Summary of Significant Accounting Policies

6 Months Ended

Jun. 30, 2019

Summary of Significant Accounting Policies

The summary of significant accounting policies presented below is designed to assist in understanding the Company’s condensed consolidated financial statements. Such condensed consolidated financial statements and the accompanying notes thereto are the representation of management. These accounting policies conform to United States generally accepted accounting principles, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of a normal and recurring nature considered for a fair presentation, have been included. Operating results for the three and six months ended June 30, 2019, are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

The condensed consolidated balance sheet at December 31, 2018, has been derived from the audited consolidated financial statements at that date but does not include all of the information and notes required by GAAP for complete financial statements. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements as of and for the year ended December 31, 2018, and related notes thereto set forth in the Company’s Annual Report on Form 10-K, filed with the SEC on March 22, 2019.

Principles of Consolidation and Basis of Presentation

The accompanying condensed consolidated financial statements include the accounts of the Company, the Operating Partnership, and all wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of the condensed consolidated financial statements and accompanying notes in conformity with GAAP requires the Company to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. These estimates are made and evaluated on an ongoing basis using information that is currently available as well as various other assumptions believed to be reasonable under the circumstances. Actual results could differ from those estimates.

Restricted Cash

Restricted cash consists of restricted cash held in escrow and restricted bank deposits. Restricted cash held in escrow includes cash held by lenders in escrow accounts for tenant and capital improvements, repairs and maintenance and other lender reserves for certain properties, in accordance with the respective lender’s loan agreement. Restricted cash held in escrow is reported in other assets, net, in the accompanying condensed consolidated balance sheets. Restricted bank deposits consist of tenant receipts for certain properties which are required to be deposited into lender-controlled accounts in accordance with the respective lender's loan agreement. Restricted bank deposits are reported in other assets, net, in the accompanying condensed consolidated balance sheets. See Note 7—"Other Assets, Net."

The following table presents a reconciliation of the beginning of period and end of period cash, cash equivalents and restricted cash reported within the condensed consolidated balance sheets to the totals shown in the condensed consolidated statements of cash flows (amounts in thousands):



	Six Months Ended June 30,
Beginning of period:	2019		2018
Cash and cash equivalents	$	43,133	$	336,500
Restricted cash	168		15,414		⁽¹⁾
Cash, cash equivalents and restricted cash	$	43,301	$	351,914

End of period:
Cash and cash equivalents	$	28,202	$	37,787
Restricted cash	168		1,900		⁽¹⁾
Cash, cash equivalents and restricted cash	$	28,370	$	39,687


(1)	Amount is attributable to continuing and discontinued operations.

Impairment of Long Lived Assets

The Company continually monitors events and changes in circumstances that could indicate that the carrying amounts of its real estate and related intangible assets may not be recoverable. When indicators of potential impairment suggest that the carrying value of real estate and related intangible assets may not be recoverable, the Company assesses the recoverability of the assets by estimating whether the Company will recover the carrying value of the assets through its undiscounted future cash flows and their eventual disposition. If, based on this analysis, the Company does not believe that it will be able to recover the carrying value of the assets, the Company will record an impairment loss to the extent that the carrying value exceeds the estimated fair value of the assets.

When developing estimates of expected future cash flows, the Company makes certain assumptions regarding future market rental income amounts subsequent to the expiration of current lease arrangements, property operating expenses, terminal capitalization and discount rates, the expected number of months it takes to re-lease the property, required tenant improvements and the number of years the property will be held for investment. The use of alternative assumptions in the future cash flow analysis could result in a different determination of the property’s future cash flows and a different conclusion regarding the existence of an impairment, the extent of such loss, as well as the carrying value of the real estate and related assets.

In addition, the Company applies a market approach using comparable sales for certain properties. The use of alternative assumptions in the market approach analysis could result in a different determination of the property’s estimated fair value and a different conclusion regarding the existence of an impairment, the extent of such loss, if any, as well as the carrying value of the real estate and related assets.

Impairment of Real Estate

During the three and six months ended June 30, 2019, no impairment losses were recorded on real estate. During the three and six months ended June 30, 2018, real estate assets related to one healthcare property with an aggregate carrying amount of $47,375,000 were determined to be impaired, using Level 2 inputs of the fair value hierarchy. The carrying value of the property was reduced to its estimated fair value of $41,544,000, resulting in an impairment charge of $5,831,000, which is included in impairment loss on real estate in the condensed consolidated statements of comprehensive (loss) income.

Impairment of Acquired Intangible Assets and Acquired Intangible Liabilities

During the three months ended June 30, 2019,no impairment losses were recorded on acquired intangible assets or acquired intangible liabilities. During the six months ended June 30, 2019, the Company recognized an impairment of one in-place lease intangible asset in the amount of approximately $1,469,000 and an impairment of one below-market lease intangible liability in the amount of approximately $407,000, related to a tenant of the Company experiencing financial difficulties, by accelerating the amortization of the intangible asset and intangible liability.

During the three months ended June 30, 2018, no impairment losses were recorded on acquired intangible assets or intangible liabilities. During the six months ended June 30, 2018, the Company recognized an impairment of one in-place lease intangible asset in the amount of approximately $21,296,000 related to a former tenant of the Company, by accelerating the amortization of the intangible asset.

Revenue Recognition, Tenant Receivables and Allowance for Uncollectible Accounts

Effective January 1, 2018, the Company recognizes non-rental related revenue in accordance with Accounting Standards Codification, or ASC, 606, Revenue from Contracts with Customers, or ASC 606. The Company has identified its revenue streams as rental income from leasing arrangements and tenant reimbursements, which are outside the scope of ASC 606. The core principle of ASC 606 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Non-rental revenue, subject to ASC 606, is immaterial to the Company's condensed consolidated financial statements.

The majority of the Company's revenue is derived from rental revenue, which is accounted for in accordance with ASC 842, Leases, or ASC 842. In accordance with ASC 842, minimum rental revenue is recognized on a straight-line basis over the term of the related lease (including rent holidays). For lease arrangements when it is not probable that the Company will collect all or substantially all of the remaining lease payments under the term of the lease, rental revenue is limited to the lesser of the rental revenue that would be recognized on a straight-line basis or the lease payments that have been collected from the lessee. Differences between rental revenue recognized and amounts contractually due under the lease agreements are credited or charged to straight-line rent receivable or straight-line rent liability, as applicable. Tenant reimbursements, which are comprised of additional amounts recoverable from tenants for common area maintenance expenses and certain other recoverable expenses, are recognized when the services are provided and the performance obligations are satisfied.

Prior to the adoption of ASC 842, tenant receivables and straight-line rent receivables were carried net of the provision for credit losses. The provision for credit losses was established for estimated losses resulting from the inability of certain tenants to meet the contractual obligations under their lease agreements. The Company’s determination of the adequacy of these provisions was based primarily upon evaluations of historical loss experience, the tenant’s financial condition, security deposits, letters of credit, lease guarantees, current economic conditions and other relevant factors. Effective January 1, 2019, upon adoption of ASC 842, the Company is no longer recording a provision for credit losses but is, instead, assessing whether or not it is probable that the Company will collect all or substantially all of the remaining lease payments under the term of the lease. Where it is not probable that the Company will collect all or substantially all of the remaining lease payments under the term of the lease, rental revenue is limited to the lesser of the rental revenue that would be recognized on a straight-line basis or the lease payments that have been collected from the lessee. For the three months ended June 30, 2019 and 2018, the Company recorded $451,000 and $7,097,000, respectively, and for the six months ended June 30, 2019 and 2018, the Company recorded $1,226,000 and $36,023,000, respectively, in bad debt expenses as a reduction in rental revenue in the accompanying condensed consolidated statements of comprehensive (loss) income.

Notes Receivable

Notes receivable are reported at their outstanding principal balance, net of any unearned income, unamortized deferred fees and costs and allowances for loan losses. The unamortized deferred fees and costs are amortized over the life of the notes receivable, as applicable and recorded in interest and other expense, net in the accompanying condensed consolidated statements of comprehensive (loss) income.

The Company evaluates the collectability of both interest and principal on each note receivable to determine whether it is collectible, primarily through the evaluation of credit quality indicators, such as the tenant's financial condition, collateral, evaluations of historical loss experience, current economic conditions and other relevant factors, including contractual terms of repayments. Evaluating a note receivable for potential impairment requires management to exercise judgment. The use of alternative assumptions in evaluating a note receivable could result in a different determination of the note's estimated fair value and a different conclusion regarding the existence of an impairment, the extent of such loss, if any, as well as the carrying value of the note receivable.

As of June 30, 2019 and December 31, 2018, the aggregate balance of the Company's note receivable was $2,700,000. The principal balance of the Company's note receivable is secured by its collateral.

For the three months ended June 30, 2019 and 2018, the Company recorded $0 and $989,000, respectively, and for the six months ended June 30, 2019 and 2018, the Company recorded $0 and $2,179,000, respectively, in provision for loan losses in the accompanying condensed consolidated financial statements.

Concentration of Credit Risk and Significant Leases

As of June 30, 2019, the Company had cash on deposit, including restricted cash, in certain financial institutions that had deposits in excess of current federally insured levels. The Company limits its cash investments to financial institutions with high credit standings; therefore, the Company believes it is not exposed to any significant credit risk on its cash deposits. To date, the Company has experienced no loss of or lack of access to cash in its accounts.

As of June 30, 2019, the Company owned real estate investments in 32 metropolitan statistical areas, or MSAs, two of which accounted for 10.0% or more of total rental revenue. Real estate investments located in the Houston-The Woodlands-Sugar Land, Texas MSA and the San Antonio-New Braunfels, Texas MSA accounted for an aggregate of 18.0% and 12.7%, respectively, of total rental revenue for the six months ended June 30, 2019.

As of June 30, 2019, the Company had three exposures to tenant concentration that accounted for 10.0% or more of total rental revenue. The leases with Post Acute Medical, LLC, Board of Regents of the University of Texas System and 21st Century Oncology, Inc. accounted for 17.8%, 17.3% and 10.8%, respectively, of total rental revenue for the six months ended June 30, 2019.

Share Repurchase Program

The Company’s share repurchase program allows for repurchases of shares of the Company’s common stock when certain criteria are met. The share repurchase program provides that all repurchases are limited to those that can be funded with equivalent reinvestments pursuant to the distribution reinvestment plan, or the DRIP, during the prior calendar year and other operating funds, as the Company's board of directors may authorize for this purpose.

Repurchases of shares of the Company’s common stock are at the sole discretion of the Company’s board of directors, provided, however, that the Company will limit the number of shares repurchased during any calendar year to 5.0% of the number of shares of common stock outstanding as of December 31 of the previous calendar year. In addition, the Company will further limit the amount of shares repurchased each quarter, subject to adjustments in accordance with the 5.0% annual share limitation. The Company’s board of directors, in its sole discretion, may suspend (in whole or in part) the share repurchase program at any time, and may amend, reduce, terminate or otherwise change the share repurchase program upon 30 days' prior notice to the Company’s stockholders for any reason it deems appropriate.

In connection with entering into the Merger Agreement, on April 10, 2019, the Company's board of directors approved the Third Amended and Restated Share Repurchase Program, or the Third Amended & Restated SRP, which became effective on May 11, 2019, and was applied beginning with repurchases made on the 2019 third quarter Repurchase Date (as defined in the Third Amended & Restated SRP). Under the Third Amended & Restated SRP, the Company only repurchases shares of common stock in connection with the death, qualifying disability or involuntary exigent circumstance (as determined by the Company's board of directors, in its sole discretion) of a stockholder, subject to certain terms and conditions specified in the Third Amended & Restated SRP. Further, under the Third Amended & Restated SRP, if the Company does not repurchase all of the shares for which repurchase requests were submitted in any quarter, outstanding repurchase requests will not automatically roll over to the subsequent quarter.

During the six months ended June 30, 2019, the Company repurchased approximately 5,528,000 shares of common stock for an aggregate purchase price of approximately $29,467,000 (an average of $5.33 per share). During the six months ended June 30, 2018, the Company repurchased approximately 9,309,000 shares of common stock for an aggregate purchase price of approximately $64,212,000 (an average of $6.90 per share).

Distribution Policy and Distributions Payable

In order to maintain its status as a REIT, the Company is required to make distributions each taxable year equal to at least 90% of its REIT taxable income, computed without regard to the dividends paid deduction and excluding capital gains. To the extent funds are available, the Company intends to continue to pay regular distributions to stockholders. Distributions are paid to stockholders of record as of the applicable record dates. Distributions are payable to stockholders from legally available funds therefor.

In connection with the REIT Merger, on April 10, 2019, the Company's board of directors approved the suspension of the Company’s distribution reinvestment plan, or DRIP, with respect to certain distributions that accrued starting in April 2019. Therefore, starting with the April 2019 distributions, which were paid on the first business day of May 2019, all distributions are paid in cash to all stockholders.

Earnings Per Share

The Company calculates basic earnings per share by dividing net (loss) income attributable to common stockholders for the period by the weighted average shares of its common stock outstanding for that period. Diluted earnings per share are computed based on the weighted average number of shares outstanding and all potentially dilutive securities. Shares of non-vested restricted common stock give rise to potentially dilutive shares of common stock. For the three months ended June 30, 2019, diluted earnings per share was computed the same as basic earnings per share because the Company recorded a loss from continuing operations, which would make potentially dilutive shares related to non-vested shares of restricted common stock, antidilutive. For the six months ended June 30, 2019, diluted earnings per share reflected the effect of approximately 22,000 of non-vested shares of restricted common stock that were outstanding as of such period. For the three and six months ended June 30, 2018, diluted earnings per share was computed the same as basic earnings per share because the Company recorded a loss from continuing operations, which would make potentially dilutive shares related to non-vested shares of restricted common stock, antidilutive.

Derivative Instruments and Hedging Activities

As required by ASC 815, Derivatives and Hedging, or ASC 815, the Company records all derivative instruments as assets and liabilities in the statement of financial position at fair value. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge or a hedge of a net investment in a foreign operation. For derivative instruments not designated as hedging instruments, the income or loss is recognized in the condensed consolidated statements of comprehensive (loss) income during the current period.

The Company is exposed to variability in expected future cash flows that are attributable to interest rate changes in the normal course of business. The Company’s primary strategy in entering into derivative contracts is to add stability to future cash flows by managing its exposure to interest rate movements. The Company utilizes derivative instruments, including interest rate swaps, to effectively convert some of its variable rate debt to fixed rate debt. The Company does not enter into derivative instruments for speculative purposes.

In accordance with ASC 815, the Company designates interest rate swap contracts as cash flow hedges of floating-rate borrowings. For derivative instruments that are designated and qualify as cash flow hedges, the gain or loss on the derivative instrument is reported as a component of other comprehensive income (loss) in the condensed consolidated statements of comprehensive (loss) income and reclassified into earnings in the same line item associated with the forecasted transaction and the same period during which the hedged transaction affects earnings. See additional discussion in Note 12—"Derivative Instruments and Hedging Activities."

The Company reflects all derivative instruments at fair value as either assets or liabilities on the condensed consolidated balance sheets. In accordance with the fair value measurement guidance Accounting Standards Update, or ASU, 2011-04, Fair Value Measurement, the Company made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

Recently Adopted Accounting Pronouncements

Leases

In February 2016, the Financial Accounting Standards Board, or FASB established ASC 842, by issuing ASU 2016-02, Leases, which replaces the guidance previously outlined in ASC 840, Leases. The new standard increases transparency by requiring the recognition by lessees of right-of-use, or ROU, assets and lease liabilities on the balance sheet for all leases with a term of greater than 12 months, regardless of lease classification. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.

The Company adopted ASC 842 effective January 1, 2019, using the modified retrospective approach. Consequently, financial information is not be updated, and the disclosures required under the new standard are not be provided for dates and periods before January 1, 2019. Further, the Company is amortizing the ROU assets and operating lease liabilities over the remaining lease term and is presenting the amortization of ROU assets - operating leases and accretion of operating lease liabilities as a single line item within operating activities in the condensed consolidated statement of cash flow for the six months ended June 30, 2019.

The Company elected the package of practical expedients, which permits it to not reassess (1) whether any expired or existing contracts are or contain leases, (2) the lease classification for any expired or existing leases, and (3) any initial direct costs for any existing leases as of the effective date. The Company did not elect the hindsight practical expedient, which permits entities to use hindsight in determining the lease term and assessing impairment.

Lessor

As a lessor, the Company's recognition of rental revenue remained largely unchanged, apart from the narrower definition of initial direct costs that can be capitalized. Effective January 1, 2019, indirect leasing costs, such as legal costs related to lease negotiations no longer meet the definition of capitalized initial direct costs under ASU 2016-02 and are recorded in general and administrative expenses in the condensed consolidated statements of comprehensive (loss) income, and are no longer capitalized.

In July 2018, the FASB issued ASU 2018-11, Targeted Improvements, to simplify the guidance, that allows lessors to combine non-lease components with the related lease components if both the timing and pattern of transfer are the same for the non-lease component and related lease component, and the lease component would be classified as an operating lease. The single combined component is accounted for under ASC 842 if the lease component is the predominant component, and is accounted for under ASC 606, if the non-lease components are the predominant components. Lessors are permitted to apply the practical expedient to all existing leases on a retrospective or prospective basis. The Company elected the practical expedient to combine its lease and non-lease components that meet the defined criteria and is accounting for the combined lease components under ASC 842. As a result, the Company is no longer presenting rental revenue and tenant reimbursements related to common area maintenance and other expense recoveries separately in the condensed consolidated statements of comprehensive (loss) income.

In December 2018, the FASB issued ASU 2018-20, Narrow-Scope Improvements for Lessors, that allows lessors to make an accounting policy election not to evaluate whether real estate taxes and other similar taxes imposed by a governmental authority on a specific lease revenue-producing transaction are the primary obligation of the lessor as owner of the underlying leased asset. A lessor that makes this election excludes these taxes from the measurement of lease revenue and the associated expense. ASU 2018-20 also requires lessors to (1) exclude lessor costs paid directly by lessees to third parties on the lessor’s behalf from variable payments and, therefore, variable lease revenue and (2) include lessor costs that are paid by the lessor and reimbursed by the lessee in the measurement of variable lease revenue and the associated expense. The Company adopted ASU 2018-20 effective January 1, 2019. The adoption of this standard resulted in a decrease of approximately $142,000 and $284,000 during the three and six months ended June 30, 2019, respectively, in rental revenue and rental expense, as the aforementioned real estate tax payments are paid by a lessee directly to a third party, and, therefore, are no longer presented on a gross basis in the Company's condensed consolidated statements of comprehensive (loss) income. The adoption of this standard had no impact on the Company's net (loss) income attributable to common stockholders.

Lessee

The Company is a lessee on six ground leases, for which one does not have a corresponding operating lease liability because the Company did not have future payment obligations at the acquisition of the lease. The Company recognized a ROU asset and operating lease liability on the Company's condensed consolidated balance sheet due to the adoption of ASU 2016-02. See Note 6 —"Leases" for further discussion.

Derivatives and Hedging

In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities, or ASU 2017-12. The objectives of ASU 2017-12 are to (i) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities and (ii) reduce the complexity of and simplify the application of hedge accounting by preparers. The Company adopted this standard on January 1, 2019. The adoption of ASU 2017-12 did not have an impact on the Company's condensed consolidated financial statements.

In October 2018, the FASB issued ASU 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes, or ASU 2018-16. ASU 2018-16 permits the use of the OIS rate based on SOFR as a United States benchmark interest rate for hedge accounting purposes under Topic 815. ASU 2018-16 was effective upon the adoption of ASU 2017-12. The Company adopted ASU 2018-16 on January 1, 2019, and its provisions did not have an impact on its condensed consolidated financial statements; however, the provisions may impact existing agreements, new contracts and transactions not yet contemplated in the future.

Disclosure Update and Simplification

In August 2018, the SEC issued a final rule, SEC Final Rule Release No. 33-10532, Disclosure Update and Simplification, that amends the interim financial statement requirements to require a reconciliation of changes in stockholders' equity in the notes or as a separate statement. This analysis should reconcile the beginning balance to the ending balance of each caption in stockholders' equity for each period for which an income statement is required to be filed and comply with the remaining content requirements of Rule 3-04 of Regulation S-X. Registrants will have to provide the reconciliation for both the year-to-date and quarterly periods and comparable periods in Form 10-Q but only for the year-to-date periods in registration statements. The final rule became effective on November 5, 2018. As a result, the Company applied these changes in the presentation of the Company's condensed consolidated statements of stockholders' equity for the three and six months ended June 30, 2019 and 2018.

Recently Issued Accounting Pronouncements Not Yet Adopted

Fair Value Measurement

In August 2018, the FASB issued ASU 2018-13, Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement, or ASU 2018-13. ASU 2018-13 removes certain disclosure requirements, including the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between the levels and the valuation processes for Level 3 fair value measurements. ASU 2018-13 also adds certain disclosure requirements, including the requirement to disclose the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, and interim periods therein. Early adoption is permitted. The Company does not anticipate ASU 2018-13 to have a material impact to the Company's condensed consolidated financial statements.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current financial statement presentation, primarily related to the recently adopted accounting pronouncements discussed within this note. Amounts previously disclosed as rental revenue, provision for doubtful accounts related to rental revenue, tenant reimbursements revenue and provision for doubtful accounts related to tenant reimbursements during the three and six months ended June 30, 2018, are now included in rental revenue and will no longer be presented separately on the condensed consolidated statements of comprehensive (loss) income.

Carter Validus Mission Critical REIT, Inc. 10-Q