10-K: Annual report pursuant to Section 13 and 15(d)

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

☒	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
	THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 31, 2014.
☐	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)

Registrant’s telephone number, including area code: 410-427-1700

 

Securities Registered Pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

 

None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes   ☒       No   ☐

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes   ☐       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 and Exchange Act of 1934 during the preceding twelve 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   ☒       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.   ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes    ☒       No   ☐

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

Large accelerated filer ☒                                                Accelerated filer ☐                        Non-accelerated filer ☐                      Smaller reporting company ☐

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

The aggregate market value of the common stock of the registrant held by non-affiliates was $4,670,627,910.40 as of June 30, 2014, the last business day of the registrant’s most recently completed second fiscal quarter.  The aggregate market value was computed using the $36.86 closing price per share for such stock on the New York Stock Exchange on such date.

As of February 13, 2015, there were 138,617,823 shares of common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

Proxy Statement for the registrant’s 2014 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2014, is incorporated by reference in Part III herein.

 

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OMEGA HEALTHCARE INVESTORS, INC.

2014 FORM 10-K ANNUAL REPORT

 

TABLE OF CONTENTS

 

		PART I
				Page
Item 1.		Business		1
		Overview		1
		Summary of Financial Information		2
		Description of the Business		3
		Taxation		4
		Government Regulation and Reimbursement		11
		Executive Officers of Our Company		15
Item 1A.		Risk Factors		15
Item 1B.		Unresolved Staff Comments		32
Item 2.		Properties		33
Item 3.		Legal Proceedings		36
Item 4.		Mine Safety Disclosures		36
		PART II
Item 5.		Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		37
Item 6.		Selected Financial Data		39
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		40
		Forward-Looking Statements, Reimbursement Issues and Other Factors Affecting Future Results		40
		Overview		40
		Portfolio and Other Developments		42
		Results of Operations		47
		Liquidity and Capital Resources		51
		Critical Accounting Policies and Estimates		55
Item 7A.		Quantitative and Qualitative Disclosures About Market Risk		57
Item 8.		Financial Statements and Supplementary Data		58
Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		58
Item 9A.		Controls and Procedures		58
		PART III
Item 10.		Directors, Executive Officers of the Registrant and Corporate Governance		60
Item 11.		Executive Compensation		60
Item 12.		Security Ownership of Certain Beneficial Owners and Management		60
Item 13.		Certain Relationships and Related Transactions, and Director Independence		60
Item 14.		Principal Accountant Fees and Services		60
		PART IV
Item 15.		Exhibits and Financial Statement Schedules		61

 

Item 1 – Business

Overview; Recent Events

Omega Healthcare Investors, Inc. (“Omega,” “we,” “our” or the “Company”) was incorporated in the State of Maryland on March 31, 1992.  We are a self-administered real estate investment trust (“REIT”), investing in income producing healthcare facilities, principally long-term care facilities located throughout the United States.  We provide lease or mortgage financing to qualified operators of skilled nursing facilities (“SNFs”) and, to a lesser extent, assisted living facilities (“ALFs”), independent living facilities and rehabilitation and acute care facilities. We have historically financed investments through borrowings under our revolving credit facilities, private placements or public offerings of our debt and equity securities, the assumption of secured indebtedness, retention of cash flow, or a combination of these methods.

In 2014, we completed the following transactions totaling approximately $566 million in new investments:

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$415 million of refinancing/consolidating mortgage loans with an existing operator.  We entered into an agreement to refinance/consolidate $117 million in existing mortgages with maturity dates ranging from 2021 to 2023 on 17 facilities into one mortgage and simultaneously provide mortgage financing for an additional 14 facilities.  The new $415 million mortgage matures in 2029 and is secured by 31 facilities totaling 3,430 licensed beds all located in the State of Michigan.  The new loan bears an initial annual cash interest rate of 9.0% and increases by 0.225% per year.

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$112.5 million mortgage loan with an existing operator.  The loan is secured by seven SNFs and two ALFs totaling 798 operating beds located in Pennsylvania (7) and Ohio (2).  The loan is cross-defaulted and cross-collateralized with our existing master lease with the operator.  The loan bears an initial annual cash interest rate of 9.5% and matures in January 2024.

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$84.2 million of new investment with an existing operator.  The investment included the purchase/leaseback of four ALFs.  Two of these facilities are located in Pennsylvania, one in Oregon and one in Arkansas with a total of 371 beds.  The new master lease has an initial annual cash yield of 6.0% with 2.5% annual escalators.

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$34.6 million of new investments with an existing operator.  The acquisitions consisted of 3 SNFs, one located in Georgia and two in South Carolina with a total of 345 beds.  The facilities were combined into a 12 year master lease with an initial annual cash yield of 9.5%.

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$8.2 million of new investment with an existing operator.  The investment included the purchase/leaseback of one SNF in Texas totaling 125 beds.

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$4.7 million of new investment with an existing operator.  The investment included the purchase /leaseback of an ALF in Arizona totaling 90 beds.

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$23.6 million of investments in our capital expenditure programs.

As of December 31, 2014, our portfolio of investments included 568 healthcare facilities located in 38 states and operated by 50 third-party operators.  We use the term “operator” to refer to our tenants and mortgagees and their affiliates who manage and/or operate our properties.  This portfolio was made up of:

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474 SNFs, 23 ALFs and 11 specialty facilities;

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fixed rate mortgages on 53 SNFs and two ALFs; and

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five facilities and one parcel of land closed/held-for-sale.

As of December 31, 2014, our gross investments in these facilities, net of impairments and before reserve for uncollectible loans, totaled approximately $4.4 billion.  In addition, we held miscellaneous investments of approximately $49.0 million at December 31, 2014, consisting primarily of secured loans to third-party operators of our facilities.

 

On October 30, 2014, we, along with our newly formed subsidiaries, OHI Healthcare Properties Holdco, Inc. (“Merger Sub”) and OHI Healthcare Properties Limited Partnership, L.P. (“Omega Operating Partnership”), entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Aviv REIT, Inc. (“Aviv”) and Aviv Healthcare Properties Limited Partnership, L.P. (the “Aviv Operating Partnership”).   The Merger Agreement provides for the merger of Aviv with and into the Merger Sub (the “Merger”), with the Merger Sub surviving as a wholly-owned subsidiary of Omega.  At the effective time of the Merger, and subject to the terms and conditions set forth in the Merger Agreement, each outstanding share of Aviv common stock shall be converted into the right to receive 0.90 of a share of Omega common stock.  In connection with the Merger, holders of limited partnership units of the Aviv Operating Partnership will receive units of the Omega Operating Partnership based on the same exchange ratio as provided for Aviv common stock in the Merger Agreement. Holders of Omega Operating Partnership units will have the right to tender their units for redemption at a redemption price equal to the fair market value of the Company’s common stock. The Company may generally elect to pay the redemption price for tendered Omega Operating Partnership units in cash or in shares of the Company common stock. We expect to complete the Merger early in the second quarter of 2015, subject to the terms and conditions of the Merger Agreement.

On February 9, 2015, we issued 10.925 million shares of our common stock in an underwritten public offering at a public offering price of $42.00 per share, before underwriting discounts and offering expenses. We intend to use the $439 million in net proceeds of the offering to redeem our outstanding $200 million aggregate principal amount 7.50% senior notes due 2020 (callable February 2015), repay outstanding borrowings under our revolving credit facility, and for general corporate purposes.

Our filings with the Securities and Exchange Commission (“SEC”), including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are accessible free of charge on our website at www.omegahealthcare.com.  The contents of our website are not incorporated by reference herein or in any of our filings with the SEC.

Summary of Financial Information

The following table summarizes our revenues by asset category for 2014, 2013 and 2012.  (See “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Note 3 – Properties”, “Note 5 – Direct Financing Leases”, “Note 6 – Mortgage Notes Receivable” and “Note 7 – Other Investments”).

 

Revenues by Asset Category
(in thousands)

 

The following table summarizes our real estate assets by asset category as of December 31, 2014 and 2013.

Assets by Category

(in thousands)

 

 

Description of the Business

Investment Strategy.  We maintain a portfolio of long-term healthcare facilities and mortgages on healthcare facilities located throughout the United States.  Our investments are generally geographically diverse and operated by a diverse group of established, middle‑market healthcare operators that meet our standards for quality and experience of management and creditworthiness.  Our criteria for evaluating potential investments includes but is not limited to:

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the quality and experience of management and the creditworthiness of the operator of the facility;

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the facility’s historical and forecasted cash flow and its ability to meet operational needs, capital expenditure requirements and lease or debt service obligations;

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the construction quality, condition and design of the facility;

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the location of the facility;

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the tax, growth, regulatory and reimbursement environment of the applicable jurisdiction;

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the occupancy rate for the facility and demand for similar healthcare facilities in the same or nearby communities; and

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the payor mix of private, Medicare and Medicaid patients at the facility.

We seek to obtain (i) contractual rent escalations under long-term, non-cancelable, “triple-net” leases and (ii) fixed-rate mortgage loans.  We typically obtain substantial liquidity deposits, 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 may pursue alternative investment structures.  The following summarizes our primary investment structures.  The average annualized yields described below reflect existing contractual arrangements.  However, due to the nature of 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, 2015, set forth below, are not necessarily indicative of future yields, which may be lower.

Purchase/Leaseback.  In a purchase/leaseback transaction, we purchase a property from an operator and lease it back to the operator over a term typically ranging from 5 to 15 years, plus renewal options.  Our leases generally provide for minimum annual rentals that are subject to annual formula increases based on factors such as increases in the Consumer Price Index.  At January 1, 2015, our average annualized yield from leases was approximately 11.6%.

Direct Financing Leases.  In addition to our typical lease agreements, we provided four 50 year leases to an operator in connection with the Ark Holding purchase/leaseback transaction that occurred during the fourth quarter of 2013.  The leases are being accounted for as direct financing leases and include annual escalators of 2.5% beginning in year 5.  At January 1, 2015, our annualized yield from the direct financing leases was 10.6%.

Fixed-Rate Mortgages.  Our mortgages typically 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. At January 1, 2015, our average annualized yield on these investments was approximately 9.5%.

The table set forth in “Item 2 – Properties” contains information regarding our properties and investments as of December 31, 2014.

Borrowing Policies.  We generally attempt to match the maturity of our indebtedness with the maturity of our investment assets and employ long-term, fixed-rate debt to the extent practicable in view of market conditions in existence from time to time.

We may use the proceeds of new indebtedness to finance our investments in additional healthcare facilities.  In addition, we may invest in properties subject to existing loans, secured by mortgages, deeds of trust or similar liens on properties.

Policies With Respect To Certain Activities.  With respect to our capital requirements, we typically rely on equity offerings, debt financing and retention of cash flow (subject to provisions in the Internal Revenue Code (the “Code”) concerning taxability of undistributed REIT taxable income), or a combination of these methods.  Our financing alternatives include bank borrowings, publicly or privately placed debt instruments, purchase money obligations to the sellers of assets or securitizations, any of which may be issued as secured or unsecured indebtedness.

 

We have the authority to issue our common stock or other equity or debt securities in exchange for property and to repurchase or otherwise reacquire our securities.

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.  The healthcare industry is highly competitive and will likely become more competitive in the future.  We face competition from other REITs, investment companies, private equity and hedge fund investors, healthcare operators, lenders, developers and other institutional investors, some of whom have greater resources and lower costs of capital than us.  Our operators compete on a local and regional basis with operators of facilities that provide comparable services. The basis of competition for our operators includes the quality of care provided, reputation, the physical appearance of a facility, price, the range of services offered, family preference, alternatives for healthcare delivery, the supply of competing properties, physicians, staff, referral sources, location and the size and demographics of the population and surrounding areas.

Increased competition makes it more challenging for us to identify and successfully capitalize on opportunities that meet our objectives. Our ability to compete is also impacted by national and local economic trends, availability of investment alternatives, availability and cost of capital, construction and renovation costs, existing laws and regulations, new legislation and population trends.  For additional information on the risks associated with our business, please see “Item 1A — Risk Factors” below.

Taxation

The following is a general summary of the material United States federal income tax considerations applicable to (i) us, (ii) the holders of our securities and (iii) our election to be taxed as a REIT. It is not tax advice. This summary is not intended to represent a detailed description of the United States federal income tax consequences applicable to a particular stockholder in view of any person’s particular circumstances, nor is it intended to represent a detailed description of the United States federal income tax consequences applicable to stockholders subject to special treatment under the federal income tax laws such as insurance companies, tax-exempt organizations, financial institutions, securities broker-dealers, investors in pass-through entities, expatriates and taxpayers subject to alternative minimum taxation.

The following discussion, to the extent it constitutes matters of law or legal conclusions (assuming the facts, representations and assumptions upon which the discussion is based are accurate), represents some of the material United States federal income tax considerations relevant to ownership of our securities. The sections of the Code relating to the qualification and operation as a REIT are highly technical and complex. The following sets forth certain material aspects of those sections. The information in this section is based on, and is qualified in its entirety by the Code; current, temporary and proposed Treasury Regulations promulgated under the Code; the legislative history of the Code; current administrative interpretations and practices of the Internal Revenue Service (“IRS”); and court decisions, in each case, as of the date of this report. In addition, the administrative interpretations and practices of the IRS include its practices and policies as expressed in private letter rulings, which are not binding on the IRS, except with respect to the particular taxpayers who requested and received those rulings.

General. We have elected to be taxed as a REIT, under Sections 856 through 860 of the Code, beginning with our taxable year ended December 31, 1992. We believe that we were organized and have operated in such a manner as to qualify for taxation as a REIT. We intend to continue to operate in a manner that will allow us to maintain our qualification as a REIT, but no assurance can be given that we have operated or will be able to continue to operate in a manner so as to qualify or remain qualified as a REIT.

 

If we qualify for taxation as a REIT, we generally will not be subject to federal corporate income taxes on our net income that is currently distributed to stockholders. However, we will be subject to certain federal income taxes as follows.  First, we will be taxed at regular corporate rates on any undistributed REIT taxable income, including undistributed net capital gains; provided, however, that if we have a net capital gain, we will be taxed at regular corporate rates on our undistributed REIT taxable income, computed without regard to net capital gain and the deduction for capital gains dividends, plus a 35% tax on undistributed net capital gain, if our tax as thus computed is less than the tax computed in the regular manner. Second, under certain circumstances, we may be subject to the “alternative minimum tax” on our items of tax preference that we do not distribute or allocate to our stockholders. Third, if we have (i) net income from the sale or other disposition of “foreclosure property,” which is held primarily for sale to customers in the ordinary course of business, or (ii) other nonqualifying income from foreclosure property, we will be subject to tax at the highest regular corporate rate on such income. Fourth, if we have net income from prohibited transactions (which are, in general, certain sales or other dispositions of property (other than foreclosure property) held primarily for sale to customers in the ordinary course of business by us, (i.e., when we are acting as a dealer), such income will be subject to a 100% tax. Fifth, if we should fail to satisfy the 75% gross income test or the 95% gross income test (as discussed below), but nonetheless have maintained our qualification as a REIT because certain other remedial requirements have been met, we will be subject to a 100% tax on an amount equal to (a) the gross income attributable to the greater of the amount by which we fail the 75% or 95% test, multiplied by (b) a fraction intended to reflect our profitability. Sixth, if we should fail to distribute by the end of each year at least the sum of (i) 85% of our REIT ordinary income for such year, (ii) 95% of our REIT capital gain net income for such year, and (iii) any undistributed taxable income from prior periods, we will be subject to a 4% excise tax on the excess of such required distribution over the amounts actually distributed. Seventh, we will be subject to a 100% excise tax on transactions with a taxable REIT subsidiary (“TRS”) that are not conducted on an arm’s-length basis. Eighth, if we acquire any asset that is defined as a “built-in gain asset” from a C corporation that is not a REIT (i.e., generally a corporation subject to full corporate-level tax) in a transaction in which the basis of the built-in gain asset in our hands is determined by reference to the basis of the asset (or any other property) in the hands of the C corporation, and we recognize gain on the disposition of such asset during the 10-year period beginning on the date on which such asset was acquired by us (such period, the “recognition period”), then, to the extent of the built-in gain (i.e., the excess of (a) the fair market value of such asset on the date such asset was acquired by us over (b) our adjusted basis in such asset on such date), our recognized gain will be subject to tax at the highest regular corporate rate. The results described above with respect to the recognition of built-in gain assume that we will not make an election pursuant to Treasury Regulations Section 1.337(d)-7(c)(5).

Ownership of Partnership Interest.  In the case of a REIT that is a direct or indirect partner in a partnership or other entity taxable as a partnership for U.S. federal income tax purposes, the Treasury Regulations provide that the REIT is deemed to own its proportionate share of the partnership’s assets, and to earn its proportionate share of the partnership’s income for purposes of the asset and gross income tests applicable to REITs as described below. Similarly, the assets and gross income of the partnership are deemed to retain the same character in the hands of the REIT.

In connection with the pending Merger, the assets of the Aviv Operating Partnership, will be combined with the Company’s assets under the Omega Operating Partnership. Thus, the Company’s proportionate share of the assets, liabilities, and items of income in the Omega Operating Partnership will be treated as the Company’s assets, liabilities, and items of income for purposes of applying the REIT requirements described below. A summary of certain rules governing the United States federal income taxation of partnerships and their partners is provided below in “Tax Aspects of Investments in the Omega Operating Partnership.”

Requirements for Qualification. The Code defines a REIT as a corporation, trust or association: (1) which is managed by one or more trustees or directors; (2) the beneficial ownership of which is evidenced by transferable shares, or by transferable certificates of beneficial interest; (3) which would be taxable as a domestic corporation, but for Sections 856 through 859 of the Code; (4) which is neither a financial institution nor an insurance company as defined in provisions of the Code; (5) the beneficial ownership of which is held by 100 or more persons; (6) during the last half year of each taxable year not more than 50% in value of the outstanding stock of which is owned, actually or constructively, by five or fewer individuals (as defined in the Code to include certain entities); and (7) which meets certain other tests, described below, regarding the nature of its income and assets and the amount of its annual distributions to stockholders. The Code provides that conditions (1) to (4) inclusive, must be met during the entire taxable year and that condition (5) must be met during at least 335 days of a taxable year of twelve months, or during a proportionate part of a taxable year of less than twelve months. For purposes of conditions (5) and (6), pension funds and certain other tax-exempt entities are treated as individuals, subject to a “look-through” exception in the case of condition (6).

Income Tests. To maintain our qualification as a REIT, we annually must satisfy two gross income requirements. First, at least 75% of our gross income (excluding gross income from prohibited transactions) for each taxable year must be derived directly or indirectly from investments relating to real property or mortgages on real property (including generally “rents from real property,” interest on mortgages on real property, and gains on sale of real property and real property mortgages, other than property described in Section 1221(a)(1) of the Code) and income derived from certain types of temporary investments. Second, at least 95% of our gross income (excluding gross income from prohibited transactions) for each taxable year must be derived from such real property investments, dividends, interest and gain from the sale or disposition of stock or securities other than property held for sale to customers in the ordinary course of business.

Rents received by us will qualify as “rents from real property” in satisfying the gross income requirements for a REIT described above only if several conditions are met. First, the amount of the rent must not be based in whole or in part on the income or profits of any person. However, any amount received or accrued generally will not be excluded from the term “rents from real property” solely by reason of being based on a fixed percentage or percentages of receipts or sales. Second, the Code provides that rents received from a tenant (other than rent from a tenant that is a TRS that meets the requirements described below) will not qualify as “rents from real property” in satisfying the gross income tests if we, or an owner (actually or constructively) of 10% or more of the value of our stock, actually or constructively owns 10% or more of such tenant, which is defined as a related party tenant. Third, if rent attributable to personal property, leased in connection with a lease of real property, is greater than 15% of the total rent received under the lease, then the portion of rent attributable to such personal property will not qualify as “rents from real property.” Finally, for rents received to qualify as “rents from real property,” we generally must not operate or manage the property or furnish or render services to the tenants of such property, other than through an independent contractor from which we derive no revenue. We may, however, directly perform certain services that are “usually or customarily rendered” in connection with the rental of space for occupancy only and are not otherwise considered “rendered to the occupant” of the property. In addition, we may directly provide a minimal amount of “non-customary” services to the tenants of a property as long as our income from the services does not exceed 1% of our income from the related property. Furthermore, we may own up to 100% of the stock of a TRS, which may provide customary and non-customary services to our tenants without tainting our rental income from the related properties. For our tax years beginning after 2004, rents for customary services performed by a TRS or that are received from a TRS and are described in Code Section 512(b)(3) no longer need to meet the 100% excise tax safe harbor. Instead, such payments avoid the excise tax if we pay the TRS at least 150% of its direct cost of furnishing such services. Beginning in 2009, we were allowed to include as qualified rents from real property rental income that is paid to us by a TRS with respect to a lease of a health care facility to the TRS provided that the facility is operated and managed by an “eligible independent contractor,” although none of our facilities were leased to any of our TRSs.

The term “interest” generally does not include any amount received or accrued (directly or indirectly) if the determination of such amount depends in whole or in part on the income or profits of any person. However, an amount received or accrued generally will not be excluded from the term “interest” solely by reason of being based on (i) a fixed percentage or (ii) percentages of gross receipts or sales. In addition, an amount that is based on the income or profits of a debtor will be qualifying interest income as long as the debtor derives substantially all of its income from the real property securing the debt from leasing substantially all of its interest in the property, but only to the extent that the amounts received by the debtor would be qualifying “rents from real property” if received directly by a REIT.

If a loan contains a provision that entitles us to a percentage of the borrower’s gain upon the sale of the real property securing the loan or a percentage of the appreciation in the property’s value as of a specific date, income attributable to that loan provision will be treated as gain from the sale of the property securing the loan, which generally is qualifying income for purposes of both gross income tests.

Interest on debt secured by mortgages on real property or on interests in real property generally is qualifying income for purposes of the 75% gross income test. However, if the highest principal amount of a loan outstanding during a taxable year exceeds the fair market value of the real property securing the loan as of the date we agreed to originate or acquire the loan, a portion of the interest income from such loan will not be qualifying income for purposes of the 75% gross income test, but will be qualifying income for purposes of the 95% gross income test. The portion of the interest income that will not be qualifying income for purposes of the 75% gross income test will be equal to the portion of the principal amount of the loan that is not secured by real property.  A modification of a mortgage loan, if it is deemed significant for income tax purposes, could be considered to be the deemed issuance of a new mortgage loan that is subject to re-testing under these rules, with the possible re-characterization of the mortgage interest on such loan as non-qualifying income for purposes of the 75% gross income test (but not the 95% gross income test, which is discussed below), as well as non-qualifying assets under the asset test (discussed below) and the deemed exchange of the modified loan for the new loan could result in imposition of the 100% prohibited transaction tax (also discussed below). The IRS recently issued guidance providing relief in the case of certain existing mortgage loans held by a REIT that are modified in response to these market conditions such that (i) the modified mortgage loan need not be re-tested for purposes of determining whether the income from the mortgage loan continues to be qualified income for purposes of the 75% gross income test or whether the mortgage loan retains its character as a qualified REIT asset for purposes of the asset test (discussed below), and (ii) the modification of the loan will not be treated as a prohibited transaction. At present, we do not hold any mortgage loans that have been modified, which would require us to take advantage of these rules for special relief.  We monitor our mortgage loans and direct financing leases for compliance with the above rules.

Prohibited Transactions. We will incur a 100% tax on the net income derived from any sale or other disposition of property, other than foreclosure property, that we hold primarily for sale to customers in the ordinary course of a trade or business. We believe that none of our assets is primarily held for sale to customers and that a sale of any of our assets would not be in the ordinary course of our business. Whether a REIT holds an asset primarily for sale to customers in the ordinary course of a trade or business depends, however, on the facts and circumstances in effect from time to time, including those related to a particular asset. Nevertheless, we will attempt to comply with the terms of safe-harbor provisions in the federal income tax laws prescribing when an asset sale will not be characterized as a prohibited transaction. The Code also provides a number of alternative exceptions from the 100% tax on “prohibited transactions” if certain requirements have been satisfied with respect to property disposed of by a REIT. These requirements relate primarily to the number and/or amount of properties disposed of by a REIT, the period of time the property has been held by the REIT, and/or aggregate expenditures made by the REIT with respect to the property being disposed of. The conditions needed to meet these requirements have been lowered for taxable years beginning in 2009 and thereafter. However, we cannot assure you that we will be able to comply with the safe-harbor provisions or that we would be able to avoid the 100% tax on prohibited transactions if we were to dispose of an owned property that otherwise may be characterized as property that we hold primarily for sale to customers in the ordinary course of a trade or business.

Foreclosure Property. We will be subject to tax at the maximum corporate rate on any income from foreclosure property, other than income that otherwise would be qualifying income for purposes of the 75% gross income test, less expenses directly connected with the production of that income. However, gross income from foreclosure property is treated as qualifying for purposes of the 75% and 95% gross income tests. Foreclosure property is any real property, including interests in real property, and any personal property incident to such real property:

 

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that is acquired by a REIT as the result of (i) the REIT having bid on such property at foreclosure, or having otherwise reduced such property to ownership or possession by agreement or process of law, after there was a default, or (ii) default was imminent on a lease of such property or on indebtedness that such property secured;

 

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for which the related loan or lease was acquired by the REIT at a time when the default was not imminent or anticipated; and

 

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for which the REIT makes a proper election to treat the property as foreclosure property.

Such property generally ceases to be foreclosure property at the end of the third taxable year following the taxable year in which the REIT acquired the property, or longer (for a total of up to six years) if an extension is granted by the Secretary of the Treasury. In the case of a “qualified health care property” acquired solely as a result of termination of a lease, but not in connection with default or an imminent default on the lease, the initial grace period terminates on the second (rather than third) taxable year following the year in which the REIT acquired the property (unless the REIT establishes the need for and the Secretary of the Treasury grants one or more extensions, not exceeding six years in total, including the original two-year period, to provide for the orderly leasing or liquidation of the REIT’s interest in the qualified health care property). This grace period terminates and foreclosure property ceases to be foreclosure property on the first day:

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on which a lease is entered into for the property that, by its terms, will give rise to income that does not qualify for purposes of the 75% gross income test, or any amount is received or accrued, directly or indirectly, pursuant to a lease entered into on or after such day that will give rise to income that does not qualify for purposes of the 75% gross income test;

 

●

on which any construction takes place on the property, other than completion of a building or any other improvement, where more than 10% of the construction was completed before default became imminent; or

 

●

which is more than 90 days after the day on which the REIT acquired the property and the property is used in a trade or business that is conducted by the REIT, other than through an independent contractor from whom the REIT itself does not derive or receive any income.

The definition of foreclosure property includes any “qualified health care property,” as defined in Code Section 856(e)(6) acquired by us as the result of the termination or expiration of a lease of such property. We have from time to time operated qualified healthcare facilities acquired in this manner for up to two years (or longer if an extension was granted). However, we do not currently own any property with respect to which we have made foreclosure property elections.  Properties that we had taken back in a foreclosure or bankruptcy and operated for our own account were treated as foreclosure properties for income tax purposes, pursuant to Code Section 856(e). Gross income from foreclosure properties was classified as “good income” for purposes of the annual REIT income tests upon making the election on the tax return. Once made, the income was classified as “good” for a period of three years, or until the properties were no longer operated for our own account. In all cases of foreclosure property, we utilized an independent contractor to conduct day-to-day operations to maintain REIT status. In certain cases, we operated these facilities through a taxable REIT subsidiary. For those properties operated through the taxable REIT subsidiary, we utilized an eligible independent contractor to conduct day-to-day operations to maintain REIT status. As a result of the foregoing, we do not believe that our participation in the operation of nursing homes increased the risk that we would fail to qualify as a REIT. Through our 2014 taxable year, we had not paid any tax on our foreclosure property because those properties had been producing losses.  We cannot predict whether, in the future, our income from foreclosure property will be significant and whether we could be required to pay a significant amount of tax on that income.

Hedging Transactions. From time to time, we may enter into hedging transactions with respect to one or more of our assets or liabilities. Our hedging activities may include entering into interest rate swaps, caps and floors, options to purchase these items and futures and forward contracts. To the extent that we enter into an interest rate swap or cap contract, option, futures contract, forward rate agreement, or any similar financial instrument to hedge our indebtedness incurred to acquire or carry “real estate assets,” any periodic income or gain from the disposition of that contract should be qualifying income for purposes of the 95% gross income test, but not the 75% gross income test. Accordingly, our income and gain from our interest rate swap agreements generally is qualifying income for purposes of the 95% gross income test, but not the 75% gross income test. To the extent that we hedge with other types of financial instruments, or in other situations, it is not entirely clear how the income from those transactions will be treated for purposes of the gross income tests. We have structured and intend to continue to structure any hedging transactions in a manner that does not jeopardize our status as a REIT. For tax years beginning after 2004, we were no longer required to include income from hedging transactions in gross income (i.e., not included in either the numerator or the denominator) for purposes of the 95% gross income test and we are no longer required to include in gross income (i.e., not included in either the numerator or the denominator) for purposes of the 75% gross income test any gross income from any hedging transaction entered into after July 30, 2008.  We did not engage in hedge transactions in 2011, 2012, 2013, or 2014.

TRS Income. A TRS may earn income that would not be qualifying income if earned directly by the parent REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation of which a TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 25% of the value of a REIT’s assets may consist of securities of one or more TRSs. Prior to 2009, a TRS was not permitted to directly or indirectly (i) operate or manage a health care (or lodging) facility, or (ii) provide to any other person (under a franchise, license, or otherwise) rights to any brand name under which a health care (or lodging) facility is operated. Beginning in 2009, TRSs became permitted to own or lease a health care facility provided that the facility is operated and managed by an “eligible independent contractor.” A TRS will pay income tax at regular corporate rates on any income that it earns. In addition, the new rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. The rules also impose a 100% excise tax on transactions between a TRS and its parent REIT or the REIT’s operators that are not conducted on an arm’s-length basis.  As stated above, we do not lease any of our facilities to any of our TRSs.

Failure to Satisfy Income Tests. If we fail to satisfy one or both of the 75% or 95% gross income tests for any taxable year, we may nevertheless qualify as a REIT for such year if we are entitled to relief under certain relief provisions of the Code. These relief provisions will be generally available if our failure to meet such tests was due to reasonable cause and not due to willful neglect, we attach a schedule of the sources of our income to our tax return, and any incorrect information on the schedule was not due to fraud with intent to evade tax. It is not possible, however, to state whether in all circumstances we would be entitled to the benefit of these relief provisions. Even if these relief provisions apply, we would incur a 100% tax on the gross income attributable to the greater of the amounts by which we fail the 75% and 95% gross income tests, multiplied by a fraction intended to reflect our profitability and we would file a schedule with descriptions of each item of gross income that caused the failure.

Asset Tests. At the close of each quarter of our taxable year, we must also satisfy the following tests relating to the nature of our assets. First, at least 75% of the value of our total assets must be represented by real estate assets (including (i) our allocable share of real estate assets held by partnerships in which we own an interest and (ii) stock or debt instruments held for less than one year purchased with the proceeds of a stock offering or long-term (at least five years) debt offering of our company), cash, cash items and government securities. Second, of our investments not included in the 75% asset class, the value of our interest in any one issuer’s securities may not exceed 5% of the value of our total assets. Third, we may not own more than 10% of the voting power or value of any one issuer’s outstanding securities. Fourth, no more than 25% of the value of our total assets may consist of the securities of one or more TRSs. Fifth, no more than 25% of the value of our total assets may consist of the securities of TRSs and other non-TRS taxable subsidiaries and other assets that are not qualifying assets for purposes of the 75% asset test.

For purposes of the second and third asset tests described above the term “securities” does not include our equity or debt securities of a qualified REIT subsidiary, a TRS, or an equity interest in any partnership, since we are deemed to own our proportionate share of each asset of any partnership of which we are a partner. Furthermore, for purposes of determining whether we own more than 10% of the value of only one issuer’s outstanding securities, the term “securities” does not include: (i) any loan to an individual or an estate; (ii) any Code Section 467 rental agreement; (iii) any obligation to pay rents from real property; (iv) certain government issued securities; (v) any security issued by another REIT; and (vi) our debt securities in any partnership, not otherwise excepted under (i) through (v) above, (A) to the extent of our interest as a partner in the partnership or (B) if 75% of the partnership’s gross income is derived from sources described in the 75% income test set forth above.

We may own up to 100% of the stock of one or more TRSs. However, overall, no more than 25% of the value of our assets may consist of securities of one or more TRSs, and no more than 25% of the value of our assets may consist of the securities of TRSs and other non-TRS taxable subsidiaries (including stock in non-REIT C corporations) and other assets that are not qualifying assets for purposes of the 75% asset test. If the outstanding principal balance of a mortgage loan exceeds the fair market value of the real property securing the loan, a portion of such loan likely will not be a qualifying real estate asset for purposes of the 75% test. The nonqualifying portion of that mortgage loan will be equal to the portion of the loan amount that exceeds the value of the associated real property. As discussed under the 75% gross income test (see above), the IRS recently provided relief from re-testing certain mortgage loans held by a REIT that have been modified as a result of the current distressed market conditions with respect to real property. At present, we do not hold any mortgage loans that have been modified, which would require us to take advantage of these rules for special relief.

After initially meeting the asset tests at the close of any quarter, we will not lose our status as a REIT for failure to satisfy any of the asset tests at the end of a later quarter solely by reason of changes in asset values. If the failure to satisfy the asset tests results from an acquisition of securities or other property during a quarter, the failure can be cured by disposition of sufficient nonqualifying assets within 30 days after the close of that quarter.

Subject to certain de minimis exceptions, we may avoid REIT disqualification in the event of certain failures under the asset tests, provided that (i) we file a schedule with a description of each asset that caused the failure, (ii) the failure was due to reasonable cause and not willful neglect, (iii) we dispose of the assets within 6 months after the last day of the quarter in which the identification of the failure occurred (or the requirements of the rules are otherwise met within such period) and (iv) we pay a tax on the failure equal to the greater of (A) $50,000 per failure and (B) the product of the net income generated by the assets that caused the failure for the period beginning on the date of the failure and ending on the date we dispose of the asset (or otherwise satisfy the requirements) multiplied by the highest applicable corporate tax rate.

Annual Distribution Requirements. 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 noncash income. 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 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.

Furthermore, if we fail to distribute during a calendar year, or by the end of January following the calendar year in the case of distributions with declaration and record dates falling in the last three months of the calendar year, at least the sum of:

 

●  85% of our REIT ordinary income for such year;

 

●  95% of our REIT capital gain income for such year; and

 

●  any undistributed taxable income from prior periods,

 

we will incur a 4% nondeductible excise tax on the excess of such required distribution over the amounts we actually distribute. We may elect to retain and pay income tax on the net long-term capital gain we receive in a taxable year. If we so elect, we will be treated as having distributed any such retained amount for purposes of the 4% excise tax described above. We have made, and we intend to continue to make, timely distributions sufficient to satisfy the annual distribution requirements. We may also be entitled to pay and deduct deficiency dividends in later years as a relief measure to correct errors in determining our taxable income. Although we may be able to avoid income tax on amounts distributed as deficiency dividends, we will be required to pay interest to the IRS based upon the amount of any deduction we take for deficiency dividends.

The availability to us of, among other things, depreciation deductions with respect to our owned facilities (which reduce our taxable income and the amount of our required dividend distributions) depends upon the determination that, for federal income tax purposes, we are the true owner of such facilities for federal income tax purposes, which is dependent on the classification of the leases to operators or our facilities as “true leases” rather than financing arrangements for federal income tax purposes. The determinations of whether (1) we are the owner of such facilities, and (2) the leases are true leases, for federal tax purposes are essentially factual matters. We believe that we will be treated as the owner of each of the facilities that we lease, and such leases will be treated as true leases for federal income tax purposes. However, no assurances can be given that the IRS will not successfully challenge our status as the owner of our facilities subject to leases, and the status of such leases as true leases, asserting that the purchase of the facilities by us and the leasing of such facilities merely constitute steps in secured financing transactions in which the lessees are owners of the facilities and we are merely a secured creditor. In such event, we would not be entitled to claim depreciation deductions with respect to any of the affected facilities. As a result, we might fail to meet the 90% distribution requirement or, if such requirement is met, we might be subject to corporate income tax or the 4% excise tax.

Reasonable Cause Savings Clause. We may avoid disqualification in the event of a failure to meet certain requirements for REIT qualification if the failures are due to reasonable cause and not willful neglect, and if the REIT pays a penalty of $50,000 for each such failure. This reasonable cause safe harbor is not available for failures to meet the 95% and 75% gross income tests or the assets tests.

Failure to Qualify. If we fail to qualify as a REIT in any taxable year, and the reasonable cause relief provisions do not apply, we will be subject to tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates. Distributions to stockholders in any year in which we fail to qualify will not be deductible, and our failure to qualify as a REIT would reduce the cash available for distribution by us to our stockholders. In addition, if we fail to qualify as a REIT, all distributions to stockholders will be taxable as dividend income, to the extent of our current and accumulated earnings and profits.  However, in such a case, subject to certain limitations of the Code, corporate distributees may be eligible for the dividends received deduction with respect to dividends that we make, and in the case of an individual, trust, or an estate, dividends are treated the same as capital gain income, which currently is subject to a maximum income tax rate that is lower than regular income tax rates.  In addition, in the case of an individual, trust or an estate, to the extent such taxpayer’s unearned income (including dividends) exceeds certain threshold amounts, the Medicare Tax on unearned income also will apply to dividend income.  Unless entitled to relief under specific statutory provisions, we would also be disqualified from taxation as a REIT for the four taxable years following the year during which qualification was lost. It is not possible to state whether in all circumstances we would be entitled to such statutory relief. Failure to qualify could result in our incurring indebtedness or liquidating investments to pay the resulting taxes.

Tax Aspects of Investments in the Omega Operating Partnership.  After the pending Merger and partnership combination, the Company will hold substantially all of its real estate assets through the Omega Operating Partnership, an “operating partnership” that holds pass-through subsidiaries. In general, an entity classified as a partnership (or a disregarded entity) for United States federal income tax purposes is a “pass-through” entity that is not subject to United States federal income tax. Rather, partners or members are allocated their proportionate shares of the items of income, gain, loss, deduction, and credit of the entity, and are potentially subject to tax on these items, without regard to whether the partners or members receive a distribution from the entity. Thus, the Company would include in its income its proportionate share of these income items for purposes of the various REIT income tests and in the computation of the Company’s REIT taxable income. Moreover, for purposes of the REIT asset tests, the Company would include its proportionate share of the assets held by the Omega Operating Partnership. Consequently, to the extent that the Company holds an equity interest in a partnership, the partnership’s assets and operations may affect the Company’s ability to qualify as a REIT.

The Company’s investment in the Omega Operating Partnership involves special tax considerations, including the possibility of a challenge by the IRS of the tax status of such partnership. If the IRS were to successfully treat the Omega Operating Partnership as an association or publicly traded partnership taxable as a corporation, as opposed to a partnership, for United States federal income tax purposes, the Omega Operating Partnership would be subject to an entity-level tax on its income. In such a situation, the character of the Company’s assets and items of gross income would change and could preclude the Company from satisfying the REIT asset tests or the gross income tests as discussed in “Income Tests” and “Asset Tests” above, which in turn could prevent the Company from qualifying as a REIT unless the Company is eligible for relief from the violation pursuant to relief provisions described above. See  “Income Tests” and “Asset Tests,” and “Failure to Qualify” above, for a discussion of the effect of the Company’s failure to meet these tests for a taxable year, and of the relief provisions. Furthermore, any change in the status of the Omega Operating Partnership for United States federal income tax purposes could be treated as a taxable event, in which case the Company could have taxable income that is subject to the REIT distribution requirements without receiving any cash.

Under the Code and Treasury Regulations, income, gain, loss, and deduction attributable to appreciated or depreciated property that is contributed to a partnership in exchange for an interest in the partnership must be allocated for United States federal income tax purposes in a manner such that the contributing partner is charged with, or benefits from, the unrealized gain or unrealized loss associated with the property at the time of the contribution. The amount of the unrealized gain or unrealized loss is generally equal to the difference between the fair market value of the contributed property at the time of contribution, and the adjusted tax basis of such property at the time of contribution. Such allocations are solely for United States federal income tax purposes and do not affect other economic or legal arrangements among the partners. These rules may apply to a contribution of property by the Company to the Omega Operating Partnership. To the extent that the Omega Operating Partnership acquires appreciated (or depreciated) properties by way of capital contributions from its partners, allocations would need to be made in a manner consistent with these requirements. Where a partner contributes cash to a partnership at a time at which the partnership holds appreciated (or depreciated) property, the Treasury Regulations provide for a similar allocation of these items to the other (i.e., non-contributing) partners.  As a result, partners, including the Company, could be allocated greater or lesser amounts of depreciation and taxable income in respect of the partnership’s properties than would be the case if all of the partnership’s assets (including any contributed assets) had a tax basis equal to their fair market values at the time of any contributions to that partnership. This could cause the Company to recognize taxable income in excess of cash flow from the partnership, which might adversely affect the Company’s ability to comply with the REIT distribution requirements discussed above.

Qualified REIT Subsidiaries. We own and operate a number of properties through qualified REIT subsidiaries (“QRSs”). The QRSs are treated as qualified REIT subsidiaries under the Code. Code Section 856(i) provides that a corporation that is a qualified REIT subsidiary shall not be treated as a separate corporation, and all assets, liabilities and items of income, deduction and credit of a qualified REIT subsidiary shall be treated as assets, liabilities and such items (as the case may be) of the REIT. Thus, in applying the tests for REIT qualification described above, the QRSs will be ignored, and all assets, liabilities and items of income, deduction, and credit of such QRSs will be treated as our assets, liabilities and items of income, deduction, and credit.

Government Regulation and Reimbursement

The health care industry is heavily regulated. Our operators are subject to extensive and complex federal, state and local healthcare laws and regulations. These laws and regulations are subject to frequent and substantial changes resulting from the adoption of new legislation, rules and regulations, and administrative and judicial interpretations of existing law.  The ultimate timing or effect of these changes, which may be applied retroactively, cannot be predicted.  Changes in laws and regulations impacting our operators, in addition to regulatory non-compliance by our operators, can have a significant effect on the operations and financial condition of our operators, which in turn may adversely impact us.  See “Item 1A – Risk Factors.”  The following is a discussion of certain laws and regulations generally applicable to our operators, and in certain cases, to us.

 

●          On January 3, 2013, a new federal Commission on Long-Term Care was established and tasked with developing a plan for the establishment, implementation and financing of a high-quality system to provide long-term care services.  In September 2013, the Commission released a report with 38 proposals for legislative and administrative actions to promote the establishment and financing of a long-term care services system that will ensure the availability of such services to those who need them.  The Commission recommended creating a national advisory committee and convening a 2015 White House Conference on aging.

●          The Healthcare Reform Law requires private health insurers that sell policies to individuals and small businesses to provide, starting in 2014, a set of “essential health benefits” in ten categories, including prescription drugs, rehabilitative and habilitative services, and chronic disease management.  As required under the law, each state has defined the essential health benefits required in that state.

●          The Healthcare Reform Law requires SNFs to implement a compliance and ethics program that is effective in preventing and detecting criminal, civil and administrative violations and in promoting quality of care.  The Department of Health and Human Services (“HHS”) has not yet issued the proposed regulations to implement this law that were due in March 2012.

Given the complexity of the Healthcare Reform Law and the substantial requirements for regulation thereunder, the impact of the Healthcare Reform Law on our operators or their ability to meet their obligations to us cannot be predicted.  The Healthcare Reform Law could result in decreases in payments to our operators or otherwise adversely affect the financial condition of our operators, thereby negatively impacting our financial condition.  Our operators may not be successful in modifying their operations to lessen the impact of any increased costs or other adverse effects resulting from changes in governmental programs, private insurance and/or employee welfare benefit plans.  The impact of the Healthcare Reform Law on each of our operators will vary depending on payor mix, resident conditions and a variety of other factors.  In addition to the provisions relating to reimbursement, other provisions of the Healthcare Reform Law may impact our operators as employers (e.g., requirements related to providing health insurance for employees). We anticipate that many of the provisions in the Healthcare Reform Law may be subject to further clarification and modification during the rule making process.

Reimbursement Generally. A significant portion of our operators’ revenue is derived from governmentally-funded reimbursement programs, consisting primarily of Medicare and Medicaid. In recent years, the federal government and many state governments have focused on reducing expenditures under the Medicare and Medicaid programs, resulting in significant cost-cutting at both the federal and state levels.   These cost-cutting measures, together with the implementation of changes in reimbursement rates such as those described below, could result in a significant reduction of reimbursement rates to our operators under both the Medicare and Medicaid programs.

On April 1, 2014, President Obama signed the “Protecting Access to Medicare Act of 2014” which calls for HHS to develop a value based purchasing program for SNFs aimed at lowering readmission rates.  Beginning in 2018, 2% of SNFs’ Medicare payments could be withheld and about 70% of those dollars would be distributed to SNFs with reduced hospital readmissions.

We currently believe that our operator coverage ratios are adequate and that our operators can absorb moderate reimbursement rate reductions and still meet their obligations to us. However, significant limits on the scopes of services reimbursed and/or reductions of reimbursement rates could have a material adverse effect on our operators’ results of operations and financial condition, which could adversely affect our operators’ ability to meet their obligations to us.

Medicaid.  State budgetary concerns, coupled with the implementation of rules under the Healthcare Reform Law, may result in significant changes in healthcare spending at the state level.  Many states are currently focusing on the reduction of expenditures under their state Medicaid programs, which may result in a reduction in reimbursement rates for our operators.  The need to control Medicaid expenditures may be exacerbated by the potential for increased enrollment in Medicaid due to unemployment and declines in family incomes.  Since our operators’ profit margins on Medicaid patients are generally relatively low, more than modest reductions in Medicaid reimbursement or an increase in the number of Medicaid patients could adversely affect our operators’ results of operations and financial condition, which in turn could negatively impact us.

The Healthcare Reform Law provided for Medicaid coverage to be expanded to all individuals under age 65 with incomes up to 133% of the federal poverty level, beginning January 1, 2014.  The federal government will pay the entire cost for Medicaid coverage for newly eligible beneficiaries for 3 years (2014 through 2016).  In 2017, the federal share declines to 95%; in 2018, to 94%; in 2019, to 93%; and in 2020 and subsequent years, to 90%.  Pursuant to the law, states may delay Medicaid expansion after 2014, but the federal payment rates will be less.

However, on June 28, 2012, the Supreme Court ruled that states could not be required to expand Medicaid or risk losing federal funding of their existing Medicaid programs. Over half of the states have expanded or are expanding Medicaid coverage as contemplated by the Healthcare Reform Law, with many of the remaining states involved in a variety of legislative proposals or discussions. HHS has stated that it will consider a limited number of premium assistance demonstration programs from states that want to privatize Medicaid expansion. States must provide a choice between at least two qualified health plans that offer very similar benefits as those required by the health insurance exchanges. Arkansas became the first state to obtain federal approval to use Medicaid funding to purchase private insurance for low-income residents.  Iowa, Michigan and Pennsylvania have also secured waivers, and Indiana has a pending waiver for alternative Medicaid expansion plans.

Medicare.  The Center for Medicaid and Medicare Services (“CMS”) estimates that aggregate Medicare payments to SNFs will increase by $750 million, or 2.0%, for the federal fiscal year that begins October 1, 2014 relative to payments in the prior federal fiscal year.  This estimated increase is attributable to a 2.5% market based increase, reduced by a 0.5% multifactor productivity adjustment required by law.  

Provisions contained in the American Taxpayer Relief Act (“ATRA”) of 2012, known colloquially as the fiscal cliff deal, are designed to reduce Medicare payments to SNFs by an estimated $600 million during 2012 to 2022.  It also reduces payments for multiple procedures or therapies provided on the same day, which will result in approximately $1.8 billion savings to Medicare over the next 10 years, which will impact SNFs as well.  Under ATRA, sequestration cuts impacting domestic and defense spending became effective March 1, 2013.  Although Medicaid is exempted from the sequestration cuts, they included a 2% cut in payments to Medicare providers and suppliers, which amounted to an estimated $11.3 billion in cuts in federal fiscal year 2013. The Bipartisan Budget Act of 2013 provides for $63 billion in sequestration relief in federal fiscal years 2014 and 2015 which will be split evenly between defense and nondefense programs.  It is unknown how Medicare will be impacted.

The “Protecting Access to Medicare Act of 2014” also extended the Medicare therapy cap exceptions process through March 31, 2015. The statutory Medicare Part B outpatient cap for occupational therapy is $1,920 for 2014, and the combined cap for physical therapy and speech therapy is also $1,920 for 2014.  These caps do not apply to therapy services covered under Medicare Part A for SNFs, although the caps apply in most other instances involving patients in SNFs or long-term care facilities who receive therapy services covered under Medicare Part B.  The exception process permits medically necessary therapy services beyond the cap limits. Expiration of the therapy cap exceptions process in the future could have a material adverse effect on our operators’ financial condition and operations, which could adversely impact their ability to meet their obligations to us.

Quality of Care Initiatives.  The CMS has implemented a number of initiatives focused on the quality of care provided by nursing homes that could affect our operators.  For instance, in December 2008, the CMS released quality ratings for all of the nursing homes that participate in Medicare or Medicaid under its “Five Star Quality Rating System.” Facility rankings, ranging from five stars (“much above average”) to one star (“much below average”) are updated on a monthly basis.  SNFs are required to provide information for the CMS Nursing Home Compare website regarding staffing and quality measures.  Based on this data and the results of state health inspections, SNFs are then rated based on the five-star rating system.  Beginning in 2015, CMS is making changes to the rating system including: (1) revising scoring methodology by which quality measure ratings are calculated for SNFs; (2) increasing the number and type of quality measures that are not solely based on self-reported data and (3) adding critical measures to staffing such as turnover and retention.   It is possible that this or any other ranking system could lead to future reimbursement policies that reward or penalize facilities on the basis of the reported quality of care parameters.

CMS has incorporated hospital readmissions review into the Quality Indicators Survey.  Under Medicare’s Inpatient Prospective Payment System, CMS began adjusting payments to hospitals for excessive readmissions of patients for heart attacks, heart failure and pneumonia during fiscal years beginning on and after October 1, 2012.  Long term care facilities will be under increased scrutiny to prevent residents from being readmitted to hospitals for these conditions in particular, and have an opportunity to demonstrate their quality of care by reducing their hospital readmission rates.  It is anticipated that hospital readmissions will be a consideration in the future in the CMS five-star rating system.

Office of the Inspector General Activities.  The Office of Inspector General’s (the “OIG”) Work Plan for government fiscal year 2015, which describes projects that the OIG plans to address during the fiscal year, includes a number of projects related to nursing homes.  Reviews of Medicare Part A and Part B payments and services for SNFs will focus on the following:  (1) (new) monitor Part B billings for abuse during non-Part A stays; (2) billing patterns for Part B services; (3) state agency verification of deficiency corrections; (4) background checks for employees; and (5) hospitalization of residents for manageable and preventable conditions. The OIG will also continue its efforts in addressing fraud and abuse.  While we cannot predict the results of the OIG’s activities, the projects could result in further scrutiny and/or oversight of nursing homes.

The OIG has identified one of its top management and performance challenges as using enforcement actions against SNFs that render substandard care. State Medicaid Fraud Units, which receive oversight and funding from the OIG are devoting substantial resources to investigating and prosecuting abuse and neglect in Medicaid-funded SNFs. To date, the OIG has placed almost 40 nursing home companies (greater than 750 SNFs) under corporate integrity agreements that include quality-monitoring provisions.

Fraud and Abuse. There are various federal and state civil and criminal laws and regulations governing a wide array of healthcare provider referrals, relationships and arrangements, including laws and regulations prohibiting fraud by healthcare providers. Many of these complex laws raise issues that have not been clearly interpreted by the relevant governmental authorities and courts.  In addition, federal and state governments are devoting increasing attention and resources to anti-fraud initiatives against healthcare providers.

The federal anti-kickback statute is a criminal statute that prohibits the knowing and willful offer, payment, solicitation or receipt of any remuneration in return for, to induce or to arrange for the referral of individuals for any item or service payable by a federal or state healthcare program. There is also a civil analogue. States also have enacted similar statutes covering Medicaid payments, and some states have broader statutes. Some enforcement efforts have targeted relationships between SNFs and ancillary providers, relationships between SNFs and referral sources for SNFs and relationships between SNFs and facilities for which the SNFs serve as referral sources. The federal self-referral law, commonly known as the “Stark Law,” is a civil statute that prohibits a physician from making referrals to an entity for “designated health services” if the physician has a financial relationship with the entity. Some of the services provided in SNFs are classified as designated health services. There are also criminal provisions that prohibit filing false claims or making false statements to receive payment or certification under Medicare and Medicaid, as well as failing to refund overpayments or improper payments. Violation of the anti-kickback statute or Stark Law may form the basis for a federal False Claims Act (“FCA”) violation. With increased frequency, the federal government is relying on a “worthless services” theory of liability in FCA cases. The allegations are that the SNF charged the government for something of value that it knowingly didn’t provide.

In addition, the federal False Claims Act allows a private individual with knowledge of fraud to bring a claim on behalf of the federal government and earn a percentage of the federal government’s recovery. Because of these incentives, these so-called “whistleblower” suits have become more frequent. The violation of any of these laws or regulations by an operator may result in the imposition of fines or other penalties, including exclusion from Medicare, Medicaid and all other federal and state healthcare programs.

Privacy. Our operators are subject to various federal, state and local laws and regulations designed to protect the confidentiality and security of patient health information, including the federal Health Insurance Portability and Accountability Act of 1996, as amended, the Health Information Technology for Economic and Clinical Health Act, and the corresponding regulations promulgated thereunder (“HIPAA”).  On January 25, 2013, the Office for Civil Rights issued a final rule modifying HIPAA to increase the requirements on our operators.  Some of the new requirements include, among other things: making business associates subject to the HIPAA Privacy and Security Rules which will require new business associate agreements; changes in determining whether a breach of unsecured protected health information occurred; new requirements for the Notice of Privacy Practices; and decreasing the time to disclose protected health information and requiring disclosures to be electronic under certain conditions.  HHS has been conducting audits of covered entities to evaluate compliance with HIPAA, and it will continue its audit program in 2015 which will also include business associates and will focus on security risk assessments.

Various states have similar laws and regulations that govern the maintenance and safeguarding of patient records, charts and other information generated in connection with the provision of professional medical services.  These laws and regulations require our operators to expend the requisite resources to secure protected health information, including the funding of costs associated with technology upgrades. Operators found in violation of HIPAA or any other privacy law or regulation may face large penalties. In addition, compliance with an operator’s notification requirements in the event of a breach of unsecured protected health information could cause reputational harm to an operator’s business.

Licensing and Certification. Our operators and facilities are subject to various federal, state and local licensing and certification laws and regulations, including laws and regulations under Medicare and Medicaid requiring operators of SNFs and ALFs to comply with extensive standards governing operations. Governmental agencies administering these laws and regulations regularly inspect our operators’ facilities and investigate complaints. Our operators and their managers receive notices of observed violations and deficiencies from time to time, and sanctions have been imposed from time to time on facilities operated by them.

Other Laws and Regulations.  Additional federal, state and local laws and regulations affect how our operators conduct their operations, including laws and regulations protecting consumers against deceptive practices and otherwise generally affecting our operators’ management of their property and equipment and the conduct of their operations (including laws and regulations involving fire, health and safety; quality of services, including care and food service; residents’ rights, including abuse and neglect laws; and the health standards set by the federal Occupational Safety and Health Administration).

General and Professional Liability.  Although arbitration agreements have been effective in limiting general and professional liabilities for long term care providers, there have been national efforts to outlaw the use of pre-dispute arbitration agreements in long term care settings.  At least one state is allowing residents to sue a SNF for failing to comply with staffing quality measures.  All of these factors have a potential impact on liability costs of our operators, which could adversely affect our operators’ ability to meet their obligations to us.

Executive Officers of Our Company

As of February 1, 2015, the executive officers of our company were as follows:

C. Taylor Pickett (53) is our Chief Executive Officer and has served in this capacity since June 2001.  Mr. Pickett has also served as Director of the Company since May 30, 2002.  Mr. Pickett’s term as a Director expires in 2017.  Mr. Pickett has also been a member of the board of trustees of Corporate Office Properties Trust, an office REIT focusing on U.S. government agencies and defense contractors, since November 2013.  Mr. Pickett is also a Director of Atherio, a technology, outsourcing, consulting and managed services company.  From January 1993 to June 2001, Mr. Pickett served as a member of the senior management team of Integrated Health Services, Inc., most recently as Executive Vice President and Chief Financial Officer.  Prior to joining Integrated Health Services, Inc. Mr. Pickett held various positions at PHH Corporation and KPMG Peat Marwick.

Daniel J. Booth (51) is our Chief Operating Officer and has served in this capacity since October 2001. From 1993 to October 2001, Mr. Booth served as a member of the management team of Integrated Health Services, Inc., most recently serving as Senior Vice President, Finance.  Prior to joining Integrated Health Services, Inc., Mr. Booth served as a Vice President in the Healthcare Lending Division of Maryland National Bank (now Bank of America).

R. Lee Crabill, Jr. (61) is our Senior Vice President of Operations and has served in this capacity since July 2001.  From 1997 to 2000, Mr. Crabill served as a Senior Vice President of Operations at Mariner Post‑Acute Network, Inc.  Prior to joining Mariner Post‑Acute Network, Inc., Mr. Crabill served as an Executive Vice President of Operations at Beverly Enterprises, Inc.

Robert O. Stephenson (51) is our Chief Financial Officer and has served in this capacity since August 2001.  From 1996 to July 2001, Mr. Stephenson served as the Senior Vice President and Treasurer of Integrated Health Services, Inc.  Prior to joining Integrated Health Services, Inc., Mr. Stephenson held various positions at CSX Intermodal, Inc., Martin Marietta Corporation and Electronic Data Systems.

Michael D. Ritz (46) is our Chief Accounting Officer and has served in this capacity since February 2007.  From April 2005 to February 2007, Mr. Ritz served as the Vice President, Accounting & Assistant Corporate Controller of Newell Rubbermaid Inc., and from August 2002 to April 2005, Mr. Ritz served as the Director, Financial Reporting of Newell Rubbermaid Inc.  From July 2001 through August 2002, Mr. Ritz served as the Director of Accounting and Controller of Novavax Inc.

As of December 31, 2014, we had 27 full-time employees, including the five executive officers listed above.

Item 1A - Risk Factors

Following are some of the risks and uncertainties that could cause the Company’s financial condition, results of operations, business and prospects to differ materially from those contemplated by the forward-looking statements contained in this report or the Company’s other filings with the SEC.  These risks should be read in conjunction with the other risks described in this report including but not limited to those described in “Taxation” and “Government Regulation and Reimbursement” under “Item 1” above.  The risks described below are not the only risks facing the Company and there may be additional risks of which the Company is not presently aware or that the Company currently considers unlikely to significantly impact the Company.  Our business, financial condition, results of operations or liquidity could be materially adversely affected by any of these risks, and, as a result, the trading price of our common stock could decline.

 

Risks Related to the Proposed Merger with Aviv

In addition to the risks related to our operators, our operations and our stock described below, the following are additional risks related to the announced proposed Merger with Aviv.

The pendency of the Merger could adversely affect the business and operations of the Company and Aviv.

In connection with the pending Merger, some tenants, operators, borrowers, managers or vendors may delay or defer decisions related to their business dealings with Aviv and the Company, which could negatively impact the revenues, earnings, cash flows or expenses of Aviv and the Company, regardless of whether the Merger is completed. Similarly, employees of Aviv and the Company may experience uncertainty about their future roles with the combined company following the Merger, which may materially adversely affect the ability of Aviv and the Company to attract and retain key personnel during the pendency of the Merger. In addition, due to operating covenants in the Merger Agreement, each of the Company and Aviv may be unable, during the pendency of the Merger, to pursue certain strategic transactions, undertake certain significant capital projects, undertake certain significant financing transactions and otherwise pursue other actions that are not in the ordinary course of business without the consent of the other, even if such actions would prove beneficial to the Company or Aviv, respectively.

The ownership percentage of the Company’s stockholders will be diluted by the Merger.

The Merger will dilute the ownership percentage of the Company’s stockholders.  Upon completion of the Merger, the Company estimates that legacy Company stockholders will own approximately 70% of the outstanding Company common stock on a fully diluted basis and former Aviv investors will own approximately 30% of the outstanding Company common stock on a fully diluted basis.  Consequently, the Company’s current stockholders, as a general matter, may have less influence over the management and policies of the Company after the effective time of the Merger than they currently exercise over the management and policies of the Company.

Failure to complete the Merger could have material adverse effects on the Company.

There can be no assurance that the conditions to closing of the Merger will be satisfied or waived or that the Merger will be completed. If the Merger is not completed, the ongoing business of the Company could be adversely affected and the Company will be subject to a variety of risks associated with the failure to complete the Merger, including the following:

●

the Company being required, under certain circumstances, to incur certain transaction costs, regardless of whether the Merger closes;

●

diversion of Company management focus and resources from operational matters and other strategic opportunities while working to implement the Merger; and

●

the market price of shares of Company common stock could decline to the extent that the current market price reflects, and is positively affected by, a market assumption that the transactions contemplated by the Merger Agreement will be completed.

The exchange ratio is fixed and will not be adjusted in the event of any change in either the Company’s or Aviv’s stock price.

Upon the closing of the Merger, each share of Aviv common stock will be converted into the right to receive 0.90 of a share of Company common stock, with cash paid in lieu of fractional shares. This exchange ratio was fixed in the Merger Agreement and will not be adjusted for changes in the market price of either Company common stock or Aviv common stock. Changes in the price of Company common stock prior to the Merger will affect the market value of the Merger consideration that Aviv stockholders will receive on the date of the Merger. Stock price changes may result from a variety of factors (many of which are beyond either company’s control), including the following:

●

market reaction to the announcement of the Merger;

●

changes in the business, operation, assets, liabilities, financial position and prospects of either company or in market assessments thereof;

●

changes in the operating performance of the Company, Aviv or similar companies;

 

 

●

changes in market valuations of similar companies;

●

market assessments of the likelihood that the Merger will be completed;

●

interest rates, general market and economic conditions and other factors generally affecting the price of the Company’s and Aviv’s common stock;

●

federal, state and local legislation, governmental regulation and legal developments in the businesses in which Aviv and the Company operate;

●

dissident stockholder activity;

●

changes that affect the Company’s and Aviv’s industry, the U.S. or global economy, or capital, financial or securities markets generally; and

●

other factors beyond the control of either the Company or Aviv.

Tax Risks Related to the Proposed Merger with Aviv

The Company may incur adverse tax consequences if Aviv has failed or fails to qualify as a REIT for United States federal income tax purposes.

Each of the Company and Aviv has operated in a manner that it believes has allowed it to qualify as a REIT for United States federal income tax purposes under the Code and intends to continue to do so through the time of the Merger. The Company intends to operate in a manner that it believes allows it to qualify as a REIT after the Merger. Neither the Company nor Aviv has requested or plans to request a ruling from the IRS that it qualifies as a REIT. Qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. The complexity of these provisions and of the applicable Treasury Regulations that have been promulgated under the Code is greater in the case of a REIT that holds its assets through a partnership (which the Company will do after the Merger). The determination of various factual matters and circumstances not entirely within the control of the Company or Aviv may affect its ability to qualify as a REIT. In order to qualify as a REIT, each of the Company and Aviv must satisfy a number of requirements, including requirements regarding the ownership of its stock and the composition of its gross income and assets. Also, a REIT must make distributions to stockholders aggregating annually at least 90% of its net taxable income, excluding any capital gains.

If Aviv has failed or fails to qualify as a REIT for United States federal income tax purposes and the Merger is completed, the Company may inherit significant tax liabilities and could lose its REIT status. Even if the Company retains its REIT status, if Aviv loses its REIT status for a taxable year before the Merger or that includes the Merger, the Company will face serious tax consequences that could substantially reduce its cash available for distribution to its stockholders because:

●

the Company, as the successor by Merger to Aviv, would generally inherit any corporate income tax liabilities of Aviv, including penalties and interest; the Company would be subject to tax on the built-in gain on each asset of Aviv existing at the time of the Merger if Omega were to dispose of an Aviv asset during a specified period (generally ten years) following the Merger; and

●

the Company could be required to pay a special distribution and/or employ applicable deficiency dividend procedures (including penalties and interest payments to the IRS) to eliminate any earnings and profits accumulated by Aviv for taxable periods that it did not qualify as a REIT.

As a result of these factors, Aviv’s failure before the Merger to qualify as a REIT could impair the Company’s ability after the Merger to expand its business and raise capital, and could materially adversely affect the value of the Company’s common stock.

Finally, Aviv has availed itself of the self-determination provisions and the deficiency dividend procedures under the REIT sections of the Code and supporting Treasury Regulations and IRS pronouncements to remedy certain potential technical violations of the REIT requirements. If there is an adjustment to Aviv’s REIT taxable income or dividends paid deductions as a result of Aviv taking such action, or other determinations by the IRS, the Company could be required to further implement the deficiency dividend procedures in order to maintain Aviv’s REIT status or take other steps to remedy any past non-compliance by Aviv. Any such further implementation of the deficiency dividend procedures could require the Company to make significant distributions to its stockholders and to pay significant penalties and interest to the IRS, which could impair the Company’s ability after the Merger to expand its business and raise capital, reduce its cash available for distribution to its stockholders and materially adversely affect the value of the Company’s common stock.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Item 2 - Properties

At December 31, 2014, our real estate investments included long-term care facilities and rehabilitation hospital investments, either in the form of purchased facilities and direct financing leased facilities that are leased to operators or other affiliates, mortgages on facilities that are operated by the mortgagors or their affiliates and facilities subject to leasehold interests.  The properties are located in 38 states and are operated by 50 operators.  We use the term “operator” to refer to our tenants and mortgagees and their affiliates who manage and/or operate our properties.  In some cases, our tenants and mortgagees contract with a healthcare operator to operate the facilities.  The following table summarizes our property investments as of December 31, 2014:

Assets Held for Sale
Genesis Healthcare			123				1				6,000
Sava Senior Care, LLC			98				1				3,234
Laurel			123				1				2,888
Parcel of Land			-				-				670
			344				3				12,792

 

 

(1)  Certain of our lease agreements contain purchase options that permit the lessees to purchase the underlying properties from us.

(2)  In general, many of our mortgages contain prepayment provisions that permit prepayment of the outstanding principal amounts thereunder.

 

 

The following table presents the concentration of our facilities by state as of December 31, 2014:

(1)  These states each include a facility/property that is classified as held-for-sale as of December 31, 2014.

Geographically Diverse Property Portfolio.  Our portfolio of properties is broadly diversified by geographic location.  Our portfolio includes healthcare properties located in 38 states.  In addition, the majority of our 2014 rental, direct financing lease and mortgage income was derived from facilities in states that require state approval for development and expansion of healthcare facilities.  We believe that such state approvals may limit competition for our operators and enhance the value of our properties.

Large Number of Tenants.  Our facilities are operated by 50 different public and private healthcare providers and/or managers.  Except for New Ark Investment, Inc. (“Ark”) (13%), Ciena Healthcare (9%), CommuniCare Health Services, Inc. (8%), Genesis HealthCare (8%), Health and Hospital Corporation (7%), subsidiaries and affiliates of Airamid Health Management (6%), Signature Holdings II, LLC (5%) and Guardian LTC Management Inc. (5%) which together hold approximately 61% of our portfolio (by investment), no other single tenant holds greater than 5% of our portfolio (by investment).

Significant Number of Long-term Leases and Mortgage Loans.  At December 31, 2014, approximately 75% of our operating leases, 100% of our mortgages and 100% of our direct financing leases have primary terms that expire after 2019.  The majority of our leased real estate properties are leased under provisions of master lease agreements.  We also lease facilities under single facility leases.  The initial terms of both types of leases typically range from 5 to 15 years, plus renewal options with the exception of our investment in the Ark leases which are 50 year leases and expire in 2063.

All of our leased properties are leased under long term, triple-net leases. The following table displays the expiration of the annualized straight-line rental revenues under our operating lease agreements as of December 31, 2014 by year without giving effect to any renewal options:

 

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, management believes 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.

 

Four putative class actions have been filed by purported stockholders of Aviv against Aviv, its directors, the Company and Merger Sub challenging the Merger. The lawsuits seek injunctive relief preventing the parties from consummating the Merger, rescission of the transactions contemplated by the Merger Agreement, imposition of a constructive trust in favor of the class upon any benefits improperly received by the defendants, compensatory damages, and litigation costs including attorneys’ fees. The four cases have been transferred to the Business and Technology Case Management Program of the Circuit Court, Baltimore City, Maryland. The plaintiffs in each case amended their complaints to add allegations that the disclosures in the Form S-4 filed with the Securities and Exchange Commission on January 5, 2015 in connection with the Merger, are inadequate to allow Aviv shareholders to make an informed decision whether to approve the Merger. On January 28, 2015, the court entered a stipulated consolidation order consolidating the four lawsuits into a single proceeding styled In re Aviv REIT Inc. Stockholder Litigation, Case No. 24-C-14-006352. On February 6, 2015, the parties filed a stipulation providing that the Second Amended Complaint filed by plaintiff Andrew Wolf shall serve as the operative consolidated complaint. On the same date, (1) Aviv, the Aviv Partnership and the Aviv directors filed a motion to dismiss the consolidated complaint and (2) the Company, Merger Sub and the Omega Operating Partnership separately moved to dismiss the consolidated complaint as to them. The plaintiffs have moved to expedite the discovery period. A hearing to consider the motions to dismiss and the plaintiffs’ request to expedite discovery has been scheduled for February 27, 2015.

The Company believes that these actions have no merit and intend to defend vigorously against them.

Not applicable.

PART II

Item 5 - Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our 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 common share:

The closing price for our common stock on the New York Stock Exchange on February 13, 2015 was $40.61 per share. As of February 13, 2015 there were 138,617,823 shares of common stock outstanding with approximately 2,741 registered holders.

The following table provides information about shares available for future issuance under our equity compensation plans as of December 31, 2014.

(1)

Reflects (i) a maximum of 541,045 shares that could be issued if certain performance conditions are achieved related to the December 31, 2013 award of performance restricted stock units, (ii) a maximum of 309,168 shares that could be issued if certain performance condition are achieved related to the January 1, 2014 award of performance restricted stock units, (iii) 122,137 restricted stock units that were granted on January 1, 2014, and (iv) 142,494 restricted stock units that were granted on December 31, 2013.

(2)

No exercise price is payable with respect to the restricted stock units and performance restricted stock units.

(3)

Reflects shares of common stock remaining available for future awards under our 2013 Stock Incentive Plans.

 

During the fourth quarter of 2014, we purchased 53,239 outstanding shares of our common stock from employees to pay the withholding taxes related to the vesting of restricted stock.

(1)

Represents shares purchased from employees to pay the withholding taxes related to the vesting of restricted stock.  The shares were not part of a publicly announced repurchase plan or program.

 

 

Item 6 - Selected Financial Data

The following table sets forth our selected financial data and operating data for our Company on a historical basis.  The following data should be read in conjunction with our audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.  Our historical operating results may not be comparable to our future operating results.  The comparability of our selected financial data is significantly affected by our acquisitions and new investments from 2010 to 2014.  See “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Portfolio and Other Developments.”

(1)

Dividends per share are those declared and paid during such period.

 

 

Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking Statements, Reimbursement Issues and Other Factors Affecting Future Results

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this document, including statements regarding potential future changes in reimbursement.  This document contains forward-looking statements within the meaning of the federal securities laws.  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 of this report;

(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 or foreclosed 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 facilities;

(vi)

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

(vii)

the availability and cost of capital;

(viii)

changes in our credit ratings and the ratings of our debt securities;

(ix)

competition in the financing of healthcare facilities;

(x)

regulatory and other changes in the healthcare sector;

(xi)

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

(xii)

changes in the financial position of our operators;

(xiii)

changes in interest rates;

(xiv)

the amount and yield of any additional investments;

(xv)

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

(xvi)

the possibility that the proposed Merger with Aviv will not close, including by the failure to obtain applicable shareholder approvals or the failure to satisfy other closing conditions under the Merger Agreement or by the termination of the Merger Agreement;

(xvii)

the possibility that the combined company will not realize estimated synergies or growth, or that such benefits may take longer to realize than expected; and

(xviii)

our ability to maintain our status as a real estate investment trust.

Overview

We have one reportable segment consisting of investments in healthcare-related real estate properties.  Our core business is to provide financing and capital to the long-term healthcare industry with a particular focus on SNFs located in the United States.  Our core portfolio consists of long-term leases and mortgage agreements.  All of our leases are “triple-net” leases, which require the tenants to pay all property-related expenses.  Our mortgage revenue derives from fixed-rate mortgage loans, which are secured by first mortgage liens on the underlying real estate and personal property of the mortgagor.

Our portfolio of investments at December 31, 2014, included 568 healthcare facilities (including five facilities closed/held-for-sale), located in 38 states and operated by 50 third-party operators.  Our gross investment in these facilities totaled approximately $4.4 billion at December 31, 2014, with 99% of our real estate investments related to long-term healthcare facilities.  The portfolio is made up of (i) 474 SNFs, (ii) 23 ALFs, (iii) 11 specialty facilities, (iv) fixed rate mortgages on 53 SNFs and two ALFs and (v) five facilities and one parcel of land that are currently closed/held-for-sale.  At December 31, 2014, we also held other investments of approximately $49.0 million, consisting primarily of secured loans to third-party operators of our facilities.

Current market and economic conditions, including deficits at both the federal and state level could result in additional cost-cutting at both the federal and state levels resulting in additional reductions to reimbursement rates and levels to our operators under both the Medicare and Medicaid programs.  State deficits could be exacerbated by the potential for increased enrollment in Medicaid due to prolonged high unemployment levels and declining family incomes, which could cause states to reduce state expenditures under their respective state Medicaid programs by lowering reimbursement rates.

 

 

We currently believe that our operator coverage ratios are strong and that our operators can absorb moderate reimbursement rate reductions under Medicaid and Medicare and still meet their obligations to us.  However, significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on an operator’s results of operations and financial condition, which could adversely affect the operator’s ability to meet its obligations to us.

Our consolidated financial statements include the accounts of (i) Omega and (ii) all direct and indirect wholly owned subsidiaries of Omega.  All inter-company accounts and transactions have been eliminated in consolidation of the financial statements.

2014 and Recent Highlights

 

Acquisition and Other Investments

See “Portfolio and Other Developments” below for a description of 2014 acquisitions and other investments.

Issuance of 10.925 Million Shares of Common Stock

On February 9, 2015, we issued 10.925 million shares of our common stock in an underwritten public offering at a public offering price of $42.00 per share, before underwriting discounts and offering expenses. We intend to use the $439 million in net proceeds of the offering to redeem our outstanding $200 million aggregate principal amount 7.50% senior notes due 2020 (callable February 2015), repay outstanding borrowings under our revolving credit facility, and for general corporate purposes.

$250 Million Equity Shelf Program

On March 18, 2013, we entered into separate Equity Distribution Agreements (collectively, the “2013 Equity Shelf Agreements”) to sell shares of our common stock having an aggregate gross sales price of up to $250 million (the “2013 Equity Shelf Program”) with several financial institutions, each as a sales agent and/or principal (collectively, the “Managers”). Under the terms of the 2013 Equity Shelf Agreements, we may sell shares of our common stock, from time to time, through or to the Managers having an aggregate gross sales price of up to $250 million. Sales of the shares will be made by means of ordinary brokers’ transactions on the New York Stock Exchange at market prices, or as otherwise agreed with the applicable Manager. We will pay each Manager compensation for sales of the shares equal to 2% of the gross sales price per share of shares sold through such Manager under the applicable 2013 Agreement. We are not obligated to sell and the Managers are not obligated to buy or sell any shares under the 2013 Equity Shelf Agreements. No assurance can be given that we will sell any shares under the 2013 Equity Shelf Agreements, or, if we do, as to the price or amount of shares that we sell, or the dates when such sales will take place.

For the year ended December 31, 2014, we issued approximately 1.8 million shares under the 2013 Equity Shelf Program, at an average price of $34.33 per share, generating gross proceeds of approximately $63.5 million, before $1.5 million of commissions and expenses.

Since inception of the 2013 Equity Shelf Program, we sold a total of 7.4 million shares of common stock generating total gross proceeds of $233.8 million under the program, before $4.7 million of commissions. As of December 31, 2014, we had approximately $16.2 million available under the 2013 Equity Shelf Program.

Redemption of Outstanding 7.5% Senior Notes due 2020

On February 11, 2015, we announced that we will redeem all $200 million aggregate principal amount of our 7.5% senior notes on March 13, 2015.

$1.2 Billion Unsecured Credit Facility

On June 27, 2014, we entered into a new $1.2 billion unsecured credit facility, comprised of a $1 billion senior unsecured revolving credit facility (the “Revolving Credit Facility”) and a $200 million senior unsecured term loan facility (the “Term Loan Facility” and, collectively, the “2014 Credit Facilities”).  The 2014 Credit Facilities replace our previous $700 million unsecured credit facility (the “2012 Credit Facilities”).  The 2014 Credit Facilities include an “accordion feature” that permits us to expand our borrowing capacity by $550 million, for maximum aggregate commitments of up to $1.75 billion.  See “Liquidity and Capital Resources – Financing Activities and Borrowing Arrangements” below for detail.

In January 2015, we entered into an engagement letter with respect to various proposed amendments to our existing 2014 Credit Facilities. Among other modifications to the 2014 Credit Facilities, the proposed amendments would increase the amount of the 2014 Credit Facilities to $1.75 billion, consisting of a $1.25 billion senior unsecured revolving credit facility, a $200 million senior unsecured term loan facility, and a $300 million senior unsecured incremental term loan facility. The amended 2014 Credit Facilities are also expected to include an accordion feature permitting us to increase the amount of the 2014 Credit Facilities to $2.0 billion and to allocate the $250 million increase to the existing revolving or term loan facilities or additional tranches thereunder as we may elect, subject to various conditions set forth in our existing 2014 Credit Facilities. The amended 2014 Credit Facilities are expected to include maturity dates of June 27, 2017, 2018 and 2019 for the incremental term loan facility, revolving credit facility and term loan facility, respectively, subject to our ability to extend the maturity date of the revolving credit facility and the incremental term loan facility to June 27, 2019 subject to various conditions. We have received commitment letters from lenders for increased amounts that would be available under the facility in accordance with the proposed amendments, subject to our completion of the Merger transactions. Our ability to complete the proposed amendments to our existing senior unsecured credit facility is subject to a number of conditions, and the completion of definitive loan documentation. Although we expect that the amendments to our senior unsecured credit facility will be completed, we can offer no assurances that the conditions to the proposed amendments will be satisfied.

HUD Mortgage Payoffs

On October 31, 2014, we paid approximately $3.6 million to retire one mortgage guaranteed by U.S. Department of Housing and Urban Development (“HUD”) that was assumed as part of an October 2011 acquisition.  The payoff resulted in a $27 thousand gain on the extinguishment of the debt due to the write-off of the $0.2 million unamortized premium offset by a prepayment fee of approximately $0.2 million.

On September 30, 2014, we paid approximately $36.1 million to retire four HUD mortgages that were assumed as part of a December 2012 acquisition.  The payoff resulted in a $1.6 million gain on the extinguishment of the debt due to the write-off of the $3.3 million premium recorded at the time of acquisition offset by a prepayment fee of approximately $1.7 million.

 

 

Issuance of $250 Million of Senior Notes

On September 11, 2014, we sold $250 million aggregate principal amount of our 4.50% Senior Notes due 2025, or the 2025 Notes. The 2025 Notes mature on January 15, 2025. The 2025 Notes bear an interest rate of 4.50% per annum, payable semi-annually in arrears on January 15 and July 15 of each year, commencing on July 15, 2015.  See “Liquidity and Capital Resources – Financing Activities and Borrowing Arrangements” below for detail.

Redemption of Diversicare Preferred Stock

On August 20, 2014, Diversicare redeemed the shares of its Series C non-convertible, redeemable preferred stock held by Omega, which had a liquidation preference of approximately $4.9 million and a dividend rate of 7% per annum.  We received approximately $5.0 million in net proceeds from the redemption of our Diversicare preferred shares.  The Diversicare preferred shares were originally issued to Omega in 2006 in connection with the restructuring of preferred stock and master lease agreements between Diversicare and Omega.  We recorded a gain of $0.6 million in other investment income.

Issuance of $400 Million 4.95% of Senior Notes Due 2024 and Exchange Offer

On March 11, 2014, we sold $400 million aggregate principal amount of our 4.95% Senior Notes due 2024.  The notes mature on April 1, 2024 and pay interest semi-annually on April 1^st and October 1^st.

On August 26, 2014, we commenced an offer to exchange $400 million of our 4.95% Senior Notes due 2024.  See “Liquidity and Capital Resources – Financing Activities and Borrowing Arrangements” below for detail.”

Repayment of $200 Million Term Loan

On December 27, 2013, we entered into a new $200 million senior unsecured, deferred draw, term loan facility (the “2013 Term Loan Facility”) that was scheduled to mature on February 29, 2016.

In January 2014, we drew all $200 million under the 2013 Term Loan Facility.  In March 2014, we paid off and terminated the 2013 Term Loan Facility with proceeds from the sale of our 4.95% Senior Notes due 2024.  See “Liquidity and Capital Resources – Financing Activities and Borrowing Arrangements” below for detail.”

Dividends

On January 14, 2015 the Board of Directors declared a common stock dividend of $0.53 per share, increasing the quarterly common dividend by $0.01 per share over the prior quarter, which was paid February 16, 2015 to common stockholders of record on February 2, 2015.

On February 17, 2014, May 15, 2014, August 15, 2014 and November 17, 2014, we paid dividends to our common stockholders in the per share amounts of $0.49, $0.50, $0.51 and $0.52, for stockholders of record on January 31, 2014, April 30, 2014, July 31, 2014 and October 31, 2014, respectively.

Portfolio and Other Developments

2014 Acquisitions and Other Investments

Pending Aviv Merger

On October 30, 2014, we, along with our newly formed subsidiaries, OHI Healthcare Properties Holdco, Inc. (“Merger Sub”) and OHI Healthcare Properties Limited Partnership, L.P. (“Omega Operating Partnership”), entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Aviv REIT, Inc. (“Aviv”) and Aviv Healthcare Properties Limited Partnership, L.P. (the “Aviv Operating Partnership”). The Merger Agreement provides for the merger of Aviv with and into the Merger Sub (the “Merger”), with the Merger Sub surviving as a wholly-owned subsidiary of Omega. At the effective time of the Merger, and subject to the terms and subject to the conditions set forth in the Merger Agreement, each outstanding share of Aviv common stock shall be converted into the right to receive 0.90 of a share of Omega common stock. In connection with the Merger, holders of limited partnership units of the Aviv Operating Partnership will receive units of an Omega Operating Partnership based on the same exchange ratio as provided for Aviv common stock in the Merger Agreement. Holders of Omega Operating Partnership units will have the right to tender their units for redemption at a redemption price equal to the fair market value of the Company’s common stock. The Company may generally elect to pay the redemption price for tendered Omega Operating Partnership units in cash or in shares of the Company common stock. We expect to complete the Merger early in the second quarter of 2015, subject to the terms and conditions of the Merger Agreement. We expect to issue approximately 45.5 million shares of Omega’s common stock and 10.3 million Omega Operating Partnership units as a result of the Merger.

 

 

Acquisition of Four ALFs in Pennsylvania, Oregon and Arkansas

On November 20, 2014, we completed a purchase/lease-back of four ALFs (two in Pennsylvania, one in Oregon and one in Arkansas) from an existing operator of Omega for approximately $84.2 million.  The four ALFs (with 371 total beds) were leased to the operator under a new master lease with an initial annual cash yield of 6.0% and include annual escalators of 2.5%.  We are in the process of completing our purchase accounting and expect the process to be complete in 2015.  As of December 31, 2014, we recorded approximately $84.2 million consisting of land ($5.1 million), building and site improvements ($76.7 million), and furniture and fixtures ($2.4 million).  We have not recorded goodwill in connection with this transaction.

Acquisition of One SNF in Texas

On July 1, 2014, we purchased one SNF located in Texas from an unrelated third party for approximately $8.2 million and leased it to an existing operator of Omega.  The 125 bed SNF was added to the operator’s existing master lease with an initial annual cash yield of 9.75%.  We recorded approximately $8.2 million consisting of land ($0.4 million), building and site improvements ($7.4 million), and furniture and fixtures ($0.4 million).  We have not recorded goodwill in connection with this transaction.

Transition of Two West Virginia Facilities to a New Operator

On July 1, 2014, we transitioned two West Virginia SNFs that we previously leased to Diversicare Healthcare Services (“Diversicare” and formerly known as Advocat) to a new unrelated third party operator.  The two facilities represent 150 operating beds.  We amended our Diversicare master lease to reflect the transition of the two facilities to the new operator and for the year ended December 31, 2014 recorded a $0.8 million provision for uncollectible straight-line accounts receivable.  Simultaneous with the Diversicare master lease amendment, we entered into a 12-year master lease with a new third party operator.

Acquisitions of Three SNFs in Georgia and South Carolina

On June 27, 2014, we purchased two SNFs from an unrelated third party for approximately $17.3 million and leased them to an existing operator of Omega.  The SNFs, located in Georgia and South Carolina with a total of 213 beds, were combined into a 12 year master lease with an initial cash yield of 9.5%.

In the third quarter of 2014, we purchased a third SNF in South Carolina with 132 beds that was added to the master lease.  The combined purchase price, including the third SNF, was $34.6 million.  We recorded approximately $34.6 million consisting of land ($0.9 million), building and site improvements ($32.1 million), and furniture and fixtures ($1.6 million).  We have not recorded goodwill in connection with this transaction.

$415 Million of Refinancing/Consolidating Mortgage Loans

On June 30, 2014, we entered into an agreement to refinance/consolidate $117 million in existing mortgages on 17 facilities into one mortgage and simultaneously provide mortgage financing for an additional 14 facilities.  The new $415 million mortgage is secured by 31 facilities totaling 3,430 licensed beds all located in the state of Michigan.  The new loan bears an initial annual cash interest rate of 9.0% and increases by 0.225% per year (e.g., beginning in year 2 the interest rate will be 9.225%, in year 3 the rate will be 9.45%, etc.).

One of the existing mortgages that was refinanced/consolidated into the new $415 million mortgage included annual interest rate escalators and required the mortgagee to pay a prepayment penalty in the event the mortgage was retired early which required us to record an effective yield interest receivable.  In connection with the refinancing/consolidating transaction which was entered into at market terms, the old mortgage was considered to be retired early since the modifications made to the terms of the mortgage were more than minor.  As of the date of the refinancing/consolidation transaction, the effective yield interest receivable was approximately $2.0 million.  We forgave the prepayment penalty associated with the retired mortgage and recorded a $2.0 million provision to write-off the effective yield interest receivable related to the retired mortgage.

Acquisition of an ALF in Arizona

On January 30, 2014, we acquired an ALF in Arizona from an unrelated third party for approximately $4.7 million. The operations of the 90 bed facility were transitioned to an existing operator of Omega.  We recorded approximately $4.7 million consisting of land ($0.4 million), building and site improvements ($3.9 million), and furniture and fixtures ($0.4 million).  We have not recorded goodwill in connection with this transaction.

$113 Million of New Mortgage Loan

On January 17, 2014, we entered into a $112.5 million first mortgage loan with an existing operator of Omega.  The loan is secured by 7 SNFs and 2 ALFs with a total of 798 operating beds located in Pennsylvania (7) and Ohio (2).  The loan is cross-defaulted and cross-collateralized with our existing master lease with the operator.  The loan bears an initial annual cash interest rate of 9.5% and matures in January 2024.

Acquisition costs related to the above transactions and the pending Merger with Aviv were expensed as period costs.  For the year ended December 31, 2014, we expensed $3.9 million of acquisition related expenses in connection with the aforementioned acquisitions.

2013 Acquisitions and Other Investments

$529 Million Purchase/Leaseback Transaction

On November 27, 2013, we closed on an aggregate $529 million purchase/leaseback transaction in connection with the acquisition of Ark Holding Company, Inc. (“Ark Holding”) by 4 West Holdings Inc.  At closing, we acquired 55 SNFs and 1 ALF operated by Ark Holding and leased the facilities back to Ark Holding, now known as New Ark Investment Inc. (“New Ark”), pursuant to four 50-year master leases, with rental payments yielding 10.6% per annum over the term of the leases.  The purchase/leaseback transaction is being accounted for as a direct financing lease.  The 56 facilities represent 5,623 licensed beds located in 12 states, predominantly in the southeastern United States.  The 56 facilities are separated by region and divided among four cross-defaulted Master Leases.  The four regions include the Southeast (39 facilities), the Northwest (7 facilities), Texas (9 facilities) and Indiana (1 facility). The initial year one contractual rent is $47 million with 2.5% escalators beginning in year five.

Acquisition of an ALF in Florida

On October 2, 2013, we purchased a 97 bed ALF in Florida for $10.3 million in cash.  The ALF was added to an existing master lease.

We completed our purchase accounting in 2014 with no change from our preliminary allocation.  We recorded approximately $10.3 million consisting of land ($0.6 million), building and site improvements ($9.0 million), and furniture and fixtures ($0.7 million).  We have not recorded goodwill in connection with this transaction.

Acquisition of four SNFs in Indiana

On October 31, 2013, we purchased four SNFs totaling 384 beds in Indiana for $22.2 million in cash.  The four SNFs were added to an existing master lease, but the terms of the lease and the purchase price were based on an existing lease agreement between the seller and the lessee which was below current market conditions.  We recorded approximately $3.0 million to below market leases as a result of the transaction for a total investment of $25.2 million.

We completed our purchase accounting in 2014 with no change from our preliminary allocation.  We recorded approximately $25.2 million consisting of land ($0.7 million), building and site improvements ($21.8 million), and furniture and fixtures ($2.7 million).  We have not recorded goodwill in connection with this transaction.

Transition of 11 Arkansas Facilities to a New Operator

On August 30, 2013, we transitioned 11 SNFs located in Arkansas that we previously leased to Diversicare Healthcare Services to a new third party operator.  The 11 facilities represent 1,084 operating beds.  We amended our Diversicare master lease to provide for reduced rent to reflect the transition of the 11 facilities to the new operator, and recorded a $2.3 million provision for uncollectible straight-line rent receivable.  Simultaneously with the amendment to the Diversicare master lease, we entered into a new master lease with the new third party operator of the 11 facilities.  The new master lease expires on August 30, 2023 and includes fixed annual rent escalators.

Acquisition costs related to the above transactions were expensed as period costs.  For the year ended December 31, 2013, we expensed $0.2 million of acquisition related expenses.

2012 Acquisitions and Investments

Arizona and California Acquisitions

During the three-month period ended December 31, 2012, we completed the acquisition of approximately $203.4 million of new investments and leased them back to a new operator.  The investments involved two separate transactions to purchase 14 facilities (12 SNFs, 1 ALF and 1 combined SNF/ALF).  The combined transactions consisted of the assumption of approximately $71.9 million of HUD indebtedness and payment of $131.5 million in cash. The $71.9 million of assumed HUD debt is comprised of 8 HUD mortgage loans with a blended interest rate of 5.50% and maturities between April 2031 and February 2045. The 14 facilities, representing 1,830 operating beds, are located in California (10) and Arizona (4). The transaction involved several separate master lease agreements covering all 14 facilities.

Transaction 1 (First Closing):  On November 30, 2012, we purchased four Arizona facilities (2 SNFs, 1 ALF and 1 combined SNF/ALF) for an aggregate purchase price of $60.0 million.  The transaction consisted of the assumption of $27.6 million of indebtedness guaranteed by HUD and $32.4 million in cash.  The blended interest rate on the HUD indebtedness assumed for the Arizona facilities was 4.73%.  The four facilities were simultaneously leased back to a new operator under a new 12 year master lease.

We recorded approximately $64.6 million consisting of land ($5.5 million), building and site improvements ($55.9 million), and furniture and fixtures ($3.2 million).  We recorded approximately $4.6 million of fair value adjustment related to above market debt assumed based on the terms of comparable debt and other market factors.  We have not recorded goodwill in connection with this transaction.

Transaction 2 (Second Closing):  In November 2012, we entered into a Purchase and Sales Agreement to purchase and then leaseback 10 California SNFs.  On November 30, 2012, we purchased five SNFs for approximately $70.2 million.  The five SNFs were then leased back to the new operator under a new 12 year master lease.

We recorded approximately $70.2 million consisting of land ($11.5 million), building and site improvements ($55.5 million), and furniture and fixtures ($3.2 million).  We have not recorded goodwill in connection with this transaction.

Transaction 2 (Third Closing):  On December 31, 2012, we purchased the remaining five California SNFs for an aggregate purchase price of $72.2 million (net of purchase price reduction of approximately $1.0 million related to funds escrowed by the seller to reimburse us for costs associated with refinancing some of the assumed HUD debt).  The transaction consisted of the assumption of $44.3 million of HUD indebtedness and $28.9 million in cash.  The blended interest rate on the HUD indebtedness assumed for the five California facilities was 5.97%.  The five SNFs were then leased back to the new operator under new 12 year master leases.

We recorded approximately $77.5 million consisting of land ($13.0 million), building and site improvements ($60.8 million), and furniture and fixtures ($3.7 million).  We recorded approximately $5.4 million of fair value adjustment related to the above market debt assumed based on the terms of comparable debt and other market factors.  We have not recorded goodwill in connection with this transaction.

Indiana Acquisitions

In 2012 we completed four transactions in Indiana involving two existing operators and 34 facilities.  The following is a summary of the transactions:

Transaction 1:  On June 29, 2012, we purchased one SNF encompassing 80 operating beds in Indiana for approximately $3.4 million and leased the facility back to an existing operator under an existing master lease.  We recorded approximately $3.4 million consisting of land ($0.2 million), building and site improvements ($2.9 million), and furniture and fixture ($0.3 million).  We have not recorded goodwill in connection with this transaction.

Transaction 2:  On June 29, 2012, we purchased four facilities encompassing 383 operating beds in Indiana for approximately $21.7 million and leased the facilities to an existing operator.  We recorded approximately $21.7 million consisting of land ($1.9 million), buildings and site improvements ($18.4 million) and furniture and fixtures ($1.4 million).  We have not recorded goodwill in connection with this transaction.

Transaction 3:  On August 31, 2012, we purchased 27 facilities (17 SNFs, four ALFs and six independent living facilities) totaling 2,892 operating beds in Indiana from an unrelated third party for approximately $203 million in cash and assumed a liability associated with the lease of approximately $13.9 million.  Simultaneous with the transaction, we also purchased one parcel of land for $2.8 million.  The purchase price of both (i) 27 facilities and (ii) the parcel of land were funded from cash on hand and borrowings from our credit facility.  The 27 facilities and land parcel were added to an existing master lease.  We recorded approximately $219.7 million consisting of land ($16.1 million), building and site improvements ($189.2 million) and furniture and fixtures ($14.4 million).  We have not recorded goodwill in connection with this transaction.

Transaction 4:  On December 31, 2012, we purchased two SNFs encompassing 167 operating beds in Indiana for approximately $9.5 million and leased these facilities back to an existing operator under a new consolidated master lease.  We recorded approximately $9.5 million consisting of land ($0.6 million), building and site improvements ($8.0 million), and furniture and fixtures ($0.9 million).  We have not recorded goodwill in connection with this transaction.

Michigan Acquisition and New Mortgage

On November 30, 2012, we completed $21.5 million of combined new investments with an existing operator and mortgagee.  The investments involved both a purchase and mortgage transaction related to two facilities and 231 operating beds.

Purchase Transaction – We purchased one ALF for $20 million from an unrelated third party and added it to an existing master lease with an existing operator.  The 171 operating bed ALF is located in Michigan.  We completed our fair value allocation in 2013.  We allocated approximately $20.0 million consisting of land ($0.4 million), building and site improvements ($18.9 million), and furniture and fixtures ($0.7 million).  We have not recorded goodwill in connection with this transaction.

Mortgage Transaction – We entered into a new $1.5 million first mortgage loan with an existing operator/mortgagee.  The mortgage is secured by a lien on one 60 operating bed SNF located in Michigan.

Texas Acquisition

On October 31, 2012, we purchased one SNF from an unrelated third party encompassing 90 operating beds in Texas for approximately $2.7 million and leased the facility to an existing operator.  We recorded approximately $2.7 million consisting of land ($0.2 million), building and site improvements ($2.2 million), and furniture and fixtures ($0.3 million).  We have not recorded goodwill in connection with this transaction.

Acquisition costs related to the above transactions were expensed as period costs.  For the year ended December 31, 2012, we expensed $0.9 million of acquisition related expenses.

Significant Lease Amendment – Genesis Healthcare

On December 1, 2012, Genesis Healthcare (“Genesis”), an existing operator to Omega, completed the purchase of Sun Healthcare Group (“Sun”), which was also an existing operator to Omega.  Prior to the purchase, Sun was our second largest tenant representing 40 facilities located in 10 states.  Prior to the purchase, we also had a master lease with Genesis representing 13 facilities located in 5 states.

In connection with the acquisition, on December 1, 2012, we entered into a new 53 facility master lease with Genesis expiring on December 31, 2025.  In 2013, we transitioned one facility to another operator reducing the number of facilities covered by the Genesis lease to 52 facilities.

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 audited consolidated financial statements and accompanying notes.

Year Ended December 31, 2014 compared to Year Ended December 31, 2013

Operating Revenues

Our operating revenues for the year ended December 31, 2014, were $504.8 million, an increase of $86.1 million over the same period in 2013.  Following is a description of certain of the changes in operating revenues for the year ended December 31, 2014:

 

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Rental income was $388.4 million, an increase of $13.3 million over the same period in 2013.  The increase was the result of new investments made in 2013 and 2014 and lease amendments made since January 1, 2013.

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Direct financing lease income was $56.7 million, an increase of $51.5 million over the same period in 2013.  The increase was primarily related to the timing of the New Ark transaction.  The direct financing lease was entered into in November 2013.

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Mortgage interest income totaled $53.0 million, an increase of $23.7 million over the same period in 2013.  The increase was primarily due to: (a) an incremental $298 million in a new mortgage loan (See $415 Million of Refinancing/Consolidating Mortgage Loans above) we entered into with an existing operator in the second quarter of 2014 and (b) a $112.5 million mortgage we entered into with an existing operator in the first quarter of 2014.

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Other investment income totaled $6.6 million, a decrease of $2.4 million over the same period in 2013.  The decrease was primarily related to interest received on a mezzanine loan that was paid off in December 2013.

Operating Expenses

Operating expenses for the year ended December 31, 2014, were $159.5 million, an increase of approximately $6.4 million over the same period in 2013.  Following is a description of certain of the changes in our operating expenses for the year ended December 31, 2013:

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Our depreciation and amortization expense was $123.3 million for the year ended December 31, 2014, compared to $128.6 million for the same period in 2013.  The decrease of $5.4 million was primarily due to the acquisition of furniture and fixtures that we acquired several years ago as part of the Capital Source transaction that are now fully depreciated partially offset by the deprecation on fourth quarter of 2013 and 2014 acquisitions and capital renovation and improvement program.

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Our general and administrative expense, excluding stock-based compensation expense, was $17.3 million, compared to $15.6 million for the same period in 2013.  The increase is primarily related to development costs related to securing additional beds license for future development.

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Our stock-based compensation expense was $8.6 million, an increase of $2.7 million over the same period in 2013.  The increase was primarily due to new restricted stocks granted to employees in December 2013 and January 2014.

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In 2014, acquisition costs were $3.9 million, compared to $0.2 million for the same period in 2013.  The $3.7 million increase was primarily the result of $3.3 million of acquisition related costs attributed to the pending Aviv Merger.

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In 2014, we recorded $3.7 million of provision for impairment, compared to $0.4 million for the same period in 2013.  The $3.2 million increase in provision of impairment was primarily the result of two facilities that were closed in 2014.

 

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Our provision for uncollectible mortgages, notes and accounts receivable was $2.7 million, compared to $2.1 million for the same period in 2013.  In 2014, we recorded $2.7 million provision for uncollectible receivables related to (i) a write-off of an effective yield interest receivable related to the refinancing (termination) of a mortgage receivable (see $415 Million of Refinancing/Consolidating Mortgage Loan above) and (ii) a straight-line receivable related to the transition of two facilities from an existing operator to a new operator.

Other Income (Expense)

For the year ended December 31, 2014, total other expenses were $126.8 million, an increase of approximately $34.8 million over the same period in 2013.  The $34.8 million increase was primarily the result of: (i) a $19.0 million increase in interest expense due to (a) an increase in borrowings outstanding and (b) an increase in the average rate of the borrowings due to the repayment of lower cost credit facility debt with higher cost long term bond debt and (ii) a $14.2 million increase in interest refinancing charge.  In 2014, we recorded approximately $3.0 million in refinancing related costs including: (a) $2.6 million write-off of deferred financing costs associated with the termination of our previous $700 million 2012 Credit Facilities, (b) $2.0 million write-off of deferred financing costs associated with the termination of our 2013 Term Loan Facility as defined under “Issuance and Repayment of $200 Million Term Loan” below and (c) $1.7 million prepayment penalty on the payoff of HUD debt in June 2014, partially offset by $3.3 million gain related the write-off of premium on the HUD debt paid off in September 2014.  In 2013, we recorded an $11.1 million gain primarily related to write-off of premium associated with HUD debt that was retired in May 2013.

2014 Taxes

Because we qualify as a REIT, we generally are not subject to Federal income taxes on the REIT taxable income that we distribute to stockholders, subject to certain exceptions.  For tax year 2014, we made common dividend payments of $258.6 million to satisfy REIT requirements relating to qualifying income. Currently, we have one TRS that is taxable as a corporation and that pays federal, state and local income tax on its net income at the applicable corporate rates.  The TRS had a net operating loss carry-forward as of December 31, 2014 of $1.0 million.  The loss carry-forward was fully reserved with a valuation allowance due to uncertainties regarding realization.  We recorded interest and penalty charges associated with tax matters as income tax expense.

Net Income

Net income for the year ended December 31, 2014 was $221.3 million compared to $172.5 million for the same period in 2013.

Funds From Operations

Our funds from operations available to common stockholders (“FFO”), for the year ended December 31, 2014, was $345.4 million, compared to $302.7 million for the same period in 2013.

We calculate and report FFO in accordance with the definition and interpretive guidelines issued by the National Association of Real Estate Investment Trusts (“NAREIT”), and, consequently, FFO is defined as net income available to common stockholders, adjusted for the effects of asset dispositions and certain non-cash items, primarily depreciation and amortization and impairment on real estate assets.  We believe that FFO is an important supplemental measure of our operating performance.  Because the historical cost accounting convention used for real estate assets requires depreciation (except on land), such accounting presentation implies that the value of real estate assets diminishes predictably over time, while real estate values instead have historically risen or fallen with market conditions.  The term FFO was designed by the real estate industry to address this issue.  FFO herein is not necessarily comparable to FFO of other REITs that do not use the same definition or implementation guidelines or interpret the standards differently from us.

FFO is a non-GAAP financial measure.  We use FFO as one of several criteria to measure the operating performance of our business.  We further believe that by excluding the effect of depreciation, amortization, impairment on real estate assets and gains or losses from sales of real estate, all of which are based on historical costs and which may be of limited relevance in evaluating current performance, FFO can facilitate comparisons of operating performance between periods and between other REITs.  We offer this measure to assist the users of our financial statements in evaluating our financial performance under GAAP, and FFO should not be considered a measure of liquidity, an alternative to net income or an indicator of any other performance measure determined in accordance with GAAP.  Investors and potential investors in our securities should not rely on this measure as a substitute for any GAAP measure, including net income.

 

The following table presents our FFO results for the years ended December 31, 2014 and 2013:

Year Ended December 31, 2013 compared to Year Ended December 31, 2012

Operating Revenues

Our operating revenues for the year ended December 31, 2013, were $418.7 million, an increase of $68.3 million over the same period in 2012.  Following is a description of certain of the changes in operating revenues for the year ended December 31, 2013:

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Rental income was $375.1 million, an increase of $60.5 million over the same period in 2012.  The increase was primarily due to: (i) new investments made in 2012 and 2013 and (ii) the full year impact of the December 2012 Genesis merger with Sun and corresponding lease extension.  In 2013, we recorded rental revenue associated with the 2012 acquisitions of approximately $54.7 million compared to approximately $11.0 million in 2012.  In 2013, we recorded rental revenue associated with the 2013 acquisitions of approximately $0.6 million.

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Direct financing lease income of $5.2 million is a result of the November 2013 Ark transaction.

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Mortgage interest income totaled $29.4 million, a decrease of $1.1 million over the same period in 2012.  The decrease was primarily due to the $12.2 million payoff of a mortgage in 2012.

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Other investment income totaled $8.9 million, an increase of $4.1 million over the same period in 2012.  The increase was primarily the result of: (i) a new $25 million investment in a mezzanine loan that was entered into during the current year and paid off in December 2013.  The mezzanine loan included an annual interest rate of 12%.  In addition, we recorded approximately $1.4 million of additional income as a result of the payoff, including a prepayment penalty of $1.0 million and acceleration of fees that we received that were being amortized over the term of the loan.

Operating Expenses

Operating expenses for the year ended December 31, 2013, were $153.0 million, an increase of approximately $17.5 million over the same period in 2012.  Following is a description of certain of the changes in our operating expenses for the year ended December 31, 2012:

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Our depreciation and amortization expense was $128.6 million for the year ended December 31, 2013, compared to $113.0 million for the same period in 2012.  The increase is primarily due to (i) a full year of depreciation related to the fourth quarter 2012 acquisitions and (ii) additional depreciation associated with the 2013 new investment, including the 2013 acquisition and capital renovation and improvement program.

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Our general and administrative expense, excluding stock-based compensation expense, was $15.6 million, compared to $15.4 million for the same period in 2012.

 

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Both periods included stock-based compensation expense of $5.9 million.

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The $2.1 million recorded in provision for uncollectible mortgages, notes and accounts receivable in 2013 was primarily related to the write-off of straight-line receivables for 11 Arkansas facilities that were transitioned from a current operator to a new operator during the third quarter of 2013.

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In 2013, acquisition costs were $0.2 million, compared to $0.9 million for the same period in 2012.

Other Income (Expense)

For the year ended December 31, 2013, total other expenses were $92.0 million, a decrease of approximately $14.1 million over the same period in 2012.  The $14.1 million decrease was primarily the result of a $4.9 million increase in interest expense due to an increase in borrowings outstanding, including debt assumed or incurred to finance the 2012 and 2013 investment, offset by a $19.0 million decrease in interest refinancing costs.  In 2013, we recorded an $11.1 million interest refinancing gain associated with the write-off of the premium for above market value debt assumed on 11 HUD mortgage loans that we paid off in May 2013.  In 2012, we recorded $7.9 million of net interest refinancing costs.  The refinancing costs included: (i) $7.1 million in costs including (a) prepayment penalties of approximately $4.5 million, (b) the write-off of deferred financing costs of $2.2 million and (c) $0.4 million of expenses associated with the tender offer and redemption of our outstanding $175 million 7% 2016 Notes and (ii) $2.5 million related to the write-off of deferred financing costs associated with the termination of the $475 million 2011 Credit Facility. The 2012 costs were partially offset by a net gain of $1.7 million associated with the write-off of the premium for above market value debt assumed on four HUD loans that were paid off early during the second quarter of 2012.

2013 Taxes

Because we qualify as a REIT, we generally are not subject to Federal income taxes on the REIT taxable income that we distribute to stockholders, subject to certain exceptions.  For tax year 2013, we made common dividend payments of $218 million to satisfy REIT requirements relating to qualifying income. Currently, we have one TRS that is taxable as a corporation and that pays federal, state and local income tax on its net income at the applicable corporate rates.  The TRS had a net operating loss carry-forward as of December 31, 2013 of $1.0 million.  The loss carry-forward was fully reserved with a valuation allowance due to uncertainties regarding realization.  We recorded interest and penalty charges associated with tax matters as income tax expense.

Net Income

Net income for the year ended December 31, 2013 was $172.5 million compared to $120.7 million for the same period in 2012.

Funds From Operations

Our funds from operations available to common stockholders (“FFO”), for the year ended December 31, 2013, was $302.7 million, compared to $222.2 million for the same period in 2012.

The following table presents our FFO results for the years ended December 31, 2013 and 2012:

 

Liquidity and Capital Resources

At December 31, 2014, we had total assets of $3.9 billion, stockholders’ equity of $1.4 billion and debt of $2.4 billion, with such debt representing approximately 62.9% of total capitalization.

The following table shows the amounts due in connection with the contractual obligations described below as of December 31, 2014.