10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on July 31, 2003
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM 10-Q
(MARK ONE)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
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 BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT).
YES X NO
----- -----
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES
OF COMMON STOCK AS OF JUNE 30, 2003.
COMMON STOCK, $.10 PAR VALUE 37,156,554
(CLASS) (NUMBER OF SHARES)
OMEGA HEALTHCARE INVESTORS, INC.
FORM 10-Q
JUNE 30, 2003
INDEX
Page No.
PART I Financial Information
Item 1. Consolidated Financial Statements:
Balance Sheets
June 30, 2003 (unaudited)
and December 31, 2002.................................... 2
Statements of Operations (unaudited)
Three and six months ended
June 30, 2003 and 2002................................... 3
Statements of Cash Flows (unaudited)
Six months ended
June 30, 2003 and 2002................................... 4
Notes to Consolidated Financial Statements
June 30, 2003 (unaudited)................................ 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............ 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk... 27
Item 4. Controls and Procedures...................................... 28
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, 2002 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
JUNE 30, 2003
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) considered necessary
for a fair presentation have been included. Certain reclassifications have been
made to the 2002 financial statements for consistency with the presentation
adopted for 2003. Such reclassifications have no effect on previously reported
earnings or equity.
In April 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("FAS
145"), which stipulates that gains and losses from extinguishment of debt
generally will not be reported as extraordinary items effective for fiscal years
beginning after May 15, 2002. We adopted this standard effective January 1,
2003. FAS 145 also specifies that any gain or loss on extinguishment of debt
that was classified as an extraordinary item in prior periods presented that
does not meet the criteria in Opinion 30 for classification as an extraordinary
item shall be reclassified. Therefore, the $77,000 and $49,000 loss on
extinguishment of debt previously reported for the three- and six-month periods
ended June 30, 2002, respectively, has been reclassified to interest expense in
our Consolidated Statements of Operations.
Due to the decrease in size of the owned and operated portfolio (one
facility as of June 30, 2003), the operations of such facilities and the net
assets employed therein are no longer considered a separate reportable segment.
Accordingly, commencing January 1, 2003, 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.
Operating results for the three- and six-month periods ended June 30, 2003
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2003. 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, 2002.
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 sell 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 is under contract, 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. Long-lived assets designated as held for sale prior to January 1,
2002 are subject to FASB 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed.
The table below summarizes our number of properties and investment by
category for the quarter ended June 30, 2003:
PURCHASE/LEASEBACK
During the three-month period ended June 30, 2003, there were no re-leases
or transfers of open facilities; however, in July, we re-leased five former Sun
Healthcare Group, Inc. ("Sun") skilled nursing facilities ("SNFs") to three
separate operators. Also in July, we amended our Master Lease with a subsidiary
of Alterra Healthcare Corporation ("Alterra"). (See Note J - Subsequent Events).
During the three-month period ended March 31, 2003, we successfully
re-leased nine facilities formerly operated by Integrated Health Services, Inc.
("IHS"). Accordingly, eight SNFs, which we held mortgages on, and one SNF, which
we leased to IHS, have been re-leased to various unaffiliated third parties.
Titles to the eight properties, which we held mortgages on, have been
transferred to wholly-owned subsidiaries of ours by Deeds in Lieu of
Foreclosure.
Specifically, during the quarter ended March 31, 2003, we leased nine SNFs
to four unaffiliated third-party operators as part of four separate
transactions. Each of the nine facilities had formerly been operated by
subsidiaries of IHS. The four transactions included: (i) a Master Lease of five
SNFs in Florida representing 600 beds to affiliates of Seacrest Healthcare
Management, LLC, which lease has a ten-year term and has an initial annual rent
of $2.5 million; (ii) a month-to-month lease (following a minimum four-month
term) on two SNFs in Georgia representing 304 beds to subsidiaries of Triad
Health Management of Georgia, LLC, which lease provides for annualized rent of
$0.7 million - the month-to-month structure results from Georgia Medicaid rate
cuts (effective February 1, 2003) and the potential for future Georgia
reimbursement changes; (iii) a lease of one SNF in Texas, representing 130 beds,
to an affiliate of Senior Management Services of America, Inc., which lease has
a ten-year term and has various rent step-ups, reaching $384,000 by year three,
thereafter, increasing by the lesser of CPI or 2.5%; and (iv) re-leased one
159-bed SNF, located in the state of Washington to a subsidiary of Sun, with an
initial lease term of eight years and initial annual rent of $0.5 million.
In an unrelated transaction during the first quarter of 2003, we recorded a
provision for impairment of $4.6 million associated with one closed facility,
located in the state of Washington, previously leased to a subsidiary of Sun as
part of a Master Lease. We intend to sell this closed facility as soon as
practicable; however, there can be no assurance if, or when, this sale will be
completed.
Also during the first quarter of 2003, we completed a restructured
transaction with Claremont Health Care Holdings, Inc. ("Claremont") (formerly
Lyric Health Care, LLC) whereby nine facilities formerly leased under two Master
Leases were combined into one new ten-year Master Lease. Annual rent under the
new lease is $6.0 million, the same amount of rent recognized in 2002 for these
properties. (See Note J - Subsequent Events).
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 become 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 June 30, 2003, fee-simple ownership of two
closed facilities, which we held mortgages on, were transferred to us by Deed in
Lieu of Foreclosure. These facilities have been transferred to closed facilities
and are included in our Consolidated Balance Sheet under "Land and buildings at
cost." 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.
During the three months ended March 31, 2003, fee-simple ownership of eight
facilities were transferred to us as discussed above (see "Purchase/Leaseback"
above). In addition, in an unrelated transaction with IHS, we received
fee-simple ownership to one closed property, which we previously held the
mortgage on, by Deed in Lieu of Foreclosure. This facility was transferred to
closed facilities and is included in our Consolidated Balance Sheet under "Land
and buildings at cost."
No provision for loss on mortgages or notes receivable was recorded during
the three- and six-month periods ended June 30, 2003 and 2002, respectively.
OWNED AND OPERATED ASSETS
At June 30, 2003, we own one, 128-bed facility that was previously
recovered from a customer and is operated for our own account. We intend to
operate the remaining owned and operated asset for our own account until we are
able to re-lease, sell or close the facility. The facility and its respective
operations are presented on a consolidated basis in our financial statements.
Nursing home revenues, nursing home expenses, assets and liabilities
included in our consolidated financial statements which relate to such owned and
operated asset are set forth in the tables below. Nursing home revenues from
this owned and operated asset 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. For 2003, nursing home revenues, nursing home expenses, operating
assets and operating liabilities for our owned and operated properties are shown
on a net basis on the face of our consolidated financial statements. For 2002,
nursing home revenues, nursing home expenses, operating assets and operating
liabilities for our owned and operated properties are shown on a gross basis on
the face of our consolidated financial statements.
Nursing home revenues and nursing home expenses in our consolidated
financial statements which relate to our owned and operated assets are as
follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2003 2002 2003 2002
------------------ ------------------
(In thousands) (In thousands)
Nursing home revenues (1)
Medicaid............................. $ 614 $ 7,488 $ 1,469 $20,991
Medicare............................. 180 2,814 452 7,071
Private & other...................... 251 1,908 663 5,896
------------------ ------------------
Total nursing home revenues (2).... 1,045 12,210 2,584 33,958
------------------ ------------------
Nursing home expenses
Patient care expenses................ 557 7,832 1,423 23,110
Administration....................... 490 3,743 1,601 8,245
Property & related................... 51 883 260 2,475
Leasehold buyout expense............. - - 582 -
Management fees...................... 52 678 128 1,878
Rent................................. - 349 28 1,477
------------------ ------------------
Total nursing home expenses (2).... 1,150 13,485 4,022 37,185
------------------ ------------------
Nursing home revenues and expenses of
owned and operated assets - net (2)..$ (105) $ - $(1,438) $ -
================== ==================
(1) Nursing home revenues from these owned and operated assets are recognized
as services are provided.
(2) Nursing home revenues and expenses of owned and operated assets for the
three- and six-months ended June 30, 2003 are shown on a net basis on the
face of our Consolidated Statements of Operations and are shown on a gross
basis for the three- and six-months ended June 30, 2002.
Accounts receivable for owned and operated assets is net of an allowance
for doubtful accounts of approximately $11.7 million at June 30, 2003 and $5.7
million at June 30, 2002.
JUNE 30,
-----------------------
2003 2002
-----------------------
(In thousands)
Beginning balance..................... $12,171 $ 8,335
Provision charged/(recovery).......... - (750)
Provision applied..................... (829) (1,880)
Collection of accounts receivable
previously written off................ 321 -
-----------------------
Ending balance........................ $11,663 $ 5,705
=======================
The assets and liabilities in our consolidated financial statements which
relate to our owned and operated assets are as follows:
June 30, December 31,
2003 2002
--------------------------
(In thousands)
ASSETS
Cash ......................................... $ 668 $ 838
Accounts receivable - net (1)................. 2,793 7,491
Other current assets (1)...................... 411 1,207
--------------------------
Total current assets....................... 3,872 9,536
--------------------------
Investment in leasehold - net (1)............. - 185
--------------------------
Land and buildings............................ 5,295 5,571
Less accumulated depreciation................. (605) (675)
--------------------------
Land and buildings - net...................... 4,690 4,896
--------------------------
Assets held for sale - net.................... 2,227 2,324
--------------------------
Total assets............................... $10,789 $16,941
==========================
LIABILITIES
Accounts payable.............................. $ 153 $ 389
Other current liabilities..................... 3,660 4,223
--------------------------
Total current liabilities.................. 3,813 4,612
--------------------------
Total liabilities (1)......................... $ 3,813 $ 4,612
==========================
Operating assets and liabilities for owned
properties - net (1)........................ $ (609) $ -
==========================
(1) Operating assets and liabilities for owned properties as of June 30, 2003
are shown on a net basis on the face of our Consolidated Balance Sheet and
are shown on a gross basis as of December 31, 2002.
CLOSED FACILITIES
During the quarter ended June 30, 2003, two facilities were transferred to
closed facilities. Both facilities were transferred from mortgage notes
receivable after we received a Deed in Lieu of Foreclosure. At this time it was
determined that no provisions for impairments were needed on the two
investments. We intend to sell the facilities as soon as practicable; however,
there can be no assurance if, or when, these sales will be completed. (See Note
J - Subsequent Events).
During the quarter ended March 31, 2003, three facilities were transferred
to closed facilities. One facility was transferred from purchase leaseback and a
non-cash impairment of $4.6 million was recorded to reduce the value of the
investment to fair value. Another facility was transferred from mortgage notes
receivable after we received a Deed in Lieu of Foreclosure. Finally, we
transferred one facility from our owned and operated portfolio into closed
facilities. No provisions for impairments were needed on the latter two
investments.
At June 30, 2003, there are 13 closed properties of which eight are
currently under a letter of intent to sell or contract for sale. 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.
These properties are included in "Land and buildings at cost" in our
Consolidated Balance Sheet.
ASSETS HELD FOR SALE
During the three-month period ended June 30, 2003, we sold one building
located in Indiana, realizing proceeds of $0.2 million, net of closing costs,
resulting in a gain of $0.1 million. During the three-month period ended June
30, 2002, we sold one building located in Texas, realizing proceeds of $1.0
million, net of closing costs, resulting in a loss of $0.3 million. There were
no sales or transfers of real estate assets held for sale during the three-month
period ended March 31, 2003. During the three-month period ended March 31, 2002,
we realized gross disposition proceeds of $0.1 million associated with the sale
of beds from two facilities.
At June 30, 2003, the carrying value of the remaining three assets held for
sale totaled $2.2 million (net of impairment reserves of $2.8 million). 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. (See Note J - Subsequent Events).
OTHER NON-CORE ASSETS
During the three-month period ended June 30, 2003, we sold an investment in
a Baltimore, Maryland asset, leased by the United States Postal Service, for
approximately $19.6 million. The purchaser paid us gross proceeds of $1.95
million and assumed the first mortgage of approximately $17.6 million. As a
result, we recorded a gain of $1.3 million, net of closing costs and other
expenses.
During the three-month period ended June 30, 2002, a charge of $3.7 million
for provision for uncollectible mortgages, notes and accounts receivable was
recognized. This charge was primarily related to 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. (See Note G - Litigation).
NOTE C - CONCENTRATION OF RISK
As of June 30, 2003, our portfolio of domestic investments consisted of 221
healthcare facilities, located in 28 states and operated by 34 third-party
operators. Our gross investment in these facilities, net of impairments, totaled
$836.8 million at June 30, 2003, with 97.2% of our real estate investments
related to long-term care facilities. This portfolio is made up of 153 long-term
healthcare facilities and two rehabilitation hospitals owned and leased to third
parties, fixed rate mortgages on 52 long-term healthcare facilities, one
long-term healthcare facility that was recovered from a customer and is
currently operated through a third-party management contract for our own account
and 13 long-term healthcare facilities that were recovered from customers and
are currently closed. At June 30, 2003, we also held miscellaneous investments
and assets held for sale of approximately $28.8 million, including a $1.3
million investment in Principal Healthcare Finance Trust and $18.1 million of
notes receivable, net of allowance.
Approximately 49.7% of our real estate investments are operated by four
public companies, including Sun Healthcare Group, Inc. (26.8%), Advocat, Inc.
("Advocat") (12.5%), Mariner Post-Acute Network ("Mariner") (7.1%), and Alterra
Healthcare Corporation ("Alterra") (3.3%). The three largest private operators
represent 10.3%, 4.0% and 3.8%, respectively, of our investments. No other
operator represents more than 2.8% of our investments. The three states in which
we have our highest concentration of investments are Florida (15.4%), California
(8.0%) and Illinois (7.9%). (See Note J - Subsequent Events).
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. 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. Due to our 2002 taxable loss, no
distribution was necessary to maintain our REIT status for 2002. Net operating
loss carry-forwards through 2002 of approximately $24.0 million are available to
help offset taxable income. In addition, we intend to make the necessary
distributions, if any, to satisfy the 2003 REIT requirements. The accumulated
and unpaid dividends relating to all series of preferred stocks total $50.1
million as of June 30, 2003. In aggregate, preferred dividends continue to
accumulate at approximately $5.0 million per quarter.
No preferred or common cash dividends were paid during the first six months
ended June 30, 2003 or the twelve months ended December 31, 2002 and 2001.
In July 2003, our Board of Directors declared a full catch-up of
cumulative, unpaid dividends for all classes of preferred stock to be paid
August 15, 2003 to preferred stockholders of record on August 5, 2003. In
addition, the Board declared the regular quarterly dividend for all classes of
preferred stock to be paid on August 15, 2003 to preferred stockholders of
record on August 5, 2003. (See Note J - Subsequent Events).
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, but has fully reserved its rights.
Upon payment of the preferred dividends on August 15, 2003, the rights of
the holders of the Series A and Series B preferred stock, and of Explorer, the
sole holder of our Series C preferred stock, to elect additional directors
resulting from the dividend arrearage will terminate. Explorer, as the holder of
a majority of the outstanding voting power of us on an as-converted basis, would
still have the right to designate a majority of the full Board pursuant to a
stockholders agreement.
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.
For the three- and six-month periods ended June 30, 2003, stock options
that were in-the-money had a dilutive effect of $0.001 per share and $0.002 per
share, respectively. There were no dilutive effects from stock options
in-the-money for the same periods in 2002.
NOTE F - STOCK-BASED COMPENSATION
We account for stock options using the intrinsic value method as defined by
APB 25, Accounting for Stock Issued to Employees. Under the terms of the 2000
Stock Incentive Plan ("Incentive Plan"), we reserved 3,500,000 shares of common
stock for grants to be issued during a period of up to ten years. Options are
exercisable at the market price at the date of grant, expire five years after
date of grant for over 10% owners and ten years from the date of grant for less
than 10% owners. Directors' shares vest over three years while other grants vest
over five years or as defined in an employee's contract. Directors, officers and
employees are eligible to participate in the Incentive Plan. At June 30, 2003,
there were 2,383,501 outstanding options granted to 19 eligible participants.
Additionally, 342,124 shares of restricted stock have been granted under the
provisions of the Incentive Plan. The market value of the restricted shares on
the date of the award was recorded as unearned compensation-restricted stock,
with the unamortized balance shown as a separate component of stockholders
equity. Unearned compensation is amortized to expense generally over the vesting
period.
Statement of Financial Accounting Standard ("SFAS") No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure, which was effective
January 1, 2003, requires certain disclosures related to our stock-based
compensation arrangements. The following table presents the effect on net income
and earnings per share if we had applied the fair value recognition provisions
of SFAS No. 123, Accounting for Stock-Based Compensation, to our stock-based
compensation.
At June 30, 2003, options currently exercisable (670,051) have a
weighted-average exercise price of $3.684, with exercise prices ranging from
$2.15 to $37.20. There are 594,486 shares available for future grants as of June
30, 2003.
The following is a summary of second quarter 2003 activity under the plan.
Stock Options
-------------------------------------------
Weighted-
Number of Average
Shares Exercise Price Price
- --------------------------------------------------------------------------------
Outstanding at December 31, 2002.... 2,374,501 $2.150 - $37.205 $3.150
Granted during 1st quarter 2003... - - -
Canceled.......................... - - -
- --------------------------------------------------------------------------------
Outstanding at March 31, 2003....... 2,374,501 $2.150 - $37.205 $3.150
Granted during 2nd quarter 2003... 9,000 3.740 - 3.740 3.740
Canceled.......................... - - -
- --------------------------------------------------------------------------------
Outstanding at June 30, 2003........ 2,383,501 $2.150 - $37.205 $3.152
================================================================================
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, 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.
On June 21, 2000, we were named as a defendant in certain litigation
brought against us in the U.S. District Court for the Eastern District of
Michigan, Detroit Division, by Madison/OHI Liquidity Investors, LLC , 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. 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 consisting of a $0.4 million cash payment for
our attorneys' fees, with the balance 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. Accordingly, a reserve of $1.25 million was recorded in 2002 relating
to this note. As of June 30, 2003, the principal balance on this note was $2.2
million prior to reserves.
In 2000, we filed suit against a title company (later adding a law firm as
a defendant), seeking damages based on claims of breach of contract and
negligence, among other things, as a result of the alleged failure to file
certain Uniform Commercial Code ("UCC") financing statements in our favor. We
filed a subsequent suit seeking recovery under title insurance policies written
by the title company. The defendants denied the allegations made in the
lawsuits. In settlement of our claims against the defendants, we agreed in the
first quarter of 2003 to accept a lump sum cash payment of $3.2 million. The
cash proceeds were offset by related expenses incurred of $1.0 million resulting
in a net gain of $2.2 million.
We and several of our wholly-owned subsidiaries have been named as
defendants in professional liability claims related to our owned and operated
facilities. Other third-party managers responsible for the day-to-day operations
of these facilities have also been named as defendants in these claims. In these
suits, patients of certain previously owned and operated facilities have alleged
significant damages, including punitive damages against the defendants. The
lawsuits are in various stages of discovery and we are unable to predict the
likely outcome at this time. We continue to vigorously defend these claims and
pursue all rights we may have against the managers of the facilities, under the
terms of the management agreements. We have insured these matters, subject to
self-insured retentions of various amounts.
NOTE H - BORROWING ARRANGEMENTS
In June, 2003, we completed a new $225 million Senior Secured Credit
Facility ("Credit Facility") arranged and syndicated by GE Healthcare Financial
Services. At the closing, we borrowed $187.1 million under the new Credit
Facility to repay borrowings under our two previous credit facilities and
replace letters of credit. In addition, proceeds from the loan are permitted to
be used to pay cumulative unpaid preferred dividends, and for general corporate
purposes.
The new Credit Facility includes a $125 million term loan ("Term Loan") and
a $100 million revolving line of credit ("Revolver") collateralized by 121
facilities representing approximately half of our invested assets. Both the Term
Loan and Revolver have a four-year maturity with a one-year extension at our
option. The Term Loan amortizes on a 25-year basis and is priced at London
Interbank Offered Rate ("LIBOR") plus a spread of 3.75%, with a floor of 6.00%.
The Revolver is also priced at LIBOR plus a 3.75% spread, with a 6.00% floor.
At June 30, 2003 we had $187.1 million of Credit Facility borrowings
outstanding and $12.5 million of letters of credit outstanding, leaving
availability of $25.4 million. The $187.1 million of outstanding borrowings had
an interest rate of 6.00% at June 30, 2003.
Borrowings under our $160.0 million secured revolving line of credit
facility of $112.0 million were paid in full upon the closing of our new Credit
Facility. Additionally, $12.5 million of letters of credit previously
outstanding against this credit facility were reissued under the new Credit
Facility. LIBOR-based borrowings under this facility had a weighted-average
interest rate of approximately 4.5% at the payoff date.
Borrowings under our $65.0 million line of credit facility, which was fully
drawn, were paid in full upon the closing of our new Credit Facility.
LIBOR-based borrowings under this facility had a weighted-average interest rate
of approximately 4.6% at the payoff date.
As a result of the new Credit Facility, for the three- and six-month
periods ended June 30, 2003, our interest expense includes $2.6 million of
non-cash interest related to the termination of our two previous credit
facilities.
NOTE I - ACCOUNTING FOR DERIVATIVES
We utilize interest rate swaps and caps 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 hedged 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 June 30,
2003, the derivative instrument was reported at its fair value of $4.1 million
as compared to its fair value at December 31, 2002 of $7.3 million. An
adjustment of $2.5 million and $3.2 million to Other Comprehensive Income was
made for the change in fair value of this cap during the three- and six-month
periods ended June 30, 2003, respectively. 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. Over the
twelve months ending December 31, 2003, $0.1 million is expected to be
amortized.
NOTE J - SUBSEQUENT EVENTS
Sun Healthcare Group Inc. On July 1, 2003, we re-leased five skilled
nursing facilities formerly leased by Sun. Specifically, we re-leased the five
former Sun SNFs in the following three separate lease transactions: (i) a Master
Lease of two SNFs in Florida, representing 350 beds, which Master Lease has a
ten-year term and has an initial annual lease rate of $1.3 million; (ii) a
Master Lease of two SNFs in Texas, representing 256 beds, which Master Lease has
a ten-year term and has an initial annual lease rate of $800,000; and (iii) a
lease of one SNF in Louisiana, representing 131 beds, which lease has a ten-year
term and requires an initial annual lease rate of $400,000. Aggregate monthly
contractual lease payments, under all three transactions, total approximately
$208,000 and commenced July 1, 2003.
Separately, we continue our ongoing restructuring discussions with Sun. At
this time, we cannot determine the timing or outcome of these discussions.
However, as a result of the above mentioned transitions of the five former Sun
facilities, Sun's contractual monthly rent, starting in July, was reduced $0.2
million from approximately $2.2 million to approximately $2.0 million. For the
month of July, Sun remitted approximately $1.51 million in lease payments versus
$1.27 million per month for April, May and June. During the second quarter, we
applied $1.37 million of security deposits, which exhausted all remaining
security deposits associated with Sun.
Alterra Healthcare Corporation. Effective July 7, 2003, we amended our
Master Lease with a subsidiary of Alterra whereby the number of leased
facilities was reduced from eight to five. The amended Master Lease has a
remaining term of approximately ten years with an annual rent requirement of
approximately $1.5 million. We are in the process of negotiating terms and
conditions for the re-lease of the remaining three properties. In the interim,
Alterra will continue to operate the facilities. The Amended Master Lease was
approved by the U.S. Bankruptcy Court in the District of Delaware.
Claremont Healthcare Holdings, Inc. Claremont failed to pay base rent due
on July 1, 2003 in the amount of $0.5 million. On July 21, 2003, we drew on a
letter of credit (posted by Claremont as a security deposit) in the amount of
$0.5 million to pay Claremont's July rent payment and we demanded that Claremont
restore the $0.5 million letter of credit. As of the date of this filing, we
have additional security deposits in the form of cash and letters of credit in
the amount of $2.0 million associated with Claremont. We are recognizing revenue
from Claremont on a cash-basis as it is received.
Other Assets. During July, we sold one held for sale facility in Indiana
for proceeds of $0.2 million, net of closing costs, resulting in a gain of
approximately $0.1 million. We also sold one closed facility located in Texas
for proceeds of $1.0 million, net of closing costs, resulting in a gain of
approximately $0.6 million.
Dividends. Our Board of Directors declared a full catch-up of cumulative,
unpaid dividends for all classes of preferred stock to be paid August 15, 2003
to preferred stockholders of record on August 5, 2003. In addition, the Board
declared the regular quarterly dividend for all classes of preferred stock to be
paid on August 15, 2003 to preferred stockholders of record on August 5, 2003.
Series A and Series B preferred stockholders of record on August 5, 2003
will be paid dividends in the amount of approximately $6.36 and $5.93 per
preferred share, respectively, on August 15, 2003. Our Series C preferred
stockholder will be paid dividends of approximately $27.31 per Series C
preferred share on August 15, 2003. The liquidation preference for our Series A,
B and C preferred stock is $25.00, $25.00 and $100.00 per share, respectively,
excluding cumulative unpaid dividends. Total August 2003 dividend payments for
all classes of preferred stock are approximately $55.1 million.
Cumulative unpaid dividends represent unpaid dividends accrued for the
period from November 1, 2000 through April 30, 2003. Regular quarterly dividends
represent dividends for the period May 1, 2003 through July 31, 2003.
Upon payment of the preferred dividends on August 15, 2003, the rights of
the holders of the Series A and Series B preferred stock, and of Explorer, the
sole holder of our Series C preferred stock, to elect additional directors
resulting from the dividend arrearage will terminate. (See Note D - Dividends).
Explorer, as the holder of a majority of the outstanding voting power of us on
an as-converted basis, would still have the right to designate a majority of the
full Board pursuant to a stockholders agreement.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
As of June 30, 2003, our portfolio of domestic investments consisted of 221
healthcare facilities, located in 28 states and operated by 34 third-party
operators. Our gross investment in these facilities, net of impairments, totaled
$836.8 million at June 30, 2003, with 97.2% of our real estate investments
related to long-term care facilities. This portfolio is made up of 153 long-term
healthcare facilities and two rehabilitation hospitals owned and leased to third
parties, fixed rate mortgages on 52 long-term healthcare facilities, one
long-term healthcare facility that was recovered from a customer and is
currently operated through a third-party management contract for our own account
and 13 long-term healthcare facilities that were recovered from customers and
are currently closed. At June 30, 2003, we also held miscellaneous investments
and assets held for sale of approximately $28.8 million, including a $1.3
million investment in Principal Healthcare Finance Trust and $18.1 million of
notes receivable, net of allowance. (See Note J - Subsequent Events).
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with GAAP in the
United States requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period.
We have identified six significant accounting policies as critical
accounting policies. These critical accounting policies are those that have the
most impact on the reporting of our financial condition and those requiring
significant judgments and estimates. With respect to these critical accounting
policies, we believe the application of judgments and assessments is
consistently applied and produces financial information that fairly presents the
results of operations for all periods presented. The six critical accounting
policies are:
Revenue Recognition. Rental income and mortgage interest income are
recognized as earned over the terms of the related Master Leases and mortgage
notes, respectively. Such income includes periodic increases based on
pre-determined formulas (i.e., such as increases in the CPI) as defined in the
Master Leases and mortgage loan agreements. Reserves are taken against earned
revenues from leases and mortgages when collection of amounts due become
questionable or when negotiations for restructurings of troubled operators lead
to lower expectations regarding ultimate collection. When collection is
uncertain, lease revenues are recorded as received, after taking into account
application of security deposits. Interest income on impaired mortgage loans is
recognized as received after taking into account application of security
deposits.
Nursing home revenues from owned and operated assets (primarily Medicare,
Medicaid and other third-party insurance) are recognized as patient services are
provided.
Impairment of Assets. We periodically evaluate our real estate investments
for impairment indicators. The judgment regarding the existence of impairment
indicators are based on factors such as market conditions, operator performance
and legal structure. If indicators of impairment are present, we evaluate the
carrying value of the related real estate investments in relationship to the
future undiscounted cash flows of the underlying facilities. Provisions for
impairment losses related to long-lived assets are recognized when expected
future cash flows are less than the carrying values of the assets. If the sum of
the expected future cash flow, including sales proceeds, is less than carrying
value, we then adjust the net carrying value of leased properties and other
long-lived assets to the present value of expected future cash flows.
Loan Impairment Policy. When management identifies an indication of
potential loan impairment, such as non-payment under the loan documents or
impairment of the underlying collateral, the loan is written down to the present
value of the expected future cash flows. In cases where expected future cash
flows cannot be estimated, the loan is written down to the fair value of the
collateral.
Accounts Receivable. Accounts receivable consists primarily of lease and
mortgage interest payments. Amounts recorded include estimated provisions for
loss related to uncollectible accounts and disputed items. On a monthly basis,
we review the contractual payment versus actual cash payment received and the
contractual payment due date versus actual receipt date. When management
identifies delinquencies, a judgment is made as to the amount of provision, if
any, that is needed.
Accounts Receivable--Owned and Operated Assets. 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.
Owned and Operated Assets and Assets Held for Sale. 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. For 2003,
operating assets and operating liabilities for our owned and operated properties
are shown on a net basis on the face of our Consolidated Balance Sheet. For
2002, operating assets and operating liabilities for our owned and operated
properties are shown on a gross basis on the face of our Consolidated Balance
Sheet and are detailed in Note B - Properties; Owned and Operated Assets. The
consolidation in 2003 is due to the decrease in the size of the owned and
operated portfolio (currently one facility).
When a formal plan to sell real estate is adopted and we hold a contract
for sale, the real estate is classified as "assets held for sale," with the net
carrying amount adjusted to the lower of cost or estimated fair value, less cost
of disposal. Depreciation of the facilities is excluded from operations after
management has committed to a plan to sell the asset. Upon adoption of 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.
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).
Revenues for the three- and six-month periods ended June 30, 2003 totaled
$20.8 million and $45.4 million, respectively, a decrease of $13.6 million and
$33.0 million, respectively, from the same periods in 2002. When excluding
nursing home revenues of owned and operated assets, revenues decreased $1.4
million and increased $1.0 million versus the three- and six-month periods ended
June 30, 2002, respectively. The decrease during the quarter was primarily the
result of operator restructurings. The increase for the six-month period is
primarily due to a legal settlement (see below).
Rental income for the three- and six-month periods ended June 30, 2003 were
$16.2 million and $32.8 million, respectively, an increase of $0.5 million and
$1.7 million from the same periods in 2002. The $0.5 million increase for the
three-month period is due to $0.6 million relating to contractual increases in
rents that became effective in the second half of 2002 and in the first half of
2003 and $0.3 million in new leases, offset by a $0.4 million reduction in lease
revenue due to foreclosures, bankruptcies and restructurings. The $1.7 million
increase for the six-month period is due to $1.3 million relating to contractual
increases in rents that became effective in the second half of 2002 and the
first half of 2003 and $1.2 million in new leases, offset by a $0.4 million
reduction in lease revenue due to foreclosures, bankruptcies and restructurings
and $0.4 million due to deferral for non-payment.
Mortgage interest income for the three- and six-month periods ended June
30, 2003 totaled $3.5 million and $7.9 million, respectively, a decrease of $1.7
million and $2.7 million from the same periods in 2002. The $1.7 million
three-month decrease is primarily the result of bankruptcies and restructurings
of $1.4 million and mortgage payoffs and normal amortization of $0.3 million.
The $2.7 million six-month decrease is primarily the result of bankruptcies and
restructurings of $2.0 million and mortgage payoffs and normal amortization of
$0.7 million.
In 2000, we filed suit against a title company (later adding a law firm as
a defendant), seeking damages based on claims of breach of contract and
negligence, among other things, as a result of the alleged failure to file
certain UCC financing statements in our favor. We filed a subsequent suit
seeking recovery under title insurance policies written by the title company.
The defendants denied the allegations made in the lawsuits. In settlement of our
claims against the defendants, we agreed in the first quarter of 2003 to accept
a lump sum cash payment of $3.2 million. The cash proceeds were offset by
related expenses incurred of $1.0 million resulting in a net gain of $2.2
million.
Expenses for the three- and six-month periods ended June 30, 2003 totaled
$15.3 million and $33.9 million, respectively, a decrease of $19.3 million and
$40.2 million from the same periods in 2002. Excluding nursing home expenses of
owned and operated assets, expenses were $15.2 million and $32.4 million,
respectively, for the three- and six-month periods ended June 30, 2003 versus
$21.2 million and $36.9 million for the same periods in 2002. The $6.0 million
decrease for the three-month period ended June 30, 2003 primarily resulted from
a provision for impairment of $2.5 million and a provision for uncollectible
mortgages, notes and accounts receivable of $3.7 million, both taken in 2002.
The $4.5 million decrease for the six-month period ended June 30, 2003 is
primarily due to $2.8 million of interest savings, $0.9 million favorable
reduction in general and administrative and legal expenses, $3.7 million
favorable reduction in provision for uncollectible mortgages, notes and accounts
receivable, off set by an increase of $2.1 million in provision for impairment
and $0.6 million in adjustments of derivatives to fair value.
Nursing home expenses, net of nursing home revenues, for owned and operated
assets for the three- and six-month periods ended June 30, 2003 were $0.1
million and $1.4 million, respectively, a decrease of $1.2 million and $1.8
million from the same periods in 2002. The decrease was a result of the decrease
in the number of owned and operated facilities from 13 at June 30, 2002 to one
at June 30, 2003.
Interest expense for the three- and six-month periods ended June 30, 2003
was $7.4 million and $12.5 million, respectively, compared to $7.2 million and
$15.3 million for the same periods in 2002. The increase for the three-month
period is primarily due to a $2.6 million non-cash interest expense related to
the termination of our two previous credit facilities. The decrease for the
six-month period is primarily due to a $39.1 million reduction of total
outstanding debt versus the same periods in 2002.
General and administrative and legal expenses for the three- and six-month
periods ended June 30, 2003, totaled $2.2 million and $4.3 million,
respectively, compared with $2.6 million and $5.1 million for the same periods
in 2002. The $0.4 million decrease for the three-month period ended June 30,
2003 is primarily due to a reduction in consulting costs relating to the
reduction in the number of our owned and operated facilities. The $0.8 million
decrease for the six-month period ended June 30, 2003 is primarily due to a
reduction in legal and consulting costs relating to the reduction in the number
of our owned and operated facilities.
A provision for impairment of $4.6 million was recorded in the first
quarter of 2003. The provision was to reduce the carrying value of a closed
building to its fair value less costs to dispose. The building is being actively
marketed for sale; however, there can be no assurance if, or when, such sale
will be completed or whether such sales will be completed on terms that allow us
to realize the carrying value of the asset. A provision for impairment of $2.5
million was recorded for the three- and six-month periods ended June 30, 2002,
to reduce the carrying value of three owned and operated buildings to their fair
value less costs to dispose.
A charge of $3.7 million for provision for uncollectible mortgages, notes
and accounts receivable was recognized during the three-month period ended June
30, 2002. This charge was primarily related to the restructuring and reduction
of debt owed by Madison, as part of the compromise and settlement of a lawsuit
with Madison.
During the three-month period ended June 30, 2003, we sold an investment in
a Baltimore, Maryland asset, leased by the United States Postal Service, for
approximately $19.6 million. The purchaser paid us gross proceeds of $1.95
million and assumed the first mortgage of approximately $17.6 million. As a
result, we recorded a gain of $1.3 million, net of closing costs and other
expenses. Also during the quarter, we sold one closed building located in
Indiana, realizing proceeds, net of closing costs, of $0.2 million, resulting in
a gain of approximately $0.1 million. During the three-month period ended June
30, 2002, we sold one building located in Texas, realizing proceeds of $1.0
million, net of closing costs, resulting in a loss of $0.3 million.
Funds from operations ("FFO") for the three- and six-month periods ended
June 30, 2003, on a fully diluted basis, was $8.5 million and $22.0 million,
respectively, an increase of $3.5 million and $10.0 million, as compared to the
$5.0 million and $12.0 million for the same periods in 2002, due to the factors
mentioned above. For the three-month period ended June 30, 2003, nursing home
revenues and expenses, on a net basis, decreased FFO by $0.1 million. For the
six-month period ended June 30, 2003, the legal settlement, previously
discussed, increased FFO by $2.2 million and nursing home revenues and expenses,
on a net basis, decreased FFO by $1.4 million. Both the legal settlement and net
impact from our owned and operated nursing home assets are included in the fully
diluted FFO for the three- and six-month periods ended June 30, 2003. 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. We generally use the National Association of Real Estate Investment
Trusts' ("NAREIT") measure of FFO. We define FFO as net income available to
common stockholders, adjusted for the effects of asset dispositions and
impairments and certain non-cash items, primarily depreciation and amortization.
FFO herein is not necessarily comparable to FFO presented by other REITs due to
the fact that not all REITs use the same definition. Diluted FFO is adjusted for
the assumed conversion of Series C preferred stock and the exercise of
in-the-money stock options. FFO does not represent cash generated from operating
activities in accordance with GAAP, and therefore, should not be considered an
alternative to net earnings or an indication of operating performance or to net
cash flow from operating activities, as determined by GAAP, as a measure of
liquidity, and such measure is not necessarily indicative of cash available to
fund cash needs. We believe that in order to facilitate a clear understanding of
our consolidated historical operating results, FFO should be examined in
conjunction with net income.
* Lower of basic or diluted FFO per share.
The table below reconciles reported revenues and expenses to revenues and
expenses excluding nursing home revenues and expenses of owned and operated
assets. Nursing home revenues and expenses of owned and operated assets for the
three- and six-month periods ended June 30, 2003 are shown on a net basis on the
face of our Consolidated Statements of Operations and are shown on a gross basis
for the three- and six-month periods ended June 30, 2002. Since nursing home
revenues are not included in reported revenues for the three- and six-month
periods ended June 30, 2003, no adjustment is necessary to exclude nursing home
revenues.
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2003 2002 2003 2002
------------------ ------------------
(In thousands) (In thousands)
Total revenues........................ $20,789 $34,404 $45,353 $78,328
Nursing home revenues of owned and
operated assets..................... - 12,210 - 33,958
------------------ ------------------
Revenues excluding nursing home
revenues of owned and operated
assets............................ $20,789 $22,194 $45,353 $44,370
================== ==================
Total expenses........................ $15,298 $34,642 $33,877 $74,109
Nursing home expenses of owned and
operated assets..................... - 13,485 - 37,185
Nursing home revenues and expenses of
owned and operated assets - net..... 105 - 1,438 -
------------------ ------------------
Expenses excluding nursing home
expenses of owned and operated
assets............................ $15,193 $21,157 $32,439 $36,924
================== ==================
PORTFOLIO DEVELOPMENTS
The partial expiration of certain Medicare rate increases has had an
adverse impact on the revenues of the operators of nursing home facilities and
has negatively impacted some operators' ability to satisfy their monthly lease
or debt payments to us. In several instances, we hold security deposits that can
be applied in the event of lease and loan defaults, subject to applicable
limitations under bankruptcy law with respect to operators seeking protection
under Chapter 11 of the Bankruptcy Act. (See "Reimbursement Issues and Other
Factors Affecting Future Results" below).
Sun Healthcare Group, Inc. During the first quarter of 2003, Sun remitted
rent of $5.0 million versus the contractual amount of $6.4 million. We agreed
with Sun to use letters of credit (posted by Sun as security deposits) in the
amount of $1.4 million to make up the difference in rent. During the second
quarter of 2003, Sun remitted rent of $5.2 million versus the contractual of
$6.7 million. The payment of $5.2 million was made up of $3.8 million in cash
and the remaining security deposits of $1.4 million. All security deposits with
Sun have been used.
Effective July 1, 2003, we re-leased five former Sun SNFs in the following
three separate lease transactions: (i) a Master Lease of two SNFs in Florida,
representing 350 beds, which Master Lease has a ten-year term and has an initial
annual lease rate of $1.3 million; (ii) a Master Lease of two SNFs in Texas,
representing 256 beds, which Master Lease has a ten-year term and has an initial
annual lease rate of $800,000; and (iii) a lease of one SNF in Louisiana,
representing 131 beds, which lease has a ten-year term and requires an initial
annual lease rate of $400,000. Aggregate monthly contractual lease payments,
under all three transactions, total approximately $208,000 and commenced July 1,
2003. (See Note J - Subsequent Events).
As a result of the above mentioned transitions of the five former Sun SNFs,
Sun's contractual monthly rent, starting in July, was reduced $0.2 million from
approximately $2.2 million to approximately $2.0 million. However, for the month
of July, Sun remitted approximately $1.51 million in lease payments, and we are
recognizing revenue from Sun on a cash-basis as it is received. We continue our
ongoing restructuring discussions with Sun. At the time of this filing, we
cannot determine the timing or outcome of these discussions. There can be no
assurance that Sun will continue to pay rent at any level, although, we believe
that alternative operators would be available to lease or buy the remaining Sun
facilities if an appropriate agreement is not completed with Sun. (See
"Reimbursement Issues and Other Factors Affecting Future Results" below).
Alterra Healthcare Corporation. Alterra announced during the first quarter
of 2003, that, in order to facilitate and complete its on-going restructuring
initiatives, they had filed a voluntary petition with the U.S. Bankruptcy Court
for the District of Delaware to reorganize under Chapter 11 of the U.S.
Bankruptcy Code. At that time, we leased eight assisted living facilities (325
units) located in seven states to subsidiaries of Alterra.
Effective July 7, 2003, we amended our Master Lease with a subsidiary of
Alterra whereby the number of leased facilities was reduced from eight to five.
The amended Master Lease has a remaining term of approximately ten years with an
annual rent requirement of approximately $1.5 million. This compares to the 2002
annualized revenue of $2.6 million. We are in the process of negotiating terms
and conditions to re-lease the remaining three properties. In the interim,
Alterra will continue to operate the three facilities. The Amended Master Lease
has been approved by the U.S. Bankruptcy Court in the District of Delaware. (See
Note J - Subsequent Events).
Claremont Healthcare Holdings, Inc. Claremont failed to pay base rent due
on July 1, 2003 in the amount of $0.5 million. On July 21, 2003, we drew on a
letter of credit (posted by Claremont as a security deposit) in the amount of
$0.5 million to pay Claremont's July rent payment and we demanded that Claremont
restore the $0.5 million letter of credit. As of the date of this filing, we
have additional security deposits in the form of cash and letters of credit in
the amount of $2.0 million. We are recognizing revenue from Claremont on a
cash-basis as it is received. (See Note J - Subsequent Events).
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2003, we had total assets of $797.7 million, stockholders
equity of $489.5 million and debt of $298.8 million, representing approximately
37.9% of total capitalization.
BANK CREDIT AGREEMENTS
In June 2003, we completed a new $225 million Senior Secured Credit
Facility ("Credit Facility") arranged and syndicated by GE Healthcare Financial
Services. At the closing, we borrowed $187.1 million under the new Credit
Facility to repay borrowings under our two previous credit facilities and
replace letters of credit. In addition, proceeds from the loan are permitted to
be used to pay cumulative unpaid preferred dividends and for general corporate
purposes.
The new Credit Facility includes a $125 million term loan ("Term Loan") and
a $100 million revolving line of credit ("Revolver") fully secured by 121
facilities representing approximately half of the our invested assets. Both the
Term Loan and Revolver have a four-year maturity with a one-year extension at
our option. The Term Loan amortizes on a 25-year basis and is priced at London
Interbank Offered Rate ("LIBOR") plus a spread of 3.75%, with a floor of 6.00%.
The Revolver is also priced at LIBOR plus a 3.75% spread, with a 6.00% floor.
At June 30, 2003, we had $187.1 million of Credit Facility borrowings
outstanding and $12.5 million of letters of credit outstanding, leaving
availability of $25.4 million. The $187.1 million of outstanding borrowings had
an interest rate of 6.00% at June 30, 2003. (See Note H - Borrowing
Arrangements).
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. 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.
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.
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. Due to our 2002 taxable loss, no distribution was necessary to maintain
our REIT status for 2002. Net operating loss carry-forwards through 2002 of
approximately $24.0 million are available to help offset taxable income. In
addition, we intend to make the necessary distributions, if any, to satisfy the
2003 REIT requirements. The accumulated and unpaid dividends relating to all
series of preferred stocks total $50.1 million as of June 30, 2003. In
aggregate, preferred dividends continue to accumulate at approximately $5.0
million per quarter.
No preferred or common cash dividends were paid during the first six months
ending June 30, 2003 and 2002, respectively. (See Note D - Dividends).
In July, 2003, our Board of Directors declared a full catch-up of
cumulative, unpaid dividends for all classes of preferred stock to be paid
August 15, 2003 to preferred stockholders of record on August 5, 2003. In
addition, the Board declared the regular quarterly dividend for all classes of
preferred stock to be paid on August 15, 2003 to preferred stockholders of
record on August 5, 2003. Total August 2003 dividend payments for all classes of
preferred stock are approximately $55.1 million. (See Note J - Subsequent
Events).
LIQUIDITY
We believe our liquidity and various sources of available capital,
including funds from operations, expected proceeds from planned asset sales and
availability under our new Credit Facility are adequate to finance operations,
meet recurring debt service requirements and fund future investments through the
next 12 months.
REIMBURSEMENT ISSUES AND OTHER FACTORS AFFECTING FUTURE RESULTS
This document contains forward-looking statements, including statements
regarding potential asset sales, potential future changes in reimbursement and
the future effect of the "Medicare cliff" on our operators. 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 "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 in Item 1 above; (ii)
regulatory changes in the healthcare sector, including without limitation,
changes in Medicare reimbursement; (iii) changes in the financial position of
our operators; (iv) uncertainties relating to the restructure of Sun's remaining
obligations and payment of contractual rents; (v) the ability of 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
pendency of a bankruptcy proceeding and retain security deposits for the
debtor's obligations; (vi) our ability to dispose of assets held for sale on a
timely basis and at appropriate prices; (vii) 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;
(viii) our ability to manage, re-lease or sell owned and operated assets; (ix)
the availability and cost of capital; and (x) competition in the financing of
healthcare facilities.
MEDICARE REIMBURSEMENT. 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 facility owned
and operated for our own 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 subject to frequent and substantial change. The
Balanced Budget Act of 1997 ("Balanced Budget Act") significantly reduced
spending levels for the Medicare and Medicaid programs. Due to the
implementation of the terms of the Balanced Budget Act, effective July 1, 1998,
the majority of skilled nursing facilities shifted from payments based on
reimbursable cost to a prospective payment system for services provided to
Medicare beneficiaries. Under the prospective payment system, skilled nursing
facilities are paid on a per diem prospective case-mix adjusted payment basis
for all covered services. Implementation of the prospective payment system has
affected each long-term care facility to a different degree, depending upon the
amount of revenue it derives from Medicare patients. Long-term care facilities
have had to attempt to restructure their operations to operate profitably under
the new Medicare prospective payment system reimbursement policies.
Legislation adopted in 1999 and 2000 increased Medicare payments to nursing
facilities and specialty care facilities on an interim basis. Section 101 of the
Balanced Budget Relief Act of 1999 ("Balanced Budget Relief Act") included a 20%
increase for 15 patient acuity categories (known as Resource Utilization Groups
("RUGS")) and a 4% across the board increase of the adjusted federal per diem
payment rate. The 20% increase was implemented in April 2000 and will remain in
effect until the implementation of refinements in the current RUG case-mix
classification system to more accurately estimate the cost of non-therapy
ancillary services. The 4% increase was implemented in April 2000 and expired
October 1, 2002.
The Benefits Improvement and Protection Act of 2000 ("Benefits Improvement
and Protection Act") included a 16.7% increase in the nursing component of the
case-mix adjusted federal periodic payment rate and a 6.7% increase in the 14
RUG payments for rehabilitation therapy services. The 16.7% increase was
implemented in April 2000 and expired October 1, 2002. The 6.7% increase is an
adjustment to the 20% increase granted in the Balance Budget Relief Act and
spreads the funds directed at three of those 15 RUGs to an additional 11
rehabilitation RUGs. The increase was implemented in April 2001 and will remain
in effect until the implementation of refinements in the current RUG case-mix
classification system.
In addition to the expiration of the 4% increase implemented in the
Balanced Budget Relief Act and the 16.7% increase implemented in the Benefits
Improvement and Protection Act, Medicare reimbursement could be further reduced
when the Centers for Medicare & Medicaid Services ("CMS") completes its RUG
refinement, thereby triggering the sunset of the temporary 20% and 6.7%
increases also established under these statutes. The expiration of the 4% and
16.7% increases under these statutes as of October 1, 2002 has had an adverse
impact on the revenues of the operators of nursing facilities and has negatively
impacted some operators' ability to satisfy their monthly lease or debt payments
to us.
On May 16, 2003, CMS published its proposed payment rates for SNFs for
federal fiscal year 2004 to become effective on October 1, 2003. The publication
of the final rates for federal fiscal year 2004 is anticipated soon, as these
rates are supposed to be published before August 1, 2003. The proposed rates and
temporary updates discussed below may be revised when the final rates are
published. Within the May 16th proposed rule, CMS proposed that the SNF update
would be a 2.9% increase in Medicare payments for federal fiscal year 2004. In
addition, on May 16, 2003, CMS announced that the two temporary payment
increases - the 20% and 6.7% add-ons for certain payment categories - will
continue to be effective for federal fiscal year 2004.
On June 10, 2003, CMS published an additonal proposed payment revision for
federal fiscal year 2004 in which CMS announced that it would incorporate a
forecast error adjustment that takes into account previous years' update errors.
According to CMS, there was a cumulative SNF market basket, or inflation
adjustment, forecast error of 3.26% for federal fiscal years 2000 through 2002.
As a result, CMS proposed to increase the national payment rate by an additional
3.26% above the 2.9% increase for federal fiscal year 2004 that was proposed in
May. As with the rates and policies published in the May 16, 2003 proposed rule,
this adjustment could change with the publication of the final payment rates,
which are supposed to be published before August 1, 2003.
Due to the temporary nature of the remaining payment increases, we cannot
be assured that the federal reimbursement will remain at levels comparable to
present levels and that such reimbursement will be sufficient for our lessees or
mortgagors to cover all operating and fixed costs necessary to care for Medicare
and Medicaid patients. We also cannot be assured that there will be any future
legislation to increase payment rates for skilled nursing facilities. If payment
rates for skilled nursing facilities are not increased in the future, some of
our lessees and mortgagors may have difficulty meeting their payment obligations
to us.
MEDICAID AND OTHER THIRD-PARTY REIMBURSEMENT. Each state has its own
Medicaid program that is funded jointly by the state and federal government.
Federal law governs how each state manages its Medicaid program, but there is
wide latitude for states to customize Medicaid programs to fit the needs and
resources of its citizens.
Rising Medicaid costs and decreasing state revenues caused by current
economic conditions have prompted an increasing number of states to cut or
consider reductions in Medicaid funding as a means of balancing their respective
state budgets. Existing and future initiatives affecting Medicaid reimbursement
may reduce utilization of (and reimbursement for) services offered by the
operators of our properties. In early 2003, many states announced actual or
potential budget shortfalls. As a result of these budget shortfalls, many states
have announced that they are implementing or considering implementing "freezes"
or cuts in Medicaid rates paid to SNF providers. We cannot predict the extent to
which Medicaid rate freezes or cuts will ultimately be adopted, the number of
states that will adopt them nor the impact of such adoption on our operators.
However, extensive Medicaid rate cuts or freezes could have a material adverse
effect on our operators' liquidity, financial condition and results of
operations, which could affect adversely their ability to make rental payments
to us.
On May 28, 2003, the federal Jobs and Growth Tax Relief Reconciliation Act
("Tax Relief Act") was signed into law, which included an increase in Medicaid
federal funding for five fiscal quarters (April 1, 2003 through June 30, 2004).
In addition, the Tax Relief Act provides state fiscal relief for federal fiscal
years 2003 and 2004 to assist states with funding shortfalls. It is anticipated
that these temporary federal funding provisions will mitigate state Medicaid
funding reductions through federal fiscal year 2004.
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 which
reduce reimbursement levels could adversely affect 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.
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 a 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.
CONCENTRATION OF RISK. Approximately 49.7% of our real estate investments
are operated by four public companies, including Sun (26.8%), Advocat (12.5%),
Mariner (7.1%), and Alterra (3.3%). The three largest private operators
represent 10.3%, 4.0% and 3.8%, respectively, of our investments. No other
operator represents more than 2.8% of our investments. The three states in which
we have our highest concentration of investments are Florida (15.4%), California
(8.0%) and Illinois (7.9%).
HEALTHCARE INVESTMENT RISKS. 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.
GENERAL REAL ESTATE RISKS. 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.
RISKS RELATED TO OWNED AND OPERATED ASSETS. As a consequence of the
financial difficulties encountered by a number of our operators, over the last
several years we 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. At June 30, 2003, we
had one facility, managed under a third-party management agreement, classified
as owned and operated. Our management contract with this third-party operator
provides that the third-party operator is responsible for regulatory compliance,
but we could be sanctioned for violation of regulatory requirements. In general,
the risks of third-party claims such as patient care and personal injury claims
are higher with respect to our owned and operated property as compared with our
leased and mortgaged assets.
We and several of our wholly-owned subsidiaries have been named as
defendants in professional liability claims related to our owned and operated
facilities. Other third-party managers responsible for the day-to-day operations
of these facilities have also been named as defendants in these claims. In these
suits, patients of certain previously owned and operated facilities have alleged
significant damages, including punitive damages against the defendants. The
lawsuits are in various stages of discovery and we are unable to predict the
likely outcome at this time. We continue to vigorously defend these claims and
pursue all rights we may have against the managers of the facilities, under the
terms of the management agreements. We have insured these matters, subject to
self-insured retentions of various amounts.
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 June 30, 2003 was $289.8 million. A one-percent increase in interest rates
would result in a decrease in the fair value of long-term borrowings by
approximately $2.6 million.
We utilize interest rate swaps and caps 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 June 30,
2003, the derivative instrument was reported at its fair value of $4.1 million
as compared to its fair value at December 31, 2002 of $7.3 million. An
adjustment of $2.5 million and $3.2 million to Other Comprehensive Income was
made for the change in fair value of this cap during the three- and six-month
periods ended June 30, 2003, respectively. 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. Over the
twelve months ending December 31, 2003, $0.1 million is expected to be
amortized.
ITEM 4 - CONTROLS 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 as of the end of the period covered by this 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 have materially affected, or are reasonably likely to affect,
our internal control over financial reporting during the most recent fiscal
quarter.
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 PART I,
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. 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.
The table below sets forth information regarding arrearages in payment
of preferred stock dividends as of June 30, 2003:
-----------------------------------------------------------------------
Annual Dividend Arrearage as of
Title of Class Per Share June 30, 2003
-----------------------------------------------------------------------
9.25% Series A Cumulative
Preferred Stock $ 2.3125 $ 13,296,875
-----------------------------------------------------------------------
8.625% Series B Cumulative
Preferred Stock $ 2.1563 $ 10,781,250
-----------------------------------------------------------------------
Series C Convertible
Preferred Stock $10.0000 $ 26,007,843
-----------------------------------------------------------------------
TOTAL $ 50,085,968
-----------------------------------------------------------------------
In July 2003, our Board of Directors declared a full catch-up of
cumulative, unpaid dividends for all classes of preferred stock to be
paid August 15, 2003 to preferred stockholders of record on August 5,
2003. In addition, the Board declared the regular quarterly dividend
for all classes of preferred stock to be paid on August 15, 2003 to
preferred stockholders of record on August 5, 2003. (See Note D -
Dividends and Note J - Subsequent Events, PART I, Item 1 hereto).
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) An Annual Meeting of Stockholders was held on April 3, 2003.
(b) The following directors were elected at the meeting for a three-year
term: Daniel A. Decker, Thomas F. Franke and Bernard J. Korman. The
following directors were not elected at the meeting but their term of
office continued after the meeting: Thomas W. Erickson, Harold J.
Kloosterman, Edward Lowenthal, Christopher W. Mahowald, Donald J.
McNamara, C. Taylor Pickett, and Stephen D. Plavin. The results of the
vote were as follows:
- --------------------------------------------------------------------------------
Daniel A. Thomas F. Bernard J.
Manner of Vote Cast Decker Franke Korman
- --------------------------------------------------------------------------------
For* 51,999,523 52,763,112 52,345,845
- --------------------------------------------------------------------------------
Withheld 993,571 230,252 647,519
- --------------------------------------------------------------------------------
Abstentions and broker
non-votes - - -
- --------------------------------------------------------------------------------
* Includes 16,774,722 votes represented by Series C preferred stock.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The following Exhibits are filed herewith:
Exhibit Description
10.1 Loan Agreement among General Electric Capital Corporation
and certain subsidiaries of Omega Healthcare Investors,
Inc., dated as of June 23, 2003.
10.2 Guaranty by Omega Healthcare Investors, Inc. for the
benefit of General Electric Capital Corporation, dated as
of June 23, 2003.
10.3 Ownership Pledge, Assignment and Security Agreement
between Omega Healthcare Investors, Inc. and General
Electric Capital Corporation, dated as of June 23, 2003.
10.4 2000 Stock Incentive Plan (as amended January 1, 2001).
31.1 Certification of the Chief Executive Officer under Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer under Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer under Section
906 of the Sarbanes - Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer under Section
906 of the Sarbanes - Oxley Act of 2002.
(b) Reports on Form 8-K
The following reports on Form 8-K were filed or furnished during
the quarter ended June 30, 2003:
Form 8-K dated May 8, 2003: Report with the following exhibit:
Press release issued by Omega Healthcare Investors, Inc. on
May 8, 2003
Form 8-K dated June 24, 2003: Report with the following exhibit:
Press release issued by Omega Healthcare Investors, Inc. on
June 23, 2003
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: July 31, 2003 By: /s/ C. TAYLOR PICKETT
-----------------------------
C. Taylor Pickett
Chief Executive Officer
Date: July 31, 2003 By: /s/ ROBERT O. STEPHENSON
-----------------------------
Robert O. Stephenson
Chief Financial Officer