Selected Financial
Information
The following table sets forth financial information for the Company which
is derived from the Consolidated Financial Statements of the Company (Dollars in
thousands, except per share data):
Years Ended December 31,
------------------------
1998 (2) 1997 1996 1995 1994
-------- ---- ---- ---- ----
Statement of Income Data:
Total revenues $ 93,104 $ 59,796 $ 38,574 $ 33,361 $ 24,226
Interest expense $ 13,057 $ 7,969 $ 7,344 $ 5,083 $ 1,116
Net income $ 40,479 $ 31,212 $ 19,732 $ 18,258 $ 15,716
Net income per share - Basic $ 1.66 $ 1.71 $ 1.52 $ 1.41 $ 1.33
Net income per share - Diluted $ 1.63 $ 1.68 $ 1.49 $ 1.41 $ 1.33
Weighted average shares outstanding - Basic 24,043,942 18,222,243 13,014,286 12,931,082 11,806,864
Weighted average shares outstanding - Diluted 24,524,600 18,572,492 13,261,291 12,970,326 18,859,714
Balance Sheet Data (as of the end of the period):
Real estate properties, net $1,337,439 $ 466,273 $ 416,034 $ 318,480 $ 280,767
Total Assets $1,615,423 $ 488,514 $ 427,505 $ 336,778 $ 283,190
Notes and bonds payable $ 559,924 $ 101,300 $ 168,618 $ 92,970 $ 40,375
Total stockholders' equity $1,017,704 $ 376,472 $ 245,964 $ 234,448 $ 236,340
Other Data:
Funds from operations - Basic (1) $ 59,667 $ 42,337 $ 28,036 $ 25,490 $ 20,919
Funds from operations - Diluted (1) $ 59,731 $ 42,337 $ 28,036 $ 25,490 $ 20,919
Funds from operations per share - Basic (1) $ 2.48 $ 2.32 $ 2.15 $ 1.97 $ 1.77
Funds from operations per share - Diluted (1) $ 2.44 $ 2.28 $ 2.11 $ 1.97 $ 1.76
Dividends declared and paid per share $ 2.07 $ 1.99 $ 1.91 $ 1.83 $ 1.75
(1) See Note 12 to Consolidated Financial Statements.
(2) See Note 2 to Consolidated Financial Statements.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
Overview
The Company operates under the Internal Revenue Code of 1986, as amended
(the "Code"), as an indefinite life real estate investment trust ("REIT"). The
Company, a self-managed and self-administered REIT, follows a general growth
strategy that integrates owning, managing, and developing income-producing real
estate properties and mortgages associated with the delivery of healthcare
services throughout the United States. Management believes that by providing
related real estate services, it can differentiate the Company's competitive
market position, expand its asset base and increase revenue.
Substantially all of the Company's revenues are derived from rentals on its
healthcare real estate property facilities, interest earned on mortgage loans
and from the temporary investment of funds in short-term instruments and from
management and development services. Leases and other financial support
arrangements with respect to the Company's healthcare real estate facilities
generally ensure that increased costs and expenses incurred with respect to the
operation of the facilities will be borne by tenants and healthcare providers
related to the facilities. The Company incurs operating and administrative
expenses, principally compensation expense for its officers and other employees,
office rental and related occupancy costs and various expenses incurred in the
process of acquiring additional properties.
Results of Operations
1998 Compared to 1997
On October 15, 1998, the Company acquired by merger Capstone Capital
Corporation ("Capstone"). The purchase price is summarized as follows (in
thousands):
Common stock $ 532,554
Preferred stock 72,052
Cash and cash equivalents 8,330
Liabilities assumed 424,897
-------
Total Purchase Price $ 1,037,833
================
The assets acquired in the Capstone
merger are summarized as follows
(in thousands):
Real estate properties $ 804,178
Mortgage notes receivable 211,590
Cash and cash equivalents 13,767
Other assets 8,298
-----
Total Assets Acquired $ 1,037,833
================
The results of operations of the Company were significantly impacted by the
Capstone merger. For the year ended December 31, 1998, net income increased
$12.3 million due to the Capstone merger. As a result of this transaction, the
Company acquired 111 properties and 75 mortgages for a fair value of $804.2
million and $211.6 million, respectively. These investments resulted in
additional master lease, straight line rent and property operating income, net
of operating expenses, for the year of $14.5 million, as well as, additional
interest and other income of $4.1 million, additional interest expense of $2.0
million under the unsecured credit facility and depreciation and amortization
expense of $2.9 million. The Company also assumed Capstone's 6.55% and 10.5%
convertible subordinated debentures and notes payable, with interest rates
ranging from 7.625% to 9.0%, with a collective fair value of $138.0 million
which resulted in interest expense of $1.4 million for the period October 15,
1998 through December 31, 1998.
For the year ended December 31, 1998, net income was $40.5 million, or
$1.66 per basic share of common stock ($1.63 per diluted share), on total
revenues of $93.1 million compared to net income of $31.2 million, or $1.71 per
basic share of common stock
-2-
($1.68 per diluted share), on total revenues of $59.8 million, for the year
ended December 31, 1997. Funds from operations ("FFO") was $59.7 million, or
$2.48 per basic share ($2.44 per diluted share), for the year ended December 31,
1998 compared to $42.3 million, or $2.32 per basic share ($2.28 per diluted
share), in 1997.
(Dollars in thousands) 1998 1997
---- ----
Revenues
Master lease rental income $ 48,777 $ 40,298
Property operating income 35,269 14,631
------ ------
Total rental income 84,046 54,929
Management fees 2,056 1,499
Interest and other income 7,002 3,368
----- -----
93,104 59,796
Expenses
General and administrative 11,126 3,807
Property operating expenses 11,978 5,008
Interest 13,057 7,969
Depreciation 15,965 11,468
Amortization 499 332
--- ---
52,625 28,584
------ ------
Net Income $ 40,479 $ 31,212
========== ==========
Total revenues for the year ended December 31, 1998 compared to the year
ended December 31, 1997, increased $33.3 million or 55.7%. Excluding the impact
of the Capstone merger, which is discussed above, total revenues for the year
ended December 31, 1998 compared to the year ended December 31, 1997, increased
$13.5 million. This increase is primarily due to increases in master lease
rental income and property operating income. During 1998, the Company acquired
nine properties and two properties under construction were completed and began
operations. Certain leases acquired from Capstone contain escalating rental
rates over the life of the leases, however, rental income is recognized as
earned on a straight line basis over the life of the lease. Therefore, $1.3
million of accrued straight line rental income is included in master lease
rental income.
Third party property management fees for the year ended December 31, 1998,
compared to the year ended December 31, 1997, increased $0.6 million or 37.2%,
due primarily to the addition of over 60 buildings with approximately 2.6
million square feet under property management.
Interest and other income for the year ended December 31, 1998 was $7.0
million compared to $3.4 million for the year ended December 31, 1997. Excluding
the effect of the Capstone merger, interest and other income decreased $0.2
million from the year ending December 31, 1997 to the year ending December 31,
1998. During the first quarter of 1997, the Company completed a secondary
offering and maintained a higher than normal average cash and short-term
investment balance.
Total expenses for the year ended December 31, 1998 were $52.6 million
compared to $28.6 million for the year ended December 31, 1997, an increase of
$24.0 million or 84.1%. General and administrative expenses increased $7.3
million. $6.3 million of this increase represents the write-off of certain
capitalized software costs, leasehold improvements, organization and other
deferred costs which were deemed to have no continuing value and incremental
internal costs incurred in conjunction with the Capstone merger. The remaining
$1.0 million increase is primarily due to the increased number of employees for
property management, development, and other service-based activities.
Property operating expenses for the year ended December 31, 1998 compared
to the year ended December 31, 1997 increased $7.0 million. Property operating
expenses rose during 1998 for the same reasons property operating income
increased.
Interest expense for the year ended December 31, 1998 compared to the year
ended December 31, 1997 increased $5.1 million. At the time of the Capstone
merger, the Company repaid the outstanding balances under both Capstone's and
the Company's own
-3-
unsecured credit facilities and entered into a $265.0 million unsecured credit
facility and a $200.0 million unsecured term loan. During the year ended
December 31, 1997, the Company had an average outstanding balance under its
unsecured credit facility of $18.1 million compared to an average outstanding
balance under its unsecured credit facility and term loan during the year ended
December 31, 1998 of $82.3 million. In addition, Capstone's subordinated
convertible debentures and notes payable were assumed by the Company in the
merger and capitalized interest increased $0.7 million from 1997 to 1998.
Depreciation expense increased $4.5 million due to the significant increase
during 1998 in depreciable properties. Excluding the effect of the Capstone
merger, depreciation expense increased $1.6 million. This increase primarily
resulted from the acquisition of nine properties during 1998 and the completion
in 1998 of two properties under construction at December 31, 1997.
1997 Compared to 1996
For the year ended December 31, 1997, net income was $31.2 million, or
$1.71 per basic share of common stock ($1.68 per diluted share), on total
revenues of $59.8 million compared to net income of $19.7 million, or $1.52 per
basic share of common stock ($1.49 per diluted share), on total revenues of
$38.6 million, for the year ended December 31, 1996. FFO was $42.3 million, or
$2.32 per basic share ($2.28 per diluted share), for the year ended December 31,
1997 compared to $28.0 million, or $2.15 per basic share ($2.11 per diluted
share), in 1996.
(Dollars in thousands) 1997 1996
---- ----
Revenues
Master lease rental income $ 40,298 $ 35,329
Property operating income 14,631 1,338
------ -----
Total rental income 54,929 36,667
Management fees 1,499 1,111
Interest and other income 3,368 796
----- ---
59,796 38,574
------ ------
Expenses
General and administrative 3,807 2,233
Property operating expenses 5,008 269
Interest 7,969 7,344
Depreciation 11,468 8,652
Amortization 332 344
--- ---
28,584 18,842
------ ------
Net Income $ 31,212 $ 19,732
========== ==========
Total revenues for the year ended December 31, 1997 compared to the year
ended December 31, 1996, increased $21.2 million or 55%. The increase is
primarily due to master lease rental income and property operating income from
18 properties acquired and two developments completed during the latter part of
the fourth quarter of 1996 and the year ended December 31, 1997, representing an
investment of approximately $102.3 million. Third party property management fees
for the year ended December 31, 1997, compared to the year ended December 31,
1996, increased $0.4 million or 35%, due to the net effect of adding third party
management contracts in Florida and Virginia and converting six master leased
properties (accounted for as third party management) to Company owned and
managed properties. Interest and other income for the year ended December 31,
1997 was $3.4 million compared to $0.8 million for the year ended December 31,
1996. During the first quarter of 1997, the Company completed a secondary
offering and maintained an average cash and short-term investment balance of
$26.1 million during the year ended December 31, 1997 compared to a $2.2 million
average cash balance during the year ended December 31, 1996.
Total expenses for the year ended December 31, 1997 were $28.6 million
compared to $18.8 million for the year ended December 31, 1996, an increase of
$9.8 million or 52%. General and administrative expenses increased $1.6 million,
primarily due to an
-4-
increase in payroll associated with the large increase in property management
and other service-based activities. Property operating expenses for the year
ended December 31, 1997, compared to the year ended December 31, 1996 increased
$4.7 million due to the conversion from master leased or acquisition of 19
Company owned and managed properties during the latter part of the fourth
quarter of 1996 and the year ended December 31, 1997. Interest expense for the
year ended December 31, 1997, compared to the year ended December 31, 1996,
increased $0.6 million due to the net effect of a decrease in average
outstanding debt balance and a decrease in average construction in progress,
which reduced capitalized interest by approximately $1.4 million. Depreciation
expense increased $2.8 million due to the acquisition of 18 properties and
completion of two properties discussed in the preceding paragraph.
Liquidity and Capital Resources
On October 15, 1998, at the time of the Capstone merger, the Company repaid
the outstanding balances under both Capstone's and the Company's own unsecured
credit facilities and entered into a $265.0 million unsecured credit facility
(the "Unsecured Credit Facility") with ten commercial banks. The Unsecured
Credit Facility bears interest at LIBOR plus 1.05%, payable quarterly, and
matures on October 15, 2001. In addition, the Company will pay, quarterly, a
commitment fee of 0.225 of 1% on the unused portion of funds available for
borrowings. At December 31, 1998, the Company had available borrowing capacity
of $94.0 million under the Unsecured Credit Facility.
At the time of the Capstone merger, the Company entered into a $200.0
million unsecured term loan (the "Term Loan Facility") with NationsBank. The
Term Loan Facility bears interest at LIBOR plus 1.05%, payable quarterly, and
matures on April 16, 1999. The Company intends to exercise the option to extend
the maturity date for an additional six month period in consideration of an
extension payment of .30 of 1%. Since the Capstone merger, the Company has
received proceeds from the sale of assets and from mortgage prepayments of
approximately $29.0 million and reduced the unpaid balance of the Term Loan
Facility to approximately $171.0 million. The Company expects that the Term Loan
Facility will be repaid by internally generated cash flow, proceeds from the
sale of additional assets, and proceeds from additional prepayments of mortgage
notes receivable. If such sources of funds are insufficient to repay the Term
Loan Facility in full, any unpaid balance is expected to be refinanced.
In 1995, the Company privately placed $90.0 million of unsecured notes (the
"Unsecured Notes") bearing interest at 7.41%, payable semi-annually ($5.0
million for 1999), and mature on September 1, 2002. The Company must repay $18.0
million of principal annually. At December 31, 1998, $72.0 million was
outstanding under the Unsecured Notes.
The Company assumed in the Capstone merger 10.5% Convertible Subordinated
Debentures and 6.55% Convertible Subordinated Debentures having an aggregate
principal balance of $78.3 million. In 1999 the Company will pay $5.3 million of
interest on these subordinated debentures.
In 1998, the Company sold an aggregate of 1.4 million shares of its common
stock. The Company received an aggregate of $37.1 million in net proceeds from
these transactions. The proceeds were used to repay debt and were also used for
acquisitions, developments and general corporate purposes.
As of March 1, 1999 the Company can issue an aggregate of approximately
$106.4 million of securities remaining under currently effective registration
statements. Due to the current market price of the Company's stock, the Company
does not presently plan to offer securities under such registration statements.
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.
The Company generated net cash from operations in 1998 of $23.5 million, a
decrease of $16.9 million from 1997 and $5.9 million from 1996. The decrease
from 1997 results primarily from the payment of accounts payable and accrued
liabilities assumed in the Capstone merger. Other significant sources and uses
of cash for investing and financing activities are set forth in the Statement of
Cash Flows in the Consolidated Financial Statements.
In October 1998, the Company purchased an ancillary hospital facility in
Lititz, Pennsylvania for approximately $4.2 million from proceeds under the
Unsecured Credit Facility.
-5-
As of December 31, 1998, the Company had an investment of approximately
$72.2 million in 13 build-to-suit developments in progress, which have a total
remaining funding commitment of approximately $34.7 million. The Company also
had 21 mortgages under development at December 31, 1998, which have a total
remaining funding commitment of approximately $28.2 million. The Company intends
to fund those commitments with funds available from operations and proceeds from
the Unsecured Credit Facility.
At December 31, 1998, the Company had stockholders' equity of $1.0 billion.
The debt to total capitalization ratio was approximately .365 to 1 at March 1,
1999.
On January 26, 1999, the Company declared an increase in its quarterly
common stock dividend from $0.525 per share ($2.10 annualized) to $0.53 per
share ($2.12 annualized) payable to stockholders of record on February 5, 1999.
This dividend was paid on February 16, 1999. The Company presently plans to
continue to pay its quarterly common stock dividends, with increases consistent
with its current practice. In the event that the Company cannot make additional
investments in 1999 because of an inability to obtain new capital by issuing
equity and debt securities, the Company will continue to be able to pay its
common stock dividends in a manner consistent with its current practice. Should
access to new capital not be available, the Company is uncertain of its ability
to increase its quarterly common stock dividends.
During 1999, the Company will pay quarterly dividends on its 8 7/8% Series
A Cumulative Preferred Stock in the annualized amount of $2.22 per share.
Under the terms of the leases and other financial support agreements
relating to most of the properties, tenants or healthcare providers are
generally responsible for operating expenses and taxes relating to the
properties. As a result of these arrangements, with limited exceptions not
material to the performance of the Company, the Company does not believe that it
will be responsible for any major 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.
The Company plans to continue to meet its liquidity needs, including
funding additional investments in 1999, 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 Unsecured Credit Facility, the Term Loan Facility,
and the Unsecured Notes from its operating revenues, the proceeds of mortgage
loan repayments, sales of real estate investments and mortgage notes receivable,
and debt market financings. The Company believes that its liquidity and sources
of capital are adequate to satisfy its cash requirements. The Company, however,
cannot be certain 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.
Impact of Inflation
Inflation has not significantly affected the earnings of the Company
because of the moderate inflation rate and the fact that most of the Company's
leases and financial support arrangements require tenants and sponsors to pay
all or some portion of the increases in operating expenses, thereby reducing the
risk of any adverse effects of inflation to the Company. In addition, inflation
will have the effect of increasing the gross revenue the Company is to receive
under the terms of the leases and financial support arrangements. Leases and
financial support arrangements vary in the remaining terms of obligations from
three to 20 years, further reducing the risk of any adverse effects of inflation
to the Company. The Unsecured Credit Facility bears interest at a variable rate;
therefore, the amount of interest payable under the Unsecured Credit Facility
will be influenced by changes in short-term rates, which tend to be sensitive to
inflation.
Real Estate Investment Trust Tax Proposals
The Clinton Administration's Fiscal Year 2000 Budget proposal includes
three provisions of interest to REITs in general, two of which potentially
affect the Company. These provisions (i) modify the structure of businesses
which are indirectly conducted by the Company and could limit or negatively
affect the Company's future ability to engage indirectly in certain business
activities that cannot be conducted directly by the Company; and (ii) repeal
tax-free conversion of large C corporations to S corporations, which would
-6-
effectively tax the built-in gains of C corporations prospectively electing
tax-free reorganizations, thus affecting an acquisition format employed by the
Company in the past. The President's Budget proposal includes numerous other
revenue provisions, none of which would materially impact the Company in the
event of their adoption. The last action on the President's Year 2000 Budget
proposal was the release by the Joint Committee on Taxation's "Description of
Revenue Provisions Contained in the President's Fiscal Year 2000 Budget
Proposal" on February 22, 1999. Congress has yet to debate the broader
implications of the President's Year 2000 Budget proposals, so there is no way
to predict the outcome of these proposals or the eventual economic effect of
these proposals on the Company if these proposals are enacted.
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 year
2000. 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. The Y2K issue 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 Company does not expect to incur costs of more than
$50,000 in this effort.
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 are 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 by March 31, 1999.
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 Company has yet to complete Y2K testing of its information systems,
operating systems and other software. 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.
Y2K Issue Compliance of Vendors and Clients
The Company has questioned its significant suppliers and clients as to
their respective responses to the Y2K issue. To date, the Company is not aware
of any suppliers or 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 in fact 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
-7-
process in a timely fashion could materially impact the Company. The Company
cannot presently determine the effect of non-compliance by the Company's
suppliers and clients.
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
Compan's payroll system interfaces directly with a vendor. The Company is in
the process of working with these institutions and its 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 be material. The Company is in the process of
inquiring 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.
Finally, 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 Company cannot reasonably estimate the amount of potential
liability and lost revenue 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 other non-critical applications. 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.
Market Risk
The Company is exposed to market risk, in the form of changing interest
rates, on its debt and mortgage notes receivable. The Company has no market risk
with respect to derivatives and foreign currency fluctuations. Management uses
daily monitoring of market conditions and analytical techniques to manage this
risk.
At December 31, 1998, the fair value of the Company's fixed rate debt
approximates its carrying value of $209.7 million. At December 31, 1998, the
fixed rate debt assumed in the Capstone merger totaled $137.7 million. This debt
was recorded at fair value at the acquisition date of October 15, 1998. Market
risk, expressed as the hypothetical increase in fair value resulting from a one
percentage point decrease in interest rates, is $7.2 million for aggregate fixed
rate debt.
At December 31, 1998, the fair value of the Company's variable rate debt
approximates its carrying value of $350.2 million. By definition, because the
interest rate is variable, the carrying amount of variable rate debt will always
approximate its fair value. Assuming the $350.2 million carrying value is held
constant, the hypothetical increase in interest expense resulting from a one
per-
-8-
centage point increase in interest rates, would be $3.5 million. The interest
rate on variable rate debt is based on and variable with European interbank
interest rates (LIBOR).
At December 31, 1998, the fair value of the Company's mortgage notes
receivable approximates its carrying value of $228.5 million. These assets,
acquired in the Capstone merger, were recorded at fair value at the acquisition
date of October 15, 1998. Market risk, expressed as the hypothetical decrease in
fair value resulting from a one percentage point increase in interest rates, is
$10.7 million on the aggregate portfolio of mortgage notes receivable.
Cautionary Language Regarding Forward Looking Statements
Statements in this Annual Report on Form 10-K 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. For a more detailed discussion of these, and other factors, see
pages 26 through 30 of Item 1 of the Company's Form 10-K for the fiscal year
ended December 31, 1998.
-9-
Report of
Independent Auditors
The Board of Directors and Stockholders
Healthcare Realty Trust Incorporated
We have audited the accompanying consolidated balance sheets of Healthcare
Realty Trust Incorporated as of December 31, 1998 and 1997, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Healthcare
Realty Trust Incorporated at December 31, 1998 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1998 in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
Nashville, Tennessee
January 29, 1999,
except for Note 14,
as to which the date is February 17, 1999
-10-
Consolidated
Balance Sheets
December 31,
------------
(Dollars in thousands) 1998 1997
---- ----
Assets
Real estate properties:
Land $ 140,617 $ 58,424
Buildings and improvements 1,169,941 423,618
Personal property 4,825 4,492
Construction in progress 72,172 14,457
------ ------
1,387,555 500,991
Less accumulated depreciation (50,116) (34,718)
------- -------
Total real estate properties, net 1,337,439 466,273
Cash and cash equivalents 14,411 5,325
Mortgage notes receivable 228,542 4,708
Other assets, net 35,031 12,208
------ ------
Total assets $ 1,615,423 $ 488,514
=========== ==========
Liabilities and Stockholders' Equity
Liabilities:
Notes and bonds payable $ 559,924 $ 101,300
Accounts payable and accrued liabilities 25,824 6,879
Other liabilities 11,971 3,863
------ -----
Total liabilities 597,719 112,042
------- -------
Commitments - -
Stockholders' equity:
Preferred stock, $.01 par value;
50,000,000 shares authorized; issued
and outstanding,
1998 - 3,000,000; 1997 - none 30 -
Common stock, $.01 par value;
150,000,000 shares authorized; issued
and outstanding,
1998 - 39,792,775; 1997 - 19,285,927 398 193
Additional paid-in capital 1,049,039 402,607
Deferred compensation (10,662) (7,689)
Cumulative net income 129,346 88,867
Cumulative dividends (150,447) (107,506)
-------- --------
Total stockholders' equity 1,017,704 376,472
--------- -------
Total liabilities and stockholders' equity $ 1,615,423 $ 488,514
=========== =========
See accompanying notes
-11-
Consolidated
Statements of Income
Year Ended December 31,
-----------------------
(Dollars in thousands, except per
share data) 1998 1997 1996
---- ---- ----
Revenues
Master lease rental income $ 48,777 $ 40,298 $ 35,329
Property operating income 35,269 14,631 1,338
Management fees 2,056 1,499 1,111
Interest and other income 7,002 3,368 796
----- ----- ---
93,104 59,796 38,574
------ ------ ------
Expenses
General and administrative 11,126 3,807 2,233
Property operating expenses 11,978 5,008 269
Interest 13,057 7,969 7,344
Depreciation 15,965 11,468 8,652
Amortization 499 332 344
--- --- ---
52,625 28,584 18,842
------ ------ ------
Net income $ 40,479 $ 31,212 $ 19,732
========== =========== ==========
Net income per share - Basic $ 1.66 $ 1.71 $ 1.52
========== ========== ==========
Net income per share - Diluted $ 1.63 $ 1.68 $ 1.49
========== ========== ==========
Shares outstanding - Basic 24,043,942 18,222,243 13,014,286
========== ========== ==========
Shares outstanding - Diluted 24,524,600 18,572,492 13,261,291
========== ========== ==========
See accompanying notes
-12-
Consolidated
Statements of Stockholders' Equity
Additional Cumulative Total
(Dollars in thousands, Preferred Common Paid-In Deferred Net Cumulative Stockholder's
except per share data) Stock Stock Capital Compensation Income Dividends Equity
----- ----- ------- ------------ ------ --------- ------
Balance at December 31, 1995 - $ 130 $ 243,419 $ (478) $ 37,923 $ (46,546) $ 234,448
Issuance of stock - 7 16,584 - - - 16,591
Shares awarded as deferred
stock compensation - 2 4,611 (4,613) - - -
Deferred stock compensation
amortization - - - 389 - - 389
Net income - - - - 19,732 - 19,732
Dividends ($1.91 per share) - - - - - (25,196) (25,196)
- - - - - ------- -------
Balance at December 31, 1996 - 139 264,614 (4,702) 57,655 (71,742) 245,964
Issuance of stock - 52 134,113 - - - 134,165
Shares awarded as deferred
stock compensation - 2 3,880 (3,882) - - -
Deferred stock compensation
amortization - - - 895 - - 895
Net income - - - - 31,212 - 31,212
Dividends ($1.99 per share) - - - - - (35,764) (35,764)
- - - - - ------- -------
Balance at December 31, 1997 - 193 402,607 (7,689) 88,867 (107,506) 376,472
Issuance of common stock - 202 567,734 - - - 567,936
Issuance of preferred stock $30 - 71,956 - - - 71,986
Shares awarded as deferred
stock compensation - 2 4,331 (4,274) - - 59
Shares issued from warrants - 1 2,411 - - - 2,412
Deferred stock compensation
amortization - - - 1,301 - - 1,301
Net income - - - - 40,479 - 40,479
Dividends - common
($2.07 per share) - - - - - (42,386) (42,386)
Dividends - preferred
($0.46224 per share) - - - - - (555) (555)
- - - - - ---- ----
Balance at December 31, 1998 $30 $ 398 $1,049,039 $(10,662) $ 129,346 $(150,447) $ 1,017,704
=== ====== ========== ======== ========= ========= ===========
See accompanying notes
-13-
Consolidated Statements of
Cash Flows
Year Ended December 31,
-----------------------
(In thousands) 1998 1997 1996
- -------------- ---- ---- ----
Operating Activities
Net income $ 40,479 $ 31,212 $ 19,732
Adjustments to reconcile net income to cash provided by
operating activities:
Depreciation and amortization 17,122 12,073 9,017
Deferred compensation 1,247 672 377
Increase (decrease) in deferred income (907) 114 (29)
Increase in other assets (7,957) (2,346) (933)
Increase (decrease) in accounts payable and
accrued liabilities (27,906) (1,340) 1,222
Increase in straight line rent (1,265) - -
One time charge to operations 3,373 - -
Gain on sales of real estate (675) - -
---- - -
Net cash provided by operating activities 23,511 40,385 29,386
------ ------ ------
Investing Activities
Acquisition and development of real estate properties (94,066) (61,813) (63,069)
Acquisition and development of mortgages (12,439) (4,708) -
Proceeds from sale of real estate 11,895 - -
Receipt (disbursement) of security deposits 134 (976) (390)
Purchase of Capstone, net of cash acquired 5,437 - -
----- - -
Net cash used in investing activities (89,039) (67,497) (63,459)
------- ------- -------
Financing Activities
Borrowings on notes and bonds payable 425,000 35,300 101,899
Repayments on notes and bonds payable (338,689) (102,618) (50,903)
Increase in notes receivable (6,439) - -
Dividends paid (42,941) (35,764) (25,196)
Proceeds from issuance of common stock 37,683 134,165 484
------ ------- ---
Net cash provided by financing activities 74,614 31,083 26,284
====== ====== ======
Increase (decrease) in cash and cash equivalents 9,086 3,971 (7,789)
----- ----- ------
Cash and cash equivalents, beginning of period 5,325 1,354 9,143
----- ----- -----
Cash and cash equivalents, end of period $ 14,411 $ 5,325 $ 1,354
========== ========== ==========
See accompanying notes
-14-
Notes to
Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Organization
The Company invests in healthcare-related properties and mortgages located
throughout the United States, including ancillary hospital facilities, physician
clinics, ambulatory surgery centers, medical office buildings, inpatient rehab
facilities, assisted living facilities, skilled nursing facilities,
comprehensive ambulatory care centers, and other facilities. 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 December 31, 1998, the Company had invested or committed to
invest in 280 properties (the "Properties") located in 130 markets nationwide,
affiliated with 61 healthcare-related entities.
Basis of Presentation
The financial statements include the accounts of the Company, its wholly
owned subsidiaries and certain other affiliated corporations with respect to
which the Company controls the operating activities and receives substantially
all economic benefits. Significant intercompany accounts and transactions have
been eliminated.
Use of Estimates in Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported in the financial statements and
accompanying notes. Actual results may differ from those estimates.
Real Estate Properties
Real estate properties are recorded at cost. Transaction fees and
acquisition costs are netted with the purchase price as appropriate. The cost of
real properties acquired is allocated between land, buildings, and personal
property based upon estimated market values at the time of acquisition.
Depreciation is provided for on a straight-line basis over the following
estimated useful lives:
Buildings and improvements 31.5 or 39.0 years
Personal property 3.0 to 7.0 years
Mortgage Notes Receivable
Mortgage notes receivable, substantially all of which were acquired in the
Capstone merger (see Note 2), were recorded at their fair value at the date of
acquisition. The mortgage portfolio has a weighted average maturity of
approximately 7 years. Interest rates, which range from 8.1% to 12.5%, are
generally adjustable each year to reflect actual increases in the Consumer Price
Index subject to a minimum increase of 4%. Substantially all of the mortgages
are subject to a prepayment penalty.
Cash and Cash Equivalents
Short-term investments with maturities of three months or less at date of
purchase are classified as cash equivalents.
Federal Income Taxes
No provision has been made for federal income taxes. The Company intends at
all times to qualify as a real estate investment trust under Sections 856
through 860 of the Internal Revenue Code of 1986, as amended. The Company must
distribute at least 95% of its real estate investment trust taxable income to
its stockholders and meet other requirements to continue to qualify as a real
estate investment trust.
Other Assets
Other assets consist primarily of receivables, deferred costs and
intangible assets. Deferred financing costs are amortized over the term of the
related credit facility using the interest method. Intangible assets are
amortized straight-line over the applicable lives of the assets, which range
from four to forty years. Accumulated amortization was $2.5 million and $1.5
million at December 31, 1998 and 1997, respectively.
Revenue Recognition
Rental income related to noncancelable operating leases is recognized as
earned over the life of the lease agreements on a straight-line basis. Any
additional rent, as defined in each lease agreement, is recognized as earned.
-15-
Stock Issued to Employees
The Company has elected to follow Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations in accounting for its stock issued to employees.
Net Income Per Share
Earnings per share have been restated for Financial Accounting Standards
Board Statement No. 128, "Earnings per Share".
Basic earnings per share is calculated using weighted average shares
outstanding less issued and outstanding but unvested restricted shares of Common
Stock.
Diluted earnings per share is calculated using weighted average shares
outstanding plus the dilutive effect of convertible debt and restricted shares
of Common Stock and outstanding stock options, using the treasury stock method
and the average stock price during the period.
Significant Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Financial Accounting Standards Board Statement No. 130, "Reporting Comprehensive
Income" ("FAS 130"), which establishes standards for reporting and displaying
comprehensive income and its components in a full set of general purpose
financial statements. The Company adopted FAS 130 effective for its fiscal year
ended December 31, 1998. Comprehensive income is the same as net income for the
Company.
In June 1997, the FASB issued Financial Accounting Standards Board
Statement No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("FAS 131"). The Company adopted FAS 131 effective for its fiscal
year ended December 31, 1998. The adoption of FAS 131 had no impact on the
Company, as the Company operates in only one business segment, consisting of
investments in healthcare related-related properties and mortgages throughout
the United States.
Reclassification
Certain reclassifications have been made in the financial statements for
the years ended 1997 and 1996 to conform to the 1998 presentation. These
reclassifications had no effect on the results of operations as previously
reported.
2. Capstone Merger
On June 8, 1998, the Company announced a definitive agreement to acquire
Capstone Capital Corporation ("Capstone"). The merger was consummated on October
15, 1998. Pursuant to the merger agreement, the Company acquired Capstone in a
stock-for-stock merger in which the stockholders of Capstone received a fixed
ratio of .8518 shares 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. The Company issued
18,906,909 shares of common stock (see Note 11) and 3,000,000 shares of
preferred stock. The transaction was accounted for as a purchase and resulted in
no goodwill.
The purchase price is summarized as follows (in thousands):
Common stock $ 532,554
Preferred stock 72,052
Cash and cash equivalents 8,330
Liabilities assumed 424,897
-------
Total Purchase Price $ 1,037,833
===========
The assets acquired in the Capstone merger are summarized as follows (in
thousands):
Real estate properties $ 804,178
Mortgage notes receivable 211,590
Cash and cash equivalents 13,767
Other assets 8,298
-----
Total Assets Acquired $ 1,037,833
===========
-16-
The unaudited proforma results of operations for the two years ended
December 31, 1998 and 1997, assuming that the Capstone merger had occurred as of
the beginning of each of those periods are (dollars in thousands, except for per
share data):
1998 1997
---- ----
Revenues $ 168,721 $ 116,974
Net income $ 73,186 $ 54,234
Net income per share - Basic $ 1.74 $ 1.39
Net income per share - Diluted $ 1.72 $ 1.38
3. Real Estate Property Leases
The Company's properties are generally leased or supported pursuant to
noncancelable, fixed-term operating leases and other financial support
arrangements with expiration dates from 1999 to 2018. Some leases and financial
arrangements provide for fixed rent renewal terms of five years, or multiples
thereof, in addition to market rent renewal terms. The leases generally provide
the lessee, during the term of the lease and for a short period thereafter, with
an option and a right of first refusal to purchase the leased property.
Each lease generally requires the lessee to pay minimum rent, additional
rent based upon increases in the Consumer Price Index or increases in net
patient revenues (as defined in the lease agreements), and all taxes (including
property tax), insurance, maintenance and other operating costs associated with
the leased property.
Amounts of rental income received from lessees who accounted for more than
10% of the Company's rental income for the three years in the period ended
December 31, 1998 were (in thousands):
1998 1997 1996
---- ---- ----
Tenet Healthcare $ 13,713 $ 13,297 $ 11,539
Columbia/HCA Healthcare Corporation 17,125 13,899 8,761
Phycor 8,899 8,218 2,160
Future minimum lease and guaranty payments under the noncancelable
operating leases and financial support arrangements as of December 31, 1998 are
as follows (in thousands):
1999 $ 133,651
2000 134,104
2001 133,359
2002 132,682
2003 133,175
2004 and thereafter 796,270
-------
$ 1,463,241
-17-
4. Real Estate Properties
The following table summarizes the Company's real estate properties by type
of facility and by state as of December 31, 1998 (dollars in thousands).
Buildings and
Number of Improvements Personal Accumulated
Facilities (1) Land and CIP Property Total Depreciation
-------------- ---- ------- -------- ----- ------------
Ancillary hospital facilities:
California 10 20,560 74,944 40 95,543 4,667
Florida 12 5,843 88,016 114 93,973 4,885
Texas 13 9,472 71,894 259 81,625 7,407
Virginia 7 11,718 54,225 87 66,031 3,870
Other states 18 12,265 146,488 59 158,811 5,811
-- ------ ------- -- ------- -----
60 59,858 435,567 559 495,983 26,640
Assisted Living Facilities:
New Jersey 2 0 13,527 0 13,527 0
Pennsylvania 7 1,017 27,654 0 28,671 90
Texas 8 0 71,153 0 71,153 301
Virginia 3 888 15,815 0 16,703 67
Other states 14 765 42,507 0 43,271 99
-- --- ------ - ------ --
34 2,670 170,656 0 173,325 557
Ambulatory surgery centers:
Florida 2 0 16,179 0 16,179 69
Missouri 2 2,958 12,555 0 15,513 59
Nevada 1 940 2,861 0 3,801 327
Texas 1 510 1,514 15 2,040 278
Other states 3 541 3,370 9 3,919 165
- --- ----- - ----- ---
9 4,949 36,479 24 41,452 898
Comprehensive ambulatory care:
California 1 2,571 19,281 0 21,853 82
Florida 6 5,866 36,367 0 42,233 764
Illinois 1 198 10,935 0 11,133 47
Texas 2 1,643 20,005 69 21,717 2,761
Other states 6 687 28,655 0 29,342 66
- --- ------ - ------ --
16 10,965 115,243 69 126,278 3,720
Inpatient rehabilitation facilities:
Alabama 1 0 17,388 0 17,388 108
Florida 1 0 11,483 0 11,483 72
Pennsylvania 6 4,675 105,461 0 110,136 521
Texas 1 1,095 11,578 0 12,673 49
Virginia 1 364 2,575 0 2,939 11
- --- ----- - ----- --
10 6,134 148,485 0 154,619 761
Medical office buildings:
Tennessee 1 3,212 5,518 0 8,730 58
Texas 1 166 1,810 0 1,976 202
Virginia 4 1,927 11,774 129 13,830 959
- ----- ------ --- ------ ---
6 5,305 19,102 129 24,536 1,219
Physician clinics:
Alabama 2 2,382 8,419 0 10,801 37
Florida 9 12,097 41,844 51 53,991 2,424
Massachusetts 5 4,204 26,003 0 30,207 111
Texas 3 6,550 22,184 461 29,195 1,932
Other states 16 5,956 23,512 0 29,467 624
-- ----- ------ - ------ ---
35 31,189 121,962 512 153,661 5,128
Skilled nursing facilities:
Colorado 3 2,885 23,522 0 26,408 1,059
Pennsylvania 3 478 20,098 0 20,576 86
Texas 2 1,795 17,670 0 19,466 887
Virginia 7 1,870 40,773 0 42,643 174
Other states 14 6,568 62,263 215 69,047 5,382
-- ----- ------ --- ------ -----
29 13,596 164,326 215 178,140 7,588
Other:
Alabama 1 182 8,569 8 8,759 1,520
Arizona 2 0 2,518 0 2,518 0
Michigan 1 4,692 9,751 0 14,443 42
Mississippi 1 538 3,718 30 4,285 519
Texas 1 539 5,737 0 6,277 26
- --- ----- - ----- --
6 5,951 30,293 38 36,282 2,107
Corporate property 0 0 0 3,279 3,279 1,498
- - - ----- ----- -----
Total property 205 140,617 1,242,113 4,825 1,387,555 50,116
=== ======= ========= ===== ========= ======
(1) Includes thirteen lessee developments.
-18-
5. Notes and Bonds Payable
Notes and bonds payable at December 31, 1998 and 1997 consisted of the
following (in thousands):
December 31,
------------
1998 1997
---- ----
Unsecured credit facility $ 171,000 $ 11,300
Term loan facility 179,200 -
Unsecured notes 72,000 90,000
6.55% Convertible subordinated debentures, net 73,219 -
10.50% Convertible subordinated debentures, net 3,823 -
Mortgage notes 60,682 -
------ -
$ 559,924 $ 101,300
=========== ===========
Unsecured Credit Facility
On October 15, 1998, concurrent with the Capstone merger, the Company
repaid the outstanding balances under both Capstone and its own unsecured credit
facilities and entered into a $265.0 million unsecured credit facility (the
"Unsecured Credit Facility") with ten commercial banks. The Unsecured Credit
Facility bears interest at LIBOR plus 1.05%, payable quarterly, and matures on
October 15, 2001. In addition, the Company will pay, quarterly, a commitment fee
of 0.225 of 1% on the unused portion of funds available for borrowings. The
Unsecured Credit Facility contains certain representations, warranties, and
financial and other covenants customary in such loan agreements. At December 31,
1998, the Company had available borrowing capacity of $94.0 million under the
Unsecured Credit Facility.
Term Loan Facility
On October 15, 1998, concurrent with the Capstone merger, the Company
entered into a $200.0 million unsecured term loan (the "Term Loan Facility")
with NationsBank. The Term Loan Facility bears interest at LIBOR plus 1.05%,
payable quarterly, and matures on April 16, 1999. The Company intends to
exercise the option to extend the maturity date for an additional six month
period in consideration of an extension payment of .30 of 1%. The Term Loan
Facility contains certain representations, warranties and financial and other
covenants customary in such loan agreements, as well as restrictions on dividend
payments if minimum tangible capital requirements are not met. At December 31,
1998, the Company had no additional available borrowing capacity under the Term
Loan Facility.
Unsecured Notes
On September 18, 1995, the Company privately placed $90.0 million of
unsecured notes (the "Unsecured Notes") with 16 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 note agreements pursuant to
which the Unsecured Notes were purchased contain certain representations,
warranties and financial and other covenants customary in such loan agreements.
Convertible Subordinated Debentures
As part of the Capstone merger, the Company assumed and recorded at fair
value $74.7 million aggregate face amount of 6.55% Convertible Subordinated
Debentures (the "6.55% Debentures") of Capstone. At December 31, 1998, the
Company had approximately $73.2 million aggregate principal amount of 6.55%
Debentures outstanding with a face amount of $74.7 million and unaccreted
discount of $1.5 million. Such rate of interest and accretion of discount
represents a yield to maturity of 7.5% per annum (computed on a semiannual bond
equivalent basis). The 6.55% Debentures are due on March 14, 2002, unless
redeemed earlier by the Company or converted by the holder, and are callable on
March 16, 2000. Interest on the 6.55% Debentures is payable on March 14 and
September 14 in each year. The 6.55% 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, at a conversion price rate of 33.6251 shares per
$1 thousand bond.
As part of the Capstone merger, the Company assumed and recorded at fair
value $3.75 million aggregate face amount of 10.5% Convertible Subordinated
Debentures (the "10.5% Debentures") of Capstone. At December 31, 1998, the
Company had approximately $3.8 million aggregate principal amount of 10.5%
Debentures outstanding with a face amount of $3.6 million and unamortized
premium of $0.2 million. Such rate of interest and amortization of premium
represents a yield to maturity of 7.5% per annum (computed on a semiannual bond
equivalent basis). The 10.5% Debentures are due on April 1, 2002, unless
redeemed earlier by the Company or converted by the holder, and are callable on
April 5, 2000. Interest on the 10.5% Debentures is payable on April 1 and
October 1 in each year. The 10.5% 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, at a conversion price rate of 52.8248 shares per
$1 thousand bond.
-19-
Mortgage Notes
As part of the Capstone merger, the Company assumed six non-recourse
mortgage notes payable, and the related collateral, as follows:
(Dollars in millions)
Book Value
Of Collateral at Balance at
Original December 31, December 31,
Mortgagor Balance Interest Rate Collateral 1998 1998
Life Insurance Co. $ 23.3 8.500% Ancillary hospital facility $ 40.1 $ 22.9
Life Insurance Co. 4.7 7.625% Ancillary hospital facility 10.2 4.5
Life Insurance Co. 17.1 8.125% Two Ambulatory surgery centers 35.0 16.8
& one ancillary hospital
facility
Bank 17.0 8.250% Six skilled nursing facilities 29.6 16.5
---- ----- ---- ----
$ 62.1 $ 114.9 $ 60.7
======= ========= ========
The $23.3 million note is payable in monthly installments of principal and
interest based on a 30 year amortization with the final payment due in July
2026. The $4.7 million note is payable in monthly installments of principal and
interest based on a 20 year amortization with the final payment due in January
2017. The three notes totaling $17.1 million are payable in monthly installments
of principal and interest based on a 25 year amortization with a balloon payment
of the unpaid balance in September 2004. The $17.0 million note bears interest
at 50 basis points in excess of the prime rate, and is payable in monthly
installments of principal and interest based on a 25 year amortization with a
balloon payment of the unpaid balance in June 2000.
Other Long-Term Debt Information
Future maturities of long-term debt are as follows (in thousands):
1999 $ 197,644
2000 112,289
2001 189,684
2002 18,742
2003 805
2004 and thereafter 40,760
------
$ 559,924
==========
During the years ended December 31, 1998, 1997 and the 1996, interest paid
totaled $11.1 million, $9.0 million and $8.4 million, and capitalized interest
totaled $1.4 million, $0.7 million and $2.2 million, respectively.
6. No-Cash Acquisitions of Real Estate
During November 1996, the Company acquired ten properties, in exchange for
an aggregate of 687,692 shares of the Company's common stock (valued at $16.1
million) and the assumption of $20.6 million of notes payable, $4.1 million of
bonds payable and $3.0 million of accounts payable and accrued liabilities, and
incurred $0.5 million in acquisition costs. In addition to the properties,
representing an aggregate investment of $44.1 million, the Company acquired $0.2
million of other assets. The Company has repaid the notes and bonds payable
assumed in the acquisition.
-20-
7. Stockholders' Equity
The Company had common and preferred shares outstanding as of the three
years ended December 31, 1998 as follows:
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
Common Shares
Balance, beginning of period 19,285,927 13,898,777 12,976,796
Issuance of stock 20,226,981 5,235,761 718,084
Shares awarded as deferred stock compensation 148,357 143,716 203,897
Shares issued from warrants 131,510 7,673 -
------- ----- -
Balance, end of period 39,792,775 19,285,927 13,898,777
========== ========== ==========
Preferred Shares
Balance, beginning of period - - -
Issuance of stock 3,000,000 - -
--------- - -
Balance, end of period 3,000,000 - -
========= = =
On October 15, 1998, the Company issued 18,906,909 shares of Common stock
and 3,000,000 shares of 8 7/8% Series A Voting Cumulative Preferred stock in a
stock-for-stock merger with Capstone Capital Corporation (see Note 2).
In July 1998, warrants for 128,149 shares of common stock were exercised.
The Company has no other warrants outstanding. During April and May 1998, the
Company sold an aggregate of 49,953 shares of common stock to a single
institutional investor. 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 $37.1 million in proceeds for
these transactions. The proceeds were used to repay outstanding borrowings under
the Unsecured Credit Facility, acquisitions, developments and for general
corporate purposes.
Effective February 14, 1997, the Company sold 5,175,000 shares of its
common stock in a secondary offering (the "Secondary Offering") under its
currently effective registration statement pertaining to $250.0 million of
equity securities, debt securities and warrants. The Company received $133.4
million in net proceeds. Promptly thereafter, the net proceeds were used, in
part, to extinguish all $71.9 million of indebtedness outstanding under the
Unsecured Credit Facility, and to repay or defease secured indebtedness in the
total amount of $6.7 million. Remaining proceeds of the Secondary Offering of
approximately $57.2 million have been invested in additional property
acquisitions, build-to-suit property development and for general corporate
purposes.
8. Benefit Plans
Executive Retirement Plan
The Company has an Executive Retirement Plan, under which an executive
designated by the Compensation Committee of the Board of Directors may receive
upon normal retirement (defined to be when the executive reaches age 65 and has
completed five years of service with the Company) 60% of the executive's final
average earnings (defined as the average of the executive's highest three years'
earnings) plus 6% of final average earnings times years of service after age 60
(but not more than five years), less 100% of certain other retirement benefits
received by the executive.
Retirement Plan for Outside Directors
The Company has a retirement plan for outside directors which upon
retirement will pay annually, for a period not to exceed 15 years, an amount
equal to the director's pay immediately preceding retirement from the Board.
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Retirement Plan Information
Net expense for both the Executive Retirement Plan and the Retirement Plan
for Outside Directors (the "Plans") for the two years in the period ended
December 31, 1998 is comprised of the following (in thousands):
1998 1997
---- ----
Service cost $ 775 $ 218
Interest cost 103 73
Other 10 (10)
-- ---
$ 888 $ 281
======= =======
The Plans are unfunded and benefits will be paid from earnings of the
Company. The following table sets forth the benefit obligations at December 31,
1998 and 1997 (in thousands).
1998 1997
---- ----
Benefit obligation at beginning of year $ 1,213 $ 744
Service cost 775 218
Interest cost 103 73
Other 10 (10)
Actuarial gain 452 188
--- ---
Benefit obligation at end of year 2,553 1,213
Unrecognized net actuarial (gain) loss (362) 90
---- --
Net pension liability in accrued liabilities $ 2,191 $ 1,303
========= =======
Accounting for the Executive Retirement Plan for the years ended December
31, 1998 and 1997 assumes discount rates of 7.04% and 7.6%, respectively, and
compensation increase rates of 2.7% and 2.7%, respectively. Accounting for the
Retirement Plan for Outside Directors assumes discount rates of 7.04% and 7.6%,
respectively.
9. Stock Plans and Warrants
1993 Employees Stock Incentive Plan
The Company is authorized to issue stock representing up to 7.5% of its
outstanding shares of common stock, (the "Employee Plan Shares") under the 1993
Employees Stock Incentive Plan (the "Employee Plan"). As of December 31, 1998
and 1997, the Company had a total of 2,470,080 and 1,073,735 Employee Plan
Shares authorized, respectively, that had not been issued. Unless terminated
earlier, the Employee Plan will terminate on January 1, 2003. As of December 31,
1998 and 1997, the Company had issued a total of 514,378 and 372,710, and had
specifically reserved, but not issued, a total of 445,000 and 141,668 Employee
Plan Shares (the "Reserved Stock"), respectively, for performance-based awards
to employees under the Employee Plan. The issuance of Reserved Stock to eligible
employees is contingent upon the achievement of specific performance criteria.
The Reserved Stock awards are subject to fixed vesting periods varying from four
to twelve years beginning on the date of issue. If an employee voluntarily
terminates employment with the Company before the end of the vesting period, the
shares are forfeited, at no cost to the Company. Once the Reserved Stock has
been issued, the employee has the right to receive dividends and the right to
vote the shares. For 1998 and 1997, compensation expense resulting from the
amortization of the value of these shares was $1.2 million and $0.6 million,
respectively.
Non-Employee Directors' Stock Plans
Prior to May 1995, the Company was authorized to issue stock options for up
to 2% of its outstanding shares of common stock under the 1993 Outside Directors
Stock Incentive Plan (the "1993 Director Plan"). During 1996 the Company
canceled all unexercised options granted pursuant to the 1993 Director Plan.
Effective May 1995, the Company enacted the 1995 Restricted Stock Plan for
Non-Employee Directors (the "1995 Directors' Plan"). The Directors' stock vests
in each Director upon the date three years from the date of issue and is subject
to forfeiture prior to such date upon termination of the Director's service, at
no cost to the Company. As of December 31, 1998 and 1997, the Company had a
total of 95,800 and 96,850 shares under the 1995 Directors' Plan authorized,
respectively, that had not been issued. As of December 31, 1998 and 1997, the
Company had issued a total of 13,473 and 12,423 shares, respectively, pursuant
to the Non-Employee Directors' Stock Plans. For 1998 and 1997, compensation
expense resulting from the amortization of the value of these shares was $89,792
and $79,354 respectively.
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1995 Employee Stock Purchase Plan
Effective May 1995, the Company adopted an Employee Stock Purchase Plan
(the "Employee Purchase Plan") pursuant to which the Company is authorized to
issue shares of common stock (the "Employee Purchase Plan Shares"). As of
December 31, 1998 and 1997, the Company had a total of 851,232 and 883,664
shares authorized under the Employee Purchase Plan, respectively, that had not
been issued or optioned. Under the Employee Purchase Plan, each eligible
employee as of May 1995 and each subsequent January 1 has been or shall be
granted an option to purchase up to $25,000 of common stock at the lesser of 85%
of the market price on the date of grant or 85% of the market price on the date
of exercise of such option (the "Exercise Date"), but at not less than book
value per share as of the December 31 immediately preceding the date of grant.
The number of shares subject to each year's option becomes fixed on the date of
grant. Eligible employees include those employees who were employed by the
Company or a subsidiary on a full-time basis as of May 1995 and those employees
with six months of service who are so employed by the Company or subsidiary as
of each subsequent January 1. Options granted under the Employee Purchase Plan
expire if not exercised 27 months after each such option's date of grant.
A summary of Employee Purchase Plan activity and related information for
the years ended December 31 is as follows:
All Options
-----------
1998 1997 1996
---- ---- ----
Outstanding, beginning of year 65,573 71,073 47,268
Granted 74,472 69,930 47,564
Exercised (12,289) (40,631) (10,132)
Forfeited (31,799) (23,723) (13,627)
Expired (10,241) (11,076) -
------- ------- -
Outstanding and exercisable at end of year 85,716 65,573 71,073
Weighted-average fair value of options granted during the year
(calculated as of the grant date) $ 5.94 $ 3.12 $ 2.70
Weighted-average exercise price of options exercised during the year $ 20.69 $ 19.48 $ 18.59
Weighted-average exercise price of options outstanding (calculated as of Dec. 31) $ 19.10 $ 21.58 $ 19.09
Range of exercise prices of options outstanding (calculated as of Dec. 31) $18.43-$19.52 $19.71-$22.47 $18.46-$19.71
Weighted-average contractual life of outstanding options (calculated as of
December 31, in years) 0.9 0.9 0.9
The fair value for these options was estimated at the date of grant using a
Black-Scholes options pricing model with the following assumptions for 1998,
1997 and 1996; risk-free interest rates of 5.00%, 6.00% and 6.30%; a dividend
yield of 7.13%, 8.02% and 8.60%; a volatility factor of the expected market
price of the Company's Common Stock of .139, .096 and .121; and an expected life
of the option of 1.13 years, respectively. The Company has determined that the
pro forma effect on net income and earnings per share for the three years in the
period ended December 31, 1998 of adopting Statement of Financial Accounting
Standards No. 123 "Accounting for Stock-Based Compensation" is not material.
Other
In 1993, the Company issued warrants to purchase up to 188,712 shares of
common stock (the "Warrants"). The Warrants were exercisable for a period of
four years commencing July 1, 1994 at a price of $19.50 per share, the then
current fair market value, subject to adjustment under applicable antidilution
provisions. The holders of the Warrants had the right to require the Company to
include the common stock underlying such Warrants in any registration statement
filed by the Company at the Company's expense. At December 31, 1998 and 1997,
the Company had a total of zero and 162,712 shares, respectively, eligible for
purchase pursuant to the Warrants. During the twelve months ended December 31,
1998 and 1997, the Company had issued a total of 131,510 and 7,673 shares,
respectively, and had cancelled 13,000 and 18,327 shares, respectively, pursuant
to the Warrants. As of December 31, 1998, the Company has no warrants
outstanding.
At December 31, 1998 and 1997, the Company had reserved 3,430,112 and
2,216,961 shares, respectively, for future issuance under stock plans.
-23-
10. 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 years in the
period ended December 31, 1998.
Year Ended Year Ended Year Ended
Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996
------------- ------------- -------------
Basic EPS
Average Shares Outstanding 24,573,885 18,605,876 13,254,233
Actual Restricted Stock Shares (529,943) (383,633) (239,947)
-------- -------- --------
Denominator - Basic 24,043,942 18,222,243 13,014,286
========== ========== ==========
Net income $ 40,478,407 $ 31,212,289 $ 19,731,623
Preferred Stock Dividend (554,688) 0 0
-------- - -
Numerator - Basic $ 39,923,719 $ 31,212,289 $ 19,731,623
============== ============== =============
Per share amount $ 1.66 $ 1.71 $ 1.52
============== ============== =============
Diluted EPS
Average Shares Outstanding 24,573,885 18,605,876 13,254,233
Actual Restricted Stock Shares (529,943) (383,633) (239,947)
Dilution for Convertible Debentures 40,017 0 0
Restricted Shares - Treasury 405,235 276,890 205,097
Dilution For Employee Stock Purchase Plan 15,597 25,032 13,981
Dilution For Warrants 19,809 48,327 27,927
------ ------ ------
Denominator - Diluted 24,524,600 18,572,492 13,261,291
========== ========== ==========
Numerator - Basic $ 39,923,719 $ 31,212,289 $ 19,731,623
Convertible Subordinated Debenture Interest 63,638 0 0
------ - -
Numerator - Diluted $ 39,987,357 $ 31,212,289 $ 19,731,623
============== ============= ============
Per share amount $ 1.63 $ 1.68 $ 1.49
============== ============= ============
11. Commitments
As of December 31, 1998, the Company had a net investment of approximately
$72.2 million in thirteen build-to-suit developments in progress, which have a
total remaining funding commitment of approximately $34.7 million. The Company
also has 21 mortgages under development at December 31, 1998, which have a total
remaining funding commitment of approximately $28.2 million.
As a part of the Capstone merger, agreements were entered into with three
individuals affiliated with Capstone that restrict competitive practices and
which the Company believes will protect and enhance the value of the real estate
properties acquired from Capstone. These agreements provide for the issuance of
150,000 shares per year of common stock of the Company to the individuals on
October 15 of the years 1999, 2000, 2001, and 2002, provided all terms of the
agreement are met.
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12. Other Data
Funds From Operations (Unaudited)
Funds from operations, 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. Funds from operations 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.
Year Ended Dec. 31,
-------------------
(Unaudited)
(Dollars in thousands) 1998 1997
---- ----
Net Income (1) $ 40,479 $ 31,212
Non-recurring items (2) 6,308 112
Gain or loss on dispositions (3) (675) -
Straight line rents (1,264) -
Preferred stock dividend (555) -
Depreciation
Real estate 15,374 11,013
Office F,F&E 0 0
Leasehold improvements 0 0
Other non-revenue producing assets 0 0
- -
15,374 11,013
------ ------
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 19,189 11,125
------ ------
Funds From Operations - Basic $ 59,667 $ 42,337
============ ===========
Convertible Subordinated Debenture Interest 64 0
-- -
Funds From Operations - Diluted $ 59,731 $ 42,337
======== ===========
Shares Outstanding - Basic 24,043,942 18,222,243
========== ==========
Shares Outstanding - Diluted 24,524,600 18,572,492
========== ==========
Funds From Operations Per Share - Basic $ 2.48 $ 2.32
============ ===========
Funds From Operations Per Share - Diluted $ 2.44 $ 2.28
============ ===========
(1) 1998 and 1997 amounts include $1.4 million and $0.7 million, respectively,
of stock-based, long-term, incentive compensation expense, a non-cash expense.
(2) Represents charges primarily to write off certain capitalized costs,
leasehold improvements, organization and other deferred costs in 1998 and a loss
from a debt restructuring in 1997.
(3) Represents gains from sales of a real estate property and a tract of land.
Return of Capital
Distributions in excess of earnings and profits generally constitute a
return of capital. For the years ended December 31, 1998, 1997 and 1996,
dividends paid per share of common stock were $2.07, $1.99 and $1.91,
respectively, which consisted of ordinary income per share of $2.07, $1.72 and
$1.65 and return of capital per share of $0.00, $0.27 and $0.26, respectively.
For the year ended December 31, 1998, dividends paid per share of preferred
stock were $0.46, all of which was ordinary income.
-25-
13. Fair Value of Financial Instruments
The carrying amounts of cash, receivables and payables are a reasonable
estimate of their fair value due to their short-term nature. The fair value of
notes and bonds payable is estimated using discounted cash flow analyses, based
on the Company's current incremental borrowing rates for similar types of
borrowing arrangements. The difference between the carrying amount and the fair
value of the Company's notes and bonds payable is not significant. At December
31, 1998, the carrying value of mortgage notes receivable approximates fair
value based on the present value of future cash flows using current market
interest rates.
14. Subsequent Events
On January 26, 1999, the Company declared an increase in its quarterly
dividend from $.525 per share ($2.10 annualized) to $.53 per share ($2.12
annualized) payable on February 16, 1999 to shareholders of record on February
5, 1999. On February 17, 1999, the Company received proceeds of approximately
$8.1 million from the sale of an ancillary hospital facility in Savannah,
Georgia.
15. Selected Quarterly Financial Data (unaudited)
Quarterly financial information for the years ended December 31, 1998 and
1997 is summarized below:
Quarter Ended
-------------
(In thousands, except per share data) March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
1998
Total revenue $ 17,333 $ 17,730 $ 18,325 $ 39,716
------------ ----------- ----------- ------------
Net income $ 8,606 $ 9,381 $ 3,050 $ 19,442
------------ ----------- ----------- ------------
Funds from operations - Basic $ 11,604 $ 12,316 $ 12,368 $ 23,379
------------ ----------- ----------- ------------
Funds from operations - Diluted $ 11,604 $ 12,316 $ 12,368 $ 23,443
------------ ----------- ----------- ------------
Net income per share - Basic $ 0.44 $ 0.46 $ 0.15 $ 0.52
------------ ----------- ----------- ------------
Net income per share - Diluted $ 0.43 $ 0.45 $ 0.15 $ 0.51
------------ ----------- ----------- ------------
Funds from operations per share - Basic $ 0.60 $ 0.61 $ 0.61 $ 0.65
------------ ----------- ----------- ------------
Funds from operations per share - Diluted $ 0.59 $ 0.60 $ 0.60 $ 0.64
------------ ----------- ----------- ------------
1997
Total revenue $ 12,842 $ 14,265 $ 15,865 $ 16,824
------------ ----------- ----------- ------------
Net income $ 6,339 $ 8,170 $ 8,328 $ 8,375
------------ ----------- ----------- ------------
Funds from operations - Basic $ 9,056 $ 10,873 $ 11,122 $ 11,286
------------ ----------- ----------- ------------
Funds from operations - Diluted $ 9,056 $ 10,873 $ 11,122 $ 11,286
------------ ----------- ----------- ------------
Net income per share - Basic $ 0.39 $ 0.43 $ 0.44 $ 0.44
------------ ----------- ----------- ------------
Net income per share - Diluted $ 0.38 $ 0.42 $ 0.43 $ 0.44
------------ ----------- ----------- ------------
Funds from operations per share - Basic $ 0.56 $ 0.58 $ 0.59 $ 0.60
------------ ----------- ----------- ------------
Funds from operations per share - Diluted $ 0.55 $ 0.57 $ 0.58 $ 0.59
------------ ----------- ----------- ------------
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