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Published on December 3, 2008
December
3, 2008
VIA U.S. MAIL, EDGAR AND
FACSIMILE
Securities
and Exchange Commission
100 F
Street, N.E.
Mail Stop
4561
Washington,
D.C. 20549
Attn: Daniel
L. Gordon
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Re:
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Omega
Healthcare Investors, Inc.
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Form
10-K for the year ended December 31,
2007
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Filed
February 15, 2008
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File
No. 001-11316
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Ladies
and Gentlemen:
On behalf
of Omega Healthcare Investors, Inc. (“Omega” or the “Company”), I am writing
this letter in response to a telephone conference call that was held on November
20, 2008 between members of management of Omega and representatives of the
Securities and Exchange Commission (the “SEC Staff”) with respect to the SEC
Staff’s review of the above-referenced Form 10-K (the “Form 10-K”).
In the
conversation held on November 20, 2008, the SEC Staff requested that we provide
a written response explaining why Omega believes that the 2006 Advocat lease
modifications added value to Omega and more specifically, why the
difference between the fair value of the financial instruments exchanged with
Advocat was accounted for as a lease inducement. The SEC Staff also
requested Omega provide additional support to explain why we believe fair value
accounting of the financial instruments was appropriate and why the difference
in the fair value of the financial instruments exchanged was the appropriate
basis to determine the value of the lease inducement.
We
believe that bifurcation of these transactions into their individual components
is the appropriate accounting treatment and is consistent with authoritative
accounting guidance. As mentioned in the Company’s previous
responses, the accounting guidance in FAS No. 115, FAS No. 133, FAS
No. 91 and EITF No. 94-8 and EITF No. 01-7 were used to determine the accounting
treatment for the exchange of the financial instruments. In summary,
the Company believes that the authoritative literature requires the application
of fair value accounting for the financial instruments exchanged. We
have not repeated certain factual information previously presented in the
Company’s detailed accounting analysis provided to the SEC Staff on September
12, 2008, rather we are including the additional information that the SEC Staff
has specifically requested.
Fair
Value Analysis:
Based on
our fair value analysis, the following is a summary of the financial instruments
exchanged (in millions):
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Investments
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Surrendered
by Omega in Exchange
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Received
from Advocat in Exchange
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Excess
Fair
Value Surrendered
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|||||||
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Series
B Convertible Preferred Stock
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||||||||||
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Fair
value of host contract
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$ | (4.7 | ) | |||||||
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Fair
value of conversion feature
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(10.2 | ) | ||||||||
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Series
C Non-convertible Preferred Stock
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$ | 4.1 | ||||||||
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2000
Note
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(2.5 | ) | ||||||||
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2006
Note
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2.5 | |||||||||
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Total
Exchanged
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$ | (17.4 | ) | $ | 6.6 | $ |
(10.8)
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Immediately
prior to the exchange of the financial instruments, the accreted (“book”) value
of the Series B Convertible Preferred Stock host contract was $3.6
million. The recorded fair value of the Series B Convertible
Preferred Stock host contract was $4.7 million; the $1.1 million difference
between fair value and book value was reported through other comprehensive
income in accordance with FAS No. 115 as an available-for-sale
security. The SEC Staff requested the Company to further explain why
the Company recognized the difference between the fair value of the host
contract and the accreted value of the host contract of $1.1 million through
income upon the exchange of the financial instruments. FAS 140
requires de-recognition of the Series B Convertible Preferred Stock and the
recognition of the Series C Non-convertible Preferred Stock at its fair
value. The Company believed the exchange of the Series B Convertible
Preferred Stock for other financial instruments resulted in the culmination of
the earning process and therefore required the Company to realize the $1.1
million difference between the fair value of the host agreement and the accreted
(“book”) value of the host agreement through earnings (i.e., the convertible
preferred securities were no longer outstanding and therefore the difference
between the fair value of the host and the accreted value is required to be
recognized in accordance with GAAP through earnings, not other comprehensive
income).
The SEC
Staff also requested additional explanation of why the Company recognized a gain
on the exchange of the 2000 Note. In 2000 when the Company received
the 2000 Note, Advocat was in severe financial distress. The terms of
the 2000 Note did not require principal payments for seven years or interest
payments until all other Advocat debt obligations were repaid. In
view of Advocat’s significant financial distress and the fact that principal
payments were not due for seven years, the Company believed at the time that the
likelihood of Advocat meeting is obligations under the 2000 Note was remote.
Accordingly, the Company believed the value of the 2000 Note was de minimis
(i.e., it was valued at zero). Further, in 2000 upon the initial
receipt of the 2000 Note, the Company elected to use the cash-basis method to
account for the 2000 Note due to the uncertainty of the Notes
collectability.
The
accrued principal and interest on the 2000 Note as of October 26, 2006 was
approximately $2.5 million. Due to the method of accounting that was
selected in 2000 (i.e., cash-basis method), the Company had not recognized any
income related to this note because it had not received cash or other forms of
consideration related to this note. In 2006, when the 2000 Note was
exchanged for a non-convertible 2006 Note, the Company reviewed the fair value
of the 2006 Note that it received and determined that the fair value of the 2006
Note was $2.5 million. Again, FAS 140 was considered in accounting
for the transfer of the financial instruments (and it was not deemed to be a
troubled debt restructuring based on Advocat’s financial improvement since
initial issuance). Accordingly, the Company recognized the gain on
the 2000 Note because it had received consideration in the form of a new note
with a fair value of $2.5 million. The 2006 Note was paid-off in full
by Advocat in 2007.
Economic
Value:
The SEC
Staff also requested that the Company provide an analysis that supports its
position that the lease modification had economic value. As mentioned
on the conference call with the SEC Staff, the modification to the master lease
agreement included two significant changes that affected the cash flow generated
by the agreement; including: (i) an increase of rent by $687,000 annually, and
(ii) an extension of eight years to the term of the master lease (from 2010 to
2018). The modification also included a provision for annual rent
increases of the lesser of 3% or 2 times the Consumer Price
Index. The following table highlights the undiscounted cash flows
(i.e., contractual rent) for the remaining term of the original lease as well as
the October 2006 amended lease agreement:
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Period
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October
2006 Amended Contractual Rent
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Original
Lease Contractual Rent
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Favorable
Change in Contractual Rent
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(in
millions)
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Oct
– Dec 2006
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$ | 3.2 | $ | 3.2 | $ | - | ||||||
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Jan
– Dec 2007
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13.7 | 13.0 | 0.7 | |||||||||
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Jan
– Dec 2008
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14.1 | 13.4 | 0.7 | |||||||||
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Jan
– Dec 2009
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14.6 | 13.9 | 0.7 | |||||||||
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Jan
– Dec 2010 and Jan – Sept 2010
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15.0 | 10.6 | 4.4 | |||||||||
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Jan
– Dec 2011
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15.5 |
[Lease
Expired]
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15.5 | |||||||||
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Jan
– Dec 2012
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15.9 |
[Lease
Expired]
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15.9 | |||||||||
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Jan
– Dec 2013
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16.4 |
[Lease
Expired]
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16.4 | |||||||||
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Jan
– Dec 2014
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16.9 |
[Lease
Expired]
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16.9 | |||||||||
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Jan
– Dec 2015
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17.4 |
[Lease
Expired]
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17.4 | |||||||||
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Jan
– Dec 2016
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17.9 |
[Lease
Expired]
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17.9 | |||||||||
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Jan
– Dec 2017
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18.5 |
[Lease
Expired]
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18.5 | |||||||||
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Jan
– Sept 2018
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14.2 |
[Lease
Expired]
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14.2 | |||||||||
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Total
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$ | 193.3 | $ | 54.1 | $ | 139.2 | ||||||
As the
above table illustrates, the amended master lease provided significant
additional contractual rent (i.e., cash flow) to the Company over the revised
term of the lease. The original term ended in September 2010; the
revised term extended the contractual rent through September 2018 and included
an increase in the annual base rent of $687,000 immediately. We
recognize that upon the expiration of the initial lease term, we most likely
would have been able to lease the buildings to Advocat or another operator;
however, in 2006, we where unable to predict what the market for these
properties would be in 2010 because such market conditions were not
foreseeable. Accordingly, we believe that the elimination of the
optionality of the contract (i.e., risk that Advocat would not renew the lease),
as well as market risk regarding prevailing rents at the time of renewal, add
considerable value to Omega because is provides more reliability and stability
to our cash flow. The original lease allowed for renewal of the lease
at Advocat’s option only. Please note that at the time of the lease
restructuring, Omega had no rights to terminate or otherwise modify the lease
prior to 2010, so the certainty of extending these cash flows to 2018, in
addition to increasing the base rent by $687,000, was of significant value to
Omega.
When
evaluating real estate investment trusts such as Omega, investors generally
favor longer term leases because of the stability it adds to our cash flow. For
example, in each of our capital-raising transactions, both our experience with
investors as well as our discussions with investment bankers indicates that the
term of our leases and mortgages is important to investors, both in terms of
evaluating stability of cash flow and assessing the terms of our leases versus
scheduled debt maturities. As a result, the added stability of our
cash flow reduces our cost of capital and therefore adds to our
profitability. We also note that the extension of the lease through
September 2018 extends the expiration of the lease beyond all of our debt
maturities.
We sincerely hope that this additional information on the Advocat Restructuring
clarifies our accounting and confirms to the SEC Staff that our accounting is in
accordance with GAAP.
If you
have any questions, or if we can be of further assistance to you in the review
process, please call me at (410) 427-1722. Our fax number is (410)
427-8822.
Omega
Healthcare Investors, Inc.
By: /s/ Robert O.
Stephenson
Robert O. Stephenson
Chief Financial Officer
cc: Jessica
Barberich
Linda van Doorn
Louise Dorsey