Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

 

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

 

 

 

 

For the quarterly period ended September 30, 2008.

 

 

 

OR

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

For the transition period from              to             

 

Commission file number 1-08895

 


 

HCP, Inc.

(Exact name of registrant as specified in its charter)

 

Maryland

 

33-0091377

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

3760 Kilroy Airport Way, Suite 300
Long Beach, CA 90806

(Address of principal executive offices)

 

(562) 733-5100
(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed since last report)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days  YES  x   NO  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer      x

 

Accelerated Filer  o

 

 

 

Non-accelerated Filer  o (Do not check if a smaller reporting company)

 

Smaller Reporting Company  o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
YES  
o  NO  x

 

As of October 29, 2008, there were 252,652,540 shares of the registrant’s $1.00 par value common stock outstanding.

 

 

 



Table of Contents

 

HCP, Inc.

INDEX

 

PART I. FINANCIAL INFORMATION

 

 

 

 

 

 

 

 

 

 

Item 1.

 

Financial Statements:

 

 

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets

 

3

 

 

 

 

 

 

 

Condensed Consolidated Statements of Income

 

4

 

 

 

 

 

 

 

Condensed Consolidated Statement of Stockholders’ Equity

 

5

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows

 

6

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

7

 

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

32

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

44

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

46

 

 

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

46

 

 

 

 

 

Item 1A.

 

Risk Factors

 

46

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

46

 

 

 

 

 

Item 6.

 

Exhibits

 

48

 

 

 

 

 

Signatures

 

 

 

55

 

2



Table of Contents

 

HCP, Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

 

 

September 30,

 

December 31,

 

 

 

2008

 

2007

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Real estate:

 

 

 

 

 

Buildings and improvements

 

$

7,733,690

 

$

7,521,415

 

Development costs and construction in progress

 

249,837

 

372,527

 

Land

 

1,563,167

 

1,569,956

 

Less accumulated depreciation and amortization

 

781,903

 

621,379

 

Net real estate

 

8,764,791

 

8,842,519

 

 

 

 

 

 

 

Net investment in direct financing leases

 

647,429

 

640,052

 

Loans receivable, net

 

1,068,240

 

1,065,485

 

Investments in and advances to unconsolidated joint ventures

 

275,593

 

248,894

 

Accounts receivable, net of allowance of $17,860 and $23,109, respectively

 

30,011

 

44,892

 

Cash and cash equivalents

 

117,052

 

96,269

 

Restricted cash

 

37,310

 

36,427

 

Intangible assets, net

 

552,906

 

623,073

 

Real estate held for sale, net

 

5,301

 

408,028

 

Other assets, net

 

532,771

 

516,133

 

Total assets

 

$

12,031,404

 

$

12,521,772

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Bank line of credit

 

$

 

$

951,700

 

Bridge loan

 

520,000

 

1,350,000

 

Senior unsecured notes

 

3,522,689

 

3,819,950

 

Mortgage debt

 

1,804,069

 

1,277,291

 

Mortgage debt on assets held for sale

 

978

 

3,470

 

Other debt

 

102,602

 

108,496

 

Intangible liabilities, net

 

249,965

 

278,143

 

Accounts payable and accrued liabilities

 

224,680

 

233,752

 

Deferred revenue

 

64,841

 

55,990

 

Total liabilities

 

6,489,824

 

8,078,792

 

Minority interests:

 

 

 

 

 

Joint venture partners

 

17,430

 

33,436

 

Non-managing member unitholders

 

230,811

 

305,835

 

Total minority interests

 

248,241

 

339,271

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $1.00 par value: 50,000,000 shares authorized; 11,820,000 shares issued and outstanding, liquidation preference of $25.00 per share

 

285,173

 

285,173

 

Common stock, $1.00 par value: 750,000,000 shares authorized; 251,925,869 and 216,818,780 shares issued and outstanding, respectively

 

251,926

 

216,819

 

Additional paid-in capital

 

4,835,014

 

3,724,739

 

Cumulative dividends in excess of earnings

 

(49,893

)

(120,920

)

Accumulated other comprehensive loss

 

(28,881

)

(2,102

)

Total stockholders’ equity

 

5,293,339

 

4,103,709

 

Total liabilities and stockholders’ equity

 

$

12,031,404

 

$

12,521,772

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

3



Table of Contents

 

HCP, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)
(Unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Revenues:

 

 

 

 

 

 

 

 

 

Rental and related revenues

 

$

233,632

 

$

205,585

 

$

657,484

 

$

554,031

 

Tenant recoveries

 

20,240

 

17,560

 

61,855

 

42,909

 

Income from direct financing leases

 

14,543

 

18,832

 

43,646

 

49,037

 

Investment management fee income

 

1,523

 

1,602

 

4,448

 

12,062

 

Total revenues

 

269,938

 

243,579

 

767,433

 

658,039

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

77,659

 

70,418

 

233,920

 

184,132

 

Operating

 

49,846

 

49,914

 

146,506

 

127,457

 

General and administrative

 

17,541

 

16,499

 

56,913

 

53,894

 

Impairments

 

3,710

 

 

13,425

 

 

Total costs and expenses

 

148,756

 

136,831

 

450,764

 

365,483

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Gain on sale of real estate interest

 

 

 

 

10,141

 

Interest and other income, net

 

62,312

 

21,538

 

128,378

 

54,724

 

Interest expense

 

(83,249

)

(103,707

)

(265,054

)

(254,434

)

Total other income (expense)

 

(20,937

)

(82,169

)

(136,676

)

(189,569

)

 

 

 

 

 

 

 

 

 

 

Income before income taxes, equity income from unconsolidated joint ventures and minority interests’ share in earnings

 

100,245

 

24,579

 

179,993

 

102,987

 

Income taxes

 

(866

)

318

 

(4,385

)

860

 

Equity income from unconsolidated joint ventures

 

1,227

 

1,242

 

3,736

 

3,758

 

Minority interests’ share in earnings

 

(5,803

)

(6,018

)

(17,055

)

(17,992

)

Income from continuing operations

 

94,803

 

20,121

 

162,289

 

89,613

 

 

 

 

 

 

 

 

 

 

 

Discontinued operations:

 

 

 

 

 

 

 

 

 

Income before gain on sales of real estate, net of income taxes

 

3,198

 

15,874

 

18,025

 

56,838

 

Gain on sales of real estate, net of income taxes

 

27,416

 

286,153

 

227,810

 

392,269

 

Total discontinued operations

 

30,614

 

302,027

 

245,835

 

449,107

 

 

 

 

 

 

 

 

 

 

 

Net income

 

125,417

 

322,148

 

408,124

 

538,720

 

Preferred stock dividends

 

(5,282

)

(5,282

)

(15,848

)

(15,848

)

Net income applicable to common shares

 

$

120,135

 

$

316,866

 

$

392,276

 

$

522,872

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.37

 

$

0.07

 

$

0.63

 

$

0.36

 

Discontinued operations

 

0.12

 

1.47

 

1.06

 

2.19

 

Net income applicable to common shares

 

$

0.49

 

$

1.54

 

$

1.69

 

$

2.55

 

Diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.37

 

$

0.07

 

$

0.63

 

$

0.36

 

Discontinued operations

 

0.12

 

1.46

 

1.05

 

2.17

 

Net income applicable to common shares

 

$

0.49

 

$

1.53

 

$

1.68

 

$

2.53

 

Weighted average shares used to calculate earnings per common share:

 

 

 

 

 

 

 

 

 

Basic

 

244,572

 

206,186

 

232,199

 

205,322

 

Diluted

 

245,906

 

207,070

 

233,391

 

206,672

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.455

 

$

0.445

 

$

1.365

 

$

1.335

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

4



Table of Contents

 

HCP, Inc.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(In thousands, except per share data)
(Unaudited)

 

 

 

Nine Months
Ended
September 30,

 

 

 

2008

 

Preferred Stock, $1.00 Par Value:

 

 

 

Shares, beginning and ending

 

11,820

 

Amounts, beginning and ending

 

$

285,173

 

 

 

 

 

Common Stock, Shares:

 

 

 

Shares at beginning of period

 

216,819

 

Issuance of common stock, net

 

34,484

 

Exercise of stock options

 

623

 

Shares at end of period

 

251,926

 

 

 

 

 

Common Stock, $1.00 Par Value:

 

 

 

Balance at beginning of period

 

$

216,819

 

Issuance of common stock, net

 

34,484

 

Exercise of stock options

 

623

 

Balance at end of period

 

$

251,926

 

 

 

 

 

Additional Paid-In Capital:

 

 

 

Balance at beginning of period

 

$

3,724,739

 

Issuance of common stock, net

 

1,088,556

 

Exercise of stock options

 

11,082

 

Amortization of deferred compensation

 

10,637

 

Balance at end of period

 

$

4,835,014

 

 

 

 

 

Cumulative Dividends in Excess of Earnings:

 

 

 

Balance at beginning of period

 

$

(120,920

)

Net income

 

408,124

 

Preferred dividends

 

(15,848

)

Common dividend ($1.365 per share)

 

(321,249

)

Balance at end of period

 

$

(49,893

)

 

 

 

 

Accumulated Other Comprehensive Loss:

 

 

 

Balance at beginning of period

 

$

(2,102

)

Change in net unrealized gains and losses on securities:

 

 

 

Unrealized losses

 

(32,836

)

Less reclassification adjustment realized in net income

 

2,746

 

Change in net unrealized gains and losses on cash flow hedges:

 

 

 

Unrealized gains

 

124

 

Less reclassification adjustment realized in net income

 

2,777

 

Changes in Supplemental Executive Retirement Plan obligation

 

76

 

Foreign currency translation adjustment

 

334

 

Balance at end of period

 

$

(28,881

)

 

 

 

 

Total Comprehensive Income (Loss):

 

 

 

Net income

 

$

408,124

 

Other comprehensive loss

 

(26,779

)

Total comprehensive income

 

$

381,345

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

5



Table of Contents

 

HCP, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)
(Unaudited)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2008

 

2007

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

408,124

 

$

538,720

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization of real estate, in-place lease and other intangibles:

 

 

 

 

 

Continuing operations

 

233,920

 

184,132

 

Discontinued operations

 

5,832

 

17,748

 

Amortization of below market lease intangibles, net

 

(6,020

)

(3,185

)

Stock-based compensation

 

10,637

 

8,516

 

Amortization of debt issuance costs

 

9,226

 

15,274

 

Recovery of loan losses

 

 

(386

)

Straight-line rents

 

(28,645

)

(39,467

)

Interest accretion

 

(20,134

)

(6,428

)

Deferred rental revenue

 

16,227

 

8,937

 

Equity income from unconsolidated joint ventures

 

(3,736

)

(3,758

)

Distributions of earnings from unconsolidated joint ventures

 

3,736

 

3,148

 

Minority interests’ share in earnings

 

17,055

 

17,992

 

Gain on sales of real estate and real estate interest

 

(227,810

)

(402,410

)

Marketable securities losses (gains), net

 

2,746

 

(4,874

)

Derivative losses, net

 

1,803

 

 

Impairments

 

13,425

 

 

Changes in:

 

 

 

 

 

Accounts receivable

 

14,881

 

(2,626

)

Other assets

 

(6,660

)

(18,384

)

Accounts payable and accrued liabilities

 

10,776

 

(3,128

)

Net cash provided by operating activities

 

455,383

 

309,821

 

Cash flows from investing activities:

 

 

 

 

 

Cash used in acquisitions and development of real estate

 

(132,436

)

(339,692

)

Lease commissions and tenant and capital improvements

 

(44,734

)

(27,029

)

Proceeds from sales of real estate, net

 

629,404

 

854,505

 

Cash used in SEUSA acquisition, net of cash acquired

 

 

(2,977,564

)

Contributions to unconsolidated joint ventures

 

(2,620

)

(2,619

)

Distributions in excess of earnings from unconsolidated joint ventures

 

8,727

 

476,992

 

Purchase of marketable securities

 

(26,101

)

(26,647

)

Proceeds from the sale of marketable securities

 

10,700

 

53,514

 

Proceeds from sales of interests in unconsolidated joint ventures

 

2,855

 

 

Principal repayments on loans receivable

 

14,590

 

101,340

 

Investment in loans receivable

 

(2,863

)

(18,615

)

Increase in restricted cash

 

(883

)

(28,461

)

Net cash provided by (used in) investing activities

 

456,639

 

(1,934,276

)

Cash flows from financing activities:

 

 

 

 

 

Net repayments under bank line of credit

 

(951,700

)

(624,500

)

Repayments of bridge and term loans

 

(830,000

)

(504,593

)

Borrowings under bridge loan

 

 

2,750,000

 

Repayments of mortgage debt

 

(63,740

)

(82,482

)

Issuance of mortgage debt

 

579,078

 

143,421

 

Repayments of senior unsecured notes

 

(300,000

)

(20,000

)

Issuance of senior unsecured notes

 

 

500,000

 

Settlement of cash flow hedges

 

(9,658

)

 

Debt issuance costs

 

(10,068

)

(18,659

)

Net proceeds from the issuance of common stock and exercise of options

 

1,060,236

 

300,591

 

Dividends paid on common and preferred stock

 

(337,097

)

(291,787

)

Distributions to minority interests

 

(28,290

)

(17,088

)

Net cash provided by (used in) financing activities

 

(891,239

)

2,134,903

 

Net increase in cash and cash equivalents

 

20,783

 

510,448

 

Cash and cash equivalents, beginning of period

 

96,269

 

58,405

 

Cash and cash equivalents, end of period

 

$

117,052

 

$

568,853

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

6



Table of Contents

 

HCP, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

(1)   Business

 

HCP, Inc. is a Maryland corporation that is organized to qualify as a real estate investment trust (“REIT”) which, together with its consolidated entities (collectively, “HCP” or the “Company”), invests primarily in real estate serving the healthcare industry in the United States. The Company acquires, develops, leases, manages and disposes of healthcare real estate and provides mortgage and specialty financing to healthcare providers.

 

(2)   Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the unaudited condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008. For further information, refer to the consolidated financial statements and notes thereto for the year ended December 31, 2007 included in the Company’s Annual Report on Form 10-K, as amended, filed with the Securities and Exchange Commission (“SEC”).

 

Use of Estimates

 

Management is required to make estimates and assumptions in the preparation of financial statements in conformity with GAAP. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of HCP, its wholly-owned subsidiaries and joint ventures that it controls, through voting rights or other means. All material intercompany transactions and balances have been eliminated in consolidation.

 

The Company applies Financial Accounting Standards Board (“FASB”) Interpretation No. 46R, Consolidation of Variable Interest Entities, as revised (“FIN 46R”), for arrangements with variable interest entities. FIN 46R provides guidance on the identification of entities for which control is achieved through means other than voting rights (“variable interest entities” or “VIEs”) and the determination of which business enterprise is the primary beneficiary of the VIE. A variable interest entity is broadly defined as an entity where either (i) the equity investors as a group, if any, do not have a controlling financial interest, or (ii) the equity investment at risk is insufficient to finance that entity’s activities without additional subordinated financial support. The Company consolidates investments in VIEs when the Company is the primary beneficiary of the VIE at either the creation of the variable interest entity or upon the occurrence of a qualifying reconsideration event. Qualifying reconsideration events include the modification of contractual arrangements and the disposal of all or a portion of an interest held by the primary beneficiary.

 

At September 30, 2008, the Company had 81 properties with a carrying value of $1.5 billion leased to a total of nine tenants that have been identified as VIEs (“VIE tenants”) and a loan with a carrying value of $78 million to a borrower that has been identified as a VIE. The Company acquired these leases and loan on October 5, 2006 in its merger with CNL Retirement Properties, Inc. (“CRP”). CRP determined it was not the primary beneficiary of these VIEs, and the Company is required to carry forward CRP’s accounting conclusions after the acquisition relative to their primary beneficiary assessments, provided the Company does not believe CRP’s accounting to be in error. The Company believes that its accounting for the VIEs is the appropriate accounting in accordance with GAAP. On December 21, 2007, the Company made an investment of approximately $900 million in mezzanine loans where each mezzanine borrower has been identified as a VIE. The Company has also determined that it is not the primary beneficiary of these VIEs.

 

7



Table of Contents

 

The Company applies Emerging Issues Task Force (“EITF”) Issue 04-5, Investor’s Accounting for an Investment in a Limited Partnership When the Investor is the Sole General Partner and the Limited Partners Have Certain Rights (“EITF 04-5”), to investments in joint ventures. EITF 04-5 provides guidance on the type of rights held by the limited partner(s) that preclude consolidation in circumstances in which the sole general partner would otherwise consolidate the limited partnership in accordance with GAAP. The assessment of limited partners’ rights and their impact on the presumption of control of the limited partnership by the sole general partner should be made when an investor becomes the sole general partner and should be reassessed if (i) there is a change to the terms or in the exercisability of the rights of the limited partners, (ii) the sole general partner increases or decreases its ownership of limited partnership interests, or (iii) there is an increase or decrease in the number of outstanding limited partnership interests. EITF 04-5 also applies to managing member interests in limited liability companies.

 

Investments in Unconsolidated Joint Ventures

 

Investments in entities which the Company does not consolidate but for which the Company has the ability to exercise significant influence over operating and financial policies are reported under the equity method. Under the equity method of accounting, the Company’s share of the investee’s earnings or losses are included in the Company’s operating results.

 

The initial carrying value of investments in unconsolidated joint ventures is based on the amount paid to purchase the joint venture interest or the carrying value of the assets prior to the sale of interests in the joint venture. To the extent that the Company’s cost basis is different from the basis reflected at the joint venture level, the basis difference is generally amortized over the life of the related assets and liabilities and included in the Company’s share of equity in earnings of the joint venture. The Company evaluates its equity method investments for impairment based upon a comparison of the fair value of the equity method investment to its carrying value. When the Company determines a decline in the fair value of the equity method investment below its carrying value is other-than-temporary, an impairment is recorded. The Company recognizes gains on the sale of interests in joint ventures to the extent the economic substance of the transaction is a sale in accordance with the American Institute of Certified Public Accountants Statement of Position 78-9, Accounting for Investments in Real Estate Ventures, and Statement of Financial Accounting Standards (“SFAS”) No. 66, Accounting for Sales of Real Estate (“SFAS No. 66”).

 

Revenue Recognition

 

Rental income from tenants is recognized in accordance with GAAP, including SEC Staff Accounting Bulletin No. 104, Revenue Recognition (“SAB 104”). The Company begins recognizing rental revenue when collectability is reasonably assured and the tenant has taken possession or controls the physical use of the leased asset. For assets acquired subject to leases the Company recognizes revenue upon acquisition of the asset provided the tenant has taken possession or controls the physical use of the leased asset. If the lease provides for tenant improvements, the Company determines whether the tenant improvements, for accounting purposes, are owned by the tenant or the Company. When the Company is the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance funded is treated as a lease incentive and amortized as a reduction of revenue over the lease term. Tenant improvement ownership is determined based on various factors including, but not limited to:

 

·      whether the lease stipulates how and on what a tenant improvement allowance may be spent;

 

·      whether the tenant or landlord retains legal title to the improvements at the end of the lease term;

 

·      whether the tenant improvements are unique to the tenant or general purpose in nature; and

 

·      whether the tenant improvements are expected to have any residual value at the end of the lease.

 

For leases with minimum scheduled rent increases, the Company recognizes income on a straight-line basis over the lease term when collectability is reasonably assured. Recognizing rental income on a straight-line basis for leases results in recognized revenue exceeding amounts contractually due from tenants. Such cumulative excess amounts are included in other assets and were $101 million and $76 million, net of allowances, at September 30, 2008 and December 31, 2007, respectively. If the Company determines that collectability of straight-line rents is not reasonably assured, the Company limits future recognition to amounts contractually owed, and, where appropriate, the Company establishes an allowance for estimated losses.

 

8



Table of Contents

 

The results for the three and nine months ended September 30, 2008, include lease termination fees of $18 million from a tenant in connection with the early termination of three leases on July 30, 2008 in its life science segment. The results for the three and nine months ended September 30, 2007, include income of $9 million and $15 million, respectively, resulting from the Company’s change in estimate relating to the collectability of straight-line rents due from Summerville Senior Living, Inc. (“Summerville”) and Emeritus Corporation (“Emeritus”), of which $6 million is included in discontinued operations for the three and nine months ended September 30, 2007. On September 4, 2007, Emeritus acquired Summerville and provided the Company with additional security under its leases with Summerville.

 

The Company maintains an allowance for doubtful accounts, including an allowance for straight-line rent receivables, for estimated losses resulting from tenant defaults or the inability of tenants to make contractual rent and tenant recovery payments. The Company monitors the liquidity and creditworthiness of its tenants and operators on an ongoing basis. This evaluation considers industry and economic conditions, property performance, credit enhancements and other factors. For straight-line rent amounts, the Company’s assessment is based on amounts recoverable over the term of the lease. At September 30, 2008 and December 31, 2007, the Company had an allowance of $43 million and $36 million, respectively, included in other assets, as a result of the Company’s determination that collectability is not reasonably assured for certain straight-line rent amounts.

 

Certain leases provide for additional rents contingent upon a percentage of the facility’s revenue in excess of specified base amounts or other thresholds. Such revenue is recognized when actual results reported by the tenant, or estimates of tenant results, exceed the base amount or other thresholds. Such revenue is recognized in accordance with SAB 104, which requires that income is recognized only after the contingency has been removed (when the related thresholds are achieved), which may result in the recognition of rental revenue in periods subsequent to when such payments are received.

 

Tenant recoveries related to reimbursement of real estate taxes, insurance, repairs and maintenance, and other operating expenses are recognized as revenue in the period the applicable expenses are incurred. The reimbursements are recognized and presented in accordance with EITF Issue 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent (“EITF 99-19”). EITF 99-19 requires that these reimbursements be recorded gross, as the Company is generally the primary obligor with respect to purchasing goods and services from third-party suppliers, has discretion in selecting the supplier and bears the credit risk.

 

The Company uses the direct finance method of accounting to record income from direct financing leases (“DFLs”). For leases accounted for as DFLs, future minimum lease payments are recorded as a receivable. The difference between the future minimum lease payments and the estimated residual values less the cost of the properties is recorded as unearned income. Unearned income is deferred and amortized to income over the lease terms to provide a constant yield. Investments in DFLs are presented net of unamortized unearned income.

 

The Company receives management fees from its investments in certain joint venture entities for various services provided as the managing member of the entities. Management fees are recorded as revenue when management services have been performed.

 

The Company recognizes gains on sales of properties in accordance with SFAS No. 66 upon the closing of the transaction with the purchaser. Gains on properties sold are recognized using the full accrual method when the collectability of the sales price is reasonably assured, the Company is not obligated to perform significant activities after the sale, the initial investment from the buyer is sufficient and other profit recognition criteria have been satisfied. Gains on sales of properties may be deferred in whole or in part until the requirements for gain recognition under SFAS No. 66 have been met.

 

Real Estate

 

Real estate, consisting of land, buildings and improvements, is recorded at cost. The Company allocates the cost of the acquisition, including the assumption of liabilities, to the acquired tangible assets and identifiable intangibles based on their estimated fair values in accordance with SFAS No. 141, Business Combinations.

 

The Company assesses fair value based on estimated cash flow projections that utilize appropriate discount and/or capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including historical operating results, known and anticipated trends, and market and economic conditions. The fair value of tangible assets of an acquired property considers the value of the property as if it was vacant.

 

9



Table of Contents

 

The Company records acquired “above and below” market leases at fair value using discount rates which reflect the risks associated with the leases acquired. The amount recorded is based on the present value of the difference between (i) the contractual amounts to be paid pursuant to each in-place lease, and (ii) management’s estimate of fair market lease rates for each in-place lease, measured over a period equal to the remaining term of the lease for above market leases and the initial term plus the extended term for any leases with bargain renewal options. Other intangible assets acquired include amounts for in-place lease values that are based on the Company’s evaluation of the specific characteristics of each tenant’s lease. Factors considered include estimates of carrying costs during hypothetical expected lease-up periods, market conditions and costs to execute similar leases. In estimating carrying costs, the Company includes estimates of lost rentals at market rates during the hypothetical expected lease-up periods, depending on local market conditions. In estimating costs to execute similar leases, the Company considers leasing commissions, legal and other related costs.

 

The Company capitalizes direct construction and development costs, including predevelopment costs, interest, property taxes, insurance and other costs directly related and essential to the acquisition, development or construction of a real estate project. In accordance with SFAS No. 34, Capitalization of Interest Cost, and SFAS No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects, construction and development costs are capitalized while substantive activities are ongoing to prepare an asset for its intended use. The Company considers a construction project as substantially complete and held available for occupancy upon the completion of tenant improvements, but no later than one year from cessation of major construction activity. Costs incurred after a project is substantially complete and ready for its intended use, or after development activities have stopped, are expensed as incurred. Costs previously capitalized related to abandoned acquisitions or developments are charged to earnings. Expenditures for repairs and maintenance are expensed as incurred.

 

The Company computes depreciation on properties using the straight-line method over the assets’ estimated useful lives. Depreciation is discontinued when a property is identified as held for sale. Building and improvements are depreciated over useful lives ranging up to 45 years. Above and below market lease intangibles are amortized primarily to revenue over the remaining noncancellable lease terms and bargain renewal periods, if any. Other in-place lease intangibles are amortized to expense over the remaining noncancellable lease term and bargain renewal periods, if any.

 

Loans Receivable and Allowance for Loan Losses

 

Loans receivable are classified as held-for-investment based on management’s intent and ability to hold the loans for the foreseeable future or to maturity. Loans held-for-investment are carried at amortized cost, reduced by a valuation allowance for estimated credit losses. The Company recognizes interest income on loans, including the amortization of discounts and premiums, using the effective interest method applied on a loan-by-loan basis. Premiums and discounts are recognized as yield adjustments over the life of the related loans. Loans are transferred from held-for-investment to held-for-sale when management’s intent is to no longer hold the loans for the foreseeable future. Loans held-for-sale are recorded at the lower of cost or fair value.

 

Allowances are established for loans based upon an estimate of probable losses for the individual loans deemed to be impaired. Impairment is indicated when it is deemed probable that the Company will be unable to collect all amounts due on a timely basis in accordance with the contractual terms of the loan. The allowance is based upon the Company’s assessment and belief of the borrower’s overall financial condition, resources and payment record; the prospects for support from any financially responsible guarantors; and, if appropriate, the realizable value of any collateral. These estimates consider all available evidence including, as appropriate, the present value of the expected future cash flows discounted at the loan’s contractual effective rate, the fair value of collateral, general economic conditions and trends, historical and industry loss experience, and other relevant factors.

 

Impairment of Long-Lived Assets and Goodwill

 

The Company assesses the carrying value of its long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived Assets (“SFAS No. 144”). If the sum of the expected future net undiscounted cash flows is less than the carrying amount of the long-lived asset, an impairment loss will be recognized by adjusting the asset’s carrying amount to its estimated fair value.

 

Goodwill is tested at least annually applying the following two-step approach in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. The first step of the test is a comparison of the fair value of the reporting unit containing goodwill to its carrying amount including goodwill. If the fair value is less than the carrying value, then the second step of the test is needed to measure the amount of potential goodwill impairment. The second step requires the fair value of the reporting unit to be allocated to all the assets and liabilities of the reporting unit as if the reporting unit had been acquired in a business combination at the date of the impairment test. The excess of the fair value of the reporting unit over the fair value of assets and liabilities is the implied value of goodwill and is used to determine the amount of impairment.

 

10



Table of Contents

 

Assets Held for Sale and Discontinued Operations

 

Certain long-lived assets are classified as held-for-sale in accordance with SFAS No. 144. Long-lived assets to be disposed of are reported at the lower of their carrying amount or their fair value less cost to sell and are no longer depreciated. Discontinued operations is defined in SFAS No. 144 as a component of an entity that has either been disposed of or is deemed to be held for sale if, (i) the operations and cash flows of the component have been or will be eliminated from ongoing operations as a result of the disposal transaction, and (ii) the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction.

 

Share-Based Compensation

 

Share-based compensation expense is recognized in accordance with SFAS No. 123R, Share-Based Payments, as revised (“SFAS No. 123R”). On January 1, 2006, the Company adopted SFAS No. 123R using the modified prospective application transition method which provides for only current and future period stock-based awards to be measured and recognized at fair value.

 

SFAS No. 123R requires all share-based awards granted on or after January 1, 2006 to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Compensation expense for awards with graded vesting is generally recognized ratably over the period from the date of grant to the date when the award is no longer contingent on the employee providing additional services. Prior to the adoption of SFAS No. 123R, the Company applied SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, for stock-based awards granted prior to January 1, 2006.

 

Cash and Cash Equivalents

 

Cash and cash equivalents includes short-term investments with original maturities of three months or less when purchased.

 

Restricted Cash

 

Restricted cash primarily consists of amounts held by mortgage lenders to provide for (i) future real estate tax expenditures, tenant improvements and capital improvements, and (ii) security deposits and net proceeds from property sales that were executed as tax-deferred dispositions.

 

Derivatives

 

During its normal course of business, the Company uses certain types of derivative instruments for the purpose of managing interest rate risk. To qualify for hedge accounting, derivative instruments used for risk management purposes must effectively reduce the risk exposure that they are designed to hedge. In addition, at inception of a qualifying hedging relationship, the underlying transaction or transactions, must be, and are expected to remain, probable of occurring in accordance with the Company’s related assertions.

 

The Company applies SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS No. 133”). SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. It requires the recognition of all derivative instruments, including embedded derivatives required to be bifurcated, as assets or liabilities in the Company’s consolidated balance sheet at fair value. Changes in the fair value of derivative instruments that are not designated as hedges or that do not meet the criteria for hedge accounting under SFAS No. 133 are recognized in earnings. For derivatives designated as hedging instruments in qualifying hedging relationships, the change in fair value of the effective portion of the derivatives is recognized in accumulated other comprehensive income (loss) whereas the change in fair value of the ineffective portion is recognized in earnings.

 

The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objectives and strategy for undertaking various hedge transactions. This process includes designating all derivatives that are part of a hedging relationship to specific forecasted transactions or recognized obligations in the balance sheet. The Company also assesses and documents, both at the hedging instrument’s inception and on a quarterly basis

 

11



Table of Contents

 

thereafter, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows associated with the respective hedged items. When it is determined that a derivative ceases to be highly effective as a hedge, or that it is probable the underlying forecasted transaction will not occur, the Company discontinues hedge accounting prospectively and reclassifies amounts recorded to accumulated other comprehensive income (loss) to earnings.

 

Income Taxes

 

In 1985, HCP, Inc. elected REIT status and believes it has always operated so as to continue to qualify as a REIT under Sections 856 to 860 of the Internal Revenue code of 1986, as amended (the “Code”). Accordingly, HCP, Inc. will not be subject to U.S. federal income tax, provided that it continues to qualify as a REIT and distributions to stockholders equal or exceed its taxable income. On July 27, 2007, the Company formed HCP Life Science REIT, a consolidated subsidiary, which elected REIT status for the year ended December 31, 2007. HCP, Inc., along with its consolidated REIT subsidiary, are each subject to the REIT qualification requirements under Sections 856 to 860 of the Code. If either REIT fails to qualify as a REIT in any taxable year, it will be subject to federal income taxes at regular corporate rates and may be ineligible to qualify as a REIT for four subsequent tax years.

 

HCP, Inc. and HCP Life Science REIT are subject to state and local income taxes in some jurisdictions, and in certain circumstances each REIT may also be subject to federal excise taxes on undistributed income. In addition, certain activities the Company undertakes must be conducted by entities which elect to be treated as taxable REIT subsidiaries (“TRSs”). TRSs are subject to both federal and state income taxes.

 

Marketable Securities

 

The Company classifies its marketable equity and debt securities as available-for-sale in accordance with the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. These securities are carried at fair value with unrealized gains and losses recognized in stockholders’ equity as a component of accumulated other comprehensive income (loss). Gains or losses on securities sold are determined based on the specific identification method. When the Company determines declines in fair value of marketable securities are other-than-temporary, a realized loss is recognized in earnings.

 

Capital Raising Issuance Costs

 

Costs incurred in connection with the issuance of both common and preferred shares are recorded as a reduction in additional paid-in capital. Debt issuance costs are deferred and included in other assets and amortized to interest expense based on the effective interest method over the remaining term of the related debt.

 

Segment Reporting

 

The Company reports its consolidated financial statements in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS No. 131”). The Company’s segments are based on the Company’s method of internal reporting which classifies its operations by healthcare sector. The Company’s business includes five segments: (i) senior housing, (ii) life science, (iii) medical office, (iv) hospital and (v) skilled nursing.

 

Prior to the Slough Estates USA Inc. (“SEUSA”) acquisition on August 1, 2007, the Company operated through two reportable segments—triple-net leased and medical office buildings. As a result of the Company’s acquisition of SEUSA, the Company added a significant portfolio of real estate assets under different leasing and property management structures and made corresponding organizational changes. The Company believes the change to its reportable segments is appropriate and consistent with how its chief operating decision maker reviews the Company’s operating results. In addition, in accordance with SFAS No. 131, all prior period segment information has been reclassified to conform to the current presentation.

 

Minority Interests and Mandatorily Redeemable Financial Instruments

 

As of September 30, 2008, there were 5.6 million non-managing member units outstanding in six limited liability companies of which the Company is the managing member: (i) HCPI/Tennessee, LLC; (ii) HCPI/Utah, LLC; (iii) HCPI/Utah II, LLC; (iv) HCP DR California, LLC; (v) HCP DR Alabama, LLC; and (vi) HCP DR MCD, LLC. The Company consolidates these entities since it exercises control and carries the minority interests at cost. The non-managing member LLC Units (“DownREIT units”) are exchangeable for an amount of cash approximating the then-current market value of shares of the Company’s common stock or, at the Company’s option, shares of the Company’s common stock (subject to certain adjustments, such as stock splits and reclassifications). Upon exchange of DownREIT units for the

 

12



Table of Contents

 

Company’s common stock, the carrying amount of the DownREIT units is reclassified to stockholders’ equity. In April 2008, as a result of the non-managing member converting its remaining HCPI/Indiana, LLC DownREIT units, HCPI/Indiana, LLC became a wholly-owned subsidiary. At September 30, 2008, the carrying and market values of the 5.6 million DownREIT units were $230.8 million and $323.0 million, respectively.

 

Life Care Bonds Payable

 

Two of the Company’s continuing care retirement communities (“CCRCs”) issue non-interest bearing life care bonds payable to certain residents of the CCRCs. Generally, the bonds are refundable to the resident or to the resident’s estate upon termination or cancellation of the CCRC agreement. An additional senior housing facility owned by the Company collects non-interest bearing occupancy fee deposits that are refundable to the resident or the resident’s estate upon the earlier of the re-letting of the unit or after two years of vacancy. Proceeds from the issuance of new bonds are used to retire existing bonds, and since the maturity of the obligations for the three facilities is not determinable, no interest is imputed. These amounts are included in other debt in the Company’s consolidated balance sheets.

 

Fair Value Measurement

 

Effective January 1, 2008, the Company implemented the requirements of SFAS No. 157, Fair Value Measurements (‘‘SFAS No. 157’’), for its financial assets and liabilities. SFAS No. 157 refines the definition of fair value, expands disclosure requirements about fair value measurements and establishes specific requirements as well as guidelines for a consistent framework to measure fair value. SFAS No. 157 defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants. Further, SFAS No. 157 requires the Company to maximize the use of observable market inputs, minimize the use of unobservable market inputs and disclose in the form of an outlined hierarchy the details of such fair value measurements.

 

SFAS No. 157 specifies a hierarchy of valuation techniques based on whether the inputs to a fair value measurement are considered to be observable or unobservable in a marketplace. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. This hierarchy requires the use of observable market data when available. These inputs have created the following fair value hierarchy:

 

·      Level 1 – quoted prices for identical instruments in active markets;

 

·      Level 2 – quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and

 

·      Level 3 – fair value measurements derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

 

The Company measures fair value using a set of standardized procedures that are outlined herein for all financial assets and liabilities which are required to be measured at fair value. When available, the Company utilizes quoted market prices from an independent third party source to determine fair value and classifies such items in Level 1. In some instances where a market price is available, but in an inactive or over-the-counter market where significant fluctuations in pricing can occur, the Company consistently applies the dealer (market maker) pricing estimate and classifies the financial asset or liability in Level 2.

 

If quoted market prices or inputs are not available, fair value measurements are based upon valuation models that utilize current market or independently sourced market inputs, such as interest rates, option volatilities, credit spreads, etc. Items valued using such internally-generated valuation techniques are classified according to the lowest level input that is significant to the fair value measurement. As a result, a financial asset or liability could be classified in either Level 2 or 3 even though there may be some significant inputs that are readily observable. Internal fair value models and techniques used by the Company include discounted cash flow and Black Scholes valuation models.

 

Based on the guidelines of SFAS No. 157, the Company has amended its techniques used in measuring the fair value of derivative and other financial asset and liability positions. These enhancements include the impact of the Company’s or counterparty’s credit risk on derivatives and other liabilities measured at fair value as well as the election of the mid-market pricing expedient outlined in the standard. The implementation of these enhancements and the adoption of SFAS No. 157 did not have a material impact on the Company’s consolidated financial position or results of operations.

 

13



Table of Contents

 

On February 12, 2008, the FASB postponed the implementation of SFAS No. 157 related to non-financial assets and liabilities until fiscal periods beginning after November 15, 2008. As a result, the Company has not applied the above fair value procedures to its goodwill and long-lived asset impairment analyses during the current period. The Company believes that the adoption of SFAS No. 157 for non-financial assets and liabilities will not have a material impact on its consolidated financial position or results of operations upon implementation for fiscal periods beginning after November 15, 2008.

 

Recent Accounting Pronouncements

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (‘‘SFAS No. 159’’). SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specified election dates. SFAS No. 159 was effective as of the beginning of an entity’s first fiscal year after November 15, 2007, and subsequent reporting periods thereafter. Currently the Company has not adopted the guidelines of SFAS No. 159 and continues to evaluate whether or not it will in future periods based on industry participant elections and financial reporting consistency with its peers.

 

In December 2007, the FASB issued SFAS No. 141R, Business Combinations, as revised (“SFAS No. 141R”). SFAS No. 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed (including intangibles), and any noncontrolling interest in the acquiree. SFAS No. 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141R is effective for fiscal years beginning after December 15, 2008. The adoption of SFAS No. 141R on January 1, 2009 will require the Company to prospectively expense all transaction costs for business combinations for which the acquisition date is on or subsequent to that date. Early adoption and retroactive application of SFAS No. 141R to fiscal years preceding the effective date is not permitted. The implementation of this standard on January 1, 2009 could materially impact the Company’s future financial results to the extent that it acquires significant amounts of real estate, as related acquisition costs will be expensed as incurred rather than the Company’s current practice of capitalizing such costs and amortizing them over the estimated useful life of the assets acquired.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB 51 (“SFAS No. 160”), which changes the accounting and reporting for minority interests. Minority interests will be recharacterized as noncontrolling interests and will be reported as a component of equity separate from the parent’s equity. Purchases or sales of equity interests that do not result in a change in control will be accounted for as equity transactions. In addition, net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement and, upon a gain or loss of control, the interest purchased or sold, as well as any interest retained, will be recorded at fair value with any gain or loss recognized in earnings. SFAS No. 160 is effective for the Company beginning January 1, 2009 and applies prospectively, except for the presentation and disclosure requirements, which apply retrospectively. To the extent that the Company purchases or disposes of interests in entities or real estate partnerships that cause a change in control in periods subsequent to adoption, the impact on its financial position or results of operations could be material, as these interests will be recognized at fair value with gains and losses recorded to earnings.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133 (“SFAS No. 161”). SFAS No. 161 establishes, among other things, the disclosure requirements for derivative instruments and hedging activities. SFAS No. 161 requires entities to provide enhanced disclosures about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008. The Company does not expect the adoption of SFAS No. 161 on January 1, 2009 to have a material impact on its consolidated financial position or results of operations.

 

In April 2008, the FASB issued FASB Staff Position (“FSP”) Financial Accounting Standard 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142. In developing assumptions about renewal or extension, FSP FAS 142-3 requires an entity to consider its own historical experience (or, if no experience, market participant assumptions) adjusted for relevant entity-specific factors in paragraph 11 of SFAS No. 142. FSP FAS 142-3 expands the disclosure requirements of SFAS No. 142 and is effective for the Company beginning January 1, 2009, with early adoption prohibited. The guidance for determining the useful life of a recognized intangible asset shall be applied prospectively to intangible assets acquired after the effective date. The disclosure requirements shall be applied prospectively to all intangible assets recognized as of, and subsequent to, the effective date. The Company does not expect the adoption of FSP FAS 142-3 on January 1, 2009 to have a material impact on its consolidated financial position or results of operations.

 

14



Table of Contents

 

In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF 03-6-1”). FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method as described in SFAS No. 128, Earnings per Share. Under the guidance in FSP EITF 03-6-1, unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSP EITF 03-6-1 is effective for the Company on January 1, 2009. All prior-period earnings per share data presented shall be adjusted retrospectively. Early application is not permitted. The Company does not expect the adoption of FSP EITF 03-6-1 on January 1, 2009 to have a material impact on its consolidated financial position or results of operations.

 

Reclassifications

 

Certain amounts in the Company’s condensed consolidated financial statements for prior periods have been reclassified to conform to the current period presentation. Assets sold or held for sale and associated liabilities have been reclassified on the balance sheets and operating results reclassified from continuing to discontinued operations in accordance with SFAS No. 144 (see Note 5). “Tenant recoveries” have been reclassified from “rental and related revenues.” “Income taxes” have been reclassified from “general and administrative” expenses. In addition, in accordance with SFAS No. 131, all prior period segment information has been reclassified to conform to the current presentation.

 

(3)   Mergers and Acquisitions

 

Slough Estates USA Inc.

 

On August 1, 2007, the Company closed its acquisition of SEUSA for aggregate cash consideration of approximately $3.0 billion. SEUSA’s life science portfolio is concentrated in the San Francisco Bay Area and San Diego County.

 

The calculation of total consideration follows (in thousands):

 

Payment of aggregate cash consideration

 

$

2,978,911

 

Estimated acquisition costs, net of cash acquired

 

3,800

 

Purchase price, net of assumed liabilities

 

2,982,711

 

Fair value of liabilities assumed, including debt

 

220,133

 

Purchase price

 

$

3,202,844

 

 

Under the purchase method of accounting, the assets and liabilities of SEUSA were recorded at their relative fair values as of the date of the acquisition. During the nine months ended September 30, 2008, the Company revised its initial purchase price allocation of its acquired interest in SEUSA, which resulted in the Company reallocating $51 million among buildings and improvements, development costs and construction in progress, land, intangible assets and investments in and advances to unconsolidated joint ventures from its preliminary allocation at December 31, 2007. The changes from the Company’s initial purchase price allocation did not have a significant impact on the Company’s results of operations for the three and nine months ended September 30, 2008.

 

15



Table of Contents

 

The following table summarizes the revised fair values of the SEUSA assets acquired and liabilities assumed as of the acquisition date of August 1, 2007 (in thousands):

 

Assets acquired

 

 

 

Buildings and improvements

 

$

1,664,156

 

Development costs and construction in progress

 

254,626

 

Land

 

827,041

 

Investments in and advances to unconsolidated joint ventures

 

68,300

 

Intangible assets

 

351,500

 

Other assets

 

37,221

 

Total assets acquired

 

$

3,202,844

 

Liabilities assumed

 

 

 

Mortgages payable and other debt

 

$

33,553

 

Intangible liabilities

 

147,700

 

Other liabilities

 

38,880

 

Total liabilities assumed

 

220,133

 

Net assets acquired

 

$

2,982,711

 

 

In connection with the Company’s acquisition of SEUSA, the Company obtained, from a syndicate of banks, a financing commitment for a $3.0 billion bridge loan under which $2.75 billion was borrowed at closing.

 

The assets, liabilities and results of operations of SEUSA are included in the consolidated financial statements from the date of acquisition.

 

Pro Forma Results of Operations

 

The following unaudited pro forma consolidated results of operations assume that the acquisition of SEUSA was completed on January 1 for the three and nine months ended September 30, 2007 (in thousands, except per share amounts):

 

 

 

Three Months Ended
September 30, 2007

 

Nine Months Ended
September 30, 2007

 

Revenues

 

$

265,215

 

$

771,590

 

Net income

 

307,361

 

449,945

 

Basic earnings per common share

 

1.47

 

2.11

 

Diluted earnings per common share

 

1.46

 

2.10

 

 

(4)   Acquisitions of Real Estate Properties

 

During the nine months ended September 30, 2008, the Company acquired a senior housing facility for $11 million, purchased a joint venture interest valued at $29 million and funded an aggregate of $126 million for construction, tenant and capital improvement projects primarily in the life science and medical office segments.

 

A summary of acquisitions during the year ended December 31, 2007, excluding SEUSA (Note 3), follows (in thousands):

 

 

 

Consideration

 

Assets Acquired

 

Acquisitions(1)

 

Cash Paid

 

Real Estate

 

Debt
Assumed

 

DownREIT
Units(2)

 

Real Estate

 

Net
Intangibles

 

Medical office

 

$

166,982

 

$

 

$

 

$

93,887

 

$

247,996

 

$

12,873

 

Hospital

 

120,562

 

35,205

 

 

84,719

 

235,084

 

5,402

 

Life science

 

35,777

 

 

12,215

 

2,092

 

48,237

 

1,847

 

Senior housing

 

15,956

 

340

 

5,148

 

 

20,772

 

672

 

 

 

$

339,277

 

$

35,545

 

$

17,363

 

$

180,698

 

$

552,089

 

$

20,794

 

 


(1)     Includes transaction costs, if any.

(2)     Non-managing member LLC units.

 

16



Table of Contents

 

(5)   Dispositions of Real Estate, Real Estate Interests and Discontinued Operations

 

Dispositions of Real Estate

 

During the three months ended September 30, 2008, the Company sold three hospitals for approximately $116 million and recognized a gain on sales of real estate of $27 million. The hospitals sold included the hospital located in Tarzana, California, which was sold for $89 million resulting in a gain on sales of real estate of $18 million. During the three months ended September 30, 2007, the Company sold 42 senior housing facilities for approximately $504 million and recognized a gain on sales of real estate of $286 million.

 

During the nine months ended September 30, 2008, the Company sold 47 properties for approximately $629 million and recognized a gain on sales of real estate of $228 million. The Company’s sales of properties were made from the following segments: (i) 68% hospital, (ii) 15% skilled nursing, (iii) 14% medical office and (iv) 3% senior housing.

 

During the nine months ended September 30, 2007, the Company sold 89 properties for approximately $896 million and recognized a gain on sales of real estate of $392 million. The Company’s sales of properties were made from the following segments: (i) 70% skilled nursing, (ii) 26% senior housing and (iii) 4% medical office.

 

Dispositions of Real Estate Interests

 

On January 5, 2007, the Company formed a senior housing joint venture (“HCP Ventures II”), which included 25 properties valued at $1.1 billion, which were encumbered by a $686 million secured debt facility. The Company received approximately $280 million in proceeds, including a one-time acquisition fee of $5.4 million, which is included in investment management fee income for the nine months ended September 30, 2007. No gain or loss was recognized for the sale of a 65% interest in this joint venture.

 

On April 30, 2007, the Company formed a medical office joint venture, HCP Ventures IV, LLC (“HCP Ventures IV”), which included 55 properties valued at approximately $585 million. Upon the disposition of an 80% interest in this venture, the Company received $196 million and recognized a gain of $10.1 million. These proceeds included a one-time acquisition fee of $3 million, which was recognized in investment management fee income for the nine months ended September 30, 2007.

 

Properties Held for Sale

 

At September 30, 2008 and December 31, 2007, the Company held for sale seven and 54 properties with carrying amounts of $5 million and $408 million, respectively.

 

Results from Discontinued Operations

 

The following table summarizes income from discontinued operations and gain on sales of real estate included in discontinued operations (dollars in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Rental and related revenues

 

$

3,826

 

$

23,185

 

$

28,011

 

$

86,049

 

Other revenues

 

 

19

 

18

 

3,066

 

 

 

3,826

 

23,204

 

28,029

 

89,115

 

Depreciation and amortization expenses

 

47

 

3,886

 

5,832

 

17,748

 

Operating expenses

 

197

 

2,862

 

3,294

 

6,800

 

Other costs and expenses

 

384

 

582

 

878

 

7,729

 

Income before gain on sales of real estate, net of income taxes

 

$

3,198

 

$

15,874

 

$

18,025

 

$

56,838

 

 

 

 

 

 

 

 

 

 

 

Gain on sales of real estate

 

$

27,416

 

$

286,153

 

$

227,810

 

$

392,269

 

 

 

 

 

 

 

 

 

 

 

Number of properties held for sale

 

7

 

62

 

7

 

62

 

Number of properties sold

 

3

 

42

 

47

 

89

 

Number of properties included in discontinued operations

 

10

 

104

 

54

 

151

 

 

17



Table of Contents

 

(6)   Net Investment in Direct Financing Leases

 

The components of net investment in DFLs consist of the following (dollars in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Minimum lease payments receivable

 

$

1,384,798

 

$

1,414,116

 

Estimated residual values

 

468,769

 

468,769

 

Less unearned income

 

(1,206,138

)

(1,242,833

)

Net investment in direct financing leases

 

$

647,429

 

$

640,052

 

Properties subject to direct financing leases

 

30

 

30

 

 

The DFLs were acquired in the Company’s merger with CRP. CRP determined that these leases were DFLs, and the Company is required to carry forward CRP’s accounting conclusions after the acquisition date relative to their assessment of these leases, provided that the Company does not believe CRP’s accounting to be in error. The Company believes that its accounting for the leases is the appropriate accounting in accordance with GAAP. Certain leases contain provisions that allow the tenants to elect to purchase the properties during or at the end of the lease terms for the aggregate initial investment amount plus adjustments, if any, as defined in the lease agreements. Certain leases also permit the Company to require the tenants to purchase the properties at the end of the lease terms. Lease payments due to the Company relating to three land-only DFLs, along with the land, with a carrying value of $59.5 million at September 30, 2008 are subordinate to and serve as collateral for first mortgage construction loans entered into by the tenants to fund development costs related to the properties.

 

(7)   Loans Receivable

 

The following table summarizes the Company’s loans receivable balance (in thousands):

 

 

 

September 30, 2008

 

December 31, 2007

 

 

 

Real Estate
Secured

 

Other

 

Total

 

Real Estate
Secured

 

Other

 

Total

 

HCR ManorCare mezzanine

 

$

 

$

1,000,000

 

$

1,000,000

 

$

 

$

1,000,000

 

$

1,000,000

 

Joint venture partners

 

 

7,053

 

7,053

 

 

7,055

 

7,055

 

Other

 

68,343

 

75,983

(1)

144,326

 

69,126

 

86,285

 

155,411

 

Unamortized discounts, fees and costs

 

 

(82,898

)(2)

(82,898

)

 

(96,740

)

(96,740

)

Loan loss allowance

 

 

(241

)

(241

)

 

(241

)

(241

)

 

 

$

68,343

 

$

999,897

 

$

1,068,240

 

$

69,126

 

$

996,359

 

$

1,065,485

 

 


(1)   Consists primarily of the Company’s loan to an affiliate of the Cirrus Group, LLC.

(2)   Consists primarily of discounts related to the Company’s HCR ManorCare mezzanine loans.

 

The Company provided an affiliate of the Cirrus Group, LLC with an interest only, senior secured term loan. The loan provides for a maturity date of December 31, 2008, with a one-year extension at the option of the borrower, under which amounts were borrowed to finance the acquisition, development, syndication and operation of new and existing surgical partnerships. This loan accrues interest at a rate of 14.0%, of which 9.5% is payable monthly and the balance of 4.5% is deferred until maturity. The loan is subject to equity contribution requirements and borrower financial covenants and is collateralized by assets of the borrower (comprised primarily of interests in partnerships operating surgical facilities in premises leased from a Cirrus affiliate, HCP Ventures IV or the Company) and is guaranteed up to $34.6 million through a combination of (i) a personal guarantee of up to $9.0 million by a principal of Cirrus, and (ii) a guarantee of the balance by other principals of Cirrus under arrangements for recourse limited only to their interests in certain entities owning real estate. During the nine months ended September 30, 2008, the borrower made principal payments aggregating $11.8 million reducing the carrying value of this loan to $78 million at September 30, 2008.

 

On December 21, 2007, the Company made an investment in mezzanine loans having an aggregate face value of $1.0 billion, for approximately $900 million, as part of the financing for The Carlyle Group’s $6.3 billion purchase of Manor Care, Inc. (“HCR ManorCare”). These loans bear interest on their face amounts at a floating rate of one-month LIBOR plus 4.0%, mature in January 2013 and are pre-payable at any time subject to a yield maintenance fee during the first twelve months. These loans are mandatorily pre-payable in January 2012 unless the borrower satisfies certain financial conditions. The loans are secured by an indirect pledge of the equity ownership in 339 HCR ManorCare facilities located in 30 states and are subordinate to other debt of approximately $3.6 billion at closing. At September 30, 2008, the carrying value of this loan was $914 million.

 

18



Table of Contents

 

(8)   Investments in and Advances to Unconsolidated Joint Ventures

 

The Company owns interests in the following entities which are accounted for under the equity method at September 30, 2008 (dollars in thousands):

 

Entity(1)

 

Properties

 

Investment(2)

 

Ownership%

HCP Ventures II

 

25 senior housing facilities

 

$

141,384

 

35

HCP Ventures III, LLC

 

13 medical office buildings

 

12,159

 

30

 

 

50 MOBs, 4 life science facilities

 

 

 

 

HCP Ventures IV, LLC

 

and 4 hospitals

 

46,417

 

20

HCP Life Science(3)

 

4 life science facilities

 

68,017

 

50 - 63

Suburban Properties, LLC

 

1 medical office building

 

4,402

 

67

Advances to unconsolidated joint ventures, net

 

 

 

3,214

 

 

 

 

 

 

$

275,593

 

 

 

 

 

 

 

 

 

Edgewood Assisted Living Center, LLC(4)(5)

 

1 senior housing facility

 

$

(480)

 

45

Seminole Shores Living Center, LLC(4)(5)

 

1 senior housing facility

 

(945)

 

50

 

 

 

 

$

(1,425)

 

 

 


(1)

 

These joint ventures are not consolidated because the Company does not control, through voting rights or other means, the entities. See Note 2 regarding the Company’s policy on consolidation.

(2)

 

Represents the carrying value of the Company’s investment in the unconsolidated joint venture. See Note 2 regarding the Company’s policy for accounting for joint venture interests.

(3)

 

Includes three unconsolidated joint ventures between the Company and an institutional capital partner for which the Company is the managing member. HCP Life Science includes the following partnerships: (i) Torrey Pines Science Center LP (50%); (ii) Britannia Biotech Gateway LP (55%); and (iii) LASDK LP (63%). The unconsolidated joint ventures were acquired as part of its purchase of Slough Estates USA Inc. on August 1, 2007.

(4)

 

As of September 30, 2008, the Company has guaranteed in the aggregate $4 million of a total of $8 million of notes payable for these two joint ventures. No liability has been recorded related to these guarantees as of September 30, 2008.

(5)

 

Negative investment amounts are included in accounts payable and accrued liabilities.

 

 

 

 

 

Summarized combined financial information for the Company’s unconsolidated joint ventures follows (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2008

 

2007(7)

 

Real estate, net

 

$

1,712,009

 

$

1,752,289

 

Other assets, net

 

199,860

 

195,816

 

Total assets

 

$

1,911,869

 

$

1,948,105

 

 

 

 

 

 

 

Notes payable

 

$

1,176,105

 

$

1,192,270

 

Accounts payable

 

49,108

 

45,427

 

Other partners’ capital

 

496,108

 

511,149

 

HCP’s capital(6)

 

190,548

 

199,259

 

Total liabilities and partners’ capital

 

$

1,911,869

 

$

1,948,105

 

 

 

 

Three Months Ended
September 30,(7)

 

Nine Months Ended
September 30,(7)

 

 

 

2008

 

2007(8)

 

2008

 

2007(8)

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

46,522

 

$

44,380

 

$

138,938

 

$

129,412

 

Net income

 

1,615

 

1,634

 

5,408

 

10,100

 

HCP’s equity income

 

1,227

 

1,242

 

3,736

 

3,758

 

Fees earned by HCP

 

1,523

 

1,602

 

4,448

 

12,062

 

Distributions received, net

 

4,208

 

2,388

 

12,463

 

480,140

 

 


(6)

 

Aggregate basis difference of the Company’s investments in these joint ventures of $80 million, as of September 30, 2008, is primarily attributable to real estate and lease related intangible assets.

(7)

 

Includes the financial information of Arborwood Living Center, LLC and Greenleaf Living Centers, LLC, which were sold on April 3, 2008 and June 12, 2008, respectively.

(8)

 

Includes the results of operations from HCP Ventures IV, LLC, whose subsidiaries were wholly-owned consolidated subsidiaries of the Company prior to April 30, 2007.

 

19



Table of Contents

 

(9)         Intangibles

 

At September 30, 2008 and December 31, 2007, intangible lease assets, comprised of lease-up intangibles, above market tenant lease intangibles, below market ground lease intangibles and intangible assets related to non-compete agreements, were $711 million and $725 million, respectively. At September 30, 2008 and December 31, 2007, the accumulated amortization of intangible assets was $158 million and $102 million, respectively.

 

At September 30, 2008 and December 31, 2007, below market lease intangibles and above market ground lease intangibles were $305 million and $311 million, respectively. At September 30, 2008 and December 31, 2007, the accumulated amortization of intangible liabilities was $55 million and $33 million, respectively.

 

(10) Other Assets

 

The Company’s other assets consisted of the following (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2008

 

2007

 

Marketable debt securities

 

$

274,550

 

$

289,163

 

Marketable equity securities

 

9,362

 

13,933

 

Goodwill

 

51,746

 

51,746

 

Straight-line rent assets, net

 

101,084

 

76,188

 

Deferred debt issuance costs, net

 

22,905

 

16,787

 

Other

 

73,124

 

68,316

 

Total other assets

 

$

532,771

 

$

516,133

 

 

The cost or amortized cost, estimated fair value and gross unrealized gains and losses on marketable securities follows (in thousands):

 

 

 

 

 

 

 

Gross Unrealized

 

 

 

Cost(1)

 

Fair Value

 

Gains

 

Losses

 

September 30, 2008:

 

 

 

 

 

 

 

 

 

Debt securities

 

$

291,101

 

$

274,550

 

$

 

$

(16,551

)

Equity securities

 

8,679

 

9,362

 

871

 

(188

)

Total investments

 

$

299,780

 

$

283,912

 

$

871

 

$

(16,739

)

 

 

 

 

 

 

 

 

 

 

December 31, 2007:

 

 

 

 

 

 

 

 

 

Debt securities

 

$

275,000

 

$

289,163

 

$

14,663

 

$

(500

)

Equity securities

 

13,874

 

13,933

 

300

 

(241

)

Total investments

 

$

288,874

 

$

303,096

 

$

14,963

 

$

(741

)

 


(1)   Represents the original cost basis of the marketable securities reduced by other-than-temporary impairments recorded through earnings, if any.

 

Marketable securities with unrealized losses at September 30, 2008 are not considered to be other-than-temporarily impaired as the Company has the intent and ability to hold these investments for a period of time sufficient to allow for an anticipated recovery in fair value. The Company’s marketable debt securities accrue interest ranging from 9.625% to 9.25%, and mature between November 2016 and May 2017.

 

During the three months ended September 30, 2008, the Company purchased $26 million of senior secured notes with an aggregate par value of $27 million that accrue interest at 9.625% and mature on November 15, 2016. During the nine months ended September 30, 2008 and 2007, the Company sold marketable debt securities with a cost basis of $10 million and $45 million, which resulted in gains of approximately $0.7 million and $3.9 million, respectively, and were recognized in interest and other income, net. During the nine months ended September 30, 2008 and 2007, the Company realized gains from the sale of various marketable equity securities totaling $0.2 million and $1.0 million, respectively, which were included in interest and other income, net. The Company recognized an other-than-temporary impairment of $3.5 million during the nine months ended September 30, 2008 on marketable equity securities with a carrying value of $8.1 million at September 30, 2008.

 

20



Table of Contents

 

(11) Debt

 

Bank Line of Credit, Bridge Loan and Term Loan

 

The Company’s revolving line of credit with a syndicate of banks provided for an aggregate $1.5 billion of borrowing capacity at September 30, 2008. This revolving line of credit facility accrues interest at a rate per annum equal to LIBOR plus a margin ranging from 0.325% to 1.00%, depending upon the Company’s debt ratings. The Company pays a facility fee on the entire revolving commitment ranging from 0.10% to 0.25%, depending upon its debt ratings. Based on the Company’s debt ratings on September 30, 2008, the margin on the revolving line of credit facility was 0.55% and the facility fee was 0.15%. The Company’s revolving line of credit facility matures on August 1, 2011.

 

At September 30, 2008, the outstanding balance of the Company’s bridge loan was $520 million. The bridge loan had an initial maturity date of July 31, 2008 that has been extended to January 31, 2009 through the exercise of an extension option. The Company has an additional 6-month extension option, subject to debt compliance and extension fees, which could be used to extend the maturity date to July 31, 2009 from January 31, 2009. This bridge loan accrues interest at a rate per annum equal to LIBOR plus a margin ranging from 0.425% to 1.25%, depending upon the Company’s debt ratings (weighted average effective interest rate of 3.38% at September 30, 2008). Based on the Company’s debt ratings on September 30, 2008, the margin on the bridge loan facility was 0.70%.

 

The Company’s revolving line of credit facility and bridge loan contain certain financial restrictions and other customary requirements, including cross-default provisions to other indebtedness. A portion of these financial covenants become more restrictive through the period ending March 31, 2009. Among other things, these covenants, using terms defined in the agreement (i) limit the ratio of Consolidated Total Indebtedness to Consolidated Total Asset Value to 60%, (ii) limit the ratio of Unsecured Debt to Consolidated Unencumbered Asset Value to 65%, (iii) require a Fixed Charge Coverage ratio of 1.75 times, and (iv) require a formula-determined Minimum Consolidated Tangible Net Worth of $4.2 billion at September 30, 2008. At September 30, 2008, the Company was in compliance with each of these restrictions and requirements of the credit revolving credit facility and bridge loan.

 

On October 24, 2008, the Company entered into a credit agreement with a syndicate of banks for a $200 million unsecured term loan, which matures on August 1, 2011. The term loan accrues interest at a rate per annum equal to LIBOR plus a margin ranging from 1.825% to 2.375% depending upon the Company’s debt ratings. Based on the Company’s debt ratings on October 24, 2008, the margin on the term loan is 2.00%. The Company received net proceeds of $197 million, which were used to repay a portion of its outstanding indebtedness under the bridge loan facility. The term loan contains certain financial restrictions and other customary requirements, similar to those included in the revolving line of credit and bridge loan.

 

Senior Unsecured Notes

 

At September 30, 2008, the Company had $3.5 billion in aggregate principal amount of senior unsecured notes outstanding. Interest rates on the notes ranged from 3.72% to 7.07% at September 30, 2008. The weighted average effective interest rate on the senior unsecured notes at September 30, 2008 and December 31, 2007, was 6.25% and 6.18%, respectively. Discounts and premiums are amortized to interest expense over the term of the related debt.

 

In September 2008, the Company repaid $300 million of maturing senior unsecured notes which accrued interest based on the three-month LIBOR plus 0.45%. The notes were repaid with funds available under the Company’s revolving line of credit facility.

 

The senior unsecured notes contain certain covenants including limitations on debt and other customary terms. At September 30, 2008, the Company was in compliance with these covenants.

 

Mortgage Debt

 

At September 30, 2008, the Company had $1.8 billion in mortgage debt secured by 227 healthcare facilities with a carrying amount of $3.6 billion. Interest rates on the mortgage notes ranged from 2.21% to 8.63% with a weighted average effective rate of 6.02% at September 30, 2008.

 

21



Table of Contents

 

In May 2008, the Company placed $259 million of seven-year mortgage financing on 21 of its senior housing assets. The assets are cross-collateralized and the debt has a fixed interest rate of 5.83%. The proceeds were used to repay outstanding indebtedness under the revolving line of credit facility and bridge loan.

 

In September 2008, the Company placed mortgage financing on our senior housing assets through Fannie Mae aggregating $319 million, which was comprised of $140 million of five-year mortgage financing on four assets and $179 million of eight-year financing on 12 assets. The assets are cross-collateralized and the debt has a weighted-average fixed interest rate of 6.39%. The Company received net proceeds aggregating $312 million, which were used to repay the outstanding indebtedness under its revolving line of credit facility.

 

Secured debt generally requires monthly principal and interest payments. Some of the loans are also cross-collateralized by multiple properties. The secured debt is collateralized by deeds of trust or mortgages on certain properties and is generally non-recourse. Mortgage debt encumbering properties typically restricts title transfer of the respective properties subject to the terms of the mortgage, prohibits additional liens, restricts prepayment, requires payment of real estate taxes, requires maintenance of the properties in good condition, requires maintenance of insurance on the properties and includes requirements to obtain lender consent to enter into and terminate material tenant leases.

 

Other Debt

 

At September 30, 2008, the Company had $102.6 million of non-interest bearing Life Care Bonds at two of its CCRCs and non-interest bearing occupancy fee deposits at another of its senior housing facilities, all of which were payable to certain residents of the facilities (collectively “Life Care Bonds”). At September 30, 2008, $41.0 million of the Life Care Bonds were refundable to the residents upon the resident moving out or to their estate upon death, and $61.6 million of the Life Care Bonds were refundable after the units are successfully remarketed to new residents.

 

Debt Maturities

 

 The following table summarizes our stated debt maturities and scheduled principal repayments, excluding debt premiums and discounts, at September 30, 2008 (in thousands):

 

Year

 

Bank
Line of
Credit

 

Bridge
Loan(1)

 

Senior
Notes

 

Mortgage
Debt

 

Other
Debt

 

Total

 

2008 (3 months)

 

$

 

$

 

$

 

$

43,073

 

$

102,602

 

$

145,675

 

2009

 

 

320,000

 

 

274,169

 

 

594,169

 

2010

 

 

 

206,421

 

298,453

 

 

504,874

 

2011

 

 

200,000

 

300,000

 

137,310

 

 

637,310

 

2012

 

 

 

250,000

 

108,625

 

 

358,625

 

Thereafter

 

 

 

2,787,000

 

937,904

 

 

3,724,904

 

 

 

$

 

$

520,000

 

$

3,543,421

 

$

1,799,534

 

$

102,602

 

$

5,965,557

 

 


(1)   On October 24, 2008, the Company entered into a credit agreement with a syndicate of banks for a $200 million term loan. The above table reflects the reclassification of the portion of the bridge loan that was repaid with proceeds from the term loan, which matures on August 1, 2011.

 

(12) Commitments and Contingencies

 

Legal Proceedings.  From time to time, the Company is a party to legal proceedings, lawsuits and other claims that arise in the ordinary course of the Company’s business. Regardless of their merits, these matters may force the Company to expend significant financial resources. Except as described in this Note 12, the Company is not aware of any other legal proceedings or claims that it believes may have, individually or taken together, a material adverse effect on the Company’s business, prospects, financial condition or results of operations. The Company’s policy is to accrue legal expenses as they are incurred.

 

On May 3, 2007, Ventas, Inc. filed a complaint against the Company in the United States District Court for the Western District of Kentucky, asserting claims of tortious interference with contract and tortious interference with prospective business advantage. The complaint alleges, among other things, that the Company interfered with Ventas’ purchase agreement with Sunrise Senior Living Real Estate Investment Trust (“Sunrise REIT”); that the Company interfered with Ventas’ prospective business advantage in connection with the Sunrise REIT transaction; and that the Company’s actions caused Ventas to suffer damages, including the payment of over $100 million in additional consideration to acquire the Sunrise REIT assets. Ventas is seeking monetary relief, including compensatory and punitive damages, against the Company.

 

22



Table of Contents

 

The Company believes that Ventas’ claims are without merit and intends to vigorously defend against Ventas’ lawsuit. On April 8, 2008, the Company filed a motion for leave to assert counterclaims against Ventas as part of the above litigation. The Company’s counterclaims allege, among other things, that Sunrise REIT fraudulently induced the Company to participate in a flawed and unfair auction process, and that absent such misconduct, the Company would have succeeded in acquiring Sunrise REIT. The Company seeks to recover compensatory and punitive damages. The proposed counterclaims further allege that Ventas, in acquiring Sunrise REIT, assumed the liability of Sunrise REIT. On July 25, 2008, the Court granted the Company’s motion over Ventas’ opposition, allowing HCP to file its counterclaims. The Court has set a trial date of August 18, 2009. The Company intends to pursue such claims vigorously; however, there can be no assurances that it will prevail on any of the claims or the amount of any recovery that may be awarded. The Company expects that defending its interests and pursuing its own claims in the foregoing matters will require it to expend significant funds. The Company is unable to estimate the ultimate aggregate amount of monetary gain, loss or financial impact with respect to these matters as of September 30, 2008.

 

In April 2007, the Company and Health Care Property Partners, a joint venture between the Company and an affiliate of Tenet Healthcare Corporation, served Tenet and certain Tenet subsidiaries with notices of default with respect to its hospital in Tarzana, California, and two other hospitals that are leased by such affiliates from the Company and Health Care Property Partners (“HCPP”). Subsequent to the delivery of such notices, the Company exercised its right to terminate the leases to Tenet of four other hospitals owned by the Company, invoking cross­default provisions under such leases. In May 2007 and September 2007, certain subsidiaries of Tenet filed complaints against the Company in the Superior Court of the State of California for the County of Los Angeles and initiated arbitration proceedings with respect to the seven hospitals owned by the Company and HCPP, in each case asserting various causes of action generally relating to the notices of default and the lease terminations. In October 2007, HCPP responded to the claims by Tenet’s subsidiaries in the arbitration proceedings, and the Company filed a counterclaim against Tenet and the plaintiffs in the California state court action. On June 30, 2008, the parties executed a definitive settlement agreement relating to the disputes that are the subject of the litigation and arbitration proceedings described above. On September 19, 2008, the parties closed the transactions contemplated by the settlement agreement, effecting, among other things: the sale of a hospital in Tarzana, California, by the Company to a Tenet affiliate; the extension of the terms of three other hospitals leased by the Company to affiliates of Tenet; and the acquisition by the Company of Tenet’s 23% interest in HCPP. All claims pending in the Superior Court of the State of California were formally dismissed on September 26, 2008, and the claims in the arbitration proceedings were formally dismissed on October 1, 2008.

 

The Company recognized $29 million of income from the settlement of the above disputes, which was included in interest and other income, net and a gain on sales of real estate for the sale of the hospital in Tarzana, California, of $18 million.

 

The fair value of consideration exchanged and related income recognized as a result of the Company’s settlement with Tenet follows (in thousands):

 

Consideration received

 

 

 

Cash proceeds for hospital in Tarzana, California and other settlement

 

$

105,760

 

Fair value of Tenet’s 23% interest in HCPP

 

29,137

 

Total consideration received

 

$

134,897

 

 

 

 

 

Consideration given

 

 

 

Fair value of hospital in Tarzana, California

 

$

88,900

 

Cash paid for Tenet’s interest in HCPP

 

17,379

 

Total consideration given

 

$

106,279

 

Settlement income

 

$

28,618

 

 

The gain on the sale of the Company’s hospital in Tarzana, California to Tenet consisted of the following (in thousands):

 

Fair value of hospital, net of costs

 

$

88,609

 

Carrying value of hospital sold

 

(70,590

)

Gain on sale of real estate

 

$

18,019

 

 

Development Commitments.  As of September 30, 2008, the Company was committed under the terms of contracts to complete the construction of properties undergoing development at a remaining aggregate cost of approximately $27 million.

 

23



Table of Contents

 

Concentration of Credit Risk.  Concentration of credit risk arises when a number of operators, tenants or obligors related to the Company’s investments are engaged in similar business activities, or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations, including those to the Company, to be similarly affected by changes in economic conditions.

 

On December 21, 2007, the Company made an investment in mezzanine loans to HCR ManorCare with an aggregate face value of $1.0 billion, for approximately $900 million. At September 30, 2008, these loans represented approximately 77% of our skilled nursing segment assets and 7% of our total segment assets.

 

At September 30, 2008, the Company had 81 of its senior housing facilities leased to nine tenants that have been identified as VIEs (“VIE Tenants”). These VIE Tenants are thinly capitalized entities that rely on the cash flow generated from the senior housing facilities to pay operating expenses, including rent obligations under their leases. The 81 senior housing facilities leased to the VIE Tenants are operated by Sunrise Senior Living Management, Inc., a wholly-owned subsidiary of Sunrise Senior Living, Inc. (“Sunrise”). Sunrise is publicly traded and is subject to the informational filing requirements of the Securities and Exchange Act of 1934, as amended, and is required to file periodic reports on Form 10-K and Form 10-Q with the SEC.

 

To mitigate credit risk of certain senior housing leases, leases are combined into portfolios that contain cross-default terms, so that if a tenant of any of the properties in a portfolio defaults on its obligations under its lease, the Company may pursue its remedies under the lease with respect to any of the properties in the portfolio. Certain portfolios also contain terms whereby the net operating profits of the properties are combined for the purpose of securing the funding of rental payments due under each lease.

 

DownREIT Partnerships.  In connection with the formation of certain DownREIT partnerships, partners generally contributed appreciated real estate to the DownREIT in exchange for DownREIT units. These contributions are generally tax-free, so that the pre-contribution gain related to the property is not taxed to the contributing partner. However, if the contributed property is later sold by the partnership, the pre-contribution gain that exists at the date of sale is specially allocated and taxed to the contributing partners. In many of the DownREITs, the Company has entered into indemnification agreements with those partners who contributed appreciated property into the partnership. Under these indemnification agreements, if any of the appreciated real estate contributed by the partners is sold by the partnership in a taxable transaction within a specified number of years after the property was contributed, HCP will reimburse the affected partners for the federal and state income taxes associated with the pre-contribution gain that is specially allocated to the affected partner under the Code (“make-whole payments”). These make-whole payments include a tax gross-up provision.

 

Credit Enhancement Guarantee.  Certain of the Company’s senior housing facilities serve as collateral for $137 million of debt (maturing May 1, 2025) that is owed by a previous owner of the facilities. The Company’s obligation under such indebtedness is guaranteed by the debtor who has an investment grade credit rating. These senior housing facilities are classified as DFLs and have a carrying value of $351 million at September 30, 2008.

 

Environmental Costs.  The Company monitors its properties for the presence of hazardous or toxic substances. The Company is not aware of any environmental liability with respect to the properties that would have a material adverse effect on the Company’s business, financial condition or results of operations. The Company carries environmental insurance and believes that the policy terms, conditions, limitations and deductibles are adequate and appropriate under the circumstances, given the relative risk of loss, the cost of such coverage and current industry practice.

 

General Uninsured Losses.  The Company obtains various types of insurance to mitigate the impact of property, business interruption, liability, flood, windstorm, earthquake, environmental and terrorism related losses. The Company attempts to obtain appropriate policy terms, conditions, limits and deductibles considering the relative risk of loss, the cost of such coverage and current industry practice. There are, however, certain types of extraordinary losses, such as those due to acts of war or other events that may be either uninsurable or not economically insurable. In addition, the Company has a large number of properties that are exposed to earthquake, flood and windstorm and the insurance for such losses carries high deductibles. Should an uninsured loss occur at a property, the Company’s assets may become impaired and the Company may not be able to operate its business at the property for an extended period of time.

 

24



Table of Contents

 

(13) Stockholders’ Equity

 

Preferred Stock

 

The following table lists the Series E cumulative redeemable preferred stock cash dividends made by the Company during the nine months ended September 30, 2008:

 

Declaration Date

 

Record Date

 

Amount
Per Share

 

Dividend
Payable Date

 

January 28

 

March 14

 

$

0.45313

 

March 31

 

April 24

 

June 16

 

$

0.45313

 

June 30

 

July 31

 

September 15

 

$

0.45313

 

September 30

 

 

The following table lists the Series F cumulative redeemable preferred stock cash dividends made by the Company during the nine months ended September 30, 2008:

 

Declaration Date

 

Record Date

 

Amount
Per Share

 

Dividend
Payable Date

 

January 28

 

March 14

 

$

0.44375

 

March 31

 

April 24

 

June 16

 

$

0.44375

 

June 30

 

July 31

 

September 15

 

$

0.44375

 

September 30

 

 

On October 30, 2008, the Company announced that its Board declared a quarterly cash dividend of $0.45313 per share on its Series E cumulative redeemable preferred stock and $0.44375 per share on its Series F cumulative redeemable preferred stock. These dividends will be paid on December 31, 2008 to stockholders of record as of the close of business on December 15, 2008.

 

Common Stock

 

During the nine months ended September 30, 2008 and 2007, the Company issued 397,000 and 1.1 million shares of common stock, respectively, under its Dividend Reinvestment and Stock Purchase Plan (“DRIP”). The Company also issued 623,000 and 328,000 shares upon exercise of stock options, and 2.0 million and 157,000 shares of common stock upon the conversion of DownREIT units during the nine months ended September 30, 2008 and 2007, respectively.

 

During the nine months ended September 30, 2008 and 2007, the Company issued 144,000 and 273,000 shares of restricted stock, respectively, under the Company’s 2006 Performance Incentive Plan. The Company also issued 131,000 and 110,000 shares upon the vesting of performance restricted stock units during the nine months ended September 30, 2008 and 2007, respectively.

 

In connection with HCP’s addition to the S&P 500 Index on March 28, 2008, the Company issued 12.5 million shares of its common stock on April 2, 2008. In a separate transaction, the Company issued 4.5 million shares to a REIT-dedicated institutional investor on April 2, 2008. The net proceeds received from these two offerings in the aggregate were approximately $560 million, which were used to repay a portion of the outstanding indebtedness under the Company’s revolving line of credit facility.

 

On August 11, 2008, the Company issued 14.95 million shares of its common and received net proceeds of approximately $481 million, which were used to repay a portion of the outstanding indebtedness under the Company’s bridge loan.

 

The following table lists the common stock cash dividends made by the Company during the nine months ended September 30, 2008:

 

Declaration Date

 

Record Date

 

Amount
Per Share

 

Dividend
Payable Date

 

January 28

 

February 7

 

$

0.455

 

February 21

 

April 24

 

May 5

 

$

0.455

 

May 19

 

July 31

 

August 11

 

$

0.455

 

August 21

 

 

25



Table of Contents

 

On October 30, 2008, the Company announced that its Board declared a quarterly cash dividend of $0.455 per share. The common stock cash dividend will be paid on November 21, 2008 to stockholders of record as of the close of business on November 10, 2008.

 

Accumulated Other Comprehensive Income (Loss) (“AOCI”)

 

 

 

September 30,

 

December 31,

 

 

 

2008

 

2007

 

 

 

(in thousands)

 

AOCI—unrealized gain (loss) on available-for-sale securities, net

 

$

(15,868

)

$

14,222

 

AOCI—unrealized loss on cash flow hedges, net

 

(11,342

)

(14,243

)

Supplemental Executive Retirement Plan minimum liability

 

(2,037

)

(2,113

)

Foreign currency translation adjustment

 

366

 

32

 

Total Accumulated Other Comprehensive Loss

 

$

(28,881

)

$

(2,102

)

 

Total Comprehensive Income (Loss)

 

The following table provides a reconciliation of comprehensive income (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Net income

 

$

125,417

 

$

322,148

 

$

408,124

 

$

538,720

 

Other comprehensive loss

 

(20,683

)

(6,600

)

(26,779

)

(10,007

)

Total comprehensive income

 

$

104,734

 

$

315,548

 

$

381,345

 

$

528,713

 

 

Substantially all of other comprehensive loss for the three and nine months ended September 30, 2008 related to the fair value of the Company’s marketable debt securities. See also discussions of marketable debt securities in Note 10.

 

(14) Segment Disclosures

 

The Company evaluates its business and makes resource allocations based on its five business segments: (i) senior housing, (ii) life science, (iii) medical office, (iv) hospital, and (v) skilled nursing. Under the senior housing, life science, hospital and skilled nursing segments, the Company invests primarily in single operator or tenant properties through acquisition and development of real estate, secured financing and marketable debt securities of operators in these sectors. Under the medical office segment, the Company invests through acquisition and secured financing in medical office buildings that are primarily leased under gross or modified gross leases, generally to multiple tenants, and which generally require a greater level of property management. The acquisition of SEUSA on August 1, 2007 resulted in a change to the Company’s reportable segments. Prior to the SEUSA acquisition, the Company operated through two reportable segments—triple-net leased and medical office buildings. The senior housing, life science, hospital and skilled nursing segments were previously aggregated under the Company’s triple-net leased segment. SEUSA’s results are included in the Company’s consolidated financial statements from the date of the Company’s acquisition on August 1, 2007. The accounting policies of the segments are the same as those described under Summary of Significant Accounting Policies (see Note 2). There were no intersegment sales or transfers during the nine months ended September 30, 2008 and 2007. The Company evaluates performance based upon property net operating income from continuing operations (“NOI”) of the combined properties in each segment.

 

Non-segment assets consist primarily of real estate held for sale and corporate assets including cash, restricted cash, accounts receivable, net and deferred financing costs. Interest expense, depreciation and amortization and non-property specific revenues and expenses are not allocated to individual segments in determining the Company’s performance measure. See Note 12 for other information regarding concentrations of credit risk.

 

26



Table of Contents

 

Summary information for the reportable segments follows (in thousands):

 

For the three months ended September 30, 2008:

 

Segments

 

Rental and
Related
Revenues

 

Tenant
Recoveries

 

Income
From
DFLs

 

Investment
Management
Fees

 

Total
Revenues

 

NOI(1)

 

Interest
and Other
Income, net

 

Senior housing

 

$

71,154

 

$

 

$

14,543

 

$

867

 

$

86,564

 

$

82,167

 

$

311

 

Life science

 

65,997

 

7,513

 

 

1

 

73,511

 

63,761

 

 

Medical office

 

65,713

 

12,315

 

 

655

 

78,683

 

42,301

 

 

Hospital

 

21,607

 

412

 

 

 

22,019

 

21,179

 

11,074

 

Skilled nursing

 

9,161

 

 

 

 

9,161

 

9,161

 

20,811

 

Total segments

 

233,632

 

20,240

 

14,453

 

1,523

 

269,938

 

218,569

 

32,196

 

Non-segment

 

 

 

 

 

 

 

30,116

 

Total

 

$

233,632

 

$

20,240

 

$

14,543

 

$

1,523

 

$

269,938

 

$

218,569

 

$

62,312

 

 

For the three months ended September 30, 2007:

 

Segments

 

Rental and
Related
Revenues

 

Tenant
Recoveries

 

Income
From
DFLs

 

Investment
Management
Fees

 

Total
Revenues

 

NOI(1)

 

Interest
and Other
Income, net

 

Senior housing

 

$

79,315

 

$

 

$

18,832

 

$

806

 

$

98,953

 

$

94,759

 

$

467

 

Life science

 

28,720

 

7,070

 

 

 

35,790

 

25,727

 

 

Medical office

 

67,173

 

10,490

 

 

796

 

78,459

 

42,042

 

 

Hospital

 

21,537

 

 

 

 

21,537

 

20,695

 

10,321

 

Skilled nursing

 

8,840

 

 

 

 

8,840

 

8,840

 

439

 

Total segments

 

205,585

 

17,560

 

18,832

 

1,602

 

243,579

 

192,063

 

11,227

 

Non-segment

 

 

 

 

 

 

 

10,311

 

Total

 

$

205,585

 

$

17,560

 

$

18,832

 

$

1,602

 

$

243,579

 

$

192,063

 

$

21,538

 

 

For the nine months ended September 30, 2008:

 

Segments

 

Rental and
Related
Revenues

 

Tenant
Recoveries

 

Income
From
DFLs

 

Investment
Management
Fees

 

Total
Revenues

 

NOI(1)

 

Interest
and Other
Income, net

 

Senior housing

 

$

212,451

 

$

 

$

43,646

 

$

2,457

 

$

258,554

 

$

245,754

 

$

914

 

Life science

 

155,527

 

25,180

 

 

3

 

180,710

 

149,293

 

 

Medical office

 

197,108

 

35,310

 

 

1,988

 

234,406

 

130,450

 

 

Hospital