<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
<TABLE>
<S> <S>
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997
OR
[ ] 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 1-9381
</TABLE>
American Health Properties, Inc.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 95-4084878
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6400 SOUTH FIDDLER'S GREEN CIRCLE 80111
SUITE 1800 (Zip Code)
ENGLEWOOD, CO
(Address of principal executive offices)
</TABLE>
(303) 796-9793
(Registrant's telephone number, including area code)
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 ____
SHARES OF REGISTRANT'S COMMON STOCK, $.01 PAR VALUE PER SHARE,
OUTSTANDING AT AUGUST 8, 1997 -- 23,559,054
SHARES OF REGISTRANT'S PSYCHIATRIC GROUP DEPOSITARY SHARES, EACH
REPRESENTING ONE-TENTH OF ONE SHARE OF PSYCHIATRIC GROUP PREFERRED STOCK, $.01
PAR VALUE, OUTSTANDING AT AUGUST 8, 1997 -- 2,083,931.
================================================================================
<PAGE> 2
AMERICAN HEALTH PROPERTIES, INC.
JUNE 30, 1997
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION PAGE
CONSOLIDATED COMPANY
<S> <C>
Item 1. Consolidated Condensed Financial Statements:
Balance sheets as of June 30, 1997 and December 31, 1996 . . . . . . . . . . . . . . . 2
Statements of operations for the three and six months ended June 30, 1997 and 1996 . . 3
Statements of cash flows for the six months ended June 30, 1997 and 1996 . . . . . . . 4
Notes to financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Item 2. Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . 9
CORE GROUP
Item 1. Core Group Combined Condensed Financial Statements:
Balance sheets as of June 30, 1997 and December 31, 1996 . . . . . . . . . . . . . . . 15
Statements of operations for the three and six months ended June 30, 1997 and 1996 . . 16
Statements of cash flows for the six months ended June 30, 1997 and 1996 . . . . . . . 17
Notes to financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Item 2. Management's Discussion and Analysis of Core Group
Combined Financial Condition and Results of Operations . . . . . . . . . . . . . . . . 22
PSYCHIATRIC GROUP
Item 1. Psychiatric Group Combined Condensed Financial Statements:
Balance sheets as of June 30, 1997 and December 31, 1996 . . . . . . . . . . . . . . . 27
Statements of operations for the three and six months ended June 30, 1997 and 1996 . . 28
Statements of cash flows for the six months ended June 30, 1997 and 1996 . . . . . . . 29
Notes to financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Item 2. Management's Discussion and Analysis of Psychiatric Group
Combined Financial Condition and Results of Operations . . . . . . . . . . . . . . . . 36
PART II OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . 43
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
</TABLE>
1
<PAGE> 3
AMERICAN HEALTH PROPERTIES, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
- ------------------------------------------------------------------- --------- ---------
<S> <C> <C>
Assets (Unaudited)
Real estate investments
Real property and mortgage notes, net $ 649,626 $ 644,380
Construction in progress 6,104 4,834
Accumulated depreciation (94,102) (90,139)
--------- ---------
561,628 559,075
Notes receivable and financing leases 6,156 8,152
Other assets 12,019 9,175
Cash and short-term investments 2,955 1,480
- ------------------------------------------------------------------- --------- ---------
$ 582,758 $ 577,882
- ------------------------------------------------------------------- --------- ---------
Liabilities and Stockholders' Equity
Bank loans payable $ 9,000 $ 48,500
Notes and bonds payable 225,723 158,601
Accounts payable and accrued liabilities 10,705 7,385
Dividends payable 13,632 13,981
Deferred income 3,866 4,276
- ------------------------------------------------------------------- --------- ---------
262,926 232,743
- ------------------------------------------------------------------- --------- ---------
Commitments and contingencies
Stockholders' equity
Preferred stock $.01 par value; 1,000 shares authorized;
208 shares issued and outstanding 2 2
Common stock $.01 par value; 100,000 shares authorized;
23,464 and 23,455 shares issued and outstanding 235 235
Additional paid-in capital 482,918 482,083
Cumulative net income 258,056 256,691
Cumulative dividends (421,379) (393,872)
- ------------------------------------------------------------------- --------- ---------
319,832 345,139
- ------------------------------------------------------------------- --------- ---------
$ 582,758 $ 577,882
- ------------------------------------------------------------------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 4
AMERICAN HEALTH PROPERTIES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
------------------- ---------------------
1997 1996 1997 1996
- ------------------------------------------- ------- ------- -------- -------
<S> <C> <C> <C> <C>
REVENUES
Rental income $17,817 $17,080 $ 35,627 $34,378
Mortgage interest income 1,531 1,493 3,048 2,986
Additional rental and interest income 3,147 3,063 6,123 6,011
Other property income 34 -- 34 --
Other interest income 242 291 1,272 673
- ------------------------------------------- ------- ------- -------- -------
22,771 21,927 46,104 44,048
- ------------------------------------------- ------- ------- -------- -------
EXPENSES
Depreciation and amortization 3,889 3,718 7,717 7,443
Property operating 77 11 88 22
Interest expense 4,478 5,513 10,585 11,279
General and administrative 1,948 1,958 3,828 3,769
Impairment loss on real estate
investments and other notes receivable -- -- 11,000 --
- ------------------------------------------- ------- ------- -------- -------
10,392 11,200 33,218 22,513
- ------------------------------------------- ------- ------- -------- -------
Minority interest 47 58 94 115
- ------------------------------------------- ------- ------- -------- -------
NET INCOME BEFORE EXTRAORDINARY ITEM 12,332 10,669 12,792 21,420
EXTRAORDINARY LOSS ON DEBT PREPAYMENT -- -- (11,427) --
- ------------------------------------------- ------- ------- -------- -------
NET INCOME $12,332 $10,669 $ 1,365 $21,420
- ------------------------------------------- ------- ------- -------- -------
ATTRIBUTABLE TO -
CORE GROUP COMMON STOCK
Net Income Before Extraordinary Item $11,129 $ 9,435 $ 21,059 $18,754
Extraordinary Loss On Debt Prepayment $ -- $ -- $(11,427) $ --
Net Income $11,129 $ 9,435 $ 9,632 $18,754
PER SHARE AMOUNTS:
Net Income Before Extraordinary Item $ 0.47 $ 0.40 $ 0.89 $ 0.80
Extraordinary Loss On Debt Prepayment $ -- $ -- $ (0.48) $ --
Net Income $ 0.47 $ 0.40 $ 0.41 $ 0.80
Dividends Declared $0.5250 $0.5050 $ 1.0500 $1.0100
Weighted Average Shares Outstanding 23,559 23,510 23,553 23,505
PSYCHIATRIC GROUP DEPOSITARY SHARES
Net Income (Loss) $ 1,203 $ 1,234 $ (8,267) $ 2,666
Net Income (Loss) Per Share $ 0.57 $ 0.59 $ (3.94) $ 1.27
Dividends Declared Per Share $0.6300 $0.6500 $ 1.3800 $1.3500
Weighted Average Shares Outstanding 2,097 2,092 2,097 2,091
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 5
AMERICAN HEALTH PROPERTIES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
-----------------------
1997 1996
- ------------------------------------------------------------------- --------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,365 $ 21,420
Extraordinary loss on debt prepayment 11,427 --
Depreciation, amortization and other non-cash items 9,033 8,577
Deferred income (249) (255)
Impairment loss on real estate
investments and other notes receivable 11,000 --
Change in other assets (1,415) 453
Change in accounts payable and accrued liabilities 3,244 (1,058)
- ------------------------------------------------------------------- --------- --------
34,405 29,137
- ------------------------------------------------------------------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition and construction of real estate properties (15,923) (8,699)
Mortgage note receivable fundings (3,684) --
Principal payments on mortgage notes receivable 35 31
Other notes receivable 114 101
Direct financing leases 158 2,097
Administrative capital expenditures (11) (38)
- ------------------------------------------------------------------- --------- --------
(19,311) (6,508)
- ------------------------------------------------------------------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings (payments) on bank loans payable (39,500) 27,000
Proceeds from notes payable issuance 218,965 --
Prepayment of notes payable (163,176) --
Principal payments on notes payable -- (29,000)
Financing costs paid (2,152) (80)
Proceeds from exercise of stock options 100 --
Dividends paid (27,856) (26,807)
- ------------------------------------------------------------------- --------- --------
(13,619) (28,887)
- ------------------------------------------------------------------- --------- --------
INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS 1,475 (6,258)
CASH AND SHORT-TERM INVESTMENTS, BEGINNING OF PERIOD 1,480 7,571
- ------------------------------------------------------------------- --------- --------
CASH AND SHORT-TERM INVESTMENTS, END OF PERIOD $ 2,955 $ 1,313
- ------------------------------------------------------------------- --------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 6
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL
American Health Properties, Inc., a Delaware corporation (the Company,
which term refers to the Company and its subsidiaries unless the context
otherwise requires), is a self-administered real estate investment trust (REIT)
that commenced operations in 1987. The Company has investments in health care
properties, including acute care, rehabilitation, long-term acute care and
psychiatric hospitals, skilled nursing, assisted living and Alzheimer's care
facilities and medical office buildings.
The Company has two distinct classes of publicly-traded shares
outstanding. The Company's common stock (the Core Group Common Stock) is
intended to reflect the separate financial performance of the Company's
investments in acute care, rehabilitation and long-term acute care hospitals,
skilled nursing, assisted living and Alzheimer's care facilities and medical
office buildings (the Core Group). The Psychiatric Group Depositary Shares are
intended to reflect the separate financial performance of the Company's
investments in psychiatric hospitals (the Psychiatric Group). The capital
structure of the Company as reflected by its two classes of shares does not
affect the legal title to assets or responsibility for liabilities of the
Company, and each holder of Core Group Common Stock or Psychiatric Group
Depositary Shares is a holder of an issue of capital stock of the entire
Company and is subject to the risks associated with an investment in the
Company and all of its businesses, assets and liabilities.
Basis of Presentation The consolidated condensed financial statements
of the Company included herein have been prepared by the Company without audit
and include all normal, recurring adjustments which are, in the opinion of
management, necessary for a fair presentation of the results of operations
pursuant to the rules and regulations of the Securities and Exchange
Commission. These financial statements should be read in conjunction with
those included in the Company's annual report on Form 10-K for the year ended
December 31, 1996. The financial statements of the Core Group and the
Psychiatric Group, which are included elsewhere herein, should also be read in
conjunction with these financial statements.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
New Accounting Standard In February 1997, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards (SFAS) No.
128, "Earnings per Share." SFAS No. 128 is intended to simplify the
computation of earnings per share (EPS) and to make the U.S. standard for
computing EPS more compatible with the EPS standards of other countries and
with that of the International Accounting Standards Committee. The effective
date for the application of SFAS No. 128 for both interim and annual periods is
after December 15, 1997. Earlier application is not permitted. Management
does not expect the application of SFAS No. 128 to have a material impact on
the Company's EPS calculation.
Interest Paid Interest paid by the Company, net of interest
capitalized, was $5,691,000 and $10,718,000 for the six months ended June 30,
1997 and 1996, respectively. The Company had $201,000 and $531,000 of
capitalized interest for the six months ended June 30, 1997 and 1996,
respectively.
5
<PAGE> 7
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
2. DEBT
In January 1997, the Company completed a $220 million public debt
offering of unsecured senior notes payable, issuing $100 million of notes with
a coupon rate of 7.05% due January 15, 2002 (2002 Notes) and $120 million of
notes with a coupon rate of 7.50% due January 15, 2007 (2007 Notes). The 2002
Notes and 2007 Notes were sold for $99,749,000 and $119,216,000, respectively,
and have effective interest rates of approximately 7.34% and 7.74%,
respectively. Interest is payable at the coupon rates semi-annually on January
15th and July 15th. The proceeds from the public debt offering were used to
pay off the Company's $152 million of 11.03% private placement debt prior to
its scheduled maturity and the Company's borrowings under its bank credit
agreement. The prepayment of the private placement debt in February 1997
resulted in an extraordinary charge in the first quarter of 1997 of $11,427,000
consisting of a make-whole premium and other costs related to the prepayment.
3. STOCKHOLDERS' EQUITY
Stock Incentive Plans During the six months ended June 30, 1997,
options to purchase 184,534 shares of Core Group Common Stock at a weighted
average exercise price of $25.38 per share were issued pursuant to the
Company's stock incentive plans. During the six months ended June 30, 1997,
options to purchase 4,700 shares of Core Group Common Stock were exercised at a
weighted average exercise price of $21.37 per share resulting in additional
equity of $100,000. Options to purchase 10,000 shares of Core Group Common
Stock at a weighted average exercise price of $23.18 per share were canceled
during the six months ended June 30, 1997. Pursuant to an election to receive
payment of his annual board fees on a deferred basis in the form of stock,
4,027 shares of Core Group Common Stock were issued to a director during the
six months ended June 30, 1997.
4. COMMITMENTS
Real Estate Properties The Company has the right to approve capital
expenditures at all of its properties, the option to fund certain capital
expenditures and, in certain situations, is obligated to fund approved capital
expenditures on terms comparable to the original investment. The base and
additional rent provisions of the leases are amended when such capital
expenditures are funded to reflect the Company's increased investment. At June
30, 1997, the Company had no commitments to fund capital expenditures pursuant
to these rights and obligations.
As of June 30, 1997, the Company had funded $4.1 million of a $6.2
million commitment to finance the acquisition and renovation of a long-term
acute care facility in Amarillo, Texas to be operated by an experienced
operator. In addition, the Company had funded $3.7 million of a $4.4 million
mortgage loan to this same operator, which is secured by a long-term acute care
facility in Houston, Texas. The Company has also agreed to provide an
additional $9.4 million of real estate financing to this same operator for
other similar facilities.
As of June 30, 1997, the Company had funded $2.0 million of a $17
million commitment to provide construction and lease financing for two skilled
nursing properties in Las Vegas, Nevada to be operated by an experienced
operator of skilled nursing facilities.
6
<PAGE> 8
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
The Company has agreed to provide $50 million of real estate financing
to an experienced operator of assisted living facilities. Approximately $29
million has been specifically identified for the construction of five
properties located in four states which will be leased to the operator upon
completion.
5. STATUS OF PSYCHIATRIC GROUP INVESTMENTS
The fundamental ongoing changes in the psychiatric industry and the
resulting negative impact on operator financial performance have resulted in
significant psychiatric investment write-downs and the periodic restructuring
of psychiatric operator payment obligations. In 1995, the Company restructured
the leases covering its two psychiatric properties in Florida, Northpointe
Behavioral Health System (Northpointe) and The Retreat, and during 1996,
provided for the partial deferral of rental and interest obligations related to
one of these properties and the partial deferral of rental obligations of its
psychiatric property in Illinois, Rock Creek Center (RCC).
Adverse publicity from a lawsuit filed against the owner of the two
Florida psychiatric hospitals in late 1996 materially exacerbated the
operational and financial difficulties of the facilities during the first
quarter of 1997. After reviewing the significantly worsened operational and
financial problems of the hospitals and various alternatives for the facilities,
the Company recorded an $11 million impairment charge in the first quarter of
1997 to reduce its total carrying value for these two investments to their
estimated fair value of $5,400,000. The financial and operational problems at
the two Florida psychiatric hospitals continued to worsen during the second
quarter of 1997, and there are ongoing defaults by these hospitals in the
performance of their financial obligations to the Company. The Retreat has not
made its monthly contractual base rent or interest payments since April 1997 nor
any contractual additional rent payments in 1997, and Northpointe has not made
its monthly contractual rent payments since January 1997 nor any interest
payments since the January 1996 payment. In addition, the owner of the
Northpointe hospital ceased operations during the second quarter of 1997.
Although the owner of The Retreat hospital currently continues to operate the
facility, it is unlikely that operations can continue for any significant period
of time without a change in the owner and operator. The Company is continuing to
explore a range of options for the two Florida properties, including the
transfer of the hospitals to new operators, conversion of the facilities to an
alternative use or sale of the properties. Due to the complexity and time
involved in adequately evaluating its options, the Company has not yet reached a
decision as to its ultimate course of action. In light of the volatile
circumstances of these two properties, the Company cannot be assured that
further write- downs of these investments will not be required.
The current term of the RCC lease expires in December 1997. The lease
agreement provides the operator with an option to renew the lease for an
additional five-year term at fair market rental. Although the Company believes
that the lease will be renewed, the Company cannot be assured that the lease
will be renewed or that, if renewed, the annual minimum rent payments will
remain at the current level of $1,000,000. Furthermore, the $2,500,000 balance
outstanding under RCC's revolving credit agreement matured June 30, 1997. The
Company is currently negotiating an extension of the revolving credit agreement
to correspond with the expiration of RCC's current lease term and will
negotiate further extensions in connection with renewal of the lease.
Meanwhile, the operator has continued to make interest payments on the
outstanding balance. Should the lease not be renewed or the revolving loan not
be repaid or extended, a negative impact to the Company may result.
Although management currently believes that the recorded investments
in the psychiatric hospitals are realizable, if the psychiatric operators are
unable to successfully adapt to the fundamental ongoing changes in the
psychiatric industry and consistently mitigate the negative impact of such
changes on their financial performance, the Company may be required to further
restructure payment obligations, identify alternative operators, pursue
alternative uses for or dispositions of the properties and/or make additional
write-downs of the value of its investments in the psychiatric hospitals. If
the Company is required to take any of these actions, various costs are likely
to be incurred by the Company in an effort to protect, maintain and pursue
alternatives for its investments. The Company does not intend to make new
investments in the psychiatric sector, and over time, may sell, restructure or
seek other means to reduce its investments in the psychiatric sector.
The dividend on the Company's Psychiatric Group Depositary Shares is
determined each quarter based upon the operating results of the Company's
Psychiatric Group. Historically, the level of dividends of the
7
<PAGE> 9
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
Psychiatric Group have varied quarter-to-quarter. Any significant advance of
additional funds to psychiatric hospital operators, modification of terms
covering the rental or interest obligations of its psychiatric properties or
nonpayment or deferral of such obligations as they become due likely will have
an adverse impact on the Company's Psychiatric Group results of operations and
cash flows, as well as the quarterly dividend payment on Psychiatric Group
Depositary Shares. In addition to the foregoing, future operating results,
cash flows and dividends of the Company's Psychiatric Group will be affected by
changes in the level of additional rent and interest, the amount of additional
financial advisory fees and, to the extent necessary, various costs which might
be incurred in an effort to protect, maintain and pursue alternatives for its
psychiatric investments. In light of the uncertainty surrounding the ultimate
financial outcome of the two Florida investments, it is likely that future
quarterly dividends on the Company's Psychiatric Group Depositary Shares will
be adjusted downward to reflect the expected continued loss of some or all of
the income from those investments and various costs incurred in an effort to
protect, maintain and pursue alternatives for those investments.
8
<PAGE> 10
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company has two distinct classes of publicly-traded shares
outstanding. The Company's common stock (the Core Group Common Stock) is
intended to reflect the separate financial performance of the Company's
investments in acute care, rehabilitation and long-term acute care hospitals,
skilled nursing, assisted living and Alzheimer's care facilities and medical
office buildings (the Core Group). The Psychiatric Group Depositary Shares are
intended to reflect the separate financial performance of the Company's
investments in psychiatric hospitals (the Psychiatric Group). The capital
structure of the Company as reflected by its two classes of shares does not
affect the legal title to assets or responsibility for liabilities of the
Company, and each holder of Core Group Common Stock or Psychiatric Group
Depositary Shares is a holder of an issue of capital stock of the entire
Company and is subject to the risks associated with an investment in the
Company and all of its businesses, assets and liabilities.
Following is a discussion of the consolidated financial condition and
results of operations of the Company which should be read in conjunction with
the consolidated financial statements and accompanying notes. For discussions
of the financial condition and results of operations of the Core Group and the
Psychiatric Group, see the management's discussion and analysis of financial
condition and results of operations of the Core Group and the Psychiatric Group
included elsewhere herein.
Factors Regarding Future Results and Forward-Looking Statements
Statements that are not historical facts contained in management's discussion
and analysis of financial condition and results of operations are
forward-looking statements that involve risks and uncertainties that could
cause actual results to differ from projected results. Certain factors that
could cause actual results to differ materially include, among others: the
financial success of the operations conducted at the Company's facilities and
the financial strength of the operators of such facilities, the continuing
ability of operators to meet their obligations to the Company under existing or
restructured agreements, changes in operators or ownership of operators, the
viability of alternative uses for the Company's properties when necessary,
changes in government policy relating to the health care industry including
reductions in reimbursement levels under the Medicare and Medicaid programs,
operators' continued eligibility to participate in the Medicare or Medicaid
programs, reductions in reimbursement by other third-party payors, lower
occupancy levels at the Company's facilities, the strength and financial
resources of the Company's competitors, the availability and cost of capital,
the Company's ability to make additional real estate investments at attractive
yields and changes in tax laws and regulations affecting real estate investment
trusts. For a further discussion of such factors, see "Management's Discussion
and Analysis of Consolidated Financial Condition and Results of Operations -
Future Operating Results" herein.
OPERATING RESULTS
Second Quarter and Year to Date 1997 Compared With 1996
For the second quarter of 1997, the Company reported net income of
$12,332,000 compared with net income of $10,669,000 for the second quarter of
1996. For the six months ended June 30, 1997, the Company reported net income
of $1,365,000 compared with net income of $21,420,000 for the six months ended
June 30, 1996. For the six months ended June 30, 1997, the Company reported net
income before extraordinary item of $12,792,000 compared with net income before
extraordinary item of $21,420,000 for the six months ended June 30, 1996. Net
income for the six months ended June 30, 1997 included an impairment loss on
psychiatric investments of ($11,000,000) and an extraordinary loss on debt
prepayment of ($11,427,000). See the
9
<PAGE> 11
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Consolidated Condensed Statements of Operations for the net income (loss) and
per share amounts attributable to the Core Group Common Stock and the
Psychiatric Group Depositary Shares.
Rental income was $17,817,000 for the second quarter of 1997, an
increase of $737,000 or 4% from $17,080,000 for the second quarter of 1996.
Rental income was $35,627,000 for the six months ended June 30, 1997, an
increase of $1,249,000 or 4% from $34,378,000 for the six months ended June 30,
1996. This increase was primarily attributable to rental income from new
properties acquired subsequent to the first quarter of 1996. These property
additions also resulted in an increase in depreciation and amortization of
$171,000 or 5% to $3,889,000 for the second quarter of 1997 compared with
$3,718,000 for the second quarter of 1996 and an increase of $274,000 or 4% to
$7,717,000 for the six months ended June 30, 1997 compared with $7,443,000 for
the same period in 1996.
Additional rental and interest income was $3,147,000 for the second
quarter of 1997, an increase of $84,000 or 3% from $3,063,000 for the second
quarter of 1996. Additional rental and interest income was $6,123,000 for the
six months ended June 30, 1997, an increase of $112,000 or 2% from $6,011,000
for the six months ended June 30, 1996. The majority of this positive
variation was attributable to various properties that began paying additional
rent for the first time.
Other property income of $34,000 for the second quarter of 1997 and
the six months ended June 30, 1997 represents property operating expense
reimbursements from medical office facility tenants.
Other interest income decreased $49,000 or 17% to $242,000 for the
second quarter of 1997 from $291,000 for the second quarter of 1996. Other
interest income increased $599,000 or 89% to $1,272,000 for the six months
ended June 30, 1997 from $673,000 for the six months ended June 30, 1996. The
decrease in other interest income for the second quarter was primarily
attributable to a lower average balance of direct financing leases in 1997.
The increase in other interest income for the first six months of 1997 was
primarily attributable to higher investable cash balances, partially offset by
a lower average balance of direct financing leases. Investable cash balances
were significantly higher during the first quarter of 1997 due to the temporary
investment of a portion of the proceeds of a public debt offering in late
January 1997 until used to prepay the Company's private placement debt in late
February 1997 after the prepayment notice period had expired.
Property operating expense was $77,000 for the second quarter of 1997,
an increase of $66,000 from $11,000 for the second quarter of 1996. Property
operating expense was $88,000 for the six months ended June 30, 1997, an
increase of $66,000 from $22,000 for the comparable period in 1996. This
increase was attributable to operating expenses associated with an investment
in a multi-tenant medical office facility during the second quarter of 1997 and
costs related to the protection and maintenance of a psychiatric property in
Florida after the hospital owner ceased hospital operations during the second
quarter of 1997.
Interest expense was $4,478,000 for the second quarter of 1997, a
decrease of $1,035,000 or 19% from $5,513,000 for the second quarter of 1996.
Interest expense was $10,585,000 for the six months ended June 30, 1997, a
decrease of $694,000 or 6% from $11,279,000 for the six months ended June 30,
1996. The decrease in interest expense during these periods was primarily
attributable to a lower weighted average effective interest rate on long-term
debt during 1997, partially offset by a higher amount of long-term debt and a
lower amount of capitalized interest in 1997. In late January 1997, the
Company sold $220 million of publicly-traded
10
<PAGE> 12
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
unsecured senior notes with a weighted average effective interest rate of
approximately 7.56%. The Company used the proceeds of this offering to pay off
the borrowings under its bank credit agreement outstanding at the time and to
prepay $152 million of 11.03% private placement debt in late February 1997
prior to its scheduled maturity, incurring an extraordinary charge in the first
quarter of 1997 of $11,427,000.
General and administrative expenses were $1,948,000 for the second
quarter of 1997, a decrease of $10,000 or 1% from $1,958,000 for the second
quarter of 1996. For the first half of 1997, general and administrative
expenses were $3,828,000, an increase of $59,000 or 2% from $3,769,000 for the
first half of 1996. These variations were primarily attributable to higher
compensation and benefits expense and an increase in travel expense, partially
offset by a reduction in financial advisory and officer hiring costs.
Future Operating Results
The operators of most of the Company's facilities derive a substantial
percentage of their total revenues from federal and state health care programs
such as Medicare and Medicaid and from other third-party payors such as private
insurance companies, self-insured employers and health maintenance
organizations. Such operators also are subject to extensive federal, state and
local government regulation relating to their operations, and the Company's
facilities are subject to periodic inspection by governmental and other
authorities to assure continued compliance with mandated procedures, licensure
requirements under state law and certification standards under the Medicare and
Medicaid programs. A reduction in reimbursement levels under the Medicare or
Medicaid programs, a reduction in reimbursement by other third-party payors or
an operator's failure to maintain its certification under Medicare or Medicaid
programs could adversely affect revenues to the Company's facilities.
The nature of health care delivery in the United States continues to
undergo change and further review at both the national and state levels.
Generally accepted goals of reform continue to include controlling costs and
improving access to medical care. Various plans to decrease the growth in
Medicare spending have been proposed by both Houses of Congress. These plans
have generally included revisions to and limits on Medicare and federal
programs providing Medicaid reimbursement to state health care programs and
potentially would have an adverse impact on the level of funds available in the
future to health care facilities. The Company's Board and management are
monitoring potential changes closely. The Company believes that these potential
changes may pose risks for certain institutions that are unwilling or unable to
respond. At the same time, the Company believes that this changing health care
environment will provide the Core Group with new opportunities for investment.
The ongoing changes in the health care industry include trends toward
shorter lengths of hospital stay, increased use of outpatient services,
increased federal, state and third-party oversight of health care company
operations and business practices, and increased demand for discounted or
capitated health care services (delivery of services at a fixed price per
capita basis to a defined group of covered parties). Furthermore, federal,
state and third-party payors continue to propose and adopt various cost
containment measures that restrict the scope of reimbursable health care
services and limit increases in reimbursement rates for such services. Payors
also are continuing to aggressively enforce compliance with program
requirements and to pursue providers that they believe have not complied with
such requirements. Outpatient business is expected to increase as advances in
medical technologies allow more procedures to be performed on an outpatient
basis and as payors continue to direct more patients from inpatient care to
outpatient care. In addition, the entrance
11
<PAGE> 13
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
of insurance companies into managed care programs is accelerating the
introduction of managed care in new localities, and states and insurance
companies continue to negotiate actively the amounts they will pay for
services. Moreover, the percentage of health care services that are reimbursed
under the Medicare and Medicaid programs continues to increase as the
population ages and as states expand their Medicaid programs. Continued
eligibility to participate in these programs is crucial to a provider's
financial strength. As a result of the foregoing, the revenues and margins may
decrease at the Company's facilities.
Notwithstanding the potential for increasing government regulation,
the Company believes that health care will continue to be delivered on a local
and regional basis and that well-managed, high-quality, cost-controlled
facilities will continue to be an integral part of local and regional health
care delivery systems. The Company also believes that certain acute care
hospitals will need to reconfigure or expand existing facilities or to
affiliate themselves with other providers so as to become part of comprehensive
and cost-effective health care systems. Such systems likely will include lower
cost treatment settings, such as ambulatory care clinics, outpatient surgery
centers, skilled nursing facilities and medical office buildings. In general,
the Core Group facilities are part of local or regional health care delivery
systems or are in the process of becoming integrated into such systems.
The Company's future operating results could be affected by the
operating performance of the Company's lessees and borrowers. The rental and
interest obligations of its facility operators are primarily supported by the
facility- specific operating cash flow. Real estate investments in the
Company's portfolio are generally further supported by one or more credit
enhancements that take the form of cross-default provisions, letters of credit,
corporate and personal guarantees, security interests in cash reserve funds,
accounts receivable or other personal property and requirements to maintain
specified financial ratios.
Fundamental changes in the psychiatric industry continue to negatively
impact the facility-specific operating cash flow at the Company's psychiatric
properties. Institutions responsible for the reimbursement of care provided to
patients who use inpatient psychiatric treatment services have directed efforts
toward decreasing their payments for such services, thereby reducing hospital
operating revenues. Some cost-cutting measures used by such institutions
include decreasing the inpatient length of stay, intensively reviewing
utilization, directing patients from inpatient care to outpatient care and
negotiating reduced reimbursement rates for services. The wider use of
psychotropic drugs also has resulted in significant declines in the average
length of stay. In addition, aggressive program compliance enforcement and
increased scrutiny of past and current billing practices has resulted in the
filing of lawsuits against some providers and significant negative publicity
which has further exacerbated the financial and operational difficulties of
providers. Although the operators of the psychiatric hospitals are responding
by increasing case management, developing lower cost outpatient and daypatient
programs and reducing operating costs, their efforts are generally not
consistently mitigating the negative impact of these fundamental psychiatric
industry changes. As a result, certain of the psychiatric hospital operators
have not met their contractual payment obligations to the Company as scheduled
and the Company cannot be assured that psychiatric hospital operators will be
able to meet such payment obligations in the future.
In general, the operators of the Company's psychiatric properties have
very limited access to financing for their operating and capital needs. The
Company currently is providing such financing under a revolving credit
agreement to the operator of one of its psychiatric properties. As of August
8, 1997, outstanding borrowings under such agreement totaled $2,500,000. To the
extent operators of the Company's psychiatric
12
<PAGE> 14
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
properties have increased working capital needs in the future, the Company may
be the only source of such financing.
The fundamental ongoing changes in the psychiatric industry and the
resulting negative impact on operator financial performance have resulted in
significant psychiatric investment write-downs and the periodic restructuring
of psychiatric operator payment obligations. In 1995, the Company restructured
the leases covering its two psychiatric properties in Florida, Northpointe
Behavioral Health System (Northpointe) and The Retreat, and during 1996,
provided for the partial deferral of rental and interest obligations related to
one of these properties and the partial deferral of rental obligations of its
psychiatric property in Illinois, Rock Creek Center (RCC).
Adverse publicity from a lawsuit filed against the owner of the two
Florida psychiatric hospitals in late 1996 materially exacerbated the
operational and financial difficulties of the facilities during the first
quarter of 1997. After reviewing the significantly worsened operational and
financial problems of the hospitals and various alternatives for the facilities,
the Company recorded an $11 million impairment charge in the first quarter of
1997 to reduce its total carrying value for these two investments to their
estimated fair value of $5,400,000. The financial and operational problems at
the two Florida psychiatric hospitals continued to worsen during the second
quarter of 1997, and there are ongoing defaults by these hospitals in the
performance of their financial obligations to the Company. The Retreat has not
made its monthly contractual base rent or interest payments since April 1997 nor
any contractual additional rent payments in 1997, and Northpointe has not made
its monthly contractual rent payments since January 1997 nor any interest
payments since the January 1996 payment. In addition, the owner of the
Northpointe hospital ceased operations during the second quarter of 1997.
Although the owner of The Retreat hospital currently continues to operate the
facility, it is unlikely that operations can continue for any significant period
of time without a change in the owner and operator. The Company is continuing to
explore a range of options for the two Florida properties, including the
transfer of the hospitals to new operators, conversion of the facilities to an
alternative use or sale of the properties. Due to the complexity and time
involved in adequately evaluating its options, the Company has not yet reached a
decision as to its ultimate course of action. In light of the volatile
circumstances of these two properties, the Company cannot be assured that
further write- downs of these investments will not be required.
The current term of the RCC lease expires in December 1997. The lease
agreement provides the operator with an option to renew the lease for an
additional five-year term at fair market rental. Although the Company believes
that the lease will be renewed, the Company cannot be assured that the lease
will be renewed or that, if renewed, the annual minimum rent payments will
remain at the current level of $1,000,000. Furthermore, the $2,500,000 balance
outstanding under RCC's revolving credit agreement matured June 30, 1997. The
Company is currently negotiating an extension of the revolving credit agreement
to correspond with the expiration of RCC's current lease term and will
negotiate further extensions in connection with renewal of the lease.
Meanwhile, the operator has continued to make interest payments on the
outstanding balance. Should the lease not be renewed or the revolving loan not
be repaid or extended, a negative impact to the Company may result.
Although management currently believes that the recorded investments
in the psychiatric hospitals are realizable, if the psychiatric operators are
unable to successfully adapt to the fundamental ongoing changes in the
psychiatric industry and consistently mitigate the negative impact of such
changes on their financial performance, the Company may be required to further
restructure payment obligations, identify alternative operators, pursue
alternative uses for or dispositions of the properties and/or make additional
write-downs of the value of its investments in the psychiatric hospitals. If
the Company is required to take any of these actions, various costs are likely
to be incurred by the Company in an effort to protect, maintain and pursue
alternatives for its investments. The Company does not intend to make new
investments in the psychiatric sector, and over time, may sell, restructure or
seek other means to reduce its investments in the psychiatric sector.
The dividend on the Company's Psychiatric Group Depositary Shares is
determined each quarter based upon the operating results of the Company's
Psychiatric Group. Historically, the level of dividends of the Psychiatric
Group have varied quarter-to-quarter. Any significant advance of additional
funds to psychiatric hospital operators, modification of terms covering the
rental or interest obligations of its psychiatric properties or nonpayment or
deferral of such obligations as they become due likely will have an adverse
impact on the Company's Psychiatric Group results of operations and cash flows,
as well as the quarterly dividend payment
13
<PAGE> 15
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
on Psychiatric Group Depositary Shares. In addition to the foregoing, future
operating results, cash flows and dividends of the Company's Psychiatric Group
will be affected by changes in the level of additional rent and interest, the
amount of additional financial advisory fees and, to the extent necessary,
various costs which might be incurred in an effort to protect, maintain and
pursue alternatives for its psychiatric investments. The quarterly dividend on
Psychiatric Group Depositary Shares was decreased to $.63 per share in the
second quarter of 1997 compared to $.75 per share in the first quarter of 1997
primarily as a result of the continuing financial and operational problems at
the two Florida psychiatric hospitals. In light of the uncertainty surrounding
the ultimate financial outcome of the two Florida investments, it is likely
that future quarterly dividends on the Company's Psychiatric Group Depositary
Shares will be adjusted downward to reflect the expected continued loss of some
or all of the income from those investments and various costs incurred in an
effort to protect, maintain and pursue alternatives for those investments.
The future operating results of the Company will be affected by
additional factors including the amount, timing and yield of additional real
estate investments and the competition for such investments. Operating results
also will be affected by the availability and terms of the Company's future
equity and debt financing. The Company's financing strategy to facilitate
future growth includes objectives to reduce its cost of capital over time and
enhance its liquidity and financial flexibility.
LIQUIDITY AND CAPITAL RESOURCES
As of August 8, 1997, the Company had remaining commitments of $17.1
million to fund real estate projects currently under construction over
approximately the next fifteen months. In addition, the Company had agreed to
provide real estate financing to two different operators aggregating
approximately $59.4 million. Of this amount, approximately $29 million has been
committed to five assisted living projects to be constructed during the next
eighteen months. The remaining $30.4 million of financing has not been
committed to specific acquisitions or projects.
The Company has continued to increase its liquidity and enhance its
financial flexibility. In January 1997, the Company completed a $220 million
public unsecured debt offering, issuing $100 million of five-year senior notes
and $120 million of ten-year senior notes. The Company used the net proceeds
to pay off all outstanding borrowings under its $150 million bank facility at
the time and to prepay all of its $152 million of outstanding private placement
debt in late February 1997. As of August 8, 1997, the Company had $6 million of
outstanding borrowings under its revolving credit facility and had $3.8 million
in cash and short-term investments. The Company's total indebtedness as of
August 8, 1997 was $231.7 million. The Company will utilize its revolving
credit facility to fund future acquisitions and its other commitments. The
Company may incur additional indebtedness or refinance existing indebtedness if
the Company determines that opportunities to pursue such transactions would be
attractive. The Company currently believes it has sufficient capital to meet
its commitments and that its cash flow and liquidity will continue to be
sufficient to fund current operations and to provide for the payment of
dividends to stockholders in compliance with the applicable sections of the
Internal Revenue Code governing real estate investment trusts.
14
<PAGE> 16
AMERICAN HEALTH PROPERTIES, INC.
CORE GROUP COMBINED CONDENSED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION> June 30, December 31,
1997 1996
- ------------------------------------------------------------------- --------- ---------
<S> <C> <C>
ASSETS (Unaudited)
Real estate investments
Real property and mortgage notes, net $ 599,967 $ 581,631
Construction in progress 6,104 4,834
Accumulated depreciation (92,737) (85,451)
--------- ---------
513,334 501,014
Financing leases 3,537 3,695
Revolving loan to Psychiatric Group 4,140 4,183
Fixed rate loan to Psychiatric Group 9,175 9,175
Other assets 11,387 8,432
Cash and short-term investments 2,955 1,480
- ------------------------------------------------------------------- --------- ---------
$ 544,528 $ 527,979
- ------------------------------------------------------------------- --------- ---------
ATTRIBUTED LIABILITIES AND TOTAL ATTRIBUTED EQUITY
Bank loans payable $ 9,000 $ 48,500
Notes and bonds payable 225,723 158,601
Accounts payable and accrued liabilities 10,705 7,385
Dividends payable 12,319 12,314
Deferred income 3,837 4,003
- ------------------------------------------------------------------- --------- ---------
261,584 230,803
- ------------------------------------------------------------------- --------- ---------
Commitments and contingencies
Total Attributed Core Group Equity 282,944 297,176
- ------------------------------------------------------------------- --------- ---------
$ 544,528 $ 527,979
- ------------------------------------------------------------------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these financial statements.
15
<PAGE> 17
AMERICAN HEALTH PROPERTIES, INC.
CORE GROUP COMBINED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION> Three Months Six Months
Ended June 30, Ended June 30,
------------------- ---------------------
1997 1996 1997 1996
- ------------------------------------------------------ ------- ------- -------- -------
<S> <C> <C> <C> <C>
REVENUES
Rental income $17,475 $16,715 $ 34,704 $33,432
Mortgage interest income 15 -- 15 --
Additional rental income 2,980 2,843 5,752 5,609
Other property income 34 -- 34 --
Other interest income 157 196 1,088 479
Interest on loans to Psychiatric Group 394 427 784 847
- ------------------------------------------------------ ------- ------- -------- -------
21,055 20,181 42,377 40,367
- ------------------------------------------------------ ------- ------- -------- -------
EXPENSES
Depreciation and amortization 3,701 3,532 7,343 7,071
Property operating 52 11 63 22
Interest expense 4,478 5,513 10,585 11,279
General and administrative 1,648 1,632 3,233 3,126
- ------------------------------------------------------ ------- ------- -------- -------
9,879 10,688 21,224 21,498
- ------------------------------------------------------ ------- ------- -------- -------
Minority interest 47 58 94 115
- ------------------------------------------------------ ------- ------- -------- -------
NET INCOME BEFORE EXTRAORDINARY ITEM 11,129 9,435 21,059 18,754
EXTRAORDINARY LOSS ON DEBT PREPAYMENT -- -- (11,427) --
- ------------------------------------------------------ ------- ------- -------- -------
NET INCOME $11,129 $ 9,435 $ 9,632 $18,754
- ------------------------------------------------------ ------- ------- -------- -------
PER COMMON SHARE AMOUNTS:
NET INCOME BEFORE EXTRAORDINARY ITEM $ 0.47 $ 0.40 $ 0.89 $ 0.80
EXTRAORDINARY LOSS ON DEBT PREPAYMENT $ -- $ -- $ (0.48) $ --
- ------------------------------------------------------ ------- ------- -------- -------
NET INCOME $ 0.47 $ 0.40 $ 0.41 $ 0.80
- ------------------------------------------------------ ------- ------- -------- -------
DIVIDENDS DECLARED $0.5250 $0.5050 $ 1.0500 $1.0100
- ------------------------------------------------------ ------- ------- -------- -------
WEIGHTED AVERAGE
COMMON SHARES OUTSTANDING 23,559 23,510 23,553 23,505
- ------------------------------------------------------ ------- ------- -------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
16
<PAGE> 18
AMERICAN HEALTH PROPERTIES, INC.
CORE GROUP COMBINED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Six Months Ended June 30,
-----------------------
1997 1996
- ------------------------------------------------------------------- --------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 9,632 $ 18,754
Extraordinary loss on debt prepayment 11,427 --
Depreciation, amortization and other non-cash items 8,591 8,142
Deferred income (231) (228)
Change in other assets (1,523) 571
Change in accounts payable and accrued liabilities 3,385 (959)
- ------------------------------------------------------------------- --------- --------
31,281 26,280
- ------------------------------------------------------------------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition and construction of real estate properties (15,923) (8,699)
Mortgage note receivable fundings (3,684) --
Direct financing leases 158 2,097
Paydowns (fundings) on revolving loan to Psychiatric Group 43 (137)
Administrative capital expenditures (11) (38)
- ------------------------------------------------------------------- --------- --------
(19,417) (6,777)
- ------------------------------------------------------------------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings (payments) on bank loans payable (39,500) 27,000
Proceeds from notes payable issuance 218,965 --
Prepayment of notes payable (163,176) --
Principal payments on notes payable -- (29,000)
Financing costs paid (2,152) (80)
Proceeds from exercise of stock options 100 --
Dividends paid (24,626) (23,681)
- ------------------------------------------------------------------- --------- --------
(10,389) (25,761)
- ------------------------------------------------------------------- --------- --------
INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS 1,475 (6,258)
CASH AND SHORT-TERM INVESTMENTS, BEGINNING OF PERIOD 1,480 7,571
- ------------------------------------------------------------------- --------- --------
CASH AND SHORT-TERM INVESTMENTS, END OF PERIOD $ 2,955 $ 1,313
- ------------------------------------------------------------------- --------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements.
17
<PAGE> 19
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CORE GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL
American Health Properties, Inc., a Delaware corporation (the Company,
which term refers to the Company and its subsidiaries unless the context
otherwise requires), is a self-administered real estate investment trust (REIT)
that commenced operations in 1987. The Company has investments in health care
properties, including acute care, rehabilitation, long-term acute care and
psychiatric hospitals, skilled nursing, assisted living and Alzheimer's care
facilities and medical office buildings.
The Company has two distinct classes of publicly-traded shares
outstanding. The Company's common stock (the Core Group Common Stock) is
intended to reflect the separate financial performance of the Company's
investments in acute care, rehabilitation and long-term acute care hospitals,
skilled nursing, assisted living and Alzheimer's care facilities and medical
office buildings (the Core Group). The Psychiatric Group Depositary Shares are
intended to reflect the separate financial performance of the Company's
investments in psychiatric hospitals (the Psychiatric Group). The capital
structure of the Company as reflected by its two classes of shares does not
affect the legal title to assets or responsibility for liabilities of the
Company, and each holder of Core Group Common Stock or Psychiatric Group
Depositary Shares is a holder of an issue of capital stock of the entire
Company and is subject to the risks associated with an investment in the
Company and all of its businesses, assets and liabilities.
Basis of Presentation The combined condensed financial statements of
the Core Group included herein have been prepared by the Company without audit
and include all normal, recurring adjustments which are, in the opinion of
management, necessary for a fair presentation of the results of operations
pursuant to the rules and regulations of the Securities and Exchange
Commission. These financial statements should be read in conjunction with
those included in the Company's annual report on Form 10-K for the year ended
December 31, 1996.
The financial statements of the Core Group include the financial
position, results of operations and cash flows of the Company's core
investments in acute care, rehabilitation and long-term acute care hospitals,
skilled nursing, assisted living and Alzheimer's care facilities and medical
office buildings, an allocated portion of the Company's general and
administrative expense, all corporate assets and liabilities and related
transactions associated with the ongoing operations of the Company which are
not separately identified with either operating group, an attributed amount of
inter-Group loans receivable from the Psychiatric Group and an attributed
amount of the Company's stockholders' equity. The Core Group financial
statements are prepared using the amounts included in the Company's
consolidated financial statements.
Although the financial statements of the Core Group and the
Psychiatric Group separately report the assets, liabilities (including
contingent liabilities), stockholders' equity and items of income, expense and
cash flow of the Company attributed to each such Group, such attribution does
not affect the respective legal title to assets or responsibility for
liabilities of the Company or any of its subsidiaries. Furthermore, such
attribution does not affect the rights of creditors of the Company or any
subsidiary, including rights under financing covenants.
18
<PAGE> 20
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CORE GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
Each holder of Core Group Common Stock or Psychiatric Group Depositary
Shares is a holder of an issue of capital stock of the entire Company and is
subject to risks associated with an investment in the Company and all of its
businesses, assets and liabilities. Financial effects arising from one Group
that affect the Company's consolidated results of operations, financial
condition, cash flows or borrowing costs may also affect the results of
operations, financial condition, cash flows or borrowing costs of the other
Group. Net losses of either Group, as well as dividends and distributions on,
and repurchases of, Core Group Common Stock or Psychiatric Group Depositary
Shares will reduce the funds of the Company legally available for dividends on
both the Core Group Common Stock and Psychiatric Group Depositary Shares.
Accordingly, the Core Group's financial statements should be read in
conjunction with the Company's consolidated financial statements and the
financial statements of the Psychiatric Group.
These financial statements include the accounts of the Core Group
business. The Core Group and the Psychiatric Group financial statements, taken
together, comprise all of the accounts included in the Company's consolidated
financial statements.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
New Accounting Standard In February 1997, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
(SFAS) No. 128, "Earnings per Share." SFAS No. 128 is intended to simplify the
computation of earnings per share (EPS) and to make the U.S. standard for
computing EPS more compatible with the EPS standards of other countries and
with that of the International Accounting Standards Committee. The effective
date for the application of SFAS No. 128 for both interim and annual periods is
after December 15, 1997. Earlier application is not permitted. Management
does not expect the application of SFAS No. 128 to have a material impact on
the Core Group's EPS calculation.
Interest Paid Interest paid by the Core Group, net of interest
capitalized, was $5,691,000 and $10,718,000 for the six months ended June 30,
1997 and 1996, respectively. The Core Group had $201,000 and $531,000 of
capitalized interest for the six months ended June 30, 1997 and 1996,
respectively.
2. DEBT
All of the Company's third-party debt is attributed to the Core Group.
In January 1997, the Company completed a $220 million public debt offering of
unsecured senior notes payable, issuing $100 million of notes with a coupon
rate of 7.05% due January 15, 2002 (2002 Notes) and $120 million of notes with
a coupon rate of 7.50% due January 15, 2007 (2007 Notes). The 2002 Notes and
2007 Notes were sold for $99,749,000 and $119,216,000, respectively, and have
effective interest rates of approximately 7.34% and 7.74%, respectively.
Interest is payable at the coupon rates semi- annually on January 15th and July
15th. The proceeds from the public debt offering were used to pay off the
Company's $152 million of 11.03% private placement debt prior to its scheduled
maturity and the Company's borrowings under its bank credit agreement. The
prepayment of
19
<PAGE> 21
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CORE GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
the private placement debt in February 1997 resulted in an extraordinary charge
in the first quarter of 1997 of $11,427,000 consisting of a make-whole premium
and other costs related to the prepayment.
3. ATTRIBUTED EQUITY
Stock Incentive Plans During the six months ended June 30, 1997,
options to purchase 184,534 shares of Core Group Common Stock at a weighted
average exercise price of $25.38 per share were issued pursuant to the
Company's stock incentive plans. During the six months ended June 30, 1997,
options to purchase 4,700 shares of Core Group Common Stock were exercised at a
weighted average exercise price of $21.37 per share resulting in additional
equity of $100,000. Options to purchase 10,000 shares of Core Group Common
Stock at a weighted average exercise price of $23.18 per share were canceled
during the six months ended June 30, 1997. Pursuant to an election to receive
payment of his annual board fees on a deferred basis in the form of stock,
4,027 shares of Core Group Common Stock were issued to a director during the
six months ended June 30, 1997.
4. COMMITMENTS
Inter-Group Loans Repayment of inter-Group loans by the Psychiatric
Group is primarily dependent upon the amount and timing of sales of the
Psychiatric Group's assets and paydowns received by the Psychiatric Group on
borrowings provided to a psychiatric hospital operator under a revolving credit
agreement. The Company's board of directors has established certain management
policies relating to the Core Group's inter-Group loans to the Psychiatric
Group. Under the policies currently in effect, which may be modified or
rescinded in the sole discretion of the Company's board of directors, the
aggregate revolving inter-Group loans owed by the Psychiatric Group to the Core
Group are limited to a maximum of $8,050,000 at any one time outstanding, which
limit is to be reduced dollar-for-dollar with any permanent repayment in the
future of borrowings under a revolving credit agreement provided to a
Psychiatric Group hospital operator. In addition, the limit on the aggregate
revolving inter-Group loans will not be reduced below $5,000,000, and except
for such revolving inter-Group loans, no additional fixed rate or other
inter-Group loans will be advanced by the Core Group to the Psychiatric Group.
Real Estate Properties The Core Group has the right to approve
capital expenditures at all of its properties, the option to fund certain
capital expenditures and, in certain situations, is obligated to fund approved
capital expenditures on terms comparable to the original investment. The base
and additional rent provisions of the leases are amended when such capital
expenditures are funded to reflect the Core Group's increased investment. At
June 30, 1997, the Core Group had no commitments to fund capital expenditures
pursuant to these rights and obligations.
As of June 30, 1997, the Core Group had funded $4.1 million of a $6.2
million commitment to finance the acquisition and renovation of a long-term
acute care facility in Amarillo, Texas to be operated by an experienced
operator. In addition, the Core Group had funded $3.7 million of a $4.4 million
mortgage loan to this same operator, which is secured by a long-term acute care
facility in Houston, Texas. The Core Group has also agreed to provide an
additional $9.4 million of real estate financing to this same operator for
other similar facilities.
20
<PAGE> 22
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CORE GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
As of June 30, 1997, the Core Group had funded $2.0 million of a $17
million commitment to provide construction and lease financing for two skilled
nursing properties in Las Vegas, Nevada to be operated by an experienced
operator of skilled nursing facilities.
The Core Group has agreed to provide $50 million of real estate
financing to an experienced operator of assisted living facilities.
Approximately $29 million has been specifically identified for the construction
of five properties located in four states which will be leased to the operator
upon completion.
21
<PAGE> 23
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Following is a discussion of the combined financial condition and
results of operations of the Core Group which should be read in conjunction
with (a) the combined financial statements and accompanying notes of the Core
Group and (b) management's discussion and analysis of financial condition and
results of operations and the financial statements and accompanying notes of
the Company and the Psychiatric Group included elsewhere herein.
Factors Regarding Future Results and Forward-Looking Statements
Statements that are not historical facts contained in management's discussion
and analysis of financial condition and results of operations are
forward-looking statements that involve risks and uncertainties that could
cause actual results to differ from projected results. Certain factors that
could cause actual results to differ materially include, among others: the
financial success of the operations conducted at the Core Group's facilities
and the financial strength of the operators of such facilities, the continuing
ability of operators to meet their obligations to the Core Group under existing
agreements, changes in operators or ownership of operators, the viability of
alternative uses for the Core Group's properties when necessary, changes in
government policy relating to the health care industry including reductions in
reimbursement levels under the Medicare and Medicaid programs, operators'
continued eligibility to participate in the Medicare or Medicaid programs,
reductions in reimbursement by other third-party payors, lower occupancy levels
at the Core Group's facilities, the strength and financial resources of the
Core Group's competitors, the availability and cost of capital, the Core
Group's ability to make additional real estate investments at attractive yields
and changes in tax laws and regulations affecting real estate investment
trusts. For a further discussion of such factors, see "Management's Discussion
and Analysis of Core Group Combined Financial Condition and Results of
Operations - Future Operating Results" herein.
OPERATING RESULTS
Second Quarter and Year to Date 1997 Compared With 1996
For the second quarter of 1997, the Core Group reported net income of
$11,129,000 or $.47 per share compared with net income of $9,435,000 or $.40
per share for the second quarter of 1996. For the six months ended June 30,
1997, the Core Group reported net income of $9,632,000 or $.41 per share
compared with net income of $18,754,000 or $.80 per share for the six months
ended June 30, 1996. For the six months ended June 30, 1997, the Core Group
reported net income before extraordinary item of $21,059,000 or $.89 per share,
an increase of $2,305,000 or 12% compared with net income before extraordinary
item of $18,754,000 or $.80 per share for the six months ended June 30, 1996.
Net income for the six months ended June 30, 1997 included an extraordinary
loss on debt prepayment of ($11,427,000) or ($.48) per share.
Rental income was $17,475,000 for the second quarter of 1997, an
increase of $760,000 or 5% from $16,715,000 for the second quarter of 1996.
Rental income was $34,704,000 for the six months ended June 30, 1997, an
increase of $1,272,000 or 4% from $33,432,000 for the six months ended June 30,
1996. This increase was primarily attributable to rental income from new
properties acquired subsequent to the first quarter of 1996. These property
additions also resulted in an increase in depreciation and amortization of
$169,000 or 5% to $3,701,000 for the second quarter of 1997 compared with
$3,532,000 for the second quarter of 1996 and an increase of $272,000 or 4% to
$7,343,000 for the six months ended June 30, 1997 compared with $7,071,000 for
the same period in 1996.
22
<PAGE> 24
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Additional rental and interest income was $2,980,000 for the second
quarter of 1997, an increase of $137,000 or 5% from $2,843,000 for the second
quarter of 1996. Additional rental and interest income was $5,752,000 for the
six months ended June 30, 1997, an increase of $143,000 or 3% from $5,609,000
for the six months ended June 30, 1996. The majority of this positive
variation was attributable to various properties that began paying additional
rent for the first time.
Other property income of $34,000 for the second quarter of 1997 and
the six months ended June 30, 1997 represents property operating expense
reimbursements from medical office facility tenants.
Other interest income decreased $39,000 or 20% to $157,000 for the
second quarter of 1997 from $196,000 for the second quarter of 1996. Other
interest income increased $609,000 or 127% to $1,088,000 for the six months
ended June 30, 1997 from $479,000 for the six months ended June 30, 1996. The
decrease in other interest income for the second quarter was primarily
attributable to a lower average balance of direct financing leases in 1997.
The increase in other interest income for the first six months of 1997 was
primarily attributable to higher investable cash balances, partially offset by
a lower average balance of direct financing leases. Investable cash balances
were significantly higher during the first quarter of 1997 due to the temporary
investment of a portion of the proceeds of a public debt offering in late
January 1997 until used to prepay the Company's private placement debt in late
February 1997 after the prepayment notice period had expired.
Interest income on inter-Group loans to the Psychiatric Group was
$394,000 for the second quarter of 1997, a decrease of $33,000 or 8% from
$427,000 for the second quarter of 1996. Interest income on inter-Group loans
to the Psychiatric Group was $784,000 for the six months ended June 30, 1997, a
decrease of $63,000 or 7% from $847,000 for the six months ended June 30, 1996.
This decrease reflects a lower average balance outstanding on loans to the
Psychiatric Group as a result of repayments by the Psychiatric Group from its
available undistributed cash flow.
Property operating expense was $52,000 for the second quarter of 1997,
an increase of $41,000 from $11,000 for the second quarter of 1996. Property
operating expense was $63,000 for the six months ended June 30, 1997, an
increase of $41,000 from $22,000 for the comparable period in 1996. This
increase was attributable to operating expenses associated with an investment
in a multi-tenant medical office facility during the second quarter of 1997.
Interest expense was $4,478,000 for the second quarter of 1997, a
decrease of $1,035,000 or 19% from $5,513,000 for the second quarter of 1996.
Interest expense was $10,585,000 for the six months ended June 30, 1997, a
decrease of $694,000 or 6% from $11,279,000 for the six months ended June 30,
1996. The decrease in interest expense during these periods was primarily
attributable to a lower weighted average effective interest rate on long-term
debt during 1997, partially offset by a higher amount of long-term debt and a
lower amount of capitalized interest in 1997. In late January 1997, the
Company sold $220 million of publicly-traded unsecured senior notes with a
weighted average effective interest rate of approximately 7.56%. The Company
used the proceeds of this offering to pay off the borrowings under its bank
credit agreement outstanding at the time and to prepay $152 million of 11.03%
private placement debt in late February 1997 prior to its scheduled maturity,
incurring an extraordinary charge in the first quarter of 1997 of $11,427,000.
23
<PAGE> 25
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General and administrative expenses were $1,648,000 for the second
quarter of 1997, an increase of $16,000 or 1% from $1,632,000 for the second
quarter of 1996. For the first half of 1997, general and administrative
expenses were $3,233,000, an increase of $107,000 or 3% from $3,126,000 for the
first half of 1996. This variation was attributable to an increase in the
Company's consolidated general and administrative expenses which are allocated
between the Core Group and Psychiatric Group primarily based on revenues, and
an increase in Core Group revenues relative to the Company's consolidated
revenues. The increase in the Company's consolidated general and administrative
expenses affecting the Core Group was primarily attributable to higher
compensation and benefits expense and an increase in travel expense, partially
offset by a reduction in officer hiring costs.
Future Operating Results
The operators of most of the Company's facilities derive a substantial
percentage of their total revenues from federal and state health care programs
such as Medicare and Medicaid and from other third-party payors such as private
insurance companies, self-insured employers and health maintenance
organizations. Such operators also are subject to extensive federal, state and
local government regulation relating to their operations, and the Company's
facilities are subject to periodic inspection by governmental and other
authorities to assure continued compliance with mandated procedures, licensure
requirements under state law and certification standards under the Medicare and
Medicaid programs. A reduction in reimbursement levels under the Medicare or
Medicaid programs, a reduction in reimbursement by other third-party payors or
an operator's failure to maintain its certification under Medicare or Medicaid
programs could adversely affect revenues to the Company's facilities.
The nature of health care delivery in the United States continues to
undergo change and further review at both the national and state levels.
Generally accepted goals of reform continue to include controlling costs and
improving access to medical care. Various plans to decrease the growth in
Medicare spending have been proposed by both Houses of Congress. These plans
have generally included revisions to and limits on Medicare and federal
programs providing Medicaid reimbursement to state health care programs and
potentially would have an adverse impact on the level of funds available in the
future to health care facilities. The Company's Board and management are
monitoring potential changes closely. The Company believes that these
potential changes may pose risks for certain institutions that are unwilling or
unable to respond. At the same time, the Company believes that this changing
health care environment will provide the Core Group with new opportunities for
investment.
The ongoing changes in the health care industry include trends toward
shorter lengths of hospital stay, increased use of outpatient services,
increased federal, state and third-party oversight of health care company
operations and business practices, and increased demand for discounted or
capitated health care services (delivery of services at a fixed price per
capita basis to a defined group of covered parties). Furthermore, federal,
state and third-party payors continue to propose and adopt various cost
containment measures that restrict the scope of reimbursable health care
services and limit increases in reimbursement rates for such services. Payors
also are continuing to aggressively enforce compliance with program
requirements and to pursue providers that they believe have not complied with
such requirements. Outpatient business is expected to increase as advances in
medical technologies allow more procedures to be performed on an outpatient
basis and as payors continue to direct more patients from inpatient care to
outpatient care. In addition, the entrance of insurance companies into managed
care programs is accelerating the introduction of managed care in new
24
<PAGE> 26
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
localities, and states and insurance companies continue to negotiate actively
the amounts they will pay for services. Moreover, the percentage of health
care services that are reimbursed under the Medicare and Medicaid programs
continues to increase as the population ages and as states expand their
Medicaid programs. Continued eligibility to participate in these programs is
crucial to a provider's financial strength. As a result of the foregoing, the
revenues and margins may decrease at the Core Group's facilities.
Notwithstanding the potential for increasing government regulation,
the Company believes that health care will continue to be delivered on a local
and regional basis and that well-managed, high-quality, cost-controlled
facilities will continue to be an integral part of local and regional health
care delivery systems. The Company also believes that certain acute care
hospitals will need to reconfigure or expand existing facilities or to
affiliate themselves with other providers so as to become part of comprehensive
and cost-effective health care systems. Such systems likely will include lower
cost treatment settings, such as ambulatory care clinics, outpatient surgery
centers, skilled nursing facilities and medical office buildings. In general,
the Core Group facilities are part of local or regional health care delivery
systems or are in the process of becoming integrated into such systems.
The Core Group's future operating results could be affected by the
operating performance of the Core Group's lessees and borrowers. The rental and
interest obligations of its facility operators are primarily supported by the
facility-specific operating cash flow. Real estate investments in the Core
Group's portfolio are generally further supported by one or more credit
enhancements that take the form of cross-default provisions, letters of credit,
corporate and personal guarantees, security interests in cash reserve funds,
accounts receivable or other personal property and requirements to maintain
specified financial ratios. In addition, financial effects arising from the
Psychiatric Group that affect the Company's consolidated results of operations,
financial condition or borrowing costs may also affect the results of
operations, financial condition or borrowing costs of the Core Group.
Accordingly, the Core Group's financial statements should be read in
conjunction with the financial statements of the Psychiatric Group and the
Company's consolidated financial statements.
The future operating results of the Core Group will be affected by
additional factors including the amount, timing and yield of additional real
estate investments and the competition for such investments. Operating results
also will be affected by the availability and terms of the Company's future
equity and debt financing. The Company's financing strategy to facilitate
future growth includes objectives to reduce its cost of capital over time and
enhance its liquidity and financial flexibility.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1997, the Core Group had $4,140,000 outstanding under
its revolving inter-Group loan to the Psychiatric Group. Under management
policies currently in effect, the Core Group may provide the Psychiatric Group
with revolving inter-Group loans of up to $8,050,000. In addition, as of June
30, 1997, the Core Group had $9,175,000 in fixed rate inter-Group loans to the
Psychiatric Group.
As of August 8, 1997, the Core Group had remaining commitments of
$17.1 million to fund real estate projects currently under construction over
approximately the next fifteen months. In addition, the Core Group had agreed
to provide real estate financing to two different operators aggregating
approximately $59.4 million. Of this amount, approximately $29 million has
been committed to five assisted living projects to be constructed
25
<PAGE> 27
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
during the next eighteen months. The remaining $30.4 million of financing has
not been committed to specific acquisitions or projects.
The Company has continued to increase its liquidity and enhance its
financial flexibility. In January 1997, the Company completed a $220 million
public unsecured debt offering, issuing $100 million of five-year senior notes
and $120 million of ten-year senior notes. The Company used the net proceeds
to pay off all outstanding borrowings under its $150 million bank facility at
the time and to prepay all of its $152 million of outstanding private placement
debt in late February 1997. As of August 8, 1997, the Company had $6 million of
outstanding borrowings under its revolving credit facility and had $3.8 million
in cash and short-term investments. The Company's total indebtedness as of
August 8, 1997 was $231.7 million. The Company will utilize its revolving
credit facility to fund its future Core Group acquisitions and its other
commitments. The Company may incur additional indebtedness or refinance
existing indebtedness if the Company determines that opportunities to pursue
such transactions would be attractive. The Company currently believes it has
sufficient capital to meet its commitments and that its cash flow and liquidity
will continue to be sufficient to fund current operations and to provide for
the payment of dividends to stockholders in compliance with the applicable
sections of the Internal Revenue Code governing real estate investment trusts.
26
<PAGE> 28
AMERICAN HEALTH PROPERTIES, INC.
PSYCHIATRIC GROUP COMBINED CONDENSED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
- ------------------------------------------------------------------- -------- --------
<S> <C> <C>
ASSETS (Unaudited)
Real estate investments
Real property and mortgage notes, net $ 49,659 $ 62,749
Accumulated depreciation (1,365) (4,688)
-------- --------
48,294 58,061
Other notes receivable 2,619 4,457
Other assets 632 743
- ------------------------------------------------------------------- -------- --------
$ 51,545 $ 63,261
- ------------------------------------------------------------------- -------- --------
ATTRIBUTED LIABILITIES AND TOTAL ATTRIBUTED EQUITY
Revolving loan from Core Group $ 4,140 $ 4,183
Fixed rate loan from Core Group 9,175 9,175
Dividends payable 1,313 1,667
Deferred income 29 273
- ------------------------------------------------------------------- -------- --------
14,657 15,298
- ------------------------------------------------------------------- -------- --------
Commitments and contingencies
Total Attributed Psychiatric Group Equity 36,888 47,963
- ------------------------------------------------------------------- -------- --------
$ 51,545 $ 63,261
- ------------------------------------------------------------------- -------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements.
27
<PAGE> 29
AMERICAN HEALTH PROPERTIES, INC.
PSYCHIATRIC GROUP COMBINED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
------------------ --------------------
1997 1996 1997 1996
- ------------------------------------------------------ ------ ------- -------- ------
<S> <C> <C> <C> <C>
REVENUES
Rental income $ 342 $ 365 $ 923 $ 946
Mortgage interest income 1,516 1,493 3,033 2,986
Additional rental and interest income 167 220 371 402
Other interest income 85 95 184 194
- ------------------------------------------------------ ------ ------- -------- ------
2,110 2,173 4,511 4,528
- ------------------------------------------------------ ------ ------- -------- ------
EXPENSES
Depreciation and amortization 188 186 374 372
Property operating 25 -- 25 --
Interest on loans from Core Group 394 427 784 847
General and administrative 300 326 595 643
Impairment loss on real estate
investments and other notes receivable -- -- 11,000 --
- ------------------------------------------------------ ------ ------- -------- ------
907 939 12,778 1,862
- ------------------------------------------------------ ------ ------- -------- ------
NET INCOME (LOSS) $1,203 $ 1,234 $ (8,267) $2,666
- ------------------------------------------------------ ------ ------- -------- ------
NET INCOME (LOSS) PER DEPOSITARY SHARE $ 0.57 $ 0.59 $ (3.94) $ 1.27
- ------------------------------------------------------ ------ ------- -------- ------
DIVIDENDS DECLARED PER DEPOSITARY SHARE $0.6300 $0.6500 $ 1.3800 $1.3500
- ------------------------------------------------------ ------ ------- -------- ------
WEIGHTED AVERAGE
DEPOSITARY SHARES OUTSTANDING 2,097 2,092 2,097 2,091
- ------------------------------------------------------ ------ ------- -------- ------
</TABLE>
The accompanying notes are an integral part of these financial statements.
28
<PAGE> 30
AMERICAN HEALTH PROPERTIES, INC.
PSYCHIATRIC GROUP COMBINED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
---------------------
1997 1996
- ------------------------------------------------------------------- -------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (8,267) $ 2,666
Depreciation, amortization and other non-cash items 442 435
Deferred income (18) (27)
Impairment loss on real estate
investments and other notes receivable 11,000 --
Change in other assets 108 (118)
Change in accounts payable and accrued liabilities (141) (99)
- ------------------------------------------------------------------- -------- -------
3,124 2,857
- ------------------------------------------------------------------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Principal payments on mortgage notes receivable 35 31
Other notes receivable 114 101
- ------------------------------------------------------------------- -------- -------
149 132
- ------------------------------------------------------------------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings (payments) on revolving loan from Core Group (43) 137
Dividends paid (3,230) (3,126)
- ------------------------------------------------------------------- -------- -------
(3,273) (2,989)
- ------------------------------------------------------------------- -------- -------
INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS -- --
CASH AND SHORT-TERM INVESTMENTS, BEGINNING OF PERIOD -- --
- ------------------------------------------------------------------- -------- -------
CASH AND SHORT-TERM INVESTMENTS, END OF PERIOD $ -- $ --
- ------------------------------------------------------------------- -------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
29
<PAGE> 31
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL
American Health Properties, Inc., a Delaware corporation (the Company,
which term refers to the Company and its subsidiaries unless the context
otherwise requires), is a self-administered real estate investment trust (REIT)
that commenced operations in 1987. The Company has investments in health care
properties, including acute care, rehabilitation, long-term acute care and
psychiatric hospitals, skilled nursing, assisted living and Alzheimer's care
facilities and medical office buildings.
The Company has two distinct classes of publicly-traded shares
outstanding. The Company's common stock (the Core Group Common Stock) is
intended to reflect the separate financial performance of the Company's
investments in acute care, rehabilitation and long-term acute care hospitals,
skilled nursing, assisted living and Alzheimer's care facilities and medical
office buildings (the Core Group). The Psychiatric Group Depositary Shares are
intended to reflect the separate financial performance of the Company's
investments in psychiatric hospitals (the Psychiatric Group). The capital
structure of the Company as reflected by its two classes of shares does not
affect the legal title to assets or responsibility for liabilities of the
Company, and each holder of Core Group Common Stock or Psychiatric Group
Depositary Shares is a holder of an issue of capital stock of the entire
Company and is subject to the risks associated with an investment in the
Company and all of its businesses, assets and liabilities.
Basis of Presentation The combined condensed financial statements of
the Psychiatric Group included herein have been prepared by the Company without
audit and include all normal, recurring adjustments which are, in the opinion
of management, necessary for a fair presentation of the results of operations
pursuant to the rules and regulations of the Securities and Exchange
Commission. These financial statements should be read in conjunction with
those included in the Company's annual report on Form 10-K for the year ended
December 31, 1996.
The financial statements of the Psychiatric Group include the
financial position, results of operations and cash flows of the Company's
psychiatric hospital investments, an allocated portion of the Company's general
and administrative expense, an attributed amount of inter-Group debt payable to
the Core Group and an attributed amount of the Company's stockholders' equity.
The Psychiatric Group financial statements are prepared using the amounts
included in the Company's consolidated financial statements.
Although the financial statements of the Psychiatric Group and the
Core Group separately report the assets, liabilities (including contingent
liabilities), stockholders' equity and items of income, expense and cash flow
of the Company attributed to each such Group, such attribution does not affect
the respective legal title to assets or responsibility for liabilities of the
Company or any of its subsidiaries. Furthermore, such attribution does not
affect the rights of creditors of the Company or any subsidiary, including
rights under financing covenants.
Each holder of Psychiatric Group Depositary Shares or Core Group
Common Stock is a holder of an issue of capital stock of the entire Company and
is subject to risks associated with an investment in the Company and all of its
businesses, assets and liabilities. Financial effects arising from one Group
that affect the Company's consolidated results of operations, financial
condition, cash flows or borrowing costs may
30
<PAGE> 32
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
also affect the results of operations, financial condition, cash flows or
borrowing costs of the other Group. In addition, net losses of either Group, as
well as dividends and distributions on, and repurchases of, Psychiatric Group
Depositary Shares or Core Group Common Stock will reduce the funds of the
Company legally available for dividends on both the Psychiatric Group
Depositary Shares and Core Group Common Stock. Accordingly, the Psychiatric
Group's financial statements should be read in conjunction with the Company's
consolidated financial statements and the financial statements of the Core
Group.
These financial statements include the accounts of the Psychiatric
Group business. The Psychiatric Group and the Core Group financial statements,
taken together, comprise all of the accounts included in the Company's
consolidated financial statements.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
New Accounting Standard In February 1997, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
(SFAS) No. 128, "Earnings per Share." SFAS No. 128 is intended to simplify the
computation of earnings per share (EPS) and to make the U.S. standard for
computing EPS more compatible with the EPS standards of other countries and
with that of the International Accounting Standards Committee. The effective
date for the application of SFAS No. 128 for both interim and annual periods is
after December 15, 1997. Earlier application is not permitted. Management
does not expect the application of SFAS No. 128 to have a material impact on
the Psychiatric Group's EPS calculation.
Interest Paid Interest paid by the Psychiatric Group on inter-Group
loans from the Core Group was $784,000 and $847,000 for the six months ended
June 30, 1997 and 1996, respectively.
2. DEBT
Inter-Group Loans Repayment of inter-Group loans by the Psychiatric
Group is primarily dependent upon the amount and timing of sales of the
Psychiatric Group's assets and paydowns received by the Psychiatric Group on
borrowings provided to a psychiatric hospital operator under a revolving credit
agreement. The Company's board of directors has established certain management
policies relating to the Psychiatric Group's inter-Group loans from the Core
Group. Under the policies currently in effect, which may be modified or
rescinded in the sole discretion of the Company's board of directors, the
aggregate revolving inter-Group loans owed by the Psychiatric Group to the Core
Group are limited to a maximum of $8,050,000 at any one time outstanding, which
limit is to be reduced dollar-for-dollar with any permanent repayment in the
future of borrowings under a revolving credit agreement provided to a
Psychiatric Group hospital operator. In addition, the limit on the aggregate
revolving inter-Group loans will not be reduced below $5,000,000, and except
for such revolving inter-Group loans, no additional fixed rate or other
inter-Group loans will be advanced to the Psychiatric Group by the Core Group.
31
<PAGE> 33
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
3. COMMITMENTS
Real Estate Properties The Psychiatric Group has the right to approve
capital expenditures at all of its properties and the option to fund certain
capital expenditures on terms comparable to the original investment. The base
and additional rent provisions of the leases are amended when such capital
expenditures are funded to reflect the Psychiatric Group's increased
investment. The Psychiatric Group had no commitments to fund such capital
expenditures at June 30, 1997.
4. STATUS OF PSYCHIATRIC GROUP INVESTMENTS
At the beginning of 1996, the hospital owner of the Psychiatric
Group's two Florida properties, Northpointe Behavioral Health System
(Northpointe) and The Retreat, retained the Intensive Resource Division of
Quorum Health Resources, Inc. (Quorum), a subsidiary of Quorum Health Group,
Inc., to operate both hospitals on a contract basis. The owner had previously
become aware of and was monitoring potential wide-ranging objections by several
large insurance companies with respect to claims presented for services
rendered. Additionally, there had been negative stories in the national media
and the local press in Florida on psychiatric care provided in Florida,
including criticism of admissions policies and practice patterns at psychiatric
hospitals in the state generally, and at these two hospitals. Legislative
hearings had been held in Florida on these issues, and various regulatory
investigations likely had been conducted or initiated. The hospitals were also
experiencing operational and cash flow difficulties which negatively impacted
their ability to fund their rental and interest obligations to the Psychiatric
Group as they became due.
During 1996, the Psychiatric Group modified its agreements with the
owner to allow for the deferral of rent and interest payments of Northpointe
while certain restructuring and restaffing of the facility occurred. Pursuant
to the deferral arrangements, Northpointe's monthly base rent payments of
$50,000 were deferred from February 1996 through September 1996 and such
deferred payments were scheduled to become payable twelve months from the month
of deferral. In accordance with the terms of the deferral arrangements,
Northpointe resumed making its full monthly base rent payments of $50,000 on
October 1, 1996. In addition, Northpointe's monthly interest payments of
$16,600 were deferred from February 1996 until March 1, 1997 on which date all
such deferred interest was scheduled to be paid in full. Northpointe's
deferred obligations are not recognized as income by the Psychiatric Group
until such time as they are paid.
In late 1996, the owner of Northpointe and The Retreat was named,
together with other operators of other psychiatric facilities in Florida, in a
lawsuit filed by several large insurance companies alleging widespread
irregularities with respect to operations in years prior to 1995. Adverse
publicity from the lawsuit materially exacerbated the operational and financial
difficulties of Northpointe and The Retreat during the first quarter of 1997.
During the first quarter of 1997, the census at Northpointe fell
significantly below the levels projected by the owner at the end of 1996 to a
level which made it appear unlikely that the owner could continue operations at
the facility. Although Northpointe had made its monthly base rent payments of
$50,000 during the fourth quarter of 1996 and for January 1997, it was unable
to pay its subsequent monthly base rent and interest obligations or its
deferred base rent and interest obligations. Adverse publicity from the
aforementioned lawsuit also began having a negative impact on The Retreat
resulting in declining census and deterioration of its cash flow during the
first quarter of 1997. Although The Retreat had made all of its
32
<PAGE> 34
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
rent and interest payments to the Psychiatric Group in 1996 and in 1997 through
April, The Retreat made its February 1997 base rent payment from lease reserve
funds and was unable to pay its $45,000 additional rent payment for the first
quarter of 1997 and its $92,000 base rent payment for May 1997. The volatile
circumstances at The Retreat and deterioration in cash flows and census levels
appeared likely to preclude the owner from continuing operations at the
facility. The owner of these two hospitals and the Psychiatric Group were
exploring a range of options for the facilities, including the transfer of the
hospitals to new operators, closing the facilities, conversion of the
facilities to an alternative use or sale of the properties. As a result of
this review, the Psychiatric Group recorded an $11,000,000 charge in the first
quarter of 1997 for impairment of the carrying value of these two investments.
Of this amount, $5,100,000 related to the Psychiatric Group's investment in
Northpointe and included a $1,675,000 reserve against the entire unpaid balance
under a revolving credit agreement and a $3,425,000 reduction in the carrying
value of its net real estate investment in Northpointe to its estimated fair
value of $2,000,000. The remaining impairment charge of $5,900,000 related to
the Psychiatric Group's investment in The Retreat and included a $49,000
reserve against the entire unpaid balance under a revolving credit agreement
and a $5,851,000 reduction in the carrying value of its net real estate
investment in The Retreat to its estimated fair value of $3,400,000. The
estimated fair values of these two investments were determined primarily based
upon the discounting of estimated future cash flows and fundamental analysis.
The financial and operational problems at the two Florida hospitals
continued to worsen during the second quarter of 1997, and there are ongoing
defaults by these hospitals in the performance of their financial obligations to
the Psychiatric Group. Northpointe has not made its monthly contractual rent
payments since January 1997 nor any interest payments since the January 1996
payment. In addition, the owner of the Northpointe hospital ceased operations
during the second quarter of 1997. The Psychiatric Group will incur estimated
costs of $75,000 per quarter ($.04 per depositary share) to protect and maintain
the property until a resolution is reached. The Retreat has not made its monthly
contractual base rent or interest payments since April 1997 nor any contractual
additional rent payments in 1997. Base rent paid by The Retreat in the second
quarter of 1997 represented $.04 per depositary share. Although the owner of The
Retreat hospital currently continues to operate the facility, it is unlikely
that operations can continue for any significant period of time without a change
in the owner and operator. The Psychiatric Group is continuing to explore a
range of options for the two Florida properties, including the transfer of the
hospitals to new operators, conversion of the facilities to an alternative use
or sale of the properties. Due to the complexity and time involved in
adequately evaluating its options, the Psychiatric Group has not yet reached a
decision as to its ultimate course of action. In light of the volatile
circumstances of these two properties, the Psychiatric Group cannot be assured
that further write-downs of these investments will not be required.
In the first quarter of 1996, Rock Creek Center (RCC) in Illinois
experienced certain documentation and procedural deficiencies that resulted in
the denial of a substantial amount of Medicare receivables and a substantial
negative adjustment to the hospital's 1995 Medicare cost report and 1996
interim Medicare reimbursement rate. These payor reimbursement issues,
combined with lower than expected census during the first quarter of 1996, had
an adverse impact on RCC's cash flow and its ability to fund its rental and
interest obligations to the Psychiatric Group in 1996 as they became due. The
net book value of the Psychiatric Group's investment in RCC, including advances
under existing revolving credit agreements and other receivables, as of June
30, 1997 totaled $7,834,000. Quarterly base rent and interest obligations of
RCC total approximately $330,000 ($.16 per depositary share). In 1996, the
Psychiatric Group reached an agreement with
33
<PAGE> 35
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
the operator for the deferral of base rent payments while the operator took
certain actions to stabilize operations and implemented its revised business
plan. Pursuant to the deferral arrangements, 100% of RCC's monthly base rent
payments of $83,000 were deferred for May and June of 1996 and 50% of such
monthly payments were deferred from July 1996 through October 1996, at which
time monthly base rent payments returned to 100%. Deferred base rent is
payable in the future only when the facility's cash exceeds a specified level.
RCC's deferred rent obligations are not recognized as income by the Psychiatric
Group until such time as they are paid. RCC has made all of its monthly rent
and interest payments in 1997 through August. Although the deferral
arrangements provided interim financial relief while the operator implemented
its strategy, the Psychiatric Group cannot be assured that the deferred amounts
will be paid or that RCC will not require additional financial relief in the
future.
The current term of the RCC lease expires in December 1997. The lease
agreement provides the operator with an option to renew the lease for an
additional five-year term at fair market rental. Although the Psychiatric Group
believes that the lease will be renewed, the Psychiatric Group cannot be assured
that the lease will be renewed or that, if renewed, the annual minimum rent
payments will remain at the current level of $1,000,000. Furthermore, the
$2,500,000 balance outstanding under RCC's revolving credit agreement matured
June 30, 1997. The Psychiatric Group is currently negotiating an extension of
the revolving credit agreement to correspond with the expiration of RCC's
current lease term and will negotiate further extensions in connection with
renewal of the lease. Meanwhile, the operator has continued to make interest
payments on the outstanding balance. Should the lease not be renewed or the
revolving loan not be repaid or extended, a significant negative impact to the
Psychiatric Group may result.
The two New York Four Winds facilities are working to develop an
integrated behavioral health care delivery system in lower and upper New York
state. Although such a system is intended to address the potential negative
consequences of the expected changes in Medicaid reimbursement and the increase
in managed care penetration in the state of New York, it is not possible for
the Psychiatric Group to predict the impact and timing of such changes and
whether the proposed system will be successful in that new environment.
Although management currently believes that the recorded investments
in the psychiatric hospitals are realizable, if the psychiatric operators are
unable to successfully adapt to the fundamental ongoing changes in the
psychiatric industry and consistently mitigate the negative impact of such
changes on their financial performance, the Psychiatric Group may be required
to further restructure payment obligations, identify alternative operators,
pursue alternative uses for or dispositions of the properties and/or make
additional write-downs of the value of its investments in the psychiatric
hospitals. If the Psychiatric Group is required to take any of these actions,
various costs are likely to be incurred by the Psychiatric Group in an effort
to protect, maintain and pursue alternatives for its investments. The
Psychiatric Group does not intend to make new investments, and over time, may
sell, restructure or seek other means to reduce its investments. The Company
retains an investment banking firm to provide financial advisory services to
the Psychiatric Group. These services include supplemental monitoring of the
performance of individual assets, assistance in potential sales or
restructurings of particular investments and continuing assessments of
available strategic alternatives for the portfolio. The cost of the financial
advisory services are specifically charged to the operating results of the
Psychiatric Group.
34
<PAGE> 36
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
The Psychiatric Group's dividend is determined quarterly based upon
each quarter's operating results. Historically, the level of dividends of the
Psychiatric Group have varied quarter-to-quarter. Any significant advance of
additional funds to operators of the Psychiatric Group's properties,
modification of terms covering the rental or interest obligations of its
properties or nonpayment or deferral of such obligations as they become due
likely will have an adverse impact on the Psychiatric Group results of
operations and cash flows, as well as the quarterly dividend payment on
Psychiatric Group Depositary Shares. In addition to the foregoing, future
operating results, cash flows and dividends of the Psychiatric Group will be
affected by changes in the level of additional rent and interest, the amount of
additional financial advisory fees and, to the extent necessary, various costs
which might be incurred in an effort to protect, maintain and pursue
alternatives for its investments. In light of the uncertainty surrounding the
ultimate financial outcome of the two Florida investments, it is likely that
future quarterly dividends will be adjusted downward to reflect the expected
continued loss of some or all of the income from those investments and various
costs incurred in an effort to protect, maintain and pursue alternatives for
those investments.
35
<PAGE> 37
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Following is a discussion of the combined financial condition and
results of operations of the Psychiatric Group which should be read in
conjunction with (a) the combined financial statements and accompanying notes
of the Psychiatric Group and (b) management's discussion and analysis of
financial condition and results of operations and the financial statements and
accompanying notes of the Company and the Core Group included elsewhere herein.
Factors Regarding Future Results and Forward-Looking Statements
Statements that are not historical facts contained in management's discussion
and analysis of financial condition and results of operations are
forward-looking statements that involve risks and uncertainties that could
cause actual results to differ from projected results. Certain factors that
could cause actual results to differ materially include, among others: the
financial success of the operations conducted at the Psychiatric Group's
facilities and the financial strength of the operators of such facilities, the
continuing ability of operators to meet their obligations to the Psychiatric
Group under existing or restructured agreements, changes in operators or
ownership of operators, the viability of alternative uses for the Psychiatric
Group's properties when necessary, changes in government policy relating to the
health care industry including reductions in reimbursement levels under the
Medicare and Medicaid programs, operators' continued eligibility to participate
in the Medicare or Medicaid programs, reductions in reimbursement by other
third-party payors, lower occupancy levels at the Psychiatric Group's
facilities, the availability and cost of capital and changes in tax laws and
regulations affecting real estate investment trusts. For a further discussion
of such factors, see "Management's Discussion and Analysis of Psychiatric Group
Combined Financial Condition and Results of Operations - Future Operating
Results" herein.
OPERATING RESULTS
Second Quarter and Year to Date 1997 Compared With 1996
For the second quarter of 1997, the Psychiatric Group reported net
income of $1,203,000 or $.57 per depositary share compared with net income of
$1,234,000 or $.59 per depositary share for the second quarter of 1996. For the
six months ended June 30, 1997, the Psychiatric Group reported a net loss of
($8,267,000) or ($3.94) per depositary share compared with net income of
$2,666,000 or $1.27 per depositary share for the six months ended June 30,
1996. The net loss for the six months ended June 30, 1997 included an
impairment loss on real estate investments and other notes receivable of
($11,000,000) or ($5.25) per depositary share.
Rental income was $342,000 for the second quarter of 1997, a decrease
of $23,000 or 6% from $365,000 for the second quarter of 1996. Rental income
was $923,000 for the six months ended June 30, 1997, a decrease of $23,000 or
2% from $946,000 for the comparable period in 1996. This decrease was primarily
attributable to a reduction in rental income due to the nonpayment of $183,000
of rent from an operator during the second quarter of 1997 offset by the
deferral of $167,000 of rent from a separate operator during the second quarter
of 1996.
Additional rental and interest income was $167,000 for the second
quarter of 1997, a decrease of $53,000 or 24% from $220,000 for the second
quarter of 1996. Additional rental and interest income was $371,000 for the six
months ended June 30, 1997, a decrease of $31,000 or 8% from $402,000 for the
comparable period in 1996. This decrease was primarily attributable to the
nonpayment of additional rent by one of the Florida properties during 1997.
36
<PAGE> 38
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Property operating expense of $25,000 for the second quarter of 1997
and the six months ended June 30, 1997 represents costs related to the
protection and maintenance of one of the properties in Florida after the
hospital owner ceased hospital operations during the second quarter of 1997.
Interest expense on inter-Group loans from the Core Group was $394,000
for the second quarter of 1997, a decrease of $33,000 or 8% from $427,000 for
the second quarter of 1996. Interest expense on inter-Group loans from the Core
Group was $784,000 for the six months ended June 30, 1997, a decrease of
$63,000 or 7% from $847,000 for the comparable period in 1996. This decrease
reflects a lower average balance outstanding on loans from the Core Group as a
result of repayments by the Psychiatric Group from its available undistributed
cash flow.
General and administrative expenses were $300,000 for the second
quarter of 1997, a decrease of $26,000 or 8% from $326,000 for the second
quarter of 1996. General and administrative expenses were $595,000 for the six
months ended June 30, 1997, a decrease of $48,000 or 7% from $643,000 for the
first half of 1996. The Company's consolidated general and administrative
expenses are allocated between the Core Group and Psychiatric Group primarily
based on revenues, however significant costs directly related to either Group
are specifically charged to the applicable Group. Costs allocated to the
Psychiatric Group based on revenues and direct costs charged to the Psychiatric
Group both decreased for the second quarter and first half of 1997 compared to
the comparable periods in 1996. The Psychiatric Group was specifically charged
for $132,000 and $248,000 of costs in the second quarter and first six months
of 1997, respectively, for financial advisory services provided primarily by an
investment banking firm which included supplemental monitoring of the
performance of the Psychiatric Group's properties and assistance in addressing
operational and cash flow difficulties of certain operators of the properties.
On a comparative basis, general and administrative expenses for the second
quarter and the six months ended June 30, 1996 included $145,000 and $285,000
of such financial advisory costs.
Future Operating Results
The operators of most of the Company's facilities derive a substantial
percentage of their total revenues from federal and state health care programs
such as Medicare and Medicaid and from other third-party payors such as private
insurance companies, self-insured employers and health maintenance
organizations. Such operators also are subject to extensive federal, state and
local government regulation relating to their operations, and the Company's
facilities are subject to periodic inspection by governmental and other
authorities to assure continued compliance with mandated procedures, licensure
requirements under state law and certification standards under the Medicare and
Medicaid programs. A reduction in reimbursement levels under the Medicare or
Medicaid programs, a reduction in reimbursement by other third-party payors or
an operator's failure to maintain its certification under Medicare or Medicaid
programs could adversely affect revenues to the Company's facilities.
The nature of health care delivery in the United States continues to
undergo change and further review at both the national and state levels.
Generally accepted goals of reform continue to include controlling costs and
improving access to medical care. Various plans to decrease the growth in
Medicare spending have been proposed by both Houses of Congress. These plans
have generally included revisions to and limits on Medicare and federal
programs providing Medicaid reimbursement to state health care programs and
potentially would have an adverse impact on the level of funds available in the
future to health care facilities.
37
<PAGE> 39
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's Board and management are monitoring potential changes closely.
The Company believes that these potential changes may pose risks for certain
institutions that are unwilling or unable to respond.
The ongoing changes in the health care industry include trends toward
shorter lengths of hospital stay, increased use of outpatient services,
increased federal, state and third-party oversight of health care company
operations and business practices, and increased demand for discounted or
capitated health care services (delivery of services at a fixed price per
capita basis to a defined group of covered parties). Furthermore, federal,
state and third-party payors continue to propose and adopt various cost
containment measures that restrict the scope of reimbursable health care
services and limit increases in reimbursement rates for such services. Payors
also are continuing to aggressively enforce compliance with program
requirements and to pursue providers that they believe have not complied with
such requirements. Outpatient business is expected to increase as advances in
medical technologies allow more procedures to be performed on an outpatient
basis and as payors continue to direct more patients from inpatient care to
outpatient care. In addition, the entrance of insurance companies into managed
care programs is accelerating the introduction of managed care in new
localities, and states and insurance companies continue to negotiate actively
the amounts they will pay for services. Moreover, the percentage of health
care services that are reimbursed under the Medicare and Medicaid programs
continues to increase as the population ages and as states expand their
Medicaid programs. Continued eligibility to participate in these programs is
crucial to a provider's financial strength. As a result of the foregoing, the
revenues and margins may decrease at the Psychiatric Group's facilities.
Fundamental changes in the psychiatric industry continue to negatively
impact the facility-specific operating cash flow at the Psychiatric Group's
properties. Institutions responsible for the reimbursement of care provided to
patients who use inpatient psychiatric treatment services have directed efforts
toward decreasing their payments for such services, thereby reducing hospital
operating revenues. Some cost-cutting measures used by such institutions
include decreasing the inpatient length of stay, intensively reviewing
utilization, directing patients from inpatient care to outpatient care and
negotiating reduced reimbursement rates for services. The wider use of
psychotropic drugs also has resulted in significant declines in the average
length of stay. In addition, aggressive program compliance enforcement and
increased scrutiny of past and current billing practices has resulted in the
filing of lawsuits against some providers and significant negative publicity
which has further exacerbated the financial and operational difficulties of
providers. Although the operators of the psychiatric hospitals are responding
by increasing case management, developing lower cost outpatient and daypatient
programs and reducing operating costs, their efforts are generally not
consistently mitigating the negative impact of these fundamental psychiatric
industry changes. As a result, certain of the Psychiatric Group hospital
operators have not met their contractual payment obligations to the Psychiatric
Group as scheduled and the Psychiatric Group cannot be assured that hospital
operators will be able to meet such payment obligations in the future.
In general, the operators of the Psychiatric Group's properties have
very limited access to financing for their operating and capital needs. The
Psychiatric Group currently is providing such financing under a revolving
credit agreement to the operator of one of its psychiatric properties. As of
August 8, 1997, outstanding borrowings under such agreement totaled $2,500,000.
In the past, the Psychiatric Group has provided similar financing to other
operators of its properties which have been unable to pay off their outstanding
borrowings. The Psychiatric Group cannot be assured that the operator
currently borrowing under a revolving credit agreement will be able to secure
replacement financing from third-party lenders or to pay off its outstanding
borrowings. To the extent the operators of the Psychiatric Group's
38
<PAGE> 40
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
properties have increased working capital needs in the future, the Psychiatric
Group may be the only source of such financing. In the event the Company's
Board of Directors determines that it is appropriate to provide additional
working capital financing to a psychiatric hospital operator, it may cause the
Core Group to make revolving inter-Group loans to the Psychiatric Group to fund
such financing (to the extent consistent with its then-existing policies),
although the Company's Board of Directors is under no obligation to do so.
At the beginning of 1996, the hospital owner of the Psychiatric
Group's two Florida properties, Northpointe Behavioral Health System
(Northpointe) and The Retreat, retained the Intensive Resource Division of
Quorum Health Resources, Inc. (Quorum), a subsidiary of Quorum Health Group,
Inc., to operate both hospitals on a contract basis. The owner had previously
become aware of and was monitoring potential wide-ranging objections by several
large insurance companies with respect to claims presented for services
rendered. Additionally, there had been negative stories in the national media
and the local press in Florida on psychiatric care provided in Florida,
including criticism of admissions policies and practice patterns at psychiatric
hospitals in the state generally, and at these two hospitals. Legislative
hearings had been held in Florida on these issues, and various regulatory
investigations likely had been conducted or initiated. The hospitals were also
experiencing operational and cash flow difficulties which negatively impacted
their ability to fund their rental and interest obligations to the Psychiatric
Group as they became due.
During 1996, the Psychiatric Group modified its agreements with the
owner to allow for the deferral of rent and interest payments of Northpointe
while certain restructuring and restaffing of the facility occurred. Pursuant
to the deferral arrangements, Northpointe's monthly base rent payments of
$50,000 were deferred from February 1996 through September 1996 and such
deferred payments were scheduled to become payable twelve months from the month
of deferral. In accordance with the terms of the deferral arrangements,
Northpointe resumed making its full monthly base rent payments of $50,000 on
October 1, 1996. In addition, Northpointe's monthly interest payments of
$16,600 were deferred from February 1996 until March 1, 1997 on which date all
such deferred interest was scheduled to be paid in full. Northpointe's
deferred obligations are not recognized as income by the Psychiatric Group
until such time as they are paid.
In late 1996, the owner of Northpointe and The Retreat was named,
together with other operators of other psychiatric facilities in Florida, in a
lawsuit filed by several large insurance companies alleging widespread
irregularities with respect to operations in years prior to 1995. Adverse
publicity from the lawsuit materially exacerbated the operational and financial
difficulties of Northpointe and The Retreat during the first quarter of 1997.
During the first quarter of 1997, the census at Northpointe fell
significantly below the levels projected by the owner at the end of 1996 to a
level which made it appear unlikely that the owner could continue operations at
the facility. Although Northpointe had made its monthly base rent payments of
$50,000 during the fourth quarter of 1996 and for January 1997, it was unable
to pay its subsequent monthly base rent and interest obligations or its
deferred base rent and interest obligations. Adverse publicity from the
aforementioned lawsuit also began having a negative impact on The Retreat
resulting in declining census and deterioration of its cash flow during the
first quarter of 1997. Although The Retreat had made all of its rent and
interest payments to the Psychiatric Group in 1996 and in 1997 through April,
The Retreat made its February 1997 base rent payment from lease reserve funds
and was unable to pay its $45,000 additional rent payment for the first quarter
of 1997 and its $92,000 base rent payment for May 1997. The volatile
circumstances at The Retreat and deterioration in cash flows and census levels
appeared likely to preclude
39
<PAGE> 41
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
the owner from continuing operations at the facility. The owner of these two
hospitals and the Psychiatric Group were exploring a range of options for the
facilities, including the transfer of the hospitals to new operators, closing
the facilities, conversion of the facilities to an alternative use or sale of
the properties. As a result of this review, the Psychiatric Group recorded an
$11,000,000 charge in the first quarter of 1997 for impairment of the carrying
value of these two investments. Of this amount, $5,100,000 related to the
Psychiatric Group's investment in Northpointe and included a $1,675,000 reserve
against the entire unpaid balance under a revolving credit agreement and a
$3,425,000 reduction in the carrying value of its net real estate investment in
Northpointe to its estimated fair value of $2,000,000. The remaining
impairment charge of $5,900,000 related to the Psychiatric Group's investment
in The Retreat and included a $49,000 reserve against the entire unpaid balance
under a revolving credit agreement and a $5,851,000 reduction in the carrying
value of its net real estate investment in The Retreat to its estimated fair
value of $3,400,000.
The financial and operational problems at the two Florida hospitals
continued to worsen during the second quarter of 1997, and there are ongoing
defaults by these hospitals in the performance of their financial obligations to
the Psychiatric Group. Northpointe has not made its monthly contractual rent
payments since January 1997 nor any interest payments since the January 1996
payment. In addition, the owner of the Northpointe hospital ceased operations
during the second quarter of 1997. The Psychiatric Group will incur estimated
costs of $75,000 per quarter ($.04 per depositary share) to protect and maintain
the property until a resolution is reached. The Retreat has not made its
monthly contractual base rent or interest payments since April 1997 nor any
contractual additional rent payments in 1997. Base rent paid by The Retreat in
the second quarter of 1997 represented $.04 per depositary share. Although the
owner of The Retreat hospital currently continues to operate the facility, it is
unlikely that operations can continue for any significant period of time without
a change in the owner and operator. The Psychiatric Group is continuing to
explore a range of options for the two Florida properties, including the
transfer of the hospitals to new operators, conversion of the facilities to an
alternative use or sale of the properties. Due to the complexity and time
involved in adequately evaluating its options, the Psychiatric Group has not yet
reached a decision as to its ultimate course of action. In light of the
volatile circumstances of these two properties, the Psychiatric Group cannot be
assured that further write-downs of these investments will not be required.
In the first quarter of 1996, Rock Creek Center (RCC) in Illinois
experienced certain documentation and procedural deficiencies that resulted in
the denial of a substantial amount of Medicare receivables and a substantial
negative adjustment to the hospital's 1995 Medicare cost report and 1996
interim Medicare reimbursement rate. These payor reimbursement issues,
combined with lower than expected census during the first quarter of 1996, had
an adverse impact on RCC's cash flow and its ability to fund its rental and
interest obligations to the Psychiatric Group in 1996 as they became due. The
net book value of the Psychiatric Group's investment in RCC, including advances
under existing revolving credit agreements and other receivables, as of June
30, 1997 totaled $7,834,000. Quarterly base rent and interest obligations of
RCC total approximately $330,000 ($.16 per depositary share). In 1996, the
Psychiatric Group reached an agreement with the operator for the deferral of
base rent payments while the operator took certain actions to stabilize
operations and implemented its revised business plan. Pursuant to the deferral
arrangements, 100% of RCC's monthly base rent payments of $83,000 were deferred
for May and June of 1996 and 50% of such monthly payments were deferred from
July 1996 through October 1996, at which time monthly base rent payments
returned to 100%. Deferred base rent is payable in the future only when the
facility's cash exceeds a specified level. RCC's deferred rent obligations are
not recognized as income by the Psychiatric Group until such time as they are
paid. RCC has made all of its monthly rent and interest payments in 1997
through August. Although the
40
<PAGE> 42
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
deferral arrangements provided interim financial relief while the operator
implemented its strategy, the Psychiatric Group cannot be assured that the
deferred amounts will be paid or that RCC will not require additional financial
relief in the future.
The current term of the RCC lease expires in December 1997. The lease
agreement provides the operator with an option to renew the lease for an
additional five-year term at fair market rental. Although the Psychiatric Group
believes that the lease will be renewed, the Psychiatric Group cannot be assured
that the lease will be renewed or that, if renewed, the annual minimum rent
payments will remain at the current level of $1,000,000. Furthermore, the
$2,500,000 balance outstanding under RCC's revolving credit agreement matured
June 30, 1997. The Psychiatric Group is currently negotiating an extension of
the revolving credit agreement to correspond with the expiration of RCC's
current lease term and will negotiate further extensions in connection with
renewal of the lease. Meanwhile, the operator has continued to make interest
payments on the outstanding balance. Should the lease not be renewed or the
revolving loan not be repaid or extended, a significant negative impact to the
Psychiatric Group may result.
The two New York Four Winds facilities are working to develop an
integrated behavioral health care delivery system in lower and upper New York
state. Although such a system is intended to address the potential negative
consequences of the expected changes in Medicaid reimbursement and the increase
in managed care penetration in the state of New York, it is not possible for
the Psychiatric Group to predict the impact and timing of such changes and
whether the proposed system will be successful in that new environment.
Although management currently believes that the recorded investments
in the psychiatric hospitals are realizable, if the psychiatric operators are
unable to successfully adapt to the fundamental ongoing changes in the
psychiatric industry and consistently mitigate the negative impact of such
changes on their financial performance, the Psychiatric Group may be required
to further restructure payment obligations, identify alternative operators,
pursue alternative uses for or dispositions of the properties and/or make
additional write-downs of the value of its investments in the psychiatric
hospitals. If the Psychiatric Group is required to take any of these actions,
various costs are likely to be incurred by the Psychiatric Group in an effort
to protect, maintain and pursue alternatives for its investments. The
Psychiatric Group does not intend to make new investments, and over time, may
sell, restructure or seek other means to reduce its investments. The Company
retains an investment banking firm to provide financial advisory services to
the Psychiatric Group. These services include supplemental monitoring of the
performance of individual assets, assistance in potential sales or
restructurings of particular investments and continuing assessments of
available strategic alternatives for the portfolio. The cost of the financial
advisory services are specifically charged to the operating results of the
Psychiatric Group.
The Psychiatric Group's dividend is determined quarterly based upon
each quarter's operating results. Historically, the level of dividends of the
Psychiatric Group have varied quarter-to-quarter. Any significant advance of
additional funds to operators of the Psychiatric Group's properties,
modification of terms covering the rental or interest obligations of its
properties or nonpayment or deferral of such obligations as they become due
likely will have an adverse impact on the Psychiatric Group results of
operations and cash flows, as well as the quarterly dividend payment on
Psychiatric Group Depositary Shares. In addition to the foregoing, future
operating results, cash flows and dividends of the Psychiatric Group will be
affected by changes in the level of additional rent and interest, the amount of
additional financial advisory fees and, to the extent necessary, various costs
which might be incurred in an effort to protect, maintain and pursue
alternatives for its investments. The quarterly dividend on Psychiatric Group
Depositary Shares was decreased to $.63 per share
41
<PAGE> 43
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
in the second quarter of 1997 compared to $.75 per share in the first quarter
of 1997 primarily as a result of the continuing financial and operational
problems at the two Florida hospitals. In light of the uncertainty surrounding
the ultimate financial outcome of the two Florida investments, it is likely
that future quarterly dividends will be adjusted downward to reflect the
expected continued loss of some or all of the income from those investments and
various costs incurred in an effort to protect, maintain and pursue
alternatives for those investments.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1997, the Psychiatric Group had $4,140,000 and $9,175,000
outstanding under its revolving inter- Group loan from the Core Group and its
fixed rate inter-Group loan from the Core Group, respectively. The Psychiatric
Group is required to use the net proceeds from the disposition of Psychiatric
Group assets to pay down its outstanding revolving inter-Group loan (to the
extent of the psychiatric hospital operator borrowings under revolving credit
agreements associated with the asset or assets sold) with any excess used to
pay down the balance outstanding under the fixed rate inter-Group loan. The
Company's Board of Directors has established certain management policies
relating to the Psychiatric Group's inter-Group loans from the Core Group.
Under the policies currently in effect, which may be modified or rescinded in
the sole discretion of the Company's Board of Directors, the aggregate
revolving inter-Group loans owed by the Psychiatric Group to the Core Group are
limited to a maximum of $8,050,000 at any one time outstanding, which limit is
to be reduced dollar-for-dollar with any permanent repayment in the future of
borrowings under a revolving credit agreement provided to a Psychiatric Group
hospital operator. In addition, the limit on the aggregate revolving
inter-Group loans will not be reduced below $5,000,000, and except for such
revolving inter-Group loans, no additional fixed rate or other inter-Group
loans will be advanced to the Psychiatric Group by the Core Group. The
Psychiatric Group has no third-party sources of additional financing and, as a
result, is dependent on the Core Group for all such financing. Although the
Core Group may make this financing available, there is no obligation of the
Company's Board of Directors to cause the Core Group to provide funds to the
Psychiatric Group if the Board of Directors determines that it is in the
Company's best interest not to do so. To the extent needed funds are not
advanced by the Core Group, the Psychiatric Group would experience immediate,
significant negative effects.
The Psychiatric Group does not expect to make any additional
acquisitions or capital investments except to the extent of existing unfunded
commitments under revolving credit agreements provided to facility operators.
Future dividend payments will be determined quarterly and will be primarily
dependent upon the financial performance of the Psychiatric Group. The
Psychiatric Group expects to distribute a substantial portion of its funds from
operations and net proceeds from asset dispositions, after payments of
inter-Group loan obligations, to holders of Psychiatric Group Depositary
Shares. In general, the Psychiatric Group will not retain any significant
amount of its cash flow, and as discussed above, its sources of financing and
liquidity will be limited.
42
<PAGE> 44
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Shareholders of American Health Properties, Inc. was
held on May 23, 1997 ("Annual Meeting").
(b) Not applicable.
(c) (i) At the Annual Meeting, James L. Fishel and James D. Harper, Jr., were
elected as Class I directors to serve for a three-year term until the 2000
Annual Meeting of Shareholders. Voting results for these directors are
summarized as follows:
James L. Fishel Votes For--22,683,364; Votes Withheld--156,229
James D. Harper, Jr. Votes For--22,668,571; Votes Withheld--171,024
Class II directors whose term of office continues until the 1998 Annual
Meeting of Shareholders include Royce Diener and Joseph P. Sullivan. Class
III directors whose term of office continues until the 1999 Annual Meeting
of Shareholders include Sheldon S. King, John P. Mamana, M.D. and Louis T.
Rosso.
(ii) At the Annual Meeting, shareholders approved the appointment of the
accounting firm of Arthur Andersen LLP as the auditors and as
independent public accountants for the Company for the fiscal year
ending December 31, 1997. Votes For--22,584,306; Votes
Against--69,500; Votes Abstained--185,790.
(d) Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
None.
43
<PAGE> 45
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 8, 1997
AMERICAN HEALTH PROPERTIES, INC.
By: JOSEPH P. SULLIVAN
----------------------------------------
Joseph P. Sullivan
Chairman of the Board, President &
Chief Executive Officer
(Principal Executive Officer)
By: MICHAEL J. MCGEE
----------------------------------------
Michael J. McGee
Senior Vice President &
Chief Financial Officer
(Principal Financial and
Accounting Officer)
44
<PAGE> 46
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1997
<CASH> 2,955
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> (94,102)
<TOTAL-ASSETS> 582,758
<CURRENT-LIABILITIES> 0
<BONDS> 225,723
0
2
<COMMON> 235
<OTHER-SE> 319,595
<TOTAL-LIABILITY-AND-EQUITY> 582,758
<SALES> 0
<TOTAL-REVENUES> 46,104
<CGS> 0
<TOTAL-COSTS> 7,805
<OTHER-EXPENSES> 11,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 10,585
<INCOME-PRETAX> 12,792
<INCOME-TAX> 0
<INCOME-CONTINUING> 12,792
<DISCONTINUED> 0
<EXTRAORDINARY> (11,427)
<CHANGES> 0
<NET-INCOME> 1,365
<EPS-PRIMARY> 0<F1>
<EPS-DILUTED> 0<F1>
<FN>
<F1>PRIMARY AND FULLY DILUTED EARNINGS PER SHARE ATTRIBUTABLE TO -
CORE GROUP COMMON STOCK
NET INCOME BEFORE EXTRAORDINARY ITEM $ 0.89
EXTRAORDINARY LOSS ON DEBT PREPAYMENT $ (0.48)
NET INCOME $ 0.41
PSYCHIATRIC GROUP DEPOSITARY SHARES
NET LOSS PER SHARE $ (3.94)
</FN>
</TABLE>
