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HR > SEC Filings for HR > Form 10-Q on 7-Nov-2012All Recent SEC Filings




Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Disclosure Regarding Forward-Looking Statements This report and other materials the Company has filed or may file with the Securities and Exchange Commission, as well as information included in oral statements or other written statements made, or to be made, by senior management of the Company, contain, or will contain, disclosures that are "forward-looking statements." Forward-looking statements include all statements that do not relate solely to historical or current facts and can be identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "target," "intend," "plan," "estimate," "project," "continue," "should," "could" and other comparable terms. These forward-looking statements are based on the current plans and expectations of management and are subject to a number of risks and uncertainties, including the risks, as described in the Company's Annual Report on Form 10-K for the year ended December 31, 2011 that could significantly affect the Company's current plans and expectations and future financial condition and results.

The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Stockholders and investors are cautioned not to unduly rely on such forward-looking statements when evaluating the information presented in the Company's filings and reports, including, without limitation, estimates and projections regarding the performance of development projects the Company is pursuing.

For a detailed discussion of the Company's risk factors, please refer to the Company's filings with the Securities and Exchange Commission, including its Annual Report on Form 10-K for the year ended December 31, 2011.

Business Overview
The Company's strategy is to own and operate medical office and other medical-related facilities that produce stable and growing rental income. Additionally, the Company provides a broad spectrum of services needed to own, develop, lease, finance and manage its portfolio of healthcare properties. The Company focuses its portfolio on outpatient-related facilities located on or near the campuses of large acute care hospitals and associated with leading health systems because management views these facilities as stable, lower-risk real estate investments. In addition to consistent growth in demand for outpatient services, management believes that the Company's diversity of tenants, which includes over 30 physician specialties, as well as surgery, imaging, and diagnostic centers, lowers the Company's overall financial and operational risk.

Substantially all of the Company's revenues are derived from operating leases on its real estate properties and interest earned on outstanding notes receivable. These sources of revenue represent the Company's primary source of liquidity to fund its dividends and its operating expenses, including interest incurred on debt, general and administrative costs such as compensation and office rent, as well as other expenses incurred in connection with managing its existing portfolio and acquiring additional properties. To the extent additional investments are not funded by these sources, the Company will fund its investment activity generally through equity or debt issuances either in the public or private markets, proceeds from asset dispositions or through proceeds from its unsecured credit facility due 2015 (the "Unsecured Credit Facility").

Executive Overview
The Company remains focused on leasing its development properties and expects leasing momentum on these properties to continue based on increased activity in recent periods. During the third quarter of 2012, the Company funded $7.0 million related to the leasing of its development portfolio, which included 12 properties in stabilization at September 30, 2012. The Company completed the construction of a medical office building in Texas during the third quarter of 2012, transferring the building into its stabilization portfolio.

During the third quarter of 2012, the Company funded $25.7 million in two construction mortgage loans related to two development projects totaling $202.6 million for Mercy Health. As of September 30, 2012, the Company has funded $94.4 million in construction mortgage loans for these projects, with $108.2 million remaining to be funded through completion in the third and fourth quarter of 2013. The Company will assume ownership of both properties upon substantial completion of construction in exchange for the repayment of the outstanding loan balances.

The acquisition environment for on-campus, multi-tenanted medical office buildings has improved since early 2012. The Company is under contract and in various stages of negotiations for assets meeting its investment criteria, and expects to fund up to $50 million during the fourth quarter of 2012 for the acquisition of healthcare facilities subject to customary due diligence, the

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execution of definitive purchase agreements and other customary conditions.

The Company also sold five real estate properties during the third quarter in which the Company had a $24.2 million net investment, generating cash proceeds of approximately $28.7 million.

On September 28, 2012, the Company sold 9,200,000 shares of common stock, par value $0.01 per share, at $22.85 per share in an underwritten public offering pursuant to the Company's existing effective registration statement. The net proceeds of the offering, after underwriting discounts and commissions and estimated offering expenses, were approximately $201.1 million. The proceeds from the offering are being used to fund the two build-to-suit healthcare facilities for Mercy Health described above, the acquisition of healthcare facilities, and other general corporate purposes, including the repayment of debt. In the interim, the Company has applied the proceeds from the offering to reduce the outstanding balance on its Unsecured Credit Facility.

At September 30, 2012, the Company's leverage ratio [debt divided by (debt plus stockholders' equity less intangible assets plus accumulated depreciation)] was reduced to approximately 41.7%, and its borrowings outstanding under the Unsecured Credit Facility totaled $34.0 million, with a capacity remaining under its financial covenants of approximately $666.0 million.

Trends and Matters Impacting Operating Results Management monitors factors and trends important to the Company and the REIT industry in order to gauge the potential impact on the operations of the Company. In addition to the matters discussed in the Company's Annual Report on Form 10-K for the year ended December 31, 2011, below are some of the factors and trends that management believes may impact future operations of the Company.

During the first nine months of 2012, the Company acquired approximately $33.1 million in real estate assets. These acquisitions were funded with borrowings on the Unsecured Credit Facility and proceeds from real estate dispositions. See Note 3 to the Condensed Consolidated Financial Statements for more information on these acquisitions.

Subsequent Acquisitions
In October 2012, the Company acquired two MOBs located in Tennessee and Washington for an aggregate purchase price of $20.4 million. The buildings aggregate approximately 86,570 square feet and are approximately 94% leased on average.

Development Activity
The Company had several development projects ongoing at September 30, 2012, including two construction mortgage notes and 12 properties in the process of stabilization subsequent to construction. See Note 6 to the Condensed Consolidated Financial Statements for more detail on these projects.

The Company's ability to complete and stabilize these facilities in a given period of time will impact the Company's results of operations and cash flows. More favorable completion dates, stabilization periods and rental rates will result in improved results of operations and cash flows, while lagging completion dates, stabilization dates, and rental rates will result in less favorable results of operations and cash flows.

Beyond the current commitments, the Company has no new developments planned. However, the Company is regularly in discussions with health systems, developers and others that could lead to attractive development opportunities. The Company will consider these projects in light of existing obligations, the acquisition environment, capital availability and cost, among other factors.

During the first nine months of 2012, the Company disposed of 16 medical office buildings for an aggregate sales price of $81.4 million. The Company's aggregate net investment in these properties was approximately $67.0 million. The Company recognized impairments of approximately $3.4 million and realized gains on sale of approximately $9.7 million. The average sales price per square foot was approximately $125. Also, during the first nine months of 2012, $21.7 million of mortgage notes receivable were repaid. Net cash proceeds from these dispositions and repayments were used to repay amounts due under the Unsecured

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Credit Facility, to fund additional real estate investments, and for general corporate purposes. See Note 3 to the Condensed Consolidated Financial Statements for more information on these dispositions.

Potential Disposition
On November 6, 2012, the Company entered into an agreement to sell a medical office building located in Brevard County, Florida for approximately $2.1 million. If this transaction proceeds to closing, an impairment charge of approximately $7.8 million would be recognized. This property was originally acquired in 1998 as part of the Company's acquisition of Capstone Capital Corporation and was occupied by a single tenant that vacated the premises in July 2010. The property operated at a loss for the nine months ended September 30, 2012. The Company expects the sale to occur during the fourth quarter of 2012.

Expiring Leases
Traditionally, approximately 15%-20% of the leases in the multi-tenanted portfolio expire each year. There were 369 leases scheduled to expire during 2012. Approximately 85% of the leases expiring in 2012 are located in buildings on hospital campuses, are distributed throughout the portfolio and are not concentrated with any one tenant, health system or location. Of the 298 leases that had expired during the first nine months of 2012, approximately 86% of the tenants had renewed, had expressed an intention to renew, or continued to occupy their leased space in a holdover lease arrangement.

Leases on three single tenant net lease properties were scheduled to expire during 2012. During the first quarter of 2012, a lease was signed on one of the properties, a 12,000 square foot property, extending the expiration of the lease for an additional eighteen months to August 2013 at the same lease rate. Leases on the other two properties expired in July 2012. A lease was signed on one of the properties, a 110,000 square foot building, which extended the maturity until July 2013 with an increase in the rental rate. The tenant vacated the other building, a 13,500 square foot property, in July 2012.

Leases on six single tenant net lease properties are scheduled to expire during 2013. Two of the properties are outpatient medical office buildings that the Company anticipates will be vacated by the existing tenants. One of the outpatient medical office buildings is located on a hospital campus and is 12,000 square feet, the other is located off campus and is 110,000 square feet. These properties generated approximately $0.4 million in net operating income during the quarter ended September 30, 2012. At the expiration of the current lease term the properties will be converted to the multi-tenant portfolio and the Company is currently working to lease the properties. The remaining four properties are inpatient rehabilitation hospitals and the Company expects the operator will continue to occupy the facilities.

Other Items Impacting Operations
Several other events that occurred in the third quarter of 2012 or are expected to occur in the fourth quarter of 2012 that may impact the Company's operations and financial results are as follows:

Upon completion of the construction of a building, the Company continues to capitalize interest for a twelve-month period on the unoccupied percentage of the building. The Company completed construction of two buildings during the fourth quarter of 2011 and will cease capitalizing interest on the buildings during the fourth quarter of 2012. As a result of not capitalizing interest on the two buildings and the increase in occupancy on buildings in which interest is still being capitalized, the Company expects an increase to interest expense in the fourth quarter of 2012 of approximately $1.1 million compared to the third quarter of 2012;

The Company completed an equity offering and issued 9,200,000 shares of common stock on September 28, 2012. As a result of having 9,200,000 additional shares of common stock, assuming the Company generated the same level of FFO in the fourth quarter of 2012, FFO per share for the fourth quarter would be a reduction of $0.02 to $0.03 per share; and

During the third quarter of 2012, the Company disposed of five properties in which the Company had a net aggregate investment of approximately $24.2 million. The sale of these properties will reduce rental income, net of expenses, by approximately $0.3 million in the fourth quarter of 2012.

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Non-GAAP Measures
Management believes that net income, as defined by GAAP, is the most appropriate earnings measurement. However, management considers certain non-GAAP financial measures to be useful supplemental measures of the Company's operating performance. A non-GAAP financial measure is generally defined as one that purports to measure historical or future financial performance, financial position or cash flows, but excludes or includes amounts that would not be so adjusted in the most comparable GAAP measure. Set forth below are descriptions of the non-GAAP financial measures management considers relevant to the Company's business and useful to investors, as well as reconciliations of these measures to the most directly comparable GAAP financial measures.
The non-GAAP financial measures presented herein are not necessarily identical to those presented by other real estate companies due to the fact that not all real estate companies use the same definitions. These measures should not be considered as alternatives to net income (determined in accordance with GAAP), as indicators of the Company's financial performance, or as alternatives to cash flow from operating activities (determined in accordance with GAAP) as measures of the Company's liquidity, nor are these measures necessarily indicative of sufficient cash flow to fund all of the Company's needs. Management believes that in order to facilitate a clear understanding of the Company's consolidated historical operating results, these measures should be examined in conjunction with net income as presented in the Condensed Consolidated Financial Statements and other financial data included elsewhere in this Quarterly Report on Form 10-Q.

Same Store Net Operating Income
Net operating income ("NOI") and same store NOI are non-GAAP financial measures of performance. Management considers same store NOI an important supplemental measure because it allows investors, analysts and Company management to measure unlevered property-level operating results and to compare those results to other real estate companies and between periods on a consistent basis. The Company defines NOI as operating revenues (property operating revenue, single-tenant net lease revenue, and rental lease guaranty income) less property operating expenses related specifically to the property portfolio. NOI excludes straight-line rent, general and administrative expenses, interest expense, depreciation and amortization, gains and losses from property sales, property management fees and other revenues and expenses not specifically related to the property portfolio. NOI may also be adjusted for certain expenses that are related to prior periods or are not considered to be part of the operations of the properties. Properties included in the same store analysis are stabilized properties that have been included in operations and were consistently reported as leased and stabilized properties for the duration of the year-over-year comparison period presented. Accordingly, properties that were recently acquired or disposed of, properties classified as held for sale, and properties in stabilization or conversion are excluded from the same store analysis.

The following table reflects the Company's same store NOI for the three months ended September 30, 2012 and 2011.

                                                                        Same Store NOI for the
                                                                   Three Months Ended September 30,
                                Number of        Investment at
(Dollars in thousands)        Properties (1)  September 30, 2012       2012 (2)          2011 (2)
Multi-tenant Properties                 121   $       1,463,149   $         27,883   $       26,550
Single-tenant Net Lease
Properties                               33             502,927             12,586           12,278
  Total                                 154   $       1,966,076   $         40,469   $       38,828


(1) Mortgage notes receivable, construction in progress, an investment in one unconsolidated joint venture, corporate property and assets classified as held for sale are excluded.
(2) Reconciliation of Same Store NOI:

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                                                Three Months Ended September 30,
(Dollars in thousands)                              2012                 2011
Rental income                                $        75,305       $        70,004
Rental lease guaranty income (a)                       1,286                 1,841
Property operating expense                           (30,115 )             (30,070 )
Exclude Straight-line rent revenue                    (1,461 )              (1,086 )
NOI                                                   45,015                40,689
NOI not included in same store                        (4,546 )              (1,861 )
  Same store NOI                             $        40,469       $        38,828

  (a) Other operating income reconciliation:
      Rental lease guaranty income           $         1,286       $         1,841
      Interest income                                     99                   133
      Management fee income                               40                    38
      Other                                               98                    49
                                             $         1,523       $         2,061

Funds from Operations
Funds from operations ("FFO") and FFO per share are operating performance measures adopted by the National Association of Real Estate Investment Trusts, Inc. ("NAREIT"). NAREIT defines FFO as the most commonly accepted and reported measure of a REIT's operating performance equal to "net income (computed in accordance with GAAP), excluding gains (or losses) from sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures." The SEC indicated in 2003 that impairment charges (losses) could not be added back to net income attributable to common stockholders in calculating FFO. However, in late October 2011, NAREIT issued an alert indicating that the SEC staff recently advised NAREIT that it currently takes no position on the matter of whether impairment charges should be added back to net income to compute FFO, and NAREIT affirmed its original definition of FFO. The Company follows the NAREIT definition to exclude impairment charges and all prior periods have been restated to agree with the current presentation.

Management believes FFO and FFO per share to be supplemental measures of a REIT's performance because they provide an understanding of the operating performance of the Company's properties without giving effect to certain significant non-cash items, primarily depreciation and amortization expense. Historical cost accounting for real estate assets in accordance with generally accepted accounting principles ("GAAP") assumes that the value of real estate assets diminishes predictably over time. However, real estate values instead have historically risen or fallen with market conditions. The Company believes that by excluding the effect of depreciation, amortization and gains or losses from sales of real estate, all of which are based on historical costs and which may be of limited relevance in evaluating current performance, FFO and FFO per share can facilitate comparisons of operating performance between periods. The Company reports FFO and FFO per share because these measures are observed by management to also be the predominant measures used by the REIT industry and by industry analysts to evaluate REITs and because FFO per share is consistently reported, discussed, and compared by research analysts in their notes and publications about REITs. For these reasons, management has deemed it appropriate to disclose and discuss FFO and FFO per share. However, FFO does not represent cash generated from operating activities determined in accordance with GAAP and is not necessarily indicative of cash available to fund cash needs. FFO should not be considered as an alternative to net income attributable to common stockholders as an indicator of the Company's operating performance or as an alternative to cash flow from operating activities as a measure of liquidity.

The comparability of FFO for the three and nine months ended September 30, 2012 compared to 2011 was primarily impacted by the various acquisitions and dispositions of the Company's real estate portfolio and the results of operations of the portfolio from period to period. Other items that impacted the comparability of FFO are discussed below:
interest expense increased for the three months ended September 30, 2012 compared to the same period in 2011 by approximately $1.0 million, or $0.01 per diluted common share, due mainly to mortgage notes assumed in acquisitions during 2012; while interest expense decreased for the nine months ended September 30, 2012 compared to the same period in 2011 by approximately $1.7 million, or $0.02 per diluted common share, due primarily to the redemption of the senior notes due 2011 (the "Senior Notes due 2011") in the first quarter of 2011. See Results of Operations for further details on items impacting interest expense;

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a loss on the extinguishment of debt of approximately $2.0 million, or $0.03 per diluted common share, was recognized during the first quarter of 2011, related to the redemption of the Senior Notes due 2011;

a lease termination fee was received in the first quarter of 2012 totaling $1.5 million, or $0.02 per diluted common share, in connection with a property disposition; and

general and administrative expenses decreased by approximately $0.8 million and $2.0 million, respectively, for the three and nine months ended September 30, 2012 compared to the same periods in 2011 mainly due to decreases in compensation and benefit costs and pursuit costs.

The table below reconciles FFO to net income (loss) attributable to common stockholders for the three and nine months ended September 30, 2012 and 2011:

                                            Three Months Ended                 Nine Months Ended
                                              September 30,                      September 30,
(Dollars in thousands, except per
share data)                               2012              2011             2012             2011
Net Income (Loss) Attributable to
Common Stockholders                  $       5,815     $        647     $     11,857     $     (3,131 )
Gain on sales of real estate
properties                                  (6,265 )         (1,357 )         (9,696 )         (1,393 )
Impairments                                  2,860            1,551            7,197            1,698
Real estate depreciation and
amortization                                23,336           21,709           70,231           62,173
Total adjustments                           19,931           21,903           67,732           62,478
Funds from Operations                $      25,746     $     22,550     $     79,589     $     59,347
Funds from Operations per Common
Share-Basic                          $        0.34     $       0.30     $       1.04     $       0.83
Funds from Operations per Common
Share-Diluted                        $        0.33     $       0.29     $       1.02     $       0.82
Weighted Average Common Shares
Outstanding-Basic                       76,712,594       76,139,055       76,534,508       71,478,463
Weighted Average Common Shares
Outstanding-Diluted                     78,020,971       77,177,114       77,799,291       72,570,555

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Results of Operations
Three Months Ended September 30, 2012 Compared to Three Months Ended
September 30, 2011
The Company's results of operations for the three months ended September 30,
2012 compared to the same period in 2011 were significantly impacted by
acquisitions, dispositions, gains on sale and impairments of properties.
                                                Three Months Ended
                                                  September 30,                  Change
(Dollars in thousands, except per share
data)                                           2012          2011           $            %
Rental income                               $   75,305     $  70,004     $  5,301         7.6  %
Mortgage interest                                2,244         1,776          468        26.4  %
Other operating                                  1,523         2,061         (538 )     (26.1 )%
                                                79,072        73,841        5,231         7.1  %
Property operating                              30,115        30,070           45         0.1  %
General and administrative                       4,732         5,530         (798 )     (14.4 )%
Depreciation                                    21,172        19,150        2,022        10.6  %
Amortization                                     2,554         2,222          332        14.9  %
Bad debt, net                                       40          (353 )        393      (111.3 )%
                                                58,613        56,619        1,994         3.5  %
Interest expense                               (18,905 )     (17,928 )       (977 )       5.4  %
Interest and other income, net                     204           199            5         2.5  %
                                               (18,701 )     (17,729 )       (972 )       5.5  %
. . .
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