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LTC > SEC Filings for LTC > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Quarterly Report



Statement Regarding Forward Looking Disclosure

This quarterly report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, adopted pursuant to the Private Securities Litigation Reform Act of 1995. Statements that are not purely historical may be forward-looking. You can identify some of the forward-looking statements by their use of forward-looking words, such as ''believes,'' ''expects,'' ''may,'' ''will,'' ''should,'' ''seeks,'' ''approximately,'' ''intends,'' ''plans,'' ''estimates'' or ''anticipates,'' or the negative of those words or similar words. Forward- looking statements involve inherent risks and uncertainties regarding events, conditions and financial trends that may affect our future plans of operation, business strategy, results of operations and financial position. A number of important factors could cause actual results to differ materially from those included within or contemplated by such forward-looking statements, including, but not limited to, the status of the economy, the status of capital markets (including prevailing interest rates), and our access to capital; the income and returns available from investments in health care related real estate, the ability of our borrowers and lessees to meet their obligations to us, our reliance on a few major operators; competition faced by our borrowers and lessees within the health care industry, regulation of the health care industry by federal, state and local governments, (including as a result of the Patient Protection and Affordable Care Act of 2010 and the Health Care and Education Reconciliation Act of 2010), changes in Medicare and Medicaid reimbursement amounts (including due to federal and state budget constraints), compliance with and changes to regulations and payment policies within the health care industry, debt that we may incur and changes in financing terms, our ability to continue to qualify as a real estate investment trust, the relative illiquidity of our real estate investments, potential limitations on our remedies when mortgage loans default, and risks and liabilities in connection with properties owned through limited liability companies and partnerships. For a discussion of these and other factors that could cause actual results to differ from those contemplated in the forward-looking statements, please see the discussion under ''Risk Factors'' contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 and in our publicly available filings with the Securities and Exchange Commission. We do not undertake any responsibility to update or revise any of these factors or to announce publicly any revisions to forward-looking statements, whether as a result of new information, future events or otherwise.

Executive Overview


We are a self-administered health care real estate investment trust (or REIT) that invests primarily in senior housing and long term healthcare properties through mortgage loans, property lease transactions and other investments. Our primary senior housing and long term healthcare property types include skilled nursing properties (or SNF), assisted living properties (or ALF), independent living properties (or ILF) and combinations thereof. Additionally, we develop purpose built, free-standing memory care properties designed to attract private-pay residents requiring dementia care services. In the third quarter of 2012, senior housing and long term healthcare properties comprised approximately 98% of our investment portfolio. We have been operating since August 1992.

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The following table summarizes our direct real estate investment portfolio which consists of properties that we own or on which we hold promissory notes secured by first mortgages as of September 30, 2012 (dollar amounts in thousands):

                                                    Nine Months Ended
                                                    September 30, 2012     Percentage        Number                 Number of
     Type of            Gross      Percentage of   Rental     Interest         of              of           SNF       ALF        ILF
     Property        Investments    Investments    Income    Income (1)   Revenues (2)   Properties (3)   Beds(4)   Units(4)   Units(4)
Skilled Nursing         $461,915           54.0%   $32,466       $2,191          50.5%               89    10,397          -      -
Assisted Living          308,419           36.1%    24,819        1,910          38.9%              102         -      4,365      -
Other Senior
Housing (5)               67,627            7.9%     5,873          260           8.9%               14       913        330     423
Schools                   12,268            1.4%     1,184            -           1.7%                2         -          -      -
Development(6)             4,671            0.6%         -            -           0.0%                -         -          -      -
Totals                  $854,900          100.0%   $64,342       $4,361         100.0%              207    11,310      4,695     423

(1) Includes interest income from mortgage loans.

(2) Includes rental income and interest income from mortgage loans.

(3) We have investments in 30 states leased or mortgaged to 41 different operators.

(4) See Item 2. Properties for discussion of bed/unit count.

(5) Other senior housing properties consist of independent living properties and properties providing any combination of skilled nursing, assisted living and/or independent living services.

(6) We have two properties under development: 120-bed skilled nursing property in Texas which will replace an existing 90-bed skilled nursing property we own and 60-unit free-standing memory care property in Colorado.

As of September 30, 2012 we had $661.1 million in carrying value of net real estate investments, consisting of $612.9 million or 92.7% invested in owned properties and properties under development and $48.2 million or 7.3% invested in mortgage loans secured by first mortgages.

During the three months ended September 30, 2012, we received a notice of prepayment from a borrower who holds seven mortgage loans secured by seven assisted living properties with a weighted average interest rate of 12.1%. We expect to receive a total of $15.2 million plus accrued interest on or about November 24, 2012 related to this payoff. We intend to use the proceeds to partially repay amounts outstanding under our Unsecured Credit Agreement.

In October 2012, we purchased vacant land in Kansas for $0.7 million. Simultaneous with the purchase, we entered into a lease agreement and development commitment in an amount not to exceed $9.9 million to fund the construction of a 77-unit assisted living and memory care property. Rent under the lease will begin upon the earlier of project completion or the fifteenth month following the effective date of lease. Initial rent at the rate of 9.25% will be calculated based on the land purchase price and construction costs funded plus 9.0% compounded on each advance under the commitment from the disbursement date until the earlier of project completion or the improvement deadline. The lease has a 10-year initial term, two 5-year renewal options and annual escalations of 2.5%.

For the nine months ended September 30, 2012, rental income and interest income from mortgage loans represented 92.6% and 6.3%, respectively, of total gross revenues. In most instances, our lease structure contains fixed annual rental escalations, which are generally recognized on a straight-line basis over the minimum lease period. Certain leases have annual rental escalations that are contingent upon changes in the Consumer Price Index and/or changes in the gross operating revenues of the property. This revenue is not recognized until the appropriate contingencies have been resolved. For the nine months ended September 30, 2012, we recorded $2.2 million in straight-line rental income and $26,000 of straight-line rent receivable reserve. At September 30, 2012, the straight-line rent receivable balance, net of reserves, for continuing and discontinued operations on the balance sheet was $25.9 million.

For leases in place at September 30, 2012, assuming no modification or replacement of existing leases and no new leased investments are added to our portfolio, we currently expect that straight-line rental income will decrease from $3.1 million for projected annual 2012 to $2.4 million for projected annual 2013 and, conversely, our cash rental income is projected to increase from $84.6 million for projected annual 2012 to $89.8 million for projected annual 2013. During the nine months ended September 30, 2012, we received

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$62.6 million of cash rental revenue and recorded amortization of lease inducement cost of $0.5 million. Many of our existing leases contain renewal options that could renew above or below current rent rates. For the nine months ended September 30, 2012 we renewed three leases by 1) replacing one expired lease with a new lease and 2) combined two other leases into one master lease. The operators of these renewed leases remained the same.

Our primary objectives are to sustain and enhance stockholder equity value and provide current income for distribution to stockholders through real estate investments in senior housing and long term care properties managed by experienced operators. To meet these objectives, we attempt to invest in properties that provide opportunity for additional value and current returns to our stockholders and diversify our investment portfolio by geographic location, operator and form of investment. We opportunistically consider investments in health care facilities in related businesses where the business model is similar to our existing model and the opportunity provides an attractive expected return. Consistent with this strategy, we pursue, from time to time, opportunities for potential acquisitions and investments, with due diligence and negotiations often at different stages of development at any particular time.

With respect to skilled nursing properties, we attempt to invest in properties that do not have to rely on a high percentage of private-pay patients. We prefer to invest in a property that has significant market presence in its community and where state certificate of need and/or licensing procedures limit the entry of competing properties.

For assisted living and independent living investments we have attempted to diversify our portfolio both geographically and across product levels. Thus, we believe that although the majority of our investments are in affordably priced units, our portfolio also includes a significant number of upscale units in appropriate markets with certain operators.

We have begun an initiative to develop purpose built, free-standing memory care properties designed to attract private-pay residents requiring dementia care services. Memory care facilities offer specialized options for seniors with Alzheimer's disease and other forms of dementia. Purpose built, free-standing memory care facilities offer an attractive alternative for private-pay residents affected by memory loss in comparison to other accommodations that typically have been provided within a secured unit of an assisted living or skilled nursing facility. These facilities offer dedicated care and specialized programming for various conditions relating to memory loss in a secured environment that is typically smaller in scale and more residential in nature than traditional assisted living facilities. Residents require a higher level of care and more assistance with activities of daily living than in assisted living facilities. Therefore, these facilities have staff available 24 hours a day to respond to the unique needs of their residents.

Substantially all of our revenues and sources of cash flows from operations are derived from operating lease rentals and interest earned on outstanding loans receivable. Our investments in mortgage loans and owned properties represent our primary source of liquidity to fund distributions and are dependent upon the performance of the operators on their lease and loan obligations and the rates earned thereon. To the extent that the operators experience operating difficulties and are unable to generate sufficient cash to make payments to us, there could be a material adverse impact on our consolidated results of operations, liquidity and/or financial condition. To mitigate this risk, we monitor our investments through a variety of methods determined by the type of health care facility and operator. Our monitoring process includes periodic review of financial statements for each facility, periodic review of operator credit, scheduled property inspections and review of covenant compliance relating to real estate taxes and insurance.

In addition to our monitoring and research efforts, we also structure our investments to help mitigate payment risk. Some operating leases and loans are credit enhanced by guaranties and/or letters of credit. In addition, operating leases are typically structured as master leases and loans are generally cross-defaulted and cross-collateralized with other loans, operating leases or agreements between us and the operator and its affiliates.

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Depending upon the availability and cost of external capital, we anticipate making additional investments in health care related properties. New investments are generally funded from cash on hand, temporary borrowings under our unsecured line of credit and internally generated cash flows. Our investments generate internal cash from rent and interest receipts and principal payments on mortgage loans receivable. Permanent financing for future investments, which replaces funds drawn under our unsecured line of credit, is expected to be provided through a combination of public and private offerings of debt and equity securities and secured and unsecured debt financing. 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.

At September 30, 2012, we had $8.3 million of cash on hand, $204.5 million available under our $240.0 million Unsecured Credit Agreement and $100.0 million available under the uncommitted private shelf agreement. Subsequent to September 30, 2012, we repaid $6.0 million under our Unsecured Credit Agreement. Accordingly, we had $29.5 million outstanding with $210.5 million available for borrowing. We have the ability to access the capital markets through the issuance of $64.6 million of common stock under our equity distribution agreement and through the issuance of debt and/or equity securities under our $167.6 million effective shelf registration. As a result, we believe our liquidity and various sources of available capital are sufficient to fund operations, meet debt service obligations (both principal and interest), make dividend distributions and finance some future investments should we determine such future investments are financially feasible.

We believe our business model has enabled and will continue to enable us to maintain the integrity of our property investments, including in response to financial difficulties that may be experienced by operators. Traditionally, we have taken a conservative approach to managing our business, choosing to maintain liquidity and exercise patience until favorable investment opportunities arise.

Healthcare Regulatory Climate

The Centers for Medicare & Medicaid Services (or CMS) annually updates Medicare skilled nursing facility prospective payment system rates and other policies. On July 29, 2011, CMS issued its final rule updating Medicare skilled nursing facility rates for fiscal year 2012, which began on October 1, 2011. Under the final rule, average Medicare rates were reduced by 11.1%, or $3.87 billion, compared to fiscal year 2011 levels. CMS stated that the rate reduction was needed to recalibrate skilled nursing facility payment rates to correct what CMS characterized as an "unintended spike" in payments in fiscal year 2011, when CMS implemented the Resource Utilization Groups, version four (or RUG-IV) patient classification system. Although CMS intended implementation of RUG-IV to be budget-neutral, CMS has taken the position that claims under the updated system show a significant increase in Medicare expenditures, in part because the proportion of patients grouped in the highest-paying RUG therapy categories greatly exceeded CMS expectations. CMS applied a 12.6% recalibration reduction, which was partially offset by a 1.7% standard rate update (which represented a 2.7% market basket update reduced by a 1.0 percentage point "multifactor productivity adjustment" mandated by the Affordable Care Act). On July 27, 2012, CMS issued a notice updating Medicare skilled nursing facility payment rates for fiscal year 2013, which began on October 1, 2012. The notice calls for a 1.8 percent update in rates (consisting of a 2.5 % market basket update, reduced by a 0.7 percentage point multifactor productivity adjustment). CMS estimates that overall Medicare payments to skilled nursing facilities in fiscal year 2013 will increase by $670 million compared to fiscal year 2012. In addition, on July 11, 2012, CMS published a proposed rule that would, among other things, codify provisions of section 3201 of the Middle Class Tax Extension and Job Creation Act of 2012 that require reductions in bad debt reimbursement to all providers, suppliers, and other entities eligible to receive bad debt reimbursement. These reductions will gradually reduce the amount Medicare skilled nursing facilities can claim as bad debt to 65% of allowable bad debt by fiscal year 2015. There can be no assurance that this rule or any future reductions in Medicare skilled nursing facility payment rates would not have an adverse effect on the financial condition of our borrowers and lessees which could, in turn, adversely impact the timing or level of their payments to us.

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In March 2010, the President signed into law the Patient Protection and Affordable Care Act, which subsequently was amended by the Health Care and Education and Reconciliation Act of 2010 (collectively referred to as the "Affordable Care Act"). The Affordable Care Act is designed to expand access to affordable health insurance, contain health care costs, and institute a variety of health policy reforms. The provisions of the sweeping law may affect us directly, as well as impact our lessees and borrowers. While certain provisions, such as expanding the insured population, may positively impact the revenues of our lessees and borrowers, other provisions, particularly those intended to reduce federal health care spending, could have a negative impact on our lessees and borrowers. Among other things, the Affordable Care Act:
reduces Medicare skilled nursing facility reimbursement by a so-called "productivity adjustment" based on economy-wide productivity gains beginning in fiscal year 2012 (as noted above); requires the development of a value-based purchasing program for Medicare skilled nursing facility services; establishes a national voluntary pilot program to bundle Medicare payments for hospital and post-acute services that could lead to changes in the delivery of post-acute services; and provides incentives to state Medicaid programs to promote community-based care as an alternative to institutional long term care services. The Affordable Care Act also includes provisions intended to expand public disclosure about nursing home ownership and operations, institute mandatory compliance and quality assurance programs, increase penalties for noncompliance, and expand fraud and abuse enforcement and penalty provisions that could impact our operators. In addition, the Affordable Care Act impacts both us and our lessees and borrowers as employers, including new requirements related to the health insurance we offer to our respective employees. Many aspects of the Affordable Care Act are being implemented through new regulations and subregulatory guidance. We cannot predict at this time what effect, if any, the various provisions of the Affordable Care Act will have on our lessees and borrowers or our business. There can be no assurances, however, that the Affordable Care Act will not adversely impact the operations, cash flows or financial condition of our lessees and borrowers, which subsequently could materially adversely impact our revenue and operations.

On August 2, 2011, President Obama signed into law the Budget Control Act of 2011, which increased the nation's debt ceiling while taking steps to reduce the federal deficit. Under this law, a bipartisan Joint Select Committee on Deficit Reduction was responsible for identifying $1.5 trillion in deficit reduction, which could include cuts in Medicare, Medicaid, and other federal spending and/or revenue increases. The Committee failed to achieve consensus on deficit reduction measures. As a result, because no legislation was adopted to achieve deficit reduction targets by the statutory deadline, absent additional legislation, an enforcement mechanism known as sequestration will trigger a total of $1.2 trillion in spending reductions in January 2013, divided between domestic and defense spending. Medicare provider payments will also be subject to sequestration, although the reductions will be capped at 2%. There can be no assurances that federal spending reductions resulting from the Budget Control Act or other budget control mechanisms will not have an adverse impact on the financial condition of our lessees and borrowers, which subsequently could materially adversely impact our company.

In addition, comprehensive reforms affecting the payment for and availability of health care services have been proposed at the state level and adopted by certain states. Congress and state legislatures can be expected to continue to review and assess alternative health care delivery systems and payment methodologies, including initiatives targeting long-term care services for Medicaid and Medicare-Medicaid dual eligible beneficiaries. Changes in the law, new interpretations of existing laws, or changes in payment methodologies may have a dramatic effect on the definition of permissible or impermissible activities, the relative costs associated with doing business and the amount of reimbursement by the government and other third party payors.

Key Transactions

During the three months ended September 30, 2012, we purchased two 144-bed skilled nursing properties located in Ohio for an aggregate purchase price of $54.0 million. Simultaneous with the purchase, we leased the properties to an unrelated third-party operator at a GAAP yield of 10.1%. The initial term of the lease is 15 years with two 5-year renewal options and annual rent escalations of the lesser of i) 2.25% for the first seven years and 2.50% for the remainder of the term or ii) a calculation based on the consumer price index. We also acquired a 90-bed skilled nursing property located in Texas for an aggregate purchase price of $6.5 million during the three months ended September 30, 2012. Simultaneous with the purchase, we added the property to an existing master lease with an unrelated third-party operator at an incremental GAAP yield of 10.7%.

Additionally, during the nine months ended September 30, 2012, we sold $85.8 million aggregate principal amount of 5.03% senior unsecured term notes in a private placement transaction. The notes have a 12-year maturity and a 10-year average life. We used the proceeds to paydown our unsecured line of credit and to fund acquisitions.

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Key Performance Indicators, Trends and Uncertainties

We utilize several key performance indicators to evaluate the various aspects of our business. These indicators are discussed below and relate to concentration risk and credit strength. Management uses these key performance indicators to facilitate internal and external comparisons to our historical operating results in making operating decisions and for budget planning purposes.

Concentration Risk. We evaluate our concentration risk in terms of asset mix, investment mix, operator mix and geographic mix. Concentration risk is valuable to understand what portion of our investments could be at risk if certain sectors were to experience downturns. Asset mix measures the portion of our investments that are real property or mortgage loans. In order to qualify as an equity REIT, at least 75 percent of our total assets must be represented by real estate assets, cash, cash items and government securities. Investment mix measures the portion of our investments that relate to our various property types. Operator mix measures the portion of our investments that relate to our top three operators. Geographic mix measures the portion of our investment that relate to our top five states. The following table reflects our recent historical trends of concentration risk (gross investment in thousands):

                                                           Period Ended
                                      9/30/12    6/30/12    3/31/12    12/31/11    9/30/11
Asset mix:
Real property                         $805,759   $743,297   $740,951   $725,031   $690,458
Loans receivable                        49,141     50,246     53,282     54,002     54,987

Investment mix:
Skilled nursing properties            $461,915   $402,093   $404,721   $389,458   $357,271
Assisted living properties             308,419    308,534    308,647    308,757    308,680
Other senior housing properties (1)     67,627     67,685     67,742     67,732     67,302
Schools                                 12,268     12,236     12,229     12,192     12,192
Under Development (2)                    4,671      2,995        894        894          -

Operator mix:
Extendicare (ALC) (3)                  $88,034   $ 88,034   $ 88,034   $ 88,034   $ 88,034
Preferred Care, Inc. (4)                84,425     85,075     85,245     88,309     88,471
Brookdale Communities                   84,210     84,210     84,210     84,210     84,210
Remaining operators                    598,231    536,224    536,744    518,480    484,730

Geographic mix:
Texas                                 $229,062   $222,989   $223,245   $207,760   $191,965
Ohio                                   110,804     56,804     56,804     56,804     56,804
Florida                                 67,830     67,859     70,150     70,217     70,282
California                              51,643     51,701     51,916     52,036     34,653
New Mexico                              49,368     49,114     48,876     48,876     48,876
Remaining states                       346,193    345,076    343,242    343,340    342,865

(1) Other senior housing properties consist of independent living properties and properties providing any combination of skilled nursing, assisted living and/or independent living services.

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