News Column

OMEGA HEALTHCARE INVESTORS INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

February 11, 2014

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

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this document, including statements regarding potential future changes in reimbursement. This document contains forward-looking statements within the meaning of the federal securities laws. These statements relate to our expectations, beliefs, intentions, plans, objectives, goals, strategies, future events, performance and underlying assumptions and other statements other than statements of historical facts. In some cases, you can identify forward-looking statements by the use of forward-looking terminology including, but not limited to, terms such as "may," "will," "anticipates," "expects," "believes," "intends," "should" or comparable terms or the negative thereof. These statements are based on information available on the date of this filing and only speak as to the date hereof and no obligation to update such forward-looking statements should be assumed. Our actual results may differ materially from those reflected in the forward-looking statements contained herein as a result of a variety of factors, including, among other things:



(i) those items discussed under "Risk Factors" in Item 1A of this report;

(ii) uncertainties relating to the business operations of the operators of our

assets, including those relating to reimbursement by third-party payors,

regulatory matters and occupancy levels;

(iii) the ability of any operators in bankruptcy to reject unexpired lease

obligations, modify the terms of our mortgages and impede our ability to

collect unpaid rent or interest during the process of a bankruptcy

proceeding and retain security deposits for the debtors' obligations;

(iv) our ability to sell closed or foreclosed assets on a timely basis and on

terms that allow us to realize the carrying value of these assets;

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

credit facilities;

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

(vii) the availability and cost of capital;



(viii) changes in our credit ratings and the ratings of our debt securities;

(ix) competition in the financing of healthcare facilities; (x) regulatory and other changes in the healthcare sector;



(xi) the effect of economic and market conditions generally and, particularly,

in the healthcare industry; (xii) changes in the financial position of our operators; (xiii) changes in interest rates; (xiv) the amount and yield of any additional investments; (xv) changes in tax laws and regulations affecting real estate investment trusts; and



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

Overview We have one reportable segment consisting of investments in healthcare-related real estate properties. Our core business is to provide financing and capital to the long-term healthcare industry with a particular focus on SNFs located in the United States. Our core portfolio consists of long-term leases and mortgage agreements. All of our leases are "triple-net" leases, which require the tenants to pay all property-related expenses. Our mortgage revenue derives from fixed-rate mortgage loans, which are secured by first mortgage liens on the underlying real estate and personal property of the mortgagor. Our portfolio of investments at December 31, 2013, included 541 healthcare facilities (including three assets held for sale), located in 38 states and operated by 49 third-party operators. Our gross investment in these facilities totaled approximately $3.9 billion at December 31, 2013, with 99% of our real estate investments related to long-term healthcare facilities. The portfolio is made up of (i) 476 SNFs, (ii) 18 ALFs, (iii) 11 specialty facilities, (iv) fixed rate mortgages on 33 SNFs and (v) three facilities and one parcel of land that are currently held for sale. At December 31, 2013, we also held other investments of approximately $53.1 million, consisting primarily of secured loans to third-party operators of our facilities. Current market and economic conditions, including deficits at both the federal and state level could result in additional cost-cutting at both the federal and state levels resulting in additional reductions to reimbursement rates and levels to our operators under both the Medicare and Medicaid programs. State deficits could be exacerbated by the potential for increased enrollment in Medicaid due to prolonged high unemployment levels and declining family incomes, which could cause states to reduce state expenditures under their respective state Medicaid programs by lowering reimbursement rates. 35

We currently believe that our operator coverage ratios are strong and that our operators can absorb moderate reimbursement rate reductions under Medicaid and Medicare and still meet their obligations to us. However, significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on an operator's results of operations and financial condition, which could adversely affect the operator's ability to meet its obligations to us. Our consolidated financial statements include the accounts of (i) Omega, (ii) all direct and indirect wholly owned subsidiaries of Omega and (iii) TC Healthcare. All inter-company accounts and transactions have been eliminated in consolidation of the financial statements.



2013 and Recent Highlights

Acquisition and Other Investments

See "Portfolio and Other Developments" below for a description of 2013 acquisitions and other investments.

2.875 Million Shares of Common Stock Offering

On October 7, 2013, we sold 2,875,000 shares of common stock in an underwritten public offering at an offering price of $30 per share before underwriting discounts and expenses. Our total net proceeds from the offering, after underwriting discounts and expenses were approximately $84.6 million.

$250 Million Equity Shelf Program

On March 18, 2013, we entered into separate Equity Distribution Agreements (collectively, the "2013 Equity Shelf Agreements") with several financial institutions, each as a sales agent and/or principal (collectively, the "Managers") to establish a $250 million Equity Shelf Program. Under the terms of the 2013 Equity Shelf Agreements, we may sell shares of our common stock, from time to time, through or to the Managers having an aggregate gross sales price of up to $250 million. We will pay each Manager compensation for sales of the shares equal to 2% of the gross sales price per share of shares sold through such Manager under the applicable 2013 Agreement. For the year ended December 31, 2013, we sold approximately 5.5 million shares under the 2013 Equity Shelf Agreements, at an average price of $30.87 per share, generating gross proceeds of approximately $170.4 million, before $3.4 million of commissions. As of December 31, 2013, we have approximately $79.6 million available for issuance under the 2013 Equity Shelf Agreements.



Termination of $245 Million Equity Shelf Program

On March 18, 2013, we terminated our $245 million Equity Shelf Program that was established in 2012 under separate Equity Distribution Agreements (collectively, the "2012 Equity Shelf Agreements). For the year ended December 31, 2013, we issued approximately 1.0 million shares under the 2012 Equity Shelf Agreements at an average price of $28.29 per share, generating gross proceeds of approximately $27.8 million, before $0.6 million of commissions. Since inception of the 2012 Equity Shelf Agreements, we have sold a total of 3.6 million shares of common stock generating total gross proceeds of $91.4 million under the program, before $1.9 million of commissions. As a result of the termination of the 2012 Equity Shelf Agreements, no additional shares were issued under the 2012 Equity Shelf Agreements.



HUD Mortgage Debt Refinancing

On March 26, 2013, we refinanced existing HUD mortgage debt on 12 properties in Arkansas for approximately $59.4 million including approximately $0.7 million of closing costs that were added to the outstanding balance and will be amortized over the term of the mortgage debt. The annual interest rate for the refinanced debt decreased from 5.55% to approximately 3.06%, with the term of the refinanced mortgages remaining unchanged.



HUD Mortgage Payoffs

On May 31, 2013, we paid approximately $51.0 million to retire 11 mortgages guaranteed by HUD that were assumed in connection with our acquisition of certain subsidiaries of CapitalSource in June 2010. The retirement of the 11 HUD mortgages resulted in a net gain of approximately $11.1 million. The net gain included the write-off of approximately $11.3 million related to the premium for recording the debt at fair value at the time of the transaction offset by a prepayment fee of approximately $0.2 million. 36 Dividends On January 15, 2014, the Board of Directors declared a common stock dividend of $0.49 per share, increasing the quarterly common dividend by $0.01 per share over the prior quarter, which is scheduled to be paid February 17, 2014 to common stockholders of record on January 31, 2014. On February 15, 2013, May 15, 2013, August 15, 2013 and November 15, 2013, we paid dividends to our common stockholders in the per share amounts of $0.45, $0.46, $0.47 and $0.48, for stockholders of record on January 31, 2013, April 30, 2013, July 31, 2013 and October 31, 2013, respectively.



Portfolio and Other Developments

The partial expiration of certain Medicare rate increases and state cuts to Medicaid reimbursement rates has had an adverse impact on the revenues of the operators of nursing home facilities and could negatively impact some operators' ability to satisfy their monthly lease or debt payment to us. See "Item 1 Business - Government Regulation and Reimbursement" above for further discussion. In several instances, we hold security deposits that can be applied in the event of lease and loan defaults, subject to applicable limitations under bankruptcy law with respect to operators seeking protection under the Bankruptcy Code.



2013 Acquisitions and Other Investments

$529 Million Purchase/Leaseback Transaction

On November 27, 2013, we closed on a purchase/leaseback transaction for 56 facilities operated by Ark Holding Company, Inc. ("Ark Holding"). The purchase/leaseback transaction was consummated in connection with the acquisition by merger of Ark Holding by 4 West Holdings, Inc. ("4 West") on November 27, 2013. Ark Holding was previously owned by the private equity firm Behrman Capital. As part of the transaction, Omega acquired title to 55 SNFs and 1 ALF and leased them back to the prior operators pursuant to four 50-year direct financing leases with rental payments to Omega yielding 10.6% per annum over the term of the lease. The 56 facilities represent 5,624 licensed beds located in 12 states, predominantly in the southeastern United States. The 56 facilities are separated by region and divided among four cross-defaulted Master Leases. The four regions include the Southeast (39 facilities), the Northwest (7 facilities), Texas (9 facilities) and Indiana (1 facility). The initial year one contractual rent is $47 million with 2.5% escalators beginning in year five.



Acquisition of an ALF in Florida

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

We are in the process of completing our fair value allocation and expect the allocation process to be complete during the first half of 2014. As of December 31, 2013, we allocated approximately $10.3 million consisting of land ($0.6 million), building and site improvements ($9.0 million), and furniture and fixtures ($0.7 million). We have not recorded goodwill in connection with this transaction.



Acquisition of four SNFs in Indiana

On October 31, 2013, we purchased four SNFs totaling 384 beds in Indiana for $22.2 million in cash. The four SNFs were added to an existing master lease, but the terms of the lease and the purchase price were based on an existing lease agreement between the seller and the lessee which was below current market conditions. We allocated approximately $3.0 million to below market leases as a result of the transaction for a total investment of $25.2 million. We are in the process of completing our fair value allocation and expect the allocation process to be complete during the first half of 2014. As of December 31, 2013, we allocated approximately $25.2 million consisting of land ($0.7 million), building and site improvements ($21.8 million), and furniture and fixtures ($2.7 million). We have not recorded goodwill in connection with this transaction. 37



Transition of 11 Arkansas Facilities to a New Operator

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



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

2012 Acquisitions and Investments

Arizona and California Acquisitions

During the three-month period ended December 31, 2012, we completed the acquisition of approximately $203.4 million of new investments and leased them back to a new operator. The investments involved two separate transactions to purchase 14 facilities (12 SNFs, 1 ALF and 1 combined SNF/ALF). The combined transactions consisted of the assumption of approximately $71.9 million of HUD indebtedness and payment of $131.5 million in cash. The $71.9 million of assumed HUD debt is comprised of 8 HUD mortgage loans with a blended interest rate of 5.50% and maturities between April 2031 and February 2045. The 14 facilities, representing 1,830 operating beds, are located in California (10) and Arizona (4). The transaction involved several separate master lease agreements covering all 14 facilities. Transaction 1 (First Closing): On November 30, 2012, we purchased four Arizona facilities (2 SNFs, 1 ALF and 1 combined SNF/ALF) for an aggregate purchase price of $60.0 million. The transaction consisted of the assumption of $27.6 million of indebtedness guaranteed by HUD and $32.4 million in cash. The blended interest rate on the HUD indebtedness assumed for the Arizona facilities was 4.73%. The four facilities were simultaneously leased back to a new operator under a new 12 year master lease. We completed our fair value allocation in 2013. We allocated approximately $64.6 million consisting of land ($5.5 million), building and site improvements ($55.9 million), and furniture and fixtures ($3.2 million). We recorded approximately $4.6 million of fair value adjustment related to above market debt assumed based on the terms of comparable debt and other market factors. We have not recorded goodwill in connection with this transaction. Transaction 2 (Second Closing): In November 2012, we entered into a Purchase and Sales Agreement to purchase and then leaseback 10 California SNFs. On November 30, 2012, we purchased five SNFs for approximately $70.2 million. The five SNFs were then leased back to the new operator under a new 12 year master lease. We completed our fair value allocation in 2013. We allocated approximately $70.2 million consisting of land ($11.5 million), building and site improvements ($55.5 million), and furniture and fixtures ($3.2 million). We have not recorded goodwill in connection with this transaction. Transaction 2 (Third Closing): On December 31, 2012, we purchased the remaining five California SNFs for an aggregate purchase price of $72.2 million (net of purchase price reduction of approximately $1.0 million related to funds escrowed by the seller to reimburse us for costs associated with refinancing some of the assumed HUD debt). The transaction consisted of the assumption of $44.3 million of HUD indebtedness and $28.9 million in cash. The blended interest rate on the HUD indebtedness assumed for the five California facilities was 5.97%. The five SNFs were then leased back to the new operator under new 12 year master leases. We completed our fair value allocation in 2013. We allocated approximately $77.5 million consisting of land ($13.0 million), building and site improvements ($60.8 million), and furniture and fixtures ($3.7 million). We recorded approximately $5.4 million of fair value adjustment related to the above market debt assumed based on the terms of comparable debt and other market factors. We have not recorded goodwill in connection with this transaction. 38 Indiana Acquisitions



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

Transaction 1: On June 29, 2012, we purchased one SNF encompassing 80 operating beds in Indiana for approximately $3.4 million and leased the facility back to an existing operator under an existing master lease. We completed our fair value allocation in 2012. We allocated approximately $3.4 million consisting of land ($0.2 million), building and site improvements ($2.9 million), and furniture and fixture ($0.3 million). We have not recorded goodwill in connection with this transaction. Transaction 2: On June 29, 2012, we purchased four facilities encompassing 383 operating beds in Indiana for approximately $21.7 million and leased the facilities to Health and Hospital Corporation. We completed our fair value allocation in 2012. We allocated approximately $21.7 million consisting of land ($1.9 million), buildings and site improvements ($18.4 million) and furniture and fixtures ($1.4 million). We have not recorded goodwill in connection with this transaction. Transaction 3: On August 31, 2012, we purchased 27 facilities (17 SNFs, four ALFs and six independent living facilities) totaling 2,892 operating beds in Indiana from an unrelated third party for approximately $203 million in cash and assumed a liability associated with the lease of approximately $13.9 million. Simultaneous with the transaction, we also purchased one parcel of land for $2.8 million. The purchase price of both (i) 27 facilities and (ii) the parcel of land were funded from cash on hand and borrowings from our credit facility. The 27 facilities and land parcel were added to an existing master lease. We completed our fair value allocation in 2013. We allocated approximately $219.7 million consisting of land ($16.1 million), building and site improvements ($189.2 million) and furniture and fixtures ($14.4 million). We have not recorded goodwill in connection with this transaction. Transaction 4: On December 31, 2012, we purchased two SNFs encompassing 167 operating beds in Indiana for approximately $9.5 million and leased these facilities back to an existing operator under a new consolidated master lease. We completed our fair value allocation in 2013. We allocated approximately $9.5 million consisting of land ($0.6 million), building and site improvements ($8.0 million), and furniture and fixtures ($0.9 million). We have not recorded goodwill in connection with this transaction.



Michigan Acquisition and New Mortgage

On November 30, 2012, we completed $21.5 million of combined new investments with an existing operator and mortgagee. The investments involved both a purchase and mortgage transaction related to two facilities and 231 operating beds. Purchase Transaction - We purchased one ALF for $20 million from an unrelated third party and added it to an existing master lease with an existing operator. The 171 operating bed ALF is located in Michigan. We completed our fair value allocation in 2013. We allocated approximately $20.0 million consisting of land ($0.4 million), building and site improvements ($18.9 million), and furniture and fixtures ($0.7 million). We have not recorded goodwill in connection with this transaction. Mortgage Transaction - We entered into a new $1.5 million first mortgage loan with an existing operator/mortgagee. The mortgage is secured by a lien on one 60 operating bed SNF located in Michigan.



Texas Acquisition

On October 31, 2012, we purchased one SNF from an unrelated third party encompassing 90 operating beds in Texas for approximately $2.7 million and leased the facility to an existing operator. We completed our fair value allocation in 2013. We allocated approximately $2.7 million consisting of land ($0.2 million), building and site improvements ($2.2 million), and furniture and fixtures ($0.3 million). We have not recorded goodwill in connection with this transaction.



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

39



Significant Lease Amendment - Genesis Healthcare

On December 1, 2012, Genesis Healthcare ("Genesis"), an existing operator to Omega, completed the purchase of Sun Healthcare Group ("Sun"), which was also an existing operator to Omega. Prior to the purchase, Sun was our second largest tenant representing 40 facilities located in 10 states. Prior to the purchase, we also had a master lease with Genesis representing 13 facilities located in 5 states. In connection with the acquisition, on December 1, 2012, we entered into a new 53 facility master lease with Genesis expiring on December 31, 2025. In 2013, we transitioned one facility to another operator reducing the number of facilities covered by the Genesis lease to 52 facilities. At December 31, 2013, Genesis was our largest operating lease tenant with $350 million in leased assets (approximately 9% of our total gross investments) located in 13 states.



2011 Acquisitions and Investments

During the fourth quarter of 2011, we (i) completed two acquisitions, (ii) funded two new mortgages and (iii) funded a new working capital note. The first acquisition was comprised of the purchase of four SNFs in Maryland and West Virginia; the second acquisition was comprised of the purchase/leaseback of 17 SNFs in five states, including Arkansas, Colorado, Florida, Michigan and Wisconsin. Acquisition costs related to the two acquisitions were approximately $1.2 million in 2011 and were expensed. In addition, we funded two new mortgages to two operators covering a total of 16 SNFs and closed a new note with an existing operator. The following is summary of the transactions and other investments:



2011 First Acquisition (Maryland and West Virginia) and New Mortgage

During the fourth quarter of 2011, we completed $86 million of combined new investments with two new operators. The combined transaction consisted of $56 million in cash and $30 million in assumed HUD indebtedness, with a combined initial annual yield of approximately 10%. The investments involved a purchase / lease back transaction and a mortgage transaction. The combined transaction consists of 7 facilities and 938 operating beds.



Purchase / Lease Back Transaction

We purchased four SNFs located in Maryland (3) and West Virginia (1), totaling 586 beds for a total investment of $61 million, including approximately $1 million to complete renovations at one facility. The consideration consisted of $31 million in cash and the assumption of $30 million in HUD - indebtedness, which bears an interest rate of 4.87% (weighted-average) and matures between March 2036 and September 2040. We completed our fair value allocation in 2012. We allocated approximately $62.7 million consisting of land ($4.4 million), buildings and site improvements ($55.0 million) and furniture and fixtures ($3.3 million). We funded approximately $1.3 million in renovation costs for one of the facilities acquired in connection with this transaction and completed the renovation during the third quarter of 2012. We recorded approximately $3.0 million of fair value adjustment related to the above market debt assumed based on the terms of comparable debt. We have not recorded goodwill in connection with this transaction.



2011 First Mortgage Transaction

We entered into a first mortgage loan with a new operator in the amount of $25 million secured by a lien on three SNFs, totaling 352 operating beds, all located in Maryland. The mortgage currently bears interest at 12% and increases to 13.5% in year 7.



2011 Second Acquisition (Arkansas, Colorado, Florida, Michigan and Wisconsin)

On December 23, 2011, we purchased 17 SNFs and leased them back to a new operator, for an aggregate purchase price of $128 million. The acquisition consisted of the assumption of $71.3 million of indebtedness guaranteed by HUD and $56.7 million in cash.

The $71.3 million of assumed HUD debt was comprised of 15 HUD mortgage loans with a blended interest rate of 5.70% and maturities between October 2029 and July 2044. 40 The 17 SNFs, representing 1,820 operating beds, are located in Arkansas (12), Colorado (1), Florida (1), Michigan (2) and Wisconsin (1). The purchase/leaseback transaction involved two separate master lease agreements covering all 17 SNFs.



We completed our fair value allocation in 2012. We allocated approximately $129.9 million consisting of land ($9.0 million), buildings and site improvements ($111.5 million) and furniture and fixtures ($9.4 million). We recorded approximately $1.9 million of fair value adjustment related to the above market debt assumed based on the terms of comparable debt. We have not recorded goodwill in connection with this transaction.

2011 Second Mortgage Transaction

On November 14, 2011, we entered into a $92.0 million new first mortgage loan with affiliates of Ciena. The loan is secured by 13 SNFs located in Michigan, which operate a total of 1,421 beds. The term of the mortgage is 10 years and it bears an initial interest rate of 11% with fixed escalators in years 4 and 7. The mortgage is cross-defaulted with existing investments with affiliates of Ciena. 2011 Funding of New Note



In December 2011, we entered into a five year $28.0 million loan agreement with an existing operator. The loan bears interest at 10% per annum.

Results of Operations

The following is our discussion of the consolidated results of operations, financial position and liquidity and capital resources, which should be read in conjunction with our audited consolidated financial statements and accompanying notes.



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

Operating Revenues

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



? Rental income was $375.1 million, an increase of $60.5 million over the same

period in 2012. The increase was primarily due to: (i) new investments made in

2012 and 2013 and (ii) the full year impact of the December 2012 Genesis

merger with Sun and corresponding lease extension. In 2013, we recorded rental

revenue associated with the 2012 acquisitions of approximately $54.7 million

compared to approximately $11.0 million in 2012. In 2013, we recorded rental

revenue associated with the 2013 acquisitions of approximately $0.6 million.

? Direct financing lease income of $5.2 million is a result of the November 2013

Ark transaction.



? Mortgage interest income totaled $29.4 million, a decrease of $1.1 million

over the same period in 2012. The decrease was primarily due to the $12.2

million payoff of a mortgage in 2012.



? Other investment income totaled $8.9 million, an increase of $4.1 million over

the same period in 2012. The increase was primarily the result of: (i) a new

$25 million investment in a mezzanine loan that was entered into during the

current year and paid off in December 2013. The mezzanine loan included an

annual interest rate of 12%. In addition, we recorded approximately $1.4

million of additional income as a result of the payoff, including a prepayment

penalty of $1.0 million and acceleration of fees that we received that were

being amortized over the term of the loan. 41 Operating Expenses Operating expenses for the year ended December 31, 2013, were $153.0 million, an increase of approximately $17.5 million over the same period in 2012. Following is a description of certain of the changes in our operating expenses for the year ended December 31, 2012:



? Our depreciation and amortization expense was $128.6 million for the year

ended December 31, 2013, compared to $113.0 million for the same period in

2012. The increase is primarily due to (i) a full year of depreciation related

to the fourth quarter 2012 acquisitions and (ii) additional depreciation

associated with the 2013 new investment, including the 2013 acquisition and

capital renovation and improvement program.



? Our general and administrative expense, excluding stock-based compensation

expense, was $15.6 million, compared to $15.4 million for the same period in

2012.



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

? The $2.1 million recorded in provision for uncollectible mortgages, notes and

accounts receivable in 2013 was primarily related to the write-off of

straight-line receivables for 11 Arkansas facilities that were transitioned

from a current operator to a new operator during the third quarter of 2013.

? In 2013, acquisition costs were $0.2 million, compared to $0.9 million for the

same period in 2012. Looking forward, we expect somewhat higher general and administrative expense in 2014, primarily reflecting the impact of 2013 acquisitions and approximately $2.7 million of additional stock-based compensation expense associated with the implementation of the previously reported new long-term incentive compensation program. Other Income (Expense) For the year ended December 31, 2013, total other expenses were $92.0 million, a decrease of approximately $14.1 million over the same period in 2012. The $14.1 million decrease was primarily the result of a $4.9 million increase in interest expense due to an increase in borrowings outstanding, including debt assumed or incurred to finance the 2012 and 2013 investment, offset by a $19.0 million decrease in interest refinancing costs. In 2013, we recorded an $11.1 million interest refinancing gain associated with the write-off of the premium for above market value debt assumed on 11 HUD mortgage loans that we paid off in May 2013. In 2012, we recorded $7.9 million of net interest refinancing costs. The refinancing costs included: (i) $7.1 million in costs including (a) prepayment penalties of approximately $4.5 million, (b) the write-off of deferred financing costs of $2.2 million and (c) $0.4 million of expenses associated with the tender offer and redemption of our outstanding $175 million 7% 2016 Notes and (ii) $2.5 million related to the write-off of deferred financing costs associated with the termination of the $475 million 2011 Credit Facility. The 2012 costs were partially offset by a net gain of $1.7 million associated with the write-off of the premium for above market value debt assumed on four HUD loans that were paid off early during the second quarter of 2012.



2013 Taxes

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



Income from Continuing Operations

Income from continuing operations for the year ended December 31, 2013 was $172.5 million compared to $120.7 million for the same period in 2012.

Funds From Operations

Our funds from operations available to common stockholders ("FFO"), for the year ended December 31, 2013, was $302.7 million, compared to $222.2 million for

the same period in 2012. 42 We calculate and report FFO in accordance with the definition and interpretive guidelines issued by the National Association of Real Estate Investment Trusts ("NAREIT"), and, consequently, FFO is defined as net income available to common stockholders, adjusted for the effects of asset dispositions and certain non-cash items, primarily depreciation and amortization and impairment on real estate assets. We believe that FFO is an important supplemental measure of our operating performance. Because the historical cost accounting convention used for real estate assets requires depreciation (except on land), such accounting presentation implies that the value of real estate assets diminishes predictably over time, while real estate values instead have historically risen or fallen with market conditions. The term FFO was designed by the real estate industry to address this issue. FFO herein is not necessarily comparable to FFO of other REITs that do not use the same definition or implementation guidelines or interpret the standards differently from us. FFO is a non-GAAP financial measure. We use FFO as one of several criteria to measure the operating performance of our business. We further believe that by excluding the effect of depreciation, amortization, impairment on real estate assets and gains or losses from sales of real estate, all of which are based on historical costs and which may be of limited relevance in evaluating current performance, FFO can facilitate comparisons of operating performance between periods and between other REITs. We offer this measure to assist the users of our financial statements in evaluating our financial performance under GAAP, and FFO should not be considered a measure of liquidity, an alternative to net income or an indicator of any other performance measure determined in accordance with GAAP. Investors and potential investors in our securities should not rely on this measure as a substitute for any GAAP measure, including net income. The following table presents our FFO results for the years ended December 31, 2013 and 2012: Year Ended December 31, 2013 2012 (in thousands)

Net income available to common $ 172,521$ 120,698 Add back loss/(deduct gain) from real estate dispositions 1,151



(11,799 )

173,672



108,899

Elimination of non-cash items included in net income: Depreciation and amortization

128,646



112,983

Add back impairments on real estate properties 415



272

Funds from operations available to common stockholders $ 302,733

$ 222,154

Year Ended December 31, 2012 compared to Year Ended December 31, 2011

Operating Revenues

Our operating revenues for the year ended December 31, 2012, were $350.5 million, an increase of $58.3 million over the same period in 2011. Following is a description of certain of the changes in operating revenues for the year ended December 31, 2012:



? Rental income was $314.6 million, an increase of $41.1 million over the same

period in 2011. The increase was primarily due to: (i) $189 million of fourth

quarter 2011 acquisitions; and (ii) new investments made during 2012. In 2012,

we recorded rental revenue associated with the 2011 acquisitions of

approximately $21.2 million compared to approximately $1.1 million in 2011. In

2012, we recorded rental revenue associated with the 2012 acquisitions of

approximately $11.0 million.



? Mortgage interest income totaled $30.4 million, an increase of $14.2 million

over the same period in 2011. The increase was primarily due to: (i) a $92.0

million first mortgage loan that we entered into with an operator in November

2011 and (ii) a $25.0 million first mortgage loan that we entered into with a

new operator in October 2011.



? Other investment income totaled $4.8 million, an increase of $2.7 million over

the same period in 2011. The increase was primarily the result of a $28.0

million term loan that we entered into with an existing operator in the fourth

quarter of 2011.



? Miscellaneous revenue was $0.7 million, an increase of $0.3 million over the

same period in 2011. 43 Operating Expenses Operating expenses for the year ended December 31, 2012, were $135.5 million, a decrease of approximately $18.9 million over the same period in 2011. Following is a description of certain of the changes in our operating expenses for the year ended December 31, 2012:



? Our depreciation and amortization expense was $113.0 million for the year

ended December 31, 2012, compared to $100.3 million for the same period in 2011. The increase is primarily due to: (i) a full year of depreciation related to the fourth quarter 2011 acquisitions and (ii) additional



depreciation associated with the 2012 new investments and capital renovation

and improvement program.



? Our general and administrative expense, excluding stock-based compensation

expense, was $15.4 million, compared to $13.4 million for the same period in

2011. The increase was primarily due to increased costs associated with acquisitions, including payroll and tax related expenses.



? Our stock-based compensation expense was $5.9 million, a decrease of $95

thousand over the same period in 2011. The decrease was primarily due to a

reduction in the fair value of the shares issued in 2012 compared to 2011 for

the annual portion of the Company's stock plan.



? In 2012, provision for impairment was $0.3 million, compared to $26.3 million

for the same period in 2011. During the first quarter of 2012, we recorded a

$0.3 million impairment charge to reduce the carrying value of two SNFs to

their estimated fair value. The $26.3 million provision of impairment recorded

in 2011 was primarily the result of: (i) $24.4 million impairment on four

Connecticut properties that we closed during the year and (ii) three other

facilities. In 2012, we sold five of these seven properties.



? No provision for uncollectible mortgages, notes and accounts receivable was

recorded in 2012, compared to $6.4 million for the same period in 2011. The

$6.4 million recorded in 2011 was related to the write-off of Formation

Capital, LLC ("Formation") straight line rent of $1.1 million and lease

inducement of $3.0 million during the second quarter of 2011. In addition,

during the fourth quarter of 2011, we recorded a $2.3 million write-off associated with our Formation working capital note.



? No nursing home expenses of owned and operated assets were recorded in 2012,

compared to $0.7 million for the same period in 2011. The decrease was due to

the deconsolidation of two owned and operated facilities effective June 1,

2010. The 2011 cost relates to run-off costs.

Other Income (Expense)

For the year ended December 31, 2012, total other expenses were $106.1 million, an increase of approximately $19.2 million over the same period in 2011. The increase in interest expense of approximately $14.4 million was primarily due to an increase in borrowings outstanding, including debt assumed or incurred (i) to finance the fourth quarter of 2011 new investments and (ii) to finance the 2012 new investments. In 2012, we recorded $7.9 million of net interest refinancing costs. The refinancing costs included $7.1 million in costs related to the tender and redemption of our $175 million of 7% Senior Notes due 2016, and $2.5 million related to the write-off of deferred financing costs associated with the termination of the $475 million 2011 Credit Facility; offset by a gain associated with the early retirement of $11.8 million in HUD indebtedness. The net gain of $1.7 million included the write-off of approximately $1.8 million of unamortized fair value adjustment of assumed debt as well as a prepayment fee of approximately $0.1 million. The $3.1 million 2011 refinancing related costs related to the write-off of deferred financing costs associated with the termination of the $320 million 2010 Credit Facility.



2012 Taxes

Because we qualify as a REIT, we generally are not subject to Federal income taxes on the REIT taxable income that we distribute to stockholders, subject to certain exceptions. For tax year 2012, we made common dividend payments of $182.2 million to satisfy REIT requirements relating to qualifying income. Currently, we have one TRS that is taxable as a corporation and that pays federal, state and local income tax on its net income at the applicable corporate rates. The TRS had a net operating loss carry-forward as of December 31, 2012 of $1.1 million. The loss carry-forward was fully reserved with a valuation allowance due to uncertainties regarding realization. We recorded interest and penalty charges associated with tax matters as income tax expense. 44



Income from Continuing Operations

Income from continuing operations for the year ended December 31, 2012 was $120.7 million compared to $52.6 million for the same period in 2011.

Funds From Operations

Our FFO, for the year ended December 31, 2012, was $222.2 million, compared to $172.5 million for the same period in 2011.

The following table presents our FFO results for the years ended December 31, 2012 and 2011: Year Ended December 31, 2012 2011 (in thousands)

Net income available to common $ 120,698$ 47,459 Deduct gain from real estate dispositions (11,799 )



(1,670 )

108,899



45,789

Elimination of non-cash items included in net income: Depreciation and amortization

112,983



100,337

Add back impairments on real estate properties 272



26,344

Funds from operations available to common stockholders $ 222,154$ 172,470

Liquidity and Capital Resources

At December 31, 2013, we had total assets of $3.5 billion, stockholders' equity of $1.3 billion and debt of $2.0 billion, with such debt representing approximately 60.9% of total capitalization.

The following table shows the amounts due in connection with the contractual obligations described below as of December 31, 2013.

Payments due by period Less than More than Total 1 year 1-3 years 3-5 years 5 years (in thousands) Debt(1) $ 2,001,424$ 5,037$ 336,795$ 211,837$ 1,447,755 Interest payments on long-term debt 965,007 102,235 203,217 185,790 473,765 Operating lease obligations 23,143 2,694 5,414 5,452 9,583 Total $ 2,989,574$ 109,966$ 545,426$ 403,079$ 1,931,103



(1) The $2.0 billion of debt outstanding includes (i) $326.0 million in

borrowings under the $500 million unsecured revolving credit facility (the

"2012 Revolving Credit Facility") due in December 2016; (ii) $200 million

unsecured, deferred draw term loan facility (the "2012 Term Loan Facility")

due in December 2017; (iii) $200 million aggregate principal amount of 7.5%

Senior Notes due February 2020; (iv) $575 million aggregate principal amount

of 6.75% Senior Notes due October 2022, (v) $400 million of 5.875% Senior

Notes due March 2024; (vi) $20 million of 9.0% subordinated debt maturing in

December 2021; (vii) $123 million of HUD Debt at a 4.85% annual interest

rate and maturing between January 2040 and January 2045; (viii) $59 million

of HUD debt at a 3.06% weighted average annual interest rate maturing July 2044; (ix) $29 million of HUD debt at a 4.87% weighted average annual interest rate maturing between March 2036 and September 2040; (x) $27 million of HUD debt at a 4.73% weighted average annual interest rate



maturing between February 2040 and February 2045 and (xi) $44 million of HUD

debt at a 5.98% weighted average annual interest rate maturing between April

2031 and March 2041. 45



Financing Activities and Borrowing Arrangements

Credit Facilities

We have a $700 million unsecured credit facility that we entered into on December 6, 2012, comprised of a $500 million unsecured revolving credit facility (the "2012 Revolving Credit Facility") and a $200 million unsecured term loan (the "2012 Term Loan Facility" and, together with the 2012 Revolving Credit Facility, collectively, the "2012 Credit Facilities"). The 2012 Credit Facilities include an "accordion feature" that permits us to expand our borrowing capacity thereunder by a combined $300 million, to a total of $1 billion. The 2012 Revolving Credit Facility is priced at LIBOR plus an applicable percentage (beginning at 150 basis points, with a range of 100 to 190 basis points) based on our ratings from Standard & Poor's, Moody's and/or Fitch Ratings, plus a facility fee based on the same ratings (initially 30 basis points, with a range of 15 to 45 basis points). At December 31, 2013, we had $326 million in borrowings outstanding under the 2012 Revolving Credit Facility. The 2012 Revolving Credit Facility matures on December 6, 2016, with an option by us to extend the maturity one additional year. The 2012 Term Loan Facility is also priced at LIBOR plus an applicable percentage (beginning at 175 basis points, with a range of 110 to 230 basis points) based our ratings from Standard & Poor's, Moody's and/or Fitch Ratings. At December 31, 2013, the full $200 million was outstanding under the 2012 Term Loan Facility. The 2012 Term Loan Facility matures on December 6, 2017. At December 31, 2013, we had a total of $526.0 million outstanding under the 2012 Credit Facilities, and no letters of credit outstanding, leaving availability of $174.0 million. For the year ended December 31, 2013, the weighted average interest rate was 1.94% for borrowings under our 2012 Credit Facilities. On December 27, 2013, we entered into a new $200 million senior unsecured, deferred draw, term loan facility (the "2013 Term Loan Facility"). The 2013 Term Loan Facility matures on February 29, 2016. No borrowings had yet been made by us under the 2013 Term Loan Facility as of December 31, 2013. In January 2014, we fully drew the $200 million available under the 2013 Term Loan Facility and used the proceeds to repay outstanding borrowings under our 2012 Revolving Credit Facility. We may prepay the 2013 Term Loan Facility at any time in whole or in part without fees or penalty. Principal amounts prepaid or repaid under the 2013 Term Loan Facility may not be borrowed. The interest rates per annum applicable to the 2013 Term Loan Facility are (a) the reserve adjusted LIBOR Rate (the "Eurodollar Rate" or "Eurodollar"), plus the applicable margin (as described below) or, at our option, (b) the base rate, plus the applicable margin (as described below), with the base rate being equal to the highest of (i) the rate of interest publicly announced by the administrative agent as its prime rate in effect, (ii) the federal funds effective rate from time to time plus 0.50% and (iii) the Eurodollar Rate determined on such day for a Eurodollar Loan with an interest period of one month plus 1.0%, in each case. The applicable margins with respect to the 2013 Term Loan Facility are determined in accordance with a performance grid based on our investment grade ratings from Standard & Poor's, Moody's and/or Fitch Ratings with respect to Omega's non-credit-enhanced, senior unsecured long-term debt. The applicable margin for the 2013 Term Loan Facility may range from 2.30% to 1.10% in the case of Eurodollar advances, and from 1.30% to 0.10% in the case of base rate advances. The default rate on the 2013 Term Loan Facility is 2.0% above the interest rate otherwise applicable to base rate loans. The credit agreements governing the 2012 Credit Facilities and the 2013 Term Loan Facility contain customary affirmative and negative covenants, including, without limitation, limitations on indebtedness; limitations on investments; limitations on liens; limitations on mergers and consolidations; limitations on sales of assets; limitations on transactions with affiliates; limitations on negative pledges; limitations on prepayment of debt; limitations on use of proceeds; limitations on changes in lines of business; limitations on repurchases of our capital stock if a default or event of default exists; and maintenance of REIT status. In addition, the credit agreements contain financial covenants, including, without limitation, those relating to maximum total leverage, maximum secured leverage, maximum unsecured leverage, minimum fixed charge coverage, minimum consolidated tangible net worth, minimum unsecured debt yield, minimum unsecured interest coverage and maximum distributions. As of December 31, 2012 and 2013, we were in compliance with all affirmative and negative covenants, including financial covenants, for our secured and unsecured borrowings. 46 HUD Loans Payoff

On May 31, 2013, we paid approximately $51.0 million to retire 11 mortgages guaranteed by HUD that were assumed in connection with our acquisition of certain subsidiaries of CapitalSource in June 2010. The retirement of the 11 HUD mortgages resulted in a net gain of approximately $11.1 million. The net gain included the write-off of approximately $11.3 million related to the premium for recording the debt at fair value at the time of the transaction offset by a prepayment fee of approximately $0.2 million.



HUD Mortgage Debt Refinancing

On March 26, 2013, we refinanced existing HUD mortgage debt on 12 properties in Arkansas for approximately $59.4 million including approximately $0.7 million of closing costs that were added to the outstanding balance and will be amortized over the term of the mortgage debt. The annual interest rate for the refinanced debt decreased from 5.55% to approximately 3.06%, with the term of the refinanced mortgages remaining unchanged.



$250 Million Equity Shelf Program

On March 18, 2013, we entered into separate Equity Shelf Agreements with the "Managers" to establish a $250 million Equity Shelf Program. Under the terms of the 2013 Equity Shelf Agreements, we may sell shares of our common stock, from time to time, through or to the Managers having an aggregate gross sales price of up to $250 million. We will pay each Manager compensation for sales of the shares equal to 2% of the gross sales price per share of shares sold through such Manager under the applicable 2013 Equity Shelf Agreement. For the year ended December 31, 2013, we sold approximately 5.5 million shares under the 2013 Equity Shelf Program, at an average price of $30.87 per share, generating gross proceeds of approximately $170.4 million, before $3.4 million of commissions. As of December 31, 2013, we have approximately $79.6 million available for issuance under the 2013 Equity Shelf Program.



Termination of $245 Million Equity Shelf Program

On March 18, 2013, we terminated our $245 million Equity Shelf Program (the "2012 Equity Shelf Program") that we entered into with several financial institutions on June 19, 2012. For the year ended December 31, 2013, we issued approximately 1.0 million shares under the 2012 Equity Shelf Program at an average price of $28.29 per share, generating gross proceeds of approximately $27.8 million, before $0.6 million of commissions. Since inception of the 2012 Equity Shelf Program, we have sold a total of 3.6 million shares of common stock generating total gross proceeds of $91.4 million under the program, before $1.9 million of commissions. As a result of the termination of the 2012 Equity Shelf Program, no additional shares were issued under the 2012 Equity Shelf Program.



Dividends

In order to qualify as a REIT, we are required to distribute dividends (other than capital gain dividends) to our stockholders in an amount at least equal to (A) the sum of (i) 90% of our "REIT taxable income" (computed without regard to the dividends paid deduction and our net capital gain), and (ii) 90% of the net income (after tax), if any, from foreclosure property, minus (B) the sum of certain items of non-cash income. In addition, if we dispose of any built-in gain asset during a recognition period, we will be required to distribute at least 90% of the built-in gain (after tax), if any, recognized on the disposition of such asset. Such distributions must be paid in the taxable year to which they relate, or in the following taxable year if declared before we timely file our tax return for such year and paid on or before the first regular dividend payment after such declaration. In addition, such distributions are required to be made pro rata, with no preference to any share of stock as compared with other shares of the same class, and with no preference to one class of stock as compared with another class except to the extent that such class is entitled to such a preference. To the extent that we do not distribute all of our net capital gain or do distribute at least 90%, but less than 100% of our "REIT taxable income" as adjusted, we will be subject to tax thereon at regular ordinary and capital gain corporate tax rates. 47 In addition, our credit agreements have certain financial covenants that limit the distribution of dividends paid during a fiscal quarter to no more than 95% of our aggregate cumulative FFO as defined in the credit agreements, unless a greater distribution is required to maintain REIT status. Solely for purposes of the credit agreements, FFO is defined as net income (or loss) plus depreciation and amortization, adjusted to take into account our interests in unconsolidated partnerships and joint ventures, and further adjusted to exclude gains or losses resulting from: (i) restructuring our debt; (ii) sales of property; (iii) sales or redemptions of preferred stock; (iv) revenue or expenses related to owned and operated assets; (v) revenues or expenses related to FIN 46 consolidation requirements, (vi) cash litigation charges up to $10.0 million over the term of the credit agreements; (vii) non-cash charges associated with the write-down of accounts due to straight-line rent; (viii) other non-cash charges for accounts and notes receivable up to $20.0 million over the term of the credit agreements; (ix) certain non-cash compensation related expenses; (x) non-cash real property impairment charges; (xi) and for purposes of the 2013 Credit Agreement, to the extent applicable, the satisfaction of outstanding unamortized loan fees with respect to the 2012 Credit Facilities; (xii) non-cash charges associated with the sale or settlement of derivative instruments; and (xiii) charges related to acquisition deal-related costs.



In 2013, we paid dividends of $1.86 per share of common stock and a total of $218 million in dividends to common stockholders.

Common Dividends

On January 15, 2014, the Board of Directors declared a common stock dividend of $0.49 per share, increasing the quarterly common dividend by $0.01 per share over the prior quarter, which is scheduled to be paid February 17, 2014 to common stockholders of record on January 31, 2014. On October 15, 2013, the Board of Directors declared a common stock dividend of $0.48 per share, increasing the quarterly common dividend by $0.01 per share over the previous quarter. The common dividends are to be paid November 15, 2013 to common stockholders of record on October 31, 2013. On July 16, 2013, the Board of Directors declared a common stock dividend of $0.47 per share, increasing the quarterly common dividend by $0.01 per share over the prior quarter, which was paid August 15, 2013 to common stockholders of record on July 31, 2013. On April 16, 2013, the Board of Directors declared a common stock dividend of $0.46 per share, increasing the quarterly common dividend by $0.01 per share over the prior quarter, which was paid May 15, 2013 to common stockholders of record on April 30, 2013. On January 16, 2013, the Board of Directors declared a common stock dividend of $0.45 per share, increasing the quarterly common dividend by $0.01 per share over the prior quarter, which was paid February 15, 2013 to common stockholders of record on January 31, 2013.



Liquidity

We believe our liquidity and various sources of available capital, including cash from operations, our existing availability under our 2012 Credit Facility and expected proceeds from mortgage payoffs are more than adequate to finance operations, meet recurring debt service requirements and fund future investments through the next twelve months.



We regularly review our liquidity needs, the adequacy of cash flow from operations, and other expected liquidity sources to meet these needs. We believe our principal short-term liquidity needs are to fund:

? normal recurring expenses; ? debt service payments; ? common stock dividends; and ? growth through acquisitions of additional properties. The primary source of liquidity is our cash flows from operations. Operating cash flows have historically been determined by: (i) the number of facilities we lease or have mortgages on; (ii) rental and mortgage rates; (iii) our debt service obligations; and (iv) general and administrative expenses. The timing, source and amount of cash flows provided by financing activities and used in investing activities are sensitive to the capital markets environment, especially to changes in interest rates. Changes in the capital markets environment may impact the availability of cost-effective capital and affect our plans for acquisition and disposition activity. Cash and cash equivalents totaled $2.6 million as of December 31, 2013, an increase of $0.9 million as compared to the balance at December 31, 2012. The following is a discussion of changes in cash and cash equivalents due to operating, investing and financing activities, which are presented in our Consolidated Statement of Cash Flows. 48 Operating Activities - Net cash flow from operating activities generated $279.9 million for the year ended December 31, 2013, as compared to $208.3 million for the same period in 2012, an increase of $71.7 million. The increase was primarily due to the full year impact of rental revenue from the 2012 investments and the partial year impact from the 2013 investment, offset by additional interest associated with financing the investments. Investing Activities - Net cash flow from investing activities was an outflow of $598.8 million for year ended December 31, 2013, as compared to an outflow of $390.7 million for the same period in 2012. The $208.1 million increase in cash outflow from investing activities relates primarily to the change in acquisition activities. During the year ended December 31, 2013, we: (i) invested $528.7 million in four direct financing lease with a new operator, (ii) acquired 5 facilities for $32.5 million, (iii) invested $31.3 million in capital improvement/renovation projects, (iv) placed $8.6 million in net new mortgages and other investments. During the year ended December 31, 2012, we: (i) acquired 50 facilities for $396.6 million, (ii) invested 29.4 million in capital improvements/renovations, (iii) had net cash inflows of $6.3 million from the mortgages and other investments. Also impacting our cash flow from investing was the net reduction of cash proceeds in 2013 for proceeds from the sale of real estate investments. In 2012 we received 29.0 million in proceeds compared to $2.3 million in 2013. Financing Activities - Net cash flow from financing activities was an inflow of $319.8 million for the year ended December 31, 2013, as compared to an inflow of $183.8 million for the same period in 2012. The $136.0 million increase in cash inflow from financing activities was primarily a result of: (i) net proceeds of $100 million on the 2012 Term Loan Facility during the first quarter of 2013; (ii) net proceeds of $193.8 million from our common stock issued through our Equity Shelf Program in 2013 as compared to $77.6 million in 2012; (iii) net proceeds of $84.6 million from issuance of 2.9 million of common stock in the fourth quarter of 2013; (iv) net proceeds of $168 million on the 2012 Credit Facility in 2013 compared to $14.5 million of net payments on the 2011 Credit Facility in 2012 and (v) a decrease in payment of $13.9 million related to deferred financing costs and refinancing costs primarily associated with (a) the issuance of our $200 million Term Loan in December 2013 compared to (b) the issuance of our $400 million 5.875% Senior Notes due 2024 in March 2012, (c) the tender offer and redemption of our outstanding $175 million 2016 Notes in March 2012, (d) a prepayment penalty related to the early retirement of four HUD mortgages in June 2012 and (e) the issuance of our $700 million 2012 Credit Facilities in December 2012. Offsetting these increases were: (i) $59.4 million proceeds from HUD debt refinancing during the first quarter of 2013 compared to the issuance of our $400 million 2024 Notes in March 2012; (ii) $114.6 million HUD mortgages payoff including routine HUD debt principal payments in 2013 compared to $190.7 million payments in 2012 including (a) $175.0 million tender offer and redemption payments for our outstanding $175 million 2016 Notes in March 2012, (b) $11.7 million early retirement of four HUD mortgages in June 2012 and (c) $4.0 million in routine HUD debt principal payments in 2012; (iii) a decrease in net proceeds of $56.1 million from our dividend reinvestment plan in 2013 compared to the same period in 2012; (iv) an increase in dividend payments of $35.9 million in 2013 related to an increase in number of shares outstanding and an increase of $0.17 per share in the common dividends.



Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles ("GAAP") in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our significant accounting policies are described in "Note 2 - Summary of Significant Accounting Policies." These policies were followed in preparing the consolidated financial statements for all periods presented. Actual results could differ from those estimates. We have identified four significant accounting policies that we believe are critical accounting policies. These critical accounting policies are those that have the most impact on the reporting of our financial condition and those requiring significant assumptions, judgments and estimates. With respect to these critical accounting policies, we believe the application of judgments and assessments is consistently applied and produces financial information that fairly presents the results of operations for all periods presented. The four critical accounting policies are:



Lease Accounting

At the inception of the lease and during the amendment process, we evaluate each lease to determine if the lease should be considered an operating lease, a sales-type lease or direct financing lease. We have determined that all of our leases except for the four 2013 New Ark Investment, Inc. ("Ark") leases should be accounted for as operating leases. The four 2013 Ark leases will be accounted for as direct financing leases. 49 For leases accounted for as operating leases, we retain ownership of the asset and record depreciation expense, see "Real Estate Investments and Depreciation" above for additional information regarding our investment in real estate leased under operating lease agreements. We also record lease revenue based on the contractual terms of the operating lease agreement which often includes annual rent escalators, see "Revenue Recognition" below for further discussion regarding the recordation of revenue on our operating leases. For leases accounted for as direct financing leases, we record the present value of the future minimum lease payments (utilizing a constant interest rate over the term of the lease agreement) as a receivable and record interest income based on the contractual terms of the lease agreement. The Ark lease agreements include annual rent escalators; see "Revenue Recognition" below for further discussion regarding the recordation of interest income on our direct financing leases. The $3.2 million of initial direct costs related to originating the direct financing leases have been deferred and recorded as "other assets" in our consolidated balance sheets.



Revenue Recognition and Allowance for Doubtful Accounts

We have various different investments that generate revenue, including leased and mortgaged properties, as well as, other investments, including working capital loans. We recognized rental income and mortgage interest income and other investment income as earned over the terms of the related master leases and notes, respectively. Substantially all of our leases contain provisions for specified annual increases over the rents of the prior year and are generally computed in one of three methods depending on specific provisions of each lease as follows: (i) a specific annual increase over the prior year's rent, generally between 2.0% and 3.0%; (ii) an increase based on the change in pre-determined formulas from year to year (i.e., such as increases in the Consumer Price Index); or (iii) specific dollar increases over prior years. Revenue under lease arrangements with fixed and determinable increases is recognized over the term of the lease on a straight-line basis. The authoritative guidance does not provide for the recognition of contingent revenue until all possible contingencies have been eliminated. We consider the operating history of the lessee, the payment history, the general condition of the industry and various other factors when evaluating whether all possible contingencies have been eliminated. We do not include contingent rents as income until the contingencies are resolved. In the case of rental revenue recognized on a straight-line basis, we generally record reserves against earned revenues from leases when collection becomes questionable or when negotiations for restructurings of troubled operators result in significant uncertainty regarding ultimate collection. The amount of the reserve is estimated based on what management believes will likely be collected. We continually evaluate the collectability of our straight-line rent assets. If it appears that we will not collect future rent due under our leases, we will record a provision for loss related to the straight-line rent asset. We review our accounts receivable as well as our straight-line rents receivable and lease inducement assets to determine their collectability. The determination of collectability of these assets requires significant judgment and is affected by several factors relating to the credit quality of our operators that we regularly monitor, including (i) payment history, (ii) the age of the contractual receivables, (iii) the current economic conditions and reimbursement environment, (iv) the ability of the tenant to perform under the terms of their lease and/or contractual loan agreements and (v) the value of the underlying collateral of the agreement. If we determine collectability of any of our contractual receivables is at risk, we estimate the potential uncollectible amounts and provide an allowance. In the case of a lease recognized on a straight-line basis or existence of lease inducements, we generally provide an allowance for straight-line accounts receivable and/or the lease inducements when certain conditions or indicators of adverse collectability are present. Gains on sales of real estate assets are recognized in accordance with the authoritative guidance for sales of real estate. The specific timing of the recognition of the sale and the related gain is measured against the various criteria in the guidance related to the terms of the transactions and any continuing involvement associated with the assets sold. To the extent the sales criteria are not met, we defer gain recognition until the sales criteria are met. 50



Depreciation and Asset Impairment

Under GAAP, real estate assets are stated at the lower of depreciated cost or fair value, if deemed impaired. Depreciation is computed on a straight-line basis over the estimated useful lives of 20 to 40 years for buildings and improvements and three to 10 years for furniture, fixtures and equipment. Management periodically, but not less than annually, evaluates our real estate investments for impairment indicators, including the evaluation of our assets' useful lives. The judgment regarding the existence of impairment indicators is based on factors such as, but not limited to, market conditions, operator performance and legal structure. If indicators of impairment are present, management evaluates the carrying value of the related real estate investments in relation to the future undiscounted cash flows of the underlying facilities. Provisions for impairment losses related to long-lived assets are recognized when expected future undiscounted cash flows are determined to be permanently less than the carrying values of the assets. An adjustment is made to the net carrying value of the leased properties and other long-lived assets for the excess of historical cost over fair value. The fair value of the real estate investment is determined by market research, which includes valuing the property as a nursing home as well as other alternative uses. All impairments are taken as a period cost at that time, and depreciation is adjusted going forward to reflect the new value assigned to the asset. If we decide to sell rental properties or land holdings, we evaluate the recoverability of the carrying amounts of the assets. If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value less costs to sell. Our estimates of cash flows and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties, and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers. For the years ended December 31, 2013, 2012, and 2011, we recognized impairment losses of $0.4 million, $0.3 million and $26.3 million, respectively. The impairments are primarily the result of closing facilities or updating the estimated proceeds we expect for the sale of closed facilities. For additional information, see Note 3 - Properties.



Loan and Direct Financing Lease Impairment

Management evaluates our outstanding mortgage notes, direct financing leases and other notes receivable. When management identifies potential loan or direct financing lease impairment indicators, such as non-payment under the loan documents, impairment of the underlying collateral, financial difficulty of the operator or other circumstances that may impair full execution of the loan documents or direct financing leases, and management believes it is probable that all amounts will not be collected under the contractual terms of the loan or direct financing leases, the loan or direct financing lease is written down to the present value of the expected future cash flows. In cases where expected future cash flows are not readily determinable, the loan or direct financing lease is written down to the fair value of the collateral. The fair value of the loan or direct financing leases is determined by market research, which includes valuing the property as a nursing home as well as other alternative uses. We currently account for impaired loans and direct financing leases using (a) the cost-recovery method, and/or (b) the cash basis method. We generally utilize the cost recovery method for impaired loans or direct financing leases for which impairment reserves were recorded. We utilize the cash basis method for impairment loans or direct financing leases for which no impairment reserves were recorded because the net present value of the discounted cash flows expected under the loan or direct financing lease and/or the underlying collateral supporting the loan or direct financing lease were equal to or exceeded the book value of the loans or direct financing leases. Under the cost recovery method, we apply cash received against the outstanding loan balance or direct financing leases prior to recording interest income. Under the cash basis method, we apply cash received to interest income. As of December 31, 2013 and 2012, we had loan loss reserves totaling $2.0 million, respectively. As of December 31, 2013 and 2012, we had no reserves for direct financing lease. In 2012, we did not record provisions for loan losses or charge-offs related to our mortgage or note receivable portfolios. In 2011, we recorded provisions for loan losses of $2.3 million related to a working capital note. In 2013, we received a $0.2 million recovery on previously written-off debt from the receivership relating to an existing operator's note.


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