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Omega Healthcare Investors Inc. (NYSE:OHI)

Q1 2008 Earnings Call

April 23, 2008 10:00 am ET

Executives

Tom Peterson - Director of Finance and IR

Bob Stephenson - CFO

Dan Booth - COO

Taylor Pickett - CEO

Analysts

Kristin Brown - Deutsche Bank

Charlie Place - Ferris, Baker Watts

Jerry Doctrow - Stifel Nicolaus

Tayo Okusanya - UBS

Operator

Good day, everyone, and welcome to today's Omega Healthcare Investors first-quarter 2008 earning results conference call. Just as a reminder today's call is being recorded. At this time, I'd like to turn the conference ever to Mr. Tom Peterson. Please go ahead, sir.

Tom Peterson

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 restructurings, rent payments, financial condition or prospects of our operators, and the 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 Form 10-K, which identify 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 included in our press release issued today; or in the case of per-share information, available under the Financial Reports section of our website; and in the case of FFO and adjusted FFO, in our press release issued today.

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

Taylor Pickett

Thanks, Tom, and good morning. I will review our adjusted first quarter 2008 FFO; our increased 2008 adjusted FFO guidance; the status of the Haven bankruptcy; and our investment activity so far this year.

Adjusted FFO for the first quarter is $0.36 per share. As a result of our strong performance during the quarter, we increased the common dividend by a $0.01 to $0.30 per share. This represents the 14th quarterly dividend increase in the last 18 quarters, with the common dividend doubling from $0.15 in the third quarter of 2003 to $0.30 per share today.

We have increased 2008 adjusted FFO guidance to a range of $1.49 to $1.55 per diluted share, up from $1.41 to $1.43 per diluted share. This guidance does not include future acquisitions.

Turning to the Haven bankruptcy, as we discussed during the last conference call, since November 2007 Haven has operated under Chapter 11 bankruptcy protection. Haven has paid all of its Omega post-petition rent obligations. Haven is currently proceeding with the sale of substantially all of its assets, with proceeds going to secured and unsecured creditors.

In a motion filed on April 17, 2008, Haven identified LifeHouse Retirement Properties, Inc., as the potential buyer of substantially all of Haven's skilled nursing facility assets. The asset purchase agreement attached to the motion reflects an acquisition price of $105 million, subject to certain adjustments and contingencies.

The asset purchased agreement requires the debtor to assume and assign the Omega leases. Based on the $105 million purchase price, the debtors state that all secured administrative and priority claims will be paid in full; and the unsecured creditors would receive about $7 million, with the potential for a substantially greater distribution.

Finally, turning to investment activity, Omega has invested $134 million year-to-date in 2008. A largest transaction is the recent $123 million CommuniCare deal, which is a combination of facility and leases and mortgages. The year one cash yield on this investment is 10.5%.

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

Bob Stephenson

Thank you, Taylor, and good morning. Our reportable FFO on a diluted basis was $23.7 million or $0.34 per share for the quarter, as compared to $25.4 million or $0.42 per share in the first quarter of 2007.

As Taylor described, our adjusted FFO was $25 million or $0.36 per share for the quarter, which excludes non-cash restricted stock compensation expense of $526,000; a non-cash provision for impairment loss associated with one facility of $1.5 million; collection of a claim associated with a prior operator's past due rental obligations of $650,000; and $45,000 of FIN 46 consolidation adjustments. Further information regarding the calculation of FFO is included in our earnings release and on our website.

Operating revenue for the quarter was $40.9 million versus $42.6 million for the first quarter of 2007. The $1.8 million decrease was primarily a result of a $5 million catch-up in revenue booked in the first quarter of 2007 associated replacing Advocat on a straight-line rent recognition in January 2007. This was partially offset by $1.5 million of revenue associated with $40 million of acquisitions completed during the third quarter of 2007, and $5 million of acquisitions completed in the first quarter of 2008.

$600,000 of revenue associated with the Sun lease amendment; $650,000 associated with the collection of a past due revenue claim; and about $0.5 million associated with the collection of Haven late fees, default interest, and DIP related fees and interest.

The first-quarter 2008 operating expense was in line with our 2007 first-quarter operating expense when you exclude the provision for impairment loss of $1.5 million and non-cash stock-based compensation expense of $526,000.

During the quarter, we started construction of a new facility in Texas to replace an existing Texas facility. As a result, we recorded a $1.5 million impairment loss to reduce the value of the facility being replaced to its estimated sales value when closed. We anticipate the new facility to be completed in mid 2009.

Interest expense for the quarter was $9.7 million versus $11.8 million for the same period in 2007. The reduction was primarily due to lower average debt on our balance sheet, combined with lower LIBOR borrowing rates.

Turning to the balance sheet, at March 31, 2008, we had approximately $1.2 billion of total assets. During the quarter, we also had several other transactions which impacted our balance sheet.

First, we completed an acquisition of $5.2 million. Second, we reclassified approximately $16.4 million from land and building to assets held for sale as a result of an amendment to our Sun Master Lease which, among other things, allows for the sale of two rehab hospitals. And finally, we sold two facilities which were classified as held for sale at December 31, 2007, for approximately $3 million, generating an accounting gain of approximately $0.5 million.

At March 31, 2008, we had credit facility availability of $171 million. On the liability side of the balance sheet, we had $569 million of debt at March 31, 2008.

For the three months ended March 31, 2008, our total debt to EBITDA was 3.9 times and our fixed charge coverage ratio was 2.9 times. When you exclude the non-cash provision for impairment loss, the revenue from a prior operator's past due rental obligations, and the non-cash restricted stock compensation expense, our total adjusted debt to adjusted EBITDA was approximately 3.8 times.

I will now turn the call over to Dan Booth, our Chief Operating Officer.

Dan Booth

Thank you, Bob, and good morning, everyone. As of March 31, 2008, Omega had a core asset portfolio of 235 facilities distributed among 26 third-party operators located within 28 states. Operator coverage ratios remained very strong during the fourth quarter of 2007.

Trailing 12-month EBITDAR coverage for the period ended 12/31 was 2.2 times versus 2.2 times for the period ended 9/30/07. Trailing 12-month EBITDAR coverage was 1.8 times as of 12/31/07 versus 1.8 times as of September 30.

Turning to new investments, on April 18, 2008, the company completed approximately $123 million of combined new investments with affiliates of CommuniCare Health Services, an existing operator.

Effective April 18, the Company purchased from several unrelated third parties seven skilled nursing facilities, one assisted living facility, and one rehabilitation hospital, allocated in Ohio, totaling 709 beds for a total investment of $48 million. The facilities were added into an existing Master Lease with CommuniCare.

Annualized cash rent increased by approximately $4.7 million subject to annual escalators and two 10 year renewal options. The term of the Master Lease was extended to April 30, 2018.

Also on April 18, 2008, and simultaneous with the close of the amended CommuniCare Master Lease, the Company entered into a first mortgage loan with CommuniCare in the amount of $74.9 million. The loan matures on April 30, 2018, and carries an interest rate of 11% per year. CommuniCare used the proceeds of the loan to acquire seven skilled nursing facilities located in Maryland, totaling 965 beds, from several unrelated third parties. The loan is secured by a lien on the seven facilities.

At the closing, $4.9 million of loan proceeds were escrowed pending the acquisition of an additional 90-bed facility also located in Maryland. The facility will be acquired by CommuniCare within an eight-month period upon satisfaction of certain contingencies, including the granting of a lien on such facilities to secure our loan. If the additional facility is not acquired, CommuniCare will be obligated to repay the $4.9 million of escrowed loan proceeds.

With the closing of this transaction, CommuniCare becomes Omega's largest operator in terms of both revenue and gross investments. As of the close, annualized revenue derived from the CommuniCare relationship totaled $31.6 million per annum or 19.3% of Omega's total investment income. Total gross investment is $315 million or 21.8% of Omega's total investment portfolio.

Omega's relationship began with CommuniCare in 2003, when they assumed the operations of two troubled facilities in Ohio. Since that time, Omega has made investments with CommuniCare in 33 facilities totaling 4,345 beds.

In brief, Omega's history with CommuniCare has been exemplary. They have repeatedly proven themselves to be an operator of the highest quality standards and integrity. In addition, CommuniCare's operating and financial performance has been extremely strong.

CommuniCare's trailing 12-months EBITDARM and EBITDAR coverage ratios for the period ended 12/31/07 was 2.4 and 1.9, respectively. We fully expect CommuniCare's historical success to continue forward with this acquisition.

As of today, Omega has $51 million in cash and credit availability to fund new investments.

Tom Peterson

Thanks Dan. This concludes our prepared comments. We will now take questions. Christina?

Question-and-Answer Session

Operator

(Operator Instructions). And our first question will come from Kristin Brown with Deutsche Bank.

Kristin Brown - Deutsche Bank

Hi good morning, guys. I just wanted to ask on the two rehab hospitals held for sale. Why the decision to sell, and are you actively marketing those assets?

Tom Peterson

The assets are being actively marketed. The decision to sell really came from Sun, the operator. And I think that it's their operating strategy to move away from those hospitals and focus on their SNF portfolio. But yes, we are actively marketing those assets; and it's likely they will be sold in the next couple months.

Kristin Brown - Deutsche Bank

And that's not included in your guidance?

Bob Stephenson

It is not included in our guidance, no.

Kristin Brown - Deutsche Bank

Okay. And then can you talk about the financing on the assets that you closed this quarter? Was that all off the credit line?

Bob Stephenson

That's correct.

Kristin Brown - Deutsche Bank

Okay. And then just in terms of the dividend reinvestment plan, how many shares were issued during the quarter?

Bob Stephenson

During the quarter -- well we ended the quarter with 69 million shares; and approximately 600,000 shares were issued, almost 700,000 during the quarter.

Kristin Brown - Deutsche Bank

Okay. And then last question, have there been sort of any meaningful additions to your watch list in terms of tenants that might be potentially problematic?

Bob Stephenson

No.

Kristin Brown - Deutsche Bank

No? Okay, thank you.

Operator

Anything further, Ms. Brown?

Kristin Brown - Deutsche Bank

That's it, thanks.

Operator

Thank you. And our next question will come from Charlie Place with Ferris, Baker Watts.

Charlie Place - Ferris, Baker Watts

Morning.

Taylor Pickett

Good morning.

Charlie Place - Ferris, Baker Watts

On the Advocat facility, are you all building that, the new property?

Taylor Pickett

We are actually, Advocat is leading the building of it. They're contractually building the facility. We did a substantial amount of work to locate and acquire the land, and we will obviously provide all the financing.

Charlie Place - Ferris, Baker Watts

And then how much do you anticipate that investment will be?

Taylor Pickett

What is it $7 million? $7 million.

Charlie Place - Ferris, Baker Watts

And how many beds is that?

Taylor Pickett

A 120 beds.

Charlie Place - Ferris, Baker Watts

Okay, great. I was wondering, Taylor, if there's any more clarity you can provide to the Haven situation as far as, what the timing is, if you have any sense of that, as far as a decision being made. Is this LifeHouse offer -- what stage is that in? Are they in a due diligence phase, or what is there?

Taylor Pickett

Yes, I can provide a little bit of color in terms of timing. In the motion that was filed on April 17, they attached the asset purchase agreement. And in the asset purchase agreement, it's an all-cash deal. There are no financing contingencies. There is a little bit of work to be done in terms of activities with the state of Connecticut. But as the agreement is laid out, on May 14 there will be an auction. And so essentially, LifeHouse is the stalking-horse for that auction. If they are outbid, they will be entitled to a breakup fee. But if they stay all on target, on May 14 we'll know who the acquirer is, whether it's the LifeHouse or some other party.

Charlie Place - Ferris, Baker Watts

In that scenario, in that purchase agreement, would your mortgage loans be repaid and they would assume the operation of the facilities? Is that the way to think about that?

Taylor Pickett

No, actually what they have requested is that Omega exercise the purchase option on the mortgages which, if you remember, in order to acquire the fee simple of the properties that are currently mortgaged, we use the proceeds. We use our debt to buy them, so there is no cash that exchanges hands.

Charlie Place - Ferris, Baker Watts

So you would own the 15 facilities outright?

Taylor Pickett

We would own -- yes, our current eight plus the seven in the mortgage. And those seven, under the terms of the agreement we struck a number of years ago, get combined into the current Master Lease. So we would have one Master Lease, all 15 facilities with the same economic terms that we have today.

Charlie Place - Ferris, Baker Watts

Okay, and they would be assuming the lease?

Taylor Pickett

They would assume and assigned to the buyer. That is correct.

Charlie Place - Ferris, Baker Watts

Okay, and is Lifehouse, did you have any relationship with them right now?

Taylor Pickett

We do not have a relationship with LifeHouse as of yet. We've had conversations with LifeHouse, and we know folks in the marketplace who have dealt with LifeHouse; and we feel comfortable with them as a potential operator.

Charlie Place - Ferris, Baker Watts

Okay. And then just one last, this is more of an accounting issue. For the FIN 46 adjustments, Bob, is that going to continue going forward, you know, in that nominal amount of around $45,000 a year or a quarter?

Bob Stephenson

When the purchase option is exercised, it goes away with the Haven.

Charlie Place - Ferris, Baker Watts

Okay, so that is related to Haven?

Bob Stephenson

That's correct.

Charlie Place - Ferris, Baker Watts

Okay. Great, okay. That's it for me. Thanks.

Bob Stephenson

Thank Charles.

Operator

(Operator Instructions). From Stifel Nicolaus we'll hear from Jerry Doctrow.

Jerry Doctrow - Stifel Nicolaus

Hi, good morning.

Bob Stephenson

Good morning Jerry.

Jerry Doctrow - Stifel Nicolaus

Couple things, just to start maybe just staying on the Haven for one second. You talk about post-petition. Are there some pre-petition amounts that you're still owed? Do they get paid up or anything that may be lost in the final settlement?

Taylor Pickett

There are pre-petition amounts that are still owed. Bob, how much is that?

Bob Stephenson

It's a little over $1 million.

Taylor Pickett

So they owe us a little over $1 million, and in order to assume our lease back they have to cure all those prior pre-petition amounts too.

Jerry Doctrow - Stifel Nicolaus

Okay

Taylor Pickett

Everyone's expectation as part of the Haven bankruptcy is that all of that will be paid.

Jerry Doctrow - Stifel Nicolaus

Okay. And then assuming May 14 happens, I think you had talked about at some point, or I guess the DRIP -- or DIP financing, rather, has kind of a -- I don't know if it was June 20 or June 30 kind of deadline. Do you expect it to be sort of settled by then? Or could we slip a little bit beyond that date?

Taylor Pickett

I think it would be settled before that. There are a lot of incentives all around to close earlier. And I'm fairly certain that that would be everyone's intention. That being said, we have to work through the state of Connecticut timing.

Jerry Doctrow - Stifel Nicolaus

Okay, okay, and there it is just license transfers, basically?

Taylor Pickett

License transfers and interim rate letters.

Jerry Doctrow - Stifel Nicolaus

Okay, okay. Just sort of reimbursement a little bit more generally. You know, Taylor, I think the investors seem to be -- not just in you guys but in the public companies as well little more nervous about nursing home reimbursements. There are some potential changes on Medicare, RUGs categories. There is obviously the cost of living thing coming up. People are more nervous about Medicaid because of state budgets. Just your sense on those issues and any potential impacts on OHI.

Taylor Pickett

You know, I would not be surprised to see states and the federal government look at rates. You may start to see some rate freezes. I would be very surprised if you start to see rates cut back; but rate freezes I think is that potentially in the cards. That being said, we look at the historically highest coverage's we've ever had, EBITDAR coverage's of 1.8 on the overall portfolio. And the bulk of our operators, right around that number; it is not large standard deviations away.

If my coverage moves down from 1.8 to 1.7, I am fine with that. We underwrite at much lower numbers. So I think there's lots of flexibility from where we sit. Obviously, it's a lot tougher on the operating companies because they see it hit their cash lines.

Jerry Doctrow - Stifel Nicolaus

Okay. And, the acquisition volumes that you have seen have obviously been picking up. There is a little noise out of, again, some other operating companies, HCSG reported some issues with a couple operators in terms of bad debt payments and stuff like that. Is there any sort of stress out there for some smaller operators that's sort of triggering the kind of investment volumes, or anything else out there in the operating environment we should be thinking about?

Taylor Pickett

Dan, do you have any comments?

Dan Booth

No, you know, we have seen the activity pick up Jerry, a little bit and become slightly more rational. But I don't think there is any dramatic change going on right now.

Jerry Doctrow - Stifel Nicolaus

Okay.

Taylor Pickett

As from our perspective, you obviously have a lot of folks who were playing in this space who aren't anymore. Including some of the finance companies that are feeling a crunch, whether it's CIT or others. We're just not seeing that that much. And so, part of what happened is the pricing has got a little more rational and we're one of the handful players out there that are active in skilled nursing facilities.

Jerry Doctrow - Stifel Nicolaus

Okay, okay. That's helpful. Then just, you're obviously developing some decent concentration with CommuniCare and Sun. How do you think about that issue from sort of a portfolio risk? And would you limit future investments with these guys?

Dan Booth

You know, I think we' have sizable concentrations with both CommuniCare and Sun. Obviously, Sun at one point tipped close to 30% of our portfolio, it's actually down closer to about 15% now, CommuniCare is up to just over 20%. But I mean, you're talking about two high, high-quality operators, Jerry. We're going to continue to be opportunistic. If either of those operators brought us deals, we certainly would not pass on looking at them just because of their current concentration levels.

Jerry Doctrow - Stifel Nicolaus

Okay. Then just about availability of capital, I think somebody mentioned, there's $51 million was on the line, or I don't know if that was line and cash. In terms of how much additional capacity that you have through rest of year or whatever, before you would need to come back for capital, and what kind of capital access you have, can you give us any color on that?

Taylor Pickett

Sure, obviously -- our need is going to depend on how quickly stuff moves through the pipeline and we do have a number of opportunities that we are looking at, albeit most of what's in the pipeline today is more in the early stage. So, you've got the $50 million available on the line. We have the potential for the sale of the two Sun rehab hospitals, which we are working through, which should be a meaningful amount of money. We've looked at some other things, whether it's the potential to do a little bit of secured debt, some form of a term loan. We think we might be able to do something there. And of course, the equity markets are still out there. But I think it all gets triangulated around what we think about our pipeline, which as I said, we've got a lot of going on. It is just all at fairly early stages.

Jerry Doctrow - Stifel Nicolaus

Okay. So in terms of a big -- stuff could come in the next quarter, but it could also be two quarters out, three quarters out? I mean, that's the right way to think about it?

Taylor Pickett

Yes, I mean, there is stuff that could come at the end of the quarter, for sure. But, you're probably looking more, Dan, when you say, is kind of third quarter for what we are looking at?

Dan Booth

In more heavily weighted toward third than second.

Taylor Pickett

Yes.

Jerry Doctrow - Stifel Nicolaus

Okay. All right, that's helpful, thanks.

Operator

Anything further, sir?

Jerry Doctrow - Stifel Nicolaus

No, thank you.

Operator

And our next question will come from Tayo Okusanya with UBS.

Tayo Okusanya - UBS

Good morning. Jerry, actually just asked my question, but congratulations on a good quarter and getting the CommuniCare deal done.

Taylor Pickett

Thanks, Tayo.

Operator

And at this time, there appears to be no further questions in the queue. (Operator Instructions) At this time there appears to be no further questions in the queue.

Tom Peterson

Thanks, Christina. Thank you for joining our first quarter earnings release call. Bob Stephenson, our CFO, will be available for any follow-up questions you may have.

Operator

That does conclude our teleconference for today. We'd like to thank everyone for your participation and have a wonderful day.

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