Good day, ladies and gentlemen, and welcome to the Medical Properties Trust first quarter 2018 earnings conference call. At this time, all participants are in a listen-only mode. If anyone should require assistance during the call, please press star then zero on your touchtone telephone to reach an operator. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, today's conference may be recorded. I'd now like to introduce your host for today's conference, Mr. Charles Lambert, treasurer and managing director. Sir, please go ahead.
Thank you. Good morning, everyone. Welcome to the Medical Properties Trust conference call to discuss our first quarter 2018 financial results. With me today are Edward K. Aldag, Jr., Chairman, President, and Chief Executive Officer of the company, and Steven Hamner, Executive Vice President and Chief Financial Officer. Our press release was distributed this morning and furnished on Form 8-K with the Securities and Exchange Commission. If you did not receive a copy, it is available on our website at www.medicalpropertiestrust.com in the investor relations section. Additionally, we're hosting a live webcast of today's call, which you can access in that same section. During the course of this call, we will make projections and certain other statements that may be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that may cause our financial results and future events to differ materially from those expressed in or underlying such forward-looking statements. We refer you to the company's reports filed with the Securities and Exchange Commission for discussion of the factors that could cause the company's actual results or future events to differ materially from those expressed in this call. The information being provided today is as of this date only, and except as required by the federal securities laws, the company does not undertake a duty to update any such information. In addition, during the course of the conference call, we will describe certain non-GAAP financial measures which should be considered in addition to and not in lieu of comparable GAAP financial measures.
Please note that in our press release, Medical Properties Trust has reconciled all non-GAAP financial measures to the most directly comparable GAAP measures in accordance with Reg G requirements. You can also refer to our website at www.medicalpropertiestrust.com for the most directly comparable financial measures and related reconciliations. I will now turn the call over to our chief executive officer, Ed Aldag.
Thank you, Charles. Good morning to you all. Thank you for listening in on our 2018 first quarter earnings call. Much of our first quarter was spent working on the two joint ventures we've discussed with you over the last few earnings calls. We're close to finalizing these two transactions. As we have previously reported, expect to be able to make some announcements during this quarter. While there can be no assurance until the documentation is actually signed, we are very pleased with where we are at this point. We will save the details for the formal announcements. The completion of these joint ventures will not only improve our already strong debt ratios and liquidity, they will provide third-party validation that our recent share price significantly undervalues our portfolio. With this quarter's reporting, we added a net of eight additional properties to our same-store reporting.
Notably this quarter, we initiated reporting on our eight Italian acute care properties. Our total same-store EBITDARM coverage for trailing 12 months Q4 2017, inclusive of the Italian property, is approximately 3.3 times, which represents a 6% year-over-year and a 7% increase quarter-over-quarter. These results are even better than what we had projected at the end of the last quarter. Within our acute care portfolio, year-over-year, EBITDARM coverage improved approximately 9%, from 3.8 times to 4.2 times, primarily driven by Q4 volume increases and improvements at our Prime hospitals. Acute care EBITDARM coverage increased to 3.3 times, which represents a 12% year-over-year and a 10% quarter-over-quarter improvement. EBITDARM coverage year-over-year for our LTACs increased by 11% to two times coverage, while IRFs declined slightly to 1.84 times. Previously noted, U.S. LTACs represent less than 4% of our total portfolio.
For just the U.S. IRF portfolio, EBITDARM coverage was 2.65 times. To follow up on the Ernest LTAC in Boise, Idaho, Vibra Healthcare and Ernest have consolidated their LTACs in Boise into a joint venture house in our building. This transformation was completed in March. We expect this facility to perform well from this point on. A couple of additional notes of interest. In April, S&P removed Prime from the rating agency's credit watch, where they were previously placed in May of last year. Prime's outlook was returned to stable by S&P after a review of their 2017 financial results. Prime continues to make tremendous strides in their operational performance as they stopped acquisitions and focused on integration, just as we predicted almost a year ago. Prime's cash EBITDARM was well over three and a half times for Q4 trailing 12 months.
Some of you may have noticed that the two New Vision hospitals in Arizona were recently forced into involuntary bankruptcy. Prior to that filing, we had already terminated their leases and have a replacement operator ready to take over those facilities. These facilities are in good markets with good patient demands. We are confident that with the right management, they can again be returned to profitable hospitals. We expect this to be a positive outcome for our investments. Moreover, as a point of reference, New Vision represents less than one-half a % of our total portfolio. Steward, our largest tenant, continues to perform well and is on track for a record year in 2018. CMS just announced the 2019 Medicare reimbursement rate proposals and once again included rate hikes to the inpatient prospective payment system, which along with DSH rate increases, will result in estimated payment increases of 3.4%.
The proposals for LTACs and IRFs were also positive. For LTAC, CMS also has proposed to eliminate the 25% Rule, which will make managing the LTACs much more palatable. As reflected in the performance noted previously, we continue to be confident in our operators' abilities to navigate the evolving healthcare landscape. Q1 2018 was a period of integration for MPT and its healthcare operators as we each laid the foundation for another good year. As we've worked our joint venture models in some select possible dispositions, we are simultaneously working our acquisition pipeline. We're excited about completing many of these opportunities throughout the year. We continue to be highly selected with our robust pipeline of potential acquisitions and joint venture opportunities. We look forward to continued strong growth in 2018. Steve?
Thank you, Ed. This morning, we reported normalized FFO of $0.36 per diluted share for the first quarter of 2018, consistent with our own and market expectations, and slightly impacted by adoption of a new accounting principle. As expected, there was very limited investment, disposition, and capital activities during the quarter, resulting in the consistent FFO from quarter to quarter. In just a few minutes, I will update you on our expectations concerning near-term investment and capital activities. First, let me describe a few items that we include in this quarter's normalized FFO. We adopted the new revenue recognition accounting rules as of the first quarter, resulting in the immediate recognition of previously deferred gains on sale of real estate of approximately $1.9 million.
The sales that generated these gains occurred quite a few years ago. This previously deferred gain was recorded this quarter through an equity adjustment, not through net income. Separately, in the first quarter of this year, we sold our Houston St. Joseph Hospital to Steward for a mortgage loan, resulting in a gain on sale of approximately $1.5 million that we subtracted from FFO in accordance with Nareit policy. As we described last quarter, we expect that in coming quarters, we will sever certain leases from Adeptus and either sell or re-lease these facilities to other operators. Accordingly, we are accelerating the amortization of the straight-line rent accrual that accumulated in the early years of these particular facilities. During the first quarter of 2018, this resulted in an adjustment to straight-line rent of about $1.8 million.
That will leave a balance of about $4 million in accrued straight-line rent related to these facilities, which we expect to write off over the next up to about six quarters. We also wrote off accrued straight-line rent aggregating about $2.8 million to the sale of the Houston St. Joseph Hospital and another facility whose lease we terminated in expectation of releasing it to a new operator. Ed mentioned that as being the New Vision facilities in Arizona. On last quarter's call, Ed described that we had successfully restructured the lease on an Ernest LTAC facility, such that it is now leased to a joint venture between Ernest and Vibra affiliates. Because this changed the classification from a direct financing lease to an operating lease, we wrote off the $1.5 million in unbilled interest that had accrued pursuant to the direct financing lease.
This unbilled interest is comparable to straight-line accruals pursuant to an operating lease, we have included it in the $6.1 million FFO adjustment, including in this morning's press release. Finally, in recent years, in accordance with GAAP rules concerning acquisitions of businesses, we have expensed certain third-party acquisition costs and then added those costs back to calculate normalized FFO. As of January 1, we adopted new GAAP, which no longer classifies real estate acquisitions as acquisitions of a business. Accordingly, these acquisition costs are now appropriately capitalized into the cost of our investments. We mentioned this last quarter, but I just take the opportunity to remind you that you will no longer see this adjustment to normalized FFO going forward. We're very pleased with the progress we have recently achieved with respect to the joint venture negotiations and documentation.
Although I'll repeat that there are no assurances that any transaction will ultimately close, we remain highly optimistic that we will have binding agreements with substantive, sophisticated investors signed in the near future. We expect to use proceeds from such investors and secured lenders to reduce debt, reinvest in additional hospital facilities, and for other strategic and general corporate purposes. Depending on the timing of any such reinvestment, there is likely to be temporary dilution of FFO. Although we continue to believe the benefits from greater diversification, lower leverage, additional liquidity, and access to attractively priced new sources of capital will be well worth any temporary impact on FFO. We continue to expect normalized FFO in 2018 of between $1.42 and $1.46 per share. This is based primarily on our current portfolio, taking into consideration our expectations about interest rates, currency markets, and other assumptions.
Importantly, our estimates of future normalized FFO do not include the impact that will result from any of the possible JV transactions, which as mentioned, may include reduction of rental income and changes to interest expense and other capital cost, along with possible additional investment income from reinvestment of sale proceeds. With that, we will be happy to take questions. Operator?
Ladies and gentlemen, if you'd like to ask a question at this time, please press the star, then the number 1 key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, you may do so by pressing the pound key. Again, if you'd like to ask a question at this time, that's star then 1. Our first question comes from the line of Jordan Sadler with KeyBanc Capital Markets. Your line is now open.
Hi, guys. Good morning. This is Katie on for Jordan, I appreciate the color you gave us on the joint venture transactions. I was just wondering if you could update us on your expectations for closing the joint venture transactions, just in particular with the European joint venture. Do you foresee that you'll need German regulatory approval, do you foresee that you could run into potential delays with that? Thank you.
As we've said, and I probably didn't make clear a few minutes ago, but we do expect execution of the joint ventures before the end of this quarter. There will be customary conditions, including, in the case of the Europe arrangement, German regulatory approval, primarily antitrust approval. It's hard to handicap the time that may take, but we are hoping it will be within 30-60 days after application.
Thank you.
Our next question comes from the line of Drew Babin with Baird. Your line is now open.
Hey, good morning.
Good morning.
Quick question on the Houston St. Joseph Hospital. I guess, the transaction, selling the property to Steward and getting the mortgage investment. I suppose, what was the purpose of that and the mechanics behind the decision to make that transaction?
The purchase by Steward, the repurchase, that is, by Steward. Remember, this was one of the IASIS properties that we bought at the end of September, and leased immediately to Steward. Steward and we agreed that we would sell the facility to Steward, and it's actually the first of a series of expected transactions, the goal of which is to lead to actually additional leased facilities and a reduction of mortgage facilities with respect to Steward. Just for example, the total transaction with Steward, real estate transaction in September of last year was about $1.4 billion, half of which was mortgages and half of which were sale-leasebacks. The goal of this anticipated sequence of transactions is to significantly rebalance that weighted toward leases versus mortgages. We expect and hope to have that completed during the course of 2018.
Thank you. On the New Vision hospital bankruptcies, obviously there's a tenant lined up to replace them. Will there be any change in the cash rents recognized there? I suppose, will there be a credit upgrade with the new tenant?
It will absolutely be a credit upgrade. It's hard not to upgrade when you're coming out of a bankrupt tenant, but it will be, in any definition, a credit upgrade. We've not completed negotiation of the new rental terms. Given the very limited exposure, I think Ed mentioned it's less than 0.5% of our total portfolio, there will be no material impact on our projected total rental income.
Okay, lastly on Prime, on the improvements that you cited there. I guess, going into this year, in your conversations with them, what are the biggest cost pressures that they're seeing? Is it more labor, materials, et cetera? I guess, where are they seeing the most pressure, and what are they doing to combat it?
The most pressure that they were having was really from an internal standpoint. It was really an integration of all of the acquisitions that they've made over the last few years into their systems. It's really not one particular cost item. It's just getting their cash collections in order with their revenue. As I reported on the last call, I can't remember the exact number, but they were recovering more than, or collecting more than more cash than their actual booked revenue. This quarter, they were right at about 100% of cash collections. I think for the remainder part of this year, they'll continue to improve their integration of those facilities. As I've stated on the call earlier, they've just done a fantastic job. The last real issue that they have is the Department of Justice lawsuit.
You may have seen that there was actually a filing where the two parties, Prime and the Department of Justice, have stated that they have reached an agreement in principle. They have stayed the lawsuit or are in the process of trying to work out the details. I can't remember the exact number of days that the court gave them to do that, but I think it's over the next few months.
Okay, thanks for the color. Appreciate it.
Our next question comes from the line of Chad Vanacore with Stifel. Your line is now open.
Hey, good morning.
Good morning.
All right. I was just thinking about maybe if you give us an update on the progress you've made releasing the former Adeptus assets. Have you received any bids, or are there any under consideration for new leases right now?
Yes, there are. In fact, Chad, we've got about $36 million in total properties that we have agreement in principle, very close to binding agreement that will move into another very well-capitalized, very experienced dominant operator in particular markets. We are marketing for sale a hospital, an acute care hospital in the Dallas area that we have significant interest on, again, from dominant operators in that market. We're not in a position where we could handicap timing or amount, but there's a high level of interest in this hospital. That's about a $30 million-$33 million investment for us. There remain another roughly $30 million-$33 million investment in multiple facilities that will not be part of a system. We are marketing those and really in the early stage of entertaining offers on individual of those facilities. That's about six or seven facilities.
Okay, that's excellent color. Steve, what would the magnitude of the impact of those accounting changes on NAV just in this quarter here?
It's minimal. It's $1.6 million, basically, which is less than $0.005. There were much more significant impacts on earnings, including new facilities that came online, interest expense that increased due to market rates going up. The accounting change was fairly limited.
All right, one last one. On page 13 in the supplemental, compared to last quarter, you disclosed two new facilities with coverage less than one and a half times. Were those the Arizona facilities or was that something else?
Chad, I'm not sure exactly. I'll have to get back with you on those. I don't think they were the Arizona facilities.
Okay, we can take that offline. Thanks for taking the question.
Our next question comes from the line of Juan Sanabria with Bank of America. Your line is now open.
Hi, thanks for the time. Yeah, just with regards to current cap rates in the transactions environment, where do you see those? Revista noted that kind of hospital cap rates are now sub 7%. Is that in line with what you're seeing, and how comfortable do you feel acquiring it at those types of prices?
Juan, we're not seeing those cap rates here in the U.S. For select properties and portfolios, you do see some of that in Europe. In Europe, we do have some exciting opportunities that may have a going-in cash rate in a sub seven or right at a seven. We're not seeing that here in the U.S.
Okay. Just a bigger picture question. We've seen a ton of consolidation in the healthcare space, CVS and Aetna, Walmart looking to make some plays into the healthcare delivery system, Amazon talking about some opportunities there to cut costs. What do you see as the impact to hospitals and maybe changes in patient flows and how they interact with physicians? How are you thinking about where the real estate is positioned with these dynamics changing?
Juan, it's a long way off before any of us know the exact answers to it. In a big macro vision that we have of it, we think that all of these are ultimately good news for hospitals. We think that having big national players that bring the focus more on a national level than the individual state levels is a good thing for hospitals. We think that it brings more patients to the hospitals, ultimately having more patients that are covered and more patients that are actually tending to their healthcare needs. We think it's good news in the long run. As I said, it's a long way off before any of us see what the actual results are.
From a hospital space, as we have always said, we think that the acute care hospitals, in particular, have continued to remain at the very top of the pyramid of the delivery system of healthcare in this country, which is why we continue to expand the percentage of our portfolio being in acute care hospitals. From people talk about the outpatient versus inpatient. From an acute care hospital, it doesn't matter to us whether the revenue is coming from an outpatient or from an inpatient. The hospital is still getting both of those revenues. When you look at the performance of not just our portfolio, but Tenet and HCA, which have also recently released their numbers, they all are improving and actually all had very strong quarters, and we think that that's exactly in line with what our expectations were.
Just one last quick one for me. Is there a way to quantify the positive impact on coverage that the flu may have had?
Well, I'm not sure you can tell exactly. As I talked about on the last quarter call, this flu season was unique in that most flu seasons, even if they're bad meaning that a lot of people have the flu, they're generally not as high acuity as we saw this year. There certainly was a benefit to hospitals with the higher acuity patients that we had. When I looked back and looked at what the admissions have been, we really didn't see that much additional admissions. I think it was a short-term blip when you look at some of the hospitals that we had that actually had to go on diversion for surgeries and other procedures because they didn't have enough beds. It really didn't seem to last for much longer than a week or two weeks.
I think it did have a positive impact, I don't think that's all of the impact that we saw.
Thank you.
Operator, let me answer Chad's question. Those two new properties were two new properties in Germany, the two new MEDIAN properties.
Our next-
Go ahead.
Next question comes from the line of Michael Carroll with RBC Capital Markets. Your line is now open.
Thanks. Ed, can you talk a little bit about your acquisition strategy and what markets have to look like for you to pursue a deal in that specific market? I'm specifically looking at the recent RCCH deal that you guys completed in Washington. I believe that's a smaller market. I think on previous calls you kind of highlighted that market was too small for you. Was the reason why you were able to get in there is because it was partnered with one of your existing relationships?
I'm not sure exactly which of the facilities you were talking about, but I've been to all of those facilities, and while the towns are not big metropolitan areas, they all do have more than one hospital operating in them. They all meet the most important need, the most important criteria that we have in doing our analysis, which is regardless of where the hospital is located, can we answer the question positively that what happens if that hospital closes down? Does the community suffer from its healthcare needs? We think that those in particular that you're questioning or asking about there with the RCCH do indeed meet those in a positive way.
Okay. Then are you interested in expanding in Kennewick with that operator, too? I know they're looking at an asset over there also.
We have not been invited to look at that particular facility.
Okay.
Mike saw that years ago when it was first being constructed, and I think it's now in bankruptcy. We're not involved at present.
Okay, great. Then can you talk a little bit about the JVs? I know you kind of highlighted that you expect the European JV to be done sometime soon. There's a second JV, right? I'm sorry if you already talked about this. Is that going to have a similar closing date?
Yeah, I didn't mean to distinguish because they're both pretty much on similar timing tracks. We hope to have both signed up, expect to have both signed up during this quarter.
All right. Do you have an estimated size of those types of deals or maybe in an aggregate of how big of a joint venture we're talking about?
Yeah, we haven't disclosed that. We'll leave that to the ultimate announcement.
Okay, great. Thank you.
Our next question comes from the line of Omotayo Okusanya with Jefferies. Your line is now open.
Hi, yes, good morning. I just wanted to go back to one question about consolidation in the healthcare space. On the flip side, we are seeing hospitals also doing some vertical integration. I think classic example is this ProMedica deal with Welltower to buy HCR ManorCare and QCP. When you start to see hospitals evolve that way, when they start to vertically integrate, does that change how you think about underwriting real estate that you may lease to them?
Tayo, I don't have the details of that particular transaction, so I can't comment on that. From an overall consolidation, we've seen this going on for a long time, and that primarily in our field has been just a consolidation of one acute care hospital with another acute care hospital or acute care hospitals. We haven't seen a lot of consolidation up and down the chain from acute care hospitals. If that were to happen with any of our operators, it would look very similar to what Steward's original model has been. It's a model that has worked very well for them and one that we obviously have endorsed with them. It would have to be on a case-by-case basis, but certainly in certain cases like Steward, it's worked very well.
Okay. That's helpful. Just back to the Arizona asset. If I recall correctly, those assets also did go bankrupt about five years ago. I'm just curious if you could just let us know over the course of those five years, what kind of happened? It seemed like things were improving and now they're back in bankruptcy. Kind of what lessons are there to learn in regards to the next time we lease those assets out, what kind of tenant credit you're looking for?
You're right. This is second time around for both of those facilities. We never missed a lease payment during the earlier run-up. We do not expect to take certainly any material, perhaps any missing a lease payment at all once we make this transition. The lesson there is, once again, make the right decision when you underwrite and buy. That starts with the question I know most people on this call are maybe tired of hearing us say, Ed just repeated it. Make sure that the hospitals we buy are needed in those communities, such that when you have a situation as we now have again in Arizona, and a particular operator, for whatever reason, is unable to operate profitably, that hospital needs to be there.
The market dynamics, the demographics are such that it should be able to be operated profitably, bringing in a competent, experienced, well-capitalized operator will achieve that. That's what we expect with these facilities.
Tayo, you may remember that these two facilities were some of the last facilities that were done that were essentially joint ventures with local physicians amongst themselves. When they got in trouble the first time, it was because the physicians were fighting with each other.
They performed very well coming out of the first bankruptcy. Some of the same old personality issues arose again, they spent more time arguing with each other than they did managing the facilities.
Gotcha. Okay. Very helpful color. Thank you.
Our next question comes from the line of Karin Ford with MUFG Securities. Your line is now open.
Oh, hi. Good morning.
Hi, Karen.
Hi. Wanted to go back to the freestanding ERs again. I saw there was some new legislation in Colorado and Texas. MedPAC was recommending a 30% cut to Medicare payments to facilities that are within six miles of a hospital. Do those things cause you to rethink the piece of those facilities that you're going to keep, maybe making that smaller? How much of the portfolio you are going to keep meets that six-mile criteria?
Karen, as we all know that the MedPAC proposal is merely that. It's a suggestion and has a long way to go before it actually became reality. None of us know what the exact answer would be, but obviously we've looked at it assuming that that was exactly what happened. I think we all have been surprised that the projected effect on our tenant's revenue is extremely small. It's less than about a 2.5% overall negative impact. Just like with any of the specific types of facilities, we expect there to be adjustments from time to time to the reimbursement schedules. We have not changed our opinion on our particular model, which is doing these freestanding ERs with acute care hospitals.
We think that the industry and the hospital association will continue to show that these are very much needed in local communities where they don't need a general acute care hospital. It has not changed our opinion of them, and if it were enacted exactly as MedPAC has proposed, it would have very little effect on our tenants.
It's a good color. Thanks for that. Last question is just on the nice coverage improvement you saw this quarter. Do you have a sense for how much the changing same-store pool impacted the coverage change?
Yeah, that's a good point out, Karen. If you look at the additions that we had, the Italian facilities, those facilities actually had a lower coverage than our overall prior same-store coverage. If you took those out, the same-store coverage would actually be even higher.
Got it. Thank you so much.
Thank you.
I'm showing no further questions in queue at this time. I'd like to turn the call back to Mr. Aldag for closing remarks.
Thank you very much. As always, we appreciate all of your interest. If you have any additional questions, please don't hesitate to call on us. Thank you very much.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day.