WELLTOWER INC. quarterly report, Q3 FY2013

Business context and reporting period

Health Care REIT, Inc. (now Welltower Inc.) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2013. The company was a healthcare and seniors-housing REIT with 1,197 properties across 46 U.S. states, the United Kingdom and Canada, including unconsolidated investments.

The January 2013 Sunrise acquisition materially expanded the seniors-housing operating business. At quarter-end, the consolidated portfolio comprised 1,140 properties; the filing also reports properties held through unconsolidated entities.

Financial performance and position

Amounts below are in millions of dollars except per-share data. Comparative periods are the three or nine months ended September 30.

Revenue growth principally reflected acquisitions and the consolidation of Sunrise operations; it should not be read as same-property growth. Q3 property operating expenses were $342.7 million and depreciation and amortization was $242.7 million. Interest expense was $116.5 million for Q3 and $336.6 million for the nine months. Same-store cash NOI increased 4% for both the quarter and nine-month period; consolidated NOI rose 40% in Q3 and 35% for nine months, largely reflecting portfolio expansion.

At September 30, total assets were $23.05 billion, total liabilities $11.10 billion, cash and cash equivalents $164.8 million and restricted cash $80.9 million. Borrowings included $847.7 million under unsecured credit arrangements, $6.40 billion of senior unsecured notes and $3.12 billion of secured debt. The company reported $1.40 billion of available capacity under its primary credit facility and compliance with debt covenants. Debt-to-book-capitalization was 47%; Q3 interest coverage was 3.32x and fixed-charge coverage 2.62x.

Material changes versus the prior period

• Nine-month revenue increased 60%, while common-stockholder net income fell 49% and diluted EPS fell from $0.61 to $0.24. Acquisition-related depreciation, interest and transaction costs, as well as the larger share count, affected comparisons.
• Resident fees and services rose to $1.16 billion for nine months from $498.3 million, principally reflecting acquired seniors-housing operating properties. Property operating expenses increased to $875.0 million from $409.2 million.
• Nine-month transaction costs increased to $117.7 million from $42.5 million, including $72.3 million related to Sunrise. No loan-loss provision was recorded in 2013, compared with $27.0 million in 2012.
• Operating cash flow rose 11%, but investing cash outflow increased to $3.20 billion. Cash declined from $1.03 billion at year-end 2012 to $164.8 million at September 30, 2013; cash distributions to stockholders of $668.8 million exceeded operating cash flow.
• The company raised $1.63 billion net from a May common-stock offering. Common shares outstanding increased to 288.4 million from 260.4 million at year-end 2012.

Outlook, risks and unusual items

Management described capital markets as supportive, expected investment opportunities to remain available, and considered liquidity sufficient for anticipated uses, subject to access and cost of external capital. The filing provides no specific earnings forecast or numerical guidance.

The board raised the annual common dividend to $3.06 per share, or $0.765 quarterly, beginning in February 2013. The filing identifies continued dividend payments as an objective, not a guarantee.

• Sunrise was a major transaction: acquired in January, it contributed $443.2 million in revenue and $145.3 million in NOI for the nine months. The company also acquired remaining interests in 49 previously unconsolidated properties in July.
• Healthcare reimbursement changes, including Medicare sequestration reductions of up to 2%, and evolving Medicare and Medicaid rules could affect operators’ finances and ability to pay rent. Management also discussed regulatory, fraud-and-abuse and health-information privacy risks.
• Other stated risks include tenant/operator financial distress, concentration, refinancing and capital-market access, interest-rate and foreign-currency movements, joint-venture performance, and the ability to reinvest disposition proceeds. Sunrise represented 19% and Genesis HealthCare 12% of reported investment concentration.
• Commitments included approximately $261.6 million of additional construction funding and $59.6 million of contingent purchase obligations. A subsequent October 7, 2013 issuance of $400 million of 4.5% senior notes due 2024 generated approximately $393 million in proceeds.
• Management stated disclosure controls were effective; it reported no material change in internal control over financial reporting during the quarter. Ordinary-course legal proceedings were not expected to have a material adverse effect.

Important facts for investors to verify

• How much of reported revenue, NOI and FFO growth reflects acquired properties, particularly Sunrise, versus organic or same-store performance.
• The drivers of lower GAAP common earnings and EPS despite higher revenue and FFO, including transaction costs, depreciation, interest and share dilution.
• Debt maturities, variable-rate exposure, refinancing needs and remaining credit-facility availability; a 1% rate increase was estimated to add $11.0 million of annual interest expense at quarter-end balances.
• Whether operating cash flow can sustainably support dividends and planned investment, given nine-month distributions exceeded operating cash flow and cash balances fell substantially.
• Operator financial health and the effects of reimbursement or regulatory changes, especially for concentrated relationships and the expanded seniors-housing operating portfolio.