NOTE
2 –PROPERTIES
In the ordinary course of our business
activities, we periodically evaluate investment opportunities and extend credit
to customers. We also regularly engage in lease and loan extensions
and modifications. Additionally, we actively monitor and manage our investment
portfolio with the objectives of improving credit quality and increasing
investment returns. In connection with portfolio management, we may
engage in various collection and foreclosure activities.
If we acquire real estate pursuant to a
foreclosure, lease termination or bankruptcy proceeding and do not immediately
re-lease or sell the properties to new operators, the assets will be included on
the balance sheet at the lower of cost or estimated fair value (see Note 3– Owned and
Operated Assets).
Leased
Property
Our leased real estate properties,
represented by 228 skilled nursing facilities (“SNFs”), seven assisted living
facilities (“ALFs”), two rehabilitation hospitals and two independent living
facilities (“ILFs”) at September 30, 2008, are leased under provisions of single
leases and master leases with initial terms typically ranging from 5 to 15
years, plus renewal options. Substantially all of our leases contain
provisions for specified annual increases over the rents of the prior year and
are generally computed in one of three methods depending on specific provisions
of each lease as follows: (i) a specific annual percentage increase over the
prior year’s rent, generally 2.5%; (ii) an increase based on the change in
pre-determined formulas from year to year (i.e., such as increases in the
Consumer Price Index (“CPI”)); or (iii) specific dollar increases over prior
years. Under the terms of the leases, the lessee is responsible for
all maintenance, repairs, taxes and insurance on the leased
properties.
During the third quarter of 2008, we
petitioned the bankruptcy court via a credit bid for the asset purchase, master
lease termination and operational transfer agreement for 15 facilities (“Haven
Properties”), in our portfolio that were previously operated by Haven, an
operator/tenant of 15 of our facilities that filed for bankruptcy in November
2007. On July 7, 2008, the bankruptcy court approved our purchase of
the operational assets of the Haven Properties and terminated our master lease
agreement with Haven. See Note 3 Owned and Operated Assets for
additional information, including the leasing of 13 of these facilities to
Formation Capital, a new operator/tenant.
During the third quarter of 2008, we
amended our master lease with an existing operator allowing for up to $25
million in additional investment in capital improvements and
renovations.
On September 30, 2008, we purchased
four SNFs, one ALF and one ILF for $40 million from subsidiaries of an existing
tenant, and leased those facilities back to the tenant. The
facilities were added to the tenant’s existing master lease and will increase
cash rent by $4.0 million annually. The $40 million acquisition price
was allocated $2.4 million to land, $35.4 million to building and $2.2 million
to personal property.
During
the second quarter of 2008, we purchased seven SNFs, one ALF and one
rehabilitation hospital for $47.4 million from an unrelated third party and
leased the facilities to an existing tenant of ours. The facilities
were added to the tenant’s existing master lease and will increase cash rent by
$4.7 million annually. The $47.4 million acquisition price was
allocated $6.6 million to land, $38.9 million to building and $1.9 million to
personal property.
During the second quarter of 2008, we
amended our master lease with an existing operator primarily to: (i) extend the
lease term of the agreement through December 2019; (ii) allow for the additional
capital investment of up to $5 million; and (iii) allow the operator the ability
to exit or lease three facilities to another operator during the lease
term.
During the second quarter of 2008, we
amended our single facility lease agreement with an existing operator primarily
to: (i) to extend the lease term from August 2013 to June 2018; and (ii) to
increase the rent from $0.8 million to $1.0 million annually beginning July 1,
2008.
During the first quarter of 2008, we
purchased one SNF for $5.2 million from an unrelated third party and leased the
facility to an existing tenant of ours. The facility was added to the
tenant’s existing master lease and will increase cash rent by $0.5 million
annually. The $5.2 million acquisition price was allocated $0.4
million to land, $4.5 million to building and $0.3 million to personal
property.
During the first quarter of 2008, we
amended our master lease with an existing operator to allow for the construction
of a new facility to replace an existing facility currently operated by the
operator. Upon completion (estimated to be in mid-2009), annual cash
rent will increase by approximately $0.7 million. As a result of our
plan to replace the existing facility, we recorded a $1.5 million impairment
loss on the existing facility during the first quarter of 2008 to record it at
its estimated fair value.
On February 1, 2008, we amended our
master lease with an existing operator and certain of its affiliates primarily
to: (i) consolidate three existing master leases into one master lease; (ii)
extend the lease term of the agreement through September 2017 for facilities
acquired in August 2006; and (iii) allow for the sale of two rehabilitation
hospitals currently operated by the operator.
Assets
Sold or Held for Sale
Assets
Sold
|
·
|
On
January 31, 2008, we sold one SNF in California for approximately $1.5
million resulting in a gain of approximately $0.4 million, which was
included in our gain/loss from discontinued operations. For
additional information, see Note 10 – Discontinued
Operations.
|
|
·
|
On
February 1, 2008, we sold a SNF in California for approximately $1.5
million resulting in a gain of approximately $46
thousand.
|
|
·
|
On
July 1, 2008, we sold two rehabilitation hospitals in California for
approximately $29 million resulting in a gain of approximately $12.3
million.
|
|
·
|
On
September 29, 2008, we sold one SNF in Texas for approximately $0.1
million resulting in a loss of approximately $0.5
million.
|
Held
for Sale
During the three months ended September
30, 2008, a $0.2 million provision for impairment charge was recorded to reduce
the carrying value of our held-for-sale facility to its estimated fair
value. At September 30, 2008, we had one SNF classified as
held-for-sale with a net book value of approximately $0.2 million.
Mortgage
Notes Receivable
On April 18, 2008, and simultaneous
with the amendment and extension of the master lease with CommuniCare Health
Services (“CommuniCare”), we entered into a first mortgage loan with CommuniCare
(“CommuniCare Loan”) in the amount of $74.9 million. This mortgage
loan matures on April 30, 2018 and carries an interest rate of 11% per year.
CommuniCare used the proceeds of the mortgage loan to acquire seven (7) SNFs
located in Maryland, totaling 965 beds from several unrelated third
parties. The CommuniCare Loan is secured by a lien on the seven (7)
facilities. At the closing, $4.9 million of CommuniCare Loan proceeds
were escrowed pending CommuniCare’s acquisition of an additional 90 bed SNF,
also located in Maryland. The proceeds held in escrow are included in
Other assets as of September 30, 2008. We anticipate that CommuniCare
will acquire this facility within eight months upon the satisfaction of certain
contingencies, including the granting of a lien on such facility to secure the
mortgage loan. If the additional facility is not acquired,
CommuniCare will be obligated to re-pay the $4.9 million of escrowed
proceeds.
Mortgage notes receivable relate to 16
long-term care facilities. The mortgage notes are secured by first
mortgage liens on the borrowers' underlying real estate and personal
property. The mortgage notes receivable relate to facilities located
in five (5) states, operated by five (5) independent healthcare operating
companies. We monitor compliance with mortgages and when necessary
have initiated collection, foreclosure and other proceedings with respect to
certain outstanding loans. As of September 30, 2008, we had no
foreclosed property, and none of our mortgages were in foreclosure
proceedings. The mortgage properties are cross-collateralized with
the master lease agreement.
Mortgage interest income is recognized
as earned over the terms of the related mortgage notes. Allowances
are provided against earned revenues from mortgage interest when collection of
amounts due becomes questionable or when negotiations for restructurings of
troubled operators lead to lower expectations regarding ultimate
collection. When collection is uncertain, mortgage interest income on
impaired mortgage loans is recognized as received after taking into account
application of security deposits.
NOTE 3 – OWNED AND OPERATED
ASSETS
At September 30, 2008, we own and are
operating two facilities with a total of 279 beds that were previously recovered
from a bankrupt operator/tenant.
Since November 2007, affiliates of
Haven, one of our operators/lessees/mortgagors were operated under Chapter 11
bankruptcy protection. Commencing in February 2008, the assets of the
Haven Properties were marketed for sale via an auction process to be conducted
through proceedings established by the bankruptcy court. The auction
process failed to produce a qualified buyer. As a result, and
pursuant to our rights as ordered by the bankruptcy court, Haven moved the
bankruptcy court to authorize us to credit bid certain of the indebtedness that
it owed to us in exchange for taking ownership of and transitioning certain of
its assets to a new entity in which we have a substantial ownership interest,
all of which was approved by the bankruptcy court on July 4,
2008. Effective as of July 7, 2008, we took ownership and/or
possession of 15 facilities previously operated by Haven and a new entity in
which we have a substantial economic ownership interest began operating these
facilities on our behalf through an independent contractor. In 2007,
the Haven Properties represented approximately 8% of our operating
revenue. As of September 30, 2008, our investment in Land and
buildings for the Haven Properties was approximately $103.7
million.
In January 2008, Haven entered into a
debtors-in-possession (“DIP”) financing agreement with us and one other
financial institution (collectively, the “DIP Lenders”), in which our initial
participation was approximately $5.0 million of a $50 million total
commitment. The agreement was originally scheduled to mature in June
2008 and yield an interest rate of prime plus 3%. On June 4, 2008,
the DIP Lenders and Haven amended the DIP agreement (the “Amended DIP”) which,
among other things, extended the term to allow Haven additional time to sell its
assets. As collateral for the Amended DIP, we received the right to
use all facility accounts receivable generated from the Omega facilities from
June 4, 2008 to satisfy any of our post-June 3, 2008 advances. As of
September 30, 2008, we had $0.2 million outstanding on the original DIP
agreement and $7.3 million outstanding related to the Amended DIP.
On August 6, 2008, we entered into a
Master Transaction Agreement (“MTA”) with affiliates of Formation Capital
(“Formation”) whereby Formation agreed (subject to certain closing conditions,
including the receipt of licensure) to lease 14 SNFs and one ALF facility under
a master lease. These facilities were formerly leased to
Haven.
On September 8, 2008, we completed the
operational transfer, effective September 1, 2008 of 12 SNFs and one ALF to
affiliates of Formation, in accordance with the terms of the MTA. The
13 facilities are located in Connecticut (5), Rhode Island (4), New Hampshire
(3) and Massachusetts (1). As part of the transaction, Genesis
Healthcare (“Genesis”) has entered into a long-term management agreement with
Formation to oversee the day-to-day operations of each of these facilities. Two
remaining facilities in Vermont will transfer upon the appropriate regulatory
approvals expected sometime in the near future. These facilities and
their respective operations are presented on a consolidated basis in our
financial statements.
Nursing home revenues, nursing home
expenses, assets and liabilities included in our unaudited consolidated
financial statements that relate to such owned and operated assets are set forth
in the tables below.
|
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
(In
thousands)
|
|
|
Nursing
home revenues (1) (2)
|
|
$ |
19,341 |
|
|
$ |
— |
|
|
$ |
19,341 |
|
|
$ |
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nursing
home expenses (2) (3)
|
|
|
20,833 |
|
|
|
— |
|
|
|
20,833 |
|
|
|
— |
|
|
Income
form nursing home operations
|
|
$ |
(1,492 |
) |
|
$ |
— |
|
|
$ |
(1,492 |
) |
|
$ |
— |
|
|
(1)
|
Nursing
home revenues from these owned and operated assets are recognized as
services are provided.
|
|
(2)
|
Nursing
revenues and expenses includes revenue and expense for 15 facilities for
the period July 7, 2008 through August 31, 2008 and two facilities from
September 1, 2008 through September 30, 2008. Nursing home
revenue for the two facilities that have not transferred to Formation
Capital in September was approximately $1.3
million.
|
|
(3)
|
Includes
$0.7 million related to employee
severance.
|
Accounts receivable from owned and
operated assets consist of amounts due from Medicare and Medicaid programs,
other government programs, managed care health plans, commercial insurance
companies and individual patients. Amounts recorded include estimated provisions
for loss related to uncollectible accounts and disputed items.
The assets and liabilities in our
unaudited consolidated financial statements which relate to our owned and
operated assets are as follows:
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
(In
thousands)
|
|
|
ASSETS
|
|
|
|
|
|
|
|
Accounts
receivable—net
|
|
$ |
13,565 |
|
|
$ |
— |
|
|
Other
current assets
|
|
|
3,381 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
Total current
assets
|
|
|
16,946 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land
and buildings
|
|
|
155 |
|
|
|
— |
|
|
Less
accumulated depreciation
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
Land
and buildings—net
|
|
|
155 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
Operating
assets for owned properties
|
|
$ |
17,101 |
|
|
$ |
— |
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
|
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
|
3,798 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
Operating
liabilities for owned properties
|
|
$ |
3,798 |
|
|
$ |
— |
|
NOTE
4 – CONCENTRATION OF RISK
As of September 30, 2008, our portfolio
of investments consisted of 255 healthcare facilities, located in 29 states and
operated by 27 third-party operators. Our gross investment in these
facilities, net of impairments and before reserve for uncollectible loans,
totaled approximately $1.5 billion at September 30, 2008, with approximately 99%
of our real estate investments related to long-term care
facilities. This portfolio is made up of 225 SNFs, seven ALFs, two
rehabilitation hospitals, two ILFs, fixed rate mortgages on 16 SNFs, two SNFs
that are owned and operated and one SNF that is currently held for
sale. At September 30, 2008, we also held miscellaneous investments
of approximately $23 million, consisting primarily of secured loans to
third-party operators of our facilities.
At September 30, 2008, approximately
24% of our real estate investments were operated by two public companies: Sun
Healthcare Group (“Sun”) (14%) and Advocat Inc. (“Advocat”)
(10%). Our largest private company operators (by investment) were
CommuniCare (22%), Signature Holding II, LLC (10%). No other operator
represents more than 9% of our investments. The three states in which
we had our highest concentration of investments were Ohio (23%), Florida (12%)
and Pennsylvania (10%) at September 30, 2008.
For the three-month period ended
September 30, 2008, our revenues from operations totaled $60.0 million, of which
approximately $19.3 million were from owned and operated assets (32%), $8.9
million were from CommuniCare (15%), $7.7 million from Sun (13%) and $5.2
million from Advocat (9%). No other operator generated more than 9%
of our revenues from operations for the three-month period ended September 30,
2008.
For the nine-month period ended
September 30, 2008, our revenues from operations totaled $144.6 million, of
which approximately $24.0 million were from Sun (17%), $22.7 million from
CommuniCare (16%), $19.3 million from owned and operated assets (13%) and $15.4
million from Advocat (11%). No other operator generated more than 9%
of our revenues from operations for the nine- month period ended September 30,
2008.
Sun and Advocat are subject to the reporting
requirements of the Securities Exchange Commission (“SEC”) and are required to
file with the SEC annual reports containing audited financial information and
quarterly reports containing unaudited interim financial
information. Sun and Advocat’s filings with the SEC can be found at
the SEC’s website at www.sec.gov. We are providing this data for
information purposes only, and you are encouraged to obtain Sun’s and Advocat’s
publicly available filings from the SEC.
NOTE
5 –DIVIDENDS
Common
Dividends
On October 16, 2008, the Board of
Directors declared a common stock dividend of $0.30 per share to be paid
November 17, 2008 to common stockholders of record on October 31,
2008.
On July 16, 2008, the Board of
Directors declared a common stock dividend of $0.30 per share. The
common dividend was paid August 15, 2008 to common stockholders of record on
July 31, 2008.
On April 16, 2008, the Board of
Directors declared a common stock dividend of $0.30 per share, an increase of
$0.01 per common share compared to the prior quarter. The common
dividend was paid May 15, 2008 to common stockholders of record on April 30,
2008.
On January 17, 2008, the Board of
Directors declared a common stock dividend of $0.29 per share, an increase of
$0.01 per common share compared to the prior quarter. The common
dividend was paid February 15, 2008 to common stockholders of record on January
31, 2008.
Series
D Preferred Dividends
On October 16, 2008, the Board of
Directors declared the regular quarterly dividends for the 8.375% Series D
Cumulative Redeemable Preferred Stock (“Series D Preferred Stock”) to
stockholders of record on October 31, 2008. The stockholders of
record of the Series D Preferred Stock on October 31, 2008 will be paid
dividends in the amount of $0.52344 per preferred share on November 17,
2008. The liquidation preference for our Series D Preferred Stock is
$25.00 per share. Regular quarterly preferred dividends for the Series D
Preferred Stock represent dividends for the period August 1, 2008 through
October 31, 2008.
On July 16, 2008, the Board of
Directors declared regular quarterly dividends of approximately $0.52344 per
preferred share on the Series D Preferred Stock that were paid August 15, 2008
to preferred stockholders of record on July 31, 2008.
On April 16, 2008, the Board of
Directors declared regular quarterly dividends of approximately $0.52344 per
preferred share on the Series D Preferred Stock that were paid May 15, 2008 to
preferred stockholders of record on April 30, 2008.
On January 17, 2008, the Board of
Directors declared regular quarterly dividends of approximately $0.52344 per
preferred share on the Series D Preferred Stock that were paid February 15, 2008
to preferred stockholders of record on January 31, 2008.
NOTE
6 – TAXES
So long as we qualify as a real estate
investment trust (“REIT”) under the Internal Revenue Code (the “Code”), we
generally will not be subject to federal income taxes on the REIT taxable income
that we distribute to stockholders, subject to certain exceptions. On
a quarterly and annual basis we test our compliance within the REIT taxation
rules to ensure that we were in compliance with the rules.
Subject to the limitation under the
REIT asset test rules, we are permitted to own up to 100% of the stock of one or
more taxable REIT subsidiary (“TRSs”). Currently, we have one TRS
that is taxable as a corporation and that pays federal, state and local income
tax on its net income at the applicable corporate rates. The TRS had
a net operating loss carry-forward as of September 30, 2008 of $1.1
million. The loss carry-forward was fully reserved with a valuation
allowance due to uncertainties regarding realization.
NOTE
7 – STOCK-BASED COMPENSATION
The following is a summary of our stock
based compensation expense for the three- and nine- month periods ended
September 30, 2008 and 2007, respectively:
|
|
|
Three
Months Ended September 30,
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
based compensation cost
|
|
$ |
526 |
|
|
$ |
545 |
|
|
$ |
1,577 |
|
|
$ |
880 |
|
2007
Stock Awards
In May 2007, we granted 286,908 shares
of restricted stock and 247,992 performance restricted stock units (“PRSU”) to
five executive officers under the 2004 Plan Stock Incentive Plan.
Restricted
Stock Award
The
restricted stock award vests one-seventh on December 31, 2007 and two-sevenths
on December 31, 2008, December 31, 2009, and December 31, 2010, respectively,
subject to continued employment on the vesting date (as defined in the
agreements filed with the SEC on May 8, 2007). As of September 30,
2008, 40,987 shares of restricted stock have vested under the restricted stock
award.
Performance
Restricted Stock Units
We awarded two types of PRSUs (annual
and cliff vesting awards) to the five executives. One half of the
PRSU awards vest annually in equal increments on December 31, 2008, December 31,
2009, and December 31, 2010, respectively. The other half of the PRSU
awards cliff vest on December 31, 2010. Vesting on both types of
awards requires achievement of total stockholder return (as defined in the
agreements filed with the SEC on May 8, 2007).
The following table summarizes our
total unrecognized compensation cost associated with the restricted stock awards
and PRSUs awarded in May 2007 as of September 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares/
Units
|
|
|
Grant
Date Fair Value Per Unit/ Share
|
|
|
Total
Compensation Cost
|
|
|
Weighted
Average Period of Expense Recognition (in months)
|
|
|
Unrecognized
Compensation Cost
|
|
|
|
|
(in
thousands, except share and per share amounts)
|
|
|
Restricted
stock
|
|
|
286,908 |
|
|
$ |
17.06 |
|
|
$ |
4,895 |
|
|
|
44 |
|
|
$ |
3,004 |
|
|
2008
Annual performance restricted stock units
|
|
|
41,332 |
|
|
|
8.78 |
|
|
|
363 |
|
|
|
20 |
|
|
|
55 |
|
|
2009
Annual performance restricted stock units
|
|
|
41,332 |
|
|
|
8.25 |
|
|
|
341 |
|
|
|
32 |
|
|
|
160 |
|
|
2010
Annual performance restricted stock units
|
|
|
41,332 |
|
|
|
8.14 |
|
|
|
336 |
|
|
|
44 |
|
|
|
206 |
|
|
3
year cliff vest performance restricted stock units
|
|
|
123,996 |
|
|
|
6.17 |
|
|
|
765 |
|
|
|
44 |
|
|
|
469 |
|
|
Total
|
|
|
534,900 |
|
|
|
|
|
|
$ |
6,700 |
|
|
|
|
|
|
$ |
3,894 |
|
As of September 30, 2008, we had 27,664
stock options and 16,495 shares of restricted stock outstanding to
directors. The stock options were fully vested as of January 1, 2007
and the restricted shares are scheduled to vest over the next three
years. As of September 30, 2008, the unrecognized compensation cost
associated with the directors’ restricted stock is $0.2 million.
NOTE
8 – FINANCING ACTIVITIES AND BORROWING ARRANGEMENTS
Bank
Credit Agreements
At September 30, 2008, we had $34.0
million outstanding under our $255 million revolving senior secured credit
facility (the “Credit Facility”) and $2.1 million was utilized for the issuance
of letters of credit, leaving availability of $218.9 million. The
$34.0 million of outstanding borrowings had a blended interest rate of 4.74% at
September 30, 2008. The revolving senior credit facility matures in
March 2010.
Pursuant to Section 2.01 of the Credit
Agreement, dated as of March 31, 2006 (the “Credit Agreement”), that governs our
Credit Facility, we were permitted under certain circumstances to increase our
available borrowing base under the Credit Agreement from $200 million up to an
aggregate of $300 million. Effective February 22, 2007, we exercised
our right to increase the available revolving commitment under Section 2.01 of
the Credit Agreement from $200 million to $255 million and we consented to add
additional properties to the borrowing base assets under the Credit
Agreement.
Our long-term borrowings require us to
meet certain property level financial covenants and corporate financial
covenants, including prescribed leverage, fixed charge coverage, minimum net
worth, limitations on additional indebtedness and limitations on dividend
payouts. As of September 30, 2008, we were in compliance with all
property level and corporate financial covenants.
Other
Long-Term Borrowings
In January 2008, we purchased from
General Electric Capital Corporation (“GE Capital”) a $39.0 million mortgage
loan due October 2012 on seven facilities then operated by
Haven. Prior to the acquisition of this mortgage, we had a $22.8
million second mortgage on these facilities, resulting in a combined $61.8
million mortgage on these facilities immediately following the purchase from GE
Capital. In conjunction with the above noted mortgage and purchase
option and the application of FIN 46R, we consolidated the financial statements
and real estate of the Haven entity that was the obligor under this mortgage
loan into our financial statements. On July 7, 2008, we took
ownership and/or possession of the Haven Properties and a new entity assumed
operations of the facilities. As a result of our taking ownership
and/or possession of the Haven facilities, pursuant to FIN 46R, effective July
7, 2008, we were no longer required to consolidate the Haven entity that was
obligated under the mortgage loan into our financial
statements. However, pursuant to FIN 46R and effective July 7, 2008,
we are required to consolidate the financial position and results of operations
of the new entity which assumed the operations of these facilities on our
behalf. Effective September 1, 2008, the new entity that we
consolidate pursuant to FIN 46R transferred the operations of 13 of the 15
facilities to Formation. Therefore, beginning on September 1, 2008,
the entity that we consolidate pursuant to FIN 46R includes only the financial
results of the two remaining facilities that are currently pending state
approval prior to the transfer of these facilities. Our consolidation
of the Haven entity obligated under the mortgage loan resulted in the following
adjustments to our consolidated balance sheet as of December 31, 2007: (i) an
increase in total gross investments of $39.0 million; (ii) an increase in
accumulated depreciation of $3.1 million; (iii) an increase in Accounts
receivable – net of $0.4 million; (iv) an increase in Other long-term borrowings
of $39.0 million; and (v) a reduction of $2.7 million in Cumulative net earnings
primarily due to increased depreciation expense. Our results of
operation reflect the impact of the consolidation of this Haven entity for the
three- and nine- month periods ended September 30, 2008 and 2007,
respectively.
6.0
Million Share Common Stock Offering
On September 19, 2008, we closed an
underwritten public offering of 6.0 million shares our common stock at $16.37
per share. The net proceeds, after deducting underwriting discounts
and offering expenses, were approximately $97 million. UBS Investment Bank was
the sole book-running manager, and Stifel Nicolaus & Company, Incorporated
was the co-manager for the offering. The net proceeds were used to
repay indebtedness under our senior credit facility and for working capital and
general corporate purposes.
5.9
Million Share Common Stock Offering
On May 6, 2008, we issued 5.9 million
shares of our common stock in a registered direct placement to a number of
institutional investors. The net proceeds from the offering were
approximately $98.8 million, after deducting the placement agent’s fee and other
estimated offering expense. Cohen & Steers Capital Advisors, LLC
acted as Placement Agent for the offering. The net proceeds were used
to repay indebtedness under our senior credit facility.
Dividend
Reinvestment and Common Stock Purchase Plan
We have a Dividend Reinvestment and
Common Stock Purchase Plan (the “DRSPP”) that allows for the reinvestment of
dividends and the optional purchase of our common stock. At September
30, 2008, we offered shares under the Plan at a 1% discount to
market. For the nine month period ended September 30, 2008, we issued
1,828,504 shares of common stock for approximately $30.5 million in net
proceeds. See
Note 12 – Subsequent Events.
NOTE
9 – LITIGATION
We are subject to various legal
proceedings, claims and other actions arising out of the normal course of
business. While any legal proceeding or claim has an element of uncertainty,
management believes that the outcome of each lawsuit, claim or legal proceeding
that is pending or threatened, or all of them combined, will not have a material
adverse effect on our consolidated financial position or results of
operations.
NOTE
10 – DISCONTINUED OPERATIONS
Statement of Financial Accounting
Standards (“SFAS”) No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, requires the presentation of the net
operating results of facilities classified as discontinued operations for all
periods presented.
The following table summarizes the
results of operations of facilities sold or held-for-sale during the three- and
nine- month periods ended September 30, 2008 and 2007,
respectively.
|
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
(in
thousands)
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental income
|
|
$ |
— |
|
|
$ |
45 |
|
|
$ |
15 |
|
|
$ |
167 |
|
|
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and
amortization
|
|
|
— |
|
|
|
7 |
|
|
|
— |
|
|
|
28 |
|
|
General and
administrative
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
3 |
|
|
Subtotal
expenses
|
|
|
— |
|
|
|
7 |
|
|
|
— |
|
|
|
31 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before gain on sale of assets
|
|
|
— |
|
|
|
38 |
|
|
|
15 |
|
|
|
136 |
|
|
(Loss)
gain on assets sold – net
|
|
|
— |
|
|
|
(1 |
) |
|
|
431 |
|
|
|
1,595 |
|
|
Discontinued
operations
|
|
$ |
— |
|
|
$ |
37 |
|
|
$ |
446 |
|
|
$ |
1,731 |
|
During the third quarter of 2008, no
revenue or expense was generated from discontinued operations. The
third quarter 2007 discontinued operations revenue and expense includes revenue
and expense from one SNF sold during the first quarter of 2008.
For the nine months ended September
30, 2008, discontinued operations includes revenue of $15 thousand for one SNF
located in California that was sold during the first quarter of 2008, generating
a gain of $0.4 million. For the nine months ended September 30, 2007,
discontinued operations include revenue and expense from three facilities that
have been sold, including revenue from the SNF sold during the first quarter of
2008. In 2007, we recorded a gain of $1.6 million for the sale of six
facilities.
NOTE
11 – EARNINGS PER SHARE
We calculate basic and diluted earnings
per common share (“EPS”) in accordance with FAS No. 128, Earnings Per
Share. The computation of basic EPS is computed by dividing
net income available to common stockholders by the weighted-average number of
shares of common stock outstanding during the relevant
period. Diluted EPS is computed using the treasury stock method,
which is net income divided by the total weighted-average number of common
outstanding shares plus the effect of dilutive common equivalent shares during
the respective period. Dilutive common shares reflect the assumed
issuance of additional common shares pursuant to certain of our share-based
compensation plans, including stock options, restricted stock and performance
restricted stock units.
The following tables set forth the
computation of basic and diluted earnings per share:
|
|
|
Three
Months Ended September 30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
(in
thousands, except per share amounts)
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing
operations
|
|
$ |
28,072 |
|
|
$ |
15,312 |
|
|
$ |
61,982 |
|
|
$ |
50,327 |
|
|
Preferred stock
dividends
|
|
|
(2,480 |
) |
|
|
(2,480 |
) |
|
|
(7,442 |
) |
|
|
(7,442 |
) |
|
Numerator for income available
to common from continuing operations – basis and diluted
|
|
|
25,592 |
|
|
|
12,832 |
|
|
|
54,540 |
|
|
|
42,885 |
|
|
Discontinued
operations
|
|
|
— |
|
|
|
37 |
|
|
|
446 |
|
|
|
1,731 |
|
|
Numerator for net income
available to common per share – basic and diluted
|
|
$ |
25,592 |
|
|
$ |
12,869 |
|
|
$ |
54,986 |
|
|
$ |
44,616 |
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings
per share
|
|
|
76,590 |
|
|
|
67,952 |
|
|
|
72,737 |
|
|
|
65,094 |
|
|
Effect of dilutive
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted
stock
|
|
|
100 |
|
|
|
— |
|
|
|
80 |
|
|
|
3 |
|
|
Stock option incremental
shares
|
|
|
12 |
|
|
|
13 |
|
|
|
12 |
|
|
|
17 |
|
|
Denominator for diluted
earnings per share
|
|
|
76,702 |
|
|
|
67,965 |
|
|
|
72,829 |
|
|
|
65,114 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share – basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income available to common from
continuing operations
|
|
$ |
0.33 |
|
|
$ |
0.19 |
|
|
$ |
0.75 |
|
|
$ |
0.66 |
|
|
Discontinued
operations
|
|
|
— |
|
|
|
— |
|
|
|
0.01 |
|
|
|
0.03 |
|
|
Net income –
basic
|
|
$ |
0.33 |
|
|
$ |
0.19 |
|
|
$ |
0.76 |
|
|
$ |
0.69 |
|
|
Earnings
per share – diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income available to common from
continuing operations
|
|
$ |
0.33 |
|
|
$ |
0.19 |
|
|
$ |
0.75 |
|
|
$ |
0.66 |
|
|
Discontinued
operations
|
|
|
— |
|
|
|
— |
|
|
|
0.01 |
|
|
|
0.03 |
|
|
Net income –
diluted
|
|
$ |
0.33 |
|
|
$ |
0.19 |
|
|
$ |
0.76 |
|
|
$ |
0.69 |
|
NOTE
12 – SUBSEQUENT EVENT
Suspension
of Optional Cash Purchases
On October 29, 2008, we announced the
immediate suspension of the optional cash purchase component of our Dividend
Reinvestment and Common Stock Purchase Plan until further
notice. Dividend reinvestment and all other features of the Plan will
continue as set forth in the Plan, including sales, transfers and certificate
issuances of stock held in participant accounts.
Stockholders participating in the Plan
who have elected to reinvest dividends will continue to have cash dividends
reinvested in accordance with the Plan. Any checks or other funds
received by Computershare Trust Company, N.A. from Plan participants on, or
after October 15, 2008, for optional cash investments will be returned without
interest.
Purchase
of 400,000 shares of Series D Preferred Stock
On October 16, 2008, we purchased
400,000 shares of our Series D Preferred Stock (NYSE:OHI PrD) at a price of
$18.90 per share. The liquidation preference for the Series D
Preferred Stock (“Series D”) is $25.00 per share. Under FASB-EITF
Issue D-42, The Effect on the
Calculation of Earnings per Share for the Redemption or Induced Conversion of
Preferred Stock, the purchase of the Series D Preferred Stock shares will
result in a fourth quarter 2008 gain of approximately $2.4
million. The gain will be net of a non-cash charge to net income
available to common shareholders of approximately $0.3 million reflecting the
write-off of the pro-rata portion of the original issuance costs of the Series D
Preferred Stock.
Forward-looking
Statements, and Other Factors Affecting Future Results
The following discussion should be read
in conjunction with the financial statements and notes thereto appearing
elsewhere in this document. This document contains forward-looking
statements within the meaning of the federal securities laws, including
statements regarding potential financings and potential future changes in
reimbursement. These statements relate to our expectations, beliefs,
intentions, plans, objectives, goals, strategies, future events, performance and
underlying assumptions and other statements other than statements of historical
facts. In some cases, you can identify forward-looking statements by
the use of forward-looking terminology including, but not limited to, terms such
as “may,” “will,” “anticipates,” “expects,” “believes,” “intends,” “should” or
comparable terms or the negative thereof. These statements are based
on information available on the date of this filing and only speak as to the
date hereof and no obligation to update such forward-looking statements should
be assumed. Our actual results may differ materially from those
reflected in the forward-looking statements contained herein as a result of a
variety of factors, including, among other things:
|
(i)
|
those
items discussed under “Risk Factors” in Item 1A to our annual report on
Form 10-K for the year ended December 31, 2007 and in Part II, Item 1A of
this report;
|
|
(ii)
|
uncertainties
relating to the business operations of the operators of our assets,
including those relating to reimbursement by third party payors,
regulatory matters and occupancy
levels;
|
|
(iii)
|
the
ability of any operators in bankruptcy to reject unexpired lease
obligations, modify the terms of our mortgages and impede our ability to
collect unpaid rent or interest during the process of a bankruptcy
proceeding and retain security deposits for the debtors’
obligations;
|
|
(iv)
|
our
ability to sell closed or foreclosed assets on a timely basis and on terms
that allow us to realize the carrying value of these
assets;
|
|
(v)
|
our
ability to negotiate appropriate modifications to the terms of our credit
facility;
|
|
(vi)
|
our
ability to manage, re-lease or sell any owned and operated
facilities;
|
|
(vii)
|
the
availability and cost of capital;
|
|
(viii)
|
our
ability to maintain our credit
ratings;
|
|
(ix)
|
competition
in the financing of healthcare
facilities;
|
|
(x)
|
regulatory
and other changes in the healthcare
sector;
|
|
(xi)
|
the
effect of economic and market conditions generally and, particularly, in
the healthcare industry;
|
|
(xii)
|
changes
in the financial position of our
operators;
|
|
(xiii)
|
changes
in interest rates;
|
|
(xiv)
|
the
amount and yield of any additional
investments;
|
|
(xv)
|
changes
in tax laws and regulations affecting real estate investment
trusts;
|
|
(xvi)
|
our
ability to maintain our status as a real estate investment
trust;
|
|
(xvii)
|
changes
in our credit ratings and the ratings of our debt and preferred
securities;
|
|
(xviii)
|
the
potential impact of a general economic slowdown on governmental budgets
and healthcare reimbursement expenditures;
and
|
|
(xix)
|
the
effect of the recent financial crisis and severe tightening in the global
credit markets.
|
Overview
We have one reportable segment
consisting of investments in healthcare related real estate
properties. Our core business is to provide financing and capital to
the long-term healthcare industry with a particular focus on skilled nursing
facilities located in the United States. Our core portfolio consists
of long-term leases and mortgage agreements. All of our leases are
“triple-net” leases, which require the tenants to pay all property-related
expenses. Our mortgage revenue derives from fixed-rate mortgage
loans, which are secured by first mortgage liens on the underlying real estate
and personal property of the mortgagor. In July 2008, we assumed
operating responsibilities for 15 of our facilities due to the bankruptcy of one
of our operator/tenants. In September, we entered into an agreement
to lease these facilities to a new operator/tenant. The new
operator/tenant assumed operating responsibility for 13 of the 15 facilities
effective September 1, 2008. We are in the process of addressing
state regulatory requirements necessary to transfer the final two properties to
the new operator/tenant.
Our
consolidated financial statements include the accounts of Omega, all direct and
indirect wholly owned subsidiaries as well as TC Healthcare, a company created
to operate the 15 facilities we assumed as a result of the bankruptcy of one our
tenant/operators. We have included the operating results and assets
and liabilities of these facilities for the period of time that we were
responsible for the operations of the facilities. Thirteen of these
facilities were transitioned to a new tenant/operator on September 1, 2008,
however, we continue to be responsible for two facilities as of September 30,
2008 that are in the process of being transitioned to the new
operator/tenant. Due to the size of the owned and operated portfolio,
the operating revenues and expenses and related operating assets and liabilities
of the owned and operated facilities are shown on a net basis in our
Consolidated Statements of Operations and Consolidated Balance Sheets,
respectively. All inter-company accounts and transactions have been
eliminated in consolidation of the financial statements.
Our
portfolio of investments at September 30, 2008, consisted of 255 healthcare
facilities, located in 29 states and operated by 27 third-party
operators. Our gross investment in these facilities totaled
approximately $1.5 billion at September 30, 2008, with 99% of our real estate
investments related to long-term healthcare facilities. This
portfolio is made up of (i) 225 skilled nursing facilities (“SNFs’), (ii) seven
assisted living facilities (“ALFs”), (iii) two rehabilitation hospitals owned
and leased to third parties, (iii) two independent living facilities (“ILFs”),
(iv) fixed rate mortgages on 16 skilled nursing facilities(“SNFs”), (v) two
skilled nursing facilities (“SNFs”) that are owned and operated and (vi) one
skilled nursing facility (“SNF”) that is currently held for sale. At
September 30, 2008, we also held other investments of approximately $23 million,
consisting primarily of secured loans to third-party operators of our
facilities.
Taxation
We have elected to be taxed as a REIT,
under Sections 856 through 860 of the Code, beginning with our taxable year
ended December 31, 1992. We believe that we have been organized and
operated in such a manner as to qualify for taxation as a REIT. We intend to
continue to operate in a manner that will maintain our qualification as a REIT,
but no assurance can be given that we have operated or will be able to continue
to operate in a manner so as to qualify or remain qualified as a
REIT. Under the Code, we generally are not subject to federal income
tax on taxable income distributed to stockholders if certain distribution,
income, asset and stockholder tests are met, including a requirement that we
must generally distribute at least 90% of our annual taxable income, excluding
any net capital gain, to stockholders. If we fail to qualify as a
REIT in any taxable year, we may be subject to federal income taxes on our
taxable income for that year and for the four years following the year during
which qualification is lost, unless the Internal Revenue Service grants us
relief under certain statutory provisions. Such an event could materially
adversely affect our net income and net cash available for distribution to our
stockholders. See also “Taxation of Foreclosure Property”
below.
Recent
Developments Regarding Government Regulation and Reimbursement
In 2007
and early 2008, the Center for Medicare and Medicaid Services (“CMS”) issued a
number of Medicaid rules that could have adverse impacts on the overall funds
available for state Medicaid programs to reimburse long-term care
providers. On June 30, 2008 the Supplemental Appropriations Act, 2008
(H.R. 2642) was signed into law delaying the implementation of a number of these
rules until April 1, 2009. The Medicaid rules that were delayed until
April 1, 2009 by the legislation involve the following
issues: intergovernmental transfers; coverage of rehabilitation
services for people with disabilities; outreach and enrollment funded by
Medicaid in schools; specialized transportation to schools for children covered
by Medicaid; graduate medical education payments; targeted case management
services and some provisions relating to state provider tax
limits. If some or all of these delayed regulations go into effect in
the future, the operators of our properties could potentially experience
reductions in Medicaid funding.
The
Supplemental Appropriations Act did not delay other recent Medicaid rules that
could have adverse impacts on the overall funds available for Medicaid programs
to reimburse long-term care providers. Congress permitted Medicaid
rules to go into effect relating to outpatient hospital services, appeals filed
through the Department of Health and Human Services and some provisions relating
to state provider tax limits. As a result of such Medicaid
regulations, the operators of our properties could potentially experience
reductions in Medicaid funding, which could adversely impact their ability to
meet their obligations to us. For example, CMS issued a Final Rule on February
22, 2008 that became effective on April 22, 2008 that reduced the maximum
allowable health care-related taxes that states can impose on providers from 6
percent to 5.5 percent. The Final Rule could result in less taxes for
providers but also less funding in states’ Medicaid systems since it limits
states' ability to fund the non-federal share of their Medicaid
programs.
On August
8 2008, CMS published a Final Rule on Medicare’s prospective payment system for
skilled nursing facilities for fiscal year 2009, which CMS estimates will
increase aggregate Medicare payments to skilled nursing facilities by $780
million. CMS notes that the increase in payments is due to an
increase in the market basket adjustment factor of 3.4 percent.
The
Medicare Improvements for Patients and Providers Act of 2008 (MIPPA) became law
on July 15, 2008 and makes a variety of changes to Medicare, some of which may
impact skilled nursing facilities. For instance, MIPPA extended the therapy caps
exceptions process through December 31, 2009. The therapy caps limit
the physical therapy, speech-language therapy and occupational therapy services
that a Medicare beneficiary can receive during a calendar year. These
caps do not apply to therapy services covered under Medicare Part A in a skilled
nursing facility, although the caps apply in most other instances involving
patients in skilled nursing facilities or long-term care facilities who receive
therapy services covered under Medicare Part B. Congress implemented
a temporary therapy caps exceptions process, which permits medically necessary
therapy services to exceed payment limits. MIPPA retroactively
extended the therapy caps exceptions process through December 31,
2009. Expiration of the therapy caps exceptions process in the future
could have a material adverse effect on our operators’ financial condition and
operations, which could adversely impact their ability to meet their obligations
to us.
CMS also
has been involved with a number of initiatives aimed at the quality of care
provided by nursing homes, which may impact our operators. For
instance, in February 2008, CMS made publicly available on its website the names
of all 136 nursing homes targeted in its Special Focus Facility program for
underperforming nursing homes. CMS plans on updating the list
regularly. In the event any of our operators do not maintain the same
or superior levels of quality care as their competitors, patients could choose
alternate facilities, which could adversely impact our operators’
revenues. In addition, the reporting of such information could lead
to future reimbursement policies that reward or penalize facilities on the basis
of the reported quality of care parameters.
The
Office of Inspector General (OIG) of the Department of Health and Human Services
has also carried out a number of projects focused on the quality of care
provided by nursing homes. For example, in September 2008, OIG
released a report based on an analysis of data from CMS' Online Survey and
Certification Reporting System (OSCAR), which contains the results of all State
nursing home surveys. The report notes that over 91 percent of
nursing homes surveyed were cited for deficiencies and complaints between 2005
and 2007. The most common deficiencies cited were quality of care,
resident assessment and quality of life. A greater percentage of
for-profit nursing homes were cited than not-for-profit and government nursing
homes.
The
downturn in the U.S. economy has negatively affected state budgets, which puts
pressure on states to decrease costs under their state Medicaid
programs. The need to control Medicaid expenditures may be
exacerbated by the potential for increased enrollment in Medicaid due to
unemployment and declines in family incomes. The states with the most
significant projected budget deficits where the Company owns facilities are
Alabama, Arizona, California, Florida, New Hampshire and Rhode
island. We expect proposals to decrease Medicaid reimbursement rates
to prior year levels, in these and other states. These potential
reductions could be compounded by the potential for federal cost-cutting efforts
that could lead to reductions in reimbursement to our operators under the
Medicare program. Medicare and Medicaid reimbursement reductions
would reduce the cash flow of our operators and their ability to make rent or
mortgage payments to us. Since the profit margins on Medicaid
patients is generally relatively low, more than modest reductions in Medicaid
reimbursement could place some operators in financial distress, which in turn
could adversely affect us. We currently believe our operator coverage
ratios are strong and that our operators can absorb reasonable reimbursement
rate reductions and still meet their obligations to us. In some
instances in the past, states have requested and received relief from the
federal government through a temporary increase in the federal matching rates
for the Medicaid program. However, significant reductions in
reimbursement rates paid to our operators under Medicaid and Medicare could
aversely affect the ability of our operators to make rent and mortgage payments
to us, and thereby adversely affect us.
Critical
Accounting Policies and Estimates
Our financial statements are prepared
in accordance with generally accepted accounting principles in the United States
of America (“GAAP”) and a summary of our significant accounting policies is
included in Note 2 – Summary of Significant Accounting Policies to our annual
report on Form 10-K for the year ended December 31, 2007. Our
preparation of the financial statements requires us to make estimates and
assumptions about future events that affect the amounts reported in our
financial statements and accompanying footnotes. Future events and
their effects cannot be determined with absolute
certainty. Therefore, the determination of estimates requires the
exercise of judgment. Actual results inevitably will differ from
those estimates, and such difference may be material to the consolidated
financial statements. We have described our most critical accounting
policies in our 2007 annual report on Form 10-K in Item 7, Management’s
Discussion and Analysis of Financial Condition and Results of
Operations. The following discussion provides additional information
about the effect on the consolidated financial statements of judgments and
estimates related to our policy regarding uncertainty in income
taxes.
Owned and Operated
Assets. When we acquire real estate pursuant to a foreclosure
proceeding, it is designated as "owned and operated assets" and is recorded at
the lower of cost or fair value and is included in real estate properties on our
Consolidated Balance Sheet. See Note 3– Owned and Operated
Assets.
Recent
Accounting Pronouncement:
FAS 157
Evaluation
On January 1, 2008, we adopted
Financial Accounting Standards Board, (“FASB”), Statement No. 157, Fair Value Measurements (“FAS
No. 157”). This standard defines fair value, establishes a
methodology for measuring fair value and expands the required disclosure for
fair value measurements. FAS No. 157 emphasizes that fair value is a
market-based measurement, not an entity-specific measurement, and states that a
fair value measurement should be determined based on the assumptions that market
participants would use in pricing the asset or liability. This
statement applies under other accounting pronouncements that require or permit
fair value measurements, the FASB having previously concluded in those
pronouncements that fair value is the relevant measurement
attribute. Accordingly, this statement does not require any new fair
value measurements. The standard applies prospectively to new fair
value measurements performed after the required effective dates, which are as
follows: (i) on January 1, 2008, the standard applied to our measurements of the
fair values of financial instruments and recurring fair value measurements of
non-financial assets and liabilities; and (ii) on January 1, 2009, the standard
will apply to all remaining fair value measurements, including non-recurring
measurements of non-financial assets and liabilities such as measurement of
potential impairments of goodwill, other intangible assets and other long-lived
assets. It also will apply to fair value measurements of non-financial assets
acquired and liabilities assumed in business combinations. On January 18, 2008,
the FASB issued proposed FASB Staff Position (“FSP”) FAS No. 157-c, Measuring Liabilities under
Statement 157, which will modify the definition of fair value by
requiring estimation of the proceeds that would be received if the entity were
to issue the liability at the measurement date. We evaluated FAS No.
157 and determined that the adoption of the provisions FAS No. 157 effective on
January 1, 2008 had no impact on our financial statements. We are
currently evaluating the impact, if any, that the provisions of FAS No. 157 that
apply on January 1, 2009 will have on our financial statements.
FAS 159
Evaluation
In February 2007, the FASB issued
Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (“SFAS No. 159”). SFAS No.
159 permits entities to choose to measure certain financial assets and
liabilities at fair value, with the change in unrealized gains and losses on
items for which the fair value option has been elected reported in
earnings. We adopted SFAS No. 159 on January 1, 2008. We
evaluated SFAS No. 159 and did not elect the fair value accounting option for
any of our eligible assets; therefore, the adoption of SFAS 159 had no impact on
our financial statements.
FAS 141(R)
Evaluation
On December 4, 2007, the Financial
Accounting Standards Board issued Statement No. 141(R), Business Combinations (“FAS
141(R)”). The new standard will significantly change the accounting
for and reporting of business combination transactions. FAS 141(R)
requires companies to recognize, with certain exception, 100 percent of the fair
value of the assets acquired, liabilities assumed and non-controlling interest
in acquisitions of less than a 100 percent controlling interest when the
acquisition constitutes a change in control; measure acquirer shares issued as
consideration for a business combination at fair value on the date of the
acquisition; recognize contingent consideration arrangements at their
acquisition date fair value, with subsequent change in fair value generally
reflected in earnings; recognition of reacquisition loss and gain contingencies
at their acquisition date fair value; expense as incurred, acquisition related
transaction costs. FAS 141(R) is effective for fiscal years beginning
after December 15, 2008 and early adoption is prohibited. We intend
to adopt the standard on January 1, 2009. We are currently evaluating
the impact, if any, that FAS 141(R) will have on our financial
statements.
Results
of Operations
The following is our discussion of the
consolidated results of operations, financial position and liquidity and capital
resources, which should be read in conjunction with our unaudited consolidated
financial statements and accompanying notes.
Three
Months Ended September 30, 2008 and 2007
Operating
Revenues
Our operating revenues for the three
months ended September 30, 2008 totaled $60.0 million, an increase of $20.8
million over the same period in 2007. The $20.8 million increase
relates primarily to: (i) $19.3 million revenue from owned and operated assets,
(ii) additional rental income as a result of the acquisition of five SNFs in
August 2007 for $39.5 million, one SNF in January 2008 for $5.2 million and
seven SNFs, one ALF and one rehabilitation hospital in April 2008 for
approximately $48 million which were all leased to existing operators, and (iii)
additional mortgage income associated with the mortgage financing of eight new
facilities; partially offset by $2.3 million due to the Haven Eldercare, LLC
(“Haven”) bankruptcy, reduction in rent related to the sale of two
rehabilitation hospitals and reduction in investment income associated with
pay-offs on working capital notes.
Operating
Expenses
Operating expenses for the three
months ended September 30, 2008 totaled $34.0 million, an increase of
approximately $20.5 million over the same period in 2007. The
increase was primarily due to an increase in owned and operated assets of $20.8
million, depreciation expense of $0.9 million; partially offset by a decrease in
provision for impairment of $1.5 million. The increase in
depreciation expenses primarily relates to the acquisitions of five SNFs in
August 2007, one SNF in January 2008 and seven SNFs, one ALF and one
rehabilitation hospital in April 2008.
Other
Income (Expense)
For the three months ended September
30, 2008, total other expenses were $9.8 million, as compared to $10.5 million
for the same period in 2007, a decrease of $0.7 million. The decrease
was primarily due to lower average LIBOR interest.
Gain
on Assets Sold – net
During the third quarter of 2008, we
sold two rehabilitation hospitals and one SNF for a net gain of $11.8
million.
Income
from Continuing Operations
Income from continuing operations for
the three months ended September 30, 2008 was $28.1 million compared to $15.3
million for the same period in 2007. The increase in income from
continuing operations is the result of the factors described above.
Nine
Months Ended September 30, 2008 and 2007
Operating
Revenues
Our operating revenues for the nine
months ended September 30, 2008 totaled $144.6 million, an increase of $24.6
million over the same period in 2007. The $24.6 million increase
relates primarily to (i) $19.3 million in revenue from owned and operated
assets, (ii) additional rental income due to the acquisition of five SNFs in
August 2007, one SNF in January 2008 and seven SNFs, one ALF and one
rehabilitation hospital in April 2008 which were all leased to existing
operators; (iii) additional mortgage income due to the mortgage financing of
eight new facilities in April 2008; (iv) an amendment to an existing operator’s
lease that extended the terms of the lease agreement and increased the annual
rent in the first quarter of 2008 and (v) additional miscellaneous revenue
primarily due to late fees. Offsetting these increases were the first
quarter 2007 reversal of approximately $5.0 million in allowance for
straight-line rent, resulting from an improvement in one of our operator’s
financial condition in 2007, the 2008 reduction of rent related to the
bankruptcy of Haven and the sale of the two rehabilitation hospitals in
2008.
Operating
Expenses
Operating expenses for the nine months
ended September 30, 2008 totaled $65.0 million, an increase of approximately
$28.5 million over the same period in 2007. The increase was
primarily due to $20.8 million in expenses from owned and operated assets and
$4.3 million of provisions for uncollectible accounts receivable associated with
Haven. The provision consisted of $3.3 million associated with
straight-line receivables and $1.0 million in pre-petition contractual
receivables. In addition, depreciation expense increased by
$2.4 million due to the acquisitions of five SNFs in August 2007, one SNF in
January 2008 and seven SNFs, one ALF and one rehabilitation hospital in April
2008. The increase in general and administrative expense is primarily
related to an increase in restricted stock expense of $0.7 million due to four
additional months of expense in 2008 versus. 2007. In May 2007, we
entered into a new restricted stock agreement with executives of the
Company.
Other
Income (Expense)
For the nine months ended September
30, 2008, total other expenses were $29.6 million, as compared to $33.3 million
for the same period in 2007, a decrease of $3.7 million. The decrease
was primarily due to lower average LIBOR interest rates and average debt
outstanding and $0.5 million associated with cash received for a legal
settlement in the second quarter of 2008.
Gain
on Assets Sold – net
For the nine months ended September
30, 2008, we sold two rehabilitation hospitals and three SNFs for a net gain of
$11.9 million.
Income
from Continuing Operations
Income from continuing operations for
the nine months ended September 30, 2008 was $62.0 million compared to $50.3
million for the same period in 2007. The increase in income from
continuing operations is the result of the factors described above.
Discontinued
Operations
Discontinued operations generally
relate to properties we disposed of or plan to dispose of and have no continuing
involvement or cash flows with the operator. These assets are
typically classified as assets held for sale - net.
For the nine months ended September
30, 2008, discontinued operations includes revenue of $15 thousand for one SNF
located in California that was sold during the first quarter of 2008, generating
a gain of $0.4 million. For the nine months ended September 30, 2007,
discontinued operations include revenue and expense from three facilities that
have been sold, including revenue from one SNF sold during the first quarter of
2008. In 2007, we recorded a gain of $1.6 million for the sale of six
facilities.
Funds
From Operations
Our funds
from operations available to common stockholders (“FFO”), for the three months
ended September 30, 2008, was $23.9 million, compared to $22.0 million, for the
same period in 2007.
We
calculate and report FFO in accordance with the definition and interpretive
guidelines issued by the National Association of Real Estate Investment Trusts
(“NAREIT”), and consequently, FFO is defined as net income available to common
stockholders, adjusted for the effects of asset dispositions and certain
non-cash items, primarily depreciation and amortization. We believe
that FFO is an important supplemental measure of our operating
performance. Because the historical cost accounting convention used
for real estate assets requires depreciation (except on land), such accounting
presentation implies that the value of real estate assets diminishes predictably
over time, while real estate values instead have historically risen or fallen
with market conditions. The term FFO was designed by the real estate
industry to address this issue. FFO herein is not necessarily
comparable to FFO of other REITs that do not use the same definition or
implementation guidelines or interpret the standards differently from
us.
We use
FFO as one of several criteria to measure operating performance of our
business. We further believe that by excluding the effect of
depreciation, amortization and gains or losses from sales of real estate, all of
which are based on historical costs and which may be of limited relevance in
evaluating current performance, FFO can facilitate comparisons of operating
performance between periods. We offer this measure to assist the
users of our financial statements in analyzing our financial performance;
however, this is not a measure of financial performance under GAAP and should
not be considered a measure of liquidity, an alternative to net income or an
indicator of any other performance measure determined in accordance with
GAAP. Investors and potential investors in our securities should not
rely on this measure as a substitute for any GAAP measure, including net
income.
The following table reconciles FFO to
net income available to common stockholders, as determined under GAAP, for the
three- and nine- months ended September 30, 2008 and 2007:
|
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income available to common stockholders
|
|
$ |
25,592 |
|
|
$ |
12,869 |
|
|
$ |
54,986 |
|
|
$ |
44,616 |
|
|
Add back loss (deduct gain)
from real estate dispositions
|
|
|
(11,806 |
) |
|
|
1 |
|
|
|
(12,283 |
) |
|
|
(1,595 |
) |
|
Sub-total
|
|
|
13,786 |
|
|
|
12,870 |
|
|
|
42,703 |
|
|
|
43,021 |
|
|
Elimination of non-cash items
included in net income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and
amortization
|
|
|
10,076 |
|
|
|
9,138 |
|
|
|
29,185 |
|
|
|
26,768 |
|
|
Funds
from operations available to common stockholders
|
|
$ |
23,862 |
|
|
$ |
22,008 |
|
|
$ |
71,888 |
|
|
$ |
69,789 |
|
|
|
Portfolio
and Recent Developments
|
Below is a brief description, by
third-party operator, of our re-leasing, restructuring or new investment
transactions that occurred during the nine months ended September 30,
2008.
Alpha
HealthCare Properties, LLC
On January 17, 2008, we purchased one
SNF for $5.2 million from an unrelated third party and leased the facility to
Alpha Health Care Properties, LLC (“Alpha”), an existing tenant of
ours. The facility was added to Alpha’s existing master lease and
provides for an additional $0.5 million of cash rent annually.
Advocat
Inc.
During the first quarter of 2008, we
amended our master lease with Advocat Inc. (“Advocat”) to allow for the
construction of a new facility to replace an existing facility currently
operated by Advocat. Upon completion (estimated to be in mid-2009),
annual cash rent will increase by approximately $0.7 million. As a
result of our plan to replace the existing facility, we recorded a $1.5 million
impairment loss related to the existing facility during the first quarter of
2008 to record it at its estimated fair value.
CommuniCare Health
Services
On April
18, 2008, we completed approximately $123 million of combined new investments
with affiliates of CommuniCare Heath Services (“CommuniCare”), an existing
operator. Effective April 18, 2008, we purchased from several
unrelated third parties seven (7) SNFs, one (1) ALF and one (1) rehabilitation
hospital, all located in Ohio, totaling 709 beds for a total investment of $47.4
million. The facilities were added into our master lease with
CommuniCare, increasing annualized cash rent under the master lease by
approximately $4.7 million, subject to annual escalators. The term of
the CommuniCare master lease was extended to April 30, 2018, with two ten-year
renewal options.
Also on April 18, 2008, and
simultaneous with the amendment and extension of the master lease with
CommuniCare, we entered into a first mortgage loan with CommuniCare in the
amount of $74.9 million. This mortgage loan matures on April 30, 2018
and carries an interest rate of 11% per year. CommuniCare used the proceeds of
the mortgage loan to acquire seven (7) SNFs located in Maryland, totaling 965
beds from several unrelated third parties. The mortgage loan is
secured by a lien on the seven (7) facilities. At the closing, $4.9
million of loan proceeds were escrowed pending CommuniCare’s acquisition of an
additional 90 bed SNF, also located in Maryland. The loan proceeds
held in escrow are included in Other assets as of September 30,
2008. We anticipate that CommuniCare will acquire this facility
within eight months upon the satisfaction of certain contingencies, including
the granting of a lien on such facility to secure the mortgage
loan. If the additional facility is not acquired, CommuniCare will be
obligated to re-pay the $4.9 million of escrowed loan proceeds. The
mortgage properties are cross-collaterialized with the master lease
agreement.
Guardian
LTC Management, Inc.
On September 30, 2008, we completed a
$40.0 million investment with subsidiaries of Guardian LTC Management, Inc.
(“Guardian”), an existing operator. The transaction involved the sale
and leaseback of four SNFs, one ALF and one ILF all located in
Pennsylvania. The facilities and related $4.0 million of initial
annual rent were added to an existing master lease with Guardian. The
amended and restated master lease now includes 21 facilities and $15.7 million
of annual rent, with annual escalators. In addition, the master lease term was
extended from August 2016 through September 30, 2018.
Transition
of Haven Properties to Formation/Genesis
In January 2008, we purchased from
General Electric Capital Corporation (“GE Capital”) a $39.0 million mortgage
loan due October 2012 on seven facilities then operated by
Haven. Prior to the acquisition of this mortgage, we had a $22.8
million second mortgage on these facilities, resulting in a combined $61.8
million mortgage on these facilities immediately following the purchase from GE
Capital. In conjunction with the above noted mortgage and purchase
option and the application of FIN 46R, we consolidated the financial statements
and real estate of the Haven entity that was the obligor under this mortgage
loan into our financial statements. On July 7, 2008, we took
ownership and/or possession of the Haven Properties and a new entity assumed
operations of the facilities. As a result of our taking ownership
and/or possession of the Haven facilities, pursuant to FIN 46R, effective July
7, 2008, we were no longer required to consolidate the Haven entity that was
obligated under the mortgage loan into our financial
statements. However, pursuant to FIN 46R and effective July 7, 2008,
we are required to consolidate the financial position and results of operations
of the new entity which assumed the operations of these facilities on our
behalf. Effective September 1, 2008, the new entity that we
consolidates pursuant to FIN 46R transferred the operations of 13 of the 15
facilities to Formation. Therefore, beginning on September 1, 2008,
the entity that we consolidates pursuant to FIN 46R includes only the financial
results of the two remaining facilities that are currently pending state
approval prior to the transfer of these facilities. Our consolidation
of the Haven entity obligated under the mortgage loan resulted in the following
adjustments to our consolidated balance sheet as of December 31, 2007: (i) an
increase in total gross investments of $39.0 million; (ii) an increase in
accumulated depreciation of $3.1 million; (iii) an increase in Accounts
receivable – net of $0.4 million; (iv) an increase in Other long-term borrowings
of $39.0 million; and (v) a reduction of $2.7 million in Cumulative net earnings
primarily due to increased depreciation expense. Our results of
operation reflect the impact of the consolidation of this Haven entity for the
three- and nine- month periods ended September 30, 2008 and 2007,
respectively.
Since November 2007 until July 7, 2008,
affiliates of Haven, one of our operators/lessees/mortgagors, operated under
Chapter 11 bankruptcy protection. Commencing in February 2008, the
assets of Haven were marketed for sale via an auction process to be conducted
through proceedings established by the bankruptcy court. The auction
process failed to produce a qualified buyer. As a result, and
pursuant to our rights as ordered by the bankruptcy court, Haven moved the
bankruptcy court to authorize us to credit bid certain of the indebtedness that
Haven owed to us in exchange for taking ownership of and transitioning certain
of the assets of Haven to a new entity in which we have a substantial ownership
interest, all of which was approved by the bankruptcy court on July 4,
2008. Effective as of July 7, 2008, we took ownership and/or
possession of 15 facilities previously operated by Haven, and a new entity in
which we have a substantial economic ownership interest began operating these
facilities on our behalf through an independent contractor. For
financial reporting purposes, the financial statements of the new entity
operating the facilities will be consolidated into our financial statements in
accordance with FIN 46R from July 7, 2008 until the facilities are re-leased or
sold. In 2007, the Haven Properties represented 9% of our total
investment and 8% of our operating revenue.
In January 2008, Haven entered into a
debtors-in-possession financing (“DIP”) agreement with us and one other
financial institution (collectively, the “DIP Lenders”), in which our initial
participation was approximately $5.0 million of a $50 million total
commitment. The agreement was originally scheduled to mature in June
2008 and yield an interest rate of prime plus 3%. On June 4,
2008, the DIP Lenders and Haven amended the DIP agreement (the “Amended DIP”)
which, among other things, extended the term to allow Haven additional time to
sell its assets. As collateral for the Amended DIP, we received the
right to use all facility accounts receivable generated from the Omega
facilities from June 4, 2008 to satisfy any of our post-June 3, 2008
advances. As of September 30, 2008, we had $0.2 million outstanding
on the original DIP agreement and $7.3 million outstanding related to the
Amended DIP.
As described above, we entered into the
MTA to re-lease the Haven Properties to affiliates of Formation. The
15 properties consist of 14 SNFs and one ALF, and are located in Connecticut
(5), Rhode Island (4), New Hampshire (3), Vermont (2) and Massachusetts
(1). As part of the transaction, Genesis Healthcare (“Genesis”) has
entered into a long-term management agreement with Formation to oversee the
day-to-day operations of each of these facilities. As of September
30, 2008, we have completed the operational transfer of 13 of the 15 Haven
Properties with an annual rent of approximately $10 million. The
operational transfer for the two remaining facilities in Vermont is subject to
the receipt of appropriate regulatory approvals, which is expected sometime in
the near future. Annual rent for the facilities that have not closed
due to regulatory requirements is approximately $2.0 million.
The master lease with Formation has an
initial term of 10 years with initial annual rent of approximately $12 million
upon regulatory approval for all facilities. In addition, Formation
has an option after the initial 12 months of the lease to convert eight of the
leased facilities into mortgaged properties, with economic terms substantially
similar to that of the original lease.
Longwood
Management Corporation
On September 17, 2008, we purchased
the land that our Pico Rivera facility is located on in California, for
approximately $1 million.
Sun
Healthcare Group, Inc.
On February 1, 2008, we amended our
master lease with Sun Healthcare Group, Inc. and certain of its affiliates
(“Sun”) primarily to: (i) consolidate three existing master leases into one
master lease; (ii) extend the lease terms of the agreement through September
2017 for facilities acquired in August 2006; and (iii) allow for the sale of two
rehabilitation hospitals currently operated by Sun. On July 1, 2008,
the two rehabilitation hospitals were sold for approximately $29.0
million. As a result of the sale, contractual rent decreased by $1.7
million annually beginning July 1, 2008.
Assets
Sold
|
·
|
On
January 31, 2008, we sold one SNF in California for approximately $1.5
million resulting in a gain of approximately $0.4 million, which was
included in our gain/loss from discontinued operations. For
additional information, see Note 10 – Discontinued
Operations.
|
|
·
|
On
February 1, 2008, we sold a SNF in California for approximately $1.5
million resulting in a gain of approximately $46
thousand.
|
|
·
|
On
July 1, 2008, we sold two rehabilitation hospitals in California for
approximately $29 million resulting in a gain of approximately $12.3
million.
|
|
·
|
On
September 29, 2008, we sold one SNF in Texas for approximately $0.1
million resulting in a loss of $0.5
million.
|
Held
for Sale
|
·
|
During
the three months ended September 30, 2008, a $0.2 million provision for
impairment charge was recorded to reduce the carrying value of our
held-for-sale facility to its estimated fair value. At
September 30, 2008, we had one SNF classified as held-for-sale with a net
book value of approximately $0.2
million.
|
Purchase
of 400,000 shares of Series D Preferred Stock
On October 16, 2008, we purchased
400,000 shares of our Series D Preferred Stock at a price of $18.90 per
share. The liquidation preference for the Series D Preferred Stock is
$25.00 per share. Under FASB-EITF Issue D-42, The Effect on the Calculation of
Earnings per Share for the Redemption or Induced Conversion of Preferred
Stock, the purchase of the Series D Preferred Stock shares will result in
a fourth quarter 2008 gain of approximately $2.4 million. The gain
will be net of a non-cash charge to net income available to common stockholders
of approximately $0.3 million reflecting the write-off of the pro-rata portion
of the original issuance costs of the Series D Preferred Stock.
Liquidity
and Capital Resources
At September 30, 2008, we had total
assets of $1.4 billion, stockholders’ equity of $803.6 million and debt of
$520.3 million, which represents approximately 39.3% of our total
capitalization.
The
following table shows the amounts due in connection with the contractual
obligations described below as of September 30, 2008.
|
|
|
Payments due by period
|
|
|
|
|
Total
|
|
|
Less
than
1
year
|
|
|
1-3
years
|
|
|
3-5
years
|
|
|
More
than
5
years
|
|
|
|
|
(In
thousands)
|
|
|
Long-term
debt (1)
|
|
$ |
520,560 |
|
|
$ |
465 |
|
|
$ |
34,785 |
|
|
$ |
310 |
|
|
$ |
485,000 |
|
|
Other
long-term liabilities
|
|
|
105 |
|
|
|
105 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
Total
|
|
$ |
520,665 |
|
|
$ |
570 |
|
|
$ |
34,785 |
|
|
$ |
310 |
|
|
$ |
485,000 |
|
|
(1)
|
The
$520.6 million includes $310 million aggregate principal amount of 7%
Senior Notes due April 2014, $175 million aggregate principal amount of 7%
Senior Notes due January 2016, $34.0 million in borrowings under the $255
million revolving senior secured credit facility that matures in March
2010.
|
Financing
Activities and Borrowing Arrangements
Bank
Credit Agreements
At September 30, 2008, we had $34.0
million outstanding under our $255 million revolving senior secured credit
facility (the “Credit Facility”) and $2.1 million was utilized for the issuance
of letters of credit, leaving availability of $218.9 million. The
$34.0 million of outstanding borrowings had a blended interest rate of 4.74% at
September 30, 2008. The revolving senior credit facility matures in
March 2010.
Pursuant to Section 2.01 of the Credit
Agreement, dated as of March 31, 2006 (the “Credit Agreement”), that governs our
Credit Facility, we were permitted under certain circumstances to increase our
available borrowing base under the Credit Agreement from $200 million up to an
aggregate of $300 million. Effective February 22, 2007, we exercised
our right to increase the available revolving commitment under Section 2.01 of
the Credit Agreement from $200 million to $255 million and we consented to add
18 of our properties to the borrowing base assets under the Credit
Agreement.
Our long-term borrowings require us to
meet certain property level financial covenants and corporate financial
covenants, including prescribed leverage, fixed charge coverage, minimum net
worth, limitations on additional indebtedness and limitations on dividend
payouts. As of September 30, 2008, we were in compliance with all
property level and corporate financial covenants.
6.0
Million Share Common Stock Offering
On September 19, 2008, we closed an
underwritten public offering of 6.0 million shares our common stock at $16.37
per share. The net proceeds, after deducting underwriting discounts
and offering expenses, were approximately $97 million. UBS Investment
Bank was the sole book-running manager, and Stifel Nicolaus & Company,
Incorporated was the co-manager for the offering. The net proceeds
were used to repay indebtedness under our senior credit facility and for working
capital and general corporate purposes.
5.9
Million Common Stock Offering
On May 6, 2008, we have issued 5.9
million shares of our common stock in a registered direct placement to a number
of institutional investors. The net proceeds from the offering were
approximately $98.8 million, after deducting the placement agent’s fee and other
estimated offering expense. Cohen & Steers Capital Advisors, LLC
acted as Placement Agent for the offering. The net proceeds were used
to repay indebtedness under our senior credit facility.
Dividend
Reinvestment and Common Stock Purchase Plan
We have a Dividend Reinvestment and
Common Stock Purchase Plan (the “DRSPP”) that allows for the reinvestment of
dividends and the optional purchase of our common stock. At September
30, 2008, we offered shares under the Plan at a 1% discount to
market. For the nine month period ended September 30, 2008, we issued
1,828,504 shares of common stock for approximately $30.5 million in net
proceeds.
On
October 29, 2008, we announced the immediate suspension of the optional cash
purchase component of our Dividend Reinvestment and Common Stock Purchase Plan
until further notice. Dividend reinvestment and all other features of
the Plan will continue as set forth in the Plan, including sales, transfers and
certificate issuances of stock held in participant accounts.
Stockholders participating in the Plan
who have elected to reinvest dividends will continue to have cash dividends
reinvested in accordance with the Plan. Any checks or other funds
received by Computershare Trust Company, N.A. from Plan participants on, or
after October 15, 2008, for optional cash investments will be returned without
interest.
Dividends
In order to qualify as a REIT, we are
required to distribute dividends (other than capital gain dividends) to our
stockholders in an amount at least equal to (A) the sum of (i) 90% of our "REIT
taxable income" (computed without regard to the dividends paid deduction and our
net capital gain), and (ii) 90% of the net income (after tax), if any, from
foreclosure property, minus (B) the sum of certain items of non-cash
income. Such distributions must be paid in the taxable year to which
they relate, or in the following taxable year if declared before we timely file
our tax return for such year and paid on or before the first regular dividend
payment after such declaration. In addition, such distributions are required to
be made pro rata, with no preference to any share of stock as compared with
other shares of the same class, and with no preference to one class of stock as
compared with another class except to the extent that such class is entitled to
such a preference. To the extent that we do not distribute all of our net
capital gain or do distribute at least 90%, but less than 100% of our "REIT
taxable income," as adjusted, we will be subject to tax thereon at regular
ordinary and capital gain corporate tax rates. In addition, our
credit facility has certain financial covenants that limit the distribution of
dividends paid during a fiscal quarter to no more than 95% of our aggregate
cumulative FFO as defined in the credit agreement, unless a greater distribution
is required to maintain REIT status. The credit agreement defines FFO
as net income (or loss) plus depreciation and amortization and shall be adjusted
for charges related to: (i) restructuring our debt; (ii) redemption of preferred
stock; (iii) litigation charges up to $5.0 million; (iv) non-cash charges for
accounts and notes receivable up to $5.0 million; (v) non-cash compensation
related expenses; (vi) non-cash impairment charges; and (vii) tax liabilities in
an amount not to exceed $8.0 million.
For the three- and nine- months ended
September 30, 2008, we paid total dividends of $25.3 million and $71.0 million,
respectively.
On
October 16, 2008, the Board of Directors declared a common stock dividend of
$0.30 per share, to be paid November 17, 2008 to common stockholders of record
on October 31, 2008. On October 16, 2008, the Board of Directors also
declared the regular quarterly dividends for our 8.375% Series D Cumulative
Redeemable Preferred Stock to stockholders of record on October 31,
2008. The stockholders of record of the Series D Preferred Stock on
October 31, 2008 will be paid dividends in the amount of $0.52344 per preferred
share on November 17, 2008. The liquidation preference for our Series
D Preferred Stock is $25.00 per share.
Liquidity
We believe our liquidity and various
sources of available capital, including cash from operations, our existing
availability under our Credit Facility and expected proceeds from mortgage
payoffs are more than adequate to finance operations, meet recurring debt
service requirements and fund future investments through the next twelve
months.
We
regularly review our liquidity needs, the adequacy of cash flow from operations,
and other expected liquidity sources to meet these needs. We believe
our principal short-term liquidity needs are to fund:
· normal
recurring expenses;
· debt
service payments;
· preferred
stock dividends;
· common
stock dividends; and
· growth
through acquisitions of additional properties.
The
primary source of liquidity is our cash flows from
operations. Operating cash flows have historically been determined
by: (i) the number of facilities we lease or have mortgages on; (ii) rental and
mortgage rates; (iii) our debt service obligations; and (iv) general and
administrative expenses. The timing, source and amount of cash flows
provided by financing activities and used in investing activities are sensitive
to the capital markets environment, especially to changes in interest
rates. Changes in the capital markets environment may impact the
availability of cost-effective capital and affect our plans for acquisition and
disposition activity.
Cash and
cash equivalents totaled $3.8 million as of September 30, 2008, an increase of
$1.8 million as compared to the balance at December 31, 2007. The
following is a discussion of changes in cash and cash equivalents due to
operating, investing and financing activities, which are presented in our
Consolidated Statements of Cash Flows.
Operating
Activities –
Net cash flow from operating activities generated $60.1 million for the nine
months ended September 30, 2008, as compared to $67.0 million for the same
period in 2007, a decrease of $6.8 million. The decrease in operating
cash flows is primarily due to timing of the funding of working capital
requirements for TC Healthcare, offset by additional revenue due to recent
acquisitions, normal rent escalators and decreased interest due to reduced
average rates and average borrowing outstanding.
Investing
Activities – Net cash flow from investing activities was an outflow of
$158.3 million for the nine months ended September 30, 2008, as compared to an
outflow of $32.6 million for the same period in 2007. The increase in
cash outflow from investing activities of $125.7 million relates primarily to
(i) the level of acquisition of $93.2 million in real estate in 2008 compared to
$39.5 million in 2007, (ii) the $74.9 million mortgage loan with one of our
operators in the second quarter of 2008; (iii) the investment of $13.2 million
in capital improvements and renovations in 2008 compared to $5.5 million in
2007; and (iv) the investment in a debtor-in-possession note with one of our
operators in 2008; offset by change in net proceeds for the sales of real estate
of $25.6 million.
In 2008 we acquired one SNF for $5.2
million in the first quarter of 2008, the acquisition of nine facilities for
$47.4 million in the second quarter of 2008 and the acquisition of six
facilities for $40 million in the third quarter of 2008. In 2007 we
acquired five SNFs for approximately $39.5 million. In 2008, we sold
two rehabilitation hospitals and three SNFs for approximately $31.9 million
compared to sales of six SNFs in 2007 for approximately $6.3
million.
Financing
Activities – Net cash flow from financing activities was an inflow of
$99.9 million for the nine months ended September 30, 2008 as compared to an
outflow of $34.4 million for the same period in 2007. The $134.3
million change in financing activities was primarily a result of an increase in
dividend reinvestment proceeds of $18.3 million, and an increase in common stock
offering of $83.1 million. In 2007, we used the majority of the
proceeds of our equity offering to repay debt. In 2008, we used the
proceeds to acquire facilities and we repaid debt of approximately $53.4
million. In addition dividend payments increased as a result of the
equity issuances by $11.4 million.
Taxation
of Foreclosure Property
We will be subject to tax at the
maximum corporate tax rate on any income from foreclosure property, other than
income that otherwise would be qualifying income for purposes of the 75% gross
income test, applicable to REITs, less expenses directly connected with the
production of that income. However, gross income from foreclosure
property will qualify for purposes of the 75% and 95% gross income tests
applicable to REITs. Foreclosure property is any real property,
including interests in real property, and any personal property incident to such
real property:
|
·
|
that
is acquired by a REIT as the result of i) the REIT having bid on such
property at foreclosure, or having otherwise reduced such property to
ownership or possession by agreement or process of law, after there was a
default or default was imminent on a lease of such property or on
indebtedness that such property secured or ii) in the case of a “qualified
health care property”, the termination of the lease with respect to such
property;
|
|
·
|
for
which the related loan or lease was acquired by the REIT at a time when
the default was not imminent or anticipated;
and
|
|
·
|
for
which the REIT makes a proper election to treat the property as
foreclosure property.
|
Such property generally ceases to be
foreclosure property at the end of the third taxable year following the taxable
year in which the REIT acquired the property, or longer (for a total of up to
six years) if an extension is granted by the Secretary of the
Treasury. In the case of a “qualified health care property” acquired
solely as a result of a termination of a lease, but not in connection with
default or an imminent default on the lease, the initial grace period terminates
on the second taxable year following the year in which the REIT acquired the
property. Our properties generally should be treated as “qualified
health care properties.” The grace period terminates and foreclosure
property ceases to be foreclosure property on the first day:
|
·
|
on
which a lease is entered into for the property that, by its terms, will
give rise to income that does not qualify for purposes of the 75% gross
income test, or any amount is received or accrued, directly or indirectly,
pursuant to a lease entered into on or after such day that will give rise
to income that does not qualify for purposes of the 75% gross income
test;
|
|
·
|
on
which any construction takes place on the property, other than completion
of a building or any other improvement, where more than 10% of the
construction was completed before default became imminent;
or
|
|
·
|
which
is more than 90 days after the day on which the REIT acquired the property
and the property is used in a trade or business which is conducted by the
REIT, other than through an independent contractor from whom the REIT
itself does not derive or receive any
income.
|
In July 2008, we assumed operating
responsibilities for the Haven Properties due to the bankruptcy of one of our
operator/tenants. In September, we entered into an agreement to lease
these facilities to a new operator/tenant. The new operator/tenant
assumed operating responsibility for 13 of the 15 facilities effective September
1, 2008. We are in the process of addressing state regulatory
requirements necessary to transfer the final two properties to the new
operator/tenant. We intend to make an election on our 2008 federal
income tax return to treat the Haven Properties as foreclosure
properties. Because we acquired possession in connection with a
foreclosure, the Haven Properties are eligible to be treated as foreclosure
property until the end of 2011. Although the Secretary of Treasury
may extend the foreclosure property period until the end of 2014, there can be
no assurance that we will receive such an extension. So long as the
Haven Properties qualify as foreclosure property, our gross income from the
properties will be qualifying income for the 75% and 95% gross income tests, but
we will generally be subject to corporate income tax at the highest rate on the
net income from the properties. If one or more of the Haven
Properties were to inadvertently fail to qualify as foreclosure property, we
would likely recognize nonqualifying income from such property for purposes of
the 75% and 95% gross income tests, which could cause us to fail to qualify as a
REIT. In addition, any gain from a sale of such property could be
subject to the 100% prohibited transactions tax. Although we intend
to sell or lease the Haven Properties to one or more unrelated third parties
prior to the end of 2011, no assurance can be provided that we will accomplish
that objective.
We are exposed to various market risks,
including the potential loss arising from adverse changes in interest
rates. We do not enter into derivatives or other financial
instruments for trading or speculative purposes, but we seek to mitigate the
effects of fluctuations in interest rates by matching the term of new
investments with new long-term fixed rate borrowing to the extent
possible.
There was no material change in our
market risks during the three months ended September 30, 2008. For
additional information, refer to Item 7A as presented in our annual report on
Form 10-K for the year ended December 31, 2007.
Disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended
(the “Exchange Act”) are controls and other procedures that are designed to
provide reasonable assurance that the information that we are required to
disclose in the reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding required
disclosure.
In connection with the preparation of
this Form 10-Q, we evaluated the effectiveness of the design and operation of
our disclosure controls and procedures as of September 30,
2008. Based on this evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were
effective at a reasonable assurance level as of September 30,
2008.
In
connection with the Haven Properties, we performed additional analyses and other
procedures to ensure that our consolidated financial statements included in this
Form 10-Q were prepared in accordance with GAAP. As a result, we
concluded that the consolidated financial statements included in this Form 10-Q
present fairly, in all material respects, our financial position, results of
operations and cash flows for the periods presented in conformity with
GAAP.
With respect to the acquired business
formerly know as Haven, our internal control over financial reporting may be
deemed to include the pre-existing internal controls relating to the operation
of the Haven Properties. The pre-existing controls, procedures and personnel
resources associated with the Haven Properties were not designed with a view to
public company reporting. While we have not formally evaluated the
internal control over financial reporting with respect to the Haven Properties,
management noted a variety of deficiencies in the pre-existing internal control
over financial reporting relating to the operations of the Haven
Properties. We believe that the controls we added are sufficient to
compensate for these deficiencies; however, such controls have yet to be
tested. These controls included additional controls over cash
disbursement as well as additional entity level controls at the TC Healthcare
entity level. As of September 30, 2008, the operational transfer of
13 of the 15 Haven Properties had been completed, and accordingly as of such
date our internal control over financial reporting only includes controls
relating to the operation of two facilities. With regards to the two
remaining facilities, the transaction agreement with Formation Capital,
including a management agreement, whereby Formation Capital (Genesis) is
responsible for managing the operation, included the cash disbursement and
receipt of the remaining facilities. We believe that we have placed
adequate controls in place to ensure appropriate financial disclosures; however,
the process is untested as of September 30, 2008. Furthermore, we do
not believe that any controls relating to the two remaining Haven Properties are
material to our internal control over financial reporting on a consolidated
basis as of September 30, 2008.
PART
II – OTHER
INFORMATION
See Note 9 – Litigation to the
Consolidated Financial Statements in PART I, Item 1 hereto, which is hereby
incorporated by reference in response to this item.
We filed our Annual Report on Form 10-K
for the year ended December 31, 2007 with the Securities and Exchange Commission
on February 15, 2008, which sets forth our risk factors in Item 1A therein. We
have not experienced any material changes from the risk factors previously
described therein, except for the risks described under “Taxation of Foreclosure
Property in PART I, Item 2 hereto and as set forth below:
General
Risks Related to Owned and Operated Properties
Our consolidated financial statements
include the accounts of a company created to operate the 15 Haven Properties
that we assumed as a result of the bankruptcy of Haven. We include the operating
results and assets and liabilities of these facilities for the period of time
that we were responsible for the operations of the respective
facilities. Thirteen of these facilities were transitioned to a new
tenant/operator on September 1, 2008, however, we continue to be responsible for
two facilities as of September 30, 2008 that are in the process of being
transitioned to the new operator/tenant.
The
entity operating the Haven Properties on our behalf (“TC Healthcare”) is
typically required to hold applicable licenses and is responsible for the
regulatory and environmental compliance at the Haven Properties, and could be
sanctioned for violation of regulatory and environmental
requirements. In addition, as a substantial economic owner of the
operating company (being run by an independent contractor), if TC Healthcare
fails to comply with the requirements of governmental reimbursement programs
such as Medicare or Medicaid, licensing and certification requirements, fraud
and abuse regulations or new legislative developments TC Healthcare may have to
cease to operate such facilities. With respect to the Haven
Properties, the risks identified under the caption "Risks Related to
the Operators of Our Facilities" in our Form 10-K for the year ended December
31, 2007 generally apply directly to us as the owner/operator of such facilities
until they are re-leased or sold.
Litigation
Related to the Haven Properties
TC
Healthcare may be named as a defendant in professional liability claims related
to the Haven Properties. In these suits, patients could allege
significant damages, including punitive damages. Since TC
Healthcare’s results will be included in our consolidated financial statements
from July 7, 2008, such potential litigation and rising insurance costs could
not only affect TC Healthcare’s ability to obtain and maintain adequate
liability and other insurance, but also may affect TC Healthcare’s ability to
run the business profitably and our financial results could suffer.
Risks
Related to Market Conditions
Government
budget deficits could lead to reduction in Medicare and Medicaid
reimbursement
The downturn in the U.S. economy has
negatively affected state budgets, which may put pressure on states to decrease
reimbursement rates for our operators to decrease state expenditures under their
state Medicaid programs. The need to control Medicaid expenditures
may be exacerbated by the potential for increased enrollment in Medicaid due to
unemployment and declines in family incomes. These potential
reductions could be compounded by the potential for federal cost-cutting efforts
that could lead to reductions in reimbursement to our operators under the
Medicare program. Potential reductions in Medicaid and Medicare
reimbursement to our operators could reduce the cash flow of our operators, and
their ability to make rent or mortgage payments to us. Since the
profit margins on Medicaid patients is generally relatively low, more than
modest reductions in Medicaid reimbursement could place some operators in
financial distress, which in turn could adversely affect us.
Our
liquidity and financial condition could be adversely affected by U.S. and
international credit markets and economic conditions.
Global market and economic conditions
continue to be disrupted and volatile and the disruption has been particularly
acute in the financial sector. Although we remain well capitalized and have not
suffered any liquidity issues as a result of these recent events, the cost and
availability of funds may be adversely affected by illiquid credit
markets. Continued turbulence in the U.S. and international markets
and economy may adversely affect our liquidity, financial condition and
profitability.
Current
levels of market volatility are unprecedented.
The capital and credit markets have
been experiencing extreme volatility and disruption for more than 12
months. In recent weeks, the volatility and disruption have reached
unprecedented levels. In some cases, the markets have exerted
downward pressure on stock prices and credit capacity for certain
issuers. Our business strategies require regular access to the
capital and credit markets. If current levels of market disruption
and volatility continue or worsen, access to capital and credit markets could be
disrupted making our strategies difficult or impractical to pursue until such
time as markets stabilize.
The
recent downturn in the credit markets has increased the cost of borrowing and
has made financing difficult to obtain, each of which may have a material
adverse effect on our results of operations and business.
Recent events in the financial markets
have had an adverse impact on the credit markets and, as a result, credit has
become more expensive and difficult to obtain. Some lenders are
imposing more stringent restrictions on the terms of credit and there may be a
general reduction in the amount of credit available in the markets in which we
conduct business. The negative impact on the tightening of the credit
markets may have a material adverse effect on us resulting from, but not limited
to, an inability to finance the acquisition of properties on favorable terms, if
at all, increased financing costs or financing with increasingly restrictive
covenants.
Our $255 million revolving senior
secured credit facility will expire in March 2010. Continued
disruption in U.S. and global credit markets could adversely affect our ability
to renew this credit facility and any renewed facility may be under terms that
are not as favorable as the current credit facility. Furthermore,
other types of financing, such as bond financings, may be unavailable or only be
available under unfavorable terms. The negative impact of the recent
adverse changes in the credit markets on the real estate sector generally or our
inability to obtain financing on favorable terms, if at all, may have a material
adverse effect on our results of operations and business.
We
are exposed to the credit risk of our customers and counterparties and their
failure to meet their financial obligations could adversely affect our
business.
Our business is subject to credit
risk. There is a risk that a customer or counterparty will fail to
meet its obligations when due. Customers and counterparties that owe
us money may default on their obligations to us due to bankruptcy, lack of
liquidity, operational failure or other reasons. Although we have
procedures for reviewing credit exposures to specific customers and
counterparties to address present credit concerns, default risk may arise from
events or circumstances that are difficult to detect or foresee. Some
of our risk management methods depend upon the evaluation of information
regarding markets, clients or other matters that are publicly available or
otherwise accessible by us. That information may not, in all cases,
be accurate, complete, up-to-date or properly evaluated. In addition,
concerns about, or a default by, one customer or counterparty could lead to
significant liquidity problems, losses or defaults by other customers or
counterparties, which in turn could adversely affect us. We may be
materially and adversely affected in the event of a significant default by our
customers and counterparties.
The
failure of a lender to fund a request (or any portion of such request) by us to
borrow money under our existing credit facility could reduce our ability to make
additional investments and pay distributions.
We have a $255 million revolving senior
secured credit facility. If a lenders which is a party to such credit
facility fails to fund a request (or any portion of such request) by us to
borrow money under such credit facility, our ability to make investments in our
business, fund our operations and pay debt service and dividends could be
reduced.
|
Exhibit
No.
|
|
Description
|
|
1.1
|
|
Underwriting
Agreement, dated as of September 15, 2008, between Omega Healthcare
Investors, Inc. and UBS Securities LLC (Incorporated by reference to
Exhibit 1.1 to the Company’s Current Report on Form 8-K, filed September
15, 2008).
|
|
10.1
|
|
Second
Consolidated Amended and Restated Master Lease, dated as of September 28,
2008, between OHI Asset (PA) Trust and Guardian LTC Management, Inc.
(Incorporated by reference to Exhibit 10.1 to the Company’s Current Report
on Form 8-K, filed October 3, 2008)
|
|
31.1
|
|
Rule
13a-14(a)/15d-14(a) Certification of the Chief Executive
Officer.
|
|
31.2
|
|
Rule
13a-14(a)/15d-14(a) Certification of the Chief Financial
Officer.
|
|
32.1
|
|
Section
1350 Certification of the Chief Executive Officer.
|
|
32.2
|
|
Section
1350 Certification of the Chief Financial
Officer.
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
OMEGA HEALTHCARE INVESTORS,
INC.
Registrant
Date: November
10,
2008 By: /S/ C. TAYLOR
PICKETT
C. Taylor Pickett
Chief
Executive Officer
Date: November
10,
2008 By: /S/ ROBERT O.
STEPHENSON
Robert O. Stephenson
Chief Financial Officer