Earnings Call Transcript - NHI Q1 2023

Operator, Operator

Greetings. And welcome to the First Quarter 2023 Conference Call. During the presentation, all participants will be in a listen-only mode, afterwards, we will conduct a question-and-answer session. As a reminder, this conference is being recorded on Wednesday, May 10, 2023. I'd now like to turn the conference to Dana Hambly. Please go ahead.

Dana Hambly, Presenter

Thank you, and welcome to the National Health Investors Conference Call to review the company's results for the first quarter of 2023. On the call today are Eric Mendelsohn, President and CEO; Kevin Pascoe, Chief Investment Officer; John Spaid, Chief Financial Officer; and David Travis, Chief Accounting Officer. The results as well as notice of the accessibility of this conference call on a listen-only basis were released after the market close yesterday in a press release that's been covered by the financial media. As a reminder, any statements in this conference call, which are not historical facts, are forward-looking statements. NHI cautions investors that any forward-looking statements may involve risks or uncertainties and are not guarantees of future performance. All forward-looking statements represent NHI's judgment as of the date of this conference call. Investors are urged to carefully review various disclosures made by NHI and its periodic reports filed with the Securities and Exchange Commission, including the risk factors and other information disclosed in NHI's Form 10-Q for the year ended March 31, 2023. Copies of these filings are available on the SEC's website at sec.gov or on NHI's website at nhireit.com. In addition, certain terms used in this call are non-GAAP financial measures, reconciliations of which are provided in NHI's earnings release and related tables and schedules, which have been filed on Form 8-K with the SEC. Listeners are encouraged to review those reconciliations provided in the earnings release together with all other information provided in that release. I'll now turn the call over to our CEO, Eric Mendelsohn.

Eric Mendelsohn, CEO

Thank you, Dana. Hello, and thanks for joining us today. We're off to a great start in 2023, with first quarter results coming in ahead of our expectations, driven by strong cash collections at over 98%, limited rent concessions, and deferral payments from four tenants. We announced new investments of $54.8 million during the quarter. We're able to utilize $2.5 million of the Bickford deferral balance in lieu of cash to create incremental value on a newly constructed community in Chesapeake, Virginia. We also benefited from $1.3 million in discrete items that only impacted the first quarter, demonstrating the value of triple net leases and preserving NOI, and the resilience of our tenants as operating fundamentals continue to improve. Our portfolio optimization has resulted in the sale of five more buildings year-to-date, with low single-digit NOI yields and coverage below one times. We continue to see the results of the optimization through significantly improved EBITDARM coverage, particularly for our need-driven senior housing tenants. The coverage improved year-over-year by 31% and sequentially by 9% to 1.11 times. This is the highest reported coverage since our first quarter of 2020, reflecting the hard work of our asset management team and our partner tenants as the pandemic effects move further away. We have more work to do, but the improving trends are encouraging. As we've talked about throughout the pandemic, the entrance fee and skilled nursing portfolios, which account for 60% of our NOI, continue to anchor the portfolio with industry leaders including NHC, SLC, ENSIGN, Watermark, and LCS. One area of disappointment for the quarter was the performance of SHOP, which is 3% of our NOI, but it is a clear strategic focus for the company. Our longer-term view on the upside potential of that portfolio has not changed, though the timeline is taking longer. We are working closely with our experienced partners Merrill Gardens and Discovery and expect better results. As we outlined in our press release last night and following our strong first quarter results, we are increasing our guidance for the year. We continue to expect strong cash collections, minimal rent concessions, and deferral payments. There are still a handful of tenants on our worry list that we are monitoring closely, and we have factored in some level of financial support. But this is a little more difficult to forecast and is a potential source of variability. We expect incremental quarterly improvement in SHOP, but given the soft first quarter results, our expectation for the full-year contribution has been lowered. Fortunately, the balance sheet and our financial profile continue to be pillars of strength, with leverage at just 4.6 times, over $5 million of liquidity, and an FAD payout ratio at 81.8%. We still have some capital we expect to recycle as we conclude our disposition activities and are well positioned to return to our historical investment trends when market conditions improve. We are content to be patient and believe we are in the enviable position of having significant capital to deploy at a time when capital seems increasingly scarce. I'll now turn the call over to John to discuss our financial results and guidance in more detail. John?

John Spaid, CFO

Thank you, Eric. Hello, everyone. As Eric mentioned, we had a better than forecasted first quarter. For the quarter ended March 31, 2023, our net income, NAREIT FFO, and normalized FFO per diluted common share are $0.79, $1.16, and $1.11 per share respectively. For the first quarter, our FAD was $47.7 million. The first quarter results for our real estate investment segments included two discrete beneficial items totaling approximately $1.3 million. First, we recognized approximately $700,000 in cash collections from two tenants on cash-basis accounting for amounts that were due in the fourth quarter of 2022. Second, we recognized approximately $600,000 from NHC for fiscal year 2022 rents related to the annual true-up adjustment of their percentage rent, which is the lease provision unique to NHC. This provision also increased NHC's 2023 rent approximately $160,000 per quarter. The segment's first quarter results also benefited from the collection of approximately $500,000 in rent deferrals from four operators, plus lower than forecasted new rent concessions. The better than expected performance in the real estate investment segment more than offset the lower than expected SHOP segment's $1.9 million net operating income results. Interest expense in the first quarter, compared to the prior year's fourth quarter, increased $1.6 million, which was largely attributable to new investments and commitments funded using proceeds from our revolver, plus a January $125 million private placement maturity, that carried a 4% coupon, which we used higher interest rate proceeds from our revolver to fund. The cash interest rate on our revolver is currently 6.25%. As Eric mentioned, we closed $54.8 million in investments in the first quarter, at an average initial first-year yield of 7.7%. After reinvesting both retired mortgage investment capital and the $2.5 million Bickford rent deferral, additional new capital deployed in the first quarter was approximately $38 million for these investments. In addition, we continue to fund commitments totaling approximately $9.4 million, as well as funded $10 million earn-out as part of our Timber Ridge joint venture. They are not being paid to the Timber Ridge OpCo, which we own 25%, and after the PropCo goes lease basis, increasing the rent and an incremental initial yield of 7.2%. Last night, we updated our full-year 2023 guidance to reflect our strong first-quarter results and other guidance modification. Our guidance includes continuing asset dispositions, rent concessions, and loan repayments throughout 2023. Our guidance includes $56.4 million in recently announced investments, plus a continuing fulfillment of our commitment. Our updated guidance still does not include any additional unidentified investments. However, we are now including additional modest repayment of outstanding deferral balances consistent with levels experienced in the last two quarters. We increase the range of our normalized FFO per share to $4.37 to $4.42 from a range of $4.24 to $4.30. One notable reason for the significant FFO increase is a change in non-cash stock-based compensation. We reduced this item by approximately $3.4 million or $0.08 per share. We also increased our FAD guidance to a range of $186.3 million to $188.9 million. During the first quarter, we did not purchase any of our stock under our existing $160 million authorization, which expires in February 2024. For the first quarter, our leverage ratio was better than expected at 4.6 times net-debt-to-adjusted EBITDA driven largely by the reduction in the accrual for stock-based compensation discussed earlier. During the quarter, we renewed our automatic shelf registration, the ATM perspective supplement, which we have not used, so we have $500 million available under the program. At the end of April, we had $201 million on our $700 million revolver, and ample liquidity with over $500 million in cash and revolver availability. Having said that, we continue to evaluate our debt and equity capital market options so that we're sure to continue to maintain appropriate liquidity levels as maturities occur and our investments rise. Our next debt maturity is our $220 million term loan due in September, followed by a $50 million private placement maturity in November. Although the debt market is very challenging, we're working with our bank syndicate group. And we expect to provide more information to you on our strategy regarding debt maturities in the second quarter. Finally, our first quarter FAD payout ratio was in line with our expectations and are well covered at 81.8%. As we announced last night, our Board of Directors declared a $0.90 per share dividend for shareholders of record June 30, 2023, and payable on August 4, 2023. With that, I'll turn the call over to Kevin. Kevin?

Kevin Pascoe, CIO

Thank you, John. I'll concentrate my comments on investment and disposition activity as well as the performance of our major asset classes and operators. We closed on the sale of two properties for net proceeds of $10 million during the first quarter, and we sold an additional three properties for net cash proceeds of $5.7 million so far in the second quarter. We currently have seven properties held for sale with a net book value of approximately $21 million. Of this total, approximately $19 million relates to the two tenants placed on cash basis accounting last quarter. Similar to our other dispositions, these properties have low single-digit NOI yield and sub-one lease coverage, so the sales should immediately improve our tenants' financial position. The current market conditions make it difficult to predict the timing of these dispositions. But our expectation is that the majority will close in the second and third quarters. While there are plenty of pipeline discussions, markets have not been accommodating, so we are not seeing many deals that reflect the reality of changes in the cost of capital. Fortunately, we're in a position where we can be patient, and ultimately, we think well-capitalized REITs will be beneficiaries, as lenders with less industry expertise reduce their exposure. Shifting to asset management, overall, first quarter contractual cash collections were strong at 98.4%. Total coverage for the company improved sequentially to 1.7 times from 1.63 times. This was driven by gains in both senior housing and skilled nursing. Remember that the coverage metrics represent trailing 12 results and do not reflect the full impact of the portfolio optimization, improving fundamentals or the strong first-quarter results. So we are optimistic we'll continue to see favorable trends. In an effort to provide more transparency for analysts and investors, we now include occupancy information for our different asset classes in the supplemental report. Total occupancy improved year-over-year by 400 basis points to 81.3% on a 440 basis point increase in senior housing and a 350 basis point increase in skilled nursing. Reviewing the need-driven platform, which is 29% of annualized cash NOI and where most of the optimization is targeted, we again saw positive coverage trends with sequential growth for the fourth straight quarter. EBITDARM coverage through December improved to 1.11 times and it’s the highest since the first quarter of 2020. The increase was driven in large part by Bickford at 1.26 times. Bickford’s pro forma coverage, which fully accounts for the April 2022 rent lease, was 1.39 times, an improvement from 1.31 times reported last quarter. This was driven by the addition of newly acquired properties and a high single-digit rate increase, which is helping to offset occupancy pressure. We received $200,000 of deferral payments from Bickford in the first quarter, and we have received over $300,000 in the second quarter. Our Bickford portfolio experienced a slight uptick in March occupancy, and they are starting to see some momentum build in the sales pipeline, lead conversions, and move-ins. As I mentioned, we added new occupancy information to our supplemental report, including a comparison of Bickford occupancy versus NICMAP Metro Market. Although there's room for improvement in the occupancy trend, Bickford’s NICMAP occupancy is 81.3%, and it's still about 90 basis points higher than the competition. We estimate monthly RevPOR to be approximately $500 higher. Aside from Bickford, coverage is increasing across our other RevPOR need-driven properties. We reported coverage at one time, which is a gain of 23% year-over-year and the fifth straight quarter of sequential improvement. While the improvement is encouraging, one-times coverage still implies that these operators are struggling. We are incorporating some level of unidentified rent concessions into the guide, which is based on the ongoing conversations we're having with a small number of need-driven tenants, in addition to tenants already on cash basis accounting. Continuing with our discretionary senior housing portfolio, this group accounts for 29% of adjusted NOI, including 26% from entrance fee communities, which continue to perform well. SLC, our largest tenant, has coverage of 1.17 times, which was down from 1.22 times last quarter. Fortunately, first quarter entrance fees still remain strong, agency utilization was down and occupancy trends remained above pre-pandemic levels. Our senior housing discretionary coverage excluding SLC, which largely reflects the performance of our other entrance fee communities, improved sequentially to 1.75 times from 1.69 times. The skilled nursing facility and specialty hospital portfolio, which represents 36% of annualized adjusted NOI, continues to have solid coverage at 2.48 times, which was up sequentially from 2.42 times, driven by improvements at both NHC and the other operators. We are monitoring Medicaid rates in our 10 SNF states as the public health emergency ends this week and the SMAP add-on phases out during 2023. We expect to hear more about Texas and Florida, our two largest SNF states by revenue, in the coming weeks. We also expect that CMS will soon release a proposed staffing mandate, so we will communicate with our operators and trade groups as those details emerge. Our SNF portfolio is anchored by NHC and Ensign, which are best-in-class operators, so we have great confidence that they will be able to adapt to staffing requirements and any other regulatory changes as they have done so many times in the past. Lastly, in our SHOP portfolio, which represents 3% of adjusted NOI, we experienced continued pressure on the margins, which declined slightly to 16.2% on weak occupancy and higher expenses. We had anticipated that the repositioning of the assets under new management would have shown better progress. So SHOP is a relatively small piece of our total portfolio. It is strategically significant as a source of both internal and external growth for our company. While we have tempered our near-term expectations, the long-term outlook has not changed, and we are committed to employing the resources necessary to achieve that goal. That concludes our prepared remarks. Operator, please open the line for questions.

Operator, Operator

And our first question is from John Kim with BMO Capital Markets. Please go ahead.

John Kim, Analyst

Thank you. Eric, you provided some insight on your SHOP expectations. I think you mentioned that your long-term views haven't changed, but when you look at your presentation, you reiterate the mid-30% margin opportunity, yet you removed the $6 million to $8 million upside. So I just wanted to ask you about the slide changes you made to your presentation. And when do you expect to get to that mid-30% margin level?

Eric Mendelsohn, CEO

Hey, John, good to hear from you. You're right. I was hoping that improvement would start showing up this year, but it looks like it's going to be more of a next-year improvement.

John Kim, Analyst

Okay, but overall, it's just, in your view, a timing-related issue. Are there concerns about the traction that you're getting on SHOP?

Eric Mendelsohn, CEO

No, no, I mean, those buildings changed operators three times in the past year. So they've been through a lot. I've had the opportunity to tour many of those buildings and see what needs to be done. We also delayed CapEx because, as I'm sure you're well aware, it was hard to get vendors and materials this past year. CapEx projects that were going to improve curb appeal and marketability are just getting underway now. So all of that means that our expectations had to be pushed back.

John Kim, Analyst

Okay. My second question is on Bickford. The coverage has gotten noticeably better, especially on a pro forma basis. I just wanted to ask about the occupancy trends, because even though above NICMAP has been trending lower, I think you mentioned part of that is rate-driven. When do you think the occupancy will improve in your Bickford portfolio?

Kevin Pascoe, CIO

So John, this is Kevin. We're starting to see the beginning of that now. Lead volume, tour volume, and move-in volume has started to increase. We have seen some normal seasonally typical move-out rates, which they have clearly not covered with the move-ins over the last few months. But again, we're starting to see the key indicators improve. Our expectation would be that through the spring, they will start to gain momentum on lead tours and move-ins, as April, May, and June tend to be stronger seasons for move-ins. So we're watching that very closely. We think they're doing all the right things to try and position people effectively to succeed and get those move-ins. So stay tuned. But like I said, we're starting to see the beginnings of that again.

John Kim, Analyst

Okay. One more question, if I may. Regarding your guidance for this year, what's included as far as G&A? Can you also discuss the impetus for the change in your stock-based compensation?

John Spaid, CFO

Hey John, this is John Spaid. Not sure how I can help you with what's in G&A. We're not expecting it to materially change from a cash G&A standpoint, quarter-over-quarter, if that helps. The large reduction in G&A expenses attributable to non-cash stock compensation was just the compensation committee and the Board of Directors' adjustment to the comp structure, which resulted in a fairly significant reduction in executive compensation. You can see that clearly in terms of the number of shares awarded in our Q4. There's also a supplemental proxy filing at the end of April, as part of our proxy process that has more discussion about the strategy of the Board of Directors and the compensation committee for non-cash stock compensation moving forward.

John Kim, Analyst

And John, that gets reviewed what metrics get reviewed once a year?

John Spaid, CFO

That's correct.

Austin Wurschmidt, Analyst

Hey everybody. Just wanted to revisit the SHOP question. So you're saying that the SHOP recovery is a 2024 event. Is that specific to achieving that mid-30% margin that you highlighted in the presentation or just seeing some improvement in the annualized run rate of $7 million to $8 million you've been at for the past couple of quarters?

Kevin Pascoe, CIO

Hey, Austin, this is Kevin. Our expectation is that we'll see incremental improvement quarter-over-quarter. Clearly, there's still work that needs to be done on that. If we're going to couch when we'll hit that margin, I think it would be into 2024, as Eric mentioned. I'm not ready to say that that's going to be there in the first quarter of 2024. I think that's going to be just again, an incremental improvement quarter-over-quarter. We do have some expectations for this year that we will see improving margins by the end of the year, but again, I'm not sure that we're going to be at the mid-30s just yet. I do think we'll be in the 20s at a minimum and then improving from there.

John Spaid, CFO

Austin, this is John Spaid. I want to follow up on that because guidance does assume that the SHOP portfolio continues to improve NOI for the rest of 2023. We’ve just had to lower our original forecast as a result of the first quarter result. The SHOP NOI is independent living NOI, meaning the majority of the expenses are fixed, and so they depend on the improvement in NOI. The SHOP portfolio is really dependent on occupancy growth. So pay attention to what's happening there as we move forward.

Austin Wurschmidt, Analyst

Yes, that makes sense. And you started to hit on my next follow-up, which was how much of an impact did the change in your SHOP outlook have on your guidance?

John Spaid, CFO

Well, I can't give you that number specifically, we don't publish that number, but it was significant. You can kind of see it when you look at the FAD numbers. When you compare how much improvement we had in the first quarter based on our results and then you look forward to the end of the year, the lift that we see in the FAD numbers, you'll see a much more muted lift in the rest of the year in the FAD, and the largest component of that is the reduction in NOI that we assumed for the remainder of the year in SHOP.

Austin Wurschmidt, Analyst

Understood. And one more for me. It looks like you removed two properties from the held-for-sale bucket. I'm just curious what the decision was related to those two?

Kevin Pascoe, CIO

Sure, this is Kevin. We talked a little bit in our prepared remarks that the environment right now is very difficult for financing. A couple of the properties that we had held for sale were more opportunistic, where people came to us with letters of interest that we felt were meaningful to pursue. But they weren't necessarily properties we were circling to sell originally. So, again, they're opportunistic. When the debt markets continued to change, they couldn't execute at the price they originally offered. It wasn't one that we felt we just had to keep pushing on. So we pulled them back into the portfolio.

Austin Wurschmidt, Analyst

So fair to say these are income-producing assets with significantly better coverage than the assets currently held for sale?

Kevin Pascoe, CIO

Relatively speaking, yes. I mean, they're ones that are better than what we have held for sale; they produce some level of income. It would still be an incremental improvement to move them, but not at any price.

Tayo Okusanya, Analyst

Hi, good afternoon, everyone. John, again, I'm still trying to understand the kind of what's driving all the changes in the guidance. Again, when I take a look at Q1, when you had the pickup of the lower G&A and things like that, it feels like it's all one-time. Would you say it's all one-time items that have driven the increase in guidance? Or is there anything in the quarter that also translates into better earnings growth in future quarters? And if there's any aspect to that, such as a lower expectation on SHOP now, I'm just trying to understand some of the moving pieces that resulted in this new guidance number?

John Spaid, CFO

Yes, sure. Well, it depends on what line you're talking about. So let's just start at the FFO line. The most material change to FFO was due to the reduction in executive compensation or compensation attributable to non-cash stock comp. That lifted FFO considerably and that’s probably the largest piece of it. Then there were the one-time effects that you talked about. Inside those one-time effects, though, are escalations that will continue to contribute for the rest of the year. You might have noticed in my prepared remarks, I talked a little bit about the NHC escalator that will continue to flow through in the second, third, and fourth quarters. There are others as well, that we picked up in those numbers. The other aspect that you don't see, and I can't give you a lot of color on, is how we're feeling about concessions. The concessions in our forecast were higher at the beginning of the year. We had literally no unexpected concessions in the first quarter. That’s great news and so we've lowered our outlook for necessary concessions for the rest of the year. So that's helped quite a bit, and that flows all the way down to the FAD line. The other piece that caused some movement was our reduction in our expectations for SHOP NOI. So putting all those major pieces together, there are quite a few other smaller pieces to discuss, which is how our guidance was adjusted between February’s guidance and the guidance we issued last night.

Tayo Okusanya, Analyst

That's actually very helpful. And then, Kevin, in your prepared comments, you did discuss again that the needs-based coverage is still 1.0. You're still having conversations with some tenants in that group about how to help them. Is all that built into the guidance as well? If not, is there a way to quantify what could be the potential outcome there?

Kevin Pascoe, CIO

So speaking for John on a bit of this, I would say we try to factor that into guidance as much as we could. We talked about having some level of unidentified amount in our forecast. As we think about the portfolio, I think the comment is still the same. We talked about last quarter, we're discussing kind of that bottom 5% of the portfolio, people that we're working with on a very regular basis, keeping very close tabs on, and ensuring that we give them the best chance for success with those relationships. We factored in a bit of that. Hopefully, we don't need to use it. But we wanted to make sure that we were forecasting based on what we're seeing in the environment right now, where people still have a little bit of challenge with occupancy that depends on their markets and labor, while it's smoothed out to some degree. We're seeing less agency, and overtime wages are still significantly high. So there's still some pressure on a subset of these operators, and we just want to make sure we're mindful of that.

John Spaid, CFO

Tayo, this is John again, let me add on another piece. Our dispositions that we've been strategically making over the last year have been part and parcel with helping our operators improve coverage. What you've seen are those coverage ratios getting materially better as a result of our portfolio optimization. We still have a few more to do. The environment for making those dispositions has gotten more difficult, so those dispositions and whether or not we can actually get them done, financing available for the buyers, etc. plays a big part in our thinking around concessions. The other piece that I want to also emphasize that I forgot to mention is for the first time can indicate we feel a little more confident about our ability to collect deferrals. So that deferral collection is now part of our guidance as well. I don't want to end this conversation without highlighting that.

Tayo Okusanya, Analyst

Got it, that's helpful. Thank you.

Operator, Operator

There are no further questions on the phone lines at this time. I'll turn the presentation back to the speakers for any closing remarks.

Eric Mendelsohn, CEO

Thanks, everyone for joining today. We'll look forward to seeing you in person at NAREIT in New York next month.

Operator, Operator

Thank you. That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.