Care Capital Properties Inc. (NYSE:CCP)
Q4 2016 Earnings Conference Call
February 28, 2017 10:00 ET
Kristen Benson - EVP & General Counsel
Ray Lewis - CEO
Tim Doman - COO
Lori Wittman - CFO
Rich Anderson - Mizuho Securities
Andrew Suh - Green Street Advisors
Dana Hambly - Stephens Inc.
Good morning and welcome to the Care Capital Properties Incorporated Fourth Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Kristen Benson, Executive Vice President and General Counsel. Please go ahead.
Thank you Gary, and good morning. Before we begin, please note that any comments made during this conference call that are not historical facts may be considered forward-looking statements within the meaning of the Federal Securities laws. These forward-looking statements are based on management's current beliefs and assumptions regarding future events and involve various risks and uncertainties, which may cause our actual results to differ materially from expectations.
Please see our report filed with the Securities and Exchange Commission including our most recent Annual Report on Form 10-K for a discussion of factors that could cause our actual results or events to differ materially from those described in the forward-looking statements. Many of these factors are beyond the control of CCP and its management.
The information we provide today speaks as of this date only and management expressly disclaims any obligation to publicly release any updates or revisions to forward-looking statements to reflect changes in expectations. Quantitative reconciliations between each non-GAAP financial measure discussed on this call and its most directly comparable GAAP measure, as well as our supplemental disclosures are available under the Investor Section of our website at www.carecapitalproperties.com.
I will now turn the call over to Ray Lewis, our Chief Executive Officer.
Thank you, Kristen. Good morning and welcome to the Care Capital Properties fourth quarter 2016 earnings call. After my opening remarks our Chief Operating Officer, Tim Doman; will provide you with an update on the portfolio followed by our Chief Financial Officer, Lori Wittman; who will go through our financial results and 2017 guidance in detail.
CCP delivered strong results in 2016 with full year normalized FFO per share coming in at $3.05. These results exceeded the high ends of our guidance which we raised twice as we moved through last year. The primary drivers behind the better and expected results include the timing and outcomes of our balance sheets, refinancing portfolio optimization activities. This outperformance enabled us to pay attractive dividends at $2.28 per share which offers an approximately 9% yield at our current valuation and represents a very security ratio of 75% on our 2016 FFO.
We accomplished all of this while strengthening our balance sheets, locking in rates, implementing a well staggered maturity schedule with no near term maturities and maintaining low leverage. I would like to take a moment to recap some of our important accomplishments in 2016. At the beginning of last year we laid four strategic priorities for the company. Migrate to a permanent capital structure, optimize the portfolio, build out our standalone infrastructure and make value enhancing investments.
I am pleased to say we not only delivered on each priority but in some instances we exceeded our expectations. First, we completely constituted our debt profile by refinancing our fixing rates on $1.2 billion of the $1.4 billion of floating rate bank debt we put in place with the spin. We were nimble and flexible, taking advantage of the best terms by accessing multiple sources of capital, including unsecured bonds, private placements, SWAP's and bank term debts.
At year end, 84% of our debt was fixed rate. Our weighted average maturity was 6.4 years and our weighted average interest rate was 3.8%. Second, we significantly improved our portfolio by investing $38 million in development or redevelopment of our asset and disposing of $124 million of non-strategic real estate. We strengthened our strategic relationships by re-positioning assets and restructuring certain of our leases. Additionally as of the end of the fourth quarter we have completed approximately $10 million of annual optimization that we introduced at the beginning of last year and at this point we are not anticipating any additional optimization in 2017.
Third, we invested in and built out our standalone infrastructure of people, processes, systems and tools. We successfully matriculated off of our transition services agreement with Ventas and relocated to our new corporate office. Finally we invested $61 million in new transactions with our preferred operators and while we would have liked to done more, we remained disciplined and thoughtful in our approach. In December, we executed on a $39 million sale leaseback of Seven Skill Nursing and Senior Housing properties with the preferred customer Velco. This off-market transaction was brought to us exclusively by Velco who knew that we could deliver a fair deal, quickly and efficiently. So we are pleased we delivered on each of our four strategic priorities in 2016 and now that we have our balance sheet and infrastructure firmly in place, our full attention will be focused on maximizing the value of our existing assets and on executing targeted value enhancing investments.
While 2016 was a productive year for the CCP the results of the broader skilled nursing industry was more mixed. The reimbursement environment was positive as Medicare service rate increased 2.4% in the 2017 fiscal year beginning in October. Medicare reimbursements were also positive with rates increasing upon 2% on average while some states like Oregon, Minnesota, Ohio and Kentucky saw significantly better rate growth. In addition, many of our operators who participated in the bundle payment programs were able to realize gain sharing revenues. However, the positive rate environment was offset by difficult labor markets, increasing lengths of stay, increasing regulatory pressure and a challenging professional liability environment in certain states. As a consequence, occupancy margins came under pressure industry wide, especially in the first half of the year.
As we look forward into 2017, many of our operators have moved aggressively to address the dynamic market changes. For instance, they have adopted to the tight labor market by increasing trainings, enhancing retention efforts and introducing flexible staffing models and decreasing the use of agency staff. This is how the operators get their labor utilization staff turnover under control but we expect the low healthcare unemployment will continue to put pressure on the wages for the foreseeable future.
On the payover side, managed care penetration has been moderating and bundled payments are expected to be implemented more deliberately under republic and administration. This should help to slow the overall rate of decline and lengths of stay. However, in markets where managed care and ACO's are prevalent providers will be continued to be pressured by reduced lengths of stay and hospital readmissions.
With respect to regulatory enforcement activity, it remains to be seen, what impact the new administration would have. However, we are hopeful that the overarching goal of reducing the burden regulation will trickle down to the healthcare industry. So the external environment, while still challenging, will hopefully begin to improve in 2017. But regardless of the environment, our operators will need to focus on strong pair and referral relationships delivering quality and managing efficiently until the favorable demographics kick in until the end of the decade.
As CCP heads into 2017, we are intent on building on the momentum that carried us through our first year as a public company and growing cash flow through investing in our portfolio and acquiring new assets. The acquisitions market has picked up dramatically and is being driven by growing imbalance between supply of capital for skilled nursing and the demand for it.
Many of the traditional lenders and larger REIT [ph] investors have either reduced their appetite for skilled nursing or left the market altogether. At the same time, there is increasing consolidation amongst operators in local markets which is driving transaction activity. As a consequence, our pipeline is larger than at any time in the last 18 months. Not only are their abundant opportunities in skilled nursing but we are looking at transactions in other complimentary structures as well. So while we will continue to be disciplining our under-writing, thoughtful in our pricing and selective in our operating partners, we are encouraged by the number of attractive opportunities that we are uncovering and evaluating.
In summary, CCP made tremendous progress in 2016 and with our experienced leadership team, strong balance sheet, enhanced portfolio, robust pipeline and well-built infrastructure, we are positioned to drive additional value in the coming year.
With that, I will turn the call over to Tim to discuss the portfolio.
Thank you, Ray. Our portfolio of 345 properties in 36 states is another consistent quarter of results. Our diversified portfolio remains balanced across markets with roughly half of the properties within the top 99 markets and Q-Mix remains stable at 55% through the third quarter of 2016. Cash NOI for 286 store properties increased 1.6% for the full year 2016 compared to the full year 2015.
Excluding the portfolio that transitioned in March 2015, as previously disclosed, our full year cash NOI growth would have been 2.2%. Portfolio coverage has declined slightly in the third quarter of 2016, the latest available tenant reporting period. Our EBITDARM and EBITDAR coverages were at 1.7 times and 1.4 times respectively. Our occupancy and licensed beds remained at 78%. Our transition to lease-up portfolio defined as properties that have transitioned to new operators over the last 18 months totaled 32 properties up 3 properties from 29 properties in the prior quarter. TTM EBITDAR coverage in the transition of lease-up portfolio was 0.9 times for the third quarter.
Turning to the heat map on Page 10 of the supplemental, we had four leases move-into and one lease move-out of the under one times EBITDA coverage range. As we have previously mentioned it is typical for leases to move-in and out of coverage ranges at the margin. Based on improvements of the recent performance we anticipate that approximately half of the NOI that was under one times EBITDAR coverage as in the third quarter will move out of this window when we report fourth quarter coverages.
Turning to redevelopment, we continue to enhance our portfolio to invest in capital at an attractive return to boost the competitiveness of our assets. We currently have 16 redevelopment and development projects underway or approved totaling $100 million. Last year, we funded approximately $38 million of these projects at an average yield of 8.5%. On the disposition front during 2015, we sold 18 facilities totaling approximately $124 million at a weighted average cap rate of 8.1% and net gain of approximately $3 million was realized. In addition, we expect to sell approximately $175 million worth of properties currently under contract during the first half of 2017. We continue to pursue opportunities to recycle capital in our portfolio and will update you on any activities throughout the year.
In summary, our diversified portfolio of quality post-acute properties delivered another strong cash flow as we successfully negotiated the industry head winds that are operator spaced. We made significant progress positioning our portfolios with quality operators that are well situated to succeed in the forward looking environment. This along with new acquisitions and selective dispositions, position the portfolio to deliver continued strong results.
With that I will turn the call over to Lori to discuss our financial results.
Thank you, Tim. I am pleased to share that strong results were produced in 2016 and introduce guidance for 2017. First our fourth quarter numbers. In the fourth quarter NAREIT FFO was approximately $62 million or $0.74 per fully diluted share compared to approximately $55 million or $0.65 per fully diluted share in the third quarter.
The increase is primarily due to the gain on the acceleration of lease intangibles. The normalized FFO in the fourth quarter was approximately $59 million or $0.71 per fully diluted share. This is down from the third quarter normalized FFO of approximately $63 million or $0.75 per fully diluted share. The decrease is due to the receipt in the third quarter of past due rent from previously transitioned tenant and $2 million short term rent referral for one tenant in the fourth quarter.
As ray mentioned during the fourth quarter we acquired the portfolio of 6 properties for $36 million at an initial cast shield of 8.5%. The portfolio was acquired and leased back to an existing tenant and there is one additional building for $3 million that is expected to be closed in the first quarter of 2017. We had total non-cash impairments in the quarter of $3.9 million. Of that total $3.6 million was associated with the non-cash impairment to goodwill taken on our valuation subsidiary.
There was a net decrease in two facilities in assets held for sale which now totals 30 properties. Four properties previously held for sale were moved back into held for use and two properties now under contract for sale were moved in. For the full year ending December 31, 2016 our normalized FFO totaled approximately $255 million or $3.05 per fully diluted share exceeding the high end of our guidance range. This compares to approximately $286 million or $3.42 per fully diluted share for the year ending December 31, 2015.
The difference is primarily due to interest expense. As a reminder the company had no debt until August 2015. The increase in interest expense of approximately $38 million is partially offset by an increase in revenue. NAREIT FFO for the full year ending December 31, 2016 was approximately $245 million or $2.92 per fully diluted share compared to approximately $277 million or $3.31 per fully diluted share for the year ending December 31, 2015.
Similarly to normalized FFO, NAREIT FFO for the year was impacted by additional interest expense. Normalized FFO for the full year 2016 totaled approximately $250 million compared to 2015 FFO of $259 million. Adjusted EBITDA for 2016 totaled approximately $312 million, an increase of 3.3% over 2015's adjusted EBITDA of approximately $302 million.
The increase in adjusted EBITDA is primarily due to the growth and revenues from new investments completed in 2015 and 2016, escalations and a full year of income from our valuation subsidiary. Cash flow for the year was very strong at $53 million after non-revenue producing capital expenditures and adjusting for four quarters of dividends. At year end our leverage was 4.5 times net debt EBITDA without the fourth quarter dividend and 4.7 times including it.
Our liquidity was excellent with $576 million available under our revolver. Our weighted average maturity is now 6.4 years at a weighted average interest rate below 3.8%. Our fixed charge coverage is exceptional at 7 times. Subsequent to year-end, we entered into a new lease at eleven facilities whose leases expired at year end. Additionally, we restructured one lease with an existing tenant. The net impact of these activities would be approximately $5 million in 2017.
Between these two transactions and transitions inclusive of the $2 million rent referral, we have utilized the full $10 million in reduced annual revenues due to portfolio optimization activities we discussed last year. Prior to turning to guidance, just want to say something about the effort of our entire company in successfully completing our facts implementation. These processes are extremely time consuming, arduous and involve almost everyone in the firm. We completed our first internal controlled audit with exceptional results and I am grateful for the work and dedication of the company to get this accomplished.
We are pleased to introduce guidance for 2017 with a range of normalized FFO of $2.80 to $2.90 per fully diluted share. The range for NAREIT FFO is $2.73 to $2.83 for fully diluted share. The major assumptions underlying our guidance are as follows: dispositions of approximately $175 million at an average cap rate of 9.5% occurring in the first half of the year. At positions comprised of reinvesting the disposition proceeds at an average cap rate of 9%, closing in the second half of the year. Redevelopment capital of approximately $20 million at an average GL's of 8.2% and non-yielding capital expenditures of approximately $1.2 million.
No new equity or debt raises during the year and as a reminder we will have a full year of interest expense based on our permitting capital structure. So interest expense is projected to be approximately $9.5 million above 2016's actual interest expense. We will have slightly higher corporate G&A and breakeven performance in our specialty valuation subsidiary. Our consent range primarily results in the uncertain timing of both the acquisitions and dispositions. As we go through the year we will keep you informed and adjust our guidance as appropriate.
With that I will turn the call back over to Ray.
Operator, we will now take questions.
We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Rich Anderson with Mizuho Securities. Please go ahead.
Thanks. Good morning and good quarter. So can you give me some explanation why you are so, you sound so confident that the under one coverage grouping will be half as much this time next quarter?
Yes I think as much we look at and talk about some of the factors that impacted our operators particularly in the first half of the last year, around staffing and expenses, we have seen that moderate as we head into the second half of last year so as we start dropping off some of those more difficult quarters at the end of 2015 and the beginning of last year and based on the current trends we are seeing, we think that that will improve the coverages in our portfolio in the near-term.
Okay. And then to be clear, there is no crossover between transitioned assets and the sub one coverage assets. So there are two different, distinct sets of properties?
Yes when you look at the heat map, Rich you will see, that we break out the assets that are in transition so.
Oh, I see okay. Lori, you said $5 million net impact from finalizing the optimization process and no more beyond that. Except when I look at the portfolio snapshot, you still have a couple of large operators that are sub one on ADAR basis, can you explain what that is about or is that still backward looking and hence not affected yet by the transition process?
Yes, so couple of things Rich, first the $5 million I talked about was for two tenants so when you look at an annual run rate for the optimization, if you will, so that's $8 million. That includes what we did in 2016 and then what I just talked about the two leases. But to answer your second question, yes it is backward looking so doesn't reflect.
Fine, so we should see two in particular stand out that are below one that are different numbers starting when you report next year, next quarter.
Are you looking at the heat map Rich or?
I am looking at Page 8, top tenant statistics star coverage of 0942 of your top five tenants.
Yes, so Windgate which is a really good operator of ours in the NorthEast, they are well connected in all the major networks and they are very well positioned. Their drop was driven by a decrease in rate and occupancy and they also had some labor and staffing pressures. But they are working at recovering that occupancy inside this going forward, they re-hired the VP of Marketing to further strengthen their hospital relationships and they've also put together a staffing company which has really helped reduce agency use. I think we will see some slight pressure through 2016 but in 2017 we are expecting improvements going forward throughout the year.
And then the other thing I think I would point out about Windgate is, there's other sources of profitability, there's ancillary businesses in senior housing assets, that are outside of our portfolio that also help support the rent payments. And then Signature, another good quality of operator of ours. They are strong culturally, vertically integrated. Several ancillary businesses, they are well connected and an active participant in the value based reimbursement programs. They are just more expense driven. But what we have seen is that they have gotten some really strong good pickups in rate in Kentucky, Ohio and North Carolina in particular. San Francisco [ph] is trending positively and they address their staffing and labor issues and we are expecting them to move out of that under one bucket next quarter when we report.
Okay. So none of that optimization that you referred to, Lori, has anything to do with those two?
Okay, last question for you Ray, you mentioned complimentary sectors in your pipeline. Can you just give us a bit more color on what is most complimentary to skill nursing?
Thank you Rich, glad you asked that. So we are looking at you know, a lot of stuff right now. I think you know, for the reasons that we talked about earlier is skilled nursing pipeline is pretty full but there is a lot of other sectors that are adjacent to and if not complimentary to skilled nursing, we are still looking at. Some examples would include behavioral psyche, geri-psyche you know, juvenile psyche, addiction and those sorts of things which are also highly fragmented industries. Tend to have a little bit better margin and definitely have favorable political tail lands. So, those are the types of assets that we think are pretty interesting and you might see us into in the future.
Okay, great. Thanks very much.
Thank you, Rich.
The next question comes from Michael Knott with Green Street Advisors. Please go ahead.
Good morning everyone. This is Andrew Suh calling for Michael Knott. On coverage, it looks like senior housing EBITDA coverages for the total portfolio declined 10 bips this quarter; could you provide some color on this business side?
Yes, sure, thank you. I think if you look at senior housing, it's a very small pool of assets. Those are typically -- well, in every circumstance part of a larger master lease with some skilled nursing assets and so you know, if you have movement in one property or another it's going to potentially move you up or down a tenth of a basis points in those - in that category just because of this year's small size of it.
Okay. And in your prepared remarks, you have mentioned robust pipeline, can you comment a little on the market lease that you see on this pipeline and how you plan to fund your acquisitions?
Yes, sure. So with respect to the first part of that question and Leefield, skilled nursing Leefield we have been underwriting it around a nine Leefield, but we think that that's probably going to move up particularly given the amount of activity in the market place you know, the opportunity to be selective. And then if you look at other asset classes like obviously senior housing, they're going to be you know, below that so that's sort of what we're seeing in the market place right now.
And to answer the second part of your question, we do have these positions that are under contract for $175 million so our plan is to recycle those proceeds, we are looking at the potential of other dispositions as Tim mentioned in his remarks, we also have free cash flow and we have room in our leverage sets to move up if we need to based on acquisition volumes.
Okay, thank you.
The next question comes from Dana Hambly with Stephens. Please go ahead.
Good morning. Ray, just follow-up on your comments on the psyche industry, the second REIT [ph] that we are aware, to talk about that this quarter, can you just give us some details on what kind of cap rate you see there, are there portfolios available or is that more kind of one off stuff that you would be looking into.
Sure. We think the behavioral industry is kind of interesting because it looks a little bit like the skilled nursing industry from a supply demand perspective in that you know, there is a lot of demand you know, the policy tailwinds, our behavior are favoring more reimbursement for behavioral as a preventative measure against you know, some of the pipe profile instances that have happened in recent times. I think you know, as we look at the industry though, there is not a lot of product out there. It tends to be relatively fragmented and so it's a good opportunity for investors like us who want to help smaller, well positioned operators you know, invest and grow in their local markets.
Cap rates for those assets, they trade a little bit better I would say than hospitals and have been pretty particularly when you start moving into you know, the acute psychiatric or addictions space, they have been trading pretty strong. Leefield will probably be better than the skilled nursing Leefields in terms of slightly lower. Primarily because they have much stronger margins and better tail lands behind the industry generally in that range.
No, it's very helpful, I appreciate that. Just looking at the Q mix by the market type, it looks like in the top 31, sequentially with a pretty big decline I think it was up on the other two market, is that fair to say that most of those facility they are more impacted by other bundled payments and other CJRs and these other demonstrations.
You know, I do think you will see in the major metro areas more impact from managed care and from bundled payments and ACOs so I think that is a general statement is true. I don't know specifically that if I can extrapolate that to you know, to what you are seeing in the portfolio.
Okay, alright, fair enough. And then couple of the operators had some comments, couple of different states for their big for E1; Texas with the UPL Program coming to a halt and then Kentucky, I think the outlook is for more favorable toward reform; possibly any comments on either one of those states?
Yes, I mean with respect to Texas, I think the operating environment is generally stable. Most of our operators have been able to adapt to the Managed Medicaid and Dual eligible program that came in in the second half of last year. Most observers are not projecting rating freeze in the current biannual session, but there are some positives. I think in particular the potential implementation of bad taxes, there is an ITT program that's back on the table and a number of our operators are looking to participate in that. And then I think there is a pretty good likelihood of a building moratorium [ph] being enacted so I would say Texas has a pretty stable environment with some good things coming in the near term. On Kentucky side, I think you are right, there were number of very positive developments in Kentucky with medical review panels and towards reform center gaining significant momentum now that they have -- you know, an entirely republican house in Kentucky.
In addition, there were some other rate benefits that our operator saw with urban wage increases and some pretty decent Medicaid rates in the state of Kentucky so you know, that operating environment is looking better and I think you know, it's causing some of the folks who were maybe looking to exit that state, reconsider that alternative.
Okay, thanks very much.
[Operator Instructions] At this time I'm showing no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Ray Lewis for any closing remarks.
Great, thank you Gary. And thank you to all of you who joined us for our call today. We look forward to catching up with you at the upcoming conferences and continuing our dialogue. And thank you for your continued support. Have a great day.
The conference is now concluded. Thank you for attending today's presentation, you may now disconnect.
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