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Omega Healthcare Investors Inc. (NYSE:OHI)

Q2 2012 Earnings Call

July 27, 2012 10:00 am ET

Executives

Michelle Reiber - IR

Taylor Pickett - CEO

Bob Stephenson - CFO

Dan Booth - COO

Analysts

John Roberts - Hilliard Lyons

James Milam - Sandler O'Neill

Omotayo Okusanya - Jefferies

Dan Bernstein - Stifel Nicolaus

Operator

Good morning and welcome to the Omega Healthcare Investors second quarter earnings call and webcast for 2012. (Operator Instructions). After today's presentation there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Michelle Reiber. Please go ahead.

Michelle Reiber

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 restructurings, rent payments, financial condition or prospects of our operators, contemplated acquisitions, and our business and portfolio outlook generally. These forward-looking statements involve risks and uncertainties which may cause actual results to differ materially.

Please see our press releases and our filings with the Securities and Exchange Commission including, without limitation, our most recent report on Form 10-K which 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, EBITDA and expenses excluding owned and operated properties. 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 Pickett.

Taylor Pickett

Thanks Michelle. Good morning and thank you for joining Omega’s second quarter 2012 earnings conference call. Adjusted FFO for the second quarter is $0.53 per share, a 13% increase from the second quarter 2011 adjusted FFO of $0.47 per share.

Our performance is consistent with the first quarter adjusted FFO of $0.55 per share when you take into account an additional $1 million in interest expense from our late first quarter bond offering and $2 million additional weighted average shares. In other words, the $0.02 decline in adjusted FFO is caused primarily by capital market transactions. We maintained our quarterly dividend of $0.42 per share. The dividend payout ratio is 80% of adjusted FFO.

We've increased our 2012 adjusted FFO guidance to a revised range of $2.12 to $2.15 per share. This guidance continues to assume $150 million in new investments during 2012.

Through June 30, we've made new investments of $46 million. The acquisition pipeline continues to be active. During the quarter, Fitch ratings initiated coverage of Omega with a BBB- investment grade rating our senior unsecured notes. We now have investment grade ratings from both Fitch and S&P.

With two investment grade ratings, our pricing on our unsecured line of credit drops by 65 basis points. Bob will now review our second quarter financial results.

Bob Stephenson

Thank you, Taylor and good morning. Our reportable FFO on a dilutive basis was $55.8 million or $0.53 per share for the quarter as compared to $42.6 million or $0.42 per diluted share in the second quarter of 2011. Our adjusted FFO was $55.7 million or $0.53 per share for the quarter and excludes a favorable $1.7 million interest refinancing cost adjustment offset by $1.5 million of non-cash stock-based compensation expense and $98,000 of expenses related to the closing of new investments. Further information regarding the calculation of FFO is included in our earnings release and on our website.

Operating revenue for the quarter was $83.8 million versus $72.6 million for the second quarter of 2011. The increase was primarily a result of $7.4 million of incremental lease revenue from a combination of acquisitions completed in the second half of 2011, capital improvements made to our facilities throughout 2011 and 2012 and lease amendments made during that same time period, $4 million of mortgage interest from new mortgages originated throughout 2011 and a $0.5 million of other investment income related to a $28 million note originated in December.

These three were partially offset by a $700,000 reduction in lease revenue related to one operator whose revenue is recorded on a cash basis and is anticipated to be current in the third quarter. The $83.8 million of revenue for the quarter includes approximately $8 million of non-cash revenue.

Operating expense for the second quarter of 2012, when excluding nursing home expenses, provisions for uncollectible accounts receivable and stock-based compensation expense increased by $2.5 million as compared to the second quarter of 2011. The increase was primarily a result of $2.4 million in depreciation and amortization expense related to the closing of approximately $370 million of new investments since July 1, 2011.

From a G&A standpoint, we project our 2012 annual G&A expense to be approximately $14.5 million assuming no extraordinary transactions or unusual events. Interest expense for the quarter when excluding refinancing cost and non-cash deferred financing cost was $24 million versus $20 million for the same period of 2011. The $4 million increase in interest expense resulted from higher debt balances associated with financings related to $370 million of new investments completed since July 1, 2011 and includes a full quarter of interest associated with the $400 million 5 7/8% bonds due 2024 that were issued in March 2012 offset by interest related to the March redemption of our then 175 million 7% bonds due 2016.

Turning to the balance sheet for the year. On June 29th, we paid $11.8 million to retire four mortgage loans guaranteed by HUD. The loans were assumed as part of the December 2011 purchase of 17 SNFs and had a blended interest rate of 6.49%. The payoff resulted in a $1.7 million gain on the extinguishment of the fair value of debt.

During the second quarter, we sold three held-for-sale facilities for total cash proceeds of $7.9 million and recorded a $2 million accounting gain. In March, we issued and sold 400 million 5.875% senior unsecured notes due 2024. Proceeds from this offering were used to tender or redeem our 175 million 7% bonds due 2016 and pay outstanding balances under our credit facility.

For the six month period ended June 30, 2012 under our equity shelf programs, we sold 759,000 shares of new common stock generating net cash proceeds of $16.1 million at an average price of $21.27 per share.

Under our dividend reinvestment and common stock purchase plan, we issued 3.2 million shares of our common stock generating net cash proceeds of $69 million at an average price of $21.52 per share.

For the three months ended June 30, 2012 our funded debt to total asset value ratio was 50% which is well within the maximum of 60%. Our funded debt to adjusted annualized EBITDA was 4.5 times and our adjusted fixed-charge coverage ratio was 3.3 times.

I will now turn the call over to Dan.

Dan Booth

Thanks Bob, and good morning everyone as of June 30, 2012 Omega had a core asset portfolio of 433 facilities distributed among 47 third party operators located within 33 states. Operator coverage ratio dropped off as expected during the first quarter of 2012.

Trailing 12 months operator coverage were only modestly affected. Trailing 12 months operator EBITDARM coverage was 2.1 times for the period ended March 31 compared to 2.2 times for the period ended December 31, 2011.

Trailing 12 months operator EBITDAR coverage for the period ended March 31 was 1.7 times compared to 1.8 times for the period ended December 31, 2011. As discussed previously, this drop in overall operator coverage is an expected temporary trend. As previous quarters benefiting from RUG-IV drop-off and are replaced by results which are effected by the 11.1% Medicare rate tax cuts.

While we anticipate modest reductions and coverage of the next two quarters as the RUG-IV results continue to drop-off. We fully expect overall operator coverage to remain and comparable to historical coverage ratios, pre-RUG-IV implementation.

Turning to new acquisitions, in the second quarter we completed two separate investments involving two of our existing operators. On June 29, Omega purchased four SNFs in Indiana for $21.7 million. The four facilities were added to an existing master lease with the Health and Hospital Corporation of Marion County. The four SNFs have 383 beds and generate an initial annual cash rent of $2.17 million.

The second acquisition involved a purchase of a single SNF located in Indiana for a total of $3.4 million. The 80 bed single asset facility was added to an existing master lease and generates an initial annual cash rent of $340,000. Year-to-date Omega has completed $46 million in new investments including capital expenditures.

While difficult to predict the timing of transaction closures, we fully anticipate achieving and possibly even exceeding our investment guidance of $150 million for the year. We currently have around entire $475,000 revolver available for new investments.

Taylor Pickett

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

Question-and-Answer Session

Operator

We will now begin the question and answer session. (Operator Instructions) And the first question comes from John Roberts of Hilliard Lyons.

John Roberts - Hilliard Lyons

On your acquisition run rate you said a $150 million for the year. You feel pretty decent about that, what your pipeline look like and what's the acquisition environment at this point?

Dan Booth

The acquisition environment is actually pretty bullish at this point. We feel very good about the $150 million as I indicated. I think well I feel very good, we will meet it and we will very likely exceed that number for the year. You know there are a number of deals out there I think the biggest issue is more timing than crossing the finish line.

John Roberts - Hilliard Lyons

And what timing are you looking at? I mean is it more likely to be back end loaded or do you have a lot on the plate to go right now?

Dan Booth

You know, there is such a lead time in these deals believe it or not and as you know we've done some deals historically where we have also assumed some hard debt which adds to that lead time. So it's hard to predict but I would have to say at this point in time that its a little spread out over the six months, it's probably back ended. It's not like you saw in 2001.

John Roberts - Hilliard Lyons

I am sorry.

Dan Booth

Much like we showed in 2011 where we had a number of deals towards the end of the quarter.

John Roberts - Hilliard Lyons

Cap rates with the property acquisitions you made in Q2 pretty consistent with what you are seeing now?

Dan Booth

Yes they are.

John Roberts - Hilliard Lyons

And what about dispositions?

Dan Booth

We have a couple of assets that are empty unlicensed facilities that will dispose off but it's, what does it Bob four assets?

Bob Stephenson

Yeah, two to three assets left in.

John Roberts - Hilliard Lyons

So there are not financial impacts there?

Dan Booth

Only the modest impact of adding a little cash to the balance sheet.

Operator

The next question is from James Milam of Sandler O'Neill.

James Milam - Sandler O'Neill

Just quickly can you just clarify for me the $46 million of investment year-to-date about $25 million of that was acquisitions and the rest is through the CapEx program, is that correct?

Dan Booth

That’s correct.

James Milam - Sandler O'Neill

And then Bob, just on the 700,000 of cash rent that’s on a cash basis, is that an incremental increase to the revenue line in the third quarter then?

Bob Stephenson

Assuming the operator follows through on their commitment that catches up, yes.

James Milam - Sandler O'Neill

And then that would be a run rate going forward?

Bob Stephenson

No, they basically missed the second quarter. So if they catch up in the third quarter as they've indicated, we’ll have a bump in the third quarter and then…

Dan Booth

It would normalize back out.

James Milam - Sandler O'Neill

Okay, so that’s the 700 that was kind of a decrease in the second quarter?

Dan Booth

Yes.

James Milam - Sandler O'Neill

Okay, got it. Thanks, and my third question is just, can you just kind of walk through sources and uses in the second quarter and then how are you thinking about them going forward? It just looks to me like you know you have the asset sales and you raised some equity through the drift on ATM but was the debt repayments and the acquisitions, I guess I am just curious how the balance sheet was funded and then what you guys anticipation is going forward especially with regards to additional equity?

Bob Stephenson

Yeah, right now the revolver is fully available of $475 million and that was our goal, given the fact that we have a lot of activity in the pipeline is to have the revolver fully available. And so in terms of sources, we’ll use the revolver to fund acquisitions and then depending on how quickly they come along and both dollar amounts and when they cross the finish line, we’ll then give some amount of equity in all likelihood to take that down but with $475 million available, you can run a lot on to that revolver without having to go to the equity market and I think any equity we do is going to be through our aftermarket program and through our optional merger plans. It’s just with what you saw.

James Milam - Sandler O'Neill

Okay and I like that; and then in the quarter just the debt repayments from the acquisitions those were funded partially with the ATM and what was just cash from operations; is that the other source?

Bob Stephenson

That’s correct.

James Milam - Sandler O'Neill

Okay, great. And then Taylor, my last one is kind of bigger picture and Dan may be you can speak about this as well, but as you look at towards the end of the year obviously you guys are very bullish on the potential for new deals, but I am just curious if you have seen any sellers such as maybe smaller or private owners that are becoming more interested in selling assets in advance with any potential backlog changes or if you have not really seen anybody changes behavior based upon that?

Taylor Pickett

I haven’t actually seen any changes in behavior, (inaudible) in October and come to us.

Dan Booth

So that’s really done in the dramatic shift in what we are seeing at then.

Taylor Pickett

We have had some yesterday, we have preliminary discussion about a modestly sized, where the discussion was we want to close by year end for taxes, but the first time that’s specifically came up in what we have been doing the last few months.

Operator

And the next question is from Tayo Okusanya [Omotayo Okusanya] of Jefferies.

Omotayo Okusanya - Jefferies

Yes, congratulations on the good quarter, a couple of questions. It’s now past July 1st, just kind of curious for fiscal year ‘13 what you are hearing in regards to Medicaid rates in some of the key states that you guys have a presence in?

Taylor Pickett

Our general sense is what we have talked about is generally stability on the Medicaid side and the Medicare side. Frankly, there are no states that we are looking at today where we have a major concern; I think Dan, do you have any?

Dan Booth

I think that’s right yeah you know other than what we have been seeing in the past on the certain states, for the most part we have exit those states, so there are no concerns on any specific states right now.

Omotayo Okusanya - Jefferies

Okay, so there are no states where you are looking out for like 5% to 10% cut or anything of that nature?

Dan Booth

No.

Omotayo Okusanya - Jefferies

Okay that’s helpful. And then on the acquisition front, again this is kind of like second year where your acquisitions have really been back weighted; I am just kind of curious is any kind of reason why that tends to happen and would you kind of expect that also to happen in 2013 as well where we have this rush of acquisitions between now and the end of the year and then things kind if cool off again?

Dan Booth

I think it’s just a coincidence and it’s just timing issue and that there is a lot of lead time on a lot of these deals and we certainly don’t plan on that now.

Taylor Pickett

It’s not seasonal on purpose.

Omotayo Okusanya - Jefferies

That is exactly like what I wanted to hear.

Operator

(Operator Instructions) We do have a follow-up question from James Milam of Sandler O'Neill.

James Milam - Sandler O'Neill

Hey guys; as long as you all are still here; can you just give out a little more color on that tenant and the reason behind why they are missing that payment in the second quarter and you know if that’s specifically to that tenant or something broader, just a little background for us please?

Taylor Pickett

Only specific of the tenant; the coverages from the operating perspective are fine, but the tenant has a stressed balance sheet which they have had for a while and they funded electronic medical records in all of their buildings with the excess cash flow that would otherwise go to pay rep; not a great choice from where we sit, but from a forward-looking perspective, probably the right thing to do and again so it is specific for that tenant, the coverage is there and we fully expect them to catch up our payment, but until we receive it, we are not going to book them.

James Milam - Sandler O'Neill

And I guess do you guys have any, did they have a conversation with you about that investment and then the subsequent short fall or is it kind of get you a little by surprise and so then you have conversation with them about don't let it happen again, something like that?

Taylor Pickett

It was more of the latter, I think they felt like they could manage their cash and will be able to make direct payment and it’s in the state of Arizona that there are Medicaid payments were slowed down and they were stopped. But again, they should have come to us obviously and they got themselves in a box and now we are working through.

Operator

And next we have a question from Dan Bernstein of Stifel Nicolaus.

Dan Bernstein - Stifel Nicolaus

Just on the pipeline, I just wanted to go more into the motivation of the sellers, do you think the Genesis on announcement help thaw the market or is there some other motivation aside from the capital gains tax issue that is motivating sellers to maybe approach you to sell their assets to you?

Taylor Pickett

I don't think the Sun-Genesis transaction has driven any of the other activity in the pipeline that we are seeing. I think it’s just a continuation of the sophistication required to run this business profitability, you know we have to change the Medicare, now we are seeing accountable care organizations come into a bunch of states; we are seeing states and think about how to deal with dual eligibles, all requiring additional sophistication.

And so it’s just a continuation of what we've seen for the last six or seven years is less sophisticated operators are looking for ways to exit the more sophisticated operators and the ones that can be profitable. And then of course you have the inevitable, just personal timing issues, you know, folks who have bought assets that are underperforming and turnaround and have decided to monetize. That’s really what we’re seeing, I think.

Dan Bernstein - Stifel Nicolaus

And are these marketed mortgage transactions or folks just approach you privately?

Taylor Pickett

Yeah, the deals that we end up with are almost always deals that people approached us right away.

Dan Bernstein - Stifel Nicolaus

Okay, and then one last question on that pipeline, is it mainly property acquisitions or you also getting proposals for you know mortgages, loans, redevelopment or development of assets, just trying to understand the tilt of that acquisition pipeline?

Taylor Pickett

The lion’s share is acquisitions say we expect price; you know, we see smothering up mortgages and a little bit of new construction, but that’s really with our existing operator base; and small compared to overall.

Dan Bernstein - Stifel Nicolaus

Okay and maybe one last question. In terms of the size of the portfolios, are you seeing any differences with what you are seeing today versus what you have historically seen and do you have any large or do you think there are any large portfolios out there you know that might be attractive?

Taylor Pickett

You know, our deals size is all over the place. You know, we haven’t done any gigantic deals that we’re seeing, deals that arrange for -- obviously we did $3.4 million deal in the first quarter, we’re looking at deals that you know are $100 million plus right now. So they're all over the place.

Dan Bernstein - Stifel Nicolaus

But typical size for what you've done in the past?

Taylor Pickett

Yeah, that will be correct.

Operator

And our next question is a follow-up from John Roberts of Hilliard Lyons.

John Roberts - Hilliard Lyons

Yeah, following up on Dan’s line of questioning; in listening to various people in the industry I have heard that, typically heard that sellers had been very reticent to sell and that they are asking basely too much for properties. Are you seeing sellers become a little bit more realistic in what they are asking for and a little bit more realistic in their willingness to sell?

Taylor Pickett

Our pipeline will be an indication of that; where it’s pretty active in our underwriting; we haven’t changed our underwriting standards or our view of the correct economics. So the fact that our pipeline is a lot more active to me indicates that sellers have become more realistic in terms of value.

John Roberts - Hilliard Lyons

And they basically are coming down with what they want to ask and it’s coming into your sweet spot so to speak?

Taylor Pickett

For right now, yes.

Operator

(Operator Instructions) Showing no further questions, we will conclude the question and answer session and I would like to turn the conference back over to Taylor Pickett for any closing remarks.

Taylor Pickett

Thank you for your help today, Laura. Thank you for joining the call, Bob will be available for any follow up questions you may have.

Operator

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

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