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Earnings Call Analysis
Summary
Q3-2018
During the recent earnings call, MedEquities focused on its re-tenanting agreement with Creative Solutions, targeting a smooth transition for the Texas Ten Portfolio by early 2019. This deal aims to restore rent income, adding approximately $0.06 to $0.07 per share from quarterly metrics. The company reported a Q3 net loss of $2.1 million and adjusted funds from operations decreasing to $7.1 million due to reduced cash flow from previous tenants. The board has delayed dividend decisions until rent payments start. Continued focus on stabilizing portfolios will be essential for recovery and future growth.
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Good day and welcome to the MedEquities Third Quarter Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Tripp Sullivan of Investor Relations. Please go ahead.
Thank you. Good morning. Welcome to the MedEquities Realty Trust conference call to review the company's results for the third quarter of 2018. On the call today will be John McRoberts, Chairman and Chief Executive Officer; and Jeff Walraven, Executive Vice President and Chief Financial Officer.
Our earnings press release and supplemental package furnished with the SEC on Form 8-K, and our Form 10-Q can be found on the Investor Relations section of our website. A replay of this call will be available shortly after the conclusion of the call through November 19, 2018. The numbers to access the replay are provided in the earnings press release. For those who listen to the replay of this call, we remind you that the remarks made herein are as of today, November 12, 2018 and will not be updated subsequent to this call.
During this call, certain comments and statements we make may be deemed forward-looking statements within the meaning prescribed by the securities laws, including statements related to our 2018 guidance and related assumptions, the future performance of our portfolio and our operators, the re-tenanting of the Texas Ten Portfolio, our future acquisitions and investment activity, financing activities, and the timing and amounts of anticipated cash distributions to our stockholders in the future.
All forward-looking statements represent MedEquities' judgment as of the date of this conference call and are subject to risk and uncertainties that can cause actual results to differ materially from our current expectations. Investors are urged to carefully review various disclosures made by the company, including the risk and other information disclosed in the company's filings with the SEC.
We will also discuss certain non-GAAP measures, including but not limited to FFO, AFFO, and adjusted EBITDAre. Definitions of these non-GAAP measures and reconciliations to the most comparable GAAP measures are included in our earnings press release, which is available at ir.medequities.com.
I'll now turn the call over to John McRoberts. Please go ahead.
Thanks, Tripp. Good morning, everyone, and welcome to the call. We released our earnings, the 10-Q, and supplemental data late Friday and announced the agreement to re-tenant the Texas Ten Portfolio on Saturday. I know many of you were attending the NAREE Conference and were returning home, so I hope you had time to digest our results and disclosures over the weekend.
This morning, I’d like to spend some time on the re-tenanting at the Texas Ten Portfolio and its impact on meeting our amended credit facility requirements, which will be specifically addressed by Jeff later in our comments section. Additionally, we will cover the impact of Texas Ten on our guidance for the remainder of 2018, discuss the rest of our portfolio and the board’s decision to delay any [actions with] dividend, as well as our priorities with the capital we have available.
In our call in August, we indicated that we were prepared to re-tenant or sell all or a portion of the Texas Ten portfolio. In the weeks since then, we’ve been extremely focused on those efforts and are pleased to have this re-tenanting agreement announced and look forward to working further with creative solutions and healthcare.
As part of this process, we’ve remained in close communication with the current tenant on point and anticipate a smooth transition to completion that is targeted for the start of 2019. Creative Solutions has a long history of success in the State of Texas. The two founders Gary Blake and Malisa Blake-Deane formed Creative in 2000 and are well-known in the industry with over 60 skilled nursing and assisted living facilities. We believe they had the second largest SNF platform in Texas with a reputation for quality patient care. They know these markets well and are familiar with the specific’s facilities and the Texas Ten portfolio.
The new 15-year lease provides 7.7 million and annual based rent. The structure of the lease provides this with proforma EBIDTAR rent coverage of 1.32, based on OnPointe’s trailing 12-months results through June 30, and assuming a 5% management fee. We also have the guarantee of the management company and the personal guarantees of the two co-founders serving as additional support for the lease.
We believe re-tenanting this portfolio with the new experienced tenant like Creative is the best long-term decision for the company. With regard to the portfolio, which again Jeff will cover in more details, coverages were higher for the non-SNF operators and slightly down for the other skilled operations.
Now, turning to our fundamental portfolio you will recall that in August, we discussed our plans to differ a portion of the rent on the Mountain's Edge Hospital until March 2019 to allow time for the expansion of the hospital to be completed. In early October, we finalized the agreement for a total of 2.4 million in rent from May 2018 to March 2019. All of the terms of that deferment are consistent with what we outlined in August.
The expansion at the Mountain's Edge Hospital is on going and on target for completion in the late first quarter 2019. We continue to fund that expansion and I have approximately 7 million remaining to be dispersed out of the original 11 million that we committed to fund. With the new OR [ph], we believe fundamental will be able to offer a broad range of surgical services, which should possibly impact patient volumes and operating results.
On October 9, we entered into an amendment to our credit agreement that was necessary primarily because of the ongoing operational and financial difficulties of the Texas Ten portfolio and secondarily due to the partial rent deferral for fundamental. The Texas Ten portfolio was a significant component of our borrowing by supporting our existing outstanding indebtedness and Jeff will discuss this amendment in more detail.
The board delayed making any decision on the dividend until the Texas Ten rent payments commence. We believe this to be a prudent decision. As disclosed in Saturday’s release, the tenant transition still must receive some regulatory approvals over which we had no control, but all signs currently indicate this process can be finished by the start of the year.
Similarly, for the credit facility and our excess capital, the most important thing for us to do is to get the Texas Ten re-tenanting done and lease payments commence. The credit agreement amendment does provide the necessary capital for us to fund our outstanding obligations for the Haven psychiatric hospital at Idaho, which is currently under construction and the Mountain's Edge expansion.
Going forward, our primary focus is on completing and funding commitments we have getting the transition done at the Texas Ten Portfolio and commencement of rent with Creative Solutions, which is a major positive event for us.
Now, let me turn the call over to Jeff who will address our third quarter financial results and revised outlook for 2018.
Thanks John. The company reported a net loss attributable to common stockholders for the third quarter of 2018 of $2.1 million or a loss of $0.07 per share. Adjusted funds from operations for the third quarter was $7.1 million or $0.22 per share. This result is a decrease of $0.08 per share from last quarter. These lower results are directly attributable to converting the existing tenant for the Texas Ten Portfolio to the cash basis of revenue recognition effective at the start of the third quarter.
Net cash applied to rent this quarter from the Texas Ten Portfolio tenant was approximately $500,000, representing a reduction of AFFO of $2.7 million for the quarter. We also wrote-off $4.8 million in a non-cash straight-line rent receivable related to the lease for the Texas Ten Portfolio during the third quarter. This amount was recorded against revenues recognized. This item only affected the GAAP operating results and FFO.
There were some additional items within the operating results this quarter, as compared to second quarter 2018 that I will address in a little more detail. First, the acquisition in late June or the Rehabilitation Hospital in Southern Indiana contributed approximately $600,000 in additional revenues. Second, general and administrative expenses decreased approximately $2.8 million. Included in this number is the effect of the 2 million in transaction cost incurred last quarter that did not recur this quarter.
I would note that these same transaction costs were not included in the determination of AFFO. Additionally, as a result of the company's REITs and performance, expected bonuses to be paid for 2018 to the company's executive management team have been eliminated creating a reduction of $1.1 million.
Of this $1.1 million approximately $700,000 represents the cumulative expenses recognized in the first half of 2018, thus providing a one-time benefit to the reported results for the third quarter that will not recur in the fourth quarter. And lastly, cash interest expense was approximately $400,000 higher as a result of both a higher weighted-average balance outstanding and interest rate as LIBOR continues to increase.
Now, I’ll spend a few minutes on our credit facility. As announced, we entered into an amendment on our credit agreement on October 9. This amendment was necessarily principally because of two matters. First, the ongoing operating and financial difficulties experienced by the tenant of the Texas Ten Portfolio, and second the deferral of a portion of the rent under the Fundamental Master Lease.
The amendment temporarily increased the advance rates on all borrowing base properties other than the Texas Ten Portfolio until December 31, 2018. The Texas 10 portfolio remains in the borrowing base at a reduced availability through that date after which time the borrowing base eligibility and availability criteria revert to their original terms under the credit agreement subject to certain conditions.
As announced, we have executed definitive agreements with Creative Solutions and healthcare to transition the Texas Ten Portfolio. So, we are confident that we are on schedule to satisfy all the conditions for this portfolio to remain borrowing base eligible as stipulated in the amendment that must occur by December 31. Currently, our total borrowing base is approximately $288 million.
We project that we will have sufficient liquidity to keep our borrowings within the borrowing base availability after any adjustments to the Texas Ten Portfolio as of January 1, 2019 and to fund remaining amounts under the Haven construction mortgage loan and Mountain’s Edge expansion project. The company's LIBOR spread increased by 75 basis points on borrowings outstanding effective with the start of the fourth quarter.
The weighted average interest rate on borrowings was 4.1% for the third quarter. Assuming no other changes to LIBOR during the fourth quarter, we would expect cash interest expense for the fourth quarter to increase by approximately $500,000, compared to Q3. Despite all of the activity with our credit facility and the impact of the Texas Ten Portfolio, we have maintained a Conservative debt profile.
At September 30, 2018, the ratio of net debt to gross assets was 38.8%, compared to 38.4% at June 30, 2018. Net debt to consolidated adjusted EBITDAre annualized for Q3 2018 was 5.4 times. I would highlight that this metric was materially affected by the non-payment of rent by the Texas Ten tenant during the quarter. On a pro forma basis, using the expected rents for the new tenant, net debt to proforma consolidated adjusted EBITDAre annualized for Q3 would have been 4.7 times.
Following up on John's comment on portfolio performance, the quarterly supplemental information report contains more detailed rent coverage on our property portfolio. Starting this quarter, while we complete the re-tenant process, we have removed Texas Ten from our stabilized portfolio and all of the coverage metrics reported for our SNF properties reflect this change.
On an aggregate basis, the stabilized portfolio for the trailing 12 months June 30, 2018 had EBITDARM coverage of 2.85 times at the guarantor level and 1.92 times at the facility level, EBITDAR coverage at 2.54 times at the guarantor level and 1.65 times at the facility level. These coverage metrics are all just slightly below last quarter's results, but still well above results from the prior year.
While much attention has rightly been focused on the performance of the Texas Ten Portfolio, we believe these coverage metrics demonstrate the relative strength and resiliency of the rest of the portfolio in the quality of the operators of our stabilized properties. I will now provide an update on 2018 guidance that has been provided in both the earnings press release and the quarterly supplemental information report.
All guidance update reflect the adjustments for the following. First, no revenue recognition for the Texas Ten Portfolio in the fourth quarter as no further rent is assumed to be collected. Rent from the new lease with Creative Solutions subject to the expected regulatory approval would add approximately $0.06 to $0.07 per share to our quarterly operating metrics beginning first quarter 2019.
Second, no additional significant investment activities throughout the remainder of this year, which would have only impacted the high-end of our guidance range as our investing activities through Q3 2018 were already within our expected range. Third, the expected higher interest expense from the Credit Amendment pricing adjustments. And lastly, lower- expected cash G&A expenses. I will highlight the net income and FFO guidance updates also reflect the non-cash write-off of straight-line rent associated with the Texas Ten Portfolio in the third quarter.
In closing, we focused our efforts and resources this quarter on re-tenanting the Texas Ten Portfolio as quickly and prudently as possible. Now that the new tenant is under contract, the smooth transition of operations remains our priority, which we believe will restore some net asset value to the company's portfolio.
Operator, we’re now ready for questions.
[Operator Instructions] The first question comes from Jordan Saddler of KeyBanc. Please go ahead.
Thanks, and good morning. I wanted to spend a minute on Creative Solutions. I know you guys provided a little bit more detail on the presentation that accompanied the press release on Saturday, but can you just describe what their net worth or the overall net worth of that entity is or maybe give us some color around how much of their real estate that they own versus is leased from the third party?
I think the bulk of their SNF’s are leased. They do own some of their assisted living facilities.
Yes. They’ve got relationships Jordan with a number of different people as far as the operating assets that they operate. So, you know prior to our agreement with them they had 55 SNF’s and seven assisted living. Four of those assisted living they do own themselves as a corporate entity. Each of the entities are separate, but they are all owned exactly 50-50 by the two owners. So, effectively the owners are the, you know the holding company. When it comes to there is a couple – there is one public non-traded REIT that has five or six assets. There is another public REIT within our peer group that has a couple of assets and then the rest are generally owned by, I’ll call it private investors and family offices that are [indiscernible].
Okay. Is there any color you can give us around the underwriting of this tenant versus OnPointe or any other perspective tenants you were considering the pipeline that sort of differentiated them and gives you comfort or can give us comfort that this is a good opportunity for shareholders?
Well this company has a longer history. So, it’s easier to look back and see kind of what they’ve done over a long period of time. And before they founded this company, they were in this industry. So, they’ve got steeped experience throughout the industry. So, that’s one differentiating factor. Due to their size, they have a good bit of scale in the Texas market and these assets just enhance that scale. They have steeped history dealing with managed care providers. Stay – even in the political arena. So, there is some marked difference between this operator and OnPointe.
Gary Blake, the prime principle is definitely very heavy into the advancement of the SNF industry within the State of Texas. They are focused in the State of Texas. They’ve been very deep into the efforts and working to reset the Medicaid rates and get the state recognized what it needs to do in that particular state. So, I mean, we dived in-depth into their historical history and the one thing we would point out through the 20 years, they’ve had their ups and the downs and that they’ve been able to whether through those and build through those.
One of their – even one of their statements throughout the process that they had made to us is that in their 20-year history they’ve never missed a rent payment. To any of their landlords and we have, I will say over the process that we’ve been going through in re-tenanting and just looking at all of the different options, as far as them and their operations we had only had heard good things amongst from other operators and other sources.
Okay. It’s helpful. And then just lastly on the dividend, can you speak to whether or not it will be, I mean so, is it being suspended may be, what are the [technical difficulty] under the credit agreement, and I think they have been restricted [technical difficulty] 2019, but maybe just help [technical difficulty] color there?
Well, our board meeting was October 31, I believe. And at that time, we were kind of in advance discussions with a couple of parties who were very interested in the entire portfolio and so we were working with both of those parties, but neither one did sign up here. So that time the board, given the [indiscernible] of land at that point in time, the board decided just [indiscernible] on the third quarter dividend until some of these things kind a felt together and then at which time, and I think that means after they’re regulatory hurdles are cleared and they actually commensurate, the board will decide at that time what to do. That’s how that kind of played out.
And as to just credit facility impacts on the dividend, the way that it was is that, should we not have a resolution to the Texas Ten credit facility had, you know included in the amendment that beginning in 2019, if we did not meet the Texas Ten revaluation criteria, which we are well-along the process of having met that and expect to have that definitely fully completed before the end of the year. But if we had not, the credit facility at that point was then taking the stance that to the extent that we declared that the board wanted to declare dividends, they wanted to input on to that particular part. That was in 2019 and subject to us not completing the Texas Ten resolution.
So, is the $0.21 per share dividend suspended until further review or is it, you’re going to remain in place and the board will decide going forward what ultimately happens with that dividend.
Well the board didn’t make any forward prediction. It just simply delayed any action on the dividend until all these things come settle down, and work in place and functioning. So, I can't predict at this point in time exactly what will happen, but the board will gather together and figure out where they want to take that after the first of the year. In the meantime, those dollars are not being spent in other areas, they are still within the company. So, it’s not like we're getting those money and diverting them to other uses.
No, I get it. I'm just trying to figure out. So, when ordinarily would that dividend would be paid? Third quarter dividend?
Normally at the end of December some time.
The dividend that was delayed would have normally, past practice at that part would have been declared on October 31 and paid last week of November, first week of December.
And right now, that’s not happening?
Right now, it has not yet been declared and the board is…
So, can you speak to whether or not you would have an expectation as to whether or not the dividend would be declared this year or to be paid this year or is that just out of your hands at this point?
I don't think it will be declared or paid in this year because based on the board's decision at the last board meeting it was a function of getting these transactions related to Texas Ten completed and employees and operative. And that won't happen until January 1. So, it would be after the beginning of the year. Whatever decision is made, I will say, had we paid it and declared and paid it in 2018 for what is worth, it would have been 100% of return of capital.
Alright. Thanks guys. I’ll leave the floor. I know there are a lot of people who want to ask questions.
Thanks Jordan.
The next question comes from Smedes Rose of Citi. Please go ahead.
Hi, thanks. Could you just talk about specifically what conditions are necessary to close this lease with Creative healthcare and then also can you, may be discuss a little more the guarantees that you talked about, the personal guarantees, and the management company's guarantees, what is kind of the balance sheet like backing those and what are the limits on the personal guarantee if there were some sort of defaults on the rents, what kind of recourse do you have?
First question was, what is the approval…
Specific conditions to closed the lease?
Yes. It’s regulatory. I mean the lease has been signed, the guarantees have been signed, and the only thing that has to happen is the state has to approve the transfer of the operations, which – there is an operating transfer agreement that is in place between the old tenant and the new tenant, but that has all been signed and so is all regulatory at this point. Now, there’s a lot of heavy lifting to do to transfer at the end of the – to efficiently transfer operations, or a lot of employees have got to go from one company to the other and contracts and things like that, but that’s standard operating procedure in these kinds of situations, but all the documents have been signed and its just regulatory approval that would be the only [indiscernible].
And that’s another part with this particular operator. They have transitioned and acquired, taken over and become the operator of a number of facilities over a number of years. They are well versed in the process, they know how to work with the state regulatory agencies and everything, you always do it in a manner to minimize cash flow interruptions that can occur in the first couple of months relative to Medicare and Medicaid billings, so that you don't create cash strains, and all of that, basically the next 50 days are being spent in full cooperation between OnPointe and Creative.
So that, on January 1 it is a smooth flip of the switch, which will include – and so the only, which we consider the regulatory aspect to be well manageable and no negative result of that that it happens all the time, and we would expect it to file their trials and those trials take 30 days to get approved or technically the state has 30 days to approve them, and that they will do that and it should be done.
Now when you speak to the balance sheet that’s where – from an entity perspective, I want to, you know I was trying to make sure from a technical basis when you look at them. Some companies have holding company's others don’t. The holding company is the two individual and the fact that they own 100% of now 72 operating entities plus management company equally in a 350 basis. From what we show is that from an EBITDAR coverage and a proforma coverage we pointed out on the slide deck, the trailing 12 at June 30 for our Ten is 1.32 times. The trailing 12 on the aggregate for all of it will end up being right at 1.37, 1.38 times for with the other assets that they have that they are operating currently.
So, there is a strong and reasonable EBITDAR coverage. When it does come to the personal guarantees and the – or just the corporate guarantees it was limited to 30 months rent and that’s really a continual recalculation. On day one that’s approximately $19.5 million of guarantee. On both the personal guarantee and management company guarantees combined.
Okay. And then on the dividend, you talked a little bit about it, but I mean, is it a reasonable assumption that given the lower rents now going forward that you would look to kind of reset this dividend as a percent of the payout, and then if you can talk about what your target goal is as a payout ratio?
Well again, I can't predict exactly what the board will end up doing with the dividend. I could say that, I can say that if we held on to the $0.21 going forward, we probably would be in the 85% payout ratio.
Mid-80s.
Mid-80s. So, still acceptable. I mean we like to keep our payout ratio lower just because it’s little more conservative and we think over the long run you get a better value for your equity, if you do that on a consistent basis, but should we stay with the 21%, we would still be well within acceptable payout ratios.
Hi, John it’s Michael Bilerman. So, you said the board met in October when they decided to delay or suspend the fourth quarter dividend, I would assume the board has been in active discussions with the management team in approving the transfer of the new lease. So, why wouldn't the board have come to a decision to be able to put everything behind them and have an updated dividend that can be communicated to the market? It seems kind of strange not to have that.
Well, what the board delayed in the action it was actually the third quarter dividend. Fourth quarter dividend would normally be discussed at our regular board meeting early February. So again, I think the board wants to see this transaction not only signed up, but in effect and the cash actually in our hands before making a final decision.
That would make it seem that there is some risk and you just responded to the fact that this lease is signed, the guarantees are in place and the only thing that needs to happen is it needs to be transitioned from a government approval perspective. So, why wouldn't the board knowing when the cash is coming in be able to tell the market, look our intent is, we're going to skip our third quarter dividend based on the fact that our tenant that comprises 25% of our rent stopped paying this cash, but we have a new lease in place that the intent is going to pay $7.7 million of cash income. It’s all intensive, purposes that they are going to pay it. By the way, if they back out of the [fleet] there is a bigger problem. So, why wouldn't the board, which I assume they have been in close contact in approving this because this is such a major transaction, why wouldn't they simply stay with the dividend policy would be for 2019?
Well, I can say, we have been in close contact with the board as we’ve gone down the path of identifying an appropriate new tenant, but the focus has been on getting all of the documents in place and executed, and we have not met as a board since we have chosen who we're going to work with going forward, and I can't tell you that we won’t have something that comes up before the next board meeting, but it has not been scheduled. So, it hasn't been discussed.
I mean, most companies will be able to convene their board on a call, on a moment's notice to be able to prove major decision. So, I don't know why you have to wait till February, it seems like a long time to have uncertainty in the marketplace, and the market like certainty, anyways. Alright, I will requeue. Thank you.
The next question comes from Bryan Maher of FBR. Please go ahead.
Yes. First, I would like to concur with Citi on that. I think the dividend, some type of decisions should have been announced if not Saturday than this morning because yes, the market like certainty especially with – when it comes to dividend. But shifting gears, as it relates to OnPointe, what can you tell us about your ability to recoup any of the back rent, what type of assets or guarantees where there with OnPointe, and how can they be so incompetent to have done what they did with this portfolio and only pay you $500,000 in the third quarter?
Well, the primary issue with interrupting the cash flow and carving out some for our sales has been in their line of credit. Their lender who is mid-cap has a single line of credit secured by receivables of both our portfolio and of the other assets that OnPointe operates. So, there are eight other assets. So, we do have a second lean of receivables, but those receivables are pledged behind the OnPointe line and OnPointe will continue – I mean behind the mid-cap line and mid-cap will continue to operate and control its line of credit.
Post this transition for the other eight, until they are transitioned to somebody else, so until mid-cap is paid in full, we can't take any action to marshal the equity in the receivables. Now, we do have a strategy that I am not prepared to discuss in this form to capture some of the equity in the receivables related to these assets, the Ten, and we will be attempting to put that in place in anticipation of this transition. So, we’ve got a plan, I just can't discuss it with you.
So, OnPointe though is going to continue to operate these assets throughout the fourth quarter until January 1, but again, you're not expecting to receive any money from them in the fourth quarter? Is that correct?
We’re not. We are not forecasting it. We may be able to collect some, but we're not going to forecast it.
And then can you just give us a little background on how the re-tenanting versus sale of the Texas Ten discussion and kind of thought process was? You know, as opposed to just selling the assets versus the re-tenanting?
We were talking to roughly, I don't know 20, 20 different operators. Some are Texas based, some are regional based, and there was not that much interest in buying the assets. There was a lot of interest in leasing the assets and so going through that process and narrowing down who the real contenders where, and who could get it done quickly and who could actually get it done it came down to two primary companies that provided us with a whole portfolio solution.
We had some that wanted parts of the portfolio, but not other parts, and then we would be left with trying to parcel out the other ones as well, but this whole portfolio of solution that we came up with really provides us with a better kind of overall solution in our mind and there just weren’t a lot of interest in buying the assets.
And then just last from me, other than what’s going on with Texas Ten in fundamental, are there any other tenants within your portfolio that you have any concerns about their ability to pay rent or else?
No.
Okay. Thank you.
The next question comes from Daniel Bernstein of Capital One. Please go ahead.
Hi, good morning. I’m going to try to look forward instead of backward. So, I wanted to understand at this point, if you could just go back over what your liquidity is today and what your liquidity – would you expect your liquidity to be once you satisfy all the bank amendment issues related to fundamental in the Texas Ten, just trying to understand what your capital capability will be next year?
Well, if you look through the rest of the year, we're really focused on making sure that this transition takes place additionally and timely and gets all from the right foot. And we’ve got some assets, some – the Mountain’s Edge and the Haven facilities and we're still funding construction on and we hope to get those kind of finished on time and converted to back to operating assets after the construction is completed. So, we’ve got plenty of capital to do that.
We expect at the end of the year once the transition is completed then we will sit down with the buying's and we will kind of recast our line of credit after the dust settles. So, we do have some capacity to do some smaller deals, but we really and they understand we need to sit down and redo the line of credit, but we all want to wait until all the dust has settled with this transition before we undertake that. And Jeff you may have some other comments.
Go ahead Dan, what you were going to follow-on.
No, I was just going to say – I didn’t know if you want to add onto that. I guess, I was trying to get more of a sense, do you have the capability at some point once you have all the [dust] settled and you start reworking on your pipeline kind of what’s your, what would be the capacity for next year, but that sounds like that’s still early up in the year until you recast the line?
Well, recast to the line is really one of the variables. So, there is multiple variables as we would look to the next steps. Right, so we need to get to the credit facility, it goes back to the previously borrowing base assets. We’ve put out the money for Havens and Mountain’s Edge. There is other receivables and mortgage notes out there that we’ve then recollected and there is a number of other variables that kind of, I would say purely from a debt perspective that’s the only source we’re looking at for capital, there is a few small deals that we could do in there under that assumption only. But as we continue forward, and we continue to bring resolution to all of the different matters there will be and what we would expect is that additional capital options will be available and we will continue to pursue those, identify those and tend to try to make the right decisions as to how to unlock those sources outside of just straight credit facility bank debt.
Okay. That's helpful. And the other question I had on, back to the dividend, under the current rules I mean even if you don't declare this quarter and you're still figuring what to do for the fourth quarter, you probably would have, you probably have to declare some level of dividends. I catch up dividend of some kind would that be right. I just want to make sure I understand?
No, for 2018…
I think somebody was asking, if the 2021 was just gone or whether [indiscernible]?
For 2018, basically on a REIT basis you got to distribute 90% of your taxable income to be within the REIT rules. Generally, you distribute at least 100% of your taxable income. At this point, based on our current taxable income calculations, we would not have to declare and pay any additional dividend in 2018 to have fully absorbed what taxable income projections for 2018. So, to the extent we declared and paid still within this year it would increase the return of capital portion of this year's dividend allocation.
So, the board just fully felt that it was prudent to wait and see the results and it wasn't prepared to set a level at this time, but let this all settle itself out and make that decision. Now, as to 2019, clearly, no we could not stay in a suspended dividend and meet the REIT rules in 2019. So that’s and we really haven't been using the term suspension. It has been delaying the board's decision as we complete the resolution.
Okay. And then one last question. I just want to understand the skilled nursing coverage ex the Texas Ten decreased a little bit, is that just all Mira Vista? I think you alluded to earlier in the call that you really don't have any other issues with tenants, but I just want to make sure I understood what was going on there in that coverage, it was just that one property, if there is some more broad?
Yes, in general it would have been more Mira Vista, mostly Mira Vista as far as the 1.39 to 1.32.
Okay. Can you talk about what fundamentals has done to kind of remedy that or what actions they have taken and then I will hop-off the line for others?
Well, they’ve gone through several different administrators there which is good to try to identify new people because the local administrator in these facilities is extremely important, but they’ve not found the right one for that facility in that market and unfortunately, they’ve gone through a few of those over the last two years and that’s – it’s good that they are trying, but it is bad for to have that kind of turnover in your leadership.
So, they still believe that that is a good facility that it should be doing a lot better than it is and they are still searching for the right person to lead that facility. We’ve talked to them about would they be interested in having somebody else to take that over and they kind of insisted that they want that facility, they think it’s a good facility and it’s correctable. So, it’s finding the right leadership in that market. But they are still committed to it.
Okay. Appreciate it. That’s all I have. Thank you for taking the questions.
The next question comes from Michael Carroll of RBC Capital Markets. Please go ahead.
Yes, thanks. Can you guys talk a little bit about the current operating trends of the Texas Ten Portfolio, I know last quarter you highlighted that they had trouble collecting receivables, are they collecting those receivables now and where has occupancy gone throughout the third quarter so far in skill mix given the expected transition, has that changed over the last quarter or so?
Well, with respect to the receivables, what they were having trouble collecting is receivables that had aged quite a bit. So, they are having minimal success in collecting those variable receivables. I think they are collecting their current receivables on a normal basis. So, what was the…
On the occupancy trends. The occupancy of third quarter over second quarter has been an uptick. The second quarter was less than first, but third quarter is greater than second on occupancy.
Okay. Then how do you think about that’s going to trend as you move into the fourth quarter, given that the tenant is expected to vacate? I mean are they still interested in improving operations at that asset or should we expect a decline going into the fourth quarter and has Creative Solutions underwritten that decline?
I would actually say that from the, I’ll call it the character of our current tenant is that – and especially the management there that is in the day-to-day. Their character there is not one to just, okay, I'm going to check out in this last 50 days and like clinical quality fall, and ignore that. They understand the necessity of a smooth transition and the value of that transition to all parties at play, and so I would not be predicting that our tenant, our current tenant in the last 50 days is just going to throw of its hands and not do anything.
They’ve already, you know, Creative had already absorbed one OnPointe facility earlier this year that wasn’t owned by us. That was owned by another party in one of the same markets, and has successfully transitioned that and like I said we don’t – I don’t expect a negative behavior out of OnPointe during this transition period. We have worked with them they are going to work with us.
I would say in the field and the individual markets they are probably very excited about this transition.
Okay. Then what actually happened in the third quarter that drove the missed rent payments, so is there something at the OnPointe corporate level that didn’t pay those. Did their credit facility vendor, basically they’ve tripped a covenant and they didn’t allow them to make those payments, what actually happened this quarter?
Well mid-cap is as, I think we’ve discussed in the past, the mid-cap line of credit has gone from half 2018 or so, million down to what is it today?
Combining 12.
Combining 12. So, you’ve got $6 million in shrinkage there. A lot of that had to do with some other these old receivables that aged out and got out. We’re not borrowing base eligible under their line of credit. So, mid-cap is, mid-cap has taken the cash and the only cash that has been available to OnPointe has been to bank its payroll, keep the vendor somewhat happy and continuing to vend and so that’s what’s happening.
Okay. Then last questions, off of what Dan was saying, about related to fundamental, did you say that they don’t have the right leadership yet to stabilize the Mountain’s Edge property and how are they going to finance, so I guess that’s not on solid footing yet?
Well, now they’ve gone through two or three different administrators over the last…
Dan was talking about Mira Vista. Mike talked about Mountain’s Edge, but I think Mike you were potentially confusing Dan’s question and so – and John’s discussion on the leadership changes was specific to the Fort Worth, Texas, Mira Vista property with fundamental, not Mountain’s Edge, Las Vegas property.
Okay. And then how’s the Mountain’s Edge property doing?
Well currently it’s not performing as it should be, but they are undergoing an expansion to add five operating rooms and the expansion consumed and shut down two procedure rooms, so it is not doing what it normally would be doing, but these five ORs, once they are complete, they’ve got a group of orthopedic surgeons who were ready and waiting to start doing a lot of procedures there. So, we are – it’s on schedule to be completed. We think it will be completed before the end of the first quarter and it will start ramping up from there. And we’ve met with these doctors on a number of occasions and they are still anxious to have this project completed.
Okay, great. Thank you.
The next question comes from Mike Mueller of JPMorgan. Please go ahead.
Hi. Couple of questions here. First of all, going back to the dividend for a second, in the slide deck, it specifically says that achieving one of the primary performance hurdles under the agreement is basically restoring some of the borrowing capacity and lowering the borrowing cost, it doesn't mention anything about the dividend, so can you just remind us is once it is designed are the lenders going to have any say whatsoever in terms of what you do with the dividend?
No. I mean their positioning was, you’ve lost a good bit of cash flow out of this tenant and we want to see that restored, and if it is not restored, we certainly want to have some say so in terms of cash leaving the company in the form of a dividend.
And I mean, outside of that the only place we have a distribution covenant that has always been there, that’s 95% of bank defined AFFO, but that’s not a [mother may I] type thing, that’s just a distribution limitation as defined within the credit agreement that’s a financial covenant that we have to honor.
And we’ve always said that.
Yes. It’s always been there.
Yes. I mean I just bring that up because the press release explicitly said that and in the slide deck it basically says that this new lease remedy is only one of them not the other. So, that’s why I was asking. And I guess the second question is if you're looking at that Texas Ten Portfolio is the EBITDA of it expected to go back to where you originally under write it or is it permanently impaired and running down at that level? Can you just give some color about expectations there?
Well. We’re not forecasting significant increases to it, although with this operator and scale they have and the things they can bring to bear with their existing relationships with the payers and insurance companies and their ability to put more of these facilities in the quick program. We expect that that will increase, but we’re not making any focus to effect fact right now.
Okay. And last part of the question. The renewal options on the lease. I know it’s up 15 years, but is that a market level reset, so let’s say because if EBITDA is running really low right now and they do get it right and it takes it back to where it was before. You get a chance to reset the lease based on market coverage at that point in time?
It is not a market value renewal. It is a continuation of the 2% bumps from that particular point.
Okay. That was it. Thank you.
And we have a follow-up from Smedes Rose of Citi. Please go ahead.
Hi, it is Michael Bilerman again. So, during the quarter, Goldman had filed a 13-B and within that they said, they were having discussions with management regarding transactions. Where they at all involved as one of the 20 bidders you talked about relating to this portfolio or is it something completely different?
Well, they were not one of the bidders for the portfolio with respect to any other conversations we have with them. We can't comment on that.
So, what exactly would they be evaluating in their engagement in a transaction with MedEquities in terms of having those discussions? I mean what would it be, what would a normal course of action be in that regard?
Well, we obviously can't comment on that. So, I doubt they would either, but you can try.
And then can you help us understand, I guess what sort of process or processes are you running outside of re-tenanting OnPointe, do you have a strategic alternatives process being done are you looking to sell the company at all?
Well, we’re always cognizant of opportunities that may be out in the marketplace to enhance the value to our shareholders. We have not hired anybody to run a process. So, but we listen to people.
So, you haven't hired any bank to advise you?
We have not hired anybody to run a process for us.
How should we think about typically when there is some form of activism, companies have both investment banking and legal expenses and sometimes as they capitalize and sometimes as they are expensed? You obviously hadn't expensed last quarter of some fee which you still haven't disclosed what that was regarding too.
Should we expect that if you're engaging with investment banks, even if they are not running a process, but acting in somewhat of a defense right, it’s not normal for a shareholder to go and start being active with you. Did those costs are being currently being capitalized or would you be expensing them?
It depends on the nature. If you just – the accounting rules are pretty…
Pretty cut and dry on this one. The transactional expense is related to an M&A type transaction would all be expensed. Unless you're doing an asset acquisition, are you able to capitalize those expenses and then put those expenses into a closed acquisition. Now, what many in real estate might consider in asset acquisition can also be determined to be a business combination for accounting purposes and those expenses will be expensed. Those costs will be expensed on and as incurred basis and so, I mean that’s when you cut it down it’s, anything that is a business combination whether even if it is just acquiring an asset, those are expensed. And M&A cost would be expensed.
So, what was the 2 million last quarter then?
As we've disclosed, it was a transactional cost.
Related to what?
We can't comment on that Michael.
All of those activities continuing or those have stopped?
Well in my prepared remarks I had said those were, we didn’t recur. Those expenses were the second quarter and they did not recur in the third quarter.
Activism costs, it appears that companies have leeway, we’ve seen company’s expenses as they go, but have also seen companies come out nine months after the fact, after they’ve been billed, expensed them. So that’s why I was trying to better understand if you have one of your largest shareholders engaging in discussions with you, whether you have legal and bank advise that you are currently capitalizing in that regard. I assume you're not entering in these discussions without having any representation?
Well, anything that would come up that would involve any kind of combination, M&A, activism whatever we would have, legal representation. I can tell you that there is nothing that we’re engaged in right now that could be construed as an activist situation.
And then just coming back in the dividend, I guess are you going to try to provide some certainty and get the board together prior to February to at least put out some…?
I’m sure we will have discussions with our board in an informal sense, whether that translates to a formal meeting and a formal action on it. I can't tell you right now.
Okay. Thank you.
And we have a follow-up from Jordan Saddler from KeyBanc. Please go ahead.
Hi, thank you. So, first of all, I had just a follow-up on the transaction cost, I think there was another 600,000 this quarter, is that right Jeff?
$600,000 of cost that we had that we have previously capitalized for asset-related acquisitions that were expensed this quarter for transactions that have now been formally abandoned at this point.
So, that would be different than 2 million from last quarter?
Right. As I described, asset acquisitions in the real estate world for a long time have crossed on to both sides, depending on certain facts and circumstances, some are treated as business combinations, and some are treated as asset acquisitions and to the extent that they are – that they meet the asset acquisition side they are capitalized while incurred and capitalized if completed or expensed when no longer considered probable. And that – the 600,000 this quarter were transactions that were definitely classified as asset acquisitions and as of this quarter we’re determined to not be probable and therefore expensed.
Okay. And so, I guess moving on to looking out and looking forward to a little bit for the company, I mean what’s next John, I mean for MRT, I mean, is there, are you pursuing a process I think last quarter, I knew you haven't engaged anybody that [shocked] the company per se, but I think you said, there are lots of options on the table here, and I'm just curious given sort of the most recent discussions with the board, what is the strategic thought process of the company going forward?
Well, I think if we go into 2019 and beyond, we’ve got to address our overhead situation. I mean, the company's overhead was built to be a bigger company and we all thought we would get there sooner. So, we would certainly make some decisions there and I think we’ve got to get in, and we got to deal with the banks and get our bank credit facility kind of recalibrated based on where we are today.
So, we would do that. We would look at our overhead and then before, but at the same time, we’re not, I mean, we’re looking for other, we are listening to other alternatives and we get those a lot. We have investment bankers talking to us. We have some unsolicited inbound calls, especially since the Bloomberg article went out there and said we had hired somebody to represent us, which was inherent assumption, but nevertheless [indiscernible]. So, we got to [ear to the rail]. And we’re open.
Okay. But for now, it’s more of a listening rather than a process you guys are personally driving?
We were actively talking with somebody. You know, we couldn't comment on it anyway. So, I mean we can't comment on.
Okay. And then two other business questions, just sort of Baylor, Memorial Hermann merger, any thoughts on how that impacts your hospital either as a credit or may be their decision to exercise the option?
They’ve not indicated to us any inclination to exercise the option. It doesn't mean they won't, but they’re just not prepared to tell us anything about it right now. I think the reason is, they have got so much going on, not only in Austin market, but across Texas that that may be a little priority for them. If you remainder the reasons that option is in there is in case, they needed to meaningfully expand that campus they didn't want to be bound by our kind of, by the REIT world’s returns given their capital in general. So, they needed to get a way out of it. So, absent that need in the short run, it is to me, it is just a priority of all the things that they have got going across the state of Texas and whether they could or would consider spending $200 million just to buy the hospital. I don't know.
We can't comment on it because they can't comment on it or won't comment on it. We do feel that the combination that they are going to go, you know that they're looking to close with themselves and Memorial Hermann is a credit to expanding and credit enhancement to the overall entity. It’s not a detriment to the Baylor credit quality.
Okay. And then one more as it related to OnPointe, the mid-cap line in credit, you said there is 12 million currently outstanding on that working capital loan?
Approximately yes. I mean, it fluctuates on a regular basis.
10 million to 12 million, generally.
Okay, in that range. And because I guess, just looking at their EBITDAR coverage based on the new rent that you guys have in place it seems that there would a couple $3 million of excess cash flow above and beyond even in new rent. So, but obviously looking at the EBITDAR it seems significant enough that there should be room to pay something. Am I thinking about this correctly?
There are definitely things that came into, I’ll call it the third quarter. There are certain annual things like insurance renewables that take place. I know – in their part that takes place in July, August time frame. The – for them specifically with the New Mexico portion of their operations etcetera on a cash et cetera of their part they had a major insurance renewal that you can't, there are certain needs to be able to and payments that would have to be made for them to be able to keep quality client patient service going and that being critical some of those items definitely took up certain pieces of cash flow during the third quarter.
Okay. What was that?
So, we would think there should be some money there to the payers based on the exact analysis you're going through, but there are other things that have to be made to keep the doors open and keep the company from [imploding] and then mid-cap is, their control on the cash basically.
Okay. And then just lastly on the portfolio, sorry to jump around a bit here, but was this portfolio or is there anything you talked about maybe scaling or re-fueling the G&A, the overhead to reflect the company's side that I guess one could argue that the company's size and scale that you guys are kind of in a box vis-à-vis, the overall size of the company for being a public company. Are there any assets that makes sense to monetize opportunistically at this point that are fairly priced in the private market may be appeared as not be appropriately reflected the stock price today?
Well, I think before we can go down that road, we have to stabilize the portfolio and get the Texas Ten transition done because until that time everybody you talk to just assumes you are in a bad spot have to sell and the kind of numbers you might be talking about are just not really acceptable. So, you get yourself in a stabilized situation and then you can deal on a fair basis with people. But yes, that’s part of what we would be looking at in 2019.
Thank you, very much.
And we have a follow-up from Daniel Bernstein of Capital One. Please go ahead.
Hi. I’ll keep it short since most of the questions were answered. Did you guys say what the corporate coverage was for the Creative Solutions lease, not just at facility level, but the corporate?
Yes, I think we said like 1.37, 1.38.
Okay. I had missed that. Okay. That was it. Thanks.
This concludes our question-and-answer session. I would like to turn the conference back over to John McRoberts. Chief Executive Officer for any closing remarks.
Well, thanks everybody for participating on the call, and as always, we're available to follow-up calls, should you want to talk to us further. So, just reach out to us, if you want to do that. Thanks.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.