ITEM 1. BUSINESS
GENERAL
The Company is a real estate investment trust which owns, leases and invests in a diversified portfolio of healthcare properties (the "Investments"). As of February 28, 1997, the Investments consisted of (i) 67 healthcare properties leased to 18 healthcare operators (the "Leased Properties") and (ii) 22 mortgage loans on healthcare properties (the "Mortgage Loans"). The Investments are located in 17 states primarily in the southeastern and western regions of the United States and represent a variety of facility types in diverse healthcare industry segments. The Investments, including commitments to invest certain of which have been partially funded, have grown from approximately $115 million at inception on June 30, 1994 to approximately $527 million on February 28, 1997.
Substantially all of the leases (the "Leases") for Leased Properties are triple net leases which require the lessees to pay all operating expenses, taxes, insurance and other costs. The Leases generally provide for increases in rent commencing after the first year, have primary terms of 10 to 15 years with options to extend the term at least 10 years and grant the lessees a right of first refusal to acquire the Company's interest. Mortgage Loans generally have initial maturities of between 5 and 15 years and bear interest at a rate which increases annually at either a specified rate or a rate based on the consumer price index. Approximately 67% of the Company's Investments as of February 28, 1997, are operated by public healthcare companies or their subsidiaries, including HEALTHSOUTH Corporation ("HEALTHSOUTH"), Columbia/HCA Healthcare Corporation ("Columbia"), MedPartners, Inc. ("MedPartners"), Integrated Health Services, Inc. ("Integrated Health"), and Tenet Healthcare Corporation ("Tenet").
The Company believes it is an important source of capital for the healthcare industry and intends to continue investing in a high-quality portfolio of properties managed by established operators of rehabilitation, alternate-site care, long-term care and acute-care facilities. The Company diversifies its portfolio by operator, geography, facility type and healthcare industry segment. Management's investment criteria emphasize evaluation of the (i) creditworthiness of a proposed lessee, borrower, guarantor, developer or, under certain circumstances, sublessee of a healthcare facility, (ii) competitive position of a proposed property, (iii) attractiveness of the industry segment and (iv) strategic fit of a proposed property with the Company's existing portfolio. The Company believes that there is significant demand for REIT financing capital in the healthcare industry. In addition, the Company believes that the substantial healthcare industry experience and industry relationships of its management and directors will help the Company identify, evaluate and complete additional investments.
The Company's primary objective is to provide current income for distribution to stockholders. The Company commenced paying quarterly dividends of $.425 per share for the quarter ended September 30, 1994, increased its quarterly dividend to $.445 per share for the quarter ended June 30, 1995, increased it to $.455 per share for the quarter ended June 30, 1996, increased it to $.46 per share for the quarter ended September 30, 1996 and increased it to $.465 per share for the quarter ended December 31, 1996.
INVESTMENT POLICY
The Company's investment objectives are to (i) generate current income for stockholders; (ii) provide the opportunity for additional returns to stockholders through the acquisition and development of additional properties and the acquisition of additional mortgages, which may require the use of additional debt or equity financing; (iii) provide stockholders with the opportunity to realize capital growth resulting from appreciation, if any, in the residual values of any properties acquired; and (iv) preserve and protect stockholders' capital. There can be no assurance that any of these objectives will be realized.
In evaluating potential investments, the Company considers such factors as (i) the geographic area, type of property and demographic profile; (ii) the location, construction quality, condition and design of the property; (iii) the current and anticipated cash available for distribution and its adequacy to meet operational
needs and lease obligations and to provide a competitive market return on equity to the Company's investors; (iv) the potential for capital appreciation, if any; (v) the growth, tax and regulatory environment of the communities in which the properties are located; (vi) the occupancy and demand for similar health facilities in the same or nearby communities; (vii) the mix of private and government sponsored patients; (viii) any potential alternative uses of the facilities; (ix) prospects for liquidity through financing or refinancing; (x) industry segment and operator diversification; and (xi) the suitability of the potential investments in light of maintaining REIT status.
In making future investments, the Company intends to focus on established, creditworthy potential lessees, borrowers and developers which meet the Company's standards for quality and experience of management. In order to determine creditworthiness of potential lessees, borrowers and developers, the Company reviews historical and prospective financial information of lessees, borrowers and developers, together with appropriate financial information of any guarantor. Factors considered in connection with such financial reviews include the net worth, profitability and cash flow, debt position, and the ability to provide additional credit enhancements.
COMPETITION
The Company competes for investments with, among other investors, healthcare providers, other healthcare-related REITs, real estate partnerships and financial institutions. Certain of these investors have greater capital resources than the Company. All of the Investments operate in a competitive environment, and patients and referral sources, including physicians, may change their preferences for a healthcare facility from time to time. The Investments compete with other similar facilities in their various locations for the support of the medical community. Additionally, other healthcare facilities in which the Company may invest will likely compete with similar facilities for the support of the medical community and the general public. Some significant competitive factors for the placing of physicians in ancillary hospital facilities and patients in medical facilities include reputation, physical appearance of the facilities, services offered, quality of care, family preferences, physician services, location and price.
GOVERNMENT REGULATION
The financial condition of the lessees, borrowers, guarantors and sublessees ("Operators") may be affected by changes in the reimbursement, licensing and certification policies of federal, state and local governments for healthcare-related facilities. Certain of the healthcare facilities underlying the Investments may also be affected by changes in accreditation standards or procedures of accrediting agencies that are recognized by governments in the certification process. In addition, expansion (including the addition of new beds or services or acquisition of medical equipment) and occasionally the discontinuation of services of healthcare facilities is generally subjected, in most states, to regulatory approval through state Certificate of Need ("CON") programs.
Rental arrangements are subject to federal and state laws and regulations governing illegal rebates, kickbacks and referrals where co-investors are physicians or others in a position to refer patients to the facilities. The effect of these laws and regulations is generally to prohibit, through the imposition of criminal and civil penalties (including program exclusion), payment arrangements that are construed to include compensation for patient referrals. Although there can be no assurance that government enforcement agencies' and courts' interpretations of these laws will be consistent with that of the Company, the Company does not believe that it has, nor is it aware that any of the Operators have, any rental arrangements that do not comply in all material respects with these laws. Legislative and regulatory proposals may be enacted or adopted in the future that adversely affect physicians and other healthcare providers that invest in healthcare facilities, regardless of whether there is compensation for referrals, by limiting reimbursement by the Medicare and Medicaid programs of otherwise covered services, requiring disclosures of such interests, or imposing civil monetary and criminal penalties for violations of proscriptions against referrals to such facilities.
State CON statutes generally provide that, prior to the addition of new beds, the construction of new facilities or the introduction of new services, a state health planning designated agency ("SHPDA") must
determine that a need exists for those beds, facilities or services. The CON process is intended to promote comprehensive healthcare planning, assist in providing high quality healthcare at the lowest possible cost and avoid unnecessary duplication by ensuring that only those healthcare facilities that are needed will be built.
Typically, the provider of services submits an application to the appropriate SHPDA with information concerning the area and population to be served, the anticipated demand for the facility or service to be provided, the amount of capital expenditure, the estimated annual operating costs, the relationship of the proposed facility or service to the overall state health plan and the cost per patient day for the type of care contemplated. Whether the CON is granted is based upon a finding of need by the SHPDA in accordance with criteria set forth in CON statutes and state and regional health facilities plans. If the proposed facility or service is found to be necessary and the applicant to be the appropriate provider, the SHPDA will issue a CON containing a maximum amount of expenditure and a specific time period for the holder of the CON to implement the approved project.
Licensure and certification are separate, but related, regulatory activities. The former is usually a state or local requirement and the latter is a federal requirement. In almost all instances, licensure and certification will follow specific standards and requirements that are set forth in readily available public documents. Compliance with the requirements is monitored by annual on-site inspections by representatives of various government agencies. To the best of the Company's knowledge, all of the hospitals affiliated with the ancillary hospital facilities have obtained all necessary CONs. To the best of the Company's knowledge, all of the Leased Properties have obtained CONs, where applicable. Loss by a facility of its ability to participate in government sponsored programs because of licensing, certification or accreditation deficiencies or because of program exclusion resulting from violations of law would have adverse effects on its revenues.
The American Medical Association has promulgated ethical guidelines on physician referrals to facilities in which they have an ownership interest. Generally, physicians are prohibited from making referrals to facilities in which they have an ownership interest unless they provide services at the facility (such as surgeons at surgery centers and physicians with staff privileges at hospitals). A narrow exception to this position is permitted when a facility is clearly needed in a community and alternative financing is not available if certain strict conditions are satisfied. While it is generally believed that this position is not intended to affect physician ownership in large, publicly-traded companies such as the Company, physicians considering an investment in the Company should be aware of the existence of these ethical considerations and consider the potential applicability to the proposed investment, including whether the physician is required to disclose his investment to patients referred to such facilities.
In addition to current regulations, the Clinton administration and Congress may propose legislation affecting the payment for and availability of health care services. Aspects of certain health care proposals, such as reductions in Medicare and Medicaid payments, if adopted, could adversely affect Operators. Alternatively, other aspects of reform proposals, such as universal health insurance coverage and coverage of certain previously uncovered services, could have a positive impact on certain Operators. It is not possible at this time to predict what, if any, reforms may be adopted by Congress or state legislatures.
The Company believes that healthcare regulations will continue to change and, therefore, regularly monitors developments in healthcare law. There can be no assurance that the operators of all of the Leased Properties will remain in compliance with applicable law.
MEDICAID, MEDICARE, BLUE CROSS AND OTHER REVENUE SOURCES
Payments for patient care earned by Operators are received from the federal Medicare program, state Medicaid programs, private insurance carriers, employers and Blue Cross plans, health maintenance organizations, preferred provider arrangements and directly from patients. Medicare payments to acute-care hospitals for inpatient services are made pursuant to the Prospective Payment System ("PPS") under which a hospital is paid a prospectively established rate based on diagnosis. In general, Medicare payments for psychiatric, cancer, long term, children's and rehabilitation hospitals, as well as distinct rehabilitation and psychiatric units in general hospitals, are exempt from PPS and continue to be reimbursed on a reasonable cost basis system.
Under regulations effective October 1, 1991, the capital related costs of PPS hospitals are to be reimbursed by the Medicare program on a prospective basis, phased in over a 10-year transition period, eventually to be a set federal rate. The effects of the new payment methodology on actual levels of reimbursement cannot yet be predicted. Properties not subject to PPS will continue to be reimbursed by Medicare for capital costs on a percentage of cost basis, subject to certain case limitations. Payments from state Medicaid programs for acute care, rehabilitative and psychiatric care are based on reasonable costs or are at fixed or capitated rates. Medicare and Medicaid payments are generally below a facility's actual charge schedule and in some cases payments are limited, delayed or reduced because of federal and sometimes state budget deficits.
In recent years, fundamental changes in the Medicare program (including the implementation of a PPS for inpatient services at medical/surgical hospitals) have resulted in reduced levels of payment for a substantial portion of healthcare services. Moreover, healthcare facilities have experienced increasing pressures from private payors attempting to control healthcare costs, that have in many instances reduced reimbursement to levels approaching that of government payors. Considerable uncertainties surround the future determination of payment levels under the Medicare program for inpatient hospital services as well as outpatient services. Certain types of healthcare services, such as ambulatory surgical centers, are undergoing major changes in utilization, services covered and reimbursement methodologies. The Company can not predict what impact these types of changes might have on the Company or the Operators.
The federal Medicare program adopted a system of reimbursement of physician services, known as resource-based relative value scale ("RBRVS"), which took effect in 1992 and was phased in through 1996. The RBRVS fee schedule and other future changes in Medicare physician reimbursement will result in a decrease from the historical levels of compensation per Medicare patient for certain physicians. In addition, a number of states have received approval from the Department of Health and Human Services to contract with managed care companies, which, in turn, enter into agreements with physicians and hospitals who participate in the Medicaid program. In many instances, physicians and hospitals receive a flat payment per enrollee in the managed care plan. Some hospitals and physicians receiving these capitated payments have experienced reductions in revenues historically received for the treatment of Medicaid patients.
In August 1993, the Omnibus Budget Reconciliation Act of 1993 ("OBRA 1993") was enacted, which included amendments to Medicare and Medicaid laws. The primary focus of these amendments were a reduction in payments to providers furnishing services under Part A of the Medicare program, and to physicians, durable medical equipment suppliers and other providers of services under Part B of the Medicare program. These amendments have resulted in substantial reductions in reimbursements to hospitals.
Considerable uncertainty surrounds the future determination of payment levels for services currently being reimbursed on a cost basis. Also, substantial areas of the Medicare program are subject to legislative and regulatory change, administrative rulings, interpretations, administration discretion, governmental funding restrictions and requirements for utilization review (such as second opinions for surgery and preadmission criteria). These matters, as well as more general governmental budgetary concerns, may significantly reduce payments under such programs made to the Operators' facilities, and there can be no assurance that future Medicare payment rates will be sufficient to cover cost increases in providing services to Medicare patients.
Blue Cross payments in different states and areas are based on costs, negotiated rates or retail rates. Payments from health maintenance organizations and preferred provider organizations generally are negotiated, usually at a discount from published charge schedules, which may take the form of a flat payment per enrollee in the plan offered by such organizations.
Third-party payors, including commercial insurance companies, health maintenance organizations, and preferred provider organizations, increasingly demand enhanced quality and lower or discounted prices from healthcare providers. Moreover, many third-party payors are adopting capitated RBRVS-based reimbursement methodologies, which are also likely to reduce potential physician reimbursements and have already adversely affected the income of many physicians. These demands may lead to reductions in present and future reimbursements for services provided by Operators. Such diminution of income could have an adverse effect on the Company's results of operations.
ENVIRONMENTAL MATTERS
Under various federal, state and local environmental laws, ordinances and regulations, an owner of real property may be liable for the costs of removal or remediation of certain hazardous or toxic substances at, under or disposed of in connection with such property, as well as certain other potential costs relating to hazardous or toxic substances (including injuries to persons and adjacent property as well as fines). Most, if not all, of these laws, ordinances and regulations contain stringent enforcement provisions including, but not limited to, the authority to impose substantial administrative, civil and criminal fines and penalties upon violators. Such laws often impose liability without regard to whether the owner knew of, or was responsible for, the presence or disposal of such substances and may be imposed on the owner in connection with the activities of an operator of the property. The cost of any required remediation, removal, fines or personal or property damages and the owner's liability therefor could exceed the value of the property and/or the aggregate assets of the owner. In addition, the presence of such substances, or the failure to properly dispose of or remediate such substances, may adversely affect the owner's ability to sell or lease such property or to borrow using such property as collateral.
Operations at the healthcare facilities underlying the Investments have been and will continue to be subject to numerous federal, state and local environmental laws, ordinances and regulations, including those relating to the generation, segregation, handling, packaging and disposal of medical wastes as well as facility siting, construction, occupational training and safety, disposal of non-medical wastes, underground storage tanks and ash emissions from incinerators. Operations of nuclear medicine departments at some of these facilities also involve the use and handling, and subsequent disposal of, radioactive isotopes and similar materials, activities which are closely regulated by the Nuclear Regulatory Commission and state regulatory agencies. In addition, several of the Investments were built prior to the time prohibitions on the use of asbestos in building construction were enacted and other such facilities may be acquired by the Company in the future.
The Company had Phase I environmental audits conducted on all of the healthcare facilities underlying the Investments. Phase I environmental audits involve preliminary reviews of title and uses of real property with little or no sampling and should not be relied upon as the final determination of the absence of environmental concerns. The audits indicated that none of the Leased Properties owned by the Company or on which the Company has Mortgage Loans contained indications of environmental contamination. Certain of the Investments have asbestos-containing building materials. Any remedial action taken in the future with respect to other properties owned by the Company containing asbestos are required to be paid by the Lessees under the Leases. In addition, all of the Leases and Mortgage Loan documents contain indemnification provisions relating to environmental liabilities or conditions, although there can be no assurances that the Operators will be able to fulfill their indemnification obligations. Moreover, the scope of such indemnification obligations may be limited and there can be no assurances that such indemnification obligations will apply to all environmental costs or liabilities incurred by the Company. Neither the Leases nor the Mortgage Loans give the Company control over the operations of the Operators or their tenants, nor will the Company monitor the properties with respect to environmental matters.
No assurance can be given that the provisions of the Leases and Mortgage Loan documents will fully protect the Company or that any prior owner, lessee, sublessee or future lessee of an Investment did not and will not create environmental conditions not known to the Company. However, the Company is not aware of any such condition or liability that would have a material adverse effect on the Company's results of operations and financial position.
INSURANCE
The Company obtains title insurance with respect to each of the Investments in amounts equal to their respective purchase prices or in the amount of the Company's committed investment, insuring that the Company holds title to each of the Investments free and clear of all liens and encumbrances, except those approved by the Company. The Company believes that the Investments are adequately covered by comprehensive liability, fire, flood (if available) and extended coverage with respect to the Investments with policy specifications and insured limits customarily carried for similar properties. However, there are certain
types of losses which may either be uninsurable or not economically insurable. The Company generally does not require the Operators to carry earthquake insurance with respect to its Investments. This decision was based upon a number of factors, including the structural design of the buildings and the general lack of seismic activity in the areas where the healthcare facilities underlying the Investments are located. Should an uninsured loss occur the Company could lose its investment in, and anticipated profits and cash flow from, an Investment.
EMPLOYEES
As of March 24, 1997, the Company employed ten people. None of the Company's employees is a member of a labor union and the Company considers its relations with its employees to be excellent.
ITEM 2.
ITEM 2. PROPERTIES
HEADQUARTERS
The Company's headquarters are located in offices at 1000 Urban Center Drive, Suite 630, Birmingham, Alabama, which are leased from an unaffiliated party pursuant to a written lease that expires July 31, 1999. The lease covers 6,204 square feet at a rental of $17.66 per square foot, aggregating $109,562 annually.
INVESTMENTS
The following table sets forth as of December 31, 1996, certain information regarding the Company's investments:
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(1) Operators are Lessees, Borrowers, Guarantors or primary sublessees of the healthcare facilities. (2) AHF means ancillary hospital facility, ACH means acute-care hospital, ALF means assisted living facility, ASF means ambulatory surgery facility, CMHH means comprehensive mental health hospital, IDF means integrated delivery facility, IRF means inpatient rehabilitation facility, ORF means outpatient rehabilitation facility, PC means physician clinic, SAC means subacute care facility, and SNF means skilled nursing facility. (3) Based on actual investment at December 31, 1996. (4) Reflects actual income earned for the year ended December 31, 1996.
Ancillary hospital facilities, which are contiguous or adjacent to a hospital, contain physician offices and provide a variety of medical services such as diagnostic, outpatient surgery and rehabilitation services, selected hospital support services and educational and research activities. Acute care hospitals provide a full range of inpatient, acute healthcare services. Assisted living facilities generally provide extended care and a variety of healthcare services to the elderly in a more residential setting. Ambulatory surgery facilities provide various surgical procedures, typically on an outpatient basis. Comprehensive mental health hospitals provide a full range of treatment for psychiatric and chemical dependency disorders. Integrated delivery facilities provide a variety of medical services such as primary care, laboratory and diagnostic services, outpatient surgery and emergency care. Inpatient rehabilitation facilities provide a full range of inpatient rehabilitation services to patients experiencing significant physical disabilities due to various conditions, such as head injury, spinal cord injury, stroke, certain orthopedic problems and neuromuscular disease. Outpatient rehabilitation facilities offer a comprehensive range of rehabilitative healthcare services, including physical and occupational therapy, and focus predominantly on orthopedic injuries, sports injuries, work injuries, hand and upper extremity injuries, back injuries and various neurological/neuromuscular conditions. Physician clinics provide a variety of
outpatient diagnostic and therapeutic healthcare services. Sub-acute care facilities provide monitoring, specialized care and comprehensive rehabilitative therapy required by subacute and medically complex patients. Skilled nursing facilities provide extended care and a variety of acute care healthcare services to the elderly.
SELECTED OPERATORS
Nine of the 17 Operators of the properties underlying the Company's Investments at December 31, 1996, are subject to the reporting requirements of the Securities and Exchange Commission (the "Commission") and file with the Commission annual reports containing audited financial information and quarterly reports for the first three quarters of each fiscal year containing unaudited financial information. Certain summary information is set forth below with respect to five public Operators whose facilities comprise approximately 51.5% of the Company's Investments at December 31, 1996. With respect to such companies, the information provided is derived for the limited purposes of this report from filings made with the Commission.
While the Company has not established any definitive credit criteria, the Company evaluates the creditworthiness of the Operators based upon a review of publicly available financial and other information, as well as a due diligence review of the individual financial statements and other non-financial information provided by the Operators, to the extent available, and other data customarily reviewed when a company makes an acquisition or significant investment. While the Company believes the information is provided in good faith and has no reason to believe that any such information is inaccurate in any material respect, the Company, in most instances, has not and cannot make an independent investigation of such information.
HEALTHSOUTH. HEALTHSOUTH, headquartered in Birmingham, Alabama, is the nation's largest provider of outpatient and rehabilitative healthcare services. HEALTHSOUTH provides these services through its national network of outpatient and inpatient rehabilitation facilities, outpatient surgery centers, medical centers and other healthcare facilities. As of December 31, 1996, HEALTHSOUTH had over 1,000 patient care locations in 50 states. HEALTHSOUTH's 1996 revenues were approximately $2.4 billion.
On February 18, 1997, HEALTHSOUTH entered into a plan and agreement of merger with Horizon/ CMS Healthcare Corporation. As a result of the merger, HEALTHSOUTH will acquire 33 inpatient rehabilitation hospitals, 58 specialty hospitals and subacute units, 282 outpatient rehabilitation facilities, 267 long-term care facilities that Horizon/CMS owns, leases or manages, a contract therapy business holding 1,400 contracts, an institutional pharmacy business serving 38,500 beds, and other healthcare services.
The following is a summary of certain financial information for HEALTHSOUTH:
HEALTHSOUTH SUMMARY CONSOLIDATED FINANCIAL INFORMATION
COLUMBIA/HCA. Columbia/HCA, headquartered in Louisville, Kentucky, provides a full range of inpatient and outpatient services and is one of the leading hospital owners and management companies in the United States. Major services provided by Columbia/HCA and its affiliated entities include acute inpatient care, inpatient psychiatric care, outpatient diagnostic services, outpatient surgery programs, outpatient psychiatric services, rehabilitation services, skilled nursing care and home healthcare/infusion services. At February 28, 1997, Columbia/HCA operated 347 hospitals, 147 surgery centers and more than 550 home health agencies and extensive ancillary service providers in 37 states, England and Switzerland. Columbia/HCA is building comprehensive networks of healthcare services, including home health, rehabilitation and skilled nursing units in local markets around the country.
MEDPARTNERS. MedPartners, with annualized revenues of approximately $5.1 billion, is the largest physician practice management company in the United States. MedPartners develops, consolidates and manages integrated healthcare delivery systems. Through its network of affiliated group and independent practice association ("IPA") physicians, MedPartners provides primary and specialty health care services to prepaid managed care enrollees and fee-for-service patients. MedPartners also operates one of the largest independent prescription benefit management programs in the United States and provides disease management services and therapies for patients with certain chronic conditions. As of December 31, 1996, MedPartners operated in 25 states through affiliations with approximately 8,875 physicians, including approximately 2,603 in group practices, 5,314 through IPA relationships and 958 who were hospital-based, providing healthcare to approximately 1.6 million prepaid enrollees.
INTEGRATED HEALTH. Integrated Health, formed in 1986, and headquartered in Owings Mills, Maryland, is one of the nation's leading providers of subacute healthcare services. Integrated Health's strategy is to use geriatric care facilities as platforms to provide a wide variety of medical and rehabilitative services more typically delivered in the acute-care hospital setting. Integrated Health's focus on providing subacute care is designed to address the fact that cost containment measures implemented by private insurers and limitations on government reimbursement of hospital costs have resulted in the discharge from hospitals of many patients who continue to require subacute care. These patients often cannot be effectively cared for in the home because of the complex monitoring and specialized medical treatment required. Because geriatric care facilities have lower capital and operating costs than acute-care hospitals, Integrated Health is able to offer these complex medical services at a significantly lower cost than acute-care hospitals. As of December 31, 1996, Integrated Health operated over 1,000 post-acute service locations in 40 states throughout the United
States. On October 21, 1996, Integrated Health announced that it had entered into a definitive merger agreement pursuant to which it will acquire Coram Healthcare Corp, which is the largest provider of home infusion services with annualized 1996 revenues of $532 million and 112 locations in 43 states.
TENET. Tenet Healthcare Corporation, headquartered in Santa Barbara, California, owns and operates 127 hospitals and numerous ancillary healthcare operations serving communities in 22 states. On January 30, 1997, Tenet acquired OrNda HealthCorp in a transaction accounted for as a pooling of interests. A substantial number of OrNda's 50 general hospitals complement the 77 general hospitals owned or leased by Tenet prior to the merger, particularly in south Florida and southern California. As of January 30, 1997, the combined company had approximately 97,000 employees and pro forma revenues of $8.8 billion for the 12 months ended November 30, 1996.
LEASES
Each Lease relates to a healthcare facility, comprised generally of the land, buildings, other improvements and certain fixtures, for a use, in most cases, restricted to the intended healthcare related use and for such other uses as may be necessary in connection with or incidental to such use (the "Primary Intended Use"). Generally, personal property is not being purchased or leased, although the Company has been granted an option to purchase any personal property necessary or appropriate for the operation of the Leased Properties for an amount equal to the then-current book value (original cost less accumulated depreciation on the books of the Lessee). The Leases have initial terms ranging from 10 to 15 years with the majority having one or more renewal terms providing in total at least 10 additional years exercisable by the Lessee. The Leases are subject to earlier termination upon the occurrence of certain contingencies. Base rent varies by Lease, taking into consideration many factors, including the credit of the Lessee, purchase price of the property, operating performance of the facility, location, type and physical condition of the facility. The Leases generally provide for additional rent commencing after the first year based on either a set percentage increase on a rate based on the consumer price index, with annual increases generally limited to a maximum of 5%.
Each Lease is a triple net lease and the Lessee is responsible thereunder, in addition to base rent and any additional rent, for all additional charges, including any fines, penalties, interest and costs which may be levied for nonpayment or late payment thereof, all taxes, assessments, levies, fees, water and sewer rents and charges, all governmental charges with respect to the applicable Leased Property, all utility and other charges, including insurance premiums, incurred in connection with the operation of the Leased Property, and ground rent in the case of the Larkin Medical Building, Virginia Beach, North Lake, North Shore, Great Lakes, Altoona, Mechanicsburg, Southwest General Medical Building, Cape Coral Medical Plaza, Bonita Bay Medical Centre and Sarasota Medical Centre facilities.
Each Lessee is required, at its expense, to maintain its leased property in good order and repair. The Company is not required to repair, rebuild or maintain the Leased Properties. Under certain Leases, the Company must purchase from the Lessees certain structural capital improvements and replacements made by such Lessees or otherwise compensate the Lessees.
Generally, the Leases also contain provisions which generally permit the Lessees, under certain circumstances, to terminate the Leases and to repurchase the applicable Leased Property for a price equal to the Minimum Repurchase Price (as defined in the Leases) or to substitute another property or properties for the applicable Leased Property. These circumstances include (i) the occurrence of certain damage to or destruction of the Leased Properties, (ii) condemnation and (iii) mutual agreement of the parties. The Integrated Health Leases contain an option, commencing at the end of the fifth year, to repurchase the Leased Property for a purchase price equal to the Minimum Repurchase Price (as defined in the Leases). Each of the Lessees has a right of first refusal to purchase the Leased Property during the terms of the Leases and for a short period of time following the expiration of the terms of the Leases on the same terms and conditions as the Company may propose to sell such Leased Property.
DEVELOPMENT ARRANGEMENTS
The Company has entered into certain development funding arrangements to provide the funding to enable healthcare operators to build facilities on property owned or leased by the Company. The Company views development funding as an effective way to acquire prime investments and to meet the significant demand on the part of qualified operators for funds for development of healthcare facilities. Providing such capital will, management believes, enhance the Company's position as a provider of funds for the healthcare industry.
The Company contracts with a qualified third party developer to construct a facility. Prior to making any funding advance for a development, the Company will enter into a contract to acquire or ground lease the real estate, will enter into a triple net lease with the third party developer and will have approval authority with regard to plans, specifications, budgets and time schedules for the completion of the development of the property. Under the terms of the development funding agreements, the Company will receive funding fees (the economic equivalent of construction period interest) on all funds advanced. Timely completion of the development in compliance with the plans, specifications, budgets and time schedules will be the contractual responsibility of the third party developer. All construction and service contracts relating to the development will be assigned to the Company. During the term of the development of a facility, funds will be advanced pursuant to requests made by the third party developer in accordance with the terms and conditions of the applicable funding agreement based on costs incurred prior to the date of such requests. As construction progresses, the Company will receive monthly reports evidencing the third party developer's compliance with the plans, specifications, budgets and time schedules, certified by appropriate architects and engineers. Change orders, if any, to the plans, specifications, budgets and time schedules will be permitted only with the approval of the Company.
Failure by the third party developer to comply with the terms of the funding agreements, including inability to meet budgets and time schedules, will constitute a default on the part of the third party developer. Depending on the nature of the default, the Company will have remedies available to it, including the authority to remove the third party developer and undertake completion of the development at the expense of the third party developer or the right to require completion of the development property or repayment of the funds invested by the Company pursuant to guarantees of the parent company of the developer. The Company believes that it has the requisite development and construction management oversight experience to complete, if necessary, a development. Upon completion of the development, the applicable Operator will have the obligation to undertake its responsibilities under the applicable Lease.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not aware of any legal action pending or threatened against it.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of stockholders during the fourth quarter of 1996.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed on the New York Stock Exchange ("NYSE") under the symbol "CCT". The following table sets forth, for the fiscal periods indicated, since the Common Stock began trading, the high and low closing sales prices of the Common Stock on the NYSE, and the dividend distributions per share declared by the Company with respect to each applicable quarter:
On March 24, 1997, the closing price of the Common Stock on the NYSE was $22 1/2 per share. As of March 14, 1997, 14,288,529 shares of Common Stock were issued and outstanding and held by approximately 500 record holders.
The Company intends to continue its policy of paying quarterly cash dividends. Future dividends will be dependent, however, upon the Company's earnings, financial requirements and other relevant factors.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The information set forth under the caption "Selected Financial Data", set forth on Page 5 of the Company's 1996 Annual Report to Shareholders, is incorporated herein by reference.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's information relating to the management's discussion and analysis of financial condition and results of operations, set forth on pages 10 through 16 of the Company's 1996 Annual Report to Shareholders under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," is incorporated herein by reference.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements and the related notes thereto, together with the report of KPMG Peat Marwick LLP thereon, set forth on Pages 17 through 27 of the Company's 1996 Annual Report to Shareholders, are incorporated herein by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors
The information with respect to directors, set forth under the caption "Election of Directors" on pages 2 through 4 of the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 1, 1997, is incorporated herein by reference.
EXECUTIVE OFFICERS
The executive officers of the Company are as follows:
Mr. Scrushy is Chairman and Chief Executive Officer of HEALTHSOUTH Corporation and is a co-founder of the Company. Prior to founding HEALTHSOUTH in 1983, Mr. Scrushy served as a Vice President of Lifemark Corporation, a NYSE-listed company. He also serves on the Board of Directors of Integrated Health Services, Inc., and MedPartners, Inc.
Mr. McRoberts was a senior officer of AmSouth Bank of Alabama (formerly AmSouth Bank N.A.), headquartered in Birmingham, Alabama, prior to becoming a co-founder, President and Chief Executive Officer of the Company. He was employed by AmSouth Bank from 1977 to 1993 and most recently was head of Corporate Banking for the Birmingham area. Mr. McRoberts' responsibilities at AmSouth also included oversight of the bank's entire healthcare lending portfolio and the Birmingham based real estate lending portfolio.
Mr. Harlan was a senior vice president of SouthTrust Bank, N.A., headquartered in Birmingham, Alabama, prior to becoming employed by the Company. He was employed by SouthTrust Bank, N.A. from 1976 to 1993 and was most recently head of the bank's healthcare lending area. Mr. Harlan serves on the advisory board of Carraway Medical Center, Inc.
Mr. Kizer, a certified public accountant, was a senior manager with KPMG Peat Marwick in its Birmingham office prior to becoming employed by the Company. Mr. Kizer was employed at KPMG Peat Marwick from 1985 to 1993. Prior to that time he was employed by Arthur Andersen in its Birmingham office.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information under the caption "Executive Compensation," set forth on pages 7 through 12 in the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 1, 1997, is incorporated herein by reference. The Comparative Performance Graph and the Compensation Committee Report on Executive Compensation, also included in the Proxy Statement, are expressly not incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the caption "Security Ownership of Certain Beneficial Owners and Management," set forth on pages 6 through 7 in the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 1, 1997, is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the caption "Certain Relationships and Related Transactions," set forth on page 13 in the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 1, 1997, is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Index to Consolidated Financial Statements, Consolidated Financial Statement Schedules and Exhibits.
1. Consolidated Financial Statements: The following consolidated financial statements of Capstone Capital Corporation are incorporated herein by reference in Item 8 from the Company's 1996 Annual Report to Shareholders:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1996 and December 31, 1995.
Consolidated Statements of Income for the Years Ended December 31, 1996 and December 31, 1995, and for the period from inception to December 31, 1994.
Consolidated Statements of Cash Flow for the Fiscal Years Ended December 31, 1996 and December 31, 1995, and for the period from inception to December 31, 1994.
Consolidated Statements of Stockholders' Equity for the Fiscal Years Ended December 31, 1996 and December 31, 1995, and for the period from inception to December 31, 1994.
Notes to Consolidated Financial Statements.
2. Consolidated Financial Statement Schedules:
Independent Auditors' Report on Consolidated Financial Statement Schedules
Schedule III -- Real Estate and Accumulated Depreciation as of December 31, 1996
Schedule IV -- Mortgage Loans on Real Estate as of December 31,
All other schedules are omitted because they are not applicable or not required or because the information is included in the Company's consolidated financial statements or notes thereto.
3. Exhibits
The exhibits listed on the accompanying Index of Exhibits are filed as a part of this report or are incorporated herein by reference.
The Company agrees to furnish to the Securities and Exchange Commission, upon request, a copy of each instrument defining the rights of holders of the Company's long-term debt.
CAPSTONE CAPITAL CORPORATION WILL FURNISH TO EACH STOCKHOLDER, UPON WRITTEN REQUEST, COPIES OF THE EXHIBITS REFERRED TO ABOVE AT A COST OF TEN CENTS PER PAGE. REQUESTS SHOULD BE ADDRESSED TO: ANDREW L. KIZER, SECRETARY, CAPSTONE CAPITAL CORPORATION, 1000 URBAN CENTER DRIVE, SUITE 630, BIRMINGHAM, ALABAMA 35242.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the last quarter of the fiscal year ended December 31, 1996.
(c) Exhibits
The response to this portion of Item 14 is submitted as a separate section of this report. See Item 14(a)(3) and separate Exhibit Index attached hereto.
(d) Financial Statement Schedules
The response to this portion of Item 14 is submitted as a separate section of this report. See Item 14(a)(2).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Birmingham, State of Alabama, on March 31, 1997.
CAPSTONE CAPITAL CORPORATION
By: /s/ JOHN W. MCROBERTS ------------------------------------ John W. McRoberts, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
INDEX TO EXHIBITS
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors Capstone Capital Corporation:
Under date of January 20, 1997, we reported on the consolidated balance sheets of Capstone Capital Corporation as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for the years ended December 31, 1996 and 1995, and for the period from June 30, 1994 (inception) to December 31, 1994, as contained in the 1996 annual report to stockholders.
These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1996. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedules as listed in the accompanying index. These consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.
In our opinion such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Birmingham, Alabama January 20, 1997 KPMG Peat Marwick LLP
CAPSTONE CAPITAL CORPORATION
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1996
(1) None of the properties is subject to encumbrance except for the Sunrise Mountainview facility which is collateral for a mortgage note with a balance as of 12/31/96 of $23,228,418.
(2) AHF means ancillary hospital facility, PC means off-campus physician clinic, ASF means ambulatory surgery facility, SAC means subacute care facility, IRF means inpatient rehabilitation facility, CMHH means comprehensive mental health hospital and ORF means outpatient rehabilitation facility, SNF means skilled nursing facility, ALF means assisted living facility.
CAPSTONE CAPITAL CORPORATION
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION - (CONTINUED)
(4) Depreciation is calculated using a 40 year life for all completed facilities. (5) Aggregate cost for federal income tax purposes. (6) Properties are under construction. Completion is expected during 1997.
CAPSTONE CAPITAL CORPORATION SCHEDULE IV-MORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1996
(1) Payments are based on an annual interest rate increase of two percent of the rate in effect for the prior twelve month period. Monthly payments are based on a 30 year amortization with a final balloon payment of principal at maturity. The note may be prepaid after August 31, 2001 with a 3% premium which decreases to 1% during the period from August 31, 2001 to August 31, 2004, after which there is no prepayment premium. (2) Payments are based on annual interest rate increases equal to the annual increase in the CPI. Monthly payments are based on a 30 year amortization with a final balloon payment of principal at maturity. The note may be prepaid after August 31, 1999 with a 1% prepayment premium until August 31, 2001, after which there is no prepayment premium. (3) Payments are based on annual interest rate increases equal to the annual increases in the CPI. Interest only payments are due through September 30, 1996 at which time monthly payments begin which are based on a 30 year amortization with a final balloon payment of principal at maturity. The note may be prepaid after August 31, 1999 with a 1% prepayment premium until August 31, 3002 after which there is no prepayment premium. (4) Payments are based on an annual interest rate increase to three percent of the rate in effect for the prior twelve month period. Monthly payments are based on a 25 year amortization with a final balloon payment of principal at maturity. The note may be prepaid at any time with a prepayment premium equal to five percent of the amount prepaid during the first loan year, decreasing by one percent per loan year thereafter. (5) Payments are based on an annual interest rate increase of three percent of the rate in effect for the prior twelve month period. Monthly payments are based on a 10 year amortization with a final balloon payment of principal at maturity. The note may be prepaid at any time with a prepayment premium equal to five percent of the amount prepaid during the first loan year, decreasing by one percent per loan year thereafter. (6) Payments are based on annual interest rate increases equal to the greater of 3% or CPI but no greater than 6%, adjusted annually. (7) Payments are based on a per annum rate of interest equal to 10.5% increased annually on each anniversary date by an amount equal to the greater of 4% or the change in the Consumer Price Index. (8) Interest only payments are due during the construction phase based on the Prime Rate plus 370 basis points, as it fluctuates. Subsequent to the construction period, the outstanding principal balance will bear interest at 12% to be adjusted annually by multiplying the fixed rate by the greater of 1.04 or the annual increase in the U.S. City Average Consumer Price Index for all Urban consumers but not more than 1.06. (9) Principal and all accrued interest are payable on the earlier of demand or January 1, 1998. (10) Interest only payments are due during the construction phase based on the NationsBank at Georgia, N. A. floating commercial rate plus one percent. After completion of construction the interest rate will be determined by adding 350 basis points to the 7 year United States Treasury and will be adjusted each year by adding 27 basis points to the last effective rate.
(11)
(12) Aggregate cost for Federal income tax purposes.