-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WYfl57K0iHNM/ivlocM7luv1HpO+5ciNlKFg7W5PuUN624IMBa6INnhwqIYu0Piv JU7+kmHR+DYpJlzkwoyY1w== 0001035704-97-000390.txt : 19971117 0001035704-97-000390.hdr.sgml : 19971117 ACCESSION NUMBER: 0001035704-97-000390 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971114 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN HEALTH PROPERTIES INC CENTRAL INDEX KEY: 0000808240 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 954084878 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-09381 FILM NUMBER: 97719485 BUSINESS ADDRESS: STREET 1: 6400 S FIDDLERS GREEN CIRCLE STREET 2: STE 1800 CITY: ENGLEWOOD STATE: CO ZIP: 80111 BUSINESS PHONE: 3037969793 MAIL ADDRESS: STREET 1: 6400 S FIDDLERS GREEN CIRCLE STREET 2: SUITE 1800 CITY: ENGLEWOOD STATE: CO ZIP: 80111 10-Q 1 FORM 10-Q FOR QUARTER ENDED SEPTEMBER 30, 1997 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________________ TO____________________ COMMISSION FILE NUMBER 1-9381
American Health Properties, Inc. (Exact name of registrant as specified in its charter) 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)
(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 NOVEMBER 7, 1997 -- 23,559,054 SHARES OF REGISTRANT'S PSYCHIATRIC GROUP DEPOSITARY SHARES, EACH REPRESENTING ONE-TENTH OF ONE SHARE OF PSYCHIATRIC GROUP PREFERRED STOCK, $.01 PAR VALUE, OUTSTANDING AT NOVEMBER 7, 1997 -- 2,083,931. ================================================================================ 2 AMERICAN HEALTH PROPERTIES, INC. SEPTEMBER 30, 1997 TABLE OF CONTENTS
PART I FINANCIAL INFORMATION PAGE CONSOLIDATED COMPANY Item 1. Consolidated Condensed Financial Statements: Balance sheets as of September 30, 1997 and December 31, 1996...................................... 2 Statements of operations for the three and nine months ended September 30, 1997 and 1996........... 3 Statements of cash flows for the nine months ended September 30, 1997 and 1996..................... 4 Notes to financial statements...................................................................... 5 Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations...................................................... 10 CORE GROUP Item 1. Core Group Combined Condensed Financial Statements: Balance sheets as of September 30, 1997 and December 31, 1996...................................... 16 Statements of operations for the three and nine months ended September 30, 1997 and 1996........... 17 Statements of cash flows for the nine months ended September 30, 1997 and 1996..................... 18 Notes to financial statements...................................................................... 19 Item 2. Management's Discussion and Analysis of Core Group Combined Financial Condition and Results of Operations............................................. 23 PSYCHIATRIC GROUP Item 1. Psychiatric Group Combined Condensed Financial Statements: Balance sheets as of September 30, 1997 and December 31, 1996...................................... 28 Statements of operations for the three and nine months ended September 30, 1997 and 1996........... 29 Statements of cash flows for the nine months ended September 30, 1997 and 1996..................... 30 Notes to financial statements...................................................................... 31 Item 2. Management's Discussion and Analysis of Psychiatric Group Combined Financial Condition and Results of Operations............................................. 37 PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K................................................................... 44
1 3 AMERICAN HEALTH PROPERTIES, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (In thousands except per share amounts)
September 30, December 31, 1997 1996 - ------------------------------------------------------------ --------- --------- ASSETS (Unaudited) Real estate investments Real property and mortgage notes, net $ 649,608 $ 644,380 Construction in progress 8,100 4,834 Accumulated depreciation (97,985) (90,139) --------- --------- 559,723 559,075 Other notes receivable and direct financing leases 5,866 8,152 Other assets 12,652 9,175 Cash and short-term investments 1,352 1,480 - ------------------------------------------------------------ --------- --------- $ 579,593 $ 577,882 - ------------------------------------------------------------ --------- --------- LIABILITIES AND STOCKHOLDERS' EQUITY Bank loans payable $ 8,500 $ 48,500 Notes and bonds payable 225,807 158,601 Accounts payable and accrued liabilities 7,180 7,385 Dividends payable 13,660 13,981 Deferred income 3,595 4,276 - ------------------------------------------------------------ --------- --------- 258,742 232,743 - ------------------------------------------------------------ --------- --------- Commitments and contingencies Stockholders' equity Preferred stock $.01 par value; 1,000 shares authorized; 208 shares issued and outstanding 2 2 Common stock $.01 par value; 100,000 shares authorized; 23,559 and 23,455 shares issued and outstanding 236 235 Additional paid-in capital 485,365 482,083 Cumulative net income 270,324 256,691 Cumulative dividends (435,076) (393,872) - ------------------------------------------------------------ --------- --------- 320,851 345,139 - ------------------------------------------------------------ --------- --------- $ 579,593 $ 577,882 - ------------------------------------------------------------ --------- ---------
The accompanying notes are an integral part of these financial statements. 2 4 AMERICAN HEALTH PROPERTIES, INC. CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Three Months Ended Nine Months Ended September 30, September 30, ------------------ -------------------- 1997 1996 1997 1996 - ------------------------------------------- ------- ------- -------- ------- REVENUES Rental income $17,945 $17,315 $ 53,572 $51,693 Mortgage interest income 1,613 1,493 4,661 4,479 Additional rental and interest income 3,124 3,092 9,247 9,103 Other property income 73 -- 107 -- Other interest income 195 238 1,467 911 - ------------------------------------------- ------- ------- -------- ------- 22,950 22,138 69,054 66,186 - ------------------------------------------- ------- ------- -------- ------- EXPENSES Depreciation and amortization 3,910 3,761 11,627 11,204 Property operating 204 11 292 33 Interest expense 4,533 5,285 15,118 16,564 General and administrative 1,987 1,876 5,815 5,645 Impairment loss on real estate investments and other notes receivable -- -- 11,000 -- - ------------------------------------------- ------- ------- -------- ------- 10,634 10,933 43,852 33,446 - ------------------------------------------- ------- ------- -------- ------- Minority interest 48 54 142 169 - ------------------------------------------- ------- ------- -------- ------- NET INCOME BEFORE EXTRAORDINARY ITEM 12,268 11,151 25,060 32,571 EXTRAORDINARY LOSS ON DEBT PREPAYMENT -- -- (11,427) -- - ------------------------------------------- ------- ------- -------- ------- NET INCOME $12,268 $11,151 $ 13,633 $32,571 - ------------------------------------------- ------- ------- -------- ------- ATTRIBUTABLE TO - CORE GROUP COMMON STOCK Net Income Before Extraordinary Item $11,087 $ 9,873 $ 32,146 $28,627 Extraordinary Loss On Debt Prepayment $ -- $ -- $(11,427) $ -- Net Income $11,087 $ 9,873 $ 20,719 $28,627 PER SHARE AMOUNTS: Net Income Before Extraordinary Item $ 0.47 $ 0.42 $ 1.36 $ 1.22 Extraordinary Loss On Debt Prepayment $ -- $ -- $ (0.48) $ -- Net Income $ 0.47 $ 0.42 $ 0.88 $ 1.22 Dividends Declared $ 0.525 $ 0.505 $ 1.575 $1.5150 Weighted Average Shares Outstanding 23,649 23,522 23,585 23,511 PSYCHIATRIC GROUP DEPOSITARY SHARES Net Income (Loss) $ 1,181 $ 1,278 $ (7,086) $ 3,944 Net Income (Loss) Per Share $ 0.56 $ 0.61 $ (3.38) $ 1.89 Dividends Declared Per Share $ 0.620 $ 0.650 $ 2.000 $2.0000 Weighted Average Shares Outstanding 2,099 2,093 2,097 2,092
The accompanying notes are an integral part of these financial statements. 3 5 AMERICAN HEALTH PROPERTIES, INC. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
Nine Months Ended September 30, ------------------------------- 1997 1996 - ----------------------------------------------------------- --------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 13,633 $ 32,571 Extraordinary loss on debt prepayment 11,427 -- Depreciation, amortization and other non-cash items 13,601 12,908 Deferred income (174) (283) Impairment loss on real estate investments and other notes receivable 11,000 -- Change in other assets (2,270) 802 Change in accounts payable and accrued liabilities (627) (3,333) - ----------------------------------------------------------- --------- -------- 46,590 42,665 - ----------------------------------------------------------- --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Acquisition and construction of real estate properties (17,919) (13,041) Mortgage note receivable fundings (3,683) -- Principal payments on mortgage notes receivable 52 47 Other notes receivable 173 154 Direct financing leases 389 2,329 Administrative capital expenditures (18) (52) - ----------------------------------------------------------- --------- -------- (21,006) (10,563) - ----------------------------------------------------------- --------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Borrowings (payments) on bank loans payable (40,000) 51,500 Proceeds from notes payable issuance 218,965 -- Prepayment of notes payable (163,176) -- Principal payments on notes payable -- (49,000) Financing costs paid (2,152) (80) Proceeds from exercise of stock options 2,176 241 Dividends paid (41,525) (40,003) - ----------------------------------------------------------- --------- -------- (25,712) (37,342) - ----------------------------------------------------------- --------- -------- INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS (128) (5,240) CASH AND SHORT-TERM INVESTMENTS, BEGINNING OF PERIOD 1,480 7,571 - ----------------------------------------------------------- --------- -------- CASH AND SHORT-TERM INVESTMENTS, END OF PERIOD $ 1,352 $ 2,331 - ----------------------------------------------------------- --------- --------
The accompanying notes are an integral part of these financial statements. 4 6 AMERICAN HEALTH PROPERTIES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL American Health Properties, Inc., a Delaware corporation (the Company, which term refers to the Company and its subsidiaries unless the context otherwise requires), is a self-administered real estate investment trust (REIT) that commenced operations in 1987. The Company has investments in health care properties, including acute care, rehabilitation, long-term acute care and psychiatric hospitals, skilled nursing, assisted living and Alzheimer's care facilities and medical office buildings. The Company's common stock (the Core Group Common Stock) is intended to reflect the separate financial performance of the Company's investments in acute care, rehabilitation and long-term acute care hospitals, skilled nursing, assisted living and Alzheimer's care facilities and medical office buildings (the Core Group). The Psychiatric Group Depositary Shares are intended to reflect the separate financial performance of the Company's investments in psychiatric hospitals (the Psychiatric Group). The proceeds from the October 1997 sale of the Company's depositary shares (Series B Depositary Shares) representing its 8.60% Cumulative Redeemable Preferred Stock, Series B (Series B Preferred Stock), as well as the dividends payable thereon, have been 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, 1996. The financial statements of the Core Group and the Psychiatric Group, which are included elsewhere herein, should also be read in conjunction with these financial statements. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. New Accounting Standard In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share." SFAS No. 128 is intended to simplify the computation of earnings per share (EPS) and to make the U.S. standard for computing EPS more compatible with the EPS standards of other countries and with that of the International Accounting Standards Committee. The effective date for the application of SFAS No. 128 for both interim and annual periods is after December 15, 1997. Earlier application is not permitted. Management does not expect the application of SFAS No. 128 to have a material impact on the Company's EPS calculation. 5 7 AMERICAN HEALTH PROPERTIES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) Interest Paid Interest paid by the Company, net of interest capitalized, was $14,306,000 and $18,736,000 for the nine months ended September 30, 1997 and 1996, respectively. The Company had $344,000 and $781,000 of capitalized interest for the nine months ended September 30, 1997 and 1996, respectively. 2. DEBT All of the Company's third-party debt is attributed to the Core Group for financial accounting and reporting purposes. In January 1997, the Company completed a $220 million public debt offering of unsecured senior notes payable, issuing $100 million of notes with a coupon rate of 7.05% due January 15, 2002 (2002 Notes) and $120 million of notes with a coupon rate of 7.50% due January 15, 2007 (2007 Notes). The 2002 Notes and 2007 Notes were sold for $99,749,000 and $119,216,000, respectively, and have effective interest rates of approximately 7.34% and 7.74%, respectively. Interest is payable at the coupon rates semi-annually on January 15th and July 15th. The proceeds from the public debt offering were used to pay off the Company's $152 million of 11.03% private placement debt prior to its scheduled maturity and the Company's borrowings under its bank credit facility outstanding at the time. The prepayment of the private placement debt in February 1997 resulted in an extraordinary charge in the first quarter of 1997 of $11,427,000 consisting of a make-whole premium and other costs related to the prepayment. 3. STOCKHOLDERS' EQUITY Preferred Equity Offering In October 1997, the Company sold 4,000,000 Series B Depositary Shares at $25 per share representing 40,000 shares of Series B Preferred Stock. Each Series B Depositary Share represents 1/100 of a share of Series B Preferred Stock, and entitles the holder to such proportion of all the rights, preferences and privileges of the Series B Preferred Stock represented thereby. The Series B Depositary Shares, and the Series B Preferred Stock represented thereby, rank senior to the Company's Core Group Common Stock, its Series A Preferred Stock (when and if issued) and its Psychiatric Group Depositary Shares, and the Psychiatric Group Preferred Stock represented thereby, with respect to dividend payments and liquidation rights. The annual dividend rate and liquidation preference with respect to each Series B Depositary Share are $2.15 and $25, respectively (equivalent to $215 and $2,500 per share of Series B Preferred Stock, respectively). Dividends on the Series B Depositary Shares, and the Series B Preferred Stock represented thereby, are cumulative from the date of original issue and, if and when declared, are payable quarterly in arrears on the last day of February, May, August and November of each year (or, if such day is not a business day, the next business day), commencing on December 1, 1997. On or after October 27, 2002, the Series B Depositary Shares, and the Series B Preferred Stock represented thereby, may be redeemed, in whole or in part, at the option of the Company at a redemption price of $25 per Series B Depositary Share (equivalent to $2,500 per share of Series B Preferred Stock), plus accrued and unpaid dividends thereon. The redemption price, other than the portion representing accrued and unpaid dividends, is payable solely out of proceeds from the sale of other capital stock of the Company. The proceeds from the sale of the Series B Depositary Shares, and the Series B Preferred Stock represented thereby, as well as the dividends payable thereon, have been attributed to the Company's Core Group for financial accounting and reporting purposes. The net proceeds of approximately $96.4 million were used to pay off the borrowings under the Company's bank credit facility outstanding at the time and the remaining proceeds will be used to fund Core Group investments. Stock Incentive Plans During the nine months ended September 30, 1997, options to purchase 194,982 shares of Core Group Common Stock at a weighted average exercise price of $25.37 per share were issued pursuant to the Company's stock incentive plans. During the nine months ended September 30, 1997, options to purchase 100,000 shares of Core Group 6 8 AMERICAN HEALTH PROPERTIES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) Common Stock were exercised at a weighted average exercise price of $21.76 per share resulting in additional equity of $2,176,000. Options to purchase 30,000 shares of Core Group Common Stock at a weighted average exercise price of $29.10 per share were canceled during the nine months ended September 30, 1997. Pursuant to an election to receive payment of his annual board fees on a deferred basis in the form of stock, 4,027 shares of Core Group Common Stock were issued to a director during the nine months ended September 30, 1997. Options to purchase 10,000 shares of Psychiatric Group Depositary Shares at a weighted average exercise price of $24.15 per share were canceled during the nine months ended September 30, 1997. 4. COMMITMENTS Real Estate Properties The Company has the right to approve capital expenditures at all of its properties, the option to fund certain capital expenditures and, in certain situations, is obligated to fund approved capital expenditures on terms comparable to the original investment. The base and additional rent provisions of the leases are amended when such capital expenditures are funded to reflect the Company's increased investment. At September 30, 1997, the Company had no commitments to fund capital expenditures pursuant to these rights and obligations. As of September 30, 1997, the Company had funded $5.4 million of a $6.2 million commitment to finance the acquisition and renovation of a long-term acute care facility in Amarillo, Texas to be operated by an experienced operator. In addition, the Company had funded $3.7 million of a $4.4 million mortgage loan to this same operator, which is secured by a long-term acute care facility in Houston, Texas. The Company has also agreed to provide an additional $9.4 million of real estate financing to this same operator for other similar facilities. As of September 30, 1997, the Company had funded $2.7 million of a $17 million commitment to provide construction and lease financing for two skilled nursing properties in Las Vegas, Nevada to be operated by an experienced operator of skilled nursing facilities. The Company has agreed to provide $50 million of real estate financing to an experienced operator of assisted living facilities. Approximately $29 million of this amount has been specifically identified for the construction of five properties located in four states, with the remaining $21 million available for future acquisitions or projects that have not yet been identified and agreed upon. The operator has undergone a change in ownership during the year and is presently reevaluating which investment opportunities it may ultimately pursue, which could impact the amount of the Company's financing commitment that is ultimately used. The Company has signed letters of intent and is currently negotiating or has under contract investments in a number of existing medical office buildings and similar facilities, which, if closed, would aggregate approximately $130 million of total investment. Although the Company anticipates closing approximately $100 million of these proposed investments in the fourth quarter of 1997 and the remainder in the first quarter of 1998, the Company cannot be assured as to the actual timing of such closings or that the proposed investments will ultimately be closed. 5. STATUS OF PSYCHIATRIC GROUP INVESTMENTS The fundamental ongoing changes in the psychiatric industry and the resulting negative impact on operator financial performance have resulted in significant psychiatric investment write-downs and the periodic restructuring of psychiatric operator payment obligations. In 1995, the Company restructured the leases covering its two psychiatric properties in Florida, Northpointe Behavioral Health System (Northpointe) and The Retreat, and during 1996, provided for the partial deferral of rental and interest obligations related to one of these 7 9 AMERICAN HEALTH PROPERTIES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) properties and the partial deferral of rental obligations of its psychiatric property in Illinois, Rock Creek Center (RCC). Adverse publicity from a lawsuit filed against the owner of the two Florida psychiatric hospitals in late 1996 materially exacerbated the operational and financial difficulties of the facilities during the first quarter of 1997. After reviewing the significantly worsened operational and financial problems of the hospitals and various alternatives for the facilities, the Company recorded an $11 million impairment charge in the first quarter of 1997 to reduce its total carrying value for these two investments to their estimated fair value of $5,400,000. The financial and operational problems at the two Florida psychiatric hospitals continued to worsen during 1997. The owner of the Northpointe hospital ceased operations during the second quarter of 1997. A restructuring of The Retreat's obligations to the Company was completed shortly after the end of the third quarter of 1997, pursuant to which the Company received $105,000 for past base rent, monthly base rent was reduced to $35,000, additional rent was eliminated until August 2000 and previous obligations of approximately $500,000 owed to the Company were consolidated in a note requiring monthly payments of approximately $18,000 commencing January 1998. Although the restructured agreement with The Retreat is a positive step in stabilizing the cash flow and operations of this facility, the Company cannot be assured that The Retreat will be able to continue to meet its restructured obligations or to continue operations, 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 ultimate course of action. In light of the volatile circumstances of these two properties, the Company cannot be assured that further write-downs of these investments will not be required. The $2,500,000 balance outstanding under RCC's revolving credit agreement matured June 30, 1997 and the current term of the RCC lease expires in December 1997. The Company and the operator are currently discussing the possible extension of the maturity of the revolving credit agreement and the lease term. Meanwhile, the operator has continued to make interest payments on the delinquent balance outstanding under the revolving credit agreement. Although the Company believes that the maturity of the revolving credit agreement and the lease term will be extended, the Company cannot be assured of this. Furthermore, if the lease term is extended, the Company cannot be assured that the annual minimum rent payments will remain at the current level of $1,000,000. Should the lease not be extended or the revolving loan not be repaid or extended, a negative impact to the Company likely would result. The two New York Four Winds facilities have been working to develop an integrated behavioral health care delivery system in lower and upper New York state. Such a system has been intended to create a cost-effective response to the potential negative reimbursement consequences of the expected movement to a managed Medicaid care environment within New York which is likely to accelerate during early 1998. However, it is not possible for the Company to predict the impact of such changes or whether the operator's system will be successful in such an environment, and some restructuring of the operator's obligations to the Company may be required for the operator to remain competitive in such an environment. Although management currently believes that the recorded investments in the psychiatric hospitals are realizable, if the psychiatric operators are unable to successfully adapt to the fundamental ongoing changes in the psychiatric industry and consistently mitigate the negative impact of such changes on their financial performance, the Company may be required to further restructure payment obligations, identify alternative operators, pursue alternative uses for or dispositions of the properties and/or make additional write-downs of the value of its investments in the psychiatric hospitals. If the Company is required to take any of these actions, various costs are 8 10 AMERICAN HEALTH PROPERTIES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) likely to be incurred by the Company in an effort to protect, maintain and pursue alternatives for its investments. The Company does not intend to make new investments in the psychiatric sector, and over time, may sell, restructure or seek other means to reduce its investments in the psychiatric sector. The dividend on the Company's Psychiatric Group Depositary Shares is determined each quarter based upon the operating results of the Company's Psychiatric Group. Historically, the level of dividends of the Psychiatric Group have varied quarter-to-quarter. Any significant advance of additional funds to psychiatric hospital operators, modification of terms covering the rental or interest obligations of its psychiatric properties or nonpayment or deferral of such obligations as they become due likely will have an adverse impact on the Company's Psychiatric Group results of operations and cash flows, as well as the quarterly dividend payment on Psychiatric Group Depositary Shares. In addition to the foregoing, future operating results, cash flows and dividends of the Company's Psychiatric Group will be affected by changes in the level of additional rent and interest, the amount of additional financial advisory fees and, to the extent necessary, various costs which might be incurred in an effort to protect, maintain and pursue alternatives for its psychiatric investments. 9 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 and Alzheimer's care facilities and medical office buildings (the Core Group). The Psychiatric Group Depositary Shares are intended to reflect the separate financial performance of the Company's investments in psychiatric hospitals (the Psychiatric Group). The proceeds from the October 1997 sale of the Company's depositary shares (Series B Depositary Shares) representing its 8.60% Cumulative Redeemable Preferred Stock, Series B (Series B Preferred Stock), as well as the dividends payable thereon, have been 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 Statements that are not historical facts contained in management's discussion and analysis of financial condition and results of operations are forward-looking statements that involve risks and uncertainties that could cause actual results to differ from projected results. Certain factors that could cause actual results to differ materially include, among others: the financial success of the operations conducted at the Company's facilities and the financial strength of the operators of such facilities, the continuing ability of operators to meet their obligations to the Company under existing or restructured agreements, changes in operators or ownership of operators, the viability of alternative uses for the Company's properties when necessary, changes in government policy relating to the health care industry including reductions in reimbursement levels under the Medicare and Medicaid programs, operators' continued eligibility to participate in the Medicare or Medicaid programs, reductions in reimbursement by other third-party payors, lower occupancy levels at the Company's facilities, the strength and financial resources of the Company's competitors, the availability and cost of capital, the Company's ability to make additional real estate investments at attractive yields and changes in tax laws and regulations affecting real estate investment trusts. For a further discussion of such factors, see "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations - Future Operating Results" herein. OPERATING RESULTS Third Quarter and Year to Date 1997 Compared With 1996 For the third quarter of 1997, the Company reported net income of $12,268,000 compared with net income of $11,151,000 for the third quarter of 1996. For the nine months ended September 30, 1997, the Company reported net income of $13,633,000 compared with net income of $32,571,000 for the nine months ended September 30, 1996. For the nine months ended September 30, 1997, the Company reported net income before extraordinary item of $25,060,000 compared with net income before extraordinary item of $32,571,000 for the nine months ended September 30, 1996. Net income for the nine months ended September 30, 1997 included an 10 12 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS impairment loss on psychiatric investments of ($11,000,000) and an extraordinary loss on debt prepayment of ($11,427,000). See the Consolidated Condensed Statements of Operations for the net income (loss) and per share amounts attributable to the Core Group Common Stock and the Psychiatric Group Depositary Shares. Rental income was $17,945,000 for the third quarter of 1997, an increase of $630,000 or 4% from $17,315,000 for the third quarter of 1996. Rental income was $53,572,000 for the nine months ended September 30, 1997, an increase of $1,879,000 or 4% from $51,693,000 for the nine months ended September 30, 1996. This increase was primarily attributable to rental income from new properties acquired subsequent to the first quarter of 1996. These property additions also resulted in an increase in depreciation and amortization of $149,000 or 4% to $3,910,000 for the third quarter of 1997 compared with $3,761,000 for the third quarter of 1996 and an increase of $423,000 or 4% to $11,627,000 for the nine months ended September 30, 1997 compared with $11,204,000 for the same period in 1996. Additional rental and interest income was $3,124,000 for the third quarter of 1997, an increase of $32,000 or 1% from $3,092,000 for the third quarter of 1996. Additional rental and interest income was $9,247,000 for the nine months ended September 30, 1997, an increase of $144,000 or 2% from $9,103,000 for the nine months ended September 30, 1996. The majority of this positive variation was attributable to various properties other than the Company's six original acute care properties. Other property income of $73,000 and $107,000 for the third quarter of 1997 and nine months ended September 30, 1997, respectively, represents property operating expense reimbursements from medical office facility tenants. Other interest income decreased $43,000 or 18% to $195,000 for the third quarter of 1997 from $238,000 for the third quarter of 1996. Other interest income increased $556,000 or 61% to $1,467,000 for the nine months ended September 30, 1997 from $911,000 for the nine months ended September 30, 1996. The decrease in other interest income for the third quarter was primarily attributable to a lower average balance of direct financing leases and a lower average balance of interest-earning borrowings outstanding under revolving credit facilities provided to psychiatric hospital operators in 1997. The increase in other interest income for the first nine months of 1997 was primarily attributable to higher investable cash balances, partially offset by a lower average balance of direct financing leases and a lower average balance of interest-earning borrowings outstanding under revolving credit facilities provided to psychiatric hospital operators in 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 $204,000 for the third quarter of 1997, an increase of $193,000 from $11,000 for the third quarter of 1996. Property operating expense was $292,000 for the nine months ended September 30, 1997, an increase of $259,000 from $33,000 for the comparable period in 1996. This increase was attributable to operating expenses associated with an investment in a multi-tenant medical office facility during the second quarter of 1997 and costs related to the protection and maintenance of a psychiatric property in Florida after the hospital operator ceased hospital operations during the second quarter of 1997. Interest expense was $4,533,000 for the third quarter of 1997, a decrease of $752,000 or 14% from $5,285,000 for the third quarter of 1996. Interest expense was $15,118,000 for the nine months ended September 30, 1997, a decrease of $1,446,000 or 9% from $16,564,000 for the nine months ended September 30, 1996. The decrease in interest expense during these periods was primarily attributable to a lower weighted average effective interest rate on long-term debt during 1997, partially offset by a higher amount of long-term debt and a lower amount of capitalized interest in 1997. In late January 1997, the Company sold $220 million of publicly-traded 11 13 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS unsecured senior notes with a weighted average effective interest rate of approximately 7.56%. The Company used the proceeds of this offering to pay off the borrowings under its bank credit 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 $1,987,000 for the third quarter of 1997, an increase of $111,000 or 6% from $1,876,000 for the third quarter of 1996. For the first nine months of 1997, general and administrative expenses were $5,815,000, an increase of $170,000 or 3% from $5,645,000 for the first nine months of 1996. This variation was primarily attributable to higher compensation and benefits expense and an increase in travel expense, partially offset by a reduction in financial advisory and officer hiring costs. Future Operating Results The operators of most of the Company's facilities derive a substantial percentage of their total revenues from federal and state health care programs such as Medicare and Medicaid and from other third-party payors such as private insurance companies, self-insured employers and health maintenance organizations. Such operators also are subject to extensive federal, state and local government regulation relating to their operations, and the Company's facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with mandated procedures, licensure requirements under state law and certification standards under the Medicare and Medicaid programs. A reduction in reimbursement levels under the Medicare or Medicaid programs, a reduction in reimbursement by other third-party payors or an operator's failure to maintain its certification under Medicare or Medicaid programs could adversely affect revenues to the Company's facilities. The nature of health care delivery in the United States continues to undergo change and further review at both the national and state levels. Generally accepted goals of reform continue to include controlling costs and improving access to medical care. Various plans to decrease the growth in Medicare spending have been proposed 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 potentially would have an adverse impact on the level of funds available in the future to health care facilities. The Company's Board and management are monitoring potential changes closely. The Company believes that these potential changes may pose risks for certain institutions that are unwilling or unable to respond. At the same time, the Company believes that this changing health care environment will provide the Core Group with new opportunities for investment. The ongoing changes in the health care industry include trends toward shorter lengths of hospital stay, increased use of outpatient services, increased federal, state and third-party oversight of health care company operations and business practices, and increased demand for discounted or capitated health care services (delivery of services at a fixed price per capita basis to a defined group of covered parties). Furthermore, federal, state and third-party payors continue to propose and adopt various cost containment measures that restrict the scope of reimbursable health care services and limit increases in reimbursement rates for such services. Payors also are continuing to aggressively enforce compliance with program requirements and to pursue providers that they believe have not complied with such requirements. Outpatient business is expected to increase as advances in medical technologies allow more procedures to be performed on an outpatient basis and as payors continue to direct more patients from inpatient care to outpatient care. In addition, the entrance of insurance companies into managed care programs is accelerating the introduction of managed care in new localities, and states and insurance companies continue to negotiate actively the amounts they will pay for services. Moreover, the percentage of health care services that are reimbursed under the Medicare and Medicaid programs continues to increase as the population ages and as states expand their Medicaid programs. Continued eligibility to participate in these programs is crucial to a provider's financial strength. As a result of the foregoing, the revenues and margins may decrease at the Company's facilities. 12 14 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS Notwithstanding the potential for increasing government regulation, the Company believes that health care will continue to be delivered on a local and regional basis and that well-managed, high-quality, cost-controlled facilities will continue to be an integral part of local and regional health care delivery systems. The Company also believes that certain acute care hospitals will need to reconfigure or expand existing facilities or to affiliate themselves with other providers so as to become part of comprehensive and cost-effective health care systems. Such systems likely will include lower cost treatment settings, such as ambulatory care clinics, outpatient surgery centers, skilled nursing facilities and medical office buildings. In general, the Core Group facilities are part of local or regional health care delivery systems or are in the process of becoming integrated into such systems. The Company's future operating results could be affected by the operating performance of the Company's lessees and borrowers. The rental and interest obligations of its facility operators are primarily supported by the facility-specific operating cash flow. Real estate investments in the Company's portfolio are generally further supported by one or more credit enhancements that take the form of cross-default provisions, letters of credit, corporate and personal guarantees, security interests in cash reserve funds, accounts receivable or other personal property and requirements to maintain specified financial ratios. Fundamental changes in the psychiatric industry continue to negatively impact the facility-specific operating cash flow at the Company's psychiatric properties. Institutions responsible for the reimbursement of care provided to patients who use inpatient psychiatric treatment services have directed efforts toward decreasing their payments for such services, thereby reducing hospital operating revenues. Some cost-cutting measures used by such institutions include decreasing the inpatient length of stay, intensively reviewing utilization, directing patients from inpatient care to outpatient care and negotiating reduced reimbursement rates for services. The wider use of psychotropic drugs also has resulted in significant declines in the average length of stay. In addition, aggressive program compliance enforcement and increased scrutiny of past and current billing practices has resulted in the filing of lawsuits against some providers and significant negative publicity which has further exacerbated the financial and operational difficulties of providers. Although the operators of the psychiatric hospitals are responding by increasing case management, developing lower cost outpatient and daypatient programs and reducing operating costs, their efforts are generally not consistently mitigating the negative impact of these fundamental psychiatric industry changes. As a result, certain of the psychiatric hospital operators have not met their contractual payment obligations to the Company as scheduled and the Company cannot be assured that psychiatric hospital operators will be able to meet such payment obligations in the future. In general, the operators of the Company's psychiatric properties have very limited access to financing for their operating and capital needs. The Company currently is providing such financing under a revolving credit agreement to the operator of one of its psychiatric properties. As of November 7, 1997, outstanding borrowings under such agreement totaled $2,500,000. To the extent operators of the Company's psychiatric properties have increased working capital needs in the future, the Company may be the only source of such financing. The fundamental ongoing changes in the psychiatric industry and the resulting negative impact on operator financial performance have resulted in significant psychiatric investment write-downs and the periodic restructuring of psychiatric operator payment obligations. In 1995, the Company restructured the leases covering its two psychiatric properties in Florida, Northpointe Behavioral Health System (Northpointe) and The Retreat, and during 1996, provided for the partial deferral of rental and interest obligations related to one of these properties and the partial deferral of rental obligations of its psychiatric property in Illinois, Rock Creek Center (RCC). 13 15 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS Adverse publicity from a lawsuit filed against the owner of the two Florida psychiatric hospitals in late 1996 materially exacerbated the operational and financial difficulties of the facilities during the first quarter of 1997. After reviewing the significantly worsened operational and financial problems of the hospitals and various alternatives for the facilities, the Company recorded an $11 million impairment charge in the first quarter of 1997 to reduce its total carrying value for these two investments to their estimated fair value of $5,400,000. The financial and operational problems at the two Florida psychiatric hospitals continued to worsen during 1997. The owner of the Northpointe hospital ceased operations during the second quarter of 1997. A restructuring of The Retreat's obligations to the Company was completed shortly after the end of the third quarter of 1997, pursuant to which the Company received $105,000 for past base rent, monthly base rent was reduced to $35,000, additional rent was eliminated until August 2000 and previous obligations of approximately $500,000 owed to the Company were consolidated in a note requiring monthly payments of approximately $18,000 commencing January 1998. Although the restructured agreement with The Retreat is a positive step in stabilizing the cash flow and operations of this facility, the Company cannot be assured that The Retreat will be able to continue to meet its restructured obligations or to continue operations, 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 ultimate course of action. In light of the volatile circumstances of these two properties, the Company cannot be assured that further write-downs of these investments will not be required. The $2,500,000 balance outstanding under RCC's revolving credit agreement matured June 30, 1997 and the current term of the RCC lease expires in December 1997. The Company and the operator are currently discussing the possible extension of the maturity of the revolving credit agreement and the lease term. Meanwhile, the operator has continued to make interest payments on the delinquent balance outstanding under the revolving credit agreement. Although the Company believes that the maturity of the revolving credit agreement and the lease term will be extended, the Company cannot be assured of this. Furthermore, if the lease term is extended, the Company cannot be assured that the annual minimum rent payments will remain at the current level of $1,000,000. Should the lease not be extended or the revolving loan not be repaid or extended, a negative impact to the Company likely would result. The two New York Four Winds facilities have been working to develop an integrated behavioral health care delivery system in lower and upper New York state. Such a system has been intended to create a cost-effective response to the potential negative reimbursement consequences of the expected movement to a managed Medicaid care environment within New York which is likely to accelerate during early 1998. However, it is not possible for the Company to predict the impact of such changes or whether the operator's system will be successful in such an environment, and some restructuring of the operator's obligations to the Company may be required for the operator to remain competitive in such an environment. Although management currently believes that the recorded investments in the psychiatric hospitals are realizable, if the psychiatric operators are unable to successfully adapt to the fundamental ongoing changes in the psychiatric industry and consistently mitigate the negative impact of such changes on their financial performance, the Company may be required to further restructure payment obligations, identify alternative operators, pursue alternative uses for or dispositions of the properties and/or make additional write-downs of the value of its investments in the psychiatric hospitals. If the Company is required to take any of these actions, various costs are likely to be incurred by the Company in an effort to protect, maintain and pursue alternatives for its investments. The Company does not intend to make new investments in the psychiatric sector, and over time, may sell, restructure or seek other means to reduce its investments in the psychiatric sector. 14 16 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS The dividend on the Company's Psychiatric Group Depositary Shares is determined each quarter based upon the operating results of the Company's Psychiatric Group. Historically, the level of dividends of the Psychiatric Group have varied quarter-to-quarter. Any significant advance of additional funds to psychiatric hospital operators, modification of terms covering the rental or interest obligations of its psychiatric properties or nonpayment or deferral of such obligations as they become due likely will have an adverse impact on the Company's Psychiatric Group results of operations and cash flows, as well as the quarterly dividend payment on Psychiatric Group Depositary Shares. In addition to the foregoing, future operating results, cash flows and dividends of the Company's Psychiatric Group will be affected by changes in the level of additional rent and interest, the amount of additional financial advisory fees and, to the extent necessary, various costs which might be incurred in an effort to protect, maintain and pursue alternatives for its psychiatric investments. The future operating results of the Company will be affected by additional factors including the amount, timing and yield of additional real estate investments and the competition for such investments. Operating results also will be affected by the availability and terms of the Company's future equity and debt financing. The Company's financing strategy to facilitate future growth includes objectives to reduce its cost of capital over time and enhance its liquidity and financial flexibility. LIQUIDITY AND CAPITAL RESOURCES As of November 7, 1997, the Company had remaining commitments of $15.5 million to fund real estate projects currently under construction over approximately the next fifteen months. In addition, the Company has agreed to provide real estate financing to two different operators aggregating approximately $59.4 million for which there are currently no definitive funding requirements. Of this amount, $50 million has been committed to the assisted living sector and $9.4 million has been committed to the long-term acute care sector. The Company also has signed letters of intent and is currently negotiating or has under contract investments in a number of existing medical office buildings and similar facilities, which, if closed, would aggregate approximately $130 million of total investment. Although the Company anticipates closing approximately $100 million of these proposed investments in the fourth quarter of 1997 and the remainder in the first quarter of 1998, the Company cannot be assured as to the actual timing of such closings or that the proposed investments will ultimately be closed. The Company has continued to increase its liquidity and enhance its financial flexibility. In January 1997, the Company completed a $220 million public unsecured debt offering, issuing $100 million of five-year senior notes and $120 million of ten-year senior notes. The Company used the net proceeds to pay off all outstanding borrowings under its bank credit facility at the time and to prepay all of its $152 million of outstanding private placement debt in late February 1997. 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 will use the remaining proceeds to fund Core Group investments. As of November 7, 1997, the Company had no outstanding borrowings under its revolving $150 million bank credit facility and had $101.1 million in cash and short-term investments. The Company's total indebtedness as of November 7, 1997 was $225.8 million. The Company will 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. 15 17 AMERICAN HEALTH PROPERTIES, INC. CORE GROUP COMBINED CONDENSED BALANCE SHEETS (IN THOUSANDS)
September 30, December 31, 1997 1996 - ----------------------------------------------------------- ------------- ------------ ASSETS (Unaudited) Real estate investments Real property and mortgage notes, net $ 599,966 $ 581,631 Construction in progress 8,100 4,834 Accumulated depreciation (96,431) (85,451) --------- --------- 511,635 501,014 Direct financing leases 3,306 3,695 Revolving loan to Psychiatric Group 3,687 4,183 Fixed rate loan to Psychiatric Group 9,175 9,175 Other assets 11,949 8,432 Cash and short-term investments 1,352 1,480 - ----------------------------------------------------------- --------- --------- $ 541,104 $ 527,979 - ----------------------------------------------------------- --------- --------- ATTRIBUTED LIABILITIES AND TOTAL ATTRIBUTED EQUITY Bank loans payable $ 8,500 $ 48,500 Notes and bonds payable 225,807 158,601 Accounts payable and accrued liabilities 6,818 7,385 Dividends payable 12,368 12,314 Deferred income 3,570 4,003 - ----------------------------------------------------------- --------- --------- 257,063 230,803 - ----------------------------------------------------------- --------- --------- Commitments and contingencies Total Attributed Core Group Equity 284,041 297,176 - ----------------------------------------------------------- --------- --------- $ 541,104 $ 527,979 - ----------------------------------------------------------- --------- ---------
The accompanying notes are an integral part of these financial statements. 16 18 AMERICAN HEALTH PROPERTIES, INC. CORE GROUP COMBINED CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Three Months Ended Nine Months Ended September 30, September 30, ------------------ -------------------- 1997 1996 1997 1996 - ---------------------------------------- ------- ------- -------- ------- REVENUES Rental income $17,590 $16,911 $ 52,294 $50,343 Mortgage interest income 97 -- 112 -- Additional rental income 2,939 2,882 8,691 8,491 Other property income 73 -- 107 -- Other interest income 113 126 1,201 605 Interest on loans to Psychiatric Group 392 425 1,176 1,272 - ---------------------------------------- ------- ------- -------- ------- 21,204 20,344 63,581 60,711 - ---------------------------------------- ------- ------- -------- ------- EXPENSES Depreciation and amortization 3,722 3,575 11,065 10,646 Property operating 129 11 192 33 Interest expense 4,533 5,285 15,118 16,564 General and administrative 1,685 1,546 4,918 4,672 - ---------------------------------------- ------- ------- -------- ------- 10,069 10,417 31,293 31,915 - ---------------------------------------- ------- ------- -------- ------- Minority interest 48 54 142 169 - ---------------------------------------- ------- ------- -------- ------- NET INCOME BEFORE EXTRAORDINARY ITEM 11,087 9,873 32,146 28,627 EXTRAORDINARY LOSS ON DEBT PREPAYMENT -- -- (11,427) -- - ---------------------------------------- ------- ------- -------- ------- NET INCOME $11,087 $ 9,873 $ 20,719 $28,627 - ---------------------------------------- ------- ------- -------- ------- PER COMMON SHARE AMOUNTS: - ------------------------- NET INCOME BEFORE EXTRAORDINARY ITEM $ 0.47 $ 0.42 $ 1.36 $ 1.22 EXTRAORDINARY LOSS ON DEBT PREPAYMENT $ -- $ -- $ (0.48) $ -- - ---------------------------------------- ------- ------- -------- ------- NET INCOME $ 0.47 $ 0.42 $ 0.88 $ 1.22 - ---------------------------------------- ------- ------- -------- ------- DIVIDENDS DECLARED $ 0.525 $ 0.505 $ 1.575 $1.5150 - ---------------------------------------- ------- ------- -------- ------- WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 23,649 23,522 23,585 23,511 - ---------------------------------------- ------- ------- -------- -------
The accompanying notes are an integral part of these financial statements. 17 19 AMERICAN HEALTH PROPERTIES, INC. CORE GROUP COMBINED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
Nine Months Ended September 30, ------------------------------- 1997 1996 - ----------------------------------------------------------- --------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 20,719 $ 28,627 Extraordinary loss on debt prepayment 11,427 -- Depreciation, amortization and other non-cash items 12,937 12,255 Deferred income (152) (243) Change in other assets (2,307) 800 Change in accounts payable and accrued liabilities (848) (3,187) - ----------------------------------------------------------- --------- -------- 41,776 38,252 - ----------------------------------------------------------- --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Acquisition and construction of real estate properties (17,919) (13,041) Mortgage note receivable fundings (3,683) -- Direct financing leases 389 2,329 Paydowns (fundings) on revolving loan to Psychiatric Group 496 132 Administrative capital expenditures (18) (52) - ----------------------------------------------------------- --------- -------- (20,735) (10,632) - ----------------------------------------------------------- --------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Borrowings (payments) on bank loans payable (40,000) 51,500 Proceeds from notes payable issuance 218,965 -- Prepayment of notes payable (163,176) -- Principal payments on notes payable -- (49,000) Financing costs paid (2,152) (80) Proceeds from exercise of stock options 2,176 241 Dividends paid (36,982) (35,521) - ----------------------------------------------------------- --------- -------- (21,169) (32,860) - ----------------------------------------------------------- --------- -------- INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS (128) (5,240) CASH AND SHORT-TERM INVESTMENTS, BEGINNING OF PERIOD 1,480 7,571 - ----------------------------------------------------------- --------- -------- CASH AND SHORT-TERM INVESTMENTS, END OF PERIOD $ 1,352 $ 2,331 - ----------------------------------------------------------- --------- --------
The accompanying notes are an integral part of these financial statements. 18 20 AMERICAN HEALTH PROPERTIES, INC. NOTES TO CORE GROUP COMBINED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL American Health Properties, Inc., a Delaware corporation (the Company, which term refers to the Company and its subsidiaries unless the context otherwise requires), is a self-administered real estate investment trust (REIT) that commenced operations in 1987. The Company has investments in health care properties, including acute care, rehabilitation, long-term acute care and psychiatric hospitals, skilled nursing, assisted living and Alzheimer's care facilities and medical office buildings. The Company's common stock (the Core Group Common Stock) is intended to reflect the separate financial performance of the Company's investments in acute care, rehabilitation and long-term acute care hospitals, skilled nursing, assisted living and Alzheimer's care facilities and medical office buildings (the Core Group). The Psychiatric Group Depositary Shares are intended to reflect the separate financial performance of the Company's investments in psychiatric hospitals (the Psychiatric Group). The proceeds from the October 1997 sale of the Company's depositary shares (Series B Depositary Shares) representing its 8.60% Cumulative Redeemable Preferred Stock, Series B (Series B Preferred Stock), as well as the dividends payable thereon, have been 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 combined condensed financial statements of the Core Group included herein have been prepared by the Company without audit and include all normal, recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results of operations pursuant to the rules and regulations of the Securities and Exchange Commission. These financial statements should be read in conjunction with those included in the Company's annual report on Form 10-K for the year ended December 31, 1996. The financial statements of the Core Group include the financial position, results of operations and cash flows of the Company's core investments in acute care, rehabilitation and long-term acute care hospitals, skilled nursing, assisted living and Alzheimer's care facilities and medical office buildings, an allocated portion of the Company's general and administrative expense, all corporate assets and liabilities and related transactions associated with the ongoing operations of the Company which are not separately identified with either operating group, an attributed amount of inter-Group loans receivable from the Psychiatric Group and an attributed amount of the Company's stockholders' equity. The Core Group financial statements are prepared using the amounts included in the Company's consolidated financial statements. Although the financial statements of the Core Group and the Psychiatric Group separately report the assets, liabilities (including contingent liabilities), stockholders' equity and items of income, expense and cash flow of the Company attributed to each such Group, such attribution does not affect the respective legal title to assets or responsibility for liabilities of the Company or any of its subsidiaries. Furthermore, such attribution does not affect the rights of creditors of the Company or any subsidiary, including rights under financing covenants. 19 21 AMERICAN HEALTH PROPERTIES, INC. NOTES TO CORE GROUP COMBINED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 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 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 all the Core Group Common Stock, Series B Depositary Shares and Psychiatric Group Depositary Shares. Accordingly, the Core Group's financial statements should be read in conjunction with the Company's consolidated financial statements and the financial statements of the Psychiatric Group. These financial statements include the accounts of the Core Group business. The Core Group and the Psychiatric Group financial statements, taken together, comprise all of the accounts included in the Company's consolidated financial statements. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. New Accounting Standard In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share." SFAS No. 128 is intended to simplify the computation of earnings per share (EPS) and to make the U.S. standard for computing EPS more compatible with the EPS standards of other countries and with that of the International Accounting Standards Committee. The effective date for the application of SFAS No. 128 for both interim and annual periods is after December 15, 1997. Earlier application is not permitted. Management does not expect the application of SFAS No. 128 to have a material impact on the Core Group's EPS calculation. Interest Paid Interest paid by the Core Group, net of interest capitalized, was $14,306,000 and $18,736,000 for the nine months ended September 30, 1997 and 1996, respectively. The Core Group had $344,000 and $781,000 of capitalized interest for the nine months ended September 30, 1997 and 1996, respectively. 2. DEBT All of the Company's third-party debt is attributed to the Core Group for financial accounting and reporting purposes. In January 1997, the Company completed a $220 million public debt offering of unsecured senior notes payable, issuing $100 million of notes with a coupon rate of 7.05% due January 15, 2002 (2002 Notes) and $120 million of notes with a coupon rate of 7.50% due January 15, 2007 (2007 Notes). The 2002 Notes and 2007 Notes were sold for $99,749,000 and $119,216,000, respectively, and have effective interest rates of approximately 7.34% and 7.74%, respectively. Interest is payable at the coupon rates semi-annually on January 15th and July 15th. The proceeds from the public debt offering were used to pay off the Company's $152 million of 11.03% private placement debt prior to its scheduled maturity and the Company's borrowings under its bank credit facility outstanding at the time. The prepayment of the private placement debt in February 1997 resulted in an extraordinary charge in the first quarter of 1997 of $11,427,000 consisting of a make-whole premium and other costs related to the prepayment. 20 22 AMERICAN HEALTH PROPERTIES, INC. NOTES TO CORE GROUP COMBINED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 3. ATTRIBUTED EQUITY Preferred Equity Offering In October 1997, the Company sold 4,000,000 Series B Depositary Shares at $25 per share representing 40,000 shares of Series B Preferred Stock. Each Series B Depositary Share represents 1/100 of a share of Series B Preferred Stock, and entitles the holder to such proportion of all the rights, preferences and privileges of the Series B Preferred Stock represented thereby. The Series B Depositary Shares, and the Series B Preferred Stock represented thereby, rank senior to the Company's Core Group Common Stock, its Series A Preferred Stock (when and if issued) and its Psychiatric Group Depositary Shares, and the Psychiatric Group Preferred Stock represented thereby, with respect to dividend payments and liquidation rights. The annual dividend rate and liquidation preference with respect to each Series B Depositary Share are $2.15 and $25, respectively (equivalent to $215 and $2,500 per share of Series B Preferred Stock, respectively). Dividends on the Series B Depositary Shares, and the Series B Preferred Stock represented thereby, are cumulative from the date of original issue and, if and when declared, are payable quarterly in arrears on the last day of February, May, August and November of each year (or, if such day is not a business day, the next business day), commencing on December 1, 1997. On or after October 27, 2002, the Series B Depositary Shares, and the Series B Preferred Stock represented thereby, may be redeemed, in whole or in part, at the option of the Company at a redemption price of $25 per Series B Depositary Share (equivalent to $2,500 per share of Series B Preferred Stock), plus accrued and unpaid dividends thereon. The redemption price, other than the portion representing accrued and unpaid dividends, is payable solely out of proceeds from the sale of other capital stock of the Company. The proceeds from the sale of the Series B Depositary Shares, and the Series B Preferred Stock represented thereby, as well as the dividends payable thereon, have been attributed to the Company's Core Group for financial accounting and reporting purposes. The net proceeds of approximately $96.4 million were used to pay off the borrowings under the Company's bank credit facility outstanding at the time and the remaining proceeds will be used to fund Core Group investments. Stock Incentive Plans During the nine months ended September 30, 1997, options to purchase 194,982 shares of Core Group Common Stock at a weighted average exercise price of $25.37 per share were issued pursuant to the Company's stock incentive plans. During the nine months ended September 30, 1997, options to purchase 100,000 shares of Core Group Common Stock were exercised at a weighted average exercise price of $21.76 per share resulting in additional equity of $2,176,000. Options to purchase 30,000 shares of Core Group Common Stock at a weighted average exercise price of $29.10 per share were canceled during the nine months ended September 30, 1997. Pursuant to an election to receive payment of his annual board fees on a deferred basis in the form of stock, 4,027 shares of Core Group Common Stock were issued to a director during the nine months ended September 30, 1997. 4. COMMITMENTS Inter-Group Loans Repayment of inter-Group loans by the Psychiatric Group is primarily dependent upon the amount and timing of sales of the Psychiatric Group's assets and paydowns received by the Psychiatric Group on borrowings provided to a psychiatric hospital operator under a revolving credit agreement. The Company's board of directors has established certain management policies relating to the Core Group's inter-Group loans to the Psychiatric Group. Under the policies currently in effect, which may be modified or rescinded in the sole discretion of the Company's board of directors, the aggregate revolving inter-Group loans owed by the Psychiatric Group to the Core Group are limited to a maximum of $7,930,000 at any one time outstanding, which limit is to be reduced dollar-for-dollar with any permanent repayment in the future of borrowings under a revolving credit agreement provided to a Psychiatric Group hospital operator. In addition, the limit on the aggregate revolving inter-Group loans will not be reduced below $5,000,000, and except for such revolving inter- 21 23 AMERICAN HEALTH PROPERTIES, INC. NOTES TO CORE GROUP COMBINED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) Group loans, no additional fixed rate or other inter-Group loans will be advanced by the Core Group to the Psychiatric Group. Real Estate Properties The Core Group has the right to approve capital expenditures at all of its properties, the option to fund certain capital expenditures and, in certain situations, is obligated to fund approved capital expenditures on terms comparable to the original investment. The base and additional rent provisions of the leases are amended when such capital expenditures are funded to reflect the Core Group's increased investment. At September 30, 1997, the Core Group had no commitments to fund capital expenditures pursuant to these rights and obligations. As of September 30, 1997, the Core Group had funded $5.4 million of a $6.2 million commitment to finance the acquisition and renovation of a long-term acute care facility in Amarillo, Texas to be operated by an experienced operator. In addition, the Core Group had funded $3.7 million of a $4.4 million mortgage loan to this same operator, which is secured by a long-term acute care facility in Houston, Texas. The Core Group has also agreed to provide an additional $9.4 million of real estate financing to this same operator for other similar facilities. As of September 30, 1997, the Core Group had funded $2.7 million of a $17 million commitment to provide construction and lease financing for two skilled nursing properties in Las Vegas, Nevada to be operated by an experienced operator of skilled nursing facilities. The Core Group has agreed to provide $50 million of real estate financing to an experienced operator of assisted living facilities. Approximately $29 million of this amount has been specifically identified for the construction of five properties located in four states, with the remaining $21 million available for future acquisitions or projects that have not yet been identified and agreed upon. The operator has undergone a change in ownership during the year and is presently reevaluating which investment opportunities it may ultimately pursue, which could impact the amount of the Core Group's financing commitment that is ultimately used. The Core Group has signed letters of intent and is currently negotiating or has under contract investments in a number of existing medical office buildings and similar facilities, which, if closed, would aggregate approximately $130 million of total investment. Although the Core Group anticipates closing approximately $100 million of these proposed investments in the fourth quarter of 1997 and the remainder in the first quarter of 1998, the Core Group cannot be assured as to the actual timing of such closings or that the proposed investments will ultimately be closed. 22 24 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS Following is a discussion of the combined financial condition and results of operations of the Core Group which should be read in conjunction with (a) the combined financial statements and accompanying notes of the Core Group and (b) management's discussion and analysis of financial condition and results of operations and the financial statements and accompanying notes of the Company and the Psychiatric Group included elsewhere herein. Factors Regarding Future Results and Forward-Looking Statements Statements that are not historical facts contained in management's discussion and analysis of financial condition and results of operations are forward-looking statements that involve risks and uncertainties that could cause actual results to differ from projected results. Certain factors that could cause actual results to differ materially include, among others: the financial success of the operations conducted at the Core Group's facilities and the financial strength of the operators of such facilities, the continuing ability of operators to meet their obligations to the Core Group under existing agreements, changes in operators or ownership of operators, the viability of alternative uses for the Core Group's properties when necessary, changes in government policy relating to the health care industry including reductions in reimbursement levels under the Medicare and Medicaid programs, operators' continued eligibility to participate in the Medicare or Medicaid programs, reductions in reimbursement by other third-party payors, lower occupancy levels at the Core Group's facilities, the strength and financial resources of the Core Group's competitors, the availability and cost of capital, the Core Group's ability to make additional real estate investments at attractive yields and changes in tax laws and regulations affecting real estate investment trusts. For a further discussion of such factors, see "Management's Discussion and Analysis of Core Group Combined Financial Condition and Results of Operations - Future Operating Results" herein. OPERATING RESULTS Third Quarter and Year to Date 1997 Compared With 1996 For the third quarter of 1997, the Core Group reported net income of $11,087,000 or $.47 per share compared with net income of $9,873,000 or $.42 per share for the third quarter of 1996. For the nine months ended September 30, 1997, the Core Group reported net income of $20,719,000 or $.88 per share compared with net income of $28,627,000 or $1.22 per share for the nine months ended September 30, 1996. For the nine months ended September 30, 1997, the Core Group reported net income before extraordinary item of $32,146,000 or $1.36 per share, an increase of $3,519,000 or 12% compared with net income before extraordinary item of $28,627,000 or $1.22 per share for the nine months ended September 30, 1996. Net income for the nine months ended September 30, 1997 included an extraordinary loss on debt prepayment of ($11,427,000) or ($.48) per share. Rental income was $17,590,000 for the third quarter of 1997, an increase of $679,000 or 4% from $16,911,000 for the third quarter of 1996. Rental income was $52,294,000 for the nine months ended September 30, 1997, an increase of $1,951,000 or 4% from $50,343,000 for the nine months ended September 30, 1996. This increase was primarily attributable to rental income from new properties acquired subsequent to the first quarter of 1996. These property additions also resulted in an increase in depreciation and amortization of $147,000 or 4% to $3,722,000 for the third quarter of 1997 compared with $3,575,000 for the third quarter of 1996 and an increase of $419,000 or 4% to $11,065,000 for the nine months ended September 30, 1997 compared with $10,646,000 for the same period in 1996. Additional rental and interest income was $2,939,000 for the third quarter of 1997, an increase of $57,000 or 2% from $2,882,000 for the third quarter of 1996. Additional rental and interest income was $8,691,000 for the nine months ended September 30, 1997, an increase of $200,000 or 2% from $8,491,000 for the nine months ended September 30, 1996. The majority of this positive variation was attributable to various properties other than the Core Group's six original acute care properties. 23 25 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS Other property income of $73,000 and $107,000 for the third quarter of 1997 and nine months ended September 30, 1997, respectively, represents property operating expense reimbursements from medical office facility tenants. Other interest income decreased $13,000 or 10% to $113,000 for the third quarter of 1997 from $126,000 for the third quarter of 1996. Other interest income increased $596,000 or 99% to $1,201,000 for the nine months ended September 30, 1997 from $605,000 for the nine months ended September 30, 1996. The decrease in other interest income for the third quarter was primarily attributable to a lower average balance of direct financing leases in 1997. The increase in other interest income for the first nine months of 1997 was primarily attributable to higher investable cash balances, partially offset by a lower average balance of direct financing leases. Investable cash balances were significantly higher during the first quarter of 1997 due to the temporary investment of a portion of the proceeds of a public debt offering in late January 1997 until used to prepay the Company's private placement debt in late February 1997 after the prepayment notice period had expired. Interest income on inter-Group loans to the Psychiatric Group was $392,000 for the third quarter of 1997, a decrease of $33,000 or 8% from $425,000 for the third quarter of 1996. Interest income on inter-Group loans to the Psychiatric Group was $1,176,000 for the nine months ended September 30, 1997, a decrease of $96,000 or 8% from $1,272,000 for the nine months ended September 30, 1996. This decrease reflects a lower average balance outstanding on loans to the Psychiatric Group as a result of repayments by the Psychiatric Group from its available undistributed cash flow. Property operating expense was $129,000 for the third quarter of 1997, an increase of $118,000 from $11,000 for the third quarter of 1996. Property operating expense was $192,000 for the nine months ended September 30, 1997, an increase of $159,000 from $33,000 for the comparable period in 1996. This increase was attributable to operating expenses associated with an investment in a multi-tenant medical office facility during the second quarter of 1997. Interest expense was $4,533,000 for the third quarter of 1997, a decrease of $752,000 or 14% from $5,285,000 for the third quarter of 1996. Interest expense was $15,118,000 for the nine months ended September 30, 1997, a decrease of $1,446,000 or 9% from $16,564,000 for the nine months ended September 30, 1996. The decrease in interest expense during these periods was primarily attributable to a lower weighted average effective interest rate on long-term debt during 1997, partially offset by a higher amount of long-term debt and a lower amount of capitalized interest in 1997. In late January 1997, the Company sold $220 million of publicly-traded unsecured senior notes with a weighted average effective interest rate of approximately 7.56%. The Company used the proceeds of this offering to pay off the borrowings under its bank credit 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 $1,685,000 for the third quarter of 1997, an increase of $139,000 or 9% from $1,546,000 for the third quarter of 1996. For the first nine months of 1997, general and administrative expenses were $4,918,000, an increase of $246,000 or 5% from $4,672,000 for the first nine months of 1996. This variation was attributable to an increase in the Company's consolidated general and administrative expenses which are allocated between the Core Group and Psychiatric Group primarily based on revenues, and an increase in Core Group revenues relative to the Company's consolidated revenues. The increase in the Company's consolidated general and administrative expenses affecting the Core Group was primarily attributable to higher compensation and benefits expense and an increase in travel expense, partially offset by a reduction in officer hiring costs. 24 26 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS Future Operating Results The operators of most of the Company's facilities derive a substantial percentage of their total revenues from federal and state health care programs such as Medicare and Medicaid and from other third-party payors such as private insurance companies, self-insured employers and health maintenance organizations. Such operators also are subject to extensive federal, state and local government regulation relating to their operations, and the Company's facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with mandated procedures, licensure requirements under state law and certification standards under the Medicare and Medicaid programs. A reduction in reimbursement levels under the Medicare or Medicaid programs, a reduction in reimbursement by other third-party payors or an operator's failure to maintain its certification under Medicare or Medicaid programs could adversely affect revenues to the Company's facilities. The nature of health care delivery in the United States continues to undergo change and further review at both the national and state levels. Generally accepted goals of reform continue to include controlling costs and improving access to medical care. Various plans to decrease the growth in Medicare spending have been proposed 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 potentially would have an adverse impact on the level of funds available in the future to health care facilities. The Company's Board and management are monitoring potential changes closely. The Company believes that these potential changes may pose risks for certain institutions that are unwilling or unable to respond. At the same time, the Company believes that this changing health care environment will provide the Core Group with new opportunities for investment. The ongoing changes in the health care industry include trends toward shorter lengths of hospital stay, increased use of outpatient services, increased federal, state and third-party oversight of health care company operations and business practices, and increased demand for discounted or capitated health care services (delivery of services at a fixed price per capita basis to a defined group of covered parties). Furthermore, federal, state and third-party payors continue to propose and adopt various cost containment measures that restrict the scope of reimbursable health care services and limit increases in reimbursement rates for such services. Payors also are continuing to aggressively enforce compliance with program requirements and to pursue providers that they believe have not complied with such requirements. Outpatient business is expected to increase as advances in medical technologies allow more procedures to be performed on an outpatient basis and as payors continue to direct more patients from inpatient care to outpatient care. In addition, the entrance of insurance companies into managed care programs is accelerating the introduction of managed care in new localities, and states and insurance companies continue to negotiate actively the amounts they will pay for services. Moreover, the percentage of health care services that are reimbursed under the Medicare and Medicaid programs continues to increase as the population ages and as states expand their Medicaid programs. Continued eligibility to participate in these programs is crucial to a provider's financial strength. As a result of the foregoing, the revenues and margins may decrease at the Core Group's facilities. Notwithstanding the potential for increasing government regulation, the Company believes that health care will continue to be delivered on a local and regional basis and that well-managed, high-quality, cost-controlled facilities will continue to be an integral part of local and regional health care delivery systems. The Company also believes that certain acute care hospitals will need to reconfigure or expand existing facilities or to affiliate themselves with other providers so as to become part of comprehensive and cost-effective health care systems. Such systems likely will include lower cost treatment settings, such as ambulatory care clinics, outpatient surgery centers, skilled nursing facilities and medical office buildings. In general, the Core Group facilities are part of local or regional health care delivery systems or are in the process of becoming integrated into such systems. 25 27 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Core Group's future operating results could be affected by the operating performance of the Core Group's lessees and borrowers. The rental and interest obligations of its facility operators are primarily supported by the facility-specific operating cash flow. Real estate investments in the Core Group's portfolio are generally further supported by one or more credit enhancements that take the form of cross-default provisions, letters of credit, corporate and personal guarantees, security interests in cash reserve funds, accounts receivable or other personal property and requirements to maintain specified financial ratios. In addition, financial effects arising from the Psychiatric Group that affect the Company's consolidated results of operations, financial condition or borrowing costs may also affect the results of operations, financial condition or borrowing costs of the Core Group. Accordingly, the Core Group's financial statements should be read in conjunction with the financial statements of the Psychiatric Group and the Company's consolidated financial statements. The future operating results of the Core Group will be affected by additional factors including the amount, timing and yield of additional real estate investments and the competition for such investments. Operating results also will be affected by the availability and terms of the Company's future equity and debt financing. The Company's financing strategy to facilitate future growth includes objectives to reduce its cost of capital over time and enhance its liquidity and financial flexibility. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 1997, the Core Group had $3,687,000 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 $7,930,000. In addition, as of September 30, 1997, the Core Group had $9,175,000 in fixed rate inter-Group loans to the Psychiatric Group. As of November 7, 1997, the Core Group had remaining commitments of $15.5 million to fund real estate projects currently under construction over approximately the next fifteen months. In addition, the Core Group has agreed to provide real estate financing to two different operators aggregating approximately $59.4 million for which there are currently no definitive funding requirements. Of this amount, $50 million has been committed to the assisted living sector and $9.4 million has been committed to the long-term acute care sector. The Core Group also has signed letters of intent and is currently negotiating or has under contract investments in a number of existing medical office buildings and similar facilities, which, if closed, would aggregate approximately $130 million of total investment. Although the Core Group anticipates closing approximately $100 million of these proposed investments in the fourth quarter of 1997 and the remainder in the first quarter of 1998, the Core Group cannot be assured as to the actual timing of such closings or that the proposed investments will ultimately be closed. The Company has continued to increase its liquidity and enhance its financial flexibility. In January 1997, the Company completed a $220 million public unsecured debt offering, issuing $100 million of five-year senior notes and $120 million of ten-year senior notes. The Company used the net proceeds to pay off all outstanding borrowings under its bank credit facility at the time and to prepay all of its $152 million of outstanding private placement debt in late February 1997. 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 will use the remaining proceeds to fund Core Group investments. As of November 7, 1997, the Company had no outstanding borrowings under its revolving $150 million bank credit facility and had $101.1 million in cash and short-term investments. The Company's total indebtedness as of November 7, 1997 was $225.8 million. The Company will 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 26 28 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CORE GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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. 27 29 AMERICAN HEALTH PROPERTIES, INC. PSYCHIATRIC GROUP COMBINED CONDENSED BALANCE SHEETS (IN THOUSANDS)
September 30, December 31, 1997 1996 - ----------------------------------------------------------- -------- -------- ASSETS (Unaudited) Real estate investments Real property and mortgage notes, net $ 49,642 $ 62,749 Accumulated depreciation (1,554) (4,688) -------- -------- 48,088 58,061 Other notes receivable 2,560 4,457 Other assets 703 743 - ----------------------------------------------------------- -------- -------- $ 51,351 $ 63,261 - ----------------------------------------------------------- -------- -------- ATTRIBUTED LIABILITIES AND TOTAL ATTRIBUTED EQUITY Revolving loan from Core Group $ 3,687 $ 4,183 Fixed rate loan from Core Group 9,175 9,175 Accounts payable and accrued liabilities 362 -- Dividends payable 1,292 1,667 Deferred income 25 273 - ----------------------------------------------------------- -------- -------- 14,541 15,298 - ----------------------------------------------------------- -------- -------- Commitments and contingencies Total Attributed Psychiatric Group Equity 36,810 47,963 - ----------------------------------------------------------- -------- -------- $ 51,351 $ 63,261 - ----------------------------------------------------------- -------- --------
The accompanying notes are an integral part of these financial statements. 28 30 AMERICAN HEALTH PROPERTIES, INC. PSYCHIATRIC GROUP COMBINED CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Three Months Ended Nine Months Ended September 30, September 30, ----------------- -------------------- 1997 1996 1997 1996 - ------------------------------------------ ------ ------- -------- ------- REVENUES Rental income $ 355 $ 404 $ 1,278 $ 1,350 Mortgage interest income 1,516 1,493 4,549 4,479 Additional rental and interest income 185 210 556 612 Other interest income 82 112 266 306 - ------------------------------------------ ------ ------- -------- ------- 2,138 2,219 6,649 6,747 - ------------------------------------------ ------ ------- -------- ------- EXPENSES Depreciation and amortization 188 186 562 558 Property operating 75 -- 100 -- Interest on loans from Core Group 392 425 1,176 1,272 General and administrative 302 330 897 973 Impairment loss on real estate investments and other notes receivable -- -- 11,000 -- - ------------------------------------------ ------ ------- -------- ------- 957 941 13,735 2,803 - ------------------------------------------ ------ ------- -------- ------- NET INCOME (LOSS) $1,181 $ 1,278 $ (7,086) $ 3,944 - ------------------------------------------ ------ ------- -------- ------- NET INCOME (LOSS) PER DEPOSITARY SHARE $ 0.56 $ 0.61 $ (3.38) $ 1.89 - ------------------------------------------ ------ ------- -------- ------- DIVIDENDS DECLARED PER DEPOSITARY SHARE $0.620 $ 0.650 $ 2.000 $2.0000 - ------------------------------------------ ------ ------- -------- ------- WEIGHTED AVERAGE DEPOSITARY SHARES OUTSTANDING 2,099 2,093 2,097 2,092 - ------------------------------------------ ------ ------- -------- -------
The accompanying notes are an integral part of these financial statements. 29 31 AMERICAN HEALTH PROPERTIES, INC. PSYCHIATRIC GROUP COMBINED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
Nine Months Ended September 30, ------------------------------- 1997 1996 - ----------------------------------------------------------- -------- ------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ (7,086) $ 3,944 Depreciation, amortization and other non-cash items 664 653 Deferred income (22) (40) Impairment loss on real estate investments and other notes receivable 11,000 -- Change in other assets 37 2 Change in accounts payable and accrued liabilities 221 (146) - ----------------------------------------------------------- -------- ------- 4,814 4,413 - ----------------------------------------------------------- -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES Principal payments on mortgage notes receivable 52 47 Other notes receivable 173 154 - ----------------------------------------------------------- -------- ------- 225 201 - ----------------------------------------------------------- -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Borrowings (payments) on revolving loan from Core Group (496) (132) Dividends paid (4,543) (4,482) - ----------------------------------------------------------- -------- ------- (5,039) (4,614) - ----------------------------------------------------------- -------- ------- INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS -- -- CASH AND SHORT-TERM INVESTMENTS, BEGINNING OF PERIOD -- -- - ----------------------------------------------------------- -------- ------- CASH AND SHORT-TERM INVESTMENTS, END OF PERIOD $ -- $ -- - ----------------------------------------------------------- -------- -------
The accompanying notes are an integral part of these financial statements. 30 32 AMERICAN HEALTH PROPERTIES, INC. NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL American Health Properties, Inc., a Delaware corporation (the Company, which term refers to the Company and its subsidiaries unless the context otherwise requires), is a self-administered real estate investment trust (REIT) that commenced operations in 1987. The Company has investments in health care properties, including acute care, rehabilitation, long-term acute care and psychiatric hospitals, skilled nursing, assisted living and Alzheimer's care facilities and medical office buildings. The Company's common stock (the Core Group Common Stock) is intended to reflect the separate financial performance of the Company's investments in acute care, rehabilitation and long-term acute care hospitals, skilled nursing, assisted living and Alzheimer's care facilities and medical office buildings (the Core Group). The Psychiatric Group Depositary Shares are intended to reflect the separate financial performance of the Company's investments in psychiatric hospitals (the Psychiatric Group). The proceeds from the October 1997 sale of the Company's depositary shares (Series B Depositary Shares) representing its 8.60% Cumulative Redeemable Preferred Stock, Series B (Series B Preferred Stock), as well as the dividends payable thereon, have been 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 combined condensed financial statements of the Psychiatric Group included herein have been prepared by the Company without audit and include all normal, recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results of operations pursuant to the rules and regulations of the Securities and Exchange Commission. These financial statements should be read in conjunction with those included in the Company's annual report on Form 10-K for the year ended December 31, 1996. The financial statements of the Psychiatric Group include the financial position, results of operations and cash flows of the Company's psychiatric hospital investments, an allocated portion of the Company's general and administrative expense, an attributed amount of inter-Group debt payable to the Core Group and an attributed amount of the Company's stockholders' equity. The Psychiatric Group financial statements are prepared using the amounts included in the Company's consolidated financial statements. Although the financial statements of the Psychiatric Group and the Core Group separately report the assets, liabilities (including contingent liabilities), stockholders' equity and items of income, expense and cash flow of the Company attributed to each such Group, such attribution does not affect the respective legal title to assets or responsibility for liabilities of the Company or any of its subsidiaries. Furthermore, such attribution does not affect the rights of creditors of the Company or any subsidiary, including rights under financing covenants. Each holder of Psychiatric Group Depositary Shares, 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 31 33 AMERICAN HEALTH PROPERTIES, INC. NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 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 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 all the 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. These financial statements include the accounts of the Psychiatric Group business. The Psychiatric Group and the Core Group financial statements, taken together, comprise all of the accounts included in the Company's consolidated financial statements. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. New Accounting Standard In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share." SFAS No. 128 is intended to simplify the computation of earnings per share (EPS) and to make the U.S. standard for computing EPS more compatible with the EPS standards of other countries and with that of the International Accounting Standards Committee. The effective date for the application of SFAS No. 128 for both interim and annual periods is after December 15, 1997. Earlier application is not permitted. Management does not expect the application of SFAS No. 128 to have a material impact on the Psychiatric Group's EPS calculation. Interest Paid Interest paid by the Psychiatric Group on inter-Group loans from the Core Group was $1,176,000 and $1,272,000 for the nine months ended September 30, 1997 and 1996, respectively. 2. DEBT Inter-Group Loans Repayment of inter-Group loans by the Psychiatric Group is primarily dependent upon the amount and timing of sales of the Psychiatric Group's assets and paydowns received by the Psychiatric Group on borrowings provided to a psychiatric hospital operator under a revolving credit agreement. The Company's board of directors has established certain management policies relating to the Psychiatric Group's inter-Group loans from the Core Group. Under the policies currently in effect, which may be modified or rescinded in the sole discretion of the Company's board of directors, the aggregate revolving inter-Group loans owed by the Psychiatric Group to the Core Group are limited to a maximum of $7,930,000 at any one time outstanding, which limit is to be reduced dollar-for-dollar with any permanent repayment in the future of borrowings under a revolving credit agreement provided to a Psychiatric Group hospital operator. In addition, the limit on the aggregate revolving inter-Group loans will not be reduced below $5,000,000, and except for such revolving inter-Group loans, no additional fixed rate or other inter-Group loans will be advanced to the Psychiatric Group by the Core Group. 32 34 AMERICAN HEALTH PROPERTIES, INC. NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 3. ATTRIBUTED EQUITY Stock Incentive Plans Options to purchase 10,000 shares of Psychiatric Group Depositary Shares at a weighted average exercise price of $24.15 per share were canceled during the nine months ended September 30, 1997. 4. COMMITMENTS Real Estate Properties The Psychiatric Group has the right to approve capital expenditures at all of its properties and the option to fund certain capital expenditures on terms comparable to the original investment. The base and additional rent provisions of the leases are amended when such capital expenditures are funded to reflect the Psychiatric Group's increased investment. The Psychiatric Group had no commitments to fund such capital expenditures at September 30, 1997. 5. STATUS OF PSYCHIATRIC GROUP INVESTMENTS At the beginning of 1996, the hospital owner of the Psychiatric Group's two Florida properties, Northpointe Behavioral Health System (Northpointe) and The Retreat, retained the Intensive Resource Division of Quorum Health Resources, Inc. (Quorum), a subsidiary of Quorum Health Group, Inc., to operate both hospitals on a contract basis. The owner had previously become aware of and was monitoring potential wide-ranging objections by several large insurance companies with respect to claims presented for services rendered. Additionally, there had been negative stories in the national media and the local press in Florida on psychiatric care provided in Florida, including criticism of admissions policies and practice patterns at psychiatric hospitals in the state generally, and at these two hospitals. Legislative hearings had been held in Florida on these issues, and various regulatory investigations likely had been conducted or initiated. The hospitals were also experiencing operational and cash flow difficulties which negatively impacted their ability to fund their rental and interest obligations to the Psychiatric Group as they became due. During 1996, the Psychiatric Group modified its agreements with the owner to allow for the deferral of rent and interest payments of Northpointe while certain restructuring and restaffing of the facility occurred. Pursuant to the deferral arrangements, Northpointe's monthly base rent payments of $50,000 were deferred from February 1996 through September 1996 and such deferred payments were scheduled to become payable twelve months from the month of deferral. In accordance with the terms of the deferral arrangements, Northpointe resumed making its full monthly base rent payments of $50,000 on October 1, 1996. In addition, Northpointe's monthly interest payments of $16,600 were deferred from February 1996 until March 1, 1997 on which date all such deferred interest was scheduled to be paid in full. Northpointe's deferred obligations were not recognized as income by the Psychiatric Group. In late 1996, the owner of Northpointe and The Retreat was named, together with other operators of other psychiatric facilities in Florida, in a lawsuit filed by several large insurance companies alleging widespread irregularities with respect to operations in years prior to 1995. Adverse publicity from the lawsuit materially exacerbated the operational and financial difficulties of Northpointe and The Retreat during the first quarter of 1997. During the first quarter of 1997, the census at Northpointe fell significantly below the levels projected by the owner at the end of 1996 to a level which made it appear unlikely that the owner could continue operations at the facility. Although Northpointe had made its monthly base rent payments of $50,000 during the fourth quarter of 1996 and for January 1997, it was unable to pay its subsequent monthly base rent and interest 33 35 AMERICAN HEALTH PROPERTIES, INC. NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) obligations or its deferred base rent and interest obligations. Adverse publicity from the aforementioned lawsuit also began having a negative impact on The Retreat resulting in declining census and deterioration of its cash flow during the first quarter of 1997. Although The Retreat had made all of its rent and interest payments to the Psychiatric Group in 1996 and in 1997 through April, The Retreat made its February 1997 base rent payment from lease reserve funds and was unable to pay its $45,000 additional rent payment for the first quarter of 1997 and its $92,000 base rent payment for May 1997. The volatile circumstances at The Retreat and deterioration in cash flows and census levels appeared likely to preclude the owner from continuing operations at the facility. The owner of these two hospitals and the Psychiatric Group were exploring a range of options for the facilities, including the transfer of the hospitals to new operators, closing the facilities, conversion of the facilities to an alternative use or sale of the properties. As a result of this review, the Psychiatric Group recorded an $11,000,000 charge in the first quarter of 1997 for impairment of the carrying value of these two investments. Of this amount, $5,100,000 related to the Psychiatric Group's investment in Northpointe and included a $1,675,000 reserve against the entire unpaid balance under a revolving credit agreement and a $3,425,000 reduction in the carrying value of its net real estate investment in Northpointe to its estimated fair value of $2,000,000. The remaining impairment charge of $5,900,000 related to the Psychiatric Group's investment in The Retreat and included a $49,000 reserve against the entire unpaid balance under a revolving credit agreement and a $5,851,000 reduction in the carrying value of its net real estate investment in The Retreat to its estimated fair value of $3,400,000. The estimated fair values of these two investments were determined primarily based upon the discounting of estimated future cash flows and fundamental analysis. The financial and operational problems at the two Florida hospitals continued to worsen during 1997. The owner of the Northpointe hospital ceased operations during the second quarter of 1997. The Psychiatric Group will incur approximately $75,000 per quarter ($.04 per depositary share) to protect and maintain the property while various alternatives are evaluated and pursued, including conversion of the facility to an alternative use or sale of the property. A restructuring of The Retreat's obligations to the Psychiatric Group was completed shortly after the end of the third quarter of 1997. 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 received $105,000 ($.05 per depositary share) for past base rent from the Retreat and such payment was recognized as income in the third quarter. In addition, the Psychiatric Group received a note for approximately $500,000, representing a consolidation of previous obligations owed by The Retreat. The note has a term of 32 months with monthly payments of approximately $18,000 scheduled to commence January 1, 1998. The note has not been recognized for financial accounting purposes. Although the restructured agreement with The Retreat is a positive step in stabilizing the cash flow and operations of this facility, the Psychiatric Group cannot be assured that The Retreat will be able to continue to meet its restructured obligations or to continue operations, 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 write-downs of these investments will not be required. In the first quarter of 1996, Rock Creek Center (RCC) in Illinois experienced certain documentation and procedural deficiencies that resulted in the denial of a substantial amount of Medicare receivables and a substantial negative adjustment to the hospital's 1995 Medicare cost report and 1996 interim Medicare reimbursement rate. These payor reimbursement issues, combined with lower than expected census during the first quarter of 1996, had an adverse impact on RCC's cash flow and its ability to fund its rental and interest obligations to the Psychiatric Group in 1996 as they became due. The net book value of the Psychiatric Group's 34 36 AMERICAN HEALTH PROPERTIES, INC. NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) investment in RCC, including advances under existing revolving credit agreements and other receivables, as of September 30, 1997 totaled $7,749,000. Quarterly base rent and interest obligations of RCC total approximately $330,000 ($.16 per depositary share). In 1996, the Psychiatric Group reached an agreement with the operator for the deferral of base rent payments while the operator took certain actions to stabilize operations and implemented its revised business plan. After a period of partial rental payments, full monthly base rent payments of $83,000 have been paid since November 1996. RCC's deferred rental obligations of approximately $333,000 are to be paid in the future only when the facility's cash exceeds a specified level and are not recognized as income by the Psychiatric Group until such time as they are paid. To date, no deferred rental obligations have been paid and the Psychiatric Group cannot be assured that RCC will be able to pay any of the deferred rental obligations in the future. The $2,500,000 balance outstanding under RCC's revolving credit agreement matured June 30, 1997 and the current term of the RCC lease expires in December 1997. The Psychiatric Group and the operator are currently discussing the possible extension of the maturity of the revolving credit agreement and the lease term. Meanwhile, the operator has continued to make interest payments on the delinquent balance outstanding under the revolving credit agreement. Although the Psychiatric Group believes that the maturity of the revolving credit agreement and the lease term will be extended, the Psychiatric Group cannot be assured of this. Furthermore, if the lease term is extended, the Psychiatric Group cannot be assured that the annual minimum rent payments will remain at the current level of $1,000,000. Should the lease not be extended or the revolving loan not be repaid or extended, a significant negative impact to the Psychiatric Group likely would result. The two New York Four Winds facilities have been working to develop an integrated behavioral health care delivery system in lower and upper New York state. Such a system has been intended to create a cost-effective response to the potential negative reimbursement consequences of the expected movement to a managed Medicaid care environment within New York which is likely to accelerate during early 1998. However, it is not possible for the Psychiatric Group to predict the impact of such changes or whether the operator's system will be successful in such an environment, and some restructuring of the operator's obligations to the Psychiatric Group may be required for the operator to remain competitive in such an environment. Although management currently believes that the recorded investments in the psychiatric hospitals are realizable, if the psychiatric operators are unable to successfully adapt to the fundamental ongoing changes in the psychiatric industry and consistently mitigate the negative impact of such changes on their financial performance, the Psychiatric Group may be required to further restructure payment obligations, identify alternative operators, pursue alternative uses for or dispositions of the properties and/or make additional write-downs of the value of its investments in the psychiatric hospitals. If the Psychiatric Group is required to take any of these actions, various costs are likely to be incurred by the Psychiatric Group in an effort to protect, maintain and pursue alternatives for its investments. The Psychiatric Group does not intend to make new investments, and over time, may sell, restructure or seek other means to reduce its investments. The Company retains an investment banking firm to provide financial advisory services to the Psychiatric Group. These services include supplemental monitoring of the performance of individual assets, assistance in potential sales or restructurings of particular investments and continuing assessments of available strategic alternatives for the portfolio. The cost of the financial advisory services are specifically charged to the operating results of the Psychiatric Group. The Psychiatric Group's dividend is determined quarterly based upon each quarter's operating results. Historically, the level of dividends of the Psychiatric Group have varied quarter-to-quarter. Any significant advance of additional funds to operators of the Psychiatric Group's properties, modification of terms covering the rental or interest obligations of its properties or nonpayment or deferral of such obligations as they become due likely will have an adverse impact on the Psychiatric Group results of operations and cash flows, as well as the 35 37 AMERICAN HEALTH PROPERTIES, INC. NOTES TO PSYCHIATRIC GROUP COMBINED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) quarterly dividend payment on Psychiatric Group Depositary Shares. In addition to the foregoing, future operating results, cash flows and dividends of the Psychiatric Group will be affected by changes in the level of additional rent and interest, the amount of additional financial advisory fees and, to the extent necessary, various costs which might be incurred in an effort to protect, maintain and pursue alternatives for its investments. 36 38 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS Following is a discussion of the combined financial condition and results of operations of the Psychiatric Group which should be read in conjunction with (a) the combined financial statements and accompanying notes of the Psychiatric Group and (b) management's discussion and analysis of financial condition and results of operations and the financial statements and accompanying notes of the Company and the Core Group included elsewhere herein. Factors Regarding Future Results and Forward-Looking Statements Statements that are not historical facts contained in management's discussion and analysis of financial condition and results of operations are forward-looking statements that involve risks and uncertainties that could cause actual results to differ from projected results. Certain factors that could cause actual results to differ materially include, among others: the financial success of the operations conducted at the Psychiatric Group's facilities and the financial strength of the operators of such facilities, the continuing ability of operators to meet their obligations to the Psychiatric Group under existing or restructured agreements, changes in operators or ownership of operators, the viability of alternative uses for the Psychiatric Group's properties when necessary, changes in government policy relating to the health care industry including reductions in reimbursement levels under the Medicare and Medicaid programs, operators' continued eligibility to participate in the Medicare or Medicaid programs, reductions in reimbursement by other third-party payors, lower occupancy levels at the Psychiatric Group's facilities, the availability and cost of capital and changes in tax laws and regulations affecting real estate investment trusts. For a further discussion of such factors, see "Management's Discussion and Analysis of Psychiatric Group Combined Financial Condition and Results of Operations - Future Operating Results" herein. OPERATING RESULTS Third Quarter and Year to Date 1997 Compared With 1996 For the third quarter of 1997, the Psychiatric Group reported net income of $1,181,000 or $.56 per depositary share compared with net income of $1,278,000 or $.61 per depositary share for the third quarter of 1996. For the nine months ended September 30, 1997, the Psychiatric Group reported a net loss of ($7,086,000) or ($3.38) per depositary share compared with net income of $3,944,000 or $1.89 per depositary share for the nine months ended September 30, 1996. The net loss for the nine months ended September 30, 1997 included an impairment loss on real estate investments and other notes receivable of ($11,000,000) or ($5.25) per depositary share. Rental income was $355,000 for the third quarter of 1997, a decrease of $49,000 or 12% from $404,000 for the third quarter of 1996. Rental income was $1,278,000 for the nine months ended September 30, 1997, a decrease of $72,000 or 5% from $1,350,000 for the comparable period in 1996. The decrease in rental income during these periods was primarily attributable to the nonpayment and subsequent reduction of base rent on one of the Florida properties during 1997, partially offset by the partial deferral of base rent on the Illinois property during 1996. Additional rental and interest income was $185,000 for the third quarter of 1997, a decrease of $25,000 or 12% from $210,000 for the third quarter of 1996. Additional rental and interest income was $556,000 for the nine months ended September 30, 1997, a decrease of $56,000 or 9% from $612,000 for the comparable period in 1996. This decrease was primarily attributable to the nonpayment of additional rent by one of the Florida properties during 1997. Other interest income decreased $30,000 or 27% to $82,000 for the third quarter of 1997 from $112,000 for the third quarter of 1996. Other interest income decreased $40,000 or 13% to $266,000 for the nine months ended September 30, 1997 from $306,000 for the nine months ended September 30, 1996. The decrease in other 37 39 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS interest income during these periods was primarily attributable to a lower average balance of interest-earning borrowings outstanding under revolving credit facilities provided to psychiatric hospital operators in 1997. Property operating expense of $75,000 and $100,000 for the third quarter of 1997 and nine months ended September 30, 1997, respectively, represents costs related to the protection and maintenance of one of the properties in Florida after the hospital owner ceased hospital operations during the second quarter of 1997. Interest expense on inter-Group loans from the Core Group was $392,000 for the third quarter of 1997, a decrease of $33,000 or 8% from $425,000 for the third quarter of 1996. Interest expense on inter-Group loans from the Core Group was $1,176,000 for the nine months ended September 30, 1997, a decrease of $96,000 or 8% from $1,272,000 for the comparable period in 1996. This decrease reflects a lower average balance outstanding on loans from the Core Group as a result of repayments by the Psychiatric Group from its available undistributed cash flow. General and administrative expenses were $302,000 for the third quarter of 1997, a decrease of $28,000 or 8% from $330,000 for the third quarter of 1996. General and administrative expenses were $897,000 for the nine months ended September 30, 1997, a decrease of $76,000 or 8% from $973,000 for the first nine months of 1996. The Company's consolidated general and administrative expenses are allocated between the Core Group and Psychiatric Group primarily based on revenues, however significant costs directly related to either Group are specifically charged to the applicable Group. Costs allocated to the Psychiatric Group based on revenues and direct costs charged to the Psychiatric Group both decreased for the third quarter and first nine months of 1997 compared to the comparable periods in 1996. The Psychiatric Group was specifically charged for $130,000 and $378,000 of costs in the third quarter and first nine months of 1997, respectively, for financial advisory services provided primarily by an investment banking firm which included supplemental monitoring of the performance of the Psychiatric Group's properties and assistance in addressing operational and cash flow difficulties of certain operators of the properties. On a comparative basis, general and administrative expenses for the third quarter and the nine months ended September 30, 1996 included $157,000 and $442,000 of such financial advisory costs. Future Operating Results The operators of most of the Company's facilities derive a substantial percentage of their total revenues from federal and state health care programs such as Medicare and Medicaid and from other third-party payors such as private insurance companies, self-insured employers and health maintenance organizations. Such operators also are subject to extensive federal, state and local government regulation relating to their operations, and the Company's facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with mandated procedures, licensure requirements under state law and certification standards under the Medicare and Medicaid programs. A reduction in reimbursement levels under the Medicare or Medicaid programs, a reduction in reimbursement by other third-party payors or an operator's failure to maintain its certification under Medicare or Medicaid programs could adversely affect revenues to the Company's facilities. The nature of health care delivery in the United States continues to undergo change and further review at both the national and state levels. Generally accepted goals of reform continue to include controlling costs and improving access to medical care. Various plans to decrease the growth in Medicare spending have been proposed 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 potentially would have an adverse impact on the level of funds available in the future to health care facilities. The Company's Board and management are monitoring potential changes closely. The Company believes that these potential changes may pose risks for certain institutions that are unwilling or unable to respond. 38 40 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS The ongoing changes in the health care industry include trends toward shorter lengths of hospital stay, increased use of outpatient services, increased federal, state and third-party oversight of health care company operations and business practices, and increased demand for discounted or capitated health care services (delivery of services at a fixed price per capita basis to a defined group of covered parties). Furthermore, federal, state and third-party payors continue to propose and adopt various cost containment measures that restrict the scope of reimbursable health care services and limit increases in reimbursement rates for such services. Payors also are continuing to aggressively enforce compliance with program requirements and to pursue providers that they believe have not complied with such requirements. Outpatient business is expected to increase as advances in medical technologies allow more procedures to be performed on an outpatient basis and as payors continue to direct more patients from inpatient care to outpatient care. In addition, the entrance of insurance companies into managed care programs is accelerating the introduction of managed care in new localities, and states and insurance companies continue to negotiate actively the amounts they will pay for services. Moreover, the percentage of health care services that are reimbursed under the Medicare and Medicaid programs continues to increase as the population ages and as states expand their Medicaid programs. Continued eligibility to participate in these programs is crucial to a provider's financial strength. As a result of the foregoing, the revenues and margins may decrease at the Psychiatric Group's facilities. Fundamental changes in the psychiatric industry continue to negatively impact the facility-specific operating cash flow at the Psychiatric Group's properties. Institutions responsible for the reimbursement of care provided to patients who use inpatient psychiatric treatment services have directed efforts toward decreasing their payments for such services, thereby reducing hospital operating revenues. Some cost-cutting measures used by such institutions include decreasing the inpatient length of stay, intensively reviewing utilization, directing patients from inpatient care to outpatient care and negotiating reduced reimbursement rates for services. The wider use of psychotropic drugs also has resulted in significant declines in the average length of stay. In addition, aggressive program compliance enforcement and increased scrutiny of past and current billing practices has resulted in the filing of lawsuits against some providers and significant negative publicity which has further exacerbated the financial and operational difficulties of providers. Although the operators of the psychiatric hospitals are responding by increasing case management, developing lower cost outpatient and daypatient programs and reducing operating costs, their efforts are generally not consistently mitigating the negative impact of these fundamental psychiatric industry changes. As a result, certain of the Psychiatric Group hospital operators have not met their contractual payment obligations to the Psychiatric Group as scheduled and the Psychiatric Group cannot be assured that hospital operators will be able to meet such payment obligations in the future. In general, the operators of the Psychiatric Group's properties have very limited access to financing for their operating and capital needs. The Psychiatric Group currently is providing such financing under a revolving credit agreement to the operator of one of its psychiatric properties. As of November 7, 1997, outstanding borrowings under such agreement totaled $2,500,000. In the past, the Psychiatric Group has provided similar financing to other operators of its properties which have been unable to pay off their outstanding borrowings. The Psychiatric Group cannot be assured that the operator currently borrowing under a revolving credit agreement will be able to secure replacement financing from third-party lenders or to pay off its outstanding borrowings. To the extent the operators of the Psychiatric Group's properties have increased working capital needs in the future, the Psychiatric Group may be the only source of such financing. In the event the Company's Board of Directors determines that it is appropriate to provide additional working capital financing to a psychiatric hospital operator, it may cause the Core Group to make revolving inter-Group loans to the Psychiatric Group to fund such financing (to the extent consistent with its then-existing policies), although the Company's Board of Directors is under no obligation to do so. At the beginning of 1996, the hospital owner of the Psychiatric Group's two Florida properties, Northpointe Behavioral Health System (Northpointe) and The Retreat, retained the Intensive Resource Division of 39 41 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS Quorum Health Resources, Inc. (Quorum), a subsidiary of Quorum Health Group, Inc., to operate both hospitals on a contract basis. The owner had previously become aware of and was monitoring potential wide-ranging objections by several large insurance companies with respect to claims presented for services rendered. Additionally, there had been negative stories in the national media and the local press in Florida on psychiatric care provided in Florida, including criticism of admissions policies and practice patterns at psychiatric hospitals in the state generally, and at these two hospitals. Legislative hearings had been held in Florida on these issues, and various regulatory investigations likely had been conducted or initiated. The hospitals were also experiencing operational and cash flow difficulties which negatively impacted their ability to fund their rental and interest obligations to the Psychiatric Group as they became due. During 1996, the Psychiatric Group modified its agreements with the owner to allow for the deferral of rent and interest payments of Northpointe while certain restructuring and restaffing of the facility occurred. Pursuant to the deferral arrangements, Northpointe's monthly base rent payments of $50,000 were deferred from February 1996 through September 1996 and such deferred payments were scheduled to become payable twelve months from the month of deferral. In accordance with the terms of the deferral arrangements, Northpointe resumed making its full monthly base rent payments of $50,000 on October 1, 1996. In addition, Northpointe's monthly interest payments of $16,600 were deferred from February 1996 until March 1, 1997 on which date all such deferred interest was scheduled to be paid in full. Northpointe's deferred obligations were not recognized as income by the Psychiatric Group. In late 1996, the owner of Northpointe and The Retreat was named, together with other operators of other psychiatric facilities in Florida, in a lawsuit filed by several large insurance companies alleging widespread irregularities with respect to operations in years prior to 1995. Adverse publicity from the lawsuit materially exacerbated the operational and financial difficulties of Northpointe and The Retreat during the first quarter of 1997. During the first quarter of 1997, the census at Northpointe fell significantly below the levels projected by the owner at the end of 1996 to a level which made it appear unlikely that the owner could continue operations at the facility. Although Northpointe had made its monthly base rent payments of $50,000 during the fourth quarter of 1996 and for January 1997, it was unable to pay its subsequent monthly base rent and interest obligations or its deferred base rent and interest obligations. Adverse publicity from the aforementioned lawsuit also began having a negative impact on The Retreat resulting in declining census and deterioration of its cash flow during the first quarter of 1997. Although The Retreat had made all of its rent and interest payments to the Psychiatric Group in 1996 and in 1997 through April, The Retreat made its February 1997 base rent payment from lease reserve funds and was unable to pay its $45,000 additional rent payment for the first quarter of 1997 and its $92,000 base rent payment for May 1997. The volatile circumstances at The Retreat and deterioration in cash flows and census levels appeared likely to preclude the owner from continuing operations at the facility. The owner of these two hospitals and the Psychiatric Group were exploring a range of options for the facilities, including the transfer of the hospitals to new operators, closing the facilities, conversion of the facilities to an alternative use or sale of the properties. As a result of this review, the Psychiatric Group recorded an $11,000,000 charge in the first quarter of 1997 for impairment of the carrying value of these two investments. Of this amount, $5,100,000 related to the Psychiatric Group's investment in Northpointe and included a $1,675,000 reserve against the entire unpaid balance under a revolving credit agreement and a $3,425,000 reduction in the carrying value of its net real estate investment in Northpointe to its estimated fair value of $2,000,000. The remaining impairment charge of $5,900,000 related to the Psychiatric Group's investment in The Retreat and included a $49,000 reserve against the entire unpaid balance under a revolving credit agreement and a $5,851,000 reduction in the carrying value of its net real estate investment in The Retreat to its estimated fair value of $3,400,000. 40 42 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS The financial and operational problems at the two Florida hospitals continued to worsen during 1997. The owner of the Northpointe hospital ceased operations during the second quarter of 1997. The Psychiatric Group will incur approximately $75,000 per quarter ($.04 per depositary share) to protect and maintain the property while various alternatives are evaluated and pursued, including conversion of the facility to an alternative use or sale of the property. A restructuring of The Retreat's obligations to the Psychiatric Group was completed shortly after the end of the third quarter of 1997. 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 received $105,000 ($.05 per depositary share) for past base rent from the Retreat and such payment was recognized as income in the third quarter. In addition, the Psychiatric Group received a note for approximately $500,000, representing a consolidation of previous obligations owed by The Retreat. The note has a term of 32 months with monthly payments of approximately $18,000 scheduled to commence January 1, 1998. The note has not been recognized for financial accounting purposes. Although the restructured agreement with The Retreat is a positive step in stabilizing the cash flow and operations of this facility, the Psychiatric Group cannot be assured that The Retreat will be able to continue to meet its restructured obligations or to continue operations, 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 write-downs of these investments will not be required. In the first quarter of 1996, Rock Creek Center (RCC) in Illinois experienced certain documentation and procedural deficiencies that resulted in the denial of a substantial amount of Medicare receivables and a substantial negative adjustment to the hospital's 1995 Medicare cost report and 1996 interim Medicare reimbursement rate. These payor reimbursement issues, combined with lower than expected census during the first quarter of 1996, had an adverse impact on RCC's cash flow and its ability to fund its rental and interest obligations to the Psychiatric Group in 1996 as they became due. The net book value of the Psychiatric Group's investment in RCC, including advances under existing revolving credit agreements and other receivables, as of September 30, 1997 totaled $7,749,000. Quarterly base rent and interest obligations of RCC total approximately $330,000 ($.16 per depositary share). In 1996, the Psychiatric Group reached an agreement with the operator for the deferral of base rent payments while the operator took certain actions to stabilize operations and implemented its revised business plan. After a period of partial rental payments, full monthly base rent payments of $83,000 have been paid since November 1996. RCC's deferred rental obligations of approximately $333,000 are to be paid in the future only when the facility's cash exceeds a specified level and are not recognized as income by the Psychiatric Group until such time as they are paid. To date, no deferred rental obligations have been paid and the Psychiatric Group cannot be assured that RCC will be able to pay any of the deferred rental obligations in the future. The $2,500,000 balance outstanding under RCC's revolving credit agreement matured June 30, 1997 and the current term of the RCC lease expires in December 1997. The Psychiatric Group and the operator are currently discussing the possible extension of the maturity of the revolving credit agreement and the lease term. Meanwhile, the operator has continued to make interest payments on the delinquent balance outstanding under the revolving credit agreement. Although the Psychiatric Group believes that the maturity of the revolving credit agreement and the lease term will be extended, the Psychiatric Group cannot be assured of this. Furthermore, if the lease term is extended, the Psychiatric Group cannot be assured that the annual minimum rent payments will remain at the current level of $1,000,000. Should the lease not be extended or the revolving loan not be repaid or extended, a significant negative impact to the Psychiatric Group likely would result. 41 43 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS The two New York Four Winds facilities have been working to develop an integrated behavioral health care delivery system in lower and upper New York state. Such a system has been intended to create a cost-effective response to the potential negative reimbursement consequences of the expected movement to a managed Medicaid care environment within New York which is likely to accelerate during early 1998. However, it is not possible for the Psychiatric Group to predict the impact of such changes or whether the operator's system will be successful in such an environment, and some restructuring of the operator's obligations to the Psychiatric Group may be required for the operator to remain competitive in such an environment. Although management currently believes that the recorded investments in the psychiatric hospitals are realizable, if the psychiatric operators are unable to successfully adapt to the fundamental ongoing changes in the psychiatric industry and consistently mitigate the negative impact of such changes on their financial performance, the Psychiatric Group may be required to further restructure payment obligations, identify alternative operators, pursue alternative uses for or dispositions of the properties and/or make additional write-downs of the value of its investments in the psychiatric hospitals. If the Psychiatric Group is required to take any of these actions, various costs are likely to be incurred by the Psychiatric Group in an effort to protect, maintain and pursue alternatives for its investments. The Psychiatric Group does not intend to make new investments, and over time, may sell, restructure or seek other means to reduce its investments. The Company retains an investment banking firm to provide financial advisory services to the Psychiatric Group. These services include supplemental monitoring of the performance of individual assets, assistance in potential sales or restructurings of particular investments and continuing assessments of available strategic alternatives for the portfolio. The cost of the financial advisory services are specifically charged to the operating results of the Psychiatric Group. The Psychiatric Group's dividend is determined quarterly based upon each quarter's operating results. Historically, the level of dividends of the Psychiatric Group have varied quarter-to-quarter. Any significant advance of additional funds to operators of the Psychiatric Group's properties, modification of terms covering the rental or interest obligations of its properties or nonpayment or deferral of such obligations as they become due likely will have an adverse impact on the Psychiatric Group results of operations and cash flows, as well as the quarterly dividend payment on Psychiatric Group Depositary Shares. In addition to the foregoing, future operating results, cash flows and dividends of the Psychiatric Group will be affected by changes in the level of additional rent and interest, the amount of additional financial advisory fees and, to the extent necessary, various costs which might be incurred in an effort to protect, maintain and pursue alternatives for its investments. LIQUIDITY AND CAPITAL RESOURCES At September 30, 1997, the Psychiatric Group had $3,687,000 and $9,175,000 outstanding under its revolving inter-Group loan from the Core Group and its fixed rate inter-Group loan from the Core Group, respectively. The Psychiatric Group is required to use the net proceeds from the disposition of Psychiatric Group assets to pay down its outstanding revolving inter-Group loan (to the extent of the psychiatric hospital operator borrowings under revolving credit agreements associated with the asset or assets sold) with any excess used to pay down the balance outstanding under the fixed rate inter-Group loan. The Company's Board of Directors has established certain management policies relating to the Psychiatric Group's inter-Group loans from the Core Group. Under the policies currently in effect, which may be modified or rescinded in the sole discretion of the Company's Board of Directors, the aggregate revolving inter-Group loans owed by the Psychiatric Group to the Core Group are limited to a maximum of $7,930,000 at any one time outstanding, which limit is to be reduced dollar-for-dollar with any permanent repayment in the future of borrowings under a revolving credit agreement provided to a Psychiatric Group hospital operator. In addition, the limit on the aggregate revolving inter-Group loans will not be reduced below $5,000,000, and except for such revolving inter-Group loans, no additional fixed rate or other inter-Group loans will be advanced to the Psychiatric Group by the Core Group. The Psychiatric 42 44 AMERICAN HEALTH PROPERTIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PSYCHIATRIC GROUP COMBINED FINANCIAL CONDITION AND RESULTS OF OPERATIONS Group has no third-party sources of additional financing and, as a result, is dependent on the Core Group for all such financing. Although the Core Group may make this financing available, there is no obligation of the Company's Board of Directors to cause the Core Group to provide funds to the Psychiatric Group if the Board of Directors determines that it is in the Company's best interest not to do so. To the extent needed funds are not advanced by the Core Group, the Psychiatric Group would experience immediate, significant negative effects. The Psychiatric Group does not expect to make any additional acquisitions or capital investments except to the extent of existing unfunded commitments under revolving credit agreements provided to facility operators. Future dividend payments will be determined quarterly and will be primarily dependent upon the financial performance of the Psychiatric Group. The Psychiatric Group expects to distribute a substantial portion of its funds from operations and net proceeds from asset dispositions, after payments of inter-Group loan obligations, to holders of Psychiatric Group Depositary Shares. In general, the Psychiatric Group will not retain any significant amount of its cash flow, and as discussed above, its sources of financing and liquidity will be limited. 43 45 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: November 7, 1997 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) 44 46 EXHIBIT INDEX
Exhibit No. Description - ------- ----------- 27 Financial Data Schedule
EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 9-MOS DEC-31-1997 SEP-30-1997 1,352 0 0 0 0 0 0 (97,985) 579,593 0 225,807 0 2 236 320,613 579,593 0 69,054 0 11,919 11,000 0 15,118 25,060 0 25,060 0 (11,427) 0 13,633 0 0 PRIMARY AND FULLY DILUTED EARNINGS PER SHARE ATTRIBUTABLE TO- CORE GROUP COMMON STOCK Net Income Before Extraordinary Item $ 1.36 Extraordinary Loss On Debt Prepayment $(0.48) Net Income $ 0.88 PSYCHIATRIC GROUP DEPOSITARY SHARES Net Loss Per Share $(3.38)
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