Medical Properties Trust, Inc. (MPT) Q1 2018 Earnings Report, Transcript and Summary

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. [Operator Instructions] 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 and/or underlying such forward-looking statements. We refer you to the company's reports filed with the Securities and Exchange Commission for a 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 security 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 and 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 discussed with you over the last few earnings calls. We are close to finalizing these two transactions and as we have previously reported, we 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 with the completion of these joint ventures. We’ll not only improve our already strong debt ratios and liquidity, they will provide third party validation that our recent share price significantly under values our portfolio. With this quarters 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 sale store EBITDAR on coverage for trailing 12 months Q4 2017, inclusive of the Italian property, it is approximately 3.3x, 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 EBITDAR and coverage improved approximately 9% from 3.8x to 4.2x, primarily driven by Q4 volume increases and improvements at our prime hospitals. Acute care EBITDAR coverage increased to 3.3x, which represents a 12% year-over-year and a 10% quarter-over-quarter improvement. EBITDAR coverage year-over-year for LTACH increased by 11% to 2x coverage, while IRFs declined slightly to 1.84x. As previously noted, U.S. LTACH represent less than 4% of our total portfolio. For just the U.S. IRF portfolio, EBITDAR coverage was 2.65x. Just to follow-up on the Ernest LTACH in Boise, Idaho, Vibra Healthcare and Ernest has consolidated their LTACH in Boise into a joint venture house in our building. This transformation was completed in March and 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 agencies credit watch, where they were previously placed in May of last year. Prime’s outlook was returned to sable by S&P as a review of their 2017 financial results. Prime continues to make tremendous strides in their operational performance as they stopped the acquisitions and focused on integration just as we predicted almost a year ago. Prime’s cash EBITDAR was well over 3.5x 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 had 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 and moreover as a point of reference New Vision represents less than 1.5% of our total portfolio. Steward, our largest tenant, continues to performance 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 in-patient perspective payment system, which along with DSH rate increases will result in estimated payment increases of 3.4%. The proposals for LTACHs and IRFs were also positive. For LTACH CMS also has proposed to eliminate the 25% rule, which will make managing the LTACH much more palatable. As reflected in the performance noted previously, we continued to be confident in our operations ability 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 and some select possible dispositions, we were simultaneously working our acquisition pipeline. We are exciting 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 our adoption of a new accounting principal. 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, but first let me describe a few items that we include in this quarters normalized FFO. We adopted to new revenue recognition accounting rules as of the first quarter, resulting in the immediate recognition of previously differed gains on sales of real-estate of approximately $1.9 million. The sales that generated these gains occurred quite a few years ago, and this previously differed 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 in accordance with NAREIT policy. As we described last quarter, we expect that in coming quarters we will sever certain leases form adapted and either sell or release 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 are 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 facility in Arizona. On last quarter’s call Ed described that we had successfully restructured the lease on an Ernest, LTACH, 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 and we have included it in the $6.1 million FFO adjustment, including in this morning press release. Finally in recent years, in accordance with GAAP rules concerning acquisitions of businesses, we have expensed a certain third-party acquisition cost 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, and accordantly 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 are very pleased with the progress we have recently achieved with respect to the joint venture negotiations and documentations. And although I’ll repeat that there are no assurances that any transaction will ultimately close, we remain highly optimistic that we will have bonding agreements with subtended, sophisticated investors singed in the near future. We expect to use proceeds from such investors and secured lenders to reduce debt, reinvest in additional hospital facilitates 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 benefit 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 costs, along with possible, additional, investment income from reinvestment of sales proceeds. And with that, we will be happy to take questions. Operator?

[Operator Instructions]. 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 and 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 like the European joint venture. Do you foresee that you will need German regulatory approval and 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 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. So it’s hard to handicap the time that may take, but we are hoping it will be within 30 to 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.

A quick question on the Houston, St. Joe Hospital. I guess the transaction on selling the property to Steward and getting the mortgage investment. I guess what was the purpose of that and the mechanics behind the decision to make that transaction?

So 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. Then 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 facility and a reduction of mortgage facilities with respect to Steward. So 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 lease backs. The goal of this anticipated sequence of transactions is to significantly rebalance that weighted toward leases versus montages. We expect and hope to have that completed during the course of 2018.

Okay. Thank you and then on the New Vision Hospital bankruptcies, obviously there is a tenant lined up to replace them. Will there be any change in the cash rents recognized there? And I suppose would there be a credit upgrade with the new tenement?

It will absolutely be a credit upgrade. It’s hard not upgrade when you are coming out of a bankrupt tenant, but it will be in any definition a credit upgrade and we’ve not completed negotiation of the new rental terms. But given the very, 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, then lastly on Prime, on the new improvements that you stated there, I guess going into this year and your conversations with them, what are the biggest costs pressures that they are seeing? Is it more labor materials, etcetera, etcetera. I guess where they are seeing the most pressure and what are they doing to combat it?

So 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 had made over the last few years into their systems. So 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 – collecting more than – more cash than their actually booked revenue. This quarter they had – were right at about 100% of cash collections. So I think for the reminder part of this year they will continue to improve their integration of those facilities and as I have stated on the call earlier, they’ve just done a fantastic job. The last issue, the 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 Department of Justice have stated that they have reached an agreement in principal and they have stayed the lawsuit or in the process of trying to work out the details. I can’t remember the exact number days that the court gave them to do that, but I think it’s over the next few months.

Okay. Thanks for the color. I appreciate it.

Our next question comes from the line of Chad Vanacore with Stifel. Your line is now open.

Hi good morning.

Good morning.

All right. So I was just thinking about maybe you can give us an update on the progress you have 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 principal, 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 are not in a position where we could handicap timing or amount, but there is a high level of interest in this hospital. That’s about a $30 million to $33 million investment for us and then there remained another roughly $30 million to $33 million investment in multiple facilities that will not be part of a system and so we are marketing those and really going to be early state of entertaining offers on individual of those facilities. That’s about six or seven facilities.

Okay, that’s excellent color. And then Steve, what was the magnitude of the impact of those accounting changes on G&A just in this quarter here?

Its $1.6 million basically, which you know is less than $0.005. So 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.

Alright, one last one. On page 13 of supplemental, compared to last quarter you just closed two new facilities with coverage less than 1.5x. 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 off line. 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 where Vista noted that hospital cap rates are now sub 7%. Is that in-line with what you are seeing and how conformable do you feel acquiring at those types of prices?

Well, we are not seeing those cap rates here in the U.S. For select properties and portfolios you do see some of that in Europe and in Europe we do have some exciting opportunities that may have a going in cash rate, in a sub 7% or right at a 7%, but we are not seeing that here in the U.S.

Okay, and just a bigger picture question. We’ve seen a ton of consolidation in the healthcare space with CVS and Aetna, Wal-Mart looking to make some plays into the healthcare delivery system, Amazon talking about some opportunities there to cut cost. What do you see as the impact to hospitals and maybe changes in patient flows and how they interact with physicians and how are you thinking about where the real-estate is positioned with these dynamics changing?

Well, that’s a great question, but 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 attending to their healthcare needs. So we think its good news in the long run. As it said, it’s a long way off before any of us see what the actually results are. From hospital spaces, as we have always said we think the acute care hospitals in particular have continued and remained at the very top of the pyramid. The top of the pyramid is a delivery system of healthcare in this country, which is why we continue to expand the percentage of our portfolio being in acute care hospitals. People talk about the out-patient versus in-patient. From an acute care hospital, it doesn’t matter to us whether the revenue is coming from an out-patient from or from an in-patient. 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.

And just one last quick one from me; is there a way to quantify the impact, the positive impact on coverage that the flu may have had?

Well, I’m not sure you can tell exactly, and as I talked about on the last quarter call, this flu season was unique and that most flu seasons even if they are bad, bad meaning that a lot of people have the flu, they are 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, but when I look 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. They really didn’t seem to last for much longer than a week or two weeks. So I think it did have a positive impact, but I don’t think that’s all of the impact that we saw.

Thank you.

And operator let me answer Chad’s question. Those two new properties were two new properties in Germany, the two medium properties.

The 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 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 previously calls you kind of highlighted that that market was too small for you. Was the reason why you were able to get into there? Is it because it was partnered with one of your existing relationships?

Well, I’m not sure exactly which of the facilities you are 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 and 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?” And we think those in particular that you are questing or asking about there with the RCCH do indeed meet those in a positive way.

Okay, and then are you interested in expanding in Kenwick with that operator too, because I know they are looking at an asset over there also?

We have not been invented to look at that particular facility.

We actually, Mike sold that years ago when it was first being constructed and I think it’s now in bankruptcy, but we are not involved with those.

Okay great. And 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 is a second JV, right? And I’m sorry if you already talked about this. Is that going to have a similar closing data?

Yeah, I didn’t mean to distinguish, because they are both pretty much on similar timing tracks. We hope to have both singed up – we expect to have both singed up during this quarter.

Alright, and do you have an estimated size of those types of deals or maybe in an aggregate of how big of a joint venture we are talking about?

Yeah, we haven’t disclosed that and we’ll leave that to the ultimate announcement.

Alright great, thank you.

Our next question comes from the line of Omotayo Okusanya with Jefferies. Your line is now open.

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, the classic example is this ProMedica deal with Welltower to buy HCR ManorCare and QCP. I mean when you start to see hospitals evolve that way, when you start to vertically integrate, does that change how you think about underwriting real-estate that you may lease to them?

Well Omotayo, I don’t have the details of that particular transaction, so I can’t comment on that. But 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 other acute care hospital or acute care hospitals. We haven’t seen a lot of consolidation up and down the chain from acute care hospitals, but if that were to happen with any of our operators, it would look very similar to what Steward’s original model has been and it’s a model that has worked very well for them one that we obviously have endorsed with them. So 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. And then I guess back to the Arizona asset, if I recall correctly, those asses also did go bankrupt about five years ago. So I’m just curious if you could just let us know over the course of those five years what kind of happened? It seems like things were improving and now they are back in bankruptcy. And kind of what lessons are there to learn in regards to the next time you lease those assets out. What kind of tenant credit are you looking for?

Your 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 of lease payment at all once we make this transaction, and the lesson there is once again to make the right decision when you underwrite and buy, and that’s started with the question I know most people in this call are maybe tired or hearing me say it, 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 and bringing in a competent, experienced, well capitalized operator will achieve that and that’s what we expect with these facilities.

Omotayo you may remember that these two facilities were some of the last facilities that were done. They 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 then performed very well coming out of the first bankruptcy and some of the same old personality issues arose again and they spent more time arguing with each other than they did managing the facilities.

Got you, okay. Very helpful color. Thank you.

Our next question comes from the line of Karin Ford with MUFG Securities. Your line is now open.

Hi, good morning.

Hi Karin.

Hi. I wanted to go back to the free standing ERs again. I saw there was some new legislation in Colorado and Texas and MedPack was recommending a 30% cut to Medicare payment to facilities that were within six miles of a hospital. Do those things cause you to rethink the piece of those facilities that you are going to keep, or maybe making that smaller, and how much of the portfolio are you going to keep meets that six mine criteria?

So Karin, as we all know that the MedPack proposal is merely that, it’s a suggestion and has a long way to go before it actually became reality. So none of us know what the exact answer would be, but obviously we’ve looked at it assuming that that was exactly what happened and I think we all have been surprised that the projected effect on our tenants revenue has been – is extremely small, its lesser than about a 2.5% overall negative impact. So just like it, with any of the operator, any of the specify types of facilities, we expect there to be adjustments from time-to-time to the reimbursement schedules, but we have not changed our opinion on our particular model, which is doing these free standing ERs with acute care hospitals and 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. So it has not changed our opinion to them and if it were enacted exactly as MedPack has proposed, it would have very little effect on our tenants.

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 Karin. It’s actually – so 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. So if you took those out, the same store coverage would actually be even higher.

Got it, thank you so much.

Thank you.

I am showing now further questions in queue at this time. I would like to turn the call back to Mr. Aldag for closing remarks.

Thank you very much and 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 and you may now disconnect. Everyone, have a great day!