10-K: Annual report pursuant to Section 13 and 15(d)
Published on March 31, 1998
EXHIBIT 13
RESPONSE TO ITEM 14(a)(1) AND (2) AND 14(d)
INFORMATION INCORPORATED BY REFERENCE FROM
ANNUAL REPORT TO SHAREHOLDERS
LISTING OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
INDEX TO FINANCIAL INFORMATION
YEAR ENDED DECEMBER 31, 1997
OMEGA HEALTHCARE INVESTORS, INC.
ANN ARBOR, MICHIGAN
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INDEX TO FINANCIAL INFORMATION
The following consolidated financial statements of Omega Healthcare
Investors, Inc. and subsidiaries, included on pages 11 through 22 of the Annual
Report of the registrant to its shareholders for the year ended December 31,
1997, are incorporated by reference in Item 8:
Consolidated Balance Sheets -- December 31, 1997 and 1996.
Consolidated Statements of Operations -- Years ended December 31, 1997,
1996 and 1995.
Consolidated Statements of Shareholders' Equity -- Years ended December
31, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows -- Years ended December 31, 1997,
1996 and 1995.
Notes to Consolidated Financial Statements -- December 31, 1997.
The following consolidated financial statement schedules of Omega
Healthcare Investors, Inc. and subsidiaries are included in Item 14(d):
Schedule III Real Estate and Accumulated Depreciation
Schedule IV Mortgage Loan on Real Estate
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are are not
required under the related instructions or are inapplicable and therefore have
been omitted.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OMEGA HEALTHCARE INVESTORS, INC.
"SAFE HARBOR" STATEMENT UNDER THE
UNITED STATES PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Statements that are not historical facts contained in Management's
Discussion and Analysis are forward-looking statements that involve risks and
uncertainties that could cause actual results to differ from projected results.
Some of the factors that could cause actual results to differ materially
include: the financial strength of the operators of the Company's facilities as
it affects their continuing ability to meet their obligations to the Company
under the terms of the Company's agreements with such operators; changes in
operators or ownership of operators; government policy relating to the
healthcare industry, including changes in the reimbursement levels under the
Medicare and Medicaid programs; operators' continued eligibility to participate
in the Medicare and Medicaid programs; changes in reimbursement by other third
party payors; occupancy levels at the Company's facilities; the availability
and cost of capital; the strength and financial resources of the Company's
competitors; the Company's ability to make additional real estate investments
at attractive yields and changes in tax laws and regulations affecting real
estate investment trusts.
Following is a discussion of the consolidated results of operations,
financial position and liquidity and capital resources of the Company which
should be read in conjunction with the consolidated financial statements and
accompanying notes.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Revenues for the year ended December 31, 1997 totaled $90,820,000,
increasing $17.7 million over 1996 revenues. The 1997 revenue growth stems
primarily from additional investments during 1996 and 1997. A partial year of
revenues from 1997 investments provided revenue increases of approximately $9.8
million, while a full year of revenues from 1996 investments added $5.1 million
to revenues. Additionally, approximately $1.9 million of the revenue growth
stems from participating incremental revenues which became effective during
1997.
Real estate investments of $779.4 million as of December 31, 1997 will
provide 1998 annualized revenues of $93.1 million. Revenues will continue at
this level until additional 1998 investments are made and additional escalation
provisions commence in 1998. Annualized revenues for 1998 represent a $20.1
million increase over the 1997 annualized revenues of $73.0 million based on
real estate investments of $593.7 million as of January 1, 1997.
The following table summarizes the years of expiration of the Company's
revenues based on the contractual maturity dates of the leases and mortgages:
The total excludes approximately $5.7 million of annualized revenues from Unison
(see Note 5).
Expenses for the year ended December 31, 1997 totaled $45,969,000,
increasing approximately $7.4 million over expenses of $38.5 million for 1996.
The 1997 provision for depreciation and amortization of real estate totaled
$16,910,000, increasing $3.2 million over 1996. This increase stems from a full
year provision for 1996 investments, plus a partial year of provision for 1997
investments.
Interest expense for the year ended December 31, 1997 was approximately
$24,423,000, compared with $20.8 million for 1996. The increase in interest
expense is primarily due to an increase in average outstanding borrowings on the
acquisition line of credit, partially offset by lower rates.
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General and administrative expenses for 1997 totaled $4.6 million or
approximately 5.1% of revenues as compared to 5.5% for 1996. The 1997 percentage
decrease stems primarily from economies of scale resulting from additional
investments made in 1997.
No provision for Federal income taxes has been made since the Company
intends to continue to qualify as a real estate investment trust under the
provisions of Sections 856 through 860 of the Internal Revenue Code of 1986, as
amended. Accordingly, the Company will not be subject to Federal income taxes on
amounts distributed to shareholders provided it distributes at least 95% of its
real estate investment trust taxable income and meets certain other conditions.
Funds from operations (FFO) for the year ended December 31, 1997 totaled
$58,815,000 an increase of $9.8 million over the $49.0 million for 1996. FFO is
net earnings available to common shareholders, excluding any gains or losses
from debt restructuring and sales of property, plus depreciation and
amortization associated with real estate investments and charges to earnings for
non-cash common stock based compensation. The 1997 growth in cash flow is
primarily due to the additional investments in 1997 and 1996 and the increase in
operating earnings before provisions for depreciation and amortization.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Revenues for the year ended December 31, 1996 totaled $73,127,000,
increasing $11.7 million over 1995 revenues. The 1996 revenue growth stems
primarily from additional investments during 1995 and 1996. A partial year of
revenues from 1996 investments provided revenue increases of approximately $6.1
million, while a full year of revenues from 1995 investments added $3.8 million
to revenues. Additionally, approximately $1.4 million of the revenue growth
stems from participating incremental revenues which became effective during
1996.
Total real estate investments of $594 million as of December 31, 1996 will
provide 1997 annualized operating revenues of $73.0 million. Revenues will
continue at this level until additional 1997 investments are made and additional
escalation provisions commence in 1997. Annualized revenues for 1997 represent
an $10.5 million increase over the 1996 annualized revenues of $62.5 million
based on investments of $516 million as of January 1, 1996.
Expenses for the year ended December 31, 1996 totaled $38,537,000,
increasing $6.6 million over expenses of $31.9 million for 1995. The 1996
provision for depreciation and amortization of real estate totaled $13,693,000,
increasing $698,000 over 1995. This increase stems from additional investments
funded in 1995 and 1996.
Interest expense for the year ended December 31, 1996 was approximately
$20,836,000, compared with $15.3 million for 1995. The increase in interest
expense is due to higher average borrowings of approximately $88 million, offset
by lower interest rates and reduced amortization of debt issue costs.
General and administrative expenses for 1996 totaled $4,008,000 or
approximately 5.5% of revenues as compared to 5.9% for 1995. The 1996 percentage
decrease relates to economies of scale stemming from additional investments made
in 1996 and 1995.
Funds from operations available for distribution for 1996 were $48,989,000,
an increase of $5.5 million from the $43.5 million for 1995. Funds from
operations for the year ended December 31, 1996 totaled $49,008,000, an increase
of $6.0 million over the $43.0 million for 1995. The 1996 growth in cash flow is
primarily due to the additional investments in 1996 and 1995 and the related
increase in operating earnings before provisions for depreciation and
amortization.
LIQUIDITY AND CAPITAL RESOURCES
The Company continually seeks new investments in healthcare properties,
primarily long-term care facilities, with the objective of profitable growth and
further diversification of the investment portfolio. Permanent financing for
future investments is expected to be provided through a combination of private
and public offerings of debt and equity securities. Management believes the
Company's liquidity and sources of available capital are adequate to finance
operations, fund future investments, and meet debt service requirements.
At December 31, 1997, the Company has a strong financial position with
total assets of $816.1 million, shareholders' equity of $468.2 million, and
long-term debt of $271.5 million, representing approximately 33% of total
capitalization. Long-term debt excludes funds borrowed under its acquisi-
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tion credit agreement. The Company anticipates eventually attaining and then
maintaining a long-term debt-to-capitalization ratio of approximately 40%. The
Company has a $200 million acquisition credit facility, of which $58.3 million
was drawn at year end and an additional $64.8 million was subsequently drawn
through February 19, 1998.
In February 1997, the Company filed a Form S-4 shelf registration statement
with the Securities and Exchange Commission registering common stock totaling
$100 million to be issued in connection with future property acquisitions.
Additionally, on August 29, 1997 the Company filed a Form S-3 registration
statement with the Securities and Exchange Commission permitting the issuance of
up to $200 million related to common stock, unspecified debt, preferred stock
and convertible securities.
The Company has demonstrated a strong capacity to access the capital
markets, raising more than $1 billion in capital since it was organized in 1992.
The Company has raised more than $450 million in equity, including $130 million
from the initial public offering in 1992, $73 million from a follow-on common
stock offering in 1994, $165 million from the HEP acquisition in 1994 and two
additional offerings, the latest being the $57.5 million issuance of preferred
stock in April 1997. Over $600 million of debt capital has been raised, some of
which has been used to retire secured borrowing debt with higher interest rates.
In 1996, the Company completed a placement of $95 million of 8.5% Convertible
Subordinated Debentures due 2001. In August 1997 the Company completed a $100
million 10-year senior note offering priced to yield 6.99%. In September 1997
the Company executed a Second Amended and Restated Loan Agreement with its banks
which provides for total borrowings of up to $200 million, reduces interest
rates from previous levels, and extends the term of the agreement to September
2000.
The Company distributes a large portion of the cash available from
operations. Cash dividends paid totaled $2.58 per share for 1997 compared with
$2.46 per share for the year ended December 31, 1996. The dividend pay-out
ratio, that is the ratio of per share amounts for dividends paid to the diluted
per share amount of funds from operations, was approximately 86% for 1997,
compared with 89% for 1996, and 88% for 1995. The Company believes that cash
provided from quarterly operating activities at current levels will continue to
be sufficient to fund normal working capital requirements and pay 1998 dividends
at a quarterly rate of $0.67 per share as declared at the January 15, 1998 Board
of Directors meeting. Approximately 45-50% of incremental cash flow from
operations is retained annually through gradual reductions in the dividend
payout ratio, to fund additional investments and provide financial flexibility.
New investments generally are funded from borrowings under the Company's
acquisition credit agreement. Interest cost incurred by the Company on
borrowings under the acquisition line will vary depending upon fluctuations in
prime and/or LIBOR rates, and upon changes in the Company's ratings by national
agencies. Borrowings bear interest at LIBOR plus 1.00% or, at the Company's
option at the prime rate. The Company expects to periodically replace funds
drawn on the acquisition credit agreement through fixed-rate long-term
borrowings, the placement of convertible debentures, or the issuance of
additional shares of capital stock. Historically, the Company's strategy has
been to match the maturity of its indebtedness with the maturity of its assets
and to employ fixed-rate long-term debt to the extent practicable.
YEAR 2000 IMPLICATIONS
The Company has assessed its current computer software for proper
functioning with respect to dates in the year 2000 and thereafter. The year 2000
issue and related costs are not expected to have a material impact on the
operations of the Company.
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CONSOLIDATED BALANCE SHEETS
OMEGA HEALTHCARE INVESTORS, INC.
See accompanying notes.
F-6
CONSOLIDATED STATEMENT OF OPERATIONS
OMEGA HEALTHCARE INVESTORS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
See accompanying notes.
F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS
OMEGA HEALTHCARE INVESTORS, INC.
See accompanying notes.
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OMEGA HEALTHCARE INVESTORS, INC.
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Omega Healthcare Investors, Inc. (the "Company") was incorporated on March
31, 1992, in the State of Maryland to (a) own and lease, and (b) provide
mortgage financing secured by income-producing healthcare facilities, with a
principal focus on diversified investments in long-term care facilities located
primarily in the United States.
The Company's operations commenced on August 14, 1992, the date of the
closing of the Company's initial public offering. It has elected to be taxed as
a real estate investment trust under Sections 856 through 860 of the Internal
Revenue Code of 1986, as amended. The Company intends to continue to qualify as
such and, therefore, will distribute at least 95% of its real estate investment
trust taxable income to its shareholders.
In 1995, the Company began to provide advisory services to Principal
Healthcare Finance Limited, a Company which owns and leases nursing homes in the
United Kingdom. (See Note 4.)
CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries after elimination of all material intercompany
accounts and transactions.
REAL ESTATE INVESTMENTS
As of December 31, 1997 the Company's real estate investments include
interests in 3 medical office buildings, 2 rehabilitation hospitals and 258
long-term care facilities, operated by 29 independent operators.
Investments in real estate properties and mortgage notes are recorded at
cost and original mortgage amount, respectively. The cost of the properties
acquired is allocated between land and buildings based generally upon
independent appraisals. Depreciation for buildings is recorded on the
straight-line basis, using estimated useful lives ranging from 20 to 39 years.
The Company considers the need to provide for reserves for potential losses on
its investments based on management's periodic review of its portfolio. On the
basis of this review to date, a provision for losses on investments has not been
deemed necessary.
CASH AND SHORT-TERM INVESTMENTS
Short-term investments consist of highly liquid investments with a maturity
date of three months or less when purchased. These investments are stated at
cost which approximates fair value.
NON-COMPETE AGREEMENTS AND GOODWILL
Non-compete agreements and the excess of the purchase price over the value
of tangible net assets acquired (i.e., goodwill from the purchase of Health
Equity Properties Incorporated) is amortized on a straight-line basis over
periods ranging from five to ten years. Accumulated amortization was $5,277,000
and $3,653,000 at December 31, 1997 and 1996, respectively.
DEFERRED FINANCING COSTS
Deferred financing costs are amortized on a straight-line basis over the
terms of the related borrowings. Amortization of financing costs totaling
$829,000, $524,000 and $1,072,000 in 1997, 1996, and 1995, respectively, is
classified as interest expense in the Consolidated Statements of Operations.
Unamortized deferred financing costs applicable to debt which is converted to
common stock are charged to paid-in capital at the date of conversion.
REVENUE RECOGNITION
Rental income and mortgage interest income is recognized as earned over the
terms of the related master leases and mortgage notes, respectively. Such income
includes periodic increases based on pre-determined formulas as defined in the
master leases and mortgage loan agreements. Certain mortgage agreements include
provisions for deferred interest which is not payable by the borrower until
maturity of the related note. The portion of deferred interest recognized as
earned approximates $614,000, $608,000 and $602,000 in 1997, 1996, and 1995,
respectively.
F-9
FEDERAL AND STATE INCOME TAXES
As a qualified real estate investment trust, the Company will not be
subject to Federal income taxes on its income, and no provisions for Federal
income taxes have been made. The reported amounts of the Company's assets and
liabilities as of December 31, 1997 exceeds the tax basis of assets by
approximately $70 million.
EARNINGS PER SHARE
Net earnings per share is computed based on the weighted average number of
common shares outstanding during the respective periods. Per share amounts for
prior periods have been restated as required by Financial Accounting Standards
Board Statement No. 128. Among the changes stemming from the new pronouncement
is a requirement to present both basic and diluted per share amounts. Diluted
earnings per share amounts reflect the dilutive effect of stock options of
52,394 shares, 44,240 shares and 9,501 shares for 1997, 1996, and 1995,
respectively. The assumed conversion of debentures is not materially dilutive.
STOCK BASED COMPENSATION
The Company grants stock options to employees and directors with an
exercise price equal to the fair value of the shares at the date of the grant.
In accordance with the provisions of APB Opinion No. 25, Accounting for Stock
Issued to Employees, compensation expense is not recognized for these stock
option grants.
ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
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. Actual results could differ from those estimates.
2. REAL ESTATE PROPERTIES
The Company's real estate properties, represented by 178 long-term care
facilities, 3 medical office buildings and 2 rehabilitation hospitals at
December 31, 1997, are leased under provisions of master leases with initial
terms ranging from 8 to 17 years, plus renewal options. Substantially all of the
master leases provide for minimum annual rentals which are subject to annual
increases based upon increases in the Consumer Price Index or increases in
revenues of the underlying properties, with certain maximum limits. Under the
terms of the leases, the lessee is responsible for all maintenance, repairs,
taxes and insurance on the leased properties.
A summary of the Company's investment in real estate properties is as
follows:
The following table summarizes the changes in real estate properties and
accumulated depreciation during 1997, 1996 and 1995:
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The future minimum rentals expected to be received for the remainder of the
initial terms of the leases are as follows:
The foregoing amounts exclude approximately $4.3 million of annual rents from
properties previously leased to Unison (see Note 5).
3. MORTGAGE NOTES RECEIVABLE
Mortgage notes receivable relate to 80 long-term care facilities. The
mortgage notes are secured by first mortgage liens on the borrowers' underlying
real estate and personal property. On an ongoing basis, management reviews
mortgage notes for collectibility. Based on management's review, no provision
for loss is considered necessary. The following table summarizes the changes in
mortgage notes during 1997 and 1996:
The face amount of mortgage notes receivable follow:
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The stated interest rates indicated above for Participating Mortgages and
Convertible Participating Mortgages are subject to annual increases based upon
increases in the Consumer Price Index or increases in revenues of the underlying
long-term care facilities, with certain maximum limits. Certain of the mortgage
notes, designated as "Convertible Participating" also permit the Company to
convert the note into ownership of the related real and personal property.
Conversions would generally result in purchase/leaseback transactions with
annual economic benefit to the Company substantially the same as under the
mortgage notes.
The estimated fair value of the Company's mortgage loans at December 31,
1997 is approximately $248,433,000. Fair value is based on the estimates of
management and on rates currently prevailing for comparable loans.
On the basis of contractual provisions of the various agreements, the
principal balances of mortgage notes receivable as of December 31, 1997 are
expected to mature or to be converted to purchase/leaseback transactions
approximately as follows: $4,368,000 in 1998, $2,064,000 in 1999, $29,358,000 in
2000, $13,664,000 in 2001, $61,657,000 in 2002, and $107,242,000 thereafter.
4. INVESTMENT IN PRINCIPAL HEALTHCARE FINANCE LIMITED AND OMEGA WORLDWIDE, INC.
In July, 1995, the Company formed and provided the initial funding for
Principal Healthcare Finance Limited ("Principal"), an Island of Jersey based
company organized to purchase and lease back nursing homes in the United
Kingdom. The Company's initial funding for Principal included approximately
$24,000,000 in the form of a Sterling denominated subordinated loan due December
31, 2000. The Company manages and provides advisory services to Principal under
a renewable contract. In October 1996, Principal completed a private placement
of equity to unaffiliated investors. Following the completion of that placement,
the Company owns directly or indirectly non-voting ordinary shares of Principal,
with total equity investment approximating $7,000,000. The Company's non-voting
ownership interest is stated on the basis of cost. At December 31, 1997,
Principal owns and leases 154 nursing homes acquired at a cost of approximately
$354 million.
In July, 1997, the Company provided Principal a guarantee of borrowings of
up to (pound)46 million (approximately $75 million), pending its placement of
permanent financing for the purchase of nursing home facilities from a public
company which operated nursing homes in the United Kingdom. Principal has
borrowed substantially all the funds available subject to such guarantee. The
Company received a fee for this guarantee of approximately $360,000 and the
nursing home facilities have been leased to third party nursing home operators.
Principal completed permanent financing for these facilities on February 27,
1998, thereby removing the requirement for the Company's guarantee.
In November 1997 the Company formed Omega Worldwide, Inc., a company which
will provide investment advisory services to and hold equity and debt interests
in real estate companies engaged in providing sale/leaseback and other capital
financing to healthcare providers throughout the world. In connection with the
formation of Omega Worldwide, Inc., the Company will receive 8.5 million shares
of Omega Worldwide, Inc. common stock in exchange for substantially all of the
interests which the Company now has with respect to Principal, including: (a)
3,337,500 Class A voting ordinary shares of Principal and warrants to purchase
10 million Class B non-voting ordinary shares of Principal expiring June 30,
2001 at an exercise price of (pound)1.50 (approximately $2.40) per share and
554,583 Class A ordinary shares of Principal expiring December 31, 2000 at an
exercise price of (pound)1.00 (approximately $1.60) per share; (b) the Company's
right to payment of (pound)15 million (approximately $24 million) from the
Sterling denominated subordinated loan; (c) the Company's interest in a ten-year
British pound currency swap contract under which Omega Worldwide, Inc. will have
the right to exchange (pound)20,000,000 for $31,740,000 on October 15, 2007; and
(d) the Advisory Services Agreement between the Company and Principal.
Omega Worldwide, Inc. has filed a Registration Statement with respect to
rights to acquire 2,250,000 shares of its common stock and 2.3 million shares to
be sold in a secondary offering by the Company. Each common shareholder of the
Company will receive a pro-rata share of approximately 5.2 million common shares
of Omega Worldwide, Inc. and will be eligible to receive a portion of the 2.25
million rights to purchase Omega Worldwide, Inc. common stock. The Company will
retain a 9% interest in Omega Worldwide, Inc. The date of the distribution of
Omega Worldwide, Inc. shares has not been set since it depends upon, among other
matters, the date of approval by the Securities and Exchange Commission. As of
the date of the distribution, the cost of assets transferred to Omega Worldwide,
Inc., less the net proceeds of the secondary offering received by the Company,
will be charged to shareholders' equity in the form of a special dividend.
Management estimates the special dividend will approximate $15 million.
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5. CONCENTRATION OF RISK
As of December 31, 1997, 94% of the Company's real estate investments
related to long-term care facilities. The Company's facilities are located in 26
states and are operated by 29 independent healthcare operating companies.
Approximately 63% of the Company's real estate investments are operated by 7
public companies: Sun Healthcare Group, Inc., (29.2%), Advocat, Inc. (14.5%),
Paragon Health Network, Inc. (formerly GranCare, Inc.) (7.5%), Unison Healthcare
Corp. (5.7%), Res-Care, Inc. (3.7%), Integrated Health Services, Inc. (1.4%) and
CMS Health South (formerly Horizon/CMS Healthcare Corp.) (1.4%). Of the
remaining 22 independent operators, none operate investments in facilities
representing more than 6.2% of the total real estate investments.
As of December 31, 1997, Unison Healthcare Corp. (Unison), was in default
of certain provisions of its lease agreements and mortgages with the Company. In
January, 1998, BritWill I and BritWill II, two subsidiaries of Unison, filed for
bankruptcy protection from creditors. The Company leased to these subsidiaries
fourteen facilities located in Indiana and Texas, and has made a mortgage loan
that is secured by first mortgages on six facilities located in Texas. The
Company's total investment approximates $45 million related to approximately
2,000 beds. Prior to bankruptcy filings by the Unison subsidiaries, the Company
terminated the leases and accelerated the mortgage loan indebtedness due to
non-payment of rents and interest totaling approximately $1.5 million. The
Company also has instituted foreclosure proceedings with respect to the
mortgages and filed suit in federal court in Texas against Unison and the
Chairman of the Board of Directors of Unison to enforce their respective
guarantees to the Company of obligations under the leases and the mortgage loan
documents. To date in the bankruptcy proceeding the parties have stipulated that
the Unison subsidiaries will pay to the Company a monthly payment for occupancy
in an amount equal to the rent that would have been payable by the BritWill
subsidiaries under the leases. In January, 1998, the Company applied $1.6
million of security deposits to the mortgage interest and principal outstanding.
The Company continues to hold approximately $2.3 million in liquidity and
security deposits to secure obligations under the leases and the mortgage loan
documents and continues to pursue its remedies against Unison and its chairman
under their respective guarantees. Annual rents and interest from the Unison
subsidiaries total approximately 5.9% of annualized revenues at December 31,
1997.
6. LIQUIDITY DEPOSITS AND ADDITIONAL SECURITY
Liquidity deposits and letters of credit received from certain operators
pursuant to leases and mortgages total $26,835,000 at December 31, 1997. These
generally represent the initial monthly rental and mortgage interest income for
periods ranging from three to six months with respect to certain of the
investments. The deposits consist of $13,965,000 held by the company, $5,047,000
held by escrow agents, and $7,823,000 in the form of letters of credit.
Additional security for rental and mortgage interest revenue from operators
is provided by covenants regarding minimum working capital and net worth, liens
on accounts receivable and other operating assets of the operators, provisions
for cross default, provisions for cross collateralization and by
corporate/personal guarantees.
7. BORROWING ARRANGEMENTS
On September 30, 1997, the Company consummated an amended and restated loan
agreement for a $200,000,000 unsecured revolving line of credit facility. Under
the restated agreement, which expires in September, 2000, the Company may use
the equivalent of $50,000,000 of the commitment for Sterling denominated
borrowings. Borrowings under the facility bear interest at LIBOR plus 1.00% or,
at the Company's option at the prime rate. Permitted borrowings under the
agreement are based upon levels of eligible real estate investments. Borrowings
of $58,300,000 at December 31, 1997 bear interest at a rate of 7.04% and
borrowings of $6,000,000 at December 31, 1996 bear interest at 7.43%.
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The following is a summary of long-term borrowings:
In 1995, the Company exchanged 9.88% Senior Subordinated Collateralized
Mortgage Accrual Notes and 7.11% Senior Mortgage Collateralized Notes for 10%
and 7.4% Unsecured Notes due July 15, 2000. The effective interest rate for the
new unsecured notes is 8.8%, with interest-only payments due semi-annually
through July 2000.
On January 24, 1996, the Company issued $95 million of 8.5% Convertible
Subordinated Debentures (the Debentures) due 2001. The Debentures are
convertible at any time into shares of Common Stock at a conversion price of
$28.625 per share. The Debentures are unsecured obligations of the Company and
are subordinate in right and payment to the Company's senior unsecured
indebtedness. As of December 31, 1997 there were 2,182,882 shares reserved for
issuance under the Debentures.
On August 5, 1997 the Company completed a $100 million public offering of
unsecured 6.95% notes due 2007. The notes were priced to yield 6.99% with
interest paid semi-annually.
Real estate investments with an original cost of approximately $33,259,000
are secured by outstanding secured borrowings totaling $22,261,000 at December
31, 1997. These borrowings are payable in aggregate monthly installments of
approximately $215,000, including interest at rates ranging from 8.3% to 9.7%.
Assuming none of the Company's borrowing arrangements are refinanced,
converted or prepaid prior to maturity, required principal payments for each of
the five years following December 31, 1997 and the aggregate due thereafter are
set forth below:
The estimated fair values of the Company's long-term borrowings is
approximately $270,539,000 at December 31, 1997 and $236,128,000 at December 31,
1996. Fair values are based on the estimates of management and on rates
currently prevailing for comparable loans.
8. FINANCIAL INSTRUMENTS
At December 31, 1997 and 1996, the carrying amounts and fair values of the
Company's financial instruments are as follows:
F-14
Fair value estimates 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 above are not necessarily
indicative of the amounts the Company would realize in a current market
exchange.
On October 15, 1997, the Company entered into a 10-year forward contract to
exchange (pound)20,000,000 at a rate of $1.587 per British Pound Sterling. This
contract was entered into in order to hedge the currency risk associated with
the Company's investment in Principal. The carrying value of the investment in
Principal is based on the rate established in the forward exchange contract.
Foreign exchange rate contracts mitigate the risk of currency movements because
any gain or loss on the contract offsets any losses or gains, respectively, on
the investment in Principal and other assets denominated in British Pounds
Sterling.
9. RETIREMENT ARRANGEMENTS
The Company has a 401(k) Profit Sharing Plan covering all eligible
employees. Under the Plan, employees are eligible to make contributions, and the
Company, at its discretion, may match contributions and make a profit sharing
contribution.
In 1993, the Company adopted the 1993 Retirement Plan for Directors, an
unfunded plan covering all members of the Board of Directors upon completion of
not less than five years service on the Board. The benefits payable upon
retirement from the Board are based on years of service and the director fees in
effect as of the date the director ceases to be a member of the Board.
In 1993, the Company also adopted the 1993 Deferred Compensation Plan which
covers all eligible employees and members of the Board. Under this unfunded
plan, the Company may award units which result in participation in the dividends
and future growth in the value of Company's common stock. The total number of
units permitted by the plan is 200,000. Units awarded to eligible participants
(59,000 units and 63,500 at December 31, 1997 and 1996, respectively) vest over
a period of five years based on the participant's initial service date.
Provisions charged to operations with respect to these retirement
arrangements totaled $667,000 in 1997, $654,000 in 1996, and $366,000 in 1995.
10. SHAREHOLDERS' EQUITY AND STOCK OPTIONS
In April, 1997 the Company issued 2.3 million shares of 9.25% Series A
Cumulative Preferred Stock at $25 per share. Dividends on the Preferred Stock
are cumulative from the date of original issue and are payable quarterly. The
Preferred Stock, which carries a liquidation preference of $25 per share, is
redeemable on or after July 1, 2002 at the option of the Company, at a
redemption price of $25 per share plus dividends accrued and unpaid at the
redemption date. Holders of Series A Preferred Stock generally have no voting
rights.
Under the terms of the 1993 Stock Option and Restricted Stock Plan as
amended in 1995, the company reserved 750,000 shares of common stock for grants
to be issued during a period of up to 10 years. Directors, officers, and key
employees are eligible to participate in the Plan. The Company
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has submitted for shareholder approval an amendment to the Plan to increase the
number of shares available under the Plan to 1,100,000. Options for 739,415
shares have been granted to eligible participants, including options for
approximately 57,000 shares granted in December, 1997 subject to shareholder
approval of the 1998 amendment. Additionally, 67,263 shares of restricted stock
have been granted under the provisions of the Plan. The market value of the
restricted shares on the date of the award has been recorded as unearned
compensation-restricted stock, with the unamortized balance shown as a separate
component of shareholders' equity. Unearned compensation is amortized to expense
over the vesting period, with charges to operations of $402,000, $240,000 and
$253,000 in 1997, 1996 and 1995, respectively.
The following is a summary of activity under the plan.
At December 31, 1997, options currently exercisable (208,808) have a
weighted average exercise price of $24.205. There were no shares available for
future grants as of December 31, 1997. At December 31, 1996 options currently
exercisable (155,162) have a weighted average exercise price of $23.42. Shares
available for future grants as of December 31, 1996 were 426,591.
In 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation." This standard prescribes a fair value based method of accounting
for employee stock options or similar equity instruments and requires certain
pro forma disclosures. For purposes of the pro forma disclosures required under
Statement 123, the estimated fair value of the options is amortized to expense
over the option's vesting period. Based on the Company's option activity, net
earnings and net earnings per share on a pro forma basis does not differ
significantly from that determined under APB 25. The estimated weighted average
fair value of options granted in 1997 and 1996 was $1.3 million and $0.2
million, respectively. In determining the estimated fair value of the Company's
stock options as of the date of grant, a Black-Scholes option pricing model was
used with the following weighted-average assumptions: risk-free interest rates
of 6.5%; a dividend yield of 6.75%; volatility factors of the expected market
price of the Company's common stock at 15%; and a weighted-average expected life
of the options of 8 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
11. DIVIDENDS
In order to qualify as a real estate investment trust, the Company must,
among other requirements, distribute at least 95% of its real estate investment
trust taxable income to its shareholders. Per share common dividend payments by
the Company were characterized in the following manner for income tax purposes:
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12. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Following are details of changes in operating assets and liabilities
(excluding the effects of noncash expenses), and other noncash transactions:
13. EXTRAORDINARY CHARGE FOR PREPAYMENT OF DEBT
During 1995, the Company entered into three transactions to prepay various
secured borrowings. The Company consummated a $100,000,000 unsecured line of
credit to replace a $60,000,000 secured line of credit. Also, as discussed in
Note 7, the Company redeemed its outstanding senior mortgage notes through the
issuance of unsecured notes. The prepayment of these borrowings resulted in an
extraordinary charge of $6,479,000, representing the fees and costs associated
with the prepayment and the write-off of unamortized deferred financing costs.
14. LITIGATION
The Company is subject to certain legal proceedings and claims which arise
in the ordinary course of its business. In the opinion of management, the amount
of ultimate liability, if any, with respect to these actions will not materially
affect the consolidated financial position.
15. COMMITMENTS
The Company has commitments, subject to certain conditions, to provide
additional financing totaling approximately $68 million as of December 31, 1997.
16. SUBSEQUENT EVENTS
A quarterly dividend of $.67 per common share was declared by the Board of
Directors on January 22, 1998, payable on February 13, 1998 to shareholders of
record on January 30, 1998. In addition, the Board declared a regular quarterly
dividend of $.578 per share to be paid on February 13, 1998 to Series A
Cumulative Preferred shareholders of record on January 30, 1998.
On January 27, 1998 the Board of Directors set the record date of February
1, 1998 for the distribution of Omega Worldwide, Inc. shares (see Note 4).
On January 14, 1998, the Company purchased five nursing homes containing
628 nursing beds in Florida, Illinois, Pennsylvania and New Hampshire for a
total of $44,900,000. Simultaneously, the Company entered into lease agreements
with Lyric Health Care Holdings, Inc., a wholly-owned subsidiary of Lyric Health
Care LLC, an affiliate of Integrated Health Services, Inc. (NYSE: IHS). The
initial term of the lease is thirteen years, at initial rents of $4,490,000
annually.
On February 27, 1998, Principal completed financing of (pound)61 million
related to it's acquisition of certain nursing homes during June, 1997, thereby
removing the requirement for the Company's guarantee of up to (pound)46 million
of Principal's borrowings (see Note 4).
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REPORT OF INDEPENDENT AUDITORS
Board of Directors
Omega Healthcare Investors, Inc.
We have audited the accompanying consolidated balance sheets of Omega
Healthcare Investors, Inc. and subsidiaries as of December 31, 1997, and 1996
and the related consolidated statements of operations, shareholders' equity, and
cash flows for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Omega
Healthcare Investors, Inc. and subsidiaries at December 31, 1997 and 1996, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
Ernst & Young LLP
February 9, 1998 (except for Note 16
as to which the date is February 27, 1998)
Detroit, Michigan
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