Omega Healthcare Investors Inc Q2 FY2023 Earnings Call

Good day, ladies and gentlemen, and welcome to the Omega Healthcare Investors Incorporated Second Quarter Earnings Conference Call. All lines have been placed on a listen-only mode and the floor will be open for questions and comments following the presentation. At this time, it is my pleasure to turn the floor over to your host, Michele Reber. Ma'am, the floor is yours. I think you are on mute.

Thank you, and good morning. With me today are Omega's CEO, Taylor Pickett; COO, Dan Booth; CFO, Bob Stephenson; and Megan Krull, Senior Vice President of Operations. Comments made today on this conference call that are not historical facts may be forward-looking statements such as statements regarding our financial projections, dividend policy, portfolio restructuring, rent payments, financial condition or prospects of our operators, contemplated dispositions or transitions, and our business and portfolio outlook generally. These forward-looking statements involve risks and uncertainties, which may cause actual results to differ materially. Please see our press releases and our filings with the Securities and Exchange Commission, including without limitation on a recent report on Form 10-K, which identify specific factors that may cause actual results or events to differ materially from those described in forward-looking statements. During the call today, we will refer to some non-GAAP financial measures, such as NAREIT FFO, adjusted FFO, FAD, and EBITDA. Reconciliations of these non-GAAP measures to the most comparable measure under generally accepted accounting principles as well as an explanation of the usefulness of the non-GAAP measures are available under the Financial Information section of our website at www.omegahealthcare.com, and in the case of NAREIT FFO and adjusted FFO, in our recently issued press release. In addition, certain operator coverage and financial information that we discuss is based on data provided by our operators that has not been independently verified by Omega. I will now turn the call over to Taylor.

Thanks, Michele. Good morning and thank you for joining our second quarter 2023 earnings conference call. Today, I will discuss our second quarter financial results and certain key operating trends. Second quarter FAD, funds available for distribution of $0.70 per share significantly exceeded the first quarter of $0.60 per share, comfortably ahead of our $0.67 per share dividend. The FAD dividend payout ratio is 96%. The large increase in FAD is primarily due to the resumption or increase in rent from cash basis operators. One operator, LaVie, paid partial rent in April and full rent in May and June, which results in a $0.035 increase in FAD quarter-over-quarter. As Dan will discuss, LaVie is still being restructured and we have agreed to partial rent payments of $2.5 million per month for the third quarter, which will reduce FAD by $0.035 from Q2 to Q3. When the LaVie restructuring is completed, we expect a significant increase in cash rents from the current agreed-upon partial rent payments. In addition, during the second quarter, we issued 6.6 million shares of common stock to fund our pipeline and delever. These additional shares will put some modest pressure on our future FAD per share. Turning to positive operating trends. First quarter EBITDAR coverage, excluding CARES Act support, continues to improve, increasing to 1.15x versus 1.09x in the prior quarter. This level of coverage reflects continued occupancy improvement, strong state reimbursement rates, and moderation in the still difficult labor market. The under 1.0x EBITDAR operators represent 29.9% of total rent. We can break the 29.9% into a handful of buckets. Operators representing 6.2% of the 29.9% are sitting on extremely strong balance sheets, and therefore, payment of rent should not be an issue. Operators representing 8.1% at first quarter EBITDAR coverage above 1.0x, and 9.5% represent those with first quarter EBITDAR coverage, when excluding the anticipated sale or transition of 23 facilities is also above 1.0x. That leaves operators representing 6.1% of which operators representing 3.5% are in active restructurings where we recently conditioned, which sees the balance of $2.6 million representing a small operating relationship. I will now turn the call over to Bob.

Thanks, Taylor, and good morning. Turning to our financials for the second quarter. Revenue for the second quarter was $250 million before adjusting for certain nonrecurring items compared to $245 million for the second quarter of 2022. The year-over-year increase is primarily the result of timing related to operator restructurings, revenue from new investments completed in 2022 and 2023, partially offset by asset sales completed through that same timeframe. Our NAREIT FFO for the second quarter was $155 million or $0.63 per share compared to $161 million or $0.66 per share for the second quarter of 2022. Our adjusted FFO was $183 million or $0.74 per share for the quarter, and our FAD was $173 million or $0.70 per share, both excluding several items and systems with historical practices as outlined in our adjusted FFO and FAD reconciliation to net income found in our earnings release as well as our second quarter financial supplemental posted to our website. As Taylor mentioned, the $0.70 FAD for the second quarter was $0.10 greater than our first quarter FAD. This increase was primarily driven by incremental revenue from LaVie. The completion of workout arrangements and timing of payments from other cash basis operators was partially offset by additional weighted average shares. In the second quarter, we closed on $270 million in new investments. The second quarter new investments, the majority of which were completed in April, are expected to produce incremental contractual rent and interest, or FAD, approximately $1.3 million in the third quarter. We have a number of operators on a cash basis for revenue recognition, including LaVie, which is projected at $2.5 million per month. We will only report FAD from our cash-based operators to the extent payments are received or security deposits are applied. It's important to note that our third quarter FAD will also be impacted by the increase in the weighted average shares outstanding as we issued 6.6 million shares for proceeds of approximately $200 million in June. For every 6 million shares issued, our quarterly FAD is negatively impacted by approximately $0.105 per share until the cash is put back to work in new investments. In summary, consistent with the commentary provided last quarter, we still expect Q4 FAD payout ratio to approximately cover our 66% dividend, with FAD to return to a normalized payout ratio in the high 80s to low 90s in 2024. Our balance sheet continues to remain strong. In the second quarter, we issued 6.6 million shares for $200 million of equity, and we also terminated our $400 million in treasury locks, which generated $93 million of cash gain, leaving us with $350 million in cash at June 30. On August 1, we used the balance sheet cash to repay a $350 million bond maturity. Looking forward, based on the current capital markets and our active pipeline, on April 1, 2024, $400 million bond maturity, we expect to continue to be opportunistic in the equity capital markets while targeting leverage in the low fives. At June 30, 99% of $5.3 billion in debt was at fixed revenues and our net funded debt to annualized adjusted normalized EBITDA of 5.1x and our fixed charge coverage ratio was 4.1x. I'll now hand it over to Dan.

Thanks, Bob, and good morning, everyone. As of June 30, 2023, Omega had an operating asset portfolio of 893 facilities with approximately 88,000 operating beds. These facilities were spread across 66 third-party operators and located within 42 states in the United Kingdom. Trailing 12-month operator EBITDAR coverage for our core portfolio as of March 31, 2023, increased to 1.1x versus 1.04x for the trailing 12-month period ended December 31, 2022. During the first quarter of 2023, our operators cumulative have recorded approximately $5.8 million in federal stimulus funds, compared to approximately $20 million recorded during the fourth quarter. Trailing 12-month operator EBITDAR coverage would have increased during the first quarter of 2023 to 1.02x, as compared to 0.92x for the fourth quarter, when excluding the benefit of any federal stimulus funds. EBITDAR coverage for the standalone core ended March 31, 2023, for our core portfolio was 1.8x including federal stimulus and 1.15x excluding the $5.8 million of federal stimulus funds. This compares favorably to the standalone fourth quarter of 1.19x and 1.09x with and without the $20 million in federal stimulus funds, respectively. Occupancy for our overall core portfolio has continued to recover from a low of 74.6% in January of 2022 to 79.6% as of mid-July of 2023 based on preliminary reporting from our operators. Turning to portfolio matters, LaVie, as previously mentioned, Omega and LaVie are in the process of restructuring their portfolio by transitioning certain underperforming facilities, most located in the state of Florida. To date, 13 facilities have been divested. Currently, Omega is in the process of selling or releasing an additional 23 facilities, most of which are expected to be transferred throughout the fourth quarter of 2023. During the second quarter of 2023, LaVie paid partial rent in April of $2.5 million and full contractual rent for May and June of $7.2 million each month. In anticipation of the future transition of 23 additional facilities, Omega has agreed to allow LaVie to short pay rent by approximately 66% during the third quarter of 2023. Maplewood, in the second quarter, short paid its contractual June and July rent by $1 million per month. We currently are working with Maplewood and the state of Greg Smith to address these shortfalls. Based on Maplewood's latest cash flow projections, which incorporate anticipated January rate increases and improved census at the Second Avenue Facility in Manhattan, Maplewood believes there is a path forward to meet its full contractual rental obligations in the first quarter of 2024. In August, we drew on a $4.8 million security deposit and we'll be applying the security deposit to any rental shortfalls realized in the third quarter. In addition to the aforementioned restructurings and transitions, Omega is working with several other relatively small operators on various restructures. Turning to new investments, as previously announced on April 14, 2023, Omega closed on a $219 million transaction, which consisted of a $114.8 million purchase lease transaction for four facilities in West Virginia and a $104.6 million in mezzanine financing. Currently with these acquisitions, Omega amended an existing operator's master lease to include the four facilities and an initial cash yield of 9.5% with 2.5% annual escalators. The mezzanine financing was given to the same existing operator bearing an interest rate of 12% and was part of the capital stack to purchase 13 additional facilities in West Virginia. Also, as previously announced, on May 1, 2023, Omega purchased one additional facility in West Virginia for $13.7 million. The facility was added to an existing operator's master lease with an initial cash yield of 10% with 2.5% annual escalators. Additionally, on June 30, 2023, Omega closed on a $10 million mezzanine loan to an existing operator. The mezzanine loan bears an interest rate of 11% and is part of a capital stack to purchase 12 facilities in Pennsylvania. Omega closed on a total of $270 million in new investments in the second quarter of 2023, including $17 million in capital expenditures. Year-to-date, Omega has closed on $313 million of new investments, including $29 million in capital expenditures. Turning to dispositions during the second quarter of 2023, Omega divested 10 facilities for a total of $45 million in proceeds. Year-to-date, Omega has divested 12 facilities for a total of $62 million in proceeds. I'll now turn the call over to Megan.

Thanks, Dan, and good morning everyone. We continue to see slow positive momentum and occupancy with the number of core facilities now recovered at 35%, up slightly from the 33% reported in the fourth quarter. Additionally, 25% of core facilities that have not yet fully recovered are at or above 84% occupancy. Staffing shortages, while continuing to moderate, persist, delaying overall recovery and continuing to vary by market. In June, we released the results of the survey of 425 nursing home providers, results of which showed that 52% are still limiting new admissions due to staffing shortages. Agency expense on a per-patient day basis for our core portfolio for the first quarter of 2023 remained at 5x where it was in 2019, which, while consistent with last quarter, did show modest month-over-month improvement, helping to offset some of these persistent expense increases. On the rate setting for adjustment, CMS issued its final 2024 payment rule resulting in a net increase of 4% or approximately $1.4 billion, which is slightly better than the 3.7% provided for in the proposed rule. This included a 6.4% net market basket update consisting of a 3% market basket increase plus a 3.6% market basket forecast error adjustment offset by a 0.2% productivity adjustment, as well as the remaining 2.3% PDPM parity adjustment recalibrations. And on the state side, while the magnitude of certain rate increases is not exactly what we had hoped for in certain areas, it is still moving in the right direction. Texas, of note, provided for at least the $19.63 COVID FMAP add-on to be included in its permanent rate setting starting September 1, in addition to a small increase above that and Florida provided for up to a 5% rate increase starting October 1. While much of the Florida rate is based on quality indicators, meaning that not all operators will see this large of an increase, it does represent somewhat of a trend in rate setting where more and more states are tying reimbursement increases to quality measures. Assuming this is done in a thoughtful manner, this is something that we welcome; however, it should never fully replace increases tied to the inflationary environment. I'll now open the call up for questions.

Our first question is from Tao Qiu from Berenberg. Go ahead.

So, LaVie was a positive surprise this quarter, appreciate the cut on the $0.305 step down for the next quarter. I think there are a few additional puts and takes for the next quarter. I think Maplewood was below expectations and you still have a security deposit to apply. I think there's one more month of rent coming from healthcare homes. The shared county is higher. I'm just wondering if you could help us reach to the third quarter on the FAD number?

It's Bob, I think the only other component to look at, I did mention the incremental revenue related to acquisitions completed in a quarter, and then also Taylor and I both mentioned that the shares issued or issued late in the quarter, so you're going to have some modest impact based on the weighted average shares.

And just one follow-up, we got the 4% Medicare update earlier this week and thanks for the comments about Texas and Florida. I think California is also pretty well known. Just wondering if you could walk us through some of your other big markets, for example, Indiana, North Carolina, Pennsylvania statues, and what are you seeing those states in terms of the 2024 Medicaid reimbursement rates?

Yes, some of them are a little bit too early to tell. Indiana, I think that they're still hoping for an inflationary increase somewhere in the 3% to 4% range, but I don't think that's been finalized quite yet. But remember in Indiana, we've got the UPL too, so that Medicaid rate setting doesn't necessarily impact our coverages the same way. Pennsylvania, I think, there was a little bit of a rate reduction actually in July. Just a small one due to, there was a budget factor, rate decrease related to the January 1st increase. And they're hoping that gets reversed in January, but again, way too soon to tell. For Pennsylvania, they had that really large increase last year, so I think they're pretty well set for the moment. And then North Carolina, that's one we've really been watching, and they were supposed to, they thought they would get their budget approved earlier, but they haven't yet. They have a $37 PPE FMAP add-on, which they've been trying to get into the rate. They think it's likely to happen. That's what the operators are pushing for at the moment because the state has pushed that $37 or most of it out, at least through August right now until they finalize the budget, but they're hopeful that they get that put in.

Thank you. As a reminder, please ask one and one follow-up question. Our next question comes from Jonathan Hughes from Raymond James. Go ahead, Jonathan.

I was hoping you could dig a little deeper on LaVie. I know that restructuring has been ongoing for some time now and that they paid more rent than expected in May and June. But I guess, why did they pay more rent if they didn't necessarily have to?

It really boils down to cash on hand that they were a little bit more liquid in the second quarter than they anticipated. And so they were able to make the full rent payment for May and June. We have got some transitions coming up, so the expectation is that their cash and their liquidity is going to go down until those transitions occur. Like with any transition that involves a sale, they take a while and there is a lot of lead time running up to that. There is a lot of third parties that we have no control over. So, the expectation at least for right now is that in the third quarter, we will see that reduced rent amount.

Okay. And then maybe my follow-up is, and I realize we are still waiting on this. But any user or updated expectations just on the staffing mandate that we have all been waiting for a few months now. I think one of the operators said, hopefully, we can have it by the end of the month, but just any views there would be helpful. Thank you.

Honestly, we don't have that crystal ball at the moment. I mean, we hear the same things that I'm sure you guys hear. I think we view the fact that this hasn't come out yet despite the fact that it should have come out in April as a positive, that hopefully CMS has gotten a ton of comments related to this, in terms of, not having a one size fits all mandate, and hopefully pushing it out until there isn't a staffing crisis. And we are hopeful that they will take a balanced approach based on how long they've been keeping. But we still have to put any clarity as to when it will come out. But remember, as well that it's going to come out of the proposed rule, right? There is going to be a comment period. And so, ACA has historically been very good at getting things more beneficial than what it first comes out of.

Thank you. And our next question comes from Connor Siversky from Wells Fargo. Go ahead.

Good morning. Thanks for having me on the call. I would like to dig into Maplewood and apologies if I missed this in Dan's remarks. But could you quantify at all what that cash flow ramp looks like from today through the end of 2023 between the lease-up of Second Avenue? And potential rate increases at the end of the year? Or worded differently, I mean, how much EBITDA can we see from the second half? How much from rate increases? And do you think that would cover the rent shortfall?

Yes. Just, I'm going to make this a relatively longer answer, Connor, just because I think the context is important. So, if you look at Maplewood as a whole, the core portfolio, excluding Second Avenue, is performing very well. Their occupancy is at pre-COVID levels. They have significant cash flow. And then you look at Second Avenue, which is in Philip 61% occupied. It has now positive cash flow pre-rent. So incremental occupancy is just going to add to that cash flow, and we expect another 10% of incremental occupancy, so from 131 residents to 151 by year-end. Obviously, that has a lot of power in terms of cash to the bottom line. On the flip side, rate increases happen typically in January. So, you do have whatever inflationary impact between now and the end of the year that will cut into a little bit into that cash flow. So to get you precise numbers is difficult; it probably doesn't change much from the million dollar deficit we're seeing today. But then just to close the loop on the rate increase piece of the puzzle, Maplewood's total revenue is about $200 million. So when you think about last year's rate increases, which were high-single, low-double-digit, with the expectation in the industry of something similar for high-end properties, that's really meaningful in terms of the amount of top-line revenue to overcome the cash deficit we have today. So, long answer to your question, but I think that context is important.

Great. Appreciate the color Taylor. That's helpful. And then just as it relates to the line of credit and the building deferral balance, I mean, what does the total TAB to OHI look like currently? How big do you expect that to get? And then is there a threshold that you wouldn't want to cross?

So, we're at $270 million round numbers, and we don't expect to fund any additional cash into that line. Remember, we have interest that we're on a cash basis with Omega. So we continue to accrue interest that obligation continues to run to Maplewood. But from a cash perspective, we're done funding that one.

And our next question comes from Michael Griffin from Citi. Go ahead, Michael.

Just maybe circling up on labor availability, in conversations with your operators, do you have a sense of kind of where agency labor utilization is trending expectations for the back half of the year? And kind of where do you need to see occupancy to get to really ease a lot of those labor pressures?

I mean, from an agency perspective, it's definitely improving. That's what we're hearing anecdotally from our operators. And certain operators are able to get out of it completely, but it's really geographically based. I mean, Florida tends to be one of the states that's having severe staffing shortages. So it really depends on where you are. And in terms of occupancy, we always talk about that national 84% and getting back up close to there. I mean, we're close to that 80%, but with agencies still high, we just need to work through some of the staffing issues to solve all those problems.

Great. That's helpful. And then maybe switching to external growth opportunities. Can you give us a sense of what the forward pipeline is looking like? You've done a number of investments year-to-date. Just kind of can you quantify maybe that opportunity set and where relative to where they might have been previously?

So I don't want to naturally quantify, but I will say it's quite active. We're looking at a fair number of deals about here in the states and abroad in the U.K. I'd say the U.K. is particularly active. We're seeing some opportunistic transactions here in the states, and we're going to try to take advantage of some of those. I think what we've done year-to-date is a pretty good proxy for what we hope to do in the next latter half of the year. As far as rates go, yes, we're seeing cap rates move up; we're starting to bid our deals, as you've seen, high 9 low 10.

Thank you. And our next question comes from Joshua Dennerlein from Bank of America. Go ahead, Joshua.

In the opening remarks, you mentioned there was a certain subset of the portfolio still covering low 1x. I didn't hear them out, but just curious, is there any kind of big picture theme that's causing that part of the portfolio to lag versus like the overall at 1.15?

I don't know that there's necessarily a theme. When you break down those buckets, LaVie, the big piece, obviously, when we talk about that, we're fixing that. But then you have another significant piece of that we'll know that we have pretty good visibility that's going to, that they'll climb out of that below one bucket. And then you get back to the handful of operators where there's not a lot of visibility. They're small. It's under 3%, and that's where we've run historically for many years. So, I think there's a pathway, honestly, to look at that below net bucket, and it's going to take a little while where we climb for that bucket and get back into less than 5% of our portfolio. It's not going to be next quarter, but we have visibility. It's pretty good.

And maybe just the part of the bucket that you expect to climb out of that, any kind of timeframe on that? Yes, I guess, maybe just time frame, just I'm trying to think through it.

I will provide two main examples. LaVie is in the final stages of restructuring, which, as Dan mentioned, is taking longer than anticipated, but it will be completed this year. Additionally, we currently have 8.1% performing above 1x. The issue here is how we report it, as we are waiting for the trailing 12 to align. Together, these two categories account for nearly 18%. Alongside the ongoing restructuring efforts, we expect to have more reporting clarity by Q1, which should reassure many stakeholders.

And our next question comes from Steve Valiquette from Barclays. Go ahead, Steve.

This is Steve Valiquette from Barclays. My first question is about how the end of the Public Health Emergency in May has affected the business in June and July. I'm looking to get a clearer understanding of its impact. Additionally, regarding the earlier question, assuming LaVie is the operator that is closest to completion, would you still agree that it aligns with reducing the number of operators with an EBITDAR coverage ratio below 1x down to the 20% range? Can you also confirm that LaVie is the operator nearest to being fully restructured?

So the public health emergency, I would say there hasn't been a very large impact. Obviously, the filing in place that's gone, but a lot of that was kind of tapered off anyway. It's not a huge impact. The other piece of it is really the FMAP piece, which we've gone over. Some of these states have large FMAP increases in most like California put that through the end of the year. Hopefully, next year, that will get added on permanently. Texas is going to have their FMAP rate in their permanent rate as well. So most of these states have either dealt with it or are scaling with it. So I would say not much of an impact at this point.

Yes, LaVie is 9.5% of 29.9, so one LaVie restructured at around 20%. There are two categories of operators, one with a very strong balance sheet at 6.2%, and another with an 8.1% bucket of operators that had Q1 EBITDAR above one-time, amounting to another 14%. We expect to gain visibility on all of this, not in the next quarter but by the time we move into 2024. I believe we will achieve a significant reduction to 6%, and we are actively working on a substantial portion of that 6%. The number should drop to historical levels below 5% if current trends continue.

Thank you. That is the last question for today. At this time, I would like to turn the call back over to Taylor Pickett for any closing remarks.

Thanks everybody for joining us today. As always, we're available for any follow-up questions. Have a great day.

Thank you. This does conclude today's conference. We thank your participation. You may disconnect your lines at this time, and have a wonderful day.