Sonida Senior Living, Inc. (SNDA) Q2 2012 Earnings Report, Transcript and Summary

Good day, and welcome to the Capital Senior Living's Second Quarter 2012 Earnings Release Conference Call. Today's conference is being recorded. The forward-looking statements in this release are subject to certain risks and uncertainties that could cause results to differ materially, including but not without limitation to, the company's ability to find suitable acquisition properties at favorable terms, financing, licensing, business conditions, risks of downturns and economic conditions generally, satisfaction of closing conditions such as those pertaining to licensure, availability of insurance at commercially reasonable rates and changes in accounting principles and interpretations among others, and other risks and factors identified from time to time in our reports filed with the Securities and Exchange Commission. At this time, I'd like to turn the call over to Mr. Larry Cohen. Please go ahead, sir.

Thank you, and good morning. Welcome to Capital Senior Living's Second Quarter 2012 Earnings Release Conference Call. I'm very pleased to report continued occupancy growth and strong operating and financial results for the second quarter. Successful execution of our strategic plan is significantly enhancing shareholder value through a focus on operations, marketing and accretive growth. Our same-community occupancy increased 160 basis points from the comparable quarter of the prior year and 20 basis points sequentially. EBITDAR margin increased by 90 basis points from the second quarter of 2011 and 40 basis points from the previous quarter. We continued to enhance our geographic concentration by acquiring high-quality senior living communities that generate meaningful increases in CFFO, earnings and net asset value. So far this year, we have acquired 7 communities for a combined purchase price of $75.6 million, and we are conducting due diligence on communities that should enable us to meet or exceed this level of transactions in the second half of 2012. As the value leader in providing quality seniors housing and care at reasonable prices, we are well positioned to make further gains as a substantially all private-pay business in an industry that benefits from need-driven demand and limited new supply. On April 30, we completed the acquisition of a senior living community in Texas for a purchase price of $19.2 million, enhancing the company's geographic concentration in Texas to a resident capacity of 3,627. This transaction is expected to add CFFO of $0.03 per share, increase earnings by $0.01 per share and increase annual revenue by more than $4 million. Occupancy at this community averages 89% with average monthly rent of $2,845. The community was financed with approximately $11.8 million of 10-year fixed-rate non-recourse debt with an interest rate of 4.48%. In our first 90 days of…

Thanks, Larry, and good morning. I hope everyone has had the chance to see the press release, which was distributed last night. In the next few minutes, I'm going to review and expand upon highlights of our financial results for the second quarter and first 6 months of 2012. A copy of the press release is available on our corporate website at www.capitalsenior.com. And if you would like to receive future press releases by e-mail, there's a place on our website for you to provide your e-mail address. For the second quarter of 2012, the company reported revenue of $77 million compared to revenue of $64.3 million in the second quarter of 2011, an increase of $12.7 million, or 19.7%. Resident and healthcare revenue increased from the second quarter of the prior year by $12.6 million, or 20.1%. We consolidated 88 communities on our income statement this quarter versus 74 in the second quarter of the prior year. Financial occupancy of the consolidated portfolio averaged 85.8% in the second quarter of 2012 compared to 85.7% in the first quarter of 2012, a sequential improvement of 10 basis points. Financial occupancy increased 190 basis points compared to the second quarter of the prior year. Average monthly rent was $2,968 per occupied unit in the second quarter of 2012, an increase of $75 per occupied unit, 2.6% higher than the second quarter of 2011. On a same-community basis, occupancies were 160 basis points higher than the second quarter of 2011 and increased 20 basis points sequentially. Same-community average rents were 1.6% higher than the second quarter of 2011. On a same-community basis, revenues increased 3.9% versus the second quarter of 2011, expenses increased 3.4% and net income grew 4.6%. As a percentage of resident and healthcare revenue, operating expenses were 59.4% in…

[Operator Instructions] We'll go first to Daniel Bernstein with Stifel, Nicolaus.

I thought maybe you could walk through the quarter in terms of the trends in occupancy from, say, the beginning of the quarter to the end of the quarter. Did you see any differences between the -- how your occupancy trended during that period? And maybe distinguish between maybe IL and AL and even maybe geographies, if that's appropriate?

I'd be happy to, Dan. If you look at the weekly results for the quarter, we had a good April, a very good May. We actually had the first few weeks of June that kind of saw some slowdown, but a very strong recovery in the third and fourth week of June and an excellent July. The feedback I'm getting from the field is outstanding. I mentioned that we had increases in July in all levels of care. It's rare that we see that, that they're across-the-board, including CCRC, IL, AL and memory care. In the -- it's interesting. In the second quarter, as I noted in the comments in the press release, we had more growth of independent living occupancy than assisted living. And that's been fairly true for not only capital, but the industry going back now to kind of middle of 2011. That being said, we had the -- an incredible amount of growth in assisted living in July and a very stable second quarter. So our assisted living occupancies have remained extremely stable and are now growing again. IL growth continues. We benefit from Texas. You probably saw a couple of weeks ago in CNBC, they rated Texas as the #1 state to do business in the country. It represents 29% of our operations, and Texas continues to be extremely solid. We saw excellent gains in Ohio in the quarter, very strong performance in Indiana, kind of the whole Midwest has performed well; in Minneapolis and Nebraska. And as I said, we get these weekly reports and monthly reports. And I'm very optimistic for the third quarter, which historically is our best quarter. And what's really interesting is how many buildings we operate that are just on the cusp, properties that were kind of low-80s. We…

Are you accelerating rate growth at all, I mean, given that some of your overall portfolio is starting to approach 90%? And I'm just trying to understand if I had to look out for a couple of more quarters, should I start to expect the occupancy growth maybe to start to slow a little bit and your rate growth start to accelerate, maybe similar to what we are starting to see in NIC MAP, or do you still see a lot more occupancy growth over the next 12 months?

We expect much more occupancy growth in the next 12 months. The way we set our rates, we have budgets that are prepared at the end of a year for the following year, and they set the rate growth projections for that year. As you can see, we budgeted 3%. If you look sequentially, we're up 70 basis points. We're very much on track for that type of 3% rent growth. Some buildings maybe a little more, some less. As we get into September, October, we'll start to really look at the annual rates very closely, and we'll forecast rate growth for next year. Again, that rate growth will also be determined as this defines what we expect for expense growth. Obviously, we're benefiting from a very slow growth economy and low inflation, a food costs as been very, very -- really haven't moved at all quite frankly. Utilities have been very, very controlled. We've been benefiting from all the electricity contracts we negotiated in non-regulated states. So we do anticipate having a greater rent growth next year. That's not yet implemented in our budgetary plans. But in our strategic plans, we had considered some better growth next year. Clearly, with improving occupancies, that will give us some more confidence to accomplish that. But I do think we are on a trajectory for good rate growth, good operating growth and very stable and good organic growth that should result in a nice, kind of, attractive growth rates on our same-store NOI growth.

Okay. And turning the tables to the acquisition pipeline, we've heard from a number of healthcare REITs that their acquisition pipeline seem to be building for the second half. You've talked about meeting or exceeding your first-half acquisitions. Is your pipeline growing? Are you seeing more sellers in the market? And maybe, what's driving the selling at this point from small operators? Is it the capital gains tax maybe increasing in 2013 potentially, or is there something else that's motivating people to sell the assets?

There are 2 factors, I believe, that are motivating sellers in the transactions that we are conducting. One is the tax rates, and we have 1 transaction where the seller -- we expect to close the transaction in September. The seller was only concerned that we close before at the end of the year because he was concerned about change of rates. But the other advantage we are seeing with our strategy of conducting these off-market transactions is developing relationships, where we have repeat transactions with sellers that have been so pleased with the feedback they received from their residents and their staff of being part of Capital Senior Living's family after we complete the acquisition that they've come back to do more business with us. So this is a very emotional transaction. We discussed this in the past. For a lot of the smaller operators that this is their baby, and they continue the relationships and communications with their staff. And -- but fortunately, the success we're having and the easy transition that we're able to accomplish on these transactions have generated more sales and more opportunities. So we're focusing on the growth. The pipeline, as you say, is very robust. We're very -- and quality is very good. But fortunately, we're not competing against the REITs for the larger transactions. We're still focused on transactions typically in 2 to 6 property-type portfolios in Ohio, in Indiana, in the Carolinas, in Texas. And the financial -- and the economic metrics of the transactions have been so consistent over the strategy that we've implemented beginning the middle of last year. But we're getting the benefit obviously of the low interest rates as the tenure has come down so much.

We'll go next to Drew Jones with Stephens Inc. Investment Bank.

Staying on the topic of acquisitions. I guess, I'm just thinking about the buy side of that transaction. Could you give us a quick update on the financing environment and whether or not there's any new competition for deals or anything unforeseen that might elongate that process?

Drew, I'll start with the financing environment, and it just continues to be extremely favorable. Obviously, all of our debt is at 10-year fixed rates, nonrecourse to the company through the government agencies, and it's all priced off the 10-year treasury. So with the 10-year staying in the 1.5 range, we would expect future deals to be very comparable or perhaps even better than the loans we've closed in the low- to mid-4% range. So the financing environment is still extremely attractive, and we plan to take full advantage of it.

On competition, it hasn't changed, Drew. I just look at the statistics. If you look at the transactions we've completed this year, and those which are under due diligence and under contract that we expect to close in the third quarter, 91% of transactions, all but actually 1 are off-market transactions. These are transactions where the sellers came directly to us. We are very well known in the industry for being acquirers in the regions, in which we operate. And I think that -- as we're seeing just by the fact that we have so many transactions coming to us before they go to market or just coming to us exclusively, I think it allows us to continue in this kind of a sweet spot where we can continue to have highly accretive acquisition growth in a very favorable environment without having much competition from other buyers.

Great. Just transitioning over to rate. If we look back at 2Q '11 and some of the occupancy trends there, is it right to think that maybe they weren't quite as many resident anniversaries in this last quarter and that maybe 3Q, there should -- we should be lapping more of those anniversaries so maybe a little more pricing power?

I think the difference in the pricing really comes through as I commented in the release. It's just a fact that we have more independent living rents coming out -- no, there's more growth in the occupancy and independent living than assisted living. So on a weighted average, because the IL rents are lower, you get out of that basis, you get a lower trend line. So -- and that will change. And one thing we are seeing, as I've said, is that our AL comparisons quarter-over-quarter were very steady. We had about 50 basis points growth in occupancy in IL in the second quarter from the first quarter. In July, it was interesting, about 60% of our growth in July came from AL with steady growth in IL, memory care and even our CCRCs. So as we have more growth in the higher levels of care as well as the software programs that we've implemented and start to benefit from some of the charged level of care charges, we should start to see a little more growth on the revenue side as well.

[Operator Instructions] We'll go next to Joe Munda with Sidoti.

A lot of the questions were answered already. But, Larry, I was wondering, if you could walk us through the criteria for rent increases for a particular property geographically? I mean, obviously, it's going to be different by state. But you touched on it a little bit. Can you walk us through and give us a little bit more clarity there?

Sure. We have a very involved process every year that starts at the community level and works its way up through our operating management team, which is looking at each line items at 0-based budget and they go through each expense item and decide what a reasonable increase is anticipated for the following year. From that, we always want to have a spread, where we have more rent growth than expense growth. So we, kind of, look at that. We look at trends in the economy. One of the advantages we have, if you look at our performance over the last couple of years compared to our peer group in NIC MAP, is that it's -- our average rents are lower than other -- many other operators based on the geography. So the rent growth is a little more accepting to some of the residents when you're increasing a $2,000 a month rent at 3% versus a $6,000 a month rent at 3%. So -- but it really ties into a process. We then will fine tune that during the course of the year. We pay a particular attention to the properties that operate below an 85% level, and then we actually look weekly at rents and units in those buildings to see how we can manage the process. Our focus is always not looking at rent growth, occupancy growth. Our focus is NOI growth. So our systems are generating information, and our managers are looking at results that are focused on driving bottom line growth. So we're happy to -- where we can push rates and maybe sacrifice some occupancy to generate cash flow growth. But it's really a system that has been utilized for many years and continues to work pretty well. But a lot of it is more than geographic, it's really more a function of making sure that we have rent growth that is exceeding our expense growth expectations.

Have you lowered any of your rents in any of your facilities?

We occasionally, in competitive markets, may give some specials on a limited number of units. We don't discount. We like to maintain the integrity. But we're seeing much less of that and less need to do that, which is very positive. So that's a positive aspect. But we typically don't discount. We typically raise the rents, both in-house rents and street rents. One advantage that we're seeing over the last year or so is during the downturn, it was a little harder to raise the rents on anniversaries to residents to keep the same level as street rents. Now, we're really looking at rent growth pretty consistently, both to the renewals as well as to new residents coming into the properties.

And do you guys have a referral network in place?

We do. Our best referral source are our residents and family members. We also work with companies like A Place for Mom and other vendors that refer to us. And then our sales and marketing directors, they're focused always on outreach, looking at geriatric physicians, discharge planning in some hospitals, social workers, a tremendous amount of activities both inside the community and within the community is quite large, trying to expand our leads and now, we're very focused on upgrading our Internet web e-marketing, realizing that's another opportunity for us to increase our leads and expand our penetration rates.

We'll go back to Daniel Bernstein with Stifel, Nicolaus.

Just 1 extra question. There's been a pretty big heatwave across the U.S. Are you expecting any bump-up in utility costs in the third quarter?

We haven't seen it yet. I'll tell you, Dan, it's a great question. I mean, we looked at the numbers, we haven't seen it. We'll wait until we get July and August numbers. But, yes, June was hot. We didn't see any utility growth. In fact, I think we were down in June. So one benefit we do have as, I mentioned, we're such a big platform in Texas as well as in some other states like Ohio. We have negotiated long-term contracts on kilowatt rates for electricity. 3 or 4 years ago, we're paying $0.07, it went down to $0.06. We're now at $0.05 a kilowatt hour in Texas, in Ohio and few other states, which is the bulk of our portfolio. So fortunately -- now usage may increase because of the heat but again, we're benefiting from very low rates. And if you look at Darren's reports as recent as June, the actual year-over-year variance in utilities was actually down. So that's not to say that something may not pop up this month or next. It has been warm. Ralph and I were in the [indiscernible] hollow at a Texas Ranger game that I think was 104 degrees. Not a pleasant temperature to be watching a baseball game. I don't know how these ball players play in this heat.

So you saw the 100 days of 100-degree heat in Texas last year?

That was last summer, exactly. But so far, we haven't seen it, Dan.

Okay. And then 1 other quick question I have here on conversions. Are you looking at doing any conversions or expansions for the acquisitions that you've done or looking at in terms of due diligence? I don't know if other smaller operators have capital to make those changes. Do you see possibilities to improve the assets that you're acquiring?

Definitely. In fact, it's interesting. We just brought some deals to the board 2 days ago. And as part of that portfolio, there was actually approval for expansion, and we've seen this in other transactions, where the sellers didn't have access to capital to finance that growth. But what we're going to do on these transactions is first, get into the operations, make sure we really understand the market, make sure there's the demand in that market for that growth on the expansions and then we'll look at that as a growth opportunity. But we are buying properties and many of them have either land for expansion and some actually have plans for expansion that just couldn't be paid for by the existing owner.

We'll go next to Todd Cohen with MTC Advisers.

Ralph, could you just please walk me through again the lease transaction that you referred to?

I'd be happy to, Todd. What we did was to avoid a potential lease covenant violation. We did a complete modification and extension of one of our major leases. And what we did was we took 2 independent living communities that had mortgage debt on them, and we exchanged those 2 independent living communities and the debt for 1 CCRC that was unencumbered. So the landlord accepted the 2 independent living communities and assumed the $18.3 million of debt. We got back the CCRC that we now own free and clear, which gives us flexibility going forward as to how we operate that community. What happened on the cash flow statement, if I'd might just expand on that, is that the Internal Revenue Service considered the $18.3 million of debt assumption as a taxable gain to the company even though the values exchanged were roughly comparable. So for book purposes, the values were comparable, and there was no gain booked on Capital Senior Living's books. But for tax purposes, we owe the IRS because $18.3 million of debt was assumed by someone else. And for that reason, we had to book nearly $7 million of an increase in our deferred tax asset and our taxes payable. And for that reason, we added that back on our cash flow statement because it was not from operations. So that's the big number on the CFFO and how that appeared. It's a difference between book accounting and tax accounting.

And now, Todd...

So you're saying you won't actually have to pay that cash tax?

No, we will have to pay the cash tax. So that the taxes that we paid some time probably later this year, partially offsetting that, was we got back about $3.4 million in shortfall deposits. So there was a small difference in the amount of taxes we'll pay. We are also doing some cost segregation studies on all of these acquisitions. And we think the result of those cost segregation studies, if you know how they work, is basically to rather than to depreciate a building over 30 years, we separate it into various asset classes that have shorter depreciable lives and reduced taxes accordingly. So we're working with third parties to help us do a cost segregation study, which we think will make up the difference in the taxes between the cash we received, the taxes that we owe. And we don't expect to be out of pocket significantly.

And then next, how many properties are in this pool now?

The pool now has 11 properties that had 10, so we contributed 2 properties and got 1 back.

Okay. And then you said the lease terms were extended out 5 years?

One of the major benefits, Todd, is that this lease, we could have extended it in 2015 for another 5 years. We now have 2 5-year options beyond 2020. But as typical of these leases, the landlord has the right to reset the underlying lease values on the date of the extension. And we've now deferred that for 5 years, so that we're assured that our leases are not going to have a step-up in 2015, which could have been very significant.

Right. Good. Okay. And then, Larry, I know you've said that you've got additional acquisition candidates, kind of, coming up in the quarter here. How far along were the ones that you think you're going to close on get you to your balance for the $150 million for the year?

We're very comfortable with our numbers and believe that if we complete our due diligence successfully and close this quarter, we'll be very close to our target for the year. So we're very well ahead of our goal of achieving transactions totaling $150 million this year.

And there are no further questions at this time. I'd like to turn the conference back over to Mr. Cohen for any additional or closing remarks.

Well, again, we thank you, all, for your support and participation on the call. As always, if there are any further questions, please feel free to contact either Ralph or myself. And we look forward to talking to you soon. Thank you very much. Have a good day.

That does conclude today's conference. Thank you for your participation.