UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
---
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 1998
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: 1-11852
________________________
HEALTHCARE REALTY TRUST INCORPORATED
(Exact name of Registrant as specified in its charter)
Maryland 62 1507028
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3310 West End Avenue
Suite 700
Nashville, Tennessee 37203
(Address of principal executive offices)
(615) 269-8175
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports 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 Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
--- ---
As of November 1, 1998, 39,775,629 shares of the Registrant's Common Stock,
$.01 par value, were outstanding.
HEALTHCARE REALTY TRUST
INCORPORATED
FORM 10-Q
September 30, 1998
TABLE OF CONTENTS
Part I - Financial Information
Item 1. Financial Statements Page
Condensed Consolidated Balance Sheets 1
Condensed Consolidated Statements of Income 2
Condensed Consolidated Statements of Cash Flows 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Managemen's Discussion and Analysis of Financial Condition
and Results of Operations 13
Part II - Other Information
Item 6. Reports on Form 8-K 22
Signature 23
1
Item 1.
Healthcare Realty Trust Incorporated
Condensed Consolidated Balance Sheets
(Dollars in thousands)
(Unaudited) (1)
ASSETS Sept 30, 1998 Dec. 31, 1997
- - ------ ------------- -------------
Real estate properties:
Land $62,046 $58,424
Buildings and improvements 504,054 423,618
Personal property 4,592 4,492
Construction in progress 10,996 19,165
------ ------
581,688 505,699
Less accumulated depreciation (43,728) (34,718)
------- -------
Total real estate properties, net 537,960 470,981
Cash and cash equivalents 2,368 5,325
Other assets, net 34,248 12,208
------ ------
Total assets $574,576 $488,514
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Notes payable $156,600 $101,300
Accounts payable and accrued liabilities 9,103 6,879
Other liabilities 4,101 3,863
Minority interest 0 0
Commitments and contingencies 0 0
- -
Total liabilities 169,804 112,042
------- -------
Stockholders' equity:
Preferred stock, $.01 par value; 50,000,000 shares
authorized; none outstanding 0 0
Common stock, $.01 par value; 150,000,000 shares authorized; 20,868,720
issued and outstanding at Sept 30, 1998 and 19,285,927 at
Dec. 31, 1997 209 193
Additional paid-in capital 444,617 402,607
Deferred compensation (11,022) (7,689)
Cumulative net income 109,904 88,867
Cumulative dividends (138,936) (107,506)
-------- --------
Total stockholders' equity 404,772 376,472
------- -------
Total liabilities and stockholders' equity $574,576 $488,514
======== ========
(1) The balance sheet at Dec. 31, 1997 has been derived from audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
(The accompanying notes, together with the Notes to the Consolidated
Financial Statements, included in the Company's Annual Report on Form 10-K for
the year ended December 31, 1997, are an integral part of these financial
statements.)
2
Healthcare Realty Trust Incorporated
Condensed Consolidated Statements of Income
For the Three Months Ended September 30, 1998 and 1997
(Unaudited)
(Dollars in thousands, except per share data)
1998 1997
---- ----
REVENUES:
Master lease rental income $8,770 $9,536
Property operating income 8,372 5,116
Management fees 425 382
Interest and other income 758 831
--- ---
18,325 15,865
------ ------
EXPENSES:
General and administrative 7,216 922
Property operating expenses 2,852 1,726
Interest 1,951 1,939
Depreciation 3,172 2,874
Amortization 84 76
-- --
15,275 7,537
------ -----
NET INCOME $3,050 $8,328
====== ======
NET INCOME PER SHARE - BASIC $0.15 $0.44
===== =====
NET INCOME PER SHARE - DILUTED $0.15 $0.43
===== =====
SHARES OUTSTANDING - BASIC 20,333,500 18,883,433
========== ==========
SHARES OUTSTANDING - DILUTED 20,773,400 19,234,675
========== ==========
(The accompanying notes, together with the Notes to the Consolidated
Financial Statements, included in the Company's Annual Report on Form 10-K for
the year ended December 31, 1997, are an integral part of these financial
statements.)
3
Healthcare Realty Trust Incorporated
Condensed Consolidated Statements of Income
For the Nine Months Ended September 30, 1998 and 1997
(Unaudited)
(Dollars in thousands, except per share data)
1998 1997
---- ----
REVENUES:
Master lease rental income $27,025 $30,164
Property operating income 23,341 9,495
Management fees 1,357 1,004
Interest and other income 1,665 2,309
----- -----
53,388 42,972
------ ------
EXPENSES:
General and administrative 9,714 2,396
Property operating expenses 7,586 3,005
Interest 5,406 6,106
Depreciation 9,392 8,372
Amortization 253 257
--- ---
32,351 20,136
------ ------
NET INCOME $21,037 $22,836
======= =======
NET INCOME PER SHARE - BASIC $1.05 $1.27
===== =====
NET INCOME PER SHARE - DILUTED $1.03 $1.24
===== =====
SHARES OUTSTANDING - BASIC 19,957,091 17,995,710
========== ==========
SHARES OUTSTANDING - DILUTED 20,406,289 18,357,406
========== ==========
(The accompanying notes, together with the Notes to the Consolidated
Financial Statements, included in the Company's Annual Report on Form 10-K for
the year ended December 31, 1997, are an integral part of these financial
statements.)
4
Healthcare Realty Trust Incorporated
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 1998 and 1997
(Unaudited)
(Dollars in thousands)
1998 1997
---- ----
Cash flows from operating activities:
Net income $21,037 $22,836
Adjustments to reconcile net income to cash provided by operating
activities:
Depreciation and amortization 9,862 8,831
Deferred compensation 941 501
Increase in other liabilities 236 357
Increase in short-term investments 0 (18,000)
Increase in other assets (14,847) (3,467)
Decrease in accounts payable and accrued liabilities 2,225 (2,610)
----- ------
Net cash provided by operating activities 19,454 8,448
------ -----
Cash flows from investing activities:
Acquisition of real estate properties (83,828) (51,755)
Disbursement of security deposits 0 (510)
- ----
Net cash used in investing activities (83,828) (52,265)
------- -------
Cash flows from financing activities:
Borrowings on long-term notes payable 66,599 19,000
Repayments on long-term notes payable (11,300) (78,618)
Deferred financing and organization costs paid 0 (31)
Dividends paid (31,430) (26,029)
Proceeds from issuance of common stock 37,548 133,804
------ -------
Net cash provided by financing activities 61,417 48,126
------ ------
Increase in cash and cash equivalents (2,957) 4,308
Cash and cash equivalents, beginning of period 5,325 1,354
----- -----
Cash and cash equivalents, end of period $2,368 $5,662
====== ======
(The accompanying notes, together with the Notes to the Consolidated
Financial Statements, included in the Company's Annual Report on Form 10-K for
the year ended December 31, 1997, are an integral part of these financial
statements.)
5
Healthcare Realty Trust
Incorporated
Notes to Condensed Consolidated Financial Statements
September 30, 1998
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Healthcare Realty Trust Incorporated (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements which are included in the Company's Annual Report on Form 10-K for
the year ended December 31, 1997. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. These financial statements should be read in
conjunction with the financial statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997.
The results of operations for the three-month and nine-month periods ending
September 30, 1998 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1998.
Certain reclassifications have been made for the period July 1, 1997
through September 30, 1997 and for the period January 1, 1997 through September
30, 1997 to conform to the 1998 presentation. These reclassifications had no
effect on the results of operations as previously reported.
Note 2. Organization
The Company invests in healthcare-related properties located throughout the
United States. The Company provides management, leasing and build-to-suit
development, and capital for the construction of new facilities as well as for
the acquisition of existing properties. As of September 30, 1998, the Company
had invested or committed to invest in 95 properties (the "Properties") located
in 48 markets in 15 states, which are supported by 17 healthcare-related
entities. The Properties include:
6
Number of (in thousands)
Properties Investment
Ancillary hospital facilities 42 $285,604
Medical office buildings 5 15,804
Physician clinics 17 47,132
Long-term care facilities 18 104,008
Comprehensive ambulatory care centers 4 43,839
Clinical laboratories 2 13,075
Ambulatory surgery centers 3 6,886
Inpatient rehabilitation facilities 4 61,618
Corporate property 0 3,356
- -----
95 $581,322
== ========
Note 3. Funds From Operations
Funds from operations ("FFO"), as defined by the National Association of
Real Estate Investment Trusts, Inc. ("NAREIT") 1995 White Paper, means net
income (computed in accordance with generally accepted accounting principles),
excluding gains (or losses) from debt restructuring and sales of property, plus
depreciation from real estate assets.
The Company considers FFO to be an informative measure of the performance
of an equity REIT and consistent with measures used by analysts to evaluate
equity REITs. FFO does not represent cash generated from operating activities in
accordance with generally accepted accounting principles, is not necessarily
indicative of cash available to fund cash needs, and should not be considered as
an alternative to net income as an indicator of the Company's operating
performance or as an alternative to cash flow as a measure of liquidity. FFO for
the three months ended September 30, 1998 and 1997, was $12.4 million, or $0.61
per basic share ($0.60 per diluted share) and $11.1 million, or $0.59 per basic
share ($0.58 per diluted share), respectively. FFO for the nine months ended
September 30, 1998 and 1997, was $36.3 million, or $1.82 per basic share ($1.78
per diluted share) and $31.1 million, or $1.73 per basic share ($1.69 per
diluted share), respectively.
7
Funds from Operations
(Dollars in thousands, except per share data)
Three Months Ended September 30,
--------------------------------
1998 1997
---- ----
Net Income (1) $3,050 $8,328
Non-recurring items 6,308 0
Gain or loss on dispositions 0 0
Straight line rents 0 0
ADD:
Depreciation
Real estate 3,010 2,794
Office F,F&E 0 0
Leasehold improvements 0 0
Other non-revenue producing assets 0 0
- -
3,010 2,794
----- -----
Amortization
Acquired property contracts 0 0
Other non-revenue producing assets 0 0
Organization costs 0 0
- -
0 0
- -
Deferred financing costs 0 0
- -
Total Adjustments 9,318 2,794
----- -----
Funds From Operations $ 12,368 $ 11,122
========= =========
Shares Outstanding - Basic 20,333,500 18,883,433
========== ==========
Shares Outstanding - Diluted 20,771,296 19,234,675
========== ==========
Funds From Operations Per Share - Basic $ 0.61 $ 0.59
======== ========
Funds From Operations Per Share - Diluted $ 0.60 $ 0.58
======== ========
(1) Net income includes $315,862 in 1998 and $168,657 in 1997 of stock
based, long-term incentive compensation expense. This expense never requires the
disbursement of cash.
8
Funds from Operations
(Dollars in thousands, except per share data)
Nine Months Ended September 30,
-------------------------------
1998 1997
---- ----
Net Income (1) $21,037 $22,836
Non-recurring items 6,308 112
Gain or loss on dispositions 0 0
Straight line rents 0 0
ADD:
Depreciation
Real estate 8,943 8,103
Office F,F&E 0 0
Leasehold improvements 0 0
Other non-revenue producing assets 0 0
- -
8,943 8,103
----- -----
Amortization
Acquired property contracts 0 0
Other non-revenue producing assets 0 0
Organization costs 0 0
- -
0 0
- -
Deferred financing costs 0 0
Total Adjustments 15,251 8,215
------ -----
Funds From Operations $ 36,288 $ 31,051
========= =========
Shares Outstanding - Basic 19,957,091 17,995,710
========== ==========
Shares Outstanding - Diluted 20,404,306 18,357,406
========== ==========
Funds From Operations Per Share - Basic $ 1.82 $ 1.73
======== ========
Funds From Operations Per Share - Diluted $ 1.78 $ 1.69
======== ========
(1) Net income includes $940,950 in 1998 and $502,141 in 1997 of stock
based, long-term incentive compensation expense. This expense never requires the
disbursement of cash.
9
Note 4. Notes Payable
Notes payable at September 30, 1998 consisted of the following (in
thousands):
Unsecured notes $72,000
Unsecured credit facility 84,600
------
$156,600
========
Unsecured Notes
On September 18, 1995, the Company privately placed $90.0 million of
unsecured notes (the "Unsecured Notes") with sixteen credit institutions. The
Unsecured Notes bear interest at 7.41%, payable semi-annually, and mature on
September 1, 2002. Beginning on September 1, 1998 and on each September 1
through 2002, the Company must repay $18.0 million of principal. The Company
made the first of these scheduled payments on September 1, 1998. The note
agreements pursuant to which the Unsecured Notes were purchased contain certain
representations, warranties and financial and other covenants customary in such
loan agreements.
Unsecured Credit Facility
On December 26, 1996, the Company's $75.0 million unsecured credit facility
(the"Unsecured Credit Facility") with four commercial banks was increased to
$100.0 million and extended to December 30, 1999. At the option of the Company,
borrowings bear interest at one of the banks' base rate or LIBOR plus 1.125%. In
addition, the Company pays a commitment fee of .225 of 1% per annum on the
unused portion of funds available for borrowings under the Unsecured Credit
Facility. The Unsecured Credit Facility contains certain representations,
warranties and financial and other covenants customary in such loan agreements.
At September 30, 1998, the Company had borrowed $84.6 million under the
Unsecured Credit Facility which resulted in available borrowing capacity of
$15.4 million. The $100.0 million Unsecured Credit Facility was refinanced on
October 15, 1998. The Company entered into new credit facilities totaling $465.0
million upon completion of the Capstone merger described in Note 7, the Merger
(see also "Liquidity and Capital Resources").
Serial and Term Bonds Payable
In conjunction with the acquisition of certain facilities in 1994 and 1996,
the Company assumed serial and term bonds payable, totaling $7.2 million. These
bonds payable were repaid or defeased during 1996 and 1997. The Company placed
funds in an irrevocable trust to defease $2.9 million of serial and term bonds,
which paid interest semi-annually at interest rates ranging from 6.9% to 8.1%.
The resulting loss from the defeasance was not material.
10
Note 5. Deferred Compensation
During 1998, 145,230 restricted shares, bringing the total to 517,940, of
the Company's common stock previously reserved were released to certain officers
of the Company upon the achievement of the Company's performance based criteria
in accordance with the terms of the First Implementation of the Company's 1993
Employees Stock Incentive Plan. These restricted shares require continued
employment, generally for 12 years from the date of release, prior to vesting.
Note 6. Commitments
As of September 30, 1998, the Company had a net investment of approximately
$17.9 million in one build-to-suit development in progress and one expansion of
an existing facility, which have a total remaining funding commitment of
approximately $2.4 million.
As of September 30, 1998, the Company, in the normal course of business,
had entered into definitive contracts to acquire 16 acres of land and a medical
office building, both in Pennsylvania, totaling approximately $5.7 million.
Note 7. Merger
On June 8, 1998, the Company announced a definitive agreement to acquire
Capstone Capital Corporation ("Capstone"). This merger was consummated on
October 15, 1998. Pursuant to this agreement, the Company acquired Capstone in a
stock-for-stock merger in which the stockholders of Capstone received a fixed
ratio of .8518 share of the Company's common stock and the holders of Capstone
preferred stock received one share of the Company's voting preferred stock in
exchange for each share of Capstone preferred stock. Subsequent to this closing,
the Company owns, or will be committed to acquire, 277 properties in 126
markets, leased to 62 healthcare providers. The Company also assumed Capstone's
unsecured credit facilities, its 6.55% convertible subordinated debentures and
its 10.50% convertible subordinated debentures (see "Liquidity and Capital
Resources").
Note 8. Stockholders' Equity
In February, 1998, the Company participated in two unit investment trust
offerings and sold an aggregate of 1,224,026 shares of its common stock. The
Company received an aggregate of $33.3 million in net proceeds from these
transactions. The proceeds were used to fully repay the outstanding borrowings
under the Unsecured Credit Facility, acquisitions, developments and for general
corporate purposes.
During April and May, 1998, the Company sold an aggregate of 49,953 shares
of common stock to a single institutional investor. The Company received an
aggregate of $1.4 million in net proceeds from these transactions. The proceeds
were used to repay outstanding borrowings under the Unsecured Credit Facility,
development and for general corporate purposes.
11
On July 1, 1998, warrants for 128,149 shares of common stock were
exercised. The company received $2.4 million in proceeds from the exercise. The
Company has no other warrants outstanding. The proceeds were used to fund
developments and for general corporate purposes.
Note 9. Net Income Per Share
The table below sets forth the computation of basic and diluted earnings
per share as required by FASB Statement No. 128 for the three and nine months
ended September 30, 1998 and 1997.
Healthcare Realty Trust Inc.
Computation of Per Share Earnings and FFO
Three Months Ended Sept 30, Nine Months Ended Sept 30,
1998 1997 1998 1997
---- ---- ---- ----
Basic EPS
Average Shares Outstanding 20,863,443 19,266,066 20,487,034 18,378,343
Actual Restricted Stock Shares (529,943) (382,633) (529,943) (382,633)
-------- -------- -------- --------
Denominator 20,333,500 18,883,433 19,957,091 17,995,710
========== ========== ========== ==========
Numerator $3,049,966 $8,327,817 $21,036,549 $22,835,776
========== ========== =========== ===========
Per share amount $0.15 $0.44 $1.05 $1.27
===== ===== ===== =====
Diluted EPS
Denominator for Basic EPS 20,333,500 18,883,433 19,957,091 17,995,710
Restricted Shares - Treasury 424,106 278,645 399,832 287,693
Dilution For Employee Stock
Purchase Plan 13,690 22,017 17,808 27,147
Dilution For Warrants 0 50,580 29,575 46,856
- ------ ------ ------
Denominator 20,771,296 19,234,675 20,404,306 18,357,406
========== ========== ========== ==========
Numerator $3,049,966 $8,327,817 $21,036,549 $22,835,776
========== ========== =========== ===========
Per share amount $0.15 $0.43 $1.03 $1.24
===== ===== ===== =====
Note 10. Changes in Accounting Principles
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and displaying comprehensive
income and its components in a full set of general purpose financial statements.
Statement 130 is effective for interim and annual periods beginning after
December 15, 1997. Comprehensive income encompasses all changes in shareholders'
equity (except those arising from transactions with owners) and includes net
income, net unrealized capital gains or losses on available for sale securities
and foreign currency translation adjustments. Comprehensive income is the same
as net income for the Company.
12
In June 1997, the FASB issued Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information, "which establishes standards
for the way public business enterprises are to report information about
operating segments in annual financial statements and requires those enterprises
to report selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
Statement No. 131 is effective for annual periods beginning after December 15,
1997. Management of the Company is currently evaluating the applicability of
Statement No. 131, which may result in expanded segment disclosures.
The Emerging Issues Task Force ("EITF") has been considering the accounting
for internal acquisition costs for real estate properties. In the past, the
Company has capitalized certain internal costs incurred in identifying,
acquiring and developing real estate properties and has depreciated the
capitalized costs over the life of the related property. At its March 19, 1998
meeting, the EITF reached a consensus on Issue No. 97-11, "Accounting for
Internal Costs Relating to Real Estate Property Acquisition," that internal
pre-acquisition costs relating to the purchase of an operating property should
be expensed as incurred. At a previous meeting, the Task Force concluded that
internal pre-acquisition costs related to the purchase of non-operating property
could be capitalized in specified circumstances. Expensing internal
pre-acquisition costs related to the purchase of operating properties will
accelerate the recognition of these costs, negatively impacting reported
earnings and funds from operations of the Company. The adoption of this EITF is
not expected to be material to the Company's financial position or its results
of operations.
13
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Operating Results
Third Quarter 1998 Compared to Third Quarter 1997
Net income for the quarter ended September 30, 1988 decreased to $3.1
million, or $0.15 per basic share ($0.15 per diluted share) from $8.3 million,
or $0.44 per basic share ($0.43 per diluted share) for the same period in 1997,
a 63.4% decrease in net income or 65.9% per basic share (65.1% per diluted
share). This decrease is primarily attributable to a $6.3 million non-recurring
charge in 1998 related to the Capstone merger as described in Note 7, the
Merger. Total revenues for the quarter ended September 30, 1998 were $18.3
million compared to $15.9 million for the quarter ended September 30, 1997,
which is an increase of $2.5 million or 15.5%. The increase is primarily due to
master lease rental income and property operating income derived from
approximately $90.7 million of property acquisitions and properties reclassified
from construction in progress subsequent to September 30, 1997. While the number
of managed properties rose from 109 properties at September 30, 1997 to 246
properties at September 30, 1998, management fees did not increase
proportionately due to the elimination in consolidation of Company owned managed
properties. Management fees increased $43,000 for the quarter ending September
30, 1998, compared to the same period in 1997 substantially due to the addition
of third party management contracts in Florida and Texas. Interest and other
income for the quarter ended September 30, 1998 was $758,000 compared to
$831,000 for the quarter ended September 30, 1997. During the quarter ended
September 30, 1997, the Company maintained an average cash and short-term
investment balance of approximately $25.5 million compared to $4.1 million for
the same period in 1998 which resulted in significantly higher interest income
in 1997. Additionally, in 1998, the Company earned interest of $265,000 from a
mortgage note related to a development project, earned $204,000 from a note
receivable, and received project reimbursements of $229,000.
Total expenses for the quarter ended September 30, 1998 were $15.3 million
compared to $7.5 million for the quarter ended September 30, 1997, which is an
increase of $7.7 million or 102.7%. This increase is mainly attributable to the
$6.3 million non-recurring charge described in the preceding paragraph.
Excluding the effect of this non-recurring charge, total expenses increased $1.4
million, or 19.0%. The remaining increase is due mainly to an increase in
property operating expenses and depreciation expense. Property operating
expenses increased $1.1 million, or 65.2%, for the quarter ended September 30,
1998 compared to 1997 due to the acquisition of or conversion from master leases
of 12 company owned/controlled and managed properties subsequent to September
30, 1997. Depreciation expense increased $298,000, or 10.4%, for the quarter
ended September 30, 1998 compared to 1997 due to the acquisition of additional
properties and the completion of properties under construction in which the
Company currently has invested approximately $90.7 million.
14
Nine Months ended September 30, 1998 Compared to Nine Months ended September 30,
1997
Net income for the nine months ended September 30, 1998 decreased to $21.0
million or $1.05 per basic share ($1.03 per diluted share) from $22.8 million or
$1.27 per basic share ($1.24 per diluted share) for the same period in 1997, a
7.9% decrease in net income or 17.3% per basic share (16.9% per diluted share).
This decrease is primarily attributable to a $6.3 million non-recurring charge,
in the third quarter of 1998, related to the Capstone merger as described in
Note 7, the Merger. Total revenues for the nine months ended September 30, 1998
were $53.4 million compared to $43.0 million for the nine months ended September
30, 1997, which is an increase of $10.4 million, or 24.2%. The increase is
primarily due to master lease rental income and property operating income
derived from approximately $90.7 million of property acquisitions and properties
reclassified from construction in progress subsequent to September 30, 1997. For
the nine months ended September 30, 1998 compared to the nine months ended
September 30, 1997, there was a $353,000 increase in property management fees
substantially due to the addition of third party management contracts in Florida
and Texas. At September 30, 1998, the Company managed 246 properties compared to
109 properties at September 30, 1997. While the number of managed properties
increased significantly, management fees did not increase proportionately due to
the elimination in consolidation of fees from Company owned managed properties.
Interest and other income for the nine months ended September 30, 1998 decreased
to $1.7 million from $2.3 million for the nine months ended September 30, 1997.
During the first quarter of 1997, the Company completed a secondary offering and
maintained an average cash and short-term investment balance of $30.5 million
during the nine months ending September 30, 1997 compared to $7.9 million during
the nine months ending September 30, 1998. Additionally, in 1998, the Company
earned interest of $570,000 from a mortgage note related to a development
project, earned $319,000 from a note receivable, and received project
reimbursements of $405,000.
Total expenses for the nine months ended September 30, 1998 were $32.4
million compared to $20.1 million for the nine months ended September 30, 1997,
which is an increase of $12.2 million, or 60.7%. This increase is mainly
attributable to the $6.3 million non-recurring charge described in the preceding
paragraph. Excluding the effect of this non-recurring charge, total expenses
increased $5.9 million, or 29.3%. Excluding this non-recurring charge, general
and administrative expenses increased $1.0 million, or 42.2%, primarily due to
an increase in non-reimbursed employees associated with the increase in
management contracts. Property operating expenses increased $4.6 million, or
15.3%, for the nine months ended September 30, 1998 compared to 1997 due to the
acquisition of or conversion from master leases of 12 Company owned/controlled
and managed properties subsequent to September 30, 1997. Depreciation expenses
increased $1.0 million, or 12.2%, due to the acquisition of additional
properties and the completion of properties under construction in which the
Company currently has invested approximately $90.7 million. Interest expense
decreased from $6.1 million to $5.4 million for the nine months ended September
30, 1998 and 1997, respectively. During the nine months ended September 30,
1998, the Company had an average outstanding balance under the unsecured credit
facility of $5.9 million compared to $15.5 million in 1997.
Liquidity and Capital Resources
As of September 30, 1998, the Company had invested, or committed to invest,
in 95 properties (the "Properties") for an aggregate investment of $581.3
million located in 48 markets
15
in 15 states, which are supported by 17 healthcare-related entities. The Company
has financed its acquisitions to date through the sale or exchange of common
stock, long-term indebtedness, borrowings under its credit facilities, and the
assumption of bonds.
In February, 1998, the Company participated in two unit investment trust
offerings and sold an aggregate of 1,224,026 shares of its common stock. The
Company received an aggregate of $33.3 million in net proceeds from these
transactions. The proceeds were used to fully repay the outstanding borrowings
under the Company's existing Unsecured Credit Facility (described in Note 4),
and for acquisitions, developments and for general corporate purposes.
During April and May, 1998, the Company sold an aggregate of 49,953 shares
of its common stock to a single institutional investor. The Company received an
aggregate of $1.4 million in net proceeds from these transactions. The proceeds
were used to repay outstanding borrowings under the Company's Unsecured Credit
Facility, fund developments and for general corporate purposes.
On September 18, 1995, the Company privately placed $90.0 million of
unsecured notes (the "Unsecured Notes") with sixteen credit institutions. The
Unsecured Notes bear interest at 7.41%, payable semi-annually, and mature on
September 1, 2002. Beginning on September 1, 1998 and on each September 1
through 2002, the Company must repay $18.0 million of principal. The Company
made the first of these scheduled payments on September 1, 1998 from cash
provided by Company operations and from proceeds borrowed under the Company's
Unsecured Credit Facility. The note agreements pursuant to which the Unsecured
Notes were purchased contain certain representations, warranties and financial
and other covenants customary in such loan agreements.
At September 30, 1998, the Company had borrowed $84.6 million under its
Unsecured Credit Facility which resulted in available borrowing capacity of
$15.4 million.
At September 30, 1998, the Company had stockholders' equity of $404.8
million. The debt to total capitalization ratio was approximately 0.28 to 1.00
at September 30, 1998.
During the quarter ended September 30, 1998, the Company funded a net of
approximately $3.7 million for construction in progress and capital additions.
The sources of these funds were cash provided by Company operations or proceeds
borrowed under its Unsecured Credit Facility.
On August 17, 1998, the Company paid a dividend of $0.52 per share to the
holders of its common stock as of the close of business on August 6, 1998. This
dividend related to the period from April 1, 1998 through June 30, 1998. In
September 1998, the Company announced payment of a dividend of $0.525 per share
to the holders of common shares on October 12, 1998. The dividend will be
payable on November 16, 1998. The dividend relates to the period July 1, 1998
through September 30, 1998.
As of September 30, 1998, the Company had a net investment of $17.9 million
in one build-to-suit development in progress and one expansion of an existing
facility, which have a total remaining funding commitment of $2.4 million. As of
September 30, 1998, the Company, in the
16
normal course of business, had entered into definitive contracts to acquire 16
acres of land and a medical office building, both in Pennsylvania, totaling
approximately $5.7 million. As a result of the merger (discussed below), the
Company assumed Capstone investment commitments, resulting in additional
committed amounts of approximately $140,000,000.
On July 1, 1998, warrants for 128,149 shares of common stock were
exercised. The Company received $2.4 million in proceeds from the exercise. The
Company has no other warrants outstanding. The proceeds were used to fund
development and for general corporate purposes.
FFO increased to $12.4 million, or $0.61 per basic share ($0.60 per diluted
share) for the quarter ended September 30, 1998 compared to $11.1 million, or
$0.59 per basic share ($0.58 per diluted share) for the same period in 1997.
Although FFO is not based upon generally accepted accounting principles, the
Company considers it to be an informative measure of the performance of an
equity REIT and consistent with measures used by analysts to evaluate equity
REITs.
On June 8, 1998, the Company announced a definitive agreement to acquire
Capstone Capital Corporation ("Capstone"). This merger was consummated on
October 18, 1998. As part of the Capstone merger, the Company assumed the
outstanding principal amount of Capstone's unsecured credit facility. As of the
merger date, the outstanding principal balance was $221.8 million. Concurrent
with the merger, the Company repaid the outstanding balances under its and
Capstone's unsecured credit facilities and entered into a $265.0 million senior
revolving credit facility (the "Senior Revolving Credit Facility") with ten
commercial banks. The Senior Revolving Credit Facility bears interest at LIBOR
plus 1.0%, payable quarterly, and matures on October 15, 2001. In addition, the
Company pays, quarterly, a commitment fee of .20 of 1% on the unused portion of
funds available for borrowings under the Senior Revolving Credit Facility. The
Senior Revolving Credit Facility contains certain representations, warranties,
and financial and other covenants customary in such loan agreements. As of the
merger date, the Company had borrowed $141.0 million under the Senior Revolving
Credit Facility.
Effective as of the Capstone merger date, the Company entered into a $200.0
million term loan (the "Senior Term Loan Facility") with NationsBank, which was
funded as of the date of merger. The Senior Term Loan Facility bears interest at
LIBOR plus 1.00%, payable quarterly, and matures on April 16, 1999. The Company
has an option to extend the maturity date for an additional six month period, in
consideration of an extension payment of .30 of 1%. The Senior Term Loan
Facility contains certain representations, warranties and financial and other
covenants customary in such loan agreements.
As part of the Capstone merger, the Company assumed approximately $3.8
million aggregate principal amount of 10.50% Convertible Subordinated Debentures
of Capstone. The 10.50% Debentures mature on April 1, 2002, unless redeemed
earlier by the Company or converted by the holders. Payments of interest to the
holders of the Debentures are required April 1 and October 1 of each year,
commencing October 1, 1995. The Debentures are convertible into shares of common
stock of the Company at the option of the holder at any time prior to redemption
or stated maturity. The 10.50% Debentures are subordinated to all existing and
future senior indebtedness of the Company and subordinated to all existing and
future liabilities and obligations of subsidiaries and partnerships of the
Company. The 10.50% Debentures are
17
redeemable, at the Company's option, in whole or from time to time in part, at
any time from April 5, 2000, through March 31, 2002, at redemption prices
ranging from 101.5% to 103.0%, plus accrued and unpaid interest to and including
the redemption date.
In addition, as part of the Capstone merger, the Company assumed
approximately $74.7 million aggregate principal amount of 6.55% Convertible
Subordinated Debentures of Capstone. The 6.55% Debentures are due on March 14,
2002 and were issued at a price of $903 per $1,000 principal amount at maturity,
which represents an original issue discount of 9.7% from the principal amount
thereof which is payable at maturity. Interest on the 6.55% Debentures is
payable on March 14 and September 14 in each year, and commenced on September
14, 1997. Such rate of interest and accrual of original issue discount
represents a yield to maturity of 9.00% per annum (computed on a semiannual bond
equivalent basis). The 6.55% Debentures are convertible into common stock of the
Company at any time before maturity.
As of September 30, 1998 the Company can issue an aggregate of
approximately $108.0 million of securities remaining under currently effective
registration statements. The Company intends to offer securities under such
registration statements from time to time to finance future acquisitions and
build-to-suit developments as they occur. The Company may, under certain
circumstances, borrow additional amounts in connection with the renovation or
expansion of its properties, the acquisition or development of additional
properties or, as necessary, to meet distribution requirements for REITs under
the Code. The Company may raise additional capital or make investments by
issuing, in public or private transactions, its equity and debt securities, but
the availability and terms of any such issuance will depend upon market and
other conditions.
Under the terms of the leases and other financial support agreements
relating to the properties, tenants or healthcare providers are generally
responsible for operating expenses and taxes relating to the properties. As a
result of these arrangements, the Company does not believe that it will be
responsible for any material increase in expenses in connection with the
properties during the respective terms of the agreements. The Company
anticipates entering into similar arrangements with respect to additional
properties it acquires or develops. After the term of the lease or financial
support agreement, or in the event the financial obligations required by the
agreement are not met, the Company anticipates that any expenditures it might
become responsible for in maintaining the properties will be funded by cash from
operations and, in the case of major expenditures, possibly by borrowings. To
the extent that unanticipated expenditures or significant borrowings are
required, the Company's cash available for distribution and liquidity may be
adversely affected.
Management believes that inflation should not have a materially adverse
effect on the Company. The majority of the leases contain some provision for
additional rent payments based on increases in various economic measures.
There has been a recent reduction in the market capitalization of REIT
stocks generally. The Company's market valuation has been, in part, affected by
this general trend; however, management believes that the quality of its
investments in healthcare real estate, its ability to provide third party
services to the healthcare industry and its conservative investment criteria
differentiate it from the majority of REITs. The Company believes that the
capital markets should recognize those differences. Nonetheless, it is possible
that this trend will have a negative impact
18
on the Company's access to capital and the amount of funds that the Company will
have available for investment. While the Company anticipates that it will be
able to access debt and equity markets on a basis that will satisfy its capital
requirements, there is no assurance that it will be able to do so. Inability to
access capital markets would limit the Company's ability to obtain funds
required to finance its plans for growth and other capital requirements.
The Company plans to continue to meet its liquidity needs, including
funding additional investments in 1998, paying its quarterly dividends (with
increases consistent with its current practices) and funding the debt service on
the 10.50% Convertible Subordinated Debentures, the 6.55% Convertible
Subordinated Debentures, the Senior Revolving Credit Facility and the Senior
Term Loan Facility. The Company expects to fund its cash requirements from its
operating revenues, the proceeds of mortgage loan repayments, sales of real
estate investments and debt and equity capital market financings. While the
Company believes that the Company's liquidity and sources of capital are
adequate to satisfy its cash requirements, the Company provides no assurance,
however, that these sources of funds will be available at a time and upon terms
acceptable to the Company in sufficient amounts to meet its liquidity needs.
Year 2000 Issue
The Year 2000 ("Y2K") issue is the result of computer programs being
written using two digits rather than four to define the applicable year.
Computer programs or hardware that have date-sensitive software or embedded
chips may recognize a date using "00" as the year 1900 rather than the Y2K. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions or engage in normal business activities. The Y2K issue relating to
the Company's corporate information technology systems, including applications
employed with respect to the real estate investments of the Company, could have
a material impact on the operations of the Company if compliance is not
completed in a timely manner. The Company's plan to resolve the Y2K issue
involves four phases: assessment, remediation, testing, and implementation.
Status of Y2K Issue Relating to the Company's Information Technology Systems
Based on the Company's completed assessment of its own software and
hardware relating to the Company's corporate information technology systems, the
Company determined that it is necessary to modify or replace certain portions of
its software and hardware so that those systems will properly utilize dates
beyond December 31, 1999. The Company presently believes that, with actual and
planned modifications or replacements of existing software and certain hardware,
material damage to the Company resulting from the Y2K issue relating to the
Company's corporate information technology systems will be fully mitigated by
March 31, 1999.
In the ordinary course of events, the Company has purchased new file
servers and replaced many older desktop microcomputers with new equipment, all
of which is certified to be Y2K compliant by the manufacturers. Additionally,
"patches" are available from the manufacturers that will bring certain equipment
into compliance, and will be installed in desktop systems as necessary. Two
non-compliant file servers currently used for data storage are scheduled to be
replaced not later than March 31, 1999.
19
The Company's assessment of computer operating systems and software
indicated that the Company's significant information systems programs should not
require remediation. Accordingly, the Company does not believe that the Y2K
presents a material exposure as it relates to the Company's services. The
Company requested, and has subsequently received, certification from all of its
significant software and operating systems vendors that the versions of their
products currently installed are fully Y2K compliant. The Y2K ssue could have a
material impact on the operations of the Company if such modifications and
replacements are not properly made or are not completed timely.
The testing phase of the Company's information systems, operating systems
and other software has not yet begun; however, the Company expects that it will
be completed in 1999. While the Company does not anticipate that testing will
disprove its vendors' certifications of compliance, remediation of any systems
or software that signal potential Y2K problems will begin immediately upon
discovery.
The Company will utilize both internal and external resources to reprogram
or replace, test, and implement the software and operating equipment for Y2K
modifications. The total cost of the Y2K project, as estimated, is not expected
to be material and is being funded through operating cash flows, and for the
most part, will be a result of normal technology system upgrades and
replacements.
Y2K Issue Compliance of Vendors and Clients
The Company has queried its significant suppliers and clients as to their
respective responses to the Y2K issue. To date, the Company is not aware of
suppliers and clients with a Y2K issue that would materially impact the
Company's results of operations, liquidity, or capital resources; however, the
Company has no means of ensuring that those parties will be Y2K compliant. The
Company has not received responses from all of its inquiries and has renewed its
solicitation for written disclosures in compliance with the Year 2000
Information and Readiness Disclosure Act. The inability of suppliers and clients
to complete their Y2K resolution process in a timely fashion could materially
impact the Company. The effect of non-compliance by the Company's suppliers and
clients is not determinable.
While the Company does have ongoing relationships with third-party payors,
suppliers, vendors, and others, it has no systems that interface directly with
third party vendors other than its accounts with financial institutions and the
Company's payroll system interfaces directly with a vendor. The Company is in
the process of working with these institutions and payroll vendor to ensure that
the Company's systems that interface directly with them are Y2K compliant by
December 31, 1999.
The Company will also have Y2K issue exposure in non-information technology
applications with respect to its real estate investments. Computer technology
employed in elevators, security systems, electrical systems and similar
applications involved in the operations of real estate properties may cause
interruptions of services with respect to those properties on and after January
1, 2000. The terms of agreements in place with respect to the bulk of the real
estate investments held by the Company impose the economic cost of compliance
upon third party lessees and mortgagees; consequently, the costs to the Company
for Y2K remediation should not
20
be material. The Company is in the process of making inquiry and assessing
responses of those third parties as to their respective Y2K issue readiness and
will require that those third parties undertake the necessary actions to ensure
Y2K compliance of the properties.
Lastly, the Y2K issue may affect the greater business environment in which
the Company operates. Due to the general uncertainty surrounding the Y2K
readiness of third parties, including federal and state governments, the effect
of the Y2K issue on the Company's lessees and mortgagees, as well as the Company
itself cannot be gauged. For example, the General Accounting Office has reported
that the systems employed in managing Medicare reimbursements is not likely to
be Y2K compliant in time to ensure the delivery of uninterrupted benefits and
services. Delay in reimbursements could negatively affect the Company's lessees
and mortgagees, resulting in a delay in receipt of payments owed to the
Company's clients, with the further possibility of delay in payments due by
those clients to the Company. Similar consequences could result from the failure
of other parties having such an indirect relationship with the Company.
Management of the Company believes it has an effective program in place to
resolve the Y2K issue in a timely manner. As noted above, the Company has not
yet completed all necessary phases of the Y2K program. In the event that the
Company does not complete any additional phases, the Company may be unable to
collect receipts in a timely manner. In addition, disruptions in the economy
generally resulting from Y2K issues could also materially adversely affect the
Company. The Company could be subject to litigation for computer systems
failure, for example, equipment shutdown or failure to properly date business
records. The amount of potential liability and lost revenue cannot be reasonably
estimated at this time. The most reasonable likely worst case Y2K scenario is
that business disruption could occur with respect to third-party payors,
suppliers, or vendors who fail to become Y2K compliant, and disruptions in the
economy generally resulting from Y2K issues could adversely impact the Company.
The Company has contingency plans for certain critical applications and is
working on such plans for others. These contingency plans involve, among other
actions, manual workarounds, increasing inventories, and adjusting staffing
strategies. The Company plans to maintain an ongoing evaluation of its Y2K
compliance readiness and contingent plans throughout 1999.
21
Cautionary Language Regarding Forward Looking Statements
Statements in this Quarterly Report on Form 10-Q that are not historical
factual statements are "forward looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. The statements include, among
other things, statements regarding the intent, belief or expectations of the
Company and its officers and can be identified by the use of terminology such as
"may", "will", "expect", "believe", "intend", "plan", "estimate", "should" and
other comparable terms. In addition, the Company, through its senior management,
from time to time makes forward looking oral and written public statements
concerning the Company's expected future operations and other developments.
Shareholders and investors are cautioned that, while forward looking statements
reflect the Company's good faith beliefs and best judgment based upon current
information, they are not guarantees of future performance and are subject to
known and unknown risks and uncertainties. Actual results may differ materially
from the expectations contained in the forward looking statements as a result of
various factors. Such factors include (i) competition for property management,
development and acquisitions, including competition for tenants and the renewal
or roll-over of existing leases; (ii) inability to locate suitable properties or
to acquire properties on terms which meet the Company's investment criteria;
(iii) the Company's ability to access debt and equity in sufficient amount to
enable it to make real estate investments or to satisfy its other uses of
capital; (iv) the Company's dependence on healthcare providers, which are
affected by legislative, regulatory, or other changes in the healthcare industry
at the local, state or federal level and by changes in the reimbursement
delivery process to providers; (v) competition for lessees, including with
respect to new leases and the renewal or roll-over of existing leases; (vi)
competition for the acquisition and financing of healthcare facilities; (vii)
the ability of the Company's lessees and mortgagors to operate the Company's
properties in a manner sufficient to maintain or increase revenues and to
generate sufficient income to make rent and loan payments; (viii) changes in
national or regional economic conditions, including changes in interest rates;
and (ix) the general uncertainty inherent in the Year 2000 issue, particularly
the uncertainty of the Year 2000 readiness of third parties who are material to
the Company's business over whom the Company has no control with the result that
the Company cannot ensure its ability to timely and cost-effectively avert or
resolve problems associated with the Year 2000 issue that may affect its
operations and business. For a more detailed discussion of these, and other,
factors, see pages 34 through 39 of Item 1 of the Company's Form 10-K for the
fiscal year ended December 31, 1997.
22
PART II - OTHER INFORMATION
Item 6. Reports on Form 8-K
(a) Reports on Form 8-K
- - --- -------------------
No reports on Form 8-K were filed by the Company during the three months
ended September 30, 1998.
23
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.
HEALTHCARE REALTY TRUST INCORPORATED
By: /s/ Timothy G. Wallace
----------------------
Timothy G. Wallace
Executive Vice President, Finance
and Chief Financial Officer
Date: November 13, 1998