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, 2017
or
☐
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 28, 2017, the registrant had 366,166,605 shares of common stock outstanding.
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets — March 31, 2017 and December 31, 2016
3
Consolidated Statements of Comprehensive Income — Three months ended March 31, 2017 and 2016
4
Consolidated Statements of Equity — Three months ended March 31, 2017 and 2016
6
Consolidated Statements of Cash Flows — Three months ended March 31, 2017 and 2016
7
Notes to Unaudited Consolidated Financial Statements
8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
26
Item 3. Quantitative and Qualitative Disclosures About Market Risk
47
Item 4. Controls and Procedures
48
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 1A. Risk Factors
49
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 5. Other Information
Item 6. Exhibits
Signatures
50
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
WELLTOWER INC. AND SUBSIDIARIES
(In thousands)
March 31, 2017
December 31, 2016
(Unaudited)
(Note)
Assets:
Real estate investments:
Real property owned:
Land and land improvements
$
2,650,473
2,591,071
Buildings and improvements
24,930,472
24,496,153
Acquired lease intangibles
1,421,277
1,402,884
Real property held for sale, net of accumulated depreciation
178,260
1,044,859
Construction in progress
390,180
506,091
Gross real property owned
29,570,662
30,041,058
Less accumulated depreciation and amortization
(4,335,160)
(4,093,494)
Net real property owned
25,235,502
25,947,564
Real estate loans receivable
574,080
622,628
Less allowance for losses on loans receivable
(6,196)
(6,563)
Net real estate loans receivable
567,884
616,065
Net real estate investments
25,803,386
26,563,629
Other assets:
Investments in unconsolidated entities
416,110
457,138
Goodwill
68,321
Cash and cash equivalents
380,360
419,378
Restricted cash
42,777
187,842
Straight-line rent receivable
348,085
342,578
Receivables and other assets
708,238
826,298
Total other assets
1,963,891
2,301,555
Total assets
27,767,277
28,865,184
Liabilities and equity
Liabilities:
Borrowings under primary unsecured credit facility
522,000
645,000
Senior unsecured notes
8,188,928
8,161,619
Secured debt
2,669,787
3,477,699
Capital lease obligations
73,470
73,927
Accrued expenses and other liabilities
817,411
827,034
Total liabilities
12,271,596
13,185,279
Redeemable noncontrolling interests
385,418
398,433
Equity:
Preferred stock
718,750
1,006,250
Common stock
365,187
363,071
Capital in excess of par value
17,134,490
16,999,691
Treasury stock
(62,306)
(54,741)
Cumulative net income
5,130,593
4,803,575
Cumulative dividends
(8,474,775)
(8,144,981)
Accumulated other comprehensive income (loss)
(177,200)
(169,531)
Other equity
1,464
3,059
Total Welltower Inc. stockholders’ equity
14,636,203
14,806,393
Noncontrolling interests
474,060
475,079
Total equity
15,110,263
15,281,472
Total liabilities and equity
NOTE: The consolidated balance sheet at December 31, 2016 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,
2017
2016
Revenues:
Rental income
367,141
415,663
Resident fees and services
670,337
602,149
Interest income
20,748
25,188
Other income
4,072
4,050
Total revenues
1,062,298
1,047,050
Expenses:
Interest expense
118,597
132,960
Property operating expenses
510,169
449,636
Depreciation and amortization
228,276
228,696
General and administrative
31,101
45,691
Transaction costs
-
8,208
Loss (gain) on derivatives, net
1,224
Loss (gain) on extinguishment of debt, net
31,356
(24)
Impairment of assets
11,031
14,314
Other expenses
11,675
Total expenses
943,429
879,481
Income (loss) from continuing operations before income taxes
and income from unconsolidated entities
118,869
167,569
Income tax (expense) benefit
(2,245)
1,725
Income (loss) from unconsolidated entities
(23,106)
(3,820)
Income (loss) from continuing operations
93,518
165,474
Gain (loss) on real estate dispositions, net
244,092
Net income
337,610
Less:
Preferred stock dividends
14,379
16,352
Preferred stock redemption charge
9,769
Net income (loss) attributable to noncontrolling interests(1)
823
153
Net income (loss) attributable to common stockholders
312,639
148,969
Average number of common shares outstanding:
Basic
362,534
355,076
Diluted
364,652
356,051
Earnings per share:
Basic:
Income (loss) from continuing operations attributable to common stockholders, including real estate dispositions
0.86
0.42
Net income (loss) attributable to common stockholders*
Diluted:
Dividends declared and paid per common share
0.87
* 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
(10,569)
(7,549)
Unrealized gains (losses) on cash flow hedges
483
Unrecognized actuarial gain (loss)
2
Foreign currency translation gain (loss)
5,713
1,372
Total other comprehensive income (loss)
(4,856)
(5,692)
Total comprehensive income (loss)
332,754
159,782
Less: Total comprehensive income (loss) attributable to noncontrolling interests(1)
3,636
15,271
Total comprehensive income (loss) attributable to common stockholders
329,118
144,511
5
CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED)
Three Months Ended March 31, 2017
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)
336,787
1,780
338,567
Other comprehensive income
(7,669)
2,813
Total comprehensive income
333,711
Net change in noncontrolling interests
932
(5,612)
(4,680)
Amounts related to stock incentive plans, net of forfeitures
336
6,903
(7,565)
(1,605)
(1,931)
Proceeds from issuance of common stock
117,204
118,984
Redemption of preferred stock
(287,500)
9,760
(9,769)
(287,509)
Option compensation expense
10
Dividends paid:
Common stock dividends
(315,415)
(14,379)
Balances at end of period
Three Months Ended March 31, 2016
354,811
16,478,300
(44,372)
3,725,772
(6,846,056)
(88,243)
4,098
585,325
15,175,885
165,321
1,082
166,403
(20,810)
15,118
160,711
(5,717)
(121,325)
(127,042)
637
25,555
(6,899)
(115)
19,178
1,505
91,600
93,105
79
(305,770)
(16,352)
356,953
16,589,738
(51,271)
3,891,093
(7,168,178)
(109,053)
4,062
480,200
14,999,794
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
3,361
1,118
Stock-based compensation expense
4,906
8,186
Loss (income) from unconsolidated entities
23,106
3,820
Rental income in excess of cash received
(18,141)
(29,669)
Amortization related to above (below) market leases, net
230
Loss (gain) on sales of properties, net
(244,092)
Distributions by unconsolidated entities
474
174
Increase (decrease) in accrued expenses and other liabilities
19,478
(13,526)
Decrease (increase) in receivables and other assets
(13,071)
1,816
Net cash provided from (used in) operating activities
385,526
380,609
Investing activities:
Cash disbursed for acquisitions
(102,356)
(171,482)
Cash disbursed for capital improvements to existing properties
(42,115)
(35,025)
Cash disbursed for construction in progress
(69,334)
(66,739)
Capitalized interest
(4,129)
(3,037)
Investment in real estate loans receivable
(25,375)
(27,251)
Other investments, net of payments
48,311
(30,773)
Principal collected on real estate loans receivable
8,792
93,774
Contributions to unconsolidated entities
(13,073)
(12,784)
24,161
11,747
Proceeds from (payments on) derivatives
8,218
Decrease (increase) in restricted cash
145,065
(394)
Proceeds from sales of real property
1,087,074
Net cash provided from (used in) investing activities
1,065,239
(241,964)
Financing activities:
Net increase (decrease) under unsecured credit facilities
(123,000)
(190,000)
Proceeds from issuance of senior unsecured notes
688,560
Payments to extinguish senior unsecured notes
(400,000)
Net proceeds from the issuance of secured debt
12,536
75,136
Payments on secured debt
(822,438)
(130,343)
Net proceeds from the issuance of common stock
119,651
93,433
Payments for deferred financing costs and prepayment penalties
(36,674)
(1,217)
Contributions by noncontrolling interests(1)
2,667
126,142
Distributions to noncontrolling interests(1)
(20,014)
(76,222)
Acquisitions of noncontrolling interests
(38)
Cash distributions to stockholders
(329,794)
(322,122)
Other financing activities
(8,022)
(7,294)
Net cash provided from (used in) financing activities
(1,492,626)
(143,927)
Effect of foreign currency translation on cash and cash equivalents
2,843
323
Increase (decrease) in cash and cash equivalents
(39,018)
(4,959)
Cash and cash equivalents at beginning of period
360,908
Cash and cash equivalents at end of period
355,949
Supplemental cash flow information:
Interest paid
109,438
134,872
Income taxes paid
3,349
2,431
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 interests in properties concentrated 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. Operating results for the three months ended March 31, 2017 are not necessarily an indication of the results that may be expected for the year ending December 31, 2017. 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, 2016.
New Accounting Standards
In May 2014, the Financial Accounting Standards Board (the “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. A reporting entity may apply the new standard using either a modified retrospective approach by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption or a full retrospective approach. We are currently evaluating the impact that the adoption of the standard will have on our consolidated financial statements and have not yet determined the method by which we will adopt the new standard. A significant source of our revenue is generated through leasing arrangements, which are specifically excluded from the new standard. We expect that the new standard will affect our accounting policies related to non-lease revenue, including certain fees in our RIDEA joint ventures, common area maintenance in our outpatient medical properties and real estate sales. Under ASU 2014-09, revenue recognition for real estate sales is mainly based on the transfer of control versus current guidance of continuing involvement. We expect that the new guidance will result in more transactions qualifying as sales of real estate and being recognized at an earlier date than under the current guidance.
In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities,” which will require entities to measure their investments at fair value and recognize any changes in fair value in net income unless the investments qualify for the new practicability exception. The practicability exception will be available for equity investments that do not have readily determinable fair values. ASU 2016-01 is effective for fiscal years and interim periods within those years, beginning after December 15, 2017. We are currently evaluating the impact that the standard will have 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 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 of this standard on our consolidated financial statements. We believe that the adoption of this standard will likely have a material impact to our consolidated balance sheet for the recognition of certain operating leases as right-of-use assets and lease liabilities. We are in the process of analyzing our lease portfolio and evaluating systems to comply with the standard’s retrospective adoption requirements.
In March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting”. ASU 2016-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is permitted. We adopted ASU 2016-09 on January 1, 2017. The standard allows companies to make a policy election as to whether
they will include an estimate of awards expected to be forfeited or whether they will account for forfeitures as they occur. We have elected to account for forfeitures as they occur. This election had an immaterial impact on our consolidated financial statements. The standard also requires an employer to classify as a financing activity in the statement of cash flow the cash paid to a tax authority when shares are withheld to satisfy the employer’s statutory income tax withholding obligation. This standard is required to be applied on a retrospective basis and resulted in an increase in net cash provided by operating activities and a decrease in net cash used in financing activities of $6,897,000 for the three months ended March 31, 2016. Upon adoption, no other provisions of ASU 2016-09 had an effect on our unaudited consolidatedfinancial statements or related footnote disclosures.
In June 2016, the FASB issued ASU No. 2016-13, “Measurement of Credit Losses on Financial Instruments”. This standard requires a new forward-looking “expected loss” model to be used for receivables, held-to-maturity debt, loans, and other instruments. ASU 2016-13 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019, and early adoption is permitted for fiscal years beginning after December 15, 2018. We are currently evaluating the impact that the standard will have on our consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-01, “Clarifying the Definition of a Business”. This standard changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. ASU 2017-01 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted. A reporting entity must apply ASU 2017-01 using a prospective approach. We adopted ASU 2017-01 on January 1, 2017 and as a result, have classified our real estate acquisitions completed during the three months ended March 31, 2017 as asset acquisitions rather than business combinations due to the fact that substantially all of the fair value of the gross assets acquired were concentrated in a single asset or group of similar identifiable assets. We have recorded identifiable assets acquired, liabilities assumed and any noncontrolling interests associated with any asset acquisitions at cost on a relative fair value basis and have capitalized transaction costs incurred.
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 relative 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 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. Effective January 1, 2017, with our adoption of ASU 2017-01, transaction costs related to asset acquisitions are capitalized as a component of purchase price and all other non-capitalizable costs are reflected in “Other Expenses” on our Consolidated Statements of Comprehensive Income. 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, 2016 for information regarding our foreign currency policies.
Triple-net Activity
March 31, 2016
4,017
15,331
37,241
114,235
1,623
Total assets acquired
41,258
131,189
(809)
Total liabilities assumed
Non-cash acquisition related activity(1)
(28,621)
101,759
Construction in progress additions
46,754
43,835
(2,028)
(1,684)
Foreign currency translation
(164)
(583)
44,562
41,568
Capital improvements to existing properties
10,495
7,438
Total cash invested in real property, net of cash acquired
96,315
150,765
(1) Includes $25,691,000 related to the acquisition of assets previously financed as real estate loans receivable and $2,871,000 related to the acquisition of assets previously financed as an investment in an unconsolidated entity.
9
Seniors Housing Operating Activity
4,304
3,440
Building and improvements
44,075
48,218
1,741
1,942
74
36
Total assets acquired(1)
50,194
53,636
(2,755)
(11)
(647)
(549)
Non-cash acquisition related activity(2)
(14,148)
32,644
53,076
8,062
4,033
(1,707)
(565)
691
(1,107)
7,046
2,361
24,254
16,808
63,944
72,245
(1) Excludes $400,000 and $113,000 of cash acquired during the three months ended March 31, 2017 and 2016, respectively.
(2) Includes $6,349,000 related to the acquisition of assets previously financed as real estate loans receivable and $7,799,000 previously financed as an investment in an unconsolidated entity.
Outpatient Medical Activity
2,895
23,310
17,637
3,496
29,704
(1,250)
(990)
28,454
16,647
14,921
28,934
(717)
(788)
Accruals(1)
3,522
(5,336)
17,726
22,810
7,366
10,779
Total cash invested in real property
53,546
50,236
(1) Represents the change in non-cash consideration accruals for amounts to be paid in periods other than the period in which the construction projects converted to operations.
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:
Triple-net
157,460
Seniors housing operating
3,634
Outpatient medical
25,910
35,363
Total development projects
187,004
Total construction in progress conversions
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
1,267,280
1,252,143
Above market tenant leases
63,184
61,700
Below market ground leases
62,224
61,628
Lease commissions
28,589
27,413
Gross historical cost
Accumulated amortization
(1,010,364)
(966,714)
Net book value
410,913
436,170
Weighted-average amortization period in years
14.4
13.7
Below market tenant leases
90,745
89,468
Above market ground leases
8,107
98,852
97,575
(54,354)
(52,134)
44,498
45,441
15.1
15.2
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
304
81
Property operating expenses related to above/below market ground leases, net
(312)
(311)
Depreciation and amortization related to in place lease intangibles and lease commissions
(39,302)
(34,454)
11
The future estimated aggregate amortization of intangible assets and liabilities is as follows for the periods presented (in thousands):
Assets
Liabilities
105,454
4,959
2018
77,561
6,106
2019
37,948
5,685
2020
24,169
5,208
2021
20,191
4,720
Thereafter
145,590
17,820
5. Dispositions, Assets Held for Sale and Discontinued Operations
We periodically sell properties for various reasons, including favorable market conditions, the exercise of tenant purchase options or reduction of concentrations (e.g., property type, operator or geography). During the three months ended March 31, 2017 and 2016, we recorded impairment charges on certain held-for-sale seniors housing operating and outpatient medical 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:
808,204
13,845
Total dispositions
822,049
Net other assets/liabilities disposed
20,933
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):
16,734
5,477
1,301
851
1,855
1,362
Provision for depreciation
245
820
3,401
3,033
Income (loss) from real estate dispositions, net
13,333
2,444
12
6. Real Estate Loans Receivable
Please see Note 2 to the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016 for discussion of our accounting policies for real estate loans receivable and related interest income.
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
7,828
8,013
Draws on existing loans
17,547
19,206
32
19,238
Net cash advances on real estate loans
25,375
27,219
27,251
Receipts on real estate loans receivable:
Loan payoffs
14,474
60,500
74,974
104,068
12,290
116,358
Principal payments on loans
667
3,107
Sub-total
15,141
75,641
107,175
119,465
Less: Non-cash activity(1)(2)
(6,349)
(60,500)
(66,849)
(25,691)
Net cash receipts on real estate loans
81,484
Net cash advances (receipts) on real estate loans
16,583
(54,265)
(12,258)
(66,523)
Change in balance due to foreign currency translation
1,718
(1,987)
Net change in real estate loans receivable
11,952
(48,548)
(81,943)
(94,201)
(1) Triple-net represents acquisitions of assets previously financed as real estate loans. Please see Note 3 for additional information.
(2) Outpatient medical represents a deed in lieu of foreclosure on a previously financed first mortgage property.
In 2016, we restructured two existing real estate loans in the triple-net segment with Genesis Healthcare. The two existing loans, with a combined principal balance of $317,000,000, were scheduled to mature in 2017 and 2018. These loans were restructured into four separate loans effective October 1, 2016. Each loan has a five-year term, a 10% interest rate and 25 basis point annual escalator. In 2016, we recorded a loan loss charge in the amount of $6,935,000 on one of the loans as the present value of expected future cash flows was less than the carrying value of the loan. We expect to collect all principal amounts due under the loans and, due to the passage of time, at March 31, 2017, the allowance for loan losses related to these loans is $6,196,000. At March 31, 2017, we had no real estate loans with outstanding balances on non-accrual status and recorded no provision for loan losses during the three months ended March 31, 2017.
Balance of impaired loans at end of period
317,049
Allowance for loan losses
6,196
Balance of impaired loans not reserved
310,853
Average impaired loans for the period
340,920
Interest recognized on impaired loans(1)
8,243
(1) Represents interest recognized in period since loans were identified as impaired.
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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%
23,108
27,005
10% to 50%
360,260
407,172
43%
32,742
22,961
(1) Excludes ownership of in-substance real estate.
At March 31, 2017, the aggregate unamortized basis difference of our joint venture investments of $211,268,000 is primarily attributable to the difference between the amount for which we purchase our interest in the entity, including transaction costs, and the historical carrying value of the net assets of the entity. This difference is being 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 (“NOICO”) 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 months ended March 31, 2017, excluding our share of NOICO in unconsolidated entities (dollars in thousands):
Number of
Percent of
Concentration by relationship:(1)
Properties
NOICO
NOICO(2)
Genesis Healthcare
86
49,048
9%
Sunrise Senior Living(3)
74,893
14%
Brookdale Senior Living
137
38,372
7%
Revera(3)
98
37,802
Benchmark Senior Living
22,614
4%
Remaining portfolio
755
329,400
59%
1,277
552,129
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 in both our triple-net and seniors housing operating segments.
(2) NOICO with our top five relationships comprised 45% of total NOICO for the year ending December 31, 2016.
(3) Revera owns a controlling interest in Sunrise Senior Living.
9. Borrowings Under Credit Facilities and Related Items
At March 31, 2017, we had a primary unsecured credit facility with a consortium of 29 banks that includes a $3,000,000,000 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, in the aggregate, 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 $1,000,000,000 in alternate currencies (none outstanding at March 31, 2017). Borrowings under the unsecured revolving credit facility are subject to interest payable at the applicable margin over LIBOR interest rate (1.88% at March 31, 2017). The applicable margin is based on certain of our debt ratings and was 0.90% at March 31, 2017. 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, 2017. The term credit facilities mature on May 13, 2021. The revolving credit facility is scheduled to mature on May 13, 2020 and can be extended for two successive terms of six months each at our option.
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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
1,010,000
945,000
Average amount outstanding (total of daily
principal balances divided by days in period)
796,356
671,044
Weighted average interest rate (actual interest
expense divided by average borrowings outstanding)
1.81%
1.29%
(1) As of March 31, 2017, letters of credit in the aggregate amount of $32,456,000 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, 2017, the annual principal payments due on these debt obligations were as follows (in thousands):
Senior
Secured
Unsecured Notes(1,2)
Debt (1,3)
284,879
450,000
421,751
871,751
605,000
499,895
1,104,895
2020(4)
675,208
149,888
825,096
2021(5,6)
1,137,674
228,993
1,366,667
Thereafter(7,8,9,10)
5,416,385
1,080,071
6,496,456
8,284,267
2,665,477
10,949,744
(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 1.6% to 6.5%.
(3) Annual interest rates range from 1.32% to 7.93%. Carrying value of the properties securing the debt totaled $4,947,646,000 at March 31, 2017.
(4) 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 $225,208,000 based on the Canadian/U.S. Dollar exchange rate on March 31, 2017).
(5) On May 13, 2016, we refinanced the funding on a $250,000,000 Canadian-denominated unsecured term credit facility (approximately $187,674,000 based on the Canadian/U.S. Dollar exchange rate on March 31, 2017). The loan matures on May 13, 2021 and bears interest at the Canadian Dealer Offered Rate plus 95 basis points (1.84% at March 31, 2017).
(6) On May 13, 2016, we refinanced the funding on a $500,000,000 unsecured term credit facility. The loan matures on May 13, 2021 and bears interest at LIBOR plus 95 basis points (1.83% at March 31, 2017).
(7) On November 20, 2013, we completed the sale of £550,000,000 (approximately $689,535,000 based on the Sterling/U.S. Dollar exchange rate in effect on March 31, 2017) of 4.8% senior unsecured notes due 2028.
(8) On November 25, 2014, we completed the sale of £500,000,000 (approximately $626,850,000 based on the Sterling/U.S. Dollar exchange rate in effect on March 31, 2017) 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.
15
The following is a summary of our senior unsecured notes principal activity during the periods presented (dollars in thousands):
Weighted Avg.
Amount
Interest Rate
Beginning balance
8,260,038
4.245%
8,645,758
4.237%
Debt issued
0.000%
700,000
4.250%
Debt extinguished
3.625%
Foreign currency
24,229
4.391%
(11,665)
3.943%
Ending balance
4.262%
8,934,093
4.266%
The following is a summary of our secured debt principal activity for the periods presented (dollars in thousands):
3,465,066
4.094%
3,478,207
4.440%
2.340%
3.060%
(806,189)
5.580%
(111,701)
4.450%
Principal payments
(16,249)
4.469%
(18,642)
4.539%
10,313
3.262%
65,488
3.669%
3.744%
3,488,488
4.400%
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, 2017, 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 $3,395,000 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, 2017 and 2016, we settled certain net investment hedges generating cash proceeds of $8,218,000 and $0, respectively. The balance of the cumulative translation adjustment will be reclassified to earnings when the hedged investment is sold or substantially liquidated.
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The following presents the notional amount of derivatives and other financial instruments as of the dates indicated (in thousands):
Derivatives designated as net investment hedges:
Denominated in Canadian Dollars
875,000
900,000
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
54,000
69,000
48,000
Derivative instruments not designated:
37,000
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)
Gain (loss) on forward exchange contracts recognized in income
2,457
(1,327)
Gain (loss) on foreign exchange contracts and term loans designated as net investment hedge recognized in OCI
OCI
(44,341)
(2,739)
12. Commitments and Contingencies
At March 31, 2017, we had 14 outstanding letter of credit obligations totaling $169,961,000 and expiring between 2017 and 2024. At March 31, 2017, we had outstanding construction in progress of $390,180,000 and were committed to providing additional funds of approximately $466,031,000 to complete construction. At March 31, 2017, we had contingent purchase obligations totaling $17,058,000. These contingent purchase obligations 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 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, 2017, we had operating lease obligations of $1,092,169,000 relating to certain ground leases and company office space and capital lease obligations of $93,697,000 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, 2017, aggregate future minimum rentals to be received under these noncancelable subleases totaled $73,840,000.
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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
14,375,000
25,875,000
Outstanding shares
Common Stock, $1.00 par value:
700,000,000
365,651,576
363,576,924
364,563,653
362,602,173
Preferred Stock. The following is a summary of our preferred stock activity during the periods indicated:
Shares
Dividend Rate
6.500%
Shares redeemed
(11,500,000)
During the three months ended March 31, 2017, we recognized a charge of $9,769,000 in connection with the redemption of the Series J preferred stock.
Common Stock. The following is a summary of our common stock issuances during the three months ended March 31, 2017 and 2016 (dollars in thousands, except per share amounts):
Shares Issued
Average Price
Gross Proceeds
Net Proceeds
2016 Dividend reinvestment plan issuances
1,058,085
60.00
63,484
2016 Option exercises
9,864
21.29
210
2016 Equity shelf program issuances
443,096
67.12
30,192
29,739
2016 Stock incentive plans, net of forfeitures
484,005
2016 Totals
1,995,050
93,886
2017 Dividend reinvestment plan issuances
1,284,719
68.33
87,985
87,784
2017 Option exercises
156,675
52.71
8,258
2017 Equity shelf program issuances
338,486
69.75
23,776
23,609
2017 Stock incentive plans, net of forfeitures
181,600
2017 Totals
1,961,480
120,019
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
0.8700
315,415
0.8600
305,770
Series I Preferred Stock
0.8125
11,680
Series J Preferred Stock
0.2347
2,699
0.4064
4,672
329,794
322,122
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, 2016
(173,496)
5,120
(1,153)
(2)
Other comprehensive income before reclassification adjustments
2,900
Net current-period other comprehensive income
Balance at March 31, 2017
(170,596)
(5,449)
Balance at December 31, 2015
(85,484)
(1,343)
(1,416)
(13,746)
(21,293)
Reclassification amount to net income
483 (1)
Balance at March 31, 2016
(99,230)
(1,341)
(933)
(1) Please see Note 11 for additional information.
14. Stock Incentive Plans
Our 2016 Long-Term Incentive Plan (“2016 Plan”) authorizes up to 10,000,000 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 2016 Plan. The 2016 Plan allows for the issuance of, among other things, stock options, stock appreciation rights, 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 $4,906,000 for the three months ended March 31, 2017 and $8,186,000 for the same period in 2016.
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15. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):
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
70
101
Non-vested restricted shares
397
253
Redeemable shares
1,651
621
Dilutive potential common shares
2,118
975
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. Please see Note 2 to the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016 for additional information. 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.
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.
20
Available-for-sale Equity Investments — Available-for-sale equity investments are recorded at their fair value based on Level 1 publicly available trading prices.
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 senior unsecured notes payable was estimated based on Level 1 publicly available trading prices. The carrying amount of the 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 — 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
430,607
465,548
485,735
521,773
Other real estate loans receivable
143,473
149,151
136,893
138,050
Available-for-sale equity investments
17,330
27,899
Foreign currency forward contracts
110,439
135,561
Financial liabilities:
Borrowings under unsecured credit facilities
8,965,318
8,879,176
2,728,171
3,558,378
9,840
4,342
Redeemable OP unitholder interests
116,917
110,502
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):
21
Fair Value Measurements as of March 31, 2017
Level 1
Level 2
Level 3
Available-for-sale equity investments(1)
Foreign currency forward contracts, net(2)
100,599
234,846
217,516
(1) Unrealized gains or losses on equity investments are recorded in accumulated other comprehensive income (loss) at each measurement date.
(2) Please see Note 11 for additional information.
Items Measured at Fair Value on a Nonrecurring Basis
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. Asset impairments (if applicable, see Note 5 for impairments of real property and Note 6 for impairments of loans receivable) are also measured at fair value on a nonrecurring basis. 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 resides 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 December 31, 2016, we reclassified interest expense on our foreign-denominated senior notes from the seniors housing operating segment to non-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 are typically leased to multiple tenants and generally require a certain level of property management.
We evaluate performance based upon net operating income from continuing operations (“NOICO”) of each segment. We define NOICO as total revenues, including tenant reimbursements, less property operating expenses. We believe NOICO provides investors relevant and useful information as it measures the operating performance of our properties at the property level on an unleveraged basis. We use NOICO 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 certain 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 NOICO. 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, 2016). 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 (which excludes unconsolidated entities) is as follows (in thousands):
22
Three Months Ended March 31, 2017:
Seniors Housing Operating
Outpatient Medical
Non-segment / Corporate
227,290
139,851
20,679
69
1,766
1,461
612
233
249,735
671,867
140,463
462,425
47,744
Net operating income from continuing operations
209,442
92,719
5,511
15,816
2,291
94,979
59,608
119,737
48,931
29,084
890
1,382
5,406
5,625
5,010
1,778
360
4,527
Income (loss) from continuing operations before income taxes and income from unconsolidated entities
149,298
65,815
34,130
(130,374)
(800)
(1,087)
(335)
(23)
5,638
(29,191)(1)
447
154,136
35,537
34,242
(130,397)
231,081
13,011
385,217
48,548
9,906,585
12,646,321
4,947,544
266,827
(1) Primarily due to the recognition of goodwill and intangible asset impairments, as well as non-recurring income tax expense.
Three Months Ended March 31, 2016:
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
196,475
92,713
597,414
6,364
20,523
5,744
100,329
79,800
101,832
47,064
2,852
3,933
1,423
204,862
70,187
38,482
(145,962)
(317)
2,767
(228)
(497)
3,081
(6,935)
34
207,626
66,019
38,288
(146,459)
23
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 the periods presented (dollars in thousands):
%
United States
858,668
80.9%
842,357
80.5%
United Kingdom
93,843
8.8%
100,555
9.6%
Canada
109,787
10.3%
104,138
9.9%
100.0%
As of
22,425,964
80.8%
23,572,459
81.7%
2,835,782
10.2%
2,782,489
2,505,531
9.0%
2,510,236
8.7%
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 provision for income taxes for the three months ended March 31, 2017 and 2016, 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, 2013 and subsequent years and by state taxing authorities for the year ended December 31, 2012 and subsequent
24
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 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. Variable Interest Entities
We have entered into joint ventures to own certain seniors housing and outpatient medical assets which are deemed to be variable interest entities (“VIE”). We have concluded that we are the primary beneficiary of these VIE’s 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 VIE’s in the aggregate (in thousands):
980,570
989,596
7,390
10,501
16,530
12,102
Total assets(1)
1,004,490
1,012,199
449,163
450,255
13,880
13,803
72,957
185,556
468,490
362,585
(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.
25
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE SUMMARY
Company Overview
Business Strategy
Key Transactions in 2017
Key Performance Indicators, Trends and Uncertainties
Corporate Governance
27
28
29
31
LIQUIDITY AND CAPITAL RESOURCES
Sources and Uses of Cash
Off-Balance Sheet Arrangements
Contractual Obligations
Capital Structure
33
RESULTS OF OPERATIONS
Summary
Non-Segment/Corporate
38
41
OTHER
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, 2016, 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 concentrated 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, 2017 (dollars in thousands):
Percentage of
Type of Property
NOICO(1)
45.3%
592
37.9%
421
16.8%
264
551,896
(1) Represents net operating income from continuing operations per Note 17 of our unaudited consolidated financial statements. 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 from continuing operations 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, 2017, rental income and resident fees and services represented 35% and 63%, 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 from continuing operations 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, 2017, we had $380,360,000 of cash and cash equivalents, $42,777,000 of restricted cash and $2,445,544,000 of available borrowing capacity under our primary unsecured credit facility.
Capital. During the three months ended March 31, 2017, we extinguished $806,189,000 of secured debt at a blended average interest rate of 5.6%. In addition, we redeemed all 11,500,000 shares of our 6.5% Series J Cumulative Redeemable Preferred Stock. During the three months ended March 31, 2017, we raised $111,761,000 through our dividend reinvestment program and 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, 2017 (dollars in thousands):
Investment Amount(1)
Capitalization Rates(2)
Book Amount(3)
41,301
6.7%
1
34,200
6.1%
28,995
6.5%
104,496
6.4%
121,156
(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. The following summarizes property dispositions made during the three months ended March 31, 2017 (dollars in thousands):
Proceeds(1)
43
1,027,951
27,519
4.8%
44
1,055,470
(1) Represents pro rata proceeds received upon disposition including any seller financing.
(2) Represents annualized contractual income that was being received in cash at date of disposition divided by disposition proceeds.
(3) Represents carrying value of assets at time of disposition. See Note 5 to our unaudited consolidated financial statements for additional information.
Dividends. Our Board of Directors increased the annual cash dividend to $3.48 per common share ($0.87 per share quarterly), as compared to $3.44 per common share for 2016, beginning in February 2017. The dividend declared for the quarter ended March 31, 2017 represents the 184thconsecutive 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”) per the Statement of Comprehensive Income and net operating income from continuing operations (“NOICO”) per Note 17 to the Consolidated Financial Statements are the most appropriate earnings measures. Other useful supplemental measures of our operating performance include funds from operations attributable to common stockholders (“FFO”) and same store NOI (“SSNOI”); 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 and SSNOI. These earnings measures (and FFO 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,
195,474
334,910
333,042
Funds from operations attributable to common stockholders
391,264
416,974
401,870
372,829
306,231
617,825
605,453
583,486
552,128
Same store net operating income
469,784
485,091
472,347
469,928
468,590
Per share data (fully diluted):
0.54
0.93
0.91
1.10
1.16
1.11
1.02
0.84
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, net of cash and IRC section 1031 deposits. 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”). Please refer to the section entitled “Non-GAAP Financial Measures” for further discussion and reconciliations of these 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:
March, 31
Net debt to book capitalization ratio
45%
42%
Net debt to undepreciated book
capitalization ratio
40%
39%
37%
36%
Net debt to market capitalization ratio
32%
30%
31%
29%
Interest coverage ratio
3.85x
4.21x
5.24x
5.26x
5.67x
Fixed charge coverage ratio
3.06x
3.34x
4.17x
4.15x
4.53x
Concentration Risk. We evaluate our concentration risk in terms of NOICO by property mix, relationship mix and geographic mix. Concentration risk is a valuable measure in understanding what portion of our NOICO could be at risk if certain sectors were to experience downturns. Property mix measures the portion of our NOICO that relates to our various property types. Relationship mix measures the portion of our NOICO that relates to our top five relationships. Geographic mix measures the portion of our NOICO that relates to our top five states (or international equivalents). The following table reflects our recent historical trends of concentration risk by NOICO for the periods indicated below:
Property mix:(1)
52%
50%
51%
48%
34%
33%
38%
16%
17%
Relationship mix:(1)
Sunrise Senior Living(2)
13%
12%
Revera(2)
6%
Remaining relationships
53%
55%
56%
Geographic mix:(1)
California
10%
8%
New Jersey
Texas
Remaining geographic areas
61%
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, 2017 (dollars in thousands):
30
Expiration Year
2022
2023
2024
2025
2026
Triple-net:
51
61
406
Base rent(1)
37,120
17,740
25,239
8,784
4,175
11,076
73,478
64,327
701,046
% of base rent
0.0%
3.9%
1.9%
2.7%
0.9%
0.4%
1.2%
7.8%
6.8%
74.3%
Units/beds
3,151
1,225
2,289
810
317
762
4,538
3,724
41,529
% of Units/beds
5.4%
2.1%
1.4%
0.5%
1.3%
71.2%
Outpatient medical:
Square feet
899,397
999,677
1,189,481
1,205,331
1,465,953
2,381,966
1,197,716
1,392,959
690,769
1,063,903
3,979,627
22,866
25,911
31,568
31,876
39,422
51,176
30,197
38,992
19,586
27,377
90,952
5.6%
6.3%
7.7%
12.5%
7.4%
9.5%
22.1%
Leases
242
275
305
276
252
177
109
96
118
151
% of Leases
10.7%
12.1%
13.5%
12.2%
11.7%
11.1%
4.2%
5.2%
(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 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, 2016, 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
58,470
Cash provided from (used in) operating activities
4,917
1%
Cash provided from (used in) investing activities
1,307,203
n/a
Cash provided from (used in) financing activities
(1,348,699)
937%
Effect of foreign currency translation
2,520
780%
24,411
Operating Activities. The change in net cash provided from operating activities was immaterial. Please see “Results of Operations” for discussion of net income fluctuations. For the three months ended March 31, 2017 and 2016, 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 an increase in dispositions, which are summarized above in “Key Transactions in 2017” and Notes 5 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
69,334
66,739
2,595
Recurring capital expenditures, tenant improvements and lease commissions
13,834
12,265
1,569
Renovations, redevelopments and other capital improvements
28,281
22,760
5,521
24%
111,449
101,764
9,685
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/redemption 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, 2017, we had investments in unconsolidated entities with our ownership 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, 2017, we had 14 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, 2017 (in thousands):
Payments Due by Period
2018-2019
2020-2021
Unsecured revolving credit facility(1)
Senior unsecured notes and term credit facilities:(2)
U.S. Dollar senior unsecured notes
6,050,000
4,100,000
Canadian Dollar senior unsecured notes(3)
225,208
Pounds Sterling senior unsecured notes(3)
1,316,385
U.S. Dollar term credit facility
505,000
5,000
500,000
Canadian Dollar term credit facility(3)
187,674
Secured debt:(2,3)
Consolidated
921,646
378,881
Unconsolidated
683,574
21,195
156,839
45,426
460,114
Contractual interest obligations:(4)
Unsecured revolving credit facility
49,683
7,845
20,919
Senior unsecured notes and term loans(3)
3,330,186
281,365
689,321
580,751
1,778,749
Consolidated secured debt(3)
526,087
73,890
159,552
110,453
182,192
Unconsolidated secured debt(3)
161,651
19,443
50,734
34,700
56,774
Capital lease obligations(5)
93,697
4,592
9,012
8,346
71,747
Operating lease obligations(5)
1,092,169
12,818
34,485
33,629
1,011,237
Purchase obligations(5)
483,089
360,773
122,316
Other long-term liabilities(6)
3,810
1,106
2,704
Total contractual obligations
17,895,690
1,067,906
3,222,528
3,547,987
10,057,269
(1) Relates to unsecured revolving credit facility with an aggregate commitment of $3,000,000,000. 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.
Please refer to “Credit Strength” above for a discussion of our leverage and coverage ratio trends. Our debt agreements contain various covenants, restrictions and events of default. Certain agreements require us to maintain 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, 2017, 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 (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 (“DRIP”) under which we may issue up to 15,000,000 shares of common stock. As of April 28, 2017, 5,893,662 shares of common stock remained available for issuance under the DRIP registration statement. We have entered into separate Equity Distribution Agreements with each of Morgan Stanley & Co. LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Goldman, Sachs & Co., UBS Securities LLC and Wells Fargo Securities, LLC relating to the offer and sale from time to time of up to $1,000,000,000 aggregate amount of our common stock (“Equity Shelf Program”). As of April 28, 2017, we had $903,411,000 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, 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 NOICO and SSNOI, 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):
163,670
110%
(85,033)
-22%
EBITDA
686,728
525,405
161,323
Net operating income from continuing operations (NOICO)
(45,285)
-8%
Same store NOI
(1,194)
0%
0.44
105%
(0.26)
-24%
1.82x
47%
1.47x
The following is a summary of our NOICO and SSNOI for the triple-net segment (dollars in thousands):
(58,433)
-19%
Non SSNOI attributable to same store properties
(13,253)
(16,181)
2,928
-18%
NOICO attributable to non same store properties(1)
(46,995)
(105,327)
58,332
-55%
SSNOI(2)
189,487
186,660
2,827
2%
(1) Change is primarily due to the acquisition of 14 properties and the conversion of 23 construction projects into revenue-generating properties subsequent to January 1, 2016 and 211 properties disposed or held for sale.
(2) Relates to 538 same store properties.
The following is a summary of our results of operations for the triple-net segment (dollars in thousands):
(56,535)
-20%
(2,174)
-10%
19%
Net operating income from continuing operations (NOICO)(1)
Other expenses:
(853)
-13%
(20,192)
-25%
Transaction costs(2)
(2,852)
-100%
29,108
(14,314)
Other expenses(2)
Total other expenses
100,437
103,306
(2,869)
-3%
Income from continuing operations before income taxes and income (loss) from unconsolidated entities
(55,564)
-27%
Income tax benefit (expense)
152%
2,557
83%
Income from continuing operations
(53,490)
-26%
Gain (loss) on real estate dispositions, net(3)
177,591
86%
Less: Net income (loss) attributable to noncontrolling interests
603
(342)
945
Net income attributable to common stockholders
384,614
207,968
176,646
85%
(1) See Note 17 to our unaudited consolidated financial statements.
(2) See Note 2 to our unaudited consolidated financial statements.
(3) See Note 5 to our unaudited consolidated financial statements.
The decrease in rental income is attributable to the disposition of properties exceeding new acquisitions. 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 For the three months ended March 31, 2017, we had one lease renewal and 25 leases with rental rate increasers ranging from 0.13% to 0.41% in our triple-net portfolio. The decrease in interest income is directly related to the volume of loan payoffs during 2016 and 2017.
Depreciation and amortization decreased as a result of the disposition of 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.
During the three months ended March 31, 2016, 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. Changes in the gain on sales of properties are related to the volume of property sales and the sales prices.
During the three months ended March 31, 2017, we completed five triple-net construction projects totaling $157,460,000 or $257,290 per bed/unit. The following is a summary of triple-net construction projects pending as of March 31, 2017 (dollars in thousands):
35
Units/Beds
Commitment
Balance
Est. Completion
Raleigh, NC
60
23,925
16,415
2Q17
Livingston, NJ
120
53,440
46,048
Piscataway, NJ
124
40,800
38,190
Bracknell, UK
64
15,825
12,213
Alexandria, VA
116
60,156
23,549
2Q18
Exton, PA
34,175
5,939
604
228,321
142,354
Interest expense for the three months ended March 31, 2017 and 2016 represents secured debt interest expense and related fees. The change in interest expense is due to the net effect and timing of assumptions, segment transitions, fluctuations in foreign currency rates, extinguishments and principal amortizations. The fluctuation in losses/gains on debt extinguishment is attributable to the large volume of extinguishments in the first quarter of 2017. The following is a summary of our triple-net secured debt principal activity (dollars in thousands):
Wtd. Avg.
594,199
4.580%
554,014
5.488%
(255,553)
5.923%
(33,919)
5.895%
3,155
2.751%
5,291
5.315%
(2,531)
5.790%
(2,987)
5.587%
339,270
3.549%
522,399
5.467%
Monthly averages
531,647
4.441%
540,554
5.482%
A portion of our triple-net properties were formed through partnerships. Income or loss from unconsolidated entities represents our share of net income or losses from partnerships where we are the noncontrolling partner. Net income attributable to noncontrolling interest represents our partners’ share of net income relating to those partnerships where we are the controlling partner.
The following is a summary of our NOICO and SSNOI for the seniors housing operating segment (dollars in thousands):
12,967
231
248
(17)
-7%
(17,109)
99
(17,208)
-17382%
192,564
196,822
(4,258)
-2%
(1) Change is primarily due to the acquisition of 41 properties subsequent to January 1, 2016.
(2) Relates to 376 same store properties.
The following is a summary of our seniors housing operating results of operations (dollars in thousands):
68,188
11%
(962)
-93%
(728)
-33%
66,498
53,531
(4,707)
-23%
17,905
18%
(3,933)
143,627
126,288
17,339
Income (loss) from continuing operations before income taxes and income (loss) from unconsolidated entities
(4,372)
-6%
(3,854)
(29,191)
(22,256)
321%
(30,482)
-46%
(17,471)
(590)
(950)
49,138
65,659
(16,521)
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, 2017, we recorded an impairment charge related to one held-for-sale property for which the fair value less costs to sell exceeded our carrying value. During the three month period ended March 31, 2017, we recorded a gain on sale related to the sale of one property previously classified as held-for-sale.
During the three month period ended March 31, 2017, we completed one seniors housing construction project representing $3,634,000 or $302,833 per unit. The following is a summary of our seniors housing operating construction projects, excluding expansions, pending as of March 31, 2017 (dollars in thousands):
37
Units
Chertsey, UK
94
39,115
22,504
1Q18
Bushey, UK
95
51,088
19,851
189
90,203
42,355
New York, NY
Project in planning stage
129,327
171,682
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 seniors housing operating property secured debt principal activity (dollars in thousands):
2,463,249
3.936%
2,290,552
3.958%
3.063%
(438,532)
5.301%
(58,533)
3.037%
7,158
3.488%
60,197
3.524%
(11,259)
3.733%
(12,170)
3.959%
2,033,152
3.663%
2,355,182
3.980%
2,162,185
3.729%
2,306,203
3.976%
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 the recognition of goodwill and intangible asset impairments as well as non-recurring income tax expense adjustments related to our investments in unconsolidated entities during the three month period ended March 31, 2017.
The following is a summary of our NOICO and SSNOI for the outpatient medical segment (dollars in thousands):
Non SSNOI on same store properties
(2,214)
(2,373)
159
(3,966)
(4,038)
72
86,539
86,302
237
(1) Change is primarily due to acquisitions of five properties and conversions of construction projects into seven revenue-generating properties subsequent to January 1, 2016.
(2) Relates to 235 same store properties.
The following is a summary of our results of operations for the outpatient medical segment (dollars in thousands):
(1,304)
299
96%
7,008
5%
7,002
(3,453)
-60%
1,867
(1,423)
58,589
54,231
4,358
Income from continuing operations before income taxes and income from unconsolidated entities
(4,352)
-11%
(107)
Income from unconsolidated entities
413
1215%
(4,046)
135
675
500%
33,432
38,153
(4,721)
-12%
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, 2017, our consolidated outpatient medical portfolio signed 93,623 square feet of new leases and 163,472 square feet of renewals. The weighted-average term of these leases was six years, with a rate of $36.86 per square foot and tenant improvement and lease commission costs of $21.36 per square foot. Substantially all of these leases during the referenced quarter contain an annual fixed or contingent escalation rent structure ranging from 0% to 5%.
The fluctuation in property operating expenses is primarily attributable to acquisitions and construction conversions of new outpatient medical facilities for which we incur certain property operating expenses. 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 months ended March 31, 2017, we recorded impairment charges related to certain held-for-sale properties for which the fair values less estimated costs to sell exceeded our carrying values.
39
During the three months ended March 31, 2017, we completed two outpatient medical construction projects representing $25,910,000 or $259 per square foot. The following is a summary of the outpatient medical construction projects, excluding expansions, pending as of March 31, 2017 (dollars in thousands):
Square Feet
Timmonium, MD
46,000
20,996
13,118
3Q17
Howell, MI
56,211
15,509
10,827
Brooklyn, NY
140,955
103,624
43,236
243,166
140,129
67,181
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 fluctuation in losses/gains on debt extinguishment is attributable to the large volume of extinguishments in the first quarter of 2017. The following is a summary of our outpatient medical secured debt principal activity (dollars in thousands):
404,079
4.846%
627,689
5.177%
(112,104)
5.889%
(19,187)
6.196%
(2,151)
6.491%
(3,142)
5.671%
289,824
4.509%
605,360
5.218%
332,085
4.664%
619,350
5.237%
A portion of our outpatient medical properties were formed through partnerships. Income or loss from unconsolidated entities represents our share of net income or losses related to certain unconsolidated property investments. Net income attributable to noncontrolling interests represents our partners’ share of net income relating to those partnerships where we are the controlling partner.
40
The following is a summary of our results of operations for the non-segment/corporate activities (dollars in thousands):
175
302%
(5,350)
-5%
(14,590)
-32%
130,607
146,020
(15,413)
Loss from continuing operations before income taxes
15,588
-95%
Loss from continuing operations
16,062
Less: Preferred stock dividends
(1,973)
Less: Preferred stock redemption charge
Net loss attributable to common stockholders
(154,545)
(162,811)
8,266
The following is a summary of our non-segment/corporate interest expense (dollars in thousands):
86,591
93,534
(6,943)
97
(37)
-38%
Primary unsecured credit facility
5,037
3,709
1,328
Loan expense
3,291
2,989
302
The change in interest expense on senior unsecured notes is due to the net effect of issuances and extinguishments. The decrease in interest expense is attributed primarily to the $450,000,000 of 4.70% senior unsecured notes extinguished in December 2016. 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, 2017 and 2016 were 2.93% and 4.36%, respectively. The decrease in general and administrative expenses for the three months ended March 31, 2017 is primarily related to a reduction in professional service fees for tax and legal consulting and compensation costs as a result of execution of our strategic initiatives. Other expenses for the three months ended March 31, 2017 included costs associated with the departure of certain executive officers and key employees.
Non-GAAP Financial Measures
We believe that net operating income from continuing operations (“NOICO”), net income and net income attributable to common stockholders (“NICS”), as defined by U.S. GAAP, are the most appropriate earnings measurements. However, we consider FFO, SSNOI, EBITDA and Adjusted 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 funds from operations attributable to common stockholders (“FFO”) as a supplemental measure of operating performance for REITs that excludes historical cost depreciation from net income. FFO, as defined by NAREIT, means NICS, 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.
As discussed in Note 17 to our unaudited consolidated financial statements, NOICO is used to evaluate the operating performance of our properties. We define NOICO 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 NOI (“SSNOI”) is used to evaluate the 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, 2016. Land parcels, loans and sub-leases as well as any properties acquired, developed/redeveloped, transitioned, sold or classified as held for sale during that period are excluded from the same store amounts. We believe NOICO and SSNOI 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 NOICO and SSNOI to make decisions about resource allocations and to assess the property level performance of our properties.
EBITDA stands for earnings (net income) 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. Covenants in our senior unsecured notes contain a financial ratios based on a definition of EBITDA that is specific to those agreements. 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 excluding unconsolidated entities and adjusted for items per our covenant. 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.
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. 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.
42
The following table reflects the reconciliation of SSNOI to NOICO, the most directly comparable U.S. GAAP measure, for the periods presented. Dollars are in thousands.
SSNOI Reconciliations:
NOICO:
310,311
310,864
279,516
207,255
199,495
210,895
99,805
94,905
92,841
597,356
617,371
605,264
583,252
Adjustments:
(14,399)
(14,251)
(14,138)
NOICO attributable to non same store properties
(106,242)
(107,491)
(76,528)
Subtotal
(121,508)
(120,641)
(121,742)
(90,666)
(60,248)
Seniors housing operating:
1,269
71
(4,532)
(17,908)
347
(3,263)
(17,677)
(16,878)
(2,611)
(2,636)
(1,974)
(9,341)
(5,276)
(3,007)
(6,411)
(11,952)
(7,912)
(4,981)
(6,180)
SSNOI:
538
189,670
189,122
188,850
376
207,568
196,232
193,218
235
87,853
86,993
87,860
1,149
SSNOI Property Reconciliation:
Total properties
Acquisitions
(60)
Developments
(34)
Held-for-sale
Segment transitions
Other(1)
(8)
Same store properties
(1) Includes eight land parcels.
The table below reflects the reconciliation of FFO to NICS, 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:
NICS
226,569
218,061
227,916
9,705
13,187
(1,530)
(162,351)
(200,165)
(17,319)
(20,616)
(15,695)
(17,897)
(18,107)
Unconsolidated entities
16,604
17,077
17,240
16,746
16,484
FFO
Average common shares outstanding:
356,646
358,932
362,088
358,891
361,237
364,369
Per share data:
0.55
0.92
1.17
1.12
1.03
The table below reflects the reconciliation of EBITDA to net income, the most directly comparable U.S. GAAP measure, for the periods presented. Dollars are in thousands.
EBITDA Reconciliations:
210,749
354,741
351,108
132,326
129,699
126,360
Income tax expense (benefit)
(1,725)
(513)
(305)
(16,585)
2,245
569,131
702,196
688,799
Interest Coverage Ratio:
Non-cash interest expense
599
(1,519)
(543)
(216)
(1,679)
3,037
4,306
4,766
4,834
4,129
Total interest
136,596
135,113
133,922
130,978
121,047
Fixed Charge Coverage Ratio:
Secured debt principal payments
18,642
19,096
18,151
18,577
16,249
Preferred dividends
Total fixed charges
171,590
170,561
168,425
165,907
151,675
The table below reflects the reconciliation of Adjusted EBITDA to net income, the most directly comparable U.S. GAAP measure, for the periods presented. Dollars are in thousands.
Twelve Months Ended
Adjusted EBITDA
Reconciliations:
844,606
724,894
880,380
1,082,070
1,254,208
504,048
517,512
526,082
521,345
506,982
5,030
(2,899)
139
(19,128)
(15,158)
866,106
883,873
896,135
901,242
900,822
2,219,790
2,123,380
2,302,736
2,485,529
2,646,854
12,676
11,682
10,801
10,357
29,643
70,579
63,245
73,754
42,910
34,702
29,976
25,883
25,807
28,869
25,588
19,252
398
(186)
17,214
48,593
Losses/impairments (gain) on sale of properties, net
(209,228)
(20,647)
(171,246)
(326,839)
(574,216)
Provision for loan losses
10,215
(2,516)
(2,448)
(1,225)
40,636
37,386
7,721
19,396
Additional other income
(2,144)
(13,955)
(11,811)
(16,664)
2,181,537
2,227,372
2,264,725
2,256,864
2,222,886
Adjusted Fixed Charge Coverage Ratio:
9,320
11,566
14,467
16,943
18,035
(1,868)
(7,589)
(4,341)
(1,681)
(3,958)
511,500
521,489
536,208
536,607
521,059
Adjusted interest coverage ratio
4.26x
4.27x
4.22x
70,076
71,836
74,170
74,466
72,073
65,408
65,407
65,406
63,434
646,984
658,733
675,785
676,479
656,566
Adjusted fixed charge coverage ratio
3.37x
3.38x
3.35x
3.39x
Our leverage ratios include book capitalization, undepreciated book capitalization and market capitalization. Book capitalization represents the sum of net debt (defined as total long-term debt less cash and cash equivalents and any IRC section 1031 deposits), total equity and redeemable noncontrolling interests. Undepreciated book capitalization represents book capitalization adjusted for accumulated depreciation and amortization. Market capitalization represents book capitalization adjusted for the fair market value of our common stock. Our leverage ratios are defined as the proportion of net debt to total capitalization. The table below reflects the reconciliation of our leverage ratios to our balance sheets for the periods presented. Dollars are in thousands.
45
Book capitalization:
745,000
1,350,000
Long-term debt obligations(1)
12,418,198
12,228,727
12,080,888
11,713,245
10,932,185
Cash & cash equivalents(2)
(355,949)
(466,585)
(456,420)
(557,659)
(380,360)
Total net debt
12,707,249
12,507,142
12,974,468
11,800,586
11,073,825
14,868,568
15,264,238
Redeemable noncontrolling interest
359,656
394,126
393,530
Book capitalization
28,066,699
27,769,836
28,632,236
27,480,491
26,569,506
Undepreciated book capitalization:
Accumulated depreciation and amortization
4,032,726
4,109,585
4,243,038
4,093,494
4,335,160
Undepreciated book capitalization
32,099,425
31,879,421
32,875,274
31,573,985
30,904,666
Net debt to undepreciated book capitalization ratio
Market capitalization:
Common shares outstanding
356,773
357,690
362,425
362,602
364,564
Period end share price
69.34
76.17
74.77
66.93
70.82
Common equity market capitalization
24,738,620
27,245,247
27,098,517
24,268,952
25,818,422
839,856
869,320
867,923
873,512
859,478
Enterprise value
39,291,975
41,627,959
41,947,158
37,949,300
38,470,475
(1) Amounts include senior unsecured notes, secured debt and capital lease obligations as reflected on our consolidated balance sheet.
(2) Inclusive of IRC section 1031 deposits, if any.
Critical Accounting Policies
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, 2016 for further information regarding significant accounting policies that impact us. There have been no material changes to these policies in 2017.
46
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, 2016, 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
7,591,593
(517,480)
7,568,832
(521,203)
1,731,448
(60,509)
2,489,276
(73,944)
9,323,041
(577,989)
10,058,108
(595,147)
Our variable rate debt, including our primary unsecured credit facility, is reflected at fair value. At March 31, 2017, we had $2,148,703,000 outstanding related to our variable rate debt. Assuming no changes in outstanding balances, a 1% increase in interest rates would result in increased annual interest expense of $21,487,000. At December 31, 2016, we had $2,311,996,000 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 $23,120,000.
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, 2017, including the impact of existing hedging arrangements, if these exchange rates were to increase or decrease by 10%, our net income from these investments would increase or decrease, as applicable, by less than $1,500,000. We will continue to mitigate these underlying foreign currency exposures with non-U.S. denominated borrowings and gains and losses on derivative contracts. 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, excluding cross currency hedging activity (dollars in thousands):
Carrying
Value
Foreign currency forward contracts(1)
101,116
14,491
87,962
722
Debt designated as hedges
1,504,059
15,041
1,481,591
13,000
1,605,175
29,532
1,569,553
13,722
(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 against us that arise in the ordinary course of our business.
Management does not believe that the resolution of any of these legal proceedings either individually or in the aggregate will have a material adverse effect on our business, results of operations or financial condition. Despite management’s view of the ultimate resolution of these legal proceedings, we may have significant legal expenses and costs associated with the defense of such matters. Further, management cannot predict the outcome of these legal proceedings and if management’s expectation regarding such matters is not correct, such proceedings could have a material adverse effect on our business, results of operations or financial condition.
From time to time, we are party to certain legal proceedings for which third parties, such as tenants, operators and/or managers, are contractually obligated to indemnify, defend and hold us harmless. In some of these matters, the indemnitors have insurance for the potential damages. In other matters, we are being defended by tenants and other obligated third parties and these indemnitors may not have sufficient insurance, assets, income or resources to satisfy their defense and indemnification obligations to us. The unfavorable resolution of such legal proceedings could, individually or in the aggregate, materially adversely affect the indemnitors’ ability to satisfy their respective obligations to us, which, in turn, could have a material adverse effect on our business, results of operations or financial condition. It is management’s opinion that there are currently no such legal proceedings pending that will, individually or in the aggregate, have such a material adverse effect.
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, 2016.
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, 2017 through January 31, 2017
101,340
66.51
February 1, 2017 through February 28, 2017
11,222
70.38
March 1 2017 through March 31, 2017
610
69.14
113,172
66.90
(1) During the three months ended March 31, 2017, 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.
10.1 Amended and Restated Employment Agreement, dated January 3, 2017, between the company and Thomas J. DeRosa (filed with the Securities and Exchange Commission as Exhibit 10.4(a) to the company’s Form 10-K filed February 22, 2017 (File No. 001-08923), and incorporated herein by reference thereto).*
10.2 Executive Retirement Agreement, dated as of February 10, 2017, by and between Jeffrey H. Miller and the company (filed with the Securities and Exchange Commission as Exhibit 10.8 to the company’s Form 10-K filed February 22, 2017 (File No. 001-08923), and incorporated herein by reference thereto).*
10.3 Separation Agreement, dated as of February 6, 2017, by and between Scott M. Brinker and the company (filed with the Securities and Exchange Commission as Exhibit 10.10 to the company’s Form 10-K filed February 22, 2017 (File No. 001-08923), and incorporated herein by reference thereto).*
10.4 Welltower Inc. 2017-2019 Long-Term Incentive Program.*
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**
*
**
Management Contract or Compensatory Plan or Arrangement
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, 2017 and December 31, 2016, (ii) the Consolidated Statements of Comprehensive Income for the three months ended March 31, 2017 and 2016, (iii) the Consolidated Statements of Equity for the three months ended March 31, 2017 and 2016, (iv) the Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016 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, 2017
By:
/s/ THOMAS J. DEROSA
Thomas J. DeRosa,
Chief Executive Officer
(Principal Executive Officer)
/s/ SCOTT A. ESTES
Scott A. Estes,
Executive Vice President - Chief Financial Officer
(Principal Financial Officer)
/s/ PAUL D. NUNGESTER, JR.
Paul D. Nungester, Jr.,
Senior Vice President & Controller
(Principal Accounting Officer)