10-Q: Quarterly report pursuant to Section 13 or 15(d)

Published on November 8, 2016

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  
  OF THE SECURITIES EXCHANGE ACT OF 1934  

 

For the quarterly period ended September 30, 2016

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  
  SECURITIES EXCHANGE ACT OF 1934  

 

For the transition period from _______________ to _______________

 

Commission file number 1-11316

 

OMEGA HEALTHCARE INVESTORS, INC.

(Exact name of Registrant as specified in its charter)
     
Maryland   38-3041398

(State of incorporation)
 

(IRS Employer

Identification No.)

 
200 International Circle, Suite 3500, Hunt Valley, MD 21030
(Address of principal executive offices)
 
(410) 427-1700
(Telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

 

Yes  x                       No  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes  x                       No  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or 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 Exchange Act).

Yes  ¨                       No  x

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of November 4, 2016.

 

Common Stock, $.10 par value 195,142,685
(Class) (Number of shares)

 

 

 

 

 

OMEGA HEALTHCARE INVESTORS, INC.

FORM 10-Q

September 30, 2016

 

TABLE OF CONTENTS

 

    Page
No.
PART I Financial Information  
     
Item 1. Financial Statements:  
  Consolidated Balance Sheets September 30, 2016 (unaudited) and December 31, 2015 2
     
  Consolidated Statements of Operations (unaudited) Three and nine months ended September 30, 2016 and 2015 3
     
  Consolidated Statements of Comprehensive Income (unaudited) Three and nine months ended September 30, 2016 and 2015 4
     
  Consolidated Statement of Changes in Equity (unaudited) Nine months ended September 30, 2016 5
     
  Consolidated Statements of Cash Flows (unaudited) Nine months ended September 30, 2016 and 2015 6
     
  Notes to Consolidated Financial Statements September 30, 2016 (unaudited) 8
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 36
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 51
     
Item 4. Controls and Procedures 51
     
PART II Other Information  
     
Item 1. Legal Proceedings 52
     
Item 1A. Risk Factors 52
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 52
     
Item 6. Exhibits 53

 

 

 

 

PART I – FINANCIAL INFORMATION

 

Item 1 - Financial Statements

 

OMEGA HEALTHCARE INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

 

    September 30,     December 31,  
    2016     2015  
    (Unaudited)      
ASSETS            
Real estate properties                
Land and buildings   $ 7,593,886     $ 6,743,958  
Less accumulated depreciation     (1,186,077 )     (1,019,150 )
Real estate properties – net     6,407,809       5,724,808  
Investments in direct financing leases – net     597,779       587,701  
Mortgage notes receivable     624,339       679,795  
      7,629,927       6,992,304  
Other investments     277,251       89,299  
      7,907,178       7,081,603  
Assets held for sale – net     91,210       6,599  
Total investments     7,998,388       7,088,202  
                 
Cash and cash equivalents     32,567       5,424  
Restricted cash     12,282       14,607  
Accounts receivable – net     225,225       203,862  
Goodwill     644,129       645,683  
Other assets     69,772       61,231  
Total assets   $ 8,982,363     $ 8,019,009  
                 
LIABILITIES AND EQUITY                
Revolving line of credit   $ 223,000     $ 230,000  
Term loans     1,100,000       750,000  
Secured borrowings – net     55,271       236,204  
Unsecured borrowings – net     3,055,368       2,352,882  
Accrued expenses and other liabilities     361,596       333,706  
Deferred income taxes     11,937       15,352  
Total liabilities     4,807,172       3,918,144  
                 
Equity:                
Common stock $.10 par value authorized – 350,000 shares, issued and outstanding – 195,136 shares as of September 30, 2016 and 187,399 as of December 31, 2015     19,514       18,740  
Common stock – additional paid-in capital     4,827,877       4,609,474  
Cumulative net earnings     1,614,678       1,372,522  
Cumulative dividends paid     (2,587,841 )     (2,254,038 )
Accumulated other comprehensive loss     (52,170 )     (8,712 )
Total stockholders’ equity     3,822,058       3,737,986  
Noncontrolling interest     353,133       362,879  
Total equity     4,175,191       4,100,865  
Total liabilities and equity   $ 8,982,363     $ 8,019,009  

 

See notes to consolidated financial statements.

 

 2

 

  

OMEGA HEALTHCARE INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

(in thousands, except per share amounts)

 

    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2016     2015     2016     2015  
Revenue                                
Rental income   $ 185,837     $ 166,623     $ 548,994     $ 430,699  
Income from direct financing leases     15,611       15,216       46,574       44,582  
Mortgage interest income     15,996       17,195       53,973       51,336  
Other investment income – net     7,194       2,940       16,800       6,488  
Total operating revenues     224,638       201,974       666,341       533,105  
                                 
Expenses                                
Depreciation and amortization     68,316       60,143       196,254       149,909  
General and administrative     12,428       10,160       34,715       26,482  
Acquisition and merger related costs     2,309       3,555       9,584       55,507  
Impairment loss on real estate properties     17,275       1,743       58,726       14,641  
(Recovery) provision for uncollectible mortgages, notes and accounts receivable     (3 )     301       3,967       292  
Total operating expenses     100,325       75,902       303,246       246,831  
                                 
Income before other income and expense     124,313       126,072       363,095       286,274  
Other income (expense)                                
Interest income     157       5       169       205  
Interest expense     (42,855 )     (38,169 )     (119,728 )     (108,776 )
Interest – amortization of deferred financing costs     (2,502 )     (1,857 )     (6,844 )     (5,036 )
Interest – refinancing costs     (1,815 )     -       (2,113 )     (8,361 )
Realized loss on foreign exchange     (222 )     -       (244 )     -  
Total other expense     (47,237 )     (40,021 )     (128,760 )     (121,968 )
                                 
Income before gain (loss) on assets sold     77,076       86,051       234,335       164,306  
Gain (loss) on assets sold – net     5,139       (2,391 )     19,931       6,411  
Income from continuing operations before income taxes     82,215       83,660       254,266       170,717  
Income taxes     (81 )     (406 )     (782 )     (945 )
Net income     82,134       83,254       253,484       169,772  
Net income attributable to noncontrolling interest     (3,585 )     (3,852 )     (11,328 )     (5,890 )
Net income available to common stockholders   $ 78,549     $ 79,402     $ 242,156     $ 163,882  
                                 
Income per common share available to common stockholders:                                
Basic:                                
Net income available to common stockholders   $ 0.40     $ 0.43     $ 1.27     $ 0.98  
Diluted:                                
Net income   $ 0.40     $ 0.43     $ 1.26     $ 0.97  
                                 
Dividends declared per common share   $ 0.60     $ 0.55     $ 1.75     $ 1.62  
                                 
Weighted-average shares outstanding, basic     194,123       184,739       190,444       167,261  
Weighted-average shares outstanding, diluted     204,078       195,183       200,528       174,824  

 

See notes to consolidated financial statements.

 

 3

 

  

OMEGA HEALTHCARE INVESTORS, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Unaudited

(in thousands)

 

    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2016     2015     2016     2015  
                         
Net income   $ 82,134     $ 83,254     $ 253,484     $ 169,772  
Other comprehensive income (loss)                                
Foreign currency translation     (6,845 )     (6,789 )     (33,411 )     (3,950 )
Cash flow hedges     980       -       (12,094 )     -  
Total other comprehensive income (loss)     (5,865 )     (6,789 )     (45,505 )     (3,950 )
Comprehensive income     76,269       76,465       207,979       165,822  
Comprehensive income attributable to noncontrolling interest (1)     (3,329 )     (3,537 )     (9,282 )     (5,708 )
Comprehensive income attributable to common stockholders (1)   $ 72,940     $ 72,928     $ 198,697     $ 160,114  

 

(1) The 2015 amounts have been adjusted to increase the comprehensive income attributable to the noncontrolling interest and decrease the comprehensive income attributable to common stockholders by $3.9 million and $5.9 million for the three and nine month periods, respectively.

 

See notes to consolidated financial statements.

 

 4

 

 

OMEGA HEALTHCARE INVESTORS, INC.

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

Unaudited

(in thousands, except per share amounts)

 

    Common
Stock Par
Value
    Additional
Paid-in
Capital
    Cumulative
Net
Earnings
    Cumulative
Dividends
Paid
    Accumulated
Other
Comprehensive
Loss
    Total
Stockholders’
Equity
    Noncontrolling
interest
    Total
Equity
 
                                                 
Balance at December 31, 2015 (187,399 common shares & 8,956 OP Units)   $ 18,740     $ 4,609,474     $ 1,372,522     $ (2,254,038 )   $ (8,712 )   $ 3,737,986     $ 362,879     $ 4,100,865  
Grant of restricted stock to company directors (18 shares at $33.09 per share)     2       (2 )                                    
Restricted stock expense           10,116                         10,116             10,116  
Payments for vesting of equity compensation plan (770 shares)     77       (23,480 )                       (23,403 )           (23,403 )
Dividend reinvestment plan (6,870 shares at an average of $33.49 per share)     687       229,082                         229,769             229,769  
Grant of stock as payment of directors fees (8 shares at an average of $32.07 per share)     1       249                         250             250  
Deferred compensation directors           (111 )                       (111 )           (111 )
Common dividends declared ($1.75 per share)                       (333,803 )           (333,803 )           (333,803 )
Conversion of OP Units to Common stock (71 shares at $35.68 per share)     7       2,559                         2,566             2,566  
Redemption of OP Units (94 units)           (10 )                       (10 )     (3,289 )     (3,299 )
OP units distributions                                         (15,738 )     (15,738 )
Foreign currency translation                             (31,912 )     (31,912 )     (1,499 )     (33,411 )
Cash flow hedges                             (11,546 )     (11,546 )     (548 )     (12,094 )
Net income                 242,156                   242,156       11,328       253,484  
Balance at September 30, 2016 (195,136 shares & 8,862 OP Units)   $ 19,514     $ 4,827,877     $ 1,614,678     $ (2,587,841 )   $ (52,170 )   $ 3,822,058     $ 353,133     $ 4,175,191  

 

See notes to consolidated financial statements.

 

 5

 

  

OMEGA HEALTHCARE INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited (in thousands)

 

    Nine Months Ended
September 30,
 
    2016     2015  
Cash flows from operating activities                
Net income   $ 253,484     $ 169,772  
Adjustment to reconcile net income to cash provided by operating activities:                
Depreciation and amortization     196,254       149,909  
Provision for impairment on real estate properties     58,726       14,641  
Provision for uncollectible mortgages, notes and accounts receivable     3,967       292  
Amortization of deferred financing costs and refinancing costs     8,957       13,397  
Accretion of direct financing leases     (8,999 )     (8,124 )
Stock-based compensation     10,116       6,682  
Gain on assets sold – net     (19,931 )     (6,411 )
Amortization of acquired in-place leases - net     (10,957 )     (4,264 )
Change in operating assets and liabilities – net of amounts assumed/acquired:                
Accounts receivable – net     203       315  
Straight-line rent receivables     (29,959 )     (26,565 )
Lease inducements     1,942       347  
Effective yield receivable on mortgage notes     (209 )     (3,159 )
Other operating assets and liabilities     (6,357 )     15,972  
Net cash provided by operating activities     457,237       322,804  
Cash flows from investing activities                
Acquisition of real estate – net of liabilities assumed and escrows acquired     (959,748 )     (288,290 )
Cash acquired in merger           84,858  
Investment in construction in progress     (44,113 )     (145,276 )
Investment in direct financing leases     (1,079 )     (6,793 )
Placement of mortgage loans     (27,895 )     (7,601 )
Proceeds from sale of real estate investments     64,746       41,541  
Capital improvements to real estate investments     (31,408 )     (18,154 )
Proceeds from other investments     49,482       37,428  
Investments in other investments     (242,999 )     (49,489 )
Collection of mortgage principal     58,149       1,025  
Net cash used in investing activities     (1,134,865 )     (350,751 )
Cash flows from financing activities                
Proceeds from credit facility borrowings     1,134,000       1,704,000  
Payments on credit facility borrowings     (1,141,000 )     (1,239,000 )
Receipts of other long-term borrowings     1,048,173       1,588,124  
Payments of other long-term borrowings     (180,934 )     (1,588,063 )
Payments of financing related costs     (11,770 )     (30,709 )
Escrow deposit for other long-term borrowing           (614,998 )
Receipts from dividend reinvestment plan     229,769       65,665  
Payments for exercised options and restricted stock – net     (23,403 )     (26,168 )
Net proceeds from issuance of common stock           439,738  
Dividends paid     (333,663 )     (253,105 )
Redemption of OP Units     (732 )      
Distributions to OP Unit Holders     (15,738 )     (6,598 )
Net cash provided by financing activities     704,702       38,886  
                 
Increase in cash and cash equivalents     27,074       10,939  
Effect of foreign currency translation on cash and cash equivalents     69       (109 )
Cash and cash equivalents at beginning of period     5,424       4,489  
Cash and cash equivalents at end of period   $ 32,567     $ 15,319  
Interest paid during the period, net of amounts capitalized   $ 116,169     $ 90,536  

 

 6

 

 

Non-cash investing and financing activities:

 

    Nine Months Ended
September 30,
 
    2016     2015  
Non- cash investing activities                
Non-cash acquisition of businesses (see Note 2 and Note 4 for details)   $ (60,079 )   $ (3,602,614 )
Non-cash surrender of mortgage (see Note 4 for details)     25,000        
Non-cash surrender of other investment (see Note 2 for details)     5,500        
Total   $ (29,579 )   $ (3,602,614 )
Non-cash financing activities                
Assumed Aviv debt   $     $ 1,410,637  
Stock exchanged in merger           1,903,441  
OP Units exchanged in merger           373,394  
Purchase option buyout obligation (see Note 2 for details)     29,579        
Change in fair value of cash flow hedges     12,094        
Other unsecured long term borrowing (see Note 2 and Note 12 for details)     3,000        
Total   $ 44,673     $ 3,687,472  

 

See notes to consolidated financial statements.

 

 7

 

 

OMEGA HEALTHCARE INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

September 30, 2016

 

NOTE 1 – BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

Business Overview and Organization

 

Omega Healthcare Investors, Inc. (“Omega,” “we,” “our” or the “Company”) has one reportable segment consisting of investments in healthcare-related real estate properties located in the United States and the United Kingdom. Our core business is to provide financing and capital to the long-term healthcare industry with a particular focus on skilled nursing facilities (“SNFs”). Our core portfolio consists of long-term leases and mortgage agreements. All of our leases are “triple-net” leases, which require the tenants to pay all property-related expenses. Our mortgage revenue derives from fixed mortgage loans, which are secured by first mortgage liens on the underlying real estate and personal property of the mortgagor.

 

Omega was formed as a real estate investment trust (“REIT”) and incorporated in the State of Maryland on March 31, 1992. In April 2015, Aviv REIT, Inc., a Maryland corporation (“Aviv”), merged (the “Aviv Merger”) with and into a wholly owned subsidiary of Omega, pursuant to the terms of that certain Agreement and Plan of Merger, dated as of October 30, 2014 (the “Merger Agreement”), by and among the Company, Aviv, OHI Healthcare Properties Holdco, Inc., a Delaware corporation and a direct wholly-owned subsidiary of Omega (“Merger Sub”), OHI Healthcare Properties Limited Partnership, a Delaware limited partnership (“Omega OP”), and Aviv Healthcare Properties Limited Partnership, a Delaware limited partnership (the “Aviv OP”).

 

Prior to April 1, 2015 and in accordance with the Merger Agreement, Omega restructured the manner in which it holds its assets by converting to an umbrella partnership real estate investment trust structure (the “UPREIT Conversion”). As a result of the UPREIT Conversion and following the consummation of the Aviv Merger, substantially all of the Company’s assets are held by Omega OP.

 

Omega OP is governed by the Second Amended and Restated Agreement of Limited Partnership of OHI Healthcare Properties Limited Partnership, dated as of April 1, 2015 (the “Partnership Agreement”). Pursuant to the Partnership Agreement, the Company and Merger Sub are the general partners of Omega OP, and have exclusive control over Omega OP’s day-to-day management. As of September 30, 2016, the Company owned approximately 96% of the issued and outstanding units of partnership interest in Omega OP (“Omega OP Units”), and investors owned approximately 4% of the Omega OP Units.

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. In our opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The results of operations for the interim periods reported herein are not necessarily indicative of results to be expected for the full year. We have evaluated all subsequent events through the date of the filing of this Form 10-Q. These unaudited consolidated financial statements should be read in conjunction with the financial statements and the footnotes thereto included in our Current Report on Form 8-K filed with the SEC on June 30, 2016.

 

Our consolidated financial statements include the accounts of (i) Omega, (ii) Omega OP, and (iii) all direct and indirect wholly owned subsidiaries of Omega. All intercompany transactions and balances have been eliminated in consolidation.

 

 8

 

  

Goodwill Impairment

 

We assess goodwill for potential impairment during the fourth quarter of each fiscal year, or during the year if an event or other circumstance indicates that we may not be able to recover the carrying amount of the net assets of the reporting unit. In evaluating goodwill for impairment on an interim basis, we assess qualitative factors such as a significant decline in real estate valuations, current macroeconomic conditions, state of the equity and capital markets and our overall financial and operating performance or a significant decline in the value of our market capitalization, to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of the reporting unit is less than its carrying amount. On an annual basis during the fourth quarter of each fiscal year, or on an interim basis if we conclude it is more likely than not that the fair value of the reporting unit is less than its carrying value, we perform a two-step goodwill impairment test to identify potential impairment and measure the amount of impairment we will recognize, if any. The goodwill is not deductible for tax purposes.

 

Asset Impairment

 

Management evaluates our real estate investments for impairment indicators at each reporting period, 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, legal structure, as well as our intent with respect to holding or disposing of the asset. 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 based on our intended use of the property are determined to be less than the carrying values of the assets. An adjustment is made to the net carrying value of the real estate investments for the excess of carrying value 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. Management’s impairment evaluation process, and when applicable, impairment calculations involve estimation of the future cash flows from management’s intended use of the property. Changes in the facts and circumstances that drive management’s assumptions may result in an impairment of the Company’s assets in a future period that could be material to the Company’s results of operations.

 

If we decide to sell real estate 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.

 

Redeemable Limited Partnership Unitholder Interests and Noncontrolling Interests

 

As of April 1, 2015 and after giving effect to the Aviv Merger, the Company owned approximately 138.8 million Omega OP Units and Aviv OP owned approximately 52.9 million Omega OP Units. Each of the Omega OP Units (other than the Omega OP Units owned by Omega) is redeemable at the election of the Omega OP Unit holder for cash equal to the then-fair market value of one share of Omega common stock, par value $0.10 per share (“Omega Common Stock”), subject to the Company’s election to exchange the Omega OP Units tendered for redemption for shares of Omega Common Stock on a one-for-one basis, subject to adjustment as set forth in the Partnership Agreement, in an unregistered transaction.

 

Effective June 30, 2015, the Company (through Merger Sub, in its capacity as the general partner of Aviv OP) caused Aviv OP to make a distribution of Omega OP Units held by Aviv OP (or equivalent value) to Aviv OP investors (the “Aviv OP Distribution”) in connection with the liquidation of Aviv OP. As a result of the Aviv OP Distribution, Omega directly and indirectly owned approximately 95% of the outstanding Omega OP Units, and the other investors owned approximately 5% of the outstanding Omega OP Units. As a part of the Aviv OP Distribution, Omega settled approximately 0.2 million units via cash settlement. As of September 30, 2016, Omega directly and indirectly owns approximately 96% of the outstanding Omega OP Units, and the other investors own approximately 4% of the outstanding Omega OP Units.

 

 9

 

  

Noncontrolling Interests

 

Noncontrolling interests is the portion of equity in the Omega OP not attributable to the Company. We present the portion of any equity that we do not own in consolidated entities as noncontrolling interests and classify those interests as a component of total equity, separate from total stockholders’ equity, on our Consolidated Balance Sheets. We include net income attributable to the noncontrolling interests in net income in our Consolidated Statements of Operations.

 

As our ownership of a controlled subsidiary increases or decreases, any difference between the aggregate consideration paid to acquire the noncontrolling interests and our noncontrolling interest balance is recorded as a component of equity in additional paid-in capital, so long as we maintain a controlling ownership interest.

 

Foreign Operations

 

The U.S. dollar is the functional currency for our consolidated subsidiaries operating in the United States. The functional currency for our consolidated subsidiaries operating in countries other than the United States is the principal currency in which the entity primarily generates and expends cash. For our consolidated subsidiaries whose functional currency is not the U.S. dollar, we translate their financial statements into the U.S. dollar. We translate assets and liabilities at the exchange rate in effect as of the financial statement date. Revenue and expense accounts are translated using an average exchange rate for the period. Gains and losses resulting from translation are included in accumulated other comprehensive loss (“AOCL”), as a separate component of equity and a proportionate amount of gain or loss is allocated to noncontrolling interest.

 

We and certain of our consolidated subsidiaries may have intercompany and third-party debt that is not denominated in the entity’s functional currency. When the debt is remeasured against the functional currency of the entity, a gain or loss can result. The resulting adjustment is reflected in results of operations, unless it is intercompany debt that is deemed to be long-term in nature and then the adjustments are included in AOCL.

 

Derivative Instruments

 

During our normal course of business, we may use certain types of derivative instruments for the purpose of managing interest rate and currency risk. To qualify for hedge accounting, derivative instruments used for risk management purposes must effectively reduce the risk exposure that they are designed to hedge. In addition, at the inception of a qualifying cash flow hedging relationship, the underlying transaction or transactions, must be, and are expected to remain, probable of occurring in accordance with the Company’s related assertions. The Company recognizes all derivative instruments, including embedded derivatives required to be bifurcated, as assets or liabilities in the Consolidated Balance Sheets at their fair value which are determined using a market approach and Level 2 inputs. Changes in the fair value of derivative instruments that are not designated in hedging relationships or that do not meet the criteria of hedge accounting are recognized in earnings. For derivatives designated as qualifying cash flow hedging relationships, the change in fair value of the effective portion of the derivatives is recognized in AOCL as a separate component of equity and a proportionate amount of gain or loss is allocated to noncontrolling interest, whereas the change in fair value of the ineffective portion is recognized in earnings. We formally document all relationships between hedging instruments and hedged items, as well as our risk-management objectives and strategy for undertaking various hedge transactions. This process includes designating all derivatives that are part of a hedging relationship to specific forecasted transactions as well as recognized obligations or assets in the Consolidated Balance Sheets. We also assess and document, both at inception of the hedging relationship and on a quarterly basis thereafter, whether the derivatives are highly effective in offsetting the designated risks associated with the respective hedged items. If it is determined that a derivative ceases to be highly effective as a hedge, or that it is probable the underlying forecasted transaction will not occur, we discontinue hedge accounting prospectively and record the appropriate adjustment to earnings based on the current fair value of the derivative. As a matter of policy, we do not use derivatives for trading or speculative purposes. At September 30, 2016 and December 31, 2015, we had $12.8 million and $0.7 million, respectively, of qualifying cash flow hedges recorded at fair value in accrued expenses and other liabilities on our Consolidated Balance Sheets.

 

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Accounts Receivable

 

Accounts receivable includes: contractual receivables, effective yield interest receivables, straight-line rent receivables and lease inducements, net of an estimated provision for losses related to uncollectible and disputed accounts. Contractual receivables relate to the amounts currently owed to us under the terms of our lease and loan agreements. Effective yield interest receivables relate to the difference between the interest income recognized on an effective yield basis over the term of the loan agreement and the interest currently due to us according to the contractual agreement. Straight-line receivables relate to the difference between the rental revenue recognized on a straight-line basis and the amounts currently due to us according to the contractual agreement. Lease inducements result from value provided by us to the lessee, at the inception or renewal of the lease, and are amortized as a reduction of rental revenue over the non-cancellable lease term.

 

On a quarterly basis, we review our accounts receivable to determine their collectability. The determination of collectability of these assets requires significant judgment and is affected by several factors relating to the credit quality of our operators that we regularly monitor, including (i) payment history, (ii) the age of the contractual receivables, (iii) the current economic conditions and reimbursement environment, (iv) the ability of the tenant to perform under the terms of their lease and/or contractual loan agreements and (v) the value of the underlying collateral of the agreement.  If we determine collectability of any of our contractual receivables is at risk, we estimate the potential uncollectible amounts and provide an allowance. In the case of a lease recognized on a straight-line basis, a mortgage recognized on an effective yield basis or the existence of lease inducements, we generally provide an allowance for straight-line, effective interest, and or lease inducement accounts receivable when certain conditions or indicators of adverse collectability are present. If the accounts receivable balance is subsequently deemed uncollectible, the receivable and allowance for doubtful account balance are written off.

 

A summary of our net receivables by type is as follows:

 

    September 30,     December 31,  
    2016     2015  
    (in thousands)  
             
Contractual receivables   $ 8,297     $ 8,452  
Effective yield interest receivables     9,237       9,028  
Straight-line receivables     199,008       175,709  
Lease inducements     9,040       10,982  
Allowance     (357 )     (309 )
Accounts receivable – net   $ 225,225     $ 203,862  

 

In the first quarter of 2016, we entered into agreements to transition 27 facilities from one of our former operators to a current operator. As a result of the transition, we wrote off approximately $3.4 million of straight line receivable from the former operator.

 

Related Party Transactions

 

The Company has a policy which generally requires related party transactions to be approved or ratified by the Audit Committee. On February 1, 2016, we acquired 10 SNFs from Laurel Healthcare Holdings, Inc. (“Laurel”) for approximately $169.0 million in cash and leased them to an unrelated existing operator. A former member of the Board of Directors of the Company, together with certain members of his immediate family, beneficially owned approximately 34% of the equity of Laurel prior to the transaction. Immediately following our acquisition, the unrelated existing operator acquired all of the outstanding equity interests of Laurel, including the interests previously held by the former director of the Company and his family.

 

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Recent Accounting Pronouncements

 

In 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which outlines a comprehensive model for entities to use in accounting for revenue arising from contracts with customers. ASU 2014-09 states that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” While ASU 2014-09 specifically references contracts with customers, it may apply to certain other transactions such as the sale of real estate or equipment. ASU 2014-09 is effective for the Company beginning January 1, 2018. In addition, the FASB has begun to issue targeted updates to clarify specific implementation issues of ASU 2014-09. These updates include ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU 2016-10, Identifying Performance Obligations and Licensing, and ASU 2016-12, Narrow-Scope Improvements and Practical Expedients. The Company is currently evaluating the provisions of ASU 2014-09 and its related updates and will be closely monitoring developments and additional guidance to determine the potential impact of the new standard. The Company intends to adopt ASU 2014-09 and its subsequent updates retrospectively. We do not expect the adoption of ASU 2014-09 and its updates to have a significant impact on our consolidated financial statements, as a substantial portion of our revenue consists of rental income from leasing arrangements and interest income from loan arrangements, both of which are specifically excluded from ASU 2014-09.

 

In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis (“ASU 2015-02”), which amends certain requirements for determining whether a variable interest entity must be consolidated. The amendments in ASU 2015-02 are effective for annual and interim reporting periods of public entities beginning after December 31, 2015 and were adopted by the Company during the quarter ended March 31, 2016. The effect of this guidance was immaterial to the Company’s consolidated results of operations, financial position and cash flows.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (“ASU 2016–01”), which makes limited amendments to the guidance in U.S. GAAP on the classification and measurement of financial instruments. The new standard significantly revises an entity's accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. It also amends certain disclosure requirements associated with the fair value of financial instruments. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, including interim periods therein. Early adoption is permitted specifically for the amendments pertaining to the presentation of certain fair value changes for financial liabilities measured at fair value. Early adoption of all other amendments is not permitted. Upon adoption, the Company will be required to make a cumulative-effect adjustment to the Consolidated Balance Sheet as of the beginning of the first reporting period in which the guidance is effective. We are currently evaluating the impact of adopting ASU 2016-01 on our consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”), which amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. ASU 2016-02 will be effective for the Company beginning January 1, 2019. Early adoption of ASU 2016-02 as of its issuance is permitted. The new standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. We are currently evaluating the impact of adopting ASU 2016-02 on our consolidated financial statements.

 

In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718) (“ASU 2016-09”). ASU 2016-09 amends the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. This guidance is effective for annual and interim reporting periods of public entities beginning after December 15, 2017, with early adoption permitted. We are currently evaluating the impact of adopting ASU 2016-09 on our consolidated financial statements.

 

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In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) (“ASU 2016-13”), which changes the impairment model for most financial assets. The new model uses a forward-looking expected loss method, which will generally result in earlier recognition of allowances for losses. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019 and early adoption is permitted for annual and interim periods beginning after December 15, 2018. We are currently evaluating the impact of adopting ASU 2016-13 on our consolidated financial statements.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 eliminates the diversity in practice related to the classification of certain cash receipts and payments for debt prepayment or extinguishment costs, the maturing of a zero coupon bond, the settlement of contingent liabilities arising from a business combination, proceeds from insurance settlements, distributions from certain equity method investees and beneficial interests obtained in a financial asset securitization. ASU 2016-15 designates the appropriate cash flow classification, including requirements to allocate certain components of these cash receipts and payments among operating, investing and financing activities. The retrospective transition method, requiring adjustment to all comparative periods presented, is required unless it is impracticable for some of the amendments, in which case those amendments would be applied prospectively as of the earliest date practicable. ASU No. 2016-15 is effective for annual and interim periods beginning after December 15, 2017 and early adoption is permitted. We are currently evaluating the impact of adopting ASU 2016-15 on our consolidated financial statements.

 

NOTE 2 – PROPERTIES AND INVESTMENTS

 

In the ordinary course of our business activities, we periodically evaluate investment opportunities and extend credit to customers. We also regularly engage in lease, and or loan extensions and modifications. Additionally, we actively monitor and manage our investment portfolio with the objectives of improving credit quality and increasing investment returns. In connection with our portfolio management, we may engage in various collection and foreclosure activities.

 

Leased Property

 

Our real estate properties, represented by 816 SNFs, 101 assisted living facilities (“ALFs”), 16 specialty facilities and one medical office building at September 30, 2016, are leased under provisions of single or master leases with initial terms typically ranging from five to 15 years, plus renewal options. Substantially all of our leases contain provisions for specified annual increases over the rents of the prior year and are generally computed in one of three methods depending on specific provisions of each lease as follows: (i) a specific annual percentage increase over the prior year’s rent, generally 2.5%; (ii) an increase based on the change in pre-determined formulas from year to year (e.g., such as increases in the Consumer Price Index (“CPI”)); or (iii) specific dollar increases over prior years. Under the terms of the leases, the lessee is responsible for all maintenance, repairs, taxes and insurance on the leased properties.

 

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The following table summarizes the significant acquisitions that occurred in 2016.

 

   

Number of

Facilities

            Land    

Building & Site

Improvements

    Furniture
& Fixtures
    Initial
Annual
Cash
 
Period   SNF     ALF    

Country/

State

  Total
Investment
      (in millions)     Yield
(%)
 
Q1     -       1     UK   $ 8.3       $ 1.4     $ 6.7     $ 0.2       7.00  
Q1     -       1     UK     6.1         0.6       5.3       0.2       7.00  
Q1     10       -     OH, VA, MI     169.0   (3)     10.5       152.5       6.0       8.50  
Q1     -       2     GA     20.2         0.8       18.3       1.1       7.50  
Q1     3       -     MD     25.0         2.5       19.9       2.6       8.50  
Q1     21       -     VA, NC     212.5         19.3       181.1       12.1       8.50  
Q2     -       10     UK     111.9   (4)     24.8       83.9       3.2       7.00  
Q2     -       3     TX     66.0   (5)     5.8       58.6       1.6       6.80  
Q2     3       -     CO, MO     31.8         3.1       26.2       2.5       9.00  
Q3     -       1     FL     4.3   (1)     2.3       1.8       0.2       8.00  
Q3     -       1     GA     2.5   (1)     0.2       2.1       0.2       8.00  
Q3     -       1     FL     16.5   (1)     1.8       14.3       0.4       8.00  
Q3     1       -     SC     10.1   (1)     2.7       6.5       0.9       9.00  
Q3     1       -     OH     9.0   (1)(6)     -       8.6       0.4       9.00  
Q3     31       -     FL, KY,TN     329.6   (1)(2)     24.6       290.8       14.2       9.00  
Total     70       20         $ 1,022.8       $ 100.4     $ 876.6     $ 45.8          

 

(1) The Company estimated the fair value of the assets acquired on the acquisition date based on certain valuation analyses that have yet to be finalized, and accordingly, the assets acquired, as detailed, are subject to adjustment once the analysis is completed.
(2) The Company’s investment includes a purchase option buyout obligation with a fair value of approximately $29.6 million. The future buyout obligation is recorded in accrued expenses and other liabilities on our Consolidated Balance Sheet. The Company also acquired a term loan with a fair value of approximately $37.0 million which is recorded in other investments on our Consolidated Balance Sheet. Refer to Note – 5 Other Investments.
(3) Acquired from a related party. Refer to Note – 1 Related Party Transactions.
(4) Omega also recorded a deferred tax asset of approximately $1.9 million in connection with the acquisition.
(5) The Company paid $63.0 million in cash at closing to acquire the facilities. We have agreed to pay an additional $1.5 million in April 2017 and the remaining $1.5 million in April 2018. The additional consideration to be paid is contractually determined and not contingent on other factors. The $3.0 million liability is recorded in unsecured borrowings – net on our Consolidated Balance Sheet.
(6) The Company paid approximately $3.5 million in cash to acquire the facility. The remainder of the purchase price (approximately $5.5 million) was funded with the redemption of an other investment note.

 

During 2016, the Company also acquired three parcels of land which are not reflected in the table above for approximately $5.9 million with the intent of building new facilities for existing operators.

 

Aviv Merger

 

On April 1, 2015, Omega completed the Aviv Merger, which was structured as a stock-for-stock merger. Under the terms of the Merger Agreement, each outstanding share of Aviv common stock was converted into 0.90 of a share of Omega common stock. In connection with the Aviv Merger, Omega issued approximately 43.7 million shares of common stock to former Aviv stockholders. As a result of the Aviv Merger, Omega acquired 342 facilities, two facilities subject to direct financing leases, one medical office building, two mortgages and other investments. Omega also assumed certain outstanding equity awards and other debt and liabilities. Based on the closing price of Omega’s common stock on April 1, 2015, the fair value of the consideration exchanged was approximately $2.3 billion.

 

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The following table highlights the final allocation of the assets acquired, liabilities assumed and consideration transferred on April 1, 2015 (in thousands):

 

Fair value of net assets acquired:        
Land and buildings   $ 3,107,530  
Investment in direct financing leases     26,823  
Mortgages notes receivable     19,246  
Other investments     23,619  
Total investments     3,177,218  
Goodwill     630,679  
Accounts receivables and other assets     17,144  
Cash acquired     84,858  
Accrued expenses and other liabilities     (223,002 )
Debt     (1,410,637 )
Fair value of net assets acquired   $ 2,276,260  

 

The completion of the final valuation in the first quarter of 2016 did not result in material changes to our Consolidated Statements of Operations or our Consolidated Balance Sheets from our preliminary purchase price allocation.

 

Pro Forma Acquisition Results

 

The facilities acquired in 2015 are included in our results of operations from the dates of acquisition. The following unaudited pro forma results of operations reflect the impact of those acquisitions as if they occurred on January 1, 2015. For a list of the 2015 transactions, refer to Note 3 – Properties in our Current Report on Form 8-K filed with the SEC on June 30, 2016. In the opinion of management, all significant necessary adjustments to reflect the effect of the acquisitions have been made.

 

    Pro Forma  
    Nine Months Ended  
    September 30, 2015  
    (in thousands, except per
share amounts, unaudited)
 
Pro Forma Revenues   $ 612,572  
Pro Forma Net income   $ 200,826  
         
Earnings per share – diluted:        
Net income – as reported   $ 0.97  
         
Net income – pro forma   $ 1.04  

 

Asset Sales, Impairments and Other

 

During the first quarter of 2016, we recorded approximately $34.6 million of impairments on 14 facilities located in six states. We reduced their net book values to their estimated fair value less costs to sell and reclassified them to assets held for sale in the first quarter of 2016. To estimate the fair value of the facilities, we utilized a market approach and Level 3 inputs (which generally consist of non-binding offers from unrelated third parties). In addition, we sold two SNFs (previously classified as held-for-sale) for approximately $2.4 million in net proceeds recognizing a gain of approximately $1.6 million. See Note 6 – Assets Held For Sale for details.

 

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During the second quarter of 2016, we sold 11 facilities for approximately $41.4 million in net proceeds recognizing a gain of approximately $13.2 million. Seven of the sold facilities were previously classified as held-for-sale. In addition, we recorded approximately $6.9 million of impairments on 15 facilities of which 12 were classified as held for sale as of June 30, 2016. We reduced their net book values to their estimated fair value less costs to sell. To estimate the fair value of the facilities, we utilized a market approach and Level 3 inputs (which generally consist of non-binding offers from unrelated third parties). See Note 6 – Assets Held For Sale for details.

 

During the third quarter of 2016, we sold six facilities for approximately $21.0 million in net proceeds recognizing a gain of approximately $5.1 million. One of the sold facilities was previously classified as held-for-sale. In addition, we recorded approximately $17.3 million of impairments on 12 facilities of which 10 are classified as held for sale as of September 30, 2016. We reduced their net book values to their estimated fair value less costs to sell. To estimate the fair value of the facilities, we utilized a market approach and Level 3 inputs (which generally consist of non-binding offers from unrelated third parties). See Note 6 – Assets Held For Sale for details.

 

Our recorded impairments were primarily the result of a decision to exit certain non-strategic facilities and operators primarily related to facilities acquired in the Aviv Merger.

 

NOTE 3 – DIRECT FINANCING LEASES

 

The components of investments in direct financing leases consist of the following:

 

    September 30,     December 31,  
    2016     2015  
    (in thousands)  
Minimum lease payments receivable   $ 4,291,776     $ 4,320,876  
Less unearned income     (3,693,997 )     (3,733,175 )
Investment in direct financing leases - net   $ 597,779     $ 587,701  
                 
Properties subject to direct financing leases     58       59  

 

New Ark Investment Inc.

 

On November 27, 2013, we closed an aggregate $529 million purchase/leaseback transaction in connection with the acquisition of Ark Holding Company, Inc. (“Ark Holding”) by 4 West Holdings Inc. At closing, we acquired 55 SNFs and 1 ALF operated by Ark Holding and leased the facilities back to Ark Holding, now known as New Ark Investment Inc. (“New Ark”), pursuant to four 50-year master leases with rental payments yielding 10.6% per annum over the term of the leases. The purchase/leaseback transaction is being accounted for as a direct financing lease.

 

The lease agreements allow the tenant the right to purchase the facilities for a bargain purchase price plus closing costs at the end of the lease term. In addition, commencing in the 41st year of each lease, the tenant will have the right to prepay the remainder of its obligations thereunder for an amount equal to the sum of the unamortized portion of the original aggregate $529 million investment plus the net present value of the remaining payments under the lease and closing costs. In the event the tenant exercises either of these options, we have the right to purchase the properties for fair value at the time.

 

The 56 facilities represent 5,623 licensed beds located in 12 states, predominantly in the southeastern United States. The 56 facilities are separated by region and divided amongst four cross-defaulted master leases. The four regions include the Southeast (39 facilities), the Northwest (7 facilities), Texas (9 facilities) and Indiana (1 facility).

 

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Additionally, we own four facilities and lease them to New Ark under a master lease which expires in 2026. The four facility lease is being accounted for as an operating lease.

 

Aviv Merger

 

On April 1, 2015, we acquired two additional direct financing leases as a result of the Aviv Merger.

 

As of September 30, 2016, the following minimum rents are due under our direct financing leases for the next five years (in thousands):

 

Year 1 Year 2 Year 3 Year 4 Year 5
$50,509 $51,688 $52,961 $54,270 $55,491

  

NOTE 4 – MORTGAGE NOTES RECEIVABLE

 

As of September 30, 2016, mortgage notes receivable relate to 24 fixed rate mortgages on 47 long-term care facilities. The mortgage notes are secured by first mortgage liens on the borrowers' underlying real estate and personal property. The mortgage notes receivable relate to facilities located in ten states, operated by eight independent healthcare operating companies. We monitor compliance with mortgages and when necessary have initiated collection, foreclosure and other proceedings with respect to certain outstanding loans.

 

Mortgage interest income is recognized as earned over the terms of the related mortgage notes, using the effective yield method. Allowances are provided against earned revenues from mortgage interest when collection of amounts due becomes questionable or when negotiations for restructurings of troubled operators lead to lower expectations regarding ultimate collection. When collection is uncertain, mortgage interest income on impaired mortgage loans is recognized as received after taking into account the application of security deposits.

 

The outstanding principal amounts of mortgage notes receivable, net of allowances, were as follows:

 

    September 30,     December 31,  
    2016     2015  
    (in thousands)  
             
Mortgage note due 2024; interest at 9.79%   $ 112,500     $ 112,500  
Mortgage note due 2028; interest at 11.00%     35,964       69,928  
Mortgage note due 2029; interest at 9.45%     412,465       413,399  
Other mortgage notes outstanding (1)     63,410       83,968  
Mortgage notes receivable, gross     624,339       679,795  
Allowance for loss on mortgage notes receivable            
Total mortgages — net   $ 624,339     $ 679,795  

 

(1) Other mortgage notes outstanding have stated interest rates ranging from 8.35% to 12.0% and maturity dates through 2053.

 

The following is a brief overview of certain mortgages entered into, acquired or assumed in 2016 or significant changes to mortgages previously reported.

 

Conversion of Mortgage Notes due 2046 to Leased Properties

 

In January 2016, we acquired three facilities via a deed-in-lieu of foreclosure from a mortgagor. The fair value of the facilities approximated the $25 million carrying value of the mortgages. These facilities have 352 operating beds and are located in Maryland. Simultaneously we leased these facilities to an existing operator.

 

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Mortgage Notes Payoff

 

On April 29, 2016, an existing operator exercised an option to repay their mortgage notes. We received proceeds of approximately $47.8 million for the mortgage notes due. In connection with the repayment of the mortgage notes we recognized a net gain of approximately $5.4 million which is recorded in mortgage interest income on our Consolidated Statements of Operations.

 

NOTE 5 – OTHER INVESTMENTS

 

A summary of our other investments is as follows:

 

    September 30,     December 31,  
    2016     2015  
    (in thousands)  
             
Other investment note due 2017; interest at 8.50%   $ 10,300     $  
Other investment note due 2019; interest at 10.50%     49,396        
Other investment note due 2020; interest at 10.00%     23,000       23,000  
Other investment note due 2020; interest at 14.00%     47,970        
Other investment note due 2022, interest at 9.00%     31,987        
Other investment note due 2028; interest at 8.50%     20,000        
Other investment note due 2030; interest at 6.66%     39,805       26,966  
Other investment notes outstanding (1)     57,795       42,293  
Other investments, gross     280,253       92,259  
Allowance for loss on other investments     (3,002 )     (2,960 )
Total other investments   $ 277,251     $ 89,299  

 

(1) Other investment notes have maturity dates through 2028 and interest rates ranging from 6.50% to 13.0%.

 

The following is a brief overview of certain notes entered into or repaid in 2016.

 

Other Investment notes due 2017

 

On February 1, 2016, we provided an operator a $15.0 million secured working capital note. The working capital note bears interest at 8.5% and matures in July 2017. As of September 30, 2016, approximately $2.6 million has been drawn and remains outstanding.

 

On March 1, 2016, we provided an operator a $15.0 million secured working capital note. The working capital note bears interest at 8.5% and matures in March 2017. As of September 30, 2016, approximately $10.3 million has been drawn and remains outstanding.

 

Other Investment note due 2019

 

On February 26, 2016, we acquired and funded a $50.0 million mezzanine note at a discount of approximately $0.75 million to a new operator. The mezzanine note bears interest at 10.50% and matures in February 2019.

 

Other Investment note due 2020

 

On July 29, 2016, we provided an existing operator $48.0 million of term loan funding. The term loan bears interest at 14% per annum (LIBOR with a floor of 1% plus 13%) and matures on July 29, 2020. The term loan requires monthly principal payments of $0.25 million through July 2019, and $0.5 million from August 2019 through maturity. In addition, a portion of the monthly interest may be accrued to the outstanding principal balance of the loan.

 

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Other Investment notes due 2022

 

On September 30, 2016, we acquired and amended a term loan with a fair value of approximately $37.0 million with an existing operator. A $5.0 million tranche of the term loan bears interest at 13% and matures on September 30, 2019 and a $32.0 million tranche of the term loan bears interest at 9% and matures on March 31, 2022.

 

Other Investment note due 2028

 

On March 1, 2016, we provided an operator a $20.0 million acquisition note. The acquisition note bears interest at 8.5% (increasing annually by 2.5%) and matures in March 2028.

 

Other Investment notes due 2022 and 2023 Payoff

 

On April 29, 2016, an existing operator of Omega exercised its option to pay off a working capital note due in 2022 and ten working capital notes due in 2023, for approximately $7.6 million.

 

NOTE 6 – ASSETS HELD FOR SALE

 

    Properties Held For Sale  
    Number of
Properties
    Net Book Value 
(in thousands)
 
       
December 31, 2015     3     $ 6,599  
Properties sold (1)     (2 )     (600 )
Properties added (2)     24       67,590  
March 31, 2016     25     $ 73,589  
Properties sold/other (1)     (7 )     (28,347 )
Properties added (2)     4       7,209  
June 30, 2016     22     $ 52,451  
Properties sold/other (1)     (4 )     (8,659 )
Properties added (2)     13       47,418  
September 30, 2016     31     $ 91,210  

 

(1) In the first quarter of 2016, we sold two SNFs for approximately $2.4 million in net proceeds recognizing a gain on sale of approximately $1.6 million. In the second quarter of 2016, we sold seven SNFs for approximately $39.2 million in net proceeds generating a gain on sale of approximately $12.5 million. We also recorded approximately $3.4 million of impairments on 12 facilities to reduce their net book values to their estimated fair value less costs to sell. In the third quarter of 2016, we sold one closed SNF for approximately $0.3 million in net proceeds. Two SNFs and one ALF classified as assets held for sale in the second quarter were no longer considered held for sale and were reclassified in the third quarter back to leased properties at their fair values (approximately $7.0 million). In addition, we recorded approximately $1.5 million of impairments on four facilities in the third quarter to further reduce their net book values to their estimated fair value less costs to sell.
(2) In the first quarter of 2016, we reclassified eight ALFs and 16 SNFs located in six states to assets held for sale. We recorded approximately $34.6 million of impairment charges on 14 of these facilities to reduce their net book values to their estimated fair value less costs to sell. In the second quarter of 2016, we reclassified three SNFs and one ALF to assets held for sale with total carrying value of $7.2 million. In the third quarter of 2016, we reclassified 12 SNFs and one ALF to assets held for sale. In the third quarter, we recorded approximately $14.8 million of impairment charges on six of these facilities to reduce their net book values to their estimated fair value less costs to sell.

 

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NOTE 7 – INTANGIBLES

 

The following is a summary of our intangibles as of September 30, 2016 and December 31, 2015:

 

    September 30,     December 31,  
    2016     2015  
    (in thousands)  
Assets:                
Goodwill   $ 644,129     $ 645,683  
                 
Above market leases   $ 23,545     $ 21,901  
In-place leases     167       386  
Accumulated amortization     (15,461 )     (14,162 )
Net intangible assets   $ 8,251     $ 8,125  
                 
Liabilities:                
Below market leases   $ 165,028     $ 165,331  
Accumulated amortization     (67,321 )     (55,131 )
Net intangible liabilities   $ 97,707     $ 110,200  

 

Goodwill was recorded in connection with the Aviv Merger and Care Homes Transaction (refer to Note 3 – Properties in our Current Report on Form 8-K filed with the SEC on June 30, 2016) and is shown as a separate line on our Consolidated Balance Sheets. Above market leases and in-place leases, net of accumulated amortization, are included in other assets on our Consolidated Balance Sheets. Below market leases, net of accumulated amortization, are included in accrued expenses and other liabilities on our Consolidated Balance Sheets. The net amortization related to the above and below market leases is included in our Consolidated Statements of Operations as an adjustment to rental income.

 

For the three months ended September 30, 2016 and 2015, our net amortization related to intangibles was $3.0 million and $1.4 million, respectively. For the nine months ended September 30, 2016 and 2015, our net amortization related to intangibles was $11.0 million and $4.3 million, respectively. The estimated net amortization related to these intangibles for the remainder of 2016 and the subsequent four years is as follows: remainder of 2016 – $3.0 million; 2017 – $11.7 million; 2018 – $10.5 million; 2019 – $9.4 million and 2020 – $9.2 million. As of September 30, 2016 the weighted average remaining amortization period of above market leases (inclusive of in-place leases) and below market leases is approximately eight years and 10 years, respectively.

 

The following is a reconciliation of our goodwill as of September 30, 2016:

 

    (in thousands)  
Balance as of December 31, 2015   $ 645,683  
Add: additional valuation adjustments related to preliminary valuations     275  
Less: foreign currency translation     (390 )
Balance as of March 31, 2016     645,568  
Less: foreign currency translation     (1,087 )
Balance as of June 30, 2016     644,481  
Less: foreign currency translation     (352 )
Balance as of September 30, 2016   $ 644,129  

 

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NOTE 8 – CONCENTRATION OF RISK

 

As of September 30, 2016, our portfolio of real estate investments consisted of 1,014 healthcare facilities, located in 42 states and the United Kingdom and operated by 81 third party operators. Our gross investment in these facilities, net of impairments and before reserve for uncollectible loans, totaled approximately $8.9 billion at September 30, 2016, with approximately 99% of our real estate investments related to long-term care facilities. Our portfolio is made up of 816 SNFs, 101 ALFs, 16 specialty facilities, one medical office building, fixed rate mortgages on 44 SNFs and two ALFs, and 34 facilities that are closed/held-for-sale. At September 30, 2016, we also held miscellaneous investments of approximately $277.3 million, consisting primarily of secured loans to third-party operators of our facilities.

 

At September 30, 2016, the three states in which we had our highest concentration of investments were Ohio (10%), Florida (9%) and Texas (9%). No single operator or manager generated more than 10% of our total revenues for the nine months ended September 30, 2016.

 

NOTE 9 – STOCKHOLDERS’ EQUITY

 

On October 13, 2016, the Board of Directors declared a common stock dividend of $0.61 per share, increasing the quarterly common dividend rate by $0.01 per share over the previous quarter, to be paid November 15, 2016 to common stockholders of record as of the close of business on October 31, 2016.

 

On July 14, 2016, the Board of Directors declared a common stock dividend of $0.60 per share, increasing the quarterly common dividend rate by $0.02 per share over the prior quarter. The common dividends were paid on August 15, 2016 to common stockholders of record as of the close of business on August 1, 2016.

 

On April 14, 2016, the Board of Directors declared a common stock dividend of $0.58 per share, increasing the quarterly common dividend by $0.01 per share over the prior quarter. The common dividends were paid May 16, 2016 to common stockholders of record on May 2, 2016.

 

On January 14, 2016, the Board of Directors declared a common stock dividend of $0.57 per share, increasing the quarterly common dividend by $0.01 per share over the previous quarter. The common dividends were paid February 16, 2016 to common stockholders of record as of February 2, 2016.

 

Dividend Reinvestment and Common Stock Purchase Plan

 

For the three-month period ended September 30, 2016, approximately 4.0 million shares of our common stock at an average price of $34.38 per share were issued through our Dividend Reinvestment and Common Stock Purchase Program for gross proceeds of approximately $136.6 million. For the nine-month period ended September 30, 2016, approximately 6.9 million shares of our common stock at an average price of $33.49 per share were issued through our Dividend Reinvestment and Common Stock Purchase Program for gross proceeds of approximately $230.1 million.

 

Accumulated Other Comprehensive Loss

 

The following is a summary of our accumulated other comprehensive loss, net of tax where applicable:

 

    September 30,     December 31,  
    2016     2015  
    (in thousands)  
             
Foreign currency translation adjustments   $ (39,939 )   $ (8,027 )
Derivative instrument adjustments     (12,231 )     (685 )
Total accumulated other comprehensive loss   $ (52,170 )   $ (8,712 )

 

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NOTE 10 – TAXES

 

Since our inception, we have elected to be taxed as a REIT under the applicable provisions of the Internal Revenue Code (the “Code”). A REIT is generally not subject to federal income tax on that portion of its REIT taxable income which is distributed to its stockholders, provided that at least 90% of such taxable income is distributed each tax year and certain other requirements are met, including asset and income tests. So long as we qualify as a REIT under the Code, we generally will not be subject to federal income taxes on the REIT taxable income that we distribute to stockholders, subject to certain exceptions.

 

If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to federal income taxes on its taxable income at regular corporate rates and dividends paid to our stockholders will not be deductible by us in computing taxable income. Further, we will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year in which qualification is denied, unless the Internal Revenue Service grants us relief under certain statutory provisions. Failing to qualify as a REIT could materially and adversely affect the Company’s net income; however, we believe we are organized and operate in such a manner as to qualify for treatment as a REIT. On a quarterly and annual basis, we test our compliance within the REIT taxation rules to ensure that we are in compliance with the REIT rules. We review our distributions and projected distributions each year to ensure we have met and will continue to meet the annual REIT distribution requirements. In 2016, we expect to distribute dividends in excess of our taxable income.

 

As a result of our UPREIT Conversion, our Company and its subsidiaries may be subject to income or franchise taxes in certain states and municipalities. Also, as a result of our UPREIT Conversion, we created five wholly owned subsidiary REITs that are subject to all of the REIT qualification rules set forth in the Code. In December 2015, we merged the five wholly owned subsidiary REITs into one wholly owned subsidiary REIT which is subject to all of the REIT qualification rules set forth in the Code.

 

Subject to the limitation under the REIT asset test rules, we are permitted to own up to 100% of the stock of one or more taxable REIT subsidiaries (“TRSs”). We have elected for two of our active subsidiaries to be treated as TRSs. One of our TRSs is subject to federal, state and local income taxes at the applicable corporate rates and the other is subject to foreign income taxes. As of September 30, 2016, our TRS that is subject to federal, state and local income taxes at the applicable corporate rates had a net operating loss carry-forward of approximately $0.8 million. The loss carry-forward is fully reserved as of September 30, 2016 with a valuation allowance due to uncertainties regarding realization.

 

During the third quarter of 2016, we recorded approximately $0.3 million of state and local income tax provision and approximately $0.2 million of tax benefit for foreign income taxes. For the nine months ended September 30, 2016, we recorded approximately $0.8 million of state and local income tax provision and approximately $35,000 of tax benefit for foreign income taxes.

 

NOTE 11 – STOCK-BASED COMPENSATION

 

The following is a summary of our stock-based compensation expense for the three and nine-month periods ended September 30, 2016 and 2015, respectively:

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2016     2015     2016     2015  
    (in thousands)  
                                 
Stock-based compensation expense   $ 3,673     $ 2,199     $ 10,116     $ 6,682  

 

 22

 

  

Restricted Stock and Restricted Stock Units

 

Restricted stock and restricted stock units (“RSUs”) are subject to forfeiture if the holder’s service to us terminates prior to vesting, subject to certain exceptions for certain qualifying terminations of employment or a change in control of the Company. Prior to vesting, ownership of the shares/units cannot be transferred. Restricted stock has the same dividend and voting rights as our common stock. RSUs accrue dividend equivalents but have no voting rights. Restricted stock and RSUs are valued at the price of our common stock on the date of grant. We expense the cost of these awards ratably over their vesting period.

 

The RSUs assumed from Aviv as part of the Aviv Merger were valued at the closing price of our stock on the date of the transaction. The portion of the vesting accruing prior to the acquisition was recorded as part of the purchase price consideration. The expense associated with the vesting that will occur after the date of the transaction is being recorded as stock compensation expense ratably over the remaining life of the RSUs.

 

We awarded 131,006 RSUs to employees on March 17, 2016.

 

Performance Restricted Stock Units and LTIP Units

 

Performance restricted stock units (“PRSUs”) and long term incentive plan units (“LTIP Units”) are subject to forfeiture if the performance requirements are not achieved or if the holder’s service to us terminates prior to vesting, subject to certain exceptions for certain qualifying terminations of employment or a change in control of the Company. The PRSUs and the LTIP Units have varying degrees of performance requirements to be earned and vested, and each PRSU and LTIP Units award represents the right to a variable number of shares of common stock or partnership units. Each LTIP Unit once earned and vested is convertible into one Omega OP Unit in Omega OP, subject to certain conditions. The earning requirements are based on either the (i) total shareholder return (“TSR”) of Omega or (ii) Omega’s TSR relative to other real estate investment trusts in the MSCI U.S. REIT Index or FTSE NAREIT Equity Health Care Index TSR (both “Relative TSR”). Vesting in general requires that the employee remain employed by us until the date specified in the applicable PRSU or LTIP agreement, which may be later than the date that the TSR or Relative TSR requirements are satisfied. We expense the cost of these awards ratably over their service period.

 

Prior to vesting and the distribution of shares, ownership of the PRSUs cannot be transferred. Dividend equivalents on the PRSUs accumulate and with respect to PRSUs granted before 2015 are paid when the PRSUs vest and with respect to PRSUs granted in 2015 or later are paid once the PRSUs are earned. While each LTIP Unit is unearned, the employee receives a partnership distribution equal to 10% of the quarterly approved regular periodic distributions per Omega OP Unit. The remaining partnership distributions (which in the case of normal periodic distributions is equal to the total approved quarterly dividend on Omega’s common stock) on the LTIP Units accumulate, and if the LTIP Units are earned, the accumulated distributions are paid.

 

The number of shares or units earned under the TSR PRSUs or LTIP Units depends generally on the level of achievement of Omega’s TSR over the indicated performance period. We awarded 372,069 LTIP Units to employees on March 17, 2016.

 

The number of shares earned under the Relative TSR PRSUs depends generally on the level of achievement of Omega’s TSR relative to other real estate investment trusts in the MSCI U.S. REIT Index or FTSE NAREIT Equity Health Care Index TSR over the performance period indicated. We awarded 307,480 Relative TSR PRSUs to employees on March 17, 2016.

 

 23

 

  

The following table summarizes our total unrecognized compensation cost as of September 30, 2016 associated with restricted stock, restricted stock units, PRSU awards, and LTIP Unit awards to employees:

 

    Grant
Year
    Shares/
Units(1) 
    Grant Date
Average
Fair Value
Per Unit/
Share
    Total
Compensation
Cost (in millions)
(2)
    Weighted
Average
Period of
Expense
Recognition
(in months)
    Unrecognized
Compensation
Cost (in
millions)
    Performance
Period
  Vesting
Dates
RSUs                                            
2013 RSU     2013       195,822     $ 29.80     $ 5.8       36     $ 0.5      N/A   12/31/14 - 12/31/16
2014 RSU     2014       106,778       29.80       3.2       36       0.3     N/A   12/31/2016
3/31/15 RSU     2015       109,985       40.57       4.5       33       2.0     N/A   12/31/2017
4/1/15 RSU     2015       40,464       40.74       1.6       33       0.7     N/A   12/31/2017
Assumed Aviv RSU     2015       18,920       24.92       0.5       21       0.1     N/A   12/31/2016
Assumed Aviv RSU     2015       7,799       35.08       0.3       33       0.1     N/A   12/31/15-12/31/17
3/17/16 RSU     2016       131,006       34.78       4.6       33       3.7     N/A   12/31/2018
Restricted Stock Units Total             610,774     $ 33.45     $ 20.5             $ 7.4          
                                                         
TSR PRSUs and LTIP Units                                                        
2016 Transition TSR     2013       101,591       8.67       0.9       36       0.1     12/31/2013-12/31/2016   12/31/2016
2016 TSR     2014       135,634       8.67       1.2       48       0.4     1/1/2014-12/31/2016   Quarterly in 2017
3/31/15 2017 LTIP Units     2015       137,249       14.66       2.0       45       1.2     1/1/2015-12/31/2017   Quarterly in 2018
4/1/2015 2017 LTIP Units     2015       54,151       14.80       0.8       45       0.5     1/1/2015-12/31/2017   Quarterly in 2018
7/31/15 2016 Transition TSR     2015       22,091       18.51       0.4       5       -     12/31/2013-12/31/2016   12/31/2016
7/31/15 2017 LTIP Units     2015       5,823       8.78       0.1       5       -     1/1/2015-12/31/2017   12/31/2017
3/17/16 2018 LTIP Units     2016       372,069       13.21       4.9       45       4.2     1/1/2016-12/31/2018   Quarterly in 2019
TSR PRSUs & LTIP Total             828,608     $ 12.36     $ 10.3             $ 6.4          
                                                         
Relative TSR PRSUs                                                        
2016 Transition Relative TSR     2013       101,588       14.24       1.4       36       0.1     12/31/2013-12/31/2016   12/31/2016
2016 Relative TSR     2014       135,634       14.24       1.9       48       0.6     1/1/2014-12/31/2016   Quarterly in 2017
3/31/15 2017 Relative TSR     2015       137,249       22.50       3.1       45       1.9     1/1/2015-12/31/2017   Quarterly in 2018
4/1/2015 2017 Relative TSR     2015       54,151       22.91       1.2       45       0.7     1/1/2015-12/31/2017   Quarterly in 2018
7/31/15 2016 Relative TSR     2015       22,100       19.60       0.4       5       -     12/31/2013-12/31/2016   12/31/2016
7/31/15 2017 Relative TSR     2015       5,826       17.74       0.1       5       -     1/1/2015-12/31/2017   12/31/2017
3/17/16 2018 Relative TSR     2016       307,480       16.45       5.1       45       4.3     1/1/2016-12/31/2018   Quarterly in 2019
Relative TSR PRSUs Total             764,028     $ 17.41     $ 13.2             $ 7.6          
Grand Total             2,203,410     $ 19.96     $ 44.0             $ 21.4          

 

(1) Shares/units are net of shares cancelled.
(2) Total compensation costs are net of shares cancelled.

 

 24

 

  

Director Restricted Stock Grants

 

As of September 30, 2016, we had 54,999 shares of restricted stock outstanding to directors. The directors’ restricted shares are scheduled to vest over the next three years. As of September 30, 2016, the unrecognized compensation cost associated with outstanding director restricted stock grants is approximately $1.7 million.

 

NOTE 12 – BORROWING ACTIVITIES AND ARRANGEMENTS

 

Secured and Unsecured Borrowings

 

The following is a summary of our borrowings:

 

        Interest Rate
as of
September 30,
    September 30,     December 31,  
    Maturity   2016     2016     2015  
              (in thousands)  
Secured borrowings:                            
Mortgage term loan             $     $ 180,000  
HUD mortgages assumed December 2011(1)   2044     3.06 %     55,271       56,204  
Total secured borrowings                 55,271       236,204  
                             
Unsecured borrowings:                            
Revolving line of credit   2018     1.82 %     223,000       230,000  
Tranche A-1 term loan   2019     2.02 %     200,000       200,000  
Tranche A-2 term loan   2017     2.02 %     200,000       200,000  
Tranche A-3 term loan   2021     2.02 %     350,000        
Omega OP term loan   2017     2.02 %     100,000       100,000  
2015 term loan   2022     2.33 %     250,000       250,000  
                  1,323,000       980,000  
                             
2023 notes   2023     4.375 %     700,000        
2024 notes   2024     5.875 %     400,000       400,000  
2024 notes   2024     4.95 %     400,000       400,000  
2025 notes   2025     4.50 %     250,000       250,000  
2026 notes   2026     5.25 %     600,000       600,000  
2027 notes   2027     4.50 %     700,000       700,000  
Other   2018     -       3,000        
Subordinated debt   2021     9.00 %     20,000       20,000  
                  3,073,000       2,370,000  
Discount - net                 (17,632 )     (17,118 )
Total unsecured borrowings                 4,378,368       3,332,882  
Total – net               $ 4,433,639     $ 3,569,086  

 

(1) Reflects the weighted average annual contractual interest rate on the mortgages at September 30, 2016 excluding a third-party administration fee of approximately 0.5% annually. Secured by real estate assets with a net carrying value of $66.7 million as of September 30, 2016.

 

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Certain of our other secured and unsecured borrowings are subject to customary affirmative and negative covenants, including financial covenants. As of September 30, 2016 and December 31, 2015, we were in compliance with all affirmative and negative covenants, including financial covenants, for our secured and unsecured borrowings.

 

Mortgage Term Loan

 

As a result of the Aviv Merger in April 2015, we acquired two subsidiaries that were borrowers under a $180.0 million mortgage term loan secured by mortgages on 28 healthcare facilities owned by one of the borrowers. On July 25, 2016, we purchased the $180.0 million mortgage term loan, effectively eliminating the debt on our consolidated financial statements. The term loan was secured by real estate assets having a net carrying value of $290.5 million at June 30, 2016. The interest rate was based on LIBOR, with a floor of 50 basis points, plus a margin of 350 basis points. The interest rate at June 30, 2016 was 4.13%. We paid $180.0 million plus a 1% premium to purchase the debt.

 

Bank Credit Facilities

 

On January 29, 2016, we amended our Omega Credit Facilities (as defined below) to add a $350 million senior unsecured incremental term loan facility. As a result of the amendment, the Omega Credit Facilities now include a $1.25 billion senior unsecured revolving credit facility (the “Revolving Credit Facility”), a $200 million senior unsecured term loan facility (the “Tranche A-1 Term Loan Facility”), a $200 million senior unsecured incremental term loan facility (the “Tranche A-2 Term Loan Facility”) and a $350 million senior unsecured incremental term loan facility (the “Tranche A-3 Term Loan Facility” and, together with the Revolving Credit Facility, the Tranche A-1 Term Loan Facility and the Tranche A-2 Term Loan Facility, collectively, the “Omega Credit Facilities”). The Tranche A-1 Term Loan Facility, the Tranche A-2 Term Loan Facility and the Tranche A-3 Term Loan Facility may be referred to collectively herein as the “Omega Term Loan Facilities”.

 

The Tranche A-3 Term Loan Facility bears interest at LIBOR plus an applicable percentage (beginning at 150 basis points, with a range of 100 to 195 basis points) based on our ratings from Standard & Poor’s, Moody’s and/or Fitch Ratings. The Tranche A-3 Term Loan Facility matures on January 29, 2021.

 

$700 Million 4.5% Senior Notes due 2023

 

On July 12, 2016, we issued $700 million aggregate principal amount of our 4.375% Senior Notes due 2023 (the “2023 Notes”). The 2023 Notes were sold at an issue price of 99.739% of their face value before the underwriters’ discount. Our net proceeds from the offering, after deducting underwriting discounts and expenses, were approximately $692.0 million. The net proceeds from the offering were used to repay outstanding borrowings under our revolving credit facility, to purchase the $180.0 million mortgage term loan and for general corporate purposes.

 

 26

 

  

NOTE 13 – FINANCIAL INSTRUMENTS

 

At September 30, 2016 and December 31, 2015, the carrying amounts and fair values of our financial instruments were as follows:

 

    September 30, 2016     December 31, 2015  
    Carrying
Amount
    Fair
Value
    Carrying
Amount
    Fair
Value
 
  (in thousands)  
Assets:      
Cash and cash equivalents   $ 32,567     $ 32,567     $ 5,424     $ 5,424  
Restricted cash     12,282       12,282       14,607       14,607  
Investments in direct financing leases – net     597,779       594,489       587,701       584,358  
Mortgage notes receivable – net     624,339       630,576       679,795       687,130  
Other investments – net     277,251       272,514       89,299       90,745  
Total   $ 1,544,218     $ 1,542,428     $ 1,376,826     $ 1,382,264  
Liabilities:                                
Revolving line of credit   $ 223,000     $ 223,000     $ 230,000     $ 230,000  
Tranche A-1 term loan     200,000       200,000       200,000       200,000  
Tranche A-2 term loan     200,000       200,000       200,000       200,000  
Tranche A-3 term loan     350,000       350,000              
Omega OP term loan     100,000       100,000       100,000       100,000  
2015 term loan     250,000       250,000       250,000       250,000  
4.375% notes due 2023 – net     698,237       725,932              
5.875% notes due 2024 – net     400,000       466,755       400,000       429,956  
4.95% notes due 2024 – net     395,758       421,791       395,333       403,064  
4.50% notes due 2025 – net     248,257       254,384       248,099       242,532  
5.25% notes due 2026 – net     598,466       645,477       598,343       612,760  
4.50% notes due 2027 – net     691,130       698,660       690,494       667,651  
Mortgage term loan due 2019                 180,000       180,000  
HUD debt – net     55,271       57,331       56,204       52,678  
Subordinated debt – net     20,520       25,429       20,613       24,366  
Other     3,000       3,000              
Total   $ 4,433,639     $ 4,621,759     $ 3,569,086     $ 3,593,007  

 

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 (see Note 2 – Summary of Significant Accounting Policies in our Current Report on Form 8-K filed with the SEC on June 30, 2016). The use of different market assumptions and estimation methodologies may have a material effect on the reported estimated fair value amounts.

 

The following methods and assumptions were used in estimating fair value disclosures for financial instruments.

 

· Cash and cash equivalents and restricted cash: The carrying amount of cash and cash equivalents and restricted cash reported in the Consolidated Balance Sheets approximates fair value because of the short maturity of these instruments (i.e., less than 90 days) (Level 1).

 

· Direct financing leases: The fair value of the investments in direct financing leases are estimated using a discounted cash flow analysis, using interest rates being offered for similar leases to borrowers with similar credit ratings (Level 3).

 

· Mortgage notes receivable: The fair value of the mortgage notes receivables are estimated using a discounted cash flow analysis, using interest rates being offered for similar loans to borrowers with similar credit ratings (Level 3).

 

 27

 

  

· Other investments: Other investments are primarily comprised of notes receivable. The fair values of notes receivable are estimated using a discounted cash flow analysis, using interest rates being offered for similar loans to borrowers with similar credit ratings (Level 3).

 

· Revolving line of credit and term loans: The fair value of our borrowings under variable rate agreements are estimated using a present value technique based on expected cash flows discounted using the current market rates (Level 3).

 

· Senior notes and subordinated debt: The fair value of our borrowings under fixed rate agreements are estimated using a present value technique based on inputs from trading activity provided by a third party (Level 2).

 

· HUD debt: The fair value of our borrowings under HUD debt agreements are estimated using an expected present value technique based on quotes obtained by HUD debt brokers (Level 2).

 

NOTE 14 – LITIGATION

 

We are subject to various legal proceedings, claims and other actions arising out of the normal course of business. While any legal proceeding or claim has an element of uncertainty, management believes that the outcome of each lawsuit, claim or legal proceeding that is pending or threatened, or all of them combined, will not have a material adverse effect on our consolidated financial position or results of operations.

 

NOTE 15 – EARNINGS PER SHARE

 

The computation of basic earnings per share (“EPS”) is computed by dividing net income available to common stockholders by the weighted-average number of shares of common stock outstanding during the relevant period. Diluted EPS is computed using the treasury stock method, which is net income divided by the total weighted-average number of common outstanding shares plus the effect of dilutive common equivalent shares during the respective period. Dilutive common shares reflect the assumed issuance of additional common shares pursuant to certain of our share-based compensation plans, including stock options, restricted stock and performance restricted stock units and the assumed issuance of additional shares related to Omega OP Units held by outside investors.

 

 28

 

 

The following tables set forth the computation of basic and diluted earnings per share:

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2016     2015     2016     2015  
    (in thousands, except per share amounts)  
Numerator:                                
Net income   $ 82,134     $ 83,254     $ 253,484     $ 169,772  
Less: net income attributable to noncontrolling interests     (3,585 )     (3,852 )     (11,328 )     (5,890 )
Net income available to common stockholders   $ 78,549     $ 79,402     $ 242,156     $ 163,882  
                                 
Denominator:                                
Denominator for basic earnings per share     194,123       184,739       190,444       167,261  
Effect of dilutive securities:                                
Common stock equivalents     1,093       1,483       1,174       1,580  
Noncontrolling interest – OP units     8,862       8,961       8,910       5,983  
Denominator for diluted earnings per share     204,078       195,183       200,528       174,824  
                                 
Earnings per share – basic:                                
Net income available to common stockholders   $ 0.40     $ 0.43     $ 1.27     $ 0.98  
Earnings per share – diluted:                                
Net income   $ 0.40     $ 0.43     $ 1.26     $ 0.97  

 

NOTE 16 – CONSOLIDATING FINANCIAL STATEMENTS

 

As of September 30, 2016, we had outstanding: (i) $700 million 4.375% Senior Notes due 2023, (ii) $400 million 5.875% Senior Notes due 2024, (iii) $400 million 4.95% Senior Notes due 2024, (iv) $250 million 4.5% Senior Notes due 2025, (v) $600 million 5.25% Senior Notes due 2026 and (vi) $700 million 4.5% Senior Notes due 2027 (collectively, the “Senior Notes”). The Senior Notes are fully and unconditionally guaranteed, jointly and severally, by each of our subsidiaries that guarantee other indebtedness of Omega or any of the subsidiary guarantors. All of our subsidiaries that guarantee the Senior Notes also guarantee amounts outstanding under the Omega Credit Facilities and 2015 term loan listed in Note 12 – Borrowing Activities and Arrangements. In addition, all such subsidiary guarantors that are subsidiaries of Omega OP also guarantee amounts outstanding under the Omega OP term loan listed in Note 12 – Borrowing Activities and Arrangements.

 

The following summarized condensed consolidating financial information segregates the financial information of the non-guarantor subsidiaries from the financial information of Omega Healthcare Investors, Inc. and the subsidiary guarantors under the Senior Notes. Our non-guarantor subsidiaries include, among others, all subsidiaries securing secured debt that is currently outstanding and our U.K. subsidiaries. The results and financial position of acquired entities are included from the dates of their respective acquisitions.

 

The 2015 financial statements presented below have been adjusted to reflect our current guarantor and non-guarantor relationships as of September 30, 2016.

 29

 

 

OMEGA HEALTHCARE INVESTORS, INC.

CONSOLIDATING BALANCE SHEET

Unaudited

(in thousands)

 

    September 30, 2016  
    Issuer &
Subsidiary
Guarantors
    Non –
Guarantor
Subsidiaries
    Elimination     Consolidated  
                         
ASSETS                                
Real estate properties                                
Land and buildings   $ 6,938,032     $ 655,854     $     $ 7,593,886  
Less accumulated depreciation     (1,142,146 )     (43,931 )           (1,186,077 )
Real estate properties – net     5,795,886       611,923             6,407,809  
Investment in direct financing leases     597,779                   597,779  
Mortgage notes receivable     624,339                   624,339  
      7,018,004       611,923             7,629,927  
Other investments     276,862       389             277,251  
      7,294,866       612,312             7,907,178  
Assets held for sale – net     91,210                   91,210  
Total investments     7,386,076       612,312             7,998,388  
                                 
Cash and cash equivalents     27,576       4,991             32,567  
Restricted cash     7,111       5,171             12,282  
Accounts receivable – net     216,597       8,628             225,225  
Goodwill     630,679       13,450             644,129  
Investments in and advances to affiliates     580,945             (580,945 )      
Other assets     58,185       11,587             69,772  
Total assets   $ 8,907,169     $ 656,139     $ (580,945 )   $ 8,982,363  
                                 
LIABILITIES AND EQUITY                                
Revolving line of credit   $ 223,000     $     $     $ 223,000  
Term loan     1,100,000                   1,100,000  
Secured borrowings           440,099       (384,828 )     55,271  
Unsecured borrowings – net     3,055,368                   3,055,368  
Accrued expenses and other liabilities     353,610       7,986             361,596  
Deferred income taxes           11,937             11,937  
Intercompany payable           7,894       (7,894 )      
Total liabilities     4,731,978       467,916       (392,722 )     4,807,172  
                                 
Equity:                                
Common stock     19,514                   19,514  
Equity investment from affiliates           164,285       (164,285 )      
Common stock – additional paid-in capital     4,827,877                   4,827,877  
Cumulative net earnings     1,614,678       23,516       (23,516 )     1,614,678  
Cumulative dividends paid     (2,587,841 )                 (2,587,841 )
Accumulated other comprehensive (loss) income     (52,170 )     422       (422 )     (52,170 )
Total stockholders’ equity     3,822,058       188,223       (188,223 )     3,822,058  
Noncontrolling interest     353,133                   353,133  
Total equity     4,175,191       188,223       (188,223 )     4,175,191  
Total liabilities and equity   $ 8,907,169     $ 656,139     $ (580,945 )   $ 8,982,363  

 

 30

 

 

OMEGA HEALTHCARE INVESTORS, INC.

CONSOLIDATING BALANCE SHEET

(in thousands)

 

    December 31, 2015  
    Issuer &
Subsidiary
Guarantors
    Non –
Guarantor
Subsidiaries
    Elimination     Consolidated  
                         
ASSETS                                
Real estate properties                                
Land and buildings   $ 6,184,507     $ 559,451     $     $ 6,743,958  
Less accumulated depreciation     (991,314 )     (27,836 )           (1,019,150 )
Real estate properties – net     5,193,193       531,615             5,724,808  
Investment in direct financing leases     587,701                   587,701  
Mortgage notes receivable     679,795                   679,795  
      6,460,689       531,615             6,992,304  
Other investments     89,299                   89,299  
      6,549,988       531,615             7,081,603  
Assets held for sale – net     6,599                   6,599  
Total investments     6,556,587       531,615             7,088,202  
                                 
Cash and cash equivalents     1,592       3,832             5,424  
Restricted cash     8,058       6,549             14,607  
Accounts receivable – net     196,107       7,755             203,862  
Goodwill     630,404       15,279             645,683  
Investments in and advances to affiliates     300,409             (300,409 )      
Other assets     53,732       7,499             61,231  
Total assets   $ 7,746,889     $ 572,529     $ (300,409 )   $ 8,019,009  
                                 
LIABILITIES AND EQUITY                                
Revolving line of credit   $ 230,000     $     $     $ 230,000  
Term loan     750,000                   750,000  
Secured borrowings           361,460       (125,256 )     236,204  
Unsecured borrowings – net     2,352,882                   2,352,882  
Accrued expenses and other liabilities     326,815       6,891             333,706  
Deferred income taxes           15,352             15,352  
Intercompany payable     (13,673 )     13,673              
Total liabilities     3,646,024       397,376       (125,256 )     3,918,144  
                                 
Equity:                                
Common stock     18,740                   18,740  
Equity investment from affiliates           156,830       (156,830 )      
Common stock – additional paid-in capital     4,609,474                   4,609,474  
Cumulative net earnings     1,372,522       18,246       (18,246 )     1,372,522  
Cumulative dividends paid     (2,254,038 )                 (2,254,038 )
Accumulated other comprehensive (loss) income     (8,712 )     77       (77 )     (8,712 )
Total stockholders’ equity     3,737,986       175,153       (175,153 )     3,737,986  
Noncontrolling interest     362,879                   362,879  
Total equity     4,100,865       175,153       (175,153 )     4,100,865  
Total liabilities and equity   $ 7,746,889     $ 572,529     $ (300,409 )   $ 8,019,009  

 

 31

 

 

OMEGA HEALTHCARE INVESTORS, INC.

CONSOLIDATING STATEMENT OF OPERATIONS

Unaudited

(in thousands)

 

    Three Months Ended September 30, 2016     Nine Months Ended September 30, 2016  
    Issuer &
Subsidiary
Guarantors
    Non –
Guarantor
Subsidiaries
    Elimination     Consolidated     Issuer &
Subsidiary
Guarantors
    Non –
Guarantor
Subsidiaries
    Elimination     Consolidated  
Revenue                                                                
Rental income   $ 170,639     $ 15,198     $ -     $ 185,837     $ 504,780     $ 44,214     $ -     $ 548,994  
Income from direct financing leases     15,611       -       -       15,611       46,574       -       -       46,574  
Mortgage interest income     15,996       -       -       15,996       53,973       -       -       53,973  
Other investment income – net     8,552       16       (1,374 )     7,194       18,120       54       (1,374 )     16,800  
Total operating revenues     210,798       15,214       (1,374 )     224,638       623,447       44,268       (1,374 )     666,341  
                                                                 
Expenses                                                                
Depreciation and amortization     62,460       5,856       -       68,316       179,219       17,035       -       196,254  
General and administrative     12,303       125       -       12,428       34,326       389       -       34,715  
Acquisition and merger related costs     2,026       283       -       2,309       5,779       3,805       -       9,584  
Impairment loss on real estate properties     17,275       -       -       17,275       58,508       218       -       58,726  
(Recovery) provision for uncollectible mortgages, notes and accounts receivable     (3 )     -       -       (3 )     705       3,262       -       3,967  
Total operating expenses     94,061       6,264       -       100,325       278,537       24,709       -       303,246  
                                                                 
Income before other income and expense     116,737       8,950       (1,374 )     124,313       344,910       19,559       (1,374 )     363,095  
Other income (expense):                                                                
Interest income     154       3       -       157       160       9       -       169  
Interest expense     (39,114 )     (5,115 )     1,374       (42,855 )     (106,807 )     (14,295 )     1,374       (119,728 )
Interest – amortization of deferred financing costs     (2,476 )     (26 )     -       (2,502 )     (6,806 )     (38 )     -       (6,844 )
Interest – refinancing costs     (1,815 )     -       -       (1,815 )     (2,113 )     -       -       (2,113 )
Realized loss on foreign exchange     (222 )     -       -       (222 )     (244 )     -       -       (244 )
Equity in earnings     3,986       -       (3,986 )     -       5,270       -       (5,270 )     -  
Total other expense     (39,487 )     (5,138 )     (2,612 )     (47,237 )     (110,540 )     (14,324 )     (3,896 )     (128,760 )
                                                                 
Income before gain on assets sold     77,250       3,812       (3,986 )     77,076       234,370       5,235       (5,270 )     234,335  
Gain on assets sold - net     5,139       -       -       5,139       19,931       -       -       19,931  
Income from continuing operations before income taxes     82,389       3,812       (3,986 )     82,215       254,301       5,235       (5,270 )     254,266  
Income taxes     (255 )     174       -       (81 )     (817 )     35       -       (782 )
Net income     82,134       3,986       (3,986 )     82,134       253,484       5,270       (5,270 )     253,484  
Net income attributable to noncontrolling interest     (3,585 )     -       -       (3,585 )     (11,328 )     -       -       (11,328 )
Net income available to common stockholders   $ 78,549     $ 3,986     $ (3,986 )   $ 78,549     $ 242,156     $ 5,270     $ (5,270 )   $ 242,156  

 

 32

 

 

OMEGA HEALTHCARE INVESTORS, INC.

CONSOLIDATING STATEMENTS OF OPERATIONS

(in thousands)

 

    Three Months Ended September 30, 2015     Nine Months Ended September 30, 2015  
    Issuer &
Subsidiary
Guarantors
    Non –
Guarantor
Subsidiaries
    Elimination     Consolidated     Issuer &
Subsidiary
Guarantors
    Non –
Guarantor
Subsidiaries
    Elimination     Consolidated  
Revenue                                                                
Rental income   $ 153,029     $ 13,594     $ -     $ 166,623     $ 402,341     $ 28,358     $ -     $ 430,699  
Income from direct financing leases     15,216       -       -       15,216       44,582       -       -       44,582  
Mortgage interest income     17,195       -       -       17,195       51,336       -       -       51,336  
Other investment income – net     2,940       -       -       2,940       6,488       -       -       6,488  
Total operating revenues     188,380       13,594       -       201,974       504,747       28,358       -       533,105  
                                                                 
Expenses                                                                
Depreciation and amortization     54,600       5,543       -       60,143       138,381       11,528       -       149,909  
General and administrative     10,064       96       -       10,160       26,201       281       -       26,482  
Acquisition and merger related costs     3,555       -       -       3,555       52,994       2,513       -       55,507  
Impairment loss on real estate properties     1,743       -       -       1,743       14,641       -       -       14,641  
Provision for uncollectible mortgages, notes and accounts receivable     301       -       -       301       292       -       -       292  
Total operating expenses     70,263       5,639       -       75,902       232,509       14,322       -       246,831  
                                                                 
Income before other income and expense     118,117       7,955       -       126,072       272,238       14,036       -       286,274  
Other income (expense):                                                                
Interest income     1       4       -       5       196       9       -       205  
Interest expense     (34,255 )     (3,914 )     -       (38,169 )     (100,966 )     (7,810 )     -       (108,776 )
Interest – amortization of deferred financing costs     (1,852 )     (5 )     -       (1,857 )     (5,020 )     (16 )     -       (5,036 )
Interest – refinancing costs     -       -       -       -       (8,361 )     -       -       (8,361 )
Equity in earnings     3,771       -       (3,771 )     -       5,771       -       (5,771 )     -  
Total other expense     (32,335 )     (3,915 )     (3,771 )     (40,021 )     (108,380 )     (7,817 )     (5,771 )     (121,968 )
                                                                 
Income before gain (loss) on assets sold     85,782       4,040       (3,771 )     86,051       163,858       6,219       (5,771 )     164,306  
(Loss) gain on assets sold – net     (2,391 )     -       -       (2,391 )     6,411       -       -       6,411  
Income from continuing operations before income taxes     83,391       4,040       (3,771 )     83,660       170,269       6,219       (5,771 )     170,717  
Income taxes     (137 )     (269 )     -       (406 )     (497 )     (448 )     -       (945 )
Net income     83,254       3,771       (3,771 )     83,254       169,772       5,771       (5,771 )     169,772  
Net income attributable to noncontrolling interest     (3,852 )     -       -       (3,852 )     (5,890 )     -       -       (5,890 )
Net income available to common stockholders   $ 79,402     $ 3,771     $ (3,771 )   $ 79,402     $ 163,882     $ 5,771     $ (5,771 )   $ 163,882  

 

 33

 

 

OMEGA HEALTHCARE INVESTORS, INC.

CONSOLIDATING STATEMENTS OF CASH FLOWS

Unaudited (in thousands)

 

    Nine Months Ended September 30, 2016  
    Issuer &
Subsidiary
Guarantors
    Non-Guarantor
Subsidiaries
    Elimination     Consolidated  
Cash flows from operating activities                                
Net income   $ 253,484     $ 5,270     $ (5,270 )   $ 253,484  
Adjustment to reconcile net income to cash provided by operating activities:                                
Depreciation and amortization     179,219       17,035             196,254  
Provision for impairment on real estate properties     58,508       218             58,726  
Provision for uncollectible mortgages, notes and accounts receivable     705       3,262             3,967  
Amortization of deferred financing and refinancing costs     8,919       38             8,957  
Accretion of direct financing leases     (8,999 )                 (8,999 )
Stock-based compensation     10,116                   10,116  
Gain on assets sold – net     (19,931 )                 (19,931 )
Amortization of acquired in-place leases - net     (10,957 )                 (10,957 )
Equity in earnings     (5,270 )           5,270        
Change in operating assets and liabilities – net of amounts assumed/acquired:                                
Accounts receivable – net     205       (2 )           203  
Straight-line rent receivables     (25,574 )     (4,385 )           (29,959 )
Lease inducements     1,942                   1,942  
Effective yield receivable on mortgage notes     (209 )                 (209 )
Other operating assets and liabilities     5,214       (11,571 )           (6,357 )
Net cash provided by operating activities     447,372       9,865             457,237  
Cash flows from investing activities                                
Acquisition of real estate – net of liabilities assumed and escrows acquired     (833,390 )     (126,358 )           (959,748 )
Investment in construction in progress     (44,113 )                 (44,113 )
Investments in subsidiaries     (120,741 )           120,741        
Investment in direct financing leases     (1,079 )                 (1,079 )
Placement of mortgage loans     (27,895 )                 (27,895 )
Proceeds from sale of real estate investments     64,746                   64,746  
Capital improvements to real estate investments     (29,761 )     (1,647 )           (31,408 )
Proceeds from other investments     47,901       1,581             49,482  
Investments in other investments     (240,865 )     (2,134 )           (242,999 )
Collection of mortgage principal     58,149                   58,149  
Net cash used in investing activities     (1,127,048 )     (128,558 )     120,741       (1,134,865 )
Cash flows from financing activities                                
Proceeds from credit facility borrowings     1,134,000                   1,134,000  
Payments on credit facility borrowings     (1,141,000 )                 (1,141,000 )
Receipts of other long-term borrowings     1,048,173                   1,048,173  
Payments of other long-term borrowings     (180,000 )     (934 )           (180,934 )
Payments of financing related costs     (11,746 )     (24 )           (11,770 )
Receipts from dividend reinvestment plan     229,769                   229,769  
Payments for exercised options and restricted stock – net     (23,403 )                 (23,403 )
Dividends paid     (333,663 )                 (333,663 )
Contributions from affiliate           120,741       (120,741 )      
Redemption of OP Units     (732 )                 (732 )
Distributions to OP Unit Holders     (15,738 )                 (15,738 )
Net cash provided by financing activities     705,660       119,783       (120,741 )     704,702  
                                 
Increase in cash and cash equivalents     25,984       1,090             27,074  
Effect of foreign currency translation on cash and cash equivalents           69             69  
Cash and cash equivalents at beginning of period     1,592       3,832             5,424  
Cash and cash equivalents at end of period   $ 27,576     $ 4,991     $     $ 32,567  

 

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OMEGA HEALTHCARE INVESTORS, INC.

CONSOLIDATING STATEMENTS OF CASH FLOWS

(in thousands)

 

    Nine Months Ended September 30, 2015  
    Issuer &
Subsidiary
Guarantors
    Non-Guarantor
Subsidiaries
    Elimination     Consolidated  
Cash flows from operating activities                                
Net income   $ 169,772     $ 5,771     $ (5,771 )   $ 169,772  
Adjustment to reconcile net income to cash provided by operating activities:                                
Depreciation and amortization     138,381       11,528             149,909  
Provision for impairment on real estate properties     14,641                   14,641  
Provision for uncollectible mortgages, notes and accounts receivable     292                   292  
Amortization of deferred financing and refinancing costs     13,381       16             13,397  
Accretion of direct financing leases     (8,124 )                 (8,124 )
Stock-based compensation     6,682                   6,682  
Gain on assets sold – net     (6,411 )                 (6,411 )
Amortization of acquired in-place leases - net     (4,264 )                 (4,264 )
Change in operating assets and liabilities – net of amounts assumed/acquired:                                
Accounts receivable, net     315                   315  
Straight-line rent receivables     (23,347 )     (3,218 )           (26,565 )
Lease inducements     347                   347  
Effective yield receivable on mortgage notes     (3,159 )                 (3,159 )
Other operating assets and liabilities     9,648       553       5,771       15,972  
Net cash provided by operating activities     308,154       14,650             322,804  
Cash flows from investing activities                                
Acquisition of real estate – net of liabilities assumed and escrows acquired     (110,806 )     (177,484 )           (288,290 )
Cash acquired in merger     84,858                   84,858  
Investment in construction in progress     (145,276 )                 (145,276 )
Investments in subsidiaries     (170,631 )     170,631              
Investment in direct financing leases     (6,793 )                 (6,793 )
Placement of mortgage loans     (7,601 )                 (7,601 )
Proceeds from sale of real estate investments     41,541                   41,541  
Capital improvements to real estate investments     (16,356 )     (1,798 )           (18,154 )
Proceeds from other investments     37,428                   37,428  
Investments in other investments     (49,489 )                 (49,489 )
Collection of mortgage principal     1,025                   1,025  
Net cash used in investing activities     (342,100 )     (8,651 )           (350,751 )
Cash flows from financing activities                                
Proceeds from credit facility borrowings     1,704,000                   1,704,000  
Payments on credit facility borrowings     (1,239,000 )                 (1,239,000 )
Receipts of other long-term borrowings     1,588,124                   1,588,124  
Payments of other long-term borrowings     (1,587,158 )     (905 )           (1,588,063 )
Payments of financing related costs     (30,709 )                 (30,709 )
Escrow deposit for other long-term borrowing     (614,998 )                 (614,998 )
Receipts from dividend reinvestment plan     65,665                   65,665  
Payments for exercised options and restricted stock – net     (26,168 )                 (26,168 )
Net proceeds from issuance of common stock     439,738                   439,738  
Dividends paid     (253,105 )                 (253,105 )
Distributions to OP Unit holders     (6,598 )                 (6,598 )
Net cash provided by (used in) financing activities     39,791       (905 )           38,886  
                                 
Increase in cash and cash equivalents     5,845       5,094             10,939  
Effect of foreign currency translation on cash and cash equivalents           (109 )           (109 )
Cash and cash equivalents at beginning of period     4,489                   4,489  
Cash and cash equivalents at end of period   $ 10,334     $ 4,985     $     $ 15,319  

 

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Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-looking Statements, Reimbursement Issues and Other Factors Affecting Future Results

 

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this document, including statements regarding potential future changes in reimbursement. This document contains forward-looking statements within the meaning of the federal securities laws. 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 Part I, Item 1A to our annual report on Form 10-K for the year ended December 31, 2015, and in Part II, Item 1A of our quarterly report on Form 10-Q for the quarters ended March 31, 2016 and June 30, 2016 and this report (if any);
(ii) uncertainties relating to the business operations of the operators of our assets, including those relating to reimbursement by third-party payors, regulatory matters and occupancy levels;
(iii) the ability of any operators in bankruptcy to reject unexpired lease obligations, modify the terms of our mortgages and impede our ability to collect unpaid rent or interest during the process of a bankruptcy proceeding and retain security deposits for the debtors’ obligations;
(iv) our ability to sell closed or foreclosed assets on a timely basis and on terms that allow us to realize the carrying value of these assets;
(v) our ability to manage, re-lease or sell any owned and operated facilities;
(vi) the availability and cost of capital to us;
(vii) changes in our credit ratings and the ratings of our debt securities;
(viii) competition in the financing of healthcare facilities;
(ix) regulatory and other changes in the healthcare sector;
(x) changes in the financial position of our operators;
(xi) the effect of economic and market conditions generally and, particularly, in the healthcare industry;
(xii) changes in interest rates;
(xiii) the amount and yield of any additional investments;
(xiv) changes in tax laws and regulations affecting real estate investment trusts, which we refer to as REITs;
(xv) the possibility that we will not realize estimated synergies or growth as a result of our merger with Aviv REIT, Inc., which was consummated on April 1, 2015, or that such benefits may take longer to realize than expected;
(xvi) the potential impact of changes in the skilled nursing facility (“SNF”) and assisted living facility (“ALF”) market or local real estate conditions on our ability to dispose of assets held for sale for the anticipated proceeds or on a timely basis, or to redeploy the proceeds therefrom on favorable terms; and
(xvii) our ability to maintain our status as a real estate investment trust.

 

Overview

 

Omega Healthcare Investors, Inc. (“Omega,” “we,” “our” or the “Company”) has one reportable segment consisting of investments in healthcare-related real estate properties located in the United States and the United Kingdom. Our core business is to provide financing and capital to the long-term healthcare industry with a particular focus on SNFs. Our core portfolio consists of long-term leases and mortgage agreements. All of our leases are “triple-net” leases, which require the tenants to pay all property-related expenses. Our mortgage revenue derives from fixed rate mortgage loans, which are secured by first mortgage liens on the underlying real estate and personal property of the mortgagor.

 

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Omega was formed as a real estate investment trust (“REIT”) and incorporated in the State of Maryland on March 31, 1992. In April 2015, Aviv REIT Inc., a Maryland corporation (“Aviv”), merged (the “Aviv Merger”) with and into a wholly owned subsidiary of Omega, pursuant to the terms of that certain Agreement and Plan of Merger, dated as of October 30, 2014 (the “Merger Agreement”), by and among the Company, Aviv, OHI Healthcare Properties Holdco, Inc., a Delaware corporation and a direct wholly-owned subsidiary of Omega (“Merger Sub”), OHI Healthcare Properties Limited Partnership, a Delaware limited partnership (“Omega OP”), and Aviv Healthcare Properties Limited Partnership, a Delaware limited partnership (the “Aviv OP”). As a result of the Aviv Merger, Omega acquired 342 facilities, two facilities subject to direct financing leases, one medical office building, two mortgages and other investments.

 

Prior to April 1, 2015 and in accordance with the Merger Agreement, Omega restructured the manner in which it holds its assets by converting to an umbrella partnership real estate investment trust structure (the “UPREIT Conversion”). As a result of the UPREIT Conversion and following the consummation of the Aviv Merger, substantially all of the Company’s assets are held by Omega OP.

 

Omega OP is governed by the Second Amended and Restated Agreement of Limited Partnership of OHI Healthcare Properties Limited Partnership, dated as of April 1, 2015 (the “Partnership Agreement”). Pursuant to the Partnership Agreement, the Company and Merger Sub are the general partners of Omega OP, and have exclusive control over Omega OP’s day-to-day management. As of September 30, 2016, the Company owned approximately 96% of the issued and outstanding units of partnership interest in Omega OP (“Omega OP Units”), and investors owned approximately 4% of the Omega OP Units.

 

Our portfolio of real estate investments at September 30, 2016, consisted of 1,014 healthcare facilities, located in 42 states and the United Kingdom and operated by 81 third party operators. Our gross investment in these facilities, net of impairments and before reserve for uncollectible loans, totaled approximately $8.9 billion at September 30, 2016, with approximately 99% of our real estate investments related to long-term care facilities. Our portfolio is made up of: (i) 816 SNFs, (ii) 101 ALFs, (iii) 16 specialty facilities, (iv) one medical office building, (v) fixed rate mortgages on 44 SNFs and two ALFs and (vi) 34 facilities that are closed/held-for-sale. At September 30, 2016, we also held miscellaneous investments of approximately $277.3 million, consisting primarily of secured loans to third-party operators of our facilities.

 

As of September 30, 2016 and December 31, 2015 we do not have any material properties or operators with facilities that are not materially occupied.

 

Our consolidated financial statements include the accounts of (i) Omega, (ii) Omega OP, and (iii) all direct and indirect wholly owned subsidiaries of Omega. All intercompany transactions and balances have been eliminated in consolidation.

 

Taxation

 

Since our inception, we have elected to be taxed as a REIT under the applicable provisions of the Internal Revenue Code (the “Code”). A REIT is generally not subject to federal income tax on that portion of its REIT taxable income which is distributed to its stockholders, provided that at least 90% of such taxable income is distributed each tax year and certain other requirements are met, including asset and income tests. So long as we qualify as a REIT under the Code, we generally will not be subject to federal income taxes on the REIT taxable income that we distribute to stockholders, subject to certain exceptions.

 

If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to federal income taxes on its taxable income at regular corporate rates and dividends paid to our stockholders will not be deductible by us in computing taxable income. Further, we will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year in which qualification is denied, unless the Internal Revenue Service grants us relief under certain statutory provisions. Failing to qualify as a REIT could materially and adversely affect the Company’s net income; however, we believe we are organized and operate in such a manner as to qualify for treatment as a REIT. On a quarterly and annual basis, we test our compliance within the REIT taxation rules to ensure that we are in compliance with the REIT rules. We review our distributions and projected distributions each year to ensure we have met and will continue to meet the annual REIT distribution requirements. In 2016, we expect to distribute dividends in excess of our taxable income.

 

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As a result of our UPREIT Conversion, our Company and its subsidiaries may be subject to income or franchise taxes in certain states and municipalities. Also, as a result of our UPREIT Conversion, we created five wholly owned subsidiary REITs that are subject to all of the REIT qualification rules set forth in the Code. In December 2015, we merged the five wholly owned subsidiary REITs into one wholly owned subsidiary REIT which is subject to all of the REIT qualification rules set forth in the Code.

 

Subject to the limitation under the REIT asset test rules, we are permitted to own up to 100% of the stock of one or more taxable REIT subsidiaries (“TRSs”). We have elected for two of our active subsidiaries to be treated as TRSs. One of our TRSs is subject to federal, state and local income taxes at the applicable corporate rates and the other is subject to foreign income taxes. As of September 30, 2016, our TRS that is subject to federal, state and local income taxes at the applicable corporate rates had a net operating loss carry-forward of approximately $0.8 million. The loss carry-forward is fully reserved as of September 30, 2016, with a valuation allowance due to uncertainties regarding realization.

 

During the third quarter of 2016, we recorded approximately $0.3 million of state and local income tax provision and approximately $0.2 million of tax benefit for foreign income taxes. For the nine months ended September 30, 2016, we recorded approximately $0.8 million of state and local income tax provision and approximately $35,000 of tax benefit for foreign income taxes.

 

Government Regulation and Reimbursement

 

The healthcare industry is heavily regulated. Our operators are subject to extensive and complex federal, state and local healthcare laws and regulations. These laws and regulations are subject to frequent and substantial changes resulting from the adoption of new legislation, rules and regulations, and administrative and judicial interpretations of existing law. The ultimate timing or effect of these changes, which may be applied retroactively, cannot be predicted. Changes in laws and regulations impacting our operators, in addition to regulatory non-compliance by our operators, can have a significant effect on the operations and financial condition of our operators, which in turn may adversely impact us. The following is a discussion of certain laws and regulations generally applicable to our operators, and in certain cases, to us.

 

Healthcare Reform. A substantial amount of rules and regulations have been issued under the Patient Protection and Affordable Care Act, as amended by the Health Care and Education and Reconciliation Act of 2010 (collectively referred to as the “Healthcare Reform Law”). We expect additional rules, regulations and interpretations under the Healthcare Reform Law to be issued that may materially affect our operators’ financial condition and operations.

 

Given the complexity of the Healthcare Reform Law and the substantial requirements for regulation thereunder, the impact of the Healthcare Reform Law on our operators or their ability to meet their obligations to us cannot be predicted. The Healthcare Reform Law could result in decreases in payments to our operators or otherwise adversely affect the financial condition of our operators, thereby negatively impacting our financial condition. Our operators may not be successful in modifying their operations to lessen the impact of any increased costs or other adverse effects resulting from changes in governmental programs, private insurance and/or employee welfare benefit plans. The impact of the Healthcare Reform Law on each of our operators will vary depending on payor mix, resident conditions and a variety of other factors. In addition to the provisions relating to reimbursement, other provisions of the Healthcare Reform Law may impact our operators as employers (e.g., requirements related to providing health insurance for employees).

 

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Reform Requirements for Long-Term Care Facilities. On September 28, 2016, the Centers for Medicare and Medicaid Services (“CMS”) issued a final rule modifying the conditions of participation in Medicare and Medicaid for SNFs. CMS stated that the regulations, last updated in 1991, were “necessary to reflect the substantial advances that had been made over the past several years in the theory and practice of service delivery and safety” within long-term care. The revisions are extensive and will require SNFs to implement new processes, make changes to current practices, and create new policies and procedures within a short timeframe to remain in compliance with their conditions for participation. Changes include provisions related to staff training, discharge planning, infection prevention and control programs, and pharmacy services, among others. While most of the regulations become effective on November 28, 2016, some of the regulations become effective in Phase 2, beginning on November 28, 2017, while others become effective in Phase 3 on November 28, 2019. According to CMS, it is estimated that the average cost for a SNF to implement the new regulations is estimated to be $62,900 the first year and $55,000 each year thereafter.

 

Reimbursement Generally. A significant portion of our operators’ revenue is derived from government-funded reimbursement programs, consisting primarily of Medicare and Medicaid. As federal and state governments focus on healthcare reform initiatives, and as the federal government and many states face significant current and future budget deficits, efforts to reduce costs by government payors will likely continue, which may result in reductions in reimbursement at both the federal and state levels. Additionally, new and evolving payor and provider programs, including but not limited to Medicare Advantage, dual eligible, accountable care organizations, and bundled payments could adversely impact our tenants’ and operators’ liquidity, financial condition or results of operations.

 

We currently believe that our operator coverage ratios are adequate and that our operators can absorb moderate reimbursement rate reductions and still meet their obligations to us. However, significant limits on the scope of services reimbursed and/or reductions of reimbursement rates could have a material adverse effect on our operators’ results of operations and financial condition, which could adversely affect our operators’ ability to meet their obligations to us.

 

Medicaid. State budgetary concerns, coupled with the implementation of rules under the Healthcare Reform Law, may result in significant changes in healthcare spending at the state level. Many states are currently focusing on the reduction of expenditures under their state Medicaid programs, which may result in a reduction in reimbursement rates for our operators. The need to control Medicaid expenditures by the states may be exacerbated by the potential for increased enrollment in Medicaid due to unemployment and declines in family incomes. Since our operators’ profit margins on Medicaid patients are generally relatively low, more than modest reductions in Medicaid reimbursement or an increase in the number of Medicaid patients could adversely affect our operators’ results of operations and financial condition, which in turn could negatively impact us.

 

The Healthcare Reform Law provided for Medicaid coverage to be expanded to all individuals under age 65 with incomes up to 133% of the federal poverty level, beginning January 1, 2014. The federal government committed to paying the entire cost for Medicaid coverage for newly eligible beneficiaries from 2014 through 2016. In 2017, the federal share will decline to 95%; in 2018, to 94%; in 2019, to 93%; and in 2020 and subsequent years, to 90%. However, the Supreme Court ruled on June 28, 2012 that states could not be required to expand Medicaid or risk losing federal funding of their existing Medicaid programs. As of June 30, 2016, thirty-two (32) states including the District of Columbia have expanded or are expanding Medicaid coverage as contemplated by the Healthcare Reform Law, with many of the remaining states involved in a variety of legislative proposals or discussions.

 

Medicare. On July 29, 2016, CMS issued a final rule regarding the FY 2017 Medicare payment rates and quality programs for SNFs, which continues the trend of shifting Medicare payments from volume to value. Aggregate payments to SNFs in FY 2017 will increase by $920 million or 2.4% over fiscal year 2016 payments. This increase is attributable to a 2.7% market basket increase, reduced by 0.3% in accordance with the multifactor productivity adjustment required by law. The new payment rates are effective on October 1, 2016.

 

As indicated above, a significant goal of the Healthcare Reform Law is to transform the delivery of health care by changing reimbursement for health care services to hold providers accountable for the cost and quality of care provided. Reimbursement methodology reforms which are becoming increasingly prevalent under health care reform include value-based purchasing, in which a portion of a provider or facility’s reimbursement is redistributed based on relative performance on designated economic, clinical quality, and patient satisfaction metrics. These reimbursement methodologies and similar programs are expected to expand, both in public and commercial health plans.

 

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On April 1, 2014, President Obama signed the “Protecting Access to Medicare Act of 2014” which called for the U.S. Department of Health and Human Services (“HHS”) to develop a value based purchasing program for SNFs aimed at lowering readmission rates beginning on October 1, 2018. Since that time, several other quality related reimbursement initiatives have been introduced or implemented. On April 26, 2015, CMS announced its goal to have 30% of Medicare payments for quality and value through alternative payment models such as Accountable Care Organizations or bundled payments by 2016 and up to 50% by the end of 2018. In March 2016, CMS announced that its 30% target for 2016 was reached in January 2016.

 

On April 1, 2016, CMS’s bundled payment program for Lower Extremity Joint Replacement (“CJR”) procedures went into effect.  The CJR bundled payment program is mandatory for all hospitals paid under the Medicare Inpatient Prospective Payment System and located in the 67 selected metropolitan areas. Through this bundled payment model, hospitals in the 67 selected metropolitan areas will receive additional payments if quality and costs exceed defined parameters or, if not, have to repay Medicare for a portion of the spending. On July 25, 2016, CMS proposed rulemaking to extend effective July 1, 2017, the CJR bundled payment models for these same areas for hip/femur fracture surgeries. The proposed rulemaking would also add bundled payment models for heart attacks and bypass surgeries in 98 randomly selected metropolitan areas effective July 1, 2017. As a result, Medicare revenues at SNFs related to hospital discharges subject to bundled payment programs in the identified geographic areas could either be either positively or negatively affected by the bundled payment program.

 

Other Medicare reimbursement initiatives which were first implemented over a year ago continue to have the potential to negatively impact Medicare revenues. The “Medicare Access and CHIP Reauthorization Act of 2015” extended the Medicare therapy cap exceptions process through December 31, 2017. The statutory Medicare Part B outpatient cap for occupational therapy is $1,960 for 2016, and the combined cap for physical therapy and speech therapy is also $1,960 for 2016. These caps do not apply to therapy services covered under Medicare Part A for SNFs, 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 exception process permits medically necessary therapy services beyond the cap limits. Expiration of the therapy cap exceptions process in the future could have a material adverse effect on our operators’ financial condition and operations, which could adversely impact their ability to meet their obligations to us.

 

The “Bipartisan Budget Act of 2015” (“BBA”) was signed by President Obama on November 2, 2015. While the BBA provides $80 billion in discretionary spending sequestration relief over two years, it also extended Medicare sequestration, which generally cuts Medicare provider and plan payments by 2% across the board, for an additional year, through 2025. The BBA also provides a uniform 2% reduction for 2024 instead of applying different rates during the first and second halves of the fiscal year. However, the fiscal year 2025 sequestration will be “front loaded,” such that, a 4% reduction will apply during the first six months of the fiscal year and no reduction will be imposed during the second half of the fiscal year.

 

Quality of Care Initiatives. In addition to quality or value based reimbursement reforms, CMS has implemented a number of initiatives focused on the quality of care provided by long term care facilities that could affect our operators. On December 2008, CMS released quality ratings for all of the nursing homes that participate in Medicare or Medicaid under its “Five Star Quality Rating System.” Facility rankings, ranging from five stars (“much above average”) to one star (“much below average”) are updated on a monthly basis. SNFs are required to provide information for the CMS Nursing Home Compare website regarding staffing and quality measures. Based on this data and the results of state health inspections, SNFs are then rated based on the five-star rating system.

 

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In furtherance of CMS’s goal of changing the rating system to increase the number and type of quality measures not solely based on self-reported data, CMS modified the new quality measures for SNFs in August 2016. The new measures are based primarily on Medicare claims data submitted by hospitals, including the following measures: (1) percentage of short-stay residents who were successfully discharged to the community; (2) percentage of short-stay residents who have had an outpatient emergency department visit; (3) percentage of short-stay residents who were re-hospitalized after a nursing home admission; (4) percentage of short-stay residents who made improvements in function; and (5) percentage of long-stay residents whose ability to move independently worsened. The sixth new quality measure, the antianxiety/hypnotic medication measure, was rejected due to difficulty in setting appropriate benchmarks for the acceptable use of the medications. These ratings were incorporated into the nursing home rating system in July 2016 and are being phased in slowly, with half of their value applied in July and full value applied in January 2017. It is possible that this or any other ranking system could lead to future reimbursement policies that reward or penalize facilities on the basis of the reported quality of care parameters.

 

CMS has incorporated hospital readmissions review into the Quality Indicators Survey. Under Medicare’s Inpatient Prospective Payment System, CMS began adjusting payments to hospitals for excessive readmissions of patients for heart attacks, heart failure and pneumonia during fiscal years beginning on and after October 1, 2012. Long term care facilities are under increased scrutiny to prevent residents from being readmitted to hospitals for these conditions in particular, and have an opportunity to demonstrate their quality of care by reducing their hospital readmission rates. The quality measures added on April 27, 2016 include a readmission measure, indicating that hospital readmissions will be a consideration in the CMS five-star rating system. Effective September 1, 2016, additional heightened and costly disciplinary remedies became applicable to SNFs. Any SNF that receives a Quality Indicators Survey deficiency cited at a Scope and Severity level of J or higher will be automatically and immediately assessed civil monetary penalties by CMS. There is no opportunity to correct the deficiencies to avoid the penalties.

 

Office of the Inspector General Activities. The Office of Inspector General’s (the “OIG”) Mid-Year Update to its Work Plan for government fiscal year 2016, which describes projects that the OIG plans to address during the fiscal year, includes three projects related specifically to nursing homes: (1) compliance with the SNF prospective payment system related to a three-day qualifying inpatient hospital stay; (2) implementation of a national background check program for long-term care employees; and (3) potentially avoidable hospitalizations of nursing home residents due to urinary tract infections.

 

Department of Justice. SNFs are under intense scrutiny for the quality of care being rendered to residents and appropriate billing practices. The Department of Justice launched ten regional Elder Justice Task Forces in 2016 which are coordinating and enhancing efforts to pursue SNFs that provide grossly substandard care to their residents. They are also focusing on therapy billing issues. These Task Forces are composed of representatives from the U.S. Attorneys’ Offices, State Medicaid Fraud Control Units, state and local prosecutors’ offices, HHS, State Adult Protective Services agencies, Long Term Care Ombudsmen programs, and law enforcement.

 

Fraud and Abuse. There are various federal and state civil and criminal laws and regulations governing a wide array of healthcare provider referrals, relationships and arrangements, including laws and regulations prohibiting fraud by healthcare providers. Many of these complex laws raise issues that have not been clearly interpreted by the relevant governmental authorities and courts.

 

These laws include: (i) federal and state false claims acts, which, among other things, prohibit providers from filing false claims or making false statements to receive payment from Medicare, Medicaid or other federal or state healthcare programs; (ii) federal and state anti-kickback and fee-splitting statutes, including the Medicare and Medicaid anti-kickback statute, which prohibit the payment or receipt of remuneration to induce referrals or recommendations of healthcare items or services, such as services provided in a SNF; (iii) federal and state physician self-referral laws (commonly referred to as the Stark Law), which generally prohibit referrals by physicians to entities for designated health services (some of which are provided in SNFs) with which the physician or an immediate family member has a financial relationship; (iv) the federal Civil Monetary Penalties Law, which prohibits, among other things, the knowing presentation of a false or fraudulent claim for certain healthcare services and (v) federal and state privacy laws, including the privacy and security rules contained in the Health Insurance Portability and Accountability Act of 1996, which provide for the privacy and security of personal health information.

 

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Violations of healthcare fraud and abuse laws carry civil, criminal and administrative sanctions, including punitive sanctions, monetary penalties, imprisonment, denial of Medicare and Medicaid reimbursement and potential exclusion from Medicare, Medicaid or other federal or state healthcare programs. Additionally, there are criminal provisions that prohibit filing false claims or making false statements to receive payment or certification under Medicare and Medicaid, as well as failing to refund overpayments or improper payments. Violation of the anti-kickback statute or Stark Law may form the basis for a federal False Claims Act violation. These laws are enforced by a variety of federal, state and local agencies and can also be enforced by private litigants through, among other things, federal and state false claims acts, which allow private litigants to bring qui tam or whistleblower actions, which have become more frequent in recent years.

 

Privacy. Our operators are subject to various federal, state and local laws and regulations designed to protect the confidentiality and security of patient health information, including the federal Health Insurance Portability and Accountability Act of 1996, as amended, the Health Information Technology for Economic and Clinical Health Act, and the corresponding regulations promulgated thereunder (collectively referred to herein as “HIPAA”). In March 2016, the HHS Office for Civil Rights began Phase 2 of its HIPAA Audit Program, which includes a review of business associates as well as covered entities. The audit focuses on compliance with the Privacy, Security, and Breach Notification Rules.

 

Various states have similar laws and regulations that govern the maintenance and safeguarding of patient records, charts and other information generated in connection with the provision of professional medical services. These laws and regulations require our operators to expend the requisite resources to secure protected health information, including the funding of costs associated with technology upgrades. Operators found in violation of HIPAA or any other privacy law or regulation may face large penalties. In addition, compliance with an operator’s notification requirements in the event of a breach of unsecured protected health information could cause reputational harm to an operator’s business.

 

Licensing and Certification. Our operators and facilities are subject to various federal, state and local licensing and certification laws and regulations, including laws and regulations under Medicare and Medicaid requiring operators of SNFs and ALFs to comply with extensive standards governing operations. Governmental agencies administering these laws and regulations regularly inspect our operators’ facilities and investigate complaints. Our operators and their managers receive notices of observed violations and deficiencies from time to time, and sanctions have been imposed from time to time on facilities operated by them. In addition, many states require certain healthcare providers to obtain a certificate of need, which requires prior approval for the construction, expansion or closure of certain healthcare facilities, which has the potential to impact some of our operators’ abilities to expand or change their businesses.

 

Americans with Disabilities Act (the “ADA”). Our properties must comply with the ADA and any similar state or local laws to the extent that such properties are public accommodations as defined in those statutes. The ADA may require removal of barriers to access by persons with disabilities in certain public areas of our properties where such removal is readily achievable. Should barriers to access by persons with disabilities be discovered at any of our properties, we may be directly or indirectly responsible for additional costs that may be required to make facilities ADA-compliant. Noncompliance with the ADA could result in the imposition of fines or an award of damages to private litigants. Our commitment to make readily achievable accommodations pursuant to the ADA is ongoing, and we continue to assess our properties and make modifications as appropriate in this respect.

 

Other Laws and Regulations. Additional federal, state and local laws and regulations affect how our operators conduct their operations, including laws and regulations protecting consumers against deceptive practices and otherwise generally affecting our operators’ management of their property and equipment and the conduct of their operations (including laws and regulations involving fire, health and safety; quality of services, including care and food service; residents’ rights, including abuse and neglect laws; and the health standards set by the federal Occupational Safety and Health Administration).

 

General and Professional Liability. Although arbitration agreements have been effective in limiting general and professional liabilities for SNF and long term care providers, there have been numerous lawsuits challenging the validity of arbitration agreements in long term care settings. As set forth in the recent conditions of participation final rule issued on September 28, 2016, pre-dispute arbitration agreements between SNFs and residents are prohibited by CMS effective November 28, 2016, thereby increasing potential liabilities for SNFs and long-term care providers. However, the authority of CMS to restrict the rights of these parties to arbitrate may be challenged by litigation.

 

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Critical Accounting Policies and Estimates

 

Our financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States, and a summary of our significant accounting policies is included in Note 2 – Summary of Significant Accounting Policies to our Current Report on Form 8-K filed with the SEC on June 30, 2016. Our preparation of the financial statements requires us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and accompanying footnotes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such difference may be material to the consolidated financial statements. We have described our most critical accounting policies in our 2015 Annual Report on Form 10-K in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

There have been no changes to our critical accounting policies or estimates since December 31, 2015. See Note 2 – Summary of Significant Accounting Policies to our Current Report on Form 8-K filed with the SEC on June 30, 2016.

 

Recent Accounting Pronouncements

 

In 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which outlines a comprehensive model for entities to use in accounting for revenue arising from contracts with customers. ASU 2014-09 states that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” While ASU 2014-09 specifically references contracts with customers, it may apply to certain other transactions such as the sale of real estate or equipment. ASU 2014-09 is effective for the Company beginning January 1, 2018. In addition, the FASB has begun to issue targeted updates to clarify specific implementation issues of ASU 2014-09. These updates include ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU 2016-10, Identifying Performance Obligations and Licensing, and ASU 2016-12, Narrow-Scope Improvements and Practical Expedients.  The Company is currently evaluating the provisions of ASU 2014-09 and its related updates and will be closely monitoring developments and additional guidance to determine the potential impact of the new standard. The Company intends to adopt ASU 2014-09 and its subsequent updates retrospectively. We do not expect the adoption of ASU 2014-09 and its updates to have a significant impact on our consolidated financial statements, as a substantial portion of our revenue consists of rental income from leasing arrangements, which are specifically excluded from ASU 2014-09.

 

In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis (“ASU 2015-02”), which amends certain requirements for determining whether a variable interest entity must be consolidated. The amendments in ASU 2015-02 are effective for annual and interim reporting periods of public entities beginning after December 31, 2015 and were adopted by the Company during the quarter ended March 31, 2016. The effect of this guidance was immaterial to the Company’s consolidated results of operations, financial position and cash flows.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (“ASU 2016-01”), which makes limited amendments to the guidance in U.S. GAAP on the classification and measurement of financial instruments. The new standard significantly revises an entity's accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. It also amends certain disclosure requirements associated with the fair value of financial instruments. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, including interim periods therein. Early adoption is permitted specifically for the amendments pertaining to the presentation of certain fair value changes for financial liabilities measured at fair value.  Early adoption of all other amendments is not permitted. Upon adoption, the Company will be required to make a cumulative-effect adjustment to the Consolidated Balance Sheet as of the beginning of the first reporting period in which the guidance is effective. We are currently evaluating the impact of adopting ASU 2016-01 on our consolidated financial statements.

 

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In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”), which amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. ASU 2016-02 will be effective for the Company beginning January 1, 2019. Early adoption of ASU 2016-02 as of its issuance is permitted. The new standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. We are currently evaluating the impact of adopting ASU 2016-02 on our consolidated financial statements.

 

In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718) (“ASU 2016-09”). ASU 2016-09 amends the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. This guidance is effective for annual and interim reporting periods of public entities beginning after December 15, 2017, with early adoption permitted. We are currently evaluating the impact of adopting ASU 2016-09 on our consolidated financial statements.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) (“ASU 2016-13”), which changes the impairment model for most financial assets. The new model uses a forward-looking expected loss method, which will generally result in earlier recognition of allowances for losses. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019 and early adoption is permitted for annual and interim periods beginning after December 15, 2018. We are currently evaluating the impact of adopting ASU 2016-13 on our consolidated financial statements.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 eliminates the diversity in practice related to the classification of certain cash receipts and payments for debt prepayment or extinguishment costs, the maturing of a zero coupon bond, the settlement of contingent liabilities arising from a business combination, proceeds from insurance settlements, distributions from certain equity method investees and beneficial interests obtained in a financial asset securitization. ASU 2016-15 designates the appropriate cash flow classification, including requirements to allocate certain components of these cash receipts and payments among operating, investing and financing activities. The retrospective transition method, requiring adjustment to all comparative periods presented, is required unless it is impracticable for some of the amendments, in which case those amendments would be applied prospectively as of the earliest date practicable. ASU No. 2016-15 is effective for annual and interim periods beginning after December 15, 2017 and early adoption is permitted. We are currently evaluating the impact of adopting ASU 2016-15 on our consolidated financial statements.

 

Results of Operations

 

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

 

Three Months Ended September 30, 2016 and 2015

 

Operating Revenues

 

Our operating revenues for the three months ended September 30, 2016, totaled $224.6 million, an increase of $22.7 million over the same period in 2015. The $22.7 million increase was primarily the result of: (i) $19.2 million of rental income associated with acquisitions and lease amendments made throughout 2016 and 2015 and (ii) a $4.3 million increase in other investment income primarily related to new notes and additional funding to existing operators.

 

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Operating Expenses

 

Operating expenses for the three months ended September 30, 2016, totaled $100.3 million, an increase of approximately $24.4 million over the same period in 2015. The increase was primarily due to: a (i) $15.5 million increase in provision for impairment losses as a result of the Company’s plan to exit certain facilities and (ii) an $8.2 million increase in depreciation and amortization expense due to new acquisitions completed since September 2015.

 

Other Income (Expense)

 

For the three months ended September 30, 2016, total other expenses were $47.2 million, an increase of approximately $7.2 million over the same period in 2015. The increase was primarily related to: (i) $4.7 million increase in interest expense related to higher debt balances outstanding to fund new investments and (ii) a $1.8 million increase in interest refinancing costs resulting from the acquisition of the $180.0 million mortgage term loan on July 25, 2016.

 

Nine Months Ended September 30, 2016 and 2015

 

Operating Revenues

 

Our operating revenues for the nine months ended September 30, 2016, totaled $666.3 million, an increase of $133.2 million over the same period in 2015. The $133.2 million increase was primarily the result of: (i) $64.6 million of rental income associated with the Aviv Merger; (ii) $8.9 million of rental income related to the Care Homes Transaction and other acquisitions and lease amendments in the United Kingdom, (iii) $44.8 million of additional rental income associated with other acquisitions and lease amendments made throughout 2016 and 2015, (iv) $10.3 million increase in other investment income primarily related to new notes and additional funding to existing operators and (v) a $2.6 million increase in mortgage interest income which includes a net gain of approximately $5.4 million resulting from an operator repaying certain mortgages.

 

Operating Expenses

 

Operating expenses for the nine months ended September 30, 2016, totaled $303.2 million, an increase of approximately $56.4 million over the same period in 2015. The increase was primarily due to: (i) a $46.3 million increase in depreciation and amortization expense due to new acquisitions completed since September 2015, (ii) a $44.1 million increase in provision for impairment losses as a result of the Company exiting certain facilities, (iii) an $8.2 million increase in general and administrative expenses primarily due to the Aviv Merger and (iv) a $3.7 million increase in provision for uncollectible mortgages, notes and accounts receivable primarily related to the write-off of approximately $3.4 million of straight line receivable from a former operator, offset by a $45.9 million decrease in acquisition and merger costs related to the Aviv Merger that occurred on April 1, 2015.

 

Other Income (Expense)

 

For the nine months ended September 30, 2016, total other expenses were $128.8 million, an increase of approximately $6.8 million over the same period in 2015. The increase was primarily the result of an increase of $11.0 million in interest expense due to an increase in borrowings outstanding to fund new investments since September 2015 and $1.8 million of increased amortization related to deferred financing costs, offset by a decrease of $6.2 million in interest refinancing costs. In 2015, we incurred $8.4 million in interest refinance costs related to the redemption of our $200 million 7.5% notes due 2020 and early retirement of 22 mortgage loans guaranteed by U.S. Department of Housing and Urban Development (“HUD”). In 2016, we incurred $2.1 million in interest refinancing cost primarily related to a $1.8 million premium related to the acquisition of the $180.0 million mortgage term loan.

 

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National Association of Real Estate Investment Trusts Funds From Operations

 

Our funds from operations (“NAREIT FFO”) for the three months ended September 30, 2016 was $162.6 million compared to $147.5 million for the same period in 2015. Our NAREIT FFO for the nine months ended September 30, 2016 was $488.5 million compared to $327.9 million for the same period in 2015.

 

We calculate and report NAREIT FFO in accordance with the definition of Funds from Operations and interpretive guidelines issued by the National Association of Real Estate Investment Trusts (“NAREIT”), and, consequently, NAREIT FFO is defined as net income, adjusted for the effects of asset dispositions and certain non-cash items, primarily depreciation and amortization and impairment on real estate assets. We believe that NAREIT 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. NAREIT FFO was designed by the real estate industry to address this issue. NAREIT FFO herein is not necessarily comparable to NAREIT FFO of other REITs that do not use the same definition or implementation guidelines or interpret the standards differently from us.

 

NAREIT FFO is a non-GAAP financial measure. We use NAREIT 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, impairment on real estate assets 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, NAREIT 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 NAREIT 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 NAREIT FFO results for the three- and nine- months ended September 30, 2016 and 2015:

 

    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2016     2015     2016     2015  
    (in thousands)  
                                 
Net income   $ 82,134     $ 83,254     $ 253,484     $ 169,772  
(Deduct gain)/add back loss from real estate dispositions     (5,139 )     2,391       (19,931 )     (6,411 )
Sub-total     76,995       85,645       233,553       163,361  
Elimination of non-cash items included in net income:                                
Depreciation and amortization     68,316       60,143       196,254       149,909  
Add back impairments on real estate properties     17,275       1,743       58,726       14,641  
NAREIT FFO (a)   $ 162,586     $ 147,531     $ 488,533     $ 327,911  

 

(a)       Includes amounts allocated to Omega stockholders and Omega OP Unit holders.

 

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Portfolio and Recent Developments

 

The following table summarizes the significant acquisitions that occurred in 2016.

 

    Number of
Facilities
                Land     Building & Site
Improvements
    Furniture
& Fixtures
    Initial
Annual
 
Period   SNF     ALF     Country/
State
  Total
Investment
  (in millions)     Cash
Yield
(%)
 
Q1     -       1     UK   $ 8.3       $ 1.4     $ 6.7     $ 0.2       7.00  
Q1     -       1     UK     6.1         0.6       5.3       0.2       7.00  
Q1     10       -     OH, VA, MI     169.0   (3)     10.5       152.5       6.0       8.50  
Q1     -       2     GA     20.2         0.8       18.3       1.1       7.50  
Q1     3       -     MD     25.0         2.5       19.9       2.6       8.50  
Q1     21       -     VA, NC     212.5         19.3       181.1       12.1       8.50  
Q2     -       10     UK     111.9   (4)     24.8       83.9       3.2       7.00  
Q2     -       3     TX     66.0   (5)     5.8       58.6       1.6       6.80  
Q2     3       -     CO, MO     31.8         3.1       26.2       2.5       9.00  
Q3     -       1     FL     4.3   (1)     2.3       1.8       0.2       8.00  
Q3     -       1     GA     2.5   (1)     0.2       2.1       0.2       8.00  
Q3     -       1     FL     16.5   (1)     1.8       14.3       0.4       8.00  
Q3     1       -     SC     10.1   (1)     2.7       6.5       0.9       9.00  
Q3     1       -     OH     9.0   (1)(6)     -       8.6       0.4       9.00  
Q3     31       -     FL, KY,TN     329.6   (1)(2)     24.6       290.8       14.2       9.00  
Total     70       20         $ 1,022.8       $ 100.4     $ 876.6     $ 45.8          

 

(1) The Company estimated the fair value of the assets acquired on the acquisition date based on certain valuation analyses that have yet to be finalized, and accordingly, the assets acquired, as detailed, are subject to adjustment once the analysis is completed.
(2) The Company’s investment includes a purchase option buyout obligation with a fair value of approximately $29.6 million. The future buyout obligation is recorded in accrued expenses and other liabilities on our Consolidated Balance Sheet. The Company also acquired a term loan with a fair value of approximately $37.0 million which is recorded in other investments on our Consolidated Balance Sheet. Refer to Note – 5 Other Investments.
(3) Acquired from a related party. Refer to Note – 1 Related Party Transactions.
(4) Omega also recorded a deferred tax asset of approximately $1.9 million in connection with the acquisition.
(5) The Company paid $63.0 million in cash at closing to acquire the facilities. We have agreed to pay an additional $1.5 million in April 2017 and the remaining $1.5 million in April 2018. The additional consideration to be paid is contractually determined and not contingent on other factors. The $3.0 million liability is recorded in unsecured borrowings – net on our Consolidated Balance Sheet.
(6) The Company paid approximately $3.5 million in cash to acquire the facility. The remainder of the purchase price million (approximately $5.5 million) was funded with the redemption of an other investment note.

 

During 2016, the Company also acquired three parcels of land which are not reflected in the table above for approximately $5.9 million with the intent of building new facilities for existing operators.

 

Acquisition of Aviv by Merger

 

On April 1, 2015, Omega completed the Aviv Merger, which was structured as a stock-for-stock merger. Under the terms of the Merger Agreement, each outstanding share of Aviv common stock was converted into 0.90 of a share of Omega common stock. In connection with the Aviv Merger, Omega issued approximately 43.7 million shares of common stock to former Aviv stockholders. As a result of the Aviv Merger, Omega acquired 342 facilities, two facilities subject to direct financing leases, one medical office building, two mortgages and other investments. Omega also assumed certain outstanding equity awards and other debt and liabilities. Based on the closing price of Omega’s common stock on April 1, 2015, the fair value of the consideration exchanged was approximately $2.3 billion.

 

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The following table highlights the final allocation of the assets acquired, liabilities assumed, and consideration exchanged on April 1, 2015 (in thousands):

 

Fair value of net assets acquired:        
Land and buildings   $ 3,107,530  
Investment in direct financing leases     26,823  
Mortgages notes receivable     19,246  
Other investments     23,619  
Total investments     3,177,218  
Goodwill     630,679  
Accounts receivables and other assets     17,144  
Cash acquired     84,858  
Accrued expenses and other liabilities     (223,002 )
Debt     (1,410,637 )
Fair value of net assets acquired   $ 2,276,260  

 

The completion of the final valuation in the first quarter of 2016 did not result in material changes to our Consolidated Statements of Operations or our Consolidated Balance Sheets from our preliminary purchase price allocation.

 

Asset Impairments, Asset Sales and Assets Held for Sale

 

During the first quarter of 2016, we recorded approximately $34.6 million of impairments on 14 facilities located in six states. We reduced their net book values to their estimated fair value less costs to sell and reclassified them to assets held for sale in the first quarter of 2016. In addition, we sold two SNFs previously classified as assets held for sale for approximately $2.4 million in net proceeds recognizing a gain on sale of approximately $1.6 million. We also reclassified eight ALFs, and 16 SNFs to assets held for sale with a total carrying value of $67.6 million.

 

During the second quarter of 2016, we recorded approximately $6.9 million of impairments on 15 facilities of which 12 were classified as held for sale as of June 30, 2016. We reduced their net book values to their estimated fair value less costs to sell. In addition, we sold 11 facilities (seven were previously held for sale) for approximately $41.4 million in net proceeds recognizing a net gain of approximately $13.2 million. We also reclassified three SNFs and one ALF to assets held for sale with total carrying value of $7.2 million.

 

During the third quarter of 2016, we recorded approximately $17.3 million of impairments on 12 facilities of which ten are classified as held for sale at September 30, 2016. We reduced their net book values to their estimated fair value less costs to sell. In addition, we sold six facilities for approximately $21.0 million in net proceeds recognizing a net gain of approximately $5.1 million. One of the sold facilities was previously classified as held-for-sale. We also reclassified 12 SNFs and one ALF to assets held for sale with a total carrying value of $47.4 million. In addition, two SNFs and one ALF classified as assets held for sale in the second quarter were no longer considered held for sale and were reclassified back to leased properties at their fair values (approximately $7.0 million).

 

Our recorded impairments were primarily the result of a decision to exit certain non-strategic facilities and operators primarily related to facilities acquired in the Aviv Merger.

 

Liquidity and Capital Resources

 

At September 30, 2016, we had total assets of $9.0 billion, total equity of $4.2 billion and debt of $4.4 billion, representing approximately 51.5% of total capitalization.

 

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Financing Activities and Borrowing Arrangements

 

Certain of our other secured and unsecured borrowings are subject to customary affirmative and negative covenants, including financial covenants. As of September 30, 2016 and December 31, 2015, we were in compliance with all affirmative and negative covenants, including financial covenants, for our secured and unsecured borrowings.

 

Mortgage Term Loan

 

As a result of the Aviv Merger in April 2015, we acquired two subsidiaries that were borrowers under a $180.0 million mortgage term loan secured by mortgages on 28 healthcare facilities owned by one of the borrowers. On July 25, 2016, we purchased the $180.0 million mortgage term loan, effectively eliminating the debt on our consolidated financial statements. The term loan was secured by real estate assets having a net carrying value of $290.5 million at June 30, 2016. The interest rate was based on LIBOR, with a floor of 50 basis points, plus a margin of 350 basis points. The interest rate at June 30, 2016 was 4.13%. We paid $180.0 million plus a 1% premium to purchase the debt.

 

Bank Credit Facilities

 

On January 29, 2016, we amended our Omega Credit Facilities (as defined below) to add a $350 million senior unsecured incremental term loan facility. As a result of the amendment, the Omega Credit Facilities now include a $1.25 billion senior unsecured revolving credit facility (the “Revolving Credit Facility”), a $200 million senior unsecured term loan facility (the “Tranche A-1 Term Loan Facility”), a $200 million senior unsecured incremental term loan facility (the “Tranche A-2 Term Loan Facility”) and a $350 million senior unsecured incremental term loan facility (the “Tranche A-3 Term Loan Facility” and, together with the Revolving Credit Facility, the Tranche A-1 Term Loan Facility and the Tranche A-2 Term Loan Facility, collectively, the “Omega Credit Facilities”). The Tranche A-1 Term Loan Facility, the Tranche A-2 Term Loan Facility and the Tranche A-3 Term Loan Facility may be referred to collectively herein as the “Omega Term Loan Facilities”.

 

The Tranche A-3 Term Loan Facility bears interest at LIBOR plus an applicable percentage (beginning at 150 basis points, with a range of 100 to 195 basis points) based on our ratings from Standard & Poor’s, Moody’s and/or Fitch Ratings. The Tranche A-3 Term Loan Facility matures on January 29, 2021.

 

At September 30, 2016, we had $223.0 million of borrowings outstanding under the Revolving Credit Facility and $750 million of borrowings outstanding under the Omega Term Loan Facilities.

 

$700 Million 4.5% Senior Notes due 2023

 

On July 12, 2016, we issued $700 million aggregate principal amount of our 4.375% Senior Notes due 2023 (the “2023 Notes”). The 2023 Notes were sold at an issue price of 99.739% of their face value before the underwriters’ discount. Our net proceeds from the offering, after deducting underwriting discounts and expenses, were approximately $692.0 million. The net proceeds from the offering were used to repay outstanding borrowings under our revolving credit facility, to purchase the $180.0 million mortgage term loan and for general corporate purposes.

 

Dividend Reinvestment and Common Stock Purchase Plan

 

For the three-month period ended September 30, 2016, approximately 4.0 million shares of our common stock at an average price of $34.38 per share were issued through our Dividend Reinvestment and Common Stock Purchase Program for gross proceeds of approximately $136.6 million. For the nine-month period ended September 30, 2016, approximately 6.9 million shares of our common stock at an average price of $33.49 per share were issued through our Dividend Reinvestment and Common Stock Purchase Program for gross proceeds of approximately $230.1 million.

 

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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.

 

For the three- and nine- months ended September 30, 2016, we paid dividends of approximately $117 million and $334 million to our common stockholders, respectively.

 

Liquidity

 

We believe our liquidity and various sources of available capital, including cash from operations, our existing availability under our Omega Credit Facilities and expected proceeds from mortgage payoffs are 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;

·   capital improvement programs;

·   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 or used in financing activities and 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 $32.6 million as of September 30, 2016, an increase of $27.1 million as compared to the balance at December 31, 2015. The following is a discussion of changes in cash and cash equivalents due to operating, investing and financing activities, which are presented in our Consolidated Statements of Cash Flows.

 

Operating Activities – Operating activities generated $457.2 million of net cash flow for the nine months ended September 30, 2016, as compared to $322.8 million for the same period in 2015. The increase was primarily related to additional cash flow generated from new investments primarily related to the Aviv Merger and Care Homes Transaction, as well as other facilities acquired and leased throughout 2016 and 2015.

 

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Investing Activities – Net cash flow from investing activities was an outflow of $1.1 billion for the nine months ended September 30, 2016, as compared to an outflow of $350.8 million for the same period in 2015. The $784.1 million increase in cash outflow from investing activities related primarily to (i) an increase of $671.5 million in acquisitions in 2016 compared to the same period of 2015, (ii) an increase of net cash outflow of $181.5 million from other investments – net in 2016 compared to the same period of 2015, (iii) an increase of $20.3 million in mortgage investment in 2016 compared to the same period of 2015 and (iv) an increase of $13.3 million in our capital renovation program investment in 2016 compared to the same period of 2015. Offsetting these cash outflows was: (i) a decrease of $101.2 million in investment in construction in progress in 2016 as compared to the same period of 2015, (ii) a $84.9 million decrease in cash resulting from the Aviv Merger in 2015, (iii) a $57.1 million increase in collection of mortgages primarily related to existing operators repaying certain mortgages and (iv) a $23.2 million increase in proceeds from the sale of real estate in 2016 compared to the same period in 2015.

 

Financing Activities – Net cash flow from financing activities was an inflow of $704.7 million for the nine months ended September 30, 2016 as compared to an inflow of $38.9 million for the same period in 2015. The $665.8 million increase in cash flow from financing activities was primarily related to (i) an $867.2 million increase in net long-term borrowings in 2016 as compared to a use of approximately $615.0 million in cash in 2015 and (ii) an increase in net proceeds of $164.1 million from our dividend reinvestment plan in 2016 as compared to the same period in 2015. Offsetting these increases was (i) a net change in cash provided by our credit facility of $472.0 million, in 2015 our credit facility provided $465.0 million in cash as compared to a use of $7.0 million in cash in 2016, (ii) in 2016 we used cash to pay dividends of $333.7 million as compared to $253.1 in 2015 and (iii) a $439.7 million decrease in cash proceeds from the issuance of common stock in 2015 as compared to 2016.

 

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

 

During the quarter ended September 30, 2016, there were no material changes in our primary market risk exposures or how those exposures are managed from the information disclosed under Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2015.

 

Item 4 – 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 of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

In connection with the preparation of this Form 10-Q, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2016. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2016.

 

Internal Control Over Financial Reporting

 

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period covered by this report identified in connection with the evaluation of our disclosure controls and procedures described above that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II OTHER INFORMATION

 

Item 1 Legal Proceedings

 

See Note 14 – Litigation to the Consolidated Financial Statements in Part I, Item 1 hereto, which is hereby incorporated by reference in response to this item.

 

Item 1A – Risk Factors

 

There have been no material changes to our risk factors as previously disclosed in Item 1A contained in Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2015 and filed with the Securities and Exchange Commission (“SEC”) on February 26, 2016 and in Item 1A contained in Part II of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2016 and filed with the SEC on August 5, 2016.

 

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

 

During the quarterly period ended September 30, 2016, Omega issued an aggregate of 56,454 shares of Omega common stock, in exchange for an equivalent number of Omega OP Units tendered to Omega OP for redemption in accordance with the provisions of the Partnership Agreement. The Company issued these shares of Omega common stock in reliance on an exemption from registration under Section 4(a)(2) of the Securities Act of 1933, as amended, based upon factual representations received from the limited partners who received the Omega common stock.

 

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Item 6–Exhibits

 

Exhibit No.    
4.1   Seventeenth Supplemental Indenture, dated as of August 9, 2016, among Omega Healthcare Investors, Inc., each of the subsidiary guarantors listed therein and U.S. Bank National Association, as trustee, related to the 5.875% Senior Notes due 2024, including the Form of 5.875% Senior Notes and Form of Subsidiary Guarantee related thereto.*
4.2   Tenth Supplemental Indenture, dated as of August 9, 2016, among Omega Healthcare Investors, Inc., each of the subsidiary guarantors listed therein and U.S. Bank National Association, as trustee, related to the 4.950% Senior Notes due 2024, including the Form of 4.950% Senior Notes and Form of Subsidiary Guarantee related thereto.*
4.3   Ninth Supplemental Indenture, dated as of August 9, 2016, among Omega Healthcare Investors, Inc., each of the subsidiary guarantors listed therein and U.S. Bank National Association, as trustee, related to the 4.50% Senior Notes due 2025, including the Form of 4.50% Senior Notes and Form of Subsidiary Guarantee related thereto.*
4.4   Sixth Supplemental Indenture, dated as of August 9, 2016, among Omega Healthcare Investors, Inc., each of the subsidiary guarantors listed therein and U.S. Bank National Association, as trustee, related to the 4.500% Senior Notes due 2027, including the Form of 4.500% Senior Notes and Form of Subsidiary Guarantee related thereto.*
4.5   Fourth Supplemental Indenture, dated as of August 9, 2016, among Omega Healthcare Investors, Inc., each of the subsidiary guarantors listed therein and U.S. Bank National Association, as trustee, related to the 5.250% Senior Notes due 2026, including the Form of 5.250% Senior Notes and Form of Subsidiary Guarantee related thereto.*
4.6   Indenture, dated as of July 12, 2016, by and among Omega, the subsidiary guarantors named therein, and U.S. Bank National Association, as trustee (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K, filed with the SEC on July 12, 2016).
4.6A   First Supplemental Indenture, dated as of August 9, 2016, among Omega Healthcare Investors, Inc., each of the subsidiary guarantors listed therein and U.S. Bank National Association, as trustee, related to the 4.375% Senior Notes due 2023, including the Form of 4.375% Senior Notes and Form of Subsidiary Guarantee related thereto.*
12.1   Ratio of Earnings to Fixed Charges.*
31.1   Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer.*
31.2   Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer.*
32.1   Section 1350 Certification of the Chief Executive Officer.*
32.2   Section 1350 Certification of the Chief Financial Officer.*
101.INS   XBRL Instance Document.
101.SCH   XBRL Taxonomy Extension Schema Document.
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB   XBRL Taxonomy Extension Label Linkbase Document.
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document.

* Exhibits that are filed herewith.

+ Management contract or compensatory plan, contract or arrangement.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

OMEGA HEALTHCARE INVESTORS, INC.

Registrant

 

Date: November 8, 2016 By: /S/ C. TAYLOR PICKETT  
      C. Taylor Pickett  
      Chief Executive Officer  
         
Date: November 8, 2016 By: /S/ ROBERT O. STEPHENSON  
      Robert O. Stephenson  
      Chief Financial Officer  

 

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