Physicians Realty Trust - Quarter Report: 2014 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

x                QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2014

 

or

 

o                   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: 001-36007

 

 

PHYSICIANS REALTY TRUST

(Exact Name of Registrant as Specified in its Charter)

 

 

 

 

(414) 978-6494

(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.  x Yes o No

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).  x Yes o No

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes x No

 

The number of the Registrant’s common shares outstanding as of November 7, 2014 was 47,381,216.

 

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PHYSICIANS REALTY TRUST

 

Quarterly Report on Form 10-Q
for the Quarter Ended September 30, 2014

 

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			Page
			Number
Part I	Financial Information
Item 1	Financial Statements (Unaudited)
	Consolidated Balance Sheets — as of September 30, 2014 and December 31, 2013		3
	Consolidated and Combined Statements of Operations — for the Three and Nine Months Ended September 30, 2014 and 2013		4
	Consolidated and Combined Statements of Equity — for the Nine Months Ended September 30, 2014		5
	Consolidated and Combined Statements of Cash Flow— for the Nine Months Ended September 30, 2014 and 2013		6
	Notes to Unaudited Consolidated and Combined Financial Statements		7
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operation		22
Item 3	Quantitative and Qualitative Disclosures About Market Risk		36
Item 4	Controls and Procedures		38
Part II	Other Information
Item 1	Legal Proceedings		38
Item 1A	Risk Factors		38
Item 6	Exhibits		41
SIGNATURES			42

 

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements made pursuant to safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts may be forward-looking statements. In particular, statements pertaining to our capital resources, property performance and results of operations contain forward-looking statements. Likewise, all of our statements regarding anticipated growth in our funds from operations and anticipated market conditions, demographics and results of operations are forward-looking statements. You can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “pro forma,” “estimates” or “anticipates” or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans or intentions.

 

These forward-looking statements reflect the views of our management regarding current expectations and projections about future events and are based on currently available information. These forward-looking statements are not guarantees of future performance and involve numerous risks and uncertainties and, thus, you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data or methods which may be incorrect or imprecise and we may not be able to realize them. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements:

 

·                  general economic conditions;

 

·                  adverse economic or real estate developments, either nationally or in the markets in which our properties are located;

 

·                  our failure to generate sufficient cash flows to service our outstanding indebtedness;

 

·                  fluctuations in interest rates and increased operating costs;

 

·                  the availability, terms and deployment of debt and equity capital, including our unsecured revolving credit facility;

 

·                  our ability to make distributions on our shares of beneficial interest;

 

·                  general volatility of the market price of our common shares;

 

·                  our limited operating history;

 

·                  our increased vulnerability economically due to the concentration of our investments in healthcare properties;

 

·                  our geographic concentrations in Texas causes us to be particularly exposed to downturns in this local economy or other changes in local real estate market conditions;

 

·                  changes in our business or strategy;

 

·                  our dependence upon key personnel whose continued service is not guaranteed;

 

·                  our ability to identify, hire and retain highly qualified personnel in the future;

 

·                  the degree and nature of our competition;

 

·                  changes in governmental regulations, tax rates and similar matters;

 

·                  defaults on or non-renewal of leases by tenants;

 

·                  decreased rental rates or increased vacancy rates;

 

·                  difficulties in identifying healthcare properties to acquire and complete acquisitions;

 

·                  competition for investment opportunities;

 

·                  our failure to successfully develop, integrate and operate acquired properties and operations;

 

·                  the impact of our investment in joint ventures;

 

·                  the financial condition and liquidity of, or disputes with, joint venture and development partners;

 

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·                  our ability to operate as a public company;

 

·                  changes in accounting principles generally accepted in the United States (or GAAP);

 

·                  lack of or insufficient amounts of insurance;

 

·                  other factors affecting the real estate industry generally;

 

·                  our failure to qualify and maintain our qualification as a real estate investment trust (or REIT) for U.S. federal income tax purposes;

 

·                  limitations imposed on our business and our ability to satisfy complex rules in order for us to qualify as a REIT for U.S. federal income tax purposes;

 

·                  changes in governmental regulations or interpretations thereof, such as real estate and zoning laws and increases in real property tax rates and taxation of REITs; and

 

·                  various other factors may materially adversely affect us, including the per share trading price of our common shares, such as:

 

·                  higher market interest rates;

·                  the number of our common shares available for future issuance or sale;

·                  our issuance of equity securities or the perception that such issuance might occur;

·                  future offerings of debt; and

·                  if securities analysts do not publish research or reports about our industry or if they downgrade our common shares or the healthcare-related real estate sector.

 

While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. You should not place undue reliance on any forward-looking statements, which speak only as of the date of this report. We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, of new information, data or methods, future events or other changes after the date of this prospectus, except as required by applicable law. For a further discussion of these and other factors that could impact our future results, performance or transactions, see Part I, Item 1A (Risk Factors) of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 and Part II, Item 1A (Risk Factors) of our Quarterly Reports on Form 10-Q for the quarterly periods ended during this fiscal 2014 and Part II, Item 1A (Risk Factors) of this report.

 

In this report, the terms “we,” “us,” “our,” “our company,” the “Trust,” the “Company,” and “Physicians Realty” refer to Physicians Realty Trust, a Maryland real estate investment trust, together with its consolidated subsidiaries, including Physicians Realty L.P., a Delaware limited partnership, which we refer to in this report as our “Operating Partnership,” and the historical business and operations of four healthcare real estate funds that we have classified for accounting purposes as our “Predecessor” and which we sometimes refer to as the “Ziegler Funds.”

 

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PART I.                          Financial Information

 

Item 1.                                 Financial Statements.

 

Physicians Realty Trust

Consolidated Balance Sheets

(In thousands, except share and per share data)

 

		September 30,			December 31,
		2014			2013
		(unaudited)
ASSETS
Investment properties:
Land and improvements		$	70,561		$	26,088
Building and improvements		567,342			193,184
Tenant improvements		5,986			5,458
Acquired lease intangibles		60,831			31,236
		704,720			255,966
Accumulated depreciation		(39,105		)	(28,427		)
Net real estate property		665,615			227,539
Real estate loan receivable		6,907			—
Investment in unconsolidated entity		1,324			—
Net real estate investments		673,846			227,539
Cash and cash equivalents		17,025			56,478
Tenant receivables, net		1,282			837
Deferred costs, net		5,097			2,105
Other assets		11,412			5,901
Total assets		$	708,662		$	292,860
LIABILITIES AND EQUITY
Liabilities:
Credit facility		$	70,000		$	—
Mortgage debt		83,420			42,821
Accounts payable		633			836
Dividend payable		11,379			5,681
Accrued expenses and other liabilities		7,222			2,685
Acquired lease intangible, net		344			—
Total liabilities		172,998			52,023
Equity:
Common shares, $0.01 par value, 500,000,000 shares authorized, 45,376,115 and 21,548,597 shares issued and outstanding as of September 30, 2014 and December 31, 2013, respectively.		453			215
Additional paid-in capital		511,500			213,359
Accumulated deficit		(37,674		)	(8,670		)
Total shareholders’ equity		474,279			204,904
Noncontrolling interests:
Operating partnership		60,679			35,310
Partially owned properties		706			623
Total noncontrolling interest		61,385			35,933
Total equity		535,664			240,837
Total liabilities and equity		$	708,662		$	292,860

 

The accompanying notes are an integral part of these consolidated and combined financial statements.

 

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Physicians Realty Trust

Consolidated and Combined Statements of Operations

(Unaudited)
(In thousands, except share and per share data)

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2014			2013			2014			2013
Revenues:
Rental revenues		$	12,506		$	2,920		$	29,555		$	7,952
Expense recoveries		1,355			798			3,445			2,399
Interest income on real estate loans and other		300			11			640			206
Total revenues		14,161			3,729			33,640			10,557
Expenses:
Interest expense, net		1,911			826			4,849			3,114
General and administrative		4,445			1,285			8,867			1,507
Operating expenses		2,531			1,130			6,367			3,578
Depreciation and amortization		4,413			1,146			10,565			3,123
Acquisition expenses		2,922			756			9,254			756
Management fees		—			—			—			475
Impairment loss		250			—			250			—
Total expenses		16,472			5,143			40,152			12,553
Loss before equity in income of unconsolidated entity, gain (loss) on sale of property, and noncontrolling interests:		(2,311		)	(1,414		)	(6,512		)	(1,996		)
Equity in income of unconsolidated entity		26			—			69			—
Gain (loss) on sale of property		34			(2		)	34			(2		)
Net loss		(2,251		)	(1,416		)	(6,409		)	(1,998		)
Less: Net (income) loss attributable to Predecessor		—			(6		)	—			576
Less: Net loss (income) attributable to noncontrolling interests —operating partnership		233			(61		)	887			(61		)
Less: Net (income) loss attributable to noncontrolling interests — partially owned properties		(76		)	323			(226		)	323
Net loss attributable to common shareholders		$	(2,094	)	$	(1,160	)	$	(5,748	)	$	(1,160	)
Net loss per share:
Basic and diluted		$	(0.06	)	$	(0.10	)	$	(0.21	)	$	(0.10	)
Weighted average common shares:
Basic and diluted		36,313,644			11,486,011			27,980,408			11,486,011
Dividends and distributions declared per common share and unit		$	0.23		$	0.18		$	0.68		$	0.18

 

The accompanying notes are an integral part of these consolidated and combined financial statements.

 

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Physicians Realty Trust and Predecessor

Consolidated and Combined Statement of Equity

(In thousands, except shares)

(Unaudited)

 

		Number of Common Shares		Par Value			Additional Paid in Capital			Accumulated Deficit			Predecessor Equity			Total Shareholders’ and Predecessor Equity			Operating Partnership Noncontrolling interest			Partially Owned Properties Noncontrolling Interest			Total Non- Controlling Interests			Total Equity
Predecessor Balance
January 1, 2013		—		$	—		$	—		$	—		$	19,068		$	19,068		$	—		$	29		$	29		$	19,097
Net (loss) income		—		—			—			—			(712		)	(712		)	—			136			136			(576		)
Transfer		—		—			—			—			36			36			—			(36		)	(36		)	—
Distributions		—		—			—			—			(211		)	(211		)	—			(209		)	(209		)	(420		)
Balance July 24, 2013		—		—			—			—			18,181			18,181						(80		)	(80		)	18,101
Physicians Realty Trust
Net proceeds from sale of common shares		21,298,597		213			225,707			—			—			225,920			—			—			—			225,920
Formation Transactions		—		—			35			—			(18,181		)	(18,146		)	18,181			(389		)	17,792			(354		)
Restricted share award grants		250,000		2			431			—			—			433			—			—			—			433
Dividends declared		—		—			—			(7,009		)	—			(7,009		)	(1,326		)	—			(1,326		)	(8,335		)
Adjustment for Noncontrolling Interests ownership in Operating Partnership		—		—			(7,391		)	—			—			(7,391		)	7,391			—			7,391			—
Contributions		—		—			(5,423		)	—			—			(5,423		)	11,534			1,276			12,810			7,387
Distributions		—		—			—			—			—			—			—			(255		)	(255		)	(255		)
Net (loss) income		—		—			—			(1,661		)	—			(1,661		)	(470		)	71			(399		)	(2,060		)
Balance December 31, 2013		21,548,597		215			213,359			(8,670		)	—			204,904			35,310			623			35,933			240,837
Net proceeds from sale of shares		23,575,000		236			295,374			—			—			295,610			—			—			—			295,610
Restricted share award grants		127,605		1			1,185			—			—			1,186			—			—			—			1,186
Issuance of shares in connection with the Ziegler shared service amendment payment		124,913		1			1,799			—			—			1,800			—			—			—			1,800
Dividends/distributions declared		—		—			—			(23,256		)	—			(23,256		)	(2,550		)	—			(2,550		)	(25,806		)
Adjustment for Noncontrolling Interests ownership in Operating Partnership		—		—			(217		)	—			—			(217		)	217			—			217			—
Issuance of Operating Partnership Units in connection with acquisitions		—		—			—			—			—			—			28,589			—			28,589			28,589
Distributions		—		—			—			—			—			—			—			(143		)	(143		)	(143		)
Net (loss) income		—		—			—			(5,748		)	—			(5,748		)	(887		)	226			(661		)	(6,409		)
Balance September 30, 2014		45,376,115		$	453		$	511,500		$	(37,674	)	$	—		$	474,279		$	60,679		$	706		$	61,385		$	535,664

 

The accompanying notes are an integral part of these consolidated and combined financial statements.

 

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Physicians Realty Trust and Predecessor

Consolidated and Combined Statements of Cash Flows

(In thousands) (Unaudited)

 

		Nine Months Ended
		September 30,
		2014			2013
Cash Flows from Operating Activities:
Net loss		$	(6,409	)	$	(1,998	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities
Depreciation and amortization		10,565			3,026
Amortization of deferred financing costs		626			330
Accelerated amortization of deferred financing costs		141			—
Amortization of lease inducements and above/below market lease intangibles		331			70
Straight-line rental revenue/expense		(2,785		)	(100		)
(Gain) loss on sale of property		(34		)	2
Equity in income of unconsolidated entity		(69		)	—
Distribution from unconsolidated entity		45			—
Change in fair value of derivative		(138		)	(206		)
Provision for bad debts		5			36
Non-cash share compensation		1,681			191
Ziegler shared service amendment payment		1,800			—
Impairment on investment property		250			—
Change in operating assets and liabilities:
Tenant receivables		(521		)	(64		)
Other assets		(1,285		)	(773		)
Accounts payable to related parties		—			(1,530		)
Accounts payable		(203		)	(316		)
Accrued expenses and other liabilities		3,445			1,298
Net cash provided by (used in) operating activities		7,445			(34		)
Cash Flows from Investing Activities:
Proceeds on sales of property		235			448
Acquisition of investment properties, net		(404,715		)	(100,084		)
Capital expenditures on existing investment properties		(551		)	—
Real estate loan receivable		(6,836		)	—
Leasing commissions		(5		)	(163		)
Lease inducement		(1,532		)	(1,543		)
Net cash used in investing activities		(413,404		)	(101,342		)
Cash Flows from Financing Activities:
Net proceeds from sale of common shares		295,610			122,873
Formation transactions		—			(354		)
Proceeds from credit facility borrowings		286,200			19,850
Payment on credit facility borrowings		(216,200		)	—
Proceeds from issuance of mortgage debt		26,550			163
Payments on mortgage debt		(1,234		)	(37,978		)
Debt issuance costs		(3,848		)	(1,074		)
Dividends paid - shareholders		(17,443		)	—
Distributions to noncontrolling interest— operating partnership		(2,665		)	—
Distributions to members and partners		—			(211		)
Distributions to noncontrolling interest — partially owned properties		(143		)	(274		)
Common shares repurchased and retired		(321		)	—
Net cash provided by financing activities		366,506			102,995
Net (decrease) increase in cash and cash equivalents		(39,453		)	1,619
Cash and cash equivalents, beginning of period		56,478			2,614
Cash and cash equivalents, end of period		$	17,025		$	4,233
Supplemental disclosure of cash flow information — interest paid during the period		$	4,113		$	2,967
Supplemental disclosure of noncash activity — assumed debt		$	15,283		$	—
Supplemental disclosure of noncash activity — issuance of Operating Partnership units in connection with acquisitions		$	28,589		$	—
Supplemental disclosure of noncash activity — contingent consideration		$	840		$	—

 

The accompanying notes are an integral part of these consolidated and combined financial statements.

 

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Physicians Realty Trust and Predecessor

Notes to Consolidated and Combined Financial Statements

 

Note 1—Organization and Business

 

Physicians Realty Trust (the “Trust”) was organized in the state of Maryland on April 9, 2013. As of September 30, 2014, the Trust was authorized to issue up to 500,000,000 common shares of beneficial interest, par value $0.01 per share (“common shares”). The Trust filed a Registration Statement on Form S-11 with the Securities and Exchange Commission (the “Commission”) with respect to a proposed underwritten initial public offering (the “IPO”) and completed the IPO of its common shares and commenced operations on July 24, 2013.

 

The Trust contributed the net proceeds from the IPO to Physicians Realty L.P. (the “Operating Partnership”), a Delaware limited partnership, and is the sole general partner of the Operating Partnership. The Trust’s operations are conducted through the Operating Partnership and wholly-owned and majority-owned subsidiaries of the Operating Partnership. The Trust, as the general partner of the Operating Partnership, controls the Operating Partnership and consolidates the assets, liabilities and results of operations of the Operating Partnership.

 

The Trust is a self-managed real estate investment trust (“REIT”) formed primarily to acquire, selectively develop, own and manage healthcare properties that are leased to physicians, hospitals and healthcare delivery systems.

 

Initial Public Offering and Formation Transactions and Follow-On Public Offerings

 

Pursuant to the IPO, the Trust issued an aggregate of 11,753,597 common shares, including common shares issued upon exercise of the underwriters’ overallotment option, and received approximately $123.8 million of net proceeds.  The Trust contributed the net proceeds of the IPO to the Operating Partnership in exchange for 11,753,597 common units of partnership interest (“OP Units”).  Concurrently with the completion of the IPO, the Trust acquired, through a series of contribution transactions, the entities that own the 19 properties that comprised the Trust’s initial properties from four healthcare real estate funds (the “Ziegler Funds”), as well as certain operating assets and liabilities, including the assumption of approximately $84.3 million of debt related to such properties. The Trust determined that the Ziegler Funds constitute the Trust’s accounting predecessor (the “Predecessor”). The Predecessor, which is not a legal entity, is comprised of the four Ziegler Funds that owned directly or indirectly interests in entities that owned the initial 19 properties in the Trust’s portfolio. The combined historical data for the Predecessor is not necessarily indicative of the Trust’s future financial position or results of operations. In addition, at the completion of the IPO, the Trust entered into a shared services agreement with B.C. Ziegler & Company (“Ziegler”) pursuant to which Ziegler provides office space, IT support, accounting support and other services to the Trust in exchange for an annual fee.

 

To acquire the ownership interests in the entities that own the 19 properties included in the Trust’s initial properties, and certain other operating assets and liabilities, from the Ziegler Funds, the Operating Partnership issued to the Ziegler Funds an aggregate of 2,744,000 OP Units, having an aggregate value of approximately $31.6 million based on the price to the public per share in the IPO. These formation transactions were effected concurrently with the completion of the IPO.

 

The net proceeds from the IPO, inclusive of shares issued pursuant to the exercise of the underwriters’ overallotment option, were approximately $123.8 million (after deducting the underwriting discount and expenses of the IPO and the formation transactions payable by the Trust). The Trust contributed the net proceeds of the IPO to the Operating Partnership in exchange for 11,753,597 OP Units on July 24, 2013, and upon closing of the IPO, the Trust owned a 79.6% interest in the Operating Partnership. The Operating Partnership used a portion of the IPO proceeds received from the Trust to purchase the 50% interest in the Arrowhead Commons property not owned by the Ziegler Funds for approximately $850,000, after which the Operating Partnership became the 100% owner of the property, and to pay certain expenses related to debt assumptions and the Trust’s senior secured revolving credit facility. The balance of the net proceeds was subsequently invested in healthcare properties.

 

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On December 11, 2013, the Trust completed a public offering of 9,545,000 common shares, including 1,245,000 common shares issued upon exercise of the underwriters’ overallotment option, resulting in net proceeds to the Trust of approximately $103.1 million. The Trust contributed the net proceeds of this offering to the Operating Partnership in exchange for 9,545,000 OP Units, and the Operating Partnership used the net proceeds of the public offering to repay borrowings under the Trust’s senior secured revolving credit facility and for general corporate and working capital purposes and funding acquisitions.

 

On May 27, 2014, the Trust completed a public offering of 12,650,000 common shares, including 1,650,000 common shares issued upon exercise of the underwriters’ overallotment option, resulting in net proceeds to the Trust of approximately $149.9 million. The Trust contributed the net proceeds of this offering to the Operating Partnership in exchange for 12,650,000 OP Units, and the Operating Partnership used the net proceeds of the public offering to repay borrowings under the Trust’s senior secured revolving credit facility and for general corporate and working capital purposes and funding acquisitions.

 

On August 19, 2014, the Trust’s Registration Statement on Form S-3 (File No. 333-197842), which we filed with the Commission on August 4, 2014, was declared effective by the Commission. (the “Shelf Registration Statement”).  The Shelf Registration Statement covers the offering, from time to time, of various securities with an aggregate value of up to $900 million and the secondary offering of common shares by certain selling shareholders.

 

On August 19, 2014, the Trust and the Operating Oartnership entered into separate At Market Issuance Sales Agreements (the “Sales Agreements”) with each of MLV & Co. LLC, KeyBanc Capital Markets Inc., JMP Securities LLC, and RBC Capital Markets, LLC (the “Agents”), pursuant to which we may issue and sell common shares having an aggregate offering price of up to $150 million, from time to time, through the Agents pursuant to the Shelf Registration Statement. In accordance with the Sales Agreements, we may offer and sell our common shares through any of the Agents, from time to time, by any method deemed to be an “at the market offering” as defined in Rule 415 under the Securities Act of 1933, as amended (the “Securities Act”), which includes sales made directly on the New York Stock Exchange (the “NYSE”), or other existing trading market, or sales made to or through a market maker. With the Trust’s express written consent, sales also may be made in negotiated transactions or any other method permitted by law. The common shares are registered under the Securities Act pursuant to the Shelf Registration Statement. During the quarterly period ended September 30, 2014, the Trust did not issue and sell any common shares pursuant to any of the Sales Agreements.

 

On September 12, 2014, the Trust completed a public offering of 10,925,000 common shares, including 1,425,000 common shares issued upon exercise of the underwriters’ overallotment option, resulting in net proceeds to the Trust of approximately $145.7 million. The Trust contributed the net proceeds of this offering to the Operating Partnership in exchange for 10,925,000 OP Units, and the Operating Partnership used the net proceeds of the public offering to repay borrowings under the Trust’s senior secured revolving credit facility and for general corporate and working capital purposes and funding acquisitions.

 

Because the IPO and the formation transactions were completed on July 24, 2013, the Trust had no operations prior to that date.  References in these notes to the consolidated and combined financial statements of Physicians Realty Trust signify the Trust for the period from July 24, 2013, the date of completion of the IPO and the formation transactions, and of the Predecessor for all prior periods.

 

Note 2—Summary of Significant Accounting Policies

 

The accompanying unaudited consolidated and combined financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the periods ended September 30, 2014 and 2013 pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X. All such adjustments are of a normal recurring nature. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the audited financial statements included in the Trust’s Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on March 21, 2014.

 

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Principles of Consolidation

 

Property holding entities and other subsidiaries of which the Trust owns 100% of the equity or has a controlling financial interest evidenced by ownership of a majority voting interest are consolidated. All inter-company balances and transactions are eliminated. For entities in which the Trust owns less than 100% of the equity interest, the Trust consolidates the property if it has the direct or indirect ability to control the entities’ activities based upon the terms of the respective entities’ ownership agreements. For these entities, the Trust records a non-controlling interest representing equity held by non-controlling interests.

 

The Trust continually evaluates all of its transactions and investments to determine if they represent variable interests in a variable interest entity (“VIE”). If the Trust determines that it has a variable interest in a VIE, the Trust then evaluates if it is the primary beneficiary of the VIE. The evaluation is a qualitative assessment as to whether the Trust has the ability to direct the activities of a VIE that most significantly impact the entity’s economic performance. The Trust consolidates each VIE in which it, by virtue of or transactions with the Trust’s investments in the entity, is considered to be the primary beneficiary.

 

Noncontrolling Interests

 

Operating Partnership: Net income or loss is allocated to noncontrolling interests based on their respective ownership percentage of the Operating Partnership. The ownership percentage is calculated by dividing the number of OP Units held by the noncontrolling interests by the total OP Units held by the noncontrolling interests and the Trust. Issuance of additional common shares and OP Units changes the ownership interests of both the noncontrolling interests and the Trust. Such transactions and the related proceeds are treated as capital transactions.

 

In connection with the closing of the IPO, the Trust and the Operating Partnership completed related formation transactions pursuant to which the Operating Partnership acquired from the Ziegler Funds, the Ziegler Funds’ ownership interests in 19 medical office buildings located in ten states in exchange for an aggregate of 2,744,000 OP Units.

 

In connection with the acquisition of a surgical center hospital in the New Orleans, Louisiana metropolitan area for approximately $37.5 million, on September 30, 2013, the Operating Partnership partially funded the purchase price by issuing 954,877 OP Units valued at approximately $11.5 million on the date of issuance.

 

During the quarterly period ended June 30, 2014, the Operating Partnership partially funded two property acquisitions by issuing an aggregate of 243,758 OP Units valued at approximately $3.1 million on the date of issuance.  The two acquisitions had a total purchase price of approximately $21.4 million.

 

During the quarterly period ended September 30, 2014, the Operating Partnership partially funded three property acquisitions by issuing an aggregate of 1,798,555 OP Units valued at approximately $25.5 million on the date of issuance.  The three acquisitions had a total purchase price of approximately $82.2 million.

 

Noncontrolling interests in the Trust represent OP Units held by the Predecessor’s prior investors and other investors.  As of September 30, 2014, the Trust held a 88.7% interest in the Operating Partnership.  As the sole general partner and the majority interest holder, the Trust consolidates the financial position and results of operation of the Operating Partnership.

 

Holders of OP Units may not transfer their units without the Trust’s prior written consent, as general partner of the Operating Partnership.  Beginning on the first anniversary of the issuance of OP Units, OP Unit holders may tender their units for redemption by the Operating Partnership in exchange for cash equal to the market price of the Trust’s common shares at the time of redemption or, for common shares on a one-for-one basis.  Such election to pay cash or issue shares to satisfy an OP Unit holder’s redemption request is solely within the control of the Trust.  Accordingly, the Trust presents the OP Units of the Operating Partnership held by the Predecessor’s prior investors and other investors as noncontrolling interests within equity in the consolidated balance sheets.

 

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Partially Owned Properties: The Trust reflects noncontrolling interests in partially owned properties on the balance sheet for the portion of properties consolidated by the Trust that are not wholly owned by the Trust. The earnings or losses from those properties attributable to the noncontrolling interests are reflected as noncontrolling interests in partially owned properties in the consolidated and combined statements of operations.

 

Investment Properties

 

A property acquired not subject to an existing lease is treated as an asset acquisition and recorded at its purchase price, inclusive of acquisition costs, allocated between land and building based upon their relative fair values at the date of acquisition.  A property acquired with an existing lease is accounted for as a business combination pursuant to the acquisition method in accordance with ASC Topic 805, Business Combinations, and assets acquired and liabilities assumed, including lease intangibles, are recorded at fair value.

 

Investments in Unconsolidated Entities

 

The Trust reports investments in unconsolidated entities over whose operating and financial policies it has the ability to exercise significant influence under the equity method of accounting.  Under this method of accounting, the Trust’s share of the investee’s earnings or losses is included in its consolidated and combined statements of operations.  The initial carrying value of investments in unconsolidated entities is based on the amount paid to purchase the entity interest.

 

Real Estate Loans Receivable

 

Real estate loans receivable consists of a mezzanine loan which is collateralized by an equity interest in a medical office building development.  Interest income on the loan is recognized as earned based on the terms of the loan subject to evaluation of collectability risks and is included in the Trust’s consolidated and combined statement of operations.

 

Dividends and Distributions

 

On September 26, 2014, the Trust’s Board of Trustees declared a cash dividend of $0.225 per common share for the quarterly period ended September 30, 2014.  The dividend was paid on October 30, 2014 to common shareholders and common OP Unit holders of record on October 16, 2014.

 

Impairment of Real Estate Property

 

The Trust evaluates the recoverability of the recorded amount of real estate property whenever events or changes in circumstances indicate that the recorded amount of an asset may not be fully recoverable. Impairment is assessed when the undiscounted expected future cash flows derived from an asset are less than its carrying amount. If the Trust determines that an asset is impaired, the impairment to be recognized is measured as the amount by which the recorded amount of the asset exceeds its fair value. Assets to be disposed of are reported at the lower of the recorded amount or fair value less cost to sell. Fair value is determined using a discounted future cash flow analysis.

 

The Trust recognized $0.3 million of an impairment loss on a medical office building in Pickerington, OH for the three and nine months ended September 30, 2014.  The property currently is vacant and the fair value was determined based on a previously accepted offer to purchase the property. The impairment was assessed because the property’s carrying amount exceeded its estimated fair value.  The Trust did not recognize any impairment for the three and nine months ended September 30, 2013.

 

Rental Revenue

 

Rental revenue is recognized on a straight-line basis over the terms of the related leases when collectability is reasonably assured. Recognizing rental revenue on a straight-line basis for leases may result in recognizing revenue for amounts more or less than amounts currently due from tenants. Amounts recognized in excess of amounts currently due from tenants are included in other assets and were $4.8 million and $2.0 million as of

 

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September 30, 2014 and December 31, 2013, respectively. If the Trust determines that collectability of straight-line rents is not reasonably assured, the Trust limits future recognition to amounts contractually owed and, where appropriate, establishes an allowance for estimated losses.  Rental revenue is reduced by amortization of lease inducements and above-market lease intangibles and increased by amortization of below-market lease intangibles on certain leases.  Lease inducements, above-market lease intangibles and below-market lease intangibles are amortized over the average remaining life of the lease.

 

Expense Recoveries

 

Expense recoveries relate to tenant reimbursement of real estate taxes, insurance and other operating expenses that are recognized as expense recovery revenue in the period the applicable expenses are incurred. The reimbursements are recorded at gross amounts, as the Trust is generally the primary obligor with respect to real estate taxes and purchasing goods and services from third-party suppliers and has discretion in selecting the supplier and bears the credit risk of tenant reimbursement.

 

The Trust has certain tenants with absolute net leases. Under these lease agreements, the tenant is responsible for operating and building expenses. For absolute net leases, the Trust does not recognize the operating expenses or expense recoveries.

 

Contingent Liability

 

The Trust will record a liability for contingent consideration (included in accrued expenses and other liabilities on its consolidated balance sheets) at fair value as of the acquisition date and reassess the fair value at the end of each reporting period, with any changes being recognized in earnings. Increases or decreases in the fair value of contingent consideration can result from changes in discount periods, discount rates and probabilities that contingencies will be met.

 

Management Estimates

 

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 as of the date of the consolidated and combined financial statements and the amounts of revenue and expenses reported in the period. Significant estimates are made for the valuation of investment property, valuation of financial instruments, impairment assessments and fair value assessments with respect to purchase price allocations. Actual results could differ from these estimates.

 

Reclassifications

 

Certain prior period amounts have been reclassified to conform to the current financial statement presentation, with no effect on the consolidated financial position or results of operations.

 

New Accounting Pronouncements

 

In April 2014, the Financial Accounting Standards Board issued Accounting Standards Updated, or ASU, 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360) which changes the requirements for reporting discontinued operations. ASU 2014-08 changes the threshold for disclosing discontinued operations and the related disclosure requirements. Pursuant to ASU 2014-08, only disposals representing a strategic shift, such as a major line of business, a major geographical area or majority equity investment, should be presented as a discontinued operation. If the disposal does qualify as a discontinued operation under ASU 2014-08, the entity will be required to provide expanded disclosures. The guidance will be applied prospectively to new disposals and new classifications of disposal groups held for sale after the effective date. ASU 2014-08 is effective for annual periods beginning on or after December 14, 2014 with early adoption permitted.  The Trust early adopted the provisions of the guidance in the first quarter of 2014.  Such adoption has had no impact on the Trust’s financial statements as no dispositions have occurred during the nine months ended September 30, 2014.

 

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In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which creates a new Topic Accounting Standards Codification (Topic 606).  The standard is principle-based and provides a five-step model to determine when and how revenue is recognized.  The core principle is that a company should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.  This standard is effective for interim or annual periods beginning after December 15, 2016 and allows for either full retrospective or modified retrospective adoption.  Early adoption of this standard is not allowed.  The Trust is currently evaluating the impact the adoption of Topic 606 will have on its financial statements.

 

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, to address financial reporting considerations about an entity’s ability to continue as a going concern.  ASU 2014-15 is effective for annual periods ending after December 15, 2016 and for interim periods within annual periods beginning after December 15, 2016.  The Trust is currently evaluating the impact the adoption will have on its financial statements.

 

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Note 3—Acquisitions and Investments

 

During the nine months ended September 30, 2014, the Trust completed acquisitions of 38 operating healthcare properties located in 10 states for an aggregate purchase price of approximately $447.2 million as summarized below:

 

Property(1)		Location		Acquisition Date		Purchase Price (in thousands)
Foundations San Antonio Surgical Hospital(2)		San Antonio, TX		February 19, 2014		$	25,556
Eagles Landing Family Practice 4 MOBs(2)		Atlanta, GA		February 19, 2014		$	20,800
21st Century Oncology 4 MOBs(3)		Sarasota, FL		February 26, 2014		$	17,486
Foundations San Antonio MOB(3)		San Antonio, TX		February 28, 2014		$	6,800
Peachtree Dunwoody MOB(3)		Atlanta, GA		February 28, 2014		$	36,726
LifeCare LTACH(2)		Fort Worth, TX		March 28, 2014		$	27,160
LifeCare LTACH(2)		Pittsburgh, PA		March 28, 2014		$	12,840
Pinnacle Health Cardiology Portfolio 2 MOBs (3)		Carlisle & Wormleyburg, PA		April 22, 2014		$	9,208
South Bend Orthopedic MOB (3)		South Bend, IN		April 30, 2014		$	14,900
Grenada Medical Complex MOB (3)		Grenada, MS		April 30,2014		$	7,100
Mississippi Sports Medicine and Orthopaedics Center MOB (2)(4)		Jackson, MS		May 23, 2014		$	16,700
Carmel Medical Pavilion MOB (3)(4)		Carmel, IN		May 28, 2014		$	4,664
Summit Urology MOB (2)		Bloomington, IN		June 30, 2014		$	4,783
Renaissance Center (3)		Oshkosh, WI		June 30, 2014		$	8,500
Presbyterian Medical Plaza MOB (3)		Monroe, NC		June 30, 2014		$	7,750
Landmark Medical Portfolio (Premier) 3 MOBs (2)(5)		Bloomington, IN		July 1, 2014		$	23,837
Carlisle II MOB (3)		Carlisle, PA		July 25, 2014		$	4,500
Surgical Institute of Monroe ASC (2)		Monroe, MI		July 28, 2014		$	6,000
The Oaks Medical Building MOB (3)		Lady Lake, FL		July 31, 2014		$	10,600
Baylor Surgicare ASC — Mansfield (3)		Mansfield, TX		September 2, 2014		$	8,500
Eye Center of Southern Indiana (2)(5)		Bloomington, IN		September 5, 2014		$	12,174
Wayne State Medical Center and MOB (2)		Troy, MI		September 10, 2014		$	46,500
El Paso Portfolio (specialty surgical hospital and 2 MOBs) (3)(5)		El Paso, TX		September 30, 2014		$	46,235
The Mark H. Zangmeister Center (3)		Columbus, OH		September 30, 2014		$	36,600
Berger Medical Center (3)		Orient, OH		September 30, 2014		$	6,785
Orthopedic One 2 MOBs (3)		Columbus, OH		September 30, 2014		$	24,500
		Westerville, OH
Total						$	447,204

 

(1)         “MOB” means medical office building, “LTACH” means long-term acute care hospital and “ASC” means ambulatory surgical center.

(2)         The Trust accounted for these acquisitions as asset acquisitions and capitalized $1.5 million of total acquisition costs to the basis of the properties.

(3)         The Trust accounted for these acquisitions as business combinations pursuant to the acquisition method and expensed total acquisition costs of $9.3 million.

(4)         The Operating Partnership partially funded the purchase price of these acquisitions by issuing a total of 243,758 OP Units valued at approximately $3.1 million in the aggregate on the date of issuance.

(5)         The Operating Partnership partially funded the purchase price of these acquisitions by issuing a total of 1,798,555 OP Units valued at approximately $25.5 million in the aggregate on the date of issuance.

 

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During the three months ended September 30, 2014, the Trust recorded revenues and net income of $7.3 million and $1.1 million, respectively, from its 2014 acquisitions.  During the nine months ended September 30, 2014, the Trust recorded revenues and net loss of $13.2 million and $1.3 million, respectively, from its 2014 acquisitions.

 

The following table summarizes the preliminary purchase price allocations of the assets acquired and the liabilities assumed, which we determined using level two and level three inputs (in thousands):

 

		1ST Quarter			2nd Quarter			3rd Quarter			Total
Land		$	18,331		$	7,275		$	18,942		$	44,548
Building and improvements		121,472			57,401			195,662			374,535
In-place lease intangible		7,585			7,061			12,374			27,020
Above market in-place lease intangible		891			465			1,219			2,575
Below market in-place lease intangible		—			(133		)	(221		)	(354		)
Investment in unconsolidated entity		1,300			—			—			1,300
Issuance of OP units		—			(3,135		)	(25,454		)	(28,589		)
Mortgage debt assumed		(10,800		)	405			(4,888		)	(15,283		)
Lease inducement		—			1,500			32			1,532
Derivative liability		—			—			(197		)	(197		)
Contingent consideration		—			—			(840		)	(840		)
Net assets acquired		$	138,779		$	70,839		$	196,629		$	406,247

 

These preliminary allocations are subject to revision within the measurement period, not to exceed one year from the date of the acquisitions.

 

Unaudited Pro Forma Financial Information

 

The following table illustrates the pro forma combined revenue, net income, and earnings per share —basic and diluted as if the Trust had acquired the above acquisitions as of January 1, 2013 (in thousands, except per share amounts):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2014			2013			2014			2013
Revenue		$	17,796		$	14,634		$	52,452		$	42,536
Net income		2,254			1,227			10,666			4,521
Net income available to common shareholders		2,066			859			9,656			3,820
Earnings per share - basic and diluted		$	0.06		$	0.07		$	0.35		$	0.33
Weighted average common shares - basic and diluted		36,313,644			11,486,011			27,980,408			11,486,011

 

Note 4—Intangibles

 

The following is a summary of the carrying amount of acquired lease intangibles as of September 30, 2014 and December 31, 2013 (in thousands):

 

		September 30, 2014									December 31, 2013
		Cost			Accumulated Amortization			Net			Cost			Accumulated Amortization			Net
Assets
In-place leases		$	56,076		$	(10,804	)	$	45,272		$	29,056		$	(8,080	)	$	20,976
Above market leases		4,755			(254		)	4,501			2,180			(48		)	2,132
Total		$	60,831		$	(11,058	)	$	49,773		$	31,236		$	(8,128	)	$	23,108
Liability
Below market lease		$	354		$	(10	)	$	344		—			—			—

 

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