UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☑
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2016
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: 1-8923
WELLTOWER INC.
(Exact name of registrant as specified in its charter)
Delaware
34-1096634
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
4500 Dorr Street, Toledo, Ohio
43615
(Address of principal executive offices)
(Zip Code)
(419) 247-2800
(Registrant’s telephone number, including area code)
Not Applicable
(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 ☑ 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 for such shorter period that the registrant was required to submit and post such files). Yes ☑ 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☑
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ☑
As of April 30, 2016, the registrant had 356,995,083 shares of common stock outstanding.
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets — March 31, 2016 and December 31, 2015
3
Consolidated Statements of Comprehensive Income — Three months ended March 31, 2016 and 2015
4
Consolidated Statements of Equity — Three months ended March 31, 2016 and 2015
6
Consolidated Statements of Cash Flows — Three months ended March 31, 2016 and 2015
7
Notes to Unaudited Consolidated Financial Statements
8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
25
Item 3. Quantitative and Qualitative Disclosures About Market Risk
48
Item 4. Controls and Procedures
49
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 1A. Risk Factors
50
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 5. Other Information
Item 6. Exhibits
Signatures
51
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
WELLTOWER INC. AND SUBSIDIARIES
(In thousands)
March 31, 2016
December 31, 2015
(Unaudited)
(Note)
Assets:
Real estate investments:
Real property owned:
Land and land improvements
$
2,596,670
2,563,445
Buildings and improvements
25,712,496
25,522,542
Acquired lease intangibles
1,346,064
1,350,585
Real property held for sale, net of accumulated depreciation
293,806
169,950
Construction in progress
297,023
258,968
Gross real property owned
30,246,059
29,865,490
Less accumulated depreciation and amortization
(4,032,726)
(3,796,297)
Net real property owned
26,213,333
26,069,193
Real estate loans receivable
725,291
819,492
Net real estate investments
26,938,624
26,888,685
Other assets:
Investments in unconsolidated entities
545,070
542,281
Goodwill
68,321
Cash and cash equivalents
355,949
360,908
Restricted cash
62,176
61,782
Straight-line rent receivable
425,231
395,562
Receivables and other assets
692,922
706,306
Total other assets
2,149,669
2,135,160
Total assets
29,088,293
29,023,845
Liabilities and equity
Liabilities:
Borrowings under primary unsecured credit facility
645,000
835,000
Senior unsecured notes
8,828,053
8,548,055
Secured debt
3,515,053
3,509,142
Capital lease obligations
75,092
75,489
Accrued expenses and other liabilities
665,645
697,191
Total liabilities
13,728,843
13,664,877
Redeemable noncontrolling interests
359,656
183,083
Equity:
Preferred stock
1,006,250
Common stock
356,953
354,811
Capital in excess of par value
16,589,738
16,478,300
Treasury stock
(51,271)
(44,372)
Cumulative net income
3,891,093
3,725,772
Cumulative dividends
(7,168,178)
(6,846,056)
Accumulated other comprehensive income (loss)
(109,053)
(88,243)
Other equity
4,062
4,098
Total Welltower Inc. stockholders’ equity
14,519,594
14,590,560
Noncontrolling interests
480,200
585,325
Total equity
14,999,794
15,175,885
Total liabilities and equity
NOTE: The consolidated balance sheet at December 31, 2015 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.
See notes to unaudited consolidated financial statements
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(In thousands, except per share data)
Three Months Ended
March 31,
2016
2015
Revenues:
Rental income
415,663
379,587
Resident fees and services
602,149
492,510
Interest income
25,188
16,994
Other income
4,050
5,086
Total revenues
1,047,050
894,177
Expenses:
Interest expense
132,960
121,080
Property operating expenses
449,636
376,461
Depreciation and amortization
228,696
188,829
General and administrative
45,691
35,138
Transaction costs
8,208
48,554
Loss (gain) on derivatives, net
-
(58,427)
Loss (gain) on extinguishment of debt, net
(24)
15,401
Impairment of assets
14,314
2,220
Total expenses
879,481
729,256
Income (loss) from continuing operations before income taxes
and income from unconsolidated entities
167,569
164,921
Income tax (expense) benefit
1,725
304
Income (loss) from unconsolidated entities
(3,820)
(12,648)
Income (loss) from continuing operations
165,474
152,577
Gain (loss) on real estate dispositions, net
56,845
Net income
209,422
Less:
Preferred stock dividends
16,352
Net income (loss) attributable to noncontrolling interests(1)
153
2,271
Net income (loss) attributable to common stockholders
148,969
190,799
Average number of common shares outstanding:
Basic
355,076
336,754
Diluted
356,051
337,812
Earnings per share:
Basic:
Income (loss) from continuing operations attributable to common stockholders, including real estate dispositions
0.42
0.57
Net income (loss) attributable to common stockholders*
Diluted:
0.56
Dividends declared and paid per common share
0.86
0.825
* Amounts may not sum due to rounding
(1) Includes amounts attributable to redeemable noncontrolling interests.
Three Months Ended March 31,
Other comprehensive income (loss):
Unrecognized gain (loss) on available for sale securities
(7,549)
(11,687)
Unrealized gains (losses) on cash flow hedges
483
(2,159)
Unrecognized actuarial gain (loss)
2
Foreign currency translation gain (loss)
1,372
(29,197)
Total other comprehensive income (loss)
(5,692)
(43,043)
Total comprehensive income (loss)
159,782
166,379
Less: Total comprehensive income (loss) attributable to noncontrolling interests(1)
15,271
(10,285)
Total comprehensive income (loss) attributable to common stockholders
144,511
176,664
5
CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED)
Three Months Ended March 31, 2016
Accumulated
Capital in
Other
Preferred
Common
Excess of
Treasury
Cumulative
Comprehensive
Noncontrolling
Stock
Par Value
Net Income
Dividends
Income (Loss)
Equity
Interests
Total
Balances at beginning of period
Comprehensive income:
Net income (loss)
165,321
1,082
166,403
Other comprehensive income
(20,810)
15,118
Total comprehensive income
160,711
Net change in noncontrolling interests
(5,717)
(121,325)
(127,042)
Amounts related to stock incentive plans, net of forfeitures
637
25,555
(6,899)
(115)
19,178
Proceeds from issuance of common stock
1,505
91,600
93,105
Option compensation expense
79
Cash dividends paid:
Common stock cash dividends
(305,770)
Preferred stock cash dividends
(16,352)
Balances at end of period
Three Months Ended March 31, 2015
328,835
14,740,712
(35,241)
2,842,022
(5,635,923)
(77,009)
5,507
297,896
13,473,049
207,151
1,925
209,076
(30,487)
(12,556)
166,033
(4,540)
75,297
70,757
85
7,672
(6,132)
(1,275)
350
20,466
1,470,355
1,490,821
Equity component of convertible debt
1,048
4,595
5,643
217
(272,569)
350,434
16,218,794
(41,373)
3,049,173
(5,924,844)
(107,496)
4,449
362,562
14,917,949
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Operating activities:
Adjustments to reconcile net income to
net cash provided from (used in) operating activities:
Other amortization expenses
1,118
1,320
Stock-based compensation expense
8,186
9,054
Loss (income) from unconsolidated entities
3,820
12,648
Rental income in excess of cash received
(29,669)
(27,244)
Amortization related to above (below) market leases, net
230
113
Loss (gain) on sales of properties, net
(56,845)
Distributions by unconsolidated entities
174
172
Increase (decrease) in accrued expenses and other liabilities
(20,423)
(47,489)
Decrease (increase) in receivables and other assets
1,816
(22,992)
Net cash provided from (used in) operating activities
373,712
226,182
Investing activities:
Cash disbursed for acquisitions
(171,482)
(1,500,994)
Cash disbursed for capital improvements to existing properties
(35,025)
(29,828)
Cash disbursed for construction in progress
(66,739)
(59,552)
Capitalized interest
(3,037)
(2,387)
Investment in real estate loans receivable
(27,251)
(384,695)
Other investments, net of payments
(30,773)
(102,126)
Principal collected on real estate loans receivable
93,774
16,501
Contributions to unconsolidated entities
(12,784)
(83,964)
11,747
89,195
Proceeds from (payments on) derivatives
72,477
Increase in restricted cash
(394)
(1,660)
Proceeds from sales of real property
177,265
Net cash provided from (used in) investing activities
(241,964)
(1,809,768)
Financing activities:
Net increase (decrease) under unsecured credit facilities
(190,000)
410,000
Proceeds from issuance of senior unsecured notes
688,560
Payments to extinguish senior unsecured notes
(400,000)
(154,654)
Net proceeds from the issuance of secured debt
75,136
82,724
Payments on secured debt
(130,343)
(208,057)
Net proceeds from the issuance of common stock
93,433
1,489,547
Decrease (increase) in deferred loan expenses
(1,217)
(4,485)
Contributions by noncontrolling interests(1)
126,142
2,514
Distributions to noncontrolling interests(1)
(76,222)
(7,417)
Cash distributions to stockholders
(322,122)
(288,921)
Other financing activities
(397)
(8,428)
Net cash provided from (used in) financing activities
(137,030)
1,312,823
Effect of foreign currency translation on cash and cash equivalents
323
(690)
Increase (decrease) in cash and cash equivalents
(4,959)
(271,453)
Cash and cash equivalents at beginning of period
473,726
Cash and cash equivalents at end of period
202,273
Supplemental cash flow information:
Interest paid
134,872
134,737
Income taxes paid
2,431
2,942
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. Business
Welltower Inc., an S&P 500 company headquartered in Toledo, Ohio, is driving the transformation of health care infrastructure. The company invests with leading seniors housing operators, post-acute providers and health systems to fund the real estate and infrastructure needed to scale innovative care delivery models and improve people’s wellness and overall health care experience. Welltower™, a real estate investment trust (REIT), owns 1,490 properties in major, high-growth markets in the United States, Canada and the United Kingdom, consisting of seniors housing and post-acute communities and outpatient medical properties. Founded in 1970, we were the first real estate investment trust to invest exclusively in health care facilities.
2. Accounting Policies and Related Matters
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with instructions to Quarterly Report on Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. During the three months ended March 31, 2016, we determined that an immaterial portion of our noncontrolling interests related to a 2015 transaction was misclassified in permanent equity rather than temporary equity based on a redemption feature of the partnership agreement and we have corrected the $114,714,000 misclassification by recording the change in the consolidated statement of equity for the three months ended March 31, 2016. Operating results for the three months ended March 31, 2016 are not necessarily an indication of the results that may be expected for the year ending December 31, 2016. For further information, refer to the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015.
New Accounting Standards
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. The standard is a comprehensive new revenue recognition model that requires revenue to be recognized in a manner to depict the transfer of goods or services to a customer at an amount that reflects the consideration expected to be received in exchange for those goods or services. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted beginning after December 15, 2016. We are currently evaluating the impact that the standard will have on our consolidated financial statements and have not yet determined the method by which we will adopt the standard.
In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis”, which makes certain changes to both the variable interest model and the voting model, including changes to (1) the identification of variable interests (fees paid to a decision maker or service provider), (2) the variable interest entity characteristics for a limited partnership or similar entity and (3) the primary beneficiary determination. We adopted ASU 2015-02 on January 1, 2016. This guidance did not have a significant impact on our consolidated financial statements.
In September 2015, the FASB issued ASU No. 2015-16, “Simplifying the Accounting for Measurement-Period Adjustments” to simplify the accounting for business combinations, specifically as it relates to measurement-period adjustments. Acquiring entities in a business combination must recognize measurement-period adjustments in the reporting period in which the adjustment amounts are determined. Also, ASU 2015-16 requires entities to present separately on the face of the income statement (or disclose in the notes to the financial statements) the portion of the amount recorded in the current period earnings, by line item, that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. We adopted ASU 2015-16 on January 1, 2016. This guidance did not have a significant impact on our consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842),” which requires lessees to recognize assets and liabilities on their balance sheet related to the rights and obligations created by most leases, while continuing to recognize expenses on their income statements over the lease term. It will also require disclosures designed to give financial statement users information regarding the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. We are currently evaluating the impact that the standard will have on our consolidated financial statements.
3. Real Property Acquisitions and Development
The total purchase price for all properties acquired has been allocated to the tangible and identifiable intangible assets, liabilities and noncontrolling interests based upon their respective fair values in accordance with our accounting policies. The results of operations for these acquisitions have been included in our consolidated results of operations since the date of acquisition and are a component of the appropriate segments. Transaction costs primarily represent costs incurred with property acquisitions, including due diligence costs, fees for legal and valuation services and termination of pre-existing relationships computed based on the fair value of the assets acquired, lease termination fees and other acquisition-related costs. Certain of our subsidiaries’ functional currencies are the local currencies of their respective countries. See Note 2 to the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2015 for information regarding our foreign currency policies.
Triple-net Activity
March 31, 2016(1)
March 31, 2015
15,331
22,983
114,235
239,728
1,623
799
Total assets acquired
131,189
263,517
(809)
(732)
Total liabilities assumed
Non-cash acquisition related activity
(28,621)
(357)
101,759
262,428
Construction in progress additions
43,835
45,360
(1,684)
(1,756)
Foreign currency translation
(583)
(642)
41,568
42,962
Capital improvements to existing properties
7,438
11,557
Total cash invested in real property, net of cash acquired
150,765
316,947
(1) Includes acquisitions with an aggregate purchase price of $115,875,000 for which the allocation of the purchase price consideration is preliminary and subject to change.
Seniors Housing Operating Activity
3,440
86,184
Building and improvements
48,218
1,016,426
1,942
62,838
36
23,014
Total assets acquired(2)
53,636
1,192,282
(208,960)
(11)
(16,164)
(225,124)
(549)
(83,194)
53,076
883,964
4,033
4,193
(565)
(1,107)
(1,472)
2,361
2,327
16,808
11,632
72,245
897,923
(1) Includes acquisitions with an aggregate purchase price of $53,636,000 for which the allocation of the purchase price consideration is preliminary and subject to change.
(2) Excludes $113,000 and $1,677,000 of cash acquired during the three months ended March 31, 2016 and 2015, respectively.
9
Outpatient Medical Activity
March 31, 2016 (1)
47,019
17,637
307,072
511
354,602
(990)
16,647
28,934
16,421
(788)
(237)
Accruals(2)
(5,336)
(1,921)
22,810
14,263
10,779
6,639
Total cash invested in real property
50,236
375,504
(1) Includes acquisitions with an aggregate purchase price of $17,637,000 for which the allocation of the purchase price consideration is preliminary and subject to change.
(2) Represents non-cash consideration accruals for amounts to be paid in future periods relating to properties that converted in the periods noted above.
Construction Activity
The following is a summary of the construction projects that were placed into service and began generating revenues during the periods presented (in thousands):
Development projects:
Outpatient medical
35,363
16,592
Total development projects
Expansion projects
19,541
Total construction in progress conversions
36,133
10
4. Real Estate Intangibles
The following is a summary of our real estate intangibles, excluding those classified as held for sale, as of the dates indicated (dollars in thousands):
In place lease intangibles
1,196,335
1,179,537
Above market tenant leases
62,544
67,529
Below market ground leases
62,643
80,224
Lease commissions
24,542
23,295
Gross historical cost
Accumulated amortization
(923,712)
(881,096)
Net book value
422,352
469,489
Weighted-average amortization period in years
14.6
13.4
Below market tenant leases
93,054
93,089
Above market ground leases
7,908
7,907
100,962
100,996
(47,983)
(46,048)
52,979
54,948
14.7
14.5
The following is a summary of real estate intangible amortization for the periods presented (in thousands):
Rental income related to above/below market tenant leases, net
81
206
Property operating expenses related to above/below market ground leases, net
(311)
(319)
Depreciation and amortization related to in place lease intangibles and lease commissions
(34,454)
(24,324)
The future estimated aggregate amortization of intangible assets and liabilities is as follows for the periods presented (in thousands):
Assets
Liabilities
84,239
3,894
2017
79,195
6,807
2018
44,698
6,181
2019
25,238
5,771
2020
22,341
5,290
Thereafter
166,641
25,036
5. Dispositions, Assets Held for Sale and Discontinued Operations
We periodically sell properties for various reasons, including favorable market conditions or the exercise of tenant purchase options. During the three months ended March 31, 2016 and 2015, we recorded impairment charges on certain held-for-sale triple-net
11
properties as the fair values less estimated costs to sell exceeded our carrying values. The following is a summary of our real property disposition activity for the periods presented (in thousands):
Real estate dispositions:
Triple-net
110,998
9,422
Total dispositions
120,420
Proceeds from real estate dispositions
Dispositions and Assets Held for Sale
Pursuant to our adoption of ASU No. 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”, operating results attributable to properties sold subsequent to or classified as held for sale after January 1, 2014 and which do not meet the definition of discontinued operations are no longer reclassified on our Consolidated Statements of Comprehensive Income. The following represents the activity related to these properties for the periods presented (in thousands):
5,477
12,166
851
2,262
1,362
1,527
Provision for depreciation
820
3,256
3,033
7,045
Income (loss) from real estate dispositions, net
2,444
5,121
6. Real Estate Loans Receivable
The following is a summary of our real estate loan activity for the periods presented (in thousands):
Outpatient
Medical
Totals
Advances on real estate loans receivable:
Investments in new loans
8,013
368,080
Draws on existing loans
19,206
32
19,238
14,330
2,285
16,615
Net cash advances on real estate loans
27,219
27,251
382,410
384,695
Receipts on real estate loans receivable:
Loan payoffs
104,068
12,290
116,358
8,568
Principal payments on loans
3,107
7,933
Sub-total
107,175
119,465
Less: Non-cash activity
(25,691)
Net cash receipts on real estate loans
81,484
Net cash advances (receipts) on real estate loans
(54,265)
(12,258)
(66,523)
365,909
368,194
Change in balance due to foreign currency translation
(1,987)
(3,096)
Net change in real estate loans receivable
(81,943)
(94,201)
362,813
365,098
12
We recorded no provision for loan losses during the three months ended March 31, 2016. At March 31, 2016, we had no real estate loans with outstanding balances on non-accrual status and no allowances for loan losses were recorded.
7. Investments in Unconsolidated Entities
We participate in a number of joint ventures, which generally invest in seniors housing and health care real estate. The results of operations for these properties have been included in our consolidated results of operations from the date of acquisition by the joint ventures and are reflected in our Consolidated Statements of Comprehensive Income as income or loss from unconsolidated entities. The following is a summary of our investments in unconsolidated entities (dollars in thousands):
Percentage Ownership(1)
10% to 49%
34,289
36,351
Seniors housing operating
10% to 50%
504,355
499,537
43%
6,426
6,393
(1) Excludes ownership of in-substance real estate.
At March 31, 2016, the aggregate unamortized basis difference of our joint venture investments of $155,831,000 is primarily attributable to appreciation of the underlying properties and transaction costs. This difference will be amortized over the remaining useful life of the related properties and included in the reported amount of income from unconsolidated entities.
8. Credit Concentration
We use net operating income from continuing operations (“NOI”) as our credit concentration metric. See Note 17 for additional information and reconciliation. The following table summarizes certain information about our credit concentration for the three month period ended March 31, 2016, excluding our share of NOI in unconsolidated entities (dollars in thousands):
Number of
Percent of
Concentration by relationship:(1)
Properties
NOI
NOI(2)
Genesis Healthcare
187
99,894
17%
Sunrise Senior Living(3)
150
75,953
13%
Brookdale Senior Living
148
42,585
7%
Revera(3)
97
35,654
6%
Benchmark Senior Living
25,875
4%
Remaining portfolio
803
317,453
53%
1,434
597,414
100%
(1) Genesis Healthcare is in our triple-net segment. Sunrise Senior Living and Revera are in our seniors housing operating segment. Benchmark Senior Living and Brookdale Senior Living are both in our triple-net and seniors housing operating segments.
(2) NOI with our top five relationships comprised 46% of total NOI for the year ending December 31, 2015.
(3) Revera owns a controlling interest in Sunrise Senior Living.
9. Borrowings Under Credit Facilities and Related Items
At March 31, 2016, we had a primary unsecured credit facility with a consortium of 28 banks that includes a $2,500,000,000 unsecured revolving credit facility, a $500,000,000 unsecured term credit facility and a $250,000,000 Canadian-denominated unsecured term credit facility. We have an option, through an accordion feature, to upsize the unsecured revolving credit facility and the $500,000,000 unsecured term credit facility by up to an additional $1,000,000,000 and the $250,000,000 Canadian-denominated unsecured term credit facility by up to an additional $250,000,000. The primary unsecured credit facility also allows us to borrow up to $500,000,000 in alternate currencies (none outstanding at March 31, 2016). Borrowings under the unsecured revolving credit facility are subject to interest payable at the applicable margin over LIBOR interest rate (1.36% at March 31, 2016). The applicable margin is based on certain of our debt ratings and was 0.925% at March 31, 2016. In addition, we pay a facility fee quarterly to each bank based on the bank’s commitment amount. The facility fee depends on certain of our debt ratings and was 0.15% at March 31, 2016. The primary unsecured credit facility is scheduled to expire October 31, 2018 and can be extended for an additional year at our option.
13
The following information relates to aggregate borrowings under the primary unsecured revolving credit facility for the periods presented (dollars in thousands):
Balance outstanding at quarter end(1)
Maximum amount outstanding at any month end
945,000
430,000
Average amount outstanding (total of daily
principal balances divided by days in period)
671,044
408,944
Weighted average interest rate (actual interest
expense divided by average borrowings outstanding)
1.29%
1.21%
(1) As of March 31, 2016, letters of credit in the aggregate amount of $48,930,000 have been issued, which reduces the borrowing capacity on the unsecured revolving credit facility.
10. Senior Unsecured Notes and Secured Debt
We may repurchase, redeem or refinance senior unsecured notes from time to time, taking advantage of favorable market conditions when available. We may purchase senior notes for cash through open market purchases, privately negotiated transactions, a tender offer or, in some cases, through the early redemption of such securities pursuant to their terms. The senior unsecured notes are redeemable at our option, at any time in whole or from time to time in part, at a redemption price equal to the sum of (1) the principal amount of the notes (or portion of such notes) being redeemed plus accrued and unpaid interest thereon up to the redemption date and (2) any “make-whole” amount due under the terms of the notes in connection with early redemptions. Redemptions and repurchases of debt, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. At March 31, 2016, the annual principal payments due on these debt obligations were as follows (in thousands):
Senior
Secured
Unsecured Notes(1,2)
Debt(1,3)
434,322
450,000
490,995
940,995
631,533
1,081,533
2019(4,5)
1,292,767
385,748
1,678,515
2020(6)
681,321
182,554
863,875
Thereafter(7,8,9,10)
6,060,005
1,363,336
7,423,341
8,934,093
3,488,488
12,422,581
(1) Amounts represent principal amounts due and do not include unamortized premiums/discounts, debt issuance costs, or other fair value adjustments as reflected on the balance sheet.
(2) Annual interest rates range from 1.41% to 6.5%.
(3) Annual interest rates range from 1.0% to 7.98%. Carrying value of the properties securing the debt totaled $6,226,111,000 at March 31, 2016.
(4) On July 25, 2014, we refinanced the funding on a $250,000,000 Canadian-denominated unsecured term credit facility (approximately $192,767,000 based on the Canadian/U.S. Dollar exchange rate on March 31, 2016). The loan matures on October 31, 2018 (with an option to extend for an additional year at our discretion) and bears interest at the Canadian Dealer Offered Rate plus 97.5 basis points (1.85% at March 31, 2016).
(5) On July 25, 2014, we refinanced the funding on a $500,000,000 unsecured term credit facility. The loan matures on October 31, 2018 (with an option to extend for an additional year at our discretion) and bears interest at LIBOR plus 97.5 basis points (1.41% at March 31, 2016).
(6) In November 2015, one of our wholly-owned subsidiaries issued and we guaranteed $300,000,000 of Canadian-denominated 3.35% senior unsecured notes due 2020 (approximately $231,321,000 based on the Canadian/U.S. Dollar exchange rate on March 31, 2016).
(7) On November 20, 2013, we completed the sale of £550,000,000 (approximately $790,955,000 based on the Sterling/U.S. Dollar exchange rate in effect on March 31, 2016) of 4.8% senior unsecured notes due 2028.
(8) On November 25, 2014, we completed the sale of £500,000,000 (approximately $719,050,000 based on the Sterling/U.S. Dollar exchange rate in effect on March 31, 2016) of 4.5% senior unsecured notes due 2034.
(9) In May 2015, we issued $750,000,000 of 4.0% senior unsecured notes due 2025. In October 2015, we issued an additional $500,000,000 of these notes under a re-opening of the offer.
(10) In March 2016, we issued $700,000,000 of 4.25% senior unsecured notes due 2026.
The following is a summary of our senior unsecured notes principal activity during the periods presented (dollars in thousands):
14
Weighted Avg.
Amount
Interest Rate
Beginning balance
8,645,758
4.237%
7,817,154
4.385%
Debt issued
700,000
4.250%
0.000%
Debt extinguished
3.625%
Debt redeemed
3.000%
Foreign currency
(11,665)
3.943%
(94,579)
4.333%
Ending balance
4.266%
7,567,921
4.352%
The following is a summary of our secured debt principal activity for the periods presented (dollars in thousands):
3,478,207
4.44%
2,941,765
4.94%
3.06%
2.34%
Debt assumed
0.00%
205,897
3.98%
(111,701)
4.45%
(192,427)
4.02%
65,488
3.67%
(15,630)
5.01%
Principal payments
(18,642)
4.54%
(49,672)
3.96%
4.40%
2,972,657
4.88%
Our debt agreements contain various covenants, restrictions and events of default. Certain agreements require us to maintain certain financial ratios and minimum net worth and impose certain limits on our ability to incur indebtedness, create liens and make investments or acquisitions. As of March 31, 2016, we were in compliance with all of the covenants under our debt agreements.
11. Derivative Instruments
We are exposed to various market risks, including the potential loss arising from adverse changes in interest rates. We may elect to use financial derivative instruments to hedge interest rate exposure. These decisions are principally based on our policy to manage the general trend in interest rates at the applicable dates and our perception of the future volatility of interest rates. In addition, non-U.S. investments expose us to the potential losses associated with adverse changes in foreign currency to U.S. Dollar exchange rates. We may elect to manage this risk through the use of forward contracts and issuing debt in foreign currencies.
Interest Rate Swap Contracts and Foreign Currency Forward Contracts Designated as Cash Flow Hedges
For instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income (“OCI”), and reclassified into earnings in the same period or periods, during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in earnings. Approximately $1,412,000 of gains, which are included in accumulated other comprehensive income (“AOCI”), are expected to be reclassified into earnings in the next 12 months.
Foreign Currency Hedges
For instruments that are designated and qualify as net investment hedges, the variability in the foreign currency to U.S. Dollar of the instrument is recorded as a cumulative translation adjustment component of OCI. During the three months ended March 31, 2016 and 2015, we settled certain net investment hedges generating cash proceeds of $0 and $72,477,000, respectively. The balance of the cumulative translation adjustment will be reclassified to earnings when the hedged investment is sold or substantially liquidated.
The following presents the notional amount of derivatives and other financial instruments as of the dates indicated (in thousands):
15
Derivatives designated as net investment hedges:
Denominated in Canadian Dollars
1,175,000
Denominated in Pounds Sterling
£
550,000
Financial instruments designated as net investment hedges:
250,000
1,050,000
Derivatives designated as cash flow hedges
Denominated in U.S. Dollars
57,000
72,000
60,000
Derivative instruments not designated:
47,000
The following presents the impact of derivative instruments on the Consolidated Statements of Comprehensive Income for the periods presented (in thousands):
Location
Gain (loss) on interest rate swaps reclassified from AOCI into income (effective portion)
(483)
(466)
Gain (loss) on forward exchange contracts recognized in income
(1,327)
2,747
Loss (gain) on option exercise(1)
Gain (loss) on foreign exchange contracts and term loans designated as net investment hedge recognized in OCI
OCI
(2,739)
184,051
(1) In April 2011, we completed the acquisition of substantially all of the real estate assets of privately-owned Genesis Healthcare Corporation. In conjunction with this transaction, we received the option to acquire an ownership interest in Genesis Healthcare. In February 2015, Genesis Healthcare closed on a transaction to merge with Skilled Healthcare Group to become a publicly traded company which required us to record the value of the derivative asset due to the net settlement feature.
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12. Commitments and Contingencies
At March 31, 2016, we had nine outstanding letter of credit obligations totaling $90,401,000 and expiring between 2016 and 2018. At March 31, 2016, we had outstanding construction in progress of $297,023,000 and were committed to providing additional funds of approximately $637,356,000 to complete construction. Purchase obligations include contingent purchase obligations totaling $28,713,000 which relate to unfunded capital improvement obligations and contingent obligations on acquisitions. Rents due from the tenant are increased to reflect the additional investment in the property.
We evaluate our leases for operating versus capital lease treatment in accordance with Accounting Standards Codification (“ASC”) Topic 840 “Leases.” A lease is classified as a capital lease if it provides for transfer of ownership of the leased asset at the end of the lease term, contains a bargain purchase option, has a lease term greater than 75% of the economic life of the leased asset, or if the net present value of the future minimum lease payments are in excess of 90% of the fair value of the leased asset. Certain leases contain bargain purchase options and have been classified as capital leases. At March 31, 2016, we had operating lease obligations of $1,056,909,000 relating to certain ground leases and company office space and capital lease obligations of $97,385,000 relating primarily to certain investment properties. Regarding ground leases, we have sublease agreements with certain of our operators that require the operators to reimburse us for our monthly operating lease obligations. At March 31, 2016, aggregate future minimum rentals to be received under these noncancelable subleases totaled $75,296,000.
13. Stockholders’ Equity
The following is a summary of our stockholders’ equity capital accounts as of the dates indicated:
Preferred Stock:
Authorized shares
50,000,000
Issued shares
25,875,000
Outstanding shares
Common Stock, $1.00 par value:
700,000,000
357,697,257
355,594,373
356,772,720
354,777,670
Common Stock. The following is a summary of our common stock issuances during the three months ended March 31, 2016 and 2015 (dollars in thousands, except per share amounts):
Shares Issued
Average Price
Gross Proceeds
Net Proceeds
February 2015 public issuance
19,550,000
75.50
1,476,025
1,423,935
2015 Dividend reinvestment plan issuances
766,488
76.38
58,547
2015 Option exercises
149,788
47.17
7,065
2015 Stock incentive plans, net of forfeitures
166,815
2015 Senior note conversions
1,048,641
2015 Totals
21,681,732
1,541,637
2016 Dividend reinvestment plan issuances
1,058,085
60.00
63,484
2016 Option exercises
9,864
21.29
210
2016 Stock incentive plans, net of forfeitures
484,005
2016 Equity shelf program issuances
443,096
67.12
30,192
29,739
2016 Totals
1,995,050
93,886
Dividends. The increase in dividends is primarily attributable to increases in our common shares outstanding as described above and an increase in common dividends per share. The following is a summary of our dividend payments (in thousands, except per share amounts):
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Per Share
Common Stock
0.8600
305,770
0.8250
272,569
Series I Preferred Stock
0.8125
11,680
Series J Preferred Stock
0.4064
4,672
322,122
288,921
Accumulated Other Comprehensive Income. The following is a summary of accumulated other comprehensive income (loss) for the periods presented (in thousands):
Unrecognized gains (losses) related to:
Foreign Currency Translation
Available for Sale Securities
Actuarial Losses
Cash Flow Hedges
Balance at December 31, 2015
(85,484)
(1,343)
(1,416)
Other comprehensive income before reclassification adjustments
(13,746)
(21,293)
Reclassification amount to net income
483(1)
Net current-period other comprehensive income
Balance at March 31, 2016
(99,230)
(1,341)
(933)
Balance at December 31, 2014
(74,770)
(1,589)
(650)
(16,641)
(2,625)
(30,953)
466(1)
466
Balance at March 31, 2015
(91,411)
(2,809)
(1) Please see note 11 for additional information.
14. Stock Incentive Plans
Our Amended and Restated 2005 Long-Term Incentive Plan (“2005 Plan”) authorizes up to 6,200,000 shares of common stock to be issued at the discretion of the Compensation Committee of the Board of Directors. Our non-employee directors, officers and key employees are eligible to participate in the 2005 Plan. The 2005 Plan allows for the issuance of, among other things, stock options, restricted stock, deferred stock units and dividend equivalent rights. Vesting periods for options, deferred stock units and restricted shares generally range from three to five years. Options expire ten years from the date of grant. Stock-based compensation expense totaled $8,186,000 for the three months ended March 31, 2016 and $9,054,000 for the same period in 2015.
15. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):
18
Numerator for basic and diluted earnings
per share - net income (loss) attributable
to common stockholders
Denominator for basic earnings per
share - weighted average shares
Effect of dilutive securities:
Employee stock options
101
200
Non-vested restricted shares
253
416
Redeemable shares
621
Convertible senior unsecured notes
442
Dilutive potential common shares
975
1,058
Denominator for diluted earnings per
share - adjusted weighted average shares
Basic earnings per share
Diluted earnings per share
The Series I Cumulative Convertible Perpetual Preferred Stock was not included in the calculations as the effect of conversions into common stock was anti-dilutive.
16. Disclosure about Fair Value of Financial Instruments
U.S. GAAP provides authoritative guidance for measuring and disclosing fair value measurements of assets and liabilities. The guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The guidance also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Please see Note 2 to the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2015 for additional information.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
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.
Mortgage Loans and Other Real Estate Loans Receivable — The fair value of mortgage loans and other real estate loans receivable is generally estimated by using Level 2 and Level 3 inputs such as discounting the estimated future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Cash and Cash Equivalents— The carrying amount approximates fair value.
Available-for-sale Equity Investments — Available-for-sale equity investments are recorded at their fair value based on Level 1 publicly available trading prices.
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Borrowings Under Primary Unsecured Credit Facility — The carrying amount of the primary unsecured credit facility approximates fair value because the borrowings are interest rate adjustable.
Senior Unsecured Notes— The fair value of the fixed rate senior unsecured notes was estimated based on Level 1 publicly available trading prices. The carrying amount of variable rate senior unsecured notes approximates fair value because they are interest rate adjustable.
Secured Debt — The fair value of fixed rate secured debt is estimated using Level 2 inputs by discounting the estimated future cash flows using the current rates at which similar loans would be made with similar credit ratings and for the same remaining maturities. The carrying amount of variable rate secured debt approximates fair value because the borrowings are interest rate adjustable.
Foreign Currency Forward Contracts — Foreign currency forward contracts are recorded in other assets or other liabilities on the balance sheet at fair market value. Fair market value is determined using Level 2 inputs by estimating the future value of the currency pair based on existing exchange rates, comprised of current spot and traded forward points, and calculating a present value of the net amount using a discount factor based on observable traded interest rates.
Redeemable OP Unitholder Interests — The fair value of our redeemable unitholder interests are recorded on the balance sheet at fair value using Level 2 inputs. The fair value is measured using the closing price of our common stock, as units may be redeemed at the election of the holder for cash or, at our option, one share of our common stock per unit, subject to adjustment in certain circumstances.
The carrying amounts and estimated fair values of our financial instruments are as follows (in thousands):
Carrying Amount
Fair Value
Financial assets:
Mortgage loans receivable
546,573
572,909
635,492
663,501
Other real estate loans receivable
178,718
182,829
184,000
185,693
Available-for-sale equity investments
15,230
22,779
Foreign currency forward contracts
100,162
129,520
Financial liabilities:
Borrowings under unsecured credit facilities
9,391,062
9,020,529
3,724,054
3,678,564
2,308
Redeemable OP unitholder interests
114,481
112,029
Items Measured at Fair Value on a Recurring Basis
The market approach is utilized to measure fair value for our financial assets and liabilities reported at fair value on a recurring basis. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The following summarizes items measured at fair value on a recurring basis (in thousands):
Fair Value Measurements as of March 31, 2016
Level 1
Level 2
Level 3
Available-for-sale equity investments(1)
Foreign currency forward contracts, net(2)
97,854
227,565
212,335
(1) Unrealized gains or losses on equity investments are recorded in accumulated other comprehensive income (loss) at each measurement date. During the year ended December 31, 2015, we recognized an other than temporary impairment charge of $35,648,000 on the Genesis Healthcare stock investment. Also, see Note 11 for details related to the gain on the derivative asset originally recognized.
(2) Please see Note 11 for additional information.
Items Measured at Fair Value on a Nonrecurring Basis
20
In addition to items that are measured at fair value on a recurring basis, we also have assets and liabilities in our balance sheet that are measured at fair value on a nonrecurring basis. As these assets and liabilities are not measured at fair value on a recurring basis, they are not included in the tables above. Assets, liabilities and noncontrolling interests that are measured at fair value on a nonrecurring basis include those acquired/assumed in business combinations (see Note 3) and asset impairments (if applicable, see Note 5 for impairments of real property and Note 6 for impairments of loans receivable). We have determined that the fair value measurements included in each of these assets and liabilities rely primarily on company-specific inputs and our assumptions about the use of the assets and settlement of liabilities, as observable inputs are not available. As such, we have determined that each of these fair value measurements generally reside within Level 3 of the fair value hierarchy. We estimate the fair value of real estate and related intangibles using the income approach and unobservable data such as net operating income and estimated capitalization and discount rates. We also consider local and national industry market data including comparable sales, and commonly engage an external real estate appraiser to assist us in our estimation of fair value. We estimate the fair value of assets held for sale based on current sales price expectations or, in the absence of such price expectations, Level 3 inputs described above. We estimate the fair value of secured debt assumed in business combinations using current interest rates at which similar borrowings could be obtained on the transaction date.
17. Segment Reporting
We invest in seniors housing and health care real estate. We evaluate our business and make resource allocations on our three operating segments: triple-net, seniors housing operating and outpatient medical. During the three months ended March 31, 2016, we reclassified four properties previously classified in the triple-net segment to the outpatient medical segment. Accordingly, the segment information provided in this note has been reclassified to conform to the current presentation for all periods presented.
Our triple-net properties include long-term/post-acute care facilities, assisted living facilities, independent living/continuing care retirement communities, care homes (United Kingdom), independent support living facilities (Canada), care homes with nursing (United Kingdom) and combinations thereof. Under the triple-net segment, we invest in seniors housing and health care real estate through acquisition and financing of primarily single tenant properties. Properties acquired are primarily leased under triple-net leases and we are not involved in the management of the property. Our seniors housing operating properties include the seniors housing communities referenced above that are owned and/or operated through RIDEA structures (see Notes 3 and 18).
Our outpatient medical properties include outpatient medical buildings and, during past years, life science buildings which are aggregated into our outpatient medical reportable segment. Our outpatient medical buildings are typically leased to multiple tenants and generally require a certain level of property management. During the three months ended June 30, 2015, we disposed of our life science investments.
We evaluate performance based upon NOI by segment. We define NOI as total revenues, including tenant reimbursements, less property level operating expenses. We believe NOI provides investors relevant and useful information because it measures the operating performance of our properties at the property level on an unleveraged basis. We use NOI to make decisions about resource allocations and to assess the property level performance of our properties.
Non-segment revenue consists mainly of interest income on non-real estate investments and other income. Non-segment assets consist of corporate assets including cash, deferred loan expenses and corporate offices and equipment among others. Non-property specific revenues and expenses are not allocated to individual segments in determining NOI.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies (see Note 2 to the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2015). The results of operations for all acquisitions described in Note 3 are included in our consolidated results of operations from the acquisition dates and are components of the appropriate segments. There are no intersegment sales or transfers.
Summary information for the reportable segments is as follows for the periods presented (in thousands):
21
Three Months Ended March 31, 2016:
Seniors Housing Operating
Outpatient Medical
Non-segment / Corporate
283,825
131,838
22,853
1,031
1,304
1,490
2,189
313
58
308,168
605,369
133,455
408,894
40,742
Net operating income from continuing operations
196,475
92,713
Reconciling items:
5,606
40,828
5,744
80,782
79,800
101,832
47,064
2,852
3,933
1,423
Income (loss) from continuing operations before income taxes and income from unconsolidated entities
205,620
49,882
38,482
(126,415)
Income tax expense
(317)
2,767
(228)
(497)
(Loss) income from unconsolidated entities
3,081
(6,935)
34
208,384
45,714
38,288
(126,912)
12,337,195
11,595,907
5,059,616
95,575
Three Months Ended March 31, 2015:
261,993
117,594
14,699
1,264
3,883
1,020
161
22
280,575
494,561
119,019
338,507
37,954
156,054
81,065
517,716
8,424
34,458
7,388
70,810
69,420
76,636
42,773
36,171
12,042
341
10,337
5,064
212,430
32,918
30,563
(110,990)
419
(533)
(48)
1,393
(15,073)
1,032
214,242
17,312
32,061
(111,038)
54,096
2,749
268,338
34,810
Our portfolio of properties and other investments are located in the United States, the United Kingdom and Canada. Revenues and assets are attributed to the country in which the property is physically located. The following is a summary of geographic information for our operations for the periods presented (dollars in thousands):
%
United States
842,357
80.5%
745,136
83.3%
United Kingdom
100,555
9.6%
91,815
10.3%
Canada
104,138
9.9%
57,226
6.4%
100.0%
As of
23,461,804
80.7%
25,995,793
89.6%
2,950,387
10.1%
1,741,973
6.0%
2,676,102
9.2%
1,286,079
4.4%
18. Income Taxes and Distributions
We elected to be taxed as a REIT commencing with our first taxable year. To qualify as a REIT for federal income tax purposes, at least 90% of taxable income (excluding 100% of net capital gains) must be distributed to stockholders. REITs that do not distribute a certain amount of current year taxable income in the current year are also subject to a 4% federal excise tax. The main differences between undistributed net income for federal income tax purposes and financial statement purposes are the recognition of straight-line rent for reporting purposes, basis differences in acquisitions, recording of impairments, differing useful lives and depreciation and amortization methods for real property and the provision for loan losses for reporting purposes versus bad debt expense for tax purposes.
Under the provisions of the REIT Investment Diversification and Empowerment Act of 2007 (“RIDEA”), for taxable years beginning after July 30, 2008, a REIT may lease “qualified health care properties” on an arm’s-length basis to a taxable REIT subsidiary (“TRS”) if the property is operated on behalf of such TRS by a person who qualifies as an “eligible independent contractor.” Generally, the rent received from the TRS will meet the related party rent exception and will be treated as “rents from real property.” A “qualified health care property” includes real property and any personal property that is, or is necessary or incidental to the use of, a hospital, nursing facility, assisted living facility, congregate care facility, qualified continuing care facility, or other licensed facility which extends medical or nursing or ancillary services to patients. We have entered into various joint ventures that were structured under RIDEA. Resident level rents and related operating expenses for these facilities are reported in the unaudited consolidated financial statements and are subject to federal and state income taxes as the operations of such facilities are included in TRS entities. Certain net operating loss carryforwards could be utilized to offset taxable income in future years.
Income taxes reflected in the financial statements primarily represents U.S. federal and state and local income taxes as well as non-U.S. income based or withholding taxes on certain investments located in jurisdictions outside the U.S. The income tax benefit for the three months ended March 31, 2016 and 2015, was primarily due to operating income or losses, offset by certain discrete items at our TRS entities. In 2014, we established certain wholly-owned direct and indirect subsidiaries in Luxembourg and Jersey and transferred interests in certain foreign investments into this holding company structure. The structure includes a property holding company that is tax resident in the United Kingdom. No material adverse current tax consequences in Luxembourg, Jersey or the United Kingdom resulted from the creation of this holding company structure and all of the subsidiary entities in the structure are treated as disregarded entities of the company for U.S. federal income tax purposes. The company reflects current and deferred tax liabilities for any such withholding taxes incurred as a result of this holding company structure in its consolidated financial statements. Generally, given current statutes of limitations, we are subject to audit by the Internal Revenue Service (“IRS”) for the year ended December 31, 2012 and subsequent years and by state taxing authorities for the year ended December 31, 2011 and subsequent years. The company and its subsidiaries are also subject to audit by the Canada Revenue Agency and provincial authorities generally for periods subsequent to our initial investments in Canada in May 2012, by HM Revenue & Customs for periods subsequent to our initial investments in the
23
United Kingdom in August 2012 and by Luxembourg taxing authorities generally for periods subsequent to our establishment of certain Luxembourg-based subsidiaries during 2014.
19. VIE Disclosure
We have entered into certain joint ventures to own certain seniors housing and outpatient medical assets which are deemed to be variable interest entities for which we have concluded that we are the primary beneficiary based on a combination of operational control of the joint venture and the rights to receive residual returns or the obligation to absorb losses arising from the joint ventures. Except for capital contributions associated with the initial joint venture formations, the joint ventures have been and are expected to be funded from the ongoing operations of the underlying properties. Accordingly, such joint ventures have been consolidated, and the table below summarizes the balance sheets of consolidated variable interest entities in the aggregate:
1,020,357
453,889
14,080
8,759
10,450
8,082
Total assets(1)
1,044,887
470,730
451,952
147,021
12,845
7,732
71,440
70,090
508,650
245,887
(1)
Note that assets of the consolidated variable interest entities can only be used to settle obligations relating to such variable
interest entities. Liabilities of the consolidated variable interest entities represent claims against the specific assets
of the variable interest entities.
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Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE SUMMARY
Company Overview
Business Strategy
Capital Market Outlook
Key Transactions in 2016
Key Performance Indicators, Trends and Uncertainties
Corporate Governance
26
27
28
30
LIQUIDITY AND CAPITAL RESOURCES
Sources and Uses of Cash
Off-Balance Sheet Arrangements
Contractual Obligations
Capital Structure
31
RESULTS OF OPERATIONS
Summary
Non-Segment/Corporate
33
35
39
OTHER
Non-GAAP Financial Measures
Other Disclosures
Critical Accounting Policies
40
44
47
Cautionary Statement Regarding Forward-Looking Statements
The following discussion and analysis is based primarily on the unaudited consolidated financial statements of Welltower Inc. for the periods presented and should be read together with the notes thereto contained in this Quarterly Report on Form 10-Q. Other important factors are identified in our Annual Report on Form 10-K for the year ended December 31, 2015, including factors identified under the headings “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” References herein to “we,” “us,” “our,” or the “company” refer to Welltower Inc. and its subsidiaries unless specifically noted otherwise.
Executive Summary
Welltower Inc. (NYSE:HCN), an S&P 500 company headquartered in Toledo, Ohio, is driving the transformation of health care infrastructure. The company invests with leading seniors housing operators, post-acute providers and health systems to fund the real estate and infrastructure needed to scale innovative care delivery models and improve people’s wellness and overall health care experience. Welltower™, a real estate investment trust (“REIT”), owns properties in major, high-growth markets in the United States, Canada and the United Kingdom, consisting of seniors housing and post-acute communities and outpatient medical properties. Our capital programs, when combined with comprehensive planning, development and property management services, make us a single-source solution for acquiring, planning, developing, managing, repositioning and monetizing real estate assets.
The following table summarizes our consolidated portfolio for the three months ended March 31, 2016 (dollars in thousands):
Percentage of
Type of Property
NOI(1)
51.6%
778
32.9%
391
15.5%
265
597,356
(1) Excludes our share of investments in unconsolidated entities. Entities in which we have a joint venture with a minority partner are shown at 100% of the joint venture amount.
Our primary objectives are to protect stockholder capital and enhance stockholder value. We seek to pay consistent cash dividends to stockholders and create opportunities to increase dividend payments to stockholders as a result of annual increases in net operating income and portfolio growth. To meet these objectives, we invest across the full spectrum of seniors housing and health care real estate and diversify our investment portfolio by property type, relationship and geographic location.
Substantially all of our revenues are derived from operating lease rentals, resident fees and services, and interest earned on outstanding loans receivable. These items represent our primary sources of liquidity to fund distributions and depend upon the continued ability of our obligors to make contractual rent and interest payments to us and the profitability of our operating properties. To the extent that our customers/partners experience operating difficulties and become unable to generate sufficient cash to make payments to us, there could be a material adverse impact on our consolidated results of operations, liquidity and/or financial condition. To mitigate this risk, we monitor our investments through a variety of methods determined by the type of property. Our proactive and comprehensive asset management process for seniors housing properties generally includes review of monthly financial statements and other operating data for each property, review of obligor/partner creditworthiness, property inspections, and review of covenant compliance relating to licensure, real estate taxes, letters of credit and other collateral. Our internal property management division actively manages and monitors the outpatient medical portfolio with a comprehensive process including tenant relations, lease expirations, the mix of health service providers, hospital/health system relationships, property performance, capital improvement needs, and market conditions among other things. In monitoring our portfolio, our personnel use a proprietary database to collect and analyze property-specific data. Additionally, we conduct extensive research to ascertain industry trends. We evaluate the operating environment in each property’s market to determine the likely trend in operating performance of the facility. When we identify unacceptable trends, we seek to mitigate, eliminate or transfer the risk. Through these efforts, we are generally able to intervene at an early stage to address any negative trends, and in so doing, support both the collectability of revenue and the value of our investment.
In addition to our asset management and research efforts, we also structure our investments to help mitigate payment risk. Operating leases and loans are normally credit enhanced by guaranties and/or letters of credit. In addition, operating leases are typically structured as master leases and loans are generally cross-defaulted and cross-collateralized with other real estate loans, operating leases or agreements between us and the obligor and its affiliates.
For the three months ended March 31, 2016, rental income and resident fees and services represented 40% and 58%, respectively, of total revenues. Substantially all of our operating leases are designed with escalating rent structures. Leases with fixed annual rental escalators are generally recognized on a straight-line basis over the initial lease period, subject to a collectability assessment. Rental income related to leases with contingent rental escalators is generally recorded based on the contractual cash rental payments due for the period. Our yield on loans receivable depends upon a number of factors, including the stated interest rate, the average principal amount outstanding during the term of the loan and any interest rate adjustments.
Our primary sources of cash include rent and interest receipts, resident fees and services, borrowings under our primary unsecured credit facility, public issuances of debt and equity securities, proceeds from investment dispositions and principal payments on loans receivable. Our primary uses of cash include dividend distributions, debt service payments (including principal and interest), real property investments (including acquisitions, capital expenditures, construction advances and transaction costs), loan advances, property operating expenses and general and administrative expenses. Depending upon the availability and cost of external capital, we believe our liquidity is sufficient to fund these uses of cash.
We also continuously evaluate opportunities to finance future investments. New investments are generally funded from temporary borrowings under our primary unsecured credit facility, internally generated cash and the proceeds from investment dispositions. Our investments generate cash from net operating income and principal payments on loans receivable. Permanent financing for future investments, which replaces funds drawn under our primary unsecured credit facility, has historically been provided through a combination of the issuance of public debt and equity securities and the incurrence or assumption of secured debt.
Depending upon market conditions, we believe that new investments will be available in the future with spreads over our cost of capital that will generate appropriate returns to our stockholders. It is also possible that investment dispositions may occur in the future. To the extent that investment dispositions exceed new investments, our revenues and cash flows from operations could be adversely affected. We expect to reinvest the proceeds from any investment dispositions in new investments. To the extent that new investment requirements exceed our available cash on-hand, we expect to borrow under our primary unsecured credit facility. At March 31, 2016, we had $355,949,000 of cash and cash equivalents, $62,176,000 of restricted cash and $1,806,070,000 of available borrowing capacity under our primary unsecured credit facility.
We believe the capital markets remain supportive of our investment strategy. For the 15 months ended March 31, 2016, we raised $4,065,959,000 in aggregate gross proceeds through the issuance of common stock and unsecured debt. The capital raised, in combination with available cash and borrowing capacity under our primary unsecured credit facility, supported pro rata gross new investments of $4,819,684,000 during 2015 and $348,241,000 during the three months ended March 31, 2016. We expect attractive investment opportunities to remain available in the future as we continue to leverage the benefits of our relationship investment strategy.
Capital. In March 2016, we issued $700,000,000 of 4.25% senior unsecured notes due 2026, generating approximately $688,560,000 of net proceeds. During the three months ended March 31, 2016, we raised $63,484,000 through our dividend reinvestment program. Also during the three months ended March 31, 2016, we raised approximately $29,739,000 under our Equity Shelf Program (as defined below).
Investments. The following summarizes our acquisitions and joint venture investments completed during the three months ended March 31, 2016 (dollars in thousands):
Investment Amount(1)
Capitalization Rates(2)
Book Amount(3)
133,925
7.2%
52,654
7.5%
1
204,216
202,462
(1) Represents stated pro rata purchase price including cash and any assumed debt but excludes fair value adjustments pursuant to U.S. GAAP.
(2) Represents annualized contractual or projected income to be received in cash divided by investment amounts.
(3) Represents amounts recorded on our books including fair value adjustments pursuant to U.S. GAAP. See Notes 3 and 7 to our unaudited consolidated financial statements for additional information.
Dispositions. We completed no property dispositions during the three months ended March 31, 2016.
Dividends. Our Board of Directors increased the annual cash dividend to $3.44 per common share ($0.86 per share quarterly), as compared to $3.30 per common share for 2015, beginning in February 2016. The dividend declared for the quarter ended March 31, 2016 represents the 180thconsecutive quarterly dividend payment.
We utilize several key performance indicators to evaluate the various aspects of our business. These indicators are discussed below and relate to operating performance, concentration risk and credit strength. Management uses these key performance indicators to facilitate internal and external comparisons to our historical operating results, in making operating decisions and for budget planning purposes.
Operating Performance. We believe that net income attributable to common stockholders (“NICS”) is the most appropriate earnings measure. Other useful supplemental measures of our operating performance include funds from operations (“FFO”), net operating income from continuing operations (“NOI”) and same store cash NOI (“SSCNOI”); however, these supplemental measures are not defined by U.S. generally accepted accounting principles (“U.S. GAAP”). Please refer to the section entitled “Non-GAAP Financial Measures” for further discussion and reconciliations of FFO, NOI and SSCNOI. These earnings measures and their relative per share amounts are widely used by investors and analysts in the valuation, comparison and investment recommendations of companies. The following table reflects the recent historical trends of our operating performance measures for the periods presented (in thousands, except per share amounts):
June 30,
September 30,
December 31,
312,573
182,043
132,931
Funds from operations
344,250
340,588
392,295
332,509
391,264
558,815
570,294
590,746
Same store cash net operating income
454,891
468,376
467,309
464,110
468,412
Per share data (fully diluted):
0.89
0.52
0.37
1.02
0.97
1.11
0.94
1.10
Credit Strength. We measure our credit strength both in terms of leverage ratios and coverage ratios. The leverage ratios indicate how much of our balance sheet capitalization is related to long-term debt. The coverage ratios indicate our ability to service interest and fixed charges (interest, secured debt principal amortization and preferred dividends). We expect to maintain capitalization ratios and coverage ratios sufficient to maintain a capital structure consistent with our current profile. The coverage ratios are based on earnings before interest, taxes, depreciation and amortization (“EBITDA”) which is discussed in further detail, and reconciled to net income, below in “Non-GAAP Financial Measures.” Leverage ratios and coverage ratios are widely used by investors, analysts and rating agencies in the valuation, comparison, investment recommendations and rating of companies. The following table reflects the recent historical trends for our credit strength measures for the periods presented:
Debt to book capitalization ratio
42%
46%
Debt to undepreciated book
capitalization ratio
38%
39%
41%
40%
Debt to market capitalization ratio
28%
32%
31%
33%
Interest coverage ratio
4.21x
5.32x
4.39x
3.88x
3.85x
Fixed charge coverage ratio
3.34x
4.19x
3.45x
3.06x
Concentration Risk. We evaluate our concentration risk in terms of NOI by property mix, relationship mix and geographic mix. Concentration risk is a valuable measure in understanding what portion of our NOI could be at risk if certain sectors were to experience downturns. Property mix measures the portion of our NOI that relates to our various property types. Relationship mix measures the portion of our NOI that relates to our top five relationships. Geographic mix measures the portion of our NOI that relates to our top five states (or international equivalents). The following table reflects our recent historical trends of concentration risk by NOI for the periods indicated below:
Property mix:(1)
55%
54%
52%
30%
15%
14%
16%
Relationship mix:(1)
Sunrise Senior Living(2)
8%
Revera(2)
5%
Remaining relationships
Geographic mix:(1)
California
10%
9%
New Jersey
Pennsylvania
Texas
Remaining geographic areas
61%
60%
58%
(1) Excludes our share of investments in unconsolidated entities. Entities in which the company has a joint venture with a minority partner are shown at 100% of the joint venture amount.
(2) Revera owns a controlling interest in Sunrise Senior Living.
Lease Expirations. The following table sets forth information regarding lease expirations for certain portions of our portfolio as of March 31, 2016 (dollars in thousands):
Expiration Year
2021
2022
2023
2024
2025
Triple-net:
56
37
57
509
Base rent(1)
0
12,846
42,371
1,267
14,603
36,164
33,110
692
12,130
66,834
920,844
% of base rent
0.0%
1.1%
3.7%
0.1%
1.3%
3.2%
2.9%
5.9%
Units/beds
1,165
3,655
123
1,074
3,614
4,731
60
831
4,189
55,755
% of Units/beds
1.5%
4.9%
0.2%
1.4%
4.8%
6.3%
5.6%
74.1%
Outpatient medical:
Square feet
590,950
1,094,266
934,195
1,101,839
1,263,066
1,267,293
2,177,744
1,127,659
1,404,564
582,325
4,245,431
16,565
27,520
24,497
28,333
32,722
32,233
45,860
27,124
37,764
17,220
100,772
4.2%
7.0%
7.3%
8.4%
8.3%
11.7%
6.9%
9.7%
25.9%
Leases
227
287
257
250
205
182
158
100
73
184
% of Leases
10.4%
13.1%
12.1%
11.4%
9.4%
4.6%
3.3%
(1) The most recent monthly base rent including straight line for leases with fixed escalators or annual cash rents for leases with contingent escalators. Base rent does not include tenant recoveries or amortization of above and below market lease intangibles.
We evaluate our key performance indicators in conjunction with current expectations to determine if historical trends are indicative
29
of future results. Our expected results may not be achieved and actual results may differ materially from our expectations. Factors that may cause actual results to differ from expected results are described in more detail in “Cautionary Statement Regarding Forward-Looking Statements” and other sections of this Quarterly Report on Form 10-Q. Management regularly monitors economic and other factors to develop strategic and tactical plans designed to improve performance and maximize our competitive position. Our ability to achieve our financial objectives is dependent upon our ability to effectively execute these plans and to appropriately respond to emerging economic and company-specific trends. Please refer to our Annual Report on Form 10-K for the year ended December 31, 2015, under the headings “Business,” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion of these risk factors.
Maintaining investor confidence and trust is important in today’s business environment. Our Board of Directors and management are strongly committed to policies and procedures that reflect the highest level of ethical business practices. Our corporate governance guidelines provide the framework for our business operations and emphasize our commitment to increase stockholder value while meeting all applicable legal requirements. These guidelines meet the listing standards adopted by the New York Stock Exchange and are available on the Internet at www.welltower.com/investors/governance. The information on our website is not incorporated by reference in this Quarterly Report on Form 10-Q, and our web address is included as an inactive textual reference only.
Liquidity and Capital Resources
Our primary sources of cash include rent and interest receipts, resident fees and services, borrowings under our primary unsecured credit facility, public issuances of debt and equity securities, proceeds from investment dispositions and principal payments on loans receivable. Our primary uses of cash include dividend distributions, debt service payments (including principal and interest), real property investments (including acquisitions, capital expenditures, construction advances and transaction costs), loan advances, property operating expenses, and general and administrative expenses. These sources and uses of cash are reflected in our Consolidated Statements of Cash Flows and are discussed in further detail below. The following is a summary of our sources and uses of cash flows (dollars in thousands):
Change
(112,818)
-24%
Cash provided from (used in) operating activities
147,530
65%
Cash provided from (used in) investing activities
1,567,804
-87%
Cash provided from (used in) financing activities
(1,449,853)
n/a
Effect of foreign currency translation
1,013
153,676
76%
Operating Activities. The change in net cash provided from operating activities is primarily attributable to increases in NOI, which is primarily due to acquisitions. Please see “Results of Operations” for further discussion. For the three months ended March 31, 2016 and 2015, cash flow provided from operations exceeded cash distributions to stockholders.
Investing Activities. The changes in net cash used in investing activities are primarily attributable to net changes in real property investments, real estate loans receivable and investments in unconsolidated entities, which are summarized above in “Key Transactions in 2016” and Notes 3 and 6 of our unaudited consolidated financial statements. The following is a summary of cash used in non-acquisition capital improvement activities (dollars in thousands):
New development
66,739
59,552
7,187
12%
Recurring capital expenditures, tenant improvements and lease commissions
12,265
10,485
1,780
Renovations, redevelopments and other capital improvements
22,760
19,343
3,417
18%
101,764
89,380
12,384
The change in new development is primarily due to the number and size of construction projects on-going during the relevant periods. Renovations, redevelopments and other capital improvements include expenditures to maximize property value, increase net operating income, maintain a market-competitive position and/or achieve property stabilization. Generally, these expenditures have increased as a result of acquisitions, primarily in our seniors housing operating segment.
Financing Activities. The changes in net cash provided from financing activities are primarily attributable to changes related to our long-term debt arrangements, the issuance/conversion of common and preferred stock and dividend payments. Please refer to Notes 9, 10 and 13 of our unaudited consolidated financial statements for additional information.
At March 31, 2016, we had investments in unconsolidated entities with our ownership generally ranging from 10% to 50%. Please see Note 7 to our unaudited consolidated financial statements for additional information. We use financial derivative instruments to hedge interest rate and foreign currency exchange rate exposure. Please see Note 11 to our unaudited consolidated financial statements for additional information. At March 31, 2016, we had nine outstanding letter of credit obligations. Please see Note 12 to our unaudited consolidated financial statements for additional information.
The following table summarizes our payment requirements under contractual obligations as of March 31, 2016 (in thousands):
Payments Due by Period
2017-2018
2019-2020
Unsecured revolving credit facility(1)
Senior unsecured notes and term credit facilities:(2)
U.S. Dollar senior unsecured notes
6,500,000
900,000
4,550,000
Pounds Sterling senior unsecured notes(3)
1,510,005
Canadian Dollar senior unsecured notes(3)
231,321
U.S. Dollar term credit facility
500,000
Canadian Dollar term credit facility(3)
192,767
Secured debt:(2,3)
Consolidated
1,122,528
568,302
Unconsolidated
485,344
21,520
37,229
28,515
398,080
Contractual interest obligations:(4)
Unsecured revolving credit facility
22,652
3,612
14,448
4,592
Senior unsecured notes and term loans(3)
3,801,797
283,905
740,684
640,220
2,136,989
Consolidated secured debt(3)
682,181
113,742
214,952
133,870
219,617
Unconsolidated secured debt(3)
135,011
12,968
32,070
29,724
60,249
Capital lease obligations(5)
97,385
3,548
9,411
8,506
75,920
Operating lease obligations(5)
1,056,909
12,105
32,816
32,103
979,885
Purchase obligations(5)
666,069
177,072
481,017
6,472
1,508
Other long-term liabilities(6)
5,285
1,106
2,950
1,229
Total contractual obligations
20,020,214
1,063,900
3,588,105
4,072,621
11,295,589
(1) Relates to unsecured revolving credit facility with an aggregate commitment of $2,500,000,000. See Note 9 to our unaudited consolidated financial statements for additional information.
(2) Amounts represent principal amounts due and do not reflect unamortized premiums/discounts or other fair value adjustments as reflected on the balance sheet.
(3) Based on foreign currency exchange rates in effect as of balance sheet date.
(4) Based on variable interest rates in effect as of balance sheet date.
(5) See Note 12 to our unaudited consolidated financial statements for additional information.
(6) Primarily relates to payments to be made under our Supplemental Executive Retirement Plan.
Our debt agreements contain various covenants, restrictions and events of default. Certain agreements require us to maintain certain financial ratios and minimum net worth and impose certain limits on our ability to incur indebtedness, create liens and make investments or acquisitions. As of March 31, 2016, we were in compliance with all of the covenants under our debt agreements. None
of our debt agreements contain provisions for acceleration which could be triggered by our debt ratings. However, under our primary unsecured credit facility, the ratings on our senior unsecured notes are used to determine the fees and interest charged.
We plan to manage the company to maintain compliance with our debt covenants and with a capital structure consistent with our current profile. Any downgrades in terms of ratings or outlook by any or all of the rating agencies could have a material adverse impact on our cost and availability of capital, which could in turn have a material adverse impact on our consolidated results of operations, liquidity and/or financial condition.
On May 1, 2015, we filed with the Securities and Exchange Commission (the “SEC”) (1) an open-ended automatic or “universal” shelf registration statement covering an indeterminate amount of future offerings of debt securities, common stock, preferred stock, depositary shares, warrants and units and (2) a registration statement in connection with our enhanced dividend reinvestment plan under which we may issue up to 15,000,000 shares of common stock. As of April 30, 2016, 10,616,909 shares of common stock remained available for issuance under this registration statement. We have entered into separate Equity Distribution Agreements with each of UBS Securities LLC, KeyBanc Capital Markets Inc. and Credit Agricole Securities (USA) Inc. relating to the offer and sale from time to time of up to $630,015,000 aggregate amount of our common stock (“Equity Shelf Program”). As of April 30, 2016, we had $378,734,000 of remaining capacity under the Equity Shelf Program. Depending upon market conditions, we anticipate issuing securities under our registration statements to invest in additional properties and to repay borrowings under our primary unsecured credit facility.
Results of Operations
Our primary sources of revenue include rent and resident fees and services. Our primary expenses include interest expense, depreciation and amortization, property operating expenses, transaction costs and general and administrative expenses. We evaluate our business and make resource allocations on our three business segments: triple-net, seniors housing operating and outpatient medical. The primary performance measures for our properties are NOI and SSCNOI, which are discussed below. Please see Note 17 to our unaudited consolidated financial statements for additional information. The following is a summary of our results of operations (dollars in thousands, except per share amounts):
(41,830)
-22%
47,014
EBITDA
525,405
519,027
6,378
1%
Net operating income from continuing operations (NOI)
79,698
Same store cash NOI
13,521
3%
(0.14)
-25%
0.08
-0.36x
-9%
-0.28x
-8%
The following is a summary of our NOI for the triple-net segment (dollars in thousands):
SSCNOI(1)
235,272
229,095
6,177
Non-cash NOI attributable to same store properties(1)
23,276
24,500
(1,224)
-5%
NOI attributable to non same store properties(2)
49,620
26,980
22,640
84%
27,593
(1) Change is due to increases in cash and non-cash NOI (described below) related to 664 same store properties.
(2) Change is primarily due to the acquisition of 88 properties and the conversion of 11 construction projects into revenue-generating properties subsequent to January 1, 2014.
During the three months ended March 31, 2016, we reclassified four properties previously classified in the triple-net segment to the outpatient medical segment. Accordingly, the information has been reclassified to conform to the current presentation for all periods presented. The following is a summary of our results of operations for the triple-net segment (dollars in thousands):
21,832
8,154
(2,393)
-62%
Other expenses:
(2,818)
-33%
58,427
-100%
10,380
(33,319)
-92%
(10,361)
12,094
545%
102,548
68,145
34,403
50%
Income from continuing operations before income taxes and income (loss) from unconsolidated entities
(6,810)
-3%
Income tax benefit (expense)
(736)
1,688
121%
Income from continuing operations
(5,858)
Gain (loss) on real estate dispositions, net(1)
(54,096)
(59,954)
Less: Net income (loss) attributable to noncontrolling interests
(342)
454
(796)
Net income attributable to common stockholders
208,726
267,884
(59,158)
(1) See Note 5 to our unaudited consolidated financial statements.
The increase in rental income is primarily attributable to the acquisitions of new properties and the conversion of newly constructed triple-net properties from which we receive rent. Certain of our leases contain annual rental escalators that are contingent upon changes in the Consumer Price Index and/or changes in the gross operating revenues of the tenant’s properties. These escalators are not fixed, so no straight-line rent is recorded; however, rental income is recorded based on the contractual cash rental payments due for the period. If gross operating revenues at our facilities and/or the Consumer Price Index do not increase, a portion of our revenues may not continue to increase. Sales of real property would offset revenue increases and, to the extent that they exceed new acquisitions, could result in decreased revenues. Our leases could renew above or below current rent rates, resulting in an increase or decrease in rental income. For the three months ended March 31, 2016, we had no lease renewals but we had 31 leases with rental rate increasers ranging from 0.01% to 0.41% in our triple-net portfolio.
The change in interest income is due to a higher loan volume in the current year, which includes two first mortgage loans to Genesis Healthcare. The decrease in other income is due to the receipt of an early prepayment fee in 2015 related to a real estate loan receivable.
During the three months ended March 31, 2016, we did not complete any construction projects. The following is a summary of triple-net construction projects pending as of March 31, 2016 (dollars in thousands):
Units/Beds
Commitment
Balance
Est. Completion
Edmond, OK
142
14,353
3Q16
Carrollton, TX
104
18,900
10,229
London, UK
28,762
17,574
Tulsa, OK
145
25,800
9,163
4Q16
Bracknell, UK
64
15,890
7,840
1Q17
Piscataway, NJ
124
30,600
23,232
Raleigh, NC
225
93,000
52,383
Livingston, NJ
120
51,440
22,378
Lititz, PA
80
15,200
4,085
Lancaster, PA
15,875
4,366
Alexandria, VA
116
60,156
11,990
1Q18
1,279
380,123
177,593
Interest expense for the three months ended March 31, 2016 and 2015 represents secured debt interest expense. The change in secured debt interest expense is due to the net effect and timing of assumptions, segment transitions, extinguishments and principal amortizations. The following is a summary of our triple-net property secured debt principal activity (dollars in thousands):
Wtd. Avg.
554,014
5.488%
670,769
5.337%
(33,919)
5.895%
(90,808)
4.089%
Foreign Currency
5,291
5.315%
(8,334)
5.316%
(2,987)
5.587%
(3,519)
5.621%
522,399
5.467%
568,108
5.562%
Monthly averages
540,554
5.482%
578,679
5.494%
In April 2011, we completed the acquisition of substantially all of the real estate assets of privately-owned Genesis Healthcare Corporation. In conjunction with this transaction, we received the option to acquire an ownership interest in Genesis Healthcare. In February 2015, Genesis Healthcare closed on a transaction to merge with Skilled Healthcare Group to become a publicly traded company which required us to record the value of the derivative asset due to the net settlement feature. This event resulted in $58,427,000 gain in the first quarter of 2015.
Depreciation and amortization increased primarily as a result of new property acquisitions and the conversions of newly constructed triple-net properties. To the extent that we acquire or dispose of additional properties in the future, our provision for depreciation and amortization will change accordingly.
Transaction costs are costs incurred with property acquisitions including due diligence costs, fees for legal and valuation services, the termination of pre-existing relationships, lease termination expenses and other similar costs. The 2015 transaction costs include a charge related to the termination of pre-existing relationships, the termination of a lease obligation and overall higher transaction volume. The fluctuation in losses/gains on debt extinguishment is primarily attributable to the volume of extinguishments and the terms of the related secured debt.
Changes in the gain on sales of properties are related to property sales which totaled zero and eleven for the three months ended March 31, 2016 and 2015, respectively. During the three months ended March 31, 2016 and 2015, we recorded impairment charges on certain held-for-sale triple-net properties as the fair values less estimated costs to sell exceeded our carrying values.
The following is a summary of our NOI for the seniors housing operating segment (dollars in thousands):
158,693
152,462
6,231
Non-cash NOI attributable to same store properties
(248)
(251)
-1%
38,030
3,843
34,187
890%
40,421
26%
(1) Relates to 298 same store properties.
(2) Change is primarily due to the acquisition of 93 properties subsequent to January 1, 2015.
The following is a summary of our seniors housing operating results of operations (dollars in thousands):
109,639
22%
0%
1,169
115%
110,808
70,387
21%
6,370
25,196
(8,109)
-67%
146,593
123,136
23,457
19%
Income (loss) from continuing operations before income taxes and income (loss) from unconsolidated entities
16,964
3,300
8,138
-54%
28,402
164%
360
1,273
(913)
-72%
45,354
16,039
29,315
183%
Fluctuations in revenues and property operating expenses are primarily a result of acquisitions and the movement of U.S. and foreign currency exchange rates. The fluctuations in depreciation and amortization are due to acquisitions and variations in
amortization of short-lived intangible assets. To the extent that we acquire or dispose of additional properties in the future, these amounts will change accordingly.
During the three month period ended March 31, 2016, we did not complete any construction projects. The following is a summary of our seniors housing operating construction projects, excluding expansions, pending as of March 31, 2016 (dollars in thousands):
Units
Camberley, UK
102
19,953
19,389
Bushey, UK
95
56,957
14,698
2Q18
Chertsey, UK
94
44,483
12,661
3Q18
291
121,393
46,748
Interest expense represents secured debt interest expense as well as interest expense related to all foreign senior unsecured debt. The increase in interest expense is attributed primarily to the $300,000,000 Canadian-denominated senior unsecured notes issued in November 2015. Please refer to Note 10 to our unaudited consolidated financial statements for additional information. The following is a summary of our seniors housing operating property secured debt principal activity (dollars in thousands):
2,290,552
3.958%
1,654,531
4.422%
3.063%
2.336%
3.976%
(58,533)
3.037%
(82,961)
3.575%
60,197
3.524%
(41,338)
3.686%
(12,170)
3.959%
(8,416)
4.327%
2,355,182
3.980%
1,810,437
4.356%
2,306,203
1,621,849
4.431%
Transaction costs fluctuate based on the volume of acquisitions in a year. For the current year, transaction costs are lower because of decreased acquisition volume. The majority of our seniors housing operating properties are formed through partnership interests. Net income attributable to noncontrolling interests represents our partners’ share of net income (loss) related to joint ventures. The fluctuations in income (loss) from unconsolidated entities is primarily due to depreciation and amortization of short-lived intangible assets and the timing of additional investments in unconsolidated entities.
The following is a summary of our NOI for the outpatient medical segment (dollars in thousands):
74,447
73,334
1,113
2%
1,493
(778)
-34%
16,773
5,460
11,313
207%
11,648
(1) Relates to 221 same store properties.
(2) Change is primarily due to acquisitions of 16 properties and conversions of construction projects into two revenue-generating properties subsequent to January 1, 2015.
During the three months ended March 31, 2016, we reclassified four properties previously classified in the triple-net segment to the outpatient medical segment. Accordingly, the information has been reclassified to conform to the current presentation for all periods presented. The following is a summary of our results of operations for the outpatient medical segment (dollars in thousands):
14,244
152
94%
14,436
2,788
(1,644)
4,291
317%
54,231
50,502
3,729
Income from continuing operations before income taxes and income from unconsolidated entities
7,919
(694)
Income from unconsolidated entities
(998)
-97%
6,227
(2,749)
3,478
135
544
(409)
-75%
38,153
34,266
3,887
11%
The increase in rental income is primarily attributable to the acquisitions of new properties and the conversion of newly constructed outpatient medical properties from which we receive rent. Certain of our leases contain annual rental escalators that are contingent upon changes in the Consumer Price Index. These escalators are not fixed, so no straight-line rent is recorded; however, rental income is recorded based on the contractual cash rental payments due for the period. If the Consumer Price Index does not increase, a portion of our revenues may not continue to increase. Sales of real property would offset revenue increases and, to the extent that they exceed new acquisitions, could result in decreased revenues. Our leases could renew above or below current rent rates, resulting in an increase or decrease in rental income. For the three months ended March 31, 2016, our consolidated outpatient medical portfolio signed 56,239 square feet of new leases and 166,012 square feet of renewals. The weighted-average term of these leases was six years, with a rate of $35.44 per square foot and tenant improvement and lease commission costs of $14.48 per square foot. Substantially all of these leases during the referenced quarter contain an annual fixed or contingent escalation rent structure ranging from the change in CPI to 5%.
During the three months ended March 31, 2016, we completed two outpatient medical construction project representing $35,363,000 or $267 per square foot. The following is a summary of the outpatient medical construction projects, excluding expansions, pending as of March 31, 2016 (dollars in thousands):
Square Feet
Stamford, CT
92,345
41,735
16,614
Missouri, TX
23,863
9,180
4,008
Marietta, GA
103,156
24,893
2,105
Wausau, WI
43,883
14,100
5,106
Castle Rock, CO
56,822
13,148
759
Brooklyn, NY
140,955
103,624
25,375
Timmonium, MD
46,000
20,996
8,763
2Q17
507,024
227,676
62,730
Total interest expense represents secured debt interest expense. The change in secured debt interest expense is primarily due to the net effect and timing of assumptions, extinguishments and principal amortizations. The following is a summary of our outpatient medical secured debt principal activity (dollars in thousands):
627,689
5.177%
609,268
5.838%
(19,187)
6.196%
(18,658)
5.696%
(3,142)
5.671%
(3,375)
6.006%
605,360
5.218%
587,235
5.841%
619,350
5.237%
597,895
5.839%
The increase in property operating expenses and depreciation and amortization is primarily attributable to acquisitions and construction conversions of new outpatient medical facilities for which we incur certain property operating expenses. Transaction costs represent costs incurred with property acquisitions including due diligence costs, fees for legal and valuation services, termination of pre-existing relationships, lease termination expenses and other similar costs. Income from unconsolidated entities represents our share of net income or losses related to the periods for which we held a joint venture investment with Forest City Enterprises and certain unconsolidated property investments. Changes in gains/losses on sales of properties are related to volume of property sales and the sales prices. A portion of our outpatient medical properties were formed through partnerships. Net income attributable to noncontrolling interests represents our partners’ share of net income or loss relating to those partnerships where we are the controlling partner.
38
The following is a summary of our results of operations for the non-segment/corporate activities (dollars in thousands):
9,972
10,553
Loss on extinguishment of debt, net
(5,064)
126,473
111,012
15,461
Loss from continuing operations before income taxes
(15,425)
(449)
935%
Loss from continuing operations
(15,874)
Less: Preferred stock dividends
Net loss attributable to common stockholders
(143,264)
(127,390)
The following is a summary of our non-segment/corporate interest expense (dollars in thousands):
73,987
64,400
9,587
88
Primary unsecured credit facility
3,709
3,047
662
Swap loss (savings)
(4)
Loan expense
2,989
3,279
(290)
The change in interest expense on senior unsecured notes is due to the net effect of issuances and extinguishments, excluding our foreign senior unsecured debt, which is in our seniors housing operating segment. Please refer to Note 10 to our unaudited consolidated financial statements for additional information. Loan expense represents the amortization of deferred loan costs incurred in connection with the issuance and amendments of debt. Loan expense changes are due to amortization of charges for costs incurred in connection with senior unsecured note issuances. The change in interest expense on the primary unsecured credit facility is due primarily to the net effect and timing of draws, paydowns and variable interest rate changes. Please refer to Note 9 of our unaudited consolidated financial statements for additional information regarding our primary unsecured credit facility.
General and administrative expenses as a percentage of consolidated revenues for the three months ended March 31, 2016 and 2015 were 4.36% and 3.93%, respectively. The increase in general and administrative expenses is primarily related to professional service fees for tax and legal consulting and costs associated with our initiatives to attract and retain appropriate personnel to achieve our business objectives.
We believe that net income, as defined by U.S. GAAP, is the most appropriate earnings measurement. However, we consider FFO, NOI and EBITDA to be useful supplemental measures of our operating performance. Historical cost accounting for real estate assets in accordance with U.S. GAAP implicitly assumes that the value of real estate assets diminishes predictably over time as evidenced by the provision for depreciation. However, since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered presentations of operating results for real estate companies that use historical cost accounting to be insufficient. In response, the National Association of Real Estate Investment Trusts (“NAREIT”) created FFO as a supplemental measure of operating performance for REITs that excludes historical cost depreciation from net income. FFO, as defined by NAREIT, means net income attributable to common stockholders, computed in accordance with U.S. GAAP, excluding gains (or losses) from sales of real estate and impairment of depreciable assets, plus depreciation and amortization, and after adjustments for unconsolidated entities and noncontrolling interests.
Net operating income from continuing operations (“NOI”) is used to evaluate the operating performance of our properties. We define NOI as total revenues, including tenant reimbursements, less property operating expenses. Property operating expenses represent costs associated with managing, maintaining and servicing tenants for our seniors housing operating and medical facility properties. These expenses include, but are not limited to, property-related payroll and benefits, property management fees, marketing, housekeeping, food service, maintenance, utilities, property taxes and insurance. General and administrative expenses represent costs unrelated to property operations or transaction costs. These expenses include, but are not limited to, payroll and benefits, professional services, office expenses and depreciation of corporate fixed assets. Same store cash NOI (“SSCNOI”) is used to evaluate the cash-based operating performance of our properties under a consistent population which eliminates changes in the composition of our portfolio. As used herein, same store is generally defined as those revenue-generating properties in the portfolio for the reporting period subsequent to January 1, 2014. Any properties acquired, developed, transitioned, sold or classified as held for sale during that period are excluded from the same store amounts. We believe NOI and SSCNOI provide investors relevant and useful information because they measure the operating performance of our properties at the property level on an unleveraged basis. We use NOI and SSCNOI to make decisions about resource allocations and to assess the property level performance of our properties.
EBITDA stands for earnings before interest, taxes, depreciation and amortization. We believe that EBITDA, along with net income and cash flow provided from operating activities, is an important supplemental measure because it provides additional information to assess and evaluate the performance of our operations. We primarily utilize EBITDA to measure our interest coverage ratio, which represents EBITDA divided by total interest, and our fixed charge coverage ratio, which represents EBITDA divided by fixed charges. Fixed charges include total interest, secured debt principal amortization and preferred dividends.
A covenant in our primary unsecured credit facility contains a financial ratio based on a definition of EBITDA that is specific to that agreement. Failure to satisfy these covenants could result in an event of default that could have a material adverse impact on our cost and availability of capital, which could in turn have a material adverse impact on our consolidated results of operations, liquidity and/or financial condition. Due to the materiality of these debt agreements and the financial covenants, we have disclosed Adjusted EBITDA, which represents EBITDA as defined above and adjusted for stock-based compensation expense, provision for loan losses and gain/loss on extinguishment of debt. We use Adjusted EBITDA to measure our adjusted fixed charge coverage ratio, which represents Adjusted EBITDA divided by fixed charges on a trailing twelve months basis. Fixed charges include total interest (excluding capitalized interest and non-cash interest expenses), secured debt principal amortization and preferred dividends. Our covenant requires an adjusted fixed charge coverage ratio of at least 1.50 times.
Other than Adjusted EBITDA, our supplemental reporting measures and similarly entitled financial measures are widely used by investors, equity and debt analysts and rating agencies in the valuation, comparison, rating and investment recommendations of companies. Management uses these financial measures to facilitate internal and external comparisons to our historical operating results and in making operating decisions. Additionally, these measures are utilized by the Board of Directors to evaluate management. Adjusted EBITDA is used to demonstrate our compliance with a comparable financial covenant in our primary unsecured credit facility and is not being presented for use by investors for any other purpose. None of our supplemental measures represent net income or cash flow provided from operating activities as determined in accordance with U.S. GAAP and should not be considered as alternative measures of profitability or liquidity. Finally, the supplemental measures, as defined by us, may not be comparable to similarly entitled items reported by other real estate investment trusts or other companies.
The table below reflects the reconciliation of FFO to net income attributable to common stockholders, the most directly comparable U.S. GAAP measure, for the periods presented. Noncontrolling interest and unconsolidated entity amounts represent adjustments to reflect our share of depreciation and amortization. Amounts are in thousands except for per share data.
FFO Reconciliations:
208,802
205,799
222,809
(190,111)
(2,046)
(31,385)
(7,249)
(10,467)
(11,647)
(9,908)
(17,319)
Unconsolidated entities
26,496
19,791
18,146
18,062
16,604
Average common shares outstanding:
350,399
351,765
353,604
351,366
353,107
354,972
Per share data:
Net income attributable to
common stockholders
0.38
1.12
The table below reflects the reconciliation of EBITDA to net income, the most directly comparable U.S. GAAP measure, for the periods presented. Interest expense includes discontinued operations. Dollars are in thousands.
EBITDA Reconciliations:
330,459
199,257
149,416
118,861
121,130
131,097
Income tax expense (benefit)
(304)
7,417
(3,344)
2,682
(1,725)
665,539
522,842
506,004
Interest Coverage Ratio:
Non-cash interest expense
(119)
4,202
(3,791)
(2,878)
599
2,387
2,060
1,865
2,358
3,037
Total interest
123,348
125,123
119,204
130,577
136,596
Fixed Charge Coverage Ratio:
Secured debt principal payments
15,630
17,336
15,817
18,281
18,642
Preferred dividends
Total fixed charges
155,330
158,811
151,373
165,210
171,590
41
The table below reflects the reconciliation of Adjusted EBITDA to net income, the most directly comparable U.S. GAAP measure, for the periods presented. Interest expense includes discontinued operations. Dollars are in thousands.
Twelve Months Ended
Adjusted EBITDA
Reconciliations:
656,518
899,126
945,612
888,549
844,606
481,321
479,083
481,778
492,169
504,048
(3,832)
2,016
8,870
6,451
5,030
799,641
793,994
798,823
826,240
866,106
33,462
30,416
31,622
30,844
29,976
25,108
43,464
41,356
34,677
19,252
1,992,218
2,248,099
2,308,061
2,278,930
2,269,018
Adjusted Fixed Charge Coverage Ratio:
7,931
8,292
8,378
8,670
9,320
(2,215)
3,636
392
(2,586)
(1,868)
487,037
491,011
490,548
498,253
511,500
Adjusted interest coverage ratio
4.09x
4.58x
4.71x
4.57x
4.44x
62,455
63,988
65,256
67,064
70,076
65,408
65,406
614,900
620,407
621,212
630,723
646,984
Adjusted fixed charge coverage ratio
3.24x
3.62x
3.72x
3.61x
3.51x
42
The following tables reflect the reconciliation of NOI and SSCNOI to net income attributable to common stockholders, the most directly comparable U.S. GAAP measure, for the periods presented. Dollars are in thousands.
NOI Reconciliations:
Total revenues:
291,732
298,038
305,460
539,805
547,081
586,826
125,593
133,856
136,190
Non-segment/corporate
1,008
957,169
978,997
1,029,484
Property operating expenses:
360,569
368,050
399,882
37,785
40,653
38,856
Total property operating expenses
398,354
408,703
438,738
Net operating income:
179,236
179,031
186,944
87,808
93,203
97,334
(121,080)
(118,861)
(121,130)
(131,097)
(132,960)
Gain (loss) on derivatives, net
(188,829)
(208,802)
(205,799)
(222,809)
(228,696)
(35,138)
(38,474)
(36,950)
(36,854)
(45,691)
(48,554)
(12,491)
(9,333)
(40,547)
(8,208)
Gain (loss) on extinguishment of debt, net
(15,401)
(18,887)
(584)
195
(2,220)
(14,314)
Other expenses
(10,583)
(35,648)
3,344
(2,682)
(2,952)
(2,631)
(3,273)
190,111
2,046
31,385
Loss (income) attributable to noncontrolling interests
(2,271)
(1,534)
(862)
(133)
(153)
(326,917)
(246,242)
(388,251)
(457,815)
(448,445)
43
Same Store Cash NOI Reconciliations:
Net operating income from continuing operations:
291,731
298,039
186,941
97,333
517,694
558,775
570,273
589,734
Adjustments:
Non-cash NOI on same store properties
(24,500)
(25,084)
(24,845)
(23,146)
(23,276)
NOI attributable to non same store properties
(26,980)
(34,713)
(39,934)
(47,620)
(49,620)
Subtotal
(51,480)
(59,797)
(64,779)
(70,766)
(72,896)
Seniors housing operating:
251
249
248
(3,843)
(17,255)
(19,054)
(32,156)
(38,030)
(3,592)
(17,002)
(18,804)
(31,907)
(37,782)
(2,053)
(2,115)
(2,052)
(1,493)
(5,460)
(11,547)
(17,266)
(20,899)
(16,773)
(7,731)
(13,600)
(19,381)
(22,951)
(18,266)
Same store cash net operating income:
664
231,934
233,260
234,694
298
162,234
160,227
155,034
221
74,208
73,822
74,382
1,183
Same Store Cash NOI Property Reconciliation:
Total Properties
Acquisitions
(197)
Developments
(20)
Held-for-sale
(26)
Other(1)
(8)
Same store properties
(1) Includes six land parcels and two loans.
United States of America
Policy and legislative changes that increase or decrease government reimbursement impact our operators and tenants that participate in Medicare, Medicaid or other government programs. The reimbursement methodologies applied to health care facilities continue to evolve. To the extent that policy or legislative changes, or new reimbursement methodologies decrease government reimbursement to our operators and tenants, our revenue and operations may be indirectly adversely affected.
Licensing and Certification
Certain health care facilities are subject to a variety of licensure and certificate of need (“CON”) laws and regulations. Where applicable, CON laws generally require, among other requirements, that a facility demonstrate the need for (1) constructing a new facility, (2) adding beds or expanding an existing facility, (3) investing in major capital equipment or adding new services, (4)
changing the ownership or control of an existing licensed facility, or (5) terminating services that have been previously approved through the CON process. State and federal officials, increasingly including the FTC and the U.S. Justice Department, are challenging CON laws for reducing competition in the industry, creating barriers to entry and expansion, limiting consumer choice, and stifling innovation. We cannot predict whether current or future efforts to repeal or amend these state laws will be successful, nor can we predict the impact that such repeals or amendments would have on our operators or tenants and their ability to meet their obligations to us.
Reimbursement
The reimbursement methodologies applied to health care facilities continue to evolve. The Centers Medicare and Medicaid (“CMS”) have pledged to shift 50% of Medicare payments to alternate payment models by 2018 and achieved their goal of attaining 30% ahead of schedule by year end 2015. Providers increasingly are entering into value-based purchasing arrangements, which to the extent Welltower’s operators and tenants enter into such agreements, could affect their reimbursement and indirectly impact our revenues and operations. For example, the CMS recently launched the Hospital Value-Based Purchasing (“VBP”) Program, which is an initiative designed to reward acute-care hospitals with incentive payments for the quality of care they provide to Medicare beneficiaries. Similarly, other public and private payors have started considering whether to base reimbursement decisions on access, price, quality, efficiency, and alignment of incentives, rewarding higher quality healthcare providers with enhanced payments and increased market share.
On October 6, 2014, the President signed into law the Improving Medicare Post-Acute Transformation Act of 2014 (“IMPACT Act”). The law requires MedPAC to submit a report to Congress by June 30, 2016, evaluating and recommending features of a post-acute payment system that establishes payment rates according to individual characteristics instead of the post-acute setting where the patient is treated. On April 7, 2016, MedPAC announced that it had completed the report and unanimously voted to send it to Congress in June 2016 as required. According to MedPAC staff, the report provides general guidelines, rather than specific details, for developing a new cross-facility payment system, including a common unit of service, a common risk adjustment system using patient characteristics, separate models to establish payments for non-therapy ancillary services and therapy services, and two outlier policies for high-cost stays and short stays. The IMPACT Act requires MedPAC to issue another report in 2023, following CMS’s development of an actual payment prototype.
On November 3, 2015, CMS published a proposed rule that would revise the discharge planning requirements that hospitals, including long-term acute care hospitals (“LTCHs”), inpatient rehabilitation facilities (“IRFs”) and home health agencies (“HHAs”) must meet in order to participate in the Medicare and Medicaid programs. Among other things, the proposed rule would require hospitals and other facilities to evaluate patients for their discharge needs and develop specific written discharge plans for them. The proposed rule would also implement the discharge planning requirements of the IMPACT Act. Provider groups have expressed concern that the proposed rule, if implemented, could create burdensome paperwork requirements, resulting in the need to hire additional staff and necessarily expend more resources.
On February 9, 2016, President Obama released his proposed budget for FY 2017. The proposed budget would cut Medicare payments to providers by $420 billion over ten years. Among other Medicare-related changes, the President’s budget plan over ten years would: (1) reduce bad debt payments to providers by $32.9 billion, (2) reduce the payment updates for post-acute care providers by $86.6 billion, (3) raise the “60% Rule” threshold for IRFs back to 75% for reductions of $2.2 billion, and (4) implement bundled post-acute care payments for reductions of $9.9 billion. If these recommendations are adopted, we cannot predict whether they will have a material impact on our operators’ or tenants’ property or business.
On February 12, 2016, CMS published a final rule regarding the obligations of Medicare providers to report and return overpayments arising under Parts A and B. The final rule, which became effective March 14, 2016, implements § 6402(a) of the Affordable Care Act, also known as the “60-day report and return statute,” which requires providers to report and return Medicare and Medicaid overpayments within the later of (a) 60 days after the overpayment is “identified,” or (b) the date any corresponding cost report is due, if applicable. An overpayment impermissibly retained under this statute could violate the federal False Claims Act and subject providers to potential Medicare and Medicaid program exclusion and penalties under the federal Civil Monetary Penalty statute.
On March 9, 2016, CMS released skilled nursing facility (“SNF”) utilization and payment data around facility costs and services. In its press release, CMS expressed concern that the amount of therapy provided for ultra-high and very high resource utilization groups is often very close to the minimum amount of minutes needed to qualify a patient for these categories. CMS referred the issue to Recovery Auditor Contractors for further investigation. On March 30, 2016, the Department of Justice launched 10 regional Elder
45
Justice Task Forces to coordinate and enhance efforts to pursue nursing homes that provide grossly substandard care to their residents. We cannot predict the extent to which increased monitoring and auditing activities by government agencies may impact our operators.
On March 11, 2016, CMS published a proposed rule to test new models regarding Medicare Part B payments for prescription drugs. The proposal is designed to test different physician and patient incentives to drive the prescribing of the most effective drugs and test new payment approaches to reward positive patient outcomes. If this proposed rule is finalized, it may impact our operators’ and tenants’ Medicare reimbursement rates, and our revenues and operations may be indirectly affected.
On March 15, 2016, the House Energy and Commerce Committee approved the Common Sense Act of 2016, which would lower the maximum rate for Medicaid provider tax assessments from 6.0% of taxpayer revenues to 5.5%. If enacted, the bill could lower funds available for state Medicaid programs and may result in lower Medicaid rates to our operators.
On March 24, 2016, CMS announced the next phase of its Initiative to Reduce Avoidable Hospitalizations among Nursing Facility Residents. Through this new payment model, CMS will encourage healthcare practitioners to provide additional treatments for especially ill or frail nursing home residents by equalizing the payments between a comprehensive assessment given at SNFs and hospitals. Participating SNFs will also receive payment to provide additional treatment for common medical conditions that often lead to avoidable hospitalizations.
On April 1, 2016, CMS’s mandatory bundled payment program for Lower Extremity Joint Replacement (“CJR”) procedures in 67 Metropolitan Statistical Areas went into effect. This could have an effect on our SNF operators as patients are down streamed for recovery.
On April 4, 2016, CMS announced the final 2017 payment rates for Medicare Advantage, with an expected average payment increase of 0.85%. Changes in Medicare Advantage plan payments may indirectly affect our operators and tenants that contract with Medicare Advantage plans.
On April 18, 2016, CMS issued a proposed rule regarding FY 2017 Medicare payment policies and rates for LTCHs. As a result of the continuation of the phase-in of site neutral payment rates for specified cases in LTCHs, CMS projects FY 2017 Medicare payments to LTCHs would decrease by 6.9%, or approximately $355 million under the rule. Payment rates would increase by 0.3% for cases that qualify for the higher standard LTCH Prospective Payment System rate. The proposed rule would also implement a 25% threshold policy (“25% rule”), under which payment adjustments are made when the number of cases an LTCH admits from a single hospital exceeds a specified threshold (generally 25%). Finally, in response to the federal district court’s review of the “Two-Midnight” payment policy in Shands Jacksonville Medical Center, Inc., et al. v. Burwell, No. 14-263 (D.D.C.), CMS proposes to remove the 0.2% Medicare Part A hospital payment cut and also its effects for FYs 2014, 2015, and 2016 by adjusting the FY 2017 payment rates. The impact of this proposal would be to increase FY 2017 payments by approximately 0.8%.
On April 21, 2016, CMS issued proposed rules regarding FY 2017 Medicare payment policies and rates for SNFs and IRFs. Under the proposed SNF rule, CMS projects that aggregate payments to SNFs will increase by $800 million, or 2.1%, from payments in fiscal year 2016. Under the proposed IRF rule, CMS projects that aggregate payments to IRFs will increase by $125 million, or 1.6%, from payments in fiscal year 2016.
National Minimum Wage
In the July 2015 Budget the UK government announced that it would introduce the National Living Wage at a premium of 50 pence above the National Minimum Wage to take effect from April 2016. The National Minimum Wage (Amendment) Regulations 2016 came into force on April 1, 2016 (“2016 Regulations”). The 2016 Regulations amend the Regulation of the National Minimum Wage Regulations 2015 to provide a National Living Wage rate of £7.20 an hour for workers aged 25 and over. The current National Minimum Wage for adults of £6.70 will continue to apply for workers aged 21 to 24. The 2016 Regulations also amend the National Minimum Wage Act 1998 by increasing the financial penalty payable by employers who underpay the National Minimum Wage from 100% to 200% of the underpayment due to each worker. The maximum fine for non-payment will be £20,000 per worker and employers who fail to pay will be banned from being a company director for up to 15 years.
Privacy
46
In the European Union (“EU”), data protection is governed by the EU Data Protection Directive 95/46/EC (the “Data Protection Directive”). The Data Protection Directive has been implemented in the UK by the Data Protection Act 1998 (the “Act”) which entered into force on March 2000 and is enforced by the Information Commissioner’s Office (“ICO”).
There is a proposal for an EU General Data Protection Regulation which would replace the Data Protection Directive and impose a significant number of new obligations including, among others, a requirement to appoint data protection officers, having detailed documentation on the processing of personal data, carrying out privacy impact assessments in certain circumstances, providing standardized data protection notices, reporting security breaches without undue delay, and providing certain rights to individuals such as a right of erasure of personal data. The EU General Data Protection Regulation is expected to have significant enforcement powers with fines proposed by the European Commission of up to 4% of annual worldwide turnover or €20 million, whichever is greater. The EU General Data Protection Regulation will likely be adopted in May 2016 with entry into force sometime in 2018. If the regulation is adopted, we cannot predict whether it will have a material impact on our operators’ or tenants’ property or business.
Licensing and Regulation
British Columbia
The Community Care and Assisted Living Act, the Residential Care Regulation, and the Community Care and Assisted Living Regulation (together, the “B.C. Act”) regulate “community care facilities” (long-term care facilities) as premises used for the purpose of supervising vulnerable persons who require three or more prescribed services (from a list that includes regular assistance with activities of daily living; distribution of medication; management of cash resources; monitoring of food intake; structured behavior management and intervention; and psychosocial or physical rehabilitative therapy).
The B.C. Act also creates a separate regime for regulating “assisted living residences,” which are facilities providing at least one but not more than two prescribed care services. These provisions will likely be amended in May or June 2016, to define “assisted living residences” as providing “one or more” prescribed care services.
Other Legislation
In Quebec, the Safety Code was amended in December 2015 to require that private seniors’ residences be equipped with a fire alarm and detection system, as well as the installation of a sprinkler system in certain private seniors’ residences. The amendments came into force March 18, 2016, except regarding the installation of the sprinkler system, which has a five year grace period, and comes into force December 2, 2020.
Our unaudited consolidated financial statements are prepared in accordance with U.S. GAAP, which requires us to make estimates and assumptions. Management considers an accounting estimate or assumption critical if:
· the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change; and
· the impact of the estimates and assumptions on financial condition or operating performance is material.
Management has discussed the development and selection of its critical accounting policies with the Audit Committee of the Board of Directors. Management believes the current assumptions and other considerations used to estimate amounts reflected in our unaudited consolidated financial statements are appropriate and are not reasonably likely to change in the future. However, since these estimates require assumptions to be made that were uncertain at the time the estimate was made, they bear the risk of change. If actual experience differs from the assumptions and other considerations used in estimating amounts reflected in our unaudited consolidated financial statements, the resulting changes could have a material adverse effect on our consolidated results of operations, liquidity and/or financial condition. Please refer to Note 2 to the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2015 for further information regarding significant accounting policies that impact us. There have been no material changes to these policies in 2016.
This Quarterly Report on Form 10-Q may contain “forward-looking” statements as defined in the Private Securities Litigation Reform Act of 1995. When the company uses words such as “may,” “will,” “intend,” “should,” “believe,” “expect,” “anticipate,”
“project,” “estimate” or similar expressions that do not relate solely to historical matters, it is making forward-looking statements. In particular, these forward-looking statements include, but are not limited to, those relating to the company’s opportunities to acquire, develop or sell properties; the company’s ability to close its anticipated acquisitions, investments or dispositions on currently anticipated terms, or within currently anticipated timeframes; the expected performance of the company’s operators/tenants and properties; the company’s expected occupancy rates; the company’s ability to declare and to make distributions to shareholders; the company’s investment and financing opportunities and plans; the company’s continued qualification as a real estate investment trust (“REIT”); the company’s ability to access capital markets or other sources of funds; and the company’s ability to meet its earnings guidance. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties that may cause the company’s actual results to differ materially from the company’s expectations discussed in the forward-looking statements. This may be a result of various factors, including, but not limited to: the status of the economy; the status of capital markets, including availability and cost of capital; issues facing the health care industry, including compliance with, and changes to, regulations and payment policies, responding to government investigations and punitive settlements and operators’/tenants’ difficulty in cost-effectively obtaining and maintaining adequate liability and other insurance; changes in financing terms; competition within the health care and seniors housing industries; negative developments in the operating results or financial condition of operators/tenants, including, but not limited to, their ability to pay rent and repay loans; the company’s ability to transition or sell properties with profitable results; the failure to make new investments or acquisitions as and when anticipated; natural disasters and other acts of God affecting the company’s properties; the company’s ability to re-lease space at similar rates as vacancies occur; the company’s ability to timely reinvest sale proceeds at similar rates to assets sold; operator/tenant or joint venture partner bankruptcies or insolvencies; the cooperation of joint venture partners; government regulations affecting Medicare and Medicaid reimbursement rates and operational requirements; liability or contract claims by or against operators/tenants; unanticipated difficulties and/or expenditures relating to future investments or acquisitions; environmental laws affecting the company’s properties; changes in rules or practices governing the company’s financial reporting; the movement of U.S. and foreign currency exchange rates; the company’s ability to maintain its qualification as a REIT; and key management personnel recruitment and retention. Other important factors are identified in the company’s Annual Report on Form 10-K for the year ended December 31, 2015, including factors identified under the headings “Business,” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Finally, the company undertakes no obligation to update or revise publicly any forward-looking statements, whether because of new information, future events or otherwise, or to update the reasons why actual results could differ from those projected in any forward-looking statements.
We are exposed to various market risks, including the potential loss arising from adverse changes in interest rates and foreign currency exchange rates. We seek to mitigate the underlying foreign currency exposures with gains and losses on derivative contracts hedging these exposures. We seek to mitigate the effects of fluctuations in interest rates by matching the terms of new investments with new long-term fixed rate borrowings to the extent possible. We may or may not elect to use financial derivative instruments to hedge interest rate exposure. These decisions are principally based on our policy to match our variable rate investments with comparable borrowings, but are also based on the general trend in interest rates at the applicable dates and our perception of the future volatility of interest rates. This section is presented to provide a discussion of the risks associated with potential fluctuations in interest rates and foreign currency exchange rates.
We historically borrow on our primary unsecured credit facility to acquire, construct or make loans relating to health care and seniors housing properties. Then, as market conditions dictate, we will issue equity or long-term fixed rate debt to repay the borrowings under our primary unsecured credit facility. We are subject to risks associated with debt financing, including the risk that existing indebtedness may not be refinanced or that the terms of refinancing may not be as favorable as the terms of current indebtedness. The majority of our borrowings were completed under indentures or contractual agreements that limit the amount of indebtedness we may incur. Accordingly, in the event that we are unable to raise additional equity or borrow money because of these limitations, our ability to acquire additional properties may be limited.
A change in interest rates will not affect the interest expense associated with our fixed rate debt. Interest rate changes, however, will affect the fair value of our fixed rate debt. Changes in the interest rate environment upon maturity of this fixed rate debt could have an effect on our future cash flows and earnings, depending on whether the debt is replaced with other fixed rate debt, variable rate debt or equity or repaid by the sale of assets. To illustrate the impact of changes in the interest rate markets, we performed a sensitivity analysis on our fixed rate debt instruments whereby we modeled the change in net present values arising from a hypothetical 1% increase in interest rates to determine the instruments’ change in fair value. The following table summarizes the analysis performed as of the dates indicated (in thousands):
Principal
Change in
balance
fair value
8,241,326
(565,078)
7,965,107
(519,901)
2,762,776
(95,285)
2,757,123
(91,376)
11,004,102
(660,363)
10,722,230
(611,277)
Our variable rate debt, including our primary unsecured credit facility, is reflected at fair value. At March 31, 2016, we had $2,063,489,000 outstanding under our variable rate debt. Assuming no changes in outstanding balances, a 1% increase in interest rates would result in increased annual interest expense of $20,635,000. At December 31, 2015, we had $2,236,733,000 outstanding under our variable rate debt. Assuming no changes in outstanding balances, a 1% increase in interest rates would have resulted in increased annual interest expense of $22,367,000.
We are subject to currency fluctuations that may, from time to time, affect our financial condition and results of operations. Increases or decreases in the value of the Canadian Dollar or Pounds Sterling relative to the U.S. Dollar impact the amount of net income we earn from our investments in Canada and the United Kingdom. Based solely on our results for the three months ended March 31, 2016, if these exchange rates were to increase or decrease by 100 basis points, our net income from these investments would decrease or increase, as applicable, by less than $1,500,000 annualized. We seek to mitigate these underlying foreign currency exposures with non-U.S. denominated borrowings and gains and losses on derivative contracts hedging these exposures. If we increase our international presence through investments in, or acquisitions or development of, seniors housing and health care properties outside the U.S., we may also decide to transact additional business or borrow funds in currencies other than U.S. Dollars, Canadian Dollars or Pounds Sterling. To illustrate the impact of changes in foreign currency markets, we performed a sensitivity analysis on our derivative portfolio whereby we modeled the change in net present values arising from a hypothetical 1% increase in foreign currency exchange rates to determine the instruments’ change in fair value. The following table summarizes the results of the analysis performed (dollars in thousands):
Carrying
Value
Foreign currency forward contracts(1)
80,568
2,779
117,452
1,915
Debt designated as hedges
1,702,772
13,000
1,728,979
1,783,340
15,779
1,846,431
14,915
(1) Amounts exclude cross currency hedge activity.
For additional information regarding fair values of financial instruments, see “Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” and Notes 11 and 16 to our unaudited consolidated financial statements.
Item 4.Controls and Procedures
Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective in providing reasonable assurance that information required to be disclosed by us in the reports we file with or submit to the SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. No changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) occurred during the fiscal quarter covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
From time to time, there are various legal proceedings pending to which we are a party or to which some of our properties are
subject arising in the normal course of business. We do not believe that the ultimate resolution of these proceedings will have a material adverse effect on our consolidated financial position or results of operations.
There have been no material changes from the risk factors identified under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015.
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
Period
Total Number of Shares Purchased(1)
Average Price Paid Per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(2)
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
January 1, 2016 through January 31, 2016
52,060
66.00
February 1, 2016 through February 29, 2016
55,318
62.08
March 1, 2016 through March 31, 2016
456
67.14
107,834
63.99
(1) During the three months ended March 31, 2016, the company acquired shares of common stock held by employees who tendered owned shares to satisfy tax withholding obligations.
(2) No shares were purchased as part of publicly announced plans or programs.
None.
4.1 Indenture, dated as of March 15, 2010, between the company and The Bank of New York Mellon Trust Company, N.A., as trustee (the “Trustee”) (filed with the Securities and Exchange Commission as Exhibit 4.1 to the company’s Form 8-K filed March 15, 2010, and incorporated herein by reference thereto).
4.2 Supplemental Indenture No. 12, dated as of March 1, 2016, between the company and the Trustee (filed with the Securities and Exchange Commission as Exhibit 4.2 to the company’s Form 8-K filed March 3, 2016, and incorporated herein by reference thereto).
12 Statement Regarding Computation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends (Unaudited).
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1 Certification pursuant to 18 U.S.C. Section 1350 by Chief Executive Officer.
32.2 Certification pursuant to 18 U.S.C. Section 1350 by Chief Financial Officer.
101.INS XBRL Instance Document*
101.SCH XBRL Taxonomy Extension Schema Document*
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document*
101.LAB XBRL Taxonomy Extension Label Linkbase Document*
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document*
101.DEF XBRL Taxonomy Extension Definition Linkbase Document*
*
Attached as Exhibit 101 to this Quarterly Report on Form 10-Q are the following materials, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets at March 31, 2016 and December 31, 2015, (ii) the Consolidated Statements of Comprehensive Income for the three months ended March 31, 2016 and 2015, (iii) the Consolidated Statements of Equity for the three months ended March 31, 2016 and 2015, (iv) the Consolidated Statements of Cash Flows for the three months ended March 31, 2016 and 2015 and (v) the Notes to Unaudited Consolidated Financial Statements.
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: May 5, 2016
By:
/s/ THOMAS J. DEROSA
Thomas J. DeRosa,
Chief Executive Officer
(Principal Executive Officer)
/s/ SCOTT A. ESTES
Scott A. Estes,
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
/s/ PAUL D. NUNGESTER, JR.
Paul D. Nungester, Jr.,
Senior Vice President and Controller
(Principal Accounting Officer)