10-Q 1 june10q.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------- FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) --- OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 or TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission file number 1-11316 OMEGA HEALTHCARE INVESTORS, INC. (Exact name of Registrant as specified in its charter) Maryland 38-3041398 (State of Incorporation) (I.R.S. Employer Identification No.) 900 Victors Way, Suite 350, Ann Arbor, MI 48108 (Address of principal executive offices) (734) 887-0200 (Telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No ---- ---- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of June 30, 2001 Common Stock, $.10 par value 20,066,142 (Class) (Number of shares)
OMEGA HEALTHCARE INVESTORS, INC. FORM 10-Q June 30, 2001 INDEX Page No. -------- PART I Financial Information Item 1. Condensed Consolidated Financial Statements: Balance Sheets June 30, 2001 (unaudited) and December 31, 2000 ................................... 2 Statements of Operations (unaudited) Three-month and Six-month periods ended June 30, 2001 and 2000 .................................. 3 Statements of Cash Flows (unaudited) Six-month period ended June 30, 2001 and 2000 .................................. 4 Notes to Condensed Consolidated Financial Statements June 30, 2001 (unaudited) ............................... 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ..............................................21 Item 3. Quantitative and Qualitative Disclosures About Market Risk .......27 PART II Other Information Item 1. Legal Proceedings ................................................28 Item 2. Changes in Securities and Use of Proceeds ........................28 Item 3. Defaults Upon Senior Securities ..................................28 Item 4. Submission of Matters to a Vote of Security Holders ..............29 Item 6. Exhibits and Reports on Form 8-K .................................31
PART 1 - FINANCIAL INFORMATION Item 1. Financial Statements OMEGA HEALTHCARE INVESTORS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands)
June 30, December 31, 2001 2000 ---- ---- (Unaudited) (See Note) ASSETS Real estate properties Land and buildings at cost ........................... $ 702,836 $ 710,542 Less accumulated depreciation ........................ (97,707) (89,870) ------- ------- Real estate properties - net ................. 605,129 620,672 Mortgage notes receivable - net ...................... 180,768 206,710 ------- ------- 785,897 827,382 Other investments ......................................... 55,709 53,242 ------ ------ 841,606 880,624 Assets held for sale - net ................................ 5,698 4,013 ----- ----- Total Investments .................................... 847,304 884,637 Cash and cash equivalents ................................. 10,795 7,172 Accounts receivable ....................................... 17,032 10,497 Other assets .............................................. 5,220 9,338 Operating assets for owned properties ..................... 41,463 36,807 ------ ------ Total Assets ......................................... $ 921,814 $ 948,451 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Revolving lines of credit ................................. $ 198,641 $ 185,641 Unsecured borrowings ...................................... 203,527 225,000 Other long-term borrowings ................................ 23,525 24,161 Subordinated convertible debentures ....................... - 16,590 Accrued expenses and other liabilities .................... 22,944 18,002 Operating liabilities for owned properties ................ 13,482 14,744 ------ ------ Total Liabilities .................................... 462,119 484,138 Preferred Stock ........................................... 212,342 207,500 Common stock and additional paid-in capital ............... 440,382 440,556 Cumulative net earnings ................................... 173,128 182,548 Cumulative dividends paid ................................. (365,654) (365,654) Unamortized restricted stock awards ....................... (284) (607) Accumulated other comprehensive loss ...................... (219) (30) ------ ----- Total Shareholders' Equity ........................... 459,695 464,313 ------- ------- Total Liabilities and Shareholders' Equity ........... $ 921,814 $ 948,451 ========= =========
Note - The balance sheet at December 31, 2000, has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements. See notes to condensed consolidated financial statements. 2 OMEGA HEALTHCARE INVESTORS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS Unaudited (In Thousands, Except Per Share Amounts)
Three Months Ended Six Months Ended June 30, June 30, ------------------ ----------------- 2001 2000 2001 2000 ---- ---- ---- ---- Revenues Rental income .......................................... $ 14,729 $ 16,268 $ 30,750 $ 34,270 Mortgage interest income ............................... 5,535 5,912 11,213 11,912 Other investment income - net .......................... 1,008 1,926 2,266 3,622 Nursing home revenues of owned and operated assets ..... 43,796 46,076 89,793 77,501 Miscellaneous .......................................... 586 266 809 357 ---- ---- ---- ---- 65,654 70,448 134,831 127,662 Expenses Nursing home expenses of owned and operated assets ..... 43,676 46,919 90,126 77,884 Depreciation and amortization .......................... 5,504 5,818 11,045 11,728 Interest ............................................... 9,243 11,277 18,915 22,375 General and administrative ............................. 3,155 1,212 5,504 2,801 Legal .................................................. 766 472 1,717 493 State taxes ............................................ 107 113 213 226 Litigation settlement expense .......................... 10,000 - 10,000 - Provision for impairment ............................... 8,381 - 8,381 4,500 Provision for uncollectable accounts ................... 681 - 681 - Severance and consulting agreement costs ............... 466 - 466 - Charges for derivative accounting ...................... 70 - 552 - ---- ---- ---- ---- 82,049 65,811 147,600 120,007 ------ ------ ------- ------- (Loss) earnings before (loss) gain on assets sold and gain on early extinguishment of debt ...................... (16,395) 4,637 (12,769) 7,655 (Loss) gain on assets sold - net ........................ (7) 10,451 612 10,451 Gain on early extinguishment of debt ..................... 2,489 - 2,737 - ----- ----- ----- ----- Net (loss) earnings ...................................... (13,913) 15,088 (9,420) 18,106 Preferred stock dividends ................................ (5,029) (2,408) (9,937) (4,816) ------ ------ ------ ------ Net (loss) earnings available to common .................. $ (18,942) $ 12,680 $ (19,357) $ 13,290 ========= ========= ========= ========= (Loss) Earnings per common share: Net (loss) earnings per share - basic .................. $ (0.95) $ 0.63 $ (0.97) $ 0.66 ======== ======== ======== ======== Net (loss) earnings per share - diluted ................ $ (0.95) $ 0.63 $ (0.97) $ 0.66 ======== ======== ======== ======== Dividends declared and paid per common share ............. $ - $ - $ - $ 0.50 ======== ======== ======= ========= Weighted Average Shares Outstanding, Basic ............... 20,013 20,129 20,013 20,055 ====== ====== ====== ====== Weighted Average Shares Outstanding, Diluted ............. 20,013 20,129 20,013 20,055 ====== ====== ====== ====== Other comprehensive income (loss): Unrealized Gain (Loss) on Omega Worldwide, Inc. ........ $ 247 $ (873) $ 247 $ (1,199) ======== ======== ======== ======== Unrealized Loss on Hedging Contracts ................... $ (82) $ - $ (436) $ - ======== ======== ========= ======== Total comprehensive (loss) income ........................ $ (13,748) $ 14,215 $ (9,609) $ 16,907 ======== ======== ======== ========
See notes to condensed consolidated financial statements. 3 OMEGA HEALTHCARE INVESTORS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Unaudited (In Thousands)
Six Months Ended June 30, 2001 2000 ---- ---- Operating activities Net (loss) earnings .............................................. $ (9,420) $ 18,106 Adjustment to reconcile net earnings to cash provided by operating activities: Depreciation and amortization ................................ 11,045 11,728 Provision for impairment ..................................... 8,381 4,500 Provision for collection losses .............................. 681 2,937 Gain on assets sold - net .................................... (612) (10,451) Gain on early extinguishment of debt ......................... (2,737) - Other ........................................................ 630 1,034 Net change in accounts receivable for Owned & Operated assets - net (3,474) (15,929) Net change in accounts payable for Owned & Operated assets ........ (2,796) 4,777 Net change in other Owned & Operated assets and liabilities ....... 1,961 (17,621) Net change in operating assets and liabilities .................... 3,108 (6,403) ----- ------ Net cash provided by (used in) operating activities ............... 6,767 (7,322) Cash flows from financing activities Proceeds of revolving lines of credit - net ....................... 13,000 10,400 Payments of long-term borrowings .................................. (38,699) (148) Receipts from Dividend Reinvestment Plan .......................... 20 367 Dividends paid .................................................... - (14,816) Deferred financing costs paid ..................................... (698) - Other ............................................................. (45) - ---- ---- Net cash used in financing activities ............................. (26,422) (4,197) Cash flow from investing activities Proceeds from sale of real estate investments - net ............... 1,364 35,093 Fundings of other investments - net ............................... (465) (4,200) Collection of mortgage principal .................................. 22,379 1,242 ------ ----- Net cash provided by investing activities ......................... 23,278 32,135 ------ ------ Increase in cash and cash equivalents ............................. 3,623 20,616 Cash and cash equivalents at beginning of period .................. 7,172 4,105 ----- ----- Cash and cash equivalents at end of period ........................ $ 10,795 $ 24,721 ======== ========
See notes to condensed consolidated financial statements. 4 OMEGA HEALTHCARE INVESTORS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) June 30, 2001 Note A - Basis of Presentation The accompanying unaudited condensed consolidated financial statements for Omega Healthcare Investors, Inc. (the "Company") have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals and impairment provisions to adjust the carrying value of assets) considered necessary for a fair presentation have been included. Certain reclassifications have been made to the 2000 financial statements for consistency with the current presentation. Such reclassifications have no effect on previously reported earnings or equity. Operating results for the three-month and six-month periods ended June 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. For further information, refer to the financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2000. Note B - Properties In the ordinary course of its business activities, the Company periodically evaluates investment opportunities and extends credit to customers. It also regularly engages in lease and loan extensions and modifications. Additionally, the Company actively monitors and manages its investment portfolio with the objectives of improving credit quality and increasing returns. In connection with portfolio management, the Company engages in various collection and foreclosure activities. When the Company acquires real estate pursuant to a foreclosure, lease termination or bankruptcy proceeding, and does not immediately re-lease the properties to new operators, the assets are included on the balance sheet as "real estate properties," and the value of such assets is reported at the lower of cost or fair value. (See "Owned and Operated Assets" below). Additionally, when a formal plan to sell real estate is adopted, the real estate is classified as "Assets Held for Sale," with the net carrying amount adjusted to the lower of cost or fair value, less cost of disposal. Based on management's current review of the Company's portfolio, a provision for impairment on the value of assets held for sale of $8.4 million was recorded for the three-month and six-month periods ended June 30, 2001. This provision relates to additional properties that were added to Assets Held for Sale during the three-month period ended June 30, 2001 as a result of the 5 foreclosure of assets leased by a defaulting customer during the quarter. A provision for impairment in the value of the Assets Held for Sale of $4.5 million was recorded for the six-month period ended June 30, 2000. A summary of the number of properties by category for the quarter ended June 30, 2001 follows:
Total Purchase / Owned & Healthcare Held for Facility Count Leaseback Mortgages Operated Facilities Sale Total --------- --------- -------- ---------- ---- ----- Balance at March 31, 2001 ................ 132 63 66 261 3 264 Properties transferred to Held for Sale .. (3) - (4) (7) 7 - Properties transferred to Owned & Operated (3) (1) 4 - - - Properties Sold / Mortgages Paid ......... - (5) - (5) (1) (6) Properties Leased / Mortgages Placed ..... 3 - (3) - - - -------------------------------------------------------------------- Balance at June 30, 2001 ................. 129 57 63 249 9 258 ==================================================================== Gross Investment ($000's) Balance at March 31, 2001 ................ $ 579,937 $ 206,774 $ 130,053 $ 916,764 $ 3,547 $ 920,311 Properties transferred to Held for Sale .. (11,499) - (1,043) (12,542) 12,542 - Properties transferred to Owned & Operated (9,133) (4,349) 13,482 - - - Properties Sold / Mortgages Paid ......... - (21,958) - (21,958) (156) (22,114) Properties Leased / Mortgages Placed ..... 22,163 - (22,163) - - - Impairment ............................... - - - - (8,344) (8,344) Capex and other .......................... - 301 1,039 1,340 (1,891) (551) ------------------------------------------------------------------------- Balance at June 30, 2001 ................. $ 581,468 $ 180,768 $ 121,368 $ 883,604 $ 5,698 $ 889,302 =========================================================================
Real Estate Dispositions The Company disposed of an Indiana facility during the three-month period ended June 30, 2001. The facility had a total of 40 beds and was classified as Assets Held for Sale. During the three-month period ended June 30, 2000, the Company recognized a gain on disposition of assets of $11.1 million from the sale of four facilities previously leased to Tenet Healthsystem Philadelphia, Inc., offset by a loss of $0.6 million on the sale of a 57 bed facility in Colorado. Notes and Mortgages Receivable Income on notes and mortgages which are impaired will be recognized as cash is received. No provision for loss on mortgages or notes receivable was recorded during the six-month periods ended June 30, 2001 and 2000. Owned and Operated Assets The Company owns 63 facilities that were recovered from customers and are operated for the Company's own account. These facilities have 4,942 beds and are located in nine states. During the three-month period ended June 30, 2001, four of the Company's previously Owned and Operated facilities were closed and reclassified to Assets Held for Sale, four foreclosure facilities were added to Owned and Operated and three facilities were re-leased to a new operator. 6 The Company intends to operate these owned and operated assets for its own account until such time as these facilities' operations are stabilized and are re-leasable or saleable at lease rates or sale prices that maximize the value of these assets to the Company. Due to the deterioration in market conditions affecting the long term care industry, the Company is unable to estimate when such re-leasing and sales objectives might be achieved and now intends to operate such facilities for an extended period. As a result, these facilities and their respective operations are presented on a consolidated basis in the Company's financial statements. The revenues, expenses, assets and liabilities included in the Company's condensed consolidated financial statements which relate to such owned and operated assets (2) are as follows:
Unaudited (In Thousands) Three Months Six Months Ended June 30, Ended June 30, -------------- -------------- 2001 2000 2001 2000 ---- ---- ---- ---- Revenues (1) Medicaid ........................ $ 26,321 $ 26,834 $ 53,561 $ 46,359 Medicare ........................ 11,324 6,495 22,514 13,250 Private & Other ................. 6,151 12,747 13,718 17,892 ----- ------ ------ ------ Total Revenues .............. 43,796 46,076 89,793 77,501 Expenses Patient Care Expenses ........... 29,568 27,729 62,721 50,103 Administration .................. 7,642 12,763 14,177 17,442 Property & Related .............. 2,746 2,576 5,960 4,871 ----- ----- ----- ----- Total Expenses .............. 39,956 43,068 82,858 72,416 Contribution Margin ............. 3,840 3,008 6,935 5,085 Management Fees ................. 2,418 2,281 4,867 3,898 Rent ............................ 1,302 1,570 2,401 1,570 ----- ----- ----- ----- Net Operating Income (Loss) ..... $ 120 $ (843) $ (333) $ (383) ======== ======== ======== ========
(1) Nursing home revenues from these owned and operated assets are recognized as services are provided. (2) The amounts shown in the condensed consolidated financial statements are not comparable, as the number of Owned and Operated facilities and the timing of the foreclosures and re- leasing activities occurred at different times during the periods presented. 7
Unaudited (In Thousands) June 30, December 31, 2001 2000 ---- ---- ASSETS Cash ....................................... $ 5,045 $ 5,364 Accounts Receivable - Net .................. 33,504 30,030 Other Current Assets ....................... 6,349 5,098 ----- ----- Total Current Assets ....................... 44,898 40,492 Investment in leasehold .................... 1,610 1,679 Land and Buildings ......................... 121,368 130,601 Less Accumulated Depreciation .............. (17,224) (17,680) ------- ------- Land and Buildings - Net ................... 104,144 112,921 ------- ------- TOTAL ASSETS ............................... $ 150,652 $ 155,092 ========= ========= LIABILITIES Accounts Payable ........................... $ 5,841 $ 8,636 Other Current Liabilities .................. 7,641 6,108 ----- ----- Total Current Liabilities .................. 13,482 14,744 ------ ------ TOTAL LIABILITIES .......................... $ 13,482 $ 14,744 ========= =========
Assets Held for Sale At June 30, 2001, the carrying value of assets held for sale totals $5.7 million (net of impairment reserves of $16.3 million). The Company intends to sell the remaining facilities as soon as practicable. However, a number of other companies are actively marketing portfolios of similar assets and, in light of the existing conditions in the long-term care industry generally, it has become more difficult to sell such properties and for potential buyers to obtain financing for such acquisitions. Thus, there can be no assurance if or when such sales will be completed or whether such sales will be completed on terms that allow the Company to realize the fair value of the assets. 8 Segment Information The following tables set forth the reconciliation of operating results and total assets for the Company's reportable segments for the three and six-month periods ended June 30, 2001 and 2000.
For the three months ended June 30, 2001 ---------------------------------------- Owned and Operated and Core Assets Held Corporate Operations For Sale and Other Consolidated ---------- -------- --------- ------------ (In Thousands) Operating Revenues ......................... $ 20,264 $ 43,796 $ - $ 64,060 Operating Expenses ......................... - (43,676) - (43,676) ----- ------- ------ ------- Net operating income ..................... 20,264 120 - 20,384 Adjustments to arrive at net income: Other revenues ........................... - - 1,594 1,594 Interest expense ......................... - - (9,243) (9,243) Depreciation and amortization ............ (4,344) (936) (224) (5,504) General and administrative ............... - - (3,155) (3,155) Legal .................................... - - (766) (766) State Taxes .............................. - - (107) (107) Litigation settlement expense ............ - - (10,000) (10,000) Severance and consulting agreement costs . - - (466) (466) Provision for uncollectable accounts ..... (681) - - (681) Provision for impairment ................. - - (8,381) (8,381) Charges for derivative accounting ........ - - (70) (70) ---- ---- ---- ---- (5,025) (936) (30,818) (36,779) ------ ---- ------- ------- Income (loss) before gain on assets sold and gain on early extinguishment of debt .... 15,239 (816) (30,818) (16,395) Gain on assets sold - net .................. - (7) - (7) Gain on early extinguishment of debt ....... - - 2,489 2,489 Preferred dividends ........................ - - (5,029) (5,029) ----- ----- ------ ------ Net income (loss) available to common ...... $ 15,239 $ (823) $ (33,358) $ (18,942) ========= ========= ========= ========= Total Assets ............................... $ 681,754 $ 156,350 $ 83,710 $ 921,814 ========= ========= ========= =========
9
For the three months ended June 30, 2000 ---------------------------------------- Owned and Operated and Core Assets Held Corporate Operations For Sale and Other Consolidated ---------- -------- --------- ------------ (In Thousands) Operating Revenues .................. $ 22,180 $ 46,076 $ - $ 68,256 Operating Expenses .................. - (46,919) - (46,919) ----- ------- ----- ------- Net operating income .............. 22,180 (843) - 21,337 Adjustments to arrive at net income: Other revenues .................... - - 2,192 2,192 Interest expense .................. - - (11,277) (11,277) Depreciation and amortization ..... (4,489) (964) (365) (5,818) General and administrative ........ - - (1,212) (1,212) Legal ............................. - - (472) (472) State Taxes ....................... - - (113) (113) Provision for impairment .......... - - - - ----- ---- ----- ----- (4,489) (964) (11,247) (16,700) ------ ---- ------- ------- Earnings (loss) ..................... 17,691 (1,807) (11,247) 4,637 Gain on Assets Sold ................. 10,451 - - 10,451 Preferred dividends ................. - - (2,408) (2,408) ----- ----- ------ ------ Net income (loss) available to common $ 28,142 $ (1,807) $ (13,655) $ 12,680 =========== =========== =========== =========== Total Assets ........................ $ 730,081 $ 167,631 $ 140,235 $ 1,037,947 =========== =========== =========== ===========
10
For the six months ended June 30, 2001 -------------------------------------- Owned and Operated and Core Assets Held Corporate Operations For Sale and Other Consolidated ---------- -------- --------- ------------ (In Thousands) Operating Revenues ......................... $ 41,963 $ 89,793 $ - $ 131,756 Operating Expenses ......................... - (90,126) - (90,126) ----- ------- ----- ------- Net operating income ..................... 41,963 (333) - 41,630 Adjustments to arrive at net income: Other revenues ........................... - - 3,075 3,075 Interest expense ......................... - - (18,915) (18,915) Depreciation and amortization ............ (8,668) (1,932) (445) (11,045) General and administrative ............... - - (5,504) (5,504) Legal .................................... - - (1,717) (1,717) State Taxes .............................. - - (213) (213) Litigation settlement expense ............ - - (10,000) (10,000) Severance and consulting agreement costs . - - (466) (466) Provision for uncollectable accounts ..... (681) - - (681) Provision for impairment ................. - - (8,381) (8,381) Charges for derivative accounting ........ - - (552) (552) ----- ----- ---- ---- (9,349) (1,932) (43,118) (54,399) ------ ------ ------- ------- Income (loss) before gain on assets sold and gain on early extinguishment of debt .... 32,614 (2,265) (43,118) (12,769) Gain on assets sold - net .................. - 612 - 612 Gain on early extinguishment of debt ....... - - 2,737 2,737 Preferred dividends ........................ - - (9,937) (9,937) ----- ----- ------ ------ Net income (loss) available to common ...... $ 32,614 $ (1,653) $ (50,318) $ (19,357) ========= ========= ========= ========= Total Assets ............................... $ 681,754 $ 156,350 $ 83,710 $ 921,814 ========= ========= ========= =========
11
For the six months ended June 30, 2000 -------------------------------------- Owned and Operated and Core Assets Held Corporate Operations For Sale and Other Consolidated ---------- -------- --------- ------------ (In Thousands) Operating Revenues .................. $ 46,182 $ 77,501 $ - $ 123,683 Operating Expenses .................. - (77,884) - (77,884) ----- ------- ------ ------- Net operating income .............. 46,182 (383) - 45,799 Adjustments to arrive at net income: Other revenues .................... - - 3,979 3,979 Interest expense .................. - - (22,375) (22,375) Depreciation and amortization ..... (9,420) (1,578) (730) (11,728) General and administrative ........ - - (2,801) (2,801) Legal ............................. - - (493) (493) State Taxes ....................... - - (226) (226) Provision for impairment .......... - - (4,500) (4,500) ----- ----- ------ ------ (9,420) (1,578) (27,146) (38,144) ------ ------ ------- ------- Earnings (loss) ..................... 36,762 (1,961) (27,146) 7,655 Gain on Assets Sold ................. 10,451 - - 10,451 Preferred dividends ................. - - (4,816) (4,816) ----- ----- ------ ------ Net income (loss) available to common $ 47,213 $ (1,961) $ (31,962) $ 13,290 =========== =========== =========== =========== Total Assets ........................ $ 730,081 $ 167,631 $ 140,235 $ 1,037,947 =========== =========== =========== ===========
Note C - Concentration of Risk and Related Issues As of June 30, 2001, the Company's portfolio of domestic investments consisted of 249 healthcare facilities, located in 29 states and operated by 31 third-party operators. The Company's gross investments in these facilities totaled $883.6 million at June 30, 2001. This portfolio is made up of 127 long-term healthcare facilities and 2 rehabilitation hospitals owned and leased to third parties, fixed rate, participating and convertible participating mortgages on 57 long-term healthcare facilities and 52 long-term healthcare facilities that were recovered from customers and are currently operated through third-party management contracts for the Company's own account. In addition, 12 facilities subject to third-party leasehold interests are included in Other Investments. The Company also holds miscellaneous investments and closed healthcare facilities held for sale of approximately $63.0 million at June 30, 2001, including $22.3 million related to two non-healthcare facilities leased by the United States Postal Service, an $8.6 million investment in Omega Worldwide, Inc., Principal Healthcare Finance Limited, an Isle of Jersey (United Kingdom) company and Principal Healthcare Finance Trust, an Australian Unit Trust, and $15.7 million of notes receivable. Seven public companies operate approximately 74.0% of the Company's investments, including Sun Healthcare Group, Inc. (24.7%), Integrated Health Services, Inc. (18.2%, including 10.8% as the manager for and 50% owner of Lyric Health Care LLC), Advocat, Inc. (12.0%), Mariner Post-Acute Network (6.2%), 12 Kindred Healthcare, Inc. (formerly known as Vencor Operating, Inc.) (6.0%), Alterra Healthcare Corporation (3.9%), and Genesis Health Ventures, Inc. (3.0%). Kindred and Genesis manage facilities for the Company's own account, included in Owned & Operated Assets. The two largest private operators represent 3.5% and 2.5%, respectively, of investments. No other operator represents more than 2.5% of investments. The three states in which the Company has its highest concentration of investments are Florida (16.1%), California (7.6%) and Illinois (7.5%). Government Healthcare Regulation, Reimbursements and Industry Concentration Risks Nearly all of the Company's properties are used as healthcare facilities, therefore, the Company is directly affected by the risk associated with the healthcare industry. The Company's lessees and mortgagors, as well as the facilities owned and operated for the Company's account, derive a substantial portion of their net operating revenues from third-party payers, including the Medicare and Medicaid programs. Such programs are highly regulated and subject to frequent and substantial changes. In addition, private payers, including managed care payers, are increasingly demanding discounted fee structures and the assumption by healthcare providers of all or a portion of the financial risk of operating a healthcare facility. Any changes in reimbursement policies which reduce reimbursement levels could adversely affect revenues of the Company's lessees and borrowers and thereby adversely affect those lessees' and borrowers' abilities to make their monthly lease or debt payments to the Company. The possibility that the healthcare facilities will not generate income sufficient to meet operating expenses or will yield returns lower than those available through investments in comparable real estate or other investments are additional risks of investing in healthcare-related real estate. Income from properties and yields from investments in such properties may be affected by many factors, including changes in governmental regulation (such as zoning laws), general or local economic conditions (such as fluctuations in interest rates and employment conditions), the available local supply and demand for improved real estate, a reduction in rental income as the result of an inability to maintain occupancy levels, natural disasters (such as earthquakes and floods) or similar factors. Real estate investments are relatively illiquid and, therefore, tend to limit the ability of the Company to vary its portfolio promptly in response to changes in economic or other conditions. Thus, if the operation of any of the Company's properties becomes unprofitable due to competition, age of improvements or other factors such that the lessee or borrower becomes unable to meet its obligations on the lease or mortgage loan, the liquidation value of the property may be substantially less, particularly relative to the amount owing on any related mortgage loan, than would be the case if the property were readily adaptable to other uses. 13 Potential Risks from Bankruptcies Generally, the Company's lease arrangements with a single operator who operates more than one of the Company's facilities is designed pursuant to a single master lease (a "Master Lease" or collectively, the "Master Leases"). Although each lease or Master Lease provides that the Company may terminate the Master Lease upon the bankruptcy or insolvency of the tenant, the Bankruptcy Reform Act of 1978 ("Bankruptcy Code") provides that a trustee in a bankruptcy or reorganization proceeding under the Bankruptcy Code (or debtor-in-possession in a reorganization under the Bankruptcy Code) has the power and the option to assume or reject the unexpired lease obligations of a debtor-lessee. In the event that the unexpired lease is assumed on behalf of the debtor-lessee, all the rental obligations thereunder generally would be entitled to a priority over other unsecured claims. However, the court also has the power to modify a lease if a debtor-lessee in a reorganization were required to perform certain provisions of a lease that the court determined to be unduly burdensome. It is not possible at this time to determine whether or not a court would hold that any lease or Master Lease contains any such provisions. If a lease is rejected, the lessor has a general unsecured claim limited to any unpaid rent already due plus an amount equal to the rent reserved under the lease, without acceleration, for the greater of one year or 15% of the remaining term of such lease, not to exceed the rent obligation for three years. Generally, with respect to the Company's mortgage loans, the imposition of an automatic stay under the Bankruptcy Code precludes the Company from exercising foreclosure or other remedies against the debtor. A mortgagee also is treated differently from a landlord in three key respects. First, the mortgage loan is not subject to assumption or rejection because it is not an executory contract or a lease. Second, the mortgagee's loan may be divided into (1) a secured loan for the portion of the mortgage debt that does not exceed the value of the property and (2) a general unsecured loan for the portion of the mortgage debt that exceeds the value of the property. A secured creditor such as the Company is entitled to the recovery of interest and costs only if and to the extent that the value of the collateral exceeds the amount owed. If the value of the collateral is less than the debt, a lender such as the Company would not receive or be entitled to any interest for the time period between the filing of the case and confirmation. If the value of the collateral does exceed the debt, interest and allowed costs may not be paid during the bankruptcy proceeding but accrue until confirmation of a plan or reorganization or some other time as the court orders. Finally, while a lease generally would either be rejected or assumed with all of its benefits and burdens intact, the terms of a mortgage, including the rate of interest and timing of principal payments, may be modified if the debtor is able to effect a "cramdown" under the Bankruptcy Code. The receipt of liquidation proceeds or the replacement of an operator that has defaulted on its lease or loan could be delayed by the approval process of any federal, state or local agency necessary for the transfer of the property or the replacement of the operator licensed to manage the facility. In addition, certain significant expenditures associated with real estate investment (such as real estate taxes and maintenance costs) are generally not reduced when circumstances cause a reduction in income from the investment. In order to protect its investments, the Company may take possession of a property or even become licensed as an operator, which might expose the Company to successorship liability to government programs or require the Company to indemnify subsequent operators to whom it might transfer the operating rights and licenses. Third party payors may also suspend payments to the Company following foreclosure 14 until the Company receives the required licenses to operate the facilities. Should such events occur, the Company's income and cash flows from operations would be adversely affected. Risks Related to Owned and Operated Assets As a consequence of the financial difficulties encountered by a number of the Company's operators, the Company has recovered various long-term care assets, pledged as collateral for the operators' obligations, either in connection with a restructuring or settlement with certain operators or pursuant to foreclosure proceedings. Under normal circumstances, the Company would classify such assets as "Assets Held for Sale" and seek to re-lease or otherwise dispose of such assets as promptly as practicable. However, a number of companies are actively marketing portfolios of similar assets and, in light of the current conditions in the long-term care industry generally, it has become more difficult both to sell such properties and for potential buyers to obtain financing to acquire such properties. During 2000, $24.3 million of assets previously classified as held for sale were reclassified to "Owned and Operated Assets" as the timing and strategy for sale or, alternatively, re-leasing, were revised in light of prevailing market conditions. The Company is typically required to hold applicable leases and is responsible for the regulatory compliance at its owned and operated facilities. The Company's management contracts with third-party operators for such properties provide that the third-party operator is responsible for regulatory compliance, but the Company could be sanctioned for violation of regulatory requirements. In addition, the risk of third-party claims such as patient care and personal injury claims may be higher with respect to Company owned and operated properties as compared to the Company's leased and mortgaged assets. Note D - Dividends On February 1, 2001, the Company announced the suspension of all common and preferred dividends. This action is intended to preserve cash to facilitate the Company's ability to obtain financing to fund its 2002 maturing indebtedness. Prior to recommencing the payment of dividends on the Company's Common stock, all accrued and unpaid dividends on the Company's Series A, B and C preferred stock must be paid in full. The Company has made sufficient distributions to satisfy the distribution requirements under the REIT rules to maintain its REIT status for 2000 and intends to satisfy such requirements under the REIT rules for 2001. The cumulative unaccrued and unpaid dividends relating to all series of the preferred stock, excluding the November 15, 2000 Series C dividends described below, total $9.9 million as of June 30, 2001. On March 30, 2001, the Company exercised its option to pay the accrued $4,666,667 Series C dividend from November 15, 2000 and the associated waiver fee by issuing 48,420 Series C preferred shares to Explorer on April 2, 2001, which are convertible into 774,722 shares of the Company's common stock at $6.25 per share. Such election resulted in an increase in the aggregate liquidation preference of Series C Preferred Stock as of April 2, 2001 to $104,842,000, including accrued dividends through that date. 15 During the six-month period ended June 30, 2000 the Company paid dividends of $2.7 million and $2.2 million, respectively, on its 9.25% Series A Cumulative Preferred Stock and 8.625% Series B Cumulative Preferred Stock. Note E - Earnings Per Share The computation of basic earnings per share is determined based on the weighted average number of common shares outstanding during the respective periods. Diluted earnings per share reflect the dilutive effect, if any, of stock options and, beginning in the third quarter of 2000, the assumed conversion of the Series C Preferred Stock. Note F - Omega Worldwide, Inc. As of June 30, 2001 the Company holds a $5.7 million investment in Omega Worldwide, Inc. ("Worldwide"), represented by 1,163,000 shares of common stock and 260,000 shares of preferred stock. The Company also holds a $1.6 million investment in Principal Healthcare Finance Limited, an Isle of Jersey (United Kingdom) company, and a $1.3 million investment in Principal Healthcare Finance Trust, an Australian Unit Trust. The Company had guaranteed repayment of Worldwide borrowings pursuant to a revolving credit facility in exchange for an initial 1% fee and an annual facility fee of 25 basis points. The Company was required to provide collateral in the amount of $8.8 million related to the guarantee of Worldwide's obligations. Worldwide repaid all borrowings under the revolving credit facility in June 2001, the Company's guarantee was terminated and the subject collateral was released. Additionally, the Company had a Services Agreement with Worldwide that provided for the allocation of indirect costs incurred by the Company to Worldwide. The allocation of indirect costs has been based on the relationship of assets under the Company's management to the combined total of those assets and assets under Worldwide's management. Upon expiration of this agreement on June 30, 2000, the Company entered into a new agreement requiring quarterly payments from Worldwide of $37,500 for the use of offices and certain administrative and financial services provided by the Company. Upon the reduction of the Company's accounting staff, the Service Agreement was renegotiated again on November 1, 2000 requiring quarterly payments from Worldwide of $32,500. Costs allocated to Worldwide for the three-month and six-month periods ended June 30, 2001 were $32,500 and $65,000, respectively, compared with $185,000 and $389,000 for the same periods in 2000. Note G - Litigation The Company is subject to various legal proceedings, claims and other actions arising out of the normal course of business. While any legal proceeding 16 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 its consolidated financial position or results of operations. On June 20, 2000, the Company and its former chief executive officer, former chief financial officer and chief operating officer were named as defendants in litigation brought by Ronald M. Dickerman, in his individual capacity, in the United States District Court for the Southern District of New York, alleging that the Company and the named executive officers violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Mr. Dickerman subsequently amended the complaint to assert his claims on behalf of an unnamed class of plaintiffs. On July 28, 2000, Benjamin LeBorys commenced a class action lawsuit making similar allegations against the Company and certain of its officers and directors in the United States District Court for the Southern District of New York. The cases were consolidated, and Mr. LeBorys was named lead plaintiff. The Company's Motion to Dismiss filed with the Court on February 16, 2001 was heard on May 29, 2001 at which time the Court dismissed the suit without prejudice and granted leave to the Plaintiffs to amend and re-file their complaint on or before July 20, 2001. As the Plaintiffs did not re-file a complaint, the Court has dismissed the suit with prejudice, resulting in a complete resolution in favor of the Company. (See Note J - Subsequent Events) On June 21, 2000, the Company was named as a defendant in certain litigation brought against it by Madison/OHI Liquidity Investors, LLC ("Madison"), a customer that claims that the Company has breached and/or anticipatorily breached a commercial contract. Mr. Dickerman is a partner of Madison and is a guarantor of Madison's obligations to the Company. Madison claims damages as a result of the alleged breach of approximately $700,000. Madison seeks damages as a result of the claimed anticipatory breach in the amount of $15 million or, in the alternative, Madison seeks specific performance of the contract as modified by a course of conduct that Madison alleges developed between Madison and the Company. The Company contends that Madison is in default under the contract in question. The Company believes that the litigation is meritless. The Company is defending vigorously and on December 5, 2000, filed counterclaims against Madison and the guarantors, including Mr. Dickerman, seeking repayment of approximately $8.8 million that Madison owes the Company. On December 29, 1998, Karrington Health, Inc. brought suit against the Company in the Franklin County, Ohio, Common Pleas Court (subsequently removed to the U.S. District Court for the Southern District of Ohio, Eastern Division) alleging that the Company repudiated and ultimately breached a financing contract to provide $95,000,000 of financing for the development of 13 assisted living facilities. Karrington was seeking recovery of approximately $34,000,000 in damages it alleged to have incurred as a result of the breach. On August 13, 2001, the Company paid Karrington $10,000,000 to settle all claims arising from the suit, but without admission of any liability or fault by the Company, which liability is expressly denied. Based on the settlement, the suit has been dismissed with prejudice. (See Note J - Subsequent Events) 17 Note H - Borrowing Arrangements The Company has a $175 million secured revolving credit facility that expires on December 31, 2002. Borrowings under the facility bear interest at 2.5% to 3.25% over LIBOR, based on the Company's leverage ratio. Borrowings of approximately $129 million are outstanding at June 30, 2001. Investments with a gross book value of approximately $240 million are pledged as collateral for this credit facility. The Company has a $75 million secured revolving credit facility that expires on March 31, 2002 as to $10 million and June 30, 2005 as to $65 million. Borrowings under the facility bear interest at 2.5% to 3.75% over LIBOR, based on the Company's leverage ratio and collateral assigned. Borrowings of approximately $69.6 million are outstanding at June 30, 2001. Investments with a gross book value of approximately $95 million are pledged as collateral for this credit facility. During the three-month and six-month periods ended June 30, 2001, the Company repurchased $19.5 million and $21.5 million, respectively, of its 6.95% Notes maturing in June 2002. At June 30, 2001, $103.5 million of these notes remain outstanding. As of June 30, 2001, the Company had an aggregate of $242 million of outstanding debt which matures in 2002, including $103.5 million of 6.95% Notes due June 2002 and $138 million on credit facilities expiring in 2002. The Company had $50 million of funding available through July 1, 2001 pursuant to an Investment Agreement with Explorer which can be used, upon satisfaction of certain conditions, to fund growth. Following the drawing in full or expiration of this commitment, Explorer will have the option to provide up to an additional $50 million to fund growth for an additional twelve-month period. (See Note D - Dividends) The Company is required to meet certain financial covenants, including prescribed leverage and interest coverage ratios on its long-term borrowings. At June 30, 2001 the Company had $28.2 million available under its secured revolving credit facilities prior to giving effect to the August settlement of the Karrington litigation described in Note G above. As a result of recognizing the Karrington settlement expense in the quarter ended June 30, 2001, the Company is not in compliance with one of the financial covenants under its credit facilities. The lenders have granted the Company a waiver through September 14, 2001 during which time all parties will be working together to resolve this covenant violation situation. Accordingly, as of the date of this report, the Company has $14.7 million available under its secured revolving credit facilities. Certain assets that served as collateral for one of the credit facilities were recovered from a customer during the quarter. These assets are no longer eligible to serve as collateral, resulting in reduced availability under the credit facility. The Company has the ability to replace this collateral and increase the availability under the line by up to an 18 additional $18.0 million subject to compliance with the applicable financial covenants. The Company's ability to draw upon the remaining availability under the credit facilities has been limited by the covenant violation noted above until such time as a permanent resolution is attained. (See Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources) Note I - Effect of New Accounting Pronouncements The Company utilizes interest rate swaps to fix interest rates on variable rate debt and reduce certain exposures to interest rate fluctuations. In June 1998, the Financial Accounting Standards Board issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, which is required to be adopted in years beginning after June 15, 2000. The Company adopted the new Statement effective January 1, 2001. The Statement requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedge item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. At June 30, 2001, the Company had two interest rate swaps with notional amounts of $32 million each, based on 30-day London Interbank Offered Rates (LIBOR). Under the terms of the first agreement, which expires in December 2001, the Company receives payments when LIBOR exceeds 6.35% and pays the counterparty when LIBOR is less than 6.35%. At June 30, 2001, 30-day LIBOR was 3.86 %. This interest rate swap may be extended for an additional twelve months at the option of the counterparty and therefore does not qualify for hedge accounting under FASB No. 133. The fair value of this swap at January 1, and June 30, 2001 was a liability of $351,344 and $727,825, respectively. The liability at January 1 was recorded as a transition adjustment in other comprehensive income and is being amortized over the initial term of the swap. Such amortization for the three-month and six-month periods ended June 30, 2001 of $87,836 and $175,672, respectively, together with the change in fair value of the swap of ($17,313) and $376,481, respectively, is included in charges for derivative accounting in the Company's Condensed Consolidated Statement of Operations. Under the second agreement, which expires December 31, 2002, the Company receives payments when LIBOR exceeds 4.89% and pays the counterparty when LIBOR is less than 4.89%. The fair value of this interest rate swap at June 30, 2001 was a liability of $260,660, which is included in other comprehensive income as required under FASB No. 133 for fully effective cash flow hedges. 19 The fair values of these interest rate swaps are included in accrued expenses and other liabilities in the Company's Condensed Consolidated Balance Sheet at June 30, 2001. Note J - Subsequent Events On June 20, 2000, the Company and its former chief executive officer, former chief financial officer and chief operating officer were named as defendants in litigation brought by Ronald M. Dickerman, in his individual capacity, in the United States District Court for the Southern District of New York, alleging that the Company and the named executive officers violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Mr. Dickerman subsequently amended the complaint to assert his claims on behalf of an unnamed class of plaintiffs. On July 28, 2000, Benjamin LeBorys commenced a class action lawsuit making similar allegations against the Company and certain of its officers and directors in the United States District Court for the Southern District of New York. The cases were consolidated, and Mr. LeBorys was named lead plaintiff. The Company's Motion to Dismiss filed with the Court on February 16, 2001 was heard on May 29, 2001 at which time the Court dismissed the suit without prejudice and granted leave to the Plaintiffs to amend and re-file their complaint on or before July 20, 2001. As the Plaintiffs did not re-file a complaint, the Court has dismissed the suit with prejudice. (See Note G - Litigation) Karrington Health, Inc. brought suit against the Company alleging that the Company repudiated and ultimately breached a financing contract to provide $95,000,000 of financing for the development of 13 assisted living facilities. Karrington was seeking recovery of approximately $34,000,000 in damages it alleges to have incurred as a result of the breach. On August 13, 2001, the Company paid Karrington $10,000,000 to settle all claims arising from the suit, but without admission of any liability or fault by the Company, which liability is expressly denied. Based on the settlement, the suit has been dismissed with prejudice. (See Note G - Litigation) 20 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations. "Safe Harbor" Statement Under the United States Private Securities Litigation Reform Act of 1995 Certain information contained in this report includes forward looking statements. Forward looking statements include statements regarding the Company's expectations, beliefs, intentions, plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements other than statements of historical facts. These statements may be identified, without limitation, by the use of forward looking terminology such as "may" "will" "anticipates" "expects" "believes" "intends" "should" or comparable terms or the negative thereof. All forward looking statements included herein are based on information available on the date hereof. Such statements only speak as of the date hereof and no obligation to update such forward looking statements should be assumed. Actual results may differ materially from those reflected in such forward looking statements as a result of a variety of factors, including, among other things: (i) the ability of the Company to dispose of assets held for sale on a timely basis and at appropriate prices; (ii) uncertainties relating to the operation of the Company's Owned and Operated Assets, including those relating to reimbursement by third-party payors, regulatory matters and occupancy levels; (iii) the general distress of the healthcare industry; (iv) continued deterioration of the operating results and financial condition of the Company's operators; (v) the ability of the Company's operators in bankruptcy to reject unexpired lease obligations, modify the terms of the Company's mortgages, and impede the ability of the Company to collect unpaid rent or interest during the pendency of a bankruptcy proceeding and retain security deposits for the debtor's obligations; (vi) the availability and cost of capital; (vii) regulatory and other changes in the healthcare sector; (viii) the ability of the Company to manage , re-lease or sell its owned and operated facilities; (ix) competition in the financing of healthcare facilities; (x) the effect of economic and market conditions and changes in interest rates; (xi) the resumption of dividends; (xii) the amount and yield of any additional investments; (xiii) changes in tax laws and regulations affecting real estate investment trusts;(xiv) access to the capital markets and the cost of capital (xv) changes in the ratings of the Company's debt securities; (xvi) and the risk factors set forth herein, including without limitation Note C - Concentration of Risk and Related Issues to the Condensed Consolidated Financial Statements included in Item 1. Following is a discussion of the consolidated results of operations, financial position and liquidity and capital resources of the Company, which should be read in conjunction with the condensed consolidated financial statements and accompanying notes. (See Note B - Properties and Note C - Concentration of Risk and Related Issues.) Results of Operations Revenues for the three-month and six-month periods ended June 30, 2001 totaled $65.7 million and $134.8 million, respectively, a decrease of $4.8 million and an increase of $7.2 million, respectively, over the periods ending 21 June 30, 2000. Excluding nursing home revenues of Owned and Operated Assets, revenues were $21.9 million and $45.0 million, respectively, for the three-month and six-month periods ended June 30, 2001, a decrease of $2.5 million and $5.1 million, respectively, from the comparable prior year periods. Rental income for the three-month and six-month periods ended June 30, 2001 totaled $14.7 million and $30.8 million, respectively, a decrease of $1.5 million and $3.5 million, respectively, over the same periods in 2000. The three-month decrease is due to $1.1 million reductions in lease revenue due to foreclosures, bankruptcies and restructurings and $0.7 million from reduced investments resulting from the sale of assets in 2000, offset by approximately $0.3 million relating to contractual increases in rents that became effective in 2001. The six-month decrease is due to $2.3 million from reductions in lease revenue due to foreclosures, bankruptcies and restructurings, and $1.8 million from reduced investments resulting from the sale of assets in 2000. These decreases are offset by $0.6 million relating to contractual increases in rents that became effective in 2001 as defined under the related agreements. Mortgage interest income for the three-month and six-month periods ended June 30, 2001 totaled $5.5 million and $11.2 million, respectively, decreasing $0.4 million and $0.7 million, respectively, from the same periods in 2000. The decrease is due to reductions from foreclosures, bankruptcies and restructurings and reduced investments resulting from the payoffs of mortgage notes. These decreases are partially offset by contractual increases in interest income that became effective in 2001 as defined under the related agreements. Nursing home revenues of owned and operated assets for the three-month and six-month periods ended June 30, 2001 totaled $43.8 million and $89.8 million, respectively, decreasing $2.3 million and increasing $12.3 million, respectively, over the same periods in 2000. The decrease for the three-month period is due to a decreased number of operated facilities versus the same three-month period in 2000 as a result of the closure of certain facilities and their reclassification to Assets Held for Sale as well as the re-lease of three facilities during the three-months ended June 30, 2001 to a new operator. The increase in the six-month period is primarily due to the inclusion of 30 facilities formerly operated by RainTree Healthcare Corporation ("RainTree") for the full six-month period ended June 30, 2001 versus four months during the six-month period ended June 30, 2000. Expenses for the three-month and six-month periods ended June 30, 2001 totaled $82.0 million and $147.6 million, respectively, increasing approximately $16.2 million and $27.6 million, respectively, over expenses of $65.8 million and $120.0 million for the three-month and six-month periods ended June 30, 2000. Nursing home expenses for owned and operated assets for the three-month period and six-month periods ended June 30, 2001 decreased by $3.2 million and increased by $12.2 million, respectively, from $46.9 million and $77.9 million for same periods in 2000. The decrease in the three-month period is due to a decreased number of facilities versus the same three-month period in 2000 as a result of the closure of certain facilities and their reclassification to Assets Held for Sale as well as the re-lease of three facilities during the three 22 months ended June 30, 2001 to a new operator. The increase in the six-month period is primarily due to the inclusion of 30 facilities formerly operated by RainTree for the full six-month period ended June 30, 2001 versus four months during the three-month period ended June 30, 2000. The provision for depreciation and amortization totaled $5.5 million and $11.0 million, respectively, during the three-month and six-month periods ended June 30, 2001. This is a decrease of $0.3 million and $0.7 million, respectively, over the same periods in 2000. The decrease is primarily due to assets sold in 2000 and lower depreciable values due to impairment charges on owned and operated properties, and a reduction in the amortization of goodwill and non-compete agreements. Interest expense for the three-month and six-month periods ended June 30, 2001 was approximately $9.2 million and $18.9 million, compared with $11.3 million and $22.4 million, respectively, for the same periods in 2000. The decrease in 2001 is primarily due to lower average outstanding borrowings during the 2001 period, partially offset by slightly higher average interest rates due to increased rate spreads under the Company's credit facilities versus last year. General and administrative expenses for the three-month and six-month periods ended June 30, 2001 totaled $3.2 million and $5.5 million, respectively, as compared to $1.2 million and $2.8 million, respectively, for the same periods in 2000, an increase of $1.9 million and $2.7 million. The increase is due primarily to consulting costs related to the efforts associated with the business objective of re-leasing the Company's owned and operated assets, restructuring activities and other non-recurring expenses including executive recruiting fees. Legal expenses for the three-month and six-month periods ended June 30, 2001 totaled $0.8 million and $1.7 million, respectively, an increase of $0.3 million and $1.2 million, respectively, over the same periods in 2000. The increase is largely attributable to legal costs associated with the foreclosure of assets and other negotiations with the Company's troubled operators as well as the defense of various lawsuits in which the Company is party to. (See Note G - Litigation) During the three-month period ended June 30, 2001 the Company recorded a $10 million litigation settlement expense related to a suit brought against it by Karrington, Health, Inc. (See Note G - Litigation) A provision for impairment of $8.4 million is included in expenses for the six-month period ended June 30, 2001. This provision was to reduce the cost basis of assets recovered from a defaulting operator to their fair value less cost to dispose, as these assets are being marketed for sale. A provision for impairment of $4.5 million was recognized in the 2000 period. A charge of $681,000 for provision for uncollectable accounts was taken during the three-month period ended June 30, 2001 relating to write-off of rents due from and funds advanced to the defaulting operator. 23 Severance and consulting agreement costs of $466,000 were recognized during the three-month period ended June 30, 2001 related to the termination of an employment contract with an officer of the Company. During the six-month period ended June 30, 2001, the Company recognized a gain on disposal of real estate of $0.6 million. For the three-month and six-month periods ended June 30, 2000, a gain of $10.5 million was recognized on the disposal of real estate. Funds from operations (FFO) for the three-month and six-month periods ended June 30, 2001 were deficits of $7.5 million and $2.7 million, respectively, a decrease of approximately $15.5 million and $21.8 million, respectively, as compared to the $8.0 million and $19.1 million for the same periods in 2000 due to factors mentioned above. Diluted FFO amounts were a deficit of $4.8 million and a positive $2.4 million, respectively, for the three-month and six-month periods ended June 30, 2001, as compared to the $9.1 million and $21.3 million for the same period in 2000 due to factors mentioned above. FFO is net earnings available to common shareholders, excluding any gains or losses from debt restructuring and the effects of asset dispositions, plus depreciation and amortization associated with real estate investments. The Company considers FFO to be one performance measure which is helpful to investors of real estate companies because, along with cash flows from operating activities, financing activities and investing activities, it provides investors an understanding of the ability of the Company to incur and service debt, to make capital expenditures and to pay dividends to its shareholders. FFO in and of itself does not represent cash generated from operating activities in accordance with GAAP and therefore should not be considered an alternative to net earnings as an indication of operating performance or to net cash flow from operating activities as determined by GAAP as a measure of liquidity and is not necessarily indicative of cash available to fund cash needs. No provision for Federal income taxes has been made since the Company continues to qualify as a real estate investment trust under the provisions of Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. Accordingly, the Company has not been subject to Federal income taxes on amounts distributed to shareholders, as it distributed at least 95% (90% in 2001) of its real estate investment trust taxable income and has met certain other conditions. Liquidity and Capital Resources The settlement of the lawsuit with Karrington Health, Inc. fixed the amount of expense associated with this claim against the Company at $10 million and was therefore recorded at June 30, 2001. The recognition of this expense has resulted in a violation of one of the financial covenants in the loan agreements with the Company's primary lenders. The lenders have granted the Company a waiver through September 14, 2001 during which time all parties will be working together to resolve this covenant violation situation. 24 At June 30, 2001 the Company had total assets of $921.8 million, shareholders' equity of $459.7 million, and long-term debt of $425.7 million, representing approximately 46.2% of total capitalization. The Company has revolving credit facilities in place, providing up to $250 million of financing, of which $198.6 million was drawn at June 30, 2001. As of the date of this report, the Company has $14.7 million available under its secured revolving credit facilities. Certain assets that served as collateral for one of the credit facilities were recovered from a customer during the quarter. These assets are no longer eligible to serve as collateral, resulting in reduced availability under the credit facility. The Company has the ability to replace this collateral and increase the availability under the line by up to an additional $18.0 million subject to compliance with the applicable financial covenants. The Company's ability to draw upon the remaining availability under the credit facilities has been limited by the covenant violation waiver noted above until such time as a permanent resolution is attained. As of June 30, 2001, the Company had an aggregate of $242 million of outstanding debt which matures in 2002, including $103.5 million of 6.95% Notes due June 2002 and $138 million on credit facilities expiring in 2002. The Company has historically distributed to shareholders a large portion of the cash available from operations. The Company's historical policy has been to make distributions on Common Stock of approximately 80% of FFO, but on February 1, 2001, the Company announced the suspension of all common and preferred dividends. This action is intended to preserve cash to facilitate the Company's ability to obtain financing to fund the 2002 debt maturities. Additionally, on March 30, 2001, the Company exercised its option to pay the accrued $4,666,667 Series C dividend from November 15, 2000 and the associated waiver fee by issuing 48,420 Series C preferred shares to Explorer on April 2, 2001, which are convertible into 774,722 shares of the Company's common stock at $6.25 per share. The Company anticipates that it will reinstate dividends on its common and preferred stock when the Company determines that it has sufficient resources or satisfactory plans to meet its 2002 debt maturities, but the Company can give no assurance as to when the dividends will be reinstated or the amount of the dividends if and when such payments are recommenced. Prior to recommencing the payment of dividends on the Company's Common stock, all accrued and unpaid dividends on the Company's Series A, B and C Preferred Stock must be paid in full. The Company has made sufficient distributions to satisfy the distribution requirements under the REIT rules to maintain its REIT status for 2000 and intends to satisfy such requirements under the REIT rules for 2001. Cash dividends paid totaled $0.50 per common share for the three-month period ended March 31, 2000. No common dividends were paid during the first and second quarters of 2001 nor during the second quarter of 2000. The Company has $50 million of funding available through July 1, 2001 pursuant to an Investment Agreement with Explorer Holdings, L.P. ("Explorer") which can be used, upon satisfaction of certain conditions, to fund growth. Following the drawing in full or expiration of this commitment, Explorer will have the option to provide up to an additional $50 million to fund growth for an additional twelve-month period. 25 Management believes the Company's liquidity and various sources of available capital, including funds from operations and expected proceeds from planned asset sales, are adequate to finance operations, meet recurring debt service requirements and fund future investments through the next 12 months, including through the waiver period, but is taking immediate steps to facilitate a refinancing of maturing 2002 debt, including the announced suspension of dividends and the pursuit of additional capital. As a result of the ongoing financial challenges facing long-term care operators, the availability of the external capital sources historically used by the Company has become extremely limited and expensive, and, therefore, no assurance can be given that the Company will be able to replace or extend the 2002 debt maturities, or that any refinancing or replacement financing would be on favorable terms to the Company. If the Company were unable to refinance its 2002 debt maturities or other indebtedness on acceptable terms, it might be forced to dispose of properties on disadvantageous terms, which might result in losses to the Company and might adversely affect the cash available for distribution to shareholders, or to pursue dilutive equity financing. If interest rates or other factors at the time of the refinancing result in higher interest rates upon refinancing, the Company's interest expense would increase, which might affect the Company's ability to make distributions to its shareholders. 26 Item 3 - Quantitative and Qualitative Disclosure About Market Risk The Company is exposed to various market risks, including the potential loss arising from adverse changes in interest rates. The Company does not enter into derivatives or other financial instruments for trading or speculative purposes, but the Company seeks to mitigate the effects of fluctuations in interest rates by matching the term of new investments with new long-term fixed rate borrowing to the extent possible. The market value of the Company's long-term fixed rate borrowings and mortgages are subject to interest rate risk. Generally, the market value of fixed rate financial instruments will decrease as interest rates rise and increase as interest rates fall. The estimated fair value of the Company's total long-term borrowings at June 30, 2001 was $398 million. A one-percent increase in interest rates would result in a decrease in the fair value of long-term borrowings by approximately $4.7 million. The Company is subject to risks associated with debt or preferred equity financing, including the risk that existing indebtedness may not be refinanced or that the terms of such refinancing may not be as favorable as the terms of current indebtedness. (See Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources. The Company utilizes interest rate swaps to fix interest rates on variable rate debt and reduce certain exposures to interest rate fluctuations. At June 30, 2001, the Company had two interest rate swaps with notional amounts of $32 million each, based on 30-day London Interbank Offered Rates (LIBOR). Under the first $32 million agreement, the Company receives payments when LIBOR interest rates exceed 6.35% and pays the counterparties when LIBOR rates are under 6.35%. The amounts exchanged are based on the notional amounts. The $32 million agreement expires in December 2001 but may be extended for an additional year by the counterparty. Under the terms of the second agreement, which expires in December 2002, the Company receives payments when LIBOR rates exceed 4.89% and pays the counterparties when LIBOR rates are under 4.89%. The combined fair value of the interest rate swaps at June 30, 2001 was a deficit of $988,485. (See Note I - Effect of New Accounting Pronouncements.) 27 PART II - OTHER INFORMATION Item 1. Legal Proceedings See Note G and Note J to the Condensed Consolidated Financial Statements in Item 1 hereto, which are hereby incorporated by reference in response to this item. Item 2. Changes in Securities and Use of Proceeds On March 30, 2001, the Company exercised its option to pay the accrued $4,666,667 Series C dividend from November 15, 2000 and the associated waiver fee by issuing 48,420 Series C preferred shares to Explorer on April 2, 2001, which are convertible into 774,722 shares of the Company's Common Stock at $6.25 per share. The shares of Series C Preferred are governed by the Articles Supplementary for Series C Convertible Preferred Stock (the "Articles Supplementary") filed with the State Department of Assessments and Taxation of Maryland on July 14, 2000. The shares of Series C Preferred were issued without registration under the Securities Act of 1933, as amended (the "Securities Act") because the issuance did not involve a sale within the meaning of the Securities Act and/or in reliance upon the private placement exemption provided by Section 4(2) of the Securities Act. Item 3. Defaults upon Senior Securities (a) Payment Defaults. Not Applicable. (b) Dividend Arrearages. On February 1, 2001, the Company announced the suspension of dividends on all common and preferred stock. See Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources. Dividends on the Company's preferred stock are cumulative, and therefore all accrued and unpaid dividends on the Company's Series A, B and C Preferred Stock must be paid in full prior to recommencing the payment of cash dividends on the Company's Common Stock. The table below sets forth information regarding arrearages in payment of preferred stock dividends: 28 Annual Dividend Per Arrearage as of Title of Class Share June 30, 2001 -------------- ----- ------------- 9.25% Series A Cumulative Preferred Stock $2.3125 $2,659,375 8.625% Series B Cumulative Preferred Stock $2.1563 2,156,250 Series C Preferred Stock $10.0000 5,039,443 --------- TOTAL $9,855,068 ========== Item 4. Submission of Matters to a Vote of Security Holders (a) The Company's Annual Meeting of Shareholders was held on May 22, 2001. (b) The following directors were elected at the meeting for a three-year term: Edward Lowenthal, Christopher W. Mahowald and Stephen D. Plavin. Thomas W. Erickson, Donald J. McNamara and Daniel A. Decker were elected to complete the remainder of the terms of the directors who resigned prior to the completion of their terms. The following directors were not elected at the meeting but their term of office continued after the meeting: Thomas F. Franke, Harold J. Kloosterman and Bernard J. Korman. 29 (a) The results of the vote were as follows:
Manner of Vote Edward Christopher Stephen D. Thomas W. Donald J. Daniel A. Cast Lowenthal W. Mahowald Plavin Erickson McNamara Decker ---- --------- ----------- ------ -------- -------- ------ For 34,078,188 34,067,752 34,072,686 34,062,778 34,063,083 34,080,253 Withheld 9,221 19,657 14,723 27,775 27,470 5,750 Against -- -- -- -- -- -- Abstentions and broker non-votes 463,944 463,944 463,944 460,800 460,800 465,350 (b) Not applicable.
30 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits - The following Exhibits are filed herewith: Exhibit Description ------- ----------- 10.1 Letter Agreement between Omega Healthcare Investors, Inc. and The Hampstead Group, L.L.C. dated as of June 1, 2001 10.2 Employment Agreement between Omega Healthcare Investors, Inc. and C. Taylor Pickett, dated June 12, 2001 (b) Reports on Form 8-K - none were filed. 31 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. OMEGA HEALTHCARE INVESTORS, INC. Registrant Date: August 14, 2001 By: /s/ C. Taylor Pickett ------------------------- C. Taylor Pickett Chief Executive Officer Date: August 14, 2001 By: /s/ Robert O. Stephenson ---------------------------- Robert O. Stephenson Chief Financial Officer 32