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Operator
Good morning, everyone, and welcome to the Diversified Healthcare Trust third quarter 2023 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please send to a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star and then one on your touchtone telephones. To withdraw your questions, you may press star and two Please also note today's event is being recorded. At this time, I'd like to turn the floor over to Melissa McCarthy, Manager of Investor Relations. Ma'am, please go ahead.
Melissa McCarthy
Thank you, and good morning. Welcome to the third quarter 2023 conference call for Diversified Healthcare Trust. Joining me on today's call are Jennifer Francis, President and Chief Executive Officer, and Matt Brown. 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 would 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 DHC's beliefs and expectations as of today, Thursday, November 2, 2023. The 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 FFL, net operating income or NOI, and cash basis net operating income or cash basis NOI. Reconciliations 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.dhcreach.com. Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our filings with the SEC. Investors are cautioned not to place under-reliance upon any forward-looking statements. Now, I'd like to turn the call over to Jennifer.
Jennifer Francis
Thank you, Melissa, and good morning. Welcome to DHC's third quarter conference call. I'd like to begin by welcoming Matt Brown as our new Chief Financial Officer and Treasurer. Matt has extensive experience at the RMR Group, where he is responsible for the company's accounting function, and he previously served as OPI's CFO for the past four years. Matt joined RMR in 2007, and for much of the time prior to becoming OPI's CFO, he was responsible for DHC's financial reporting. I've been working with Matt for years and welcome him to DHC. In early September, we mutually agreed to terminate our merger agreement with OPI. Each company agreed to bear its own costs and expenses in connection with the terminated transaction, and it was agreed that neither party would pay a termination fee. Beginning in late September, we took the following steps to move forward. First, we engaged B. Riley Securities as our financial advisor to help evaluate options to address our near-term capital needs, including upcoming debt maturities. These capital raising options may include asset sales, joint ventures, and permissible financings that can include but are not limited to issuance of preferred equity or zero coupon bonds. This process may lead to and include other options before we're finished. Second, we're in discussions with our bank group to possibly extend the maturity date of our credit facility and to amend certain covenants that would allow DHC additional flexibility to use proceeds from capital-raising initiatives to pay off debt and fund the capital that we've recently deferred, which is an important part of the recovery in our shop communities. Third, in addition to the deferral of certain redevelopment capital, we've initiated a disposition strategy for a number of assets in order to increase liquidity at the company. Our goal is to pay off maturing debt and restart the capital projects we've deferred. The assets that we've selected for disposition come from each of our operating segments and are geographically diverse. Finally, the DH Board of Trustees approved an amendment to our bylaws to reduce the allowed maximum percentage ownership of DHC common stock from 9.8% to 5% in order to preserve cumulative net operating losses, or NOLs. These NOLs are valuable to DHC and can be used to offset any taxable gains on asset sales in our disposition strategy, as well as to offset other gains in the future. It's important to note that this new ownership limitation is applicable on a prospective basis, and any owner of more than 5% of DHC's common shares as of November 1, 2023, is not required to reduce their ownership to meet this requirement. The sequencing and timing of our plan to address near-term debt maturities and return DHC to growth is still to be determined, but we're working diligently to advance this plan on all fronts and look forward to updating the investment community when appropriate. Moving on to our third quarter results, yesterday we reported normalized FFO of $0.03 per share, which is an increase from negative $0.06 per share in the prior year quarter. This improvement was driven largely by growth in our shop segment. The quarter was also highlighted by a 13.2% increase in revenue, a 370 basis point increase in occupancy to 78.4%, and a 7% increase in average monthly rate over the prior year. The overall backdrop in the senior living industry continues to be supportive of a recovery. New supply and construction starts both remained at their lowest levels in years. The overall labor market has become more favorable, and there is evidence of decreasing labor costs across the industry. Evidence of the positive momentum in the labor market can be seen both on an industry level with wage pressures decreasing sequentially from Q2 and within DHC's shop segment with an $11.3 million decrease or 64% reduction in contract labor from the prior year. Generally, shop progress can be attributable to strategic operational improvements, strong industry fundamentals, and our capital investments into our communities. During the quarter, we invested $49 million, bringing year-to-date shop spend to $128 million. However, costs for our shop operators remain elevated due to insurance premium increases acquiring new staff, and seasonal expenses, such as the impact of heat waves across the United States this summer. While the shop recovery remains pressured by higher operating expenses and our deferral of capital, our operators continue to achieve rental rate growth and occupancy gains above the industry benchmark for comparable properties year over year. Moving to our office portfolio, in our same property office portfolio, Rental income increased less than 1%, and cash basis NOI decreased 2.7% compared to the third quarter of last year, which Matt will address shortly. We ended the quarter at 93% occupancy in this portfolio, which is an 80% basis point increase from a year ago. There was strong leasing activity in our office portfolio during the third quarter, as evidenced by 289,000 square feet of new and renewal leases signed. with a 14.8% roll-up in rents and a weighted average lease term of 8.1 years. At the end of the quarter, we had a leasing pipeline of over 670,000 square feet. I'll now turn the call over to Matt to review our financial results.
Melissa
Thanks, Jennifer, and good morning, everyone. Normalized FFO for the third quarter was $8.3 million, or 3 cents per share. an increase of $22.5 million from negative $14 million in the prior year. While we are pleased with this improvement, sequentially normalized FFO declined $3.8 million, mainly driven by a $2 million decline in our shop segment that I'll address shortly, and an increase in interest expense as a result of continued increases in SOFR. Our consolidated same property cash basis NOI was $56.2 million, which is a $22.1 million or 64.6% year-over-year improvement. The changes by segment are as follows. Office same property cash basis NOI was $27.6 million, representing a year-over-year decline of $754,000, mainly driven by increased expenses due to a tenant contraction. On a sequential quarter basis, cash basis NOI declined $1.9 million in line with expectations based on higher cooling costs in the summer months. Job same property cash basis NOI was $21 million, representing a significant year-over-year increase of $22.8 million. On a sequential quarter basis, cash basis NOI declined $2 million, made up of the following. An increase in expenses of $9.8 million, most notably $5.3 million in wages, payroll taxes, and benefits, $2.6 million in insurance premium increases, and $2.3 million from seasonal cooling costs in the summer months. These expense increases were partially offset by an increase in revenue of $7.8 million, driven by a 100 basis point increase in occupancy. Turning to the balance sheet, we ended the quarter with over $279 million in cash and restricted cash. As a reminder, we have $700 million of debt maturing in the first half of 2024 and are not currently in compliance with our debt and currents covenant, which prevents us from issuing any new debt or refinancing existing debt. Our consolidated income available for debt service to annual debt service coverage grew to 1.17 times from 1.08 times last quarter, below the 1.5 times minimum requirement. The annual EBITDA shortfall to achieve compliance is $61 million. As we look forward, we believe we have several viable options available to us to address our near-term capital needs, and as Jennifer outlined, we are pursuing all of these options concurrently. We have a significant pool of unencumbered assets with a gross book value of approximately $5.9 billion available to pursue various strategies. Regarding our credit facility, we have added a property in Hawaii to satisfy the aggregate appraised value of the collateral properties requirement following notice of a non-monetary default in June 2023. we are currently engaging in discussions to possibly extend the maturity date of the credit facility and to amend certain covenants to provide DHC additional flexibility to use proceeds from capital raising initiatives. As we are in ongoing negotiations, we will not provide detail on specific terms, but look forward to disclosing more information when available. As part of our liquidity management and financing strategies, we have begun to defer certain redevelopment capital across our portfolio. As a result, we currently expect aggregate capital expenditures to total $240 to $260 million in 2023 from an initial forecast of approximately $315 million and $200 to $220 million in 2024 from an initial forecast of approximately $330 million. Based on the execution of our financing strategies, the path to covenant compliance will impact the timing of restarting these deferred projects to continue to drive the shop recovery. In closing, we are actively evaluating all strategies to strengthen DHC's balance sheet, regain debt covenant compliance, source additional capital to fund our ongoing shop recovery, and best position the company for long-term growth. We currently expect to regain debt compliance by the end of 2024, and based on the execution of certain financing strategies being contemplated, it could lead to covenant compliance sooner. That concludes our prepared remarks. Operator, please open the line for questions.
Operator
Ladies and gentlemen, at this time, we'll begin that question and answer session. To ask a question, you may press star and then one on your touchtone telephones. If you are using a speakerphone, we ask that you please pick up the handset prior to pressing the keys to ensure the best sound quality. To withdraw your questions, you may press star and two. Once again, that is star and then one to join the question queue. Our first question today comes from Brian Mayor from B. Reilly FBR, please go ahead with your question.
Brian
Thank you, and good morning. A couple for me this morning. Let's start with the covenant compliance. I think you're at 1.17. Our model had you at 1.22 for the quarter, so we're not too far off. I think the prior commentary from management was by mid-year. 2024 and i think matt you just said by year end 2024 barring some changes you know dispositions and what have you um what what's pushing pushing that back again you know we're kind of getting to it in the second quarter of 2024.
Melissa
I think, Brian, it really relates to the growth in our shop segment. You know, we do expect to see that continue to improve. But as you saw in this quarter's results, we did have some negative impact from operating expenses. Some of those are seasonal. However, some of those are going to continue, such as wages and insurance costs. So we think, you know, realistically, you know, by the end of 24, you know, makes sense. However, if the shop growth is in excess of forecast, it could be closer to the middle of the year.
Jennifer Francis
I just want to add to that, Brian, that Matt talked about the deferral of capital in his prepared remarks, and we have deferred capital, and that capital deferral will have an impact on our operators' ability to grow rate and to grow occupancy. I mean, obviously, we are still projecting real growth in the shop segment, but as soon as we can start redeploying that deferred capital, our operators will be able to push results.
Brian
Yeah, and I can understand and agree with deferring some capital That being said, properties where you might have previously done a deep dive in a refresh, you know, instead maybe changing carpet and, you know, putting paint on it, you know, maybe a, you know, capital improvement light, but still something that refreshes the property. Is that something that's being considered?
Jennifer Francis
Without a doubt. I mean, we're still expecting in 24, 200 to 220 million of capital spend. So, We've deferred capital. We haven't suspended capital. So there are still improvements going on, and we will see results from those improvements.
Brian
Okay. Moving on to the bylaws changes, I found that to be interesting, specifically as it relates to the NOLs. Matt, can you share with us what the current NOLs available are?
Melissa
Sure. At DHC, they're currently in excess of $300 million, and for our TRS entity, they're in excess of $100 million, so over $400 million in the aggregate.
Brian
Great. And then we noticed that the other operators within SHOP did a little bit better than our expectations, and the five-star stuff was a little lighter than we had thought. Is there anything going on there, particularly in the other operators, that can further juice the NOI coming out of those properties?
Jennifer Francis
They're just really having positive results, growing occupancy, pushing rate. I think there's still a great deal of opportunity with our other operators and with Alaris to push rate and, you know, continue to push the rate associated with level of care and making sure that residents are at the appropriate level of care. And so, no, they're just, you know, they're for the most part doing a really good job.
Brian
Shifting gears to the asset sales, and I know you probably don't want to get into too much detail on that, but can you give us any more color as to if they're, you know, more along the lines of one-offs or if they're portfolios? I think you talked about your prepared comments across segments and across geographies. Can you give us any more cover, level of magnitude of proceeds, et cetera?
Jennifer Francis
Yeah, so they are, it is across, the properties are across all of our operating segments. It's a pretty challenging time right now to sell assets. We feel pretty positive about the properties that we've picked. We picked the assets that we believe have the most desirable characteristics for buyers. It's really not a market for large portfolio sales, so I think that these dispositions will be in small, you know, bite-sized dispositions, one, two, three assets, maybe some much smaller portfolios, but it's certainly not, you know, one or two or three large portfolios. It's a pretty, you know, like I said, it's a challenging time to sell assets, but because of the quality of these assets, we think that we'll be successful. You know, we're out with, you know, close to a billion in assets that we're engaging brokers with.
Brian
Um, that that's good color. And, you know, we we've come across articles saying that, you know, entities like Bain Capital have an over $2 billion fund, you know, looking to, you know, buy assets in, in your world. And I suspect that, you know, Ventas and Welltower might be interested as well, but I'll leave that up to you guys and your brokers. Last for me on, and I know you didn't really want to go too far down this road on the credit facility. But would you say that the bank group is receptive to your overtures? And if you were to look for an extension, are you kind of thinking six months or a year? Just any broad strokes there would be really helpful.
Melissa
Yeah, Brian, it's tough to provide too much color because we are in ongoing negotiations. Thus far, we've been dealing with the admin agent, and we believe we've reached terms with them. And now it's really engaging in the rest of the bank group, and we need approval from 100%. As it relates to a maturity extension, you know, we'd love to get a year, but it's too early to really definitively say at this point.
Brian
Okay. Thank you very much.
Operator
Thanks, Brian. Once again, if you would like to ask a question, please press star and then 1. To withdraw your questions, you may press star and two. Again, that is star and then one to join the question queue. And ladies and gentlemen, in showing no additional questions, I'd like to turn the floor back over to management for any closing remarks.
Jennifer Francis
Thank you, and thank you all for joining our call today. Operator, that concludes our call.
Operator
And ladies and gentlemen, with that, we'll conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.
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