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Omega Healthcare Investors, Inc (NYSE:OHI)

Q4 2013 Earnings Call

February 4, 2014, 10:00 AM ET

Executives

Michele Reber - Investor Relations

Taylor Pickett - Chief Executive Officer

Robert Stephenson - Chief Financial Officer

Daniel Booth - Chief Operating Officer

Analysts

Jeff Theiler - Green Street Advisors

Daniel Bernstein - Stifel

Omotayo Okusanya - Jefferies

John Roberts - Hilliard Lyons

Operator

Good day, and welcome to the Omega Healthcare Investors' fourth quarter 2013 earnings call and webcast. (Operator Instructions) I would now like to turn the conference over to Michele Reber. Please go ahead.

Michele Reber

Thank you and good morning. With me today are Omega's CEO, Taylor Pickett; CFO, Bob Stephenson; and COO, Dan Booth.

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 acquisition 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 identifies 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, FAD 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 Taylor.

Taylor Pickett

Thanks, Michele. Good morning and thank you for joining Omega's fourth quarter 2013 earnings conference call. Adjusted FFO for the fourth quarter is $0.65 per share, which is a 12% increase over 2012 fourth quarter adjusted FFO of $0.58 per share.

Normalized funds available for distribution, FAD, for the quarter is $0.59 per share. We increased our quarterly common dividend to $0.49 per share. This is a 2.1% increase from last quarter and a 9% increase from the fourth quarter of 2012. We've now increased the dividend, six consecutive quarters. The dividend payout ratio is 75% of adjusted FFO and 83% of FAD.

We've announced our 2014 FAD guidance range of $2.44 to $2.47 per share and 2014 adjusted FFO guidance range of $2.69 to $2.72 per share. We have not included acquisitions in our guidance, expect for the $113 million first mortgage loan closed in January.

We estimate that every $100 million in new acquisitions will add approximately $0.025 to our FAD run rate on an annualized basis and $3.03 to our adjusted FFO run rate, also on an annualized basis.

As a deal flow reminder, we've made new investments of over $2 billion in the last four years. Our pipeline remains fairly active, but as in prior years, acquisition activity will likely be choppy.

Bob, will now review our fourth quarter financial results.

Robert Stephenson

Thank you, Taylor, and good morning. Our reportable FFO on a diluted basis was $79.9 million or $0.65 per share for the quarter as compared to $61.4 million or $0.55 per share in the fourth quarter of 2012.

As Taylor mentioned, our adjusted FFO was $79.9 million or $0.65 per share for the quarter and excludes the impact of $1.5 million of non-cash stock-based compensation expense, $1.4 million of one-time revenue, $200,000 recovery related to provision for uncollectible notes receivable and $100,000 of expense associated with acquisition. Further information regarding the calculation of FFO is included in our earnings release and on our website.

Operating revenue for the quarter was $111.1 million versus $95 million for the fourth quarter of 2012. The increase was primarily a result of incremental lease revenue from a combination of acquisitions completed since late fourth quarter of 2012, capital improvements made to our facilities and lease amendments made during that same time period.

The $111 million of revenue for the quarter includes approximately $8.3 million of non-cash revenue. We expect the non-cash revenue component to be between $7 million and $8 million per quarter for 2014.

Operating expense for the fourth quarter of 2013, when excluding acquisition-related costs, stock-based compensation expense, impairment charges and the provision for uncollectible accounts receivable, increased by $1.7 million as compared to the fourth quarter of 2012. The increase was primarily a result of increased depreciation and amortization expenses related to closing of approximately $846 million of new investments since mid fourth quarter of 2012 and a slight decrease in our G&A expense due to timing.

We project our 2014 annual G&A expense, excluding stock-based compensation expense, will be between $16.5 million and $17 million and the growth primarily related to new investments completed over the past 12 months. In addition, we expect our 2014 annual non-cash stock-based compensation expense will be approximately $8.6 million.

Interest expense for the quarter, when excluding non-cash deferred financing cost, was $25.3 million versus $24.5 million for the same period in 2012. The $800,000 increase resulted from higher debt balances associated with the financings related to the new investments completed in 2013.

Turning to the balance sheet for the year. In March, we refinanced approximately $59 million of debt related to 12 mortgage loans guaranteed by the Department of Housing and Urban Development. The 12 HUD mortgage loans had a blended interest rate of 5.55% per annum with maturities in July, 2044. The refinanced interest rate is approximately 3.06% per annum and did not change the loan maturity days.

In May, we paid $51 million to retire 11 mortgage loans guaranteed by HUD. The loans were assumed as part of the 2010 CapitalSource acquisition and had a blended interest rate of 6.61%. The payoff resulted in an $11 million net gain for the extinguishment of fair market value of debt classified as interest refinancing cost on our income statement.

In October, in an underwritten public offering, we issued 2.875 million shares of common stock, generating net cash proceeds of $85 million. During the fourth quarter of 2013, we completed $561 million of new investments. Dan will go over these in a few minutes. The new investments were financed, primarily with borrowings under a $500 million unsecured credit facility and balance sheet cash.

In late December, we closed on $200 million term loan priced at LIBOR plus 175 basis points, which is short liquidity for potential new investments. At December 31, the new term loan was completely available for use. In January, we borrowed the entire $200 million and used the proceeds to repay borrowings on our credit facility. We plan to look to the capital markets in the first part of 2014 for loan term financing.

For the year ended December 31, 2013, on our equity shelf program and our dividend reinvestment and common stock purchase plan, we issued a combined 8.4 million shares of common stock, generating gross cash proceeds of $254 million. For the three months ended December 31, 2013, our funded debt to total asset ratio was 46% and our funded debt to adjusted annualized EBITDA was 4.7x. And finally, our adjusted fixed charge coverage ratio was 4.1x.

I'll now turn the call over to Dan.

Daniel Booth

Thanks, Bob, and good morning, everyone. As of December 31, 2013, Omega had a core asset portfolio of 538 facilities with 58,885 operating beds, distributed among 49 third-party operators, located within 37 states.

Trailing 12 month operator EBITDARM coverage remains stable as of September 30, 2013, at 1.9x versus 1.9x as of June 30. Trailing 12 month operator EBITDAR coverage also remains stable at 1.5x versus 1.5x as of June 30.

Turning to new investments. During the fourth quarter of 2013, Omega completed $569 million of new investments, including capital expenditures. The investments involved three separate transactions and included the previously announced Ark transaction.

On November 27, 2013, the company completed a $529 million sale/leaseback transaction for 56 facilities operated by Ark Holding Company. As part of the transaction, Omega acquired titles of 55 skilled nursing facilities and one assisted living facility, and leased them back to the prior operators, pursuant to four 50-year capital lease agreements, with rental payments to Omega yielding 10.6% per annum over the term on lease.

The 56 facilities represent 5,624 licensed beds located in 12 states, predominantly in the southeastern United States. The 56 facilities are separated by a region and divided amongst four cross-defaulted master leases. The four regions include the Southeast, the Northwest, Texas and Indiana. The initial year one contractual rent is $47 million with 2.5% escalators beginning in year five.

In addition to the Ark transaction, the company completed two separate acquisitions in October, with two existing operators totaling $33 million. The acquisitions consisted of one assisted living facility in Florida and four skilled nursing facilities located in Indiana. Each of the facilities was added to existing master leases.

Subsequent to the end of 2013, on January 17, 2014, the company entered into a $112.5 million first mortgage loan with an existing operator of the company. The loan is secured by nine skilled nursing facilities, totaling 784 operating beds, located in Pennsylvania and Ohio. The loan is cross-defaulted and cross-collateralized with the company's existing master lease with the operator.

The loan bears an initial annual interest rate of 9.5%. Omega continues to see a steady pace of investment opportunities. As of today, Omega has a combination of revolver availability and cash totaling $325 million.

Taylor Pickett

Thanks, Dan. Andrew, we're ready to open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Jeff Theiler of Green Street Advisors.

Jeff Theiler - Green Street Advisors

Your most recent investment was this first mortgage loan and the Ark investment had no escalators for the first five years. Is this the start of a pattern or are you thinking about moving away from the typical 2% rent bumps we've seen for skilled nursing investments because of low growth and provider payments or is it just coincidence that this is the way these two investments are structured?

Taylor Pickett

Really, just coincidence. The Ark, obviously, very big and very long-term and so that was just part of the negotiation of the underlying economics. The first mortgage has escalators, and it's consistent with the master lease when it's crossed in two's. So that's I'd say, more traditional in terms of the economics.

Jeff Theiler - Green Street Advisors

What are the escalators on the first mortgage?

Daniel Booth

2%.

Jeff Theiler - Green Street Advisors

And what's the interest coverage on the first mortgage?

Daniel Booth

It's an excess of 1.4x.

Taylor Pickett

Jeff, consistent with our typical underwriting per lease.

Jeff Theiler - Green Street Advisors

And can you just give a quick commentary on cap rates. What you're seeing out there in the market, whether they look to be trending down or flatter?

Robert Stephenson

I'd say they're relatively flat. We work down into the 9s last year, in terms of cash-on-cash. And I think our view is that's where they're going to be this year for the foreseeable future. There's a fair amount of capital, not any of the large guys, but there is still a fair amount of capital out there looking at SNF assets.

Operator

The next question comes from Daniel Bernstein of Stifel.

Daniel Bernstein - Stifel

Can you provide the term, the actual maturity date of the loan you did in the first quarter?

Daniel Booth

It was 10 years initial term.

Daniel Bernstein - Stifel

It was 10 year?

Daniel Booth

Yes.

Daniel Bernstein - Stifel

And then in terms of the acquisition opportunities out there, are you seeing a lot of these larger acquisitions like Ark or are you seeing more of the bread and butter, $25 million, $50 million opportunities that you traditionally have done? And also just trying to understand, where are these sellers coming from? Is it more private equity? Is it the smaller operators having trouble, dealing with reimbursement changes? So just trying to understand, what's driving the acquisition market today?

Taylor Pickett

We're not seeing a lot of deals the size of Ark, I would say that. There is just not a lot of private operators that hold that many assets, number one. So I would say, we are seeing more of the $50 million to $100 million deal size, which has sort of been our bread and butter for the last several years. And we were seeing that sellers is traditionally more mom and pops. I mean there's obviously a lot of different pressure on them coming from a lot of different directions, and over time these folks -- it's still a very fragmented industry, one-by-one are deciding to slowly sell out. So that's what we expect to see, at least in the short-run.

Daniel Bernstein - Stifel

Do you think the cap rates can back up a little bit if you start doing a little bit more on the smaller operator transactions rather than the Ark size transactions? Do you think cap rates will backup a little bit or are we kind of stuck in this 9s area that you mentioned?

Taylor Pickett

I think given the amount of capital that's still out in the marketplace, something in the 9s -- 9, 9.5; you'll occasionally see stuff that pushes towards 10, but I don't see many transactions being done at 10%, as an example.

Daniel Bernstein - Stifel

And then, in terms of the capital structure, are you still thinking long-term about 50-50 debt-to-equity. I don't remember what you said in terms of debt-to-EBITDA. But has anything changed in terms of your thoughts on your capital structure for whatever reason?

Robert Stephenson

We'll continue to be modestly levered debt-to-EBITDA in that 4x to 5x range. And the math there is 50-50 debt-to-equity over time and there is really no change there.

Daniel Bernstein - Stifel

And no change in terms of, you used the term loan in the first quarter versus going out in the unsecured market. Are you thinking you want to decrease your debt maturity length on your balance sheet, debt duration on your balance sheet, or is that really was just a circumstance of the cost? I am just trying to understand, you're going to use a little bit shorter-term debt versus longer-term debt given the increase in interest rates?

Taylor Pickett

No. I think we're going to continue to go long, and Bob, mentioned that in the first part of this year, we're going to look at long term financing for our existing short-term borrowings, including that $200 million piece of term debt. So part of our guidance includes the expectation that we'll have prominent financing in place at some early point of 2014 to fully open up the revolver and take out that little $200 million term loan.

Daniel Bernstein - Stifel

There are no prepayment penalties on that that you're worried about?

Taylor Pickett

It is effectively a bridge because we knew we had like a $113 million closing, and as Dan mentioned, the pipeline is still pretty active.

Operator

The next question comes from Omotayo Okusanya of Jefferies.

Omotayo Okusanya - Jefferies

I was just hoping you could talk a little bit about Genesis in particular, and kind of how things are going there with some of their cost restructuring programs? They have kind of talked in the fourth quarter about census potentially being a little bit light. And I was just kind of curious about what you were hearing from them?

Taylor Pickett

For our part of the Genesis portfolio, we've seen a little bit of dip in occupancy, but nothing of any significance. Dan?

Daniel Booth

No, we're just consistent with what we've seen. Genesis has come out and indicated some softening in occupancy, but we've seen that across the board, really not just our portfolio, but from other operators and across the country, but it's been very, very modest, and it hasn't really materially affected coverages from where we fit.

Omotayo Okusanya - Jefferies

And then also, I know it's still six months early, but generally any sense you're kind of getting from states in regards to the overall fiscal conditions and what they maybe doing in regards to Medicaid rates come July 1?

Taylor Pickett

We feel pretty good about what we're hearing at the state level. And as you said it's still a little early to fully predict it, but our view today is that we should see modest increases, 1%, 2%, 2.5%, 5% increases in general across the states with budgets in relatively good shape. So on the Medicaid side of the coin, we feel pretty good that that's going to be steady.

Omotayo Okusanya - Jefferies

And then just one final question. Any thoughts just in regards to, I mean there was a recent Wall Street Journal article a few days ago, they were kind of talking about ACOs, and the mix results they've actually had in regards to saving money. Just kind of curious what your thoughts are on that? If you still kind of think ACOs ultimately will have some type of impact on the skilled nursing industry or whether it's just way too early to tell?

Taylor Pickett

I think it's a little early to tell. And though it was an interesting article, even in that article it was little bit difficult to glean what percentage the savings were. They talked about what was hundred or somewhat million or what was the full bucket in terms of what they are measuring. So it wasn't totally clear to us. I think the great news in form or another skilled nursing facilities are going to be an integral part because it's still by far the cheapest setting to do from a Medicare perspective. But it was an interesting article as you pointed out, because I think there was an expectation for larger savings or at least broader savings and it remains to be seen.

Operator

The next question comes from John Roberts of Hilliard Lyons.

John Roberts - Hilliard Lyons

Can you just go a little bit more maybe into the size and composition of the acquisition pipeline?

Taylor Pickett

The size is, once again, we're looking at a number of deals as far as the range of deals. It's anywhere from a few millions dollars, one-off deals to I would say up to $100 million deals. What is the size that we're underwriting to that? I mean it's not billions, it's in hundreds of millions, but when we talk about pipeline, we talk about what we're looking, not what we have underwritten and signed term sheets on.

So that curve moves up and down quite a bit depending on where we are during a calendar year and what size deals we're looking at, obviously a large deal would impact that tremendously. So I'd say, once again, it's choppy. There is a bunch of deals out in the market in that you are, but typical size that we normally see, which is sort of the $5 million to $100 million range.

Robert Stephenson

Just to add to that a little bit, as far as I know, there is no Ark size deals floating around that we're aware of.

John Roberts - Hilliard Lyons

The bulk of it I would assume is SNFs? You did ALF in Q4, but that's probably not something you're normally going to do?

Taylor Pickett

Well, we did an ALF in Q4, we did an ALF in Q1. We're going continue to do some ALFs to the extent that we have opportunities to do them. I don't know that we're going to get an opportunity to bid on the gigantic ALF transactions if there are ever anymore to come down the road, but we're going to aggressively bid on ALF deals, particularly if it rounds out a market for one of our existing operators.

John Roberts - Hilliard Lyons

So you will do them more selectively within sort of existing geographic areas or with the existing operators?

Daniel Booth

Well, I'll expand upon that. If we come across an assisting lending operator that we work well with and that we can develop our relationship with, we will certainly entertain doing a transaction of that type without the existence of an existing SNF relationship.

Operator

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

Taylor Pickett

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

Operator

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

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