10-K: Annual report pursuant to Section 13 and 15(d)

Published on February 15, 2008





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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[X]            ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
              THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007.

[ ]          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 or Other Jurisdiction
(I.R.S. Employer Identification No.)
of Incorporation or Organization)
  
   
9690 Deereco Road, Suite 100
  
Timonium, MD
21093
(Address of Principal Executive Offices)
(Zip Code)

Registrant's telephone number, including area code: 410-427-1700
Securities Registered Pursuant to Section 12(b) of the Act:

Title of Each Class                                               
 
Name of Exchange onWhich Registered                            
 Common Stock, $.10 Par Value
   and associated stockholder protection rights
New York Stock Exchange
 8.375% Series D Cumulative Redeemable Preferred Stock, $1
    Par Value
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:
None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [X] No [  ]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [  ] No [X]

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 and Exchange Act of 1934 during the preceding twelve 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [X]

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

Large accelerated filer [X]                                                       Accelerated filer [ ]                                 Non-accelerated filer [ ]                                                       Smaller reporting company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [  ] No [X ]

The aggregate market value of the common stock of the registrant held by non-affiliates was $1,066,970,003.  The aggregate market value was computed using the $15.83 closing price per share for such stock on the New York Stock Exchange on June 29, 2007.

As of February 1, 2008 there were 68,891,836 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for the registrant’s 2008 Annual Meeting of Stockholders to be held on May 22, 2008, to be filed with
 the Securities and Exchange Commission not later than 120 days after December 31, 2007, is incorporated by reference in Part III herein.
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OMEGA HEALTHCARE INVESTORS, INC.
2007 FORM 10-K ANNUAL REPORT


 
   
   
PART I
  
 
Page
Item 1.     Business
1
         Overview
 1
1
2
         Taxation
3
9
14
Item 1A.  Risk Factors
14
25
Item 2.     Properties
26
Item 3.     Legal Proceedings
28
28
   
PART II
  
   
29
Item 6.      Selected Financial Data
31
32
32
          Overview
32
34
          Results of Operations
36
41
43
46
46
46
47
Item 9B.   Other Information
48
   
   
PART III
  
   
49
49
49
49
49
   
PART IV
  
   
50


 




We were incorporated in the State of Maryland on March 31, 1992.  We are a self-administered real estate investment trust (“REIT”), investing in income-producing healthcare facilities, principally long-term care facilities located in the United States. We provide lease or mortgage financing to qualified operators of skilled nursing facilities (“SNFs”) and, to a lesser extent, assisted living facilities (“ALFs”), rehabilitation and acute care facilities. We have historically financed investments through borrowings under our revolving credit facilities, private placements or public offerings of debt or equity securities, the assumption of secured indebtedness, or a combination of these methods.

Our portfolio of investments, as of December 31, 2007, consisted of 236 healthcare facilities, located in 27 states and operated by 28 third-party operators. This portfolio was made up of:

 
•
222 long-term healthcare facilities and two rehabilitation hospitals owned and leased to third parties;
 
•
fixed rate mortgages on 9 long-term healthcare facilities; and
 
•
3 long term care facilities as held-for-sale.

As of December 31, 2007, our gross investments in these facilities, net of impairments and before reserve for uncollectible loans, totaled approximately $1.3 billion.  In addition, we also held miscellaneous investments of approximately $14 million at December 31, 2007, consisting primarily of secured loans to third-party operators of our facilities.

Our filings with the Securities and Exchange Commission (“SEC”), including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are accessible free of charge on our website at www.omegahealthcare.com.


The following tables summarize our revenues and real estate assets by asset category for 2007, 2006 and 2005.  (See Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations, Note 3 – Properties and Note 4 – Mortgage Notes Receivable).
 
 
Revenues by Asset Category
 (in thousands)
   
Year Ended December 31,
  
   
2007
    
2006
    
2005
  
Core assets:
                  
Lease rental income
   $ 152,061     $ 126,892     $ 95,330  
Mortgage interest income
     3,888       4,402       6,527  
Total core asset revenues
     155,949       131,294       101,857  
Other asset revenue
     2,821       3,687       3,219  
Miscellaneous income
     788       532       4,459  
Total revenue
   $ 159,558     $ 135,513     $ 109,535  




Assets by Category
(in thousands)
   
As of December 31,
  
   
2007
    
2006
  
Core assets:
            
Leased assets
  $ 1,274,722     $ 1,235,679  
Mortgaged assets
    31,689       31,886  
Total core assets
    1,306,411       1,267,565  
Other assets
    13,683       22,078  
Total real estate assets before held for sale assets
    1,320,094       1,289,643  
Held for sale assets
    2,870       4,663  
Total real estate assets
  $ 1,322,964     $ 1,294,306  


Investment Strategy.  We maintain a diversified portfolio of long-term healthcare facilities and mortgages on healthcare facilities located throughout the United States.  In making investments, we generally have focused on established, creditworthy, middle-market healthcare operators that meet our standards for quality and experience of management. We have sought to diversify our investments in terms of geographic locations and operators.

In evaluating potential investments, we consider such factors as:

 
•
the quality and experience of management and the creditworthiness of the operator of the facility;
 
•
the facility's historical and forecasted cash flow and its ability to meet operational needs, capital expenditure requirements and lease or debt service obligations, providing a competitive return on our investment;
 
•
the construction quality, condition and design of the facility;
 
•
the geographic area of the facility;
 
•
the tax, growth, regulatory and reimbursement environment of the jurisdiction in which the facility is located;
 
•
the occupancy and demand for similar healthcare facilities in the same or nearby communities; and
 
•
the payor mix of private, Medicare and Medicaid patients.

One of our fundamental investment strategies is to obtain contractual rent escalations under long-term, non-cancelable, "triple-net" leases and fixed-rate mortgage loans, and to obtain substantial liquidity deposits.  Additional security is typically provided by covenants regarding minimum working capital and net worth, liens on accounts receivable and other operating assets, and various provisions for cross-default, cross-collateralization and corporate/personal guarantees, when appropriate.

We prefer to invest in equity ownership of properties.  Due to regulatory, tax or other considerations, we may pursue alternative investment structures, which can achieve returns comparable to equity investments.  The following summarizes the primary investment structures we typically use.  Average annualized yields reflect existing contractual arrangements.  However, in view of the ongoing financial challenges in the long-term care industry, we cannot assure you that the operators of our facilities will meet their payment obligations in full or when due.  Therefore, the annualized yields as of January 1, 2008 set forth below are not necessarily indicative of or a forecast of actual yields, which may be lower.

 
Purchase/Leaseback.  In a Purchase/Leaseback transaction, we purchase the property from the operator and lease it back to the operator over terms typically ranging from 5 to 15 years, plus renewal options.  The leases originated by us generally provide for minimum annual rentals which are subject to annual formula increases based upon such factors as increases in the Consumer Price Index (“CPI”).  The average annualized yield from leases was approximately 12.3% at January 1, 2008.

 
Fixed-Rate Mortgage.  These mortgages have a fixed interest rate for the mortgage term and are secured by first mortgage liens on the underlying real estate and personal property of the mortgagor. The average annualized yield on these investments was approximately 12.3% at January 1, 2008.

The table set forth in Item 2 – Properties contains information regarding our real estate properties, their geographic locations, and the types of investment structures as of December 31, 2007.

Borrowing Policies.  We may incur additional indebtedness and have historically sought to maintain an annualized total debt-to-EBITDA ratio in the range of 4 to 5 times.  Annualized EBITDA is defined as earnings before interest, taxes, depreciation and amortization for a twelve month period.  We intend to periodically review our policy with respect to our total debt-to-EBITDA ratio and to modify the policy as our management deems prudent in light of prevailing market conditions.  Our strategy generally has been to match the maturity of our indebtedness with the maturity of our investment assets and to employ long-term, fixed-rate debt to the extent practicable in view of market conditions in existence from time to time.

We may use proceeds of any additional indebtedness to provide permanent financing for investments in additional healthcare facilities.  We may obtain either secured or unsecured indebtedness and may obtain indebtedness that may be convertible into capital stock or be accompanied by warrants to purchase capital stock.  Where debt financing is available on terms deemed favorable, we generally may invest in properties subject to existing loans, secured by mortgages, deeds of trust or similar liens on properties.

If we need capital to repay indebtedness as it matures, we may be required to liquidate investments in properties at times which may not permit realization of the maximum recovery on these investments.  This could also result in adverse tax consequences to us.  We may be required to issue additional equity interests in our company, which could dilute your investment in our company.  (See Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations; Liquidity and Capital Resources).

Policies With Respect To Certain Activities. If our Board of Directors determines that additional funding is required, we may raise such funds through additional equity offerings, debt financing, and retention of cash flow (subject to provisions in the Internal Revenue Code concerning taxability of undistributed REIT taxable income) or a combination of these methods.

Borrowings may be in the form of bank borrowings, secured or unsecured, and publicly or privately placed debt instruments, purchase money obligations to the sellers of assets, long-term, tax-exempt bonds or financing from banks, institutional investors or other lenders, or securitizations, any of which indebtedness may be unsecured or may be secured by mortgages or other interests in our assets.  Holders of such indebtedness may have recourse to all or any part of our assets or may be limited to the particular asset to which the indebtedness relates.

We have authority to offer our common stock or other equity or debt securities in exchange for property and to repurchase or otherwise reacquire our shares or any other securities and may engage in such activities in the future.

Subject to the percentage of ownership limitations and gross income and asset tests necessary for REIT qualification, we may invest in securities of other REITs, other entities engaged in real estate activities or securities of other issuers, including for the purpose of exercising control over such entities.

We may engage in the purchase and sale of investments.  We do not underwrite the securities of other issuers.

Our officers and directors may change any of these policies without a vote of our stockholders.

In the opinion of our management, our properties are adequately covered by insurance.


The following is a general summary of the material U.S. federal income tax considerations applicable to us and to the holders of our securities and our election to be taxed as a REIT.  It is not tax advice.  The summary is not intended to represent a detailed description of the U.S. federal income tax consequences applicable to a particular stockholder in view of any person’s particular circumstances, nor is it intended to represent a detailed description of the U.S. federal income tax consequences applicable to stockholders subject to special treatment under the federal income tax laws such as insurance companies, tax-exempt organizations, financial institutions, securities broker-dealers, investors in pass-through entities, expatriates and taxpayers subject to alternative minimum taxation.
 
The following discussion, to the extent it constitutes matters of law or legal conclusions (assuming the facts, representations, and assumptions upon which the discussion is based are accurate), accurately represents some of the material U.S. federal income tax considerations relevant to ownership of our securities.  The sections of the Internal Revenue Code (the “Code”) relating to the qualification and operation as a REIT are highly technical and complex.  The following discussion sets forth the material aspects of the Code sections that govern the federal income tax treatment of a REIT and its stockholders.  The information in this section is based on the Code; current, temporary, and proposed Treasury regulations promulgated under the Code; the legislative history of the Code; current administrative interpretations and practices of the Internal Revenue Service (“IRS”); and court decisions, in each case, as of the date of this report.  In addition, the administrative interpretations and practices of the IRS include its practices and policies as expressed in private letter rulings, which are not binding on the IRS, except with respect to the particular taxpayers who requested and received those rulings.
 
General.  We have elected to be taxed as a REIT, under Sections 856 through 860 of the Code, beginning with our taxable year ended December 31, 1992.  We believe that we have been organized and operated in such a manner as to qualify for taxation as a REIT. We intend to continue to operate in a manner that will maintain our qualification as a REIT, but no assurance can be given that we have operated or will be able to continue to operate in a manner so as to qualify or remain qualified as a REIT.
 
The sections of the Code that govern the federal income tax treatment of a REIT are highly technical and complex.  The following sets forth the material aspects of those sections.  This summary is qualified in its entirety by the applicable Code provisions, rules and regulations promulgated thereunder, and administrative and judicial interpretations thereof.
 
If we qualify for taxation as a REIT, we generally will not be subject to federal corporate income taxes on our net income that is currently distributed to stockholders.  However, we will be subject to federal income tax as follows: First, we will be taxed at regular corporate rates on any undistributed REIT taxable income, including undistributed net capital gains; provided, however, that if we have a net capital gain, we will be taxed at regular corporate rates on our undistributed REIT taxable income, computed without regard to net capital gain and the deduction for capital gains dividends, plus a 35% tax on undistributed net capital gain, if our tax as thus computed is less than the tax computed in the regular manner.  Second, under certain circumstances, we may be subject to the “alternative minimum tax” on our items of tax preference that we do not distribute or allocate to our stockholders.  Third, if we have (i) net income from the sale or other disposition of “foreclosure property,” which is held primarily for sale to customers in the ordinary course of business, or (ii) other nonqualifying income from foreclosure property, we will be subject to tax at the highest regular corporate rate on such income.  Fourth, if we have net income from prohibited transactions (which are, in general, certain sales or other dispositions of property (other than foreclosure property) held primarily for sale to customers in the ordinary course of business by us, i.e., when we are acting as a dealer), such income will be subject to a 100% tax.  Fifth, if we should fail to satisfy the 75% gross income test or the 95% gross income test (as discussed below), but have nonetheless maintained our qualification as a REIT because certain other requirements have been met, we will be subject to a 100% tax on an amount equal to (a) the gross income attributable to the greater of the amount by which we fail the 75% or 95% test, multiplied by (b) a fraction intended to reflect our profitability.  Sixth, if we should fail to distribute by the end of each year at least the sum of (i) 85% of our REIT ordinary income for such year, (ii) 95% of our REIT capital gain net income for such year, and (iii) any undistributed taxable income from prior periods, we will be subject to a 4% excise tax on the excess of such required distribution over the amounts actually distributed.  Seventh, we will be subject to a 100% excise tax on transactions with a taxable REIT subsidiary (“TRS”) that are not conducted on an arm’s-length basis.  Eighth, if we acquire any asset, which is defined as a “built-in gain asset” from a C corporation that is not a REIT (i.e., generally a corporation subject to full corporate-level tax) in a transaction in which the basis of the built-in gain asset in our hands is determined by reference to the basis of the asset (or any other property) in the hands of the C corporation, and we recognize gain on the disposition of such asset during the 10-year period, which is defined as the “recognition period,” beginning on the date on which such asset was acquired by us, then, to the extent of the built-in gain (i.e., the excess of (a) the fair market value of such asset on the date such asset was acquired by us over (b) our adjusted basis in such asset on such date), our recognized gain will be subject to tax at the highest regular corporate rate.  The results described above with respect to the recognition of built-in gain assume that we will not make an election pursuant to Treasury Regulations Section 1.337(d)-7(c)(5).
 
Requirements for Qualification. The Code defines a REIT as a corporation, trust or association: (1) which is managed by one or more trustees or directors; (2) the beneficial ownership of which is evidenced by transferable shares, or by transferable certificates of beneficial interest; (3) which would be taxable as a domestic corporation, but for Sections 856 through 859 of the Code; (4) which is neither a financial institution nor an insurance company subject to the provisions of the Code; (5) the beneficial ownership of which is held by 100 or more persons; (6) during the last half year of each taxable year not more than 50% in value of the outstanding stock of which is owned, actually or constructively, by five or fewer individuals (as defined in the Code to include certain entities); and (7) which meets certain other tests, described below, regarding the nature of its income and assets and the amount of its annual distributions to stockholders.  The Code provides that conditions (1) to (4), inclusive, must be met during the entire taxable year and that condition (5) must be met during at least 335 days of a taxable year of twelve months, or during a proportionate part of a taxable year of less than twelve months.  For purposes of conditions (5) and (6), pension funds and certain other tax-exempt entities are treated as individuals, subject to a “look-through” exception in the case of condition (6).
 
Income Tests.  In order to maintain our qualification as a REIT, we annually must satisfy two gross income requirements.  First, at least 75% of our gross income (excluding gross income from prohibited transactions) for each taxable year must be derived directly or indirectly from investments relating to real property or mortgages on real property (including generally “rents from real property,” interest on mortgages on real property, and gains on sale of real property and real property mortgages, other than property described in Section 1221(a)(1) of the Code) and income derived from certain types of temporary investments.  Second, at least 95% of our gross income (excluding gross income from prohibited transactions) for each taxable year must be derived from such real property investments, dividends, interest and gain from the sale or disposition of stock or securities other than property held for sale to customers in the ordinary course of business.
 
Rents received by us will qualify as “rents from real property” in satisfying the gross income requirements for a REIT described above only if several conditions are met.  First, the amount of the rent must not be based in whole or in part on the income or profits of any person.  However, any amount received or accrued generally will not be excluded from the term “rents from real property” solely by reason of being based on a fixed percentage or percentages of receipts or sales.  Second, the Code provides that rents received from a tenant will not qualify as “rents from real property” in satisfying the gross income tests if we, or an owner (actually or constructively) of 10% or more of the value of our stock, actually or constructively owns 10% or more of such tenant, which is defined as a related party tenant.  Third, if rent attributable to personal property, leased in connection with a lease of real property, is greater than 15% of the total rent received under the lease, then the portion of rent attributable to such personal property will not qualify as “rents from real property.” Finally, for rents received to qualify as “rents from real property,” we generally must not operate or manage the property or furnish or render services to the tenants of such property, other than through an independent contractor from which we derive no revenue.  We may, however, directly perform certain services that are “usually or customarily rendered” in connection with the rental of space for occupancy only and are not otherwise considered “rendered to the occupant” of the property.  In addition, we may provide a minimal amount of “non-customary” services to the tenants of a property, other than through an independent contractor, as long as our income from the services does not exceed 1% of our income from the related property.  Furthermore, we may own up to 100% of the stock of a TRS, which may provide customary and non-customary services to our tenants without tainting our rental income from the related properties.  For our tax years beginning after 2004, rents for customary services performed by a TRS or that are received from a TRS and are described in Code Section 512(b)(3) no longer need to meet the 100% excise tax safe harbor.  Instead, such payments avoid the excise tax if we pay the TRS at least 150% of its direct cost of furnishing such services.
 
The term “interest” generally does not include any amount received or accrued (directly or indirectly) if the determination of such amount depends in whole or in part on the income or profits of any person.  However, an amount received or accrued generally will not be excluded from the term “interest” solely by reason of being based on a fixed percentage or percentages of gross receipts or sales.  In addition, an amount that is based on the income or profits of a debtor will be qualifying interest income as long as the debtor derives substantially all of its income from the real property securing the debt from leasing substantially all of its interest in the property, but only to the extent that the amounts received by the debtor would be qualifying “rents from real property” if received directly by a REIT.
 
If a loan contains a provision that entitles us to a percentage of the borrower’s gain upon the sale of the real property securing the loan or a percentage of the appreciation in the property’s value as of a specific date, income attributable to that loan provision will be treated as gain from the sale of the property securing the loan, which generally is qualifying income for purposes of both gross income tests.
 
Interest on debt secured by mortgages on real property or on interests in real property generally is qualifying income for purposes of the 75% gross income test.  However, if the highest principal amount of a loan outstanding during a taxable year exceeds the fair market value of the real property securing the loan as of the date we agreed to originate or acquire the loan, a portion of the interest income from such loan will not be qualifying income for purposes of the 75% gross income test, but will be qualifying income for purposes of the 95% gross income test.  The portion of the interest income that will not be qualifying income for purposes of the 75% gross income test will be equal to the portion of the principal amount of the loan that is not secured by real property.
 
Prohibited Transactions.  We will incur a 100% tax on the net income derived from any sale or other disposition of property, other than foreclosure property, that we hold primarily for sale to customers in the ordinary course of a trade or business.  We believe that none of our assets is primarily held for sale to customers and that a sale of any of our assets would not be in the ordinary course of our business.  Whether a REIT holds an asset primarily for sale to customers in the ordinary course of a trade or business depends, however, on the facts and circumstances in effect from time to time, including those related to a particular asset.  Nevertheless, we will attempt to comply with the terms of safe-harbor provisions in the federal income tax laws prescribing when an asset sale will not be characterized as a prohibited transaction.  We cannot assure you, however, that we can comply with the safe-harbor provisions or that we will avoid owning property that may be characterized as property that we hold primarily for sale to customers in the ordinary course of a trade or business.
 
Foreclosure Property.  We will be subject to tax at the maximum corporate rate on any income from foreclosure property, other than income that otherwise would be qualifying income for purposes of the 75% gross income test, less expenses directly connected with the production of that income.  However, gross income from foreclosure property is treated as qualifying for purposes of the 75% and 95% gross income tests.  Foreclosure property is any real property, including interests in real property, and any personal property incident to such real property:
 
 
•
that is acquired by a REIT as the result of the REIT having bid on such property at foreclosure, or having otherwise reduced such property to ownership or possession by agreement or process of law, after there was a default or default was imminent on a lease of such property or on indebtedness that such property secured;
 
 
•
for which the related loan or lease was acquired by the REIT at a time when the default was not imminent or anticipated; and
 
 
•
for which the REIT makes a proper election to treat the property as foreclosure property.
 
Property generally ceases to be foreclosure property at the end of the third taxable year following the taxable year in which the REIT acquired the property, or longer if an extension is granted by the Secretary of the Treasury.  This grace period terminates and foreclosure property ceases to be foreclosure property on the first day:
 
 
•
on which a lease is entered into for the property that, by its terms, will give rise to income that does not qualify for purposes of the 75% gross income test, or any amount is received or accrued, directly or indirectly, pursuant to a lease entered into on or after such day that will give rise to income that does not qualify for purposes of the 75% gross income test;
 
 
•
on which any construction takes place on the property, other than completion of a building or any other improvement, where more than 10% of the construction was completed before default became imminent; or
 
 
•
which is more than 90 days after the day on which the REIT acquired the property and the property is used in a trade or business which is conducted by the REIT, other than through an independent contractor from whom the REIT itself does not derive or receive any income.
 
After the year 2000, the definition of foreclosure property was amended to include any “qualified health care property,” as defined in Code Section 856(e)(6) acquired by us as the result of the termination or expiration of a lease of such property.  We have operated qualified healthcare facilities acquired in this manner for up to two years (or longer if an extension was granted).  However, we do not currently own any property with respect to which we have made foreclosure property elections.  Properties that we had taken back in a foreclosure or bankruptcy and operated for our own account were treated as foreclosure properties for income tax purposes, pursuant to Internal Revenue Code Section 856(e).  Gross income from foreclosure properties was classified as “good income” for purposes of the annual REIT income tests upon making the election on the tax return.  Once made, the income was classified as “good” for a period of three years, or until the properties were no longer operated for our own account.  In all cases of foreclosure property, we utilized an independent contractor to conduct day-to-day operations in order to maintain REIT status.  In certain cases we operated these facilities through a taxable REIT subsidiary.  For those properties operated through the taxable REIT subsidiary, we utilized an eligible independent contractor to conduct day-to-day operations to maintain REIT status.  As a result of the foregoing, we do not believe that our participation in the operation of nursing homes increased the risk that we would fail to qualify as a REIT.  Through our 2005 taxable year, we had not paid any tax on our foreclosure property because those properties had been producing losses.  We cannot predict whether, in the future, our income from foreclosure property will be significant and/or whether we could be required to pay a significant amount of tax on that income.
 
Hedging Transactions.  From time to time, we enter into hedging transactions with respect to one or more of our assets or liabilities.  Our hedging activities may include entering into interest rate swaps, caps and floors, options to purchase these items, and futures and forward contracts.  To the extent that we enter into an interest rate swap or cap contract, option, futures contract, forward rate agreement, or any similar financial instrument to hedge our indebtedness incurred to acquire or carry “real estate assets,” any periodic income or gain from the disposition of that contract should be qualifying income for purposes of the 95% gross income test, but not the 75% gross income test.  Accordingly, our income and gain from our interest rate swap agreements generally is qualifying income for purposes of the 95% gross income test, but not the 75% gross income test.  To the extent that we hedge with other types of financial instruments, or in other situations, it is not entirely clear how the income from those transactions will be treated for purposes of the gross income tests.  We have structured and intend to continue to structure any hedging transactions in a manner that does not jeopardize our status as a REIT.  For tax years beginning after 2004, we were no longer required to include income from hedging transactions in gross income (i.e., not included in either the numerator or the denominator) for purposes of the 95% gross income test.
 
TRS Income.  A TRS may earn income that would not be qualifying income if earned directly by the parent REIT.  Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS.  A corporation of which a TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS.  Overall, no more than 20% of the value of a REIT’s assets may consist of securities of one or more TRSs.  However, a TRS does not include a corporation which directly or indirectly (i) operates or manages a health care (or lodging) facility, or (ii) provides to any other person (under a franchise, license, or otherwise) rights to any brand name under which a health care (or lodging) facility is operated.  A TRS will pay income tax at regular corporate rates on any income that it earns.  In addition, the new rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation.  The rules also impose a 100% excise tax on transactions between a TRS and its parent REIT or the REIT’s tenants that are not conducted on an arm’s-length basis.
 
Failure to Satisfy Income Tests.  If we fail to satisfy one or both of the 75% or 95% gross income tests for any taxable year, we may nevertheless qualify as a REIT for such year if we are entitled to relief under certain provisions of the Code.  These relief provisions will be generally available if our failure to meet such tests was due to reasonable cause and not due to willful neglect, we attach a schedule of the sources of our income to our tax return, and any incorrect information on the schedule was not due to fraud with intent to evade tax.  It is not possible, however, to state whether in all circumstances we would be entitled to the benefit of these relief provisions.  Even if these relief provisions apply, we would incur a 100% tax on the gross income attributable to the greater of the amounts by which we fail the 75% and 95% gross income tests, multiplied by a fraction intended to reflect our profitability and we would file a schedule with descriptions of each item of gross income that caused the failure.
 
Resolution of Related Party Tenant Issue.  In the fourth quarter of 2006, we determined that, due to certain provisions of the Series B preferred stock issued to us by Advocat, Inc. (“Advocat”) in 2000 in connection with a restructuring, Advocat may have been considered to be a “related party tenant” under the rules applicable to REITs.  As a result, we (1) took steps in 2006 to restructure our relationship with Advocat and ownership of Advocat securities in order to avoid having the rent received from Advocat classified as received from a “related party tenant” in taxable years after 2006, and (2) submitted a request to the IRS on December 15, 2006, that in the event that rental income received by us from Advocat would not be qualifying income for purposes of the REIT gross income tests, such failure during taxable years prior to 2007 was due to reasonable cause.  During 2007, we entered into closing agreement with the IRS covering all affected taxable periods prior to 2007 to the effect that our failure to meet the 95% gross income tests as a result of the Advocat rental income being considered to be received from a “related party tenant” was due to reasonable cause.  In connection with reaching this agreement with the IRS as to the Advocat related party tenant income issue, we paid to the IRS penalty income taxes and interest totaling approximately $5.6 million for the tax years 2002 through 2006. We had previously accrued $5.6 million of income tax liabilities as of December 31, 2006.  As a result of the execution of closing agreement with the IRS as to our taxable years 2002 through 2006 and the restructuring of our relationship with Advocat in October 2006, we believe we have fully resolved all tax issues relating to rental income received from Advocat prior to 2007 and have been advised by tax counsel that we will not receive any non-qualifying related party tenant income from Advocat in 2007 and future fiscal years. Accordingly, we do not expect to incur tax expense associated with related party tenant income in periods commencing January 1, 2007.

Asset Tests.  At the close of each quarter of our taxable year, we must also satisfy the following tests relating to the nature of our assets.  First, at least 75% of the value of our total assets must be represented by real estate assets (including (i) our allocable share of real estate assets held by partnerships in which we own an interest and (ii) stock or debt instruments held for not more than one year purchased with the proceeds of a stock offering or long-term (at least five years) debt offering of our company), cash, cash items and government securities.  Second, of our investments not included in the 75% asset class, the value of our interest in any one issuer’s securities may not exceed 5% of the value of our total assets.  Third, we may not own more than 10% of the voting power or value of any one issuer’s outstanding securities.  Fourth, no more than 20% of the value of our total assets may consist of the securities of one or more TRSs.  Fifth, no more than 25% of the value of our total assets may consist of the securities of TRSs and other non-TRS taxable subsidiaries and other assets that are not qualifying assets for purposes of the 75% asset test.
 
For purposes of the second and third asset tests the term “securities” does not include our equity or debt securities of a qualified REIT subsidiary, a TRS, or an equity interest in any partnership, since we are deemed to own our proportionate share of each asset of any partnership of which we are a partner.  Furthermore, for purposes of determining whether we own more than 10% of the value of only one issuer’s outstanding securities, the term “securities” does not include: (i) any loan to an individual or an estate; (ii) any Code Section 467 rental agreement; (iii) any obligation to pay rents from real property; (iv) certain government issued securities; (v) any security issued by another REIT; and (vi) our debt securities in any partnership, not otherwise excepted under (i) through (v) above, (A) to the extent of our interest as a partner in the partnership or (B) if 75% of the partnership’s gross income is derived from sources described in the 75% income test set forth above.
 
We may own up to 100% of the stock of one or more TRSs.  However, overall, no more than 20% of the value of our assets may consist of securities of one or more TRSs, and no more than 25% of the value of our assets may consist of the securities of TRSs and other non-TRS taxable subsidiaries (including stock in non-REIT C corporations) and other assets that are not qualifying assets for purposes of the 75% asset test.  If the outstanding principal balance of a mortgage loan exceeds the fair market value of the real property securing the loan, a portion of such loan likely will not be a qualifying real estate asset for purposes of the 75% test.  The nonqualifying portion of that mortgage loan will be equal to the portion of the loan amount that exceeds the value of the associated real property.
 
After initially meeting the asset tests at the close of any quarter, we will not lose our status as a REIT for failure to satisfy any of the asset tests at the end of a later quarter solely by reason of changes in asset values.  If the failure to satisfy the asset tests results from an acquisition of securities or other property during a quarter, the failure can be cured by disposition of sufficient nonqualifying assets within 30 days after the close of that quarter.
 
For our tax years beginning after 2004, subject to certain de minimis exceptions, we may avoid REIT disqualification in the event of certain failures under the asset tests, provided that (i) we file a schedule with a description of each asset that caused the failure, (ii) the failure was due to reasonable cause and not willful neglect, (iii) we dispose of the assets within 6 months after the last day of the quarter in which the identification of the failure occurred (or the requirements of the rules are otherwise met within such period), and (iv) we pay a tax on the failure equal to the greater of (A) $50,000 per failure, and (B) the product of the net income generated by the assets that caused the failure for the period beginning on the date of the failure and ending on the date we dispose of the asset (or otherwise satisfy the requirements) multiplied by the highest applicable corporate tax rate.
 
Annual Distribution Requirements.  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 noncash income.  Such distributions must be paid in the taxable year to which they relate, or in the following taxable year if declared before we timely file our tax return for such year and paid on or before the first regular dividend payment after such declaration.  In addition, such distributions are required to be made pro rata, with no preference to any share of stock as compared with other shares of the same class, and with no preference to one class of stock as compared with another class except to the extent that such class is entitled to such a preference.  To the extent that we do not distribute all of our net capital gain, or 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.
 
Furthermore, if we fail to distribute during a calendar year, or by the end of January following the calendar year in the case of distributions with declaration and record dates falling in the last three months of the calendar year, at least the sum of:
 
•            85% of our REIT ordinary income for such year;
 
•            95% of our REIT capital gain income for such year; and
 
•            any undistributed taxable income from prior periods,
 
we will incur a 4% nondeductible excise tax on the excess of such required distribution over the amounts we actually distribute.  We may elect to retain and pay income tax on the net long-term capital gain we receive in a taxable year.  If we so elect, we will be treated as having distributed any such retained amount for purposes of the 4% excise tax described above.  We have made, and we intend to continue to make, timely distributions sufficient to satisfy the annual distribution requirements.  We may also be entitled to pay and deduct deficiency dividends in later years as a relief measure to correct errors in determining our taxable income.  Although we may be able to avoid income tax on amounts distributed as deficiency dividends, we will be required to pay interest to the IRS based upon the amount of any deduction we take for deficiency dividends.
 
The availability to us of, among other things, depreciation deductions with respect to our owned facilities depends upon the treatment by us as the owner of such facilities for federal income tax purposes, and the classification of the leases with respect to such facilities as “true leases” rather than financing arrangements for federal income tax purposes.  The questions of whether (1) we are the owner of such facilities and (ii) the leases are true leases for federal tax purposes, are essentially factual matters.  We believe that we will be treated as the owner of each of the facilities that we lease, and such leases will be treated as true leases for federal income tax purposes.  However, no assurances can be given that the IRS will not successfully challenge our status as the owner of our facilities subject to leases, and the status of such leases as true leases, asserting that the purchase of the facilities by us and the leasing of such facilities merely constitute steps in secured financing transactions in which the lessees are owners of the facilities and we are merely a secured creditor.  In such event, we would not be entitled to claim depreciation deductions with respect to any of the affected facilities.  As a result, we might fail to meet the 90% distribution requirement or, if such requirement is met, we might be subject to corporate income tax or the 4% excise tax.
 
Reasonable Cause Savings Clause.  We may avoid disqualification in the event of a failure to meet certain requirements for REIT qualification if the failures are due to reasonable cause and not willful neglect, and if the REIT pays a penalty of $50,000 for each such failure.  This reasonable cause safe harbor is not available for failures to meet the 95% and 75% gross income tests, the rules with respect to ownership of securities of more than 10% of a single issuer, and the new rules provided for failures of the asset tests.
 
Failure to Qualify. If we fail to qualify as a REIT in any taxable year, and the reasonable cause relief provisions do not apply, we will be subject to tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates.  Distributions to stockholders in any year in which we fail to qualify will not be deductible and our failure to qualify as a REIT would reduce the cash available for distribution by us to our stockholders.  In addition, if we fail to qualify as a REIT, all distributions to stockholders will be taxable as ordinary income, to the extent of current and accumulated earnings and profits, and, subject to certain limitations of the Code, corporate distributees may be eligible for the dividends received deduction.  Unless entitled to relief under specific statutory provisions, we would also be disqualified from taxation as a REIT for the four taxable years following the year during which qualification was lost.  It is not possible to state whether in all circumstances we would be entitled to such statutory relief.  Failure to qualify could result in our incurring indebtedness or liquidating investments in order to pay the resulting taxes.
 
Other Tax Matters. We own and operate a number of properties through qualified REIT subsidiaries, (“QRSs”).  The QRSs are treated as qualified REIT subsidiaries under the Code.  Code Section 856(i) provides that a corporation which is a qualified REIT subsidiary shall not be treated as a separate corporation, and all assets, liabilities, and items of income, deduction, and credit of a qualified REIT subsidiary shall be treated as assets, liabilities and such items (as the case may be) of the REIT.  Thus, in applying the tests for REIT qualification described in this prospectus under the heading “Taxation of Omega,” the QRSs will be ignored, and all assets, liabilities and items of income, deduction, and credit of such QRSs will be treated as our assets, liabilities and items of income, deduction, and credit.
 
In the case of a REIT that is a partner in a partnership, the REIT is treated as owning its proportionate share of the assets of the partnership and as earning its allocable share of the gross income of the partnership for purposes of the applicable REIT qualification tests.  Thus, our proportionate share of the assets, liabilities, and items of income of any partnership, joint venture, or limited liability company that is treated as a partnership for federal income tax purposes in which we own an interest, directly or indirectly, will be treated as our assets and gross income for purposes of applying the various REIT qualification requirements.


Medicare. 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 any facilities that may be owned and operated for our own account from time to time, derive a substantial portion of their net operating revenues from third-party payors, including the Medicare and Medicaid programs.  These programs are highly regulated by federal, state and local laws, rules and regulations and are subject to frequent and substantial change.

In 1997, the Balanced Budget Act significantly reduced spending levels for the Medicare and Medicaid programs, in part because the legislation modified the payment methodology for SNFs by shifting payments for services provided to Medicare beneficiaries from a reasonable cost basis to a prospective payment system.  Under the prospective payment system, SNFs are paid on a per diem prospective case-mix adjusted 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 such facility derives from Medicare patients.

Legislation adopted in 1999 and 2000 provided for a few temporary increases to Medicare payment rates, but these temporary increases have since expired.  Specifically, in 1999 the Balanced Budget Refinement Act included a 4% across-the-board increase of the adjusted federal per diem payment rates for all patient acuity categories (known as “Resource Utilization Groups” or “RUGs”) that were in effect from April 2000 through September 30, 2002.  In 2000, the Benefits Improvement and Protection Act included a 16.7% increase in the nursing component of the case-mix adjusted federal periodic payment rate, which was implemented in April 2000 and also expired October 1, 2002.  The October 1, 2002 expiration of these temporary increases has had an adverse impact on the revenues of the operators of SNFs and has negatively impacted some operators’ ability to satisfy their monthly lease or debt payments to us.

The Balanced Budget Refinement Act and the Benefits Improvement and Protection Act also established temporary increases, beginning in April 2001, to Medicare payment rates to SNFs that were designated to remain in place until the Centers for Medicare and Medicaid Services (“CMS”), implemented refinements to the existing RUG case-mix classification system to more accurately estimate the cost of non-therapy ancillary services.  The Balanced Budget Refinement Act provided for a 20% increase for 15 RUG categories until CMS modified the RUG case-mix classification system.  The Benefits Improvement and Protection Act modified this payment increase by reducing the 20% increase for three of the 15 RUGs to a 6.7% increase and instituting an additional 6.7% increase for eleven other RUGs.

On August 4, 2005, CMS published its final rule, effective October 1, 2005, establishing Medicare payments for SNFs under the prospective payment system for federal fiscal year 2006 (October 1, 2005 to September 30, 2006).  The final rule modified the RUG case-mix classification system and added nine new categories to the system, expanding the number of RUGs from 44 to 53.  The implementation of the RUG refinements triggered the expiration of the temporary payment increases of 20% and 6.7% established by the Balanced Budget Refinement Act and the Benefits Improvement and Protection Act, respectively.

Additionally, CMS announced updates in the final rule to reimbursement rates for SNFs in federal fiscal year 2006 based on an increase in the “full market-basket” of 3.1%.  In the August 4, 2005 final rule, CMS estimated that the increases in Medicare reimbursements to SNFs arising from the refinements to the prospective payment system and the market basket update under the final rule would offset the reductions stemming from the elimination of the temporary increases during federal fiscal year 2006.  CMS estimated that there would be an overall increase in Medicare payments to SNFs totaling $20 million in fiscal year 2006 compared to 2005.

On July 27, 2006, CMS posted a notice updating the payment rates to SNFs for fiscal year 2007 (October 1, 2006 to September 30, 2007).  The market basket increase factor for 2007 was 3.1 %. CMS estimated that the payment update would increase aggregate payments to SNFs nationwide by approximately $560 million in fiscal year 2007 compared to 2006.

On August 3, 2007, CMS published its final rule for updating the payment rates used under the prospective payment system for SNFs for federal fiscal year 2008 (October 1, 2007 to September 30, 2008).  The market basket increase for fiscal year 2008 is 3.3%.  Under the final rule, aggregate Medicare payments for nursing homes would increase by approximately $690 million for fiscal year 2008.  In addition, the rule revises and rebases the SNF market basket, which is used in calculating SNF payment rates.

In August 2007, the United States House of Representatives passed the Children’s Health and Medicare Protection (“CHAMP”) Act, which proposed significant cuts to the Medicare program.  This bill would have limited the SNF market basket increase for 2008 to the first quarter of fiscal year 2008.  After the first quarter, the bill would have decreased the update to zero.  Although Congress did not include this provision in the Medicare legislation enacted in December 2007, the House of Representatives subsequently dropped these and all other Medicare provisions from the legislation, it remains possible that such Medicare provisions will be considered by the full Congress in the future.

A 128% temporary increase in the per diem amount paid to SNFs for residents who have AIDS took effect on October 1, 2004.  This temporary payment increase arose from the Medicare Prescription Drug Improvement and Modernization Act of 2003, or the (Medicare Modernization Act).  Although CMS also noted that the AIDS add-on was not intended to be permanent, the increase remained in effect through fiscal year 2007 and the final rule updating payment rates for SNFs for fiscal year 2008 indicated that the increase will continue to remain in effect for fiscal year 2008.

A significant change enacted under the Medicare Modernization Act is the creation of a new prescription drug benefit, Medicare Part D, which went into effect January 1, 2006.  The significant expansion of benefits for Medicare beneficiaries arising under the expanded prescription drug benefit could result in financial pressures on the Medicare program that might could result in future legislative and regulatory changes with impacts for our operators.  As part of this new program, the prescription drug benefits for patients who are dually eligible for both Medicare and Medicaid are being transitioned from Medicaid to Medicare, and many of these patients reside in long-term care facilities.  The Medicare program experienced significant operational difficulties in transitioning prescription drug coverage for this population when the benefit went into effect on January 1, 2006. Although it is unclear whether or how issues involving Medicare Part D might have any direct financial impacts on our operators, a June 2007 report by the Medicare Payment Advisory Commission (MedPAC, which is an independent body that advises Congress on Medicare payment policies) examined how Part D is affecting pharmacy services for residents of nursing facilities and other stakeholders and considered alternative approaches for delivering Part D benefits in nursing facilities.  MedPAC did not make recommendations, although the report indicated that MedPAC will continue monitoring the delivery of Part D benefits to residents of long-term care facilities.

On February 8, 2006, the President signed into law a $39.7 billion budget reconciliation package called the Deficit Reduction Act of 2005 (“Deficit Reduction Act”), to lower the federal budget deficit.  The Deficit Reduction Act included estimated net savings of $8.3 billion from the Medicare program over 5 years.

The Deficit Reduction Act contained a provision reducing payments to SNFs for allowable bad debts.  Previously, Medicare reimbursed SNFs for 100% of beneficiary bad debt arising from unpaid deductibles and coinsurance amounts.  In 2003, CMS released a proposed rule seeking to reduce bad debt reimbursement rates for certain providers, including SNFs, by 30% over a three-year period.  Subsequently, in early 2006 the Deficit Reduction Act reduced payments to SNFs for allowable bad debts by 30% effective October 1, 2005 for those individuals not dually eligible for both Medicare and Medicaid.  Bad debt payments for the dually eligible population will remain at 100%.  Consistent with this legislation, CMS finalized its 2003 proposed rule on August 18, 2006, and the regulations became effective on October 1, 2006.  CMS estimates that implementation of this bad debt provision will result in a savings to the Medicare program of $490 million from FY 2006 to FY 2010.

The Deficit Reduction Act also contained a provision governing the therapy caps that went into place under Medicare on January 1, 2006.  The therapy caps limit the physical therapy, speech-language therapy and occupation therapy services that a Medicare beneficiary can receive during a calendar year.  The therapy caps were in effect for calendar year 1999 and then suspended by Congress for three years.  An inflation-adjusted therapy limit ($1,590 per year) was implemented in September of 2002, but then once again suspended in December of 2003 by the Medicare Modernization Act.  Under the Medicare Modernization Act, Congress placed a two-year moratorium on implementation of the caps, which expired at the end of 2005.

The inflation-adjusted therapy caps are set at $1,810 for calendar year 2008.  These caps do not apply to therapy services covered under Medicare Part A in a SNF, although the caps apply in most other instances involving patients in SNFs or long-term care facilities who receive therapy services covered under Medicare Part B.  The Deficit Reduction Act permitted exceptions in 2006 for therapy services to exceed the caps when the therapy services are deemed medically necessary by the Medicare program.  The Tax Relief and Health Care Act of 2006, signed into law on December 20, 2006, extend these exceptions through December 31, 2007.  The Medicare, Medicaid, and SCHIP Extension Act of 2007 signed into law on December 29, 2007 extend the exceptions through June 30, 2008.  Future and continued implementation of the therapy caps could have a material adverse effect on our operators’ financial condition and operations, which could adversely affect their ability to meet their payment obligations to us.

In general, we cannot be assured that federal reimbursement will remain at levels comparable to present levels or 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 Medicare payment rates for SNFs, and if such payment rates for SNFs 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 their citizens.  Currently, Medicaid is the single largest source of financing for long-term care in the United States.  Rising Medicaid costs and decreasing state revenues caused by recent 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 recent years, many states have 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 reimbursement rates, including rates paid to SNF and long-term care providers, or reductions in Medicaid enrollee benefits, including long-term care benefits.  We cannot predict the extent to which Medicaid rate freezes, cuts or benefit reductions ultimately will be adopted, the number of states that will adopt them or the impact of such adoption on our operators.  However, extensive Medicaid rate cuts, freezes or benefit reductions could have a material adverse effect on our operators’ liquidity, financial condition and operations, which could adversely affect their ability to make lease or mortgage payments to us.

The Deficit Reduction Act included $4.7 billion in estimated savings from Medicaid and the State Children’s Health Insurance Program over five years.  The Deficit Reduction Act gave states the option to increase Medicaid cost-sharing and reduce Medicaid benefits, accounting for an estimated $3.2 billion in federal savings over five years.  The remainder of the Medicaid savings under the Deficit Reduction Act comes primarily from changes to prescription drug reimbursement ($3.9 billion in savings over five years) and tightened policies governing asset transfers ($2.4 billion in savings over five years).

Asset transfer policies, which determine Medicaid eligibility based on whether a Medicaid applicant has transferred assets for less than fair value, became more restrictive under the Deficit Reduction Act, which extended the look-back period to five years, moved the start of the penalty period and made individuals with more than $500,000 in home equity ineligible for nursing home benefits (previously, the home was excluded as a countable asset for purposes of Medicaid eligibility).  These changes could have a material adverse effect on our operators’ financial conditions and operations, which could adversely affect their ability to meet their payment obligations to us.

Private payors, including managed care payors, increasingly are demanding discounted fee structures and the assumption by healthcare providers of all or a portion of the financial risk of operating a healthcare facility.  Efforts to impose greater discounts and more stringent cost controls are expected to continue.  Any changes in reimbursement policies that reduce reimbursement levels could adversely affect the revenues of our lessees and mortgagors, thereby adversely affecting those lessees’ and mortgagors’ abilities to make their monthly lease or debt payments to us.

In May of 2007, CMS awarded 13 states and the District of Columbia grants totaling over $547 million to build Medicaid long-term care programs that provide alternatives to nursing home care and help keep people remain at home.  Similarly, individual states have been promoting alternatives to nursing homes to cope with the aging population through laws and the development and promotion of community-based systems of care.  CMS’ grants and the activities of states evidence a shift from a focus on institutional care to a system that offers more choices, including home and community-based services.  This trend could have potential adverse effects on our operators’ financial conditions, which could affect their ability to meet their payment obligations to us.

Fraud and Abuse Laws and Regulations.  There are various extremely complex and largely uninterpreted federal and state laws governing a wide array of referrals, relationships and arrangements and prohibiting fraud by healthcare providers, including criminal provisions that prohibit filing false claims or making false statements to receive payment or certification under Medicare and Medicaid, and failing to refund overpayments or improper payments.  The federal and state governments are devoting increasing attention and resources to anti-fraud initiatives against healthcare providers.  Penalties for healthcare fraud have been increased and expanded over recent years, including broader provisions for the exclusion of providers from the Medicare and Medicaid programs.  The Office of the Inspector General for the U.S. Department of Health and Human Services (“OIG-HHS”), has described a number of ongoing and new initiatives for 2007 to study instances of potential overbilling and/or fraud in SNFs and nursing homes under both Medicare and Medicaid.  The OIG-HHS, in cooperation with other federal and state agencies, also continues to focus on the activities of SNFs in certain states in which we have properties.

In addition, the federal False Claims Act allows a private individual with knowledge of fraud to bring a claim on behalf of the federal government and earn a percentage of the federal government’s recovery.  Because of these monetary incentives, these so-called ‘‘whistleblower’’ suits have become more frequent.  Some states currently have statutes that are analogous to the federal False Claims Act.  The Deficit Reduction Act encourages additional states to enact such legislation and may encourage increased enforcement activity by permitting states to retain 10% of any recovery for that state’s Medicaid program if the enacted legislation is at least as rigorous as the federal False Claims Act.  The violation of any of these laws or regulations by an operator may result in the imposition of fines or other penalties that could jeopardize that operator’s ability to make lease or mortgage payments to us or to continue operating its facility.

Other Laws.  Other laws that impact how our operators conduct their operations include federal and state laws designed to protect the confidentiality and security of patient health information, state and local licensure laws, laws protecting consumers against deceptive practices, and laws generally affecting our operators management of property and equipment and how our operators generally conduct their operations, such as fire, and health and safety laws; and federal and state laws affecting assisted living facilities mandating quality of services and care, and quality of food service; resident rights (including abuse and neglect laws) and health standards set by the federal Occupational Safety and Health Administration.  Additional costs to comply with these rules could have a material adverse effect on our operators' financial condition, which could cause the revenues of our operators to decline and potentially jeopardize their ability to meet their obligations to us.

Legislative and Regulatory Developments.  Each year, legislative and regulatory proposals are introduced or proposed in Congress and state legislatures as well as by federal and state agencies that, if implemented, could result in major changes in the healthcare system, either nationally or at the state level. In addition, regulatory proposals and rules are released on an ongoing basis that may have major impacts on the healthcare system generally and the industries in which our operators do business.  Legislative and regulatory developments can be expected to occur on an ongoing basis at the local, state and federal levels that have direct or indirect impacts on the policies governing the reimbursement levels paid to our facilities by public and private third-party payors, the costs of doing business and the threshold requirements that must be met for facilities to continue operation or to expand.

The Medicare Modernization Act, which is one example of such legislation, was enacted in December 2003. The significant expansion of other benefits for Medicare beneficiaries under this Act, such as the prescription drug benefit, could create financial pressures on the Medicare program that might result in future legislative and regulatory changes with impacts on our operators. Although the creation of a prescription drug benefit for Medicare beneficiaries was expected to generate fiscal relief for state Medicaid programs, the structure of the benefit and costs associated with its implementation may mitigate the relief for states that originally was anticipated.

The Deficit Reduction Act is another example of such legislation.  The provisions in the legislation designed to create cost savings from both Medicare and Medicaid could diminish reimbursement for our operators under both Medicare and Medicaid.

CMS also launched, in 2002, the Nursing Home Quality Initiative program in 2002, which requires nursing homes participating in Medicare to provide consumers with comparative information about the quality of care at the facility.  In the fall of 2007, CMS plans to initiate a new quality campaign, Advancing Excellence for America’s Nursing Home Residents, to be conducted over the next two years with the ultimate goal being improvement in quality of life and efficiency of care delivery.  In the event any of our operators do not maintain the same or superior levels of quality care as their competitors, patients could choose alternate facilities, which could adversely impact our operators’ revenues.  In addition, the reporting of such information could lead to reimbursement policies that reward or penalize facilities on the basis of the reported quality of care parameters.

In late 2005, CMS began soliciting public comments regarding a demonstration to examine pay-for-performance approaches in the nursing home setting that would offer financial incentives for facilities delivering high quality care.  CMS anticipates that the demonstration will begin in 2008.  CMS will also commence the next phase of the Post Acute Care Payment Reform Demonstration (PAC-PRD) project in 2008, where information will be collected about Medicare beneficiaries’ experiences in post-acute care settings.  The purpose of the demonstration project, which was mandated by the Deficit Reduction Act of 2005, is to use the information obtained to guide future Medicare payment policy.

Other proposals under consideration include efforts by individual states to control costs by decreasing state Medicaid reimbursements in the current or future fiscal years and federal legislation addressing various issues, such as improving quality of care and reducing medical errors throughout the health care industry. We cannot accurately predict whether specific proposals will be adopted or, if adopted, what effect, if any, these proposals would have on operators and, thus, our business.




As of February 1, 2008, the executive officers of our company were:

C. Taylor Pickett(46) is the Chief Executive Officer and has served in this capacity since June 2001. Mr. Pickett is also a Director and has served in this capacity since May 30, 2002.  Mr. Pickett’s term as a Director expires in 2008.  Prior to joining our company, Mr. Pickett served as the Executive Vice President and Chief Financial Officer from January 1998 to June 2001 of Integrated Health Services, Inc., a public company specializing in post-acute healthcare services. He also served as Executive Vice President of Mergers and Acquisitions from May 1997 to December 1997 of Integrated Health Services, Inc.  Prior to his roles as Chief Financial Officer and Executive Vice President of Mergers and Acquisitions, Mr. Pickett served as the President of Symphony Health Services, Inc. from January 1996 to May 1997.

Daniel J. Booth (44) is the Chief Operating Officer and has served in this capacity since October 2001. Prior to joining our company, Mr. Booth served as a member of Integrated Health Services’ management team since 1993, most recently serving as Senior Vice President, Finance. Prior to joining Integrated Health Services, Mr. Booth was Vice President in the Healthcare Lending Division of Maryland National Bank (now Bank of America).

R. Lee Crabill, Jr.(54) is the Senior Vice President of Operations of our company and has served in this capacity since July 2001. Mr. Crabill served as a Senior Vice President of Operations at Mariner Post-Acute Network, Inc. from 1997 through 2000. Prior to that, he served as an Executive Vice President of Operations at Beverly Enterprises.

Robert O. Stephenson (44) is the Chief Financial Officer and has served in this capacity since August 2001. Prior to joining our company, Mr. Stephenson served from 1996 to July 2001 as the Senior Vice President and Treasurer of Integrated Health Services, Inc.  Prior to Integrated Health Services, Mr. Stephenson held various positions at CSX Intermodal, Inc., Martin Marietta Corporation and Electronic Data Systems.

Michael D. Ritz (39) is the Chief Accounting Officer and has served in this capacity since February 2007.  Prior to joining our company, Mr. Ritz served as the Vice President, Accounting & Assistant Corporate Controller from April 2005 until February 2007 and the Director, Financial Reporting from August 2002 until April 2005 for Newell Rubbermaid Inc.  Prior to Newell Rubbermaid Inc., Mr. Ritz served as the Director of Accounting and Controller of Novavax Inc. from July 2001 through August 2002.

As of December 31, 2007, we had 19 full-time employees, including the five executive officers listed above.



You should carefully consider the risks described below. These risks are not the only ones that we may face. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us. If any of the following risks occurs, our business, financial condition or results of operations could be materially and adversely affected.
 
Risks Related to the Operators of Our Facilities

Our financial position could be weakened and our ability to fulfill our obligations under our indebtedness could be limited if any of our major operators were unable to meet their obligations to us or failed to renew or extend their relationship with us as their lease terms expire, or if we were unable to lease or re-lease our facilities or make mortgage loans on economically favorable terms. These adverse developments could arise due to a number of factors, including those listed below.

The bankruptcy, insolvency or financial deterioration of our operators could delay our ability to collect unpaid rents or require us to find new operators for rejected facilities.

We are exposed to the risk that our operators may not be able to meet their obligations, which may result in their bankruptcy or insolvency. Although our leases and loans provide us the right to terminate an investment, evict an operator, demand immediate repayment and other remedies, title 11 of the United States Code, 11 U.S.C. §§ 101-1532, as amended and supplemented, (the “Bankruptcy Code”), affords certain protections to a party that has filed for bankruptcy that would probably render certain of these remedies unenforceable, or, at the very least, delay our ability to pursue such remedies.  In addition, an operator in bankruptcy may be able to restrict our ability to collect unpaid rent or mortgage payments during the bankruptcy case.

Furthermore, 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 under government programs (or otherwise) 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.

A debtor may have the right to assume or reject a lease with us under bankruptcy law and his or her decision could delay or limit our ability to collect rents thereunder.

If one or more of our lessees files bankruptcy relief, the Bankruptcy Code provides that a debtor has the option to assume or reject the unexpired lease within a certain period of time. However, our lease arrangements with operators that operate more than one of our facilities are generally made pursuant to a single master lease covering all of that operator’s facilities leased from us, and consequently, it is possible that in bankruptcy the debtor-lessee may be required to assume or reject the master lease as a whole, rather than making the decision on a facility by facility basis, thereby preventing the debtor-lessee from assuming only the better performing facilities and terminating the leasing arrangement with respect to the poorer performing facilities. The Bankruptcy Code generally requires that a debtor must assume or reject a contract in its entirety. Thus, a debtor cannot choose to keep the beneficial provisions of a contract while rejecting the burdensome ones; the contract must be assumed or rejected as a whole. However, where under applicable law a contract (even though it is contained in a single document) is determined to be divisible or severable into different agreements, or similarly where a collection of documents are determined to constitute separate agreements instead of a single, integrated contract, then in those circumstances a debtor/trustee may be allowed to assume some of the divisible or separate agreements while rejecting the others. Whether a master lease agreement would be determined to be a single contract or a divisible agreement, and hence whether a bankruptcy court would require a master lease agreement to be assumed or rejected as a whole, would depend on a number of factors some of which may include, but may not necessarily be limited to, the following:

·  
applicable state law;
·  
the parties’ intent;
·  
whether the master lease agreement and related documents were executed contemporaneously;
·  
the nature and purpose of the relevant documents;
·  
whether the obligations in various documents are independent;
·  
whether the leases are coterminous;
·  
whether a single check is paid for all properties;
·  
whether rent is apportioned among the leases;
·  
whether termination of one lease constitutes termination of all;
·  
whether the leases may be separately assigned or sublet;
·  
whether separate consideration exists for each lease; and
·  
whether there are cross-default provisions.
 
The Bankruptcy Code provides that a debtor has the power and the option to assume, assume and assign to a third party, or reject the unexpired lease. In the event that the unexpired lease is assumed on behalf of the debtor-lessee, obligations under the lease generally would be entitled to administrative priority over other unsecured pre-bankruptcy claims. If the debtor chooses to assume the lease (or assume and assign the lease), then the debtor is required to cure all monetary defaults, or provide adequate assurance that it will promptly cure such defaults. However, the debtor-lessee may not have to cure historical non-monetary defaults under the lease to the extent that they have not resulted in an actual pecuniary loss, but the debtor-lessee must cure non-monetary defaults under the lease from the time of assumption going forward. A debtor must generally pay all rent payments coming due under the lease after the bankruptcy filing but before the assumption or rejection of the lease. The Bankruptcy Code provides that the debtor-lessee must make the decision regarding assumption, assignment or rejection within a certain period of time. For cases filed on or after October 17, 2005, the time period to make the decision is 120 days, subject to extension ‘‘for cause.’’  A bankruptcy court may only extend this period beyond 90 days if the lessor consents in writing.

If a tenant rejects a lease under the Bankruptcy Code, it is deemed to be a pre-petition breach of the lease, and the lessor’s claim arising therefrom may be 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%, not to exceed three years, of the remaining term of such lease, following the earlier of the petition date and repossession or surrender of the leased property.  If the debtor rejects the lease, we would be entitled to have the facility returned to us.  In that event, if we were unable to re-lease the facility to a new operator on favorable terms or only after a significant delay, we could lose some or all of the associated revenue from that facility for an extended period of time, which could also result in impairment of the facility.

With respect to our mortgage loans, the imposition of an automatic stay under bankruptcy law could negatively impact our ability to foreclose or seek other remedies against a mortgagor.

Generally, with respect to our mortgage loans, the imposition of an automatic stay under the Bankruptcy Code precludes us from exercising foreclosure or other remedies against the debtor without first obtaining stay relief from the bankruptcy court. Pre-petition creditors generally do not have rights to the cash flows from the properties underlying the mortgages unless their security interest in the property includes such cash flows. Mortgagees may, however, receive periodic payments from the debtor/mortgagors. Such payments are referred to as adequate protection payments. The timing of adequate protection payments and whether the mortgagees are entitled to such payments depends on negotiating an acceptable settlement with the mortgagor (subject to approval of the bankruptcy court) or on 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 several respects. The mortgagee’s loan may be divided into a secured claim for the portion of the mortgage debt that does not exceed the value of the property securing the debt and a general unsecured claim for the portion of the mortgage debt that exceeds the value of the property. A secured creditor such as our company is entitled to the recovery of interest and reasonable fees, costs and charges provided for under the agreement under which such claim arose 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 as well as reasonable fees, costs, and charges are not necessarily required to be paid during the progress of the bankruptcy case, but they will accrue until confirmation of a plan of reorganization/liquidation and are generally paid at confirmation or such other time as the court orders unless the debtor voluntarily makes a payment.  If the value of the collateral held by a secured creditor is less than the secured debt (including such creditor’s secured debt and the secured debt of any creditor with a more senior security interest in the collateral), 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 assumed, assumed and assigned, or rejected with all of its benefits and burdens intact, the terms of a mortgage, including the rate of interest and the timing of principal payments, may be modified under certain circumstances if the debtor is able to effect a ‘‘cram down’’ under the Bankruptcy Code.  Before such a ‘‘cram down’’ is allowed, the Bankruptcy Court must conclude that the treatment of the secured creditor’s claim is ‘‘fair and equitable.’’

If an operator files bankruptcy, our leases with the debtor could be re-characterized as a financing agreement, which could negatively impact our rights under the lease.

Another risk regarding our leases is that in an operator’s bankruptcy the leases could be re-characterized as a financing agreement.  In making such a determination, a bankruptcy court may consider certain factors, which may include, but are not necessarily limited to, the following:

·  
whether rent is calculated to provide a return on investment rather than to compensate the lessor for loss, use and possession of the property;
 
·  
whether the property is purchased specifically for the lessee’s use or whether the lessee selected, inspected, contracted for, and received the property;
 
·  
whether the transaction is structured solely to obtain tax advantages;
 
·  
whether the lessee is entitled to obtain ownership of the property at the expiration of the lease, and whether any option purchase price is unrelated to the value of the land; and
 
·  
whether the lessee assumed many of the obligations associated with outright ownership of the property, including responsibility for maintenance, repair, property taxes and insurance.
 
If an operator defaults under one of our mortgage loans, we may have to foreclose on the mortgage or protect our interest by acquiring title to the property and thereafter making substantial improvements or repairs in order to maximize the facility’s investment potential.  Operators may contest enforcement of foreclosure or other remedies, seek bankruptcy protection against our exercise of enforcement or other remedies and/or bring claims for lender liability in response to actions to enforce mortgage obligations.  If an operator seeks bankruptcy protection, the automatic stay provisions of the Bankruptcy Code would preclude us from enforcing foreclosure or other remedies against the operator unless relief is first obtained from the court having jurisdiction over the bankruptcy case. High ‘‘loan to value’’ ratios or declines in the value of the facility may prevent us from realizing an amount equal to our mortgage loan upon foreclosure.

Operators that fail to comply with the requirements of governmental reimbursement programs such as Medicare or Medicaid, licensing and certification requirements, fraud and abuse regulations or new legislative developments may be unable to meet their obligations to us.

Our operators are subject to numerous federal, state and local laws and regulations that are subject to frequent and substantial changes (sometimes applied retroactively) resulting from legislation, adoption of rules and regulations, and administrative and judicial interpretations of existing law. The ultimate timing or effect of these changes cannot be predicted. These changes may have a dramatic effect on our operators’ costs of doing business and on the amount of reimbursement by both government and other third-party payors.  The failure of any of our operators to comply with these laws, requirements and regulations could adversely affect their ability to meet their obligations to us.  In particular:

·  
Medicare and Medicaid.  A significant portion of our SNF operators’ revenue is derived from governmentally-funded reimbursement programs, primarily Medicare and Medicaid, and failure to maintain certification and accreditation in these programs would result in a loss of funding from such programs.  Loss of certification or accreditation could cause the revenues of our operators to decline, potentially jeopardizing their ability to meet their obligations to us.  In that event, our revenues from those facilities could be reduced, which could in turn cause the value of our affected properties to decline.  State licensing and Medicare and Medicaid laws also require operators of nursing homes and assisted living facilities to comply with extensive standards governing operations.  Federal and state agencies administering those laws regularly inspect such facilities and investigate complaints. Our operators and their managers receive notices of potential sanctions and remedies from time to time, and such sanctions have been imposed from time to time on facilities operated by them.  If they are unable to cure deficiencies, which have been identified or which are identified in the future, such sanctions may be imposed and if imposed may adversely affect our operators’ revenues, potentially jeopardizing their ability to meet their obligations to us.
 
·  
Licensing and Certification.  Our operators and facilities are subject to regulatory and licensing requirements of federal, state and local authorities and are periodically audited by them to confirm compliance.  Failure to obtain licensure or loss or suspension of licensure would prevent a facility from operating or result in a suspension of reimbursement payments until all licensure issues have been resolved and the necessary licenses obtained or reinstated.  Our SNFs require governmental approval, in the form of a certificate of need that generally varies by state and is subject to change, prior to the addition or construction of new beds, the addition of services or certain capital expenditures.  Some of our facilities may be unable to satisfy current and future certificate of need requirements and may for this reason be unable to continue operating in the future.  In such event, our revenues from those facilities could be reduced or eliminated for an extended period of time or permanently.
 
·  
Fraud and Abuse Laws and Regulations.  There are various extremely complex and largely uninterpreted federal and state laws governing a wide array of referrals, relationships and arrangements and prohibiting fraud by healthcare providers, including criminal provisions that prohibit filing false claims or making false statements to receive payment or certification under Medicare and Medicaid, or failing to refund overpayments or improper payments.  Governments are devoting increasing attention and resources to anti-fraud initiatives against healthcare providers.  The Health Insurance Portability and Accountability Act of 1996 and the Balanced Budget Act expanded the penalties for healthcare fraud, including broader provisions for the exclusion of providers from the Medicare and Medicaid programs.  Furthermore, the Office of Inspector General of the U.S. Department of Health and Human Services in cooperation with other federal and state agencies continues to focus on the activities of SNFs in certain states in which we have properties.  In addition, the federal False Claims Act allows a private individual with knowledge of fraud to bring a claim on behalf of the federal government and earn a percentage of the federal government’s recovery.  Because of these incentives, these so-called ‘‘whistleblower’’ suits have become more frequent.  The violation of any of these laws or regulations by an operator may result in the imposition of fines or other penalties that could jeopardize that operator’s ability to make lease or mortgage payments to us or to continue operating its facility.
 
·  
Other Laws.  Other laws that impact how our operators conduct their operations include federal and state laws designed to protect the confidentiality and security of patient health information, state and local licensure laws, laws protecting consumers against deceptive practices, and laws generally affecting our operators management of property and equipment and how our operators generally conduct their operations, such as fire, health and safety laws; and federal and state laws affecting assisted living facilities mandating quality of services and care, and quality of food service; resident rights (including abuse and neglect laws) and health standards set by the federal Occupational Safety and Health Administration.  We can not predict the effect additional costs to comply with these laws may have on the revenues of our operators, and thus their ability to meet their obligations to us.
 
·  
Legislative and Regulatory Developments.  Each year, legislative proposals are introduced or proposed in Congress and in some state legislatures that would affect major changes in the healthcare system, either nationally or at the state level. The Medicare Prescription Drug, Improvement and Modernization Act of 2003, or Medicare Modernization Act, which is one example of such legislation, was enacted in late 2003.  The Medicare reimbursement changes for the long term care industry under this Act are limited to a temporary increase in the per diem amount paid to SNFs for residents who have AIDS.  The significant expansion of other benefits for Medicare beneficiaries under this Act, such as the expanded prescription drug benefit, could result in financial pressures on the Medicare program that might result in future legislative and regulatory changes with impacts for our operators.  Other proposals under consideration include efforts by individual states to control costs by decreasing state Medicaid reimbursements, efforts to improve quality of care and reduce medical errors throughout the health care industry and cost-containment initiatives by public and private payors.  We cannot accurately predict whether any proposals will be adopted or, if adopted, what effect, if any, these proposals would have on operators and, thus, our business.
 
Regulatory proposals and rules are released on an ongoing basis that may have major impacts on the healthcare system generally and the skilled nursing and long-term care industries in particular.

Our operators depend on reimbursement from governmental and other third-party payors and reimbursement rates from such payors may be reduced.

Changes in the reimbursement rate or methods of payment from third-party payors, including the Medicare and Medicaid programs, or the implementation of other measures to reduce reimbursements for services provided by our operators has in the past, and could in the future, result in a substantial reduction in our operators’ revenues and operating margins.  Additionally, net revenue realizable under third-party payor agreements can change after examination and retroactive adjustment by payors during the claims settlement processes or as a result of post-payment audits.  Payors may disallow requests for reimbursement based on determinations that certain costs are not reimbursable or reasonable or because additional documentation is necessary or because certain services were not covered or were not medically necessary.  There also continue to be new legislative and regulatory proposals that could impose further limitations on government and private payments to healthcare providers.  In some cases, states have enacted or are considering enacting measures designed to reduce their Medicaid expenditures and to make changes to private healthcare insurance.  We cannot assure you that adequate reimbursement levels will continue to be available for the services provided by our operators, which are currently being reimbursed by Medicare, Medicaid or private third-party payors.  Further limits on the scope of services reimbursed and on reimbursement rates could have a material adverse effect on our operators’ liquidity, financial condition and results of operations, which could cause the revenues of our operators to decline and potentially jeopardize their ability to meet their obligations to us.

Our operators may be subject to significant legal actions that could subject them to increased operating costs and substantial uninsured liabilities, which may affect their ability to pay their lease and mortgage payments to us.

As is typical in the healthcare industry, our operators are often subject to claims that their services have resulted in resident injury or other adverse effects. The insurance coverage maintained by our operators may not cover all claims made against them nor continue to be available at a reasonable cost, if at all. In some states, insurance coverage for the risk of punitive damages arising from professional liability and general liability claims and/or litigation may not, in certain cases, be available to operators due to state law prohibitions or limitations of availability. As a result, our operators operating in these states may be liable for punitive damage awards that are either not covered or are in excess of their insurance policy limits. We also believe that there has been, and will continue to be, an increase in governmental investigations of long-term care providers, particularly in the area of Medicare/Medicaid false claims, as well as an increase in enforcement actions resulting from these investigations. Insurance is not available to cover such losses. Any adverse determination in a legal proceeding or governmental investigation, whether currently asserted or arising in the future, could have a material adverse effect on an operator’s financial condition.  If an operator is unable to obtain or maintain insurance coverage, if judgments are obtained in excess of the insurance coverage, if an operator is required to pay uninsured punitive damages, or if an operator is subject to an uninsurable government enforcement action, the operator could be exposed to substantial additional liabilities.

Increased competition as well as increased operating costs have resulted in lower revenues for some of our operators and may affect the ability of our tenants to meet their payment obligations to us.

The healthcare industry is highly competitive and we expect that it may become more competitive in the future. Our operators are competing with numerous other companies providing similar healthcare services or alternatives such as home health agencies, life care at home, community-based service programs, retirement communities and convalescent centers. We cannot be certain the operators of all of our facilities will be able to achieve occupancy and rate levels that will enable them to meet all of their obligations to us. Our operators may encounter increased competition in the future that could limit their ability to attract residents or expand their businesses and therefore affect their ability to pay their lease or mortgage payments.

The market for qualified nurses, healthcare professionals and other key personnel is highly competitive and our operators may experience difficulties in attracting and retaining qualified personnel. Increases in labor costs due to higher wages and greater benefits required to attract and retain qualified healthcare personnel incurred by our operators could affect their ability to pay their lease or mortgage payments. This situation could be particularly acute in certain states that have enacted legislation establishing minimum staffing requirements.

Risks Related to Us and Our Operations

In addition to the operator related risks discussed above, there are a number of risks directly associated with us and our operations.

We rely on external sources of capital to fund future capital needs, and if we encounter difficulty in obtaining such capital, we may not be able to make future investments necessary to grow our business or meet maturing commitments.

In order to qualify as a REIT under the Code, we are required, among other things, to distribute each year to our stockholders at least 90% of our REIT taxable income. Because of this distribution requirement, we may not be able to fund, from cash retained from operations, all future capital needs, including capital needs to make investments and to satisfy or refinance maturing commitments. As a result, we rely on external sources of capital, including debt and equity financing. If we are unable to obtain needed capital at all or only on unfavorable terms from these sources, we might not be able to make the investments needed to grow our business, or to meet our obligations and commitments as they mature, which could negatively affect the ratings of our debt and even, in extreme circumstances, affect our ability to continue operations. Our access to capital depends upon a number of factors over which we have little or no control, including general market conditions and the market’s perception of our growth potential and our current and potential future earnings and cash distributions and the market price of the shares of our capital stock.  Generally speaking, difficult capital market conditions in our industry during the past several years and our need to stabilize our portfolio have limited our access to capital.  While we currently have sufficient cash flow from operations to fund our obligations and commitments, we may not be in position to take advantage of attractive investment opportunities for growth in the event that we are unable to access the capital markets on a timely basis or we are only able to obtain financing on unfavorable terms.

Our ability to raise capital through sales of equity is dependent, in part, on the market price of our common stock, and our failure to meet market expectations with respect to our business could negatively impact the market price of our common stock and limit our ability to sell equity.

As with other publicly-traded companies, the availability of equity capital will depend, in part, on the market price of our common stock which, in turn, will depend upon various market conditions and other factors that may change from time to time including:

·  
the extent of investor interest;
 
·  
the general reputation of REITs and the attractiveness of their equity securities in comparison to other equity securities, including securities issued by other real estate-based companies;
 
·  
our financial performance and that of our operators;
 
·  
the contents of analyst reports about us and the REIT industry;
 
·  
general stock and bond market conditions, including changes in interest rates on fixed income securities, which may lead prospective purchasers of our common stock to demand a higher annual yield from future distributions;
 
·  
our failure to maintain or increase our dividend, which is dependent, to a large part, on growth of funds from operations which in turn depends upon increased revenues from additional investments and rental increases; and
 
·  
other factors such as governmental regulatory action and changes in REIT tax laws.
 
The market value of the equity securities of a REIT is generally based upon the market’s perception of the REIT’s growth potential and its current and potential future earnings and cash distributions.  Our failure to meet the market’s expectation with regard to future earnings and cash distributions would likely adversely affect the market price of our common stock.

We are subject to risks associated with debt financing, which could negatively impact our business, limit our ability to make distributions to our stockholders and to repay maturing debt.

Financing for future investments and our maturing commitments may be provided by borrowings under our $255 million revolving senior secured credit facility, as amended (“Credit Facility”), private or public offerings of debt, the assumption of secured indebtedness, mortgage financing on a portion of our owned portfolio or through joint ventures.  We are subject to risks normally associated with debt financing, including the risks that our cash flow will be insufficient to make timely payments of interest, that we will be unable to refinance existing indebtedness and that the terms of refinancing will not be as favorable as the terms of existing indebtedness.  If we are unable to refinance or extend principal payments due at maturity or pay them with proceeds from other capital transactions, our cash flow may not be sufficient in all years to pay distributions to our stockholders and to repay all maturing debt.  Furthermore, if prevailing interest rates, changes in our debt ratings or other factors at the time of refinancing result in higher interest rates upon refinancing, the interest expense relating to that refinanced indebtedness would increase, which could reduce our profitability and the amount of dividends we are able to pay.  Moreover, additional debt financing increases the amount of our leverage.

Certain of our operators account for a significant percentage of our real estate investment and revenues.

            At December 31, 2007, approximately 29% of our real estate investments were operated by two public companies: Sun Healthcare Group, Inc. (“Sun”) (18%) and Advocat (11%).  Our largest private company operators (by investment) were CommuniCare Health Services (“CommuniCare”) (15%), Signature Holding II, LLC (11%), Haven Healthcare (9%), Guardian LTC Management, Inc. (7%), Nexion Health Inc. (6%) and Essex Healthcare Corporation (6%).  No other operator represents more than 4% of our investments.  The three states in which we had our highest concentration of investments were Ohio (22%), Florida (13%) and Pennsylvania (8%) at December 31, 2007.

For the year ended December 31, 2007, our revenues from operations totaled $159.6 million, of which approximately $30.9 million were from Sun (19%), $23.4 million from Advocat (15%) and $21.2 million from CommuniCare (13%).  No other operator generated more than 9% of our revenues from operations for the year ended December 31, 2007.

The failure or inability of any of these operators to pay their obligations to us could materially reduce our revenues and net income, which could in turn reduce the amount of dividends we pay and cause our stock price to decline.

Unforeseen costs associated with the acquisition of new properties could reduce our profitability.

Our business strategy contemplates future acquisitions that may not prove to be successful. For example, we might encounter unanticipated difficulties and expenditures relating to any acquired properties, including contingent liabilities, or newly acquired properties might require significant management attention that would otherwise be devoted to our ongoing business. If we agree to provide funding to enable healthcare operators to build, expand or renovate facilities on our properties and the project is not completed, we could be forced to become involved in the development to ensure completion or we could lose the property. These costs may negatively affect our results of operations.



Our assets may be subject to impairment charges.

We periodically, but not less than annually, evaluate our real estate investments and other assets for impairment indicators. The judgment regarding the existence of impairment indicators is based on factors such as market conditions, operator performance and legal structure. If we determine that a significant impairment has occurred, we would be required to make an adjustment to the net carrying value of the asset, which could have a material adverse affect on our results of operations and funds from operations in the period in which the write-off occurs. During the year ended December 31, 2007, we recognized an impairment loss associated with one facility for approximately $1.4 million.

We may not be able to sell certain closed facilities for their book value.

From time to time, we close facilities and actively market such facilities for sale. To the extent we are unable to sell these properties for our book value; we may be required to take a non-cash impairment charge or loss on the sale, either of which would reduce our net income.

Our substantial indebtedness could adversely affect our financial condition.

We have substantial indebtedness and we may increase our indebtedness in the future.

As of December 31, 2007, we had total debt of approximately $574 million, of which $48 million consisted of borrowings under our Credit Facility, $310 million of which consisted of our 7% senior notes due 2014, $175 million of which consisted of our 7% senior notes due 2016 and $39 million of non-recourse debt to us resulting from the consolidation of a variable interest entity (“VIE”) in accordance with Financial Accounting Standards Board Interpretation No. 46R, Consolidation of Variable Interest Entities, (“FIN 46R”).  Our level of indebtedness could have important consequences to our stockholders.  For example, it could:

·  
limit our ability to satisfy our obligations with respect to holders of our capital stock;
·  
increase our vulnerability to general adverse economic and industry conditions;
·  
limit our ability to obtain additional financing to fund future working capital, capital expenditures and other general corporate requirements, or to carry out other aspects of our business plan;
·  
require us to dedicate a substantial portion of our cash flow from operations to payments on indebtedness, thereby reducing the availability of such cash flow to fund working capital, capital expenditures and other general corporate requirements, or to carry out other aspects of our business plan;
·  
require us to pledge as collateral substantially all of our assets;
·  
require us to maintain certain debt coverage and financial ratios at specified levels, thereby reducing our financial flexibility;
·  
limit our ability to make material acquisitions or take advantage of business opportunities that may arise;
·  
expose us to fluctuations in interest rates, to the extent our borrowings bear variable rates of interests;
·  
limit our flexibility in planning for, or reacting to, changes in our business and industry; and
·  
place us at a competitive disadvantage compared to our competitors that have less debt.

Our real estate investments are relatively illiquid.

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. All of our properties are ‘‘special purpose’’ properties that could not be readily converted to general residential, retail or office use.  Healthcare facilities that participate in Medicare or Medicaid must meet extensive program requirements, including physical plant and operational requirements, which are revised from time to time.  Such requirements may include a duty to admit Medicare and Medicaid patients, limiting the ability of the facility to increase its private pay census beyond certain limits.  Medicare and Medicaid facilities are regularly inspected to determine compliance and may be excluded from the programs—in some cases without a prior hearing—for failure to meet program requirements.  Transfers of operations of nursing homes and other healthcare-related facilities are subject to regulatory approvals not required for transfers of other types of commercial operations and other types of real estate.  Thus, if the operation of any of our properties becomes unprofitable due to competition, age of improvements or other factors such that our lessee or mortgagor 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.  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 with a new operator licensed to manage the facility.  In addition, certain 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.  Should such events occur, our income and cash flows from operations would be adversely affected.

As an owner or lender with respect to real property, we may be exposed to possible environmental liabilities.

Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner of real property or a secured lender, such as us, may be liable in certain circumstances for the costs of investigation, removal or remediation of, or related releases of, certain hazardous or toxic substances at, under or disposed of in connection with such property, as well as certain other potential costs relating to hazardous or toxic substances, including government fines and damages for injuries to persons and adjacent property. Such laws often impose liability without regard to whether the owner knew of, or was responsible for, the presence or disposal of such substances and liability may be imposed on the owner in connection with the activities of an operator of the property. The cost of any required investigation, remediation, removal, fines or personal or property damages and the owner’s liability therefore could exceed the value of the property and/or the assets of the owner.  In addition, the presence of such substances, or the failure to properly dispose of or remediate such substances, may adversely affect our operators’ ability to attract additional residents, the owner’s ability to sell or rent such property or to borrow using such property as collateral which, in turn, would reduce the owner’s revenues.

Although our leases and mortgage loans require the lessee and the mortgagor to indemnify us for certain environmental liabilities, the scope of such obligations may be limited. For instance, most of our leases do not require the lessee to indemnify us for environmental liabilities arising before the lessee took possession of the premises. Further, we cannot assure you that any such mortgagor or lessee would be able to fulfill its indemnification obligations.

The industry in which we operate is highly competitive. This competition may prevent us from raising prices at the same pace as our costs increase.

We compete for additional healthcare facility investments with other healthcare investors, including other REITs. The operators of the facilities compete with other regional or local nursing care facilities for the support of the medical community, including physicians and acute care hospitals, as well as the general public. Some significant competitive factors for the placing of patients in skilled and intermediate care nursing facilities include quality of care, reputation, physical appearance of the facilities, services offered, family preferences, physician services and price. If our cost of capital should increase relative to the cost of capital of our competitors, the spread that we realize on our investments may decline if competitive pressures limit or prevent us from charging higher lease or mortgage rates.

We are named as defendants in litigation arising out of professional liability and general liability claims relating to our previously owned and operated facilities that if decided against us, could adversely affect our financial condition.

We and several of our wholly-owned subsidiaries have been named as defendants in professional liability and general 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. There can be no assurance that we will be successful in our defense of these matters or in asserting our claims against various managers of the subject facilities or that the amount of any settlement or judgment will be substantially covered by insurance or that any punitive damages will be covered by insurance.

We are subject to significant anti-takeover provisions.

Our articles of incorporation and bylaws contain various procedural and other requirements which could make it difficult for stockholders to effect certain corporate actions. Our Board of Directors is divided into three classes and the members of our Board of Directors are elected for terms that are staggered. Our Board of Directors also has the authority to issue additional shares of preferred stock and to fix the preferences, rights and limitations of the preferred stock without stockholder approval. We have also adopted a stockholders rights plan which provides for share purchase rights to become exercisable at a discount if a person or group announces a tender or exchange offer for our common stock or acquires a significant amount of our common stock. These provisions could discourage unsolicited acquisition proposals or make it more difficult for a third party to gain control of us, which could adversely affect the market price of our securities.

We may change our investment strategies and policies and capital structure.

Our Board of Directors, without the approval of our stockholders, may alter our investment strategies and policies if it determines in the future that a change is in our stockholders’ best interests.  The methods of implementing our investment strategies and policies may vary as new investments and financing techniques are developed.

If we fail to maintain our REIT status, we will be subject to federal income tax on our taxable income at regular corporate rates.

We were organized to qualify for taxation as a REIT under Sections 856 through 860 of the Code. We believe that we have been organized and operated in such a manner as to qualify for taxation as a REIT under the Code and intend to continue to operate in a manner that will maintain our qualification as a REIT. We entered into a closing agreement with the IRS in December 2007 resolving certain issues in a manner that did not, and will not in the future, adversely affect our qualification for taxation as a REIT as discussed under the heading “Taxation – Resolution of Related Party Tenant Issue” in Item 1 above.  Qualification as a REIT involves the satisfaction of numerous requirements, some on an annual and some on a quarterly basis, established under highly technical and complex provisions of the Code for which there are only limited judicial and administrative interpretations and involve the determination of various factual matters and circumstances not entirely within our control.  We cannot assure you that we will at all times satisfy these rules and tests.

If we were to fail to qualify as a REIT in any taxable year, as a result of a determination that we failed to meet the annual distribution requirement or otherwise, we would be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates with respect to each such taxable year for which the statute of limitations remains open. Moreover, unless entitled to relief under certain statutory provisions, we also would be disqualified from treatment as a REIT for the four taxable years following the year during which qualification is lost. This treatment would significantly reduce our net earnings and cash flow because of our additional tax liability for the years involved, which could significantly impact our financial condition.

We generally must distribute annually at least 90% of our taxable income to our stockholders to maintain our REIT status. 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.

Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.

Even if we remain qualified for taxation as a REIT, we may be subject to certain federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes. Any of these taxes would decrease cash available for the payment of our debt obligations. In addition, we may derive income through TRS, which will then be subject to corporate level income tax at regular rates.

Complying with REIT requirements may affect our profitability.

To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the nature and diversification of our assets, the sources of our income and the amounts we distribute to our stockholders. Thus we may be required to liquidate otherwise attractive investments from our portfolio in order to satisfy the asset and income tests or to qualify under certain statutory relief provisions. We may also be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution (e.g., if we have assets which generate mismatches between taxable income and available cash). Then, having to comply with the distribution requirement could cause us to: (i) sell assets in adverse market conditions; (ii) borrow on unfavorable terms; or (iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt. As a result, satisfying the REIT requirements could have an adverse effect on our business results and profitability.

We depend upon our key employees and may be unable to attract or retain sufficient numbers of qualified personnel.

Our future performance depends to a significant degree upon the continued contributions of our executive management team and other key employees. Accordingly, our future success depends on our ability to attract, hire, train and retain highly skilled management and other qualified personnel. Competition for qualified employees is intense, and we compete for qualified employees with companies that may have greater financial resources than we have. Our employment agreements with our executive officers provide that their employment may be terminated by either party at any time. Consequently, we may not be successful in attracting, hiring, and training and retaining the people we need, which would seriously impede our ability to implement our business strategy.

In the event we are unable to satisfy regulatory requirements relating to internal controls, or if these internal controls over financial reporting are not effective, our business could suffer.

Section 404 of the Sarbanes-Oxley Act of 2002 requires companies to do a comprehensive evaluation of their internal controls. As a result, each year we evaluate our internal controls over financial reporting so that our management can certify as to the effectiveness of our internal controls and our auditor can publicly attest to this certification. Our efforts to comply with Section 404 and related regulations regarding our management’s required assessment of internal control over financial reporting and our independent auditors’ attestation of that assessment has required, and continues to require, the commitment of significant financial and managerial resources.  If for any period our management is unable to ascertain the effectiveness of our internal controls or if our auditors cannot attest to management’s certification, we could be subject to regulatory scrutiny and a loss of public confidence, which could have an adverse effect on our business.

Risks Related to Our Stock

The market value of our stock could be substantially affected by various factors.

The share price of our stock will depend on many factors, which may change from time to time, including:

·  
the market for similar securities issued by REITs;
·  
changes in estimates by analysts;
·  
our ability to meet analysts’ estimates;
·  
general economic and financial market conditions; and
·  
our financial condition, performance and prospects.

Our issuance of additional capital stock, warrants or debt securities, whether or not convertible, may reduce the market price for our shares.

We cannot predict the effect, if any, that future sale of our capital stock, warrants or debt securities, or the availability of our securities for future sale, will have on the market price of our shares, including our common stock. Sales of substantial amounts of our common stock or preferred shares, warrants or debt securities convertible into or exercisable or exchangeable for common stock in the public market or the perception that such sales might occur could reduce the market price of our stock and the terms upon which we may obtain additional equity financing in the future.

In addition, we may issue additional capital stock in the future to raise capital or as a result of the following:

·  
The issuance and exercise of options to purchase our common stock. We have in the past and may in the future issue additional options or other securities convertible into or exercisable for our common stock under remuneration plans. We may also issue options or convertible securities to our employees in lieu of cash bonuses or to our directors in lieu of director’s fees.
·  
The issuance of shares pursuant to our dividend reinvestment and direct stock purchase plan.
·  
The issuance of debt securities exchangeable for our common stock.
·  
The exercise of warrants we may issue in the future.
·  
Lenders sometimes ask for warrants or other rights to acquire shares in connection with providing financing. We cannot assure you that our lenders will not request such rights.

There are no assurances of our ability to pay dividends in the future.

In 2001, our Board of Directors suspended dividends on our common stock and all series of preferred stock in an effort to generate cash to address then impending debt maturities. In 2003, we paid all accrued but unpaid dividends on all series of preferred stock and reinstated dividends on our common stock and all series of preferred stock. However, our ability to pay dividends may be adversely affected if any of the risks described above were to occur. Our payment of dividends is subject to compliance with restrictions contained in our Credit Facility, the indenture relating to our outstanding 7% senior notes due 2014, the indenture relating to our outstanding 7% senior notes due 2016 and our preferred stock. All dividends will be paid at the discretion of our Board of Directors and will depend upon our earnings, our financial condition, maintenance of our REIT status and such other factors as our Board may deem relevant from time to time. There are no assurances of our ability to pay dividends in the future. In addition, our dividends in the past have included, and may in the future include, a return of capital.

Holders of our outstanding preferred stock have liquidation and other rights that are senior to the rights of the holders of our common stock.

Our Board of Directors has the authority to designate and issue preferred stock that may have dividend, liquidation and other rights that are senior to those of our common stock. As of the date of this filing, 4,739,500 shares of our 8.375% Series D cumulative redeemable preferred stock were issued and outstanding. The aggregate liquidation preference with respect to this outstanding preferred stock is approximately $118.5 million, and annual dividends on our outstanding preferred stock are approximately $9.9 million.  Holders of our preferred stock are generally entitled to cumulative dividends before any dividends may be declared or set aside on our common stock.  Upon our voluntary or involuntary liquidation, dissolution or winding up, before any payment is made to holders of our common stock, holders of our preferred stock are entitled to receive a liquidation preference of $25 per share with respect to the Series D preferred stock, plus any accrued and unpaid distributions.  This will reduce the remaining amount of our assets, if any, available to distribute to holders of our common stock.  In addition, holders of our preferred stock have the right to elect two additional directors to our Board of Directors if six quarterly preferred dividends are in arrears.

Legislative or regulatory action could adversely affect purchasers of our stock.

In recent years, numerous legislative, judicial and administrative changes have been made in the provisions of the federal income tax laws applicable to investments similar to an investment in our stock. Changes are likely to continue to occur in the future, and we cannot assure you that any of these changes will not adversely affect our stockholder’s stock.  Any of these changes could have an adverse effect on an investment in our stock or on market value or resale potential.  Stockholders are urged to consult with their own tax advisor with respect to the impact that recent legislation may have on their investment and the status of legislative, regulatory or administrative developments and proposals and their potential effect.


None.



At December 31, 2007, our real estate investments included long-term care facilities and rehabilitation hospital investments, either in the form of purchased facilities which are leased to operators, mortgages on facilities which are operated by the mortgagors or their affiliates and facilities subject to leasehold interests.  The facilities are located in 27 states and are operated by 28 unaffiliated operators.  The following table summarizes our property investments as of December 31, 2007:

Investment Structure/Operator
  
Number of
Beds
    
Number of
Facilities
    
Occupancy
Percentage(1)
    
Gross
Investment
(in thousands)
  
                         
Purchase/Leaseback(2)
                        
                         
Sun Healthcare Group, Inc.
    4,860       42       87     $ 233,323  
CommuniCare Health Services, Inc.
    2,781       18       91       189,986  
Signature Holding II, LLC
    2,111       18       84       137,490  
Advocat, Inc
    4,338       36       78       132,424  
Haven Healthcare
    1,787       15       89       118,186  
Guardian LTC Management, Inc.
    1,308       17       86       85,971  
Nexion Health Inc
    2,412       20       80       79,833  
Essex Healthcare Corporation
    1,388       13       76       79,354  
Alpha Healthcare Properties, LLC
    840       7       82       50,224  
Mark Ide Limited Liability Company
     832       8       79       25,595  
StoneGate Senior Care LP
    664       6       84       21,781  
Infinia Properties of Arizona, LLC
    378       4       60       19,364  
Rest Haven Nursing Center, Inc
    200       1       90       14,400  
Conifer Care Communities, Inc
    204       3       91       14,367  
Washington N&R, LLC
    286       2       72       12,152  
USA Healthcare, Inc
    271       2       41       10,329  
Triad Health Management of Georgia II, LLC
     304       2       98       10,000  
Ensign Group, Inc
    271       3       92       9,656  
Lakeland Investors, LLC
    300       1       74       8,931  
Hickory Creek Healthcare Foundation, Inc
     138       2       86       7,250  
Emeritus Corporation
    52       1       88       5,674  
Longwood Management Corporation
     185       2       92       5,425  
Generations Healthcare, Inc
    60       1       82       3,007  
      25,970       224       83       1,274,722  
                                 
Assets Held for Sale
                                
Active Facilities
    157       2       70       2,550  
Closed Facility
    -       1       -       320750  
      157       3       70       2,870  
Fixed - Rate Mortgages(3)
                                
                                 
Advocat Inc
    423       4       83       12,534  
Parthenon Healthcare, Inc
    300       2       70       10,945  
CommuniCare Health Services, Inc
    150       1       94       6,752  
Texas Health Enterprises/HEA Mgmt. Group, Inc
     147       1       67       943  
Evergreen Healthcare
    100       1       68       515  
      1,120       9       80       31,689  
                                 
Total
    27,247       236       83     $ 1,309,281  
                                 
                                 

(1)  Represents the most recent data provided by our operators.
(2) Certain of our lease agreements contain purchase options that permit the lessees to purchase the underlying properties from us.
(3) In general, many of our mortgages contain prepayment provisions that permit prepayment of the outstanding principal amounts thereunder.


The following table presents the concentration of our facilities by state as of December 31, 2007.

   
Number of
Facilities
    
Number of
Beds
    
Gross
Investment
(in thousands)
    
% of
Gross
Investment
  
Ohio
     37       4,574     $ 282,604       21.5  
Florida
     25       3,125       171,850       13.1  
Pennsylvania
     17       1,597       110,225       8.4  
Texas
     21       2,968       82,457       6.3  
California
     15       1,277       59,717       4.6  
Louisiana
     14       1,668       55,343       4.2  
Colorado
     8       895       52,709       4.0  
Arkansas
     11       1,181       44,289       3.4  
Alabama
     10       1,218       41,409       3.2  
Massachusetts
     6       682       38,884       3.0  
Rhode Island
     4       639       38,740       3.0  
Connecticut
     5       562       36,409       2.8  
Kentucky
     10       855       36,251       2.8  
West Virginia
     8       860       34,575       2.6  
Tennessee
     6       726       28,715       2.2  
Georgia
     4       661       24,679       1.9  
North Carolina
     5       707       22,709       1.7  
Idaho
     4       412       21,705       1.7  
New Hampshire
     3       225       21,620       1.7  
Arizona
     4       378       19,364       1.5  
Washington
     2       194       17,473       1.3  
Indiana
     5       429       15,605       1.2  
Illinois
     4       478       14,406       1.1  
Vermont
     2       279       14,227       1.1  
Missouri
     2       286       12,152       0.9  
Iowa
     3       271       10,649       0.8  
Utah
     1       100       515       0.0  
                                 
Total
     236       27,247     $ 1,309,281       100.0  
                                 

Geographically Diverse Property Portfolio. Our portfolio of properties is broadly diversified by geographic location.  We have healthcare facilities located in 27 states.  In addition, the majority of our 2007 rental and mortgage income was derived from facilities in states that require state approval for development and expansion of healthcare facilities.  We believe that such state approvals may limit competition for our operators and enhance the value of our properties.

Large Number of Tenants. Our facilities are operated by 28 different public and private healthcare providers.  Except for Sun (18%), CommuniCare (15%), Advocat (11%), and Signature Holding II, LLC (11%), which together hold approximately 55% of our portfolio (by investment), no other single tenant holds greater than 10% of our portfolio (by investment).

Significant Number of Long-term Leases and Mortgage Loans. A large portion of our core portfolio consists of long-term lease and mortgage agreements.  At December 31, 2007, approximately 89% of our leases and mortgages had primary terms that expire in 2010 or later.  The majority of our leased real estate properties are leased under provisions of master lease agreements.  We also lease facilities under single facility leases.  The initial term, on both type of leases, typically range from 5 to 15 years, plus renewal options.  Substantially all of the leases provide for minimum annual rentals that are subject to annual increases based upon increases in the CPI or increases in revenues of the underlying properties, with certain limits.  Under the terms of the leases, the lessee is responsible for all maintenance, repairs, taxes and insurance on the leased properties.





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.

 
We and several of our wholly-owned subsidiaries have been named as defendants in professional liability claims related to our former 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 majority of these lawsuits representing the most significant amount of exposure were settled in 2004.  There currently is one lawsuit pending that is in the discovery stage, and we are unable to predict the likely outcome of this lawsuit at this time.

In 1999, we filed suit against a former tenant seeking damages based on claims of breach of contract.  The defendants denied the allegations made in the lawsuit.  In settlement of our claim against the defendants, we agreed in the fourth quarter of 2005 to accept a lump sum cash payment of $2.4 million.  The cash proceeds were offset by related expenses incurred of $0.8 million, resulting in a net gain of $1.6 million paid December 22, 2005.

In 2005, we accrued $1.1 million for potential obligations relating to disputed capital improvement requirements associated with a lease that expired June 30, 2005.  Although no formal complaint for damages was filed against us, in February 2006, we agreed to settle this dispute for approximately $1.0 million.


 

No matters were submitted to stockholders during the fourth quarter of the year covered by this report.


PART II


Our shares of common stock are traded on the New York Stock Exchange under the symbol “OHI.”  The following table sets forth, for the periods shown, the high and low prices as reported on the New York Stock Exchange Composite for the periods indicated and cash dividends per share:

2007
  
2006
  
                                       
Quarter
  
High
    
Low
    
Dividends
Per Share
  
Quarter
  
High
    
Low
    
Dividends
Per Share
  
First
   $ 19.170     $ 16.460     $ 0.26  
First
   $ 14.030     $ 12.360     $ 0.23  
Second
     18.070       15.530       0.27  
Second
     13.920       11.150       0.24  
Third
     16.790       12.000       0.27  
Third
     15.500       12.560       0.24  
Fourth
     17.360       14.650       0.28  
Fourth
     18.000       14.810       0.25  
                    $ 1.08                       $ 0.96  

The closing price for our common stock on the New York Stock Exchange on February 1, 2008 was $16.28 per share.  As of February 1, 2008 there were 68,891,836 shares of common stock outstanding with 2,921 registered holders.

The following table provides information about all equity awards under our company’s 2004 Stock Incentive Plan, 2000 Stock Incentive Plan and 1993 Amended and Restated Stock Option and Restricted Stock Plan as of December 31, 2007.

Equity Compensation Plan Information

   
(a)
    
(b)
    
(c)
  
Plan category
  
Number of securities to be issued upon exercise of outstanding options, warrants and rights
(1)
    
Weighted-average exercise price of outstanding options, warrants and rights (2)
    
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a) (3)
  
Equity compensation plans approved by security holders
     282,656     $ 14.13       2,339,410  
Equity compensation plans not approved by security holders
     —       —       —  
Total
     282,656     $ 14.13       2,339,410  

(1)  
Reflects 34,664 shares issuable upon the exercise of outstanding options and 247,992 shares issuable in respect of performance restricted stock units that vest over the years 2008 through 2010.
(2)  
No exercise price is payable with respect to the performance or restricted stock rights, and accordingly the weighted-average exercise price is calculated based solely on outstanding options.
(3)  
Reflects shares of Common Stock remaining available for future issuance under our 2000 and 2004 Stock Incentive Plans.




During the fourth quarter of 2007, 13,898 shares of our common stock were purchased from employees to pay the withholding taxes associated with employee exercising of stock options.

Period
  
Total Number of Shares Purchased (1)
    
Average Price Paid per Share
    
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
    
Maximum Number (or Approximate Dollar Value) of Shares that May be Purchased Under these Plans or Programs
  
October 1, 2007 to October 31, 2007
     -     $ -       -     $ -  
November 1, 2007 to November 30, 2007
     -       -       -       -  
December 1, 2007 to December 31, 2007
     13,898       16.05       -       -  
Total
     13,898     $ 16.05       -     $ -  

(1)  Represents shares purchased from employees to pay the withholding taxes related to the exercise of employee stock options. The shares were not part of a publicly announced repurchase plan or program.

We expect to continue our policy of paying regular cash dividends, although there is no assurance as to future dividends because they depend on future earnings, capital requirements and our financial condition.  In addition, the payment of dividends is subject to the restrictions described in Note 14 to our consolidated financial statements.






The following table sets forth our selected financial data and operating data for our company on a historical basis.  The following data should be read in conjunction with our audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.  Our historical operating results may not be comparable to our future operating results.

   
Year Ended December 31,
  
   
2007
    
2006
    
2005
    
2004
    
2003
  
   
(in thousands, except per share amounts)
  
Operating Data
                              
Revenues from core operations                                                   
  $ 159,558     $ 135,513     $ 109,535     $ 86,972     $ 76,803  
Revenues from nursing home operations
     -       -       -       -       4,395  
Total revenues                                               
  $ 159,558     $ 135,513     $ 109,535     $ 86,972     $ 81,198  
Income from continuing operations
  $ 67,598     $ 55,905     $ 37,289     $ 13,414     $ 27,813  
Net income (loss) available to common shareholders
     59,451       45,774       25,355       (36,715 )     3,516  
Per share amounts:
                                        
Income (loss) from continuing operations:
Basic                                               
  $ 0.88     $ 0.78     $ 0.46     $ (0.96 )   $ 0.21  
Diluted                                               
    0.88       0.78       0.46       (0.96 )     0.20  
Net income (loss) available to common:
Basic                                               
  $ 0.90     $ 0.78     $ 0.49     $ (0.81 )   $ 0.09  
Diluted                                               
    0.90       0.78       0.49       (0.81 )     0.09  
                                         
Dividends, Common Stock(1)                                                   
    1.08       0.96       0.85       0.72       0.15  
Dividends, Series A Preferred(1)                                                   
    -       -       -       1.16       6.94  
Dividends, Series B Preferred(1)                                                   
    -       -       1.09       2.16       6.47  
Dividends, Series C Preferred(2)                                                   
    -       -       -       2.72       29.81  
Dividends, Series D Preferred(1)                                                   
    2.09       2.09       2.09       1.52       -  
                                         
Weighted-average common shares outstanding,
basic                                               
    65,858       58,651       51,738       45,472       37,189  
Weighted-average common shares outstanding,diluted
     65,886       58,745       52,059       45,472       38,154  

   
December 31,
  
   
2007
    
2006
    
2005
    
2004
    
2003
  
Balance Sheet Data
Gross investments
   $ 1,322,964     $ 1,294,306     $ 1,129,405     $ 940,442     $ 820,982  
Total assets
     1,182,287       1,175,370       1,036,042       849,576       736,775  
Revolving lines of credit
     48,000       150,000       58,000       15,000       177,074  
Other long-term borrowings
     525,709       526,141       508,229       364,508       103,520  
Stockholders’ equity
     586,127       465,454       440,943       442,935       440,130  
                                         

(1)  
Dividends per share are those declared and paid during such period.
(2)  
Dividends per share are those declared during such period, based on the number of shares of common stock issuable upon conversion of the outstanding Series C preferred stock.






The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this document.  This document contains forward-looking statements within the meaning of the federal securities laws, including statements regarding potential financings and potential future changes in reimbursement.  These statements relate to our expectations, beliefs, intentions, plans, objectives, goals, strategies, future events, performance and underlying assumptions and other statements other than statements of historical facts.  In some cases, you can identify forward-looking statements by the use of forward-looking terminology including, but not limited to, terms such as “may,” “will,” “anticipates,” “expects,” “believes,” “intends,” “should” or comparable terms or the negative thereof.  These statements are based on information available on the date of this filing and only speak as to the date hereof and no obligation to update such forward-looking statements should be assumed.  Our actual results may differ materially from those reflected in the forward-looking statements contained herein as a result of a variety of factors, including, among other things:

(i)  
those items discussed under “Risk Factors” in Item 1A herein;
(ii)  
uncertainties relating to the business operations of the operators of our assets, including those relating to reimbursement by third-party payors, regulatory matters and occupancy levels;
(iii)  
the ability of any operators in bankruptcy to reject unexpired lease obligations, modify the terms of our mortgages and impede our ability to collect unpaid rent or interest during the process of a bankruptcy proceeding and retain security deposits for the debtors’ obligations;
(iv)  
our ability to sell closed assets on a timely basis and on terms that allow us to realize the carrying value of these assets;
(v)  
our ability to manage, re-lease or sell any owned and operated facilities;
(vi)  
the availability and cost of capital;
(vii)  
competition in the financing of healthcare facilities;
(viii)  
regulatory and other changes in the healthcare sector;
(ix)  
the effect of economic and market conditions generally and, particularly, in the healthcare industry;
(x)  
changes in interest rates;
(xi)  
the amount and yield of any additional investments;
(xii)  
changes in tax laws and regulations affecting real estate investment trusts;
(xiii)  
our ability to maintain our status as a real estate investment trust; and
(xiv)  
changes in the ratings of our debt and preferred securities.


Our portfolio of investments at December 31, 2007, consisted of 236 healthcare facilities, located in 27 states and operated by 28 third-party operators.  Our gross investment in these facilities totaled approximately $1.3 billion at December 31, 2007, with 98% of our real estate investments related to long-term healthcare facilities.  This portfolio is made up of 222 long-term healthcare facilities, two rehabilitation hospitals owned and leased to third parties, fixed rate mortgages on nine long-term healthcare facilities and three long-term healthcare facilities that are currently held for sale.  At December 31, 2007, we also held other investments of approximately $14 million, consisting primarily of secured loans to third-party operators of our facilities.


The following significant highlights occurred during the twelve-month period ended December 31, 2007.

Financing

7.130 Million Common Stock Offering

On April 3, 2007, we completed an underwritten public offering of 7,130,000 shares our common stock at $16.75 per share, less underwriting discounts. The sale included 930,000 shares sold in connection with the exercise of an over-allotment option granted to the underwriters.  We received approximately $112.9 million in net proceeds from the sale of the shares, after deducting underwriting discounts and offering expenses.  UBS Investment Bank acted as sole book-running manager for the offering.  Banc of America Securities LLC, Deutsche Bank Securities and Stifel Nicolaus acted as co-managers for the offering.  The net proceeds were used to repay indebtedness under our credit facility.

Dividend Reinvestment and Common Stock Purchase Plan

We have a Dividend Reinvestment and Common Stock Purchase Plan (“DRSPP”) that allows for the reinvestment of dividends and the optional purchase of our common stock at a discount to the market.  During the third quarter, we suspended the optional purchase portion of the plan, but maintained the dividend reinvestment portion of the plan.  On October 16, 2007, we announced that effective November 15, 2007 we would reinstate the optional purchase portion of the plan providing a 1% discount to the market.  For the three-month period ended December 31, 2007, a total of 424,926 shares were issued for approximately $6.7 million in net proceeds.  For the twelve-month period ended December 31, 2007, a total of 1,189,779 shares were issued for approximately $18.9 million in net proceeds.

Dividends

Common Dividends

On January 17, 2008, the Board of Directors declared a common stock dividend of $0.29 per share, an increase of $0.01 per common share compared to the prior quarter.  The common dividend will be paid February 15, 2008 to common stockholders of record on January 31, 2008.

On October 16, 2007, the Board of Directors declared a common stock dividend of $0.28 per share, an increase of $0.01 per common share compared to the prior quarter.  The common dividend was paid November 15, 2007 to common stockholders of record on October 31, 2007.

On July 17, 2007, the Board of Directors declared a common stock dividend of $0.27 per share that was paid August 15, 2007 to common stockholders of record on July 31, 2007.

On April 18, 2007, the Board of Directors declared a common stock dividend of $0.27 per share, an increase of $0.01 per common share compared to the prior quarter.  The common dividend was paid May 15, 2007 to common stockholders of record on April 30, 2007.

On January 16, 2007, the Board of Directors declared a common stock dividend of $0.26 per share, an increase of $0.01 per common share compared to the prior quarter.  The common dividend was paid February 15, 2007 to common stockholders of record on January 31, 2007.

Series D Preferred Dividends

On January 17, 2008, the Board of Directors declared regular quarterly dividends of approximately $0.52344 per preferred share on its 8.375% Series D cumulative redeemable preferred stock (the “Series D Preferred Stock”), that were paid February 15, 2008 to preferred stockholders of record on January 31, 2008.  The liquidation preference for our Series D Preferred Stock is $25.00 per share.  Regular quarterly preferred dividends for the Series D Preferred Stock represent dividends for the period November 1, 2007 through January 31, 2008.

On October 16, 2007, the Board of Directors declared the regular quarterly dividends of approximately $0.52344 per preferred share on the Series D preferred stock that were paid November 15, 2007 to preferred stockholders of record on October 31, 2007.

On July 17, 2007, the Board of Directors declared the regular quarterly dividends of approximately $0.52344 per preferred share on the Series D preferred stock that were paid August 15, 2007 to preferred stockholders of record on July 31, 2007.

On April 18, 2007, the Board of Directors declared regular quarterly dividends of approximately $0.52344 per preferred share on the Series D Preferred Stock that were paid May 15, 2007 to preferred stockholders of record on April 30, 2007.

On January 16, 2007, the Board of Directors declared regular quarterly dividends of approximately $0.52344 per preferred share on the Series D Preferred Stock that were paid February 15, 2007 to preferred stockholders of record on January 31, 2007.


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 payment to us.  See “Healthcare Reimbursement and Regulation” under Item 1 above.  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 title 11 of the United States Code, 11 U.S.C. §§ 101-1532, as amended and supplemented, (the “Bankruptcy Code”).

Below is a brief description, by third-party operator, of new investments or operator related transactions that occurred during the year ended December 31, 2007.

New Investments and Re-leasing Activities

Signature Holding II, LLC

On July 31, 2007, we completed a transaction with Litchfield Investment Company, LLC and its affiliates (“Litchfield”) to purchase five (5) SNFs for a total investment of $39.5 million.  The facilities total 645 beds and are located in Alabama (1), Georgia (2), Kentucky (1) and Tennessee (1). We also provided a $2.5 million loan in the form of a subordinated note as part of the transaction, which was repaid during the fourth quarter of 2007.  Simultaneously with the close of the purchase transaction, the facilities were combined into an Amended and Restated Master Lease with Signature Holding II, LLC (formerly known as Home Quality Management, Inc).  The Amended and Restated Master Lease was extended until July 31, 2017.  The investment allocated to land, building and personal property is $6.3 million, $32.1 million and $1.1 million, respectively.

Advocat, Inc.

We continuously evaluate the payment history and financial strength of our operators and have historically established allowance reserves for straight-line rent adjustments for operators that do not meet our internal revenue requirements.  We consider factors such as payment history, the operator’s financial condition as well as current and future anticipated operating trends and regulatory impacts on our operators when evaluating whether to establish allowances.

We have reviewed Advocat’s financial statements annually and noted that since 2000 Advocat’s external auditors issued Advocat a “going concern” opinion.  We reviewed Advocat’s 2006 annual report and noted that Advocat was issued an unqualified opinion by its independent auditors (i.e., the auditors removed the going concern qualification).  We also reviewed Advocat’s financial statements and noted an improvement in its financial condition.  As a result, we reversed approximately $5.0 million of allowance previously established for straight line rent in the first quarter of 2007.  This change in estimate resulted in an additional $0.08 per share of income from continuing operations and net income for the first quarter of 2007 and for the twelve months ended December 31, 2007.

Haven Eldercare, LLC

In January 2008, we purchased from General Electric Capital Corporation (“GE Capital”) a $39.0 million mortgage loan on seven facilities operated by Haven Eldercare, LLC (“Haven”) due October 2012.  Prior to the acquisition of this mortgage, we had a $22.8 million second mortgage on these facilities.  We now have a combined $61.8 million mortgage on these facilities.  We have an option to purchase these facilities that would allow us a fee simple interest in the facilities.  If we exercise the purchase option, the seven facilities would be combined with an existing eight facilities master lease.  We have historically consolidated this investment for reporting purposes, including the $39.0 million mortgage that GE Capital previously owned.  The borrowers and guarantors under the mortgage, and the lessee, sublessees and guarantors in respect of the master lease are all debtors-in-possession in chapter 11 proceeding being jointly administered in the United States Bankruptcy Court for the District of Connecticut, New Haven Division.

We have evaluated our current receivables as well as our other investments with Haven and do not believe that reserves for impairment or for the collection of our current and straight-line receivables is warranted at December 31, 2007.  Our portion of Haven’s portfolio of assets continues to perform well.  We also have adequate liquidity deposits to cover the outstanding current receivables.

In conjunction with the application of Financial Accounting Standard Board Interpretation No. 46(R), Consolidation of Variable Interest Entities, (“FIN 46R”), we consolidated the financial statements and related real estate of the Haven subsidiary that is the debtor under our $22.8 million mortgage into our financial statements.  The impact of consolidating the Haven subsidiary resulted in the following adjustments to our consolidated balance sheet as of December 31, 2007: (1) an increase in total gross investments of $39.0 million; (2) an increase in accumulated depreciation of $3.1 million; (3) an increase in accounts receivable of $0.4 million;  (4) an increase in other long-term borrowings of $39.0 million; (5) and a reduction of $2.7 million in cumulative net earnings primarily due to increased depreciation expense.  Our results of operation reflect the impact of the consolidation of the Haven subsidiary for the three- and twelve- month periods ended December 31, 2007 and 2006, respectively.  The Haven subsidiary’s only business activity is to own the seven facilities subject to our mortgage and lease them to another Haven affiliate.

For additional information related to the consolidation of the Haven subsidiary, refer to Note 1 – Organization and Basis of Presentation.

CommuniCare Health Services, Inc.

In 2007, we began construction on a long-term acute care hospital that is expected to be completed in 2008.  In 2007, we amended our master lease agreement with the operator to include this facility.

Mortgage Activities

In 2007, we had no significant mortgage activity.

Assets Held for Sale

At December 31, 2007, we had three facilities classified as held for sale with a net book value of approximately $2.9 million.  In 2007, we recorded an impairment reserve of $1.4 million on one of the facilities to reduce the carrying value to its estimated fair market value.  Two of the facilities are being sold to their current operator, under the terms of the lease agreement which included a purchase option.  The third facility is currently under contract and is expected to sell during the first quarter of 2008.

Asset Sales

·  
In November 2007, we sold two SNFs in Iowa for approximately $2.8 million resulting in a gain of $0.4 million.

·  
In May 2007, we sold two SNFs in Texas for their net book values, generating cash proceeds of approximately $1.8 million.

·  
In March 2007, we sold a SNF in Arkansas for approximately $0.7 million resulting in a loss of $15 thousand.  The results of this operation and the related loss are included in discontinued operations.

·  
In February 2007, we sold a closed SNF in Illinois for approximately $0.1 million resulting in a loss of $35 thousand.  The results of this operation and the related loss are included in discontinued operations.

·  
In January 2007, we sold two ALFs in Indiana for approximately $3.6 million resulting in a gain of approximately $1.7 million.  The results of these operations and the related gains are included in discontinued operations.

Other

In December 2007, we entered into a closing agreement with the IRS resolving our Advocat related party tenant issue.  See “Taxation – Resolution of Related Party Tenant Issue” in Item 1 above.


The following is our discussion of the consolidated results of operations, financial position and liquidity and capital resources, which should be read in conjunction with our audited consolidated financial statements and accompanying notes.



Year Ended December 31, 2007 compared to Year Ended December 31, 2006

Operating Revenues

Our operating revenues for the year ended December 31, 2007 totaled $159.6 million, an increase of $24.0 million over the same period in 2006.  The $24.0 million increase was primarily a result of new investments made throughout 2006 and 2007, a change in an accounting estimate related to one of our operators, partially offset by reduction in mortgage interest income and restructuring associated with the Advocat securities.

Detailed changes in operating revenues for the year ended December 31, 2007 are as follows:

·  
Rental income was $152.1 million, an increase of $25.2 million over the same period in 2006.  The increase is primarily due to additional rental income from the third quarter 2006 acquisition of 30 SNFs and one independent living center from Litchfield, the third quarter 2007 acquisition of five SNFs from Litchfield and a change in accounting estimate related to one of our operators as more fully disclosed in Note 3 – Properties and Note 2 –. Summary of Significant Accounting Policies.  During the first quarter of 2007, we determined that we should reverse approximately $5.0 million of allowance previously established for straight-line rent, as a result of an improvement in Advocat’s financial condition.
·  
Mortgage interest income totaled $3.9 million, a decrease of $0.5 million over the same period in 2006.  The decrease was primarily the result of a $10 million loan payoff that occurred in the second quarter of 2006.
·  
Other investment income totaled $2.8 million, a decrease of $0.9 million over the same period in 2006.  The primary reason for the decrease was due to restructuring Advocat securities we owned.
·  
Miscellaneous revenue was $0.8 million, an increase of $0.3 million over the same period in 2006.

Operating Expenses

Operating expenses for the year ended December 31, 2007 totaled $48.5 million, an increase of approximately $1.9 million over the same period in 2006.  The increase was primarily due to $4.0 million of increased depreciation expense, a $1.4 million provision for impairment on real estate properties, offset by a reduction of $3.1 million of restricted stock-based compensation expense compared to 2006.

Detailed changes in our operating expenses for the year ended December 31, 2007 versus the same period in 2006 are as follows:

·  
Our depreciation and amortization expense was $36.0 million, compared to $32.1 million for the same period in 2006.  The increase is due to the third quarter 2006 acquisition of 30 SNFs and one independent living center and the third quarter 2007 acquisition of the five Litchfield facilities.
·  
Our general and administrative expense, when excluding stock-based compensation expense related to performance restricted stock units, was $9.7 million, compared to $9.2 million for the same period in 2006.  The increase was primarily due to additional personnel costs related to additional personnel and annual merit increases, offset by reduction in consulting costs, primarily associated with the 2006 restatement.
·  
Our restricted stock-based compensation expense was $1.4 million, a decrease of $3.1 million over the same period in 2006.  The decrease primarily relates to the third quarter 2006 vesting of performance awards granted to executives in 2004.
·  
In 2006, we recorded a $0.8 million provision for uncollectible notes receivable.

Other Income (Expense)

For the year ended December 31, 2007, our total other net expenses were $43.8 million as compared to $31.8 million for the same period in 2006.  The significant changes are as follows:

·  
Our interest expense, excluding amortization of deferred costs and refinancing related interest expenses, for the year ended December 31, 2007 was $42.1 million, compared to $42.2 million for the same period in 2006.
·  
For the year ended December 31, 2006, we sold our remaining 760,000 shares of Sun’s common stock for approximately $7.6 million, realizing a gain on the sale of these securities of approximately $2.7 million.
·  
For the year ended December 31, 2006 in accordance with FAS No. 133, we recorded a $9.1 million fair value adjustment to reflect the change in fair value during 2006 of our derivative instrument (i.e., the conversion feature of a redeemable convertible preferred stock security in Advocat, a publicly traded company; see Note 5 – Other Investments).
·  
For the year ended December 31, 2006, we recorded a $3.6 million gain on Advocat securities (see Note 5 – Other Investments).
·  
For the year ended December 31, 2006, we recorded a $0.8 million non-cash charge associated with the redemption of the remaining 20.7% of our $100 million aggregate principal amount of 6.95% unsecured notes due 2007 not otherwise tendered in 2005.
·  
For the year ended December 31, 2006, we recorded a one time, non-cash charge of approximately $2.7 million relating to the write-off of deferred financing costs associated with the termination of our prior credit facility.

2007 Taxes

As more fully disclosed under “Taxation – Resolution of Related Party Tenant Issue” in Item 1 above, during the fourth quarter of 2006, we identified a related party tenant issue with one of our operators, Advocat, that could have been interpreted as affecting our compliance with federal income tax rules applicable to REITs regarding related party tenant income.  As a result of the related party tenant issue, we recorded a provision for income taxes of $2.3 million in 2006.  During the fourth quarter of 2006, we restructured our agreement with Advocat and have been advised by tax counsel that we will not receive a nonqualfying related party income from Advocat in future periods.  As a result of the restructured agreement, we do not expect to incur tax expense associated related party tenant income in periods commencing after January 1, 2007.  During the fourth quarter of 2007, we entered into a closing agreement with the IRS for the tax years 2002-2006.  In 2007, we recorded $7 thousand of tax credit related to resolving interest and penalties for the tax years 2002-2006.

So long as we qualify as a REIT we generally will not be subject to Federal income taxes on the REIT taxable income that we distribute to stockholders, subject to certain exceptions.  For tax year 2007, preferred and common dividend payments of $81.3 million made throughout 2007 satisfy the 2007 REIT requirements relating to qualifying income.  We are permitted to own up to 100% of a TRS.  Currently, we have one TRS that is taxable as a corporation and that pays federal, state and local income tax on its net income at the applicable corporate rates.  The TRS had a net operating loss carry-forward as of December 31, 2007 of $1.1 million.  The loss carry-forward was fully reserved with a valuation allowance due to uncertainties regarding realization.  We recorded interest and penalty charges associated with tax matters as income tax expense.

Income from continuing operations

Income from continuing operations for the year ended December 31, 2007 was $67.6 million compared to $55.9 million for the same period in 2006.  The increase in income from continuing operations is the result of the factors described above.

2007 Discontinued Operations

Discontinued operations relate to properties we disposed of or plan to dispose of and are currently classified as assets held for sale.

For the year ended December 31, 2007, discontinued operations include the revenue of $0.2 million and expense of $31 thousand and a gain of $1.6 million on the sale of four SNFs and two ALFs.

For the year ended December 31, 2006, discontinued operations include the revenue of $0.6 million and expense of $0.9 million and a gain of $0.2 million on the sale of three SNFs and one ALF.

For additional information, see Note 18 – Discontinued Operations.

Funds From Operations

Our funds from operations available to common stockholders (“FFO”), for the year ended December 31, 2007, was $93.5 million, compared to $76.7 million for the same period in 2006.

We calculate and report FFO in accordance with the definition and interpretive guidelines issued by the National Association of Real Estate Investment Trusts (“NAREIT”), and, consequently, FFO is defined as net income available to common stockholders, adjusted for the effects of asset dispositions and certain non-cash items, primarily depreciation and amortization.  We believe that FFO is an important supplemental measure of our operating performance.  Because the historical cost accounting convention used for real estate assets requires depreciation (except on land), such accounting presentation implies that the value of real estate assets diminishes predictably over time, while real estate values instead have historically risen or fallen with market conditions.  The term FFO was designed by the real estate industry to address this issue.  FFO herein is not necessarily comparable to FFO of other REITs that do not use the same definition or implementation guidelines or interpret the standards differently from us.

We use FFO as one of several criteria to measure the operating performance of our business.  We further believe that by excluding the effect of depreciation, amortization and gains or losses from sales of real estate, all of which are based on historical costs and which may be of limited relevance in evaluating current performance, FFO can facilitate comparisons of operating performance between periods and between other REITs.  We offer this measure to assist the users of our financial statements in evaluating our financial performance under GAAP, and FFO should not be considered a measure of liquidity, an alternative to net income or an indicator of any other performance measure determined in accordance with GAAP.  Investors and potential investors in our securities should not rely on this measure as a substitute for any GAAP measure, including net income.

The following table presents our FFO results for the years ended December 31, 2007 and 2006:

   
Year Ended December 31,
  
   
2007
    
2006
  
   
(in thousands)
  
Net income available to common
   $ 59,451     $ 45,774  
Deduct gain from real estate dispositions(1)
     (1,994 )     (1,354 )
      57,457       44,420  
Elimination of non-cash items included in net income:
                
Depreciation and amortization(2)
     36,056       32,263  
Funds from operations available to common stockholders
   $ 93,513     $ 76,683  
                 
(1)  
The deduction of the gain from real estate dispositions includes the facilities classified as discontinued operations in our consolidated financial statements.  The gain deducted includes $1.6 million gain and $0.2 million gain related to facilities classified as discontinued operations for the year ended December 31, 2007 and 2006, respectively.
(2)  
The add back of depreciation and amortization includes the facilities classified as discontinued operations in our consolidated financial statements.  FFO for 2007 and 2006 includes depreciation and amortization of $28 thousand and $0.2 million, respectively, related to facilities classified as discontinued operations.

Year Ended December 31, 2006 compared to Year Ended December 31, 2005

Operating Revenues

Our operating revenues for the year ended December 31, 2006 totaled $135.5 million, an increase of $26.0 million over the same period in 2005.  The $26.0 million increase was primarily a result of new investments made throughout 2005 and 2006.  The increase in operating revenues from new investments was partially offset by a reduction in mortgage interest income and one-time contractual interest revenue associated with the payoff of a mortgage during the first quarter of 2005.

Detailed changes in operating revenues for the year ended December 31, 2006 are as follows:

·  
Rental income was $126.9 million, an increase of $31.6 million over the same period in 2005.  The increase was due to new leases entered into throughout 2006 and 2005, as well as rental revenue from the consolidation of a variable interest entity.
·  
Mortgage interest income totaled $4.4 million, a decrease of $2.1 million over the same period in 2005.  The decrease was primarily the result of normal amortization, a $60 million loan payoff that occurred in the first quarter of 2005 and a $10 million loan payoff that occurred in the second quarter of 2006.
·  
Other investment income totaled $3.7 million, an increase of $0.5 million over the same period in 2005.  The primary reason for the increase was due to dividends and accretion income associated with the Advocat securities.
·  
Miscellaneous revenue was $0.5 million, a decrease of $3.9 million over the same period in 2005.  The decrease was due to contractual revenue owed to us resulting from a mortgage note prepayment that occurred in the first quarter of 2005.

Operating Expenses

Operating expenses for the year ended December 31, 2006 totaled $46.6 million, an increase of approximately $13.1 million over the same period in 2005.  The increase was primarily due to $8.3 million of increased depreciation expense, $3.3 million of incremental restricted stock expense and a $0.8 million provision for uncollectible notes receivable, partially offset by a 2005 leasehold termination expense for $1.1 million.

Detailed changes in our operating expenses for the year ended December 31, 2006 versus the same period in 2005 are as follows:

·  
Our depreciation and amortization expense was $32.1 million, compared to $23.8 million for the same period in 2005.  The increase is due to new investments placed throughout 2005 and 2006, as well as depreciation from the consolidation of a VIE.
·  
Our general and administrative expense, when excluding restricted stock amortization expense and compensation expense related to the performance restricted stock units, was $9.2 million, compared to $7.4 million for the same period in 2005.  The increase was primarily due to $1.2 million of restatement related expenses and normal inflationary increases in goods and services.
·  
For the year ended December 31, 2006, in accordance with FAS No. 123R, we recorded approximately $3.3 million (included in general and administrative expense) of compensation expense associated with the performance restricted stock units (see Note 13 – Stock Based Compensation).
·  
In 2006, we recorded a $0.8 million provision for uncollectible notes receivable.
·  
In 2005, we recorded a $1.1 million lease expiration accrual relating to disputed capital improvement requirements associated with a lease that expired June 30, 2005.

Other Income (Expense)

For the year ended December 31, 2006, our total other net expenses were $31.8 million as compared to $36.3 million for the same period in 2005.  The significant changes are as follows:

·  
Our interest expense, excluding amortization of deferred costs and refinancing related interest expenses, for the year ended December 31, 2006 was $42.2 million, compared to $29.9 million for the same period in 2005.  The increase of $12.3 million was primarily due to higher debt on our balance sheet versus the same period in 2005 and from consolidation of interest expense from a VIE in 2006.
·  
For the year ended December 31, 2006, we sold our remaining 760,000 shares of Sun’s common stock for approximately $7.6 million, realizing a gain on the sale of these securities of approximately $2.7 million.
·  
For the year ended December 31, 2006, in accordance with FAS No. 133, we recorded a $9.1 million fair value adjustment to reflect the change in fair value during 2006 of our derivative instrument (i.e., the conversion feature of a redeemable convertible preferred stock security in Advocat, a publicly traded company; see Note 5 – Other Investments).
·  
For the year ended December 31, 2006, we recorded a $3.6 million gain on Advocat securities (see Note 5 – Other Investments).
·  
For the year ended December 31, 2006, we recorded a $0.8 million non-cash charge associated with the redemption of the remaining 20.7% of our $100 million aggregate principal amount of 6.95% unsecured notes due 2007 not otherwise tendered in 2005.
·  
For the year ended December 31, 2006, we recorded a one time, non-cash charge of approximately $2.7 million relating to the write-off of deferred financing costs associated with the termination of our prior credit facility.
·  
During the year ended December 31, 2005, we recorded a $3.4 million provision for impairment of an equity security.  In accordance with FASB No. 115, the $3.4 million provision for impairment was to write-down our 760,000 share investment in Sun’s common stock to its then current fair market value.
·  
For the year ended December 31, 2005, we recorded $1.6 million in net cash proceeds resulting from settlement of a lawsuit filed suit filed by us against a former tenant.

2006 Taxes

During the fourth quarter of 2006, we determined that certain terms of the Advocat Series B non-voting, redeemable convertible preferred stock held by us could be interpreted as affecting our compliance with federal income tax rules applicable to REITs regarding related party tenant income.  As such, Advocat, one of our lessees, may be deemed to be a “related party tenant” under applicable federal income tax rules.  In such event, our rental income from Advocat would not be qualifying income under the gross income tests that are applicable to REITs.  In order to maintain qualification as a REIT, we annually must satisfy certain tests regarding the source of our gross income.  The applicable federal income tax rules provide a “savings clause” for REITs that fail to satisfy the REIT gross income tests if such failure is due to reasonable cause.  A REIT that qualifies for the savings clause will retain its REIT status but will pay a tax under section 857(b)(5) and related interest.  On December 15, 2006, we submitted to the IRS a request for a closing agreement to resolve the “related party tenant” issue.  As a result of the related party tenant issue associated with Advocat, we recorded a provision for income taxes of $2.3 million and $2.4 million, for the year ended December 31, 2006 and 2005, respectively.

2006 Discontinued Operations

Discontinued operations relate to properties we disposed of or plan to dispose of and are currently classified as assets held for sale.

For the year ended December 31, 2006, discontinued operations include revenue of $0.6 million and expense of $0.9 million and a gain of $0.2 million on the sale of three SNFs and one ALF.

For the year ended December 31, 2005, discontinued operations include revenue of $4.6 million and expense of $11.1 million and a gain of $8.0 million on the sale of eight SNFs, six ALFs and 50.4 acres of undeveloped land.

For additional information, see Note 18 – Discontinued Operations.

Funds From Operations

Our FFO for the year ended December 31, 2006, was $76.7 million, compared to $42.7 million for the same period in 2005.  For the information regarding the presentation of FFO, see “Year Ended December 31, 2007 compared to Year Ended December 31, 2006 – Funds From Operations” above.

The following table presents our FFO results for the years ended December 31, 2006 and 2005:

   
Year Ended December 31,
  
   
2006
    
2005
  
   
(in thousands)
  
Net income available to common
   $ 45,774     $ 25,355  
Deduct gain from real estate dispositions(1)
     (1,354 )     (7,969 )
      44,420       17,386  
Elimination of non-cash items included in net income:
                
Depreciation and amortization(2)
     32,263       25,277  
Funds from operations available to common stockholders
   $ 76,683     $ 42,663  
                 
(1)  
The deduction of the gain from real estate dispositions includes the facilities classified as discontinued operations in our consolidated financial statements.  The gain deducted includes $1.2 million from a distribution from an investment in a limited partnership in 2006 and $0.2 million gain and $8.0 million gain related to facilities classified as discontinued operations for the year ended December 31, 2006 and 2005, respectively.
(2)  
The add back of depreciation and amortization includes the facilities classified as discontinued operations in our consolidated financial statements.  FFO for 2006 and 2005 includes depreciation and amortization of $0.2 million and $1.5 million, respectively, related to facilities classified as discontinued operations.




At December 31, 2007, we had total assets of $1.2 billion, stockholders’ equity of $586.1 million and debt of $573.7 million, representing approximately 49.5% of total capitalization.


The following table shows the amounts due in connection with the contractual obligations described below as of December 31, 2007.

   
Payments due by period
  
   
Total
    
Less than
1 year
    
1-3 years
    
3-5 years
    
More than
5 years
  
   
(in thousands)
  
Long-term debt(1)
   $ 573,995     $ 435     $ 48,960     $ 39,600     $ 485,000  
Operating lease obligations
     293       251       42       -       -  
Total
  $ 574,288     $ 686     $ 49,002     $ 39,600     $ 485,000  

(1)  
The $574.0 million includes $310 million aggregate principal amount of 7% Senior Notes due April 2014, $175 million aggregate principal amount of 7% Senior Notes due January 2016, $48.0 million in borrowings under the $255 million revolving senior secured credit facility that matures in March 2010 and the Haven subsidiary’s $39 million first mortgage with General Electric Capital Corporation that expires in October 2012.

Financing Activities and Borrowing Arrangements

Bank Credit Agreements

At December 31, 2007, we had $48.0 million outstanding under our $255 million revolving senior secured credit facility (“Credit Facility”) and $2.1 million was utilized for the issuance of letters of credit, leaving availability of $204.9 million.  The $48.0 million of outstanding borrowings had a blended interest rate of 6.15% at December 31, 2007.  Borrowings under the credit agreement are due March 2010.

Pursuant to Section 2.01 of the credit agreement dated as of March 31, 2006 that governs the Credit Facility, we were permitted under certain circumstances to increase our available borrowing base under the credit agreement from $200 million up to an aggregate of $300 million.  Effective February 22, 2007, we exercised our right to increase the available revolving commitment under Section 2.01 of the credit agreement from $200 million to $255 million and we consented to add 18 of our properties to the borrowing base assets under the credit agreement.  At December 31, 2007, we pledged real estate assets with a gross book value of $281.0 million as collateral for the Credit Facility.  At December 31, 2007 and 2006, we had letters of credit outstanding of $2.1 million and $2.5 million, respectively.  The blended borrowing interest rate for 2007 and 2006 was 6.15% and 6.60%, respectively.  In 2007, we paid approximately $0.7 million in fees and expenses associated with increasing the available revolving commitment.

 
Our long-term borrowings require us to meet certain property level financial covenants and corporate financial covenants, including prescribed leverage, fixed charge coverage, minimum net worth, limitations on additional indebtedness and limitations on dividend payouts.  As of December 31, 2007, we were in compliance with all property level and corporate financial covenants.
 
 
Equity Financing
 
In 2007, we completed an underwritten public offering for 7.13 million shares of our common stock at $16.75 per shares and received $112.9 million in net proceeds.  In 2007, we also received $18.9 million in proceeds for the issuance of 1.2 million shares from our DRSPP.


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 addition, our credit facility has certain financial covenants that limit the distribution of dividends paid during a fiscal quarter to no more than 95% of our aggregate cumulative FFO as defined in the credit agreement, unless a greater distribution is required to maintain REIT status.  The credit agreement defines FFO as net income (or loss) plus depreciation and amortization and shall be adjusted for charges related to: (i) restructuring our debt; (ii) redemption of preferred stock; (iii) litigation charges up to $5.0 million; (iv) non-cash charges for accounts and notes receivable up to $5.0 million; (v) non-cash compensation related expenses; (vi) non-cash impairment charges; and (vii) tax liabilities in an amount not to exceed $8.0 million.  In 2007, we paid dividends of $1.08 per share of common stock and $2.09 per share of preferred stock.  In 2007, we paid a total of $81.3 million in dividends to common and preferred stockholders.


Liquidity

We believe our liquidity and various sources of available capital, including cash from operations, our existing availability under our Credit Facility and expected proceeds from mortgage payoffs are more than adequate to finance operations, meet recurring debt service requirements and fund future investments through the next twelve months.

We regularly review our liquidity needs, the adequacy of cash flow from operations, and other expected liquidity sources to meet these needs.  We believe our principal short-term liquidity needs are to fund:
· normal recurring expenses;
· debt service payments;
· preferred stock dividends;
· common stock dividends; and
· growth through acquisitions of additional properties.

The primary source of liquidity is our cash flows from operations.  Operating cash flows have historically been determined by: (i) the number of facilities we lease or have mortgages on; (ii) rental and mortgage rates; (iii) our debt service obligations; and (iv) general and administrative expenses.  The timing, source and amount of cash flows provided by financing activities and used in investing activities are sensitive to the capital markets environment, especially to changes in interest rates.  Changes in the capital markets environment may impact the availability of cost-effective capital and affect our plans for acquisition and disposition activity.

Cash and cash equivalents totaled $2.0 million as of December 31, 2007, a increase of $1.3 million as compared to the balance at December 31, 2006.  The following is a discussion of changes in cash and cash equivalents due to operating, investing and financing activities, which are presented in our Consolidated Statement of Cash Flows.

Operating Activities – Net cash flow from operating activities generated $84.5 million for the year ended December 31, 2007, as compared to $62.8 million for the same period in 2006, an increase of $21.7 million.

Investing Activities– Net cash flow used in investing activities was an outflow of $29.9 million for the year ended December 31, 2007, as compared to an outflow of $161.4 million for the same period in 2006.  The decrease in cash outflow from investing activities of $131.4 million relates primarily to the timing of acquisitions completed in 2006 compared to 2007.  For the year ended December 31, 2006, we acquired real estate, primarily 30 SNFs and one independent living center from Litchfield for $178.9 million.  For the year ended December 31, 2007, we purchased five SNFs from Litchfield for $39.5 million.  In 2006, we sold shares of Sun’s common stock for approximately $7.6 million in proceeds.

Financing Activities– Net cash flow from financing activities was an outflow of $53.4 million for year ended December 31, 2007 as compared to an inflow of $95.3 million for the same period in 2006.  The $148.7 million change in financing cash flow was a result of a net payment of $102.4 million on our credit facility and other borrowings during the twelve months of 2007 as compared to net proceeds of $130.6 million for the same period in 2006; an increase in dividend payments of $14.4 million as compared to the same period in 2006; and the reduction in proceeds from the optional cash purchase portion of the DRSPP of $14.2 million as compared to the same period in 2006; offset by proceeds of $112.9 million from a common stock offering in the second quarter of 2007, the proceeds of which were used to repay borrowing under our credit facility.  We used a majority of the proceeds from 2006 borrowings under our credit facility to acquire properties from Litchfield.


The preparation of financial statements in conformity with generally accepted accounting principles (“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.  Our significant accounting policies are described in Note 2 to our audited consolidated financial statements.  These policies were followed in preparing the consolidated financial statements for all periods presented.  Actual results could differ from those estimates.

We have identified four significant accounting policies that we believe are 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 assumptions, 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 four critical accounting policies are:

Revenue Recognition

We have various different investments that generate revenue, including leased and mortgaged properties, as well as, other investments, including working capital loans.  We recognized rental income and mortgage interest income and other investment income as earned over the terms of the related master leases and notes, respectively.

Substantially all of our leases contain provisions for specified annual increases over the rents of the prior year and are generally computed in one of three methods depending on specific provisions of each lease as follows: (i) a specific annual increase over the prior year’s rent, generally 2.5%; (ii) an increase based on the change in pre-determined formulas from year to year (i.e., such as increases in the CPI); or (iii) specific dollar increases over prior years.  Revenue under lease arrangements with specific determinable increases is recognized over the term of the lease on a straight-line basis.  SEC Staff Accounting Bulletin No. 101 Revenue Recognition in Financial Statements does not provide for the recognition of contingent revenue until all possible contingencies have been eliminated.  We consider the operating history of the lessee, the payment history, the general condition of the industry and various other factors when evaluating whether all possible contingencies have been eliminated.  We have historically not included, and generally expect in the future not to include, contingent rents as income until received.

In the case of rental revenue recognized on a straight-line basis, we generally record reserves against earned revenues from leases when collection becomes questionable or when negotiations for restructurings of troubled operators result in significant uncertainty regarding ultimate collection.  The amount of the reserve is estimated based on what management believes will likely be collected.  We continually evaluate the collectability of our straight-line rent assets.  If it appears that we will not collect future rent due under our leases, we will record a provision for loss related to the straight-line rent asset.

Recognizing rental income on a straight-line basis results may cause recognized revenue exceeding contractual amounts due from our tenants.  Such cumulative excess amounts are included in accounts receivable and were $33.9 million and $20.1 million, net of allowances, at December 31, 2007 and 2006, respectively.

Gains on sales of real estate assets are recognized pursuant to the provisions of SFAS No. 66, Accounting for Sales of Real Estate.  The specific timing of the recognition of the sale and the related gain is measured against the various criteria in SFAS No. 66 related to the terms of the transactions and any continuing involvement associated with the assets sold.  To the extent the sales criteria are not met, we defer gain recognition until the sales criteria are met.

Depreciation and Asset Impairment

Under GAAP, real estate assets are stated at the lower of depreciated cost or fair value, if deemed impaired.  Depreciation is computed on a straight-line basis over the estimated useful lives of 20 to 40 years for buildings and improvements and three to 10 years for furniture, fixtures and equipment.  Management periodically, but not less than annually, evaluates our real estate investments for impairment indicators, including the evaluation of our assets’ useful lives.  The judgment regarding the existence of impairment indicators is based on factors such as, but not limited to, market conditions, operator performance and legal structure.  If indicators of impairment are present, management evaluates the carrying value of the related real estate investments in relation to the future undiscounted cash flows of the underlying facilities.  Provisions for impairment losses related to long-lived assets are recognized when expected future undiscounted cash flows are determined to be permanently less than the carrying values of the assets.  An adjustment is made to the net carrying value of the leased properties and other long-lived assets for the excess of historical cost over fair value.  The fair value of the real estate investment is determined by market research, which includes valuing the property as a nursing home as well as other alternative uses. All impairments are taken as a period cost at that time, and depreciation is adjusted going forward to reflect the new value assigned to the asset.

If we decide to sell rental properties or land holdings, we evaluate the recoverability of the carrying amounts of the assets.  If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value less costs to sell.  Our estimates of cash flows and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties, and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers.

For the years ended December 31, 2007, 2006, and 2005, we recognized impairment losses of $1.4 million, $0.5 million and $9.6 million, respectively, including amounts classified within discontinued operations.

Loan Impairment

Management, periodically but not less than annually, evaluates our outstanding loans and notes receivable.  When management identifies potential loan impairment indicators, such as non-payment under the loan documents, impairment of the underlying collateral, financial difficulty of the operator or other circumstances that may impair full execution of the loan documents, and management believes it is probable that all amounts will not be collected under the contractual terms of the loan, the loan is written down to the present value of the expected future cash flows.  In cases where expected future cash flows are not readily determinable, the loan is written down to the fair value of the collateral.  The fair value of the loan is determined by market research, which includes valuing the property as a nursing home as well as other alternative uses.  We recorded loan impairments of $0.0 million, $0.9 million and $0.1 million for the years ended December 31, 2007, 2006 and 2005, respectively.

We currently account for impaired loans using the cost-recovery method applying cash received against the outstanding principal balance prior to recording interest income (see Note 5 – Other Investments).  At December 31, 2007 and 2006, we had allowances for loan losses of $2.2 million on two working capital notes.

Assets Held for Sale and Discontinued Operations

Pursuant to the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the operating results of specified real estate assets that have been sold, or otherwise qualify as held for disposition (as defined by SFAS No. 144), are reflected as assets held for sale in our balance sheet.  Assets that qualify as held for sale may also be considered as a discontinued operation if, (a) the operation and cash flows of the asset have been or will be eliminated from future operations and (b) we will not have significant involvement with the asset after its disposition. For assets that qualify as discontinued operations, we have reclassified the operations of those assets to discontinued operations in the consolidated statements of operations for all periods presented and assets held for sale in the consolidated balance sheet for all periods presented.

For the year ended December 31, 2007, we had three assets held for sale with a combined net book value of $2.9 million.  Discontinued operations includes the revenue of $0.2 million and expense of $31 thousand for 6 facilities.  It also includes the gain of $1.6 million on the sale of six SNFs and two ALFs.

For the year ended December 31, 2006, we had seven assets held for sale with a combined net book value of $4.7 million, which includes a reclassification of one asset with a net book value of $1.1 million that was reclassified as held for sale and discontinued operations during 2007.  Discontinued operations includes revenue of $0.6 million and expense of $0.9 million and a gain of $0.2 million on the sale of three SNFs and one ALF.

For the year ended December 31, 2005, we had nine assets held for sale with a net book value of approximately $7.0 million, which includes a reclassification of five assets with a net book value of $4.6 million that were sold or reclassified as held for sale and discontinued operations during 2006 and one asset with a net book value of $1.1 million that was reclassified as held for sale and discontinued operations during 2007.  Discontinued operations includes revenue of $4.6 million and expense of $11.1 million and a gain of $8.0 million on the sale of eight SNFs, six ALFs and 50.4 acres of undeveloped land.

Effects of Recently Issued Accounting Standards

FIN 48 Evaluation

On January 1, 2008, we adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes,an interpretation of FASB Statement No. 109, Accounting for Income Taxes.  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, by defining a criterion that an individual tax position must meet for any part of that position to be recognized in an enterprise’s financial statements.  The interpretation requires a review of all tax positions accounted for in accordance with FASB Statement No. 109 and applies a more-likely-than-not recognition threshold.  A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with the taxing authority that has full knowledge of all relevant information.  We are subject to the provisions of FIN 48 beginning January 1, 2007.  We evaluated FIN 48 and determined that the adoption of FIN 48 had no impact on our financial statements.

FAS 157 Evaluation

In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements (“FAS No. 157”).  This standard defines fair value, establishes a methodology for measuring fair value and expands the required disclosure for fair value measurements.  FAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and states that a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability.  This statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those pronouncements that fair value is the relevant measurement attribute.  Accordingly, this statement does not require any new fair value measurements.  FAS No. 157 is effective for fiscal years beginning after November 15, 2007, and we intend to adopt the standard on January 1, 2008.  We are currently evaluating the impact, if any, that FAS No. 157 will have on our financial statements.

FAS 159 Evaluation

In February 2007, the FASB issued Statement of Financial Accounting Standards (“FAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”).  SFAS No. 159 permits entities to choose to measure certain financial assets and liabilities at fair value, with the change in unrealized gains and losses on items for which the fair value option has been elected and reported in earnings.  SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact, if any, that SFAS No. 159 will have on our financial statements.

FAS 141(R) Evaluation

On December 4, 2007, the Financial Accounting Standards Board issued Statement No. 141(R), Business Combinations (FAS 141(R)).  The new standard will significantly change the accounting for and reporting of business combination transactions.  FAS 141(R) requires companies to recognize, with certain exception, 100 percent of the fair value of the assets acquired, liabilities assumed and non-controlling interest in acquisitions of less than a 100 percent controlling interest when the acquisition constitutes a change in control; measure acquirer shares issued as consideration for a business combination at fair value on the date of the acquisition; recognize contingent consideration arrangements at their acquisition date fair value, with subsequent change in fair value generally reflected in earnings; recognition of reacquisition loss and gain contingencies at their acquisition date fair value; expense as incurred, acquisition related transaction costs.  FAS 141(R) is effective for fiscal years beginning after December 15, 2008 and early adoption is prohibited.  We intend to adopt the standard on January 1, 2009.  We are currently evaluating the impact, if any, that FAS 141(R) will have on our financial statements.



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 following disclosures of estimated fair value of financial instruments are subjective in nature and are dependent on a number of important assumptions, including estimates of future cash flows, risks, discount rates and relevant comparable market information associated with each financial instrument.  The use of different market assumptions and estimation methodologies may have a material effect on the reported estimated fair value amounts.  Accordingly, the estimates presented below are not necessarily indicative of the amounts we would realize in a current market exchange.

Mortgage notesreceivable - The fair value of mortgage notes receivable is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Notesreceivable - The fair value of notes receivable is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Borrowings under lines of credit arrangement - The carrying amount approximates fair value because the borrowings are interest rate adjustable.

Senior unsecured notes - The fair value of the senior unsecured notes is estimated by discounting the future cash flows using the current borrowing rate available for the similar debt.

The market value of our long-term fixed rate borrowings and mortgages is subject to interest rate risks.  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 December 31, 2007 was approximately $570.2 million.  A one percent increase in interest rates would result in a decrease in the fair value of long-term borrowings by approximately $26.5 million at December 31, 2007.  The estimated fair value of our total long-term borrowings at December 31, 2006 was approximately $693.7 million, and a one percent increase in interest rates would have resulted in a decrease in the fair value of long-term borrowings by approximately $30.7 million.

While we currently do not engage in hedging strategies, we may engage in such strategies in the future, depending on management’s analysis of the interest rate environment and the costs and risks of such strategies.



The consolidated financial statements and the report of Ernst & Young LLP, Independent Registered Public Accounting Firm, on such financial statements are filed as part of this report beginning on page F-1.  The summary of unaudited quarterly results of operations for the years ended December 31, 2007 and 2006 is included in Note 16 to our audited consolidated financial statements, which is incorporated herein by reference in response to Item 302 of Regulation S-K.


None.



Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are controls and other procedures that are designed to provide reasonable assurance that the information that we are required to disclose in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

In connection with the preparation of our Form 10-K as of and for the year ended December 31, 2007, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2007.  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of December 31, 2007.


Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934, as amended, as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by a company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in  accordance with GAAP and includes those policies and procedures that:

·  
 Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company;