CareTrust REIT - Q1 2023

Transcript

Operator (participant)

Good day. Good day. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to the CareTrust REIT Q1 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press the star one. Thank you. I would now like to turn the call over to Senior Vice President, Lauren Beale. You may begin your conference.

Lauren Beale (SVP)

Thank you. Welcome to CareTrust REIT's Q1 2023 Earnings Call. Participants should be aware that this call is being recorded, and listeners are advised that any forward-looking statements made on today's call are based on management's current expectations, assumptions, and beliefs about CareTrust's business and the environment in which it operates. These statements may include projections regarding future financial performance, dividends, acquisitions, investments, returns, financings, and other matters, and may or may not reference other matters affecting the company's business or the businesses of its tenants, including factors that are beyond their control, such as natural disasters, pandemics such as COVID-19, and governmental actions. The company's statements today and its business generally are subject to risks and uncertainties that could cause actual results to materially differ from those expressed or implied herein.

Listeners should not place undue reliance on forward-looking statements and are encouraged to review CareTrust's SEC filings for a more complete discussion of factors that could impact results, as well as any financial or other statistical information required by SEC Regulation G. Except as required by law, CareTrust REIT and its affiliates do not undertake to publicly update or revise any forward-looking statements where changes arise as a result of new information, future events, changing circumstances, or for any other reason. During the call, the company will reference non-GAAP metrics such as EBITDA, FFO, and FAD, or FAD, and normalized EBITDA, FFO, and FAD. When viewed together with GAAP results, the company believes these measures can provide a more complete understanding of its business, but cautions that they should not be relied upon to the exclusion of GAAP reports.

Yesterday, CareTrust filed its Form 10-Q and accompanying press release and its quarterly financial supplement, each of which can be accessed on the Investor Relations section of CareTrust's website at www.caretrustreit.com. A replay of this call will also be available on the website for a limited period. On the call this morning are Dave Sedgwick, President and Chief Executive Officer, Bill Wagner, Chief Financial Officer, and James Callister, Chief Investment Officer. I'll now turn the call over to Dave Sedgwick, CareTrust REIT's President and CEO. Dave?

Dave Sedgwick (President and CEO)

Good morning, everyone, and thank you for joining us. Before handing the call over to James and Bill, I'll address 3 topics: investment activity since our last call, a portfolio update, and some thoughts on the regulatory environment. First, back in November, we talked about how we anticipated that more deals would be steered our way as sellers grow frustrated with delays and retrades due to the tighter credit markets. Today, we are pleased to report that that increased flow of deals has occurred and has begun to result in exciting new investments for us. Since our last call, we've successfully closed on 3 transactions, totaling 3 skilled nursing and 2 seniors housing facilities for a combined $47 million. The stabilized blended yield for these deals comes in at 9.6%.

As meaningful as these investments are to the company this , maybe more importantly, these deals officially start 3 new relationships with operators we believe will not only improve the lives of employees, residents, and patients at these facilities, but also fuel future growth opportunities for CareTrust. The pipeline today sits at between $150 million-$200 million. Second, the existing portfolio is overall in very good shape. Since the very start of the pandemic, we expanded the way we report coverage to 3 views: pre-pandemic, excluding Provider Relief Fund, and amortizing Provider Relief Fund through their eligible periods. Excluding the Provider Relief Fund, trailing-12 property-level EBITDAR coverage for the portfolio through December 2022 remained strong overall at 2.01 times compared to the 12 months leading up to September 2022.

Last quarter, I gave more color around one skilled nursing operator not in our top ten with negative lease coverage that accounted for roughly $5 million of contractual rent. At the time of last quarter's call in February, they had not paid rent since November of 2022 and had very recently terminated their CEO. They have made a full rent payment in March, a partial rent payment of $100,000 in April, and thus far, no rent in May. They replaced their CEO just last week, we're talking through all options with them. We're striving to determine the best path forward for this portfolio as soon as possible since its status is still one of the main things keeping us from issuing guidance. I'm pleased to report that we've made progress since our last call.

Of the retained facilities, we transitioned 2 Wisconsin assisted living facilities from Noble Senior Services to The Pennant Group. Wisconsin is a region of strength for Pennant, and they are working closely with the Department of Health to obtain licensure and have begun meaningful improvements to turn those 2 facilities around. Since our last call, we have sold 1 small seniors housing facility that was previously counted as held for sale for approximately $3 million. On the regulatory front, our operators have been preparing for the end of the Public Health Emergency, which expires today, potentially impacting some operators while being essentially a non-event for others. The Public Health Emergency has implications for the Medicaid rate as the 6.25% add-on from CMS winds down by the end of the year.

We are, for the most part, encouraged by the steps many states have taken to permanently address the increased cost of care for operators due to the pandemic and the subsequent high inflation. My last issue for the regulatory environment relates to the proposed minimum staffing requirement from the Biden administration. As we sit here today, there is still a lot that is unknown, but it is generally believed that despite the severe staffing crisis in healthcare generally, and skilled nursing specifically, some form of staffing requirement will be issued. The industry is working hard to educate regulators in D.C. on what a requirement could inflict on operators and what conditions would make said requirement manageable. Things like additional funding or employment rate hurdles or a phased timeline, et cetera.

We're hopeful that the time CMS is taking is evidence of them weighing seriously the realities on the ground that are being shared with them. Heading into June, we're really pleased with the progress made to date toward our main priorities for the year. Namely, returning to asset acquisitions, sourcing more off-market deals, expanding our operator bench, increasing the dividend, and further de-risking the portfolio through active asset management work, all while maintaining a leverage profile that provides tremendous flexibility in a challenging market. With that, James will talk to you about our recent activity and pipeline.

James Callister (CIO)

Thanks, Dave, and good morning, everyone. As Dave mentioned, this year we're off to an exciting start with approximately $47 million in new acquisitions, consisting of 3 transactions, 5 facilities, and 3 new operator relationships. At the end of Q1, we closed on a 280-bed, 2-facility skilled nursing portfolio in Texas and Kansas. We paid approximately $17 million for the portfolio, with the Texas facility being a tack on to our existing master lease with Momentum Skilled Services, and the Kansas facility being leased to Summit Healthcare Management, a new operator for us. Combined stabilized annual rent for these facilities is approximately $1.69 million. Earlier this month, we closed 2 transactions, with each starting a new operator relationship.

First, we acquired a 148-bed skilled nursing facility in the Atlanta metro area for approximately $12 million, and leased the same to The Elevation Group, an operator founded by brothers Ken and Dan Funk, two industry veterans with many years of combined experience operating skilled nursing facilities. The annual rent for this property is approximately $1.14 million. We followed the Atlanta closing by acquiring a 136-unit, two-facility memory care portfolio in the Chicago area for approximately $18 million. We leased these buildings to Chapters Living, a Midwest-based memory care operator in its early growth stage and co-founded by Danny Stricker, an experienced leader in the seniors housing industry. The initial annual stabilized rent for Chapters is $1.7 million. These transactions reflect what is one of our top priorities this year, a return to acquisitions.

Given the current lending environment, we continue to opportunistically pursue actionable deals where we feel our access to capital, low execution risk, and reputation as a quality transactions partner make us a particularly attractive buyer. A sustained return to acquisitions requires that we not only deepen and expand our relationships with the best-in-class operators that make up our operator bench, but it also requires a commitment of resources and effort to actively seek out prospective operators that we can confidently grow with in the future. Last year, we allocated some internal resources to enhance our focus on expanding our network of prospective tenants. We are seeing that commitment of resources paying off with the addition of these three new operators this year.

As you may recall, last year we also strategically provided some debt financing, in part as a means of establishing relationships with operators we had admired from a distance. Our purposeful, relationship-based lending program in large part yielded the opportunity to acquire the Georgia facility by utilizing connection we made as part of 1 of the loans we extended last year. We are gratified to see last year's move to strategic lending activities already begin to bear fruit in our current pipeline of acquisition opportunities. As Dave referenced in his comments, deal flow remains strong. Most incoming transactions consist of between 1 and 4 facilities, with only a small number of larger portfolios hitting the market. We are seeing sellers continuing to divest non-strategic assets.

We also continue to see a number of inbound transactions with facilities that are in some stage of operational distress, unable to make debt service under variable rate loan obligations, or facing maturity date risk. We see some motivated sellers adjusting pricing expectations as more highly leveraged buyers remain somewhat on the sidelines given the banks continue tightening on lending activities. We remain optimistic that we can continue to source accretive transactions over the coming quarters. With that, I'll turn it over to Bill.

Bill Wagner (CFO)

Thanks, James. For the quarter, normalized FFO decreased 2.4% over the prior year quarter to $35 million.

Normalized FAD decreased by 3.5% to $36.6 million. On a per share basis, normalized FFO decreased $0.02 to $0.35 per share, and normalized FAD also decreased $0.02 to $0.37 per share. Rental income for the quarter was $46.2 million compared to $47.7 million in Q4. The decrease of $1.5 million is due largely to the following four items. The first two of these items were discussed on last quarter's call. First, we received approximately $1.2 million less of cash rents from tenants who are on a cash basis, $700,000 of which related to exhausting the security deposit of the negative coverage tenant in Q4. Second, we received approximately $1.1 million less cash related to a prior tenant in Q1 than in Q4.

This $2.3 million decrease was offset by, third, an increase in rents from CPI bumps of $319,000. Fourth, a write-off of a straight-line rent receivable of $440K in Q4 but none in Q1. Interest income was up $308,000, mainly due to a fee paid on a $15 million note that was paid off at the end of Q1. As a result of the payoff, I would expect interest income to be more like the Q4 number, less $500,000, which was the quarterly interest on the $15 million note. Interest expense was up $219,000 from Q4 due to higher interest rates offset by lower borrowings under the revolver. Subsequent to quarter end, we drew $30 million on the revolver for acquisitions.

G&A expense increased $248,000 from Q4 due to higher short-term incentive compensation offset by lower stock compensation and other corporate related items. The big decrease in stock compensation is due to stock forfeitures that occurred when Mark Lamb left the company. I would expect stock compensation to return to a quarterly run rate of around $1.5 million. Even with that increase, G&A expense for the year will be around $21 million. Cash collections for the quarter came in at 96.3% of contractual rent. In April we collected 97.5%. We didn't issue any shares under our ATM program this quarter. After quarter end we entered into a forward sale and have to date issued approximately $1.8 million shares at an average gross price of $19.91 before we entered the blackout period.

As a result, our liquidity remains extremely strong with approximately $25 million in cash and $435 million available under the revolver. Leverage also continued to be strong with a Net Debt to Normalized EBITDA ratio of 3.8 times, which is below our stated range of 4-5 times. Our Net Debt to enterprise value was 26% as of quarter end, and we achieved a fixed charge coverage ratio of 5 times. Lastly, we had hoped by this time we would have reinstated guidance as we have done in past years. We expect to begin issuing guidance once we have made sufficient progress with the previously discussed portfolio repositioning work. With that, I'll turn it back to Dave.

Dave Sedgwick (President and CEO)

Thanks, Bill. We hope our report's been helpful, and, thanks for your continued interest and support, and be happy to take your questions now.

Operator (participant)

Thank you. As a reminder, if you would like to ask a question, press star followed by 1 on your telephone keypad. Your first question comes from the line of Steven Valiquette with Barclays. Your line is open.

Steven Valiquette (Managing Director and Equity Research Analyst)

Thanks. Hello, everyone. Thanks for taking the question. Just a question here, maybe, just kind of looking at page 11 in the slide, that just kind of the geographic diversification. Obviously with just so much of the portfolio concentrated in Texas and California, just curious if you have any just updated thoughts on the, the state Medicaid rate updates in those two states in particular, just given how critical they are to the overall geographic footprint of the property portfolio. If any other states just stick out one way or the other, curious any other thoughts, other states that you think are critical as well as far as just the overall Medicaid rate outlook and updates that are happening this year? Thanks.

Dave Sedgwick (President and CEO)

Thanks, Steve. California seems pretty settled in terms of the operators there and their outlook. They feel like the certainty that they have, the visibility that they have to the path for the Medicaid rate increases there are good. We feel comfortable with California. With Texas, that literally is, since the legislature there is currently in session, it's a day by day, couple of times a day, conversation with some of our operators that are there. Texas, we love the state. They're long overdue for a rate increase. There's probably more optimism about an increase passing than we've seen in a long time. We should know in the next couple of weeks how that's gonna pan out.

Regardless, both California and Texas represent not just states that we like, but, states with some of our very best operators, who have strong coverage and great teams. We're, we're not really sweating, the news coming out of those two states.

Steven Valiquette (Managing Director and Equity Research Analyst)

Okay. All right. Any other states worth calling out just besides those kind of big two, or is everything else just kind of status quo or not material one way or the other from your, from your perspective?

Dave Sedgwick (President and CEO)

Yeah. Most of the other states have already passed some sort of FMAP adjustment. Again, we're not concerned about the other states and what they're doing on the Medicaid front. We wish that some would have done more and some would have moved earlier, nothing probably worth noting on this call.

Steven Valiquette (Managing Director and Equity Research Analyst)

Okay. All right. All right, appreciate it. Thanks.

Dave Sedgwick (President and CEO)

Thanks, Steve.

Operator (participant)

Your next question comes from the line of Jonathan Hughes with Raymond James. Your line is open.

Jonathan Hughes (Managing Director and Senior Research Associate)

There. I look forward to next quarter when we can have more guidance clarity. I won't ask about that now since you already talked about it. I do wanna ask about EBITDA coverage, ex HHS funds outside the top 10 tenants. I saw that's dropped by about 20 basis points or so from last quarter. Was that because of the, 3% operator that went further into negative coverage territory, or was it deterioration from other operators? Just trying to get that breakdown since you had quoted that number last quarter.

Dave Sedgwick (President and CEO)

Yeah, Jonathan. Primarily. It's primarily that negative EBITDA coverage operator. If you strip that one operator out, then that line item goes from 0.88 times to 1.73 times.

Jonathan Hughes (Managing Director and Senior Research Associate)

Helpful. Thank you. Turning to acquisitions, the recent yields on some of the investments completed this current quarter we're in are in that mid to high 9s. That included a few assisted living facilities, which is higher than I would have expected for seniors housing. Are you seeing yields on assisted living facilities approach those of skilled nursing within your investment pipeline, or was that a bit of a unique situation?

Bill Wagner (CFO)

I think as a general matter, Jonathan, I would say yields on seniors is creeping up a little bit, but still mid to high 5% for the most part. Mid to high 8% for the most part. I would say that, the yields on the investments we've done this year so far in seniors are more a factor of where we feel like we've been able to get a really attractive basis, based on the circumstances behind why the sellers wanna get out. That kind of allowed us to go a little higher on the yield by underwriting with the tenants because there's gonna be room there based on a lower basis.

Jonathan Hughes (Managing Director and Senior Research Associate)

Okay. Are those 3 new relationships year to date subject to exclusivity agreements? Meaning if they have potential expansion plans in the future, that you would have the right to take a first look at financing any of that growth?

Bill Wagner (CFO)

A couple of them do, but it's somewhat soft. Jonathan, it's kind of maybe a ROFO if they're looking to finance or do a REIT kind of deal that they'll kind of approach us first. It's a little bit soft. That's kind of what we get from them. That if they're gonna go do REIT deals, they bring them to us first to look at with them to see if we can come together.

Jonathan Hughes (Managing Director and Senior Research Associate)

Got it. Okay, one more from me. I saw a few assisted living facilities were transitioned to Pennant. Will those be added to the Pennant guarantee by Ensign, are those separate from that?

Dave Sedgwick (President and CEO)

Those are separate from that guarantee.

Jonathan Hughes (Managing Director and Senior Research Associate)

All right. That's it for me. Thank you for the time.

Dave Sedgwick (President and CEO)

Thanks, Jonathan.

Operator (participant)

Your next question comes from the line of Austin Wurschmidt with KeyBank. Your line is open.

Austin Wurschmidt (Director and Equity Research Analyst)

Great, good morning out there. With respect to the non-ten, top 10 tenant update, I mean, is the partial rent payment a reflection at all of a gradually improving situation, just like we've heard, more broadly around labor occupancy? With the Medicaid rate increase, that are coming in July, could operations improve to a level where you could reach a resolution that might, result in a rent cut and, maybe a lease extension? Do you think that moving away and moving on from this asset is a more likely outcome? Just curious where your thought process is right now.

Dave Sedgwick (President and CEO)

Well, I think at this stage in the discussions, it's just too early to speculate. Like I said, either in my remarks or in the press release, all options are really on the table right now. They really did just last week solve for the CEO that they had terminated right before last quarter's call. They've been taking some time to figure out their priorities and where they wanna take things. Could we end up selling this portfolio this year? We certainly could. You know, lot of discussion still has to take place with these guys to figure out what they wanna do and what's the best path forward for both parties.

Austin Wurschmidt (Director and Equity Research Analyst)

Understood. Has anything changed with respect to, these locations and quality of the assets versus when you initially underwrote them? I think you partially answered this, but would you expect, a resolution one way or another before the end of the year?

Dave Sedgwick (President and CEO)

Well, certainly the financial situation has deteriorated significantly compared to when we originally underwrote them. Occupancy took a big hit during the pandemic. Going into COVID, they were performing pretty well. This is probably the portfolio that got hit hardest and performed the poorest in our portfolio because of COVID, and they've been having a hard time recovering. My hope and expectation is that we'll have something resolved before year-end.

Austin Wurschmidt (Director and Equity Research Analyst)

Dave, with respect to the minimum staffing requirements you spoke about, which, kind of remains in process. Based on what ynow, what % of your tenant base would you consider being kind of at risk of a potential mandate? Are you looking more closely at staffing in your underwriting of new deals?

Dave Sedgwick (President and CEO)

I hate to say it, but it's really impossible to comment on that because we don't know what the form, final form is gonna be on the regulation. We don't know, for example, what staff is going to be included. Will administrative staff be included or not? Will non-nursing staff be included somehow? There's just too many variables there to comment on it. We'll just have to wait and see how it finally comes out.

Austin Wurschmidt (Director and Equity Research Analyst)

That's fair. Thanks for the time.

Dave Sedgwick (President and CEO)

All right, Austin. Thanks.

Operator (participant)

Your next question comes from the line of Michael Carroll with RBC Capital Markets. Your line is open.

Michael Carroll (Senior Analyst)

Yeah, thanks. Dave, I wanted to stick on this 2.8% tenant. I know last quarter that you were highlighting that the situation could be resolved, or at least you have some type of plan by the time you report it today. Is there something going on? I guess, how's that situation evolving, and has it surprised you that it's taking so long?

Dave Sedgwick (President and CEO)

I was hopeful that we would have a more meaningful update for you, but I'm not necessarily surprised that it's taken this long. That it has taken them, I think, longer than they've expected and that we expected for them to replace their CEO, which just happened last week. You know, the direction that they wanna take the company has been kinda in process and evolving from week to week, depending on who they're interviewing and what things that they're pursuing. Yeah, not terribly surprised, but continue to be hopeful that we'll find resolution here quickly. The tone of the conversations with these guys is very friendly and productive. We're making progress.

Michael Carroll (Senior Analyst)

Okay. Is it fair to read through it that, they wanna keep these assets given they hired a new CEO to start running the company?

Dave Sedgwick (President and CEO)

That's a pretty good inference, I think, in the fact that they, made a full rent payment in March and a partial in April, and we'll see what we can get in May. Yeah, it seems like they're working on stabilizing the assets.

Michael Carroll (Senior Analyst)

Are they making progress on stabilizing the assets? I know it's hard to look at just the coverage ratios, but it sounds like the coverage ratios dropped pretty meaningfully. I mean, are they making progress since those were reported?

Dave Sedgwick (President and CEO)

You know, the kind of progress that show up in the financials we haven't seen it yet.

Michael Carroll (Senior Analyst)

Okay. Just last one from me. Can you talk a little bit about the types of investments that you're tracking? I mean, are these mostly stabilized deals, or are they really transitions and needing new operators to drive better results? I guess why I kinda say that is it looks like the Summit and the Chapters deals just provided rent abatements. I mean, is that abatements for them to improve operating results?

James Callister (CIO)

I would say a little bit of both, Mike. I think, one of the abatements was more because you had a brand-new tenant just launching who needed a little room to start, to get through the lag between, providing the service and billing and getting the reimbursement. The other one was very much a, they're working on a turn. They needed a little bit of room to get that turn underway and going before paying full freight on the rent. They're both very short abatements.

Michael Carroll (Senior Analyst)

Yeah. Is that similar to what's in your pipeline right now too?

James Callister (CIO)

There's some of that in there, yeah, but there's also a mix of other stuff that's cash flowing and that, where a rent ramp really isn't gonna be needed. There are some where, you have some sellers selling kind of these non-strategic assets and that maybe haven't had a ton of attention paid to them for a little while. There's easy levers we talk with the operators about pulling, but it may take a few months to get there. There's also definitely cash flowing assets in the pipeline that, that we're looking at that we would underwrite and kind of look to execute on based on our historic yields.

Michael Carroll (Senior Analyst)

Okay, great. Thank you.

Dave Sedgwick (President and CEO)

Thanks, Mike.

Operator (participant)

As a reminder, if you would like to ask a question, press star followed by 1 on your telephone keypad. Your next question comes from the line of Tayo Okusanya with Credit Suisse. Your line is open.

Tayo Okusanya (Senior Equity Research Analyst)

Hi. Yes, good morning out there. I just wanted to follow up, along Jonathan's question about, he asked about the non-top 10, but I wanted to ask about the top 10 tenants. I mean, there's still a couple of them at this point where the rent coverage is, not even close to 1. It's meaningfully below 1, 0.4, 0.5, 0.6. How do we think about recovery for, you know, for these type of tenants where then the coverage is, significantly below 1, even if they're current on rent payment?

Dave Sedgwick (President and CEO)

The way we think about these operators in our top 10, specifically they have something in common, which is they have a really good corporate credit behind them, and they have other properties outside of our relationship that are performing much better than ours. We really view it as a matter of time for them to get things back north of 1 times coverage. Tricky thing for 1 of these guys, Aspen, is It represents just 2 facilities. When you have a situation like that, if just 1 building is not, hitting on all cylinders, it can throw the whole thing kind of sideways from a coverage perspective. They're a large regional player with a great credit. We're not.

We don't think rent will be an issue with any of those guys.

Tayo Okusanya (Senior Equity Research Analyst)

Okay. Along those same lines of thematically, anything specific about, why your assets and their portfolios seem to be, struggling, but the other assets seem to be doing well and, that's what's helping with the corporate guarantee? Like, what's uniquely happening at your assets? I don't know whether it's something thematic, whether it's a case-by-case basis.

Dave Sedgwick (President and CEO)

Yeah. Tayo, I would say it's You really have to look at it building by building. Some of the buildings that they are running for us are doing really well and others are not. This business is hyperlocal, and the way these operators run their business is very local as well. Getting those right local leaders in place tends to be the primary lever that is needed so that the subsequent levers can get pulled in place.

Tayo Okusanya (Senior Equity Research Analyst)

Yeah, that's helpful. Thank you.

Dave Sedgwick (President and CEO)

All right. Thank you.

Operator (participant)

There are no further questions at this time. I turn the call back over to Dave Sedgwick for closing remarks.

Dave Sedgwick (President and CEO)

Well, I really appreciate everybody's time and continued interest. If there's anything else, please give us a call. Otherwise, we'll see many of you in New York at Nareit in June. Have a great day.

Operator (participant)

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