Notes to Interim Consolidated Financial Statements
Unaudited
March 31, 2019
Note 1 - Organization and Nature of Business
MedEquities Realty Trust, Inc. (the “Company”), which was incorporated in the state of Maryland on April 23, 2014, is a self-managed and self-administered company that invests in a diversified mix of healthcare properties and healthcare-related real estate debt investments. As of March 31, 2019, the Company had investments of $589.4 million, net in 34 real estate properties and six healthcare-related real estate debt investments. The Company owns 100% of all of its properties and investments, other than Baylor Scott & White Medical Center - Lakeway (“Lakeway Hospital”), in which the Company owns a 51% interest through a consolidated partnership (the “Lakeway Partnership”). All of the Company’s assets are held by, and its operations conducted through, its operating partnership, MedEquities Realty Operating Partnership, LP, which is a 100% owned subsidiary of the Company. The Company has elected to be taxed as a real estate investment trust (“REIT”) for U.S. federal income tax purposes.
Note 2 - Accounting Policies and Related Matters
The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements. In the opinion of management, the accompanying unaudited consolidated financial statements reflect all adjustments consisting of normal recurring adjustments necessary for a fair presentation of its financial position and results of operations. Interim results of operations are not necessarily indicative of the results that may be achieved for a full year. The consolidated financial statements and related notes do not include all information and footnotes required by GAAP for annual reports. These interim consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2018, included in the Company’s 2018 Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on February 25, 2019.
The interim consolidated financial statements include the accounts of the Company’s wholly owned subsidiaries and subsidiaries in which the Company has a controlling interest. All material intercompany transactions and balances have been eliminated in consolidation.
For information about significant accounting policies, refer to the Company’s audited consolidated financial statements and notes thereto for the year ended December 31, 2018 included in the Company’s 2018 Annual Report on Form 10-K filed with the SEC on February 25, 2019. During the three months ended March 31, 2019, there were no material changes to these policies except as noted below.
Revenue Recognition
Revenue is recognized in a manner to depict the transfer of goods or services to a customer at an amount that reflects the consideration expected to be received in exchange for those goods or services. Currently, all the Company’s lease arrangements are classified as operating leases and contain escalating rent provisions. Leases with fixed periodic rent escalators are generally recognized on a straight-line basis over the initial term, subject to a collectability assessment. Certain payments to tenants are accounted for as lease incentives and amortized as a reduction of revenue over the related lease term.
The Company monitors the liquidity and creditworthiness of tenants and operators on a continuous basis. This evaluation considers industry and economic conditions, property performance, credit enhancements and other factors. The Company exercises judgment in establishing allowances and considers payment history and current credit status in developing these estimates. These estimates may differ from actual results, which could be material to the consolidated financial statements.
The Company’s leases are generally “triple-net” leases with terms requiring operating expenses associated with the Company’s facilities, such as taxes, insurance and utilities, to be paid directly by the Company’s tenants. Under certain of these leases, the Company pays the taxes directly to the taxing authority and receives reimbursement from the tenant. In these instances, the Company presents its cost and the tenant’s reimbursement on a gross basis in the consolidated income statement, reflected in rental income and property-related expenses. Leases in the Company’s medical office building require tenants to reimburse the Company for certain property operating expenses including, but not limited to, real estate taxes, property insurance, routine maintenance and repairs, utilities and property management expenses. The reimbursements are recorded in rental income, and the expenses are recorded in property-related expenses.
8
Mortgage Notes and Other Receivables
Mortgage notes and other receivables are classified as held-for-investment based on management’s intent and ability to hold the loans for the foreseeable future or to maturity. The Company recognizes interest income on loans, including the amortization of any discounts and premiums, using the interest method applied on a loan-by-loan basis subject to an evaluation of collectability risks. Premiums, discounts and related costs are recognized as yield adjustments over the term of the related loans.
Allowances are established for loans based upon an estimate of probable losses on an individual basis if they are determined to be impaired. Loans are impaired when it is deemed probable that the Company will be unable to collect all amounts due on a timely basis in accordance with the contractual terms of the loan. The allowance is based upon management’s assessment of the borrower’s overall financial condition, resources and payment record; the prospects for support from any financially responsible guarantors; and, if appropriate, the net realizable value of any collateral. These estimates consider all available evidence including, as appropriate, the present value of the expected future cash flows discounted at the loan’s effective interest rate, the fair value of collateral, general economic conditions and trends, historical and industry loss experience, and other relevant factors.
Recent Accounting Developments
On January 1, 2019, the Financial Accounting Standards Board’s (“FASB”) new leases standard included in Accounting Standards Codification 842, Leases, became effective for the Company. A modified retrospective transition approach is required, applying the new standard to all leases existing at the date of initial application. The Company adopted the new standard on January 1, 2019 and used the effective date as its date of initial application. Consequently, financial information has not been updated and the disclosures required under the new standard are not provided for dates and periods before January 1, 2019.
The new standard provides a number of optional practical expedients in transition. The Company has elected the “package of practical expedients”, which permits it not to reassess under the new standard the Company’s prior conclusions about lease identification, lease classification and initial direct costs. The Company did not elect the use-of-hindsight or the practical expedient pertaining to land easements, the latter not being applicable to the Company.
The most significant effect for the Company as lessee relates to the recognition of new right-of-use assets and lease liabilities on its consolidated balance sheet for the corporate office lease and one ground lease. As of March 31, 2019, the Company had $3.2 million gross ($2.5 million, net) in right of use assets, which are included in Other assets, net on the consolidated balance sheet and $3.2 million in related lease liabilities which are included in Accounts payable and accrued liabilities on the consolidated balance sheet. These amounts are based on the present value of the remaining minimum rental payments under current leasing standards for these two existing operating leases.
For leases where the Company is the lessor, the new standard did not have a material effect on its consolidated financial statements. The Company currently has one medical office building in which the Company provides services to maintain the asset. While the new standard identifies common area maintenance as a non-lease component of the Company’s real estate lease contracts, the Company applied the practical expedient to account for its gross real estate leases in its one medical office building and associated common area maintenance components as a single, combined operating lease component. Consequently, the new standard’s changed guidance on contract components did not significantly affect the Company’s financial reporting.
In addition, due to the new standard’s narrowed definition of initial direct costs, lease origination costs that were previously capitalized as initial direct costs and amortized to expense over the lease term are now expensed as incurred.
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326),” which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. The standard also requires additional disclosures related to significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. The amended guidance is effective for fiscal years, and interim periods within those years, beginning January 1, 2020, with early adoption permitted for the fiscal years, and interim periods within those fiscal years, beginning January 1, 2019. The Company is evaluating the impact of adopting this new accounting standard on the Company’s consolidated financial statements and currently expects that it will not have a material impact.
Note 3 – Merger Agreement
On January 2, 2019, the Company entered into an Agreement and Plan of Merger (as amended, the “Merger Agreement”) with Omega Healthcare Investors, Inc. (“Omega”). Pursuant to the terms of the Merger Agreement, the Company will merge with and into Omega, with Omega continuing as the surviving company in the merger. Each share of Company common stock will be converted at the effective time of the merger into the right to receive (i) 0.235 of a share of common stock of Omega, subject to adjustment under certain limited circumstances, plus the right to receive cash in lieu of any fractional shares of Omega common stock; and (ii) an amount in cash equal to $2.00, subject to adjustment under certain limited circumstances. Pursuant to the terms of the Merger Agreement, the Company will declare a special dividend of $0.21 per share of common stock payable to the holders of the Company’s common stock as of the closing date of the merger, which will be payable together with the cash consideration in the merger in accordance with the terms of the Merger Agreement (the “Closing Dividend”).
9
The merger is subject to
customary closing conditions, including, but not limited to, the approval of the Company’s stockholders.
The special meeting of the Company’s stockholders to vote on the merger is scheduled for May 15, 2019.
The proposed merger transaction is currently exp
ected to close in the
second quarter
of 2019.
Additional information regarding the merger is included in the Company’s definitive proxy statement filed with the SEC on April 8, 2019.
Note 4 – Portfolio Activity
Texas Ten Portfolio Master Lease Update
Effective January 1, 2019, a new 15-year triple net master lease commenced with certain affiliates of Creative Solutions in Healthcare, Inc. (“Creative Solutions”) for the Company’s portfolio of ten skilled nursing facilities located throughout Texas (the “Texas Ten Portfolio”) previously leased to affiliates of OnPointe (the “Prior Texas Ten Tenant”). The lease with the Prior Texas Ten Tenant was terminated on December 31, 2018. The initial annual base rent under the lease is approximately $7.7 million with annual lease escalators of 2.0% and two, five-year tenant renewal options. The Texas Ten Portfolio accounted for approximately 24.1% of the Company’s total real estate properties, net as of March 31, 2019.
Fundamental Healthcare Master Lease Update
The Company leases a portfolio of four properties to subsidiaries of Fundamental Healthcare (“Fundamental”) pursuant to a triple-net master lease with expected base rent of approximately $9.6 million for 2019. Effective October 6, 2018, the Company amended the master lease to defer approximately $2.4 million in base rent for May 2018 through March 2019 associated with Mountain’s Edge Hospital, which has undergone an expansion. The amendment requires the deferred rent amount to be paid in equal monthly installments over the remainder of 2019 beginning in April 2019. Interest on the outstanding deferred rent accrues interest at 9.0% during the deferral and repayment periods. As of March 31, 2019, the deferred rent balance was $2.3 million, which is recorded in other assets on the Company’s consolidated balance sheet.
In April 2019, Fundamental requested to continue the deferral of $0.2 million in monthly rent and a delay in the commencement of repaying the Total Abatement Amount, including any additional deferred rent amounts, until operations of the expansion begin at the Mountain’s Edge facility, which is currently expected to be in June 2019. The Company is currently in discussions with Fundamental regarding this request. There can be no assurances that it will be resolved prior to the closing of the merger with Omega.
Concentrations of Credit Risks
The following table contains information regarding tenant concentration in the Company’s portfolio, based on the percentage of revenue for the three months ended March 31, 2019 and 2018, related to tenants, or affiliated tenants, that exceed 10% of revenues:
|
|
% of Total Revenue for the
three months ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Baylor Scott & White Health
|
|
22.0%
|
|
|
21.9%
|
|
Vibra Healthcare
|
|
15.4%
|
|
|
11.4%
|
|
Fundamental Healthcare
|
|
14.9%
|
|
|
15.3%
|
|
Creative Solutions in Healthcare
(1)
|
|
14.5%
|
|
|
-
|
|
Life Generations Healthcare
|
|
12.9%
|
|
|
12.9%
|
|
Prior Texas Ten Tenant
(1)
|
|
-
|
|
|
21.4%
|
|
|
(1)
|
On December 31, 2018, the lease with the Prior Texas Ten Tenant was terminated. The Company entered into a 15-year triple-net master lease agreement with certain affiliates of Creative Solutions for the Texas Ten Portfolio, which commenced on January 1, 2019. See “Texas Ten Portfolio Master Lease Update” above.
|
10
The following table contains information regarding the geographic concentration of the properties in the Company’s portfolio as of
March
3
1
, 201
9
, which includes percentage of rental income for the
three
months ended
March 31
, 201
9
and 201
8
(dollars in thousands):
|
|
|
|
|
|
|
|
% of Total
|
|
|
% of Rental Income
|
|
State
|
|
Number of
Properties
|
|
Gross Investment
|
|
|
Real Estate
Property Investments
|
|
|
Three months ended
March 31, 2019
|
|
|
Three months ended
March 31, 2018
|
|
Texas
|
|
17
|
|
$
|
300,259
|
|
|
50.1%
|
|
|
52.4%
|
|
|
59.1%
|
|
California
|
|
7
|
|
|
154,726
|
|
|
25.8%
|
|
|
22.9%
|
|
|
21.6%
|
|
Nevada
|
|
4
|
|
|
69,268
|
|
|
11.6%
|
|
|
12.4%
|
|
|
12.1%
|
|
South Carolina
|
|
1
|
|
|
20,000
|
|
|
3.3%
|
|
|
3.2%
|
|
|
3.2%
|
|
Indiana
|
|
3
|
|
|
38,415
|
|
|
6.4%
|
|
|
6.4%
|
|
|
2.4%
|
|
Connecticut
|
|
1
|
|
|
10,133
|
|
|
1.7%
|
|
|
1.6%
|
|
|
1.6%
|
|
Tennessee
|
|
1
|
|
|
6,386
|
|
|
1.1%
|
|
|
1.1%
|
|
|
-
|
|
|
|
34
|
|
$
|
599,187
|
|
|
100.0%
|
|
|
100.0%
|
|
|
100.0%
|
|
Note 5 – Debt
The table below details the Company’s debt balance at March 31, 2019 and December 31, 2018 (in thousands):
|
|
March 31, 2019
|
|
|
December 31, 2018
|
|
Term loan- secured
|
|
$
|
125,000
|
|
|
$
|
125,000
|
|
Revolving credit facility- secured
|
|
|
160,100
|
|
|
|
153,800
|
|
Unamortized deferred financing costs
|
|
|
(547
|
)
|
|
|
(663
|
)
|
|
|
$
|
284,553
|
|
|
$
|
278,137
|
|
The Company’s Second Amended and Restated Credit Agreement (as amended, the “Credit Agreement”) provides for a $300 million revolving credit facility that matures in February 2021 and a $125 million term loan that matures in February 2022. The revolving credit facility has one 12-month extension option, subject to certain conditions, including the payment of a 0.15% extension fee. At March 31, 2019 and 2018, the weighted-average interest rate under the Credit Agreement was 5.0% and 3.8%, respectively.
Total costs related to the revolving credit facility at March 31, 2019 were $1.4 million, gross ($1.3 million, net), of which $0.4 million, gross ($0.3 million, net) are related to the Third Amendment to the Credit Agreement entered into on February 20, 2019 (the “Third Amendment”) and the Second Amendment entered into on October 9, 2018 (the “Second Amendment” and, together with the Third Amendment, the “Credit Amendments”). These costs are included in Other assets, net on the consolidated balance sheet at March 31, 2019 and will be amortized to interest expense through February 2021, the maturity date of the revolving credit facility, and June 30, 2019, the date the extended borrowing base availability provisions expire under the Credit Amendments. The total amount of deferred financing costs associated with the term loan at March 31, 2019 was $1.0 million, gross ($0.5 million, net), of which $0.2 million, gross ($0.1 million, net) are related to the Credit Amendments. These costs are netted against the balance outstanding under the term loan on the Company’s consolidated balance sheet and will be amortized to interest expense through February 2022, the maturity date of the term loan, and June 30, 2019.
The Company recognized amortization expense of deferred financing costs, included in interest expense on the consolidated statements of operations, of $1.4 million and $0.3 million for the three months ended March 31, 2019 and 2018, respectively. The amortization expense for the three months ended March 31, 2019 includes approximately $0.9 million for the write-off of unamortized deferred financing costs related to the reduction in total commitments under the Credit Agreement included as part of the Third Amendment to the Credit Agreement.
The Third Amendment amended certain terms, covenants and conditions of the Credit Agreement and the Second Amendment including, but not limited to the following:
|
•
|
Retained the increase in the applicable margin included in the Second Amendment of 2.00% and 3.50% for LIBOR-rate loans and 1.00% and 2.50% for base-rent loans, depending on the Company’s leverage ratio (prior to the Second Amendment, the applicable margin was 1.75% to 3.00% for LIBOR-rate loans and 0.75% to 2.00% for base-rate loans, depending on the Company’s leverage ratio);
|
|
•
|
Temporarily increased the borrowing base availability attributable to the Company’s borrowing base assets, other than the Texas Ten Portfolio, until June 30, 2019;
|
11
|
•
|
Restricts the Company’s use of proceeds from borrowing under the Credit Agre
ement solely for the remaining funding obligations for the expansion of the Mountain’s Edge Hospital and the Company’s construction mortgage loan to Haven Healthcare, unless approved by lenders representing two
-
thirds of the outstanding commitments under t
he Credit Agreement.
|
|
•
|
Reduced the maximum amount available under the revolving credit facility from $300 million to $175 million, which, when combined with the $125 million term loan, provides total commitments available to the Company under the Credit Agreement of $300 million;
|
|
•
|
Required any principal repayment on the Medistar Gemini Mortgage Loan and Medistar Stockton Loan to be used to pay down the outstanding balance on the revolving credit facility; and
|
|
•
|
Prohibits the Company from declaring any dividend on or prior to June 30, 2019, other than, subject to certain conditions, (i) a dividend to our common stockholders attributable to the fourth quarter of 2018 not to exceed $0.21 per share, with payment conditioned upon approval by our stockholders of the merger with Omega and subject to the Company maintaining a minimum of $2.0 million in unrestricted cash and cash equivalents upon payment of such dividend, and (ii) the closing dividend pursuant to the terms of the merger agreement with Omega.
|
At May 8, 2019, the Company had $285.1 million in borrowings outstanding, of which $160.1 million was outstanding under the revolving credit facility with a weighted-average interest rate of 5.2%,
reflecting a 2.75% spread over LIBOR and $125.0
million was outstanding on the term loan. As of May 8, 2019, the Company had approximately $4.0
million in pre-approved borrowing capacity under the Credit Agreement.
Management’s Assessment of Future Borrowing Base Availability and Future Plans
All the Company’s outstanding borrowings under the Credit Agreement will be repaid upon closing of the announced merger with Omega, as discussed in further detail in Note 3. In the event the merger is delayed or does not close as anticipated, the additional borrowing base availability and borrowings provided by the Credit Agreement, along with the Company’s current cash on hand and expected monthly net cash flows, are projected to provide sufficient liquidity to the Company to satisfy outstanding funding obligations, comprised primarily of the Haven construction mortgage loan and Mountain’s Edge construction project; ongoing operating expenses, including interest payments under the Credit Agreement; and required distributions to stockholders to satisfy REIT requirements through May 2020. Upon expiration of the extension of the borrowing base availability included in the Third Credit Amendment through June 30, 2019, the Company expects its unrestricted cash and cash equivalents on hand would be sufficient to pay down the approximately $15.1 million in excess borrowings over the estimated borrowing base availability at that date.
If the Company’s unrestricted cash and cash equivalents as of July 1, 2019 are not sufficient to cover any borrowings under the Credit Agreement that exceed borrowing base availability, and the Company’s merger with Omega has not yet occurred, management would seek an additional modification of its Credit Agreement to remedy the over-advanced position, which may include, but is not limited to, granting the lenders a first mortgage interest in its real estate portfolio in order to secure all amounts outstanding under the Credit Agreement. Based upon preliminary discussions with the lead agent under the Credit Agreement, management believes that a conversion to a mortgaged-back facility is executable and the value of the Company’s real estate investments is sufficient to cover amounts outstanding on the facility.
Interest Rate Swap Agreements
To mitigate exposure to interest rate risk, on February 10, 2017, the Company entered into four interest rate swap agreements, effective April 10, 2017, on the full $125 million term loan to fix the variable LIBOR interest rate at 1.84%, plus the LIBOR spread under the Credit Agreement, which was
2.75% at March 31, 2019 and at May 8, 2019.
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.
The changes in the fair value of derivatives designated and that qualify as cash flow hedges are recorded in Accumulated other comprehensive income. Those amounts reported in Accumulated other comprehensive income related to these interest rate swaps will be reclassified to Interest expense as interest payments are made on the Company’s variable-rate debt. During the next 12 months, the Company estimates that an additional $0.7 million will be reclassified from Other comprehensive income as a decrease to Interest expense.
The fair value of the Company’s derivative financial instruments at March 31, 2019 and December 31, 2018 was an asset of $
1.1
million and $2.2 million, respectively, and was included in Other assets, net on the consolidated balance sheets.
12
The table below details the location in the
consolidated
financial statements of the
gain
(loss)
recognized on interest rate derivatives designated as c
ash f
low hedges for the three
mon
ths ended
March 31
, 201
9
and 2018
(dollars in thousands):
|
|
Three Months Ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Amount of gain (loss) recognized in other comprehensive income
|
|
$
|
(859
|
)
|
|
$
|
1,709
|
|
Amount of gain (loss) reclassified from accumulated other comprehensive income into interest expense
|
|
|
205
|
|
|
|
(78
|
)
|
Total change in accumulated other comprehensive income
|
|
$
|
(1,064
|
)
|
|
$
|
1,787
|
|
As of March 31, 2019, the Company did not have any derivatives in a net liability position including accrued interest but excluding any adjustments for nonperformance risk.
Covenants
The Credit Agreement contains customary financial and operating covenants, including covenants relating to the Company’s total leverage ratio, fixed charge coverage ratio, tangible net worth, maximum distribution/payout ratio and restrictions on recourse debt, secured debt and certain investments. The Credit Agreement also contains customary events of default, in certain cases subject to customary cure periods, including among others, nonpayment of principal or interest, material breach of representations and warranties, and failure to comply with covenants. Any event of default, if not cured or waived, could result in the acceleration of any outstanding indebtedness under the Credit Agreement. The Company was in compliance with all financial covenants as of March 31, 2019.
Note 6 - Incentive Plan
The Company’s Amended and Restated 2014 Equity Incentive Plan (the “Plan”) provides for the grant of stock options, share awards (including restricted common stock and restricted stock units), stock appreciation rights, dividend equivalent rights, performance awards, annual incentive cash awards and other equity-based awards, including Long Term Incentive Plan (“LTIP”) units, which are convertible on a one-for-one basis into units of limited partnership interest in the Company’s operating partnership. As of March 31, 2019, the Plan had 3,356,723 shares authorized for issuance with 2,134,091 shares available for future issuance, subject to certain adjustments set forth in the Plan.
Restricted Stock
Awards of restricted stock are awards of the Company’s common stock that are subject to restrictions on transferability and other restrictions as established by the Company’s compensation committee on the date of grant that are generally subject to forfeiture if employment terminates prior to vesting. Upon vesting, all restrictions would lapse. Except to the extent restricted under the award agreement, a participant awarded restricted stock will have all of the rights of a stockholder as to those shares, including, without limitation, the right to vote and the right to receive dividends on the shares. The awards generally cliff vest over three years or vest ratably over three years from the date of grant. The value of the awards is determined based on the market value of the Company’s common stock on the date of grant. The Company expenses the cost of restricted stock ratably over the vesting period.
Restricted Stock Units
The Company’s restricted stock unit (“RSU”) awards represent the right to receive unrestricted shares of common stock based on the achievement of Company performance objectives as determined by the Company’s compensation committee. Grants of RSUs prior to 2016 generally entitle recipients to shares of common stock equal to 0% up to 100% of the number of RSUs granted at the vesting date, based on two independent criteria measured over a three-year period: (i) the Company’s absolute total stockholder return (“TSR”) and (ii) the Company’s TSR relative to the MSCI US REIT Index (symbol: RMS). Grants of RSUs during and subsequent to 2016 generally entitle recipients to shares of common stock equal to 0% up to 150% of the number of RSUs granted at the vesting date, based on four independent criteria measured over a three-year period: (i) the Company’s growth in gross real estate investments, (ii) the Company’s growth in Adjusted Funds From Operations (“AFFO”) per share, (iii) the Company’s absolute TSR and (iv) the Company’s TSR relative to the FTSE NAREIT Equity Healthcare REIT Index.
RSUs are not eligible to vote or subject to receive dividend equivalents prior to vesting. Dividend equivalents are credited to the recipient and are paid only to the extent the applicable criteria are met, the RSUs vest, and the related common stock is issued.
The grant date fair value of RSUs subject to vesting based on the Company’s absolute TSR and TSR relative to a REIT index is estimated using a Monte Carlo simulation that utilizes inputs such as expected future volatility of the Company’s common stock, volatilities of certain peer companies included in the applicable indexes upon which the relative TSR performance is measured, estimated risk-free interest rate and the expected service periods of three years. The grant date fair value of RSUs subject to vesting based on the Company’s growth in gross real estate investments and the Company’s growth in AFFO per share is determined based on the market value of the Company’s common stock on the date of grant. The Company assesses the probability of achievement of the
13
growth in gross real estate investments and growth in AFFO per share and records expense for the awards based on the probable achievement
of these metrics. The Company recognizes the cost of
RSUs
ratably over the vesting period.
The following tables summarize the stock-based award activity for the three months ended March 31, 2019 and 2018:
|
|
Restricted Stock Awards
|
|
|
Weighted-Average
Grant Date Fair Value Per Restricted Stock Award
|
|
|
RSU Awards
|
|
|
Weighted-Average Grant Date Fair Value Per RSU
|
|
Outstanding as of December 31, 2018
|
|
|
140,618
|
|
|
$
|
11.28
|
|
|
|
458,625
|
|
|
$
|
9.75
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Vested
|
|
|
(26,820
|
)
|
|
|
11.76
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding as of March 31, 2019
|
|
|
113,798
|
|
|
$
|
11.16
|
|
|
|
458,625
|
|
|
$
|
9.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted Stock Awards
|
|
|
Weighted-Average
Grant Date Fair Value Per Restricted Stock Award
|
|
|
RSU Awards
|
|
|
Weighted-Average Grant Date Fair Value Per RSU
|
|
Outstanding as of December 31, 2017
|
|
|
313,819
|
|
|
$
|
13.42
|
|
|
|
660,598
|
|
|
$
|
9.52
|
|
Granted
|
|
|
46,788
|
|
|
|
11.14
|
|
|
|
937
|
|
|
|
11.13
|
|
Vested
|
|
|
(24,232
|
)
|
|
|
13.27
|
|
|
|
(8,312
|
)
|
|
|
9.35
|
|
Outstanding as of March 31, 2018
|
|
|
336,375
|
|
|
$
|
13.11
|
|
|
|
653,223
|
|
|
$
|
9.53
|
|
The table below summarizes compensation expense related to share-based payments, included in general and administrative expenses, for the three months ended March 31, 2019 and 2018 (in thousands):
|
|
For the three months
ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Restricted stock
|
|
$
|
127
|
|
|
$
|
492
|
|
Restricted stock units
|
|
|
373
|
|
|
|
564
|
|
Stock-based compensation
|
|
$
|
500
|
|
|
$
|
1,056
|
|
The remaining unrecognized cost from stock-based awards at March 31, 2019 was approximately $2.4 million and will be recognized over a weighted-average period of 1.4 years.
Upon closing of the announced merger with Omega, as discussed in further detail in Note 3, all unvested restricted shares will vest. All outstanding restricted stock units will be forfeited.
Note 7 - Commitments and Contingencies
Commitments
On January 5, 2018, the Company closed on a construction mortgage note receivable with a maximum principal amount of up to $19.0 million to Haven Behavioral Healthcare, Inc. to fund the purchase and conversion of an existing long-term acute care hospital to a 72-bed inpatient psychiatric hospital in Meridian, Idaho. As of May 8, 2019, the Company has funded the entire $19.0
million pursuant to this commitment.
In April 2017, the Company agreed to make available an aggregate amount of up to $11.0 million for the construction and equipping of certain new surgical suites at Mountain’s Edge Hospital, subject to certain terms and conditions. The base rent associated with this property will be increased by an amount equal to the in-place lease rate, currently 9.5% of the amount advanced, as advances are made. As of May 8, 2019, approximately $8.6 million has been funded pursuant to this commitment.
In connection with entering into the master lease with Creative Solutions, the Company agreed to indemnify Creative Solutions for certain Medicare liabilities up to a maximum amount of approximately $0.8 million. As of May 8, 2019, no claims have been made against this commitment.
Contingencies
From time to time, the Company or its properties may be subject to claims and suits in the ordinary course of business. The Company’s lessees and borrowers have indemnified, and are obligated to continue to indemnify, the Company against all liabilities arising from the operations of the properties and are further obligated to indemnify it against environmental or title problems affecting
14
the real estate underlyi
ng such
facilities. Other than as discussed below, the Company is not aware of any pending or threatened litigation that, if resolved against the Company, would have a material adverse effect on its consolidated financial condition, results of operations o
r cash flows.
Litigation
On February 21, 2019, a purported stockholder of the Company filed a lawsuit against the Company, its board of directors and Omega in the United States District Court for the District of Maryland, entitled
Brekka v. MedEquities Realty Trust, Inc., et al.
, Case 1:19-cv-00535-JKB. The complaint alleges, among other things, that the Company, its board of directors and Omega violated certain federal securities laws by making materially incomplete and misleading statements in, and/or omitting certain information that is material to stockholders from, Omega’s Registration Statement on Form S-4, as filed with the SEC on February 11, 2019 (the “Form S-4”), relating to the proposed merger between the Company and Omega. The complaint seeks, among other things, an injunction preventing the parties from filing an amendment to the Form S-4, an injunction preventing the consummation of the merger and, in the event the merger is consummated, rescission of the merger or damages, plus attorneys’ fees and costs.
On February 22, 2019, another purported stockholder of the Company filed a derivative and class action lawsuit against the Company, its board of directors and Omega in the Circuit Court for Baltimore City, entitled
Scarantino v. McRoberts et al
. The complaint alleges, among other things, violations of fiduciary duties by the Company’s board of directors in connection with its approval of the Company’s proposed merger with Omega and the omission from the Form S-4 of certain information that is material to stockholders. The complaint seeks, among other things, an injunction preventing the parties from filing an amendment to the Form S-4, an injunction preventing the consummation of the merger and, in the event the merger is consummated, rescission of the merger or damages, plus attorneys’ fees and costs.
On March 17, 2019, a purported stockholder of MedEquities filed a class action lawsuit against MedEquities and the MedEquities Board in the United States District Court for the Middle District of Tennessee, entitled
Bushansky v. MedEquities Realty Trust, Inc., et al.,
Case 3:19-cv-00231. The complaint alleges, among other things, that MedEquities and the MedEquities Board violated Section 14(a) of the Exchange Act by making materially incomplete and misleading statements in, and/or omitting certain information that is material to stockholders from, the Form S-4. The complaint seeks, among other things, an injunction preventing the consummation of the merger and, in the event the merger is consummated, rescission of the merger or damages, plus attorneys’ fees and costs.
On March 29, 2019, a purported stockholder of MedEquities filed a class action lawsuit against MedEquities and the MedEquities Board in the Circuit Court for Baltimore County, Maryland, entitled
Russell v. MedEquities Realty Trust, Inc., et al.
, Case No. C-03-CV-19-000721. The complaint alleges, among other things, that MedEquities and the MedEquities Board breached their fiduciary duties by: (i) failing to fulfill their fiduciary oversight function; (ii) authorizing the filing of a materially incomplete and misleading proxy statement/prospectus; and (iii) authorizing in the company’s Amended and Restated Bylaws the enactment of an exclusive venue designation whereby the Circuit Court for Baltimore City, Maryland is the sole and exclusive forum for certain litigation against the company, or if that court does not have jurisdiction, the U.S. District Court for the District of Maryland, Baltimore Division (the “Exclusive Venue Bylaw”). The complaint seeks, among other things, an injunction preventing the special meeting of MedEquities stockholders to vote on the transaction and, in the event the transaction is implemented, rescission of the transaction or damages, a declaration that the Exclusive Venue Bylaw is invalid, an injunction preventing the enforcement of the Exclusive Venue Bylaw, and attorneys’ fees and costs.
The Company believes that the claims asserted in the above referenced lawsuits are without merit and intends to vigorously defend the Company and the director defendants against these claims.
Other
In September 2016, the Company received a Civil Investigative Demand (“CID”) from the U.S. Department of Justice (“DOJ”), which indicates that it is conducting an investigation regarding alleged violations of the False Claims Act, Stark Law and Anti-Kickback Statute in connection with claims that may have been submitted to Medicare and other federal payors for services rendered to patients at Lakeway Hospital or by providers with financial relationships with Lakeway Hospital. The CID requested certain documents and information related to the Company’s acquisition and ownership of Lakeway Hospital. The Company has learned that the DOJ is investigating the Company’s conduct in connection with its investigation of financial relationships related to Lakeway Hospital, including allegations by the DOJ that the Company violated and is continuing to violate the Anti-Kickback Statute and the False Claims Act. The Company is cooperating fully with the DOJ in connection with the CID and has produced all of the information that has been requested to date.
The Company believes that the acquisition, ownership and leasing of Lakeway Hospital through the Lakeway Partnership was and is in compliance with all applicable laws. However, due to the uncertainties surrounding this matter and its ultimate outcome, the Company is unable to determine any estimate or range of loss.
Reference Note 8 for discussion of the common stock dividend to be paid upon stockholder approval of the merger.
15
Note
8
- Equity
Conditional Dividend
On February 27, 2019, the Company announced that its board of directors declared a conditional cash dividend of $0.21 per share, payable to holders of the Company’s common stock as of the record date of March 11, 2019. Payment is conditioned upon the Company’s stockholders’ approval of the merger. If the merger is approved by the Company’s stockholders, the conditional dividend will be paid as soon as practicable following the certification of the results of the special meeting, and the Company will announce publicly the date the conditional dividend will be paid. Due to the contingent nature of the conditional dividend, the Company’s common stock began trading with “due bills,” representing an assignment of the right to receive the conditional dividend, beginning on March 8, 2019 (one business day prior to the March 11 record date for the conditional dividend) through the date the conditional dividend is paid. This dividend will be recorded on the Company’s consolidated balance sheet upon approval by the stockholders of the merger.
The conditional dividend is in addition to, and separate from, the Closing Dividend, which will be payable together with the cash consideration in the merger.
Note 9 - Earnings per Share
The Company applies the two-class method for determining earnings per common share as its outstanding restricted shares of common stock with non-forfeitable dividend rights are considered participating securities. The following table sets forth the computation of earnings per common share for the three months ended March 31, 2019 and 2018 (amounts in thousands, except per share amounts):
|
|
Three Months Ended March 31,
|
|
Numerator:
|
|
2019
|
|
|
2018
|
|
Net income
|
|
$
|
2,103
|
|
|
$
|
6,154
|
|
Less: Net income attributable to noncontrolling
interest
|
|
|
(739
|
)
|
|
|
(985
|
)
|
Net income attributable to common stockholders
|
|
|
1,364
|
|
|
|
5,169
|
|
Less: Allocation to participating securities
|
|
|
(5
|
)
|
|
|
(71
|
)
|
Net income available to common stockholders
|
|
$
|
1,359
|
|
|
$
|
5,098
|
|
|
|
|
|
|
|
|
|
|
Denominator
|
|
|
|
|
|
|
|
|
Basic weighted-average common shares
|
|
|
31,726
|
|
|
|
31,550
|
|
Dilutive potential common shares
|
|
|
9
|
|
|
|
60
|
|
Diluted weighted-average common shares
|
|
|
31,735
|
|
|
|
31,610
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted earnings per common share
|
|
$
|
0.04
|
|
|
$
|
0.16
|
|
Note 10 - Fair Value of Financial Instruments
Financial Assets and Liabilities Measured at Fair Value
The Company’s financial assets and liabilities measured at fair value on a recurring basis currently include derivative financial instruments. These derivative financial instruments are valued in the market using discounted cash flow techniques. These techniques incorporate Level 1 and Level 2 inputs. The market inputs are utilized in the discounted cash flow calculation considering the instrument’s term, notional amount, discount rate and credit risk. Significant inputs to the derivative valuation model for interest rate swaps are observable in active markets and are classified as Level 2 in the hierarchy. The fair value of the Company’s interest rate swaps assets, which are included in Other assets, net on the consolidated balance sheets, was $1.1 million and $2.2 million at March 31, 2019 and December 31, 2018, respectively. See Note 5 for further discussion regarding the Company’s interest rate swap agreements.
Financial Assets and Liabilities Not Carried at Fair Value
The carrying amounts of cash and cash equivalents, restricted cash, receivables, payables and right-of-use assets and lease liabilities are reasonable estimates of their fair value as of March 31, 2019. The fair value of the Company’s mortgages and note receivable as of March 31, 2019 is estimated by using Level 2 inputs such as discounting the estimated future cash flows using current market rates for similar loans that would be made to borrowers with similar credit ratings and for the same remaining maturities. As of March 31, 2019, the fair value of the Company’s $54.6 million of mortgage notes and note receivable was estimated to be approximately $54.7 million.
16
At
March 31, 2019
, the Company’s indebtedness was comprised of borrowings under the credit facility
that bear interest at L
IBOR plus a margin
(Level 2)
. The fair value of borrowings under the credit facility is considered to be equivalent to their carrying value
s
as the debt is at variable rates currently available and resets on a monthly basis.
Fair value estimates are made at a specific point in time, are subjective in nature, and involve uncertainties and matters of significant judgment. Settlement at such fair value amounts may not be possible.
17