Earnings Call Transcript - NHI Q2 2023

Operator, Operator

Greetings, and welcome to the National Health Investors Second Quarter 2023 Earnings Call. As a reminder, today's call is being recorded on Wednesday, August 9, 2023. I would now like to turn the conference over to Dana Hambly. Please go ahead.

Dana Hambly, Moderator

Thank you, and welcome to the National Health Investors conference call to review the company's results for the second 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 closed 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 quarter ended June 30, 2023. Copies of these findings 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. Hello, and thanks, everyone, for joining us today. We are making progress on our return to growth through our portfolio optimization, improvements in SHOP operations, and strategic positioning of the balance sheet. Our second quarter results generally experienced stable cash collections as well as increased deferral repayments. However, the quarter was impacted by one-time concessions specific to two senior housing operators, totaling approximately $1.9 million or $0.04 per share when compared to the first quarter of 2023. As we often discuss, some of our senior housing tenants are struggling in this post-pandemic era, which introduces variability to our quarterly results. Our long-term outlook has not changed as fundamentals improve in the need-driven senior housing and SHOP portfolios, while our CCRC and SNF platforms remain pillars of stability. Since the end of the first quarter, we completed the sale of seven properties, including one property for $23.7 million that was not previously held for sale and was sold for a substantial gain. This was an opportunistic disposition of a property that needed significant capital expenditures and was cash flow negative to our tenant, which would have likely led to future rent concessions. We currently have just four properties held for sale, which allows us to shift more of our attention and energy to growth initiatives. We see the benefits from the dispositions and other portfolio optimization efforts through significantly improved EBITDARM coverage. This is particularly evident for our need-driven senior housing tenants where coverage, which reflects the impact of our portfolio optimization, improved year-over-year by 37% and sequentially by 10% to 1.22 times. This is the highest ever reported since separately breaking out this category. Favorable occupancy trends and moderating wage inflation give us optimism that coverage will continue to move higher. The SHOP portfolio improved NOI to $2.1 million from $1.9 million in the first quarter of 2023. While still performing below initial expectations, the move-in trends have improved recently, generating a sizable 170 basis point gain in July occupancy, and we are midway through our capital expenditures campaign with encouraging results. Kevin will provide more details in just a moment. We anticipate improving SHOP NOI in the second half of 2023, and our longer-term view of the upside potential remains unchanged. The balance sheet and our financial profile are in great shape with leverage at just 4.6 times and more than $500 million of revolver capacity. We are very focused on external growth opportunities, which are starting to look more attractive as capital becomes increasingly scarce. We are seeing the direct impact of higher interest rates in the form of more financing opportunities and second tries at deals that fell through for lack of equity financing. As outlined in last night's press release, we adjusted our guidance, which reflects this quarter's higher-than-expected concessions. John will discuss the updated guidance in more detail during his prepared remarks. I want to assure investors that we have taken immediate action to address this quarter's shortfall and therefore expect better results in the third and fourth quarters. Our long-term view of the industry remains incredibly optimistic, and we have plenty of dry powder to support our internal and external growth opportunities. I'll now turn the call over to Kevin to provide more details on our operations.

Kevin Pascoe, CIO

Thank you, Eric. 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 seven properties for net proceeds of $42 million since the end of the first quarter, leaving just four properties held for sale. Since the second quarter of 2021, we completed the sale of 48 senior housing and skilled nursing properties for net proceeds of $392 million. These properties generated low single-digit NOI yields with very thin lease coverage. With this process effectively complete, we are in a great position to deploy capital given our low leverage and an acquisition environment that seems to be moving towards a buyer's market. The pipeline is starting to reflect the changes in our cost of capital. We have multiple letters of intent in process, so we are confident we'll announce new investment activity before the end of the year. Shifting to asset management. Overall, second quarter contractual cash collections were approximately 97%. Relative to the first quarter and excluding the impact of discrete items, we collected approximately $1.9 million less from two senior housing tenants. This included approximately $800,000 in rent concessions to one operator and approximately $1.1 million in lower collections from a tenant on cash basis accounting. As Eric noted, we have taken action to address the shortfall, including allocating additional asset management resources and selling negative cash flow properties. We are already benefiting from these actions, which gives us confidence that our third and fourth quarter results will improve. EBITDARM coverage for the company increased sequentially to 1.75 times from 1.7 times, driven by gains in senior housing. Remember that the coverage metrics represent trailing 12-month results and do not reflect better occupancy and margin trends we generally experienced in the second quarter of 2023. Total occupancy improved year-over-year by 280 basis points to 81.7% on a 240-basis point increase in senior housing and a 330-basis point increase in skilled nursing. Reviewing the need-driven platform, which is 26% of annualized cash NOI, we again saw positive trends with coverage at 1.22 times, representing the fifth straight quarter of sequential growth. The increase was driven in large part by Bickford at 1.41 times, which now reflects the full impact of the April 2022 rent reset. Bickford's second quarter occupancy improved by 40 basis points to 82% compared to the first quarter of 2023, and average monthly occupancy improved throughout the quarter with June at 82.7%. The strong net move-ins continued into the third quarter, and spot occupancy at the end of last week was 83.7%. Bickford repaid over $350,000 in deferrals during the second quarter, with a similar amount expected in the third quarter. Aside from Bickford, coverage is increasing across the other 40 need-driven properties, which account for approximately 13% of annualized NOI. We reported coverage at 1.07 times, which is the highest reported coverage since the second quarter of 2020 and the sixth straight quarter of sequential improvement. While the trend is encouraging at just over 1 times coverage, the environment for these operators remains difficult even with reported occupancy at 87%. This asset class is where most of our optimization efforts have been focused. The progress has been slow but steady, and we think improving industry fundamentals, coupled with our direct actions, will result in fewer rent concessions. Continuing with our discretionary senior housing portfolio, this group accounts for 30% of adjusted NOI, including 27% from entrance-fee communities. SLC, our largest tenant, improved coverage sequentially to 1.28 times from 1.17 times, driven by excellent entrance-fee sales in the first quarter, which continued into the second. Our senior housing discretionary coverage, excluding SLC, which largely reflects the performance of our other entrance-fee communities, declined sequentially to 1.34 times from 1.75 times. This was driven by higher entrance-fee refunds at a couple of properties in the first quarter. We know this business can be bumpy from quarter to quarter due to the variable nature of entrance-fee sales and refunds, but this is certainly not on our worry list. The SNF and specialty hospital portfolio, which represents 37% of annualized adjusted NOI, reported solid coverage at 2.48 times, which is unchanged sequentially. SNF occupancy improved by 330 basis points year-over-year to 79%. Since the start of the pandemic, NHI has provided a rent deferral to only one SNF operator in late 2021 and early 2022. This operator started repaying the balance in the second half of 2022 and thus far has repaid more than 50% of the deferral amount. NHC and ENSIGN obviously anchor our SNF portfolio, but we've been happy with the performance of all the operators, which gives us confidence in their ability to adapt to any new rule changes, including a potential staffing mandate. Lastly, in our SHOP portfolio, which represents 3% of adjusted NOI, we are still experiencing margin pressure, and the performance is below our initial projections. But we are making progress and the portfolio did generate a $200,000 sequential NOI improvement. The margin improved 170 basis points from the first quarter to 17.9%, and monthly occupancy increased for a fourth straight month through June to 75.6%. The sales pipeline has been building gradually throughout the year, and June proved to be our strongest move-in and net move-in month of the year. This bodes well for July as preliminary results indicate that monthly occupancy increased another 170 basis points to 77.3%. The recent trends give us conviction in our longer-term view that this portfolio can generate NOI dollars in the high teens and margins in the mid-30% range. This provides an excellent source of internal growth while building a platform with a long runway for external growth. I'll now turn the call over to John to discuss our financial results and guidance.

John Spaid, CFO

Thank you, Kevin, and hello, everyone. For the quarter ended June 30, 2023, our net income, NAREIT FFO and normalized FFO per diluted common share were $0.92, $1.05, and $1.06 per share, respectively. In the second quarter, our FAD was $44.6 million. Our second quarter results were mixed with both improving SHOP performance and better deferral collections but higher than forecasted concessions. Our second quarter FAD declined by $3.2 million compared to the first quarter of 2023. But recall, as we noted in our Q1 remarks, the first quarter results for our Real Estate Investments segment included two discrete beneficial items totaling approximately $1.3 million. When compared to the first quarter of 2023, second quarter FAD was further impacted by approximately $1.9 million in lower cash collections and higher rent concessions to two operators. These sequential impacts to FAD were partially offset by an increase of approximately $200,000 in the collection of rent defaults from five operators, lower recurring SHOP capital expenditures, and rent increases from annual rent escalators. As Eric mentioned, the SHOP's portfolio NOI improved modestly to $2.1 million in the second quarter from $1.9 million in the first quarter of 2023. During the second quarter, we sold six properties, five of which were previously in assets held for sale for $39.1 million in proceeds and net gains of $11.3 million. Subsequent to the end of the second quarter, we closed on one additional property for $2.9 million in net proceeds, leaving four properties and assets held for sale with approximately $10.9 million in net book value. Interest expense in the second quarter compared to the first quarter was flat, largely attributable to lower total debt, offset by higher average interest rates. Last night, we updated our full-year 2023 guidance. Our guidance reflects additional improvement in the repayment of prior deferral balances, consistent with levels experienced in the first and second quarters. It includes continuing asset dispositions and loan repayments, additional rent concessions, higher lease incentive amortization expense attributable to the Timber Ridge earn-out paid in February, and higher interest rates for the remainder of 2023. Our guidance includes $60.6 million in recently announced investments, plus the continuing fulfillment of our commitments, but it does not include any additional unidentified investments. We adjusted our FAD guidance to a range of $185 million to $186.8 million. The slight reduction is driven primarily by higher-than-expected second quarter concessions, which includes lower-than-expected cash basis customer collections and incremental assets sold in Q2, not previously in our guidance, and higher interest expense, all offset by better-than-guided deferral collections. We also adjusted the range for our normalized FFO to a range of $107.1 million to $188.8 million. On a per share basis, this equates to a midpoint of $4.33, down 1.4% from $4.39. The updated normalized FFO guidance reflects the changes to FAD as well as changes to our noncash rental revenue, which includes straight-line rent and amortization of lease incentives. For the second quarter, our leverage ratio was unchanged from the first quarter at 4.6 times net debt to adjusted EBITDA. At the end of July, we had $186 million outstanding on our $700 million revolver, providing ample liquidity of over $500 million in cash and revolver availability. We also have a full $500 million available under our ATM program. As previously announced, we entered into a new two-year $200 million term loan during the second quarter. The proceeds were used to pay off a term loan maturing in September 2023. The new term loan bears a variable interest at the same credit spread over SOFR as the now paid-off term loan. We're grateful to the participating syndicate of nine banks, a very strong show of support at a time of increasingly scarce capital. We believe this validates our decision early in the pandemic to optimize our real estate portfolio while preserving a strong balance sheet, which now creates a strategic advantage as we execute on external growth. Finally, our second quarter FAD payout ratio was 87.6%. As we announced last night, our Board of Directors declared a $0.90 per share dividend for shareholders of record September 29, 2023, and payable on November 3, 2023. Once again, thank you all for joining the call today. This concludes our prepared remarks. Operator, please open the lines for questions.

Operator, Operator

We will now take our first question from Juan Sanabria at BMO Capital Markets. Please go ahead.

Juan Sanabria, Analyst

Hi, good morning. Just a question on deferrals. I recognize that you guys talked about it being a bumpy kind of road, but generally trending upwards. So just curious kind of what happened to surprise sequentially? And Eric, I think you mentioned that an incremental asset was sold that had negative coverage that should improve the situation going forward. I guess, are there any other assets like that aren't held for sale but may be looked at as a disposition candidate going forward, given the still kind of choppy recovery.

Eric Mendelsohn, CEO

Juan, it's Eric. You had a couple of questions there. One was about lumpy deferrals and any other assets. The answer is no. We've got four smallish assets held for sale. I think the total value we estimated slightly over $10 million. As far as deferrals are concerned, we're very overgranted in terms of concessions. We don't want to do it. In this case, there was a building that had a negative cash flow and was heading towards more deferrals, and we had an opportunity to sell it at a gain, and frankly, lowering our exposure to this tenant seemed very prudent since they were a major user of deferrals. So, we took advantage of that.

Juan Sanabria, Analyst

I guess why wasn't that one building already on the target disposition list would be the thought?

Eric Mendelsohn, CEO

It was a quality building in a strong market that had the potential to generate profit if managed effectively. We were reluctant to sell, but we lacked a suitable operator in that area, and the one we had was not performing well. At the right moment, a well-capitalized operator approached us, making it a timely transaction that allowed us to reduce our risk with this particular tenant.

Juan Sanabria, Analyst

And then just as a follow-up, hoping you could maybe expand on the investments pipeline. The mix of assets you're looking at or the mix between traditional fee simple and loans as well as kind of just the size overall of the opportunity set?

Kevin Pascoe, CIO

Sure. Juan, this is Kevin. We're looking at kind of anything and everything right now. That said, it's more focused on the needs-driven senior housing side. Skilled nursing is absolutely still in play as well as our other asset classes that we have in the portfolio. But we have seen a little more action on the senior housing side. Some more basis-type plays, which traditionally haven't been a fit for us. But with the right operator, the right market, and the right structure, we have found them interesting. On the structure side, we still want to own the real estate. So, it's what we've been working towards to develop that pipeline. You will see more likely than not some element of lending where we can have a pipeline to be able to acquire assets that may not always be true. There are some instances out there where we think there are some good lending opportunities to afford us good yields that we may not want to have as assets long-term. For now, it's a good opportunity for the portfolio. So, it's going to be a mix, which is kind of what you've seen from us before, but still with an eye towards acquisitions as much as possible. It's just finding the right opportunity. And then, again, kind of rebuilding the pipeline for us to be able to execute, whether that's to buy the real estate today or set it up for a future acquisition.

Juan Sanabria, Analyst

Thank you.

Operator, Operator

We'll now move on to our next question from Austin Wurschmidt at KeyBanc Capital Markets. Please proceed.

Austin Wurschmidt, Analyst

So, based on July results and kind of some of the sales you've completed, do you expect deferrals going forward to return to a first quarter run rate or even improve based on the additional sales that you have in the pipeline? Can you just give some direction around that, your expectation for that figure moving forward?

John Spaid, CFO

Austin, this is John Spaid. I'll do my best. Concessions are still in guidance, but we're trying to move as quickly as we can to put an end to them. That was part of our strategy in the second quarter. One of the things that is happening to us is we have cash basis tenants that are slow in payoffs during the quarter, and we're trying to recover those rents in subsequent quarters. We're trying to get them back on even payment streams as quickly as we can. So that's the upside to our guidance that we can recover the rents owed to us that weren't paid in the second quarter that were part of our missing NOI and then get them to pay what they owe us consistently on time moving forward. The risk is that the senior housing industry continues to have some bumps, and they're not able to do that. So, we're working as hard as we can to achieve that.

Austin Wurschmidt, Analyst

Got it. That's helpful. And then I wanted to hit on Bickford for a moment. Occupancy, I think, was stable. Coverage continues to improve, and it's now been over a year since you added the language about doubting they can remain a going concern. But I guess do you feel like they're through the worst of it at this point? Or are there other hurdles that they still need to climb? What's sort of the latest update there?

Kevin Pascoe, CIO

Sure. Austin, this is Kevin. I believe NHI has accomplished what it set out to do. The portfolio is continuing to improve, with occupancy and coverage on the rise. We have completed the necessary work, and as a responsible steward of the portfolio, we are always reviewing to determine if there are properties worth holding onto. Currently, Bickford is performing well, and we believe there are still opportunities for them to enhance their business. They can collaborate with their financial partners to decide whether to sell some properties or potentially restructure some debt. They are not finished with their business operations. Regarding NHI, our structure and relationship are strong, and as I mentioned, we expect to see continued improvement quarter after quarter.

Austin Wurschmidt, Analyst

Appreciate the comment. Thank you.

Kevin Pascoe, CIO

Thanks, Austin.

Operator, Operator

We'll proceed with our next question on the line from Juan Sanabria with BMO Capital Markets. Please go ahead.

Juan Sanabria, Analyst

Eric, could you elaborate on the comments regarding Bickford? You seemed a bit more cautious about their ability to remain solvent, considering their other debt. Are those risks diminishing? I'm interested in knowing if there could be a possibility of transitions since the operator may not be profitable if they lose assets outside of your partnership with them.

Eric Mendelsohn, CEO

That's a fair question, Juan. Look, our portfolio is doing great, and it would be very simple for them if they only had our buildings and their home health and their pharmacy. It would be a money-making venture. They do have other buildings that have variable rate debt. Through no fault of their own, that debt has ratcheted up. So, they have unforeseen expenses due to that debt, and they're working with their banks to either refinance to HUD, sell those properties, or run them better. All of that is ongoing, and we're monitoring that closely. Based on what they're doing with our portfolio, things are getting slightly better.

Juan Sanabria, Analyst

Thank you for that. You mentioned that the dispositions were higher than expected, which led to a slight adjustment in guidance. I am curious about the yields from those dispositions in terms of rent that will flow through the P&L related to those sales in the second quarter.

John Spaid, CFO

Juan, in our business update, there's a table that provides information about yield. It's important to keep in mind that one reason for our dispositions is the concessions they're leading to. Therefore, that yield truly reflects the concessions resulting from these actions. A significant aspect of our strategy is to maintain a strong balance sheet when we aren't seeing the returns we need. I would mention that one property was expedited this year due to changes in the law in the state it was operating in. It became more challenging to transfer the license if we delayed too much. We evaluated the risks of that disposition in light of the legal changes in that state and decided to proceed more quickly. We're actively working, Juan, to resolve all of this noise as quickly as possible this year. This particular asset did impact our guidance slightly because we initially thought it could contribute to our free adjusted funds from operations this year. However, the risks associated with that operator led us to choose to move on from it.

Juan Sanabria, Analyst

That's helpful. And then just a final comment or question, I should say. What are you guys seeing broadly between independent living and assisted? It's been a topic, obviously, through earnings season. And as part of that or more broadly, I guess, are you seeing any price competition, either discounting, waiving of fees, et cetera, given some of the distress we've seen in seniors' housing more broadly, either with your operators or the competitor set?

Kevin Pascoe, CIO

Sure. This is Kevin again. I would say that we've seen the more need-driven FAD rebound faster. I think we've both seen that in macro, but also within our portfolio. As we've talked about, our independent communities have been slower to respond on occupancy, but you also think that's associated with having a couple of manager changes over the last 12 to 24 months, which has not been helpful for them in rebuilding their pipeline. More recently, we've seen some gains in independent living, as we noted in our prepared comments, and feel like the operating partners have done a good job of rebuilding the teams and those sales funnels. We believe that should continue. There is an element of concessions going on in both assisted and independent. As we look at some of the NICMAP, it would suggest increases in Street rates, but then or at least, and in addition to the customers that are already in the communities. We know that there are concessions going on, and even as it relates to our independent building, trying to get occupancy has been the priority. So, there are concessions happening to ensure that we're getting net move-ins, which is starting to happen. Overall, we've been pleased with that piece. However, it is challenging to increase rates while trying to fill communities.

Juan Sanabria, Analyst

Thank you, very helpful.

John Spaid, CFO

Thank you.

Operator, Operator

And we'll get to our next question on the line from Austin Wurschmidt with KeyBanc Capital Markets.

Austin Wurschmidt, Analyst

You kind of commented on the Bickford debt refinancing. So, I had a follow-up. I mean it's been in the works now for a little while now, it feels like. And I'm just wondering, are we talking about a significant amount of debt? And is there any sense around the timeline of when they could receive the HUD financing?

Kevin Pascoe, CIO

This is Kevin again. There are efforts with other banks to extend the current debt while trying to improve the capital environment. We can all agree that sourcing debt right now is very challenging. For the HUD takeout related to those specific buildings, they need to stabilize their operations for HUD to take them out at a reasonable level, which is the primary focus for Bickford. They have made several attempts so far and have a couple more in progress. I believe they can achieve this, but there are execution steps they need to complete to ultimately close the deals. When they do, it will significantly improve their financial position concerning their debt. Their plan is feasible, but it will require a little more time.

Austin Wurschmidt, Analyst

Got it. That's helpful. Lastly, Eric, can you share anything about the negotiations and plans for renewing or possibly an early renewal of the 2026 NHC leases?

Eric Mendelsohn, CEO

Just that their discussions are ongoing.

Austin Wurschmidt, Analyst

Would you expect anything that could get announced or completed before the end of this year?

Eric Mendelsohn, CEO

That's probably not by the end of the year. It's probably a next-year type of thing.

Austin Wurschmidt, Analyst

Appreciated, thank you.

Operator, Operator

We'll get to our next question on the line from Connor Siversky with Wells Fargo. Please go ahead.

Connor Siversky, Analyst

In the midst of some of the weakness we've seen in independent living throughout this earnings cycle and some of the commentary from NAREIT, is this an area of senior housing where any would like to allocate capital to at the present? Or are there better opportunities that exist within assisted living or skilled nursing from your perspective?

Kevin Pascoe, CIO

This is Kevin. As it currently stands, I think the yields are going to be slightly better on the more need-driven product, which is where a lot of our attention has been lately. I think there could be some opportunities on the independent side. First and foremost, though, we want to make sure we get our portfolio something closer to stable before we do a lot more investment there. That said, whether it's with our current operating partners or with a new operating partner that could bring some communities and a new relationship to us, we would absolutely explore that. To date, though, we haven't seen the yields be enticing on independent living. That's probably closer to where we see some implied cost of capital still. So, there's not an accretive margin. We're tending to focus our efforts elsewhere.

Connor Siversky, Analyst

That's great, Kevin. And sticking with capital allocation, it sounds like more about your plans for the second half of '23 over here. Specifically, do you anticipate paying down any additional debt or any activity on the equity side?

John Spaid, CFO

So, right now, we're in great shape in terms of our leverage so that we could deploy a little more leverage towards acquisitions. That would be our initial plan. What we're trying to do is get back to that growth and demonstrate that the noise has been eliminated from our name, and the growth is back, which would then improve the equity and lower our total cost of capital. Once we get into a steady stream of investments, we would then start entertaining tapping equity again. I would remind you that we do have a $160 million authorization to repurchase our stock. So, that's always on the table, particularly since we have some leverage to be able to do just that.

Connor Siversky, Analyst

That’s very helpful thank you, guys.

Operator, Operator

And we have no further questions on the line. Please continue with the presentation or any closing remarks.

Eric Mendelsohn, CEO

Thanks, everyone, for your time and interest today, and we'll see many of you at NAREIT.

Operator, Operator

Thank you very much, and thank you, everyone. That does conclude the conference call for today. We thank you for your participation and ask you to disconnect your lines. Have a good day, everyone.