Caretrust REIT, Inc. quarterly report, Q2 FY2019

CareTrust REIT, Inc. — Q2 2019 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2019; unaudited. CareTrust is a healthcare-property REIT that primarily leases properties to third-party operators. At quarter-end, it had 213 leased facilities, three company-operated independent living facilities, and additional mortgage and preferred-equity investments.

Financial performance and position

Metric	Q2 2019	Q2 2018	Six months 2019	Six months 2018
Total revenue	$46.2 million	$39.0 million	$85.9 million	$77.1 million
Net income	$19.7 million	$13.3 million	$35.8 million	$27.9 million
Diluted EPS	$0.21	$0.17	$0.39	$0.36
Operating cash flow	—	$61.7 million	$42.1 million

• Q2 revenue increased 19% and net income increased 48%; six-month revenue increased 11% and net income increased 28%. Six-month 2018 results included a $2.1 million real-estate sale gain.
• Calculated net margin was approximately 42.6% in Q2 2019 versus 34.0% in Q2 2018, and 41.6% for the first half versus 36.2%. These comparisons reflect the accounting presentation change described below.
• Q2 rental income rose 27%, primarily from acquisitions and rent increases. Depreciation increased with the expanded property base; G&A rose 37% in Q2, mainly due to higher wages, stock compensation and other corporate costs. Q2 interest expense was unchanged at $7.3 million.
• First-half investing outflow was $297.2 million, principally for acquisitions and loan investments. Financing inflow was $201.3 million, including equity proceeds and net borrowings. Cash declined $34.2 million to $2.6 million.
• At June 30, total debt principal was $545.0 million ($539.1 million carrying value): $300 million of 5.25% notes due 2025, a $200 million term loan due 2026, and $45 million drawn on a $600 million revolving facility. Total assets were $1.532 billion and equity was $958.1 million.
• Quarterly common dividends were $0.225 per share. The filing says management expects available cash, operating cash flows and access to credit and equity markets to fund operations, scheduled debt service and planned dividends for at least 12 months.

Material changes and transactions

• CareTrust acquired 19 properties in the first half—16 skilled nursing facilities and three multi-service campuses—for approximately $291.3 million. The acquisitions represented 2,571 beds/units and are expected to produce initial annual cash rent of $26.2 million, an approximately 9.0% initial blended yield.
• An April public offering of 6.64 million shares generated approximately $149 million net proceeds, used to repay acquisition-related revolver borrowings. The company also raised $47.9 million gross under its prior ATM program in Q1; no shares were sold under its new $300 million ATM program by June 30.
• On January 1, 2019, the company adopted the new lease accounting standard. Certain tenant property-tax recoveries are now excluded when tenants pay third parties directly; amounts paid by CareTrust are presented as rental income. Accordingly, 2018 tenant reimbursements and property-tax expenses do not have directly comparable 2019 line items. The filing reports $0.5 million and $1.3 million of such taxes in Q2 and the first half of 2019, respectively.
• Ensign accounted for 34% of Q2 rental income and 37% of first-half rental income, down from 42% in each 2018 period. Ensign leased 93 facilities; a default under one facility in its master leases can trigger a default across those leases.

Outlook, risks and unusual items

• After quarter-end, CareTrust terminated its master lease with Trillium affiliates covering 18 properties. It was negotiating a new lease for 11 Iowa and Georgia properties; Trillium was to continue operating seven Ohio properties pending transfer to new operators. CareTrust expected a roughly $2.4 million write-off of accounts and straight-line rent receivable in Q3.
• The company was negotiating a sale of three Ohio properties, with a target September 1, 2019 closing, subject to diligence and other contingencies. If completed as anticipated, the properties would be held for sale and incur an estimated $7.1 million impairment. The expected rental-income decline would be partly offset by temporary seller-financing interest income. Three non-binding letters of intent had been received for leasing the other four Ohio properties.
• No specific full-year earnings or acquisition guidance is provided. Management described future investments as dependent on suitable opportunities and financing availability. Dividends remain subject to board discretion, notwithstanding REIT distribution requirements.
• Key risks include tenant ability to pay and operate in compliance with regulation, tenant concentration, acquisition and capital-market access, refinancing and interest-rate exposure, and maintaining REIT status. A 100-basis-point rate increase was estimated to raise first-half interest expense by about $1.2 million; no interest-rate swaps were in place. The filing also notes uncertainty over LIBOR after 2021.
• CareTrust reported compliance with applicable debt covenants at June 30. It reported no material legal proceedings and no material change in previously disclosed risk factors. Disclosure controls were assessed as effective.

Investor verification priorities

• Track the Trillium lease transition, the expected $2.4 million write-off, the proposed Ohio sale and potential $7.1 million impairment, and the status of replacement operators.
• Verify the realized rent, yield and integration of the 19 acquired properties, and how further acquisitions are funded across debt and equity.
• Monitor Ensign’s share of rental income and tenant credit/coverage, including exposure under its cross-default master leases.
• Assess liquidity and leverage alongside the low $2.6 million cash balance, revolving-facility availability, debt maturities, variable-rate exposure and continued dividend funding.
• Interpret reported revenue and expense trends with the 2019 lease-accounting reclassification in mind; the filing does not provide a directly comparable recast of 2018 line items.