National Health Investors, Inc. (NHI) Q3 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the National Health Investors' Third Quarter 2013 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Tuesday, November 5, 2013. I would now like to turn the conference over to Tripp Sullivan of Corporate Communications. Please go ahead, sir.

Thank you, Charlene. Good morning. Welcome to the National Health Investors' conference call to review the company's results for the third quarter of 2013. On the call today will be Justin Hutchens, President and Chief Executive Officer; and Roger Hopkins, Chief Accounting Officer. The results, as well as notice of the accessibility in this conference call on a listen-only basis over the Internet were released last night. And our press release has been covered by the financial media. As we start, let me remind you that statements in this conference call that are not historical facts are forward-looking statements. NHI cautions investors that any forward-looking statements may involve risks or uncertainties and are not guarantees of future performance. All forward-looking statements represent NHI's judgment as of the date of this conference call. Investors are urged to carefully review various disclosures made by NHI in its periodic reports filed with the Securities and Exchange Commission, including the risk factors and other information disclosed in NHI's Form 10-K for the year ended December 31, 2012. Copies of these filings are available on the SEC's website at www.sec.gov or at NHI's website at www.nhireit.com. In addition, certain items used in this call are non-GAAP financial measures, reconciliations of which are provided in the company's earnings release and accompanying tables and schedules, which has been filed on Form 8-K with the SEC. Listeners are encouraged to review those reconciliations provided in the earnings release, together with all other information provided in that release. I'll now turn the call over to Justin Hutchens. Please go ahead.

Thank you, Tripp. Good morning, everyone, and thank you for joining us. With me today is Roger Hopkins, our Chief Accounting Officer. We reported $0.94 of normalized FFO in the quarter, a 17.2% increase and greater than we had anticipated, which Roger will explain in a moment. We have completed $258 million of investments year-to-date. And we have experienced great performance from our portfolio, particularly the Bickford joint venture. I'll go through all of that in more detail in a few minutes. Roger will walk through our financial results.

Thanks, Justin. Good morning, everyone. My comments this morning are consistent with our disclosures in Form 10-Q, our earnings press release and our supplemental data report filed yesterday afternoon with the SEC. I am very pleased to report strong normalized FFO growth for the third quarter of 2013. Normalized FFO for the third quarter rose 17.2% over the same period in 2012, primarily as a result of revenues from our new investments funded up $241,549,000 in 2013. Normalized FFO for the third quarter was $26,193,000 or $0.94 per diluted common share compared with $22,357,000 or $0.80 per diluted share in the same period in 2012. Normalized FAD for the third quarter was $25,359,000 or $0.91 per diluted share compared with $21,736,000 or $0.78 per diluted share for the same period in 2012. Normalized FFO and normalized FAD for the third quarter of 2013 excluded the positive impact on net income of a recovery of a previous write-down of $2,061,000. This write-down was related to a note receivable, but ended up being paid in full in the amount of $3,293,000. Net income attributable to common stockholders for the third quarter of 2013 was $42,744,000 or $1.53 per diluted share compared with net income of $14,351,000 or $0.52 per diluted share for the same period in 2012. Net income for the third quarter includes the accounting impact of the recovery of $2,061,000 plus a gain of $19,370,000 on the sale of 6 skilled nursing facilities to our tenant, National HealthCare Corporation. We plan to defer recognition of the tax gain on the sale of these facilities by utilizing the like-kind exchange rules under Section 1031 of the Internal Revenue Code. Large transactions that are infrequent or unpredictable in nature that affect net income are adjusted in our reconciliation of our net income to normalized FFO and normalized FAD. Our revenues for the third quarter were up $7,450,000 or 30.6% compared to the same period in 2012 due to the volume and timing of our new investments in 2012 and 2013. Straight-line rental income was $1,713,000 in the third quarter. The revenues from our RIDEA-structured joint venture with Bickford amounted to $5,387,000 in the third quarter and represents 16.8% of our total revenues from continuing operations. Our RIDEA joint venture with Bickford currently owns 27 assisted living and memory care facilities and also has 3 facilities under construction. As described last quarter, our annual contractual lease revenue from the operating company on the joint venture is $18,836,000 plus annual escalators in operating cash flow. Revenues and expenses for each year presented in our income statements exclude those properties that were sold or that meet the accounting criteria as being held-for-sale, with such revenues and expenses being reclassified to discontinued operations. This reconciliation -- or reclassification, had no impact on previously reported net income. Revenues from discontinued operations in the third quarter related to 6 skilled nursing facilities that we sold to our tenant, NHC, in August. Rental income from our owned assets represented 91% of our third quarter revenue. Interest income on our notes represented 6%. And investment income represented 3%. Depreciation expense, for financial statement purposes, decreased $59,000 in the third quarter of 2013 compared to the same period in 2012, as a result of certain assets being reclassified in 2012 that were previously held-for-sale. Absent that reclassification in 2012, depreciation expense would've shown an increase of $1,894,000 in the third quarter of 2012 compared to the same period in 2012. This increase is indicative of our growth in new real estate investments in 2012. Our interest expense and amortization of loan costs increased $2,436,000 during the third quarter compared to the same period in 2012, as a result of additional borrowings to fund our new real estate investments in 2012 and 2013. Interest expense in the third quarter includes amortization of debt costs of $110,000. Our general and administrative expenses for the third quarter of 2013 increased only $118,000 from the same period in 2012. Share-based compensation expense was $253,000 for the third quarter. We estimate the market value of our stock options granted each year using the Black-Scholes pricing model. Our normalized FFO for the third quarter of 2013 was $0.94 per diluted share, which has overstated our expected third quarter results by $0.03 per diluted share due to the timing of the sale of the 6 facilities to NHC, the timing of our purchase of 8 skilled nursing facilities from our former not-for-profit borrower, ElderTrust, which we leased to NHC, and lower general and administrative costs. We ended the third quarter with cash and investments in marketable securities of $21,027,000. Our debt on September 30, 2013 consisted of borrowings on our unsecured revolving credit facility of $191 million, unsecured bank term loans of $120 million with a maturity of almost 7 years and $80 million of Fannie Mae secured debt, maturing in July 2015. In August, we paid off a secured mortgage debt of $19,250,000 scheduled to mature in November. We have $59 million available to draw in our revolving credit facility. At September 30, 2013, we have ongoing construction projects with 3 tenants totaling $38,500,000 relating to 3 new assisted living facilities and expansion and renovation of a senior living campus and an expansion and renovation of an acute care hospital. The total funds advanced so far on these projects for land and construction amounts to $21,254,000. We expect our normal monthly cash flows and borrowings on our revolving credit facility will be the primary sources of capital to fund our operations for the remainder of 2013. We continue to evaluate long-term debt financing options. Each of these forms of debt capital will come at a higher interest cost as compared to our revolving debt credit. We currently estimate that we will have one or more of these longer-term debt instruments in place in 2014. As shown in our supplemental data report, we calculate our EBITDA coverage of our interest expense to be 17:1. On an annualized basis, our consolidated debt-to-EBITDA is 3:1. I'd now like to turn the call back over to Justin with comments about our investment portfolio and our 2013 normalized FFO guidance.

Thanks, Roger. Looking at our portfolio statistics, lease service coverage remains very strong, with a weighted average lease service coverage ratio of 2.88x. As a reminder, you can find details on the ratios for our properties on Page 6 of our supplemental. NOI is up 6% sequentially in the Bickford-RIDEA portfolio, while occupancy was 85.2% for the quarter, which is a 90-basis point improvement over the prior quarter. Our new investment volume is $258 million for the year. Our pipeline continues to be very active, with mostly private-paid senior housing assets. We have added 12 new operators to our portfolio over the past 5 years. And we have already had repeat business with half of those operators. We have also grown our portfolio to handful of our long-term existing customers. We plan to continue to grow by servicing our current customers and continue to look for opportunities to add new operators to the mix. Turning to our outlook, we are raising and tightening our guidance for normalized FFO for 2013 and raising the top end of the range to $3.53 to $3.55 per diluted share. In regards to capital planning, we have plans to continue to term out debt with staggered maturities over the near and long term. Due to our low leverage balance sheet, we still anticipate that we won't need to raise equity in the near term, absent a transformational investment opportunity. In summary, the pipeline is strong, and has been consistently strong for the past several quarters. The business environment is favorable. And we are creating new relationships among operators and deepening the existing partnerships that we have currently. Our win-win approach has resonated with operators and has us on track for another great year for NHI. Operator, we're now ready for questions.

[Operator Instructions] Our first question comes from the line of Karin Ford with KeyBanc Capital Markets.

My first question was just on the terming out of the line. I think in the past, you've talked about a couple of options, maybe a secured HUD option and then a private placement. Are those 2 options still on the table? And can you give us an update as to what you think indicative rates might be for you guys on those 2 items? And then I know you said 2014, but just if you could pinpoint a little better on timing, that would be helpful.

Karin, we wish we could nail down the timing. That's a little bit uncertain at this point. But we certainly believe those options are available, continue to be available to us. We believe that the indicative rates for HUD would be in the range of 4%. We believe that private placement, perhaps in the 10- to 12-year range, would be 5%, perhaps more. But, of course, those rates are fluid and wouldn't be known absolutely until we execute on either one of those instruments.

That's helpful. My second question is also on the capital lines. Given the increase in your cost of equity today, I know your leverage level still remains low and below sort of your longer-term target. But do you feel a greater sense of urgency, especially in light of the fact because the pipeline continues to be really good? Do you feel a greater sense of urgency today to perhaps tap the equity markets sooner than you had previously thought?

Well, Karin, this is Justin. I mentioned in my prepared remarks that absent a transformational investment, we don't anticipate utilizing equity in the near term. If volume gets ahead of schedule, certainly, we would entertain it. At this point in time, if we just were to grow at our kind of our targeted pace, which is usually around $100 million, $150 million a year, we think we could utilize debt all through 2014. There's a debt maturity that Roger mentioned that occurs in 2015. It's Fannie Mae debt, $80 million. The cost of that debt is 7%. That would probably be -- there'll probably a consideration in 2015 to utilize equity, particularly when we can pay down that relatively expensive debt. But in the near term, we're just going to continue to utilize debt financing, utilize the sources that Roger mentioned most likely and match the timing up with our investments that we plan to make in 2014. But like I said, if we get ahead of schedule, then we would certainly consider equity at that time.

And then last question is, is there any change that you're seeing in the marketplace in terms of cap rates or any change in your required returns on investment?

From last quarter, we really haven't experienced any change at all.

[Operator Instructions] Our next question comes from the line of Todd Stender with Wells Fargo.

It's obvious your debt profile is still very low certainly relative to the peer group, but it continues to edge higher due to your active investment pace. Could we just get an update on how the board feels about where NHI's debt level's going? I'm sure they like the growth of the company, but it is coming from a level that they probably got used to, essentially no debt for quite a while. I'm just kind of getting their pulse of how they feel about it?

Sure, Todd. This is Justin. We have targeted 4 to 5x fixed charge cover and 4 to 5x debt to EBITDA. And if we can manage to those metrics, we'll continue to be in the lower part of the peer group in terms of the leverage.

Okay. So essentially relative to the peers, well, sometimes they edge up to about 7 or 8x. That's helpful. And then, just, if you can give some color? And correct me if I'm wrong, is Discovery Senior Living and Chancellor held? Are they new to your portfolio?

Discovery Senior Living is a new customer. They came to us this year. We've entered into really 2 transactions with them. One is to acquire a campus in Alabama that includes independent living and assisted living. It was a CCRC that have been converted to rental -- a rental model. It's a very good fit given the senior housing background that Discovery has. We've also committed some financing to construct an assisted living project in Naples, Florida with them. Chancellor Health Care is an existing customer. We had purchased the campus last year in Loma Linda, California. It's independent living and skilled nursing. And we've agreed recently with Chancellor to fund the construction of an assisted living community on that campus. And also, we just made a purchase, some of the assisted living property in the Baltimore area of Maryland that will be leased to Chancellor and operated by Chancellor. So we've had an opportunity to expand that relationship.

Okay. And Justin, if you can just expand on some of those yields that you look at on new development, whether it's in the Baltimore area or in California. Is there any difference in some of those initial yields?

Well, the yields that we went with, in this case, we went with -- the Maryland property, by the way, is not a development. It's a stabilized asset. We charge 8% for that. We do think there's some opportunity for operational improvement that Chancellor will benefit from. And, of course, that will benefit from a credit standpoint. And then we charge 9% on the construction. So there's about 100-basis point premium that we get for financing the construction. But, of course, the risk profile of that construction is lower than most because it's being built on the existing campus that has natural built-in feeders that we can refer to the new assisted living community.

Okay, that's helpful. And then just lastly, the loan to Bickford, was that at a 9%?

The loan to Bickford, the mezz financing was -- I think it was 11%.

Okay. Just kind of getting a feel for some of the comparisons with the risk.

Yes. So and then same as the case with the loan to Discovery. In both cases, we charged 12%, actually. So we get double-digit interest rates on those mezz loans that we make that are committed as part of a construction financing.

Our next question comes from the line of Daniel Bernstein with Stifel. Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division: I got -- I'm going to switch away from the seniors housing and look at the NHC lease coverage that was up, it looks like, year-over-year. When we look at -- a lot of other reporters on the skilled side and the REIT side, it looks like lease coverage just deteriorated I assume from sequestration. What do you think is helping NHC's lease coverage on a year-over-year basis? Are they doing something different? Do they have some competitive advantages over skilled competitors? Just trying to understand the strength in that portfolio.

Sure. Well, one thing that was our understanding across-the-board is that summer was relatively weak in skilled nursing. We have a quarter lag in our coverage ratio. So it'll be interesting to see them updated. I don't see -- I don't expect much change, but there could be some change when we add in Q3. NHC's coverage ratio is based on corporate coverage. We own about half of their real estate assets. They have a whole another group of assets that are unencumbered. Plus, they have other lines of business that are included in that corporate coverage. So they're offsetting any SNF performance change with their ancillary businesses. And obviously, they're doing a good job with that. And they're at 4.1x cover. And then our non-NHC SNFs are covering at 1.82x. And we feel really good about their performance moving forward as well. Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division: Are the other -- the non-NHC SNFs, are those corporate coverage? Or is that property level?

Yes. The non-NHC SNFs are property level coverage. Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division: Okay, okay. So anybody doing ancillaries or adding home health et cetera, is not going to benefit?

Right. Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division: Obviously, there's also been a lot of talk in the industry about seniors housing construction, where that's heading. Have you changed your investment criteria in any way, I mean in terms of what cap rates you're looking for? Whether you do triple net or the RIDEA? And in particular also whether you've thought about CapEx needs on properties you're looking in. Is any of your investment due diligence changes the result of the tick-up in construction of seniors house?

One part of our due diligence that's always been in place is to check to see if there's new supply entering markets that -- where we're contemplating an investment. And for the past 5 years, the answer was generally no. Now, of course, there is new supply that we're finding as we look at various markets. And so I would consider that a change. The criteria hasn't changed, but the results are different because there is, in fact, new supply of being added in several markets. In terms of our overall investment criteria, we're going to be mindful of the new supply, and particularly, the price point that the new supply would have to support when they enter our market. One advantage that I think we have, for instance, with the Bickford construction is that we're financing at a $150,000 a unit, which is relatively low given the fact that the price point that product attracts is around $5,000 a unit. So we have some room -- a little bit of wiggle room when we enter our market. Generally, we'll enter our market as a price leader and -- but not always. There's some markets where we will -- we will enter the market with a new product and not be the price leader. But to the extent that there's new construction that is entering as the price leader in the market, funds we're operating at mid to mid-high price point product or that at least we own a mid to mid-high price point product I feel like were somewhat insulated from the new supply. So that's something we look at. But the dynamics are changing due to new construction. There's no question about it. Good news is that demand is still very strong. Performance is solid across the industry. So we remain very confident, moving forward as we continue to make investments in private pay senior housing. Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division: Okay. Are there any other geographies you would, in particular, want to invest in or not invest in as a result of what you're seeing in the construction data or what you're seeing on the ground that may not already be in the construction data?

Well, I would say that is 2 states that we've noticed, at least in our due diligence, to have a similarly very active construction pipeline is Florida and Texas. So we're very focused on those 2 states and paying attention to the new supply coming on for the -- naturally, those are 2 states that support a rapidly growing, aging demographic, so it makes sense that there'd be more supply being added there. But I do think that there's a lot of operators and investors that have figured out that there is an aging supply, particularly in Florida. And if you can enter with a new product, then -- that's well-located, then you can probably take some market share. So there's some attractive opportunities in Florida, but there's probably markets that are at risk of being overbuilt. So we're watching that very closely. Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division: But do you think maybe the newer assets will take market share from the older? Is that the right thing to...

I do. That is -- as long as -- and the trick is though, and I don't think everybody will be successful doing this, you have to be able to build efficiently enough that you do not have to be the price leader to compete in the market. If you go at the high end of the market, I think some developers and operators are going to price themselves out of markets, which will lead to distress and then probably a repricing of the asset. But given where construction costs are and the experience we've had, I do think there's opportunities to enter markets, not be the price leader, which positions you really well to take from the price leader in the market, as well as compete with other mid to high price point product.

And we have a follow-up question from the line of Karin Ford with KeyBanc Capital.

Just along the same line, you've got a really nice rebound in occupancy in the RIDEA portfolio, both year-over-year and quarter-over-quarter. Can you just talk about what the outlook is looking like for occupancy? I know there's, I think, there's still some fill-up there. Just your thoughts as we head into sort of the seasonally slower period here, do you think that occupancy will continue to trend up?

Sure, Karin. I don't mind telling you that we have visibility on a very strong revenue quarter, in our joint venture with Bickford. And that's just assuming occupancy stays flat. The reason for that is just some carryover from the occupancy increase we had in Q3. Also, there's -- they have it's kind of a seasonal rent increase they do. There's a lot of increases that happen to happen in the month of November. I also expect expenses to drift up as well on Q4. But all together, we think we're looking at a strong quarter. I don't have a feel for anything beyond that, but I will also add this, just a little color, that improvement that the portfolio had in Q3 did not improve -- include any benefit from those turnaround assets I mentioned on our previous call. So there's been a lot of focus there by Bickford management. We expect improvement in those assets over time as well. So I look forward to that improvement down the road a bit. Meanwhile, the rest of that portfolio has drifted up. And Bick's done a very good job, I think, managing really the portfolio from every perspective.

That's helpful. And then on the investment side, are there any big portfolio transactions that are, currently, your pipeline under consideration today? And/or do you expect any additional deals to close before year-end?

We have several hundred million dollars under review right now. It may be the busiest pipeline we've had since I've been here at NHI. There's no guarantees, of course. We may close 0, but we're very busy. I wouldn't rule out a year-end close, but I wouldn't predict one either. And our guidance, of course, doesn't consider any investment activity that, that would happen because anything that does happen, the benefit occurs in 2014. So when we get around to giving our 2014 guidance, we'll have more clarity at that point.

Okay. And big deals, are they in that pipeline?

Well, let me say this. When we -- you know our profile. I always say, someday, we'll have that transformational large opportunity. And when we do, well, like to your question earlier, we'll consider raising equity. But then again, that deal hasn't come yet. In 5 years, we've been making a living off of the small portfolios and the one-off assets and have done a great job, I think, executing on that game plan. We're always open to large transactions. But generally, that's not in our real house.

And then just finally, just a housekeeping question. The guidance language in the press release mentioned a tick-up in G&A in the fourth quarter. Can you just give us a little more color on that?

Karin, this is Roger. We had lower G&A than we expected in the third quarter. We think we'll have a little bit higher G&A in the fourth quarter relating to tax, capital planning, year-end compensation, these sorts of things. And I think our activity, investment activity over 2013 is a driver of a lot of that expected G&A in the fourth quarter.

Okay. It's like a few hundred thousand dollars or something like that?

Yes, yes.

Our next question comes from the line of Adam Joseph with West Main Partners.

A question, if I could circle. The comment that you made in reference to the states of, let's say, Texas and Florida, what are you seeing on the pipeline for potential opportunities if we move out West, Arizona, California? Do you guys have any sense on what that growth channel might look like in the future?

Well, I can tell you I have seen some development in Arizona, both in the senior housing and in the Medicare-supported subacute market. But California is, I'm sure you know, is a very difficult state to generate a new development because it takes an awful long time to get projects underway. We're not seeing a lot of volume in California and any other states out West that -- I can't -- there's none that's really jumping out at me in terms of having an above-average amount of development volume.

Okay. And then finally, just so I'm clear, did you say there was $59 million left on the revolver? Is that correct?

Yes. The $59 million left, one thing I should point out to, is we have an accordion feature, where we can tap another $150 million. So I'm very confident that if we need to move quickly, that we have plentiful access to capital to continue our investment activity until we, in fact, term out the line.

And pardon me, Mr. Hutchens. There are no further questions at this time. I'll turn the -- I'll now turn the call back to you. Please continue with your presentation or closing remarks.

Okay, thank you. I'm sure you can tell that we're very upbeat, positive about the results at NHI and the outlook for the company. We appreciate your time on the call, and look forward to talking again on our next call.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation, and ask that you please disconnect your line.