Q4 2022 Diversified Healthcare Trust Earnings Call
Speaker 2: Good day and welcome to the diversified healthcare trust 4th quarter 2022 earnings conference call.
Speaker 2: All participants will be in a listen only mode.
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Speaker 2: Please note, this event is being recorded. I would now like to turn the conference over to Melissa McCarthy, managing manager of investor relations. Please go ahead.
Speaker 2: Good morning and welcome to Diversified Healthcare Trust covering the fourth quarter 2022 results.
Speaker 2: Joining me on today's call are Jennifer Francis, President and Chief Executive Officer, and Rick Sidel, Chief Financial Officer and Treasurer. Today's call includes the presentation by management, followed by a question and answer session. I would like to note that the transcription, recording, and retransmission of today's conference called monstrous responsabil short.
Speaker 2: are strictly prohibited without the prior written consent of diverse by health care trust or DHC.
Speaker 2: Today's conference call contains four-looking statements within the meaning of the Private Security's litigation reform act of 1995 and other securities laws. These four-looking statements are based upon DHC's current beliefs and expectations as of today, Thursday, March 2, 2023. The company undertakes no obligation to revise or publicly-
Speaker 2: Net operating income or NOI, and cash faces net operating income or cash faces NOI. Reconciliation of net income or loss attributable to common shareholders to these non-gap figures and the components to calculate AFFL, CAD, or FAD.
Speaker 2: are available in our supplemental operating and financial data package found on our website at www.dhpreet.com. Actual results may differ materially from those projected in any full looking statements. Additional information concerning factors that could cause those differences is contained in our files.
Speaker 2: and proposed acquisition of a Laris Life Inc. by ABP Acquisition LLC.
Speaker 2: In light of the pendency of the tender offer, we do not intend to speak to these matters on today's call and instead refer you to our current report on Form 8K we filed with the SEC on February 2nd, 2023 and to the offer to purchase filed by a LARIS Life Inc. with the SEC on February 17th, 2023 for additional information.
Speaker 2: across our portfolio and support the operators and asset managers that are implementing the recovery strategy in our senior living communities.
Speaker 2: All of our operators have been successful in growing occupancy and revenue during the year, while they worked diligently to battle inflationary pressures that are impacting labor, utilities, food, and other expenses across our portfolio.
Speaker 2: Rick and I will provide details this morning on some of their successes and also on some of the challenges still to overcome in the year ahead.
Speaker 2: After market closed yesterday, DHC reported normalized FFO of three cents per share for the fourth quarter.
Speaker 3: The year over year and quarter over quarter improvement in normalized FFO from negative seven cents per share and negative six cents per share respectively was largely driven by continued improvements in three areas within our shop segment during the fourth quarter.
Speaker 3: First, growth in net operating income and operating leverage for the quarter in the year. Second, in acceleration in occupancy recovery and rate growth during the quarter, and third, a decrease from the third quarter in the use of contract labor and the associated costs. Starting with the positive trends in our shop segment.
Speaker 3: Many of our metrics are trending positively, but most notably, occupancy improved 380 basis points year-over-year to 76.3% and same property occupancy also increased 380 basis points year-over-year to 76.7%.
Speaker 3: We're continuing a consistent trend of improvement as this is our seventh consecutive quarter of occupancy growth in this segment. As we saw a 180 basis point increase in occupancy from the last quarter in our same property occupancy and a 160 basis point increase over the last quarter in our consolidated portfolio. Our transition to communities achieved a year-over-year occupancy increase of 6-6.
Speaker 3: prior to the pandemic as the assisted living sector had experienced more over supply than independent living.
Speaker 3: Occupancy improvements have been bolstered by our operators improved marketing and sales processes and by the positive impact of our ongoing capital investment strategy. We believe that continued focus in these areas will yield further improved performance. We are encouraged by the quarters progress in occupancy.
Speaker 3: but we believe there is still room for improvement across this segment. Shop revenue increased $33 million a year over year, or 14 percent, and 3.5 percent since the last quarter.
Speaker 3: These increases in revenue were driven primarily by higher rental and care revenue and reduced discounts, a direct result of the sales training that has been implemented by all of our operators.
Speaker 3: Average monthly rates increase nearly 9% year over year, as our operators are pushing rate across the board. While this occupancy and revenue growth are encouraging, elevated expenses in our shop segment remain a challenge. This quarter's property level operating expenses increased by close to $19 million or 8% from last year.
Speaker 3: during the quarter with agency usage down significantly from the third quarter, although there's still improvement needed in our communities with skilled nursing units.
Speaker 3: Our operators remain very focused on employee recruitment and retention. Recruitment efforts include the use of dedicated hiring specialists, careful evaluation of competitive wages, and the more frequent use of sign-on bonuses.
Speaker 3: Retention efforts center on paying competitive wages to existing employees, active employee engagement, consistent career path development, and generally fostering a strong workplace culture within their teams. While the cost and availability of labor remains a challenge in this industry. Retention efforts center on paying competitive wages to existing employees, active employee engagement, consistent career path development, and generally fostering a strong workplace culture within their teams.
Speaker 3: The recruitment and retention of nurses remains the greatest staffing challenge for our operators.
Speaker 3: We've made significant progress with our planned renovation projects and our managed senior living communities.
Speaker 3: We've added a page to our supplemental package that highlights and provides detail on our development projects and our shop segment.
Speaker 3: Renovation projects were completed at 36 of our communities in 2022. In 2023, we're in active stages of planning our construction for renovations at 89 communities, and we anticipate approximately 70 percent of these projects will be completed by year end.
Speaker 3: As I've said in the past, we believe that our capital spend in communities is an important part of the turnaround underway in this segment.
Speaker 3: Turning to our office portfolio segment, year over year, rental income was up slightly in our same property office portfolio, but fourth quarter cash basis NLI was down slightly by 90 basis points due to a number of one-time expenses across our portfolio.
Speaker 3: For leasing activity, we executed 182,000 square feet of new and renewal leases in the quarter with strong roll-up and rents of 8.9% and a weighted average lease term of 9.2
Speaker 3: We ended the quarter at 90% occupancy in our same property office portfolio segment and had a leasing pipeline of just over 1 million square feet at year end, in line with our pipeline in the third quarter.
Speaker 3: We have just over 110,000 square feet of transactions in our pipeline where leases have been signed, or are in letter of intent stage with leases being negotiated.
Speaker 3: I'd like to speak briefly about our wellness centers, centers, which accounted for 3.6% of our fourth quarter NOI. In January , we terminated the leases of a 10-in-3 wellness centers located in Tampa, Atlanta, and the suburban DC area. These are extremely well-located properties in affluent submarkets.
Speaker 3: Subsequent to termination, we have assigned lease for one of the locations and have assigned letter of intent for the two other clubs. Also in February , we announced that we'd amended our credit facility to provide DHC Covenant relief while we continue to execute on our recovery strategy this year. I'll now turn the call over to Rick, who will provide more detail on our financial
Speaker 4: percent from the third quarter.
Speaker 4: Our consolidated cash basis and a Y increased approximately $18.9 million from the third quarter with growth in each of our segments.
Speaker 4: Cash and OI from our shop segment increased $13.6 million while our office portfolio segment increased $3.5 million or 12.3% and our triple net lease senior living communities and wellness centers increased $1.8 million or 21.5%.
Speaker 4: These increases were partly attributable to certain events specific to the quarter.
Speaker 4: First, in our shop segment, we recognize an insurance recovery of $3.6 million related to expenses recognized in the third quarter due to hurricane IN.
Speaker 4: In our triple net least senior living communities and wellness centers, we recognize $3 million of percentage rent as we do each year during the fourth quarter, which was partially offset by an $800,000 decrease in cash on a Y related to the wellness center default that Jennifer just discussed.
Speaker 4: Finally, we recognize a lease termination benefit of $3 million related to one of our office redevelopment projects when we had the opportunity to negotiate a favorable termination as the tenant was at risk of default.
Speaker 4: On next provide additional detail on our shop segment performance that I believe illustrates the work we and our operators have ahead of us and the opportunity for the portfolio.
Speaker 4: Our total shop in OI for the fourth quarter of $7.9 million included 119 communities operating with 11,582 units that had negative NOI totaling $18.7 million or NOI margins of negative 16%.
Speaker 4: Approximately 44 of these communities have occupancies over 75 percent. It will focus on growing rates and controlling expenses to return to profitability.
Speaker 4: The remaining 75 communities will focus on occupancy, rate, and expense control as part of their business plan.
Speaker 4: We also had 111 communities with 13,764 units that produced positive NLI of $27.2 million. Average NLI margin in these communities was 18%, which included 23 communities that were below 75% occupied. We expect to see margin expansion as these communities bring in additional residents.
Speaker 4: and are better able to leverage fixed costs as occupancy increases. We also expect our operators to continue to push rates and expand margins in our communities with stabilized occupancies as we continue to face inflationary cost pressures.
Speaker 4: General and administrative expenses decreased $2.8 million or approximately 33% from a year ago and $415,000 from the third quarter as a result of our lower management fees.
Speaker 4: Our manager's business management fees continue to be calculated based on our market capitalization and not on the historical cost of our assets, which resulted in a reduced fee paid to RMR in the fourth quarter, which, when annualized, equates to a $21 million reduction. The interest and other income of $9.2 million of the quarter included $3.2 million.
Speaker 4: as a result of higher interest rates on our floating rate credit facility.
Speaker 4: In October , we repaid a mortgage note on a life science property for approximately $10 million and as Jennifer mentioned in February , we announced an amendment to our credit facility.
Speaker 4: This amendment provides us with fixed charge coverage ratio covenant relief into 2024 while our shop segment recovers and allows us flexibility to continue investing in our portfolio to accelerate that recovery. The amendment also reduced the minimum liquidity requirement from $200 million to $100 million.
Speaker 4: In exchange, we have paid down the facility to $450 million, have agreed to a 40 basis point increase in the interest rate, and no longer have the ability to rebarrow funds. Our credit facility is secured by mortgages recorded on 61 medical office and lifeline's properties.
Speaker 4: These properties totaling 5.3 million square feet are located in 21 states including Washington, DC. We're approximately 90% occupied and generated 18.7 million dollars cash basis NOI in the fourth quarter.
Speaker 4: At your end, we had total outstanding debt of $3.1 billion and net debt of $2.4 billion was equal to just 30.6% of gross assets.
Speaker 4: We have no significant materities until 2024, and we have over $5.8 billion of unencumbered grocery and estate assets. As we've previously said, investing in our portfolio is a priority for us, and we continue to execute on plans to improve our properties, to grow occupancy, push rental rates, and enhance the overall value of the portfolio.
Speaker 4: In the fourth quarter, we spent $118.6 million on capital expenditures across the portfolio, which included $99.4 million of capital improvements in redevelopment within our shop segment. That concludes our prepared remarks. Operator, please open up the line for questions.
Speaker 2: We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone's thumb. If you are using a speaker phone, please pick up your handphone before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time we will pause momentarily to assemble our roster.
Speaker 2: The first question comes from Joshua Denderline from Bank of America. Please go ahead. The second question comes from Joshua Denderline from Bank of America.
Speaker 5: Yeah, guys, thanks for the time and the question. I'm just kind of curious how you guys are thinking about the shop recovery going forward. And then, maybe, you know, you've done some cat-backs to the properties like an additional cat-backs you might want to put in. And if there's any additional kind of, you mentioned sales training that the operator's bringing in place, like any kind of additional initiatives that might kind of help get that kind of kicking up higher going forward. Sure. Thanks. Good morning and thanks for the question. You know, I think that the operation...
Speaker 3: that we then have higher conversion rate. That's just one of the many things. I mean, there are improvements across the board that they're focused on. As far as the capital, where we will continue to spend capital in this portfolio this year and next, it's been extremely well-received by the residents in the communities and by the employees.
Speaker 4: the spend on that additional kind of catbacks you're planning to put in the properties of the next two years. Sure, right. Yeah, so we spent a little over $300 million in 2022 and about $228 of it was in the shop portfolio. We expect it to continue kind of at that level for 2023 as well. We do have some flexibility and can be pretty nimble in adjusting which projects are moved forward at which time.
Speaker 4: A lot of the planning is done and we're really getting to the execution phase, which is great. But I would say that shop portfolio likely to get about $225 or so million in 2023. And then I guess we'll see how the results come out. But I expect to see some really great returns on that cost throughout the portfolio. Generally in the high teens, low 20% returns. So we'll have the ability to pivot then into 2024, but it'll really depend on what the cost capital looks like and everything else. But we're really excited about the potential growth and the portfolio.
Speaker 2: Thanks, guys. I'll jump back in the queue. Thanks. Great. Thanks. As a reminder, if you would like to ask a question, please press star and one to be joined into the question queue. The next question comes from Brian Leher with B. Ridley. Please go ahead. Thank you. Good morning, Jennifer and Rick. And sorry if I missed any of this. My call got dropped for a moment. But on the shop rates of 8.9% year over year.
Speaker 3: There's a good story in pushing rate. In addition, some of the sales training that we talked about, or that we've been talking about, is also sales training for having those difficult conversations with the residents and families of the residents about pushing rate and overcoming objectives.
Speaker 2: know if you're comfortable commenting on this but you've had pretty good momentum on the occupancy side lately. I know that you know if you look at trade rags and what have you know some of your competitors they talk about one queue typically being a little bit seasonally weaker but do you think that that puts a kink at all in the current momentum you have? I don't think so. I mean traditionally q4 and q1r a little slower but
Speaker 2: second half, you know, trying to get to that in current covenant at 1.5. I know that there's some noise in the numbers because you just paid down the facility 250 million or so. But even looking at the 4Q over 3Q momentum in, you know, net debt to EBITDA metrics was, you know, which improved hugely and EBITDA metrics expense again improved hugely. Can you give us any flavor on how you're thinking about the insurance test?
Speaker 1: The.
Speaker 1: For some to.
Speaker 6: Ladies and gentlemen, thank you for your patience. We've reconnected with our speakers. We currently have Brian Mahur on the question cue.
Speaker 4: Great. I don't know if you guys heard my question or not. Can you hear me now? Yep, we can. And Brian , we did. And apologize. Our line went dead. So we quickly called back in. I think Rick is prepared to answer your question. Great. Because my email lit up as soon as you guys dropped up. Sorry about that, Brian . So I think the question just to recap is basically when, you know, how close are we to the 1.5?
Speaker 4: So, the downside have happened, you know, kind of on a pro forma basis for that, where it about 1.04 right now, and that leaves us with needing to improve NOI by about $74 million to get back to compliance. So, we do believe there's a path there. The question as far as when is a difficult one to answer. There are a lot of moving variables.
Speaker 4: But we think we're executing on the right plan, again, investing in the shop portfolio while also very focused on managing them operationally. We think the recipe for success to get back there. This number is only about 53% of where the portfolio used to perform back in 2019. So we think it's achievable. We just need to actually execute on it now. So that's where all of our focuses. Great. And just to be clear, I mean, in our model, we have you getting there by year end, you know, we'll see how that plays out. But the trends are clearly, you know, moving in the right direction. But maybe you can just talk to briefly and then I'll hop back in the queue kind of plans B and C if that weren't to happen. I mean, you continue to talk about $5.8 billion, none and convert assets.
Speaker 4: I would suspect that you could sell some or JB some, you know, to kind of get where you need to be for 2024 if push came to shove. That's right, Brian . And thanks for the question. There are a couple of levers, you know, you're correct that we could, we have some great MOB and life sciences assets that many investors are interested in. So whether it was a disposition more likely a JB, like the
Speaker 3: The other thing is our capital spend, while we believe that the capital spend is pretty important, we've planned it in a way that it's being done in phases, so that we, you know, some of our, many of our large capital projects are broken up into phase one, phase two.
Speaker 3: projection of that capital spend.
Speaker 4: Great, thanks Jennifer for raising congratulations on the good momentum here. Thanks very much Brian . Once again if you have a question please cut star then one to enter the question queue. That's star then one to enter the question queue.
Speaker 7: our call.
Speaker 6: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.