Sabra Health Care REIT, Inc. Q2 FY2022 Earnings Call

Welcome to the Sabra Health Care REIT Second Quarter 2022 Earnings Conference Call. I would like to turn the conference over to your host, Lukas Hartwich, EVP, Finance. Please go ahead, Mr. Hartwich.

Thank you and good morning. Before we begin, I want to remind you that we will be making forward-looking statements in our comments and in response to your questions concerning our expectations regarding our future financial position and results of operations, including our expectations regarding our tenants and operators, and our expectations regarding our acquisition, disposition and investment plans. These forward-looking statements are based on management's current expectations and are subject to risks and uncertainties that could cause actual results to differ materially, including the risks listed in our Form 10-K for the year ended December 31st, 2021 as well as in our earnings press release, included as Exhibit 99.1 to the Form 8-K we furnished to the SEC yesterday. We undertake no obligation to update our forward-looking statements to reflect subsequent events or circumstances and you should not assume later in the quarter that the comments we make today are still valid. In addition, references will be made during this call to non-GAAP financial results. Investors are encouraged to review these non-GAAP financial measures as well as the explanation and reconciliation of these measures to the comparable GAAP results included on the financials page of the Investors section of our website at sabrahealth.com. Our Form 10-Q, earnings release, and supplement can also be accessed in the Investors section of our website. And with that, let me turn the call over to Rick Matros, CEO, President and Chair of Sabra Health Care REIT.

Thanks Lucas and thanks, everybody, for joining us today. To start, I just want to note that how we're looking at the business and talking about the business is a little bit different now. From our perspective, we've moved from pandemic to endemic and that's just an acceptance. We think of the reality is the virus is always going to be here in some form or fashion. The number of cases, both for staff and residents that we have on a daily basis throughout the portfolio is in the hundreds, it's not thousands, much less tens of thousands as we saw during the worst of the pandemic. So, we prefer not to be here, obviously, but we think it's here to stay and the levels of cases that we're seeing at the facilities, both again in terms of staff and in terms of residents, is not impactful in and of itself on the business. Other things are impactful, but that in and of itself isn’t impact along the business. Moving to reimbursement, we've added some disclosure to show two charts; one, the extensions of FMAPs and we're showing our top 10 states, so extension for FMAPs and the actual Medicaid rate increases that we would normally get on an annual basis. And what we've seen and this reflects in comments we've made over the past year and a half about the tone changing in a lot of the states, relative to Medicaid underfunding the business and state budgets being better than anticipated throughout the pandemic. So, we're really pleased that with the number of states that have extended FMAP for a pretty long period of time through 2023 in a number of cases and in those states that give much larger than historical increases for annual Medicaid rate increases. And in the case of a couple of states, we got both FMAP extensions and regular Medicaid rate increases. So, all-in that affects approximately 60% of our skilled nursing portfolio. And as you think about the CARES Act and things like that tailing off, PHE has been extended through October. We are somewhat optimistic that it will be extended through year-end. But other things have fallen off. So, we really look to the states to be helpful here. And certainly, in those states that took these actions, it's incredibly helpful, and will help with staffing issues as well. I also want to note and express our appreciation of CMS for the final rule. That was a 340 basis point improvement over what the proposed rule was – and important to note that, of that 340 basis point improvement, 110 basis points was specifically due to capturing inflationary costs. Obviously, it doesn't capture all the inflation, but at least it's a step in the right direction. And since its part of the formula, we should expect to see inflation capture in next year's market basket as well. Additionally, although occupancy in our skilled portfolio improved 100 basis points sequentially from first quarter to second quarter. We are seeing a slowing down in July, both due to seasonality and continued labor pressures. Labor pressures are not as bad as they were at their worst. Agency has come down and hiring is up, but it's still going to be a slog for a while. It's tough, and it has hampered the rate of recovery relative to how quickly patients could be admitted. But we're also seeing seasonality come back. We haven't seen seasonality over the last couple of years. And both those factors apply to our senior housing portfolio as well as our skilled nursing portfolio. Moving on to investments and our overall strategy, our investment activity continues to be healthy, although most of the deals we see are in the senior housing space with some opportunities in the behavioral space. Although, we don't see many opportunities in the skilled space, buyers reached to many of our skilled assets at attractive pricing. As a result, we anticipate ample proceeds to fund new investments and so any increase in leverage as we saw in this quarter is specifically due to timing, and we, therefore, don't intend to access the markets. These dispositions will also result in the lowest skilled exposure in the portfolio since prior to the CCP merger. While that asset class will still be our largest will be a much more diversified REIT, with senior housing and behavioral balancing us out. In terms of ESG, we are close to publishing our second annual report. We expect that to be out in the next several weeks and look forward to any important comments as people have a chance to review that report. And with that, I'll turn the call over to Talya.

Thank you, Rick. I'm going to start with some brief comments on the performance of our fully owned managed senior housing portfolio and then provide an update on the initiatives that we have undertaken, to allow us to continue to diversify our portfolio and improve the durability of Sabra's revenue stream. In the second quarter of 2022, we saw continued improvement in the operating performance of our wholly-owned managed senior housing portfolio, despite the impact of the Omicron variant, which worsened ongoing labor challenges. As occupancy and rates continue to rise, operating leverage is a positive, providing a list of cash net operating income. The headline numbers for the quarter on a same-store basis are as follows: Occupancy for the second quarter of 2022, excluding non-stabilized assets was 80.7%, driven by a 290 basis point increase in our assisted living communities, and a 60 basis point rise in our independent living community, compared to the prior quarter. Comparing second quarter 2022 to second quarter 2021, occupancy in our assisted living communities increased 620 basis points, and 230 basis points in our independent living communities. Same-store occupancy has consistently trended up across our portfolio since the COVID-19 surge in early 2022. RevPAR for the period, excluding non-stabilized assets was $6,291 in our assisted living portfolio, a 6.6% increase over second quarter 2021 and $2,671 in our independent living communities, a 3.2% increase over second quarter 2021. Rising occupancy, coupled with rate growth reflects both the stickiness of existing residents and our operators' ability to balance rate increases while attracting new residents. Excluding government stimulus funds, cash NOI for the quarter increased nearly 11% over the prior quarter and 44% in our assisted living portfolio alone. This dramatic increase in cash NOI and assisted living is largely attributable to higher revenue in our wholly-owned living portfolio. Because this portfolio has more memory care, the occupancy impact from COVID-19 surges has been greater, but the rebound has also been faster. Cash NOI margin, excluding government stimulus funds increased 1.5 percentage points, driven by our assisted living portfolio, where margin expanded by four full percentage points over the prior quarter. Our operators continue to address labor challenges and now inflation, impacting costs, such as food and utilities. Higher expenses are partially offset by revenue growth but continued to impact the rebound of NOI margin. While in-place residents have been receiving 6% to 8% rate increases year-over-year, new residence rates are 10% to 13% higher on a year-over-year basis. Strong leasing velocity continues across our portfolio with gross move-outs normalizing and even dropping below pre-pandemic levels. Availability and competition for staff remain a challenge that is mitigated but not yet solved by higher wages. Last quarter, I mentioned that we had undertaken a comprehensive review of our portfolio with the intent of recycling assets and recycling capital. We are now determining which properties are long-term holds and which are candidates for conversion, repositioning or sale. As we continue to convert select properties for use as addiction treatment facilities, our investment in behavioral health is increasing. At the end of the second quarter, Sabra's investment in behavioral health included 14 properties and two mortgages with a total investment of approximately $730 million. We intend to invest an additional $27.6 million of capital to complete the conversion of three of these properties, all of which have been leased to operators. Subsequent to the end of the quarter, we executed leases with behavioral health operators on three wholly-owned properties, two had operated as skilled nursing facilities and one is a memory care community. We are now in the process of converting those buildings for use of inpatient addiction treatment facilities. The investment value of these properties will be approximately $47.5 million, with an expected stabilized yield of approximately 9%. Together, this represents more than $800 million invested and committed to behavioral health real estate, consistent with our discussion last quarter. In the past 12 months, 43% of adults in the US who sought mental health or addiction treatment were unable to access care because of cost, availability, lack of treatment options and wait times. We are committed to supporting the delivery of behavioral health services by creating and financing the places where they happen, so that these critical services are accessible to all, regardless of age, income or location. In doing so, we are creating value in our portfolio by generating higher returns in durable income streams as well as continuing to diversify our portfolio. Our attention to this underserved sector is being noticed, and we are now in active discussions with more operators on additional conversion opportunities. Our portfolio review has also led us to explore selling some of our skilled nursing assets. Despite recent dislocation in the lending markets, buyers' appetite for skilled nursing properties remains active and pricing strong. At the same time, we remain highly selective in our new investments as we manage our capital. We view recycling capital and assets as another path to continue to enhance and diversify our portfolio without accessing the capital markets for funding. And with that, I will turn the call over to Michael Costa, Sabra’s Chief Financial Officer.

Thanks, Talya. For the second quarter of 2022, we recognized normalized FFO per share of $0.39 and normalized AFFO per share of $0.38. And compared to the first quarter of 2022, normalized FFO per share increased $0.01, primarily due to higher NOI from our consolidated senior housing managed portfolio, higher normalized FFO from the Enlivant joint venture, primarily related to $3.4 million of government grant income received during the quarter and a decrease in stock compensation expense as a result of adjusting payout estimates on performance-based awards that were set pre-pandemic. These amounts are partially offset by lower NOI from tenants, whose rent is accounted for on a cash basis. This decrease is primarily due to the first quarter collections under the Avamere lease that we highlighted on last quarter's call. As a reminder, in the first quarter, we recognized rent from Avamere for December 2021 and January 2022 at their pre-adjusted rent together with rent for February and March 2022 at their adjusted ramp. Compared to the first quarter of 2022, normalized AFFO per share was flat since normalized AFFO does not include stock compensation expense, and therefore, the pickup noted for normalized FFO does not impact normalized AFFO. Cash NOI for the quarter totaled $118 million compared to $123.5 million in the first quarter. This decrease is primarily the result of $5.2 million of lower cash rent, mostly related to the difference I noted earlier in rent collected from Avamere as well as fluctuations in collections from tenants accounted for on a cash basis. Cash NOI in the first quarter included a $2.3 million lease termination payment on a facility that was closed and subsequently sold, which also accounts for the change in interest and other income this quarter. Cash NOI for the second quarter includes $3.6 million of support payments made by our unconsolidated joint venture to Enlivant, which is partially offset by $3.4 million of grant income recognized as Enlivant joint venture. As we noted last quarter, funding for support payments did not require additional capital contributions from Sabra, but rather were funded with proceeds received by the Enlivant joint venture from TPG. These decreases are partially offset by a $2.7 million sequential improvement in cash NOI from our senior housing managed portfolio. Cash collections from our tenants remain strong and are in line with historical standards. Less than 6% of our NOI is below one-time EBITDARM coverage with rents on nearly all of those tenants being recognized on a cash basis. Additionally, more than half of the tenants with EBITDARM coverage below one-time are paying their full contractual rent to us. As of June 30, 2022, our annualized cash NOI was $450.3 million and our SNF exposure represented 60.7% of our annualized cash NOI, down 100 basis points from the first quarter and down 640 basis points from a year ago. G&A costs for the quarter totaled $8.6 million compared to $10.4 million in the first quarter of 2022. Excluding the stock compensation expense adjustments, I referenced earlier, recurring cash G&A was $7.8 million compared to $7.9 million in the first quarter. During the quarter, we recognized impairment charges totaling $11.7 million related to four SNFs that are being evaluated for sale as part of our initiative to reposition our portfolio and recycle capital. Now turning to the balance sheet. Over the past several years, we have prioritized strengthening our balance sheet, not only with regards to our leverage levels, but also with a focus on maturity laddering and reducing our variable rate debt exposure. This three-pronged approach to managing our balance sheet has proved invaluable in the current debt environment and positions us well moving forward. We have no material maturities until 2024, which reduces our refinancing risk in the near term. Additionally, we have reduced the level of unhedged variable rate debt from 27.2% of our consolidated debt at the end of 2018 to 6.6% today. Excluding our revolver, our unhedged variable rate debt is only 1% of our consolidated debt as of June 30. Because of our hedging activities, our annual interest expense is approximately $4 million lower than otherwise would be at today's market rates. We are in compliance with all of our debt covenants and our liquidity as of June 30, 2022, totaled approximately $924.8 million, consisting of unrestricted cash and cash equivalents of $67.2 million and available borrowings of $857.7 million under our revolving credit facility. As of June 30, our leverage was 5.44 times. While this leverage level is above our long-term target of 5 times, we view this as simply a short-term timing mismatch. During the quarter, the balance on our revolver increased $125.5 million, as we closed on our investment in the Sienna joint venture, and we expect to pay down a revolver by the end of the year, as we receive proceeds from completed and pending sales, which are expected to generate over $210 million in gross proceeds. Once these proceeds are received and we repay our revolver borrowings, we expect leverage to be closer to 5 times. We continue to focus on strengthening our balance sheet and portfolio without accessing the capital markets and are well positioned to do just that. Regarding our capital recycling program, Talya referenced in her prepared remarks, there are two points I would like to make. First, the assets we are selling are primarily poorly performing assets that are on a cash basis, and we have been recognizing rents received from them that are below their contractual rents. Second, while we can't comment on the specifics of the sales until they close, we feel it is important to point out that through a combination of recently completed investments, like our joint venture with Sienna, which has a 6.5% stabilized yield and future investments in our senior housing managed and behavioral health portfolios, we expect to be able to replace the NOI from these sold assets, while meaningfully increasing the quality of our portfolio and durability of our earnings. On August 3, 2022, our Board of Directors declared a quarterly cash dividend of $0.30 per share of common stock. The dividend will be paid on August 31, 2022 to common stockholders of record as of the close of business on August 17, 2022. The dividend represents a payout of 79% of our normalized AFFO per share of $0.38. Lastly, I would like to address our decision to not issue guidance this quarter. We continue to see positive momentum on occupancy and labor availability, albeit at a slower pace than expected. The timing and velocity of the recovery remains unknown and this, combined with macroeconomic volatility continues to make it difficult to confidently provide a meaningful estimate of our earnings at this time. And with that, we'll open up the lines for Q&A.

Thank you. Our first question comes from Juan Sanabria with BMO. Your line is now open.

Hi. Good morning. Just maybe hoping to spend some time on the transition assets you mentioned 25 that are either in process or in the future. Just trying to get a sense of the earnings impact of that, how much rents are those guys paying during the downtime of repositioning the assets? And just kind of the rent uplift or degradation that we should expect as those assets are first repositioned and then released to new tenants, just trying to get a better sense of earnings really?

Yes. Hey, Juan. As I mentioned earlier, the assets we are selling aren't performing well. This applies to the assets we are moving to new operators. Essentially, we aim to transition these to new operators because we believe the current ones aren't achieving the potential these facilities have. In most, if not all cases, these transactions are cash-based. We receive a limited amount of rent from these portfolios. We believe they are good assets in strong markets, but a better operator could enhance performance and increase the earnings we’ve been receiving from the existing operators. There may be some initial challenges as they transition operations, but we view this positively for our portfolio in the long run.

The other thing I would add, Juan, is that, this is all going to happen in one day. So the impact is incremental and not even going to be visible to the investment community because of the way these things get spread. One of the portfolios we actually started talking about some time ago, about 1.5 years ago, which is in New York, and that's still ongoing because everything takes effect. And some of these decisions also, certainly in the case of the New York portfolio, in the case of another portfolio were impacted by the pandemic in terms of how it impacted the operators. In these cases, it was a couple of individuals who had been running these companies for a long time, and they're just done, the pandemic just finished and they just pointed out. And so a lot of this stuff has actually been pretty cooperative. Actually, none of it's been antagonistic or adversarial at all. So that's really the way to think about it. 25% is in a lot of facilities. And if you spread those transitions out over the period of time, it's going to take for them to actually occur at any given moment, it's just not going to have much of an impact.

And then on the dispositions themselves, the $210 million that you talked about, can you comment on or provide the cash or the rents that were flowing through FFO in the second quarter on those assets?

Yes. Yes, Juan. We're not in a position to talk about nor should we talk about those sales until they've closed. Once we have the cash in hand and those sales are closed, we could provide additional color on what's going away. I think the part that should provide you and everybody else for that matter, comfort is the statement that I made in my prepared remarks, which is we expect to be able to replace that NOI with the investments that we're making. So you can just take a guess at the kind of investments we're making, what the associated cap rates are with that. And you could assume it's going to be somewhere at least equal to that, if not lower than that.

So these are specifically skilled nursing assets. And as mentioned, we've been talking about for a while now. There's just an appetite for that out there from private buyers and private capital who have existing operating companies and since these are the cash tenants, the yield we're getting is pretty fantastic, which goes to Mike's comment that even reinvesting in senior housing is a positive outcome for the company.

Thank you.

Thank you. Our next question comes from Michael Griffin with Citi. Your line is now open.

Hi, thanks for taking the question. I'm just curious, what caused the tick-down in skilled nursing coverage this quarter? And sort of where could you see that trending throughout the rest of the year?

Yes. You have to keep in mind that, we're moving one quarter further away from the large injection of stimulus into the space. You had a quarter last year, where there was stimulus coming in, mainly in the form of the provider relief fund. And then this quarter, the latest quarter that we picked up had virtually nothing in it. I think the more comparable metric is to look at the coverage we disclosed on our SNF portfolio without PRS funds and see how that compares to last quarter, which is stable.

Yes. And so, I said a little bit differently, we're not seeing declining trends there. It's simply a matter of what Mike just talked about.

Okay. That's helpful. And then just one question on the capital markets. Just given that the equity cost of capital seems to be improving, I guess, why not try to tap into those capital markets as opposed to selling the assets?

Well, you might have a different perspective, but I want to remind everyone of how the investment community reacted when we used the ATM last year, particularly during our $100 million equity offering at $14.40 last fall. The response was almost intense, with people eager to express their discontent. However, we are not divesting from assets that you might consider strong. Some of these have been negatively impacted by the pandemic, and as we evaluate them, the path to recovery is likely to be long and difficult, and some may never truly recover. As Mike mentioned earlier, we believe that this approach will enhance the long-term stability of our earnings, and it will also leave us with a more diversified REIT in the end.

Yes. And the other thing I'll add to that is, as Rick alluded to, we're not just selling assets to fund growth, right? Could we access the equity market today? I don't want to. I don't think the price is appropriate for us to do that, even though I think we're trading over NAV as we sit here today. We're not just selling assets to fund growth, that's one benefit of it. But the more important part of it is, a term you keep hearing in our prepared remarks and in our comments is, the durability of earnings. We're repositioning our portfolio. We're improving our portfolio and we're creating a better portfolio for when the capital markets are going to be more favorable and that could fuel additional growth. So, I wouldn't look at it solely that we're selling assets just to buy new assets.

The other thing I'd say is just to put this in perspective, 25 facilities isn’t a lot of facilities. When you look at the size of our portfolio, $200 million in disposition proceeds, when we normally do about $100 million a year anyway, isn't that just not that significant. So, it's not like we're restructuring the entire company or anything like that. We're fine-tuning it really.

All right. That’s it from me. Thanks for the time.

Thank you. Our next question comes from Vikram Malhotra with Mizuho Group. Your line is now open.

Thank you for taking my question. I wanted to clarify that you mentioned 6% of the tenants are under one-time coverage. What was that figure last quarter? And you also mentioned that about 50% of those are cash paying. Could you please clarify that?

Yes. To answer your first question, that number has remained fairly consistent over the last couple of quarters. Most of the tenants in that 6% I mentioned are on a cash basis. More than half of that 6% are paying their contractual rent. It's important to highlight this because there's often an immediate assumption when hearing that someone is not covering their rent, leading to the belief that they won't pay it. That's not accurate in this case. We are receiving contractual rents from these tenants, not just below contractual amounts. We are actually getting the full contractual rents, even though we classify it on a cash basis, and despite their EBITDARM Coverage being below one. This should provide some reassurance that there are no adjustments expected because they are below that one-time coverage and are still making payments.

That's helpful. You mentioned the sequential dip in cash income or cash rent was primarily due to the Avamere change. Going forward, can you clarify whether your underwriting accounts for any additional tenants potentially unable to pay rent, or is it simply a steady state for now?

It's steady as she goes for now. But I would also, I'm always going to caution everybody, the recovery is slower than we were all like, in large part due to the labor pressures. And as we've been talking about the last several quarters, even though we've had a pretty steady portfolio, there's always a chance that if this thing drags on, people may need some assistance, but we use assistance as not material to the company overall and shouldn't affect our underwriting.

Okay. Great. And then just one last question on the diversification plan. This was brought up last quarter as well, but you've observed improving trends on the skill side, particularly focused on behavioral. Could you revisit for us if there are specific goals regarding the mix you'd like to achieve? Is part of this still aimed at reducing risk in the SNF portfolio? Please update us on your thoughts about further diversification.

We are very optimistic about the skilled space, and even as we diversify, more than half of our portfolio will still consist of skilled nursing. With every positive trend in that area in the coming years, we will benefit because it will continue to represent a significant portion of our portfolio, and we are comfortable with that. Historically, if we look back before the merger when we had a 50% allocation compared to over 60% for skilled nursing, the investment community viewed us as a more diversified REIT and we traded at a higher multiple during those times. Our goal is to mitigate risk by spreading it across more asset classes that we are confident in. However, we do not intend to reduce our skilled nursing exposure from the current levels; instead, we aim to be a bit more diversified to avoid complete reliance on one asset class and to lessen dependence on market sentiment.

That makes sense.

The diversification of payer volatility and expectations regarding it are important. Senior housing is primarily funded by private pay, while skilled nursing relies mostly on government payers. Behavioral health incorporates a variety of funding sources, but for us, it leans more towards commercial insurance with some government pay involvement. This is relevant because some investors feel uneasy about potential changes to Medicare or Medicaid. I believe this approach should help reduce the intensity of that risk.

Great. Thanks for the color.

Thank you. Our next question comes from Tal Shu with Stifel. Your line is now open.

Hi, good morning everyone. First of all, thank you for the state-by-state disclosure FMAP and Medicaid rate growth. I think the data is really helpful to clarify the amount of state support out there still despite perhaps the pullback at federal level. It looks like a lot of the support is going to sustain through at least midyear 2023. And the Medicare refinement has improved for next year. So I'm curious how you think about Medicaid funding beyond 2023, what is more permanent in nature and whether we will see a funding cliff for certain states at some point?

A lot of it depends on the state budgets at any given time, and the conversations have become much more positive. Previously, state budget issues led to a lack of constructive dialogue. However, we are now observing access issues across the country; for instance, Wyoming recently experienced a 10% reduction in beds due to financial problems. Over the last seven years, 1,000 nursing homes have closed in the West, with an additional 400 expected to close soon. The decline is accelerating. We believe this could foster a better environment for discussions with the states beyond 2023, assuming their budgets are in a good position. Even when budgets weren't strong, it didn't significantly impact the situation. This has been a positive development. The pandemic has underscored the issues operators have been highlighting, particularly regarding the under-funding of Medicaid in most states. We have witnessed many facilities shutting down, which could create significant issues for states, especially in terms of access for indigent Medicaid patients. Senior housing options will not be available for them, and home health services will be limited. Many individuals may end up remaining in hospitals due to a lack of alternatives and funds. I don't want to elaborate too much, but that's my perspective on the matter.

Okay. And to follow-up on that point, staffing has been a constraint on admission and top line, at least in the past few quarters. Now that we have more clarity on Medicare and Medicare way seems to be growing better for some space. Does it make sense for operators to kind of increase their investment in labor? Does it make sense for Sabra to kind of provide more liquidity and bridge to operators so that we can get ahead of the positive reimbursement expenses that are coming down further?

I believe there are a few key points to consider. First, operators have already made significant wage increases even before recent changes. This will facilitate improvements. They recognize that even if labor conditions improve, there was a labor shortage prior to the pandemic. The core issue is increasing occupancy. When RUG IV was implemented, only short-term rehab patients were accepted, which led to a decreasing length of stay and consequently declining occupancy rates. This situation becomes particularly challenging for a business that operates with 90% fixed costs. While we don't anticipate occupancy levels returning to pre-pandemic standards, we expect to see ongoing improvements in both skilled nursing and senior housing sectors. The combination of rate hikes in skilled nursing along with demographic growth will be beneficial. However, operators are unlikely to keep all the profits for themselves; they will likely reinvest in their workforce. Regarding our role at Sabra, we believe there are investment opportunities in technology that can enhance operational efficiency, and we are open to collaborating with our operators on these initiatives. Many operators currently lack advanced labor management systems that can enhance employee flexibility. We are willing to explore ways to assist our operators, especially as this recovery period extends. We are prepared to increase our support, and financially, we are in a strong position to do so.

Understood. That's good to know. If I may ask one more question about the environment, I think the assets are smaller in nature, which can make occupancy more volatile. However, it seems that the wholly owned asset occupancy growth has been quite strong for two quarters, with an increase of 350 basis points this quarter and 750 year-on-year, leading to some decent operating leverage. I'm assuming the joint venture is experiencing similar strength. I'm curious if this recent momentum has influenced your discussions with TPG. What would it take to restart the marketing process, and what kind of upside can we expect?

The trends with the joint venture are similar, so it's essentially in the same direction. This doesn't alter our decision regarding TPG. We are currently at a stage where we need to market the portfolio based on the 2023 numbers that are credible. The management team at Enlivant is focused on beginning the budget process around Labor Day and creating a 2023 budget that bankers can use for marketing. We anticipate that the marketing process will begin later this year and continue into 2023. It's not just about the portfolio for us, as TPG's decision to exit wasn't limited to real estate; they also chose to exit the operating company, which was designed to support a much larger business than currently exists. This company has a considerable burn rate that we are not positioned to sustain alongside the leverage and other challenges. We are hoping for a successful process but do not anticipate changing our stance on supporting the marketing effort.

Got it. Thank you very much.

Thank you. Our next question comes from Rich Anderson with SMBC. Your line is now open. Rich Anderson, your line is open, please check your mute button.

My button was the issue.

Good morning Rick.

How are you doing? Good morning. I want to approach the question about the future of Medicaid from a different perspective. You have these FMAP add-ons, which is positive. States are currently benefiting from various past stimulus measures. Is this a scenario where you have every reason to anticipate growth in Medicaid or to increase your Medicaid expenditures for the upcoming year, but possibly, states might view this as a temporary situation? Do you think it’s possible that we will return to more typical increases of 1% to 2% in the near future?

I believe it will largely depend on state budgets as we move into 2023 and beyond. Through discussions with various states, they acknowledge the need to take further action. Therefore, I don't anticipate them reverting to the typical annual increases of 1.7% just because COVID is behind us, especially as long as the funding remains in place. Additionally, within state systems, there are inflationary factors at play. Many states are facing a delay of one to two years before all costs are fully recognized, but these inflationary factors will influence Medicaid rates moving forward. One positive aspect is that we initially expected to wait two years for the Medicaid cost report process to align with the current realities. However, many states have acted sooner than expected because they have the financial resources and they recognize the challenges at hand. Looking ahead, there is a formula that will help maintain higher rates. Furthermore, I want to emphasize that some states are beginning to experience serious access issues, which could lead to negative publicity. This will also be a contributing factor. Overall, these developments are encouraging and should help sustain momentum, although it may not apply uniformly across all 50 states, as we’re not seeing a consistent situation in every state right now. However, in enough states, it is beneficial for those of us operating in those regions.

Do you think Texas 12% add-on could foreshadow them being more accommodative when it comes to their base Medicaid rate when they ultimately decide that? Is this something that we could look at is that's interesting as a foreshadowing event? Is that possible?

I would never predict anything about Texas. That's positive. And look, there's no legislative session this year. So it's not anything that has come up as an issue again until 2023. So I mean, I think we were all pleasantly surprised that what Texas did, but I'll just kind of leave it at that. I was pleasantly surprised. I don’t know that it foreshadows anything in that state.

Sure. First of all, the joint venture consists of older legacy ALC assets for those who remember that company. The 11 wholly owned assets we have are geographically clustered and were acquired by TPG, making them larger in terms of units per community, among other factors. They also have more memory care, as I noted earlier. This leads to a different dynamic in the income statement since they are simply larger. Additionally, their response to COVID in terms of occupancy has shown a bit more volatility due to the memory care aspect. Generally, they also tend to have higher rates because of the memory care offerings.

And I'd also note that we're more than happy to have the same management team running the wholly owned Enlivant portfolio for us.

Thanks, very much.

Yes.

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

Hey, can you guys hear me okay?

Yes.

Appreciate the wait-room music and Rich took most of my questions, but just running back to seasonality. I'm wondering if there are any forward indicators that you have identified that may suggest you actually see that occupancy ramp up. For example, I know, for a period, Massachusetts had ended elective procedures, which has now come to an end. But are operators discussing at all a ramp-up in electives and anything else that might push more patients into the SNF portfolio?

Yes. Conversations with the operators indicate that they are not experiencing issues with demand flow. The main concern is the number of admissions they can manage while providing the necessary care. Most states have relaxed restrictions on elective procedures, and all operators are admitting patients, although some are doing so more slowly than they would prefer. Many operators hope that as the volume of patients increases, it will align with some improvements in labor, leading to a recovery in operations.

Okay. Understood.

So a little bit hard to predict, obviously.

Right. Understood. And then just jumping back to potential transitions, as it relates to behavioral health. I know there's been conversation in the past on the difficulties related to entitlements for that kind of asset class. And I'm wondering if your transition a specific SNF asset, for example, to behavior health or senior housing. Do you have to change the entitlement in that process, or is that an easier route to go down, versus a greenfield development or something of that nature?

The short answer is that it really depends on the situation. There is no one-size-fits-all answer. We conduct a zoning analysis for each case to determine what is possible. We examine situations where we have needed a zoning change, variance, or special use permit. Sometimes pursuing these changes is worthwhile, as they can enhance the community’s tax base. However, there are instances where gaining approval from the neighbors is unlikely. Hence, it varies greatly. The conversions we have successfully executed have typically been in areas where zoning was already permitted, which is the most efficient path forward. Therefore, we tend to prioritize these cases unless we identify a straightforward option elsewhere.

Got it. Okay. That's helpful color. Thank you.

Thank you. Our next question comes from Steven Valiquette with Barclays. Your line is open.

Thanks. Hello, everybody. Thanks for taking the question. I guess, as I'm kind of looking at pages five and six in the supplement, the skilled nursing occupancy sort of flattish or bouncing around five quarters in a row. Well, it did improve in the last quarter. Just I guess one question on occupancy and then one question on the skilled mix. I guess just first on the occupancy, do you have any guess for how much the staffing shortages in skilled labor within your SNF portfolio maybe holding back occupancy, whether it's tens of basis points or hundreds of basis points? And then the second question is just on the skilled mix being trending down five quarters in a row. But over that time, we've seen elective procedures generally rebounding over that same five-quarter period. So I guess the question is, are the skilled staffing shortages impacting the Medicare occupancy more than Medicaid? Is it really just as simple as that? Just want to understand kind of that dynamic around the skilled mix.

Yes. It's quite challenging for us to gauge how staffing shortages are affecting occupancy. During the Omicron surge, we could see a clear connection due to the number of staff unavailable, but now it's more complicated. It’s not in the hundreds of basis points, but I would estimate at least 100 basis points, though it’s difficult to determine precisely. Regarding the skilled mix, in the last five quarters, it has remained relatively stable for three of those quarters. It has decreased slightly in the last two quarters; it was approximately 40% for the three preceding quarters. With elective surgery, the relationship under the Patient Driven Payment Model (PDPM) is different from what it was before. Previously, there was a complete correlation, but now it's not as straightforward since we are taking on more complex longer-term Medicare nursing patients.

Thank you. Our next question comes from Joshua Dennerlein with Bank of America. Your line is open. Joshua, your line is open. Please check your mute button.

Could you guys hear me? It was a little static right there at the end for me.

Yes.

I just wanted to go back to the kind of the market for skilled nursing acquisitions, maybe understand them kind of the motivations of buyers to be so aggressive on the assets. And maybe how they're financing them, considering how much debt has gone up and they're still being aggressive. I don't know if you have any other color or comments on that?

You need to think about this from a different perspective, viewing it as an operating model. When I was an operator, I had a similar viewpoint. These operators don't solely focus on the skilled nursing business; they also have therapy services, a pharmacy, home health, and lab and radiology services. The facility itself, along with the value it provides, serves as a means to generate revenue from other ancillary businesses. We don't see this as them overpaying; it’s simply a different model. We are acquiring the real estate while they are purchasing the holdco to drive additional revenue and net operating income for their various related businesses. This capability allows them to pay more, which is why it’s not about overpayment. They often consider a bridge to HUD in their approach.

That makes sense. And then one quick question on hiring. It does seem like net hiring in the health care space and skilled nursing, senior housing starting to improve. How quickly do new hires make a difference on whether a skilled nursing facility can have more admits. These new hires coming from the contract agency side, people looking for more stability on where there's a risk of recession or is it going to take some time to train some of the new hires that are coming into the space. And we don't see a lot of immediate uptick in the ability for SNF to increase occupancy from those hires?

Yes, nearly all of the impact occurs on day one because the new hires are already qualified. The licensees have their licenses, and certified nursing assistants typically come certified. For those who aren't certified, operators either have their own certification programs or have arrangements with third-party programs to get them certified quickly. They can still perform certain tasks as certified nursing assistants. From an admissions standpoint, once they start, they are ready to go. If you hire 10 employees tomorrow, they will be able to provide the necessary care and begin generating revenue based on those additional employees immediately.

That's good to know. Thanks. That's all I have.

Thank you. Our next question comes from John Pawlowski with Green Street. Your line is now open.

Thanks for taking question. I have a question about just the trajectory of occupancy and how we kind of on the SNF business and how we get back to pre-COVID levels. So, I guess I'm a little surprised that we haven't seen bigger, bigger increases in recent months. And so, when you've got supply actually negative in the sector, Rick, you mentioned labor might only be holding occupancy back by 100 basis points.

No, it's purely labor. I'm estimating how much labor is affecting growth. If we were increasing by 100 basis points each month, we would be in a good position. That's a significant number, especially when before Delta, we were growing by nearly 70 basis points a month in our skilled occupancy. Based on that pre-Delta growth, we thought we would be nearly back to pre-pandemic levels early this year. The 100 basis points is not insignificant, and I should have specified that it might take us about 100 basis points and potentially affect us by the same amount each month. Even if we could return to the 70 basis points a month we experienced before Delta, we would be in a fairly good position regarding occupancy by early next year. Growth would continue beyond that due to supply and demographic factors. This subsequent growth is crucial because, as I mentioned earlier, 90% of costs are fixed. There's an inflection point; for instance, if the number of patients in a facility increases from 80 to 83, that directly contributes to the bottom line, providing additional cash to allocate towards staffing and other investments in the building.

Okay. That makes sense. I misunderstood the 100 bps drag on growth versus just the spot occupancy level. A question on the conversions – okay. A question on the conversions of obsolete skilled nursing into behavioral health. Just curious if you can help me visualize these facilities, what were the common threads that actually made these properties obsolete? And then how do you get comfortable that there will be deep enough demand pool and a behavioral health paper that wasn't there and a skilled nursing wrapper?

The obsolescence factor generally relates to the number of rooms, room sizes, and the economics of operating a skilled nursing business in a specific location. Older buildings tend to be quite common in this sector. Converting these buildings can significantly change the revenue stream. You can also incorporate semi-private rooms, which are quite typical in addiction treatment facilities. We often use residential models, even if that means reducing the number of rooms to create more competitive spaces for meetings and other activities. Shared bathrooms, similar to dormitory setups, are also acceptable in addiction treatment settings due to the shorter stays, which wouldn't be feasible in senior housing. This limitation is important when considering older skilled nursing facilities that lack fully equipped private bathrooms in each room.

Okay. Just a follow-up there, Talya. I think you mentioned 9% stabilized yield. How many years does it take to get to that 9% stabilized yield?

It's influenced by a few factors. One key element is the payer type or payer mix. For example, if it primarily serves Medicaid patients, it can reach that level quite quickly due to high demand and limited supply. Additionally, during these conversions, we sometimes implement a percentage rent model until we reach a specific occupancy level. With commercial insurance, the occupancy might take a couple of years to stabilize, and during this time, we apply percentage rent until we achieve that 9% or so. The actual yield may vary depending on the asset involved.

Okay. Thanks you to taking the questions.

Thank you. Our next question is a follow-up from Juan Sanabria with BMO Capital Market. Your line is now open.

Hi. Thanks. It sounds like some of these assets you are either selling or transitioning just aren't paying rents and therein lies the upside as you redevelop or redeploy the proceeds. So just curious what the delta is between contractual rent and cash collection to get sense of magnitude of potential upside?

So in terms of the delta between cash basis rents and contractual, it varies. And I don't have these specific numbers on these assets that we're selling. So I really can't give you that color right now.

It doesn't make sense to give an aggregate number, Juan, because there's just too wide. The variances are too wide.

It could range from zero to full contractual rent forecasting – ?

Overall across the portfolio, the potential upside depends on whether tenants start repaying rent or if you transition them to a new operator who pays rent.

Again, we have cash basis – so we have cash basis tenants that pay us full rent, 100% of their contractual rent, and we have some that don't. And that's going to vary. I mean, some better and more dire situations are paying zero, and some are paying somewhere between their full contractual rent and zero. It's a number that bounces around one. I wish I would had a better answer to you on that.

For the second quarter, you can't give what was accrued for cash collected versus what was?

We don't accrue rents on – for cash basis tenants. That's why they're a cash basis.

Okay. Accrued and/or cash versus the lease amount – can you give that number for the second quarter?

I cannot give you that number for the second quarter.

But you don't accrue the cash-based tenants.

Got it. Okay. Thanks.

Thank you. And I'm currently showing no further questions. At this time, I'd like to turn the call back over to Rick Matros for closing remarks.

Thanks everybody for your time today. We're always available, if you all want to do, just give us a call. Hope everybody has a good remainder of the summer and a great Labor Day. Take care.

This concludes today's conference call. Thank you for participating. You may now disconnect.