt and equity, without the high cost of a full blown follow-on equity offering. It provides us the ability to match funds more closely with our capital needs over time and avoids much of the negative impact of issuing equity in larger marketed offerings. To-date no shares have been issued under the program and we would expect to utilize our available cash and some portion of our available revolver before doing so.

Finally, just a couple comments on our tenant disclosures that Rick touched on a little bit earlier. Effective this quarter we have modified our reporting of our tenant data, including our rent coverage metric as follows:

All coverage amounts are now reported one quarter in arrears versus one month in arrears as previously reported. So our coverage amounts reported this quarter reflect data from the calendar fourth quarter of 2012 compared to our coverage amount as reported in the fourth quarter of 2012, which reflected data from September to November 2012. So as such, the data reported this quarter has a two-month overlap to the data reported in the fourth quarter of 2012.

Secondarily, we'll revise certain calculations of coverage this quarter as follow. EBITDAR coverage is now based on our portfolio of assets only. In the prior quarter this metric reflected coverage’s including and taking into account the credit enhancement provided by parent guarantee from Sun.

Our EBITDARM coverage is calculated on a consistent basis with prior quarters, so no change on EBITDARM coverage. And finally, to provide insight into the credit enhancement provided by the Genesis guarantee, we've added a consolidated fixed charge coverage disclosure for Genesis. This coverage provides insight into the level of the Genesis operations as a whole, cover all of their rent and debt service obligations.

This coverage ratio of 1.18 times is calculated based on consolidated pro forma adjusted EBITDAR over consolidated pro forma rents and debt service payments for the fourth quarter of 2012. It excludes the impact of expected synergies, which will be captured as they occur in future quarters. Including the expected synergies of $50 million annually, this coverage would have been 1.29 times.

So with that, I'll turn the call back over to Rick.

Rick Matros

Thanks Harold. We’ll open it up to Q&A now.

Question-and-Answer Session

Operator

(Operator Instructions). We'll hear first from Michael Carroll with RBC Capital.

Michael Carroll - RBC Capital

Yes, thank you. Hey Rick, with regards to the CMS proposed rules last night, how do you think the reporting of distinct therapy days impacts the profitability of skilled nursing facilities?

Rick Matros

Hey Mike, how are you doing? I think it's pretty negligible, because it's the lowest therapy category. So for most of our operators, that category is a pretty small percentage of their overall rehab. So I don't think it's going to affect it very much at all.

Michael Carroll - RBC Capital

Okay, great. And then with your investment pipeline, should we expect that activity in the second quarter will be similarly slow and kind of accelerating in the back half of the year?

Rick Matros

I would expect us to have a little bit more activity in the second quarter than the first quarter, but certainly we're back end loaded, but there should be enough tick in the second quarter.

Michael Carroll - RBC Capital

Okay. And then Harold, with regard to the HUD refinancings that we've been talking about for the past several quarters, I thought there was a $60 million trench that was going to come in the first quarter. Was that delayed for some reason?

Harold Andrews

No, the $60 million trench is still in process. The first quarter effort was really to what we're going to working on and try to get it filed. We should have that filed with HUD in the next week or two, but the expectation has always been that that would come probably the end of July/August timeframe to be completed. Obviously it depends on HUD's cooperation. We're pretty confident that by late summer we'll have that completed.

Michael Carroll - RBC Capital

Okay, then the $30 million trench that was going to come in at the end of the year, is that going to get pushed off into 2014?

Harold Andrews

I don't think so, but it is HUD, so you can't say for sure, but we're also working on that one simultaneously. We are keeping them separate, so we can get the first one on file, but still expect that toward the latter part of this year.

Michael Carroll - RBC Capital

Okay. And then are there any other trenches that you are working on that may come in 2014 that we should think about modeling in?

Harold Andrews

Actually once we complete these two, we’ll have all of our mortgage debt refinancing taken care of and so there won’t be any more opportunities. We’ll basically have termed out all of our mortgage debt over 30 years, and have replaced what’s now at GE that comes due in 2015, so that will be the end of the opportunities for us with the existing mortgage debt.

Michael Carroll - RBC Capital

All right, great. Thanks guys.

Operator

We’ll take our next question from Rob Mains with Stifel.

Rob Mains - Stifel Nicolaus

Yes, thanks. Good morning Rick. Any change in the competitive environment for acquisitions? You said that usually you are not facing a lot of competition?

Rick Matros

No. We don’t see any change there. I think we would expect to see who we normally see. LTC and NHI on senior housing, maybe occasionally SNF and then nothing new on SNF. We’d see Omega, and you saw these before they were public anyways, so the fact that they are public doesn’t really change anything. We haven’t seen the private non-traded as much as we saw in 2011, that still hasn’t changed, but we’ll see.

Rob Mains - Stifel Nicolaus

Okay, and asset pricing is stable as well?

Rick Matros

Yes. We haven’t seen any change in asset pricing to-date. I know a couple of the other guys on calls had said they noticed some compression on senior housing level, that’s skilled nursing, we haven’t seen that.

Rob Mains - Stifel Nicolaus

Okay. And then you mentioned that you’d expect Genesis coverage’s to improve going forward, and a part of that is Synergy. Just generically when you look at your SNF Holdings, given that the transition to or from the 11% cut is increasing in the rearview mirror. Do you expect SNF coverage’s in general to gradually improve this year?

Rick Matros

Yes. Well, just a couple of comments. Our non-Genesis tenants, although small, all have really strong coverage, actually stronger than Genesis’s coverage. But I would want to market that if it’ going to help obviously, but I would like to think as they become more efficient and parent guarantee aside and get through – because the synergies are going to help the fixed coverage.

They are probably not going to really affect the facility level, because most the synergies reveal their head level. But once they and get through synergies and get sort of that diversion away from them, then I would expect to see coverage improve. But I think in fairness to them, if it just stays stable for the time being, while they are focused getting this merger behind them, I think we’d be happy with that.

Rob Mains - Stifel Nicolaus

Okay, that’s helpful. All right, that’s all I have. Thank you.

Operator

We’ll hear next from Emmanuel Korchman with Citi.

Emmanuel Korchman - Citi

Hey guys. Just looking out over your deal pipeline, could you maybe give us some idea of what’s going to come, maybe split between relationship deals and deals with new tenants or operators. What’s going to be debt and what’s going to be kind of real estate and maybe a better idea on timing?

Talya Nevo-Hacohen

It's Talya here. I’d say, you can never be that good of predicting timing; I wish I were, but I can certainly say that there is a reasonable amount of deals coming to us from our existing tenant base.

Rick mentioned the New Dawn guys, how we expect to do, we would anticipate doing additional deal with them. There are other tenants that we have done deals with that continue to bring us our transactions to look at. Sometimes they are speculative, they are an auction process and we bid alongside them; sometimes they are deals that they already have tied up.

Of course the probability of getting those closed are much higher than they are when we are involved in an auction process or looking at something through a broker or an advisor.

So if I probability rate them, I bet it’s closer to a 50/50 split of what we’ll realize through kind of a broad process versus what we’ll be able to acquire through our existing relationship.

Emmanuel Korchman - Citi

And maybe on debt investments versus real estate?

Talya Nevo-Hacohen

Well, the debt investments are for the most part just associated with development pipelines. Some sort of relationship, so we’ve got a few associated with the development pipeline agreement that we headed out last fall with Stoney River for Phoenix Group, and that’s the same organization. So there we have people who’d provide development loans, a recap prior to stabilization using mortgage debt.

So I think to the extent you see us doing mortgage financing or debt financing, it’s going to be primarily in a situation that’s – I would characterize it as long term loan. It‘s just the loan is an interim step to the ownership.

Rick Matros

Yes and the only potential exception there, because we are not in the business of being a bank, the only potential exception there is there are a couple of states on a skilled nursing side, where if you do a sale lease back, the State Medicaid system doesn’t take that into consideration in terms of capital structure and then subsequent pass-through to revenue.

But if you do it in the form of a mortgage, rather than a sale lease back, then that actually improves the operator’s revenue. So if we wind up doing any skilled nursing deals, and in those states, Maryland and Michigan come to mind, that’s where you might see us do something, but that’s about it.

Emmanuel Korchman - Citi

Great. That was all for me. Thank you.

Operator

We will hear next from Omotayo Okusanya with Jeffries Investment Bank.

David Schiffmann - Jefferies & Co.

Good afternoon guys. This is David Schiffmann here for Omotayo.

Rick Matros

Okay, hey David.

David Schiffmann - Jefferies & Co.

I’m just wondering, just based on recent NIC (ph) data that’s come out, sort of suggests a lot of new construction activity for memory care and assisted living, given that that’s your new focus for development. Just wondering what you’re seeing on the ground in your existing markets and kind of for your future developments and how that changes your underwriting if at all?

Rick Matros

Well, in terms of what we are seeing on the ground, we are not seeing -- because we focus with smaller (inaudible) operators and local and secondary and tertiary markets, these are the markets these guys live in. So we are not seeing any other new development, other than the projects that these guys undertake.

We tend not to see the bigger guys focus on these markets, because the local guys do tend to own them when they are secondary and tertiary, so we are not seeing anything sort of broad based or where we are seeing a development project in the market that we like, we are not seeing two or three or four of the development projects, we are just not seeing that at all.

So I still think it’s very market and developer/operator specific, and again, no trends to indicate otherwise. So in terms of the underwriting, it doesn’t really affect how we underwrite.

Talya Nevo-Hacohen

I’ll add to that a couple of things. One is, while there is an up-tick on an absolute basis, the numbers are actually still quite small in terms of percentages, and then it’s still challenging for operators and developers to get capital. So unless they have their own capital to execute, construction transactions, which if you do, it’s still tough. There are only a handful of lenders outside of HUD that are willing to lend, and so that in that itself, it really creates a very strong governor on the amount of development that can start.

The other thing I’d add is, one of the things that we focus on in our underwrite on development projects is market study, and we look NFS supply demand and what we are really looking at and trying to target are those communities, those areas that have an unbelievable demand with very little supply.

So the demand indicators are so strong, it’s not like there’s some demand for additional supply, but it’s under served by 7x, 10x, 20x, it’s those kind of markets. So that even if there’s another facility that gets built, there is still under served demand. So we really look at the gaps that exist in terms of supply in various markets.

David Schiffmann - Jefferies & Co.

Great. Thank you very much for the color.

Operator

(Operator Instructions). At this time I show that we have no further questions. I’d like to turn the call over to Rick Matros for closing remarks.

Rick Matros

Thanks and just a couple of closing comments. One, a little bit more on the development stuff. So in terms of how we see the year rolling out, from a timing perspective on getting deals done, I think it will looks like the last two years where we have a lot more in the back end and the front end. But based on again, on current trend and pipeline activity, we don’t have any concern about not hitting our assumptions relative to deal flow.

From the perspective of how it differs from the past couple of years, again our focus is going to be on AL Memory Care, and you are going to see more development projects from us, and that’s really critical from our perspective, because given the size of our company, to bring on as many new assets, particularly in the senior housing arena as we see coming on over these next few years, really is almost transformitive for our portfolio.

And given the fact that the characteristics of the resident in assisted living is so much different than when most of the assisted living facilities that currently exist were constructed, we think that with enough products in place, that are much more conducive to meeting the needs of an assisted living resident that has many more cognitive and mobility issues than residents even as recently as five years ago, that would reside in nursing homes.

And with Memory Care being a relatively new business, having purpose built memory care facilities, that again take into consideration the characteristics of those residents, we think is very positive thing.

And the other things to be mindful of when it comes to assisted living and memory care facilities is because it’s a need based resident now and acuity is going to continue to rise, you’ve got staffing needs and so to have a physical plant configuration that lends itself to a more efficient staffing model is critical as well to maintain the quality of the margins in both the assisted living and the memory care facilities.

So we are looking forward to that. We are looking forward to doing more repeat business with existing tenants and other than that, we’d see again on the reimbursement side a pretty benign if not slightly positive environment.

And with that, both Talya and Harold and I are available for calls. You guys have our numbers and our e-mail. We’ll be responsive to you. We appreciate the support and thank you for your time today. Take care.

Operator

Ladies and gentlemen, this does conclude today’s conference. We thank you for your participation. You may now disconnect.

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