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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-11316
OMEGA HEALTHCARE INVESTORS, INC.
(Exact Name of Registrant as Specified in its Charter)
Maryland 38-3041398
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
9690 Deereco Rd., Suite 100
Timonium, Maryland 21093
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: 410-427-1700
Securities Registered Pursuant to Section 12(b) of the Act:
Name of Exchange on
Title of Each Class Which Registered
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Common Stock, $.10 Par Value and
associated stockholder protection rights New York Stock Exchange
9.25% Series A Preferred Stock, $1 Par Value New York Stock Exchange
8.625% Series B Preferred Stock, $1 Par Value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
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 and Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes [X]
The aggregate market value of the voting stock of the registrant held by
non-affiliates was $176,157,108. The aggregate market value was computed using
the $7.58 closing price per share for such stock on the New York Stock Exchange
on June 28, 2002.
As of February 14, 2003 there were 37,140,625 shares of common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's definitive Proxy Statement, which will be filed with the
Commission on or before March 5, 2003, is incorporated by reference in Part III
of this Form 10-K.
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OMEGA HEALTHCARE INVESTORS, INC.
2002 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART 1
PAGE
Item 1. Business of the Company.................................................................... 1
Overview................................................................................ 1
Summary of Financial Information........................................................ 4
Description of the Business............................................................. 4
Executive Officers of Our Company....................................................... 8
Item 2. Properties................................................................................. 9
Item 3. Legal Proceedings.......................................................................... 11
Item 4. Submission of Matters to a Vote of Security Holders........................................ 11
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.................. 12
Item 6. Selected Financial Data.................................................................... 13
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 14
Overview................................................................................ 14
Critical Accounting Policies and Estimates.............................................. 16
Results of Operations................................................................... 17
Portfolio Developments.................................................................. 21
Liquidity and Capital Resources......................................................... 23
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................. 24
Item 8. Financial Statements and Supplementary Data................................................ 26
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....... 26
PART III
Item 10. Directors and Executive Officers of the Registrant......................................... 26
Item 11. Executive Compensation..................................................................... 26
Item 12. Security Ownership of Certain Beneficial Owners and Management............................. 26
Item 13. Certain Relationships and Related Transactions............................................. 26
Item 14. Controls and Procedures.................................................................... 26
PART IV
Item 15. Exhibits, Financial Statements, Financial Statement Schedules and Reports on Form 8-K..... 27
PART I
Item 1 - Business of the Company
Overview
We were incorporated in the State of Maryland on March 31, 1992. We are a
self-administered real estate investment trust, or REIT, investing in
income-producing healthcare facilities, principally long-term care facilities
located in the United States. We provide lease or mortgage financing to
qualified operators of skilled nursing facilities and, to a lesser extent,
assisted living and acute care facilities. We have historically financed
investments through borrowings under our revolving credit facilities, private
placements or public offerings of debt or equity securities, the assumption of
secured indebtedness, or a combination of these methods.
As of December 31, 2002, our portfolio of domestic investments consisted of
222 healthcare facilities, located in 28 states and operated by 34 third-party
operators. Our gross investments in these facilities, net of impairments and
before reserve for uncollectible loans, totaled $852.1 million. This portfolio
is made up of:
o 146 long-term healthcare facilities and two rehabilitation hospitals
owned and leased to third parties;
o fixed rate, participating and convertible participating mortgages on
63 long-term healthcare facilities;
o two long-term healthcare facilities that were recovered from customers
and are currently operated through third-party management contracts
for our own account; and,
o eight long-term healthcare facilities that were recovered from
customers and are currently closed.
In addition, we have one facility subject to a leasehold interest. We also
hold miscellaneous investments and closed healthcare facilities held for sale of
approximately $39.2 million at December 31, 2002, including $16.9 million
related to a non-healthcare facility leased by the United States Postal Service,
a $1.3 million investment in Principal Healthcare Finance Trust ("the Trust"),
and $11.4 million of notes receivable, net of allowance.
Approximately 55.8% of our real estate investments were operated by five
public companies, including Sun Healthcare Group, Inc. (25.7%), Advocat Inc.
(12.5%) Integrated Health Services, Inc. (7.3%), Mariner Post-Acute Network,
Inc. (7.0%), and Alterra Healthcare Corporation (3.3%). The two largest private
operators represent 10.1% and 3.7%, respectively, of our investments. No other
operator represents more than 2.7% of our investments. The three states in which
we have our highest concentration of investments are Florida (16.2%), California
(7.8%) and Illinois (7.7%).
Our company's filings with the Securities and Exchange Commission,
including our annual report on Form 10-K, our quarterly reports on Form 10-Q,
current reports on Form 8-K and amendments to those reports are accessible free
of charge (through a hyperlink) on our website at www.omegahealthcare.com.
Government Healthcare Regulation, Reimbursements and Industry Concentration
Risks. Nearly all of our properties are used as healthcare facilities;
therefore, we are directly affected by the risk associated with the healthcare
industry. Our lessees and mortgagors, as well as the facilities owned and
operated for our own account, derive a substantial portion of their net
operating revenues from third-party payors, including the Medicare and Medicaid
programs. These programs are highly regulated by federal, state and local laws,
rules and regulations and subject to frequent and substantial change. The
Balanced Budget Act of 1997 significantly reduced spending levels for the
Medicare and Medicaid programs. Due to the implementation of the terms of the
Balanced Budget Act, effective July 1, 1998, the majority of skilled nursing
facilities shifted from payments based on reimbursable cost to a prospective
payment system for services provided to Medicare beneficiaries. Under the
prospective payment system, skilled nursing facilities are paid on a per diem
prospective case mix adjusted payment basis for all covered services.
Implementation of the prospective payment system has affected each long-term
care facility to a different degree, depending upon the amount of revenue it
derives from Medicare patients. Long-term care facilities have had to attempt to
restructure their operations to operate profitably under the new Medicare
prospective payment system reimbursement policies.
Legislation adopted in 1999 and 2000 increased Medicare payments to nursing
facilities and specialty care facilities on an interim basis. Section 101 of the
Balanced Budget Relief Act of 1999 ("Balance Budget Relief Act") included a 20%
increase for 15 patient acuity categories (known as Resource Utilization Groups
("RUGS")) and a 4% across the board increase of the adjusted federal per diem
payment rate. The 20% increase was implemented in April 2000 and will remain in
effect until the implementation of refinements in the current RUG case-mix
classification system to more accurately estimate the cost of non-therapy
ancillary services. The 4% increase was implemented in April 2000 and expired
October 1, 2002.
The Benefits Improvement and Protection Act of 2000 ("Benefits Improvement
and Protection Act") included a 16.7% increase in the nursing component of the
case mix adjusted federal periodic payment rate and a 6.7% increase in the 14
RUG payments for rehabilitation therapy services. The 16.7% increase was
implemented in April 2000 and expired October 1, 2002. The 6.7% increase is an
adjustment to the 20% increase granted in the Balance Budget Relief Act and
spreads the funds directed at three of those 15 RUGs to an additional 11
rehabilitation RUGs. The increase was implemented in April 2001 and will remain
in effect until the implementation of refinements in the current RUG case-mix
classification system.
In addition to the expiration of the 4% increase implemented in Balance
Budget Relief Act and the 16.7% increase implemented in Benefits Improvement and
Protection Act, Medicare reimbursement could be further reduced when CMS
completes its RUG refinement due to the termination of the 20% and 6.7%
increases. However, the Medicare Payment Advisory Commission has recommended
that the 20% and 6.7% increases be folded into the base rate upon the completion
of the RUG refinement. The partial expiration of the increases under these
statutes as of October 1, 2002 has had an adverse impact on the revenues of the
operators of nursing facilities and has negatively impacted some operators'
ability to satisfy their monthly lease or debt payments to us.
Due to the temporary nature of the remaining payment increases, we cannot
assure you that the federal reimbursement will remain at levels comparable to
present levels and that such reimbursement will be sufficient for our lessees or
mortgagors to cover all operating and fixed costs necessary to care for Medicare
and Medicaid patients. We also cannot assure you that there will be any future
legislation to increase payment rates for skilled nursing facilities. If payment
rates for skilled nursing facilities are not increased in the future, some of
our lessees and mortgagors may have difficulty meeting their payment obligations
to us.
Each state has its own Medicaid program that is funded jointly by the state
and federal government. Federal law governs how each state manages its Medicaid
program, but there is wide latitude for states to customize Medicaid programs to
fit the needs and resources of its citizens. The Balanced Budget Act repealed
the federal payment standard, also known as the Boren Amendment, for hospitals
and nursing facilities under Medicaid, increasing states' discretion over the
administration of Medicaid programs. A number of states are considering
legislation designed to reduce their Medicaid expenditures which could result in
decreased revenues for our lessees and mortgagors.
In addition, private payors, including managed care payors, are
increasingly demanding discounted fee structures and the assumption by
healthcare providers of all or a portion of the financial risk of operating a
healthcare facility. Efforts to impose greater discounts and more stringent cost
controls are expected to continue. Any changes in reimbursement policies which
reduce reimbursement levels could adversely affect the revenues of our lessees
and mortgagors and thereby adversely affect those lessees' and mortgagors'
abilities to make their monthly lease or debt payments to us.
The possibility that the healthcare facilities will not generate income
sufficient to meet operating expenses or will yield returns lower than those
available through investments in comparable real estate or other investments are
additional risks of investing in healthcare-related real estate. Income from
properties and yields from investments in such properties may be affected by
many factors, including changes in governmental regulation (such as zoning
laws), general or local economic conditions (such as fluctuations in interest
rates and employment conditions), the available local supply and demand for
improved real estate, a reduction in rental income as the result of an inability
to maintain occupancy levels, natural disasters (such as earthquakes and floods)
or similar factors.
Real estate investments are relatively illiquid and, therefore, tend to
limit our ability to vary our portfolio promptly in response to changes in
economic or other conditions. Thus, if the operation of any of our properties
becomes unprofitable due to competition, age of improvements or other factors
such that the lessee or borrower becomes unable to meet its obligations on the
lease or mortgage loan, the liquidation value of the property may be
substantially less, particularly relative to the amount owing on any related
mortgage loan, than would be the case if the property were readily adaptable to
other uses.
Potential Risks from Bankruptcies. Our lease arrangements with operators who
operate more than one of our facilities are generally made pursuant to a single
master lease ("Master Lease") covering all of that operator's facilities.
Although each lease or Master Lease provides that we may terminate the Master
Lease upon the bankruptcy or insolvency of the tenant, the Bankruptcy Reform Act
of 1978 ("Bankruptcy Act") provides that a trustee in a bankruptcy or
reorganization proceeding under the Bankruptcy Act, or a debtor-in-possession in
a reorganization, has the power and the option to assume or reject the unexpired
lease obligations of a debtor-lessee. In the event that the unexpired lease is
assumed on behalf of the debtor-lessee, all the rental obligations generally
would be entitled to a priority over other unsecured claims. However, the court
also has the power to modify a lease if a debtor-lessee, in a reorganization,
were required to perform certain provisions of a lease that the court determined
to be unduly burdensome. It is not possible to determine at this time whether or
not any of our leases or Master Leases contain any such provision. If a lease is
rejected, the lessor has a general unsecured claim limited to any unpaid rent
already due plus an amount equal to the rent reserved under the lease, without
acceleration, for the greater of one year or 15% of the remaining term of such
lease, not to exceed three years.
Generally, with respect to our mortgage loans, the imposition of an
automatic stay under the Bankruptcy Act precludes us from exercising foreclosure
or other remedies against the debtor. Pre-petition creditors generally do not
have rights to the cash flows from the properties underlying the mortgages. The
timing of the collection from mortgagors in bankruptcy depends on negotiating an
acceptable settlement with the mortgagor (and subject to approval of the
bankruptcy court) or the order of the bankruptcy court in the event a negotiated
settlement cannot be achieved. A mortgagee also is treated differently from a
landlord in three key respects. First, the mortgage loan is not subject to
assumption or rejection because it is not an executory contract or a lease.
Second, the mortgagee's loan may be divided into (1) a secured loan for the
portion of the mortgage debt that does not exceed the value of the property and
(2) a general unsecured loan for the portion of the mortgage debt that exceeds
the value of the property. A secured creditor such as ourselves is entitled to
the recovery of interest and costs only if, and to the extent that, the value of
the collateral exceeds the amount owed. If the value of the collateral exceeds
the amount of the debt, interest and allowed costs may not be paid during the
bankruptcy proceeding, but accrue until confirmation of a plan of reorganization
or such other time as the court orders. If the value of the collateral held by a
senior creditor is less than the secured debt, interest on the loan for the time
period between the filing of the case and confirmation may be disallowed.
Finally, while a lease generally would either be rejected or assumed with all of
its benefits and burdens intact, the terms of a mortgage, including the rate of
interest and timing of principal payments, may be modified if the debtor is able
to affect a "cramdown" under the Bankruptcy Act.
The receipt of liquidation proceeds or the replacement of an operator that
has defaulted on its lease or loan could be delayed by the approval process of
any federal, state or local agency necessary for the transfer of the property or
the replacement of the operator licensed to manage the facility. In addition,
some significant expenditures associated with real estate investment, such as
real estate taxes and maintenance costs, are generally not reduced when
circumstances cause a reduction in income from the investment. In order to
protect our investments, we may take possession of a property or even become
licensed as an operator, which might expose us to successor liability to
government programs or require us to indemnify subsequent operators to whom we
might transfer the operating rights and licenses. Third party payors may also
suspend payments to us following foreclosure until we receive the required
licenses to operate the facilities. Should such events occur, our income and
cash flow from operations would be adversely affected.
Summary of Financial Information
The following tables summarize our net revenues and real estate assets by
asset category for 2002, 2001 and 2000. (See Item 7 - Management's Discussion
and Analysis of Financial Condition and Results of Operations, Note 2 -
Properties, Note 3 - Mortgage Notes Receivable and Note 16 - Segment Information
to our audited Consolidated Financial Statements).
Revenues by Asset Category
(In thousands)
Years Ended December 31,
2002 2001 2000
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Core assets:
Lease rental income..................................................................... $ 64,821 $ 61,189 $ 67,308
Mortgage interest income................................................................ 20,954 20,784 24,126
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Total core asset revenues.......................................................... 85,775 81,973 91,434
Other asset revenue........................................................................ 5,302 4,845 6,594
Miscellaneous income....................................................................... 1,757 2,642 2,206
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Total revenue before owned and operated assets..................................... 92,834 89,460 100,234
Owned and operated assets revenue.......................................................... 44,277 168,158 175,559
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Total revenue...................................................................... $137,111 $257,618 $275,793
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Real Estate Assets by Asset Category
(In thousands)
As of December 31,
2002 2001 2000
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Core assets:
Leased assets........................................................................... $663,617 $604,777 $579,941
Mortgaged assets........................................................................ 173,914 195,193 206,710
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Total core assets.................................................................. 837,531 799,970 786,651
Other assets............................................................................... 36,887 50,791 53,242
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Total real estate assets before owned and operated assets.......................... 874,418 850,761 839,893
Owned and operated and held for sale assets................................................ 7,895 87,467 134,614
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Total real estate assets........................................................... $882,313 $938,228 $974,507
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Description of the Business
Investment Policies. We maintain a diversified portfolio of long-term
healthcare facilities and mortgages on healthcare facilities located in the
United States. In making investments, we generally have focused on established,
creditworthy, middle-market healthcare operators that meet our standards for
quality and experience of management. We have sought to diversify our
investments in terms of geographic locations, operators and facility types. As a
consequence of our dividend arrearages and upcoming Fleet debt maturity, we have
not recently made facility investments and do not intend to make facility
investments unless, and until we address our Fleet revolving line of credit
facility which expires on December 31, 2003.
In evaluating potential investments, we consider such factors as:
o the quality and experience of management and the creditworthiness of
the operator of the facility;
o the facility's historical, current and forecasted cash flow and its
adequacy to meet operational needs, capital expenditures and lease or
debt service obligations, providing a competitive return on investment
to us;
o the construction quality, condition and design of the facility;
o the geographic area and type of facility;
o the tax, growth, regulatory and reimbursement environment of the
community in which the facility is located;
o the occupancy and demand for similar healthcare facilities in the same
or nearby communities; and
o the payor mix of private, Medicare and Medicaid patients.
One of our fundamental investment strategies is to obtain contractual rent
escalations under long-term, non-cancelable, "triple-net" leases and revenue
participation through participating mortgage loans, and to obtain substantial
liquidity deposits. Additional security is typically provided by covenants
regarding minimum working capital and net worth, liens on accounts receivable
and other operating assets, and various provisions for cross-default,
cross-collateralization and corporate/personal guarantees, when appropriate.
We prefer to invest in equity ownership of properties. Due to regulatory,
tax or other considerations, we sometimes pursue alternative investment
structures, including convertible participating and participating mortgages,
that achieve returns comparable to equity investments. The following summarizes
the four primary investment structures currently used by us. Average annualized
yields reflect existing contractual arrangements. However, in view of the
ongoing financial challenges in the long-term care industry, we cannot assure
you that the operators of our facilities will meet their payment obligations in
full or when due. Therefore, the annualized yields as of January 1, 2003 set
forth below are not necessarily indicative of or a forecast of actual yields,
which may be lower.
Purchase/Leaseback. In a Purchase/Leaseback transaction, we purchase the
property from the operator and lease it back to the operator over terms
typically ranging from 10 to 16 years, plus renewal options. The leases
originated by us generally provide for minimum annual rentals which are
subject to annual formula increases based upon such factors as increases in
the consumer price index ("CPI") or increases in the revenue streams
generated by the underlying properties, with certain fixed minimum and
maximum levels. Generally, the operator holds an option to repurchase the
property at set dates at prices based on specified formulas. The average
annualized yield from leases was 11.26% at January 1, 2003.
Convertible Participating Mortgage. Convertible participating mortgages are
secured by first mortgage liens on the underlying real estate and personal
property of the mortgagor. Interest rates are usually subject to annual
increases based upon increases in the CPI or increases in the revenues
generated by the underlying long-term care facilities, with certain maximum
limits. Convertible participating mortgages afford us the option to convert
our mortgage into direct ownership of the property, generally at a point
six to nine years from inception. If we exercise our purchase option, we
are obligated to lease the property back to the operator for the balance of
the originally agreed term and for the originally agreed participations in
revenues or CPI adjustments. This allows us to capture a portion of the
potential appreciation in value of the real estate. The operator has the
right to buy out our option at prices based on specified formulas. The
average annualized yield on these mortgages was approximately 10.39% at
January 1, 2003.
Participating Mortgage. Participating mortgages are similar to convertible
participating mortgages except that we do not have a purchase option.
Interest rates are usually subject to annual increases based upon increases
in the CPI or increases in revenues of the underlying long-term care
facilities, with certain maximum limits. The average annualized yield on
these investments was approximately 11.33% at January 1, 2003.
Fixed-Rate Mortgage. These mortgages have a fixed interest rate for the
mortgage term and are secured by first mortgage liens on the underlying
real estate and personal property of the mortgagor. The average annualized
yield on these investments was 11.19% at January 1, 2003.
The following table identifies the years of expiration of the payment
obligations due to us under existing contractual obligations as of January 1,
2003. This information is provided solely to indicate the scheduled expiration
of payment obligations due to us, and is not a forecast of expected revenues.
Mortgage
Rent Interest Total %
-------------------------------------------------
(In thousands)
2003............................................................................ $ 600 $ 4,108 $ 4,708 4.97%
2004............................................................................ - 1,310 1,310 1.38
2005............................................................................ 1,445 - 1,445 1.53
2006............................................................................ 6,945 2,691 9,636 10.18
2007............................................................................ 180 53 233 0.25
Thereafter...................................................................... 65,066 12,246 77,312 81.69
--------------------------------------------------
Total...................................................................... $74,236 $20,408 $94,644 100.00%
==================================================
The table set forth in Item 2 - Properties, contains information regarding
our real estate properties, their geographic locations, and the types of
investment structures as of December 31, 2002.
Borrowing Policies. We may incur additional indebtedness and have
historically sought to maintain a long-term debt-to-total capitalization ratio
in the range of 40% to 50%. Total capitalization is total stockholders' equity
plus long-term debt. We intend to periodically review our policy with respect to
our debt-to-total capitalization ratio and to modify the policy as our
management deems prudent in light of prevailing market conditions. Our strategy
generally has been to match the maturity of our indebtedness with the maturity
of our investment assets, and to employ long-term, fixed-rate debt to the extent
practicable in view of market conditions in existence from time to time.
We may use proceeds of any additional indebtedness to provide permanent
financing for investments in additional healthcare facilities. We may obtain
either secured or unsecured indebtedness, and may obtain indebtedness which may
be convertible into capital stock or be accompanied by warrants to purchase
capital stock. Where debt financing is present on terms deemed favorable, we
generally may invest in properties subject to existing loans, secured by
mortgages, deeds of trust or similar liens on properties.
Industry turmoil and continuing adverse economic conditions have caused the
terms on which we can obtain additional borrowings to become unfavorable. If we
need capital to repay indebtedness as it matures, we may be required to
liquidate investments in properties at times which may not permit realization of
the maximum recovery on these investments. This could also result in adverse tax
consequences to us. We may be required to issue additional equity interests in
our company, which could dilute your investment in our company. (See Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources).
Federal Income Tax Considerations. We intend to make and manage our
investments, including the sale or disposition of property or other investments,
and to operate in such a manner as to qualify as a REIT under the Internal
Revenue Code, unless, because of changes in circumstances or changes in the
Internal Revenue Code, our Board of Directors determines that it is no longer in
our best interest to qualify as a REIT. As a REIT, we generally will not pay
federal income taxes on the portion of our taxable income which is distributed
to stockholders.
Securities Or Interest In Persons Primarily Engaged In Real Estate
Activities. In November 1997, we formed Omega Worldwide, Inc. ("Worldwide"), a
company which provides asset management services and management advisory
services, as well as equity and debt capital to the healthcare industry,
particularly residential healthcare services to the elderly. On April 2, 1998,
we contributed substantially all of our assets in Principal Healthcare Finance
Limited ("PHFL"), an Isle of Jersey (United Kingdom) company, to Worldwide in
exchange for approximately 8.5 million shares of Worldwide common stock and
260,000 shares of Series B preferred stock. Of the 8.5 million shares of
Worldwide common stock we received, approximately 5.2 million were distributed
on April 2, 1998 to our stockholders, and we sold 2.3 million shares on April 3,
1998.
During 2002, we sold our investment in Worldwide. Pursuant to a tender
offer by Four Seasons Health Care Limited ("Four Seasons") for all of the
outstanding shares of common stock of Worldwide, we sold our investment, which
consisted of 1.2 million shares of common stock and 260,000 shares of preferred
stock, to Four Seasons for cash proceeds of approximately $7.4 million
(including $3.5 million for preferred stock liquidation preference and accrued
preferred dividends). In addition, we sold our investment in PHFL, which
consisted of 990,000 ordinary shares and warrants to purchase 185,033 ordinary
shares, to an affiliate of Four Seasons for cash proceeds of $2.8 million. Both
transactions were completed in September 2002 and provided aggregate cash
proceeds of $10.2 million. We realized a gain from the sale of our investments
in Worldwide and PHFL of $2.2 million. As of December 31, 2002, we no longer own
any interest in Worldwide or PHFL.
In April 1999, in conjunction with an acquisition by Worldwide, we acquired
an interest in Principal Healthcare Finance Trust, an Australian Unit Trust,
which owns 47 nursing home facilities and 446 assisted living units in Australia
and New Zealand. As of December 31, 2002, we hold a $1.3 million investment in
the Trust.
Policies With Respect To Certain Activities. If our Board of Directors
determines that additional funding is required, we may raise such funds through
additional equity offerings, debt financing, retention of cash flow (subject to
provisions in the Internal Revenue Code concerning taxability of undistributed
REIT taxable income) or a combination of these methods.
In the event that our Board of Directors determines to raise additional
equity capital, it has the authority, without stockholder approval, to issue
additional common stock or preferred stock in any manner and on such terms and
for such consideration it deems appropriate, including in exchange for property.
In July 2000, we issued shares of our Series C Convertible Preferred Stock to
Explorer Holdings, L.P. ("Explorer") in exchange for an investment of $100.0
million.
Borrowings may be in the form of bank borrowings, secured or unsecured, and
publicly or privately placed debt instruments, purchase money obligations to the
sellers of assets, long-term, tax-exempt bonds or financing from banks,
institutional investors or other lenders, securitizations, any of which
indebtedness may be unsecured or may be secured by mortgages or other interests
in the asset. Such indebtedness may be recourse to all or any part of our assets
or may be limited to the particular asset to which the indebtedness relates.
On December 21, 2001, we reached amended agreements with the bank groups
under both of our revolving credit facilities. As of the closing of the rights
offering and the private placement to Explorer on February 21, 2002, these
amendments became effective.
As part of the amendment regarding our $75.0 million revolving credit
facility, we prepaid $10.0 million originally scheduled to mature in March 2002.
This voluntary prepayment resulted in a permanent reduction in the total
commitment, thereby reducing the credit facility to $65.0 million. The agreement
regarding our $175.0 million revolving credit facility included a one-year
extension in maturity from December 31, 2002 to December 31, 2003, and a
reduction in the total commitment from $175.0 million to $160.0 million. As of
December 31, 2002, our borrowings were $65.0 million and $112.0 million under
the $65.0 million and the $160.0 million credit facilities, respectively.
We have authority to offer our common stock or other equity or debt
securities in exchange for property and to repurchase or otherwise reacquire our
shares or any other securities and may engage in such activities in the future.
Similarly, we may offer additional interests in our operating partnership that
are exchangeable into common shares or, at our option, cash, in exchange for
property. We also may make loans to our subsidiaries.
Subject to the percentage of ownership limitations and gross income and
asset tests necessary for REIT qualification, we may invest in securities of
other REITs, other entities engaged in real estate activities or securities of
other issuers, including for the purpose of exercising control over such
entities.
We may engage in the purchase and sale of investments. We do not underwrite
the securities of other issuers.
Our officers and directors may change any of these policies without a vote
of our stockholders.
In the opinion of our management, our properties are adequately covered by
insurance.
Competition. We compete for additional healthcare facility investments with
other healthcare investors, including other real estate investment trusts. The
operators of the facilities compete with other regional or local nursing care
facilities for the support of the medical community, including physicians and
acute care hospitals, as well as the general public. Some significant
competitive factors for the placing of patients in skilled and intermediate care
nursing facilities include quality of care, reputation, physical appearance of
the facilities, services offered, family preferences, physician services and
price.
Executive Officers of Our Company
At the date of this report, the executive officers of our company are:
C. Taylor Pickett (41) is the Chief Executive Officer and has served in
this capacity since June 12, 2001. Prior to joining our company, Mr. Pickett
served as the Executive Vice President and Chief Financial Officer from January
1998 to June 2001 of Integrated Health Services, Inc., a public company
specializing in post-acute healthcare services. He also served as Executive Vice
President of Mergers and Acquisitions from May 1997 to December 1997 of
Integrated Health Services. Prior to his roles as Chief Financial Officer and
Executive Vice President of Mergers and Acquisitions, Mr. Pickett served as the
President of Symphony Health Services, Inc. from January 1996 to May 1997.
Daniel J. Booth (39) is the Chief Operating Officer and has served in this
capacity since October 15, 2001. Prior to joining our company, Mr. Booth served
as a member of Integrated Health Services, Inc.'s management team since 1993,
most recently serving as Senior Vice President, Finance. Prior to joining
Integrated Health Services, Mr. Booth was Vice President in the Healthcare
Lending Division of Maryland National Bank (now Bank of America).
R. Lee Crabill, Jr. (49) is the Senior Vice President of Operations of our
company and has served in this capacity since July 30, 2001. Mr. Crabill served
as a Senior Vice President of Operations at Mariner Post-Acute Network from 1997
through 2000. Prior to that, he served as an Executive Vice President of
Operations at Beverly Enterprises.
Robert O. Stephenson (39) is the Chief Financial Officer and has served in
this capacity since August 1, 2001. Prior to joining our company, Mr. Stephenson
served from 1996 to July 2001 as the Senior Vice President and Treasurer of
Integrated Health Services, Inc., a public company specializing in post-acute
healthcare services. Prior to Integrated Health Services, Mr. Stephenson served
in management roles at CSX Intermodal, Martin Marietta Corporation and
Electronic Data Systems.
As of December 31, 2002, we had 16 full-time employees and two part-time
employees, including the four executive officers listed above.
Item 2 - Properties
At December 31, 2002, our real estate investments included long-term care
facilities and rehabilitation hospital investments, either in the form of
purchased facilities which are leased to operators, mortgages on facilities
which are operated by the mortgagors or their affiliates and facilities owned
and operated for our account, including facilities subject to leasehold
interests. The facilities are located in 28 states and are operated by 34
unaffiliated operators. The following table summarizes our property investments
as of December 31, 2002:
Gross
No. Of No. Of Occupancy Investment
Investment Structure/Operator Beds Facilities Percentage(1) (In thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
Purchase/Leaseback
Sun Healthcare Group, Inc......................... 5,419 50 87 $218,985
Advocat, Inc...................................... 3,027 29 78 91,567
Claremont Health Care Holdings, Inc............... 1,251 9 77 86,400
Alden Management Services, Inc.................... 868 4 59 31,646
Alterra Healthcare Corporation.................... 325 8 77 27,890
Harborside Healthcare Corporation................. 465 4 85 22,868
Haven Healthcare.................................. 442 4 94 22,387
StoneGate SNF Properties, LP...................... 664 6 84 21,781
Infinia Properties of Arizona, LLC................ 378 4 66 17,852
USA Healthcare, Inc............................... 550 5 77 14,879
Conifer Care Communities, Inc..................... 181 3 86 14,365
Washington N&R, LLC............................... 286 2 86 12,152
Peak Medical of Idaho, Inc........................ 224 2 72 10,500
HQM of Floyd County, Inc.......................... 283 3 92 10,250
Integrated Health Services, Inc................... 142 1 74 10,000
Corum Healthcare Management, LLC.................. 300 1 68 8,151
Hickory Creek Healthcare Foundation, Inc.......... 138 2 90 7,250
Mark Ide Limited Liability Company................ 274 3 84 6,885
American Senior Communities, LLC.................. 78 2 57 6,195
Liberty Assisted Living Centers, LP............... 120 1 95 5,995
Eldorado Care Center, Inc. & Magnolia Manor, Inc.. 167 2 61 5,100
LandCastle Diversified LLC........................ 238 2 53 3,900
Lamar Healthcare, Inc............................. 102 1 50 2,540
----------------------------------------------------------------------------
15,922 148 80 659,538
Owned and Operated Assets--Fee
Nexion Health Management, Inc..................... 197 2 84 5,572
----------------------------------------------------------------------------
197 2 84 5,572
Owned and Operated Assets--Leasehold Interest
Mark Ide Management Group, Inc.................... 91 1 54 286
----------------------------------------------------------------------------
91 1 54 286
Closed Facilities
Closed Facilities................................. - 8 - 4,078
----------------------------------------------------------------------------
- 8 - 4,078
Closed Mortgages
Hasmark Corporation............................... - 2 - 6,183
Integrated Health Services, Inc. (Crystal Springs) - 1 - 4,903
----------------------------------------------------------------------------
- 3 - 11,086
Participating Mortgages
Integrated Health Services, Inc................... 1,034 8 91 47,571
----------------------------------------------------------------------------
1,034 8 91 47,571
Fixed Rate Mortgages
Mariner Post-Acute Network, Inc................... 1,679 12 92 59,688
Essex Healthcare Corporation...................... 633 6 77 15,120
Advocat, Inc...................................... 423 4 77 14,748
Parthenon Healthcare, Inc......................... 300 2 76 10,971
Hickory Creek Healthcare Foundation, Inc.......... 731 16 72 10,112
Tiffany Care Centers, Inc......................... 319 5 78 4,697
Texas Health Enterprises/HEA Mgmt. Group, Inc..... 450 3 67 3,778
Evergreen Healthcare.............................. 191 2 66 2,420
Covenant Care Midwest, Inc........................ 150 1 60 1,816
Paris Nursing Home, Inc........................... 144 1 70 593
----------------------------------------------------------------------------
5,020 52 80 123,943
Reserve for uncollectible loans...................... - - - (8,686)
----------------------------------------------------------------------------
Total........................................ 22,264 222 81 $843,388
============================================================================
(1) Generally represents data for the twelve-month period ending December 31,
2002.
The following table presents the concentration of our facilities by state
as of December 31, 2002:
Total % of
Number of Total Investment Total
Facilities Beds (In thousands) Investment
------------------------------------------------------------------------------
Florida............................................ 25 2,770 $137,804 16.2
California......................................... 19 1,556 66,586 7.8
Illinois........................................... 12 1,732 65,860 7.7
Ohio............................................... 14 1,445 59,513 7.0
Texas.............................................. 15 1,746 42,404 5.0
Michigan........................................... 9 1,232 42,009 4.9
North Carolina..................................... 8 1,154 40,389 4.7
Arkansas........................................... 12 1,253 39,325 4.6
Indiana............................................ 26 1,432 36,341 4.3
Alabama............................................ 9 1,152 35,932 4.2
Massachusetts...................................... 7 600 32,214 3.8
West Virginia...................................... 7 734 30,579 3.6
Kentucky........................................... 9 757 26,963 3.2
Connecticut........................................ 5 442 22,637 2.7
Washington......................................... 3 360 21,574 2.5
Tennessee.......................................... 6 642 21,553 2.5
Pennsylvania....................................... 2 413 19,900 2.3
Arizona............................................ 4 378 17,852 2.1
Iowa............................................... 9 700 16,995 2.0
Colorado........................................... 4 218 16,948 2.0
Missouri........................................... 7 605 16,849 2.0
Georgia............................................ 2 304 12,000 1.4
Idaho.............................................. 3 264 11,100 1.3
New Hampshire...................................... 1 68 5,800 0.7
Louisiana.......................................... 1 131 4,603 0.5
Kansas............................................. 1 40 3,419 0.4
Oklahoma........................................... 1 36 3,178 0.4
Utah............................................... 1 100 1,747 0.2
------------------------------------------------------------------------------
222 22,264 $852,074 100.0
Reserve for uncollectible loans.................... (8,686)
------------------------------------------------------------------------------
Total........................................ 222 22,264 $843,388 100.0
==============================================================================
Our core portfolio consists of long-term lease and mortgage agreements. Our
leased real estate properties are leased under provisions of Master Leases with
initial terms typically ranging from 10 to 16 years, plus renewal options.
Substantially all of the master leases provide for minimum annual rentals that
are subject to annual increases based upon increases in the CPI or increases in
revenues of the underlying properties, with certain limits. Under the terms of
the leases, the lessee is responsible for all maintenance, repairs, taxes and
insurance on the leased properties.
Our owned and operated facilities, like those of our lessees and
mortgagees, are subject to government regulation and derive a substantial
portion of their net operating revenues from third-party payors, including the
Medicare and Medicaid programs. These facilities are managed by independent
third parties under management contracts. These managers are responsible for the
day-to-day operation of the facilities, including, among other things, patient
care, staffing, billing and collection of patient accounts and facility-level
financial reporting. For their services, the managers are paid a management fee,
typically based on a percentage of nursing home revenues. As of December 31,
2002, we had three properties classified as owned and operated. (See Note 19 -
Subsequent Events to our audited Consolidated Financial Statements).
As a consequence of the financial difficulties encountered by a number of
our operators, we have recovered various long-term care assets pledged as
collateral for the operators' obligations either in connection with a
restructuring or settlement with certain operators or pursuant to foreclosure
proceedings. Under normal circumstances, we would seek to re-lease or otherwise
dispose of such assets as promptly as practicable. When we adopt a plan to sell
a property and hold a contract for sale, the property is classified as Assets
Held for Sale.
As of December 31, 2002, there are four properties in assets held for sale,
representing a total investment, net of impairment of $2.3 million. No assurance
can be given that the sales will be realized.
Item 3 - Legal Proceedings
We are subject to various legal proceedings, claims and other actions
arising out of the normal course of business. While any legal proceeding or
claim has an element of uncertainty, we believe that the outcome of each lawsuit
claim or legal proceeding that is pending or threatened, or all of them
combined, will not have a material adverse effect on our consolidated financial
position or results of operations.
On June 21, 2000, we were named as a defendant in certain litigation
brought against us in the U.S. District Court for the Eastern District of
Michigan, Detroit Division, by Madison/OHI Liquidity Investors, LLC ("Madison"),
for the breach and/or anticipatory breach of a revolving loan commitment. Ronald
M. Dickerman and Bryan Gordon are partners in Madison and limited guarantors
("Guarantors") of Madison's obligations to us. Effective as of September 30,
2002 the parties settled all claims in the suit in consideration of Madison's
payment of the sum of $5.4 million. The payment by Madison consists of a $0.4
million cash payment for our attorneys' fees, with the balance evidenced by the
amendment of the existing promissory note from Madison to us. The note reflects
a principal balance of $5.0 million, with interest accruing at 9% per annum,
payable over three years upon liquidation of the collateral securing the note.
The note is also fully guaranteed by the Guarantors; provided that if all
accrued interest and 75% of original principal has been repaid within 18 months,
the Guarantors will be released. As of December 31, 2002, we have received the
$0.4 million cash payment and payments of principal and interest on the note
equal to $2.7 million. The financial statements have been adjusted to reflect
the restructuring and reduction of our investment in connection with the
settlement of this matter.
On December 29, 1998, Karrington Health, Inc. ("Karrington") brought suit
against us in the Franklin County, Ohio, Common Pleas Court (subsequently
removed to the U.S. District Court for the Southern District of Ohio, Eastern
Division) alleging that we repudiated and ultimately breached a financing
contract to provide $95 million of financing for the development of 13 assisted
living facilities. Karrington was seeking recovery of approximately $34 million
in damages it alleged to have incurred as a result of the breach. On August 13,
2001, we paid Karrington $10 million to settle all claims arising from the suit,
but without our admission of any liability or fault, which liability is
expressly denied. Based on the settlement, the suit has been dismissed with
prejudice. The settlement was recorded in the quarter ended June 30, 2001.
Item 4 - Submission of Matters to a Vote of Security Holders
No matters were submitted to stockholders during the fourth quarter of the
year covered by this report.
PART II
Item 5 - Market for Registrants' Common Equity and Related Stockholder Matters
Our company's shares of Common Stock are traded on the New York Stock
Exchange under the symbol OHI. The following table sets forth, for the periods
shown, the high and low prices as reported on the New York Stock Exchange
Composite for the periods indicated and cash dividends per share:
2002 2001
-------------------------------------------- ------------------------------------------
Dividends Dividends
Quarter High Low Per Share Quarter High Low Per Share
-------------------------------------------- ------------------------------------------
First $ 6.2000 $ 3.8000 $ 0.00 First $ 4.7188 $ 1.7500 $ 0.00
Second 7.6600 5.0300 0.00 Second 3.3906 1.3438 0.00
Third 7.5800 4.5500 0.00 Third 3.6406 2.4531 0.00
Fourth 5.9400 3.2500 0.00 Fourth 6.2813 2.9063 0.00
------------------------------------------- ------------------------------------------
$ 0.00 $ 0.00
======= ========
The closing price on December 31, 2002 was $3.74 per share. As of December
31, 2002, there were 37,140,625 shares of common stock outstanding with
approximately 1,800 registered holders and approximately 14,350 beneficial
owners.
We do not know when or if we will resume dividend payments on our common
stock or, if resumed, what the amount or timing of any dividend will be. All
accrued and unpaid dividends on our Series A, B and C preferred stock must be
paid in full before dividends on our common stock can be resumed.
Item 6 - Selected Financial Data
The following selected financial data with respect to our company should be
read in conjunction with our audited Consolidated Financial Statements which are
listed herein under Item 15 and are included on pages F-1 through F-37.
Year ended December 31,
------------------------------------------------------
2002 2001 2000 1999 1998
------------------------------------------------------
(In thousands, except per share amounts)
Operating Data
Revenues from core operations................................... $ 92,834 $ 89,460 $100,234 $121,906 $109,314
Revenues from nursing home operations........................... 4,277 168,158 175,559 26,223 -
------------------------------------------------------
Total revenues................................................ $137,111 $257,618 $275,793 $148,129 $109,314
------------------------------------------------------
Net (loss) earnings available to common (before gain (loss)
on assets sold, (loss) gain on early extinguishment of debt
in 2002 and 2001, gain on distribution of Omega Worldwide in
1998 and provision for impairment):........................... $(21,894) $(29,432) $(14,784) $ 40,047 $ 41,777
------------------------------------------------------
Net (loss) earnings before gain (loss) on assets sold, (loss)
gain on early extinguishment of debt in 2002 and 2001
and gain on distribution of Omega Worldwide in 1998.......... $(17,145) $(19,046) $(59,546) $ 30,178 $ 43,171
Net (loss) earnings available to common........................ (34,761) (36,651) (66,485) 10,040 68,015
Per share amounts:
Net (loss) earnings available to common (before gain (loss) on
assets sold and provision for impairment):
Basic........................................................ $ (0.63) $ (1.47) $ (0.74) $ 2.01 $ 2.09
Diluted...................................................... (0.63) (1.47) (0.74) 2.01 2.08
Net (loss) earnings available to common before (loss) gain on
early extinguishment of debt:
Basic........................................................ $ (1.00) $ (1.98) $ (3.32) $ 0.51 $ 3.39
Diluted...................................................... (1.00) (1.98) (3.32) 0.51 3.39
Net (loss) earnings available to common:
Basic........................................................ $ (1.00) $ (1.83) $ (3.32) $ 0.51 $ 3.39
Diluted...................................................... (1.00) (1.83) (3.32) 0.51 3.39
Dividends, Common Stock (1).................................... - - 1.00 2.80 2.68
Dividends, Series A Preferred (1).............................. - - 2.31 2.31 2.31
Dividends, Series B Preferred (1).............................. - - 2.16 2.16 1.08
Dividends, Series C Preferred (2).............................. - - 0.25 - -
Weighted-average common shares outstanding, Basic.............. 34,739 20,038 20,052 19,877 20,034
Weighted-average common shares outstanding, Diluted............ 34,739 20,038 20,052 19,877 20,041
December 31,
-------------------------------------------------------
2002 2001 2000 1999 1998
-------------------------------------------------------
Balance Sheet Data
Gross investments.............................................. $882,313 $938,228 $974,507 $1,072,398 $1,069,646
Total assets................................................... 802,620 890,839 948,451 1,038,731 1,037,207
Revolving lines of credit...................................... 177,000 193,689 185,641 166,600 123,000
Other long-term borrowings..................................... 129,462 219,483 249,161 339,764 342,124
Subordinated convertible debentures............................ - - 16,590 48,405 48,405
Stockholders' equity........................................... 479,701 450,690 464,313 457,081 505,762
- ----------
(1) Dividends per share are those declared and paid during such period.
(2) Dividends per share are those declared during such period, based on the
number of shares of common stock issuable upon conversion of the
outstanding Series C.
Item 7 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
This document contains forward-looking statements, including statements
regarding potential asset sales, potential future changes in reimbursement, the
future effect of the "Medicare cliff" on our operators and plans to refinance or
extend our upcoming debt maturity. These statements relate to our expectations,
beliefs, intentions, plans, objectives, goals, strategies, future events,
performance and underlying assumptions and other statements other than
statements of historical facts. In some cases, you can identify forward-looking
statements by the use of forward-looking terminology including "may," "will,"
"anticipates," "expects," "believes," "intends," "should" or comparable terms or
the negative thereof. These statements are based on information available on the
date of this filing and only speak as to the date hereof and no obligation to
update such forward-looking statements should be assumed. Our actual results may
differ materially from those reflected in the forward-looking statements
contained herein as a result of a variety of factors, including, among other
things: (i) those items discussed in Item 1 above; (ii) regulatory changes in
the healthcare sector, including without limitation, changes in Medicare
reimbursement; (iii) changes in the financial position of our operators; ( iv)
the ability of operators in bankruptcy to reject unexpired lease obligations,
modify the terms of our mortgages, and impede our ability to collect unpaid rent
or interest during the pendency of a bankruptcy proceeding and retain security
deposits for the debtor's obligations; (v) our ability to dispose of assets held
for sale on a timely basis and at appropriate prices; (vi) uncertainties
relating to the operation of our owned and operated assets, including those
relating to reimbursement by third-party payors, regulatory matters and
occupancy levels; (vii) our ability to manage, re-lease or sell owned and
operated assets; (viii) the availability and cost of capital; and (ix)
competition in the financing of healthcare facilities.
Overview
The long-term care industry changed dramatically following the Balanced
Budget Act of 1997, which introduced the prospective payment system for the
reimbursement of Medicare patients in skilled nursing facilities, implementing
an acuity-based reimbursement system in lieu of the cost-based reimbursement
system historically used. The prospective payment system significantly reduced
payments to nursing home operators. That reduction, in turn, has negatively
affected the revenues of our nursing home facilities and the ability of our
nursing home operators to service their capital costs to us. Many nursing home
operators, including a number of our large nursing home operators, have sought
protection under Chapter 11 of the Bankruptcy Act.
In response to the adverse impact of the prospective payment system
reimbursement cuts, the Federal government passed the Balanced Budget Refinement
Act of 1999 ("Balanced Budget Refinement Act") and the Benefits Improvement and
Protection Act of 2000 ("Benefits Improvement and Protection Act"), both of
which increased payments to nursing home operators on an interim basis. In prior
years these increases positively affected the revenues of our nursing home
facilities and the ability of our nursing home operators to service their
capital costs to us. In addition, the facilities that we own and currently
operate for our own account were positively affected in prior years by the
Balanced Budget Refinement Act and Benefits Improvement and Protection Act.
Certain of the increases in Medicare reimbursement for skilled nursing
facilities provided for under the Balanced Budget Refinement Act and the
Benefits Improvement and Protection Act ceased in October 2002. The partial
expiration of Balance Budget Relief Act and Benefits Improvement and Protection
Act increases as of October 1, 2002 has had an adverse impact on the revenues of
the operators of nursing facilities and has negatively impacted some operators'
ability to satisfy their monthly lease or debt payments to us. For further
discussion, see "Item 1-Overview-Government Healthcare Regulation Reimbursements
and Industry Concentration Risks." Unless Congress enacts additional
legislation, the loss of revenues associated with this occurrence will continue
to have an adverse effect on our operators. Due to the temporary nature of the
remaining payment increases, we cannot assure you that the federal reimbursement
will remain at levels comparable to present levels and that such reimbursement
will be sufficient for our lessees or mortgagors to cover all operating and
fixed costs necessary to care for Medicare and Medicaid patients. We also cannot
assure you that there will be any future legislation to increase payment rates
for skilled nursing facilities. If payment rates for skilled nursing facilities
are not increased in the future, some of our lessees and mortgagors may have
difficulty meeting their payment obligations to us.
In addition, each state has its own Medicaid program that is funded jointly
by the state and federal government. Federal law governs how each state manages
its Medicaid program, but there is wide latitude for states to customize
Medicaid programs to fit the needs and resources of its citizens. The Balanced
Budget Act repealed the federal payment standard, also known as the Boren
Amendment, for hospitals and nursing facilities under Medicaid, increasing
states' discretion over the administration of Medicaid programs. A number of
states are considering legislation designed to reduce their Medicaid
expenditures which could result in decreased revenues for our lessees and
mortgagors.
The initial impact of the prospective payment system negatively affected
our financial results and our access to capital sources to fund growth and
refinance existing indebtedness. To obtain sufficient liquidity to enable us to
address the maturity in July 2000 and February 2001 of indebtedness totaling
$129.8 million, we issued $100.0 million of Series C preferred stock to Explorer
Holdings, L.P. ("Explorer") in July 2000 as described in more detail in Note 10
- - Stockholders' Equity and Stock Options to our audited Consolidated Financial
Statements.
As a consequence of the financial difficulties encountered by a number of
our nursing home operators in the late 1990's, we have recovered various
long-term care assets pledged as collateral for the operators' obligations
either in connection with a restructuring or settlement with certain operators
or pursuant to foreclosure proceedings. Under normal circumstances, we would
seek to re-lease or otherwise dispose of such assets as promptly as practicable.
However, a number of companies were actively marketing portfolios of similar
assets and, in light of the market conditions in the long-term care industry
generally, it had become more difficult both to sell these properties and for
potential buyers to obtain financing to acquire them. As a result, during 2000,
$24.3 million of assets previously classified as held for sale were reclassified
to "owned and operated assets" as the timing and strategy for sale or,
alternatively, re-leasing, were revised in light of prevailing market
conditions.
At December 31, 2001, we owned 33 long-term healthcare facilities that had
been recovered from customers and were operated for our own account. Due to
re-leasing and asset sales, we owned three such facilities at December 31, 2002.
During 2000 and 2001, we experienced a significant increase in nursing home
revenues attributable to the increase in owned and operated assets. During 2002,
these increases abated as we re-leased, sold or closed all but three of these
facilities. For the twelve months ended December 31, 2002, 32% of our revenues
were from owned and operated assets as compared to 65% for the same twelve-month
period in 2001. In addition, in connection with the recovery of these assets, we
often fund working capital and deferred capital expenditure needs for a
transitional period until license transfers and other regulatory matters are
completed and reimbursement from third-party payors recommences. Our management
intends to sell or re-lease these assets as promptly as possible, consistent
with achieving valuations that reflect our management's estimate of fair value
of the assets. We do not know, however, if, or when, the dispositions will be
completed or whether the dispositions will be completed on terms that will
enable us to realize the fair value of such assets.
In February 2001, we suspended dividends on all common and preferred stock.
We do not know when, or if, we will resume dividend payments on our common stock
or, if resumed, what the amount or timing of any dividend will be. Prior to
recommencing the payment of dividends on our common stock, all accrued and
unpaid dividends on our Series A, B and C preferred stock must be paid in full.
We have made sufficient distributions to satisfy the distribution requirements
under the REIT rules of the Internal Revenue Code of 1986 to maintain our REIT
status for 2001. For tax year 2002, we are currently projecting a tax loss;
therefore, we anticipate no distribution will be required to satisfy the 2002
REIT rules. However, if we have taxable income, we intend to make the necessary
distributions to satisfy the 2002 REIT requirements.
On February 6, 2002, we refinanced our investment in a Baltimore, Maryland
asset leased by the United States Postal Service ("USPS") resulting in $13.0
million of net cash proceeds. The new, fully-amortizing mortgage has a 20-year
term with a fixed interest rate of 7.26%. This transaction is cash neutral to us
on a monthly basis, as lease payments due from USPS equal debt service on the
new loan.
On February 21, 2002, we raised gross proceeds of $50.0 million through the
completion of a rights offering and simultaneous private placement to Explorer.
The proceeds from the rights offering and private placement were used to repay
outstanding indebtedness and for working capital and general corporate purposes.
During 2002, we paid off the remaining $97.5 million of our 6.95% Notes
that matured in June 2002, resulting in a loss on early extinguishment of debt
of approximately $49,000. In addition, during 2002, as a result of foreclosure
proceedings, we relinquished title to certain properties with a net carrying
value of approximately $5.2 million in satisfaction of certain mortgage
obligations owed to the Department of Housing and Urban Development ("HUD") in
the amount of $5.2 million.
On June 21, 2000, we were named as a defendant in certain litigation
brought against us in the U.S. District Court for the Eastern District of
Michigan, Detroit Division, by Madison/OHI Liquidity Investors, LLC ("Madison"),
for the breach and/or anticipatory breach of a revolving loan commitment. Ronald
M. Dickerman and Bryan Gordon are partners in Madison and limited guarantors
("Guarantors") of Madison's obligations to us. Madison claimed damages as a
result of the alleged breach of approximately $0.7 million and damages in an
amount ranging from $15 to $28 million for the anticipatory breach. We filed
counterclaims against Madison and the guarantors seeking repayment of
approximately $7.4 million of unpaid principal on the loan, plus accrued
interest. Effective as of September 30, 2002, the parties settled all claims in
the suit in consideration of Madison's payment of the sum of $5.4 million. The
payment by Madison consists of a $0.4 million cash payment for our attorneys'
fees, with the balance evidenced by the amendment of the existing promissory
note from Madison to us. The note reflects a principal balance of $5.0 million,
with interest accruing at 9% per annum, payable over three years upon
liquidation of the collateral securing the note. The note is also fully
guaranteed by the Guarantors; provided that if all accrued interest and 75% of
original principal has been repaid within 18 months, the Guarantors will be
released. Accordingly, a reserve of $1.25 million was recorded relating to this
note.
Critical Accounting Policies
The preparation of financial statements in conformity with generally
accepted accounting principles ("GAAP") in the United States requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Our significant accounting policies are described
in Note 1 in the Notes to Consolidated Financial Statements. These policies were
followed in preparing the consolidated financial statements for all periods
presented. Actual results could differ from those estimates.
We have identified six significant accounting policies as critical
accounting policies. These critical accounting policies are those that have the
most impact on the reporting of our financial condition and those requiring
significant judgments and estimates. With respect to these critical accounting
policies, we believe the application of judgments and assessments is
consistently applied and produces financial information that fairly presents the
results of operations for all periods presented. The six critical accounting
policies are:
Owned and Operated Assets and Assets Held for Sale. When we acquire real
estate pursuant to a foreclosure proceeding, it is designated as "owned and
operated assets" and is recorded at the lower of cost or fair value and is
included in real estate properties on our Consolidated Balance Sheet. Operating
assets and operating liabilities for the owned and operated properties are shown
separately on the face of our Consolidated Balance Sheet and are detailed in
Note 16--Segment Information.
When a formal plan to sell real estate is adopted and we hold a contract
for sale, the real estate is classified as "assets held for sale," with the net
carrying amount adjusted to the lower of cost or estimated fair value, less cost
of disposal. Depreciation of the facilities is excluded from operations after
management has committed to a plan to sell the asset. Upon adoption of Financial
Accounting Standards Board ("FASB") 144 as of January 1, 2002, long-lived assets
sold or designated as held for sale after January 1, 2002 are reported as
discontinued operations in our financial statements.
Impairment of Assets. We periodically evaluate our real estate investments
for impairment indicators. The judgment regarding the existence of impairment
indicators are based on factors such as market conditions, operator performance
and legal structure. If indicators of impairment are present, we evaluate the
carrying value of the related real estate investments in relationship to the
future undiscounted cash flows of the underlying facilities. Provisions for
impairment losses related to long-lived assets are recognized when expected
future cash flows are less than the carrying values of the assets. If the sum of
the expected future cash flow, including sales proceeds, is less than carrying
value, we then adjust the net carrying value of leased properties and other
long-lived assets to the present value of expected future cash flows.
Loan Impairment Policy. When management identifies an indication of
potential loan impairment, such as non-payment under the loan documents or
impairment of the underlying collateral, the loan is written down to the present
value of the expected future cash flows. In cases where expected future cash
flows cannot be estimated, the loan is written down to the fair value of the
collateral.
Accounts Receivable. Accounts receivable consists primarily of lease and
mortgage interest payments. Amounts recorded include estimated provisions for
loss related to uncollectible accounts and disputed items. On a monthly basis,
we review the contractual payment versus actual cash payment received and the
contractual payment due date versus actual receipt date. When management
identifies delinquencies, a judgment is made as to the amount of provision, if
any, that is needed.
Accounts Receivable--Owned and Operated Assets. Accounts receivable from
owned and operated assets consist of amounts due from Medicare and Medicaid
programs, other government programs, managed care health plans, commercial
insurance companies and individual patients. Amounts recorded include estimated
provisions for loss related to uncollectible accounts and disputed items.
Revenue Recognition. Rental income and mortgage interest income are
recognized as earned over the terms of the related Master Leases and mortgage
notes, respectively. Such income includes periodic increases based on
pre-determined formulas (i.e., such as increases in the CPI) as defined in the
Master Leases and mortgage loan agreements. Reserves are taken against earned
revenues from leases and mortgages when collection of amounts due become
questionable or when negotiations for restructurings of troubled operators lead
to lower expectations regarding ultimate collection. When collection is
uncertain, lease revenues are recorded as received, after taking into account
application of security deposits. Interest income on impaired mortgage loans is
recognized as received after taking into account application of security
deposits.
Nursing home revenues from owned and operated assets (primarily Medicare,
Medicaid and other third party insurance) are recognized as patient services are
provided.
Results of Operations
The following is our discussion of the consolidated results of operations,
financial position and liquidity and capital resources, which should be read in
conjunction with our consolidated financial statements and accompanying notes.
Year Ended December 31, 2002 compared to Year Ended December 31, 2001
Our revenues for the year ended December 31, 2002 totaled $137.1 million, a
decrease of $120.5 million over 2001 revenues. Excluding nursing home revenues
of owned and operated assets, revenues were $92.8 million for the year ended
December 31, 2002, an increase of $3.4 million from the comparable prior year
period.
Our rental income for the year ended December 31, 2002 totaled $64.8
million, an increase of $3.6 million over 2001 rental income. The increase is
due to $8.0 million from new leases on assets previously classified as owned and
operated and $0.9 million of contractual rent increases on the existing
portfolio. This increase is partially offset by a reduction of revenues of $5.3
million due to bankruptcies and restructurings.
Our mortgage interest income for the year ended December 31, 2002 totaled
$21.0 million, increasing $0.2 million. The increase is due to $1.1 million for
new investments placed during 2001 and receipt in 2002 of $1.6 million of
interest due in 2001 and not received until 2002, offset by $1.5 million from
loans paid off, $0.9 million due to restructurings and bankruptcies and $0.1
million due to normal amortization of the portfolio.
Our nursing home revenues of owned and operated assets for the year ended
December 31, 2002 totaled $44.3 million, decreasing $123.9 million over 2001
nursing home revenues. This decrease is due to the releasing, sale and/or
closure of 30 assets in 2002.
Our expenses for the year ended December 31, 2002 totaled $154.3 million,
decreasing approximately $122.4 million over expenses of $276.7 million for
2001.
Our nursing home expenses for owned and operated assets decreased to $65.7
million from $176.2 million in 2001 due to the releasing, sale and/or closure of
30 owned and operated assets during the year. In 2002, nursing home expenses
included a $5.9 million provision for uncollectible accounts receivable and $4.3
million of expenses related to leasehold buy outs. Nursing home expenses in 2001
included a $7.3 million provision for uncollectible accounts receivable.
The 2002 provision for depreciation and amortization of real estate totaled
$21.3 million, decreasing $0.8 million over 2001. The decrease consists
primarily of $0.4 million of leasehold amortization expense for leaseholds
written down in 2001 or sold in 2002 and $0.6 million from properties sold,
impaired or reclassified to held for sale, offset by $0.2 million from
properties previously classified as mortgages.
Our interest expense for the year ended December 31, 2002 was approximately
$27.3 million, compared with $36.3 million for 2001. The decrease in 2002 is due
to the payoff of $97.5 million of 6.95% Notes that matured in June 2002 and
lower average borrowings on our credit facilities.
Our general and administrative expenses for 2002 totaled $6.3 million as
compared to $10.4 million for 2001, a decrease of $4.1 million. The decrease is
due to lower consulting costs, primarily related to the owned and operated
facilities and cost reductions due to reduced staffing, travel and other
employee-related expenses.
Our legal expenses for 2002 totaled $2.9 million as compared to $4.3
million in 2001. The decrease is largely attributable to a reduction of legal
costs associated with our owned and operated facilities due to the releasing,
sale and/or closure of 30 owned and operated assets during the year.
In the fourth quarter of 2002, we recognized a $7.0 million refinancing
expense as we were unable to complete a planned commercial mortgage-backed
securities ("CMBS") transaction due to the impact on our operators resulting
from reductions in Medicare reimbursement and concerns about potential Medicaid
rate reductions. We continue to actively pursue refinancing alternatives in
order to extend current debt maturities. Among other things, we are continuing
discussions to extend or refinance our $160 million Fleet credit facility,
currently scheduled to mature in December 2003. At this time, there can be no
assurance that we will be able to reach acceptable agreements with our bank
lenders and/or other capital sources to achieve the desired refinancing.
A provision for impairment of $15.4 million and $9.6 million is included in
expenses for 2002 and 2001, respectively. The 2002 provision consisted of $12.4
million to reduce the carrying value of eight closed facilities to their fair
value less cost to dispose, including $2.7 million for two facilities previously
classified as held for sale, and $3.0 million related to owned and operated
assets that management determined were impaired. The 2001 provision included
$8.3 million to reduce facilities recovered from operators and classified as
held for sale assets to fair value less cost to dispose, and $1.2 million
related to other real estate assets that management determined were impaired.
We recognized a provision for loss on uncollectible mortgages, notes and
accounts receivable of $8.8 million in 2002. The provision included $4.9 million
associated with the write down of two mortgage loans to bankrupt operators and
$3.5 million related to the restructuring of debt owed by Madison/OHI Liquidity
Investors, LLC ("Madison") as part of the compromise and settlement of a lawsuit
with Madison. (See Note 14 - Litigation to our audited Consolidated Financial
Statements). The 2002 provision also included $0.4 million to adjust accounts
receivable to their net realizable value. In 2001, we recognized a provision for
uncollectible mortgages, notes and accounts receivable of $0.7 million to adjust
the carrying value of accounts receivable to net realizable value.
In 2001, we recorded a $5.1 million charge for severance, moving and
consulting agreement costs. This charge was comprised of $4.6 million for
relocation of our corporate headquarters and $0.5 million for consulting and
severance payments to a former executive.
In 2001, we recorded a $10 million litigation settlement to settle a suit
brought by Karrington Health, Inc. in 1998. This settled all claims arising from
the suit, but without our admission of any liability or fault, which liability
is expressly denied. Based on the settlement, the suit was dismissed with
prejudice.
During 2002, we recorded a non-cash gain of $0.9 million related to the
maturity and payoff of two interest rate swaps with a notional amount of $32.0
million each. We recorded a non-cash charge of $1.3 million for 2001 related to
the adoption of FASB Statement No. 133, Accounting for Derivative Instruments
and Hedging Activities, which was required to be adopted in years beginning
after June 15, 2000.
During 2002, we recognized a gain on assets sold of $2.5 million, primarily
from the sale of our investment in Omega Worldwide, Inc. ("Worldwide"). Pursuant
to a tender offer by Four Seasons Health Care Limited ("Four Seasons") for all
of the outstanding shares of common stock of Worldwide, we sold our investment,
which consisted of 1.2 million shares of common stock and 260,000 shares of
preferred stock, to Four Seasons for cash proceeds of approximately $7.4 million
(including $3.5 million for preferred stock liquidation preference and accrued
preferred dividends). In addition, we sold our investment in Principal
Healthcare Finance Limited, an Isle of Jersey company ("PHFL"), which consisted
of 990,000 ordinary shares and warrants to purchase 185,033 ordinary shares, to
an affiliate of Four Seasons for cash proceeds of $2.8 million. Both
transactions were completed in September 2002 and provided aggregate cash
proceeds of $10.2 million. We realized a gain from the sale of our investments
in Worldwide and PHFL of $2.2 million. We no longer own any interest in
Worldwide or PHFL. In addition, we sold certain other assets in 2002 realizing
cash proceeds of $7.5 million, resulting in a net accounting gain of $0.3
million. During 2001, we sold certain other assets realizing cash proceeds of
$3.9 million, resulting in an accounting loss of $0.7 million.
During 2002, we recognized a loss of $49,000 on early extinguishment of
debt with the repurchase of $62.7 million of the remaining $97.5 million of our
6.95% Notes that matured in June of 2002. For the year ending December 31, 2001,
we repurchased $27.5 million of the same 6.95% Notes maturing in June 2002,
recognizing a gain on early extinguishment of debt of $3.1 million.
Our funds from operations for the year ended December 31, 2002, on a fully
diluted basis totaled $8.9 million, an increase of $4.6 million as compared to
the $4.3 million for 2001 due to factors mentioned above. After adjusting for
the non-recurring provision for loss on mortgages, notes and accounts
receivable, severance and consulting costs, one-time revenue adjustments,
refinancing expense and litigation settlement expense, funds from operations on
a fully diluted basis was $27.6 million in 2002, an increase of $2.1 million
from the year ended December 31, 2001. Funds from operations is net earnings
available to common stockholders, excluding any gains or losses from debt
restructuring and the effects of asset dispositions, plus depreciation and
amortization associated with real estate investments. Diluted funds from
operations is the lower of funds from operations and funds from operations
adjusted for the assumed conversion of Series C preferred stock and the exercise
of in-the-money stock options. We consider funds from operations to be one
performance measure which is helpful to investors of real estate companies
because, along with cash flows from operating activities, financing activities
and investing activities, it provides investors an understanding of our ability
to incur and service debt and to make expenditures. Funds from operations in and
of itself does not represent cash generated from operating activities in
accordance with generally accepted accounting principles and therefore should
not be considered an alternative to net earnings as an indication of operating
performance, or to net cash flow from operating activities as determined by
generally accepted accounting principles in the United States, as a measure of
liquidity and is not necessarily indicative of cash available to fund cash
needs.
No provision for federal income taxes has been made since we qualify as a
real estate investment trust ("REIT") under the provisions of Sections 856
through 860 of the Internal Revenue Code of 1986, as amended. Accordingly, we
have not been subject to federal income taxes on amounts distributed to
stockholders, since we have distributed at least 90% of our REIT taxable income
for taxable year 2001 (95% prior to 2001) and have met certain other conditions.
For tax year 2002, we are currently projecting a tax loss; therefore, we
anticipate no distribution will be required to satisfy the 2002 REIT rules.
However, if we have taxable income, we intend to make the necessary
distributions to satisfy the 2002 REIT requirements.
Year Ended December 31, 2001 compared to Year Ended December 31, 2000
Our revenues for the year ended December 31, 2001 totaled $257.6 million, a
decrease of $18.2 million over 2000 revenues. Excluding nursing home revenues of
owned and operated assets, revenues were $89.5 million for the year ended
December 31, 2001, a decrease of $10.8 million from the comparable prior year
period.
Our rental income for the year ended December 31, 2001 totaled $61.2
million, a decrease of $6.1 million over 2000 rental income. The decrease is due
to $6.3 million from reductions in lease revenue due to foreclosures,
bankruptcies, restructurings and reserve for non-payment of certain leases, and
$1.8 million from reduced investments caused by 2000 and 2001 asset sales. These
decreases are offset by $1.3 million relating to contractual increases in rents
that became effective in 2001 as defined under the related agreements and $0.7
million relating to assets previously classified as owned and operated.
Our mortgage interest income for the year ended December 31, 2001 totaled
$20.8 million, decreasing $3.3 million over 2000 mortgage interest income. The
decrease is due to $1.6 million from reductions due to foreclosures,
bankruptcies, restructurings and reserve for non-payment of certain mortgages
and $2.0 million from reduced investments caused by the payoffs of mortgages.
These decreases are partially offset by $0.2 million relating to contractual
increases in interest income that became effective in 2001 as defined under the
related agreements and $0.1 million relating to assets previously classified as
owned and operated.
Our nursing home revenues of owned and operated assets for the year ended
December 31, 2001 totaled $168.1 million, decreasing $7.4 million over 2000
nursing home revenues. The decrease is due to the sale and re-leasing of certain
owned and operated assets during the year.
Our expenses for the year ended December 31, 2001 totaled $276.7 million,
decreasing approximately $58.7 million over expenses of $335.3 million for 2000.
Our nursing home expenses for owned and operated assets decreased to $176.2
million from $179.0 million in 2000 due to the sale and re-leasing of certain
owned and operated assets during the year. In 2001, nursing home expenses
included a $7.3 million provision for uncollectible accounts receivable versus a
$1.0 million provision for uncollectible accounts receivable in 2000.
The 2001 provision for depreciation and amortization of real estate totaled
$22.1 million, decreasing $1.2 million over 2000. The decrease primarily
consists of $0.9 million depreciation expense for properties sold or held for
sale and a reduction in amortization of non-compete agreements of $0.7 million
offset by $0.3 million additional depreciation expense from properties
previously classified as mortgages and new investments placed in service in 2000
and 2001.
Our interest expense for the year ended December 31, 2001 was approximately
$36.3 million, compared with $42.4 million for 2000. The decrease in 2001 is due
to both lower average interest rates during the 2001 period and lower average
borrowings.
Our general and administrative expenses for 2001 totaled $10.4 million as
compared to $6.4 million for 2000, an increase of $4.0 million. The increase is
due primarily to increased consulting costs related to the foreclosures and
lease restructures.
Our legal expenses for 2001 totaled $4.3 million as compared to $2.5
million in 2000. The increase is largely attributable to legal costs associated
with operator bankruptcy filings and negotiations with our troubled operators.
A provision for impairment of $9.6 million is included in expenses for
2001. This provision included $8.3 million to reduce facilities recovered from
operators and now classified as held for sale assets to fair value less cost to
dispose, and $1.2 million related to other real estate assets our management has
determined is impaired.
We recognized a provision for loss on uncollectible accounts of $0.7
million in 2001, adjusting the carrying value of accounts receivable to net
realizable value. In 2000, we recognized a provision for loss on mortgages and
notes receivable of $15.3 million, adjusting the carrying value of mortgages to
the estimated value of their collateral and notes receivable to their net
realizable value.
We recorded a $10 million litigation settlement expense in 2001 to settle a
suit brought by Karrington Health, Inc. in 1998. This settled all claims arising
from the suit, but without our admission of any liability or fault, which
liability is expressly denied. Based on the settlement, the suit was dismissed
with prejudice.
In 2001, we recorded a $5.1 million charge for severance, moving and
consulting agreement costs. This charge was comprised of $4.6 million for
relocation of our corporate headquarters and $0.5 million for consulting and
severance payments to our former Senior Vice President and General Counsel. In
2000, we recognized a $4.7 million charge for severance and consulting payments
to our former Chief Executive Officer and former Chief Financial Officer.
We recorded a non-cash charge of $1.3 million for 2001 related to the
adoption of FASB Statement No. 133, Accounting for Derivative Instruments and
Hedging Activities, which was required to be adopted in years beginning after
June 15, 2000. No such charge was recorded in 2000, as we adopted this new
statement effective January 1, 2001.
During 2001, we sold certain of our core and other assets realizing
proceeds of $3.9 million, resulting in a loss of $0.7 million. During 2000, we
completed asset sales yielding net proceeds of $34.7 million, resulting in a
gain of $10.0 million.
During 2001, we repurchased $27.5 million of our 6.95% Notes maturing in
June 2002, recognizing a gain on early extinguishment of debt of $3.1 million.
Our funds from operations for the year ended December 31, 2001 on a fully
diluted basis totaled $4.3 million, a decrease of $14.9 million as compared to
the $19.2 million for 2000 due to factors mentioned above. After adjusting for
the non-recurring provision for loss on mortgages, notes and accounts
receivable, severance and consulting costs, one-time revenue adjustments and
legal settlement expense, funds from operations for the year was $25.5 million,
a decrease of $8.9 million from the year ended December 31, 2000. Funds from
operations is net earnings available to common stockholders, excluding any gains
or losses from debt restructuring and the effects of asset dispositions, plus
depreciation and amortization associated with real estate investments. Diluted
funds from operations is the lower of funds from operations and funds from
operations adjusted for the assumed conversion of Series C preferred stock and
Subordinated Convertible Debentures and the exercise of in-the-money stock
options. We consider funds from operations to be one performance measure which
is helpful to investors of real estate companies because, along with cash flows
from operating activities, financing activities and investing activities, it
provides investors an understanding of our ability to incur and service debt and
to make expenditures. Funds from operations in and of itself does not represent
cash generated from operating activities in accordance with generally accepted
accounting principles and therefore should not be considered an alternative to
net earnings as an indication of operating performance, or to net cash flow from
operating activities as determined by generally accepted accounting principles
in the United States, as a measure of liquidity and is not necessarily
indicative of cash available to fund cash needs.
No provision for federal income taxes has been made since we qualify as a
REIT under the provisions of Sections 856 through 860 of the Internal Revenue
Code of 1986, as amended. Accordingly, we have not been subject to federal
income taxes on amounts distributed to stockholders, as we have distributed at
least 95% of our REIT taxable income for taxable years before 2001 and have met
certain other conditions. In 2001, and future taxable years, we are required to
distribute at least 90% of our REIT taxable income.
Portfolio Developments
The partial expiration of certain Medicare rate increases has had an
adverse impact on the revenues of the operators of nursing home facilities and
has negatively impacted some operators' ability to satisfy their monthly lease
or debt payment to us. In several instances we hold security deposits that can
be applied in the event of lease and loan defaults, subject to applicable
limitations under bankruptcy law with respect to operators seeking protection
under Chapter 11 of the Bankruptcy Act. (See Item 1 - Business of the Company -
Overview).
Alterra Healthcare Corporation. On January 14, 2003, we were notified by
Alterra Healthcare Corporation ("Alterra") that it did not intend to pay January
rent and that a restructuring of its Master Lease was necessary. We currently
lease eight assisted living facilities (325 units) located in seven states to
subsidiaries of Alterra. The Master Lease requires annual rent for 2003 of
approximately $3.2 million. On January 14, 2003, we declared an "Event of
Default" under its Master Lease and demanded payment under its Alterra
guarantee.
On January 22, 2003, Alterra announced that, in order to facilitate and
complete its on-going restructuring initiatives, they had filed a voluntary
petition with the U.S. Bankruptcy Court for the District of Delaware to
reorganize under Chapter 11 of the U.S. Bankruptcy Code. We intend to
aggressively pursue all avenues afforded us in order to enforce the terms and
conditions under the lease.
Integrated Health Services, Inc. Integrated Health Services, Inc. ("IHS")
filed for Chapter 11 bankruptcy protection in February 2000. With the exception
of a small portion of prepetition interest (approximately $63,000), IHS paid its
contractual mortgage interest from its bankruptcy filing in February 2000 until
October 2001. In November 2001, IHS informed us that it did not intend to pay
future rent and mortgage interest due. In January, 2002, IHS resumed making
payments to us. Revenue has been recorded as payments were received. At December
31, 2002, we held three mortgages on properties owned by IHS: a $35.6 million
mortgage collateralized by six facilities located in Florida and Texas; a $12
million mortgage collateralized by two facilities located in Georgia; and a $4.9
million mortgage collateralized by one facility located in Florida. Annual
contractual interest income on each of the mortgages is approximately $4.11
million, $1.28 million and $0.55 million, respectively. We also have a lease
with IHS for one property in the state of Washington, representing an investment
of $10.0 million and annualized contractual revenue of $1.49 million. IHS
rejected this lease on November 9, 2001.
In December 2002, an agreement was approved by the United States Bankruptcy
Court in Wilmington, Delaware between IHS and us, whereby upon notice provided
by us, IHS will convey ownership of eight skilled nursing facilities (five in
Florida, two in Georgia, and one in Texas) to one of our affiliates and transfer
the operations to our designee. Current appraisals of the properties underlying
the $12.0 million and $35.6 million mortgage loans indicate collateral value
supporting our mortgage loan balances. Accordingly, we do not expect to record
any reserves relative to these loans at this time. The amount of the $4.9
million mortgage has been fully reserved.
On February 1, 2003, we entered into a Master Lease, to re-lease a 130-bed
Texas facility, formerly operated by IHS, with Senior Management Services of
Treemont, Inc. The initial term is ten years with rent culminating at $0.4
million annually by the end of the third year. We are in the process of
negotiating lease arrangements on each of the remaining seven properties. (See
Note 19 - Subsequent Events to our audited Consolidated Financial Statements).
Lyric Healthcare LLC. We entered into a forbearance agreement with Lyric
Healthcare LLC ("Lyric") through August 31, 2001, whereby we received $541,266
of the $0.9 million monthly rent due under the Lyric leases through November
2001. On November 7, 2001, we were notified by Lyric that we would no longer be
receiving payments. In January, 2002, Lyric resumed making payments to us.
Revenue has been recorded as received. Our original investment in the ten
facilities covered under the lease is $95.4 million.
Effective January 1, 2003, we completed a restructured transaction with
Claremont Health Care Holdings, Inc. (formerly Lyric Health Care, LLC) whereby
nine facilities formerly leased under two Master Leases were combined into one
new ten year Master Lease. Annual rent under the new lease is $6.0 million, the
same amount of rent recognized in 2002 for these properties. As part of the
restructure, one facility located in Sarasota, Florida was closed and is
currently being marketed for sale. As a result of this closure, we recorded a
non-cash impairment of approximately $6.8 million in the fourth quarter of 2002.
In anticipation of this restructure, on November 1, 2002, Trans Health
Management replaced IHS as manager of these nine properties. (See Note 19 -
Subsequent Events to our audited Consolidated Financial Statements).
Mariner and Professional Healthcare Settlement. Effective September 1,
2001, we entered into a comprehensive settlement with Mariner Post-Acute
Network, Inc. ("Mariner") resolving all outstanding issues relating to our loan
to Professional Healthcare Management Inc. ("PHCM"), a subsidiary of Mariner.
Pursuant to the settlement, the PHCM loan is secured by a first mortgage on 12
skilled nursing facilities owned by PHCM with 1,679 operating beds. PHCM
remained obligated on the total outstanding loan balance as of January 18, 2000,
the date Mariner filed for protection under Chapter 11 of the Bankruptcy Act,
and paid us our accrued interest at a rate of approximately 11% for the period
from the filing date until September 1, 2001. Monthly payments with interest at
the rate of 11.57% per annum resumed October 1, 2001.
On February 1, 2001, four Michigan facilities, previously operated by PHCM
and subject to our pre-petition mortgage, were transferred by PHCM to Ciena
Health Care Management ("Ciena") who paid for the facilities by execution of a
promissory note that was assigned to us. PHCM was given a $4.5 million credit on
February 1, 2001 and an additional $3.5 million credit as of September 1, 2001,
both against the PHCM loan balance in exchange for the assignment of the
promissory note to us. The $8.7 million balance of the promissory note, which
was secured by a first mortgage on the four facilities, was paid in full during
2002.
Following the closing under the settlement agreement, the outstanding
principal balance on the PHCM loan is approximately $59.7 million. The PHCM loan
term is nine years, with PHCM having the option to extend for an additional
eleven years. PHCM has the option to prepay the PHCM loan between February 1,
2005 and July 31, 2005.
Sun Healthcare Group, Inc. On February 4, 2003, Sun Healthcare Group, Inc.
("Sun") remitted rent of $1.6 million versus the contractual amount of $2.1
million. We have agreed with Sun to use a letter of credit (posted by Sun as a
security deposit) in the amount of $0.5 million to make up the difference in
rent and agreed to temporarily forebear in declaring a default under the lease
caused by Sun's failure to restore the $0.5 million letter of credit. The letter
of credit was otherwise expiring on February 28, 2003 and was not being renewed.
We hold additional security deposits (in the form of cash and letters of credit)
of $2.3 million.
On February 7, 2003, Sun announced "that it has opened dialogue with many
of its landlords concerning the portfolio of properties leased to Sun and
various of its consolidated subsidiaries (collectively, the `Company'). The
Company is seeking a rent moratorium and/or rent concessions with respect to
certain of its facilities and is seeking to transition its operations of certain
facilities to new operators while retaining others." To this end, Sun has
initiated conversations with us regarding a restructure of our lease. At this
stage, it is too early to predict the outcome of those conversations. (See Note
19 - Subsequent Events to our audited Consolidated Financial Statements).
As of December 31, 2002, we have an original investment balance of $219.0
million relating to the Sun portfolio under agreements providing for annual
rental income of $25.1 million in 2002 and $25.7 million in 2003.
Other Operators. In April 2001, we were informed by TLC Healthcare, Inc.
("TLC") that it could no longer meet its payroll and other operating
obligations. We had leases and mortgages with TLC representing eight properties
with 1,049 beds and an initial investment of $27.5 million. As a result of this
action, one facility in Texas with an initial investment of $2.5 million was
leased to a new operator, Lamar Healthcare, Inc. and four prope