LTC PROPERTIES INC - Quarter Report: 2008 June (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

 

FORM 10-Q

 

(Mark One)

 

For the Transition period from          to

 

Commission file number 1-11314

 

LTC PROPERTIES, INC.

(Exact name of Registrant as specified in its charter)

 

 

31365 Oak Crest Drive, Suite 200

Westlake Village, California  91361

(Address of principal executive offices, including zip code)

 

(805) 981-8655

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether registrant (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 registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  x  No  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  ¨  No  x

 

The number of shares of common stock outstanding on July 28, 2008 was 23,094,625.

 

 

Table of Contents

 

LTC PROPERTIES, INC.

 

FORM 10-Q

 

June 30, 2008

 

INDEX

 

		Page
PART I — Financial Information
Item 1. Financial Statements
	Consolidated Balance Sheets	3
	Consolidated Statements of Income and Comprehensive Income	3
	Consolidated Statements of Cash Flows	3
	Notes to Consolidated Financial Statements	3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3. Quantitative and Qualitative Disclosures about Market Risk		37
Item 4. Controls and Procedures		27
PART II — Other Information
Item 1. Legal Proceedings		28
Item 1A. Risk Factors		28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		29
Item 3. Defaults Upon Senior Securities		29
Item 4. Submission of Matters to a Vote of Security Holders		29
Item 5. Other Information		30
Item 6. Exhibits		30

 

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LTC PROPERTIES, INC.

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except per share amounts)

 

		June 30, 2008			December 31, 2007
		(unaudited)
ASSETS
Real Estate Investments:
Buildings and improvements, net of accumulated depreciation and amortization: 2008 - $123,045; 2007 - $115,766		$	338,430		$	342,222
Land		34,639			34,429
Properties held for sale, net of accumulated depreciation and amortization: 2008 - $0; 2007 - $0		—			463
Mortgage loans receivable, net of allowance for loan losses: 2008 - $880; 2007 - $890		90,160			91,278
Real estate investments, net		463,229			468,392
Other Assets:
Cash and cash equivalents		13,909			42,631
Debt issue costs, net		188			326
Interest receivable		2,366			2,553
Prepaid expenses and other assets		21,725		(1)	20,447
Notes receivable		3,337			3,292
Marketable securities		6,466		(2)	6,464
Total Assets		$	511,220		$	544,105
LIABILITIES AND STOCKHOLDERS’ EQUITY
Bank borrowings		$	—		$	—
Mortgage loans payable		32,432			47,165
Bond payable		4,690			5,130
Accrued interest		257			349
Accrued expenses and other liabilities		5,406			5,381
Distributions payable		3,030			3,406
Total Liabilities		45,815			61,431
Minority interest		3,134			3,518
Stockholders’ equity:
Preferred stock $0.01 par value: 15,000 shares authorized; shares issued and outstanding: 2008 – 8,056; 2007 – 8,802		189,901			208,553
Common stock: $0.01 par value; 45,000 shares authorized; shares issued and outstanding: 2008 – 23,091; 2007 – 22,872		231			229
Capital in excess of par value		320,611			316,609
Cumulative net income		513,123			490,588
Other		876			956
Cumulative distributions		(562,471		)	(537,779		)
Total Stockholders’ Equity		462,271			479,156
Total Liabilities and Stockholders’ Equity		$	511,220		$	544,105

 

(1)          On June 30, 2008 and December 31, 2007, we had $1,770,000 and $1,502,000, respectively, in straight-line rent receivable from a lessee that qualifies as a related party because the lessee’s Chief Executive Officer is on our Board of Directors.  See Note 9. Transactions with Related Party for further discussion.

 

(2)          At June 30, 2008 and December 31, 2007, we had a $6,500,000 face value investment in marketable securities issued by a lessee that qualifies as a related party because lessee’s Chief Executive Officer is on our Board of Directors.  See Note 9. Transactions with Related Party for further discussion.

 

See accompanying notes.

 

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LTC PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Amounts in thousands, except per share amounts)

(Unaudited)

 

		Three Months Ended June 30,							Six Months Ended June 30,
		2008				2007			2008			2007
Revenues:
Rental income		$	14,625		(1)	$	14,430		$	29,259	(1)	$	28,815
Interest income from mortgage loans		2,577				3,785			5,235			7,254
Interest and other income		649			(2)	1,578			1,204		(2)	2,453
Total revenues		17,851				19,793			35,698			38,522
Expenses:
Interest expense		1,085				1,235			2,261			2,483
Depreciation and amortization		3,730				3,562			7,422			7,090
Legal expenses		73				116			98			145
Operating and other expenses		1,509				1,938			3,320			3,527
Total expenses		6,397				6,851			13,101			13,245
Income before non-operating income and minority interest		11,454				12,942			22,597			25,277
Minority interest		77				86			154			172
Income from continuing operations		11,377				12,856			22,443			25,105
Discontinued operations:
Loss from discontinued operations		—				(13		)	—			(26		)
Gain on sale of assets, net		—				—			92			149
Net income from discontinued operations		—				(13		)	92			123
Net income		11,377				12,843			22,535			25,228
Preferred stock buyback		—				—			989			—
Preferred stock dividends		(3,847			)	(4,234		)	(7,705		)	(8,473		)
Net income available to common stockholders		$	7,530			$	8,609		$	15,819		$	16,755
Net Income per Common Share from Continuing Operations net of Preferred Stock Dividends and Preferred Stock Buyback:
Basic		$	0.33			$	0.37		$	0.69		$	0.71
Diluted		$	0.33			$	0.36		$	0.68		$	0.70
Net Income per Common Share from Discontinued Operations:
Basic		$	—			$	—		$	—		$	0.01
Diluted		$	—			$	—		$	—		$	0.01
Net Income per Common Share Available to Common Stockholders:
Basic		$	0.33			$	0.37		$	0.69		$	0.71
Diluted		$	0.33			$	0.36		$	0.69		$	0.71
Basic weighted average shares outstanding		22,969				23,529			22,916			23,505
Comprehensive income
Net income		$	11,377			$	12,843		$	22,535		$	25,228
Reclassification adjustment		(40			)	(406		)	(80		)	(566		)
Total comprehensive income		$		11,337		$	12,437		$	22,455		$	24,662

 

(1)          During the three and six months ended June 30, 2008, we received $974,000 and $1,939,000, respectively, in rental income and recorded $130,000 and $269,000, respectively, in straight-line rental income from a lessee that qualifies as a related party because the lessee’s Chief Executive Officer is on our Board of Directors.  See Note 9. Transactions with Related Party for further discussion.

 

(2)          During the three and six months ended June 30, 2008, we recognized $180,000 and $360,000, respectively, of interest income from our investment in marketable securities issued by a lessee that qualifies as a related party because the lessee’s Chief Executive Officer is on our Board of Directors.  See Note 9. Transactions with Related Party for further discussion.

 

NOTE:  Computations of per share amounts from continuing operations, discontinued operations and net income are made independently.  Therefore, the sum of per share amounts from continuing operations and discontinued operations may not agree with the per share amounts from net income available to common stockholders.

 

See accompanying notes.

 

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LTC PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

 

		Six months ended June 30,
		2008			2007
OPERATING ACTIVITIES:
Net income		$	22,535		$	25,228
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization – continuing operations		7,422			7,090
Depreciation and amortization – discontinuing operations		—			26
Minority interest		154			172
Stock-based compensation expense		617			979
Straight-line rental income		(1,870		)(1)	(2,398		)
Other non-cash items, net		273			(1,226		)
Gain on sale of real estate investments, net		(92		)	(149		)
Decrease in accrued interest payable		(92		)	(11		)
Decrease in interest receivable		67			244
Net change in other assets and liabilities		40			(320		)
Net cash provided by operating activities		29,054			29,635
INVESTING ACTIVITIES:
Investment in real estate properties and capital improvements, net		(3,533		)	(2,857		)
Proceeds from sale of real estate investments		555			158
Investment in real estate mortgages		(8,135		)	—
Principal payments received on mortgage loans receivable		9,508			29,047
Proceeds from redemption of marketable debt securities		—			4,049
Advance under notes receivable		(300		)	(40		)
Principal payments received on notes receivable		309			870
Net cash (used in) provided by investing activities		(1,596		)	31,227
FINANCING ACTIVITIES:
Principal payments on mortgage loans payable and bonds payable		(15,173		)	(958		)
Preferred stock buyback		(14,276		)	—
Redemption of minority interests		(510		)	—
Distributions paid to minority interests		(164		)	(172		)
Distributions paid to stockholders		(26,057		)	(26,217		)
Other		—			160
Net cash used in financing activities		(56,180		)	(27,187		)
(Decrease) Increase in cash and cash equivalents		(28,722		)	33,675
Cash and cash equivalents, beginning of period		42,631			29,887
Cash and cash equivalents, end of period		$	13,909		$	63,562
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid		$	2,215		$	2,371
Non-cash investing and financing transactions:
Conversion of preferred stock to common stock		2,745			329

 

(1) During the three and six months ended June 30, 2008, we recorded $130,000 and $269,000, respectively, in straight-line rental income from a lessee that qualifies as a related party because the lessee’s Chief Executive Officer is on our Board of Directors.  See Note 9. Transactions with Related Party for further discussion.

 

See accompanying notes.

 

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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.

 

We have prepared consolidated financial statements included herein without audit (except for the balance sheet at December 31, 2007 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, 2008 and 2007 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 a 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 provide 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 handling the purchase and disposition of assets.  We, as the general partner, are responsible for the ongoing, major, and central operations of the partnership and make all management decisions.  In addition, we, as the general partner, assume the risk for all operating losses, capital losses, and are entitled to substantially all capital gains (i.e. asset 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 United States generally accepted accounting principles have been condensed or omitted pursuant to rules and regulations governing the presentation of interim financial statements; 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, 2008 and 2007 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 generally are not taxed on income that is distributed to our stockholders.

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurement” (SFAS No. 157).  SFAS No. 157 provides guidance for using fair value to measure assets and liabilities.  The standard expands required disclosures about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings.  SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. SFAS No. 157 does not expand the use of fair

 

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LTC PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

(Unaudited)

 

value in any new circumstances.  SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  On February 14, 2008, the FASB issued FASB Staff Position No. 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13” (or SFAS No. 157-1).  SFAS No. 157-1 amends SFAS No. 157, to exclude the FASB issued Statement of Financial Accounting Standards No. 13, “Accounting for Leases” ( or SFAS No. 13), and other accounting pronouncements that address fair value measurements for purposes of lease classification or measurement under SFAS No. 13.  However, this scope exception does not apply to assets acquired and liabilities assumed in a business combination that are required to be measured at fair value under FASB Statement No. 141(R), “Business Combinations” (or SFAS No. 141(R)), regardless of whether those assets and liabilities are related to leases.  Adoption of SFAS No. 157 on January 1, 2008 did not have a material effect on our consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 141(R) and requires the acquiring entity in a business combination to measure the assets acquired, liabilities assumed (including contingencies) and any noncontrolling interests at their fair values on the acquisition date. The statement also requires that acquisition-related transaction costs be expensed as incurred and acquired research and development value be capitalized.  In addition, acquisition-related restructuring costs are to be capitalized only if they meet certain criteria. SFAS No. 141(R) is effective for fiscal years beginning December 15, 2008. We are currently evaluating the impact of the required prospective application of SFAS No.141(R) on our results of operations and financial position.

 

In December 2007, the FASB also issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51” (or SFAS No. 160).  SFAS No. 160 requires the classification of noncontrolling interests (formerly, minority interests) as a component of consolidated equity. In addition, net income will include the total income of all consolidated subsidiaries with the attribution of earnings and other comprehensive income between controlling and noncontrolling interests reported as a separate disclosure on the face of the consolidated income statement. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. SFAS No. 160 also addresses accounting and reporting for a change in control of a subsidiary. SFAS No. 160 is effective for fiscal years beginning December 15, 2008, and is required to be adopted prospectively, except for the presentation and disclosure requirements, which are required to be adopted retrospectively. We are currently evaluating the impact of the application of SFAS No.160 on our results of operations and financial position.

 

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value of Option for Financial Assets and Financial Liabilities” (or SFAS No. 159).  SFAS No. 159 permits entities to choose to measure certain financial assets and liabilities at fair value, with the change in unrealized gains and losses on items for which the fair value option has been elected reported in earnings.  SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.  We did not adopt the elective fair market value option in our 2008 financial statements.

 

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LTC PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

(Unaudited)

 

2.              Real Estate Investments

 

Owned Properties.  At June 30, 2008, we owned properties in 23 states consisting of 62 skilled nursing properties with a total of 7,209 beds, 84 assisted living properties with a total of 3,744 units and one school.  Owned properties are leased pursuant to non-cancelable operating leases generally with an initial term of 10 to 30 years.  Many of the leases contain renewal options and two contain limited period options that permit the operators to purchase the properties.  The leases provide for fixed minimum base rent during the initial and renewal periods.  The majority of our leases contain provisions for specified annual increases over the rents of the prior year and are generally computed in one of four ways depending on specific provisions of each lease:  (i) a specified percentage increase over the prior year, generally between 2.0% and 2.5%; (ii) the higher of (i) or a calculation based on the Consumer Price Index; (iii) as a percentage of facility net patient revenues in excess of base amounts or (iv) specific dollar increases.  Each lease is a triple net lease which requires the lessee to pay all taxes, insurance, maintenance and repairs, capital and non-capital expenditures and other costs necessary in the operations of the facilities.

 

During the six months ended June 30, 2008, we sold for $600,000 a vacant parcel of land adjacent to a skilled nursing property in New Mexico to a third party.  We received net cash proceeds of $555,000 and recognized a $92,000 gain on sale.  We also acquired a 30-bed skilled nursing property located in Ohio for an aggregate price of $1,014,000 that was added to an existing master lease at a 10% yield and we agreed to provide funding up to $2,000,000 to purchase land, construct and equip a new replacement building which will be a combined skilled nursing and assisted living property.  This investment will be at the higher of one-year LIBOR plus 5.3% or 10% and construction must be completed by January 18, 2011.  Additionally, during the six months ended June 30, 2008, we invested $1,292,000, at an average yield of approximately 10%, under agreements to expand and renovate 13 existing properties operated by six different operators.  As of June 30, 2008, the total commitment remaining for projects currently under renovation was $2,251,000.  We also invested $1,227,000 in capital improvements to existing properties under various lease agreements whose rental rates already reflected this investment.

 

During the six months ended June 30, 2007, we invested $2,590,000 under agreements to expand and renovate 12 properties operated by seven different operators.  Also during the six months ended June 30, 2007 we sold a closed, previously impaired skilled nursing property to a third party for a purchase price of $166,000.  As a result of the sale, we recognized a net gain of $149,000 during the quarter ended June 30, 2007.  Additionally, we invested $267,000 in capital improvements to existing properties under various lease agreements whose rental rates already reflected this investment.

 

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.

 

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LTC PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

(Unaudited)

 

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,
		2008			2007			2008			2007
Rental income		$	—		$	—		$	—		$	—
Interest and other income		—			—			—			—
Interest expense		—			—			—			—
Depreciation and amortization		—			(13		)	—			(26		)
Operating and other expenses		—			—			—			—
Income from discontinued operations		$	—		$	(13	)	$	—		$	(26	)

 

Mortgage Loans.  At June 30, 2008, we had investments in 49 mortgage loans secured by first mortgages on 44 skilled nursing properties with a total of 5,029 beds, 17 assisted living properties with 854 units and one school.  These properties are located in 15 states.  At June 30, 2008, the mortgage loans had interest rates ranging from 7.0% to 13.4% and maturities ranging from 2008 to 2019.  In addition, some loans contain certain guarantees, provide for certain facility fees and generally have 20-year or 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 three months ended June 30, 2008, we invested $6,754,000, net of closing fees, in a mortgage loan secured by six assisted living properties with 108 units located in Texas.  This loan has an initial interest rate of 9.5%, increasing 0.15% annually, with a 20-year amortization and matures in June 2018.  Also, during the three months ended June 30, 2008, we received $6,939,000 plus accrued interest related to the payoff of three mortgage loans secured by three skilled nursing properties.

 

During the six months ended June 30, 2008, we invested $938,000, net of closing fees, in a mortgage loan secured by an assisted living property with 41 units located in Florida.  This loan has an initial interest rate of 10.5%, increasing 0.125% annually, with a 25-year amortization and matures in November 2009.

 

Additionally, during the six months ended June 30, 2008, we invested $443,000 under two existing mortgage loans for capital improvements. We also received $2,569,000 in regularly scheduled principal payments.

 

During the six months ended June 30, 2007, we received $26,683,000 plus accrued interest related to the payoff of eight mortgage loans secured by eleven skilled nursing properties.  We also received $2,364,000 in regularly scheduled principal payments.

 

3.              Notes Receivable

 

During the six months ended June 30, 2008, we received $309,000 and funded $300,000 in principal payments under various loans and line of credit agreements with certain operators.  At June 30, 2008, we had six loans outstanding with a carrying value of $3,337,000 at a weighted average interest rate of 11.8%.  Subsequent to June 30, 2008, we received $200,000 in principal payments under a line of credit agreement.

 

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LTC PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

(Unaudited)

 

4.              Marketable Securities

 

At June 30, 2008, we had an investment in $6,500,000 face value of Skilled Healthcare Group, Inc. (or SHG) Senior Subordinated Notes with a face rate of 11.0% and an effective yield of 11.1%.  Interest on the notes is payable semi-annually in arrears and the notes mature on January 15, 2014.  One of our board members is the chief executive officer of SHG. See Note 9. Transactions with Related Party for further discussion.

 

During the six months ended June 30, 2007, SHG redeemed $3,500,000 face value of our original $10,000,000 face value Senior Subordinated Notes at a redemption price equal to 111% of the principal amount of the notes, plus accrued and unpaid interest.  As a result of this early redemption, we recognized additional interest income of $385,000 during the six months ended June 30, 2007.

 

We account for this investment in marketable debt securities as held-to-maturity in accordance with SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities” at amortized cost, adjusted for any related premiums (discounts) over the estimated remaining period until maturity.

 

5.              Debt Obligations

 

During the three months ended June 30, 2008, we paid off a mortgage loan the amount of $14,188,000 secured by four assisted living properties located in Ohio.  The retired debt bore an interest rate of 7.27%.  Also, during the six months ended June 30, 2008, we paid $985,000 in regularly scheduled principal payments.  At June 30, 2008 we had four mortgage loans and a bond payable outstanding with a carrying value of $37,122,000 at a weighted average interest rate of 8.20%

 

At June 30, 2008, we had no outstanding borrowings under our $90,000,000 Unsecured Revolving Credit Agreement and the full amount was available for borrowing.  During the six months ended June 30, 2008, pricing under the Unsecured Revolving Credit Agreement based on our borrowing election was Prime Rate plus 0.50% or LIBOR plus 1.50%.

 

Subsequent to June 30, 2008, we amended and extended our Unsecured Revolving Credit Agreement at an initial commitment amount of $80,000,000.  The Credit Agreement provides for the opportunity to increase the credit amount up to a total of $120,000,000.  The prior agreement did not have an expansion provision.  The Credit Agreement provides a revolving line of credit with no scheduled maturities other than the maturity date of July 17, 2011.  The interest rates under the Credit Agreement remain the same as under our prior credit agreement.

 

6.              Stockholders’ Equity

 

Preferred Stock.  During the six months ended June 30, 2008 holders of 109,809 shares of our 8.5% Series E Cumulative Convertible Preferred Stock (Series E preferred stock) elected to convert such shares into 219,618 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 104,652 at June 30, 2008.  Subsequent to June 30, 2008, holders of 1,700 shares or our Series E preferred stock elected to convert such shares into 3,400 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 101,252 shares.

 

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LTC PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

(Unaudited)

 

During the six months ended June 30, 2008, we invested $14,276,000 to repurchase a total of 636,300 shares of our 8.0% Series F Cumulative Preferred Stock (or Series F preferred stock) at an average cost of $22.44 per share, including commissions.  The Series F preferred stock has a liquidation value of $25.00 per share.  As required by EITF D-42, “The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock,” the discounted purchase price on these shares, which is the liquidation value over the fair value, is reflected on the income statement netted with the original issue discount and is added to net income in calculating net income available to common shareholders.  After this purchase, 6,003,700 shares of our Series F preferred stock remained issued and outstanding.

 

Common Stock.  In June 2007 our Board of Directors terminated the prior existing share repurchase program and authorized a new share repurchase program enabling us to repurchase up to 5,000,000 shares of our common stock.  In January 2008, the Board of Directors amended the share repurchase program to include authorization to repurchase our outstanding preferred securities.  After the Series F preferred stock repurchase, as mentioned above, we continue to have an open Board authorization to purchase an additional 3,470,621 shares.

 

We have one limited partnership and reserved 179,882 shares of our common stock under this partnership agreement.  We consolidate the limited partnership since we exercise control and we carry the minority interest at cost.  The limited partners can exercise their conversion rights and be paid, at our election, in shares of our common stock or for an amount of cash approximating the then current market value of shares of our common stock.  Historically, we have elected to pay cash upon limited partners’ election to exercise their conversion rights. If we elected to issue shares of our common stock upon limited partners’ election to exercise their conversion rights, the carrying amount of the partnership is reclassified to stockholder’s equity.

 

During the six months ended June 30, 2008, one of our limited partners exercised its conversion rights and exchanged a portion of its interest in the limited partnership.  In accordance with the limited partnership agreement, we paid $510,000 for the redemption of 22,000 shares owned by the limited partner.  Since the market value of the common stock converted was greater than the book value of the partnership interests received, we recognized a $136,000 increase in the basis of the properties underlying the limited partnership interest acquired.  At June 30, 2008 the carrying value (excluding accrued preferred returns) and the market value of the partnership conversion rights are $3,058,000 and $4,598,000, respectively.

 

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

 

		Six months ended June 30, 2008						Six months ended June 30, 2007
		Declared			Paid			Declared			Paid
Preferred Stock
Series C		$	1,636		$	1,636		$	1,636		$	1,636
Series E		65			123			197			203
Series F		6,004			6,322			6,640			6,640
		7,705			8,081			8,473			8,479
Common Stock		17,976		(1)	17,976		(1)	17,738		(2)	17,738		(2)
Total		$	25,681	(3)	$	26,057	(3)	$	26,211	(3)	$	26,217	(3)

(1)		Represents $0.130 per share per month for the six months ended June 30, 2008.
(2)		Represents $0.125 per share per month for the six months ended June 30, 2007.
(3)		The difference between declared and paid is the change in distributions payable on the balance sheet at June 30 and December 31.

 

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LTC PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

(Unaudited)

 

In July 2008, we declared a monthly cash dividend of $0.130 per common share per month for the months of July, August and September 2008, payable on July 31, August 29 and September 30, 2008, respectively, to stockholders of record on July 23, August 21 and September 22, 2008, respectively.

 

Other Equity.  Other equity consists of accumulated comprehensive income of $876,000 and $956,000 at June 30, 2008 and December 31, 2007, respectively.  This balance represents the net unrealized holding gains on available-for-sale REMIC Certificates recorded in 2005 when we repurchased the loans in the underlying loan pool.  This amount is being amortized to increase interest income over the remaining life of the loans that we repurchased from the REMIC Pool.  See Note 6. Real Estate Investments to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2007 for further discussion of the repurchase of the loans underlying our investment in REMIC Certificates.

 

Stock-Based Compensation.  Effective January 1, 2006, we adopted SFAS No. 123(R) which 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.  Thus, for all options that vested during a fiscal year, regardless of when they were granted, compensation expense was recognized during that fiscal year according to SFAS No. 123(R).  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.

 

During the three and six months ended June 30, 2008, $35,000 and $71,000, respectively, of compensation expense was recognized related to the vesting of stock options.  During the three and six months ended June 30, 2007, $17,000 and $36,000, respectively, of compensation expense was recognized related to the vesting of stock options.  No stock options were issued during the three and six months ended June 30, 2008.  During the three and six months ended June 30, 2007, 174,500 options to purchase common stock were issued at an exercise price of $23.79 and vest ratably over a three-year period.  Also during the three and six months ended June 30, 2007, 30,000 options to purchase common stock were issued at an exercise price of $23.47 and vest ratably over a three-year period.  At June 30, 2008, the total number of stock options that are scheduled to vest through December 31, 2008, 2009 and 2010 is 0; 68,167 and 68,170, respectively.  We have no stock options outstanding that are scheduled to vest beyond 2011.  The remaining compensation expense to be recognized related to the future service period of unvested outstanding stock options for 2008, 2009 and 2010 is $71,000, $140,000 and $59,000, respectively.

 

During the three and six months ended June 30, 2008, we recognized $271,000 and $546,000, respectively, of compensation expense related to the vesting of restricted common stock, respectively.  No restricted common stock was granted during the three and six months ended June 30, 2008.  During the three and six months ended June 30, 2007, we recognized $618,000 and $943,000, respectively, of compensation expense related to the vesting of restricted common stock.  During the six months ended June 30, 2007, we granted 40,000 shares of restricted common stock at $25.98 per share, 46,500 shares of restricted common stock at $23.79 per share, and 12,000 shares of restricted common stock at $23.47 per share.  These shares vest ratably over a three-year period.  Also, during the six months ended June 30, 2007, we extended the vesting of 27,120 shares of unvested restricted common stock to align the vesting dates with the 40,000 share grant previously discussed.  The compensation expense recognized related to this vesting modification was immaterial.  Additionally, during the six months ended June 30, 2007, we modified the vesting of 54,960 shares of unvested restricted common stock by accelerating the vesting so that the 54,960 shares vested ratably from March through December 2007.  Prior to this modification the shares were vesting in two traunches ratably over two and three years, respectively.

 

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LTC PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

(Unaudited)

 

During the three and six months ended June 30, 2008, we adopted and our shareholders approved The 2008 Equity Participation Plan which replaces The 2004 Restricted Stock Plan, The 2004 Stock Option Plan and The 1998 Equity Participation Plan.  Under The 2008 Equity Participation Plan, 600,000 shares of common stock have been reserved for awards, including nonqualified stock option grants and restricted stock grants to officers, employees, non-employee directors and consultants.  The terms of the awards granted under The 2008 Equity Participation Plan are set by our compensation committee at its discretion.

 

7.              Commitments and Contingencies

 

At June 30, 2008, we had the following commitments outstanding:

 

We committed to provide Alterra $2,500,000 over three years ending December 4, 2009, to invest in leasehold improvements to properties they lease from us.  This investment 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 ALC, under certain conditions, up to $5,000,000 per year, throughout the term of the lease, for expansion of the 37 properties they lease from us.  Should we invest such funds, ALC’s 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 invested.  To date ALC has not requested any funds under this agreement.  See Note 8. Major Operators for further discussion on ALC’s ownership reorganization.

 

We committed to provide Preferred Care up to $6,500,000 on specific projects on three skilled nursing properties they lease from us.  The minimum rent will increase for each specific project by an amount equal to 11% of either (a) our final funding including compounded interest during construction for two specific projects or (b) our periodic funding plus the related compounded interest on each advance from the date invested through the end of the month for one specific project.  As of June 30, 2008 we invested $271,000 under this agreement.  These commitments expire on March 31, 2010.

 

We committed to make certain capital improvements to be mutually agreed upon by us and the lessee on a skilled nursing property.  The minimum rent will increase by our investment in these capital improvements multiplied by 11%.  As of June 30, 2008 we invested $99,000 under this agreement.

 

We committed to provide a lessee of two skilled nursing properties with the following:  (i) up to $260,000 to invest in capital improvements to a property they lease from us; (ii) up to $735,000 to invest in capital improvements on two properties they lease from us, however, under this commitment, the minimum rent will increase by the amount of the capital funding multiplied by 11%.  These commitments expire on November 1, 2008.  As of June 30, 2008, we invested $300,000 under this commitment.

 

We committed to provide a lessee an accounts receivable financing on three skilled nursing properties.  The loan has a credit limit not to exceed $450,000, and interest rate of 8.75%, and matures on June 30, 2008.  To date, we invested $250,000 under this agreement.  Subsequent to June 30, 2008, we extended the maturity to June 30, 2009.  We also committed to provide this lessee $2,000,000 to renovate, equip and reopen an existing closed building as part of a skilled nursing property they lease from us.  The commitment includes interest compounded at 10.25% on each advance made from each disbursement date until the final distribution of the commitment.  The renovation must be completed by July 31, 2008.  Upon final distribution of the capital allowance, minimum rent shall increase by the total commitment multiplied by 10.25%.  As of June 30, 2008 we invested $1,118,000 under this agreement.  Additionally, we committed to provide this lessee with $2,000,000 to purchase land, construct and equip a new building which will be

 

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LTC PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

(Unaudited)

 

a combined skilled nursing and assisted living property.  The commitment includes our expenses and interest which will be compounded at the higher of one year LIBOR plus 5.30% or 10% on each advance made from each disbursement date until the final distribution of the commitment.  Construction must be completed by January 18, 2011.  Upon the earlier of the final distribution of the capital allowance or January 18, 2011, minimum rent shall increase by the total commitment multiplied by the higher of one year LIBOR plus 5.30% or 10%. To date, no funds have been requested under this agreement.

 

We committed to provide a lessee with $800,000 to invest in capital improvements to five skilled nursing properties they lease from us.  The commitment includes interest compounded at 10% on each advance made from the disbursement date until the final distribution of the commitment.  The capital improvements must be completed by July 31, 2008.  Upon final distribution of the capital allowance, minimum rent shall increase by the total commitment multiplied by 10%.  As of June 30, 2008 we invested $54,000 under this agreement.

 

 We committed to provide a lessee accounts receivable financing on two skilled nursing properties.  The loan has a credit limit not to exceed $600,000, and interest rate of 10%, and matures on March 25, 2011.  As of June 30, 2008 we funded $500,000 under this agreement.

 

We committed to provide a lessee accounts receivable financing on a skilled nursing property.  The loan has a credit limit not to exceed $200,000 and interest rate of 10%.  As of June 30, 2008 we invested $200,000 under this agreement.  Subsequent to June 30, 2008 we received $200,000 under this accounts receivable financing.  We also committed to provide this lessee $500,000 for specific capital improvements on the same skilled nursing property.   This commitment includes interest compounded at 13% on each advance made from the disbursement date until the final distribution of this commitment.  Upon final distribution of the capital allowance, minimum rent shall increase by the total commitment multiplied by 13%.  These commitments expire on March 31, 2009.  To date, no funds have been requested under this agreement.

 

We committed to provide a lessee with $2,500,000 to invest in capital improvements and expansion of a combined assisted living and skilled nursing property they lease from us.  The commitment includes interest compounded at 10% on each advance made from the disbursement date until the final distribution of the commitment.  Upon final distribution of the capital allowance, minimum rent shall increase by the total commitment multiplied by 10%.  This commitment will expire if the lessee fails to provide a project proposal for approval by December 31, 2008.  Upon approval of the project proposal, this commitment will expire 20 months from the date of approval.  To date, no funds have been requested under this agreement.

 

We committed to provide a borrower $400,000 to invest in capital improvements to the property secured by the loan.  The principal balance of the loan will increase on the date any funds are disbursed by an amount equal to such funding and shall bear interest at the then current interest rate for the existing loan.  The monthly loan payment will increase at each increase to the principal balance.   The commitment expires on January 1, 2009.  To date, no funds have been requested under this agreement.

 

We committed to provide a borrower $316,000 to invest in capital improvements to the property secured by the loan.  The principal balance of the loan will increase on the date any funds are disbursed by an amount equal to such funding and shall bear interest at the then current interest rate for the existing loan.  The monthly loan payment will increase at each increase to the principal balance.   The commitment expires on February 25, 2009.  As of June 30, 2008, we invested $122,000 under this agreement.

 

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LTC PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

(Unaudited)

 

We committed to provide a borrower $322,000 to invest in capital improvements to the property secured by the loan.  The principal balance of the loan will increase on the date any funds are disbursed by an amount equal to such funding and shall bear interest at the then current interest rate for the existing loan.  The monthly loan payment will increase at each increase to the principal balance.   The commitment expires on February 25, 2009.  As of June 30, 2008, we invested $321,000 under this agreement.

 

8.              Major Operators

 

We have three operators, based on properties subject to lease agreements and secured by mortgage loans that represent between 10% and 20% of our total assets and three operators from each of which we derive over 10% of our rental revenue and interest income from mortgage loans.

 

In 2006, Extendicare Services, Inc. (or EHSI), one of our major operators, effected a reorganization whereby it completed a spin-off of Assisted Living Concepts, Inc (or ALC).  ALC is now a NYSE traded public company operating assisted living centers. The remaining EHSI assets and operations were converted into a Canadian REIT (Extendicare REIT) listed on the Toronto Stock Exchange (or TSX).  Both Extendicare REIT and ALC continue to be parties to the leases with us.

 

Alterra Healthcare Corporation (or Alterra) is a wholly owned subsidiary of a publicly traded company, Brookdale Senior Living, Inc. (or Brookdale).

 

The following table summarizes Extendicare REIT’s, ALC’s and Brookdale’s financial information as of and for the three months ended March 31, 2008 per the operators’ public filings (in thousands).   Our other operator is privately owned and thus no public financial information is available:

 

 

		Extendicare REIT (1)			ALC			Brookdale
		(in thousands)			(in thousands)			(in thousands)
Current assets		$	337,709		$	32,917		$	312,354
Non-current assets		1,160,457			433,686			4,501,382
Current liabilities		365,250			59,634			582,969
Non-current liabilities		1,167,446			118,108			2,884,651
Stockholders’ (deficit) equity		(34,530		)	288,861			1,346,116
Gross revenue		491,551			60,247			480,648
Operating expenses		478,668			51,809			481,199
Income(loss) from continuing operations		3,858			4,051			(55,093		)
Net income (loss)		3,578			4,051			(55,093		)
Cash provided by operations		11,969			16,259			40,629
Cash used in investing activities		(11,815		)	(3,466		)	(56,102		)
Cash (used in) provided by financing activities		(16,488		)	(12,717		)	34,105

 

* The financial information contained in the foregoing table for Extendicare REIT, ALC and Brookdale is based on information we obtained from such companies’ available public filing and, therefore, we have not independently verified the accuracy of such information.

 

(1) The numbers show for Extendicare REIT are Canadian dollars and are prepared in accordance with Canadian GAAP.

 

Extendicare REIT and ALC, collectively lease 37 assisted living properties with a total of 1,427 units owned by us representing approximately 12.3%, or $62,871,000, of our total assets at June 30, 2008 and 16.4% of rental revenue and interest income from mortgage loans recognized as of June 30, 2008 excluding the effect of straight-line rent and effective interest income from mortgage loans.

 

Alterra, a wholly owned subsidiary of Brookdale, leases 35 assisted living properties with a total of 1,416 units owned by us representing approximately 12.2%, or $62,310,000, of our total assets at June 30, 2008 and 15.2% of rental revenue and interest income from mortgage loans recognized as of June 30, 2008 excluding the effect of straight-line rent and effective interest income from mortgage loans.

 

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LTC PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

(Unaudited)

 

Preferred Care, Inc. (or Preferred Care), through various wholly owned subsidiaries, operates 33 skilled nursing properties with a total of 4,021 beds that we own or on which we hold mortgages secured by first trust deeds.  This represents approximately 12.8%, or $65,247,000, of our total assets at June 30, 2008 and 14.9% of rental revenue and interest income from mortgage loans recognized as of June 30, 2008 excluding the effect of straight-line rent and effective interest income from mortgage loans.

 

Our financial position and ability to make distributions may be adversely affected by financial difficulties experienced by Alterra, Extendicare REIT & ALC, Preferred Care, or any of our lessees and borrowers, including any 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.

 

9.              Transactions with Related Party

 

We have two related party transactions with Mr. Boyd W. Hendrickson, one of our independent directors.  His interest in these transactions arises indirectly and as a result of serving as Chief Executive Officer of Skilled Healthcare Group, Inc. (or SHG).

 

In December 2005, we purchased, on the open market, $10,000,000 face value of SHG Senior Subordinated Notes with a face rate of 11.0% and an effective yield of 11.1%.  In May 2007, SHG redeemed $3,500,000 face value of the $10,000,000 face value Senior Subordinated Notes at a redemption price equal to 111% of the principal amount of the notes, plus accrued and unpaid interest.  At June 30, 2008, we have a remaining investment in $6,500,000 face value of SHG Senior Subordinated Notes.  During the three and six months ended June 30, 2008, we recognized $180,000 and $360,000, respectively, of interest income related to the SHG Senior Subordinated Notes.  Interest on the notes is payable semi-annually in arrears and the notes mature on January 15, 2014.

 

In addition, during September 2007 SHG purchased the assets of Laurel Healthcare (or Laurel).  In February 2006 we entered into a 15-year master lease agreement with Laurel.  One of the assets SHG purchased was Laurel’s leasehold interests in the skilled nursing properties Laurel leased from us under Laurel’s master lease agreement.  Our Board of Directors, with Mr. Hendrickson abstaining, ratified our consent to the assignment of Laurel’s master lease to SHG.  The economic terms of the master lease agreement did not change as a result of our assignment of the master lease to SHG.  During the three and six months ended June 30, 2008, SHG paid us $974,000 and $1,939,000, respectively, in rent and we recorded $130,000 and $269,000, respectively, of straight-line rental income from SHG.  At June 30, 2008, the straight-line rent receivable from SHG was $1,770,000.

 

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LTC PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

(Unaudited)

 

10.       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,
		2008			2007			2008			2007
Net income		$	11,377		$	12,843		$	22,535		$	25,228
Preferred stock buyback		—			—			989			—
Preferred stock dividends		(3,847		)	(4,234		)	(7,705		)	(8,473		)
Net income for basic net income per share		7,530			8,609			15,819			16,755
Effect of dilutive securities:
Convertible preferred stock		28			96			66			197
Net income for diluted net income per share		$	7,558		$	8,705		$	15,885		$	16,952
Shares for basic net income per share		22,969			23,529			22,916			23,505
Effect of dilutive securities:
Stock options and restricted stock		48			72			40			71
Convertible preferred stock		105			361			124			371
Shares for diluted net income per share		23,122			23,962			23,080			23,947
Basic net income per share		$	0.33		$	0.37		$	0.69		$	0.71
Diluted net income per share		$	0.33		$	0.36		$	0.69		$	0.71

 

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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, 2008:

 

Type of Property		Gross Investments (in thousands)			Percentage of Investments		For the six months ended 6/30/08 Rental Income (in thousands)			For the six months ended 6/30/08 Interest Income (2) (in thousands)			Percentage of Revenues (3)		Number of Properties		Number of Beds/ Units		Investment per Bed/Unit (in thousands)			Number of Operators (1)		Number of States (1)
Assisted Living Properties		$	282,406		48.1	%	$	14,541		$	1,484		46.5	%	101		4,598		$	61.42		11		22
Skilled Nursing Properties		291,728			49.7	%	14,135			3,598			51.4	%	106		12,238		$	23.84		40		19
Schools		13,020			2.2	%	583			153			2.1	%	2		N/A		N/A			2		2
Totals		$	587,154		100.0	%	$	29,259		$	5,235		100.0	%	209		16,836

 

(1)          We have investments in 29 states leased or mortgaged to 49 different operators.

(2)          Includes Interest Income from Mortgage Loans.

(3)          Includes Rental Income and Interest Income from Mortgage Loans.

 

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 and interest earned on outstanding loans receivable.  Our investments in mortgage loans and owned properties 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 periodic 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.

 

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 market value of a property.  Some operating leases and loans are 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, 2008, rental income and interest income from mortgage loans represented 82% and 15%, respectively, of total gross revenues.   Our lease structure contains fixed annual rental escalations, which are generally recognized on a straight-line basis over the minimum lease period in

 

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accordance with SFAS No. 13. “Accounting for Leases.”  Certain leases have 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 minimize non-cash straight-line rent over time.  For the six months ended June 30, 2008 and 2007, we recorded $1.9 million and $2.4 million, respectively, in straight-line rental income.  Straight-line rent on a same store basis will decrease from $3.6 million for projected annual 2008 to $2.7 million for projected annual 2009 assuming no new leased investments are added to our portfolio.  During the six months ended June 30, 2008 we received $27.7 million of cash rental revenue and recorded $0.3 million of lease inducement cost.  At June 30, 2008 and December 31, 2007, the straight-line rent receivable balance recorded under the caption “Prepaid Expenses and Other Assets” on the balance sheet was $12.4 million and $10.5 million, respectively.

 

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 cash on hand and 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.  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.  The timing, source and amount of cash flows provided by financing activities and used in investing activities are sensitive to the capital markets environment, especially to changes in interest rates.  Changes in capital markets environment may impact the availability of cost-effective capital.  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 Transactions

 

During the three months ended June 30, 2008, we invested $6.8 million, net of closing fees, in a mortgage loan secured by six assisted living properties with 108 units located in Texas.  This loan has an initial interest rate of 9.5%, increasing 0.15% annually, with a 20-year amortization and matures in June 2018.  Subsequent to June 30, 2008, we amended and extended our Unsecured Revolving Credit Agreement at an initial commitment amount of $80.0 million.  The Credit Agreement provides for the opportunity to increase the credit amount up to a total of $120.0 million.  The prior agreement did not have an expansion provision.  The Credit Agreement provides a revolving line of credit with no scheduled maturities other than the maturity date of July 17, 2011.  The interest rates under the Credit Agreement remain the same as under our prior credit agreement, Prime Rate plus 0.50% or LIBOR plus 1.50%.

 

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.

 

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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 three 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:

 

		Period Ended
		6/30/08			03/31/08			12/31/07			9/30/07			6/30/07
		(gross investment, in thousands)
Asset mix:
Real property		$	496,114		$	495,202		$	492,880		$	492,844		$	491,133
Loans receivable		91,040			91,955			92,168			86,500			89,401
Investment mix:
Assisted living properties		$	282,406		$	275,313		$	274,333		$	274,428		$	274,454
Skilled nursing properties		291,728			298,824			297,695			291,896			293,060
School		13,020			13,020			13,020			13,020			13,020
Operator mix:
Alterra		$	84,210		$	84,210		$	84,210		$	84,210		$	84,210
Preferred Care, Inc. (1)		87,490			93,197			92,042			85,326			84,551
ALC		88,034			88,034			88,034			88,034			88,034
Remaining operators		327,420			321,716			320,762			321,774			323,739
Geographic mix:
California (2)		$	40,835		$	42,251		$	42,490		$	42,722		$	43,910
Colorado (2)		27,581			27,581			27,518			27,459			27,401
Florida		43,975			47,368			46,385			46,444			46,432
Ohio		55,862			55,121			54,010			53,943			53,685
Texas		106,568			102,245			101,721			95,768			95,871
Washington		27,412			27,504			27,593			27,680			27,764
Remaining states		284,921			285,087			285,331			285,328			285,471

 

(1)                      Preferred Care, Inc. leases 25 skilled nursing properties under two master leases, one skilled nursing property under a separate lease agreement and operates seven skilled nursing properties securing six mortgage loans receivable we have with unrelated third parties and one mortgage loans receivable we have with Preferred Care.

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

 

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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 relates 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
		6/30/08		3/31/08		12/31/07		9/30/07		6/30/07
Debt to book capitalization ratio		7.4	(1)%	10.0	%	9.8	%	9.8	%	9.6	%
Debt to market capitalization ratio		4.6	(1)%	6.2	%	6.4	%	6.6	%	6.6	%
Interest coverage ratio		15.0	x (2)	13.6	x	13.0	x	13.3		14.4	x
Fixed charge coverage ratio		3.3	x (2)	3.2	x	2.9	x	3.0	x	3.2	x

 

(1)                      Decrease due to repayment of our $14.2 million mortgage loan secured by four assisted living properties located in Ohio.

(2)                      Increase due to decrease in interest expense relating to repayment of our $14.2 million mortgage loan secured by four assisted living properties located in Ohio.

 

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.

 

Management regularly monitors the economic and other factors listed above.  We develop strategic and tactical plans designed to improve performance and maximize our competitive position. Our ability to achieve our financial objectives is dependent upon our ability to effectively execute these plans and to appropriately respond to emerging economic and company-specific trends.  The timing, source and amount of cash flows provided by financing activities and used in investing activities are sensitive to the capital markets environment, especially to changes in interest rates.  Changes in capital markets environment may impact the availability of cost-effective capital.

 

Operating Results

 

Three months ended June 30, 2008 compared to three months ended June 30, 2007

 

Revenues for the three months ended June 30, 2008 decreased to $17.9 million from $19.8 million for the same period in 2007 primarily due to decreases in interest income from mortgage loans and decreases in interest and other income, as discussed below.  Rental income for the three months ended June 30, 2008 increased $0.2 million from the same period in 2007 primarily as a result of rental increases provided for in existing lease agreements ($0.5 million) partially offset by lower straight-line rental income net of amortization of lease costs ($0.3 million).  Same store cash rental income, properties owned for the three

 

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