<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
<TABLE>
<C> <S>
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
</TABLE>
For the quarterly period ended March 31, 1998
<TABLE>
<C> <S>
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 MAY 12, 1998 -- 24,102,415
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 MAY 12, 1998 -- 2,083,931.
================================================================================
<PAGE> 2
AMERICAN HEALTH PROPERTIES, INC.
MARCH 31, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION PAGE
<S> <C>
CONSOLIDATED COMPANY
Item 1. Consolidated Condensed Financial Statements:
Balance sheets as of March 31, 1998 and December 31, 1997 . . . . . . . . . . . . . . . . . . 2
Statements of operations for the three months ended March 31, 1998 and 1997 . . . . . . . . . 3
Statements of cash flows for the three months ended March 31, 1998 and 1997 . . . . . . . . . 4
Notes to financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Item 2. Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . 10
CORE GROUP
Item 1. Core Group Combined Condensed Financial Statements:
Balance sheets as of March 31, 1998 and December 31, 1997 . . . . . . . . . . . . . . . . . . 18
Statements of operations for the three months ended March 31, 1998 and 1997 . . . . . . . . . 19
Statements of cash flows for the three months ended March 31, 1998 and 1997 . . . . . . . . . 20
Notes to financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Item 2. Management's Discussion and Analysis of Core Group
Combined Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . 24
PSYCHIATRIC GROUP
Item 1. Psychiatric Group Combined Condensed Financial Statements:
Balance sheets as of March 31, 1998 and December 31, 1997 . . . . . . . . . . . . . . . . . . 30
Statements of operations for the three months ended March 31, 1998 and 1997 . . . . . . . . . 31
Statements of cash flows for the three months ended March 31, 1998 and 1997 . . . . . . . . . 32
Notes to financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Item 2. Management's Discussion and Analysis of Psychiatric Group
Combined Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . 38
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
</TABLE>
1
<PAGE> 3
AMERICAN HEALTH PROPERTIES, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
- --------------------------------------------------------------- --------- ---------
(Unaudited)
<S> <C> <C>
ASSETS
Real estate investments
Real property and mortgage notes, net $ 787,292 $ 745,776
Construction in progress 7,147 4,729
Accumulated depreciation (107,084) (102,235)
--------- ---------
687,355 648,270
Other notes receivable and direct financing leases 5,294 5,553
Other assets 13,848 13,696
Cash and short-term investments 3,056 23,053
- --------------------------------------------------------------- --------- ---------
$ 709,553 $ 690,572
=============================================================== ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Bank loans payable $ 15,000 $ --
Mortgage note payable 17,819 17,922
Notes and bonds payable 225,975 225,891
Accounts payable and accrued liabilities 8,980 13,193
Dividends payable 15,111 14,847
Deferred income 3,584 3,758
- --------------------------------------------------------------- --------- ---------
286,469 275,611
- --------------------------------------------------------------- --------- ---------
Commitments and contingencies
Stockholders' equity
Preferred stock $.01 par value; 1,000 shares authorized;
8-1/2% Cumulative Redeemable Preferred Stock,
Series B; $2,500 liquidation value;
40 shares issued and outstanding 100,000 100,000
Psychiatric Group Preferred Stock;
208 shares issued and outstanding 2 2
Common stock $.01 par value; 100,000 shares authorized;
23,965 and 23,557 shares issued and outstanding 239 236
Additional paid-in capital 492,885 482,030
Cumulative net income 297,276 283,453
Cumulative dividends (467,318) (450,760)
- --------------------------------------------------------------- --------- ---------
423,084 414,961
- --------------------------------------------------------------- --------- ---------
$ 709,553 $ 690,572
=============================================================== ========= =========
</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 Ended March 31,
----------------------------
1998 1997
- ---------------------------------------------------- ---------- --------
<S> <C> <C>
REVENUES
Rental income $ 21,358 $ 17,810
Mortgage interest income 1,653 1,517
Additional rental and interest income 3,420 2,976
Other property income 335 --
Other interest income 241 1,030
- ---------------------------------------------------- -------- --------
27,007 23,333
- ---------------------------------------------------- -------- --------
EXPENSES
Depreciation and amortization 4,874 3,828
Property operating 1,215 11
Interest expense 4,942 6,107
General and administrative 2,106 1,880
Impairment loss on real estate
and notes receivable -- 11,000
- ---------------------------------------------------- -------- --------
13,137 22,826
Minority interest 47 47
- ---------------------------------------------------- -------- --------
INCOME BEFORE EXTRAORDINARY ITEM 13,823 460
EXTRAORDINARY LOSS ON DEBT PREPAYMENT -- (11,427)
- ---------------------------------------------------- -------- --------
NET INCOME (LOSS) $ 13,823 $(10,967)
==================================================== ======== ========
SERIES B PREFERRED DIVIDEND REQUIREMENT $ (2,150) $ --
==================================================== ======== ========
ATTRIBUTABLE TO CORE GROUP COMMON STOCK
AND PSYCHIATRIC GROUP DEPOSITARY SHARES -
INCOME BEFORE EXTRAORDINARY ITEM $ 11,673 $ 460
======== ========
NET INCOME (LOSS) $ 11,673 $(10,967)
======== ========
ATTRIBUTABLE TO -
CORE GROUP COMMON STOCK
Income before extraordinary item $ 10,434 $ 9,930
Extraordinary loss on debt prepayment $ -- $(11,427)
Net income (loss) $ 10,434 $ (1,497)
Basic per share amounts -
Income before extraordinary item $ 0.44 $ 0.42
Extraordinary loss on debt prepayment $ -- $ (0.48)
Net income (loss) $ 0.44 $ (0.06)
Weighted average common shares 23,716 23,458
Diluted per share amounts -
Income before extraordinary item $ 0.43 $ 0.42
Extraordinary loss on debt prepayment $ -- $ (0.48)
Net income (loss) $ 0.43 $ (0.06)
Weighted average common shares and
dilutive potential common shares 23,992 23,649
Dividends declared per common share $ 0.5450 $ 0.5250
PSYCHIATRIC GROUP DEPOSITARY SHARES
Net income (loss) $ 1,239 $ (9,470)
Basic per share amounts -
Net income (loss) $ 0.59 $ (4.54)
Weighted average depositary shares 2,084 2,084
Diluted per share amounts -
Net income (loss) $ 0.59 $ (4.54)
Weighted average depositary shares and
dilutive potential depositary shares 2,102 2,084
Dividends declared per depositary share $ 0.6400 $ 0.7500
</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>
Three Months Ended March 31,
----------------------------
1998 1997
- ------------------------------------------------------ --------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 13,823 $ (10,967)
Extraordinary loss on debt prepayment -- 11,427
Depreciation, amortization and other non-cash items 5,503 4,498
Deferred income (44) (102)
Impairment loss on real estate and notes receivable -- 11,000
Change in other assets (365) (1,292)
Change in accounts payable and accrued liabilities (4,343) (1,112)
- ------------------------------------------------------ --------- ---------
14,574 13,452
- ------------------------------------------------------ --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition and construction of real estate properties (43,776) (1,733)
Mortgage note receivable fundings (179) --
Principal payments on mortgage notes receivable 21 17
Other notes receivable -- 41
Direct financing leases 259 (77)
Administrative capital expenditures (13) (1)
- ------------------------------------------------------ --------- ---------
(43,688) (1,753)
- ------------------------------------------------------ --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings (payments) on bank loans payable 15,000 (48,500)
Proceeds from notes payable issuance -- 218,965
Prepayment of notes payable -- (163,176)
Principal payments on mortgage note payable (103) --
Financing costs paid (6) (2,150)
Proceeds from sale of common stock 9,475 --
Proceeds from exercise of stock options 1,045 --
Dividends paid (16,294) (13,980)
- ------------------------------------------------------ --------- ---------
9,117 (8,841)
- ------------------------------------------------------ --------- ---------
INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS (19,997) 2,858
CASH AND SHORT-TERM INVESTMENTS, BEGINNING OF PERIOD 23,053 1,480
- ------------------------------------------------------ --------- ---------
CASH AND SHORT-TERM INVESTMENTS, END OF PERIOD $ 3,056 $ 4,338
====================================================== ========= =========
</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, Alzheimer's care and
medical office/clinic facilities.
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, Alzheimer's care and medical office/clinic facilities (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 Company's Series B Depositary Shares,
and the Series B Preferred Stock represented thereby, are attributed to the
Company's Core Group for financial accounting and reporting purposes. The
Series B Depositary Shares, and the Series B Preferred Stock represented
thereby, rank senior to the Company's Core Group Common Stock and its
Psychiatric Group Depositary Shares with respect to dividend payments and
liquidation rights. Attribution of the components of the Company's capital
structure to its Core Group and Psychiatric Group for financial accounting and
reporting purposes does not affect the legal title to assets or responsibility
for liabilities of the Company, and each holder of Core Group Common Stock,
Series B Depositary Shares 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, 1997. 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 Standards In the first quarter of 1998, the Company
adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income". SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements. The adoption of this statement had no impact on
the Company's financial statements.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", establishes standards for reporting financial and descriptive
information about reportable operating segments. In general, reportable
operating segments are components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing
performance. The required adoption in 1998 of SFAS No. 131 is not expected to
have a material impact on the Company's financial statements.
5
<PAGE> 7
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
In February 1998, the Financial Accounting Standards Board issued SFAS
No. 132, "Employer's Disclosures about Pensions and Other Post Retirement
Benefits". SFAS No. 132 revises employer's disclosures about pension and other
post retirement benefits to the extent practicable, requires additional
information on changes in the benefit obligations and fair values of plan
assets that will facilitate financial analysis, and eliminates certain
disclosures that are no longer useful. The required adoption in 1998 of SFAS
No. 132 is not expected to have a material impact on the Company's financial
statements.
Interest Paid Interest paid by the Company, net of interest
capitalized, was $8,529,000 and $5,561,000 for the three months ended March 31,
1998 and 1997, respectively. The Company had $118,000 and $107,000 of
capitalized interest for the three months ended March 31, 1998 and 1997,
respectively.
2. STOCKHOLDERS' EQUITY
Equity Offering In February 1998, the Company completed an offering
of 353,201 additional shares of Core Group Common Stock resulting in net
proceeds of approximately $9.5 million.
Stock Incentive Plans During the three months ended March 31, 1998,
options to purchase 140,424 shares of Core Group Common Stock at a weighted
average exercise price of $28.14 per share were issued pursuant to the
Company's stock incentive plans. During the three months ended March 31, 1998,
options to purchase 55,000 shares of Core Group Common Stock were exercised at
a weighted average exercise price of $19.01 per share resulting in additional
equity of $1,045,000. Options to purchase 2,000 shares of Psychiatric Group
Depositary Shares at a weighted average exercise price of $16.42 per share
expired during the three months ended March 31, 1998.
3. EARNINGS PER SHARE
The following is a reconciliation of the income and share amounts used
in the basic and diluted per share computations of income before extraordinary
item attributable to Core Group Common Stock and Psychiatric Group Depositary
Shares:
<TABLE>
<CAPTION>
Three Months Ended March 31,
------------------------------------------
1998 1997
-------------------- -------------------
(In thousands) Income Shares Income Shares
- -------------------------------------------- -------------------- -------------------
<S> <C> <C> <C> <C>
ATTRIBUTABLE TO CORE GROUP
Income before extraordinary item $ 12,584 -- $ 9,930 --
Less Series B preferred dividend requirement (2,150) -- -- --
Outstanding common shares -- 23,715 -- 23,455
Deferred common shares -- 1 -- 3
-------------------- -------------------
Basic EPS components 10,434 23,716 9,930 23,458
Effect of dilutive potential common shares
Stock options -- 145 -- 102
DERs -- 131 -- 89
Subordinated convertible bonds payable -- -- -- --
-------------------- -------------------
Diluted EPS components $ 10,434 23,992 $ 9,930 23,649
==================== ===================
</TABLE>
6
<PAGE> 8
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------------
1998 1997
----------------- ------------------
(In thousands) Income Shares Income Shares
- --------------------------------------- ----------------- ------------------
<S> <C> <C> <C> <C>
ATTRIBUTABLE TO PSYCHIATRIC GROUP
Basic EPS components $ 1,239 2,084 $(9,470) 2,084
Effect of dilutive potential
depositary shares
Stock options -- -- -- --
DERs -- 18 -- --
----------------- ------------------
Diluted EPS components $ 1,239 2,102 $(9,470) 2,084
================= ==================
</TABLE>
4. COMMITMENTS
As of March 31, 1998, the Company had funded $5.7 million of a $17
million commitment to develop two skilled nursing properties in Las Vegas,
Nevada to be operated by an experienced operator of skilled nursing facilities.
The Company has a $35 million forward funding commitment to develop up to five
assisted living facilities to be managed by an experienced operator of assisted
living facilities. As of March 31, 1998, the Company had funded $1.4 million
under this commitment for the development of two facilities having total
development costs of approximately $10 million. The Company has a similar
commitment of $22.5 million to develop up to 11 Alzheimer's care facilities to
be managed by an experienced operator of Alzheimer's care facilities. The
Company also has agreed to provide an additional $9.4 million of real estate
financing to an experienced operator of long-term acute care facilities for
which there are currently no identified projects.
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 impairment losses on psychiatric investments and the periodic
restructuring of psychiatric operator payment obligations in previous years.
The Company recorded an $11 million charge in the first quarter of 1997 for
impairment of the carrying value of its two psychiatric investments in Florida.
The Northpointe property, at which the operator ceased paying its obligations
to the Company in February 1997 and ceased hospital operations in the second
quarter of 1997, continues to remain idle. The Company incurred costs of
approximately $225,000 during the first quarter of 1998 ($.11 per Psychiatric
Group Depositary Share) to protect and maintain this property, including
approximately $150,000 for unexpected expenditures. Although on an ongoing
basis, the Company expects to incur costs of approximately $75,000 per quarter
($.04 per Psychiatric Group Depositary Share) to protect and maintain this
property while various alternatives for the property are evaluated and pursued,
there can be no assurance that other unexpected costs will not be incurred.
Early in the fourth quarter of 1997, a restructuring of The Retreat's
obligations to the Company was completed. The Retreat's restructured base rent
is $35,000 per month ($105,000 per quarter or $.05 per Psychiatric Group
Depositary Share) and additional rent will not accrue or be payable until
August 1, 2000. The Company has received the base rent payments under the
restructured terms through May 1998 but The Retreat is currently in default on
other obligations owed to the Company. Although the restructured agreement
with The Retreat was a positive step in stabilizing the cash flow and
operations of this facility, as evidenced by the current default, the Company
cannot be assured that The Retreat will be able to continue to meet its
restructured obligations or continue operations. Continued operations at The
Retreat will remain in doubt even if there is a change in the owner or operator
of the facility or if the Company provides additional financial assistance. The
Company is continuing to explore a range of options for each of 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 evaluating its options, the Company
has not yet reached a decision as to its
7
<PAGE> 9
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
ultimate course of action. In light of the volatile circumstances of these two
properties, the Company cannot be assured that further impairment losses on
these investments will not be required.
Although the $2,500,000 balance outstanding under Rock Creek Center's
(RCC) revolving credit agreement matured in June 1997 and the initial term of
the RCC lease expired in December 1997, RCC has continued to make interest
payments on the revolving credit agreement and the Company has agreed to a
short-term extension of the initial lease term to September 30, 1998 while
negotiations for a long-term renewal of the lease and repayment or extension of
the revolving credit agreement continue. Other local and national operators
have also expressed interest in the facility. RCC has met its rent and
interest obligations to the Company through May 1998, however, the Company
cannot be assured that RCC will not experience future operational and cash flow
difficulties as it has in the past. In addition, the Company cannot be assured
that a new lease will be accomplished or that, if accomplished, the minimum
rent payments will be at the current annualized level of $1,000,000. Should
the current lease not be renewed on a long-term basis or the revolving loan not
be repaid or extended with the existing operator and a facility lease with a
new operator on similar terms as the current lease is not accomplished, a
significant negative impact to the Company's Psychiatric Group likely will
result. The Company's total revenue from the RCC investment for the first
quarter of 1998 was $.17 per Psychiatric Group Depositary Share.
Both New York Four Winds facilities are continuing their plans to
develop a lower-cost integrated behavioral health care delivery system in lower
and upper New York state. Such a system is intended to create a cost-effective
response to the negative reimbursement consequences of the accelerating
movement to a managed care environment within New York. Both facilities have
recently begun contracting on a fixed-price basis for the entire behavioral
health component of various managed care contracts. The Company cannot be
assured that the facilities will be able to adequately respond to the
increasing price pressures within their markets or that their new contracts
will be profitable. In addition, it is not possible to predict the impact of
further changes in the psychiatric industry or whether the operator's system
will be successful in a managed care environment, and the Company cannot be
assured that some restructuring of the operator's obligations to the Company
will not be required for the operator to remain competitive in such an
environment. In addition, the interest rate on the Four Winds Hospital -
Saratoga mortgage note will be reset in June 1999, if extended, to the lesser
of (i) 325 basis points over the ten-year treasury rate at that time or (ii)
various indexed rates for various reset periods specified in the note agreement
and selected by the borrower during the first two years of the extension term.
If reset at March 31, 1998, the interest rate on the note would have been
approximately 9.0% and would have a negative impact on total revenue of the
Company's Psychiatric Group of approximately $.30 per Psychiatric Group
Depositary Share on an annual basis.
Although management currently believes that the recorded amounts of
its psychiatric investments are realizable, if the psychiatric operators are
unable to adapt to the fundamental ongoing changes in the psychiatric industry
successfully and consistently mitigate the negative impact of the ongoing
changes on their financial performance, the Company may be required to
restructure payment obligations further, identify alternative operators, pursue
alternative uses for or dispositions of the properties and/or recognize
additional impairment losses on its psychiatric investments. 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 currently 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. In addition, the
Company continues to encourage each of the psychiatric operators to pursue
financing alternatives which might enable them to acquire the properties and/or
repay their borrowings from the Company, as the case may be. Subject to the
rights of the holders of the Company's Series B Depositary Shares, and the
Series B Preferred Stock represented thereby, and any other preferred stock of
the Company then outstanding, the Company expects to use the net
8
<PAGE> 10
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
proceeds of any future psychiatric property sales and/or psychiatric operator
borrowing repayments to first repay then outstanding inter-Group loans and/or
other liabilities owed by the Psychiatric Group and to distribute all remaining
net proceeds, if any, in cash or Core Group Common Stock to holders of
Psychiatric Group Depositary Shares. The Company cannot be assured that the
efforts of psychiatric operators to obtain alternative financing will be
successful or, if successful, that the amounts of such financing would be
sufficient to enable the Company to realize the carrying amounts of its
psychiatric investments.
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 on 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, interest rate adjustments on mortgage
notes receivable, 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.
9
<PAGE> 11
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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, Alzheimer's care and medical office/clinic facilities (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 Company's Series B Depositary Shares,
and the Series B Preferred Stock represented thereby, are attributed to the
Company's Core Group for financial accounting and reporting purposes. The
Series B Depositary Shares, and the Series B Preferred Stock represented
thereby, rank senior to the Company's Core Group Common Stock and its
Psychiatric Group Depositary Shares with respect to dividend payments and
liquidation rights. Attribution of the components of the Company's capital
structure to its Core Group and Psychiatric Group for financial accounting and
reporting purposes does not affect the legal title to assets or responsibility
for liabilities of the Company, and each holder of Core Group Common Stock,
Series B Depositary Shares 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 This
report includes and incorporates by reference statements that are not purely
historical and are "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, including statements regarding the
Company's expectations, beliefs, intentions or strategies regarding the future.
All statements other than historical fact contained in this report, including
without limitation statements regarding rent or interest to be received from
the Company's operators and tenants, plans with respect to individual
facilities, expectations with respect to the specific terms and renewals of
leases of the Company's facilities, the Company's anticipated dividend payout
ratios, the Company's liquidity position, projected expenses associated with
operating or maintaining individual properties, the Company's ability to
realize the recorded amounts of its investments and the potential effect of new
or existing regulations on the operations conducted at the Company's
facilities, are forward- looking statements. All forward-looking statements
included or incorporated by reference in this report are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update such forward-looking statements. Although the Company
believes that the assumptions and expectations reflected in such forward-
looking statements are reasonable, it can give no assurance that such
expectations will prove to have been correct or that the Company will take any
actions that may presently be planned.
Certain factors that could cause actual results to differ materially
from those expected include, among others: the financial success of the
operations conducted at the Company's facilities and the financial strength of
the operators and tenants of such facilities, the continuing ability of
operators and tenants 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' and tenants' continued eligibility to participate in the Medicare or
Medicaid programs, reductions in reimbursement by other third- party payors,
the impact of managed care pricing pressures, the requirement to provide care
on a fixed-price basis, lower occupancy levels at the Company's facilities, a
downturn in market lease rates for medical office space, higher than expected
costs associated with the maintenance and operation of the Company's medical
office/clinic facilities, higher than
10
<PAGE> 12
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
expected turnover at the Company's medical office/clinic facilities, a
reduction in demand for the services provided 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 certain of
these factors, see "- Future Operating Results" herein.
OPERATING RESULTS
First Quarter 1998 Compared With 1997
For the first quarter of 1998, the Company reported income before
extraordinary item attributable to Core Group Common Stock and Psychiatric
Group Depositary Shares of $11,673,000 compared with $460,000 for the first
quarter of 1997, which included an impairment loss on psychiatric investments
of ($11,000,000). For the first quarter of 1998, the Company reported net
income attributable to Core Group Common Stock and Psychiatric Group Depositary
Shares of $11,673,000 compared with a net loss of ($10,967,000) for the first
quarter of 1997. An extraordinary loss on debt prepayment of ($11,427,000) was
reported in the first quarter of 1997. See the Consolidated Condensed
Statements of Operations for the comparative gross and per share amounts
attributable to the Core Group Common Stock and the Psychiatric Group
Depositary Shares.
Rental income was $21,358,000 for the first quarter of 1998, an
increase of $3,548,000 or 20% from $17,810,000 for the first quarter of 1997.
This increase was primarily attributable to rental income from new Core Group
properties acquired subsequent to the first quarter of 1997. These property
additions also resulted in an increase in depreciation and amortization of
$1,046,000 or 27% to $4,874,000 for the first quarter of 1998 compared with
$3,828,000 for the first quarter of 1997.
Mortgage interest income was $1,653,000 for the first quarter of 1998,
an increase of $136,000 or 9% from $1,517,000 in 1997. This increase was
primarily attributable to the funding of a mortgage note receivable in the
second quarter of 1997.
Additional rental and interest income was $3,420,000 for the first
quarter of 1998, an increase of $444,000 or 15% from $2,976,000 for the first
quarter of 1997. This net increase was attributable to increases in additional
rent of $340,000 from acute care properties and $24,000 from long-term care
properties and an increase of $90,000 in additional rent and interest from
psychiatric properties, partially offset by a $10,000 decrease in additional
rent from rehabilitation properties.
Other property income of $335,000 for the first quarter of 1998
primarily represents property operating expense reimbursements and parking
revenue from medical office/clinic facility tenants.
Other interest income decreased $789,000 or 77% to $241,000 for the
first quarter of 1998 from $1,030,000 for the first quarter of 1997. This
decrease was primarily attributable to lower investable cash balances and a
lower average balance of direct financing leases during the first quarter of
1998 compared to the first quarter of 1997. 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 $1,215,000 for the first quarter of
1998, an increase of $1,204,000 from $11,000 for the first quarter of 1997.
Approximately $979,000 of this increase was attributable to operating expenses
of Core Group medical office/clinic facilities acquired subsequent to the first
quarter of 1997 and
11
<PAGE> 13
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
$225,000 was attributable to costs related to the protection and maintenance of
a closed psychiatric property in Florida, including approximately $150,000 for
unexpected expenditures.
Interest expense was $4,942,000 for the first quarter of 1998, a
decrease of $1,165,000 or 19% from $6,107,000 for the first quarter of 1997.
This decrease in interest expense was primarily attributable to a lower
weighted average effective interest rate on long-term debt during the first
quarter of 1998, partially offset by a higher amount of long- term debt. 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 facility 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 $2,106,000 for the first
quarter of 1998, an increase of $226,000 or 12% from $1,880,000 for the first
quarter of 1997. This variation was primarily attributable to hiring of
additional personnel, higher compensation and benefits expense and an increase
in travel expense, partially offset by a reduction in financial advisory
services provided to the Psychiatric Group.
Future Operating Results
The operators and tenants 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 and tenants also are subject to
extensive federal, state and local government regulation relating to their
operations, and most of 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 or tenant'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 and passed by both Houses of Congress.
These plans generally include revisions to and limits on Medicare and federal
programs providing Medicaid reimbursement to state health care programs and
have had and potentially would have an adverse impact on the level of funds
available in the future to health care facilities. The Balanced Budget Act of
1997 contains extensive changes to the Medicare and Medicaid programs intended
to reduce the projected amount of increase in Medicare spending by an estimated
$115 billion and Medicaid spending by an estimated $13 billion over five years.
In addition, the Budget Act repealed certain limits on states' ability to
reduce their Medicaid reimbursement levels. The Budget Act has the potential to
reduce significantly federal spending on health care services provided at each
of the Company's facilities and provided by the physician tenants of the
Company's medical office/clinic facilities, and to affect revenues of the
Company's operators and tenants adversely. In particular, the Budget Act's
limitations on reimbursable costs and reductions in payment incentives and
capital related payments, as well as the change toward a prospective payment
system, may have a material adverse effect on operator revenues at the
Company's rehabilitation, long-term acute care, and psychiatric hospitals. The
Budget Act's freeze on acute care hospital reimbursement rates may also have an
adverse effect on the operator revenues at the Company's acute care hospitals.
In addition, the prospective payment system imposed by the Budget Act on the
operators of the Company's skilled nursing facilities may have a material
adverse effect on the operator revenues at such facilities if the operators are
unable to effectively respond to the financial
12
<PAGE> 14
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
incentives provided by the prospective payment system. The Company cannot be
assured that the changes effected by the Budget Act will not have a material
adverse effect on the Company's financial condition or results of operation.
The Company's Board and management are monitoring the effect of the
Budget Act on the Company's facilities and potential changes to reimbursement
programs closely. The Company believes that the changes effected by the Budget
Act and changes proposed at the federal and state level 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 enforce compliance with program requirements
aggressively 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. States are also expanding their
Medicaid programs. Continued eligibility to participate in these programs is
crucial to a provider's financial strength. As a result of the foregoing,
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, long-term acute care hospitals, skilled nursing facilities, assisted
living and Alzheimer's care facilities and medical office/clinic facilities.
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.
Aggregate revenues from five leases maturing in February 1999
accounted for 38% of the Company's total revenues in 1997. Four of these
properties are leased to subsidiaries of American Medical International, Inc.
(AMI), a subsidiary of Tenet Healthcare Corporation, and the other property is
leased to a subsidiary of Columbia/HCA Healthcare Corporation (Columbia). Each
such lease grants the operator options, exercisable on not less than six months
notice, to extend the term of the lease for eight consecutive five-year renewal
terms. Base
13
<PAGE> 15
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
and additional rent during the first three to four extended terms would be on
the same terms and conditions as the current initial term. Minimum rent during
the final four to five extended terms would be fair market rental but without
separate additional rent. Each lease also grants the operator options,
exercisable on not less than six months notice, to purchase the leased property
at fair market value at the expiration of any term of the lease. If these
leases are not renewed and the current operators do not exercise their options
to purchase the properties, the Company will be required to seek new operators
for the properties. Based on various factors, including an assessment of the
operational and financial performance of the tenant hospitals, management of
the Company currently believes that exercise of the lease renewal options for
these facilities by AMI and Columbia is the most likely outcome, however, until
actual notice of exercise is received, such an outcome is not certain.
Fundamental changes in the psychiatric industry continue to impact
negatively 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 consistently 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 Psychiatric Group's properties have
very limited access to financing for their operating and capital needs. To the
extent the psychiatric hospitals 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 impairment losses on psychiatric investments and the periodic
restructuring of psychiatric operator payment obligations in previous years.
The Company recorded an $11 million charge in the first quarter of 1997 for
impairment of the carrying value of its two psychiatric investments in Florida.
The Northpointe property, at which the operator ceased paying its obligations
to the Company in February 1997 and ceased hospital operations in the second
quarter of 1997, continues to remain idle. The Company incurred costs of
approximately $225,000 during the first quarter of 1998 ($.11 per Psychiatric
Group Depositary Share) to protect and maintain this property, including
approximately $150,000 for unexpected expenditures. Although on an ongoing
basis, the Company expects to incur costs of approximately $75,000 per quarter
($.04 per Psychiatric Group Depositary Share) to protect and maintain this
property while various alternatives for the property are evaluated and pursued,
there can be no assurance that other unexpected costs will not be incurred.
Early in the fourth quarter of 1997, a restructuring of The Retreat's
obligations to the Company was completed. The Retreat's restructured base rent
is $35,000 per month ($105,000 per quarter or $.05 per Psychiatric Group
Depositary Share) and additional rent will not accrue or be payable until
August 1, 2000. The Company has received the base rent payments under the
restructured terms through May 1998 but The Retreat is currently in default on
other obligations owed to the Company. Although the restructured agreement
with The Retreat was a positive step in stabilizing the cash flow and
operations of this facility, as evidenced by the current default, the Company
cannot be assured that The Retreat will be able to continue to meet its
restructured obligations or continue operations. Continued operations at The
Retreat will remain in doubt even if there is a
14
<PAGE> 16
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
change in the owner or operator of the facility or if the Company provides
additional financial assistance. The Company is continuing to explore a range
of options for each of 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
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 impairment losses on
these investments will not be required.
Although the $2,500,000 balance outstanding under Rock Creek Center's
(RCC) revolving credit agreement matured in June 1997 and the initial term of
the RCC lease expired in December 1997, RCC has continued to make interest
payments on the revolving credit agreement and the Company has agreed to a
short-term extension of the initial lease term to September 30, 1998 while
negotiations for a long-term renewal of the lease and repayment or extension of
the revolving credit agreement continue. Other local and national operators
have also expressed interest in the facility. RCC has met its rent and interest
obligations to the Company through May 1998, however, the Company cannot be
assured that RCC will not experience future operational and cash flow
difficulties as it has in the past. In addition, the Company cannot be assured
that a new lease will be accomplished or that, if accomplished, the minimum rent
payments will be at the current annualized level of $1,000,000. Should the
current lease not be renewed on a long-term basis or the revolving loan not be
repaid or extended with the existing operator and a facility lease with a new
operator on similar terms as the current lease is not accomplished, a
significant negative impact to the Company's Psychiatric Group likely will
result. The Company's total revenue from the RCC investment for the first
quarter of 1998 was $.17 per Psychiatric Group Depositary Share.
Both New York Four Winds facilities are continuing their plans to
develop a lower-cost integrated behavioral health care delivery system in lower
and upper New York state. Such a system is intended to create a cost-effective
response to the negative reimbursement consequences of the accelerating
movement to a managed care environment within New York. Both facilities have
recently begun contracting on a fixed-price basis for the entire behavioral
health component of various managed care contracts. The Company cannot be
assured that the facilities will be able to adequately respond to the
increasing price pressures within their markets or that their new contracts
will be profitable. In addition, it is not possible to predict the impact of
further changes in the psychiatric industry or whether the operator's system
will be successful in a managed care environment, and the Company cannot be
assured that some restructuring of the operator's obligations to the Company
will not be required for the operator to remain competitive in such an
environment. In addition, the interest rate on the Four Winds Hospital -
Saratoga mortgage note will be reset in June 1999, if extended, to the lesser
of (i) 325 basis points over the ten-year treasury rate at that time or (ii)
various indexed rates for various reset periods specified in the note agreement
and selected by the borrower during the first two years of the extension term.
If reset at March 31, 1998, the interest rate on the note would have been
approximately 9.0% and would have a negative impact on total revenue of the
Company's Psychiatric Group of approximately $.30 per Psychiatric Group
Depositary Share on an annual basis.
Although management currently believes that the recorded amounts of
its psychiatric investments are realizable, if the psychiatric operators are
unable to adapt to the fundamental ongoing changes in the psychiatric industry
successfully and consistently mitigate the negative impact of the ongoing
changes on their financial performance, the Company may be required to
restructure payment obligations further, identify alternative operators, pursue
alternative uses for or dispositions of the properties and/or recognize
additional impairment losses on its psychiatric investments. 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 currently 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. In addition, the
Company continues to encourage each of the psychiatric operators to pursue
financing alternatives which might enable them
15
<PAGE> 17
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
to acquire the properties and/or repay their borrowings from the Company, as
the case may be. Subject to the rights of the holders of the Company's Series B
Depositary Shares, and the Series B Preferred Stock represented thereby, and
any other preferred stock of the Company then outstanding, the Company expects
to use the net proceeds of any future psychiatric property sales and/or
psychiatric operator borrowing repayments to first repay then outstanding
inter-Group loans and/or other liabilities owed by the Psychiatric Group and to
distribute all remaining net proceeds, if any, in cash or Core Group Common
Stock to holders of Psychiatric Group Depositary Shares. The Company cannot be
assured that the efforts of psychiatric operators to obtain alternative
financing will be successful or, if successful, that the amounts of such
financing would be sufficient to enable the Company to realize the carrying
amounts of its psychiatric investments.
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 on 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, interest rate adjustments on mortgage
notes receivable, 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 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.
Many existing information systems currently record years in a
two-digit format and will be unable to properly interpret dates beyond the year
1999 which could lead to business disruptions (the Year 2000 Issue). The
Company is currently upgrading its internal information systems in the normal
course of business and does not expect the Year 2000 Issue to have a material
impact on the Company's future operations or financial results. However, the
Company's future operations could be disrupted and/or its financial results
could be negatively impacted by the Year 2000 Issue if the Company's lessees
and borrowers do not adequately address the Year 2000 Issue with respect to
their information systems. As health care providers, the Company's lessees and
borrowers generally rely extensively on information systems, including systems
for capturing patient and cost information and for billing and collecting
reimbursement for health care services provided. Furthermore, the Company's
lessees and borrowers likewise are dependent on a variety of third parties who
must also adequately address the Year 2000 Issue, including private and
government payors. Although, the Company believes that its lessees and
borrowers are generally addressing their Year 2000 Issues, it is not possible
for the Company to determine or be assured that adequate remediation of the
Year 2000 Issue will be accomplished by such lessees and borrowers.
Furthermore, it is not possible for the Company to determine or be assured that
the various payors and other third parties upon which the Company's lessees and
borrowers are dependent for reimbursement and information will accomplish
adequate remediation of their Year 2000 Issues. Accordingly, although the
Company believes that the impact of the Year 2000 Issue, as it relates to its
internal information systems, will not be material, the Company cannot be
assured that the Year 2000 Issues of its lessees and borrowers, and the third
parties upon which they are dependent, will not have a material impact on the
Company's future operations and/or financial results.
16
<PAGE> 18
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
As of May 12, 1998, the Company had a remaining commitment of
approximately $10.5 million to fund the development of two skilled nursing
facilities. In addition, the Company had a $35 million forward funding
commitment to develop up to five assisted living facilities to be managed by an
experienced operator of assisted living facilities. As of May 12, 1998, $1.7
million has been funded under this commitment for the development of two
facilities having total development costs of approximately $10 million. The
Company has a similar commitment of $22.5 million to develop up to 11
Alzheimer's care facilities to be managed by an experienced operator of
Alzheimer's care facilities. The Company also has agreed to provide an
additional $9.4 million of real estate financing to an experienced operator of
long-term acute care facilities for which there are currently no identified
projects.
The Company has continued to increase its liquidity and enhance its
financial flexibility. In October 1997, the Company completed a $100 million
preferred equity offering and used the net proceeds to pay off all outstanding
borrowings under its bank credit facility at the time and used the remaining
proceeds to fund Core Group investments. In December 1997, the Company closed
on a new $250 million unsecured revolving bank credit facility which matures on
December 31, 2000. In February 1998, the Company completed an offering of
353,201 additional shares of Core Group Common Stock resulting in net proceeds
of approximately $9.5 million. As of May 12, 1998, the Company had $7.0
million of outstanding borrowings under its $250 million bank credit facility
and had $.7 million in cash and short-term investments. The Company's total
indebtedness as of May 12, 1998 was $251.8 million. The Company expects to
utilize its bank 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.
17
<PAGE> 19
AMERICAN HEALTH PROPERTIES, INC.
CORE GROUP COMBINED CONDENSED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
- --------------------------------------------------------------- --------- ---------
(Unaudited)
<S> <C> <C>
ASSETS
Real estate investments
Real property and mortgage notes, net $ 737,691 $ 696,154
Construction in progress 7,147 4,729
Accumulated depreciation (105,154) (100,493)
--------- ---------
639,684 600,390
Direct financing leases 2,794 3,053
Revolving loan to Psychiatric Group 2,801 3,379
Fixed rate loan to Psychiatric Group 9,175 9,175
Other assets 13,234 13,082
Cash and short-term investments 3,056 23,053
- --------------------------------------------------------------- --------- ---------
$ 670,744 $ 652,132
=============================================================== ========= =========
ATTRIBUTED LIABILITIES AND TOTAL ATTRIBUTED EQUITY
Bank loans payable $ 15,000 $ --
Mortgage note payable 17,819 17,922
Notes and bonds payable 225,975 225,891
Accounts payable and accrued liabilities 8,151 12,760
Dividends payable 13,777 13,555
Deferred income 3,566 3,736
- --------------------------------------------------------------- --------- ---------
284,288 273,864
- --------------------------------------------------------------- --------- ---------
Commitments and contingencies
Total Attributed Core Group Equity 386,456 378,268
- --------------------------------------------------------------- --------- ---------
$ 670,744 $ 652,132
=============================================================== ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
18
<PAGE> 20
AMERICAN HEALTH PROPERTIES, INC.
CORE GROUP COMBINED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
1998 1997
- ------------------------------------------------- -------- --------
<S> <C> <C>
REVENUES
Rental income $ 21,003 $ 17,229
Mortgage interest income 113 --
Additional rental income 3,126 2,772
Other property income 335 --
Other interest income 161 931
Interest income on loans to Psychiatric Group 365 390
- ------------------------------------------------- -------- --------
25,103 21,322
- ------------------------------------------------- -------- --------
EXPENSES
Depreciation and amortization 4,686 3,642
Property operating 990 11
Interest expense 4,942 6,107
General and administrative 1,854 1,585
- ------------------------------------------------- -------- --------
12,472 11,345
Minority interest 47 47
- ------------------------------------------------- -------- --------
INCOME BEFORE EXTRAORDINARY ITEM 12,584 9,930
EXTRAORDINARY LOSS ON DEBT PREPAYMENT -- (11,427)
- ------------------------------------------------- -------- --------
NET INCOME (LOSS) $ 12,584 $ (1,497)
================================================= ======== ========
SERIES B PREFERRED DIVIDEND REQUIREMENT $ (2,150) $ --
- ------------------------------------------------- ======== ========
ATTRIBUTABLE TO CORE GROUP COMMON STOCK -
INCOME BEFORE EXTRAORDINARY ITEM $ 10,434 $ 9,930
======== ========
NET INCOME (LOSS) $ 10,434 $ (1,497)
======== ========
Basic per share amounts -
Income before extraordinary item $ 0.44 $ 0.42
Extraordinary loss on debt prepayment $ -- $ (0.48)
Net income (loss) $ 0.44 $ (0.06)
Weighted average common shares 23,716 23,458
Diluted per share amounts -
Income before extraordinary item $ 0.43 $ 0.42
Extraordinary loss on debt prepayment $ -- $ (0.48)
Net income (loss) $ 0.43 $ (0.06)
Weighted average common shares and
dilutive potential common shares 23,992 23,649
Dividends declared per common share $ 0.5450 $ 0.5250
</TABLE>
The accompanying notes are an integral part of these financial statements.
19
<PAGE> 21
AMERICAN HEALTH PROPERTIES, INC.
CORE GROUP COMBINED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
1998 1997
- -------------------------------------------------------------------- --------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 12,584 $ (1,497)
Extraordinary loss on debt prepayment -- 11,427
Depreciation, amortization and other non-cash items 5,285 4,278
Deferred income (40) (89)
Change in other assets (365) (1,339)
Change in accounts payable and accrued liabilities (4,739) (971)
- -------------------------------------------------------------------- --------- ---------
12,725 11,809
- -------------------------------------------------------------------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition and construction of real estate properties (43,776) (1,733)
Mortgage note receivable fundings (179) --
Direct financing leases 259 (77)
Paydowns on revolving loan to Psychiatric Group 578 34
Administrative capital expenditures (13) (1)
- -------------------------------------------------------------------- --------- ---------
(43,131) (1,777)
- -------------------------------------------------------------------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings (payments) on bank loans payable 15,000 (48,500)
Proceeds from notes payable issuance -- 218,965
Prepayment of notes payable -- (163,176)
Principal payments on mortgage note payable (103) --
Financing costs paid (6) (2,150)
Proceeds from sale of common stock 9,475 --
Proceeds from exercise of stock options 1,045 --
Dividends paid (15,002) (12,313)
- -------------------------------------------------------------------- --------- ---------
10,409 (7,174)
- -------------------------------------------------------------------- --------- ---------
INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS (19,997) 2,858
CASH AND SHORT-TERM INVESTMENTS, BEGINNING OF PERIOD 23,053 1,480
- -------------------------------------------------------------------- --------- ---------
CASH AND SHORT-TERM INVESTMENTS, END OF PERIOD $ 3,056 $ 4,338
==================================================================== ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
20
<PAGE> 22
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, Alzheimer's care and
medical office/clinic facilities.
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, Alzheimer's care and medical office/clinic facilities (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 Company's Series B Depositary Shares,
and the Series B Preferred Stock represented thereby, are attributed to the
Company's Core Group for financial accounting and reporting purposes. The
Series B Depositary Shares, and the Series B Preferred Stock represented
thereby, rank senior to the Company's Core Group Common Stock and its
Psychiatric Group Depositary Shares with respect to dividend payments and
liquidation rights.
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, 1997.
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, Alzheimer's care and medical office/clinic
facilities, 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 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 Core Group Common Stock, Series B Depositary Shares 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. In addition, net losses of either Group, as well as
dividends and distributions on, and repurchases or redemptions of, Core Group
Common Stock, Series B Depositary Shares or Psychiatric Group Depositary Shares
will reduce the funds of the Company legally available for dividends on Core
Group Common Stock, Series B Depositary Shares and Psychiatric Group Depositary
Shares. Accordingly, the Core
21
<PAGE> 23
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CORE GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
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 Standards In the first quarter of 1998, the Company
adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income". SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements. The adoption of this statement had no impact on
the Core Group's financial statements.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", establishes standards for reporting financial and descriptive
information about reportable operating segments. In general, reportable
operating segments are components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing
performance. The required adoption in 1998 of SFAS No. 131 is not expected to
have a material impact on the Core Group's financial statements.
In February 1998, the Financial Accounting Standards Board issued SFAS
No. 132, "Employer's Disclosures about Pensions and Other Post Retirement
Benefits". SFAS No. 132 revises employer's disclosures about pension and other
post retirement benefits to the extent practicable, requires additional
information on changes in the benefit obligations and fair values of plan
assets that will facilitate financial analysis, and eliminates certain
disclosures that are no longer useful. The required adoption in 1998 of SFAS
No. 132 is not expected to have a material impact on the Core Group's financial
statements.
Interest Paid Interest paid by the Core Group, net of interest
capitalized, was $8,529,000 and $5,561,000 for the three months ended March 31,
1998 and 1997, respectively. The Core Group had $118,000 and $107,000 of
capitalized interest for the three months ended March 31, 1998 and 1997,
respectively.
2. ATTRIBUTED EQUITY
Equity Offering In February 1998, the Company completed an offering
of 353,201 additional shares of Core Group Common Stock resulting in net
proceeds of approximately $9.5 million.
Stock Incentive Plans During the three months ended March 31, 1998,
options to purchase 140,424 shares of Core Group Common Stock at a weighted
average exercise price of $28.14 per share were issued pursuant to the
Company's stock incentive plans. During the three months ended March 31, 1998,
options to purchase 55,000 shares of Core Group Common Stock were exercised at
a weighted average exercise price of $19.01 per share resulting in additional
equity of $1,045,000.
22
<PAGE> 24
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO CORE GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
3. EARNINGS PER SHARE
The following is a reconciliation of the income and share amounts used
in the basic and diluted per share computations of income before extraordinary
item attributable to Core Group Common Stock:
<TABLE>
<CAPTION>
Three Months Ended March 31,
------------------------------------------
1998 1997
-------------------- -------------------
(In thousands) Income Shares Income Shares
- -------------------------------------------- -------------------- -------------------
<S> <C> <C> <C> <C>
Income before extraordinary item $ 12,584 -- $ 9,930 --
Less Series B preferred dividend requirement (2,150) -- -- --
Outstanding common shares -- 23,715 -- 23,455
Deferred common shares -- 1 -- 3
-------------------- -------------------
Basic EPS components 10,434 23,716 9,930 23,458
Effect of dilutive potential common shares
Stock options -- 145 -- 102
DERs -- 131 -- 89
Subordinated convertible bonds payable -- -- -- --
-------------------- -------------------
Diluted EPS components $ 10,434 23,992 $ 9,930 23,649
==================== ===================
</TABLE>
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 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 at any time
in the sole discretion of the Company's Board, the aggregate revolving
inter-Group loans owed by the Psychiatric Group to the Core Group are limited
to a maximum of $7,870,000 at any one time outstanding, which limit is to be
reduced dollar-for-dollar by any permanent repayment in the future of
borrowings under a revolving credit agreement provided to a Psychiatric Group
hospital operator; provided that the limit on the aggregate revolving
inter-Group loans will not be reduced below $5,000,000. 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 As of March 31, 1998, the Core Group had
funded $5.7 million of a $17 million commitment to develop two skilled nursing
properties in Las Vegas, Nevada to be operated by an experienced operator of
skilled nursing facilities. The Core Group has a $35 million forward funding
commitment to develop up to five assisted living facilities to be managed by an
experienced operator of assisted living facilities. As of March 31, 1998, the
Core Group had funded $1.4 million under this commitment for the development of
two facilities having total development costs of approximately $10 million.
The Core Group has a similar commitment of $22.5 million to develop up to 11
Alzheimer's care facilities to be managed by an experienced operator of
Alzheimer's care facilities. The Core Group also has agreed to provide an
additional $9.4 million of real estate financing to an experienced operator of
long-term acute care facilities for which there are currently no identified
projects.
23
<PAGE> 25
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 This
report includes and incorporates by reference statements that are not purely
historical and are "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, including statements regarding the
Company's expectations, beliefs, intentions or strategies regarding the future.
All statements other than historical fact contained in this report, including
without limitation statements regarding rent or interest to be received from
the Company's operators and tenants, plans with respect to individual
facilities, expectations with respect to the specific terms and renewals of
leases of the Company's facilities, the Company's anticipated dividend payout
ratios, the Company's liquidity position, projected expenses associated with
operating individual properties, the Company's ability to realize the recorded
amounts of its investments and the potential effect of new or existing
regulations on the operations conducted at the Company's facilities, are
forward-looking statements. All forward-looking statements included or
incorporated by reference in this report are based on information available to
the Company on the date hereof, and the Company assumes no obligation to update
such forward-looking statements. Although the Company believes that the
assumptions and expectations reflected in such forward-looking statements are
reasonable, it can give no assurance that such expectations will prove to have
been correct or that the Company will take any actions that may presently be
planned.
Certain factors that could cause actual results to differ materially
from those expected include, among others: the financial success of the
operations conducted at the Company's facilities and the financial strength of
the operators and tenants of such facilities, the continuing ability of
operators and tenants 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' and tenants' continued eligibility to participate in the Medicare or
Medicaid programs, reductions in reimbursement by other third- party payors,
the impact of managed care pricing pressures, the requirement to provide care
on a fixed-price basis, lower occupancy levels at the Company's facilities, a
downturn in market lease rates for medical office space, higher than expected
costs associated with the maintenance and operation of the Company's medical
office/clinic facilities, higher than expected turnover at the Company's
medical office/clinic facilities, a reduction in demand for the services
provided 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,
increases in general and administrative expenses attributable to the Core Group
as Core Group revenues increase relative to those of the Psychiatric Group and
changes in tax laws and regulations affecting real estate investment trusts.
For a further discussion of certain of these factors, see "- Future Operating
Results" herein.
OPERATING RESULTS
First Quarter 1998 Compared With 1997
For the first quarter of 1998, the Core Group reported income before
extraordinary item attributable to Core Group Common Stock of $10,434,000, or
$.44 per share on a basic basis, an increase of $504,000 or 5% compared with
$9,930,000, or $.42 per share on a basic basis, for the first quarter of 1997.
The Core Group reported net income attributable to Core Group Common Stock of
$10,434,000, or $.44 per share on a basic basis,
24
<PAGE> 26
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
for the first quarter of 1998 compared with a net loss of ($1,497,000), or
($.06) per share on a basic basis, for the first quarter of 1997. An
extraordinary loss on debt prepayment of ($11,427,000), or ($.48) per share on
a basic basis, was reported in the first quarter of 1997.
Rental income was $21,003,000 for the first quarter of 1998, an
increase of $3,774,000 or 22% from $17,229,000 for the first quarter of 1997.
This increase was primarily attributable to rental income from new properties
acquired subsequent to the first quarter of 1997. These property additions also
resulted in an increase in depreciation and amortization of $1,044,000 or 29%
to $4,686,000 for the first quarter of 1998 compared with $3,642,000 for the
first quarter of 1997.
Mortgage interest income of $113,000 for the first quarter of 1998 was
attributable to the funding of a mortgage note receivable in the second quarter
of 1997.
Additional rental income was $3,126,000 for the first quarter of 1998,
an increase of $354,000 or 13% from $2,772,000 for the first quarter of 1997.
This net increase was attributable to increases in additional rent of $340,000
from acute care properties and $24,000 from long-term care properties,
partially offset by a $10,000 decrease in additional rent from rehabilitation
properties.
Other property income of $335,000 for the first quarter of 1998
primarily represents property operating expense reimbursements and parking
revenue from medical office/clinic facility tenants.
Other interest income decreased $770,000 or 83% to $161,000 for the
first quarter of 1998 from $931,000 for the first quarter of 1997. This
decrease was primarily attributable to lower investable cash balances and a
lower average balance of direct financing leases during the first quarter of
1998 compared to the first quarter of 1997. 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
$365,000 for the first quarter of 1998, a decrease of $25,000 or 6% from
$390,000 for the first quarter of 1997. 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 $990,000 for the first quarter of 1998,
an increase of $979,000 from $11,000 for the first quarter of 1997. This
increase was attributable to operating expenses associated with medical
office/clinic facilities acquired subsequent to the first quarter 1997.
Interest expense was $4,942,000 for the first quarter of 1998, a
decrease of $1,165,000 or 19% from $6,107,000 for the first quarter of 1997.
This decrease in interest expense was primarily attributable to a lower
weighted average effective interest rate on long-term debt during the first
quarter of 1998, partially offset by a higher amount of long- term debt. 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 facility 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 $1,854,000 for the first
quarter of 1998, an increase of $269,000 or 17% from $1,585,000 for the first
quarter of 1997. This variation was attributable to an increase in the
Company's consolidated general and administrative expenses which are allocated
between the Core Group and
25
<PAGE> 27
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 hiring of additional personnel, higher
compensation and benefits expense and an increase in travel expense. Since the
Company's consolidated general and administrative expenses are allocated
between the Core Group and Psychiatric Group primarily based on revenues, the
amount of such expenses allocated to the Core Group will increase in the future
if revenues of the Psychiatric Group decline for any reason, including the
disposition or restructuring of Psychiatric Group assets or the nonpayment by
Psychiatric Group operators of their rent and interest obligations to the
Psychiatric Group.
Future Operating Results
The operators and tenants 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 and tenants also are subject to
extensive federal, state and local government regulation relating to their
operations, and most of 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 or tenant'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 and passed by both Houses of Congress.
These plans generally include revisions to and limits on Medicare and federal
programs providing Medicaid reimbursement to state health care programs and
have had and potentially would have an adverse impact on the level of funds
available in the future to health care facilities. The Balanced Budget Act of
1997 contains extensive changes to the Medicare and Medicaid programs intended
to reduce the projected amount of increase in Medicare spending by an estimated
$115 billion and Medicaid spending by an estimated $13 billion over five years.
In addition, the Budget Act repealed certain limits on states' ability to
reduce their Medicaid reimbursement levels. The Budget Act has the potential to
reduce significantly federal spending on health care services provided at each
of the Core Group's facilities and provided by the physician tenants of the
Core Group's medical office/clinic facilities, and to affect revenues of the
Core Group's operators and tenants adversely. In particular, the Budget Act's
limitations on reimbursable costs and reductions in payment incentives and
capital related payments, as well as the change toward a prospective payment
system, may have a material adverse effect on operator revenues at the Core
Group's rehabilitation and long-term acute care hospitals. The Budget Act's
freeze on acute care hospital reimbursement rates may also have an adverse
effect on the operator revenues at the Core Group's acute care hospitals. In
addition, the prospective payment system imposed by the Budget Act on the
operators of the Core Group's skilled nursing facilities may have a material
adverse effect on the operator revenues at such facilities if the operators are
unable to effectively respond to the financial incentives provided by the
prospective payment system. The Company cannot be assured that the changes
effected by the Budget Act will not have a material adverse effect on the Core
Group's financial condition or results of operation.
The Company's Board and management are monitoring the effect of the
Budget Act on the Core Group's facilities and potential changes to
reimbursement programs closely. The Company believes that the changes effected
by the Budget Act and changes proposed at the federal and state level may pose
risks for certain
26
<PAGE> 28
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 enforce compliance with program requirements
aggressively 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. States are also expanding their Medicaid
programs. Continued eligibility to participate in these programs is crucial to
a provider's financial strength. As a result of the foregoing, 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, long-term acute care hospitals, skilled nursing facilities, assisted
living and Alzheimer's care facilities and medical office/clinic facilities.
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.
Aggregate revenues from five leases maturing in February 1999
accounted for 41% of the Core Group's total revenues in 1997. Four of these
properties are leased to subsidiaries of American Medical International, Inc.
(AMI), a subsidiary of Tenet Healthcare Corporation, and the other property is
leased to a subsidiary of Columbia/HCA Healthcare Corporation (Columbia). Each
such lease grants the operator options, exercisable on not less than six months
notice, to extend the term of the lease for eight consecutive five-year renewal
terms. Base and additional rent during the first three to four extended terms
would be on the same terms and conditions as the current initial term. Minimum
rent during the final four to five extended terms would be fair market rental
but without separate additional rent. Each lease also grants the operator
options, exercisable on not less than six
27
<PAGE> 29
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
months notice, to purchase the leased property at fair market value at the
expiration of any term of the lease. If these leases are not renewed and the
current operators do not exercise their options to purchase the properties, the
Company will be required to seek new operators for the properties. Based on
various factors, including an assessment of the operational and financial
performance of the tenant hospitals, management of the Company currently
believes that exercise of the lease renewal options for these facilities by AMI
and Columbia is the most likely outcome, however, until actual notice of
exercise is received, such an outcome is not certain.
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.
Many existing information systems currently record years in a two-digit
format and will be unable to properly interpret dates beyond the year 1999 which
could lead to business disruptions (the Year 2000 Issue). The Company is
currently upgrading its internal information systems in the normal course of
business and does not expect the Year 2000 Issue to have a material impact on
the future operations or financial results of the Company's Core Group. However,
the future operations of the Company's Core Group could be disrupted and/or its
financial results could be negatively impacted by the Year 2000 Issue if the
Company's Core Group lessees and borrowers do not adequately address the Year
2000 Issue with respect to their information systems. As health care providers,
the Company's Core Group lessees and borrowers generally rely extensively on
information systems, including systems for capturing patient and cost
information and for billing and collecting reimbursement for health care
services provided. Furthermore, the Company's Core Group lessees and borrowers
likewise are dependent on a variety of third parties who must also adequately
address the Year 2000 Issue, including private and government payors. Although,
the Company believes that the Core Group lessees and borrowers are generally
addressing their Year 2000 Issues, it is not possible for the Company to
determine or be assured that adequate remediation of the Year 2000 Issue will be
accomplished by such lessees and borrowers. Furthermore, it is not possible for
the Company to determine or be assured that the various payors and other third
parties upon which the Company's Core Group lessees and borrowers are dependent
for reimbursement and information will accomplish adequate remediation of their
Year 2000 Issues. Accordingly, although the Company believes that the impact of
the Year 2000 Issue, as it relates to its internal information systems, will not
be material to the Company's Core Group, the Company cannot be assured that the
Year 2000 Issues of its Core Group lessees and borrowers, and the third parties
upon which they are dependent, will not have a material impact on the future
operations and/or financial results of the Company's Core Group.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1998, the Core Group had $2,801,000 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 $7,870,000. In addition, as of March
31, 1998, the Core Group had $9,175,000 in fixed rate inter-Group loans to the
Psychiatric Group.
As of May 12, 1998, the Core Group had a remaining commitment of
approximately $10.5 million to fund the development of two skilled nursing
facilities. In addition, the Company had a $35 million forward funding
commitment to develop up to five assisted living facilities to be managed by an
experienced operator of assisted living facilities. As of May 12, 1998, $1.7
million has been funded under this commitment for the development of two
facilities having total development costs of approximately $10 million. The
Core Group has a similar commitment of $22.5 million to develop up to 11
Alzheimer's care facilities to be managed by an experienced operator of
Alzheimer's care facilities. The Core Group also has agreed to provide an
additional $9.4 million of
28
<PAGE> 30
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
real estate financing to an experienced operator of long-term acute care
facilities for which there are currently no identified projects.
The Company has continued to increase its liquidity and enhance its
financial flexibility. In October 1997, the Company completed a $100 million
preferred equity offering and used the net proceeds to pay off all outstanding
borrowings under its bank credit facility at the time and used the remaining
proceeds to fund Core Group investments. In December 1997, the Company closed
on a new $250 million unsecured revolving bank credit facility which matures on
December 31, 2000. In February 1998, the Company completed an offering of
353,201 additional shares of Core Group Common Stock resulting in net proceeds
of approximately $9.5 million. As of May 12, 1998, the Company had $7.0
million of outstanding borrowings under its $250 million bank credit facility
and had $.7 million in cash and short-term investments. The Company's total
indebtedness as of May 12, 1998 was $251.8 million. The Company expects to
utilize its bank 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.
29
<PAGE> 31
AMERICAN HEALTH PROPERTIES, INC.
PSYCHIATRIC GROUP COMBINED CONDENSED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
- --------------------------------------------------------------- -------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Real estate investments
Real property and mortgage notes, net $ 49,601 $ 49,622
Accumulated depreciation (1,930) (1,742)
-------- --------
47,671 47,880
Other notes receivable 2,500 2,500
Other assets 614 614
- --------------------------------------------------------------- -------- --------
$ 50,785 $ 50,994
=============================================================== ======== ========
ATTRIBUTED LIABILITIES AND TOTAL ATTRIBUTED EQUITY
Revolving loan from Core Group $ 2,801 $ 3,379
Fixed rate loan from Core Group 9,175 9,175
Accounts payable and accrued liabilities 829 433
Dividends payable 1,334 1,292
Deferred income 18 22
- --------------------------------------------------------------- -------- --------
14,157 14,301
- --------------------------------------------------------------- -------- --------
Commitments and contingencies
Total Attributed Psychiatric Group Equity 36,628 36,693
- --------------------------------------------------------------- -------- --------
$ 50,785 $ 50,994
=============================================================== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
30
<PAGE> 32
AMERICAN HEALTH PROPERTIES, INC.
PSYCHIATRIC GROUP COMBINED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
1998 1997
- --------------------------------------------- -------- --------
<S> <C> <C>
REVENUES
Rental income $ 355 $ 581
Mortgage interest income 1,540 1,517
Additional rental and interest income 294 204
Other interest income 80 99
- --------------------------------------------- -------- --------
2,269 2,401
- --------------------------------------------- -------- --------
EXPENSES
Depreciation and amortization 188 186
Property operating 225 --
Interest expense on loans from Core Group 365 390
General and administrative 252 295
Impairment loss on real estate
and notes receivable -- 11,000
- --------------------------------------------- -------- --------
1,030 11,871
- --------------------------------------------- -------- --------
NET INCOME (LOSS) $ 1,239 $ (9,470)
============================================= ======== ========
Basic per share amounts -
Net income (loss) $ 0.59 $ (4.54)
Weighted average depositary shares 2,084 2,084
Diluted per share amounts -
Net income (loss) $ 0.59 $ (4.54)
Weighted average depositary shares and
dilutive potential depositary shares 2,102 2,084
Dividends declared per depositary share $ 0.6400 $ 0.7500
</TABLE>
The accompanying notes are an integral part of these financial statements.
31
<PAGE> 33
AMERICAN HEALTH PROPERTIES, INC.
PSYCHIATRIC GROUP COMBINED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
1998 1997
- -------------------------------------------------------------------- -------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 1,239 $ (9,470)
Depreciation, amortization and other non-cash items 218 220
Deferred income (4) (13)
Impairment loss on real estate and notes receivable -- 11,000
Change in other assets -- 47
Change in accounts payable and accrued liabilities 396 (141)
- -------------------------------------------------------------------- -------- --------
1,849 1,643
- -------------------------------------------------------------------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Principal payments on mortgage notes receivable 21 17
Other notes receivable -- 41
- -------------------------------------------------------------------- -------- --------
21 58
- -------------------------------------------------------------------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on revolving loan from Core Group (578) (34)
Dividends paid (1,292) (1,667)
- -------------------------------------------------------------------- -------- --------
(1,870) (1,701)
- -------------------------------------------------------------------- -------- --------
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.
32
<PAGE> 34
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, Alzheimer's care and
medical office/clinic facilities.
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 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, Alzheimer's care and medical
office/clinic facilities (the Core Group). The Company's Series B Depositary
Shares, and the Series B Preferred Stock represented thereby, are attributed to
the Company's Core Group for financial accounting and reporting purposes. The
Series B Depositary Shares, and the Series B Preferred Stock represented
thereby, rank senior to the Company's Core Group Common Stock and its
Psychiatric Group Depositary Shares with respect to dividend payments and
liquidation rights.
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, 1997.
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 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, Core Group Common
Stock or Series B 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. In addition, net losses of either Group, as well as
dividends and distributions on, and repurchases or redemptions of, Psychiatric
Group Depositary Shares, Core Group Common Stock or Series B Depositary Shares
will reduce the funds of the Company legally available for dividends on
Psychiatric Group Depositary Shares, Core Group Common Stock and Series B
Depositary Shares. 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.
33
<PAGE> 35
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
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 Standards In the first quarter of 1998, the Company
adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income". SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements. The adoption of this statement had no impact on
the Psychiatric Group's financial statements.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", establishes standards for reporting financial and descriptive
information about reportable operating segments. In general, reportable
operating segments are components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing
performance. The required adoption in 1998 of SFAS No. 131 is not expected to
have a material impact on the Psychiatric Group's financial statements.
In February 1998, the Financial Accounting Standards Board issued SFAS
No. 132, "Employer's Disclosures about Pensions and Other Post Retirement
Benefits". SFAS No. 132 revises employer's disclosures about pension and other
post retirement benefits to the extent practicable, requires additional
information on changes in the benefit obligations and fair values of plan
assets that will facilitate financial analysis, and eliminates certain
disclosures that are no longer useful. The required adoption in 1998 of SFAS
No. 132 is not expected to have a material impact on the Psychiatric Group's
financial statements.
Interest Paid Interest paid by the Psychiatric Group on inter-Group
loans from the Core Group was $365,000 and $390,000 for the three months ended
March 31, 1998 and 1997, 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 has established certain 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 at any time in
the sole discretion of the Company's Board, the aggregate revolving inter-Group
loans owed by the Psychiatric Group to the Core Group are limited to a maximum
of $7,870,000 at any one time outstanding, which limit is to be reduced
dollar-for-dollar by any permanent repayment in the future of borrowings under
a revolving credit agreement provided to a Psychiatric Group hospital operator;
provided that the limit on the aggregate revolving inter-Group loans will not
be reduced below $5,000,000. 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.
34
<PAGE> 36
3. ATTRIBUTED EQUITY
Stock Incentive Plans Options to purchase 2,000 shares of Psychiatric
Group Depositary Shares at a weighted average exercise price of $16.42 per
share expired during the three months ended March 31, 1998.
4. EARNINGS PER SHARE
The following is a reconciliation of the income and share amounts used
in the basic and diluted per share computations of income before extraordinary
item attributable to Psychiatric Group Depositary Shares:
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------------
1998 1997
-------- --------
(In thousands) Income Shares Income Shares
------------------ -----------------
<S> <C> <C> <C> <C>
Basic EPS components $ 1,239 2,084 $(9,470) 2,084
Effect of dilutive potential depositary shares
Stock options - - - -
DERs - 18 - -
-------- ------- ------- -------
Diluted EPS components $ 1,239 2,102 $(9,470) 2,084
================== =================
</TABLE>
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 impairment losses on psychiatric investments and the periodic
restructuring of psychiatric operator payment obligations in previous years. The
Psychiatric Group recorded an $11 million charge in the first quarter of 1997
for impairment of the carrying value of its two psychiatric investments in
Florida. The Northpointe property, at which the operator ceased paying its
obligations to the Psychiatric Group in February 1997 and ceased hospital
operations in the second quarter of 1997, continues to remain idle. The
Psychiatric Group incurred costs of approximately $225,000 during the first
quarter of 1998 ($.11 per depositary share) to protect and maintain this
property, including approximately $150,000 for unexpected expenditures. Although
on an ongoing basis, the Psychiatric Group expects to incur costs of
approximately $75,000 per quarter ($.04 per depositary share) to protect and
maintain this property while various alternatives for the property are evaluated
and pursued, there can be no assurance that other unexpected costs will not be
incurred. Early in the fourth quarter of 1997, a restructuring of The Retreat's
obligations to the Psychiatric Group was completed. The Retreat's restructured
base rent is $35,000 per month ($105,000 per quarter or $.05 per depositary
share) and additional rent will not accrue or be payable until August 1, 2000.
The Psychiatric Group has received the base rent payments under the restructured
terms through May 1998 but The Retreat is currently in default on other
obligations owed to the Psychiatric Group. Although the restructured agreement
with The Retreat was a positive step in stabilizing the cash flow and operations
of this facility, as evidenced by the current default, the Psychiatric Group
cannot be assured that The Retreat will be able to continue to meet its
restructured obligations or continue operations. Continued operations at The
Retreat will remain in doubt even if there is a change in the owner or operator
of the facility or if the Psychiatric Group provides additional financial
assistance. The Psychiatric Group is continuing to explore a range of options
for each of 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 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 impairment
losses on these investments will not be required.
35
<PAGE> 37
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
Although the $2,500,000 balance outstanding under Rock Creek Center's
(RCC) revolving credit agreement matured in June 1997 and the initial term of
the RCC lease expired in December 1997, RCC has continued to make interest
payments on the revolving credit agreement and the Psychiatric Group has agreed
to a short-term extension of the initial lease term to September 30, 1998 while
negotiations for a long-term renewal of the lease and repayment or extension of
the revolving credit agreement continue. Other local and national operators
have also expressed interest in the facility. RCC has met its rent and
interest obligations to the Psychiatric Group through May 1998, however, the
Psychiatric Group cannot be assured that RCC will not experience future
operational and cash flow difficulties as it has in the past. In addition, the
Psychiatric Group cannot be assured that a new lease will be accomplished or
that, if accomplished, the minimum rent payments will be at the current
annualized level of $1,000,000. Should the current lease not be renewed on a
long-term basis or the revolving loan not be repaid or extended with the
existing operator and a facility lease with a new operator on similar terms as
the current lease is not accomplished, a significant negative impact to the
Company's Psychiatric Group likely will result. The Psychiatric Group's total
revenue from the RCC investment for the first quarter of 1998 was $.17 per
depositary share.
Both New York Four Winds facilities are continuing their plans to
develop a lower-cost integrated behavioral health care delivery system in lower
and upper New York state. Such a system is intended to create a cost-effective
response to the negative reimbursement consequences of the accelerating
movement to a managed care environment within New York. Both facilities have
recently begun contracting on a fixed-price basis for the entire behavioral
health component of various managed care contracts. The Psychiatric Group
cannot be assured that the facilities will be able to adequately respond to the
increasing price pressures within their markets or that their new contracts
will be profitable. In addition, it is not possible to predict the impact of
further changes in the psychiatric industry or whether the operator's system
will be successful in a managed care environment, and the Psychiatric Group
cannot be assured that some restructuring of the operator's obligations to the
Psychiatric Group will not be required for the operator to remain competitive
in such an environment. In addition, the interest rate on the Four Winds
Hospital - Saratoga mortgage note will be reset in June 1999, if extended, to
the lesser of (i) 325 basis points over the ten-year treasury rate at that time
or (ii) various indexed rates for various reset periods specified in the note
agreement and selected by the borrower during the first two years of the
extension term. If reset at March 31, 1998, the interest rate on the note would
have been approximately 9.0% and would have a negative impact on total revenue
of the Psychiatric Group of approximately $.30 per Psychiatric Group Depositary
Share on an annual basis.
Although management currently believes that the recorded amounts of
its psychiatric investments are realizable, if the psychiatric operators are
unable to adapt to the fundamental ongoing changes in the psychiatric industry
successfully and consistently mitigate the negative impact of the ongoing
changes on their financial performance, the Psychiatric Group may be required
to restructure payment obligations further, identify alternative operators,
pursue alternative uses for or dispositions of the properties and/or recognize
additional impairment losses on its investments. 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 currently
intend to make new investments, and over time, may sell, restructure or seek
other means to reduce its investments. In addition, the Psychiatric Group
continues to encourage each of the psychiatric operators to pursue financing
alternatives which might enable them to acquire the properties and/or repay
their borrowings from the Psychiatric Group, as the case may be. Subject to the
rights of the holders of the Company's Series B Depositary Shares, and the
Series B Preferred Stock represented thereby, and any other preferred stock of
the Company then outstanding, the Psychiatric Group expects to use the net
proceeds of any future property sales and/or operator borrowing repayments to
first repay then outstanding inter-Group loans and/or other liabilities owed by
the Psychiatric Group and to distribute all remaining net proceeds, if any, in
cash or Core Group Common Stock of the Company to holders of Psychiatric Group
Depositary Shares. The
36
<PAGE> 38
AMERICAN HEALTH PROPERTIES, INC.
NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
Psychiatric Group cannot be assured that the efforts of psychiatric operators
to obtain alternative financing will be successful or, if successful, that the
amounts of such financing would be sufficient to enable the Psychiatric Group
to realize the carrying amounts of its investments. The Company continues to
retain 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 on 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, interest rate
adjustments on mortgage notes receivable, 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.
37
<PAGE> 39
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 This
report includes and incorporates by reference statements that are not purely
historical and are "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, including statements regarding the
Company's expectations, beliefs, intentions or strategies regarding the future.
All statements other than historical fact contained in this report, including
without limitation statements regarding rent or interest to be received from
the Company's operators, plans with respect to individual facilities,
expectations with respect to the specific terms and renewals of leases of the
Company's facilities, the Company's anticipated dividend payout ratios, the
Company's liquidity position, projected expenses associated with maintaining
individual properties, the Company's ability to realize the recorded amounts of
its investments and the potential effect of new or existing regulations on the
operations conducted at the Company's facilities, are forward-looking
statements. All forward-looking statements included or incorporated by
reference in this report are based on information available to the Company on
the date hereof, and the Company assumes no obligation to update such
forward-looking statements. Although the Company believes that the assumptions
and expectations reflected in such forward-looking statements are reasonable,
it can give no assurance that such expectations will prove to have been correct
or that the Company will take any actions that may presently be planned.
Certain factors that could cause actual results to differ materially
from those expected 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, the impact of managed care pricing
pressures, the requirement to provide care on a fixed-price basis, lower
occupancy levels at the Company's facilities, a reduction in demand for the
services provided 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 certain of these factors, see "- Future
Operating Results" herein.
OPERATING RESULTS
First Quarter 1998 Compared With 1997
For the first quarter of 1998, the Psychiatric Group reported net
income of $1,239,000 or $.59 per Psychiatric Group Depositary Share on a basic
basis, compared with a net loss of ($9,470,000), or ($4.54) per Psychiatric
Group Depositary Share on a basic basis, for the first quarter of 1997. The
net loss for the first quarter of 1997 included an impairment loss on real
estate and notes receivable of ($11,000,000), or ($5.28) per Psychiatric Group
Depositary Share on a basic basis.
Rental income was $355,000 for the first quarter of 1998, a decrease
of $226,000 or 39% from $581,000 for the first quarter of 1997. The decrease
in rental income was primarily attributable to the reduction of base
38
<PAGE> 40
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
rent from one of the Florida properties during the first quarter of 1998 as a
result of a lease restructuring early in the fourth quarter of 1997.
Additionally, the first quarter of 1997 included base rent received for one
month from the other Florida property before the operator stopped paying rent
and subsequently ceased operations in the second quarter of 1997.
Additional rental and interest income was $294,000 for the first
quarter of 1998, an increase of $90,000 or 44% from $204,000 for the first
quarter of 1997. This increase was primarily attributable to an increase in
additional interest received from the Four Winds Hospital - Katonah facility.
Property operating expense of $225,000 for the first quarter of 1998
represents costs related to the protection and maintenance of one of the
properties in Florida, including approximately $150,000 for unexpected
expenditures, incurred after the operator ceased operations in the second
quarter of 1997.
Interest expense on inter-Group loans from the Core Group was $365,000
for the first quarter of 1998, a decrease of $25,000 or 6% from $390,000 for
the first quarter of 1997. 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 $252,000 for the first
quarter of 1998, a decrease of $43,000 or 15% from $295,000 for the first
quarter of 1997. 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 first quarter of 1998 compared to the comparable
period in 1997. The Psychiatric Group was specifically charged for $77,000 of
costs in the first quarter of 1998 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
first quarter of 1997 included $116,000 of such financial advisory costs.
Future Operating Results
The operators and tenants 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 and tenants also are subject to
extensive federal, state and local government regulation relating to their
operations, and most of 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 or tenant'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 and passed by both Houses of Congress.
These plans generally include revisions to and limits on Medicare and federal
programs providing Medicaid reimbursement to state health care programs and
have had and potentially would have an adverse impact on the level of funds
available in the future to health care facilities. The Balanced
39
<PAGE> 41
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Budget Act of 1997 contains extensive changes to the Medicare and Medicaid
programs intended to reduce the projected amount of increase in Medicare
spending by an estimated $115 billion and Medicaid spending by an estimated $13
billion over five years. In addition, the Budget Act repealed certain limits
on states' ability to reduce their Medicaid reimbursement levels. The Budget
Act has the potential to reduce significantly federal spending on health care
services provided at each of the Psychiatric Group's facilities, and to affect
revenues of the Psychiatric Group's operators adversely. In particular, the
Budget Act's limitations on reimbursable costs and reductions in payment
incentives and capital related payments, as well as the change toward a
prospective payment system, may have a material adverse effect on operator
revenues at the Psychiatric Group's hospitals. The Company cannot be assured
that the changes effected by the Budget Act will not have a material adverse
effect on the Psychiatric Group's financial condition or results of operation.
The Company's Board and management are monitoring the effect of the
Budget Act on the Psychiatric Group's facilities and potential changes to
reimbursement programs closely. The Company believes that the changes effected
by the Budget Act and changes proposed at the federal and state level 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 enforce compliance with program requirements
aggressively and to pursue providers that they believe have not complied with
such requirements. Outpatient business is expected to increase as advances in
treatment techniques and pharmacology allow more care to be provided 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. States are also expanding their Medicaid
programs. Continued eligibility to participate in these programs is crucial to
a provider's financial strength. As a result of the foregoing, revenues and
margins may decrease at the Psychiatric Group's facilities.
Fundamental changes in the psychiatric industry continue to impact
negatively 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 consistently 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.
40
<PAGE> 42
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 provided such financing under a revolving credit agreement to
the operator of one of its psychiatric properties. As of March 31, 1998,
outstanding borrowings under such agreement totaled $2,500,000, which amount
remains outstanding even though the financing matured June 30, 1997. 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 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.
The fundamental ongoing changes in the psychiatric industry and the
resulting negative impact on operator financial performance have resulted in
significant impairment losses on psychiatric investments and the periodic
restructuring of psychiatric operator payment obligations in previous years. The
Psychiatric Group recorded an $11 million charge in the first quarter of 1997
for impairment of the carrying value of its two psychiatric investments in
Florida. The Northpointe property, at which the operator ceased paying its
obligations to the Psychiatric Group in February 1997 and ceased hospital
operations in the second quarter of 1997, continues to remain idle. The
Psychiatric Group incurred costs of approximately $225,000 during the first
quarter of 1998 ($.11 per depositary share) to protect and maintain this
property, including approximately $150,000 for unexpected expenditures. Although
on an ongoing basis, the Psychiatric Group expects to incur costs of
approximately $75,000 per quarter ($.04 per depositary share) to protect and
maintain this property while various alternatives for the property are evaluated
and pursued, there can be no assurance that other unexpected costs will not be
incurred. Early in the fourth quarter of 1997, a restructuring of The Retreat's
obligations to the Psychiatric Group was completed. The Retreat's restructured
base rent is $35,000 per month ($105,000 per quarter or $.05 per depositary
share) and additional rent will not accrue or be payable until August 1, 2000.
The Psychiatric Group has received the base rent payments under the restructured
terms through May 1998 but The Retreat is currently in default on other
obligations owed to the Psychiatric Group. Although the restructured agreement
with The Retreat was a positive step in stabilizing the cash flow and operations
of this facility, as evidenced by the current default, the Psychiatric Group
cannot be assured that The Retreat will be able to continue to meet its
restructured obligations or continue operations. Continued operations at The
Retreat will remain in doubt even if there is a change in the owner or operator
of the facility or if the Psychiatric Group provides additional financial
assistance. The Psychiatric Group is continuing to explore a range of options
for each of 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 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 impairment
losses on these investments will not be required.
Although the $2,500,000 balance outstanding under Rock Creek Center's
(RCC) revolving credit agreement matured in June 1997 and the initial term of
the RCC lease expired in December 1997, RCC has continued to make interest
payments on the revolving credit agreement and the Psychiatric Group has agreed
to a short-term extension of the initial lease term to September 30, 1998 while
negotiations for a long-term renewal of the lease and repayment or extension of
the revolving credit agreement continue. Other local and national operators
have also expressed interest in the facility. RCC has met its rent and
interest obligations to the Psychiatric Group through May 1998, however, the
Psychiatric Group cannot be assured that RCC will not experience future
operational and cash flow difficulties as it has in the past. In addition, the
Psychiatric Group cannot be assured that a new lease will be accomplished or
that, if accomplished, the minimum rent payments will
41
<PAGE> 43
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
be at the current annualized level of $1,000,000. Should the current lease not
be renewed on a long-term basis or the revolving loan not be repaid or extended
with the existing operator and a facility lease with a new operator on similar
terms as the current lease is not accomplished, a significant negative impact to
the Company's Psychiatric Group likely will result. The Psychiatric Group's
total revenue from the RCC investment for the first quarter of 1998 was $.17 per
depositary share.
Both New York Four Winds facilities are continuing their plans to
develop a lower-cost integrated behavioral health care delivery system in lower
and upper New York state. Such a system is intended to create a cost-effective
response to the negative reimbursement consequences of the accelerating movement
to a managed care environment within New York. Both facilities have recently
begun contracting on a fixed-price basis for the entire behavioral health
component of various managed care contracts. The Psychiatric Group cannot be
assured that the facilities will be able to adequately respond to the increasing
price pressures within their markets or that their new contracts will be
profitable. In addition, it is not possible to predict the impact of further
changes in the psychiatric industry or whether the operator's system will be
successful in a managed care environment, and the Psychiatric Group cannot be
assured that some restructuring of the operator's obligations to the Psychiatric
Group will not be required for the operator to remain competitive in such an
environment. In addition, the interest rate on the Four Winds Hospital -
Saratoga mortgage note will be reset in June 1999, if extended, to the lesser of
(i) 325 basis points over the ten-year treasury rate at that time or (ii)
various indexed rates for various reset periods specified in the note agreement
and selected by the borrower during the first two years of the extension term.
If reset at March 31, 1998, the interest rate on the note would have been
approximately 9.0% and would have a negative impact on total revenue of the
Psychiatric Group of approximately $.30 per Psychiatric Group Depositary Share
on an annual basis.
Although management currently believes that the recorded amounts of
its psychiatric investments are realizable, if the psychiatric operators are
unable to adapt to the fundamental ongoing changes in the psychiatric industry
successfully and consistently mitigate the negative impact of the ongoing
changes on their financial performance, the Psychiatric Group may be required
to restructure payment obligations further, identify alternative operators,
pursue alternative uses for or dispositions of the properties and/or recognize
additional impairment losses on its investments. 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 currently
intend to make new investments, and over time, may sell, restructure or seek
other means to reduce its investments. In addition, the Psychiatric Group
continues to encourage each of the psychiatric operators to pursue financing
alternatives which might enable them to acquire the properties and/or repay
their borrowings from the Psychiatric Group, as the case may be. Subject to the
rights of the holders of the Company's Series B Depositary Shares, and the
Series B Preferred Stock represented thereby, and any other preferred stock of
the Company then outstanding, the Psychiatric Group expects to use the net
proceeds of any future property sales and/or operator borrowing repayments to
first repay then outstanding inter-Group loans and/or other liabilities owed by
the Psychiatric Group and to distribute all remaining net proceeds, if any, in
cash or Core Group Common Stock of the Company to holders of Psychiatric Group
Depositary Shares. The Psychiatric Group cannot be assured that the efforts of
psychiatric operators to obtain alternative financing will be successful or, if
successful, that the amounts of such financing would be sufficient to enable
the Psychiatric Group to realize the carrying amounts of its investments. The
Company continues to retain 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
42
<PAGE> 44
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 on 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, interest rate
adjustments on mortgage notes receivable, 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.
Many existing information systems currently record years in a
two-digit format and will be unable to properly interpret dates beyond the year
1999 which could lead to business disruptions (the Year 2000 Issue). The
Company is currently upgrading its internal information systems in the normal
course of business and does not expect the Year 2000 Issue to have a material
impact on the future operations or financial results of the Company's
Psychiatric Group. However, the future operations of the Company's Psychiatric
Group could be disrupted and/or its financial results could be negatively
impacted by the Year 2000 Issue if the Company's Psychiatric Group lessees and
borrowers do not adequately address the Year 2000 Issue with respect to their
information systems. As health care providers, the Company's Psychiatric Group
lessees and borrowers generally rely extensively on information systems,
including systems for capturing patient and cost information and for billing
and collecting reimbursement for health care services provided. Furthermore,
the Company's Psychiatric Group lessees and borrowers likewise are dependent on
a variety of third parties who must also adequately address the Year 2000
Issue, including private and government payors. Although, the Company believes
that the Psychiatric Group lessees and borrowers are generally addressing their
Year 2000 Issues, it is not possible for the Company to determine or be assured
that adequate remediation of the Year 2000 Issue will be accomplished by such
lessees and borrowers. Furthermore, it is not possible for the Company to
determine or be assured that the various payors and other third parties upon
which the Company's Psychiatric Group lessees and borrowers are dependent for
reimbursement and information will accomplish adequate remediation of their
Year 2000 Issues. Accordingly, although the Company believes that the impact of
the Year 2000 Issue, as it relates to its internal information systems, will
not be material to the Company's Psychiatric Group, the Company cannot be
assured that the Year 2000 Issues of its Psychiatric Group lessees and
borrowers, and the third parties upon which they are dependent, will not have a
material impact on the future operations and/or financial results of the
Company's Psychiatric Group.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1998, the Psychiatric Group had $2,801,000 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 at
any time 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 $7,870,000 at any one time outstanding, which
limit is to be reduced dollar-for-dollar by any permanent repayment in the
future of borrowings under a revolving credit agreement provided to a
Psychiatric Group hospital operator; provided that the limit on the aggregate
revolving inter-Group loans will not be reduced below $5,000,000. 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
43
<PAGE> 45
AMERICAN HEALTH PROPERTIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP
COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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. Future dividend payments will be
determined quarterly and will be primarily dependent upon the financial
performance of the Psychiatric Group. Subject to the rights of the holders of
the Company's Series B Depositary Shares, and the Series B Preferred Stock
represented thereby, and any other preferred stock of the Company then
outstanding, 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.
44
<PAGE> 46
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
None.
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: May 12, 1998
AMERICAN HEALTH PROPERTIES, INC.
By: JOSEPH P. SULLIVAN By: MICHAEL J. MCGEE
-------------------------------- -----------------------------------
Joseph P. Sullivan Michael J. McGee
Chairman of the Board, President Senior Vice President &
& Chief Executive Officer Chief Financial Officer
(Principal Executive Officer) (Principal Financial and
Accounting Officer)
45
<PAGE> 47
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> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 3,056
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> (107,084)
<TOTAL-ASSETS> 709,553
<CURRENT-LIABILITIES> 0
<BONDS> 243,794
0
100,002
<COMMON> 239
<OTHER-SE> 322,843
<TOTAL-LIABILITY-AND-EQUITY> 709,553
<SALES> 0
<TOTAL-REVENUES> 27,007
<CGS> 0
<TOTAL-COSTS> 6,089
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,942
<INCOME-PRETAX> 13,823
<INCOME-TAX> 0
<INCOME-CONTINUING> 13,823
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,823
<EPS-PRIMARY> 0.44<F1>
<EPS-DILUTED> 0.43<F2>
<FN>
<F1>Basic earnings per share attributable to -
Core Group Common Stock
Net income $ 0.44
Psychiatric Group Depositary Shares
Net income $ 0.59
<F2>Diluted earnings per share attributable to -
Core Group Common Stock
Net income $ 0.43
Psychiatric Group Depositary Shares
Net income $ 0.59
</FN>
</TABLE>
