Q2 2023 Diversified Healthcare Trust Earnings Call

Good morning, and welcome to the diversified health care Trust.

Second quarter 2023 earnings call.

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I would now like to turn the conference over to Melissa Mccarthy manager of Investor Relations. Please go ahead.

Good morning, and welcome to diversified healthcare Trust call covering second quarter 2023 result.

Joining me on today's call are Jennifer Francis President and Chief Executive Officer, and Brookside out Chief Financial Officer and Treasurer.

Today's call includes a presentation by management, followed by a question and answer session with sell side analysts.

I'd like to note that the recording and retransmission of today's conference call are strictly prohibited without the prior written consent of the company.

Today's conference call contains forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995 and other securities laws.

These forward looking statements are based upon D. H these beliefs and expectations as of today Wednesday August 2nd 2023.

Company undertakes no obligation to revise or publicly release the results of any revision to the forward looking statements made in today's conference call other than through filings with the Securities and Exchange Commission or SEC.

In addition, this call may contain non-GAAP numbers, including normalized funds from operations or normalized <unk> EBITDA net operating income or NOI and cash basis, net operating income or cash basis NOI.

Conciliation of net income or loss to these non-GAAP figures are available in our financial results package, which can be found on our website at www Dot D. H C REIT dotcom.

Actual results may differ materially from those projected in any forward looking statement.

Additional information concerning factors that could cause those differences is contained in our filings with the SEC and.

Investors are cautioned not to place undue reliance upon any forward looking statements.

Now I'd like to turn the call over to Jennifer.

Thank you Melissa and good morning, Thank you for joining us on D. C. 's second quarter 2023 conference call.

On today's call, we'll provide an update on D. H sees merger with office properties income trust or OPI.

And on our operational and financial results.

Two weeks ago, we filed a registration statement with the SEC has scheduled a special meeting of shareholders on August 30th 2023, where our shareholders will be asked to vote on proposal to approve the merger.

With shareholder approval, we expect to close the transaction shortly thereafter.

We continue to believe this merger represents the best opportunity available to create long term value for DHT shareholders through a larger more diversified REIT.

With more than $700 million of debt coming to coming due in 2024 and being out of compliance with our debt incurrence covenants D. C continues to face steep challenges in the coming year.

As discussed in our monthly business updates the turnaround of our senior housing operating portfolio was inconsistent unpredictable and has not occurred fast enough and will not occur in time to address these challenges.

Further as things stand the agency had insufficient liquidity to fund the capital investments needed to continue the turnaround underway in our shop segment.

As a result of these operating challenges we do not believe we will be able to increase DH six current annual dividend of <unk> per share until 2025 at the earliest.

Following the completion of the merger the combined company will immediately be in compliance with its debt covenants, allowing access to multiple capital sources to continue to fund the sharp turnaround to address upcoming debt maturities.

The merger will be immediately accretive to our leverage as well as normalized F. F O N C. A D in.

In addition, the pro rata annual dividends of the combined company represents a 267% immediate increase for D C shareholders.

D. C will also gain access to opioids diverse portfolio of high quality assets and strong tenant base.

During the second quarter Obeah O P. I began implementing its financial strategy, but the merger.

Dancing strategy for the merger and has closed on more than $108 million and mortgage financing with an aggregate implied cap rate of seven 5% on the appraised value of the properties.

Considering today's tight credit market OPI has the ability to finance these properties underscores the quality of the OPI portfolio.

We believe the merger is the best available alternative for DHT shareholders to preserve and create long term value.

Now turning to our second quarter results.

After market closed yesterday D. H C reported normalized <unk> of five cents per share for the second quarter.

Proving $22.5 million from last year the.

The improvement was largely attributable to improvements in our shop segment.

Total shop occupancy increased 420 basis points year over year to 77, 8% and average monthly rates increased by seven 3%, resulting in an increase in shop NOI of $16 $4 million over the same period.

New supply and construction starts are at record low levels and as construction costs remain high and financing availability is limited.

When should aid in our shop recovery.

A driving factor of that recovery is our capital investment plan aimed at increasing occupancy and rate through completing high return yielding projects to reposition our communities in their markets. We're beginning to see the initial benefits of our investments through increased occupancy and rate and a five 7% reduction in repair and.

Maintenance expenses year over year.

Correct result of these completed projects.

Margins in our shop segment increased by 540 basis points over the prior year and 180 basis points sequentially.

Although shop operating performance reflects progress over prior year results. The performance improvement has flattened during the quarter as our operators confront materially higher costs.

And the insurance that we expect will weigh on future financial results.

As a result, we expect results for the second half of 2023 shop, NOI will be approximately equal to the first half of 2023 with no real growth during the second half of the year and we do not believe we will be able to regain debt covenant compliance before mid 2024 at the earliest.

Turning to our office portfolio segment, and our same property office portfolio rental income increased three 3% and cash basis NOI increased five 3% compared to the second quarter of last year, we ended the quarter at 93% occupancy in this portfolio.

Leasing activity in our total office portfolio segment increased since the first quarter 324000 square feet of new and renewal leases were signed in the quarter with the average roll up in rents of 1.3% and a weighted average lease term of six nine years, we ended the quarter with a leasing pipeline of more.

700000 square feet subsequent to quarter end, 58% of this pipeline or 406000 square feet of leases either signed or are in LOI stage with leases being negotiated.

Our office portfolio segment comprised of approximately $8 8 million square feet of high quality Medical office and life science properties remain stabilized and well occupied with a strong tenant base opi's portfolio is comprised of well occupied properties with a high proportion of investment grade tenants.

It is buildings are well located office buildings that are more likely than those and the average office building portfolio to prosper in a generally weaker office market environment.

The merger resulted in a combined portfolio with greater scale and diversity with approximately $2 $1 billion of gross total gross assets.

533 properties in 40 States and Washington D C.

I'll now turn the call over to Rick who will provide more detail on our financial results.

Thanks, Jennifer and good morning, everyone.

Second quarter, we reported normalized desktop phone was $12 1 million or five cents per share flat from the first quarter, but an improvement of nine cents per share from the second quarter of 2022.

Adjusted EBITDA increased 30% from the prior year to $62 $1 million, but is down 1% from the first quarter.

Consolidated cash basis, NOI increased $22 million or 46% from the second quarter of last year to approximately $64 $3 million.

This increase was primarily attributable to improvements in our shop segment, which had an increase of $16 $4 million of cash basis NOI.

Occupancy in our shop segment decreased 420 basis points since the second quarter of last year, and 90 basis points. Since the first quarter of 2023 average monthly rates increased seven 3% year over year, but decrease slightly 60 basis points sequentially.

Year over year increases in occupancy and rates resulted in a 13, 7% increase in shop revenues, while property operating expenses increased seven 3% margin improved 540 basis points year over year, but only 180 basis points sequentially.

For the second quarter of 148 of our communities produced positive NOI of $34 $4 million and 82 communities produced negative NOI of $11 $3 million.

While the number of positive NOI producing communities has increased by <unk> 20 from last quarter. We noted 101 communities had decreased N O Y in the second quarter compared to the first quarter.

The decrease of NOI in these communities is illustrative of the uneven and unpredictable recovery of this portfolio.

Labor continues to be our largest shop cost at nearly 52% of revenue and while we have seen improvements in decreasing contract labor. We are seeing the need to adjust wages to be in line with market and many of our communities.

Competition for top talent remains fierce and our operators need our support to continue to improve the workforce at our communities.

Similarly, our insurance costs are increasing significantly and will be a headwind moving forward.

Interest expense was $47 $4 million for the second quarter, representing a 15% reduction from a year ago attributable to the $500 million prepayment of nine and three quarter percent senior notes in June of 2022, partially offset by higher interest on our credit facility, which had a weighted average interest rate of 8.1.

<unk> percent for the quarter.

As previously disclosed in late June the administrative agent of our credit facility notified us They had completed new appraisals of the 61 medical office and life science properties, securing the facility and determine the value of decreased resulting in a non monetary default.

We have since received a waiver of this default through September 32023, allowing us time to complete the merger.

Also as previously stated for more than two years, we have not been in compliance with our consolidated income available for debt service and current covenant, which prevents us from issuing any new debt.

We've been refinancing existing debt, while the ratio, which is currently 1.0 wait times remains below the one five times required.

As of June 32023, we had $700 million of debt maturing in the next 12 months and approximately $357 million of cash and restricted cash.

We note that our shop segment has begun to improve but after consultation with our operators. We expect the shop NOI in the second half of this year will be approximately equal to the first.

We continue to expect the DHT will not be in compliance with the statin current covenants until mid year 2024 at the earliest which is too late to address our upcoming debt maturities.

Pending merger with OPI will result in a combined company that will immediately be in compliance with its financial covenants and be able to refinance maturing debt.

The merger will be immediately accretive to F O for DHT shareholders and provide an annualized dividend of $1 per combined company sure.

If the merger does not close we will be forced to defer capital investment in our portfolio significantly delaying the turnaround of our shop segment, and we will be forced to raise expensive rescue financing, which would be dilutive to DHT shareholders.

For these reasons along with other benefits we are actively working towards closing the merger.

We remain committed to executing our business plan to create long term value.

We are confident that the merger with OPI will provide the necessary liquidity and financial flexibility to address all near term debt maturities and better position our shareholders to benefit from the combined company's long term growth.

That concludes our prepared remarks, operator, please open up the line for questions.

We will now open the call for questions and answers.

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If you're using a speakerphone please pick up your handset 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.

The first question comes from Bryan Maher with B Riley Securities.

Please go ahead.

Thank you and good morning, Jennifer and Rick and I guess, we have a new automated oh host for the conference calls so that's interesting.

Good morning, Brian .

A couple of questions for me, maybe starting with medical office building.

And I don't know maybe for a wreck it it seems like even though occupancy was a rental income and cash.

No rental income and NOI margins were down can you explain what's going on there was any transaction activity anything we're missing as it relates to that.

There is Brian that's a good question. So in our non same store portfolio. So it was part of the Redevelopments. We had a tenant that are that we terminated following their their default and now pending bankruptcy. So we took a $6 $8 million straight line rent write off related to that tenant, but we weren't.

April two recovered security deposits. So there's a there's a decrease.

A decrease or a hit in NOI, but theres actually a pickup in cash NOI. So that's the difference that creates that disconnect.

Okay. That's helpful. And then maybe yeah, we're getting a lot of questions on on this cost pressure situations.

Yeah. Some of your competitors well tower included you know I've talked about cost pressures easing can you talk about what the delta might be between your portfolio and some of the others I think that that storyline, it's caught some people off guard.

Sure I would say that a lot of our insurance renewals are July 1st and we're seeing it.

Varies by operator, but we're seeing increases between 10 and 100% so pretty significant.

Similarly, there's been considerable wage pressure.

Yeah, that's always a thing in senior living and the the operators manage it really well but.

Where we see the need there still intense a shortage of caregivers around the country.

In particular, I think in the southeast and for just labor in General and then.

Nurses are still in high demand. So I think we need to adjust wages to be competitive and then you have to deal with all of the wage compression that happens within a community to make sure things are fair.

We will try to recover that through rate increases, but there's usually a disconnect and timing. So you know again, that's their significant headwinds and <unk>.

We're continuing to make investments in the portfolio and the workforce. We do believe that eventually we will see higher margins and returns from these investments but.

We you know the good news is we did recover a bit faster than we had projected in the first half of 2023, but we expect it to flatten out a little bit in the second half.

Okay, and then last from me and I'll hop back in the queue on the Capex spending.

We know that you plan to spend a lot. This year our model had called for I think we were at $285 million or so doesn't seem like you're maybe pacing at that rate and you're sitting on $357 million in cash at quarter end is there anything going on there are you slowing your capex.

And.

To be cautious in case, the mergers not approved or are you just moving forward as you had planned as if it was January 1st.

We are moving forward as if it was January 1st week.

We really believe we've prioritized the capital spend throughout the portfolio and the returns that will generate when these projects are done in the communities are stabilized or pretty significant generally high teens or 20% returns.

We have faced some delays, it's primarily permitting type things that we thought would be wrapped up by now that have continued to drag on so we are making progress.

But because of the delays our estimate for the year has probably come down a little bit where previously we were probably targeting 375. We think we can we can catch it up and we'll probably be closer to $3 50.

For for this year with.

With a similar number next year.

About $250 million of that $3 50 is expected to be spent in the shop portfolio, where the portfolio needs. The most investment and where we see the greatest returns. So again, it's a little bit delayed because of permitting but for the most part it's it's.

It's consistent with what we've been trying to do.

Okay. Thank you.

Okay.

Again, if you have a question. Please press Star then one.

Yeah.

Okay.

This concludes our question and answer session I would like to turn the conference back over to Jennifer Francis President and Chief Executive Officer for any closing remarks.

Thank you operator, and thank you all for joining our call today.

That concludes our call.

Yeah.

The conference has concluded thank you for participating you may now disconnect.

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