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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 March 31, 2003
or
____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission file number 1-11316
OMEGA HEALTHCARE
INVESTORS, INC.
(Exact name of Registrant as specified in its charter)
Maryland 38-3041398
(State of Incorporation) (I.R.S. Employer Identification No.)
9690 Deereco Road, Suite 100, Timonium, MD 21093
(Address of principal executive offices)
(410) 427-1700
(Telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of ther Exchange Act).
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of March 31, 2003.
Common Stock, $.10 par value 37,149,445
(Class) (Number of shares)
OMEGA HEALTHCARE INVESTORS, INC.
FORM 10-Q
March 31, 2003
INDEX
Page No.
PART I Financial Information
Item 1. Consolidated Financial Statements:
Balance Sheets
March 31, 2003 (unaudited)
and December 31, 2002.................................... 2
Statements of Operations (unaudited)
Three months ended
March 31, 2003 and 2002.................................. 3
Statements of Cash Flows (unaudited)
Three months ended
March 31, 2003 and 2002.................................. 4
Notes to Consolidated Financial Statements
March 31, 2003 (unaudited)............................... 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............. 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk... 25
Item 4. Controls and Procedures...................................... 26
PART II Other Information
Item 1. Legal Proceedings............................................ 26
Item 2. Changes in Securities and Use of Proceeds ................... 26
Item 3. Defaults Upon Senior Securities.............................. 26
Item 4. Submission of Matters to a Vote of Security Holders.......... 27
Item 6. Exhibits and Reports on Form 8-K............................. 27
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
OMEGA HEALTHCARE INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
March 31, December 31,
2003 2002
-------------------------------
(Unaudited) (See note)
ASSETS
Real estate properties
Land and buildings at cost................................................... $ 713,373 $ 669,188
Less accumulated depreciation................................................ (123,023) (117,986)
-------------------------------
Real estate properties - net.............................................. 590,350 551,202
Mortgage notes receivable - net.............................................. 124,667 173,914
-------------------------------
715,017 725,116
Other investments - net......................................................... 40,722 36,887
-------------------------------
755,739 762,003
Assets held for sale - net...................................................... 2,324 2,324
-------------------------------
Total investments............................................................ 758,063 764,327
Cash and cash equivalents....................................................... 25,673 15,178
Accounts receivable - net....................................................... 3,769 2,766
Interest rate cap............................................................... 6,634 7,258
Other assets.................................................................... 5,970 5,597
Operating assets for owned properties........................................... - 8,883
Operating assets and liabilities for owned properties - net..................... 222 -
-------------------------------
Total assets................................................................. $ 800,331 $ 804,009
===============================
LIABILITIES AND STOCKHOLDERS EQUITY
Revolving lines of credit....................................................... $ 177,000 $ 177,000
Unsecured borrowings............................................................ 100,000 100,000
Other long-term borrowings...................................................... 29,344 29,462
Accrued expenses and other liabilities.......................................... 8,902 13,234
Operating liabilities for owned properties...................................... - 4,612
-------------------------------
Total liabilities............................................................ 315,246 324,308
-------------------------------
Preferred stock................................................................. 212,342 212,342
Common stock and additional paid-in capital..................................... 484,788 484,766
Cumulative net earnings......................................................... 157,230 151,245
Cumulative dividends paid....................................................... (365,654) (365,654)
Unamortized restricted stock awards............................................. (116) (116)
Accumulated other comprehensive loss............................................ (3,505) (2,882)
-------------------------------
Total stockholders equity.................................................... 485,085 479,701
-------------------------------
Total liabilities and stockholders equity.................................... $ 800,331 $ 804,009
===============================
Note - The balance sheet at December 31, 2002 has been derived from the audited
consolidated financial statements at that date, but does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements.
See notes to consolidated financial statements.
OMEGA HEALTHCARE INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited
(In thousands, except per share amounts)
Three Months Ended
March 31,
2003 2002
--------------------------
Revenues
Rental income................................................................ $ 16,674 $ 15,431
Mortgage interest income..................................................... 4,392 5,412
Other investment income - net................................................ 990 1,103
Nursing home revenues of owned and operated assets........................... - 21,748
Litigation settlement........................................................ 2,187 -
Miscellaneous................................................................ 321 230
--------------------------
24,564 43,924
Expenses
Nursing home expenses of owned and operated assets.......................... - 23,700
Nursing home revenues and expenses of owned and operated assets - net....... 1,333 -
Depreciation and amortization................................................ 5,329 5,326
Interest..................................................................... 5,112 8,138
General and administrative................................................... 1,471 1,719
Legal........................................................................ 558 855
State taxes.................................................................. 158 129
Provision for impairment..................................................... 4,618 -
Adjustment of derivatives to fair value...................................... - (400)
--------------------------
18,579 39,467
--------------------------
Net income...................................................................... 5,985 4,457
Preferred stock dividends....................................................... (5,029) (5,029)
--------------------------
Net income (loss) available to common........................................... $ 956 $ (572)
==========================
Income (loss) per common share:
Net income (loss) per share, basic........................................... $ 0.03 $ (0.02)
==========================
Net income (loss) per share, diluted......................................... $ 0.03 $ (0.02)
==========================
Dividends declared and paid per common share.................................... $ - $ -
==========================
Weighted-average shares outstanding, basic...................................... 37,145 27,421
==========================
Weighted-average shares outstanding, diluted.................................... 37,145 27,421
==========================
Components of other comprehensive income:
Unrealized gain on Omega Worldwide, Inc...................................... $ - $ 547
==========================
Unrealized (loss) gain on hedging contracts.................................. $ (623) $ 283
==========================
Total comprehensive income...................................................... $ 5,362 $ 5,287
==========================
See notes to consolidated financial statements.
OMEGA HEALTHCARE INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
(In thousands)
Three Months Ended
March 31,
2003 2002
--------------------------
Operating activities
Net income .................................................................. $ 5,985 $ 4,457
Adjustment to reconcile net income to cash provided by operating activities:
Depreciation and amortization............................................. 5,329 5,326
Provision for impairment.................................................. 4,618 -
Adjustment of derivatives to fair value................................... - (400)
Other..................................................................... 702 630
Net change in accounts receivable for owned and operated assets - net........... 2,680 (1,398)
Net change in accounts payable for owned and operated assets.................... 429 (1,658)
Net change in other owned and operated assets and liabilities................... 940 (192)
Net change in operating assets and liabilities.................................. (6,164) 3,453
--------------------------
Net cash provided by operating activities....................................... 14,519 10,218
--------------------------
Cash flows from financing activities
Proceeds from revolving lines of credit - net................................... - 387
Proceeds from refinancing - net................................................. - 13,635
Payments of long-term borrowings................................................ (118) (35,616)
Receipts from Dividend Reinvestment Plan........................................ - 1
Proceeds from rights offering and private placement - net....................... - 44,600
Deferred financing costs paid................................................... (321) (1,547)
Other........................................................................... - 23
--------------------------
Net cash (used in) provided by financing activities............................. (439) 21,483
--------------------------
Cash flow from investing activities
Capital improvements and funding of other investments........................... (32) (421)
Disposal of non-real estate assets.............................................. - (80)
Investments in other assets..................................................... (4,029) -
Collection of mortgage principal................................................ 476 1,942
--------------------------
Net cash (used in) provided by investing activities............................. (3,585) 1,441
--------------------------
Increase in cash and cash equivalents........................................... 10,495 33,142
Cash and cash equivalents at beginning of period................................ 15,178 11,445
--------------------------
Cash and cash equivalents at end of period...................................... $ 25,673 $ 44,587
==========================
Interest paid during the period................................................. $ 5,601 $ 7,272
==========================
See notes to consolidated financial statements.
Omega Healthcare Investors, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
March 31, 2003
Note A - Basis of Presentation
The accompanying unaudited consolidated financial statements for Omega
Healthcare Investors, Inc. have been prepared in accordance with accounting
principles generally accepted in the United States ("GAAP") for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by GAAP for complete financial statements. In our opinion,
all adjustments (consisting of normal recurring accruals) considered necessary
for a fair presentation have been included. Certain reclassifications have been
made to the 2002 financial statements for consistency with the presentation
adopted for 2003. Such reclassifications have no effect on previously reported
earnings or equity.
In April 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("FAS
145"), which stipulates that gains and losses from extinguishment of debt
generally will not be reported as extraordinary items effective for fiscal years
beginning after May 15, 2002. We adopted this standard effective January 1,
2003. FAS 145 also specifies that any gain or loss on extinguishment of debt
that was classified as an extraordinary item in prior periods presented that
does not meet the criteria in Opinion 30 for classification as an extraordinary
item shall be reclassified. Therefore, the $28,000 gain on extinguishment of
debt previously reported for the three-month period ended March 31, 2002 has
been reclassified to interest expense in our Consolidated Statements of
Operations.
Due to the decrease in size of the owned and operated portfolio (one
facility as of March 31, 2003), the operations of such facilities and the net
assets employed therein are no longer considered a separate reportable segment.
Accordingly, commencing January 1, 2003, the operating revenues and expenses and
related operating assets and liabilities of the owned and operated facilities
are shown on a net basis in our Consolidated Statements of Operations and
Consolidated Balance Sheets, respectively.
Operating results for the three-month period ended March 31, 2003 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2003. For further information, refer to the financial statements
and footnotes included in our annual report on Form 10-K for the year ended
December 31, 2002.
Note B - Properties
In the ordinary course of our business activities, we periodically evaluate
investment opportunities and extend credit to customers. We also regularly
engage in lease and loan extensions and modifications. Additionally, we actively
monitor and manage our investment portfolio with the objectives of improving
credit quality and increasing returns. In connection with portfolio management,
we engage in various collection and foreclosure activities.
When we acquire real estate pursuant to a foreclosure, lease termination or
bankruptcy proceeding and do not immediately sell the properties to new
operators, the assets are included on the balance sheet as "real estate
properties," and the value of such assets is reported at the lower of cost or
fair value. (See Owned and Operated Assets below). Additionally, when a formal
plan to sell real estate is adopted and is under contract, the real estate is
classified as "Assets Held for Sale," with the net carrying amount adjusted to
the lower of cost or fair value, less cost of disposal.
Upon adoption of Financial Accounting Standards Board ("FASB") 144 as of
January 1, 2002, long-lived assets sold or designated as held for sale after
January 1, 2002 are reported as discontinued operations in our financial
statements. Long-lived assets designated as held for sale prior to January 1,
2002 are subject to FASB 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed.
A summary of the number of properties by category for the quarter ended
March 31, 2003 follows:
Assets
Total Held
Purchase / Mortgages Owned & Closed Healthcare for
Facility Count Leaseback Receivable Operated Facilities Facilities Sale Total
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002........... 148 63 3 8 222 4 226
Properties transferred to assets
held for sale........................ - - - - - - -
Properties closed...................... (1) (1) (1) 3 - - -
Properties sold/mortgages paid......... - - - - - - -
Transition leasehold interest.......... - - (1) - (1) - (1)
Properties leased /mortgages placed.... - - - - - - -
Properties transferred to
purchase/leaseback................... 8 (8) - - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2003............ 155 54 1 11 221 4 225
====================================================================================================================================
Investment ($000's)
- ---------------------------------------
Balance at December 31, 2002........... $659,538 $173,914 $ 5,571 $ 4,079 $843,102 $ 2,324 $845,426
Properties transferred to assets
held for sale........................ - - - - - - -
Properties closed...................... (5,900) (1,200) (309) 7,409 - - -
Properties sold/mortgages paid......... - - - - - - -
Transition leasehold interest.......... - - - - - - -
Properties leased/mortgages placed..... - - - - - - -
Properties transferred to
purchase/leaseback................... 47,571 (47,571) - - - - -
Impairment on properties............... - - - (4,618) (4,618) - (4,618)
Capex and other........................ - (476) 32 - (444) - (444)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2003............ $701,209 $124,667 $ 5,294 $ 6,870 $838,040 $ 2,324 $840,364
====================================================================================================================================
Purchase/Leaseback
During the three-month period ended March 31, 2003, we successfully
re-leased nine facilities formerly operated by Integrated Health Services, Inc.
("IHS"). Accordingly, eight skilled nursing facilities ("SNFs"), which we held
mortgages on, and one SNF, which we leased to IHS, have been re-leased to
various unaffiliated third parties. Titles to the eight properties, which we
held mortgages on, have been transferred to wholly-owned subsidiaries of ours by
Deeds in Lieu of Foreclosure.
Specifically, during the quarter ended March 31, 2003, we leased nine SNFs
to four unaffiliated third-party operators as part of four separate
transactions. Each of the nine facilities had formerly been operated by
subsidiaries of IHS. The four transactions included: (i) a Master Lease of five
SNFs in Florida representing 600 beds to affiliates of Seacrest Healthcare
Management, LLC, which lease has a ten-year term and has an initial annual rent
of $2.5 million; (ii) a month-to-month lease (following a minimum four-month
term) on two SNFs in Georgia representing 304 beds to subsidiaries of Triad
Health Management of Georgia, LLC, which lease provides for annualized rent of
$0.7 million - the month-to-month structure results from Georgia Medicaid rate
cuts (effective February 1, 2003) and the potential for future Georgia
reimbursement changes; (iii) a lease of one SNF in Texas, representing 130 beds,
to an affiliate of Senior Management Services of America, Inc., which lease has
a ten-year term and has various rent step-ups, reaching $384,000 by year three,
thereafter, increasing by the lesser of CPI or 2.5%; and (iv) re-leased one
159-bed SNF, located in the state of Washington to a subsidiary of Sun
Healthcare Group, Inc. ("Sun"), with an initial lease term of eight years and
initial annual rent of $0.5 million.
In an unrelated transaction, we recorded a provision for impairment of $4.6
million associated with one closed facility, located in the state of Washington,
previously leased to a subsidiary of Sun as part of a Master Lease. We intend to
sell this closed facility as soon as practicable; however, there can be no
assurance if, or when, this sale will be completed.
Also during the first quarter of 2003, we completed a restructured
transaction with Claremont Health Care Holdings, Inc. (formerly Lyric Health
Care, LLC) whereby nine facilities formerly leased under two Master Leases were
combined into one new ten-year Master Lease. Annual rent under the new lease is
$6.0 million, the same amount of rent recognized in 2002 for these properties.
Mortgages Receivable
Mortgage interest income is recognized as earned over the terms of the
related mortgage notes. Reserves are taken against earned revenues from mortgage
interest when collection of amounts due 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 application of security deposits.
During the three months ended March 31, 2003, titles to eight facilities
were transferred to us as discussed above (see Purchase/Leaseback). In addition,
in an unrelated transaction with IHS, we received title to one closed property
by Deed in Lieu of Foreclosure, which we held the mortgage on. This facility has
been transferred to closed facilities and is included in our Consolidated
Balance Sheet under "Land and buildings at cost." We intend to sell this closed
facility as soon as practicable; however, there can be no assurance if, or when,
this sale will be completed.
No provision for loss on mortgages or notes receivable was recorded during
the three-month periods ended March 31, 2003 and 2002, respectively.
Owned and Operated Assets
At March 31, 2003, we own one, 128-bed facility that was previously
recovered from a customer and is operated for our own account.
During the three months ended March 31, 2003, we bought out a leasehold
interest in one Indiana facility for $0.5 million. In addition, we closed one
Illinois facility, which was previously classified as an owned and operated
asset. This facility has been transferred to closed facilities and is included
in our Consolidated Balance Sheet under "Land and buildings at cost." We intend
to sell this closed facility as soon as practicable; however, there can be no
assurance if or when this sale will be completed.
We intend to operate the remaining owned and operated asset for our own
account until we are able to re-lease, sell or close the facility. The facility
and its respective operations are presented on a consolidated basis in our
financial statements.
Nursing home revenues, nursing home expenses, assets and liabilities
included in our consolidated financial statements which relate to such owned and
operated asset are set forth in the tables below. Nursing home revenues from
this owned and operated asset are recognized as services are provided. The
amounts shown in the consolidated financial statements are not comparable, as
the number of owned and operated facilities and the timing of the foreclosures
and re-leasing activities have occurred at different times during the periods
presented. For 2003, nursing home revenues, nursing home expenses, operating
assets and operating liabilities for our owned and operated properties are shown
on a net basis on the face of our consolidated financial statements. For 2002,
nursing home revenues, nursing home expenses ,operating assets and operating
liabilities for our owned and operated properties are shown on a gross basis on
the face of our consolidated financial statements.
Nursing home revenues and nursing home expenses in our consolidated
financial statements which relate to our owned and operated assets are as
follows:
Three Months Ended
March 31,
--------------------------
2003 2002
--------------------------
(In thousands)
Nursing home revenues (1)
Medicaid...................................... $ 855 $13,503
Medicare...................................... 272 4,257
Private & other............................... 412 3,988
--------------------------
Total nursing home revenues (2)............. 1,539 21,748
--------------------------
Nursing home expenses
Patient care expenses......................... 866 15,278
Administration................................ 1,111 4,502
Property & related............................ 209 1,592
Leasehold buyout expense...................... 582 -
Management fees............................... 76 1,200
Rent.......................................... 28 1,128
--------------------------
Total nursing home expenses (2)............. 2,872 23,700
--------------------------
Nursing home revenues and expenses of owned
and operated assets - net (2)............... $(1,333) $ -
==========================
(1) Nursing home revenues from these owned and operated assets are recognized
as services are provided.
(2) Nursing home revenues and expenses of owned and operated assets for the
three months ended March 31, 2003 are shown on a net basis on the face of
our Consolidated Statements of Operations and are shown on a gross basis
for the three months ended March 31, 2002.
Accounts receivable for owned and operated assets is net of an allowance
for doubtful accounts of approximately $11.3 million at March 31, 2003 and $6.9
million at March 31, 2002.
March 31,
-------------------------
2003 2002
-------------------------
(In thousands)
Beginning balance............................. $12,171 $ 8,335
Provision charged/(recovery).................. - (750)
Provision applied............................. (829) (667)
-------------------------
Ending balance................................ $11,342 $ 6,918
=========================
The table below reconciles reported revenues and expenses to revenues and
expenses excluding nursing home revenues and expenses of owned and operated
assets. Nursing home revenues and expenses of owned and operated assets for the
three-month period ended March 31, 2003 are shown on a net basis on the face of
our Consolidated Statements of Operations and are shown on a gross basis for the
three-month period ended March 31, 2002. Since nursing home revenues are not
included in reported revenues for the three-month period ended March 31, 2003,
no adjustment is necessary to exclude nursing home revenues.
Three Months Ended
March 31,
------------------------
2003 2002
------------------------
(In thousands)
Total revenues................................ $24,564 $43,924
Nursing home revenues of owned and
operated assets........................... - 21,748
------------------------
Revenues excluding nursing home revenues
of owned and operated assets............ $24,564 $22,176
========================
Total expenses................................ $18,579 $39,467
Nursing home expenses of owned and
operated assets........................... - 23,700
Nursing home revenues and expenses of
owned and operated assets - net........... 1,333 -
------------------------
Expenses excluding nursing home expenses
of owned and operated assets............ $17,246 $15,767
========================
The assets and liabilities in our consolidated financial statements which
relate to our owned and operated assets are as follows:
March 31, December 31,
2003 2002
--------------------------
(In thousands)
ASSETS
Cash ......................................... $ 562 $ 838
Accounts receivable - net (1)................. 4,810 7,491
Other current assets (1)...................... 277 1,207
--------------------------
Total current assets....................... 5,649 9,536
--------------------------
Investment in leasehold - net (1)............. - 185
--------------------------
Land and buildings............................ 5,294 5,571
Less accumulated depreciation................. (567) (675)
--------------------------
Land and buildings - net...................... 4,727 4,896
--------------------------
Assets held for sale - net.................... - 2,324
--------------------------
Total assets............................... $10,376 $16,941
==========================
LIABILITIES
Accounts payable.............................. $ 818 $ 389
Other current liabilities..................... 4,047 4,223
--------------------------
Total current liabilities.................. 4,865 4,612
--------------------------
Total liabilities (1)......................... $ 4,865 $ 4,612
==========================
Operating assets and liabilities for owned
properties - net (1)........................ $ 222 $ -
==========================
(1) Operating assets and liabilities for owned properties as of March 31, 2003
are shown on a net basis on the face of our Consolidated Balance Sheet and
are shown on a gross basis as of December 31, 2002.
Closed Facilities
During the quarter ended March 31, 2003, three facilities were transferred
to closed facilities. One facility was transferred from purchase leaseback and a
non-cash impairment of $4.6 million was recorded to reduce the value of the
investment to fair value. Another facility was transferred from mortgage notes
receivable after we received a Deed in Lieu of Foreclosure. Finally, we
transferred one facility from our owned and operated portfolio into closed
facilities. At this time it was determined that no provisions for impairments
were needed on the latter two investments. We intend to sell the facilities as
soon as practicable. There can be no assurance if, or when, such sales will be
completed or whether such sales will be completed on terms that allow us to
realize the carrying value of the assets.
At March 31, 2003, there are 11 closed properties that are not currently
under contract for sale. These properties are included in "Land and buildings at
cost" in our Consolidated Balance Sheet.
Assets Held for Sale
At March 31, 2003, the carrying value of four assets held for sale totaled
$2.3 million (net of impairment reserves of $2.8 million). There can be no
assurance if, or when, such sales will be completed or whether such sales will
be completed on terms that allow us to realize the carrying value of the assets.
There were no sales or transfers of real estate assets held for sale during
the quarter ended March 31, 2003. During the three months ended March 31, 2002,
we realized gross disposition proceeds of $80,000 associated with the sale of
beds from two facilities. These beds were part of the facilities that were
classified as assets held for sale during 2001. Accordingly, they are subject to
FASB 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed.
Note C - Concentration of Risk and Related Issues
As of March 31, 2003, our portfolio of domestic investments consisted of
221 healthcare facilities, located in 28 states and operated by 35 third-party
operators. Our gross investment in these facilities, net of impairments and
before reserve for uncollectible loans, totaled $843.0 million at March 31 2003,
with 97.2% of our real estate investments related to long-term care facilities.
This portfolio is made up of 153 long-term healthcare facilities and two
rehabilitation hospitals owned and leased to third parties, fixed rate, and
convertible participating mortgages on 54 long-term healthcare facilities and
one long-term healthcare facility that was recovered from a customer and is
currently operated through a third-party management contract for our own account
and 11 long-term healthcare facilities that were recovered from customers and
are currently closed. At March 31, 2003, we also held miscellaneous investments
and assets held for sale of approximately $43.0 million, including $16.8 million
related to a non-healthcare facility leased by the United States Postal Service,
a $1.3 million investment in Principal Healthcare Finance Trust and $15.5
million of notes receivable, net of allowance.
Approximately 49.5% of our real estate investments are operated by four
public companies, including Sun Healthcare Group, Inc. (26.5%), Advocat, Inc.
("Advocat") (12.6%), Mariner Post-Acute Network ("Mariner") (7.1%), and Alterra
Healthcare Corporation ("Alterra") (3.3%). The three largest private operators
represent 10.3%, 4.0% and 3.8%, respectively, of our investments. No other
operator represents more than 2.7% of our investments. The three states in which
we have our highest concentration of investments are Florida (16.1%), California
(7.9%) and Illinois (7.8%).
Government Healthcare Regulation, Reimbursements and Industry Concentration
Risks
Nearly all of our properties are used as healthcare facilities; therefore,
we are directly affected by the risk associated with the healthcare industry.
Our lessees and mortgagors, as well as the facility owned and operated for our
own account, derive a substantial portion of their net operating revenues from
third-party payors, including the Medicare and Medicaid programs. These programs
are highly regulated by federal, state and local laws, rules and regulations and
subject to frequent and substantial change. The Balanced Budget Act of 1997
("Balanced Budget Act") significantly reduced spending levels for the Medicare
and Medicaid programs. Due to the implementation of the terms of the Balanced
Budget Act, effective July 1, 1998, the majority of skilled nursing facilities
shifted from payments based on reimbursable cost to a prospective payment system
for services provided to Medicare beneficiaries. Under the prospective payment
system, skilled nursing facilities are paid on a per diem prospective case-mix
adjusted payment basis for all covered services. Implementation of the
prospective payment system has affected each long-term care facility to a
different degree, depending upon the amount of revenue it derives from Medicare
patients. Long-term care facilities have had to attempt to restructure their
operations to operate profitably under the new Medicare prospective payment
system reimbursement policies.
Legislation adopted in 1999 and 2000 increased Medicare payments to nursing
facilities and specialty care facilities on an interim basis. Section 101 of the
Balanced Budget Relief Act of 1999 ("Balance Budget Relief Act") included a 20%
increase for 15 patient acuity categories (known as Resource Utilization Groups
("RUGS")) and a 4% across the board increase of the adjusted federal per diem
payment rate. The 20% increase was implemented in April 2000 and will remain in
effect until the implementation of refinements in the current RUG case-mix
classification system to more accurately estimate the cost of non-therapy
ancillary services. The 4% increase was implemented in April 2000 and expired
October 1, 2002.
The Benefits Improvement and Protection Act of 2000 ("Benefits Improvement
and Protection Act") included a 16.7% increase in the nursing component of the
case-mix adjusted federal periodic payment rate and a 6.7% increase in the 14
RUG payments for rehabilitation therapy services. The 16.7% increase was
implemented in April 2000 and expired October 1, 2002. The 6.7% increase is an
adjustment to the 20% increase granted in the Balance Budget Relief Act and
spreads the funds directed at three of those 15 RUGs to an additional 11
rehabilitation RUGs. The increase was implemented in April 2001 and will remain
in effect until the implementation of refinements in the current RUG case-mix
classification system.
In addition to the expiration of the 4% increase implemented in the Balance
Budget Relief Act and the 16.7% increase implemented in the Benefits Improvement
and Protection Act, Medicare reimbursement could be further reduced when the
Centers for Medicare & Medicaid Services ("CMS") completes its RUG refinement
due to the termination of the 20% and 6.7% increases. However, the Medicare
Payment Advisory Commission has recommended that the 20% and 6.7% increases be
folded into the base rate upon the completion of the RUG refinement. The partial
expiration of the increases under these statutes as of October 1, 2002 has had
an adverse impact on the revenues of the operators of nursing facilities and has
negatively impacted some operators' ability to satisfy their monthly lease or
debt payments to us. Recently, CMS announced a delay in the implementation of
further refinements in reimbursement rates until October 1, 2004, at the
earliest. Because the revised reimbursement rates have not yet been published,
it is unclear what effect they will have on us, or if the add-on payments
included in the second part of the mitigating legislation will be included in
these new rates.
Due to the temporary nature of the remaining payment increases, we cannot
be assured that the federal reimbursement will remain at levels comparable to
present levels and that such reimbursement will be sufficient for our lessees or
mortgagors to cover all operating and fixed costs necessary to care for Medicare
and Medicaid patients. We also cannot be assured that there will be any future
legislation to increase payment rates for skilled nursing facilities. If payment
rates for skilled nursing facilities are not increased in the future, some of
our lessees and mortgagors may have difficulty meeting their payment obligations
to us.
Each state has its own Medicaid program that is funded jointly by the state
and federal government. Federal law governs how each state manages its Medicaid
program, but there is wide latitude for states to customize Medicaid programs to
fit the needs and resources of its citizens. The Balanced Budget Act repealed
the federal payment standard, also known as the Boren Amendment, for hospitals
and nursing facilities under Medicaid, increasing states' discretion over the
administration of Medicaid programs. A number of states have adopted or are
considering reductions in their Medicaid expenditures which could result in
decreased revenues for our lessees and mortgagors.
In addition, private payors, including managed care payors, are
increasingly demanding discounted fee structures and the assumption by
healthcare providers of all or a portion of the financial risk of operating a
healthcare facility. Efforts to impose greater discounts and more stringent cost
controls are expected to continue. Any changes in reimbursement policies which
reduce reimbursement levels could adversely affect the revenues of our lessees
and mortgagors and thereby adversely affect those lessees' and mortgagors'
abilities to make their monthly lease or debt payments to us.
The possibility that the healthcare facilities will not generate income
sufficient to meet operating expenses or will yield returns lower than those
available through investments in comparable real estate or other investments are
additional risks of investing in healthcare-related real estate. Income from
properties and yields from investments in such properties may be affected by
many factors, including changes in governmental regulation (such as zoning
laws), general or local economic conditions (such as fluctuations in interest
rates and employment conditions), the available local supply and demand for
improved real estate, a reduction in rental income as the result of an inability
to maintain occupancy levels, natural disasters (such as earthquakes and floods)
or similar factors.
Real estate investments are relatively illiquid and, therefore, tend to
limit our ability to vary our portfolio promptly in response to changes in
economic or other conditions. Thus, if the operation of any of our properties
becomes unprofitable due to competition, age of improvements or other factors
such that the lessee or borrower becomes unable to meet its obligations on the
lease or mortgage loan, the liquidation value of the property may be
substantially less, particularly relative to the amount owing on any related
mortgage loan, than would be the case if the property were readily adaptable to
other uses.
Potential Risks from Bankruptcies
Our lease arrangements with operators who operate more than one of our
facilities are generally made pursuant to a single master lease ("Master Lease")
covering all of that operator's facilities. Although each lease or Master Lease
provides that we may terminate the Master Lease upon the bankruptcy or
insolvency of the tenant, the Bankruptcy Reform Act of 1978 ("Bankruptcy Act")
provides that a trustee in a bankruptcy or reorganization proceeding under the
Bankruptcy Act, or a debtor-in-possession in a reorganization, has the power and
the option to assume or reject the unexpired lease obligations of a
debtor-lessee. In the event that the unexpired lease is assumed on behalf of the
debtor-lessee, all the rental obligations generally would be entitled to a
priority over other unsecured claims. However, the court also has the power to
modify a lease if a debtor-lessee, in a reorganization, were required to perform
certain provisions of a lease that the court determined to be unduly burdensome.
It is not possible to determine at this time whether or not any of our leases or
Master Leases contain any such provision. If a lease is rejected, the lessor has
a general unsecured claim limited to any unpaid rent already due plus an amount
equal to the rent reserved under the lease, without acceleration, for the
greater of one year or 15% of the remaining term of such lease, not to exceed
three years.
Generally, with respect to our mortgage loans, the imposition of an
automatic stay under the Bankruptcy Act precludes us from exercising foreclosure
or other remedies against the debtor. Pre-petition creditors generally do not
have rights to the cash flows from the properties underlying the mortgages. The
timing of the collection from mortgagors in bankruptcy depends on negotiating an
acceptable settlement with the mortgagor (and subject to approval of the
bankruptcy court) or the order of the bankruptcy court in the event a negotiated
settlement cannot be achieved. A mortgagee also is treated differently from a
landlord in three key respects. First, the mortgage loan is not subject to
assumption or rejection because it is not an executory contract or a lease.
Second, the mortgagee's loan may be divided into (1) a secured loan for the
portion of the mortgage debt that does not exceed the value of the property and
(2) a general unsecured loan for the portion of the mortgage debt that exceeds
the value of the property. A secured creditor such as ourselves is entitled to
the recovery of interest and costs only if, and to the extent that, the value of
the collateral exceeds the amount owed. If the value of the collateral exceeds
the amount of the debt, interest and allowed costs may not be paid during the
bankruptcy proceeding, but accrue until confirmation of a plan of reorganization
or such other time as the court orders. If the value of the collateral held by a
senior creditor is less than the secured debt, interest on the loan for the time
period between the filing of the case and confirmation may be disallowed.
Finally, while a lease generally would either be rejected or assumed with all of
its benefits and burdens intact, the terms of a mortgage, including the rate of
interest and timing of principal payments, may be modified if the debtor is able
to affect a "cramdown" under the Bankruptcy Act.
The receipt of liquidation proceeds or the replacement of an operator that
has defaulted on its lease or loan could be delayed by the approval process of
any federal, state or local agency necessary for the transfer of the property or
the replacement of the operator licensed to manage the facility. In addition,
some significant expenditures associated with real estate investment, such as
real estate taxes and maintenance costs, are generally not reduced when
circumstances cause a reduction in income from the investment. In order to
protect our investments, we may take possession of a property or even become
licensed as an operator, which might expose us to successor liability to
government programs or require us to indemnify subsequent operators to whom we
might transfer the operating rights and licenses. Third party payors may also
suspend payments to us following foreclosure until we receive the required
licenses to operate the facilities. Should such events occur, our income and
cash flow from operations would be adversely affected.
Risks Related to Owned and Operated Assets
As a consequence of the financial difficulties encountered by a number of
our operators, over the last several years we have recovered various long-term
care assets, pledged as collateral for the operators' obligations, either in
connection with a restructuring or settlement with certain operators or pursuant
to foreclosure proceedings. We are typically required to hold applicable
licenses and are responsible for the regulatory compliance at our owned and
operated facilities. At March 31, 2003, we had one facility, managed under a
third party management agreement, classified as owned and operated. Our
management contract with this third-party operator provides that the third-party
operator is responsible for regulatory compliance, but we could be sanctioned
for violation of regulatory requirements. In general, the risks of third-party
claims such as patient care and personal injury claims are higher with respect
to our owned and operated property as compared with our leased and mortgaged
assets.
We and several of our wholly-owned subsidiaries have been named as
defendants in professional liability claims related to our owned and operated
facilities. Other third-party managers responsible for the day-to-day operations
of these facilities have also been named as defendants in these claims. In these
suits, patients of certain previously owned and operated facilities have alleged
significant damages, including punitive damages against the defendants. The
lawsuits are in various stages of discovery and we are unable to predict the
likely outcome at this time. We continue to vigorously defend these claims and
pursue all rights we may have against the managers of the facilities, under the
terms of the management agreements. We have insured these matters, subject to
self-insured retentions of various amounts.
Note D - Dividends
In order to qualify as a real estate investment trust ("REIT"), we are
required to distribute dividends (other than capital gain dividends) to our
stockholders in an amount at least equal to (A) the sum of (i) 90% of our "REIT
taxable income" (computed without regard to the dividends paid deduction and our
net capital gain) and (ii) 90% of the net income (after tax), if any, from
foreclosure property, minus (B) the sum of certain items of non-cash income. In
addition, if we dispose of any built-in gain asset during a recognition period,
we will be required to distribute at least 90% of the built-in gain (after tax),
if any, recognized on the disposition of such asset. Such distributions must be
paid in the taxable year to which they relate, or in the following taxable year
if declared before we timely file our tax return for such year and paid on or
before the first regular dividend payment after such declaration. In addition,
such distributions are required to be made pro rata, with no preference to any
share of stock as compared with other shares of the same class, and with no
preference to one class of stock as compared with another class except to the
extent that such class is entitled to such a preference. To the extent that we
do not distribute all of our net capital gain or do distribute at least 90%, but
less than 100% of our "REIT taxable income," as adjusted, we will be subject to
tax thereon at regular ordinary and capital gain corporate tax rates.
On February 1, 2001, we announced the suspension of all common and
preferred dividends. Prior to recommencing the payment of dividends on our
common stock, all accrued and unpaid dividends on our Series A, B and C
preferred stock must be paid in full. Due to our 2002 taxable loss, no
distribution was necessary to maintain our REIT status for 2002. Net operating
loss carryforwards through 2002 of approximately $24.0 million are available to
help offset taxable income. In addition, we intend to make the necessary
distributions, if any, to satisfy the 2003 REIT requirements. The accumulated
and unpaid dividends relating to all series of preferred stocks total $45.1
million as of March 31, 2003. In aggregate, preferred dividends continue to
accumulate at approximately $5.0 million per quarter.
No common cash dividends were paid during 2002 and 2001. We can give no
assurance as to if, or when, the dividends will be reinstated on the preferred
stock or common stock, or the amount of the dividends if and when such payments
are recommenced.
On March 30, 2001, we exercised our option to pay the accrued $4,666,667
Series C dividend from November 15, 2000 and the associated deferral fee by
issuing 48,420 Series C preferred shares to Explorer Holdings, L.P. on April 2,
2001, which are convertible into 774,720 shares of our common stock at $6.25 per
share. Such election resulted in an increase in the aggregate liquidation
preference of Series C preferred stock as of April 2, 2001 to $104,842,000.
Dividends paid in stock to a specific class of stockholders, such as our payment
of our Series C preferred stock in April 2001, constitute dividends eligible for
the 2001 dividends paid deduction.
Since dividends on the Series A and Series B preferred stock have been in
arrears for more than 18 months, the holders of the Series A and Series B
preferred stock (voting together as a single class) continue to have the right
to elect two additional directors to our Board of Directors in accordance with
the terms of the Series A and Series B preferred stock and our Bylaws. Explorer,
the sole holder of the Series C preferred stock, also has the right to elect two
other additional directors to our Board of Directors in accordance with the
terms of the Series C preferred stock and our Bylaws. Explorer, without waiving
its rights under the terms of the Series C preferred stock or the Stockholders
Agreement, has advised us that it is not currently seeking the election of the
two additional directors resulting from the Series C dividend arrearage unless
the holders of the Series A and Series B preferred stock seek to elect
additional directors, but has fully reserved its rights.
Note E - Earnings Per Share
The computation of basic earnings per share is determined based on the
weighted-average number of common shares outstanding during the respective
periods. Diluted earnings per share reflect the dilutive effect, if any, of
stock options and the assumed conversion of the Series C preferred stock.
Note F - Stock-Based Compensation
We account for stock options using the intrinsic value method as defined by
APB 25, Accounting for Stock Issued to Employees. Under the terms of the 2000
Stock Incentive Plan ("Incentive Plan"), we reserved 3,500,000 shares of common
stock for grants to be issued during a period of up to ten years. Options are
exercisable at the market price at the date of grant, expire five years after
date of grant for over 10% owners and ten years from the date of grant for less
than 10% owners. Directors' shares vest over three years while other grants vest
over five years or as defined in an employee's contract. Directors, officers and
employees are eligible to participate in the Incentive Plan. At March 31, 2003,
there were 2,374,501 outstanding options granted to 19 eligible participants.
Additionally, 327,121 shares of restricted stock have been granted under the
provisions of the Incentive Plan. The market value of the restricted shares on
the date of the award was recorded as unearned compensation-restricted stock,
with the unamortized balance shown as a separate component of stockholders
equity. Unearned compensation is amortized to expense generally over the vesting
period.
Statement of Financial Accounting Standard ("SFAS") No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure, which was effective
January 1, 2003, requires certain disclosures related to our stock-based
compensation arrangements. The following table presents the effect on net income
and earnings per share if we had applied the fair value recognition provisions
of SFAS No. 123, Accounting for Stock-Based Compensation, to our stock-based
compensation.
Three Months Ended
March 31,
------------------------
2003 2002
------------------------
(In thousands, except
per share amounts)
Net income (loss ) available to common........ $ 956 $ (572)
Add: Stock-based compensation expense
included in net income (loss) available
to common............................... - -
-----------------------
956 (572)
Less: Stock-based compensation expense
determined under the fair value based
method for all awards................... 66 171
-----------------------
Pro forma net income (loss) available
to common................................... $ 890 $ (743)
=======================
Earnings per share:
Basic, as reported............................ $0.03 $(0.02)
=======================
Basic, pro forma.............................. $0.02 $(0.03)
=======================
Diluted, as reported.......................... $0.03 $(0.02)
=======================
Diluted, pro forma............................ $0.02 $(0.03)
=======================
At March 31, 2003, options currently exercisable (313,154) have a
weighted-average exercise price of $5.238, with exercise prices ranging from
$2.15 to $37.20. There are 618,489 shares available for future grants as of
March 31, 2003.
The following is a summary of first quarter 2003 activity under the plan.
Stock Options
-------------------------------------------
Weighted-
Number of Average
Shares Exercise Price Price
- --------------------------------------------------------------------------------
Outstanding at December 31, 2002... 2,374,501 $2.150 - $37.205 $3.150
Granted during 2003.............. - - -
Canceled......................... - - -
- --------------------------------------------------------------------------------
Outstanding at March 31, 2003...... 2,374,501 $2.150 - $37.205 $3.150
================================================================================
Note G - Litigation
We are subject to various legal proceedings, claims and other actions
arising out of the normal course of business. While any legal proceeding or
claim has an element of uncertainty, management believes that the outcome of
each lawsuit claim or legal proceeding that is pending or threatened, or all of
them combined, will not have a material adverse effect on our consolidated
financial position or results of operations. (See Note C - Concentration of Risk
and Related Issues; Risks Related to Owned and Operated Assets).
On June 21, 2000, we were named as a defendant in certain litigation
brought against us in the U.S. District Court for the Eastern District of
Michigan, Detroit Division, by Madison/OHI Liquidity Investors, LLC ("Madison"),
for the breach and/or anticipatory breach of a revolving loan commitment. Ronald
M. Dickerman and Bryan Gordon are partners in Madison and limited guarantors
("Guarantors") of Madison's obligations to us. Effective as of September 30,
2002 the parties settled all claims in the suit in consideration of Madison's
payment of the sum of $5.4 million consisting of a $0.4 million cash payment for
our attorneys' fees, with the balance evidenced by the amendment of the existing
promissory note from Madison to us. The note reflects a principal balance of
$5.0 million, with interest accruing at 9% per annum, payable over three years
upon liquidation of the collateral securing the note. The note is also fully
guaranteed by the Guarantors; provided that if all accrued interest and 75% of
original principal has been repaid within 18 months, the Guarantors will be
released. Accordingly, a reserve of $1.25 million was recorded in 2002 relating
to this note. As of March 31, 2003, the principal balance on this note was $2.2
million prior to reserves.
In 2000, we filed suit against a title company (later adding a law firm as
a defendant), seeking damages based on claims of breach of contract and
negligence, among other things, as a result of the alleged failure to file
certain Uniform Commercial Code ("UCC") financing statements in our favor. We
filed a subsequent suit seeking recovery under title insurance policies written
by the title company. The defendants denied the allegations made in the
lawsuits. In settlement of our claims against the defendants, we agreed in the
first quarter of 2003 to accept a lump sum cash payment of $3.2 million. The
cash proceeds were offset by related expenses incurred of $1.0 million resulting
in a net gain of $2.2 million.
We and several of our wholly-owned subsidiaries have been named as
defendants in professional liability claims related to our owned and operated
facilities. Other third-party managers responsible for the day-to-day operations
of these facilities have also been named as defendants in these claims. In these
suits, patients of certain previously owned and operated facilities have alleged
significant damages, including punitive damages against the defendants. The
lawsuits are in various stages of discovery and we are unable to predict the
likely outcome at this time. We continue to vigorously defend these claims and
pursue all rights we may have against the managers of the facilities, under the
terms of the management agreements. We have insured these matters, subject to
self-insured retentions of various amounts.
Note H - Borrowing Arrangements
On December 21, 2001, we reached amended agreements with the bank groups
under both of our revolving credit facilities. The amendments became effective
as of the closing of the rights offering and private placement to Explorer on
February 21, 2002. The amendments included modifications and/or eliminations to
certain financial covenants.
The amendment regarding our $175.0 million revolving credit facility
included a one-year extension in maturity from December 31, 2002 to December 31,
2003 and a reduction in the total commitment from $175.0 million to $160.0
million.
As part of the amendment regarding our $75.0 million revolving credit
facility, we prepaid $10.0 million in December 2001, originally scheduled to
mature in March 2002. This voluntary prepayment resulted in a permanent
reduction in the total commitment, thereby reducing the credit facility to $65.0
million.
Our $160.0 million secured revolving line of credit facility expires on
December 31, 2003. Borrowings under this facility bear interest at 2.50% to
3.25% over London Interbank Offered Rate ("LIBOR") through December 31, 2002 and
3.00% to 3.25% over LIBOR after December 31, 2002. Borrowings of $112.0 million
were outstanding as of March 31, 2003. Additionally, $12.5 million of letters of
credit were outstanding against this credit facility at March 31, 2003. These
letters of credit were collateral for certain long-term borrowings and supported
insurance programs associated with our owned and operated assets. LIBOR-based
borrowings under this facility bear interest at a weighted-average rate of 4.36%
at March 31, 2003. Cost for the letters of credit range from 2.50% to 3.25%,
based on our leverage ratio. Real estate investments with a gross book value of
approximately $238.8 million are pledged as collateral for this revolving line
of credit facility at March 31, 2003.
Our $65.0 million line of credit facility expires on June 30, 2005.
Borrowings under this facility bear interest at 2.50% and 3.75% over LIBOR,
based on our leverage ratio and collateral assignment. Borrowings of $65.0
million were outstanding at March 31, 2003. LIBOR-based borrowings under this
facility bear interest at a weighted-average rate of 4.59% at March 31, 2003.
Real estate investments with a gross book value of approximately $117.1 million
are pledged as collateral for this revolving line of credit facility at March
31, 2003.
At March 31, 2003, we had $177.0 million of LIBOR-based borrowings
outstanding and $12.5 million of letters of credit outstanding, leaving
availability of $35.5 million.
Note I - Accounting for Derivatives
We utilize interest rate swaps and caps to fix interest rates on variable
rate debt and reduce certain exposures to interest rate fluctuations. We do not
use derivatives for trading or speculative purposes. We have a policy of only
entering into contracts with major financial institutions based upon their
credit ratings and other factors. When viewed in conjunction with the underlying
and offsetting exposure that the derivatives are designed to hedge, we have not
sustained a material loss from those instruments nor do we anticipate any
material adverse effect on our net income or financial position in the future
from the use of derivatives.
To manage interest rate risk, we may employ options, forwards, interest
rate swaps, caps and floors or a combination thereof depending on the underlying
exposure. We may employ swaps, forwards or purchased options to hedge qualifying
forecasted transactions. Gains and losses related to these transactions are
deferred and recognized in net income as interest expense in the same period or
periods that the underlying transaction occurs, expires or is otherwise
terminated. In June 1998, the Financial Accounting Standards Board issued
Statement No. 133, Accounting for Derivative Instruments and Hedging Activities,
which was required to be adopted in years beginning after June 15, 2000. We
adopted the new Statement effective January 1, 2001. The Statement requires us
to recognize all derivatives on the balance sheet at fair value. Derivatives
that are not hedges must be adjusted to fair value through income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the fair
value of derivatives will either be offset against the change in fair value of
the hedged assets, liabilities, or firm commitments through earnings or
recognized in Other Comprehensive Income until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings.
In September 2002, we entered into a 61-month, $200.0 million interest rate
cap with a strike of 3.50% that has been designated as a cash flow hedge. Under
the terms of the cap agreement, when LIBOR exceeds 3.50%, the counterparty will
pay us $200.0 million multiplied by the difference between LIBOR and 3.50% times
the number of days when LIBOR exceeds 3.50%. The unrealized gain/loss in the
fair value of cash flow hedges are reported on the balance sheet with
corresponding adjustments to accumulated Other Comprehensive Income. On March
31, 2003, the derivative instrument was reported at its fair value of $6.6
million as compared to its fair value at December 31, 2002 of $7.3 million. An
adjustment of $0.6 million to Other Comprehensive Income was made for the change
in fair value of this cap during the quarter ended March 31, 2003. Over the term
of the interest rate cap, the $10.1 million cost will be amortized to earnings
based on the specific portion of the total cost attributed to each monthly
settlement period. Over the twelve months ending December 31, 2003, $0.1 million
is expected to be amortized.
Note J - Subsequent Events
Sun Healthcare Group, Inc. During the first quarter of 2003, Sun remitted
rent of $5.0 million versus the contractual amount of $6.4 million. We agreed
with Sun to use letters of credit (posted by Sun as security deposits) in the
amount of $1.4 million to make up the difference in rent and agreed to
temporarily forebear in declaring a default under the lease caused by Sun's
failure to restore the $1.4 million letter of credit.
Also, during the quarter, Sun announced "that it has opened dialogue with
many of its landlords concerning the portfolio of properties leased to Sun and
various of its consolidated subsidiaries (collectively, the 'Company'). The
Company is seeking a rent moratorium and/or rent concessions with respect to
certain of its facilities and is seeking to transition its operations of certain
facilities to new operators while retaining others." To this end, Sun has
initiated conversations with us regarding a restructure of our lease. Although
it is too early to predict the outcome of these conversations, it is likely that
Sun's overall contractual rent will be reduced on certain facilities and that
certain other facilities may be transitioned and re-leased to unaffiliated
third-party operators. In April and May of 2003, Sun paid $1.3 million and $1.3
million, respectively, versus the monthly contractual rent of $2.2 million. We
applied security deposits in the amount of $1.4 million. At the date of this
filing, Sun has exhausted its security deposits with us. The accompanying
consolidated financial statements do not reflect any adjustments relating to the
potential outcome of these matters.
As of March 31, 2003, we have an original investment balance of $219.0
million relating to the Sun portfolio under agreements providing for annual
rental income of $25.1 million in 2002 and $25.7 million in 2003.
Other Investments. On May 7, 2003, we sold our investment in a Baltimore,
Maryland asset, leased by the United States Postal Service, to FL Lajolla, Inc.
for approximately $19.6 million. FL Lajolla, Inc. paid us $1.95 million and
assumed a first mortgage of approximately $17.6 million. As a result of this
transaction, our debt balance is approximately $289 million versus $306 million
at March 31, 2003.
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
This document contains forward-looking statements, including statements
regarding potential asset sales, potential future changes in reimbursement, the
future effect of the "Medicare cliff" on our operators and plans to refinance or
extend our upcoming debt maturity. These statements relate to our expectations,
beliefs, intentions, plans, objectives, goals, strategies, future events,
performance and underlying assumptions and other statements other than
statements of historical facts. In some cases, you can identify forward-looking
statements by the use of forward-looking terminology including "may," "will,"
"anticipates," "expects," "believes," "intends," "should" or comparable terms or
the negative thereof. These statements are based on information available on the
date of this filing and only speak as to the date hereof and no obligation to
update such forward-looking statements should be assumed. Our actual results may
differ materially from those reflected in the forward-looking statements
contained herein as a result of a variety of factors, including, among other
things: (i) those items discussed in Item 1 above; (ii) regulatory changes in
the healthcare sector, including without limitation, changes in Medicare
reimbursement; (iii) changes in the financial position of our operators; (iv)
the ability of operators in bankruptcy to reject unexpired lease obligations,
modify the terms of our mortgages, and impede our ability to collect unpaid rent
or interest during the pendency of a bankruptcy proceeding and retain security
deposits for the debtor's obligations; (v) our ability to dispose of assets held
for sale on a timely basis and at appropriate prices; (vi) uncertainties
relating to the operation of our owned and operated assets, including those
relating to reimbursement by third-party payors, regulatory matters and
occupancy levels; (vii) our ability to manage, re-lease or sell owned and
operated assets; (viii) the availability and cost of capital; and (ix)
competition in the financing of healthcare facilities.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with GAAP in the
United States requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period.
We have identified six significant accounting policies as critical
accounting policies. These critical accounting policies are those that have the
most impact on the reporting of our financial condition and those requiring
significant judgments and estimates. With respect to these critical accounting
policies, we believe the application of judgments and assessments is
consistently applied and produces financial information that fairly presents the
results of operations for all periods presented. The six critical accounting
policies are:
Owned and Operated Assets and Assets Held for Sale. When we acquire real
estate pursuant to a foreclosure proceeding, it is designated as "owned and
operated assets" and is recorded at the lower of cost or fair value and is
included in real estate properties on our Consolidated Balance Sheet. For 2003,
operating assets and operating liabilities for our owned and operated properties
are shown on a net basis on the face of our Consolidated Balance Sheet. For
2002, operating assets and operating liabilities for our owned and operated
properties are shown on a gross basis on the face of our Consolidated Balance
Sheet and are detailed in Note B - Properties; Owned and Operated Assets. The
consolidation in 2003 is due to the decrease in the size of the owned and
operated portfolio (currently one facility).
When a formal plan to sell real estate is adopted and we hold a contract
for sale, the real estate is classified as "assets held for sale," with the net
carrying amount adjusted to the lower of cost or estimated fair value, less cost
of disposal. Depreciation of the facilities is excluded from operations after
management has committed to a plan to sell the asset. Upon adoption of FASB 144
as of January 1, 2002, long-lived assets sold or designated as held for sale
after January 1, 2002 are reported as discontinued operations in our financial
statements.
Impairment of Assets. We periodically evaluate our real estate investments
for impairment indicators. The judgment regarding the existence of impairment
indicators are based on factors such as market conditions, operator performance
and legal structure. If indicators of impairment are present, we evaluate the
carrying value of the related real estate investments in relationship to the
future undiscounted cash flows of the underlying facilities. Provisions for
impairment losses related to long-lived assets are recognized when expected
future cash flows are less than the carrying values of the assets. If the sum of
the expected future cash flow, including sales proceeds, is less than carrying
value, we then adjust the net carrying value of leased properties and other
long-lived assets to the present value of expected future cash flows.
Loan Impairment Policy. When management identifies an indication of
potential loan impairment, such as non-payment under the loan documents or
impairment of the underlying collateral, the loan is written down to the present
value of the expected future cash flows. In cases where expected future cash
flows cannot be estimated, the loan is written down to the fair value of the
collateral.
Accounts Receivable. Accounts receivable consists primarily of lease and
mortgage interest payments. Amounts recorded include estimated provisions for
loss related to uncollectible accounts and disputed items. On a monthly basis,
we review the contractual payment versus actual cash payment received and the
contractual payment due date versus actual receipt date. When management
identifies delinquencies, a judgment is made as to the amount of provision, if
any, that is needed.
Accounts Receivable - Owned and Operated Assets. Accounts receivable from
owned and operated assets consist of amounts due from Medicare and Medicaid
programs, other government programs, managed care health plans, commercial
insurance companies and individual patients. Amounts recorded include estimated
provisions for loss related to uncollectible accounts and disputed items.
Revenue Recognition. Rental income and mortgage interest income are
recognized as earned over the terms of the related Master Leases and mortgage
notes, respectively. Such income includes periodic increases based on
pre-determined formulas (i.e., such as increases in the CPI) as defined in the
Master Leases and mortgage loan agreements. Reserves are taken against earned
revenues from leases and mortgages when collection of amounts due become
questionable or when negotiations for restructurings of troubled operators lead
to lower expectations regarding ultimate collection. When collection is
uncertain, lease revenues are recorded as received, after taking into account
application of security deposits. Interest income on impaired mortgage loans is
recognized as received after taking into account application of security
deposits.
Nursing home revenues from owned and operated assets (primarily Medicare,
Medicaid and other third-party insurance) are recognized as patient services are
provided.
Results of Operations
The following is a discussion of our consolidated results of operations,
financial position and liquidity and capital resources which should be read in
conjunction with the consolidated financial statements and accompanying notes.
(See Note B - Properties and Note C - Concentration of Risk and Related Issues).
Revenues for the three-month period ended March 31, 2003 totaled $24.6
million, a decrease of $19.4 million as compared to the same period in 2002.
When excluding nursing home revenues of owned and operated assets, revenues
increased $2.4 million versus the three-month period ended March 31, 2002. The
increase was primarily a result of legal settlement.
Rental income for the three-month period ended March 31, 2003 was $16.7
million, an increase of $1.3 million over the same period in 2002. The $1.3
million increase for the three-month period is due to $0.8 million relating to
contractual increases in rents that became effective in the second half of 2002
and in the first quarter of 2003 and $0.9 million relating to leases on assets
previously classified as owned and operated. These increases were partially
offset by a $0.4 million reduction in lease revenue due to foreclosures,
bankruptcies and restructurings.
Mortgage interest income for the three-month period ended March 31, 2003
totaled $4.4 million, a decrease of $1.0 million as compared to the same period
in 2002. The $1.0 million decrease is due to a reduction of interest income due
to bankruptcies and restructurings of $0.6 million and mortgage payoffs and
normal amortization of $0.4 million.
In 2000, we filed suit against a title company (later adding a law firm as
a defendant), seeking damages based on claims of breach of contract and
negligence, among other things, as a result of the alleged failure to file
certain UCC financing statements in our favor. We filed a subsequent suit
seeking recovery under title insurance policies written by the title company.
The defendants denied the allegations made in the lawsuits. In settlement of our
claims against the defendants, we agreed in the first quarter of 2003 to accept
a lump sum cash payment of $3.2 million. The cash proceeds were offset by
related expenses incurred of $1.0 million resulting in a net gain of $2.2
million.
Expenses for the three-month period ended March 31, 2003 totaled $18.6
million, a decrease of $20.9 million, from the three-month period ending March
31, 2002. Excluding nursing home expenses of owned and operated assets, expenses
were $17.2 million for the three-month period ending March 31, 2003 versus $15.8
million for the same period in 2002. This $1.4 million increase in expenses was
a result of a $4.6 million provision for impairment, partially offset by
favorable reductions in general and administrative and legal expenses of $0.5
million, interest expense savings of $3.0 million.
Nursing home expenses, net of nursing home revenues, for owned and operated
assets for the three-month period ended March 31, 2003 were $1.3 million
compared to $2.0 million for the same period in 2002. This decrease was a result
of the decrease in the number of owned and operated facilities from 19 at March
31, 2002 to one at March 31, 2003.
Interest expense for the three-month period ended March 31, 2003 was $5.1
million compared with $8.1 million for the same period in 2002. This decrease is
primarily due to an $85.2 million reduction of total outstanding debt versus the
same period in 2002.
General and administrative and legal expenses for the three-month period
ended March 31, 2003, totaled $2.0 million, compared with $2.6 million for the
same period in 2002. The decrease is due to a reduction in consulting and legal
costs primarily related to the reduction in the number of our owned and operated
facilities.
A provision for impairment of $4.6 million was recorded for the three-month
period ended March 31, 2003. The provision was to reduce the carrying value of a
closed building to its fair value less costs to dispose. The building is being
actively marketed for sale; however, there can be no assurance if, or when, such
sale will be completed or whether such sales will be completed on terms that
allow us to realize the carrying value of the asset.
Funds from operations ("FFO") for the three-month period ended March 31,
2003, on a fully diluted basis, was $13.5 million, an increase of $6.5 million,
as compared to the $7.0 million for the same period in 2002 due to the factors
mentioned above. The legal settlement increased FFO by $2.2 million and nursing
home revenues and expenses, on a net basis, decreased FFO by $1.3 million. Both
the legal settlement and net impact from our owned and operated nursing home
assets are included in the $13.5 million of fully diluted FFO. We believe that
FFO is an important supplemental measure of our operating performance. Because
the historical cost accounting convention used for real estate assets requires
depreciation (except on land), such accounting presentation implies that the
value of real estate assets diminishes predictably over time, while real estate
values instead have historically risen or fallen with market conditions. The
term FFO was designed by the real estate industry to address this issue. We
generally use the National Association of Real Estate Investment Trusts'
("NAREIT") measure of FFO. We define FFO as net income available to common
stockholders, adjusted for the effects of asset dispositions and impairments and
certain non-cash items, primarily depreciation and amortization. FFO herein is
not necessarily comparable to FFO presented by other REITs due to the fact that
not all REITs use the same definition. Diluted FFO is adjusted for the assumed
conversion of Series C preferred stock and the exercise of in-the-money stock
options. FFO does not represent cash generated from operating activities in
accordance with GAAP, and therefore, should not be considered an alternative to
net earnings or an indication of operating performance or to net cash flow from
operating activities, as determined by GAAP, as a measure of liquidity, and such
measure is not necessarily indicative of cash available to fund cash needs. We
believe that in order to facilitate a clear understanding of our consolidated
historical operating results, FFO should be examined in conjunction with net
income.
The following table reconciles net income (loss) available to common to
FFO.
Three Months Ended
March 31,
------------------------
2003 2002
------------------------
(In thousands, except
per share amounts)
Net income (loss) available to common......... $ 956 $ (572)
Plus impairment charge...................... 4,618 -
------------------------
Sub-total................................. 5,574 (572)
Elimination of non-cash items included in
net income(loss):
Depreciation.............................. 5,282 5,280
Amortization.............................. 47 46
Adjustment of derivatives to fair value... - (400)
------------------------
Funds from operations, basic.................. 10,903 4,354
Series C Preferred Dividends.................. 2,621 2,621
------------------------
Funds from operations, diluted................ $13,524 $ 6,975
========================
Weighted-average common shares
outstanding, basic.......................... 37,145 27,421
Assumed conversion of Series C
Preferred Stock........................... 16,775 16,775
Assumed exercise of stock options........... 3 1,057
------------------------
Weighted-average common shares
outstanding, diluted........................ 53,923 45,253
========================
Funds from operations, basic.................. $ 0.29 $ 0.16
========================
Funds from operations, diluted *.............. $ 0.25 $ 0.15
========================
* Lower of basic or diluted FFO per share.
Medicare Developments
During the years 1999 and 2000, Congress enacted various legislation, which
was intended to provide some relief to the extensive Medicare cut-backs
resulting from the Balanced Budget Act. The legislation adopted in 1999 and 2000
increased Medicare payments to nursing facilities and specialty care facilities
on an interim basis. Section 101 of the Balanced Budget Relief Act included a
20% increase for 15 patient acuity categories (known as RUGs) and a 4% across
the board increase of the adjusted federal per diem payment rate. The 20%
increase was implemented in April 2000 and will remain in effect until the
implementation of refinements in the current RUG case-mix classification system
to more accurately estimate the cost of non-therapy ancillary services. The 4%
increase was implemented in April 2000 and expired October 1, 2002.
The Benefits Improvement and Protection Act included a 16.7% increase in
the nursing component of the case mix adjusted federal periodic payment rate and
a 6.7% increase in the 14 RUG payments for rehabilitation therapy services. The
16.7% increase was implemented in April 2000 and expired October 1, 2002. The
6.7% increase is an adjustment to the 20% increase granted in the Balance Budget
Relief Act and spreads the funds directed at three of those 15 RUGs to an
additional 11 rehabilitation RUGs. The increase was implemented in April 2001
and will remain in effect until the implementation of refinements in the current
RUG case-mix classification system.
In addition to the expiration of the 4% increase implemented in Balance
Budget Relief Act and the 16.7% increase implemented in Benefits Improvement and
Protection Act, Medicare reimbursement could be further reduced when CMS
completes its RUG refinement due to the termination of the 20% and 6.7%
increases. However, the Medicare Payment Advisory Commission has recommended
that the 20% and 6.7% increases be folded into the base rate upon the completion
of the RUG refinement. The partial expiration of the increases under these
statutes as of October 1, 2002 has had an adverse impact on the revenues of the
operators of nursing facilities and has negatively impacted some operators'
ability to satisfy their monthly lease or debt payments to us. Recently, CMS
announced a delay in the implementation of further refinements in reimbursement
rates until October 1, 2004, at the earliest. Because the revised reimbursement
rates have not yet been published, it is unclear what effect they will have on
us, or if the add-on payments included in the second part of the mitigating
legislation will be included in these new rates.
Due to the temporary nature of the remaining payment increases, we cannot
be assured that the federal reimbursement will remain at levels comparable to
present levels and that such reimbursement will be sufficient for our lessees or
mortgagors to cover all operating and fixed costs necessary to care for Medicare
and Medicaid patients. We also cannot be assured that there will be any future
legislation to increase payment rates for skilled nursing facilities. If payment
rates for skilled nursing facilities are not increased in the future, some of
our lessees and mortgagors may have difficulty meeting their payment obligations
to us.
Portfolio Developments
The partial expiration of certain Medicare rate increase has had an adverse
impact on the revenues of the operators of nursing home facilities and has
negatively impacted some operators' ability to satisfy their monthly lease or
debt payments to us. In several instances, we hold security deposits that can be
applied in the event of lease and loan defaults, subject to applicable
limitations under bankruptcy law with respect to operators seeking protection
under Chapter 11 of the Bankruptcy Act. (See Note C - Concentration of Risk and
Related Issues).
Alterra Healthcare Corporation. We currently lease eight assisted living
facilities (325 units) located in seven states to subsidiaries of Alterra. In
the first quarter of 2003, we were notified by Alterra that it did not intend to
pay January rent and that a restructuring of its Master Lease was necessary.
Subsequently, Alterra resumed and has continued to pay lease payments to us at
an annualized rent of $1.45 million versus the fourth quarter of 2002 annualized
contractual rent of approximately $2.6 million. We are currently recognizing
revenue on a cash basis.
Alterra also announced during the first quarter of 2003, that, in order to
facilitate and complete its on-going restructuring initiatives, they had filed a
voluntary petition with the U.S. Bankruptcy Court for the District of Delaware
to reorganize under Chapter 11 of the U.S. Bankruptcy Code. We are in the
process of attempting to negotiate a restructure of the Master Lease. At this
time it is too early to predict the outcome of the negotiations, including the
ultimate impact of the bankruptcy proceedings or any subsequent developments.
Claremont Health Care Holdings, Inc. During the first quarter of 2003, we
completed a restructured transaction with Claremont Health Care Holdings, Inc.
(formerly Lyric Health Care, LLC) whereby nine facilities formerly leased under
two Master Leases were combined into one new ten-year Master Lease. Annual rent
under the new lease is $6.0 million, the same amount of rent recognized in 2002
for these properties.
Integrated Health Services, Inc. During the three-month period ended March
31, 2003, we successfully re-leased nine facilities formerly operated by IHS.
Accordingly, eight SNFs, which we held mortgages on, and one SNF, which we
leased to IHS, have been re-leased to various unaffiliated third parties. Titles
to the eight properties, which we held mortgages on, have been transferred to
wholly-owned subsidiaries of ours by Deeds in Lieu of Foreclosure.
Specifically, during the quarter ended March 31, 2003, we leased nine SNFs
to four unaffiliated third-party operators as part of four separate
transactions. Each of the nine facilities had formerly been operated by
subsidiaries of IHS. The four transactions included: (i) a Master Lease of five
SNFs in Florida representing 600 beds to affiliates of Seacrest Healthcare
Management, LLC, which lease has a ten-year term and has an initial annual rent
of $2.5 million; (ii) a month-to-month lease (following a minimum four-month
term) on two SNFs in Georgia representing 304 beds to subsidiaries of Triad
Health Management of Georgia, LLC, which lease provides for annualized rent of
$0.7 million - the month-to-month structure results from Georgia Medicaid rate
cuts (effective February 1, 2003) and the potential for future Georgia
reimbursement changes; (iii) a lease of one SNF in Texas, representing 130 beds,
to an affiliate of Senior Management Services of America, Inc., which lease has
a ten-year term and has various rent step-ups, reaching $384,000 by year three,
thereafter, increasing by the lesser of CPI or 2.5%; and (iv) re-leased one
159-bed SNF, located in the state of Washington to a subsidiary of Sun, with an
initial lease term of eight years and initial annual rent of $0.5 million.
Closure of these lease transactions terminates substantially all remaining
contractual and debt relationships with IHS.
Sun Healthcare Group, Inc. During the first quarter of 2003, Sun remitted
rent of $5.0 million versus the contractual amount of $6.4 million. We have
agreed with Sun to use letters of credit (posted by Sun as security deposits) in
the amount of $1.4 million to make up the difference in rent and agreed to
temporarily forebear in declaring a default under the lease caused by Sun's
failure to restore the $1.4 million letter of credit. We hold additional
security deposits (in the form of cash and letters of credit) in the amount of
$1.4 million as of March 31, 2003.
Also during the quarter, Sun announced "that it has opened dialogue with
many of its landlords concerning the portfolio of properties leased to Sun and
various of its consolidated subsidiaries (collectively, the `Company'). The
Company is seeking a rent moratorium and/or rent concessions with respect to
certain of its facilities and is seeking to transition its operations of certain
facilities to new operators while retaining others." To this end, Sun has
initiated conversations with us regarding a restructure of our lease. At this
stage, it is too early to predict the outcome of these conversations. (See Note
J - Subsequent Events).
In an unrelated transaction during the quarter, we recorded a provision for
impairment of $4.6 million associated with one closed facility, located in the
state of Washington, previously leased to a subsidiary of Sun as part of the
overall Sun Master Lease. We intend to sell this closed facility as soon as
practicable; however, there can be no assurance if or when this sale will be
completed.
As of March 31, 2003, we have an original investment balance of $219.0
million relating to the Sun portfolio under agreements providing for annual
rental income of $25.1 million in 2002 and $25.7 million in 2003.
Liquidity and Capital Resources
At March 31, 2003, we had total assets of $800.3 million, stockholders
equity of $485.1 million and debt of $306.3 million, representing approximately
38.7% of total capitalization.
Bank Credit Agreements
We have two secured revolving credit facilities, providing up to $225.0
million of financing. At March 31, 2003, $177.0 million was outstanding and
$12.5 million was utilized for the issuance of letters of credit, leaving
availability of $35.5 million.
On December 21, 2001, we reached amended agreements with the bank groups
under both of our revolving credit facilities. The amendments became effective
as of the closing of the rights offering and private placement to Explorer on
February 21, 2002. The amendments included modifications and/or eliminations to
certain financial covenants.
The amendment regarding our $175.0 million revolving credit facility
included a one-year extension in maturity from December 31, 2002 to December 31,
2003 and a reduction in the total commitment from $175.0 million to $160.0
million.
As part of the amendment regarding our $75.0 million revolving credit
facility, we prepaid $10.0 million in December 2001, originally scheduled to
mature in March 2002. This voluntary prepayment resulted in a permanent
reduction in the total commitment, thereby reducing the credit facility to $65.0
million. Our $65.0 million line of credit facility expires on June 30, 2005.
(See Note H - Borrowing Arrangements).
Dividends
In order to qualify as a REIT, we are required to distribute dividends
(other than capital gain dividends) to our stockholders in an amount at least
equal to (A) the sum of (i) 90% of our "REIT taxable income" (computed without
regard to the dividends paid deduction and our net capital gain) and (ii) 90% of
the net income (after tax), if any, from foreclosure property, minus (B) the sum
of certain items of non-cash income. In addition, if we dispose of any built-in
gain asset during a recognition period, we will be required to distribute at
least 90% of the built-in gain (after tax), if any, recognized on the
disposition of such asset. Such distributions must be paid in the taxable year
to which they relate, or in the following taxable year if declared before we
timely file our tax return for such year and paid on or before the first regular
dividend payment after such declaration. In addition, such distributions are
required to be made pro rata, with no preference to any share of stock as
compared with other shares of the same class, and with no preference to one
class of stock as compared with another class except to the extent that such
class is entitled to such a preference. To the extent that we do not distribute
all of our net capital gain or do distribute at least 90%, but less than 100% of
our "REIT taxable income," as adjusted, we will be subject to tax thereon at
regular ordinary and capital gain corporate tax rates.
In prior years, we have historically distributed to stockholders a large
portion of the cash available from operations. Our historical policy has been to
make distributions on common stock of approximately 80% of FFO, but on February
1, 2001, we announced the suspension of all common and preferred dividends.
No preferred or common cash dividends were paid during the first three
months ending March 31, 2003 and 2002, respectively. (See Note D - Dividends).
We can give no assurance as to when or if the dividends will be reinstated on
the preferred stock or common stock, or the amount of the dividends if and when
such payments are recommenced. Prior to recommencing the payment of dividends on
our common stock, all accrued and unpaid dividends on our Series A, B and C
preferred stock must be paid in full. Due to our 2002 taxable loss, no
distribution was necessary to maintain our REIT status for 2002. We project net
operating loss carryforwards through 2002 of approximately $24.0 million help
offset taxable income. In addition, we intend to make the necessary
distributions, if any, to satisfy the 2003 REIT requirements. In aggregate,
preferred dividends continue to accumulate at approximately $5.0 million per
quarter.
Liquidity
We believe our liquidity and various sources of available capital,
including funds from operations, expected proceeds from planned asset sales and
our ability to negotiate an extension of our current debt maturities are
adequate to finance operations, meet recurring debt service requirements and
fund future investments through the next 12 months. We continue to actively
pursue refinancing alternatives in order to extend current debt maturities and
provide greater financial flexibility. Among other things, we will continue
discussions to extend or refinance our $160.0 million credit facility, currently
scheduled to mature in December 2003. At this time, there can be no assurance
that we will be able to reach acceptable agreements with our bank lenders and/or
other capital sources to achieve the desired refinancing.
Item 3 - Quantitative and Qualitative Disclosure About Market Risk
We are exposed to various market risks, including the potential loss
arising from adverse changes in interest rates. We do not enter into derivatives
or other financial instruments for trading or speculative purposes, but we seek
to mitigate the effects of fluctuations in interest rates by matching the term
of new investments with new long-term fixed rate borrowing to the extent
possible.
The market value of our long-term fixed rate borrowings and mortgages are
subject to interest rate risk. Generally, the market value of fixed rate
financial instruments will decrease as interest rates rise and increase as
interest rates fall. The estimated fair value of our total long-term borrowings
at March 31, 2003 was $294.8 million. A one-percent increase in interest rates
would result in a decrease in the fair value of long-term borrowings by
approximately $4.1 million.
We are subject to risks associated with debt or preferred equity financing,
including the risk that existing indebtedness may not be refinanced or that the
terms of such refinancing may not be as favorable as the terms of current
indebtedness. If we were unable to refinance our debt maturities on acceptable
terms, we might be forced to dispose of properties on disadvantageous terms,
which might result in losses to us and might adversely affect the cash available
for distribution to stockholders, or to pursue dilutive equity financing. (See
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources).
We utilize interest rate swaps and caps to fix interest rates on variable
rate debt and reduce certain exposures to interest rate fluctuations. We do not
use derivatives for trading or speculative purposes. We have a policy of only
entering into contracts with major financial institutions based upon their
credit ratings and other factors. When viewed in conjunction with the underlying
and offsetting exposure that the derivatives are designed to hedge, we have not
sustained a material loss from those instruments nor do we anticipate any
material adverse effect on our net income or financial position in the future
from the use of derivatives.
To manage interest rate risk, we may employ options, forwards, interest
rate swaps, caps and floors or a combination thereof depending on the underlying
exposure. We may employ swaps, forwards or purchased options to hedge qualifying
forecasted transactions. Gains and losses related to these transactions are
deferred and recognized in net income as interest expense in the same period or
periods that the underlying transaction occurs, expires or is otherwise
terminated. In June 1998, the Financial Accounting Standards Board issued
Statement No. 133, Accounting for Derivative Instruments and Hedging Activities,
which was required to be adopted in years beginning after June 15, 2000. We
adopted the new Statement effective January 1, 2001. The Statement requires us
to recognize all derivatives on the balance sheet at fair value. Derivatives
that are not hedges must be adjusted to fair value through income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the fair
value of derivatives will either be offset against the change in fair value of
the hedged assets, liabilities, or firm commitments through earnings or
recognized in Other Comprehensive Income until the hedge item is recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings.
In September 2002, we entered into a 61-month, $200.0 million interest rate
cap with a strike of 3.50% that has been designated as a cash flow hedge. Under
the terms of the cap agreement, when LIBOR exceeds 3.50%, the counterparty will
pay us $200.0 million multiplied by the difference between LIBOR and 3.50% times
the number of days when LIBOR exceeds 3.50%. The unrealized gain/loss in the
fair value of cash flow hedges are reported on the balance sheet with
corresponding adjustments to accumulated Other Comprehensive Income. On March
31, 2003, the derivative instrument was reported at its fair value of $6.6
million as compared to its fair value at December 31, 2002 of $7.3 million. An
adjustment of $0.6 million to Other Comprehensive Income was made for the change
in fair value of this cap during the quarter ended March 31, 2003. Over the term
of the interest rate cap, the $10.1 million cost will be amortized to earnings
based on the specific portion of the total cost attributed to each monthly
settlement period. Over the twelve months ending December 31, 2003, $0.1 million
is expected to be amortized.
Item 4 - Control and Procedures
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures within 90 days of the filing date of this quarterly
report and, based on that evaluation, our principal executive officer and
principal financial officer have concluded that these controls and procedures
are effective. There have been no significant changes in our internal controls
or in other factors that could significantly affect these controls subsequent to
the date of the evaluation.
Disclosure controls and procedures are the controls and other procedures
designed to ensure that information that we are required to disclose in our
reports under the Exchange Act is recorded, processed, summarized and reported
within the time periods required. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
we are required to disclose in the reports that we file under the Exchange Act
is accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate to allow
timely decisions regarding required disclosure.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
See Note G - Litigation to the Consolidated Financial Statements in PART I,
Item 1 hereto, which is hereby incorporated by reference in response to this
item.
Item 2. Changes in Securities and Use of Proceeds
None this period.
Item 3. Defaults upon Senior Securities
(a) Payment Defaults. Not Applicable.
(b) Dividend Arrearages. On February 1, 2001, we announced the suspension
of dividends on all common and preferred stock. (See Management's
Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources). Dividends on our
preferred stock are cumulative: therefore, all accrued and unpaid
dividends on our Series A, B and C Preferred stock must be paid in
full prior to recommencing the payment of cash dividends on our Common
Stock. In aggregate, preferred dividends continue to accumulate at
approximately $5.0 million per quarter.
The table below sets forth information regarding arrearages in
payment of preferred stock dividends:
-----------------------------------------------------------------------
Annual Dividend Arrearage as of
Title of Class Per Share March 31, 2003
-----------------------------------------------------------------------
9.25% Series A Cumulative
Preferred Stock $ 2.3125 $ 11,967,188
-----------------------------------------------------------------------
8.625% Series B Cumulative
Preferred Stock $ 2.1563 $ 9,703,125
-----------------------------------------------------------------------
Series C Convertible
Preferred Stock $10.0000 $ 23,386,793
-----------------------------------------------------------------------
TOTAL $ 45,057,106
-----------------------------------------------------------------------
Since dividends on the Series A and Series B preferred stock have
been in arrears for more than 18 months, the holders of the Series A
and Series B preferred stock (voting together as a single class)
continue to have the right to elect two additional directors to our
Board of Directors in accordance with the terms of the Series A and
Series B preferred stock and our Bylaws. Explorer, the sole holder of
the Series C preferred stock, also has the right to elect two other
additional directors to our Board of Directors in accordance with the
terms of the Series C preferred stock and our Bylaws. Explorer,
without waiving its rights under the terms of the Series C preferred
stock or the Stockholders Agreement, has advised us that it is not
currently seeking the election of the two additional directors
resulting from the Series C dividend arrearage unless the holders of
the Series A and Series B preferred stock seek to elect additional
directors.
Item 4. Submission of Matters to a Vote of Security Holders
(a) An Annual Meeting of Stockholders was held on April 3, 2003.
(b) The following directors were elected at the meeting for a three-year
term: Daniel A. Decker, Thomas F. Franke and Bernard J. Korman. The
following directors were not elected at the meeting but their term of
office continued after the meeting: Thomas W. Erickson, Harold J.
Kloosterman, Edward Lowenthal, Christopher W. Mahowald, Donald J.
McNamara, C. Taylor Pickett, and Stephen D. Plavin. The results of the
vote were as follows:
- --------------------------------------------------------------------------------
Daniel A. Thomas F. Bernard J.
Manner of Vote Cast Decker Franke Korman
- --------------------------------------------------------------------------------
For* 51,999,523 52,763,112 52,345,845
- --------------------------------------------------------------------------------
Withheld 993,571 230,252 647,519
- --------------------------------------------------------------------------------
Abstentions and broker
non-votes - - -
- --------------------------------------------------------------------------------
*Includes 16,774,722 votes represented by Series C preferred stock.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - The following Exhibits are filed herewith:
Exhibit Description
99.1 Certification of the Chief Executive Officer under Section 906
of the Sarbanes - Oxley Act of 2002.
99.2 Certification of the Chief Financial Officer under Section 906
of the Sarbanes - Oxley Act of 2002.
(b) Reports on Form 8-K - none were filed during the quarter ended March
31, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OMEGA HEALTHCARE INVESTORS, INC.
Registrant
Date: May 9, 2003 By: /s/ C. TAYLOR PICKETT
------------------------------------
C. Taylor Pickett
Chief Executive Officer
Date: May 9, 2003 By: /s/ ROBERT O. STEPHENSON
------------------------------------
Robert O. Stephenson
Chief Financial Officer
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, C. Taylor Pickett, Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Omega Healthcare
Investors, Inc. (the "Registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Registrant as of, and for, the periods presented in this
quarterly report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 9, 2003
/s/ C. TAYLOR PICKETT
---------------------------
C. Taylor Pickett
Chief Executive Officer
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Robert O. Stephenson, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Omega Healthcare
Investors, Inc. (the "Registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Registrant as of, and for, the periods presented in this
quarterly report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 9, 2003
/s/ ROBERT O. STEPHENSON
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Robert O. Stephenson
Chief Financial Officer