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EX-10.1 - EXHIBIT 10.1 - NATIONAL HEALTH INVESTORS INCnhi-9302015x10qex101.htm
EX-31.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER AND PRINCIPAL ACCOUNTING OFFICER - NATIONAL HEALTH INVESTORS INCnhi-9302015x10qex312.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - NATIONAL HEALTH INVESTORS INCnhi-9302015x10qex311.htm
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EX-32 - CERTIFICATION OF CEO AND PFO AND PAO - NATIONAL HEALTH INVESTORS INCnhi-9302015x10qex32.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
(Mark One)
[ x ]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the quarterly period ended September 30, 2015
 
 
[ ]
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 001-10822
National Health Investors, Inc.
(Exact name of registrant as specified in its charter)
Maryland
 
62-1470956
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
222 Robert Rose Drive, Murfreesboro, Tennessee
 
37129
(Address of principal executive offices)
 
(Zip Code)
(615) 890-9100
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ x ] No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files) Yes [ x ] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer          [ x ]
 
Accelerated filer                      [ ]
Non-accelerated filer            [ ]
 
Smaller reporting company     [ ]
(Do not check if a smaller reporting company)
 
 

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

There were 37,566,221 shares of common stock outstanding of the registrant as of November 3, 2015.



Table of Contents


2


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NATIONAL HEALTH INVESTORS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)

 
September 30,
2015
 
December 31,
2014
 
(unaudited)
 
 
Assets:
 
 
 
Real estate properties:
 
 
 
Land
$
136,336

 
$
127,566

Buildings and improvements
1,939,943

 
1,854,855

Construction in progress
12,343

 
6,428

 
2,088,622

 
1,988,849

Less accumulated depreciation
(245,409
)
 
(212,300
)
Real estate properties, net
1,843,213

 
1,776,549

Mortgage and other notes receivable, net
117,828

 
63,630

Investment in preferred stock, at cost
38,132

 
38,132

Cash and cash equivalents
14,197

 
3,287

Marketable securities
35,148

 
15,503

Straight-line rent receivable
53,646

 
35,154

Equity-method investment and other assets
29,615

 
50,705

Assets held for sale, net
1,346

 

Total Assets
$
2,133,125

 
$
1,982,960

 
 
 
 
Liabilities and Equity:
 
 
 
Debt
$
1,009,144

 
$
862,726

Accounts payable and accrued expenses
19,887

 
15,718

Dividends payable
31,931

 
28,864

Lease deposit liabilities
21,275

 
21,648

Real estate purchase liabilities
3,750

 
3,000

Deferred income
2,472

 
1,071

Total Liabilities
1,088,459

 
933,027

 
 
 
 
Commitments and Contingencies

 

 
 
 
 
National Health Investors Stockholders' Equity:
 
 
 
Common stock, $.01 par value; 60,000,000 shares authorized;
 
 
 
37,566,221 and 37,485,902 shares issued and outstanding, respectively
376

 
375

Capital in excess of par value
1,035,551

 
1,033,896

Cumulative dividends in excess of net income
(1,898
)
 
(569
)
Accumulated other comprehensive income
875

 
6,223

Total National Health Investors Stockholders' Equity
1,034,904

 
1,039,925

Noncontrolling interest
9,762

 
10,008

Total Equity
1,044,666

 
1,049,933

Total Liabilities and Equity
$
2,133,125

 
$
1,982,960


The accompanying notes to condensed consolidated financial statements are an integral part of these condensed consolidated financial statements. The Condensed Consolidated Balance Sheet at December 31, 2014 was derived from the audited consolidated financial statements at that date.


3


NATIONAL HEALTH INVESTORS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share and per share amounts)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
(unaudited)
 
(unaudited)
Revenues:
 
 
 
 
 
 
 
Rental income
$
54,459

 
$
41,669

 
$
159,624

 
$
123,335

Interest income from mortgage and other notes
2,507

 
1,754

 
7,149

 
5,258

Investment income and other
1,316

 
1,055

 
3,573

 
3,182

 
58,282

 
44,478

 
170,346

 
131,775

Expenses:
 
 
 
 
 
 
 
Depreciation
13,485

 
9,596

 
39,502

 
28,373

Interest, including amortization of debt discount and issuance costs
9,772

 
7,005

 
27,471

 
20,720

Legal
117

 
66

 
295

 
149

Franchise, excise and other taxes
114

 
78

 
352

 
790

General and administrative
1,691

 
2,164

 
8,050

 
6,948

Loan recovery

 

 
(491
)
 

 
25,179

 
18,909

 
75,179

 
56,980

 
 
 
 
 
 
 
 
Income before equity-method investee and noncontrolling interest
33,103

 
25,569

 
95,167

 
74,795

Income (loss) from equity-method investee
(252
)
 
(53
)
 
(765
)
 
157

Investment and other gains
1,126

 

 
1,126

 

Net income
33,977

 
25,516

 
95,528

 
74,952

Less: net income attributable to noncontrolling interest
(377
)
 
(266
)
 
(1,062
)
 
(872
)
Net income attributable to common stockholders
$
33,600

 
$
25,250

 
$
94,466

 
$
74,080

 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
37,566,221

 
33,055,992

 
37,563,503

 
33,053,386

Diluted
37,583,141

 
33,088,570

 
37,611,841

 
33,087,029

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Net income attributable to common stockholders - basic
$
.89

 
$
.76

 
$
2.51

 
$
2.24

Net income attributable to common stockholders - diluted
$
.89

 
$
.76

 
$
2.51

 
$
2.24



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

4


NATIONAL HEALTH INVESTORS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
(unaudited)
 
(unaudited)
Net income
$
33,977

 
$
25,516

 
$
95,528

 
$
74,952

Other comprehensive income:
 
 
 
 
 
 
 
Change in unrealized gains (losses) on securities
401

 
(716
)
 
(438
)
 
624

Increase (decrease) in fair value of cash flow hedge
(2,896
)
 
3,010

 
(1,592
)
 
(126
)
Less: reclassification adjustment for amounts recognized in net income
(1,185
)
 
(1,209
)
 
(3,318
)
 
(2,927
)
Total other comprehensive income (loss)
(3,680
)
 
1,085

 
(5,348
)
 
(2,429
)
Comprehensive income
30,297

 
26,601

 
90,180

 
72,523

Less: comprehensive income attributable to noncontrolling interest
(377
)
 
(266
)
 
(1,062
)
 
(872
)
Comprehensive income attributable to common stockholders
$
29,920

 
$
26,335

 
$
89,118

 
$
71,651



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

5


NATIONAL HEALTH INVESTORS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

 
Nine Months Ended
 
September 30,
 
2015
 
2014
 
(unaudited)
Cash flows from operating activities:
 
 
 
Net income
$
95,528

 
$
74,952

Adjustments to reconcile net income to net cash provided by
 
 
 
operating activities:
 
 
 
Depreciation
39,502

 
28,373

Amortization
2,589

 
1,816

Straight-line rental income
(18,492
)
 
(12,692
)
Gain on sale of real estate
(1,126
)
 

Gain on sale of marketable securities
(61
)
 

Write-off of debt issuance costs

 
2,145

Loan recovery
(491
)
 

Share-based compensation
1,930

 
1,796

Loss (income) from equity-method investee
765

 
(157
)
Change in operating assets and liabilities:
 
 
 
Equity-method investment and other assets
(693
)
 
4

Accounts payable and accrued expenses
(56
)
 
(493
)
Deferred income
1,401

 
(2,529
)
Net cash provided by operating activities
120,796

 
93,215

Cash flows from investing activities:
 
 
 
Investment in mortgage and other notes receivable
(73,092
)
 
(1,439
)
Collection of mortgage and other notes receivable
19,128

 
1,350

Investment in real estate
(104,066
)
 
(35,688
)
Investment in real estate development
(8,807
)
 
(6,022
)
Investment in renovations of existing real estate
(2,757
)
 
(3,078
)
Payment of real estate purchase liability

 
(1,600
)
Proceeds from disposition of real estate properties
9,593

 

Purchases of marketable securities
(2,495
)
 

Proceeds from sales of marketable securities
3,750

 

Net cash used in investing activities
(158,746
)
 
(46,477
)
Cash flows from financing activities:
 
 
 
Net change in borrowings under revolving credit facilities
(157,000
)
 
(86,000
)
Proceeds from convertible senior notes

 
200,000

Proceeds from issuance of secured debt
78,084

 
38,007

Borrowings on term loans
225,000

 
130,000

Payments on term loans
(554
)
 
(250,815
)
Debt issuance costs
(2,362
)
 
(8,899
)
Equity offering costs
(275
)
 

Proceeds from exercise of stock options
1

 

Distributions to noncontrolling interest
(1,308
)
 
(1,589
)
Dividends paid to stockholders
(92,726
)
 
(75,195
)
Net cash provided by (used in) financing activities
48,860

 
(54,491
)
 
 
 
 
Increase (decrease) in cash and cash equivalents
10,910

 
(7,753
)
Cash and cash equivalents, beginning of period
3,287

 
11,312

Cash and cash equivalents, end of period
$
14,197

 
$
3,559


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

6


NATIONAL HEALTH INVESTORS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(in thousands)

 
Nine Months Ended
 
September 30,
 
2015
 
2014
 
(unaudited)
Supplemental disclosure of cash flow information:
 
 
 
Interest paid, net of amounts capitalized
$
21,029

 
$
13,460

Supplemental disclosure of non-cash investing and financing activities:
 
 
 
Tax deferred exchange funds applied to investment in real estate
$

 
$
23,813

Contingent consideration in asset acquisition
$
750

 
$
3,000

Accounts payable related to investments in real estate
$
686

 
$
2,623

Conversion of note balance into real estate investment
$
255

 
$

Transfer of lease escrow deposit to marketable securities
$
21,277

 
$



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

7


NATIONAL HEALTH INVESTORS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(unaudited, in thousands except share and per share amounts)

 
Common Stock
 
Capital in Excess of Par Value
 
Cumulative Dividends in Excess of Net Income
 
Accumulated Other Comprehensive Income
 
Total National Health Investors Stockholders' Equity
 
Noncontrolling Interest
 
Total Equity
 
Shares
 
Amount
 
 
 
 
 
 
Balances at December 31, 2014
37,485,902

 
$
375

 
$
1,033,896

 
$
(569
)
 
$
6,223

 
$
1,039,925

 
$
10,008

 
$
1,049,933

Total comprehensive income

 

 

 
94,466

 
(5,348
)
 
89,118

 
1,062

 
90,180

Distributions to noncontrolling interest

 

 

 

 

 

 
(1,308
)
 
(1,308
)
Equity offering costs

 

 
(275
)
 

 

 
(275
)
 

 
(275
)
Shares issued on stock options exercised
80,319

 
1

 

 

 

 
1

 

 
1

Share-based compensation

 

 
1,930

 

 

 
1,930

 

 
1,930

Dividends declared, $2.55 per common share

 

 

 
(95,795
)
 

 
(95,795
)
 

 
(95,795
)
Balances at September 30, 2015
37,566,221

 
$
376

 
$
1,035,551

 
$
(1,898
)
 
$
875

 
$
1,034,904

 
$
9,762

 
$
1,044,666


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

8


NATIONAL HEALTH INVESTORS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(unaudited)

NOTE 1. SIGNIFICANT ACCOUNTING POLICIES

We, the management of National Health Investors, Inc., ("NHI" or the "Company") believe that the unaudited condensed consolidated financial statements of which these notes are an integral part include all normal, recurring adjustments that are necessary to fairly present the condensed consolidated financial position, results of operations and cash flows of NHI in all material respects. The Condensed Consolidated Balance Sheet at December 31, 2014 has been derived from the audited consolidated financial statements at that date. We assume that users of these condensed consolidated financial statements have read or have access to the audited December 31, 2014 consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations and that the adequacy of additional disclosure needed for a fair presentation, except in regard to material contingencies, may be determined in that context. Accordingly, footnotes and other disclosures which would substantially duplicate those contained in our most recent Annual Report on Form 10-K for the year ended December 31, 2014 have been omitted. This condensed consolidated financial information is not necessarily indicative of the results that may be expected for a full year for a variety of reasons including, but not limited to, acquisitions and dispositions, changes in interest rates, rents and the timing of debt and equity financings. For a better understanding of NHI and its condensed consolidated financial statements, we recommend reading these condensed consolidated financial statements in conjunction with the audited consolidated financial statements for the year ended December 31, 2014, which are included in our 2014 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission, a copy of which is available at our web site: www.nhireit.com.

Principles of Consolidation - The accompanying condensed consolidated financial statements include our accounts and the accounts of our wholly-owned subsidiaries, joint ventures, partnerships and consolidated variable interest entities ("VIE") where NHI controls the operating activities of the VIE, if any. All intercompany transactions and balances have been eliminated in consolidation. Net income is reduced by the portion of net income attributable to noncontrolling interests.

A VIE is broadly defined as an entity with one or more of the following characteristics: (a) the total equity investment at risk is insufficient to finance the entity's activities without additional subordinated financial support; (b) as a group, the holders of the equity investment at risk lack (i) the ability to make decisions about the entity's activities through voting or similar rights, (ii) the obligation to absorb the expected losses of the entity, or (iii) the right to receive the expected residual returns of the entity; or (c) the equity investors have voting rights that are not proportional to their economic interests, and substantially all of the entity's activities either involve, or are conducted on behalf of, an investor that has disproportionately few voting rights.

We apply Financial Accounting Standards Board ("FASB") guidance for our arrangements with variable interest entities ("VIEs") which requires us to identify entities for which control is achieved through means other than voting rights and to determine which business enterprise is the primary beneficiary of the VIE. In accordance with FASB guidance, management must evaluate each of the Company’s contractual relationships which creates a variable interest in other entities. If the Company has a variable interest and the entity is a VIE, then management must determine whether or not the Company is the primary beneficiary of the VIE. If it is determined that the Company is the primary beneficiary, NHI consolidates the VIE. We identify the primary beneficiary of a VIE as the enterprise that has both: (i) the power to direct the activities of the VIE that most significantly impact the entity's economic performance; and (ii) the obligation to absorb losses or the right to receive benefits of the VIE that could be significant to the entity. We perform this analysis on an ongoing basis.

At September 30, 2015, we held an interest in four unconsolidated VIEs, consisting of 1) a start-up lessee in which NHI's variable interest consists of its leasehold interest, analogous to a financing arrangement, and of which we concluded that NHI was not the primary beneficiary (Note 2); 2) our joint venture in an operating company organized under provisions of the REIT Investment Diversification and Empowerment Act, (“RIDEA”) of which we concluded that NHI was not the primary beneficiary (Note 3); 3) a note receivable from, a guarantee on a letter of credit for, and a purchase option with, an unconsolidated VIE of whom we concluded that NHI was not the primary beneficiary (Note 4); and 4) two construction mortgage notes receivable aggregating $67,071,000 from an unconsolidated VIE of whom we concluded that NHI was not the primary beneficiary (Note 4). Our direct support of the above VIEs has been limited to the transactions described herein, and any decision to furnish additional direct support would be at our discretion and not obligatory. We believe our exposure to loss as a result of our involvement with these unconsolidated VIEs would be limited to our carrying value of these investments and the amount of our commitment as guarantor under the letter of credit. Generally, we lack, either directly or through related parties, any material input in the activities that most significantly impact the economic performance of these entities.


9


We apply FASB guidance related to investments in joint ventures based on the type of controlling rights held by the members' interests in limited liability companies that may preclude consolidation by the majority equity owner in certain circumstances in which the majority equity owner would otherwise consolidate the joint venture.

We structure our joint ventures to be compliant with the provisions of RIDEA, which permits NHI to receive rent payments through a triple-net lease between a property company and an operating company and is designed to give NHI the opportunity to capture additional value on the improving performance of the operating company through distributions to a taxable REIT subsidiary ("TRS"). Accordingly, the TRS holds our equity interest in an unconsolidated operating company, which we do not control, and provides an organizational structure that will allow the TRS to engage in a broad range of activities and share in revenues that would otherwise be non-qualifying income under the REIT gross income tests.

Investments. - Investments in marketable debt and equity securities are categorized as trading, available-for-sale or held-to-maturity. Our investments in marketable equity securities are classified as available-for-sale securities. Unrealized gains and losses on available-for-sale securities are recorded in stockholders' equity. Our investments in marketable debt securities, consisting of U.S. government debt and long-term certificates of deposit, are classified as held-to-maturity because we have the intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts to maturity. We evaluate our securities for other-than-temporary impairments on at least a quarterly basis. Realized gains and losses from the sale of available-for-sale securities are determined on a specific-identification basis.

A decline in the market value of any available-for-sale or held-to-maturity security below cost that is deemed to be other-than-temporary results in an impairment to reduce the carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. To determine whether an impairment is other-than-temporary, we consider whether we have the ability and intent to hold the investment until a market price recovery and consider whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to year-end and forecasted performance of the investment.

Equity-Method Investment - We report our TRS' investment in an unconsolidated entity, over whose operating and financial policies we have the ability to exercise significant influence but not control, under the equity method of accounting. Under this accounting method, our pro rata share of the entity's earnings or losses is included in our Condensed Consolidated Statements of Income. Additionally, we adjust our investment carrying amount to reflect our share of changes in an equity-method investee's capital resulting from its capital transactions.

The initial carrying value of our equity-method investment is based on the fair value of the net assets of the entity at the time we acquired our interest. We estimate fair values of the net assets of our equity-method investee based on discounted cash flow models. The inputs we use in these models are based on assumptions that are within a reasonable range of current market rates for the respective investments.

We evaluate our equity-method investment for impairment whenever events or changes in circumstances indicate that the carrying value of our investment may exceed the fair value. If it is determined that a decline in the fair value of our investment is not temporary, and if such reduced fair value is below its carrying value, an impairment is recorded. Determining fair value involves significant judgment. Our estimates consider all available evidence including the present value of the expected future cash flows discounted at market rates, general economic conditions and other relevant factors.

Noncontrolling Interest - We present the portion of any equity that we do not own in entities that we control (and thus consolidate) as noncontrolling interest and classify such interest as a component of consolidated equity separate from total NHI stockholders' equity in our Condensed Consolidated Balance Sheets. In addition, we exclude net income attributable to the noncontrolling interest from net income attributable to common shareholders in our Condensed Consolidated Statements of Income.

Use of Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Earnings Per Share - The weighted average number of common shares outstanding during the reporting period is used to calculate basic earnings per common share. Diluted earnings per common share assume the exercise of stock options using the treasury stock method, to the extent dilutive, and also incorporate the potential dilutive impact of our 3.25% convertible senior notes due 2021. We apply the treasury stock method to our convertible debt instruments, the effect of which is that conversion

10


will not be assumed for purposes of computing diluted earnings per share unless the average share price of our common stock for the period exceeds the conversion price per share.

New Accounting Pronouncements - In February 2015 the FASB issued ASU 2015-16, Amendments to the Consolidation Analysis, under ASU 2015-02, which is generally effective for fiscal years and interim periods beginning after December 15, 2015. ASU 2015-02 changes the consolidation analysis for all reporting entities. The changes primarily affect the consolidation of limited partnerships and their equivalents (e.g., limited liability corporations), the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships, as well as structured vehicles such as collateralized debt obligations. We have yet to determine the method by which ASU 2015-02 will be adopted in 2016, and we are continuing to study the effect that our eventual adoption of this standard will have on our reported financial position and results of operations, the extent of which is not reasonably estimable at this time.

In April 2015 the FASB issued ASU 2015-03, Interest-Imputation of Interest, whose primary effect is to mandate that debt issuance costs be reported in the balance sheet as a direct deduction from the face amount of the related liability. Debt issuance costs have previously been presented among assets on the balance sheet. The standard does not affect the recognition and measurement of debt issuance costs. The ASU is effective for public business entities for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted. In August 2015 the FASB issued ASU 2015-15, Interest-Imputation of Interest (Subtopic 835-30) Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting. The ASU clarifies the treatment of debt issuance costs related to revolving credit facilities, upon which ASU 2015-03 was silent. ASU 2015-15 notes that the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. We believe our eventual adoption of these standards on the imputation of interest will have no material effect on our reported financial position and results of operations.

In August 2015 the FASB issued ASU 2015-14, which defers the effective date of ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 provides a principles-based approach for a broad range of revenue generating transactions, including the sale of real estate, which will generally require more estimates and more judgment and more disclosures than under current guidance. Because this ASU specifically excludes lease contracts from its scope, its application is not expected to impact our recognition of rental income on a straight-line basis. ASU 2014-09 is now effective for public entities for annual periods beginning after December 15, 2017, including interim periods therein. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. We have yet to determine the method by which ASU 2014-09 will be adopted in 2018 and we are continuing to study the effect that our eventual adoption of this standard will have on our reported financial position and results of operation, the extent of which is not reasonably estimable at this time.

NOTE 2. REAL ESTATE

As of September 30, 2015, we owned 179 health care real estate properties located in 31 states and consisting of 112 senior housing communities, 62 skilled nursing facilities, 3 hospitals and 2 medical office buildings. Our senior housing properties include assisted living facilities, senior living campuses, independent living facilities, and entrance-fee communities. These investments (excluding assets classified as held for sale, pre-development costs of $375,000 and our corporate office of $910,000) consisted of properties with an original cost of approximately $2,087,337,000, rented under triple-net leases to 26 lessees.

Chancellor

On August 31, 2015, we acquired a 29-unit memory care facility in Portland, Oregon, for $6,772,000 in cash inclusive of closing costs of approximately $97,000. We leased the facility to Chancellor Health Care for 15 years with renewal options at an initial lease rate of 7.75% plus annual escalators. Because the facility was owner-occupied, the acquisition was accounted for as an asset purchase.

Brook Retirement Communities

On August 31, 2015, we acquired a 42-unit independent living and assisted living community in Roscommon, Michigan, for $6,000,000 in cash plus closing costs of $49,000. We leased the facility to The Brook Retirement Communities of Roscommon, Inc., for 10 years with renewal options at an initial lease rate of 7.5% plus annual escalators. Because the facility was owner-occupied, the acquisition was accounted for as an asset purchase.




11


East Lake

On July 1, 2015, we acquired two senior living campuses in Nashville and Indianapolis and one assisted living/memory care facility in Charlotte for $66,900,000 in cash. We leased the facilities to an affiliate of East Lake Capital Management (“East Lake”) for an initial term of 10 years, plus renewal options. The lease calls for an annual payment of $4,683,000 in the first year with fixed annual escalators of 3.5% through year four and 3.0% thereafter. In conjunction with the lease, East Lake acquired a purchase option on the properties as a whole, exercisable beginning in year six of the lease for approximately $81,000,000 and thereafter subject to escalation on a basis consistent with rental escalations and other funding in place. In connection with the lease, we have committed to invest an additional $400,000 for specified capital improvements. The investment will be added to the basis on which the lease amount is calculated. In addition, we have committed to a lessee earn out of $8,000,000 contingent on reaching and maintaining certain metrics and a contingent earn out of $750,000 payable to the seller upon East Lake reaching certain metrics. At acquisition, we estimated the seller contingent earnout payment to be probable and, accordingly, have reflected that amount in our Condensed Consolidated Balance Sheet at September 30, 2015. Contingent payments earned will be an addition to the lease base when funded. Pending final valuation, we have apportioned our cost of the East Lake facilities at approximately 6% for land and land improvements and 94% for buildings and equipment.

The East Lake Facilities were owner-occupied at acquisition, and accordingly we accounted for the transaction as an asset purchase. Because we neither control East Lake nor have any role in its day-to-day management, we have no material input into activities that most significantly impact the entities’ economic performance, and we account for our transactions with East Lake at amortized cost. We are not obligated to provide further support to East Lake, and accordingly the maximum extent of our exposure to loss is limited to our investment in the facilities.

Holiday

As of September 30, 2015, we leased 25 independent living facilities to NH Master Tenant, LLC, an affiliate of Holiday Retirement ("Holiday"). The master lease term of 17 years began in December 2013 and provides for 2015 cash rent of $33,351,000 plus annual escalators of 4.5% in 2016 and 2017 and a minimum of 3.5% each year thereafter.

Of our total revenues, $10,954,000 (19%) and $10,954,000 (25%) were derived from Holiday for the three months ended September 30, 2015 and 2014, including $2,616,000 and $2,975,000 in straight-line rent, respectively. For the nine months ended September 30, 2015 and 2014, of our total revenues, $32,863,000 (19%) and $32,863,000 (25%) were derived from Holiday including $7,849,000 and $8,926,000 in straight-line rent, respectively. NH Master Tenant, LLC continues to operate the facilities pursuant to a management agreement with a Holiday-affiliated manager.

Bickford

As of September 30, 2015, we owned an 85% equity interest and Sycamore Street, LLC ("Sycamore"), an affiliate of Bickford Senior Living ("Bickford"), owned a 15% equity interest in our consolidated subsidiary ("PropCo") which owns 32 assisted living/memory care facilities plus 5 facilities in pre-development and development. The facilities are leased to an operating company, ("OpCo"), in which we retain a non-controlling 85% ownership interest. The facilities are managed by Bickford. Our joint venture is structured to comply with the provisions of RIDEA.

On July 31, 2015, our subsidiary, PropCo, acquired a 92 unit assisted living/memory care facility located in Lancaster, Ohio for $21,000,000 in cash. The facility was leased under terms structured to comply with provisions of RIDEA, to the operating company, OpCo, of which we retain an 85/15 ownership interest with Bickford, as discussed in Note 3. Because the facility was owner-occupied, the acquisition was accounted for as an asset purchase.

In February 2015 the joint venture announced it would develop five senior housing facilities in Illinois and Virginia. Each community will be managed by Bickford and will consist of 60 private-pay assisted living and memory care units. Construction started in mid-2015, with openings planned beginning in late 2016. The total estimated project cost is $55,000,000. During the third quarter of 2015, we purchased land for three of the five planned assisted living facilities. Total capitalized costs related to these properties as of September 30, 2015, including land purchases, were $8,123,000. We have accumulated an additional $375,000 in pre-development costs for the remaining two sites.

As of September 30, 2015, the annual contractual rent from OpCo to PropCo is $23,853,000, plus fixed annual escalators. NHI has an exclusive right to Bickford's future acquisitions, development projects and refinancing transactions. Of our total revenues, $6,150,000 (11%) and $5,324,000 (12%) were recognized as rental income from Bickford for the three months ended September 30, 2015 and 2014, and $17,844,000 (10%) and $15,789,000 (12%) for the nine months ended September 30, 2015 and 2014, respectively.


12


NHC

As of September 30, 2015, we leased 42 facilities under two master leases to National HealthCare Corporation (“NHC”), a publicly-held company and the lessee of our legacy properties. The facilities leased to NHC consist of 3 independent living facilities and 39 skilled nursing facilities (4 of which are subleased to other parties for whom the lease payments are guaranteed to us by NHC). These facilities are leased to NHC under the terms of an amended master lease agreement originally dated October 17, 1991 ("the 1991 lease") which includes our 35 remaining legacy properties and a master lease agreement dated August 30, 2013 ("the 2013 lease") which includes 7 skilled nursing facilities in New England.

The 1991 lease has been amended to extend the lease expiration to December 31, 2026. There are two additional 5-year renewal options, each at fair rental value of such leased property as negotiated between the parties and determined without including the value attributable to any improvements to the leased property voluntarily made by NHC at its expense. Under the terms of the lease, the base annual rental is $30,750,000 and rent escalates by 4% of the increase, if any, in each facility's revenue over a 2007 base year. The 2013 lease provides for a base annual rental of $3,450,000 and has a lease expiration of August 2028. Under the terms of the 2013 lease, rent escalates 4% of the increase, if any, in each facility's revenue over a 2014 base year. For both the 1991 lease and the 2013 lease, we refer to this additional rent component as “percentage rent.” During the last three years of the 2013 lease, NHC will have the option to purchase the facilities for $49,000,000.

The following table summarizes the percentage rent income from NHC (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Current year
$
596

 
$
573

 
$
1,788

 
$
1,719

Prior year final certification1

 

 
94

 
15

Total percentage rent income
$
596

 
$
573

 
$
1,882

 
$
1,734

1 For purposes of the percentage rent calculation described in the master lease Agreement, NHC’s annual revenue by facility for a given year is certified to NHI by March 31st of the following year.

Of our total revenues, $9,133,000 (16%) and $9,109,000 (20%) were derived from NHC for the three months ended September 30, 2015 and 2014, respectively, and $27,492,000 (16%) and $27,337,000 (21%) for the nine months ended September 30, 2015 and 2014, respectively.

Senior Living Communities

Beginning in December 2014 we leased eight retirement communities with 1,671 units to Senior Living Communities, LLC (“Senior Living”). The 15-year master lease contains two 5-year renewal options and provides for initial cash rent of $31,000,000, plus annual escalators of 4% in years two through four and 3% thereafter.

For the eight Senior Living properties acquired by us in December 2014 in a transaction accounted for as a business combination, the unaudited pro forma revenue, net income and net income available to common stockholders of the combined entity for the three and nine months ended September 30, 2014 is provided below as if the acquisition date had been January 1, 2013 (in thousands except per share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2014
Revenue
$
54,335

 
$
161,342

Net income
$
30,067

 
$
88,667

Net income available to common stockholders
$
29,801

 
$
87,795

Earnings per common share - basic
$
0.79

 
$
2.34

Earnings per common share - diluted
$
0.79

 
$
2.34


Supplemental pro forma information above includes revenues from the lease recognized on a straight-line basis, depreciation, and appropriate interest costs.


13


Of our total revenues for the three and nine months ended September 30, 2015, we recorded $9,855,000 (17%) and $29,566,000 (17%), respectively, in lease revenue from Senior Living, of which $2,105,000 and $6,316,000 respectively, represented straight-line rent. Net earnings from this acquisition were $4,549,000 and $13,715,000 for the same periods.

Disposition of Assets

On September 30, 2015, we sold for $9,593,000 two properties with a carrying value of $8,467,000 and recognized a gain on the disposition of $1,126,000. The properties represented the last two skilled nursing facilities of a disposal group that was originally under contract and classified during 2011 and 2012 as held-for-sale. As previously disclosed, the sale for the disposal group as a whole, being subject to certain conditions precedent as to financing, did not occur. NHI then proceeded to dispose of three of the properties in December 2013, the first of the group having been sold in 2011. On completion of these disposals to our tenant, Fundamental, a monthly rental of $250,000 was attached to the two remaining skilled nursing facilities through the end of the original lease term, February 2016, the properties having an average age in excess of 40 years. With the impending cessation of the lease, the two properties were aggressively marketed for immediate sale under conditions less favorable than those prevailing in 2011.

Assets Held for Sale

In August 2015 we committed to a plan to sell a skilled nursing facility in Idaho. We have reached agreement with our tenant on a sales price of $3,000,000 for the property, which has a carrying value of $1,346,000. We recorded lease income from the property for the three and nine months ended September 30, 2015 of $80,000 and $241,000, respectively, and for the three and nine months ended September 30, 2014 lease income was $78,000 and $235,000, respectively. The Idaho property does not meet the accounting criteria to be reported as a discontinued operation as its disposal will not result in a strategic shift that would have a major effect on our operations or financial results.

NOTE 3. EQUITY-METHOD INVESTMENT AND OTHER ASSETS

Our equity-method investment in OpCo and other assets consist of the following (in thousands):
 
September 30,
2015
 
December 31,
2014
Equity-method investment in OpCo
$
8,659

 
$
9,424

Debt issuance costs
12,153

 
11,491

Accounts receivable and other assets
4,633

 
3,818

Reserves for replacement, insurance and tax escrows
4,170

 
4,324

Lease escrow deposits

 
21,648

 
$
29,615

 
$
50,705


Upon the acquisition of our investment in OpCo in 2012, our purchase price was allocated to the assets acquired based upon their estimated relative fair values. We account for this investment using the equity method because OpCo is intended to be self-financing, and we do not control the entity, nor do we have any role in its day-to-day management. Financial reporting standards for equity method investments require that we account for the difference between the cost basis of our investment in OpCo and our pro rata share of the amount of underlying equity in the net assets of OpCo as though OpCo were a consolidated subsidiary. Accordingly, the excess of the original purchase price over the fair value of identified tangible assets at acquisition of $8,986,000 is treated as implied goodwill and is subject to periodic review for impairment in conjunction with our equity method investment. We noted no decline in values as of September 30, 2015, losses in the investee arising from new development not present at acquisition, to which no goodwill is attributed. OpCo is intended to be self-financing, and aside from initial investments therein, no direct support has been provided by NHI to OpCo since inception on September 30, 2012. While PropCo's rental revenues associated with the related properties are sourced from OpCo, a decision to furnish additional direct support would be at our discretion and not obligatory. As a result, we believe our maximum exposure to loss at September 30, 2015, due to our investment in OpCo, would be limited to our equity interest.

In July 2015 the balance of funds held as a lease security deposit, payable in December 2030, was reclassified as marketable securities upon the investment of these funds in government agency debt securities and as long-term certificates of deposit. See Note 6.

Reserves for replacement, insurance and tax escrows include amounts required to be held on deposit in accordance with regulatory agreements governing our Fannie Mae and HUD mortgages. Debt issuance costs are being amortized over the expected term of the debt instruments to which they are related.

14


NOTE 4. MORTGAGE AND OTHER NOTES RECEIVABLE

At September 30, 2015, we had investments in mortgage notes receivable with a carrying value of $86,222,000, secured by real estate and UCC liens on the personal property of 9 health care properties, and other notes receivable with a carrying value of $31,607,000, guaranteed by significant parties to the notes or by cross-collateralization of properties with the same owner. No allowance for doubtful accounts was considered necessary at September 30, 2015.

Timber Ridge

In February 2015, we entered into an agreement to lend LCS-Westminster Partnership III LLP (“LCS-WP”), an affiliate of Life Care Services, the manager of the facility, up to $154,500,000. The loan agreement conveys a mortgage interest and will facilitate the construction of Phase II of Timber Ridge at Talus (“Timber Ridge”), a Type-A Continuing Care Retirement Community in the Seattle, WA area.

The loan takes the form of two notes under a master credit agreement. The senior note (“Note A”) totals $60,000,000 at a 6.75% interest rate with 10 basis-point escalators after year three, and has a term of 10 years. We have funded $28,000,000 of Note A as of September 30, 2015. Note A is interest-only and is locked to prepayment for three years. After year three, the prepayment penalty starts at 5% and declines 1% per year. The second note ("Note B") is a construction loan for up to $94,500,000 at an annual interest rate of 8% and a 5 year maturity. We anticipate funding Note B through December 2016 and anticipate substantial repayment with new resident entrance fees upon the opening of Phase II. The total amount funded on Note B was $39,071,000 as of September 30, 2015.

NHI has a purchase option on the entire Timber Ridge property for the greater of fair market value or $115,000,000 during a purchase option window of 120 days that will contingently open in year five or upon earlier stabilization of the development, as defined. The current basis of our investment in Timber Ridge loans is $67,071,000, but we are obligated to complete the funding of both Notes A and B of up to $154,500,000 which represents the maximum exposure to loss of NHI due to our relationship with Timber Ridge. Because we neither control the entity, nor have any role in its day-to-day management, we account for our investment in LCS-WP at amortized cost.

Senior Living Communities

In connection with the December 2014 Senior Living acquisition, described in Note 2, we provided a $15,000,000 revolving line of credit, the maturity of which mirrors the 15-year term of the master lease. Borrowings are used to finance construction projects within the Senior Living Portfolio, including building additional units. Up to $5,000,000 of the facility may be used to meet general working capital needs. Amounts outstanding under the facility, $5,321,000 at September 30, 2015, bear interest at an annual rate equal to the 10-year U.S. Treasury rate, 2.06% at September 30, 2015, plus 6%.

Sycamore

In July 2013 we extended a $9,200,000 loan to our joint venture partner, Sycamore, to fund a portion of their acquisition from a third party of six senior housing communities consisting of 342 units. The loan is guaranteed by principals of Bickford and has a 12% annual interest. As a result of the loan, PropCo acquired a $97,000,000 purchase option exercisable over the term of the loan, covering all of the properties, in whole or in part. Terms of the loan and the purchase option have been extended through June 2018. In June 2014 we entered into a $500,000 revolving loan to Sycamore to fund pre-development expenses related to potential future projects. Interest is payable monthly at 10% and the note, as extended, matures in June 2018. At September 30, 2015, the revolving loan had an outstanding balance of $412,000. Sycamore is intended to be self-financing, and our direct support has been limited to the loans described herein and a $3,550,000 letter of credit for the benefit of Sycamore. We are not obligated to extend support to Sycamore beyond our current basis in the loans and letter of credit to them; accordingly our investment in this extension of credit represents our maximum exposure to loss. However, because we do not control Sycamore, nor do we have any role in the day-to-day management, we account for loans provided to Sycamore at amortized cost.

Repayments

In June 2015 Santé Partners, LLC (“Santé”) repaid its $11,700,000 mortgage obligation originally scheduled to come due on July 31. The mortgage was secured by a 70-bed transitional rehabilitation center, for which NHI had held a purchase option. Additionally, in June 2015, NHI was repaid in full on a $1,000,000 mortgage note secured by a skilled nursing facility in Texas.
Recovery

In June 2015 we received $491,000 as a secured creditor in the final settlement of a bankruptcy proceeding.

15


NOTE 5. INVESTMENT IN PREFERRED STOCK, AT COST

We recognized $818,000 and $2,454,000 in preferred dividend income from LTC (a publicly-traded REIT) for the three and nine months ended September 30, 2015 and 2014, respectively, on our investment in 2,000,000 shares of their cumulative preferred stock carried at its original cost of $38,132,000. The preferred stock, which was purchased in September 1998, is not listed on a stock exchange, is considered a non-marketable security and is recorded at cost in our Condensed Consolidated Balance Sheets. The non-voting preferred stock is convertible into 2,000,000 shares of LTC common stock whose closing price at September 30, 2015 was $42.67 per share. The preferred stock has an annual cumulative coupon rate of 8.5% payable quarterly and a liquidation preference of $19.25 per share. While not the fair value of our preferred stock investment, we provide the above information as pertinent to the reader's estimation of the fair value of our investment. In accordance with ASC Topic 825 Financial Instruments, paragraph 10-50 Disclosure-Overall, we have determined that it is not practicable to estimate the fair value of our cost basis investment in preferred stock due to excessive costs related to inherent subjectivities in refining the estimate to a degree that is likely to materially augment the information provided above. Further, we have identified no events that may have had an adverse effect on its fair value which would have required revisiting the instrument's carrying value.

NOTE 6. INVESTMENTS IN MARKETABLE SECURITIES

Our investments in marketable securities include available-for-sale securities which are reported at fair value and investments in marketable debt securities which consist of U.S. government agency debt and long-term certificates of deposit. Unrealized gains and losses on available-for-sale securities are presented as a component of accumulated other comprehensive income. Realized gains and losses from securities sales are determined based upon specific identification of the securities. Marketable debt securities are classified as held-to-maturity and stated at amortized cost, adjusted for amortization of premiums and accretion of discounts to maturity.

Marketable securities consist of the following (in thousands):
 
September 30, 2015
 
December 31, 2014
 
Amortized Cost

 
Fair Value

 
Amortized Cost

 
Fair Value

Common stock of other healthcare REITs
$
4,088

 
$
15,065

 
$
4,088

 
$
15,503

Held-to-maturity securities
$
20,083

 
$
20,192

 
$

 
$


Gross unrealized gains related to available-for-sale securities were $10,977,000 at September 30, 2015 and $11,415,000 at December 31, 2014.

NOTE 7. DEBT

Debt consists of the following (in thousands):
 
September 30,
2015
 
December 31,
2014
Revolving credit facility - unsecured
$
217,000

 
$
374,000

Convertible senior notes - unsecured (net of discount of $6,141 and $6,963)
193,859

 
193,037

Bank term loans - unsecured
250,000

 
250,000

HUD mortgage loans (net of discount of $1,596 and $1,662)
45,201

 
45,689

Private placement term loans - unsecured
225,000

 

Fannie Mae term loans - secured, non-recourse
78,084

 

 
$
1,009,144

 
$
862,726













16


Aggregate principal maturities of debt as of September 30, 2015 for each of the next five years and thereafter are as follows (in thousands):
Twelve months ended September 30
 
2016
$
762

2017
787

2018
814

2019
842

2020
467,871

Thereafter
545,805

 
1,016,881

Less: discount
(7,737
)
 
$
1,009,144


In June 2015 we entered into an amended $800,000,000 senior unsecured credit facility with a group of banks. The facility can be expanded, subject to certain conditions, up to an additional $250,000,000. The amended credit facility provides for: (1) a $550,000,000 unsecured, revolving credit facility that matures in June 2020 (inclusive of an embedded 1-year extension option) with interest at 150 basis points over LIBOR (19 bps at September 30, 2015); (2) a $130,000,000 unsecured term loan that matures in June 2020 with interest at 175 basis points over LIBOR; and (3) two existing term loans which remain in place totaling $120,000,000, maturing in June 2020 and bearing interest at 175 basis points over LIBOR. At closing, the new facility replaced a smaller credit facility last amended in March 2014 that provided for $700,000,000 of total commitments. The employment of interest rate swaps for our fixed term debt leaves only our revolving credit facility exposed to variable rate risk. Our swaps and the financial instruments to which they relate are described in the table below, under the caption “Interest Rate Swap Agreements.”

At September 30, 2015 we had $333,000,000 available to draw on the revolving portion of the credit facility. The unused commitment fee is 40 basis points per annum. The unsecured credit facility requires that we maintain certain financial ratios within limits set by our creditors. To date, these ratios, which are calculated quarterly, have been within the limits required by the credit facility agreements.

In March 2015 we obtained $78,084,000 in Fannie Mae financing. The term debt financing consists of interest-only payments at an annual rate of 3.79% and a 10-year maturity. The mortgages are non-recourse and secured by thirteen properties in NHI’s joint venture with Bickford. Proceeds were used to reduce borrowings on NHI's unsecured bank credit facility. The notes are secured by the facilities previously pledged as security on Fannie Mae term debt that was retired in December 2014.

In January 2015 we issued $125,000,000 of 8-year notes with a coupon of 3.99% and $100,000,000 of 12-year notes with a coupon of 4.51% to a private placement lender. The notes are unsecured and require quarterly payments of interest only until maturity. We used the proceeds from the notes to pay down borrowings on our revolving credit facility. Terms and conditions of the new financing are similar to those under our bank credit facility with the exception of provisions regarding prepayment premiums.

In March 2014 we issued $200,000,000 of 3.25% senior unsecured convertible notes due April 2021 (the "Notes"). Interest is payable April 1st and October 1st of each year. The Notes are convertible at an initial conversion rate of 13.926 shares of common stock per $1,000 principal amount, representing a conversion price of approximately $71.81 per share for a total of approximately 2,785,200 underlying shares. The conversion rate is subject to adjustment upon the occurrence of certain events, as defined in the indenture governing the Notes, but will not be adjusted for any accrued and unpaid interest except in limited circumstances. The conversion option is considered an "optional net-share settlement conversion feature," meaning that upon conversion, NHI's conversion obligation may be satisfied, at our option, in cash, shares of common stock or a combination of cash and shares of common stock. Our average stock price in for the third quarter of 2015 is less than the conversion price, making the conversion option anti-dilutive for the three months ended September 30, 2015. For the year-to-date period, 2015 dilution is determined by computing an average of incremental shares included in each quarterly diluted EPS computation, resulting in a dilutive effect of the conversion feature of 6,314 shares for the nine months ended September 30, 2015.

The embedded conversion options (1) do not require net cash settlement, (2) are not conventionally convertible but can be classified in stockholders’ equity under ASC 815-40, and (3) are considered indexed to NHI’s own stock. Therefore, the conversion feature satisfies the conditions to qualify for an exception to the derivative liability rules, and the Notes are split into debt and equity components. The value of the debt component is based upon the estimated fair value of a similar debt instrument without the conversion feature at the time of issuance and was estimated to be approximately $192,238,000. The $7,762,000 difference between the contractual principal on the debt and the value allocated to the debt was recorded as an equity component and represents

17


the estimated value of the conversion feature of the instrument. The excess of the contractual principal amount of the debt over its estimated fair value, the original issue discount, is amortized to interest expense using the effective interest method over the estimated term of the Notes. The effective interest rate used to amortize the debt discount and the liability component of the debt issue costs was approximately 3.9% based on our estimated non-convertible borrowing rate at the date the Notes were issued.

The total cost of issuing the Notes was $6,063,000, $275,000 of which was allocated to the equity component and $5,788,000 of which was allocated to the debt component and subject to amortization over the estimated term of the notes. The remaining unamortized balance at September 30, 2015, was $4,393,000.

Our HUD mortgage loans are secured by ten properties in our joint venture with Bickford. Nine mortgage notes require monthly payments of principal and interest from 4.3% to 4.4% (inclusive of mortgage insurance premium) and mature in August and October 2049. One additional HUD mortgage loan assumed in 2014 requires monthly payments of principal and interest of 2.9% (inclusive of mortgage insurance premium) and matures in October 2047. The loan has an outstanding principal balance of $9,359,000 and a net book value of $7,764,000, which approximates fair value.

The following table summarizes interest expense (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Interest expense at contractual rates
$
9,000

 
$
6,426

 
$
25,223

 
$
17,126

Capitalized interest
(92
)
 
(156
)
 
(296
)
 
(367
)
Amortization of debt issuance costs, debt discount and premium
864

 
735

 
2,544

 
1,816

Debt issuance costs expensed due to credit facility modifications

 

 

 
2,145

Total interest expense
$
9,772

 
$
7,005

 
$
27,471

 
$
20,720


Interest Rate Swap Agreements

To mitigate our exposure to interest rate risk, we have entered into the following interest rate swap contracts on our bank term loans as of September 30, 2015 (dollars in thousands):
Date Entered
 
Maturity Date
 
Fixed Rate
 
Rate Index
 
Notional Amount
 
Fair Value
May 2012
 
April 2019
 
3.29%
 
1-month LIBOR
 
$
40,000

 
$
(787
)
June 2013
 
June 2020
 
3.86%
 
1-month LIBOR
 
$
80,000

 
$
(3,427
)
March 2014
 
June 2020
 
3.91%
 
1-month LIBOR
 
$
130,000

 
$
(5,888
)

See Note 11 for fair value disclosures about our variable and fixed rate debt and interest rate swap agreements.

NOTE 8. COMMITMENTS AND CONTINGENCIES

Bickford

In February 2015 our joint venture with Bickford announced plans to develop five senior housing facilities in Illinois and Virginia. Each community will be managed by Bickford and consist of 60 private-pay assisted living and memory care units. These five properties will represent the culmination of plans announced in 2012 between NHI and Bickford to construct a total of eight facilities. The first three communities, all in Indiana, opened in 2013 and 2014. Pre-development and land acquisition on the five facilities started in mid-2015 with openings planned beginning in late 2016. The total estimated project cost is $55,000,000. As of September 30, 2015, land and pre-development costs incurred on the project totaled $8,498,000.

In February 2014 we entered into a commitment on a letter of credit for the benefit of Sycamore which holds a minority interest in PropCo. At September 30, 2015 our commitment on the letter of credit totaled $3,550,000.

In June 2014 we entered into a $500,000 revolving loan with Bickford affiliate, Sycamore, to fund pre-development expenses related to potential future projects. Interest is payable monthly at 10% and the note, as extended, matures in June 2018. At September 30, 2015, the revolving loan had an outstanding balance of $412,000.




18


Chancellor

In October 2013, we entered into a $7,500,000 commitment to build a 46-unit free-standing assisted living and memory care community on our Linda Valley senior living campus in Loma Linda, California. We began construction during the first quarter of 2014 and had funded $7,326,000 as of September 30, 2015. The initial lease term is for 15 years at an annual rate of 9% plus a fixed annual escalator. NHI purchased the Linda Valley campus in 2012 and leased it to Chancellor Health Care ("Chancellor"), who has been operating the campus since 1993. We also committed to provide up to $1,150,000 for renovations and improvements related to our recent acquisitions of senior housing communities in Oregon and Maryland, which we have leased to Chancellor. We began renovations during the first quarter of 2014 and had funded $564,000 as of September 30, 2015. We receive rent income on funds advanced for each construction project.

Discovery

As a lease inducement, we have a contingent commitment to fund a series of payments up to $2,500,000 in connection with our September 2013 lease to Discovery Senior Living ("Discovery") of a senior living campus in Rainbow City, Alabama. Discovery would earn the contingent payments upon gaining, and maintaining, a specified lease coverage ratio. Remaining payments will be assessed for funding in installments of $750,000 through September 2016 when the residual is potentially due. As of September 30, 2015, incurring the contingent payments was not considered probable. Accordingly, no provision for these payments is reflected in the Condensed Consolidated Balance Sheet.

East Lake

In connection with our July 2015 lease, NHI has committed to East Lake certain lease incentive payments of $8,000,000 contingent on reaching and maintaining certain metrics, a contingent earnout of $750,000 payable to the seller upon attaining certain metrics, and the funding of an additional $400,000 for specified capital improvements. At acquisition, we estimated the seller contingent earnout payment to be probable and accordingly, have reflected that amount in our Condensed Consolidated Balance Sheet at September 30, 2015. Contingent payments earned will be included in the lease base when funded.

Kentucky River

In March 2012, we entered into a long-term lease extension and construction commitment to an affiliate of Community Health Systems under which we provided $7,463,000 for extensive renovations and additions to our Kentucky River Medical Center, a general acute care hospital in Jackson, Kentucky. Funding for this investment was added to the basis on which the lease amount is calculated. The construction project commenced during the first quarter of 2013 and was completed in 2015. The 10-year lease extension began July 1, 2012, with an additional 5-year renewal option.

Life Care Services

See Note 4 for a discussion of our loan commitments to an affiliate of Life Care Services.

Prestige

We agreed to fund capital improvements of up to $2,000,000 in connection with two of the skilled nursing facilities we lease to Prestige Senior Living. As of September 30, 2015, we had fully funded this commitment. The capital improvements were added to our original investment in the properties and are included in the lease base. Additionally, we have committed to fund contingent earn out payments up to a maximum of $6,390,000 based on the achievement of certain financial metrics as measured periodically through December 31, 2015. At acquisition, we estimated probable contingent payments of $3,000,000 to be likely and have reflected that amount in the condensed consolidated financial statements. Contingent payments earned will be included in the lease base when funded.

Santé

We are committed to fund a $3,500,000 expansion and renovation program at our Silverdale, Washington senior living campus and as of September 30, 2015, had funded $2,621,000, which was added to the basis on which the lease amount is calculated. In addition, we have a contingent commitment to fund two lease inducement payments of $1,000,000 each. Santé would earn the payments upon attaining and sustaining a specified lease coverage ratio. If earned, the first payment would be due following calendar year 2015 and the second payment would be due following calendar year 2016. At acquisition, incurring the contingent payments was not considered probable. Accordingly, no provision for these payments is reflected in the Condensed Consolidated Balance Sheet.

19



Senior Living Communities

In connection with our December 2014 Senior Living acquisition, we have provided a $15,000,000 revolving line of credit to Senior Living, the maturity of which mirrors the term of the master lease. Borrowings will be used to finance construction projects within the Senior Living Portfolio, including building additional units. Up to $5,000,000 of the facility may be used to meet general working capital needs. Amounts outstanding under the facility, $5,321,000 at September 30, 2015, bear interest at an annual rate equal to the 10-year U.S. Treasury rate, 2.06% at September 30, 2015, plus 6%.

Senior Living Management

We have entered into agreements with our current tenant, Senior Living Management, to fund up to $1,430,000 for renovations to our facilities in Georgia and Louisiana. As amounts are funded, they are added to the lease base. As of September 30, 2015, we had funded $908,000 toward this commitment.

Signature

In 2012 we provided an affiliate of Signature Senior Living with a revolving loan facility of $1,500,000, bearing interest at a current rate of 10%, to fund pre-development activities internationally. With the extension of $250,000 in funding on March 31, 2015, the facility is fully drawn.

Litigation

Our facilities are subject to claims and suits in the ordinary course of business. Our lessees and borrowers have indemnified, and are obligated to continue to indemnify us, against all liabilities arising from both the operation of the facilities and are further obligated to indemnify us against environmental or title problems affecting the real estate underlying such facilities. While there may be lawsuits pending against certain of the owners and/or lessees of our facilities, management believes that the ultimate resolution of all such pending proceedings will have no material adverse effect on our financial condition, results of operations or cash flows.

NOTE 9. SHARE-BASED COMPENSATION

We recognize share-based compensation for all stock options granted over the requisite service period using the fair value of these grants as estimated at the date of grant using the Black-Scholes pricing model, and all restricted stock granted over the requisite service period using the market value of our publicly-traded common stock on the date of grant.

Share-Based Compensation Plans

The Compensation Committee of the Board of Directors ("the Committee") has the authority to select the participants to be granted options; to designate whether the option granted is an incentive stock option ("ISO"), a non-qualified option, or a stock appreciation right; to establish the number of shares of common stock that may be issued upon exercise of the option; to establish the vesting provision for any award; and to establish the term any award may be outstanding. The exercise price of any ISO’s granted will not be less than 100% of the fair market value of the shares of common stock on the date granted, and the term of an ISO may not be more than ten years. The exercise price of any non-qualified options granted will not be less than 100% of the fair market value of the shares of common stock on the date granted unless so determined by the Committee.

In May 2012, our stockholders approved the 2012 Stock Incentive Plan ("the 2012 Plan") pursuant to which 1,500,000 shares of our common stock were made available to grant as share-based payments to employees, officers, directors or consultants. As of September 30, 2015, there were 305,000 shares available for future grants under the 2012 Plan. The individual restricted stock and option grant awards vest over periods up to five years. The term of the options under the 2012 Plan is up to ten years from the date of grant. Through a vote of our shareholders on May 7, 2015, we have increased the maximum number of shares under the plan from 1,500,000 shares to 3,000,000 shares; increased the automatic annual grant to non-employee directors from 15,000 shares to 20,000 shares; and limited the Company's ability to re-issue shares under the Plan.

In May 2005, our stockholders approved the NHI 2005 Stock Option Plan ("the 2005 Plan") pursuant to which 1,500,000 shares of our common stock were made available to grant as share-based payments to employees, officers, directors or consultants. As of September 30, 2015, the 2005 Plan has expired and no additional shares may be granted under the 2005 Plan. The individual restricted stock and option grant awards vest over periods up to ten years. The term of the options outstanding under the 2005 Plan is up to ten years from the date of grant.

20



Compensation expense is recognized only for the awards that ultimately vest. Accordingly, forfeitures that were not expected may result in the reversal of previously recorded compensation expense. The compensation expense reported for the three months ended September 30, 2015 and 2014 was $233,000 and $223,000, respectively, and for the nine months ended September 30, 2015 and 2014 was $1,930,000 and $1,796,000, respectively.

At September 30, 2015, we had, net of expected forfeitures, $665,000 of unrecognized compensation cost related to unvested stock options which is expected to be expensed over the following periods: 2015 - $233,000, 2016 - $386,000 and 2017 - $46,000. Stock-based compensation is included in general and administrative expense in the Condensed Consolidated Statements of Income.

The following table summarizes our outstanding stock options:
 
Nine Months Ended
 
September 30,
 
2015
 
2014
Options outstanding January 1,
871,671

 
516,674

Options granted under 2012 Plan
450,000

 
400,000

Options granted under 2005 Plan
20,000

 

Options exercised under 2012 Plan
(421,657
)
 

Options canceled under 2012 Plan
(100,000
)
 
(15,000
)
Options exercised under 2005 Plan
(50,002
)
 
(26,670
)
Options outstanding, September 30,
770,012

 
875,004

 
 
 
 
Exercisable at September 30,
496,664

 
648,323


NOTE 10. EARNINGS AND DIVIDENDS PER SHARE

The weighted average number of common shares outstanding during the reporting period is used to calculate basic earnings per common share. Diluted earnings per common share assume the exercise of stock options and the conversion of our convertible debt using the treasury stock method, to the extent dilutive. If our average stock price for the period increases over the conversion price of our convertible debt, the conversion feature will be considered dilutive.

The following table summarizes the average number of common shares and the net income used in the calculation of basic and diluted earnings per common share (in thousands, except share and per share amounts):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Net income attributable to common stockholders
$
33,600

 
$
25,250

 
$
94,466

 
$
74,080

 
 
 
 
 
 
 
 
BASIC:
 
 
 
 
 
 
 
Weighted average common shares outstanding
37,566,221

 
33,055,992

 
37,563,503

 
33,053,386

 
 
 
 
 
 
 
 
DILUTED:
 
 
 
 
 
 
 
Weighted average common shares outstanding
37,566,221

 
33,055,992

 
37,563,503

 
33,053,386

Stock options
16,920

 
32,578

 
42,024

 
33,643

Convertible subordinated debentures

 

 
6,314

 

Average dilutive common shares outstanding
37,583,141

 
33,088,570

 
37,611,841

 
33,087,029

 
 
 
 
 
 
 
 
Net income per common share - basic
$
.89

 
$
.76

 
$
2.51

 
$
2.24

Net income per common share - diluted
$
.89

 
$
.76

 
$
2.51

 
$
2.24

 
 
 
 
 
 
 
 
Incremental shares excluded since anti-dilutive:
 
 
 
 
 
 
 
Net share effect of stock options with an exercise price in excess of the average market price for our common shares
107,993

 
24,659

 
42,052

 
26,734

 
 
 
 
 
 
 
 
Regular dividends declared per common share
$
.85

 
$
.77

 
$
2.55

 
$
2.31

 
 
 
 
 
 
 
 



21



NOTE 11. FAIR VALUE OF FINANCIAL INSTRUMENTS

Our financial assets and liabilities measured at fair value (based on the hierarchy of the three levels of inputs described in Note 1 to the consolidated financial statements contained in our most recent Annual Report on Form 10-K) on a recurring basis include marketable securities, derivative financial instruments and contingent consideration arrangements. Marketable securities consist of common stock of other healthcare REITs. Derivative financial instruments include our interest rate swap agreements. Contingent consideration arrangements relate to certain provisions of recent real estate purchase agreements involving both business combinations.

Marketable securities. We utilize quoted prices in active markets to measure debt and equity securities; these items are classified as Level 1 in the hierarchy and include the common and preferred stock of other healthcare REITs.

Derivative financial instruments. Derivative financial instruments are valued in the market using discounted cash flow techniques. These techniques incorporate Level 1 and Level 2 inputs. The market inputs are utilized in the discounted cash flow calculation considering the instrument's term, notional amount, discount rate and credit risk. Significant inputs to the derivative valuation model for interest rate swaps are observable in active markets and are classified as Level 2 in the hierarchy.

Contingent consideration. Contingent consideration arrangements are classified as Level 3 and are valued using unobservable inputs about the nature of the contingent arrangement and the counter-party to the arrangement, as well as our assumptions about the probability of full settlement of the contingency.
Assets and liabilities measured at fair value on a recurring basis are as follows (in thousands):
 
 
 
Fair Value Measurement
 
Balance Sheet Classification
 
September 30,
2015
 
December 31,
2014
Level 1
 
 
 
 
 
Common stock of other healthcare REITs
Marketable securities
 
$
15,065

 
$
15,503

Level 2
 
 
 
 
 
Interest rate swap asset
Other assets
 
$

 
$

Interest rate swap liability
Accrued expenses
 
$
10,102

 
$
5,193

Level 3
 
 
 
 
 
Contingent consideration
Real estate purchase liabilities
 
$
3,750

 
$
3,000


The following table presents a reconciliation of Level 3 liabilities measured at fair value on a recurring basis for the nine months ended September 30, 2015 and 2014 (in thousands):
 
Fair Value Beginning of Period

 
Transfers Into Level 3

 
Realized Gains and (Losses)

 
Purchases, Issuances and Settlements, net

 
Fair Value at End of Period

 
Total Period Losses Included in Earnings Attributable to the Change in Unrealized Losses Relating to Assets Held at End of Year

2015
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration
$
3,000

 
$

 
$

 
$
750

 
$
3,750

 
$

 
 
 
 
 
 
 
 
 
 
 
 
2014
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration
$
2,600

 
$

 
$

 
$
1,400

 
$
4,000

 
$


Carrying values and fair values of financial instruments that are not carried at fair value at September 30, 2015 and December 31, 2014 in the Condensed Consolidated Balance Sheets are as follows (in thousands):

22


 
Carrying Amount
 
Fair Value Measurement
 
2015
 
2014
 
2015
 
2014
Level 1
 
 
 
 
 
 
 
Marketable securities, held to maturity
$
20,083

 
$

 
$
20,192

 
$

Level 2
 
 
 
 
 
 
 
Variable rate debt
$
467,000

 
$
624,000

 
$
467,000

 
$
624,000

Fixed rate debt
$
542,144

 
$
238,726

 
$
559,648

 
$
254,150

 
 
 
 
 
 
 
 
Level 3
 
 
 
 
 
 
 
Mortgage and other notes receivable
$
117,828

 
$
63,630

 
$
125,759

 
$
72,435

The fair value of mortgage and other notes receivable is based on credit risk and discount rates that are not observable in the marketplace and therefore represents a Level 3 measurement.

Fixed rate debt. Fixed rate debt is classified as Level 2 and its value is based on quoted prices for similar instruments or calculated utilizing model derived valuations in which significant inputs are observable in active markets.

Carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to their short-term nature. The fair value of our borrowings under our revolving credit facility are reasonably estimated at their carrying value at September 30, 2015 and December 31, 2014, due to the predominance of floating interest rates, which generally reflect market conditions.

NOTE 12. SUBSEQUENT EVENTS

On November 3, 2015, we issued $50,000,000 of 8-year notes with a coupon of 3.99% and $50,000,000 of 10-year notes with a coupon of 4.33% to a private placement lender. The notes are unsecured and require quarterly payments of interest only until maturity. We used the proceeds from the notes to pay down borrowings on our revolving credit facility. Terms and conditions of the new financing are similar to those under our bank credit facility with the exception of provisions regarding prepayment premiums.

23


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

Forward Looking Statements

References throughout this document to NHI or the Company include National Health Investors, Inc., and its consolidated subsidiaries. In accordance with the Securities and Exchange Commission’s “Plain English” guidelines, this Quarterly Report on Form 10-Q has been written in the first person. In this document, the words “we”, “our”, “ours” and “us” refer only to National Health Investors, Inc. and its consolidated subsidiaries and not any other person. Unless the context indicates otherwise, references herein to “the Company” include all of our consolidated subsidiaries.

This Quarterly Report on Form 10-Q and other materials we have filed or may file with the Securities and Exchange Commission, as well as information included in oral statements made, or to be made, by our senior management contain certain “forward-looking” statements as that term is defined by the Private Securities Litigation Reform Act of 1995. All statements regarding our expected future financial position, results of operations, cash flows, funds from operations, continued performance improvements, ability to service and refinance our debt obligations, ability to finance growth opportunities, and similar statements including, without limitation, those containing words such as “may,” “will,” “believes,” “anticipates,” “expects,” “intends,” “estimates,” “plans,” and other similar expressions are forward-looking statements.

Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results in future periods to differ materially from those projected or contemplated in the forward-looking statements as a result of, but not limited to, the following factors:

*
We depend on the operating success of our tenants and borrowers for collection of our lease and interest income;

*
We depend on the success of property development and construction activities, which may fail to achieve the operating results we expect;

*
We are exposed to the risk that our tenants and borrowers may become subject to bankruptcy or insolvency proceedings;

*
We are exposed to risks related to governmental regulations and payors, principally Medicare and Medicaid, and the effect that lower reimbursement rates would have on our tenants’ and borrowers’ business;

*
We are exposed to the risk that the cash flows of our tenants and borrowers would be adversely affected by increased liability claims and liability insurance costs;

*
We are exposed to risks related to environmental laws and the costs associated with liabilities related to hazardous substances;

*
We are exposed to the risk that we may not be fully indemnified by our lessees and borrowers against future litigation;

*
We depend on the success of our future acquisitions and investments;

*
We depend on our ability to reinvest cash in real estate investments in a timely manner and on acceptable terms;

*
We may need to incur more debt in the future, which may not be available on terms acceptable to us;

*
We have covenants related to our indebtedness which impose certain operational limitations and a breach of those covenants could materially adversely affect our financial condition and results of operations;

*
We are exposed to the risk that the illiquidity of real estate investments could impede our ability to respond to adverse changes in the performance of our properties;

*
We are exposed to risks associated with our investments in unconsolidated entities, including our lack of sole decision-making authority and our reliance on the financial condition of other interests;

*
We depend on revenues derived mainly from fixed rate investments in real estate assets, while a portion of our debt capital used to finance those investments bear interest at variable rates. This circumstance creates interest rate risk to the Company;

*
We are exposed to the risk that our assets may be subject to impairment charges;


24


*
We depend on the ability to continue to qualify for taxation as a real estate investment trust;

*
We have ownership limits in our charter with respect to our common stock and other classes of capital stock which may delay, defer or prevent a transaction or a change of control that might involve a premium price for our common stock or might otherwise be in the best interests of our stockholders;

*
We are subject to certain provisions of Maryland law and our charter and bylaws that could hinder, delay or prevent a change in control transaction, even if the transaction involves a premium price for our common stock or our stockholders believe such transaction to be otherwise in their best interests.

See the notes to the annual audited consolidated financial statements in our most recent Annual Report on Form 10-K for the year ended December 31, 2014, and “Business” and “Risk Factors” under Item 1 and Item 1A therein for a further discussion of these and of various governmental regulations and other operating factors relating to the healthcare industry and the risk factors inherent in them. You should carefully consider these risks before making any investment decisions in the Company. These risks and uncertainties are not the only ones facing the Company. There may be additional risks that we do not presently know of or that we currently deem immaterial. If any of the risks actually occur, our business, financial condition, results of operations, or cash flows could be materially adversely affected. In that case, the trading price of our shares of stock could decline and you may lose part or all of your investment. Given these risks and uncertainties, we can give no assurance that these forward-looking statements will, in fact, occur and, therefore, caution investors not to place undue reliance on them.

Executive Overview

National Health Investors, Inc., is a self-managed real estate investment trust ("REIT") specializing in sale-leaseback, joint-venture, mortgage and mezzanine financing of need-driven and discretionary senior housing and medical investments. Our portfolio consists of real estate investments in independent, assisted and memory care communities, entrance-fee communities, senior living campuses, skilled nursing facilities, specialty hospitals and medical office buildings. Other investments include mortgages and notes, the preferred stock and marketable securities of other REITs, and a joint venture structured to comply with the provisions of the REIT Investment Diversification Empowerment Act of 2007 (“RIDEA”). Through this RIDEA joint venture, we invest in facility operations managed by independent third-parties. For the nine months ended September 30, 2015, our investment portfolio generated $170,346,000 of income. We fund our real estate investments primarily through: (1) cash flow, (2) debt offerings, including bank lines of credit and ordinary term debt, and (3) the sale of equity securities.

Portfolio

At September 30, 2015, our operations consisted of investments in real estate and mortgage and other notes receivable involving 188 facilities in 31 states. These investments include 115 senior housing communities, 68 skilled nursing facilities, 3 hospitals, 2 medical office buildings and other notes receivable. These investments (excluding pre-development costs of $375,000 and our corporate office of $910,000) consisted of properties with an original cost of approximately $2,087,337,000, rented under triple-net leases to 26 lessees, and $117,828,000 aggregate carrying value of mortgage and other notes receivable due from 14 borrowers.

We classify all of the properties in our portfolio as either senior housing or medical properties. Because our leases represent different underlying revenue sources and result in differing risk profiles, we further classify our senior housing communities as either need-driven (assisted and memory care communities and senior living campuses) or discretionary (independent living and entrance-fee communities.) For the table below, 3 parcels of land acquired have been included in their intended category.

Senior Housing – Need-Driven includes assisted and memory care communities ("ALF") and senior living campuses ("SLC") which primarily attract private payment for services from residents who require assistance with activities of daily living. Need-driven properties are subject to regulatory oversight.

Senior Housing – Discretionary includes independent living and entrance-fee communities ("EFC") which primarily attract private payment for services from residents who are making the lifestyle choice of living in an age-restricted multi-family community that offers social programs, meals, housekeeping and in some cases access to healthcare services. Discretionary properties are subject to limited regulatory oversight. There is a correlation between demand for this type of community and the strength of the housing market.

Medical Properties within our portfolio primarily receive payment from Medicare, Medicaid and health insurance. These properties include skilled nursing facilities ("SNF"), medical office buildings and specialty hospitals that attract patients who have a need for acute or complex medical attention, preventative medicine, or a need for rehabilitation services. Medical properties are subject to state and federal regulatory oversight and, in the case of Hospitals, JCAHO accreditation.

25


The following tables summarize our gross investments in real estate and mortgage and other notes receivable and year-to-date revenue as of September 30, 2015 (dollars in thousands):

Real Estate Properties
Properties

 
Beds/Sq. Ft.*

 
Revenue
 
%
 
Investment
 
Senior Housing - Need-Driven
 
 
 
 
 
 
 
 
 
 
 
Assisted Living
67

 
3,257

 
$
32,076

 
19.2
%
 
$
482,450

 
 
Senior Living Campus
10

 
1,344

 
7,815

 
4.7
%
 
145,742

 
 
Total Senior Housing - Need-Driven
77

 
4,601

 
39,891

 
23.9
%
 
628,192

 
Senior Housing - Discretionary
 
 
 
 
 
 
 
 
 
 
 
Independent Living
28

 
3,114

 
33,858

 
20.3
%
 
503,512

 
 
Entrance-Fee Communities
7

 
1,587

 
29,017

 
17.4
%
 
467,160

 
 
Total Senior Housing - Discretionary
35

 
4,701

 
62,875

 
37.7
%
 
970,672

 
 
Total Senior Housing
112

 
9,302

 
102,766

 
61.6
%
 
1,598,864

 
Medical Facilities
 
 
 
 
 
 
 
 
 
 
 
Skilled Nursing Facilities
62

 
8,061

 
50,299

 
30.2
%
 
426,855

 
 
Hospitals
3

 
181

 
5,809

 
3.5
%
 
51,131

 
 
Medical Office Buildings
2

 
88,517

*
750

 
0.4
%
 
10,487

 
 
Total Medical Facilities
67

 
 
 
56,858

 
34.1
%
 
488,473

 
 
Total Real Estate Properties
179

 
 
 
$
159,624

 
95.7
%
 
$
2,087,337

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage and Other Notes Receivable
 
 
 
 
 
 
 
 
 
 
Senior Housing - Need-Driven
2

 
190

 
$
583

 
0.4
%
 
$
6,113

 
Senior Housing - Discretionary
1

 
400

 
2,181

 
1.3
%
 
67,071

 
Medical Facilities
6

 
450

 
1,569

 
0.9
%
 
13,037

 
Other Notes Receivable

 

 
2,816

 
1.7
%
 
31,607

 
 
Total Mortgage and Other Notes Receivable
9

 
1,040

 
7,149

 
4.3
%
 
117,828

 
 
Total Portfolio
188

 
 
 
$
166,773

 
100.0
%
 
$
2,205,165


Portfolio Summary
Properties

 
Beds/Sq. Ft.*

 
Revenue
 
%
 
Investment
 
Real Estate Properties
179

 
 
 
$
159,624

 
95.7
%
 
2,087,337

 
Mortgage and Other Notes Receivable
9

 
 
 
7,149

 
4.3
%
 
117,828

 
 
Total Portfolio
188

 
 
 
$
166,773

 
100.0
%
 
2,205,165

 
 
 
 
 
 
 
 
 
 
 
 
Summary of Facilities by Type
 
 
 
 
 
 
 
 
 
 
Senior Housing - Need-Driven
 
 
 
 
 
 
 
 
 
 
 
Assisted Living
69

 
3,447

 
$
32,659

 
19.6
%
 
$
488,564

 
 
Senior Living Campus
10

 
1,344

 
7,815

 
4.7
%
 
145,742

 
 
Total Senior Housing - Need-Driven
79

 
4,791

 
40,474

 
24.3
%
 
634,306

 
Senior Housing - Discretionary
 
 
 
 
 
 
 
 
 
 
 
Entrance-Fee Communities
8

 
1,987

 
31,198

 
18.7
%
 
534,231

 
 
Independent Living
28

 
3,114

 
33,858

 
20.3
%
 
503,512

 
 
Total Senior Housing - Discretionary
36

 
5,101

 
65,056

 
39.0
%
 
1,037,743

 
 
Total Senior Housing
115

 
9,892

 
105,530

 
63.3
%
 
1,672,049

 
Medical Facilities
 
 
 
 
 
 
 
 
 
 
 
Skilled Nursing Facilities
68

 
8,511

 
51,294

 
30.8
%
 
439,893

 
 
Hospitals
3

 
181

 
6,383

 
3.8
%
 
51,131

 
 
Medical Office Buildings
2

 
88,517

*
750

 
0.4
%
 
10,486

 
 
Total Medical
73

 


 
58,427

 
35.0
%
 
501,510

 
Other

 


 
2,816

 
1.7
%
 
31,606

 
 
Total Portfolio
188

 

 
$
166,773

 
100.0
%
 
2,205,165

 
 
 
 
 
 
 
 
 
 
 
 
Portfolio by Operator Type
 
 
 
 
 
 
 
 
 
 
Public
53

 
 
 
$
34,617

 
20.76
%
 
$
258,976

 
National Chain (Privately-Owned)
27

 
 
 
37,173

 
22.29
%
 
498,811

 
Regional
96

 
 
 
87,523

 
52.48
%
 
1,315,048

 
Small
12

 
 
 
7,460

 
4.47
%
 
132,330

 
 
Total Portfolio
188

 


 
$
166,773

 
100.00
%
 
2,205,165


26


For the nine months ended September 30, 2015, operators of facilities which provided more than 3% of our total revenues were (in alphabetical order): Bickford Senior Living; Health Services Management; Holiday Retirement; Legend Healthcare; National HealthCare Corp; and Senior Living Communities.

As of September 30, 2015, our average effective annualized rental income was $7,914 per bed for skilled nursing facilities, $9,931 per unit for senior living campuses, $13,976 per unit for assisted living facilities, $14,497 per unit for independent living facilities, $24,379 per unit for entrance fee communities, $42,791 per bed for hospitals, and $11 per square foot for medical office buildings.

We invest a portion of our funds in the preferred and common shares of other publicly-held healthcare REITs to ensure a substantial portion of our assets are invested for real estate purposes. At September 30, 2015, such investments had a carrying value of $53,197,000.

Recent Events and Operational Effects
The announcement of the departure of our then-CEO, Justin Hutchens, on August 11, 2015, marked the beginning of a sequence of events and circumstances in which the quoted market price of our common shares began trending lower.
Mr. Hutchens’ accrued bonus, no longer due, was reversed, resulting in a boost to earnings of $575,000 during the third quarter, when the reversal was recorded. For the year as a whole, no equivalent impact was achieved, as the reversal effected a cancellation of earlier accruals during the first and second quarters, with no net effect for the nine months.
Market-wide jitters in August and early September, triggered by concerns over China and expectations of a looming Federal Reserve benchmark federal funds rate hike, negatively impacted our share price and quoted interest rates on senior unsecured debt, making strategic refinancing temporarily inadvisable, further resulting in our continued carry of substantial portions of our debt within our lower-interest, floating-rate, revolving credit facility. Carrying debt subject to interest rate risk, but ultimately at lower rates than planned, contributed to NHI exceeding the upper limit of its AFFO guidance range.
By the end of August continuing through the first two weeks of September 2015, our share price had traded down by as much as 18% from its quarter-opening price. As a result, contemplated access to capital through a strategic issuance of common shares on our ATM equity program was put on indefinite hold.
These events and circumstances combined to boost per share earnings by either suppressing levels of expense or constricting the denominator of shares outstanding. Where true efficiencies have been gained – in the absence of a continuing accrual for executive compensation (rather than its reversal), a smaller denominator used in per share calculations, or the quarter’s pause from refinancing at higher interest rates – forthcoming annual AFFO annual earnings guidance has been revised upward.

While we have clarity on the top end of our new AFFO guidance range, our guidance allows for the uncertainty in the structure and timing of the financing to fund our previously announced investments.  Our guidance range includes earnings impacts for the remainder of the year as follows:  First, the September 2015 sale of two facilities to our tenant Fundamental and the resulting net impact to lease revenue; second, the third quarter reversal of previously accrued executive compensation; and third, increased interest expense as a result of terming out $100 million of borrowing on our revolving credit facility.

On October 5, 2015, we announced the promotion to Chief Executive Officer from within our team of Eric Mendelsohn, formerly Executive Vice President of Corporate Finance and interim Chief Executive Officer since early August 2015.
Areas of Focus

While there has been a change in our CEO, our governing philosophy will continue to guide us down the path that has positioned NHI as a leader among diversified health care REITs. We will maintain pursuit of a disciplined investment strategy of appropriate volume with mission-oriented partners, while at the same time retaining our commitment to a conservative balance sheet. To that end, we are evaluating and will potentially make additional investments during the remainder of 2015 as we monitor and improve our existing properties. We seek tenants with whom we can partner in relationships where our business goals are aligned. We believe that this approach fuels steady, and thus, enduring growth for our partners and for NHI.

Within our industry, demand for healthcare real estate continues at high levels, partly attributable to the availability of senior unsecured debt at still historically low rates. As a result of the availability of debt and equity capital, a multitude of buyers seeking investment opportunities, including unlisted REITs and private equity funds, have joined to keep capitalization rates low and led NHI to more value-based investment judgments.


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According to a 2011 estimate by the U.S. Department of Health and Human Services (the “HHS study”), the number of Americans 65 and older is expected to grow 36% between 2010 and 2020, compared to a 9% cumulative growth for the general population. An increase in this age demographic is expected to increase demand for senior housing properties of all types in the coming decades. Demand is increasing for private-pay senior housing properties in countries outside the U.S. as well. We therefore consider real estate and note investments with U.S. entities who seek to expand their senior housing operations into countries where local-market demand is sufficiently demonstrated.
The combination of historically low interest rates, available capital and demographic trends as highlighted in the HHS study have been credited with fueling an environment in which potential overbuilding in certain markets and record M&A activity are conspicuous features. Additionally, the largest portion of future demographic growth will be attributable to the aging of “baby boomers” whose advent dates from 1946 and whose effects on senior housing are still some years away. Further, recent volatility in the capital markets has been conjectured to create conditions in which a negative “wealth effect” - where significant economic decisions are put on hold - might potentially begin to affect large segments of the population and thereby impact occupancy at senior housing facilities. Still, despite these concerns, no wavering of demand in the pipeline or for end-product has yet manifested itself, and health care REITs continue to report strong profitability. Recent events including stock market turmoil, low cap rates, and oversupply in certain major cities have had the collateral effect of refocusing NHI and industry efforts into internal growth.

Using our relationship-driven model, we look for opportunities to support new and existing tenants and borrowers with the capital needed to expand existing facilities and to initiate ground-up development of new facilities in markets where there is demonstrated demand for a particular product type. The projects we agree to finance have attractive upside potential and are expected to provide above-average returns to our shareholders to mitigate the risks inherent with property development and construction.

NHI is continuing its targeted acquisition program, although an increased emphasis on internal growth will contribute to our plans for capital deployment. Strong regional demographic trends continue to provide the context for further outside growth in the remainder of 2015 and in the years ahead. We plan to fund any new real estate and mortgage investments in the coming year using our liquid assets and debt financing. Should the weight of additional debt as a result of new acquisitions suggest the need to rebalance our capital structure, we would then expect to access the capital markets through our ATM or other equity offerings. Our disciplined investment strategy implemented through measured increments of debt and equity sets the stage for annual dividend growth, continued low leverage, a portfolio of diversified, high-quality assets, and business relationships with experienced tenants and borrowers who we make our priority.

For the nine months ended September 30, 2015, approximately 30% of our revenue was derived from operators of our skilled nursing facilities that receive a significant portion of their revenue from governmental payors, primarily Medicare and Medicaid. Such revenues are subject annually to statutory and regulatory changes, and in recent years, have been reduced due to federal and state budgetary pressures. In 2009, we began to diversify our portfolio by directing a significant portion of our investments into properties which do not rely primarily on Medicare and Medicaid reimbursement, but rather on private pay sources. While we will occasionally acquire skilled nursing facilities in good physical condition with a proven operator and strong local market fundamentals, our current investment focus is on acquiring senior housing assets (including assisted living and memory care facilities, independent living facilities, senior living campuses and entrance-fee communities).

As a diversified health-care REIT, we have reached a point of relative equilibrium in balancing our lease portfolio across three asset classes. Large acquisitions in 2013 and 2014 have laid a foundation of diversification across asset types and exemplify our strategy of focusing on well-established tenants who are recognized leaders in their industries. Considering individual tenant lease revenue as a percentage of total revenue, Bickford Senior Living is our largest assisted living/memory care tenant, an affiliate of Holiday Retirement is our largest independent living tenant, National HealthCare Corporation is our largest skilled nursing tenant and for 2015, Senior Living Communities is our largest entrance-fee community tenant.

The following table illustrates our total portfolio revenue by asset class (in thousands):
 
Nine Months Ended September 30,
 
2015
 
%
 
2014
 
%
Medical Facilities
$
58,427

 
35%
 
$
56,816

 
44%
Senior Housing - Need-Driven
40,474

 
24%
 
35,382

 
27%
Senior Housing - Discretionary
65,056

 
39%
 
33,842

 
27%
Other
2,816

 
2%
 
2,553

 
2%
 
$
166,773

 
100%
 
$
128,593

 
100%


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As longer term borrowing rates increase, there will be pressure on the spread between our cost of capital and the returns we earn. Expected demand for senior housing, which has been a partial trigger for cash flowing into the industry and the resultant decrease in cap rates, will likely in the long run cause lease rates to rise and thus provide some partial relief from pressures squeezing the cost of, and return on, invested capital. Our cost of capital increases as we transition portions of our short-term revolving borrowings at variable interest rates into debt instruments with longer maturities and fixed rates. Managing risk involves trade-offs with the competing goal of maximizing short-term profitability. Our intention is to strike an appropriate balance between these opposing interests within the confines of our investor profile.
We manage our business with a goal of increasing the regular annual dividends paid to shareholders. Our Board of Directors approves a regular quarterly dividend which is reflective of expected taxable income on a recurring basis. Our transactions that are infrequent and non-recurring that generate additional taxable income have been distributed to shareholders in the form of special dividends. Taxable income is determined in accordance with the Internal Revenue Code and differs from net income for financial statements purposes determined in accordance with U.S. generally accepted accounting principles. Our goal of increasing annual dividends requires a careful balance between identification of high-quality lease and mortgage assets in which to invest and the cost of our capital with which to fund such investments. We consider the competing interests of short and long-term debt (interest rates, maturities and other terms) versus the higher cost of new equity. We accept some level of risk associated with leveraging our investments. We intend to continue to make new investments that meet our underwriting criteria and where we believe the spreads over our cost of capital will generate sufficient returns to our shareholders.

Our projected dividends for the current year and actual dividends for the last three years are as follows:
 
20151
 
2014
 
2013
 
2012
 
Regular
$
3.40

 
$
3.08

 
$
2.90

 
$
2.64

 
Special

 
$

 
$

 
$
0.22

2 
 
$
3.40

 
$
3.08

 
$
2.90

 
$
2.86

 
 
 
 
 
 
 
 
 
 
1 Based on $.85 per share for first, second and third quarters of 2015, annualized
2 Paid to shareholders of record in January 2013

Our increased investments in healthcare real estate beginning in 2009 have been partially accomplished by our ability to effectively leverage our balance sheet. However, we continue to maintain a relatively low leverage balance sheet compared with the value of our assets and with many in our peer group. We believe that our fixed charge coverage ratio, which is the ratio of Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization, including amounts in discontinued operations, excluding real estate asset impairments and gains on dispositions) to fixed charges (interest expense and principal payments on debt), and the ratio of consolidated debt to Adjusted EBITDA are meaningful measures of our ability to service our debt. We use these two measures as a useful basis to compare the strength of our balance sheet with those in our peer group.

We calculate our fixed charge coverage ratio as approximately 6.3x for the nine months ended September 30, 2015 (see our later discussion of Adjusted EBITDA and a reconciliation to our net income). On an annualized basis, our consolidated net debt-to-Adjusted EBITDA ratio is approximately 4.7x.

Annual dividend growth, a low leverage balance sheet, a portfolio of diversified, high-quality assets, and prioritizing business relationships with experienced operators continue to be the key drivers of our business plan.

Critical Accounting Policies

See our most recent Annual Report on Form 10-K for a discussion of critical accounting policies including those concerning revenue recognition, our status as a REIT, principles of consolidation, evaluation of impairments and allocation of property acquisition costs.











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Investment Highlights

Since January 1, 2015, we have made or announced the following real estate and note investments (dollars in thousands):
 
 
Properties
 
Asset Class
 
Amount
Lease Investments
 
 
 
 
 
 
Chancellor Health Care - acquisition
 
1
 
SHO
 
$
6,675

Brook Retirement Communities - acquisition
 
1
 
SHO
 
$
6,000

Bickford Senior Living - new construction
 
5
 
SHO
 
$
55,000

Bickford Senior Living - acquisition
 
1
 
SHO
 
21,000

East Lake Capital Mgmt - acquisition
 
3
 
SHO
 
66,900

Note Investments
 
 
 
 
 
 
Life Care Services - refinancing and new construction
 
1
 
SHO
 
154,500

 
 
 
 
 
 
$
310,075


Chancellor

In an asset acquisition on August 31, 2015, we acquired a 29-unit memory care facility in Portland, Oregon, for $6,772,000 in cash inclusive of closing costs of approximately $97,000. The facility will be leased to existing partner Chancellor Health Care for 15 years with renewal options at an initial lease rate of 7.75% plus annual escalators.

Brook Retirement Communities

In an asset acquisition on August 31, 2015, we acquired a 42-unit independent living and assisted living community in Roscommon, Michigan, for $6,000,000 in cash and $49,000 in closing costs. The community will be leased to a new partner, The Brook Retirement Communities of Roscommon, Inc., for 10 years with renewal options at an initial lease rate of 7.5% plus annual escalators.

Bickford

In February 2015 our joint venture with Bickford Senior Living ("Bickford") announced plans to develop five senior housing facilities in Illinois and Virginia. These five properties will represent the culmination of a program announced in 2012 between NHI and Bickford to construct a total of eight facilities. The first three communities, all in Indiana, opened in 2013 and 2014. Land acquisition and pre-development on the five facilities started in mid-2015 with openings planned beginning in 2016. The total estimated project cost is $55,000,000. Each community will consist of 60 private-pay assisted living and memory care units managed by Bickford Senior Living.

On July 31, 2015, our subsidiary, PropCo, acquired a 92 unit assisted living/memory care facility located in Lancaster, Ohio for $21,000,000 in cash.Valuation was based on an 8.0% capitalization rate on its trailing net operating income performance. The facility was leased to the operating company, OpCo, of which we retain an 85/15 ownership interest with Bickford.

East Lake

On July 1, 2015, we acquired two senior living campuses in Nashville and Indianapolis and one assisted living/memory care facility in Charlotte for $66,900,000 in cash. In addition, we have committed to East Lake certain lease incentive payments contingent on reaching and maintaining certain metrics and a contingent earn out of $750,000 payable to the seller upon East Lake reaching certain metrics. As earned, the lease incentive payments would be due in installments of up to $4,000,000 in each of years three and four of the lease with any subsequently earned residual due by year seven. At acquisition, we estimated probable contingent payments to the seller totaling $750,000 and have, accordingly, reflected that amount in the Condensed Consolidated Balance Sheet. Contingent payments earned will be an addition to the lease base when funded.

We leased the facilities to East Lake Capital Management (“East Lake”) for an initial term of 10 years, plus renewal options. The lease calls for an annual payment of $4,683,000 in the first year with fixed annual escalators of 3.5% through year four and 3.0% thereafter. In conjunction with the lease, East Lake acquired a purchase option on the properties as a whole, exercisable beginning in year six of the lease for approximately $81,000,000 and thereafter subject to escalation on a basis consistent with rental escalations and other funding in place. On entering the lease, we committed to funding up to an additional $400,000 for specified capital improvements. The investment will be added to the basis on which the lease amount is calculated.


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Life Care Services

On February 10, 2015, we entered into an agreement to lend LCS-Westminster Partnership III LLP (“LCS-WP”), an affiliate of Life Care Services, the manager of the facility, up to $154,500,000. The loan agreement conveys a mortgage interest and will facilitate the construction of Phase II of Timber Ridge at Talus (“Timber Ridge”), a Type-A Continuing Care Retirement Community in the Seattle, WA area.

The loan takes the form of two notes under a master credit agreement. The senior note (“Note A”) totals $60,000,000 at a 6.75% interest rate with 10 basis-point escalators after year three, and has a term of 10 years. We have funded $28,000,000 of Note A as of June 30, 2015. Note A is interest-only and is locked to prepayment for three years. After year three, the prepayment penalty starts at 5% and declines 1% per year. The second note ("Note B") is a construction loan for up to $94,500,000 at an annual interest rate of 8% and a 5 year maturity. We anticipate funding Note B through December 2016 and anticipate substantial repayment with new resident entrance fees upon the opening of Phase II. The total amount funded on Note B was $39,071,000 as of September 30, 2015.

NHI has a purchase option on the entire Timber Ridge property for the greater of fair market value or $115,000,000 during a purchase option window of 120 days that will contingently open in year five or upon earlier stabilization of the development, as defined.

Significant Operators

As discussed in Note 2 to the condensed consolidated financial statements, we have four operators from whom we individually derive at least 10% of our rental income as follows (dollars in thousands):
 
 
 
 
 
Rental Income
 
 
 
 
 
 
Investment
 
Nine Months Ended September 30,
 
 
Lease
 
Asset Class