424B3: Prospectus filed pursuant to Rule 424(b)(3)

 

 

 

 

 

 

 

 

 

 

 

 

 

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X   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

                Maryland     38-3041398

                (State of Incorporation)     (I.R.S. Employer Identification No.)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to the filing requirements for the past 90 days.

Yes X     No __

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of “accelerated filer and larger accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one:)

Large accelerated filer __         Accelerated filer  X           Non-accelerated filer __ 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  __      No X  

 

 

 

 

(in thousands)

		June 30,			December 31,
			2006			2005
			(Unaudited)
ASSETS
Real estate properties
Land and buildings at cost		$	1,060,226		$	996,127
Less accumulated depreciation			(171,948	)		(157,255	)
Real estate properties - net			888,278			838,872
Mortgage notes receivable - net			32,381			104,522
			920,659			943,394
Other investments - net			29,060			23,490
			949,719			966,884
Assets held for sale - net			248			1,243
Total investments			949,967			968,127
Cash and cash equivalents			14,053			3,948
Accounts receivable			6,342			5,885
Other assets			13,998			37,769
Total assets		$	984,360		$	1,015,729
LIABILITIES AND STOCKHOLDERS’ EQUITY
Revolving line of credit		$	—		$	58,000
Unsecured borrowings - net			484,739			505,429
Other long-term borrowings			41,800			2,800
Accrued expenses and other liabilities			22,399			19,563
Operating liabilities for owned properties			125			256
Total liabilities			549,063			586,048
Stockholders’ equity:
Preferred stock			118,488			118,488
Common stock and additional paid-in-capital			680,443			663,607
Cumulative net earnings			245,843			227,701
Cumulative dividends paid			(568,150	)		(536,041	)
Cumulative dividends - redemption			(43,067	)		(43,067	)
Unamortized restricted stock awards			—			(1,167	)
Accumulated other comprehensive income			1,740			160
Total stockholders’ equity			435,297			429,681
Total liabilities and stockholders’ equity		$	984,360		$	1,015,729

Note - The balance sheet at December 31, 2005 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

 

See notes to consolidated financial statements.

 

 

		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2006			2005			2006			2005
Revenues
Rental income		$	29,042		$	22,514		$	57,975		$	44,262
Mortgage interest income			1,154			1,240			2,338			3,196
Other investment income - net			533			385			1,058			682
Miscellaneous			332			1,146			441			4,312
Total operating revenues			31,061			25,285			61,812			52,452
Expenses
Depreciation and amortization			7,542			6,044			15,060			11,742
General and administrative			2,313			2,123			4,662			4,235
Provision for uncollectible mortgages, notes and accounts receivable			-			83			-			83
Leasehold expiration expense			-			750			-			750
Total operating expenses			9,855			9,000			19,722			16,810
Income before other income and expense			21,206			16,285			42,090			35,642
Other income (expense):
Interest and other investment income			69			24			182			65
Interest			(9,447	)		(6,948	)		(19,056	)		(13,722	)
Interest - amortization of deferred financing costs			(431	)		(525	)		(1,074	)		(1,031	)
Interest - refinancing costs			-			-			(3,485	)		-
Provision for impairment on equity securities			-			(3,360	)		-			(3,360	)
Total other expense			(9,809	)		(10,809	)		(23,433	)		(18,048	)
Income from continuing operations			11,397			5,476			18,657			17,594
(Loss) from discontinued operations			(136	)		(3,219	)		(515	)		(6,033	)
Net income			11,261			2,257			18,142			11,561
Preferred stock dividends			(2,481	)		(2,864	)		(4,962	)		(6,423	)
Preferred stock conversion and redemption charges			-			(2,013	)		-			(2,013	)
Net income (loss) available to common		$	8,780		$	(2,620	)	$	13,180		$	3,125
Income (loss) per common share:
Basic:
Income from continuing operations		$	0.15		$	0.01		$	0.24		$	0.18
Net income (loss)		$	0.15		$	(0.05	)	$	0.23		$	0.06
Diluted:
Income from continuing operations		$	0.15		$	0.01		$	0.24		$	0.18
Net income (loss)		$	0.15		$	(0.05	)	$	0.23		$	0.06
Dividends declared and paid per common share		$	0.24		$	0.21		$	0.47		$	0.41
Weighted-average shares outstanding, basic			58,158			51,031			57,787			50,980
Weighted-average shares outstanding, diluted			58,237			51,365			57,858			51,339
Components of other comprehensive income:
Net income		$	11,261		$	2,257		$	18,142		$	11,561
Unrealized gain on investments			881			-			1,580			-
Total comprehensive income		$	12,142		$	2,257		$	19,722		$	11,561

 

 

See notes to consolidated financial statements.

 

		Six Months Ended June 30,
			2006			2005
Operating activities
Net income		$	18,142		$	11,561
Adjustment to reconcile net income to cash provided by operating activities:
Depreciation and amortization (including amounts in discontinued operations)			15,069			12,793
Provision for impairment on real estate properties (including amounts in discontinued operations)			121			3,700
Provision for uncollectible mortgages, notes and accounts receivable			—			83
Provision for impairment on equity securities			—			3,360
Refinancing costs			3,485			—
Amortization of deferred financing costs			1,074			1,031
Loss on assets sold - net			381			4,202
Restricted stock amortization expense			585			571
Other			(23	)		(1,516	)
Net change in accounts receivable			(457	)		1,541
Net change in other assets			1,598			135
Net change in operating assets and liabilities			2,708			(3,078	)
Net cash provided by operating activities			42,683			34,383
Cash flows from investing activities
Acquisition of real estate			—			(120,696	)
Proceeds from sale of real estate investments			657			24,995
Cash in transit from sale			—			(12,689	)
Capital improvements and funding of other investments			(3,649	)		(1,338	)
Proceeds from other investments			17,242			1,262
Investments in other investments			(20,339	)		(5,897	)
Collection of mortgage principal			10,392			60,492
Net cash provided by (used in) investing activities			4,303			(53,871	)
Cash flows from financing activities
Proceeds from credit facility borrowings			48,200			168,000
Payments on credit facility borrowings			(106,200	)		(81,500	)
Receipts from other long-term borrowings			39,000			—
Prepayment of re-financing penalty			(755	)		—
Receipts from dividend reinvestment plan			17,320			757
Receipts/(payments) from exercised options - net			225			(810	)
Dividends paid			(32,109	)		(28,134	)
Redemption of preferred stock			—			(50,013	)
Payment on common stock offering			(178	)		(28	)
Deferred financing costs paid			(2,384	)		(333	)
Net cash (used in) provided by financing activities			(36,881	)		7,939
Increase (decrease) in cash and cash equivalents			10,105			(11,549	)
Cash and cash equivalents at beginning of period			3,948			12,083
Cash and cash equivalents at end of period		$	14,053		$	534
Interest paid during the period		$	12,644		$	13,867

 

See notes to consolidated financial statements.

In the ordinary course of our business activities, we periodically evaluate investment opportunities and extend credit to customers. We also regularly engage in lease and loan extensions and modifications. Additionally, we actively monitor and manage our investment portfolio with the objectives of improving credit quality and increasing returns. In connection with portfolio management, we may engage in various collection and foreclosure activities.

 

If we acquire real estate pursuant to a foreclosure, lease termination or bankruptcy proceeding and do not immediately re-lease or sell the properties to new operators, the assets will be included on the balance sheet as “foreclosed real estate properties,” and the value of such assets is reported at the lower of cost or estimated fair value.

The table below summarizes our number of properties and investment by category for the six months ended June 30, 2006:

					Mortgage						Total
		Leased			Notes			Facilities			Healthcare
Facility Count			Property			Receivable			Held for Sale			Facilities
Balance at December 31, 2005			192			32			3			227
Properties sold/mortgages paid			-			(15	)		(3	)		(18	)
Properties transferred to assets held for sale			(1	)		-			1			-
Properties transferred to purchase/leaseback			7			(7	)		-			-
Balance at June 30, 2006			198			10			1			209
Investment ($000’s)
Balance at December 31, 2005		$	996,127		$	104,522		$	1,243		$	1,101,892
Properties sold/mortgages paid			-			(48,990	)		(1,860	)		(50,850	)
Properties transferred to assets held for sale			(865	)		-			865			-
Properties transferred to purchase/leaseback			61,750			(22,750	)		-			39,000
Impairment on properties			(121	)		-			-			(121	)
Capital expenditures and other			3,335			(401	)		-			2,934
Balance at June 30, 2006		$	1,060,226		$	32,381		$	248		$	1,092,855

Our leased real estate properties, represented by 196 long-term care facilities and two rehabilitation hospitals at June 30, 2006, are leased under provisions of single leases and master leases with initial terms typically ranging from 5 to 15 years, plus renewal options. Substantially all of the leases and master leases provide for minimum annual rentals that are subject to annual increases based upon increases in the

Set forth below is a summary of the transactions that occurred in the six months ended June 30, 2006.

·

During the three months ended March 31, 2006, Haven Eldercare, LLC (“Haven”), an existing operator of ours, entered into a $39 million first mortgage loan with General Electric Capital Corporation (“GE Loan”). Haven used the $39 million of proceeds to partially repay on a $62 million mortgage it has with us. Simultaneously, we subordinated the payment of our remaining $23 million of the mortgage note, due in October 2012, to that of the GE Loan. As a result of this transaction, the interest rate on our remaining mortgage note to Haven rose from 10% to approximately 15%, with annual escalators.

·

In conjunction with the above transactions and the application of FIN 46R, we consolidated the financial statements and related real estate of this Haven entity into our financial statements. The consolidation resulted in the following changes to our consolidated balance sheet as of June 30, 2006: (1) an increase in total gross investments of $39.0 million; (2) an increase in accumulated depreciation of $0.8 million; (3) an increase in other long-term borrowings of $39.0 million; and (4) a reduction of $0.8 million in cumulative net earnings for the six months ended June 30, 2006 due to the increased depreciation expense. General Electric Capital Corporation and Haven’s other creditors do not have recourse to our assets. We have an option to purchase the mortgaged facilities for a fixed price in 2012. Our results of operations reflect the effects of the consolidation of this entity, which is being accounted for similarly to our other purchase-leaseback transactions.

·	There were no acquisitions made during the three and six months ended June 30, 2006.

·	On June 30, 2006, we sold two SNFs in California resulting in an accounting loss of approximately $0.1 million.

·	On March 31, 2006, we sold a SNF in Illinois resulting in an accounting loss of approximately $0.2 million.

·	At June 30, 2006, we had one asset held for sale with a net book value of approximately $0.2 million.

·	During the three months ended March 31, 2006, a $0.1 million provision for impairment charge was recorded to reduce the carrying value to its sales price of one facility that was under contract to be sold that was subsequently sold during the second quarter of 2006.

Mortgage notes receivable relate to 10 long-term care facilities. The mortgage notes are secured by first mortgage liens on the borrowers' underlying real estate and personal property. The mortgage notes receivable relate to facilities located in five states, operated by seven independent healthcare operating companies. We monitor compliance with mortgages and when necessary have initiated collection, foreclosure and other proceedings with respect to certain outstanding loans. As of June 30, 2006, we had no foreclosed property, and none of our mortgages were in foreclosure proceedings.

Mortgage interest income is recognized as earned over the terms of the related mortgage notes. Reserves are taken against earned revenues from mortgage interest when collection of amounts due becomes questionable or when negotiations for restructurings of troubled operators lead to lower expectations regarding ultimate collection. When collection is uncertain, mortgage interest income on impaired mortgage loans is recognized as received after taking into account application of security deposits.

On June 16, 2006, we received approximately $10 million in proceeds on a mortgage loan payoff. We held mortgages on 15 facilities located in Indiana, representing 619 beds.

During the three months ended March 31, 2006, Haven used the $39 million of proceeds from the GE Loan to partially repay on a $62 million mortgage it has with us. Simultaneously, we subordinated the payment of its remaining $23 million on the mortgage note to that of the GE Loan (see Note - 2 Properties; Leased Property).

In order to qualify as a REIT, we are required to distribute dividends (other than capital gain dividends) to our stockholders in an amount at least equal to (A) the sum of (i) 90% of our "REIT taxable income" (computed without regard to the dividends paid deduction and our net capital gain), and (ii) 90% of the net income (after tax), if any, from foreclosure property, minus (B) the sum of certain items of non-cash income. In addition, if we dispose of any built-in gain asset during a recognition period, we will be required to distribute at least 90% of the built-in gain (after tax), if any, recognized on the disposition of such asset. Such distributions must be paid in the taxable year to which they relate, or in the following taxable year if declared before we timely file our tax return for such year and paid on or before the first regular dividend payment after such declaration. In addition, such distributions are required to be made pro rata, with no preference to any share of stock as compared with other shares of the same class, and with no preference to one class of stock as compared with another class except to the extent that such class is entitled to such a preference. To the extent that we do not distribute all of our net capital gain or do distribute at least 90%, but less than 100% of our "REIT taxable income," as adjusted, we will be subject to tax thereon at regular ordinary and capital gain corporate tax rates. In addition, our $200 million revolving senior secured credit facility (“Credit Facility”) has certain financial covenants that limit the distribution of dividends paid during a fiscal quarter to no more than 95% of our aggregate cumulative funds from operations (“FFO”) as defined in the loan agreement governing the Credit Facility (the “Loan Agreement”), unless a greater distribution is required to maintain REIT status. The Loan Agreement defines FFO as net income (or loss) plus depreciation and amortization and shall be adjusted for charges related to: (i) restructuring our debt; (ii) redemption of preferred stock; (iii) litigation charges up to $5.0 million; (iv) non-cash charges for accounts and notes receivable up to $5.0 million; (v) non-cash compensation related expenses; and (vi) non-cash impairment charges.

On July 17, 2006, the Board of Directors announced a common stock dividend of $0.24 per share to be paid August 15, 2006 to common stockholders of record on July 31, 2006.

On April 18, 2006, the Board of Directors declared a common stock dividend of $0.24 per share, an increase of $0.01 per common share compared to the prior quarter. The common dividend was paid May 15, 2006 to common stockholders of record on April 28, 2006.

On January 17, 2006, the Board of Directors declared a common stock dividend of $0.23 per share, an increase of $0.01 per common share compared to the prior quarter. The common stock dividend was paid February 15, 2006 to common stockholders of record on January 31, 2006.

 

On July 17, 2006, the Board of Directors declared the regular quarterly dividends for the 8.375% Series D Cumulative Redeemable Preferred Stock (“Series D Preferred Stock”) to stockholders of record on July 31, 2006. The stockholders of record of the Series D Preferred Stock on July 31, 2006 will be paid dividends in the amount of $0.52344 per preferred share on August 15, 2006. The liquidation

 

On April 18, 2006, the Board of Directors declared regular quarterly dividends of approximately $0.52344 per preferred share on the Series D Preferred Stock that were paid May 15, 2006 to preferred stockholders of record on April 28, 2006.

On January 17, 2006, the Board of Directors declared regular quarterly dividends of approximately $0.52344 per preferred share on the Series D Preferred Stock that were paid February 15, 2006 to preferred stockholders of record on January 31, 2006.

 

As a qualified REIT, as long as we distribute 100% of our taxable income, we will not be subject to Federal income taxes on our income, and no provisions for Federal income taxes have been made. We are permitted to own up to 100% of a “taxable REIT subsidiary” (“TRS”). Currently, we have two TRSs that are taxable as corporations and that pay federal, state and local income tax on their net income at the applicable corporate rates. These TRSs had net operating loss carry-forwards as of June 30, 2006 of $10.1 million. These loss carry-forwards were fully reserved with a valuation allowance due to uncertainties regarding realization.

Prior to January 1, 2006, we accounted for stock based compensation using the intrinsic value method as defined by APB Opinion No. 25, Accounting for Stock Issued to Employees. Effective January 1, 2006, we adopted FAS No. 123R using the modified prospective method. Accordingly, we have not restated prior period amounts. The additional expense to be recorded in 2006 as a result of this adoption is approximately $3 thousand. Under the provisions of FAS No. 123R, the “Unamortized restricted stock awards” line on our consolidated balance sheet, a contra-equity line representing the amount of unrecognized share-based compensation costs, is no longer presented. Accordingly, for the six-month period ended June 30, 2006, the amount that had been on the “Unamortized restricted stock awards” line was reversed through the “Common stock and additional paid-in-capital” line on our consolidated balance sheet.

 

At June 30, 2006, under the 2000 Plan, there were outstanding options for 50,912 shares of common stock granted to eight participants currently exercisable with a weighted-average exercise price of $13.58, with exercise prices ranging from $2.96 to $37.20. There were 559,960 shares available for future grants as of June 30, 2006. A breakdown of the options outstanding under the 2000 Plan as of June 30, 2006, by price range, is presented below:

Option Price Range		Number			Weighted Average Exercise Price			Weighted Average Remaining Life (Years)			Number Exercisable			Weighted Average Price on Options Exercisable
$2.96 -$3.81			11,918		$	3.41			5.51			11,918		$	3.41
$6.02 -$9.33			22,330		$	6.67			6.06			20,661		$	6.46
$20.25 -$37.20			18,333		$	28.23			2.02			18,333		$	28.23

On April 20, 2004, our Board of Directors approved the 2004 Stock Incentive Plan (the “2004 Plan”), which was subsequently approved by our stockholders at our annual meeting held on June 3, 2004. Under the terms of the 2004 Plan, we reserved 3,000,000 shares of common stock. The exercise price per share of an option under the 2004 Plan cannot be less than fair market value (as defined in the 2004 Plan) on the date of grant. The exercise price per share of an option under the 2004 Plan cannot be reduced after the date of grant, nor can an option be cancelled in exchange for an option with a lower exercise price per share. Directors, officers, employees and consultants are eligible to participate in the 2004 Plan. As of June 30, 2006, a total of 348,695 shares of restricted stock and 317,500 restricted stock units have been granted under the 2004 Plan, and as of June 30, 2006, there were no outstanding options to purchase shares of common stock under the 2004 Plan.

At June 30, 2006, the only options outstanding to purchase shares of our common stock were options issued under our 2000 Plan for 52,581 shares of common stock. For the quarter ended June 30, 2006, no options were granted under any of our stock incentive plans. The following is a summary of option activity under the 2000 Plan:

Stock Options		Number of Shares			Exercise Price			Weighted- Average Price			Weighted-Average Remaining Contractual Term
Outstanding at December 31, 2005			227,440		$$	2.760-37.205		$	5.457			4.6
Granted during 1st quarter 2006
Exercised			(174,191	)		2.760-9.330			2.979			—
Cancelled			(668	)		22.452-22.452			22.452			—
Outstanding at March 31, 2006			52,581		$$	2.960-37.205		$	13.448			4.4
Granted during 2nd quarter 2006
Exercised			—			—-—			—			—
Cancelled			—			—-—			—			—
Outstanding at June 30, 2006			52,581		$$	2.960-37.205		$	13.448			4.2
Vested at June 30, 2006			50,912		$$	2.960-37.205		$	13.583			4.0

Non-Vested Options		Number of Shares			Exercise Price			Weighted- Average Price			Weighted-Average Remaining Contractual Term
Non-vested at December 31, 2005			74,985		$$	2.760-9.330		$	3.200			7.0
Vested during 1st quarter 2006			(73,316	)		2.760-9.330			3.059			—
Non-vested at March 31, 2006			1,669		$$	9.330-9.330		$	9.330			7.8
Vested during 2nd quarter 2006			—			—-—			—			—
Non-vested at June 30, 2006			1,669		$$	9.330-9.330		$	9.330			7.5

 

Cash received from exercise under all stock-based payment arrangements for the six months ended June 30, 2006 and 2005 was $0.9 million and $0.1 million, respectively. Cash used to settle equity instruments granted under stock-based payment arrangements for the six months ended June 30, 2006 and 2005 was $0.7 million and $0.9 million, respectively.

In 2005, we accounted for our stock-based compensation arrangements in accordance with the intrinsic value method as defined by Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees.” The following table presents the effect on net income and earnings per share if we had applied the fair value recognition provisions of FAS No. 123R to our stock-based compensation.

The reported and pro forma net income and earnings per share figures for 2006 in the table are the same because share-based compensation expense is calculated under the provisions of FAS No. 123R. The 2006 amounts are included in the table below to provide detail for comparative purposes to the 2005 amounts.

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
		(in thousands, except per share amounts)
Net income (loss) to common stockholders		$	8,780		$	(2,620	)	$	13,180		$	3,125
Add: Stock-based compensation expense included in net income (loss) to common stockholders			292			285			585			571
			9,072			(2,335	)		13,765			3,696
Less: Stock-based compensation expense determined under the fair value based method for all awards			292			342			585			690
Pro forma net income (loss) to common stockholders		$	8,780		$	(2,677	)	$	13,180		$	3,006
Earnings (loss) per share:
Basic, as reported		$	0.15		$	(0.05	)	$	0.23		$	0.06
Basic, pro forma		$	0.15		$	(0.05	)	$	0.23		$	0.06
Diluted, as reported		$	0.15		$	(0.05	)	$	0.23		$	0.06
Diluted, pro forma		$	0.15		$	(0.05	)	$	0.23		$	0.06

 

 

For the six-month period ended June 30, 2006, we issued 1,822 shares of restricted common stock to each non-employee director and an additional 2,000 shares of restricted common stock to the Chairman of the Board under the 2004 Plan for a total of 11,110 shares. These shares represent a payment of the portion of the directors’ annual retainer that is payable in shares of our common stock.

As of June 30, 2006, there was $670 thousand of total unrecognized compensation cost related to these restricted stock awards.

On September 10, 2004, we entered into performance restricted stock unit agreements with our four executive officers under the 2004 Plan. A total of 317,500 restricted stock units were issued under the 2004 Plan and will fully vest into shares of common stock when our company attains $0.30 per share of adjusted funds from operations (as defined in the applicable restricted stock unit agreements) for two (2) consecutive quarters, with vesting accelerating upon a qualifying termination of employment or upon the occurrence of a change of control (as defined in the applicable restricted stock unit agreements). The performance restricted stock units expire on December 31, 2007 if the performance criteria has not been met. The issuance of restricted stock units has no impact on our calculation of diluted earnings per common share at this time; however, under our current method of accounting for stock-based compensation, the expense related to the restricted stock units will be recognized when it becomes probable that the vesting requirements will be met.

 

At June 30, 2006, we had no outstanding borrowings under our $200 million revolving senior secured credit facility (the “New Credit Facility”); however, $2.9 million was utilized for the issuance of letters of credit, leaving availability of $197.1 million. The New Credit Facility, entered into on March 31, 2006, is being provided by Bank of America, N.A., as Administrative Agent, Deutsche Bank Trust Company Americas, UBS Securities LLC, General Electric Capital Corporation, LaSalle Bank N.A., and Citicorp North America, Inc. and will be used for acquisitions and general corporate purposes.

 

 

The New Credit Facility replaced our previous $200 million senior secured credit facility (the “Prior Credit Facility”), that was terminated on March 31, 2006. We will realize a 125 basis point savings on LIBOR-based loans under the New Credit Facility, as compared to LIBOR-based loans under our Prior Credit Facility. The New Credit Facility matures on March 31, 2010, and includes an “accordion feature” that permits us to expand our borrowing capacity to $300 million during our first two years.

 

Our long-term borrowings require us to meet certain property level financial covenants and corporate financial covenants, including prescribed leverage, fixed charge coverage, minimum net worth, limitations on additional indebtedness and limitations on dividend payouts. As of June 30, 2006, we were in compliance with all property level and corporate financial covenants.

On December 16, 2005, we initiated a tender offer and consent solicitation for all of our outstanding $100 million aggregate principal amount 6.95% notes due 2007 (the “2007 Notes”). On December 30, 2005, we accepted for purchase 79.3% of the aggregate principal amount of the 2007 Notes outstanding that were tendered. On December 30, 2005, our Board of Directors also authorized the redemption of all outstanding 2007 Notes that were not otherwise tendered. On December 30, 2005, upon our irrevocable funding of the full redemption price for the 2007 Notes and certain other acts required by the Indenture governing the 2007 Notes, the Trustee of the 2007 Notes certified in writing to us (the “Certificate of Satisfaction and Discharge”) that the Indenture was satisfied and discharged as of December 30, 2005, except for certain administrative provisions. In accordance with FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, (“FAS 140”) we removed 79.3% of the aggregate principal amount of the 2007 Notes, which were tendered in our tender offer and consent solicitation, and the corresponding portion of the funds held in trust by the Trustee to pay the tender price from our balance sheet and recognized $2.8 million of additional interest expense associated with the tender offer. On January 18, 2006, we completed the redemption of the remaining 2007 Notes not otherwise tendered. Accordingly, we reduced other assets, representing the funds deposited with the Trustee, and unsecured borrowings by $21 million. In connection with the redemption and in accordance with FAS 140, we recognized $0.8 million of additional interest expense in the first quarter of 2006. As of January 18, 2006, none of the 2007 Notes remained outstanding.

 

During the three months ended March 31, 2006, Haven used the $39 million of proceeds from the GE Loan to partially repay a portion of a $62 million mortgage it has with us. Simultaneously, we subordinated the payment of its remaining $23 million on the mortgage note to that of the GE Loan. In conjunction with the above transactions and the application of FIN 46R, we consolidated the financial statements of this Haven entity into our financial statements, which contained the long-term borrowings with General Electric Capital Corporation of $39.0 million. The loan has an interest rate of approximately seven percent and is due in 2012. The lender of the $39.0 million does not have recourse to our assets (see Note - 2 Properties; Leased Property).

We and several of our wholly-owned subsidiaries have been named as defendants in professional liability claims related to our former owned and operated facilities. Other third-party managers responsible for the day-to-day operations of these facilities have also been named as defendants in these claims. In these suits, patients of certain previously owned and operated facilities have alleged significant damages, including punitive damages against the defendants. The majority of these lawsuits representing the most significant amount of exposure were settled in 2004. There currently is one lawsuit pending that is in the discovery stage, and we are unable to predict the likely outcome of this lawsuit at this time.

Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, requires the presentation of the net operating results of facilities sold during 2006 or currently classified as held-for-sale as income from discontinued operations for all periods presented. We incurred a net loss from discontinued operations of approximately $0.1 million and $0.5 million for the three- and six-month periods ended June 30, 2006, respectively, in the accompanying consolidated statements of operations.

The following table summarizes the results of operations of facilities sold or held-for-sale during the three and six months ended June 30, 2006 and 2005, respectively.

		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2006			2005			2006			2005
		(in thousands)
Revenues
Rental income		$	—		$	1,430		$	—		$	2,896
Other income			—			12			—			24
Subtotal revenues			—			1,442			—			2,920
Expenses
Depreciation and amortization			—			496			9			1,051
General and administrative			3			—			4			—
Provision for impairment			—			—			121			3,700
Subtotal expenses			3			496			134			4,751
Income (loss) before loss on sale of assets			(3	)		946			(134	)		(1,831	)
Loss on assets sold - net			(133	)		(4,165	)		(381	)		(4,202	)
Loss from discontinued operations		$	(136	)	$	(3,219	)	$	(515	)	$	(6,033	)

 

The computation of basic earnings per common share (“EPS”) is computed by dividing net income available to common stockholders by the weighted-average number of shares of common stock outstanding during the relevant period. Diluted EPS reflects the potential dilution that could occur from shares issuable through stock-based compensation, including stock options and restricted stock rewards.

For the three- and six-month periods ended June 30, 2006 and 2005, the dilutive effect from stock options was immaterial.

 

 

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this document. This document contains forward-looking statements within the meaning of the federal securities laws, including statements regarding potential financings and potential future changes in reimbursement. 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, but not limited to, terms such as “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 under “Risk Factors” in Item 1A to our annual report on Form 10-K for the year ended December 31, 2005;

(ii)	uncertainties relating to the business operations of the operators of our assets, including those relating to reimbursement by third-party payors, regulatory matters and occupancy levels;

(iii)

the ability of any 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 process of a bankruptcy proceeding and retain security deposits for the debtors’ obligations;

(iv)	our ability to sell closed assets on a timely basis and on terms that allow us to realize the carrying value of these assets;

(v)	our ability to negotiate appropriate modifications to the terms of our credit facility;

(vi)	our ability to manage, re-lease or sell any owned and operated facilities;

(vii)

the availability and cost of capital;

(viii)

competition in the financing of healthcare facilities;

(ix)	regulatory and other changes in the healthcare sector;

(x)	the effect of economic and market conditions generally and, particularly, in the healthcare industry;

(xi)	changes in interest rates;

(xii)

the amount and yield of any additional investments;

(xiii)

changes in tax laws and regulations affecting real estate investment trusts; and

(xiv)

changes in the ratings of our debt and preferred securities.

At June 30, 2006, our portfolio of domestic investments consisted of 209 healthcare facilities, located in 27 states and operated by 34 third-party operators. Our gross investment in these facilities, net of impairments and before reserve for uncollectible loans, totaled approximately $1.1 billion at June 30, 2006, with approximately 98% of our real estate investments related to long-term care facilities. This portfolio is made up of 196 long-term healthcare facilities, two rehabilitation hospitals owned and leased to third parties, fixed rate mortgages on 10 long-term healthcare facilities and one long-term healthcare facility that is currently held for sale. At June 30, 2006, we also held other investments of approximately $29 million, consisting primarily of secured loans to third-party operators of our facilities.

Critical Accounting Policies and Estimates

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and a summary of our significant accounting policies is included in Note 2 to our annual report on Form 10-K for the year ended December 31, 2005. Our preparation of the financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenue and expenses during the reporting period.

We have identified five significant accounting policies that we believe are 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 assumptions, 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 five critical accounting policies are:

With the exception of certain master leases, rental income and mortgage interest income are recognized as earned over the terms of the related master leases and mortgage notes, respectively. Such income generally 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 becomes questionable or when negotiations for restructurings of troubled operators result in significant uncertainty regarding ultimate collection. The amount of the reserve is estimated based on what management believes will likely be collected. When collection is uncertain, lease revenues are recorded when received, after taking into account application of security deposits. Interest income on impaired mortgage loans is recognized when received after taking into account application of principal repayments and security deposits.

We recognize the minimum base rental revenue under master leases with fixed increases on a straight-line basis over the term of the related lease. Accrued straight-line rents represent the rental revenue recognized in excess of rents due under the lease agreements at the balance sheet date.

Gains on sales of real estate assets are recognized pursuant to the provisions of SFAS No. 66, Accounting for Sales of Real Estate. The specific timing of the recognition of the sale and the related gain is measured against the various criteria in SFAS No. 66 related to the terms of the transactions and any continuing involvement associated with the assets sold. To the extent the sales criteria are not met, we defer gain recognition until the sales criteria are met.

Under GAAP, real estate assets are stated at the lower of depreciated cost or fair value, if deemed impaired. Depreciation is computed on a straight-line basis over the estimated useful lives of 20 to 40 years for buildings and improvements and three to ten years for furniture, fixtures and equipment. Management periodically, but not less than annually, evaluates our real estate investments for impairment indicators, including the evaluation of our assets’ useful lives. The judgment regarding the existence of impairment indicators is based on factors such as, but not limited to, market conditions, operator performance and legal structure. If indicators of impairment are present, management evaluates the carrying value of the related real estate investments in relation to the future undiscounted cash flows of the underlying facilities. Provisions for impairment losses related to long-lived assets are recognized when expected future undiscounted cash flows are determined to be permanently less than the carrying values of the assets. An adjustment is made to the net carrying value of the leased properties and other long-lived assets for the excess of historical cost over fair value. The fair value of the real estate investment is determined by market research, which includes valuing the property as a nursing home as well as other alternative uses. All impairments are taken as a period cost at that time, and depreciation is adjusted going forward to reflect the new value assigned to the asset.

If we decide to sell rental properties or land holdings, we evaluate the recoverability of the carrying amounts of the assets. If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value less costs to sell. Our estimates of cash flows and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties, and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers.

During the six months ended June 30, 2006, we recognized an impairment loss associated with one facility of approximately $0.1 million.

Management, periodically but not less than annually, evaluates our outstanding loans and notes receivable. When management identifies potential loan impairment indicators, such as non-payment under the loan documents, impairment of the underlying collateral, financial difficulty of the operator or other circumstances that may impair full execution of the loan documents, and management believes these indicators are permanent, then 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. The fair value of the loan is determined by market research, which includes valuing the property as a nursing home as well as other alternative uses.

Pursuant to the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the operating results of specified real estate assets that have been sold, or otherwise qualify as held for disposition (as defined by SFAS No. 144), are reflected as discontinued operations in the consolidated statements of operations for all periods presented.

Financial Accounting Standards Board Interpretation No. 46R, Consolidation of Variable Interest Entities, or FIN 46R, addresses the consolidation by business enterprises of variable interest entities (“VIEs”). FIN 46R provides criteria that, if met, would create a VIE, which would then be subject to consolidation. If an entity is determined to be a VIE, the party deemed to be the primary beneficiary is required to consolidate the VIE. The primary beneficiary is the party that has the most variability in expected gains or losses of the VIE.

In order to determine which party is the primary beneficiary, we must calculate the expected losses and expected residual returns of the VIE. The analysis requires a projection of expected cash flows and the assignment of probabilities to each possible cash flow outcome. Estimating expected cash flows and assigning probabilities of each outcome of the VIE requires us to use significant judgment. If assumptions used to estimate the expected cash flows prove to be inaccurate, our conclusions regarding which party is the VIE’s primary beneficiary could be incorrect, resulting in us improperly consolidating the VIE when we are not the primary beneficiary or not consolidating the VIE when we are the primary beneficiary.

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 audited consolidated financial statements and accompanying notes.

Our operating revenues for the three months ended June 30, 2006 totaled $31.1 million, an increase of $5.8 million, over the same period in 2005. The $5.8 million increase was primarily a result of new investments made throughout 2005 as well as scheduled contractual increases in rents. The increase in operating revenues from new investments was partially offset by a reduction in mortgage interest income and one-time contractual interest revenue associated with the payoff of a mortgage during the first quarter of 2005.

Detailed changes in operating revenues for the three months ended June 30, 2006 are as follows:

·	Rental income was $29.0 million, an increase of $6.5 million over the same period in 2005. The increase was due to new leases entered into throughout 2005, scheduled contractual increases in rents, and from consolidation of a VIE.

·	Mortgage interest income totaled $1.2 million, a decrease of $0.1 million over the same period in 2005. The decrease was primarily the result of normal amortization and a $10 million loan payoff that occurred in the second quarter of 2006.

·	Miscellaneous revenue was $0.3 million, a decrease of $0.8 million over the same period in 2005. The decrease was due to contractual revenue owed to us and received in the second quarter of 2005 resulting from a mortgage note prepayment that occurred in the first quarter of 2005.

Operating expenses for the three months ended June 30, 2006 totaled $9.9 million, an increase of approximately $0.9 million over the same period in 2005. The increase was primarily due to $1.5 million of increased depreciation expense partially offset by a 2005 leasehold expiration expense.

Detailed changes in our operating expenses for the three months ended June 30, 2006 versus the same period in 2005 are as follows:

·	Our depreciation and amortization expense was $7.5 million, compared to $6.0 million for the same period in 2005. The increase is due to new investments placed throughout 2005 and the consolidation of a VIE in 2006.

·	Our general and administrative expense, when excluding restricted stock amortization expense, was $2.0 million, compared to $1.8 million for the same period in 2005. The increase was primarily due to normal inflationary increases in goods and services.

·	In 2005, we recorded a $0.1 million provision for uncollectible notes receivable.

·	In 2005, we recorded a $0.8 million lease expiration accrual relating to disputed capital improvement requirements associated with a lease that expired June 30, 2005.

For the three months ended June 30, 2006, our total other net expenses were $9.8 million as compared to $10.8 million for the same period in 2005. The significant changes are as follows:

·

Our interest expense, excluding amortization of deferred costs and refinancing related interest expenses, for the three months ended June 30, 2006 was $9.4 million, compared to $6.9 million for the same period 2005. The increase of $2.5 million was primarily due to higher debt on our balance sheet versus the same period in 2005 and from consolidation of a VIE in 2006.

·

During the three months ended June 30, 2005, we recorded a $3.4 million provision for impairment on an equity security. In accordance with FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, the $3.4 million provision for impairment was to write-down our 760,000 share investment in Sun Healthcare Group, Inc.’s (“Sun”) common stock to its then current fair market value.

Our operating revenues for the six months ended June 30, 2006 totaled $61.8 million, an increase of $9.4 million, over the same period in 2005. The $9.4 million increase was primarily a result of new investments made throughout 2005 as well as scheduled contractual increases in rents. The increase in operating revenues from new investments was partially offset by a reduction in mortgage interest income and one-time contractual interest revenue associated with the payoff of a mortgage during the first quarter of 2005.

Detailed changes in operating revenues for the six months ended June 30, 2006 are as follows:

·	Rental income was $58.0 million, an increase of $13.7 million over the same period in 2005. The increase was due to new leases entered into throughout 2005, scheduled contractual increases in rents, and the consolidation of a VIE in 2006.

·

Mortgage interest income totaled $2.3 million, a decrease of $0.9 million over the same period in 2005. The decrease was primarily the result of normal amortization, a $60 million loan payoff that occurred in the first quarter of 2005 and a $10 million loan payoff that occurred in the second quarter of 2006.

·	Miscellaneous revenue was $0.4 million, a decrease of $3.9 million over the same period in 2005. The decrease was due to contractual revenue owed to us and received in the second quarter of 2005 resulting from a mortgage note prepayment that occurred in the first quarter of 2005.

Operating expenses for the six months ended June 30, 2006 totaled $19.7 million, an increase of approximately $2.9 million over the same period in 2005. The increase was primarily due to $3.3 million of increased depreciation expense partially offset by a 2005 leasehold termination expense.

Detailed changes in our operating expenses for the six months ended June 30, 2006 versus the same period in 2005 are as follows:

·	Our depreciation and amortization expense was $15.1 million, compared to $11.7 million for the same period in 2005. The increase is due to new investments placed throughout 2005 and the consolidation of a VIE in 2006.

·	Our general and administrative expense, when excluding restricted stock amortization expense, was $4.1 million, compared to $3.7 million for the same period in 2005. The increase was primarily due to normal inflationary increases in goods and services.

·	In 2005, we recorded a $0.1 million provision for uncollectible notes receivable.

·	In 2005, we recorded a $0.8 million lease expiration accrual relating to disputed capital improvement requirements associated with a lease that expired June 30, 2005.

For the six months ended June 30, 2006, our total other net expenses were $23.4 million as compared to $18.0 million for the same period in 2005. The significant changes are as follows:

·

Our interest expense, excluding amortization of deferred costs and refinancing related interest expenses, for the six months ended June 30, 2006 was $19.1 million, compared to $13.7 million for the same period 2005. The increase of $5.3 million was primarily due to higher debt on our balance sheet versus the same period in 2005 and from consolidation of a VIE in 2006.

·	For the six months ended June 30, 2006, we recorded a $0.8 million non-cash charge associated with the redemption of the remaining 20.7% of our $100 million aggregate principal amount of 6.95% unsecured notes due 2007 not otherwise tendered in 2005.

·	For the six months ended June 30, 2006, we recorded a one time, non-cash charge of approximately $2.7 million relating to the write-off of deferred financing costs associated with the termination of our prior credit facility.

·

During the six months ended June 30, 2005, we recorded a $3.4 million provision for impairment of an equity security. In accordance with FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, the $3.4 million provision for impairment was to write-down our 760,000 share investment in Sun’s common stock to its then current fair market value.

 

Discontinued operations relate to properties we disposed of in 2006 or are currently held-for-sale and are accounted for as discontinued operations under SFAS No. 144. For the three and six months ended June 30, 2006, we sold two SNFs in California resulting in an accounting loss of approximately $0.1 million.

At June 30, 2006, we had one asset held for sale with a net book value of approximately $0.2 million.

During the three months ended March 31, 2006, a $0.1 million provision for impairment charge was recorded to reduce the carrying value to its sales price of one facility that was under contract to be sold that was subsequently sold during the second quarter of 2006.

In accordance with SFAS No. 144, the $0.4 million realized net loss is reflected in our consolidated statements of operations as discontinued operations. See Note 9 - Discontinued Operations.

In February 2004, NAREIT informed its member companies that it was adopting the position of the Securities and Exchange Commission (“SEC”) with respect to asset impairment charges and would no longer recommend that impairment write-downs be excluded from FFO. In the tables included in this disclosure, we have applied this interpretation and have not excluded asset impairment charges in calculating our FFO. As a result, our FFO may not be comparable to similar measures reported in previous disclosures. According to NAREIT, there is inconsistency among NAREIT member companies as to the adoption of this interpretation of FFO. Therefore, a comparison of our FFO results to another company's FFO results may not be meaningful.

The following table presents our FFO results reflecting the impact of asset impairment charges (the SEC's interpretation) for the three and six months ended June 30, 2006 and 2005:

		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2006			2005			2006			2005
		(in thousands)
Net income available to common		$	8,780		$	(2,620	)	$	13,180		$	3,125
Add back loss from real estate dispositions			133			4,165			381			4,202
Sub-total			8,913			1,545			13,561			7,327
Elimination of non-cash items included in net income:
Depreciation and amortization			7,542			6,540			15,069			12,793
Funds from operations available to common stockholders		$	16,455		$	8,085		$	28,630		$	20,120

As a qualified REIT, as long as we distribute 100% of our taxable income, we will not be subject to Federal income taxes on our income, and no provisions for Federal income taxes have been made. We are permitted to own up to 100% of a “taxable REIT subsidiary” (“TRS”). Currently, we have two TRSs that are taxable as corporations and that pay federal, state and local income tax on their net income at the applicable corporate rates.

Below is a brief description, by third-party operator, of our re-leasing, restructuring or new investment transactions that occurred during the six months ended June 30, 2006.

On June 16, 2006, we received approximately $10 million in proceeds on a mortgage loan payoff. We held mortgages on 15 facilities located in Indiana, representing 619 beds.

·

During the three months ending March 31, 2006, Haven Eldercare, LLC (“Haven”), an existing operator of ours, entered into a $39 million first mortgage loan with General Electric Capital Corporation (“GE Loan”). Haven used the $39 million of proceeds to partially repay on a $62 million mortgage it has with us. Simultaneously, we subordinated the payment of our remaining $23 million on the mortgage note, due in October 2012, to that of the GE Loan. As a result of this transaction, the interest rate on our remaining mortgage note to Haven rose from 10% to approximately 15%, with annual escalators.

·

In conjunction with the above transactions and the application of FIN 46R, we consolidated the financial statements and related real estate of this Haven entity into our financial statements. The consolidation resulted in the following changes to our consolidated balance sheet as of June 30, 2006: (1) an increase in total gross investments of $39.0 million; (2) an increase in accumulated depreciation of $0.8 million; (3) an increase in other long-term borrowings of $39.0 million; and (4) a reduction of $0.8 million in cumulative net earnings for the six months ended June 30, 2006 due to the increased depreciation expense. General Electric Capital Corporation and Haven’s other creditors do not have recourse to our assets. Our results of operations reflect the effects of the consolidation of this entity, which is being accounted for similarly to our other purchase-leaseback transactions.

·	On June 30, 2006, we sold two SNFs in California resulting in an accounting loss of approximately $0.1 million.

·	On March 31, 2006, we sold a SNF in Illinois resulting in an accounting loss of approximately $0.2 million.

·	We had one asset held for sale as of June 30, 2006 with a net book value of approximately $0.2 million.

·	During the three months ended March 31, 2006, a $0.1 million provision for impairment charge was recorded to reduce the carrying value to its sales price of one facility that was under contract to be sold, which was subsequently sold during the second quarter of 2006.

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 Code.

At June 30, 2006, we had total assets of $984.4 million, stockholders’ equity of $435.3 million and debt of $526.5 million, which represents approximately 54.7% of our total capitalization.

		Payments due by period
		Total			Less than 1 year			1-3 years			3-5 years			More than 5 years
		(In thousands)
Long-term debt (1)		$	526,800		$	390		$	850		$	960		$	524,600
Other long-term liabilities			616			231			385			-			-
Total		$	527,416		$	621		$	1,235		$	960		$	524,600