UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended September 30, 2003
For the transition period from to
HEALTH CARE PROPERTY INVESTORS, INC.
(Exact name of registrant as specified in its charter)
4675 MacArthur Court, Suite 900
Newport Beach, California 92660
(Address of principal executive offices)
(949) 221-0600
(Registrant’s telephone number, including area code)
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 ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ¨
As of November 11, 2003, there were 64,796,060 shares of $1.00 par value common stock outstanding.
INDEX
PART I. FINANCIAL INFORMATION
Item 1.
Item 2.
Item 3.
Item 4.
Item 6.
Signatures
Health Care Property Investors, Inc.
Condensed Consolidated Balance Sheets
(Amounts in Thousands)
September 30,
2003
December 31,
2002
Assets
Real Estate Investments:
Buildings and Improvements
Accumulated Depreciation
Construction in Progress
Land
Loans Receivable, Net
Investments in and Advances to Joint Ventures
Accounts Receivable, Net of Allowance for Doubtful Accounts of $2,720 and $2,918 as of September 30, 2003 and December 31, 2002, respectively
Other Assets
Cash and Cash Equivalents
Total Assets
Liabilities and Stockholders’ Equity
Bank Notes Payable
Redeemable Preferred Stock
Senior Notes Payable
Mortgage Notes Payable
Accounts Payable, Accrued Expenses and Deferred Income
Minority Interests in Joint Ventures
Minority Interests Convertible into Common Stock
Stockholders’ Equity:
Preferred Stock
Common Stock
Additional Paid-In Capital
Other Equity
Cumulative Net Income
Cumulative Dividends
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
See accompanying Notes to Condensed Consolidated Financial Statements.
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Condensed Consolidated Statements of Income
(Unaudited)
(Amounts in Thousands, Except Per Share Amounts)
Three Months
Ended September 30,
Nine Months
Revenue
Rental Income, Triple Net Properties
Rental Income, Managed Properties
Interest and Other Income
Expense
Interest Expense
Real Estate Depreciation
Managed Properties Operating Expenses
General and Administrative Expenses
Income From Operations
Minority Interests
Income Before Discontinued Operations
Discontinued Operations
Operating Income from Discontinued Operations
Gain/(Loss) on Real Estate Dispositions and Impairments on Real Estate
Net Income
Dividends to Preferred Stockholders
Preferred Stock Redemption Charges
Net Income Applicable to Common Shares
Basic Earnings Per Common Share
Income from Continuing Operations Applicable to Common Shares
Diluted Earnings Per Common Share
Weighted Average Shares Outstanding—Basic
Weighted Average Shares Outstanding—Diluted
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Condensed Consolidated Statement of Stockholders’ Equity
OtherEquity
CumulativeNet Income
CumulativeDividends
TotalStockholders’Equity
Balances, December 31, 2002
Stock Options Exercised
Stock Grants Issued
Stock Grants Cancelled
Common Stock Issued
Preferred Stock Issued
Preferred Stock Redemption
Dividends Paid—Preferred Shares
Dividends Paid—Common Shares
Deferred Compensation
Other Comprehensive Gain
Balances, September 30, 2003
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Condensed Consolidated Statements of Cash Flows
Cash Flows From Operating Activities:
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Real Estate Depreciation in Discontinued Operations
Amortization of Deferred Compensation and Debt Costs
Joint Venture Adjustments
Loss on Sale of Real Estate Properties
Changes in:
Accounts Receivable
Net Cash Provided By Operating Activities
Cash Flows From Investing Activities:
Acquisition of Real Estate
Proceeds from the Sale of Real Estate Properties, Net
Investments in Loans Receivable
Investments in Joint Ventures
Net Cash Used In Investing Activities
Cash Flows From Financing Activities:
Net Change in Bank Notes Payable
Repayment of Senior Notes Payable
Issuance of Senior Notes
Cash Proceeds from Issuing Common Stock
Cash Proceeds from Issuing Preferred Stock
Redemption of Preferred Stock
Payments on Mortgages
Dividends Paid
Other Financing Activities
Net Cash (Used In)/Provided By Financing Activities
Net Increase In Cash And Cash Equivalents
Cash And Cash Equivalents, Beginning Of Period
Cash And Cash Equivalents, End Of Period
Interest Paid, Net of Capitalized Interest
See accompanying Notes to Condensed Consolidated Financial Statements
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
(1) SIGNIFICANT ACCOUNTING POLICIES
We, the management of Health Care Property Investors, Inc., believe that the unaudited financial information contained in this report reflects all adjustments that are necessary to state fairly the financial position, the results of operations, and the cash flows of the Company. Unless the context otherwise indicates, the Company or HCPI means Health Care Property Investors, Inc. and its subsidiaries and joint ventures. We both recommend and presume that users of this interim financial information read or have read or have access to the audited financial statements for the preceding fiscal year ended December 31, 2002. Therefore, notes to the financial statements and other disclosures that would repeat the disclosures contained in our most recent annual report to security holders have been omitted. This interim financial information does not necessarily represent a full year’s operations for various reasons, including acquisitions and dispositions, changes in rents and interest rates, and the timing of debt and equity financings.
Application of Critical Accounting Policies:
Certain critical accounting policies are complex and involve judgments by management, including the use of estimates and assumptions, which affect the reported amounts of assets, liabilities, revenues and expenses. As a result, changes in these estimates and assumptions could significantly affect our financial position or results of operations. We base our estimates on various assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. The significant and critical accounting policies used in the preparation of our financial statements are more fully described in our Annual Report on Form 10-K for the year ended December 31, 2002.
In May 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 150 (FAS 150) “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” FAS 150 would require that mandatorily redeemable financial instruments be classified as a liability and valued at the instruments’ settlement value as of the balance sheet date. As a result, consolidated partnerships with a limited life would be considered mandatorily redeemable and therefore fall under FAS 150. On October 29, 2003, the FASB met and voted to defer implementation of the provisions of FAS 150 that require the valuation and establishment of a liability for limited life entities. Thus, with the exception of a preferred stock redemption charge (see Note 8), any impact from FAS 150 is not reflected in the Company’s operating results for the three and nine months ended September 30, 2003. The pronouncement would have applied to seven limited life partnerships. Effective October 2003, we amended the agreement for one of these partnerships to remove the limited-life provision. The minority interests in this partnership are currently not mandatorily redeemable and, thus, the partnership is not subject to the provisions of FAS 150. The minority interests in this partnership had a September 30, 2003 settlement value of approximately $23,000,000. As of September 30, 2003, we have estimated the settlement value of the minority interests in the seven partnerships to be approximately $38,000,000 which is approximately $25,000,000 more than the carrying amount of such minority interests.
Reclassifications:
We have made reclassifications, where necessary, for comparative financial statement presentations.
(2) REAL ESTATE INVESTMENTS
As of September 30, 2003, our portfolio of properties, including equity investments, consisted of 446 properties located in 43 states. These properties were comprised of 31 hospitals, 175 long-term care facilities,
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
124 retirement and assisted living facilities, 85 medical office buildings and 31 other healthcare facilities. Our gross undepreciated investment in these properties, which includes equity investments, was approximately $3,208,342,000 at September 30, 2003.
Total new investments for the three and nine months ended September 30, 2003 are summarized as follows:
Ended
Acquisition of Properties
Loans
New Construction and Expansion
For the nine months ended September 30, 2003, we acquired 11 properties for an aggregate purchase price of $190,100,000. These properties have an average annual lease rate of 9.7%. The properties consist of five assisted living facilities, four continuing care retirement communities, one medical office building and one health and wellness center.
American Retirement Corporation
During the quarter ended September 30, 2003, we acquired four continuing care retirement communities from American Retirement Corporation (ARC) for $163.5 million. Prior to the acquisition, we owned a 9.8% equity interest in the entities that owned these four facilities. Three of the facilities have been leased to ARC. The fourth facility has been leased to a third party that has contracted with ARC to manage the facility. The leases have a ten-year term and an annual lease rate of 9.5% with annual rent increases of 2.75%. In addition, we closed a $7 million secured loan to ARC. ARC used the proceeds from these transactions to repay $113 million in first mortgage debt on the properties. After transaction costs and reserves, and after giving credit for our existing minority interest in the properties valued at $3 million, the remaining net proceeds of $52 million were used by ARC to prepay a portion of our existing mezzanine loan, including accrued interest.
In the periods prior to the quarter ended September 30, 2003, we accrued interest at 13.25% on our mezzanine loan to ARC and reserved the difference between 13.25% and the 19.5% contractual rate. During the quarter ended September 30, 2003, we recognized $1.8 million in interest income through the full repayment (including interest accrued to 19.5%) of the portion of the mezzanine loan related to the four properties discussed in the preceding paragraph. We also reversed a portion of the reserves on the remaining $76 million mezzanine loan. The interest income generated related to such reversal was $2.9 million and represents the difference between our previous accrual rate of 13.25% and the current 16.5% accrual rate. We determine the accrual rate on the ARC mezzanine loan by evaluating the sufficiency of the net asset value (fair value of properties less first mortgage debt and other liabilities) of our collateral.
(3) OPERATORS
At September 30, 2003, we had 315 properties leased to 89 operators under triple net leases, 46 properties securing loans to 13 operators and 85 properties with approximately 625 gross or modified gross leases with multiple tenants that are managed by independent property management companies on our behalf (Managed Portfolio). Under a triple net lease, in addition to the rent obligation, the lessee is generally responsible for all operating expenses of the property such as utilities, property taxes, insurance, repairs and maintenance. Under
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gross or modified gross leases, we may be responsible for property taxes, repairs, and/or insurance on the leased properties.
Tenet Healthcare Corporation accounted for 14.4% and 14.7% of our total revenue for the three and nine months ended September 30, 2003, and 17.2% and 17.1% of our total revenue for the three and nine months ended September 30, 2002.
(4) INVESTMENTS IN AND ADVANCES TO JOINT VENTURES
As of September 30, 2003, we had an 80% interest in each of five joint ventures that lease six long-term care facilities, a 45%-50% interest in four joint ventures that each operate an assisted living facility and a 9.8% interest in five limited liability companies that own an aggregate of five retirement living communities. The five limited liability companies are subsidiaries of American Retirement Corporation (see Note 2). Since the other members in the joint ventures have significant voting rights relative to acquisition, sale and refinancing of assets, as well as approval rights with respect to budgets, we account for these investments using the equity method of accounting.
Combined summarized unaudited financial information of the unconsolidated joint ventures follows:
Real Estate Investments, Net
Notes Payable to Third Parties
Mortgage Notes Payable to Third Parties—ARC
Accounts Payable
Other Partners’ Capital
Investments and Advances from HCPI, Net
Total Liabilities and Partners’ Capital
Rental and Interest Income
HCPI’s Equity in Joint Venture Net Income
Distributions to HCPI
The change in amounts above are the result of an initial investment in seven limited companies on September 30, 2002, and subsequent dissolution of two limited liability companies that are subsidiaries of ARC on September 23, 2003.
As of September 30, 2003, we have guaranteed approximately $7,100,000 of notes payable obligations for four of these joint ventures (see Note 13). As of September 30, 2003, the five retirement living communities owned by the five limited liability companies of which we have a 9.8% interest secured $52,497,000 of first mortgages with fixed and variable interest rates ranging from 2.54% to 9.5% and maturity dates ranging from January 2004 to June 2025.
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Included in “Other Partners’ Capital” above are the proceeds from a $75,800,000 loan and a $112,750,000 loan as of September 30, 2003 and December 31, 2002, respectively, from HCPI to a subsidiary of American Retirement Corporation.
(5) DISCONTINUED OPERATIONS
During the quarter ended September 30, 2003, we sold five facilities for an aggregate sales price of $12.8 million, resulting in a net gain on sale of $5.1 million. For the nine months ended September 30, 2003, we sold 14 facilities for an aggregate sales price of $27.4 million and a net gain on sale of $8.1 million. In addition, we recognized a total of $11.7 million of impairment losses on 13 facilities during the first nine months of 2003, but no impairment losses were recognized during the third quarter.
As of September 30, 2003, we had 16 facilities with a net book value of $29,028,000 that we expected to sell. The operations of these facilities, as well as 21 other facilities that had been sold between January 1, 2002 and September 30, 2003, are included in Discontinued Operations.
(6) LOANS RECEIVABLE
The following is a summary of loans receivable:
Secured loans
Other
Total loans receivable is net of reserves of $916,000 and $1,227,000 at September 30, 2003 and December 31, 2002, respectively.
(7) NOTES PAYABLE
On February 28, 2003, we issued $200,000,000 of 6.00% Senior Notes due 2015. Interest on these notes is payable semi-annually in March and September.
During the nine months ended September 30, 2003, we paid off $31,000,000 of maturing long-term debt with an average interest rate of 7.09% and redeemed $5,000,000 in Medium Term Notes due March 10, 2015, which carried an interest rate of 9.00%.
(8) PREFERRED STOCK
On September 15, 2003, we issued 4,000,000 shares of 7.25% Series E Cumulative Redeemable Preferred Stock at $25 per share, generating gross proceeds of $100,000,000.
Preferred Stock Redemptions
On May 2, 2003, we redeemed all of our outstanding 8.6% series C preferred stock. The amount paid to redeem the preferred stock was approximately $99.4 million plus accrued dividends. The redemption above our carrying amount of the series C preferred stock gave rise to a non-operating charge of $11.8 million in the second quarter of 2003.
On September 10, 2003, we redeemed all of our outstanding 7.875% series A preferred stock. The amount paid to redeem the series A preferred stock was approximately $60.9 million plus accrued dividends. The redemption above our carrying amount of the series A preferred stock gave rise to a non-operating charge of $2.2 million in the third quarter of 2003.
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On August 28, 2003, we announced we would redeem all of our outstanding 8.7% series B preferred stock. The preferred stock balance was reclassified to Redeemable Preferred Stock liability at its settlement value in accordance with FAS 150. On October 1, 2003, we redeemed the series B preferred stock. The amount paid to redeem the series B preferred stock was approximately $133.7 million plus accrued dividends. The redemption above our carrying amount of the series B preferred stock gave rise to a non-operating charge of $4.6 million in the third quarter of 2003.
(9) COMMON STOCK
On July 10, 2003, the Company issued 1,400,000 shares of common stock at a net offering price of $41.50 per share, generating gross proceeds of $58,100,000.
During the quarter ended September 30, 2003, we raised $36.1 million from the sale of our common stock, at an average price per share of $42.06, under our Dividend Reinvestment and Stock Purchase Plan (DRIP). During the nine months ended September 30, 2003, we raised $94.2 million under the DRIP at an average price per share of $38.31. Beginning January 1, 2004, we will reduce the discount on our shares of common stock purchased through the DRIP from 2% to 1%.
(10) OTHER EQUITY
Other equity consists of the following:
Unamortized Balance of Deferred Compensation
Notes Receivable From Officers and Directors for Purchase of Common Stock
Accumulated Other Comprehensive Loss
Total Other Equity
Other comprehensive loss is a reduction to net income in calculating comprehensive income. Comprehensive income is the change in equity from non-owner sources. Our comprehensive income reflects the change in the fair market value of our interest rate swap. Comprehensive income for the nine months ended September 30, 2003 and 2002 was $114,930,000 and $107,693,000, respectively.
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Stock Options Granted:
As of January 1, 2002, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation” (FAS 123) for all employee stock options awarded or granted after January 1, 2002. Therefore, the cost related to stock-based employee compensation included in the determination of net income for the three and nine months ended September 30, 2003 and 2002 is less than that which would have been recognized if the fair value recognition provisions of FAS 123 had been applied to all awards since the original effective date of FAS 123. Previously, we had accounted for all stock options under Accounting Principles Board Opinion 25 (APB 25), “Accounting for Stock Issued to Employees,” which is permitted under FAS 123. The following table is presented in accordance with Statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation” and illustrates the effect on net income and earnings per share if the fair value recognition provisions of FAS 123 had been applied to all outstanding and unvested awards in each period.
Net Income, as Reported
Add: Stock-Based Compensation Expense Included in Reported Net Income
Deduct: Total Stock-Based Compensation Expense Determined Under Fair Value Based Method for all Awards
Pro Forma Net Income
Earnings Per Share:
Basic—as Reported
Basic—Pro Forma
Diluted—as Reported and Pro Forma
(11) OPERATING PARTNERSHIP UNITS
As of September 30, 2003, there were a total of 1,581,179 non-managing member units which are convertible into our common stock on a one-for-one basis and are outstanding for three limited liability companies of which we are the managing member: HCPI/Utah, LLC, HCPI/Utah II, LLC and HCPI/Indiana, LLC. Non-managing member units are reflected on the balance sheet as a liability of $55,321,000 at September 30, 2003.
(12) EARNINGS PER COMMON SHARE
Basic earnings per common share is computed by dividing Net Income applicable to common shares by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per common share is calculated including the effect of dilutive securities. Options to purchase shares of common stock that have an exercise price in excess of the average market price of the common stock during the period are not included because they are not dilutive.
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Basic Earnings Per Common Share:
Dilutive Options
Diluted Earnings Per Common Share:
(13) COMMITMENTS AND CONTINGENCIES
COMMITMENTS
As of September 30, 2003, we had contractually committed to acquire one medical office building for $3,200,000. As of September 30, 2003, we had contractually committed to fund additional development of facilities on existing properties of approximately $14,346,000, and were contractually committed to fund $29,414,000 for construction of new health care facilities excluding $67,000,000 of construction related to the acquisition of MedCap Properties, LLC (see Note 14). We also are committed to fund a $7,000,000 loan to ARC (See Note 2). When disclosing our contractual commitments, we include only those commitments that are evidenced by binding contracts. We expect that a significant portion of these commitments will be funded; however, experience suggests that some contractually committed acquisitions may not close for various reasons including unsatisfied closing conditions, competitive financing sources, or the operator’s inability to obtain required internal or governmental approvals.
CONTINGENCIES
In connection with the transfer of operations of certain long-term care or assisted living facilities from existing lessees to replacement lessees/operators, we have provided limited indemnities and guaranties pertaining to certain matters relating to such facilities prior to the date transfer date. Our maximum potential exposure for these limited indemnities and guaranties was $2,555,000 as of September 30, 2003, although we expect actual costs, if any, related to these indemnities to be nominal.
Joint venture debt is a liability of the joint venture, is typically secured by the joint venture property and is non-recourse to us. As of September 30, 2003, we have guaranteed $7.1 million of the joint venture mortgage and other indebtedness in the event the joint venture partnership defaults under the terms of the mortgage. The
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mortgages guaranteed are secured by the property of the joint venture partnership that could be sold in order to satisfy the outstanding obligation.
(14) SUBSEQUENT EVENTS
On October 2, 2003, the Company and HCP Medical Office Portfolio, a joint venture that was formed in June 2003 by GE Commercial Finance and the Company, completed the $575 million acquisition of MedCap Properties, LLC, which includes ownership interests in 113 medical office buildings. The acquisition was structured in three components.
HCP Medical Office Portfolio acquired 100 of the medical office buildings at an acquisition price of $460 million. We are the managing member of HCP Medical Office Portfolio and have a one-third interest therein. In addition to our indirect ownership interest in the medical office buildings through our joint venture interest, we will earn acquisition and management fees and an additional return if certain investment hurdles are achieved with respect to these properties. At the time of the acquisition, the joint venture assumed $26 million in mortgage debt at an interest rate of approximately 7%.
Eight of the acquired medical office buildings, with an investment value of $49 million, were contributed to a joint venture between us and senior MedCap management. The joint venture issued 1,064,539 units valued at $45.26 each, which are redeemable for cash or, at our option, HCPI common stock beginning October 2, 2004.
The remaining five buildings are construction projects we acquired with scheduled completion dates in 2004 and an expected total cost of $67 million. These assets will be acquired by HCP Medical Office Portfolio upon completion of construction.
On October 23, 2003, our Board of Directors declared a quarterly dividend of $0.83 per common share payable on November 20, 2003 to stockholders of record as of the close of business on November 4, 2003.
Our Board of Directors also declared a cash dividend of $0.53368 per share on our series E cumulative preferred stock. The dividend will be paid on December 31, 2003 to stockholders of record as of the close of business on December 15, 2003.
(15) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value. The carrying amount for Cash and Cash Equivalents approximates fair value because of the short-term maturity of those instruments. Fair values for Secured Loans Receivable and Senior Notes and Mortgage Notes Payable are based on the estimates of management and on rates currently prevailing for comparable loans and instruments of comparable maturities, and are as follows:
Carrying
Amount
Fair
Value
Secured Loans Receivable
Senior Notes and Mortgage Notes Payable
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(16) NEW PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board issued interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51 (the “Interpretation”) effective immediately for all variable interest entities created after January 31, 2003 and for the first fiscal year or interim period beginning after June 15, 2003 for variable interest entities in which an enterprise holds a variable interest that is acquired before February 1, 2003. On October 8, 2003, the FASB met and agreed to defer the effective date of the Interpretation for variable interests acquired before February 1, 2003. The deferral will require public companies to adopt the provisions of the Interpretation at the end of periods ending after December 15, 2003 (that is, December 31, 2003 for us). The Interpretation requires the consolidation of variable interest entities in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Currently, entities are generally consolidated by an enterprise that has a controlling financial interest through ownership of a majority voting interest in the entity. We are currently evaluating the effects on us, if any, of the issuance of the Interpretation.
See Note 10 for a discussion of our adoption of Statement of Financial Accounting Standard No. 148 “Accounting for Stock-Based Compensation,” an Amendment of FAS 123. The effect of this Statement on our financial statements is not material.
In April 2003, the FASB released Statement of Financial Accounting Standards No. 149 “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The effect of this pronouncement on our financial statements is not material.
In May 2003, the FASB released Statement of Financial Accounting Standards No. 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” effective for financial instruments entered into or modified after May 15, 2003. See Note 1 for a discussion of the impact of FAS 150 for the three and nine months ended September 30, 2003.
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GENERAL
Health Care Property Investors, Inc., including our wholly-owned subsidiaries and affiliated joint ventures (HCPI), generally acquires health care facilities and leases them on a long-term basis to health care providers. We also lease medical office space to providers and physicians on a shorter term basis. In addition, we provide mortgage financing on health care facilities. As of September 30, 2003, our portfolio of properties, including equity investments, consisted of 446 facilities located in 43 states. These facilities were comprised of 31 hospitals, 175 long-term care facilities, 124 retirement and assisted living facilities, 85 medical office buildings and 31 other healthcare facilities. Our gross undepreciated investment in these properties, which includes equity investments, was approximately $3.2 billion at September 30, 2003.
For the nine months ended September 30, 2003, we acquired 11 properties for an aggregate purchase price of $190,100,000. These properties have an average annual lease rate of 9.7%. The properties consist of five assisted living facilities, four continuing care retirement communities, one medical office building and one health and wellness center. The acquisitions included a $163,500,000 acquisition of four continuing care retirement communities from American Retirement Corporation (ARC). These facilities have been leased for a ten-year term at an annual lease rate of 9.5% with annual rent increases of 2.75%.
On October 2, 2003, we and HCP Medical Office Portfolio, a joint venture that was formed in June 2003 by GE Commercial Finance and us, completed the $575,000,000 acquisition of MedCap Properties, LLC, which includes ownership interests in 113 medical office buildings. We are the managing member of HCP Medical Office Portfolio and have a one-third economic interest therein.
We financed the acquisitions primarily through proceeds from the issuance of new debt and equity, from asset sales and the use of our line of credit.
We have written commitments to acquire or construct an additional $53,960,000 of health care real estate. See Note 13 to the Condensed Consolidated Financial Statements.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Certain critical accounting policies applicable to us are complex and involve judgments by management, including the use of estimates and assumptions, which affect the reported amounts of assets, liabilities, revenues and expenses. As a result, changes in these estimates and assumptions could significantly affect our financial position or results of operations. We base our estimates on various assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. The significant and critical accounting policies used in the preparation of our financial statements are more fully described in our Annual Report on Form 10-K for the year ended December 31, 2002.
In May 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 150 (FAS 150) “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” FAS 150 would require that mandatorily redeemable financial instruments be classified as a liability and valued at the instruments’ settlement value as of the balance sheet date. As a result, consolidated partnerships with a limited life would be considered mandatorily redeemable and therefore fall under FAS 150. On October 29, 2003, the FASB met and voted to defer implementation of the provisions of FAS 150 that require the valuation and establishment of a liability for limited life entities. Thus, with the exception of a preferred stock redemption charge (see Note 8 to the Condensed Consolidated Financial Statements) any impact from FAS 150 is not reflected in the Company’s operating results for the three and nine months ended September 30, 2003. The pronouncement would have applied to seven limited life partnerships. Effective October 2003, we amended the
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agreement for one of these partnerships to remove the limited-life provision. The minority interests in this partnership are currently not mandatorily redeemable and, thus, the partnership is not subject to the provisions of FAS 150. The minority interests in this partnership had a September 30, 2003 settlement value of approximately $23,000,000. As of September 30, 2003, we have estimated the settlement value of the minority interests in the seven partnerships to be approximately $38,000,000 which is approximately $25,000,000 more than the carrying amount of such minority interests.
RESULTS OF OPERATIONS
Net Income applicable to common shares for the three and nine months ended September 30, 2003 totaled $38,680,000 and $80,414,000, or $0.61 and $1.30 per share on a diluted basis on revenue of $102,957,000 and $291,941,000, respectively. This compares with Net Income applicable to common shares of $31,017,000 and $89,331,000, or $0.53 and $1.54 per share on a diluted basis on revenue of $89,427,000 and $255,274,000, respectively, for the three and nine months ended September 30, 2002. Included in Net Income applicable to common shares for the three and nine months ended September 30, 2003, are preferred stock redemption charges of $6,782,000, or $0.11 per share on a diluted basis, and $18,553,000, or $0.30 per share on a diluted basis, respectively. Also included in Net Income applicable to common shares for the three and nine months ended September 30, 2003 is a net gain on real estate dispositions of $5,086,000, or $0.08 per share on a diluted basis and a net loss on real estate dispositions of $3,549,000, or $0.06 per share on a diluted basis, respectively. Included in the net loss on real estate dispositions for the nine months ended September 30, 2003, are impairment losses on 13 facilities of $11,652,000. Included in Net Income applicable to common shares for the three and nine months ended September 30, 2002 is a net loss on real estate dispositions of $479,000 and $1,084,000, or $0.01 and $0.02 per share on a diluted basis, respectively. Included in net loss of real estate dispositions for the three and nine months ended September 30, 2003, are impairment losses on one facility, and four facilities of $400,000 and $1,707,000, respectively.
Additionally, included in Net Income applicable to common shares is the net effect of the Securities and Exchange Commission Staff Accounting Bulletin No. 101 (SAB 101) “Revenue Recognition in Financial Statements”, which delayed the recognition of approximately $5,000,000 and $4,000,000, for 2003 and 2002, respectively, of cash receipts paid by tenants for additional rents from the first quarter to subsequent quarters each year.
Rental Income attributable to Triple Net Leases for the three and nine months ended September 30, 2003 increased 3.2% and 6.4%, or $1,996,000 and $11,212,000, to $64,514,000 and $187,749,000, respectively, as compared to the same period in the prior year. The increases were primarily the result of rents received from approximately $64,000,000 of acquisitions made since the second quarter of 2002 and positive rent growth, offset by rent reductions on certain properties (see discussion in “Supplementary Financial and Operating Information” below).
Rental Income attributable to Managed Properties for the three and nine months ended September 30, 2003 increased 9.9% and 10.8%, or $2,142,000 and $6,792,000, to $23,714,000 and $69,628,000, respectively, as compared to the same periods in the prior year. There was a related increase in Managed Properties Operating Expenses in the three and nine months ended September 30, 2003 of 11.9% and 18.5%, or $994,000 and $4,183,000, to $9,331,000 and $26,839,000, respectively compared to the same periods of 2002. These increases were generated primarily from 2002 acquisition activity and positive rent growth.
Interest and Other Income for the three and nine months ended September 30, 2003 increased 176.0% and 117.4%, or $9,392,000 and $18,663,000, to $14,729,000 and $34,564,000, respectively, as compared to the same periods in the prior year. These increases primarily were the result of the $125,000,000 loan and equity investment with American Retirement Corporation made at the end of the third quarter of 2002 as well as interest income recognized in conjunction with the acquisition of four American Retirement Corporation facilities (see Note 2 to the Condensed Consolidated Financial Statements.)
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Interest Expense for the three and nine months ended September 30, 2003 increased 11.0% and 20.9%, or $2,239,000 and $11,693,000, to $22,606,000 and $67,748,000, respectively, as compared to the same periods in the prior year. These increases were primarily the result of the issuance of $250,000,000 aggregate principal amount of 6.45% senior notes in the second quarter of 2002 as well as the issuance of $200,000,000 aggregate principal amount of 6.00% senior notes in February 2003.
General and Administrative Expenses for the three and nine months ended September 30, 2003 increased 34.3% and 29.9%, or $1,405,000 and $3,780,000, to $5,507,000 and $16,420,000, respectively, as compared to the same periods in the prior year. These increases were primarily due to an increase in compensation costs as well as an increase in expenses associated with troubled operators and their related properties.
Real Estate Depreciation for the three and nine months ended September 30, 2003 increased 3.6% and 7.4%, or $675,000 and $4,045,000, to $19,538,000 and $58,361,000, respectively, as compared to the same periods in 2002. The increases resulted from depreciation on the properties acquired during 2002 and the first six months of 2003.
LIQUIDITY AND CAPITAL RESOURCES
We have financed investments through the sale of common and preferred stock, issuance of medium-term and long-term debt, issuance of units in subsidiaries in exchange for contributed properties, assumption of mortgage debt, the mortgaging of certain of our properties, use of short-term bank lines and use of internally generated cash flows. We have also raised cash through the disposition of assets in 2000, 2001 and 2002 and the first nine months of 2003. Management believes that our liquidity and sources of capital are adequate to finance our operations for the foreseeable future. The availability of cost effective sources of capital may impact future investments in additional facilities.
At September 30, 2003, stockholders’ equity totaled $1,210,157,000 and our equity securities had a market value of $3,172,218,000. Total debt represented 31.8% and 55.5% of our total market and book capitalization, respectively as of September 30, 2003. Our senior debt is rated BBB+/BBB+/Baa2 by Standard & Poor’s, Fitch and Moody’s, respectively.
Tabulated below is our debt maturity table by year and in the aggregate.
2003 (October—December)
2004
2005
2006
2007
Thereafter
During the nine months ended September 30, 2003, we paid off $31,000,000 of maturing long-term debt with an average interest rate of 7.09% and redeemed $5,000,000 in Medium Term Notes due March 10, 2015, which carried an interest rate of 9.00%. These payments were initially financed with funds available under our revolving lines of credit.
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Revolving Lines of Credit
We have a three-year revolving line of credit totaling $490,000,000. Borrowings under the line of credit averaged $86,000,000 for the quarter ended September 30, 2003, at an average rate of 1.89%. The average bank interest rate on borrowings of $89,000,000 was 2.53% for the third quarter of 2002. As of November 10, 2003, borrowings under the line were $376,000,000. The increase is a result of the MedCap Properties, LLC acquisition (see Note 14 to the Condensed Consolidated Financial Statements).
Secured Debt
At September 30, 2003, we had a total of $166,195,000 in Mortgage Notes Payable secured by 33 health care facilities with a net book value of approximately $282,397,000. Interest rates on the Mortgage Notes ranged from 2.75% to 10.63% with an average rate of 7.9%.
On July 10, 2003, we issued 1,400,000 shares of common stock at a net offering price of $41.50 per share, generating proceeds of $58,100,000.
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As of September 30, 2003, there were a total of 1,581,179 non-managing member units which are convertible into our common stock on a one-for-one basis and are outstanding for three limited liability companies of which we are the managing member: HCPI/Utah, LLC, HCPI/Utah II, LLC and HCPI/Indiana, LLC. Non-managing member units, which are reflected on the balance sheet as a liability of $55,321,000 at September 30, 2003.
Shelf Registration
As of November 3, 2003, we had approximately $366,151,000 available for future issuances of debt and equity securities under a shelf registration statement filed with the Securities and Exchange Commission. These securities may be issued from time to time in the future based on our needs and then existing market conditions.
Letters of Credit and Depository Accounts
At September 30, 2003, we held approximately $13,622,000 in depository accounts and $39,987,000 in irrevocable letters of credit from commercial banks to secure a number of lessees’ lease obligations and borrowers’ loan obligations. We may draw upon the letters of credit or depository accounts if there are any defaults under the leases or loans. Amounts available under letters of credit could change based upon facility operating conditions and other factors and such changes may be material.
Facility Rollovers
As of September 30, 2003, we had 12 facilities that are subject to lease expirations and mortgage maturities during the remainder of 2003. These facilities currently represent approximately 0.7% of annualized cash provided by leases and loans. For the year ending December 31, 2004, we have 11 facilities, representing approximately 3.1% of annualized cash provided by leases and loans, subject to lease expirations and mortgage maturities.
Off Balance Sheet Arrangements
As of September 30, 2003, we had an 80% interest in each of five joint ventures that lease six long-term care facilities, a 45%-50% interest in four joint ventures that each operate an assisted living facility and a 9.8% interest in five limited liability companies that own an aggregate of five retirement living communities. The five limited liability companies are subsidiaries of American Retirement Corporation (see Note 2 to the Condensed Consolidated Financial Statements). Since the other members in the joint ventures have significant voting rights relative to acquisition, sale and refinancing of assets as well as approval rights with respect to budgets, we account for these investments using the equity method of accounting.
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(Amounts in
thousands)
The change in amounts above are the result of an initial investment in seven limited companies on September 30, 2002 and subsequent dissolution of two limited liability companies on September 23, 2003 that are subsidiaries of ARC.
As of September 30, 2003, we had guaranteed approximately $7,100,000 on notes payable obligations for four of these joint ventures (see Note 13 to the Condensed Consolidated Financial Statements). As of September 30, 2003, the five retirement living communities owned by the five limited liability companies of which we have a 9.8% interest secured $52,497,000 of first mortgages with fixed and variable interest rates ranging from 2.54% to 9.5% and maturity dates ranging from January 2004 to June 2025.
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SUPPLEMENTARY FINANCIAL AND OPERATING INFORMATION
Major Operators
Listed below are our major operators, which represent three percent or more of our annualized cash provided by leases and loans (defined below) as of September 30, 2003 (dollar amounts in thousands).
Annualized
Cash Provided byLeases and Loans
Percentage of Total
Annualized CashProvided by Leasesand Loans
Tenet Healthcare Corporation (THC)
American Retirement Corporation (ACR)
Emeritus Corporation (ESC)
HealthSouth Corporation (HRC)
Kindred Health Care, Inc. (KIND)
HCA Inc. (HCA)
Beverly Enterprises (BEV)
Not-For-Profit Investment Grade Tenants
Other Publicly Traded Operators or Guarantors (10 Operators)
Other Non Public Operators and Tenants
Grand Total
All of the companies listed above are publicly traded companies and are subject to the informational filing requirements of the Securities and Exchange Act of 1934, as amended, and accordingly file periodic financial statements on Form 10-K and Form 10-Q with the Securities and Exchange Commission.
Renewal Information
The following reflects the impact of properties subject to lease expirations, lessees’ renewal options and/or purchase options, and mortgage maturities on annualized cash provided by leases and loans as of September 30, 2003.
AnnualizedCash Provided by
Leases and Loans
Year
Annualized cash provided by leases and loans
Annualized cash provided by leases and loans is intended to be an estimate of cash provided by leases and loans for the 12 months ending September 30, 2004 for assets owned on September 30, 2003 and is calculated as (a) base rents, interest or, in the case of our managed properties, net operating income, to be received by us during the 12 months ended September 30, 2004 under existing contracts; plus (b) additional rents received by us during the 12 months ended September 30, 2003, which were approximately $25 million for all customers; plus
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or minus (c) adjustments for the following items (to the extent they are expected to impact rents, interest or net operating income during the 12 months ending September 30, 2004): assets expected to be sold; known or expected changes in rent due to contract expirations or rent resets; and known or expected rent reductions. We calculate the net operating income of our managed properties by subtracting from rent the expenses not covered by the tenant under the gross leases underlying such properties. Our estimates of annualized cash provided by leases and loans are based on management assumptions and the information available to us at the time of this report. Actual annualized cash provided by leases and loans could differ materially from the estimates presented in this report.
Hospital Portfolio
As of September 30, 2003, we derived 27% of our annualized cash provided by leases and loans, or $100 million, from 31 hospitals.
Tenet Healthcare Corporation
As of September 30, 2003, Tenet Healthcare Corporation (“Tenet”) leased from us eight acute care hospitals and one medical office building in which we have an aggregate investment of $460 million. Rents from these hospitals constitute approximately 16% of our annualized cash provided by leases and loans. While two of the hospital leases are scheduled to expire on May 31, 2004 and May 31, 2005, Tenet can renew the leases for an additional five years by providing notice six months prior to lease expiration. Tenet exercised five year extensions on the six facility leases with current terms set to expire in February 2004. In October 2003, Tenet transferred one of these six facility leases for a hospital located in Poplar Bluff, Missouri to Health Management Associates (HMA). HMA is a health care services operator with hospitals concentrated primarily in the southeast and southwest areas of the United States. Current annual rent on the hospital is $3.7 million.
Tenet has recently informed us that one of our hospitals located in Tarzana, California, and operated by Tenet under a lease which was recently renewed for an additional five years is affected by State of California Senate Bill 1953 (SB 1953), which requires certain seismic safety building standards for acute care hospital facilities. We and Tenet are currently reviewing the SB 1953 compliance of this hospital, multiple plans of action to cause such compliance, the estimated time for completing the same and the cost of performing necessary remediation of the property. We cannot currently estimate the potential costs of SB 1953 compliance with respect to the affected hospital or the final allocation of such costs between us and Tenet. Current annual rent on the hospital is $10.8 million and the net book value is $81 million.
Tenet announced its adoption of new policies, as of January 1, 2003, for calculating Medicare reimbursement for patients who require high cost treatments (“outlier payments”). Net Tenet rents were $13.9 million for the quarters ended September 30, 2003 and September 30, 2002. Cash flow coverage of rents decreased to 4.6 for the twelve months ended June 30, 2003. This is down from a coverage level of 5.1 for the twelve months ended June 30, 2002.
Tenet is currently undergoing an investigation by the Securities and Exchange Commission relating to its billing practices and financial and other disclosures. In addition, according to public disclosures by Tenet, the United States Department of Justice is suing Tenet over Medicare fraud allegations; the U.S. Attorney’s office is investigating Tenet’s use of physician relocation agreements and Medicare outlier payments; a federal grand jury has returned an indictment accusing a subsidiary of Tenet of illegal use of physician relocation agreements; the Internal Revenue Service has assessed a $157 million tax deficiency against Tenet; the United States Senate Finance Committee is investigating Tenet’s corporate governance practices with respect to federal health care programs; Tenet is litigating several federal securities class action and shareholder derivative suits and several state law actions; a former executive of Tenet recently received a $253 million judgment against Tenet for certain stock incentive awards; and Tenet is subject to other federal and state investigations regarding its business
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practices. Tenet is responding to a Justice Department subpoena regarding the outlier payments at our Tarzana facility. We cannot predict the impact, if any, that these recent developments may have on individual hospital performance and the related rent.
HealthSouth Corporation
Five percent of our annualized cash provided by leases and loans is generated from facilities leased to HealthSouth Corporation (“HealthSouth”), primarily from nine rehabilitation hospitals. In March 2003, the Securities and Exchange Commission charged HealthSouth and its former chief executive officer with inflating earnings and overstating assets. HealthSouth has announced that it is undergoing a financial audit and forensic examination to assess the accuracy of its financial information. In October 2003, HealthSouth announced that it paid its semi-annual interest payments to bondholders and announced its intention to remain current on all interest payments. The nine rehabilitation hospitals leased by HealthSouth have an average remaining lease term of four years not taking into account renewal options. The average age of these hospitals is 14 years. Third quarter 2003 occupancy on the nine facilities, as provided by HealthSouth, ranged from 56% to 99%, with an average occupancy of 75%. HealthSouth is current on rent payments through October 2003.
We are excluding HealthSouth’s results from cash flow coverage and operating results presentation for the hospital portfolio until greater assurances about HealthSouth’s financial information are received.
Long-Term Care Portfolio
We currently derive 24% of our annualized cash provided by leases and loans, or $87 million, from the long-term care sector. Reduced reimbursements, a nursing shortage and increased liability insurance costs continue to challenge this sector and have caused a diminution in cash flow coverage.
Certain temporary Medicare add-on payments expired in October 2002 causing a decline in Medicare reimbursement to nursing homes of approximately 9% as of October 1, 2002. A planned limitation on Medicare Part B rehabilitation therapy procedures went into effect September 1, 2003 and further reduced Medicare reimbursement. However, the annual market basket increase to Medicare rates for long-term care facilities took effect October 1, 2003, partially offsetting the forgoing, and resulting in an aggregate 6% increase in Medicare rates. In addition, most state Medicaid rates were increased slightly providing further revenue and sector stabilization.
Centennial HealthCare Corporation
In late 2002, we sent default and lease termination notices to Centennial HealthCare Corporation and certain of its subsidiaries (“Centennial”) for non-payment of rent under 17 leases and non-payment of interest and principal under a secured loan, and to a third party lessee for non-payment of rent on three facilities managed by Centennial. In December 2002, Centennial filed voluntary petitions for Chapter 11 reorganization with the U.S. Bankruptcy Court. As of November 30, 2002, the total obligations of Centennial and the third party lessees under the 20 leases and the secured loan were approximately $900,000 per month.
Our gross investment in the 20 leased facilities and the facility subject to the secured loan was approximately $67 million, and the book value of these properties, net of depreciation as of September 30, 2003, was approximately $40 million. During 2003, we successfully transitioned the operations of 11 of the 20 leased facilities to new tenants. Eight facilities are expected to remain with Centennial and one facility is for sale. During the third quarter of 2003, we received rent for the properties of approximately $530,000 per month. Monthly revenue attributable to the facilities is expected to be approximately $550,000 per month after all lease arrangements and sales are finalized, representing a revenue decrease of $350,000 per month, or approximately $0.07 per diluted share of common stock annually.
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Assisted and Retirement Living Portfolio
We currently derive 25% of our annualized cash provided by leases and loans, or $90 million, from the retirement and assisted living industry. The assisted living component of this sector is experiencing high vacancies and high insurance costs. However, some occupancies, resident monthly payment rates and bottom line performance have been improving. The retirement component of this sector continues to experience relatively strong census levels as well as bottom line performance.
Managed Medical Office And Clinic Portfolio
As of September 30, 2003, we have 85 managed properties comprised of 67 medical office buildings (“MOBs”), one surgery center, eight healthcare laboratory and biotech research facilities and 9 physician group practice clinics with triple net, gross and modified gross leases with multiple tenants that are managed by independent property management companies on our behalf (“Managed Portfolio”). These facilities are consolidated because they are either fully or majority owned and controlled by us or our subsidiaries. Rents and operating income attributable to these properties are included in Rental Income, Managed Properties in our financial statements. Expenses related to the operation of these facilities are recorded as Operating Expenses, Managed Properties.
Our 4.2 million square foot managed medical office, health care laboratory and biotech research, and physician group practice clinic portfolio currently produces approximately 16% of our annualized cash provided by leases and loans. Net Operating Income (NOI), defined as Rental Income, Managed Properties net of Managed Properties Operating Expenses, for the third quarter 2003 increased by $1,148,000 from the third quarter 2002 due to 2002 acquisitions and internal growth. The occupancy level within this portfolio was 94% at September 30, 2003.
PORTFOLIO OVERVIEW:
Long-Term
CareFacilities
Annualized cash provided by leases and loans by type(1),(2)
Percentage of Annualized cash provided by leases and loans
Investment(3)
Return on Investments(5)
Number of Properties
Assets Expected to be Sold
Number of Beds/Units(8)
Number of Square Feet
Investment per Bed/Unit(5)
Investment per Square Foot(5)
Occupancy Data-Current Quarter(6),(8)
Occupancy Data-Prior Quarter(6),(8)
Cash Flow Coverage(6),(7),(8)
Before Management Fees
After Management Fees
“Annualized cash provided by leases and loans” is intended to be an estimate of cash provided by leases and loans for the 12 months ending September 30, 2004 for assets owned on September 30, 2003 and is calculated as (a) base rents, interest or, in the case of our managed properties, net operating income, to be received by us during the 12 months ended September 30, 2004 under existing contracts; plus (b) additional
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rents received by us during the 12 months ended September 30, 2003, which were approximately $25 million in the aggregate; plus or minus (c) adjustments for the following items (to the extent they are expected to impact rents, interest or net operating income during the 12 months ending September 30, 2004): assets expected to be sold; known or expected changes in rent due to contract expirations or rent resets; and known or expected rent reductions. We calculate the net operating income of our managed properties by subtracting from rent the expenses not covered by the tenant under the gross leases underlying such properties. Our estimates of annualized cash provided by leases and loans are based on management assumptions and the information available to us at the time of this release. Actual annualized cash provided by leases and loans could differ materially from the estimates presented in this report.
CAUTIONARY LANGUAGE REGARDING FORWARD LOOKING STATEMENTS
Statements in this Quarterly Report that are not historical factual statements are “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The statements include, among other things, statements regarding our intent, belief or expectations and can be identified by the use of terminology such as “may,” “will,” “expect,” “believe,” “intend,” “plan,” “estimate,” “should” and other comparable terms or the negative thereof. Among the forward-looking statements are statements regarding expected returns from properties held by Tenet Healthcare Corporation, HealthSouth Corporation and Centennial HealthCare Corporation under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Supplementary Financial and Operating Information” and statements as to the adequacy of our future liquidity and sources of capital under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.” In addition, we, through our senior management, from time to time make forward looking oral and written public statements concerning our expected future operations and other developments. Readers are cautioned that, while forward looking statements reflect our good faith belief and best judgment based upon current information, they are not guarantees of future performance and are subject to known and unknown risks and uncertainties. Actual results may differ materially from the expectations contained in the forward looking statements as a result of various factors. In addition to other factors set forth in this Quarterly Report and our Annual Report on Form 10-K for the year ended December 31, 2002 and other documents we file with the Securities and Exchange Commission, readers should consider the following:
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NEW PRONOUNCEMENTS
See Note 10 to the Condensed Consolidated Financial Statements for our adoption of Statement of Financial Accounting Standard No. 148 “Accounting for Stock-Based Compensation,” an Amendment of FAS 123. The effect of this Statement on our financial statements is not material.
See Note 1 to the Condensed Consolidated Financial Statements for a discussion of our adoption of Statement of Financial Accounting Standards No. 150 (FAS 150) “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our investments are financed by the sale of common stock, long-term debt, internally generated cash flows and short-term bank debt.
We generally have fixed base rent on our leases; in addition, there can be additional rent based on a percentage of increased revenue over specified base period revenue of the properties and/or increases based on inflation indices or other factors. Financing costs are comprised of dividends on preferred and common stock, fixed interest on long-term debt and variable interest on short-term bank debt.
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On a more limited basis, we have provided mortgage loans to operators of health care facilities in the normal course of business. All of the mortgage loans receivable have fixed interest rates or interest rates with periodic fixed increases.
We may assume existing mortgage notes payable as part of an acquisition transaction. Currently we have two mortgage notes payable with variable interest rates and the remaining mortgage notes payable have fixed interest rates or interest rates with fixed periodic increases. Our senior notes are at fixed rates with the exception of a $25,000,000 variable rate senior note for which the interest rate was fixed by means of a swap contract. The variable rate loans are at interest rates below the current prime rate of 4.00%, and fluctuations are tied to the prime rate or to a rate currently below the prime rate.
At September 30, 2003, we are exposed to market risks related to fluctuations in interest rates only on $4,075,000 of variable rate mortgage notes payable and $129,200,000 of variable rate bank debt. As of November 10, 2003, the bank line balance and floating rate exposure thereon had increased to $376,000,000.
Fluctuation in the interest rate environment will not affect our future earnings and cash flows on our fixed rate debt until that debt matures and must be replaced or refinanced. Interest rate changes will affect the fair value of the fixed rate instruments. Conversely, changes in interest rates on variable rate debt would change our future earnings and cash flows, but not affect the fair value on those instruments. Assuming a one percentage point increase in the interest rate related to the variable rate debt including the mortgage notes payable and the bank lines of credit, and assuming no change in the outstanding balance as of year end, interest expense for 2003 would increase by approximately $1,333,000.
We do not believe that the future market rate risks related to the above securities will have a material impact on us or the results of our future operations. Readers are cautioned that most of the statements contained in the “Disclosures about Market Risk” paragraphs are forward looking and should be read in conjunction with the disclosures under the heading “Cautionary Language Regarding Forward Looking Statements” previously set forth.
Item 4. 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 Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, 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. As we do not control or manage these entities, our disclosure controls and procedures with respect to such entities are necessarily substantially more limited than those we maintain with respect to our consolidated subsidiaries.
As required by Rule 13a-15(b) under 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 and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2003. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.
There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
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PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits:
28
4.12
29
30
31
* Management Contract or Compensatory Plan or Arrangement.
b) Reports on Form 8-K:
For the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant’s Registration Statements on Form S-8 Nos. 33-28483, 333-90353 and Nos. 333-108838 filed May 11, 1989, November 5, 1999 and September 16, 2003, respectively, and Form S-8 Nos. 333-54786 and 333-54784 each filed February 1, 2001.
Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue.
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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 12, 2003
(Registrant)
James G. Reynolds
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
Mary Brennan Carter
Vice President and Chief Accounting Officer
(Principal Accounting Officer)
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