LTC Properties, Inc. (LTC) Q3 2016 Earnings Report, Transcript and Summary

Welcome to the LTC Properties Third Quarter 2016 Analyst and Investor Call and Webcast. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Ms. Wendy Simpson, CEO of LTC Properties. Please go ahead.

Thank you, Melissa. Good morning, everyone and thank you for joining us today. People joining me on this call are Pam Kessler, our CFO and Clint Malin, our Chief Investment Officer. You'll hear from them both momentarily. Year-to-date in 2016, LTC has underwritten $126 million of investments, including $39 million of development commitments. Our under-development projects are down year-over-year as our operators and we turn our attention to stabilizing all of these new properties. Clint will have more specific comments about our current properties under construction and what we see that may be underwritten in the near future. However, we have been investing and underwriting for periods beyond 2017. At the end of the quarter, we had $45 million committed to spend on de novo projects at rates between 7.4% and 9%. $3.3 million of those commitments will begin generating income to LTC in 2016 and all of 2017. However, approximately $42 million will provide us with 2018 revenue increases and increases in years beyond that. Additionally, we have committed to spend $34.5 million at average rates over 9% to reposition or renovate properties we own, including our Michigan properties. The investment is structured as a loan. The Michigan properties are one of our best performing group of assets. The operators are innovative and we have a high likelihood that they will use these capital dollars. Our income increases upon each funding and therefore revenue will increase immediately rather than when the entire project is completed. As such, we have provided for additional 2017 growth. The transaction environment for the deals we're interested in pursuing is not robust at this time. Despite this, I believe LTC is positioned to provide its shareholders with real growth in 2017 and 2018 without additional transactions. Additional transactions which we will continually court, will be added growth. Our balance sheet remains at a conservative leverage ratio. We have sufficient capital available to fund these commitments and do acquisitions that would be accretive to LTC. Clint will discuss our pipeline and our operator statistics. First, though, I'll turn the call over to Pam for our financial review.

Thank you, Wendy. Normalized FFO increased 11.6% year-over-year for the third quarter of 2016 to $29.7 million or $0.76 a share on a fully diluted per-share basis. Revenues for the quarter increased 16.9% or $5.9 million, year-over-year. The improvement primarily reflects acquisitions, completed development in capital improvement projects, lease amendments, as well as an increase in interest income from mortgage loans resulting from loan originations, CapEx spending under existing loans and the amendment to our Michigan loan. This was partially offset by a reduction in revenue from properties sold and mortgage loan payoffs. Second quarter interest expense was $6.8 million, an increase of $2.5 million over the comparable 2015 quarter due primarily to the sale of senior unsecured notes and greater utilization of our line of credit to fund investments and development. Transaction costs decreased $568,000 year-over-year. The 2015 quarter included $537,000 of costs related to the acquisition of a 10-property portfolio. Excluding costs related to the large acquisition in the prior year, transaction costs were comparable between the two quarters. General and administrative expenses were $4.5 million or $756,000 higher this quarter compared to a year ago due to increased staffing, short-term and long-term incentive compensation programs, marketing and various costs associated with being a public company. In G&A for the remainder of the year, I reaffirm guidance given last quarter of approximately $5.5 million per quarter. During the quarter, we recognized a $1.8 million net gain related to the sale of an assisted living community in Florida and the school in New Jersey. Turning to the balance sheet, during the quarter, we acquired a parcel of land and improvements in Kentucky for $5.4 million. We committed a total of $24.3 million to construct a 143-bed skilled nursing center. We originated a $1.4 million mezzanine loan in the third quarter that Clint will discuss in more detail. Additionally, we invested $10.8 million in properties under development and capital improvement projects during the third quarter. We funded $2 million under existing mortgage loans and received $519,000 in principal payments and mortgage loan payoffs. During the quarter, we repaid $45 million under our line of credit and currently have borrowings of $77 million outstanding and $523 million available under our revolver. Also during the quarter, we sold $40 million of 3.99% senior unsecured notes. These notes have periodic scheduled principal payments and a 15-year final maturity. We also repaid $12.5 million under our private shelf agreement with Prudential and accordingly have $12.5 million available for borrowing under that agreement. During the quarter, we received $7.7 million of net proceeds from the sale of 152,623 shares of common stock under our at-the-market offering program. The proceeds were used to fund our investment and development activities and pay down debt. Subsequent to September 30th, we acquired a parcel of land in Illinois for $1.6 million. We committed a total of $14.5 million to construct a 66-unit memory care community. Also subsequent to September 30th, we increased our fourth quarter monthly cash dividend by 5.6%, from $0.18 per share to $0.19 per share. At the end of the quarter, LTC maintained investment-grade credit metrics with a debt to annualized normalized EBITDA of 3.9 times, a normalized annualized fixed charge coverage ratio of 5.4 times and a debt to enterprise value of 22.4%. I'll now turn the call over to Clint.

Thank you, Pam. Good morning, everyone. And again, thank you for joining us today. With the announcement of our two recent development projects with Anthem and Carespring, our underwritten investment commitments for the year totals $126 million, as Wendy mentioned. $70 million of this investment activity comprises acquisitions, with the average age of the five properties acquired being just two years. additionally, 50% of this year's investment activity has been committed towards private pay assets. Investments to date in 2016 demonstrate our focus on diversifying revenues derived from private pay assets and our strategy to continue reducing the average age of assets in LTC's portfolio. During the third quarter, Anthem Memory Care opened two LTC-owned private-pay memory care communities and Thrive Senior Living received its certificate of occupancy for a 89-unit assisted living and memory care community. The property, to be operated by Thrive, is expecting receipt of its healthcare license next week to begin admitting residents. As of yesterday, Thrive has 31 deposits funded for new resident move-ins. We expect one additional private-pay development project to open near year-end, bringing our 2016 new development openings to six. Development financing has played a key role in LTCs growth strategy over the past six years. This growth has brought new private-pay operator relationships to LTC and expanded revenues derived from private-pay assets. Upon completion of our development projects currently under construction, we will have added through development nearly $300 million of new properties to our portfolio. As the development cycle matures, our pace of new development commitment has slowed. We attribute this slowing pace into land sites becoming more challenging to identify, as well as increasing costs associated with land, labor and materials. Year-over-year, our new development commitments have decreased from $112 million in 2015 to $39 million year-to-date in 2016. When we began our development financing program in 2011, we anticipated a five- to seven-year development cycle, so this slowing is consistent with our initial expectations. In the third quarter, we closed on a $1.4 million mezzanine commitment secured by two skilled nursing centers located in Oregon. This investment yields a 15% current pay interest rate to LTC and establishes a new relationship for us with a regionally focused operating company based in the Northwest. As year-end approaches, we're seeing sale leaseback deal flow moderate, as Wendy mentioned. Deal pricing in the market continues to be at a premium, especially for private pay assets and with evolving dynamics in play for skilled nursing, we're being selective in opportunities we pursue at this time. Discipline in our investment underwriting has served us well historically and we do not feel current market conditions warrant an aggressive acquisition strategy. Currently, we have approximately $50 million of development opportunities in the pipeline with existing operating partners. These opportunities are comprised of replacement projects, expansions and new development both for private pay and post-acute care properties. We're continually engaged with our existing operating partners to help them grow their businesses and explore opportunities together. Looking at our portfolio, Q2 trailing 12-month EBITDARM and EBITDAR coverage on a same-store basis is 2.04 times and 1.48 times for our skilled nursing portfolio and 1.54 times and 1.32 times for our assisted living portfolio. Coverage metrics for the portfolio as a whole remain comparable with the prior quarter. Although coverage in our skilled nursing portfolio experienced a slight decrease of four basis points from the prior quarter, we have analyzed recent data and, barring any unexpected changes in Q3 performance from our operating partners, our skilled nursing portfolio continues to target the 1.5 times coverage ratio referenced on last quarter's earnings call. Now I'll turn the call back to Wendy.

Thank you, Clint. Before turning the call back over to Wendy, I'd like to make a correction to my G&A statement. There was a collective gasp here in the room. I accidentally said $5.5 million. $4.5 million is the run rate. That's the same expense we had this quarter. I believe that is a good run rate for the rest of the year. So, that's $4.5 million per quarter. Thank you.

Thank you, Pam. From LTC's point of view, it is currently difficult to underwriting new SNF deal that would not be with a strong operator already in our portfolio. In this environment, if we were to add a new operator, they would have to have a strong market presence and provide LTC with appropriate credit enhancements securing the new investment. Underwriting is more complicated until we can see the impact of the several changes happening in the SNF industry. This would include such evaluations as the impact of managed care, the shorter length of stay, the star ratings impact, to name a few of the new challenges. When we invest, asset quality, scale and span of the operations and the strength of the operating company in the marketplace are critical factors in our underwriting process. That is not to say we will not invest in SNF assets. We have always been and remain capital supporters to this industry. We just currently need more data and history to feel we can properly underwrite certain deals. Last quarter, we reduced our guidance from $3.05 to $3.09 to $3.00 to $3.03, so last quarter our range was $3.00 to $3.03 and that reflected our second quarter share issuance under our ATM and the terming of some of our utilized bank line. In the third quarter, we have had some positive changes, including increasing our dividend by 5.6% and we've had some positive changes in our current portfolio. So, I'm now giving guidance in the range of $3.03 to $3.05. As has been our practice, we're not including possible fourth quarter transactions or additional terming out of our bank lines. Thank you, Melissa and we will turn it over to questions.

[Operator Instructions]. Our first question comes from the line of Jordan Sadler with KeyBanc Capital Markets. Please proceed with your question.

This is Jeff Gaston on for Jordan. In light of some of the recent transaction announcements made by your peers this week, I was curious about how your Brookdale and Genesis portfolios have been performing. Can you give us any color there and potentially what coverage is on those portfolios, as well?

On the Brookdale portfolio that we have, we have 37 properties leased to them. And overall, we've had a very strong portfolio with them. I think as an organization, they've had a lot of pressure and a lot of distraction, so we have seen a little bit of deterioration on occupancy on the Brookdale properties, but still very strong overall. And right now, the coverage with that entire portfolio sits at 1.66 times which is a very strong and healthy coverage, with a full 5% management fee and that's an EBITDAR coverage which is still very strong coverage on the Brookdale portfolio. Genesis has still maintained similar to what it was last time, really no significant change on the Genesis portfolio from where we were at previously with them. So, very consistent to prior quarter for Genesis.

Given that those operators have been announcing large changes to some of their leases, I was curious if you have any interest in doing the same. It sounds like Brookdale is fine, but was curious if you might have an interest in doing something like that for Genesis.

Our portfolio with Genesis is much smaller. We're just not of same size or scale, so I don't see something happening in our portfolio.

But, we're talking to them about a replacement facility.

We're actively looking at opportunities with them and we have a project that we're working on now, I mentioned last time, for a replacement project in a CO1 state.

You mentioned that the transaction markets are not as robust as they've sort of been leading up to this point. Can you give a little color on some of these deals and how they're stacking up against your underwriting requirements and I guess where the disconnect is?

The first part of the year, we saw a lull in transaction activity and then going into middle of the year we saw a big spike in volume of large skilled nursing portfolios being marketed. And usually, the aggregation of those portfolios are of size where it would bring on significant concentration within our portfolio and we've just seen not to be an opportunity for us. So, now, some of those transactions, I know at least one of them was announced by our competitor this week, but now we've seen a lull to where we haven't seen all those transactions have closed yet or not. And we haven't seen a lot of new activity. There's onesie-twosies here and there, but typically on the skilled side, that's been typically older, maybe more challenged assets which really hasn't fit our profile of investing on the skilled nursing side.

But, on the private-pay side, we're still seeing premium prices with low lease rates and it's just not penciling out for us, even with a nice cost of capital despite the current market. The prices just are too high and the returns too low.

Our next question comes from the line of Paul Morgan with Canaccord Genuity. Please proceed with your question.

Just wondering like the delay at the Glenville development. Can you comment on what the catalyst was there since it's delayed for two quarters?

Sure. There was a few permit items after they got the certificate of occupancy, so just a couple minor slowdowns, but nothing significant and that project is on course right now. So, nothing to be concerned about.

Earlier in the year, you had been anticipating a potential bump-up in the cap rates. What has been the more recent trend? Any changes in the cap rate for those markets or the coastal markets in the past three or six months?

I guess we haven't focused specifically on the coastal markets, but as Wendy just indicated, we're seeing that cap rates have not come up, especially on the private-pay side. On the skilled side, I think some of the recent announced deals, cap rates have come up on the skilled nursing side, but those are really for larger portfolios. And again, with those larger portfolios, we don't know what's comprised in those pools. But, on the private pay side, we have not seen any rise in cap rates.

Our next question comes from the line of Aaron Wolf with Stifel. Please proceed with your question.

Question on the mezz loan. Is this the only loan of this kind in your book? And if so, is this something that you might consider doing, going forward, more deals like this?

Sure. We have a couple loans in the portfolio. As we've talked about on our previous calls, we've started working out a mezzanine in preferred equity platform, where we have, first part of the year, we've brought on an individual to run that platform for us. And it's in part of the business we're targeting. We think there's a lot of opportunity for us in using a mezzanine and preferred equity financing program to reach out to an operator base that has typically not utilized sale leaseback financing as part of their capital structure. So, we really view this as a way to grow our relationships and being able to bring a product offering to operating companies that are -- something that are more familiar to them. And as we build relationships with these organizations, the hope is that we can convert those relationships into sale leaseback transactions over time.

We talked a little about operators at the beginning of the call. do you know if your operators are seeing more pressures in the secondary or primary markets in terms of wage inflation and threats from new supply? Any color on that would be helpful.

As far as wage pressures, we haven't seen anything specific regarding wage pressure that's happening today, although it is something that our operators are talking about and something they're cognizant and aware of. Regarding increased competition, it's really market-to-market on whether there is increased competition. And as you can see from our supplemental, we track lease-ups and overall, our projects have been fairly strong. The project I talked about on the prepared remarks that's opening next week with Thrive Senior Living, they already have 31 deposits out of 89-unit project. So, we view that as a pretty strong lease-up in the Myrtle Beach area which would be considered a secondary tertiary market. So, it really goes back market-to-market, but we have not seen specific concerns, but our operators are talking about and they're aware of the potential. And we have seen, as Wendy mentioned, development with our operating partners slow down as they tend to focus on operations on their existing portfolios.

Our next question comes from the line of Karin Ford with MUFG Securities. Please proceed with your question.

Wendy, appreciated your comments earlier on your conservatism surrounding field nursing underwriting, given the uncertainty and the challenges there. Was just wondering if you saw pricing on the smaller deals follow suit and sellers adjust expectations up closer to the nine-plus cap rate handle. Would that help you get more comfortable with getting more active or is the uncertainty just too high that it almost doesn't matter where pricing is today?

No, uncertainty isn't that deep. It's what the seller wants us to buy into and if they want us to buy into a trailing 12 with not enough current information in the probably prior nine to impact the future. But, if the deals are based on current trends, then we're back in the market and certainly at those returns. but, right now, what we're seeing is that some of the potential sellers are hoping that these trends will just go away and they'll get back to where they were. And that may happen. We're just not going to buy it right now.

What EBITDAR coverage level are you underwriting or would you look for today?

We're still doing 1.5 on skilled with a 5% and 1.2 on private-pay with a 5%. And we're well aware that some other REITs use a much lower management percentage. And so, we have consistently used 5%. We have consistently used the operations from the facility and we don't use a corporate coverage. We have not pruned what we give you in same-store by putting some of the assets in a workout category and taking the more challenged and putting them on another level. So, what we give you is absolutely comparable quarter to quarter.

And then, just on your skilled nursing EBITDAR coverage, can you just give us a quick update on the two properties that were dragging coverage down? Have they resolved themselves? And how are labor costs doing? And are you willing to call a bottom on this quarter or do you think we may have another quarter or two to go?

On the two properties that I had talked about previously where there were some challenges, financial performance has changed significantly on those two properties. There's still the open pending licensure challenge at the one property in Texas, but it's on appeal with our operator and we're expecting a hearing to take place here hopefully some time this month or early next month to resolve that. But, those two buildings, the financial performance has definitely turned up.

So, is this quarter the bottom, do you think, Clint?

As I mentioned, we think that a targeted 1.5 times coverage with the vantage point we have into the portfolio and looking not only at trailing 12 off of Q2 but looking at more recent quarters' activity and where it's at, we think that, barring any significant changes in the third quarter that we're not anticipating or that our operators are not anticipating, we feel that the 1.5 is a targeted range. And as we brought on new investments for skilled -- as Wendy mentioned, we're underwriting at 1.5. As those fold into the same-store coverage, we do expect overall that our coverage in our portfolio on the skilled side would come down to that range and we think that's a consistent level.

And in terms of your question about labor costs, all of the operators we've talked to, we've talked to most of them, are seeing creep in labor costs. But, one of the things that they're finding maybe a little bit more challenging is just the pool of labor. So, there are a couple of things that they're paying attention to. One is just the increase in labor costs and the other is the decrease in the labor pool. And we all don't want to see something happen where everybody's going back to registry time which is very destructive. So, our operators are paying a lot of attention to employee retention and the cost of the employees. So, there is a lot of attention on that, Karen.

You had a property in lease-up in Illinois that looked like leasing had slipped from last quarter to this quarter. Can you just give us some color on that?

Sure. The operator had an unexpected number of deaths that happened. It's a memory care community, that property. So, we did see as of -- well, it was reported September 30 that that occupancy had come down. But, as of yesterday, the occupancy at that property come back up to 30% which is just shy of what it was in the previous quarter. So, they're starting to see some positive traction to get back to where they were on that. It was just timing on that. And Wendy did make a point, they did actually have -- the executive director at that community, they did have a change. So, in addition to that change and the executive director did have a little bit of slippage on the marketing aspect on that. but again, they're back at, as of yesterday 30% which is just shy of where they were at last quarter.

Our next question comes from the line of John Kim with BMO Capital Markets. Please proceed with your question.

Just a follow-up on Jeff's question on restructuring leases or the potential to do that. Your SNF EBITDAR coverage is now 1.48 which doesn't sound bad, but it's a drop from last year at 1.7. At what point do you consider restructuring your leases as far as EBITDAR coverage?

Well, again, that's with the 5% management fee. So, you add that onto the profit that the operator is making covering 1.4 and that's a significant profit. I would say I'd consider renegotiating our contracts when our operators are suffering and I don't see them suffering. They're turning around a couple of properties that are bringing down that percentage. The fact that we have done so many transactions in the last year that we underwrote at 1.5 that is now bringing down that average because it's a mathematical calculation. And the Michigan loan, we added $40 million on that. So, we're far away from having to address a lease change.

Yes, they're going down from 1.7 to 1.5 was purposeful for us, because we monetized it.

And the newer assets as well as the Michigan investment. So, that's not deterioration because of challenges. That was sort of expected with investments that we deploy capital into. So, I think it should be viewed as a positive.

Yes. we don't currently have a work-out situation or a situation where we believe that our rent stream is at all in danger. And I think we stand at a zero accounts receivable in terms of rent. So, we don't have any unpaid rent.

So, when you're talking about taking into consideration the operator, if they're struggling or not, is that for the Company as a whole or just particular to the assets that they leased with you?

We put buildings in master leases for reasons and we want to make sure we have a credit enhancement that looks across just one property, but across multiple properties. And if there was a significant challenge in a specific asset, we may work with an operator if they wanted to look at possibly selling that asset. I mean, that's one way we could look at a solution with an operating partner if there was a challenge within one asset within a master lease.

If we had an operator that had significant challenges in other part of its business, we certainly would sit down at the table with that company and see if we could participate in some restructuring of their business. But, I don't see any of that happening with the operators that we currently have.

On occupancy, it looks like you had a decline in occupancy by about 70 basis points on a year-over-year basis. And on the SNF side, it seems like it's in line with the market, but on the assisted living side, it appears lower than the NICS averages. Can you just perhaps add some commentary to this?

I'd say the small decline in occupancy quarter-over quarter was primarily attributed to the Brookdale properties which again, as I mentioned earlier, still have very strong coverage for that portfolio. Obviously Brookdale's had a lot of distractions that they've been working on, so I think that may be the primary reason why there's been a small decrease in occupancy change within that portfolio. But, again, the coverage supporting the Brookdale investment is still very strong and healthy.

And where do you see that going, with supply picking up over the next couple quarters?

That's something we'll continue to monitor from an asset management standpoint to see where that progresses. So, we're not aware of any significant changes in that at the moment, but it's something that we've, over the last number of quarters on our call, we've talked about Brookdale when there's been headline news about them and it's something we're actively engaged with and monitoring.

It's a very small amount, but you sold a school in New Jersey this quarter. And I didn't see that in your supplemental last quarter.

Yes. It was announced as a subsequent event last quarter in the queue and the press release. But, it's only one school that we own, so it probably wasn't a standout to you.

How did you come about owning a school?

It's a long story. It goes back to the 1990s and we were incubating an education REIT and we owned quite a few schools at the time. And in the early 2000s, we divested of those and that was just the last remaining school that we had. It was in New Jersey and we got an offer for it and sold it to the operator.

[Operator Instructions]. Our next question comes from the line of Rich Anderson with Mizuho Securities. Please proceed with your question.

So, is that the last school? Are you out of the school business?

Are you cheering out there? We don't have to spend 15 minutes of every investor meeting talking about the school anymore.

So, you're done?

Done, yes.

And then, is the Thrive asset the Wichita asset in the supplemental?

No, it's the one in Muriel's Inlet in South Carolina.

Where does that appear?

Go to page 10. It's the last project on page 10 on the lease-up section.

Okay, so you're in lease-up. So, you'd be out of the de novo process, I guess or that schedule, right?

No, it's out of the development because--

I just wanted to make sure I understood, okay. So, Clint, you said you have a $50 million pipeline of future development projects, but in the same breath you guys have said it's become more difficult to find deals to underwrite, given cost pressures and whatnot. So, how would you describe that $50 million? Is that just almost a formality-type number or are they real opportunities? Why would you assess the probability of you moving forward in any of that?

I'd say probably three quarters is probably very real. It's in projects we're working with operators that are in our portfolio. So, I'd say that at least three quarters of that is probably fairly likely.

And Wendy, you mentioned your guidance increase this quarter. You said good things are happening, you mentioned the dividend which doesn't have anything to do with the guidance, but obviously it's a reflection of good things. But, I'm curious, we're talking about small numbers, but what got you from -- gave you $0.02 more to cheer about this year? Was it mainly internal growth or was it external growth factors?

It was mainly internal growth. And you probably are not surprised that, when we do our projections, we're a little bit more conservative. So, when I'm giving you guidance, we have made some assumptions and we probably assume that there might be a rate increase, so our cost of capital, our interest cost, might have been a little higher. We also have a couple of properties that contribute based on additional revenue, so we have some percentage income from a couple of our investments. One of them is our preferred investment with the assets in Arizona. So, we don't count that as income until we get it as cash and they've been doing very well on that asset, so we got a little bit more cash. We got cash from an operator who does -- we have a percentage rent increase. So, a few of those things add up to $300,000 to $600,000 and then you've got $0.01 or $0.02.

Yes, with a little of this and a little of that.

Yes and capitalized interest, as well.

And mentioning the preferred business, I understand it's incubating now, but how big do you think that that could be? What's the size of that pipeline years from now or four or five years from now?

Rich, I think you're probably looking out four to five years. It's hard to say where that would be. But, what we've talked about is putting a threshold of $50 million on that to get that book of business to that level.

So, no change? Because that's what you've said in the past, right?

Yes. what we're finding right now, Rich, is as we've been talking to potential operators to invest with, they're finding it a little more difficult to get the senior in place, like a lot of banks have done what they want to do for 2016. So, it's been a little bit slower than we had anticipated at the end of the second quarter. But, we still think that there's a good market there for us.

So, without the senior, then there's no place for your [indiscernible] role, you're saying?

Correct.

And then, finally, I probably ask this question once a quarter, but a lot of financing activities, ATM activity. What would you say, Pam, your dry powder is? Even though you may not be seeing a whole lot in the way of investments, where do you stand on that, where you get to a certain level of leverage before you would have to consider equity again?

Yes, comfortably we could do about $250 million more in debt before reaching our leverage threshold. So, I feel very comfortable we can fund what we have today and for the foreseeable future.

Thank you. This concludes our question and answer session. I would now like to turn the conference back to Ms. Simpson for any final remarks.

Thank you, Melissa and thank you for everyone on the call. and we look forward to talking to you after year-end. Have a great Holiday season if we don't see you. Bye-bye.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.