HCP, Inc. (now Healthpeak Properties) — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. HCP was a healthcare-focused REIT investing across senior housing, post-acute/skilled nursing, life science, medical office and hospital properties. Results include HCR ManorCare from its April 7, 2011 acquisition date, so reported year-over-year comparisons are materially affected by the transaction.
Financial performance and position
- Revenue: Q2 revenue was $488.7 million, up 62% from $301.9 million; six-month revenue was $820.4 million, up 38% from $596.7 million. Q2 direct-financing-lease income rose to $143.7 million from $12.0 million, principally reflecting HCR ManorCare.
- Profit and EPS: Q2 net income was $234.3 million versus $88.6 million; net income attributable to HCP was $228.8 million versus $85.1 million. Q2 common EPS was $0.55, compared with $0.27. For six months, net income was $308.2 million versus $172.7 million and common EPS was $0.74 versus $0.52.
- Cash flow: Six-month operating cash flow was $432.8 million, up from $276.1 million. Investing activities used $4.265 billion, largely for the HCR ManorCare acquisition; financing activities provided $3.071 billion. Cash and equivalents ended at $276.2 million, down from $1.037 billion at year-end 2010.
- Margins and operating measure: Q2 NOI was $381.1 million versus $219.0 million; six-month NOI was $627.2 million versus $431.2 million. NOI is a company-defined non-GAAP measure and excludes, among other items, interest, depreciation and corporate expenses. Diluted FFO per share was $0.78 for Q2 and $1.19 for six months; adjusted diluted FFO per share was $0.77 and $1.35, respectively. FFO is non-GAAP and is not cash flow.
- Assets and liquidity: Total assets were $17.693 billion at June 30, versus $13.332 billion at December 31. HCP had a $1.5 billion revolving facility with no borrowings and $112.7 million of letters of credit outstanding. Management said operating cash flow and financing activities should meet liquidity needs over the next 12 months.
- Debt: Debt principal totaled about $7.525 billion, excluding $89 million of resident-related life-care bonds; reported carrying value of senior notes and mortgages was $7.488 billion. Senior unsecured notes totaled $5.7 billion at a 5.64% weighted-average effective rate; mortgage debt was $1.8 billion at 6.11%. HCP reported compliance with debt covenants.
- Dividends: Common dividends declared were $0.48 per share each quarter in the first half, versus $0.465 per quarter in 2010. The board declared another $0.48 quarterly dividend in July 2011.
Material changes and notable items
- HCP acquired substantially all HCR ManorCare real estate for stated consideration of approximately $6.017 billion, including $3.802 billion cash net of cash acquired and $1.990 billion fair value of HCP loans settled. It acquired 334 facilities and invested a further $95 million for a 9.9% interest in the operating company. The assets are leased under a long-term triple-net master lease supported by an HCR ManorCare guaranty.
- The HCR transaction drove much of the increase in assets, debt, lease income and post-acute exposure. HCR ManorCare represented 34% of total gross assets and 28% of Q2 company revenue; it accounted for 94% of post-acute/skilled-nursing gross assets.
- HCP raised $2.4 billion through senior note issuance and approximately $1.273 billion net through a March common-stock offering to help finance the acquisition. The large increase in weighted-average shares also affects per-share comparisons.
- Other significant items included $34.8 million of incremental interest income from early repayment of Genesis loans; approximately $23 million of income from settling HCR ManorCare loans above carrying value; a $7.8 million gain on consolidating HCP Ventures II; and $5.7 million from a litigation settlement related to proceeds owed on an asset sale. Acquisition-related fees and financing costs also raised expenses.
- Interest expense increased to $105.1 million in Q2 from $72.7 million, primarily due to the notes issued to fund the acquisition. General and administrative expense increased to $34.9 million from $20.5 million, primarily reflecting acquisition costs.
Outlook, risks and contingencies
- No specific earnings or FFO guidance is provided. Management cautioned that first-half results are not necessarily indicative of full-year results and said liquidity needs over the next 12 months are expected to be met through operations and financing.
- Ventas litigation remains material: a prior jury awarded approximately $102 million in compensatory damages, which HCP had provided for in 2009. In May 2011, the appeals court remanded Ventas’s punitive-damages claim for trial; rehearing was denied in July. A trial was scheduled for February 21, 2012. HCP said it could not estimate the probability or ultimate amount of additional loss. A $103 million letter of credit supports the matter.
- HCP identified risks including capital-market access, interest rates and debt management, healthcare regulation, operator and tenant financial weakness, litigation, and changes in reimbursement. It specifically cited a July 2011 CMS final rule reducing Medicare skilled-nursing-facility PPS payments by 11.1% in FY2012 versus FY2011.
- Other exposures include a Cirrus-affiliate loan on cost-recovery status, with interest accrual suspended; HCP said collateral value exceeded the loan but noted further restructuring or impairment could become necessary. HCP also guaranteed $4 million of mortgage debt for certain joint ventures.
- HCP reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter.
Investor verification priorities
- Review HCR ManorCare lease terms, guaranty strength, integration of the acquired facilities and the effect of the Medicare reimbursement reduction on the operator’s ability to pay rent.
- Assess reported earnings and FFO in light of acquisition-related income, transaction costs, financing costs, share issuance and the non-GAAP adjustments.
- Track the Ventas punitive-damages trial, potential additional exposure and the related letter of credit.
- Monitor debt maturities, refinancing access, covenant headroom and liquidity after acquisition spending and dividends.