LTC PROPERTIES INC - Quarter Report: 2005 June (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

 

FORM 10-Q

 

(Mark One)

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2005

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition period from              to             

 

Commission file number 1-11314

 

LTC PROPERTIES, INC.

(Exact name of Registrant as specified in its charter)

 

Maryland		71-0720518
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

 

22917 Pacific Coast Highway, Suite 350
Malibu, California  90265

(Address of principal executive offices)

 

(310) 455-6010

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether Registrant (1) has filed all reports 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 Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes    ý    No    o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).   Yes    ý    No    o

 

Shares of Registrant’s common stock, $.01 par value, outstanding July 29, 2005 – 23,184,443

 

 

LTC PROPERTIES, INC.

 

FORM 10-Q

 

June 30, 2005

 

INDEX

 

PART I — Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II — Other Information
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits

 

2

 

LTC PROPERTIES, INC.

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except per share amounts)

 

		June 30, 2005			December 31, 2004
		(unaudited)
ASSETS
Real Estate Investments:
Buildings and improvements, net of accumulated depreciation and amortization: 2005 - $89,756; 2004 - $83,369		$	357,635		$	359,347
Land		27,056			26,401
Mortgage loans receivable, net of allowance for doubtful accounts: 2005 and 2004 - $1,280		112,189			90,878
REMIC Certificates		30,616			44,053
Real estate investments, net		527,496			520,679
Other Assets:
Cash and cash equivalents		13,962			4,315
Debt issue costs, net		1,065			1,348
Interest receivable		3,007			3,161
Prepaid expenses and other assets		3,726			4,451
Notes receivable		3,576			13,926
Total Assets		$	552,832		$	547,880
LIABILITIES AND STOCKHOLDERS’ EQUITY
Mortgage loans payable		$	70,533		$	71,286
Bonds payable and capital lease obligations		13,401			13,967
Senior mortgage participation payable		14,962			15,407
Accrued interest		640			649
Accrued expenses and other liabilities		4,008			3,040
Distributions payable		5,905			3,618
Total Liabilities		109,449			107,967
Minority interest		3,518			3,706
Stockholders’ equity:
Preferred stock $0.01 par value: 15,000 shares authorized; shares issued and outstanding: 2005 – 9,023; 2004 – 9,201		214,073			218,532
Common stock: $0.01 par value; 45,000 shares authorized; shares issued and outstanding: 2005 – 21,649; 2004 – 21,374		216			214
Capital in excess of par value		295,121			292,740
Cumulative net income		342,974			311,336
Other		(1,496		)	2,070
Cumulative distributions		(411,023		)	(388,685		)
Total Stockholders’ Equity		439,865			436,207
Total Liabilities and Stockholders’ Equity		$	552,832		$	547,880

 

See accompanying notes.

 

3

 

LTC PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Amounts in thousands, except per share amounts)

(Unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2005			2004			2005			2004
Revenues:
Rental income		$	12,237		$	11,644		$	28,109		$	23,096
Interest income from mortgage loans and notes receivable		3,230			2,334			5,912			4,472
Interest income from REMIC Certificates		1,219			2,047			2,683			4,438
Interest and other income		310			578			3,163			1,443
Total revenues		16,996			16,603			39,867			33,449
Expenses:
Interest expense		2,223			3,357			4,480			6,670
Depreciation and amortization		3,317			3,210			6,570			6,345
Legal expenses		63			91			136			109
Operating and other expenses		1,203			1,482			3,118			2,733
Total expenses		6,806			8,140			14,304			15,857
Income before non-operating income and minority interest		10,190			8,463			25,563			17,592
Non-operating income		—			—			6,217			—
Minority interest		(86		)	(259		)	(172		)	(542		)
Income from continuing operations		10,104			8,204			31,608			17,050
Discontinued operations:
Income from discontinued operations		—			76			—			156
Gain (loss) on sale of assets, net		30			(257		)	30			718
Net income (loss) from discontinued operations		30			(181		)	30			874
Net income		10,134			8,023			31,638			17,924
Preferred stock redemption charge		—			—			—			(4,029		)
Preferred stock dividends		(4,341		)	(3,581		)	(8,688		)	(8,527		)
Net income available to common stockholders		$	5,793		$	4,442		$	22,950		$	5,368
Net Income per Common Share from Continuing Operations net of Preferred Stock Dividends:
Basic		$	0.27		$	0.24		$	1.06		$	0.24
Diluted		$	0.27		$	0.24		$	1.02		$	0.24
Net Income (Loss) per Common Share from Discontinued Operations:
Basic		$	—		$	(0.01	)	$	—		$	0.05
Diluted		$	—		$	(0.01	)	$	—		$	0.05
Net Income per Common Share Available to Common Stockholders:
Basic		$	0.27		$	0.23		$	1.06		$	0.29
Diluted		$	0.27		$	0.23		$	1.02		$	0.29
Basic weighted average shares outstanding		21,614			19,165			21,553			18,576
Comprehensive income
Net income		$	10,134		$	8,023		$	31,638		$	17,924
Unrealized gain on available-for-sale securities		—			568			—			568
Reclassification adjustment		—			—			(3,610		)	—
Total comprehensive income		$	10,134		$	8,591		$	28,028		$	18,492

 

See accompanying notes.

 

4

 

LTC PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

 

		Six Months Ended June 30,
		2005			2004
OPERATING ACTIVITIES:
Net income		$	31,638		$	17,924
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		6,570			6,429
Realization of reserve on note receivable		(3,905		)	—
Realization of deferred gain on note receivable		(3,610		)	—
Straight-line rental income		(387		)	(585		)
Other non-cash charges		1,863			1,417
Gain on sale of real estate investments, net		(30		)	(718		)
Increase (decrease) in accrued interest		141			(80		)
Net change in other assets and liabilities		1,117			1,175
Net cash provided by operating activities		33,397			25,562
INVESTING ACTIVITIES:
Investment in real estate mortgages		(18,928		)	(6,223		)
Investment in REMIC Certificates		—			(3,898		)
Conversion of REMIC Certificates to mortgage loans		(855		)	—
Conversion of mortgage loans to owned properties		(310		)	(81		)
Investment in real estate properties and capital improvements, net		(2,775		)	(4,056		)
Proceeds from sale of real estate investments and other assets, net		102			212
Principal payments received on mortgage loans receivable and REMIC Certificates		8,550			12,652
Advances under notes receivable		(759		)	(386		)
Principal payments received on notes receivable		15,072			130
Redemption of investment in senior secured notes		—			12,281
Net cash provided by investing activities		97			10,631
FINANCING ACTIVITIES:
Borrowings under the line of credit		2,000			36,500
Repayments of borrowings under the line of credit		(2,000		)	(35,000		)
Mortgage principal payments on the senior mortgage participation		(445		)	(415		)
Net proceeds from issuance of preferred stock		—			98,462
Principal payments on mortgage loans payable and capital lease obligations		(1,319		)	(8,233		)
Redemption of preferred stock		—			(126,305		)
Repurchase of common stock		(2,958		)	—
Distributions paid		(20,051		)	(18,049		)
Other		926			1,721
Net cash used in financing activities		(23,847		)	(51,319		)
Increase (decrease) in cash and cash equivalents		9,647			(15,126		)
Cash and cash equivalents, beginning of period		4,315			17,919
Cash and cash equivalents, end of period		$	13,962		$	2,793
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid		$	4,206		$	6,500
Non-cash investing and financing transactions:
Exchange of limited partnership units for common stock		—			2,466
Exchange of mortgage loans for owned properties		1,690			9,277
Exchange of REMIC Certificates for mortgage loans receivable		9,567			12,025
Assumption of mortgage loans payable for acquisitions of real estate assets		—			2,098
Conversion of preferred stock to common stock		4,460			19,875

 

See accompanying notes.

 

5

 

LTC PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.     General

 

LTC Properties, Inc., a Maryland corporation, is a real estate investment trust (or REIT) that invests primarily in long term care properties through mortgage loans, property lease transactions and other investments.

 

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 have prepared consolidated financial statements included herein without audit (except for the balance sheet at December 31, 2004 which is audited) and in the opinion of management have included all adjustments necessary for a fair presentation of the results of operations for the three and six months ended June 30, 2005 and 2004 pursuant to the rules and regulations of the Securities and Exchange Commission.  The accompanying consolidated financial statements include the accounts of our company, its wholly-owned subsidiaries and controlled partnership.  All significant intercompany accounts and transactions have been eliminated in consolidation.  Control over the partnership is based on the provisions of the partnership agreement that provides us with a controlling financial interest in the partnership.  Under the terms of the partnership agreement, our company, as general partner, is responsible for the management of the partnership’s assets, business and affairs.  Certain of our rights and duties in management of the partnership include making all operating decisions, setting the capital budget, executing all contracts, making all employment decisions, and the purchase and disposition of assets.  The general partner is responsible for the ongoing, major, and central operations of the partnership and makes all management decisions.  In addition, the general partner assumes the risk for all operating losses, capital losses, and is entitled to substantially all capital gains (appreciation).

 

The limited partners have virtually no rights and are precluded from taking part in the operation, management or control of the partnership.  The limited partners are also precluded from transferring their partnership interests without the express permission of the general partner.  However, we can transfer our interest without consultation or permission of the limited partners.

 

Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations; however, we believe that the disclosures in the accompanying financial statements are adequate to make the information presented not misleading.

 

Certain reclassifications have been made to the prior period financial statements to conform to the current period presentation and as required by Statement of Financial Accounting Standards (or SFAS) No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.”  The results of operations for the three and six months ended June 30, 2005 are not necessarily indicative of the results for a full year.

 

No provision has been made for federal or state income taxes.  Our company qualifies as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended.  As such, we are not taxed on income that is distributed to our stockholders.

 

6

 

2.              Real Estate Investments

 

Owned Properties.  At June 30, 2005, our investment in owned properties consisted of 57 skilled nursing properties with a total of 6,626 beds, 88 assisted living properties with a total of 4,175 units and one school in 23 states.

 

During the three months ended June 30, 2005, we converted two mortgage loans on two skilled nursing properties with a total of 87 beds into owned properties.  One of the mortgage loans with a principal balance of $694,000 was converted through an auction in accordance with a bankruptcy court order that approved the sale of substantially all of the borrower’s assets to us in exchange for $310,000 in cash plus our bankruptcy claim of approximately $956,000.  This property is leased to a third party under a 10-year lease with two five year renewal options.  The initial annual lease payment is $180,000 and increases 2.5% annually.  The initial annual lease rate is based on our commitment to fund up to $300,000 for capital improvements as described in Note 7. Commitments and Contingencies.  The other mortgage loan with a principal balance of $996,000 was converted to an owned property through a deed-in-lieu foreclosure transaction.  This property is leased to a third party under a 10-year lease with three five year options to extend.  The initial annual lease payment beginning in December 2005 is $129,000 and increases 2% annually beginning July 1, 2007.  The lease also provides the lessee with an option to purchase the property for $1,050,000 plus the cost of our capital improvements less a credit of 1% of the purchase price per year for each year of the term of the lease immediately preceding the lessee’s exercise of the purchase option.  The lessee may exercise the purchase option only in the second and fourth year of the lease term.

 

During the six months ended June 30, 2005, we purchased a 114 bed skilled nursing property in Texas for $2,624,000.  The property together with another skilled nursing property we own is leased to a third party operator under a 20-year master lease with two five year options to extend.  The initial annual master lease payment is $648,000 and increases 2% annually.  We also invested $151,000 in capital improvements to existing properties during the first half of 2005.

 

During the three months ended June 30, 2005, we sold vacant land adjacent to an assisted living property in Ohio.  We received $102,000 in cash and recognized a $30,000 gain on the sale.

 

In accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” properties held for sale at any reporting period include only those properties available for immediate sale in their present condition and for which management believes that it is probable that a sale of the property will be completed within one year.  Properties held for sale are carried at the lower of cost or fair value less estimated selling costs.  No depreciation expense is recognized on properties held for sale.  In addition, the operating results of real estate assets designated as held for sale and all gains and losses from real estate sold are included in discontinued operations in the consolidated statement of income.

 

7

 

Set forth in the table below are the components of the net income from discontinued operations (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2005			2004			2005			2004
Rental income		$	—		$	114		$	—		$	244
Interest and other income		—			—			—			—
Interest expense		—			—			—			—
Depreciation and amortization		—			(40		)	—			(84		)
Legal expenses		—			—			—			—
Operating and other expenses		—			2			—			(4		)
Income from discontinued operations		$	—		$	76		$	—		$	156

 

Mortgage Loans.  At June 30, 2005, we had investments in 50 mortgage loans secured by first mortgages on 43 skilled nursing properties with a total of 5,233 beds, 13 assisted living properties with 933 units and one school located in 22 states.  At June 30, 2005, the mortgage loans had interest rates ranging from 6.0% to 12.8% and maturities ranging from 2005 to 2019.  In addition, the loans contain certain guarantees, provide for certain facility fees and generally have 25-year amortization schedules.  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.

 

During the quarter ended June 30, 2005, we originated one new mortgage loan secured by a skilled nursing property with 104 beds in Georgia.  The principal balance of the new loan is $5,000,000 and the amount funded to the borrower after fees and tax impounds was $4,928,000.  The mortgage loan has a five year term and bears interest at 10% in the first year and increases 12.5 basis points annually thereafter.  In addition, during the second quarter 2005, we funded an additional $102,000 under an existing mortgage loan for capital improvements.

 

Additionally, we acquired $10,469,000 face value mortgage loans secured by five skilled nursing properties from a REMIC pool we originated.  We exchanged the REMIC Certificates we owned and paid $855,000 in cash, which represents the outstanding loan balances and accrued interest of outside REMIC Certificate holders which resulted in the dissolution of the 1996-1 REMIC Pool.  The weighted average effective interest rate on these loans is approximately 11.9%.

 

During the six months ended June 30, 2005, we acquired a mortgage loan on a 151 bed skilled nursing property located in California from a REMIC pool we originated.  We paid $2,254,000, which represents the outstanding loan balance.  During the second quarter of 2005, this loan was repaid in full.

 

Also during the six months ended June 30, 2005, we originated one mortgage loan in the amount of $500,000 secured by two skilled nursing properties located in Texas with a total of 124 beds.  Subsequently, this note was paid in full.  For further discussion see Note 3. Notes Receivable.  We also originated three new mortgage loans secured by three properties with a total of 125 assisted living units and 289 skilled nursing beds.  The combined principal balance of the new loans is $10,763,000 and the amount funded to the borrowers after fees and tax impounds was $10,658,000.  The mortgage loans have five to ten year terms and bear interest ranging from 9.5% to 11.3%.  We also funded an additional $588,000 under existing mortgage loans for capital improvements.

 

During the six months ended June 30, 2005, we received $2,170,000 plus accrued interest related to the payoff of a mortgage loan secured by a skilled nursing property located in Arizona.

 

8

 

Subsequent to June 30, 2005, we purchased eight loans from the remaining REMIC pool we originated.  We paid $15,158,000 which represents the outstanding principal balance of the loans plus accrued interest.  These loans have a weighted average interest rate of 11.4%.

 

REMIC Certificates.  As of June 30, 2005, we had REMIC Certificates with a net book value of $30,616,000.  Of the $30,616,000, $27,736,000 of our net book value represents face value certificated interests in the principal balances of the underlying mortgage pools while the remaining $2,880,000 net book value of our REMIC Certificates are interest-only certificates that represent the present value of the difference between the expected cash flows resulting from the mortgage pools and the interest being paid on the principal based certificates.  At June 30, 2005, the mortgage loans had a total unpaid principal balance of $53,058,000.  There are $19,033,000 of senior certificates outstanding that have priority over the $27,736,000 of face value certificates we retained.  Subsequent to our purchase of eight loans from the remaining REMIC Pool as described above, there were $3,431,000 of senior certificates outstanding and mortgage loan balances totaling $37,462,000 underlying the certificates in the remaining REMIC pool.

 

Our investment in the $30,616,000 of REMIC certificates is supported by the difference between the $53,058,000 in mortgage pool principal and the $19,033,000 of senior certificates outstanding, or $34,025,000 resulting in collateral in excess of our net book value of $3,409,000.

 

Interest only certificates and certificates with an investment rating of “BB” or higher are classified as available-for-sale and unrated certificates and certificates with an investment rating of “B” or lower are classified as held-to-maturity.  As of June 30, 2005, available-for-sale certificates were recorded at their fair value of approximately $2,880,000.  These cash flows have been discounted at a rate of 25.00% to arrive at the estimated fair market value of the interest-only certificates.

 

At June 30, 2005, held-to-maturity certificates had a book value of $27,736,000 and an estimated fair value of $28,054,000.  As of June 30, 2005, the effective yield on the available-for-sale certificates and the held-to-maturity certificates, based on expected future cash flows discounted to give effect to potential risks associated with prepayments and unanticipated credit losses, was 35.00% and 11.85%, respectively.

 

During the three months ended June 30, 2005, the 1996-1 REMIC Pool was fully retired.  We paid $855,000 in cash and exchanged our remaining interest in the 1996-1 REMIC Certificates and we received five mortgage loans with and estimated fair value of $10,398,000 and an unamortized principal balance of $10,469,000.  Accordingly, we recorded a $71,000 discount on these loans which will be amortized as a yield adjustment to increase interest income over the remaining life of the loans.  Additionally, we will amortize the $1,051,000 balance in Other Comprehensive Income that resulted from transferring the loans at fair value as required by SFAS No. 115 “Accounting for Certain Investments in debt and Equity Securities” as a yield adjustment to increase interest income over the life of the related loans.

 

9

 

3.              Notes Receivable

 

At December 31, 2004, we held a Promissory Note (or Note) issued by Centers for Long Term Care, Inc. (or CLC) and Healthcare Holdings, Inc. (or HHI), a wholly owned subsidiary of CLC.  The face value of the note was $21,269,000 and the book value was $10,709,000.  The Note had a maturity date of October 1, 2007, an interest rate of 8.0% per year compounded monthly, accruing to the balance of the Note and was secured by all 1,452,794 shares of Assisted Living Concepts, Inc. (or ALC) common stock owned by HHI.  Cash payments of principal and interest were due upon maturity.  However, any proceeds from the sale of the collateral would result in a prepayment of the Note.  During the first quarter of 2005, we advanced $168,000 under the Note and added $191,000 in compound interest to the principal balance.  Also during the first quarter of 2005, we loaned Center Healthcare, Inc. (or CHC), a private company that purchased CLC in 2003, $500,000 which was secured by two skilled nursing properties in Texas with a total of 124 beds and all of the assets owned by HHI, this Note was repaid in full.

 

On January 31, 2005, Extendicare, Inc. and its wholly-owned U.S. subsidiary, Extendicare Health Services, Inc. (or EHSI) acquired ALC.  Accordingly, in February 2005, we received $22,309,000 in cash from CHC and HHI as payment in full for the Note and the $500,000 mortgage loan, including accrued and unpaid interest through the payoff date.  As a result of the payoff, we recognized $3,667,000 in rental income related to past due rents that were not previously accrued, $2,335,000 of interest income related to past due interest that was not previously accrued, a $477,000 reimbursement for certain expenses paid on behalf of CLC in prior years, a $1,000,000 bonus accrual related to the realization of the value of the Note and non-operating income of $6,217,000 ($3,610,000 of which was classified as Accumulated Comprehensive Income in the equity section of the balance sheet at December 31, 2004).  The $6,217,000 of non-operating income is net of $1,298,000 of legal and investment advisory fees related to the transaction that resulted in the Note payoff.

 

4.              Debt Obligations

 

At June 30, 2005, we have no outstanding balances under our Unsecured Revolving Credit.  During the three and six months ended June 30, 2005, pricing under the Unsecured Revolving Credit ranged between LIBOR plus 2.75% and LIBOR plus 3.25%.

 

5.              Senior Mortgage Participation Payable

 

In 2002, we completed a loan participation transaction whereby we issued a $30,000,000 senior participating interest in 22 of our first mortgage loans that had a total unpaid principal balance of $58,627,000 (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 senior participation balance is secured by the entire Participation Loan Pool.

 

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 extinguishments of the senior participation are tied to the underlying maturities of loans in the Participation Loan Pool, which range from 8 to 158 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.”

 

10

 

During the six months ended June 30, 2005 and 2004, the senior participation received principal payments of $445,000 and $415,000, respectively.  At June 30, 2005, 19 loans remain in the Participation Loan Pool and $14,962,000 was outstanding under the senior mortgage participation.

 

6.              Stockholders’ Equity

 

Preferred Stock.  During the six months ended June 30, 2005, holders of 178,402 shares of our 8.5% Series E Cumulative Convertible Preferred Stock (Series E preferred stock) notified us of their election to convert such shares into 356,804 shares of our common stock at the Series E preferred stock conversion rate of $12.50 per share.  Total shares reserved for issuance of common stock related to the conversion of Series E preferred stock were 765,734 at June 30, 2005.  Subsequent to June 30, 2005, holders of 11,497 shares of our Series E preferred stock notified us of their election to convert such shares into 22,994 shares of our common stock.  After these conversions, total shares reserved for issuance of common stock related to the conversion of Series E preferred stock were 742,740.

 

During the six months ended June 30, 2004, we issued 4,000,000 shares of Series F Cumulative Redeemable Preferred Stock (or Series F preferred stock) in a registered direct placement generating net cash proceeds of $98,462,000.  The cash proceeds and cash on hand were used to redeem all of our Series A and Series B preferred stock.  Accordingly, we recognized $4,029,000 of original issue costs related to the Series A and Series B preferred stock redeemed as a preferred stock redemption charge in the six months ended June 30, 2004.

 

Common Stock.  During the six months ended June 30, 2005, we repurchased and retired 167,600 shares of common stock for an aggregate purchase price of $2,958,000, an average of $17.65 per share.  The shares were purchased on the open market under a Board authorization to purchase up to 5,000,000 shares.  Including these purchases, 2,515,800 shares have been purchased under this authorization.  Therefore, we continue to have an open Board authorization to purchase an additional 2,484,200 shares.  During the six months ended June 30, 2004 we did not repurchase common stock.

 

During the six months ended June 30, 2005, a total of 89,100 stock options were exercised at a total option value of $509,000 and a total market value as of the dates of exercise of $1,703,000.   Subsequent to June 30, 2005, a total of 12,000 stock options were exercised at a total option value of $166,000 and a total market value as of the dates of exercise of $268,000.

 

During the six months ended June 30, 2004, two of our limited partners exercised their conversion rights and exchanged their interests in five of our limited partnerships.  In accordance with the partnership agreements, at our option, we issued 168,365 shares of our common stock to one limited partner and paid approximately $109,000 for the redemption of 7,027 shares owned by another limited partner.

 

Subsequent to June 30, 2005, we sold 1,500,000 shares of common stock in a registered direct placement for $22.08 per share.  Net proceeds of $32,623,000 will be used for general corporate purposes including acquisitions, loan originations and debt retirement.  In 2004 we filed a Form S-3 “shelf” registration.  Subsequent to the registered direct placement discussed above, we have approximately $105,000,000 available on our shelf registration and 23,184,443 shares of common stock outstanding.

 

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Distributions.  We declared and paid the following cash dividends (in thousands):

 

		Six months ended June 30, 2005						Six months ended June 30, 2004
		Declared			Paid			Declared			Paid
Preferred Stock
Series A		$	—		$	—		$	1,019		$	1,860
Series B		—			—			1,118			1,491
Series C		1,636			1,636			1,636			1,636
Series E		412			507			1,932			2,338
Series F		6,640			6,640			2,822			822		(1)
		8,688			8,783			8,527			8,147
Common Stock		13,650		(2)	11,268		(2)	9,902		(2)	9,902		(2)
Total		$	22,338	(3)	$	20,051	(3)	$	18,429	(3)	$	18,049	(3)

 

(1)          Represents 22 days of accrued dividends.

(2)          Represents $0.30 per share in the first quarter of 2005 and $0.11 per share per month in the second quarter of 2005 and $0.25 per share in the first quarter of 2004 and $0.275 in the second quarter of 2004.

(3)          The difference between declared and paid is the change in distributions payable on the balance sheet at June 30 and December 31.

 

Subsequent to June 30, 2005, we declared a monthly cash dividend of $0.11 per share on our common stock for the months of July, August and September 2005, payable on August 1, September 1 and October 3, 2005, respectively, to stockholders of record on July 22, August 24, and September 26, 2005, respectively.

 

Other Equity.  Other equity consists of the following (in thousands):

 

		June 30, 2005			December 31, 2004
					(audited)
Notes receivable from stockholders		$	(338	)	$	(508	)
Deferred compensation		(354		)	(228		)
Accumulated comprehensive (loss) income		(804		)	2,806
Total Other Equity		$	(1,496	)	$	2,070

 

During the six months ended June 30, 2005, we received $169,000 in principal payments on notes receivable from stockholders.  Also during the six months ended June 30, 2005, we realized a $3,610,000 gain that was included in Accumulated Comprehensive Income at December 31, 2004 which was related to a note receivable that was paid in full during the period as described more fully in Note 3. Notes Receivable.

 

During the six months ended June 30, 2005, we issued 8,000 shares of restricted common stock at $19.62 per share.  These shares vest ratably over a three year period.  Additionally, during the six months ended June 30, 2005, 10,800 shares of unvested restricted stock were canceled.  During the quarters ended June 30, 2005 and 2004, $124,000 and $87,000, respectively, of compensation expense was recognized related to the vesting of restricted stock.  During the six months ended June 30, 2005 and 2004, $228,000 and $172,000, respectively, of compensation expense was recognized related to the vesting of restricted stock.

 

Stock-Based Compensation.  On December 16, 2004, the FASB issued SFAS No. 123(revised 2004), Share-Based Payment, which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”.  SFAS No. 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to

 

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Employees” (APB 25), and amends SFAS No. 95 “Statement of Cash Flows”.  Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123.  However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values.  Pro forma disclosure is no longer an alternative.  The Securities and Exchange Commission has delayed the adoption requirement of SFAS No. 123(R) until January 1, 2006.  We expect to adopt SFAS No. 123(R) on January 1, 2006 as required.

 

SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods:

 

1)              A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date.

 

2)              A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

 

We plan to adopt SFAS No. 123(R) using the “modified-prospective” method.  We adopted the fair-value-based method of accounting for share-based payments effective January 1, 2003, using the prospective method described in SFAS No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure” and therefore have recognized compensation expense related to all employee stock-based awards granted, modified or settled after January 1, 2003.

 

Currently, we use the Black-Scholes-Merton formula to estimate the value of stock options granted to employees.  This model requires management to make certain estimates including stock volatility, discount rate and the termination discount factor.  If management incorrectly estimates these variables, the results of operations could be affected.  We expect to continue to use this acceptable option valuation model upon the required adoption of SFAS No. 123(R).  Because SFAS No. 123(R) must be applied not only to new awards but to previously granted awards that are not fully vested on the effective date, and because we adopted SFAS No. 123 using the prospective transition method (which applied only to awards granted, modified or settled after the adoption date), compensation cost for some previously granted awards that were not recognized under SFAS No. 123 will be recognized under SFAS No. 123(R).  However, had we adopted SFAS No. 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share below.  SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature.  Because we qualify as a REIT under the Internal Revenue Code of 1986, as amended, we are not subject to Federal income taxation.  Therefore, this new reporting requirement will not have an impact on our statement of cash flows.

 

Prior to January 1, 2003, we accounted for stock option grants in accordance with APB 25 and related Interpretations.  Historically, we granted stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant.  Under APB 25, because the exercise price of our employee stock options equaled the market price of the underlying stock on the date of grant, no compensation expense was recognized.  Effective January 1, 2003, we adopted SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” on a prospective

 

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basis for all employee awards granted, modified or settled on or after January 1, 2003.  During the six months ended June 30, 2005, 15,000 options to purchase common stock were granted at an exercise price of $19.62 and vest ratably over a three year period.  Additionally, during the six months ended June 30, 2005, 4,000 unvested options to purchase common stock were cancelled.  During the six months ended June 30, 2004, 30,000 options to purchase common stock were granted at an exercise price of $15.13 and vest ratably over a three year period.  Accordingly, $10,000 and $19,000 of compensation expense was recognized during the three and six months ended June 30, 2005, respectively, related to the vesting of these options as compared to $4,000 and $4,000 during the three and six months ended June 30, 2004, respectively.

 

The following table illustrates the effect on net income and earnings per share as if the fair value method had been applied to all outstanding and unvested awards in each period (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2005			2004			2005			2004
Net income available to common stockholders, as reported		$	5,793		$	4,442		$	22,950		$	5,368
Add: Stock-based compensation expense in the period		10			4			19			4
Deduct: Total stock-based compensation expense determined under fair value method for all awards		(12		)	(5		)	(26		)	(10		)
Pro forma net income available to common stockholders		$	5,791		$	4,441		$	22,943		$	5,362
Net income per common share available to common stockholders:
Basic – as reported		$	0.27		$	0.23		$	1.06		$	0.29
Basic – pro forma		$	0.27		$	0.23		$	1.06		$	0.29
Diluted – as reported		$	0.27		$	0.23		$	1.02		$	0.29
Diluted – pro forma		$	0.27		$	0.23		$	1.02		$	0.29

 

Note: Adjustments to compensation expense related to restricted shares have been excluded from this table since expense for restricted shares is already reflected in net income and is the same under APB No. 25 and SFAS No. 123.

 

7.              Commitments and Contingencies

 

As of June 30, 2005, we had the following commitments outstanding:

 

We committed to provide Alterra Healthcare Corporation (or Alterra) $2,500,000 over three years ending December 4, 2006, to invest in leasehold improvements to properties they lease from us and an additional $2,500,000 over the next succeeding three years ending December 4, 2009 to expand properties they lease from us.  Both of these investments would be made at a 10% annual return to us.  To date Alterra has not requested any funds under this agreement.

 

We committed to provide EHSI up to $5,000,000 per year, under certain conditions, for expansion of the 37 properties they lease from us.  Should we invest such funds, EHSI’s monthly minimum rent would increase by an amount equal to (a) 9.5% plus the positive difference, if any, between the average yield on the U.S. Treasury 10-year note for the five days prior to funding, minus 420 basis points (expressed as a percentage), multiplied by (b) the amounts funded.  To date EHSI has not requested any funds under this agreement.

 

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We committed to provide a lessee an accounts receivable financing on a skilled nursing facility.  The loan has a credit limit not to exceed $150,000 and an interest rate of 10%.  The commitment expires if the first advance is not requested by the borrower within a year of the agreement’s commencement date and the term of the loan is not to exceed two years from the date of the first request for advance.  To date $124,000 has been funded under this agreement.  We also committed to invest $300,000 in capital improvements for this facility.  To date no funds have been requested under this agreement.

 

We committed to provide a lessee an accounts receivable financing on a skilled nursing facility.  The loan has a credit limit not to exceed $75,000 and an interest rate of 10%.  The commitment expires if the first advance is not requested by the borrower within six months of the agreement’s commencement date and the term of the loan is six months from the date of the first request for advance.  To date $7,000 has been requested under this agreement.  We have also committed to replace the roof and install a fire sprinkler system for this facility.  The lessee’s monthly minimum rent will increase by an amount equal to 11% of our investment in these capital improvements.  To date no funds have been requested under this agreement.

 

We have a commitment to provide a lessee with up to $165,000 to invest in leasehold improvements to a property they lease from us.  The commitment expires on August 29, 2005.  The lessee’s monthly minimum rent will increase by an amount equal to 11% of our funding.

 

We have a commitment to provide an additional $800,000 under the terms of an existing mortgage loan agreement.  Amounts funded under this agreement are added to the loan balance and are to be used for capital improvements.  To date, we have funded $587,000 under this agreement.

 

8.              Major Operators

 

We have four operators, based on properties subject to lease agreements and secured by mortgage loans that represent between 10% and 20% of our total assets.  EHSI, one of our major operators, is the wholly owned subsidiary of a publicly traded company, Extendicare Inc., which as a publicly traded company files quarterly financial information with the Securities and Exchange Commission.  Our other operators are privately owned and thus no public financial information is available.  The following table summarizes Extendicare Inc.’s assets, stockholders’ equity, annual revenue and net income from continuing operations as of or for the three months ended March 31, 2005, per the lessee’s public filings:

 

 

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EHSI, a wholly owned subsidiary of Extendicare Inc., leased 37 assisted living properties with a total of 1,427 units owned by us representing approximately 12.5%, or $69,183,000, of our total assets at June 30, 2005 and 19.5 % of rental income recognized in 2005 excluding the effects of straight line rent and the CLC and HHI note payoff as more fully described in Note 3. Notes Receivable.

 

Alterra Healthcare Corporation (or Alterra) leases 35 assisted living properties with a total of 1,416 units we own representing approximately 12.3%, or $68,184,000, of our total assets at June 30, 2005 and 19.5% of rental revenue recognized in 2005 excluding the effects of straight line rent and the CLC and HHI note payoff as more fully described in Note 3. Notes Receivable.

 

CHC leased 26 skilled nursing properties with a total of 3,114 beds owned by us representing approximately 10.3%, or $57,189,000, of our total assets at June 30, 2005 and 12.8% of rental revenue recognized in 2005 excluding the effects of straight line rent and the CLC and HHI note payoff as more fully described in Note 3. Notes Receivable.

 

Sunwest Management, Inc. (or Sunwest) operates eight assisted living properties with a total of 958 units that we own or on which we hold mortgages secured by first trust deeds.  This represents approximately 10.2%, or $56,181,000 of our total assets at June 30, 2005, and 13.3% of rental revenue and 5.3% of interest income from mortgage loans recognized in 2005 excluding the effects of straight line rent and the CLC and HHI note payoff as more fully described in Note 3. Notes Receivable.

 

Our financial position and our ability to make distributions may be adversely affected by financial difficulties experienced by Alterra, CHC, EHSI, Sunwest or any of our other lessees and borrowers, including bankruptcies, inability to emerge from bankruptcy, insolvency or general downturn in business of any such operator, or in the event any such operator does not renew and/or extend its relationship with us or our borrowers when it expires.

 

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9.              Earnings per Share

 

The following table sets forth the computation of basic and diluted net income per share
(in thousands, except per share amounts):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2005			2004			2005			2004
Net income		$	10,134		$	8,023		$	31,638		$	17,924
Preferred stock redemption charges		—			—			—			(4,029		)
Preferred stock dividends		(4,341		)	(3,581		)	(8,688		)	(8,527		)
Net income for basic net income per share		5,793			4,442			22,950			5,368
Effect of dilutive securities:
Convertible preferred stock		203			—			2,047			—
Convertible limited partnership units		—			—			172			—
Net income for diluted net income per share		$	5,996		$	4,442		$	25,169		$	5,368
Shares for basic net income per share		21,614			19,165			21,553			18,576
Effect of dilutive securities:
Stock options		84			121			92			147
Convertible preferred stock		766			—			2,774			—
Convertible limited partnership units		—			—			202			—
Shares for diluted net income per share		22,464			19,286			24,621			18,723
Basic net income per share		$	0.27		$	0.23		$	1.06		$	0.29
Diluted net income per share		$	0.27		$	0.23		$	1.02		$	0.29

 

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Item 2.                                                           MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Executive Overview

 

Business

 

LTC Properties, Inc. a self-administered, health care real estate investment trust (or REIT) commenced operations in 1992.  We invest primarily in long-term care and other health care related properties through mortgage loans, property lease transactions and other investments.  The following table summarizes our portfolio as of June 30, 2005:

 

Type of Property		Gross Investments			Percentage of Investments		Revenues (2)			Percentage of Revenues		Number of Properties		Number of Beds/Units		Investment per Bed/Unit			Number of Operators (1)		Number of States (1)
		(in thousands)					(in thousands)									(in thousands)
Assisted Living Facilities		$	313,561		50.7	%	$	16,776		45.7	%	101		5,108		$	61.39		10		23
Skilled Nursing Facilities		261,335			42.3	%	16,539			45.1	%	100		11,859		22.04			41		22
Schools		13,020			2.1	%	706			1.9	%	2		N/A		N/A			2		2
REMIC Certificates		30,616			4.9	%	2,683			7.3	%	29	(3)	3,309	(3)	16.03		(4)	16		12
Totals		$	618,532		100.0	%	$	36,704		100.0	%	203		16,967

 

(1)          We have investments in 32 states leased or mortgaged to 48 different operators.

(2)          Revenues exclude interest and other income from non-mortgage loan sources and the effect of the note payoff by CLC and HHI as more fully described in Note 3. Notes Receivable.

(3)          The number of properties and beds are not included in the total line because we do not own the mortgage on these properties.

(4)          Represents principal balance per bed as of June 30, 2005.

 

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.  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.

 

Substantially all of our revenues and sources of cash flows from operations are derived from operating lease rentals, interest earned on outstanding loans receivable and interest earned on our investment in Real Estate Mortgage Investment Conduits (or REMIC) Certificates.  In the past, we completed securitizations by transferring mortgage loans to newly created REMICs that, in turn, issued mortgage pass-through certificates aggregating approximately the same amount.  A portion of the REMIC Certificates were then sold to third parties and a portion of the REMIC Certificates were retained by us.  The REMIC Certificates we retained are subordinated in right of payment to the REMIC Certificates sold to third parties and a portion of the REMIC Certificates we retained are interest-only certificates which have no principal amount and entitle us to receive cash flows designated as interest.

 

Our investments in mortgage loans, owned properties and REMIC Certificates represent our primary source of liquidity to fund distributions and are dependent upon the performance of the operators on their lease and loan obligations and the rates earned thereon.  To the extent that the operators experience operating difficulties and are unable to generate sufficient cash to make payments to us, there could be a material adverse impact on our consolidated results of operations, liquidity and/or financial condition.  To mitigate this risk, we monitor our investments through a variety of methods determined by the type of health care facility and operator.  Our monitoring process includes review of financial statements for each facility, periodic review of operator credit, scheduled property inspections and review of covenant compliance relating to real estate taxes and insurance.

 

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In addition to our monitoring and research efforts, we also structure our investments to help mitigate payment risk.  We typically invest in or finance up to 90 percent of the stabilized appraised value of a property.  Operating leases and loans are normally credit enhanced by guaranties and/or letters of credit.  In addition, operating leases are typically structured as master leases and loans are generally cross-defaulted and cross-collateralized with other loans, operating leases or agreements between us and the operator and its affiliates.

 

For the six months ended June 30, 2005, rental income and interest income represented 72% and 18%, respectively, of total gross revenues (excluding the effect of the note payoff by CLC and HHI as more fully described in Note 3. Notes Receivable).  Our lease structure contains fixed annual rental escalations, which are generally recognized on a straight-line basis over the minimum lease period, and annual rental escalations that are contingent upon changes in the Consumer Price Index and/or changes in the gross operating revenues of the property.  This revenue is not recognized until the appropriate contingencies have been resolved.  This lease structure initially generates lower revenues and net income but enables us to generate additional growth and minimized non-cash straight-line rent over time.

 

Depending upon the availability and cost of external capital, we anticipate making additional investments in health care related properties.  New investments are generally funded from temporary borrowings under our unsecured line of credit and internally generated cash flows.  Our investments generate internal cash from rent and interest receipts and principal payments on mortgage loans receivable and REMIC Certificates.  Permanent financing for future investments, which replaces funds drawn under our unsecured line of credit, is expected to be provided through a combination of public and private offerings of debt and equity securities and the incurrence of secured debt.  We believe our liquidity and various sources of available capital are sufficient to fund operations, meet debt service obligations (both principal and interest), make dividend distributions and finance future investments.

 

Key Performance Indicators, Trends and Uncertainties

 

We utilize several key performance indicators to evaluate the various aspects of our business.  These indicators are discussed below and relate to concentration risk and credit strength.  Management uses these key performance indicators to facilitate internal and external comparisons to our historical operating results, in making operating decisions and for budget planning purposes.

 

Concentration Risk.  We evaluate our concentration risk in terms of asset mix, investment mix, operator mix and geographic mix.  Concentration risk is valuable to understand what portion of our investments could be at risk if certain sectors were to experience downturns. Asset mix measures the portion of our investments that are real property.  In order to qualify as an equity REIT, at least 75 percent of our total assets must be represented by real estate assets, cash, cash items and government securities.  Investment mix measures the portion of our investments that relate to our various property types.  Operator mix measures the portion of our investments that relate to our top four operators.  Geographic mix measures the portion of our investment that relate to our top five states.  The following table reflects our recent historical trends of concentration risk:

 

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		Period Ended
		6/30/05			3/31/05			12/31/04			9/30/04			6/30/04
		(gross investment, in thousands)
Asset mix:
Real property		$	474,447		$	471,635		$	469,117		$	464,226		$	470,122
Loans receivable		113,469			102,919			92,158			78,034			76,749
REMIC Certificates		30,616			40,796			44,053			43,879			45,159
Investment mix:
Assisted living facilities		$	313,561		$	313,599		$	310,530		$	301,415		$	301,433
Skilled nursing facilities		261,335			247,935			237,725			227,825			236,168
School		13,020			13,020			13,020			13,020			9,270
REMIC Certificates		30,616			40,796			44,053			43,879			45,159
Operator mix:
Alterra Healthcare Corporation		$	84,194		$	84,194		$	84,194		$	84,194		$	84,194
Center Healthcare, Inc.		73,334			72,824			65,198			60,777			60,613
Extendicare Health Services, Inc.		88,034			88,105			88,105			88,105			88,105
Sunwest		64,615			64,520			64,043			58,893			58,893
Remaining operators		277,739			264,911			259,735			250,291			255,066
Geographic mix:
California		$	50,788		$	53,211		$	46,312		$	46,397		$	46,480
Colorado (1)		27,263			27,164			27,169			27,114			27,109
Florida		47,471			44,512			44,534			39,701			39,707
Iowa (1)		20,993			20,925			20,936			20,635			20,632
Ohio		50,562			50,061			50,084			50,108			50,130
Texas		88,165			86,728			83,845			74,854			74,944
Washington (1)		21,227			21,291			21,353			21,368			28,468
Remaining states		281,447			270,662			267,042			262,083			259,401

 

(1)                     Tied for fifth most concentrated state calculated by the number of facilities in each state.

 

Credit Strength.  We measure our credit strength both in terms of leverage ratios and coverage ratios.  Our leverage ratios include debt to book capitalization and debt to market capitalization.  The leverage ratios indicate how much of our balance sheet capitalization is related to long-term debt.  Our coverage ratios include interest coverage ratio and fixed charge coverage ratio.  The coverage ratios indicate our ability to service interest and fixed charges (interest plus preferred dividends).  The coverage ratios are based on earnings before interest, taxes, depreciation and amortization.  Leverage ratios and coverage ratios are widely used by investors, analysts and rating agencies in the valuation, comparison, rating and investment recommendations of companies.  The following table reflects the recent historical trends for our credit strength measures:

 

		Three Months Ended
		6/30/05		3/31/05		12/31/04		9/30/04		6/30/04
Debt to book capitalization ratio		18.4	%	18.4	%	18.8	%	21.5	%	28.5	%
Debt to market capitalization ratio		12.8	%	14.3	%	13.3	%	16.4	%	22.7	%
Interest coverage ratio		7.1	x	6.8	x(1)	6.4	x	5.5	x	4.5	x
Fixed charge coverage ratio		2.4	x	2.3	x(1)	2.2	x	2.2	x	2.2	x

 

(1)                     Excluding the effects of the CLC and HHI note payoff as more fully described in Note 3. Notes Receivable.  If the effects of the CLC and HHI note payoff were included, the interest coverage ratio would be 9.3x and the fixed charge coverage ratio would be 3.2x.

 

We evaluate our key performance indicators in conjunction with current expectations to determine if historical trends are indicative of future results. Our expected results may not be achieved and actual results may differ materially from our expectations.  This may be a result of various factors, including, but not limited to

 

•                  The status of the economy;

•                  The status of capital markets, including prevailing interest rates;

•                  Compliance with and changes to regulations and payment policies within the health care industry;

•                  Changes in financing terms;

•                  Competition within the health care and senior housing industries; and

•                  Changes in federal, state and local legislation.

 

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