NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2018
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
The Company
- National Health Investors, Inc. (“NHI”), established in 1991 as a Maryland corporation, is a self-managed real estate investment trust (“REIT”) specializing in sale-leaseback, joint-venture, mortgage and mezzanine financing of need-driven and discretionary senior housing and medical investments. Our portfolio consists of lease, mortgage and other note investments in independent living facilities, assisted living facilities, entrance-fee communities, senior living campuses, skilled nursing facilities, specialty hospitals and medical office buildings. Other investments have included marketable securities and a joint venture structured to comply with the provisions of the REIT Investment Diversification Empowerment Act of 2007 (“RIDEA”) through which we invested in facility operations managed by independent third-parties. We fund our real estate investments primarily through: (1) operating cash flow, (2) debt offerings, including bank lines of credit and term debt, both unsecured and secured, and (3) the sale of equity securities. Units, beds and square footage disclosures in this annual report on Form 10-K are unaudited.
Principles of Consolidation
- The accompanying consolidated financial statements include our accounts and the accounts of our wholly-owned subsidiaries, joint ventures, partnerships and consolidated variable interest entities (“VIE”), if any. All intercompany transactions and balances have been eliminated in consolidation. Net income is reduced by the portion of net income attributable to noncontrolling interests.
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 apply Financial Accounting Standards Board (“FASB”) guidance for our arrangements with 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. In accordance with FASB guidance, management must evaluate each of the Company’s contractual relationships which creates a variable interest in other entities. If the Company has a variable interest and the entity is a VIE, then management must determine whether the Company is the primary beneficiary of the VIE. If it is determined that the Company is the primary beneficiary, NHI consolidates the VIE. We identify the primary beneficiary of a VIE as the enterprise that has both: (i) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance; and (ii) the obligation to absorb losses or the right to receive benefits of the VIE that could be significant to the entity. We perform this analysis on an ongoing basis.
If, after consideration of the VIE accounting
lit
eratu
re,
the Company has determined that an entity is not a VIE, the Company assesses the need for consolidation
under
all other
provi
s
ion
s
of ASC 810. These provisions provide for consolidation of majority-owned
en
titie
s
through
a majority
voti
ng interest
held by the Company providing control.
At
December 31, 2018
, we held an interest in
six
unconsolidated VIEs. Because we generally lack either directly or through related parties any material input in the activities that most significantly impact their economic performance, we have concluded that NHI is not the primary beneficiary. Accordingly, we account for our transactions with these entities and their subsidiaries at amortized cost.
Our VIEs are summarized below by date of initial involvement. For further discussion of the nature of the relationships, including the sources of our exposure to these VIEs, see the notes to our consolidated financial statements cross-referenced below.
|
|
|
|
|
|
|
|
|
|
|
Date
|
Name
|
Source of Exposure
|
Carrying Amount
|
Maximum Exposure to Loss
|
Note Reference
|
2012
|
Bickford Senior Living
|
Various
1
|
$
|
53,649,000
|
|
$
|
77,878,000
|
|
Notes 2, 3
|
2014
|
Senior Living Communities
|
Notes and straight-line receivable
|
$
|
44,376,000
|
|
$
|
57,475,000
|
|
Notes 2, 3
|
2014
|
Life Care Services affiliate
|
Notes receivable
|
$
|
57,939,000
|
|
$
|
59,781,000
|
|
Note 3
|
2016
|
Senior Living Management
|
Notes and straight-line receivable
|
$
|
26,584,000
|
|
$
|
26,584,000
|
|
Note 3
|
2017
|
Evolve Senior Living
|
Note receivable
|
$
|
9,928,000
|
|
$
|
9,928,000
|
|
—
|
2018
|
Life Care Services affiliate
|
Notes receivable
|
$
|
85,017,000
|
|
$
|
178,200,000
|
|
Note 3
|
1
Notes, straight-line rent receivables & unamortized lease incentives
We are not obligated to provide support beyond our stated commitments to these tenants and borrowers whom we classify as VIEs, and accordingly our maximum exposure to loss from these relationships is limited to the amount of our commitments, as shown above and discussed in the notes. When the above relationships involve leases, some additional exposure to economic loss is present. Generally, additional economic loss on a lease, if any, would be limited to that resulting from a short period of arrearage and non-payment of monthly rent before we are able to take effective remedial action, as well as costs incurred in transitioning the lease. The potential extent of such loss will be dependent upon individual facts and circumstances, cannot be quantified, and is therefore not included in the tabulation above. Typically, the only carrying amounts involving our leases are accumulated straight-line receivables.
We apply FASB guidance related to investments in joint ventures based on the type of controlling rights held by the members’ interests in limited liability companies that may preclude consolidation by the majority equity owner in certain circumstances in which the majority equity owner would otherwise consolidate the joint venture.
We have structured our joint ventures to be compliant with the provisions of RIDEA which permits NHI to receive rent payments through a triple-net lease between a property company and an operating company and allows NHI the opportunity to capture additional value on the improving performance of the operating company through distributions to a taxable REIT subsidiary (“TRS”). Accordingly, prior to the termination of our joint venture on September 30, 2016, our TRS held NHI’s equity interest in an unconsolidated operating company, which we did not control, thus providing an organizational structure that allowed the TRS to engage in a broad range of activities and share in revenues that were otherwise non-qualifying income under the REIT gross income tests.
Noncontrolling Interest -
We have excluded net income attributable to the noncontrolling interest from net income attributable to common shareholders in our Consolidated Statement of Income for the
year ended
December 31, 2016
. As of
December 31, 2018
and during the
years ended
December 31, 2018
and
December 31, 2017
, there were no noncontrolling interests.
Equity-Method Investment
- Through September 30, 2016, we reported our TRS investment in an unconsolidated entity, over whose operating and financial policies we had the ability to exercise significant influence but not control, under the equity method of accounting. Under this accounting method, our pro rata share of the entity’s earnings or losses was included in our Consolidated Statements of Income. Additionally, we adjusted our investment carrying amount to reflect our share of changes in the equity-method investee’s capital resulting from its capital transactions. On September 30, 2016, we unwound the joint venture underlying the TRS and ceased participation in the operations which comprised all its activity.
Use of Estimates -
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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.
Earnings Per Share
- The weighted average number of common shares outstanding during the reporting period is used to calculate basic earnings per common share. Diluted earnings per common share assume the exercise of stock options using the treasury stock method, to the extent dilutive. Diluted earnings per share also incorporate the potential dilutive impact of our 3.25% convertible senior notes due 2021. We apply the treasury stock method to our convertible debt instruments, the effect of which is that conversion will not be assumed for purposes of computing diluted earnings per share unless the average share price of our common stock for the period exceeds the conversion price per share.
Fair Value Measurements
- Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between
market participants at the measurement date. A three-level fair value hierarchy is required to prioritize the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs.
The three levels of inputs used to measure fair value are as follows:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
If the fair value measurement is based on inputs from different levels of the hierarchy, the level within which the entire fair value measurement falls is the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. When an event or circumstance alters our assessment of the observability and thus the appropriate classification of an input to a fair value measurement which we deem to be significant to the fair value measurement as a whole, we will transfer that fair value measurement to the appropriate level within the fair value hierarchy.
Real Estate Properties -
Real estate properties are recorded at cost or, if acquired through business combination, at fair value, including the fair value of contingent consideration, if any. Cost or fair value at the time of acquisition is allocated among land, buildings, improvements, lease and other intangibles, and personal property. For properties acquired in transactions accounted for as asset purchases, the purchase price allocation is based on the relative fair values of the assets acquired. Cost includes the amount of contingent consideration, if any, deemed to be probable at the acquisition date. Contingent consideration is deemed to be probable to the extent that a significant reversal in amounts recognized is not likely to occur when the uncertainty associated with the contingent consideration is subsequently resolved. Cost also includes capitalized interest during construction periods. We use the straight-line method of depreciation for buildings over their estimated useful lives of 40 years, and improvements over their estimated useful lives ranging to 25 years. For contingent consideration arising from business combinations, the liability is adjusted to estimated fair value at each reporting date through earnings. For contingent consideration arising from asset acquisitions, the liability is adjusted to the amount considered probable each reporting period, with changes reflected as an adjustment to the basis of the related assets.
We evaluate the recoverability of the carrying value of our real estate 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.
Mortgage and Other Notes Receivable -
Each quarter, we evaluate the carrying values of our notes receivable on an instrument-by-instrument basis for recoverability 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 a note receivable becomes more than 30 days delinquent as to contractual principal or interest payments, the loan is classified as non-performing, and thereafter we recognize all amounts due when received. If necessary, an impairment is measured as the amount by which the carrying amount exceeds 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.
Cash and Cash Equivalents and Restricted Cash
- Cash equivalents consist of all highly liquid investments with an original maturity of three months or less. Restricted cash includes amounts required to be held on deposit in accordance with agency agreements governing our Fannie Mae and HUD mortgages.
The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the Company’s Consolidated Balance Sheets with the same amounts shown on the Company’s Consolidated Statements of Cash Flows
(in thousands)
:
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
2018
|
|
2017
|
Cash and cash equivalents
|
$
|
4,659
|
|
|
$
|
3,063
|
|
Restricted cash
|
5,253
|
|
|
5,012
|
|
|
$
|
9,912
|
|
|
$
|
8,075
|
|
Concentration of Credit Risks
- Our credit risks primarily relate to cash and cash equivalents and investments in mortgage and other notes receivable. Cash and cash equivalents are primarily held in bank accounts and overnight investments. We maintain our bank deposit accounts with large financial institutions in amounts that often exceed federally-insured limits. We have not experienced any losses in such accounts. Our mortgages and other notes receivable consist primarily of secured loans on facilities.
Our financial instruments, principally our investments in notes receivable, are subject to the possibility of loss of the carrying values as a result of the failure of other parties to perform according to their contractual obligations which may make the instruments less valuable. We obtain collateral in the form of mortgage liens and other protective rights for notes receivable and continually monitor these rights in order to reduce such possibilities of loss. We evaluate the need to provide for reserves for potential losses on our financial instruments based on management’s periodic review of our portfolio on an instrument-by-instrument basis.
Deferred Loan Costs
- Costs incurred to acquire debt are amortized by the effective interest method over the term of the related debt.
Deferred Income
- Deferred income primarily includes non-refundable lease commitment fees received by us, which are amortized into income over the expected period of the related loan or lease. In the event that our financing commitment to a potential borrower or lessee expires, the related commitment fees are recognized into income immediately. Commitment fees may be charged based on the terms of the lease agreements and the creditworthiness of the parties.
Rental Income
- Base rental income is recognized using the straight-line method over the term of the lease to the extent that lease payments are considered collectible. Under certain leases, we receive additional contingent rent, which is calculated on the increase in revenues of the lessee over a base year or base quarter. We recognize contingent rent annually or quarterly based on the actual revenues of the lessee once the target threshold has been achieved. Lease payments that depend on a factor directly related to future use of the property, such as an increase in annual revenues over a base year, are considered to be contingent rentals and are excluded from the schedule of minimum lease payments.
If rental income calculated on a straight-line basis exceeds the cash rent due under a lease, the difference is recorded as an increase to straight-line rent receivable in the Consolidated Balance Sheets and an increase in rental income in the Consolidated Statements of Income. If rental income on a straight-line basis is calculated to be less than cash received, there is a decrease in the same accounts.
Rental income is reduced for the non-cash amortization of payments made upon the eventual settlement of commitments and contingencies originally identified and recorded as lease inducements. We record contingent consideration arising from lease inducements to the extent that it is probable that a significant reversal of amounts recognized will not occur when the uncertainty associated with the contingent consideration is subsequently resolved.
We identify a lease as non-performing if a required payment is not received within 30 days of the date it is due. Our policy related to rental income on non-performing leased real estate properties is to recognize rental income in the period when the related cash is received.
Interest Income
from Mortgage and Other Notes Receivable
- Interest income is recognized based on the interest rates and principal amounts outstanding on the notes receivable. Under certain notes, we receive additional contingent interest, which is calculated on the increase in the current year revenues of a borrower over a base year. We identify a mortgage loan as non-performing if a required payment is not received within 30 days of the date it is due. Our policy related to mortgage interest income on non-performing mortgage loans is to recognize mortgage interest income in the period when the cash is received. As of
December 31, 2018
, we had not identified any of our mortgages as non-performing.
Derivatives
- In the normal course of business, we are subject to risk from adverse fluctuations in interest rates. We have chosen to manage this risk through the use of derivative financial instruments, primarily interest rate swaps. Counterparties to these contracts are major financial institutions. We are exposed to credit loss in the event of nonperformance by these counterparties. We do not use derivative instruments for trading or speculative purposes. Our objective in managing exposure to market risk is to limit the impact on cash flows.
To qualify for hedge accounting, our interest rate swaps must effectively reduce the risk exposure that they are designed to hedge. In addition, at inception of a qualifying cash flow hedging relationship, the underlying transaction or transactions must be, and be expected to remain, probable of occurring in accordance with our related assertions. All of our hedges are cash flow hedges.
We recognize all derivative instruments, including embedded derivatives required to be bifurcated, as assets or liabilities at their fair value in the Consolidated Balance Sheets. Changes in the fair value of derivative instruments that are not designated as hedges or that do not meet the criteria of hedge accounting are recognized in earnings. For derivatives designated in qualifying cash flow hedging relationships, the change in fair value of the effective portion of the derivatives is recognized in accumulated other comprehensive income (loss), whereas the change in fair value of the ineffective portion is recognized in earnings. Gains and losses are reclassified from accumulated other comprehensive income (loss) into earnings once the underlying hedged transaction is recognized in earnings.
Federal Income Taxes
- We intend at all times to qualify as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. Until 2016, we recorded income tax expense or benefit with respect to one of our subsidiaries which was taxed under provisions similar to those applicable to regular corporations. Aside from such income taxes which may be applicable to the taxable income in the 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 at least equal to or in excess of 90% our taxable income. Accordingly, no provision for federal income taxes has been made in the consolidated financial statements, except for the provision on the taxable income of the TRS, which is included in our consolidated statements of income under the caption, “Income tax expense of taxable REIT subsidiary.” Our failure to continue to qualify under the applicable REIT qualification rules and regulations would have a material adverse impact on our financial position, results of operations and cash flows.
Earnings and profits, which determine the taxability of dividends to stockholders, differ from net income reported for financial reporting purposes due primarily to differences in the basis of assets, estimated useful lives used to compute depreciation expense, gains on sales of real estate, non-cash compensation expense and recognition of commitment fees.
Our tax returns filed for years beginning in 2015 are subject to examination by taxing authorities. We classify interest and penalties related to uncertain tax positions, if any, in our consolidated financial statements as a component of income tax expense.
Segment Disclosures
- We are in the business of owning and financing health care properties. We are managed as one segment, rather than multiple segments, for internal purposes and for internal decision making.
Reclassifications
- We have reclassified certain balances where necessary to conform the presentation of prior periods to the current period. These reclassifications had no effect on previously reported net income.
New Accounting Pronouncements
- For a review of recent accounting pronouncements pertinent to our operations and management’s judgment as to the impact that the eventual adoption of these pronouncements will have on our financial position and results of operation, see Note 14.
NOTE 2. REAL ESTATE
As of
December 31, 2018
, we owned
220
health care real estate properties located in
33
states and consisting of
143
senior housing communities,
72
skilled nursing facilities,
3
hospitals and
2
medical office buildings. Our senior housing properties include assisted living facilities, senior living campuses, independent living facilities, and entrance-fee communities. These investments (excluding our corporate office of
$2,471,000
) consisted of properties with an original cost of approximately
$2,815,894,000
, rented under triple-net leases to
30
lessees.
Acquisitions and New Leases of Real Estate
During the
year ended
December 31, 2018
, we announced the following real estate investments and commitments as described below
(dollars in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
Operator
|
|
Date
|
|
Properties
|
|
Asset Class
|
|
Amount
|
The Ensign Group
|
|
January/May 2018
|
|
3
|
|
SNF
|
|
$
|
43,404
|
|
Bickford Senior Living
|
|
April 2018
|
|
5
|
|
SHO
|
|
69,750
|
|
Comfort Care Senior Living
|
|
May 2018
|
|
2
|
|
SHO
|
|
17,140
|
|
Ignite Medical Resorts
|
|
December 2018
|
|
1
|
|
SNF
|
|
25,350
|
|
|
|
|
|
|
|
|
|
$
|
155,644
|
|
Ensign
On January 12, 2018, NHI acquired from a developer a skilled nursing facility in Waxahachie, Texas for a cash investment of
$14,404,000
, and in May, we acquired from another developer
two
skilled nursing facilities in Garland and Fort Worth, Texas, for a cash investment totaling
$29,000,000
. Additional consideration of
$1,275,000
for the Waxahachie property and
$1,250,000
for each of Garland and Ft. Worth were contributed by the lessee, The Ensign Group (“Ensign”). We have capitalized the tenant contributions as a component of the cost of the facilities and have recorded the contributions as deferred revenue, which we are amortizing to revenue over the term of the master lease to which these properties have now been added. The remaining term of the master lease extends through April 2031, plus renewal options. The blended initial lease rate is set at
8.1%
, subject to annual escalators based on prevailing inflation rates. The acquisitions were accounted for as an asset purchase and fulfill our original commitment to acquire and lease to Ensign
four
skilled nursing facilities in New Braunfels, Waxahachie, Garland and Fort Worth, Texas.
Comfort Care
On May 31, 2018, NHI acquired
two
assisted living facilities in Bridgeport and Saginaw, Michigan for a cash investment of
$17,140,000
, inclusive of
$100,000
in closing costs. We leased the facilities to affiliates of Comfort Care Senior Living (“Comfort Care”) for a term of fifteen years at an initial lease rate of
7.25%
with annual escalators adjusted for prevailing inflation rates, subject to a floor and ceiling of
2%
and
3%
, respectively. The lease provides for an initial six-month cash escrow. With the acquisition, NHI also obtained fair value-based purchase options for
two
newly constructed facilities operated by Comfort Care, with the purchase option windows to open upon stabilization. The acquisition was accounted for as an asset purchase.
Ignite
In December 2018, we reached an agreement with Ignite Team Partners, LLC, d/b/a Ignite Medical Resorts, to develop a
$25,350,000
skilled nursing facility in suburban Milwaukee. The facility is currently under construction with an expected opening date in the fourth quarter of 2019. The facility will be leased to Ignite Healthcare, Inc. (“Ignite”) for a term of
12
years, with
two
ten
-year renewal options, at an initial lease rate of
9.5%
plus annual fixed escalators. Ignite will be eligible for an earn-out of up to
$2,000,000
, to be funded beginning in 2026 upon the attainment of specified metrics. NHI will have a right of first offer on future Ignite projects. We accounted for the transaction as an asset purchase. At
December 31, 2018
, we had funded
$4,674,000
, including
$2,000,000
for the purchase of land.
Major Customers
Bickford
As of
December 31, 2018
, our Bickford Senior Living (“Bickford”) portfolio consists of leases with primary lease expiration dates as follows
(in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease Expiration
|
|
|
June 2023
|
September 2024
|
September 2027
|
May 2031
|
April 2033
|
Total
|
Number of Properties
|
13
|
|
10
|
|
4
|
|
20
|
|
5
|
|
52
|
|
2018 Annual Contractual Rent
|
$
|
11,133
|
|
$
|
9,264
|
|
$
|
1,515
|
|
$
|
19,988
|
|
$
|
3,165
|
|
$
|
45,065
|
|
2018 Straight Line Rent Adjustment
|
588
|
|
(260
|
)
|
221
|
|
3,865
|
|
614
|
|
5,028
|
|
Total Revenues
|
$
|
11,721
|
|
$
|
9,004
|
|
$
|
1,736
|
|
$
|
23,853
|
|
$
|
3,779
|
|
$
|
50,093
|
|
|
|
|
|
|
|
|
On April 30, 2018, we acquired an assisted living/memory-care portfolio in Ohio and Pennsylvania comprising
five
facilities,
one
of which is subject to a ground lease with remaining term, including extensions, of
50
years. The purchase price was
$69,750,000
, including
$500,000
in closing costs and
$1,750,000
in specified capital improvements, which will be added to the lease base upon funding. In addition to the cash consideration stated above, we recorded an intangible liability of
$590,000
to
recognize our above-market obligation for the ground lease. We included this portfolio in a separate master lease with Bickford which provides for a lease rate of
6.85%
, with annual fixed escalators over a term of
15
years plus renewal options, subject to a fair market value rent reset feature available to NHI between years
three
and
five
.
Of our total revenues,
$50,093,000
(
17%
),
$41,606,000
(
15%
) and
$30,732,000
(
12%
) were recognized as rental income from Bickford for the
years ended
December 31, 2018
,
2017
and
2016
, including
$5,028,000
,
$5,102,000
, and
$858,000
in straight-line rent income, respectively.
Senior Living Communities
As of
December 31, 2018
, we leased
nine
retirement communities to Senior Living Communities (“Senior Living”) under a
15
-year master lease which began in December 2014, contains
two
5
-year renewal options and provides for an annual escalator of
4%
in 2018 and
3%
thereafter.
Of our total revenue,
$45,868,000
(
16%
),
$45,735,000
(
16%
) and
$40,332,000
(
16%
) in lease revenues were derived from Senior Living for the
years ended
December 31, 2018
,
2017
and
2016
, respectively, including
$5,436,000
,
$6,984,000
and
$7,369,000
in straight-line rent.
Holiday
As of
December 31, 2018
, we leased
25
independent living facilities to an affiliate of Holiday Retirement (“Holiday”) at an original cost of
$493,000,000
. The
17
-year master lease began in December 2013 and provides for a minimum annual escalator of
3.5%
after 2017.
Of our total revenues,
$43,311,000
(
15%
),
$43,817,000
(
16%
) and
$43,817,000
(
18%
) were derived from Holiday for the years ended
December 31, 2018
,
2017
and
2016
, respectively, including
$5,616,000
,
$7,397,000
and
$8,965,000
in straight-line rent, respectively. Our tenant operates the facilities pursuant to a management agreement with a Holiday-affiliated manager.
In November 2018, we entered into a lease amendment and guaranty release (“the Agreement”) with Holiday. The Agreement extends the term of the lease, increases required minimum capital expenditure per unit and provides NHI with a stronger projected 2019 lease coverage ratio. Below is a summary of the provisions of the new agreement:
|
|
•
|
We are to receive consideration of approximately
$65,762,000
consisting of a combination of cash and real estate equaling $55,125,000 and the forfeiture to us of $10,637,000 which is one-half of the original
$21,275,000
security deposit.
|
|
|
•
|
The agreement provided that, in lieu of cash mentioned above, we could have sole discretion to acquire a Holiday property that will be leased back to Holiday at an agreed-upon rent and subject to the same terms and conditions of the amended master lease. On January 31, 2019, we acquired a senior housing facility in Vero Beach, Florida as discussed in Note 15.
|
|
|
•
|
The lease maturity is extended by five years to December 31, 2035, and will be secured by the remaining half of the NHI-held security deposit. Additionally, NHI is requiring
$5,000,000
of equity to be contributed into the Holiday tenant entity (“the Credit Enhancement”). The use of the Credit Enhancement will be limited to payment of NHI rent and NHI-approved capital expenditures. Future return of the Credit Enhancement will further be limited by performance measures, including liquidity and lease service coverage ratio covenants. The Agreement also requires that
$6,500,000
of equity be contributed to the Holiday management company.
|
|
|
•
|
Effective January 1, 2019, Holiday rent was reset to
$31,500,000
for the existing 25 properties, as opposed to the
$39,000,000
previously obligated, with escalators commencing annually November 1, 2020, equal to the greater of
2.0%
or
45%
of trailing 12 months year‐over‐year revenue growth of the NHI/Holiday portfolio, not to exceed
3.0%
.
|
|
|
•
|
We have committed to invest up to
$5,000,000
in capital expenditures into the communities at a
7.0%
lease rate on funds drawn. In addition, Holiday has committed to a minimum of
$1,500
per unit in annual capital expenditures.
|
|
|
•
|
NHI and Holiday are reviewing the portfolio to identify underperforming properties within the existing Holiday lease. A subsequent sale of properties, if any, would reduce the rent owed us by
7.0%
of the net proceeds received by NHI. Stated levels of our security deposit and tenant Credit Enhancement will not be adjusted as a result of any future sale.
|
NHC
As of
December 31, 2018
, we leased
42
facilities under
two
master leases to National HealthCare Corporation (“NHC”), a publicly-held company and the lessee of our legacy properties. The facilities leased to NHC consist 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 of an amended master lease agreement originally dated October 17, 1991 (the “1991 lease”) which includes our
35
remaining legacy properties and a master lease agreement dated August 30, 2013 (the “2013 lease”) which includes
7
skilled nursing facilities acquired from a third party.
The 1991 lease has been amended to extend the lease expiration to December 31, 2026. There are
two
additional
5
-year renewal options, each at fair rental value of such leased property as negotiated between the parties and determined without including the value attributable to any improvements to the leased property voluntarily made by NHC at its expense. Under the terms of the lease, the base annual rental is
$30,750,000
and rent escalates by
4%
of the increase, if any, in each facility’s revenue over a 2007 base year. The 2013 lease provides for a base annual rental of
$3,450,000
and has a lease expiration of August 2028. Under the terms of the 2013 lease, rent escalates
4%
of the increase, if any, in each facility’s revenue over a 2014 base year. For both the 1991 lease and the 2013 lease, we refer to this additional rent component as “percentage rent.” During the last three years of the 2013 lease, NHC will have the option to purchase the facilities for
$49,000,000
.
The following table summarizes the percentage rent income from NHC (
in thousands
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
|
2016
|
Current year
|
$
|
3,411
|
|
|
$
|
3,127
|
|
|
$
|
2,932
|
|
Prior year final certification
1
|
285
|
|
|
194
|
|
|
547
|
|
Total percentage rent
|
$
|
3,696
|
|
|
$
|
3,321
|
|
|
$
|
3,479
|
|
1
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 31st of the following year.
Of our total revenues,
$37,843,000
(
13%
),
$37,467,000
(
13%
) and
$37,626,000
(
15%
) in
2018
,
2017
and
2016
, respectively, were derived from NHC.
The chairman of our board of directors is also a director on NHC’s board of directors. As of
December 31, 2018
, NHC owned
1,630,462
shares of our common stock.
Tenant Non-Compliance
Affiliates of East Lake
In documents we have previously filed with and furnished to the SEC, we have used the shorthand “East Lake” to refer to the East Lake Capital Management affiliated entities for whom we have acted or continue to act as landlord. These entities consist of EL FW Intermediary I, LLC (for the Freshwater/Watermark continuing care retirement communities) and SH Regency Leasing, LLC (for the
three
assisted living facilities in Tennessee, Indiana and North Carolina referred to as “Regency”).
On June 15, 2018, East Lake Capital Management LLC and certain related entities, including Regency, filed suit against NHI and NHI-REIT of Axel, LLC, in the District Court of Dallas County, Texas; 95th Judicial District
for injunctive and declaratory relief and unspecified monetary damages, including attorney’s fees. The suit sought, among other things, to enjoin NHI from making certain references to East Lake in NHI’s public filings. In response to this lawsuit, related litigation, and other circumstances, we entered motions calling for the immediate appointment of a receiver and for pre-judgment possession, hearing, and bond.
Resulting from these claims and counterclaims, on December 6, 2018, the plaintiff parties entered into an agreement with NHI under Texas Rule of Civil Procedure 11, which rule ensures the enforceability of an agreement between lawyers in a case when the agreement is in writing and filed in the papers of the court. As a result of the agreement, Regency vacated our facilities in Indiana and North Carolina on December 7, 2018 and in Tennessee on December 14, 2018. Due to a decrease in occupancy and the deferral of needed maintenance and capital expenditures related to their operation, NHI made arrangements with operators to manage the three facilities. NHI will receive
95%
of operating cash flow, if any, as generated by the facilities until such time as operations become stabilized or more formal agreements are entered into.
The original libel action of the East Lake affiliated entities survives the Rule 11 agreement and is set to continue in February 2019. NHI is not precluded from further action in damages under terms of the lease.
As of December 31, 2018, based on our assessment of likely undiscounted cash flows we determined no impairment charge was required on the land, building and improvements formerly leased to Regency. We wrote off straight-line receivables from the Regency properties totaling
$1,820,000
during the fourth quarter of 2018.
Of our total revenues,
$5,103,000
(
2%
),
$5,466,000
(
2%
), and
$5,444,000
(
2%
) in lease revenues were derived from Regency for the years ended
December 31, 2018
,
2017
and
2016
, respectively.
With Regency’s relinquishment of possession of the
three
NHI facilities as discussed above, our prospective entry into management agreements with operators willing to venture into speculative operations entails structuring the agreements so that NHI, who stands to gain the most from rehabilitation of the properties, will likely expect to absorb most of the losses, if any, that these operators will encounter during revitalization of operations at the three properties. As a result of finalizing these agreements, entity-level operations at each facility may be considered variable interests, the operators may be considered variable interest entities (“VIEs”), and NHI may potentially be considered the primary beneficiary of those entities. Consequently, NHI may be required to consolidate these operations in 2019. If so, we expect that our statements of income will reflect revenues and expenses from these foreclosed operations. During 2018, activities at these facilities were immaterial to the results of NHI’s operations.
For operations which we place in our TRS, we have NOL carryforwards of
$462,000
available to offset taxable income in the TRS. The carry-forwards expire beginning in 2028.
Other
In the second quarter of 2018, we identified a single-property lease with a tenant in Wisconsin as non-performing. Lease revenues from the tenant have comprised less than
1%
of our rental income, and the tenant is
two months
, or
$840,000
, in arrears on its rent payments to us as of December 31, 2018. In accordance with our revenue recognition policies, we will recognize future rental income from the lease in the period in which cash is received. Additionally, we may transition the lease to a new tenant. As a consequence of this course of action, the related straight-line receivable is considered uncollectible. Accordingly, in June 2018, we wrote off the balance of
$1,436,000
pertaining to this tenant and included this amount in loan and realty losses in our consolidated statement of income. Personal guarantees totaling
$3,000,000
remain in place.
We have determined that another of our tenants, The LaSalle Group, with five buildings in Illinois and Texas, is in material non-compliance with provisions of our lease regarding mandated coverage ratios, working capital requirements and timeliness of rent payments. Lease revenues from the tenant have comprised less than
2%
of our rental income, and the tenant is two months in arrears on its rent payments to us as of December 31, 2018. As of October 31, 2018, we wrote off the accumulated straight-line rent receivable of
$1,496,000
, we ceased recording straight-line rent income, and we adopted the cash basis for recognition of revenues from this tenant. We have made
no
rent concessions to the tenant as of December 31, 2018.
Based on our assessment of current operations and the availability of suitable operating partners, we are seeking new tenants or managers for the other properties mentioned above. If we enter into a management agreement rather than a lease as we seek to stabilize the operations of these facilities and if our resulting operating partner does not have adequate liquidity to accept the risks and rewards of ownership, NHI might be deemed the primary beneficiary of the operations and might be required to consolidate those statements of financial position and results of operations of the managers or operating partners into our consolidated financial statements.
Of our total revenue,
$5,540,000
(
2%
),
$6,141,000
(
2%
), and
$1,957,000
(
1%
) in lease revenues were derived from the above other tenants for the years ended
December 31, 2018
,
2017
and
2016
, respectively.
In February 2019 we released a tenant from the provisions of a forbearance letter we originally issued in October 2017.
Utilization of Tenant Escrow Deposits
We have available to us a total of
$3,485,000
in escrowed deposits for the above-mentioned non-compliant tenants. Through the end of 2018, we made
no
draws against these deposits. When tenants have been changed to cash basis and prior to adjudication of any amounts in controversy, we assess the probability of recovery, if any, through legal recourse against amounts on escrow. We consider available escrowed funds to the extent, under governing lease provisions, that specified costs incurred are to be borne by the tenant. Accordingly, we have recognized
$2,534,000
as a receivable against these escrowed deposits to satisfy property tax liabilities and as reimbursement for expenses explicitly delineated under the leases.
Other Lease Activity
We have adjusted rental income for the amortization of lease inducement payments resulting from the settlement of contingencies identified in Note 6. Amortization of these payments against revenues was
$387,000
,
$119,000
and
$40,000
for the years ended December 31, 2018, 2017 and 2016, respectively.
Future Minimum Lease Payments
At
December 31, 2018
, the future minimum lease payments (excluding percentage rent) to be received by us under our operating leases with our tenants are as follows (
in thousands
):
|
|
|
|
|
|
2019
|
|
$
|
304,887
|
|
2020
|
|
254,321
|
|
2021
|
|
255,806
|
|
2022
|
|
258,245
|
|
2023
|
|
252,602
|
|
Thereafter
|
|
1,705,141
|
|
|
|
$
|
3,031,002
|
|
NOTE 3. MORTGAGE AND OTHER NOTES RECEIVABLE
At
December 31, 2018
, we had investments in mortgage notes receivable with a carrying value of
$202,877,000
secured by real estate and UCC liens on the personal property of
12
facilities and other notes receivable with a carrying value of
$43,234,000
guaranteed by significant parties to the notes or by cross-collateralization of properties with the same owner. At
December 31, 2017
, we had investments in mortgage notes receivable with a carrying value of
$98,110,000
and other notes receivable with a carrying value of
$43,376,000
.
No
allowance for doubtful accounts was considered necessary at
December 31, 2018
or
2017
.
Life Care Services - Sagewood
On December 21, 2018 we entered into an agreement to lend LCS-Westminster Partnership IV LLP (“Life Care Services IV”), an affiliate of Life Care Services, the manager of the facility, up to
$180,000,000
. The loan agreement conveys a mortgage interest and will facilitate the construction of Phase II of Sagewood, a Type-A Continuing Care Retirement Community in Scottsdale, AZ.
The loan takes the form of two notes under a master credit agreement. The senior note (“Note A”) totals
$118,800,000
at a
7.25%
interest rate with
10
basis-point annual escalators after year
three
and has a term of
10
years. We have funded
$76,653,000
of Note A as of December 31, 2018. Note A is interest-only and is locked to prepayment until January 2021. After 2020, the prepayment penalty starts at
2%
and declines to
1%
in 2022. The second note (“Note B”) is a construction loan for up to
$61,200,000
at an annual interest rate of
8.5%
and carries a
five
-year maturity. The total amount funded on Note B was
$10,165,000
as of December 31, 2018.
Life Care Services - Timber Ridge
In February 2015, we entered into an agreement to lend up to
$154,500,000
to LCS-Westminster Partnership III LLP (“LCS-WP”), an affiliate of Life Care Services (“LCS”). The loan agreement conveys a mortgage interest and facilitated the construction of Phase II of Timber Ridge at Talus (“Timber Ridge”), a Type-A continuing care retirement community in Issaquah, WA managed by LCS. Our loan to LCS-WP represents a variable interest. As an affiliate of a larger company, LCS-WP is structured to limit liability for potential damage claims, is capitalized to achieve that purpose and is considered a VIE within the definition set forth in Note 1.
The loan took the form of
two
notes under a master credit agreement. The senior note (“Note A”) totals
$60,000,000
at a
6.75%
interest rate with
10
basis-point escalators after year
three
, and has a term of
10
years. We have funded
$57,939,000
of Note A as of
December 31, 2018
. Note A is interest-only and is locked to prepayment for
three
years. Beginning in February 2018, the prepayment penalty started at
5%
and will decline
1%
annually for five years.
Note B was a construction loan for up to
$94,500,000
at an annual interest rate of
8%
and a
five
-year maturity and was fully drawn during 2016. Repayment began during the fourth quarter of 2016, and the balance remaining on Note B at
December 31, 2017
, of
$1,953,000
was repaid during the first quarter of 2018. We recognized
$515,000
in interest income from unamortized commitment fees, on early retirement of the note.
NHI has an option to purchase the entire Timber Ridge property for the greater of a mutually agreed-upon fair market value or
$115,000,000
during a window of
120 days
that is set to open in February 2019.
Bickford
At
December 31, 2018
, our construction loans to Bickford are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commencement
|
|
Rate
|
|
Maturity
|
|
Commitment
|
|
Drawn
|
|
Location
|
July 2016
|
|
9%
|
|
5 years
|
|
$
|
14,000,000
|
|
|
$
|
(13,047,000
|
)
|
|
Illinois
|
January 2017
|
|
9%
|
|
5 years
|
|
14,000,000
|
|
|
(11,931,000
|
)
|
|
Michigan
|
January 2018
|
|
9%
|
|
5 years
|
|
14,000,000
|
|
|
(4,515,000
|
)
|
|
Virginia
|
July 2018
|
|
9%
|
|
5 years
|
|
14,700,000
|
|
|
(2,978,000
|
)
|
|
Michigan
|
|
|
|
|
|
|
$
|
56,700,000
|
|
|
$
|
(32,471,000
|
)
|
|
|
The construction loans are secured by first mortgage liens on substantially all real and personal property as well as a pledge of any and all leases or agreements which may grant a right of use to the subject property. Usual and customary covenants extend to the agreements, including the borrower’s obligation for payment of insurance and taxes. NHI has a purchase option on the properties at stabilization, whereby annual rent will be set with a floor of
9.55%
, based on NHI’s total investment, plus fixed annual escalators. On these and future loan development projects, Bickford as the borrower is entitled to up to
$2,000,000
per project in incentive loan draws based upon the achievement of predetermined operational milestones, the funding of which will increase the principal amount and NHI's future purchase price and eventual NHI lease payment.
Our loans to Bickford represent a variable interest. Bickford is structured to limit liability for potential claims for damages, is capitalized to achieve that purpose and is considered a VIE.
Senior Living Communities
In connection with the acquisition in December 2014 of the properties leased to Senior Living, we provided a
$15,000,000
revolving line of credit, the maturity of which mirrors the
15
-year term of the master lease. Borrowings are used to finance construction projects within the Senior Living portfolio, including building additional units. The facility, which may be used to meet general working capital needs, is subject to reduction to
$5,000,000
in 2019 and up to the lease maturity in December 2029. Amounts outstanding under the facility,
$1,900,000
at
December 31, 2018
, bear interest at an annual rate equal to the prevailing
10
-year U.S. Treasury rate,
2.69%
at
December 31, 2018
, plus
6%
.
In March 2016, we extended
two
mezzanine loans of up to
$12,000,000
and
$2,000,000
, respectively, to affiliates of Senior Living, to partially fund construction of a
186
-unit senior living campus on Daniel Island in South Carolina. The loans bear interest payable monthly at a
10%
annual rate and mature in March 2021. The loans were fully drawn at
December 31, 2018
, and provide NHI with a purchase option on the development upon its meeting certain operational metrics. The option is to remain open during the term of the loans, plus any extensions.
Our loans to Senior Living and its subsidiaries represent a variable interest. Senior Living is structured to limit liability for potential claims for damages, is appropriately capitalized for that purpose and is considered a VIE.
Senior Living Management
On August 3, 2016, we entered into an agreement to furnish to our current tenant, Senior Living Management, Inc. (“SLM”), through its affiliates, loans of up to
$24,500,000
to facilitate SLM’s acquisition of
five
senior housing facilities that it currently operates. The loans consist of
two
notes under a master credit agreement, include both a mortgage and a corporate loan, and bear interest at
8.25%
with terms of
five
years, plus optional
one
and
two
-year extensions. NHI has a right of first refusal if SLM elects to sell the facilities. The loans were fully funded as of
December 31, 2018
.
Our loans to SLM represent a variable interest. SLM is structured to limit liability for potential damage claims, is capitalized for that purpose and is considered a VIE.
Evolve
On August 7, 2017, we completed a first mortgage loan of
$10,000,000
to Evolve for the purchase of a memory care facility in New Hampshire. The loan provides for annual interest of
8%
and a maturity of
five
years plus renewal terms at the option of the borrower. Terms of the loan grant NHI a
10%
participation in the property’s appreciation during the period the loan is outstanding,
and NHI also has the option to purchase the facility at fair market value after the second year of the loan. Our loan to Evolve represents a variable interest. Evolve is structured to limit liability for potential claims for damages, is capitalized to achieve that purpose and is considered a VIE.
Other Note Activity
In June 2017 Traditions of Minnesota paid off the undiscounted balance of
$4,256,000
on its mortgage note outstanding to NHI. With the early payoff, we recognized interest income of
$922,000
related to a prepayment penalty and the retirement of the remaining unamortized discount.
NOTE 4. OTHER ASSETS
Our other assets consist of the following (
in thousands
):
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
2018
|
|
2017
|
Accounts receivable and prepaid expenses
|
$
|
6,381
|
|
|
$
|
2,429
|
|
Unamortized lease incentive payments
|
7,456
|
|
|
2,563
|
|
Regulatory escrows
|
8,208
|
|
|
8,208
|
|
Restricted cash
|
5,253
|
|
|
5,012
|
|
|
$
|
27,298
|
|
|
$
|
18,212
|
|
Regulatory escrows include mandated deposits in connection with our entrance fee communities in Connecticut. Restricted cash includes amounts required to be held on deposit in accordance with agency agreements governing our Fannie Mae and HUD mortgages.
NOTE 5. DEBT
Debt consists of the following (
in thousands
):
|
|
|
|
|
|
|
|
|
|
December 31,
2018
|
|
December 31,
2017
|
Revolving credit facility - unsecured
|
$
|
84,000
|
|
|
$
|
221,000
|
|
Bank term loans - unsecured
|
550,000
|
|
|
250,000
|
|
Private placement term loans - unsecured
|
400,000
|
|
|
400,000
|
|
HUD mortgage loans (net of discount of $1,320 and $1,402)
|
42,906
|
|
|
43,645
|
|
Fannie Mae term loans - secured, non-recourse
|
96,044
|
|
|
96,367
|
|
Convertible senior notes - unsecured (net of discount of $1,391 and $2,637)
|
118,609
|
|
|
144,938
|
|
Unamortized loan costs
|
(9,884
|
)
|
|
(10,453
|
)
|
|
$
|
1,281,675
|
|
|
$
|
1,145,497
|
|
Aggregate principal maturities of debt as of
December 31, 2018
for each of the next five years and thereafter are as follows (
in thousands
):
|
|
|
|
|
Twelve months ended December 31,
|
|
2019
|
$
|
1,187
|
|
2020
|
1,230
|
|
2021
|
121,279
|
|
2022
|
335,328
|
|
2023
|
476,379
|
|
Thereafter
|
358,867
|
|
|
1,294,270
|
|
Less: discounts
|
(2,711
|
)
|
Less: unamortized loan costs
|
(9,884
|
)
|
|
$
|
1,281,675
|
|
Revolving credit facility and bank term loans - unsecured
On September 17, 2018, we executed a
$300,000,000
expansion of our bank credit facility, discussed below, whereby our total unsecured credit facility consists of
$250,000,000
and $300,000,000 term loans and a
$550,000,000
revolving credit facility. The $250,000,000 term loan and $550,000,000 revolving facility mature in August 2022, and the $300,000,000 term loan matures in September 2023.
The revolving facility fee is currently
20
basis points per annum, and based on our current leverage ratios, the facility presently provides for floating interest on the revolver and the term loans at 30-day LIBOR plus
115
and a blended
127
basis points, respectively. At
December 31, 2018
and
December 31, 2017
, 30-day LIBOR was
252
and
156
basis points, respectively. Within the facility, the employment of interest rate swaps for our fixed term debt leaves only our revolving credit facility and newly issued term loan of $300,000,000 exposed to interest rate risk through April 2019, when our $40,000,000 swap expires. Our swaps and the financial instruments to which they relate are described in the table below, under the caption “Interest Rate Swap Agreements.”
At
December 31, 2018
, we had
$466,000,000
available to draw on the revolving portion of our credit facility, to which usual and customary covenants extend. Among other stipulations, the unsecured credit facility agreement requires that we maintain certain financial ratios within limits set by our creditors. These ratios, which are calculated quarterly, have been within the limits specified in the credit facility agreements.
Pinnacle Bank is a participating member of our banking group. A member of NHI’s board of directors and chairman of our audit committee is also the chairman of Pinnacle Financial Partners, Inc., the holding company for Pinnacle Bank. NHI’s local banking transactions are conducted primarily through Pinnacle Bank.
Private placement term loans - unsecured
Our unsecured private placement term loans, payable interest-only, are summarized below (
in thousands
):
|
|
|
|
|
|
|
|
|
|
Amount
|
|
Inception
|
|
Maturity
|
|
Fixed Rate
|
|
|
|
|
|
|
|
$
|
125,000
|
|
|
January 2015
|
|
January 2023
|
|
3.99%
|
50,000
|
|
|
November 2015
|
|
November 2023
|
|
3.99%
|
75,000
|
|
|
September 2016
|
|
September 2024
|
|
3.93%
|
50,000
|
|
|
November 2015
|
|
November 2025
|
|
4.33%
|
100,000
|
|
|
January 2015
|
|
January 2027
|
|
4.51%
|
$
|
400,000
|
|
|
|
|
|
|
|
Except for specific debt-coverage ratios, covenants pertaining to the private placement term loans are generally conformed with those governing our credit facility.
HUD mortgage loans
Our HUD mortgage loans are secured by
ten
properties leased to Bickford and having a net book value of
$50,867,000
at
December 31, 2018
.
Nine
mortgage notes require monthly payments of principal and interest from
4.3%
to
4.4%
(inclusive of mortgage insurance premium) and mature in August and October 2049.
One
additional HUD mortgage loan assumed in 2014, at a discount, requires monthly payments of principal and interest of
2.9%
(inclusive of mortgage insurance premium) and matures in October 2047. The loan has an outstanding principal balance of
$8,705,000
and a carrying value of
$7,385,000
, which approximates fair value.
Fannie Mae term loans - secured, non-recourse
In March 2015 we obtained
$78,084,000
in Fannie Mae financing. The term debt financing consists of interest-only payments at an annual rate of
3.79%
and a
10
-year maturity. The mortgages are non-recourse and secured by
thirteen
properties leased to Bickford. In a December 2017 acquisition, we assumed additional Fannie Mae debt that amortizes through 2025 when a balloon payment will be due, is subject to prepayment penalties until 2024, bears interest at a nominal rate of
4.6%
, and has remaining balance of
$17,960,000
at December 31, 2018. All together, these notes are secured by facilities having a net book value of
$138,273,000
at December 31, 2018.
Convertible senior notes - unsecured
In March 2014 we issued
$200,000,000
of
3.25%
senior unsecured convertible notes due April 2021 (the “Notes”) with interest payable April 1st and October 1st of each year. The Notes were convertible at an initial rate of
13.93
shares of common stock per
$1,000
principal amount, representing a conversion price of approximately
$71.81
per share for a total of approximately
2,785,200
underlying shares. The conversion rate is subsequently adjusted upon each occurrence of certain events, as defined in the indenture governing the Notes, including the payment of dividends at a rate exceeding that prevailing in 2014. The conversion option was accounted for as an “optional net-share settlement conversion feature,” meaning that upon conversion, NHI’s conversion obligation may be satisfied, at our option, in cash, shares of common stock or a combination of cash and shares of common stock. Because we have the ability and intent to settle the convertible securities in cash upon exercise, we use the treasury stock method to account for potential dilution.
During the
years ended
December 31, 2018
and
2017
, we undertook targeted open-market repurchases of certain of these convertible notes. Payments of cash negotiated in the transactions were dependent on prevailing market conditions, our liquidity requirements, contractual restrictions, individual circumstances of the selling parties and other factors. Settlement of the notes requires management to allocate the consideration we ultimately pay between the debt component and the equity conversion feature as though they were separate instruments. The allocation is effected by determining the fair value of the debt component first, with any remainder allocated to the conversion feature. Amounts expended to settle the notes are recognized first as a settlement of the notes at our carrying value and then are recognized in income to the extent the portion allocated to the debt instrument differs from carrying value. The remainder of the allocation, if any, is treated as settlement of equity and adjusted through our capital in excess of par account.
A roll-forward of our convertible note balances, including the effect of year-to-date amortization, net of issuance costs, is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2017
|
Cash Paid
|
Amortization
|
December 31,
2018
|
Face Amount
|
$
|
147,575
|
|
$
|
(27,575
|
)
|
$
|
—
|
|
$
|
120,000
|
|
Discount
|
(2,637
|
)
|
$
|
458
|
|
$
|
788
|
|
(1,391
|
)
|
Issuance Costs
|
(1,752
|
)
|
$
|
297
|
|
$
|
545
|
|
(910
|
)
|
Carrying Value
|
$
|
143,186
|
|
|
|
$
|
117,699
|
|
Total expenditures of
$29,985,000
include paid amounts of
$27,558,000
allocated to the note retirement with the remaining expenditure of
$2,427,000
allocated to capital in excess of par. A loss of
$738,000
for the
year ended
December 31, 2018
, resulted from the excess of cash expenditures over the book value of the notes retired, net of discount and issuance costs.
As of
December 31, 2018
, our senior unsecured convertible notes were convertible at a rate of
14.42
shares of common stock per $1,000 principal amount, representing a conversion price of approximately
$69.36
per share for a total of
1,730,174
remaining underlying shares. For the
year ended
December 31, 2018
, dilution resulting from the conversion option within our convertible debt is
80,123
shares. If NHI’s current share price increases above the adjusted
$69.36
conversion price, further dilution will be
attributable to the conversion feature. On
December 31, 2018
, the value of the convertible debt, computed as if the debt were immediately eligible for conversion, exceeded its face amount by
$10,697,000
.
Interest Rate Swap Agreements
Our existing interest rate swap agreements will collectively continue through June 2020 to hedge against fluctuations in variable interest rates applicable to our $250,000,000 bank term loan. With the amendment to our credit facility in August 2017, the introduction to the bank term loan of a LIBOR floor not present in the hedges resulted in hedge inefficiency of
$353,000
, which we credited to interest expense in 2017. On January 1, 2018, we adopted ASU 2017-12 Derivatives and Hedging:
Targeted Improvements to Accounting for Hedging Activities
, as discussed in Note 14. Upon the adoption of the new standard, we reversed cumulative ineffectiveness, resulting in a retroactive net charge to retained earnings and a credit to accumulated other comprehensive income (loss) of
$235,000
as of
January 1, 2018
. During the next year, approximately
$963,000
of gains, which are included in accumulated other comprehensive income (loss), are projected to be reclassified into earnings.
As of
December 31, 2018
, we employ the following interest rate swap contracts to mitigate our interest rate risk on the $250,000,000 term loan (
dollars in thousands
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Date Entered
|
|
Maturity Date
|
|
Fixed Rate
|
|
Rate Index
|
|
Notional Amount
|
|
Fair Value
|
May 2012
|
|
April 2019
|
|
2.84%
|
|
1-month LIBOR
|
|
$
|
40,000
|
|
|
$
|
130
|
|
June 2013
|
|
June 2020
|
|
3.41%
|
|
1-month LIBOR
|
|
$
|
80,000
|
|
|
$
|
480
|
|
March 2014
|
|
June 2020
|
|
3.46%
|
|
1-month LIBOR
|
|
$
|
130,000
|
|
|
$
|
687
|
|
If the fair value of the hedge is an asset, we include it in our Consolidated Balance Sheets among other assets, and, if a liability, as a component of accrued expenses. See Note 11 for fair value disclosures about our interest rate swap agreements. Net asset (liability) balances for our hedges included as components of consolidated other comprehensive income on
December 31, 2018
and
2017
were
$1,297,000
and
$(588,000)
, respectively.
The following table summarizes interest expense (
in thousands
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
|
2016
|
Interest expense on debt at contractual rates
|
$
|
45,789
|
|
|
$
|
40,385
|
|
|
$
|
36,197
|
|
Losses reclassified from accumulated other
|
|
|
|
|
|
comprehensive income (loss) into interest expense
|
164
|
|
|
2,627
|
|
|
3,928
|
|
Ineffective portion of cash flow hedges
|
—
|
|
|
(353
|
)
|
|
18
|
|
Capitalized interest
|
(212
|
)
|
|
(510
|
)
|
|
(549
|
)
|
Charges taken on amending bank credit facility
|
—
|
|
|
583
|
|
|
—
|
|
Amortization of debt issuance costs and debt discount
|
3,314
|
|
|
3,592
|
|
|
3,514
|
|
Total interest expense
|
$
|
49,055
|
|
|
$
|
46,324
|
|
|
$
|
43,108
|
|
NOTE 6. COMMITMENTS AND CONTINGENCIES
In the normal course of business, we enter into a variety of commitments, typical of which are those for the funding of revolving credit arrangements, construction and mezzanine loans to our operators to conduct expansions and acquisitions for their own account, and commitments for the funding of construction for expansion or renovation to our existing properties under lease. In our leasing operations we offer to our tenants and to sellers of newly-acquired properties a variety of inducements which originate contractually as contingencies but which may become commitments upon the satisfaction of the contingent event. Contingent payments earned will be included in the respective lease bases when funded. The tables below summarize our existing, known commitments and contingencies according to the nature of their impact on our leasehold or loan portfolios.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Class
|
|
Type
|
|
Total
|
|
Funded
|
|
Remaining
|
Loan Commitments:
|
|
|
|
|
|
|
|
|
|
LCS Sagewood Note A
|
SHO
|
|
Construction
|
|
$
|
118,800,000
|
|
|
$
|
(76,653,000
|
)
|
|
$
|
42,147,000
|
|
LCS Sagewood Note B
|
SHO
|
|
Construction
|
|
61,200,000
|
|
|
(10,165,000
|
)
|
|
51,035,000
|
|
LCS Timber Ridge Note A
|
SHO
|
|
Construction
|
|
60,000,000
|
|
|
(58,158,000
|
)
|
|
1,842,000
|
|
Bickford Senior Living
|
SHO
|
|
Construction
|
|
56,700,000
|
|
|
(32,471,000
|
)
|
|
24,229,000
|
|
Senior Living Communities
|
SHO
|
|
Revolving Credit
|
|
15,000,000
|
|
|
(1,900,000
|
)
|
|
13,100,000
|
|
|
|
|
|
|
$
|
311,700,000
|
|
|
$
|
(179,347,000
|
)
|
|
$
|
132,353,000
|
|
See Note 3 to our consolidated financial statements for full details of our loan commitments. As provided above, loans funded do not include the effects of discounts or commitment fees.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Class
|
|
Type
|
|
Total
|
|
Funded
|
|
Remaining
|
Development Commitments:
|
|
|
|
|
|
|
|
|
|
Ignite Medical Resorts
|
SNF
|
|
Construction
|
|
25,350,000
|
|
|
(4,674,000
|
)
|
|
20,676,000
|
|
Woodland Village
|
SHO
|
|
Renovation
|
|
7,450,000
|
|
|
(6,867,000
|
)
|
|
583,000
|
|
Senior Living Communities
|
SHO
|
|
Renovation
|
|
6,830,000
|
|
|
(4,772,000
|
)
|
|
2,058,000
|
|
Bickford Senior Living
|
SHO
|
|
Renovation
|
|
1,750,000
|
|
|
(1,597,000
|
)
|
|
153,000
|
|
Navion Senior Solutions
|
SHO
|
|
Construction
|
|
650,000
|
|
|
—
|
|
|
650,000
|
|
Discovery Senior Living
|
SHO
|
|
Renovation
|
|
500,000
|
|
|
(289,000
|
)
|
|
211,000
|
|
|
|
|
|
|
$
|
42,530,000
|
|
|
$
|
(18,199,000
|
)
|
|
$
|
24,331,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Class
|
|
Type
|
|
Total
|
|
Funded
|
|
Remaining
|
Contingencies:
|
|
|
|
|
|
|
|
|
|
Bickford Senior Living
|
SHO
|
|
Lease Inducement
|
|
$
|
10,000,000
|
|
|
$
|
(7,500,000
|
)
|
|
$
|
2,500,000
|
|
Bickford Senior Living
|
SHO
|
|
Incentive Loan Draws
|
|
8,000,000
|
|
|
(250,000
|
)
|
|
7,750,000
|
|
Navion Senior Solutions
|
SHO
|
|
Lease Inducement
|
|
4,850,000
|
|
|
—
|
|
|
4,850,000
|
|
Ignite Medical Resorts
|
SNF
|
|
Lease Inducement
|
|
2,000,000
|
|
|
—
|
|
|
2,000,000
|
|
|
|
|
|
|
$
|
24,850,000
|
|
|
$
|
(7,750,000
|
)
|
|
$
|
17,100,000
|
|
Contingent lease inducement payments of $10,000,000 related to the
five
Bickford development properties constructed in 2016 and 2017 include a licensure incentive of
$250,000
per property and a three-tiered operator incentive schedule paying up to an additional
$1,750,000
, based on the attainment of certain performance metrics. Upon funding, these payments are added to the lease base and amortized against rental income.
Litigation
On June 15, 2018, East Lake Capital Management LLC and certain related entities, including Regency, filed suit against NHI and NHI-REIT of Axel, LLC, in the District Court of Dallas County, Texas; 95th Judicial District
for injunctive and declaratory relief and unspecified monetary damages, including attorney’s fees. The suit sought, among other things, to enjoin NHI from making certain references to East Lake in NHI’s public filings. In response to this lawsuit, related litigation, and other circumstances, we entered motions calling for the immediate appointment of a receiver and for pre-judgment possession, hearing, and bond.
Resulting from these claims and counterclaims, on December 6, 2018, the plaintiff parties entered into an agreement with NHI under Texas Rule of Civil Procedure 11, which rule ensures the enforceability of an agreement between lawyers in a case when the agreement is in writing and filed in the papers of the court. The agreement provided that Regency vacate our facilities in Indiana and North Carolina on December 7, 2018 and in Tennessee on December 14, 2018. Further, Regency agreed to provide minimal levels of cooperation in transitioning the facilities.
The original libel action of the East Lake affiliated entities survives the Rule 11 agreement and is set to continue in January 2019. NHI is not precluded from further action in damages under terms of the lease.
Our facilities are subject to claims and suits in the ordinary course of business. Our lessees and borrowers have indemnified, and are obligated to continue to indemnify us, against all liabilities arising from the operation of the facilities, and are further
obligated to indemnify us against environmental or title problems affecting the real estate underlying such facilities. While there may be lawsuits pending against certain of the owners and/or lessees of the facilities, management believes that the ultimate resolution of all such pending proceedings will have no material effect on our financial statements.
NOTE 7. INVESTMENT AND OTHER GAINS
The following table summarizes our investment and other gains
(in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
|
2016
|
Gains on sales of marketable securities
|
$
|
—
|
|
|
$
|
10,038
|
|
|
$
|
29,673
|
|
Gain on sale of real estate
|
—
|
|
|
50
|
|
|
4,582
|
|
Other gains
|
—
|
|
|
—
|
|
|
1,657
|
|
|
$
|
—
|
|
|
$
|
10,088
|
|
|
$
|
35,912
|
|
During the years ended December 31, 2017 and 2016, we recognized gains on sales of marketable securities which were reclassified from accumulated other comprehensive income.
NOTE 8. SHARE-BASED COMPENSATION
We recognize share-based compensation for all stock options granted over the requisite service period using the fair value of these grants as estimated at the date of grant using the Black-Scholes pricing model over the requisite service period using the market value of our publicly-traded common stock on the date of grant.
Share-Based Compensation Plans
The Compensation Committee of the Board of Directors (the “Committee”) has the authority to select the participants to be granted options; to designate whether the option granted is an incentive stock option (“ISO”), a non-qualified option, or a stock appreciation right; to establish the number of shares of common stock that may be issued upon exercise of the option; to establish the vesting provision for any award; and to establish the term any award may be outstanding. The exercise price of any ISO’s granted will not be less than 100% of the fair market value of the shares of common stock on the date granted and the term of an ISO may not be more than ten years. The exercise price of any non-qualified options granted will not be less than 100% of the fair market value of the shares of common stock on the date granted unless so determined by the Committee.
In May 2012, our stockholders approved the 2012 Stock Incentive Plan (the “2012 Plan”) pursuant to which
1,500,000
shares of our common stock were made available to grant as share-based payments to employees, officers, directors or consultants. Through a vote of our shareholders in May 2015, we increased the maximum number of shares under the plan from
1,500,000
shares to
3,000,000
shares; increased the automatic annual grant to non-employee directors from
15,000
shares to
20,000
shares; and limited the Company’s ability to re-issue shares under the Plan. Through a second amendment approved on May 4, 2018, our shareholders voted to increase the maximum number of shares under the plan to
3,500,000
and to increase the automatic annual grant to non-employee directors to
25,000
. The individual restricted stock and option grant awards may vest over periods up to
five
years. The term of the options under the 2012 Plan is up to
ten
years from the date of grant. As of
December 31, 2018
, there were
921,669
shares available for future grants under the 2012 Plan.
In May 2005, our stockholders approved the NHI 2005 Stock Option Plan (“the 2005 Plan”) pursuant to which
1,500,000
shares of our common stock were made available to grant as share-based payments to employees, officers, directors or consultants. The 2005 Plan has expired and
no
additional shares may be granted under the 2005 Plan. The individual restricted stock and option grant awards vest over periods up to
ten
years. The term of the options outstanding under the 2005 Plan is up to
ten
years from the date of grant.
Compensation expense is recognized only for the awards that ultimately vest. Accordingly, forfeitures that were not expected may result in the reversal of previously recorded compensation expense. We consider the historical employee turnover rate in our estimate of the number of stock option forfeitures. Our compensation expense reported for the
years ended
December 31, 2018
,
2017
and
2016
was
$2,490,000
,
$2,612,000
and
$1,732,000
, respectively, and is included in general and administrative expense in the Consolidated Statements of Income.
Determining Fair Value of Option Awards
The fair value of each option award was estimated on the grant date using the Black-Scholes option valuation model with the weighted average assumptions indicated in the following table. Each grant is valued as a single award with an expected term based upon expected employee and termination behavior. Compensation cost is recognized on the graded vesting method over the requisite service period for each separately vesting tranche of the award as though the award were, in substance, multiple awards. The expected volatility is derived using daily historical data for periods preceding the date of grant. The risk-free interest rate is the approximate yield on the United States Treasury Strips having a life equal to the expected option life on the date of grant. The expected life is an estimate of the number of years an option will be held before it is exercised.
Stock Options
The weighted average fair value per share of options granted was
$4.49
,
$5.76
and
$3.65
for
2018
,
2017
and
2016
, respectively.
The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
Dividend yield
|
6.5%
|
|
5.3%
|
|
6.2%
|
Expected volatility
|
19.4%
|
|
19.8%
|
|
19.1%
|
Expected lives
|
2.9 years
|
|
2.9 years
|
|
2.9 years
|
Risk-free interest rate
|
2.39%
|
|
1.49%
|
|
0.91%
|
Stock Option Activity
The following tables summarize our outstanding stock options:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
Number
|
|
|
Weighted Average
|
|
Remaining
|
|
Aggregate
|
|
of Shares
|
|
|
Exercise Price
|
|
Contractual Life (Years)
|
|
Intrinsic Value
|
Outstanding December 31, 2015
|
741,676
|
|
|
$60.43
|
|
|
|
|
Options granted under 2012 Plan
|
470,000
|
|
|
$60.78
|
|
|
|
|
Options exercised under 2005 Plan
|
(61,666
|
)
|
|
$52.36
|
|
|
|
|
Options exercised under 2012 Plan
|
(608,331
|
)
|
|
$65.18
|
|
|
|
|
Outstanding December 31, 2016
|
541,679
|
|
|
$65.84
|
|
|
|
|
Options granted under 2012 Plan
|
495,000
|
|
|
$74.90
|
|
|
|
|
Options exercised under 2005 Plan
|
(15,000
|
)
|
|
$47.52
|
|
|
|
|
Options exercised under 2012 Plan
|
(155,829
|
)
|
|
$65.73
|
|
|
|
|
Options canceled under 2012 Plan
|
(6,668
|
)
|
|
$60.52
|
|
|
|
|
Outstanding December 31, 2017
|
859,182
|
|
|
$70.11
|
|
|
|
|
Options granted under 2012 Plan
|
560,000
|
|
|
$64.33
|
|
|
|
|
Options exercised under 2005 Plan
|
(6,668
|
)
|
|
$72.11
|
|
|
|
|
Options exercised under 2012 Plan
|
(462,167
|
)
|
|
$65.03
|
|
|
|
|
Options canceled under 2012 Plan
|
(30,001
|
)
|
|
$66.73
|
|
|
|
|
Outstanding December 31, 2018
|
920,346
|
|
|
$69.24
|
|
3.35
|
|
$
|
5,798,000
|
|
|
|
|
|
|
|
|
|
Exercisable December 31, 2018
|
476,992
|
|
|
$70.93
|
|
2.88
|
|
$
|
2,204,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining
|
Grant
|
|
Number
|
|
|
Exercise
|
|
|
Contractual
|
Date
|
|
of Shares
|
|
|
Price
|
|
|
Life in Years
|
2/25/2014
|
|
15,000
|
|
|
$
|
61.31
|
|
|
0.15
|
2/20/2015
|
|
50,002
|
|
|
$
|
72.11
|
|
|
1.14
|
2/22/2016
|
|
36,668
|
|
|
$
|
60.52
|
|
|
2.15
|
3/8/2016
|
|
26,667
|
|
|
$
|
63.63
|
|
|
2.19
|
2/22/2017
|
|
399,170
|
|
|
$
|
74.78
|
|
|
3.15
|
9/1/2017
|
|
10,000
|
|
|
$
|
80.55
|
|
|
3.68
|
2/20/2018
|
|
382,839
|
|
|
$
|
64.33
|
|
|
4.14
|
Outstanding December 31, 2018
|
|
920,346
|
|
|
|
|
|
The weighted average remaining contractual life of all options outstanding at
December 31, 2018
is
3.35 years
. Including outstanding stock options, our stockholders have authorized an additional
1,842,015
shares of common stock that may be issued under the share-based payments plans.
The following table summarizes our outstanding non-vested stock options:
|
|
|
|
|
|
|
Number of Shares
|
|
|
Weighted Average Grant Date Fair Value
|
Non-vested December 31, 2017
|
400,019
|
|
|
$5.10
|
Options granted under 2012 Plan
|
560,000
|
|
|
$4.49
|
Options vested under 2012 Plan
|
(494,996
|
)
|
|
$4.62
|
Options vested under 2005 Plan
|
(6,668
|
)
|
|
$4.91
|
Non-vested options canceled under 2012 Plan
|
(15,001
|
)
|
|
$4.99
|
Non-vested December 31, 2018
|
443,354
|
|
|
$4.87
|
At
December 31, 2018
, we had, net of expected forfeitures,
$586,000
of unrecognized compensation cost related to unvested stock options which is expected to be expensed over the following periods:
2019
-
$528,000
and
2020
-
$58,000
. Stock-based compensation is included in general and administrative expense in the Consolidated Statements of Income.
The intrinsic value of the total options exercised for the years ended
December 31, 2018
,
2017
and
2016
was
$6,105,000
or
$13.02
per share;
$2,314,000
or
$13.55
per share, and
$4,730,000
or
$7.06
per share, respectively.
NOTE 9. EARNINGS AND DIVIDENDS PER COMMON SHARE
The weighted average number of common shares outstanding during the reporting period is used to calculate basic earnings per common share. Diluted earnings per common share assume the exercise of stock options and vesting of restricted shares using the treasury stock method, to the extent dilutive. Dilution resulting from the conversion option within our convertible debt is determined by computing an average of incremental shares included in each quarterly diluted EPS computation. If NHI’s current share price increases above the adjusted conversion price, further dilution will be attributable to the conversion feature.
The following table summarizes the average number of common shares and the net income used in the calculation of basic and diluted earnings per common share
(in thousands, except share and per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
|
2016
|
Net income attributable to common stockholders
|
$
|
154,333
|
|
|
$
|
159,365
|
|
|
$
|
151,540
|
|
|
|
|
|
|
|
BASIC:
|
|
|
|
|
|
Weighted average common shares outstanding
|
41,943,873
|
|
|
40,894,219
|
|
|
39,013,412
|
|
|
|
|
|
|
|
DILUTED:
|
|
|
|
|
|
Weighted average common shares outstanding
|
41,943,873
|
|
|
40,894,219
|
|
|
39,013,412
|
|
Stock options and restricted shares
|
67,735
|
|
|
67,703
|
|
|
52,497
|
|
Convertible senior notes - unsecured
|
80,123
|
|
|
189,531
|
|
|
89,471
|
|
Average dilutive common shares outstanding
|
42,091,731
|
|
|
41,151,453
|
|
|
39,155,380
|
|
|
|
|
|
|
|
Net income per common share - basic
|
$
|
3.68
|
|
|
$
|
3.90
|
|
|
$
|
3.88
|
|
Net income per common share - diluted
|
$
|
3.67
|
|
|
$
|
3.87
|
|
|
$
|
3.87
|
|
|
|
|
|
|
|
Net share effect of anti-dilutive stock options
|
518
|
|
|
573
|
|
|
6,366
|
|
|
|
|
|
|
|
Regular dividends declared per common share
|
$
|
4.00
|
|
|
$
|
3.80
|
|
|
$
|
3.60
|
|
NOTE 10. INCOME TAXES
Beginning with our inception in 1991, we have elected to be taxed as a REIT under the Internal Revenue Code (the “Code”). We elected that our subsidiary established on September 30, 2012 in connection with the Bickford arrangement (which previously held our ownership interest in an operating company) be taxed as a TRS under provisions of the Code. The TRS was subject to federal and state income taxes like those applicable to regular corporations. As discussed in Note 2, we terminated our participation in the joint venture resident in our TRS on September 30, 2016. Aside from such income taxes which have been applicable to any taxable income in the TRS, we will not be subject to federal income tax provided that we continue to qualify as a REIT and make distributions to stockholders equal to or in excess of 90% of our taxable income.
Per share dividend payments to common stockholders for the last three years are characterized for tax purposes as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(Unaudited)
|
2018
|
|
2017
|
|
2016
|
Ordinary income
|
$
|
3.33730
|
|
|
$
|
2.93054
|
|
|
$
|
2.67863
|
|
Capital gain
|
—
|
|
|
0.20643
|
|
|
0.92137
|
|
Return of capital
|
0.66270
|
|
|
0.66303
|
|
|
—
|
|
Dividends paid per common share
|
$
|
4.00
|
|
|
$
|
3.80
|
|
|
$
|
3.60
|
|
Our consolidated provision for state and federal income tax expense (benefit) for the years ended
December 31, 2018
,
2017
, and
2016
was
$138,000
,
$124,000
, and
$854,000
, respectively. In regard to our TRS, at the conclusion of 2016 we maintained a deferred tax asset of approximately
$433,000
, all of which had been fully reserved through a valuation allowance. During 2017, as a result of the enactment of a new statutory federal income tax rate, that tax asset has been revalued at
$334,000
, all of which is still fully reserved.
We have recorded state income tax expense of
$138,000
,
$124,000
and
$105,000
or the years ended
December 31, 2018
,
2017
, and
2016
, respectively, related to a franchise tax levied by the state of Texas that has attributes of an income tax. Our state income taxes described above are combined in franchise, excise and other taxes in our Consolidated Statements of Income. Income taxes related to the equity interest in the unconsolidated operating company whose interest is owned by our TRS are included in our Consolidated Statements of Income under the caption Income tax expense of taxable REIT subsidiary.
We made state income tax payments of
$124,000
,
$170,000
,and
$30,000
for the years ended
December 31, 2018
,
2017
, and
2016
, respectively.
NOTE 11. FAIR VALUE OF FINANCIAL INSTRUMENTS
Our financial assets and liabilities measured at fair value (based on the hierarchy of the three levels of inputs described in Note 1 on a recurring basis have included marketable securities, derivative financial instruments and contingent consideration arrangements. Marketable securities have consisted of common stock of other healthcare REITs. Derivative financial instruments include our interest rate swap agreements. Contingent consideration arrangements relate to certain provisions of recent real estate purchase agreements involving business combinations.
Derivative financial instruments
. Derivative financial instruments are valued in the market using discounted cash flow techniques. These techniques incorporate primarily Level 2 inputs. The market inputs are utilized in the discounted cash flow calculation considering the instrument’s term, notional amount, discount rate and credit risk. Significant inputs to the derivative valuation model for interest rate swaps are observable in active markets and are classified as Level 2 in the hierarchy.
Assets and liabilities measured at fair value on a recurring basis are as follows
(in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurement
|
|
Balance Sheet Classification
|
|
December 31,
2018
|
|
December 31,
2017
|
Level 2
|
|
|
|
|
|
Interest rate swap asset
|
Other assets
|
|
$
|
1,297
|
|
|
$
|
159
|
|
Interest rate swap liability
|
Accounts payable and accrued expenses
|
|
$
|
—
|
|
|
$
|
747
|
|
Carrying values and fair values of financial instruments that are not carried at fair value at
December 31, 2018
and
2017
in the Consolidated Balance Sheets are as follows (
in thousands
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Carrying Amount
|
|
Fair Value Measurement
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Level 2
|
|
|
|
|
|
|
|
Variable rate debt
|
$
|
628,010
|
|
|
$
|
465,642
|
|
|
$
|
634,000
|
|
|
$
|
471,000
|
|
Fixed rate debt
|
$
|
653,665
|
|
|
$
|
679,855
|
|
|
$
|
644,745
|
|
|
$
|
679,385
|
|
|
|
|
|
|
|
|
|
Level 3
|
|
|
|
|
|
|
|
Mortgage and other notes receivable
|
$
|
246,111
|
|
|
$
|
141,486
|
|
|
$
|
244,206
|
|
|
$
|
140,049
|
|
The fair value of mortgage and other notes receivable is based on credit risk and discount rates that are not observable in the marketplace and therefore represents a Level 3 measurement.
Fixed rate debt is classified as Level 2 and its value is based on quoted prices for similar instruments or calculated utilizing model derived valuations in which significant inputs are observable in active markets.
Carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to their short-term nature. The fair value of our borrowings under our credit facility are reasonably estimated at their contractual value at
December 31, 2018
and
2017
, due to the predominance of floating interest rates, which generally reflect market conditions.
NOTE 12. LIMITS ON COMMON STOCK OWNERSHIP
The Company’s charter contains certain provisions which are designed to ensure that the Company’s status as a REIT is protected for federal income tax purposes. One of the provisions ensures that any transfer (of shares) which would cause NHI to be beneficially owned by fewer than
100
persons or would cause NHI to be “closely-held” under the Internal Revenue Code would be void which, subject to certain exceptions, result in no stockholder being allowed to own, either directly or indirectly pursuant to certain tax attribution rules, more than
9.9%
of the Company’s common stock with the exception of prior agreements in 1991 which were confirmed in writing in 2008 with the Company’s founders Dr. Carl E. Adams and Jennie Mae Adams and their lineal descendants. Based on these agreement, the ownership limit for all other stockholders is approximately
7.5%
. If a stockholder’s stock ownership exceeds the limit, then such shares over the limit become Excess Stock within the meaning in the Company’s charter whose rights to vote and receive dividends in certain situations. Our charter gives our Board of Directors broad powers to prohibit and rescind any attempted transfer in violation of the ownership limits. In addition, W. Andrew Adams’ Excess Holder Agreement also provides that he will not own shares of stock in any tenant of the Company if such ownership would cause the Company to constructively
own more than a
9.9%
interest in such tenant. The purpose of these provisions is to protect the Company’s status as a REIT for tax purposes.
NOTE 13. SELECTED QUARTERLY FINANCIAL DATA
(UNAUDITED)
The following table sets forth selected quarterly financial data for the two most recent fiscal years (
in thousands, except share and per share amounts)
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
Quarter Ended
|
|
March 31,
|
|
June 30,
|
|
September 30,
|
|
December 31,
|
Net revenues
|
$
|
72,746
|
|
|
$
|
72,956
|
|
|
$
|
74,915
|
|
|
$
|
73,995
|
|
|
|
|
|
|
|
|
|
Net income attributable to common stockholders
|
$
|
38,432
|
|
|
$
|
37,839
|
|
|
$
|
40,979
|
|
|
$
|
37,083
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding:
|
|
|
|
|
|
|
|
Basic
|
41,532,154
|
|
|
41,704,819
|
|
|
42,187,077
|
|
|
42,351,443
|
|
Diluted
|
41,576,876
|
|
|
41,786,829
|
|
|
42,434,499
|
|
|
42,568,720
|
|
|
|
|
|
|
|
|
|
Earnings per common share:
|
|
|
|
|
|
|
|
Net income attributable to common stockholders - basic
|
$
|
.93
|
|
|
$
|
.91
|
|
|
$
|
.97
|
|
|
$
|
.88
|
|
Net income attributable to common stockholders - diluted
|
$
|
.92
|
|
|
$
|
.91
|
|
|
$
|
.97
|
|
|
$
|
.87
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
Quarter Ended
|
|
March 31,
|
|
June 30,
|
|
September 30,
|
|
December 31,
|
Net revenues
|
$
|
66,388
|
|
|
$
|
69,836
|
|
|
$
|
71,352
|
|
|
$
|
71,083
|
|
Investment and other gains
|
10,088
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Net income attributable to common stockholders
|
$
|
44,230
|
|
|
$
|
38,245
|
|
|
$
|
39,092
|
|
|
$
|
37,798
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding:
|
|
|
|
|
|
|
|
Basic
|
39,953,804
|
|
|
40,982,244
|
|
|
41,108,699
|
|
|
41,532,130
|
|
Diluted
|
40,108,762
|
|
|
41,245,173
|
|
|
41,448,263
|
|
|
41,803,615
|
|
|
|
|
|
|
|
|
|
Earnings per common share:
|
|
|
|
|
|
|
|
Net income attributable to common stockholders - basic
|
$
|
1.11
|
|
|
$
|
.93
|
|
|
$
|
.95
|
|
|
$
|
.91
|
|
Net income attributable to common stockholders - diluted
|
$
|
1.10
|
|
|
$
|
.93
|
|
|
$
|
.94
|
|
|
$
|
.90
|
|
NOTE 14. RECENT ACCOUNTING PRONOUNCEMENTS
In May 2014 the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09,
Revenue from Contracts with Customers
. ASU 2014-09 provides a principles-based approach for a broad range of revenue generating transactions, including the sale of real estate, which will generally require more estimates, judgment and disclosures than under current guidance.
The Company adopted this standard using the modified retrospective method on January 1, 2018. The ASU provides for revenues from leases to continue to follow the guidance in Topics 840 and 842 (when adopted) and provides for loans to follow established guidance in Topic 310. Because this ASU specifically excludes these areas of our operations from its scope, there was no impact to our accounting for lease revenue and interest income resulting from the ASU. Additionally, the other significant types of contracts in which we periodically engage, sales of real estate to customers, typically never remain executory across points in time, so that nuances related to the timing of revenue recognition as mandated under Topic 606 are not expected to impact our results of operations or financial position. Because all performance obligations from these contracts can therefore be expected to continue to fall within a single period, the timing of our revenue recognition from future sales of real estate is not expected to be affected by the ASU. A number of practical expedients are available in applying the recognition and measurement principles within the standard, including those permitting the aggregation of contract revenues and costs with components of interest income or amortization expense whose period of aggregation, within parameters, is not considered to be of significant duration for separate treatment. We realized no significant revenues in 2018 within the scope of ASU 2014-09, and, accordingly, adoption of the ASU did not have a material impact on the timing and measurement of the Company’s revenues.
In February 2016 the FASB issued ASU 2016-02,
Leases
, which has been codified under ASC Topic 842. In July and December 2018 the FASB updated the pending Topic 842 with ASU 2018-11, Leases – Targeted Improvements, and ASU 2018-20, Narrow-
Scope Improvements for Lessors, respectively. ASU 2018-11 provides a new transition method under which we will apply the new leases standard as of the application date and recognize a cumulative-effect adjustment, as appropriate, to the opening balance of retained earnings in the period of adoption. Consequently, our reporting for the comparative periods presented in the financial statements in which we adopt the new leases standard will continue to be in accordance with current GAAP (Topic 840, Leases).
ASU 2018-20 was issued to address implementation issues related to Topic 842. We adopted Topic 842 on January 1, 2019 (the “application date”), and, effective with our adoption, we elected the package of practical expedients allowing, among other provisions, for transition with no reassessment of the lease classification for any expired or existing leases. No cumulative effect adjustment to retained earnings was necessary, based on our analysis. The Narrow-Scope Improvements for Lessors under ASU 2018-20 requires NHI to exclude from variable payments, and therefore revenue, our costs paid by our tenants directly to third parties. Some of our leases require property tax and insurance costs be covered by our tenants through escrow reimbursement. We serve as the administrative agent for these escrow transactions and ASU 2018-20 requires the implied revenue and expense impact of these transactions, $4,159,000 for the year ended December 31, 2018, be included in our consolidated financial statements.
The principal difference between Topic 842 and previous guidance is that, for lessees, lease assets and lease liabilities arising from operating leases will be recognized in the balance sheet. While the accounting applied by a lessor is largely unchanged from that applied under previous GAAP, changes have been made to align i) certain lessor and lessee accounting guidance, and ii) key aspects of the lessor accounting model with the revenue recognition guidance in Topic 606, Revenue from Contracts with Customers, which we adopted January 1, 2018. Under Topic 842 and unlike prior GAAP, a buyer-lessor in a sale-leaseback transaction will be required to apply the sale and leaseback guidance to determine whether the transaction qualifies as a sale. Topic 842 includes provisions which generally conform with Topic 606, and the presence of a seller-lessee repurchase option on real estate in a sale and leaseback transaction will result in recording the transaction as a financing that would otherwise meet the lease accounting requirements for buyer-lessors under previous guidance. Going forward under Topic 842, for us as lessor, existing sale-leaseback or other leases that undergo modifications may trigger reconsideration of continued accounting for the lease.
Because NHI has ceased inclusion of purchase options in new sale-leaseback transactions, we expect no material effects from the change in sale-leaseback guidance as it relates to repurchase options..
In April 2018, we entered into a ground lease as lessee in connection with our acquisition of certain real estate assets. In accordance with transition elections allowed under Topic 842, discussed above, we have continued to account for the lease as an operating lease. Upon adoption of the standard, as lessee we recognized a right-of-use asset and a lease liability at the application date. No cumulative effect adjustment to retained earnings was required to effect a net balance sheet adjustment resulting in an additional operating lease liability and right-of-use asset approximating $1,176,000, as a result of our adoption of Topic 842.
Consistent with present standards, upon the adoption of Topic 842, NHI will continue to account for lease revenue on a straight-line basis for most leases. Under Topic 842 only initial direct costs that are incremental to the lessor are capitalized, a standard consistent with NHI’s current practice. Under provisions of ASU 2018-20, discussed above, we will continue to exclude from variable payments lessor costs paid by our lessees directly to third parties, as consistent with our current practice.
In June 2016, the FASB issued ASU 2016-13,
Financial Instruments - Credit Losses
. ASU 2016-13 will require more timely recognition of credit losses associated with financial assets. While current GAAP includes multiple credit impairment objectives for instruments, the previous objectives generally delayed recognition of the full amount of credit losses until the loss was probable of occurring. The amendments in ASU 2016-13, whose scope is asset-based and not restricted to financial institutions, eliminate the probable initial recognition threshold in current GAAP and, instead, reflect an entity’s current estimate of all expected credit losses. Currently, when credit losses were measured under GAAP, we generally only considered past events and current conditions in measuring the incurred loss. The amendments in ASU 2016-13 broaden the information that we must consider in developing our expected credit loss estimate for assets measured either collectively or individually. The use of forecasted information incorporates more timely information in the estimate of expected credit loss that will be more useful to users of the financial statements. ASU 2016-13 is effective for public entities for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, aligns the transition requirements and clarifies that operating lease receivables are excluded from the scope of ASU 2016-13. Instead, impairment of operating lease receivables is to be accounted for under ASC 842. Because we are likely to continue to invest in loans and generate receivables, adoption of ASU 2016-13 and the clarifying ASU 2018-19 in 2020 will have some effect on our accounting for our loan investments, though the nature of those effects will depend on the composition of our loan portfolio at that time; accordingly, we are in the initial stages of evaluating the extent of the effects, if any, that adopting the provisions of ASU 2016-13 in 2020 will have on NHI.
In November 2016, the FASB issued ASU 2016-18,
Restricted Cash
. ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents, generally by requiring the inclusion of restricted cash and restricted cash equivalents with cash and
cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in this ASU do not provide a definition of restricted cash or restricted cash equivalents. ASU 2016-18 is effective for public entities for fiscal years beginning after December 15, 2017, including interim periods. ASU 2016-18 improves financial reporting by conforming diverse practice to a single standard. In the fourth quarter of 2018 we reclassified amounts previously included among other assets and described as “reserves for replacement, insurance and tax escrows” as “restricted cash.” The adoption of ASU 2016-18, effective January 1, 2018, had no effect on net income or retained earnings and had no effect on other line items in our consolidated balance sheets or statements of income.
In August 2017 the FASB issued ASU 2017-12, Derivatives and Hedging:
Targeted Improvements to Accounting for Hedging Activities
, which is available for early adoption in any interim period after issuance of the update, or alternatively requires adoption for fiscal years beginning after December 15, 2018. The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. On January 1, 2018, we adopted ASU 2017-12, among whose provisions is a change in the timing and income statement line item for ineffectiveness related to cash flow hedges. The transition method is a modified retrospective approach that requires the Company to recognize the cumulative effect of initially applying the ASU as an adjustment to accumulated other comprehensive income (loss) with a corresponding adjustment to the opening balance of retained earnings as of the beginning of the fiscal year that we adopt the update. The primary provision in the ASU requiring an adjustment to our beginning consolidated retained earnings in 2018 is the change in timing and income statement line item for ineffectiveness related to cash flow hedges. In applying the transition guidance provided in the ASU, as of January 1, 2018, cumulative ineffectiveness of $235,000 as adjusted for any prior off-market cashflow hedges was reclassified out of beginning retained earnings and into accumulated other comprehensive income (loss).
NOTE 15. SUBSEQUENT EVENTS
Wingate
On January 15, 2019, we acquired a senior living campus in Massachusetts for a purchase price of
$50,300,000
, including closing costs of
$300,000
. The facility is leased to Wingate Healthcare, Inc. (“Wingate”) for a term of
10
years, with
three
five
-year renewal options, at an initial lease rate of
7.5%
plus annual fixed escalators. We have committed to the additional funding of up to
$1,900,000
in capital improvements, and the lease provides for incentives of
$5,000,000
to become available beginning in 2020 upon the attainment of certain operating metrics. NHI will have a right of first offer on
two
additional Wingate-operated facilities. We accounted for the transaction as an asset acquisition.
Holiday
On January 31, 2019, we acquired a senior housing facility in Vero Beach, Florida in exchange for
$38,000,000
toward the receivable of
$55,125,000
arising from the Holiday lease amendment, as discussed in Note 2. We added the property to our Holiday master lease at an initial lease rate of
6.71%
. Upon our acquisition of the Vero Beach property, under provisions of ASC Topic 842,
Leases
, we reconsidered our accounting for the Holiday lease, with no changes considered necessary. Holiday settled the remaining payable to NHI with cash of
$17,125,000
at closing.