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Edited Transcript of CTRE earnings conference call or presentation 14-Feb-19 6:00pm GMT

Q4 2018 CareTrust REIT Inc Earnings Call

Mission Viejo Feb 19, 2019 (Thomson StreetEvents) -- Edited Transcript of CareTrust REIT Inc earnings conference call or presentation Thursday, February 14, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David M. Sedgwick

CareTrust REIT, Inc. - COO

* Gregory K. Stapley

CareTrust REIT, Inc. - Chairman, President & CEO

* Lauren Beale

CareTrust REIT, Inc. - Controller

* Mark D. Lamb

CareTrust REIT, Inc. - CIO

* William M. Wagner

CareTrust REIT, Inc. - CFO, Treasurer & Secretary

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Conference Call Participants

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* Chad Christopher Vanacore

Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst

* Daniel Marc Bernstein

Capital One Securities, Inc., Research Division - Research Analyst

* John P. Kim

BMO Capital Markets Equity Research - Senior Real Estate Analyst

* Jonathan Hughes

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Jordan Sadler

KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst

* Michael Albert Carroll

RBC Capital Markets, LLC, Research Division - Analyst

* Todd Jakobsen Stender

Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to CareTrust REIT Fourth Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference may be recorded.

I would now like to turn the conference over to your host, Ms. Lauren Beale, CareTrust Controller. Ma'am, you may begin.

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Lauren Beale, CareTrust REIT, Inc. - Controller [2]

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Thank you. Welcome to CareTrust REIT's Q4 and Fiscal Year 2018 Earnings Call. Please note that this call is being recorded.

Before we begin, please be advised that any forward-looking statements made on today's call are based on management's current expectations, assumptions and beliefs about CareTrust's business and the environment in which it operates. These statements may include projections regarding future financial performance, dividends, acquisitions, investments, returns, financings and other matters, all of which are subject to risks and uncertainties that could cause actual results to materially differ from those expressed or implied herein. Listeners should not place undue reliance on forward-looking statements and are encouraged to review CareTrust's SEC filings for a more complete discussion of factors that could impact results as well as any financial or other statistical information required by SEC Regulation G.

During the call, the company will reference non-GAAP metrics, such as EBITDA, FFO and FAD, and normalized EBITDA, FFO and FAD. When viewed together with its GAAP results, the company believes these measures can provide a more complete understanding of its business, but cautions that they should not be relied upon to the exclusion of GAAP reports. Except as required by law, CareTrust REIT and its affiliates do not undertake to publicly update or revise any forward-looking statements or changes arise as a result of new information, future events, changing circumstances or for any other reasons. Listeners are also advised that CareTrust yesterday filed its Form 10-K, an accompanying press release and its quarterly financial supplement, each of which can be accessed on the Investor Relations section of CareTrust's website at www.caretrustreit.com. A replay of this call will also be available on the website for a limited period. Management on the call this morning include Bill Wagner, Chief Financial Officer; Dave Sedgwick, Chief Operating Officer; Mark Lamb, Chief Investment Officer; and Eric Gillis, Director of Asset Management.

I will now turn the call over to Greg Stapley, CareTrust REIT's Chairman and CEO.

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [3]

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Thanks, Lauren. Good morning, and welcome everybody. 2018 started as a somewhat difficult year for us here at CareTrust, but we're pleased to be reporting that we finished the year with FFO per share of $1.28, which was in line with both consensus and our guidance and a net debt-to-EBITDA at year-end at an all-time low of 3.3x. It was actually really a little bit better than that. Had we left our aftermarket program in the barn during the second half and avoided the dilution we took, we still could have posted a net debt-to-EBITDA well below the low end of our target range of 4 to 5x. However, as the year wore on, we saw on the horizon both clouds and opportunity, which are frequently, as you know, the same thing. And so with imminent deals in the pipe and a constructive view for 2019, we deemed it prudent to reduce debt and increase liquidity. As most of you know, our fundraising philosophy, whether off the ATM or through secondaries, is to do our best to match lender equity raises as closely as possible to our capital deployments. Using the ATM allows us to raise equity capital at a fraction of the cost that a secondary would carry and we can turn it off and on based on our sense of the market and our view of our pipeline at any time. Q4 demand, in particular for our equity, was robust and through the quarter and since we've raised $98 million off the ATM. This matched nicely in amount, although not perfectly in timing, with the $100 million in new investments we've made since October 1. Although these last couple of announced deals closed later than expected and were thus unable to contribute to 2018 earnings, we believe that the accretion they represent going forward was well worth the short-term deceleration in our FFO per share growth. So we're happy with where we've been and even more excited about where we're going. We've closed on $53 million in new assets already in 2019 and as the 8-K we filed at the end of January illustrates, we stand on the cusp of another new growth opportunity, which, if we can get it successfully closed, would surpass in size anything we've done to date. And after those investments, we'll still have plenty of dry powder. We've just expanded and extended our revolving credit facility, moved maturity on another $200 million of our debt out to 7 years and we're still seeing substantial interest in our equity. We have $22 million of cash on hand, and our conservative payout ratio will give us another $30 million to $40 million in retained cash that we can redeploy in the remainder of this year. This matters immensely as we contemplate a real estate cycle, which, by some accounts, and we're not taking a side or making any predictions here, but some might say it might be getting just a little bit long in the tooth. So we're ready for whatever opportunities may arise and we plan to carefully manage our assets and the balance sheet to remain ready as the cycle plays out over the next couple of years.

With that, I'd like to turn some time over to the team to fill you in on the details. Dave will talk a little bit about our current assets and operators, then Mark will discuss recent acquisitions and opportunities. Then Bill will wrap up the financials. Dave?

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David M. Sedgwick, CareTrust REIT, Inc. - COO [4]

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Thanks, Craig, and good morning. Now our strategy has never been to grow for growth's sake and 2018 was the year where the value of that discipline was proven. As Greg mentioned, there were plenty of opportunities to overpay. Instead, we held our ground and used the lull to position ourselves for better acquisitions in the future, and they have begun to come but I'll let Mark talk about that pipeline in a minute. As usual, let me update you on changes in the portfolio, starting with our newest new operator. Tennessee-based Providence Health Group joined us in Q4 through a single-asset acquisition in West Virginia. Providence is owned and led by respected skilled-nursing veteran Doug Cox. Doug has assembled a great team of operational, financial and clinical talent to operate 10 facilities in the middle of the country. The first couple of months in our new asset have been traffic and we're now looking to add facilities to their master lease. In other parts of the portfolio, we've seen our operators make some tremendous strides, particularly in some of the -- we'll call them pre-stabilized assets we acquired in late 2017. I'll give you a couple of examples. Cascadia Healthcare, based in Idaho, took over several Kindred and Orianna buildings. Adding those facilities immediately took their master lease coverage down to levels that in any other setting would be uncomfortable for both landlord and tenant. However, turning around non-stabilized facilities is something they know well and for which they have a proven track record, and it's something we're intimately familiar with as well as formal turnaround operators ourselves. So we didn't panic when we saw the expected dip in coverage, which often happens during the first 6 to 18 months of the turnaround or repositioning, depending on the size and complexity of the job. We're really impressed with the solid work that Cascadia has done. If you ask them, they'll say they still have a lot left to accomplish. But their overall trailing 3 annualized coverage today is back up to about 1.8x. Another example is Texas- and Louisiana-based PMG. They had a similar experience as they tackled the 3 Texas Kindred facilities we acquired for them in Q4 of 2017. Regrettably, the first several months produced choppy results as they absorbed the new acquisitions and incorporated their operating model into them. We're also carrying out significant CapEx projects in all 3. Part of our deal with them included us funding the CapEx for a strategic repositioning of these assets, which impacted operations as well. So they've had their fair share of headwinds as they worked to stabilize the buildings. Nevertheless, looking at the trailing 4 annualized numbers as of November, new lease coverage in those buildings is now approaching 3x, and they're still not quite done with the last remodel. Just a sampling of what great operators can do with good pre-stabilized opportunities. We're pleased to be associated with these 2 great operators and several others, both in our portfolio and waiting in the wings. So we're staying firmly focused on our operator-first model, and we're continuing to look for more and better ways to evaluate, monitor, educate and support our tenants and their operations. As I previewed on the last earnings calls, effective January 1, we've added the qualitative data from PointRight to our operator scorecards. This qualitative facility and market data is further strengthening our underwriting and asset management processes. Perhaps more importantly, our contracted PointRight allows us to give their data to our smaller tenants who would otherwise be unable to afford it themselves, so they can use it to make smarter and more timely management decisions, improve operations and enhance their ability to compete in the narrowing network environment. Finally, looking at the broader skilled-nursing industry, the landscape remains stable with no major changes from last quarter, our operating experience, our operators in a stable reimbursement environment and the coming new PDPM reimbursement model combined to inform our positive outlook on the sector, even during this low -- before the long-rumored demographic surge starts to make an impact.

And with that, I'll hand it over to Mark to talk about the pipeline. Mark?

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Mark D. Lamb, CareTrust REIT, Inc. - CIO [5]

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Thanks, Dave, and hello, everyone. In Q4, we closed approximately $31 million in investments, acquiring 3 skilled-nursing facilities. In the process, we added, as Dave mentioned, a great new tenant in Providence Health Group and tacked on a facility a piece to our existing master leases with Metron and Eduro. We also invested $4.4 million in revenue-enhancing CapEx into the portfolio. These acquisitions brought our total investments for 2018 to $116.4 million. Just a note about underwriting. Although $116 million is a pretty light year by our standards, we're not unhappy with the result, since it reflects the discipline that we believe is critical for our long-term health and success. It can be hard to pass on deals when they could be had just by lowering our underwriting standards a little or by focusing more on our brokers' rosy pro forma than an asset's actual performance. But we learned long ago that getting pricing right, although it's not a guarantee of success, improves the chances of succeeding immeasurably, while overpaying is rarely anything but a prelude to pain. So we stuck to our guns and we are now poised for a hopefully outstanding 2019. And those hopes are starting to be realized. As we might correct -- as you might correctly imagine, we spent much of the third and fourth quarters moving the ball on the recently announced Q1 transactions and beyond.

In January, we purchased Oakview Heights in Illinois for $9 million as a tack on for our existing tenant WLC Management. And earlier this week, we closed on a 4-building sale lease back with another existing tenant, Covenant Care, for just under $44 million. This transaction allowed us to consolidate and eliminate 3 separate short-term standalone leases that we had ticked up in a prior deal and rolled them, and the new assets together into a single unified long-term master lease with Covenant Care. Lastly, as Greg mentioned, we recently 8-K-ed a definitive agreement to purchase 12 facilities in the Southeast for $211 million, which we currently anticipate will close in Q2, if we are successful in obtaining the several remaining approvals and transition agreements.

Moving to our pipeline. It sits today in the $275 million to $300 million range and is almost exclusively made up of skilled-nursing assets and includes projected tack-ons with existing operators as well as deals that we can pair with new operators. Please remember that when we quote our pipe, we only quote deals that we are actively pursuing, which meet the yield coverage and underwriting standards we have in place from time to time, and then only if we have a reasonable level of confidence we can lock them up and close them.

And now I'll turn it over to Bill to discuss the financials.

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William M. Wagner, CareTrust REIT, Inc. - CFO, Treasurer & Secretary [6]

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Thanks, Mark. For the quarter, we are pleased to report that normalized FFO grew by 14% over the prior year quarter to $27.1 million, normalized FAD also grew by 14% to $27.9 million. Normalized FFO per share grew by 3% over the prior year quarter to $0.32 and normalized FAD per share also grew by 3% to $0.33. Given our most recent dividend of $0.205 per share, this equates to a payout ratio of 64% on FFO and 62% on FAD, which again represents one of the best covered dividends in the health care REIT sector. We have continued to strengthen our leverage and liquidity positions. To that, for the quarter and through today, we have issued 5 million shares at an average price of $19.73, resulting in $96.7 million of net proceeds. For 2018 and year-to-date through today, we issued 12.7 million shares resulting in $227.3 million of net proceeds. We also just closed on a new $600 million revolver and a $200 million 7-year term loan, reducing our borrowing costs again and pushing our earliest debt maturities out to 2024. Proceeds from the term loan, we paid off the entire revolver. We also have $22 million cash on hand as of today. Today, we have just $5.8 million authorization left on the ATM, so we plan to put up a new one shortly. As Greg noted, we intend to use it to match fund smaller deals when we can and for larger deals we can still raise equity via overnights. But we intend to do so judiciously as long as health and intelligent growth of CareTrust has been paramount in our decision making and we intend to keep it that way.

For guidance, in yesterday's press release, we initiated our 2019 annual guidance range projecting normalized FFO per share of $1.30 to $1.32 and normalized FAD per share of $1.35 to $1.37. This guidance includes all investments made to date, the recently completed credit facility amendment, our diluted weighted average share count of 88.6 million shares and also relies on the following assumptions: one, no additional investments or dispositions nor any further debt or equity issuances this year; two, inflation-based rent escalations, which account for almost all of our escalators at an average of 2%. Our total revenues for the year, again, including only acquisitions made to date are projected at approximately $153 million, which includes approximately $1.8 million of straight-line rent; three, our 3 independent living facilities are projected to do about $500,000 in NOI this year; four, interest income of approximately $2 million; five, interest expense of approximately $26 million. In our calculations, we have assumed a LIBOR rate of 2.5%, that plus the newly reduced grid-based LIBOR margin rates of 125 bps on the revolver and 150 bps on the 7-year term loan, make up the floating rates on our revolver and term loan. Interest expense also includes roughly $2.1 million of amortization of deferred financing fees; and six, we are projecting G&A of approximately $12.8 million to $14.2 million. Our G&A projection also includes roughly $4.4 million of amortization of stock comp. As for our credit stacks. Calculated on a run-rate basis as of today, our net debt-to-EBITDA is approximately 3.3x, leverage is about 20% of enterprise value and our fixed charge coverage ratio is approximately 6x. We also have $22 million of cash on hand.

And with that, I'll turn it back to Greg.

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [7]

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Thanks, Bill. We hope this discussion has been helpful. We thank all of you again for your continued support. And with that, we'd be happy to open it up for questions. Valerie?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Jordan Sadler of KeyBanc Capital.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [2]

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First question is regarding the 8-K and the commentary, Mark, you offered regarding the portfolio that you guys are under contract on, that $211 million. Is there any incremental information you could share at this point regarding that portfolio surrounding markets or coverage? That'd be helpful.

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [3]

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Yes, this is Greg, Jordan. Honestly, we've tried very much to sort of downplay that transaction. We had to file the 8-K because the SEC regulations required an 8-K to be filed when a definitive material agreement is entered into, even if that agreement contains multiple contingencies and diligence and other hurdles left to clear. So we are not out of the woods on that yet. We don't -- we do have a number of things that has to be done yet. There are multiple parties involved. We really don't have their permission to talk very much about it. And we will give you more information as hurdles are cleared, and a hope for closing draws nearer.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [4]

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Okay. Are there any milestone dates or events that we should look for? Or...

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [5]

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Yes, there is a number of things that have to be done but the situation is a little bit fluid. Yes, there are some approvals that have to be obtained. And I'm not sure that we know exactly what dates those approvals have to be obtained by. We do know that there are some regulatory filings that have to be made here this week, and those are being made. So right now I would tell you that it's so far so good. But we're not counting our chickens before they're hatched.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [6]

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Okay. Would you say if this is in an existing -- these assets are in existing market or not?

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [7]

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Some are and some aren't.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [8]

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Okay. And then are they also included in that pipeline of $275 million to $300 million?

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [9]

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Yes, they are.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [10]

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Okay. And then may be for you, Bill. In the guide, I might have missed this, what's the escalator embedded in the guide for the year?

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William M. Wagner, CareTrust REIT, Inc. - CFO, Treasurer & Secretary [11]

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2%.

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Operator [12]

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Our next question comes from Jonathan Hughes of Raymond James.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [13]

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In earlier commentary, on the $43 million Covenant deal announced earlier this week, that was a sale leaseback, which is not your typical strategy, turnaround strategy. I realize that was an existing relationship. But do you see more opportunities for those kind of traditional sale leasebacks with your existing operators for properties they operate that you don't already own.

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Mark D. Lamb, CareTrust REIT, Inc. - CIO [14]

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You know there are a few operators that own some real estate. But I think for the most part, those opportunities are few and far between. As you know, most of our -- or a good chunk of our operators have -- we've given them their start and have kind of launched them. And then there are some, kind of, call it, more mature operators that have some existing buildings, and those existing buildings are a combination of owned and leased assets. So I wouldn't say this would be the norm for us.

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [15]

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Yes, Jonathan. Between -- for Covenant Care in particular, between the 4 assets we acquired and the 5 assets that we took the mortgage on, that represents the last of their own real estate for them.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [16]

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Okay. All right, fair enough. And then maybe one for Dave. I was hoping you could talk about Texas, where you drive about 20% of rents. Can you just talk about skilled nursing fundamentals for the portfolio there, maybe occupancy or coverage? And how your portfolio is performing in what's been characterized as a challenging market by some of the other skilled nursing operators there?

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Mark D. Lamb, CareTrust REIT, Inc. - CIO [17]

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Jonathan, it's actually Mark, so since I cover Texas, I can probably take this. So as you know, our 2 operators in Texas are Ensign and PMG. Dave's comments with respect to PMG were the 3 Kindred assets that we took over, they continue to do well in those assets. And there's 4 other buildings that we acquired back in 2016 with them that they continue to do well. And so I think it's safe to say that our portfolio in Texas is performing well, but I don't necessarily have coverage metrics at my fingertips. But that state, the Medicaid rate, it’s no secret, is not great. I think it's second to last in -- of all the states in terms of Medicaid rate. But from a fundamental perspective, development come way down. You don't see buildings popping out of the ground, like you did, say, 3 or 4 years ago. And then there are obviously some troubled operators that are currently going through some things in the state. And the good flexible operators that we target, the Ensigns, the PMGs of the world, have been able to kind of manage the roadblocks. And we think is the bed tax going to pass? Possibly. [Quit 3] is getting hopefully another $200 million in funding. So we still feel very good about Texas and certainly about the operating metrics of the tenants there that we have.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [18]

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Okay. That's [fair enough]. So of the 35 or so properties you have in Texas are what 20, 25 or so are Ensign?

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Mark D. Lamb, CareTrust REIT, Inc. - CIO [19]

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Probably 28, because 7 are PMG, right?

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [20]

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Yes, okay. All right. And then just one more, and maybe this one's for Dave. But -- and I know it might be a tough one to answer, but it's about PDPM. It's supposed to be budget neutral, most projections for operators, at least the projections I've seen are, I guess, positive or breakeven, is there a chance that revenues would ultimately, actually fall short? I'm just trying to understand the downside to PDPM since most only talk about that upside opportunity.

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David M. Sedgwick, CareTrust REIT, Inc. - COO [21]

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No. This is Dave. It's a really good question. I'll give you -- and it's tough to comment on the entire industry. But I'll give you a little anecdote. We were -- Eric and I were meeting with one of our Midwest operators a couple of weeks ago. And as we were drilling down deep into their operations, we did talk about PDPM. They use the largest electronic medical-record system in the states right now, I believe, and that's PointClickCare. And PCC has done -- is doing analysis and doing projections for all of their customers. For our operators that we were with, they showed a significant increase to their revenue, which is great because that's -- most of that is going to just drop to the bottom line and not even factoring in any efficiencies that they're going to get by having the flexibility around their therapy cost. And I asked the same question that you're asking, which is, "I bet they say that to all the girls." And his response was, actually, it's about 50-50. And when they talk to PCC about that, PCC said that, this is a fun call that we're having with you, but they don't all sound like this, because some people are in a situation where they have to make some serious changes or they're going to be in a tough spot. So I think that's good news because if everybody, of course, does much better, then you might see a situation like we saw in 2011 with RUG-IV where they reversed course really quickly. But as we can view the future, it looks like there are going to be winners and losers here. And even for those who may not be winners on the top line, they will have the flexibility with this -- with how they staff therapy to do better.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [22]

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That's great. And then no operators in your stable -- and that latter camp where it might be concerning?

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David M. Sedgwick, CareTrust REIT, Inc. - COO [23]

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Nothing we are aware of. We haven't done that deep dive with everybody on PDPM. But the operators that we have talked to are positive about it.

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [24]

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Yes, Jonathan, it's Greg. I would just add one thing, as Dave mentioned, is that we're still talking to operators about that. Something new that we're doing in the next month, we're holding an operator conference here in Southern California for all of our skilled nursing operators to come in, and PDPM will be front and center on the agenda for discussion there. So by this time, 30 days from now or so, we should have all those answers in the bag.

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Operator [25]

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Our next question comes from Chad Vanacore of Stifel.

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Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [26]

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So historically your targeted leverage has been in that 4 to 5x, but you're currently sitting underlevered around 3.3x. Should we think about your remaining on the lower end of that historical range through 2019 or popping back up to the middle of the range through acquisitions?

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William M. Wagner, CareTrust REIT, Inc. - CFO, Treasurer & Secretary [27]

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Chad, it's Bill. All that will depend on investment flow and where our equity is trading as we continue down 2019. But I think if -- for modeling purposes, if you keep it towards the lower end of the range, that's probably a good safe bet, given where we're trading at today.

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Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [28]

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All right. So now thinking about your pipeline, that sits strong, close to $300 million. Is that largely SNF? And then we had, had discussions about the transaction market maybe in 2018 not looking as attractive to you. What's making 2019 look more attractive?

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Mark D. Lamb, CareTrust REIT, Inc. - CIO [29]

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So the answer to the first question, this is Mark, is yes, it's predominantly SNFs. In terms of 2019, I don't know that I have a specific answer. As I look at the pipeline, I think it's made up of current assets that are just not strategic to specific operators, and so they want to go ahead and get rid of those assets whether they're not geographically kind of in the footprint or for whatever reason they just don't make sense for that specific operator anymore. And then there are just other assets where you have the operator just wants to exit, and -- for whatever reason. So I don't know that we are seeing a particular pattern so far in 2019, I can tell you we've seen an uptick in total transactions from, call it, late in the year. We're seeing a lot of deal flow. We're seeing probably a little more on the assisted living and senior housing side than the skilled nursing space right now. You know that NIC is next week. So I would anticipate a lot -- the brokerage community holding deals back to be able to preview those at the one-on-ones next week. So I don't know that there is a specific pattern so far to 2019 as to why deal flow has picked up. But we are seeing it in the numbers.

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Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [30]

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So Mark, you mentioned maybe seeing some exiting operators. Is anyone coming here and saying, hey, PDPM's coming up later in the year, we have to make some investment to take advantage of that. Maybe we don't particularly want to make that investment. So let's punt this out to another operator?

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Mark D. Lamb, CareTrust REIT, Inc. - CIO [31]

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No, I think there -- we're seeing mom-and-pops that are still looking to sell. Nobody has specifically said, hey, PDPM is coming and we just want to monetize. I think the brokerage community has done a very good job of letting those mom-and-pops know what the investment is going to need to be in PDPM to be successful. So I'm sure that has some bearing. But I don't think we've seen mom-and-pops that are saying, hey, we're heading for the hills. We don't want to go through another change. I'm sure maybe there is a small fraction of thinking about PDPM and the changes, helps them to get off the sideline. But at the end of the day, you just -- you have mom-and-pops that are looking at relatively low cap rates and can monetize their assets today in certain stage for good numbers on a price-per-bed basis.

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Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [32]

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All right. Just one more question for me. Feel it is probably better answered by Greg. What kind of considerations have you given in increasing the dividend just given your pretty low payout ratio? And then how do you measure that versus bring investment or -- into acquisitions?

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [33]

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Sure. If you look back historically at our dividend pattern, every year, we have raised that dividend. And we have -- and it typically gets raised in the first quarter of the year. So I would anticipate a dividend increase coming by the next quarter. But we've always looked to keep that dividend at the low end of the peer group in terms of a payout ratio. And our investors have been very, very supportive of our philosophy of ploughing as much of that back into the company by way of returning earnings as we can each year, and it's served us well.

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William M. Wagner, CareTrust REIT, Inc. - CFO, Treasurer & Secretary [34]

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Chad, when you think about the dividend growth, we first -- they are taxable income. So as our GAAP income increases every year with investments, we have to raise the dividend just to clear the taxable income.

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Operator [35]

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Our next question comes from Michael Carroll of RBC Capital Markets.

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Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [36]

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Greg, with that portfolio deal that you announced, what is the bigger stumbling block that you have to get through? Is it that you have to complete your due diligence? Or do you have to wait for the seller to officially take control of this facility?

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [37]

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Diligence is largely completed. We actually got some good news on that just this morning. And -- but there is lots and lots of decision makers involved in various steps of the process, and it's a little like herding cats, and we don't have the whip on this one. So we are doing our best to keep up with it and to see that it gets down to its intended and logical conclusion. But it is not a simple transaction by any means. Any time you get that many parties in a deal, the difficulty of getting it done goes up exponentially and that's just where we're at. But we're used to complex deals. We closed some deals that were similar, probably not as difficult but similar in terms of their size, number of parties and complexity at the end of 2017 and we're cautiously optimistic that we can do it again.

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Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [38]

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Okay. And I know these are pretty good assets in good markets. But would you consider this a transition portfolio, since you're switching out the operators. Or how difficult will that be?

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [39]

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I would say that part of the portfolio is -- a small part of the portfolio is transitioned, but a large part of it, it's pretty stable. There's still some upside in all of it. But we feel very, very good about the assets and what we're paying for them. And we feel very good about the operators we're bringing into run them.

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Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [40]

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Okay. Great. And then, Mark, related to valuations. How have you seen cap rates for the product overall? Have you seen them ticking a little bit lower, given the more attractive market and maybe PDPM coming in towards the end of the year?

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Mark D. Lamb, CareTrust REIT, Inc. - CIO [41]

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No, I don't think so. I think you still have markets in states like California, Virginia, Maryland on a, call it, a price-for-better or even on a cap rate basis are still where they were 2 or 3 years ago, so very -- attractive states are maintaining. I think maybe, call it, some of the secondary states where you have more barriers to entry. Most of those states or most of the deals that we're seeing in those states are maybe not cash flowing and are trading at a price per bed. So it's -- I think, in general, maybe the notion is that cap rates are moving up. I would say that's probably the case in some of the secondary and tertiary markets in states. But in the primary markets, good cash flowing skilled-nursing assets are still trading at historical norms over the last -- what we've seen in the last 2 or 3 years.

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Operator [42]

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Our next question comes from John Kim of BMO Capital Markets.

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John P. Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [43]

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On the $211 million portfolio acquisition. How did you come up with the 12 assets? Were they -- did you cherry-pick them from a larger portfolio? Or were these the assets the seller marketed for sale specifically?

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [44]

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Yes, John, it's Greg. And I'll let Mark weigh in on this too, but for lack of a better term, we did cherry-pick it to a certain degree. It doesn't mean every asset is a high flyer or perfect, like I just said, there is still some upside left across the portfolio. But the good news is that the operators we're bringing in to run these are all experienced operators who are in those markets, who know those markets extremely well and who see the remaining upside in what are arguably stabilized or pretty close to stabilized assets. And we're pretty optimistic about the future of that investment.

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John P. Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [45]

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You mentioned one of them -- at least one of the new operators will be in existing relationship. Is that -- can we assume that either Ensign or PMG who are -- are in the market with you?

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [46]

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Yes. We're not ready to discuss that yet.

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John P. Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [47]

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Okay. And then the 12 separate special-purpose entities. I'm just curious, is that typical for a portfolio acquisition, the way that you structured the acquisition?

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Mark D. Lamb, CareTrust REIT, Inc. - CIO [48]

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Yes, John, this is Mark. It's really just a function of this structure. It's -- we're purchasing the membership interest in the entities from the buyer. I mean, this is -- it's not uncommon. It's historically, we've done this maybe once or twice. So -- but it's just a function of this transaction.

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John P. Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [49]

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Okay. And then I'm not sure if I missed this earlier, but on your acquisition pipeline or just opportunities that you're looking at, can you just discuss what you're seeing in senior housing?

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Mark D. Lamb, CareTrust REIT, Inc. - CIO [50]

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Yes, senior housing is really kind of a mixed bag. I mean, there's everything from, call it, non-stabilized, barely cash flowing primary, secondary, tertiary markets to stabilized. So we're certainly tracking and underwriting these types of deals. But it's -- senior housing right now seems to be a mixed bag. Now granted -- we're not seeing everything and we're probably seeing mainly kind of tertiary and secondary markets, which we've historically acquired in. But it's really a mixed bag and there is a decent amount of deal flow on the market for those property types in those markets.

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John P. Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [51]

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Is there a preference that you have in senior housing as far as value add or higher growth versus something a little bit more stable?

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Mark D. Lamb, CareTrust REIT, Inc. - CIO [52]

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Yes, I think our preference is stable and cash flowing. Maybe if you can do some value add by way of investing some CapEx in, but as you know, turning to senior housing asset is a lot different than turning to SNF asset. You can turn a SNF asset possibly in 3 to 6 months. Turning to senior housing asset can take years. And that's not really a space that we want to play in. And we're a lot more comfortable seeing a skilled nursing facility that has some immediate upside via changes in the cost structure. We'll take a little bit of risk on -- from that perspective. But on the senior housing side, it's a long, tough slog to fully get a building nursed back to health. And so that, I would say stabilized, call it, more core would be our preference.

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Operator [53]

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Our next question comes from Todd Stender of Wells Fargo.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [54]

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Can you hear me, okay?

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [55]

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We can, Todd.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [56]

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Great. Just looking at the Covenant Care transactions, where are the new properties in California, I guess, in relation to the existing ones? And then what coverage were they underwritten at? And what were the existing ones covering at?

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Mark D. Lamb, CareTrust REIT, Inc. - CIO [57]

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So the property locations are, 1 in Northern California and 3 in Southern California. When you blend the entire portfolio of all 8 buildings, I believe the coverage, including what we call [QASP], is up in the 1.4 to 1.5x range. I don't have it in front of me, we can circle back after the call. But well covering assets on a completely blended basis with the 1 master lease. So across the 8 assets, it's doing well.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [58]

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And the new ones were -- this is a sale leaseback. So Covenant Care was selling assets, is that correct?

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Mark D. Lamb, CareTrust REIT, Inc. - CIO [59]

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That's right.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [60]

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Okay. And then my -- part two of the question is, looks like the mortgage you provided Covenant Care is securing a couple -- a few assets in Illinois. Can you provide the terms on this? Where I eventually want to go with the question is that, as they potentially monetize more assets, is this going to be just your standard-issue, short-term mortgage? Or could this convert to fee, simple interest as they look at tax-advantage methods to unload more real estate?

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [61]

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Yes, Todd, this is Greg. That piece of the transaction was a little unusual for us. They were trying to sort out their capital stack. It made sense for us to give them a small mortgage on 5 assets at a 9% rate in a very short term. We don't anticipate these assets converting to our ownership, nor frankly do we anticipate those assets staying with Covenant Care for a very long time.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [62]

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Okay. So they could come to market and at that point maybe you look at them?

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [63]

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We have looked at them and we're happy to lend on them. But we don't see them as acquisition opportunities for our -- we have an Illinois operator we like a lot, but I think 5 more buildings for him in the near term would be more than we want him to take on.

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Operator [64]

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(Operator Instructions) Our next question comes from Daniel Bernstein of Capital One.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [65]

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This might be a little bit more hypothetical, but with PDPM coming in and maybe margins moving up on rehab, are you talking to any operators who are looking to bring rehab back in house? And do you think that maybe if it doesn't improve lease coverage, does it improve your fixed charge coverage, corporate coverage and guarantees with your operators? And how are you thinking about that in terms of future underwriting?

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David M. Sedgwick, CareTrust REIT, Inc. - COO [66]

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Daniel, this is Dave. Yes, we are talking to our operators about that, and there's a lot of discussion that they're having internally and with their rehab providers to see which format makes sense. And they are -- several of them are planning on going in-house with rehab. And if they're not, they're in active discussions with their therapy providers to come up with a different arrangement to pay for those therapists as they are now not so much a profit center but a cost center. So that's in motion right now. And I think it'll -- we'll see different ways to skin that cap as the months progress.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [67]

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Okay. Great. But do you think it might be something that can improve the corporate coverage in support for your leases on a longer-term basis? I'm just -- that's what I'm getting at.

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David M. Sedgwick, CareTrust REIT, Inc. - COO [68]

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We do. And it's ready difficult, Dan, to quantify that yet. All the operators are going to treat it a little bit differently in terms of what kind of reduction to the therapy cost that they'll experience, and -- so all we can see right now is that common sense says that it will improve margins. But it's just too difficult to quantify that at this stage.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [69]

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Okay. And then in terms of your pipeline, the number you gave out obviously has a large portfolio in there. But the rest of it and -- is that mainly acquisitions? Or you're thinking about funding any more mortgages or development? I'm just trying to understand the composition there, acquisitions versus something else?

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [70]

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Yes, Dan, this is Greg. So funding mortgages is not something that we normally go out and look for. And we've done it a couple of times to facilitate acquisitions. We have a mortgage with Providence up here in St-Bernardino, and now we have these mortgages in Illinois with Covenant Care. But both of those mortgages were short-term mortgages that facilitated to a larger transaction. In terms of development, we currently have the 2 development projects that are now being completed and are in lease-up, up in the Idaho with Cascadia Healthcare. They're doing super well and we're really excited about them. And we could look to do more development on a very, very limited basis down the road if it makes sense. It's really hard to get new development to pencil when you compare it to simply buying and improving existing nursing home stock. But occasionally, you can find that sweet spot and we have done that in the Boise-Nampa area.

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Operator [71]

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I'm showing no further questions at this time. I'd like to turn the conference back over to Greg Stapley for any closing remarks.

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Gregory K. Stapley, CareTrust REIT, Inc. - Chairman, President & CEO [72]

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Thanks, Valerie, and thank you, everybody, for being on the call. Obviously, we appreciate your support and if any of you have any additional questions, we are here and ready to answer for anyone and everyone. Thank you.

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Operator [73]

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Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.