CareTrust REIT, Inc. Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to CareTrust REIT’s Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now turn the conference to your host, Ms. Lauren Beale, CareTrust Controller. Ma’am, you may begin.

Thank you, and welcome to CareTrust REIT’s second quarter 2020 earnings call. Participants should be aware that this call is being recorded, and listeners are advised that any forward-looking statements made on today’s call are based on management's current expectations, assumptions, and beliefs about CareTrust’s business and the environment in which it operates. These statements may include projections regarding future financial performance, dividends, acquisitions, investments, returns, financings, and other matters and may or may not reference other matters affecting the company’s business or the businesses of its tenants, including factors that are beyond their control, such as natural disasters, pandemics such as COVID-19, and governmental actions. The company’s statements today and its business generally are subject to risks and uncertainties that could cause actual results to materially differ from those expressed or implied herein. Listeners should not place undue reliance on forward-looking statements and are encouraged to review CareTrust’s SEC filings for a more complete discussion of factors that could impact results as well as any financial or other statistical information required by SEC Regulation G. Except as required by law, CareTrust REIT and its affiliates do not undertake to publicly update or revise any forward-looking statements where changes arise as a result of new information, future events, changing circumstances, or for any other reason. During the call, the company will reference non-GAAP metrics such as EBITDA, FFO, and FAD, and normalized EBITDA, FFO, and FAD. When viewed together with GAAP results, the company believes these measures can provide a more complete understanding of its business but cautions that they should not be relied upon to the exclusion of GAAP reports. CareTrust filed its Form 10-Q yesterday along with its accompanying press release and its quarterly financial supplement, each of which can be accessed on the Investor Relations section of CareTrust’s website at www.caretrustreit.com. A replay of this call will also be available on the website for a limited period. Management on the call this morning includes Bill Wagner, Chief Financial Officer; Dave Sedgwick, Chief Operating Officer; Mark Lamb, Chief Investment Officer; and Eric Gillis, Vice President of Portfolio Management and Investments. I will now turn the call over to Greg Stapley, CareTrust REIT’s Chairman and CEO.

Thanks, Lauren, and good morning, everyone. While the resurgence of COVID-19 has been difficult on multiple fronts, there are some bright spots out there that we are talking about. First and foremost, we are grateful to be able to report that our tenants and their staff are working through it, thanks in part to the government relief measures provided to date. Our skilled nursing tenants are earnestly caring for their patients and otherwise holding up well. We are also encouraged by the recently commenced federal rollout of point-of-care rapid results testing to nursing homes nationwide. The government is reportedly delivering 600 to 700 testing platforms a week, with an eye to getting them into all of the nation’s 15,000 nursing facilities as quickly as possible. Several of our facilities are near the top of the distribution list. This has been a giant missing piece in the infection control puzzle in the nation’s inpatient care facilities. Short of having an effective vaccine, point-of-care rapid results testing is likely to be the biggest advance in the ongoing war against COVID-19. Real-time testing in places where so many of our most susceptible citizens reside should begin saving lives immediately. We hope that senior housing facilities will be next in line for these testing capabilities too. We also hope that the government will move to protect even more of our vulnerable elderly by including senior housing providers in the next round of stimulus support. As for CareTrust tenants, you'll recall that about 85% of our rental revenue comes from our skilled nursing assets. Our SNF operators and their care staffs are working hard daily to keep their heads above water while protecting our vulnerable seniors. They are getting better at it every day, as more is learned about COVID-19 and as more resources become available to aid them in the fight. In addition to the state and federal relief dollars, the regulatory relief provided has been immensely helpful. The suspension of the three-day qualifying stay for Medicare eligibility is the most prominent example. Hopefully, this highlights the fact that the 'stroke of the pen' risk that some in the credit community have over is actually a double-edged sword. Yes, the lion's share of SNF revenues coming from government sources means changes in policy or reimbursement rates can hurt providers, at least until the providers adjust, which usually happens pretty quickly. But if the government’s response to this pandemic proves anything, it’s that both state and federal officials understand and are fully committed to the long-term health and economic survival of post-acute care as a truly essential industry. That is an undeniable plus in difficult times like these, not to mention the fact that the government is the most financially capable customer any business could have, especially when economic conditions are most challenging. So while we don’t want to project an 'everything’s fine' message, everyone knows that everything’s not fine. We also don’t want to convey doom and gloom either. Having been in the operating trenches ourselves and seeing the hard work and significant resources being devoted to the fight, we believe our providers are well-positioned to continue weathering the storm in the near term. As for CareTrust itself, I’m pleased to report that we remain in great shape. We collected 99.3% of rents from April through July, and August rent collections are on track and continuing to come in as expected. We have the lowest leverage in company history today at 3.1 times net debt-to-EBITDA at this moment. Interest costs on the little bit of floating rate debt we do have are at historic lows, and we have no debt maturities on the horizon before 2024. Our $600 million revolving credit line is undrawn, and we have around $20 million in cash on hand. Plus, our conservative payout ratio leaves us with a sizeable chunk of very cheap capital that we can invest at solid returns. All of these funds are fully available to support our opportunistic growth strategy without raising a cent in new debt or equity unless we want to. Speaking of investments, although the pandemic has put a crimp in M&A activity over the past few months, we expect to start announcing new investments again very soon. With that, I’d like the team to briefly talk about our results for the last quarter, as well as our thoughts on the next couple, and then we’ll open it up for Q&A. Dave?

Thanks, Greg. I want to pick up where I left off from our last quarter's call. So first, regarding the COVID impact. As of this week, we have 59 facilities across 15 operators reporting at least one positive COVID patient. However, as you may recall, we have viewed a running COVID count as misleading due to inconsistency in testing practices and the initial unavailability of universal testing. We believe the early reports of positive cases with high mortality rates were grossly inaccurate. This has proven correct with broad testing now finding high numbers of asymptomatic positive cases and less lower mortality rates. But it’s still an especially serious threat to vulnerable seniors and those with preexisting conditions. Thankfully, all of our operators today report a higher degree of preparedness with personal protective equipment and continuing confidence in their infection control and isolation protocols. So even though the virus is more widespread today than a few months ago, the industry is actually in better shape to deal with it. Next, let me address occupancy. Although a recent report from the National Investment Center stated that seniors housing occupancy dropped nationally by 280 bps from Q1 to Q2, I’m pleased to report that from March through July, seniors housing occupancy in our portfolio held steady. This reinforces our long-held view that the mid-market positioning of our seniors housing facilities appears to be more needs-based, as prospective residents have not been able to move in or wait out the pandemic on their own. On the skilled nursing front, occupancy has declined. We’ve said it before, but it bears repeating, any analysis of nursing home occupancy has to bifurcate the short-term rehab or skilled patients from the long-term care residents. Those skilled patients represent higher revenue and margin and offset to a degree declines in overall occupancy. Not including Ensign, our overall skilled nursing portfolio occupancy drops 684 bps, or almost 9%, from March through July, but the higher margin skilled occupancy increased 571 bps, or almost 37%, over the same period. The additional skilled revenue provides a meaningful partial offset to the overall occupancy loss and increased expenses associated with COVID. I’m also happy to report that portfolio-wide, the June and July occupancy trend in our skilled nursing facilities is showing a significant leveling off of the initial downward curve from census. As people get out more and hospitals continue to slowly reopen for elective surgeries, we expect census to start rebounding. I’ll shift gears now to focus on the government relief measures thus far. In addition to the positive revenue and infection control benefits from the waiver of Medicare's three-day qualifying stay requirement, direct payments to providers have been critical in providing the short-term liquidity bridge that most of them have needed. The Families First Coronavirus Response Act provided states with a temporary 6.2% increase in Federal Medical Assistance Percentages, or FMAP, for their Medicaid programs. Many states increased skilled nursing Medicaid rates with those FMAP funds, and we believe more will do so. Our updated estimate of the impact to our SNF tenants from the additional FMAP funding is approximately $21.1 million through July. There’s also the CARES Act and its several components. The first three rounds of CARES Act disbursements plus the lifting of sequestrations account for an estimated benefit to our SNF tenants of approximately $86.5 million so far. Although one of our tenants announced on Wednesday that they are not going to need the CARES Act fund and that they have refunded their share of it to the federal government. Thanks to these emergency measures, as well as the speedy adjustments our tenants have made, liquidity has been sufficient for our operators, providing necessary runway for the fundamentals to recover as everyone works through this. We should mention that in addition to those funds, CMS announced on July 31 a 2.2% increase to Medicare rates starting with the new October 1 fiscal year, resulting in an estimated $750 million in additional revenue next year for the sector. Now, of course, there’s intense interest in the future of COVID’s impact on the industry. How long will the state of emergency last? Will the government funding be sufficient? Our belief from day one has been and continues to be that skilled nursing is a necessary component of the continuum of care and that state and federal governments will not allow the industry to fail. We can’t predict how long the recovery will take. But there are four milestones that we’re tracking to judge how close we’re getting to turning the corner on COVID. The first milestone is clinical capability. That includes several key elements. Like Greg talked about, we need point-of-care rapid result testing solutions at all skilled nursing and seniors housing facilities. We’re pleased to see this starting to happen now. Also included in clinical capability are the continued advances in therapies for treating patients infected by the virus. The second milestone we monitor closely is government funding. A fourth round of funding for nursing homes was recently announced for $5 billion. We have yet to see exactly how it will be distributed, but all indications are that it will be more targeted toward those in greatest need. One of those significant and immediate needs is in private pay seniors housing, which has only barely begun to get attention from lawmakers. CareTrust has recently made a significant contribution on behalf of our seniors housing operators to the lobbying effort underway to educate legislators on the critical need for relief funding for private pay seniors housing operators. The success of this effort is critical for the nation’s seniors and the people who serve them. The third milestone we’re watching is hospital volumes, both through the emergency department and elective procedures returning to pre-pandemic levels. Recently, the CDC reported that by the month of May, emergency department visits declined by 42% from pre-pandemic levels. In the 10 weeks following the declaration of the national emergency, visits by people over the age of 75 for heart attack dropped by approximately 28%, and for strokes by 24%. The recent resurgence of COVID may extend that trend. The fourth milestone, of course, is the vaccine. We’re encouraged by the aggressive efforts by the industry and the FDA to bring an effective vaccine to market in record time. Some of these milestones will be met simultaneously across the industry and others will be operator and market-specific. To wrap up, we continue to be proud of our association with people and companies who are managing so well through these extraordinary circumstances. As I said last quarter, as we weigh the current challenges along with the support provided to date, we continue to see a path forward for our operators to continue to care for their residents, keep their caregivers employed, and pay their rent as they fulfill their role as a critical part of the solution to this crisis. With that, I’ll pass the call over to Mark to discuss investments.

Thanks, Dave, and hello everyone. On the investment front, Q2 was relatively quiet for us from a closing perspective, but it wasn’t due to a lack of effort. We continue to be open for business, looking for external growth opportunities that work for our operator bench as well as for us. Deals that we chased that fit our guidelines were either mistimed or mispriced. Perhaps that’s why one industry publication reported this week that healthcare M&A for Q2 was the lightest ever, much of it being in Europe rather than in the U.S. The pricing reset that one might logically expect in the current environment has been slow to materialize, at least on the seller side. This is not unusual in our experience, and we continue to push sellers for realistic pricing while at the same time acknowledging that buyers must be competitive too. But as you might imagine, the price discovery process is more unpredictable than ever right now. We are sticking to our underwriting standards while we continue to aggressively pursue deals, even as we attempt to adjust on the fly for the uncertainties posed by the ongoing pandemic. In addition to historical cash flows and other underwriting metrics we would normally consider, there are additional factors that have lately come into sharper focus in our underwriting. This includes the strength or weakness in the operating profile of the outgoing operator. Are they too large or too inefficient to respond quickly to the rapid changes affecting the business? Or are they too small or too unsophisticated to maneuver through today’s changing environment? We’re looking harder at skilled mix, average daily reimbursement rates, and how well current operators are capturing revenue opportunities. We’re analyzing their staffing patterns and other operating expenses for evidence of under-management that can easily be corrected. Perhaps most importantly, we’re looking very hard at our incoming operators and their plan for the assets. Does it enhance their economies of scale? How much and how fast do we think they can change the operating profile of the asset through the execution of their business plan? And what evidence do we have of their operational history that they are likely to succeed? That’s an oversimplification of the process, but hopefully, you get the idea. Plus, after we factor in all of the above, at the moment, there are still COVID-related headwinds that we must account for, which is tricky but not impossible as evidenced by our pipeline, which I’ll discuss in a moment. Thankfully, the current investment scene has begun to show signs of life in recent weeks. There appear to be more senior housing opportunities, though they are still largely composed of mostly broken or non-stabilized assets. There are some SNF operators that seem to be finally seeing a window of opportunity to exit the business, though many of those assets are challenged as well. However, we continue to dig through the opportunities and mine for the diamonds in the rough. Despite the challenging bid-ask spread, we are cautiously optimistic that we will see and be competitive on more opportunities as we head toward the end of the year. As a reminder, year-to-date, we’ve executed on $26 million in new investments. The current pipeline sits in the $125 million to $150 million range. It consists mainly of singles and doubles in both the SNFs and seniors housing spaces. Our pipeline also includes a few portfolio opportunities that will not only strengthen existing tenant relationships but will also allow us to further diversify our tenant base by commencing former relationships with longstanding operators that we’ve been courting for some time. Please remember that when we quote our pipeline, we only quote deals that we are actively pursuing under our current underwriting standards, and only if we have a reasonable level of confidence that we can lock them up and close them in the relative near term. And now, I’ll turn it over to Bill to discuss the financials.

Thanks, Mark. For the quarter, normalized FFO was $32.1 million or $0.34 per share, and normalized FAD was $33.6 million or $0.35 per share. At the quarter's end, our payout ratio remains at or among the lowest of our peers at approximately 74% on normalized FFO and 71% on normalized FAD. Leverage was at an all-time low on a net debt-to-normalized EBITDA ratio basis of 3.2 times, and net debt to enterprise value was 23%. During the first quarter, we put in place a new $500 million ATM and a $150 million stock buyback plan. Neither has been utilized to date. Our liquidity remains extremely strong, with more than $20 million in cash on hand today, even after having recently paid $8 million of semi-annual interest on our bonds and $24 million of quarterly common dividends. We also have $600 million of availability under our revolver, and we produce almost $9 million of cash per quarter even after this year’s increase in our dividend. To give you an idea of just how much liquidity we have, if we were to acquire roughly $300 million of assets per year over the next two years at yields approximately what we have done historically and funded those investments exclusively with our revolver while retaining cash, we would still be just under the high end of our stated target leverage range of 4 to 5 times on a debt-to-EBITDA basis. Cash collections for contractual cash rent in July were just under 99%, and so far in August, they are at 93%. We expect to end August collections at around 99% as well. Moving on to guidance, despite the pandemic, we see no reason at present to alter our guidance for 2020, which has a reminder called for normalized FFO per share of $1.32 to $1.34 and normalized FAD per share of $1.38 to $1.40 based on a diluted weighted average share count of 95.6 million shares. With the year more than half over, let me update you on some of the assumptions that were used in that guidance. Rental revenues were projected at approximately $167 million for the year, which included $100,000 of straight-line rent, and assumed CPI at an average of 1.75%. CPI bumps for June and since have been around 50 bps. So, not including any new investments we might make in the back half of the year, I’m expecting rental revenues to be a little less than $167 million for the year. Interest income was projected to be around $1.3 million. Given that interest income is already at $2.3 million for the first half of the year, but all the material loans have now been paid off, I wouldn’t expect interest income for the year to go much higher. We used the proceeds from the mortgage loan payoffs to fully pay down the revolver to zero. Interest expense was projected to be approximately $26 million. This assumed a LIBOR rate of 1.75%, which is a lot higher than it is today. Given where LIBOR is today and that we paid down the revolver to zero, I would expect interest expense to come in a bit lower. Interest expense also included roughly $2 million of amortization of deferred financing fees, and I don’t think there will be any change there. We projected G&A of approximately $13.9 million to $15.8 million, which includes roughly $3.7 million of amortization of stock compensation. I would expect us to come in towards the high end of the range for the year. As we've all noted in our comments today, although there are still some uncertainties around what comes next in the pandemic, our tenants are performing well and we are cautiously optimistic about the foreseeable future. We simply point out the obvious: significant developments in the COVID-19 pandemic and the government’s responses there too could alter our outlook at any time. In the meantime, we'll be staying close to our tenants and working hard to help them, and by extension us, to navigate our way through the coming weeks and months. And with that, I’ll turn it back to Greg.

Thanks, Bill. We hope this discussion has been helpful for you. We are grateful for your continued interest and support. And with that, we’d be happy to open it up again for questions. Valerie?

Thank you. [Operator Instructions] Our first question comes from Jordan Sadler of KeyBanc Markets. Your line is open.

Thank you and good morning. I wanted to – hi, guys. Wanted to start off on the pipeline, if you could – Mark, you gave some good color, but maybe we could dive in a little bit deeper curious about sort of the mix. Maybe we could split it out in terms of our percent seniors housing versus SNFs, but also geos and pricing. So I’m curious if – geographically, if you’re able to look a little bit more broadly given sort of the federal support. Or are you kind of looking a little bit more broadly than you might have otherwise. And then on pricing, are you seeing any dislocation that would get to what might ordinarily be more attractive pricing?

So let me start off with the first of your three or four questions. So from a mixed perspective, it’s about 70-30 SNFs to senior housing. From a geographical perspective, I think that’s actually the most important piece of our underwriting. If you look at certain states that have not been impacted as severely – from an underwriting perspective, it’s a lot easier. You can certainly strip out the COVID-related expenses from the stimulus and any revenue uptick. So those buildings on an asset by asset basis that have had little to no COVID exposure are fairly straightforward. In fact, a couple of those fit the profile of assets in our current pipeline. Regarding the broader geographical question, you have certain states, like California, for instance, where on a pre-COVID basis, buildings traded at kind of the highest price per bed metrics that we’ve ever seen. California continues to be an extremely hot market. So operators and buyers will continue to be very aggressive out west. While in the Midwest and certainly up in the Northeast, in some states, you can’t give buildings away because of reimbursement—in terms of length of stay, and because of the impact of COVID. So to conclude and to help pull it all together, I would say geography is very, very important. Additionally, what states are doing to support COVID—in California, there’s talk of a couple of increases to Medicaid over the next 12 to 18 months. So we factor that in, while other states have seen a hit and we are hearing that there could potentially be some challenges with the Medicaid rate. So geography is probably one of the biggest considerations we have as we look to bring on acquisitions.

Great. And then just as a follow-up, and I’ll leave the floor. On the geographies, I’m not sure if I’m reading you as California being more attractive because of what the state is doing or more expensive because of what they’re doing. I’m kind of curious if you would be interested in sort of the value plays and like either the Midwest or Northeast or if that stuff is just too risky?

Well, I think it depends—as we’ve always said, it’s operator first. If operators feel like they can go into certain Midwest markets or even Northeastern markets and execute, then we would go there and obviously adjust our underwriting and come up with value based on where they can execute on their business plan. So we would take into consideration what the in-place cash flows are doing and then adjust for COVID and other factors. We continue to be operator-led and as folks want to grow, even in markets that may be perceived as somewhat challenged on the rate front. If there’s a reason, as I said in my prepared remarks, from a scale or a business plan perspective, then we would go there. We would obviously need to risk-adjust our pricing.

Okay. Thank you.

Thank you. Our next question comes from Jonathan Hughes of Raymond James. Your line is open.

Hey, good afternoon, good morning out there, yes. Can you give us some details on the tenant or tenants that are not current on rents right now? What’s their asset mix in your expectations for them to become current?

Hey, Jonathan. This is Dave. Right now, we haven’t made any rent concessions and everybody’s current. We’ve got one operator that’s not in our top 10 list. Actually, we have two senior housing operators, not in our top 10 list that aren’t exactly current. One of those has asked us to consider a rent concession, and we’ve just begun to evaluate that. So that’s the current status on rent.

The two tenants that haven’t paid are Premier and Noble. They don’t usually pay until around the 10th so they’re in line with past months.

Got it, okay. And Bill, what percentage of rents are on a cash basis today? I don’t know if it’s any, but could you give us that percentage and then are there any operators on the threshold of maybe going from accrual to cash basis?

A lot of the straight-line rent or call it the tenants that had big straight-line rents associated with their rental incomes were taken to cash last year in Q3. So we don’t really have, and as you heard in my comments on guidance, we don’t have a lot of straight-line rent. Only about $100,000 is expected to be recognized this year. So as I look at rental revenues, they’re almost all on a cash basis.

Okay, fair enough. Another one for Dave, you said seniors housing occupancy is flat, I believe since March. Yes, I look at Premier, and the coverage there continues to deteriorate. Can you just talk about what’s going on there? What’s the plan to reverse that trend? And hopefully, when can things recover?

The story really hasn’t changed very much there, Jonathan. Their occupancy has actually held steady through the pandemic as well. If you recall from prior calls last year, they had some challenges and real headwinds at a couple of their buildings from a regulatory perspective. Just by the end of last year, they had turned the corner there, but had quite a bit of ground to cover going into the pandemic. We saw occupancy tick up, and it’s just held steady since. So it’s a challenging time for anybody that had been turning things around to make a lot of progress with it during the pandemic. We’re actually gratified to see them hold steady through this so far.

Okay. Appreciate that color. I got one more, maybe for Mark, but there were some FAD payout comments in the press release that I thought were interesting as it relates to external growth. You talked about the pipeline, the geographic mix, and the asset mix earlier on Jordan’s question. What’s going to be the deciding factor on actually closing and announcing some of those deals? Is it going to be continued proof of case counter or just sellers finally, maybe acquiescing on price? The pipeline’s about the same as last quarter. I’m just wondering, when do we actually see a competitor, and I know you’re hopeful by the end of the year, but trying to get maybe a little bit better visibility on timing?

Yes. I would say that the deals we’re actively pursuing, we’re just making sure that our operators are comfortable that our normal diligence is checking out. And then obviously, we need to solve for the unknowns. Typically, you do that from a structural perspective. What happens if there’s a COVID outbreak a week before close—those types of things. In every deal, it’s a little bit different and every seller is a little bit different. So we have to structurally account for that. I would say, as Greg alluded to in his comments, that hopefully we’ll be announcing some soon as we’ve been working hard over the past six months to get to the point where we can say that.

Okay. Alright. I look forward to seeing that. Appreciate the time.

Thanks.

Thank you. Our next question comes from Connor Siversky of Berenberg. Your line is open.

Hey guys, it’s Keegan on for Connor. So first, just want to touch on, so you guys have high exposure states like Texas and California. Maybe touch on the contingency plan around these states facing spikes in cases recently. Would you have any new protocols in place to help mitigate it?

Yes. As you look at our portfolio in Texas and California, you’ll see the heavy concentration there of the Ensign Group as our primary tenant in those states. Having the Ensign Group as our primary tenant is a pretty strong contingency plan. Their coverage, as you can see, has been incredible. They just announced and had their earnings call yesterday and had a record performance. While we’re certainly monitoring and staying close to all of our operators there and throughout the portfolio, we take quite a bit of comfort as we see not just Ensign, but all of our operators mitigate quite a bit. Any drops in overall census by seeing that skilled mix increase. In spite of the virus spreading there, we don’t have elevated concern for those two states.

Okay. Thanks for the color there. And I guess the follow-up, how has your approach to testing changed since the first quarter? I know last quarter, you guys mentioned that the availability was largely dictated by local authorities. Have you been able to source it on your own?

Not for—we have not for lack of trying. We are pleased that the federal government is finally making some progress there in shipping directly to nursing homes. Our operators have largely struck deals or formed relationships with local labs to solve the problem on their own. We’ve continued as recently as a few days ago to pound on the door of companies like Abbott to try to shake loose those rapid result, molecular testing capabilities for our operators. But their supply chain hasn’t caught up to demand, and thus far, hasn’t allowed us as a new relationship to source anything for our tenants. But we continue to push for that.

Okay. Thank you for your time.

Welcome.

Thank you. I’m showing no questions at this time. I’ll turn the call back over to Greg Stapley for any closing remarks.

Thanks, Valerie. And again, thanks everybody for being on the call today. If you have any other questions, you know where to find us. We’re happy to take your calls. Have a good weekend.

Ladies and gentlemen, this does conclude today’s conference. You may all disconnect. Have a wonderful day.