Earnings Transcript for RHE - Q1 Fiscal Year 2016

Executives: Brett Maas – Hayden Investor Relations Bill McBride – Chairman and Chief Executive Officer Allan Rimland – President and Chief Financial Officer

Analysts: Ephraim Fields – Echo Lake Capital Larry Raiman – LDR Capital Management Joshua Horowitz – Palm Global

Operator: Good day everyone and welcome to the AdCare Health Systems Inc First Quarter 2016 Earnings Call. Today’s conference is being recorded. And at this time, I would like to turn the conference over to Mr. Brett Maas, Hayden IR. Please go ahead.

Brett Maas: Thank you. Joining me on the call today are Bill McBride, AdCare’s Chairman and Chief Executive Officer and Allan Rimland, AdCare’s President and Chief Financial Officer; Clinton Cain, AdCare’s Senior Vice President and Chief Accounting Officer. I would also like to mention this call is being simulcast on the company’s website at www.adcarehealth.com. I’m now going to read the forward-looking statements. Any forward-looking statements made today are based on management’s current expectations, assumptions and beliefs about AdCare’s business and the environment in which the company operates. These statements are subject to risks and uncertainties that could cause AdCare’s actual results to materially differ from those expressed or implied on this call. Listeners should not place undue reliance on forward-looking statements and are encouraged to review AdCare’s SEC filings for a more complete discussion of factors that could impact AdCare’s results. Except as required by Federal Securities Laws, AdCare does not undertake to publicly update or revise any forward-looking statements, where changes arise as a result of new information, future events, changing circumstances or for any other reason. After management concludes their remarks, they will respond to questions. Now, I would like to turn the call over to Chairman and Chief Executive Officer of AdCare, Bill McBride. Bill, please go ahead.

Bill McBride: Thanks, Brett. Good morning and thanks to everyone for joining us today. We’ve continued to identify opportunities to maximize shareholder value and I’m encouraged with the progress we’ve made during the first few months of 2016. As we’ve previously announced, the Board is evaluating strategic alternatives and we’ve hired Stifel as our financial advisor to help us through this process. Simultaneously, we continue to take steps to increase the value of our property portfolio, reduce interest cost and extend maturities to the refinancing of our debt, continue to streamline our corporate infrastructure to lower our operating expenses and to divest non-core assets. We made measureable progress on all fronts since the start of 2016. During the first quarter, we executed a Master Lease Agreement with our new operator Skyline Healthcare. Skyline began operating nine of our facilities located in Arkansas on April 1st. Skyline is a well established, well capitalized operator in the state of Arkansas and other states across the eastern U.S. and it is known for their outstanding nursing staff and high caliber delivery of sub-acute and long-term care. The lease agreement also included a short-term option for Skyline to purchase the facilities for $55 million. Subsequent to quarter-end, Skyline exercised this option and we have recently executed a purchase and sale agreement. The completion of this sale is expected to occur on or before August 2016 subject to certain closing conditions. We will expect to utilize the portion of the proceeds from the sale of approximately $30 million to repay mortgage debt associated with the properties implying net proceeds of approximately $25 million. The Board will consider the use of the net proceeds from the sale in the context of the review of our strategic alternatives. In 2012, prior to the implementation of the strategic plan and prior to the management team being selective, the company subleased three of its lease facilities in Georgia to New Beginnings for approximately no spreads over the lease payment that we repaid. In January, New Beginnings filed a petition to reorganize its finances under the U.S. Federal Bankruptcy Court. To-date the operators neither affirm nor rejected our Master Lease. They continue to pay us partial post-petition rent and we continue to work with them to resolve the issues arising from the bankruptcy filing as well as evaluating potential backup operators. In addition, New Beginnings has informed us that the Jeffersonville facility has been decertified by Medicare and Medicaid and the Oceanside facility has received a similar notification by Medicare and Medicaid. New Beginnings is considering appealing both decertification and the Oceanside decertification is subject to stay by the Bankruptcy Court. We will keep you pried as we make progress toward a final resolution of that matter. We also continue to make progress on reducing our G&A expenses as a significant number of plant headcount reductions were implemented. In the next few quarters, we expect further declines in G&A both on headcount and on compensation expenses. As you may recall from our last earnings conference call, we’ve identified and planned to divest of approximately $1.5 million of non-core real-estate assets primarily office buildings in a parcel of excess lands that are no longer necessary to support our business. To-date, we’ve sold two office buildings and are under contract to sell another office building and a parcel of excess lands. With that, I’ll now turn the call over to Allan Rimland, our President and CFO to elaborate on some of the items that I’ve mentioned and for a review of our financial results.

Allan Rimland : Thank you, Bill and good morning everyone. Before reviewing the first quarter’s financial results, I wanted to review the operational progress by our tenants. In the fourth quarter of 2015, we established a set of operating metrics we used to analyze and report on the performance of our lease, sub-lease portfolio. For the three months ending March 31, 2016, our occupancy rate was approximately 82.8%, the skilled mix was 13% and our rent coverage before and after management fees was 1.4 and 1.0 respectively. I would note that the operating metrics exclude our Arkansas facilities due to the switch in operators and the pending sale of the assets. In three of our Georgia facilities, currently operated by New Beginnings due to the current bankruptcy proceedings. I wanted to also point out that the operating metrics include for the first time our two Oklahoma facilities and now have three months of trailing operator performance with our new tenant Southwest LTC. These facilities slightly negatively affected the overall portfolio’s metrics given the recent operating trends for January 1st. Before turning to financials, I wanted to send it back over to Bill for a few initial comments.

Bill McBride: Yeah, thanks Allan. Just wanted to make a comment here, in regard to our two largest states if you take Arkansas and the mix since it’s under contract for sale, you got Ohio and Georgia. Ohio will be getting a significant Medicaid rate increase on July 01, 2016 as Ohio chosen to finally rebate their Medicaid cost from 2006 and roll that forward. So we expect in our Ohio facility the operator will get in the range of $10 to $15 a day on the building depending on the location of those buildings which equates to about 7% to 8% Medicaid rate increase. This will significantly enhance their cash flow and obviously our coverage ratio of our rent on those properties. In Georgia, which is our largest state actually, we are anticipating a 2.8% Medicaid rate increase effective of July 1st of this year. So we are expecting to see these coverages improve in the months ahead.

Allan Rimland: Thanks, Bill. Let’s turn to the financials. As a reminder, the presentation of our first quarter financial results includes the reclassification of our operating results and facilities that are transferred operations to discontinued operations in both current and prior years’ period. Comparative periods are not indicative of our financial performance given our change in business model. Revenues in the first quarter was $7.1 million. We recognized our revenues in accordance with GAAP which for most leases is on a straight line rent accrual basis. However, due to our switch of Arkansas operators, rental revenues for the first quarter from Aria are recognized based on the cash rent amount owed. Additionally, rental revenues from New Beginnings are recognized based on cash receipts due to the bankruptcy proceedings related to the operators Bill mentioned. To the extend revenues reported on a straight line basis and assuming that the Aria and New Beginnings leases remained in place, reported revenues would be approximately $400,000 higher or an aggregate $7.5 million. In addition, rental escalators in the range of approximately 2.5% are beginning to be effective for many of our tenants given the facilities were transferred earlier last year or so. On an annual basis, cash rents will increase approximately $600,000 again, assuming the Aria and New Beginnings remain in place. General and administrative expenses were $2.5 million for the quarter, inclusive of $480,000 of stock-based compensation and approximately $125,000 related to our Ohio facility management services contract. In addition, in the quarter we had certain non-recurring expenses primarily legal cost related to the Aria, Skyline and New Beginnings matters and higher accounting cost due to our annual audit. We continue to expect additional reductions in G&A under our new operating model in the next few months as personnel cost savings are realized and non-personnel cost reduce as well. Interest expense was $1.8 million in the first quarter of 2016 but does not reflect the benefit of netting approximately $4 million of restricted cash against loan balances which occurred near quarter-end. I’d also note that the interest expense include approximately $200,000 of the amortization of deferred loan cost. Net loss attributable to AdCare’s stockholders for the first quarter was $3.7 million or $0.19 loss per basic and diluted share. Turning to review of our balance sheet, cash and cash equivalents in March 31, totaled $2.3 million compared to $2.7 million at December 31st. Restricted cash and investments in March 31st totaled $8.9 million as compared to $12.7 million at year-end, again reflecting the move of restricted cash that was netted against net balances. Total debt at March 31st was $118.4 million compared to $122.8 million at December 31st including liabilities of disposal group held for sale of $940,000 and $958,000, and net of $2.5 million and $2.7 million of deferred financing costs respectively. I would point out that the presentation of the net of deferred financing costs is a new accounting standard that was implemented earlier this year. For those investors who have reviewed our 10-K filed last night, I wanted to point that out that our debt in particular are short-term debt and does not reflect pending refinances and extensions. Also upon review of the 10-Q, you will see further progress in reducing our operating – capital accounts namely AR, pre-pay, accounts payable and accrued expenses. We expect further reductions in such accounts over the next several months as we continue to wind down the legacy business related issues. We are also pleased to reaffirm our post-transition outlook of $0.25 to $0.30 per share in AFFO. This outlook has been guideline -- in place in affirmation of the New Beginnings lease. From a financial perspective, we are pleased with the continued progress we have made with respect to the balance sheet and G&A reductions and look forward to further improvements on both fronts in the coming months. I will now turn the call back over to Bill.

Bill McBride: Thanks, Allan. We have continued to accomplish a lot in basically transitioning AdCare out of the operations business into a property holding company. We are encouraged by the progress we’ve made. Thanks to our shareholders who supported us in this transition and with that, I will now open it up to any questions. Operator?

Operator: Thank you. [Operator Instructions]. First we’ll hear from Randal Dobler, private investor.

Unidentified Analyst: Hi guys, wondering a question regarding the deferred shares. Any thoughts on [indiscernible] preferred share on the open market, can I get your comments on that?

Allan Rimland: Sure, Randal. This is Allan Rimland. With regards to the preferred, I mean obviously we’re looking at all the different instruments that we have up there, the common the preferred. To some extent we look at cash refundable, so I think we do evaluate – As Bill mentioned earlier, especially with the pending Skyline’s sale and $25 million of essentially net proceeds that the Board will look at in the context of the overall review of strategic alternatives.

Unidentified Analyst: And one other question since you sold the nine properties, how does that affect the preferred shares as far as – I mean I know on a sale of a company, preferred are paid out $25 a share and you’re selling nine facilities which are 35% of your assets. Is there some metric there that use to protect the preferred investors?

Bill McBride: The sale of assets are not from an overall perspective, there’s a required shareholder vote. There will be no direct protection on the context of sale of those assets. Obviously that cash comes back in the company, and is deployed based on where the Board sends it. So there’s no protection from that perspective.

Allan Rimland: But I mean the sale of Arkansas from the preferred perspective, while they don’t get taken out so to speak, there’s not a change in control, there’s not a sale of substantial of all the assets of the company that would sort of trigger some sort of repayment of the preferred, this company will become more de-leveraged. Obviously with the sale of $55 million of assets you pay off $30 million of debt, you are also paying off substantially all of the company’s bank debt at that point. So, what you’re really left with from a debt perspective excluding the convertibles about $10 million but excluding the convertibles what you’re really left with is the company the substantial amount of – remaining is long-term fixed rate non-covenant debt which consists mostly of HUD, FHA, SBA, etcetera. So that’s really primarily what you’ve got left. So I would take the position and I think the preferred shareholders should look at it as the company is de-leveraged and de-leveraged in a way that reduces any significant short-term issues coming up for the company. So it’s a much different balance sheet from a risk perspective if Arkansas sale.

Unidentified Analyst: I just was concerned that you sold off assets one-off eventually there is significantly less assets than when the preferred was issued and as far as collecting the money, there’s no control over exactly what happens with the proceeds that was just the concern.

Allan Rimland: Yeah, I mean except that obviously that you’re going to have $25 million of proceeds from the company. The highest and best use of the proceeds is not rocket science to figure out is to reinvest that in other properties at a similar equity return to what you were earning at Arkansas. If you did that, it would basically put the company back into the same position that it was in before relative to FFO. We’re not saying that we’re going to do that at this point in time, but that’s certainly an option for the company. Since we’re looking at strategic alternatives and with the help of our advisor, we’ll be considering all options for what we decide to do with that. Obviously, certain people that might be looking at the company, might be more interested in the cash, they might be looking at the redeploying the cash in other ways, they may be looking at variety of options. So right now, we’re not going to say exactly what we’re going to do with that until we work our way through strategic options and evaluate that with the Board. But, you would have that cash to invest to provide additional revenues FFO to put the preferred back into the same position that it was in. You could also be in a better position relative to the debt than you are today. So…

Unidentified Analyst: Right. Very good. Thank you.

Operator: [Operator Instructions]. Next we’ll hear from Ephraim Fields, Echo Lake Capital.

Ephraim Fields : Hi guys and congratulations on the continued progress that you guys are making. I just had a question about some of the refinancing I know you guys are working on, I apologize I didn’t get a chance to fully read through the 10-Q but I know you mentioned some of the refinancing you’re working on. So I was just wondering if you just talk briefly about the advantages of those recent refinancing, is it just coming out of this debt or would be also lower cost debt and will be -- restricted cash, how should we be thinking about as far as refinance --?

Allan Rimland: Sure and Ephraim it’s Allan, nice to hear from you. Obviously it’s detailed in the 10-Q that we just finished up couple days ago. There were a number of refinancing with private bank, mostly related to Arkansas facilities. So from a cost perspective, the only thing that we’ve done to those refinancing is netted – in dollars the restricted cash against the balance sheet which appears in the 10-Q. The entire refinancing of the Arkansas portfolio was then put on the backburner so to speak, because we knew that the Arkansas sale is likely to happen. So away from that, we have two extensions of our Sumter in Georgetown facility with private bank, those are both ready to go at a HUD. Georgetown we have the HUD commitment in place and that should close in the next 30 to 45 days and that will reduce interest costs probably about 100 basis points or so. Sumter should be here from HUD in the next 30 days or so with a similar reduction in interest rates. We’ve also extended our Quail Creek facility for another two years at about the same interest rates as well. Most of the big reductions that we’ve secured affirm when the connection with a private bank refinancing of the Arkansas portfolio.

Ephraim Fields: Got it. Thanks very much.

Allan Rimland: And I think as Bill mentioned, post the Arkansas facility our balance sheet becomes a lot cleaner. I would say that the disclosure of AdCare has been fairly long and torturous and you’ll see some fairly streamlined disclosure in terms of debt so your ability to actually forecast debt interest expense balance those maturities becomes a little straightforward.

Bill McBride: Yeah, the other advantage affirm, thanks for the question, is in addition to the interest cost savings which is significant and important in my opinion moving debt from being short-term bank debt with covenant that are tied to operating performance and restricted cash requirements based on performance to long-term fixed rates HUD debt with very little covenant and obviously a fixed lower interest rate puts the company in a more conservative position relative to its balance sheet. So there’s two advantages, the initial and ongoing interest savings but also really just the risk of that debt could ever be called or covenant related tie or maturities etcetera, etcetera. So I think there’s two nice advantages to those refinancing.

Ephraim Fields: Thank you.

Operator: Thank you. Next we’ll hear from Larry Raiman, LDR Capital Management.

Larry Raiman: Thank you. Quick question, you filed a notice regarding the New York Stock Exchange delisting and your requirement to produce a plan by May 18th -- in New York Stock Exchange of actions taken and have to get it done in a year or so. Could you just explain what this pertains to and the action the company is taking to address it?

Allan Rimland: Sure, Larry. This is Allan. I think it’s detailed in our 8-K and obviously is disclosed in 10-Q, we received the letter from the New York Stock Exchange market several weeks ago about being below continued listing standards. And for those interested, one can look through the listing standards but basically we did not meet the book capitalization test that they have. And it’s a scaled test either $2 million, $4 million $6 million of book equity depending upon the historical earnings of the company. There are exceptions related to market cap, assets in revenue that we also fail to meet. So was the mechanical test and there was good dialog with the New York Stock Exchange market has different interpretations thereof and again I think they were specific in terms of the not meeting of that test. We have formulated a plan; we will present it to the New York Stock Exchange probably later today or tomorrow. The plan has a number of different – it’s probably not appropriate to go into those details or so but I think there are various different ways in terms of addressing each of those elements whether it’s book capitalization, market cap revenue and assets or so, but we plan to present that plan. And New York Stock Exchange has already seen the draft plan just a couple minor comments on it. We would expect that the New York Stock Exchange would agree and accept that compliance plan.

Larry Raiman: Okay. Thank you. And I noticed on your website you do provide updated kind of complete presentations, the last one as of this morning was dated in February which gave very nice disclosure. Will you be updating that just because there’s been so many moving parts with regard to some assets being sold, G&A being restructured? Will you provide an update on your run rate of cash flow, debt levels and things like that so we can properly evaluate the securities?

Allan Rimland: Larry, we’ll be likely posting an updated presentation early next week. We do want to get the Q out and reflect the current numbers. Also on our website that you may see that Bill would be participating in an investor conference next week so it will be fresh and new next week for --.

Larry Raiman: Great. Thank you very much.

Operator: Thank you. Next we’ll hear from Joshua Horowitz, Palm Global.

Joshua Horowitz: Hi, thanks for taking my questions and good job on all the progress. I did though have a comment about something that Bill -- with respect to the gentleman’s question about redeploying capital to new projects that create similar equity returns buying back preferred shares and I guess, nothing ground breaking here, but I would say that buying back those shares that are discount to par was an unambiguous game and savings on interest first putting that money into the market into a new project which would obviously involve an element of risk and execution and there’s the difference in your return. So I guess as a preferred shareholder and even if I was a common shareholder of the company I would prefer to see the company retire those shares that are meaningful discount.

Bill McBride: I understand your position what I said was I think the highest percentage return you could get would be redeploying that capital in terms of doing the deals. Now obviously you compare that on a risk adjusted basis to buying preferred and you look at all of those options. So I didn’t say they are equal risk but I said it’s the highest return on the equity invested would be additional deals with leverage. However, that said, there is also some opportunities to invest within our own portfolio. So you can take your existing facilities and really make some expenditures into them to really bring them up to a higher quality standard or allow them to participate in higher contracted revenue sources that could provide some pretty substantial return benefits going back into your existing building. So, there is a number of options you can look at but obviously, looking at buying back preferred at a discount would be an option that the Board would consider.

Joshua Horowitz: Great. Thank you for the color and great job on everything.

Bill McBride: Thanks.

Operator: And thank you. At this time, we have no further questions. I would like to turn the conference back over to management for additional or closing remarks.

Bill McBride: Thanks for everyone joining us today. I did want to make one comment I thought it would come up more in the question areas. But if you look at the metrics that we’re now providing on how our portfolio is performing, and you really go out and you compare that I listen to all the Healthcare REITs conference calls. And you really compare that to how their facilities are performing, what you’ll see in a lot of cases they segregate some of their portfolios to what they call stable and non-stable. The basic definition that a lot of them use is if the operator has changed within 18 months, and you’ve got a new operator, you’ve got new Medicare rates coming in, that they call that unstable. And they segregate those portfolios in terms of performance. And if you look at all of our facilities really would be in that category of not stable, except perhaps New Beginnings, all of our operators have been in these buildings for a short period of time. And if you look at the coverages and the occupancy that you see out there in the portfolio it’s very similar to what all the other REITs have in their portfolio that have undergone an operator change within recent history. So, I would just point that out for those who like to sort of compare our existing portfolio to other REIT portfolios, they are experiencing the same sort of changes and improvements with new operators as we expect to have in ours. So with that, I would like to thank you all for joining us today. Look forward to updating you on our progress during our next call. Thanks again.

Operator: Thank you. That does conclude today’s presentation. Thank you for your participation. You may now disconnect.