Omega Healthcare Investors(US:OHI)2019-02-26 19:48Part I Business Omega Healthcare Investors is a REIT financing the long-term healthcare industry via triple-net leases and mortgages for SNFs and ALFs in the U.S. and U.K Overview; Recent Events Omega operates as a REIT providing capital to the long-term healthcare industry, completed approximately $471 million in new investments in 2018, and agreed to acquire MedEquities Realty Trust for about $600 million in January 2019 - Omega's core business is providing financing and capital to the long-term healthcare industry, focusing on Skilled Nursing Facilities (SNFs) and Assisted Living Facilities (ALFs) through triple-net leases and mortgage agreements24 - As of December 31, 2018, the company's portfolio consisted of 924 healthcare facilities in 41 states and the U.K., operated by 68 third-party operators, with a total investment value of approximately $8.6 billion27 - On January 2, 2019, Omega entered into an agreement to acquire MedEquities Realty Trust, Inc for total consideration of approximately $600 million, including assumed debt28 2018 New Investments Summary | Investment Type | Amount (millions) | Description | | :--- | :--- | :--- | | Secured Term Loan | $131.3 | Secured by 11 facilities in PA & VA, interest rate of 9.35% | | First Mortgage Loan | $44.2 | Secured by 5 SNFs in MI, initial interest rate of 9.5% | | New Investments (Acquisition) | $35.1 | Acquisition of 3 SNFs and 1 ILF in PA, initial cash yield of 9.5% | | New Investments (U.K.) | $9.1 | Acquisition of 2 care homes in the U.K., initial cash yield of 8.5% | | Other Acquisitions & Investments | $70.7 | Acquired 9 SNFs and 1 ALF for $60.7M and invested $10.0M in a mezzanine loan | | Capital Expenditure Programs | $180.9 | Investments in capital improvement programs | | Total | $471.3 | | Summary of Financial Information by Asset Category This section breaks down revenues and assets by category from 2016 to 2018, showing a slight revenue decline in 2018 while total investments remained stable at approximately $9.1 billion Revenues by Asset Category (in thousands) | Category | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Rental income | $767,340 | $775,176 | $743,885 | | Income from direct financing leases | $1,636 | $32,336 | $62,298 | | Mortgage interest income | $70,312 | $66,202 | $69,811 | | Total core assets revenues | $839,288 | $873,714 | $875,994 | | Other investment income | $40,228 | $29,225 | $21,852 | | Miscellaneous income | $2,166 | $5,446 | $2,981 | | Total operating revenues | $881,682 | $908,385 | $900,827 | Assets by Category (in thousands) | Category | As of Dec 31, 2018 | As of Dec 31, 2017 | | :--- | :--- | :--- | | Total real estate investments | $7,746,410 | $7,655,960 | | Investments in direct financing leases - net | $132,262 | $364,965 | | Mortgage notes receivable - net | $710,858 | $671,232 | | Total core assets | $8,589,530 | $8,692,157 | | Other investments - net | $504,626 | $276,342 | | Investment in unconsolidated joint venture | $31,045 | $36,516 | | Assets held for sale - net | $989 | $86,699 | | Total investments | $9,126,190 | $9,091,714 | Description of the Business The company's strategy focuses on a diverse portfolio of healthcare facilities operated by creditworthy operators, structured as triple-net leases and fixed-rate mortgages, while facing industry competition - The company's investment criteria include the operator's quality and creditworthiness, facility cash flow, physical condition, location, and the regulatory and reimbursement environment3436 - Competition in the healthcare industry is high, coming from other REITs, private equity, hedge funds, and other institutional investors, some with greater resources and lower capital costs44 Primary Investment Structures and Yields (as of Dec 31, 2018) | Investment Structure | Typical Term | Average Annualized Yield | | :--- | :--- | :--- | | Triple-Net Operating Leases | 5 to 15 years | ~9.2% | | Direct Financing Leases | N/A | ~9.0% | | Fixed-Rate Mortgages | N/A | ~10.1% | Taxation of Omega This section details Omega's tax structure as a REIT, outlining the requirements to maintain this status, including income tests, asset tests, and distribution mandates - To maintain its REIT qualification, Omega must annually satisfy two gross income tests: at least 75% of gross income must come from real property investments, and at least 95% must be from such investments plus other passive sources52 - The company must satisfy several asset tests at the end of each quarter, including that at least 75% of total assets are real estate assets, cash, or government securities68 - A critical requirement for REIT status is the annual distribution of at least 90% of its "REIT taxable income" to stockholders7576 - If Omega fails to qualify as a REIT, it would be subject to federal income tax at regular corporate rates and would be disqualified from REIT status for the following four taxable years80 Government Regulation and Reimbursement The healthcare industry and Omega's operators are subject to extensive regulations, with significant revenue reliance on Medicare and Medicaid, making them vulnerable to reimbursement changes - A significant portion of the revenue for Omega's operators is derived from government-funded programs like Medicare and Medicaid, making them susceptible to reimbursement reductions100 - CMS issued a final rule for FY 2019 that replaces the SNF PPS RUG-IV payment model with a new value-based Patient Driven Payment Model (PDPM), effective October 1, 2019104 - The Office of Inspector General (OIG) and the Department of Justice (DOJ) have increased scrutiny on SNFs, focusing on quality of care, staffing levels, and billing practices111113 - Operators are subject to strict fraud and abuse laws, including the Anti-kickback Statute and Stark Law, violations of which can lead to severe sanctions116117 Executive Officers of Our Company This section provides biographical details for the company's five key executive officers as of February 1, 2019 - C. Taylor Pickett has served as Chief Executive Officer since June 2001 and as a Director since May 2002127 - The executive team consists of C. Taylor Pickett (CEO), Daniel J. Booth (COO), Steven J. Insoft (Chief Corporate Development Officer), Robert O. Stephenson (CFO), and Michael D. Ritz (Chief Accounting Officer)127128129130131 Risk Factors This section outlines significant risks affecting the company, categorized into operator-related, operational, taxation, stock-related, and acquisition-specific risks Risks Related to the Operators of Our Facilities The company's stability depends on its operators' ability to meet obligations, facing risks from operator bankruptcy, extensive government regulation, and reliance on Medicare/Medicaid reimbursement - The bankruptcy or insolvency of operators poses a significant risk, as it could limit or delay the company's ability to collect unpaid rent and mortgage payments136137 - Operators' revenues are highly dependent on government reimbursement programs like Medicare and Medicaid, and funding reductions could materially harm their financial condition143148150 - Failure by operators to comply with numerous federal, state, and local regulations could result in fines, penalties, or exclusion from reimbursement programs, jeopardizing their ability to make payments142143145 Risks Related to Us and Our Operations Omega faces operational risks including reliance on external capital, debt covenants, interest rate fluctuations, potential asset impairments, and international investment uncertainties like Brexit - Due to the REIT distribution requirement of at least 90% of taxable income, the company relies on external debt and equity financing for future capital needs162 - Covenants in debt agreements limit operational flexibility, and a breach could lead to default, while the planned phase-out of LIBOR creates uncertainty for variable-rate debt173168 - The company's investments in the U.K. subject it to risks from currency exchange rate fluctuations and the economic and legal uncertainty surrounding Brexit182184186 - The company has significant investment concentrations in Florida (10%), Texas (10%), and Michigan (8%), exposing it to adverse conditions in those states185 Risks Related to Taxation This section highlights the critical risk of failing to maintain REIT status, which would subject the company to corporate income tax and significantly reduce cash flow - Failure to maintain qualification as a REIT would subject the company to federal income tax at regular corporate rates, significantly reducing net earnings and cash available for distribution195196 - Complying with REIT requirements may force the company to liquidate otherwise attractive investments or make distributions at disadvantageous times to meet income, asset, and distribution tests200 - The Tax Cuts and Jobs Act of 2017 introduced broad changes that could impact the computation of the company's taxable income and required distributions201202 Risks Related to Our Stock The market value of Omega's common stock is subject to volatility, potential dilution from future equity or debt issuances, and the uncertainty of future dividend payments - The market price of the company's stock is subject to volatility and can be affected by factors such as market perception of REITs, analyst reports, and interest rates207 - Future sales of capital stock or convertible debt could dilute the ownership interests of existing stockholders and negatively impact the market price of the common stock207211 - There is no assurance of the company's ability to pay dividends in the future, as payments depend on earnings, financial condition, and maintaining REIT status213 Risks Related to our Proposed Acquisition of MedEquities The pending acquisition of MedEquities presents risks including potential non-completion, integration challenges, failure to realize synergies, and possible adverse tax consequences - The consummation of the merger with MedEquities is subject to a number of conditions, and there is no assurance that the merger will be completed216217 - The company may be unable to successfully integrate the MedEquities business or realize the anticipated synergies, which could result in the merger not being accretive to earnings219225 - Omega may incur adverse tax consequences if MedEquities has failed to qualify as a REIT for U.S. federal income tax purposes228 Unresolved Staff Comments The company reports that there are no unresolved staff comments from the SEC - None229 Properties As of year-end 2018, Omega's portfolio included 924 properties across 41 states and the U.K., with geographic concentrations in Florida, Texas, and Michigan - The portfolio is operated by 68 different healthcare providers, with the top five operators representing approximately 38% of the total portfolio by investment237 Top 5 State Concentrations by Gross Real Estate Investment (as of Dec 31, 2018) | Location | % of Gross Real Estate Investment | | :--- | :--- | | Florida | 9.75% | | Texas | 9.62% | | Michigan | 8.02% | | Ohio | 6.90% | | Indiana | 6.88% | Operating Lease Expiration Schedule (Annualized Straight-line Rental Revenue) | Expiration Year | Revenue Expiring ($ in thousands) | | :--- | :--- | | 2019 | $2,174 | | 2020 | $4,039 | | 2021 | $4,940 | | 2022 | $36,756 | | 2023 | $13,667 | | Thereafter | $510,996 | Legal Proceedings The company faces a consolidated securities class action lawsuit alleging false or misleading statements regarding an operator's financial condition, which it intends to defend vigorously - A securities class action lawsuit was filed against the company and certain officers in November 2017, alleging violations of the Securities Exchange Act of 1934240242 - The lawsuit claims the company made misleading statements and failed to disclose adverse facts about an operator's financial health and its ability to pay rent242 - A related shareholder derivative action was filed in August 2018, which has been stayed pending the resolution of the securities class action245 Mine Safety Disclosures The company reports that there are no mine safety disclosures applicable to its operations - None247 Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities This section provides details on Omega's common stock (NYSE: OHI), including shareholder count, equity compensation plans, and a report of no equity repurchases in Q4 2018 - Omega's common stock is traded on the New York Stock Exchange under the symbol "OHI" with 204,229,335 shares outstanding as of February 19, 2019249 - The company did not purchase any of its outstanding equity securities during the fourth quarter of 2018252 Equity Compensation Plan Information (as of Dec 31, 2018) | Plan Category | Securities to be issued upon exercise | Weighted-average exercise price | Securities remaining available for future issuance | | :--- | :--- | :--- | :--- | | Approved by security holders | 3,011,181 | $— | 5,085,092 | | Not approved by security holders | — | $— | — | | Total | 3,011,181 | $— | 5,085,092 | Selected Financial Data This section presents a five-year summary of selected historical financial and operating data for Omega and its operating partnership from 2014 to 2018 Omega Selected Financial Data (2016-2018, in thousands) | Metric | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Operating Data | | | | | Revenues | $881,682 | $908,385 | $900,827 | | Net income | $293,884 | $104,910 | $383,367 | | Diluted EPS | $1.40 | $0.51 | $1.90 | | Dividends per Share | $2.64 | $2.54 | $2.36 | | Balance Sheet Data (Year-End) | | | | | Gross investments | $9,126,190 | $9,091,714 | $9,166,129 | | Total assets | $8,590,877 | $8,773,305 | $8,949,260 | | Total equity | $3,764,484 | $3,888,258 | $4,211,986 | Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) This MD&A provides management's perspective on financial condition and results, covering the business outlook, 2018 highlights, portfolio changes, and an analysis of operating results Overview and Outlook Management notes stable portfolio occupancy despite industry declines, but operators face challenges from labor costs and managed care, with a positive long-term outlook driven by demographics and PDPM - Operators are experiencing increased labor costs and declines in their quality payor mix, driven by managed care pressure on lengths of stay and rates271 - The Texas operating environment is challenging for SNF operators due to low statewide occupancy and low Medicaid reimbursement rates271 - Management believes operators will generally benefit from the October 2019 change in the Medicare payment system to the Patient Driven Payment Model (PDPM) and from projected growth in elderly demographics273 2018 and Recent Highlights In 2018, Omega completed new investments totaling approximately $471 million and agreed in January 2019 to acquire MedEquities Realty Trust for about $600 million - The company completed approximately $471 million in new investments during 2018, including loans, acquisitions in the U.S. and U.K., and capital expenditure programs275277 - On January 2, 2019, Omega agreed to acquire MedEquities Realty Trust, Inc for approximately $600 million in a stock and cash transaction, including assumed debt276 Portfolio and Other Developments This section details a slowdown in acquisition activity from 2016 to 2018, with a notable 2018 transaction involving the transition of 22 facilities to new operating leases - In 2018, the company transitioned 22 facilities with a net carrying value of $184.5 million from a direct financing lease with one operator to new operating leases with five existing operators282 Acquisition Summary (2016-2018) | Year | Number of Facilities Acquired | Total Investment (in millions) | | :--- | :--- | :--- | | 2018 | 15 | $105.7 | | 2017 | 51 | $412.7 | | 2016 | 90 | $1,022.8 | Asset Sales, Impairments, Accounts Receivable and Other This section details significant portfolio restructuring, including asset sales, impairments, and challenges with operators like Orianna, Signature Healthcare, and Daybreak Venture - Orianna Health Systems filed for Chapter 11 bankruptcy in March 2018, and Omega managed the transition and sale of its facilities, a process concluded in early 2019308311313 - In May 2018, Omega completed a consensual, out-of-court restructuring with Signature Healthcare, which involved creating a new holding company (Agemo), deferring rent, and providing a new working capital loan318 - Daybreak Venture, an operator primarily in Texas, was placed on a cash basis for revenue recognition in 2017 and received further rent deferrals in late 2018 and early 2019320321 Asset Sales and Impairments (2017-2018) | Metric | 2018 | 2017 | | :--- | :--- | :--- | | Facilities Sold | 78 | 52 | | Net Proceeds from Sales | ~$309.6M | ~$257.8M | | Gain on Sale | ~$24.8M | ~$53.9M | | Impairments on Real Estate | ~$35.0M | ~$99.1M | | Impairments on Direct Financing Leases | ~$27.2M | ~$198.2M | Results of Operations This section analyzes operating results, noting that while 2018 revenue decreased, net income rose significantly due to substantially lower impairment charges compared to 2017 - The decrease in 2018 revenue was primarily due to a $30.7 million drop in direct financing lease income, largely from placing operator Orianna on a cash basis325 - The significant increase in 2018 net income was mainly due to a large reduction in impairment charges, which fell from $198.2 million in 2017 to $27.2 million in 2018326 Comparison of Operations (in millions) | Metric | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Total Operating Revenues | $881.7 | $908.4 | $900.8 | | Total Operating Expenses | $408.9 | $647.1 | $391.1 | | Impairment (Real Estate & DFL) | $57.0 | $297.3 | $58.7 | | Net Income | $293.9 | $104.9 | $383.4 | | Nareit FFO | $587.4 | $444.3 | $660.1 | Liquidity and Capital Resources As of year-end 2018, the company had $8.6 billion in assets and $4.6 billion in debt, with liquidity from operations, credit facilities, and asset sales deemed adequate for the next year - Net cash provided by operating activities decreased by $78.5 million to $499.4 million in 2018, primarily due to lost income from Orianna and a $50.0 million payment to an operator357 - In 2018, the company issued approximately 2.3 million shares under its Equity Shelf Program, generating net proceeds of $75.5 million350 - The company paid total dividends of $528.7 million to its common stockholders in 2018, at a rate of $0.66 per share per quarter352353 Contractual Obligations as of Dec 31, 2018 (in thousands) | Obligation | Total | Less than 1 year | Years 2-3 | Years 4-5 | More than 5 years | | :--- | :--- | :--- | :--- | :--- | :--- | | Debt | $4,585,990 | $— | $333,000 | $1,602,990 | $2,650,000 | | Interest payments on long-term debt | $1,272,957 | $203,960 | $402,181 | $336,416 | $330,400 | Critical Accounting Policies and Estimates Management identifies four critical accounting policies requiring significant judgment: Lease Accounting, Revenue Recognition, Investment Impairment, and Allowance for Losses on Mortgages and Investments - The four critical accounting policies identified are: Lease Accounting, Revenue Recognition and Allowance for Doubtful Accounts, Depreciation and Real Estate Investment Impairment, and Allowance for Losses on Mortgages, Other Investments and Direct Financing Leases361 - The company evaluates real estate investments for impairment when indicators are present by comparing the carrying value to future undiscounted cash flows, a process involving significant management estimation374 - Allowances for losses on loans and receivables are based on quarterly evaluations of collectability, considering factors like delinquency and borrower financial strength, which requires significant judgment371376 Quantitative and Qualitative Disclosures About Market Risk The company is primarily exposed to interest rate risk, which it mitigates by matching investment terms with long-term, fixed-rate borrowings and using derivative instruments for hedging - The company's primary market risk is from changes in interest rates, which affect the fair value of its fixed-rate debt and mortgages378 - A hypothetical one percent increase in interest rates would result in an estimated decrease of $227.2 million in the fair value of the company's long-term borrowings as of December 31, 2018384 - The company uses interest rate swap agreements to hedge interest rate risk, such as converting a variable-rate term loan to an effective fixed rate of 3.8005%385 Financial Statements and Supplementary Data This item incorporates by reference the company's consolidated financial statements and the independent auditor's report, which are filed beginning on page F-1 - The consolidated financial statements and the report of Ernst & Young LLP, Independent Registered Public Accounting Firm, are filed beginning on page F-1 of the report386 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports that there have been no changes in or disagreements with its accountants on accounting and financial disclosure - None387 Controls and Procedures Management concluded that the company's disclosure controls and procedures, as well as its internal control over financial reporting, were effective as of December 31, 2018 - The Chief Executive Officer and Chief Financial Officer concluded that the company's disclosure controls and procedures were effective as of December 31, 2018389 - Management assessed the effectiveness of internal control over financial reporting and concluded that it was effective as of December 31, 2018, based on the COSO framework392 Other Information The company reports that there is no other information to disclose under this item - None395 Part III Directors, Executive Officers of the Registrant and Corporate Governance Information on directors and corporate governance is incorporated by reference from the 2019 proxy statement, while executive officer information is provided in Part I of this report - Information required by this item is incorporated by reference from the company's definitive proxy statement for the 2019 Annual Meeting of Stockholders398 Executive Compensation Information regarding executive compensation is incorporated by reference from the company's definitive proxy statement for the 2019 Annual Meeting of Stockholders - Information required by this item is incorporated by reference from the company's definitive proxy statement for the 2019 Annual Meeting of Stockholders400 Security Ownership of Certain Beneficial Owners and Management Information regarding security ownership is incorporated by reference from the company's definitive proxy statement for the 2019 Annual Meeting of Stockholders - Information required by this item is incorporated by reference from the company's definitive proxy statement for the 2019 Annual Meeting of Stockholders401 Certain Relationships and Related Transactions, and Director Independence Information regarding related party transactions and director independence is incorporated by reference from the company's 2019 proxy statement - Information required by this item is incorporated by reference from the company's definitive proxy statement for the 2019 Annual Meeting of Stockholders402 Principal Accountant Fees and Services Information regarding principal accountant fees and services is incorporated by reference from the company's 2019 proxy statement - Information required by this item is incorporated by reference from the company's definitive proxy statement for the 2019 Annual Meeting of Stockholders403 Part IV Exhibits and Financial Statement Schedules This section lists the consolidated financial statements, financial statement schedules, and all exhibits filed as part of the Form 10-K report - This item lists the consolidated financial statements, schedules (Schedule II, Schedule III, Schedule IV), and exhibits included with the filing406407 Form 10-K Summary The company has elected not to include a summary of the information required by Form 10-K under this optional item - The company has elected not to include summary information under this item408 Financial Statements Report of Independent Registered Public Accounting Firm Ernst & Young LLP issued unqualified opinions on the financial statements and internal controls for both Omega and its operating partnership as of December 31, 2018 - Ernst & Young, LLP provided an unqualified opinion on the consolidated financial statements for both Omega and Omega OP for the three years ended December 31, 2018411425 - The auditor also issued an unqualified opinion on the effectiveness of each company's internal control over financial reporting as of December 31, 2018412426 Consolidated Financial Statements This section contains the primary consolidated financial statements for Omega and its operating partnership for the years ended December 31, 2018, 2017, and 2016 Omega Healthcare Investors, Inc. - Key Financials (in thousands) | Metric | 2018 | 2017 | | :--- | :--- | :--- | | Balance Sheet | | | | Total Assets | $8,590,877 | $8,773,305 | | Total Liabilities | $4,826,393 | $4,885,047 | | Total Equity | $3,764,484 | $3,888,258 | | Income Statement | | | | Total Operating Revenues | $881,682 | $908,385 | | Net Income | $293,884 | $104,910 | Notes to Consolidated Financial Statements The notes provide detailed disclosures supplementing the financial statements, covering accounting policies, asset breakdowns, debt arrangements, and subsequent events like the MedEquities merger