The following discussion and analysis is based primarily on the consolidated financial statements of
National Health Investors, Inc.for the periods presented and should be read together with the notes thereto contained in this Annual Report on Form 10- K. Otherimportant factors are identified in "Item 1. Business" and "Item 1A. Risk Factors" above.
National Health Investors, Inc., incorporated under the laws of Marylandin 1991, is a real estate investment trust ("REIT") which invests in income-producing health care properties primarily in the long-term care and senior housing industries. As of December 31, 2013, our portfolio consisted of real estate, mortgage and note investments and other investments in the preferred stock and marketable securities of other REITs. We are a self-managed REIT investing in health care real estate or in the operations thereof through independent third-party managers that generate current income to be distributed to stockholders. We have pursued this mission by investing primarily in leased properties, loans and RIDEA transactions. These investments include senior housing, skilled nursing facilities, hospitals and medical office buildings, all of which are collectively referred to herein as "Health Care Facilities." Senior housing includes assisted living facilities, senior living campuses, and independent living facilities. We typically fund these investments through three sources of capital: (1) debt offerings, including bank lines of credit and ordinary term debt, (2) current cash flow, and (3) the sale of equity securities.
December 31, 2013, our continuing operations were comprised of investments in real estate and mortgage and other notes receivable in 168 health care facilities located in 30 states consisting of 94 senior housing communities, 68 skilled nursing facilities, 4 hospitals, 2 medical office buildings and other notes receivable. These investments (excluding our corporate office of $882,000) consisted of properties with an original cost of approximately $1,421,120,000, rented under triple-net leases to 23 lessees, and $60,639,000aggregate carrying value of mortgage and other notes receivable due from 15 borrowers. 26
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The following tables summarize our investments in real estate and mortgage and other notes receivable as of
Real Estate Properties Properties Beds/Sq. Ft.* Revenue Assisted Living 58 2,857
$ 29,559Senior Living Campus 5 797 6,827 Independent Living 28 3,114 2,329 Senior Housing Communities 91 6,768 38,715 Skilled Nursing Facilities 61 8,174 59,058 Hospitals 3 181 7,171 Medical Office Buildings 2 88,517 * 1,085 Total Real Estate Properties157
Mortgage and Other Notes Receivable
Assisted Living 2 190
$ 732Senior Living Campus 1 76 115 Senior Housing Communities 3 266 847 Skilled Nursing Facilities 7 594 2,777 Hospital 1 70 1,203 Other Notes Receivable - - 2,781
Total Mortgage and Other Notes Receivable 11
$ 7,608Total Portfolio 168 $ 113,637Portfolio Summary Properties Investment % Revenue Real Estate Properties 157 93.3 % $ 106,029Mortgage and Other Notes Receivable 11 6.7 % 7,608 Total Portfolio 168 100.0 % $ 113,637Summary of Facilities by Type Assisted Living 60 26.7 % $ 30,290Independent Living 28 2.0 % 2,329 Senior Living Campus 6 6.1 % 6,942 Senior Housing Communities 94 34.8 % 39,561 Skilled Nursing Facilities 68 54.4 % 61,835 Hospitals 4 7.4 % 8,375 Medical Office Buildings 2 1.0 % 1,085 Other - 2.4 % 2,781 Total Real Estate Portfolio 168 100.0 % $ 113,637Portfolio by Operator Type Public 53 37.8 % $ 43,013National Chain (Privately-Owned) 29 4.4 % 4,941 Regional 75 50.0 % 56,838 Small 11 7.8 % 8,870 Total Real Estate Portfolio 168 100.0 % $
For the year ended
December 31, 2013, operators of facilities which provided more than 3% of our total revenues were (in alphabetical order): Bickford Senior Living; Emeritus Senior Living; Fundamental Long Term Care Holdings; Health Services Management; Landmark Senior Living; Legend Healthcare; National HealthCare Corp.; SeniorHealth of Rutherford; Senior Living Management Corporation; SP Silverdale; and White Pine Senior Living.
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We invest a portion of our funds in the preferred and common shares of other publicly-held healthcare REITs to ensure a substantial portion of our assets are invested for real estate purposes. At
December 31, 2013, such investments had a carrying value of $50,782,000.
Areas of Focus
We are evaluating and will potentially make additional investments during 2014 while we continue to monitor and improve our existing properties. We seek tenants who will become mission-oriented partners in relationships where our business goals are aligned. This approach fuels steady, and thus, enduring growth for NHI and our tenants. While deal flow among the largest in our peer group may be slowing, there are smaller portfolio assets in secondary markets with prospective yields that justify our attention. Our investment focus, regardless of asset type, is on high quality opportunities-- defined by us to mean (a) the tenant has a track record of successful operations, (b) the tenant has the necessary credit to meet it's lease obligation to us; and (c) the facility is in good physical condition and (d) is positioned in a local market that offers the potential to achieve excellent financial results. As we make new investments, we expect to maintain a relatively low level of debt compared to the value of our assets and relative to our peers in the industry. Approximately 52% of our revenue from continuing operations has come from operators of our skilled nursing facilities that receive a significant portion of their revenue from governmental payors, primarily
Medicareand Medicaid. Such revenues are subject annually to statutory and regulatory changes, and in recent years, have been reduced due to federal and state budgetary pressures. As a result, in 2009, we began to diversify our portfolio by directing a significant portion of our investments into properties which do not rely primarily on Medicareand Medicaidreimbursement, but rather on private pay sources. While we will occasionally acquire skilled nursing facilities in good physical condition with a proven operator and strong local market fundamentals, our current investment focus is on acquiring senior housing assets (including assisted living and memory care facilities, independent living facilities and senior living campuses). With the acquisition of the 25 independent living properties from Holiday in December 2013, discussed in further detail under Investment Highlights, less than 40% of our contractual revenue for 2014 is expected to come from skilled nursing facilities. With this acquisition, we have further diversified across asset types and have achieved a concentration of revenue from large national tenants who are recognized leaders in their industries. Bickford Senior Livingis our largest assisted living/memory care tenant, Holiday Acquisition Holdingsis our largest independent living tenant and National HealthCare Corporation is our largest skilled nursing tenant, as measured by annual contractual lease revenue from these tenants as a percentage of total revenue from continuing operations. If longer term borrowing rates increase as anticipated, there will be pressure on the spread between our cost of capital and the returns we earn. We expect that pressure to be partially mitigated by market forces that lead to an increase in lease rates. We expect our cost of capital will increase as a result of our plan to transition some of our short term revolving borrowings into debt instruments with longer maturities and increased overall interest rates. Managing risk involves trade-offs with the competing goal of maximizing short-term profitability. Our intention is to strike an appropriate balance between these competing interests within the context of our investor profile. We are continuing to explore additional funding resources including bank term loans, convertible debt, debt private placement and secured government agency financing. We manage our business with a goal of increasing the regular annual dividends paid to shareholders. Our Board of Directors approves a regular quarterly dividend which is reflective of expected taxable income on a recurring basis. Our transactions that are infrequent and non-recurring that generate additional taxable income have been distributed to shareholders in the form of special dividends. Taxable income is determined in accordance with the Internal Revenue Code and differs from net income for financial statements purposes determined in accordance with U.S. generally accepted accounting principles. Our goal of increasing annual dividends requires a careful balance between identification of high-quality lease and mortgage assets in which to invest and the cost of our capital with which to fund such investments. We consider the competing interests of short and long-term debt (interest rates, maturities and other terms) versus the higher cost of new equity. We accept some level of risk associated with leveraging our investments. We intend to continue to make new investments that meet our underwriting criteria and where we believe the spreads over our cost of capital will generate sufficient returns to our shareholders. 28
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Our regular and special dividends for the last four years are as follows:
2013 2012 2011 2010 Regular
$ 2.90 $ 2.64 $ 2.50 $ 2.36Special $ - $ 0.221 $ 0.22$ - $ 2.90 $ 2.86 $ 2.72 $ 2.36
1 Paid to shareholders of record in
Our increased investments in healthcare real estate beginning in 2009 have been partially accomplished by our ability to effectively leverage our balance sheet. However, we continue to maintain a relatively low leverage balance sheet compared with the value of our assets and with many in our peer group. We believe that our fixed charge coverage ratio, which is the ratio of Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization, including amounts in discontinued operations, excluding real estate asset impairments and gains on dispositions) to fixed charges (interest expense and principal payments on debt), and the ratio of consolidated debt to Adjusted EBITDA are meaningful measures of our ability to service our debt. We use these two measures as a useful basis to compare the strength of our balance sheet with those in our peer group. We calculate our fixed charge coverage ratio as approximately 12:1 for the year ended
December 31, 2013(see page 47 for a discussion of Adjusted EBITDA and a reconciliation to our net income). On an annualized basis, our consolidated debt-to-Adjusted EBITDA ratio is 5:1. Annual dividend growth, a low leverage balance sheet, a portfolio of diversified, high-quality assets, and prioritizing business relationships with experienced tenants and borrowers continue to be the key drivers of our business plan. According to a 2011 estimate by the U.S. Department of Health and Human Services, the number of Americans 65 and older is expected to grow 36% between 2010 and 2020, compared to a 9% growth rate for the general population. An increase in this age demographic is expected to increase the demand for senior housing properties of all types in the coming decades.
There is increasing demand for private-pay senior housing properties in countries outside the U.S. We will consider real estate and note investments with U.S. entities who seek to expand their senior housing operations into countries where local-market demand is sufficiently demonstrated. We have a current investment of
We expect to fund any new investments in real estate and mortgage notes in 2014 using our liquid investments and debt financing unless the size of an acquisition leads us to consider issuing equity securities to fund some or all of such acquisition in order to maintain a relatively low level of debt in comparison to the value of our assets.
Critical Accounting Policies
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in
the United States of America. These accounting principles require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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. Actual results could differ from those estimates and cause our reported net income to vary significantly from period to period. If actual experience differs from the assumptions and other considerations used in estimating amounts reflected in our consolidated financial statements, the resulting changes could have a material adverse effect on our consolidated results of operations, liquidity and/or financial condition.
We consider an accounting estimate or assumption critical if:
1. the nature of the estimates or assumptions is material due to the levels
of subjectivity and judgment necessary to account for highly uncertain
matters or the susceptibility of such matters to change; and 2. the impact of the estimates and assumptions on financial condition or operating performance is material. 29
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Our significant accounting policies and the associated estimates, judgments and the issues which impact these estimates are as follows:
Valuations and Impairments
The majority of our tenants and borrowers are in the long-term health care industry (SNFs and ALFs) where SNFs derive their revenues primarily from
The long-term health care industry has also experienced a dramatic increase in professional liability claims and in the cost of insurance to cover such claims. These factors combined to cause a number of bankruptcy filings, bankruptcy court rulings and court judgments affecting our lessees and borrowers. In prior years, we have determined that impairment of certain of our investments had occurred as a result of these events. We evaluate the recoverability of the carrying values of our properties on a property-by-property basis. On a quarterly basis, we review our properties for recoverability when events or circumstances, including significant physical changes in the property, significant adverse changes in general economic conditions and significant deteriorations of the underlying cash flows of the property, indicate that the carrying amount of the property may not be recoverable. The need to recognize an impairment charge is based on estimated undiscounted future cash flows from a property compared to the carrying value of that property. If recognition of an impairment charge is necessary, it is measured as the amount by which the carrying amount of the property exceeds the fair value of the property. For notes receivable, we evaluate the estimated collectibility of contractual loan payments and general economic conditions on an instrument-by-instrument basis. On a quarterly basis, we review our notes receivable for ability to realize on such notes when events or circumstances, including the non-receipt of contractual principal and interest payments, significant deteriorations of the financial condition of the borrower and significant adverse changes in general economic conditions, indicate that the carrying amount of the note receivable may not be recoverable. If necessary, impairment is measured as the amount by which the carrying amount exceeds the fair value as measured by the discounted cash flows expected to be received under the note receivable or, if foreclosure is probable, the fair value of the collateral securing the note receivable. We evaluate our marketable equity securities for other-than-temporary impairments. An impairment of a marketable equity security would be considered "other-than-temporary" unless we have the ability and intent to hold the investment for a period of time sufficient for a forecasted market price recovery up to (or beyond) the cost of the investment and evidence indicates the cost of the investment is recoverable within a reasonable period of time. The initial carrying value of investments in unconsolidated entities is based on the amount paid to purchase the interest or the estimated fair value of the assets prior to our acquisition of interests in the entity. An aggregate basis difference between the cost of our equity method investee and the amount of underlying equity in its net assets is primarily attributable to goodwill, which is not amortized. We evaluate for impairment our equity method investments and related goodwill based upon a comparison of the estimated fair value of the investments to their carrying value. When we determine a decline in the estimated fair value of such an investment below its carrying value is other than temporary, an impairment is recorded. No impairments to the carrying value of our equity method investee have been recorded for any period presented. While we believe that the carrying amounts of our properties and arrangement with Bickford are recoverable and our notes receivable, marketable securities and other investments are realizable, it is possible that future events could require us to make significant adjustments or revisions to these estimates. The determination of the fair value and whether a shortfall in operating revenues or the existence of operating losses is indicative of a loss in value that is other than temporary involves significant judgment. Our estimates consider all available evidence including, as appropriate, the present value of the expected future cash flows discounted at market rates, general economic conditions and trends, the duration of the fair value deficiency, and any other relevant factors. While we believe our assumptions are reasonable, changes in these assumptions may have a material impact on our financial results.
We collect interest and rent from our customers. Generally, our policy is to recognize revenues on an accrual basis as earned. However, there are certain of our customers, for whom we have determined, based on insufficient historical collections and the lack of expected future collections, that revenue for interest or rent is not probable of collection until received. For these 30
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investments, our policy is to recognize interest or rental income when assured, which we consider to be the period the amounts are collected. We identify investments as nonperforming if a required payment is not received within 30 days of the date it is due. This policy could cause our revenues to vary significantly from period to period. Revenue from minimum lease payments under our leases is recognized on a straight-line basis to the extent that future lease payments are considered collectible. Lease payments that depend on a factor directly related to future use of the property, such as an increase in annual revenues over base year revenues, are considered to be contingent rentals, are included in rental income when they are determinable and earned, and are excluded from future minimum lease payments.
As part of the process of preparing our consolidated financial statements, significant management judgment is required to evaluate our compliance with REIT requirements. Our determinations are based on interpretation of tax laws, and our conclusions may have an impact on the income tax expense recognized. We believe that we have operated our business so as to qualify as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"), and we intend to continue to operate in such a manner, but no assurance can be given that we will be able to qualify at all times. Effective
October 1, 2012, we began to record income tax expense or benefit with respect to our subsidiary which will be taxed as a Taxable REIT Subsidiary ("TRS") under provisions similar to those applicable to regular corporations. Aside from such income taxes that may be applicable to the taxable income in our TRS, we will not be subject to U.S. federal income tax, provided that we continue to qualify as a REIT and make distributions to stockholders equal to or in excess of our taxable income. This treatment substantially eliminates the "double taxation" (at the corporate and stockholder levels) that typically applies to corporate dividends. Our failure to continue to qualify under the applicable REIT qualification rules and regulations would cause us to owe state and federal income taxes and would have a material adverse impact on our financial position, results of operations and cash flows.
Principles of Consolidation
The consolidated financial statements include our accounts, the accounts of our wholly-owned subsidiaries and the accounts of joint ventures in which we own a majority voting interest with the ability to control operations and where no substantive participating rights or substantive kick-out rights have been granted to the noncontrolling interests. In addition, we consolidate a legal entity deemed to be a variable interest entity ("VIE") in which we are determined to be the primary beneficiary. All material inter-company transactions and balances have been eliminated in consolidation. We apply
Financial Accounting Standards Board("FASB") guidance for our arrangements with variable interest entities ("VIEs") which requires us to identify entities for which control is achieved through means other than voting rights and to determine which business enterprise is the primary beneficiary of the VIE. A VIE is broadly defined as an entity with one or more of the following characteristics: (a) the total equity investment at risk is insufficient to finance the entity's activities without additional subordinated financial support; (b) as a group, the holders of the equity investment at risk lack (i) the ability to make decisions about the entity's activities through voting or similar rights, (ii) the obligation to absorb the expected losses of the entity, or (iii) the right to receive the expected residual returns of the entity; or (c) the equity investors have voting rights that are not proportional to their economic interests, and substantially all of the entity's activities either involve, or are conducted on behalf of, an investor that has disproportionately few voting rights. We consolidate investments in VIEs when we are determined to be the primary beneficiary of the VIE. We may change our assessment of a VIE due to events such as modifications of contractual arrangements that affect the characteristics or adequacy of the entity's equity investments at risk and the disposal of all or a portion of an interest held by the primary beneficiary.
Real property developed by us is recorded at cost, including the capitalization of interest during construction. The cost of real property investments acquired is allocated to net tangible and identifiable intangible assets based on their respective fair values. Tangible assets primarily consist of land, buildings and improvements. The remaining purchase price is allocated among identifiable intangible assets, if any. We make estimates as part of our allocation of the purchase price of acquisitions to the various components of the acquisition based upon the relative fair value of each component. The most significant components of our allocations are typically the allocation of fair value to land, equipment, buildings and other improvements, and intangible assets, if any. Our estimates of the values of these components will affect the amount of depreciation and amortization we record over the estimated useful life of the property acquired or the remaining lease term. 31
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Properties Asset Class
Lease Investments Holiday Acquisition Holdings LLC 25 Senior Housing $
7 Skilled Nursing
Fundamental Long Term Care Holdings, LLC 2 Skilled Nursing 27,750 Chancellor Healthcare 2 Senior Housing 17,000 Emeritus Senior Living 1 Senior Housing 15,300 Discovery Senior Living 1 Senior Housing 12,000 Note Investments Bickford Senior Living 1 Senior Housing 9,200 Discovery Senior Living 1 Senior Housing 2,500
$ 751,585We have two operators, National HealthCare Corporation ("NHC") and Bickford Senior Living("Bickford"), from whom we individually derive at least 10% of our income from operations. Beginning in December 2013, a third major operator, Holiday Acquisition Holdings LLC("Holiday"), has leased 25 independent living facilities from us which contractually obligates Holiday, in 2014 and going forward, to make lease payments which will aggregate to more than 25% of NHI revenues, based on our 2013 leases in place.
December 2013we acquired 25 independent living facilities from Holiday, an affiliate of Holiday Retirement, for $491,000,000plus transaction costs of $1,959,000. The total purchase price was allocated to the assets acquired based upon their relative fair values, preliminarily estimated as $21,700,000to land, $471,259,000to buildings and improvements. No intangibles were identified in the acquisition. Such allocations have not been finalized as we await conclusive asset valuations and, as such, the results of the allocation are preliminary and subject to adjustment. This portfolio is located in 12 states. We have leased this portfolio to a subsidiary of Holiday, who continues to operate the facilities pursuant to a management agreement with a Holiday-affiliated manager. The master lease term of 17 years began in December 2013and provides for initial cash rent of $31,915,000plus annual escalators of 4.5% in the first 3 years and a minimum of 3.5% each year thereafter. Holiday will be our largest tenant in 2014, with anticipated lease revenues in excess of 25% of our total revenues. Holiday's obligations to us under the master lease are guaranteed by its indirect parent, Holiday AL Holdings, LP. We funded this acquisition with proceeds of a $250,000,000term loan and proceeds from a public offering of 5,175,000 shares of our common stock at $57per share. The net proceeds from the offering were approximately $282,542,000, after deducting $12,500,000in underwriting discounts, commissions and other offering expenses. Bickford As of December 31, 2013, we owned an 85% equity interest and an affiliate of Bickford owned a 15% equity interest in our consolidated subsidiary ("PropCo") which owns 29 assisted living/memory care facilities and also has 1 facility under construction. The facilities are leased to an operating company, ("OpCo"), in which we also share an 85/15 ownership interest with an affiliate of Bickford, who controls the entity. Our joint venture is structured to comply with the provisions of RIDEA. On June 28, 2013, PropCo purchased 17 assisted living and memory care facilities which were managed by Bickford. The facilities total 750 units and are located in Illinois, Indiana, Iowaand Nebraska. Of these facilities, 14 were acquired from a subsidiary of Care Investment Trust, Inc.("Care") for $124,549,000, consisting of $44,021,000in cash and assumption of secured debt with a fair value of $80,528,000. As part of this transaction, we recognized all identifiable tangible assets and liabilities assumed at fair value at the date of acquisition (there were no identifiable intangible assets or liabilities assumed) and attributed $4,360,000to the fair value of the land, $120,189,000to the fair value of the buildings and improvements and expensed $63,00032
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in transaction costs at closing. The 14 newly-acquired facilities have been leased to OpCo for an initial term of 5 years at an aggregate annual lease amount of
Concurrent with this acquisition, PropCo also completed a
$12,910,000purchase and leaseback of three assisted living facilities located in Iowa, Nebraskaand Indianatotaling 107 units from affiliates of Bickford. The acquisition was accounted for as an asset purchase. PropCo's previous master lease with Bickford was amended to include these three properties and the annual lease amount was increased from $7,750,000to $9,086,000, plus annual fixed escalators beginning January 1of each succeeding year. All other significant terms of the existing master lease remain unchanged. As described above, the current annual contractual rent from OpCo to PropCo is $18,836,000, plus fixed annual escalators. During the quarter ended December 31, 2013, PropCo completed major construction and received certificates of occupancy on two assisted living facilities which were under development. Under the terms of the current development lease agreement, NHI continues to receive rent of 9% on the total amount of development costs, including land, which totaled $17,796,000as of December 31, 2013. Of these costs, $15,084,000relate to the facilities for which occupancy certificates have been received. Of our total revenue from continuing operations, $14,586,000(12%), $5,164,000(6%) and $4,235,000(5%) were recorded as rental income from Bickford for the years ended December 31, 2013, 2012, and 2011, respectively. As of December 31, 2013, the carrying value of our investment in the operating company, OpCo, was $9,494,000. The excess of the original purchase price over the fair value of identified tangible assets at acquisition of $8,986,000is treated as implied goodwill and is subject to periodic review for impairment in conjunction with our equity method investment as a whole. With PropCo's acquisition of additional Bickford properties in June 2013, an assignment was entered into whereby the operations of the 17 newly acquired facilities were conveyed by an affiliate of Bickford to OpCo. The transaction mandated the effective cut-off of operating revenues and expenses and the settlement of operating assets and liabilities at the acquisition date. Specified remaining net tangible assets were assigned to OpCo at the transferor's carryover basis resulting in an adjustment, through NHI's capital in excess of par value to our equity method investment in OpCo, of $817,000. Unaudited summarized income statements for OpCo are presented below (in thousands): Year Ended December 31, 2013 2012 Revenues $ 42,636 $ 6,335Operating expenses, including management fees 27,419
Lease expenses 14,579
Depreciation and amortization 256 16 Net Income $ 382
NHI has an exclusive right to Bickford's future acquisitions, development projects and refinancing transactions. At
July 2013, we extended a $9,200,000loan to Bickford to fund a portion of their acquisition of six senior housing communities consisting of 342 units. The loan is guaranteed by principals of Bickford and has a two-year maturity plus a one-year extension option with 12% annual interest. As a result of this transaction and existing agreements governing the nature of our relationship with Bickford, PropCo has acquired a $97,000,000purchase option on the properties which is exercisable over the term of the loan.
Of our total revenue from continuing operations,
$34,756,000(29%), $33,056,000(35%) and $32,619,000(39%) in 2013, 2012 and 2011, respectively, were derived from NHC, a publicly-held company and the lessee of our legacy properties. As of December 31, 2013, we leased 42 health care facilities to NHC consisting of 3 independent living facilities and 39 skilled nursing facilities (4 of which are subleased to other parties for whom the lease payments are guaranteed to us by NHC). These facilities are leased to NHC under the terms an amended Master Lease Agreement dated October 17, 1991("the 1991 lease") which includes 33
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our 35 remaining legacy properties and a Master Lease Agreement dated
August 30, 2013("the 2013 lease"), discussed below, which includes seven skilled nursing facilities acquired from ElderTruston August 31, 2013. In December 2012, we entered into an extension of the 1991 lease through December 2026. Under the terms of the lease, rent escalates by 4% of the increase, if any, in each facility's revenue over a 2007 base year. We refer to this additional rent component as "percentage rent." The following table summarizes the percentage rent received and recognized from NHC (in thousands): Year Ended December 31, 2013 2012 2011 Current year $ 2,275 $ 1,530 $ 1,530Prior year final certification1 746 997 560 Total percentage rent $ 3,021 $ 2,527 $ 2,0901 For purposes of the percentage rent calculation described in the Master Lease Agreement, NHC's annual revenue by facility for a given year is certified to NHI by March 31stof the following year. As previously disclosed, in December 2012, NHI entered into an agreement with NHC to sell six skilled nursing facilities for $21,000,000in cash. The properties had a carrying value of $1,611,000. The sale was completed on August 31, 2013, and resulted in a gain for financial statement purposes of $19,370,000after transaction costs of $19,000. We plan to defer recognition of the tax gain on the sale of these facilities by utilizing the like-kind exchange rules under Section 1031 of the Internal Revenue Code. The results of operation of the facilities sold were classified as discontinued operations for all periods presented in our Consolidated Statements of Income. To reflect this transaction, effective January 1, 2014, NHI's annual base rent will be reduced by $2,950,000. On August 30, 2013, we acquired seven skilled nursing facilities (and one vacant assisted living facility) in Massachusettsand New Hampshirefrom our former not-for-profit borrower ElderTrust of Florida, Inc.("ElderTrust") for consideration of $37,417,000, consisting of $23,676,000in cash, inclusive of closing costs, and the cancellation of notes receivable from ElderTrustwith a principal balance of $13,741,000. Beginning September 1, 2013, the facilities were placed under a new triple net lease to the current manager, NHC, for an initial period of 15 years commencing with a lease amount of $350,000for the remainder of 2013. In 2014, the lease provides for a base annual rental of $3,450,000. Under the terms of the lease, rent escalates 4% of the increase in each facility's revenue over the 2014 base year. Because ElderTrustwas the owner and operator of the facilities, we accounted for the transaction as an asset acquisition. During the last three years of the lease, NHC will have the option to purchase the facilities for $49,000,000.
April 2013, we completed the purchase of two skilled nursing facilities located in Cantonand Corinth, Texasfor a purchase price of $26,150,000in cash, plus consideration related to the Corinthfacility of $1,600,000conditional upon the achievement of certain operating metrics, which continued to be probable as of December 31, 2013. The facilities, which total 254 beds, have been leased to affiliates of Fundamental Long Term Care Holdings, LLC("Fundamental") for an initial term of 10 years at a lease rate of 9% plus annual fixed escalators. The lease includes three 5-year renewal options at the terms which exist upon renewal. In October 2013, we agreed to sell three older skilled nursing facilities to affiliates of our current tenant, Fundamental, for $18,500,000. The properties had a carrying value of $17,068,000. We plan to defer recognition of the tax gain on the sale of these facilities by utilizing the like-kind exchange rules under Section 1031 of the internal Revenue Code. Our lease revenue from these facilities was $3,316,000, $3,231,000, and $3,067,000for the years ended December 31, 2013, 2012, and 2011, respectively. We completed this sale on December 31, 2013. Pursuant to the purchase option, rents associated with the remaining properties will be fixed at $250,000per month, without escalation, through the first renewal term in February 2016. Subsequent to the sale of the Arlington, Richardsonand Cantonfacilities, Fundamental leases four facilities from NHI. Chancellor In October 2013, we completed a $9,000,000acquisition of a 63-unit senior housing community in Baltimore, Maryland, and leased the facility to Chancellor Health Care, LLCfor an initial term of seven years, plus renewal options. The lease rate in the first year will be 8% plus a fixed annual escalator. Because the facility was owner-occupied, we accounted for the acquisition as an asset purchase. We also committed to provide up to $500,000for renovations and improvements. Additionally, we have committed $7,500,000to build a 46-unit free-standing assisted living and memory care community, expanding our Linda Valleysenior living campus in Loma Linda, California. The initial lease term is for 15 years at an annual 34
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rate of 9% plus a fixed annual escalator. NHI purchased the
July 2013we completed a $15,300,000acquisition of The Inn at Halcyon Villagein Marysville, Ohio("Halcyon"). The 76-unit assisted living and memory care community is leased to Emeritus Senior Living for an initial term of 15 years with options to extend. Rent in the first year of the lease will be $1,140,000. Annual fixed escalators begin in the third lease year. Discovery In September 2013, we completed a $12,000,000acquisition of Regency Pointe Retirement Communityin Rainbow City, Alabama. The 120-unit senior housing community is leased to Discovery Senior Living ("Discovery") for an initial term of 15 years with three 5-year renewal options. Rent in the first year of the lease is $942,000plus annual fixed escalators. As a lease inducement, upon obtaining certain operating metrics, Discovery will be eligible over years two, three and four of the lease for contingent payments totaling up to $2,500,000which, if paid, we will amortize as an adjustment to rental income over the remaining lease term. At acquisition, the likelihood that we would incur the contingent payments was considered reasonably possible but not probable. Accordingly, no provision for these payments is reflected in the consolidated financial statements. In October 2013, we provided a $2,500,000second mortgage loan to an affiliate of Discovery for the construction of a 120-unit senior housing community in Naples, Florida. Construction began in the fourth quarter of 2013. The loan is guaranteed by principals of Discovery and has a five-year maturity with monthly payments of interest at a 12% annual rate.
Other Lease Activity
Our leases are typically structured as "triple net leases" on single-tenant properties having an initial leasehold term of 10 to 15 years with one or more 5-year renewal options. As such, there may be reporting periods in which we experience few, if any, lease renewals or expirations. During the year ended
December 31, 2013, we had 1 expiring lease which was renewed with the existing tenant on substantially similar lease terms. In October 2013, our current tenant, Weatherly Associates, LLC, exercised their option to purchase our Weatherly, PAsenior housing facility for $5,315,000. The property had a carrying value of $3,591,000resulting in a gain for financial statement purposes. We plan to defer recognition of the tax gain on the sale of this facility by utilizing the like-kind exchange rules under Section 1031 of the Internal Revenue Code. Our lease revenue from the facility was $353,000, $403,000, and $403,000for the years ended December 31, 2013, 2012, and 2011, respectively.
Real Estate and Mortgage Write-downs
Our borrowers and tenants experience periods of significant financial pressures and difficulties similar to other health care providers. Governments at both the federal and state levels have enacted legislation to lower, or at least slow, the growth in payments to health care providers. Furthermore, the cost of professional liability insurance has increased significantly during this same period. Since inception, a number of our facility operators and mortgage loan borrowers have undergone bankruptcy. Others have been forced to surrender properties to us in lieu of foreclosure or, for certain periods, have failed to make timely payments on their obligations to us.
We believe that the carrying amounts of our real estate properties are recoverable and that mortgage notes receivable are realizable and supported by the value of the underlying collateral. However, it is possible that future events could require us to make significant adjustments to these carrying amounts.
Potential Effects of Medicare Reimbursement
Our tenants who operate skilled nursing facilities receive a significant portion of their revenues from governmental payors, primarily
Medicare(federal) and Medicaid(states). Changes in reimbursement rates and limits on the scope of services reimbursed to skilled nursing facilities could have a material impact on the operators' liquidity and financial condition. On May 1, 2013, the Centers for Medicare & Medicaid Services("CMS") released a proposed rule outlining a 1.4% increase in their Medicarereimbursement for fiscal 2014 beginning on October 1, 2013. We currently estimate that our borrowers and lessees will be able to withstand this nominal Medicareincrease due to their credit quality, profitability and their debt or lease coverage ratios, although no assurances can be given as to what the ultimate effect that similar Medicareincreases on an annual basis would have on each of our borrowers and lessees. According to industry studies, state Medicaidfunding is not expected to keep pace with inflation. Federal legislative policies have been adopted and continue to be proposed that would reduce Medicareand/or Medicaidpayments to skilled nursing facilities. Accordingly, for the near-term, we are treating as cautionary the Federal Government's recent re-commitment, after debating a 'chained CPI' indexing, to fully index Social Securityto inflation. In this cautious approach, any near-term acquisitions of skilled nursing facilities are planned on a selective basis, with emphasis on operator quality and newer construction. 35
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As discussed in the notes to the consolidated financial statements, former not-for-profit borrowers, SeniorTrust and
ElderTrust, appointed receivers to effect the sale of their assets and the winding up of those entities. These two mortgage borrowers were adversely impacted by previous Medicarerate adjustments due to their payor mix, their current payment coverage ratios and limited net equity. The impact of net reductions in Medicarereimbursement had an adverse effect on the value of the underlying real estate assets. In March 2013, the financial condition of SeniorTrust reflected their declining net operating income over the previous twelve months and indicated a further adverse change in the estimated value of the collateral for our notes receivable at that time. As a result, we recorded an impairment on this former note receivable of $4,037,000based on such estimated value. Litigation Settlement In April 2013, we entered into a settlement agreement concerning litigation with the two borrowers mentioned above, ElderTrustand SeniorTrust. As described earlier, we agreed to purchase the seven skilled nursing facilities which served as collateral for the note from ElderTrust. The purchase was completed on August 30, 2013. Additionally, we agreed to a full settlement of our notes receivable from SeniorTrust for $15,000,000in cash. Our notes from SeniorTrust were paid in full on June 28, 2013. At the time of the settlement agreement, our annualized interest-only cash flows from SeniorTrust and ElderTrusttotaled approximately $1,980,000. With an additional net investment of $8,676,000, our estimated annualized cash flows beginning in 2014, before any rent escalation, will be $3,450,000.
The table below illustrates the projected effect of the settlement on annualized cash flows and return on investment (in thousands):
Before Settlement After Settlement Difference SeniorTrust $ 15,000 $ -
$ (15,000 )ElderTrust 13,741 37,417 23,676 Total Investment $ 28,741 $ 37,417 $ 8,676Estimated Annualized Cash Flow $ 1,980 $ 3,450 $ 1,470Estimated Annualized Cash Flow as % of Total Investment 6.9 % 9.2 % 16.9 % The above analysis focuses entirely upon cash flow and investment return without considering qualitative portfolio improvements inherent in transitioning from a mortgage note to a triple net lease. Additionally, the above analysis does not consider the effect of future rent escalations or the future cost of borrowings used to acquire the seven ElderTrustproperties. 36
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Results of Operations
The significant items affecting revenues and expenses are described below (in thousands): Years ended December 31, Period Change 2013 2012 $ % Revenues: Rental income ALFs leased to Bickford Senior Living
$ 14,219 $ 4,646 $ 9,573NM SNFs leased to Fundamental Long Term Care 3,494 1,777 1,717 96.6 % Hospital leased to Polaris 2,140 528 1,612 NM ALF leased to Landmark Senior Living 1,579 35 1,544 NM SLC leased to SantÉ Partners 2,114 744 1,370 NM SLC leased to Chancellor Health Care 1,207 276 931 NM SNFs leased to NHC 33,974 33,056 918 2.8 % SNFs leased to Legend Healthcare 11,918 11,099 819 7.4 % Other new and existing leases 28,913 25,539 3,374 13.2 % 99,558 77,700 21,858 28.1 % Straight-line rent adjustments, new and existing leases 6,471 3,782 2,689 71.1 % Total Rental Income 106,029 81,482 24,547 30.1 % Interest income from mortgage and other notes Capital Funding Group 2,062 626 1,436 NM Bickford Senior Living 531 8 523 NM ElderTrust 644 1,068 (424 ) (39.7 )% SeniorTrust 475 999 (524 ) (52.5 )% Bell Oden - 853 (853 ) NM Other new and existing mortgages 3,921 3,872
49 1.3 %
Total Interest Income from Mortgage and
Other Notes 7,633 7,426 207 2.8 % Investment income and other 4,166 4,409 (243 ) (5.5 )% Total Revenue 117,828 93,317 24,511 26.3 % Expenses: Depreciation ALFs leased to Bickford Senior Living 4,229 1,344 2,885 NM ALF leased to Landmark Senior Living 581 - 581 NM SLC leased to SantÉ Partners 679 226 453 NM Hospital leased to Polaris 440 76 364 NM Other new and existing assets 14,172 13,126
1,046 8.0 %
Total Depreciation 20,101 14,772 5,329 36.1 % Interest expense and amortization of loan costs 9,229 3,492 5,737 NM Franchise, excise and other taxes 616 771 (155 ) (20.1 )% General and administrative 9,254 7,799 1,455 18.7 % Loan and realty (recoveries) losses, net 1,976 (2,195 ) 4,171 NM Other expenses 784 766 18 2.3 % 41,960 25,405 16,555 65.2 % Income before equity-method investee, discontinued operations and noncontrolling interest 75,868 67,912 7,956 11.7 % Income from equity-method investee 324 45 279 NM Investment and other gains 3,306 4,877 (1,571 ) (32.2 )% Income from continuing operations 79,498 72,834 6,664 9.1 % Income from discontinued operations 5,426 6,098 (672 ) (11.0 )% Gain on sale of real estate 22,258 11,966 10,292 86.0 % Net income 107,182 90,898 16,284 17.9 % Net income attributable to noncontrolling interest (999 ) (167 ) (832 ) NM Net income attributable to common stockholders
$ 106,183 $ 90,731 $ 15,45217.0 % NM - not meaningful 37
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Financial highlights of the year ended
• Rental income increased
the prior year primarily as a result of new real estate investments of
minimally to the increase, as it was placed in service during the last
days of the year. Future increases in rental income depend on our ability
to make new investments which meet our underwriting criteria. • Interest income from mortgage and other notes for 2014 is expected to be
lower than 2013 due to (1) the settlement of outstanding notes receivable
balances from not-for-profit borrowers,
of a previous writedown of
$2,061,000. Unless we continue to make new investments in loans in 2014 and future years, our interest income will decrease due to the normal amortization and scheduled maturities of our loans. • Depreciation expense recognized in continuing operations increased
investments completed during 2012 and 2013.
• Interest expense, which includes amortization of loan costs of
relates to our borrowings on our credit facility and debt assumptions to
fund new real estate and loan investments. Amortization of loan costs for
modifications we made to the credit facility at the end of the second
quarter. Upfront fees and other loan-related costs are amortized over the
term of the credit facility. The increase in interest expense and loan
cost amortization of
fund new real estate investments in 2012 and 2013. We expect to fund
additional healthcare real estate investments in 2014 with borrowings from
our bank credit facility and longer-term debt, both secured and unsecured,
which will increase our interest expense. • General and administrative expenses for 2013 increased
$1,455,000when compared to 2012 primarily due to higher consulting and advisory costs
resulting from our increased investment activity, employee compensation
completed during 2013.
• Loan and realty losses include an impairment of of
collateral for the SeniorTrust note. In
previous writedown of
$2,061,000. • Investment and other gains include the write-off of a $3,256,000contingent purchase liability that is not required to be paid. We recognized a gain of $19,370,000on our sale of six skilled nursing facilities to our tenant, NHC, and a gain of $2,888,000on two other
dispositions discussed in Note 2 to the consolidated financial statements.
The results of operations for facilities included in assets held for sale or sold, including the gain or loss on such sales, have been reported in the current and prior periods as discontinued operations. The reclassifications to retrospectively reflect the disposition of these facilities had no impact on previously reported net income. 38
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The significant items affecting revenues and expenses are described below (in thousands): Years ended December 31, Period Change 2012 2011 $ % Revenues: Rental income SNFs leased to Legend Healthcare
$ 11,099 $ 6,512 $ 4,58770.4 % ALFs leased to Bickford Senior Living 4,646 3,485 1,161 33.3 % SLC leased to SantÉ Partners 744 - 744 NM ALFs leased to Senior Living Management 3,703 3,239 464 14.3 % ALF leased to Selah Management Group 1,391 843 548 65.0 % Other new and existing leases 56,117 54,676 1,441 2.6 % 77,700 68,755 8,945 13.0 % Straight-line rent adjustments, new and existing leases 3,782 3,853 (71 ) (1.8 )% Total Rental Income 81,482 72,608 8,874 12.2 % Interest income from mortgage and other notes Capital Funding Group 626 70 556 NM Other new and existing mortgages 6,800 6,582
218 3.3 %
Total Interest Income from Mortgage and
Other Notes 7,426 6,652 774 11.6 % Investment income and other 4,409 4,479 (70 ) (1.6 )% Total Revenue 93,317 83,739 9,578 11.4 % Expenses: Depreciation SNFs leased to Legend Healthcare
$ 1,923 $ 277 $ 1,646NM SNFs leased to Fundamental reclassified to continuing operations 907 - 907 NM Other new and existing assets 11,942 11,173
769 6.9 %
Total Depreciation 14,772 11,450 3,322 29.0 % Interest expense: Change in fair value of interest rate swap agreement - 1,197 (1,197 ) NM Interest expense and amortization of loan costs 3,492 2,651
841 31.7 %
Total Interest Expense 3,492 3,848 (356 ) (9.3 )% Loan and realty (recoveries) losses, net (2,195 ) (99 ) (2,096 ) NM Share-based compensation expense 2,168 3,087 (919 ) (29.8 )% Salaries, wages & benefits 3,334 2,863 471 16.5 % Other expenses 3,834 3,034 800 26.4 % 25,405 24,183 1,222 5.1 % Income before equity-method investment, discontinued operations and noncontrolling interest 67,912 59,556 8,356 14.0 % Income from equity-method investment 45 - 45 NM Investment and other gains 4,877 10,261 (5,384 ) (52.5 )% Income from continuing operations 72,834 69,817 3,017 4.3 % Income from discontinued operations 6,098 7,967 (1,869 ) (23.5 )% Gain on sale of real estate 11,966 3,348 8,618 NM Net income 90,898 81,132 9,766 12.0 % Net income attributable to noncontrolling interest (167 ) - (167 ) NM Net income attributable to common stockholders
$ 90,731 $ 81,132 $ 9,59911.8 % NM - not meaningful 39
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Financial highlights of the year ended
• Rental income increased
prior year primarily as a result of new real estate investments of
$75,806,000in 2011 and $129,851,000in 2012.
• Interest income from mortgage and other notes increased
new loan investments of
in 2012. • Depreciation expense increased
$3,322,000primarily as the result of
were reclassified from discontinued operations after the agreement to sell
the facilities was canceled. The adjustment to depreciation expense of
depreciation on these properties had the disposal group been continuously
classified as held and used.
• Interest expense related to borrowings on our credit facility to fund new
real estate and loan investments. Upfront fees and other loan-related
costs are amortized over the term of the credit facility. The
decrease in the fair value of the interest rate swap agreement increased
interest expense in 2011 since the agreement, which was terminated in
2011, did not qualify for hedge accounting treatment. In 2012, adjustments
hedge were recorded in Other Comprehensive Income and not as a component
of operations as the new interest rate swap qualified for hedge
accounting. An increase in interest payments and loan cost amortization of
$841,000resulted from expanded borrowings, offset by a lower LIBORunderlying our floating-rate debt in 2012. • Our net loan and realty recoveries of $2,195,000in 2012 reflect a recovery of $4,495,000on mortgage notes receivable, net of the SeniorTrust mortgage note impairment of $2,300,000as discussed in the
notes to the consolidated financial statements. NHI's collection history
with SeniorTrust and the deterioration of the financial condition and
creditworthiness of the borrower indicated that the carrying value of the
mortgage note receivable was not recoverable.
• Share-based compensation expense decreased in 2012 based upon lower stock
volatility which is a key input to the Black-Scholes pricing model for
determining the market value of our stock options granted to directors and
employees. The value of the options is expensed over the vesting period of
the individual grants.
• Investment and other gains in 2012 includes income of
to an equity participation formula as part of a mortgage note payoff in
December 2012from one of our borrowers.
• One of our subsidiaries (1) reached a settlement regarding the final tax
return for the operations acquired through foreclosure, and (2) agreed to
settle a claim for personal injury in relation to a matter which arose
prior to our acquisition of the subsidiary. These settlements resulted in
charges against income in 2012 in the amounts of
respectively, and are included in other expenses.
The results of operations for facilities included in assets held for sale or sold, including the gain or loss on such sales, have been reported in the current and prior periods as discontinued operations. The reclassifications to retrospectively reflect the disposition of these facilities had no impact on previously reported net income. 40
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Liquidity and Capital Resources
Sources and Uses of Funds
Our primary sources of cash include rent payments, principal and interest payments on mortgage and other notes receivable, dividends received on our investments in the common and preferred shares of other REITs, proceeds from the sales of real property and borrowings from our term loans and revolving credit facility. Our primary uses of cash include dividend distributions to our shareholders, debt service payments (both principal and interest), new investments in real estate and notes and general corporate overhead.
These sources and uses of cash are reflected in our Consolidated Statements of Cash Flows as summarized below (dollars in thousands):
Year Ended One Year
Change Year Ended One Year Change
12/31/2013 12/31/2012 $ % 12/31/11 $ % Cash and cash equivalents at beginning of period
$ 9,172 $ 15,886 $ (6,714 )(42.3 )% 2,664 $ 13,222496.3 % Net cash provided by operating activities 104,193 86,266 17,927 20.8 % 76,854 9,412 12.2 % Net cash used in investing activities (625,824 ) (99,810 ) (526,014 ) 527.0 % (55,474 ) (44,336 ) 79.9 % Net cash provided by (used in) financing activities 523,771 6,830 516,941 NM (8,158 ) 14,988 NM Cash and cash equivalents at end of period $ 11,312 $ 9,172 $ 2,140
23.3 % 15,886
Operating Activities - Net cash provided by operating activities for the year ended
December 31, 2013increased primarily as a result of the collection of lease payments on new real estate investments completed during 2012 and 2013.
Investing Activities - Net cash flows used in investing activities for the year ended
Financing Activities - Net cash flows provided by financing activities for the year ended
December 31, 2013increased as a result of a new $250,000,000term loan, $282,542,000in proceeds from an equity offering and increased borrowings on our revolving credit facility all of which were used to fund real estate investments, partially offset by $85,145,000in dividends paid to stockholders.
December 31, 2013, our liquidity was strong, with $106,962,000available in cash, highly-liquid marketable securities and borrowing capacity on our revolving credit facility. In addition, our investment in LTC preferred stock is convertible into 2,000,000 shares of common stock whose per share price ranged between $35and $40during the quarter ended December 31, 2013. Cash proceeds from lease and mortgage collections, loan payoffs and the recovery of previous write-downs have been distributed as dividends to stockholders, used to retire our indebtedness, and accumulated in bank deposits for the purpose of making new real estate and mortgage loan investments. On June 28, 2013, we entered into a $370,000,000unsecured credit facility that includes $120,000,000of 7-year term loans that are fully drawn. The facility includes an uncommitted incremental facility feature allowing for an additional $130,000,000of borrowings. The credit facility provides for unsecured, revolving borrowings of up to $250,000,000with a maturity of 5 years (inclusive of a one year extension option) and interest initially at 140 basis points over LIBOR, and $80,000,000and $40,000,000unsecured, 7-year term loans with interest initially at 150 basis points over LIBOR. Interest rates are referenced to our Consolidated Leverage Ratio, as defined, and were adjusted in December 2013to 165 basis points over LIBORfor the revolving credit facility and 175 basis points over LIBORfor the term loans to account for debt undertaken in conjunction with our Holiday acquisition. There is an unused commitment fee of 35 basis points per annum. At December 31, 2013, we had $83,000,000available to draw on the revolving portion of the credit facility. Quoted 30-day LIBORwas 17 basis points on December 31, 2013. On November 27, 2013, we announced the sale of 5,175,000 shares of our common stock at $57per share. The net proceeds from the offering were approximately $282,542,000, after deducting $12,500,000in underwriting discounts, commissions and other offering expenses. This offering represents the largest capital transaction since our initial public offering. Following this transaction, in December 2013, we closed on a new term loan with a syndicate of banks led by Wells Fargo, which provided us with a new $250,000,000term loan which has the same maturity as our revolving credit facility. Interest on the new term loan is 175 basis points over LIBOR. We used $492,959,000of the combined proceeds from the stock offering and term loan to acquire 25 independent living properties from affiliates of Holiday Acquisition Holdings LLC. 41
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The unsecured credit facility mentioned above requires that we maintain certain financial ratios within limits set by our creditors. To date, these ratios, which are calculated quarterly, have been well within the limits required by the credit facility agreements. We continually assess the impact of any new investments and the underlying capital requirements on these limits. In the future, our resource allocation decisions may be driven in part by the need to maintain compliance with these creditor-imposed limits. As part of the Care acquisition described in Note 2, we assumed Fannie Mae mortgage loans with principal balances of
$71,090,000and $7,234,000at December 31, 2013, which have interest at rates of 6.85% and 7.17%, respectively, and mature on July 1, 2015. The loans are subject to early-payment penalties extending until December 2014. At that time, we may consider other favorable arrangements. In August 2013, with borrowings from our revolving credit facility, we paid off a $19,250,000mortgage which carried interest at 300 basis points over LIBORand had a scheduled maturity of November 2013. To mitigate our exposure to interest rate risk, we have entered into the following interest rate swap contracts on two of our term loans as of December 31, 2013(dollars in thousands): Date Entered Maturity Date Fixed Rate Rate Index Notional Amount Fair Value May 2012 April 2019 3.29% 1-month LIBOR $ 40,000 $ 544 June 2013 June 2020 3.86% 1-month LIBOR $ 80,000 $ 431 We plan to refinance the borrowings on our revolving credit facility into longer-term debt instruments. We will consider secured debt from U.S. Govt. agencies, including HUD, private placements of unsecured debt, and public offerings of debt and equity. We anticipate that our historically low cost of debt capital will rise in the near to mid-term, as the federal government inevitably transitions away from quantitative easing. Because of consensus expectations of resultant rising interest rates, refinancing the borrowings on our revolving credit facility continues to be a high priority. If we modify or replace existing debt, we would incur debt issuance costs. These fees would be subject to amortization over the term of the new debt instrument and may result in the write-off of fees associated with debt which has been replaced or modified. Sustaining long-term dividend growth will require that we consider all forms of capital mentioned above, with the goal of maintaining a low-leverage balance sheet as mitigation against potential adverse changes in the business of our tenants and borrowers. We intend to comply with REIT dividend requirements that we distribute at least 90% of our annual taxable income for the year ending December 31, 2013and thereafter. During 2013, we declared total dividends (regular and special) of $2.90per common share in 2013, $2.86per common share in 2012, and $2.715per common share in 2011. Dividends declared for the fourth quarter of each fiscal year are paid by the end of the following January and are, with some exceptions, treated for tax purposes as having been paid in the fiscal year just ended as provided in IRS Code Sec. 857(b)(8). The 2012 and 2011 dividends declared included a special dividend of $.22per common share. The special dividend for 2012 was due to a recovery of a previous writedown at the end of December 2012. The record date for shareholders was required to be in January 2013, therefore, the special dividend was taxable to shareholders in 2013. We declare special dividends when we compute our REIT taxable income in an amount that exceeds our regular dividends for the fiscal year.
Off Balance Sheet Arrangements
We currently have no outstanding guarantees. For a discussion of our letter of credit with an affiliate of Bickford, see our discussion in this section under Contractual Obligations, below. Our equity method investment in OpCo is intended to be self-financing, and aside from initial investments therein, no direct support has been provided by NHI to OpCo since inception on
September 30, 2012. We have concluded that OpCo meets the accounting criteria to be considered a VIE. However, because we do not control the entity, nor do we have any role in the day-to-day management, we are not the primary beneficiary of the entity, and we account for our investment using the equity method. We have no material obligation arising from our investment in OpCo, and we believe our maximum exposure to loss at December 31, 2013, due to this involvement, would be limited to our equity interest. 42
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Contractual Obligations and Contingent Liabilities
Less than 1 More than 5 Total year 1-3 years 3-5 years years Debt, including interest1
$ 689,576$ - $ 111,912 $ 25,485 $ 552,179Real estate purchase liabilities 2,600 1,000 1,600 - - Construction commitments 34,450 34,450 - - - Loan commitments 2,000 2,000 - - - $ 728,626 $ 37,450 $ 113,512 $ 25,485 $ 552,1791 Interest is calculated based on the interest rate at December 31, 2013through maturity of the 7-year term loans, the revolving credit facility, and the mortgages assumed in our arrangement with Bickford, based on the balances outstanding as of December 31, 2013. The calculation also includes an unused commitment fee of .35%.
Commitments and Contingencies
December 31, 2013, our consolidated subsidiary, PropCo, had purchased land and begun construction on one assisted living facilities having a maximum cost of $9,000,000. Our costs incurred to date, including land, were $2,712,000. In a further transaction, we have a commitment of $2,785,000on a letter of credit for the benefit of our joint venture partner, an affiliate of Bickford.
October 2013, we entered into a $7,500,000commitment to build a 46-unit free-standing assisted living and memory care community, expanding our Linda Valleysenior living campus in Loma Linda, California. We expect to begin construction during the first quarter of 2014. The initial lease term is for 15 years at an annual rate of 9% plus a fixed annual escalator. NHI purchased the Linda Valleycampus in 2012 and leased it to Chancellor Health Care, who has been operating the campus since 1993. We also committed to provide up to $500,000for renovations and improvements related to our recent acquisition of a 63-unit senior housing community in Baltimore, Marylandwhich we have leased to Chancellor Health Care. We expect to begin the renovations during the first quarter of 2014.
As a lease inducement, we have a contingent commitment to fund a series of payments up to
$2,500,000in connection with our September 2013lease to Discovery of a senior living campus in Rainbow City, Alabama. Discovery would earn the contingent payments upon obtaining, and maintaining, a specified lease coverage ratio. As earned, the payments would be due in installments of $750,000in each of years two and three of the lease with the residual due in year four. As of December 31, 2013, the likelihood that we would incur the contingent payments was not considered probable. Accordingly, no provision for these payments is reflected in the consolidated financial statements.
March 2012, we entered into a long-term lease extension and construction commitment to Jackson Hospital Corporation, an affiliate of Community Health Systems, to provide up to $8,000,000for extensive renovations and additions to our Kentucky River Medical Center, a general acute care hospital in Jackson, Kentucky. This investment will be added to the basis on which the lease amount is calculated. The construction project commenced during the first quarter of 2013 and is expected to continue over 43
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two years. Total construction costs incurred as of
Legend HealthcareIn October 2011, we completed a purchase/leaseback of four skilled nursing facilities in Texaswith affiliates of Legend Healthcare, LLC("Legend") for $55,278,000, which included contingent consideration of $5,478,000. In December 2012, we funded $2,222,000of this contingent consideration. We had previously anticipated the remaining $3,256,000, which was recorded as a purchase liability, to be funded. During the quarter ended December 31, 2013, we determined that Legend had not achieved the required operating metrics and therefore would not qualify for this remaining consideration. As a result, we have recorded a gain of $3,256,000on the settlement of this purchase liability and have included this amount in investment and other gains in our Consolidated Statements of Income. SantÉ We have a $2,000,000supplemental construction commitment to our borrower, SantÉ Partners, LLC("SantÉ"). This additional loan amount becomes available to the borrower when the 70-bed transitional rehabilitation hospital, completed in March 2011, achieves certain operating metrics. NHI also has the option to purchase and lease back the hospital when it achieves a predetermined level of stabilized net operating income. We had previously committed to fund a $3,500,000expansion and renovation program in connection with our August 2012acquisition of the senior living campus in Silverdale, Washingtonleased to SantÉ. As of December 31, 2013, we had fully funded this commitment, which was added to the basis on which the lease amount is calculated. Also in connection with our Silverdale, Washingtonsenior living campus, we have a contingent commitment to fund two lease inducement payments of $1,000,000each. SantÉ would earn the payments upon obtaining, and maintaining, a specified lease coverage ratio. If earned, the first payment would be due after the second lease year and the second payment would be due after the third lease year. At acquisition, the likelihood that we would incur the contingent payments was not considered probable. Accordingly, no provision for these payments is reflected in the consolidated financial statements. 44
Table of Contents FFO, AFFO & FAD Funds From Operations - FFO Our funds from operations for the year ended
December 31, 2013increased $7,503,000, or 8.0%, over the same period in 2012. Our normalized FFO for the year ended December 31, 2013increased $12,448,000, or 14.1%, over the same period in 2012, primarily as the result of our new real estate investments in 2012 and 2013. FFO represents net earnings available to common stockholders, excluding real estate asset impairments and gains on dispositions, plus depreciation associated with real estate investments. Normalized FFO excludes from FFO certain items which, due to their infrequent or unpredictable nature, may create some difficulty in comparing FFO for the current period to similar prior periods, and may include, but are not limited to, impairment of non-real estate assets, gains and losses attributable to the acquisition and disposition of assets and liabilities, and recoveries of previous write-downs. We believe that FFO and normalized FFO are important supplemental measures of operating performance for a REIT. 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. Since real estate values instead have historically risen and fallen with market conditions, presentations of operating results for a REIT that uses historical cost accounting for depreciation could be less informative, and should be supplemented with a measure such as FFO. The term FFO was designed by the REIT industry to address this issue.
Adjusted Funds From Operations - AFFO
Our normalized AFFO for the year ended
We believe that normalized AFFO is an important supplemental measure of operating performance for a REIT. Generally accepted accounting principles ("GAAP") require a lessor to recognize contractual lease payments into income on a straight-line basis over the expected term of the lease. This straight-line adjustment has the effect of reporting lease income that is significantly more or less than the contractual cash flows received pursuant to the terms of the lease agreement. Normalized AFFO is useful to our investors as it reflects the rate escalators inherent in the contractual lease payments received from our lessees.
Funds Available for Distribution - FAD
Our normalized FAD for the year ended
December 31, 2013increased $11,528,000, or 13.2%, over the same period in 2012 due primarily to the impact of real estate investments completed during 2012 and 2013. In addition to the adjustments included in the calculation of normalized AFFO, normalized FAD excludes the impact of depreciation not associated with real estate investments and stock based compensation.
We believe that normalized FAD is an important supplemental measure of operating performance for a REIT as a useful indicator of the ability to distribute dividends to shareholders.
These operating performance measures may not be comparable to similarly titled measures used by other REITs. Consequently, our FFO, normalized FFO, normalized AFFO & normalized FAD may not provide a meaningful measure of our performance as compared to that of other REITs. Since other REITs may not use our definition of these operating performance measures, caution should be exercised when comparing our Company's FFO, normalized FFO, normalized AFFO & normalized FAD to that of other REITs. These financial performance measures do not represent cash generated from operating activities in accordance with GAAP (these measures do not include changes in operating assets and liabilities) and therefore should not be considered an alternative to net earnings as an indication of operating performance, or to net cash flow from operating activities as determined by GAAP as a measure of liquidity, and is not necessarily indicative of cash available to fund cash needs. 45
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The following table reconciles net income attributable to common stockholders, the most directly comparable GAAP metric, to FFO, Normalized FFO, Normalized AFFO and Normalized FAD and is presented for both basic and diluted weighted average common shares (in thousands, except share and per share amounts): Years ended
2013 2012 2011 Net income attributable to common stockholders
$ 106,183 $ 90,731 $ 81,132Elimination of certain non-cash items in net income: Real estate depreciation in continuing operations 17,646 13,182 10,516 Real estate depreciation related to noncontrolling interest (537 ) (68 ) - Real estate depreciation in discontinued operations 557 2,209 542 Net gain on sales of real estate (22,258 ) (11,966 ) (3,348 ) Funds from operations $ 101,591 $ 94,088 $ 88,842Investment gains (3,256 ) (4,760 ) (9,899 ) Loan costs expensed due to credit facility amendments 416 - - Non-cash write-off of straight-line rent receivable - 963 - Change in fair value of interest rate swap agreement - - 1,197 Legal settlement - 365 - Loan impairments and (recoveries), net 1,976 (2,195 ) (99 ) Other items, net 208 26 135 Normalized FFO $ 100,935 $ 88,487 $ 80,176Straight-line lease revenue, net (6,560 ) (3,664 ) (3,778 ) Straight-line lease revenue, net, related to noncontrolling interest 55 - - Non-cash write-off of straight-line rent receivable - (963 ) - Normalized AFFO $ 94,430 $ 83,860 $ 76,398Non-real estate depreciation in continuing operations 2,455 1,590 934 Non-real estate depreciation related to noncontrolling interest (97 ) (19 ) - Non-cash stock based compensation 2,339 2,168 3,087 Normalized FAD $ 99,127 $ 87,599 $ 80,419BASIC
Weighted average common shares outstanding 28,362,398 27,811,813 27,719,096 FFO per common share
$ 3.58 $ 3.38 $ 3.21Normalized FFO per common share $ 3.56 $ 3.18 $ 2.89Normalized AFFO per common share $ 3.33 $ 3.02 $ 2.76Normalized FAD per common share $ 3.50$
Weighted average common shares outstanding 28,397,702 27,838,720 27,792,592 FFO per common share
$ 3.58 $ 3.38 $ 3.20Normalized FFO per common share $ 3.55 $ 3.18 $ 2.88Normalized AFFO per common share $ 3.33 $ 3.01 $ 2.75Normalized FAD per common share $ 3.49 $ 3.15 $ 2.8946
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We consider Adjusted EBITDA to be an important supplemental measure because it provides information which we use to evaluate our performance and serves as an indication of our ability to service debt. We define Adjusted EBITDA as consolidated earnings before interest, taxes, depreciation and amortization, including amounts in discontinued operations, excluding real estate asset impairments and gains on dispositions and certain items which, due to their infrequent or unpredictable nature, may create some difficulty in comparing Adjusted EBITDA for the current period to similar prior periods, and may include, but are not limited to, impairment of non-real estate assets, gains and losses attributable to the acquisition and disposition of assets and liabilities, and recoveries of previous write-downs. Since others may not use our definition of Adjusted EBITDA, caution should be exercised when comparing our Adjusted EBITDA to that of other companies. The following table reconciles net income, the most directly comparable GAAP metric, to Adjusted EBITDA: Years ended December 31, 2013 2012 2011 Net income
$ 107,182 $ 90,898 $ 81,132Interest expense 9,229 3,492 2,651 Franchise, excise and other taxes 616 771 837
Depreciation in continuing and discontinued operations 20,658 16,981 11,992 Net gain on sales of real estate
(22,258 ) (11,966 ) (3,348 ) Investment gains (3,256 ) (4,760 ) (9,899 ) Loan costs expensed due to credit facility amendments 416 - - Non-cash write-off of straight-line rent receivable - 963 - Change in fair value of interest rate swap agreement - - 1,197 Legal settlement - 365 - Loan impairments and (recoveries), net 1,976 (2,195 ) (99 ) Other items, net 208 26 135 Adjusted EBITDA
$ 114,771 $ 94,575 $ 84,59847
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