Back to GetFilings.com

The accompanying notes to interim condensed consolidated financial statements are an integral part of these financial statements. The interim condensed balance sheet at December 31, 2003 is taken from the audited financial statements at that date.

The accompanying notes to interim condensed consolidated financial statements are an integral part of these financial statements.

(continued)

The accompanying notes to interim condensed consolidated financial statements are an integral part of these financial statements.

The accompanying notes to interim condensed consolidated financial statements are an integral part of these financial statements.

Note 1. SIGNIFICANT ACCOUNTING POLICIES:

We, the management of National Health Investors, Inc., believe that the unaudited financial statements to which these notes are attached include all adjustments which are necessary to fairly present the financial position, results of operations and cash flows of National Health Investors, Inc. ("NHI" or the "Company"). We assume that users of these interim financial statements have read or have access to the audited December 31, 2003 financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations and that the adequacy of additional disclosure needed for a fair presentation, except in regard to material contingencies, may be determined in that context. Accordingly, footnotes and other disclosures which would substantially duplicate the disclosure contained in our most recent annual report to stockholders have been omitted. This interim financial information is not necessarily indicative of the results that may be expected for a full year for a variety of reasons including acquisitions and dispositions, changes in interest rates, rents and the timing of debt and equity financings. Our audited December 31, 2003 financial statements are available at our web site: www.nhinvestors.com.

Note 2. NEW ACCOUNTING PRONOUNCEMENTS:

New Accounting Pronouncements - In August 2001, the FASB issued SFAS 144. SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"), and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB 30"), for the disposal of a segment of a business (as previously defined in APB 30). SFAS 144 retains the fundamental provisions of SFAS 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with SFAS 121. SFAS 144 also broadens the scope of defining discontinued operations. NHI adopted SFAS 144 on January 1, 2002. As the result of the adoption of SFAS 144, NHI has reported as discontinued operations in its consolidated statements of income, the revenues and expenses of one medical office building that NHI sold during the first quarter of 2003, two nursing facilities sold and one nursing facility designated for sale during the third quarter of 2003 (and sold during the second quarter of 2004), another nursing facility sold in the second quarter of 2004, and the related gains or losses on the sales.

In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145 rescinds Statement of Financial Accounting Standards No. 4, "Reporting Gains and Losses From Extinguishment of Debt" ("SFAS 4"), which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of the related income tax effect. As a result, the criteria in APB 30 will now be used to classify those gains and losses. SFAS 145 amends SFAS 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. As permitted, NHI elected to adopt SFAS 145 effective January 1, 2002. As a result, gains of $65,000 on the retirement of convertible subordinated debentures during the first quarter of 2003 have been included in investment interest and other income.

On December 31, 2002, the FASB issued Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" ("SFAS 148"). SFAS 148 amends Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123"), to provide alternative methods of transition to SFAS 123's fair value method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure provisions of SFAS 123 and APB Opinion No. 28, "Interim Financial Reporting", to require disclosure in the summary of significant accounting policies of the effects of an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While SFAS 148 does not amend SFAS 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of SFAS 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for the compensation using the fair value method of SFAS 123 or the intrinsic value method of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). See Note 3.

In May 2003 the FASB issued Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". SFAS 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. SFAS 150 was generally effective for NHI July 1, 2003. The adoption of SFAS 150 has not had a material effect on NHI's financial statements.

In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires that the guarantor recognize, at the inception of certain guarantees, a liability for the fair value of the obligation undertaken in issuing such guarantees. FIN 45 also requires additional disclosure requirements about the guarantor's obligations under certain guarantees that it has issued. The initial recognition and measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002 and the disclosure requirements are effective for financial statement periods ending after December 15, 2002. Through June 30, 2004, adoption of FIN 45 has not had a material effect on the Company's financial statements. The future effect of FIN 45 on the Company's financial statements will depend on whether the Company enters into new or modifies existing guarantees.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which requires the consolidation of variable interest entities by the primary beneficiary of such variable interest entities. FIN 46, as revised by the FASB, generally requires that variable interest entities must be consolidated by their primary beneficiary effective March 31, 2004. The Company adopted FIN 46 at March 31, 2004. The Company is not the primary beneficiary of any variable interest entity and, therefore, has not consolidated any additional entities as the result of adoption of FIN 46. The Company has five first mortgage loans with five variable interest entities (total outstanding balances of $19,439,000 at June 30, 2004) that operate five skilled nursing facilities. However, the Company is not the primary beneficiary of these variable interest entities. The Company's maximum exposure to loss as a result of its involvement with these variable interest entities is the outstanding balance of the first mortgage notes receivable.

Note 3. STOCK OPTION PLAN

NHI has stock option plans that provide for the granting of options to key employees and directors of NHI to purchase shares of common stock at a price no less than the market value of the stock on the date the option is granted. Options to purchase 135,000 shares vested immediately upon grant and may be exercised at any time prior to expiration. Options to purchase 140,000 shares vest approximately six years after grant and may be exercised during a 30 day vesting period prior to expiration. The term of the options is five years (135,000 shares) or six years (140,000 shares). The following table summarizes option activity:

The weighted average remaining contractual life of options outstanding at June 30, 2004 is 2.57 years. NHI's Board of Directors has authorized an additional 450,800 shares of common stock that may be issued under the stock option plans.

Based on the number of options granted and the historical and expected future trends of factors affecting valuation of those options, management believes that the additional compensation cost, as calculated in accordance with SFAS 123, has no effect on NHI's earnings per share for the three and six months ended June 30, 2004 and 2003.

Note 4. REAL ESTATE PROPERTIES:

The following table summarizes NHI's real estate properties by leased facilities and operating facilities:

(Dollars in thousands)

Foreclosure and Other Troubled Real Estate Properties

We are treating or have previously treated the Washington State, New England, Kansas and Missouri properties described below as foreclosure properties for federal income tax purposes. With certain elections, unqualified income generated by the properties is expected to be treated as qualified income for up to six years from the purchase date for purpose of the income-source tests that must be satisfied by REITs to maintain their tax status.

Washington State Properties - On October 16, 1998, we accepted deeds in lieu of foreclosure on four long-term care properties in Washington State. We have included the operating revenues and expenses of these facilities in our operating results since October 1998. The Highline Care Center was sold in June 2002 for proceeds of $882,000. The facility had been closed since December 2000. During the third quarter of 2003, the Park Ridge Care Center and Park West Care Center were sold for proceeds of $5,200,000. The resulting loss of $397,000 on the sale was reflected in the discontinued operations caption of the December 31, 2003 consolidated statements of income. During the second quarter of 2004, the Sehome center was sold for proceeds of $1,034,000. The resulting loss of $345,000 on the sale is reflected in the discontinued operations caption of the June 30, 2004 consolidated statements of income. The Sehome center had been designated as "held for sale", consistent with the provisions of SFAS 144, effective the third quarter of 2003. The facility was closed on March 19, 2004. The results of operations of this facility have been included in discontinued operations for all periods presented. We have disposed of all four long-term care properties in Washington State.

New England Properties - In the third quarter of 1999, we accepted deeds in lieu of foreclosure on three nursing homes and one retirement center in New Hampshire and four nursing homes in Massachusetts. During 2001, we sold the properties to a not-for-profit entity and provided 100% seller financing to close the sale. We account for this transaction under the deposit method in accordance with the provisions of Statement of Financial Accounting Standards No. 66, "Accounting for Sales of Real Estate" ("SFAS 66"). Consistent with the deposit method, we have not recorded the sale of the assets and continue to record the results of operations of these properties each period. No down-payment was made by the buyer and no subsequent payments have been received. As required by paragraph 5(b) of SFAS 66, the buyer's initial and continuing investments must be adequate to demonstrate a commitment to pay for the property. This requirement has not been met. As required by paragraph 5(d) of SFAS 66, the seller must have transferred to the buyer the usual risks and rewards of ownership in a transaction that is in substance a sale and does not have a substantial continuing involvement with the property. This requirement has not been met. Operating revenue, operating expense, depreciation and related cash flows are included in NHI's financial statements. Any future cash received from the buyer will be reported as a deposit until the down payment and continuing investment criteria of SFAS 66 are met, at which time we will account for the sale under the full accrual method. The new owner is seeking to refinance these properties but to date has been unsuccessful. No deposits have been received to date. Management believes that the carrying amount of these properties at June 30, 2004 of $28,309,000 is realizable.

Kansas and Missouri Properties - In July 2001, we were awarded, through foreclosure, possession of nine nursing homes in Kansas and Missouri and have recorded the operating revenues and expenses of these facilities since that date. NHC has been engaged to manage these facilities. During 2001, prior to the foreclosure sales on these properties, we recorded a $4,000,000 writedown of our mortgage note receivable from these properties. Management believes that the carrying amount of these properties at June 30, 2004 of $20,255,000 is realizable.

Alterra Properties - In March 2001, Alterra defaulted on its rent payment for eleven properties and NHI immediately terminated the leases and arranged for new lessees. We have filed suit for damages against Alterra. On January 22, 2003, Alterra filed bankruptcy. As a result, damages against Alterra will be subject to the bankruptcy process. The new lessees took possession of the centers during the late spring and summer of 2001. Under the terms of the new leases, we experienced reduced rental income in 2001 and 2002. Lease income for the six months ended June 30, 2004, and 2003 was $1,500,000 and $1,650,000 respectively. Furthermore, in the third quarter of 2003, we recognized as income $1,195,000 of cash that was received previously but which had been subject to dispute. Based on the rental payments received and expected to be received, and our impairment analyses, we recorded an impairment of $4,900,000 during 2001. We believe that the carrying amount of these properties at June 30, 2004 of $31,479,000 is realizable.

Integrated Health Services, Inc. ("IHS") - IHS filed bankruptcy in February 2000 and failed to make its required mortgage payments to SouthTrust Bank on six Texas nursing homes. At that time, NHI owned a 50% participation in this loan with SouthTrust Bank. Effective September 1, 2001, IHS deeded the six nursing homes to a subsidiary of NHI in return for the forgiveness of the debt held jointly by SouthTrust Bank and NHI. We recorded these six nursing homes and certain non-recourse debt to SouthTrust Bank at the estimated fair value of the properties of approximately $44,700,000. NHI leases the six Texas health care centers to IHS under a 66-month lease with minimum payments equal to approximately $3,078,000 per year plus additional rent based on cash flow of the facilities. We collect these rent payments and service non-recourse debt owed to SouthTrust Bank, which debt service is substantially equal to the rent payments collected. Through a separate participation agreement, NHI and SouthTrust each beneficially own 50% of the lease revenue. Our interest in the lease revenue is represented by a note receivable from SouthTrust Bank. We have a legal right of offset as it relates to the non-recourse debt and note receivable with SouthTrust Bank. Therefore, the $19,052,000 note receivable offsets the non-recourse debt in the consolidated balance sheet. IHS has the right to terminate its lease with us with 90 days notice. Lease payments commenced September 1, 2001 and are current. We believe that the carrying amount of our net investment in these properties of approximately $14,379,000 at June 30, 2004 is realizable. Our net investment is composed of $40,016,000 of realty reduced by $25,637,000 of debt. Manor House of Charlotte - In June 2002, the owner and corporate guarantor surrendered possession, provided a deed in lieu of foreclosure to us, made tax payments current, paid $1,016,000 toward the debt and deeded to us an unimproved parcel of land in another state. As a result, we released the parent's guarantee. Prior to our accepting the deed in lieu of foreclosure, the borrower paid $1,175,000 on the loan balance and the remaining loan balance of $2,173,000 was determined to be the fair value of the foreclosed real estate. The property was immediately leased to a new operator in June of 2002. Under the terms of the new lease, we experienced reduced revenue in periods subsequent to 2001. We believe the carrying amount of our net investment in this property at June 30, 2004 of $1,979,000 is realizable.

Two New Jersey Centers - During the third quarter of 2001, we filed a foreclosure lawsuit against the borrower and separate action against the individual guarantors and owners of these two New Jersey facilities. In January, 2003, NHI received these properties through foreclosure and immediately leased the facilities to a new operator, Royal Holding, LLC, who brought past due property taxes current and agreed to monthly lease payments. The lease includes monthly rent of $155,000, with provisions for increases in later periods through 2016 and provides the lessee with a purchase option during the term of the lease at amounts which decrease over time. The lease with Royal Holding, LLC is being accounted for as an operating lease. Presently, NHI has not begun to recognize rental income from these properties on a straight-line basis due to concerns about collectibility of the future increases.

Based on the previous loan history, and in accordance with SFAS 114 analysis, we recorded impairments of $5,304,000 during 2001. The borrower on the previous loan did not have the ability to make payments. The tenant on the new lease is making payments. Lease income of $1,169,000 and $1,541,000 was recognized on the property for the six months ended June 30, 2004 and 2003, respectively. We believe that the carrying amount of our net investment in this property at June 30, 2004 of $12,534,000 is realizable.

Marriott Senior Living Services - In July 2003, we reached an agreement with Marriott Senior Living Services ("Marriott") to terminate their leases with us on four assisted living facilities, two of which are located in Florida, one in Texas and one in New Jersey. Under the terms of the settlement with Marriott, we were paid $6,211,000 to settle our claims for certain deferred maintenance and repairs, for accrued real estate taxes, and to compensate us for future rental periods. A portion ($1,580,000) of the $6,211,000 received has been reserved for known costs related to existing needs for maintenance and repairs. In addition, $223,000 was allocated to pay property taxes due. The remainder of $4,408,000 was recognized as rental income in the third quarter of 2003.

We leased the New Jersey facility to Sunrise Living Services, Inc. ("Sunrise"), which company acquired the outstanding stock of Marriott in March 2003. We leased the Texas facility to Medallion Senior Living at Dallas, LLC. We leased the two Florida facilities to The Palms of Maitland, Inc. and The Place at West Palm Beach, Inc.

Based on rental payments received and expected to be received, and our impairment analysis, we recorded an impairment of $5,400,000 during the third quarter of 2003 on one of the Florida facilities. The impairment was necessitated by the financial condition of the new lessee, the physical condition of the facility and significant market competition. Lease income of $1,160,000 and $2,497,000 was recognized on these four facilities for the six months ended June 30, 2004 and 2003, respectively. We believe that the carrying amount of these properties at June 30, 2004 of $38,143,000 is realizable.

Note 5. MORTGAGE AND OTHER NOTES RECEIVABLE:

Note Receivable from National Health Realty, Inc.

Effective December 31, 2002, in exchange for an equal amount of cash, National Health Realty, Inc. ("NHR") transferred to us three mortgage notes receivable secured by three long-term care facilities in Florida with total principal balances outstanding of $15,672,000. The transfer agreement with NHR included provisions that, beginning January 2, 2004, allowed us to put to NHR the transferred notes at any time, with 60 days notice, at a price equal to the outstanding principal and interest balance or require NHR to make debt service payments if not made by the debtors. The agreement also provided that NHR could repurchase after July 1, 2003, the notes from us at a price equal to the then outstanding principal and interest balance. Consistent with the provisions of Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 140"), we accounted for the transfer of the notes receivable from NHR as a loan to NHR rather than as a purchase of the notes. As a result, we recognized notes receivable from NHR on our consolidated balance sheet of December 31, 2002 and recognized interest income from NHR during 2003. NHR repurchased the notes in December 2003 at the outstanding principal balance of $14,922,000 plus accrued interest, thereby eliminating our note receivable from NHR. NHR is another REIT to which NHC provides advisory services. NHR owns 225,000 shares of our common stock.

Installment Method Mortgage Receivable

Autumn Hills Convalescent Centers, Inc. (HSM of Texas, new borrower) - In 1997, we funded a mortgage loan for Autumn Hills Convalescent Centers, Inc. ("Autumn Hills") in the original principal amount of $51,500,000. Collateral for the loan included first mortgages on thirteen long-term health care facilities in Texas and certain corporate and personal guarantees. Principal and interest payments between April 2000 and May 2001 were only partially made and the debtor filed for bankruptcy on May 15, 2001. Based on these events and SFAS 114 analyses, we recorded impairments of $10,000,000 and $7,900,000 during 2001 and 2000, respectively, to reduce the loan to our estimate of net realizable value. The debtor's plan of reorganization, confirmed on January 28, 2002, required the debtor to reaffirm the original debt and accrued interest and commence monthly payments on April 10, 2002, which it did until October of 2002, at which time the borrower advised us that payments could no longer be made. We applied $1,600,000 of payments received in the third quarter of 2002 against our loan balance, and we initiated foreclosure action during the fourth quarter of 2002. Our net receivable balance at December 31, 2002, after the above writedowns and principal reductions, was $28,855,000.

On January 7, 2003, NHI received the projects through foreclosure and then sold the facilities to an unrelated not-for-profit entity, HSM of Texas, providing seller financing. NHI accounts for the sale of the properties using the installment method, consistent with the provisions of SFAS 66. The new borrower has made monthly principal and interest payments during 2003. The new loan with HSM of Texas bears interest at 5.85%, is payable at $354,000 monthly and matures in December 2007. The outstanding balance at June 30, 2004 is $26,811,000, which we believe is realizable. The average recorded investment in the loan was $27,151,000 and $30,530,000 for the six months ended June 30, 2004 and 2003, respectively. The related amount of interest income recognized on the loan was $1,487,000 and $1,480,000 for the six months ended June 30, 2004 and 2003, respectively.

American Medical Associates, Inc. ("AMA") - Two first mortgage loans totaling $13,646,000 to AMA were secured by three Florida-based nursing homes. The loans, funded in 1995 and 1996, were cross-collateralized and cross-defaulted. Management's analysis of the future expected cash flows consistent with SFAS 114, historical occupancy, and operating income of the project resulted in the recording of a $5,200,000 writedown of this mortgage loan value during 2002. The borrower filed for bankruptcy protection in January 2003.

In January, 2004, we assigned our right to credit bid our mortgage to a third party who purchased the facilities in February, 2004. On May 1, 2004 NHI provided financing to the new purchaser of the three Florida-based nursing homes formerly owned by American Medical Associates, Inc. The new financing consists of three new mortgage loans (each with two notes) and four new working capital loans. The first of the loans is to Central Florida Health Care Properties, Inc. consisting of Mortgage Note A for $5,552,000 at 8% and Mortgage Note B for $448,000. The second of the loans is to Williston Health Care Center, Inc. consisting of Mortgage Note A for $5,655,000 at 8% and Mortgage Note B for $345,000. The third of the loans is to HealthCare Properties, Inc. consisting of Mortgage Note A for $2,293,000 at 8% and Mortgage Note B for $207,000. The mortgage notes all mature May 14, 2009.

Three of the four working capital loans are for $225,000 each and are to each of the three new borrowers, Central Florida Health Care Properties, Inc., Williston Health Care Center, Inc. and HealthCare Properties, Inc. The three working capital loans mature on May 14, 2005, carry a 6% interest rate, and have a total outstanding balance of $375,000 at June 30, 2004. The fourth working capital loan called the Second Stage Working Capital Note for $1,000,000 is for all three borrowers, Central Florida Health Care Properties, Inc., Williston Health Care Center, Inc., and Health Care Properties, Inc. and may be used once the center has fully drawn their individual working capital note. The note matures on May 14, 2005, carries an interest rate of prime plus 2%, and has not been funded at June 30, 2004.

Management believes that the remaining carrying amount of $8,362,000, net of prior writedowns, at June 30, 2004 is supported by the value of the collateral. The average recorded investment in the mortgage loans was $8,372,000 and $8,382,000 for the six months ended June 30, 2004 and 2003, respectively. The related amount of interest income recognized on the mortgage loans was $93,000 and $0 for the six months ended June 30, 2004 and 2003, respectively.

Borrower Bankruptcy and Other Non-Performing Loans

Ashton Woods - At June 30, 2004, we hold 75%, or $4,129,000, of a $5,506,000 first mortgage with Ashton Woods. The remaining 25% of the loan is held by SouthTrust Bank. The loan is secured by a first mortgage on a nursing home located in Atlanta, Georgia and is further secured by the lease payments which are made by Ashton Woods Healthcare, Inc. Note A under the loan is in the amount of $4,250,000, amortizing over 25 years at 6.5% per annum and due in September, 2013. Note B is an interest free note in the amount of $1,256,000, is payable out of excess cash flow of the facility and if not repaid by September, 2013, is forgiven in full. Management believes that the remaining carrying amount of $1,076,000 at June 30, 2004 is supported by the value of the collateral. The average recorded investment in the Ashton Woods loan was $1,089,000 and $1,120,000 for the six months ended June 30, 2004 and 2003, respectively. The related amount of interest income recognized on the loan was $104,000 and $108,000 for the six months ended June 30, 2004 and 2003, respectively.

Midwest Nursing Home Investors, Inc. ("Midwest") - An approximate $8,735,000 first mortgage loan made to Midwest in 1997 is secured by three nursing homes in Kansas and Wisconsin. The properties are cross defaulted and cross collateralized and are managed by Rainmakers, LLC who operates long-term care facilities in Kansas, Missouri and Wisconsin. Payments to NHI are past due and the loan is in default on a number of technical covenants. Management's analysis of the future expected cash flows consistent with SFAS 114, historical occupancy and operating income of the project resulted in the recording of a $2,000,000 writedown of this mortgage loan value during 2002 and an additional writedown of $2,000,000 during 2003. Management believes that the remaining carrying value amount of $4,324,000 at June 30, 2004 is supported by the value of the collateral. The average recorded investment in the Midwest loan was $4,324,000 and $6,465,000 for the six months ended June 30, 2004 and 2003, respectively. The related amount of interest income recognized on the loan was $-0- and $292,000 for the six months ended June 30, 2004 and 2003, respectively.

Allgood HealthCare, Inc. ("Allgood") - We have two loans secured by five properties which are operated by Allgood. The loans have an outstanding balance of approximately $21,716,000, before writedown. Both of these loans were guaranteed by the two separate estates of the principals of the operator. As a result of the payment and technical defaults, the loans have been declared in default and the principal amount due has been accelerated. In January 2003, the borrowers filed for bankruptcy protection. Management's analysis of the future expected cash flows consistent with SFAS 114, historical occupancy and operating income of the project resulted in the recording of a $5,000,000 writedown of this mortgage loan in 2002. During the third quarter of 2003, NHI received a $1,000,000 payment from the estate of one of the owners of Allgood. This estate was released from further liability. Based on management's updated analysis of the future expected cash flows of this note, this payment was applied to reduce the principal balance outstanding. Management believes that the remaining carrying amount of $15,716,000 at June 30, 2004 is supported by the value of the collateral. The average recorded investment in the Allgood loans were $15,716,000, and $16,614,000 for the six months ended June 30, 2004 and 2003, respectively. Beginning in January, 2004, the borrower voluntarily began making monthly payments of $86,700. The related amount of interest income recognized on the loans was $520,000, and $-0-for the six months ended June 30, 2004 and 2003, respectively.

Somerset on Lake Saunders - This facility has suffered from poor occupancy and other operational issues. Management's analysis of the future cash flows consistent with SFAS 114, historical occupancy and operating income of the project resulted in the recording of a $1,500,000 writedown of this mortgage loan value during the first quarter of 2003. This loan was sold in January 2004 for cash proceeds of $1,750,000 resulting in a gain of $1,302,000, which is included in loan recoveries.

Note 6. INVESTMENTS IN MARKETABLE SECURITIES:

Our investments in marketable securities include available for sale securities and held to maturity securities. Unrealized gains and losses on available for sale securities are recorded in stockholders' equity in accordance with SFAS 115. Realized gains and losses from securities sales are determined on the specific identification of the securities.

Gross unrealized gains and gross unrealized losses related to available for sale securities are as follows:

During the six months ended June 30, 2004 and 2003, we received and recognized $2,202,000 and $2,336,000, respectively, of dividend and interest income from our marketable securities. Such income is included in non-operating income in the consolidated statements of income.

Proceeds from the sale of investments in marketable securities during the six months ended June 30, 2004 was $10,823,000. Gross investment gains of $2,682,000 were realized on these sales during the six months ended June 30, 2004, $687,000 of which is included in security recoveries and $1,995,000 of which is included in non-operating income in the consolidated statements of income.

Assisted Living Concepts, Inc. Convertible Debentures - During 1999 and 2001, NHI purchased approximately $29,707,000 face amount of certain convertible debentures issued by Assisted Living Concepts, Inc. ("ALC") at a discount of approximately $13,771,000. As a result of ALC declaring bankruptcy on October 1, 2001, we, in accordance with the provisions of SFAS 115, measured and recorded an other-than-temporary decline in value of our investment of $5,709,000 at December 31, 2001.

During 2002, in order to protect our status as a REIT, we sold a portion of our investments in ALC convertible debentures to an employee of our investment advisor, NHC. Proceeds included a note receivable of $5,818,000 after a cash payment of $650,000 received in 2001. No gain or loss was realized on this sale during 2002. Our collateral on the note consisted of the underlying securities. As a result, the note receivable was subject to a risk of accounting loss if the underlying value of the collateral declined below the carrying value of the note receivable. The note was a non-recourse promissory note which bore interest at a variable rate (LIBOR plus .5% at December 31, 2003) and provided for periodic escalation of the rate. The note matured June 30, 2012, and had a balance of $4,593,000 at December 31, 2003, after payments of $1,225,000 during 2003. The note was collected in the six months ended June 30, 2004 for proceeds of $4,593,000.

The carrying value but not the face amount of the ALC debentures owned by us was reduced by $72,000 and $659,000 related to a securities litigation settlement during 2003 and 2002, respectively. ALC debentures with a face amount of $126,000 and a carrying value of $114,000 were called by ALC in May 2003. ALC debentures with a face amount of $406,000 and carrying value of $372,000 were called by ALC in October 2002. The remaining ALC debentures with a face amount of $4,655,000 and a carrying value of $4,013,000 were called during the six months ended June 30, 2004 for proceeds of $4,700,000 resulting in a gain of $687,000 which is included in security recoveries discussed above.

Eldertrust Common Stock - During the six months ended June 30, 2004, 316,900 shares of Eldertrust common stock with a carrying amount of $3,293,000 were called for $12.50 cash per share resulting in cash proceeds of $3,961,000 and a gain of $668,000, which is included in non-operating income discussed above.

LTC Properties, Inc. Common Stock - During 1998 and 1999, NHI purchased 774,800 shares of LTC common stock for $10,762,000. As a result of an other than temporary impairment in value of its investment and in accordance with the provision of SFAS 115, NHI recognized a $5,555,000 realized loss on this investment during the year ended December 31, 2002. NHI believes that the carrying value of this investment of $12,862,000 at June 30, 2004 is realizable.

Note 7: DEBT, PREFERRED STOCK AND RELATED GUARANTEES

NHI had certain letters of credit of $10,835,000 that matured during 2001. As a result, NHI purchased at face value all of the outstanding first mortgage tax exempt bonds that were secured by the letters of credit. In regard to its investment in and liability under these first mortgage bonds, NHI has a legal right of offset. Therefore, the first mortgage bonds purchased, having a balance of $330,000 and $460,000 at June 30, 2004 and December 31, 2003, respectively, offset NHI's debt obligations in the consolidated balance sheet. Mortgage bonds with a principal balance of $9,110,000 were remarketed during 2003 at no gain or loss.

1997 Debentures - On January 29, 1997, NHI issued $60,000,000 of 7% convertible subordinated debentures (the "1997 debentures") due on February 1, 2004. We redeemed the remaining $39,917,000 of these 1997 debentures during the quarter ended March 31, 2003.

Preferred Stock Conversion - On April 30, 2004, 100% of NHI's 8.5% cumulative convertible preferred stock, with a balance of 747,994 shares or $18,700,000, was called by NHI for redemption into common stock of NHI at a conversion rate of .905 shares of common stock for each share of preferred stock. This resulted in an additional 676,922 shares of common stock issued and outstanding. Dividends on the preferred stock were accrued and paid through April 30, 2004.

Note 8. COMMITMENTS, CONTINGENCIES AND GUARANTEES:

At June 30, 2004, we were committed, subject to due diligence and financial performance goals, to fund approximately $739,000 in health care real estate projects, none of which is expected to be funded within the next 12 months. The commitments include mortgage loans or purchase leaseback agreements for one long-term health care center and one assisted living facility, at rates ranging from 10.0% to 10.5%.

We have also guaranteed bank loans in the amount of $229,165 to key employees utilized for the exercise of stock options. The loan guarantees, which are limited to $100,000 per individual per year, are with full recourse and are collateralized by marketable securities equal to at least 125% of the loan amount outstanding. The individual borrowers also personally guarantee the loans. None of the outstanding loans are to or for any director or executive officer. Our potential accounting loss related to these guaranteed bank loans, if all collateral failed, is the face amount of the guaranteed loans outstanding. We have not accrued a liability for our potential obligation under these guarantees.

We believe that we have operated our business so as to qualify as a REIT under Section 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code") and we intend to continue to operate in such a manner, but no assurance can be given that we will be able to qualify at all times. If we qualify as a REIT, we will generally not be subject to federal corporate income taxes on our net income that is currently distributed to our stockholders. This treatment substantially eliminates the "double taxation" (at the corporate and stockholder levels) that typically applies to corporate dividends. Our 2001 and 2000 federal tax returns are currently under audit by the Internal Revenue Service. Our failure to continue to qualify under the applicable REIT qualification rules and regulations would cause us to owe state and federal income taxes and would have a material adverse impact on our financial position, results of operations and cash flows.

Contingency related to damaged property

One of our owned nursing home properties, leased to a subsidiary of NHC and located in Nashville, Tennessee, was damaged by a tragic fire on September 25, 2003 which resulted in the loss of life or critical injury to a number of patients. The building has been closed to patient care while NHI and NHC assess damages. NHC is NHI's largest lessee, operating 39 of NHI's 162 properties.

Under the terms of NHI's lease with NHC, NHC is required to restore the leased property so as to make it at least equal in value to that which existed prior to the damage. The lease also requires NHC to indemnify and hold harmless NHI from any and all demands and claims arising from the use of the property, including any negligence or violation by NHC.

NHI is a loss payee and additional named insured under the terms of NHC's property and casualty insurance policy. The policy includes business interruption insurance and NHI believes it will receive 100% of any rent due on the facility through the expected reconstruction process or until NHC elects to terminate the lease on this facility as described below. Currently, rental income from the center totals approximately $250,000 annually.

Furthermore, NHI is an additional named insured on NHC's professional and general liability insurance policy. NHC has stated that the lessee, NHC HealthCare/Nashville, LLC and its parent NHC collectively have liability coverage of $1,000,000 per occurrence and $3,000,000 in the aggregate per location and annual aggregate excess coverage of $7,500,000 that is attributable to all of NHC's operated centers.

A provision of the lease allows that if substantial damage occurs during the lease term, NHC may terminate the lease with respect to the damaged property. If the lease is so terminated, NHC will have no obligation to repair the property and NHI will receive the entire insurance proceeds related to the building damage. NHC is obligated to continue to indemnify and hold harmless NHI from any and all demands arising from the use of the property. NHI retains the right to license the beds under any lease termination.

NHI has been named as a defendant in thirty-two lawsuits filed by patients and/or representatives of patients arising out of the fire. Eleven of these cases have been settled at no cost to NHI. These cases have been consolidated with all other lawsuits arising out of the fire in the Third Circuit Court for Davidson County, Tennessee. Discovery is ongoing. NHI plans to vigorously defend against the allegations in these lawsuits. As of June 30, 2004, management believes it is too early to make any assessment of any potential liability or cost to NHI.

At June 30, 2004, NHI has not accrued any liability for this contingent matter but will continue to closely monitor the situation. There can be no assurance that claims will not exceed the limits of the insurance coverage or that additional claims will not be asserted against NHI. NHI's potential liability from this incident or NHC's ability to meet any indemnification obligation to NHI cannot be determined at this time. If NHC were unable to meet its obligations to NHI either as to indemnification, if required, or as to the payment of rent, it may have a material adverse impact on our financial position, results of operations and cash flows.

Note 9. EARNINGS PER COMMON SHARE:

Basic earnings per share is based on the weighted average number of common shares outstanding during the period. Net income is reduced by dividends to holders of cumulative convertible preferred stock.

Diluted earnings per common share assumes, if dilutive, the conversion of cumulative convertible preferred stock, the conversion of convertible subordinated debentures, and the exercise of stock options using the treasury stock method. Net income is increased for interest expense on the convertible subordinated debentures, if dilutive.

The following table summarizes the average number of common shares and common equivalent shares and the net income used in the calculation of basic and diluted earnings per share.

	Three Months Ended		Six Months Ended
	June 30		June 30
	2004	2003	2004	2003
BASIC:
Weighted average common shares	27,267,605	26,720,197	27,021,602	26,704,594
Income from continuing operations	$11,008,000	$11,230,000	$24,591,000	$21,728,000
Dividends paid to preferred stockholders	(117,000)	(398,000)	(514,000)	(795,000)
Income from continuing operations available to
common stockholders	10,891,000	10,832,000	24,077,000	20,933,000
Discontinued operations	953,000	(414,000)	805,000	1,208,000
Net income available to common stockholders	$11,844,000	$10,418,000	$24,882,000	$22,141,000
Income from continuing operations per
common share	$ .40	$ .41	$ .89	$ .78
Discontinued operations per common share	.03	(.02)	.03	.05
Net income per common share	$ .43	$ .39	$ .92	$ .83
DILUTED:
Weighted average common shares	27,267,605	26,720,197	27,021,602	26,704,594
Stock options	94,550	35,539	101,508	25,965
Convertible subordinated debentures	172,016	220,624	176,334	229,886
Average common shares outstanding	27,534,171	26,976,360	27,299,444	26,960,445
Income from continuing operations	$11,008,000	$11,230,000	$24,591,000	$21,728,000
Dividends paid to preferred stockholders	(117,000)	(398,000)	(514,000)	(795,000)
Interest on convertible subordinated debentures	30,000	38,000	62,000	79,000
Income from continuing operations available to
common stockholders	$10,921,000	$10,870,000	$24,139,000	$21,012,000
Discontinued operations	953,000	(414,000)	805,000	1,208,000
Net income available to common stockholders
assuming conversion of convertible
subordinated debentures to common stock,
if dilutive	$11,874,000	$10,456,000	$24,944,000	$22,220,000
Income from continuing operations per
common share	$ .40	$ .40	$ .88	$ .78
Discontinued operations per common share	.03	(.01)	.03	.04
Net income per common share	$ .43	$ .39	$ .91	$ .82
Incremental Shares Excluded Since Anti-dilutive:
Convertible subordinated debentures	---	---	---	481,581
8.5% Preferred Stock	215,722	676,918	446,320	676,918
Stock options	---	30,000	---	90,000

In accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share", the above incremental shares were excluded from the computation of diluted earnings per share, since inclusion of these incremental shares in the calculation would have been anti-dilutive.