DIVERSIFIED HEALTHCARE TRUST quarterly report, Q2 FY2017

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Business context and reporting period

The supplied filing is Senior Housing Properties Trust’s unaudited Form 10-Q for the quarter and six months ended June 30, 2017. This differs from the request metadata, which names Diversified Healthcare Trust; the filing itself identifies Senior Housing Properties Trust as the registrant. At quarter-end, it owned 434 properties across 42 states and Washington, D.C., spanning senior living communities, medical office buildings (MOBs) and wellness centers.

Financial performance and position

Amounts below are in millions, except per-share data and percentages.

  • Revenue: Second-quarter revenue was $265.0, up 1.4% year over year; six-month revenue was $529.6, up 1.9%. Q2 rental income was $166.6 and resident fees and services were $98.4.
  • Earnings: Q2 operating income was $64.5 versus $75.4; net income attributable to common shareholders was $16.0 versus $39.2, and diluted EPS was $0.07 versus $0.17. For six months, common-shareholder net income was $48.2 versus $70.5, with EPS of $0.20 versus $0.30.
  • Margins and property results: Q2 operating margin was approximately 24.4% of revenue, compared with 28.9% a year earlier. Consolidated NOI, a non-GAAP measure, was $162.2 versus $163.9 (about 61.2% versus 62.7% of revenue). Managed senior living NOI declined 9.8% in Q2; MOB NOI declined 0.8%.
  • FFO: Q2 FFO was $85.5 ($0.36 per share), down from $111.5 ($0.47); Normalized FFO was $103.6 ($0.44), down from $111.7 ($0.47). Six-month FFO was $190.4 ($0.80) and Normalized FFO $212.0 ($0.89), versus $221.4 ($0.93) and $222.0 ($0.94), respectively. These are non-GAAP measures.
  • Cash flow and distributions: Six-month operating cash flow was $201.6 versus $216.2; investing cash outflow was $72.2 versus $226.5; financing cash outflow was $133.9 versus $1.7. Real estate improvements used $57.1. Cash and cash equivalents were $27.2 at quarter-end; restricted cash was $13.8. The Trust paid $0.39 per share in each of the first two quarters and declared another $0.39 distribution for August 2017.
  • Debt and liquidity: Total liabilities were $3,842.8, down from $4,028.3 at December 31, 2016. Balance-sheet debt and capital lease amounts totaled about $3,522.7, including $434.0 drawn on the $1.0 billion revolver; $566.0 remained available. The Trust reported covenant compliance. In August, it extended the revolver maturity from January 2018 to January 2022 and reduced its pricing; it also reduced the spread on the $200 million term loan.

Material changes and unusual items

  • Revenue rose modestly, but operating income and common-shareholder earnings fell. The Q2 comparison included a $7.4 loss on early debt extinguishment in 2017, while Q2 2016 included a $4.1 property-sale gain.
  • General and administrative expense rose to $22.9 from $12.0 in Q2, primarily reflecting $10.8 of estimated RMR management incentive fees. The six-month incentive-fee estimate was $14.0; actual fees, if any, depend on the full-year return test and were expected to be payable in 2018.
  • The Trust recorded a $5.1 impairment of its Five Star Senior Living share investment, reducing it to $1.50 per share. It also received approximately $255.8 net proceeds from a March joint venture in which a sovereign institutional investor acquired a 45% interest in a Boston MOB; the Trust retained control and consolidated the property.
  • In April–June, it prepaid mortgages with approximately $297.2 aggregate principal, including a $5.4 premium on one repayment. Revolver borrowings increased to fund, among other items, debt repayments and distributions.

Outlook, commentary and risks

Management stated that it believed operating cash flows, cash balances and available borrowing capacity would be sufficient for operating and capital costs, debt service and distributions over the next 12 months and thereafter. No quantified earnings or acquisition guidance was provided. The Trust expected to continue evaluating acquisitions and dispositions; a proposed Minnesota MOB acquisition remained conditional.

  • Senior living occupancy and rent coverage weakened: triple-net senior living occupancy was 84.6% versus 85.4%, with rent coverage of 1.27x versus 1.33x. Managed-community occupancy was also lower year over year, while rates increased modestly.
  • Five Star was the largest tenant and managed the Trust’s senior living communities. Its leased properties represented 27.5% of gross real estate book value, and rental income from Five Star was 19.3% of total revenue. The filing describes risks of tenant financial stress, rent default and operational underperformance.
  • Management cited new senior-living supply and competition, potential weakness in occupancy and rates, labor and operating-cost pressures, and uncertainty around Medicare/Medicaid policy and healthcare regulation. Although approximately 97% of NOI came from properties where most revenues were from private resources, reimbursement and policy changes could still affect tenants and operators.
  • Floating-rate exposure was material: the filing estimated that a 100-basis-point increase would raise annual floating-rate interest expense by about $9.8 million at then-current borrowings. Related-party relationships with RMR, Five Star and other affiliates, and the resulting conflicts-of-interest risks, are also disclosed.
  • The Trust reported effective disclosure controls and no material change in internal control over financial reporting; it described enhancements to electronic-payment verification controls. It reported no material change to previously disclosed risk factors.

Investor verification priorities

  1. Confirm the registrant/entity intended: the filing is for Senior Housing Properties Trust, not Diversified Healthcare Trust.
  2. Assess Five Star’s ability to pay rent and operate communities, including occupancy, rent coverage, receivables and the concentration of revenue and property value.
  3. Reconcile reported FFO and Normalized FFO to GAAP results, especially the treatment of incentive fees, impairment and debt-extinguishment losses.
  4. Review debt maturities, refinancing access, floating-rate exposure, covenant headroom and the post-quarter credit-agreement amendments.
  5. Evaluate whether cash generation supports distributions and planned capital spending, and verify the status and funding of announced acquisitions.
  6. Review senior-living operating trends, competitive supply, regulatory/reimbursement developments and related-party management arrangements.