National Health Investors, Inc. (NYSE:NHI) Q3 2023 Earnings Call Transcript

National Health Investors, Inc. (NYSE:NHI) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Greetings, and welcome to the National Health Investors Third Quarter 2023 Earnings Call. At the start of the presentation, all lines will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, we are recording the call today, Wednesday, November 8, 2023. I would now like to turn the conference over to Dana Hambly. Please go ahead.

Dana Hambly: Thank you, and welcome to the National Health Investors conference call to review the results for the third quarter of 2023. On the call today are Eric Mendelsohn, President and CEO; and Kevin Pascoe, Chief Investment Officer; John Spaid, Chief Financial Officer; and David Travis, Chief Accounting Officer. The results as well as notice of the accessibility of this conference call were released after the market closed yesterday in a press release that’s been covered by the financial media. Any statements in this conference call which 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 and its periodic reports filed with the Securities and Exchange Commission, including the risk factors and other information disclosed in NHI’s Form 10-Q for the quarter ended September 30, 2023. The Copies of these filings are available on the SEC’s website at sec.gov or on NHI’s website at nhireit.com In addition, certain terms used in this call are non-GAAP financial measures. Reconciliations of which are provided in NHI’s earnings release and related tables and schedules, which have been furnished 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 our CEO, Eric Mendelsohn.

Eric Mendelsohn: Hello, and thanks for joining us today. We’re pleased to report a very strong quarter with our funds available for distribution or FAD exceeding our expectations by increasing 2% year-over-year and 8% sequentially. These quarterly results were driven by a number of factors, including a stable cash collection rate, record deferral repayments of $2.3 million, discrete catch-up payments of $1 million from two cash basis tenants for past due rent and no unexpected rent concessions. Operating metrics in the real estate investment and Shop segments continue to trend higher, which bolsters our confidence in the organic growth opportunities. Given the outperformance in the third quarter and current visibility into the fourth quarter, we are increasing our FAD guidance for the year.

John will provide more details in a few minutes. The foundation for the higher results this quarter is the hard work of our operating partners who continue to make steady improvement in operating fundamentals. EBITDARM coverage increased sequentially across all asset classes and largest tenants. Bickford, for instance, has pushed trailing 12 month rent coverage to 1.45x and we’re happy to see that their sales focus continue to drive average occupancy gains through the third quarter, including 85.2% in September, the highest it’s been since the start of the pandemic. Bickford repaid over $750,000 in deferrals during the quarter and we expect a similar or higher amount in the fourth quarter. The portfolio’s optimization particularly within our needs-driven senior housing portfolio excluding, Bickford, continues to bear fruit with coverage improving for the seventh straight quarter to 1.09 times on a trailing 12 basis.

While this coverage is below our comfort level, we’re generally encouraged by the trends. These operators repaid deferrals of approximately $1.4 million in the third quarter, which we believe is a good indication that operations continue to improve. The entrance fee and skilled nursing portfolios, which contribute approximately 60% of our NOI, continue to generate great results and this is our expectation for the foreseeable future. Our Senior Housing Portfolio or SHOP, has certainly had its fair share of challenges and is not generating the performance, we would have expected up to this point. That said, we’re starting to see more consistency with three straight quarters of operating and financial gains. We’re very happy with the momentum in occupancy, which has now grown for seven straight months to 81.2% in September.

That is an increase of over 600 basis points, from the February low and the highest reported month since, November of 2021. The preliminary October results show that occupancy continued to move higher as well. SHOP is an important vehicle for organic growth and serves as a platform for external opportunities. So we’re committed to dedicating the resources, necessary to make these communities best-in-class. We announced last night, that we are amending Discovery Senior Living’s leases on eight properties and we continue to work closely with other tenants, particularly our cash basis tenants to optimize their cash flows. To that end, we completed the sale of three properties last week and have just one remaining property currently held for sale.

I want to remind investors that two years ago, I said, we would be selling up to $400 million of underperforming real estate assets. We’re substantially complete with that process and I point to our improved coverage, as the positive results of these efforts. The balance sheet continues to position NHI for growth, with leverage at just 4.4 times and over $500 million in available liquidity we have ample capacity to deploy without the immediate need for equity. Not surprisingly, the interest rate environment has had a clear impact on the financial markets. The dearth of capital, and looming debt maturities should favor well-capitalized REITs like NHI. We will be patient and stay focused on our organic opportunities including, the monetization of our $34 million in outstanding deferral balances, and the significant upside in the SHOP portfolio.

We note that many of our pipeline discussions over the last year, has sellers perpetually about 100 basis points behind the changes everyone is seeing in the cost of capital. That was the case this last quarter, as the 10-year treasury hit 5%. We think there is an ungrounded optimism that the cost of capital increases are temporary, and we are regularly advising customers to make sure they live to fight another day. They should be realistic about the hire for longer, cost of capital, and the growing liquidity in senior housing and carefully choose a partner that will work with them towards their success in the long run. In sum, we’ve made great strides to enhance the quality of our portfolio, while maintaining our strong financial discipline as industry fundamentals continue to become more favorable, NHI is in a great position to participate in what we expect to be many years of exceptional future growth.

I’ll now turn the call over to Kevin to provide more details on our operations. Kevin?

Kevin Pascoe: Thank you, Eric. I’ll concentrate my comments on investment and disposition activity, as well as the performance of our major asset classes and operators. We closed on the sale of four properties for net proceeds of $8.3 million plus $1.6 million in seller financing in the third quarter and to date in the fourth quarter. These underperforming properties were formally leased by two cash basis tenants, which now puts them in better financial health thereby improving coverage, limiting future rent concessions and accelerating deferral repayment. We currently have one property held-for-sale, which we expect to sell by the end of 2023 or early 2024. During the third quarter, we amended a loan with CFG that increased the balance from $8.1 million to $25 million and increased the rate from 9% to 10%.

We are reviewing several new and recycled pipeline deals that would be immediately accretive. As Eric noted though, the interest rate environment has added more friction to the process. Fortunately, we have buyers today with plenty of capital to deploy and expect that our patients will be rewarded. Shifting to asset management. Overall, we had a very successful third quarter with strong cash collections, driven primarily by record deferral repayments, continued occupancy and margin gains across the Real Estate Investments segment and encouraging SHOP performance. With industry trends steadily improving, we are seeing fewer tenant issues, which is allowing our team to shift more resources to the few remaining challenges. This is evident in the significant sequential improvement from the second quarter.

Reviewing the need-driven platform, which is 29% of annualized cash NOI, we again saw positive trends with coverage at 1.26 times, representing the sixth straight quarter of sequential growth. Occupancy has been improving year-over-year and sequentially and our operators expect resident rate growth to remain above average in the 6% to 8% range. The coverage increase was driven in large part by Bickford at 1.45 times on a trailing 12-month basis. The Bickford occupancy trends have been excellent. Third quarter average occupancy was up 220 basis points sequentially to 84.2%, while September occupancy at 85.2% represents a 400 basis point gain from the April 2023 low. Agency utilization is down significantly, which is helping to mitigate wage inflation and build company culture.

Bickford EBITDARM coverage for the trailing 12 months, which better reflects the more recent performance was 1.61 times in the third quarter. Bickford’s deferral repayments are based on achieving financial performance levels, which we think is a good alignment of interest and allows NHI to participate more directly in the company’s recovery. This has proved a successful strategy so far, as Bickford’s repayments have increased every quarter. We do have a scheduled rent reset on April 1st next year and are in early stage discussions to amend the existing terms. Regardless of the outcome, we expect that our Bickford related rental income grows in 2024. Aside from Bickford, coverage is increasing across the other 37 new driven properties. We reported coverage of 1.09 times, which is the highest since the second quarter of 2020 and in the seventh straight quarter of sequential improvement.

This is certainly encouraging but some tenants continue to require some financial assistance. As described in our press release, we are in negotiations with affiliates of Discovery Senior Living related to our master lease on six properties that was scheduled to reset on November 1 and individual leases on two other properties. While still subject to change, we are currently expecting to delay the rent reset on the master lease and temporarily reduced rent on the other two properties resulting in a 10% to 12% reduction in Discovery’s 2024 base rent. Similar to the current Bickford agreement, deferral repayments are expected to be tied to financial performance to better align NHI with improving fundamentals. Continuing with our Discretionary Senior Housing portfolio, this group accounts for 29% of adjusted NOI including 26% from insurance fee communities.

SLC our largest tenant, increased coverage sequentially to 1.31x from 1.28x driven by another solid quarter of entrance fee sales. Discretionary coverage excluding SLC, which largely reflects the performance of our other entrance fee communities improved sequentially to 1.5x from 1.34x. This was driven by strong entrance fee sales during the second quarter, which more than offset higher entrance fee refunds in a couple of properties that we mentioned in our last conference call. The SNF and specialty hospital portfolio which represents 35% of annualized adjusted NOI, reported solid coverage at 2.62x, which improved sequentially from 2.48x. The move higher was generally across the portfolio driven primarily by NHC’s coverage of 3.29x, up from 3.02x.

The one SNF operator that received a rent deferral has now fully repaid the bonds. We are communicating frequently with significant operators to better understand the potential impact proposed of staffing and action plan. The proposed rule to owners was better than the year, especially with the year time frame to prepare. Given strong coverage and exceptional operators in our portfolio that are constantly adjusting to regulations, we do not expect disruptive [indiscernible]. In our SHOP portfolio, we are generating sustained operating and financial improvement throughout the portfolio with our partners Discovery and Merrill Gardens. As detailed in the earnings press release, monthly occupancy has been building momentum since February. The SHOP average third quarter occupancy increased 350 basis points to 79% and ended on a strong note with September occupancy at 81.2%.

This is setting up for a positive fourth quarter, as preliminary results indicate further gains in October occupancy to 82.2%. The third quarter NOI margin improved sequentially by 90 basis points to 18.8% driven by a 4.9% resident revenue growth and a 3.7% increase in operating expense. Our focus continues to be on driving occupancy hires which is as limited for growth. As the early effects of [indiscernible] follow off, we expect operating margin growth to give significant operating leverage in the independent [indiscernible]. Our long-term view was that the portfolio can generate NOI dollar in the high-teens on margin and the 35% range has remained unchanged. With that, I’ll turn the call over to John to discuss financial results. John?

John Spaid: Thank you, Kevin, and hello everyone. For the quarter ended September 30, 2023 our net income, NAREIT FFO and normalized FFO per diluted common share were $0.68, $1.08 and $1.08 per share respectively. For the third quarter, our FAD was $48.2 million. Our third quarter FAD increased by $3.6 million compared to the second quarter of 2023. When compared to the second quarter of 2023, third quarter FAD included $2.3 million of deferral repayments, which was an increase of $1.6 million. The third quarter also benefited from the receipt of $1 million of discrete payments from two tenants on the cash basis of accounting. $800,000 in lower rent concessions and $300,000 in higher interest income. The SHOP portfolio NOI improved modestly to $2.3 million in the third quarter from $2.1 million in the second quarter of 2023.

The SHOP CapEx increased by approximately $450,000 so the impact to FAD was a decrease of $200,000. We also benefited from lower expected franchise tax expense, which was $250,000 lower in Q3 compared to Q2 and will continue to benefit our results through the end of the year. I want to mention two items today, which we’ll be talking more about as we end the year and issue our 2024 guidance in February. First, we recognize rents from cash basis tenants as received, which include any repayments of deferrals and which impact net income, FFO and FAD when collected. For all other tenants, rental income including any outstanding deferrals collected is recognized on a straight-line basis. That means any repayment of deferrals collected in advance of one contractually owned will positively impact FAD in the period received, but have no effect on our net income or FFO metrics.

Remember GAAP rental income generally remains consistent from period to period. So the increased cash collected is therefore offset by a corresponding decrease in the straight-line rent revenue component. Of the previously mentioned $2.3 million in Q3 deferral collections, approximately $1 million was collected in advance of when contractually owed thus benefiting FAD, but not net income or the FFO metrics. Second, in the past the company’s new lease investment activity helped offset the eventual negative non-cash revenue impacts that generally occurs for leases in the second half of their lease storms. Base cash rent collected in the second half of a customer’s lease term will exceed the GAAP rental income amount resulting in a negative non-cash straight-line rental income.

For example, the straight-line rents receivable associated with senior living communities was approximately $40 million as of September 30. Senior Living Communities plus an increasing number of our leases are entering the second half of their lease lines and will be generating increasingly more negative non-cash straight-line rental income, which represents a reversal of the collection of the built-up straight-line rent receivables. Absent lease modifications, our new leasing activity with minimum rent escalators, we expect the company will have negative non-cash straight-line rental income resulting in a growing negative variance between our FFO and FAD metrics. Turning to the quarter’s disposition. During the third quarter, we sold one property for $2.9 million in net proceeds and a $600,000 gain.

Subsequent to the end of the third quarter, we closed on the sale of three additional properties for $5.4 million in net proceeds plus $1.6 million in seller financing yielding 9% on one of the transactions. NHI currently has one property classified as held for sale with a net book value of $5 million, and a contractual fourth quarter rent of approximately $300,000. Last night, we updated our full year 2023 guidance. Our guidance reflects the repayment of prior deferral balances consistent with levels experience in the first nine months of 2023 or approximately $1 million. Our guidance includes continuing asset dispositions and loan repayments, additional rent concessions and continuing fulfillment of our existing commitments, but it does not include any additional unidentified investment.

Finally, our guidance also includes the impacts due to the discovery lease amendments through the end of the year. In February, we’ll have more to say on these amendments when we issue our 2024 guidance. We increased our FAD guidance to a range of $186 million to $187.6 million. The slight increase is driven primarily by higher than forecasted deferral repayments and collections from two gas basis tenants lower-than-expected rent concessions and higher interest income primarily from the amended CFG loan agreement, lower franchise tax expense offset by higher interest expense. We focus a great deal on our FAD results because we feel FAD provides a better picture into our operating cash flow including routine capital expenditures and our share of the cash flows generated from our unconsolidated activities all of which support our dividend.

We also adjusted the range for our normalized FFO to a range of $185.6 million to $187 million. On a per share basis this equates to a midpoint of $4.30. The updated normalized FFO guidance reflects improved cash basis and deferred rent collections as well as a reduction in straight-line revenue due to the acceleration of contractual deferred rents collected early and an increase in the credit loss reserve related to one non-performing loan. Remember, we recognized the expense and income due to changes in our credit loss reserves in all of our FFO metrics, which creates increased volatilities in these metrics from time to time. When compared to our initial February 2023 midpoint guidance for NAREIT FFO and normalized FFO, our November midpoints provided last night or $0.08 and $0.03 higher.

While we saw some volatility in our guidance this year we continue to be focused on over delivery. For the third quarter our leverage ratio was 4.4 times net debt to adjusted EBITDA a slight improvement from 4.6 times in the second quarter. At the end of October we had $194 million outstanding on our $700 million revolver providing ample liquidity of over $500 million in cash and revolver availability. We also have a full $500 million available under our ATM program. On November 3, we paid off $50 million of maturity private placement notes using our revolver. As previously mentioned on prior calls and after this retirement our variable interest rate debt today represents approximately 39% of our total debt capital stat. Our strategy continues to be to look to a new long-term debt issuance that will improve our average debt maturities in the next year.

In the meantime, we are benefiting from our balance sheet’s low leverage to offset the negative impacts from higher than longer short-term interest rates. Finally, our third quarter FAD payout ratio was 81.1%. As we announced last night, our Board of Directors declared a $0.90 per share dividend for shareholders of record December 29 2023 and payable on January 26 2024. That concludes our prepared remarks. So once again thank you for joining our call today. With that operator, please open the lines for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] First question comes from Juan Sanabria with BMO Capital Markets. Please proceed.

Juan Sanabria: Good morning guys. Just wanted to ask about Discovery. Kevin gave some parameters on the potential decrease in rent. But just curious how large the contractual in-place rents are today, is the least and a couple of assets being discussed represent all of your triple-net exposure to Discovery that’s outlined in the pie? And part two of this question is, can you quantify the potential other tenants in terms of size of rents that are being discussed as the last draft of dealing with some of the COVID adjustments?

Kevin Pascoe: Sure. Hey, Juan this is Kevin. Just to make sure I understand your question. I mean, so as we said we have eight buildings with them. They represent about 4% of revenues. We’re looking at a modest reduction on the cash pay side with some upside on revenues to — as they continue to improve. And one thing I would highlight is they have been able to improve both occupancy on our triple net and our SHOP side. Again, I want to make sure I’m answering more specifically the question you had in order of magnitude was what again?

Juan Sanabria: No. I just wanted to make sure that the 10% to 12% reduction you highlighted was applicable to the full 4% of revenues that Discovery represents not a subset. So that answers it. I guess the part B was — I think there was an illusion to maybe some other smaller tenants that may need to have some production whether temporary or permanent, how big that potentially could be? Just to quantify the potential net impact from the third quarter run rate?

Kevin Pascoe: I guess, the way I would characterize that is more around looking at the coverage that was in place being at the 1.09 times exclusive of Bickford. While things have improved quarter-over-quarter, it’s not exactly where we want things to be. So while I would say that there’s not one specifically that we’re overly concerned about. It’s more of, I’d call an allowance for doubtful accounts where you have a little bit of a reserve. We’ve seen that number come down significantly. As we talked about this quarter, we didn’t have any unscheduled concessions. So we’re — I think we’re on the right trajectory. We’re also just being cautious in the way we’re managing the portfolio and communicating with the Street.

Juan Sanabria: And then on the SHOP business, just curious if you could talk about the rate environment to drive the new customer volumes and the occupancy really ramp up, and how the two operator discovery in Merrill Gardens you’re thinking about annual rate increases versus last year? Just to give us a sense of again, how pricing is changing?

Kevin Pascoe: Sure. I mean as we’ve highlighted the priority has really been to get occupancy. So if you look at our published materials you see that the RevPOR is up slightly, but fairly flat. So it’s been a push to get the occupancy. I would characterize the pricing that’s been in place as more one-time concessions to get those. So we’ll still have our normal increases, we’re in our budgeting process. Now I would expect on the whole that you’ll see something along the lines of what I mentioned in my prepared remarks in terms of in-place increases. But the fact of the matter is that we’re still, again, trying to push that occupancy and using some one-time incentives to get occupancy up which will — I would think we’ll keep RevPOR a little bit flattish for the near term.

Juan Sanabria: Okay. Great. And then just one last one, if you wouldn’t mind. Bickford, we’ve talked about in the past with regards to their credit profile outside of NHI and stress they’ve had. Any latest thoughts on how that stands and risk to the OpCo, given again, outside of the NHI lease?

Kevin Pascoe: Sure. This is Kevin again. I think as we’ve articulated in prior calls, they do have some owned properties that have bank financing on them. So, again, as we’ve acknowledged the banking environment is difficult right now. Rates are going up. That does put a little bit of pressure on the cash flow. But we’ve worked really hard to effectively silo off our portfolio from those effects. There are some things that they’re still working on in terms of some maturities they have over the next year or so. They’ll need to work with their banking partners to extend and modify those loans. I know they’re in those discussions right now. So stay tuned. That said, I feel like as we can show in our information. They’re on much better footing now and they’re headed in the right direction.

Juan Sanabria: Thank you very much.

Operator: Our next question comes from Richard Anderson with Wedbush. Please proceed.

Richard Anderson: Thanks. Good morning. The situation was — I’m getting some feedback here. Let me turn it off. Okay. The situation on the discovery both in the SHOP and the Triple Net categories, would you be able to draw a parallel in terms of how they’re performing and sort of the reasons why you’re kind of giving some rent in the Triple Net space? And also how SHOP is sort of not quite keeping up with the growth profile that you were hoping? Is it sort of a common knitting with Discovery and specifically how they’re operating their asset?

Kevin Pascoe: Sure. Hey Richard. This is Kevin. So one thing for Discovery I will note is they’ve seen occupancy improvement on both the Triple Net and the SHOP side. We’ve seen more velocity on the SHOP side so far this year than we have on Triple Net. That — we also had one of our first amendments that we made during the pandemic was in this portfolio, where we allowed for a reset, we needed a little more velocity to get to where that rent step-up was going to be. And frankly, the portfolio — the Triple Net portfolio just hadn’t made it yet. So we’re looking to just push out that step up for a period of time allow the momentum to continue to build on the occupancy front and then we can reprice. But in the interim, like we did with Bickford, which has worked well, we’ll be able to have some revenue participation over a threshold where we start to get some additional deferral repayments.

So, not what we wanted to see. The fact of the matter is I think some of it is timing, some of it is just local markets. We have seen a lot more occupancy improvement out of the SHOP portfolio. I would say furthermore I mean I think Merrill and Discovery are doing a good job on SHOP. Merrill had similar challenges on the front end in terms of gaining occupancy within the — that portfolio. So, there are some things we’re focused on within that relationship. I don’t think at least as it relates to SHOP they’re an outlier in terms of their improvement when just benchmarking them against the other operating partner we have there. I think those properties needed a lot of time and attention to get going in the right direction and we’re finally getting there.

Richard Anderson: Okay. Good enough. So maybe an accounting question for John. You mentioned SLC negative straight-line rent during the second half of their lease term. But is that did you make any comment about negative straight-line rent for all of the portfolio when you net it all together or just for SLC maybe a few others?

John Spaid: No, I was making a broader comment. And I just wanted to mention that there’s been maybe an assumption that straight-line revenue is always positive. So, the expectation going forward you should see it flip to negative.