Sabra Health Care REIT Inc

NASDAQ:SBRA

Earnings Call Transcript 2018-Q1

[Operator]

Good day, ladies and gentlemen, and welcome to the Sabra Health Care REIT First Quarter 2018 Earnings Conference Call. This call is being recorded. I would now like to turn the call over to Michael Costa, EVP, Finance. Please go ahead, Mr. Costa.

[Michael Costa, EVP, Finance]

Thank you. Before we begin, I want to remind you that we will be making forward-looking statements in our comments and in response to your questions concerning our expectations regarding our acquisition, disposition and investment plans, our portfolio repositioning and enhancement, and our expectations regarding our future financial position and results of operations.

These forward-looking statements are based on management’s current expectations and are subject to risks and uncertainties that could cause actual results to differ materially, including the risks listed in our Form 10-K for the year ended December 31, 2017 and in our Form 10-Q that was filed with the SEC yesterday as well as in our earnings press release included as Exhibit 99.1 to the Form 8-K we furnished to the SEC yesterday.

We undertake no obligation to update our forward-looking statements to reflect subsequent events or circumstances, and you should not assume later in the quarter that the comments we make today are still valid.

In addition, references will be made during this call to non-GAAP financial results. Investors are encouraged to review these non-GAAP financial measures as well as explanation and reconciliation of these measures to the comparable GAAP results included on the Financials page of the Investor Relation section of our website at www.sabrahealth.com. Our Form 10-Q, earnings release and supplement can also be accessed in the Investors section of our website.

And with that, let me turn the call over to Rick Matros, Chairman and CEO of Sabra Health Care REIT.

[Rick Matros, Chairman and CEO]

Thanks, Mike. And thanks for joining us everybody.

So, let me get the mood down and get really imagining there in California while you’re listening to us today. So, let me first talk about guidance, how we’ll get into details. But, we had a minor adjustment to guidance that simply reflected a change in timing and taking out the preferred and our existing notes. All other assumptions remain unchanged.

I want to talk a little bit about all the various reimbursement changes. We have 2.4% market basket increase, effective October 1st of this year, therapy caps were eliminated. That’s actually a pretty good deal for the space. Value-based payments, we expect overall to be -- for our operators on an aggregate basis to be relatively neutral when it comes to value-based payments. And just to provide a little bit more detail, about 60% of the space will be winners, meaning that they’ll retain some or all of the 2%; the top performers have an opportunity to get a 1% increase and their Medicare rates, the -- of the bottom 40%, 25% of the bottom will take the biggest hit, but that hit actually will only translate to a 0.5% decrease in their NOI. So, even to those that don’t do well on value-based payments, the downside is pretty limited, not that you ever want to see any decrease in NOI but 0.5 point.

The Patient Driven Payment Model, so that’s PDPM, is a simplified system, revised from what used to be called RCS-I. It’s still revenue neutral but some of the changes include the following. Significantly reduced cost to operators estimated at $2 billion in savings to the industry. The incentives will shift from solely short-term rehab to complex nursing. It’s a case-mix payment system with 5 categories rather than the current 66 RUGs categories. So, a much simplified system. The 5 categories are broken down into physical therapy, occupational therapy, speech therapy, nursing and non-therapy ancillary services which you’ll see referred to as NTAS. So, therapy rates will be lower than what they were but there’ll be corresponding increases in nursing.

Physical therapy and occupational therapy payments will taper down after 20 days. That’s up from 14 days in RCS-I. Concurrent and group therapy will now be allowed at the 25% of rehab revenues, which will help margins. The historical utilization level for concurrent and group therapy back when it used to exist was 26%. So, 25% really just reflects the reality of what it always was, when it was in place. Obviously it’s been gone for quite a few years. So, that’s another positive for us.

The reimbursement incentives for nursing will have the important benefit of increasing a percent of skilled nursing patients that have longer length of stays, mitigating the length of stay problems that exists with the focus on short-term rehab. So, if you just look at the numbers, CMS is going to do an analysis and maybe you guys do as well that’s based on the existing population of skilled nursing patients. The key here is that the existing population is going to change. Operators always follow the incentives. We’ve seen it historically in the past when the new rehab categories were put in. That’s where the operators went. They started admitting and clinical protocols to be able to take care of patients with the highest needs on rehab, which really is why so much of the rehab under the current system is in the ultrahigh and very high categories. So, expect to see significant changes in behavior on the part of our operators as they start emphasizing nursing patients and not just solely rehab patients, which will -- the nursing patients will have a longer length of stay, so that obviously has a dual benefit of mitigating the length of stay issues, focusing on short-term rehab and therefore resulting in higher occupancy.

The other benefit with this system change is we’ll no longer have minutes obviously because it’s going to a case mix system. And that should positively impact DoJ investigations. As you all know, the DoJ investigations were based on the assumption that providers had too higher percentage in the ultrahigh and very high categories and therefore must be doing something wrong.

I’d also note that we’ve never really seen this level of collaboration between CMS and the industry before. So that’s greatly appreciated. It actually started before the current administration. The American Healthcare Association has been involved with CMS in these changes for four years. But since the administration came in the office, the cooperative attitude and working relationships between business and CMS has also increased dramatically.

I’ll now just make a comment about our asset divestiture program. Harold will get into the details on it. But, all of our asset sales are progressing, as previously communicated, in both pricing and timing.

In terms of our acquisition pipeline, it currently stands at $400 million; it’s almost entirely senior housing. The competitive market remains the same as it’s been. And at this point, we see cap rates stable. So, both on the skilled side and the senior housing side, we think there’s been some commentary that there some people are seeing the beginning of some cap rate expansion on senior housing. We haven’t seen that to any significant degree at this point.

Our focus continues to be on the execution of our divestiture program, our proprietary development pipeline and executing our small deals. We’ve been shown large deals but they tend to be both messy and not compelling, and we simply have no need to follow that path. By year-end assuming no other skilled divestitures, we’ll have skilled exposure down to 61%, that’s down 13% from August of 2017 and just 4 points higher than where were pre the merger with CCP. When we think about our skilled exposure, I just want to make a note here, it’s really more about the operator than it is about the states. So, as we look at our current operators and we look at operators as we look at additional deals going forward, it’s really looking for operators who fit our preferred profile.

Move now to our operating results. Skilled occupancy sequentially was 80.9%, just up a tick. Skilled mix was up 40 basis points at 37.6%. Our EBITDA coverage was 1.33, down from 1.37. That was specifically due to one of our tenants who took over the operations of another one of our tenants, and while that transition was occurring, their coverage was down some, but their coverage was still 1.54; it just had been higher before that. So, we actually expect that to go up. So, we didn’t see any trends sort of across the rest of our tenants; I’ll talk a little bit more about that in a couple of minutes.

The difference in Signature Health I want to point out, because we show coverage of 1.22 on a pro forma basis. So, under the current restructured deal whether there is a change in rehab pricing and there are also 4 facilities being divested, which we’ll get a rent credit from, it would put them at 1.3. And that’s what the deal was predicated upon.

For senior housing, sequential occupancy was down 50 basis points to 86.8%. EBITDAR coverage was flat or 1.09. On our senior housing managed wholly-owned facilities, occupancy was up sequentially to 92.1% from 91.7%. The Specialty Hospitals sequential occupancy was 83.4%, up from 79.3% with EBITDAR coverage of 3.45. Occupancy was up and coverage was somewhat lower, specifically due to Signature Behavioral hospitals, which were acquired in 2017 coming into the numbers. They have lower occupancies and cover rather than the other specialty hospitals and usually run about 1.6 times but they also tend to have higher occupancy.

And we talk about all-in operating results, not same-store, because given all the changes in our portfolio over the last year, looking at our overall operating results that post same-store mix, a lot more same-store just doesn’t make the same level of sense that it did a year ago.

And in terms of our top 10, let me make a couple of comments and things I saw in some of the notes that came out last night. In terms of Genesis, going from 1.26 to 1.22, they actually reported a pretty good quarter this morning. But that said, we’re getting pretty close to the point where our old testament is done with. And it’s just not going to matter much to us anymore, which has been the point of this divestiture program to begin with.

In terms of Avamere, which was just slightly down, Avamere is doing fine. They’ve got a strong portfolio; they have six facilities in Washington State that they have issues with. In fact, all the operators in Washington State have issues because of substantively poor Medicare -- poor Medicaid rates. And I think we’ll see one or two things happen with Washington State. Avamere may sell a facility, one of the six facilities, so that would help. But the other thing is there’s conversations going on with the state legislature where Medicaid rates are going to be potentially be increased that’s being considered. Either that will happen, or Avamere will simply wait out, fallout, since some of the smaller operators are really struggling. So, we absolutely have no concerns about the Avamere portfolio. It’s a small piece of their overall portfolio. They are strong operators.

In terms of Holiday, you all may have seen an announcement today from the Nye Senior that they came to a deal with Nye Senior, where these 51 facilities they have with Nye Senior will be converted from a triple net-lease to manage contracts. That’s a good outcome for Holiday. Those 51 facilities have been a burden on the guarantor sub. So from our perspective, that’s a real positive and will strengthen the guarantor sub. So, it was a constructive deal. I think everybody knows, Nye Senior going through a process right now and it was -- that would also be -- that new understanding or that new agreement rather and that new structure will help them theoretically in their process as well. So for us, it was good news. I know the Holiday team feels really good about that negotiation and getting those 51 facilities out of guarantor sub.

And in terms of Senior Care Centers, they ticked down 0.01 point that’s not really ticking. They had no downward trends. Their coverage is not strong as we noted on the last, and we’re keeping an eye on them. Their coverage slightly ticked up in the current quarter. But, look, they are an operator; we’re keeping an eye on. There is an interested buyer that we’re having conversations with. We don’t know as we sit here today, whether we will get anything done, but it’s interesting enough for us to take a look at. And if we were to do that, obviously our skilled exposure would come down more so than one with our exposure in Texas.

On the other hand, with some of the new management changes that are going on, as we said on the last call, there is some real opportunity to improve their operation. So, we’ll see. But, we are a very open minded to looking at the divestiture of all or some of those assets. And as we -- as those negotiations start to materialize, we’ll keep everybody posted on that.

And with that, I’ll turn it over to Talya and then Talya will turn it over Harold and then we’ll go to Q&A. Talya?

[Talya Nevo-Hacohen, EVP, Chief Investment Officer and Treasurer]

Thank you, Rick. This is the first time that we have walked through the results of our managed portfolio in our quarterly earnings call. Until this quarter when we closed on the Enlivant transaction, the managed portfolio had been very small and consisted primarily of our retirement homes in Canada. So that is where I’ll begin my comments.

Sabra owns 10 homes in Canada, eight of which are independent living and two of which are assisted living and memory care facilities. Sienna Senior Living, a publicly traded company on the Toronto Stock Exchange, manages eight independent living facilities in Ontario and British Columbia and one assisted living property in Ontario for Sabra. The remaining property, Maison Calgary is managed by Baybridge Senior Living, a privately held company that is actually merged with Amica, bought Amica last year. Sienna has been managing the homes for the last year and has focused on building and maintaining occupancy and improving the quality of resident services.

In the first quarter of 2018, the Sienna managed properties achieved 91.9% occupancy compared to 92.7% in the preceding quarter, a 80 basis-point decline, which was a direct result of lower traffic and tours because of the harsh flu season. And it achieved 40.6% cash net operating income margin compared to 35.8 in the preceding quarter as a result of tighter cost control and reversal of onetime accrual.

Maison Calgary which provides assisted living and memory care services to private pay residents in Calgary continued to perform well in the first quarter with 92.5% occupancy compared to 89.6% occupancy in the preceding quarter, mostly to leasing momentum on the assisted living sites and achieved 33.2% cash NOI margin compared to 27.9% margin in the preceding quarter, primarily as a result of lower nursing labor costs. With revenue per occupied unit of just under $7,300 a month, Maison Calgary is property that provides an alternative for long-term care for those who are able to pay privately.

Moving to the U.S. Of the remaining 14 wholly owned managed properties, 11 are managed by Enlivant and 3 are managed by Pathway to Living which also leases an additional property from Sabra in Green Bay, Wisconsin. The wholly owned Enlivant portfolio located in Pennsylvania, West Virginia and Delaware performed well in the first quarter of 2018. Average occupancy rose 110 basis points to 92.7% compared with 91.6% occupancy in the preceding quarter. Revenue per occupied unit increased to $4,986 per month, which was slightly higher than the preceding quarter and 2.8% higher than underwritten for the quarter, again despite a tough flu season. Cash net operating income margin was 26.8% compared to 23% in the preceding quarter.

The three Pathway properties, two in Central Wisconsin and one outside of Minneapolis which were part of our proprietary development pipeline, totaled 174 units with the mix of assisted living and memory care. Pathways have been working to improve occupancy and operating performance since taking over these properties from a prior operator. In the first quarter, average occupancy rose to 89.3% from 81.8% at Marshfield One. Note that this includes only one property as the other two were acquired by Sabra in the fourth quarter of 2017 and are currently categorized as prestabilized. Cash NOI margin for all three combined was 16.7%, in line with the previous quarter.

In January 2018, Sabra also acquired a 49% interest in a joint venture with TPG which owns 172 properties located in 18 states across the U.S., all managed by Enlivant. Despite a severe flu season, Enlivant properties did not give up much on occupancy and rate. Average occupancy for the was 80.7% compared to 81.3% in the preceding quarter and revenue per occupied unit was just under $4,000 per month, which is only 1.2% less, underwritten for the quarter.

Cash net operating income margin was 25.8%, compared to 26.4% in the preceding quarter, reflecting the impact of the revenue items that I reviewed and some non-occurring expenses including higher utility costs and snow related costs. Residents at Enlivant properties receive annual increases once a year at the end of the year and management believes that they will be able to continue to push both rate and occupancy. At this level of occupancy, incremental revenue has an outsized impact on margin and we remain optimistic that the Enlivant team will continue to improve overall revenue and net operating income in this portfolio.

I’ll now turn the call over to Harold Andrews, Sabra’s Chief Financial Officer.

[Harold Andrews, CFO]

Thanks Talya.

For the three months ended March 31, 2018, we reported revenues and NOI of $166.1 million and $163.3 million respectively compared to $62.7 million and $60.2 million for the first quarter 2017. These increases are due predominately to revenues and NOI generated from the properties acquired in the CCP Merger and the Enlivant transactions.

FFO for the quarter was $113.4 million and on a normalized basis was $111.6 million after the exclusion of $1 million of CCP Merger and transition related costs, $0.9 million net recovery of doubtful accounts and loan losses, and $1.9 million primarily related to non-recurring other income, which is $0.63 per share. This normalized FFO compares to $36.4 million or $0.55 per share of normalized FFO for the first quarter of 2017, a per share increase of 14.5%.

AFFO, which excludes from FFO merger and acquisition costs and certain non-cash revenues and expenses was $106.4 million and on a normalized basis was $104.2 million after the exclusion of $0.6 million of CCP related transition costs, $1 million net recovery of doubtful accounts and loan losses and $1.9 million primarily related to non-recurring other income or $0.58 per share. This compared to normalized AFFO of $35.2 million or $0.53 per share in the first quarter of 2017, a per share increase of 9.4%.

For the quarter, we recorded net income attributable to common stockholders of $59.9 million compared to $16.3 million for the first quarter of 2017. G&A cost for the quarter totaled $7.9 million and included the following, $1.1 million of stock-based compensation expense, $0.6 million of CCP related transition costs, and $0.8 million of operating costs for HealthTrust, the valuation firm that was acquired in the CCP Merger, which we sold during this quarter. Recurring cash G&A excluding CCP transition costs and HealthTrust operating expenses were $5.3 million or 3.3% of NOI for the quarter. We expect our quarterly recurring cash G&A run rate to be approximately $5.2 million to $5.6 million per quarter.

During the quarter, we incurred charges totaling $1.2 million of provision for doubtful accounts and loan losses, primarily related to $2.2 million general reserves related to straight-line rental income and loan loss, offset by $1 million recovery of cash rental income. Our interest expense for the quarter totaled $35.8 million compared to $15.8 million in the first quarter of 2017. Included in interest expense was $2.5 million of non-cash items compared to $1.6 million in the first quarter of 2017.

As of March 31, 2018, our weighted average interest rate excluding borrowings under the unsecured revolving credit facility and including our share of the Enlivant joint venture debt was 4.1%. Borrowings under the unsecured revolving credit facility bore interest at 3.13% at March 31, 2018, an increase of 32 basis points over the fourth quarter of 2017.

We recognized a point $0.5 million net loss on sale of real estate during the first quarter of 2018, primarily associated with the sale of one skilled nursing facility. During the quarter, we invested $477.8 million on the Enlivant assets. In addition, we invested $47 million on two skilled nursing transitional care facilities and one senior housing community with an average cash yield of 8%. These investments were funded with cash on hand and borrowings under our revolving credit facility.

As of March 31, 2018, we had total liquidity of $435.1 million comprised of currently available funds under our revolving credit facility of $389 million and cash and cash equivalents $46.1 million.

We remain compliant with all of our debt covenants and continue to maintain a strong balance sheet with a following pro forma credit metrics which incorporate among other items, aggregate CCP rent reductions of $28.2 million and investment in disposition activity concluded after quarter end. Net debt to adjusted EBITDA of 5.48 times, net debt to adjusted EBITDA including unconsolidated joint venture debt of 5.97 times, interest coverage of 4.23 times, fixed charge coverage of 3.72 times, total debt to asset value, 49%, secured debt to asset value, 8% unencumbered asset value to unsecured debt, 224%.

Regarding our net debt to adjusted EBITDA, I would point out that it includes the full impact of the $19 million Genesis rent reduction and the $28.2 million impact of the CCP portfolio repositioning. As we complete the genesis and other planned asset sales, we expect this leverage to decline over the balance of 2018 to around 5.25 times or 5.75 times including unconsolidated joint venture debt.

On May 2, 2018, we announced that we will redeem all 5,750,000 outstanding shares of our Series A preferred stock on June 1, 2018. These shares will be redeemed at a redemption price of $25 per share, plus any accrued and unpaid dividends in the amount of approximately $0.445 per share for an aggregate payment of $146.3 million.

On May 9, 2018, the Company announced that its Board of Directors declared a quarterly cash dividend of $0.45 per share of common stock. The dividend will be paid on May 31, 2018 to common stockholders of record on the close of business on May 21, 2018. I’d also note that this dividend is about 78% of our normalized AFFO for the quarter.

We have updated our 2018 earnings guidance range as follows on a per share -- per common share diluted basis. Net income attributable to common stockholders, $1.98 to $2.06, FFO $2.48 to $2.56, normalized FFO $2.47 to $2.55, AFFO $2.28 to $2.36, and normalized AFFO $2.27 to $2.35. These updates reflect the revised timing for completing the Series As preferred stock redemption and the elimination of the previously anticipated refinancing by $500 million of 5.5% senior secured notes due 2021 and $200 million 5.375% senior unsecured notes due 2023 during the second half of 2018.

Our current expectations for pricing of a 2018 unsecured bond offering to complete refinancing is not compelling at this time. Accordingly, we will be patient and pursue any such refinancing opportunistically prior to the relevant maturity debt. These changes impacted our guidance range through higher interest expense and preferred stock dividends as well as the elimination of the loss on extinguishment of debt which impacted net income, FFO and AFFO amounts only.

Finally, a quick update on the Genesis asset sales. We continue to make great progress towards completion of the Genesis sales as we discussed last quarter. Of the 46 identified as being marketed for sale last quarter, we have now closed on six, which generate gross proceeds of $20.5 million. 25 are subject to two separate purchase and sale agreement for expected aggregate gross proceeds of $254 million. And remaining 15 are under three separate LOIs with expected aggregate gross proceeds of $79.8 million. These sales are expected to trigger residual rents to us of $10.2 million per year for the following 4.28 years as provided for in our agreement with Genesis. All sales are expected to be completed by the end of 2018 with the majority closing by the early part of the third quarter. Upon completion of the sales, we expect to have continuing annual cash rents from Genesis including residual rents generated from sold assets of approximately $20.6 million or 3.7% of our annualized cash NOI.

And with that, I think we’ll open it up to Q&A

[Operator]

Thank you. [Operator Instructions] And our first question comes from Tayo Okusanya from Jefferies. Your line is open.

[Tayo Okusanya, Jefferies]

Yes. Good afternoon. I think, it’s good morning over there, and congrats on a pretty solid quarter. Couple of quick questions. First of all, the whole Medicare situation with the 2.4% increase that all makes sense. Could you give us some commentary just on the Medicaid side, what you’re kind of hearing from states as they gear up for the new July 1 fiscal year for most of the states?

[Rick Matros, Chairman and CEO]

Yes, pretty much, not much different than it’s been. We’re not going to see much, we’re not going to see much negativity. These Medicaid increases have been really modest the past number of years, and I wouldn’t expect that to change this year. I mean, we’ve got a couple of states like Washington state, which has particularly weak Medicaid rates that are having active discussions because they really see that their operators are struggling in that state. In Texas, there is pretty substantive efforts going on that the REITs are actually or some of the REITs are actually supporting with the National Trade Association to change the system there. But, even if that were to happen, that they only have elections every two years. So, that’s 2019 issue. And as far as every other place, I don’t think there is any major sort of efforts going on to change anything in the other states. I think it’s going to be business as usual.

[Tayo Okusanya, Jefferies]

Then, second of all, you did make just some passing comments on the Nye Senior transaction with Holiday. I’m just curious, is this something you guys would consider doing with your Holiday portfolio just kind of given your coverage at 1.1, 2?

[Rick Matros, Chairman and CEO]

No. First of all, remember, I know we have to remind everybody, it’s independent living, it’s not a healthcare model. And so, we underwrote the deal at 1.1 as it appears to do Holiday deals. So, they’re performing where it was underwritten at. Their EBITDA margins are 40%. It’s a pretty healthy business. So no, we don’t intend to do that. I think, obviously, I can’t talk to Nye Senior. I think in this case, while it was something that Holiday wanted to do with Nye Senior, because it’s a positive for their cap structure, I think for Nye Senior as they go through the process, to the extent that potential buyers may not want to hold on to all the assets and Holiday is a pretty big chunk for them, it gives them kind of an easy -- an easy access. [Ph] So, I think it gives them a little bit more flexibility when they talk to buyers.

So, it happened really for some very specific reasons related to that profit. And we don’t see ourselves doing anything different from Holiday. If fact, we would like to do more with Holiday. There just haven’t been the opportunities independent. Independent living isn’t a huge space, as you know in the states, the way it is in Canada. And there is really, almost no new development on independent living. The only development we see that it ever relates to independent living is when guys are building campuses with full CCRCs or just sort of multi-level senior housing facilities, they may have some IL cottages or units.

[Operator]

And our next question comes from Juan Sanabria from Bank from America. Your line is open.

[Kevin Fischbeck, Bank from America]

Hey. This is Kevin on for Juan.

[Rick Matros, Chairman and CEO]

Hey, Kevin.

[Kevin Fischbeck, Bank from America]

I just had a question regarding Signature. In press release, you guys mentioned the deferred rent and possibility of resetting the base rent, once all obligations are taken care of. I guess, what is the metrics for that, is it coverage, cash flows or just paying off or paying down the financial claims that they have?

[Harold Andrews, CFO]

It really is dependent on their future cash flows. So, the first priority is got to get the med malpractice obligations paid. Then they got to get the DoJ payments taken care of. And as restructure the deal, every landlord’s portfolio is separated in the separate silos. And so, we’re looking to our -- the performance of our portfolio to generate cash flow. And the obligations for DoJ and med mals is more shared across silos. But once those are c care of, then the cash flow that our silos generate are going to allow us to reset rents as those cash flows improve down the road. So, we don’t have any expectation that’s going to happen anytime soon. But, it’s something that’s there thinking about it more in terms of those demographics really start to change over the next couple of years and the performance from that. So we will have that opportunity to recruit there, but we’re not making any assumptions about those recruitments at this point.

[Rick Matros, Chairman and CEO]

The other couple of points I’d make on opportunity for recruitment, even more -- even in addition to the demographic is, if you think about everything that Signature has gone through with the restructuring has been a huge diversion for the senior management team. Senior management team for the first time in a very long time is going to be able to solely focus on the business. So that’s an intangible, but we think that’s very helpful. And with all the reimbursement changes that those would be positives as well. And despite the fact that -- and I think you’ve seen sort of across the space, everybody’s metrics have become a lot more stable on the skilled nursing side. Even as they begin to improve, you’re still going to see decline in supply of skilled nursing, which is just going to enhance the occupancy opportunities in addition to -- in addition to the demographics.

So, we think there’s some real positive there, but as Harold said, noting in the numbers because it’s impossible to give both timing and the actual metrics.

[Operator]

Thank you. And our next question comes from Smedes Rose from Citi. Your line is open.

[Smedes Rose, Citi]

Hi, thanks. I just wanted to ask you on the SNF coverage came in 1.33, I think. And I think in earlier remarks you had said you expected to trend to 1.38 to 1.4 times. Is that something that will happen over the course of the year as the rent reductions continue to kick in? And also with your positive views on the CMS proposals, do you think that coverage level could go higher relative to that initial expectation?

[Rick Matros, Chairman and CEO]

Yes. So, on the first question in terms of what the ones -- that’s specifically due to one tenant who got pretty strong coverage that’s Cadia at 1.54. They’ve taken over the operation of one of our other tenants. And so just the timing of that regulatory approvals and just going through the amount of time it’s going to take to transition get those systems in place. There’s been some declining of coverage. The coverage was quite a bit higher. So, it’s still strong at 1.54. So, the 1.33 has nothing to do with the merger or anything else that we’ve done, specific to that. So, we should see that tick up as a start, integrating those additional facilities and those operations start improving. And it’ll be a little bit of a slow climb, because we report on trailing 12 basis. But, again, they are really operator, and even with reduced coverage, still on 1.54.

So, in terms of your, in terms of your second question. So obviously, first of all, we’ve gotten to October 2019 before this happened. And I think, what I would expect to see behaviorally based on history is that operators will start admitting patients and start transitioning before the October 19 date. So, they can hit the ground running a little bit more. So by way of example, when that 10 plus years ago when the new rehab categories came in and the incentive to go after those higher acuity rehab patients in RUG 66 was so apparent, we started seeing operators at mid dose kinds of patients pre October, 1 of that year, even though they weren’t getting fully reimbursed. So, they would have time to acclimate and demonstrate their referral sources that they could provide the kind of outcome that their referral sources would look for and they could therefore be preferred provider. So, I think we’ll see some of the same behavior over the course of 2019, next year. But as those changes actually take the hold, I absolutely expect to see improved coverage.

And I would also note that we currently have operators in certain states where there are robust Medicaid systems. So, even though Medicare may not incentivize them to go after more complex nursing patients, pulmonary dialysis, whatever the case may be, the Medicaid system allows them to do that. And within those operators, we’re not seeing any length of stay issues. Because even though they’re also focused on taking a short term rehab patients, which inherently has length of stay pressure, they’ve got a nice percentage of these complex nursing patients that have a much longer length of stay, and that mitigates the length of stay on the short-term rehab patients. So, I definitely see that as beneficial. And even though it’s hard to completely predict timing, when you look at all the combined factors of a better market basket, the elimination of therapy caps, the new systems coming in on October 19, a little bit of a bleed in of the demographic probably next year and the continued reduction in supply really all bodes well for the states. And this is kind of silly stat out there that I may have mentioned on the last year that by 2025, the industry will be 100% occupied, based on variety of factors, mostly demographic and supply. So, yes, we would expect to see coverage improve over the course of time.

[Smedes Rose, Citi]

Thank you. I appreciate. I also just wanted to ask, in your outlook for the year, what sort of improvements are you expecting at Enlivant this year. I know it’s sort of in -- it’s a turnaround portfolio that you talked about when you brought it. So occupancy a little under 80%. And because it sounded like you emphasize a continued occupancy gains, I guess maybe at the expense of rate or maybe how does that kind of play out over the course of the year?

[Rick Matros, Chairman and CEO]

So, I would just say a couple of things, one, rates has not been an issue overall. And in the owned portfolio, for the 11 that we own, they’re actually well ahead of projections in occupancy. And on the joint venture, they’ve got hit somewhat by the flu as Tayo mentioned in January, February but already saw a nice rebound in March. So, we expect occupancy to tick up on a continual basis, but occupancy moves incrementally. You’ve got movement and you’ve got folks leaving obviously. So, you’re not going to see 3% to 4% increase in a short period of time but you’ll see incremental improvement. And we believe that they will get industry averages. Talya is there anything.

[Talya Nevo-Hacohen, EVP, Chief Investment Officer and Treasurer]

No, I think they also have the ability depending on markets to push rates more or less, and that’s really a function of local market dynamics.

[Operator]

Thank you. [Operator Instructions] And our next question comes from Chad Vanacore from Stifel. Your line is open.

[Chad Vanacore, Stifel]

Great. So, just update on Senior Care Centers, coverage there is pretty thing. So, how are those changes proceeding on that portfolio and how are you thinking about it going forward?

[Rick Matros, Chairman and CEO]

So two things, one, operationally, they basically are treading water. They ticked up slightly in the first quarter, but it’s not substantive. So, the CEO, -- the COO has only been there for, I think six months, something like that. And they are in the middle of doing a CEO search. They actually had the CFO doing all three positions for quite some time, which just hurts obviously. So, there is a lot of -- when I talk about the blocking and tackling as opposed to sort of industry headwinds, because of their issues in the C suite and the lack of stability there, that’s really hurt their strategic direction in their operational results. We do like the new COO, we know him. And that’s allowed the CFO to get more focused on his particular responsibilities, and hopefully they’ll conclude the CEO search shortly.

So, it’s really, like basic cost controls; it really is blocking and tackling. Cost controls, labor management, things that most of our operators really do well at, that they’ve really suffered. So, we expect them to actually just continue to tread water for a while. So, we don’t see them declining. They haven’t been declining. We just don’t expect to see a lot of uplift for most this year. I think the elimination of therapy caps and the market basket obviously will help, but it will help everybody. So, that’s something to look forward to until operationally they get their act together. But, we do have unsolicited interest from a particular buyer as I noted. And so we are exploring that. And so we’re very open to doing something in terms of the divestiture, either all or some of those assets. And so, we’re just sort of keeping an eye on it. We’re trying to be helpful with them in terms of anything that we can do for them from a business plan perspective or resources that we can recommend to them. So, that’s kind of where it is.

So, we’re not super concerned about anything at this point. They sold a pharmacy, which allowed them to pay down a huge chunk of debt they have with us. We noted that in our press release. So, I think that was important. And we encourage them to do that. So, we feel like there has been a good dialogue with them on the things that they can do to improve your business. So, we do think there will be an improvement. I don’t expect to see improvement this year. And as I said, we’ll update everybody on whether this interest that we have in the portfolio is something that we want to act on. But Texas is a tough state. It’s the one state where there’s actually skilled nursing facilities being built. You don’t really see that in much of the rest of the country. So, that’s really as much as we can say on that right now. So not overly concerned, but we’ll keep an eye on it, we’ll keep the dialogue going and we’ll pursue things with the potential buyer.

[Chad Vanacore, Stifel]

And then, just thinking about the Cadia portfolio, which is formerly operated by NMS. Have they largely cleaned up the sins of the past management and what’s left to improve those operations?

[Rick Matros, Chairman and CEO]

Yes. So, the Cadia portfolio isn’t the former NMS portfolio, it’s kind of flip. So, Cadia was actually our first big acquisition when we formed the REIT in December of 2011. And it was actually also in conjunction with our first equity offering. So, Cadia took over the NMS facilities, and their management team is fully intact. So from the management perspective it’s Cadia that’s operating it. It took a little bit longer than I think everybody liked to get all the regulatory approvals to get change of ownerships done, and all that kind of stuff. So, the NMS operations suffered a little bit in that time. But we feel good that they’re really getting their arms around it. We’re starting to see incremental improvement. And again, even with sort of the burden of taking on the NMS facilities, which affected sort of the combined coverage of NMS and Cadia, we still got Cadia with all the buildings at 1.54 coverage.

[Chad Vanacore, Stifel]

All right. One last quick one for me. After the sales of property and repayment that you outlined in your guidance, what’s the best use of incremental cash flow, is the debt repayment, development, pipeline, acquisition, something else?

[Harold Andrews, CFO]

Yes. Certainly in the short term, we’ve got some outstanding borrowers on the revolver, so will pay those down. And that’s really where you see the improvements in our expected leverage over the course of the year, getting that back down to the 5.25 area that’s really driven by taking proceeds from asset sales, paying down the revolver. I mean, it also leaves us room to be opportunistic in acquisitions that we could still do a fair amount of acquisitions somewhere between 150, 200 million to keep our leverage in an area that we’re comfortable with, but the first thing will be to pay down debt.

[Operator]

Thank you. And our next question comes from Eric Fleming from SunTrust. Your line is open.

[Eric Fleming, SunTrust]

Yes. I just want to take dig deeper on the decision. So, I appreciate more detail on what’s going on with Genesis, but outside of Genesis, where are you in terms of any additional CTC assets or a legacy sovereign assets that you are disclosing on?

[Rick Matros, Chairman and CEO]

There’s nothing else that we haven’t announced that we’re considering. We’re pretty comfortable with the group of operators we have all in, other than the comments that I made on Senior Care Centers. So, I wouldn’t expect to see much else from us. As I mentioned earlier, Avamere may sell a facility in Washington State. So, you might -- you may see something incremental here or there, one here one there. But in terms of our operators, we don’t expect to see much change going forward other than that we early talked about.

[Operator]

Thank you. Our next question comes from Daniel Bernstein from Capital One Securities. Your line is open.

[Daniel Bernstein, Capital One Securities]

I figure I’ll be one person who asks about the pipeline, instead of whatever other properties are moving in and out. So, you mentioned you haven’t seen really cap rates move at all in seniors. Just your outlook for senior and skilled nursing. What are you seeing in terms of between of the bid spread between what you’re going to pay and what the sellers are asking for? Is that widened at all, is it coming back in maybe -- what does that portend for investment volume the rest of this year.

[Talya Nevo-Hacohen, EVP, Chief Investment Officer and Treasurer]

So, a couple of thoughts. Most of the bidders out there are private equity firms of varying sizes and they’re buying assets to the expectation of engaging managers, management for call it 5% or so management fee. So fundamentally, if we’re looking at net leasing o property, we’re going to be off by somewhere between 10% and 30% just on the coverage ratio because the cap rates there being applied to 100% of NOI are at the number at our lease cap or oftentimes more aggressive than our lead cap rate. So if you start off with 10% to 30%, we’re off by 10% to 30% and then you add on another call it 10% because cap rate differences, that adds up to the range that we’re typically seeing for somewhere in the order of I’m going to say 15% to 30% or 40%, depending on whether the high end -- it depends on whether someone is buying stabilized asset or the high end of that disparity is when they’re buying an asset that’s a lease up and there is an expectation that these will occur and buyer is buying on that expectation as we are buying mostly on cash flow.

[Rick Matros, Chairman and CEO]

So, that’s obviously specific to senior housing, Dan. And it’s not as we’re opposed to doing management agreements. There are some operators out there, one of who we do things with right now that we think are very good. It’s just that even at that level, the level of pricing is just unrealistic. And we think there are going to be some really nice buying opportunities over the next few years for all of us, as those things don’t pan out the way they’re currently being underwritten by the private equity teams. But the other thing I would say is that for us, it doesn’t really matter that much. I mean, we as you know have been really committed to having a relatively uneventful year, just executing on these final pieces. And most of that is close to completion. We are much better positioned as a company than we were prior to all the activity in 2017. But, we also understand that there was so much that we did that’s really taking the market quite some time to absorb it and to see that we actually can execute on everything as we said we would.

So, we’ll continue to look to get some small things done. We’ve got things coming in on the proprietary development pipeline. And I would just note there, just as a reminder that those are brand new purpose built senior housing facilities at cap rate that are 7.5% or north of 7.5% rent coverage. So, great pricing because of how we structured it when we cut those deals. So that’s really going to be the focus. And I think that should accrue to the benefit of all of our constituents. And if things change and there are different opportunities there, then we’ll act on those. We’ll have plenty of capital available to continue to get things done.

[Daniel Bernstein, Capital One Securities]

Okay. And you’re indifferent to managed versus leases, just depends on where the value is on seniors…

[Rick Matros, Chairman and CEO]

Yes, exactly. You’ve got to get things on the up, not when they’re stabilized. And that’s one of the issues that we see, because we’ve obviously seen a lot of the deals that have been underwritten by the private equity groups. And in the projections that they’re buying into just are unrealistic from our perspective. We just don’t see them happening under any circumstances. But if we were to see some opportunities, then, yes, great. We’ll be happy to act on it. So, it always depends on the opportunity, the operators very specifically and then the market of course.

[Talya Nevo-Hacohen, EVP, Chief Investment Officer and Treasurer]

I’ll pile on one more thing for you, Dan. And that is while the market -- while bidders are being very aggressive, they are also very commonly overbidding to get into the mix and then re-trading. So on any given week, we get at least 2 and closer to 5 phone calls on deals that we have bid on where the buyer has -- where the trade has fallen apart. And I think that most of the time because it’s consistent, they are falling apart on re-trade on price. So I think the other piece of the equation that’s occurring now is the resetting of seller expectations.

[Rick Matros, Chairman and CEO]

So, there may be some opportunities there for us because it isn’t just a reset on price with that particular buyer, it’s a creditability issue obviously. So ,even if we come in a little bit lighter, at least there’s certainty of closing. But again, to the extent that provides more opportunities for us, they’re not going to be huge deals, they are going to be what we said we want to be focused on issues, and that’s getting small deals that are accretive and keeping things relatively uneventful.

[Daniel Bernstein, Capital One Securities]

So, maybe investment yields haven’t gone up, but maybe there are few signs of cracks there in terms of the buyer aggressiveness or the re-trades?

[Rick Matros, Chairman and CEO]

Yes. And we’ve seen some of these cracks for a while. We actually saw some of them last year with recycled deals and investor deals. And we would have expected to see some cap rate expansion already as a result of that. But looks like it’s going to take a cumulative effect of a number of those things happening more frequently. And so, those sellers, to Talya’s point, reset their expectations. And brokers by the way have to think about their creditability as well. So, it’s brokers resetting some of their own expectations as well as sellers.

[Daniel Bernstein, Capital One Securities]

Okay. One more quick question, I know it’s getting longer. So, I agree with you, PDPM is going to be very good for the SNF industry. But this year you saw the 1% Medicare rate increase of wage pressure. Am I missing something in terms of why should we be positive or confident that lease coverage won’t go down further for the industry and maybe different for your portfolio versus the industry? Is there something you’re seeing the operators do in terms of mitigating wage pressure or occupancy or skilled mix? Something that’s giving you confidence that it will get worse?

[Rick Matros, Chairman and CEO]

You said 1% on Medicare. It’s 2.4%.

[Daniel Bernstein, Capital One Securities]

I mean for fiscal -- for this year, you still have only a 1%...

[Rick Matros, Chairman and CEO]

Yes. So, I think all those factors you talked about, wage pressures, they’ve been there and people are trying to manage, are still managing through them. And by the way that’s also very market specific. So, the larger MSA, the metro areas have more wage pressure than others. The percentage of our portfolio in those large MSAs is relatively small. But I think even with all those pressures and the lack of good reimbursement increases, we’ve seen couple of quarters now, not just with us but with our peers who’s basically all skilled nursing and a couple of areas they have large exposure skilled nursing that things have been stabilizing. We have been saying all along that we expect that -- if we’re not close to bottom, if we’re not at bottom, we’re pretty close to bottom.

So I think you make a fair point, but I think the operators have done a pretty good job in generally adjusting to managing wage pressures. And one of the ways they do that is -- and we’ve seen this in our portfolio, is the percentage of contract labor that our operators have used has decreased because contract labor costs you at least a third more than your in-house labor. So, we’re also seeing a trend, and you’re going to see this continue, particularly when PDPM comes into place or as it get closer where more and more operators are going to go in-house on therapy are as opposed to having third-party contracts, so they have total control over those costs and they get more of the benefit. That’s going to trend for quite some time. But, we’re seeing that trend continue to happen now and you’ll see that accelerate.

So, for the third-party contract, we have companies, I think it’s going to be tougher for them. It’s not anything that affects Sabra, I think most of the REITs, most of those operating companies that have those that historically driven value, I think that’s going to be an issue going forward. So again, I think we’re pretty close to bottom. I think guys will hang in there. So, things tick down as I think it’ll be a pretty small increment, and that we’ll be able to hang in there until they get the reimbursement increase in October and therapy caps go away.

[Daniel Bernstein, Capital One Securities]

It sounds like that maybe lease coverage could tick down a little bit but if people bring therapy in-house and maybe corporate coverage to get better to. Is that a way -- that’s the way to think about?

[Rick Matros, Chairman and CEO]

Yes, absolutely and when we think about our tenant coverage, really because we have that one -- the issue with the one tenant who was taking over the operations, which we think is a good thing for us going forward. It was really very specific to that issue. Otherwise, you really wouldn’t -- you would have seen extremely stable, sequential coverage on our skilled portfolio.

[Operator]

Thank you. [Operator instructions] And I am showing no further questions from our phone lines. I would now like to turn the conference back over to Rick Matros for any closing remarks.

[Rick Matros, Chairman and CEO]

Thanks everybody for joining us today. I appreciate the time and the support and for good questions. And we’re as always -- we’re available for additional calls with any of you that want to get on the phone with us, and look forward to seeing a bunch of you at REIT Week. Take care.

[Operator]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Everyone. Have a wonderful day.