MEDICAL PROPERTIES TRUST INC

On January 1, 2019, we adopted Accounting Standards Update (“ASU”) 2016-02, “Leases”, (“ASU 2016-02”). ASU 2016-02 sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). We adopted this standard using the modified retrospective approach and have elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, permits the following: no reassessment of whether existing contracts are or contain a lease; no reassessment of lease classification for existing leases; and no reassessment of initial direct costs for existing leases. Additionally, we made certain elections permitted in accordance with ASU 2018-11, “Leases (Topic 842): – Targeted Improvements.” which (1) permits entities to apply the transition provisions of the new standard at its adoption date instead of at the earliest comparative period presented in its financial statements and (2) permits lessors to account for lease and non-lease components as a single lease component in a contract if certain criteria are met.

As noted earlier, we acquire and develop healthcare facilities and lease the facilities to healthcare operating companies under long-term net leases (typical initial fixed terms ranging from 10 to 15 years) and most include renewal options at the election of our tenants, generally in five year increments. More than 95% of our leases provide annual rent escalations based on increases in the consumer price index (or similar index outside the U.S.) and/or fixed minimum annual escalations ranging from 0.5% to 3.0%.  Many of our domestic leases contain purchase options with pricing set at various terms but in no case less than our total investment.  For five properties with a carrying value of $210 million, our leases require a residual value guarantee from the tenant.  Our leases typically require the tenant to handle and bear most of the costs associated with our properties including repair/maintenance, property taxes, and insurance. We routinely inspect our properties to ensure the residual value of each of our assets is being maintained.  Except for leases noted below as direct finance leases (“DFLs”), all of our leases are classified as operating leases.

We have leased land on which certain of our facilities reside, along with corporate office and equipment. Our leases have remaining lease terms of 5.3 years to 42.5 years, some of which may include options to extend the leases up to, or just beyond, the depreciable life of the properties that occupy the leased land. Renewal options that we are reasonably certain to exercise are recognized in our right-of-use assets and lease liabilities. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at lease commencement date in determining the present value of future payments.

Properties subject to ground leases are subleased to our tenants, except for three Adeptus transition properties.

Net income for the three months ended March 31, 2019, was $75.8 million, compared to $90.6 million for the three months ended March 31, 2018. This decrease is primarily due to expected lower revenues as a result of property sales post the 2018 first quarter including 71 properties sold to form the Primotop joint venture in the 2018 third quarter. This decrease is partially offset by additional revenue from new investments post the 2018 first quarter along with additional straight-line rent revenue recorded from the conversion of Steward mortgage loans to fee simple real estate throughout 2018. Funds from operations (“FFO”), after adjusting for certain items (as more fully described in Reconciliation of Non-GAAP Financial Measures), was $117.8 million for the 2019 first quarter as compared to $131.5 million for the 2018 first quarter. Similar to net income, this decrease in FFO is primarily due to lower revenue from the property sales post March 31, 2018.

Property-related expenses totaled $3.1 million and $2.2 million for the quarters ended March 31, 2019 and 2018, respectively. As noted above under the caption “Other income,” this increase was primarily due to the grossing up of certain expenses (such as ground lease, property taxes and insurance) as part of our implementation of the lease accounting standard on January 1, 2019.

General and administrative expenses totaled $23.5 million for the 2019 first quarter, which is a $5.6 million increase from the prior year first quarter. The majority of the increase relates to stock compensation expense from our performance-based awards. Given our strong performance in 2018 with a total shareholder return of 25% along with our current acquisition pipeline and expectations to close a substantial amount of acquisitions in 2019, we believe it is more likely that such performance awards will be earned and have adjusted our stock compensation expense accordingly.