ITEM 1. BUSINESS
GENERAL
Health Care REIT, Inc. (the "Company") is a self-administered real estate investment trust that invests in health care facilities, primarily nursing homes and assisted living facilities. The Company also invests in specialty care facilities. As of December 31, 1999, long-term care facilities, which include nursing homes and assisted living facilities, comprised approximately 90% of the investment portfolio. Founded in 1970, the Company was the first real estate investment trust to invest exclusively in health care facilities.
As of December 31, 1999, the Company had $1,240,223,000 of real estate investments, inclusive of credit enhancements, in 238 facilities located in 34 states and managed by 38 different operators. At that date, the portfolio included 182 assisted living facilities, 48 nursing homes, six specialty care facilities, and two behavioral care facilities. At December 31, 1999, the Company had approximately $53,356,000 in unfunded commitments.
The Company's primary objectives are to protect shareholders' capital and enhance shareholder value. The Company seeks to pay consistent cash dividends to shareholders and create opportunities to increase dividend payments from annual increases in rental and interest income and portfolio growth. To meet these objectives, the Company invests primarily in long-term care facilities managed by experienced operators and diversifies its investment portfolio by operator and geographic location.
The Company anticipates investing in additional health care facilities through operating lease arrangements with, and mortgage financings for, qualified health care operators. Capital for future investments may be provided by borrowing under the Company's revolving credit facilities, public offerings or private placements of debt or equity, and the assumption of secured indebtedness.
PORTFOLIO OF PROPERTIES
The following table reflects the diversification of the Company's portfolio as of December 31, 1999:
- -------------------------- (1) Investments include real estate investments and credit enhancements which amounted to $1,227,798,000 and $12,425,000, respectively.
(2) Investment Per Bed/Unit was computed by using the total investment amount of $1,293,579,000 which includes real estate investments, unfunded commitments for which initial funding has commenced, and credit enhancements which total $1,227,798,000, $53,356,000 and $12,425,000, respectively.
(3) The Company has investments in properties located in 34 states, managed by 38 different operators.
Nursing Homes
Skilled nursing facilities provide inpatient skilled nursing and custodial services as well as rehabilitative, restorative and transitional medical services. In some instances, nursing facilities supplement hospital care by providing specialized care for medically complex patients whose conditions require intense medical and therapeutic services, but who are medically stable enough to have these services provided in facilities that are less expensive than acute care hospitals.
Assisted Living Facilities
Assisted living facilities provide services to aid in everyday living, such as bathing, meals, security, transportation, recreation, medication supervision and limited therapeutic programs. More intensive medical needs of the resident are often met within assisted living facilities by home health providers, close coordination with the resident's physician and skilled nursing facilities. Assisted living facilities are increasingly successful as lower cost, less institutional alternatives for the health problems of the elderly or medically frail.
Specialty Care Facilities
Specialty care facilities provide specialized inpatient services for specific illnesses or diseases, including, among others, coronary and cardiovascular services. Specialty care facilities are lower cost alternatives to acute care hospitals.
Behavioral Care Facilities
Behavioral care facilities offer comprehensive inpatient and outpatient psychiatric treatment programs. Programs are tailored to the individual and include individual, group and family therapy.
INVESTMENTS
The Company invests in income producing health care facilities with a primary focus on long-term care facilities, which include skilled nursing facilities and assisted living facilities. The Company also invests in specialty care facilities. The Company intends to continue to diversify its investment portfolio by operator and geographic location.
In determining whether to finance a facility, the Company focuses on: (a) the experience of the operator; (b) the financial and operational feasibility of the property; (c) the financial strength of the borrower or lessee; (d) the security available to support the financing; and (e) the amount of capital committed to the property by the borrower or lessee. Management conducts market research and analysis for all potential investments. In addition, Management reviews the value of all properties, the interest rates and debt service coverage requirements of any debt to be assumed and the anticipated sources for repayment for such debt.
The Company's investments primarily take the form of operating lease transactions, permanent mortgage loans and construction financings. Substantially all of the Company's investments are designed with escalating rate structures. The Company's policy is to structure long term financings to maximize returns. Depending upon market conditions, the Company believes that appropriate new investments will be available in the future with substantially the same spreads over its costs of borrowing.
Mortgage loans and operating leases are normally secured by guarantees and/or letters of credit. As of December 31, 1999, letters of credit from commercial banks and cash deposits aggregating $44,790,000 were available to the Company as security for operating lease, permanent mortgage loan and construction loan obligations. In addition, the leases and loans are generally cross-defaulted and the loans are cross-collateralized with any other mortgage loans, leases, or other agreements between the operator or any affiliate of the operator and the Company.
The Company typically finances up to 90% of the appraised value of a property. Economic terms normally include annual rate increases and fair market value based purchase options in operating leases, and may include contingent interest for mortgage loans.
The Company monitors its investments through a variety of methods, which are determined by the type of health care facility and operator. The monitoring process includes a review and analysis of facility, borrower or lessee, and guarantor financial statements; periodic site visits; property reviews; and meetings with operators. Such reviews of operators and facilities generally encompass licensure and regulatory compliance materials and reports, contemplated building improvements and other material developments.
For certain investments, the Company receives warrants or other similar equity instruments that provide the Company with an opportunity to share in an operator's enterprise value. As of December 31, 1999, the Company had warrants from 19 operators to purchase their common stock or partnership interest. None of the warrants are publicly traded.
In connection with investments in two operators, the Company also received warrants that were converted into shares of common stock. As of December 31, 1999, those shares of common stock were recorded on the Company's balance sheet at a value of $863,000.
Operating Leases
Each facility, which includes the land, buildings, improvements and related rights (the "Leased Properties") owned by the Company is leased to a health care provider pursuant to a long-term lease (collectively, the "Leases"). The Leases generally have a fixed term of 10 to 15 years and contain multiple five- to ten-year renewal options. Each Lease is a triple net lease requiring the lessee to pay rent and all additional charges incurred in the operation of the Leased Property. The lessees are required to repair, rebuild and maintain the Leased Properties.
The net value of the Company's completed leased properties aggregated approximately $767,825,000 at December 31, 1999. The base rents range from approximately 7.68% to 14.91% per annum of the Company's net book value in the leased properties. The rental yield to the Company from Leases depends upon a number of factors including the initial rent charged, any rental adjustments and the amount of the commitment fee charged at the inception of the transaction. The base rents for the renewal periods are generally fixed rents set at a spread above the Treasury yield for the corresponding period.
Permanent Mortgage Loans
The Company's investments in permanent mortgage loans are structured to provide the Company with interest income, principal amortization and commitment fees. Virtually all of the approximately $374,390,000 of permanent mortgage loans as of December 31, 1998, were first mortgage loans.
The interest rate on the Company's investments in permanent mortgage loans for operating facilities ranges from 9.00% to 14.04% per annum on the outstanding balances. The yield to the Company on permanent mortgage loans depends upon a number of factors, including the stated interest rate, average principal amount outstanding during the term of the loan, the amount of the commitment fee charged at the inception of the loan and any interest rate adjustments.
The permanent mortgage loans for operating facilities made through December 31, 1999, are generally subject to seven- to ten-year terms with 25-year amortization schedules that provide for a balloon payment of the outstanding principal balance at the end of the term. Generally, the permanent mortgage loans provide five to seven years of prepayment protection.
Direct Investments
Management determines the appropriate classification of a direct investment at the time of acquisition and reevaluates such designation as of each balance sheet date. Debt securities which are classified as held to maturity are stated at historical cost. Equity investments are stated at historical cost. At December 31, 1999, direct investments included the preferred stock of one private corporation, subordinated debt in six private corporations, and ownership representing a 31% interest in Atlantic Healthcare Finance L.P., a property investment group that specializes in the financing, through sale and leaseback transactions, of nursing homes located in the United Kingdom and continental Europe.
Construction Financing
The Company provides construction financing that by its terms converts either into a long-term operating lease or mortgage loan upon the completion of the facility. Generally, the rates on the outstanding balances of the Company's construction financings are 225 to 350 basis points over the prime rate of a specified financial institution. The Company also typically charges a commitment fee at the commencement of the financing. The construction financing period commences upon funding and terminates upon the earlier of the completion of development of the applicable facility or the end of a specified period, generally 12 to 18 months. During the term of the construction financing, funds are advanced pursuant to draw requests made by the operator in accordance with the terms and conditions of the applicable financing agreement, which terms require, among other things, a site visit by a Company representative prior to the advancement of funds. Monthly payments are made on the total amount of the proceeds advanced during the development period.
During the construction financing period, the Company generally requires additional security and collateral in the form of either payment and performance bonds and/or completion guarantees by either one, or a combination of, the operator's parent entity, other affiliates of the operator, or one or more of the individual principals of the operator.
At December 31, 1999, the Company had outstanding construction financings of $68,862,000 ($58,954,000 leased properties and $9,908,000 mortgage loans) and was committed to providing additional financing of approximately $53,356,000 to complete construction.
BORROWING POLICIES
The Company may arrange for long-term borrowing from banks, private placements to institutional investors, or public offerings. For other short-term purposes, the Company may, from time to time, negotiate lines of credit, or arrange for other short-term borrowing from banks or others.
In addition, the Company may incur mortgage indebtedness on real estate that it has acquired through purchase, foreclosure or otherwise. When terms are deemed favorable, the Company may invest in properties subject to existing loans and mortgages. In addition, the Company may obtain financing for unleveraged properties in which it has invested or may refinance properties acquired on a leveraged basis.
Under documents pertaining to existing indebtedness, the Company is subject to various restrictions with respect to secured and unsecured indebtedness.
ALLOWANCE FOR LOAN LOSSES
The Company maintains an allowance for possible loan losses that is evaluated quarterly to determine its adequacy. See Notes 1 and 5 of Notes to Financial Statements. At December 31, 1999, the total allowance of $5,587,000 was not allocated to any specific properties. The Company believes that its allowance is adequate.
COMPETITION
The Company competes with other real estate investment trusts, real estate partnerships, banks, insurance companies and other investors in the acquisition, leasing and financing of health care facilities.
The operators of the facilities compete on a local and regional basis with operators of facilities that provide comparable services. Operators compete for patients and residents based on a number of factors, including quality of care, reputation, physical appearance of facilities, services offered, family preferences, physicians, staff and price.
EMPLOYEES
As of December 31, 1999, the Company employed 23 full-time employees.
CERTAIN GOVERNMENT REGULATIONS
The Company invests in single purpose health care facilities. The Company's customers must comply with the licensing requirements of federal, state and local health agencies, and with the requirements of municipal building codes, health codes, and local fire departments. In granting and renewing a facility's license, the state health agency considers, among other things, the physical buildings and equipment, the qualifications of the administrative personnel and clinical staffs, the quality of health care programs and compliance with applicable laws.
Many of the facilities operated by the Company's customers receive a substantial portion of their revenues from the federal Medicare program and state Medicaid programs; therefore, the Company's revenues may be indirectly affected by changes in these programs. The amount of program payments can be changed by legislative or regulatory actions and by determinations by agents for the programs. Since Medicaid programs are funded by both the states and the federal government, the amount of payments can be affected by changes at either the state or federal level. There is no assurance that payments under these programs will remain at levels comparable to present levels or be sufficient to cover costs allocable to these patients.
Under Medicare and Medicaid programs, acute care hospitals are generally paid a fixed amount per discharge (based on the patient's diagnosis) for inpatient services. Behavioral and rehabilitation hospitals are generally paid on a cost basis, subject to limitations based on a "target amount" per discharge. The target amount is based on updates to the facility's costs per discharge in a base year. Medicare payment rules for such hospitals were changed effective October 1, 1997 to further limit reimbursable costs, reduce payment incentives for providers whose costs are below the target amount, and reduce capital-related payments by 15%. The target amount for any facility is now capped at the 75th percentile of the target amounts for facilities of the same type. (For new facilities, the target is 110% of the median costs per discharge of similar hospitals.) In addition, the target amount update is set at 0% for federal fiscal 1998. Depending on how the facility's costs per discharge compare to its target amount, increases thereafter range from 0% to the "market basket" percentage reflecting the inflation rate for costs of items purchased by similar facilities.
In addition, payments to rehabilitation hospitals and units will be based on fixed rates per discharge that vary according to the nature of the patient's condition. The new system will be phased in over three years beginning with the cost reporting year commencing after October 1, 2000.
Medicare and Medicaid programs have traditionally reimbursed nursing facilities for the reasonable direct and indirect allowable costs incurred in providing routine services (as defined by the programs), subject to certain cost ceilings. In 1998, the Medicare cost-based reimbursement system was replaced by a federal per diem rate based on the patient's condition, which is phased in over three years. (New facilities are immediately paid based on the federal rate.) The new per diem rate will be the sole payment for both direct nursing care ("Part A services") and ancillary services that were previously billed separately from the cost-based reimbursement system ("Part B services"). Capital costs are also included in the per diem rate. Many states have also converted to a system based on prospectively determined fixed rates, which may be based in part on historical costs. The operations of long-term care companies have been negatively impacted by these changes in reimbursement, among other factors. Some of these companies have filed for bankruptcy protection. While the Company has not been affected by any bankruptcy filings, a reduction in revenues could result in bankruptcy filings by significant customers of the Company. Furthermore, any failure by these customers to effectively conduct their operations could have a material adverse effect on their business reputation or on their ability to enlist and maintain patients in their facilities.
Due in part to the potential negative effect of the prospective payment system on the financial condition of long-term care facilities, Standard & Poor's placed many long-term care facility companies on a `credit watch' in November 1998. In March, 1999, Standard & Poor's lowered the ratings of several long-term care facility companies, particularly those companies with substantial debt.
On November 29, 1999, the President signed legislation that provides additional payments for certain Medicare providers. Among other things, Medicare payments to skilled nursing facilities were increased by 4 percent per year for fiscal 2001 and 2002, and per diem payments for the 15 categories representing the most medically complex cases were increased by 20 percent.
Until 1997, state Medicaid programs were required to pay hospitals and nursing facilities based on rates that were reasonable and adequate to meet the costs that must be incurred by efficiently and economically operated facilities in order to provide services in conformity with federal and state standards and to assure reasonable access to patients. This law restricted the ability of the states to reduce Medicaid payments. Congress repealed this requirement in 1997. Under the new law, states need only publish the methodology used to develop the proposed rates, along with a justification for the methodology, and allow public comment. This change could result in reduced Medicaid payments to facilities operated by the Company's customers.
Medicare and Medicaid regulations could adversely affect the resale value of the Company's health care facilities. Medicare regulations provide that effective December 1, 1997, when a facility changes ownership (by sale or under certain lease transactions), reimbursement for depreciation and interest will be based on the cost to the owner of record as of August 5, 1997, less depreciation allowed. Previously, the buyer would use its cost of purchase up to the original owner's historical cost BEFORE depreciation. Medicaid regulations allow a limited increase in the valuation of nursing facilities (but not hospitals) during the time the seller owned the facility. Other Medicaid regulations provide that upon resale, facilities are responsible to pay back prior depreciation reimbursement payments that are "recaptured" as a result of the sale.
Recent interpretations of the Medicare laws limit the ability of hospitals and nursing facilities to be reimbursed for interest costs that are deemed to be unnecessary because the facilities have other funds derived from patient care activities that were put to other uses (such as investments) or transferred to related parties. This could reduce reimbursement to Company customers for interest on loans from the Company.
Health care facilities that participate in Medicare or Medicaid must meet extensive program requirements, including physical plant and operational requirements, which are revised from time to time. Such requirements may include a duty to admit Medicare and Medicaid patients, limiting the ability of the facility to increase its private pay census beyond certain limits. Medicare and Medicaid facilities are regularly inspected to determine compliance, and may be excluded from the programs--in some cases without a prior hearing--for failure to meet program requirements.
Under the Medicare program, "peer review organizations" have been established to review the quality and appropriateness of care rendered by health care providers. These organizations may not only deny claims that fail to meet their criteria, but can also fine and/or recommend termination of participation in the program.
Recent changes in the Medicare and Medicaid programs will likely result in increased use of "managed care" organizations to meet the needs of program beneficiaries. These organizations selectively contract with health care facilities, resulting in some facilities being excluded from the ability to serve program beneficiaries.
Health care facilities also receive a substantial portion of their revenues from private insurance carriers, health maintenance organizations, preferred provider organizations, self-insured employees and other health benefit payment arrangements. Such payment sources increasingly pay facilities under contractual arrangements that include a limited panel of providers and/or discounted or
other special payment arrangements, including arrangements that shift the risk of high utilization to the providers. A number of states have established rate-setting agencies which control inpatient health care facility rates, including private pay rates.
Recent federal legislation substantially expanded activities to enforce laws against fraud and abuse in federally funded health care programs. These laws prohibit misrepresentations in billings and cost reports, payments to parties who influence purchases or referrals of covered services, and provision of unnecessary services.
President Clinton's budget proposal for fiscal 2001 would reduce payments to Medicare providers by $6.37 billion over five years, $4.3 billion of which comes from hospitals. The budget does not contain substantial funding reductions in payments to skilled nursing facilities, according to Administration officials. The budget also includes funding for new programs to improve quality of care in Medicare and Medicaid-certified nursing facilities, much of which would be used to bolster state enforcement efforts and to improve federal oversight of state agencies. The budget proposal would also maintain and upgrade the Nursing Home Compare World Wide Web site, which publishes information concerning certification inspections. It is impossible to predict with any certainty what form any budget legislation may ultimately take.
In order to meet a federal requirement, most states required providers to obtain certificates of need prior to construction of inpatient facilities and certain outpatient facilities. However, in 1987, the federal requirement was repealed. Some states have repealed these requirements, which may result in increased competition, and other states are considering similar repeals.
Nursing facilities compete with other subacute care providers, including rehabilitation centers and hospitals. Many of these providers have underutilized facilities and are converting some or all of their facilities into nursing facilities. Some of these entities operate on a tax-exempt basis, which gives them a capital cost advantage. Furthermore, some states have granted rest homes the ability to provide limited nursing care services.
Certain states have adopted pre-admission screening and other programs to promote utilization of outpatient and home-based services as an alternative to inpatient facility services. Recent changes in Medicaid regulations allow states to use Medicaid funding for alternatives to traditional inpatient care, including home health care and assisted living facilities.
TAXATION
General
A corporation, trust or association meeting certain requirements may elect to be treated as a "real estate investment trust." Beginning with its first fiscal year and in all subsequent years, the Company has elected to be treated as a real estate investment trust under Sections 856 to 860, inclusive, of the Internal Revenue Code of 1986, as amended (the "Code"). The Company intends to operate in such manner as to continue to qualify as a real estate investment trust for federal income tax purposes. No assurance can be given that the actual results of the Company's operations for any one taxable year will satisfy such requirements.
To qualify as a real estate investment trust, the Company must satisfy a variety of complex requirements each year, including organizational and stock ownership tests and percentage tests relating to the sources of its gross income, the nature of its assets and the distribution of its income.
Generally, for each taxable year during which the Company qualifies as a real estate investment trust, it will not be taxed on the portion of its taxable income (including capital gains) that is distributed to shareholders. Any undistributed income or gains will be taxed to the Company at regular corporate tax rates. Any undistributed net long-term capital gains taxed to the Company will be treated as having been distributed to the shareholders and will be included by them in determining the amount of their capital gains. The tax paid by the Company on those gains will be allocated among the shareholders and may be claimed as a credit on their tax returns. The shareholders will receive an increase in the basis of their shares in the Company equal to the difference the capital gain income and the tax credit allocated to them. The Company will be subject to tax at the highest corporate rate on its net income from foreclosure property, regardless of the amount of its distributions. The highest corporate tax rate is currently 35%. The Company may elect to treat any real property it acquires by foreclosure as foreclosure property. This would permit the Company to hold such property until the end of the third taxable year following the year of acquisition without adverse consequences. With the consent of the Treasury Department, this period can be extended for up to three additional taxable years. Subject to certain limitations, the Company will also be subject to an additional tax equal to 100% of the net income, if any, derived from prohibited transactions. A prohibited transaction is defined as a sale or disposition of inventory-type property or property held by the Company primarily for sale to customers in the ordinary course of its trade or business, which is not property acquired on foreclosure.
The Company is subject to a nondeductible federal excise tax equal to 4% of the amount, if any, by which 85% of its ordinary income plus 95% of its capital gain net income (plus distribution deficiencies from prior years) exceeds distributions actually paid or treated as paid to shareholders during the taxable year, plus current year income upon which the Company pays tax and any overdistribution from prior years. Due to the growth of the Company's income, primarily as a result of large capital gains from the exercise of purchase options under leases, the Company did not satisfy this requirement in 1998, and 1997 and incurred an excise tax of approximately $315,000 and $360,000 respectively, in those years. This requirement was met for 1999. There is a cumulative underdistribution of $6,242,000 that will carry over to 2000 and later years until reduced by distributions in a subsequent year that exceed the percentage of that year's income that is required to be distributed currently.
Failure To Qualify
While the Company intends to operate so as to qualify as a real estate investment trust under the Code, if in any taxable year the Company fails to qualify, and certain relief provisions do not apply, its taxable income would be subject to tax (including alternative minimum tax) at corporate rates. If that occurred, the Company might have to dispose of a significant amount of its assets or incur a significant amount of debt in order to pay the resulting federal income tax. Further distributions to its stockholders would not be deductible by the Company nor would they be required to be made.
Distributions out of the Company's current or accumulated earnings and profits would be taxable to stockholders as dividends and would be eligible for the dividends received deduction for corporations. No portion of any distributions would be eligible for designation as a capital gain dividend. Further, the Company would be unable to pass through its undistributed capital gains and the related tax paid by the Company.
Unless entitled to relief under specific statutory provisions, the Company also would be disqualified from taxation as a real estate investment trust for the four taxable years following the year during which qualification was lost.
The foregoing is only a summary of some of the significant federal income tax considerations affecting the Company and is qualified in its entirety by reference to the applicable provisions of the Code, the rules and regulations promulgated thereunder, and the administrative and judicial interpretations thereof. Stockholders of the Company are urged to consult their own tax advisors as to the effects of these rules and regulations on them. In particular, foreign stockholders should consult with their tax advisors concerning the tax consequences of ownership of shares in the Company, including the possibility that distributions with respect to the shares will be subject to federal income tax withholding.
SUBSIDIARIES AND AFFILIATES
The Company has formed subsidiaries in connection with its real estate transactions. As of December 31, 1999, the Company's wholly-owned subsidiaries consisted of the following entities:
ITEM 2.
ITEM 2. PROPERTIES
The Company's headquarters are currently located at One SeaGate, Suite 1500, Toledo, Ohio 43604. The following table sets forth certain information regarding the facilities that comprise the Company's investments as of December 31, 1999.
- -------------------------- (1) Investments include real estate investments and credit enhancements which amounted to $1,227,798,000 and $12,425,000, respectively.
(2) Reflects contract rate of annual base rent or interest recognized or to be recognized upon completion of construction.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table sets forth, for the periods indicated, the high and low prices of the Company's Common Stock on the New York Stock Exchange, as reported on the Composite Tape and dividends paid per share. There were 5,240 shareholders of record as of December 31, 1999.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data for the five years ended December 31, 1999, are derived from the audited consolidated financial statements of the Company.
- -------------------------- (1) General and administrative and other expenses include loan expense, management fees through November 30, 1995, provision for losses, expenses related to disposition of investments and other operating expenses.
(2) On November 30, 1995, the Company's advisor merged into the Company. Consideration for this transaction totaled approximately $5,048,000 which was solely comprised of 282,407 Shares. In addition, the Company acquired approximately $46,000 in net assets and incurred approximately $792,000 of related transaction expenses. The consideration, plus related transaction expenses, were accounted for as a settlement of a management contract.
(3) The earnings per share amounts prior to 1997 have been restated as required to comply with Statement of Financial Accounting Standards No. 128, Earnings Per Share. For further discussion of earnings per share and the impact of Statement No. 128, see the notes to the consolidated financial statements beginning on page 23.
(4) Cash available for distribution is defined as net cash provided from operating activities less preferred dividends, but does not consider the effects of changes in operating assets and liabilities such as other receivables and accrued expenses. The Company uses cash available for distribution in evaluating investments and the Company's operating performance. Cash available for distribution does not represent cash generated from operating activities in accordance with generally accepted accounting principles, is not necessarily indicative of cash available to fund cash needs, and should not be considered as an alternative to net income as an indicator of the Company's operating performance or as an alternative to cash flow as a measure of liquidity.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1999, the Company's net real estate investments totaled approximately $1,222,211,000, which included 182 assisted living facilities, 48 nursing facilities, six specialty care facilities and two behavioral care facilities. Depending upon the availability and cost of external capital, the Company anticipates making additional investments in health care related facilities. New investments are funded from temporary borrowings under the Company's line of credit arrangements, internally generated cash and the proceeds derived from asset sales. Permanent financing for future investments, which replaces funds drawn under the line of credit arrangements, is expected to be provided through a combination of private and public offerings of debt and equity securities, and the assumption of secured debt. The Company believes its liquidity and various sources of available capital are sufficient to fund operations, meet debt service and dividend requirements, and finance future investments.
During 1999, the underperformance of publicly owned nursing home and assisted living companies, combined with the much publicized shift in equity funds flow from income-oriented investments to high-growth opportunities, impaired the stock valuations of all health care REITs. The availability of external capital is limited and expensive, constraining new investment activity and earnings growth. The Company believes the restrictive capital environment will continue until the prospects for the long-term care industry improve.
In October 1999, the Company announced a $200 million asset divestiture program, which is proceeding as planned. The Company believes the limited asset sales will strengthen the Company's portfolio and generate liquidity, enhancing the Company's balance sheet. This strategy should position the Company for new investment and growth opportunities in the future.
During 1999, the Company invested $81,008,000 in real property, provided permanent mortgage financings of $17,565,000, made construction advances of $169,085,000, funded $7,462,000 of equity related investments and had net advances on working capital loans of $9,440,000. During 1999, the Company received principal payments on real estate mortgages of $4,515,000, proceeds of $38,216,000 from the prepayment of mortgage loans, and proceeds of $18,112,000 derived from property sales. As of December 31, 1999, the Company had approximately $53,356,000 in unfunded commitments.
During 1999, 43 of the above-mentioned construction projects completed the construction phase of the Company's investment process and were converted to permanent real property investments, with an aggregate investment of $226,695,000, and twelve construction loans converted to permanent mortgage loans with an aggregate investment balance of $67,553,000.
As of December 31, 1999, the Company had shareholders' equity of $706,996,000 and a total outstanding debt balance of $538,842,000, which represents a debt to equity ratio of 0.76 to 1.0.
In January 1999, the Company announced the sale of 3,000,000 shares of cumulative convertible preferred stock. These shares have a liquidation value of $25.00 per share and will pay quarterly dividends equivalent to the greater of $0.5625 or the quarterly dividend then payable per common share on an as converted basis. The preferred shares are convertible into common stock at a conversion price of $25.625 per share. The Company has the right to redeem the preferred shares after five years.
In February 1999, the Company entered into a $75,000,000 Secured Credit Facility. The Credit Facility bears interest at the lender's prime rate or LIBOR plus 2.0%, with a floor of 7.0%. At December 31, 1999, $60,000,000 was advanced under this Credit Agreement.
In March 1999, the Company completed the sale of $50 million of 8.17% Senior Unsecured Notes due March 15, 2006.
As of December 31, 1999, the Company had an unsecured revolving line of credit expiring March 31, 2001 in the amount of $175,000,000 bearing interest at the lender's prime rate or LIBOR plus 1.0%. In addition, the Company had an unsecured revolving line of credit in the amount of $20,000,000 bearing interest at the lender's prime rate expiring April 30, 2000. At December 31, 1999, under the Company's line of credit arrangements, available funding totaled $17,500,000.
As of December 31, 1999, the Company has effective shelf registrations on file with the Securities and Exchange Commission under which the Company may issue up to $380,319,000 of securities including debt, convertible debt, common and preferred stock. Depending upon market conditions, the Company anticipates issuing securities under such shelf registrations to invest in additional health care facilities and to repay borrowings under the Company's line of credit arrangements.
RESULTS OF OPERATIONS DECEMBER 31, 1999 VS. DECEMBER 31, 1998
Revenues for the year ended December 31, 1999, were $129,307,000 compared to $97,992,000 for the year ended December 31, 1998, an increase of $31,315,000 or 32%. Revenue growth resulted primarily from increased operating rent income of $30,747,000, from additional real estate investments made during the past twelve to fifteen months.
Expenses for the year ended December 31, 1999, totaled $53,669,000, an increase of $17,986,000 from expenses of $35,683,000 for the year ended December 31, 1998. The increase in total expenses for the year ended December 31, 1999 was primarily related to an increase in interest expense, additional expense associated with the provision for depreciation, and an increase in general and administrative expenses.
Interest expense for the year ended December 31, 1999, was $26,916,000 compared with $18,030,000 for the year ended December 31, 1998. The increase in interest expense during 1999 was primarily due to the issuance in March 1999 of the Senior Unsecured Notes Due 2006, the addition of $60,000,000 borrowed under the Secured Credit Facility and higher average borrowings under the unsecured lines of credit during 1999, which were offset by the amount of capitalized interest recorded in 1999.
The Company capitalizes certain interest costs associated with funds used to finance the construction of properties owned directly by the Company. The amount capitalized is based upon the borrowings outstanding during the construction period using the rate of interest which approximates the Company's cost of financing. The Company's interest expense is reduced by the amount capitalized. Capitalized interest for the year ended December 31, 1999, totaled $8,578,000, as compared with $7,740,000 for the same period in 1998.
The provision for depreciation for the year ended December 31, 1999, totaled $17,885,000, an increase of $7,631,000 over the year ended 1998 as a result of additional real property investments.
General and administrative expense for the year ended December 31, 1999, totaled $7,359,000 as compared with $6,114,000 for the year ended December 31, 1998. The expenses for the year ended December 31, 1999, were 5.69% of revenues as compared with 6.24% for the year ended December 31, 1998.
Dividend payments associated with the Company's outstanding preferred stock for the year ended December 31, 1999, totaled $12,814,000 as compared with $4,160,000 for 1998.
As a result of the various factors mentioned above, net income available for common shareholders for the year ended December 31, 1999, was $62,824,000, or $2.21 per share, as compared with $58,149,000, or $2.24 per share for the year ended December 31, 1998.
RESULTS OF OPERATIONS DECEMBER 31, 1998 VS. DECEMBER 31, 1997
Revenues for the year ended December 31, 1998, were $97,992,000 compared to $73,308,000 for the year ended December 31, 1997, an increase of $24,684,000 or 34%. Revenue growth resulted primarily from increased operating rent income of $19,775,000, interest income of $1,516,000, and loan and commitment fees of $2,245,000 from additional real estate investments made during the past twelve to fifteen months.
Expenses for the year ended December 31, 1998, totaled $35,683,000, an increase of $8,853,000 from expenses of $26,830,000 for the year ended December 31, 1997. The increase in total expenses for the year ended December 31, 1998, was primarily related to an increase in interest expense, additional expense associated with the provision for depreciation, and an increase in general and administrative expenses.
Interest expense for the year ended December 31, 1998, was $18,030,000 compared with $15,365,000 for the year ended December 31, 1997. The increase in interest expense during 1998 was primarily due to the issuance in March 1998 of the Senior Unsecured Notes due 2008, which was offset by the amount of capitalized interest recorded in 1998.
The Company capitalizes certain interest costs associated with funds used to finance the construction of properties owned directly by the Company. The amount capitalized is based upon the borrowings outstanding during the construction period using the rate of interest which approximates the Company's cost of financing. The Company's interest expense is reduced by the amount capitalized. Capitalized interest for the year ended December 31, 1998, totaled $7,740,000, as compared with $2,306,000 for the same period in 1997.
The provision for depreciation for the year ended December 31, 1998, totaled $10,254,000, an increase of $4,967,000 over the year ended 1997 as a result of additional operating lease investments.
General and administrative expense for the year ended December 31, 1998, totaled $6,114,000 as compared with $4,858,000 for the year ended December 31, 1997. The expenses for the year ended December 31, 1998, were 6.24% of revenues as compared with 6.63% for the year ended December 31, 1997.
Dividend payments associated with the Company's outstanding preferred stock for the year ended December 31, 1998, totaled $4,160,000. There were no such dividend payments in 1997.
As a result of the various factors mentioned above, net income available for common shareholders for the year ended December 31, 1998, was $58,149,000, or $2.24 per share, as compared with $46,478,000, or $2.12 per share for the year ended December 31, 1997.
IMPACT OF INFLATION
During the past three years, inflation has not significantly affected the earnings of the Company because of the moderate inflation rate. Additionally, earnings of the Company are primarily long-term investments with fixed interest rates. These investments are mainly financed with a combination of equity, senior notes and borrowings under the revolving lines of credit. During inflationary periods, which generally are accompanied by rising interest rates, the Company's ability to grow may be adversely affected because the yield on new investments may increase at a slower rate than new borrowing costs. Presuming the current inflation rate remains moderate and long-term interest rates do not increase significantly, the Company believes that inflation will not impact the availability of equity and debt financing.
YEAR 2000 COMPLIANCE
The Year 2000 compliance issue concerns the inability of certain systems and devices to properly use or store dates beyond December 31, 1999. This could have resulted in system failures, malfunctions, or miscalculations that would have disrupted normal operations. The Company did not experience any Year 2000 related problems. In addition, the Company's outside vendors and tenant/borrowers did not encounter any significant problems related to Year 2000 issues.
The Company's expenditures for remedies were not material.
The Company does not anticipate any future risk due to the Year 2000, but will continue to monitor all computer software and hardware throughout the next year.
OTHER INFORMATION
This document and supporting schedules may contain "forward-looking" statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties, which may cause the Company's actual results in the future to differ materially from expected results. These risks and uncertainties include, among others, competition in the financing of health care facilities, the availability and cost of capital, the ability of the Company's lessees and borrowers to make payments under their leases and loans, and regulatory and other changes in the health care sector, as described in the Company's filings with the Securities and Exchange Commission.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to various market risks, including the potential loss arising from adverse changes in interest rates. The Company seeks to mitigate the effects of fluctuations in interest rates by matching the term of new investments with new long-term fixed rate borrowings to the extent possible.
The market value of the Company's long-term fixed rate borrowings is subject to interest rate risk. Generally, the market value of fixed rate financial instruments will decrease as interest rates rise and increase as interest rates fall. The estimated fair value of the Company's senior unsecured notes were $258 million and $239 million at December 31, 1999 and 1998, respectively. A 1% increase in interest rates would result in a decrease in fair value of the Company's senior unsecured notes by approximately $11 million at both December 31, 1999 and 1998.
The Company is subject to risks associated with debt financing, including the risk that existing indebtedness may not be refinanced or that the terms of such refinancing may not be as favorable as the terms of current indebtedness. The majority of the Company's borrowings were completed pursuant to indentures or contractual agreements which limit the amount of indebtedness the Company may incur. Accordingly, in the event that the Company is unable to raise additional equity or borrow money because of these limitations, the Company's ability to acquire additional properties may be limited.
At December 31, 1999, the Company's variable interest rate debt exceeded its variable interest rate assets, presenting an exposure to rising interest rates. The Company may or may not elect to use financial derivative instruments to hedge variable interest rate exposure. Such decisions are principally based on the Company's policy to match its variable rate investments with comparable borrowings, but is also based on the general trend in interest rates at the applicable dates and the Company's perception of future volatility of interest rates.
Potential Risks from Bankruptcies
The Company is exposed to the risk that its operators may not be able to meet the rent and interest payments due the Company, which may result in an operator bankruptcy or insolvency. Although the Company's operating lease agreements and loans provide the Company the right to terminate an investment, evict an operator, demand immediate repayment, and other remedies, the Bankruptcy laws afford certain rights to a party that has filed for bankruptcy or reorganization. An operator in bankruptcy may be able to restrict the Company's ability to collect unpaid rent or interest, and collect interest during the bankruptcy proceeding.
The receipt of liquidation proceeds or the replacement of an operator that has defaulted on its lease or loan could be delayed by the approval process of any federal, state or local agency necessary for the transfer of the property or the replacement of the operator licensed to manage the facility. In addition, the Company may be required to fund certain expenses (i.e. real estate taxes and maintenance) to retain control of a property. In some instances the Company may take possession of a property, which may expose the Company to successor liabilities. Should such events occur, the Company's revenue and operating cash flow may be adversely affected.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
REPORT OF INDEPENDENT AUDITORS
Shareholders and Directors Health Care REIT, Inc.
We have audited the accompanying consolidated balance sheets of Health Care REIT, Inc. as of December 31, 1999 and 1998, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedules listed in the Index at Item 14 (a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Health Care REIT, Inc. at December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
January 21, 2000 Toledo, Ohio
HEALTH CARE REIT, INC. CONSOLIDATED BALANCE SHEETS
See accompanying notes
HEALTH CARE REIT, INC. CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes
HEALTH CARE REIT, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
See accompanying notes
HEALTH CARE REIT, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes
Health Care REIT, Inc. Notes to Consolidated Financial Statements
1. ACCOUNTING POLICIES AND RELATED MATTERS
INDUSTRY
The Company is a self-administered real estate investment trust that invests primarily in long-term care facilities, which include nursing homes and assisted living facilities. The Company also invests in specialty care facilities.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries after the elimination of all significant intercompany accounts and transactions.
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
LOANS RECEIVABLE
Loans receivable consist of long-term mortgage loans, construction-period loans maturing in two years or less, and working capital loans. Interest income on loans is recognized as earned based upon the principal amount outstanding. The loans are primarily collateralized by a first mortgage on or assignment of partnership interest in the related facilities which consist of nursing homes, assisted living facilities, behavioral care facilities, and specialty care hospitals.
REAL PROPERTY INVESTMENTS
Certain properties owned by the Company are leased under operating leases and are recorded at cost. These properties are depreciated on a straight-line basis over their estimated useful lives. The carrying value of long-lived assets is reviewed quarterly on a property by property basis to determine if facts and circumstances suggest that the assets may be impaired or that the depreciable life may need to be changed. The Company considers external factors relating to each asset. If these external factors and the projected undiscounted cash flows of the asset over the remaining amortization period indicate that the asset will not be recoverable, the carrying value will be adjusted to the estimated fair value. As of December 31, 1999, the Company does not believe there is any indication that the carrying value or the amortization period of its assets needs to be adjusted. The leases generally extend for a minimum ten-year period and provide for payment of all taxes, insurance and maintenance by the lessees. In general, operating lease income includes base rent payments plus fixed annual rent increases, which are recognized on a straight-line basis over the minimum lease period. This income is greater than the amount of cash received during the first half of the lease term.
CAPITALIZATION OF CONSTRUCTION PERIOD INTEREST
The Company capitalizes interest costs associated with funds used to finance the construction of properties owned directly by the Company. The amount capitalized is based upon the borrowings outstanding during the construction period using the rate of interest which approximates the Company's cost of financing.
The Company capitalized interest costs of $8,578,000, $7,740,000 and $2,306,000 during 1999, 1998 and 1997, respectively, related to construction of real property owned by the Company. The Company's interest expense reflected in the statement of income has been reduced by the amounts capitalized.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level believed adequate to absorb potential losses in the Company's loans receivable. The determination of the allowance is based on a quarterly evaluation of these loans, including general economic conditions and estimated collectibility of loan payments.
1. ACCOUNTING POLICIES AND RELATED MATTERS (CONTINUED)
DEFERRED LOAN EXPENSES
Deferred loan expenses are costs incurred by the Company in connection with the issuance of short-term and long-term debt. The Company amortizes these costs over the term of the debt using the straight-line method, which approximates the interest yield method.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of all highly liquid investments with an original maturity of three months or less.
DIRECT INVESTMENTS
Management determines the appropriate classification of a direct investment at the time of acquisition and reevaluates such designation as of each balance sheet date. Debt securities which are classified as held to maturity are stated at historical cost. Equity investments are stated at historical cost. Direct investments included the preferred stock of one private corporation, subordinated debt in six private corporations, and ownership representing a 31% interest in Atlantic Healthcare Finance L.P., a property investment group that specializes in the financing, through sale and leaseback transactions, of nursing homes located in the United Kingdom and continental Europe.
MARKETABLE SECURITIES
Marketable securities available for sale are stated at market value with unrealized gains and losses reported in a separate component of shareholders' equity. Marketable securities reflect the market value of the common stock of two publicly owned corporations, which were obtained by the Company at no cost, and the fair value of the common stock related to warrants in one publicly owned corporation in excess of the exercise price.
LOAN AND COMMITMENT FEES
Loan and commitment fees are earned by the Company for its agreement to provide direct and standby financing to, and credit enhancement for, owners of health care facilities. The Company amortizes loan and commitment fees over the initial fixed term of the lease, the mortgage or the construction period related to such investments.
FEDERAL INCOME TAX
No provision has been made for federal income taxes since the Company has elected to be treated as a real estate investment trust under the applicable provisions of the Internal Revenue Code, and the Company believes that it has met the requirements for qualification as such for each taxable year. See Note 10.
NET INCOME PER SHARE
Basic earnings per share is computed by dividing income available to common shareholders by the weighted-average number of shares for the period. The computation of diluted earnings per share is similar to basic earnings per share, except that the number of shares is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued.
COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement 130, Reporting Comprehensive Income. Statement 130 establishes guidelines for the reporting and display of comprehensive income and its components. Comprehensive income includes unrealized gains or losses on the Company's marketable securities and foreign currency translation adjustments. These items are included as a component of shareholders' equity.
NEW ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities", which is effective January 1, 2001. Under the Statement, all financial instruments meeting the definition of a derivative will be carried at fair value. The impact that this statement will have on the Company has not been determined. The Company currently has no derivative instruments nor has engaged in any hedging activities.
2. LOANS RECEIVABLE
The following is a summary of loans receivable (in thousands):
Mortgage loans include $6,741,000 of direct financing leases in 1998. Loans to related parties (various entities whose ownership includes two Company directors) included above are at rates comparable to other third party borrowers equal to or greater than the Company's net interest cost on borrowings to support such loans. The amount of interest income and loan and commitment fees from related parties amounted to $3,639,000, $1,236,000 and $980,000 for 1999, 1998 and 1997, respectively.
The following is a summary of mortgage loans at December 31, 1999 (in thousands):
2. LOANS RECEIVABLE (CONTINUED)
3. REAL ESTATE INVESTMENTS
The following table summarizes certain information about the Company's real estate properties as of December 31, 1999 (in thousands):
3. REAL ESTATE INVESTMENTS (CONTINUED)
At December 31, 1999, future minimum lease payments receivable under operating leases are as follows (in thousands):
2000 $ 76,866 2001 83,167 2002 84,916 2003 85,829 2004 86,714 Thereafter 506,662 -------------
TOTAL $ 924,154 =============
The Company converted $16,309,000, $73,430,000, and $13,103,000, of mortgage loans into operating lease properties in 1999, 1998 and 1997, respectively. This noncash activity is appropriately not reflected in the accompanying statements of cash flows.
The Company has leased one nursing home and five assisted living facilities to an operator that has a director who is also a director of the Company and the Company is constructing two assisted living facilities that will be leased to this operator upon completion. The Company recognized $1,266,000 of rental income from this operator in 1999. The Company did not recognize rental income from this operator in 1998 or 1997. In 1999, a director of the Company was appointed as a director of an operator which leases seven facilities from the Company. The Company recognized $1,546,000 of rental income from this operator in 1999.
4. CONCENTRATION OF RISK
As of December 31, 1999, long-term care facilities, which include nursing homes and assisted living facilities, comprised 92% of the Company's real estate investments and were located in 34 states. Investments in assisted living facilities comprised 70% of the Company's real estate investments. The Company's investments with the three largest operators totaled approximately 29%. No single operator has a real estate investment balance which exceeds 14% of total real estate investments, including credit enhancements.
5. ALLOWANCE FOR LOAN LOSSES
The following is a summary of the allowance for loan losses (in thousands):
During 1997, two loans with an aggregate balance of $12,073,000 and a specifically identified allowance of $6,000,000 were extinguished. The Company recognized payments of $6,073,000 and recorded a charge of $6,000,000 against the allowance for loan losses.
6. BORROWINGS UNDER LINE OF CREDIT ARRANGEMENTS AND RELATED ITEMS
The Company has an unsecured credit arrangement with a consortium of ten banks providing for a revolving line of credit (revolving credit) in the amount of $175,000,000 which expires on March 31, 2001. The agreement specifies that borrowings under the revolving credit are subject to interest payable in periods no longer than three months on either the agent bank's base rate of interest or 1.0% over LIBOR interest rate (based at the Company's option). The effective interest rate at December 31, 1999 was 7.05%. In addition, the Company pays a commitment fee ranging from an annual rate of 0.20% to 0.375% and an annual agent's fee of $50,000. Principal is due upon expiration of the agreement. The Company has another unsecured line of credit with a bank for a total of $20,000,000 which expires April 30, 2000. Borrowings under this line of credit are subject to interest at the bank's prime rate of interest (8.50% at December 31, 1999) and are due on demand.
6. BORROWINGS UNDER LINE OF CREDIT ARRANGEMENTS AND RELATED ITEMS (CONTINUED)
The following information relates to aggregate borrowings under the line of credit arrangements (in thousands, except percentages):
7. SENIOR NOTES AND OTHER LONG-TERM OBLIGATIONS
The Company has $290,000,000 of unsecured Senior Notes with interest ranging from 7.06% to 8.34% and maturing at various dates to 2008.
The Company has two mortgage notes payable, collateralized by two health care facilities with interest rates from 7.625% to 12% and maturing at various dates to 2034.
The Company has one secured note collateralized by one health care facility with interest at 2% over LIBOR (8.16% at December 31, 1999).
The Company has a $75,000,000 secured line of credit, collateralized by fourteen health care facilities, with interest at 2% over LIBOR (7.69% at December 31, 1999). The outstanding balance at December 31, 1999 was $60,000,000.
The carrying values of the health care properties securing the mortgages and secured debt totaled $154,224,000 at December 31, 1999.
At December 31, 1999, the annual principal payments on these long-term obligations are as follows (in thousands):
8. STOCK INCENTIVE PLANS AND RETIREMENT ARRANGEMENTS
The Company's 1995 Stock Incentive Plan authorized up to 2,200,000 shares of Common Stock to be issued at the discretion of the Board of Directors. The 1995 Plan replaced the 1985 Incentive Stock Option Plan. The options granted under the 1985 Plan continue to vest through 2005 and expire ten years from the date of grant. Officers and key salaried employees of the Company are eligible to participate in the 1995 Plan. The 1995 Plan allows for the issuance of stock options, restricted stock grants and Dividend Equivalency Rights. In addition, during 1997, the Company adopted a Stock Plan for Non-Employee Directors which authorizes up to 240,000 shares to be issued.
8. STOCK INCENTIVE PLANS AND RETIREMENT ARRANGEMENTS (CONTINUED)
The following summarizes the activity in the Plans for the years ended December 31 (shares in thousands):
The stock options generally vest over a five year period and expire ten years from the date of grant. Options at December 31, 1999, had exercise prices ranging from $17.875 to $27.375 per share and a weighted average contractual life of 4.7 years.
The Company issued 86,250, 74,100 and 157,000 restricted shares during 1999, 1998 and 1997, respectively, including 9,000, 2,250 and 2,000 shares for directors in 1999, 1998 and 1997, respectively. Vesting periods range from six months for directors to periods of five to ten years for officers and key salaried employees. Expense, which is recognized as the shares vest based on the market value at the date of the award, totaled $1,080,000, $601,000 and $257,000 in 1999, 1998 and 1997, respectively.
The Company has elected to follow APB Opinion No. 25, Accounting for Stock Issued to Employees in accounting for its employee stock options as permitted under FASB Statement No. 123 ("FASB 123"), Accounting for Stock-Based Compensation, and, accordingly, recognizes no compensation expense for the stock option grants when the market price on the underlying stock on the date of grant equals the exercise price of the Company's employee stock option.
Pro forma information has been determined as if the Company had accounted for its employee stock options and restricted shares under the fair value method. The pro forma disclosures are not likely to be representative of the effects on reported net income for future years because they do not take into consideration stock based incentives granted prior to 1995. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following range of assumptions: risk-free interest rates from 5.10% to 7.60%, dividend yields of 8% to 9%, expected lives of seven years, and expected volatility of .18% to .23%. Had compensation cost for the stock based compensation plans been determined in accordance with FASB 123, net income would have been reduced by $621,000, $393,000, and $212,000 in 1999, 1998 and 1997, respectively.
The Company has a 401-(k) Profit Sharing Plan covering all eligible employees. Under the Plan, eligible employees may make contributions, and the Company may make a profit sharing contribution. Company contributions to this Plan totaled $144,000, $120,000, and $110,000 in 1999, 1998 and 1997, respectively.
9. PREFERRED STOCK
In January 1999, the Company announced the sale of 3,000,000 shares of Series C Cumulative Convertible Preferred Stock. These shares have a liquidation value of $25.00 per share and will pay dividends equivalent to the greater of (i) the annual dividend rate of $2.25 per share (a quarterly dividend rate of $0.5625 per share); or (ii) the quarterly dividend then payable per common share on an as converted basis. The preferred shares are convertible into common stock at a conversion price of $25.625 per share. The Company has the right to redeem the preferred shares after five years.
In May 1998, the Company sold 3,000,000 shares of 8.875% Series B Cumulative Redeemable Non-Voting Preferred Stock with a liquidation preference of $25.00 per share. Dividends are payable quarterly in arrears. On and after May 1, 2003, the Preferred Stock may be redeemed for cash at the option of the Company, in whole or in part, at $25.00 per share, plus accrued and unpaid dividends thereon to the redemption date.
10. DISTRIBUTIONS
To qualify as a real estate investment trust for federal income tax purposes, 95% of taxable income (not including capital gains) must be distributed to shareholders. Real estate investment trusts which do not distribute a certain amount of current year taxable income in the current year are also subject to a 4% federal excise tax. The Company's excise tax expense was $0, $315,000 and $360,000 for the years ended December 31, 1999, 1998 and 1997, respectively. Undistributed net income for federal income tax purposes amounted to $6,242,000 at December 31, 1999. The principal reasons for the difference between undistributed net income for federal income tax purposes and financial statement purposes are the recognition of straight-line rent for reporting purposes and the provision for losses for reporting purposes versus bad debt expense for tax purposes. Cash distributions paid to shareholders, for federal income tax purposes, are as follows:
11. COMMITMENTS AND CONTINGENCIES
At December 31, 1999, the Company had outstanding commitments to provide financing for facilities in the approximate amount of $53,356,000 for ongoing construction activity expected over the next twelve to fifteen months. The above commitments are generally on similar terms as existing financings of a like nature with rates of return to the Company based upon current market rates at the time of the commitment.
The Company has agreements to purchase two health care facilities, or the loans with respect thereto, in the event that the present owners default upon their obligations. In consideration for these agreements, the Company receives and recognizes fees annually related to these agreements. Although the terms of these agreements vary, the purchase prices are equal to the amount of the outstanding obligations financing the facility. These agreements expire through the year 2005. In addition, the Company has an outstanding letter of credit relating to one construction project. At December 31, 1999, obligations under these agreements for which the Company was contingently liable aggregated approximately $12,425,000.
12. SHAREHOLDER RIGHTS PLAN
Under the terms of a Shareholder Rights Plan approved by the Board of Directors in July 1994, a Preferred Share Right (Right) is attached to and automatically trades with each outstanding share of Common Stock.
The Rights, which are redeemable, will become exercisable only in the event that any person or group becomes a holder of 15% or more of the Common Stock, or commences a tender or exchange offer which, if consummated, would result in that person or group owning at least 15% of the Common Stock. Once the Rights become exercisable, they entitle all other shareholders to purchase one one-thousandth of a share of a new series of junior participating preferred stock for an exercise price of $48.00. The Rights will expire on August 5, 2004 unless exchanged earlier or redeemed earlier by the Company for $.01 per Right at any time before public disclosure that a 15% position has been acquired.
13. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):
The diluted earnings per share calculation excludes the dilutive effect of 1,813,000 and 179,000 shares for 1999 and 1998, respectively because the exercise price was greater than the average market price. The Series C Cumulative Convertible Preferred Stock was not included in this calculation as the effect of the conversion was anti-dilutive.
14. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.
Mortgage Loans--The fair value of all mortgage loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Working Capital and Construction Loans--The carrying amount is a reasonable estimate of fair value for working capital and construction loans because the interest earned on these instruments is variable.
Cash and Cash Equivalents--The carrying amount approximates fair value because of the short maturity of these financial instruments.
Marketable Securities --The assets are recorded at their fair market value.
Direct Investments--Direct investments are recognized at historical cost, which the Company believes approximates fair market value.
Borrowings Under Line of Credit Arrangements--The carrying amount of the line of credit approximates fair value because the borrowings are interest rate adjustable.
Senior Unsecured Notes and Industrial Development Bonds--The fair value of the senior unsecured notes payable was estimated by discounting the future cash flow using the current borrowing rate available to the Company for similar debt.
Mortgage Notes Payable--Mortgage notes payable is a reasonable estimate of fair value.
Secured Debt--Same as Line of Credit Arrangements.
14. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The carrying amounts and estimated fair values of the Company's financial instruments at December 31, 1999 and 1998, are as follows (in thousands):
15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations of the Company for the years ended December 31, 1999 and 1998 (in thousands, except per share data):
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable. PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated herein by reference to the information under the heading "Election of Three Directors" and "Executive Officers of the Company" in the definitive proxy statement of the Company which will be filed with the Commission prior to May 4, 2000.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference to the information under the heading "Remuneration" in the definitive proxy statement of the Company which will be filed with the Commission prior to May 4, 2000.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by reference to the information under the heading "Security Ownership of Directors and Management" in the definitive proxy statement of the Company which will be filed with the Commission prior to May 4, 2000.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by reference to the information under the heading "Certain Relationships and Related Transactions" in the definitive proxy statement of the Company which will be filed with the Commission prior to May 4, 2000.
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
2. The following Financial Statement Schedules are included in Item 14 (d):
III - Real Estate and Accumulated Depreciation IV - Mortgage Loans on Real Estate
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
3. Exhibit Index:
3.1 Second Restated Certificate of Incorporation.
3.2 By-Laws, as amended.
4.1 The Registrant, by signing this Report, agrees to furnish the Securities and Exchange Commission upon its request a copy of any instrument which defines the rights of holders of long-term debt of Registrant and which authorizes a total amount of securities not in excess of 10% of the total assets of the Registrant.
4.2 Indenture dated as of April 17, 1997 by and between Health Care REIT, Inc. and Fifth Third Bank.
4.3 First Supplemental Indenture dated as of April 17, 1997 by and between Health Care REIT, Inc. and Fifth Third Bank.
4.4 Second Supplemental Indenture dated as of March 13, 1998 between Health Care REIT, Inc. and Fifth Third Bank.
4.5 Third Supplemental Indenture dated as of March 18, 1999 between Health Care REIT, Inc. and Fifth Third Bank.
10.1 Rights Agreement.
10.2 Note Purchase Agreement between Health Care REIT, Inc. and each of the Purchasers a Party thereto, dated as of April 8, 1993.
10.3 Loan Agreement dated as of March 28, 1997 by and among Health Care REIT, Inc., its subsidiaries, the banks signatory thereto, Keybank National Association, as Administrative Agent, and Fleet Bank, N.A., as Syndication Agent.
10.4 Note Purchase Agreement between Health Care REIT, Inc. and each of the Purchasers a Party thereto, dated as of April 15, 1995.
10.5 The 1985 Incentive Stock Option Plan of Health Care REIT, Inc. as amended.
10.6 The Health Care REIT, Inc. 1995 Stock Incentive Plan
21 Subsidiaries of the Registrant.
23 Consent of Independent Auditors.
24 Powers of Attorney.
27 Financial Data Schedules (Edgar version only).
(b) Reports on Form 8-K filed in the fourth quarter of 1999:
None.
(c) Exhibits:
The exhibits listed in Item 14(a)(3) above are filed with this Form 10-K.
(d) Financial Statement Schedules:
Financial statement schedules are included in pages 37 through 43.
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 on by the undersigned thereunto duly authorized.
HEALTH CARE REIT, INC. (Registrant)
By: /s/GEORGE L. CHAPMAN ----------------------------------- Chairman, Chief Executive Officer, President and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 20, 2000 by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ WILLIAM C. BALLARD, JR.* - ----------------------------------- William C. Ballard, Jr., Director
/s/ PIER C. BORRA* - ----------------------------------- Pier C. Borra, Director
/s/ JEFFREY H. DONAHUE* - ----------------------------------- Jeffrey H. Donahue, Director
/s/BRUCE DOUGLAS* - ----------------------------------- Bruce Douglas, Director
/s/ PETER J. GRUA* - ----------------------------------- Peter J. Grua, Director
/s/ SHARON M. OSTER* - ----------------------------------- Sharon M. Oster, Director
/s/ BRUCE G. THOMPSON* - ----------------------------------- Bruce G. Thompson, Director
/s/ R. SCOTT TRUMBULL* - ---------------------------------- R. Scott Trumbull, Director
/s/ RICHARD A. UNVERFERTH* - ---------------------------------- Richard A. Unverferth, Director
/s/ GEORGE L. CHAPMAN - ---------------------------------- George L. Chapman, Chairman, Chief Executive Officer, President and Director (Principal Executive Officer)
/s/ EDWARD F. LANGE, JR.* - ---------------------------------- Edward F. Lange, Jr., Chief Financial Officer (Principal Financial Officer)
/s/ MICHAEL A. CRABTREE* - ---------------------------------- Michael A. Crabtree, Controller (Principal Accounting Officer)
*By: /s/GEORGE L. CHAPMAN - ----------------------------------- George L. Chapman, Attorney-in-Fact
HEALTH CARE REIT, INC. SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1999
SCHEDULE III - Continued
SCHEDULE III - Continued
SCHEDULE III - Continued
SCHEDULE III - Continued
(1) Represents mortgage loans converted to operating leases.
SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE HEALTH CARE REIT, INC. DECEMBER 31, 1999
(1) Includes collection of negative principal amortization.
(2) Includes properties originally financed with mortgage loans that were purchased during the periods indicated.
EXHIBIT INDEX
The following documents are included in this Form 10-K as an Exhibit:
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(1) Incorporated by reference to Exhibit 3(ii) to the Registrant's Form 8-K filed October 24, 1997.
(2) Incorporated by reference to Exhibit 4.1 to the Registrant's Form 8-K filed on April 21, 1997.
(3) Incorporated by reference to Exhibit 4.2 to the Registrant's Form 8-K filed on April 21, 1997.
(4) Incorporated by reference to Exhibit 4.2 to the Registrant's Form 8-K filed on March 11, 1998.
(5) Incorporated by reference to Exhibit 4.2 to the Registrant's Form 8-K filed on March 17, 1999.
(6) Incorporated by reference to Exhibit 2 to the Registrant's Form 8-A filed on August 3, 1994 (File No. 1-8923).
(7) Incorporated by reference to Exhibits 1-4 of the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1993.
(8) Incorporated by reference to Exhibit 10.1 of the Registrant's Form 8-K filed on April 8, 1997.
(9) Incorporated by reference to Exhibit 4 of the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1996.
(10) Incorporated by reference to Exhibit 4.4 to the Registrant's Registration Statement on Form S-8 (File No. 333-1237) filed on February 27, 1996.
(11) Incorporated by reference to Exhibit 4.1 to the Registrant's Registration Statement on Form S-8 (File No. 333-1239) filed on February 27, 1996.