Omega Healthcare Investors, Inc. — Q2 2017 Form 10-Q Summary
Business context and reporting period
Quarterly report for the period ended June 30, 2017, filed August 9, 2017. Omega is a self-administered REIT operating through an UPREIT structure with OHI Healthcare Properties Holdco and Omega Healthcare Properties Limited Partnership. The company provides capital and financing to the long-term healthcare sector, primarily through triple-net leases and mortgage loans focused on skilled nursing facilities.
At June 30, 2017, the portfolio comprised 999 healthcare facilities in 42 states and the United Kingdom, operated by 77 third-party operators. Approximately 99% of real estate investments related to long-term care facilities. Omega and its subsidiaries owned approximately 96% of Omega OP units.
Key financial metrics
| Metric | Three months ended June 30, 2017 | Three months ended June 30, 2016 | Six months ended June 30, 2017 | Six months ended June 30, 2016 |
|---|---|---|---|---|
| Operating revenues | $235.8 million | $228.8 million | $467.5 million | $441.7 million |
| Net income | $68.2 million | $113.2 million | $177.3 million | $171.4 million |
| Net income available to common stockholders | $65.3 million | $108.1 million | $169.7 million | $163.6 million |
| Diluted EPS | $0.33 | $0.57 | $0.86 | $0.86 |
| NAREIT FFO | $150.9 million | $172.3 million | $331.9 million | $325.9 million |
| Dividends declared per share | $0.63 | $0.58 | $1.25 | $1.15 |
Six-month operating cash flow was $265.6 million, compared with $286.9 million in the prior-year period. Investing activities used $135.9 million, while financing activities used $202.6 million. Cash and cash equivalents declined to $21.0 million from $93.7 million at December 31, 2016.
At June 30, 2017, total assets were $8.9 billion, total equity was $4.2 billion and debt was approximately $4.4 billion, equal to approximately 51.5% of total capitalization. Net real estate investments were $6.4 billion, mortgage notes receivable were $662.7 million and other investments were $279.0 million.
Reported operating expense margins were approximately 40.2% for the second quarter and 40.0% for the first six months, based on operating revenues and total operating expenses. Net income margins were approximately 28.9% and 37.9%, respectively; the second-quarter margin was reduced by refinancing costs and other unusual items.
Material changes versus the prior comparable period
- Second-quarter revenue increased $7.0 million, or approximately 3.0%, primarily from acquisitions, lease amendments and additional investment income, partially offset by lower mortgage interest income.
- Six-month revenue increased $25.8 million, or approximately 5.8%, driven by acquisitions, lease amendments and higher other investment income.
- Second-quarter net income available to common stockholders decreased approximately 39.6%, primarily because of $22.0 million of refinancing costs, higher interest expense, higher depreciation and amortization, higher uncollectible-account provisions and greater impairment losses.
- Six-month net income available to common stockholders increased approximately 3.7%, while six-month NAREIT FFO increased approximately 1.8%. Six-month results benefited from lower impairment and acquisition costs but were affected by higher interest and refinancing costs.
- Second-quarter operating expenses increased $8.1 million, primarily due to higher depreciation and amortization, uncollectible-account provisions and real estate impairments. Six-month operating expenses decreased $15.7 million because impairments and acquisition costs were substantially lower than in 2016.
- The company acquired 20 facilities during the first six months for total investment of approximately $140.4 million, including 18 United Kingdom assisted living facilities acquired in the second quarter for $124.2 million. It also acquired two land parcels for approximately $5.5 million.
- During the first six months, the company sold facilities and direct-financing-lease assets and recorded net gains on asset sales of $6.8 million. Seven facilities with a carrying value of $18.9 million remained held for sale at June 30, 2017.
Debt, liquidity and capital structure
- On May 25, 2017, Omega entered into new $1.8 billion senior unsecured revolving and term loan facilities, including a $1.25 billion revolving facility, a $425 million U.S. dollar term loan and a £100 million sterling term loan. The facilities include an accordion feature allowing aggregate commitments to increase to $2.5 billion, subject to conditions.
- At June 30, 2017, outstanding borrowings included $155.0 million under the revolving facility, $425.0 million under the U.S. term loan, £100.0 million under the sterling term loan, $250.0 million under the amended 2015 term loan and $100.0 million under the Omega OP term loan.
- In April 2017, Omega issued $550 million of 4.75% senior notes due 2028 and $150 million of additional 4.50% senior notes due 2025. Proceeds were used to redeem $400 million of 5.875% notes due 2024, repay term-loan and revolving-credit borrowings, and fund related purposes.
- The company recorded approximately $22.0 million of second-quarter refinancing costs, including an $11.8 million call premium and write-offs of deferred financing costs. Debt covenants were reported to be satisfied at June 30, 2017.
- Management stated that cash from operations, available credit facilities and expected mortgage-payoff proceeds should be adequate for operations, debt service, capital improvements, dividends and acquisitions over the next twelve months.
Outlook, management commentary, risks and unusual items
- Management expects to continue selling the seven facilities classified as held for sale within the next twelve months or over the next few quarters.
- Two top-ten operators were approximately 90 days past due on rent. One faced liquidity pressure following a management transition; the other was affected by liability issues in Kentucky and ongoing discussions regarding a Department of Justice investigation. Omega continued to accrue rental revenue from the first operator but may switch to cash-basis recognition and reassess asset values if performance deteriorates.
- Several operators have responded to subpoenas or information requests from the Department of Justice or other regulators. The filing states that one top-ten operator was in ongoing settlement discussions with the Department of Justice.
- Key sector risks include government reimbursement reductions, Medicaid and Medicare reform, value-based purchasing, operator liquidity and bankruptcy, healthcare regulation, quality-of-care and fraud-and-abuse enforcement, interest-rate and capital-market conditions, foreign currency exposure and the ability to maintain REIT status.
- CMS proposed or implemented changes affecting skilled nursing reimbursement, quality reporting, value-based purchasing and prospective payment methodologies. The filing states that the ultimate impact of healthcare reform and reimbursement changes could not be predicted.
- Management declared a quarterly dividend of $0.64 per share on July 13, 2017, payable August 15, 2017. The company expects 2017 dividends to exceed taxable income.
- The company adopted ASU 2016-09 effective January 1, 2017; management reported no material impact. It was evaluating the potential effects of revenue, lease and credit-loss standards scheduled for future adoption.
- Legal proceedings were described as arising in the normal course of business, with management believing that pending or threatened matters would not have a material adverse effect on consolidated financial position or results of operations.
Most important facts for investors to verify
- Reconcile the decline in second-quarter EPS and NAREIT FFO with the refinancing costs, higher interest expense, impairments and operator-credit provisions.
- Monitor rent collections, receivables and potential cash-basis revenue recognition for the two delinquent top-ten operators.
- Review debt maturities, variable-rate exposure, refinancing costs, credit-facility availability and compliance with financial covenants.
- Assess whether the $0.64 quarterly dividend is adequately supported by recurring cash flow and FFO after debt service and capital requirements.
- Track the disposition of the seven held-for-sale facilities and any additional impairments or gains and losses on sale.
- Evaluate the effect of Medicare and Medicaid reimbursement changes, CMS quality requirements and Department of Justice or other regulatory matters on operator coverage and rent-paying capacity.
- Confirm portfolio concentration, including the 10% investment exposure to Ciena Healthcare and the substantial concentration in skilled nursing and other long-term care facilities.