Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2013.
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-08895
HCP, INC.
(Exact name of registrant as specified in its charter)
Maryland
33-0091377
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
3760 Kilroy Airport Way, Suite 300
Long Beach, CA 90806
(Address of principal executive offices)
(562) 733-5100
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files). YES x NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer x
Accelerated Filer o
Non-accelerated Filer o
Smaller Reporting Company o
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) YES o NO x
As of October 25, 2013, there were 456,271,507 shares of the registrant’s $1.00 par value common stock outstanding.
INDEX
PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements:
Condensed Consolidated Balance Sheets
3
Condensed Consolidated Statements of Income
4
Condensed Consolidated Statements of Comprehensive Income
5
Condensed Consolidated Statements of Equity
6
Condensed Consolidated Statements of Cash Flows
7
Notes to the Condensed Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
26
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
42
Item 4.
Controls and Procedures
43
PART II. OTHER INFORMATION
Item 1A.
Risk Factors
44
Unregistered Sales of Equity Securities and Use of Proceeds
Item 5.
Other Information
Item 6.
Exhibits
45
Signatures
47
2
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(Unaudited)
September 30,
December 31,
2013
2012
ASSETS
Real estate:
Buildings and improvements
$
10,530,094
10,330,668
Development costs and construction in progress
247,268
236,864
Land
1,841,333
1,833,607
Accumulated depreciation and amortization
(1,918,842
)
(1,661,572
Net real estate
10,699,853
10,739,567
Net investment in direct financing leases
6,993,352
6,881,393
Loans receivable, net
390,803
276,030
Investments in and advances to unconsolidated joint ventures
206,004
212,213
Accounts receivable, net of allowance of $1,843 and $1,668, respectively
27,343
34,150
Cash and cash equivalents
49,414
247,673
Restricted cash
48,224
37,848
Intangible assets, net
507,754
552,540
Real estate and intangible assets held for sale, net
130,765
145,621
Other assets, net
835,997
788,520
Total assets(1)
19,889,509
19,915,555
LIABILITIES AND EQUITY
Bank line of credit
285,000
—
Term loan
221,748
222,694
Senior unsecured notes
6,565,934
6,712,624
Mortgage debt
1,410,407
1,676,544
Intangible liabilities on assets held for sale
1,729
Other debt
77,503
81,958
Intangible liabilities, net
103,059
104,180
Accounts payable and accrued liabilities
303,966
293,994
Deferred revenue
71,655
68,055
Total liabilities(2)
9,039,272
9,161,778
Commitments and contingencies
Common stock, $1.00 par value: 750,000,000 shares authorized; 455,873,953 and 453,191,321 shares issued and outstanding, respectively
455,874
453,191
Additional paid-in capital
11,306,717
11,180,066
Cumulative dividends in excess of earnings
(1,106,494
(1,067,367
Accumulated other comprehensive loss
(15,879
(14,653
Total stockholders’ equity
10,640,218
10,551,237
Joint venture partners
25,228
14,752
Non-managing member unitholders
184,791
187,788
Total noncontrolling interests
210,019
202,540
Total equity
10,850,237
10,753,777
Total liabilities and equity
(1) The Company’s consolidated total assets at September 30, 2013 and December 31, 2012 include assets of certain variable interest entities (“VIEs”) that can only be used to settle the liabilities of those VIEs. At September 30, 2013: other assets, net, $2 million. At December 31, 2012: accounts receivable, net, $2 million; cash and cash equivalents, $10 million; and other assets, net, $2 million. See Note 16 to the Condensed Consolidated Financial Statements for additional information.
(2) The Company’s consolidated total liabilities at September 30, 2013 and December 31, 2012 include liabilities of certain VIEs for which the VIE creditors do not have recourse to HCP, Inc. At September 30, 2013: accounts payable and accrued liabilities, $10 million. At December 31, 2012: other debt, $0.2 million; accounts payable and accrued liabilities, $14 million; and deferred revenue, $2 million. See Note 16 to the Condensed Consolidated Financial Statements for additional information.
See accompanying Notes to the Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Three Months Ended September 30,
Nine Months Ended September 30,
Revenues:
Rental and related revenues
280,588
241,993
833,461
714,438
Tenant recoveries
25,986
23,425
75,335
69,656
Resident fees and services
37,589
36,076
112,070
107,824
Income from direct financing leases
157,253
155,834
472,409
465,345
Interest income
42,078
10,278
68,611
12,313
Investment management fee income
464
460
1,406
1,423
Total revenues
543,958
468,066
1,563,292
1,370,999
Costs and expenses:
Interest expense
108,088
103,355
326,094
309,399
Depreciation and amortization
104,859
87,170
317,430
254,463
Operating
76,569
72,653
224,982
210,034
General and administrative
45,423
19,415
90,080
54,299
Impairments
7,878
Total costs and expenses
334,939
290,471
958,586
836,073
Other income, net
1,584
770
16,887
2,232
Income before income taxes and equity income from unconsolidated joint ventures
210,603
178,365
621,593
537,158
Income taxes
(1,033
602
(3,563
1,145
Equity income from unconsolidated joint ventures
13,892
13,396
44,278
42,803
Income from continuing operations
223,462
192,363
662,308
581,106
Discontinued operations:
Income before gain on sales of real estate
5,098
6,680
15,874
16,620
Gain on sales of real estate
8,298
9,185
2,856
Total discontinued operations
25,059
19,476
Net income
236,858
199,043
687,367
600,582
Noncontrolling interests’ share in earnings
(3,102
(2,935
(9,625
(9,070
Net income attributable to HCP, Inc.
233,756
196,108
677,742
591,512
Preferred stock dividends
(17,006
Participating securities’ share in earnings
(474
(479
(1,330
(2,154
Net income applicable to common shares
233,282
195,629
676,412
572,352
Basic earnings per common share:
Continuing operations
0.48
0.44
1.43
1.32
Discontinued operations
0.03
0.02
0.06
0.04
0.51
0.46
1.49
1.36
Diluted earnings per common share:
0.01
0.45
Weighted average shares used to calculate earnings per common share:
Basic
455,345
429,557
454,553
420,049
Diluted
456,078
430,778
455,388
421,404
Dividends declared per common share
0.525
0.50
1.575
1.50
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Other comprehensive income (loss):
Change in net unrealized gains on securities:
Unrealized gains
5,374
1,355
5,716
Reclassification adjustment realized in net income
(9,131
Change in net unrealized gains (losses) on cash flow hedges:
Unrealized gains (losses)
(3,710
(2,734
5,635
(3,513
191
129
751
308
Change in Supplemental Executive Retirement Plan obligation
56
46
167
136
Foreign currency translation adjustment
(56
243
(3
289
Total other comprehensive income (loss)
(3,519
3,058
(1,226
2,936
Total comprehensive income
233,339
202,101
686,141
603,518
Total comprehensive income attributable to noncontrolling interests
Total comprehensive income attributable to HCP, Inc.
230,237
199,166
676,516
594,448
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
Cumulative
Accumulated
Additional
Dividends
Other
Total
Common Stock
Paid-In
In Excess
Comprehensive
Stockholders’
Noncontrolling
Shares
Amount
Capital
Of Earnings
Income (Loss)
Equity
Interests
January 1, 2013
9,625
Other comprehensive loss
Issuance of common stock, net
1,859
78,647
80,506
(2,997
77,509
Repurchase of common stock
(51
(2,451
(2,502
Exercise of stock options
875
16,622
17,497
Amortization of deferred compensation
33,833
Common dividends ($1.575 per share)
(716,869
Distributions to noncontrolling interests
(11,536
Issuance of noncontrolling interests
12,387
September 30, 2013
Preferred Stock
January 1, 2012
11,820
285,173
408,629
9,383,536
(1,024,274
(19,582
9,033,482
187,140
9,220,622
9,070
Other comprehensive income
Preferred stock redemption
(11,820
(285,173
(10,327
(295,500
19,096
744,412
763,508
(2,438
761,070
(196
(7,971
(8,167
2,451
49,058
51,509
16,947
Preferred dividends
(6,679
Common dividends ($1.50 per share)
(631,549
(11,759
Noncontrolling interests in acquisitions
27,432
826
Purchase of noncontrolling interests
(417
September 30, 2012
429,980
10,185,982
(1,081,317
(16,646
9,517,999
209,854
9,727,853
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of real estate, in-place lease and other intangibles:
4,346
11,876
Amortization of above and below market lease intangibles, net
(6,414
(1,855
Amortization of deferred financing costs, net
13,922
12,415
Straight-line rents
(28,559
(33,608
Loan and direct financing lease interest accretion
(65,296
(71,923
Deferred rental revenues
73
1,101
(44,278
(42,803
Distributions of earnings from unconsolidated joint ventures
2,724
2,775
(9,185
(2,856
Gain on sales of marketable securities, net
(11,350
Foreign currency and derivative losses, net
386
Changes in:
Accounts receivable, net
6,389
(5,082
Other assets
(43,939
(7,303
(13,769
(21,697
Net cash provided by operating activities
843,680
720,953
Cash flows from investing activities:
Acquisitions of real estate
(63,878
(172,380
Development of real estate
(96,914
(87,119
Leasing costs and tenant and capital improvements
(33,964
(42,817
Proceeds from sales of real estate, net
3,777
7,238
Distributions in excess of earnings from unconsolidated joint ventures
1,194
2,051
Purchases of marketable debt securities
(16,706
(214,859
Proceeds from the sale of marketable securities
28,403
Principal repayments on loans receivable
231,004
4,660
Investments in loans receivable
(316,494
(145,597
Increase in restricted cash
(10,376
(1,875
Net cash used in investing activities
(273,954
(650,698
Cash flows from financing activities:
Net borrowings (repayments) under bank line of credit
283,082
(454,000
Borrowings under term loan
214,789
Issuance of senior unsecured notes
750,000
Repayments of senior unsecured notes
(150,000
(250,000
Repayments of mortgage debt
(285,005
(109,569
Issuance of mortgage and other debt
6,798
Deferred financing costs
(18,256
Net proceeds from the issuance of common stock and exercise of options
92,504
804,412
Dividends paid on common and preferred stock
(638,228
Net cash used in financing activities
(768,639
(7,285
Effect of foreign exchange on cash and cash equivalents
654
Net increase (decrease) in cash and cash equivalents
(198,259
62,970
Cash and cash equivalents, beginning of period
33,506
Cash and cash equivalents, end of period
96,476
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) Business
HCP, Inc., an S&P 500 company, together with its consolidated entities (collectively, “HCP” or the “Company”), invests primarily in real estate serving the healthcare industry in the United States (“U.S.”). The Company is a Maryland corporation and was organized to qualify as a self-administered real estate investment trust (“REIT”) in 1985. The Company is headquartered in Long Beach, California, with offices in Nashville, Tennessee and San Francisco, California. The Company acquires, develops, leases, manages and disposes of healthcare real estate, and provides financing to healthcare providers. The Company’s portfolio is comprised of investments in the following five healthcare segments: (i) senior housing, (ii) post-acute/skilled nursing, (iii) life science, (iv) medical office and (v) hospital. The Company makes investments within the healthcare segments using the following five investment products: (i) properties under lease, (ii) debt investments, (iii) developments and redevelopments, (iv) investment management and (v) investments in senior housing operations utilizing the structure permitted by the Housing and Economic Recovery Act of 2008, which is commonly referred to as “RIDEA.”
(2) Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Management is required to make estimates and assumptions in the preparation of financial statements in conformity with GAAP. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from management’s estimates.
The condensed consolidated financial statements include the accounts of HCP, Inc., its wholly-owned subsidiaries and joint ventures or variable interest entities (“VIEs”) that it controls through voting rights or other means. Intercompany transactions and balances have been eliminated upon consolidation. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the Company’s financial position, results of operations and cash flows have been included. Operating results for the nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. The accompanying unaudited interim financial information should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2012 included in the Company’s Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (the “SEC”).
Certain amounts in the Company’s condensed consolidated financial statements have been reclassified for prior periods to conform to the current period presentation. Assets sold or held for sale and associated liabilities have been reclassified on the condensed consolidated balance sheets and the related operating results reclassified from continuing to discontinued operations on the condensed consolidated statements of income (see Note 4).
Acquisition Costs
Transaction costs related to acquisitions of businesses, including properties, are expensed as incurred.
Recent Accounting Pronouncements
In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2013-10, Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes (a consensus of the FASB Emerging Issues Task Force) (“ASU 2013-10”). This update permits the Fed Funds Effective Swap Rate (“OIS”) to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to the interest rates on direct Treasury obligations of the U.S. government (“UST”) and the London Interbank Offered Rate (“LIBOR”). The amendments are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The adoption of ASU 2013-10 on July 17, 2013 did not have a material impact on the Company’s consolidated financial position or results of operations.
In February 2013, the FASB issued Accounting Standards Update No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”). This update requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. The adoption of ASU 2013-02 on January 1, 2013 did not have a material impact on the Company’s consolidated financial position or results of operations.
In July 2012, the FASB issued Accounting Standards Update No. 2012-01, Continuing Care Retirement Communities—Refundable Advance Fees (“ASU 2012-01”). This update clarifies the situations in which recognition of deferred revenue for refundable advance fees is appropriate. The adoption of ASU 2012-01 on January 1, 2013 did not have a material impact on the Company’s consolidated financial position or results of operations.
(3) Real Estate Property Investments
$1.73 Billion Senior Housing Portfolio Acquisition (the “Blackstone JV Acquisition”)
During the fourth quarter of 2012 and first quarter of 2013, the Company acquired 133 senior housing communities for $1.73 billion from a joint venture between Emeritus Corporation (“Emeritus”) and Blackstone Real Estate Partners VI, an affiliate of the Blackstone Group (the “Blackstone JV”). Located in 29 states, the portfolio encompasses a diversified care mix of 61% assisted living, 25% independent living, 13% memory care and 1% skilled nursing based on units. Based on operating performance at closing, the 133 communities consisted of 99 that were stabilized and 34 that were in lease-up. The transaction closed in two stages: (i) 129 senior housing facilities during the fourth quarter of 2012 for $1.7 billion; and (ii) four senior housing facilities during the first quarter of 2013 for $38 million. The Company paid $1.73 billion in cash consideration and assumed $13 million of mortgage debt to acquire: (i) real estate with a fair value of $1.57 billion, (ii) intangible assets with a fair value of $174 million; and (iii) assumed intangible liabilities with a fair value of $4 million.
Emeritus operates the communities pursuant to a new triple-net master lease for 128 properties (the “Master Lease”) and five individual leases, all guaranteed by Emeritus (together, the “Leases”). The Leases provide aggregate contractual rent in the first year of $105.8 million. The contractual rent will increase annually by the greater of the percentage increase in the Consumer Price Index (“CPI”) or 3.7% on average over the initial five years, and thereafter by the greater of CPI or 3.0% for the remaining initial lease term. At the beginning of the sixth lease year, rent on the 34 lease-up properties will increase to the greater of the percentage increase in CPI or fair market, subject to a floor of 103% and a cap of 130% of the prior year’s rent.
The Master Lease properties are grouped into three pools that share comparable characteristics. The Leases have initial terms of 14 to 16 years. Emeritus has two extension options, which, if exercised, will provide for lease terms of 30 to 35 years.
Concurrent with the acquisition in 2012, Emeritus purchased nine communities from the Blackstone JV, for which the Company provided secured debt financing of $52 million with a four-year term. The loan is secured by the underlying real estate and is prepayable at Emeritus’ option. The interest rate on the loan was initially 6.1% and will gradually increase during its four year term to 6.8%.
Pro Forma Results of Operations
The following unaudited pro forma consolidated results of operations assume that the Blackstone JV Acquisition was completed as of January 1, 2012 (in thousands, except per share amounts):
Three Months Ended September 30, 2012
Nine Months Ended September 30, 2012
Revenues
494,516
1,450,349
206,448
622,797
Net income applicable to HCP, Inc.
203,513
613,727
Basic earnings per common share
1.35
Diluted earnings per common share
1.34
Other Real Estate Acquisitions
In addition to the Blackstone JV Acquisition (discussed above), during the nine months ended September 30, 2013, the Company acquired a senior housing facility for $18 million, exercised its purchase option for a senior housing facility it previously leased for $16 million and acquired 38 acres of land in the post-acute/skilled nursing segment for $0.4 million.
9
A summary of real estate acquisitions for the nine months ended September 30, 2012 follows (in thousands):
Consideration
Assets Acquired
Segment
Cash Paid
Debt and Other Liabilities Assumed
Noncontrolling Interest
Real Estate
Net Intangibles
Medical office
157,556
35,120
27,346
(1)
170,443
49,579
Life science
7,964
86
7,580
470
Senior housing
3,860
3,541
319
Hospital
3,000
172,380
184,564
50,368
(1) Represents non-managing member limited liability company units.
During the nine months ended September 30, 2013 and 2012, the Company funded an aggregate of $123 million and $126 million, respectively, for construction, tenant and other capital improvement projects, primarily in its senior housing, life science and medical office segments.
(4) Dispositions of Real Estate and Discontinued Operations
During the nine months ended September 30, 2013, the Company sold a senior housing facility for $4 million. In addition, in September 2013, the Company sold a 62-bed hospital located in Greenfield, Wisconsin in exchange for a 60-bed hospital located in Webster, Texas and recognized a gain of $8 million based on the fair value of the hospital acquired. During the nine months ended September 30, 2012, the Company sold a medical office building for $7 million.
At September 30, 2013, four hospitals were classified as held for sale, with a carrying value of $131 million. At December 31, 2012, properties classified as held for sale included a senior housing facility and five hospitals with a combined aggregate carrying value of $146 million.
The following table summarizes operating loss from discontinued operations and gain on sales of real estate included in discontinued operations (dollars in thousands):
6,460
10,260
20,458
31,023
Depreciation and amortization expenses
1,433
2,969
Operating expenses
18
75
Other income (expense), net
(74
593
229
2,452
Gain on sales of real estate, net of income taxes
Number of properties included in discontinued operations
10
(5) Net Investment in Direct Financing Leases
The components of net investment in direct financing leases (“DFLs”) consisted of the following (dollars in thousands):
Minimum lease payments receivable(1)
24,811,003
25,217,520
Estimated residual values
4,010,514
Less unearned income
(21,828,165
(22,346,641
Properties subject to direct financing leases
361
(1) The minimum lease payments receivable are primarily attributable to HCR ManorCare, Inc. (“HCR ManorCare”) ($23.7 billion and $24.0 billion at September 30, 2013 and December 31, 2012, respectively). The triple-net master lease with HCR ManorCare provides for annual rent of $506 million beginning April 1, 2013 (prior to April 1, 2013, annual rent was $489 million). The rent increases by 3.5% per year over the next three years and by 3% for the remaining portion of the initial lease term. The properties are grouped into four pools, and HCR ManorCare has a one-time extension option for each pool with rent increased for the first year of the extension option to the greater of fair market rent or a 3% increase over the rent for the prior year. Including the extension options, which the Company determined to be bargain renewal options, the four leased pools had total initial available terms ranging from 23 to 35 years.
Certain leases contain provisions that allow the tenants to elect to purchase the properties during or at the end of the lease terms for the aggregate initial investment amount plus adjustments, if any, as defined in the lease agreements. Certain leases also permit the Company to require the tenants to purchase the properties at the end of the lease terms.
During the three months ended September 30, 2013, the Company placed a 14-property senior housing DFL (the “DFL Portfolio”) on non-accrual status. Based on the Company’s determination that the collection of all rental payments is no longer reasonably assured, rental revenue for the DFL Portfolio will be recognized on a cash basis. Furthermore, the Company assessed the DFL Portfolio for impairment. The Company determined that the DFL Portfolio was not impaired at September 30, 2013, based on its belief that: (i) it is not probable that it will not collect all of the rental payments under the terms of the lease; and (ii) the fair value of the underlying collateral exceeds the DFL Portfolio’s $376 million carrying amount. The fair value of the DFL Portfolio was estimated based on a discounted cash flow model, which inputs are considered to be a Level 3 measurement within the fair value hierarchy. Inputs to this valuation model include real estate capitalization rates, industry growth rates and operating margins, some of which influence the Company’s expectation of future cash flows from the DFL Portfolio and, accordingly, the fair value of its investment. During the three months ended September 30, 2013 and 2012, the Company recognized DFL income of $5.1 million and $7.0 million, respectively, and received cash payments of $6.1 million and $5.6 million, respectively, from the DFL Portfolio. During the nine months ended September 30, 2013 and 2012, the Company recognized DFL income of $19.1 million and $20.8 million, respectively, and received cash payments of $17.6 million and $17.3 million, respectively, from the DFL Portfolio.
(6) Loans Receivable
The following table summarizes the Company’s loans receivable (in thousands):
December 31, 2012
Real Estate Secured
Other Secured
Mezzanine
245,535
145,150
Other(1)
161,471
147,264
Unamortized discounts, fees and costs
(2,793
(2,974
Allowance for loan losses
(13,410
229,332
128,766
(1) Includes $110 million and $72 million at September 30, 2013 and December 31, 2012, respectively, of construction loans outstanding related to senior housing development projects. At September 30, 2013, the Company had $37 million remaining in its commitments to fund development projects.
Other Secured Loans
Barchester Loan. On May 2, 2013, the Company acquired £121 million ($188 million) of subordinated debt at a discount for £109 million ($170 million). The loan was secured by an interest in 160 facilities leased and operated by Barchester Healthcare (“Barchester”). On August 23, 2013, the Company acquired an additional investment in this loan of £9 million ($14 million) at a discount for £5 million ($8 million). This loan accrued interest on its face value at a floating rate LIBOR plus a weighted-average margin of 3.14%. This loan investment was financed by a GBP denominated draw on the Company’s revolving line of credit facility that is discussed in Note 10. On September 6, 2013, the Company received £129 million ($202 million) from the par payoff of its Barchester debt investments; as a result, the Company recognized interest income of $24 million representing primarily the debt investments’ unamortized discounts. A portion of the proceeds from the Barchester repayment were used to repay the total outstanding amount of the Company’s GBP denominated draw on its revolving line of credit facility.
Tandem Health Care Loan. On July 31, 2012, the Company closed a mezzanine loan facility to lend up to $205 million to Tandem Health Care (“Tandem”), an affiliate of Formation Capital, as part of the recapitalization of a post-acute/skilled nursing portfolio. At closing, the loan was subordinate to $400 million in senior mortgage debt and $137 million in senior mezzanine debt. The Company funded $100 million (the “First Tranche”) at closing and funded an additional $102 million (the “Second Tranche”) in June 2013. The Second Tranche was used to repay the senior mezzanine debt. At September 30, 2013, the loan was subordinate to $443 million of senior mortgage debt. The loan bears interest at a fixed rate of 12% and 14% per annum for the First and Second Tranches, respectively. The facility has a total term of up to 63 months from the initial closing, is prepayable at the borrower’s option and is secured by real estate partnership interests. The loan is subject to a prepayment premium if repaid on or before the third anniversary from the initial closing date.
11
Delphis Operations, L.P. Loan. The Company holds a secured term loan made to Delphis Operations, L.P. (“Delphis” or the “Borrower”) that is collateralized by all of the assets of the Borrower. The Borrower’s collateral is comprised primarily of interests in partnerships operating surgical facilities, of which one partnership leases a property owned by the Company. In December 2009, the Company determined that the loan was impaired. Further, in January 2011 the Company placed the loan on cost-recovery status, whereby accrual of interest income was suspended, and any payments received from the Borrower are applied to reduce the recorded investment in the loan.
As part of a March 2012 agreement (the “2012 Agreement”) between Delphis, certain past and current principals of Delphis and the Cirrus Group, LLC (the “Guarantors”), and the Company, the Company agreed, among other things, to allow the distribution of $1.5 million to certain of the Guarantors from funds generated from sales of assets that were pledged as additional collateral for this loan. Further, the Company, as part of the 2012 Agreement, agreed to provide financial incentives to the Borrower regarding the liquidation of the primary collateral assets for this loan.
Pursuant to the 2012 Agreement, the Company received the remaining cash ($4.8 million, after reducing this amount by $0.5 million for related legal expenses) and other consideration ($2.1 million) of $6.9 million from the Guarantors. In addition, during 2012, the Company received $38.1 million in net proceeds from the sales of two of the primary collateral assets, which proceeds, together with the cash payments and other consideration, were applied to reduce the carrying value of the loan. The carrying value of the loan was $29.2 million and $30.7 million at September 30, 2013 and December 31, 2012, respectively. During the nine months ended September 30, 2013, the Company received cash payments from the Borrower of $1.5 million. At September 30, 2013, the Company believes the fair value of the collateral supporting this loan is in excess of its carrying value.
(7) Investments in and Advances to Unconsolidated Joint Ventures
The Company owns interests in the following entities that are accounted for under the equity method at September 30, 2013 (dollars in thousands):
Entity(1)
Properties/Segment
Investment(2)
Ownership%
HCR ManorCare
post-acute/skilled nursing operations
85,777
9.5
HCP Ventures III, LLC
13 medical office
7,251
30
HCP Ventures IV, LLC
54 medical office and 4 hospital
30,420
20
HCP Life Science(3)
4 life science
68,992
50-63
Horizon Bay Hyde Park, LLC
1 senior housing
6,725
72
Suburban Properties, LLC
1 medical office
6,666
67
Advances to unconsolidated joint ventures, net
173
Edgewood Assisted Living Center, LLC
(429
Seminole Shores Living Center, LLC
(697
50
(1,126
(1) These entities are not consolidated because the Company does not control, through voting rights or other means, the joint ventures.
(2) Represents the carrying value of the Company’s investment in the unconsolidated joint venture. Negative balances are recorded in accounts payable and accrued liabilities on the Company’s Condensed Consolidated Balance Sheets.
(3) Includes three unconsolidated joint ventures between the Company and an institutional capital partner for which the Company is the managing member. HCP Life Science includes the following partnerships (and the Company’s ownership percentage): (i) Torrey Pines Science Center, LP (50%); (ii) Britannia Biotech Gateway, LP (55%); and (iii) LASDK, LP (63%).
Summarized combined financial information for the Company’s unconsolidated joint ventures follows (in thousands):
Real estate, net
3,676,367
3,731,740
Goodwill and other assets, net
5,802,930
5,734,318
Total assets
9,479,297
9,466,058
Capital lease obligations and mortgage debt
6,782,574
6,875,932
Accounts payable
1,060,153
971,095
Other partners’ capital
1,452,308
1,435,885
HCP’s capital(1)
184,262
183,146
Total liabilities and partners’ capital
(1) The combined basis difference of the Company’s investments in these joint ventures of $20 million, as of September 30, 2013, is primarily attributable to goodwill, real estate, capital lease obligations, deferred tax assets and lease related net intangibles.
12
1,055,889
1,057,567
3,208,752
3,196,086
Net income (loss)
1,739
(8,851
22,232
8,416
HCP’s share in earnings (1)
Fees earned by HCP
Distributions received by HCP
1,390
1,419
3,918
4,826
(1) The Company’s joint venture interest in HCR ManorCare is accounted for using the equity method and results in an ongoing reduction of DFL income, proportional to HCP’s ownership in HCR ManorCare. The Company recorded a reduction of $15.4 million and $46.6 million for the three and nine months ended September 30, 2013, respectively. The Company recorded a reduction of $14.9 million and $44.4 million for the three and nine months ended September 30, 2012, respectively. Further, the Company’s share of earnings from HCR ManorCare (equity income) increases for the corresponding reduction of related lease expense recognized at the HCR ManorCare level.
(8) Intangibles
At September 30, 2013 and December 31, 2012, intangible lease assets, comprised of lease-up intangibles, above market tenant lease intangibles and below market ground lease intangibles, were $784 million and $794 million, respectively. At September 30, 2013 and December 31, 2012, the accumulated amortization of intangible assets was $276 million and $241 million, respectively.
At September 30, 2013 and December 31, 2012, intangible lease liabilities, comprised of below market lease intangibles and above market ground lease intangible liabilities were $208 million and $194 million, respectively. At September 30, 2013 and December 31, 2012, the accumulated amortization of intangible liabilities was $105 million and $90 million, respectively.
(9) Other Assets
The Company’s other assets consisted of the following (in thousands):
Straight-line rent assets, net of allowance of $34,123 and $33,521, respectively
358,514
306,294
Marketable debt securities, net(1)
238,834
222,809
Leasing costs, net
98,406
93,763
Deferred financing costs, net
37,379
45,490
Goodwill
50,346
Marketable equity securities
24,829
Other(2)
52,518
44,989
Total other assets
(1) Includes £137 million ($222 million and $223 million at September 30, 2013 and December 31, 2012, respectively) of Four Seasons senior unsecured notes translated into U.S. dollars (see below for additional information).
(2) Includes a $5.4 million allowance for losses related to accrued interest receivable on the Delphis loan, which accrued interest is included in other assets. At both September 30, 2013 and December 31, 2012, the carrying value of interest accrued related to the Delphis loan was zero. See Note 6 for additional information about the Delphis loan and the related impairment. At both September 30, 2013 and December 31, 2012, includes a loan receivable of $10 million from HCP Ventures IV, LLC, an unconsolidated joint venture (see Note 7 for additional information) with an interest rate of 12% which matures in May 2014. The loan is secured by HCP’s joint venture partner’s 80% partnership interest in the joint venture.
During the nine months ended September 30, 2013, the Company realized gains from the sale of marketable equity securities of $11 million, which were included in other income, net. At December 31, 2012, the fair value and adjusted cost basis of the marketable equity securities were $24.8 million and $17.1 million, respectively. The marketable equity securities were classified as available-for-sale.
Four Seasons Health Care Senior Unsecured Notes
On June 28, 2012, the Company purchased senior unsecured notes with an aggregate par value of £138.5 million at a discount for £136.8 million ($214.9 million). The notes were issued by Elli Investments Limited, a subsidiary of Terra Firma, a European private equity firm, as part of its financing for the acquisition of Four Seasons Health Care (“Four Seasons”), an elderly and specialist care provider in the United Kingdom. The notes mature in June 2020 and are non-callable through June 2016. The notes bear interest on their par value at a fixed rate of 12.25% per annum, with an original issue discount resulting in a yield to maturity of 12.5%. This investment was financed by a GBP denominated unsecured term loan that is discussed in Note 10. These senior unsecured notes are accounted for as marketable debt securities and classified as held-to-maturity.
13
(10) Debt
Bank Line of Credit and Term Loan
The Company’s $1.5 billion unsecured revolving line of credit facility (the “Facility”) matures in March 2016 and contains a one-year extension option. Borrowings under the Facility accrue interest at LIBOR plus a margin that depends on the Company’s debt ratings. The Company pays a facility fee on the entire revolving commitment that depends upon its debt ratings. Based on the Company’s debt ratings at September 30, 2013, the margin on the Facility was 1.075%, and the facility fee was 0.175%. The Facility also includes a feature that will allow the Company to increase the borrowing capacity by an aggregate amount of up to $500 million, subject to securing additional commitments from existing lenders or new lending institutions. At September 30, 2013, the Company had $285 million outstanding under the Facility.
On July 30, 2012, the Company entered into a credit agreement with a syndicate of banks for a £137 million ($222 million at September 30, 2013) four-year unsecured term loan (the “Term Loan”) that accrues interest at a rate of GBP LIBOR plus 1.20%, based on the Company’s current debt ratings. Concurrent with the closing of the Term Loan, the Company entered into a four-year interest rate swap contract that fixes the interest rate of the Term Loan at 1.81%, subject to adjustments based on the Company’s debt ratings. The Term Loan contains a one-year committed extension option.
The Facility and Term Loan contain certain financial restrictions and other customary requirements, including cross-default provisions to other indebtedness. Among other things, these covenants, using terms defined in the agreements, (i) limit the ratio of Consolidated Total Indebtedness to Consolidated Total Asset Value to 60%, (ii) limit the ratio of Secured Debt to Consolidated Total Asset Value to 30%, (iii) limit the ratio of Unsecured Debt to Consolidated Unencumbered Asset Value to 60%, (iv) require a minimum Fixed Charge Coverage ratio of 1.5 times and (v) require a formula-determined Minimum Consolidated Tangible Net Worth of $9.2 billion at September 30, 2013. At September 30, 2013, the Company was in compliance with each of these restrictions and requirements of the Facility and Term Loan.
Senior Unsecured Notes
At September 30, 2013, the Company had senior unsecured notes outstanding with an aggregate principal balance of $6.6 billion. At September 30, 2013, interest rates on the notes ranged from 1.22% to 6.98% with a weighted average effective interest rate of 5.10% and a weighted average maturity of five years. Discounts and premiums are amortized to interest expense over the term of the related senior unsecured notes. The senior unsecured notes contain certain covenants including limitations on debt, maintenance of unencumbered assets, cross-acceleration provisions and other customary terms. The Company believes it was in compliance with these covenants at September 30, 2013.
On February 28, 2013, the Company repaid $150 million of maturing 5.625% senior unsecured notes.
On November 19, 2012, the Company issued $800 million of 2.625% senior unsecured notes due in 2020. The notes were priced at 99.7% of the principal amount with an effective yield to maturity of 2.7%; net proceeds from this offering were $793 million.
On July 23, 2012, the Company issued $300 million of 3.15% senior unsecured notes due in 2022. The notes were priced at 98.9% of the principal amount with an effective yield to maturity of 3.3%; net proceeds from the offering were $294 million.
On June 25, 2012, the Company repaid $250 million of maturing 6.45% senior unsecured notes. The notes were repaid with proceeds from the Company’s June 2012 common stock offering.
On January 23, 2012, the Company issued $450 million of 3.75% senior unsecured notes due in 2019. The notes were priced at 99.5% of the principal amount with an effective yield to maturity of 3.8%; net proceeds from the offering were $444 million.
Mortgage Debt
At September 30, 2013, the Company had $1.4 billion in aggregate principal amount of mortgage debt outstanding secured by 132 healthcare facilities (including redevelopment properties) with a carrying value of $2.0 billion. At September 30, 2013, interest rates on the mortgage debt ranged from 0.69% to 8.69% with a weighted average effective interest rate of 6.16% and a weighted average maturity of four years.
14
Mortgage debt generally requires monthly principal and interest payments, is collateralized by real estate assets and is generally non-recourse. Mortgage debt typically restricts transfer of the encumbered assets, prohibits additional liens, restricts prepayment, requires payment of real estate taxes, requires maintenance of the assets in good condition, requires maintenance of insurance on the assets and includes conditions to obtain lender consent to enter into or terminate material leases. Some of the mortgage debt is also cross-collateralized by multiple assets and may require tenants or operators to maintain compliance with the applicable leases or operating agreements of such real estate assets.
Other Debt
At September 30, 2013, the Company had $78 million of non-interest bearing life care bonds at two of its continuing care retirement communities and non-interest bearing occupancy fee deposits at two of its senior housing facilities, all of which were payable to certain residents of the facilities (collectively, “Life Care Bonds”). The Life Care Bonds are generally refundable to the residents upon the termination of the contract or upon the successful resale of the unit.
Debt Maturities
The following table summarizes the Company’s stated debt maturities and scheduled principal repayments at September 30, 2013 (in thousands):
Year
Line of Credit
Term Loan(1)
Total(2)
2013 (Three months)
400,000
14,003
414,003
2014
487,000
180,042
667,042
2015
308,421
708,421
2016
900,000
291,738
1,698,486
2017
550,477
1,300,477
Thereafter
3,650,000
71,825
3,721,825
6,587,000
1,416,506
8,510,254
(Discounts) and premiums, net
(21,066
(6,099
(27,165
8,483,089
(1) Represents £137 million translated into U.S. dollars.
(2) Excludes $78 million of other debt that represents Life Care Bonds that have no scheduled maturities.
(11) Commitments and Contingencies
Legal Proceedings
From time to time, the Company is a party to legal proceedings, lawsuits and other claims that arise in the ordinary course of the Company’s business. The Company is not aware of any legal proceedings or claims that it believes may have, individually or taken together, a material adverse effect on the Company’s business, prospects, financial condition, results of operations or cash flows. The Company’s policy is to expense legal costs as they are incurred.
Concentration of Credit Risk
Concentrations of credit risks arise when one or more operators, tenants or obligors related to the Company’s investments are engaged in similar business activities, or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations, including those to the Company, to be similarly affected by changes in economic conditions. The Company regularly monitors various segments of its portfolio to assess potential concentrations of risks. The Company does not have significant foreign operations.
15
The following table provides information regarding the Company’s concentrations with respect to certain operators and tenants; the information provided is presented for the gross assets and revenues that are associated with certain operators and tenants as percentages of the respective segment’s and total Company’s assets and revenues:
Segment Concentrations:
Percentage of Senior Housing Gross Assets
Percentage of Senior Housing Revenues
Operators
Emeritus
37.3
%
34.8
20.3
34.6
20.5
Sunrise Senior Living (“Sunrise”)(1)
17.2
17.5
11.5
15.6
12.2
15.7
11.0
9.6
11.7
11.8
Brookdale Senior Living (“Brookdale”)(2)
10.6
10.7
14.4
11.6
14.2
Percentage of Post-Acute/ Skilled Nursing Gross Assets
Percentage of Post-Acute/ Skilled Nursing Revenues
88.1
89.3
72.7
87.2
81.3
90.9
Total Company Concentrations:
Percentage of Total Company Assets
Percentage of Total Company Revenues
32.1
31.5
27.0
30.7
28.0
31.2
14.6
14.3
6.6
12.6
6.7
Sunrise(1)
6.8
4.0
5.0
4.4
5.2
Brookdale(2)
4.2
4.1
4.7
(1) Certain of the Company’s properties are leased to tenants who have entered into management contracts with Sunrise to operate the respective property on their behalf. The Company’s concentration of gross assets includes properties directly leased to Sunrise and properties that are managed by Sunrise on behalf of third party tenants.
(2) At September 30, 2013 and December 31, 2012, Brookdale percentages exclude $778 million and $759 million, respectively, of senior housing assets related to 21 senior housing facilities that Brookdale operates on the Company’s behalf under a RIDEA structure. Assuming that these assets were attributable to Brookdale, the percentage of senior housing assets for Brookdale would be 21% at both September 30, 2013 and December 31, 2012. Assuming that these assets were attributable to Brookdale, the percentage of total assets for Brookdale would be 8% at both September 30, 2013 and December 31, 2012. For the three and nine months ended September 30, 2013, Brookdale percentages exclude $37.6 million and $112.0 million, respectively, of senior housing revenues related to these facilities. Assuming that these revenues were attributable to Brookdale, the percentage of senior housing revenues for Brookdale would be 31% for both the three and nine months ended September 30, 2013. Assuming that these revenues were attributable to Brookdale, the percentage of total revenues for Brookdale would be 11% for both the three and nine months ended September 30, 2013. For the three and nine months ended September 30, 2012, Brookdale percentages exclude $36.1 million and $106.8 million, respectively, of senior housing revenues related to these facilities. Assuming that these revenues were attributable to Brookdale, the percentage of senior housing revenues for Brookdale would be 38% for both the three and nine months ended September 30, 2012. Assuming that these revenues were attributable to Brookdale, the percentage of total revenues for Brookdale would be 12% for both the three and nine months ended September 30, 2012.
HCR ManorCare’s summarized condensed consolidated financial information follows (in millions):
Real estate and other property, net
3,008.7
3,046.6
158.5
120.5
Goodwill, intangible and other assets, net
5,563.7
5,625.4
8,730.9
8,792.5
Debt and financing obligations
6,289.0
6,374.6
Accounts payable, accrued liabilities and other
1,021.8
1,021.9
1,420.1
1,396.0
16
1,030.3
1,037.8
3,131.7
3,113.3
Operating, general and administrative expense
(888.1
(880.8
(2,677.4
(2,663.7
Depreciation and amortization expense
(36.3
(41.6
(110.0
(125.2
(103.8
(105.2
(312.3
(317.3
2.3
3.7
10.1
Income before income taxes
13.9
36.0
(1.8
(4.8
(11.6
(4.7
2.6
9.1
24.4
12.5
To mitigate the credit risk of leasing properties to certain senior housing and post-acute/skilled nursing operators, leases with operators are often combined into portfolios that contain cross-default terms, so that if a tenant of any of the properties in a portfolio defaults on its obligations under its lease, the Company may pursue its remedies under the lease with respect to any of the properties in the portfolio. Certain portfolios also contain terms whereby the net operating profits of the properties are combined for the purpose of securing the funding of rental payments due under each lease.
Credit Enhancement Guarantee
Certain of the Company’s senior housing facilities serve as collateral for $113 million of debt (maturing May 1, 2025) that is owed by a previous owner of the facilities. This indebtedness is guaranteed by the previous owner who has an investment grade credit rating. These senior housing facilities, which are classified as DFLs, had a carrying value of $376 million as of September 30, 2013.
(12) Equity
On April 23, 2012, the Company redeemed all of its outstanding preferred stock consisting of 4,000,000 shares of its 7.25% Series E preferred stock and 7,820,000 shares of its 7.10% Series F preferred stock. The shares of Series E and Series F preferred stock were redeemed at a price of $25 per share, or $295.5 million in aggregate, plus all accrued and unpaid dividends to the redemption date. As a result of the redemption, which was announced on March 22, 2012, the Company incurred a charge of $10.4 million during the three months ended March 31, 2012 related to the original issuance costs of the preferred stock (this charge is presented as an additional preferred stock dividend in the Company’s condensed consolidated statements of income).
The following table lists the common stock cash dividends declared by the Company in 2013:
Declaration Date
Record Date
Amount Per Share
Dividend Payable Date
January 24
February 4
February 19
April 25
May 6
May 21
July 25
August 5
August 20
October 24
November 4
November 19
In October 2012, the Company completed a $979 million offering of 22 million shares of common stock at a price of $44.50 per share, which proceeds were primarily used to fund the Blackstone JV Acquisition.
In June 2012, the Company completed a $376 million offering of 8.97 million shares of common stock at a price of $41.88 per share, which proceeds were primarily used to repay $250 million of maturing senior unsecured notes.
In March 2012, the Company completed a $359 million offering of 9.0 million shares of common stock at a price of $39.93 per share, which proceeds were primarily used to redeem all outstanding shares of the Company’s preferred stock.
17
The following is a summary of the Company’s other common stock issuances (shares in thousands):
Dividend Reinvestment and Stock Purchase Plan
1,681
675
Conversion of DownREIT units(1)
85
Vesting of restricted stock units(2)
110
385
(1) Non-managing member LLC units.
(2) Issued under the Company’s 2006 Performance Incentive Plan.
Accumulated Other Comprehensive Loss
The following is a summary of the Company’s accumulated other comprehensive loss (in thousands):
Unrealized gains on available for sale securities
7,776
Unrealized losses on cash flow hedges, net
(12,066
(18,452
Supplemental Executive Retirement Plan minimum liability
(2,983
(3,150
Cumulative foreign currency translation adjustment
(830
(827
Total accumulated other comprehensive loss
Noncontrolling Interests
At September 30, 2013, non-managing members hold an aggregate of 4 million units in four limited liability companies (“DownREITs”), for which the Company is the managing member. At September 30, 2013, the carrying and fair values of these DownREIT units were $185 million and $246 million, respectively.
(13) Segment Disclosures
The Company evaluates its business and makes resource allocations based on its five business segments: (i) senior housing, (ii) post-acute/skilled nursing, (iii) life science, (iv) medical office and (v) hospital. Under the senior housing, post-acute/skilled nursing, life science and hospital segments, the Company invests or co-invests primarily in single operator or tenant properties, through the acquisition and development of real estate, management of operations (RIDEA) and by debt issued by operators in these sectors. Under the medical office segment, the Company invests or co-invests through the acquisition and development of medical office buildings (“MOBs”) that are leased under gross, modified gross or triple-net leases, generally to multiple tenants, and which generally require a greater level of property management. The accounting policies of the segments are the same as those described in Note 2 to the Consolidated Financial Statements for the year ended December 31, 2012 in the Company’s Annual Report on Form 10-K filed with the SEC. There were no intersegment sales or transfers during the nine months ended September 30, 2013 and 2012. The Company evaluates performance based upon property net operating income from continuing operations (“NOI”), adjusted NOI and interest income of the combined investments in each segment.
Non-segment assets consist primarily of corporate assets including cash and cash equivalents, restricted cash, accounts receivable, net, marketable equity securities, deferred financing costs and, if any, real estate held-for-sale. Interest expense, depreciation and amortization and non-property specific revenues and expenses are not allocated to individual segments in determining the Company’s performance measure. See Note 11 for other information regarding concentrations of credit risk.
Summary information for the reportable segments follows (in thousands):
For the three months ended September 30, 2013:
Segments
Rental Revenues(1)
Resident Fees and Services
Interest Income
Investment Management Fee Income
Total Revenues
NOI(2)
Adjusted NOI(2) (Cash NOI)
149,443
3,121
190,153
162,391
148,997
Post-acute/skilled
138,289
38,642
176,931
137,642
120,258
72,531
1
72,532
58,440
56,352
88,473
463
88,936
52,255
52,214
15,091
315
15,406
14,119
14,148
463,827
424,847
391,969
For the three months ended September 30, 2012:
114,661
877
151,614
125,865
113,401
135,183
9,135
144,318
135,029
116,573
71,194
71,195
59,403
56,341
85,800
459
86,259
50,852
49,669
14,414
266
14,680
13,526
13,165
421,252
384,675
349,149
For the nine months ended September 30, 2013:
448,600
8,328
568,998
487,501
440,395
411,912
59,656
471,568
409,965
356,544
221,088
221,091
179,775
170,957
265,902
1,403
267,305
160,170
157,742
33,703
627
34,330
30,882
42,369
1,381,205
1,268,293
1,168,007
For the nine months ended September 30, 2012:
341,353
1,686
450,863
379,251
341,794
403,209
9,842
413,051
402,690
345,936
215,569
215,572
177,339
171,179
246,661
1,420
248,081
148,030
144,272
42,647
785
43,432
39,919
38,696
1,249,439
1,147,229
1,041,877
(1) Represents rental and related revenues, tenant recoveries and income from DFLs.
(2) NOI is a non-GAAP supplemental financial measure used to evaluate the operating performance of real estate. The Company defines NOI as rental and related revenues, including tenant recoveries, resident fees and services, and income from DFLs, less property level operating expenses. NOI excludes interest income, investment management fee income, interest expense, depreciation and amortization, general and administrative expenses, litigation settlement, impairments, impairment recoveries, other income, net, income taxes, equity income from and impairments of investments in unconsolidated joint ventures, and discontinued operations. The Company believes NOI provides relevant and useful information because it reflects only income and operating expense items that are incurred at the property level and presents them on an unleveraged basis. Adjusted NOI is calculated as NOI after eliminating the effects of straight-line rents, DFL accretion, amortization of above and below market lease intangibles, and lease termination fees. Adjusted NOI is sometimes referred to as “cash NOI.” The Company uses NOI and adjusted NOI to make decisions about resource allocations and to assess and compare property level performance. The Company believes that net income is the most directly comparable GAAP measure to NOI. NOI should not be viewed as an alternative measure of operating performance to net income as defined by GAAP because it does not reflect the aforementioned excluded items. Further, the Company’s definition of NOI may not be comparable to the definition used by other REITs or real estate companies, as those companies may use different methodologies for calculating NOI.
19
The following is a reconciliation of reported net income to NOI and adjusted NOI (in thousands):
(42,078
(10,278
(68,611
(12,313
(464
(460
(1,406
(1,423
(1,584
(770
(16,887
(2,232
1,033
(602
3,563
(1,145
(13,892
(13,396
(6,680
(25,059
(19,476
NOI
(12,604
(11,821
DFL accretion
(19,822
(23,433
(65,386
(71,072
(346
(533
Lease termination fees
(205
(175
(220
(574
NOI adjustments related to discontinued operations
99
436
293
1,757
Adjusted NOI
The Company’s total assets by segment were (in thousands):
7,811,003
7,654,221
Post-acute/skilled nursing
6,269,566
6,080,826
3,969,723
3,932,397
2,686,241
2,661,394
542,187
505,393
Gross segment assets
21,278,720
20,834,231
(2,192,342
(1,900,221
Net segment assets
19,086,378
18,934,010
Assets held-for-sale, net
Other non-segment assets
672,366
835,924
At September 30, 2013, goodwill of $50 million was allocated to segment assets as follows: (i) senior housing—$31 million, (ii) post-acute/skilled nursing—$3 million, (iii) medical office—$11 million, and (iv) hospital—$5 million.
(14) Earnings Per Common Share
The following table illustrates the computation of basic and diluted earnings per share (in thousands, except per share amounts):
Numerator
Noncontrolling interests’ share in continuing operations
Income from continuing operations applicable to HCP, Inc.
220,360
189,428
652,683
572,036
Participating securities’ share in continuing operations
Income from continuing operations applicable to common shares
219,886
188,949
651,353
552,876
Denominator
Basic weighted average common shares
Dilutive potential common shares
733
1,221
835
Diluted weighted average common shares
Restricted stock and certain of the Company’s performance restricted stock units are considered participating securities, because dividend payments are not forfeited even if the underlying award does not vest, which require the use of the two-class method when computing basic and diluted earnings per share.
Options to purchase approximately 0.9 million and 0.5 million shares of common stock that had an exercise price (including deferred compensation expense) in excess of the average closing market price of the Company’s common stock during the three months ended September 30, 2013 and 2012, respectively, were not included in the Company’s earnings per share calculations because they are anti-dilutive. Restricted stock and performance restricted stock units representing 7,500 shares of common stock during the three months ended September 30, 2013 were not included because they are anti-dilutive. Additionally, 6.0 million shares issuable upon conversion of 3.9 million DownREIT units during the three months ended September 30, 2013 were not included because they are anti-dilutive. During the three months ended September 30, 2012, 6.4 million shares issuable upon conversion of 4.4 million DownREIT units were not included because they are anti-dilutive.
(15) Supplemental Cash Flow Information
The following table provides supplemental cash flow information (in thousands):
Supplemental cash flow information:
Interest paid, net of capitalized interest
363,229
339,190
Income taxes paid (refunded)
(2
1,645
Capitalized interest
10,852
18,517
Supplemental schedule of non-cash investing activities:
Accrued construction costs
18,495
18,024
Fair value of real estate acquired in exchange for sale of real estate
15,204
21
Supplemental schedule of non-cash financing activities:
Vesting of restricted stock units
Cancellation of restricted stock
Conversion of non-managing member units into common stock
2,997
2,398
Noncontrolling interests issued in connection with acquisitions
Mortgages and other liabilities assumed with real estate acquisitions
12,728
Unrealized gains on available-for-sale securities and derivatives designated as cash flow hedges, net
6,990
2,203
See additional information regarding supplemental non-cash financing activities related to a real estate exchange in Note 4 and the preferred stock redemption in Note 12.
(16) Variable Interest Entities
Unconsolidated Variable Interest Entities
At September 30, 2013, the Company leased 48 properties to a total of seven VIE tenants and has additional investments in a loan and marketable debt securities to VIE borrowers. The Company has determined that it is not the primary beneficiary of these VIEs.
The Company holds an interest-only, senior secured term loan made to a borrower (Delphis Operations, L.P.) that has been identified as a VIE (see Note 6 for additional information on the Delphis loan). The Company does not consolidate the VIE because it does not have the ability to control the activities that most significantly impact the VIE’s economic performance. The loan is collateralized by all of the assets of the borrower (comprised primarily of interests in partnerships that operate surgical facilities, of which one partnership is a tenant of the Company).
The Company holds commercial mortgage-backed securities (“CMBS”) issued by Federal Home Loan Mortgage Corporation (“Freddie MAC”) through a special purpose entity that has been identified as a VIE. The Company does not consolidate the VIE because it does not have the ability to control the activities that most significantly impact the VIE’s economic performance. The CMBS issued by the VIE are backed by mortgages on senior housing facilities.
The carrying value and classification of the related assets, liabilities and maximum exposure to loss as a result of the Company’s involvement with these VIEs are presented below at September 30, 2013 (in thousands):
VIE Type
Maximum Loss Exposure(1)
Asset/Liability Type
Carrying Amount
VIE tenants—operating leases
262,598
Lease intangibles, net and straight-line rent receivables
14,526
VIE tenants—DFLs
1,091,935
Net investment in DFLs
602,366
Loan—senior secured
29,151
Debt investment
16,984
Marketable debt securities
(1) The Company’s maximum loss exposure related to the VIE tenants represents the future minimum lease payments over the remaining term of the respective leases, which may be mitigated by re-leasing the properties to new tenants. The Company’s maximum loss exposure related to its loans and marketable debt securities to the VIE borrowers represents its current aggregate carrying amount.
As of September 30, 2013, the Company has not provided, and is not required to provide, financial support through a liquidity arrangement or otherwise, to its unconsolidated VIEs, including circumstances in which it could be exposed to further losses (e.g., cash shortfalls). See Notes 5 and 6 for additional descriptions of the nature, purpose and activities of the Company’s unconsolidated VIEs and interests therein.
Consolidated Variable Interest Entities
In September 2013, the Company made loans to two entities that entered into a tax credit structure (“Tax Credit Subsidiaries”). The Company consolidates the Tax Credit Subsidiaries because they are VIEs and the Company is the primary beneficiary of these VIEs. The assets and liabilities of the Tax Credit Subsidiaries substantially consist of notes receivable, prepaid expenses, notes payable and accounts payable and accrued liabilities generated from their operating activities. Assets generated by the operating activities of the Tax Credit Subsidiaries may only be used to settle their contractual obligations.
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In September 2011, the Company formed a partnership in which it has a 90% ownership interest in a joint venture entity that owns and operates 21 properties in a RIDEA structure (“RIDEA Entity”). The Company consolidated the RIDEA Entity as a result of the rights it acquired through the joint venture agreement with Brookdale. In the fourth quarter of 2012, upon the occurrence of a reconsideration event, it was determined that this RIDEA Entity was a VIE and that the Company was the primary beneficiary of the VIE; therefore, the Company continued to consolidate this entity. During the second quarter of 2013, upon the occurrence of a reconsideration event, it was determined that this RIDEA Entity was no longer a VIE; however, the Company continues to consolidate the RIDEA Entity. The assets and liabilities of this RIDEA Entity substantially consist of cash and cash equivalents, accounts receivable, and accounts payable and accrued liabilities generated from its operating activities. The assets generated by the operating activities of the RIDEA Entity may be used to settle its contractual obligations, which include lease obligations to the Company. The Company is entitled to its ownership share of the RIDEA Entity’s assets; however, it does not guarantee its liabilities (or contractual obligations) and is not liable to its general creditors.
(17) Fair Value Measurements
The following table illustrates the Company’s financial assets and liabilities measured at fair value on a recurring basis in the condensed consolidated balance sheets. Recognized gains and losses are recorded in other income, net on the Company’s condensed consolidated statements of income. During the nine months ended September 30, 2013, there were no transfers of financial assets or liabilities within the fair value hierarchy.
The financial assets and liabilities carried at fair value on a recurring basis at September 30, 2013 follow (in thousands):
Financial Instrument(1)
Fair Value
Level 2
Level 3
Currency swap liabilities
(1,897
Interest-rate swap assets
1,564
Interest-rate swap liabilities
(9,283
Warrants
180
(9,436
(9,616
(1) Interest rate and currency swaps as well as common stock warrant fair values are determined based on observable and unobservable market assumptions utilizing standardized derivative pricing models.
(18) Disclosures About Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued liabilities are reasonable estimates of fair value because of the short-term maturities of these instruments. The fair values of loans receivable, bank line of credit, term loan, mortgage debt and other debt are based on rates currently prevailing for similar instruments with similar maturities. The fair values of interest-rate and currency swap contracts as well as common stock warrants are determined based on observable and unobservable market assumptions using standardized pricing models. The fair values of senior unsecured notes and marketable equity and debt securities are determined utilizing market quotes.
The table below summarizes the carrying values and fair values of the Company’s financial instruments (in thousands):
Carrying Value
Loans receivable, net(2)
402,243
279,850
Marketable debt securities(1)
272,745
234,137
Marketable equity securities(1)
Warrants(3)
670
Bank line of credit(2)
Term loan(2)
Senior unsecured notes(1)
7,027,982
7,432,012
Mortgage debt(2)
1,452,732
1,771,155
Other debt(2)
Interest-rate swap assets(2)
89
Interest-rate swap liabilities(2)
9,283
12,699
Currency swap liabilities(2)
1,897
2,641
(1) Level 1: Fair value calculated based on quoted prices in active markets.
(2) Level 2: Fair value based on quoted prices for similar or identical instruments in active or inactive markets, respectively, or calculated utilizing model derived valuations in which significant inputs or value drivers are observable in active markets.
(3) Level 3: Fair value determined based on significant unobservable market inputs using standardized derivative pricing models.
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(19) Derivative Financial Instruments
The following table summarizes the Company’s outstanding interest-rate and foreign currency swap contracts as of September 30, 2013 (dollars and GBP in thousands):
Date Entered
Maturity Date
Hedge Designation
Fixed Rate/Buy Amount
Floating/Exchange Rate Index
Notional/ Sell Amount
Fair Value(1)
July 2005(2)
July 2020
Cash Flow
3.82
BMA Swap Index
45,600
(6,319
November 2008(3)
October 2016
5.95
1 Month LIBOR+1.50%
26,600
(2,964
July 2012(4)
June 2016
1.81
1 Month GBP LIBOR+1.20%
£
137,000
July 2012(5)
68,200
Buy USD/Sell GBP
43,500
(1) Interest-rate and foreign currency swap assets are recorded in other assets, net and interest-rate and foreign currency swap liabilities are recorded in accounts payable and accrued liabilities on the condensed consolidated balance sheets.
(2) Represents three interest-rate swap contracts with an aggregate notional amount of $45.6 million which hedge fluctuations in interest payments on variable-rate secured debt due to overall changes in hedged cash flows.
(3) Acquired in conjunction with mortgage debt assumed related to real estate acquired on December 28, 2010. Hedges fluctuations in interest payments on variable-rate secured debt due to fluctuations in the underlying benchmark interest rate.
(4) Hedges fluctuations in interest payments on variable-rate unsecured debt due to fluctuations in the underlying benchmark interest rate.
(5) Currency swap contract (buy USD/sell GBP) hedges the foreign currency exchange risk related to a portion of the Company’s forecasted interest receipts on GBP denominated senior unsecured notes. Represents six foreign exchange contracts to sell £7.2 million at a rate of 1.5695 on various dates through June 2016.
The Company uses derivative instruments to mitigate the effects of interest rate and foreign currency fluctuations on specific forecasted transactions as well as recognized financial obligations or assets. Utilizing derivative instruments allows the Company to manage the risk of fluctuations in interest and foreign currency rates related to the potential impact these changes could have on future earnings and forecasted cash flows. The Company does not use derivative instruments for speculative or trading purposes.
The primary risks associated with derivative instruments are market and credit risk. Market risk is defined as the potential for loss in value of a derivative instrument due to adverse changes in market prices. Credit risk is the risk that one of the parties to a derivative contract fails to perform or meet its financial obligation. The Company does not obtain collateral associated with its derivative contracts, but monitors the credit standing of its counterparties on a regular basis. Should a counterparty fail to perform, the Company would incur a financial loss to the extent that the associated derivative contract was in an asset position. At September 30, 2013, the Company does not anticipate non-performance by the counterparties to its outstanding derivative contracts.
On July 27, 2012, the Company entered into a foreign currency swap contract to hedge the foreign currency exchange risk related to a portion of the forecasted interest receipts from its GBP denominated senior unsecured notes (see additional discussion of the Four Seasons senior unsecured notes in Note 9). The cash flow hedge has a fixed USD/GBP exchange rate of 1.5695 (buy $11.4 million and sell £7.2 million semi-annually) for a portion of its forecasted semi-annual cash receipts denominated in GBP. The foreign currency swap contract matures in June 2016 (the end of the non-call period of the senior unsecured notes). The fair value of the contract at September 30, 2013 was a liability of $1.9 million and is included in accounts payable and accrued liabilities. During the nine months ended September 30, 2013, there was no ineffective portion related to this hedge.
On July 27, 2012, the Company entered into an interest-rate swap contract that is designated as hedging the interest payments on its GBP denominated Term Loan due to fluctuations in the underlying benchmark interest rate (see additional discussion of the Term Loan in Note 10). The cash flow hedge has a notional amount of £137 million and expires in June 2016 (the maturity of the Term Loan). The fair value of the contract at September 30, 2013 was $1.6 million and is included in other assets, net. During the nine months ended September 30, 2013, there was no ineffective portion related to this hedge.
At September 30, 2013, the Company expects that the hedged forecasted transactions for each of the outstanding qualifying cash flow hedging relationships remain probable of occurring, and as a result, no gains or losses recorded to accumulated other comprehensive loss are expected to be reclassified to earnings.
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To illustrate the effect of movements in the interest rate and foreign currency markets, the Company performed a market sensitivity analysis on its outstanding hedging instruments. The Company applied various basis point spreads to the underlying interest rate curves and foreign currency exchange rates of the derivative portfolio in order to determine the instruments’ change in fair value. The following table summarizes the results of the analysis performed (dollars in thousands):
Effects of Change in Interest and Foreign Currency Rates
+50 Basis Points
-50 Basis Points
+100 Basis Points
-100 Basis Points
July 2005
1,442
(1,455
2,890
(2,904
November 2008
404
(379
796
July 2012 (interest-rate swap)
3,038
(2,902
6,008
(5,872
July 2012 (foreign currency swap)
(580
123
(932
475
(20) Impairments
During the three months ended September 30, 2012, the Company executed an expansion of its relationship with its tenant General Atomics in Poway, CA, to a total of 396,000 square feet, consisting of the following: (i) a lease extension of 281,000 square feet through June 2024, (ii) a new 10-year lease for a 115,000 square foot building to be developed and (iii) the purchase of a 19 acre land parcel from the Company for $19 million. As a result of the land sale, the Company recognized an impairment charge of $7.9 million, which reduced the carrying value of the Company’s investment from $27 million to the $19 million sales price. The fair value of the Company’s land parcel was based on the sales price from its disposition in conjunction with this transaction. The contractual sales price of the land parcel was considered to be a Level 2 measurement within the fair value hierarchy.
(21) Subsequent Events
The Company’s Board of Directors, after its deliberations during the third quarter 2013, terminated its former Chairman, Chief Executive Officer and President on October 2, 2013. As a result of the termination, general and administrative expenses for the three and nine months ended September 30, 2013 include severance-related charges of $26.4 million related to: (i) the acceleration of $16.7 million of deferred compensation for restricted stock units and options that vested upon termination; and (ii) severance payments and other costs of approximately $9.7 million.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Language Regarding Forward-Looking Statements
Statements in this Quarterly Report on Form 10-Q that are not historical factual statements are “forward-looking statements.” We intend to have our forward-looking statements covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with those provisions. Forward-looking statements include, among other things, statements regarding our and our officers’ intent, belief or expectation as identified by the use of words such as “may,” “will,” “project,” “expect,” “believe,” “intend,” “anticipate,” “seek,” “forecast,” “plan,” “estimate,” “could,” “would,” “should” and other comparable and derivative terms or the negatives thereof. In addition, we, through our officers, from time to time, make forward-looking oral and written public statements concerning our expected future operations, strategies, securities offerings, growth and investment opportunities, dispositions, capital structure changes, budgets and other developments. Readers are cautioned that, while forward-looking statements reflect our good faith belief and reasonable assumptions based upon current information, we can give no assurance that our expectations or forecasts will be attained. Therefore, readers should be mindful that forward-looking statements are not guarantees of future performance and that they are subject to known and unknown risks and uncertainties that are difficult to predict. As more fully set forth under “Part I, Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, factors that may cause our actual results to differ materially from the expectations contained in the forward-looking statements include:
(a) Changes in global, national and local economic conditions, including a prolonged period of weak economic growth;
(b) Volatility in the capital markets, including changes in interest rates and the availability and cost of capital;
(c) Our ability to manage our indebtedness level and changes in the terms of such indebtedness;
(d) The effect on healthcare providers of the automatic spending cuts enacted by Congress (“Sequestration”) on entitlement programs, including Medicare, which will, unless modified, result in future reductions in reimbursements;
(e) The ability of our operators, tenants and borrowers to conduct their respective businesses in a manner sufficient to maintain or increase their revenues and to generate sufficient income to make rent and loan payments to us and our ability to recover investments made, if applicable, in their operations;
(f) The financial weakness of some operators and tenants, including potential bankruptcies and downturns in their businesses, which results in uncertainties regarding our ability to continue to realize the full benefit of such operators’ and/or tenants’ leases;
(g) Changes in federal, state or local laws and regulations, including those affecting the healthcare industry that affect our costs of compliance or increase the costs, or otherwise affect the operations of our operators, tenants and borrowers;
(h) The potential impact of future litigation matters, including the possibility of larger than expected litigation costs, adverse results and related developments;
(i) Competition for tenants and borrowers, including with respect to new leases and mortgages and the renewal or rollover of existing leases;
(j) Our ability to negotiate the same or better terms with new tenants or operators if existing leases are not renewed or we exercise our right to replace an existing operator or tenant upon default;
(k) Availability of suitable properties to acquire at favorable prices and the competition for the acquisition and financing of those properties;
(l) The financial, legal, regulatory and reputational difficulties of significant operators of our properties;
(m) The risk that we may not be able to achieve the benefits of investments within expected time-frames or at all, or within expected cost projections;
(n) The ability to obtain financing necessary to consummate acquisitions on favorable terms;
(o) The risks associated with our investments in joint ventures and unconsolidated entities, including our lack of sole decision making authority and our reliance on our joint venture partners’ financial condition and continued cooperation; and
(p) Changes in the credit ratings on United States (“U.S.”) government debt securities or default or delay in payment by the U.S. of its obligations.
Except as required by law, we undertake no, and hereby disclaim any, obligation to update any forward-looking statements, whether as a result of new information, changed circumstances or otherwise.
The information set forth in this Item 2 is intended to provide readers with an understanding of our financial condition, changes in financial condition and results of operations. We will discuss and provide our analysis in the following order:
· Executive Summary
· 2013 Transaction Overview
· Dividends
· Critical Accounting Policies
· Results of Operations
· Liquidity and Capital Resources
· Funds from Operations (“FFO”)
· Off-Balance Sheet Arrangements
· Contractual Obligations
· Inflation
· Recent Accounting Pronouncements
Executive Summary
We are a Maryland corporation and were organized to qualify as a self-administered real estate investment trust (“REIT”) that, together with our unconsolidated joint ventures, invests primarily in real estate serving the healthcare industry in the U.S. We acquire, develop, lease, manage and dispose of healthcare real estate, and provide financing to healthcare providers. At September 30, 2013, our portfolio of investments, including properties in our Investment Management Platform, consisted of interests in 1,163 facilities. Our Investment Management Platform represents the following joint ventures: (i) HCP Ventures III, LLC, (ii) HCP Ventures IV, LLC and (iii) the HCP Life Science ventures.
Our business strategy is based on three principles: (i) opportunistic investing, (ii) portfolio diversification and (iii) conservative financing. We actively redeploy capital from investments with lower return potential or shorter investment horizons into assets representing longer term investments with attractive risk-adjusted return potential. We make investments where the expected risk-adjusted return exceeds our cost of capital and strive to capitalize on our operator, tenant and other business relationships to grow our business.
Our strategy contemplates acquiring and developing properties on terms that are favorable to us. Generally, we prefer larger, more complex private transactions that leverage our management team’s experience and our infrastructure. We follow a disciplined approach to enhancing the value of our existing portfolio, including ongoing evaluation of potential disposition of properties that no longer fit our strategy.
We primarily generate revenue by leasing healthcare properties under long-term leases with fixed and/or inflation indexed escalators. Most of our rents and other earned income from leases are received under triple-net leases or leases that provide for substantial recovery of operating expenses; however, some of our medical office and life science leases are structured as gross or modified gross leases. Operating expenses are generally related to medical office building (“MOB”) and life science leased properties and senior housing properties managed by eligible independent contractors on our behalf (“RIDEA properties”). Accordingly, for such MOBs, life science facilities and RIDEA properties, we incur certain property operating expenses, such as real estate taxes, repairs and maintenance, property management fees, utilities, employee costs for resident care and insurance. Our growth for these assets depends, in part, on our ability to (i) increase rental income and other earned income from leases by increasing rental rates and occupancy levels; (ii) maximize tenant recoveries given underlying lease structures; and (iii) control operating and other expenses. Our operations are impacted by property specific, market specific, general economic and other conditions.
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2013 Transaction Overview
Investment Transactions
During the nine months ended September 30, 2013, we made investments of $541 million, which included the following:
· On September 25, 2013, we acquired a 60-bed hospital located in Webster, Texas valued at $15 million; in exchange we sold a 62-bed hospital located in Greenfield, Wisconsin and recognized a gain of $8 million.
· On September 6, 2013, we received £129 million ($202 million) from the par payoff of our Barchester debt investments, resulting in interest income of $24 million from the acquisition-related discounts. We acquired these debt investments in two tranches: (i) £121 million at a discount for £109 million in May 2013; and (ii) £9 million at a discount for £5 million in August 2013.
· On June 25, 2013, we funded the $102 million second tranche of our 2012 mezzanine loan facility to Tandem Health Care, an affiliate of Formation Capital, as part of the recapitalization of a post-acute/skilled nursing portfolio. The funds from the second tranche were used to repay debt senior to our loan. The loan bears interest at a fixed rate of 12% and 14% per annum for the first and second transactions, respectively. The facility will have a total term of up to 63 months from the initial closing in July 2012. The mezzanine loan facility is subordinate to $443 million of senior mortgage debt.
· In March 2013, we acquired the four remaining senior housing facilities from our previously announced 2012 Blackstone JV Acquisition for $38 million.
· We funded $208 million to acquire a senior housing facility and marketable debt securities, and to fund construction and other capital projects, primarily in our life science, medical office and senior housing segments.
During the nine months ended September 30, 2013, we placed into service a 70,000 square foot building located in Mountain View, California that is 100% leased.
Financing Activities
On February 28, 2013, we repaid $150 million of maturing 5.625% senior unsecured notes.
On October 24, 2013, we announced that our Board declared a quarterly common stock cash dividend of $0.525 per share. The common stock dividend will be paid on November 19, 2013 to stockholders of record as of the close of business on November 4, 2013 and represents an annualized dividend pay rate of $2.10 per share.
Critical Accounting Policies
The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to use judgment in the application of accounting policies, including making estimates and assumptions. We base estimates on the best information available to us at the time, our experience and on various other assumptions believed to be reasonable under the circumstances. These estimates affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions or other matters had been different, it is possible that different accounting would have been applied, resulting in a different presentation of our condensed consolidated financial statements. From time to time, we re-evaluate our estimates and assumptions. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current estimates and assumptions about matters that are inherently uncertain. A summary of our critical accounting policies is included in our Annual Report on Form 10-K for the year ended December 31, 2012 in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations”; our critical accounting policies have not changed during 2013.
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Results of Operations
We evaluate our business and allocate resources among our five business segments: (i) senior housing, (ii) post-acute/skilled nursing, (iii) life science, (iv) medical office and (v) hospital. Under the senior housing, life science, post-acute/skilled nursing and hospital segments, we invest or co-invest primarily in single operator or tenant properties, through the acquisition and development of real estate, management of operations (“RIDEA”) and by debt issued by operators in these sectors. Under the medical office segment, we invest or co-invest through the acquisition and development of MOBs that are leased under gross, modified gross or triple-net leases, generally to multiple tenants, and which generally require a greater level of property management.
We use net operating income from continuing operations (“NOI”) and adjusted NOI to assess and compare property level performance, including our same property portfolio (“SPP”), and to make decisions about resource allocations and to assess and compare property level performance. We believe these measures provide investors relevant and useful information because they reflect only income and operating expense items that are incurred at the property level and present them on an unleveraged basis. We believe that net income is the most directly comparable GAAP measure to NOI. NOI should not be viewed as an alternative measure of operating performance to net income as defined by GAAP since NOI excludes certain components from net income. Further, NOI may not be comparable to that of other REITs or real estate companies, as they may use different methodologies for calculating NOI. See Note 13 to the Condensed Consolidated Financial Statements for additional segment information and the relevant reconciliations from net income to NOI and adjusted NOI.
Operating expenses are generally related to MOB and life science leased properties and senior housing properties managed by eligible independent contractors on our behalf (RIDEA properties). We generally recover all or a portion of MOB and life science expenses from the tenants (tenant recoveries). The presentation of expenses as operating or general and administrative is based on the underlying nature of the expense. Periodically, we review the classification of expenses between categories and make revisions based on changes in the underlying nature of the expenses.
Our evaluation of results of operations by each business segment includes an analysis of our SPP and our total property portfolio. SPP information allows us to evaluate the performance of our leased property portfolio under a consistent population by eliminating changes in the composition of our portfolio of properties. We identify our SPP as stabilized properties that remained in operations and were consistently reported as leased properties or RIDEA properties for the duration of the year-over-year comparison periods presented. Accordingly, it takes a stabilized property a minimum of 12 months in operations under a consistent reporting structure to be included in our SPP. Newly acquired operating assets are generally considered stabilized at the earlier of lease-up (typically when the tenant(s) controls the physical use of at least 80% of the space) or 12 months from the acquisition date. Newly completed developments, including redevelopments, are considered stabilized at the earlier of lease-up or 24 months from the date the property is placed in service. SPP NOI excludes certain non-property specific operating expenses that are allocated to each operating segment on a consolidated basis.
Comparison of the Three Months Ended September 30, 2013 to the Three Months Ended September 30, 2012
During the fourth quarter of 2012 and first quarter of 2013, we acquired a portfolio of 133 senior housing communities (the “Blackstone JV Acquisition”; see additional information in Note 3 to the Condensed Consolidated Financial Statements). The transaction closed in two stages: (i) 129 senior housing facilities during the fourth quarter of 2012 for $1.7 billion; and (ii) four senior housing facilities during the first quarter of 2013 for $38 million. The results of operations from the acquisitions are reflected in our condensed consolidated financial statements from those respective dates.
Segment NOI and Adjusted NOI
The tables below provide selected operating information for our SPP and total property portfolio for each of our five business segments. Our consolidated SPP consists of 923 properties representing properties acquired or placed in service and stabilized on or prior to January 1, 2012 and that remained in operations under a consistent reporting structure through September 30, 2013. Our consolidated total property portfolio represents 1,089 and 950 properties at September 30, 2013 and 2012, respectively, and excludes properties classified as discontinued operations.
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Results are as of and for the three months ended September 30, 2013 and 2012 (dollars and square feet in thousands except per capacity data):
Senior Housing
SPP
Total Portfolio
Change
Rental revenues(1)
114,868
207
34,782
1,513
152,457
150,737
1,720
187,032
36,295
(24,027
(24,248
221
(24,641
(24,872
231
128,430
126,489
1,941
36,526
(3,464
(6,985
3,521
(10,806
(3,821
(2,440
(5,121
2,681
(257
(358
101
(148
210
122,269
114,025
8,244
35,596
Adjusted NOI % change
7.2
Property count(2)
311
445
Average capacity (units)(3)
35,306
35,313
45,396
Average annual rent per unit(4)
13,871
12,929
13,197
(1) Represents rental and related revenues and income from direct financing leases (“DFLs”).
(2) From our past presentation of SPP for the three months ended September 30, 2012, we removed a senior housing property from SPP that was sold.
(3) Represents average capacity as reported by the respective tenants or operators for the twelve-month period and a quarter in arrears from the periods presented.
(4) Average annual rent per unit includes operating income from properties under a RIDEA structure, which are included based on NOI.
SPP NOI and Adjusted NOI. SPP NOI increased primarily as a result of rent increases related to new leases or leases not recognized on a straight-line basis (cash basis) and increased NOI from RIDEA properties; these increases were partially offset by a decline in DFL income as a result of a 14-property DFL portfolio (the “DFL Portfolio”) that was placed on a cash basis during the three months ended September 30, 2013. SPP adjusted NOI improved primarily as a result of annual rent increases including increases from properties that were previously transitioned from Sunrise to other operators and increased NOI from RIDEA properties.
Total Portfolio NOI and Adjusted NOI. In addition to the impact of our SPP, our total portfolio NOI and adjusted NOI primarily increased as a result of our Blackstone JV Acquisition.
Post-Acute/Skilled Nursing
3,106
(146
(154
(647
(493
138,143
3,114
2,613
(13
(155
142
(17,382
(18,312
930
120,759
4,186
3,685
3.6
312
Average capacity (beds)(3)
39,826
39,850
Average annual rent per bed
12,142
11,715
(1) Represents rental and related revenues and income from DFLs.
(2) From our past presentation of SPP for the three months ended September 30, 2012, we removed a post-acute/skilled nursing property from SPP that was sold.
NOI and Adjusted NOI. SPP and total portfolio NOI and adjusted NOI primarily increased as a result of annual rent escalations.
Life Science
60,469
60,204
265
61,891
61,797
94
10,181
9,267
914
10,640
9,397
1,243
70,650
69,471
1,179
1,337
(12,182
(10,516
(1,666
(14,091
(11,791
(2,300
58,468
58,955
(487
(963
(2,942
(2,827
(115
(1,864
(3,010
1,146
(39
135
(174
(43
(166
(181
(6
55,306
56,088
(782
(1.4
)%
Property count
105
111
Average occupancy
91.9
90.1
91.8
89.5
Average occupied square feet
6,234
6,112
6,496
6,268
Average annual rent per occupied square foot
During the three months ended September 30, 2013, 108,000 square feet of new and renewal leases commenced at an average annual base rent of $23.68 per square foot compared to 64,000 square feet of expiring and terminated leases with an average annual base rent of $30.25 per square foot.
Medical Office
66,224
66,787
(563
73,771
72,344
1,427
13,006
12,898
108
14,702
13,456
1,246
79,230
79,685
(455
2,673
(30,936
(31,116
(36,218
(34,948
(1,270
48,294
48,569
(275
(60
(982
922
(299
(1,331
1,032
146
79
282
148
134
(24
48,356
47,666
690
2,545
1.4
Property count(1)
184
208
205
90.0
91.4
89.8
91.2
11,397
11,576
12,754
12,605
(1) From our past presentation of SPP for the three months ended September 30, 2012, we removed a MOB that was placed into redevelopment in 2013, which no longer meets our criteria for SPP as of the date it was placed into redevelopment.
Total Portfolio NOI and Adjusted NOI. Total portfolio NOI and adjusted NOI increased primarily as a result of the impact of our MOB acquisitions in 2012.
During the three months ended September 30, 2013, 492,000 square feet of new and renewal leases commenced at an average annual base rent of $21.42 per square foot compared to 491,000 square feet of expiring and terminated leases with an average annual base rent of $23.36 per square foot.
31
13,060
13,078
(18
14,447
13,842
605
644
573
71
572
13,704
13,651
53
677
(972
(886
(86
(888
(84
12,732
12,765
(33
686
(108
794
371
(249
620
(317
(87
(230
(342
(112
13,101
12,570
531
983
Average capacity (beds)(2)
1,448
1,453
1,535
1,484
38,876
37,043
39,401
37,879
(1) From our past presentation of SPP for the three months ended September 30, 2012, we removed five hospitals from SPP that were sold or classified as held for sale.
(2) Represents capacity as reported by the respective tenants or operators for the twelve-month period and a quarter in arrears from the periods presented. Certain operators in our hospital portfolio are not required under their respective leases to provide operational data.
SPP NOI and Adjusted NOI. SPP adjusted NOI increased primarily as a result of a new lease on our Plano hospital.
Total Portfolio NOI and Adjusted NOI. In addition to the impact of our SPP, our total portfolio NOI and adjusted NOI primarily increased as a result of rents on our Fresno hospital that was placed in service in January 2013.
Other Income and Expense Items
Interest income increased $32 million to $42 million for the three months ended September 30, 2013. The increase was primarily the result of interest income from the repayment of our Barchester loan in September 2013 (acquired earlier in 2013 at discounted prices) and interest earned from the second tranche of our mezzanine loan facility to Tandem Health Care (see Note 6 to the Condensed Consolidated Financial Statements for additional information).
Interest expense increased $5 million to $108 million for the three months ended September 30, 2013. The increase was primarily the result of increases in indebtedness and a decrease of capitalized interest related to assets that were under development in our life science and medical office segments and were placed in service during 2013 and 2012. These increases were partially offset by a reduction in interest rates.
Our exposure to expense fluctuations related to our variable rate indebtedness is substantially mitigated by our interest rate swap contracts. For a more detailed discussion of our interest rate risk, see “Quantitative and Qualitative Disclosures About Market Risk” in Item 3.
The table below sets forth information with respect to our debt, excluding premiums and discounts (dollars in thousands):
As of September 30,(1)
Balance:
Fixed rate
8,185,353
7,813,925
Variable rate
324,902
40,404
8,510,255
7,854,329
32
Percent of total debt:
96
100
Weighted average interest rate at end of period:
5.21
5.49
1.57
4.53
Total weighted average rate
5.07
5.47
(1) Excludes $78 million and $85 million at September 30, 2013 and 2012, respectively, of other debt that represents non-interest bearing life care bonds and occupancy fee deposits at certain of our senior housing facilities, which have no scheduled maturities. At September 30, 2013, $72 million of variable-rate mortgages and a £137 million ($222 million) term loan are presented as fixed-rate debt as the interest payments under such debt have been swapped (pay fixed and receive float). At September 30, 2012, $87 million of variable-rate mortgages are presented as fixed-rate debt as the interest payments under such debt have been swapped (pay fixed and receive float); the interest rates for swapped debt are presented at the swapped rates.
Depreciation and amortization expense increased $18 million to $105 million for the three months ended September 30, 2013. The increase was primarily the result of the impact of our senior housing facility and MOB acquisitions in 2012.
General and administrative expenses
General and administrative expenses increased $26 million to $45 million for the three months ended September 30, 2013. The three months ended September 30, 2013 included $26.4 million of severance-related charges resulting from the termination of our former Chairman, Chief Executive Officer and President (see Note 21 to the Condensed Consolidated Financial Statements for additional information).
During the three months ended September 30, 2012, we recognized an impairment of $8 million as a result of the sale a life science land parcel (see Note 20 to the Condensed Consolidated Financial Statements for additional information). No impairments were recognized during the three months ended September 30, 2013.
During the three months ended September 30, 2013, we sold a hospital and recognized a gain of $8 million. There were no sales of properties during the three months ended September 30, 2012.
Comparison of the Nine Months Ended September 30, 2013 to the Nine Months Ended September 30, 2012
During the fourth quarter of 2012 and first quarter of 2013, we acquired a portfolio of 133 senior housing communities (the “Blackstone JV Acquisition”, see additional information in Note 3 to the Condensed Consolidated Financial Statements). The transaction closed in two stages: (i) 129 senior housing facilities during the fourth quarter of 2012 for $1.7 billion; and (ii) four senior housing facilities during the first quarter of 2013 for $38 million. The results of operations from the acquisitions are reflected in our condensed consolidated financial statements from those respective dates.
The tables below provide selected operating information for our SPP and total property portfolio for each of our five business segments. Our consolidated SPP consists of 920 properties representing properties acquired or placed in service and stabilized on or prior to January 1, 2012 and that remained in operations under a consistent reporting structure through September 30, 2013. Our consolidated total property portfolio represents 1,089 and 950 properties at September 30, 2013 and 2012, respectively, and excludes properties classified as discontinued operations.
33
Results are as of and for the nine months ended September 30, 2013 and 2012 (dollars and square feet in thousands except per capacity data):
346,093
341,257
4,836
107,247
4,246
458,163
449,081
9,082
560,670
449,177
111,493
(70,933
(68,017
(2,916
(73,169
(69,926
(3,243
387,230
381,064
6,166
108,250
(12,692
(21,664
8,972
(34,371
(21,677
(12,694
(12,202
(14,706
2,504
(939
(1,074
541
361,397
343,620
17,777
98,601
45,391
13,668
12,989
13,017
12,992
(2) From our past presentation of SPP for the nine months ended September 30, 2012, we removed a senior housing property from SPP that was sold.
SPP NOI and Adjusted NOI. SPP NOI increased primarily as a result of rent increases related to new leases or leases not recognized on a straight-line basis (cash basis) and increased NOI from RIDEA properties; these increases were partially offset by a decline in DFL income as a result of the DFL Portfolio that was placed on a cash basis during the three months ended September 30, 2013. SPP adjusted NOI improved primarily as a result of annual rent increases including increases from properties that were previously transitioned from Sunrise to other operators and increased NOI from RIDEA properties.
8,703
(445
(515
70
(1,947
(519
(1,428
411,467
402,694
8,773
7,275
(271
(422
151
(53,184
(56,366
3,182
34
358,046
345,940
12,106
10,608
3.5
12,001
11,591
(2) From our past presentation of SPP for the nine months ended September 30, 2012, we removed a post-acute/skilled nursing property from SPP that was sold.
180,455
179,917
538
188,309
184,600
3,709
31,320
30,639
681
32,779
30,969
1,810
211,775
210,556
1,219
5,519
(35,990
(34,460
(1,530
(41,313
(38,230
(3,083
175,785
176,096
(311
2,436
(9,211
(5,530
(3,681
(8,759
(6,300
(2,459
160
352
(192
(180
(194
(19
166,540
170,743
(4,203
(222
(2.5
102
92.8
91.1
91.6
89.2
6,206
6,090
6,465
6,212
SPP NOI and Adjusted NOI. SPP NOI decreased primarily as a result of mark-to-market rent reductions on renewed leases. SPP adjusted NOI decreased primarily as a result of a $4 million rent payment received in February 2012 in connection with a lease amendment and mark-to-market rent reductions, partially offset by annual rent escalations.
Total Portfolio NOI and Adjusted NOI. In addition to the impact of our SPP, our total portfolio NOI increased primarily as a result of rents on recent development projects placed in service during 2013 and 2012.
During the nine months ended September 30, 2013, 369,000 square feet of new and renewal leases commenced at an average annual base rent of $28.37 per square foot compared to 236,000 square feet of expiring and terminated leases with an average annual base rent of $36.68 per square foot.
199,726
200,178
(452
225,181
209,714
15,467
35,771
36,205
(434
40,721
36,947
3,774
235,497
236,383
19,241
(90,390
(90,335
(55
(105,732
(98,631
(7,101
145,107
146,048
(941
12,140
(1,796
(3,355
1,559
(3,152
(3,747
595
359
152
750
240
510
(26
(251
225
143,644
142,649
995
13,470
0.7
90.6
90.4
11,479
11,542
12,822
12,085
(1) From our past presentation of SPP for the nine months ended September 30, 2012, we removed a MOB that was placed into redevelopment in 2013, which no longer meets our criteria for SPP as of the date it was placed into redevelopment.
35
Total Portfolio NOI and Adjusted NOI. Total portfolio NOI and adjusted NOI increased primarily as a result of the impact of our MOB acquisitions during 2012.
During the nine months ended September 30, 2013, 1.4 million square feet of new and renewal leases commenced at an average annual base rent of $21.59 per square foot compared to 1.8 million square feet of expiring and terminated leases with an average annual base rent of $22.03 per square foot.
28,151
38,615
(10,464
31,868
40,907
(9,039
1,835
1,741
1,740
95
29,986
40,356
(10,370
(8,944
(2,819
(2,722
(97
(2,821
(2,728
(93
27,167
37,634
(10,467
(9,037
18,556
(454
19,010
17,969
(889
18,858
(6,407
(260
(6,147
(6,482
(334
(6,148
39,316
36,920
2,396
3,673
6.5
38,798
36,377
39,253
37,218
(1) From our past presentation of SPP for the nine months ended September 30, 2012, we removed five hospitals from SPP that were sold or classified as held for sale.
SPP and Total Portfolio NOI and Adjusted NOI. SPP and total portfolio NOI primarily decreased due to a net $12 million correction of an error that reduced previously recognized straight-line rents and to increasing amortization of below market lease intangibles related to our Medical City Dallas hospital. SPP and total portfolio adjusted NOI increased due to annual rent increases, a new lease on our Plano hospital and rents on our Fresno hospital that was placed in service in January 2013.
Interest income increased $56 million to $69 million for the nine months ended September 30, 2013. The increase was primarily the result of interest income from the repayment of our Barchester loan in September 2013 (acquired earlier in 2013 at discounted prices), and interest earned from our Four Seasons senior unsecured notes purchased in 2012 and the second tranche of our mezzanine loan facility to Tandem Health Care (see Notes 6 and 9 to the Condensed Consolidated Financial Statements for additional information).
Interest expense increased $17 million to $326 million for the nine months ended September 30, 2013. The increase was primarily the result of increases in indebtedness and a decrease of capitalized interest related to assets that were under development in our life science and medical office segments and were placed in service during 2013 and 2012. These increases were partially offset by a reduction in interest rates.
36
Depreciation and amortization expense increased $63 million to $317 million for the nine months ended September 30, 2013. The increase was primarily the result of the impact of our senior housing facility and MOB acquisitions during 2012.
General and administrative expenses increased $36 million to $90 million for the nine months ended September 30, 2013. The nine months ended September 30, 2013 included $26.4 million of severance-related charges resulting from the termination of our former Chairman, Chief Executive Officer and President (see Note 21 to the Condensed Consolidated Financial Statements for additional information). The increase in general and administrative expenses was also attributable to an insurance recovery of $7 million received in 2012 for previously incurred legal expenses.
During the nine months ended September 30, 2012, we recognized an impairment of $8 million as a result of the sale of a life science land parcel (see Note 20 to the Condensed Consolidated Financial Statements for additional information). No impairments were recognized during the nine months ended September 30, 2013.
Other income, net increased $15 million to $17 million for the nine months ended September 30, 2013. The increase was primarily the result of gains from the sale of marketable equity securities during 2013 of $11 million.
During the nine months ended September 30, 2013, we sold two properties realizing a gain of $9 million. During the nine months ended September 30, 2012, we sold one property realizing a gain of $3 million.
On March 22, 2012, we announced the redemption of all outstanding shares of preferred stock. On April 23, 2012, we redeemed all outstanding shares of our preferred stock and paid all accrued and unpaid dividends to the redemption date. During the nine months ended September 30, 2012, we incurred a redemption charge of $10.4 million related to the original issuance costs of the preferred stock (this charge is presented as an additional preferred stock dividend in our consolidated income statements).
Liquidity and Capital Resources
Our principal liquidity needs are to: (i) fund recurring operating expenses, (ii) meet debt service requirements including principal payments and maturities in the last three months of 2013, (iii) fund capital expenditures, including tenant improvements and leasing costs, (iv) fund acquisition and development activities, and (v) make dividend distributions. We anticipate that cash flow from continuing operations over the next 12 months will be adequate to fund our business operations, debt service payments, recurring capital expenditures and cash dividends to shareholders. Capital requirements relating to maturing indebtedness, acquisitions and development activities may require funding from borrowings and/or equity and debt offerings.
Access to capital markets impacts our cost of capital and ability to refinance maturing indebtedness, as well as our ability to fund future acquisitions and development through the issuance of additional securities or secured debt. Credit ratings impact our ability to access capital and directly impact our cost of capital as well. For example, as noted below, our revolving line of credit facility accrues interest at a rate per annum equal to LIBOR plus a margin that depends upon our debt ratings. We also pay a facility fee on the entire revolving commitment that depends upon our debt ratings. As of October 25, 2013, we had a credit rating of BBB+ from Fitch, Baa1 from Moody’s and BBB+ from S&P on our senior unsecured debt securities.
Net cash provided by operating activities was $844 million and $721 million for the nine months ended September 30, 2013 and 2012, respectively. The increase in operating cash flows is primarily the result of the following: (i) the impact of our investments in 2012 and 2013, (ii) assets placed in service during 2012 and 2013 and (iii) rent escalations and resets in 2012 and 2013, which increases were partially offset by increased debt interest payments. Our cash flows from operations are dependent upon the occupancy level of multi-tenant buildings, rental rates on leases, our tenants’ performance on their lease obligations, the level of operating expenses and other factors.
37
The following are significant investing and financing activities for the nine months ended September 30, 2013:
· made investments of $280 million (development and acquisition of real estate), net of loan repayments of $231 million;
· paid dividends on common stock of $717 million, which were generally funded by cash provided by our operating activities; and
· borrowed $283 million under our unsecured revolving line of credit facility to fund, among other things, the aforementioned investments and repaid $435 million of mortgages and senior unsecured notes.
Debt
Our $1.5 billion unsecured revolving line of credit facility (the “Facility”) matures in March 2016 and contains a one-year extension option. Borrowings under the Facility accrue interest at LIBOR plus a margin that depends upon our debt ratings. We pay a facility fee on the entire revolving commitment that depends on our debt ratings. Based on our debt ratings at October 25, 2013, the margin on the Facility was 1.075%, and the facility fee was 0.175%. The Facility also includes a feature that will allow us to increase the borrowing capacity by an aggregate amount of up to $500 million, subject to securing additional commitments from existing lenders or new lending institutions. At September 30, 2013, we had $285 million outstanding under the Facility.
On July 30, 2012, we entered into a credit agreement with a syndicate of banks for a £137 million ($222 million at September 30, 2013) four-year unsecured term loan (the “Term Loan”) that accrues interest at a rate of GBP LIBOR plus 1.20%, based on our current debt ratings. Concurrent with the closing of the Term Loan, we entered into a four-year interest rate swap contract that fixes the rate of the Term Loan at 1.81%, subject to adjustments based on our debt ratings. The Term Loan contains a one-year committed extension option.
The Facility and Term Loan contain certain financial restrictions and other customary requirements. Among other things, these covenants, using terms defined in the agreements, (i) limit the ratio of Consolidated Total Indebtedness to Consolidated Total Asset Value to 60%, (ii) limit the ratio of Secured Debt to Consolidated Total Asset Value to 30%, (iii) limit the ratio of Unsecured Debt to Consolidated Unencumbered Asset Value to 60%, (iv) require a minimum Fixed Charge Coverage ratio of 1.5 times and (v) require a formula-determined Minimum Consolidated Tangible Net Worth of $9.2 billion at September 30, 2013. At September 30, 2013, we were in compliance with each of these restrictions and requirements of the Facility and Term Loan.
Our Facility also contains cross-default provisions to other indebtedness of ours, including in some instances, certain mortgages on our properties. Certain mortgages contain default provisions relating to defaults under the leases or operating agreements on the applicable properties by our operators or tenants, including default provisions relating to the bankruptcy filings of such operator or tenant. Although we believe that we would be able to secure amendments under the applicable agreements if a default as described above occurs, such a default may result in significantly less favorable borrowing terms than currently available, material delays in the availability of funding or other material adverse consequences.
At September 30, 2013, we had senior unsecured notes outstanding with an aggregate principal balance of $6.6 billion. Interest rates on the notes ranged from 1.22% to 6.98% with a weighted average effective interest rate of 5.10% and a weighted average maturity of five years at September 30, 2013. The senior unsecured notes contain certain covenants including limitations on debt, maintenance of unencumbered assets, cross-acceleration provisions and other customary terms. We believe we were in compliance with these covenants at September 30, 2013.
At September 30, 2013, we had $1.4 billion in aggregate principal amount of mortgage debt outstanding is secured by 132 healthcare facilities (including redevelopment properties) with a carrying value of $2.0 billion. Interest rates on the mortgage debt ranged from 0.69% to 8.69% with a weighted average effective interest rate of 6.16% and a weighted average maturity of four years at September 30, 2013.
38
Mortgage debt generally requires monthly principal and interest payments, is collateralized by real estate assets and is generally non-recourse. Mortgage debt typically restricts transfer of the encumbered assets, prohibits additional liens, restricts prepayment, requires payment of real estate taxes, requires maintenance of the assets in good condition, requires maintenance of insurance on the assets and includes conditions to obtain lender consent to enter into and terminate material leases. Some of the mortgage debt is also cross-collateralized by multiple assets and may require tenants or operators to maintain compliance with the applicable leases or operating agreements of such real estate assets.
At September 30, 2013, we had $78 million of non-interest bearing life care bonds at two of our continuing care retirement communities and non-interest bearing occupancy fee deposits at two of our senior housing facilities, all of which were payable to certain residents of the facilities (collectively, “Life Care Bonds”). The Life Care Bonds are generally refundable to the residents upon the termination of the contract or upon the successful resale of the unit.
The following table summarizes our stated debt maturities and scheduled principal repayments at September 30, 2013 (in thousands):
Amount(1)
(1) Excludes $78 million of other debt that represents Life Care Bonds that have no scheduled maturities.
Derivative Instruments
We use derivative instruments to mitigate the effects of interest rate and foreign currency fluctuations on specific forecasted transactions as well as recognized financial obligations or assets. We do not use derivative instruments for speculative or trading purposes.
The following table summarizes our outstanding interest-rate and foreign currency swap contracts as of September 30, 2013 (dollars and GBP in thousands):
July 2005(1)
July 2012
(1) Represents three interest-rate swap contracts with an aggregate notional amount of $45.6 million which hedge fluctuations in interest payments on variable-rate secured debt due to overall changes in hedged cash flows.
For a more detailed description of our derivative instruments, see Note 19 to the Condensed Consolidated Financial Statements and “Quantitative and Qualitative Disclosures About Market Risk” in Item 3.
39
At September 30, 2013, we had 456 million shares of common stock outstanding. At September 30, 2013, equity totaled $10.9 billion, and our equity securities had a market value of $18.9 billion.
At September 30, 2013, non-managing members hold an aggregate of 4 million units (“DownREITs”) in four limited liability companies for which we are the managing member. The DownREIT units are exchangeable for an amount of cash approximating the then-current market value of shares of our common stock or, at our option, shares of our common stock (subject to certain adjustments, such as stock splits and reclassifications).
Shelf Registration
We have a prospectus that we filed with the U.S. Securities and Exchange Commission (the “SEC”) as part of a registration statement on Form S-3ASR, using a shelf registration process which expires in July 2015. Under the “shelf” process, we may sell any combination of the securities in one or more offerings. The securities described in the prospectus include common stock, preferred stock, depositary shares, debt securities and warrants.
The prospectus only provides a general description of the securities we may offer. The prospectus may not be used to sell securities unless accompanied by a prospectus supplement or a free writing prospectus. Each time we sell securities under the shelf registration, we will provide a prospectus supplement that will contain specific information about the terms of the securities being offered and of the offering. The prospectus supplement may also add, update or change information contained in the prospectus.
We may offer and sell the securities pursuant to the prospectus through underwriters, dealers or agents or directly to purchasers, on a continuous or delayed basis. The securities may also be resold by selling security holders. The prospectus supplement for each offering will describe in detail the plan of distribution for that offering and will set forth the names of any underwriters, dealers or agents involved in the offering and any applicable fees, commissions or discount arrangements. We intend to use the net proceeds from the sales of the securities as set forth in the applicable prospectus supplement, and unless otherwise set forth therein, we will not receive any proceeds if the securities are sold by a selling security holder.
Funds From Operations (“FFO”)
We believe FFO applicable to common shares, diluted FFO applicable to common shares, and basic and diluted FFO per common share are important supplemental non-GAAP measures of operating performance for a REIT. Because the historical cost accounting convention used for real estate assets utilizes straight-line depreciation (except on land), such accounting presentation implies that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen and fallen with market conditions, presentations of operating results for a REIT that uses historical cost accounting for depreciation could be less informative. The term FFO was designed by the REIT industry to address this issue.
FFO is defined as net income applicable to common shares (computed in accordance with GAAP), excluding gains or losses from acquisition and dispositions of depreciable real estate or related interests, impairments of, or related to, depreciable real estate, plus real estate and DFL depreciation and amortization, with adjustments for joint ventures. Adjustments for joint ventures are calculated to reflect FFO on the same basis. FFO does not represent cash generated from operating activities in accordance with GAAP, is not necessarily indicative of cash available to fund cash needs and should not be considered an alternative to net income. We compute FFO in accordance with the current National Association of Real Estate Investment Trusts’ (“NAREIT”) definition; however, other REITs may report FFO differently or have a different interpretation of the current NAREIT definition from us. In addition, we present FFO before the impact of severance-related charges, litigation settlement charges, preferred stock redemption charges, impairments (recoveries) of non-depreciable assets and merger-related items (defined below) (“FFO as adjusted”). Management believes FFO as adjusted is a useful alternative measurement. This measure is a modification of the NAREIT definition of FFO and should not be used as an alternative to net income (determined in accordance with GAAP).
40
Details of certain items that affect comparability are discussed under “Results of Operations” above. The following is a reconciliation of net income applicable to common shares, the most direct comparable financial measure calculated and presented in accordance with GAAP, to FFO and FFO as adjusted (in thousands, except per share data):
DFL depreciation
3,631
3,234
10,589
9,426
(8,298
FFO from unconsolidated joint ventures
16,642
16,043
52,539
50,495
Noncontrolling interests’ and participating securities’ share in earnings
3,576
3,414
10,955
11,224
Noncontrolling interests’ and participating securities’ share in FFO
(5,162
(4,821
(15,569
(15,512
FFO applicable to common shares
336,071
290,242
1,003,239
848,665
Distributions on dilutive convertible units
3,302
3,148
9,966
Diluted FFO applicable to common shares
339,373
293,390
1,013,205
858,062
Diluted FFO per common share
0.73
0.67
2.20
2.01
Weighted average shares used to calculate diluted FFO per common share
462,082
437,043
461,403
427,388
Impact of adjustments to FFO:
Severance-related charges(1)
26,374
Preferred stock redemption charge(2)
10,432
Impairments(3)
18,310
FFO as adjusted applicable to common shares
362,445
298,120
1,029,613
866,975
Distributions on dilutive convertible units and other
3,247
3,127
9,907
9,345
Diluted FFO as adjusted applicable to common shares
365,692
301,247
1,039,520
876,320
Diluted FFO as adjusted per common share
0.79
0.69
2.25
2.05
Weighted average shares used to calculate diluted FFO as adjusted per common share
(1) The Company’s Board of Directors, after deliberations during the third quarter 2013, terminated its former Chairman, Chief Executive Officer and President on October 2, 2013. As a result of the termination, we incurred severance-related charges of $26.4 million that include: (i) the acceleration of $16.7 million of deferred compensation for restricted stock units and options that vested upon termination; and (ii) severance payments and other costs of approximately $9.7 million. See Note 21 to the Condensed Consolidated Financial Statements for additional information.
(2) In connection with the redemption of our preferred stock, we incurred a one-time, non-cash redemption charge of $10.4 million related to the original issuance costs of the preferred stock.
(3) The impairment charge of $7.9 million related to the sale of a land parcel in our life science segment.
41
Off-Balance Sheet Arrangements
We own interests in certain unconsolidated joint ventures as described under Note 7 to the Condensed Consolidated Financial Statements. Except in limited circumstances, our risk of loss is limited to our investment in the joint venture and any outstanding loans receivable. In addition, we have certain properties which serve as collateral for debt that is owed by a previous owner of certain of our facilities, as described under Note 11 to the Condensed Consolidated Financial Statements. Our risk of loss for these certain properties is limited to the outstanding debt balance plus penalties, if any. We have no other material off-balance sheet arrangements that we expect would materially affect our liquidity and capital resources except those described below under “Contractual Obligations.”
Contractual Obligations
The following table summarizes our material contractual payment obligations and commitments at September 30, 2013 (in thousands):
Total(1)
Less than One Year
2014-2015
2016-2017
More than Five Years
Line of credit
887,000
1,650,000
488,463
842,215
Construction loan commitments(3)
37,389
7,740
29,649
Development commitments(4)
20,943
17,433
3,510
Ground and other operating leases
220,789
1,711
11,522
8,014
199,542
Interest(5)
2,192,980
51,629
725,312
528,282
887,757
10,982,355
492,516
2,145,456
3,535,259
4,809,124
(2) Represents £137 million translated into U.S. dollars.
(3) Represents commitments to finance development projects and related working capital financings.
(4) Represents construction and other commitments for developments in progress.
(5) Interest on variable-rate debt is calculated using rates in effect at September 30, 2013.
Inflation
Our leases often provide for either fixed increases in base rents or indexed escalators, based on the Consumer Price Index or other measures, and/or additional rent based on increases in the tenants’ operating revenues. Most of our MOB leases require the tenant to pay a share of property operating costs such as real estate taxes, insurance and utilities. Substantially all of our senior housing, life science, post-acute/skilled nursing and hospital leases require the operator or tenant to pay all of the property operating costs or reimburse us for all such costs. We believe that inflationary increases in expenses will be offset, in part, by the operator or tenant expense reimbursements and contractual rent increases described above.
See Note 2 to the Condensed Consolidated Financial Statements for the impact of new accounting standards. There are no accounting pronouncements that have been issued, but not yet adopted by us, that we believe will materially impact our condensed consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We use derivative financial instruments in the normal course of business to mitigate interest rate and foreign currency risk. We do not use derivative financial instruments for speculative or trading purposes. Derivatives are recorded on the condensed consolidated balance sheets at their fair value. See Note 19 to the Condensed Consolidated Financial Statements for additional information.
To illustrate the effect of movements in the interest rate and foreign currency markets, we performed a market sensitivity analysis on our hedging instruments. We applied various basis point spreads to the underlying interest rate curves and foreign currency exchange rates of the derivative portfolio in order to determine the instruments’ change in fair value. Assuming a one percentage point change in the underlying interest rate curve and foreign currency exchange rates, the estimated change in fair value of each of the underlying derivative instruments would not exceed $6 million. See Note 19 to the Condensed Consolidated Financial Statements for additional analysis details.
Interest Rate Risk. At September 30, 2013, we are exposed to market risks related to fluctuations in interest rates on the following: (i) $285 million of variable-rate line of credit borrowings, (ii) $25 million of variable-rate senior unsecured notes and (iii) $15 million of variable-rate mortgage debt payable (excludes $72 million of variable-rate mortgage notes that have been hedged through interest-rate swap contracts) that are partially offset by properties with a gross value of $83 million that are subject to leases where the payments fluctuate with changes in LIBOR. Additionally, our exposure to market risks related to fluctuations in interest rates excludes our GBP denominated $222 million (£137 million) variable-rate Term Loan that has been hedged through interest-rate swap contracts.
Interest rate fluctuations will generally not affect our future earnings or cash flows on our fixed rate debt and assets unless such instruments mature or are otherwise terminated. However, interest rate changes will affect the fair value of our fixed rate instruments. Conversely, changes in interest rates on variable rate debt and investments would change our future earnings and cash flows, but not significantly affect the fair value of those instruments. Assuming a one percentage point increase in the interest rate related to the variable-rate investments and variable-rate debt, and assuming no other changes in the outstanding balance as of September 30, 2013, our annual interest expense would increase by approximately $2 million, or less than $0.01 per common share on a diluted basis.
Foreign Currency Risk. At September 30, 2013, our exposure to foreign currency exchange rates relates to forecasted interest receipts from our GBP denominated senior unsecured notes (see additional discussion of the Four Seasons senior unsecured notes in Note 9 to the Condensed Consolidated Financial Statements). Our foreign currency exchange exposure is mitigated by the forecasted interest and principal payments from our GBP denominated unsecured Term Loan (see Note 10 to the Condensed Consolidated Financial Statements for additional information), and a foreign currency swap contract for approximately 85% of the forecasted interest receipts from our Four Seasons senior unsecured notes through their non-call period, which ends on June 15, 2016.
Market Risk. We have investments in marketable debt securities classified as held-to-maturity, because we have the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are recorded at amortized cost and adjusted for the amortization of premiums and discounts through maturity. We consider a variety of factors in evaluating an other-than-temporary decline in value, such as: the length of time and the extent to which the market value has been less than our current adjusted carrying value; the issuer’s financial condition, capital strength and near-term prospects; any recent events specific to that issuer and economic conditions of its industry; and our investment horizon in relationship to an anticipated near-term recovery in the market value, if any. At September 30, 2013, the fair value and adjusted carrying value of marketable debt securities were $273 million and $239 million, respectively.
Item 4. Controls and Procedures
Disclosure Controls and Procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer), to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Also, we have investments in certain unconsolidated entities. Our disclosure controls and procedures with respect to such entities are substantially more limited than those we maintain with respect to our consolidated subsidiaries.
As required by Rules 13a-15(b) and 15d-15(b) of the Securities Exchange Act of 1934, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer), of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2013. Based upon that evaluation, our Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer) concluded that our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 1A. Risk Factors
There are no material changes to the risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a)
None.
(b)
(c)
The table below sets forth information with respect to purchases of our common stock made by us or on our behalf or by any “affiliated purchaser,” as such term is defined in Rule 10b-18(a)(3) of the Securities Exchange Act of 1934, as amended, during the three months ended September 30, 2013.
Period Covered
Total Number Of Shares Purchased(1)
Average Price Paid Per Share
Total Number Of Shares (Or Units) Purchased As Part Of Publicly Announced Plans Or Programs
Maximum Number (Or Approximate Dollar Value) Of Shares (Or Units) That May Yet Be Purchased Under The Plans Or Programs
July 1-31, 2013
3,826
45.05
September 1-30, 2013
1,472
41.42
5,298
44.04
(1) Represents restricted shares withheld under our 2006 Performance Incentive Plan (the “2006 Incentive Plan”), to offset tax withholding obligations that occur upon vesting of restricted shares. Our 2006 Incentive Plan provides that the value of the shares withheld shall be the closing price of our common stock on the date the relevant transaction occurs.
Item 5. Other Information
On October 31, 2013, we entered into amendments to the existing employment agreements (each an “Amendment”) with each of Paul F. Gallagher, Executive Vice President and Chief Investment Officer, and Timothy M. Schoen, Executive Vice President and Chief Financial Officer which memorialize the terms previously agreed to in binding term sheets, as previously disclosed. We also entered into a substantially similar Amendment with James W. Mercer, Executive Vice President, General Counsel and Corporate Secretary. Additionally, we entered into restricted stock unit award agreements (each an “Award Agreement”) with each of Messrs. Gallagher, Schoen and Mercer with respect to a one-time grant of restricted stock units with a value of $1,000,000. Pursuant to the Award Agreement, fifty percent of the restricted stock units will vest on each of the first and second anniversaries of the grant.
The foregoing summary of each Amendment and Award Agreement is qualified in its entirety by the text of such agreements, copies of which are attached as Exhibits 10.4 through 10.9 to this Quarterly Report on Form 10-Q and incorporated herein by reference.
Item 6. Exhibits
2.2
Purchase and Sale Agreement, dated as of October 16, 2012, by and among BRE/SW Portfolio LLC, those owner entities listed on Schedule 1 thereto, HCP, Inc. and Emeritus Corporation; and First Amendment to such Purchase and Sale Agreement, by and among such parties, dated as of December 4, 2012 (incorporated by reference to Exhibit 2.2 to HCP’s Quarterly Report on Form 10-Q (File No. 1-08895) filed May 2, 2013).
3.1
Articles of Restatement of HCP (incorporated by reference to Exhibit 3.1 to HCP’s Registration Statement on Form S-3 (Registration No. 333-182824), filed on July 24, 2012).
3.2
Fourth Amended and Restated Bylaws of HCP (incorporated herein by reference to Exhibit 3.1 to HCP’s Current Report on Form 8-K (File No. 1-08895) filed September 25, 2006).
3.2.1
Amendment No. 1 to Fourth Amended and Restated Bylaws of HCP (incorporated by reference herein to Exhibit 3.2.1 to HCP’s Quarterly Report on Form 10-Q (File No. 1-08895) for the quarter ended September 30, 2007).
3.2.2
Amendment No. 2 to Fourth Amended and Restated Bylaws of HCP (incorporated herein by reference to Exhibit 3.2.2 to HCP’s Quarterly Report on Form 10-Q (File No. 1-08895) for the quarter ended September 30, 2009).
3.2.3
Amendment No. 3 to Fourth Amended and Restated Bylaws of HCP (incorporated herein by reference to Exhibit 3.1 to HCP’s Current Report on Form 8-K (File No. 1-08895), filed March 10, 2011).
3.2.4
Amendment No. 4 to Fourth Amended and Restated Bylaws of HCP (incorporated herein by reference to Exhibit 3.1 to HCP’s Current Report on Form 8-K (File No. 1-08895), filed October 3, 2013).
Employment Agreement, dated October 2, 2013, by and between the Company and Lauralee Martin (incorporated herein by reference to Exhibit 10.1 to HCP’s Current Report on Form 8-K (File No. 1-08895) filed October 3, 2013). †
10.2
Term Sheet Amendment to Employment Agreement, dated October 3, 2013, by and between the Company and Timothy M. Schoen (incorporated herein by reference to Exhibit 10.2 to HCP’s Current Report on Form 8-K (File No. 1-08895) filed October 3, 2013). †
10.3
Term Sheet Amendment to Employment Agreement, dated October 3, 2013, by and between the Company and Paul F. Gallagher (incorporated herein by reference to Exhibit 10.3 to HCP’s Current Report on Form 8-K (File No. 1-08895) filed October 3, 2013). †
10.4
Amendment No. 2, dated as of October 31, 2013, to the Employment Agreement, dated as of January 26, 2012, by and between the Company and Paul F. Gallagher.*†
10.5
Amendment No. 2, dated as of October 31, 2013, to the Employment Agreement, dated as of January 26, 2012, by and between the Company and Timothy M. Schoen.*†
Amendment No. 2, dated as of October 31, 2013, to the Employment Agreement, dated as of October 25, 2012, by and between the Company and James W. Mercer.*†
Restricted Stock Unit Award Agreement, dated as of October 3, 2013, by and between the Company and Paul F. Gallagher.*†
10.8
Restricted Stock Unit Award Agreement, dated as of October 3, 2013, by and between the Company and Timothy M. Schoen.*†
10.9
Restricted Stock Unit Award Agreement, dated as of October 31, 2013, by and between the Company and James W. Mercer.*†
31.1
Certification by Lauralee E. Martin, HCP’s Principal Executive Officer, Pursuant to Securities Exchange Act Rule 13a-14(a). *
Certification by Timothy M. Schoen, HCP’s Principal Financial Officer, Pursuant to Securities Exchange Act Rule 13a-14(a). *
Certification by Lauralee E. Martin, HCP’s Principal Executive Officer, Pursuant to Securities Exchange Act Rule 13a-14(b) and 18 U.S.C. Section 1350. **
32.2
Certification by Timothy M. Schoen, HCP’s Principal Financial Officer, Pursuant to Securities Exchange Act Rule 13a-14(b) and 18 U.S.C. Section 1350. **
101.INS
XBRL Instance Document.*
101.SCH
XBRL Taxonomy Extension Schema Document.*
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.*
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.*
101.LAB
XBRL Taxonomy Extension Labels Linkbase Document.*
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.*
*
Filed herewith.
**
Furnished herewith.
†
Management Contract or Compensatory Plan or Arrangement.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 4, 2013
HCP, Inc.
(Registrant)
/s/ LAURALEE E. MARTIN
Lauralee E. Martin
President and Chief Executive Officer
(Principal Executive Officer)
/s/ TIMOTHY M. SCHOEN
Timothy M. Schoen
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
/s/ SCOTT A. ANDERSON
Scott A. Anderson
Senior Vice President and
Chief Accounting Officer
(Principal Accounting Officer)