OMEGA HEALTHCARE INVESTORS INC annual report, FY2018

Omega Healthcare Investors, Inc. 2018 Form 10-K Summary

Business context and reporting period

Annual report for the fiscal year ended December 31, 2018, filed February 26, 2019. Omega is a self-administered healthcare REIT operating through OHI Healthcare Properties Limited Partnership. Its portfolio emphasizes long-term, triple-net healthcare leases and fixed-rate mortgage investments, primarily involving skilled nursing facilities.

At year-end, the portfolio included 924 facilities in 41 states and the United Kingdom, operated by 68 third-party operators.
Portfolio composition included 735 skilled nursing facilities, 116 assisted living facilities, 14 specialty facilities, one medical office building, mortgage investments on 54 facilities, and four closed or held-for-sale facilities.
Omega owned approximately 96% of Omega OP; outside investors owned approximately 4%.

Financial performance and key metrics

Metric	2018	2017	Change
Operating revenues	$881.7 million	$908.4 million	Down $26.7 million
Net income	$293.9 million	$104.9 million	Up $189.0 million
Net income available to common stockholders	$281.6 million	$100.4 million	Up $181.2 million
Basic EPS	$1.41	$0.51	Up $0.90
Diluted EPS	$1.40	$0.51	Up $0.89
Nareit FFO	$587.4 million	$444.3 million	Up $143.1 million
Net cash from operating activities	$499.4 million	$577.9 million	Down $78.5 million

Approximate margins were 56.4% for operating income, 33.3% for net income, and 66.6% for Nareit FFO, calculated from reported revenue. Nareit FFO is a non-GAAP measure and should not be treated as a substitute for GAAP net income or liquidity.

Revenue mix included $767.3 million of rental income, $1.6 million of direct financing lease income, $70.3 million of mortgage interest income, and $40.2 million of other investment income.
Operating expenses declined to $408.9 million from $647.1 million, primarily because 2017 included substantially higher impairment charges.
Depreciation and amortization was $281.3 million; general and administrative expense increased to $63.5 million from $47.7 million.
Net real estate impairment was $29.8 million, compared with $99.1 million in 2017. Direct financing lease impairment was $27.2 million, compared with $198.2 million in 2017.
Omega paid $528.7 million of common dividends in 2018, or $2.64 per share, compared with $2.54 per share in 2017. Quarterly dividends were $0.66 per share.

Fourth-quarter 2018 results

Revenue was $219.8 million, compared with $221.2 million in fourth-quarter 2017.
Net income was $64.9 million, compared with $65.2 million in fourth-quarter 2017.
Net income available to common stockholders was $62.2 million, or $0.31 per diluted share, compared with $62.4 million, or $0.31 per diluted share, in fourth-quarter 2017.
The quarter included approximately $3.2 million of real estate impairments and a $15.5 million gain on sales of facilities.

Balance sheet, debt, liquidity and capital allocation

Total assets were $8.6 billion, total equity was $3.8 billion, and reported debt was approximately $4.6 billion at December 31, 2018.
Debt represented approximately 54.9% of total capitalization.
Cash, cash equivalents and restricted cash were $11.7 million, down $85.1 million from year-end 2017. Cash and cash equivalents alone were $10.3 million.
Net cash used in investing activities was $173.2 million, including $105.1 million of real estate acquisitions, $139.4 million of construction-in-progress investment, and $385.7 million of investments in other investments. Real estate sale proceeds were $309.6 million.
Net cash used in financing activities was $410.7 million, including $528.7 million of dividends paid. The company issued approximately 2.3 million shares under its equity shelf program for net proceeds of $75.5 million and issued approximately 1.5 million shares through its dividend reinvestment plan for $46.8 million.
Debt maturities were reported as $333.0 million in 2021, $903.0 million in 2022, $700.0 million in 2023, and $2.65 billion thereafter. No principal maturities were scheduled for 2019 or 2020 in the reported debt table.
Management stated that cash from operations, credit facility availability, asset sales, and expected investment payoffs were adequate to fund operations, debt service, capital improvements, dividends, and planned investments for the next twelve months.
The company was in compliance with its debt covenants at year-end.

Material changes versus the prior comparable period

Revenue declined 2.9%, primarily because of facility sales and the placement of certain operators on a cash basis due to nonpayment or collectability concerns. Mortgage interest and other investment income increased.
Net income and FFO increased substantially because 2017 contained significant impairments and debt-refinancing costs. The improvement therefore includes a meaningful reduction in unusual and non-cash charges.
Operating cash flow declined despite higher reported net income, principally because of lost Orianna direct financing lease income and a $50.0 million payment related to an operator purchase option.
Omega sold 78 facilities in 2018 for approximately $309.6 million of net proceeds and recognized a $24.8 million net gain, compared with 52 facilities sold and a $53.9 million gain in 2017.
Core assets declined to $8.59 billion from $8.69 billion, while other investments increased to $504.6 million from $276.3 million.
Loan reserves declined to $108.1 million from $177.5 million, largely reflecting the reduction and restructuring of the Orianna exposure.
The company adopted the new revenue recognition standard and recognized a $10.0 million deferred gain through opening equity; management stated the adoption did not materially affect the financial statements.

Guidance, outlook, risks and unusual items

Management expected generally stable occupancy and operator coverage, but noted increasing labor and liability costs, declining Medicare and private-pay mix, reimbursement pressure, and localized occupancy weakness.
Management expected operators generally to meet their obligations, while identifying financial stress at certain operators, particularly in Texas. Texas represented approximately 10% of investments and had challenging occupancy and Medicaid reimbursement conditions.
Management expected the October 2019 transition from RUG-IV to the Patient Driven Payment Model to benefit operators over time, although the near-term effects remain uncertain.
Orianna entered Chapter 11 in 2018. Omega recorded an additional $27.2 million allowance in the fourth quarter, leaving a net direct financing lease investment of approximately $120.5 million at year-end. In January 2019, the remaining 15 facilities were sold for $176 million of consideration, including a $30.0 million seller note. Omega received $78.8 million from the related distribution trust on February 13, 2019; further recoveries remain contingent on collections and final creditor and wind-down costs.
Agemo was formed in a restructuring of Signature Healthcare. Omega deferred up to $6.3 million of annual rent for three years, committed approximately $4.5 million annually for capital expenditures, and provided a working-capital loan of up to $25 million, of which $14.3 million was outstanding at year-end.
Daybreak fell approximately two months behind on rent in the fourth quarter. Omega agreed to defer approximately $4.2 million of fourth-quarter 2018 rent and approximately $2.5 million in each of the first two quarters of 2019.
On January 2, 2019, Omega agreed to acquire MedEquities Realty Trust. Expected consideration, including assumed debt, was approximately $600 million. Closing was expected in the first half of 2019 but remained subject to customary conditions, including shareholder approval and regulatory and legal conditions.
Key risks include operator bankruptcies and defaults, Medicare and Medicaid reimbursement reductions, labor costs, quality and regulatory enforcement, concentration in major operators and states, refinancing and interest-rate exposure, LIBOR transition risk, impairment risk, litigation, REIT qualification, and the integration and financing of the MedEquities transaction.
A securities class action and related derivative actions concerning alleged disclosures about operator performance, lease impairments and receivable collectability were pending. The company could not predict the outcome or estimate potential costs.

Most important facts for investors to verify

Reconcile reported net income and FFO growth to the large year-over-year reduction in impairment and refinancing charges.
Review operator coverage, rent collections, receivable aging and non-accrual or cash-basis accounting, particularly for Agemo, Daybreak, Ciena, Genesis and the residual Orianna exposure.
Assess the $4.6 billion debt load, 2021-2023 maturities, variable-rate debt, covenant headroom and refinancing assumptions.
Evaluate whether the $499.4 million of operating cash flow adequately supports the $528.7 million dividend, capital commitments and planned acquisitions.
Confirm the timing, funding, assumed debt and expected accretion or dilution from the approximately $600 million MedEquities acquisition.
Review the remaining $213.1 million of unfunded construction and capital-improvement commitments and the potential $7.4 million operator-transition indemnity exposure.
Monitor Texas reimbursement and occupancy trends, the October 2019 PDPM implementation, and the effects of labor and liability-cost inflation.
Confirm the status and potential exposure from the pending securities and derivative litigation.