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HCP > SEC Filings for HCP > Form 10-Q on 2-May-2013All Recent SEC Filings

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Form 10-Q for HCP, INC.


2-May-2013

Quarterly Report


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

Cautionary Language Regarding Forward-Looking Statements

Statements in this Quarterly Report on Form 10-Q that are not historical factual statements are "forward-looking statements." We intend to have our forward-looking statements covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with those provisions. Forward-looking statements include, among other things, statements regarding our and our officers' intent, belief or expectation as identified by the use of words such as "may," "will," "project," "expect," "believe," "intend," "anticipate," "seek," "forecast," "plan," "estimate," "could," "would," "should" and other comparable and derivative terms or the negatives thereof. In addition, we, through our officers, from time to time, make forward-looking oral and written public statements concerning our expected future operations, strategies, securities offerings, growth and investment opportunities, dispositions, capital structure changes, budgets and other developments. Readers are cautioned that, while forward-looking statements reflect our good faith belief and reasonable assumptions based upon current information, we can give no assurance that our expectations or forecasts will be attained. Therefore, readers should be mindful that forward-looking statements are not guarantees of future performance and that they are subject to known and unknown risks and uncertainties that are difficult to predict. As more fully set forth under "Part I, Item 1A. Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, factors that may cause our actual results to differ materially from the expectations contained in the forward-looking statements include:

(a) Changes in global, national and local economic conditions, including a prolonged period of weak economic growth;

(b) Volatility in the capital markets, including changes in interest rates and the availability and cost of capital;

(c) Our ability to manage our indebtedness level and changes in the terms of such indebtedness;

(d) The effect on healthcare providers of the automatic spending cuts enacted by Congress ("Sequestration") on entitlement programs, including Medicare, will, unless modified, result in future reductions in reimbursements;

(e) The ability of our operators, tenants and borrowers to conduct their respective businesses in a manner sufficient to maintain or increase their revenues and to generate sufficient income to make rent and loan payments to us and our ability to recover investments made, if applicable, in their operations;

(f) The financial weakness of some operators and tenants, including potential bankruptcies and downturns in their businesses, which results in uncertainties regarding our ability to continue to realize the full benefit of such operators' and/or tenants' leases;

(g) Changes in federal, state or local laws and regulations, including those affecting the healthcare industry that affect our costs of compliance or increase the costs, or otherwise affect the operations of our operators, tenants and borrowers;

(h) The potential impact of future litigation matters, including the possibility of larger than expected litigation costs, adverse results and related developments;

(i) Competition for tenants and borrowers, including with respect to new leases and mortgages and the renewal or rollover of existing leases;

(j) Our ability to negotiate the same or better terms with new tenants or operators if existing leases are not renewed or we exercise our right to replace an existing operator or tenant upon default;

(k) Availability of suitable properties to acquire at favorable prices and the competition for the acquisition and financing of those properties;

(l) The financial, legal, regulatory and reputational difficulties of significant operators of our properties;

(m) The risk that we may not be able to achieve the benefits of investments within expected time-frames or at all, or within expected cost projections;

(n) The ability to obtain financing necessary to consummate acquisitions on favorable terms;


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(o) The risks associated with our investments in joint ventures and unconsolidated entities, including our lack of sole decision making authority and our reliance on our joint venture partners' financial condition and continued cooperation; and

(p) Changes in the credit ratings on U.S. government debt securities or default or delay in payment by the United States of its obligations.

Except as required by law, we undertake no, and hereby disclaim any, obligation to update any forward-looking statements, whether as a result of new information, changed circumstances or otherwise.

The information set forth in this Item 2 is intended to provide readers with an understanding of our financial condition, changes in financial condition and results of operations. We will discuss and provide our analysis in the following order:

Executive Summary

2013 Transaction Overview

Dividends

Critical Accounting Policies

Results of Operations

Liquidity and Capital Resources

Funds from Operations ("FFO")

Off-Balance Sheet Arrangements

Contractual Obligations

Inflation

Recent Accounting Pronouncements

Executive Summary

We are a Maryland corporation and were organized to qualify as a self-administered real estate investment trust ("REIT") that, together with our unconsolidated joint ventures, invests primarily in real estate serving the healthcare industry in the United States ("U.S."). We acquire, develop, lease, manage and dispose of healthcare real estate, and provide financing to healthcare providers. At March 31, 2013, our portfolio of investments, including properties in our Investment Management Platform, consisted of interests in 1,164 facilities. Our Investment Management Platform represents the following joint ventures: (i) HCP Ventures III, LLC, (ii) HCP Ventures IV, LLC and
(iii) the HCP Life Science ventures.

Our business strategy is based on three principles: (i) opportunistic investing,
(ii) portfolio diversification and (iii) conservative financing. We actively redeploy capital from investments with lower return potential or shorter investment horizons into assets representing longer term investments with attractive risk-adjusted return potential. We make investments where the expected risk-adjusted return exceeds our cost of capital and strive to capitalize on our operator, tenant and other business relationships to grow our business.

Our strategy contemplates acquiring and developing properties on terms that are favorable to us. Generally, we prefer larger, more complex private transactions that leverage our management team's experience and our infrastructure. We follow a disciplined approach to enhancing the value of our existing portfolio, including ongoing evaluation of potential disposition of properties that no longer fit our strategy.

We primarily generate revenue by leasing healthcare properties under long-term leases with fixed and/or inflation indexed escalators. Most of our rents and other earned income from leases are received under triple-net leases or leases that provide for substantial recovery of operating expenses; however, some of our medical office and life science leases are structured as gross or modified gross leases. Operating expenses are generally related to medical office building ("MOB") and life science leased properties and senior housing properties managed on our behalf ("RIDEA properties"). Accordingly, for such MOBs, life science facilities and RIDEA properties, we incur certain property operating expenses, such as real estate taxes, repairs and maintenance, property management fees, utilities, employee costs for resident care and insurance. Our growth for these assets depends, in part, on our ability to (i) increase rental income and other earned income from leases by increasing rental rates and occupancy levels; (ii) maximize tenant recoveries given underlying lease structures; and (iii) control operating and other expenses. Our operations are impacted by property specific, market specific, general economic and other conditions.


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2013 Transaction Overview

Investment Transactions

During the quarter ended March 31, 2013, we made investments of $96 million as follows: (i) $38 million to purchase the four remaining senior housing facilities from our previously announced Blackstone JV Acquisition; and (ii) $58 million to fund development and other capital projects, primarily in our life science, medical office and senior housing segments.

During the quarter ended March 31, 2013, we placed into service a 70,000 square feet building located in Mountain View, California that is 100% leased.

Financing Activities

On February 28, 2013, we repaid $150 million of maturing 5.625% senior unsecured notes.

Dividends

On April 25, 2013, we announced that our Board declared a quarterly common stock cash dividend of $0.525 per share. The common stock dividend will be paid on May 21, 2013 to stockholders of record as of the close of business on May 6, 2013 and represents an annualized dividend pay rate of $2.10 per share.

Critical Accounting Policies

The preparation of financial statements in conformity with U.S. generally accepted accounting principles ("GAAP") requires our management to use judgment in the application of accounting policies, including making estimates and assumptions. We base estimates on the best information available to us at the time, our experience and on various other assumptions believed to be reasonable under the circumstances. These estimates affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions or other matters had been different, it is possible that different accounting would have been applied, resulting in a different presentation of our condensed consolidated financial statements. From time to time, we re-evaluate our estimates and assumptions. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current estimates and assumptions about matters that are inherently uncertain. A summary of our critical accounting policies is included in our Annual Report on Form 10-K for the year ended December 31, 2012 in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"; our critical accounting policies have not changed during 2013.

Results of Operations

We evaluate our business and allocate resources among our five business segments: (i) senior housing, (ii) post-acute/skilled nursing, (iii) life science, (iv) medical office and (v) hospital. Under the senior housing, life science, post-acute/skilled nursing and hospital segments, we invest or co-invest primarily in single operator or tenant properties, through the acquisition and development of real estate, management of operations and by debt issued by operators in these sectors. Under the medical office segment, we invest or co-invest through the acquisition and development of MOBs that are leased under gross, modified gross or triple-net leases, generally to multiple tenants, and which generally require a greater level of property management.

We use net operating income from continuing operations ("NOI") and adjusted NOI to assess and compare property level performance, including our same property portfolio ("SPP"), and to make decisions about resource allocations. We believe these measures provide investors relevant and useful information because they reflect only income and operating expense items that are incurred at the property level and present them on an unleveraged basis. We believe that net income is the most directly comparable GAAP measure to NOI. NOI should not be viewed as an alternative measure of operating performance to net income as defined by GAAP since NOI excludes certain components from net income. Further, NOI may not be comparable to that of other REITs, as they may use different methodologies for calculating NOI. See Note 13 to the Condensed Consolidated Financial Statements for additional segment information and the relevant reconciliations from net income to NOI and adjusted NOI.

Operating expenses are generally related to MOB and life science leased properties and senior housing properties managed on our behalf (RIDEA properties). We generally recover all or a portion of MOB and life science expenses from the tenants (tenant recoveries). The presentation of expenses as operating or general and administrative is based on the underlying nature of the expense. Periodically, we review the classification of expenses between categories and make revisions based on changes in the underlying nature of the expenses.


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Our evaluation of results of operations by each business segment includes an analysis of our SPP and our total property portfolio. SPP information allows us to evaluate the performance of our leased property portfolio under a consistent population by eliminating changes in the composition of our portfolio of properties. We identify our SPP as stabilized properties that remained in operations and were consistently reported as leased properties or RIDEA properties for the duration of the year-over-year comparison periods presented. Accordingly, it takes a stabilized property a minimum of 12 months in operations under a consistent reporting structure to be included in our SPP. Newly acquired operating assets are generally considered stabilized at the earlier of lease-up (typically when the tenant(s) controls the physical use of at least 80% of the space) or 12 months from the acquisition date. Newly completed developments, including redevelopments, are considered stabilized at the earlier of lease-up or 24 months from the date the property is placed in service. SPP NOI excludes certain non-property specific operating expenses that are allocated to each operating segment on a consolidated basis.

Comparison of the Three Months Ended March 31, 2013 to the Three Months Ended March 31, 2012

During the fourth quarter of 2012 and first quarter of 2013, we acquired a portfolio of 133 senior housing communities (the "Blackstone JV Acquisition", see additional information in Note 3 to the Condensed Consolidated Financial Statements). The transaction closed in two stages: (i) 129 senior housing facilities during the fourth quarter of 2012 for $1.7 billion; and (ii) four senior housing facilities during the first quarter of 2013 for $38 million. The results of operations from the acquisitions are reflected in our condensed consolidated financial statements from those respective dates.

Segment NOI and Adjusted NOI

The tables below provide selected operating information for our SPP and total property portfolio for each of our five business segments. Our consolidated SPP consists of 924 properties representing properties acquired or placed in service and stabilized on or prior to January 1, 2012 and that remained in operations under a consistent reporting structure through March 31, 2013. Our consolidated total property portfolio represents 1,090 and 935 properties at March 31, 2013 and 2012, respectively, and excludes properties classified as discontinued operations.

Results are as of and for the three months ended March 31, 2013 and 2012 (dollars and square feet in thousands except per capacity data):

Senior Housing



                                       SPP                          Total Portfolio
                           2013        2012       Change      2013        2012       Change
Rental revenues(1)       $ 115,575   $ 113,500   $  2,075   $ 149,091   $ 113,500   $ 35,591
Resident fees and
services                    36,891      36,179        712      36,891      36,179        712
Total revenues             152,466     149,679      2,787     185,982     149,679     36,303
Operating expenses         (23,498 )   (20,966 )   (2,532 )   (24,391 )   (21,614 )   (2,777 )
NOI                        128,968     128,713        255     161,591     128,065     33,526
Straight-line rents         (6,118 )    (7,910 )    1,792     (13,177 )    (7,910 )   (5,267 )
DFL accretion               (5,031 )    (5,149 )      118      (5,031 )    (5,149 )      118
Amortization of above
and below market
lease intangibles, net        (358 )      (358 )        -        (190 )      (358 )      168
Adjusted NOI             $ 117,461   $ 115,296   $  2,165   $ 143,193   $ 114,648   $ 28,545
Adjusted NOI % change                                 1.9 %

Property count(2)              312         312                    445         312
Average capacity
(units)(3)                  35,401      35,396                 45,402      35,396
Average annual rent
per unit(4)              $  13,292   $  13,056              $  12,710   $  13,056



(1) Represents rental and related revenues and income from direct financing leases ("DFLs").

(2) From our past presentation of SPP for the three months ended March 31, 2012, we removed two senior housing properties from SPP that were sold or classified as held for sale.

(3) Represents average capacity as reported by the respective tenants or operators for the twelve-month period and a quarter in arrears from the periods presented.

(4) Average annual rent per unit, includes operating income from properties under a RIDEA structure that are based on NOI.


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SPP NOI and Adjusted NOI. SPP NOI increased primarily as a result of rent escalations related to new leases or leases not subject to straight-line rents. SPP adjusted NOI improved primarily as a result of annual rent escalations and an increase in rental revenues from properties that were previously transitioned from Sunrise to other operators. The increases in SPP NOI and adjusted NOI were partially offset by a decline in additional rents, which are based on the facility's performance.

Total Portfolio NOI and Adjusted NOI. Including the impact of our SPP, our total portfolio NOI and adjusted NOI primarily increased as a result of our Blackstone JV Acquisition.

Post-Acute/Skilled Nursing



                                   SPP                           Total Portfolio
                      2013        2012       Change       2013        2012       Change
Rental
revenues(1)         $ 136,103   $ 133,673   $   2,430   $ 136,103   $ 133,673   $   2,430
Operating
expenses                 (146 )      (198 )        52        (647 )      (200 )      (447 )
NOI                   135,957     133,475       2,482     135,456     133,473       1,983
Straight-line
rents                    (170 )      (163 )        (7 )      (170 )      (163 )        (7 )
DFL accretion         (19,139 )   (20,473 )     1,334     (19,139 )   (20,473 )     1,334
Amortization of
above and below
market lease
intangibles, net           11          11           -          11          11           -
Adjusted NOI        $ 116,659   $ 112,850   $   3,809   $ 116,158   $ 112,848   $   3,310
Adjusted NOI %
change                                            3.4 %
Property count(2)         312         312                     312         312
Average capacity
(beds)(3)              39,855      39,798                  39,855      39,798
Average annual
rent per bed        $  11,722   $  11,361               $  11,722   $  11,361



(1) Represents rental and related revenues and income from DFLs.

(2) From our past presentation of SPP for the three months ended March 31, 2012, we removed a post-acute/skilled nursing property from SPP that was sold or classified as held for sale.

(3) Represents average capacity as reported by the respective tenants or operators for the twelve-month period and a quarter in arrears from the periods presented.

NOI and Adjusted NOI. SPP and total portfolio NOI and adjusted NOI primarily increased as a result of annual rent escalations from 268 post-acute/skilled nursing facilities classified as DFLs from HCR ManorCare, Inc. (see Notes 5 and 11 to the Condensed Consolidated Financial Statements for additional information regarding the net investment in DFLs and HCR ManorCare, respectively).

Life Science



                                  SPP                            Total Portfolio
                     2013        2012       Change        2013        2012       Change
Rental and
related revenues   $  60,129   $  59,887   $     242    $  62,438   $  61,410   $   1,028
Tenant
recoveries            10,505      10,279         226       10,892      10,420         472
Total revenues        70,634      70,166         468       73,330      71,830       1,500
Operating
expenses             (11,794 )   (11,687 )      (107 )    (13,383 )   (12,884 )      (499 )
NOI                   58,840      58,479         361       59,947      58,946       1,001
Straight-line
rents                 (3,331 )       340      (3,671 )     (3,692 )        81      (3,773 )
Amortization of
above and
below market
lease
intangibles, net          97          89           8           85          77           8
Adjusted NOI       $  55,606   $  58,908   $  (3,302 )  $  56,340   $  59,104   $  (2,764 )
Adjusted NOI %
change                                          (5.6 )%
Property count           101         101                      110         108
Average
occupancy               92.7 %      90.9 %                   91.4 %      88.9 %
Average occupied
square feet            6,195       6,079                    6,423       6,146
Average annual
rent per
occupied sq. ft.   $      44   $      46                $      43   $      47

NOI and Adjusted NOI. SPP and total portfolio NOI increased primarily as a result of an increase in life science occupancy, partially offset by mark-to-market rent reductions. SPP and total portfolio adjusted NOI decreased primarily as a result of a $4 million rent payment received in February 2012 in connection with a lease amendment and mark-to-market rent reductions, partially offset by annual rent escalations and an increase in life science occupancy.

During the three months ended March 31, 2013, 183,000 square feet of new and renewal leases commenced at an average annual base rent of $33.17 per square foot compared to 105,000 square feet of expiring with an average annual base rent of $50.31 per square foot.


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Medical Office



                                           SPP                        Total Portfolio
                                2013       2012      Change      2013       2012     Change
Rental and related revenues   $ 66,438   $ 66,125   $    313   $ 74,507   $ 68,297   $ 6,210
Tenant recoveries               11,231     11,545       (314 )   12,748     11,658     1,090
Total revenues                  77,669     77,670         (1 )   87,255     79,955     7,300
Operating expenses             (29,446 )  (29,358 )      (88 )  (34,296 )  (31,705 )  (2,591 )
NOI                             48,223     48,312        (89 )   52,959     48,250     4,709
Straight-line rents             (1,048 )   (1,315 )      267     (1,522 )   (1,359 )    (163 )
Amortization of above and
below market lease
intangibles, net                    98         67         31        234         30       204
Adjusted NOI                  $ 47,273   $ 47,064   $    209   $ 51,671   $ 46,921   $ 4,750
Adjusted NOI % change                                    0.4 %

Property count(1)                  183        183                   206        186
Average occupancy                 91.5 %     91.1 %                91.2 %     91.1 %
Average occupied square
feet                            11,591     11,508                12,915     11,844
Average annual rent per
occupied sq. ft.              $     26   $     26              $     27   $     26



(1) From our past presentation of SPP for the three months ended March 31, 2012, we removed three MOBs that were placed into redevelopment in 2012 and 2013, which no longer meet our criteria for SPP as of the date they were placed into redevelopment.

SPP Portfolio NOI and Adjusted NOI. SPP adjusted NOI increased primarily as a result of rent escalations, partially offset by a one-time rental revenue adjustment.

Total Portfolio NOI and Adjusted NOI. In addition to the impact from our SPP, NOI and adjusted NOI increased primarily as a result of the impact of our MOB acquisitions during 2012.

During the quarter ended March 31, 2013, 340,000 square feet of new and renewal leases commenced at an average annual base rent of $24.36 per square foot compared to 580,000 square feet of expiring and terminated leases with an average annual base rent of $24.33 per square foot.

Hospital



                                           SPP                       Total Portfolio
                                2013       2012     Change      2013       2012     Change
Rental and related revenues   $ 19,068   $ 18,042   $ 1,026   $ 20,207   $ 18,806   $ 1,401
Tenant recoveries                  563        572        (9 )      563        572        (9 )
Total revenues                  19,631     18,614     1,017     20,770     19,378     1,392
Operating expenses                (887 )     (929 )      42       (888 )     (930 )      42
NOI                             18,744     17,685     1,059     19,882     18,448     1,434
Straight-line rents                (90 )     (184 )      94       (232 )     (337 )     105
Amortization of above and
below market lease
intangibles, net                  (192 )     (192 )       -       (218 )     (218 )       -
Adjusted NOI                  $ 18,462   $ 17,309   $ 1,153   $ 19,432   $ 17,893   $ 1,539
Adjusted NOI % change                                   6.7 %

Property count                      16         16                   17         17
Average capacity (beds)(1)       2,379      2,375                2,410      2,406
Average annual rent per bed   $ 32,533   $ 30,723             $ 33,726   $ 31,300


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