10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on November 1, 2002
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
or
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission file number 1-11316
OMEGA HEALTHCARE
INVESTORS, INC.
(Exact name of Registrant as specified in its charter)
Maryland 38-3041398
(State of Incorporation) (I.R.S. Employer Identification No.)
9690 Deereco Road, Suite 100, Timonium, MD 21093
(Address of principal executive offices)
(410) 427-1700
(Telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of September 30, 2002
Common Stock, $.10 par value 37,135,149
(Class) (Number of shares)
OMEGA HEALTHCARE INVESTORS, INC.
FORM 10-Q
September 30, 2002
INDEX
Page No.
PART I Financial Information
Item 1. Consolidated Financial Statements:
Balance Sheets
September 30, 2002 (unaudited)
and December 31, 2001.................................... 2
Statements of Operations (unaudited)
Three- and nine-month periods ended
September 30, 2002 and 2001.............................. 3
Statements of Cash Flows (unaudited)
Nine-month periods ended
September 30, 2002 and 2001.............................. 4
Notes to Consolidated Financial Statements
September 30, 2002 (unaudited)........................... 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............ 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk... 27
Item 4. Controls and Procedures...................................... 29
PART II Other Information
Item 1. Legal Proceedings............................................ 29
Item 2. Changes in Securities and Use of Proceeds.................... 29
Item 3. Defaults Upon Senior Securities.............................. 29
Item 4. Submission of Matters to a Vote of Security Holders.......... 30
Item 6. Exhibits and Reports on Form 8-K............................. 30
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
OMEGA HEALTHCARE INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands)
Note - The balance sheet at December 31, 2001 has been derived from the audited
consolidated financial statements at that date, but does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements.
See notes to consolidated financial statements.
OMEGA HEALTHCARE INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In Thousands, Except Per Share Amounts)
See notes to consolidated financial statements.
OMEGA HEALTHCARE INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In Thousands)
See notes to consolidated financial statements.
OMEGA HEALTHCARE INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 2002
Note A - Basis of Presentation
The accompanying unaudited consolidated financial statements for Omega
Healthcare Investors, Inc. have been prepared in accordance with accounting
principles generally accepted in the United States ("GAAP") for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by GAAP for complete financial statements. In our opinion,
all adjustments (consisting of normal recurring accruals and impairment
provisions to adjust the carrying value of assets) considered necessary for a
fair presentation have been included. Operating results for the three- and
nine-month periods ended September 30, 2002 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2002. For
further information, refer to the financial statements and footnotes included in
our annual report on Form 10-K for the year ended December 31, 2001.
Note B - 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 returns. In connection with portfolio management,
we engage in various collection and foreclosure activities.
When we acquire real estate pursuant to a foreclosure, lease termination or
bankruptcy proceeding, and do not immediately re-lease the properties to new
operators, the assets are included on the balance sheet as "real estate
properties," and the value of such assets is reported at the lower of cost or
fair value. See Owned and Operated Assets below. Additionally, when a formal
plan to sell real estate is adopted and an agreement is imminent, the real
estate is classified as "Assets Held for Sale," with the net carrying amount
adjusted to the lower of cost or fair value, less cost of disposal.
Upon adoption of Financial Accounting Standards Board ("FASB") 144 as of
January 1, 2002, long-lived assets sold or designated as held for sale after
January 1, 2002 are reported as discontinued operations in our financial
statements.
A summary of the number of properties by category for the quarter ended
September 30, 2002 follows:
Purchase / Leaseback
During the three-month period ending September 30, 2002, we leased two
properties, previously classified as Owned and Operated Assets, to Hickory Creek
Healthcare Foundation, Inc. The initial term for the Master Lease is for ten
years and includes an option to renew for an additional ten years. The initial
annual base rent is $0.4 million.
Additionally, during the quarter, we closed three buildings that were
previously leased to USA Healthcare, Inc. under a Master Lease and recorded a
provision for impairment of $1.9 million. The Master Lease was amended to remove
the three buildings with no reduction in rental income. We intend to sell these
closed facilities as soon as practicable; however, there can be no assurance if
or when these sales will be completed.
Mortgages Receivable
Mortgage interest income is recognized as earned over the terms of the
related mortgage notes. Reserves are taken 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.
During the three months ended September 30, 2002, Ciena Health Care
Management paid off, in full, their existing $8.7 million mortgage on four
Michigan facilities.
In addition, a provision for loss on mortgages of $4.9 million and $6.9
million was recorded for the three- and nine-month periods ending September 30,
2002, respectively, as compared with $19,000 and $700,000 for the same time
period in 2001.
Owned and Operated Assets
At September 30, 2002, we own eight facilities that were recovered from
customers and are operated for our own account. These facilities have 677 beds
and are located in three states.
During the three-month period ended September 30, 2002, we leased two
properties previously classified as Owned and Operated to a third-party
operator. See Purchase / Leaseback above. In addition, we incurred a $1.7
million expense associated with the termination of our leasehold interest in
three Alabama skilled nursing facilities that were classified as Owned and
Operated assets.
We intend to operate the remaining Owned and Operated assets for our own
account until we are able to re-lease, sell, terminate our leasehold interest or
close the facilities. These facilities and their respective operations are
presented on a consolidated basis in our financial statements. See Note J -
Subsequent Events.
During the three-month period ended September 30, 2002, a non-cash
provision of $5.0 million for uncollectable accounts receivable related to our
Owned and Operated assets was recorded.
The revenues, expenses, assets and liabilities included in our consolidated
financial statements which relate to such owned and operated assets are set
forth in the table below. Nursing home revenues from these owned and operated
assets are recognized as services are provided. The amounts shown in the
consolidated financial statements are not comparable, as the number of Owned and
Operated facilities and the timing of the foreclosures and re-leasing activities
have occurred at different times during the periods presented.
The revenues, expenses, assets and liabilities in our consolidated
financial statements which relate to our owned and operated assets are as
follows:
(1) Nursing home revenues from these owned and operated assets are recognized
as services are provided.
(2) EBITDA represents earnings before interest, income taxes, depreciation and
amortization. We consider it to be a meaningful measure of performance of
our Owned and Operated Assets. EBITDA, in and of itself, does not represent
cash generated from operating activities in accordance with GAAP and
therefore should not be considered an alternative to net earnings as an
indication of operating performance or to net cash flow from operating
activities as determined by GAAP as a measure of liquidity, and is not
necessarily indicative of cash available to fund cash needs.
September 30, December 31,
2002 2001
---------------------------------------
(Unaudited)
(In Thousands)
ASSETS
Cash................................... $ 2,307 $ 6,549
Accounts receivable--net............... 10,916 27,121
Other current assets................... 1,078 2,125
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Total current assets................ 14,301 35,795
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Investment in leasehold--net........... 196 661
Land and buildings..................... 11,950 80,071
Less accumulated depreciation.......... (2,132) (8,647)
---------------------------------------
Land and buildings--net................ 9,818 71,424
---------------------------------------
Total assets........................... $ 24,315 $107,880
=======================================
LIABILITIES
Accounts payable....................... $ 1,075 $ 4,816
Other current liabilities.............. 2,943 5,371
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Total current liabilities........... 4,018 10,187
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Total liabilities...................... $ 4,018 $ 10,187
=======================================
Accounts receivable for owned and operated assets is net of an allowance
for doubtful accounts of approximately $10.8 million at September 30, 2002 and
$8.3 million at December 31, 2001.
Assets Held for Sale
At September 30, 2002, the carrying value of assets held for sale totaled
$6.0 million (net of impairment reserves of $7.3 million). We intend to sell the
remaining facilities as soon as practicable. There can be no assurance if or
when such sales will be completed or whether such sales will be completed on
terms that allow us to realize the carrying value of the assets.
Segment Information
The following tables set forth the reconciliation of operating results and
total assets for our reportable segments for the three- and nine-month periods
ending September 30, 2002 and 2001.
Note C - Concentration of Risk and Related Issues
As of September 30, 2002, our portfolio of domestic investments consisted
of 225 healthcare facilities, located in 28 states and operated by 34
third-party operators. Our gross investment in these facilities, before reserve
for uncollectible loans, totaled $861.1 million at September 30, 2002, with
97.3% of our real estate investments related to long-term care facilities. This
portfolio is made up of 145 long-term healthcare facilities and two
rehabilitation hospitals owned and leased to third parties, fixed-rate,
participating and convertible participating mortgages on 65 long-term healthcare
facilities and four long-term healthcare facilities that were recovered from
customers and are currently operated through third-party management contracts
for our own account and five facilities which are closed. In addition, four
facilities subject to third-party leasehold interests are included in Other
Investments. We also hold miscellaneous investments and closed healthcare
facilities held for sale of approximately $47.7 million at September 30, 2002,
including $22.1 million related to two non-healthcare facilities leased by the
United States Postal Service ("USPS").
Approximately 67.8% of our real estate investments are operated by seven
public companies, including Sun Healthcare Group, Inc. (25.4%), Integrated
Health Services, Inc. ("IHS") (18.6%, including 11.1% as the manager for and 50%
owner of Lyric Health Care LLC), Advocat, Inc. (12.4%), Mariner Post-Acute
Network (6.9%), Alterra Healthcare Corporation ("Alterra") (4.0%), Kindred
Healthcare, Inc. ("Kindred") (formerly known as Vencor Operating, Inc.) (0.5%).
At September 30, 2002 the three largest private operators represent 3.6%, 2.7%
and 2.7% of investments, respectively. No other operator represents more than
2.5% of investments. The three states in which we have our highest concentration
of investments are Florida (16.5%), California (7.7%) and Illinois (7.7%).
Government Healthcare Regulation, Reimbursements and Industry Concentration
Risks
Nearly all of our properties are used as healthcare facilities; therefore,
we are directly affected by the risk associated with the healthcare industry.
Our lessees and mortgagors, as well as the facilities Owned and Operated for our
account, derive a substantial portion of their net operating revenues from
third-party payors, including the Medicare and Medicaid programs. These programs
are highly regulated by federal, state and local laws, rules and regulations and
are subject to frequent and substantial changes. See Management's Discussion and
Analysis of Financial Condition and Results of Operations - Medicare
Developments.
In addition, private payors, including managed care payors, are
increasingly demanding discounted fee structures and the assumption by
healthcare providers of all or a portion of the financial risk of operating a
healthcare facility. Efforts to impose greater discounts and more stringent cost
controls are expected to continue. Any changes in reimbursement policies that
reduce reimbursement levels could adversely affect the amounts we receive with
respect to our owned and operated portfolio and the revenues of our lessees and
mortgagors and thereby adversely affect those lessees' and mortgagors' abilities
to make their monthly lease or debt payments to us.
The possibility that the healthcare facilities will not generate income
sufficient to meet operating expenses or will yield returns lower than those
available through investments in comparable real estate or other investments are
additional risks of investing in healthcare-related real estate. Income from
properties and yields from investments in such properties may be affected by
many factors, including changes in governmental regulation (such as zoning
laws), general or local economic conditions (such as fluctuations in interest
rates and employment conditions), the available local supply and demand for
improved real estate, a reduction in rental income as the result of an inability
to maintain occupancy levels, natural disasters (such as earthquakes and floods)
or similar factors.
Real estate investments are relatively illiquid and, therefore, tend to
limit our ability to vary our portfolio promptly in response to changes in
economic or other conditions. Thus, if the operation of any of our properties
becomes unprofitable due to competition, age of improvements or other factors
such that the lessee or borrower becomes unable to meet its obligations on the
lease or mortgage loan, the liquidation value of the property may be
substantially less, particularly relative to the amount owing on any related
mortgage loan, than would be the case if the property were readily adaptable to
other uses.
Potential Risks from Bankruptcies
Our lease arrangements with operators who operate more than one of our
facilities are generally made pursuant to a single master lease ("Master Lease")
covering all of that operator's facilities. Although each lease or Master Lease
provides that we may terminate the Master Lease upon the bankruptcy or
insolvency of the tenant, the Bankruptcy Reform Act of 1978 ("Bankruptcy Act")
provides that a trustee in a bankruptcy or reorganization proceeding under the
Bankruptcy Act, or a debtor-in-possession in a reorganization, has the power and
the option to assume or reject the unexpired lease obligations of a
debtor-lessee. In the event that the unexpired lease is assumed on behalf of the
debtor-lessee, all the rental obligations generally would be entitled to a
priority over other unsecured claims. However, the court also has the power to
modify a lease if a debtor-lessee, in reorganization, were required to perform
certain provisions of a lease that the court determined to be unduly burdensome.
It is not possible to determine at this time whether or not any of our leases or
Master Leases contains any such provision. If a lease is rejected, the lessor
has a general unsecured claim limited to any unpaid rent already due plus an
amount equal to the rent reserved under the lease, without acceleration, for the
greater of one year or 15% of the remaining term of such lease, not to exceed
three years.
Generally, with respect to our mortgage loans, the imposition of an
automatic stay under the Bankruptcy Act precludes us from exercising foreclosure
or other remedies against the debtor. Pre-petition creditors generally do not
have rights to the cash flows from the properties underlying the mortgages. The
timing of the collection from mortgagors in bankruptcy depends on negotiating an
acceptable settlement with the mortgagor (and subject to approval of the
bankruptcy court) or the order of the bankruptcy court in the event a negotiated
settlement cannot be achieved. A mortgagee also is treated differently from a
landlord in three key respects. First, the mortgage loan is not subject to
assumption or rejection because it is not an executory contract or a lease.
Second, the mortgagee's loan may be divided into (1) a secured loan for the
portion of the mortgage debt that does not exceed the value of the property and
(2) a general unsecured loan for the portion of the mortgage debt that exceeds
the value of the property. A secured creditor such as ourselves is entitled to
the recovery of interest and costs only if, and to the extent that, the value of
the collateral exceeds the amount owed. If the value of the collateral exceeds
the amount of the debt, interest and allowed costs may not be paid during the
bankruptcy proceeding, but accrue until confirmation of a plan of reorganization
or such other time as the court orders. If the value of the collateral held by a
senior creditor is less than the secured debt, interest on the loan for the time
period between the filing of the case and confirmation may be disallowed.
Finally, while a lease generally would either be rejected or assumed with all of
its benefits and burdens intact, the terms of a mortgage, including the rate of
interest and timing of principal payments, may be modified if the debtor is able
to affect a "cramdown" under the Bankruptcy Act.
The receipt of liquidation proceeds or the replacement of an operator that
has defaulted on its lease or loan could be delayed by the approval process of
any federal, state or local agency necessary for the transfer of the property or
the replacement of the operator licensed to manage the facility. In addition,
some significant expenditures associated with real estate investment, such as
real estate taxes and maintenance costs, are generally not reduced when
circumstances cause a reduction in income from the investment. In order to
protect our investments, we may take possession of a property or even become
licensed as an operator, which might expose us to successor liability to
government programs or require us to indemnify subsequent operators to whom we
might transfer the operating rights and licenses. Third-party payors may also
suspend payments to us following foreclosure until we receive the required
licenses to operate the facilities. Should such events occur, our income and
cash flow from operations would be adversely affected.
Risks Related to Owned and Operated Assets
As a consequence of the financial difficulties encountered by a number of
our operators, we have recovered various long-term care assets, pledged as
collateral for the operators' obligations, either in connection with a
restructuring or settlement with certain operators or pursuant to foreclosure
proceedings. We are typically required to hold applicable licenses and are
responsible for the regulatory compliance at our owned and operated facilities.
Our management contracts with third-party operators for these properties provide
that the third-party operator is responsible for regulatory compliance, but we
could be sanctioned for violation of regulatory requirements. In addition, the
risk of third-party claims such as patient care and personal injury claims is
higher with respect to our owned and operated properties as compared with our
leased and mortgaged assets.
Note D - Dividends
In order to qualify as a real estate investment trust ("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. In
addition, if we dispose of any built-in gain asset during a recognition period,
we will be required to distribute at least 90% of the built-in gain (after tax),
if any, recognized on the disposition of such asset. 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.
On February 1, 2001, we announced the suspension of all common and
preferred dividends. This action was intended to preserve cash to facilitate our
ability to obtain financing to fund the 2002 debt maturities. Prior to
recommencing the payment of dividends on our common stock, all accrued and
unpaid dividends on our Series A, B and C preferred stock must be paid in full.
We have made sufficient distributions to satisfy the distribution requirements
under the REIT rules to maintain our REIT status for 2001. For tax year 2002, we
are currently projecting a tax loss; therefore, we anticipate no distribution
will be required to satisfy the 2002 REIT rules. However, if we have taxable
income, we intend to make the necessary distributions to satisfy the 2002 REIT
requirements. The accumulated and unpaid dividends relating to all series of
preferred stocks total $35.0 million as of September 30, 2002. In aggregate,
preferred dividends continue to accumulate at approximately $5.0 million per
quarter.
On March 30, 2001, we exercised our option to pay the accrued $4,666,667
Series C dividend from November 15, 2000 and the associated deferral fee by
issuing 48,420 Series C preferred shares to Explorer Holdings, L.P. ("Explorer")
on April 2, 2001, which are convertible into 774,720 shares of our common stock
at $6.25 per share. Such election resulted in an increase in the aggregate
liquidation preference of Series C Preferred Stock as of April 2, 2001 to
$104,842,000. Dividends paid in stock to a specific class of stockholders, such
as our payment of our Series C preferred stock in April 2001, constitute
dividends eligible for the 2001 dividends paid deduction.
Since dividends on the Series A and Series B Preferred Stock have been in
arrears for more than 18 months, the holders of the Series A and Series B
Preferred Stock (voting together as a single class) continue to have the right
to elect two additional directors to our Board of Directors in accordance with
the terms of the Series A and Series B Preferred Stock and our Bylaws. Explorer,
the sole holder of the Series C Preferred Stock, also has the right to elect two
other additional directors to our Board of Directors in accordance with the
terms of the Series C Preferred Stock and our Bylaws. Explorer, without waiving
its rights under the terms of the Series C Preferred Stock or the Stockholders
Agreement, has advised us that it is not currently seeking the election of the
two additional directors resulting from the Series C dividend arrearage unless
the holders of the Series A and Series B Preferred Stock seek to elect
additional directors.
Note E - Earnings Per Share
The computation of basic earnings per share is determined based on the
weighted-average number of common shares outstanding during the respective
periods. Diluted earnings per share reflect the dilutive effect, if any, of
stock options and the assumed conversion of the Series C Preferred Stock.
Note F - Omega Worldwide, Inc. and Principal Healthcare Finance Limited
During the three-month period ending September 30, 2002, we sold our
investment in Omega Worldwide, Inc. ("Worldwide"). Pursuant to a tender offer by
Four Seasons Health Care Limited ("Four Seasons") for all of the outstanding
shares of common stock of Worldwide, we sold our investment, which consisted of
1.2 million shares of common stock and 260,000 shares of preferred stock, to
Four Seasons for cash proceeds of approximately $7.4 million (including $3.5
million for preferred stock liquidation preference and accrued preferred
dividends). In addition, we sold our investment in Principal Healthcare Finance
Limited, an Isle of Jersey company ("PHFL"), which consisted of 990,000 ordinary
shares and warrants to purchase 185,033 ordinary shares, to an affiliate of Four
Seasons for cash proceeds of $2.8 million. Both transactions were completed in
September 2002 and provided aggregate cash proceeds of $10.2 million. We
realized a gain from the sale of our investments in Worldwide and PHFL of $2.2
million. As of September 30, 2002, we no longer own any interest in Worldwide or
PHFL.
As of September 30, 2002, we hold a $1.3 million investment in Principal
Healthcare Finance Trust, an Australian Unit Trust.
Note G - 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, we believe 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.
On June 21, 2000, we were named as a defendant in certain litigation
brought against us by Madison/OHI Liquidity Investors, LLC ("Madison"), for the
breach and/or anticipatory breach of a revolving loan commitment. Ronald M.
Dickerman and Bryan Gordon are partners in Madison and limited guarantors
("Guarantors") of Madison's obligations to us. Madison claimed damages as a
result of the alleged breach of approximately $0.7 million and damages in an
amount ranging from $15 to $28 million for the anticipatory breach. We filed
counterclaims against Madison and the guarantors seeking repayment of
approximately $7.4 million of unpaid principal on the loan, plus accrued
interest. Effective as of September 30, 2002, the parties settled all claims in
the suit in consideration of Madison's payment of the sum of $5.4 million. The
payment by Madison consists of a $0.4 million cash payment for our attorneys'
fees, with the balance to be evidenced by the amendment of the existing
promissory note from Madison to us. The note reflects a principal balance of
$5.0 million, with interest accruing at 9% per annum, payable over three years
upon liquidation of the collateral securing the note. The note is also fully
guaranteed by the Guarantors; provided that if all accrued interest and 75% of
original principal has been repaid within 18 months, the Guarantors will be
released. As of September 30, 2002, we have received the $0.4 million cash
payment and payments of principal and interest on the note equal to $2.0
million. The financial statements have been adjusted to reflect the
restructuring and reduction of our investment in connection with the settlement
of this matter.
Note H - Borrowing Arrangements
On December 21, 2001, we reached amended agreements with the bank groups
under both of our revolving credit facilities. The amendments became effective
as of the closing of the rights offering and private placement to Explorer on
February 21, 2002. The amendments included modifications and/or eliminations to
certain financial covenants.
The amendment regarding our $175.0 million revolving credit facility
included a one-year extension in maturity from December 31, 2002 to December 31,
2003 and a reduction in the total commitment from $175.0 million to $160.0
million.
As part of the amendment regarding our $75.0 million revolving credit
facility, we prepaid $10.0 million in December 2001, originally scheduled to
mature in March 2002. This voluntary prepayment resulted in a permanent
reduction in the total commitment, thereby reducing the credit facility to $65.0
million.
Our $160.0 million secured revolving line of credit facility expires on
December 31, 2003. Borrowings under this facility bear interest at 2.50% to
3.25% over London Interbank Offered Rate ("LIBOR") through December 31, 2002 and
3.00% to 3.25% over LIBOR after December 31, 2002. Borrowings of $124.8 million
were outstanding as of September 30, 2002. Additionally, $12.5 million of
letters of credit were outstanding against this credit facility at September 30,
2002. These letters of credit were collateral for certain long-term borrowings
and supported insurance programs associated with our owned and operated assets.
LIBOR-based borrowings under this facility bear interest at a weighted-average
rate of 4.83% at September 30, 2002. Cost for the letters of credit range from
2.50% to 3.25%, based on our leverage ratio. Real estate investments with a
gross book value of approximately $239.4 million are pledged as collateral for
this revolving line of credit facility at September 30, 2002.
Our $65.0 million line of credit facility expires on June 30, 2005.
Borrowings under this facility bear interest at 2.50% and 3.75% over LIBOR,
based on our leverage ratio and collateral assignment. Borrowings of $65.0
million were outstanding at September 30, 2002. LIBOR based borrowings under
this facility bear interest at a weighted-average rate of 5.32% at September 30,
2002. Real estate investments with a gross book value of approximately $117.1
million are pledged as collateral for this revolving line of credit facility at
September 30, 2002.
During the three-month period ended September 30, 2002, we repaid $17.9
million of LIBOR based borrowings associated with our revolving credit
facilities. At September 30, 2002, we had $189.8 million of LIBOR based
borrowings outstanding and $12.5 million of letters of credit outstanding,
leaving availability of $22.7 million.
Note I - Accounting for Derivatives
We utilize interest rate swaps and hedges to fix interest rates on variable
rate debt and reduce certain exposures to interest rate fluctuations. We do not
use derivatives for trading or speculative purposes. We have a policy of only
entering into contracts with major financial institutions based upon their
credit ratings and other factors. When viewed in conjunction with the underlying
and offsetting exposure that the derivatives are designed to hedge, we have not
sustained a material loss from those instruments nor do we anticipate any
material adverse effect on our net income or financial position in the future
from the use of derivatives.
To manage interest rate risk, we may employ options, forwards, interest
rate swaps, caps and floors or a combination thereof depending on the underlying
exposure. We may employ swaps, forwards or purchased options to hedge qualifying
forecasted transactions. Gains and losses related to these transactions are
deferred and recognized in net income as interest expense in the same period or
periods that the underlying transaction occurs, expires or is otherwise
terminated. In June 1998, the Financial Accounting Standards Board issued
Statement No. 133, Accounting for Derivative Instruments and Hedging Activities,
which was required to be adopted in years beginning after June 15, 2000. We
adopted the new Statement effective January 1, 2001. The Statement requires us
to recognize all derivatives on the balance sheet at fair value. Derivatives
that are not hedges must be adjusted to fair value through income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the fair
value of derivatives will either be offset against the change in fair value of
the hedged assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedge item is recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings.
In September 2002, we entered into a 61-month, $200.0 million interest rate
cap with a strike of 3.50% that has been designated as a cash flow hedge. Under
the terms of the cap agreement, when LIBOR exceeds 3.50%, the counterparty will
pay us $200.0 million multiplied by the difference between LIBOR and 3.50% times
the number of days when LIBOR exceeds 3.50%. The unrealized gain/loss in the
fair value of cash flow hedges are reported on the balance sheet with
corresponding adjustments to accumulated other comprehensive income. On
September 30, 2002, the derivative instrument was reported at its fair value as
an Other Asset of $8.6 million. An adjustment of $1.5 million to Other
Comprehensive Income was made for the change in fair value of this cap during
the quarter. Each quarter, the unrealized gain/loss held in accumulated Other
Comprehensive Income will be adjusted to reflect the change in the fair value of
this interest rate cap. This reclassification is consistent with the recognition
of earnings for hedged items. Over the term of the interest rate cap, the $10.1
million cost will be amortized to earnings based on the specific portion of the
total cost attributed to each monthly settlement period.
Also in September 2002, we terminated two interest rate swaps with notional
amounts of $32.0 million each. Under the terms of the first swap agreement,
which would have expired on December 2002, we received payments when LIBOR
exceeded 6.35% and paid the counterparty when LIBOR was less than 6.35%. This
interest rate swap was extended in December 2001 to December 2002 at the option
of the counterparty and therefore did not qualify for hedge accounting under
FASB No. 133. The fair value of this swap at September 30, 2002 and December 31,
2001 was a liability of $0 and $1.3 million, respectively.
The fair value of the first swap agreement at January 1, 2001 was recorded
as a liability and a transition adjustment in Other Comprehensive Income, which
was amortized over the initial term of the swap ending December 31, 2001. The
change in fair value was $0.7 million and $1.3 million for the three- and
nine-month periods ending September 30, 2002, respectively, as compared with
$0.5 million and $0.8 million the same periods in 2001. The change in fair
value, along with the amortization, is included in charges for derivative
accounting in our Consolidated Statement of Operations.
Under the second swap agreement, which was scheduled to expire December 31,
2002, we received payments when LIBOR exceeded 4.89% and paid the counterparty
when LIBOR was less than 4.89%. The fair value of this interest rate swap at
September 30, 2002 and December 31, 2001 was a liability of $0.3 million and
$0.8 million, respectively. The change in fair value was $0.2 million and $0.6
million for the three- and nine-month periods ending September 30, 2002,
respectively, as compared to $0.5 million and $.08 million for the three- and
nine-month periods in 2001. The change in fair value is included in other
comprehensive income as required under FASB No. 133 for fully effective cash
flow hedges.
The fair values of these interest rate swaps are included in accrued
expenses and other liabilities in our Consolidated Balance Sheet at September
30, 2002 and December 31, 2001.
Notes J - Subsequent Events
On October 1, 2002, we entered into a Master Lease to lease two facilities,
a 60-bed facility in Kendallville, Indiana and an 86-bed facility in
Knightsville, Indiana, to Kendallville Manor Investors, LLC and Cloverleaf of
Knightsville Investors, LLC, respectively, both Indiana limited liability
companies. The initial term for the Master Lease is ten years with an initial
annual rent payment of $540,000. Simultaneously, and in a related transaction,
we sub-leased a 68-bed facility in Owensville, Indiana to Owensville Manor
Investors, LLC, an Indiana limited liability company. The initial term of the
sub-lease shall be for the balance of the term on the Ground Lease, set to
expire on February, 28, 2006, with an initial annual rent payment of $360,000,
as compared to Omega's annual ground lease rent obligation of $518,000. If Omega
is still the tenant under the Ground Lease after one year, then the annual
rental payment under the Kendallville and Knightsville Master Lease permanently
increases by $40,000 per annum beginning in the second lease year.
As a result of re-leasing efforts subsequent to the end of the third
quarter, the total number of Owned and Operated Assets decreased from eight as
of September 30, 2002 to five as of the filing date hereof.
Unrelated to our Owned and Operated assets, on October 1, 2002, we entered
into a Master Lease to re-lease two facilities, formerly leased to Alterra
Healthcare Corporation, including a 36-bed facility and a 42-bed facility in
Jeffersonville, Indiana to Residential Care VIII LLC, an Indiana limited
liability company. The initial term for the two properties is five years with an
initial annual rent payment of $105,000, increasing to $345,000 in the second
lease year.
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion contains forward-looking statements. These
statements relate to our expectations regarding our beliefs, intentions, plans,
objectives, goals, strategies, future events or 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 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 report and
only speak as of 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 such forward-looking statements as a result
of a variety of factors, including, among other things: (i) our ability to
dispose of assets held for sale on a timely basis and at appropriate prices;
(ii) uncertainties relating to the operation of our Owned and Operated Assets,
including those relating to reimbursement by third-party payors, regulatory
matters and occupancy levels; (iii) our ability to manage, re-lease or sell our
owned and operated facilities; (iv) regulatory and other changes in the
healthcare sector; (v) the ability of our 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 a bankruptcy proceeding and
retain security deposits for the debtor's obligations; (vi) competition in the
financing of healthcare facilities; (vii) the effect of economic and market
conditions generally, and particularly in the healthcare industry; (viii)
changes in interest rates; (ix) the amount and yield of any additional
investments; (x) changes in tax laws and regulations affecting real estate
investment trusts; (xi) access to the capital markets and the cost of capital;
(xii) changes in the ratings of our debt securities; and (xiii) the risk factors
discussed in Note C - Concentration of Risk and Related Issues.
Results of Operations
The following is a discussion of our consolidated results of operations,
financial position and liquidity and capital resources which should be read in
conjunction with the consolidated financial statements and accompanying notes.
See Note B - Properties and Note C - Concentration of Risk and Related Issues.
Revenues for the three- and nine-month periods ending September 30, 2002
totaled $30.9 million and $109.2 million, respectively, a decrease of $35.9
million and $92.5 million from the same periods ending September 30, 2001.
Excluding nursing home revenues for Owned and Operated assets, revenues were
$24.1 million and $68.5 million, respectively, for the three- and nine-month
periods ending September 30, 2002, an increase of $1.1 million and $0.4 million
from the comparable prior year periods.
Rental income for the three- and nine-month periods ending September 30,
2002 was $16.5 million and $47.6 million, respectively, an increase of $1.6
million and $1.9 million over the same periods in 2001. The $1.6 million
increase for the three-month period is due to $0.2 million relating to
contractual increases in rents that became effective in 2002 and $2.2 million
relating to leases on assets previously classified as owned and operated, offset
by a $0.7 million reduction in lease revenue due to foreclosures, bankruptcies
and restructurings and $0.1 million from a property that was sold in 2001. The
$1.9 million increase in the nine-month period is due to $0.6 million relating
to leases with contractual increases in rents that became effective in 2002 and
$5.6 million relating to assets previously classified as owned and operated,
offset by a $4.1 million reduction in lease revenue due to foreclosures,
bankruptcies and restructurings and $0.2 million from a property that was sold
in 2001.
Mortgage interest income for the three- and nine-month periods ending
September 30, 2002 totaled $5.3 million and $15.9 million, respectively, an
increase of $0.2 million and a decrease of $0.4 million from the same periods in
2001. The $0.2 million increase in the three-month period is due to $0.3 million
of new investments placed in 2001, offset by reduced investments resulting from
the payoffs of mortgage notes, reduction in interest due to foreclosures,
bankruptcies, restructurings and normal amortization of $0.1 million. The $0.4
million decrease in the nine-month period is due to reduced investments
resulting from the payoffs and restructuring and deferrals of mortgage notes of
$1.3 million, reduced interest due to normal amortization of $0.1 million,
offset by $1.0 million of new investments placed in 2001.
Nursing home revenues of owned and operated assets for the three- and
nine-month periods ending September 30, 2002 totaled $6.8 million and $40.8
million, respectively, a decrease of $37.0 million and $92.8 million from the
same periods in 2001. This is due to a significant decrease in the number of
operated facilities versus the same period in 2001 (eight at September 30, 2002
as compared to 60 at September 30, 2001).
Expenses for the three- and nine-month periods ending September 30, 2002
totaled $40.9 million and $115.0 million, respectively, a decrease of $26.5
million and $100.0 million compared with expenses of $67.4 million and $215.0
million, respectively, for the three- and nine-month periods ending September
30, 2001. Excluding nursing home expenses of owned and operated assets, expenses
were $21.2 million for the three-month period ending September 30, 2002 versus
$23.0 million for the same period in 2001 and $58.1 million for the nine-month
period ending September 30, 2002 versus $80.5 million for the same period in
2001.
Nursing home expenses for owned and operated assets for the three- and
nine-month periods ending September 30, 2002 were $19.7 million and $56.9
million, respectively, a decrease of $24.7 million and $77.7 million from the
same periods in 2001. During the three-month period ended September 30, 2002, a
non-cash provision of $5.0 million for uncollectable accounts receivable related
to our Owned and Operated assets was recorded. In addition, we recorded $1.7
million for the termination of our leasehold interest in three Alabama skilled
nursing facilities that were classified as Owned and Operated assets. This
offset is due to 52 fewer facilities in 2002 versus the same period in 2001.
The provision for depreciation and amortization totaled $5.3 million and
$16.0 million, respectively, for the three- and nine-month periods ending
September 30, 2002. This $0.2 million and $0.6 million decrease versus the same
periods in 2001 is primarily due to assets sold in 2001 and lower depreciable
values due to impairment charges on owned and operated properties recorded
during 2001.
Interest expense for the three- and nine-month periods ending September 30,
2002 was $6.4 million and $21.7 million, respectively, compared with $9.1
million and $28.0 million for the same periods in 2001. This decrease is
primarily due to a $106.5 million reduction of total outstanding debt and lower
average interest rates versus the same periods in 2001.
General and administrative and legal expenses for the three- and nine-month
periods ending September 30, 2002, totaled $2.2 million and $7.3 million,
respectively, compared with $3.3 million and $10.6 million, respectively, for
the same periods in 2001. The decrease is due to a reduction in staffing, as
well as a reduction in consulting and legal costs primarily related to our owned
and operated facilities.
During the nine-month period ended September 30, 2001, we recorded a $10.0
million litigation settlement expense related to a suit brought against us by
Karrington Health, Inc. ("Karrington"). On December 29, 1998, Karrington brought
suit against us alleging that we repudiated and ultimately breached a financing
contract and was seeking recovery of approximately $34.0 million in damages it
alleges to have incurred as a result of the breach. On August 13, 2001, we paid
Karrington $10.0 million to settle all claims arising from the suit, but without
admission of any liability or fault by us, which liability is expressly denied.
Based on the settlement, the suit was dismissed with prejudice.
A provision for impairment of $2.4 million and $4.9 million for the three-
and nine-month periods ending September 30, 2002 and $0.0 and $8.4 million for
the three- and nine-month periods ending September 30, 2001 is included in
expenses. The $2.4 million provision was to reduce the carrying value of one
owned and operated building and three core buildings that were closed during the
quarter to their fair value less costs to dispose. These buildings are being
actively marketed for sale; however, there can be no assurance if or when such
sales will be completed or whether such sales will be completed on terms that
allow us to realize the carrying value of the assets. The $4.9 million for the
nine-month period ending September 30, 2002 was to reduce the value of three
closed owned and operated buildings and three closed core buildings to their
fair value less cost to dispose. The $8.4 million provision for the nine-month
period ending September 30, 2001 was to reduce the cost basis of assets
recovered from a defaulting operator to their fair value less cost to dispose.
Charges of $5.2 million and $8.9 million for provision for uncollectible
mortgages, notes and accounts receivable were recognized during the three- and
nine-month periods ending September 30, 2002 as compared with $0.0 and $0.7
million for the same time period in 2001. The $5.2 million charge was primarily
related to the write down of one loan to a bankrupt operator during the quarter.
The $8.9 million consists primarily of the write down of the loan during the
quarter as well as the restructuring and reduction of debt owed by Madison/OHI
Liquidity Investors, LLC ("Madison"), as part of the compromise and settlement
of a lawsuit with Madison which occurred in the second quarter of 2002. On June
21, 2000, we were named as a defendant in certain litigation brought against us
by Madison, for the breach and/or anticipatory breach of a revolving loan
commitment. We filed counterclaims against Madison and its guarantors seeking
repayment of approximately $7.4 million of unpaid principal on the loan, plus
accrued interest. After the trial began on July 22, 2002, the parties agreed to
settle all claims in the suit in consideration of the payment to us by Madison
of the sum of $5.4 million, consisting of $0.4 million in cash and a $5.0
million note. See Note G - Litigation. A charge of $0.7 million was taken during
the nine-month period ending September 30, 2001 relating to write-off of rents
due from a defaulting operator.
Severance, moving and consulting agreement costs of $4.3 million and $4.8
million were recognized during the three- and nine-month periods ended September
30, 2001. The severance, moving and consulting agreement costs of $4.3 million
were recorded in the three-month period ended September 30, 2001 in connection
with our planned relocation to Maryland. The nine-month period ended September
30, 2001 also included $0.5 million related to the termination of an employment
contract with an officer of our company.
During the three-month period ending September 30, 2002, we sold our
investment in Omega Worldwide, Inc. ("Worldwide"). Pursuant to a tender offer by
Four Seasons Health Care Limited ("Four Seasons") for all of the outstanding
shares of common stock of Worldwide, we sold our investment, which consisted of
1.2 million shares of common stock and 260,000 shares of preferred stock, to
Four Seasons for cash proceeds of approximately $7.4 million (including $3.5
million for preferred stock liquidation preference and accrued preferred
dividends). In addition, we sold our investment in Principal Healthcare Finance
Limited, an Isle of Jersey company ("PHFL"), which consisted of 990,000 ordinary
shares and warrants to purchase 185,033 ordinary shares, to an affiliate of Four
Seasons for cash proceeds of $2.8 million. Both transactions were completed in
September 2002 and provided aggregate cash proceeds of $10.2 million. We
realized a gain from the sale of our investments in Worldwide and PHFL of $2.2
million. As of September 30, 2002, we no longer own any interest in Worldwide or
PHFL. For the nine-month period ending September 30, 2002, we sold one building,
realizing proceeds of $1.0 million, net of closing costs, resulting in a loss of
$0.3 million, as well as the above mentioned Worldwide and PHFL transaction. For
the three-month period ending September 30, 2001, we disposed of one healthcare
facility resulting in a loss on sale of $1.5 million. The loss on sale of $0.9
million for the nine-month period ended September 30, 2001 includes a gain on
sale of $0.6 million from the sale of three healthcare facilities.
During the nine-month period ending September 30, 2002, we recorded a loss
of $0.1 million related to the early retirement of $63.1 million of our 6.95%
Notes due June, 2002. See Liquidity and Capital Resources. We recorded a gain of
$0.2 million and $3.0 million, respectively, for the three- and nine-month
periods ending September 30, 2001 related to the early retirement of $3.9
million and $25.4 million, respectively, of these same 6.95% Notes.
Funds from operations ("FFO") for the three- and nine-month periods ending
September 30, 2002 was a deficit of $7.7 million and $1.0 million, respectively,
a decrease of $8.2 million and an increase of $1.3 million, as compared with
$0.5 million and a deficit of $2.3 million for the same periods in 2001 due to
the results described above. Fully diluted FFO was a deficit of $5.1 million and
a positive $6.9 million, respectively, for the three- and nine-month periods
ending September 30, 2002, a decrease of $8.2 million and an increase of $1.4
million, as compared with a positive $3.1 million and $5.5 million for the same
periods in 2001. FFO is defined as net earnings available to common
stockholders, excluding any gains or losses from debt restructuring, the effects
of asset dispositions and impairments, plus depreciation and amortization
associated with real estate investments. Diluted FFO is adjusted for the assumed
conversion of Series C Preferred Stock and the exercise of in-the-money stock
options. We consider FFO to be one performance measure which is helpful to
investors of real estate companies because, along with cash flows from operating
activities, financing activities and investing activities, it provides investors
an understanding with our ability to incur and service debt, to make capital
expenditures and to pay dividends to our stockholders. FFO, in and of itself,
does not represent cash generated from operating activities in accordance with
GAAP and therefore should not be considered an alternative to net earnings as an
indication of operating performance or to net cash flow from operating
activities as determined by GAAP as a measure of liquidity and is not
necessarily indicative of cash available to fund cash needs.
No provision for federal income taxes has been made since we continue to
qualify as a REIT under the provisions of Sections 856 through 860 of the
Internal Revenue Code of 1986, as amended. Accordingly, we have not been subject
to federal income taxes on amounts distributed to stockholders, since we have
distributed at least 90% of our REIT taxable income for taxable year 2001 (95%
prior to 2001) and have met certain other conditions.
Medicare Developments
During the year 2000, Congress enacted various legislation which was
intended to provide some relief to the extensive Medicare cut-backs resulting
from the Balanced Budget Act of 1997. The relief came in the form of four add-on
payments.
On September 30, 2002, two of the add-ons, the 4% increase for all patient
categories in the Resource Utilization Group ("RUG") system and the 16.7%
increase for nursing-related costs, expired. Earlier this year, the other two
add-on payments, were extended by the Centers for Medicare and Medicaid Services
("CMS") through September 30, 2003.
Partially offsetting the elimination of these add-ons, CMS provided a 2.6%
market basket increase in payments to skilled nursing facilities.
Overall, the elimination of these two add-ons is expected to have an
adverse affect on all of our skilled nursing home operators, and result in a
decrease in operating performance to rent coverage. While we believe the wide
diversification of our portfolio coupled with the sustainable capital structure
of most of our operators will not result in a material interruption in revenue,
we cannot predict the ultimate response to these Medicare cuts.
Furthermore, we believe there remains some likelihood that these add-ons
could be partially reinstated by Congress either during the "lame duck" session
prior to year end, or when Congress reconvenes in January 2003.
Portfolio Developments
During the quarter, we entered into a Master Lease to lease two facilities,
previously classified as Owned and Operated, one in Indiana and the other in
Ohio, to Hickory Creek Healthcare Foundation, Inc., a Georgia not-for-profit
corporation. The initial term of the Master Lease is for ten years and includes
an option to renew for an additional ten years. The initial annual base rent is
$415,000. Also during the quarter, we closed three buildings that were
previously leased to USA Healthcare, Inc. The Master Lease was amended to remove
the three buildings with no reduction in rental income. In addition, we
terminated our leasehold interest in three Alabama skilled nursing facilities.
See Note B -Properties. As a result of the above mentioned transactions, the
total number of Owned and Operated assets declined by five, leaving eight
remaining facilities at quarter end. See Note J - Subsequent Events.
During the three months ended September 30, 2002, Ciena Health Care
Management paid off, in full, their existing $8.7 million mortgage on four
Michigan facilities.
We are continuing our negotiations with Integrated Health Services, Inc.
and its affiliate, Lyric Health Care LLC, to reach a permanent restructuring
agreement or to transition the facilities to a new operator or operators.
Liquidity and Capital Resources
At September 30, 2002, we had total assets of $823.9 million, stockholders'
equity of $491.5 million and debt of $319.5 million, representing approximately
39.4% of total capitalization.
We have two secured revolving credit facilities, providing up to $225.0
million of financing. At September 30, 2002, $189.8 million was outstanding and
$12.5 million was utilized for the issuance of letters of credit, leaving
availability of $22.7 million.
On December 21, 2001, we reached amended agreements with the bank groups
under both of our revolving credit facilities. The amendments became effective
as of the closing of the rights offering and private placement to Explorer
Holdings, L.P. ("Explorer") on February 21, 2002. The amendments included
modifications and/or eliminations to certain financial covenants.
The amendment regarding our $175.0 million revolving credit facility
included a one-year extension in maturity from December 31, 2002 to December 31,
2003 and a reduction in the total commitment from $175.0 million to $160.0
million.
As part of the amendment regarding our $75.0 million revolving credit
facility, we prepaid $10.0 million in December 2001, originally scheduled to
mature in March 2002. This voluntary prepayment resulted in a permanent
reduction in the total commitment, thereby reducing the credit facility to $65.0
million. Our $65.0 million line of credit facility expires on June 30, 2005. See
Note H - Borrowing Arrangements.
In prior years, we have historically distributed to stockholders a large
portion of the cash available from operations. Our historical policy has been to
make distributions on common stock of approximately 80% of FFO, but on February
1, 2001, we announced the suspension of all common and preferred dividends. This
action was intended to preserve cash to facilitate our ability to obtain
financing to fund the 2002 debt maturities. Additionally, on March 30, 2001, we
exercised our option to pay the accrued $4,666,667 Series C dividend from
November 15, 2000 and the associated waiver fee by issuing 48,420 Series C
preferred shares to Explorer on April 2, 2001, which is convertible into 774,720
shares of our common stock at $6.25 per share.
No preferred or common cash dividends were paid during the first nine
months ending September 30, 2002 and 2001, respectively. See Note D - Dividends.
We can give no assurance as to when or if the dividends will be reinstated on
the preferred stock or common stock, or the amount of the dividends if and when
such payments are recommenced. Prior to recommencing the payment of dividends on
our common stock, all accrued and unpaid dividends on our Series A, B and C
preferred stock must be paid in full. We have made sufficient distributions to
satisfy the distribution requirements under the REIT rules to maintain its REIT
status for 2001 and intend to satisfy such requirements under the REIT rules for
2002. In aggregate, preferred dividends continue to accumulate at approximately
$5.0 million per quarter.
On February 6, 2002, we refinanced our investment in a Baltimore, Maryland
asset leased by the United States Postal Service ("USPS") resulting in $13.0
million of net cash proceeds. The new, fully-amortizing mortgage has a 20-year
term with a fixed interest rate of 7.26%. This transaction is cash neutral to us
on a monthly basis, as lease payments due from USPS equal debt service on the
new loan.
On February 21, 2002, we raised gross proceeds of $50.0 million through the
completion of a rights offering and simultaneous private placement to Explorer.
The proceeds from the rights offering and private placement were used to repay
outstanding indebtedness and for working capital and general corporate purposes.
During June, 2002, we paid off the remaining $61.9 million of our 6.95%
Notes maturing in June 2002. In addition, during June 2002, our HUD obligation
of $5.2 million was removed from our Consolidated Balance Sheet as a result of
foreclosure proceedings.
During the three-month period ended September 30, 2002, we repaid $17.9
million of LIBOR based borrowings associated with our revolving credit
facilities. At September 30, 2002, we had $189.8 million of LIBOR based
borrowings outstanding and $12.5 million of letters of credit outstanding,
leaving availability of $22.7 million.
We believe our liquidity and various sources of available capital,
including funds from operations and expected proceeds from planned asset sales
are adequate to finance operations, meet recurring debt service requirements and
fund future investments through the next 12 months.
Item 3 - Quantitative and Qualitative Disclosure About Market Risk
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.
The market value of our long-term fixed rate borrowings and mortgages are
subject to interest rate risk. Generally, the market value of fixed rate
financial instruments will decrease as interest rates rise and increase as
interest rates fall. The estimated fair value of our total long-term borrowings
at September 30, 2002 was $304.6 million. A one-percent increase in interest
rates would result in a decrease in the fair value of long-term borrowings by
approximately $3.8 million.
We are subject to risks associated with debt or preferred equity financing,
including the risk that existing indebtedness may not be refinanced or that the
terms of such refinancing may not be as favorable as the terms of current
indebtedness. See Management's Discussion and Analysis of Financial Condition
and Results of Operations - Liquidity and Capital Resources.
We utilize interest rate swaps and hedges to fix interest rates on variable
rate debt and reduce certain exposures to interest rate fluctuations. We do not
use derivatives for trading or speculative purposes. We have a policy of only
entering into contracts with major financial institutions based upon their
credit ratings and other factors. When viewed in conjunction with the underlying
and offsetting exposure that the derivatives are designed to hedge, we have not
sustained a material loss from those instruments nor do we anticipate any
material adverse effect on our net income or financial position in the future
from the use of derivatives.
To manage interest rate risk, we may employ options, forwards, interest
rate swaps, caps and floors or a combination thereof depending on the underlying
exposure. We may employ swaps, forwards or purchased options to hedge qualifying
forecasted transactions. Gains and losses related to these transactions are
deferred and recognized in net income as interest expense in the same period or
periods that the underlying transaction occurs, expires or is otherwise
terminated. In June 1998, the Financial Accounting Standards Board ("FASB")
issued Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities, which was required to be adopted in years beginning after June 15,
2000. We adopted the new Statement effective January 1, 2001. The Statement
requires us to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through income.
If the derivative is a hedge, depending on the nature of the hedge, changes in
the fair value of derivatives will either be offset against the change in fair
value of the hedged assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedge item is recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings.
In September 2002, we entered into a 61-month, $200.0 million interest rate
cap with a strike of 3.50% that has been designated as a cash flow hedge. Under
the terms of the cap agreement, when LIBOR exceeds 3.50%, the counterparty will
pay us $200.0 million multiplied by the difference between LIBOR and 3.50% times
the number of days when LIBOR exceeds 3.50%. The unrealized gain/loss in the
fair value of cash flow hedges are reported on the balance sheet with
corresponding adjustments to accumulated other comprehensive income. On
September 30, 2002, the derivative instrument was reported at its fair value as
an Other Asset of $8.6 million. An adjustment of $1.5 million to Other
Comprehensive Income was made for the change in fair value of this cap during
the quarter. Over time, the unrealized loss held in accumulated Other
Comprehensive Income will be reclassified to earnings. This reclassification is
consistent with the recognition of earnings for hedged items. Over the next
twelve months, $44,000 is expected to be reclassified to earnings from Other
Comprehensive Income.
Also in September 2002, we terminated two interest rate swaps with notional
amounts of $32.0 million each. Under the terms of the first swap agreement,
which would have expired on December 2002, we received payments when LIBOR
exceeded 6.35% and paid the counterparty when LIBOR was less than 6.35%. This
interest rate swap was extended in December 2001 to December 2002 at the option
of the counterparty and therefore did not qualify for hedge accounting under
FASB No. 133. The fair value of this swap at September 30, 2002 and December 31,
2001 was a liability of $0 and $1.3 million, respectively.
The initial liability associated with the first swap agreement at January
1, 2001 was recorded as a transition adjustment in Other Comprehensive Income
and was recognized over the initial term of the swap ending December 31, 2001.
As such, the liability was fully amortized by December 31, 2001. The change in
fair value was $0.7 million and $1.3 million for the three- and nine-month
periods ending September 30, 2002, respectively, as compared with $0.5 million
and $0.8 million the same periods in 2001. The change in fair value, along with
the amortization, is included in charges for derivative accounting in our
Consolidated Statement of Operations.
Under the second swap agreement, which was scheduled to expire December 31,
2002, we received payments when LIBOR exceeded 4.89% and paid the counterparty
when LIBOR was less than 4.89%. The fair value of this interest rate swap at
September 30, 2002 and December 31, 2001 was a liability of $0.3 million and
$0.8 million, respectively. The change in fair value of $0.2 million and $0.6
million for the three- and nine-month periods ending September 30, 2002,
respectively, as compared to $0.5 million and $.08 million for the three- and
nine-month periods in 2001. The change in fair value is included in other
comprehensive income as required under FASB No. 133 for fully effective cash
flow hedges.
The fair values of these interest rate swaps are included in accrued
expenses and other liabilities in our Consolidated Balance Sheet at September
30, 2002 and December 31, 2001.
Item 4 - Control and Procedures
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures within 90 days of the filing date of this quarterly
report and, based on that evaluation, our principal executive officer and
principal financial officer have concluded that these controls and procedures
are effective. There have been no significant changes in our internal controls
or in other factors that could significantly affect these controls subsequent to
the date of the evaluation.
Disclosure controls and procedures are the controls and other procedures
designed to ensure that information that we are required to disclose in our
reports under the Exchange Act is recorded, processed, summarized and reported
within the time periods required. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
we are required to disclose in the reports that we file under the Exchange Act
is accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate to allow
timely decisions regarding required disclosure.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
See Note G - Litigation to the Consolidated Financial Statements in Item 1
hereto, which is hereby incorporated by reference in response to this item.
Item 2. Changes in Securities and Use of Proceeds
None this period.
Item 3. Defaults upon Senior Securities
(a) Payment Defaults. Not Applicable.
(b) Dividend Arrearages. On February 1, 2001, we announced the suspension
of dividends on all common and preferred stock. See Management's
Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources. Dividends on our
preferred stock are cumulative: therefore, all accrued and unpaid
dividends on our Series A, B and C Preferred Stock must be paid in
full prior to recommencing the payment of cash dividends on our Common
Stock. In aggregate, preferred dividends continue to accumulate at
approximately $5.0 million per quarter. The table below sets forth
information regarding arrearages in payment of preferred stock
dividends:
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Annual Dividend Arrearage as of
Title of Class Per Share September 30, 2002
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9.25% Series A Cumulative
Preferred Stock $ 2.3125 $ 9,307,813
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8.625% Series B Cumulative
Preferred Stock $ 2.1563 $ 7,546,875
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Series C Convertible
Preferred Stock $ 10.0000 $ 18,144,693
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TOTAL $ 34,999,381
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Since dividends on the Series A and Series B Preferred Stock have been in
arrears for more than 18 months, the holders of the Series A and Series B
Preferred Stock (voting together as a single class) continue to have the right
to elect two additional directors to our Board of Directors in accordance with
the terms of the Series A and Series B Preferred Stock and our Bylaws. Explorer,
the sole holder of the Series C Preferred Stock, also has the right to elect two
other additional directors to our Board of Directors in accordance with the
terms of the Series C Preferred Stock and our Bylaws. Explorer, without waiving
its rights under the terms of the Series C Preferred Stock or the Stockholders
Agreement, has advised us that it is not currently seeking the election of the
two additional directors resulting from the Series C dividend arrearage unless
the holders of the Series A and Series B Preferred Stock seek to elect
additional directors.
Item 4. Submission of Matters to a Vote of Security Holders
None this period.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit - The following Exhibits are filed herewith:
Exhibit Description
99.1 Certification of the Chief Executive Officer under Section
302 of the Sarbanes - Oxley Act of 2002.
99.2 Certification of the Chief Financial Officer under Section
302 of the Sarbanes - Oxley Act of 2002.
(b) Reports on Form 8-K - none were filed.
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 1, 2002 By: /s/ C. TAYLOR PICKETT
--------------------------------
C. Taylor Pickett
Chief Executive Officer
Date: November 1, 2002 By: /s/ ROBERT O. STEPHENSON
--------------------------------
Robert O. Stephenson
Chief Financial Officer