ITEM 1. BUSINESS.
American Health Properties, Inc. (the "Company," which term refers to the Company and its subsidiaries unless the context otherwise requires) is a self-administered real estate investment trust ("REIT") that commenced operations in 1987. The Company has investments in health care facilities that are operated by qualified third party health care providers, as well as a medical office building.
In July 1995, the Company sought to separate the economic attributes of its core portfolio of investments (the "Core Group") and its portfolio of psychiatric hospital investments (the "Psychiatric Group") into two distinct portfolios, with two distinct classes of publicly-traded shares intended to represent those portfolios. On July 25, 1995, the Company distributed one Psychiatric Group Depositary Share (the "Depositary Shares") for every ten shares of the Company's common stock, $.01 par value (the "Common Stock"), held of record on July 14, 1995, each such Depositary Share representing a one-tenth interest in one share of the Company's Psychiatric Group Preferred Stock, $.01 par value (the "Psychiatric Group Stock"). The assets, liabilities and expenses of the Company have been allocated between the two portfolios, and dividends and other payouts or distributions with respect to the Common Stock and the Psychiatric Group Stock are expected to be primarily a function of the individual financial performance of the Core Group and the Psychiatric Group. Accordingly, the Company has separated its business and properties into two distinct business units: (a) the Core Group, which includes the Company's acute care, rehabilitation and long-term acute care hospitals, assisted living, skilled nursing and Alzheimer's care facilities and a medical office building, and (b) the Psychiatric Group, which includes all of the Company's investments in psychiatric hospitals. However, the change in the capital structure of the Company effected by the issuance of the Psychiatric Group Stock does not affect the legal title to assets or responsibility for liabilities of the Company, and each holder of the Company's Common Stock or Depositary Shares is a holder of an issue of capital stock of the entire Company and is subject to risks associated with an investment in the Company and all of its businesses, assets and liabilities.
The Company's principal executive office is located at 6400 South Fiddler's Green Circle, Suite 1800, Englewood, Colorado 80111, and its telephone number at such address is (303) 796-9793.
THE CORE GROUP
The Core Group's current portfolio of investments consists of 13 acute care hospitals, three rehabilitation hospitals, four assisted living facilities, one long-term acute care hospital (currently under construction), four skilled nursing facilities, a medical office building and two Alzheimer's care facilities. As of December 31, 1996, the net book value of the Core Group's total assets was $528 million. Of the Core Group's real estate assets at that date, 84% in net book value represented the acute care segment, 6% represented the rehabilitation segment, 4% represented the assisted living segment, 3% represented the skilled nursing segment, 2% represented the medical office building and 1% represented the Alzheimer's care segment. As of December 31, 1996, all of the Core Group's real estate assets were held in fee.
The Core Group's facilities are diversified geographically across 15 states, are distributed among large and small population centers, and are operated by 13 experienced management companies. These operators include the following companies or their subsidiaries: Tenet Healthcare Corporation ("Tenet," formerly American Medical International, Inc.), Columbia/HCA Healthcare Corporation, Paracelsus Healthcare Corporation, Community Health Systems, Inc. (formerly Dynamic Health, Inc.), PrimeCare International, Inc., Horizon/CMS Healthcare Corporation (formerly Continental Medical Systems, Inc.), Emeritus Corporation, Unison HealthCare Corporation (formerly Signature Health Care Corporation), Shannon Health System, HealthSouth Corporation, CDM/WestMar, Autumn Hills and Spectrum Comprehensive Care, Inc. Facilities operated by Tenet represented 55% of the Core Group's total revenues for the year ended December 31, 1996.
Approximately 73% of the Core Group's property revenues for the year ended December 31, 1996 were secured by corporate guarantees of these operating companies or their subsidiaries. Also, as of December 31, 1996, letters of credit from commercial banks and cash deposits aggregating $18.5 million were available to
the Core Group as security for lease financings. Leases for 15 of the Core Group's facilities, representing 60% of the Core Group's property revenues for the year ended December 31, 1996, contain cross-default provisions.
THE CORE GROUP FACILITIES
The Company's 28 Core Group facilities consist of 13 acute care hospitals (the "Acute Care Hospitals"), three rehabilitation hospitals (the "Rehabilitation Hospitals"), four assisted living facilities (the "Assisted Living Facilities"), one long-term acute care hospital (currently under construction) (the "Long-Term Acute Care Hospital"), four skilled nursing facilities (the "Skilled Nursing Facilities"), a medical office building and two Alzheimer's care facilities (the "Alzheimer's Care Facilities" and together, the "Core Group Facilities"). All of the Core Group Facilities are owned by the Company.
Acute Care Hospitals. The Acute Care Hospitals provide a wide range of services, which may include fully-equipped operating and recovery rooms, obstetrics, radiology, intensive care, open-heart surgery and coronary care, neurosurgery, neonatal intensive care, magnetic resonance imaging, nursing units, oncology, clinical laboratories, respiratory therapy, physical therapy, nuclear medicine, rehabilitation services and outpatient services.
Rehabilitation Hospitals. The Rehabilitation Hospitals provide acute rehabilitation care on a multidisciplinary, physician-directed basis to severely disabled patients. In addition to general medical rehabilitation programs, the Rehabilitation Hospitals offer a number of specialty programs, including pulmonary, ventilator, neurobehavioral, brain injury and pain programs. Each of the Rehabilitation Hospitals is operated pursuant to a joint venture between a publicly-held, national rehabilitation hospital operator and a local health care provider.
Assisted Living Facilities. The Assisted Living Facilities provide a special combination of housing, supportive services, personalized assistance and health care services designed to respond to the individual needs of the elderly and other persons who require help with activities of daily living. These services are available 24 hours a day to meet both scheduled and unscheduled needs in a way that promotes maximum dignity and independence for each resident.
Long-Term Acute Care Hospital. The Long-Term Acute Care Hospital provides care for patients with complex medical conditions that require more intensive care, monitoring, or emergency back-up than that available in most skilled nursing-based subacute programs. Most Long-Term Acute Care Hospital patients have severe chronic health problems and are medically unstable or at risk of medical instability. These patients have historically been treated in general acute care hospitals. The most common cases treated in this setting include high acuity ventilator-dependent patients and patients with multiple system failures related to cancer, spinal cord injuries or head injuries. The average length of stay in this setting commonly ranges from 60 to 90 days.
Skilled Nursing Facilities. The Skilled Nursing Facilities are skilled nursing centers that provide a broad range of health care services, including skilled nursing care, subacute care, rehabilitation therapy and other specialized services to the elderly and to other patients with medically complex needs who can be cared for outside of the acute care hospital environment and generally cannot be efficiently and effectively cared for at home.
Medical Office Building. The Company owns a 60,000 square-foot medical office building located in Murrieta, California known as Walsh Medical Arts Center. The medical office building is located across the street from Sharp Healthcare Murrieta, a developing medical campus that includes 49 acute care beds and 42 skilled nursing beds operated by Sharp Healthcare system of San Diego.
Alzheimer's Care Facilities. The Alzheimer's Care Facilities were developed in consultation with leading medical experts in the treatment of Alzheimer's disease and dementia, and have a strong health care orientation rather than the more customary residential care orientation.
The following is a listing of the Core Group portfolio of investments as of March 1, 1997.
CORE GROUP FACILITIES
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(1) Reflects gross investment, except for facilities under construction, for which the Company's total investment commitment is reflected.
(2) Reflects contract rate of annual base rent received or estimated to be received upon completion of construction. (3) Each lease provides the lessee with renewal options to extend the term of the lease beyond the primary term.
(4) Currently under construction.
(5) Autumn Hills is the operator of these facilities. MQ Development I, L.P. is the lessee of Pinehaven I and MQ Development II, L.P. is the lessee of Pinehaven II.
See the Notes to the Consolidated Financial Statements, the Notes to the Core Group Combined Financial Statements and Schedule III -- Real Estate and Accumulated Depreciation included in this Annual Report on Form 10-K for additional information regarding the Core Group Facilities and for the carrying value and accumulated depreciation of the Core Group Facilities.
THE PSYCHIATRIC GROUP
The Psychiatric Group's portfolio of psychiatric hospital investments consists of three psychiatric hospitals owned by the Company and two mortgage loans secured by psychiatric hospitals (the "Psychiatric Hospitals"). As of December 31, 1996, the net book value of the Psychiatric Group total assets was $63.3 million. Of the Psychiatric Group's real estate assets at that date, 35% in net book value were held in fee and 65% in net book value were held as mortgages.
The Psychiatric Hospitals provide a wide range of inpatient and outpatient care for children, adolescents and adults, including specialized care relating to eating disorders, substance abuse and psychiatric illness. Fundamental changes in the psychiatric industry in recent years have reduced the operating cash flow at the
Psychiatric Hospitals. These changes have had, and may continue to have, an adverse effect on the results of operations of the Psychiatric Hospital operators and borrowers. As a result, certain of the Psychiatric Hospital operators have had, and may continue to have, difficulty meeting their payment obligations to the Psychiatric Group. See "Management's Discussion and Analysis of Psychiatric Group Combined Financial Condition and Results of Operations -- Operating Results -- Future Operating Results" included elsewhere herein.
The following is a listing of the current Psychiatric Group portfolio of investments as of March 1, 1997.
PSYCHIATRIC GROUP HOSPITALS
- --------------- (1) Reflects gross investment less write-downs.
(2) Reflects contract rate of annual base rent or interest.
(3) Each lease and mortgage provides the lessee or borrower with renewal options to extend the term of the lease or mortgage beyond the primary term.
(4) Investment held in the form of a mortgage rather than owned by the Company.
(5) Quorum is the operator of these facilities. The Anclote Psychiatric Hospital, Ltd. is the lessee of Northpointe Behavioral Health System and The Retreat Psychiatric Hospital, Ltd. is the lessee of The Retreat.
(6) Actual base rent received for the year ended December 31, 1996 for Northpointe Behavioral Health System, The Retreat and Rock Creek Center was $200,000, $1,100,000 and $667,000, respectively. See "Management's Discussion and Analysis of Psychiatric Group Combined Financial Condition and Results of Operations" included elsewhere herein.
See the Notes to the Consolidated Financial Statements, the Notes to the Psychiatric Group Combined Financial Statements and Schedule III -- Real Estate and Accumulated Depreciation included in this Annual Report on Form 10-K for additional information regarding the leased Psychiatric Hospitals and the mortgage loans and for the carrying value and accumulated depreciation of the Psychiatric Hospitals.
LEASES AND MORTGAGE LOANS
The Company owns the 13 Acute Care Hospitals, three of the Psychiatric Hospitals, the three Rehabilitation Hospitals, the four Assisted Living Facilities, one Long-Term Acute Care Hospital (currently under construction), the four Skilled Nursing Facilities, a medical office building and the two Alzheimer's
Care Facilities which are collectively referred to herein as the "Leased Properties" or individually as a "Leased Property".
The leases for the Leased Properties provide for base rental rates that generally range from 9.0% to 13.4% per annum of the acquisition price less write-downs of the related Leased Property. Rental rates vary by lease, taking into consideration many factors, including, but not limited to, credit of the lessee, operating performance of the Leased Property, interest rates, and location, type and physical condition of the Leased Property. The leases provide for additional rents that are generally based upon a percentage of increased revenues over specified base period revenues of the related Leased Properties.
The obligations under the leases are generally guaranteed by the parent corporation of the lessee, if the lessee is a subsidiary, or have some other form of credit enhancement such as a letter of credit or a security deposit. Certain of the Company's leases are with subsidiaries of the operators described above and are non-recourse to such operators. Approximately 66% of the Company's property revenues for the year ended December 31, 1996 were secured by corporate guarantees. Also, as of December 31, 1996, letters of credit from commercial banks and cash deposits aggregating $20.5 million were available to the Company as security for lease and construction development obligations.
The leases are on a "triple net" basis, and the lessee is responsible thereunder for all additional charges, including every fine, penalty, interest and cost that may be levied for non-payment or late payment thereof, for taxes, assessments, levies, fees, water and sewer rents and charges, all governmental charges with respect to the Leased Property and all utility and other charges incurred in the operation of the Leased Property. Each lessee is required, at its expense, to maintain the Leased Property in good order and repair. The Company is not required to repair, rebuild or maintain the Leased Properties.
Core Group Facilities
Acute Care Hospitals. The Acute Care Hospital leases provide for a fixed term of ten to 17 years and one or more renewal options of from five to ten years each. In addition to monthly base rent, all of the Acute Care Hospital leases provide for the quarterly payment of additional rent in an amount equal to (i) a specified percentage of the amount by which the gross revenues (as defined) attributable to the Leased Property for the year exceeded the gross revenues derived from such Leased Property during a specified base year ("Excess Gross Revenues") up to a designated dollar amount (the "Transition Amount"). Should the Transition Amount be reached in any year, additional rent is equal to a reduced percentage of the Excess Gross Revenues for the remainder of such year.
Pursuant to the terms of the Acute Care Hospital leases, the Company has the right to approve capital expenditures (only in excess of $2 million for certain leases), the option to fund certain capital expenditures under some of the leases and, in certain situations, is obligated to fund approved capital expenditures on terms comparable to the original investment. The base and additional rent provisions of leases are amended when such capital expenditures are funded to reflect the Company's increased investment.
Six of the Acute Care Hospitals are operated by subsidiaries of American Medical International, Inc. ("AMI"), a subsidiary of Tenet, under long-term leases with the Company, which comprised 55% of the Core Group's total revenues for the year ended December 31, 1996. AMI has guaranteed certain obligations of its subsidiaries under such leases and each such lease is cross-defaulted to the other AMI leases. Five of the AMI leases grant to AMI the option, exercisable on not less than six months nor more than 24 months notice, to purchase the Leased Property upon the expiration of any term of the lease at the Fair Market Value of the Leased Property at the expiration of said term. Four of these leases with purchase options expire in 1999 and one of such leases expires in 2004. For purposes of the second preceding sentence, "Fair Market Value" means the price that a willing buyer not compelled to buy would pay to a willing seller not compelled to sell for such property at the applicable expiration less the portion of such price attributable to capital additions paid for by AMI. The determination of such price will take into account (i) that the applicable lease is assumed not to be in effect on the Leased Property and (ii) that the seller of such Leased Property must pay for title insurance and closing costs.
One of the other Acute Care Hospital leases provides the lessee with an option to purchase the property at the end of the term of the lease at the fair market value of the Leased Property. Three of the leases generally provide the lessee with an option to purchase the property at the end of the term of the lease at the greater of the fair market value (or some percentage thereof) or total investment cost (as defined). One of the leases provides the lessee with a purchase option, on or after the fifth anniversary of the lease, at the greater of fair market value or total investment cost (as defined). One of the leases provides the lessee with a purchase option during the term of the lease at a predetermined purchase price designed to provide the Company with a favorable total return on its investment. In addition, this lease provides the lessee with an option to purchase the property at the end of the term of the lease at the greater of 90% of the fair market value of the Leased Property or 125% of the total investment cost (as defined).
Rehabilitation Hospitals. The Rehabilitation Hospital leases provide for an initial term of ten years and three renewal periods of five years each, except in the case of the MountainView Regional Rehabilitation Hospital lease, which provides for two renewal periods of ten years each and a third renewal period of up to fifteen years. In addition to monthly base rent, the Rehabilitation Hospital leases provide for the quarterly payment of additional rent in an amount equal to a specified percentage of Excess Gross Revenues. The Rehabilitation Hospital leases each grant to the operator the option to purchase the Rehabilitation Hospital upon expiration of any term of the lease at the greater of the fair market value of, or the Company's cost basis in, the Rehabilitation Hospital at the expiration of said term.
Assisted Living Facilities. The Assisted Living Facility leases provide for a ten year initial term with six renewal periods of five years each. Each of the four Assisted Living Facilities is operated by an affiliate of Emeritus Corporation ("Emeritus") and all of the facilities are cross-defaulted. The Assisted Living Facility leases provide for monthly base rent plus additional rent payable quarterly in an amount equal to the sum of (i) the additional rent for the immediately preceding year and (ii) an amount equal to a specified percentage of the sum of base rent and additional rent payable for the immediately preceding year. The leases provide the tenant with the option to purchase the property at the end of the fixed term or at the end of any extended term at the greater of (i) fair market value minus the tenant's share of the appreciation amount (as defined) less the fair market value of any improvements funded by the tenant or (ii) the Company's total investment (as defined).
Long-Term Acute Care Hospital. The Company has recently entered into an agreement with Spectrum Comprehensive Care, Inc. ("Spectrum") to provide construction financing for a facility in Amarillo, Texas. The Company will purchase the facility and enter into a ten-year lease with Spectrum upon its completion. The lease will provide for monthly payments of base rent along with quarterly payments of additional rent in an amount equal to four percent of Excess Gross Revenues. The participation rate in Excess Gross Revenues drops to one percent upon reaching a predetermined rate of return. The lease will provide the tenant with three renewal terms of ten years each and the option to purchase the property at the end of the fixed term or at the end of any extended term at the greater of (i) fair market value or (ii) the Company's total investment (as defined). The lease will be guaranteed by Spectrum.
Skilled Nursing Facilities. The Skilled Nursing Facility leases provide for an initial term of ten years and three renewal periods of ten years each. Each of the four Skilled Nursing Facilities is operated by an affiliate of Unison Healthcare Group, Inc. (formerly Signature Health Care Corporation) ("Unison") and all of the facilities are cross-defaulted. Additionally, the obligations under each lease are guaranteed by Unison and an affiliate of Unison. The leases provide for a monthly base rent plus additional rent payable quarterly in an amount equal to the sum of (i) additional rent for the immediately preceding year and (ii) an amount equal to a specified percentage of the sum of base rent and additional rent payable for the immediately preceding year. Each of the Skilled Nursing Facility leases provides the tenant with an option to purchase the property at the end of the fixed term or the end of any extended term at the greater of fair market value or the total investment cost (as defined), provided that the option to purchase the property is simultaneously exercised on each of the four Skilled Nursing Facilities. The leases also provide the tenant with a right of first refusal to purchase the property on the same terms and conditions as received by and acceptable to the Company.
Medical Office Building. The medical office building is master-leased for a seven-year remaining term to a partnership consisting of 22 physicians who are the primary tenants of the building.
Alzheimer's Care Facilities. The Alzheimer's Care Facility leases provide for a ten-year initial term with three renewal periods of ten years each. The Alzheimer's Care Facility leases provide for monthly base rent plus additional rent payable quarterly in an amount equal to the sum of (i) additional rent for the immediately preceding year and (ii) an amount equal to a specified percentage of the sum of base rent and additional rent payable for the immediately preceding year. The leases provide the tenant with the option to purchase the property at the end of the fixed term or at the end of any extended term at a purchase price equal to the greater of the fair market value or total investment cost (as defined).
Psychiatric Group Facilities
Psychiatric Hospitals. The leases for two of the owned Psychiatric Hospitals provide for an initial term expiring in 2000 with three renewal periods for ten years each. The lease for the third owned Psychiatric Hospital has an initial term expiring in 1997 with one renewal period for five years and two renewal periods for ten years each. In addition to monthly base rent, the leases provide for the quarterly payment of additional rent in an amount equal to a specified percentage of Excess Gross Revenues.
The Company has made mortgage loans to two of the Psychiatric Hospitals. The two mortgage loans are secured by first mortgages and security interests in the two separate Psychiatric Hospitals. The two loans are also cross-collateralized. The two mortgage loans have an initial term of ten years with two optional ten-year extension terms. Pursuant to the terms of the mortgage loans, the Company may receive additional interest each year in an amount equal to a specified percentage of Excess Gross Revenues.
Continuing challenges facing psychiatric hospitals have resulted in restructuring of the payment obligations of the operators of the Company's Psychiatric Hospitals during 1996, as well as significant write-downs of such investments in prior years. In addition, late in 1996 the owners of two of the Company's Psychiatric Hospitals in Florida, together with other operators of psychiatric hospitals in Florida, were named in a suit filed by several large insurance companies. The suit alleges wide-spread irregularities with respect to operations in 1994 and prior years. Adverse consequences from this lawsuit will likely have a negative impact on the Psychiatric Group's results of operations and cash flows as well as its quarterly dividend payment. The Company does not believe this litigation will have a material adverse effect on the financial condition or results of operations of the consolidated Company or the Core Group.
For a fuller discussion of the restructuring of the Company's Psychiatric Group investments during 1996 and certain issues facing the operators of the Company's Psychiatric Group Facilities, see "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations -- Operating Results -- Future Operating Results" and "Management's Discussion and Analysis of Psychiatric Group Combined Financial Condition and Results of Operations -- Operating Results -- Future Operating Results" included elsewhere herein.
COMPETITION
The Company competes with health care providers, real estate partnerships, other real estate investment trusts and other investors, including insurance companies and banks, generally in the acquisition, leasing and financing of health care facilities.
Management of the Company believes that the Facilities in which it has invested are providers of high quality health care services in their respective markets. The operators of the Facilities compete on a local and regional basis with other operators of comparable facilities. They compete with independent operators as well as managers of multiple facilities, some of which are substantially larger and have greater resources than the operators of the Facilities. Some of these competing facilities are operated for profit while others are owned by governmental agencies or tax-exempt, not-for-profit organizations. The Company believes that the Facilities compete favorably with other hospitals based upon many factors, including the services and specialties offered,
quality of management, ease of access, reputation and the ability to attract competent physicians and maintain strong physician relationships.
ENVIRONMENTAL MATTERS
Under various federal, state and local laws and regulations, an owner of real estate is liable for the costs of removal or remediation of certain hazardous or toxic substances on such property. Such laws often impose such liability without regard to whether the owner knew of, or was responsible for, the presence of such hazardous or toxic substances. The costs of remediation or removal of such substances may be substantial, and the presence of such substances, or the failure to promptly remediate such substances, may adversely affect the owner's ability to sell such real estate or to borrow using such real estate as collateral. In connection with its ownership and operation of the Facilities, the Company may be potentially liable for such costs.
The Company conducts Phase I environmental assessments on properties it acquires, which assessments are intended to discover information regarding, and to evaluate the environmental condition of, the surveyed properties and surrounding properties. The Phase I assessments typically include a historical review, a public records review, a preliminary investigation of the site and surrounding properties, screening for the presence of asbestos, polychlorinated biphenyls and underground storage tanks and the preparation and issuance of a written report, but do not include soil sampling or subsurface investigations. In each case where Phase I assessments resulted in specific recommendations for remedial actions, the Company's management has taken action with respect to the issues raised.
The Phase I assessments obtained by the Company have not revealed any environmental liability that the Company believes would have a material adverse effect on the Company's business, assets or results of operations. Nevertheless, it is possible that these assessments do not reveal all environmental liabilities or that there are material environmental liabilities of which the Company is unaware. Moreover, no assurances can be given that (i) future laws, ordinances or regulations will not impose any material environmental liability or (ii) the current environmental condition of the Facilities will not be affected by tenants and occupants of the Facilities, by the condition of properties in the vicinity of the Facilities (such as the presence of underground storage tanks) or by third parties unrelated to the Company.
The Company believes that the Facilities are in compliance in all material respects with all federal, state and local ordinances and regulations regarding hazardous or toxic substances. The Company has not been notified by any governmental authority and is not otherwise aware of any material noncompliance, liability or claim relating to hazardous or toxic substances in connection with any of its present or former properties.
GOVERNMENT REGULATIONS AND PAYOR ARRANGEMENTS
Each of the Facilities is a health care related facility and the amount of additional rent or additional interest, if any, which is based on the lessee's or mortgagor's gross revenue, and the ability of the operators of the Facilities to meet their payment obligations to the Company, are subject to changes in the reimbursement policies of federal, state and local governments. In addition, the acquisition or construction of a health care facility is generally subject to state and local regulatory approval.
The operators of most of the Facilities derive a substantial percentage of their total revenues from federal and state health care programs such as Medicare and Medicaid and from other third party payors such as private insurance companies, self-insured employers and health maintenance organizations. Such operators are also subject to extensive federal, state and local government regulation relating to their operations, and the Company's facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with mandated procedures, licensure requirements under state law and certification standards under the Medicare and Medicaid programs. A change in reimbursement levels under the Medicare or Medicaid programs, a reduction in reimbursement by other third party payors or an operator's failure to maintain its certification under the Medicare or Medicaid programs could adversely affect revenues to the Facilities.
In recent years, an increasing number of legislative proposals have been introduced or proposed in Congress and in some state legislatures that would effect major changes in the health care system, either nationally or at the state level. Among the proposals under consideration are cost controls on hospitals, insurance market reforms to increase the availability of group health insurance to small businesses and the requirement that all businesses offer health insurance to their employees. In addition, Congress is considering various proposals relating to the Medicare and Medicaid programs, including a proposal to offer medical savings accounts in lieu of Medicare coverage and a proposal to abandon the current Medicaid funding system in favor of federal block grants to states. The proposals adopted and under consideration by Congress are designed to reduce federal government spending on the Medicare and Medicaid programs. Accordingly, these proposed legislative changes could adversely affect revenues to the Facilities.
Acute Care Hospitals. Acute care hospitals are subject to extensive federal, state and local legislation and regulation. Acute care hospitals undergo periodic inspections regarding standards of medical care, equipment and hygiene as a condition of licensure. In certain states the construction, acquisition or lease of an acute care hospital may be subject to certificate of need review. Various licenses and permits also are required for narcotics, laboratories, pharmacies, radioactive materials and certain equipment. Each facility eligible for accreditation is accredited by the Joint Commission on Accreditation of Health Care Organizations. Accreditation is required for participation in government-sponsored provider programs, such as Medicare and Medicaid.
Acute care hospitals are subject to and comply with various forms of utilization review. In addition, under the Medicare program, each state must have a Professional Review Organization to carry out a federally-mandated system of review of Medicare patient admission, treatment and discharge. Medical and surgical services and practices are extensively supervised by committees of staff doctors at each acute care hospital, and are reviewed by each acute care hospital's local governing board and quality-assurance personnel. New regulations governing the control of disposal of hazardous wastes may increase the costs of operating acute care facilities.
The lessees and mortgagors of the Facilities, which provide acute care hospital services, receive payments for patient care from the federal Medicare program for elderly and disabled patients. Medicaid and other state programs for medically indigent patients, private insurance carriers, employers, Blue Cross or Blue Shield plans, health maintenance organizations, preferred provider organizations and directly from patients.
Medicare payments for most inpatient hospital services provided by acute care general hospitals are made under a "prospective payment system" ("PPS") under which a hospital is paid a prospectively determined rate per discharge. The PPS payment rate includes reimbursement for capital related costs. These rates vary according to a patient classification system that is based on clinical, diagnostic and other factors. Acute care hospitals are reimbursed for cost reimbursable items at a tentative rate with final settlement determined after submission of annual cost reports and audits thereof by the Medicare fiscal intermediary. In general, payments made by Medicare are less than established charges for such services. Medicare payments may be delayed due to audits by Medicare fiscal intermediaries conducted under federal government regulations.
Medicaid payments for acute care hospitals will vary from state to state. These payments may be based on a percentage of reasonable cost, a fixed rate per discharge, a capitated payment, or other payment arrangements. If a state selects a cost-based reimbursement methodology, acute care hospitals are reimbursed at a tentative rate with final settlement determined after submission of annual cost reports and audits thereof by Medicaid. In general, payments made by Medicaid are less than established charges for such services. Additionally, Medicaid payments may be delayed due to state budget deficits and audits by Medicaid fiscal intermediaries conducted under federal government regulations.
Blue Cross and Blue Shield payments in different states and areas are based on cost, a per diem, or other negotiated rates and may also be subject to payment delay. Payments from health maintenance organizations and preferred provider organizations generally are negotiated, either at a discount from charges or on a per capita, risk-sharing basis with stop-loss provisions for high severity cases. In more developed markets such as California and Florida, the Company's hospitals are now entering into risk-sharing, or capitated, arrangements. These arrangements reimburse the hospital based on a fixed fee per participant in a managed care plan with
the hospital assuming the costs of services provided, regardless of the level of utilization. If utilization is higher than anticipated and/or costs are not effectively controlled, such arrangements could produce low or negative operating margins.
Rehabilitation Hospitals. Rehabilitation hospitals are also subject to extensive federal, state and local legislation and regulation. Rehabilitation hospitals are subject to periodic inspections and licensure requirements and construction, acquisition or lease of such hospitals may be subject to certificate of need review. Outpatient rehabilitation services and free-standing inpatient rehabilitation facilities are generally reimbursed under the same payment arrangement as acute care hospitals, except as noted below. Medicare payments for inpatient rehabilitative services are based on reasonable operating cost, subject to a per discharge limitation. If a facility operates below the cost per discharge limitation, it will qualify for a bonus payment. If a facility operates above the cost per discharge limitation, it will be reimbursed solely to the extent of the limitation. Defined capital costs and outpatient services related to Medicare beneficiaries are reimbursed based on reasonable cost. All Medicare inpatient and outpatient services are reimbursed at a tentative rate with final settlement determined after submission of annual cost reports and audits thereof by the Medicare fiscal intermediary. In general, payments made by Medicare are less than established charges for such services. Additionally, Medicare payments may be delayed due to audits by Medicare fiscal intermediaries under federal government regulations.
Assisted Living Facilities. Assisted living facilities are subject to state and local legislation and regulation. Assisted living facilities are not currently regulated by the federal government. Assisted living facilities are subject to licensure requirements, and are surveyed on a regular basis to determine whether such facilities are in compliance with the requirements for participation in the Medicaid program in the states where assisted living facilities are eligible for Medicaid reimbursement. The operator of the Company's Assisted Living Facilities targets the private pay sector of the assisted living services market, and does not target Medicaid patients for admission to its facilities. Private pay patients utilize private insurance sources for payment or use their income and savings to pay for care in assisted living facilities.
Long-Term Acute Care Facilities. The development and operation of Long-Term Acute Care Hospitals (LTACs) are subject to federal, state and local licensure and certification laws which regulate, among other things, the services provided, distribution of pharmaceuticals, equipment, staffing requirements, operating policies, fire prevention and compliance with building codes. LTACs are designated long stay, acute hospitals by the Health Care Financing Administration (HCFA). Medicare payments for LTAC services are based on reasonable operating costs, subject to a per discharge limitation. In order to qualify for exemption from the prospective payment system, LTACs are required to maintain an average length of stay of at least 25 days.
Skilled Nursing Facilities. Skilled nursing facilities are also subject to extensive federal, state and local legislation and regulation. Construction, acquisition or lease of Skilled nursing facilities may also be subject to certificate of need review. Skilled nursing facilities are subject to licensure requirements, and are surveyed on a regular basis to determine whether such facilities are in compliance with the requirements for participation in the Medicare and Medicaid programs. Medicare provides coverage for beneficiaries who require skilled nursing and certain related medical services, such as physical, occupational and speech therapy, pharmaceuticals, medical supplies and ancillary, diagnostic and other necessary services of the type provided by skilled nursing facilities. Medicare benefits are not available for patients requiring intermediate and custodial levels of care. In general, Medicare payments for skilled nursing services are based on the lesser of actual allowable routine, ancillary and capital costs or charges. All Medicare inpatient services are reimbursed at a tentative rate with final settlement determined after submission of annual cost reports and audits thereof by the Medicare fiscal intermediary. Although Medicaid programs vary from state to state, reimbursement rates are typically determined by the state from cost reports filed annually by each facility, on a prospective or retrospective basis. Under most state Medicaid programs, individual facilities are reimbursed on a prospective rate system, subject to retroactive adjustment. Under a prospective system, per diem rates are established based upon certain historical costs of providing services during the prior year, adjusted to reflect factors such as inflation and any additional services required to be performed. Providers must accept reimbursement from Medicaid as payment in full for the services rendered.
Alzheimer's Care Facilities. Alzheimer's care facilities are classified as long-term care facilities and are reimbursed under the same payment arrangements as long-term care facilities to the extent that the operator elects to participate in the Medicare and Medicaid programs.
Psychiatric Hospitals. In addition to the licensing, certificate of need and Medicare/Medicaid rules and regulations, there are a number of specific federal and state laws affecting psychiatric hospitals, such as the regulation of civil commitments of patients, admitting procedures, and disclosure of information regarding patients being treated for chemical dependency. Many states have adopted a "patient's bill of rights" which sets forth standards governing the treatment of patients of psychiatric hospitals, such as using the least restrictive treatment method, allowing patient access to telephone and mail, allowing a patient to see a lawyer, and requiring the patient to be treated with dignity. The lessees and mortgagors of the Psychiatric Hospitals receive payments for patient care from the federal Medicare program for elderly and disabled patients, Medicaid and other state programs for medically indigent patients, private insurance carriers, employers, Blue Cross or Blue Shield plans, health maintenance organizations, preferred provider organizations and directly from patients.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company are as follows:
JOSEPH P. SULLIVAN -- Mr. Sullivan was elected President and Chief Executive Officer of the Company and a member of the Board of Directors effective February 11, 1993. Mr. Sullivan was elected Chairman of the Board of Directors in November 1996. Prior to that, Mr. Sullivan spent 20 years with Goldman, Sachs & Co. where he had overall investment banking responsibility for numerous companies in the health care field.
MICHAEL J. MCGEE -- Mr. McGee has been Senior Vice President and Chief Financial Officer of the Company since January 1996, has served as Treasurer of the Company since August 1995 and has served as Controller of the Company since November 1989. Mr. McGee was a certified public accountant with Arthur Andersen LLP from 1977 to November 1989.
C. GREGORY SCHONERT -- Mr. Schonert has been Senior Vice President and Chief Development Officer of the Company since April 1988. Prior to that Mr. Schonert was Assistance Administrator of Marketing and Planning at St. Joseph's Hospital, Houston, Texas from February 1987. From September 1985 until February 1987, Mr. Schonert was a Manager in the Corporate Development Department of AMI.
THOMAS T. SCHLECK -- Mr. Schleck has been the Senior Vice President and Chief Investment Officer of the Company since April 1996 and Secretary since May 1996. Prior to that Mr. Schleck was a Managing Director/Partner of Covington Group, LC from July 1994 to April 1996, and from October 1988 to May 1994 he was Chief Financial Officer and Treasurer of EPIC Healthcare Group, Inc. From March 1982 to October 1988, Mr. Schleck was Corporate Vice President/Treasurer of AMI, and prior to that, he held various positions in health care lending with Bank of America NT&SA from June 1970 to March 1982.
Each executive officer is elected by the Board of Directors at its first meeting after each annual meeting of the shareholders and serves until such time as his successor is elected.
ITEM 2.
ITEM 2. PROPERTIES.
See "Item 1. Business" for a description of properties owned by the Company or subject to mortgages held by the Company.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not currently involved in any material litigation nor, to the Company's knowledge, is any litigation currently threatened against the Company or its properties, other than routine litigation arising in the ordinary course of business that, if determined adversely, would not have a material adverse effect on the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S VOTING STOCK AND RELATED STOCKHOLDER MATTERS.
The Common Stock of American Health Properties, Inc. is traded on The New York Stock Exchange ("NYSE") under the trading symbol "AHE." The Psychiatric Group Depositary Shares of American Health Properties, Inc. are traded on the NASDAQ National Market System ("NASDAQ") under the trading symbol "AHEPZ." The table below shows the reported high and low sales prices (i) for the Company's Common Stock as reported by the NYSE Composite Tape for the last two fiscal years and the cash dividends declared per share with respect to such periods, and (ii) for the Company's Psychiatric Group Depositary Shares as reported by NASDAQ for the last two fiscal years and the cash dividends declared per share with respect to such periods.
- --------------- (1) On July 25, 1995, the Company made a distribution of one Depositary Share for every ten shares of Common Stock held of record on July 14, 1995, each such Depositary Share representing a one-tenth interest in one share of Psychiatric Group Stock. On July 11, 1995, the Company declared dividends totaling $.5750 for the second quarter of 1995, comprised of a dividend of $.4950 to be paid on the Common Stock and a dividend of $.08 to be paid on each one-hundredth of a share of Psychiatric Group Stock, which is equivalent to $.80 per Depositary Share. The high and low sales prices of the Common Stock for the periods subsequent to July 25, 1995 reflect the value of the Common Stock after the Distribution.
As of March 13, 1997, the reported high and low sales prices (i) for the Company's Common Stock for 1997 were $26 and $22 7/8, respectively, and (ii) for the Company's Psychiatric Group Depositary Shares for 1997 were $19 1/2 and $15 1/2, respectively. As of March 13, 1997, there were approximately (i) 4,303 holders of record and 23,455,027 shares outstanding of the Company's Common Stock, and (ii) 3,477 holders of record and 2,083,931 shares outstanding of the Company's Psychiatric Group Depositary Shares.
In general, dividends on the Company's capital stock are limited by the Company's unsecured revolving credit agreement to 95% of cash flow available for debt service, less interest expense, plus gains on asset dispositions and certain proceeds from the disposition of Psychiatric Group assets after the repayment of Psychiatric Group indebtedness ("PG Excess Proceeds"). Dividends or other distributions paid out of PG Excess Proceeds will be available only for the Psychiatric Group Stock and will be limited to $30 million in the aggregate and $15 million in any calendar year.
The Company expects that quarterly dividends on the Common Stock and the Psychiatric Group Stock in the future will be based primarily upon the funds from operations attributable to the Core Group and the Psychiatric Group, respectively. Specifically, the Company expects to maintain the Common Stock dividend payout ratio at less than 90% of annual funds from operations attributable to the Core Group and the
Psychiatric Group Stock dividend payout ratio (excluding distributions out of PG Excess Proceeds) at less than 95% of annual funds from operations attributable to the Psychiatric Group.
In addition, the Company expects to use the net proceeds from the disposition of the Psychiatric Group assets initially to repay then outstanding inter-Group loans or other debt owed by the Psychiatric Group and then to distribute all remaining net proceeds, if any, to holders of Psychiatric Group Stock by dividend, tender offer, open market or privately negotiated repurchases or otherwise (in cash, or in Common Stock valued at a ten trading day average market value prior to the time of the distribution).
The payment of dividends on the Common Stock and the Psychiatric Group Stock will also be dependent in part upon the financial condition of the Company as a whole.
The Company expects the aggregate annual dividends paid on the Common Stock and the Psychiatric Group Stock to be at least sufficient to cause the Company to maintain its status as a REIT. In order to permit the Company to qualify as a REIT, the Company must distribute to stockholders at least 95% of its annual REIT taxable income (which essentially is its net ordinary income, excluding capital gains). Generally, as a result of non-cash items, primarily depreciation, cash dividends have exceeded and may continue to exceed the Company's REIT taxable income and to that extent represent a return of capital.
Dividends on the Common Stock and the Psychiatric Group Stock will be limited to the available dividend amount attributable to the Core Group and the Psychiatric Group, respectively. The available dividend amount is similar to the amount that would be legally available under Delaware law for the payment of dividends by the Core Group or the Psychiatric Group, as the case may be, if such Group were a separate Delaware corporation. There can be no assurance that there will be an available dividend amount with respect to either Group. As of December 31, 1996, the available dividend amount attributable to the Core Group and the Psychiatric Group as of that date was at least $296.9 million and $48 million, respectively. All dividends on Common Stock will be deemed to be out of the Core Group's funds and all dividends on Psychiatric Group Stock will be deemed to be out of the Psychiatric Group's funds.
Dividends on the Common Stock and Psychiatric Group Stock will be further limited to the amount of funds of the Company legally available under Delaware law for the payment of dividends by the Company on its capital stock. As of December 31, 1996, the funds of the Company legally available for the payment of dividends would have been at least $344.9 million. Payments of dividends on either the Common Stock or the Psychiatric Group Stock will decrease the amount of funds legally available for the payment of dividends on both the Common Stock and the Psychiatric Group Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
Set forth below for the years ended December 31, 1996, 1995, 1994, 1993 and 1992 is (a) selected consolidated financial data with respect to the Company, (b) selected combined financial data for the Core Group, and (c) selected combined financial data for the Psychiatric Group. The selected financial data should be read in conjunction with the Consolidated, Core Group Combined and Psychiatric Group Combined Financial Statements and accompanying Notes included elsewhere herein.
- --------------- (1) Includes gain of $19,742,000 and $11,064,000 in 1993 and 1992, respectively, on the sale of properties or partnership interests therein.
(2) Includes write-downs of $30,000,000 in 1994 and $45,000,000 in 1992 relating to investments in psychiatric properties.
(3) For purposes of computing per share and weighted average data for periods prior to the July 25, 1995 distribution of the Depositary Shares, the number of shares of Common Stock are assumed to be the same as the corresponding number of shares of the Common Stock outstanding prior to July 25, 1995, while the number of Depositary Shares are assumed to be one-tenth of the corresponding number of shares of the Common Stock outstanding prior to July 25, 1995.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Following is a discussion of the consolidated financial condition and results of operations of the Company which should be read in conjunction with the consolidated financial statements and accompanying notes. For discussions of the financial condition and results of operations of the Core Group and the Psychiatric Group, see the management's discussion and analysis of financial condition and results of operations of the Core Group and the Psychiatric Group included elsewhere herein.
Factors Regarding Future Results and Forward-Looking Statements Statements that are not historical facts contained in management's discussion and analysis of financial condition and results of operations are forward-looking statements that involve risks and uncertainties that could cause actual results to differ from projected results. Factors that could cause actual results to differ materially include, among others: the financial success of the operations conducted at the Company's facilities and the financial strength of the operators of such facilities, the continuing ability of operators to meet their obligations to the Company under existing or restructured agreements, changes in operators or ownership of operators, changes in government policy relating to the health care industry including reductions in reimbursement levels under the Medicare and Medicaid programs, operators' continued eligibility to participate in the Medicare or Medicaid programs, reductions in reimbursement by other third party payors, lower occupancy levels at the Company's facilities, the strength and financial resources of the Company's competitors, the availability and cost of capital, the Company's ability to make additional real estate investments at attractive yields and changes in tax laws and regulations affecting real estate investment trusts. For a further discussion of such factors, see "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations -- Future Operating Results" herein.
Distribution of Psychiatric Group Depositary Shares On July 25, 1995, the Company completed the distribution of 2,085,675 Psychiatric Group Depositary Shares to holders of its common stock (the Distribution). Shareholders received one Psychiatric Group Depositary Share for every ten shares of common stock held of record at the close of business on July 14, 1995. Each Psychiatric Group Depositary Share represents one-tenth of a share of Psychiatric Group Preferred Stock. The Distribution was designed to separate the economic attributes of the Company's investments in psychiatric hospitals (the Psychiatric Group) and its investments in acute care, rehabilitation and longterm acute care hospitals, skilled nursing, assisted living and Alzheimer's care facilities and a medical office building (the Core Group) into two distinct portfolios, with two distinct classes of publicly-traded shares intended to represent those portfolios. In connection with the Distribution, the Company directly assigned or, if not directly assigned, allocated its assets, liabilities and stockholders' equity, and its revenues, expenses and cash flow items, between the Core Group and Psychiatric Group. The Psychiatric Group Depositary Shares are intended to reflect the separate financial performance of the Psychiatric Group. The Company's common stock (the Core Group Common Stock) is intended to reflect the separate financial performance of the Core Group. However, the change in the capital structure of the Company effected by the Distribution does not affect the respective legal title to assets or responsibility for liabilities of the Company, and each holder of Core Group Common Stock or Psychiatric Group Depositary Shares is a holder of an issue of capital stock of the entire Company and is subject to the risks associated with an investment in the Company and all of its businesses, assets and liabilities.
OPERATING RESULTS
1996 Compared to 1995
In 1996, the Company reported net income of $44,379,000 compared with net income of $42,381,000 in 1995. Net income in 1995 included a $2,652,000 premium from the prepayment of a mortgage loan and reflects $300,000 of additional costs related to the Distribution. See the Consolidated Statements of Operations for the comparative gross and per share amounts of net income attributable to the Core Group Common Stock and the Psychiatric Group Depositary Shares.
Rental income was $69,488,000 in 1996, an increase of $1,695,000 or 3% from $67,793,000 in 1995. This net increase was primarily attributable to rental income from new properties acquired subsequent to the first quarter of 1995, which was partially offset by a reduction in rental income due to the sale of two psychiatric properties during the first quarter of 1995 and the nonpayment of $734,000 of rent by two psychiatric operators during 1996. The net property additions also resulted in a net increase in depreciation and amortization of $639,000 or 4% to $15,016,000 in 1996 compared with $14,377,000 in 1995.
Mortgage interest income was $5,980,000 in 1996, a decrease of $752,000 or 11% from $6,732,000 in 1995. This net decrease was primarily attributable to the payoff of a mortgage loan on a hospital located in Austin, Texas in October 1995.
Additional rental and interest income was $12,342,000 in 1996, an increase of $1,217,000 or 11% from $11,125,000 in 1995. This positive variation was primarily attributable to increased additional rent from the Company's six original acute care properties.
Other interest income decreased $4,466,000 or 80% to $1,114,000 in 1996 from $5,580,000 in 1995. Other interest income in 1995 included approximately $1,500,000 of interest on a construction loan that subsequently converted to a mortgage loan in the third quarter of 1995. In addition, this variation was due to a lower average balance of borrowings outstanding under revolving credit facilities provided to psychiatric hospital operators, the nonpayment of $182,000 of interest by a psychiatric operator during 1996, and a lower average balance of direct financing leases, partially offset by higher investable cash balances.
Interest expense was $21,842,000 in 1996, a decrease of $5,215,000 or 19% from $27,057,000 in 1995. Interest expense decreased as a result of the $24 million, $29 million and $20 million senior notes maturities in May 1995, May 1996 and September 1996, respectively, lower average bank loan borrowings during 1996 and an increase in capitalized interest in 1996 compared to 1995.
General and administrative expenses were $7,471,000 in 1996, an increase of $632,000 or 9% from $6,839,000 in 1995. This increase was primarily attributable to higher shareholder reporting costs as a result of the Distribution, higher financial advisory services provided primarily by an investment banking firm which included supplemental monitoring of the performance of the Company's psychiatric properties and assistance in addressing operational and cash flow difficulties of certain operators of the psychiatric properties and higher travel and legal costs. In addition, stock incentive expense was lower in 1995 due to the reversal of a significant amount of such expense upon termination of two officers.
The $300,000 of targeted stock issuance costs in 1995 was an additional accrual made in the second quarter of 1995 to reflect the increased costs of the Distribution. The increased costs primarily reflected higher legal and accounting fees and printing and shipping costs as a result of the extended filing period.
1995 Compared to 1994
In 1995, the Company reported net income of $42,381,000 compared with net income of $9,693,000 in 1994. Net income in 1994 reflects a write-down of psychiatric real estate investments of $30,000,000 as a result of accelerating negative trends in the psychiatric industry, and net income in 1995 reflects a reduction in income due to the sale of three psychiatric properties and the lease restructurings of two psychiatric investments subsequent to September 1994. Net income in 1995 included a $2,652,000 premium from the prepayment of a mortgage loan while net income in 1994 included $710,000 of fee income related to the prepayment of a construction loan. Net income for 1995 and 1994 reflect costs related to the Distribution of $300,000 and $1,450,000, respectively. See the Consolidated Statements of Operations for the comparative gross and per share amounts of net income or loss attributable to the Core Group Common Stock and the Psychiatric Group Depositary Shares.
Rental income was $67,793,000 in 1995, an increase of $61,000 from $67,732,000 in 1994. This net increase was primarily attributable to rental income from new properties acquired and various capital additions subsequent to the first quarter of 1994, which was partially offset by a reduction in rental income due to the sale of three psychiatric properties and the lease restructurings of two psychiatric investments. These factors,
combined with lower depreciation expense on psychiatric properties written down in June 1994, resulted in a net increase in depreciation and amortization of $274,000 to $14,377,000 in 1995 compared with 1994.
Mortgage interest income increased $945,000 to $6,732,000 in 1995 from $5,787,000 in 1994. This increase was primarily attributable to the conversion of a construction loan on a hospital located in Austin, Texas to a mortgage loan during the third quarter of 1995. In October 1995, the Company received $29.15 million as proceeds from the payoff of this mortgage loan, which represented $26.5 million in principal and a $2.65 million prepayment premium.
Additional rental and interest income was $11,125,000 in 1995, an increase of $1,619,000 or 17% from $9,506,000 in 1994. This positive variation was attributable to increased additional rent from six of the Company's original acute care properties and more recently purchased properties generating additional rent for the first time in 1995.
Other interest income increased $1,578,000 to $5,580,000 in 1995 from $4,002,000 in 1994. Other interest income in 1995 included a $2.65 million premium from the prepayment of a mortgage loan in October 1995. Other interest income in 1994 included $710,000 of fee income related to the prepayment of a construction loan in February 1994. The remaining net decrease in other interest income during 1995 resulted from a lower average construction loan balance, a lower average balance of short-term investments and a lower average balance of borrowings outstanding under revolving credit facilities provided to psychiatric hospital operators, which was partially offset by a higher average balance of direct financing leases.
Interest expense was $27,057,000 in 1995, an increase of $956,000 or 4% from $26,101,000 in 1994. Interest expense increased as a result of higher average bank loan borrowings during 1995 and a reduction in capitalized interest in 1995 compared to 1994. This was partially offset by a reduction in interest expense on senior notes payable as a result of a $24 million maturity in May 1995.
General and administrative expenses increased to $6,839,000 in 1995 from $5,376,000 in 1994. In the second quarter of 1994, the Company reversed $750,000 of a corporate relocation accrual recorded in the fourth quarter of 1993 after the Company decided to maintain its headquarters in Denver, Colorado. The remaining net increase in 1995 was primarily attributable to increased compensation and benefits expense and costs incurred related to financial advisory services provided to the Psychiatric Group by an investment banking firm.
In 1994, $1,450,000 was accrued for the cost of the planned Distribution. The $300,000 of targeted stock issuance costs in 1995 was an additional accrual made in the second quarter of 1995 to reflect the increased costs of the Distribution. The increased costs primarily reflect higher legal and accounting fees and printing and shipping costs as a result of the extended filing period.
Future Operating Results
The operators of most of the Company's facilities derive a substantial percentage of their total revenues from federal and state health care programs such as Medicare and Medicaid and from other third-party payors such as private insurance companies, self-insured employers and health maintenance organizations. Such operators also are subject to extensive federal, state and local government regulation relating to their operations, and the Company's facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with mandated procedures, licensure requirements under state law and certification standards under the Medicare and Medicaid programs. A reduction in reimbursement levels under the Medicare or Medicaid programs, a reduction in reimbursement by other third-party payors or an operator's failure to maintain its certification under Medicare or Medicaid programs could adversely affect revenues to the Company's facilities.
The nature of health care delivery in the United States continues to undergo change and further review at both the national and state levels. Generally accepted goals of reform continue to include controlling costs and improving access to medical care. Various plans to decrease the growth in Medicare spending have been proposed by both Houses of Congress. These plans have generally included revisions to and limits on Medicare and federal programs providing Medicaid reimbursement to state health care programs and potentially would
have an adverse impact on the level of funds available in the future to health care facilities. The Company's Board and management are monitoring potential changes closely. The Company believes that these potential changes may pose risks for certain institutions that are unwilling or unable to respond. At the same time, the Company believes that this changing health care environment will provide the Core Group with new opportunities for investment.
The ongoing changes in the health care industry include trends toward shorter lengths of hospital stay, increased use of outpatient services, increased federal, state and third-party oversight of health care company operations and business practices, and increased demand for discounted or capitated health care services (delivery of services at a fixed price per capita basis to a defined group of covered parties). Furthermore, federal, state and third-party payors continue to propose and adopt various cost containment measures that restrict the scope of reimbursable health care services and limit increases in reimbursement rates for such services. Payors also are continuing to aggressively enforce compliance with program requirements and to pursue providers that they believe have not complied with such requirements. Outpatient business is expected to increase as advances in medical technologies allow more procedures to be performed on an outpatient basis and as payors continue to direct more patients from inpatient care to outpatient care. In addition, the entrance of insurance companies into managed care programs is accelerating the introduction of managed care in new localities, and states and insurance companies continue to negotiate actively the amounts they will pay for services. Moreover, the percentage of health care services that are reimbursed under the Medicare and Medicaid programs continues to increase as the population ages and as states expand their Medicaid programs. Continued eligibility to participate in these programs is crucial to a provider's financial strength. As a result of the foregoing, the revenues and margins may decrease at the Company's facilities.
Notwithstanding the potential for increasing government regulation, the Company believes that health care will continue to be delivered on a local and regional basis and that well-managed, high-quality, cost-controlled facilities will continue to be an integral part of local and regional health care delivery systems. The Company also believes that certain acute care hospitals will need to reconfigure or expand existing facilities or to affiliate themselves with other providers so as to become part of comprehensive and cost-effective health care systems. Such systems likely will include lower cost treatment settings, such as ambulatory care clinics, outpatient surgery centers, skilled nursing facilities and medical office buildings. In general, the Core Group facilities are part of local or regional health care delivery systems or are in the process of becoming integrated into such systems.
The Company's future operating results could be affected by the operating performance of the Company's lessees and borrowers. The rental and interest obligations of its facility operators are primarily supported by the facility-specific operating cash flow. Real estate investments in the Company's portfolio are generally further supported by one or more credit enhancements that take the form of cross-default provisions, letters of credit, corporate and personal guarantees, security interests in cash reserve funds, accounts receivable or other personal property and requirements to maintain specified financial ratios.
Fundamental changes in the psychiatric industry continue to negatively impact the facility-specific operating cash flow at the Company's psychiatric properties. Institutions responsible for providing insurance coverage to patients who use inpatient psychiatric treatment services have directed efforts toward decreasing their payments for such services, thereby reducing hospital operating revenues. Although the operators of the psychiatric hospitals are responding by increasing case management, developing lower cost outpatient and daypatient programs and reducing operating costs, their efforts are generally not consistently mitigating the negative impact of these fundamental psychiatric industry changes. As a result, certain of the psychiatric hospital operators have not met their contractual payment obligations to the Company as scheduled and there can be no assurance that psychiatric hospital operators will be able to meet such payment obligations in the future. The Company has in the past, restructured obligations and written down its investments in certain psychiatric facilities, and has consented, in certain circumstances, to the release or modification of some of the related credit enhancements.
The Company currently is providing financing under revolving credit agreements to the operators of three of its psychiatric hospitals which are the primary source of financing for these operators' operating and capital
needs. As of March 19, 1997, outstanding borrowings under such agreements totaled $4,225,000, and the Company has committed to fund an additional $1,475,000 of borrowings upon request, subject to certain conditions. To the extent the psychiatric hospitals have increased working capital needs in the future, the Company may be the only source of such financing.
Although management currently believes that the recorded investments in the psychiatric hospitals are realizable, if the psychiatric operators are unable to successfully adapt to the fundamental ongoing changes in the psychiatric industry and consistently mitigate the negative impact of such changes on their financial performance, the Company may be required to further restructure payment obligations, identify and pursue alternative uses for the properties and/or make additional write-downs of the value of its investments in the psychiatric hospitals. The Company does not intend to make new investments in the psychiatric sector, and over time, may sell, restructure or seek other means to reduce its investments in the psychiatric sector. The Psychiatric Group Depositary Shares were distributed in July 1995 in an effort to effectively separate the economic attributes of the Company's psychiatric investments (the Psychiatric Group) from its core investments in acute care, rehabilitation and long-term acute care hospitals, skilled nursing, assisted living and Alzheimer's care facilities and a medical office building (the Core Group).
The dividend on the Company's Psychiatric Group Depositary Shares is determined each quarter based upon the operating results of the Company's Psychiatric Group. Any significant advance of additional funds to psychiatric hospital operators, modification of terms covering the rental or interest obligations of its psychiatric properties or nonpayment or deferral of such obligations as they become due likely will have an adverse impact on the Company's Psychiatric Group results of operations and cash flows, as well as the quarterly dividend payment on Psychiatric Group Depositary Shares. The nonpayment and deferral of rental and interest obligations of two operators in 1996 was responsible for the reduction in the quarterly dividend on Psychiatric Group Depositary Shares from $.80 per share in the fourth quarter of 1995 to $.70 per share in the first quarter of 1996 and $.65 per share in the second and third quarters of 1996. Although the quarterly dividend on Psychiatric Group Depositary Shares was increased to $.80 per share in the fourth quarter of 1996, there can be no assurance that the quarterly dividend will not be reduced in the future.
The future operating results of the Company will be affected by additional factors including the amount, timing and yield of additional real estate investments and the competition for such investments. Operating results also will be affected by the availability and terms of the Company's future equity and debt financing. The Company's financing strategy to facilitate future growth includes objectives to reduce its cost of capital over time and enhance its liquidity and financial flexibility. The Company believes that the distribution of the Psychiatric Group Depositary Shares in 1995 facilitated achievement of these objectives. Subsequent to the Distribution, the Company raised $50.3 million of additional equity for the Core Group in October 1995 through the sale of 2.5 million shares of its Core Group Common Stock and in December 1995, closed on a new $150 million unsecured revolving credit facility with improved pricing and terms. In January 1997, the Company completed its first public debt offering, selling $220 million of unsecured senior notes at a weighted average effective interest rate of approximately 7.56%. The Company used a portion of the proceeds of this offering to prepay $152 million of 11.03% private placement debt in February 1997 prior to its scheduled maturity, incurring an extraordinary charge in the first quarter of 1997 of $11.4 million consisting of a make-whole premium and other costs related to the prepayment.
LIQUIDITY AND CAPITAL RESOURCES
As of March 19, 1997, the Company had remaining commitments to fund real estate projects under construction of approximately $4 million. In addition, the Company had agreed to provide real estate financing to three different operators aggregating approximately $81 million. Of this amount, approximately $46 million has been committed to five assisted living and two skilled nursing projects to be constructed over the next fifteen months and $4.4 million has been committed to the financing of an existing long-term acute care hospital within the next two months. The remaining $30.6 million of financing has not been committed to specific acquisitions or projects. Aggregate unfunded commitments under revolving credit agreements provided to psychiatric hospital operators totaled $1.5 million as of March 19, 1997.
The Company has continued to increase its liquidity and enhance its financial flexibility. In October 1995, the Company received $29.15 million as proceeds from the payoff of its interest in a mortgage loan and completed an offering of 2.5 million additional shares of Core Group Common Stock resulting in net proceeds of $50.3 million. In December 1995, the Company closed on a new $150 million unsecured revolving credit facility which matures on December 27, 1998. In January 1997, the Company completed a $220 million public unsecured debt offering, issuing $100 million of five-year senior notes and $120 million of ten-year senior notes. The Company used the net proceeds to pay off all outstanding borrowings under its $150 million bank facility at the time and to prepay all of its $152 million of outstanding private placement debt in late February 1997. As of March 19, 1997, the Company had no outstanding borrowings under its revolving credit facility and had $3.4 million in cash and short-term investments. The Company's total indebtedness as of March 19, 1997 was $225.6 million. The Company will utilize its revolving credit facility to fund future acquisitions and its other commitments. The Company may incur additional indebtedness or refinance existing indebtedness if the Company determines that opportunities to pursue such transactions would be attractive. The Company's unsecured publicly-traded senior debt carries investment grade ratings from Duff & Phelps Credit Rating Co. (BBB-), Moody's Investors Service (Baa3) and Standard & Poor's (BBB-). The Company currently believes it has sufficient capital to meet its commitments and that its cash flow and liquidity will continue to be sufficient to fund current operations and to provide for the payment of dividends to stockholders in compliance with the applicable sections of the Internal Revenue Code governing real estate investment trusts.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Following is a discussion of the combined financial condition and results of operations of the Core Group which should be read in conjunction with (a) the combined financial statements and accompanying notes of the Core Group and (b) management's discussion and analysis of financial condition and results of operations and the financial statements and accompanying notes of the Company and the Psychiatric Group included elsewhere herein.
Factors Regarding Future Results and Forward-Looking Statements Statements that are not historical facts contained in management's discussion and analysis of financial condition and results of operations are forward-looking statements that involve risks and uncertainties that could cause actual results to differ from projected results. Factors that could cause actual results to differ materially include, among others: the financial success of the operations conducted at the Core Group's facilities and the financial strength of the operators of such facilities, the continuing ability of operators to meet their obligations to the Core Group under existing agreements, changes in operators or ownership of operators, changes in government policy relating to the health care industry including reductions in reimbursement levels under the Medicare and Medicaid programs, operators' continued eligibility to participate in the Medicare or Medicaid programs, reductions in reimbursement by other third party payors, lower occupancy levels at the Core Group's facilities, the strength and financial resources of the Core Group's competitors, the availability and cost of capital, the Core Group's ability to make additional real estate investments at attractive yields and changes in tax laws and regulations affecting real estate investment trusts. For a further discussion of such factors, see "Management's Discussion and Analysis of Core Group Combined Financial Condition and Results of Operations -- Future Operating Results" herein.
OPERATING RESULTS
1996 Compared to 1995
In 1996, the Core Group reported net income of $38,800,000 or $1.65 per share, an increase of $2,693,000 or 7% compared with net income of $36,107,000 or $1.69 per share in 1995. Net income in 1995 included a premium of $2,652,000 or $.12 per share from the prepayment of a mortgage loan.
Rental income was $67,499,000 in 1996, an increase of $2,759,000 or 4% from $64,740,000 in 1995. This increase was primarily attributable to rental income from new properties acquired subsequent to the first quarter of 1995. These property additions also resulted in an increase in depreciation and amortization of $697,000 or 5% to $14,272,000 in 1996 compared with $13,575,000 in 1995.
The Core Group had no mortgage interest income in 1996 compared to $845,000 in 1995 as a result of the payoff of a mortgage loan on a hospital located in Austin, Texas in October 1995.
Additional rental income was $11,530,000 in 1996, an increase of $1,125,000 or 11% from $10,405,000 in 1995. This positive variation was primarily attributable to increased additional rent from the Core Group's six original acute care properties.
Other interest income decreased $4,173,000 or 85% to $721,000 in 1996 from $4,894,000 in 1995. Other interest income in 1995 included approximately $1,500,000 of interest on a construction loan that subsequently converted to a mortgage loan in the third quarter of 1995. In addition, this variation was due to a lower average balance of direct financing leases and higher investable cash balances during 1996 compared with 1995.
Interest income on inter-Group loans to the Psychiatric Group was $1,679,000 in 1996, a decrease of $350,000 or 17% from $2,029,000 in 1995. This decrease reflects a lower average balance outstanding on loans to the Psychiatric Group, which was primarily attributable to $15,150,000 of repayments by the Psychiatric Group from the proceeds of asset sales and the paydown of borrowings under revolving credit agreements provided to Psychiatric Group hospital operators during the first quarter of 1995.
Interest expense was $21,842,000 in 1996, a decrease of $5,215,000 or 19% from $27,057,000 in 1995. Interest expense decreased as a result of the $24 million, $29 million and $20 million senior notes maturities in
May 1995, May 1996 and September 1996, respectively, lower average bank loan borrowings during 1996 and an increase in capitalized interest in 1996 compared to 1995.
General and administrative expenses were $6,299,000 in 1996, an increase of $401,000 or 7% from $5,898,000 in 1995. This variation was attributable to an increase in the Company's consolidated general and administrative expenses which are allocated between the Core Group and Psychiatric Group primarily based on revenues, and an increase in Core Group revenues relative to the Company's consolidated revenues. The increase in the Company's consolidated general and administrative expenses affecting the Core Group was primarily attributable to higher shareholder reporting costs as a result of the Distribution and higher travel and legal costs. In addition, stock incentive expense was lower in 1995 due to the reversal of a significant amount of such expense upon termination of two officers.
1995 Compared to 1994
In 1995, the Core Group reported net income of $36,107,000 or $1.69 per share compared with net income of $32,548,000 or $1.56 per share in 1994. Net income in 1995 included a premium of $2,652,000 or $.12 per share from the prepayment of a mortgage loan while net income in 1994 included fee income of $710,000 or $.03 per share related to the prepayment of a construction loan.
Rental income was $64,740,000 in 1995, an increase of $4,985,000 or 8% from $59,755,000 in 1994. This increase was primarily attributable to rental income from new properties acquired and various capital additions subsequent to the first quarter of 1994. These property additions also resulted in an increase in depreciation and amortization of $1,273,000 to $13,575,000 in 1995 compared with 1994.
Mortgage interest income in 1995 was $845,000 compared to $0 in 1994. This increase was attributable to the conversion of a construction loan on a hospital located in Austin, Texas to a mortgage loan during the third quarter of 1995. In October 1995, the Core Group received $29.15 million as proceeds from the payoff of this mortgage loan, which represented $26.5 million in principal and a $2.65 million prepayment premium.
Additional rental income was $10,405,000 in 1995, an increase of $1,497,000 or 17% from $8,908,000 in 1994. This positive variation was attributable to increased additional rent from six of the Core Group's original acute care properties and more recently purchased properties generating additional rent for the first time.
Other interest income increased $1,918,000 to $4,894,000 in 1995 from $2,976,000 in 1994. Other interest income in 1995 included a $2.65 million premium from the prepayment of a mortgage loan in October 1995. Other interest income in 1994 included $710,000 of fee income related to the prepayment of a construction loan in February 1994. The remaining net decrease in other interest income during 1995 resulted from a lower average construction loan balance and a lower average balance of short-term investments, which was partially offset by a higher average balance of direct financing leases.
Interest income on inter-Group loans to the Psychiatric Group was $2,029,000 in 1995, a decrease of $2,012,000 or 50% from $4,041,000 in 1994. This decrease reflects a lower average balance outstanding on loans to the Psychiatric Group, which was primarily attributable to $15,150,000 of repayments by the Psychiatric Group from the proceeds of asset sales and the paydown of borrowings under revolving credit agreements provided to Psychiatric Group hospital operators.
Interest expense was $27,057,000 in 1995, an increase of $956,000 or 4% from $26,101,000 in 1994. Interest expense increased as a result of higher average bank loan borrowings during 1995 and a reduction in capitalized interest in 1995 compared to 1994. This was partially offset by a reduction in interest expense on senior notes payable as a result of a $24 million maturity in May 1995.
General and administrative expenses increased to $5,898,000 in 1995 from $4,425,000 in 1994. This variation was attributable to an increase in the Company's consolidated general and administrative expenses which are allocated between the Core Group and Psychiatric Group primarily based on revenues, and an increase in Core Group revenues relative to the Company's consolidated revenues. In the second quarter of 1994, the Company reversed $750,000 of a corporate relocation accrual recorded in the fourth quarter of 1993 after the Company decided to maintain its headquarters in Denver, Colorado. The remaining net increase in
the Company's consolidated general and administrative expenses in 1995 was primarily attributable to increased compensation and benefits expense.
Future Operating Results
The operators of most of the Company's facilities derive a substantial percentage of their total revenues from federal and state health care programs such as Medicare and Medicaid and from other third-party payors such as private insurance companies, self-insured employers and health maintenance organizations. Such operators also are subject to extensive federal, state and local government regulation relating to their operations, and the Company's facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with mandated procedures, licensure requirements under state law and certification standards under the Medicare and Medicaid programs. A reduction in reimbursement levels under the Medicare or Medicaid programs, a reduction in reimbursement by other third-party payors or an operator's failure to maintain its certification under Medicare or Medicaid programs could adversely affect revenues to the Company's facilities.
The nature of health care delivery in the United States continues to undergo change and further review at both the national and state levels. Generally accepted goals of reform continue to include controlling costs and improving access to medical care. Various plans to decrease the growth in Medicare spending have been proposed by both Houses of Congress. These plans have generally included revisions to and limits on Medicare and federal programs providing Medicaid reimbursement to state health care programs and potentially would have an adverse impact on the level of funds available in the future to health care facilities. The Company's Board and management are monitoring potential changes closely. The Company believes that these potential changes may pose risks for certain institutions that are unwilling or unable to respond. At the same time, the Company believes that this changing health care environment will provide the Core Group with new opportunities for investment.
The ongoing changes in the health care industry include trends toward shorter lengths of hospital stay, increased use of outpatient services, increased federal, state and third-party oversight of health care company operations and business practices, and increased demand for discounted or capitated health care services (delivery of services at a fixed price per capita basis to a defined group of covered parties). Furthermore, federal, state and third-party payors continue to propose and adopt various cost containment measures that restrict the scope of reimbursable health care services and limit increases in reimbursement rates for such services. Payors also are continuing to aggressively enforce compliance with program requirements and to pursue providers that they believe have not complied with such requirements. Outpatient business is expected to increase as advances in medical technologies allow more procedures to be performed on an outpatient basis and as payors continue to direct more patients from inpatient care to outpatient care. In addition, the entrance of insurance companies into managed care programs is accelerating the introduction of managed care in new localities, and states and insurance companies continue to negotiate actively the amounts they will pay for services. Moreover, the percentage of health care services that are reimbursed under the Medicare and Medicaid programs continues to increase as the population ages and as states expand their Medicaid programs. Continued eligibility to participate in these programs is crucial to a provider's financial strength. As a result of the foregoing, the revenues and margins may decrease at the Core Group's facilities.
Notwithstanding the potential for increasing government regulation, the Company believes that health care will continue to be delivered on a local and regional basis and that well-managed, high-quality, cost-controlled facilities will continue to be an integral part of local and regional health care delivery systems. The Company also believes that certain acute care hospitals will need to reconfigure or expand existing facilities or to affiliate themselves with other providers so as to become part of comprehensive and cost-effective health care systems. Such systems likely will include lower cost treatment settings, such as ambulatory care clinics, outpatient surgery centers, skilled nursing facilities and medical office buildings. In general, the Core Group facilities are part of local or regional health care delivery systems or are in the process of becoming integrated into such systems.
The Core Group's future operating results could be affected by the operating performance of the Core Group's lessees and borrowers. The rental and interest obligations of its facility operators are primarily supported by the facility-specific operating cash flow. Real estate investments in the Core Group's portfolio are generally further supported by one or more credit enhancements that take the form of cross-default provisions, letters of credit, corporate and personal guarantees, security interests in cash reserve funds, accounts receivable or other personal property and requirements to maintain specified financial ratios. In addition, financial effects arising from the Psychiatric Group that affect the Company's consolidated results of operations, financial condition or borrowing costs may also affect the results of operations, financial condition or borrowing costs of the Core Group. Accordingly, the Core Group's financial statements should be read in conjunction with the financial statements of the Psychiatric Group and the Company's consolidated financial statements.
The future operating results of the Core Group will be affected by additional factors including the amount, timing and yield of additional real estate investments and the competition for such investments. Operating results also will be affected by the availability and terms of the Company's future equity and debt financing. The Company's financing strategy to facilitate future growth includes objectives to reduce its cost of capital over time and enhance its liquidity and financial flexibility. The Company believes that the distribution of the Psychiatric Group Depositary Shares in 1995 facilitated achievement of these objectives. Subsequent to the Distribution, the Company raised $50.3 million of additional equity for the Core Group in October 1995 through the sale of 2.5 million shares of its Core Group Common Stock and in December 1995, closed on a new $150 million unsecured revolving credit facility with improved pricing and terms. In January 1997, the Company completed its first public debt offering, selling $220 million of unsecured senior notes at a weighted average effective interest rate of approximately 7.56%. The Company used a portion of the proceeds of this offering to prepay $152 million of 11.03% private placement debt in February 1997 prior to its scheduled maturity, incurring an extraordinary charge in the first quarter of 1997 of $11.4 million consisting of a make-whole premium and other costs related to the prepayment.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1996, the Core Group had $4,183,000 outstanding under its revolving inter-Group loan to the Psychiatric Group. Under management policies currently in effect, the Core Group may provide the Psychiatric Group with revolving inter-Group loans of up to $8,750,000. In addition, as of December 31, 1996, the Core Group had $9,175,000 in fixed rate inter-Group loans to the Psychiatric Group.
As of March 19, 1997, the Core Group had remaining commitments to fund real estate projects under construction of approximately $4 million. In addition, the Core Group had agreed to provide real estate financing to three different operators aggregating approximately $81 million. Of this amount, approximately $46 million has been committed to five assisted living and two skilled nursing projects to be constructed over the next fifteen months and $4.4 million has been committed to the financing of an existing long-term acute care hospital within the next two months. The remaining $30.6 million of financing has not been committed to specific acquisitions or projects.
The Company has continued to increase its liquidity and enhance its financial flexibility. In October 1995, the Company's Core Group received $29.15 million as proceeds from the payoff of its interest in a mortgage loan and completed an offering of 2.5 million additional shares of Core Group Common Stock resulting in net proceeds of $50.3 million. In December 1995, the Company closed on a new $150 million unsecured revolving credit facility which matures on December 27, 1998. In January 1997, the Company completed a $220 million public unsecured debt offering, issuing $100 million of five-year senior notes and $120 million of ten-year senior notes. The Company used the net proceeds to pay off all outstanding borrowings under its $150 million bank facility at the time and to prepay all of its $152 million of outstanding private placement debt in late February 1997. As of March 19, 1997, the Company had no outstanding borrowings under its revolving credit facility and had $3.4 million in cash and short-term investments. The Company's total indebtedness as of March 19, 1997 was $225.6 million. The Company will utilize its revolving credit facility to fund its future Core Group acquisitions and its other commitments. The Company may incur additional indebtedness or refinance existing indebtedness if the Company determines that opportunities to pursue such transactions
would be attractive. The Company's unsecured publicly-traded senior debt currently carries investment grade ratings from Duff & Phelps Credit Rating Co. (BBB-), Moody's Investors Service (Baa3) and Standard & Poor's (BBB-). The Company currently believes it has sufficient capital to meet its commitments and that its cash flow and liquidity will continue to be sufficient to fund current operations and to provide for the payment of dividends to stockholders in compliance with the applicable sections of the Internal Revenue Code governing real estate investment trusts.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Following is a discussion of the combined financial condition and results of operations of the Psychiatric Group which should be read in conjunction with (a) the combined financial statements and accompanying notes of the Psychiatric Group and (b) management's discussion and analysis of financial condition and results of operations and the financial statements and accompanying notes of the Company and the Core Group included elsewhere herein.
Factors Regarding Future Results and Forward-Looking Statements Statements that are not historical facts contained in management's discussion and analysis of financial condition and results of operations are forward-looking statements that involve risks and uncertainties that could cause actual results to differ from projected results. Factors that could cause actual results to differ materially include, among others: the financial success of the operations conducted at the Psychiatric Group's facilities and the financial strength of the operators of such facilities, the continuing ability of operators to meet their obligations to the Psychiatric Group under existing or restructured agreements, changes in operators or ownership of operators, changes in government policy relating to the health care industry including reductions in reimbursement levels under the Medicare and Medicaid programs, operators' continued eligibility to participate in the Medicare or Medicaid programs, reductions in reimbursement by other third party payors, lower occupancy levels at the Psychiatric Group's facilities, the strength and financial resources of the Psychiatric Group's competitors, the availability and cost of capital, the Psychiatric Group's ability to make additional real estate investments at attractive yields and changes in tax laws and regulations affecting real estate investment trusts. For a further discussion of such factors, see "Management's Discussion and Analysis of Psychiatric Group Combined Financial Condition and Results of Operations -- Future Operating Results" herein.
OPERATING RESULTS
1996 Compared to 1995
In 1996, the Psychiatric Group reported net income of $5,579,000 or $2.67 per share, a decrease of $695,000 or 11% compared with net income of $6,274,000 or $3.00 per share in 1995. The decrease in net income in 1996 was primarily attributable to a reduction in income due to the sale of two psychiatric properties during the first quarter of 1995 and the nonpayment of rental and interest obligations by two psychiatric operators at various times during 1996.
Rental income was $1,989,000 in 1996, a decrease of $1,064,000 or 35% from $3,053,000 in 1995. This decrease was primarily attributable to a reduction in rental income due to the sale of two psychiatric properties during the first quarter of 1995 and the nonpayment of $734,000 of rent by two psychiatric operators during 1996. The property sales resulted in a decrease in depreciation and amortization of $58,000 or 7% to $744,000 in 1996 compared with $802,000 in 1995.
Additional rental and interest income was $812,000 in 1996, an increase of $92,000 or 13% from $720,000 in 1995. These differences were primarily attributable to variations in revenues upon which such additional rent and interest is based.
Other interest income decreased $293,000 or 43% to $393,000 in 1996 from $686,000 in 1995. This decrease was primarily attributable to lower average borrowings under revolving credit agreements provided to psychiatric hospital operators as a result of the sale of two psychiatric properties and the lease restructurings of two psychiatric investments during the first quarter of 1995 and the nonpayment $182,000 of interest by a psychiatric operator during 1996.
Interest expense on inter-Group loans from the Core Group was $1,679,000 in 1996, a decrease of $350,000 or 17% from $2,029,000 in 1995. This decrease reflects a lower average balance outstanding on loans from the Core Group, which was primarily attributable to $15,150,000 of repayments to the Core Group from the proceeds of the previously mentioned property sales and restructurings.
General and administrative expenses were $1,172,000 in 1996, an increase of $231,000 or 25% from $941,000 in 1995. The Company's consolidated general and administrative expenses are allocated between the Core Group and Psychiatric Group primarily based on revenues, however significant costs directly related to either Group are specifically charged to the applicable Group. Although costs allocated to the Psychiatric Group based on revenues decreased in 1996, the Psychiatric Group was specifically charged for $467,000 of costs in 1996 compared with $225,000 in 1995 for financial advisory services. These services were provided primarily by an investment banking firm which included supplemental monitoring of the performance of the Psychiatric Group's properties and assistance in addressing operational and cash flow difficulties of certain operators of the properties.
The $300,000 of targeted stock issuance costs in 1995 was an additional accrual made in the second quarter of 1995 to reflect the increased costs of the Distribution. The increased costs primarily reflected higher legal and accounting fees and printing and shipping costs as a result of the extended filing period.
1995 Compared to 1994
In 1995, the Psychiatric Group reported net income of $6,274,000 or $3.00 per share compared with a net loss of ($22,855,000) or ($10.96) per share in 1994. The net loss in 1994 reflects a write-down of psychiatric real estate investments of $30,000,000 or $14.38 per share as a result of accelerating negative trends in the psychiatric industry. Net income for 1995 and 1994 reflect costs related to the Distribution of $300,000 or $.14 per share and $1,450,000 or $.70 per share, respectively. Net income in 1995 reflects a reduction in income due to the sale of three psychiatric properties and the lease restructurings of two psychiatric investments subsequent to September 1994.
Rental income was $3,053,000 in 1995, a decrease of $4,924,000 or 62% from $7,977,000 in 1994. This decrease was primarily attributable to a reduction in rental income due to the sale of three psychiatric properties and the lease restructurings of two psychiatric investments. The property sales, together with lower depreciation expense on psychiatric properties written down in June 1994, resulted in a decrease in depreciation and amortization of $999,000 to $802,000 in 1995 compared with 1994.
Additional rental and interest income was $720,000 in 1995, an increase of $122,000 from $598,000 in 1994. This positive variation was attributable to an increase in the facility revenues upon which such additional rent and interest is based.
Other interest income decreased $340,000 to $686,000 in 1995 from $1,026,000 in 1994. This decrease was primarily attributable to lower average borrowings under revolving credit agreements provided to psychiatric hospital operators as a result of the sale of two psychiatric properties and the lease restructurings of two psychiatric investments.
Interest expense on inter-Group loans from the Core Group was $2,029,000 in 1995, a decrease of $2,012,000 or 50% from $4,041,000 in 1994. This decrease reflects a lower average balance outstanding on loans from the Core Group, which was primarily attributable to $15,150,000 of repayments to the Core Group from the proceeds of the previously mentioned property sales and restructurings.
General and administrative expenses decreased to $941,000 in 1995 from $951,000 in 1994. The Company's consolidated general and administrative expenses are allocated between the Core Group and Psychiatric Group primarily based on revenues, however significant costs directly related to either Group are specifically charged to the applicable Group. Although costs allocated to the Psychiatric Group based on revenues decreased, the Psychiatric Group was specifically charged for $225,000 of costs related to financial advisory services provided to the Psychiatric Group by an investment banking firm.
In 1994, $1,450,000 was accrued for the cost of the planned Distribution. The $300,000 of targeted stock issuance costs in 1995 was an additional accrual made in the second quarter of 1995 to reflect the increased costs of the Distribution. The increased costs primarily reflect higher legal and accounting fees and printing and shipping costs as a result of the extended filing period.
Future Operating Results
The operators of most of the Company's facilities derive a substantial percentage of their total revenues from federal and state health care programs such as Medicare and Medicaid and from other third-party payors such as private insurance companies, self-insured employers and health maintenance organizations. Such operators also are subject to extensive federal, state and local government regulation relating to their operations, and the Company's facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with mandated procedures, licensure requirements under state law and certification standards under the Medicare and Medicaid programs. A reduction in reimbursement levels under the Medicare or Medicaid programs, a reduction in reimbursement by other third-party payors or an operator's failure to maintain its certification under Medicare or Medicaid programs could adversely affect revenues to the Company's facilities.
The nature of health care delivery in the United States continues to undergo change and further review at both the national and state levels. Generally accepted goals of reform continue to include controlling costs and improving access to medical care. Various plans to decrease the growth in Medicare spending have been proposed by both Houses of Congress. These plans have generally included revisions to and limits on Medicare and federal programs providing Medicaid reimbursement to state health care programs and potentially would have an adverse impact on the level of funds available in the future to health care facilities. The Company's Board and management are monitoring potential changes closely. The Company believes that these potential changes may pose risks for certain institutions that are unwilling or unable to respond.
The ongoing changes in the health care industry include trends toward shorter lengths of hospital stay, increased use of outpatient services, increased federal, state and third-party oversight of health care company operations and business practices, and increased demand for discounted or capitated health care services (delivery of services at a fixed price per capita basis to a defined group of covered parties). Furthermore, federal, state and third-party payors continue to propose and adopt various cost containment measures that restrict the scope of reimbursable health care services and limit increases in reimbursement rates for such services. Payors also are continuing to aggressively enforce compliance with program requirements and to pursue providers that they believe have not complied with such requirements. Outpatient business is expected to increase as advances in medical technologies allow more procedures to be performed on an outpatient basis and as payors continue to direct more patients from inpatient care to outpatient care. In addition, the entrance of insurance companies into managed care programs is accelerating the introduction of managed care in new localities, and states and insurance companies continue to negotiate actively the amounts they will pay for services. Moreover, the percentage of health care services that are reimbursed under the Medicare and Medicaid programs continues to increase as the population ages and as states expand their Medicaid programs. Continued eligibility to participate in these programs is crucial to a provider's financial strength. As a result of the foregoing, the revenues and margins may decrease at the Psychiatric Group's facilities.
Fundamental changes in the psychiatric industry continue to negatively impact the facility-specific operating cash flow at the Psychiatric Group's properties. Institutions responsible for providing insurance coverage to patients who use inpatient psychiatric treatment services have directed efforts toward decreasing their payments for such services, thereby reducing hospital operating revenues. Some cost-cutting measures used by such institutions include decreasing the inpatient length of stay, intensively reviewing utilization, directing patients from inpatient care to outpatient care and negotiating reduced reimbursement rates for services. The wider use of psychotropic drugs also has resulted in significant declines in the average length of stay. In addition, aggressive program compliance enforcement and increased scrutiny of past and current billing practices has resulted in the litigation of some providers and significant negative publicity which has further exacerbated the financial and operational difficulties of providers. Although the operators of the psychiatric hospitals are responding by increasing case management, developing lower cost outpatient and daypatient programs and reducing operating costs, their efforts are generally not consistently mitigating the negative impact of these fundamental psychiatric industry changes. As a result, certain of the Psychiatric Group hospital operators have not met their contractual payment obligations to the Psychiatric Group as scheduled and there can be no assurance that Psychiatric Group operators will be able to meet such payment obligations in the future.
The Psychiatric Group currently is providing financing under revolving credit agreements to the operators of three of its psychiatric hospitals. As of March 19, 1997, outstanding borrowings under such agreements totaled $4,225,000, and the Psychiatric Group has committed to fund an additional $1,475,000 of borrowings upon request, subject to certain conditions. These borrowings, which are partially secured by accounts receivable and certain personal property and which contain events of default that would be triggered by defaults under the lease relating to the relevant psychiatric hospital, are the primary source of financing for these operators' operating and capital needs. These psychiatric hospitals have, from time to time, been unable to generate sufficient cash flow for working capital and the development of new programs. In certain cases, these psychiatric hospitals have not been able to pay down the outstanding borrowings under the revolving credit agreements provided by the Psychiatric Group or to secure replacement financing from third-party lenders and there can be no assurance that such operators will be able to fund such obligations when they become due. To the extent the psychiatric hospitals have increased working capital needs in the future, the Psychiatric Group may be the only source of such financing. In the event the Company's Board of Directors determines that it is appropriate to provide additional working capital financing to a psychiatric hospital operator, it may cause the Core Group to make revolving inter-Group loans to the Psychiatric Group to fund such financing (to the extent consistent with its then-existing policies), although the Company's Board of Directors is under no obligation to do so.
The fundamental ongoing changes in the psychiatric industry and the resulting negative impact on operator financial performance have resulted in significant psychiatric investment write-downs in 1992 and 1994 and the periodic restructuring of psychiatric operator payment obligations. Although management currently believes that the recorded investments in the psychiatric hospitals are realizable, if the psychiatric operators are unable to successfully adapt to the fundamental ongoing changes in the psychiatric industry and consistently mitigate the negative impact of such changes on their financial performance, the Psychiatric Group may be required to further restructure payment obligations, identify and pursue alternative uses for the properties and/or make additional write-downs of the value of its investments in the psychiatric hospitals. The Psychiatric Group does not intend to make new investments, and over time, may sell, restructure or seek other means to reduce its investments. The Psychiatric Group has sold three of its psychiatric properties since September 1994. The Psychiatric Group Depositary Shares were distributed in July 1995 in an effort to effectively separate the economic attributes of the Company's psychiatric investments (the Psychiatric Group) from its core investments in acute care, rehabilitation and long-term acute care hospitals, skilled nursing, assisted living and Alzheimer's care facilities and a medical office building (the Core Group). In September 1995, the Company retained an investment banking firm to provide a broad range of financial advisory services to the Psychiatric Group. These services include supplemental monitoring of the performance of individual assets, assistance in potential sales or restructurings of particular investments and continuing assessments of available strategic alternatives for the portfolio. The cost of the financial advisory services are specifically charged to the operating results of the Psychiatric Group.
At the beginning of 1996, the owner of the Florida facilities retained the Intensive Resource Division of Quorum Health Resources, Inc. (Quorum), a subsidiary of Quorum Health Group, Inc., to operate both hospitals on a contract basis. The owner had previously become aware of and was monitoring potential wide-ranging objections by several large insurance companies with respect to claims presented for services rendered. Additionally, there had been negative stories in the national media and the local press in Florida on psychiatric care provided in Florida, including criticism of admissions policies and practice patterns at psychiatric hospitals in the state generally, and at these two hospitals. Legislative hearings had been held in Florida on these issues, and various regulatory investigations likely had been conducted or initiated. The hospitals were also experiencing operational and cash flow difficulties which negatively impacted their ability to fund their rental and interest obligations to the Psychiatric Group as they became due. Quarterly contractual base rent and interest obligations of Northpointe and The Retreat total approximately $200,000 and $278,000 ($.10 and $.13 per Psychiatric Group Depositary Share), respectively.
During 1996, the Psychiatric Group modified its agreements with the owner to allow for the deferral of rent and interest payments of Northpointe while certain restructuring and restaffing of the facility occurred. Pursuant to the deferral arrangements, Northpointe's monthly contractual base rent payments of $50,000 were
deferred from February 1996 through September 1996 and such deferred payments were scheduled to become payable twelve months from the month of deferral. In accordance with the terms of the deferral arrangements, Northpointe resumed making its full monthly contractual base rent payments of $50,000 on October 1, 1996. In addition, Northpointe's monthly contractual interest payments of $16,600 were deferred from February 1996 until March 1, 1997 on which date all such deferred interest was scheduled to be paid in full. Northpointe's deferred obligations are not recognized as income by the Psychiatric Group until such time as they are paid. Northpointe's rent and interest deferrals in 1996 amounted to approximately $.28 per Psychiatric Group Depositary Share.
In late 1996, the owner of Northpointe and The Retreat was named, together with other operators of other psychiatric facilities in Florida, in a lawsuit filed by several large insurance companies alleging widespread irregularities with respect to operations in years prior to 1995. Adverse publicity from the lawsuit appears to have exacerbated the operational and financial difficulties of Northpointe. The census at Northpointe in 1997 has been significantly below the levels projected by the owner at the end of 1996. As a result, the facility is experiencing substantial cash flow and operational difficulties. Although Northpointe had made its monthly contractual base rent payments of $50,000 during the fourth quarter of 1996 and for January 1997, it has been unable to pay its subsequent monthly contractual rent and interest obligations or its deferred rent and interest obligations. The Psychiatric Group has not further modified the Northpointe lease or revolving credit agreement, although further modification may be necessary. The owner recently appointed a new executive director and marketing director for the facility; however in view of the facility's current financial difficulties, there can be no assurance that the efforts under way will be successful in rebuilding the census and cash flow for 1997 to a level sufficient to allow the facility to meet its obligations.
The Psychiatric Group is continuing to closely monitor this situation. The Psychiatric Group remains committed to maximizing the value of its investment in Northpointe and believes the highest value for the property is most likely as a health care facility. However, in view of the rapidly changing circumstances at the facility, the Psychiatric Group, in conjunction with its financial advisor, is evaluating a range of possibilities including alternative uses for the facility and its related land. At December 31, 1996, the Psychiatric Group's total investment in Northpointe was $7,170,000 consisting of a net investment in the real estate of $5,495,000 and advances under a revolving credit agreement of $1,675,000. The volatility of the current circumstances may not allow for an orderly evaluation and pursuit of the various alternatives, and accordingly there can be no assurance that the financial results from a restructured arrangement as a psychiatric facility, an alternative use or a disposition will allow the realization of the Psychiatric Group's recorded investment in Northpointe.
At December 31, 1996, the Psychiatric Group's total investment in The Retreat was $9,450,000 consisting of a net investment in the real estate of $9,400,000 and advances under a revolving credit agreement of $50,000. The Retreat made all of its contractual rent and interest payments to the Psychiatric Group in 1996. Adverse publicity from the aforementioned lawsuit currently appears to be having a less severe impact on The Retreat, however, the facility has still experienced some deterioration of its cash flow and a decline in census during 1997. Although The Retreat has made its monthly contractual base rent and interest payments in 1997 through March, The Retreat made its February 1997 contractual base rent payment of $92,000 from lease reserve funds and has not yet paid its additional rent in the first quarter of 1997 of approximately $45,000. An increase in operational difficulties and further cash flow deterioration could occur if efforts currently being undertaken by the owner are unsuccessful. Accordingly, there can be no assurance that the Retreat will be able to continue to meet its obligations or that some measure of rent and interest relief will not be necessary in the future. Additionally, if circumstances at The Retreat become more volatile, the Psychiatric Group may be required to consider various alternatives for the facility.
In the first quarter of 1996, Rock Creek Center (RCC) in Illinois experienced certain documentation and procedural deficiencies that resulted in the denial of a substantial amount of Medicare receivables and a substantial negative adjustment to the hospital's 1995 Medicare cost report and 1996 interim Medicare reimbursement rate and experienced lower than expected census which had an adverse impact on RCC's cash flow and its ability to fund its rental and interest obligations to the Psychiatric Group in 1996 as they became due. The net book value of the Psychiatric Group's investment in RCC, including advances under existing revolving credit agreements and other receivables, as of December 31, 1996 totaled $8,002,000, and quarterly
contractual base rent and interest obligations of RCC total approximately $324,000 ($.15 per Psychiatric Group Depositary Share). In 1996, the Psychiatric Group advanced $214,000 on behalf of the operator to pay property taxes on the facility, and reached an agreement with the operator for the deferral of base rent payments while the operator took certain actions to stabilize operations and implemented its revised business plan. Pursuant to the deferral arrangements, 100% of RCC's monthly base rent payments of $83,000 were deferred for May and June of 1996 and 50% of such monthly payments were deferred from July 1996 through October 1996, at which time monthly base rent payments returned to 100%. Deferred base rent is payable in the future only when the facility's cash exceeds a specified level, and the property tax advance is payable in monthly installments. RCC's deferred rent obligations are not recognized as income by the Psychiatric Group until such time as they are paid. The Psychiatric Group's property tax advance has been reduced by monthly payments to $122,000 as of December 31, 1996. RCC's rent deferral amounted to approximately $.16 per Psychiatric Group Depositary Share for 1996. Although the deferral arrangements provided interim financial relief while the operator implemented its strategy, there can be no assurance that the deferred amounts will be paid or that RCC will not require additional financial relief in the future.
The current term of the RCC lease expires in December 1997. The lease agreement provides the operator with an option to renew the lease for an additional five-year term at fair market rental. Although the Psychiatric Group believes that the lease will be renewed, there can be no assurance that the lease will be renewed or that, if renewed, the annual minimum rent payments will remain at the current level of $1,000,000. Furthermore, the $2,500,000 balance outstanding under RCC's revolving credit agreement matures June 30, 1997. The Psychiatric Group believes that it will extend the term of the revolving credit agreement to correspond with the expiration of RCC's current lease term and will negotiate further extensions in connection with renewal of the lease. Should the lease not be renewed or the revolving loan not be repaid or extended, a significant negative impact to the Psychiatric Group could result.
In 1996, the Psychiatric Group completed formal documentation of an agreement with the operator of the two New York Four Winds facilities to release certain of its security interests in the operator's short-term assets on a staged basis. The operator believes that the release of this collateral will permit it to obtain the capital required to develop an integrated behavioral health care delivery system in lower and upper New York State, of which the two Four Winds facilities will be an integral part. Although such a system is intended to address the potential negative consequences of the expected changes in Medicaid reimbursement and the increase in managed care penetration in the state of New York, it is not possible to predict the impact and timing of such changes and whether the proposed system will be successful in that new environment.
The Psychiatric Group's dividend is determined quarterly based upon each quarter's operating results. Any significant advance of additional funds to operators of the Psychiatric Group's properties, modification of terms covering the rental or interest obligations of its properties or nonpayment or deferral of such obligations as they become due likely will have an adverse impact on the Psychiatric Group results of operations and cash flows, as well as the quarterly dividend payment on Psychiatric Group Depositary Shares. The nonpayment and deferral of rental and interest obligations of two operators in 1996 was responsible for the reduction in the quarterly dividend on Psychiatric Group Depositary Shares from $.80 per share in the fourth quarter of 1995 to $.70 per share in the first quarter of 1996 and $.65 per share in the second and third quarters of 1996. Although the quarterly dividend was increased to $.80 per share in the fourth quarter of 1996, there can be no assurance that the quarterly dividend will not be reduced in the future.
LIQUIDITY AND CAPITAL RESOURCES
As of March 19, 1997, the Psychiatric Group had aggregate unfunded commitments under revolving credit agreements provided to psychiatric hospital operators of $1.5 million.
At December 31, 1996, the Psychiatric Group had $4,183,000 and $9,175,000 outstanding under its revolving inter-Group loan from the Core Group and its fixed rate inter-Group loan from the Core Group, respectively. The Psychiatric Group is required to use the net proceeds from the disposition of Psychiatric Group assets to pay down its outstanding revolving inter-Group loan (to the extent of the psychiatric hospital operator borrowings under revolving credit agreements associated with the asset or assets sold) with any
excess used to pay down the balance outstanding under the fixed rate inter-Group loan. The Psychiatric Group reduced the combined balance of the revolving inter-Group and fixed rate inter-Group loans by $15,150,000 in the first quarter of 1995 with proceeds from such asset sales and operator borrowing paydowns. The Company's Board of Directors has established certain management policies relating to the Psychiatric Group's inter-Group loans from the Core Group. Under the policies currently in effect, which may be modified or rescinded in the sole discretion of the Company's Board of Directors, the aggregate revolving inter-Group loans owed to the Core Group by the Psychiatric Group are limited to a maximum of $8,750,000 at any one time outstanding, which limit is to be reduced dollar-for-dollar with any permanent repayment in the future of borrowings under revolving credit agreements provided to Psychiatric Group hospital operators. In addition, the limit on the aggregate revolving inter-Group loans will not be reduced below $5,000,000, and except for such revolving inter-Group loans, no additional fixed rate or other inter-Group loans will be advanced to the Psychiatric Group by the Core Group. The Psychiatric Group has no third-party sources of additional financing and, as a result, is dependent on the Core Group for all such financing. Although the Core Group may make this financing available, there is no obligation of the Company's Board of Directors to cause the Core Group to provide funds to the Psychiatric Group if the Board of Directors determines that it is in the Company's best interest not to do so. To the extent needed funds are not advanced by the Core Group, the Psychiatric Group would experience immediate, significant negative effects.
The Psychiatric Group does not expect to make any additional acquisitions or capital investments except to the extent of existing unfunded commitments under revolving credit agreements provided to facility operators. Future dividend payments will be determined quarterly and will be primarily dependent upon the financial performance of the Psychiatric Group. The Psychiatric Group expects to distribute a substantial portion of its funds from operations and net proceeds from asset dispositions, after payments of inter-Group loan obligations, to holders of Psychiatric Group Depositary Shares. In general, the Psychiatric Group will not retain any significant amount of its cash flow, and as discussed above, its sources of financing and liquidity will be limited.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's consolidated balance sheets as of December 31, 1996 and 1995 and its consolidated statements of operations, stockholders' equity and cash flows for the years ended December 31, 1996, 1995 and 1994, together with a report of Arthur Andersen LLP, independent public accountants, are included elsewhere herein. The Core Group's and the Psychiatric Group's combined balance sheets as of December 31, 1996 and 1995, and their combined statements of operations, total attributed equity and cash flows for the years ended December 31, 1996, 1995 and 1994, together with reports of Arthur Andersen LLP, independent public accountants, also are included elsewhere herein. See "Index to Financial Statements."
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.
There is hereby incorporated by reference the information to appear under the caption "Election of Directors" in the Company's proxy statement for its May 23, 1997 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996. See "Item 1. Business -- Executive Officers of the Company" for a description of the Executive Officers of the Company.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
There is hereby incorporated by reference the information to appear under the caption "Compensation of Directors and Executive Officers" in the Company's proxy statement for its May 23, 1997 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
There is hereby incorporated by reference the information to appear under the caption "Principal Shareholders of the Company" in the Company's proxy statement for its May 23, 1997 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K.
(A)(1) AND (2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.
The financial statements and schedule listed in the accompanying index to the consolidated, Core Group combined and Psychiatric Group combined financial statements, are filed as part of this Annual Report on Form 10-K.
(A)(3) EXHIBITS.
10.8 -- First Amendment to Credit Agreement dated as of December 10, 1996 between American Health Properties, Inc. and Wells Fargo Bank, N.A., as agent for the Lenders, filed as Exhibit 10.2 to the Company's Current Report on Form 8-K dated January 21, 1997, and incorporated by reference. *21 -- List of subsidiaries of the Company *23 -- Consent of Independent Public Accountants *24 -- Powers of Attorney (included in signature page) *27 -- Financial Data Schedule *99.1 -- Four Winds, Inc. Financial Highlights
- --------------- * Filed herewith
(B) REPORTS ON FORM 8-K.
None
AMERICAN HEALTH PROPERTIES, INC.
AND FINANCIAL STATEMENT SCHEDULE
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To American Health Properties, Inc.:
We have audited the accompanying consolidated balance sheets of American Health Properties, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. 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 financial position of American Health Properties, Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Denver, Colorado, March 24, 1997.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these financial statements.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these financial statements.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these financial statements.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THE COMPANY
American Health Properties, Inc., a Delaware corporation (the Company, which term refers to the Company and its subsidiaries unless the context otherwise requires), is a self-administered real estate investment trust (REIT) that commenced operations in 1987. The Company has investments in health care properties, including acute care, rehabilitation, long-term acute care and psychiatric hospitals, skilled nursing, assisted living and Alzheimer's care facilities and a medical office building.
Distribution of Psychiatric Group Depositary Shares On July 25, 1995, the Company completed the distribution of 2,085,675 Psychiatric Group Depositary Shares to holders of its common stock (the Distribution). Shareholders received one Psychiatric Group Depositary Share for every ten shares of common stock held of record at the close of business on July 14, 1995. Each Psychiatric Group Depositary Share represents one-tenth of a share of Psychiatric Group Preferred Stock. The Distribution was designed to separate the economic attributes of the Company's investments in psychiatric hospitals (the Psychiatric Group) and its investments in acute care, rehabilitation and long-term acute care hospitals, skilled nursing, assisted living and Alzheimer's care facilities and a medical office building (the Core Group) into two distinct portfolios, with two distinct classes of publicly-traded shares intended to represent those portfolios. In connection with the Distribution, the Company specifically assigned or, if not directly assigned, allocated its assets, liabilities and stockholders' equity, and its revenues, expenses and cash flow items, between the Core Group and Psychiatric Group. The Psychiatric Group Depositary Shares are intended to reflect the separate financial performance of the Psychiatric Group. The Company's common stock (the Core Group Common Stock) is intended to reflect the separate financial performance of the Core Group. However, the change in the capital structure of the Company effected by the Distribution does not affect the respective legal title to assets or responsibility for liabilities of the Company, and each holder of Core Group Common Stock or Psychiatric Group Depositary Shares is a holder of an issue of capital stock of the entire Company and is subject to the risks associated with an investment in the Company and all of its businesses, assets and liabilities.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation The accompanying consolidated financial statements include the accounts of the Company and all subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The financial statements of the Core Group and the Psychiatric Group also are included elsewhere herein. For purposes of computing per share data for periods prior to the actual Distribution, the number of shares of Core Group Common Stock are assumed to be the same as the corresponding number of shares of the Company's common stock prior to the Distribution, while the number of Psychiatric Group Depositary Shares are assumed to be one-tenth of the corresponding number of shares of the Company's common stock prior to the Distribution.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Short-Term Investments Cash and short-term investments consist of cash and all highly liquid investments with an original maturity date of less than three months and are stated at cost which approximates fair value.
Real Estate Properties The Company accounts for its property leases as operating leases. The Company records properties at cost and allocates the cost between land and buildings and improvements based on
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
independent appraisals. Depreciation of properties is recorded on a straight-line basis over the estimated useful lives of the buildings and improvements (21 to 42 years).
Impairment of Real Estate Properties and Notes Receivable The Company reviews for the possible impairment of its real estate properties and notes receivable whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. In general, an impairment of such assets would be indicated if the estimated future cash flows expected to result from the use of such assets and their eventual disposition is less than their carrying amounts.
Deferred Income Fees received, net of related direct costs, associated with the origination or amendment of leases and mortgages are deferred and amortized at a constant effective rate over the remaining initial term of the related leases and mortgage notes receivable.
Deferred Costs Deferred financing costs are amortized over the term of the related debt at a constant effective rate.
Stock-Based Compensation In 1996, the Company adopted Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation" which defines a fair value based method of accounting for stock-based compensation. As allowed by SFAS 123, the Company has elected to continue to measure employee stock-based compensation expense using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees".
Federal Income Taxes The Company intends at all times to operate so as to qualify as a REIT under Sections 856 to 860 of the Internal Revenue Code. As such, the Company will not be subject to federal income tax.
Qualification as a REIT under Sections 856 to 860 of the Internal Revenue Code applies to the Company as a whole, rather than the Core Group or Psychiatric Group individually. Dividends paid by the Company on its Core Group Common Stock and Psychiatric Group Depositary Shares must be sufficient in the aggregate for the Company to meet the minimum distribution requirements of the Internal Revenue Code. The Company's earnings and profits as a whole, without reference to the Core Group or Psychiatric Group individually, is used to determine the taxable character of dividends paid to holders of its Core Group Common Stock and Psychiatric Group Depositary Shares.
Earnings and profits, which determine the taxable character of dividends paid to stockholders, differ from net income for financial reporting purposes due primarily to timing differences in the recognition of deferred income, real estate property write-downs, mortgage note impairment reserves and various accruals and differences between the estimated useful lives used to compute depreciation for financial statement purposes and a 40-year life generally used in determining earnings and profits. The cost basis of the Company's real estate properties is generally the same for financial reporting and earnings and profits purposes, except for properties written down for financial reporting purposes and properties for which the previous owner's basis is required to be carried forward for tax purposes.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
REAL ESTATE PROPERTIES
The following table summarizes the Company's investment in health care real estate properties as of December 31, 1996:
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1996, the Company had the following construction in progress:
In the second quarter of 1996, the Company acquired an acute care property in West Valley City, Utah (Pioneer Valley Hospital) in exchange for its acute care properties in Jefferson, Louisiana (Elmwood Medical Center) and Halstead, Kansas (Halstead Hospital). The exchange was accounted for at the net book value of
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the properties exchanged. Pioneer Valley Hospital is leased to the same operator that had leased the two exchanged properties under comparable terms and at a lease rate equivalent to the combined lease rates of the two exchanged properties.
The fundamental ongoing changes in the psychiatric industry and the resulting negative impact on operator financial performance have resulted in significant psychiatric investment write-downs in 1992 and 1994 and the periodic restructuring of psychiatric operator payment obligations. In 1995, the Company restructured the leases covering its two psychiatric properties in Florida, and during 1996, provided for the partial deferral of rental and interest obligations related to one of these properties and the partial deferral of rental obligations of its psychiatric property in Illinois. Although management currently believes that the recorded investments in the psychiatric hospitals are realizable, if the psychiatric operators are unable to successfully adapt to the fundamental ongoing changes in the psychiatric industry and consistently mitigate the negative impact of such changes on their financial performance, the Company may be required to further restructure payment obligations, identify and pursue alternative uses for the properties and/or make additional write-downs of the value of its investments in the psychiatric hospitals. The Company does not intend to make new investments in the psychiatric sector, and over time, may sell, restructure or seek other means to reduce its investments in the psychiatric sector.
The dividend on the Company's Psychiatric Group Depositary Shares is determined each quarter based upon the operating results of the Company's Psychiatric Group. Any significant advance of additional funds to psychiatric hospital operators, modification of terms covering the rental or interest obligations of its psychiatric properties or nonpayment or deferral of such obligations as they become due likely will have an adverse impact on the Company's Psychiatric Group results of operations and cash flows, as well as the quarterly dividend payment on Psychiatric Group Depositary Shares.
The Company's properties are leased under "net" leases pursuant to which the lessees are responsible for all maintenance, repairs, taxes, and insurance of the leased properties. The leases provide for the payment of minimum base rent and additional rent during the fixed term and any renewal terms. Additional rent is generally based on the increase in annual gross revenues of the related facility or consumer price index as specified in the lease agreements.
The Company has the right to approve capital expenditures at all properties, the option to fund certain capital expenditures and, in certain situations, is obligated to fund approved capital expenditures on terms comparable to the original investment. At December 31, 1996, the Company had no commitments to fund capital expenditures pursuant to these rights and obligations. The base and additional rent provisions of the leases are amended when such capital expenditures are funded to reflect the Company's increased investment.
The Company has agreed to provide $13.8 million of real estate financing to an experienced operator of long-term acute care hospitals. Of this amount, $4.4 million has been specifically identified for a property in Houston, Texas. In addition, the Company has agreed to provide $50 million of real estate financing to an experienced operator of assisted living facilities. Approximately $29 million has been specifically identified for the construction of five properties located in four states which will be leased to the operator upon completion. The Company has also agreed to provide $17 million of real estate construction and lease financing for two skilled nursing properties in Las Vegas, Nevada to be operated by an experienced operator of skilled nursing facilities.
Six of the Company's acute care properties are leased to subsidiaries of American Medical International, Inc. (AMI), a subsidiary of Tenet Healthcare Corporation. The six leases are covered by cross-default provisions and the lease obligations are unconditionally guaranteed by AMI. In 1996, revenues from these leases accounted for 50% of the Company's total revenues.
Aggregate revenues from five leases maturing in 1999 accounted for 40% of the Company's total revenues in 1996. Four of these properties are leased to subsidiaries of AMI and the other property is leased to a
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
subsidiary of Columbia/HCA Healthcare Corporation. Each such lease grants the operator options, exercisable on not less than six months notice, to extend the term of the lease for eight consecutive five-year renewal terms. Base and additional rent during the first three to four extended terms would be on the same terms and conditions as the current initial term. Minimum rent during the final four to five extended terms would be fair market rental but no separate additional rent. Each lease also grants the operator options, exercisable on not less than six months notice, to purchase the leased property at fair market value at the expiration of any term of the lease.
Future minimum annual rentals under the Company's noncancellable operating leases for calendar years 1997 through 2001 and thereafter are approximately $71,400,000, $70,400,000, $47,500,000, $43,300,000, $40,100,000 and $90,000,000, respectively. These amounts do not reflect any adjustments for the nonpayment of rent by psychiatric operators, deferrals of rent which may be granted to such operators or the payment of rent previously deferred.
MORTGAGE NOTES RECEIVABLE
Four Winds Hospital -- Saratoga $18,137,000 The Company has a mortgage note receivable secured by a first mortgage and security interest in the real property of Four Winds Hospital in Saratoga Springs, New York. The note has an initial term of ten years with two optional ten-year extension terms. The initial term maturity date is June 30, 1999. The interest rate on the note is 12.42% with interest only payable monthly through June 30, 1995 and monthly principal and interest payments of $194,000 payable thereafter.
Four Winds Hospital -- Katonah $27,600,000 The Company has a mortgage note receivable secured by a first mortgage and security interest in the real property of Four Winds Hospital in Katonah (Westchester County), New York. The note has an initial term of ten years with two optional ten-year extension terms. The initial term maturity date is November 30, 2002. The annual interest rate on the note was 12.71%, 13.07% and 13.44%, in 1994, 1995 and 1996, respectively, and increases .36% annually thereafter until reaching 14.49% where it remains through maturity. Interest only is payable monthly.
The Company has recorded a $7,950,000 reserve for impairment of its mortgage notes receivable and records interest on its mortgage notes as interest payments are received.
Pursuant to the terms of the mortgage notes receivable, the Company may receive additional interest each year based on the increase in annual operating revenues of the related psychiatric facility. The Company may provide permanent financing for capital additions at the facilities.
The carrying amount of mortgage notes receivable is a reasonable estimate of fair value, as the pricing and terms of the notes are indicative of current rates and credit risk.
OTHER NOTES RECEIVABLE
The Company provides financing at variable rates to certain psychiatric hospital operators under revolving credit agreements. The aggregate commitment under these credit agreements was $5,700,000 as of December 31, 1996. Borrowings under the credit agreements are subject to compliance with various covenants and are partially secured by accounts receivable and other personal property of the operators. As of December 31, 1996, $4,225,000 was outstanding under revolving credit agreements at a weighted average contractual interest rate of 11.25%. The weighted average amount of borrowings under revolving credit agreements outstanding during 1996 was $4,414,000 at a weighted average interest rate, reflecting deferrals, of 7.4% with a maximum of $4,475,000 outstanding during the year.
The pricing and terms of other notes receivable are indicative of current rates and credit risk, and therefore, the current carrying amount of these financial instruments is a reasonable estimate of fair value.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DIRECT FINANCING LEASES
In connection with its investments in certain acute and long-term care properties, the Company also has provided equipment leasing for terms of five to seven years which are classified as direct financing leases. As of December 31, 1996, the Company's aggregate net investment in these direct financing leases was $3,695,000, represented by total minimum lease payments receivable of $4,423,000 less unearned income of $728,000. Future minimum annual lease payments under these leases for calendar years 1997 through 2001 are approximately $1,262,000, $1,262,000, $1,262,000, $624,000 and $13,000, respectively.
DEBT
Bank Loans Payable The Company has a $150 million unsecured revolving credit agreement with a syndicate of banks that matures on December 27, 1998 and bears an annual facility fee based on the total commitment. This agreement provides for interest on outstanding borrowings based on either LIBOR plus a margin or the prime rate plus, in certain circumstances, a margin. The margin on LIBOR or prime rate borrowings and the annual facility fee may vary and are dependent upon various conditions, including the Company's debt ratings and the level of borrowings outstanding. Currently, the Company is able to borrow at either LIBOR plus 87.5 basis points or the prime rate, and the annual facility fee is 25 basis points.
The weighted average amount of borrowings under bank credit agreements outstanding during 1996, 1995 and 1994 was $21,622,000, $27,467,000 and $5,404,000 at weighted average interest rates of 6.4%, 7.5% and 6.9%, respectively. The maximum amount outstanding under bank credit agreements in 1996, 1995 and 1994 was $53,000,000, $73,000,000 and $20,500,000, respectively. As of December 31, 1996, the Company had $48,500,000 of borrowings outstanding under its bank credit agreement with a weighted average interest rate of 6.7%.
The duration of borrowings under the Company's unsecured revolving credit agreement are generally less than 90 days at variable pricing indicative of current short-term borrowing rates. Accordingly, carrying amount is a reasonable estimate of fair value.
Senior Notes Payable At December 31, 1996, the Company had $72 million of 11.45% unsecured senior notes payable outstanding that were issued pursuant to a $125 million private placement in 1989 and $80 million of 10.41% unsecured senior notes payable outstanding that were issued pursuant to a $100 million private placement in 1990. The weighted average amount of borrowings under these senior note issues during 1996, 1995 and 1994 was $178,250,000, $211,000,000 and $225,000,000 at weighted average effective interest rates of 11.03%, 11.06% and 11.09%, respectively. In February 1997, the Company prepaid the $152 million outstanding balance of these senior note issues resulting in an extraordinary charge in the first quarter of 1997 of $11,427,000 consisting of a make-whole premium and other costs related to the prepayment.
In January 1997, the Company completed a $220 million public debt offering of unsecured senior notes payable, issuing $100 million of notes with a coupon rate of 7.05% due January 15, 2002 (2002 Notes) and $120 million of notes with a coupon rate of 7.50% due January 15, 2007 (2007 Notes). The 2002 Notes and 2007 Notes were sold for $99,749,000 and $119,216,000, respectively, and have effective interest rates of approximately 7.34% and 7.74%, respectively. Interest is payable at the coupon rates semi-annually on January 15th and July 15th. The proceeds from the public debt offering were used to pay off the Company's two issues of private placement debt prior to its scheduled maturity and the Company's borrowings under its bank credit agreement.
An estimate of rates currently available to the Company for debt with similar terms was used to determine the fair value of the Company's senior notes payable. As of December 31, 1996 and 1995, the estimated fair value of senior notes payable was $163 million and $215 million, respectively.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Subordinated Convertible Bonds Payable The Company's Convertible Dual Currency Subordinated Bonds (the Swiss Bonds) were sold in Switzerland pursuant to public subscription in 1990. The Swiss Bonds have a coupon rate of 8.5% and are convertible at the option of the holder at any time until July 9, 2000 into shares of the Company's common stock at a conversion price of $23.45 per share and a fixed exchange rate of Sfr. 1.41 per U.S. $1.00. There were no conversions of Swiss Bonds in the last three years. Final redemption of the 1,491 remaining Swiss Bonds will be made in U.S. dollars of $7,455,000 on July 19, 2000 provided additional conversions or redemption have not occurred earlier. Interest on outstanding Swiss Bonds is payable annually in arrears in Swiss francs in July. Accrued and accreted interest is not paid on Swiss Bonds converted into common stock. The Company has reserved approximately 225,000 unissued shares of common stock for potential future Swiss Bond conversions.
The fair value of the Company's subordinated convertible bonds payable is based on the quoted market price of the bonds as traded in Switzerland. As of December 31, 1996 and 1995, the estimated fair value of subordinated convertible bonds payable was $6,757,000 and $6,573,000, respectively.
Debt Covenants Covenants and restrictions in the Company's various debt agreements include limitations on secured borrowings, restrictions covering the use of proceeds from asset sales and payments of dividends and requirements relating to the maintenance of specified financial covenants, including those relating to minimum tangible net worth, fixed charge coverage and ratios of liabilities to minimum tangible net worth and asset values.
Annual Maturities The aggregate amount of maturities of the Company's outstanding debt at December 31, 1996, as adjusted for the sale of $220 million of senior notes in January 1997 and the prepayment of $152 million of senior notes in February 1997, is $7,455,000, $100,000,000 and $120,000,000 in 2000, 2002 and 2007, respectively.
Interest Interest capitalized on construction in progress was $895,000, $198,000 and $883,000 in 1996, 1995 and 1994, respectively. Interest paid, net of interest capitalized, in 1996, 1995 and 1994 was $21,547,000, $26,232,000 and $24,924,000, respectively.
PENSION PLANS
The Company has a defined contribution pension plan covering all of its employees. Pension expense in 1996, 1995 and 1994 was $247,000, $238,000 and $207,000, respectively.
The Company has an unfunded defined benefit pension plan covering non-employee members of its Board of Directors upon completion of sixty months of membership on the Board. The benefits, limited to ten years, are based on years of service and the annual base director fee in effect as of the date a director ceases to be a member of the Board.
The following tables set forth the amounts recognized in the Company's financial statements:
Actuarial present value of benefit obligations:
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Components of net pension cost:
Discount rates of 7.5% and 7.0% for 1996 and 1995, respectively, and a 10.0% increase in annual base director fees once every five years were used in determining the actuarial present value of the projected benefit obligation. The discount rates used in determining the net pension cost for 1996, 1995 and 1994 were 7.0%, 8.5% and 7.0%, respectively.
STOCK INCENTIVE PLANS
The Company's stock incentive plans provide for the issuance of up to 2,600,000 shares of stock to directors and key employees of the Company. There were 1,092,809 shares available to grant further stock incentives at December 31, 1996. Pursuant to the terms of the Company's stock incentive plans, stock options, restricted stock, deferred shares and dividend equivalent rights (DERs) were adjusted to reflect the Distribution.
The following is a summary of stock incentives activity:
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a summary of significant ranges of outstanding and exercisable options at December 31, 1996:
Restrictions on shares of restricted stock lapse each year following the date of award with respect to one-sixth, one-fifth, one-quarter or one-half of the total number of shares awarded, as the case may be. Expense is determined based on the market value at the date of award and is recognized over the period such restrictions lapse.
The exercise price of stock options is equal to the fair market value of the shares on the dates the options were granted. Stock options granted to directors become exercisable immediately or over two years and stock options granted to key employees become exercisable over two to four years. Stock options terminate ten years from the date of grant. Options on 629,579, 536,815 and 611,987 shares of Core Group Common Stock were exercisable at December 31, 1996, 1995 and 1994 with weighted average exercise prices of $22.90, $23.29 and $25.67 per share, respectively. Options on 64,210 and 53,683 Psychiatric Group Depositary Shares were exercisable at December 31, 1996 and 1995 with weighted average exercise prices of $22.75 and $23.21 per share, respectively.
DERs have been granted in tandem with some of the stock options granted to key employees. At each dividend declaration date, a calculation is made to determine the number of shares that could be acquired if dividends were paid on shares under option for a period of up to five years from the date of grant and on accumulated DER shares for a period of up to ten years from the date of grant, and such number of shares are accumulated for the benefit of option holders over the term of the option grant. Upon exercise or expiration of the related option, each option holder is entitled to receive additional shares equivalent to the accumulated number of related DER shares. Expense related to the DER shares is equal to the equivalent amount of dividends used to determine the number of DER shares. Directors may elect to receive payment of their annual Board fees on a deferred basis in the form of stock of the Company. These deferred shares, and related accumulated DER shares, are issued to the director making such an election at the end of each three-year deferral period. At December 31, 1996, substantially all deferred and DER shares were issuable upon exercise of the related vested options or otherwise unrestricted.
Total stock-based compensation expense recognized under APB 25 in 1996, 1995 and 1994 was $1,251,000, $1,026,000 and $944,000, respectively.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As determined under SFAS 123, the weighted average fair value at the date of grant for options to purchase Core Group Common Stock granted during 1996 was $4.84 per option. The weighted average fair value at the date of grant for options granted in 1995, adjusted to reflect the Distribution, was $5.32 per option for Core Group Common Stock and $5.28 per option for Psychiatric Group Depositary Shares. The fair value of options was estimated using an option pricing model with the following weighted average assumptions:
The weighted average fair value at the date of grant for restricted and deferred shares of Core Group Common Stock granted during 1996 was $22.53 per share. The weighted average fair value at the date of grant for restricted and deferred shares granted in 1995, adjusted to reflect the Distribution, was $18.95 per share for Core Group Common Stock and $18.69 per share for Psychiatric Group Depositary Shares.
If the fair value based method of accounting defined by SFAS 123 had been used to measure and recognize stock-based compensation expense, the pro forma effect on the reported amounts of net income and net income per share of the consolidated Company, the Core Group and the Psychiatric Group for 1996 and 1995 would not have been material. The pro forma effect for 1996 and 1995 may not be representative of the pro forma effect in future years because it does not take into consideration stock-based incentives granted prior to 1995.
PREFERRED STOCK PURCHASE RIGHTS PLAN
On April 20, 1990, the Company distributed to shareholders one preferred stock purchase right (each a Right) for each outstanding share of common stock. Under certain conditions, each Right may be exercised to purchase one one-hundredth of a share of preferred stock, Series A, par value $.01 per share (the Series A Preferred Shares), of the Company at a price of $45. The Company's Psychiatric Group Depositary Shares do not include the Rights or entitle holders thereof to receive the Rights, which are applicable only to the Company's Core Group Common Stock. The total number of Rights currently issued or issuable, including Rights issuable in connection with common stock which may be issued under the Company's stock incentive plans and upon the conversion of the Company's outstanding Swiss Bonds, is approximately 25,721,000. Approximately 257,000 Series A Preferred Shares could be purchased upon the exercise of all Rights currently issued or issuable. The number of Rights outstanding and Series A Preferred Shares issuable upon exercise, as well as the Series A Preferred Share purchase price, are subject to customary antidilution adjustments.
The Rights are evidenced by the certificates for shares of common stock, and in general are not transferable apart from the common stock or exercisable until after a party has acquired beneficial ownership of, or made a tender offer for, 10% or more of the outstanding common stock of the Company (an Acquiring Person), or the occurrence of other events as specified in the Rights Plan. Under certain conditions as specified in the Rights Plan, including but not limited to the acquisition by a party of 15% or more of the outstanding common stock of the Company or the acquisition of the Company in a merger or other business combination, each holder of a Right (other than an Acquiring Person whose Rights will be void) will receive upon exercise thereof and payment of the exercise price that number of shares of common stock of the Company or of the other party, as applicable, having a market value of two times the exercise price of the Right.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Rights expire on April 20, 2000, and until exercised, the holder thereof, as such, will have no rights as a shareholder of the Company. At the Company's option, the Rights may be redeemed in whole at a price of $.01 per Right at any time prior to becoming exercisable. In general, the Company also may exchange the Rights at a ratio of one share of common stock per Right after becoming exercisable but prior to the acquisition of 50% or more of the outstanding shares of common stock by any party.
Series A Preferred Shares issuable upon exercise of the Rights will not be redeemable. Each Series A Preferred Share will have 100 votes and will be entitled to (a) dividends in an amount equal to the greater of $1.00 or 100 times the amount of the dividends per share paid on the common stock, (b) a liquidation preference in an amount equal to the greater of $100 or 100 times the amount per share paid on the common stock and (c) a payment in connection with a business combination (in which shares of common stock are exchanged) equal to 100 times the amount per share paid on the common stock.
DIVIDENDS
A quarterly dividend of $.525 per share for Core Group Common Stock, or approximately $12,314,000, was declared by the Board of Directors on January 24, 1997, payable on February 24, 1997 to shareholders of record on February 10, 1997. A quarterly dividend of $.80 per share for Psychiatric Group Depositary Shares, or approximately $1,667,000, was declared by the Board of Directors on January 24, 1997, payable on February 24, 1997 to shareholders of record on February 10, 1997. The aggregate dividends of $13,981,000 have been reflected as dividends payable in the accompanying consolidated financial statements as of December 31, 1996. Dividends of $2.02 per share paid on Core Group Common Stock during the year ended December 31, 1996 are characterized as $1.84 of ordinary income and $.18 of return of capital for tax purposes. Dividends of $2.80 per share paid on Psychiatric Group Depositary Shares during the year ended December 31, 1996 are characterized as $2.55 of ordinary income and $.25 of return of capital for tax purposes.
In general, dividends on the Company's capital stock are limited by the Company's unsecured revolving credit agreement to 95% of cash flow available for debt service, less interest expense, plus gains on asset dispositions and certain proceeds (PG Excess Proceeds) from the disposition of Psychiatric Group assets after the repayment of Psychiatric Group indebtedness. Dividends or other distributions paid out of PG Excess Proceeds will be available only for the Psychiatric Group Depositary Shares and will be limited to $30 million in the aggregate and $15 million in any calendar year.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
QUARTERLY FINANCIAL DATA (UNAUDITED)
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(1) Includes costs related to the Distribution of $300,000.
(2) Includes a premium of $2,652,000 received in connection with the prepayment of a mortgage note receivable.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULE
We have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in this Annual Report on Form 10-K, and have issued our report thereon dated March 24, 1997. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index of financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Denver, Colorado, March 24, 1997.
SCHEDULE III -- REAL ESTATE AND ACCUMULATED DEPRECIATION
AMERICAN HEALTH PROPERTIES, INC. DECEMBER 31, 1996 (DOLLARS IN THOUSANDS)
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(a) The cost basis of the properties for Federal income tax purposes is the same as the gross carrying amount; except for those properties for which a write-down was recorded in 1994 and the property in Cheraw, South Carolina for which the previous owner's basis of $3.7 million is required to be carried forward. (b) Most properties have had improvements since their initial construction. The range of dates reflects the construction date of the original structures through the latest date of improvements. (c) This property was conveyed to the Company in December 1992 in connection with the restructuring and forgiveness of a mortgage note receivable. The $21.4 million mortgage note receivable had been written down in June 1992 to $10 million. Subsequent recovery of a $1.1 million interest reserve fund from the mortgagee reduced the Company's recorded investment in the note to $8.8 million (net of unamortized fees) which became the Company's basis in the property upon its conveyance. The property was subsequently written down by $2.3 million, net in 1994. (d) This property was written down by $6.6 million, net in 1994.
SCHEDULE III -- REAL ESTATE AND ACCUMULATED DEPRECIATION
AMERICAN HEALTH PROPERTIES, INC. DECEMBER 31, 1996 (DOLLARS IN THOUSANDS)
SUMMARY OF REAL ESTATE AND ACCUMULATED DEPRECIATION ACTIVITY:
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To American Health Properties, Inc.:
We have audited the accompanying combined balance sheets of the Core Group (a business unit of American Health Properties, Inc.) as of December 31, 1996 and 1995, and the related combined statements of operations, total attributed equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the management of American Health Properties, Inc. 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 financial position of the Core Group as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Denver, Colorado, March 24, 1997.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
CORE GROUP COMBINED BALANCE SHEETS
The accompanying notes are an integral part of these financial statements.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
CORE GROUP COMBINED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
CORE GROUP COMBINED STATEMENTS OF TOTAL ATTRIBUTED EQUITY
The accompanying notes are an integral part of these financial statements.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
CORE GROUP COMBINED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these financial statements.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CORE GROUP COMBINED FINANCIAL STATEMENTS
THE COMPANY
American Health Properties, Inc., a Delaware corporation (the Company, which term refers to the Company and its subsidiaries unless the context otherwise requires), is a self-administered real estate investment trust (REIT) that commenced operations in 1987. The Company has investments in health care properties, including acute care, rehabilitation, long-term acute care and psychiatric hospitals, skilled nursing, assisted living and Alzheimer's care facilities and a medical office building.
Distribution of Psychiatric Group Depositary Shares On July 25, 1995, the Company completed the distribution of 2,085,675 Psychiatric Group Depositary Shares to holders of its common stock (the Distribution). Shareholders received one Psychiatric Group Depositary Share for every ten shares of common stock held of record at the close of business on July 14, 1995. Each Psychiatric Group Depositary Share represents one-tenth of a share of Psychiatric Group Preferred Stock. The Distribution was designed to separate the economic attributes of the Company's investments in psychiatric hospitals (the Psychiatric Group) and its investments in acute care, rehabilitation and long-term acute care hospitals, skilled nursing, assisted living and Alzheimer's care facilities and a medical office building (the Core Group) into two distinct portfolios, with two distinct classes of publicly-traded shares intended to represent those portfolios. In connection with the Distribution, the Company directly assigned or, if not directly assigned, allocated its assets, liabilities and stockholders' equity, and its revenues, expenses and cash flow items, between the Core Group and Psychiatric Group, as more fully described below. The Psychiatric Group Depositary Shares are intended to reflect the separate financial performance of the Psychiatric Group. The Company's common stock (the Core Group Common Stock) is intended to reflect the separate financial performance of the Core Group.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation The financial statements of the Core Group include the financial position, results of operations and cash flows of the Company's core investments in acute care, rehabilitation and long-term acute care hospitals, skilled nursing, assisted living and Alzheimer's care facilities and a medical office building, an allocated portion of the Company's general and administrative expense, all corporate assets and liabilities and related transactions associated with the ongoing operations of the Company which are not separately identified with either operating group, an attributed amount of inter-Group loans receivable from the Psychiatric Group and an attributed amount of the Company's stockholders' equity. For purposes of computing per share data for periods prior to the actual Distribution, the number of shares of Core Group Common Stock are assumed to be the same as the corresponding number of shares of the Company's common stock prior to the Distribution. The Core Group financial statements are prepared using the amounts included in the Company's consolidated financial statements.
Although the financial statements of the Core Group and the Psychiatric Group separately report the assets, liabilities (including contingent liabilities), stockholders' equity and items of income, expense and cash flow of the Company attributed to each such Group, such attribution does not affect the respective legal title to assets or responsibility for liabilities of the Company or any of its subsidiaries. Furthermore, such attribution does not affect the rights of creditors of the Company or any subsidiary, including rights under financing covenants.
Each holder of Core Group Common Stock or Psychiatric Group Depositary Shares is a holder of an issue of capital stock of the entire Company and is subject to risks associated with an investment in the Company and all of its businesses, assets and liabilities. Financial effects arising from one Group that affect the Company's consolidated results of operations, financial condition, cash flows or borrowing costs may also affect the results of operations, financial condition, cash flows or borrowing costs of the other Group. Net losses of either Group, as well as dividends and distributions on, and repurchases of, Core Group Common Stock or Psychiatric Group Depositary Shares will reduce the funds of the Company legally available for
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CORE GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
dividends on both the Core Group Common Stock and Psychiatric Group Depositary Shares. Accordingly, the Core Group's financial statements should be read in conjunction with the Company's consolidated financial statements and the financial statements of the Psychiatric Group.
These financial statements include the accounts of the Core Group business. The Core Group and the Psychiatric Group financial statements, taken together, comprise all of the accounts included in the Company's consolidated financial statements.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Short-Term Investments Cash and short-term investments consist of cash and all highly liquid investments with an original maturity date of less than three months and are stated at cost which approximates fair value.
Real Estate Properties The Core Group accounts for its property leases as operating leases. The Core Group records properties at cost and allocates the cost between land and buildings and improvements based on independent appraisals. Depreciation of Core Group real estate properties is recorded on a straight-line basis over the estimated useful lives of the buildings and improvements (27 to 42 years).
Impairment of Real Estate Properties and Inter-Group Loans The Core Group reviews for the possible impairment of its real estate properties and inter-Group loans whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. In general, an impairment of such assets would be indicated if the estimated future cash flows expected to result from the use of such assets and their eventual disposition is less than their carrying amounts.
Deferred Income Fees received, net of related direct costs, associated with the origination or amendment of leases are deferred and amortized at a constant effective rate over the remaining initial term of the related leases.
Deferred Costs Deferred financing costs are amortized over the term of the related debt at a constant effective rate.
Stock-Based Compensation In 1996, the Core Group adopted Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation" which defines a fair value based method of accounting for stock-based compensation. As allowed by SFAS 123, the Core Group has elected to continue to measure employee stock-based compensation expense using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees".
Federal Income Taxes The Company intends at all times to operate so as to qualify as a REIT under Sections 856 to 860 of the Internal Revenue Code. As such, the Company will not be subject to federal income tax.
Qualification as a REIT under Sections 856 to 860 of the Internal Revenue Code applies to the Company as a whole, rather than the Core Group or Psychiatric Group individually. Dividends paid by the Company on its Core Group Common Stock and Psychiatric Group Depositary Shares must be sufficient in the aggregate for the Company to meet the minimum distribution requirements of the Internal Revenue Code. The Company's earnings and profits as a whole, without reference to the Core Group or Psychiatric Group individually, is used to determine the taxable character of dividends paid to holders of its Core Group Common Stock and Psychiatric Group Depositary Shares.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CORE GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Earnings and profits, which determine the taxable character of dividends paid to stockholders, differ from net income for financial reporting purposes due primarily to timing differences in the recognition of deferred income, real estate property write-downs, mortgage note impairment reserves and various accruals and differences between the estimated useful lives used to compute depreciation for financial statement purposes and a 40-year life generally used in determining earnings and profits. The cost basis of the Company's real estate properties is generally the same for financial reporting and earnings and profits purposes, except for properties written down for financial reporting purposes and properties for which the previous owner's basis is required to be carried forward for tax purposes.
CORPORATE ACTIVITIES, INTER-GROUP LOANS, THIRD-PARTY DEBT AND EQUITY
Financial Activities As a matter of policy, the Company manages all financial activities on a centralized, consolidated basis. Such financial activities include the investment of surplus cash; the issuance and repayment of all short-term and long-term debt; and the issuance of common and preferred stock. These activities are then attributed to the Core Group and the Psychiatric Group in the manner described herein.
Historical Debt and Equity Transactions All third-party debt ($207,101,000 and $207,378,000 at December 31, 1996 and 1995, respectively) has been attributed to the Core Group. However, the Psychiatric Group was attributed (a) fixed rate inter-Group loans owing to the Core Group at December 31, 1994 of $20,000,000, an amount determined by the Board to be appropriate in relation to the assets and expected cash flow of the Psychiatric Group and its cash requirements and (b) revolving inter-Group loans owing to the Core Group at December 31, 1994 of $9,428,000, an amount equal to the outstanding borrowings owed to the Psychiatric Group from psychiatric hospital operators under revolving credit agreements at that date. As a result of such attributed inter-Group loans, and in light of the carrying value of each Group's assets and its other liabilities at December 31, 1994, the equity attributed to the Core Group at that date was $259,199,000 and the equity attributed to the Psychiatric Group at that date was $48,302,000.
Historically, the Psychiatric Group was attributed inter-Group loans owing to the Core Group from the date of the first Psychiatric Group asset purchase in 1988 to December 31, 1994 in amounts equal to the Psychiatric Group's net cash requirements not otherwise funded by the proceeds of equity issuances attributed to the Psychiatric Group. All such inter-Group loans were initially designated as floating rate loans (with an interest rate equal to the prevailing prime rate plus 2%), but portions of such inter-Group loans were re-designated as fixed rate loans in amounts that corresponded with designated portions of third-party fixed rate senior debt issued by the Company from time to time (with an interest rate equal to that borne by third-party fixed rate senior debt plus 2%). Proceeds of equity issuances after 1988 were attributed to the Psychiatric Group in amounts determined to be appropriate in relation to the assets and expected cash flow of the Psychiatric Group, its cash requirements and its inter-Group debt at the time of such issuances. Equity proceeds attributed to the Psychiatric Group were deemed to correspondingly reduce inter-Group debt. In general, dividends paid by the Company were attributed to the Core Group and the Psychiatric Group on the basis of their respective contributions to funds from operations, excluding expenses associated with litigation, relocation, issuance of Psychiatric Group Depositary Shares and termination of purchase commitments which were not considered to be routine costs of ongoing operations.
Third-Party Debt All of the Company's third-party debt has been attributed to the Core Group. This debt and its relevant terms are summarized in the following paragraphs.
Bank loans payable The Company has a $150 million unsecured revolving credit agreement with a syndicate of banks that matures on December 27, 1998 and bears an annual facility fee based on the total commitment. This agreement provides for interest on outstanding borrowings based on either LIBOR plus a margin or the prime rate plus, in certain circumstances, a margin. The margin on LIBOR and prime rate borrowings and the annual facility fee may vary and are dependent upon various conditions, including the
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CORE GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Company's debt ratings and the level of borrowings outstanding. Currently, the Company is able to borrow at either LIBOR plus 87.5 basis points or the prime rate, and the annual facility fee is 25 basis points.
The weighted average amount of borrowings under bank credit agreements outstanding during 1996, 1995 and 1994 was $21,622,000, $27,467,000 and $5,404,000 at weighted average interest rates of 6.4%, 7.5% and 6.9%, respectively. The maximum amount outstanding under bank credit agreements in 1996, 1995 and 1994 was $53,000,000, $73,000,000 and $20,500,000, respectively. As of December 31, 1996, the Company had $48,500,000 of borrowings outstanding under its bank credit agreement with a weighted average interest rate of 6.7%.
The duration of borrowings under the Company's unsecured revolving credit agreement are generally less than 90 days at variable pricing indicative of current short-term borrowing rates. Accordingly, carrying amount is a reasonable estimate of fair value.
Senior notes payable At December 31, 1996, the Company had $72 million of 11.45% unsecured senior notes payable outstanding that were issued pursuant to a $125 million private placement in 1989 and $80 million of 10.41% unsecured senior notes payable outstanding that were issued pursuant to a $100 million private placement in 1990. The weighted average amount of borrowings under these senior note issues during 1996, 1995 and 1994 was $178,250,000, $211,000,000 and $225,000,000 at weighted average effective interest rates of 11.03%, 11.06% and 11.09%, respectively. In February 1997, the Company prepaid the $152 million outstanding balance of these senior note issues resulting in an extraordinary charge in the first quarter of 1997 of $11,427,000 consisting of a make-whole premium and other costs related to the prepayment.
In January 1997, the Company completed a $220 million public debt offering of unsecured senior notes payable, issuing $100 million of notes with a coupon rate of 7.05% due January 15, 2002 (2002 Notes) and $120 million of notes with a coupon rate of 7.50% due January 15, 2007 (2007 Notes). The 2002 Notes and 2007 Notes were sold for $99,749,000 and $119,216,000, respectively, and have effective interest rates of approximately 7.34% and 7.74%, respectively. Interest is payable at the coupon rates semi-annually on January 15th and July 15th. The proceeds from the public debt offering were used to pay off the Company's two issues of private placement debt prior to its scheduled maturity and the Company's borrowings under its bank credit agreement.
An estimate of rates currently available to the Company for debt with similar terms was used to determine the fair value of the Company's senior notes payable. As of December 31, 1996 and 1995, the estimated fair value of senior notes payable was $163 million and $215 million, respectively.
Subordinated convertible bonds payable The Company's Convertible Dual Currency Subordinated Bonds (the Swiss Bonds) were sold in Switzerland pursuant to public subscription in 1990. The Swiss Bonds have a coupon rate of 8.5% and are convertible at the option of the holder at any time until July 9, 2000 into shares of the Company's common stock at a conversion price of $23.45 per share and a fixed exchange rate of Sfr. 1.41 per U.S. $1.00. There were no conversions of Swiss Bonds in the last three years. Final redemption of the 1,491 remaining Swiss Bonds will be made in U.S. dollars of $7,455,000 on July 19, 2000 provided additional conversions or redemption have not occurred earlier. Interest on outstanding Swiss Bonds is payable annually in arrears in Swiss francs in July. Accrued and accreted interest is not paid on Swiss Bonds converted into common stock. The Company has reserved approximately 225,000 unissued shares of common stock for potential future Swiss Bond conversions.
The fair value of the Company's subordinated convertible bonds payable is based on the quoted market price of the bonds as traded in Switzerland. As of December 31, 1996 and 1995, the estimated fair value of subordinated convertible bonds payable was $6,757,000 and $6,573,000, respectively.
Debt covenants Covenants and restrictions in the Company's various debt agreements include limitations on secured borrowings, restrictions covering the use of proceeds from asset sales and payments of
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CORE GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
dividends and requirements relating to the maintenance of specified financial covenants, including those relating to minimum tangible net worth, fixed charge coverage and ratios of liabilities to minimum tangible net worth and asset values.
Annual maturities The aggregate amount of maturities of the Company's outstanding debt at December 31, 1996, as adjusted for the sale of $220 million of senior notes in January 1997 and the prepayment of $152 million of senior notes in February 1997, is $7,455,000, $100,000,000 and $120,000,000 in 2000, 2002 and 2007, respectively.
Interest Interest capitalized on construction in progress was $895,000, $198,000 and $883,000 in 1996, 1995 and 1994, respectively. Interest paid, net of interest capitalized, in 1996, 1995 and 1994 was $21,547,000, $26,232,000 and $24,924,000, respectively.
Inter-Group Loans The weighted average outstanding amount of revolving inter-Group loans owed by the Psychiatric Group to the Core Group during 1996, 1995 and 1994 was $4,666,000, $5,497,000 and $9,106,000 at weighted average interest rates of 10.27%, 10.82% and 9.15%, respectively.
The weighted average outstanding amount of fixed rate inter-Group loans owed by the Psychiatric Group to the Core Group during 1996, 1995 and 1994 was $9,175,000, $10,979,000 and $24,706,000 at a weighted average interest rate of 13% for all three years. There were no new fixed rate loans made to the Psychiatric Group during these three years. Paydowns were received from the proceeds of equity transactions in 1994 attributed to the Psychiatric Group and the net proceeds from sales of Psychiatric Group real estate investments in 1995 and 1994.
Repayment of inter-Group loans by the Psychiatric Group is primarily dependent upon the amount and timing of sales of the Psychiatric Group's assets and paydowns received by the Psychiatric Group on borrowings provided to psychiatric hospital operators under revolving credit agreements. The Core Group received $4,325,000 of revolving inter-Group loan repayments and $10,825,000 of fixed rate inter-Group loan repayments in 1995 and $5,772,000 of fixed rate inter-Group loan repayments in 1994 from the Psychiatric Group as a result of such operator borrowing paydowns and asset sales.
The Company's Board has established certain management policies relating to the Core Group's inter-Group loans to the Psychiatric Group. Under the policies currently in effect, which may be modified or rescinded in the sole discretion of the Company's Board, the aggregate revolving inter-Group loans owed by the Psychiatric Group to the Core Group are limited to a maximum of $8,750,000 at any one time outstanding, which limit is to be reduced dollar-for-dollar with any permanent repayment in the future of borrowings under revolving credit agreements provided to Psychiatric Group hospital operators. In addition, the limit on the aggregate revolving inter-Group loans will not be reduced below $5,000,000, and except for such revolving inter-Group loans, no additional fixed rate or other inter-Group loans will be advanced by the Core Group to the Psychiatric Group.
If the Psychiatric Group sells any assets out of the ordinary course, the net proceeds from such sales (after transaction costs and reserves for contingencies) will be applied, first, to repay revolving inter-Group loans owed by the Psychiatric Group to the Core Group to the extent of outstanding borrowings provided to psychiatric hospital operators under revolving credit agreements associated with the asset or assets sold, second, to repay the outstanding fixed rate inter-Group loans owed by the Psychiatric Group to the Core Group (until repaid in full), and third, to repay other revolving inter-Group loans owed by the Psychiatric Group to the Core Group (until repaid in full), before any remaining net proceeds from such sales may be used to make distributions to holders of Psychiatric Group Depositary Shares.
Excess cash received by the Psychiatric Group (other than net proceeds from asset sales) will be applied to reduce revolving inter-Group loans owed by the Psychiatric Group to the Core Group (until repaid in full), subject to the ability of the Psychiatric Group, at the option of the Board, to re-borrow cash from the Core
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CORE GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Group up to the limitations mentioned previously to cover future cash needs of the Psychiatric Group (including, without limitation, to fund dividends in a manner consistent with the dividend policy then applicable to the Psychiatric Group Depositary Shares).
Fixed rate inter-Group loans owed by the Psychiatric Group to the Core Group are unsecured, bear interest at a fixed rate of approximately 13% per annum (which was equal to the weighted average interest rate on the Company's fixed rate senior debt issues at the time the loans were attributed plus 2%), and are prepayable without premium at any time, at the option of the Board.
Revolving inter-Group loans owed by the Psychiatric Group to the Core Group are unsecured, bear interest at a floating rate equal to the prevailing prime rate plus 2% (10.25% at December 31, 1996) and are prepayable without premium at any time, at the option of the Board.
The carrying amounts of the inter-Group loans owed to the Core Group by the Psychiatric Group are a reasonable estimate of fair value, as the pricing and terms of the loans are indicative of current rates and credit risk.
Cash received by the Psychiatric Group in excess of required repayments of inter-Group loans owed by the Psychiatric Group may, at the option of the Company's Board, be advanced to the Core Group as revolving inter-Group loans (to the extent such cash can be used beneficially by the Core Group), or otherwise be invested on behalf of the Psychiatric Group. Revolving inter-Group loans owed by the Core Group to the Psychiatric Group bear interest at a floating rate equal to the weighted average interest rate borne by the Company's revolving debt (or, for periods in which there is no such revolving debt outstanding, the interest rate at which the Company could borrow on a revolving basis), and are prepayable without premium at any time, at the option of the Board.
Nothing in the foregoing policies obligates the Board to cause the Core Group to provide funds to the Psychiatric Group if the Board determines it is in the best interests of the Company not to do so.
Equity Transactions Subsequent to the Distribution Subsequent to the Distribution, the proceeds of Core Group Common Stock issuances as well as cash required to fund Core Group Common Stock dividends or repurchases are attributed solely to the Core Group and the proceeds of Psychiatric Group Depositary Share issuances (e.g., upon exercise of management stock options) as well as cash required to fund Psychiatric Group Depositary Share dividends or repurchases are attributed solely to the Psychiatric Group.
General and Administrative Expenses General and administrative expenses of the Company that cannot be directly attributed to either Group are allocated to the Core Group and the Psychiatric Group on the basis of their respective contributions to revenues (excluding inter-Group revenues and revenues from investment dispositions), provided that at no time will such expenses allocated to either Group be less than $250,000. The Company's general and administrative expenses consist primarily of employment and related benefits, professional services, shareholder reporting, franchise taxes, travel and other related corporate activity.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CORE GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
REAL ESTATE PROPERTIES
The following table summarizes the Core Group's investment in health care real estate properties as of December 31, 1996:
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CORE GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1996, the Core Group had the following construction in progress:
In the second quarter of 1996, the Core Group acquired an acute care property in West Valley City, Utah (Pioneer Valley Hospital) in exchange for its acute care properties in Jefferson, Louisiana (Elmwood Medical Center) and Halstead, Kansas (Halstead Hospital). The exchange was accounted for at the net book value of the properties exchanged. Pioneer Valley Hospital is leased to the same operator that had leased the two exchanged properties under comparable terms and at a lease rate equivalent to the combined lease rates of the two exchanged properties.
The Core Group's properties are leased under "net" leases pursuant to which the lessees are responsible for all maintenance, repairs, taxes, and insurance of the leased properties. The leases provide for the payment of minimum base rent and additional rent during the fixed term and any renewal terms. Additional rent is generally based on the increase in annual gross revenues of the related facility or consumer price index as specified in the lease agreements.
The Core Group has the right to approve capital expenditures at all properties, the option to fund certain capital expenditures and, in certain situations, is obligated to fund approved capital expenditures on terms comparable to the original investment. At December 31, 1996, the Core Group had no commitments to fund capital expenditures pursuant to these rights and obligations. The base and additional rent provisions of the leases are amended when such capital expenditures are funded to reflect the Core Group's increased investment.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CORE GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The Core Group has agreed to provide $13.8 million of real estate financing to an experienced operator of long-term acute care hospitals. Of this amount, $4.4 million has been specifically identified for a property in Houston, Texas. In addition, the Core Group has agreed to provide $50 million of real estate financing to an experienced operator of assisted living facilities. Approximately $29 million has been specifically identified for the construction of five properties located in four states which will be leased to the operator upon completion. The Core Group has also agreed to provide $17 million of real estate construction and lease financing for two skilled nursing properties in Las Vegas, Nevada to be operated by an experienced operator of skilled nursing facilities.
Six of the Core Group's acute care properties are leased to subsidiaries of American Medical International, Inc. (AMI), a subsidiary of Tenet Healthcare Corporation. The six leases are covered by cross-default provisions and the lease obligations are unconditionally guaranteed by AMI. In 1996, revenues from these leases accounted for 55% of the Core Group's total revenues.
Aggregate revenues from five leases maturing in 1999 accounted for 43% of the Core Group's total revenues in 1996. Four of these properties are leased to subsidiaries of AMI and the other property is leased to a subsidiary of Columbia/HCA Healthcare Corporation. Each such lease grants the operator options, exercisable on not less than six months notice, to extend the term of the lease for eight consecutive five-year renewal terms. Base and additional rent during the first three to four extended terms would be on the same terms and conditions as the current initial term. Minimum rent during the final four to five extended terms would be fair market rental but no separate additional rent. Each lease also grants the operator options, exercisable on not less than six months notice, to purchase the leased property at fair market value at the expiration of any term of the lease.
Future minimum annual rentals under the Core Group's noncancellable operating leases for calendar years 1997 through 2001 and thereafter are approximately $68,700,000, $68,700,000, $45,800,000, $42,200,000, $40,100,000 and $90,000,000, respectively.
DIRECT FINANCING LEASES
In connection with its investments in certain acute and long-term care properties, the Core Group also has provided equipment leasing for terms of five to seven years which are classified as direct financing leases. As of December 31, 1996, the Core Group's aggregate net investment in these direct financing leases was $3,695,000, represented by total minimum lease payments receivable of $4,423,000 less unearned income of $728,000. Future minimum annual lease payments under these leases for calendar years 1997 through 2001 are approximately $1,262,000, $1,262,000, $1,262,000, $624,000 and $13,000, respectively.
PENSION PLANS
The Company has a defined contribution pension plan covering all of its employees. Pension expense allocated to the Core Group in 1996, 1995 and 1994 was $222,000, $210,000 and $170,000, respectively.
The Company has an unfunded defined benefit pension plan covering non-employee members of its Board of Directors upon completion of sixty months of membership on the Board. The benefits, limited to ten years, are based on years of service and the annual base director fee in effect as of the date a director ceases to be a member of the Board. Net periodic pension cost allocated to the Core Group in 1996, 1995 and 1994 was $177,000, $142,000 and $123,000, respectively. The Notes to the Consolidated Financial Statements of the Company should be read for further details regarding this plan.
STOCK INCENTIVE PLANS
The Company's stock incentive plans provide for the issuance of shares of the Company's stock to directors and key employees as stock incentives. Pursuant to the terms of the Company's stock incentive plans,
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CORE GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
stock options, restricted stock, deferred shares and dividend equivalent rights (DERs) were adjusted to reflect the Distribution. Total stock-based compensation expense recognized under APB 25 and allocated to the Core Group in 1996, 1995 and 1994 was $1,139,000, $961,000 and $777,000, respectively. If the fair value based method of accounting defined by SFAS 123 had been used to measure and recognize stock-based compensation expense, the pro forma effect on the reported amounts of net income and net income per share of the Core Group for 1996 and 1995 would not have been material. The pro forma effect for 1996 and 1995 may not be representative of the pro forma effect in future years because it does not take into consideration stock-based incentives granted prior to 1995. The Notes to the Consolidated Financial Statements of the Company should be read for further details regarding the Company's stock incentive plans.
PREFERRED STOCK PURCHASE RIGHTS PLAN
The Company has a preferred stock purchase rights plan which provides for the distribution of one preferred stock purchase right (each a Right) to shareholders for each outstanding share of common stock. Under certain conditions, each Right may be exercised to purchase one one-hundredth of a share of preferred stock, Series A, par value $.01 per share (the Series A Preferred Shares), of the Company at a price of $45. The Company's Psychiatric Group Depositary Shares do not include the Rights or entitle holders thereof to receive the Rights, which are applicable only to the Company's Core Group Common Stock. The Notes to the Consolidated Financial Statements of the Company should be read for further details regarding the Company's preferred stock purchase rights plan.
DIVIDENDS
A quarterly dividend of $.525 per share for Core Group Common Stock, or approximately $12,314,000, was declared by the Board of Directors on January 24, 1997, payable on February 24, 1997 to shareholders of record on February 10, 1997. This dividend has been reflected as dividends payable in the accompanying financial statements as of December 31, 1996. Dividends of $2.02 per share paid on Core Group Common Stock during the year ended December 31, 1996 are characterized as $1.84 of ordinary income and $.18 of return of capital for tax purposes.
In general, dividends on the Company's capital stock are limited by the Company's unsecured revolving credit agreement to 95% of cash flow available for debt service, less interest expense, plus gains on asset dispositions and certain proceeds (PG Excess Proceeds) from the disposition of Psychiatric Group assets after the repayment of Psychiatric Group indebtedness. Dividends or other distributions paid out of PG Excess Proceeds will be available only for the Psychiatric Group Depositary Shares and will be limited to $30 million in the aggregate and $15 million in any calendar year.
QUARTERLY FINANCIAL DATA (UNAUDITED)
- ---------------
(1) Includes a premium of $2,652,000 received in connection with the prepayment of a mortgage note receivable.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To American Health Properties, Inc.:
We have audited the accompanying combined balance sheets of the Psychiatric Group (a business unit of American Health Properties, Inc.) as of December 31, 1996 and 1995, and the related combined statements of operations, total attributed equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the management of American Health Properties, Inc. 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 financial position of the Psychiatric Group as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Denver, Colorado, March 24, 1997.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
PSYCHIATRIC GROUP COMBINED BALANCE SHEETS
The accompanying notes are an integral part of these financial statements.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
PSYCHIATRIC GROUP COMBINED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
PSYCHIATRIC GROUP COMBINED STATEMENTS OF TOTAL ATTRIBUTED EQUITY
The accompanying notes are an integral part of these financial statements.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
PSYCHIATRIC GROUP COMBINED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these financial statements.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO PSYCHIATRIC GROUP COMBINED FINANCIAL STATEMENTS
THE COMPANY
American Health Properties, Inc., a Delaware corporation (the Company, which term refers to the Company and its subsidiaries unless the context otherwise requires), is a self-administered real estate investment trust (REIT) that commenced operations in 1987. The Company has investments in health care properties, including acute care, rehabilitation, long-term acute care and psychiatric hospitals, skilled nursing, assisted living and Alzheimer's care facilities and a medical office building.
Distribution of Psychiatric Group Depositary Shares On July 25, 1995, the Company completed the distribution of 2,085,675 Psychiatric Group Depositary Shares to holders of its common stock (the Distribution). Shareholders received one Psychiatric Group Depositary Share for every ten shares of common stock held of record at the close of business on July 14, 1995. Each Psychiatric Group Depositary Share represents one-tenth of a share of Psychiatric Group Preferred Stock. The Distribution was designed to separate the economic attributes of the Company's investments in psychiatric hospitals (the Psychiatric Group) and its investments in acute care, rehabilitation and long-term acute care hospitals, skilled nursing, assisted living and Alzheimer's care facilities and a medical office building (the Core Group) into two distinct portfolios, with two distinct classes of publicly-traded shares intended to represent those portfolios. In connection with the Distribution, the Company directly assigned or, if not directly assigned, allocated its assets, liabilities and stockholders' equity, and its revenues, expenses and cash flow items, between the Psychiatric Group and Core Group, as more fully described below. The Psychiatric Group Depositary Shares are intended to reflect the separate financial performance of the Psychiatric Group. The Company's common stock (the Core Group Common Stock) is intended to reflect the separate financial performance of the Core Group.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation The financial statements of the Psychiatric Group include the financial position, results of operations and cash flows of the Company's psychiatric hospital investments, an allocated portion of the Company's general and administrative expense, an attributed amount of inter-Group debt payable to the Core Group and an attributed amount of the Company's stockholders' equity. For purposes of computing per share data for periods prior to the actual Distribution, the number of Psychiatric Group Depositary Shares are assumed to be one-tenth of the corresponding number of shares of the Company's common stock prior to the Distribution. The Psychiatric Group financial statements are prepared using the amounts included in the Company's consolidated financial statements.
Although the financial statements of the Psychiatric Group and the Core Group separately report the assets, liabilities (including contingent liabilities), stockholders' equity and items of income, expense and cash flow of the Company attributed to each such Group, such attribution does not affect the respective legal title to assets or responsibility for liabilities of the Company or any of its subsidiaries. Furthermore, such attribution does not affect the rights of creditors of the Company or any subsidiary, including rights under financing covenants.
Each holder of Psychiatric Group Depositary Shares or Core Group Common Stock is a holder of an issue of capital stock of the entire Company and is subject to risks associated with an investment in the Company and all of its businesses, assets and liabilities. Financial effects arising from one Group that affect the Company's consolidated results of operations, financial condition, cash flows or borrowing costs may also affect the results of operations, financial condition, cash flows or borrowing costs of the other Group. In addition, net losses of either Group, as well as dividends and distributions on, and repurchases of, Psychiatric Group Depositary Shares or Core Group Common Stock will reduce the funds of the Company legally available for dividends on both the Psychiatric Group Depositary Shares and Core Group Common Stock. Accordingly, the Psychiatric Group's financial statements should be read in conjunction with the Company's consolidated financial statements and the financial statements of the Core Group.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO PSYCHIATRIC GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
These financial statements include the accounts of the Psychiatric Group business. The Psychiatric Group and the Core Group financial statements, taken together, comprise all of the accounts included in the Company's consolidated financial statements.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Real Estate Properties The Psychiatric Group accounts for its property leases as operating leases. The Psychiatric Group records properties at cost and allocates the cost between land and buildings and improvements based on independent appraisals. Depreciation of Psychiatric Group real estate properties is recorded on a straight-line basis over 21 years, the estimated useful lives of the buildings and improvements.
Impairment of Real Estate Properties and Notes Receivable The Psychiatric Group reviews for the possible impairment of its real estate properties and notes receivable whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. In general, an impairment of such assets would be indicated if the estimated future cash flows expected to result from the use of such assets and their eventual disposition is less than their carrying amounts.
Deferred Income Fees received, net of related direct costs, associated with the origination or amendment of leases and mortgages are deferred and amortized at a constant effective rate over the remaining initial term of the related leases and mortgage notes receivable.
Stock-Based Compensation In 1996, the Psychiatric Group adopted Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation" which defines a fair value based method of accounting for stock-based compensation. As allowed by SFAS 123, the Psychiatric Group has elected to continue to measure employee stock-based compensation expense using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees".
Federal Income Taxes The Company intends at all times to operate so as to qualify as a REIT under Sections 856 to 860 of the Internal Revenue Code. As such, the Company will not be subject to federal income tax.
Qualification as a REIT under Sections 856 to 860 of the Internal Revenue Code applies to the Company as a whole, rather than the Core Group or Psychiatric Group individually. Dividends paid by the Company on its Core Group Common Stock and Psychiatric Group Depositary Shares must be sufficient in the aggregate for the Company to meet the minimum distribution requirements of the Internal Revenue Code. The Company's earnings and profits as a whole, without reference to the Core Group or Psychiatric Group individually, is used to determine the taxable character of dividends paid to holders of its Core Group Common Stock and Psychiatric Group Depositary Shares.
Earnings and profits, which determine the taxable character of dividends paid to stockholders, differ from net income for financial reporting purposes due primarily to timing differences in the recognition of deferred income, real estate property write-downs, mortgage note impairment reserves and various accruals and differences between the estimated useful lives used to compute depreciation for financial statement purposes and a 40-year life generally used in determining earnings and profits. The cost basis of the Company's real estate properties is generally the same for financial reporting and earnings and profits purposes, except for properties written down for financial reporting purposes and properties for which the previous owner's basis is required to be carried forward for tax purposes.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO PSYCHIATRIC GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
CORPORATE ACTIVITIES, INTER-GROUP LOANS, THIRD-PARTY DEBT AND EQUITY
Financial Activities As a matter of policy, the Company manages all financial activities on a centralized, consolidated basis. Such financial activities include the investment of surplus cash; the issuance and repayment of all short-term and long-term debt; and the issuance of common and preferred stock. These activities are then attributed to the Core Group and the Psychiatric Group in the manner described herein.
Historical Debt and Equity Transactions All third-party debt ($207,101,000 and $207,378,000 at December 31, 1996 and 1995, respectively) has been attributed to the Core Group. However, the Psychiatric Group was attributed (a) fixed rate inter-Group loans owing to the Core Group at December 31, 1994 of $20,000,000, an amount determined by the Board to be appropriate in relation to the assets and expected cash flow of the Psychiatric Group and its cash requirements and (b) revolving inter-Group loans owing to the Core Group at December 31, 1994 of $9,428,000, an amount equal to the outstanding borrowings owed to the Psychiatric Group from psychiatric hospital operators under revolving credit agreements at that date. As a result of such attributed inter-Group loans, and in light of the carrying value of each Group's assets and its other liabilities at December 31, 1994, the equity attributed to the Core Group at that date was $259,199,000 and the equity attributed to the Psychiatric Group at that date was $48,302,000.
Historically, the Psychiatric Group was attributed inter-Group loans owing to the Core Group from the date of the first Psychiatric Group asset purchase in 1988 to December 31, 1994 in amounts equal to the Psychiatric Group's net cash requirements not otherwise funded by the proceeds of equity issuances attributed to the Psychiatric Group. All such inter-Group loans were initially designated as floating rate loans (with an interest rate equal to the prevailing prime rate plus 2%), but portions of such inter-Group loans were re-designated as fixed rate loans in amounts that corresponded with designated portions of third-party fixed rate senior debt issued by the Company from time to time (with an interest rate equal to that borne by third-party fixed rate senior debt plus 2%). Proceeds of equity issuances after 1988 were attributed to the Psychiatric Group in amounts determined to be appropriate in relation to the assets and expected cash flow of the Psychiatric Group, its cash requirements and its inter-Group debt at the time of such issuances. Equity proceeds attributed to the Psychiatric Group were deemed to correspondingly reduce inter-Group debt. In general, dividends paid by the Company were attributed to the Core Group and the Psychiatric Group on the basis of their respective contributions to funds from operations, excluding expenses associated with litigation, relocation, issuance of Psychiatric Group Depositary Shares and termination of purchase commitments which were not considered to be routine costs of ongoing operations.
Third-Party Debt All of the Company's third-party debt has been attributed to the Core Group; however, the Psychiatric Group, together with the Core Group, is subject to all of the terms, restrictions and covenants relating to such third-party debt. These include limitations on secured borrowings, restrictions covering the use of proceeds from asset sales and payments of dividends and requirements relating to the maintenance of specified financial covenants, including those relating to minimum tangible net worth, fixed charge coverage and ratios of liabilities to minimum tangible net worth and asset values. The third-party debt attributed to the Core Group at December 31, 1996 includes $152,000,000 of unsecured senior notes payable and $6,601,000 of subordinated convertible bonds payable. The aggregate amount of maturities of the Company's outstanding third-party debt at December 31, 1996, as adjusted for the sale of $220 million of senior notes in January 1997 and the prepayment of $152 million of senior notes in February 1997, is $7,455,000, $100,000,000 and $120,000,000 in 2000, 2002 and 2007, respectively. The Notes to the Consolidated Financial Statements of the Company should be read for further details regarding the Company's third-party debt.
Inter-Group Loans The weighted average outstanding amount of revolving inter-Group loans owed by the Psychiatric Group to the Core Group during 1996, 1995 and 1994 was $4,666,000, $5,497,000 and $9,106,000 at weighted average interest rates of 10.27%, 10.82% and 9.15%, respectively.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO PSYCHIATRIC GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted average outstanding amount of fixed rate inter-Group loans owed by the Psychiatric Group to the Core Group during 1996, 1995 and 1994 was $9,175,000, $10,979,000 and $24,706,000 at a weighted average interest rate of 13% for all three years. There were no new fixed rate loans made to the Psychiatric Group during these three years. Paydowns were funded with the proceeds of equity transactions in 1994 attributed to the Psychiatric Group and the net proceeds from sales of Psychiatric Group real estate investments in 1995 and 1994.
Repayment of inter-Group loans by the Psychiatric Group is primarily dependent upon the amount and timing of sales of the Psychiatric Group's assets and paydowns received by the Psychiatric Group on borrowings provided to psychiatric hospital operators under revolving credit agreements. The Psychiatric Group made $4,325,000 of revolving inter-Group loan repayments and $10,825,000 of fixed rate inter-Group loan repayments in 1995 and $5,772,000 of fixed rate inter-Group loan repayments in 1994 to the Core Group as a result of such operator borrowing paydowns and asset sales.
The Company's Board has established certain policies relating to the Core Group's inter-Group loans to the Psychiatric Group. Under the policies currently in effect, which may be modified or rescinded in the sole discretion of the Company's Board, the aggregate revolving inter-Group loans owed by the Psychiatric Group to the Core Group are limited to a maximum of $8,750,000 at any one time outstanding, which limit is to be reduced dollar-for-dollar with any permanent repayment in the future of borrowings under revolving credit agreements provided to Psychiatric Group hospital operators. In addition, the limit on the aggregate revolving inter-Group loans will not be reduced below $5,000,000, and except for such revolving inter-Group loans, no additional fixed rate or other inter-Group loans will be advanced by the Core Group to the Psychiatric Group.
If the Psychiatric Group sells any assets out of the ordinary course, the net proceeds from such sales (after transaction costs and reserves for contingencies) will be applied, first, to repay revolving inter-Group loans owed by the Psychiatric Group to the Core Group to the extent of outstanding borrowings provided to psychiatric hospital operators under revolving credit agreements associated with the asset or assets sold, second, to repay the outstanding fixed rate inter-Group loans owed by the Psychiatric Group to the Core Group (until repaid in full), and third, to repay other revolving inter-Group loans owed by the Psychiatric Group to the Core Group (until repaid in full), before any remaining net proceeds from such sales may be used to make distributions to holders of Psychiatric Group Depositary Shares.
Excess cash received by the Psychiatric Group (other than net proceeds from asset sales) will be applied to reduce revolving inter-Group loans owed by the Psychiatric Group to the Core Group (until repaid in full), subject to the ability of the Psychiatric Group, at the option of the Board, to re-borrow cash from the Core Group up to the limitations mentioned previously to cover future cash needs of the Psychiatric Group (including, without limitation, to fund dividends in a manner consistent with the dividend policy then applicable to the Psychiatric Group Depositary Shares).
Fixed rate inter-Group loans owed by the Psychiatric Group to the Core Group are unsecured, bear interest at a fixed rate of approximately 13% per annum (which was equal to the weighted average interest rate on the Company's fixed rate senior debt issues at the time the loans were attributed plus 2%) and are prepayable without premium at any time, at the option of the Board.
Revolving inter-Group loans owed by the Psychiatric Group to the Core Group are unsecured, bear interest at a floating rate equal to the prevailing prime rate plus 2% (10.25% at December 31, 1996) and are prepayable without premium at any time, at the option of the Board.
The carrying amounts of the inter-Group loans owed by the Psychiatric Group to the Core Group are a reasonable estimate of fair value, as the pricing and terms of the loans are indicative of current rates and credit risk.
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO PSYCHIATRIC GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Cash received by the Psychiatric Group in excess of required repayments of inter-Group loans owed by the Psychiatric Group may, at the option of the Company's Board, be advanced to the Core Group as revolving inter-Group loans (to the extent such cash can be used beneficially by the Core Group) or otherwise be invested on behalf of the Psychiatric Group. Revolving inter-Group loans owed by the Core Group to the Psychiatric Group bear interest at a floating rate equal to the weighted average interest rate borne by the Company's revolving debt (or, for periods in which there is no such revolving debt outstanding, the interest rate at which the Company could borrow on a revolving basis), and are prepayable without premium at any time, at the option of the Board.
Nothing in the foregoing policies obligates the Board to cause the Core Group to provide funds to the Psychiatric Group if the Board determines it is in the best interests of the Company not to do so.
Equity Transactions Subsequent to the Distribution Subsequent to the Distribution, the proceeds of Core Group Common Stock issuances as well as cash required to fund Core Group Common Stock dividends or repurchases are attributed solely to the Core Group, and the proceeds of Psychiatric Group Depositary Share issuances (e.g., upon exercise of management stock options) as well as cash required to fund Psychiatric Group Depositary Share dividends or repurchases are attributed solely to the Psychiatric Group.
General and Administrative Expenses General and administrative expenses of the Company that cannot be directly attributed to either Group are allocated to the Psychiatric Group and the Core Group on the basis of their respective contributions to revenues (excluding inter-Group revenues and revenues from investment dispositions), provided that at no time will such expenses allocated to either Group be less than $250,000. All general and administrative expenses allocated to the Psychiatric Group are paid currently, regardless of when such expenses are paid to third parties by the Company. As such, the Psychiatric Group financial statements do not reflect any liabilities for such allocated general and administrative expenses. The Company's general and administrative expenses consist primarily of employment and related benefits, professional services, shareholder reporting, franchise taxes, travel and other related corporate activity.
PSYCHIATRIC BUSINESS
Fundamental changes in the psychiatric industry continue to negatively impact the facility-specific operating cash flow at the Psychiatric Group's properties. Institutions responsible for providing insurance coverage to patients who use inpatient psychiatric treatment services have directed efforts toward decreasing their payments for such services, thereby reducing hospital operating revenues. Some cost-cutting measures used by such institutions include decreasing the inpatient length of stay, intensively reviewing utilization, directing patients from inpatient care to outpatient care and negotiating reduced reimbursement rates for services. The wider use of psychotropic drugs also has resulted in significant declines in the average length of stay. In addition, aggressive program compliance enforcement and increased scrutiny of past and current billing practices has resulted in the litigation of some providers and significant negative publicity which has further exacerbated the financial and operational difficulties of providers. Although the operators of the psychiatric hospitals are responding by increasing case management, developing lower cost outpatient and daypatient programs and reducing operating costs, their efforts are generally not consistently mitigating the negative impact of these fundamental psychiatric industry changes. As a result, certain of the Psychiatric Group hospital operators have not met their contractual payment obligations to the Psychiatric Group as scheduled and there can be no assurance that Psychiatric Group operators will be able to meet such payment obligations in the future.
The Psychiatric Group currently is providing financing under revolving credit agreements to the operators of three of its psychiatric hospitals. As of December 31, 1996, outstanding borrowings under such agreements totaled $4,225,000, and the Psychiatric Group has committed to fund an additional $1,475,000 of borrowings upon request, subject to certain conditions. These borrowings, which are partially secured by accounts receivable and certain personal property and which contain events of default that would be triggered by
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO PSYCHIATRIC GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
defaults under the lease relating to the relevant psychiatric hospital, are the primary source of financing for these operators' operating and capital needs. These psychiatric hospitals have, from time to time, been unable to generate sufficient cash flow for working capital and the development of new programs. In certain cases, these psychiatric hospitals have not been able to pay down the outstanding borrowings under the revolving credit agreements provided by the Psychiatric Group or to secure replacement financing from third-party lenders and there can be no assurance that such operators will be able to fund such obligations when they become due. To the extent the psychiatric hospitals have increased working capital needs in the future, the Psychiatric Group may be the only source of such financing. In the event the Company's Board of Directors determines that it is appropriate to provide additional working capital financing to a psychiatric hospital operator, it may cause the Core Group to make revolving inter-Group loans to the Psychiatric Group to fund such financing (to the extent consistent with its then-existing policies), although the Company's Board of Directors is under no obligation to do so.
As more fully discussed under "Real Estate Properties" and "Mortgage Notes Receivable", the fundamental ongoing changes in the psychiatric industry and the resulting negative impact on operator financial performance have resulted in significant psychiatric investment write-downs in 1992 and 1994 and the periodic restructuring of psychiatric operator payment obligations. Although management currently believes that the recorded investments in the psychiatric hospitals are realizable, if the psychiatric operators are unable to successfully adapt to the fundamental ongoing changes in the psychiatric industry and consistently mitigate the negative impact of such changes on their financial performance, the Psychiatric Group may be required to further restructure payment obligations, identify and pursue alternative uses for the properties and/or make additional write-downs of the value of its investments in the psychiatric hospitals. The Psychiatric Group does not intend to make new investments, and over time, may sell, restructure or seek other means to reduce its investments. The Psychiatric Group has sold three of its psychiatric properties since September 1994 and expects to use the net proceeds of any future sales to repay then outstanding inter-Group loans or other debt owed by the Psychiatric Group and to distribute all remaining net proceeds, if any, in cash or common stock to holders of Psychiatric Group Depositary Shares.
The Psychiatric Group's dividend is determined quarterly based upon each quarter's operating results. Any significant advance of additional funds to operators of the Psychiatric Group's properties, modification of terms covering the rental or interest obligations of its properties or nonpayment or deferral of such obligations as they become due likely will have an adverse impact on the Psychiatric Group results of operations and cash flows, as well as the quarterly dividend payment on Psychiatric Group Depositary Shares.
REAL ESTATE PROPERTIES
The following table summarizes the Psychiatric Group's investment in health care real estate properties as of December 31, 1996:
AMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO PSYCHIATRIC GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The total revenues, including interest income from other notes receivable, from each of the above psychiatric excluding Northpointe Behavioral Health System (Northpointe), were in excess of 10% of total Psychiatric Group revenues in 1996.
In March 1995, the Psychiatric Group restructured the terms of its two Florida psychiatric hospital investments. Pursuant to the restructuring, which was effective January 1, 1995, the annual minimum rental obligation of The Retreat psychiatric hospital in Sunrise, Florida was reduced from $2,359,000 to $1,100,000, and the annual minimum rental obligation of Northpointe in Tarpon Springs, Florida was reduced from $855,000 to $600,000.
At the beginning of 1996, the owner of the Florida facilities retained the Intensive Resource Division of Quorum Health Resources, Inc. (Quorum), a subsidiary of Quorum Health Group, Inc., to operate both hospitals on a contract basis. The owner had previously become aware of and was monitoring potential wide-ranging objections by several large insurance companies with respect to claims presented for services rendered. Additionally, there had been negative stories in the national media and the local press in Florida on psychiatric care provided in Florida, including criticism of admissions policies and practice patterns at psychiatric hospitals in the state generally, and at these two hospitals. Legislative hearings had been held in Florida on these issues, and various regulatory investigations likely had been conducted or initiated. The hospitals were also experiencing operational and cash flow difficulties which negatively impacted their ability to fund their rental and interest obligations to the Psychiatric Group as they became due. Quarterly contractual base rent and interest obligations of Northpointe and The Retreat total approximately $200,000 and $278,000 ($.10 and $.13 per Psychiatric Group Depositary Share), respectively.
During 1996, the Psychiatric Group modified its agreements with the owner to allow for the deferral of rent and interest payments of Northpointe while certain restructuring and restaffing of the facility occurred. Pursuant to the deferral arrangements, Northpointe's monthly contractual base rent payments of $50,000 were deferred from February 1996 through September 1996 and such deferred payments were scheduled to become payable twelve months from the month of deferral. In accordance with the terms of the deferral arrangements, Northpointe resumed making its full monthly contractual base rent payments of $50,000 on October 1, 1996. In addition, Northpointe's monthly contractual interest payments of $16,600 were deferred from February 1996 until March 1, 1997 on which date all such deferred interest was scheduled to be paid in full. Northpointe's deferred obligations are not recognized as income by the Psychiatric Group until such time as they are paid. Northpointe's rent and interest deferrals in 1996 amounted to approximately $.28 per Psychiatric Group Depositary Share.
In late 1996, the owner of Northpointe and The Retreat was named, together with other operators of other psychiatric facilities in Florida, in a lawsuit filed by several large insurance companies alleging widespread irregularities with respect to operations in years prior to 1995. Adverse publicity from the lawsuit appears to have exacerbated the operational and financial difficulties of Northpointe. The census at Northpointe in 1997 has been significantly below the levels projected by the owner at the end of 1996. As a result, the facility is experiencing substantial cash flow and operational difficulties. Although Northpointe had made its monthly contractual base rent payments of $50,000 during the fourth quarter of 1996 and for January 1997, it has been unable to pay its subsequent monthly contractual rent and interest obligations or its deferred rent and interest obligations. The Psychiatric Group has not further modified the Northpointe lease or revolving credit agreement, although further modification may be necessary. The owner recently appointed a new executive director and marketing director for the facility; however in view of the facility's current financial difficulties, there can be no assurance that the efforts under way will be successful in rebuilding the census and cash flow for 1997 to a level sufficient to allow the facility to meet its obligations.
The Psychiatric Group is continuing to closely monitor this situation. The Psychiatric Group remains committed to maximizing the value of its investment in Northpointe and believes the highest value for the property is most likely as a health care facility. However, in view of the rapidly changing circumstances at the
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NOTES TO PSYCHIATRIC GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
facility, the Psychiatric Group, in conjunction with its financial advisor, is evaluating a range of possibilities including alternative uses for the facility and its related land. At December 31, 1996, the Psychiatric Group's total investment in Northpointe was $7,170,000 consisting of a net investment in the real estate of $5,495,000 and advances under a revolving credit agreement of $1,675,000. The volatility of the current circumstances may not allow for an orderly evaluation and pursuit of the various alternatives, and accordingly there can be no assurance that the financial results from a restructured arrangement as a psychiatric facility, an alternative use or a disposition will allow the realization of the Psychiatric Group's recorded investment in Northpointe.
At December 31, 1996, the Psychiatric Group's total investment in The Retreat was $9,450,000 consisting of a net investment in the real estate of $9,400,000 and advances under a revolving credit agreement of $50,000. The Retreat made all of its contractual rent and interest payments to the Psychiatric Group in 1996. Adverse publicity from the aforementioned lawsuit currently appears to be having a less severe impact on The Retreat, however, the facility has still experienced some deterioration of its cash flow and a decline in census during 1997. Although The Retreat has made its monthly contractural base rent and interest payments in 1997 through March, The Retreat made its February 1997 contractual base rent payment of $92,000 from lease reserve funds and has not yet paid its additional rent in the first quarter of 1997 of approximately $45,000. An increase in operational difficulties and further cash flow deterioration could occur if efforts currently being undertaken by the owner are unsuccessful. Accordingly, there can be no assurance that the Retreat will be able to continue to meet its obligations or that some measure of rent and interest relief will not be necessary in the future. Additionally, if circumstances at The Retreat become more volatile, the Psychiatric Group may be required to consider various alternatives for the facility.
In the first quarter of 1996, Rock Creek Center (RCC) in Illinois experienced certain documentation and procedural deficiencies that resulted in the denial of a substantial amount of Medicare receivables and a substantial negative adjustment to the hospital's 1995 Medicare cost report and 1996 interim Medicare reimbursement rate and experienced lower than expected census which had an adverse impact on RCC's cash flow and its ability to fund its rental and interest obligations to the Psychiatric Group in 1996 as they became due. The net book value of the Psychiatric Group's investment in RCC, including advances under existing revolving credit agreements and other receivables, as of December 31, 1996 totaled $8,002,000, and quarterly contractual base rent and interest obligations of RCC total approximately $324,000 ($.15 per Psychiatric Group Depositary Share). In 1996, the Psychiatric Group advanced $214,000 on behalf of the operator to pay property taxes on the facility, and reached an agreement with the operator for the deferral of base rent payments while the operator took certain actions to stabilize operations and implemented its revised business plan. Pursuant to the deferral arrangements, 100% of RCC's monthly base rent payments of $83,000 were deferred for May and June of 1996 and 50% of such monthly payments were deferred from July 1996 through October 1996, at which time monthly base rent payments returned to 100%. Deferred base rent is payable in the future only when the facility's cash exceeds a specified level, and the property tax advance is payable in monthly installments. RCC's deferred rent obligations are not recognized as income by the Psychiatric Group until such time as they are paid. The Psychiatric Group's property tax advance has been reduced by monthly payments to $122,000 as of December 31, 1996. RCC's rent deferral amounted to approximately $.16 per Psychiatric Group Depositary Share for 1996. Although the deferral arrangements provided interim financial relief while the operator implemented its strategy, there can be no assurance that the deferred amounts will be paid or that RCC will not require additional financial relief in the future.
The current term of the RCC lease expires in December 1997. The lease agreement provides the operator with an option to renew the lease for an additional five-year term at fair market rental. Although the Psychiatric Group believes that the lease will be renewed, there can be no assurance that the lease will be renewed or that, if renewed, the annual minimum rent payments will remain at the current level of $1,000,000. Furthermore, the $2,500,000 balance outstanding under RCC's revolving credit agreement matures June 30, 1997. The Psychiatric Group believes that it will extend the term of the revolving credit agreement to correspond with the expiration of RCC's current lease term and will negotiate further extensions in connection
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NOTES TO PSYCHIATRIC GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
with renewal of the lease. Should the lease not be renewed or the revolving loan not be repaid or extended, a significant negative impact to the Psychiatric Group could result.
The Psychiatric Group's properties are leased under "net" leases pursuant to which the lessees are responsible for all maintenance, repairs, taxes, and insurance of the leased properties. The leases provide for the payment of minimum base rent and additional rent during the fixed term and any renewal terms. Additional rent is generally based on the increase in annual gross revenues of the related facility or a minimum amount as specified in the lease agreements.
The Psychiatric Group has the right to approve capital expenditures at all properties and the option to fund certain capital expenditures on terms comparable to the original investment. The base and additional rent provisions of the leases are amended when such capital expenditures are funded to reflect the Psychiatric Group's increased investment.
Future minimum annual rentals under the Psychiatric Group's noncancellable operating leases for calendar years 1997 through 2000 are approximately $2,700,000, $1,700,000, $1,700,000 and $1,100,000, respectively. These amounts do not reflect any adjustments for the nonpayment of rent, deferrals of rent which may be granted to operators or the payment of rent previously deferred.
MORTGAGE NOTES RECEIVABLE
Four Winds Hospital -- Saratoga $18,137,000 The Psychiatric Group has a mortgage note receivable secured by a first mortgage and security interest in the real property of Four Winds Hospital in Saratoga Springs, New York. The note has an initial term of ten years with two optional ten-year extension terms. The initial term maturity date is June 30, 1999. The interest rate on the note is 12.42% with interest only payable monthly through June 30, 1995 and monthly principal and interest payments of $194,000 payable thereafter.
Four Winds Hospital -- Katonah $27,600,000 The Psychiatric Group has a mortgage note receivable secured by a first mortgage and security interest in the real property of Four Winds Hospital in Katonah (Westchester County), New York. The note has an initial term of ten years with two optional ten-year extension terms. The initial term maturity date is November 30, 2002. The annual interest rate on the note was 12.71%, 13.07% and 13.44%, in 1994, 1995 and 1996, respectively, and increases .36% annually thereafter until reaching 14.49% where it remains through maturity. Interest only is payable monthly.
The Psychiatric Group has recorded a $7,950,000 reserve for impairment of its mortgage notes receivable and records interest on its mortgage notes as interest payments are received.
In 1996, the Psychiatric Group completed formal documentation of an agreement with the operator of the two New York Four Winds facilities to release certain of its security interests in the operator's short-term assets on a staged basis. The operator believes that the release of this collateral will permit it to obtain the capital required to develop an integrated behavioral health care delivery system in lower and upper New York State, of which the two Four Winds facilities will be an integral part. Although such a system is intended to address the potential negative consequences of the expected changes in Medicaid reimbursement and the increase in managed care penetration in the state of New York, it is not possible to predict the impact and timing of such changes and whether the proposed system will be successful in that new environment.
Pursuant to the terms of the mortgage notes receivable, the Psychiatric Group may receive additional interest each year based on the increase in annual operating revenues of the related psychiatric facility. The Psychiatric Group may provide permanent financing for capital additions at the facilities.
The carrying amount of mortgage notes receivable is a reasonable estimate of fair value, as the pricing and terms of the notes are indicative of current rates and credit risk.
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NOTES TO PSYCHIATRIC GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
OTHER NOTES RECEIVABLE
The Psychiatric Group provides financing at variable rates to certain psychiatric hospital operators under revolving credit agreements. The aggregate commitment under these credit agreements was $5,700,000 as of December 31, 1996. Borrowings under the credit agreements are subject to compliance with various covenants and are partially secured by accounts receivable and other personal property of the operators. As of December 31, 1996, $4,225,000 was outstanding under revolving credit agreements at a weighted average contractual interest rate of 11.25%. The weighted average amount of borrowings under revolving credit agreements outstanding during 1996 was $4,414,000 at a weighted average interest rate, reflecting deferrals, of 7.4% with a maximum of $4,475,000 outstanding during the year. As discussed under "Real Estate Properties", the $2,500,000 outstanding balance under the revolving credit agreement to RCC matures June 30, 1997.
The pricing and terms of other notes receivable are indicative of current rates and credit risk, and therefore, the current carrying amount of these financial instruments is a reasonable estimate of fair value.
PENSION PLANS
The Company has a defined contribution pension plan covering all of its employees. Pension expense allocated to the Psychiatric Group in 1996, 1995 and 1994 was $25,000, $28,000 and $37,000, respectively.
The Company has an unfunded defined benefit pension plan covering non-employee members of its Board of Directors upon completion of sixty months of membership on the Board. The benefits, limited to ten years, are based on years of service and the annual base director fee in effect as of the date a director ceases to be a member of the Board. Net periodic pension cost allocated to the Psychiatric Group in 1996, 1995 and 1994 was $20,000, $19,000 and $26,000, respectively. The Notes to the Consolidated Financial Statements of the Company should be read for further details regarding this plan.
STOCK INCENTIVE PLANS
The Company's stock incentive plans provide for the issuance of shares of the Company's stock to directors and key employees as stock incentives. Pursuant to the terms of the Company's stock incentive plans, stock options, restricted stock, deferred shares and dividend equivalent rights (DERs) were adjusted to reflect the Distribution. Total stock-based compensation expense recognized under APB 25 and allocated to the Psychiatric Group in 1996, 1995 and 1994 was $112,000, $65,000 and $167,000, respectively. If the fair value based method of accounting defined by SFAS 123 had been used to measure and recognize stock-based compensation expense, the pro forma effect on the reported amounts of net income and net income per share of the Psychiatric Group for 1996 and 1995 would not have been material. The pro forma effect for 1996 and 1995 may not be representative of the pro forma effect in future years because it does not take into consideration stock-based incentives granted prior to 1995. The Notes to the Consolidated Financial Statements of the Company should be read for further details regarding the Company's stock incentive plans.
PREFERRED STOCK PURCHASE RIGHTS PLAN
The Company has a preferred stock purchase rights plan which provides for the distribution of one preferred stock purchase right (each a Right) to shareholders for each outstanding share of common stock. Under certain conditions, each Right may be exercised to purchase one one-hundredth of a share of preferred stock, Series A, par value $.01 per share (the Series A Preferred Shares), of the Company at a price of $45. The Company's Psychiatric Group Depositary Shares do not include the Rights or entitle holders thereof to receive the Rights, which are applicable only to the Company's Core Group Common Stock. The Notes to the Consolidated Financial Statements of the Company should be read for further details regarding the Company's preferred stock purchase rights plan.
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NOTES TO PSYCHIATRIC GROUP COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
DIVIDENDS
A quarterly dividend of $.80 per share for Psychiatric Group Depositary Shares, or approximately $1,667,000, was declared by the Board of Directors on January 24, 1997, payable on February 24, 1997 to shareholders of record on February 10, 1997. The dividend has been reflected as dividends payable in the accompanying financial statements as of December 31, 1996. Dividends of $2.80 per share paid on Psychiatric Group Depositary Shares during the year ended December 31, 1996 are characterized as $2.55 of ordinary income and $.25 of return of capital for tax purposes.
In general, dividends on the Company's capital stock are limited by the Company's unsecured revolving credit agreement to 95% of cash flow available for debt service, less interest expense, plus gains on asset dispositions and certain proceeds (PG Excess Proceeds) from the disposition of Psychiatric Group assets after the repayment of Psychiatric Group indebtedness. Dividends or other distributions paid out of PG Excess Proceeds will be available only for the Psychiatric Group Depositary Shares and will be limited to $30 million in the aggregate and $15 million in any calendar year.
QUARTERLY FINANCIAL DATA (UNAUDITED)
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(1) Includes costs related to the Distribution of $300,000.
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 Englewood, State of Colorado, on the 28th day of March, 1997.
AMERICAN HEALTH PROPERTIES, INC.
By: MICHAEL J. MCGEE
------------------------------------ Michael J. McGee Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Joseph P. Sullivan and Michael J. McGee, and each or either of them as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign any or all amendments to this report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, or his substitute may lawfully do or cause to be done by virtue hereof.
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 date indicated.
EXHIBIT INDEX
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