UNITED STATES
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 June 30, 2006.
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 1-8895

 

HEALTH CARE PROPERTY INVESTORS, INC.

(Exact name of registrant as specified in its charter)

Maryland		33-0091377
(State or other jurisdiction of		(I.R.S. Employer
incorporation of organization)		Identification No.)

 

3760 Kilroy Airport Way, Suite 300
Long Beach, CA 90806
(Address of principal executive offices)

(562) 733-5100
(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  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “Accelerated Filer and Large Accelerated Filer” in Rule 12b-2 of the Exchange Act. (check one):    Large Accelerated Filer  x Accelerated Filer  o  Non-accelerated Filer  o

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

As of July 31, 2006, there were 137,301,582 shares of $ 1.00 par value common stock outstanding.

 

 

HEALTH CARE PROPERTY INVESTORS, INC.

INDEX

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Condensed Consolidated Balance Sheets
	Condensed Consolidated Statements of Income
	Condensed Consolidated Statement of Stockholders’ Equity
	Condensed Consolidated Statements of Cash Flows
	Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II. OTHER INFORMATION
Item 1A.	Risk Factors
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 4.	Submissions of Matters to a Vote of Security Holders
Item 6.	Exhibits
Signatures

 

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HEALTH CARE PROPERTY INVESTORS, INC.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

		June 30, 2006			December 31, 2005
		(Unaudited)
ASSETS
Real estate:
Buildings and improvements		$	3,734,016		$	3,424,857
Developments in process		21,862			22,286
Land		352,437			334,750
Less accumulated depreciation and amortization		657,182			600,562
Net real estate		3,451,133			3,181,331
Loans receivable, net:
Joint venture partners		7,006			7,006
Others		138,681			179,825
Investments in and advances to unconsolidated joint ventures		51,142			48,598
Accounts receivable, net of allowance of $1,373 and $1,205, respectively		12,422			13,313
Cash and cash equivalents		21,476			21,342
Restricted cash		2,375			2,270
Intangibles, net		60,849			38,804
Real estate held for sale, net		45,746			60,521
Other assets, net		67,775			44,255
Total assets		$	3,858,605		$	3,597,265
LIABILITIES AND STOCKHOLDERS’ EQUITY
Bank line of credit		$	265,100		$	258,600
Senior unsecured notes		1,476,587			1,462,250
Mortgage debt		454,802			236,096
Accounts payable and accrued liabilities		76,782			68,718
Deferred revenue		35,973			22,551
Total liabilities		2,309,244			2,048,215
Minority interests:
Joint venture partners		23,893			20,905
Non-managing member unitholders		133,821			128,379
Total minority interests		157,714			149,284
Stockholders’ equity:
Preferred stock, $1.00 par value: 50,000,000 shares authorized; 11,820,000 shares issued and outstanding, liquidation preference of $25 per share		285,173			285,173
Common stock, $1.00 par value: 750,000,000 shares authorized; 137,049,212 and 136,193,764 shares issued and outstanding, respectively		137,049			136,194
Additional paid-in capital		1,464,181			1,446,349
Cumulative net income		1,620,601			1,521,146
Cumulative dividends		(2,115,671		)	(1,988,248		)
Accumulated other comprehensive income (loss)		314			(848		)
Total stockholders’ equity		1,391,647			1,399,766
Total liabilities and stockholders’ equity		$	3,858,605		$	3,597,265

 

See accompanying Notes to Condensed Consolidated Financial Statements.

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HEALTH CARE PROPERTY INVESTORS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Revenues and other income:
Rental revenues and other income		$	131,008		$	110,137		$	251,469		$	210,697
Equity income from unconsolidated joint ventures		2,714			88			6,536			299
Interest and other income		6,360			6,012			22,107			11,191
		140,082			116,237			280,112			222,187
Costs and expenses:
Interest		33,640			25,372			65,733			48,610
Depreciation and amortization		31,838			26,671			62,233			49,846
Operating		19,118			15,388			36,682			28,689
General and administrative		8,434			8,827			16,826			16,146
Impairments		4,711			—			4,711			—
		97,741			76,258			186,185			143,291
Income before minority interests		42,341			39,979			93,927			78,896
Minority interests		(4,170		)	(3,031		)	(7,947		)	(6,178		)
Income from continuing operations		38,171			36,948			85,980			72,718
Discontinued operations:
Operating income		1,114			1,933			2,602			4,883
Gain on sales of real estate, net		2,282			4,166			10,873			8,904
		3,396			6,099			13,475			13,787
Net income		41,567			43,047			99,455			86,505
Preferred stock dividends		(5,283		)	(5,283		)	(10,566		)	(10,566		)
Net income applicable to common shares		$	36,284		$	37,764		$	88,889		$	75,939
Basic earnings per common share:
Continuing operations		$	0.24		$	0.24		$	0.55		$	0.46
Discontinued operations		0.03			0.04			0.10			0.11
Net income applicable to common shares		$	0.27		$	0.28		$	0.65		$	0.57
Diluted earnings per common share:
Continuing operations		$	0.24		$	0.23		$	0.55		$	0.46
Discontinued operations		0.02			0.05			0.10			0.10
Net income applicable to common shares		$	0.26		$	0.28		$	0.65		$	0.56
Weighted average shares used to calculate earnings per common share:
Basic		136,484			134,445			136,262			133,968
Diluted		137,192			135,214			137,024			134,871

 

See accompanying Notes to Condensed Consolidated Financial Statements.

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HEALTH CARE PROPERTY INVESTORS, INC.

 

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(In thousands)

(Unaudited)

 

																					Accumulated
												Additional									Other
		Preferred Stock					Common Stock					Paid-In			Cumulative						Comprehensive
		Shares		Amount			Shares		Amount			Capital			Net Income			Dividends			Income (Loss)			Total
December 31, 2005		11,820		$	285,173		136,194		$	136,194		$	1,446,349		$	1,521,146		$	(1,988,248	)	$	(848	)	$	1,399,766
Exercise of stock options		—		—			287		287			4,175			—			—			—			4,462
Other issuances of common stock, net		—		—			568		568			9,409			—			—			—			9,977
Net income		—		—			—		—			—			99,455			—			—			99,455
Preferred stock dividends		—		—			—		—			—			—			(10,566		)	—			(10,566		)
Common stock dividends		—		—			—		—			—			—			(116,857		)	—			(116,857		)
Amortization of deferred compensation		—		—			—		—			4,248			—			—			—			4,248
Other comprehensive income, net		—		—			—		—			—			—			—			1,162			1,162
June 30, 2006		11,820		$	285,173		137,049		$	137,049		$	1,464,181		$	1,620,601		$	(2,115,671	)	$	314		$	1,391,647

 

See accompanying Notes to Condensed Consolidated Financial Statements.

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HEALTH CARE PROPERTY INVESTORS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Six Months Ended June 30,
		2006			2005
Cash flows from operating activities:
Net income		$	99,455		$	86,505
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of real estate and in-place lease intangibles:
Continuing operations		62,233			49,846
Discontinued operations		804			1,532
Amortization of above and below market lease intangibles, net		(921		)	(1,427		)
Stock-based compensation		4,248			3,198
Debt issuance costs amortization		1,804			1,573
Recovery of loan losses		—			(56		)
Straight-line rents		(4,721		)	(2,742		)
Equity income from unconsolidated joint ventures		(6,536		)	(299		)
Distributions of earnings from unconsolidated joint ventures		5,623			299
Minority interests		7,947			6,178
Impairments		4,711			—
Gain on sales of real estate, net		(10,873		)	(8,904		)
Changes in:
Accounts receivable		891			1,205
Other assets		(282		)	(324		)
Accounts payable, accrued liabilities and deferred revenue		9,484			3,573
Net cash provided by operating activities		173,867			140,157
Cash flows from investing activities:
Acquisition and development of real estate		(264,133		)	(130,620		)
Lease commissions and tenant and capital improvements		(8,093		)	(1,464		)
Net proceeds from sales of real estate		27,609			41,587
Distributions from (contributions to) unconsolidated joint ventures		(563		)	8,000
Purchase of securities		(12,895		)	—
Principal repayments on loans receivable		44,298			11,661
Investment in loans receivable		(3,154		)	(6,634		)
Increase in restricted cash		(105		)	(13,311		)
Net cash used in investing activities		(217,036		)	(90,781		)
Cash flows from financing activities:
Borrowings (repayments) under bank lines of credit		6,500			(184,800		)
Repayment of mortgage debt		(19,373		)	(2,927		)
Issuance of mortgage debt		161,874			—
Repayment of senior unsecured notes		(135,000		)	(10,000		)
Issuance of senior unsecured notes		148,606			247,357
Net proceeds from the issuance of common stock and exercise of options		14,237			34,324
Dividends paid on common and preferred stock		(127,423		)	(123,454		)
Distributions to minority interests		(6,118		)	(7,948		)
Net cash provided by (used in) financing activities		43,303			(47,448		)
Net increase in cash and cash equivalents		134			1,928
Cash and cash equivalents, beginning of period		21,342			16,962
Cash and cash equivalents, end of period		$	21,476		$	18,890

 

See accompanying Notes to Condensed Consolidated Financial Statements.

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HEALTH CARE PROPERTY INVESTORS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1) Business

Health Care Property Investors, Inc. is a real estate investment trust (“REIT”) that, together with its consolidated entities (collectively, “HCP” or the “Company”), invests directly, or through joint ventures and mortgage loans, in healthcare related properties located throughout the United States.

(2) Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the unaudited condensed consolidated financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2006, are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, filed with the Securities and Exchange Commission (“SEC”).

Use of Estimates

Management is required to make estimates and assumptions in the preparation of financial statements in conformity with GAAP. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ.

Principles of Consolidation

The consolidated financial statements include the accounts of HCP, its wholly owned subsidiaries and its controlled, through voting rights or other means, joint ventures. All material intercompany transactions and balances have been eliminated in consolidation.

The Company applies Financial Accounting Standards Board (“FASB”) Interpretation No. 46R, Consolidation of Variable Interest Entities, as revised (“FIN 46R”), for entities in which control is achieved through means other than voting rights (“variable interest entities” or “VIEs”) and for the determination of which business enterprise is the primary beneficiary of the VIE. A variable interest entity is broadly defined as an entity where either (i) the equity investors as a group, if any, do not have a controlling financial interest or (ii) the equity investment at risk is insufficient to finance that entity’s activities without additional financial support. The Company consolidates investments in VIEs when it is determined that the Company is the primary beneficiary of the VIE at either the creation of the variable interest entity or upon the occurrence of a reconsideration event.

The Company applies Emerging Issues Task Force (“EITF”) Issue 04-5, Investor’s Accounting for an Investment in a Limited Partnership When the Investor is the Sole General Partner and the Limited Partners Have Certain Rights (“EITF 04-5”), in determining what rights held by the limited partner(s) preclude consolidation in circumstances in which the sole general partner would otherwise consolidate the limited partnership in accordance with GAAP. The assessment of limited partners’ rights and their impact on the presumption of control of the limited partnership by the sole general partner should be made when an investor becomes the sole general partner and should be reassessed if (i) there is a change to the terms or in the exercisability of the rights of the limited partners, (ii) the sole general partner increases or decreases its ownership of limited partnership interests, or (iii) there is an increase or decrease in the number of outstanding limited partnership interests. This EITF issue also applies to managing members in limited liability companies.

Investments in entities which the Company does not consolidate but for which the Company has the ability to exercise significant influence over operating and financial policies are reported under the equity method of accounting. Generally, under the equity method of accounting, the Company’s share of the investee’s earnings or losses is included in the Company’s operating results.

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Revenue Recognition

Rental income from tenants is recognized in accordance with GAAP, including SEC Staff Accounting Bulletin No. 104, Revenue Recognition (“SAB 104”). For leases with minimum scheduled rent increases, the Company recognizes income on a straight-line basis over the lease term when collectibility is reasonably assured. Recognizing rental income on a straight-line basis for leases results in recognized revenue exceeding amounts contractually due from tenants. Such cumulative excess amounts are included in other assets and were approximately $25 million and $19 million, net of allowances, at June 30, 2006 and December 31, 2005, respectively. In the event the Company determines that collectibility of straight-line rents is not reasonably assured, the Company limits future recognition to amounts contractually owed, and, where appropriate, the Company establishes an allowance for estimated losses. Certain leases provide for additional rents based upon a percentage of the facility’s revenue in excess of specified base periods or other thresholds. Such revenue is deferred until the related thresholds are achieved.

The Company monitors the liquidity and creditworthiness of its tenants and borrowers on an ongoing basis. The evaluation considers industry and economic conditions, property performance, security deposits and guarantees, and other matters. The Company establishes provisions and maintains an allowance for estimated losses resulting from the possible inability of its tenants and borrowers to make payments sufficient to recover recognized assets. For straight-line rent amounts, the Company’s assessment is based on income recoverable over the term of the lease. At June 30, 2006 and December 31, 2005, the Company had an allowance of $25 million and $22 million, respectively, included in other assets, as a result of the Company’s determination that collectibility is not reasonably assured for certain straight-line rent amounts.

Loans Receivable

Loans receivable are classified as held-to-maturity because the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. The Company recognizes interest income on loans, including the amortization of discounts and premiums, using the effective interest method.

Real Estate

Real estate, consisting of land, buildings, and improvements, is recorded at cost. The Company allocates acquisition costs to the acquired tangible and identified intangible assets and liabilities, primarily lease intangibles, based on their estimated fair values in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations.

The Company assesses fair value based on estimated cash flow projections that utilize appropriate discount and/or capitalization rates, third party appraisals and available market information. Estimates of future cash flows are based on a number of factors including historical operating results, known and anticipated trends, and market and economic conditions. The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant.

The Company records acquired above-and-below market leases at their fair value using a discount rate which reflects the risks associated with the leases acquired, equal to the difference between (i) the contractual amounts to be paid pursuant to each in-place lease and (ii) management’s estimate of fair market lease rates for each corresponding in-place lease, measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the term for any below-market fixed rate renewal options for below-market leases. Other intangible assets acquired include amounts for in-place lease values that are based on the Company’s evaluation of the specific characteristics of each tenant’s lease. Factors to be considered include estimates of carrying costs during hypothetical expected lease-up periods, market conditions, and costs to execute similar leases. In estimating carrying costs, the Company includes real estate taxes, insurance and other operating expenses, and estimates of lost rentals at market rates during the expected lease-up periods, depending on local market conditions. In estimating costs to execute similar leases, the Company considers leasing commissions, legal and other related costs.

Real estate assets and related intangibles are periodically reviewed for potential impairment by comparing the carrying amount to the expected undiscounted future cash flows to be generated from the assets. If the sum of the expected future net undiscounted cash flows is less than the carrying amount of the property, the Company will recognize an impairment loss by adjusting the asset’s carrying amount to its estimated fair value. Fair value for properties to be held and used is based on the present value of the future cash flows expected to be generated from the asset. Properties held for sale are recorded at the lower of their carrying amount or fair value less costs to dispose.

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Developments in process are carried at cost, which includes pre-construction costs essential to the development of the property, construction costs, capitalized interest, and other costs directly related to the property. Capitalization of interest ceases when the property is ready for service, which generally is near the date that a certificate of occupancy is obtained. Expenditures for tenant improvements and leasing commissions are capitalized and amortized over the terms of the respective leases. Repairs and maintenance costs are expensed as incurred.

The Company computes depreciation on properties using the straight-line method over the assets’ estimated useful lives. Depreciation is discontinued when a property is identified as held for sale. Buildings and improvements are depreciated over useful lives ranging up to 45 years. Above-and-below market rent intangibles are amortized primarily to revenue over the remaining noncancellable lease terms and bargain renewal periods. Other in-place lease intangibles are amortized to expense over the remaining lease terms and bargain renewal periods. At June 30, 2006 and December 31, 2005, lease intangible assets, net were $60.8 million and $38.8 million, respectively. At June 30, 2006 and December 31, 2005, lease intangible liabilities, net were $13.6 million and $5.3 million, respectively, and are included in deferred revenue.

Income Taxes

The Company has elected and believes it operates so as to qualify as a REIT under Sections 856 to 860 of the Internal Revenue Code of 1986, as amended (the “Code”). Under the Code, the Company generally is not subject to federal income tax on its taxable income distributed to stockholders if certain distribution, income, asset, and shareholder tests are met. A REIT must distribute at least 90% of annual taxable income to stockholders.

Certain activities the Company undertakes must be conducted by entities which elect to be treated as taxable REIT subsidiaries (“TRSs”). TRSs are subject to both federal and state income taxes. The Company’s income tax expense for the six months ended June 30, 2006 and 2005 was insignificant.

Discontinued Operations

Certain long lived assets are classified as discontinued operations in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”). Long-lived assets to be disposed of are reported at the lower of their carrying amount or their fair value less costs to sell. Further, depreciation of these assets ceases at the time the assets are classified as discontinued operations. Discontinued operations is defined in SFAS No. 144 as a component of an entity that has either been disposed of or is deemed to be held for sale if both the operations and cash flows of the component have been or will be eliminated from ongoing operations as a result of the disposal transaction, and the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction.

The Company periodically sells assets based on market conditions and the exercise of purchase options by tenants. The operating results of properties meeting the criteria established in SFAS No. 144 are reported as discontinued operations in the Company’s consolidated statements of income. Discontinued operations for the three and six months ended June 30, 2006, include eight and 14 properties with revenues of $1.4 million and $3.4 million, respectively. The Company had 28 and 32 properties classified as discontinued operations for the three and six months ended June 30, 2005, with revenues of $2.8 and $6.7 million, respectively. During the six months ended June 30, 2006 and 2005, eight properties were sold in each period, with net gains on real estate dispositions of $10.9 million and $8.9 million, respectively. At June 30, 2006 and December 31, 2005, the number of assets held for sale were six and 14 with carrying amounts of $45.7 million and $60.5 million, respectively, and are included in real estate held for sale, net on our consolidated balance sheets.

Stock-Based Compensation

On January 1, 2002, the Company adopted the fair value method of accounting for stock-based compensation in accordance with SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transaction and Disclosure (“SFAS No. 148”). The fair value provisions of SFAS No. 123 were adopted prospectively with the fair value of all new stock option grants recognized as compensation expense beginning January 1, 2002. Since only new grants are accounted for under the fair value method, stock-based compensation expense is less than that which would have been recognized if the fair value method had been applied to all awards. Compensation expense for awards with graded vesting is generally recognized ratably over the period from the date of grant to the date when the award is no longer contingent on the employee providing additional services.

SFAS No. 123R, Share-Based Payments (“SFAS No. 123R”), which is a revision of SFAS No. 123, was issued in December 2004. Generally, the approach in SFAS No. 123R is similar to that in SFAS No. 123. However, SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, be recognized in the income

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statement based on their fair values. Pro forma disclosure is no longer an alternative.  On January 1, 2006, the Company adopted SFAS No. 123R using the modified prospective application transition method which provides for only current and future period stock-based awards to be measured and recognized at fair value. The adoption of SFAS No. 123R did not have a significant impact on the Company’s financial position or results of operations since the fair value provisions of SFAS No. 123 were adopted prospectively on January 1, 2002.

The following table reflects net income and earnings per share, adjusted as if the fair value based method had been applied to all outstanding stock awards (in thousands, except per share amounts):

 

Cash and Cash Equivalents

Cash and cash equivalents represent short term investments with original maturities of three months or less when purchased.

Restricted Cash

Restricted cash primarily consists of amounts held by mortgage lenders to provide for future real estate tax expenditures and tenant improvements and security deposits.

Derivatives

The Company applies SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137, SFAS No. 138 and SFAS No. 148 (“SFAS No. 133”), which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. It requires the recognition of all derivative instruments as assets or liabilities in the Company’s condensed consolidated balance sheets at fair value. Changes in the fair value of derivative instruments that are not designated as hedges or that do not meet the hedge accounting criteria of SFAS No. 133 are recognized in earnings. For derivatives designated as hedging instruments in qualifying cash flow hedges, the effective portion of changes in fair value of the derivatives is recognized in accumulated other comprehensive income (loss) whereas the ineffective portion is recognized in earnings.

The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objectives and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as cash flow hedges to specific assets and liabilities in the consolidated balance sheet. The Company also assesses and documents, both at the hedging instrument’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows associated with the hedged items. When it is determined that a derivative ceases to be highly effective as a hedge, the Company discontinues hedge accounting prospectively.

Marketable Securities

The Company classifies its existing marketable equity securities as available-for-sale in accordance with the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, (“SFAS No. 115”). These

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securities are carried at market value, with unrealized gains and losses reported in stockholders’ equity as a component of accumulated other comprehensive income (loss). Gains or losses on securities sold are based on the specific identification method. There were no sales of securities for the six months ended June 30, 2006 and 2005.

All debt securities are classified as held-to-maturity because the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts to maturity.

Segment Reporting

The Company reports its consolidated financial statements in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS No. 131”). The Company’s segments are based on the Company’s method of internal reporting which classifies its operations by leasing activities. The Company’s segments include: medical office buildings (“MOBs”) and triple-net leased facilities.

New Accounting Pronouncements

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”), which replaces Accounting Principles Board Opinion No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principles. It requires retrospective application to prior periods’ financial statements of changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 did not have a significant impact on the Company’s financial position or results of operations.

In April 2006 the FASB issued FASB Staff Position FIN 46R-6, “Determining the Variability to Be Considered in Applying FASB Interpretation No. 46R” (“FSP FIN 46R-6”). FSP FIN 46R-6 addresses how variability should be considered when applying FIN 46R. Variability affects the determination of whether an entity is a VIE, which interests are variable interests, and which party, if any, is the primary beneficiary of the VIE that is required to be consolidated. FSP FIN 46R-6 clarifies that the design of the entity also should be considered when identifying which interests are variable interests.

FSP FIN 46R-6 must be applied prospectively to all entities in which the Company first becomes involved, beginning September 1, 2006. Early application is permitted. The Company does not expect that the adoption of FSP FIN 46R-6 will have a material effect on the Company’s financial position or results of operations.

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). This interpretation, among other things, creates a two step approach for evaluating uncertain tax positions. Recognition (step one) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Measurement (step two) determines the amount of benefit that more-likely-than-not will be realized upon settlement. Derecognition of a tax position that was previously recognized would occur when a company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. FIN 48 specifically prohibits the use of a valuation allowance as a substitute for derecognition of tax positions, and it has expanded disclosure requirements.  FIN 48 is effective for fiscal years beginning after December 15, 2006, in which the impact of adoption should be accounted for as a cumulative-effect adjustment to the beginning balance of retained earnings. The Company is evaluating FIN 48 and has not yet determined the impact the adoption will have on the Company’s financial position or results of operations.

Reclassifications

Certain reclassifications have been made for comparative financial statement presentation.

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(3) Merger with CNL Retirement Properties, Inc. and Acquisition of CNL Retirement Corp.

On May 1, 2006, HCP entered into a definitive merger agreement with CNL Retirement Properties, Inc. (“CRP”) under which a wholly owned subsidiary of HCP will merger with CRP.  Upon the consummation of the  merger with CRP, stockholders holding shares of CRP common stock will be entitled to receive consideration consisting of $11.1293 in cash and 0.0865 of a share of HCP common stock. CRP had 264.2 million shares of common stock outstanding at March 31, 2006.  Consummation of the merger with CRP is subject to several conditions, including the registration of the HCP shares to be issued as consideration and the approval of the merger by the CRP stockholders.  On August 4, 2006, the Company’s registration statement on Form S-4 (No. 333-135569) was declared effective by the Securities and Exchange Commission.  The special meeting of stockholders of CRP to consider and approve the merger of CRP with a subsidiary of the Company is scheduled for September 26, 2006. If the stockholders of CRP approve the merger, the Company expects to close the acquisitions of CRP and CRC in October 2006. In connection with the merger with CRP, HCP has also entered into a definitive merger agreement with respect to CNL Retirement Corp. (“CRC”), the external advisor to CRP, pursuant to which all  outstanding shares of CRC capital stock will be converted into the right to receive in the aggregate 4,378,923 shares of HCP common stock.  The proposed merger with CRP and with the proposed merger with CRC are each conditioned upon the consummation of the other.

HCP intends to finance the merger cash consideration and costs, including approximately $2.94 billion cash portion of the consideration payable to CRP stockholders, under new revolving, term and bridge facilities to be entered into by HCP before the closing of the merger providing for aggregate borrowings of up to $4.4 billion. HCP has received executed commitments for the $4.4 billion of such related financings. All of HCP’s domestic subsidiaries will guarantee any outstanding obligations under the facilities. The bridge commitment provides for a 364 day facility and the term commitment and revolving commitment for two and three year terms, respectively, with interest rates varying depending on HCP’s credit ratings. The facilities will contain covenants similar to those contained in HCP’s existing credit agreement, including leverage ratios, a secured debt ratio, an unsecured debt ratio, a fixed charge coverage ratio and a minimum net worth test. In addition, the bridge and term loan facilities impose certain mandatory prepayments with the proceeds from asset sales, capital market transactions, and contributions to joint ventures..

(4) Operator Concentration

Tenet Healthcare Corporation (“Tenet”) (NYSE: THC) and American Retirement Corporation (“ARC”) (NYSE: ARC) accounted for 9.3% and 7.6%, respectively, of the Company’s revenue during the six months ended June 30, 2006, and accounted for 11.6% and 9.3% respectively, of the Company’s revenue during the six months ended June 30, 2005. The carrying amount of the Company’s real estate assets leased to Tenet and ARC at June 30, 2006, was $337.8 million and $368.0 million, respectively.

On July 25, 2006, ARC was acquired by Brookdale Senior Living Inc. (“Brookdale”) (NYSE: BKD). As of March 31, 2006, Brookdale operates over 400 senior living facilities in 32 states.

These companies are publicly traded and are subject to the informational filing requirements of the Securities and Exchange Act of 1934, as amended. Accordingly, each is required to file periodic reports on Form 10-K and Form 10-Q with the Securities and Exchange Commission.

Certain operators of the Company’s properties are experiencing financial, legal and regulatory difficulties. The loss of a significant operator or a combination of smaller operators could have a material impact on the Company’s financial position or results of operations.

(5) Acquisitions and Dispositions

A summary of acquisitions through June 30, 2006, follows (in thousands):

 

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A summary of fiscal year 2005 acquisitions follows (in thousands):

 

(1)                Includes transaction costs, if any.

(2)                Non-managing member LLC units.

During the six months ended June 30, 2006, the Company acquired properties aggregating $329.9 million, including the following significant acquisitions:

On June 1, 2006, the Company acquired two senior housing properties for $27 million, through a sale-leaseback transaction.  These facilities have an initial lease term of fifteen years, with two ten-year renewal options. The initial annual lease rate is approximately 9.0% with annual escalators based on the Consumer Price Index (“CPI”) that have a floor of 2.75%.

On May 31, 2006, the Company acquired nine assisted living and independent living facilities for $99 million, including assumed debt valued at $61 million, through a sale-leaseback transaction. These facilities have an initial lease term of ten years, with two ten-year renewal options. The initial annual lease rate is approximately 8.0% with annual CPI-based escalators.

During the three months ended March 31, 2006, the Company acquired 13 medical office buildings for $138 million, including DownREIT units valued at $6 million, in related transactions. The 13 buildings, with 730,000 rentable square feet, have an initial yield of 7.3%.

On February 8, 2006, the Company acquired four laboratory, office and biotechnology manufacturing buildings located in San Diego, California for $30 million. The initial yield on these buildings is 6.1%, with the stabilized yield expected to be 8.3%. The buildings include approximately 158,000 rentable square feet.

On February 24, 2006, the Company acquired two medical office buildings for approximately $21 million including assumed debt valued at $12 million. The two buildings, with 157,000 rentable square feet, have an initial yield of 8.0%.

During the six months ended June 30, 2006, the Company sold eight properties for $28 million and recognized gains of approximately $11 million.

See Note 17 for a discussion of acquisitions and dispositions subsequent to June 30, 2006.

(6) Investments in and Advances to Unconsolidated Joint Ventures

HCP Medical Office Portfolio, LLC

HCP Medical Office Portfolio, LLC (“HCP MOP”) is a joint venture formed in June 2003 between the Company and an affiliate of General Electric Company (“GE”). HCP MOP is engaged in the acquisition, development and operation of MOB properties. The Company has a 33% ownership interest therein and is the managing member. Activities of the joint venture requiring equity capital are generally funded on a transactional basis by the members in proportion to their ownership interests. Cash distributions are made to the members in proportion to their ownership interests until GE’s cumulative return, as defined, exceeds specified thresholds. Thereafter, the Company will be entitled to an additional promoted interest. In addition, the joint venture agreement includes buy/sell provisions and imposes certain restrictions on the transfer of the Company’s joint venture interests by the Company and GE to third parties.

The Company uses the equity method of accounting for its investment in HCP MOP because it exercises significant influence through voting rights and its position as managing member. However, the Company does not consolidate HCP MOP since it does not control, through voting rights or other means, the joint venture as GE has substantive participating decision-making rights and has the majority of the economic interest. The accounting policies of HCP MOP are the same as those described in the summary of significant accounting policies (see Note 2).

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Summarized unaudited condensed financial information of HCP MOP is as follows:

 

 

The Company has not guaranteed any indebtedness or other obligations of HCP MOP. Generally, the Company may only be required to provide additional funding to HCP MOP under limited circumstances as specified in the related agreements. At June 30, 2006, investments in and advances to unconsolidated joint ventures include outstanding advances to HCP MOP of $4.2 million.

In August and September 2005, ten medical office buildings owned by HCP MOP, principally in Louisiana and the surrounding area, sustained varying degrees of damage due to hurricanes Katrina and Rita. The four buildings have incurred substantial damage and are a total loss. For the years ended December 31, 2005 and 2004, the four buildings generated revenues for HCP MOP of $0.9 million and $1.4 million, respectively. As of December 31, 2005, the $3.8 million carrying value of these four buildings was written off and an equal amount was recorded as a receivable for the expected insurance proceeds. At December 31, 2005, the remaining six buildings had resumed operations with repairs completed as of June 30, 2006. Revenues of HCP MOP for the six facilities were $2.0 million and $2.8 million for the six months ended June 30, 2006 and 2005, respectively.

Repairs and other related expenditures for damages caused by hurricanes Katrina and Rita during the six months ended June 30, 2006, were approximately $1.9 million, and were added to the expected insurance receivable. The Company has property, business interruption and other related insurance coverage to mitigate the financial impact of these types of events; such coverage is subject to various limits and deductible provisions based on the terms of the policies. Any excess insurance recovery above the carrying value of the assets is expected to be recognized by HCP MOP as a gain at the time the claims are settled with the insurance carrier.  For the six months ended June 30, 2006, HCP MOP has received $3.0 million in proceeds from its insurance carriers, which have been applied to outstanding insurance receivables.

During the six months ended June 30, 2006, HCP MOP sold 33 MOBs with 1.3 million of rentable square feet for $99.1 million, net of transaction costs, and recognized aggregate gains of approximately $18.7 million. In connection with these transactions, approximately $64.9 million of HCP MOP’s mortgage debt was either repaid or assumed by the purchasers.

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Other Unconsolidated Joint Ventures

The Company owns interests in the following entities, which are accounted for on the equity method of accounting at June 30, 2006 (in thousands):

 

(1)           Represents the Company’s investment in the identified unconsolidated joint venture. Negative investment amounts are included in accounts payable and accrued liabilities in the Company’s consolidated balance sheet. See Note 2 regarding the Company’s policy for accounting for joint venture interests.

(2)           The Company’s ownership interest and economic interest are substantially the same.

Summarized unaudited condensed combined financial information for the other unconsolidated joint ventures follows:

 

 

As of June 30, 2006, the Company has guaranteed approximately $7.2 million of a total of $15.4 million of notes payable for four of these joint ventures.

(7) Loans Receivable

Loans receivable consist of the following:

		June 30, 2006									December 31, 2005
		Secured			Unsecured			Total			Secured			Unsecured			Total
		(in thousands)
Joint venture partners		$	—		$	7,006		$	7,006		$	—		$	7,006		$	7,006
Other		138,325			1,420			139,745			175,426			6,663			182,089
Loan loss allowance		—			(1,064		)	(1,064		)	—			(2,264		)	(2,264		)
		$	138,325		$	7,362		$	145,687		$	175,426		$	11,405		$	186,831

 

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On February 9, 2006, the Company refinanced two existing loans secured by a hospital in Texas. The loans were combined into a new single loan that carries an interest rate of 8.5% per annum and matures in 2016. The original loans matured in January 2006 and had a weighted average interest rate of 10.35%.

On March 14, 2006, the Company received $38 million in proceeds, including $7.3 million in excess of the carrying value, upon the early repayment of a secured loan receivable due May 1, 2010. The amount received in excess of the carrying value of the secured loan receivable was recorded as interest income and is included in interest and other income in the Company’s Condensed Consolidated Statements of Income for the six months ended June 30, 2006. This loan was secured by nine skilled nursing facilities and carried an interest rate of 11.4% per annum.

(8) Debt

Senior unsecured notes. At June 30, 2006, the Company had $1.5 billion in aggregate principal of senior unsecured notes outstanding. Interest rates on the notes ranged from 4.88% to 7.62% with a weighted average effective rate of 6.04% at June 30, 2006. Discounts and premiums are amortized to interest expense over the term of the related debt.

On February 27, 2006, the Company issued $150 million of 5.625% senior unsecured notes due 2013. The notes were priced at 99.071% of the principal amount for an effective yield of 5.788%. The Company received net proceeds of $149 million, which were used to repay outstanding indebtedness and for other general corporate purposes.

During the six months ended June 30, 2006, the Company repaid $135 million of maturing senior unsecured notes which accrued interest at a weighted average rate of 6.7%. These notes were repaid with funds available under the Company’s bank lines of credit.

The senior unsecured notes contain certain covenants including limitations on debt and other customary terms.

Mortgage debt. At June 30, 2006, the Company had $454.8 million in mortgage debt secured by 70 healthcare facilities with a carrying amount of $754.2 million. Interest rates on the mortgage notes ranged from 3.75% to 9.32% with a weighted average effective rate of 6.32% at June 30, 2006.

During the six months ended June 30, 2006, the Company obtained $165 million of 10-year mortgage financing with a weighted average effective rate of 6.36% in four separate transactions. The Company received net proceeds of $162 million, which were used to repay outstanding indebtedness and for other general corporate purposes.

The instruments encumbering the properties restrict title transfer of the respective properties subject to the terms of the mortgage, prohibit additional liens, restrict prepayment, require payment of real estate taxes, maintenance of the properties in good condition, maintenance of insurance on the properties and include a requirement to obtain lender consent to enter into material tenant leases.

Bank lines of credit. At June 30, 2006, borrowings under the Company’s $500 million three-year line of credit were $265.1 million with a weighted average interest rate of 5.83%. The Company’s bank line of credit matures in October 2007. Borrowings under the bank line of credit accrue interest at 65 basis points over LIBOR with a 15 basis point facility fee. In addition, a negotiated rate option, whereby the lenders participating in the credit facility bid on the interest to be charged and which may result in a reduced interest rate, is available for up to 50% of borrowings. The credit facility also contains an “accordion” feature allowing borrowings to be increased by $100 million under certain conditions.

The credit agreement contains certain financial restrictions and other customary requirements. Among other things, these covenants, using terms defined in the agreement, limit (i) Consolidated Total Indebtedness to Consolidated Total Asset Value to 60%, (ii) Secured Debt to Consolidated Total Asset Value to 30% and (iii) Unsecured Debt to Consolidated Unencumbered Asset Value to 60%. The agreement also requires that the Company must maintain (i) a Fixed Charge Coverage ratio, as defined, of 1.75 times and (ii) a formula-determined Minimum Tangible Net Worth. As of June 30, 2006, the Company was in compliance with each of these restrictions and requirements.

On February 14, 2006, the Company entered into a 60 day Term Loan Agreement for $200 million. Loans outstanding under the Term Loan Agreement accrue interest at a rate per annum equal to LIBOR plus a margin ranging from 0.75% to 1.50%, depending upon the Company’s senior unsecured long term debt ratings.  On April 18, 2006, the Company repaid all amounts outstanding under the Loan Term Agreement.

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(9) Stockholders’ Equity

Common Stock

During the six months ended June 30, 2006 and 2005, the Company issued 395,000 and 495,000 shares, respectively, of common stock under its Dividend Reinvestment and Stock Purchase Plan. The Company issued 287,000 and 1,375,000 shares upon exercise of stock options during the six months ended June 30, 2006 and 2005, respectively.

During the six months ended June 30, 2006 and 2005, the Company issued 100,000 and 115,000 shares of restricted stock, respectively, under the Company’s 2000 Stock Incentive Plan (the “Incentive Plan”). The Company also issued 117,000 and 2,800 shares upon the vesting of performance restricted stock units during the six months ended June 30, 2006 and 2005, respectively.

On April 25, 2006, the Company announced that its Board of Directors declared a quarterly cash dividend of $0.425 per share of common stock. The common stock cash dividend was paid on May 19, 2006 to stockholders of record as of the close of business on May 8, 2006.

On July 27, 2006, the Company announced that its Board of Directors declared a quarterly cash dividend of $0.425 per share of common stock. The common stock cash dividend will be paid on August 18, 2006 to stockholders of record as of the close of business on August 7, 2006.

Preferred Stock

On April 25, 2006, the Company announced that its Board of Directors declared a quarterly cash dividend of $0.45313 per share on its Series E cumulative redeemable preferred stock and $0.44375 per share on its Series F cumulative redeemable preferred stock. These dividends were paid on June 30, 2006 to stockholders of record as of the close of business on June 15, 2006.

On July 27, 2006, the Company announced that its Board of Directors declared a quarterly cash dividend of $0.45313 per share on its Series E cumulative redeemable preferred stock and $0.44375 per share on its Series F cumulative redeemable preferred stock. These dividends will be paid on September 30, 2006 to stockholders of record as of the close of business on September 15, 2006.

Accumulated Other Comprehensive Income  (“AOCI”)

 

Other comprehensive income and loss amounts are additions to and reductions of net income, respectively, in calculating comprehensive income. Comprehensive income for the six months ended June 30, 2006 and 2005 was $100.6 million and $86.5 million, respectively.

(10) Impairments

During the six months ended June 30, 2006, three properties were deemed impaired resulting in impairment charges of $4.7 million. Impairment charges principally arose as a result of an assessment of the planned near-term disposition of two properties and a decrease in expected cash flows from a third property. During the six months ended June 30, 2005, no properties were determined to be impaired.

(11) Segment Disclosures

The Company’s business consists of financing and leasing healthcare-related real estate. The Company evaluates its business and makes resource allocations on its two business segments—triple-net leased facilities and medical office buildings. Within the triple-net leased segment, the Company invests in healthcare-related real estate through acquisitions and secured financings of primarily single tenant properties. Properties acquired are generally leased under triple-net leases.

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Within the medical office building segment, the Company acquires medical office buildings that are primarily leased under gross or modified gross leases and generally require a greater level of property management. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (See Note 2). There are no intersegment sales or transfers. The Company evaluates performance based upon the net operating income of the combined properties in each segment.

Non-segment revenue consists mainly of interest on unsecured loans and fee income. Non-segment assets consist of corporate assets including cash, restricted cash, accounts receivable, and deferred financing costs. Interest expense, depreciation and amortization, and other non-property specific revenues and expenses are not allocated to individual segments in measuring each segment’s performance.

Summary information for the reportable segments follows (in thousands):

For the three months ended June 30, 2006:

Segments		Rental Revenues			Equity Income from Unconsolidated Joint Ventures			Interest and Other Income			Total Revenues			NOI(1)
Triple-net leased facilities:
Senior housing facilities		$	35,582		$	14		$	457		$	36,053		$	33,137
Hospitals		24,886			—			2,216			27,102			24,886
Skilled nursing facilities		22,389			—			567			22,956			22,389
Other healthcare facilities		6,953			—			—			6,953			5,710
Total triple-net leased facilities		$	89,810		$	14		$	3,240		$	93,064		$	86,122
Medical office buildings		41,198			2,700			—			43,898			25,768
Non-segment revenues and other income		—			—			3,120			3,120			—
Total		$	131,008		$	2,714		$	6,360		$	140,082		$	111,890

 

For the three months ended June 30, 2005:

Segments		Rental Revenues			Equity Income from Unconsolidated Joint Ventures			Interest and Other Income			Total Revenues			NOI(1)
Triple-net leased facilities:
Senior housing facilities		$	26,005		$	137		$	694		$	26,836		$	23,656
Hospitals		23,790			—			1,515			25,305			23,790
Skilled nursing facilities		22,017			—			1,477			23,494			21,995
Other healthcare facilities		6,190			—			—			6,190			4,983
Total triple-net leased facilities		$	78,002		$	137		$	3,686		$	81,825		$	74,424
Medical office buildings		32,135			(49		)	—			32,086			20,325
Non-segment revenues and other income		—			—			2,326			2,326			—
Total		$	110,137		$	88		$	6,012		$	116,237		$	94,749

 

For the six months ended June 30, 2006:

Segments		Rental Revenues			Equity Income from Unconsolidated Joint Ventures			Interest and Other Income			Total Revenues			NOI(1)
Triple-net leased facilities:
Senior housing facilities		$	69,735		$	113		$	1,483		$	71,331		$	64,211
Hospitals		44,397			—			4,537			48,934			44,397
Skilled nursing facilities		44,711			—			9,068			53,779			44,600
Other healthcare facilities		13,418			—			—			13,418			10,915
Total triple-net leased facilities		$	172,261		$	113		$	15,088		$	187,462		$	164,123
Medical office buildings		79,208			6,423			—			85,631			50,664
Non-segment revenues and other income		—			—			7,019			7,019			—
Total		$	251,469		$	6,536		$	22,107		$	280,112		$	214,787

 

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For the six months ended June 30, 2005:

Segments		Rental Revenues			Equity Income from Unconsolidated Joint Ventures			Interest and Other Income			Total Revenues			NOI(1)
Triple-net leased facilities:
Senior housing facilities		$	49,675		$	337		$	1,472		$	51,484		$	45,721
Hospitals		43,932			—			3,036			46,968			43,932
Skilled nursing facilities		43,448			—			2,995			46,443			43,640
Other healthcare facilities		12,674			—			—			12,674			10,179
Total triple-net leased facilities		$	149,729		$	337		$	7,503		$	157,569		$	143,472
Medical office buildings		60,968			(38		)	—			60,930			38,536
Non-segment revenues and other income		—			—			3,688			3,688			—
Total		$	210,697		$	299		$	11,191		$	222,187		$	182,008

 

(1)        Net Operating Income from Continuing Operations (“NOI”) is a non-GAAP supplemental financial measure used to evaluate the operating performance of real estate properties. The Company defines NOI as rental revenues, including tenant reimbursements, less property-level operating expenses, which exclude depreciation and amortization, general and administrative expenses, impairments, interest expense and discontinued operations. The Company believes NOI provides investors relevant and useful information because it measures the operating performance of the Company’s real estate at the property level on an unleveraged basis. The Company uses NOI to make decisions about resource allocations and assess property-level performance. The Company believes that net income is the most directly comparable GAAP measure to NOI. NOI should not be viewed as an alternative measure of operating performance to net income as defined by GAAP since it does not reflect the aforementioned excluded items. Further, NOI may not be comparable to that of other real estate investment trusts, as they may use different methodologies for calculating NOI.

The following is a reconciliation from NOI to reported net income, a financial measure under GAAP (in thousands):

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Net operating income from continuing operations		$	111,890		$	94,749		$	214,787		$	182,008
Equity income from unconsolidated joint ventures		2,714			88			6,536			299
Interest and other income		6,360			6,012			22,107			11,191
Interest expense		(33,640		)	(25,372		)	(65,733		)	(48,610		)
Depreciation and amortization		(31,838		)	(26,671		)	(62,233		)	(49,846		)
General and administrative		(8,434		)	(8,827		)	(16,826		)	(16,146		)
Impairments		(4,711		)	—			(4,711		)	—
Minority interests		(4,170		)	(3,031		)	(7,947		)	(6,178		)
Discontinued operations		3,396			6,099			13,475			13,787
Net income		$	41,567		$	43,047		$	99,455		$	86,505

 

The Company’s total assets by segment were (in thousands):

 

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(12) Supplemental Cash Flow

Supplemental Cash Flow Information

 

(13) Earnings Per Share of Common Stock

The Company computes earnings per share in accordance with SFAS No. 128, Earnings Per Share. Basic earnings per common share is computed by dividing net income applicable to common shares by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per common share is calculated including the effect of dilutive securities. Approximately 2.1 million and 0.9 million options to purchase shares of common stock during the three months ended June 30, 2006 and 2005, respectively, and 1.9 million and 0.9 million during the six months ended June 30, 2006 and 2005, respectively, were not included because they are not dilutive. Additionally, 6.1 million shares issuable upon conversion of 3.6 million non-managing member units during the three and six months ended June 30, 2006, and 5.0 million shares issuable upon conversion of 2.5 million non-managing member units during the three months ended June 30, 2005, were not included because they are not dilutive.

		Three Months Ended June 30,
		2006								2005
		Income			Shares		Per Share			Income			Shares		Per Share
		(in thousands, except per share amounts)
Basic earnings per common share:
Net income applicable to common shares		$	36,284		136,484		$	0.27		$	37,764		134,445		$	0.28
Dilutive options and unvested restricted stock		—			708		(0.01		)	—			769		—
Diluted earnings per common share		$	36,284		137,192		$	0.26		$	37,764		135,214		$	0.28

 

		Six Months Ended June 30,
		2006								2005
		Income			Shares		Per Share			Income			Shares		Per Share
		(in thousands, except per share amounts)
Basic earnings per common share:
Net income applicable to common shares		$	88,889		136,262		$	0.65		$	75,939		133,968		$	0.57
Dilutive options and unvested restricted stock		—			762		—			—			903		(0.01		)
Diluted earnings per common share		$	88,889		137,024		$	0.65		$	75,939		134,871		$	0.56

 

(14) Derivative Financial Instruments

In July 2005, the Company entered into three interest-rate swap contracts that are designated as hedging the variability in expected cash flows for variable rate debt assumed in connection with the acquisition of a portfolio of real estate assets in July 2005. The cash flow hedges have a notional principal amount of $45.6 million and expire in July 2020. The fair value of these contracts at June 30, 2006, was $1.9 million and is included in other assets. For the six months ended June 30, 2006, the Company recognized increased interest expense of $131,000 attributable to the contracts. The Company determined that these swap agreements were highly effective in offsetting future variability of interest cash flows related to the assumed mortgages. The effective portion of gains and losses on these contracts is recognized in accumulated other comprehensive income, net whereas the ineffective portion is recognized in earnings. During the six months ended June 30, 2006, there was no ineffective portion related to these hedges.

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(15) Commitments and Contingencies

The Company, from time to time, is party to legal proceedings, lawsuits and other claims in the ordinary course of the Company’s business. These claims, even if not meritorious, could force the Company to spend significant financial resources. The Company is not aware of any legal proceedings or claims that it believes will have, individually or taken together, a material adverse effect on its business, prospects, financial condition or results of operations.

State of California Senate Bill 1953.  One of the Company’s properties located in Tarzana, California is affected by State of California Senate Bill 1953 (“SB 1953”), which requires certain seismic safety building standards for acute care hospital facilities. This hospital is operated by Tenet under a lease expiring in February 2009. The Company and Tenet are currently reviewing the SB 1953 compliance of this hospital, multiple plans of action to cause such compliance, the estimated time for completing the same, and the cost of performing necessary remediation of the property. We cannot currently estimate the remediation costs that will need to be incurred prior to 2013 in order to make the facility SB 1953-compliant through 2030 and the final allocation of any remediation costs between the Company and Tenet. Rent on the hospital for the six months ended June 30, 2006 was $4.2 million and for the years ended December 31, 2005 and 2004 was $10.8 million and $10.6 million, respectively, and the carrying amount was $75.0 million at June 30, 2006.

Master Trust Liabilities.  Certain residents of two of the Company’s senior housing facilities have entered into a master trust agreement with the operator of the facilities whereby amounts paid upfront by such residents were deposited into a trust account. These funds were then made available to the senior housing operator in the form of a non-interest bearing loan to provide permanent financing for the related communities. The operator of the senior housing facility is the borrower under these arrangements; however, two of the Company’s properties are collateral under the master trust agreements. As of June 30, 2006, the remaining obligation under the master trust agreements for these two properties is $10.1 million. The Company’s property is released as collateral as the master trust liabilities are extinguished.

CRP and CRC Merger Related Costs.   The Company expects to incur substantial costs in connection with its mergers with CRP and CRC, such as legal, accounting and certain financial advisor fees, which must be paid even if the merger is not completed.  As of June 30, 2006, the Company has incurred $4.0 million of merger related costs which would be written off if the mergers with CRP and CRC are not completed.

Promoted Interests and Other Contractual Obligations. Upon the achievement of certain return thresholds and the occurrence of certain events, the Company may be obligated to make payments to certain joint venture partners pursuant to the terms and provisions of their contractual agreements with the partnership. From time to time in the normal course of the Company’s business, the Company enters into various contracts with third parties that may obligate it to make payments or perform other obligations upon the occurrence of certain events.

Earnout Obligations.  Pursuant to the terms of certain acquisition-related agreements, the Company may be obligated to make additional payments (“Earnouts”) upon the achievement of certain criteria. If it is probable at the time of acquisition of the related properties that the Earnout criteria will be achieved, the Earnout payments are accrued. Otherwise, the additional purchase consideration is recognized when the performance criteria are achieved.  During the six months ended June 30, 2006, the Company made earnout payments in the aggregate of $3.7 million.

General Uninsured Losses.  The Company obtains various types of insurance to mitigate the impact of property, business interruption, liability, flood, earthquake and terrorism related losses. The Company attempts to obtain appropriate policy terms, conditions, limits and deductibles, considering the relative risk of loss, the cost of such coverage and current industry practice. There are, however, certain types of extraordinary losses, such as those due to acts of war or other events, that may be either uninsurable or not economically insurable. Although the Company has obtained coverage to mitigate the impact of various casualty losses, with policy specifications and insured limits that it believes are commercially reasonable, there can be no assurance that the Company will be able to collect under such policies or that the policies will provide adequate coverage. Should an uninsured loss occur at a property, the Company’s assets may become impaired and the Company may not be able to operate its business at the property for an extended period of time.

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(16) Stock Incentive Plans

On May 11, 2006, the Company’s stockholders approved the 2006 Performance Incentive Plan (the “2006 Incentive Plan”).  The 2006 Incentive Plan replaces the Company’s 2000 Stock Incentive Plan and provides for the granting of stock based compensation, including stock options, restricted stock, and performance restricted stock units, to officers, employees and directors in connection with their employment with or services provided to the Company.  The maximum number of shares available for future awards over the term of the 2006 Incentive Plan is 8.5 million shares at June 30, 2006, of which 4.2 million may be issued as restricted stock and performance restricted stock units.

Stock Options

Stock options are generally granted with an exercise price equal to the fair market value of the underlying stock on the date of grant. Stock options generally vest ratably over a five-year period. Vesting of certain options may accelerate upon retirement, a change in control of the Company, as defined, and other events. A summary of the option activity is presented in the following table (in thousands, except per share amounts):

 

The following table summarizes additional information concerning outstanding and exercisable stock options at June 30, 2006 (options in thousands):

 

The following table summarizes additional information concerning unvested stock options at June 30, 2006 (options in thousands):

 

Proceeds received from options exercised under the Stock Incentive Plans for the six months ended June 30, 2006 and 2005, was $4.5 million and $21.8 million, respectively. The total intrinsic value of options exercised during the six months ended June 30, 2006 and 2005 was $3.5 million and $14.2 million, respectively. The total intrinsic value of options outstanding and exercisable as of June 30, 2006 was $10.2 million.

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The fair value of the stock options granted during the six months ended June 30, 2006 and 2005 was estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the table below. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life (estimated period of time outstanding) of the stock options granted was estimated using the historical exercise behavior of employees. Expected volatility was based on historical volatility for a period equal to the stock option’s expected life, ending on the day of grant, and calculated on a weekly basis.

 

The weighted average fair value per share at the date of grant for options awarded during the six months ended June 30, 2006 and 2005, was $2.18 and $1.92, respectively.

Restricted Stock and Performance Restricted Stock Units

Under the 2006 Incentive Plan, restricted stock and performance restricted stock units generally vest over a three to five year period. The vesting of certain restricted shares and units may accelerate upon retirement, a change in control of the Company, as defined, and other events. When vested, each performance restricted stock unit is convertible into one share of common stock. The restricted stock and performance restricted stock units are valued on the grant date based on the market price of a common share on that date. Generally, the Company recognizes the fair value of the awards over the applicable vesting period as compensation expense.

The following table summarizes additional information concerning unvested restricted stock and restricted stock units at June 30, 2006 (shares in thousands):

 

The total fair values of restricted stock and restricted stock units vested, based on the market price on the vesting date, during the six months ended June 30, 2006 and 2005 were $4.7 million and $4.1 million, respectively.

As of June 30, 2006, there was $24.8 million of total unrecognized compensation cost, related to unvested share-based compensation arrangements granted under the Company’s incentive plans, is expected to be recognized over a weighted-average period of 3.5 years.

(17) Subsequent Events

On July 25, 2006, the Company sold a building, with 204,000 rentable square feet, for $73 million and recognized a gain of approximately $32 million.

On July 28, 2006, the Company acquired two assisted living facilities in exchange for three assisted living facilities valued at approximately $20 million and $37 million in cash.  The two acquired properties have an initial effective lease term of ten years, with two ten-year renewal options, and an initial contractual annual lease rate of 7.0% with escalators based on the lessee’s revenue growth.   The acquired properties are included in a new master lease that contains a total of six properties leased to the same operator.

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

Cautionary Language Regarding Forward-looking Statements

Statements in this Quarterly Report that are not historical factual statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The statements include, among other things, statements regarding the intent, belief or expectations of Health Care Property Investors, Inc. and its officers and can be identified by the use of terminology such as “may,” “will,” “expect,” “believe,” “intend,” “plan,” “estimate,” “should” and other comparable terms or the negative thereof. In addition, we, through our senior management, from time to time make forward-looking oral and written public statements concerning our expected future operations and other developments. Readers are cautioned that, while forward-looking statements reflect our good faith belief and best judgment based upon current information, they are not guarantees of future performance and are subject to known and unknown risks and uncertainties. Actual results may differ materially from the expectations contained in the forward-looking statements as a result of various factors. In addition to the factors set forth under “Part I, Item 1A - Risk Factors” in the Company’s Annual Report and “Part II, Item 1A — Risk Factors” in this Quarterly Report, readers should consider the following:

a)              Legislative, regulatory, or other changes in the healthcare industry at the local, state or federal level which increase the costs of, or otherwise affect the operations of, our tenants and borrowers;

b)             Changes in the reimbursement available to our tenants and borrowers by governmental or private payors, including changes in Medicare and Medicaid payment levels and the availability and cost of third party insurance coverage;

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

d)             Availability of suitable healthcare facilities to acquire at favorable prices and the competition for such acquisition and financing of healthcare facilities;

e)              The ability of our tenants and borrowers to operate our properties in a manner sufficient to maintain or increase revenues and to generate sufficient income to make rent and loan payments;

f)                The financial weakness of some operators, including potential bankruptcies, which results in uncertainties regarding our ability to continue to realize the full benefit of such operators’ leases;

g)             Changes in national or regional economic conditions, including changes in interest rates and the availability and cost of capital;

h)             The risk that we will not be able to sell or lease facilities that are currently vacant;

i)                 The potential costs of SB 1953 compliance with respect to our hospital in Tarzana, California;

j)                 The financial, legal and regulatory difficulties of two significant operators, Tenet and HealthSouth; and

k)              The potential impact of existing and future litigation matters.

Readers should consider that many of these risks and uncertainties are also applicable to CNL Retirement Properties, Inc. (“CRP”) and its business and any forward-looking statements made by or whith respect to CRP or its business. We have entered into a definitive merger agreement pursuant to which, subject to the satistaction or waiver of the conditions therein, a wholly owned subsidiary of ours will merge into CRP.  Additional risks and uncertainties to which our forward-looking statements are subject include our ability to integrate the CRP business and to achieve expected synergies, operating efficiencies and other benefits within expected time-frames or at all, or within expected cost  projections, and to preserve the goodwill of the acquired businesses, as well as our ability to obtain financing necessary to consummate the acquisition or on favorable terms.

Executive Summary

We are a real estate investment trust (“REIT”) that invests in healthcare-related properties located throughout the United States. We develop, acquire, and manage healthcare real estate and provide mortgage financing to healthcare providers. We invest directly, often structuring sale-leaseback transactions, and through joint ventures. At June 30, 2006, our real estate portfolio, excluding assets held for sale but including assets held through joint ventures and mortgage loans, consisted of interests in 534 facilities located in 42 states.

Our business strategy is based on three principles: (i) opportunistic investing, (ii) portfolio diversification and (iii) conservative financing. We actively redeploy capital from investments with lower return potential into assets with higher

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return potential, and recycle capital from shorter term to longer term investments. We make investments where the expected risk-adjusted return exceeds our cost of capital and strive to leverage our operator and other business relationships.

Our strategy contemplates acquiring and developing properties on favorable terms. We attempt to structure transactions that are tax-advantaged and mitigate risks in our underwriting process. Generally, we prefer larger, more complex private transactions that leverage our management team’s experience and our infrastructure. During the six months ended June 30, 2006, we made gross investments of $352 million. These investments had an average first year yield on cost of just over 7.7%. Our investments for the six months ended June 30, 2006 were allocated among the following healthcare sectors: (i) 41% senior housing facilities; (ii) 50% Medical Office Buildings (“MOBs”); and (iii) 9% other healthcare facilities.

We follow a disciplined approach to enhancing the value of our existing portfolio, including the ongoing evaluation of properties that no longer fit our strategy for potential disposition. We sold eight properties during the six months ended June 30, 2006 for $28 million and had six properties with a carrying amount of $45.7 million classified as held for sale at June 30, 2006.

We primarily generate revenue by leasing healthcare-related properties under long-term operating leases. Most of our rents are received under triple-net leases; however, MOB rents are typically structured as gross or modified gross leases. Accordingly, for MOBs we incur certain property operating expenses, such as real estate taxes, repairs and maintenance, property management fees, utilities and insurance. Our growth depends, in part, on our ability to (i) increase rental income by increasing occupancy levels and rental rates, (ii) maximize tenant recoveries given underlying lease structures, and (iii) control operating and other expenses. Our operations are impacted by property-specific, market-specific, general economic and other conditions.

Access to external capital on favorable terms is critical to the success of our strategy. We attempt to match the long-term duration of our leases with long-term fixed rate financing. At June 30, 2006, 14% of our consolidated debt is at variable interest rates. We intend to maintain an investment grade rating on our fixed income securities and manage various capital ratios and amounts within appropriate parameters. As of June 30, 2006, our senior debt is rated BBB+ (Watch with Negative Implications) by Standard & Poor’s Ratings Group, BBB+ (watch negative) by Fitch Ratings and Baa2 (Review for Downgrade) by Moody’s Investors Service.  We believe the recent actions by Standard & Poor’s Rating Group and Moody’s Investors Service to add us to “Watch with Negative Implications” and “Review for Downgrade”, respectively, are due to the manner in which we are initially financing the announced merger with CRP.

Capital market access impacts our cost of capital and our ability to refinance existing indebtedness as it matures, as well as to fund future acquisitions and development through the issuance of additional securities. Our ability to access capital on favorable terms is dependent on various factors, including general market conditions, interest rates, credit ratings on our securities, perception of our potential future earnings and cash distributions, and the market price of our capital stock.

2006 Overview

Merger with CNL Retirement Properties, Inc. and Acquisition of CNL Retirement Corp.

On May 1, 2006, we entered into a definitive merger agreement with CNL Retirement Properties, Inc. (“CRP”) under which a wholly owned subsidiary of ours will merge with CRP.  Upon the consummation of the  merger with CRP, stockholders holding shares of CRP common stock will be entitled to receive consideration consisting of $11.1293 in cash and 0.0865 of a share of our common stock. CRP had 264.2 million shares of common stock outstanding at March 31, 2006.  Consummation of the merger with CRP is subject to several conditions, including the registration of the our shares to be issued as consideration and the approval of the merger by the CRP stockholders.   On August 4, 2006, our registration statement on Form S-4 (No. 333-135569) was declared effective by the Securities and Exchange Commission.  The special meeting of stockholders of CRP to consider and approve the merger with our subsidiary is scheduled for September 26, 2006.  If the stockholders of CRP approve the merger, we expect to close the acquisitions of CRP and CRC in October 2006. In connection with the merger with CRP, we have also entered into a definitive merger agreement with respect to CNL Retirement Corp. (“CRC”), the external advisor to CRP, pursuant to which all of the outstanding shares of CRC capital stock will be converted into the right to receive in the aggregate 4,378,923 shares of our common stock.  The proposed merger with CRP and the proposed merger with CRC are each conditioned upon the consummation of the other.  As of June 30, 2006, we have incurred $4.0 million of merger related costs which would be written off if our mergers with CRP and CRC are not completed.

We intend to finance the merger cash consideration and costs, including approximately $2.94 billion cash portion of the consideration payable to CRP stockholders, under new revolving, term and bridge facilities to be entered into by us before the closing of the merger providing for aggregate borrowings of up to $4.4 billion. We have received executed commitments for the $4.4 billion of such related financings. All of our domestic subsidiaries will guarantee any outstanding obligations under the facilities. The bridge commitment provides for a 364 day facility and the term commitment and revolving commitment for two and three year terms, respectively, with interest rates varying depending on our credit ratings.

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