OMEGA HEALTHCARE INVESTORS INC quarterly report, Q2 FY2018

Business Context and Reporting Period

Omega Healthcare Investors, Inc. is a self-administered healthcare REIT structured as an UPREIT through OHI Healthcare Properties Limited Partnership. The company invests primarily in triple-net leases, mortgages and loans supporting skilled nursing facilities, assisted living facilities and other healthcare properties in the U.S. and U.K. This combined Form 10-Q covers the three and six months ended June 30, 2018; financial statements are unaudited.

At June 30, 2018, the portfolio included 936 healthcare facilities in 41 states and the U.K., operated by 67 third-party operators. Approximately 99% of real estate investments related to long-term care facilities. Omega owned approximately 96% of Omega OP.

Key Financial Metrics

Metric	Three Months Ended June 30	Six Months Ended June 30
Total operating revenues	$219.9 million, down from $235.8 million	$440.1 million, down from $467.5 million
Net income	$82.0 million, up from $68.2 million	$169.9 million, down from $177.3 million
Net income available to common stockholders	$78.5 million, up from $65.3 million	$162.8 million, down from $169.7 million
Basic and diluted EPS	$0.39, versus $0.33	$0.82, versus $0.86
NAREIT FFO	$155.5 million, up from $150.9 million	$303.5 million, down from $331.9 million
Dividends declared per share	$0.66, versus $0.63	$1.32, versus $1.25

Operating income before other income and expense was $135.6 million for the quarter and $256.2 million for the six months. Calculated operating margins were approximately 61.6% and 58.2%, respectively. Net margins were approximately 37.3% for the quarter and 38.6% for the six months.

Six-month rental income was $386.8 million, essentially flat with $386.5 million in the prior year.
Direct financing lease income declined to $0.5 million from $15.5 million in the quarter and to $1.1 million from $31.1 million for the six months, principally because of Orianna.
General and administrative expense increased to $15.2 million from $11.5 million in the quarter and to $31.7 million from $24.1 million for the six months.
Net cash provided by operating activities was $217.2 million, compared with $264.2 million in the prior-year period.
Net cash used in investing activities was $6.3 million, compared with $135.9 million in the prior year, reflecting substantially higher property-sale proceeds.
Net cash used in financing activities was $294.1 million, compared with $202.6 million in the prior year, primarily reflecting dividends and debt activity.
Cash, cash equivalents and restricted cash totaled $13.5 million at June 30, 2018, down $83.3 million from December 31, 2017.

Balance Sheet, Debt and Liquidity

Total assets were $8.57 billion and total equity was $3.85 billion at June 30, 2018.
Debt was approximately $4.45 billion, representing about 53.6% of total capitalization. Debt consisted primarily of $902.2 million of term loans and $3.33 billion of senior notes and other unsecured borrowings, net of discounts and financing costs.
The revolving line of credit balance was $220.0 million, compared with $290.0 million at year-end 2017.
HUD-secured borrowings declined from $53.1 million at year-end to zero after the related mortgages were assumed by an operator in connection with a property sale.
Management stated that liquidity, operating cash flow, available credit facilities and expected mortgage-payoff proceeds were adequate for operations, debt service, dividends and planned investments over the following twelve months.
The company was in compliance with applicable debt covenants at June 30, 2018.

Material Changes Versus the Prior Comparable Period

Quarterly revenue decreased 6.7%, while quarterly net income increased 20.3%, primarily because the prior-year quarter included $22.0 million of refinancing costs and the current period had lower impairment expense.
Six-month revenue decreased 5.9% and net income decreased 4.1%, driven mainly by the loss of Orianna direct financing lease income and lower miscellaneous income.
Six-month NAREIT FFO declined 8.6%, despite higher quarterly FFO, reflecting the effects of operator disruptions and lost direct financing lease income.
The company acquired nine facilities for approximately $53.1 million during the first six months, plus two land parcels for approximately $3.5 million.
The company sold 14 facilities in the first quarter and 45 facilities plus one ancillary building in the second quarter. First-half net proceeds from real estate sales were $222.0 million.
At June 30, three facilities with a net book value of $3.8 million were classified as held for sale.
The company issued approximately $27.5 million of common stock under its equity shelf program and approximately $27.1 million through its dividend reinvestment and stock purchase plan during the first six months.
Adoption of the revenue standard resulted in a $10.0 million opening-equity adjustment related to a deferred gain; management reported no material overall impact on the financial statements.

Guidance, Outlook, Risks and Unusual Items

The filing does not provide a formal full-year earnings or FFO guidance range.
Management expected the strategic asset-repositioning program, involving sales of non-core properties and reinvestment in longer-term assets, to continue through much of 2018.
Orianna was in Chapter 11 proceedings. The company had not recognized direct financing lease income or operating lease income from Orianna for the period from July 1, 2017 through June 30, 2018. The related direct financing lease investment, net of a $172.2 million allowance, was $337.7 million.
After quarter-end, Omega declared the Orianna DIP facility in default, terminated further funding and terminated the restructuring support agreement. The company stated it was pursuing alternative strategies to protect assets and shareholder value. It transitioned 13 Mississippi facilities and one Indiana facility to existing operators for stated annual contractual rents of $12.0 million and $0.5 million, respectively.
Management stated that it remained confident the eventual resolution of the former Orianna portfolio would produce annual rent or rent equivalents in the previously stated range of $32 million to $38 million, but the outcome remained uncertain.
Other operator risks included reimbursement reductions, regulatory changes, occupancy and operating performance, operator bankruptcies, collectability of receivables, interest-rate changes, access to capital and the ability to re-lease or sell underperforming assets.
Accounts receivable included $226.6 million of straight-line rent receivables and $48.5 million of lease inducements. Two operators were placed on a cash basis during the quarter, and approximately $2.8 million of straight-line rent receivables was written off.
Remaining commitments for construction and capital improvements were $280.0 million at June 30, 2018. The company also committed up to approximately $13.6 million of capital expenditures for Agemo, of which approximately $13.1 million remained unfunded.
The company was defending a securities class action alleging misleading disclosures concerning an operator’s financial condition, rent payments, lease impairments and receivables. The potential costs and outcome could not be estimated.
Lease accounting guidance was scheduled for adoption on January 1, 2019, and the company was still evaluating its impact. Credit-loss guidance was scheduled for later adoption and was also under evaluation.

Investor Verification Priorities

Verify the resolution, recoveries and ultimate rent performance of the former Orianna portfolio, including the impact of the DIP default and terminated restructuring agreement.
Assess operator concentration and credit exposure, particularly to Ciena, Agemo, Genesis and other financially stressed operators.
Reconcile NAREIT FFO and dividend coverage with GAAP net income and operating cash flow, noting the significant decline in six-month FFO.
Review debt maturities, interest-rate exposure, revolver availability and compliance with financial covenants.
Evaluate the collectability of straight-line rent receivables, lease inducements, mortgage notes and other operator loans.
Monitor the $280.0 million of remaining capital commitments, assets held for sale and the continued asset-repositioning program.
Review the securities litigation, healthcare reimbursement changes, regulatory requirements and the potential effect of operator bankruptcies on cash rents and asset values.