LTC PROPERTIES INC - Annual Report: 2002 (Form 10-K)

Table of Contents

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-K

(Mark One)

LTC PROPERTIES, INC.
(Exact name of Registrant as specified in its charter)

22917 Pacific Coast Highway, Suite 350
Malibu, California  90265
(Address of principal executive offices)

Registrant’s telephone number, including area code: (805) 981-8655

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:  NONE

     Indicate by check mark whether the Company (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Company’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

     Indicate by check mark whether the Company is an accelerated filer.

     The aggregate market value of voting and non-voting stock held by non-affiliates of the Company was approximately $140,167,800 as of June 28, 2002 (the last business day of the Company’s most recently completed second fiscal quarter).

17,898,122
(Number of shares of common stock outstanding as of March 10, 2003)

Table of Contents

STATEMENT REGARDING FORWARD LOOKING DISCLOSURE

Certain information contained in this annual report includes statements that are not purely historical and are “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding our expectations, beliefs, intentions or strategies regarding the future.  All statements other than historical facts contained in this annual report are forward looking statements.  These forward looking statements involve a number of risks and uncertainties.  All forward looking statements included in this annual report are based on information available to us on the date hereof, and we assume no obligation to update such forward looking statements.  Although we believe that the assumptions and expectations reflected in such forward looking statements are reasonable, no assurance can be given that such expectations will prove to have been correct.  The actual results achieved by us may differ materially from any forward looking statements due to the risks and uncertainties of such statements.

General

LTC Properties, Inc., a health care real estate investment trust (a “REIT”), was organized on May 12, 1992 in the State of Maryland and commenced operations on August 25, 1992.  We invest primarily in long-term care and other health care related properties through mortgage loans, property lease transactions and other investments. During 1998, we began making investments in the education industry by investing in private and charter schools from pre-school through eighth grade.  Our primary objectives are to sustain and enhance stockholder equity value and provide current income for distribution to stockholders through real estate investments in long-term care properties and other health care related properties managed by experienced operators providing quality care.  To meet these objectives, we attempt to invest in properties that provide opportunity for additional value and current returns to our stockholders and diversify our investment portfolio by geographic location, operator and form of investment.  In recent years, several publicly held operators of long-term care facilities and two publicly held operators of assisted living facilities have filed for reorganization under Chapter 11 of the federal bankruptcy laws.  Also see “Government Regulation” below.  As a result of the significant financial difficulties experienced by these and other operators, we have made few investments in the last four years.

In accordance with “plain English” guidelines provided by the Securities and Exchange Commission, whenever we refer to “our company” or to “us”, or use the terms “we” or “our”, we are referring to LTC Properties, Inc. and/or its subsidiaries.

We were organized to qualify, and intend to continue to qualify, as a REIT.  So long as we qualify, with limited exceptions, we may deduct distributions, both preferred dividends and common dividends, to our stockholders from our taxable income.  We have made distributions, and intend to continue to make distributions to our stockholders, in order to eliminate any federal tax liability.

Owned Properties.  During 2002, we acquired one 126-bed skilled nursing property for a total cost of $1.9 million subject to mortgage debt of approximately $1.4 million due to a REMIC pool originated by us.  This property is leased to CLC Healthcare, Inc. (see Item 8. FINANCIAL STATEMENTS — Note 8. CLC Healthcare, Inc. for further discussion).  During 2002 we invested approximately $1.0 million in the expansion and improvement of existing properties.  Mortgage loans with outstanding principal balances totaling $3.8 million that were secured by two skilled nursing properties with a total of 150 beds were converted into owned properties.  As of December 31, 2002, our investment in owned properties consisted of 59 skilled nursing properties with a total of 6,896 beds, 88 assisted living properties with a total of 4,182 units and one school in 23 states, representing a gross investment of approximately $469.7 million.

2

Table of Contents

During the year ended December 31, 2002, we sold 15 skilled nursing facilities and one assisted living property for a total sales price of $40.0 million.  Our gross investment in the properties before impairments and accumulated depreciation was $43.9 million and the net book value, after impairments and accumulated depreciation was $23.0 million.  Net proceeds from these sales were $15.6 million, including a 10-year, $3.6 million note with a face rate of 7.0% which we discounted to $2.6 million for an effective rate of 13.0%, and the reduction of approximately $12.8 million in mortgage debt due to REMIC Pools originated by us, and a $11.1 million reduction in outstanding borrowings under our Senior Secured Revolving Line of Credit (the “Secured Revolving Credit”).  As a result of these sales, $6.0 million of commitments under the Secured Revolving Credit were reduced.  Substantially all of the remaining net proceeds from these sales were used to further reduce outstanding borrowings under the Secured Revolving Credit.  These sales resulted in a net gain of approximately $14.5 million.

The majority of our long-term care properties are leased to lessees pursuant to long-term operating leases that generally have an initial term of 6 to 20 years and provide for increases in the rent based upon specified rate increases, increases in revenues over defined base periods, or increases based on consumer price indices.  All leases are triple net leases that require the lessee to pay all taxes, insurance, maintenance and other costs of the properties.

Mortgage Loans.  As part of our strategy of making long-term investments in properties used in the provision of long-term health care services, we provide mortgage financing on such properties based on our established investment underwriting criteria.  (See “Investment and Other Policies” in this Section.)  We also provide construction loans that by their terms convert into purchase/lease transactions or permanent financing mortgage loans upon completion of construction. At December 31, 2002, we had 39 mortgage loans secured by first mortgages on 36 skilled nursing properties with a total of 4,095 beds and eight assisted living residences with 369 units located in 20 states.  At December 31, 2002, the mortgage loans had a weighted average interest rate of 11.75%, generally have 25-year amortization schedules, have balloon payments due from 2003 to 2018 and provide for certain facility fees.  The majority of the mortgage loans provide for annual increases in the interest rate based upon a specified increase of 10 to 25 basis points.

On August 1, 2002, we completed a loan participation transaction whereby we issued a $30.0 million senior participating interest in 22 of our first mortgage loans that had a total unpaid principal balance of $58.6 million (the “Participation Loan Pool”) to a private bank.  The Participation Loan Pool had a weighted average interest rate of 11.6% and a weighted average scheduled term to maturity of 77 months.  The $30.0 million senior participation is secured by the entire Participation Loan Pool.  We received net proceeds from the issuance of the senior participation of $29.8 million which we used to reduce commitments and amounts outstanding under our Secured Revolving Credit.

The senior participation receives interest at a rate of 9.25% per annum, payable monthly in arrears, on the then outstanding principal balance of the senior participation.  In addition, the senior participation receives all mortgage principal collected on the Participation Loan Pool until the senior participation balance has been reduced to zero.  We retain interest received on the Participation Loan Pool in excess of the 9.25% paid to the senior participation.  The ultimate extinguishment of the senior participation is tied to the underlying maturities of loans in the Participation Loan Pool, which range from 6 to 194 months.  We have accounted for the participation transaction as a secured borrowing under Statement of Financial Accounting Standards (“SFAS”) No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.”

We maintain a long-term investment interest in mortgages we originate either through the direct retention of the mortgages or through the retention of REMIC Certificates originated in our securitizations.  We are a REIT and, as such, make our investments with the intent to hold them for long-term purposes.  However, we may securitize a portion of our mortgage loan portfolio when a securitization provides us with the best available form of capital to fund additional long-term investments.  In addition, we believe that the REMIC Certificates we retain from our securitizations provide our stockholders with a more diverse real estate investment while maintaining the returns we desire.

3

Table of Contents

REMIC Certificates.  We complete a securitization by transferring mortgage loans to a newly created Real Estate Mortgage Investment Conduit (“REMIC”) that, in turn, issues mortgage pass-through certificates aggregating approximately the same amount.  A portion of the REMIC Certificates are sold to third parties and a portion of the REMIC Certificates are retained by us.  The REMIC Certificates we retain are subordinated in right of payment to the REMIC Certificates sold to third parties and a portion of the REMIC Certificates we retain are interest-only certificates which have no principal amount and entitle us to receive cash flows designated as interest.  At December 31, 2002, we had investments in REMIC Certificates with a carrying value of $64.4 million and a fair market value of $48.7 million.  See Note 6. Real Estate Investments for further discussion of our investments in REMIC Certificates.

Investment and Other Policies

Objectives and Policies.  Our investment policy is to invest primarily in income-producing long-term care properties.  In recent years, several publicly held providers of long-term care facilities and two publicly held providers of assisted living facilities have filed for reorganization under Chapter 11 of the federal bankruptcy laws.  Also see “Government Regulation” below.  As a result of the significant financial difficulties experienced by these and other providers, we have made few investments in the last four years.

Historically our investments have consisted of:

In evaluating potential investments, we consider such factors as:

For investments in long-term care properties we place emphasis on properties that have low investment per bed/unit ratios and do not have to rely on the provision of ancillary services to cover debt service or lease obligations.  In addition, with respect to skilled nursing properties, we attempt to invest in properties that do not have to rely on a high percentage of private-pay patients.  We seek to invest in properties that are located in suburban and rural areas of states with improving reimbursement climates.  Prior to every investment, we conduct a property site review to assess the general physical condition of the property and the potential of additional sub-acute services.  In addition, we review the environmental reports, state survey and financial statements of the property before the investment is made.  We prefer to invest in a property that has a significant market presence in its community and where state certificate of need and/or licensing procedures limit the entry of competing properties.  We believe that assisted living facilities are an important sector in the long-term care market and our investments have included direct ownership of assisted living properties.  We believe that

4

Table of Contents

assisted living facilities represent a lower cost long-term care alternative for senior adults than skilled nursing facilities.  We invest primarily in assisted living properties that attract the moderate-income private pay patients in smaller communities, preferably in states that have adopted Medicaid waiver programs or are in the process of adopting or reviewing their policies and reimbursement programs to provide funding for assisted living residences.  We believe that locating residences in a state with a favorable regulatory and reimbursement climate should provide a stable source of residents eligible for Medicaid reimbursement to the extent private-pay residents are not available, and should provide alternative sources of income for residents when their private funds are depleted and they become Medicaid eligible.

The terms of our existing Secured Revolving Credit facility limit our investments outside of health care real estate to $20.0 million.  There are no other formal restrictions imposed in our investment in any single type of property or joint venture; however, difficult capital market conditions in the long-term care sector of the health care industry has in the last three years limited our access to traditional forms of growth capital.  As a result of the tight capital markets for the long-term care sector of the health care industry, we have reduced our investment activity since 2000.  At December 31, 2002, we had no outstanding commitments to provide mortgage or sale/leaseback financing. 

Borrowing Policies.  We may incur additional indebtedness when, in the opinion of our Board of Directors, it is advisable.  We may incur such indebtedness to make investments in additional long-term care properties or to meet the distribution requirements imposed upon REITs under the Internal Revenue Code of 1986, as amended. For other short-term purposes, we may, from time to time, negotiate lines of credit, or arrange for other short-term borrowings from banks or otherwise.  We may also arrange for long-term borrowings through public offerings or from institutional investors.  To the extent that we receive net cash proceeds from such borrowings, the terms of our revolving credit facility require us to reduce the outstanding commitment and repay an equal amount of the net cash proceeds received from such borrowings on amounts outstanding under the revolver. 

In addition, we may incur mortgage indebtedness on real estate which we have acquired through purchase, foreclosure or otherwise.  We may also obtain mortgage financing for unleveraged or underleveraged properties in which we have invested or may refinance properties acquired on a leveraged basis.  There is no limitation on the number or amount of mortgages that may be placed on any one property, and we have no policy with respect to limitations on borrowing, whether secured or unsecured. 

Prohibited Investments and Activities.  Our policies, which are subject to change by our Board of Directors without stockholder approval, impose certain prohibitions and restrictions on various of our investment practices or activities including prohibitions against:

5

Table of Contents

Competition

In the healthcare industry, we compete for real property investments with health care providers, other health care related REITs, real estate partnerships, banks, insurance companies and other investors.  Many of our competitors are significantly larger and have greater financial resources and lower cost of capital than we have available to us.  Our ability to compete successfully for real property investments will be determined by numerous factors, including our ability to identify suitable acquisition targets, our ability to negotiate acceptable terms for any such acquisition and the availability and cost of capital.  Difficult capital market conditions for the long-term care sector of the health care industry has limited our access to traditional forms of growth capital.  As a result of the tight capital markets for the long-term care sector of the health care industry, we have reduced our investment activity since 2000.

The lessees and borrowers of our properties compete on a local, regional and, in some instances, national basis with other health care providers.  The ability of the lessee or borrower to compete successfully for patients or residents at our properties depends upon several factors, including the levels of care and services provided by the lessees or borrowers, the reputation of the providers, physician referral patterns, physical appearances of the properties, family preferences, financial condition of the operator and other competitive systems of health care delivery within the community, population and demographics.

Difficulties Experienced by Major Operators

The majority of our revenue is derived from the long-term care sector.  Reduced reimbursements, a staffing shortage and increased liability insurance costs and professional liability claims continue to plague the industry.  Certain temporary Medicare add-on payments enacted in The Balanced Budget Refinement Act of 1999 and Medicare, Medicaid and SCHIP Benefit and Protection Act of 2000 expired in October 2002.  As a result, Medicare reimbursement to nursing homes declined about 9%, as of October 1, 2002.  Other add-on payments associated with certain classifications are scheduled to expire October 1, 2003 unless Congress acts to restore the payments.  A planned limitation on patient Medicare rehabilitation therapy procedures scheduled for January 1, 2003 has been delayed until July 2003.  The therapy cap may be further delayed.  However, if the cap is enacted it is anticipated that Medicare reimbursement will be further reduced.

Due to economic challenges facing many states, nursing homes will likely continue to be under funded.  Some states have already and some states have proposed to reduce Medicaid reimbursement to nursing home providers.  Management believes that inadequate Medicare and Medicaid reimbursements and other issues discussed above will cause losses and reduced financial performance for many long-term care facilities and operators.  Also see “Government Regulation” below.

Sun Healthcare Group, Inc. (“Sun”) did not pay February 2003 rent and requested that we terminate the leases for nine properties, with a net book value of $45.8 million at December 31, 2002, leased directly from us.  Annual rent on the nine properties aggregated $4.1 million in 2002.  We are actively negotiating terms with replacement lessees for these properties.  Sun indicated its intent to continue leasing from us four other properties and retain two other properties financed by mortgages that are in a REMIC pool originated by us.  As of December 31, 2002, Sun owed approximately $6.0 million to the REMIC for these two mortgaged properties. Our net book value of the four leased properties at December 31, 2002 was approximately $10.3 million and the properties generate approximately $1.4 million in rental income. 

See  “Item 8.  FINANCIAL STATEMENTS—Note 3. Major Operators” for a discussion of issues associated with Assisted Living Concepts, Inc. (“ALC”) and Alterra Healthcare Corporation (“Alterra”).  Also see “Governmental Regulation” below.  Given the negative impact of these changes on the financial performance of operators of nursing homes and assisted living facilities, we continually evaluate the realizability of our real estate and marketable debt securities investment

6

Table of Contents

portfolios.  As a result of our analyses, we recorded a non-cash impairment charge on certain properties in our real estate investment portfolio (properties we own or on which we hold first mortgages or REMIC Certificates) totaling $7.8 million ($0.7 million of which is included in discontinued operations) in 2002.  In 2001, we recorded a non-cash impairment charge and costs of foreclosure and lease terminations on certain properties and securities in our real estate and marketable debt securities investment portfolios totaling $28.6 million ($8.9 million of which is included in discontinued operations), of which $17.3 million relates to our real estate investment portfolio.  See “Item 8.  FINANCIAL STATEMENTS — Note 5.  Impairment Charge” for further discussion of the impairment charges we have recorded.

CLC Healthcare, Inc.

In 2002, LTC Healthcare, Inc. changed its name to CLC Healthcare, Inc. (“CLC”).

During 1998, we completed the spin-off of all CLC voting common stock through a taxable dividend distribution to the holders of our common stock, Cumulative Convertible Series C Preferred Stock and Convertible Subordinated Debentures.  Upon completion of the distribution, CLC began operating as a separate public company.  Beginning in September 1999, CLC began leasing skilled nursing properties owned or financed by us, assumed the leases of certain additional properties and closed certain properties with our consent.  We previously financed or leased these properties to lessees who experienced financial difficulties to such extent that the lessees were not able to comply with lease provisions or debt provisions underlying the properties.  CLC assumed leases for these properties.  As a result CLC assumed leases of troubled facilities and was not able to pay, nor did we record as income, rent under its leases with us in 2002 and 2001.  In November and December of 2002, CLC paid us $0.3 million per month.  CLC indicated that these payments were for rent; however, based on our assessment of CLC’s financial condition, we recorded these payments as reductions to CLC’s line of credit with us.  In January and February of 2003, CLC paid us a total of $0.7 million that we also applied as reductions to CLC’s line of credit with us.  In 2002, CLC paid us, and we recorded as income, $0.5 million in interest on its line of credit with us.  In 2001, we did not receive, nor did we record as income, interest on CLC’s line of credit with us.  See discussion of the line of credit below.

Pursuant to an intercompany agreement entered into at the time CLC was formed, CLC has agreed not to engage in activities or make investments that involve real estate, unless it has first provided us with written notice of the material terms and conditions of such activities or investments, and we have determined not to pursue such activities or investments either by providing written notice to CLC rejecting the opportunity or by allowing a 10-day notice period to lapse.  Pursuant to the intercompany agreement, we also agreed to notify each other of, and make available to each other, investment opportunities that either company develops or of which either company becomes aware but is unable or unwilling to pursue.  The intercompany agreement has a term of 10 years but shall terminate earlier upon a change of control of our company.

As of December 31, 2002, 23 of our skilled nursing properties, which represents approximately 7.8%, or $46.8 million (including impairments totaling $7.1 million on three properties) of our total assets were leased to CLC.  In 2002, we sold a wholly owned subsidiary, LTC-Fort Tucum, Inc. to CLC for a $0.5 million note (“Fort Tucum Note”) bearing no interest for one year and thereafter interest at 8% annually for two years.  CLC has certain rights to extend the note at its maturity.  LTC-Fort Tucum, now owned by CLC, acquired two skilled nursing properties in New Mexico, previously owned by an unrelated third party and operated by Integrated Health Services, Inc., in a deed-in-lieu of foreclosure transaction.  These properties are financed with debt from a REMIC pool originated by us.  CLC began operating the two properties during the second quarter of 2002.

The 23 properties we lease to CLC under individual six-year leases provide for total rents of $3.0; $4.0; $4.8; $5.4; $5.9 and $6.5 million respectively, in years 2002 through 2007.  The leases contain two five-year renewal options with increases of 2% annually.  These leases have a provision for acceleration should there be a change of control, as defined in the lease, of CLC.  Additionally, CLC owns and operates the two New Mexico properties discussed above which are financed with mortgage loans payable to a REMIC pool originated by us.

7

Table of Contents

CLC has advised us that their Form 10-K for the year ended December 31, 2002 will contain a “going concern” qualified opinion from CLC’s outside auditors.  CLC has sustained operating losses and net losses every year since inception, currently has no outside financing availability other than the line of credit with us discussed below.  Further, CLC has recorded an actuarially based accrual for general and professional liability of approximately $12.6 million.  See below for discussion of CLC’s insurance coverage.

We have discussed with CLC’s Board of Directors the possible transfer of the 23 leased properties to other lessees.  The independent directors of CLC’s Board has agreed, at this time, to permit us to solicit other lessees for these properties.  We have agreed with CLC that until June 30, 2003, and contingent on our reaching an agreement with another lessee, we would purchase from CLC the leasehold improvements, furniture, fixtures and equipment and pay CLC a mutually agreeable lease breakage fee for any property leased to a new lessee.  We have also agreed to give CLC a rent abatement retroactive to March 1, 2003 on any lease where we enter into a lease with a new lessee.

Management cannot predict, at this time, when or if any or all CLC leases will be transferred to other lessees or what value any new leases would represent for the properties leased.  Such new leases may result in a future impairment charge if the net book value of the properties exceeds the undiscounted cash flow from the new leases.

These discussions with CLC could involve a significant restructuring of CLC by the Board and management of CLC and during this process it is likely that we will need to advance working capital or offer additional rent concessions to CLC for its reorganization.  The amount of a potential advance has not been agreed to, and the eventual realization of all CLC’s obligations to us, including future advances, is not, at this time estimable.

Additionally, we hold a Promissory Note (“Note”) issued by Healthcare Holdings, Inc. (“Holdings”), a wholly owned subsidiary of CLC, in the face amount of $7.0 million.  The Note was received in December 2001 in exchange for our right to receive 1,238,076 shares of Assisted Living Concepts, Inc. (“ALC”) common stock distributed concurrently with ALC’s emergence from bankruptcy on December 31, 2001.  The Note is for a term of five years and bears interest at 5.0%, compounded annually and accruing to the principal balance plus interest at 2.0% on the original principal balance of $7.0 million, which is payable in cash annually.  We did not accrue any interest income on the Note in 2002.  In January 2003, we received $0.1 million from CLC, which represents the 2.0% on the original principal balance of $7.0 million which is payable in cash annually.  Thus, CLC is current on its interest payments due under the Note.  The Note is a full recourse obligation of Holdings and is secured by all of the assets owned now or in the future by Holdings and contains a provision for acceleration should there be a change of control of Holdings or CLC.

At December 31, 2002, Holdings owned 1,452,794 shares of ALC common stock with a fair market value based on the closing price of ALC stock on December 31, 2002 of $4.4 million, $1.2 million face value of ALC senior secured debentures and $0.6 million face value of junior subordinated debentures.  At December 31, 2002, the book value of the Note was $3.1 million, which represented the fair market value of the 1,238,076 shares acquired by Holdings on December 31, 2001.

Our Chairman, President and Chief Executive Officer serves as a Board member and Chief Executive Officer of CLC. Our Executive Vice President, Chief Investment Officer serves as a Board member and President of CLC. Our Vice President, Taxes serves as CLC's Vice President, Taxes. On March 7, 2003, our Chief Financial Officer resigned as CLC's Chief Financial Officer but remains a Board member of CLC. Additionally, we have an indemnification agreement covering these officers who also serve as Board members of CLC and one current CLC outside director.

CLC has advised us that it no longer has general and professional liability insurance in Texas and Florida.  CLC no longer operates in Florida; however, it has claims arising from operations prior to its exit from the Florida market.  CLC does provide for a reserve for potential insurance losses based on an estimate of incurred but not reported losses; however, should CLC incur a significant uninsured loss, it may not have the resources to pay the

8

Table of Contents

loss.  As mentioned above, CLC has recorded an actuarially based accrual for general and professional liability of approximately $12.6 million as of December 31, 2002.  At this time, CLC has stated that given the current litigation environment and unpredictability of jury trials, the existing claims could develop in a way which may present a material adverse affect on CLC’s financial position, results of operations or liquidity.

We have provided CLC with a secured line of credit that bears interest at 10% and matures April 1, 2008.  Effective October 1, 2002, we amended the secured line of credit provided by our company to CLC.  The amendment reduced the line from $20.0 million to $10.0 million and added certain restrictions as to the use of funds drawn under the line.  The line of credit continues to bear interest at 10%, matures on April 1, 2008 and contains a provision for acceleration should there be a change of control of CLC.  In consideration of this amendment, we waived until November 30, 2002, defaults under our leases with CLC for non-payment of rent.  During 2002, we advanced CLC $0.8 million and CLC repaid us $1.4 million under the line of credit which had a balance of $4.7 million at December 31, 2002.  In March 2003, we advanced CLC $1.0 million under the line of credit.

All of the aforementioned transactions and amendments to agreements between our company and CLC were approved by the respective disinterested and/or independent members of the Board of Directors of each company.  All interested and/or non-independent Board members abstained from any such vote.

Employees

We currently employ 15 people.

Investor Information

We do not currently maintain an Internet website.  We will provide, as soon as reasonably possible after these reports are filed with the Securities and Exchange Commission, at no charge and upon request, paper copies of our Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended.  Requests may be made in writing or by telephone at the address or telephone number listed on the cover of the Form 10-K.

Governmental Regulation

General.  The lessees or borrowers of our skilled nursing properties derive a substantial portion of their revenue from third party payors, including the Medicare and Medicaid programs.  The Medicare program was enacted in 1965 to provide a nationwide, federally funded health insurance program for the elderly and certain disabled persons.  The Medicaid program is a joint federal-state cooperative arrangement established for the purpose of enabling states to furnish medical assistance on behalf of aged, blind or disabled individuals, and members of families with dependent children, whose income and resources are insufficient to meet the costs of necessary medical services. Within the Medicare and Medicaid statutory framework, there are substantial areas subject to administrative regulations and rulings, interpretation and discretion which may affect payments made to providers under these programs.  The amounts of program payments received by our lessees or borrowers can be changed by legislative or regulatory actions and by determinations made by fiscal intermediaries and other payment agents acting on behalf of the programs.

Medicare PPS System and Related Legislation.  Medicare reimbursement for skilled nursing facilities is based on a prospective payment system (“PPS”) under which facilities are paid a federal per diem rate for virtually all covered services.  Payment is determined by resource utilization groups (“RUGs”).  The PPS system, which was mandated by the Balanced Budget Act of 1997 (the “Balanced Budget Act”), was phased in starting with cost reporting periods beginning on or after July 1, 1998.  All facilities were paid at the full federal rate beginning October 1, 2001.  PPS has resulted in more intense price competition and lower margins for operators.  There can be no assurance that operators will be successful in reducing costs of services below the PPS reimbursement rates, or that the failure of operators to do so will not have a material adverse effect on their liquidity, financial condition and results of operations which in turn could affect adversely their ability to make rental payments or mortgage payments to us.

9

Table of Contents

The Balanced Budget Refinement Act, enacted in November 1999 (“BBRA 1999”), and the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 (“BIPA 2000”) sought to mitigate some of the reductions in reimbursement to skilled nursing facilities resulting from the Balanced Budget Act.  While many of the payment increases mandated by these two bills expired October 1, 2002, SNFs continue to benefit from a BBRA 1999 provision (subsequently modified by BIPA 2000) that temporarily increases payments for certain high-acuity patients.  Specifically, the legislation temporarily increases the PPS per diem rates for certain specific patient acuity categories, beginning April 1, 2000, and ending when the Centers for Medicare & Medicaid Services (“CMS”), formerly the Health Care Financing Administration (“HCFA”), implements a refined RUG system that better accounts for medically-complex patients.  The Secretary of HHS did not implement such refinements in fiscal year 2003, and the Bush Administration has indicated that the refinements also will not be implemented in fiscal year 2004.

The Balanced Budget Act also instituted a consolidated billing requirement for skilled nursing facilities, which required facilities to submit Medicare claims to the fiscal intermediary for virtually all Medicare services that its residents receive, except for certain specifically excluded services.  The BBRA 1999 excluded additional items from the consolidated billing requirement. Moreover, BIPA 2000 limited consolidated billing requirements to items and services furnished to skilled nursing facility residents in a Medicare Part A covered stay and therapy services covered under Part B.  In other words, for residents not covered under a Part A stay, facilities may choose to bill for non-therapy Part B services and supplies, or they may elect to have suppliers continue to bill Medicare directly for these services.

Moreover, the Balanced Budget Act established: (1) a $1,500 per beneficiary annual cap for all outpatient physical therapy services and speech language pathology services; and (2) a $1,500 per beneficiary annual cap for all outpatient occupational therapy services.  The BBRA 1999 and BIPA 2000 suspended implementation of these caps through 2002.  While Congress did not extend the moratorium before it expired, CMS has announced that it will not begin enforcing the therapy caps until July 1, 2003, and that the caps are indexed for inflation, bringing the caps to $1,590.

Balanced Budget Act – Medicaid.  The Balanced Budget Act also repealed the Boren Amendment, which required state Medicaid programs to reimburse nursing facilities for the costs that are incurred by efficiently and economically operated nursing homes.  Since repeal, many states have sought to lower their reimbursement payment rates, and several have succeeded.  It is unclear at this time the extent to which additional state Medicaid programs will adopt changes in their Medicaid reimbursement systems, or, if adopted and implemented, what affect such initiatives would have on operators.  There can be no assurance that future changes in Medicaid reimbursement rates to nursing facilities will not have an adverse effect on the operators, and thus, us.  Further, the Balanced Budget Act allows states to mandate enrollment in managed care systems without seeking approval from HHS for waivers from certain Medicaid requirements as long as certain standards are met.  These managed care programs have historically exempted institutional care although some states have instituted pilot programs to provide such care under managed care programs.  Nevertheless, several states use capitated managed care financing for at least a portion of their long-term care programs. We are not able to predict whether any future states’ waiver provisions will change the Medicaid reimbursement systems for long-term care facilities from cost-based or fee-for-service to managed care negotiated or capitated rates or otherwise affect the level of payments to operators.  Moreover, many states are facing significant budget shortfalls, and most states are taking steps to implement cost controls within their Medicaid programs.  Significant limits on the scope of services reimbursed and on rates of reimbursement under the Medicaid program could have a material adverse effect on the operators’ liquidity, financial condition and results of operations, which in turn could affect adversely their ability to make rental payments or mortgage payments to us.

On January 12, 2001, the Secretary of HHS issued final regulations to implement changes to the Medicaid “upper payment limit” requirements and additional restrictions were issued January 18, 2002.  The purpose of the rule is to stop states from using certain accounting techniques to inappropriately obtain extra federal Medicaid matching funds that are not necessarily spent on health care services for Medicaid beneficiaries.  Although the rule is being phased in over eight years to reduce the adverse impact on certain states, the rule eventually could result in

10

Table of Contents

decreased federal funding to state Medicaid programs, which, in turn, could prompt certain states to reduce Medicaid reimbursements to providers, including nursing facilities.

Future Legislative Changes.  We expect Congress to continue to consider measures to reduce the growth in Medicare and Medicaid expenditures.  As noted previously, certain of the increases in Medicare reimbursement for skilled nursing facilities provided for under the Balanced Budget Refinement Act and the Benefits Improvement and Protection Act expired in October 2002.  Congress has not enacted additional legislation to date to further extend these provisions.  No assurances can be given as to whether Congress will increase or decrease reimbursement in the future, the timing of any such action, or the form of relief, if any, that may be enacted.  In addition, the Medicare Payment Advisory Commission (“MedPAC”), an independent federal body established to advise Congress on issues affecting the Medicare program, reportedly will recommend in a March 2003 report that Congress adopt additional reductions in skilled nursing facility reimbursement. While the MedPAC recommendations are not binding on Congress, they may affect Congressional consideration of future Medicare reimbursement legislation.

Both the Medicare and Medicaid programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy, intermediary determinations and governmental funding restrictions, all of which may materially increase or decrease the rate of program reimbursement to health care facilities.  We cannot predict at this time whether any additional measures will be adopted or if adopted and implemented, what effect such proposals would have on lessees or borrowers of our health care properties.  There can be no assurance that payments under state and federal governmental programs will remain at levels comparable to present levels or will be sufficient to cover the costs of patients eligible for reimbursement pursuant to the programs.

Certain states are currently evaluating various proposals to restructure health care delivery within their respective jurisdictions.  It is uncertain at this time what legislation of this type will ultimately be enacted and implemented or whether other changes in the administration or interpretation of governmental health care programs will occur. We anticipate that state legislatures will continue to review and assess various health care reform proposals and alternative health care systems and payment methodologies.  We are unable to predict the ultimate impact of any future state restructuring of the health care delivery system, but such changes could have a material adverse effect on the operators’ liquidity, financial condition and results of operations, which in turn could affect adversely their ability to comply with the terms of the leases or loans, including making rental payments or mortgage payments to us.

Licensure. The lessees or borrowers of our health care properties are subject to extensive state and local laws and regulations relating to licensure, conduct of operations, and services provided within the facilities.  The nursing operations of our lessees and borrowers are subject to regulation and licensing by state and local health and social services agencies and other regulatory authorities.  In order to maintain their operating licenses, health care facilities must comply with standards concerning medical care, equipment and hygiene.  Although regulatory requirements vary from state to state, these requirements generally address among other things: personnel education and training; staffing levels; patient records; facility services; quality of care provided; physical residence specifications; food and housekeeping services; and residents’ rights and responsibilities.  These facilities are subject to periodic survey and inspection by governmental authorities.  The properties are also subject to various state and local building codes and other ordinances, including zoning and safety codes.

Certificate of Need.  Certificate of Need (“CON”) statutes and regulations control the development and expansion of health care services and properties in certain states.  The CON process is intended to promote quality health care and to avoid the unnecessary duplication of services, equipment and properties.  CON or similar laws generally require that approval be obtained from the designated state health planning agency for certain acquisitions and capital expenditures, and that such agency determine that a need exists prior to the expansion of existing facilities, construction of new facilities, addition of beds, acquisition of major items of equipment or introduction of new services.  Additionally, several states have instituted moratoria on new CONs or the approval of new beds.  CONs or other similar approvals may be required in connection with our future

11

Table of Contents

acquisitions and/or expansions.  There can be no assurance that our lessees or borrowers or we will be able to obtain the CONs or other approvals necessary for any or all such projects.

Survey and Certification.  Long-term care facilities must comply with certain requirements to participate either as a skilled nursing facility under Medicare or a nursing facility under Medicaid.  Regulations promulgated pursuant to the Omnibus Budget Reconciliation Act of 1987 obligate facilities to demonstrate compliance with requirements relating to resident rights, resident assessment, quality of care, quality of life, physician services, nursing services, pharmacy services, dietary services, rehabilitation services, infection control, physical environment and administration.  Regulations governing survey, certification, and enforcement procedures to be used by state and federal survey agencies to determine facilities’ level of compliance with the participation requirements for Medicare and Medicaid were adopted by HCFA effective July 1, 1995.  These regulations require that surveys focus on resident outcomes.  They also state that all deviations from participation requirements will be considered deficiencies, but a facility may have certain minor deficiencies and be in substantial compliance with the regulations.  The regulations identify various remedies that may be imposed against facilities and specify the categories of deficiencies for which they will be applied.  These remedies include, but are not limited to: civil money penalties of up to $10,000 per day or “per instance” facility closure and/or transfer of residents in emergencies; denial of payment for new or all admissions; directed plans of correction; and directed in-service training.  Failure to comply with applicable requirements for participation may also result in termination of the provider’s Medicare and Medicaid provider agreements.  Termination of an operator’s Medicare or Medicaid provider agreement could have a material adverse effect on the operator’s liquidity, financial condition and results of operations, which, in turn, could affect adversely its ability to make rental payments or mortgage payments to us.

The federal government has implemented several initiatives in recent years designed to improve the quality of care in nursing homes and to reduce fraud in the Medicare program.  These initiatives include tougher enforcement measures by state surveying authorities, empowering specialized contractors to track down Medicare scams and program waste, and expanded use of “fraud fighters” by Medicare contractors.  Moreover, in April 2002, HHS announced a Nursing Home Quality Initiative pilot program for six states, which are Colorado, Florida, Maryland, Ohio, Rhode Island and Washington.  This pilot program was designed to provide consumers with comparative information about nursing home quality measures.  The initiative rated every nursing facility and SNF operating in these states on specific quality of care indicators, including percentages of patients with infections, bedsores, and unplanned weight loss, among others.  On April 24, 2002, HHS released initial quality data from nursing homes in the pilot program’s six states.  The quality data, along with other information about individual nursing facilities, have been made available to the public through Medicare’s consumer web site, newspaper ads and a telephone help line.  On November 12, 2002, HHS announced that the program is being launched nationwide.  For the national project, HHS is using 10 quality measures, falling into two categories -- six for chronic care patients (long-term stay residents) and four for post-acute care patients (short-term patients).  On November 13, 2002, CMS published advertisements in newspapers in every state that included a sampling of the quality data. The complete listing is available on the CMS internet site.

Referral Restrictions and Fraud and Abuse.  The Medicare and Medicaid anti-kickback statute, 42 U.S.C. § 1320a-7b(b), prohibits the knowing and willful solicitation or receipt of any remuneration “in return for” referring an individual, or for recommending or arranging for the purchase, lease, or ordering, of any item or service for which payment may be made under Medicare or a state health care program.  In addition, the statute prohibits the offer or payment of remuneration “to induce” a person to refer an individual, or to recommend or arrange for the purchase, lease, or ordering of any item or service for which payment may be made under the Medicare or state health care programs.  The statute and the so-called safe harbor regulations establish numerous exceptions by defining conduct, which are not subject to prosecution or other enforcement remedies.  Violation of the anti-kickback statute could result in criminal conviction, as well as civil money penalties and exclusions.

The Ethics in Patient Referrals Act (“Stark I”), effective January 1, 1992, generally prohibits physicians from referring Medicare patients to clinical laboratories for testing if the referring physician (or a member of the physician’s immediate family) has a “financial relationship,” through ownership or compensation, with the

12

Table of Contents

laboratory.  The Omnibus Budget Reconciliation Act of 1993 contains provisions commonly known as “Stark II” (“Stark II”) expanding Stark I by prohibiting physicians from referring Medicare and Medicaid patients to an entity with which a physician has a “financial relationship” for the furnishing of certain items set forth in a list of “designated health services,” including physical therapy, occupational therapy, home health services, and other services.  Subject to certain exceptions, if such a financial relationship exists, the entity is generally prohibited from claiming payment for such services under the Medicare or Medicaid programs, and civil monetary penalties may be assessed for each prohibited claim submitted.  On January 4, 2001, HCFA released the first part of the long-awaited Stark II final rule.  This final rule is divided into two phases.  Phase I focuses on the provisions related to prohibited referrals, the general exception to ownership and compensation arrangement prohibitions and the related definitions.  Most of Phase I of the rulemaking became effective January 4, 2002, one year after the date of its publication in the Federal Register.  Phase I of the final rule eases certain of the restrictions in the proposed rule, including the criteria for qualifying as a group practice.  The final rule also, among other things: conforms the supervision requirements to HCFA coverage and payment policies for the specific services; clarifies the definitions of designated health services and indirect financial relationships; and creates new exceptions for indirect compensation arrangements and compensation of faculties in academic medical centers. Phase II of the final rule has not yet been released. Phase II will cover the remaining portions of the statute, including those pertaining to Medicaid.

Other provisions in the Social Security Act and in other federal and state laws authorize the imposition of penalties, including criminal and civil fines and exclusions from participation in Medicare and Medicaid, for false claims, improper billing and other offenses.

We are unable to predict the effect of future administrative or judicial interpretations of the laws discussed above, or whether other legislation or regulations on the federal or state level in any of these areas will be adopted, what form such legislation or regulations may take, or their impact on lessees or borrowers of our health care properties.  We endeavor to structure our arrangements with our properties’ lessees and borrowers and others to comply with applicable regulatory requirements, but there can be no assurance that statutory or regulatory changes, or subsequent administrative rulings or interpretations, will not require us to modify or restructure certain arrangements, or that we will not be required to expend significant amounts to maintain compliance.

Health Information Practices.  The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) mandates, among other things, the adoption of standards for the exchange of electronic health information in an effort to encourage overall administrative simplification and enhance the effectiveness and efficiency of the health care industry. Among the standards that HHS will adopt pursuant to the Health Insurance Portability and Accountability Act are standards for the following:

Although HIPAA was intended ultimately to reduce administrative expenses and burdens faced within the health care industry, we believe the law could initially bring about significant and, in some cases, costly changes. HHS has released three rules to date mandating the use of new standards with respect to certain health care transactions and health information. The first rule requires the use of uniform standards for common health care transactions, including health care claims information, plan eligibility, referral certification and authorization, claims status, plan enrollment and disenrollment, payment and remittance advice, plan premium payments and coordination of benefits.

13

Table of Contents

Second, HHS has released new standards relating to the privacy of individually identifiable health information. These standards not only require our lessees’ or borrowers’ compliance with rules governing the use and disclosure of protected health information, but they also require entities to impose those rules, by contract, on any business associate to whom such information is disclosed.

Third, on February 20, 2003, HHS issued final rules governing the security of health information. This rule specifies a series of administrative, technical, and physical security procedures covered entities must use to assure the confidentiality of electronic protected health information.

HHS finalized the new transaction standards on August 17, 2000, and covered entities, such as our lessees or borrowers, originally were required to comply with the new standards by October 16, 2002.  Congress passed legislation in December 2001 that delayed the compliance date for one year (until October 16, 2003), but only for entities that submit a compliance plan to HHS by the original implementation deadline.  On February 20, 2003, HHS published certain modifications to the final transaction standards, but these changes do not affect the October 16, 2003 compliance deadline. The privacy standards were issued on December 28, 2000, and, after certain delays, became effective April 14, 2001, with a compliance date of April 14, 2003. The security standards are effective April 21, 2003, with a compliance date of April 21, 2005 for most covered entities. Sanctions for failing to comply with HIPAA include criminal penalties and civil sanctions. 

We believe the lessees or borrowers of our health care properties are aware of and should be evaluating the effect of HIPAA.  We believe our lessees or borrowers cannot at this time estimate the cost of such compliance, nor estimate the cost of compliance with standards that have not yet been finalized.  The new and proposed health information standards are likely to have a significant effect on the manner in which the lessees or borrowers of our health care properties handle health data and communicate with payors.  However, based on our current knowledge, we cannot currently estimate the cost of compliance or if there will be a material adverse effect on our business, financial condition or results of operations as a result of our lessees or borrowers experiencing increased costs for compliance.

Compliance Program.  On March 16, 2000, the Office of Inspector General of HHS (“OIG”) issued guidance to help nursing facilities design effective voluntary compliance programs to prevent fraud, waste, and abuse in health care programs, including Medicare and Medicaid.  The guidance, Compliance Program Guidance for Nursing Facilities, was published as a notice in the Federal Register. 

Taxation of Our Company

General.  We believe that we have been organized and have operated in such a manner as to qualify for taxation as a REIT under Sections 856 to 860 of the Internal Revenue Code of 1986, as amended, commencing with our taxable year ended December 31, 1992, and we intend to continue to operate in such a manner.  No assurance can be given that we have operated or will be able to continue to operate in a manner so as to qualify or to remain so qualified.  This summary is qualified in its entirety by the applicable Internal Revenue Code provisions, rules and regulations, and administrative and judicial interpretations.

If we qualify for taxation as a REIT, we will generally not be subject to federal corporate income taxes as long as we distribute all of our taxable income as dividends.  This treatment substantially eliminates the “double taxation” (i.e., at the corporate and stockholder levels) that generally results from investment in a corporation.  However, we will continue to be subject to federal income tax under certain circumstances.

Requirements for Qualification.  The Internal Revenue Code defines a REIT as a corporation, trust or association:

14

Table of Contents

The Internal Revenue Code provides that conditions (1) to (4), inclusive, must be met during the entire taxable year and that condition (5) must be met during at least 335 days of a taxable year of 12 months, or during a proportionate part of a taxable year of less than 12 months.

Income Tests.  There presently are two gross income requirements that we must satisfy to qualify as a REIT:

Cancellation of indebtedness income generated by us is not taken into account in applying the 75% and 95% income tests discussed above.  A “prohibited transaction” is a sale or other disposition of property (other than foreclosure property) held for sale to customers in the ordinary course of business.  Any gain realized from a prohibited transaction is subject to a 100% penalty tax.

Asset Tests.  We, at the close of each quarter of our taxable year, must also satisfy four tests relating to the nature of our assets. 

Ownership of a Partnership Interest or Stock in a Corporation.  We own interests in various partnerships.  In the case of a REIT that is a partner in a partnership, Treasury regulations provide that for purposes of the REIT

15

Table of Contents

income and asset tests the REIT will be deemed to own its proportionate share of the assets of the partnership, and will be deemed to be entitled to the income of the partnership attributable to such share.  The ownership of an interest in a partnership by a REIT may involve special tax risks, including the challenge by the Internal Revenue Service of the allocations of income and expense items of the partnership, which would affect the computation of taxable income of the REIT, and the status of the partnership as a partnership (as opposed to an association taxable as a corporation) for federal income tax purposes. 

We also own interests in a number of subsidiaries which are intended to be treated as qualified real estate investment trust subsidiaries.  The Internal Revenue Code provides that such subsidiaries will be ignored for federal income tax purposes and all assets, liabilities and items of income, deduction and credit of such subsidiaries will be treated as assets, liabilities and such items of our company. 

If any partnership or qualified real estate investment trust subsidiary in which we own an interest were treated as a regular corporation (and not as a partnership or qualified real estate investment trust subsidiary) for federal income tax purposes, we would likely fail to satisfy the REIT asset test prohibiting a REIT from owning greater than 10% of the voting power of the stock or value of securities of any issuer, as described above, and would therefore fail to qualify as a REIT.  We believe that each of the partnerships and subsidiaries in which we own an interest will be treated for tax purposes as a partnership or qualified real estate investment trust subsidiary, respectively, although no assurance can be given that the Internal Revenue Service will not successfully challenge the status of any such organization.

REMIC. A regular or residual interest in a REMIC will be treated as a real estate asset for purposes of the REIT asset tests, and income derived with respect to such interest will be treated as interest on an obligation secured by a mortgage on real property, assuming that at least 95% of the assets of the REMIC are real estate assets.  If less than 95% of the assets of the REMIC are real estate assets, only a proportionate share of the assets of and income derived from the REMIC will be treated as qualifying under the REIT asset and income tests.  All of our REMIC Certificates are secured by real estate assets, therefore we believe that our REMIC interests fully qualify for purposes of the REIT income and asset tests.

Annual Distribution Requirements.  In order to qualify as a REIT, we are required to distribute dividends (other than capital gain dividends) to our stockholders annually in an amount at least equal to:

These annual distributions are paid in the taxable year to which they relate.  Alternatively, they must be declared and payable to stockholders of record in either October, November, or December and paid during January of the following year.  In addition, if we elect, the dividends may be declared before the due date of the tax return (including extensions) and paid on or before the first regular dividend payment date after such declaration, and we must specify the dollar amount in our tax returns.

Amounts distributed must not be preferential; that is, every stockholder of the class of stock with respect to which a distribution is made must be treated the same as every other stockholder of that class, and no class of stock may be treated otherwise than in accordance with its dividend rights as a class.

16

Table of Contents

To the extent that we do not distribute all of our net long-term capital gain or distribute at least 90%
(95% for taxable years ending prior to January 1, 2001), but less than 100%, of our “real estate investment trust taxable income,” as adjusted, it will be subject to tax on such amounts at regular corporate tax rates.  Furthermore, if we should fail to distribute during each calendar year (or, in the case of distributions with declaration and record dates in the last three months of the calendar year, by the end of the following January) at least the sum of:

we would be subject to a 4% excise tax on the excess of such required distributions over the amounts actually distributed.  Any real estate investment trust taxable income and net capital gain on which this excise tax is imposed for any year is treated as an amount distributed during that year for purposes of calculating such tax.

Failure to Qualify.  If we fail to qualify for taxation as a REIT in any taxable year, and certain relief provisions do not apply, we will be subject to tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates.  Distributions to stockholders in any year in which we fail to qualify as a REIT will not be deductible by us, nor will any distributions be required to be made. Unless entitled to relief under specific statutory provisions, we will also be disqualified from taxation as a REIT for the four taxable years following the year during which qualification was lost. It is not possible to state whether in all circumstances we would be entitled to the statutory relief.  Failure to qualify for even one year could substantially reduce distributions to stockholders and could result in our incurring substantial indebtedness (to the extent borrowings are feasible) or liquidating substantial investments in order to pay the resulting taxes.

99 Act.  The 99 Act has made a number of substantial changes to the qualification and tax treatment of REITs.  The REIT changes are generally effective for taxable years commencing after December 31, 2000.  The following is a brief summary of certain of the significant REIT provisions contained in the 99 Act.

17

Table of Contents

State and local taxation.  We may be subject to state or local taxation in various state or local jurisdictions, including those in which we transact business or reside.  The state and local tax treatment of our company may not conform to the federal income tax consequences discussed above.

18

Table of Contents

Investment Portfolio

At December 31, 2002, our “direct real estate investment portfolio” (properties that we own or on which we hold promissory notes secured by first mortgages) consisted of investments in 95 skilled nursing properties with 10,991 beds, 96 assisted living properties with 4,551 units and one school in 30 states. We had approximately $469.7 million (before accumulated depreciation of $64.3 million) invested in properties we own and lease to lessees, approximately $84.0 million invested in mortgage loans (before allowance for doubtful accounts of $1.3 million), and investments in REMIC Certificates with a carrying value of approximately $64.4 million ($66.8 million at amortized cost, prior to any adjustment of available-for-sale certificates to fair market value).

Skilled nursing facilities provide restorative, rehabilitative and nursing care for people not requiring the more extensive and sophisticated treatment available at acute care hospitals.  Many skilled nursing facilities provide ancillary services that include occupational, speech, physical, respiratory and IV therapies, as well as provide sub-acute care services which are paid either by the patient, the patient’s family, or through federal Medicare or state Medicaid programs.  Assisted living facilities serve elderly persons who require assistance with activities of daily living, but do not require the constant supervision skilled nursing facilities provide. Services are usually available 24-hours a day and include personal supervision and assistance with eating, bathing, grooming and administering medication. The facilities provide a combination of housing, supportive services, personalized assistance and health care designed to respond to individual needs.

The school in our real estate investment portfolio is a charter school.  Charter schools provide an alternative to the traditional public school.  Charter schools are generally autonomous entities authorized by the state or locality to conduct operations independent from the surrounding public school district.  Laws vary by state, but generally charters are granted by state boards of education either directly or in conjunction with local school districts or public universities.  Operators are granted charters to establish and operate schools based on the goals and objectives set forth in the charter.  Upon receipt of a charter, schools receive an annuity from the state for each student enrolled.

Owned Properties.  At December 31, 2002, we owned 59 skilled nursing properties with a total of 6,896 beds,
88 assisted living properties with a total of 4,182 units and one school in 23 states, representing a gross investment of approximately $469.7 million.  The properties are leased pursuant to non-cancelable leases generally with an initial term of 6 to 20 years.  The leases provide for a fixed minimum base rent during the initial and renewal periods.  Most of the leases provide for annual fixed rent increases or increases based on consumer price indices over the term of the lease. In addition, certain of our leases provide for additional rent through revenue participation (as defined in the lease agreement) in incremental revenues generated by the facilities over a defined base period, effective at various times during the term of the lease.  Each lease is a triple net lease which requires the lessee to pay additional charges including all taxes, insurance, assessments, maintenance and repair (capital and non-capital expenditures), and other costs necessary in the operation of the facility.  Many of the leases contain renewal options and one contains a limited period option that permits the operator to purchase the property.

19

Table of Contents

The following table sets forth certain information regarding our owned properties as of December 31, 2002
(dollar amounts in thousands) :

20

Table of Contents

Mortgage Loans.  At December 31, 2002, we had 39 mortgage loans secured by first mortgages on 36 skilled nursing properties with a total of 4,095 beds and eight assisted living residences with 369 units located in 20 states. At December 31, 2002, the mortgage loans had a weighted average interest rate of 11.75%, generally have 25-year amortization schedules, have balloon payments due from 2003 to 2018 and provide for certain facility fees.  The majority of the mortgage loans provide for annual increases in the interest rate based upon a specified increase of 10 to 25 basis points.

The following table sets forth certain information regarding our mortgage loans as of December 31, 2002
(dollar amounts in thousands) :

In general, the mortgage loans may not be prepaid except in the event of the sale of the collateral property to a third party that is not affiliated with the borrower, although partial prepayments (including the prepayment premium) are often permitted where a mortgage loan is secured by more than one property upon a sale of one or more, but not all, of the collateral properties to a third party which is not an affiliate of the borrower.  The terms of the mortgage loans generally impose a premium upon prepayment of the loans depending upon the period in which the prepayment occurs, whether such prepayment was permitted or required, and certain other conditions such as upon the sale of the property under a pre-existing purchase option, destruction or condemnation, or other circumstances as approved by us.  On certain loans, such prepayment amount is based upon a percentage of the then outstanding balance of the loan, usually declining ratably each year.  For other loans, the prepayment premium is based on a yield maintenance formula.  In addition to a lien on the mortgaged property, the loans are generally secured by certain non-real estate assets of the properties and contain certain other security provisions in the form of letters of credit, pledged collateral accounts, security deposits, cross-default and cross-collateralization features and certain guarantees.

On August 1, 2002, we completed a loan participation transaction whereby we issued a $30.0 million senior participating interest in 22 of our first mortgage loans that had a total unpaid principal balance of $58.6 million (the “Participation Loan Pool”) to a private bank.  The Participation Loan Pool had a weighted average interest rate of 11.6% and a weighted average scheduled term to maturity of 77 months.  The $30.0 million senior participation is secured by the entire Participation Loan Pool.  We received net proceeds from the issuance of the senior participation of $29.8 million that we used to reduce commitments and amounts outstanding under our Secured Revolving Credit.

21

Table of Contents

The senior participation receives interest at a rate of 9.25% per annum, payable monthly in arrears, on the then outstanding principal balance of the senior participation.  In addition, the senior participation receives all mortgage principal collected on the Participation Loan Pool until the senior participation balance has been reduced to zero.  We retain interest received on the Participation Loan Pool in excess of the 9.25% paid to the senior participation.  The ultimate extinguishment of the senior participation is tied to the underlying maturities of loans in the Participation Loan Pool which range from 6 to 194 months.  We have accounted for the participation transaction as a secured borrowing under SFAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.”

REMIC Certificates.  At December 31, 2002, we had investments in REMIC Certificates with a carrying value of $64.4 million ($66.8 million at amortized cost prior to any adjustment of available-for-sale certificates to fair market value). 

These certificates are pledged as collateral for our Secured Revolving Line of Credit.  The REMIC Certificates we retain are subordinate in rank and right of payment to the REMIC Certificates sold to third-party investors and as such would bear the first risk of loss in the event of an impairment to any of the underlying mortgages. The REMIC Certificates are collateralized by four pools consisting of 85 first mortgage loans secured by 120 skilled nursing properties with a total of 14,242 beds in 20 states. Each mortgage loan, all of which we originated, is evidenced by a promissory note and secured by a mortgage, deed of trust, or other similar instrument that creates a first mortgage lien on a fee simple estate in real property.  The $245.2 million current principal amount of mortgage loans represented by the REMIC Certificates have a weighted average interest rate of approximately 10.91%, and scheduled maturities ranging from 2003 to 2028. 

The following table sets forth certain information regarding the mortgage loans securing the REMIC Certificates as of December 31, 2002 (dollar amounts in thousands):

22

Table of Contents

The mortgage loans underlying the REMIC Certificates generally have 25-year amortization schedules with final maturities due from 2003 to 2028, unless prepaid prior thereto.  Contractual principal and interest distributions with respect to the $66.8 million amortized cost basis, of REMIC Certificates (excluding unrealized losses on changes in estimated fair value of $2.4 million) we retained are subordinated to distributions of interest and principal with respect to the $181.6 million of REMIC Certificates held by third parties.  Thus, based on the terms of the underlying mortgages and assuming no unscheduled prepayments occur nor are any maturities extended as a result of the inability of the borrower to refinance, scheduled principal distributions on the REMIC Certificates we retained will commence in August 2004 with final distributions in April 2028.  Distributions on any of the REMIC Certificates will depend, in large part, on the amount and timing of payments, collections, delinquencies and defaults with respect to the mortgage loans represented by the REMIC Certificates, including the exercise of certain purchase options under existing property leases or the sale of the mortgaged properties.  Each of the mortgage loans securing the REMIC Certificates contains similar prepayment and security provisions as our mortgage loans.

As part of the REMIC transactions discussed above, we serve as the sub-servicer and, in such capacity, are responsible for performing substantially all of the servicing duties relating to the mortgage loans represented by the REMIC Certificates.  We receive monthly fees equal to a fixed percentage of the then outstanding mortgage loan balance in the REMIC, which in our opinion represent currently prevailing terms for similar transactions.  In addition, we will act as the special servicer to restructure any mortgage loans in the REMIC that default.

At December 31, 2002, the REMIC Certificates we held had an effective interest rate of approximately 17.04% based on the expected future cash flows with no unscheduled prepayments.

We are a party to various claims and lawsuits arising in connection with general and professional liability claims against the lessees or borrowers of our properties, which in our opinion are not singularly or in the aggregate material to our results of operations or financial condition.  These cases name as defendants the facilities' operators, and also name LTC Properties, Inc. as a defendant, even though (through our affiliate) we are a non-posessory landlord of these properties. All of the cases involve allegations regarding the wrongful death of a resident, including claims of negligence per se in connection with the care received by these now deceased residents, violations of certain statutory resident rights and/or penal code sections, gross negligence, punitive damages and malice. We did not operate these properties. The various claims and lawsuits may include matters involving general or professional liability, which is the responsibility of our lessees and borrowers pursuant to insurance and indemnification provisions in the leases or loans.  See “Item 8.  FINANCIAL STATEMENTS – Note 13. Contingencies” for further discussions.

None.

23

Table of Contents

In February 2003, we declared a $0.10 per common share dividend payable on March 31, 2003 to stockholders of record on March 21, 2003.  We intend to distribute to our stockholders an amount at least sufficient to satisfy the distribution requirements of a REIT.  Cash flows from operating activities available for distribution to stockholders will be derived primarily from interest and rental payments from our real estate investments.  Provisions of our Secured Revolving Credit limit common and preferred cash dividends to no more than 110% of consolidated taxable income.  All distributions will be made subject to approval of the Board of Directors and will depend on the earnings of our company, its financial condition and such other factors as the Board of Directors deem relevant.  In order to qualify for the beneficial tax treatment accorded to REITs by Sections 856 through 860 of the Internal Revenue Code, we are required to make distributions to holders of our shares equal to at least 90% (95% for years ending prior to January 1, 2001) of our “REIT taxable income.”  (See “Annual Distribution Requirements” beginning on page 16.)

24

Table of Contents

The following table of selected financial information should be read in conjunction with our company’s financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K.