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EX-32 - CERTIFICATION OF CEO AND PFO AND PAO - NATIONAL HEALTH INVESTORS INCnhi-9302017x10qex32.htm
EX-31.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER AND PRINCIPAL ACCOUNTING OFFICER - NATIONAL HEALTH INVESTORS INCnhi-9302017x10qex312.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - NATIONAL HEALTH INVESTORS INCnhi-9302017x10qex311.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, 2017
 
 
[ ]
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, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth 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)
 
Emerging growth company     [ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

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 41,532,154 shares of common stock outstanding of the registrant as of November 6, 2017.



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,
2017
 
December 31,
2016
 
(unaudited)
 
 
Assets:
 
 
 
Real estate properties:
 
 
 
Land
$
188,783

 
$
172,003

Buildings and improvements
2,421,302

 
2,285,122

Construction in progress
10,835

 
15,729

 
2,620,920

 
2,472,854

Less accumulated depreciation
(363,035
)
 
(313,080
)
Real estate properties, net
2,257,885

 
2,159,774

Mortgage and other notes receivable, net
149,299

 
133,493

Cash and cash equivalents
3,926

 
4,832

Straight-line rent receivable
90,224

 
72,518

Other assets
18,598

 
33,016

Total Assets
$
2,519,932

 
$
2,403,633

 
 
 
 
Liabilities and Equity:
 
 
 
Debt
$
1,111,292

 
$
1,115,981

Accounts payable and accrued expenses
19,144

 
20,874

Dividends payable
39,454

 
35,863

Lease deposit liabilities
22,375

 
21,325

Total Liabilities
1,192,265

 
1,194,043

 
 
 
 
Commitments and Contingencies

 

 
 
 
 
Stockholders' Equity:
 
 
 
Common stock, $.01 par value; 60,000,000 shares authorized;
 
 
 
41,531,038 and 39,847,860 shares issued and outstanding, respectively
415

 
398

Capital in excess of par value
1,295,709

 
1,173,588

Cumulative net income in excess of dividends
34,262

 
29,873

Accumulated other comprehensive income (loss)
(2,719
)
 
5,731

Total Stockholders' Equity
1,327,667

 
1,209,590

Total Liabilities and Equity
$
2,519,932

 
$
2,403,633


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, 2016 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,
 
2017
 
2016
 
2017
 
2016
 
(unaudited)
 
(unaudited)
Revenues:
 
 
 
 
 
 
 
Rental income
$
68,204

 
$
59,272

 
$
197,077

 
$
171,374

Interest income from mortgage and other notes
3,045

 
3,669

 
10,125

 
10,136

Investment income and other
103

 
310

 
374

 
1,963

 
71,352

 
63,251

 
207,576

 
183,473

Expenses:
 
 
 
 
 
 
 
Depreciation
17,023

 
15,240

 
50,006

 
43,668

Interest, including amortization of debt discount and issuance costs
12,241

 
10,816

 
35,730

 
31,745

Legal
215

 
156

 
417

 
406

Franchise, excise and other taxes
268

 
271

 
802

 
826

General and administrative
2,513

 
2,169

 
9,143

 
7,218

Loan and realty losses

 
1,131

 

 
15,856

 
32,260

 
29,783

 
96,098

 
99,719

 
 
 
 
 
 
 
 
Income before equity-method investee, TRS tax expense, investment and
 
 
 
 
 
 
 
other gains and noncontrolling interest
39,092

 
33,468

 
111,478

 
83,754

Loss from equity-method investee

 
(754
)
 

 
(1,214
)
Income tax expense attributable to taxable REIT subsidiary

 
(933
)
 

 
(749
)
Investment and other gains

 
1,657

 
10,088

 
29,737

Net income
39,092

 
33,438

 
121,566

 
111,528

Less: net income attributable to noncontrolling interest

 
(406
)
 

 
(1,176
)
Net income attributable to common stockholders
$
39,092

 
$
33,032

 
$
121,566

 
$
110,352

 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
41,108,699

 
39,283,919

 
40,681,582

 
38,735,262

Diluted
41,448,263

 
39,651,900

 
40,937,337

 
38,876,025

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Net income attributable to common stockholders - basic
$
.95

 
$
.84

 
$
2.99

 
$
2.85

Net income attributable to common stockholders - diluted
$
.94

 
$
.83

 
$
2.97

 
$
2.84



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,
 
2017
 
2016
 
2017
 
2016
 
(unaudited)
 
(unaudited)
Net income
$
39,092

 
$
33,438

 
$
121,566

 
$
111,528

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

 
119

 
(26
)
 
7,576

Reclassification for amounts recognized in investment and other gains

 

 
(10,038
)
 
(23,498
)
Increase (decrease) in fair value of cash flow hedge
(290
)
 
1,287

 
(515
)
 
(6,525
)
Reclassification for amounts recognized as interest expense
695

 
975

 
2,129

 
2,993

Total other comprehensive income (loss)
405

 
2,381

 
(8,450
)
 
(19,454
)
Comprehensive income
39,497

 
35,819

 
113,116

 
92,074

Less: comprehensive income attributable to noncontrolling interest

 
(406
)
 

 
(1,176
)
Comprehensive income attributable to common stockholders
$
39,497

 
$
35,413

 
$
113,116

 
$
90,898



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,
 
2017
 
2016
 
(unaudited)
Cash flows from operating activities:
 
 
 
Net income
$
121,566

 
$
111,528

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation
50,006

 
43,668

Amortization
4,154

 
2,663

Straight-line rental income
(18,956
)
 
(16,583
)
Non-cash interest income on construction loans
(708
)
 
(668
)
Gain on sale of real estate
(50
)
 
(4,582
)
Loss on extinguishment of debt
591

 

Non-cash write-offs due to lease transition

 
15,856

Gain on sale of equity-method investee

 
(1,657
)
Gain on sale of marketable securities
(10,038
)
 
(23,498
)
Non-cash stock-based compensation
2,270

 
1,481

Amortization of commitment fees and note receivable discounts
(393
)
 
(303
)
Amortization of lease incentives
69

 

Loss from equity-method investee

 
1,214

Change in operating assets and liabilities:
 
 
 
Other assets
(4,825
)
 
34

Accounts payable, accrued expenses and other liabilities
2,274

 
163

Net cash provided by operating activities
145,960

 
129,316

 
 
 
 
Cash flows from investing activities:
 
 
 
Investments in mortgage and other notes receivable
(44,729
)
 
(75,522
)
Collections of mortgage and other notes receivable
30,025

 
16,461

Investments in real estate
(133,251
)
 
(288,965
)
Investments in real estate development
(9,901
)
 
(24,499
)
Investments in renovations of existing real estate
(5,614
)
 
(913
)
Payment allocated to lease purchase option

 
(6,400
)
Long-term escrow deposit

 
(4,500
)
Proceeds from disposition of real estate properties
450

 
27,723

Proceeds from sale of marketable securities
18,182

 
56,449

Net cash used in investing activities
(144,838
)
 
(300,166
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Net change in borrowings under revolving credit facilities
9,000

 
94,600

Borrowings on term loans
250,000

 
75,000

Payments on term loans
(250,593
)
 
(573
)
Debt issuance costs
(4,149
)
 
(114
)
Taxes remitted in relation to employee stock options exercised
(586
)
 
(1,135
)
Proceeds from issuance of common shares, net
122,198

 
104,190

Convertible bond redemption
(14,312
)
 

Distributions to noncontrolling interest

 
(1,305
)
Distribution to acquire non-controlling interest

 
(6,462
)
Dividends paid to stockholders
(113,586
)
 
(102,440
)
Net cash provided by (used in) financing activities
(2,028
)
 
161,761

 
 
 
 
Decrease in cash and cash equivalents
(906
)
 
(9,089
)
Cash and cash equivalents, beginning of period
4,832

 
13,286

Cash and cash equivalents, end of period
$
3,926

 
$
4,197


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,
 
2017
 
2016
 
(unaudited)
Supplemental disclosure of cash flow information:
 
 
 
Interest paid, net of amounts capitalized
$
32,004

 
$
27,395

Supplemental disclosure of non-cash investing and financing activities:
 
 
 
Change in accounts payable related to acquisition of non-controlling interest
$

 
$
10,546

Change in accounts payable related to investments in real estate development
$
1,500

 
$
980

Tenant investment in leased asset
$
1,250

 
$

Conversion of note balance into real estate investment
$

 
$
9,753



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 STATEMENT OF STOCKHOLDERS’ EQUITY
(unaudited, in thousands except share and per share amounts)

 
Common Stock
 
Capital in Excess of Par Value
 
Cumulative Net Income in Excess of Dividends
 
Accumulated Other Comprehensive (Loss) Income
 
Total Equity
 
Shares
 
Amount
 
 
 
 
Balances at December 31, 2016
39,847,860

 
$
398

 
$
1,173,588

 
$
29,873

 
$
5,731

 
$
1,209,590

Total comprehensive income

 

 

 
121,566

 
(8,450
)
 
113,116

Partial redemption of equity component of convertible debt

 

 
(1,744
)
 

 

 
(1,744
)
Issuance of common stock, net
1,660,045

 
17

 
122,181

 

 

 
122,198

Shares issued on options exercised, net of shares withheld
23,133

 

 

 

 

 

Taxes remitted on employee stock options exercised

 

 
(586
)
 

 

 
(586
)
stock-based compensation

 

 
2,270

 

 

 
2,270

Dividends declared, $2.85 per common share

 

 

 
(117,177
)
 

 
(117,177
)
Balances at September 30, 2017
41,531,038

 
$
415

 
$
1,295,709

 
$
34,262

 
$
(2,719
)
 
$
1,327,667





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, 2017
(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, 2016 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, 2016 consolidated financial statements and that the adequacy of additional disclosure needed for a fair presentation, except regarding 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, 2016 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, 2016, which are included in our 2016 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”), 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 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 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, 2017, we held an interest in eight unconsolidated VIEs and, because we generally lack either directly or through related parties any material input in the activities that most significantly impact their economic performance, we have concluded that NHI is not the primary beneficiary. Accordingly, we account for our transactions with these entities and their subsidiaries at amortized cost.











9


Our VIEs are summarized below by date of initial involvement. For further discussion of the nature of the relationships, including the sources of our exposure to these VIEs, see the notes to our condensed consolidated financial statements cross-referenced below.
Date
Name
Source of Exposure
Carrying Amount
Maximum Exposure to Loss
Sources of Exposure
2012
Bickford / Sycamore
Various1
$
21,196,000

$
39,528,000

Notes 2, 3, 6
2014
Senior Living Communities
Notes and straight-line receivable
$
35,862,000

$
50,258,000

Note 2, 3
2014
Life Care Services affiliate
Notes receivable
$
66,300,000

$
73,852,000

Note 3
2015
East Lake Capital Mgmt.
Straight-line receivable
$
2,816,000

$
2,816,000

Note 2
2016
The Ensign Group developer
N/A
$

$

Note 2
2016
Senior Living Management
Notes and straight-line receivable
$
25,880,000

$
25,880,000

Note 3
2017
Ravn Senior Solutions
Straight-line receivable
$
172,000

$
172,000

Note 2
2017
Evolve Senior Living
Note receivable
$
9,903,000

$
9,903,000

Note 3
1 Notes & straight-line rent receivables, unamortized lease incentives and letter-of-credit commitment
 
We are not obligated to provide support beyond our stated commitments to these tenants and borrowers whom we classify as VIEs, and accordingly our maximum exposure to loss as a result of these relationships is limited to the amount of our commitments, as shown above and discussed in the notes. When the above relationships involve leases, some additional exposure to economic loss is present. Generally, additional economic loss on a lease, if any, would be limited to that resulting from a short period of arrearage and non-payment of monthly rent before we are able to take effective remedial action, as well as costs incurred in transitioning the lease. The potential extent of such loss will be dependent upon individual facts and circumstances, cannot be quantified, and is therefore not included in the tabulation above. Typically, the only carrying amounts involving our leases are accumulated straight-line receivables.

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.

Equity-Method Investment - Through September 30, 2016, we reported our taxable REIT subsidiary (“TRS”) investment in an unconsolidated entity, over whose operating and financial policies we had 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 was included in our Condensed Consolidated Statements of Income. Additionally, we adjusted our investment carrying amount to reflect our share of changes in the equity-method investee’s capital resulting from its capital transactions. On September 30, 2016, we unwound the joint venture underlying the TRS and ceased participation in the operations which comprised all its activity.

Noncontrolling Interest - We have excluded net income attributable to the noncontrolling interest from net income attributable to common shareholders in our Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2016. As of December 31, 2016 and during the nine months ended September 30, 2017, we did not hold any noncontrolling interests.

Real Estate Properties - Real estate properties are recorded at cost or, if acquired through business combination, at fair value, including the fair value of contingent consideration, if any. Cost or fair value at the time of acquisition is allocated among land, buildings, tenant improvements, lease and other intangibles, and personal property. For properties acquired in transactions accounted for as asset purchases, the purchase price allocation is based on the relative fair values of the assets acquired. Cost includes the amount of contingent consideration, if any, deemed to be probable at the acquisition date. Cost also includes capitalized interest during construction periods. We use the straight-line method of depreciation for buildings over their estimated useful lives of 40 years, and improvements over their estimated useful lives ranging to 25 years. For contingent consideration arising from business combinations, the liability is adjusted to estimated fair value at each reporting date through earnings.

Reclassifications - We have reclassified certain balances where necessary to conform the presentation of prior periods to the current period. We have combined our investment in marketable securities into other assets in our Condensed Consolidated Balance Sheet at December 31, 2016. These reclassifications had no effect on previously reported net income. Additionally, we corrected an immaterial error in our Condensed Consolidated Statement of Comprehensive Income three months ended September 30, 2016 of $1,950,000, increasing Other Comprehensive Income to $35,819,000. The captions, “Reclassification for amounts recognized as interest expense,” “Total other comprehensive income (loss),” “Comprehensive income,” and “Comprehensive income attributable to common stockholders” in the Condensed Consolidated Statement of Comprehensive Income were affected.


10


Use of Estimates - The preparation of 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 assumes the exercise of stock options using the treasury stock method, to the extent dilutive. Diluted earnings per share also incorporate the potential dilutive impact of our convertible senior notes. We apply the treasury stock method to our convertible debt instruments, the effect of which is that conversion will not be assumed for purposes of computing diluted earnings per share unless the average share price for the period exceeds the conversion price per share.

New Accounting Pronouncements - For a review of recent accounting pronouncements pertinent to our operations and management’s judgment as to the impact that the eventual adoption of these pronouncements will have on our financial position and results of operation, see Note 12.

NOTE 2. REAL ESTATE

As of September 30, 2017, we owned 207 health care real estate properties located in 32 states and consisting of 134 senior housing communities (“SHO”), 68 skilled nursing facilities (“SNF”), 3 hospitals and 2 medical office buildings. Our senior housing communities include assisted living facilities, senior living campuses, independent living facilities, and entrance-fee communities. These investments (excluding our corporate office of $1,298,000) consisted of properties with an original cost of approximately $2,619,622,000, rented under triple-net leases to 29 lessees.

During the nine months ended September 30, 2017, we made investments related to real estate as described below (dollars in thousands):
Operator
 
Date
 
Properties
 
Asset Class
 
Amount
Ravn Senior Solutions
 
February 2017
 
2
 
SHO
 
$
16,100

Prestige Care
 
March 2017
 
1
 
SHO
 
26,200

The LaSalle Group
 
March 2017
 
5
 
SHO
 
61,865

The Ensign Group
 
March 2017
 
1
 
SNF
 
15,096

Bickford Senior Living
 
June 2017
 
1
 
SHO
 
10,400

Acadia Healthcare
 
July 2017
 
1
 
HOSP
 
4,840

 
 
 
 
 
 
 
 
$
134,501


Ravn Senior Solutions

On February 21, 2017, we acquired two assisted living/memory-care facilities totaling 86 units in Hendersonville, North Carolina, for $16,100,000 in cash, inclusive of $100,000 in closing costs and the funding of $207,000 in specified capital improvements. We leased the facilities to Ravn Senior Solutions (“RSS”) for an initial lease term of 15 years plus renewal options. The initial annual lease rate is 7.35%, plus fixed annual escalators. Additionally, the master lease conveys to NHI an option to purchase a third facility operated by RSS upon attainment of stabilization, as defined, at a specified capitalization rate based on the resulting metrics. The acquisition was accounted for as an asset purchase.

In addition, we have committed to RSS certain earnout payments contingent on reaching and maintaining specified performance metrics. As earned, the earnout payments, totaling $1,500,000, would be due in installments of up to $1,000,000 for performance measured as of December 31, 2018, with any subsequently earned cumulative unpaid amounts to be measured and due as earned for the periods ending December 31, 2019 and/or 2020. Upon funding, contingent payments earned will be added to the lease base.

RSS’s relationship to NHI consists of its leasehold interests and purchase options and is considered a variable interest, analogous to a financing arrangement. RSS is structured to limit liability for potential damage claims, is capitalized for that purpose and is considered a VIE.




11


Prestige

On March 10, 2017, we acquired a 102-unit assisted living community in Portland, Oregon for $26,200,000, inclusive of closing costs of $112,000. We leased the facility to Prestige Care (“Prestige”) under our existing master lease, which has a remaining lease term of 12 years plus renewal options. The lease provides for an initial annual lease rate of 7% plus annual escalators of 3.5% in years two through four and 2.5% thereafter. The acquisition was accounted for as an asset purchase.

In addition, we have committed to Prestige certain earnout payments contingent on reaching and maintaining specified performance metrics. If earned, the earnout payments, totaling $1,000,000, would be due in installments of up to $1,000,000 for performance measured as of December 31, 2017, with any subsequently earned cumulative unpaid amounts to be measured and due as earned for the period ending December 31, 2018. Upon funding, contingent payments earned will be added to the lease base.

The LaSalle Group

On March 16, 2017, we acquired five memory care communities totaling 223 units in Texas and Illinois for $61,800,000 in cash plus closing costs of $65,000. We leased the facilities to The LaSalle Group (“LaSalle”) for an initial lease term of 15 years. The lease provides for an initial annual lease rate of 7% plus annual escalators of 3.5% in years two and three and 2.5% thereafter. The acquisition was accounted for as an asset purchase.

In addition, we have committed to LaSalle certain earnout payments contingent on reaching and maintaining specified performance metrics. As earned, the earnout payments, totaling $5,000,000, would be due in installments of up to $2,500,000 for performance measured as of December 31, 2018, with any subsequently earned cumulative unpaid amounts to be measured and due as earned for the trailing periods ending December 31, 2019 and/or 2020. Upon funding, contingent payments earned will be added to the lease base.

The Ensign Group

On March 24, 2017, we acquired from a developer a 126-bed skilled nursing facility in New Braunfels, Texas for a cash investment of $13,846,000 plus $1,250,000 contributed by the lessee, The Ensign Group (“Ensign”). The facility is included under our existing master lease for the remaining lease term of 14 years plus renewal options. The initial lease rate is set at 8.35% plus annual escalators based on prevailing inflation rates. The acquisition was accounted for as an asset purchase.

With the acquisition of the New Braunfels property, NHI has a continuing commitment to purchase, from the developer, three new skilled nursing facilities in Texas for $42,000,000 which are newly developed and are leased to Legend Healthcare and subleased to Ensign. The fixed-price nature of the commitment creates a variable interest for NHI in the developer, whom NHI considers to lack sufficient equity to finance its operations without recourse to additional subordinated debt. The presence of these conditions causes the developer to be considered a VIE.

Acadia

In July 2017, we acquired a 10-acre parcel of land (“Property”) for a cash price of $4,840,000. The Property was conveyed to NHI by a subsidiary of our tenant, Acadia Healthcare Company (“Acadia”), who is the lessee of NHI’s TrustPoint Hospital in Murfreesboro, Tennessee, which is situated on adjacent land. Our ground lease with Acadia covers a 10-year period and bears an initial rate of 7%, subject to escalation after the third year. Additionally, the lease confers a purchase option on the property, on which Acadia intends to construct a sister facility. The option opens in 2020, extends through June 2023, and is to be exercisable at our original purchase price. In connection with the ground lease, the window of Acadia’s existing purchase option on the TrustPoint Hospital facility was shifted from 2018 to 2020 to coincide with the option window on the Property. Of our total revenues, $638,000 and $608,000 were derived from Acadia for the three months ended September 30, 2017 and 2016, respectively and $1,854,000 and $1,824,000 were derived from Acadia for the nine months ended September 30, 2017 and 2016, respectively.

Significant Customers

Bickford

On June 1, 2017, we acquired an assisted living/memory-care facility totaling 60 units in Lansing, Michigan, for $10,400,000 in cash, inclusive of $200,000 in closing costs. Additionally, we have committed to the funding of $475,000 in specified capital improvements, which will be added to the lease base. We leased the facility to Bickford Senior Living (“Bickford”) for an initial

12


term of 14 years plus renewal options. The initial lease rate is 7.25%, plus annual fixed escalators. We accounted for the acquisition as an asset purchase.

In April and August 2017, Bickford opened the last two of the five-facility development project announced in 2015. As of September 30, 2017, our Bickford lease portfolio consists of 43 facilities. Newly-constructed facilities have an annual lease rate of 9% at completion, after six months of free rent. NHI has a right to future Bickford acquisitions, development projects and refinancing transactions. Of these facilities, 35 were held in a RIDEA structure and operated as a joint venture until September 30, 2016, when NHI and Sycamore, an affiliate of Bickford, entered into a definitive agreement terminating the joint venture and converting Bickford’s participation to a triple-net tenancy with assumption of existing leases and terms. Through September 30, 2016, NHI owned an 85% equity interest and Sycamore owned a 15% equity interest in our consolidated subsidiary (“PropCo”). The facilities were leased to an operating company (“OpCo”), in which NHI previously held a non-controlling 85% ownership interest. The facilities are managed by Bickford. Our joint venture was structured to comply with the provisions of REIT Investment Diversification Empowerment Act of 2007 (“RIDEA”). On September 30, 2016, we unwound the joint venture underlying the RIDEA and reacquired Bickford’s share of its assets. Effective May 1, 2017, NHI and Bickford announced a new amended and restated master lease covering 20 Bickford properties. Under terms of the new master lease, the base term for these properties will now extend to May 2031. Additionally, effective June 28, 2017, the leases of thirteen properties acquired in June 2013 and initially set for expiration in June 2018 have been renewed and extended through June 2023.

As of September 30, 2017 our Bickford portfolio includes three master leases structured as following (in thousands):

 
Lease Expiration
 
 
Sept / Oct 2019
June 2023
May 2031
Total
Number of Properties
10

13

20

43

2017 Annual Contractual Rent
$
8,994

$
10,809

$
16,691

$
36,494

Straight Line Rent Adjustment
(347
)
226

4,885

4,764

Total Revenues
$
8,647

$
11,035

$
21,576

$
41,258

 
 
 
 
 

Of our total revenues, $10,897,000 (15%) and $8,528,000 (13%) were recognized as rental income from Bickford for the three months ended September 30, 2017 and 2016, including $1,600,000 and $484,000 in straight-line rent income, respectively. Of our total revenues, $30,170,000 (15%) and $21,999,000 (12%) were recognized as rental income from Bickford for the nine months ended September 30, 2017 and 2016, including $3,416,000 and $482,000 in straight-line rent income, respectively.

In September 2017, we transitioned the lease of a 126-unit assisted living portfolio from our then tenant as the result of material noncompliance with lease terms. On September 30, 2017, we entered with Bickford into a 10-year lease, beginning October 1. The agreement provides for an initial annual lease payment of $1,500,000 with a 4% escalator in effect for years two through four and 3% thereafter. Additionally, the lease provides a purchase option which opens immediately and is co-terminus with the lease. The option will be exercisable for the greater of $21,400,000 or at a capitalization rate of 8.5% on the forward 12-month rental at the time of exercise.

Holiday

As of September 30, 2017, we leased 25 independent living facilities to an affiliate of Holiday Retirement (“Holiday”). The master lease term of 17 years began in December 2013 and currently provides for a minimum escalator of 3.5% through the end of the lease term.

Of our total revenues, $10,954,000 (15%) and $10,954,000 (17%) were derived from Holiday for the three months ended September 30, 2017 and 2016, including $1,849,000 and $2,241,000 in straight-line rent income, respectively. Of our total revenues, $32,863,000 (16%) and $32,863,000 (18%) were derived from Holiday for the nine months ended September 30, 2017 and 2016, including $5,547,000 and $6,724,000 in straight-line rent income, respectively. Our tenant operates the facilities pursuant to a management agreement with a Holiday-affiliated manager.

NHC

As of September 30, 2017, 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

13


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 acquired from a third party.

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 1991 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 the 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,
 
2017
 
2016
 
2017
 
2016
Current year
$
782

 
$
733

 
$
2,345

 
$
2,199

Prior year final certification1

 

 
194

 
547

Total percentage rent income
$
782

 
$
733

 
$
2,539

 
$
2,746

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, $9,318,000 (13%) and $9,270,000 (15%) were derived from NHC for the three months ended September 30, 2017 and 2016, respectively and $28,149,000 (14%) and $28,357,000 (15%) were derived from NHC for the nine months ended September 30, 2017 and 2016, respectively.

The chairman of our board of directors is also a director on NHC’s board of directors. As of September 30, 2017, NHC owned 1,630,462 shares of our common stock.

Senior Living Communities

As of September 30, 2017, we leased nine retirement communities totaling 1,970 units to Senior Living Communities, LLC (“Senior Living”). The 15-year master lease, which began in December 2014, contains two 5-year renewal options and provides for an annual escalator of 4% in 2018 and 3% thereafter.

Of our total revenues, $11,431,000 (16%) and $9,855,000 (16%) in rental income were derived from Senior Living for the three months ended September 30, 2017 and 2016, respectively, including $1,746,000 and $1,795,000 in straight-line rent income. Of our total revenue, $34,293,000 (17%) and $29,566,000 (16%) in lease revenues were derived from Senior Living for the nine months ended September 30, 2017 and 2016, respectively, including $5,238,000 and $5,386,000 in straight-line rent.

On August 25, 2017, we committed to funding up to $6,830,000 toward a facilities upgrade program. Senior Living’s contribution to the program will include continuing its capital expenditures in amounts exceeding its contractual lease commitments and covering identified needs within the nine-facility independent living portfolio discussed above. Amounts funded by NHI will be added to the lease base on which NHI’s rental income is calculated. No funding had occurred under the agreement as of September 30, 2017.

Other Lease Activity

Tenant Non-Compliance

In October 2017, we issued a letter of forbearance to one of our tenants for a default on our lease terms involving lease coverage and arrearages to certain vendors. Rent to the Company was current as of September 30, 2017. For the nine months ended September 30, 2017, lease revenues from the tenant and its affiliates comprise less than 4% of our rental income, and the related straight-line rent receivable was approximately $3,200,000 at September 30, 2017. We continue to work with the tenant to resolve these defaults.



14


HSM Lease Extension

Effective as of May 1, 2017, we amended and extended our lease with Health Services Management (“HSM”) covering six skilled nursing facilities in Florida. The amended lease calls for $9,800,000 in first year cash rent, plus fixed annual escalators over a term of 12 years. The new agreement replaced the lease set to expire September 30, 2017, which provided for a total cash rent of $7,241,000 in 2016.

Dispositions

On March 22, 2016, we sold a skilled nursing facility in Idaho for cash consideration of $3,000,000. The carrying value of the facility was $1,346,000, and we recorded a gain of $1,654,000. For the nine months ended September 30, 2016, lease income from the property was $73,000. In May 2016 we sold two skilled nursing facilities for total consideration of $24,600,000 and realized a gain of $2,805,000 on the disposal. In June 2016, we recognized a gain of $123,000 on the sale of a vacant land parcel. No significant dispositions have occurred in 2017.

NOTE 3. MORTGAGE AND OTHER NOTES RECEIVABLE

At September 30, 2017, we had net investments in mortgage notes receivable with a carrying value of $105,715,000, secured by real estate and UCC liens on the personal property of 9 facilities, and other notes receivable with a carrying value of $43,584,000, 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, 2017 or December 31, 2016.

Bickford

At September 30, 2017, our construction loans to Bickford are summarized as follows:
 
Rate
 
Maturity
 
Commitment
 
Drawn
 
Location
July 2016
9%
 
5 years
 
$
14,000,000

 
$
(8,703,000
)
 
Illinois
January 2017
9%
 
5 years
 
14,000,000

 
(2,895,000
)
 
Michigan
 
 
 
 
 
$
28,000,000

 
$
(11,598,000
)
 
 

The promissory notes are secured by first mortgage liens on substantially all real and personal property as well as a pledge of any and all leases or agreements which may grant a right of use to the subject property. Usual and customary covenants extend to the agreements, including the borrower’s obligation for payment of insurance and taxes. NHI has a purchase option on the properties at stabilization, whereby annual rent will be set with a floor of 9.55%, based on NHI’s total investment, plus fixed annual escalators.

Our loans to Bickford represent a variable interest as do our leases, which are considered analogous to financing arrangements. Bickford is structured to limit liability for potential claims for damages, is capitalized to achieve that purpose and is considered a VIE.

Evolve

On August 7, 2017, we completed a first mortgage loan of $10,000,000 to Evolve Senior Living (“Evolve”) for the purchase of a 40 unit memory care facility in New Hampshire. The loan provides for annual interest of 8% and a maturity of five years plus renewal terms at the option of the borrower. Terms of the loan grant NHI a 10% participation in the property’s appreciation during the period the loan is outstanding, and NHI also has the option to purchase the facility at fair market value after the second year of the loan. Our loan to Evolve represents a variable interest. Evolve is structured to limit liability for potential claims for damages, is capitalized to achieve that purpose and is considered a VIE.

Timber Ridge

In February 2015, we entered into an agreement to lend up to $154,500,000 to LCS-Westminster Partnership III LLP (“LCS-WP”), an affiliate of Life Care Services (“LCS”). The loan agreement conveys a mortgage interest and facilitated the construction of Phase II of Timber Ridge at Talus (“Timber Ridge”), a Type-A Continuing Care Retirement Community in Issaquah, WA managed by LCS. Our loan to LCS-WP represents a variable interest. As an affiliate of a larger company, LCS-WP is structured to limit liability for potential damage claims, is capitalized to achieve that purpose and is considered a VIE.


15


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 $52,448,000 of Note A as of September 30, 2017. Note A is interest-only and is locked to prepayment for three years. After year three in February 2018, the prepayment penalty starts at 5% and declines 1% per year. Note B is a construction loan for up to $94,500,000 at an annual interest rate of 8% and a five-year maturity and was fully drawn during 2016. We began receiving repayment with new resident entrance fees upon the opening of Phase II during the fourth quarter of 2016. Repayment of Note B amounted to $79,809,000 as of September 30, 2017.

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.

Senior Living Communities

In connection with the acquisition in December 2014 of the properties leased to Senior Living, 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, $604,000 at September 30, 2017, bear interest at an annual rate equal to the prevailing 10-year U.S. Treasury rate, 2.33% at September 30, 2017, plus 6%.

In March 2016, we extended two mezzanine loans of up to $12,000,000 and $2,000,000, respectively, to affiliates of Senior Living, to partially fund construction of a 186-unit senior living campus on Daniel Island in South Carolina. The loans bear interest payable monthly at a 10% annual rate and mature in March 2021. The loans were fully drawn at September 30, 2017, and provide NHI with a purchase option on the development upon its meeting certain operational metrics. The option is to remain open during the term of the loans, plus any extensions.

Our loans to Senior Living and its subsidiaries represent a variable interest as does our lease, which is considered to be analogous to a financing arrangement. Senior Living is structured to limit liability for potential claims for damages, is appropriately capitalized for that purpose and is considered a VIE.

Senior Living Management

On August 3, 2016, we entered into an agreement to furnish to our current tenant, Senior Living Management, Inc. (“SLM”), through its affiliates, loans of up to $24,500,000 to facilitate SLM’s acquisition of five senior housing facilities that it currently operates. The loans consist of two notes under a master credit agreement, include both a mortgage and a corporate loan, and bear interest at 8.25% with terms of five years, plus optional one and two-year extensions. NHI has a right of first refusal if SLM elects to sell the facilities. The loans were fully funded as of September 30, 2017.

Our loans to SLM represent a variable interest as do our leases, which are analogous to financing arrangements. SLM is structured to limit liability for potential damage claims, is capitalized for that purpose and is considered a VIE.

Other Note Activity

In June 2017 Traditions of Minnesota paid off the undiscounted balance of $4,256,000 on its mortgage note outstanding to NHI. With the early payoff, we recognized interest income of $922,000 related to a prepayment penalty and the retirement of the remaining unamortized discount.

NOTE 4. OTHER ASSETS

Other assets consist of the following (in thousands):
 
September 30,
2017
 
December 31,
2016
Accounts receivable and other assets
$
6,249

 
$
9,017

Regulatory escrows
8,208

 
8,208

Reserves for replacement, insurance and tax escrows
4,141

 
4,046

Marketable securities

 
11,745

 
$
18,598

 
$
33,016



16


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.

NOTE 5. DEBT

Debt consists of the following (in thousands):
 
September 30,
2017
 
December 31,
2016
Convertible senior notes - unsecured (net of discount of $3,637 and $4,717)
$
183,938

 
$
195,283

Revolving credit facility - unsecured
167,000

 
158,000

Bank term loan - unsecured
250,000

 
250,000

Private placement term loans - unsecured
400,000

 
400,000

HUD mortgage loans (net of discount of $1,423 and $1,487)
43,824

 
44,354

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

 
78,084

Unamortized loan costs
(11,554
)
 
(9,740
)
 
$
1,111,292

 
$
1,115,981


Aggregate principal maturities of debt as of September 30, 2017 for each of the next five years and thereafter are as follows (in thousands):
Twelve months ended September 30,
 
2018
$
814

2019
842

2020
871

2021
188,475

2022
417,931

Thereafter
518,973

 
1,127,906

Less: discount
(5,060
)
Less: unamortized loan costs
(11,554
)
 
$
1,111,292


On August 3, 2017, we amended our unsecured $800,000,000 credit facility, originally scheduled to mature in June 2020, consolidating our three bank term loans into a single $250,000,000 term loan and providing for an extension of the maturity of the term loan and the $550,000,000 revolving credit facility to August 2022. The amended facility provides for floating interest on the term loan and revolver to be initially set at 30-day LIBOR plus 130 and 115 bps, respectively, based on current leverage metrics. Additional significant amendments to the facility include the refinement of the collateral pool, imposition of a 0% floor LIBOR base, movement from the payment of unused commitment fees to a facility fee of 20 basis points and the composition of creditors participating in our loan syndication. The employment of interest rate swaps to fix LIBOR on our bank 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.”

Our existing interest rate swap agreements collectively will continue through June 2020 to hedge against fluctuations in variable interest rates applicable to the $250,000,000 term loan. Some new hedge inefficiency will result from introducing to the debt instrument a LIBOR floor that is not present in the hedges. To better reflect earnings, in the first quarter of 2018 we expect to adopt the proposed ASU discussed in Note 12 to the condensed consolidated financial statements, below among whose provisions is expected to be the requirement to reflect the entire change in the fair value of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is presented.

At September 30, 2017, we had $383,000,000 available to draw on the revolving portion of our credit facility. The unsecured credit facility agreement 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.

Pinnacle Bank is a participating member of our banking group. A member of NHI’s board of directors and chairman of our audit committee is also the chairman of Pinnacle Financial Partners, Inc., the holding company for Pinnacle Bank. NHI’s local banking transactions are conducted primarily through Pinnacle Bank.

17





Our unsecured private placement term loans are summarized below (in thousands):
Amount
 
Inception
 
Maturity
 
Fixed Rate
 
 
 
 
 
 
 
$
125,000

 
January 2015
 
January 2023
 
3.99%
50,000

 
November 2015
 
November 2023
 
3.99%
75,000

 
September 2016
 
September 2024
 
3.93%
50,000

 
November 2015
 
November 2025
 
4.33%
100,000

 
January 2015
 
January 2027
 
4.51%
$
400,000

 
 
 
 
 
 

On August 8, 2017, we amended our private placement term loan agreements to largely conform those agreements with the amendment to our bank credit facility which was noted above.

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 leased to Bickford. The notes are secured by facilities having a net book value of $108,573,000 at September 30, 2017.

As of September 30, 2017, we had outstanding $187,575,000 of 3.25% senior unsecured convertible notes due April 2021 (the “Notes”). Interest is payable April 1st and October 1st of each year. As adjusted for terms of the indenture, which, at inception in March 2014, initially called for a conversion rate and price of 13.93 shares and $71.81, respectively, the Notes are convertible at a conversion rate of 14.20 shares of common stock per $1,000 principal amount, representing a conversion price of approximately $70.42 per share for a total of 2,663,745 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. Because we have the ability and intent to settle the convertible securities in cash upon exercise, we use the treasury stock method to account for potential dilution. For the nine months ended September 30, 2017, dilution resulting from the conversion option within our convertible debt is 186,545 shares. If NHI’s current share price increases above the adjusted $70.42 conversion price, further dilution will be attributable to the conversion feature. On September 30, 2017, the value of the convertible debt, computed as if the debt were immediately eligible for conversion, exceeded its face amount by $18,306,000.

The embedded conversion options (1) do not require net cash settlement, (2) are not conventionally convertible but can be classified in stockholders’ equity under Accounting Standards Codification (“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 carrying value of the debt component is based upon the estimated fair value at the time of issuance of a similar debt instrument without the conversion feature and is now estimated to be approximately $181,503,000.
 
The $6,072,000 difference between the contractual principal and the carrying value of the debt represents unamortized debt issuance costs and discount. The initial value allocated to the debt was recorded as the equity component, represented the estimated value of the conversion feature of the instrument at issuance, and was offset by a like amount recorded as the discount on the Notes, which is being amortized to interest expense 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, 2017, was $2,435,000.

During the nine months ended September 30, 2017, we undertook targeted open-market repurchases of certain of the convertible notes. Payments of cash negotiated in the transactions were dependent on prevailing market conditions, our liquidity requirements, contractual restrictions, individual circumstances of the selling parties and other factors. The total balance of notes repurchased and retired through September 30, 2017, net of unamortized original issue discount and associated issuance costs, was $12,003,000,

18


resulting in the recognition of losses on the note retirements for the three and nine months ended September 30, 2017, of $495,000 and $591,000, respectively, calculated as the excess of cash paid over the carrying value of that portion of the notes accounted for as debt. For the retirement of that portion of the outlay allocated to the fair value of the conversion feature, $1,744,000 was charged to additional paid-in capital during the nine months ended September 30, 2017.

Our HUD mortgage loans are secured by ten properties leased to Bickford and having a net book value of $53,016,000 at September 30, 2017. 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 $8,962,000 and a net book value of $7,539,000, which approximates fair value.

The following table summarizes interest expense (in thousands):
 
Three Months Ended
 
Nine Months Ended

September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
Interest expense on debt at contractual rates
$
10,225

 
$
9,138

 
$
30,570

 
$
26,486

Losses reclassified from accumulated other
 
 
 
 
 
 
 
comprehensive income into interest expense
695

 
975

 
2,129

 
2,993

Ineffective portion of cash flow hedges
(350
)
 
(26
)
 
(350
)
 
113

Capitalized interest
(301
)
 
(144
)
 
(462
)
 
(460
)
Loss on bond retirement
495

 

 
591

 

Charges taken on restructuring credit facility
584

 

 
584

 

Amortization of debt issuance costs and debt discount
893

 
873

 
2,668

 
2,613

Total interest expense
$
12,241


$
10,816


$
35,730


$
31,745


Interest Rate Swap Agreements

Our existing interest rate swap agreements will collectively continue through June 2020 to hedge against fluctuations in variable interest rates applicable to our $250,000,000 bank term loan. The introduction to the debt instrument of a LIBOR floor not present in the hedges resulted in hedge inefficiency of approximately $350,000, which we credited to interest expense. During the next twelve months, approximately $1,546,000 of losses, which are included as a component of accumulated other comprehensive income, are projected to be reclassified into earnings. As of September 30, 2017, we employ the following interest rate swap contracts to mitigate our interest rate risk on the $250,000,000 term loan (dollars in thousands):

Date Entered
 
Maturity Date
 
Fixed Rate
 
Rate Index
 
Notional Amount
 
Fair Value
May 2012
 
April 2019
 
2.84%
 
1-month LIBOR
 
$
40,000

 
$
15

June 2013
 
June 2020
 
3.41%
 
1-month LIBOR
 
$
80,000

 
$
(886
)
March 2014
 
June 2020
 
3.46%
 
1-month LIBOR
 
$
130,000

 
$
(1,606
)

See Note 10 for fair value disclosures about our variable and fixed rate debt and interest rate swap agreements.

NOTE 6. COMMITMENTS AND CONTINGENCIES

In the normal course of business, we enter into a variety of commitments, typical of which are those for the funding of revolving credit arrangements, construction and mezzanine loans to our operators to conduct expansions and acquisitions for their own account, and commitments for the funding of construction for expansion or renovation to our existing properties under lease. In our leasing operations we offer to our tenants and to sellers of newly-acquired properties a variety of inducements which originate contractually as contingencies but which may become commitments upon the satisfaction of the contingent event. Contingent payments earned will be included in the respective lease bases when funded. The tables below summarize our existing, known commitments and contingencies according to the nature of their impact on our leasehold or loan portfolios.


19


 
Asset Class
 
Type
 
Total
 
Funded
 
Remaining
Loan Commitments:
 
 
 
 
 
 
 
 
 
Life Care Services Note A
SHO
 
Construction
 
$
60,000,000

 
$
(52,448,000
)
 
$
7,552,000

Bickford Senior Living
SHO
 
Construction
 
28,000,000

 
(11,598,000
)
 
16,402,000

Senior Living Communities
SHO
 
Revolving Credit
 
15,000,000

 
(604,000
)
 
14,396,000

Senior Living Communities
SHO
 
Mezzanine
 
14,000,000

 
(14,000,000
)
 

 
 
 
 
 
$
117,000,000

 
$
(78,650,000
)
 
$
38,350,000


See Note 3 for full details of our loan commitments. As provided above, loans funded do not include the effects of discounts or commitment fees. We expect to fully fund the Life Care Services Note A during 2018. Funding of the promissory note commitments to Bickford is expected to transpire monthly throughout 2017.

 
Asset Class
 
Type
 
Total
 
Funded
 
Remaining
Development Commitments:
 
 
 
 
 
 
 
 
 
Legend/The Ensign Group
SNF
 
Purchase
 
$
56,000,000

 
$
(14,000,000
)
 
$
42,000,000

Chancellor Health Care
SHO
 
Construction
 
650,000

 
(62,000
)
 
588,000

East Lake/Watermark Retirement
SHO
 
Renovation
 
10,000,000

 
(5,900,000
)
 
4,100,000

Santé Partners
SHO
 
Renovation
 
3,500,000

 
(2,621,000
)
 
879,000

Bickford Senior Living
SHO
 
Renovation
 
2,400,000

 

 
2,400,000

East Lake Capital Management
SHO
 
Renovation
 
400,000

 

 
400,000

Senior Living Communities
SHO
 
Renovation
 
6,830,000

 

 
6,830,000

Woodland Village
SHO
 
Renovation
 
350,000

 
(248,000
)
 
102,000

 
 
 
 
 
$
80,130,000

 
$
(22,831,000
)
 
$
57,299,000


As discussed in Note 2, we remain obligated to purchase, from a developer, three new skilled nursing facilities in Texas for $42,000,000 which are leased to Legend and subleased to Ensign.

 
Asset Class
 
Type
 
Total
 
Funded
 
Remaining
Contingencies:
 
 
 
 
 
 
 
 
 
Bickford / Sycamore
SHO
 
Lease Inducement
 
$
10,000,000

 
$
(2,000,000
)
 
$
8,000,000

East Lake Capital Management
SHO
 
Lease Inducement
 
8,000,000

 

 
8,000,000

Sycamore Street (Bickford affiliate)
SHO
 
Letter-of-credit
 
1,930,000

 

 
1,930,000

Ravn Senior Solutions
SHO
 
Lease Inducement
 
1,500,000

 

 
1,500,000

Prestige Care
SHO
 
Lease Inducement
 
1,000,000

 

 
1,000,000

The LaSalle Group
SHO
 
Lease Inducement
 
5,000,000

 

 
5,000,000

 
 
 
 
 
$
27,430,000

 
$
(2,000,000
)
 
$
25,430,000


Contingent payments related to the five Bickford development properties constructed in 2016 and 2017 include a licensure incentive of $250,000 per property. Additionally, each property is subject to a three-tiered operator incentive schedule paying up to an additional $1,750,000, based on the attainment of certain performance metrics. As funded, these payments are added to the lease base and amortized against rental income.

In connection with our July 2015 lease to East Lake of three senior housing properties, NHI has committed to certain lease inducement payments of $8,000,000 contingent on reaching and maintaining certain metrics, which have been assessed as not probable of payment and which we have not recorded on our balance sheets as of September 30, 2017. We are unaware of circumstances that would change our initial assessment as to the contingent lease incentives. Not included in the above table is a seller earnout of $750,000, which is recorded on our balance sheets within accounts payable and accrued expenses.

In February 2014 we entered into a commitment on a letter of credit for the benefit of Sycamore, an affiliate of Bickford, which previously held a minority interest in PropCo (see Note 2). At September 30, 2017, our commitment on the letter of credit totaled $1,930,000. As of September 30, 2017, our direct support of Sycamore is limited to our guarantee on the letter of credit established for their benefit. Sycamore, as an affiliate company of Bickford, is structured to limit liability for potential claims for damages, is capitalized to achieve that purpose and is considered a VIE.


20


See Note 2 for a description of lease inducements contingently payable to RSS, Prestige and LaSalle.

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 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 the 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 7. INVESTMENT AND OTHER GAINS

The following table summarizes our investment and other gains (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,

2017
 
2016
 
2017
 
2016
Gains on sales of real estate
$

 
$

 
$
50

 
$
4,582

Gains on sales of marketable securities

 

 
10,038

 
23,498

Gain on disposal of equity-method investee

 
1,657

 

 
1,657

 
$

 
$
1,657

 
$
10,088

 
$
29,737


In January and February 2017, we recognized gains of $10,038,000 on sales totaling $11,718,000 of marketable securities with a carrying value of $11,745,000 and an adjusted cost of $1,680,000 at December 31, 2016. Total proceeds of $18,182,000 from marketable securities include settlements occurring in 2017 of $6,464,000 that resulted from sales in December 2016.

NOTE 8. STOCK-BASED COMPENSATION

We recognize stock-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.

Stock-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 stock-based payments to employees, officers, directors or consultants. Through a vote of our shareholders on May 7, 2015, we 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. As of September 30, 2017, there were 951,668 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.

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 stock-based payments to employees, officers, directors or consultants. 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.


21


Compensation expense is recognized only for the awards that ultimately vest. Accordingly, forfeitures that were not expected will result in the reversal of previously recorded compensation expense. The compensation expense reported for the three months ended September 30, 2017 and 2016 was $405,000 and $251,000, respectively, and is included in general and administrative expense in the Condensed Consolidated Statements of Income. For the nine months ended September 30, 2017 and 2016, compensation expense included in general and administrative expense was $2,270,000 and $1,481,000, respectively.

At September 30, 2017, we had, net of expected forfeitures, $959,000 of unrecognized compensation cost related to unvested stock options which is expected to be expensed over the following periods: 2017 - $342,000, 2018 - $552,000 and 2019 - $65,000.

The weighted average fair value per share of options granted during the nine months ended September 30, 2017 and 2016 was $5.88 and $3.65, respectively. The fair value of each grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

 
2017
 
2016
Dividend yield
5.3%
 
6.2%
Expected volatility
19.8%
 
19.1%
Expected lives
3.4 years
 
2.9 years
Risk-free interest rate
1.49%
 
0.91%

The following table summarizes our outstanding stock options:
 
Nine Months Ended
 
September 30,
 
2017
 
2016
Options outstanding January 1,
541,679

 
741,676

Options granted under 2012 Plan
495,000

 
470,000

Options exercised under 2012 Plan
(155,829
)
 
(608,331
)
Options forfeited under 2012 Plan
(6,668
)
 

Options exercised under 2005 Plan
(15,000
)
 
(61,666
)
Options outstanding, September 30,
859,182

 
541,679

 
 
 
 
Exercisable at September 30,
465,831

 
188,331


NOTE 9. EARNINGS AND DIVIDENDS PER COMMON 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):

22


 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
Net income attributable to common stockholders
$
39,092

 
$
33,032

 
$
121,566

 
$
110,352

 
 
 
 
 
 
 
 
BASIC:
 
 
 
 
 
 
 
Weighted average common shares outstanding
41,108,699

 
39,283,919

 
40,681,582

 
38,735,262

 
 
 
 
 
 
 
 
DILUTED:
 
 
 
 
 
 
 
Weighted average common shares outstanding
41,108,699

 
39,283,919

 
40,681,582

 
38,735,262

Stock options
74,769

 
93,437

 
69,210

 
49,248

Convertible subordinated debentures
264,795

 
274,544

 
186,545

 
91,515

Average dilutive common shares outstanding
41,448,263

 
39,651,900

 
40,937,337

 
38,876,025

 
 
 
 
 
 
 
 
Net income per common share - basic
$
.95

 
$
.84

 
$
2.99

 
$
2.85

Net income per common share - diluted
$
.94

 
$
.83

 
$
2.97

 
$
2.84

 
 
 
 
 
 
 
 
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
403

 

 
760

 
8,490

Regular dividends declared per common share
$
.95

 
$
.90

 
$
2.85

 
$
2.70

 
 
 
 
 
 
 
 

NOTE 10. 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 condensed consolidated financial statements contained in our most recent Annual Report on Form 10-K) on a recurring basis have included marketable securities, derivative financial instruments and contingent consideration arrangements. Marketable securities have consisted 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 business combinations.

Marketable securities. We utilize quoted prices in active markets to measure equity securities; these items are classified as Level 1 in the hierarchy and include the common stock of other publicly held 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,
2017
 
December 31,
2016
Level 1
 
 
 
 
 
Common stock of other healthcare REITs
Other assets
 
$

 
$
11,745

 
 
 
 
 
 
Level 2
 
 
 
 
 
Interest rate swap asset
Other assets
 
$
15

 
$

Interest rate swap liability
Accounts payable and accrued expenses
 
$
2,492

 
$
4,279







23


Carrying values and fair values of financial instruments that are not carried at fair value at September 30, 2017 and December 31, 2016 in the Condensed Consolidated Balance Sheets are as follows (in thousands):
 
Carrying Amount
 
Fair Value Measurement
 
2017
 
2016
 
2017
 
2016
Level 2
 
 
 
 
 
 
 
Variable rate debt
$
411,292

 
$
404,828

 
$
417,000

 
$
408,000

Fixed rate debt
$
700,000

 
$
711,153

 
$
701,590

 
$
706,332

 
 
 
 
 
 
 
 
Level 3
 
 
 
 
 
 
 
Mortgage and other notes receivable
$
149,299

 
$
133,493

 
$
153,372

 
$
133,229


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.

Mortgage and other notes receivable. 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.

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 and other variable rate debt are reasonably estimated at their notional amounts at September 30, 2017 and December 31, 2016, due to the predominance of floating interest rates, which generally reflect market conditions.

NOTE 11. SUBSEQUENT EVENT

Marathon/Village Concepts

On November 3, 2017, we committed up to $7,100,000 to fund the expansion of our independent living community in Chehalis, Washington leased to Marathon Development and Village Concepts Retirement Communities (“Marathon”). Upon funding, incurred amounts will be added to the lease base. As of November 7, 2017, no funding had occurred under the agreement.

NOTE 12. RECENT ACCOUNTING PRONOUNCEMENTS

In May 2014 the Financial Accounting Standards Board (“FASB”) issued 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, judgment and disclosures than under current guidance. In August 2015 the FASB issued ASU 2015-14, which defers the effective date of ASU 2014-09. ASU 2014-09 is now effective for public entities for annual periods beginning after December 15, 2017, including interim periods therein.

The Company plans on adopting this standard using the modified retrospective method on January 1, 2018. The ASU provides for revenues from leases to continue to follow the guidance in Topics 840 and 842 (when adopted) and provides for loans to follow established guidance in Topic 310. Because this ASU specifically excludes these areas of our operations from its scope, we do not expect any impact to our accounting for lease revenue and interest income to result from the ASU. Additionally, the other significant types of contracts in which we engage, sales of real estate to customers, typically never remain executory across points in time. Because all performance obligations from these contracts would therefore fall within a single period, the timing of our revenue recognition from sales of real estate is not expected to be affected by the ASU. We have substantially completed our analysis of the ASU, whose eventual adoption is not expected to have a material impact on the timing and measurement of the Company’s income.

In February 2016 the FASB issued ASU 2016-02, Leases. Public companies will be required to apply ASU 2016-02 for all accounting periods beginning after December 15, 2018. Early adoption is permitted. All leases with lease terms greater than one year are subject to ASU 2016-02, including leases in place as of the adoption date. The principal difference of Topic 842 from previous guidance is that, for lessees, lease assets and lease liabilities arising from operating leases will be recognized in the balance sheet. While, the accounting applied by a lessor is largely unchanged from that applied under previous GAAP, significant changes to lessor accounting have been made in order to align i) certain lessor and lessee accounting guidance, and ii) key aspects of the lessor accounting model with the revenue recognition guidance in Topic 606 Revenue from Contracts with Customers, which will be effective for NHI prior to our adoption of Topic 842. Management believes changes from the alignment of lessor/lessee accounting and changes to conform with Topic 606 will present the most significant impact to NHI in our reporting of financial position and the results of operations. The Company will continue to evaluate the impact on our consolidated financial statements.

24


Consistent with present standards, NHI will continue to account for lease revenue on a straight-line basis for most leases. Also consistent with NHI’s current practice, under ASU 2016-02 only initial direct costs that are incremental to the lessor will be capitalized. We are in the initial stages of evaluating the extent of the effects, if any, that adopting the provisions of ASU 2016-12 in 2019 will have on NHI.

In June 2016 the FASB issued ASU 2016-13, Financial Instruments - Credit Losses. ASU 2016-13 will require more timely recognition of credit losses associated with financial assets. While current GAAP includes multiple credit impairment objectives for instruments, the previous objectives generally delayed recognition of the full amount of credit losses until the loss was probable of occurring. The amendments in ASU 2016-13, whose scope is asset-based and not restricted to financial institutions, eliminate the probable initial recognition threshold in current GAAP and, instead, reflect an entity’s current estimate of all expected credit losses. Previously, when credit losses were measured under GAAP, we generally only considered past events and current conditions in measuring the incurred loss. The amendments in ASU 2016-13 broaden the information that we must consider in developing our expected credit loss estimate for assets measured either collectively or individually. The use of forecasted information incorporates more timely information in the estimate of expected credit loss that will be more useful to users of the financial statements. ASU 2016-13 is effective for public entities for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Because we are likely to continue to invest in loans and generate receivables, adoption of ASU 2016-13 in 2020 will have some effect on our accounting for these investments, though the nature of those effects will depend on the composition of our loan portfolio at that time; accordingly, we are in the initial stages of evaluating the extent of the effects, if any, that adopting the provisions of ASU 2016-13 in 2020 will have on NHI.

In November 2016 the FASB issued ASU 2016-18, Restricted Cash. ASU 2016-18 will require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents, generally by requiring the inclusion of restricted cash and restricted cash equivalents with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in this ASU do not provide a definition of restricted cash or restricted cash equivalents. ASU 2016-18 is effective for public entities for fiscal years beginning after December 15, 2017, including interim periods. The adoption of ASU 2016-18 is not expected to have a material effect on our consolidated financial statements.

In January 2017 the FASB issued ASU 2017-01, Clarifying the Definition of a Business. ASU 2017-01 narrowed the definition of a business in evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under the current implementation guidance in Topic 805, there are three elements of a business-inputs, processes, and outputs. Currently the definition of outputs contributes to broad interpretations of the definition of a business. Additionally, the standard provides that when substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. For purposes of this test, land and buildings can be combined along with the intangible assets for any in-place leases. For most of NHI’s acquisitions of investment property, this screen would be met and, therefore, not meet the definition of a business. ASU 2017-01 is effective for public entities for fiscal years beginning after December 15, 2017, including interim periods. Early application of this standard is generally allowed for acquisitions acquired after the standard was issued but before the acquisition has been reflected in financial statements. We adopted the provisions of ASU 2017-01 in the first quarter of 2017. The adoption of ASU 2017-01 did not have a material effect on our consolidated financial statements. Our acquisitions in 2017 were accounted for as asset acquisitions.

In August 2017 the Financial Accounting Standards Board issued ASU 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities, which is available for early adoption in any interim period after issuance of the update, or alternatively requires adoption for fiscal years beginning after December 15, 2018. The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. The transition method is a modified retrospective approach that will require the Company to recognize the cumulative effect of initially applying the ASU as an adjustment to accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earnings as of the beginning of the fiscal year that an entity adopts the update. The primary provision in the ASU that will require an adjustment to beginning retained earnings is the change in timing and income statement line item for ineffectiveness related to cash flow and net investment hedges. As a result of the transition guidance provided in the ASU, cumulative ineffectiveness that has previously been recognized on cash flow and net investment hedges that are still outstanding and designated as of the date of adoption, will be adjusted and removed from beginning retained earnings and placed in accumulated other comprehensive income. While the Company continues to assess all potential impacts of the standard, we currently expect adoption to have an immaterial impact on our consolidated financial statements.


25


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 factors including, but not limited to, the following:

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

*
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 refinance existing debt or incur additional 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;

*
Certain tenants in our portfolio account for a significant percentage of the rent we expect to generate from our portfolio, and the failure of any of these tenants to meet their obligations to us could materially and adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders;

*
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;


26


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

*
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;

*
If our efforts to maintain the privacy and security of Company information are not successful, we could incur substantial costs and reputational damage, and could become subject to litigation and enforcement actions.

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, 2016, 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 and/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., established in 1991 as a Maryland corporation, 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 facility investments. Our portfolio consists of real estate investments in independent living facilities, assisted living facilities, entrance-fee communities, senior living campuses, skilled nursing facilities, specialty hospitals and medical office buildings. Other investments have included mortgages and other notes, marketable securities, and a joint venture structured to comply with the provisions of the REIT Investment Diversification Empowerment Act of 2007 (“RIDEA”). Through a RIDEA joint venture, we have invested in facility operations managed by independent third-parties. We fund our real estate investments primarily through: (1) operating cash flow, (2) debt offerings, including bank lines of credit and term debt, both unsecured and secured, and (3) the sale of equity securities.

Portfolio

At September 30, 2017, we had investments in real estate and mortgage and other notes receivable involving 216 facilities located in 32 states. These investments involve 139 senior housing properties, 72 skilled nursing facilities, 3 hospitals, 2 medical office buildings and other notes receivable. These investments (excluding our corporate office of $1,298,000) consisted of properties with an original cost of approximately $2,619,622,000, rented under triple-net leases to 29 lessees, and $149,299,000 aggregate net carrying value of mortgage and other notes receivable due from 11 borrowers.

Our investments in real estate are located within the United States and our investments in mortgage loans are secured by real estate located within the United States. We are managed as one unit for internal reporting and decision making. Therefore, our reporting reflects our financial position and operations as a single segment.

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 living and memory care communities and senior living campuses) or discretionary (independent living and entrance-fee communities.)

Senior Housing – Need-Driven includes assisted living 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.


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Senior Housing – Discretionary includes independent living (“ILF”) 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 Facilities within our portfolio primarily receive payment from Medicare, Medicaid and health insurance. These properties include skilled nursing facilities (“SNF”), medical office buildings (“MOB”) and hospitals that attract patients who have a need for acute or complex medical attention, preventative medicine, or rehabilitation services. Medical properties are subject to state and federal regulatory oversight and, in the case of hospitals, Joint Commission accreditation.

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The following tables summarize our investments in real estate and mortgage and other notes receivable as of September 30, 2017 (dollars in thousands):

Real Estate Properties
Properties

 
Beds/Sq. Ft.*

 
Revenue
 
%
 
Investment
 
Senior Housing - Need-Driven
 
 
 
 
 
 
 
 
 
 
 
Assisted Living
85

 
4,160

 
$
51,967

 
25.1
%
 
$
757,220

 
 
Senior Living Campus
10

 
1,323

 
12,157

 
5.9
%
 
162,007

 
 
Total Senior Housing - Need-Driven
95

 
5,483

 
64,124

 
31.0
%
 
919,227

 
Senior Housing - Discretionary
 
 
 
 
 
 
 
 
 
 
 
Independent Living
29

 
3,212

 
34,520

 
16.6
%
 
512,322

 
 
Entrance-Fee Communities
10

 
2,363

 
37,780

 
18.2
%
 
597,576

 
 
Total Senior Housing - Discretionary
39

 
5,575

 
72,300

 
34.8
%
 
1,109,898

 
 
Total Senior Housing
134

 
11,058

 
136,424

 
65.8
%
 
2,029,125

 
Medical Facilities
 
 
 
 
 
 
 
 
 
 
 
Skilled Nursing Facilities
68

 
8,813

 
54,103

 
26.1
%
 
524,040

 
 
Hospitals
3

 
181

 
5,799

 
2.8
%
 
55,971

 
 
Medical Office Buildings
2

 
88,517

*
751

 
0.3
%
 
10,486

 
 
Total Medical Facilities
73

 
 
 
60,653

 
29.2
%
 
590,497

 
 
Total Real Estate Properties
207

 
 
 
$
197,077

 
95.0
%
 
$
2,619,622

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage and Other Notes Receivable
 
 
 
 
 
 
 
 
 
 
Senior Housing - Need-Driven
4

 
252

 
$
1,210

 
0.6
%
 
$
31,501

 
Senior Housing - Discretionary
1

 
400

 
4,045

 
2.0
%
 
66,300

 
Medical Facilities
4

 
270

 
1,644

 
0.8
%
 
7,914

 
Other Notes Receivable

 

 
3,226

 
1.6
%
 
43,584

 
 
Total Mortgage and Other Notes Receivable
9

 
922

 
10,125

 
5.0
%
 
149,299

 
 
Total Portfolio
216

 
 
 
$
207,202

 
100.0
%
 
$
2,768,921


Portfolio Summary
Properties

 
Beds/Sq. Ft.*

 
Revenue
 
%
 
Investment
 
Real Estate Properties
207

 
 
 
$
197,077

 
95.0
%
 
$
2,619,622

 
Mortgage and Other Notes Receivable
9

 
 
 
10,125

 
5.0
%
 
149,299

 
 
Total Portfolio
216

 
 
 
$
207,202

 
100.0
%
 
$
2,768,921

 
 
 
 
 
 
 
 
 
 
 
 
Summary of Facilities by Type
 
 
 
 
 
 
 
 
 
 
Senior Housing - Need-Driven
 
 
 
 
 
 
 
 
 
 
 
Assisted Living
89

 
4,412

 
$
53,177

 
25.7
%
 
$
788,721

 
 
Senior Living Campus
10

 
1,323

 
12,157

 
5.9
%
 
162,007

 
 
Total Senior Housing - Need-Driven
99

 
5,735

 
65,334

 
31.6
%
 
950,728

 
Senior Housing - Discretionary
 
 
 
 
 
 
 
 
 
 
 
Entrance-Fee Communities
11

 
2,763

 
41,825

 
20.2
%
 
663,876

 
 
Independent Living
29

 
3,212

 
34,520

 
16.6
%
 
512,322

 
 
Total Senior Housing - Discretionary
40

 
5,975

 
76,345

 
36.8
%
 
1,176,198

 
 
Total Senior Housing
139

 
11,710

 
141,679

 
68.4
%
 
2,126,926

 
Medical Facilities
 
 
 
 
 
 
 
 
 
 
 
Skilled Nursing Facilities